and factory / 7035

COVERAGE INITIATED ON: 2019.04.12 LAST UPDATE: 2019.08.07

Shared Research Inc. has produced this report by request from the company discussed in the report. The aim is to provide an “owner’s manual” to investors. We at Shared Research Inc. make every effort to provide an accurate, objective, and neutral analysis. In order to highlight any biases, we clearly attribute our data and findings. We will always present opinions from company management as such. Our views are ours where stated. We do not try to convince or influence, only inform. We appreciate your suggestions and feedback. Write to us at [email protected] or find us on Bloomberg.

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INDEX

How to read a Shared Research report: This report begins with the trends and outlook section, which discusses the company’s most recent earnings. First-time readers should start at the business section later in the report.

Executive summary ------3 Key financial data ------5 Recent updates ------7 Highlights ------7 Trends and outlook ------8 Quarterly trends and results ------8 Q3 FY08/19 results ------10 Business ------18 Business description ------18 Segment overview and business model ------20 IoT business (in FY08/18, 41.7% of sales and 22.8% of operating profit) ------26 Other businesses (in FY08/18, 0.9% of sales and 0.1% of OP) ------31 Market and value chain------32 E-book industry ------32 Online game industry ------35 IoT industry ------36 Internet advertising market ------36 Real estate industry ------38 Competitors ------40 Strengths and weaknesses ------43 Historical results and financial statements ------44 Income statement ------44 Balance sheet ------46 Cash flow statement ------47 Historical performance ------48 1H FY08/19 results ------48 Q1 FY08/19 results ------49 FY08/18 results ------50 Q3 FY08/18 results ------51 Other information ------52 Mission ------52 News and topics ------52 Corporate governance and top management ------53 Dividend policy ------54 Major shareholders ------55 Employees ------55 Profile ------56

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Executive summary

Business overview

◤ and factory is a startup company with businesses in two areas: smartphone apps and IoT. Established in September 2014, the company has already achieved a significant level of growth and profitability. In FY08/18, sales were JPY1.9bn, operating profit was JPY365mn, and the operating profit margin was 19.1%. CAGR for sales in the three years through FY08/18 was 158%. The company moved into the black on an operating basis in the second year after its establishment, and CAGR for operating profit was 224% in the two years leading up to FY08/18. The company listed on the Mothers market of the Tokyo Stock Exchange in the fourth year after its establishment.

◤ As of August 31, 2018, in the Smartphone Apps business (in FY08/18, 57% of sales and 77% of operating profit) the company developed and offered entertainment-oriented apps, such as manga apps and gamer-forum apps (online message boards for players of social media games). The company has developed free-to-use manga apps with Square Enix and large publishers such as Hakusensha. and factory develops gamer-forum apps mostly in house. In manga apps, the company obtains revenue by charging e-comic download fees (rental fees). These apps also draw advertising revenue based on the number of clicks made on banner ads placed through ad networks. Gamer-forum apps also take in advertising revenue (affiliate revenues and revenue from clicks on ad network-based banner ads). Monthly active users (MAUs) in Q3 FY08/19 numbered 4.6mn, mainly young people. (In manga apps, the company has 4.3mn MAUs, ranking it second in the industry despite its late entry. In gamer-forum apps, MAUs number around 0.3mn). Average revenue per user, or ARPU, after revenue sharing is approximately JPY26 for manga apps. ARPU for gamer-forum apps is around JPY52.

◤ In the IoT business (in FY08/18, 42% of sales and 23% of operating profit), the company plans, develops, and operates the &AND HOSTEL brand of smart hostels, where visitors can experience services made possible by IoT. In this segment, the company also provides IoT solutions for lodging facilities, including innto (a property management system) and tabii (a tablet-based service). &AND HOSTEL (nine locations planned as of August 31, 2019) breaks down into two business categories. The first category encompasses planning and developing &AND HOSTEL facilities on property owned by other parties. The second category involves acquiring property, planning and developing &AND HOSTEL facilities, and selling them to investors. In the first instance, the company receives planning- and development-related compensation through consulting, real estate brokerage, and other means. In the second, it earns gains on the sale of real estate. In both cases, the company manages the hostels and receives compensation from hostel owners in return. Outside of the hostel business, innto (installed at 204 locations as of end-May19) revenue comes from proceeds from sales and system maintenance and operation fees, which are shared with business partner Almex. tabii (2,024 tablets in operation) also draws advertising revenue for the company.

◤ Many companies are involved in smartphone apps. Shared Research believes that the overlap between the Smartphone Apps business and the IoT business is what sets and factory apart. In the IoT business, the company takes advantage of expertise in UI/UX technology* and data analysis and monetization methods it accumulated through the Smartphone Apps business to innovate in real estate and other domains that are slow to deploy technology.

* A user interface (UI) refers to all information the user sees, such as designs, fonts, and external appearance. The user experience (UX) describes the feelings and sensations the user gains through a product or service.

President Takamasa Ohara and other members of the management team are young, with most of them born in the 1980s; the average age of the company’s employees is 32. (The company had 65 employees as of August 31, 2018.) Viewing its youthful vitality as an advantage, the company prides itself on having a flexible and strategic culture of open innovation that is unfettered by past traditions.

Trends and outlook

◤ For FY08/19, and Factory forecasts sales of JPY3.9bn (+102.0% YoY), operating profit of JPY511mn (+40.0% YoY), recurring profit of JPY504mn (+39.7% YoY), and net income of JPY350mn (+34.3% YoY). On April 22, 2019, the company revised up its sales forecast from JPY3.1bn to JPY3.9bn, because the property developed by the company in the &AND HOSTEL

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business was larger than initially expected, resulting in higher sale price than initial forecast. Meanwhile, it made no changes to initial profit forecasts against a background of continuous proactive investment targeting growth areas (such as investment in advertising expenses to accelerate manga app growth).

◤ In cumulative Q3 FY08/19, sales were JPY1.5bn (the company did not compile quarterly financial statements in Q3 FY08/18), operating profit was JPY155mn, recurring profit was JPY131mn, and net income was JPY89mn. Q3 sales reached 39.6% of the full-year company forecast, while operating profit reached 30.4%. Through FY08/18, the cycle from investment to recovery lasted two years, but, in FY08/19, the company plans to recover investments made in 1H during 2H.

◤ and factory does not disclose its medium-term management plans, but the company clearly emphasizes its focus on achieving growth and profitability. In the past, the interval of time between investment and recovery (prior to listing on the Mothers market of the Tokyo Stock Exchange in September 2018) was two years. The company intends to accelerate this process, shortening the interval to one year. In addition to achieving growth in existing areas that form the core of the Smartphone Apps business (such as establishing an undisputed leadership position in the manga apps category by increasing the number of partners and boosting MAUs), the company plans to set the stage for building new businesses. By entering the fields of game-walkthrough apps and ad networks* specializing in manga apps (see the “Medium-term outlook” section for details), the company plans to boost ARPU and lower costs. In the IoT business, and factory aims to strengthen alliances with partner companies and concentrate on categories where technology rollout is lagging (such as lodging facilities and housing), expanding its business to encompass offices, commercial property, schools, and healthcare facilities.

*An ad network is an arrangement in which multiple advertising media (such as websites, social media, blogs, etc.) are bundled together to create an ad distribution network. It allows advertisers to place ads across multiple publishers without having to deal with each publisher individually.

Strengths and weaknesses Strengths

▷ UI/UX technologies and data, data analysis, and monetization methods accumulated through the smartphone business ▷ Unique approach and foresight in the IoT business ▷ Youthful team leads to a flexible and strategic culture of open innovation and swift decision-making

Weaknesses

▷ Most intellectual property is owned by business partners ▷ A young company that knows only success ▷ No experience in hiring new graduates

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Key financial data

Income statement FY08/15 FY08/16 FY08/17 FY08/18 FY08/19 (JPYmn) Parent Cons. Parent Parent Par. Est. Sales 112 372 689 1,916 3,870 YoY - 231.9% 85.2% 178.3% 102.0% Gross profit - 166 506 1,114 YoY - - 204.4% 120.0% GPM - 44.7% 73.5% 58.1% Operating profit -40 35 224 365 511 YoY - - 543.8% 63.2% 39.9% OPM - 9.3% 32.5% 19.1% 13.2% Recurring profit -42 37 223 361 504 YoY - - 500.8% 61.5% 39.7% RPM - 10.0% 32.4% 18.8% 13.0% Ne t in c o me -43 -6 174 261 350 YoY - - - 49.9% 34.3% Net margin - - 25.3% 13.6% 9.0% Per share data (JPY) Shares issued (year-end; '000) 8,421.0 8,421.0 8,421.0 8,421.0 EPS -5.2 -0.8 20.7 30.9 37.2 EPS (fully diluted) - - - - - Dividend per share - - - - - Book value per share 3.0 2.2 22.9 53.8 Balance sheet (JPYmn) Cash and cash equivalents - 79 172 672 Total current assets - 193 480 1,126 Tangible fixed assets - 1 48 74 Investments and other assets - 26 33 81 Intangible fixed assets - 0 32 41 Total assets - 220 594 1,323 Accounts payable - 21 13 63 Short-term debt - 80 97 136 Total current liabilities - 159 262 653 Long-term debt - 27 140 216 Total fixed liabilities - 27 140 216 Total liabilities - 185 401 870 Net assets - 220 594 1,323 Total interest-bearing debt - 107 237 352 Cash flow statement (JPYmn) Cash flows from operating activities - 36 46 516 Cash flows from investing activities - -27 -94 -131 Cash flows from financing activities - 22 130 116 Financial ratios ROA (RP-based) - 33.9% 54.9% 37.7% ROE - -18.9% 164.7% 80.7% Equity ratio 18.6% 15.6% 32.4% 34.3% Source: Shared Research based on company data; per-share data has been adjusted for the stock split. Note: The YoY comparison in the consolidated results for FY08/16 is based on the simple calculation versus non-consolidated results for FY08/15. The YoY comparison in the non-consolidated results for FY08/17 is based on the simple calculation versus consolidated results for FY08/16.

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Segment sales and profit FY08/15 FY08/16 FY08/17 FY08/18 FY08/19 (JPYmn） Act. Act. Act. Act. Est. Total sales 112 372 689 1,916 3,870 YoY - 231.9% 85.2% 178.3% 102.0% Smartphone Apps - - 604 1,099 na YoY ---82.0%- % of total sales - - 87.7% 57.4% - IoT - - 63 800 na YoY ---1179.6%- % of total sales - - 9.1% 41.7% - Other - - 22 17 na YoY ----22.8% - % of total sales - - 3.2% 0.9% - Operating profit -40 35 224 365 511 YoY - - 543.8% 63.2% 39.9% Smartphone Apps - - 394 480 na YoY ---21.7%- % of operating profit - - 108.6% 77.0% - OPM - - 65.2% 43.6% - IoT - - -30 142 na YoY ----- % of operating profit - - - 22.8% - OPM ---17.8%- Other - - -1 1 na YoY ----- % of operating profit - - - 0.1% - OPM - - - 4.2% - Company-wide expenses - - -139 -257 na Source: Shared Research based on company data; per-share data has been adjusted for the stock split.

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Recent updates Highlights On August 7, 2019, Shared Research updated the report following interviews with and factory, inc.

On July 12 2019, the company announced earnings results for Q3 FY08/19; see the results section for details.

On the same day, the company announced a stock split.

The company will carry out a two-for-one stock split of ordinary shares held by shareholders listed on the shareholders registry at the end of July 31 2019 (Wednesday), the record date. The effective date will be August 1, 2019 (Thursday).

On the same day, the company also announced a capital and business alliance with Square Enix Co., Ltd. (a wholly owned subsidiary of Square Enix Holdings Co., Ltd. [TSE1: 9684]).

Outline of the business alliance

▷ Further strengthen partnerships in the publishing filed, with a focus on manga apps. ▷ Build up the relationship with the objective of new initiatives in the games area. Number of shares newly acquired by the other party, and ratio to number of issued shares Square Enix acquired 189,892 shares (4% of issued shared) in the company from its major company shareholder Shu Takehana, by using an off-market negotiated transaction on July 12.

On the same day, the company announced a business alliance with Shogakukan Inc.

Outline of the business alliance Planning and development for the renewal, and post-renewal operation, of Shogakukan’s manga app and web service “Sunday Webry.”

On the same day, the company announced a business alliance with AIQ Corporation.

Outline of the business alliance Exploring a comprehensive business alliance, centering on application of IoT and AI.

For previous releases and developments, please refer to the News and topics section.

07/57 and factory/7035 RCoverage LAST UPDATE: 2019.08.07 Research Coverage Report by Shared Research Inc. | https://sharedresearch.jp

Trends and outlook

Quarterly trends and results

Cumulative FY08/17 FY08/18 FY08/19 (JPYmn) Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4 Total sales 175 332 485 689 255 612 1,014 1,916 470 995 1,531 YoY - - - 85.2% 45.7% 84.3% 109.0% 178.3% 84.1% 62.6% 51.1% Smartphone Apps 165 307 439 604 203 466 758 1,099 394 814 1,229 YoY - - - - 23.0% 51.8% 72.7% 82.0% 94.1% 74.7% 62.1% % of total sales 94.3% 92.5% 90.5% 87.7% 79.6% 76.1% 74.8% 57.4% 83.9% 81.8% 80.3% Gamer-forum apps 134 244 325 421 103 231 326 429 61 101 148 YoY - - - - -23.1% -5.3% 0.3% 1.9% -40.8% -56.3% -54.6% % of total sales 76.6% 73.5% 67.0% 61.1% 40.4% 37.7% 32.2% 22.4% 13.0% 10.2% 9.7% Manga apps - 2 16 51 61 153 287 466 211 504 839 YoY - - - - - 7550.0% 1693.8% 813.7% 245.9% 229.4% 192.3% % of total sales - 0.6% 3.3% 7.4% 23.9% 25.0% 28.3% 24.3% 44.9% 50.7% 54.8% Other manga-related apps ------274273.00123.00 123 YoY ------% of total sales ------2.7%2.2%15.5%12.4%8.0% Other 31 61 98 132 39 82 119 163 49 86 119 YoY - - - - 25.8% 34.4% 21.4% 23.5% 25.6% 4.9% 0.0% % of total sales 17.7% 18.4% 20.2% 19.2% 15.3% 13.4% 11.7% 8.5% 10.4% 8.6%7.8% IoT 1 11 28 63 38 134 240 800 66 152 251 YoY - - - - 3700.0% 1118.2% 757.5% 1179.6% 74.0% 13.1% 4.4% % of total sales 0.6% 3.3% 5.8% 9.1% 14.9% 21.9% 23.7% 41.7% 14.1% 15.2% 16.4% Other 9 14 18 22 14 27 29 17 9 29 52 YoY - - - - 55.6% 92.9% 61.1% -22.8% -33.5% 8.6% 78.3% % of total sales 5.1% 4.2% 3.7% 3.2% 5.5% 4.4% 2.9% 0.9% 2.0% 2.9% 3.4% Cost of sales 38 79 130 182 68 154 284 803 208 410 642 YoY - - - - 78.9% 305.3% 259.9% 517.4% 14.2% 502.2% 316.8% Cost ratio 21.7% 23.8% 26.8% 26.5% 26.7% 25.2% 28.1% 41.9% 44.4% 41.2% 41.9% Cost of sales 38 79 130 182 68 154 284 430 208 410 642 Non-personnel costs ------372--- SG&A expenses 48 95 172 282 141 336 520 748 219 483 734 YoY - - - - 193.8% 253.7% 202.2% 165.0% 55.2% 43.6% 41.2% SG&A ratio (% of total sales) 27.4% 28.6% 35.5% 41.0% 55.3% 54.9% 51.3% 39.1% 46.6% 48.5% 47.9% Personnel expenses 17 37 64 105 44 90 138 227 na na na YoY - - - - 158.8% 143.2% 115.6% 116.2% - - - % of total sales 9.7% 11.1% 13.2% 15.2% 17.3% 14.7% 13.6% 11.8% - - - Advertising expenses 3 6 17 47 56 149 235 293 na 263 na YoY - - - - 1766.7% 2383.3% 1282.4% 523.4% - 76.5% - % of total sales 1.7% 1.8% 3.5% 6.8% 22.0% 24.3% 23.2% 15.3% - - - Other SG&A expenses 28 52 91 131 41 97 146 227 na na na YoY - - - - 46.4% 86.5% 60.4% 73.3% - - - % of total sales 16.0% 15.7% 18.8% 19.0% 16.1% 15.8% 14.4% 11.8% - - - Operating profit 90 156 185 224 46 122 209 365 42 103 155 YoY - - - 543.8% -48.9% -21.8% 13.2% 63.2% -7.8% -15.6% -25.7% OPM 51.4% 47.0% 38.1% 32.5% 18.0% 19.9% 20.7% 19.1% 9.0% 10.3% 10.2% Smartphone Apps 125 220 308 394 93 193 303 480 124 264 390 YoY - - - - -25.6% -12.3% -1.5% 21.7% 33.8% 36.5% 28.7% % of total OP 105.0% 102.3% 106.2% 108.6% 108.1% 85.8% 81.4% 77.0% 116.5% 115.3% 112.4% OPM 75.8% 71.7% 70.2% 65.2% 45.8% 41.4% 40.0% 43.6% 31.6% 32.4% 31.8% IoT -6 -5 -18 -30 -7 32 69 142 -24 -35 -43 YoY ------% of total OP -5.0% -2.3% -6.2% -8.6% -8.1% 14.2% 18.6% 22.8% -22.0% -15.3% -12.4% OPM - - - - - 23.9% 28.9% 17.8% -35.6% -23.1% -17.2% Other, company-wide expenses -29 -59 -105 -142 -40 -103 -163 -256 6 9 10 YoY ------% of total OP ------5.5%3.7%6.7% Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods.

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Quart erly FY08/17 FY08/18 FY08/19 (JPYmn) Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4 Total sales 175 157 153 203 255 357 401 903 470 526 536 YoY - - - - 45.7% 127.4% 162.1% 344.8% 84.1% 47.2% 33.7% Smartphone Apps 165 142 132 165 203 263 293 341 394 420 415 YoY - - - - 23.0% 85.2% 122.0% 106.7% 94.1% 59.7% 41.5% % of total sales 94.3% 90.4% 86.3% 81.3% 79.6% 73.7% 73.1% 37.8% 83.9% 79.9% 77.3% Gamer-forum apps 134 110 81 96 103 128 95 103 61 40 47 YoY - - - - -23.1% 16.4% 17.3% 7.3% -40.8% -68.8% -50.5% % of total sales 76.6% 70.1% 52.9% 47.3% 40.4% 35.9% 23.7% 11.4% 13.0% 7.6% 8.8% Manga apps - 2 14 35 61 92 134 179 211 293 335 YoY - - - - - 4500.0% 857.1% 411.4% 245.9% 218.5% 150.0% % of total sales - 1.3% 9.2% 17.2% 23.9% 25.8% 33.4% 19.8% 44.9% 55.8% 62.5% Other manga-related apps ------271573.0050.00- YoY ------% of total sales ------6.7%1.7%15.5%9.5%- Other 3130373439433744493733 YoY - - - - 25.8% 43.3% - 29.4% 25.6% -14.0% -10.8% % of total sales 17.7% 19.1% 24.2% 16.7% 15.3% 12.0% 9.2% 4.9% 10.4% 7.0% 6.2% IoT 1 10 17 35 38 96 106 560 66 85 99 YoY - - - - 3700.0% 860.0% 523.5% 1500.0% 74.0% -11.0% -6.5% % of total sales 0.6% 6.4% 11.1% 17.2% 14.9% 26.9% 26.4% 62.0% 14.1% 16.3% 18.5% Other 954314132292022 YoY - - - - 55.6% - -50.0% -33.3% -33.5% - - % of total sales 5.1% 3.2% 2.6% 1.5% 5.5% 2.1% 0.5% 0.2% 2.0% 3.8% 4.2% MA U (mn) Smartphone apps 0.59 0.88 1.02 1.32 2.00 2.20 2.57 2.85 3.30 4.01 4.60 YoY 126.9% 252.0% 308.0% 407.7% 239.0% 150.0% 152.0% 115.9% 65.0% 82.3% 79.0% % of total MAU 0.3% 0.6% 0.7% 0.7% 0.8% 0.6% 0.6% 0.3% 0.7% 0.8% 0.9% Gamer-forum apps 0.59 0.70 0.71 0.67 0.92 0.70 0.53 0.47 0.51 0.39 0.30 YoY 126.9% 180.0% 184.0% 157.7% 55.9% 0.0% -25.4% -29.9% -44.6% -44.3% -43.4% % of total MAU 100.0% 79.5% 69.6% 50.8% 46.0% 31.8% 20.6% 16.5% 15.5% 9.7%6.5% Manga apps - 0.18 0.31 0.65 1.08 1.50 2.04 2.38 2.79 3.62 4.30 YoY - - - - - 733.3% 558.1% 266.2% 158.3% 141.3% 110.8% % of total MAU - 20.5% 30.4% 49.2% 54.0% 68.2% 79.4% 83.5% 84.5% 90.3% 93.5% ARPU (monthly sales / MAU; JPY) Gamer-forum apps 76 52 38 48 37 61 60 73 40 34 52 YoY - - - - -50.7% 16.4% 57.1% 52.9% 6.8% -43.9% -12.6% Manga apps - 4 15 18 19 20 26 27 34 32 26 YoY - - - - - 452.0% 74.8% 51.4% 80.2% 54.5% -1.3% Cost of sales 384151536886130518208201232 YoY - - - - 78.9% 109.8% 154.9% 877.4% 206.3% 134.0% 78.7% Cost ratio 21.7% 26.1% 33.3% 26.1% 26.7% 24.1% 32.4% 57.4% 44.4% 38.3% 43.3% Cost of sales 384151536886130146208201232 Non-personnel costs ------372--- SG&A expenses 48 47 77 111 141 195 183 228 219 483 734 YoY - - - - 193.8% 314.9% 137.7% 105.4% 55.2% 147.5% 301.0% SG&A ratio (% of total sales) 27.4% 29.9% 50.3% 54.7% 55.3% 54.6% 45.6% 25.2% 46.6% 91.8% 136.9% Operating profit 90 66 29 39 46 76 87 156 42 61 52 YoY - - - - -48.9% 15.2% 200.0% 300.0% -7.8% -20.3% -39.7% Smartphone Apps 125 95 88 87 93 100 110 176 124 139 127 YoY - - - - -25.6% 5.3% 25.0% 102.3% 33.8% 39.0% 15.2% % of total OP 105.0% 99.0% 117.3% 114.5% 108.1% 71.9% 74.8% 70.7% 116.5% 106.7% 241.3% OPM 75.8% 66.9% 66.7% 52.7% 45.8% 38.0% 37.5% 51.6% 31.6% 33.1% 30.5% IoT -6 1 -13 -11 -7 39 37 73 -24 -12 -8 YoY - - - - - 3800.0% - - - -129.5% -122.0% % of total OP -5.0% 1.0% -17.3% -14.5% -8.1% 28.1% 25.2% 29.3% -22.0% -9.0% -6.9% OPM - 10.0% - - - 40.6% 34.9% 13.0% - -13.5% -8.2% Other, company-wide expenses -29 -30 -46 -37 -40 -63 -60 -93 6 3 -66 YoY ------% of total OP ------5.5%2.1%-125.8% Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods. Starting in Q1 FY08/19, the “Other, corporate” row under “Operating profit” will be renamed “Other” (and will no longer include companywide expenses).

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Q3 FY08/19 results Overview

◤ Cumulative Q3 FY08/19 (non-consolidated): Sales were JPY1.5bn (the company did not compile quarterly financial statements in Q3 FY08/18), operating profit was JPY155mn, recurring profit was JPY131mn, and net income was JPY89mn.

◤ Cumulative Q3 sales reached 39.6% of the full-year company forecast, while operating profit reached 30.4%. Sales and operating profit were weighted towards 2H in the company’s initial forecasts, because the company plans to sell property developed in its &AND HOSTEL business in 2H in the IoT business. Therefore the company has no intention to change its full-year company forecasts announced on April 22, 2019.

◤ Sales: JPY1.5bn (the company did not compile quarterly financial statements in Q3 FY08/18). In the Smartphone Apps business, sales were JPY1.2bn (+62.1% YoY), while sales reached JPY251mn (+4.4% YoY) in the IoT business. Sales for Other businesses totaled JPY52mn (+78.3% YoY). The Smartphone Apps business and the IoT business accounted for 80.3% and 16.4% of total sales, respectively. Other businesses had a 3.4% share of total sales.

◤ Operating profit: JPY155mn (the company did not compile quarterly financial statements in Q3 FY08/18). In the Smartphone Apps business, operating profit was JPY390mn (+28.7% YoY). Operating loss in the IoT business was JPY43mn (versus operating profit of JPY69mn in cumulative Q3 FY08/18), while Other businesses recorded JPY10mn in operating profit. The Smartphone Apps business accounted for 112.4% of total operating profit, the IoT business for -17.2%, and Other businesses for 6.7%.

◤ The company revealed its aim to move its listing to the First Section of the Tokyo Stock Exchange, and announced corporate actions including a capital and business alliance with Square Enix in order to improve corporate value, and the implementation of a stock split (a 2-for-1 split, with a record date of July 31) to improve liquidity and increasing the number of shareholders, and the introduction of shareholder benefits.

Results by business Smartphone Apps business Sales were JPY1.2bn (+62.1% YoY), and operating profit was JPY390mn (+28.7% YoY). Manga UP! and Manga Park (manga apps developed in collaboration with Square Enix Co., Ltd. and Hakusensha, Inc., respectively) both saw solid growth, as initiatives including aggressive advertising and the release of new manga series boosted monthly active users (MAU), and new manga additions lifted average revenue per user (ARPU). Manga Mee, a manga app of Shueisha’s girls’ manga made available to users every day, has also seen solid growth in MAU and APRU since its release in November 2018. MAU of the company’s manga apps grew 110.8% YoY to 4.3mn users. ARPU, which is calculated by dividing sales by MAU, fell 1.3% YoY.

▷ In general, ARPU differs in nature to MAU in that the effect of ARPU improvement measures tends to diminish once ARPU has

risen beyond a certain level. As more than two years have passed since the company started releasing manga apps, and factory

plans to prioritize growth in MAU over growth in ARPU, but it will still look to maintain ARPU at the current level or higher.

▷ As app development was completed in June 2019, sales are expected to be booked in Q4 rather than in Q3.

IoT business Sales were JPY251mn (+4.4% YoY), and operating loss was JPY43mn (compared with an operating profit of JPY69mn in cumulative Q3 FY08/18). In this business, progress in terms of planning and development of the &AND HOSTEL brand of smart hostels (lodging facilities offering experiences made possible through IoT) contributed to solid revenue from consulting and real estate brokerage fees related to developing hostels. In February 2019, and factory newly opened &AND HOSTEL MINOWA and &AND HOSTEL ASAKUSA. At end Q3 FY08/19, innto (lodging management system) was in use at 204 facilities (+33 versus end February, 2019) and total facilities adopting tabii (a guest room tablet service) as of end-Q3 FY08/19 was 2,024 (+686 versus end February, 2019) thanks primarily to its introduction at Henn na Hotel among other facilities. On the other hand, operating loss grew due to active investment, such as set-up costs for &AND HOSTEL and increased costs associated with heightened expansion of innto and tabii.

▷ A new &AND HOSTEL is due to be opened in Osaka in August 2019.

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Other businesses In this segment, the company mainly provides internet advertising agency services. Sales were JPY52mn (+78.3% YoY), and operating profit was JPY10mn (information regarding operating profit was not disclosed in Q3 FY08/18).

Other topics Capital and business alliance with Square Enix Both companies will develop a range of measures to accelerate further growth of “Manga UP!,” which has grown into one of the largest manga apps in Japan, leveraging the capital and business alliance. Additionally, as a new initiative in the games area, they will develop and operate “Final Fantasy Brave Exvius Digital Ultimania,” the first companion app (an official guide app) for “Final Fantasy Brave Exvius.” Square Enix acquired 189,892 shares (4% of issued shared) in the company from major company shareholder Shu Takehana, by an off-market negotiated transaction on July 12.

▷ The social gaming market appears to be showing signs of maturing, with uncertainty growing over the momentum of hit titles

that have driven the market until now and user preferences and the types of games being played undergoing change. As a

result, past methods used by sites and apps providing gaming tips are maturing in the same way, and in the case of and factory,

MAU is continuing to fall for its Saikyo Series. The company has indicated that one of its solutions to this will be to grow earnings

through the creation of new customer value, such as by providing official guide apps in partnership with game development

companies and providing user experiences linked to the original game.

▷ The above-mentioned official guide app will employ a monthly subscription model (monthly fee of JPY800).

▷ A major advantage of an official guide app is that customers can be drawn from the original game.

Business alliance with Shogakukan The company will work on the renewal and post-renewal operation of the “Sunday Webry” manga app owned by Shogakukan. Business alliance with AIQ The company entered into a business alliance agreement with AIQ, its first investment in the AI domain, with a focus on “IoT x AI” collaboration, using user data in services relating to accommodation. In future, the company aims to create new value together with AIQ, in areas not limited to the lodging business.

For details on previous quarterly and annual results, please refer to the Historical financial statements section.

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Full-year FY08/19 company forecasts

FY08/16 FY08/17 FY08/18 FY08/19 (JPYmn) FY Act. FY Act. 1H Act. 2H Act. FY Act. 1H Act. 2H Est. FY Est. Sales 372 689 612 1,304 1,916 995 2,875 3,870 YoY 231.9% 85.2% - - 178.3% 62.6% 120.4% 102.0% Cost of sales 205 182 154 649 803 410 na na Gross profit 166 506 458 656 1,114 586 - - GPM 44.7% 73.5% 74.8% 50.3% 58.1% 58.8% - - SG&A expenses 132 282 336 412 748 483 na na SG&A ratio 35.4% 41.0% 54.9% 31.6% 39.1% 48.5% - - Operating profit 35 224 122 243 365 103 408 511 YoY - 543.8% - - 63.2% -15.6% 67.8% 39.9% OPM 9.3% 32.5% 19.9% 18.6% 19.1% 10.3% 14.2% 13.2% Recurring profit 37 223 na na 361 82 422 504 YoY - 500.8% - - 61.5% - - 39.7% RPM 10.0% 32.4% - - 18.8% 8.2% 14.7% 13.0% Net in co me -6 174 na na 261 55 295 350 YoY - - - - 49.9% - - 34.3% Net margin -1.7% 25.3% - - 13.6% 5.6% 10.3% 9.0% Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods. Overview For FY08/19, on a non-consolidated basis the company forecasts sales of JPY3.9bn (+102.0% YoY), operating profit of JPY511mn (+39.9% YoY), recurring profit of JPY504mn (+39.7% YoY), and net income of JPY350mn (+34.3% YoY). On April 22, 2019, the company revised up its sales forecast from JPY3.1bn to JPY3.9bn, because the property for sale developed by the company in the &AND HOSTEL business was larger than expected, resulting in higher sale price than initial forecast. Meanwhile, it made no changes to initial profit forecasts against a background of continuous proactive investment targeting growth areas (such as investment in advertising expenses to accelerate manga app growth).

The company plans to invest during 1H and recover that investment in 2H. Consequently, and factory expects 1H sales will rise 50.3% and operating profit will fall 93.4% YoY. In 2H, the company expects sales to rise 61.9% and operating profit to increase 106.8% YoY. In the past, the company had an investment recovery cycle of approximately two years. From FY08/19, it intends to shorten this cycle to one year.

Quarterly forecasts (sales, operating profit)

(JPYmn) Investment Return Investment Return 1,459 1,400 1,200 1,000 903 800 691 500 600 420 357 401 373 400 153 255 175 157 203 156 130 200 90 66 76 87 29 39 46 5 3 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Est. Q2 Est. Q3 Est. Q4 Est. FY08/17 FY08/18 FY08/19

Sales Operating profit

Source: Shared Research based on company data

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Investment recovery cycle

Segment Investments Return Investments Return [Repeated] Action/result Spent ad expenses Increased profit Spent ad expenses Increase profit Key factor Expanded registered users Increased MAU Expand registered users of Increase MAU from rise the of manga apps manga apps and increase number of manga apps Smartphone new titles operated Apps [New] Action/result Increase development staff Raise profit lev els Key factor Create business base in Expand new areas to be new areas the nex t pillar of business [Repeated] Action/result Spent initial opening costs Contributed to profit Spend initial opening costs Contribute to profit Key factor ＆AND HOSTEL Opened several facilities ＆AND HOSTEL Open several facilities IoT [New] Action/result Spent dev elopment costs Released officially Increase various costs Expand profit Key factor innto、tabii Expand operation of innto Increase installation along and tabii with business expansion

FY08/17–FY08/18 FY08/19 Source: Shared Research based on company data Outlook Smartphone Apps business In addition to growth from its existing manga apps, the company plans to introduce a number of new manga apps. In November 2018, the company launched a manga app called Manga Mee in collaboration with Shueisha. In December 2018, it began distributing Comic every, a free manga app it developed in collaboration with Beaglee Inc. (TSE1: 3981). and factory is planning to enter alliances with other companies.

The company also aims to boost earnings by launching a manga-specific ad network business, COMIAD (for details, see the section entitled “Medium-term outlook”), leveraging the MAUs of manga apps the company already owns.

IoT business The company is promoting the adoption of technology in the lodging business by investing aggressively in innto (a reservation management system) and tabii (service for hotels based around tablet devices). The company intends to boost earnings by expanding these and similar services. and factory also intends to reinforce alliances with partner companies in the areas of housing and lodging.

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Medium-term outlook

Aiming to achieve growth and profitability, accelerate investment recovery The company does not publicize its medium-term management plan, but its primary mission in the stock market is to “achieve growth and profitability.” The company says it aims to shorten its investment-recovery cycle and accelerate growth. Before listing on the Mothers market of the Tokyo Stock Exchange in September 2018, the interval of time between investment and recovery was two years. The company plans to shorten this period to one year. Keeping the impact of investments foremost in mind, the company plans to accelerate its growth further by recovering 1H investments in 2H.

Earnings growth target

Source: Shared Research based on company data Companywide strategy In the Smartphone Apps business, the company aims to expand its platform by growing in existing categories (gamer-forum apps for players of social media games and manga apps) and moving into new ones. In the IoT business, and factory plans to strengthen its alliances with partner companies to step up the adoption of technology in areas where it is lacking. Currently, the company is concentrating on lodging facilities and housing; it plans to expand its activities to include offices, commercial property, schools, and healthcare facilities.

Companywide strategy

Source: Shared Research based on company data Growth strategy in the Smartphone Apps business Introduce official game-walkthrough apps The company has developed and operates the Saikyo Series bulletin board-style app through which users can exchange tips and tricks for popular social media games and recruit co-players. In addition, and factory intends to launch official game-walkthrough apps*. By creating official walkthrough apps that interface with social games, the company aims to create a new business model employing additional monetization methods. For example, with the Saikyo Series gamer-forum apps, the company incurs advertising expenses to attract users, and advertising revenue is the only monetization method. With official walkthrough apps, the company expects to increase ARPU by generating revenue in additional ways, such as through user interaction, fees, and game revenue sharing. At the same time, and factory expects to attract users via social game apps and expects the cost of user acquisition to decrease accordingly.

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* Game walkthrough is a guide aimed at improving players’ skills in a specific game. They are often designed to assist players in completing a full game or a specific element of a game.

Establish a dominant leadership position in the manga apps industry In 2017, the company began offering two manga apps: Manga UP!, which was developed jointly with Square Enix Co., Ltd. (TSE1: 9684), and Manga Park with Hakusensha, Inc. In November 2018, the company launched a third manga app, Manga Mee, which it developed with Shueisha Inc. In December 2018, it began distributing Comic every, a free manga app it developed in collaboration with Beaglee Inc. (TSE1: 3981). and factory is planning to operate similar apps with other publishers.

According to the May 2019 edition of Nielsen Mobile Netview, four apps that and factory operates (Manga UP!, Manga Park, Manga Mee, and Comic every) generated 4.3mn MAUs together in May 2019, ranking the company second in Japan. (Industry MAU rankings were 4.8mn for first, 4.3mn for and factory, and 3.4mn for third.) By generating additional MAUs from new manga apps, the company plans to achieve an undisputed industry leadership position. (See the “Business overview” section.)

Establishing a No. 1 MAU position by operating numerous manga apps

Source: Shared Research based on Nielsen Mobile Netview, May 2019, and totals calculated by the company Note: As of May 2019 Roll out new business by utilizing existing assets In October 2018, the company launched COMIAD, an ad network* dedicated to manga apps aimed at leveraging MAUs of the company’s manga apps. The company intends for the ad network to become another pillar of earnings in the Smartphone Apps business, supplementing gamer-forum apps and manga apps. The company says a high percentage of ads sent to smartphones are for social games or manga. With COMIAD, and factory intends to mine its user base more extensively. Initially, the company aims to monetize ad space within its own manga apps. As the next step, and factory intends to create a large manga network that includes apps managed by other companies, as well.

*An ad network is an arrangement in which multiple advertising media (such as websites, social media, blogs, etc.) are bundled together to create an ad distribution network. It allows advertisers to place ads across multiple publishers without having to deal with each publisher individually.

Changes in online advertising products Online display advertising began with advertisers buying space on media for a period of time, i.e. manual, human-mediated advertising. The market diversified, with Ad servers—systems for automatically distributing ads—appearing, and publishers becoming able to rotate multiple ads in the same advertising space. New pricing models also appeared, such as cost-per-click (CPC) advertising.

Ad networks that bundled different media together came onto the scene. This made it easy for advertisers to distribute targeted ads. In time, advertising inventory marketplaces known as ad exchanges sprung up, allowing ad networks to trade adverts and impressions.

Demand-side platforms (DSPs) then appeared in response to calls for greater efficiency. DSPs offer access to multiple ad exchanges and ad networks, and maximize effectiveness. On the flip side, publishers began using sell-side platforms (SSPs)—also offering access to multiple ad exchanges and ad networks—in an attempt to maximize ad revenue. The advent of DSPs and SSPs paved the way for real-time bidding.

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Advertising in internet media

Early 2000s Late 2000s Present Future

Email ads Email ads

Email ads Manual display ads Email ads Manual display ads

Manual display ads RTB

Sales by salepeople by Sales Ad networks RTB Manual display ads Ad networks advertising Programmatic

Ad networks

Ad networks

Source: Shared Research based on company data from VOYAGE GROUP, Inc.

Growth strategy in the IoT business Leverage &AND HOSTEL to move into new businesses The company is considering the launch of a business that combines IoT and AI by making use of guest-related user data collected through its lodging-related businesses: &AND HOSTEL (a smart hostel brand designed to evoke a futuristic sensation as lodgers experience IoT), innto (a property management service for simple lodging facilities), and tabii (service based around in-room tablet devices). As real estate is not its core business, the company explains that the real reason for increasing the number of &AND HOSTEL location is to generate more customer data that can be monetized in diverse ways. The goal of and factory’s IoT business is to generate business value by introducing technology into areas where it is currently lagging and making those industries more convenient as a result.

Lodging facilities are currently the core focus of and factory’s IoT business, but the company also intends to take the IoT business into housing and other fields. Given the broad-ranging nature of real estate, the company thinks business opportunities abound for bringing more technology into offices, food and beverage establishments, and educational facilities. Food and beverage establishments, for example, might take advantage of IoT to accept advance orders or move away from cash payments. Using the internet or smartphones to register customers would facilitate a shift from paper to virtual currencies and other payment methods. By moving aggressively into fields where it thinks it can add value, and factory intends to change the nature of those fields and make them more efficient.

IoT business: Expand into housing-related areas

Source: Shared Research based on company data

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Business alliance with TEPCO Energy Partner and factory has a business alliance in place with TEPCO Energy Partner, Inc., a group company of Tokyo Electric, concerning tabii, a tablet-device-based service from and factory that is provided at hotels (alliance agreement dated October 16, 2018). This move marks the first phase of the company’s efforts to accelerate the uptake of tabii tablets. As Japan’s largest electricity retailer, TEPCO Energy Partner has access to many customers in the hotel business. Through the alliance, the companies will offer lodging facilities a bundled service that includes both the tabii service and electricity. This agreement gives and factory access to TEPCO Energy Partner’s customers throughout Japan.

Launch of Homes of the Future project with NTT Docomo To introduce IoT technologies into housing, and factory and NTT Docomo, Inc. (TSE1: 9437) are working on an IoT Smart Home® project incorporating IoT devices and sensors. Currently, the project is undergoing verification testing. The eventual goal is to create “homes of the future,” in which artificial intelligence is used to automatically adjust home environments to manage the comfort and health of their residents. The companies began this collaboration in June 2017 as part of the I TOP Yokohama* project. The project will combine NTT Docomo’s IoT access control engine, which controls the IoT devices developed by a number of other manufacturers, and factory’s experience with producing Japan’s first smart hostel (&AND HOSTEL), and the company’s platform app (&IoT). The companies expect this project to facilitate the remote management of IoT devices and the amassing of data, which can be linked with AI and big data analytics. Building on this base of AI/big data analytics, the companies plan to use verified data from the Homes of the Future project to generate algorithms for use in services.

*In April 2017, the city of Yokohama launched this project to leverage the Minato Mirai IT industry cluster, which benefits Yokohama’s economy. Through this project, the city aims to encourage the creation of businesses that use IoT by fostering interaction, alliances, projects, and human resource development. “I TOP” is a shortened form of IoT Open innovation Partners.”

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Business Business description and factory is a startup company with businesses in two areas: Smartphone Apps*1 and IoT*2. In the Smartphone Apps business, the company explores and leverages the business potential of smartphones. In the IoT business, the company seeks to apply UI/UX technologies*3 accumulated in the Smartphone Apps business, along with expertise in data analysis and monetization methods. As a result, and factory aims to prompt innovation in areas where technology adoption is currently lagging, such as real estate, housing, and healthcare. In FY08/18, sales were JPY1.9bn, operating profit was JPY365mn, and the operating profit margin was 19.1%.

*1 Software that can be downloaded on a smartphone and used to access games, bulletin boards, social networking sites, email, calendars, and music players. This software uses smartphone operating systems, typically Android or iOS. *2 Short for the Internet of Things, IoT describes the concept of physical items being connected over the internet. IoT may refer to new services that make this concept a reality, to a business model, or to elemental technologies. Some industry pundits believe that the ability to connect a wide range of items over the internet, collect resulting data, and analyze and make use of this data will make the provision of innovative, high-value-added functions and services possible. *3 A user interface (UI) refers to all information the user sees, such as designs, fonts, and external appearances. The user experience (UX) describes the feelings and sensations the user experiences through a product or service.

As of August 31, 2018, the Smartphone Apps business (in FY08/18, 57% of sales and 77% of operating profit) focused on manga apps the company developed with large publishers, and the development and provision of entertainment-oriented apps, such as gamer-forum apps (details to follow). In the IoT business, (42% of sales and 23% of operating profit) the company plans, develops, and operates the &AND HOSTEL brand of smart hostels that allows visitors to experience IoT devices*4. In this segment, the company also provides IoT solutions for lodging facilities, including innto (a property management system) and tabii (a tablet-based service for lodging facilities).

*4 A device that can be connected to the internet. The 2017 White Paper on Information and Communications in Japan describes an IoT device as “a device that has a unique IP address and can be connected to the internet. Such electronic devices are broad in scope, ranging from devices used as sensor network terminals to devices with computing functions.” Worldwide, the number of IoT devices is expected to grow from an estimated 17.3 billion in 2017 to more than 30.0 billion in 2020.

Established in September 2014, the company is already achieving both growth and profitability. In the three years to FY08/18, sales grew at a CAGR of 158%. The company became profitable in its second year, and CAGR for operating profit over the two years leading up to FY08/18 was 224%. In its fourth year, the company listed on the Mothers market of the Tokyo Stock Exchange (listing date: September 6, 2018).

Sales and operating profit

(JPYmn) (JPYmn) 3,500 1,200 Saikyo series apps Manga 3,070 3,000 Other manga 1,000 Others in the Smartphone Apps segment IoT 2,500 800

1,916 2,000 511 600

365 1,500 400 224 1,000 200 35 688 -40 500 0 372 112 0 (200) FY08/15 FY08/16 FY08/17 FY08/18 FY08/19 Est.

Source: Shared Research based on company data Note: Figures for FY08/16 are consolidated. Other years are non-consolidated.

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Breakdown of sales and operating profit* Two core businesses

(JPYmn) - Outer circle: Sales - Inner circle: Operating profit 17 1% 1 0% 142 23% F08/18 Sales 800 1,916 480 42% 77% 1,099 57%

Source: Company data Smartphone Apps IoT Other

Source: Shared Research based on company data *Operating profit above refers to the sum of segment profits and does not include companywide expenses (JPY257mn in FY08/18). UI/UX design capabilities a basis for expansion into other areas of business The Smartphone Apps business has been the core of the company since its establishment in September 2014. By developing smartphone apps, the company has accumulated in-house expertise in UI/UX design. UI/UX design is important because of the role it plays in the “conversion” of smartphone users (persuading users to tap on ads on their smartphone screens, register as members, send inquiries, or buy products). UI/UX design expertise enables the company to develop apps for the IoT business and generate synergies that go beyond the boundaries of the two businesses.

Both businesses offer services that provide value through experience gained by operating smartphone apps and devices. and factory thinks the value of services is determined by their operability, and by the benefits and experience they deliver; in other words, the UI/UX design. As UI/UX design capabilities indicate the ability to predict and fulfill user needs from user perspectives, and factory thinks these abilities are important across all aspects of business, not just when developing apps and devices.

The Smartphone Apps business has thus spawned a number of others. UI/UX design (business) expertise has helped make the company’s new business initiatives profitable.

A flexible, strategic, open, and innovative corporate culture, unfettered by hidebound tradition The company’s 65 employees (as of August 31, 2018) are young (average age of 32) and led by a youthful management team. Three board members were born in the 1980s, including Takamasa Ohara (president and representative director, born in 1984), Rinji Aoki (born in 1983 and in charge of the Smartphone Apps business), and Yuki Umemoto (born in 1980 and in charge of the IoT business). More than half of employees are engineers and designers, with producers and administrators making up the remainder. The company forms small teams to work on each app title, allocating the staff needed to handle all aspects of app production. Within these units, the company pursues a plan-do-check-act (PDCA) cycle, progressing from planning to development, operation, analysis, improvement, marketing, and then back to planning. The company handles all processes in-house for each unit.

The company takes advantage of the youth of its staff to foster a flexible and strategic culture of open innovation. In the Smartphone Apps business, the company collaborates with numerous large publishers. In the IoT business, and factory collaborates with NTT Docomo (TSE1: 9437) and the city of Yokohama in the Homes of the Future Project. The company explains that many of its diverse collaborative relationships with partner companies were the result of proposals from those companies. Shared Research understands that and factory’s UI/UX design capabilities and corporate culture are important reasons for such collaboration.

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Segment overview and business model

Smartphone Apps business (in FY08/18, 57.4% of sales, 77.0% of operating profit)

Smartphone Apps FY08/15 FY08/16 FY08/17 FY08/18 FY08/19 Sales and profit (JPYmn) Act. Act. Act. Act. Est. Sales na na 604 1,099 na YoY - - - 82.0% % of total sales - - 87.7% 57.4% Gamer-forum apps na na 421 429 YoY - - - 1.9% % of total sales - - 61.1% 22.4% Manga apps na na 51 466 YoY - - - 813.7% % of total sales - - 7.4% 24.3% Other manga-related apps na na - 42 YoY ---- % of total sales - - - 2.2% Other na na 132 163 YoY - - - 23.5% % of total sales - - 19.2% 8.5% Operating profit na na 394 480 na YoY - - - 21.7% - % of total OP - - 108.6% 77.0% - OPM - - 65.2% 43.6% - MAU (mn) - 0.26 1.32 2.85 YoY - - 407.7% 115.9% Gamer-forum apps - 0.26 0.67 0.47 YoY - - 157.7% -29.9% % of total MAU - 100.0% 50.8% 16.5% Manga apps - - 0.65 2.38 YoY - - - 266.2% % of total MAU - 0.0% 49.2% 83.5% Source: Shared Research based on company data Note: Monthly active users (MAUs) are as of Q4 of each fiscal year. Overview The Smartphone Apps business has two main drivers: the &AND COMICS service that provides manga apps developed in collaboration with large publishers. These apps include Manga UP!, Manga Park, Manga Mee, and Comic every, and the &AND APPS service offering gamer-forum apps for multiplayer social media games*5, such as the Saikyo Series. In FY08/18, manga apps accounted for 46% of sales in the Smartphone Apps business, gamer-forum apps 39%, and other apps 15%. Manga apps generate revenue from both advertising and in-app fees, while advertising is the revenue source for gamer-forum apps.

*5 Multiplayer: the ability to play social media games with other users. and factory’s gamer-forum apps offer an online message board where mobile gamers can recruit co-players and exchange tips and tricks that help them advance their play within specific games.

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Service categories & AND COMICS & AND APPS

Source: Company data

Organization of the Smartphone Apps business Sell Distribute in-app ads Sell ad spaces ad spaces

Provide servicesProvide services Receive ad fees Receive ad fees

Ad fees Provide Provide Operate Consulting Sell Sell services services apps services ad spaces ad spaces and factory and Provide Customers (users) Customers materials Ad agencies, other Customers (advertisers) Customers Platform operators Platform Partners Partners

Distribute Receive Receive Receive profits consulting ad fees ad fees fees Source: Shared Research based on company data

MAUs by quarter

(mn people) Gamer-forum apps Manga apps 5.00 4.60 4.50 4.01 4.00 3.50 3.30 2.85 3.00 2.57 2.50 2.20 4.30 2.00 3.62 2.00 2.79 1.32 2.38 1.50 1.08 1.50 2.04 0.88 1.02 1.00 0.65 0.59 0.18 0.31 0.26 0.25 0.25 0.26 0.50 0.71 0.92 0.59 0.70 0.67 0.70 0.53 0.47 0.51 0.39 0 0.00 0.26 0.25 0.25 0.26 0.30 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 FY08/16 FY08/17 FY08/18 FY08/19

Source: Shared Research based on company data Note: MAU figures are average values for each quarter.

Manga apps (&AND COMICS) and factory offers a number of smartphone manga apps developed with other companies: Manga UP!, developed with Square Enix Co., Ltd. (TSE1: 9684); Manga Park, developed with Hakusensha, Inc.; and Manga Mee, developed with Shueisha Inc. The company provides these apps to smartphone users via distribution platforms such as the App Store (operated by Apple Inc.) and

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Google Play (operated by Google Inc.). Other manga apps typically charge users per comic viewed (around JPY300–400 per title). By comparison, the manga apps and factory provides are basically free to read, in one-story units or episodes. (When not free, they are around JPY20 per story.) The strength of the company’s manga apps lies in its knowledge of how to boost MAU and ARPU, such as through mixing past well-known titles and original works, ending manga instalments at cliff hangers to encourage continued reading, mixing free and paid-for manga, and the level and method of charging. Manga apps (including “other manga-related apps”) accounted for 26.5% of sales in FY08/18.

Business model for manga apps The company receives both advertising revenue (obtained through ad networks*6 when users click on in-app advertising banners displayed placed through ad networks*6) and fee revenue (download fees from the sale of e-comics) from the manga apps it develops and provides.

*6 An ad network is an arrangement in which multiple advertising media (such as websites, social media, blogs, etc.) are bundled together to create an ad distribution network. It allows advertisers to place ads across multiple publishers without having to deal with each publisher individually

The company’s main costs are expenses paid to app developers and advertising expenses associated with attracting new users. In some instances, in order to attract new users, the company will adopt a strategy of paying advertising expenses equivalent to 100% of the income obtained through the manga apps listed below during the preceding month while keeping an eye on various key performance indicators. These arrangements continue for a specified period.

For Q4 or FY08/18, MAUs numbered approximately 2.4mn people (+267.7% YoY). Despite being a latecomer to the business, launching manga apps first in January 2017, the company says its research shows it ranks third in the industry in terms of MAUs. (See the “Medium-term outlook” section.) ARPU during that period (revenue per month per MAU: based on the company’s share of net revenue after deducting platform fees and the share for publishers) was JPY27 (+50.7% YoY).

In November 2018, the company began collaborating with Shueisha, launching a manga app called Manga Mee. Shueisha is a venerated member of Japan’s comics culture, having first published Ribon (a manga for young girls) in 1955. In December 2018, and factory began operating a manga app with Beaglee Inc. (TSE1: 3981), the leading Japanese e-comics distributor*7, in terms of performance. The company also plans to partner with other businesses in the future while aiming to become the industry leader in terms of MAU acquisition (explained in detail below).

*7 Member numbers exceeded 1.5mn in September 2018. The following month, cumulative downloads exceeded 900mn comics (book-length volumes). and factory’s manga apps Square Enix Holdings Partner Hakusensha Shueisha Beeglee Inc. Co., Ltd. (TSE1: 9684) (Unlisted) (Unlisted) (TSE1: 3981) App operated Manga UP! Manga Park Manga Mee Comic every App release Jan. 2017 Aug. 2017 Nov. 2018 Dec. 2018 M ain lineup Monthly Shonen Gangan Hana to Yume RIBON Over 15,000 episodes at the (Boys' comics) (Girls comics) (Girls comics) time of release Monthly Big Ganga LaLa Margaret (one of the biggest among free (Y outh comics) (Girls comics) (Girls comics) comic apps) Monthly Gangan Joker MELODY BETSUMA (Y outh comics) (Girls comics) (Girls comics) Young Gangan Young Animal Cocohana (Youth comics) (Youth comics) (Comics for female adults) Monthly Gfantasy Le Paradis Cookie (Women and youth comics) (Romance comics) (Girls comics)

+ original content + original content + original content + original content Source: Shared Research based on company data

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ARPU by quarter for manga apps

Source: Shared Research based on company data Note: Figures are indexed with ARPU for Manga UP! in March 2017 set at a value of “100.” ARPU figures for dates after March 2017 indicate simple averages for multiple apps, including new apps.

Relationship between the launch of a new app and ARPU simple averages It usually takes several months for a new app to establish a solid ARPU. Accordingly, the ARPU simple average tends to decline temporarily immediately after the launch of a new app.

Manga apps business environment The paper-based manga market has continued to shrink, but in recent years, growth of the e-manga market has exceeded the rate of contraction of the paper-based manga market, and in a broad sense, the manga market as a whole is growing. In general, all players in the e-manga market are benefitting from growth of the e-manga market, but in the case of and factory, growth in MAU of its apps is outstripping average growth of the market.

Manga is generally read for leisure, so it is in competition with other forms of entertainment for leisure time. With the spread of smartphones, though, manga can now be enjoyed even when time is short, and the company has been devising methods to encourage use of its apps even for a short period of time, such as by further dividing up manga apps instalments.

Manga UP!: A smartphone manga app developed with Square Enix Co., Ltd. and launched on January 7, 2017. In addition to content from the manga magazine Gangan, the app distributes original Manga UP! content.

Features:

◤ Square Enix’s popular manga lineup: Serial publication of the company’s manga magazines, such as Monthly Shonen Gangan for boys, Young Gangan for young men, and Monthly Gangan JOKER, as well as original works and other companies’ titles. Usually contains more than 100 works and is updated daily.

◤ Free to use: Under this consumption pattern, users are allocated “manga points” (MPs), which indicate how much content they may view free-of-charge. The balance is automatically refilled to a maximum of 80 MPs twice each day, at 8:00 am and 8:00 pm. (Generally, 20 MPs are required to view one episode, so a user could view up to eight episodes per day for free.) In addition to MPs, users can earn MP+ points or buy Cs (coins)*8. MP+ points are obtained when users view commercial content, respond to surveys, or register and apply for affiliated companies’ services. The number of MP+ points that can be accrued is unlimited. Coins are used to make in-app purchases. An equivalent number of any of these types of points (20 MPs, 20 MP+ points, or 20 Cs) is needed to view one episode, and exhausted points are subtracted in the same order (MPs first, then MP+ points, then and Cs). Some leading titles require MP+ points or Cs (cannot be viewed with MPs).

*8120 coins = JPY120; 240 coins (plus 10 MP+ for free) = JPY240; 360 coins (plus 20 MP+ for free) = JPY360

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Manga Park: A smartphone manga app developed with Hakusensha, Inc. (a Shueisha Inc. affiliate) and launched on August 2, 2017. For the first time in the history of manga apps, Manga Park offers audio content performed by voice actors.

Features:

◤ Hakusensha’s popular manga lineup: In addition to content from the manga magazines Young Animal*, for young men, and Hana to Yume, for girls, the app distributes original Manga Park content.

◤ Free to use: Under this consumption system, users are allocated FREE Coins, which indicate how much content they may view free-of-charge. The balance is automatically refilled to a maximum of 80 coins twice each day, at 6:00 am and 9:00 pm. (Generally, 20 coins are required to view one episode, so a user could view up to eight episodes per day for free.) In addition to FREE Coins, Bonus Coins and, simply, Coins are available. Bonus coins can be obtained by registering for other company services or installing certain apps, while Coins*9 are points that can be bought and used for in-app purchases. An equivalent number of any of these types of coins (20 FREE Coins, 20 Bonus Coins, or 20 Coins) is needed to view one episode, and spent coins are subtracted in the same order (FREE Coins first, then Bonus Coins, and then Coins). Some leading titles require Bonus Coins or Coins (cannot be viewed with FREE Coins).

*9120 coins = JPY120; 240 coins = JPY240; 360 coins = JPY360

◤ Other content: In addition to manga, the app offers audio content performed by voice actors and videos of pop idols.

Manga Mee: The company developed this free manga app together with Shueisha Inc. and launched it on November 1, 2018. This app provides Shueisha’s titles for girls and young women, including magazines Ribon, Margaret, Bessatsu Margaret, Cocohana, Cookie, The Margaret, and Monthly office YOU. The app also enables users to view original content and popular completed works that change daily. A number of projects are underway on the app to freshen up content, such as a special fan comic using the Chibi Maruko-chan character and a project that involves re-releasing past manga in color versions. The company has even created a new prize for popular new content.

Features:

◤ Shueisha’s popular manga catalog: Shueisha is one of Japan’s longest-selling comic publishers, having launched Ribon more than 60 years ago, in 1955. Users of the app have access to this catalog, which included some 90 works at the time the app was launched.

◤ Free to use: Content is distributed per episode rather than per volume. The app adopts a “wait-to-read” formula, in which free app users need to wait 23 hours until they are issued a ticket to read the next installment. Users can also purchase coins that enable them to continue reading as much as they wish.

◤ Magazine subscription: Subscribers get access to the online editions of manga magazines, which are available on the app the day the print editions go on sale. Readers can avoid the hassle of carrying around printed magazines or forgetting to purchase the material.

◤ UI design: Two types of manga viewers are available, allowing users to read horizontally or vertically.

Comic every: On December 19, 2018, and factory launched Comic every, a free manga app, in collaboration with Beaglee Inc. (TSE1: 3981), Japan’s leading company in e-comics, in terms of performance. The company explains that the new manga app will incorporate and factory’s expertise in app operation and UI/UX design and Beaglee’s ability to source extensive content. The app will be aimed at creating an “individualized manga experience” for each user, providing a service that goes beyond generation and gender.

Features:

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◤ At the time of its release, Comic every already offered more than 15,000 manga titles, one of the largest collections among free manga apps. It also distributes original content from Beaglee for free. Moving forward, and factory also plans on offering original manga exclusive to Comic every.

◤ Free to use: Content is distributed per episode rather than per volume. The app adopts a “wait-to-read” formula, in which free app users need to wait three hours until they are issued a ticket to read the next episode. Users can recover one of these free tickets for every three hours spent waiting and can possess a maximum of four tickets at once. A user can enjoy a maximum of eight episodes in one day if he or she does not forget to use these free tickets when they become available.

Business policy and strategy In the Smartphone Apps business, one of the company’s business policies is to create businesses by investing management resources in areas of growth within the smartphone apps market. Currently, the company is focusing on online forum apps for multiplayer games and manga apps, as it sees smartphone game apps (market size as of FY2018 valued at JPY960bn according to the Yano Research Institute) and manga apps (market size as of FY2016 valued at JPY161.7bn) as growth areas. (See the “Market and value chain” section.) Although the market for smartphone games is large, games require huge amounts of money and time to develop, and competition to attract users is fierce. Consequently, creating major hit titles is no easy task. As chances of failure are high, rather than developing smartphone game apps itself, the company’s strategy is to generate stable earnings by providing online forums for popular multiplayer game apps (offered by other companies) through which users can acquire tips and recruit co-players.

As with game apps, the company’s strategy in manga apps is to form alliances with large publishers rather than aggressively develop and launch original titles that could either be very successful or very unsuccessful. and factory works with large publishers, providing the popular titles they own. The two sides share the development and promotional risks. The company plans to continue developing and releasing more manga apps under this model.

Collaboration with multiple large publishers The value chain for e-comics includes the author, production company, publisher, e-comics agent, and e-comics store. (See the “Market and value chain.”) and factory has adopted a strategy of working with multiple large publishers: Square Enix Co., Ltd. (TSE1: 9684), Hakusensha, Inc. (an affiliate of Shueisha Inc.), and Shueisha Inc. The company collaborates with these publishers to develop manga apps for smartphones, operating a separate app for each publisher. For this reason, and factory differs from many e-comics stores in that it does not need to source individual content via agents.

Gamer-forum apps for social media games (&AND APPS) The company’s Saikyo Series (a series of gamer-forum apps) provides online forums for popular social media games run by other companies through which app users can recruit co-players and discuss tips and tricks to advance their play. and factory distributes the Saikyo Series via Apple Inc.’s App Store and Google Inc.’s Google Play. Key apps in this series are [Saikyo] Multiplayer Gamer Forum for Granblue Fantasy, [Saikyo] Multiplayer Gamer Forum for Puzzle & Dragons, [Saikyo] Multiplayer Gamer Forum for Monster Strike, and [Saikyo] Multiplayer Gamer Forum for White Cat Project. The company offers a different app for each game, which provides opportunities for users to actively exchange opinions. In FY08/18, this category generated 22.4% of sales.

Business model for the Saikyo Series The Saikyo Series generates revenue through advertising, which comes in two forms.

◤ Affiliate*10 revenues generated through purchases of in-app items*11 via and factory’s apps (Note: Apple discontinued its affiliate program for apps and in-app content on iOS and Mac in October 2018; see below for more information)

◤ Revenue generated when app users click on advertising banners placed through ad networks

*10 An arrangement through which an advertiser’s products or services are offered through third-party apps or sites. The companies managing these apps or sites receive compensation (advertising revenue) if the user purchases the products or services advertised after tapping the advertisements on screen.

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*11 Items that can be added to a user account to enhance player characteristics by, for example, speeding recovery or increasing power. Some items create advantages or can help users progress in the game and still others are tools of convenience.

In Q4 of FY08/18, MAUs numbered approximately 0.5mn people (-29.9% YoY). In the same period, ARPU (average revenue per user; monthly advertising revenue per MAU) was JPY73 (+52.9% YoY). Principal costs were app development expenses and costs for attracting new users (advertising expense).

Starting into official apps The company has developed and operates the Saikyo Series message board-style app that allows users to exchange tips and recruit co-players for popular smartphone game apps provided by other companies. In addition, and factory intends to launch official game-walkthrough apps. By creating official game-walkthrough apps that interface with social games, the company aims to create a new business model employing additional monetization methods (refer to the “Medium-term management outlook”).

Discontinuation of Apple’s affiliate program In August 2018, Apple announced that, as of October 1, 2018, it would discontinue its affiliate program for apps and in-app content on iOS and Mac. Launched on September 1, 2004, the program provided a commission to individuals or companies that linked to an Apple product when a purchase was made. In November 2016, Apple reduced commissions under the affiliate program from 7% to 2.5%. As of October 1, 2018, commissions had been removed completely. Apple explained that it had discontinued the program for apps because its launch of the Apple Store for the new iOS and MacOS made apps easier to find. The program continues to cover music, movies, books, and all other content.

The company is affected by the discontinuation of the App Store, as some revenue from the Saikyo Series depended on and factory’s affiliation with the App Store. No longer able to receive a 2.5% commission, the company aims to cover this shortfall through other ads. The company is also developing new earning methods, such as launching the official apps outlined above.

IoT business (in FY08/18, 41.7% of sales and 22.8% of operating profit)

IoT FY08/15 FY08/16 FY08/17 FY08/18 FY08/19 Sales and profit (JPYmn) Act. Act. Act. Act. Est. Sales na na 63 800 na YoY - - - 1179.6% - % of total sales - - 9.1% 41.7% - Operating profit na na -30 142 na YoY ----- % of total OP - - - 22.8% - OPM ---17.8%- &AND HOSTEL (buildings) na na na 6 na YoY ----- intto installation (no. of facilities) na na na 89 na YoY ----- tabii (units) na na na 275 na YoY ----- Source: Shared Research based on company data

In this segment, the company plans, develops, and operates the &AND HOSTEL brand of smart hostels. Also in this segment, and factory provides IoT solutions for lodging facilities, including innto (a property management system) and tabii (a tablet-based service).

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The three main elements of the IoT business

Source: Shared Research based on company data

Organization of the IoT business

&IoT (and factory)

Plan, develop Owners (companies) Feedback data Pay fees IoT device manufacturers &AND HOSTEL Prov ide services Provide device and API Pay fees

Pay fees Accommodation Prov ide services Co-develop facilities Users innto Pay fees Pay fees Partner Prov ide services companies List ads tabii Advertiser Request Pay Ad (companies) ad listing fees agencies Projects Co-develop other than Provide services accommodation Pay fees Provide data Source: Shared Research based on company data Business model for &AND HOSTEL smart hostels The company plans, develops, and operates the &AND HOSTEL brand of smart hostel facilities, which enable guests to experience IoT devices. These smart hostels use the company’s platform app (called &IoT; see the “Business policy and strategy” section) and IoT to provide comfortable guest environments. The company had opened nine such hostels as of end-May 2019 and plans to bring this number to nine by end-FY08/19.

&AND HOSTEL breaks down into two business categories: The first involves planning and developing facilities on property owned by other parties (seven locations planned as of end-2018). The second category entails acquiring property, planning and developing &AND HOSTEL facilities, and selling them to investors (two locations, each requiring JPY500–600mn). In the first instance, the company receives compensation for consulting, real estate brokerage and other services. In the second, and factory earns gains on the sale of real estate. The company runs the hostels itself in both cases and receives compensation from hostel owners in return.

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As the hostels are dormitory-style (shared room accommodation facilities), accommodation prices do not vary significantly by season. Inbound tourists account for 60–70% of guests, who are mostly male. Guests are mainly attracted through online travel agents (OTAs), such as Expedia and Booking.com.

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&AND HOSTEL locations

Source: Shared Research based on company data

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Business model for innto innto is a property management system* for smart hostels that and factory developed jointly with open innovation partner Almex Inc., of the USEN-NEXT Group. As of end-May , 2019, the system had been installed at 204 locations. innto enables the centralized management of information related to guest rooms: reservations, room rates, available rooms, and fees. To date, most systems of this sort have been aimed at medium- to large-scale facilities. Such systems were ill-suited to smaller properties because startup costs were high and the time between initial contract and the start of service was long. Aimed at simple lodging facilities, innto is cloud-based, can be launched quickly, and has low launch and running costs. The service also draws on and factory’s UI/UX design expertise, which the company says makes operations intuitive and convenient. The company shares revenue with Almex on system sales and also receives recurring revenue from system maintenance and operation. Initial setup is free.

* The broad definition refers to management systems that cover entire hotels or other facilities. In a narrow sense, a property management system is used for rooms only. innto, which is used only for rooms, aims to make the operation of lodging facilities more efficient and save resources. Its principal functions are reservation management, scheduling, room status monitoring, guest management, ledger and report generation, accommodation plan and fee scheduling, and master planning.

Comparison of property management systems Company System Description and factory developed this property management system with an open innovation partner (Almex Inc., a USEN-NEXT Group company). Aimed at simple lodging and factory innto facilities, this system enables the centralized management of information related to reservations, selling prices, room rates, availability, and fee. This portal system is provided by Almex Inc., a USEN-NEXT Group company. Designed for use at business hotels and other hotels where lodging is the focus, the Almex Inc. Wincal system has a simple interface and is designed to reduce the amount of work for front desk staff. The system is available in on-premise and cloud-based versions. This cloud-based hotel system has a market share of around 70%. Use ranges widely, from lodging-focused hotels to large city hotels. The company has installed NEC Corporation NEHOPS the system in numerous large-scale city hotels and nationwide chains of hotels with more than 300 locations. This cloud-based hotel system, provided by Fujitsu, has the top share of the market Fujitsu Limited GLOVIA for simple, non-customized, multitenant cloud-based property management systems. TAP Co., Ltd. TAP This system has a high share of the market for resort hotels, its forte.

This cloud-based hotel system has a top share of the market at foreign-owned Oracle Corporation Japan OPERA hotels and is installed at more than 40,000 locations worldwide.

Source: Shared Research based on data from the company and the Hotelier website (https: //www.hotelier.jp/support/pms.html)

Business model for tabii tabii is a service that and factory developed and is based around tablet devices placed in hotel guest rooms. (As of end-May, 2019, 2,024 tabii tablets were in operation.) The company earns advertising revenue, such as placement fees for ads viewed on these in-room tablets. The tablets not only offer information specific to the facility but also information on local restaurants and tourist spots, as well as a wide range of selectable entertainment content (including music and comedy videos). According to the company, this service, designed to enhance the guest’s travel experience, raises the perceived room value for the hotel’s diverse customer bases.

Facilities that use tabii save costs by making service guides, terms and conditions, and other documents available electronically. The company explains that tabii-based help screens and Q&A chatbots address many guest questions, reducing the need for guests to telephone staff or request personal assistance. As a result, hotels can increase operating efficiency without boosting running costs.

As tabii uses an advertising-based model, lodging facilities pay no monthly fees, and the service is available free of charge to guests.

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Business policy and strategy In the IoT business, the company seeks to apply the UI/UX technologies it accumulated through the Smartphone Apps business, along with expertise in data analysis and monetization methods, to prompt innovation in areas where technology adoption is currently lagging, such as real estate, housing, and healthcare. and factory also promotes IoT through &IoT, a platform app. This app integrates the operation of individual IoT devices via their APIs (which are provided by the device manufacturers). In addition to improving device operability, &IoT streamlines customer operations. By combining &IoT, innto (property management system), and tabii (tablet-based service for hotels), the company aims to expand its platform business by utilizing big data obtained from IoT devices.

For example, hotel guests can use tablets to operate IoT devices. This approach automates a range of hotel business activities, from room reservations to the services provided during a guest’s stay, reducing staff requirements, saving resources, and improving operating efficiency. At the same time, analyzing the big data obtained on tablets from the IoT devices in individual guest rooms can help hotels understand guest characteristics and preferences and optimize hospitality for the guest’s next stay. The company aims to develop a highly targeted marketing business through these IoT strategies.

Strategy for the IoT business

Source: Shared Research based on company data

Other businesses (in FY08/18, 0.9% of sales and 0.1% of OP)

In this segment, and factory mainly conducts an advertising agency business, distributing ads to smartphone apps and media operated by other companies.

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Market and value chain

E-book industry Market scale According to research by Impress Research Institute, the e-book market was worth JPY197.6bn (+24.7% YoY) in 2016. This represents CAGR of 25.7% from JPY62.9bn in 2011. Impress expects the market to continue growing, reaching JPY312.0bn in 2021 (CAGR of 9.6% for the five years through 2021).

Digital publishing (e-books + e-magazines) market scale (JPYbn)

(JPYbn) 400 356.0 350 341.0 322.0 44.0 295.0 43.0 300 41.0 263.0 38.0 250 227.8 35.0

30.2 200 182.6 24.2 141.1 150 298.0 312.0 281.0 101.3 14.5 257.0 7.7 228.0 100 65.1 76.8 197.6 65.6 57.4 2.2 3.9 158.4 46.4 126.6 50 35.5 93.6 18.2 72.9 9.4 62.9 1.0 1.8 4.5 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17F FY18F FY19F FY20F FY21F E-books E-magazines

Source: Shared Research based on data from Impress Research Institute

E-book market scale (JPYbn)

250 25.0%

197.6 200 20.0%

35.9 158.4 150 15.0% 30.8 126.6 13.4%

24.2 100 93.6 10.4% 10.0% 72.9 20.5 161.7 62.9 7.9% 15.5 127.7 11.5 50 5.6% 102.4 5.0% 4.2% 73.1 51.4 3.5% 57.4

0 0.0% FY11 FY12 FY13 FY14 FY15 FY16

E-comics Other e-books E-books as % of total publishing industry market (JPYbn) Source: Shared Research based on data from Impress Research Institute and All Japan Magazine and Book Publisher’s and Editor’s Association

E-comics account for more than 80% of e-books, driving growth in the e-book market. E-comics achieved CAGR of 25.8% between 2011, when the market was worth JPY51.4bn, and 2016, when it was worth JPY161.7bn. This is in direct contrast to the publishing industry, which comprises primarily printed books and manga and had shrunk by an annual average of 2.9% to JPY1.5tn in 2016, from its peak of JPY2.7tn in 1996. The e-comics market accounted for 3.5% of the overall publishing market in 2011, but this grew to 13.4% by 2016, an increase of 9.9pp over five years.

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(Reference) Publishing industry market scale (JPYbn)

(JPYbn) 3,000 2,656.38

2,500

2,000

1,470.90 1,500

1,000

500

74.40 0 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Magazines Books

Source: Shared Research based on data from the All Japan Magazine and Book Publisher’s and Editor’s Association Factors in e-book market expansion Shared Research sees the following factors as being behind the expansion of the e-book market, with e-comics as the growth driver.

◤ Spread of smartphones, tablets, and other smart devices: Since 2010, consumer possession of smart devices has rapidly increased to the point that most people now regularly have a device close at hand. Smartphones have larger screens than older mobile phones, making them easier on the eyes, and many people also have tablets with even bigger screens.

Households using mobile phones, smartphones, and tablets (Japan) 94.4% 95.0% 95.6% 96.3% 93.2% 94.5% 94.5% 94.5% 94.8% 94.6% 94.7% 94.8% 100% 92.2% 90.0% 91.3% 82.6% 90% 78.5% 78.2% 75.1% 80% 72.0% 71.8% 70% 62.6% 64.2% 60% 49.5% 50% 33.3% 34.4% 36.4% 40% 29.3% 26.3% 30% 21.9% 15.3% 20% 9.7% 8.5% 10% 0% 7.2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Mobile phones Smartphones Tablets

Source: Shared Research based on Survey on IT Use from the Ministry of Internal Affairs and Communications *“Mobile phones” includes PHS, PDAs from 2009 to 2012, and smartphones from 2010.

◤ Shift to broadband for wireless LANs: There has been a shift toward broadband (LTE) for mobile phone and smartphone communications, with the number increasing to 121mn LTE users (70% of mobile phone and smartphone users) as of the end of March 2017.

LTE contract holders and ratio to total number of mobile phone and smartphone users

160 80% 70% 140 62% 70% 120 55% 60%

100 43% 50%

80 31% 40% 60 121 30% 103 40 15% 87 20% 68 46 20 2% 10% 0% 20 0 0 2 0% Mar 2010 Mar 2011 Mar 2012 Mar 2013 Mar 2014 Mar 2015 Mar 2016 Mar 2017

Number of LTE contracts % of total subscribers of mobile phones and smartphones (right axis)

Source: Shared Research based on Quarterly Data on Telecommunications Service Contract Numbers and Market Share from the Ministry of Internal Affairs and Communications

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◤ Increase in advertising spending and improvement in promotional techniques: E-bookstores are placing significant ad spending into TV commercials and are also actively working to build new member registration by using banner ads and offering free content online.

◤ Increase in e-comic users as a result of the above

Value chain for the e-book market The e-book value chain includes players such as the author or production company, publisher, e-book agent*, and e-bookstore. The flow of e-book sales and distribution is typically as follows: First, a work produced by a writer with the help of an editor at a publishing company is processed by a production company (contracted by the publisher) into digital content ready for distribution. The publisher concludes a sales agreement with an e-book agent and requests the securing of sales routes. The e-book agent then concludes sales agreements with multiple e-bookstores to secure sales routes. Afterward, the publisher sends the digital content and book data processed by the production company to the e-book agency, and the e-bookstores with which the agency has concluded agreements sell and distribute the digital content to consumers.

The e-book agency not only collects and manages digital content, but also keeps track of e-bookstores’ sales and distribution performances for reporting to the publisher. However, in some cases the roles of each player are not distinct. For example, an e-book agency may conduct production and distribution functions in addition to normal agency work, or a publisher may operate its own e-bookstore.

*The sale of published material (printed books) in Japan is covered by two legal systems: the resale price maintenance system (resale system) and the consignment sales system. Agency functions for e-books differ from printed material in that there is no delivery of physical product from the publisher or printer to bookstores and no collection of unsold products. In terms of printed matter, the agency also performs financial functions in the event of any hold-up in collections from bookstores or advance payments to the publisher, but such functions are not necessary in the case of e-books.

Value chain for e-book market General e-book business and factory Infocom Amazon Rakuten Sony Toppan Printing Dai Nippon Printing

Kindle Kobo Reader (sales discontinued) Lideo (sales discontinued) Smartphone Users (devices) smartphones Smartphones Smartphones Smartphones Smartphone (Android) Smartphones, PCs PC Content Payment (Comic apps) Meccha Comics Reader Store E-book store Kindle Store Rakuten Kobo BookLive! honto and factory ekubostore BookWeb Plus Content Payment (Content) Infocom booklista Bitway E-book agents Media Do MobileBook.jp from publishers (Sony, Toppan, others) (Toppan Printing) Content Payment - Square Enix - Hakusensha Publishers Publishers Publishers Publishers Publishers Publishers - Shueisha Content Payment Content Payment

Authors and producers Authors and producers Authors and producers Authors and producers Authors and producers Authors and producers Authors and producers

Source: Shared Research based on Trends in the Electronic Book Market from Japan Fair Trade Commission’s Competition Policy Research Center, Beaglee Inc. Share Issue and Stock Reporting Prospectus, and Basic Textbook on E-Book Production and Circulation, edited by Yashio Uemura Factors differentiating e-book apps E-bookstores typically compete based on, and differentiate themselves through, content, price, usability, marketing and promotion, and overseas development. In terms of content, they can set themselves apart by harnessing IT technologies such as AI, strengthening product lineups and conducting initial exclusive distribution. Usability includes ease of reading (e.g., vertical scrolling), faster download speeds, and enhanced search and e-bookshelf functions. In terms of marketing, an e-bookstore spends on advertising and promotion to improve its brand power and uses free content and banner ads to attract new members.

E-bookstore fees: the rise of free apps and the subscription model E-bookstores use a range of fee systems, including monthly payments, per-book purchases, rental fees, and subscription models. They also employ free models that distribute titles and collect advertising revenue. The company’s manga apps utilize a hybrid model that both distributes titles for free while collecting advertising revenue and charges in-app fees (See the “Business overview” section for details on the company’s business model). With the monthly fee model, users pay a set amount each month and use points granted in line with this amount to purchase content. With the per-book model, users pay a designated amount each time they purchase content. The rental model includes both monthly and per-book fees, but content cannot be viewed after a certain period of time. The subscription model allows unlimited reading for a fixed monthly fee. Examples of this

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model are Amazon’s Kindle Unlimited (JPY980 monthly, tax included), the Book Pass (KDDI) monthly all-you-can-read plan (JPY606), and the COMIC C’moA (NTT Solmare Corporation) all-you-can-read light plan (JPY780) and full plan (JPY1,480). NTT Docomo’s fixed-price all-you-can-read service d-Magazine (JPY432), primarily for e-magazines, began in June 2014 and has steadily grown its user count, reaching 3.3mn by the end of March 2016. Kindle Unlimited, which expanded services to include Japan starting on August 3, 2016, enables unlimited reading of more than 120,000 Japanese books, 30,000 comics and magazines, and 1.2mn foreign books for a fixed monthly fee of JPY980.

Online game industry

According to the JOGA Online Game Market Research Report 2018 (issued by Japan Online Game Association), the 2017 domestic online game market was up 6.3% YoY to JPY1.4tn. Within this market, the online PC game market was worth JPY83.6bn (-9.3% YoY), the social game (mainly feature phones) market was worth JPY37.9bn (+6.5% YoY), and the smart device (smartphone and tablet) game market was worth JPY1.2tn (+7.6% YoY). The value of the game market is rising along with smart devices, but the PC market continues to shrink.

Domestic online game market trends

(JPYbn) Feature phones Smartphones and tablets PCs and consumer game machines 1,400 1,360 1,280 38 36 1,200 1,104 53 1,000 931 842 80 800 161 1,239 577 1,152 600 945 407 736 400 357 550 236 230 200 129 153 82 102 113 103 37 78 58 0 5 23 82 102 112 124 130 133 141 142 131 115 106 92 84 0 58 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: Shared Research based on data from JOGA “Online Game Market Research Report 2018” and other sources

The 2018 Internet White Paper (Internet White Paper Editorial Committee) points out that growth in native app games for smartphones and tablets has contributed significantly to growth of the domestic online game market. Behind this is the high ARPU structure for smartphones and tablets (ARPU of JPY8,075), but ARPU is just an average; in fact, some users are spending mere hundreds of yen per month, while others spend hundreds of thousands of yen per month and millions of yen per year. In a high ARPU structure, in which the lack of a basic fee sets the hurdle to begin playing as low as possible but requires payment to move to the next level of game play, a particularly useful tool in persuading the consumer to spend money is the “randomly dropped item” formula (the so-called “gacha”). Manufacturer development costs increase each year, which is one of the reasons a high ARPU structure is needed. The average development cost of a single game for smartphones and tablets in 2016 was up 30% YoY to JPY164mn, and production time was long at about 12 months. Not only have storylines and other elements required when creating games become more intricate but, as smartphone performance and screen definition have increased, graphics and sound work going into characters and scenarios have become more complex, all of which has resulted in rising development costs.

The domestic online game market became a trillion-yen industry in 2015 and has continued to expand since then. With gaming entering consumers’ lives as a commonplace form of entertainment, consumer concern regarding the transparency of screen displays regarding gacha is just one example of the issues tackled not just by individual companies offering games, but by the government and the gaming industry, including platform operators. As devices and telecommunications continue to evolve, it is likely that new gaming formats and business models will arise. The white paper concludes that for the future of this trillion-yen industry, it will be critical to protect consumers and abide by the law when responding to these changes.

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According to the “Global Games Market Report 2017” by Newzoo, global game software revenue is projected to grow from USD101.1bn in 2016 to USD128.5bn in 2020. Of this, mobile games are expected to grow from USD38.6bn to USD64.9bn in the same time period. The share of mobile games within the game software market is also projected to grow from 39% to 50%.

IoT industry

According to data from IHS Technology cited in the Ministry of Internal Affairs and Communications’ 2018 White Paper on Information and Communications in Japan, the number of IoT devices* connected to the internet is expected to rise from 27.5bn in 2017 to 40.3bn in 2020 (growth of 1.47x). Due to the continuous progress of internet and sensor technologies, around the world a host of new items (such as consumer electronics, automobiles, buildings, and factories) are slated for connectivity, in addition to those that are already connected (such as PCs and smartphones). As of 2017, smartphones and other communication devices made up the largest share of IoT devices around the world. As this market is maturing, the authors of this white paper predict growth in this category will be relatively low. They anticipate sharp increases in the categories of “automobiles and transportation equipment,” due to the shift to IoT as connected cars become more common; in “healthcare” as the digital healthcare market expands; and in “industrial applications (factories, infrastructure, and logistics)” as the numbers of smart factories and smart cities increase.

* According to IHS Technology’s definition, an IoT device is a device or sensor network terminal that has a unique IP address and can be connected to the internet.

IoT devices around the world

(bn) 50 45 40.30 40 0.617 35.44 1.44 Medical, defense, 0.507 35 31.05 1.16 aerospace 0.416 9.49 Automotive 30 27.49 0.92 7.28 0.345 2.19 24.10 0.284 0.75 5.45 Industrial 25 0.234 4.24 2.2 20.51 2.21 7.63 0.203 3.27 0.60 2.22 6.72 20 17.07 5.93 Computer 2.49 2.2 5.2 15 1.82 2.11 0.47 4.53 1.93 0.38 3.89 Consumer 3.38 10 17.57 18.93 13.22 14.73 16.12 Communication 5 9.36 11.31 0 2014 2015 2016 2017 2018 Est. 2019 Est. 2020 Est.

Source: Shared Research based on data from IHS Technology from the 2018 White Paper on Information and Communications in Japan, Ministry of Internal Affairs and Communications

Internet advertising market

According to Japan’s Advertising Spending study by Dentsu, the size of the internet advertising market in Japan was JPY1.5tn in 2017 (with media spending of JPY1.2tn and production costs of JPY288.8bn). Internet advertising surpassed radio advertising in 2004, magazine advertising in 2006, and newspaper advertising in 2009. At the time of the Dentsu study, internet advertising was second to television with a 23.6% share of total advertising spending. While advertising spending has been falling for the four traditional mass media formats of television, newspapers, radio, and magazines, internet advertising spending continues to grow.

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Advertisement costs by media format

Ad spending (JPYbn) YoY (%) % of total ad spending 2015 2016 2017 2015 2016 2017 2015 2016 2017 Total advertising spending 6,171.0 6,288.0 6,390.7 100.3 101.9 101.6 100.0 100.0 100.0 Four mass media ad expenses 2,869.9 2,859.6 2,793.8 97.6 99.6 97.7 46.5 45.5 43.7 Newspapers 567.9 543.1 514.7 93.8 95.6 94.8 9.2 8.6 8.1 Magazines 244.3 222.3 202.3 97.7 91.0 91.0 4.0 3.5 3.2 Radio 125.4 128.5 129.0 98.6 102.5 100.4 2.0 2.0 2.0 TV 1,932.3 1,965.7 1,947.8 98.8 101.7 99.1 31.3 31.3 30.5 Internet ad expenses 1,159.4 1,310.0 1,509.4 110.2 113.0 115.2 18.8 20.8 23.6 Media expenses 919.4 1,037.8 1,220.6 111.5 112.9 117.6 14.9 16.5 19.1 Ad production expenses 240.0 272.2 288.8 105.5 113.4 106.1 3.9 4.3 4.5 Promotional media expenses 2,141.7 2,118.4 2,087.5 99.1 98.9 98.5 34.7 33.7 32.7 Source: Shared Research based on Dentsu’s Japan’s Advertising Spending study

Within the expanding market for internet advertising, growth is particularly pronounced in the area of programmatic advertising that leverages automated ad technology to maximize advertising revenue and ad effectiveness. Programmatic advertising grew 27% YoY in 2017 to JPY940bn, marking continuous annual growth of around 20%.

Domestic online advertising fees

(JPYbn) Display ads Keyword-targeted ads Publishers' fees (ad space) Publishers' fees (optimized ads) Ad production costs Online advertising market

1,400 289

1,200 272

1,000 240 227 800 218 205 940 187 167 738 161 162 623 600 511 141 232 339 412 175 193 285 400 120 128 93 59 200 376 331 363 351 334 324 308 314 297 300 222 270 281 118 181 0 50 74 85 CY01 CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15CY16CY17 Source: Shared Research based on Dentsu, Inc. materials

The growth of internet advertising can be traced to changes in media exposure, where a consumer’s contact time with the four traditional mass media formats has been on a downward trend, while continuing to increase for the internet. Hakuhodo DY Media Partners’ Time Series Analysis from the Annual Media Consumption Report 2018 (survey period: January 25 to February 9, 2018) shows that in the past 10 years, contact time with television, radio, newspapers, and magazines has declined by annual rates of 1.1%, 3.7%, 5.7%, and 3.2%, respectively, whereas contact time with the internet has been increasing at an annual rate of 10.0%. As consumers spend more time (or at least increase the proportion of total time spent) viewing and using the internet, advertisers will likely continue to allocate more of their budgets to internet advertising.

Use of four mass media and internet 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 (average minutes per day) Total 319.3 323.9 347.9 350.0 351.4 353.1 385.6 383.7 393.8 378.0 396.0 (YoY) -4.8% 1.4% 7.4% 0.6% 0.4% 0.5% 9.2% -0.5% 2.6% -4.0% 4.8% Television 161.4 163.5 172.8 161.4 161.4 151.5 156.9 152.9 153.0 147.3 144.0 (YoY) -6.1% 1.3% 5.7% -6.6% 0.0% -6.1% 3.6% -2.5% 0.1% -3.7% -2.2% (% of total) 50.5% 50.5% 49.7% 46.1% 45.9% 42.9% 40.7% 39.8% 38.9% 39.0% 36.4% Radio 35.2 31.1 28.7 33.0 31.9 35.2 30.5 28.9 30.1 24.5 24.2 (YoY) -20.0% -11.6% -7.7% 15.0% -3.3% 10.3% -13.4% -5.2% 4.2% -18.6% -1.2% (% of total) 11.0% 9.6% 8.2% 9.4% 9.1% 10.0% 7.9% 7.5% 7.6% 6.5% 6.1% Newspaper 28.5 26.0 27.8 23.3 24.0 27.1 23.4 19.9 20.4 19.8 15.9 (YoY) -11.8% -8.8% 6.9% -16.2% 3.0% 12.9% -13.7% -15.0% 2.5% -2.9% -19.7% (% of total) 8.9% 8.0% 8.0% 6.7% 6.8% 7.7% 6.1% 5.2% 5.2% 5.2% 4.0% Magazine 17.1 17.6 16.0 18.6 16.6 16.0 13.6 13.0 13.8 11.9 12.3 (YoY) -12.8% 2.9% -9.1% 16.3% -10.8% -3.6% -15.0% -4.4% 6.2% -13.8% 3.4% (% of total) 5.4% 5.4% 4.6% 5.3% 4.7% 4.5% 3.5% 3.4% 3.5% 3.1% 3.1% Internet 77.1 85.7 102.6 113.7 117.5 123.4 161.3 169.0 176.6 174.5 199.6 (YoY) 14.1% 11.2% 19.7% 10.8% 3.3% 5.0% 30.7% 4.8% 4.5% -1.2% 14.4% (% of total) 24.1% 26.5% 29.5% 32.5% 33.4% 34.9% 41.8% 44.0% 44.8% 46.2% 50.4% PC 59.4 67.6 77.4 81.7 77.1 72.8 69.1 68.1 61.0 59.3 66.6 (YoY) 4.9% 13.8% 14.5% 5.6% -5.6% -5.6% -5.1% -1.4% -10.4% -2.8% 12.3% (% of total) 18.6% 20.9% 22.2% 23.3% 21.9% 20.6% 17.9% 17.7% 15.5% 15.7% 16.8% Tablet na na na na na na 18.2 20.6 24.9 25.0 29.9 (YoY) na na na na na na na 13.2% 20.9% 0.4% 19.6% (% of total) na na na na na na 4.7% 5.4% 6.3% 6.6% 7.6% Mobile 17.7 18.1 25.2 32.0 40.4 50.6 74.0 80.3 90.7 90.2 103.1 (YoY) 60.9% 2.3% 39.2% 27.0% 26.3% 25.2% 46.2% 8.5% 13.0% -0.6% 14.3% (% of total) 5.5% 5.6% 7.2% 9.1% 11.5% 14.3% 19.2% 20.9% 23.0% 23.9% 26.0% Source: Shared Research based on Hakuhodo DY Media Partners data

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Shared Research thinks that the penetration of internet advertising will continue to rise as consumers spend more of their waking hours online (via PCs, smartphones, or other devices). Shared Research also thinks that one driver of growth in internet advertising is a greater emphasis on cost effectiveness. As companies look to market more effectively, they are likely to become increasingly open to flexible solutions, combining traditional mass-media advertising with other methods and approaches.

There are other business opportunities that have expanded with the proliferation of the internet. The value of payments made online has mushroomed. The table below shows changes in the size of the e-commerce market for B-to-C (business-to-consumer) transactions in Japan, based on Ministry of Economy, Trade and Industry (METI) statistics. E-commerce has continued to grow steadily and the ratio of e-commerce to the overall B-to-C market increased to 5.4% in 2016 and 5.8% in 2017.

B2C market size in Japan 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 (JPYbn) B2C e-commerce market size 6,089 6,696 7,788 8,459 9,513 11,166 12,797 13,775 15,136 16,505 YoY 13.9% 10.0% 16.3% 8.6% 12.5% 17.4% 14.6% 7.6% 9.9% 9.0% E-commerce ratio 1.8% 2.1% 2.8% 3.2% 3.4% 3.9% 3.9% 4.8% 5.4% 5.8% Source: Shared Research based on METI data

According to estimates published by the Nomura Research Institute in November 2015, the e-commerce market should reach JPY25.6tn (about double the FY2014 market size of JPY12.6tn) by FY2021. The spread of smartphones has made e-commerce accessible regardless of time and place, boosting market growth. The research also estimates that the Japanese smart payment market, which was JPY53.6tn in FY2014, will expand to JPY91.3tn by FY2021 as the government accelerates infrastructure improvement in preparation for the Tokyo Olympic Games. (Smart payment is a method for electronic payments between companies and consumers).

Real estate industry Japanese real estate transactions Market size After peaking in fiscal 2014, Japanese real estate transactions declined in fiscal 2015 before a slight recovery in fiscal 2016. The value of Japanese real estate transactions executed by listed companies in fiscal 2016 was JPY4.1tn (+0.5% YoY). The trend towards recovery continued in FY12/17, with the value of Japanese real estate transactions executed by listed companies reaching JPY5.0tn in FY12/17 (+21.1% YoY). Against a backdrop of reduced property supply, soaring construction costs, and a labor shortage, real estate prices are rising*1 and the cap rate*2 is declining due to higher prices. Meanwhile, widening yield spreads*3 accompanying declining interest rates saw the real estate funds market expand to JPY32.5tn (+4.5% YoY) in 2017. In addition to growth in J-REIT, private placement funds specializing in Japanese real estate are also growing. Bank lending to the real estate sector is also trending upward.

*1 Rising property prices: Prices of newly built condominiums in the Tokyo metropolitan area rose from JPY55.5mn/unit in 2016 to JPY56.8mn (+2.3%) in 2017 (source: Real Estate Economic Institute, simple average of monthly prices). Prices for pre-owned condominiums rose 2.9% YoY from JPY34.8mn/70sqm in 2016 to JPY35.8mn/70sqm in 2017 (source: Tokyo Kantei). *2 Cap rate: Short for capitalization rate. Yield used when determining property prices from net earnings generated by a property. Net operating income ÷ cap rate = property price. *3 Yield spread: Gap between cap rate and 10-year government bond yield.

Real estate transactions by listed companies and number of transactions

7,000 1,340 1,400 1,241 1,259 1,199 1,155 6,000 1,124 1,200 5,448.4 5,289.0 1,014 4,976.3 5,000 1,000 846 859 4,348.9 4,599.7 4,122.8 810 4,089.7 4,108.2 4,000 800 648 3,208.4 676 673 3,140.4 594 3,155.0 2,390.3 2,645.7 3,000 524 2,627.9 2,232.7 502 513 2,658.5 1,999.9 600 2,480.1 2,408.2 2,557.2 2,408.2 2,032.5 2,054.9 2,000 1,858.5 1,664.8 1,722.5 400 1,818.1 1,811.3 1,601.9 1,730.9 801.5 1,198.1 1,107.0 1,163.0 983.1 1,000 1,958.6 2,240.0 1,111.5 1,954.0 2,148.6 2,089.8 200 1,890.1 1,551.0 1,821.3 949.1 1,057.0 878.2 925.5 677.3 809.8 553.3 856.8 739.4 847.2 0 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15FY16FY17 (JPYbn) 1H transactions 2H transactions Number of transactions (right axis) Source: Shared Research based on Urban Research Institute Corporation, Real Estate Topics

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Hotels In 2017, there were 28.7mn overseas tourist arrivals in Japan (+19.3% YoY). Hotel occupancy rates have been trending upward, since bottoming out in 2011, as the number of overseas tourists to Japan has increased.

Number of International Visitors to Japan (mn) and hotel occupancy rates (%) Foreign traveler visiting Japan (mn) Occupancy (nationwide; right axis) Occupancy (Tokyo right axis) Occupancy (Osaka; right axis) Occupancy (Aichi; right axis) 70 100% 60.00 95% 60 87.8% 90% 84.2% 85.2% 85.1% 50 82.7% 80.6% 80.0% 85% 83.2% 86.3% 83.3% 84.8% 40.00 80% 40 78.6% 79.0% 73.9% 74.1% 78.7% 76.6% 72.7% 70.9% 75% 30 69.5% 74.2% 74.4% 75.4% 68.3% 69.6% 67.3% 72.1% 70% 20 62.3% 67.0% 67.7% 65% 65.0% 28.69 24.04 60% 10 60.1% 19.73 13.41 55% 8.61 6.21 8.35 10.36 0 50% 2010 2011 2012 2013 2014 2015 2016 2017 2020 2030 Government Government plan plan Source: Shared Research based on Japan National Tourism Organization’s Foreign Tourists in Japan Statistics, and Ministry of Land, Infrastructure, Transport and Tourism, Accommodation Travel Survey

According to the Ministry of Health, Labour and Welfare, 79,842 facilities provided accommodation to tourists as of March 31, 2017 (+1,323 YoY). Of this figure, 10,101 facilities were hotels and 39,489 were ryokan (Japanese-style inns); 29,559 fell under the simple lodging facility category. In the five years leading up to March 31, 2017, the annual average rate of growth in ryokan numbers was -0.4%, but the annual average growth rate in simple lodging facility numbers (including hostels) was +3.8%.

Tourist accommodation in Japan

(no. of facilities) 120,000 94,910 100,000 84,411 25,150 81,087 81,404 80,412 79,519 78,898 78,519 79,842 80,000 23,050 23,719 24,504 25,071 25,560 26,349 60,000 27,169 29,559

40,000 67,891 50,846 46,906 46,196 44,744 43,363 41,899 40,661 39,489 20,000 7,944 9,710 9,863 9,796 9,809 9,879 9,967 10,101 0 009,603 0 FY98 FY08 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Hotel Ryokan (Japanese-style hotel) Common lodging house Boarding house

Source: Shared Research based on data from the 2016 Report on Public Health Administration and Services, Ministry of Health, Labour and Welfare

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Competitors

Many companies are involved in smartphone apps. Shared Research believes that the overlap between the Smartphone Apps business and the IoT business is what sets and factory apart. In the IoT business, the company takes advantage of expertise in UI/UX technology, and data analysis and monetization methods that it accumulated through the Smartphone Apps business to innovate in real estate and other domains that are slow to deploy technology.

Shared Research considers the companies described below to be competitors or similar peer companies in either the Smartphone App or IoT businesses.

Smartphone Apps business Sites with gaming tips The market for sites with gaming tips was led by individual affiliate program participants*, and the market expanded as companies entered. The following companies also operate sites of this nature.

▷ GameWith: Operated by GameWith, Inc. (TSE1: 6552) ▷ Game8: Operated by Game8 Inc., a wholly owned consolidated subsidiary of Gunosy Inc. (TSE1: 6047) ▷ GAMY: Operated by CyberZ, Inc., a wholly owned consolidated subsidiary of CyberAgent, Inc. (TSE1: 4751) ▷ Altema: Operated by NLINKS Inc. (TSE JASDAQ: 6578)

*Refers to individuals who operate websites, email magazines, social sites and similar commodities, generating income mainly through affiliate advertising (results-based advertising)

Sites with gaming tips: Comparison with major competitors Ticker Company Fiscal Sales OP OPM ROA ROE Equity Businesses year (JPYmn) (JPYmn) (RP-based) ratio (% of sales) 6047 Gunosy FY03/18 11,201 1,938 17.3% 18.3% 6.0% 75.1% Gunosy Ads (57), ADNW 36), Other (7) NHK Broadcast contracting and collection (80), Chat Real 6578 NLINKS FY02/18 3,958 315 8.0% 29.1% 41.3% 46.1% Estate (10), Game Strategy Website Operation (9), Other (1) Advertising sales at game strategy and other websites 6552 GameWith FY05/18 2,677 1,168 43.6% 46.7% 41.1% 79.9% (99％) 7035 and factory FY08/18 1,916 365 19.1% 37.7% 80.7% 34.3% Smartphone APP (57), IoT (42), Other (1) Average 4,938 947 22.0% 32.9% 42.3% 58.8% Source: Shared Research based on company data and factory’s sales are smaller than those of other companies that operate sites with gaming tips, but OPM is second-highest (GameWith is first), and ROA is comparatively high.

Manga apps Many companies in addition to and factory have manga apps (operate e-bookstores). The largest company is Amazon, followed by a number of listed companies and many others. Listed companies include Amutus Corporation (a subsidiary of Infocom Corporation [TSE1: 4348]), Papyless Co., Ltd. (TSE JASDAQ: 3641), Beaglee Inc. (TSE1: 3981), and eBOOK Initiative Japan Co., Ltd. (TSE1: 3658). Like its subsidiary, Amutus, Infocom competes with and factory in the manga apps business. Infocom has also moved into the healthcare-related IoT business, a sector that and factory intends to enter.

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Main companies involved in e-comics

Sources: Shared Research based on official journals and individual company data

Manga apps: Comparison with major competitors Ticker Company Fiscal Sales OP OPM ROA ROE Equity Businesses year (JPYmn) (JPYmn) (RP-based) ratio (% of sales) 4348 Infocom FY03/18 45,774 5,829 12.7% 16.8% 17.9% 73.2% Business Solution (54), Digital Entertainment (46) 3678 Media Do FY02/18 37,213 930 2.5% 3.1% 8.7% 15.3% E-books (97), media promotion (2), other (1) 3641 Papyles FY03/18 16,202 1,278 7.9% 14.7% 17.2% 60.4% Sales of e-books (100) 3658 eBOOK Initiative Japan FY03/18 11,882 254 2.1% 5.1% 5.5% 58.4% E-books (63), cross media (37) 3981 Beaglee FY12/17 8,972 1,125 12.5% 14.8% 16.3% 64.7% Content platform business (100) 7035 and factory FY08/18 1,916 365 19.1% 37.7% 80.7% 34.3% Smartphone APP (57), IoT (42), Other (1) Average 20,327 1,630 9.5% 15.4% 24.4% 51.0% Source: Shared Research based on company data

Although its sales are smaller than competitors in the e-comics business, and factory has the highest OPM. Similarly, and factory is the leader in terms of efficiency indicators (ROA and ROE).

IoT business Real estate transactions are often characterized by information asymmetry between buyer and seller. A wave of “real estate tech” companies has entered the market, aiming to reduce these asymmetries by using internet, big data, AI, and other technologies. For example, portal and online appraisal sites offer property pricing information. Builders can use crowdfunding to raise money from individual investors over the internet to construct condominiums or buildings, and AI can be used to analyze property values.

Although these companies exist, few are taking the same approach as and factory, using smartphone apps as leverage to enter the real estate business. Shared Research believes Robot Home Co., Ltd. (subsidiary of TATERU, Inc. [TSE1: 1435]) serves as a useful reference.

◤ Robot Home Co., Ltd. (subsidiary of TATERU, Inc.* [TSE1: 1435]) provides “Apartment kit,” a smartphone-based property management app for apartment owners and “TATERU kit,” an app aimed at people who live in TATERU apartments. TATERU kit can be used to open and close smartphone-activated doors and provide security by using smartphones linked with tags. The app for IoT-enabled equipment also allows the use of smartphones for controlling air conditioners, televisions, other

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home electronics, and lighting. It also offers features through which tablets inside of apartments serve as central controllers, facilitating chats with the management company.

* TATERU, Inc. (TSE1: 1435): The company operates TATERU Apartment**, an apartment management platform it developed. This platform handles a variety of services, such as providing land information, facilitating the planning and construction of designed apartments, and managing rentals. **This platform matches people online (via smartphone) who are interested in managing apartments with people who own land. It also provides a host of other services, such as proposing IoT apartments, construction services, and rental management.

IoT business: Comparison with reference companies Ticker Company Fiscal Sales OP OPM ROA ROE Equity Businesses year (JPYmn) (JPYmn) (RP-based) ratio (% of sales) 6047 TATERU FY12/18E 76,611 7,113 9.3% - - - Apartment (97), Funding (1), bnb (1), Robot Home (2) 7035 and factory FY08/19E 3,070 511 19.1% - - - Smartphone APP (57), IoT (42), Other (1) - Robot Home FY12/18E 1,246 336 9.5% - - - Rental apartment management app, IoT device app Average 39,841 3,812 14.2% - - - Source: Shared Research based on company data Note: Forecast figures for Robot Home, a subsidiary of TATERU, are based on the upcoming fiscal year’s forecast for TATERU’s segment. The sales composition for and factory is based on FY08/18 performance.

and factory has a higher OPM than Robot Home, due to a higher OPM in the Smartphone Apps business.

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Strengths and weaknesses

Strengths

◤ UI/UX technologies and data, data analysis, and monetization methods accumulated in the smartphone business: The company was established in 2014 to consider and pursue business possibilities involving smartphones. Since then, and factory has accumulated UI/UX technologies and data related to conversion that is central to the Smartphone Apps business. The ability to analyze and steadily monetize that data helped the company become profitable in its second year. UI/UX design is important because of the role it plays in the “conversion” of smartphone users (persuading users to tap on ads on their smartphone screens, register as members, send inquiries, or buy products). Its UI/UX design capabilities helped and factory get started in the new business category of free manga apps and, despite being a latecomer, develop the e-comics industry’s third-largest customer base in just two years (MAUs in August 2018: 2.6mn).

◤ Unique approach and foresight in the IoT business: The prospect of everything being connected over the internet leads many companies to see IoT as a potential growth business and the key to their future success, with mixed results. and factory has taken a more focused approach, looking specifically at introducing IoT in industries where the adoption of technology is lagging: real estate, housing, and healthcare. Also, in the IoT business, the company is leveraging expertise gained through the Smartphone Apps business (UI/UX technologies and data, data analysis, and monetization methods). Within the IoT business, the company has already become profitable in &AND HOSTEL. These smart hostels, which the company plans, develops, and operates, help guests experience IoT devices firsthand. The company has created a platform app, called &IoT. The company worked with the manufacturers of IoT devices, obtained application programming interfaces (APIs) for their devices and then developed &IoT by integrating apps that operate individually on various IoT devices into a single app. The company is seeking to add value by linking &IoT with innto (a property management system) and tabii (a tablet-based service for lodging facilities).

◤ Youthful team leads to a flexible and strategic culture of open innovation and swift decision-making: The company’s employees are young (average age of 32) and led by a youthful management team. Three board members were born in the 1980s, including Takamasa Ohara (president, born in 1984), Rinji Aoki (born in 1983 and in charge of the Smartphone Apps business), and Yuki Umemoto (born in 1980 and in charge of the IoT business). Many core members of the management team and employees were recruited directly by President Ohara through his connections as a university student or companies where he worked after graduating. Therefore, many employees have a shared common ground, which facilitates communications. The company prides itself on having the flexibility to take on new challenges and monetize businesses quickly. and factory also pursues open innovation with publishers (Square Enix, Hakusensha, and Shueisha) and other large companies (NTT Docomo and TEPCO Energy Partner).

Weaknesses

◤ Most intellectual property is owned by business partners: and factory is a platform provider rather than a content producer. The development of smartphone games, manga, and other IP requires huge investments of time and money, and the chances of failure are high. For this reason, rather than developing IP itself the company tends to source these assets from other companies or enter alliances for development and operation. Taking less risk means the company reaps commensurately lower rewards than IP owners obtain when their ventures are successful.

◤ A young company that knows only success: Established in 2014, sales have grown by a CAGR of 158% in the three years leading up to FY08/18. The company became profitable on an operating basis in its second year, and operating profit has grown by a CAGR of 224% in FY08/17 and FY08/18. In other words, the company has never experienced any major failures. Shared Research thinks the company may be risk-averse as a result, as employees are afraid to take on projects that may not sustain this success, and may be unresponsive to significant changes in the outside environment.

◤ No experience in training new graduates: Until the hire of one new graduate in April 2019, the company has hired core employees entirely from other companies and through direct connections, and has no experience training new graduates. All hires where therefore mid-career, work-ready people rather than inexperienced new graduates. At present, the company has no framework for training human resources over the medium term.

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Historical results and financial statements Income statement

Income statement FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent Sales 112 372 689 1,916 YoY - 231.9% 85.2% 178.3% Cost of sales - 205 182 803 Gross profit - 166 506 1,114 YoY - - 204.4% 120.0% GPM - 44.7% 73.5% 58.1% SG&A expenses - 132 282 748 SG&A ratio - 35.4% 41.0% 39.1% Operating profit -40 35 224 365 YoY - - 543.8% 63.2% OPM -35.7% 9.3% 32.5% 19.1% Non-operating income (expenses) - 4 5 2 Interest income -000 Commission income - - 1 - Outsourcing fees - - 2 - Gain on donation of noncurrent assets - - 1 - Tax refunds - - - 0 Subsidy income - - - 2 Other income -400 Non-operating expenses - 1 5 6 Interest expenses - 1 1 6 Rents - - 3 - Guarantee fees - - 0 1 Other expenses - 0 0 0 Recurring profit -42 37 223 361 YoY - - 500.8% 61.5% RPM -37.5% 10.0% 32.4% 18.8% Extraordinary gains - - - - Extraordinary losses - 8 16 4 Income taxes -203497 Implied tax rate - 68.6% 16.3% 27.0% Minority interests - - - Ne t in c o me -43 -6 174 261 YoY - - - 49.9% Net margin -38.2% -1.7% 25.3% 13.6% Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods. SG&A expenses FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent Directors' bonuses 35 41 Salaries and allowances 31 51 102 Hiring and training expenses 9 Advertising expenses 47 293 Compensations 16 29 R&D expenses 10 19 Depreciation 10 Provision for doubtful accounts 1 -0 0 Provision for bonuses 3 16 Other 0 84 87 276 Total 0 132 282 748 Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods.

In the three years leading up to FY08/18, the company achieved an average annual sales growth of 158%. The company became profitable on an operating basis in FY08/16, its second year after establishment. Average annual growth in operating profit has been 224% in the two years leading up to FY08/18.

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Results vs. Initial Est. FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent Sales (Initial Est.) - - - 1,810 Sales (Results) 112 372 689 1,916 Results vs. Initial Est. - - - 5.9% Operating profit (Initial Est.) - - - 343 Operating profit (Results) -40 35 224 365 Results vs. Initial Est. - - - 6.5% Recurring profit (Initial Est.) 337 Recurring profit (Results) -42 37 223 361 Results vs. Initial Est. - - - 7.1% Net income (Initial Est.) 220 Net income (Results) -43 -6 174 261 Results vs. Initial Est. - - - 18.4% Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods. Profit margins FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent Gross profit - 166 506 1,114 GPM - 44.7% 73.5% 58.1% Operating profit -40 35 224 365 OPM -35.7% 9.3% 32.5% 19.1% EBITDA - 91 244 397 EBITDA margin - 24.6% 35.4% 20.7% Net margin - -1.7% 25.3% 13.6% Financial ratios ROA (RP-based) - 16.9% 57.5% 37.7% ROE - -18.9% 164.7% 80.7% Total asset turnover - 1.69 1.69 2.00 Inventory turnover - - 3.4 13.0 Days of inventory - - 107.5 28.1 Working capital - 82 224 256 Current ratio - 121.4% 183.6% 172.4% Quick ratio - 121.8% 139.7% 166.7% OCF / Current liabilities - 0.23 0.22 1.13 Net debt / Equity - 81.7% 33.4% -70.7% OCF / Total liabilities - 0.2 0.1 0.6 Cash cycle (days) - 63.5 135.2 52.1 Changes in working capital - 82 142 32 Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods.

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Balance sheet

Balance sheet FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent ASSETS Cash and deposits 79 172 672 Notes and accounts receivable 103 129 302 Inventories - - 108 16 Merchandise and finished goods - 0 16 Real estate for sale in process - 107 - Prepaid expenses 5 12 14 Advances paid 54286 Deferred tax assets - 8 22 Other - 11014 Allowance for doubtful accounts -1 -0 -1 Total current assets 193 480 1,126 Buildings and structures 1 39 62 Tools, furniture, and fixtures 2 16 28 Accumulated depreciation -2 -7 -16 Total tangible fixed assets 1 48 74 Total intangible fixed assets - 32 41 Investment securities 1 1 11 Deferred tax assets - 8 13 Other 25 24 57 Investments and other assets 26 33 81 Total fixed assets 27 113 196 Total assets 220 594 1,323

LIA BILITIES Notes and accounts payable 21 13 63 Short-term debt - 80 97 136 Short-term borrowings 65 65 65 Current portion of bonds 15 32 71 Accounts payable–other 30 101 285 Income taxes payable 20 39 91 Provision for bonuses - 9 24 Provision for directors' bonuses - - 16 Other - 27 2 39 Total current liabilities 159 262 653 Long-term debt - 27 140 216 Long-term borrowings 27 140 216 Other ---- Total fixed liabilities 27 140 216 Total interest-bearing debt - 107 237 352 Total liabilities 185 401 870 Net assets Capital stock 34 34 34 Capital surplus 33 33 33 Retained earnings -34 125 385 Treasury stock --- Total net assets 34 192 453 Total liabilities and net assets 220 594 1,323 Working capital - 82 224 256 Total interest-bearing debt - 107 237 352 Net debt - 28 64 -320 Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods.

Current assets account for 85% of total assets. On the other side of the balance sheet, however, long-term borrowings account for 27% of total liabilities and net assets. Accounts payable in relation to the IoT business also account for 22% (in FY08/18; the company was listed in September 2018).

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Cash flow statement

Cash flow statement FY08/15 FY08/16 FY08/17 FY08/18 (JPYmn) Parent Cons. Parent Parent Cash flows from operating activities (1) 36 46 516 Pretax profit 29 208 357 Depreciation 572032 Amortization of goodwill - - - Increase (decrease) in accounts receivable -76 -38 -173 Increase (decrease) in inventories - -108 92 Increase (decrease) in accounts payable 19 -2 50 Other 8 -35 159 Cash flows from investing activities (2) -27 -94 -131 Purchase of tangible fixed assets -9 -60 -67 Purchase of intangible fixed assets -0 -34 -22 Payments and collection of guarantee deposits -17 3 -31 Purchase of investment securities - - -10 Other -0 -4 -11 Free cash flow (1+2) - 10 -48 385 Cash flows from financing activities 22 130 116 Change in short-term debt 65 Change in long-term debt -43 130 116 Acquisition of treasury stock - - - Dividends paid - - - Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods. Cash flows from operating activities Operating activities continue to be a net source of cash.

Cash flows from investing activities Investing activities continue to be a net cash outflow, mainly due to the acquisition of tangible and intangible fixed assets.

Cash flows from financing activities Prior to listing in September 2018, the company mainly raised funds through long-term borrowings.

Per share data FY08/15 FY08/16 FY08/17 FY08/18 (JPY) Parent Cons. Parent Parent Shares issued (year-end:'000) 105.26 105.26 105.26 4,210.52 EPS -419.81 87.20 1,652.00 61.88 EPS (fully diluted) - - - - Dividend per share - - - - Book value per share 238.22 325.60 1,828.80 107.60 Per Share Data (split adjusted; JPY) FY08/15 FY08/16 FY08/17 FY08/18 Stock split adjustment factor 40 40 40 1 Shares issued (year-end:'000) 4,210.52 4,210.52 4,210.52 4,210.52 EPS -10.50 -1.53 41.30 61.88 EPS (fully diluted) - - - - Dividend per share - - - - Book value per share 5.96 4.42 45.72 107.60 Source: Shared Research based on company data Note: Figures may differ from company data due to differences in rounding methods.

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Historical performance

1H FY08/19 results Overview

◤ 1H FY08/19 (non-consolidated): Sales were JPY995mn (the company did not compile half-year financial statements in 1H FY08/18), operating profit was JPY103mn, recurring profit was JPY82mn, and net income was JPY55mn. Sales and operating profit exceeded the company forecast by 8.2% and 1,187%, respectively. The company plans to use the amounts that exceeded forecast in 1H for investment in 2H.

◤ 1H sales reached 32.4% of the full-year company forecast, while operating profit reached 20.1%. Through FY08/18, the cycle from investment to recovery lasted two years, but, in FY08/19, the company plans to recover investments made in 1H during 2H.

◤ Sales: JPY995mn (the company did not compile half-year financial statements in 1H FY08/18). In the Smartphone Apps business, sales were JPY814mn (+74.7% YoY), while sales reached JPY152mn (+13.1% YoY) in the IoT business. Sales for Other businesses totaled JPY29mn (+8.6% YoY). The Smartphone Apps business and the IoT business accounted for 81.8% and 15.2% of total sales, respectively. Other businesses had a 2.9% share of total sales.

◤ Operating profit: JPY103mn (the company did not compile half-year financial statements in 1H FY08/18). In the Smartphone Apps business, operating profit was JPY264mn (+36.5% YoY). Operating loss in the IoT business was JPY35mn (versus operating profit of JPY32mn in 1H FY08/18), while Other businesses recorded JPY9mn in operating profit. The Smartphone Apps business accounted for 115.3% of total operating profit, the IoT business for -23.1%, and Other businesses for 8.4%.

Results by business Smartphone Apps business Sales were JPY814mn (+74.7% YoY), and operating profit was JPY264mn (+36.5% YoY). Manga UP! and Manga Park (manga apps developed in collaboration with Square Enix Co., Ltd. and Hakusensha, Inc., respectively) both saw solid growth, as initiatives including aggressive advertising and the release of new manga series boosted monthly active users (MAU), and new manga additions lifted average revenue per user (ARPU). Manga Mee, a manga app of Shueisha’s girls’ manga made available to users every day, has also seen solid growth in MAU and APRU since its release in November 2018. MAU of and factory’s manga apps grew 141.3% YoY to 3.62mn users. ARPU, which is calculated by dividing sales by MAU, rose 54.5% YoY.

The company announced that it concluded a business alliance agreement with Nihon Bungeisha Co., Ltd., a wholly owned subsidiary of RIZAP Group (SSE Ambitious: 2928), with regards to the planning, development, and operation of Nihon Bungeisha’s manga app. This agreement with Nihon Bungeisha had not been anticipated at the beginning of FY08/19. The two companies will select and distribute works, mainly those published in manga magazines such as Weekly Manga Goraku and Comic Heaven, as well as publish original works exclusively on the app, targeting high-ARPU users in their 20s to 30s.

IoT business Sales were JPY152mn (+13.1% YoY), and operating loss was JPY35mn (compared with an operating profit of JPY32mn in 1H FY08/18). In this business, progress in terms of planning and development of the &AND HOSTEL brand of smart hostels (lodging facilities offering experiences made possible through IoT) contributed to solid revenue from consulting and real estate brokerage fees related to developing hostels. In February 2019, and factory newly opened &AND HOSTEL NINOWA and &AND HOSTEL ASAKUSA. At end 1H FY08/19, innto (lodging management system) was in use at 171 facilities (+24 versus end Q1 FY08/19) and total facilities adopting tabii (a guest room tablet service) had increased thanks to its introduction at Henn na Hotel Kyoto among other facilities (1,338 tablets in operation as of February 28, 2019). On the other hand, operating loss grew due to active investment, such as set-up costs for &AND HOSTEL and increased expenses for hiring business development personnel, which is associated with heightened expansion of innto and tabii.

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Other businesses In this segment, the company mainly provides internet advertising agency services and produces articles. Sales were JPY29mn (+8.6% YoY), and operating profit was JPY9mn (information regarding operating profit was not disclosed in 1H FY08/18).

Q1 FY08/19 results Overview

◤ Q1 FY08/19 (non-consolidated): Sales were JPY470mn (the company did not compile quarterly financial statements in Q1 FY08/18), operating profit was JPY42mn, recurring profit was JPY37mn, and net income was JPY25mn. Sales exceeded the company forecast of JPY420mn by 11.9%, and operating profit exceeded the company forecast of JPY5mn by 740.0%.

◤ Q1 sales reached 15.3% of the full-year company forecast, while operating profit was 8.3%, recurring profit was 7.4%, and net income was 7.2%. Through FY08/18, the cycle from investment to recovery lasted two years, but, in FY08/19, the company plans to recover investments made in 1H during 2H.

◤ Sales: JPY470mn (the company did not compile quarterly financial statements in Q1 FY08/18). In the Smartphone Apps business, sales were JPY394mn (+94.1% YoY), while sales reached JPY66mn (+74.0% YoY) in the IoT business. Sales for Other businesses totaled JPY9mn (-33.5% YoY). The Smartphone Apps business and the IoT business accounted for 83.9% and 14.1% of total sales, respectively. Other businesses had a 2.0% share of total sales.

◤ Operating profit: JPY42mn (the company did not compile quarterly financial statements in Q1 FY08/18). In the Smartphone Apps business, operating profit was JPY124mn (+33.8% YoY). Operating loss in the IoT business was JPY24mn (versus JPY7mn in operating loss in Q1 FY08/18), while Other businesses recorded JPY6mn in operating profit. The Smartphone Apps business accounted for 116.5% of total operating profit, the IoT business for -22.0%, and Other businesses for 5.5%.

Results by business Smartphone Apps business Sales were JPY394mn (+94.1% YoY), and operating profit was JPY124mn (+33.8% YoY). Contributing to the increases were Manga UP!, which the company developed with Square Enix Co., Ltd., and Manga Park, a manga app that and factory developed in collaboration with Hakusensha, Inc. Both apps were launched during FY08/17. In November 2018, the company released Manga Mee, a manga app that allows users to read manga for young girls published by Shueisha daily. In the initial stages following its release, this app ranked second among apps in the book category, recording one of the top results among the company’s series of manga apps. Active advertising and promotion and the launch of a new comic series pushed up the average number of monthly active users (MAUs; Shared Research estimates that the number of MAUs of manga apps rose 153% YoY to JPY2.73mn). ARPU, which is calculated by dividing sales by MAU, rose 84% YoY.

Through COMIAD, an ad network specializing in manga apps, the company plans to initially sell advertising space in its own manga apps. In the next phase, it plans to establish a large manga network that includes manga apps from other companies. The company has begun a pilot ad network using its own manga apps and has already received many inquiries from other companies wishing to add their manga apps to the network. As such, it is considering to advance into the second phase of its plan ahead of schedule.

In December 2018, and factory launched Comic every, a new manga app, with Beaglee, which manages Manga Oukoku, one of the largest e-comics site in Japan. This app takes advantage of the company’s capacity for development and management and Beaglee’s ability to source extensive content.

IoT business Sales were JPY66mn (+74.0% YoY), and operating loss was JPY24mn (compared with an operating loss of JPY7mn in Q1 FY08/18). In this business, performance was strong in terms of planning and development of the &AND HOSTEL brand of smart hostels (lodging facilities offering experiences made possible through IoT). When developing these hostels, the company generated revenue from consulting and real estate brokerage. At end-Q1 FY08/19, innto (a property management system) was in use with 147 facilities (+58 versus end-FY08/18) and total facilities adopting tabii (a guest room tablet service) had increased thanks to its

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introduction at Henn na Hotel Haneda and other facilities. On the other hand, operating loss grew due to active investment, such as set-up costs for &AND HOSTEL and increased costs associated with heightened expansion of innto and tabii.

Other businesses In this segment, the company mainly provides internet advertising agency services and produces articles. Sales were JPY9mn (-33.5% YoY), and operating profit was JPY6mn (information regarding operating profit was not disclosed in Q1 FY08/18).

FY08/18 results Overview FY08/18 (non-consolidated): Sales were JPY1.9bn (+178.3% YoY), operating profit was JPY365mn (+63.2% YoY), recurring profit was JPY361mn (+61.5% YoY), and net income was JPY261mn (+49.9% YoY). These figures outpaced the company’s forecast for sales (by 5.9%), operating profit (by 6.5%), recurring profit (by 7.1%), and net income (by 18.4%).

Sales Sales rose 178.3% YoY, to JPY1.9bn. In the Smartphone Apps business, sales grew 82.0% YoY, to JPY1.1bn, and in the IoT business surged 517.4% YoY, to JPY803mn. In the Smartphone Apps business, sales outpaced the company’s forecast by 11.7%. In the IoT business, sales were slightly lower than forecast (down 0.8%). As a percentage of total sales, the Smartphone Apps business accounted for 57.4%, the IoT business for 41.7%, and Other businesses for 0.9%.

Operating profit Operating profit expanded 63.2% YoY, to JPY365mn. In the Smartphone Apps business, operating profit was JPY480mn (+21.7% YoY). In the IoT business, operating profit was JPY142mn, compared with an operating loss of JPY30mn in the preceding year. The Smartphone Apps business accounted for 77.0% of total operating profit, the IoT business for 22.8%, and Other businesses for 0.2%.

Results by business Smartphone Apps business Sales were JPY1.1bn (+82.0% YoY), and operating profit was JPY480mn (+21.7% YoY). Contributing to the increases were Manga UP!, which the company developed with Square Enix Co., Ltd., and Manga Park, a manga app that and factory developed in collaboration with Hakusensha, Inc. Both apps were launched during FY08/17. Active advertising and promotion and the launch of a new comic series pushed up the average number of monthly active users (MAUs) from 1.3mn in Q4 of FY08/17 to 2.9mn in Q4 of FY08/18. At the same time, average revenue per user (ARPU) rose as the result of measures to extend publication of popular content and introduce new works. (In August 2018, ARPU was up 14.2% YoY.) In the Saikyo Series, the company made ongoing UI improvements while focusing on providing advertising services that generate stable earnings. It also stepped up alliances with partner companies. Sales were robust as a result.

IoT business Sales were JPY803mn (+517.4% YoY), and operating profit was JPY142mn (compared with an operating loss of JPY30mn in FY08/17). In this business, performance was strong in terms of planning and development of the &AND HOSTEL brand of smart hostels. When developing these hostels, the company generated revenue from consulting and real estate brokerage. The company also sold one facility it had developed independently (&AND HOSTEL ASAKUSA STATION).

Other businesses In this segment, the company mainly provides internet advertising agency services and produces articles. Sales were JPY17mn (-22.8% YoY), and operating profit was JPY1mn (an operating loss of JPY1mn in FY08/17).

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Q3 FY08/18 results Overview In cumulative Q3 FY08/18, sales were JPY1.0bn, operating profit was JPY209mn, recurring profit was JPY206mn, and net income was JPY134mn. (No YoY comparisons are provided, as the company prepared no quarterly financial statements in Q3 of FY08/17.) These figures represented a 56.0% achievement of the company’s full-year forecast for sales, 61.0% for operating profit, 61.1% for recurring profit, and 60.9% for net income. In the Smartphone Apps business, the company concentrated on expanding revenue from existing smartphone apps and releasing new apps through joint development with other companies. In the IoT business, the company focused on launching &AND HOSTEL-brand smart hostels.

Results by business Smartphone Apps business In this business, sales were JPY758mn and operating profit was JPY303mn. Aggressive advertising and the addition of new content lifted MAUs for the company’s jointly developed manga apps: Manga UP! (with Square Enix Co., Ltd.) and Manga Park (with Hakusensha, Inc.). ARPU also rose, owing to extended runs for popular content and the addition of new works. These app services have remained popular since their launch in FY08/17. In the Saikyo Series, the company concentrated on making ongoing UI improvements and generating stable earnings through the provision of advertising services. and factory also strengthened ties with partner companies, leading to solid segment sales.

IoT business Sales were JPY240mn and operating profit was JPY69mn. The company made favorable progress on the planning and development of the &AND HOSTEL brand of smart hostels (lodging facilities with rooms that offer high IoT connectivity). As a result, the company saw a steady increase in fees from consulting on hostel development and real estate brokerage. In March 2018, the company launched innto, a property management system, with an open innovation partner.

Other businesses Sales from Other businesses amounted to JPY15mn, and operating profit was JPY2mn. The company mainly provided internet advertising agency services and produced articles.

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Other information

History

Date Description September 2014 Company established October 2014 Entered the Smartphone Apps business by acquiring Dokodemo Mirror, a smartphone app, from Ignis Ltd. Began offering an iOS version of the Saikyo Series bulletin board-style app where users can exchange tips and tricks and recruit co-players April 2015 Entered a capital alliance with Ignis Ltd. June 2016 Opened &AND HOSTEL, a smart hostel, in Fukuoka, marking the launch of the IoT business January 2017 Launched iOS and Android versions of Manga UP!, a smartphone manga app, in collaboration with Square Enix Co., Ltd. April 2017 Opened &AND HOSTEL ASAKUSA NORTH May 2017 Opened &AND HOSTEL UENO June 2017 In collaboration with the city of Yokohama and NTT Docomo, Inc., began operating the Homes of the Future project, which leverages IoT Smart Home August 2017 Launched iOS and Android versions of Manga Park, a smartphone manga app, in collaboration with Hakusensha, Inc. February 2018 Opened &AND HOSTEL AKIHABARA March 2018 Opened &AND HOSTEL KANDA Began providing innto, a property management system for simple lodging facilities, which was developed in collaboration with Almec Corporation, of the USEN-NEXT Group May 2018 Developed and began offering tabii, a tablet-based service for hotel rooms September 2018 Listed on the Mothers Market of the Tokyo Stock Exchange October 2018 Launched COMIAD, an ad network service that bundles ad space on multiple manga apps October 2018 Announced business alliance with TEPCO Energy Partner, Inc., in the tablet service business November 2018 Launched iOS and Android versions of Manga Mee, a smartphone manga app, in collaboration with Shueisha Inc.

Source: Shared Research based on company data

The company was established in September 2014 as a wholly owned subsidiary of famous, Inc., which itself had been established in May 2012 by Takamasa Ohara (and factory’s CEO) to conduct business as an advertising agency. While running famous, President Ohara became aware of business opportunities in the smartphone apps business, so he set up a subsidiary to pursue the business full time. In October 2014, President Ohara and other directors of famous acquired the company’s shares, as they believed that further expansion of the smartphone apps business would require independence.

Mission and factory sees itself as a “smartphone idea company” that pursues business opportunities that smartphones make possible. The company’s employees have varied backgrounds and the company encourages them to leverage their areas of expertise to generate ideas and actively pursue areas with new potential. As the “and” in its name suggests, the company’s mission is to provide services that make people’s lives more fulfilling by bringing a little “something extra” to their everyday lives.

News and topics April 2019 On April 22, 2019, the company announced the sale of real estate for sale.

Sale of property developed by the company in the &AND HOSTEL smart hostel business, which had been planned for Q4

▷ Purchaser: Not disclosed, at request of the purchaser ▷ Sale price: Not disclosed, at request of the purchaser (the sale price is equal to or greater than roughly 10% of the company’s FY08/18 sales of JPY1.9bn) ▷ Contract conclusion date: April 26, 2019 (planned) ▷ Repayment of funds: The company plans to repay debt from financial institutions following the sale

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On the same day, the company announced a revision to its full-year FY08/19 forecasts.

Revisions to full-year FY08/19 forecasts

▷ Sales: JPY3.9bn (previous forecast: JPY3.1bn) ▷ Operating profit: JPY511mn (no change to previous forecast) ▷ Recurring profit: JPY504mn (no change to previous forecast) ▷ Net income attributable to parent company shareholders: JPY350mn (no change to previous forecast) ▷ EPS: JPY75.42 (no change to previous forecast)

Reasons for the revision

▷ The company revised up its sales forecast because the sale of real estate held for sale announced on the same day involved a property larger in scale than originally expected, and the sale price greatly exceeded initial forecast. ▷ Meanwhile, initial forecasts for operating profit, recurring profit, and net income all remained unchanged. This is because the company is prioritizing medium- to long-term growth and looking to invest aggressively in growth areas while assessing the

current business environment. In specific, it plans to invest in advertising expenses to accelerate manga app growth and expand recruitment of personnel in the Smartphone Apps and IoT businesses. ▷ The following factors, with the potential to cause changes, will arise in Q3 and Q4: Completion of app development and continuous investment in growth areas. Even so, the company plans to secure its revised sales and initial operating income targets for the full year.

On April 12, 2019, the company announced that it concluded a business alliance agreement with Nihon Bungeisha Co., Ltd., a wholly owned subsidiary of RIZAP Group (SSE Ambitious: 2928), with regards to the planning, development, and operation of Nihon Bungeisha’s manga app.

On the same day, the company announced that it decided to borrow JPY600mn to fund the purchase of real estate for sale.

Corporate governance and top management

Form of organization and capital structure Controlling shareholder None Parent company ticker - Directors Number of directors under Articles of Incorporation 10 Directors' terms under Articles of Incorporation 1 year Number of independent outside directors 1 Audit & Supervisory Board Number of members of Audit & Supervisory Board under Articles of Incorporation 10 Number of independent outside members of Audit & Supervisory Board 2 Other Number of independent outside officers (directors and members of Audit & Supervisory Board) 3 Part icipat ion in elect ronic vot ing plat form None Other initiatives to enhance voting rights of investors None Providing convocation notice in English None Disclosure of directors' compensation None Disclosure of executive officers' compensation None Policy on determining amount of compensation and calculation methodology In place Takeover defenses None Source: Shared Research based on company data

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Top management Takamasa Ohara, President and Representative Director Born in August 1984, Ohara started a number of companies between his days as a university student and the launch of and factory. He joined CA Mobile in April 2009. That June, he was dispatched to a subsidiary, zeronana Inc. He established docks Inc. in 2011, famous Inc. and Tsutekoto Inc. (now Eichi, Inc.) in 2012, and Day’s Inc. in 2014. As explained in the History section above, and factory was formed in September 2014 as a wholly owned subsidiary of famous, Inc. In October, Ohara and other directors acquired and factory’s shares from famous, Inc., with the aim of expanding the company.

President Ohara explains that when he established the company, he brought together people with whom he had come into contact through work since his 20s. Qian Kun, CEO of IGNIS Ltd. (TSE Mothers: 3689), was an older colleague of Ohara’s when they were both at zeronana, a subsidiary of CA Mobile. IGNIS is one of the major shareholders of the company.

Rinji Aoki, Director (in charge of the Smartphone Apps Division) Born in November 1983. Joined CA Mobile in 2006. Dispatched to zeronana Inc. in 2008. Joined docks, Inc. in 2012. Became a director of and factory in 2015. Was a colleague of President Ohara at zeronana, a CA Mobile subsidiary, when Ohara was stationed there. Has led the company’s Smartphone Apps business since its founding.

Yuki Umemoto, Director (in charge of the IoT Division) Born in September 1980. Joined Fujitsu Ten Ltd. (now Denso Ten Corp.) in 2004. Joined GREE, Inc. in 2010. In 2013, joined FreakOut Inc. (now FreakOut Holdings, Inc.). Became an executive officer at curations Inc. in 2015. Joined the company in January 2016. Appointed executive officer in August 2016 and named director in 2017.

Ryo Mizutani, Director (in charge of Corporate Division) Born in April 1983. Joined Daiwa Securities SMBC (now Daiwa Securities Co. Ltd.) in April 2007. Became a director at and factory in November 2014. Took charge of and factory’s Corporate Division based on his specialized knowledge and expertise in the field of finance. Was a friend of President Ohara’s during his student years.

Corporate governance and factory has put a management and administrative structure based on its fundamental shareholder orientation in place, with policies focused on expanding earnings as a sustainable company and enhancing corporate value. The company also strives to increase management efficiency and speed. Recognizing its corporate responsibility to society, the company provides various services that contribute to society and seeks to achieve harmony among parties that hold an interest in the company.

To ensure the transparency and objectivity of its business activities, when putting a management and administrative management system in place, the company intends to establish a structure for monitoring the business execution process and disclosing information in a timely manner.

Dividend policy

The company recognizes shareholder returns as an important management priority. However, having been established only recently, the company believes that, rather than dividends, the best ways to increase shareholder returns are augmenting retained earnings in preparation to expand the business; increasing working capital in order to build a robust financial system and increase the company’s operations; and making capital investments.

For this reason, and factory has paid no dividends since its establishment, and the company plans to continue expanding retained earnings for the foreseeable future. While concentrating on boosting profitability and expanding its base of operations, and factory plans to provide shareholders with stable ongoing returns, taking the status of retained earnings expansion and the business environment surrounding the company into consideration. Furthermore, the company has no current plans regarding the potential timing or amount of dividends.

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If the company does pay dividends from surplus, its fundamental policy is to pay these dividends annually, at the end of the fiscal year, with the dividend amount determined at the general meeting of shareholders. The company’s Articles of Incorporation provide for the issuance of interim dividends, based on a resolution by the Board of Directors.

Major shareholders

Shareholding Top shareholders Shares held ratio

Takamasa Ohara 2,535,600 60.2% Shu Takehana 493,960 11.7% Rinji Aoki 435,600 10.3% IGNIS Ltd. 210,520 5.0% Ryo Mizutani 135,120 3.2% Yohei Iimura 130,920 3.1% Ikuo Ishida 72,760 1.7% Yuki Umemoto 54,560 1.3% Yasuhiro Suzuki 36,520 0.9% Yuki Umetani 36,400 0.9% Mitsuhisa Toya 36,400 0.9% Shares issued (as of August 31, 2018) 4,210,520 100.0%

Source: Shared Research based on company data

Employees

FY08/15 FY08/16 FY08/17 FY08/18 Number of employees 8 17 41 65

YoY - 112.5% 141.2% 58.5% Source: Shared Research based on company data

Glossary

UI/UX: A user interface (UI), which refers to all information the user sees, such as designs, fonts, and external appearance. The user experience (UX) describes the feelings and sensations the user experiences through a product or service.

Ad network: An arrangement in which multiple advertising media (such as websites, social media, blogs, etc.) are bundled together to create an ad distribution network. It allows advertisers to place ads across multiple publishers without having to deal with each publisher individually.

Affiliate: An arrangement through which an advertiser’s products or services are made available within a third-party app or site. The company managing the app or site receives compensation (advertising revenue) if the user purchases the products or services.

API: An application programming interface is a set of subroutine definitions, communication protocols, and tools for building software that provides building blocks for computer programs. An API allows applications and programs to interact with other software and functions.

Fourth Industrial Revolution: Technological innovation in areas such as IoT (described below), big data, and artificial intelligence. (AI) is a core element of this revolution. “Big data” refers to massive quantities of data that are difficult to register, store, manage, and analyze using conventional database management systems. “Artificial intelligence” indicates intelligence that resides in artificial (i.e., not human) computer systems and is capable of learning, reasoning, recognizing, and decision-making.

ICT: Information and communication technology

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IoT: Short for the Internet of Things, IoT describes the concept of physical items being connected over the internet. IoT may refer to new services that make this concept a reality, to a business model, or to elemental technologies. Some industry pundits believe that the ability to connect a wide range of items over the internet, collect resulting data, and analyze and make use of this data will make the provision of innovative, high-value-added functions and services possible.

IoT device: A device that can be connected to the internet. The 2017 White Paper on Information and Communications in Japan describes an IoT device as “a device that has a unique IP address and can be connected to the internet. These electronic devices are broad in scope, ranging from devices used as sensor network terminals to devices with computing functions.” Worldwide, the number of IoT devices is expected to grow from an estimated 17.3 billion in 2017 to more than 30.0 billion in 2020.

Labor force: The number of people aged 15 years or more who are able and willing to work.

MAUs: The number of monthly active users (MAUs) indicates the number of people who use an app in a given month.

Multiplay: The ability to play smartphone game apps with other users.

On-premise: Servers, software, and other information systems located within facilities managed by their users

Open innovation: Bringing together knowledge and technologies from a broad range of sources when developing new technologies and products.

Platform: The foundation upon, or environment in, which applications operate.

Revenue share: The allocation of obtained revenue to partner companies according to standards set in advance.

Test marketing location: A location where products under development can be provided to target consumers to gauge their reactions.

Profile

Company Name Head Office 1F and 2F, Sumitomo Fudosan Aobadai Tower and factory, inc. 3-6-28 Aobadai, Meguro-ku, Tokyo, Japan Phone Listed On - Mothers market, Tokyo Stock Exchange Established Exchange Listing September 16, 2014 September 9, 2018 Website Fiscal Year-End https: //andfactory.co.jp/ August 31 IR Contact IR Web - https: //andfactory.co.jp/ir/

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