Financial Summary

Recent Updates

Highlights

On January 12, 2012, Round One released monthly sales data for December: click here to go direct to the Monthly Trends section.

(For original English-language release in PDF format, please click here.)

On December 8, 2011, the company released monthly sales data for November.

On November 29, 2011, the company announced it had concluded a sale-and-leaseback of its Kawasaki Daishi store. The impact from the deal was already factored into the company’s FY03/12 forecast.

(For original PDF announcement in Japanese-language only please click here.)

On November 10, 2011,the company announced 1H/Q2 FY03/12 results: click here to go direct to the 1H/Q2 FY09/11 results section and click here to go to the revised FY03/12 outlook.

(For original PDF announcement in Japanese-language only please click here.)

The company also released monthly sales data for October.

For corporate releases and developments more than three months old please refer to the News & Topics section.

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Trends & Outlook

Monthly Trends

December 2011 sales figures were down 0.2% YoY, with comparable store sales off 4.8% YoY. The total number of reported locations was 109 shops.

Quarterly Trends

1H FY03/12 Results (Announced on November 10, 2011; please refer to tables above)

In addition to releasing 1H results the company also upwardly revised its FY03/12 forecast.

Sales were up 10.7% YoY at 46.0 billion yen driven by:

• The introduction of new game machines, such as the collaboration with the popular One Piece manga series on a new game machine
• Consumers increasing preference for entertainment that satisfied the characteristics of being value-for-money, close-at-hand and short following March 2011’s earthquake, which resulted in strong demand for Round One’s offerings

By segment, sales performance was as follows (percentages in parenthesis are for comparable store sales):

• Bowling: +9.2% YoY (+4.7% YoY)
• Amusement: +7.6% YoY (+3.3% YoY)
• Karaoke: +27.2% YoY (+20.6% YoY)
• SPO-CHA: +8.4% YoY (+8.4 % YoY)

The company’s high marginal profit ratio (SR Inc. estimated this at around 79%) resulted in operating profit rising 70.9% YoY to 9.4 billion yen. 2.6 billion yen in extraordinary losses were booked for the period (of which 2.4 billion yen was due to losses realized on the sale and leasebacks), resulting in a net loss of 2.4 billion yen (vs. a net loss of 5.5 billion yen in 1H FY03/11).

Looking at performance vs. the company forecast, sales came in 1.7%, or 1.5 billion yen, above plan. Operating profit meanwhile beat the forecast by 3.5 billion yen, or 28.0%. The net loss, on the other hand, came in around forecast due to realized losses from sale and leasebacks.

As a result of recent performance and the gap between its initial forecast the company revised its full year forecast.

Comparing actual results to the company forecast, the company noted that due to the factors mentioned above, sales exceeded the initial forecast by approximately 1.6 billion yen (3.6% over the forecast). Also, recurring profit beat the initial forecast by 2.3 billion yen (47.9% above forecast) because in addition to higher sales, lease expenses were also lower. Net income though came in roughly in line with forecast as the company incurred extraordinary losses on the completion of sale & leaseback agreements.

Given this and recent trends in the operating environment, the company revised its full-year forecasts for FY03/12.

During 1H FY03/12 the company completed sale & leaseback agreements for three sites: Machida, Itabashi, and Namba Sennichimae (provisional name, scheduled to be opened in spring 2012). 1H’s extraordinary losses mainly related to these transactions.

According to a company press release, the Machida site was sold to Retail Balloon LLC (a special purpose company funded through a tokumei kumiai silent partnership by Japan Retail Fund Investment Corp. (TSE 8953)), while the other two sites were both sold to Japan Retail Fund Investment.

The company used the funds from the sale of the Itabashi site (around 2.4 billion yen) to pay down interest-bearing debt. The funds from the sale of the Namba Sennichimae site (about 8.0 billion yen) were used to repay interest-bearing debt owed to R1 Namba (the company that owns the property) and as a result the company disposed of its guaranteed liabilities.

The company’s interest-bearing debt as of end-March 2011 was 136.2 billion yen, but after deducting cash and cash equivalents of 22.8 billion yen, net debt was 113.4 billion yen. However, by end-September 2011 gross interest-bearing debt had fallen to 125.4 billion yen, and net debt was 98.0 billion yen. The company initially forecast net interest-bearing debt would be cut to 98.6 billion by end March 2012, but it has achieved this six months ahead of schedule. As of end March 2011 the company had guaranteed liabilities of 8.2 billion yen (not included in its interest-bearing debt), but this was paid down following the Namba Sennichimae site sales & leaseback agreement.

Q1 FY03/12 Results

The company released Q1 FY03/12 results on August 8, 2011 (see table above).

Sales were up 12.9% YoY at 22.2 billion yen. Consumers increasing preference for entertainment that satisfied the characteristics of being value-for-money, close-at-hand and short meant demand was strong for Round One’s services, said the company.

Due primarily to higher-than-expected sales (approximately 840 million yen) and lower lease expenses (around 290 million yen) recurring profit exceeded the company forecast by about 1.9 billion yen.

The company forecast had assumed comparable store sales for Q1 FY03/12 would be up 3.1% YoY, instead actual sales were 7.2% higher YoY. Higher comparable store sales were driven by:

• A preference among consumers for “cheap, close and short” entertainment in the wake of March 2011’s earthquake.

• Low YoY base effects for comparable-store sales.

• Fee revisions (except for the Amusement segment).

By segment, sales performance was as follows:

• Bowling: +11.3% YoY

• Amusement: +11.6% YoY

• Karaoke: +32.0% YoY

• SPO-CHA: +7.9% YoY

Q1 FY03/12 got off to a good start, although the company maintained its 1H and FY03/12 forecast. The company, however, noted that if results for Q2 FY03/12 came in at the same levels as Q1 it would upwardly revise its full year outlook.

The 1H FY03/12 company forecast is assuming a 2.0% increase in comparable store sales. Yet Q1 FY03/12 comparable store sales were up 7.2% and July 2011 comparable store sales rose 4.3% YoY – above the company plan.  

Full Year(FY03/12) Outlook

FY03/12 New Openings

FY03/13 New Opening Schedule (Tentative; as of August 2011)

On November 10, 2011, the company announced a revision to its FY03/12 forecast, the revision was as follows:

• Sales: 89.5 billion yen (vs. previous estimate of 88.0 billion yen)
• Operating profit: 16.0 billion yen (vs. previous estimate of 12.5 billion yen)
• Recurring profit: 11.0 billion yen (vs. previous estimate of 8.0 billion yen)
• Net income: 3.3 billion yen (unchanged)

The company noted that 1H results and recent performance had come in above initial forecasts. The net income forecast is based on assumptions that sale and leasebacks will be executed that will bolster the company’s financial performance.

Following the revisions to its forecast, the company was anticipating comparable stores sales would increase 1.7% YoY (1H result: +5.7% YoY; 2H forecast: -2.2% YoY) and group-wide sales would rise 6.2% YoY (1H result: +10.7% YoY; 2H forecast: +6.2% YoY). The previous forecast expected comparable store sales to be basically unchanged YoY and group-wide sales to grow 4.4% YoY.

Comparable store sales in October 2011 fell 4.0% YoY, but the company explained that this was due to following factors:

• Base effect from the previous year (in October 2010, comparable store sales grew a strong 6.0% YoY).
• Weekends and holiday weather (the company’s sites receive more customers when it rains and there was little rain).
• A slowdown in individual consumption.

These factors were expected to improve going into November 2011 and the company stated its October 2011 results were in line with expectations given the weather and the other factors described above.

The company has forecast 4.6 billion yen in sale & leaseback driven losses for FY03/12. These losses are expected to be roughly split between 1H and 2H. As a result, the company was expecting to repay its interest-bearing debt ahead of the schedule set out in its Midterm Business Plan.

Longer-Term Outlook

Summary of Midterm Business Plan (excerpt from a company brochure published August 9, 2010):

“Our plan for roughly the next five years (through the March 2016 business year) follows below.

• The method we use will be to switch to a lease after selling off the store (land and building) assets (sale & leaseback).
• The implementation of these sale & leaseback process is expected to generate losses. Some disadvantages include reduced net income for the term due to extraordinary accounting losses as well as the possible outflow of cash reserves to repay borrowings. At the same time, advantages include reduced lease fees (interest burden) after the sale, which should improve the store’s balance of payments.
• We plan to repay between 20 and 30 billion yen in interest-bearing debt by using sale & leaseback transactions.
• With the stores that we have currently operating and ones we are planning, we expect company-wide recurring profit to reach 20.0 billion yen as early as FY03/16 through reduced lease fees and lower finance leases, even if sales continue at current levels at all stores.”

Based on company presentations held on February 16, 2011; May 9, 2011; and August 11; and November 14, 2011, and interviews with the company, SR Inc. has summarized below several issues that it considers key to understanding possible future developments. In order to get back onto a growth track the company needs to steadily pay down interesting bearing debt and additionally make a success of its US operations and open new stores.

1)What will happen with the store openings planned for FY03/12 and beyond?

Domestic:

An update on the status of planned openings in FY03/12 and beyond (in Namba Sennichimae, Tokyo’s 23 wards and Ikebukuro) is given below. Store openings beyond those already planned are, in principle, suspended. But the company commented that additional stores may be opened in cases where certain criteria are met. These include: developers shouldering the majority of the initial investment (including interior decorating), the site is within the Tokyo metropolitan area or, if elsewhere, located in a large-scale shopping mall.

Namba

The company concluded a sale & leaseback agreement during 1H FY03/12 and plans to open the store in spring 2012. The company expects the site to generate sales of around 2.4 billion yen and recurring profit of approximately 700 million yen over one financial year.

Tokyo’s 23 Wards

Details to be decided; The company plans to open a standard format store inside a large shopping center in spring 2012.

Ikebukuro The company signed a sale & leaseback agreement for this site, which is scheduled to open in winter 2012. The company expects the site to generate sales of around 1.6 billion yen and recurring profit of approximately 300 million yen over one financial year.

Overseas:

The company opened its first U.S. store in late August 2010 at the Puente Hills Mall in Los Angeles and the store had beat expectations (initial forecasts were for annual sales of roughly 600,000 dollars plus). Given the company would like to open another two to three stores, it was assessing if the performance of the first store was replicable (for more details on the U.S. bowling market please click here to go directly to the Market Overview section ).

The company noted that bowling companies that operate a similar format to Round One in the US, i.e. using bowling as the center-piece for an entertainment complex, do not exist and this differentiation presents a business opportunity there, similar to what the company saw when it entered the Japanese market.

2）Sale & leaseback of existing stores and repayment of interest-bearing debt

The company stated that from FY03/12 it will sequentially introduce a sale and leaseback structure at existing stores.

By proceeding with an average annual debt repayment of 25 billion yen, in line with its Midterm Business Plan, the company aims to be effectively debt free by the end of FY03/16.

In order to realize the above-mentioned repayments on interest-bearing debt, the company has determined it must implement the sale & leaseback process at 42 to 43 existing stores from March 2012. Specifically, it will implement a sale & leaseback at approximately eight stores a year. A typical store has assets of 2.2 to 2.3 billion yen, debt of 1.9 billion yen, and capital of 300 to 400 million yen. Assuming that the loss on sale is from 600 to 700 million yen, the company will record an annual loss of about five billion yen a year (600-700 million yen × 8 stores). Moreover, the company commented that, based on cash outflow assumptions during the year of from 300 million yen to 400 million yen, the annual amount of cash outflow will be in the region of three billion yen (300 million yen to 400 million yen × 8 stores).

The implementation of sale & leasebacks will enable an average annual debt repayment of 15 billion yen (average debt reduction of 1.9 billion yen per store × 8 stores). In addition, as depreciation and amortization costs equivalent to approximately 10 billion yen will actually be sources of cash, the company intends to make total repayments of interest-bearing debt of 25 billion yen a year.

The implementation of sale & leasebacks will be carried out while watching cash flow from operations. Specifically, during the second half of the above-mentioned Midterm Business Plan, there may be an increase in the level of cash flow from operations and the company intends to gradually increase the number of stores for sale. Also, from March 2012 on, the company said that it plans to avoid recording a net loss by keeping losses on sales within the range of recurring profit, and to also increase net income in each period.

However, the above is merely a base-case scenario, interest-bearing debt repayments may speed up depending on levels of recurring profit, or vice versa, there may be scenarios where the repayment schedule slows down. For example, increases in the level of recurring profit could cause sale-and-leaseback related losses to rise beyond assumptions.

The company has paid down debt slightly ahead of schedule - net interest-bearing debt as of end-September 2011 was 98.0 billion yen. As a result, at the November 14, 2011, results meeting, President Sugino noted the possibility of having zero net debt ahead of plan, stating it was feasible the company could achieve this as early as end-March 2014. (Assuming it can pay down on average 25.0 billion yen in debt annually, the company would be net debt free by end-FY09/15.)

3）Other comments

• The company stated on February 16, 2011 that for the time being, it would not use equity or equity-like financing, essentially promising no further dilution for the existing shareholders.

• The company noted at its May 19, 2011 earnings briefing it was much more comfortable about its capital position when compared to the financial anxieties it experienced in 2009.

• Approximately 27.1 billion yen is due for refinancing over FY03/12, of which around 17.3 billion yen has been agreed to already by financial institutions. The remaining loan balance was being dealt with by financial institutions who had dealt with the company’s refinancing in the past (according to comments made at the company results briefing held on August 11, 2011).

• As of late 2011, heavy-users drove a high portion of sales, but the company noted at its November 14, 2011, results briefing that it was planning measures to increase the frequency of store visits by light users, which will be implemented in FY03/13 and beyond.

• Once the company is debt free it was looking to implementing the following initiatives:

- Open additional North American stores

- Open stores in the Tokyo metropolitan area, where the company currently has a comparatively small domestic footprint

The company will also to restrict outgoing cash flow to an absolute minimum, but it had positioned these initiatives as top priorities as of its results meeting on November 14, 2011.

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Business

Summary

Core business - Operation of Amusement Complex Centers

Round One specializes in running amusement complex centers across Japan, mainly in Kansai (Southern-Central Japan, including Osaka, Kobe, and Kyoto) and Kanto (Eastern Japan including Tokyo) regions. In particular, it has a substantial presence in “Hokusetsu”, a region comprising parts of Osaka, Kyoto and Hyogo Prefectures. The amusement services start with Bowling as well as Game, Karaoke and SPO-CHA (abbreviation for “Sports Challenge”). Capturing profitability metrics at each service level is difficult, as they are all provided in a same location and for the same customers, and it is therefore hard to appropriately allocate direct costs and overhead to each category. The marginal profitability appears to be the highest in Bowling, followed by Game. For Bowling, the marginal profitability is suggested to be over 90% while Game is relatively lower due to variable costs associated with prizes in redemption type machines etc. Karaoke has a high exposure to variable costs; this service includes offerings of foods and drinks to customers. For SPO-CHA, marginal profitability was initially expected to be higher, but lower than originally forecast sales meant higher fixed cost ratio.

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Business Description

The company’s amusement centers are divided into “Standard” and “Stadium.” Bowling and Game are the two main revenue pillars at Standard facilities, while SPO-CHA is the key feature for the Stadium format. Stadium is a newer type, and it was seen as an important new driver for sales when it was first introduced. However the SPO-CHA concept has failed to generate sufficient traction in the market as traffic flow tends to slow substantially after a period of initial post-opening excitement. Most recently SPO-CHA had been considered by the company as more of brand advertising tool, flagship stores increasing Round One clout and “carrying the aura” to smaller centers in the vicinity.

Bowling(36.8% of sales in FY03/11):This category comprises sales of bowling games (rounds plus rental shoes, etc.) and vending machines (drinks, snacks, etc.).

Game (41.8%): This category comprises sales from game machines including medal games, “UFO Catchers” redemption crane games, video games etc., all installed in the centers. The business here makes the company the largest arcade game operator in Japan, and that means that the newest and most popular machines from all vendors are always installed in the centers.

Karaoke (8.0%): This category comprises sales associated with karaoke room rentals and food & drink services for customers of karaoke.

SPO-CHA (10.4%): This category comprises sales associated with admission tickets for SPO-CHA (“Sports Challenge”) areas of the centers. This service is available only in Stadium (43 out of 109 total centers at the end of FY03/11). Stadium facilities are larger than Standard (Stadium facilities have room for SPO-CHA). The top two floors in Stadium facilities are often dedicated to SPO-CHA. SPO-CHA includes spa relaxation facilities, three-on-three basketball, and older and less “current” games (air hockey, batting practice, roller skating etc.). Once customers enter the area, all these services (with the exception of some food services) are available at no additional cost within the time period specified by the ticket.

Other (3.1%): This category comprises sales associated with rent from tenants like hamburger shops located in the centers as well as small unclassified amusement services.

Development of New Centers

New Center Openings (Source: Company Data Processed by SR Inc.)

The company had 109 amusement complex centers as of the end of FY03/11, the oldest opened in FY03/95. Through FY03/05 to FY03/08 Round One was focusing on Stadium format centers. However, in FY03/09 and FY03/10, it eased off opening new Stadium format centers. It requires about 2 years from the decision to open a new center to actual opening. The company has slowed the pace of new store openings: from 10 plus stores a year (FY03/06-FY03/10) to four openings in FY03/11 and just one planned opening in FY03/12.

Target facility layout

Cost structure analysis

According to the company its marginal profit ratio is approximately 70% to 80%. The average spending per customer has been and is likely to be stable at 2,000-2,200 yen. That means that the number of customers is the main driver of earnings and the most immediate way to enhance earnings is to enhance the number of customers in existing centers.

Round One’s business model is such that fixed costs per center have a tendency to decline in a medium or long term view. The company’s typical model shows that the annual leasing expense through the first year to the third year is 203 million yen versus 123 million yen through the fourth year to the sixth year and 94 million in the 7th year and onward (see table below). When assuming constant sales levels, the leasing expenses equate to 16.9%, 10.3%, 7.8% of sales, respectively, throughout the three periods. It should be expected that operating profit margins should improve in line with the decreases of exposure to the leasing expenses when other conditions remain unchanged.

The reason for such consistent declines of leasing costs is that Round One gradually enjoys declining burden associated with the initial investments. The renewals for leasing contracts, except for Bowling, are carried out every three years, and the first renewals at the beginning of the fourth year gives the company lowered costs as the initial investments aren’t required to renew a lease. For Bowling, there should be no changes in leasing costs over the first six years, but they will come down at the beginning of the 7th year (lease term is 6 years). More importantly, Bowling has the least exposure to leasing costs in terms of comparison with the overall sales, i.e., 10.0%. On top of this, it has the least exposure to variable costs (high marginal profitability), and thus this is regarded as the key earnings pillar with the company. Bowling leasing costs / sales comes down to 1.1% in the 7th year and onward, and it is presumed that Bowling should see even higher profit margins than the levels during the first six years. Bowling requires almost no additional investments when renewing leasing contracts, unlike other categories, and therefore the rate of declines in leasing costs are large. A key assumption in this analysis is that sales levels for Bowling are relatively stable.

Age of Centers

The number of centers in their 1st year to 3rd year continued increasing through FY03/09, but double-digit store growth from FY03/06-FY03/10 has been reduced substantially in the FY03/11 opening schedule (see Trends and Outlook for detail). This means that the mix of centers 4 years or older continues to grow, which has an obvious impact on overall costs as discussed in Cost Structure.

Special Purpose Companies, the Driver for the Fast Growth

Out of 109 amusement centers as of the end of FY03/11, approximately 57 were held through Special Purpose Companies (SPC). The structure allowed Round One to take advantage of non-recourse loans which made it possible to use higher leverage than recourse loans. Indeed, the company has achieved aggressive new center openings through use of leverage, resulting in more center opening than would have otherwise been possible. Typically, 30% of the new center assets to be held in an SPC are funded by equity from the company and the remaining 70% by non-recourse loans issued by the SPC. The leasing period for assets held in the SPC is typically seven or eight years, and the redemption period for the non-recourse loans is five years. The company initially viewed the SPC risk as relatively low, due to the unique nature of the assets (creditors would be better served to help the company work-out the situation rather than seizing the assets for a liquidation attempt). However, adverse market conditions in FY03/11 forced the company to re-evaluate its consolidated debt position with SPC debt. The company announced a plan in Q1 FY03/11 which potentially involved sale & leaseback transactions and possible store closures to reduce its balance sheet leverage.

As of the end of FY03/11, the total outstanding balance of long-term non-recourse loans (including the current portion of long-term debt payable) used in the SPC structures was 41.8 billion yen.

The specific type of debt used in the SPCs has slowly been changing to standard corporate loans as the non-recourse loans mature. The loans are guaranteed by the entire company instead of being secured by specific assets.

Strengths and Weaknesses

Strengths

• The company's business model is unique in that it combines Bowling, Games and Karaoke in one large amusement center, increasing both its customer drawing power and stability of revenues. While these markets are unlikely to grow, Round One can leverage this advantage and continue expanding as the sole operator of nation-wide amusement complexes. As with many mature markets, it might be too late for newcomers, even incumbents in each of three relevant individual markets, to enter the market for amusement complex centers. Indeed, large game machine makers tried to do it and failed in the past as they failed to master the tricky art of profitably managing bowling alleys.

• Strong brand name.“Round One”is well recognized by the consumer and the company’s nationwide presence allows it to advertise its brand on the major TV networks.

• Strong cash flow generating ability. Although high earnings growth of the past decade is unlikely to be repeated, once the wave of store openings subsides, Round One amusement centers should bring joy not only to the bowling fans but to investors as well. An important condition however is for the decline in the comparable store sales to be stemmed.

Weaknesses

• Hard to scrap underperforming facilities. While many roadside retailers can close their stores relatively easily, the company’s large scale centers are unique and not easy to off-load. It takes 2 years to open a store and would take large accounting losses to close one. However, the Fuchu Station-area store opened in FY03/11 was able to make use of a pre-furnished building, and so the company was able to begin operations only about half a year after deciding to open the venue. If the company was to continue utilizing pre-furnished venues, then this could reduce some of the risk associated with new store openings.

• Having a high presence in its market, it is harder to find new venues of profitable growth. While overseas expansion offers such possibilities, differences in regulations and country risk mean that success in replicating the company’s business model is less than certain.

• Weak economy and shrinking disposable incomes are impacting sales just when the company is about to enjoy improving cash flows from its previous expansion. That negatively affects financial health and is restricting near term strategic options.

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Market & Value Chain

Market Overview

Bowling was well accepted in Japan when it was imported in 1960s. In those days, it was not unusual to queue for hours to play, and anyone with excess funds was keen to invest in bowling alleys as long as they could find suitable land. The number of the centers had once reached 4,000 but has since declined from this peak to around 900 as of June 2011. Japanese people now have access to a wide variety of entertainment options, leading to a smaller portion of disposable income being spent on bowling.

The market for Round One’s services is no longer in a secular growth stage. It shows some cyclical characteristics, but more than responding to normal economic cycles, it goes through other cycles that are more related to product innovation and emergence of competing entertainment options. For instance, when automatic scoring was introduced in bowling alleys in Japan, it fueled a temporary boom. On the other hand, when mobile phone content started rapidly gaining acceptance among young people, handsets took away a portion of their disposable incomes and negatively impacted other amusement alternatives, including bowling. The impact tends to wear off after an initial surge, creating a “hindsight cycle”. Generally speaking, any such cycles are short-lived, so Round One’s markets (bowling, games) seem to have a slow contraction trend arguably driven by changing demographics.

With 109 centers nationwide (FY03/11 end), Round One has approximately 30% of the market (company estimate). Its share of the number of bowling centers is about 10%, reflecting the fact that the company tends to have far more lanes per center than smaller peers. The company entered the market late, in early 1980s, around the end of the era when such commercially successful entries were still possible. The company not only opened bowling alleys but introduced a completely new model (under the Round One brand), combining bowling with games, karaoke, and other amusement options. This model came to dominate the market. The market size is currently about 80-90 billion yen with approximately 10 centers closing each year, with an expected continued contraction of the market. However, Round One has the potential to pursue sales increases by increasing its share as smaller competitors exit the market.

The market for arcade games is saturated, due to previous growth and the over-supply of games and centers which were developed to meet expectations of what the market could have been. The total market size is approximately 500 billion yen, down from a peak of 700 billion yen. The contraction of the market has motivated some incumbents to reconsider participation, and some large national operators are selling assets to smaller regional firms. The overcapacity has caused ripple effects through the value chain as game manufacturers reacted to limit production of game titles. Smaller arcade operators are slow to replace machines due to financing challenges, and manufacturers respond by making fewer games, which in turn impacts larger arcade operators through limited choice.

U.S. Market

The company opened its first overseas in late August 2010 in Los Angeles and as of August 2011 was considering opening more U.S. stores. According to company Q1 FY03/12 presentation materials, the U.S. bowling market had the following characteristics:

Overview

• Market size: 7.0 billion dollars (approximately 6.7 times the size of the Japanese market based on an 80 yen to the dollar exchange rate).

• Number of centers: 5,350 Center (Private sector: about 4,800 centers; Others (Military/Association operated etc): about 550 centers).

• Bowling population: about 71 million people (defined as people bowling at least once a year).

Other market features:

• The two largest operators have 400 stores with second-tier players having around 50 stores, most of the other operators are family-owned businesses.

• Recession-resistant - the market has displayed continued stable growth over the past few years.

• Older bowling alleys have been closed down over the years and about 20-50 of these stores per year are then renovated into other facilities (such as go-kart tracks, video game arcades, mini golf courses, etc.).

• Participation rates for bowling are very high compared to other leisure activities (golf, fishing, tennis, billiards, cycling, roller skating, ice skating, marathon running etc).

• Bowling alleys are viewed as social venues with an above average income user levels increasing.

Customers

Customer breakdown by generations with the company is as follows: people in their teens and twenties collectively account for 50% of the total. The 30-40s age range accounts for about 10% to 20%. The remaining 30% to 40% is accounted for by other generations. The population in Japan is unlikely to grow in the future, and the proportion of young people to the total population is likely to decline. When this trend is taken into account, the key customer base (younger people) should suffer from proportionally larger declines than the overall population in Japan. As a result, this could lead to decreases in customers in the future. However, current young customers (if they have made it a part of their lives to come to amusement centers) could potentially become repeat customers even in their thirties and forties.

Suppliers

Round One sources equipment for its facilities, otherwise there are no major procurement items. All equipment is leased, not purchased. Suppliers of game machines include Sega Sammy (TSE 6460), Namco Bandai (TSE 7832), and Taito, a subsidiary of Square Enix (TSE 9684). Most game suppliers also operate their own arcade game chains. Round One does not seem to receive volume discounts from these suppliers despite being a very large customer. However, its size allows for quicker delivery times and ensures early availability of the newest “hot” game machines.

Barriers to Entry

The mature market with limited growth potential makes a profitable entry less possible and therefore less attractive. Both the existence of a national Round One franchise and its expertise in managing this franchise create high barriers to entry for would-be competitors. Additionally, several billion yen is required for facilities investment, which is a significant barrier to entry. Some game manufacturers have attempted to enter the bowling market but found their expertise (arcade games) was not transferable into bowling, and abandoned their attempts.

Competitors

There are no direct competitors that run national chains. Neighborhood operators of bowling centers, game arcades, and karaoke centers are all competitors to varying degrees. Smaller operator Sport is considered a distant second runner in the industry, operating 14 plain-vanilla bowling centers. But no company has succeeded in replicating the national scale and highly standardized model that Round One has accomplished. In the words of management, “there is no Round 2” in the market. Arcade game operators such as Sega Sammy (TSE 6460), Namco Bandai (TSE 7832) and Square Enix’s (TSE 9684) Taito, as well as smaller players like Adores (Jasdaq 4712) and Warehouse (TSE 4724) are competitors in a broader sense but they lack either scale or exposure to the profitable bowling segment.

Substitutes

Essentially, Round One’s services provide customers with amusement and/or entertainment, and thus any other equivalents could be substitutes. However, the mainstay bowling has distinguished characteristics that make it unique and somewhat ‘sticky’ with players – the rules are relatively simple, skill is not required for enjoyment, and it is relatively inexpensive. Given these factors, it is unlikely that the market for bowling could quickly decline from current levels. The diversification of amusement and/or entertainment will likely keep on making progress, but bowling should survive as one of the key categories even in a long-term view.

Group Companies

In the past, the company had a consolidated subsidiary involved in point card issuance. It was not successful as a standalone business and was liquidated in FY03/02. As a result Round One stopped reporting its consolidated accounts from FY03/03. At the same time, the company started using SPCs from 2002 after a suggestion from a leasing company. Under then prevalent accounting rules, such SPCs were off-balance sheet and therefore did not trigger a consolidated reporting requirement. This changed a few years later and the company restarted consolidated account from FY03/07 reflecting all its SPC-related assets and liabilities. On an income statement front, sales, recurring profit, and net profit are almost the same at the parent and consolidated levels. At the operating profit level, the parent company pays the rent to SPCs. They in turn pay the parent a dividend equal to rent minus interest, maintenance expenses, outsourced administration fees etc. Such dividend is booked by the parent as a non-operating item. The SPCs have typical equity ratio of 10% (financed by the parent), the balance is loan debt. On a balance sheet front, the parent does not reflect any SPC entities. According to company data, consolidated subsidiaries included 4 SPCs (Tokutei Mokuteki Kaisha) and 57 Tokumei Kumiai (Japanese Commercial Code Association similar to a US LLP and often called Japanese LLP) as of the end of FY03/11. While technically different both types are special purpose vehicles that lease the company's amusement complex centers. Additional discussion of the SPC use can be found here. Since the American subsidiary Round One Entertainment Inc. became consolidated from March 2011 there are differences in sales and net income figures at the parent and consolidated levels.

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Strategy

Overseas expansion plans are expected to be developed further after comparable sales are stabilized and the company’s financial state improves. President Sugino firmly believes that overseas expansion will take place in the future. The logic is that Round One will be unable to sufficiently grow if it sticks to existing business model and the existing domestic market. Round One opened its first overseas center in Los Angeles, California in August 2010 and hoped to open another in FY03/11. Looking back on the key factors why President Sugino started in the business in the early 1980s, he was convinced that he was able to provide customers with higher quality amusement services than peers while spending less. According to his most recent analysis, he is convinced he can do this in North America.

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Historical Financial Statements

Summary

Earnings Results Discussion for the Year Preceding Current Fiscal Year (For Reference Purposes)

FY03/11 Results

On May 11, 2011, the company released FY03/11 results.

Sales were up 2.7% YoY at 84.3 billion yen. The 11 stores opened during FY03/10 and the four stores opened in FY03/11 contributed to higher sales. Operating profit, however, fell 5.1% YoY to 11.4 billion yen due to a 2.2% YoY fall in sales at pre-existing stores. Meanwhile recurring profit was down 11.7% YoY to 6.9 billion yen due to an increase in interest expenses. The company posted a net loss of 12.7 billion yen, primarily due to the recording of 27.3 billion yen in extraordinary losses. The bulk of extraordinary losses came from a 21.5 billion yen loss due to changes in plans for new store openings, with another 3.2 billion yen loss from the application of asset retirement obligation accounting standards, and another 1.8 billion yen in impairment losses. Losses from changes in plans to new store openings resulted from the selling off of land and buildings that were being held for future stores, and a switch to leasing contracts.

Recurring profit came in about 1.1 billion yen less than the company forecast. The reasons behind the shortfall were a change in lease depreciation accounting to the declining-balance method from the straight-line method (approximately 500 million yen contribution), sales falling short of projections (approximately 190 million yen) and an increase in personnel costs (about 250 million yen).

The net loss for the period was 12.7 billion yen, which was 1.2 billion yen worse than the company’s downwardly revised forecast issued in February 2011. The worse-than-expected net loss was due to extraordinary losses of 27.3 billion yen vs. its forecast 26.5 billion yen in extraordinary losses, as well as below expectations recurring profit numbers. Extraordinary losses exceeded projections partly because of 363 million yen in disaster related provisions related to the Tohoku Earthquake.

Q3 FY03/11 Results

On February 10, 2011, the company released Q3 FY03/11 results. At the same time, it released an upward revision to its FY03/11 earnings forecasts.

The revised FY03/11 forecast was as follows:

Sales: 84.5 billion yen (vs. previous forecast of 86.0 billion yen)

Operating profit: 13.0 billion yen (vs. previous forecast of 14.0 billion yen)

Recurring profit: 8.0 billion yen (vs. previous forecast of 9.0 billion yen)

Net loss: 11.5 billion yen (vs. previous forecast of 2.4 billion yen net loss)

The company commented that the downward revision to its sales forecast was due to the reflection of the Q3 cumulative results, which recovered slower than the company expected. The company also commented that operating profit was revised down due to the lower sales forecast and the company’s fixed cost ratio. The net loss was revised due to additional extraordinary losses of 13.1 billion yen incurred from changes in the operating structure for new and existing stores (the company had already announced an expected 8.9 billion yen of extraordinary losses on October 22, 2010). SR Inc. speculates that extraordinary losses of 13.1 billion yen were mainly incurred from selling the Umeda site as the company had previously commented (the company plans to use a sale and leaseback structure for the new store).

Comparable store sales in January 2011 were flat YoY, the result of special factors such as the fact that the games played by the Japan soccer team in the Asia Cup predominately took place on weekends. The company commented that since October 2010 comparable store sales have increased by about 3 to 4% YoY, once effects of days of the week and other special factors are considered.

Currently (as of February 2011), Karaoke and SPO-CHA are performing strongly, Game is continuing its solid performance, while results in Bowling are practically unchanged YoY. In Karaoke, performance has been strong since the company introduced new equipment into its centers (“Joysound Crosso by Xing Inc.” and “Live Dam Daiichikosho Co., Ltd.”). Round One believes that its aggressive introduction of new equipment is now starting to produce results. In SPO-CHA, the company had initially anticipated an increase in revenues due to easy comparisons vs. FY03/10 as well as the anticipated impact from TV advertising. However, it now thinks it’s hard to say whether or not this strong performance will continue in the future. In Bowling, comparable store sales returned to positive growth in October 2010, but subsequently dipped back into negative territory.

Q2 FY03/11 Results

Round One released Q2 FY03/11 results on November 10, 2010. FY03/11 1H results were in line with the company’s revised estimate announced on November 5. As a percentage of the 1H company forecast, Q2 numbers were as follows:

Sales: 48.3% (vs. FY forecast of 86.0 billion yen)

Operating profit: 39.3% (vs. FY forecast of 14.0 billion yen)

Recurring profit: 34.6% (vs. FY forecast of 9.0 billion yen)

Net loss: 5.5 billion yen (vs. FY estimate, net loss of 2.4 billion yen)

Recurring profit of 3.1 billion yen in Q2 (1H) was 1.4 billion yen lower than the initial forecast of 4.5 billion yen. The main reason for the shortfall was lower than expected sales. Round One’s business has high marginal profitability. Therefore, when sales initially forecast to grow by 5.1% YoY instead grew only by 1.8% YoY, it substantially impacted the profit figures. The net loss for the period was a result of 3.2 billion yen of extraordinary losses recorded in Q1 related to asset retirement obligations, and 8.8 billion yen in Q2 incurred from selling the Ikebukuro site (see further discussion below).

The company left the full year forecast (revised on October 22, 2010) unchanged assuming it would make up for the 1H shortfall in 2H. The rationale behind this view is the optimism about the sales trends –comparable store sales were positive in October 2010 for the first time in 40 months (+6% YoY) and the company expects this strength to persist as new major amusement (game) machines and new karaoke equipment started arriving in its facilities. In fact, the company has been blaming weak amusement performance on the lack of new attractive machines for some time, but reversed its tone to one of optimism as manufacturers finally started bringing new models to the market.

October 2010 had an additional Sunday compared to the previous year, but even excluding the effect, the comparable store sales in October 2010 growth would likely have been about 4%. The company didn’t specifically identify reasons why areas that had been performing poorly, such as Bowling and SPO-CHA, reversed course, saying “we cannot speculate about the reasons until we have three consecutive months of positive figures”.

In Game, the company completed the introduction of the virtual game “Mobile Suit Gundam: Extreme Vs (by Namco Bandai Holdings Inc.)” at the end of October. It plans aggressive further introductions of new models through the calendar year end, including the card-based game “Sengoku Taisen (by Sega Corporation)” in late November, virtual reality game “Metal Gear Arcade (by Konami),” and the medal game “Panorama Fantasy (by Konami)” in late December. In Karaoke, performance has been strong since introducing new equipment into one-third of its centers in April 2010 (“Joysound Crosso by Xing Inc.”).The company plans to introduce a new machine model into about one-third of its centers in November 2010 (“Live Dam Daiichikosho Co., Ltd.”).

Q1 FY03/11 Results

Round One released Q1 FY03/11 results on August 9, 2010. As a percentage of the 1H company forecast, Q1 numbers were as follows:

• Sales: 45.9% (vs. 1H forecast of 42.9 billion yen)

• Operating profit: 32.1% (vs. 1H forecast of 6.8 billion yen)

• Recurring profit: 21.9% (vs. 1H forecast of 4.5 billion yen)

• Net income: -1.4 billion yen (vs. 1H estimate of 680 million yen)

The company recorded a net loss of 1.4 billion yen, mostly due to an extraordinary loss related to asset retirement obligations of 3.2 billion yen (new accounting standards came into effect in FY03/11).

There was no change to the 1H and full year forecasts. However, due to the continuing decline of bowling sales at existing stores and the possibility that there will be additional extraordinary losses (see discussion in Longer-Term Outlook), in SR Inc.’s opinion, the company may find it difficult to meet its planned performance.

Full Year FY03/10 Results

The company announced FY03/10 Q4 and full year results on May 14, 2010.

Sales were 82.1 billion yen (+5.3% YoY), operating profit 12.0 billion yen (-11.6% YoY), recurring profit 7.8 billion yen (-19.9% YoY), net income 3.4 billion yen (-14.6% YoY).

As a percentage of the revised company forecast, the results were as follows:

• Sales: 98.9% (vs. forecast of 83.0 billion yen)

• Operating profit: 91.8% (vs. full year forecast of 13.1 billion yen)

• Recurring profit: 87.2% (vs. full year forecast of 9.0 billion yen)

• Net income: 82.8% (vs. full year forecast of 4.1 billion yen)

FY03/10 Results Report Card (vs. revised estimates announced early Q4)

Revenues

Target: 83 billion yen (+6.4% YoY)

Result: 82.1 billion yen (+5.3% YoY)

Gross Profit

Target: 14.8 billion yen (-3.5% YoY, 17.9% GPM)

Result: 13.8 billion yen (-10.1% YoY, 16.8% GPM)

SG&A, Operating Profit

Target: 1.7 billion yen SG&A (-1.1% YoY; SG&A/Sales 2.1%)

Result: 1.8 billion yen SG&A (-1.2% YoY; SG&A/Sales 2.2%)

Target: 13.1 billion yen OP (-3.8% YoY; 15.8% OPM)

Result: 12.0 billion yen OP (-11.6 YoY; 14.7% OPM)

Recurring Profit

Target: 9.0 billion yen (-8.1% YoY; 10.8% RPM)

Result: 7.8 billion yen (-19.6% YoY; 9.6% RPM)

Net Income

Target: 4.1 billion yen (+3.1% YoY; 4.9% NPM)

Result: 3.4 billion yen (-15.4% YoY; 4.1% NPM)

Overall, FY03/10 results were disappointing although it could be argued that the weakness had to be expected and the company communicated the difficulties well through the period. The end results however, were a miss relative to the forecast revised down in February 2010.

The company remains focused on getting back to a growth trajectory. SR notes that as of May 2010 end, the comparable store sales seem to have bottomed and therefore the company’s FY03/11 forecast can probably be considered more reliable than the previous ones. The company assumptions for FY03/11 and the discussion by SR Inc. are presented in the detailed discussion below.

FY03/10 Results Highlights

FY03/10 was a challenging year. A number of external factors impacted the performance. Particular culprits were weak consumption and the flu outbreak earlier in the year. The new flu type had an extended impact – not only normal public fears regarding the virus, but also persistent calls from schools and authorities to keep children away from public places. Combined with weak incomes and lower highway tolls (encouraging longer family trips at the expense of local entertainment) this meant a substantial drop in family traffic to Round One facilities.

Additionally, the lack of new hit medal prize machines also impacted both Game revenues and (likely) overall traffic.

On a positive side, the company was able to weather the storm related to the financial crisis, specifically the refinancing of its multiple SPCs (refinancing a total of 12.8 billion yen of consolidated loans), a sudden threat to the very existence of the business. As of FY03/10 end it would appear that the worst was behind the company, although uncertainties surrounding future refinancing remained (negotiations were underway for approximately 17.7 billion yen needs in FY03/11; further negotiations were scheduled for 39.7 billion yen for FY03/12-FY03/13, according to the FY03/10 analyst meeting materials).

Another smaller positive was the success of network bowling installed in all facilities. The new approach, made possible by Round One’s nationwide presence, high market share, and innovativeness, likely helped stem the decline of bowling revenues which otherwise might have been much worse.

FY03/10 Q3 Results

Round One released Q3 FY03/10 results on February 10, 2010. As a percentage of the full year company forecast, the cumulative Q3 numbers were as follows:

Sales: 72.1% (vs. full year forecast of 83 billion yen)

Operating profit: 58.6% (vs. full year forecast of 13.1 billion yen)

Recurring profit: 51.4% (vs. full year forecast of 9 billion yen)

Net income: 54.3% (vs. full year forecast of 4.1 billion yen)

Q3 (Oct-Dec 09) sales were 19 billion yen (+5.9% YoY). Operating profit was 1.6 billion yen (-22.2% YoY).

The store count was 104 (+3 during Q3).

The FY03/10 earnings forecast was revised down simultaneously. The updated estimate is as follows:

Sales: 83 billion yen (-3.5% from previous)

Operating profit: 13.1 billion yen (-10.3% from previous)

Recurring profit: 9.0 billion yen (-14.3% from previous)

Net income: 4.1 billion yen (-16.3% from previous)

Sales in the Bowling segment in Q3 were 6.9 billion yen (+6.2% YoY, 70.5% of the full year plan). Q3 comparable store sales were -8.6% (9 month cumulative -3.5% YoY). Lower sales were partially due to economic conditions and reduced demand driven by fears of the swine flu. From discussions with the company, SR Inc. sees the current strategy as one to maintain current tactical measures previously introduced (limited discounting and direct marketing) while waiting for the economy to recover. "Ganbare! Bowling Bancho!", the popular network bowling game (see Business Description), was a bright spot; the company estimated 1 million total unique tournament players and positive comparable store sales growth (between 6% to 7%).

The company seemed cautiously optimistic regarding the competitive situation in the bowling industry, commenting that difficult economic conditions should weaken and eventually force out smaller operators. In the shorter term, the company had planned to improve advertising efforts in Q1 FY03/11 (more television in the marketing mix) to drive sales during Golden Week (beginning of May).

Sales in the Game segment were 8.3 billion yen (+8.3% YoY, 73.5% of the full year plan). Q3 comparable store sales for segment were -9.2% (9 month cumulative -10.3% YoY). Key contributing factors for lower comparable store sales were lower family traffic and stale game content. Family traffic has declined approximately 20% YoY, accounting for over 6% of the 9% decline in Game comparable sales, according to the company. Family traffic is expected to recover when concerns about the flu subside, but the same could not be said for content. Core game players have typically been playing medal games, and manufacturers have been slow to bring new games to market. The segment performance was not without a silver lining: “catcher” (redemption crane) games had positive YoY sales. The company also suggested that consolidation in the market was beginning, which could benefit the remaining operators.

During the Q3 results meeting presentation, the company emphasized focus on game content to improve segment performance. The company bought about 100 new Konami machines in February, and is looking for more. The company also indicated that it wanted manufacturers to increase advertising, even if it means higher prices.

Q3 sales in other business segments were as follows:

• Sales in Karaoke: 1.5 billion yen (+6.6% YoY). 9-month cumulative sales were 4.4 billion yen (72.2% of the full year plan). Q3 comparable store sales were -15.3% (-13.0% 9-month cumulative).
• Sales in SPO-CHA: 1.8 billion yen (-7.8% YoY). 9-month cumulative sales were 6.5 billion yen (72.0% of the full year plan). Q3 comparable store sales were -16.6% (-9.2% 9-month cumulative).
• Sales in Other: 668 million yen (+13.8% YoY). 9-month cumulative sales were 2.2 billion yen (72.8% of the full year plan). Q3 comparable store sales were -12.1% (-0.9% 9-month cumulative).

The company is focused on improving finances over the short to medium term: reducing the number of money losing stores (13 out of 104 were unprofitable, as of Q3 FY03/10) and reducing debt. Store age should help with store profitability; lease payments drop about 7% after the fourth year of operation (see Cost Structure Analysis), and over 70% of stores will be 4 years or older in FY03/11. Closing stores would be an option of ‘last resort’ if turnaround efforts are unsuccessful (closing a store costs between 700 million to 1.3 billion yen). The company indicated an internal goal of being largely debt free within 10 years. SPC-related debt on the balance sheet was approximately 63 billion yen (including short term debt) at Q3 FY03/10 end.

SR Inc. understands that the total refinancing needs for FY03/11 are approximately 14 billion yen, of which the company will need to contribute approximately 3 billion yen to shore up SPC equity positions. Refinancing the SPC debt involves replacing non-recourse loans with corporate loans, which should have a positive impact on overall costs (facility rental expenses are essentially the interest payments made by the SPCs, and corporate loans typically have lower interest payments than non-recourse loans).

Additional Information on Convertible Bonds

President Sugino lent shares to Nikko Citigroup to short sell before Nikko Citigroup bought the company’s convertible bonds, which raised concerns of self-dealing from some institutional investors. President Sugino is adamant that not only was this not any kind of self-dealing, but was the only available option to pull the company out of the financing crisis caused by post Lehman Shock lending reluctance. Nikko Citigroup would not have been a buyer of the convertible bonds without the ability to hedge stock price risk (achieved through short selling the shares). Importantly, Nikko Citigroup was the only investment bank that agreed to take the risk and underwrite such a deal.

Investors who buy convertible bonds are typically attracted by the conversion option value as opposed to the bond component. The option is valued based on the probability of conversion (will the stock price be higher than the conversion price). To separate the option price from the stock value, many convertible bond investors will short sell the stock to offset any gains or losses in the shares (the investor is long stock through the bond’s conversion, and is also short the stock through the short sale, for a net exposure of zero).

FY03/10 Q2 (1H) Results

1H Consolidated results were released on November 11, 2009 - sales increased 5.4% YoY; operating profit declined 19.2 YoY%; recurring profit declined 32.0% YoY; net income -11.8% YoY. The company indicated that the negative trend continued through October as weak consumption and persistent fears of the swine flu had a negative impact on customer traffic. The company assumes that macroeconomic pressures will remain, and therefore is employing some tactical measures to improve operating results such as extended opening hours and efforts to boost patronage. Specifically, operating hours were extended at a majority of stores (24 hours during the weekends) beginning October 31, and Round One has introduced the mobile membership channel to attract more customers through direct marketing with reduced operating costs. The company also announced enhanced networked functionality to improve the tournament play of its popular “Ganbare! Bowling Bancho!” game.

Full year consolidated estimates were revised downward: sales of 86 billion yen (down 5.5% from original estimates), operating profit of 14.6 billion yen (down 11.5% from original estimates), recurring profit of 10.5 billion yen (down 19.2% from original estimates), and net income of 4.9 billion yen (down 22.2% from original estimates).

Specific review of segments and outlook

Game

Reported sales figures for the Game segment were beneath initial company estimates. Performance for the quarter was up 185 million yen, 1.1%, YoY. Comments from Round One indicated that the lack of new game titles as well as challenging macroeconomic conditions prevented performance to the company plan. The outlook for the segment going into 2H was mixed – economic pressure is expected to persist, but there were some indications that new game titles might be available which would boost sales, and proposed DPJ stimulus could increase disposable income.

Bowling

Concern regarding the H1N1 flu resulted in lower sales in the Bowling segment than company estimates. Specifically, some customers (older individuals and families) have been bowling less frequently. 1H sales of 15bn yen were less than initial estimates by 942 million yen, but had positive growth of 10.7% YoY. Sales in the Bowling segment have typically accounted for over 35% of total sales; the YoY top-line increase is helping to offset below-plan growth in other segments.

Karaoke

Sales of 3.0 billion yen in the Karaoke segment were positive 6.5% YoY, but lower than the company estimate of 3.2 billion yen. Some competitors in the market are doing relatively well considering the economic conditions (keeping revenues flat to slightly up) – these operators are changing prices based on time of day that customers arrive. The result of the flexible pricing is that customer spend has declined for these operators, but customer count has not.

SPO-CHA

The SPO-CHA segment was the only segment that reported lower sales on a YoY basis (4.7 billion yen vs. 4.8 billion for 1H FH03/09. When discussing the segment, Round One indicated that performance of urban SPO-CHA facilities was relatively better than regional locations.

FY03/10 Q1 Results

In Q1 FY03/10, released on 7th August, sales were 19.5 billion yen (up 4.5% YoY), operating profit 2.1 billion yen (down 36.3%), recurring profit 1.1 billion yen (down 54.8%) and net profit 0.6 billion yen (down 53.3%). When compared with company estimates, the shortfall in sales was 491 million yen (-2.5%), recurring profit 138 million yen (-10.9%) and net profit 45 million yen (-6.8%). The components of the recurring profit shortfall are as follows:

Delayed installation of new game machines led to smaller-than-expected leasing costs and depreciation, with positive impacts to earnings in the quarter. Meanwhile, sales fell short of company estimates and advertising costs such as those for running TV commercials as well as Game promotion costs turned out to be larger than expected, pushing down earnings.

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Income Statement

Results vs. Historical Company Estimates

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Balance Sheet

Assets

The bulk of fixed assets at the end of FY03/11 were tangible fixed assets effectively all associated with the company's operations of amusement complex centers.

Liabilities

Interest-bearing debt as of end-FY03/11 stood at 136.2 billion yen, slightly down on the FY03/10 figure of 138.9 billion yen. While the non-recourse loan balance decreased to 41.8 billion yen from 56.8 billion yen during the same period.

Shareholders' equity

Shareholders' equity as of end-March 2011 declined 6.2 billion YoY to 80 billion yen, due to a net loss of 12.7 billion yen, 1.8 billion yen in dividends paid and new equity issuance of 4.1 billion yen.

Shareholder Returns

Over the past five years in a row, the company delivered cash dividends of 20 yen per share after adjusting for stock splits. According to company estimates, 20 yen per share is expected in FY03/11. For the time being, the company intends to stick to this policy of maintaining 20 yen per share with its cash dividends, while there is no target for payout ratio.

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Cash Flow Statement

Operating Cash Flow

The company's operating cash flow is mostly influenced by pretax profit and depreciation. In other words, changes in working capital have a limited impact. This is because 1) customers pay in cash, 2) there are no major procurement items, and 3) the level of inventory is very low.
Investment Cash Flow

Investment cash flow in FY03/11 was -23.7 billion yen. When combined with operating cash flow, it was -1.1 billion yen while free cash flow (pretax profit, plus depreciation, plus goodwill write-off, plus working capital changes, plus tax charges and plus capital expenditure) was -10.5 billion yen. Round One has exhibited meaningful outflows in operating and investment cash flows from FY03/07.

Financing Cash Flow

Technical accounting detail: Round One’s financial cash flows differ significantly when comparing parent and consolidated data. SPCs were only included in consolidation after FY03/06, due to a change in accounting conventions. Therefore, financing cash flows before FY03/07 do not fully reflect financing activities during the period. (See SPC discussion for more detail).

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Other Information

History

Sugino Kosan (the predecessor to Round One) was founded in 1980. It was running a roller skating court business but soon realized that sales were too concentrated on weekends making the business unattractive. The company was going to close the rink and transform it into a warehouse but Sugino, then a university student, suggested opening a bowling alley instead and was tasked with its management. Sugino set out to construct a bowling alley that he would enjoy, with the logic that because he was the same age as his target consumer group that he was the demographic. His bowling alley proved to be very successful and he proceeded to open similar centers across Osaka. He formed Round One (the former one) in March 1993. Later, he added other amusement services such as arcade games and karaoke, making the whole operations in a center something unique.

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News & Topics

August, 2011

On August 24, 2011, the company announced it had concluded a sale-and-leaseback of its Round One Stadium Itabashi store and its tentatively named Round One Stadium Nanba Sennichi-mae store (currently under construction and slated for opening in spring 2012).

(For original Japanese language release in PDF format please click here)

Deal Overview

The transaction was concluded on 24 August, 2011, and the buyer of the assets was Japan Retail Fund Investment Corp. (TSE 8953).

Repayment of Interest-bearing debt

The company says the proceeds from the sale of the Itabashi store (about 2.4 billion yen) will be used for repayment of interest-bearing debt. In addition, funds from the sale of the Nanba Sennichi-mae store (about 8.0 billion yen) would be used to repay interesting bearing debt at R1 the holding company for the property and the liabilities of which would no longer be guaranteed by Round One.

Impact on Earnings

The sale of the two properties is expected to generate a loss of around 1.0 to 1.2 billion yen and had already been factored into the earnings forecast and therefore the current projections will not be revised, the company said.

On August 8, 2011, the company released Q1 FY03/12 results: click here to go direct to the Q1 FY03/12 results section.

(For original English-language release in PDF format, please click here.)

The company also released monthly sales data for July.

May 2011

On May 11, 2011, the company released FY03/11 results: click here to go direct to the FY03/11 results section.

(For original Japanese-language only release in PDF format please click here.)

At the same time, the company released April monthly sales data.

According to the company, repairs and safety checks had been completed in all stores before Golden Week, and equipment had been restored to its pre-quake operational status.

April 2011

On April 14, 2011, the company announced it had signed a sale-and-leaseback agreement for its Machida store, which it expects to be signed by April 18, 2011.

March 2011

On March 29, 2011, the company made an announcement regarding the operating conditions of its centers as of 10 a.m. that morning.

• Two centers were completely closed: Fukushima and Sendai Nigatake.
• Bowling facilities were closed at Ashikaga, Soka, and Morioka.

According the company, it had completely or partially closed some centers to carry out repairs and safety inspections. The company said that actual buildings were fine. The company was trying to determine the effect on business from indirect influences like electricity outages and conservation schemes, as well as direct factors like changes in consumer sentiment.

Note: The company has a dedicated support page for disaster victims on its website.

On March 28, 2011, the company made an announcement regarding the operating conditions of its centers as of 9 p.m. that evening.

• Three centers were completely closed: Fukushima, Morioka, and Sendai Nigatake.
• Bowling facilities were closed at Ashikaga, and Soka.

On March 14, 2011, the company made an announcement regarding the March 11 Tohoku earthquake.

Damage situation report:

• No staff or customers sustained any injuries.
• Some centers sustained damage to their buildings and had fixtures fall down (especially in Tohoku, northeastern Japan, and Kanto, around Tokyo). Additionally, some centers had operations completely or partially suspended in response to electricity shortages.
• Six centers were completely closed: Fukushima, Koriyama, Morioka, Sendai Nigatake, Ichikawa Onitaka, and Saitama Konosu.

(The company has a total of 107 locations in Japan.)

• Some centers had some services suspended:

Yachiyo Murakami (bowling)

Ichihara (bowling and some bame facilities)

Utsunomiya (some bowling lanes and some SPO-CHA facilities)

Ashikaga (bowling)

Maebashi (some bowling lanes and some SPO-CHA facilities)

Ageo (some SPO-CHA facilities)

Iruma (some SPO-CHA facilities)

Soka (bowling and some Game facilities)

Adachi Kohoku (bowling and some game facilities)

Minamisuna (bowling)

Yokohama Station West Exit (some karaoke facilities)

Note: "SPO-CHA" includes a number of sporting facilities (e.g., batting cages and billiards).

• Operations were continuing normally at the remaining 88 centers in western Japan, Shikoku, Kyushu, Okinawa, etc.

Impact on financial performance:

• In addition to the Round One centers directly affected by the disaster, the company shortened operating hours by six hours per day (or nine hours per day when including scheduled electricity outages) for centers served by either Tohoku Electric Power Co., Inc. (TSE 9506) or the Tokyo Electric Power Co., Inc. (TSE 9501).

Additionally, the company plans to cooperate with nationwide power conservation measures all of its centers as long as operations are not significantly disrupted.

The company was assessing the possible consequences of the above and said that it would release details if it became clear that earnings could be impacted.

On March 10, 2011, the company announced the sale and leaseback of its Umeda store. According to the company, there would be no change in store operation (scheduled opening: March 25, 2011) and any impact was already incorporated in the FY03/11 forecasts (revised on February 10, 2011).

February 2011

On February 10, 2011, the company released Q3 FY03/11 results. At the same time, the company released a downward revision to its FY03/11 forecasts.

On February 10, 2011, the company announced opening schedule of Fuchu and Umeda. The company commented that those stores would be opening during March 2011, ahead of schedule. The company expects 700 million yen in annual sales from Fuchu and annual sales of 2 billion yen from Umeda.

November 2010

On November 5, 2010, the company announced October monthly sales data and a revision to 2Q (1H) FY03/11 forecasts. The revised figures were as follows:

• Sales: 41.6 billion yen (previous forecast: 42.9 billion yen)
• Operating profit: 5.5 billion yen (previous forecast: 6.8 billion yen)
• Recurring profit: 3.1 billion yen (previous forecast: 4.5 billion yen)
• Net loss: 5.5 billion yen (previous forecast: net income of 680 million yen)

The company explained that change in forecasts was due to the combination of sluggish sales beneath expectations and increased costs (especially wages). Weakness in Bowling and SPO-CHA were the main contributors to lower sales. Net income was revised down to a loss due to extraordinary losses of 8.9 billion yen (previously announced on October 22, 2010). There was no change to the FY03/11 forecasts announced on October 22, 2010.

October

On October 22, 2010, the company announced a new store opening in Ikebukuro.

In the same release, it also announced a revision to FY03/11 forecasts. Sales, operating profit and recurring profit forecasts were unchanged, but net income was revised down to a loss of 2.4 billion yen vs. the previous forecast of positive 2.5 billion yen. The company mentioned that revision was due to extraordinary losses of 8.9 billion yen incurred from selling the Ikebukuro site (the company plans to use a sale and leaseback structure for the new store).

August

On August 9, 2010, the company announced its first quarter results and released its Midterm Business Plan.

Summary of Midterm Business Plan (excerpt from a company brochure published August 9, 2010):

“Our plan for roughly the next five years (through the March 2016 business year) follows below.

• The method we use will be to switch to a lease after selling off the store (land and building) assets (sale & leaseback).
• The implementation of these sale & leaseback process is expected to generate losses. Some disadvantages include reduced net income for the term due to extraordinary accounting losses as well as the possible outflow of cash reserves to repay borrowings. At the same time, advantages include reduced lease fees (interest burden) after the sale, which should improve the store’s balance of payments.
• We plan to repay between 20 and 30 billion yen in interest-bearing debt by using sale & leaseback transactions.
• With the stores that we have currently operating and ones we are planning, we expect company-wide recurring profit to reach 20.0 billion yen as early as FY03/16 through reduced lease fees and lower finance leases, even if sales continue at current levels at all stores.”

June

On June 2, 2010 the company announced that its board of directors made a decision on the same day to issue new shares in a secondary public offering to overseas investors.

Details are as follows:

• Maximum of 16,000,000 shares will be issued overseas excluding US and Canada (14,000,000 offering plus 2,000,000 green shoe to underwriter Deutsche bank AG, London branch).

• The book building was set from June 2 to June 4, 2010, however the price was already set on June 2, 2010.

• The shares were offered at 526 yen, about an 7.56% discount to the June 2, 2010 closing price of 569 yen. The amount that the company would receive was set at 512.1 yen, the difference being the underwriter’s fee. The company therefore raised 8,193.6 million yen.

• The funds are planned to be used to finance openings of four specific standard type facilities in Japan (Osaka Namba, Osaka Umeda, and Tokyo Ikebukuro) and the US (CA, Puente Hills Mall).

• The company commented that issuing the shares also strengthens the capital base, adding that it has successfully been placing a corporate bond issue of 20 billion yen (previously registered).

• SR Inc. believes that the issue is a positive event – not only will the company be able to open new centers in extremely attractive domestic locations but it also improves the company’s financial health, impacted by what were in essence exogenous factors a few years ago. The approximate 20% dilution should probably be seen in that light.

April

On April 1, 2010, Round One announced that conversions of Convertible Bonds No. 1 through 4 had been completed in March.

March

On March 25, 2010, the company announced the conversion of Convertible Bond No. 4. The conversion resulted in an additional 3,390,435 shares, for a total of 79,452,914 shares outstanding (as of March 25, 2010).

In addition, Round One provided an update on the company capital structure following the conversion of Convertible Bond No. 4: total capital was 20.9 billion yen.

On March 10, 2010, Round One announced the fixing price for Convertible Bond No.4 at 530.9 yen per share. The purchase date is March 25, 2010. SR Inc. estimates an additional 3.4 million shares for a total of 79.5 million shares outstanding.

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Top Management

Masahiko Sugino, born in 1961, CEO & President is the founder of the company. He is the key driving force for the massive growth of Round One in the past. He has been and is likely to remain the key person for all important decision making.

Kenzaburo Yoshida, born in 1947, managing director, joined the company in 1997. He is currently in charge of operations. He used to bowl professionally.

Yoshito Tagawa, born in 1948, director, joined the company in 1992. His tasks include risk management. He also used to bowl professionally.

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Employees

At the end of FY03/11, the company reported a total of 5,597 employees on a consolidated basis (1,249 full time employees and the equivalent of 4,348 part-time workers). At the parent level the company employed 5,528 employees with 1,180 full time and 4,348 part-time workers.

At the parent level, on average, employees were about 30.8 years old, earning a salary of 5.2 million yen, and have worked for the company for 4.5 years. It requires 10 to 15 full-time employees to open a new center on average, and the center would have 100 to 250 part-time employees on a registration basis to run the center.

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Major Shareholders

As of the end of FY03/11, the largest ten shareholders collectively accounted for 52.3% of shares outstanding, according to the annual report. The top shareholder is Masahiko Sugino, the current CEO & President and the founder, holding 20.8% of the company and 33.1% when the holdings by his eldest son Kosuke Sugino (12.2%) are added.

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Investor Relations

Results meetings for analysts and institutional investors are currently held on a quarterly basis in Tokyo and on a half year basis in Osaka. IR Contact is Noriaki Tanabe, General Manager of Investor Relations (Phone: +81-72-224-5115).

"Quiet Period." The company’s quiet period begins approximately two weeks before earnings announcements, during which time the company’s IR will not be available for investor interviews.

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By the Way

Round One has an interesting multilingual pamphlet which helps non-Japanese speakers, which is also interesting to see ‘how’ the sales process works for different services. Click here for the PDF.

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Latest Q&A

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