KNBA Kinbasha Gaming International Inc (CE)

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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

Executive 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, which we sold the business rights 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, for $26,000 per month for two years.

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.  For the fiscal year ended March 31, 2013 ("fiscal year 2013"), the yen compared to the dollar was weaker than the yen compared to the dollar for the fiscal year ended March 31, 2012 ("fiscal year 2012").  Accordingly, our financial position as of March 31, 2013 and the results of our operations for fiscal year 2013 expressed in dollars would be weaker than the results of our operations expressed in yen, as compared to our financial position as of March 31, 2012 and the results of operations for fiscal year 2012.  

Our revenues increased to $93.9 million for fiscal year 2013 from $91.2 million for fiscal year 2012.  The principal reason for this increase is related to the material impact the March 2011 earthquake had on our fiscal year 2012 operations.  Our operations for the first six months of fiscal year 2012 were significantly affected by the general down turn in the Japanese economy due to the earthquake.  As the Japanese economy recovered from the earthquake so did our operations.

Our net income increased to $11.7 million for fiscal year 2013 from a net loss of $6.0 million for fiscal year 2012.  The improvement in our operating results was due principally to increased gaming revenues as we recovered from the effects of the March 2011 earthquake.  In addition, in the third quarter of fiscal year 2013 we had a gain of $3.0 million as a result of a change in accounting estimate for employee retirement benefits due to a change in our policy relating to those benefits.  Additionally, in the fourth quarter of fiscal year 2013, we had a gain of $5.2 million as a result of a debt modification agreement we entered into in February 2012.

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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 March 31, 2013, we had total debt of $132.3 million, of which $97.1 million was in default.  We incurred most of the debt, which is now in default during 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.  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 is to follow the “chain store” model and open new or acquire existing 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 additional parlors in Ibaraki prefecture where we are the largest operator with 18 parlors.  We are a dominant force in the pachinko industry in this prefecture 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 dependent on our ability to attract global investors to creative financing instruments in the form of high yield securitized convertible debt and equity offerings.  During the past several years we have been unable to obtain financing through traditional methods such as bank loans because of our financial condition, and we can give no assurance that we will be.

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Our net gaming revenues increased by $6.0 million or 7.1% for fiscal year 2013 from fiscal year 2012.  This increase was a result of an increase in wagers with a moderate decrease in pay-outs, which more than offset the decrease resulting from a 5.1% decrease in the yen/dollar exchange rate.  Total wagers and net gaming revenues, when expressed in yen, increased by 4.2% and 12.5%, respectively, for fiscal year 2013 from fiscal year 2012.  

Total wagers for fiscal year 2012 were adversely affected during the first six months due to the March 2011 earthquake and a general decline in the Japanese economy.  Also, as a result of the earthquake, we closed a parlor that was badly damaged.  This parlor was reopened in April 2012.

Our pay-out ratio decreased to 82.3% for fiscal year 2013 from 83.6% for fiscal year 2012, which positively impacted our net gaming revenues.  Our pay-out 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 pay-outs, which have a lower cost than special prizes.  In addition, the increase in pay-outs was offset by a decrease in the pay-out ratio.  We intentionally increased the pay-out ratio for the first six months of fiscal year 2012 to generate greater customer traffic following the March 2011 earthquake.

Revenues from our food and beverage operations decreased to $3.4 million for fiscal year 2013 from $6.7 million for fiscal year 2012.  This decrease was primarily due to the July 1, 2012 sale of the business rights, to a related party, for our remaining three restaurants.  We did not generate any significant revenues from these restaurants except approximately $234,000 of rental income from those three restaurants after the sale.

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Our cost of revenues decreased by $6.2 million from fiscal year 2012 to fiscal year 2013 for a number of reasons.  Salaries and wages decreased by $1.7 million primarily due to reduced welfare expenses including fringe benefits and resignation benefits.  In fiscal year 2012, facilities and other expense included $1.8 million relating to repairs and recovery from the damage caused by the March 2011 earthquake.  Cost of revenues, other (primarily our food and beverage operations) decreased $1.1 million in fiscal year 2013 due to the sale of the business rights for our remaining three restaurants on July 1, 2012.  In fiscal year 2013 depreciation expense decreased by $2.9 million because of a decrease in the unit cost of pachinko machine purchased.  Disposal of property and equipment expense increased $1.3 million in fiscal year 2013 because of the replacement of property and equipment during the year.

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Marketing and advertising expenses decreased to $3.2 million for fiscal year 2013 from $3.7 million for fiscal year 2012.  This decrease was 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.

In the third quarter of fiscal year 2013, we recognized a $3.0 million gain from a change in employee retirement benefits.  This gain resulted from a change in October 2012 in our policy for termination benefits payable to our employees upon termination of employment, which reduced other liabilities by that amount.  We accounted for this change as a change in accounting estimate.  

General and administrative expenses remained relatively stable from fiscal year 2012 to fiscal year 2013.  However, a 5.1% decrease in the yen/dollar exchange rate resulted in a decrease of $1.0 million in general and administrative expenses in fiscal year 2013.  In addition, general and administrative expenses for fiscal year 2012 included $750,000 of compensation expense relating to shares issued in March 2012 to our chief executive officer.

Other Income (Expense)

Interest expense increased $65,000 from fiscal year 2012 to fiscal year 2013.  Expressed in yen, our total debt as of March 31, 2013 was relatively stable as compared to March 31, 2012.  As such, the increase in interest expense when expressed in dollars was primarily to the decrease in the yen/dollar exchange rate.  

We recognized gains from the extinguishment of debt of $5.2 million and $870,000 in fiscal years 2013 and 2012, respectively.  The gain in fiscal year 2013 related to a loan in the amount of $6.5 million (including principal, accrued interest and default interest) that we restructured with the lender in February 2012 to provide that if we made 12 monthly payments of $12,000 and a final payment of $840,000 in February 2013, the balance of the debt ($5.2 million) was forgiven.  The gain in fiscal year 2012 was due to the forgiveness of $870,000 of lease payments and penalty interest by an equipment lessor.  

Financial Condition and Liquidity

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Financial Condition

Property and equipment decreased to $104.9 million as of March 31, 2013 from $120.4 million as of March 31, 2012, principally because of a 14.5% decrease in the yen/dollar exchange rate.  We had $5.8 million of capital expenditures relating to the pachinko parlor we reopened in April 2012, which were offset in part by reduced net value of assets due to disposal of replaced facilities at our other pachinko parlors.

Other assets decreased to $12.1 million as of March 31, 2013 from $14.2 million as of March 31, 2012 due primarily to the 14.5% decrease in the yen/dollar exchange rate.

Our accounts payable and accrued expenses decreased to $21.1 million as of March 31, 2013 from $25.9 million as of March 31, 2012.  The decrease is principally due to (1) a decrease in repair and recovery expenses, (2) a decrease in payables related to the cost of the food business for the three restaurants we sold in July 2012, and (3) to the 14.5% decrease in the yen/dollar exchange rate.

Our debt, consisting of capital lease obligations, notes payable default, notes payable, notes payable related party and bonds, was $132.3 million as of March 31, 2013 and $159.8 million as of March 31, 2012.  As of March 31, 2013, the total debt included $109.6 million of principal and $22.7 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 $100.8 million as of March 31, 2013 (including $85.3 million in default), bears interest at 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 $31.6 million as of March 31, 2013 (including $9.4 million which is in default), bears interest at rates from 6.0% per annum to 44.75% per annum (other than default rates).

Debt in Default

As of March 31, 2013, we were in default on debt in the aggregate amount of $97.1 million, as compared to $112.0 million at March 31, 2012.  As of March 31, 2013, debt in default included principal of $77.6 million and accrued interest (including default or penalty interest) of $19.5 million.  The decrease in the amount of debt in default was due to principal repayments.

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 as of March 31, 2013.  The outstanding balances are as of March 31, 2013.

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(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 years 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.

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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.  

In 2009, the Japanese government imposed a moratorium on lenders regarding loans to homeowners and small to medium sized businesses.  Lenders were encouraged, but not obligated, to agree to loan modifications to extend maturity dates, reduce payments and forgive portions of the loan.  This moratorium expired on March 31, 2013.  Although the Japanese government asked financial institutions to continue as they had during the moratorium, it is possible that some of our lenders may have been dissuaded from more aggressive collection efforts by the moratorium, and may bring litigation or foreclosure actions.   

Our future success depends in large part on our ability to restructure and refinance our debt in order to reduce interest costs and match current debt payments with available cash flow.  If we are unable to restructure or refinance our debt, we face potential litigation and foreclosure on our existing assets.  A number of our larger lenders have in the past year assigned their loans to third parties, and we do not have enough experience with them to understand how they may seek to collect the loans or their willingness to work out a debt settlement.  Further, collection or foreclosure actions by some lenders may induce other lenders to take similar actions.  If the Company’s future financial resources or the lenders payment requirements change such that we cannot continue to meet our lenders requirements, our lenders could force Kinbasha Japan into a liquidation bankruptcy, in which event we would lose our pachinko licenses and Kinbasha Japan would cease operations.

Cash Flows

During the fiscal years 2013 and 2012, we generated $37.1 million and $34.4 million, respectively, of cash flows from operating activities.  The increase in cash flows from operating activities was the result of higher net income for fiscal year 2013 and the adverse impact the 2011 earthquake in Japan had on our operations for fiscal year 2012.

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During the fiscal years 2013 and 2012, we used cash of $27.8 million and $19.7 million, respectively, for investing activities.  This change was due to $5.8 million of capital expenditures relating to the pachinko parlor we reopened in April 2012 and an increase in expenditures in fiscal year 2013 for pachinko machines at our other parlors.

During the fiscal years 2013 and 2012, we used cash of $9.7 million and $12.1 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.  The Company anticipates that in future years, we will be required to use any positive cash flows to pay down our debt until we satisfy our contractual obligations.

Liquidity

Although we had net income of $11.7 million for fiscal year 2013, we had working capital and shareholders’ deficits as of March 31, 2013.  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 the 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 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, 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.

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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 want to open or acquire new pachinko parlors to generate greater positive cash flow.  To do this, we will need additional financing and during the past several years we have been unable to obtain such financing because of our financial condition.  There are no assurances that we will be able to obtain this financing or be successful in our plans.

Our 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 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 94.16 yen to 1 dollar as of March 31, 2013, and 82.27 yen to 1 dollar as of March 31, 2012.  The average exchange rate was 82.98 yen to 1 dollar and 78.97 yen to 1 dollar for the years ended March 31, 2013 and 2012, respectively. 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.

Critical Accounting Policies and Estimates  

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes.  Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, and which form the basis for making judgments about the carrying values of assets and liabilities.  Actual results could differ from those estimates.

We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment:

·

stock-based compensation; and

·

calculation of default interest

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Stock-based Compensation

We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the stock award using the straight-line method.  Because our common stock is thinly traded, we have made estimates of the fair value of the common stock based not only on market prices but other factors such as financial condition and results of operations.  

In March 2012, we issued 4,500,000 shares of common stock as compensation to our Chief Executive Officer, which we valued at $0.50 per share.  

We retained an independent valuation firm to perform a valuation of our common stock as of March 2012, the valuation date.  The following approach to valuation was applied by the independent valuation firm.  The independent valuation firm utilized and examined the three approaches to value: cost, market and income.  The cost approach was not a material factor in the valuation process due to the historically significant depreciation of our asset base.  The market approach utilized two methods.  The first market approach was an analysis of the thinly traded transactions in the public market place for our common stock.  The second market approach applied certain merger and acquisition multiples, which utilized four relevant guideline company transactions.  The four guideline company transactions were selected based on the existence of merger and acquisition multiples which reflected risks and rewards similar to ours.  The market approach also applied a lack of marketability discount factor of 15% reflecting the thinly traded nature of our common stock, and a 10% minority interest discount factor based on the identified guideline company transactions.  The income approach applied a built up discount rate to our projected earnings and debt-free cash flow, using our projected sales, operating expenses, capital expenditures and changes in working capital.  The resulting valuation estimates were checked for sensitivity and were considered the best estimate available based on the Company achieving stable operations in the future at the projected growth rates, EBITDA, cash flows, gross profit margins, and rates of return over time.   

Calculation of Default Interest

Most of our debt provides for penalties or default interest upon default, generally at 14% per annum.  We make estimates of the amount of penalties or default interest based on our interpretation of the underlying debt agreement as to when the penalty or default rate commences and the amount on which the penalty or default rate applies.  Our interpretation may be materially different than the interpretation of our lenders, and if our lenders' interpretation is finally determined to be correct, we could be required to record additional penalties and default interest.  

Our Election under Section 107(b) of the JOBS Act

As an emerging growth company, we have made the irrevocable election to not adopt the extended transition period for complying with new or revised accounting standards under Section 107(b), as added by Section 102(b), of the JOBS Act.  This election allows companies to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies.

Factors that may Affect Future Operating Results and Certain Investment Considerations

Our business faces significant risks.  If any of the events or circumstances described below occurs, our business, financial condition or results of operations could suffer, and the trading price of our shares of common stock could decline significantly.  Investors should consider the specific risk factors discussed below, together with the “Cautionary Note Regarding Forward-Looking Information” and the other information contained in this report and the other documents that we will file from time to time with the Securities and Exchange Commission.

Risks Relating to Our Financial Condition, Liquidity and Results of Operations

We are in default on a significant amount of debt, and if some of our lenders commence collection or foreclosure actions Kinbasha Japan could be forced into bankruptcy.

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In the early part of the 2000s, we incurred a significant amount of debt to finance business expansion, including the opening of five new pachinko parlors, the renovation of two parlors, the opening of five restaurants and the purchase of two hotels.  Most of this debt is secured by our assets, generally the assets acquired with the debt.  As a result of a downturn in the pachinko industry and other factors, we did not generate the revenues we anticipated, and since 2006 we have defaulted on a significant portion of this debt.  As of March 31, 2013, we were in default on debt in the aggregate amount of $97.1 million, which amount includes principal of $77.6 million and accrued interest (including penalty or default interest) of $19.5 million.  During this period, we have worked with our lenders and in many cases have obtained forbearances and loan modifications that have allowed us to effectively extend the maturity 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.  Our future success depends in large part on our ability to restructure and refinance our debt in order to reduce interest costs and match current debt payments with available cash flow.  If we are unable to restructure or refinance our debt, we face potential litigation and foreclosure on our existing assets.  Further, collection or foreclosure actions by some lenders may induce other lenders to take similar actions.  Because we do not have the financial resources to pay our defaulted debt, our creditors could force Kinbasha Japan into a liquidation bankruptcy, in which event we would lose our pachinko licenses and Kinbasha Japan would cease operations.

Our working capital deficit and net losses raise doubts about our ability to continue as a going concern.

At March 31, 2013, we had a working capital deficit of $127 million due primarily to our debt in default.  The report of our auditors for the years ended March 31, 2013 and 2012 includes an explanatory paragraph to their audit opinion stating that our accumulated net losses, working capital deficiency and delinquent debt raises substantial doubt about our ability to continue as a going concern.  We can provide no assurance that our plans will be sufficient to enable us to sustain our operations without raising additional debt or equity financing, which we may not be able to do on terms favorable to us or at all.

The expiration on March 31, 2013 of a moratorium on lenders regarding debts of homeowners and small and medium sized businesses imposed by the Japanese government commencing in 2009 may induce one or more of our lenders of our defaulted debt to bring litigation to collect their loans or foreclose upon the collateral securing their loans, which would materially and adversely affect our business.  

In 2009, the Japanese government imposed a moratorium on lenders regarding loans to homeowners and small to medium sized businesses.  Lenders were encouraged, but not obligated, to agree to loan modifications to extend maturity dates, reduce payments and forgive portions of the loan.  This moratorium expired on March 31, 2013.  It is possible that some of our lenders may have been dissuaded from more aggressive collection efforts by the moratorium, and may bring litigation or foreclosure actions if the moratorium ends.  Further, actions by some lenders may induce other lenders to take similar actions.

Some of our lenders may not agree with our calculation of penalties or default interest that we recorded in our results of operations, and if their interpretation is determined to be correct, we would be required to record additional expense that could be material.

Most of our debt provides for penalties or default interest upon default, generally at 14% per annum.  We make estimates of the amount of penalties or default interest based on our interpretation of the underlying debt agreement as to when the penalty or default rate commences and the amount on which the penalty or default rate applies.  Some of our lenders may not agree with our interpretation, and if their interpretation is finally determined to be correct, we would be required to record additional expense penalties and default interest that could be material.  

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Risks Related to Our Pachinko Business

We may be unable to obtain the financing to implement our strategy of opening new or acquire existing pachinko parlors in the Tokyo metropolitan area and the Ibaraki prefecture.  

Our business plan contemplates that we will open or acquire 15 pachinko parlors in the Tokyo metropolitan area and Ibaraki prefecture in the next five years.  We estimate that we will need between $9 million and $11 million to open each new pachinko parlor and to operate the parlor until it is cash flow positive.  We will have to obtain this financing from third parties to open or acquire these parlors because our loan agreements require us to pay any excess cash flows from operations to repay our existing debt.  As of the date of this report, we have no commitments for additional financing, and it will be very difficult to obtain financing because of our recent results of operations and our current financial condition.  Accordingly, we can give no assurance that we will be able to obtain the financing to open any new parlors.   

We may be adversely affected by any breach by the special prize wholesalers or prize buyers of the independence requirements adopted under the tri-party system.

Because Japanese law prohibits any flow of cash, whether direct or indirect, from pachinko parlors to customers, we, the special prize wholesalers and the prize buyers must be completely independent from each other.  Although the special prize wholesalers and prize buyers are third parties over which we exercise no control outside of our contractual relationship with the prize wholesalers, if we become aware of a lack of independence between any of our special prize wholesalers and the prize buyers they contract with, we would be required to remedy the situation by either ceasing our transactions with the relevant wholesaler or requesting the wholesaler to cease its transactions with the relevant prize buyer.  If we cease transactions with a prize wholesaler and enter into arrangements with a new prize wholesaler, all the prize buyers associated with the prior wholesaler would also be replaced or be required to enter into new arrangements with the new wholesaler, which could result in a disruption to our business operations at the affected pachinko parlors.

Future changes in the government regulations pertaining to the gaming and pachinko industries could adversely affect our business.

The Japanese pachinko industry is heavily regulated by a system of laws created and enforced by various national and prefectural government entities.  Although casino gambling is legally forbidden in Japan, pachinko has been designated as a non-gambling form of adult entertainment.  The tri-party system, established as an indirect mechanism for providing cash prizes without transgressing anti-gambling regulations, is permitted but highly regulated.  However, government regulations regarding the definition of pachinko as a ‘non-gambling’ activity and/or restrictions regarding the indirect awarding of cash or similar prizes could change, and could have a significant impact on pachinko operators in continuing normal business operations.  For example, a regulation was adopted in 2004 with the aim of de-emphasizing the gambling nature of pachislo, setting a cap on the potential pay-out value of bonus rounds that could be accumulated during the course of play.  This regulation resulted in a sharp drop in the popularity of pachislo, which adversely impacted the operating results of pachinko operators across the industry, including us.

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Because our business is dependent on discretionary spending by our customers, we may suffer declines in revenues during adverse economic times in Japan such as have occurred the past several years.

The pachinko business is dependent on discretionary spending by consumers.  During adverse economic times such as the past several years, rising unemployment and decreasing personal incomes result in reduced discretionary funds.  This in turn may reduce the amounts consumers spend on pachinko, which could adversely affect our results of operations.   

We face intense competition in Japan.

The Japanese pachinko industry is highly competitive.  It is estimated that there are approximately 4,000 operators and 12,000 parlors housing an aggregate of approximately 4.5 million pachinko machines throughout the country.  Most of the pachinko operators operate one or two parlors.  However, there are a number of large operators, the largest of which is Maruhan Co., Ltd., that in 2012 operated 285 parlors with 189,000 pachinko machines throughout Japan and generated total wagers of more than $24 billion.  Dynam Co., Ltd., the second largest operator in Japan, operated 347 parlors with 154,000 pachinko machines in 46 of the 47 Japanese prefectures and generated more than $10 billion in total wagers.   The third largest operator is Gaia Co. Ltd., which in 2012 had 191 parlors and 96,000 machines that generated more than $4 billion of total wagers.  We are not aware of any other operator that has more than 60 parlors in Japan.  In Japan, we rank 80th in the industry by total wagers and 50th in the industry by number of pachinko parlors.  Our larger competitors, and many of our other competitors, may have greater access to financial, marketing and managerial resources than we do, have greater brand recognition and may offer different array of pachinko and other games.  

The trend in the Japanese pachinko industry is to open larger parlors with more than 700 pachinko machines.  These large parlors are drawing customers from smaller parlors, particularly those with less than 300 pachinko machines (as are some of our parlors).  

In addition, we face competition from other types of entertainment and gaming activities, including offshore gaming, web-based gaming, and potentially interactive gaming channels.  For example, social networking websites in Japan such as Mixi, and mobile phone gaming applications such as Mobage, have recently introduced alternative gaming platforms which may compete with our pachinko gaming business.  Horse racing, which is run by the Japan Racing Association and local government, may also compete with us.  

If our current or target customers choose to participate in these activities rather than our pachinko games, our operations and revenue would be negatively impacted. If we cannot effectively compete with our competitors, our business, results of operations, financial condition and prospects may be materially and adversely affected.

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We face the risk of fraud or cheating .

Players may attempt to commit fraud or cheat in order to increase the number of pachinko balls and pachislo tokens they collect.  Acts of fraud or cheating could involve, among others, the use of counterfeit pachinko balls or pachislo tokens, the use of counterfeit special prizes, tampering with our machines and systems, or other tactics, possibly in collusion with our employees.  Examples of these activities include a customer opening a pachinko machine and attaching a device to the machine that inflates its winning rate, or using a device to emit microwave or radio interference with computerized components of the pachinko machines, or other attempts to play the machine without inserting the required payment.  We did not identify any material failure of our anti-cheating and anti-counterfeiting surveillance systems during the past decade, however, any failure by us in discovering such acts or schemes in a timely manner could result in losses in our pachinko operations.  An allegation or a finding of improper conduct on our part, or on the part of one or more of our current or future employees or management that is attributable to us, or an actual or alleged system security defect or failure attributable to us, could be deemed to be a regulatory breach for which we could be subject to revocation or suspension of our operating license for the relevant pachinko hall.  In addition, any such occurrence could lead to negative publicity, which could damage our reputation and would materially and adversely affect our business, results of operations, financial condition and prospects.

Risks Related to the Structure of our Business Generally and Stock Ownership

We have no independent directors, and thus our board of directors does not provide independent oversight of our management.

Each of our directors is also an executive officer of the Company, and thus we have no directors who are independent of management.  As a result of having no independent directors, our board of directors cannot provide any independent oversight of the actions and performance of management.  Further, the lack of independent directors can result in conflicts of interest between our minority stockholders and the controlling officers and directors, as these individuals have the power to make determinations affecting their own interests, such as compensation.  Lastly, we have no directors who can independently review and approve transactions between us and our principal stockholder, such as our borrowings from these individuals, and compensation arrangements between these individuals in their capacities as executive officers.

The composition of our board of directors would not satisfy the listing requirements for the Nasdaq Stock Market or any securities exchange, such as the American Stock Exchange, which require that a majority of the directors be independent.  Our common stock is currently quoted on the OTCQX, which does not have any requirements regarding the independence of directors.

Our management controls a substantial percentage of our outstanding voting securities.

Our chief executive officer owns 62.6% of our outstanding common stock, and two of his brothers who are not active in the business own 16.5% of our outstanding common stock.  Consequently, it would be impossible for a third party to obtain control of the Company, or influence its day-to-day operations, without the concurrence of the chief executive officer and his other family members.

We depend on our executive officers and key personnel and the loss of them could adversely affect our business.

Our success depends upon the efforts and abilities of our executive officers and other key personnel, particularly Masatoshi Takahama, our Chief Executive Officer, Masami Umezono, our Chief Financial Officer, and Satoshi Okamura, our Chief Operating Officer, to provide strategic direction, manage our operations and maintain a cohesive and stable environment.  Our ability to operate successfully and manage our potential future growth also depends significantly upon our ability to attract, retain and motivate highly skilled and qualified operations, marketing, managerial and financial personnel.  We face competition for such personnel, and we may not be able to attract, retain and motivate these individuals.  The loss of our executive officers or other key personnel for any reason or our inability to hire, retain and motivate additional qualified personnel in the future could prevent us from sustaining or growing our business.

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Because all of our operations are conducted through our subsidiary, Kinbasha Japan, our performance will be determined by the performance of this subsidiary.

Kinbasha has no operations independent of those of Kinbasha Japan, and its principal asset is its investment in Kinbasha Japan.  As a result, we are dependent upon the performance of Kinbasha Japan and will be subject to the financial, business and other factors affecting Kinbasha Japan as well as general economic and financial conditions in Japan.  Further, Kinbasha will depend on dividends or loans from Kinbasha Japan to meet its cash funding requirements except to the extent it can raise funds through the sale of securities or through loans.  

Our operating assets, directors and officers are in Japan, and therefore it may be difficult for our shareholders to serve our directors and officers and to enforce in the United States judgments against them and us relating to the civil liability provisions of the United States federal securities laws.

Kinbasha is a Florida holding company whose principal asset is the stock of Kinbasha Japan.  All of the Company's current operations are conducted in Japan.  In addition, all of our directors and officers are nationals and residents of Japan.  As a result, it may be more difficult for our shareholders to effect service of process within the United States upon our directors and officers and may also be difficult for our shareholders to enforce in the United States judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors .

We do not intend to pay cash dividends in the foreseeable future.

For the foreseeable future, we do not intend to declare or pay any dividends on our common stock.  We intend to retain our earnings, if any, to finance the development and expansion of our business.  Any future decision to declare or pay dividends will be made by our board of directors and will depend upon a number of factors including our financial condition and results of operations. In addition, under our current bank financing agreements, we are not permitted to pay cash dividends without the prior written consent of the lender.

We will incur additional costs as a result of being a reporting company in the United States and we have no experience as a United States reporting company.

We become subject to the periodic reporting requirements of the United States Securities Exchange Act of 1934, as amended (the "Exchange Act"), in January 2013.  Our status as a reporting company under the Exchange Act causes us to incur additional legal, accounting and other expenses that we have not previously incurred, including costs related to compliance with the requirements of the Sarbanes-Oxley Act of 2002.  We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly.  None of our current directors or executive officers has served in such capacity with any other United States reporting company.   We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

Fluctuations in the exchange rate between the yen and the dollar could adversely affect our business and the value of our common stock.

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The value of our common stock will be indirectly affected by the currency exchange rate between the dollar and the yen.  Because our functional currency is the yen, and accordingly our earnings and assets are denominated in yen, 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.  Fluctuations in the exchange rate will also affect the relative value of any dividend from Kinbasha Japan that will be exchanged into dollars and earnings from, and the value of, any dollar denominated investment that we make in the future.  

Our common stock is thinly traded in the OTCQX, and shareholders may be unable to sell at or near ask prices or at all if they need to sell their shares to raise money or otherwise desire to liquidate their shares.

Our common stock is currently listed on the OTCQX, and is thinly traded, meaning the number of persons interested in purchasing our shares at or near ask prices at any given time may be relatively small or non-existent.  This situation is attributable to a number of factors, including the fact that we have a small number of freely tradable shares (approximately 611,300 shares at March 31, 2013), and we are a small public company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk-averse and would be reluctant to follow a company of our size and expanding into a related but new line of business as we are, or purchase or recommend the purchase of our shares until such time as we became more seasoned and proven.  As a consequence, there may be periods of several days or far more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price.  We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained, or that current trading levels will be sustained.  Due to these conditions, we can give you no assurance that you will be able to sell your shares at or near ask prices or at all if you need money or otherwise desire to liquidate your shares.

If securities or industry analysts do not publish research reports about our business, our stock price and trading volume could decline.

Small, relatively unknown public companies can achieve visibility in the trading market through research and reports that industry or securities analysts publish.  However, to our knowledge, no analysts cover our company.  The lack of published reports by independent securities analysts could limit the interest in our stock and negatively affect our stock price.  We do not have any control over research and reports these analysts publish or whether they will be published at all.  If any analyst who does cover us downgrades our common stock, our stock price would likely decline.  If any analyst initiates and then ceases coverage of the Company or fails to regularly publish reports on us, we could lose visibility in the financial markets or never achieve such visibility, which in turn could cause our common stock price or trading volume to stagnate or decline.

Shareholders may have difficulty selling our common stock because it is a “penny stock.”

Since our common stock is not listed on the Nasdaq Stock Market or any national securities exchange, if the trading price of our common stock is below $5.00 per share, trading in our common stock will be subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These rules require additional disclosures by broker-dealers in connection with any trades involving a stock defined as a penny stock. These disclosures include a schedule explaining the penny stock market and the risks associated therewith and impose various sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and accredited investors (generally defined as an investor with a net worth in excess of $1,000,000 or annual income exceeding $200,000 individually or $300,000 together with a spouse).  For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to the sale.  The broker-dealer also must disclose the commissions payable to the broker-dealer, current bid and offer quotations for the penny stock and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealer’s presumed control over the market.  This information must be provided to the customer orally or in writing before or with the written confirmation of trade sent to the customer.  Monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. The additional burdens imposed upon broker-dealers by such requirements could discourage broker-dealers from effecting transactions in our common stock, which could severely limit the market liquidity of the common stock and the ability of holders of the common stock to sell their shares.

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The market price of our common stock may be adversely affected by market volatility.

The market price of our common stock is likely to be volatile and could fluctuate widely in response to many factors, including:

·

announcements of the results of our operations or the operations of our competitors,

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announcements of technological innovations by us or our competitors,

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announcements of new services, products or new contracts by us or our competitors,

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actual or anticipated variations in our operating results due to the level of development expenses and other factors, and

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changes in financial estimates by securities analysts and whether our earnings meet or exceed such estimates,

ITEM 7A.