Business and Other Risks
The Nippon Paint Group operates a paint and coatings business on a global scale. We believe that the proper understanding and management of risks at our Group are essential for the sustainable growth of our businesses. Therefore, we have established a risk management system based on our Basic Policy on Internal Control Systems. This section contains forward-looking statements, and these statements are based on our judgments as of the filing date of the Annual Securities Report.
1. Risk Management System
We monitor risks associated with the business operations of our Group properly and continuously through reports and deliberations at meetings of the Board of Directors and Executive Management Committee and other important meetings.
In FY2020, we established a Risk Management Committee, which is chaired by the Representative Executive Officer and President of the Company, to replace the existing CSR Committee. This Risk Management Committee is responsible for discussing the management of important risks related to safety, the environment, compliance and other matters as well as for the continuous review and improvement of the internal control system of our Group. The Risk Management Committee meets regularly. Committee members monitor the status of establishment and operation of risk management systems (internal control systems) at our Group companies and discuss measures to appropriately deal with major risks affecting the entire Group. In addition, the Risk Management Committee has established subcommittees covering themes such as credit management and information management that require collaboration among Group companies and departments. These subcommittees are taking concrete actions to reduce risks.
Our Internal Audit Department conducts risk assessment surveys by collecting and analyzing risk information at important Group companies in Japan and other countries. The Internal Audit Department reports the survey results to the Audit Committee and the Representative Executive Officer and President and gives feedback to important Group companies in Japan and other countries in order to share information about issues and discuss policies for addressing risks. In this manner, the Internal Audit Department performs the internal audit function by monitoring the effectiveness of our Group’s risk management system (internal control system).
2. Risk Management Activities
The Nippon Paint Group’s partner companies and Nippon Paint Holdings’ business divisions conduct the cycle of risk management activities independently to effectively manage risks, while also using monitoring and reviews to spiral-up this cycle. The Risk Management Committee conducts the cycle of risk management activities throughout our Group through support, coordination, information sharing, and the receipt of reports involving our Group’s partner companies and our business departments. The goal is to appropriately deal with important risks and spiral-up of the risk management activity cycle by using monitoring and reviews.
3. Risks Related to Business Operations
(1) Risk of changes in our markets
Our Group’s products are used in a broad range of industries including automobiles, construction, construction materials, metal products, electrical machinery, and ships around the world, centered on China and other regions of Asia and Japan. As a result, our Group’s performance may be affected by changes in the economic conditions caused by changes in the business environment in countries and regions where our Group conducts manufacturing and sales activities. These changes are associated with geopolitical issues including Brexit and the U.S.-China trade war, natural disasters and progress with ending the COVID-19 pandemic. In particular, demand for paint and coatings products grows proportionally with population, GDP growth and urbanization. This demand is susceptible to changes in the markets caused by the deterioration of economic conditions in countries where our Group conducts business activities and in related industries.
Our Group will strive to achieve sustainable growth by pursuing aggressive M&A strategy and creating new demand such as by utilizing advanced technologies to develop anti-viral products and environmentally friendly products, promoting brand strategies and using the complementary supply of products among our Group companies. In addition, we will strengthen our presence in existing markets through aggressive marketing activities including digital marketing in order to achieve sustainable growth. However, there is no guarantee that these measures will be effective at maintaining or increasing demand. A decline in demand that exceeds our expectations may adversely affect the financial position and performance of our Group.
(2) Risk related to selling prices
Our Group determines selling prices by taking into consideration raw material prices, market needs, moves of competitors and other factors. Our Group takes actions to reduce the risk of fluctuations in raw material prices such as by monitoring raw material prices, reviewing procurement methods and strengthening cost management in order to increase the sales volume and secure profits through flexible pricing. In addition, we work on deploying products with a competitive advantage and reinforcing sales channels. However, a sudden and sharp increase in raw material prices and a decline in the selling prices of our Group’s products due to a decrease in the brand power of products or an increase in competition may adversely affect the financial position and performance of our Group due to decreases in revenue and earnings as a result of a decline in profitability.
(3) Risk related to overseas business activities
Our Group is aggressively expanding overseas businesses. Our operations have expanded to 29 countries and regions. In FY2020, overseas sales (after elimination of intersegment transactions) accounted for approximately 79% of total net sales. The primary risks that are expected concerning our overseas business activities are as follows. These risks, if they happen, may adversely affect the businesses, financial position, and performance of our Group.
a. Exchange rate volatility
The financial statements of our Group’s overseas subsidiaries are prepared in foreign currencies and are converted into Japanese yen when the consolidated financial statements are prepared. As a result, changes in the exchange rates of currencies such as the Chinese yuan, the U.S. dollar, and the Australian dollar against the Japanese yen may affect our Group’s financial position and performance even if there are no significant changes in our Group’s earnings on a local currency basis.
In addition, our Group conducts manufacturing and sales activities on a global scale through our overseas subsidiaries and has manufacturing bases around the world, centered on China and other Asian regions and Japan. Our Group focuses on local production for local consumption for the products manufactured and sold by our Group. As a result, exchange rate movements do not have a significant impact on the competitiveness of our Group’s products. However, the appreciation of the currency at a manufacturing base could reduce the price competitiveness of our products against competitors’ products, which in turn may affect the financial position and performance of our Group.
b. Changes in political and economic conditions
If unforeseeable events such as major changes in laws, regulations and tax systems, rapid changes in political and economic conditions, and social and political turmoil such as terrorism, war, and disaster occur in countries in which our Group conducts business activities, such as China and other Asian regions and Japan, causing problems involving the procurement of raw materials, the suspension of operations at manufacturing bases, and the suspension of manufacturing and shipments due to the disruption of logistics, our Group’s financial position and performance may be adversely affected. Our Group depends on Asian markets for a significant portion of sales. In particular, the Chinese market accounts for a large percentage of sales. As a result, our Group’s financial position and performance may be affected by the economic and political conditions and other factors in China.
c. Compliance with foreign laws and regulations
Our Group is subject to environmental regulations and laws and regulations related to occupational health and safety, labor-management relations, foreign investments, national security, consumer protection, competition, taxation systems, bribery and export controls in countries and regions in which our Group conducts business activities. If our Group violates these laws and regulations, there may be civil, criminal or regulatory penalties. As a result, our Group’s financial position and performance, and by extension, our brand image and social credibility, may be affected.
d. Other risks
Our Group’s overseas business activities are vulnerable to various risks, such as labor disputes, securing human resources, and differences in business practices, in addition to the risks described in (a) through (c) above. Our Group is identifying and responding quickly and appropriately to risks related to policy proposals, markets, and laws and regulations and to other risks by transferring significant authority to executive officers by using the Company with Three Committees corporate governance structure and strengthening our Group’s business management functions. However, there is no guarantee that we will be able to identify and respond quickly and appropriately to all risks. If these risks materialize, our Group’s financial position and performance could be adversely affected. If there are greater than expected expenses for entering new markets and expanding into new business fields for business activities overseas, or if we are unable to effectively manage our overseas subsidiaries (in particular, subsidiaries newly acquired by Nippon Paint Holdings), our Group’s financial position and performance may be adversely affected.
(4) Risks related to raw materials
a. Procurement of raw materials
There is a risk that our Group will be unable to fulfill our responsibility to supply products to customers because we cannot procure raw materials due to the suspension of production at raw materials manufacturers as a result of the COVID-19 pandemic, natural disasters, accidents and other reasons, as well as disruptions of supply chains. In order to minimize the impact of natural disasters, accidents and other unforeseen events, our Group strives to ensure the stable procurement of raw materials through the interchangeability of raw materials, the use of multiple suppliers and the global procurement of raw materials. However, taking these actions cannot totally eliminate the impact of suspensions of production activities at raw materials manufacturers and disruptions of supply chains. If a delay occurs in the supply of products due to difficulties involving the procurement of raw materials, our Group’s financial position and performance may be adversely affected.
b. Price fluctuations of raw materials
Our Group depends greatly on petrochemical-based materials as raw materials (approx. 50% of all raw materials) because of the characteristics of our products. Consequently, the prices of raw materials at our Group are affected by changes in the prices of crude oil and naphtha. In addition, there is a possibility that demand for raw materials will change suddenly and significantly due to the impact of the COVID-19 pandemic on economic activities of countries around the world. Prices of raw materials may be affected by procurement risk caused by natural disasters and accidents and by climate change and other environmental policies and laws and regulations in Japan and other countries. For the stable procurement of raw materials, our Group takes actions to reduce the risk of raw material price volatility such as by strengthening relationships with suppliers by concentrating on key suppliers of raw materials, using many areas for the production of raw materials and using long-term supply contracts. However, these actions do not completely eliminate the impact of changes in crude oil and naphtha prices and of the COVID-19 pandemic. If raw material prices increase suddenly and significantly, or if we cannot raise the prices of products in a timely and rational manner to pass on the increase in raw material prices, our Group’s financial position and performance may be adversely affected.
(5) Risk related to human resources
There are three major risks related to human resources: (a) risk involving hiring young people and people with specialized skills, (b) risk involving a decrease in the number of employees in Japan, and (c) risk involving the retention of employees.
a. Hiring young people and people with specialized skills
Our Group is working to recruit people with outstanding capabilities in various countries by visiting universities and graduate schools in Japan and other countries to hold recruitment events and by providing internship programs targeting international students. To attract people with specialized skills, we are also strengthening corporate branding activities, such as by starting joint research projects with the University of Tokyo Graduate School. In addition, we are expanding mid-career recruitment activities, such as by conducting recruitment activities at academic conferences. If we are unable to hire young people and people with specialized skills at the right timing despite these activities, if the training of new employees does not progress as planned, or if we are unable to retain the young people and people with specialized skills after training, the financial position and performance of our Group may be adversely affected.
b. Decline in the number of employees in Japan
Our Group expects a decrease in the number of employees in Japan due to a greater number of retirees. Our Group has been taking actions to deal with this decrease. For instance, we have started a personnel system that allows employees to continue working for a longer time, such as by enhancing the reemployment system for retirees. We have also been using fewer people and improving productivity at factories by using environmentally friendly, cutting-edge production facilities, the IoT and the digital transformation. In January 2021, we raised the salary of all our Group’s employees in Japan by an average of more than 3% with the aim of becoming more competitive in terms of salary in relation to competitors to prevent the loss of employees. We will also improve the working environment by using digital technologies such as digital workplace solutions. In addition, we will leverage the strengths of our global network to increase the utilization of “borderless” talent including overseas personnel. Through these measures, we will aim to recruit and retain the people, including individuals with specialized skills that we require. However, there is no guarantee that we can slow down the decrease in the number of employees in Japan even if these actions are taken. If our business activities are hindered by the inability to maintain the number of employees necessary for our Group’s business activities, including overseas business expansion, the financial position and performance of our Group may be adversely affected.
c. Retention of employees
Our Group’s partner companies in Asia generally have a high mobility of employees. Our Group is making the corporate brand more powerful through various public relations activities and making the SDGs and ESG the priorities of management by taking actions such as establishing a “green” factory in India. In addition, we acquired 100% ownership of the Asian JVs and the Indonesia business to simplify the capital ownership structure in order to strengthen the operational integration of our Group. These actions are aimed at increasing employee retention by reinforcing employee engagement. However, if our Group’s business activities are hindered by our inability to recruit the number of employees necessary for business activities despite these actions, including problems at our overseas business operations caused by failing to retain employees including the management team at our Group’s Asian companies, the financial position and performance of our Group may be adversely affected.
(6) M&A risks
Our Group aims for sustainable growth by using M&A in Japan and other countries that contribute to the Maximization of Shareholder Value (MSV). Two examples are the acquisitions of Australia-based paint manufacturer DULUXGROUP LIMITED and Turkish paint manufacturer BETEK BOYA VE KIMYA SANAYI ANONIM SIRKETI, which are now wholly owned subsidiaries. Our criteria for selecting M&A targets are to earn returns higher than the cost of capital, coupled with an earnings per share (EPS) accretion. We determine priorities for potential M&A targets while taking into consideration financial discipline. When examining potential acquisition targets, we also consider factors including market trends; customer needs; the business performance, financial position, technological superiority and market competitiveness of acquisition targets; our Group’s business portfolio; and the results of risk analysis of M&A transactions.
However, our Group’s financial position and performance may be adversely affected if we are unable to complete an acquisition as planned; if there are significant changes in the business environment or the competitive landscape after the acquisition; if we are unable to recover funds invested because we fail to operate or expand the acquired business as planned and create synergies from the acquisition as we initially expected; if we incur additional expenses; if we are required to recognize an impairment loss on goodwill; or if we cannot maintain financial discipline due to a large debt. Furthermore, our Group’s financial position and performance may be adversely affected if the post-merger integration does not progress as expected and if our Group is unable to capture the expected benefits of synergies and economies of scale. These problems may cause a drastic change in our management policy and a decline in earnings due to a reduction of the scale of businesses, a loss of economics of scale and other reasons.
To address these risks, our Group completed the acquisition of an additional equity stake in the Asian JVs operated by Nippon Paint Holdings and the Wuthelam Group and the conversion of the Indonesia business into a Nippon Paint Holdings’ subsidiary on January 25, 2021. The goals are increasing our earnings per share (EPS), achieving the total optimization of resource allocation by preventing outflows of profits and enabling prompt decision-making and business execution. This established a foundation for sustainable growth by taking the final step to complete our partnership with the Wuthelam Group of nearly 60 years. We expect to increase our market share in the fast-growing Asia region by using this foundation to improve operational efficiency. However, there is no guarantee that we can capture these benefits as expected. In addition, there is a possibility that the investments in the Asian JVs and the Indonesia business will make our Group more susceptible to the impact of changes in the global business environment, such as a decrease in demand for paint and coatings and fine chemicals products due to the COVID-19 pandemic.
(7) Customer needs and preferences
Demand for our Group’s products is greatly influenced by the preferences and needs of our Group’s customers and the consumers who are the end users of our products. To grow, we need to accurately understand the preferences and needs of customers and consumers, create innovative products (improve existing products and develop new products) to meet customer demand, and manufacture and sell these products. To target demand created by the COVID-19 pandemic, we are developing anti-viral and anti-bacterial products such as PROTECTON brand anti-viral and anti-bacterial paint and Nippe Face Guard with anti-fog and anti-reflection properties. However, our Group’s financial position and performance may be adversely affected if we fail to accurately forecast the demand for our Group’s products due to the inability to understand the preferences and needs of our customers and consumers, or if the creation of innovative products requires more expenses and time than expected.
(8) Shrinking demand for our Group’s products due to technological innovation
Our Group’s technological development has several objectives: creating technologies that enhance added value of customers; replacing existing products with environmentally friendly products; creating new demand; and developing next-generation production systems. Technology development plans may have to be postponed or terminated if the expected results are not achieved. For example, our Group may be unable to develop new technologies and products in a timely manner due to the speed of technological progress. There is also a risk of a competitor manufacturing and selling a revolutionary new product with capabilities that far exceed our Group’s existing technologies. Any of these events could reduce our Group’s market share in Japan and other countries, and the financial position and performance of our Group may be adversely affected.
The paint industry faces the long-term challenge of the potential emergence of films or other alternatives to paint that are more price competitive, lighter and have a smaller environmental impact in order to meet the needs of our customers, primarily in the automotive coatings business. There is a possibility that the paint industry will be affected by the increasing use of these alternative products. In addition, if these alternatives for paint become mainstream products due to technological innovation, coupled with government policies for carbon neutral initiatives, the overall paint industry would be affected, including the possibility that demand for paint products will decline or be eliminated. If this happens, our Group’s businesses, financial position and performance may be adversely affected.
Our Group is engaged in intense competition with companies in Japan and other countries. We expect that paint manufacturers will be divided between global major paint manufacturers who will pursue the economics of scale and local niche paint manufacturers who will adapt to local cultures and customer needs.
Our Group is a global major paint manufacturer. Global major paint manufacturers are capturing the market shares of local niche paint manufacturers through M&A and other initiatives by leveraging their cost competitiveness and ability to respond quickly to the tightening of environmental regulations in recent years. As a result, the top 10 paint manufacturers have more than 50% of the global market. The competition for market share among global major paint manufacturers is becoming more intense. Our Group has recently been expanding the scale of businesses by acquiring companies overseas. We can expect that other global major paint manufacturers will take similar actions for the realignment of their business portfolios. They will use their ability to procure funds for acquisitions and other initiatives with the aim of acquiring technological capabilities necessary to comply with environmental regulations of different countries and procure raw materials at a lower cost. As a result, the competition among global major paint manufacturers may become even more heated. Our Group’s financial position and performance may be adversely affected if our market share in Japan and other countries decrease because we fall behind the competition among global major paint manufacturers with respect to the scale of businesses and speed of management; if there is downward pressure on prices due to increased competition; or if a major paint manufacturing group with financial, technological and procurement strengths is created.
(10) R&D activities
We conduct R&D activities to provide solutions to various social issues by maximizing the appeal of paint and coating through our technological capabilities. We are also strengthening the collaboration between the comprehensive strengths of our engineers in Japan and overseas and our external networks. We are currently focusing on the development of anti-viral products by organizing a team of experts from across the Group. Our Group’s businesses, financial position and performance may be adversely affected if our Group’s R&D activities do not produce products with higher quality or lower cost or require more expenses or time than expected to produce products.
(11) Dependence on third parties for manufacturing and sales
Our Group outsources part of the manufacturing and sales activities for its products to external third parties. These manufacturing and sales contractors are either affiliated companies or long-term business partners. As a result, it is unlikely that the relationships between our Group and these companies will deteriorate. However, our Group’s businesses, financial position and performance may be adversely affected because our Group’s manufacturing and sales activities may be hindered if these third-party companies damage their relationships with our Group or establish close relationships with our competitors; or if their business operations deteriorate or are interrupted due to a natural disaster and other incident.
In addition, if manufacturing and sales activities of these third parties fail to satisfy our Group’s standards in terms of quality and other properties or fall behind our competitors and their subcontractors in terms of quality and other properties, there may be adverse effects on the quality and reputation of our products and services as well as on manufacturing and sales activities and brand value.
(12) Risk related to damaging the brand value
Our Group has a high market share in Asia, notably in China. We have a powerful brand in Asia, as demonstrated by the high brand recognition of the LiBang brand in China. Our Group places the highest priority on achieving a high level of recognition of our companies and maintains and reinforces the power of our brands by continuously conducting high-profile advertising activities. However, our Group’s brand value may be damaged by factors including problems related to the safety, performance, quality or quality labeling of our Group’s products, etc., accidents resulting from our Group’s products, misconduct, criminal acts, or scandals by the management team or employees, or other problems.
In addition, any harmful rumors caused by media reports, Internet posts or social media may adversely affect our Group’s businesses, financial position and performance as well as our brand image and social credibility, regardless of the authenticity or accuracy of the rumors.
4. Risks Related to Medium-Term Plan
Our Group announced a new Medium-Term Plan on March 5, 2021, as stated in “1. Management Policy, Management Environment and Challenges to be Addressed (1) Management Policy, Management Strategy, etc. ② Medium- to Long-Term Management Strategy of Company.” Key pillars of regional and business strategy of the new Medium-Term Plan are: (i) Growing profits through increase of market share while maintaining margins in high-growth markets of Asia, including China, and Turkey; (ii) Securing revenue and profit growth that outperforms the market growth in stable-growth market of Oceania; (iii) Making investments in updating and streamlining production facilities in Japan in order to increase competitive advantage and productivity and create new demand; (iv) Aiming to increase market share and acquire new customers by reinforcing technological strengths and quality assurance system in the automotive coatings business; and (v) Expanding paint-related businesses into China and the wider Asian region by applying the experiences and know-how in SAF (Sealants, Adhesives & Fillers), CC (Construction Chemicals) and ETICS (External Thermal Insulation Composition System) owned by DULUXGROUP LIMITED and BETEK BOYA VE KIMYA SANAYI ANONIM SIRKETI. Key pillars of our sustainability and M&A strategy, which has the goals of sustainable growth and improving our operating profit margin, are: (i) Defining the “Purpose” of the Nippon Paint Group; (ii) Commitment to SDGs/ESG; (iii) Operational transformation through digitalization; (iv) Supply chain reform; and (v) Aggressively pursuing M&A opportunities. However, the ability of our Group to achieve these goals will be influenced by many risks and challenges, including those described in “II. Business Overview 2. Business risks.” These risks include the risk that the markets in our Group’s operating regions and sales of products do not grow as expected; the risk that we cannot make capital investments described in the new Medium-Term Plan or that these capital investments, even if they are implemented, do not produce expected benefits, such as improving production efficiency; the risk that our relationships with important customers will deteriorate because our Group’s technological strengths and quality assurance systems do not improve; the risk that our Group is unable to manage or utilize our subsidiaries; and the risk that our Group’s costs will increase or our competitiveness will be undermined as a result of complying with environmental regulations.
The Medium-Term Plan incorporates assumptions and forecasts regarding the business environment. Examples include assumptions and forecasts concerning the market environment in Japan and other countries, actions of companies, competition with other companies, changes in laws and regulations, technological innovations, changes in foreign exchange rates and raw material prices, and the status of the COVID-19 pandemic. If these assumptions and forecasts differ from events in the future or if our Group is unable to change our strategies or business operations in a timely manner in response to changes in the business environment, our Group may not be able to achieve the goals of the Medium-Term Plan.
5. Risks Related to Financial Position
(1) Impairment of goodwill and other intangible assets
Our Group recognize goodwill resulting from M&A transactions on the Consolidated Statement of Financial Position and has other intangible assets. Goodwill and other intangible assets as of the end of fiscal 2020 amounted to 424,168 million yen and 230,099 million yen, respectively (excluding the acquisitions of the 100% ownership of the Asian JVs with the Wuthelam Group and the Indonesia business owned by the Wuthelam Group).
Goodwill and intangible assets with indefinite useful lives are not amortized but are subject to impairment tests every fiscal year, regardless of any signs of impairment. In the impairment test, the higher of the fair value less disposal costs and the value in use in the cash-generating unit is measured as the recoverable amount. However, the assumptions made in the fair value calculation after deduction of the disposal costs or the assumptions made in the future by the disposal of the cash-generating unit during and after the use of the cash-generating unit, which serves as the basis for the calculation of the value in use, are affected by changes in economic conditions. Therefore, there is a possibility of impairment losses related to goodwill that were not expected and intangible assets for which the useful life cannot be determined, which could adversely affect our Group’s businesses, financial position and performance.
(2) Interest-bearing debt and financing
Our Group uses borrowings from financial institutions and corporate bonds to procure funds. Borrowings and bonds (excluding those scheduled to be repaid or redeemed within one year) were 467,627 yen million at the end of FY2020. Some or all of this interest-bearing debt is denominated in foreign currencies or have floating interest rates. Some of the bonds and borrowings denominated in foreign currencies are hedged by interest rate derivative transactions such as interest rate swaps and interest rate currency swaps. However, if interest rates rise or exchange rates fluctuate in the future, interest-bearing debt expenses may increase, which could adversely affect our Group’s businesses, financial position and performance.
In addition, cash flows may be adversely affected by the Group’s financial position, such as the interest-bearing debt ratio, a downturn in financial markets, an increase in interest rates, a decline in our Group’s credit standing, such as a reduction in the credit rating by an external rating agency, and a downward revision in the outlook for sales and earnings, Furthermore, terms used for the procurement of funds using equity or debt may become worse or there may be restrictions on the ability to procure funds. Any of these events may have a negative effect on our Group’s businesses, financial position and performance.
(3) Risk that capital investments do not produce profits
Our Group needs to continuously make capital investments to enhance production capacity and improve productivity to pursue the Maximization of Shareholder Value (MSV) and sustainable growth. From FY2021 to FY2023, our Group plans to make aggressive capital investments for growth in markets around the world and defensive capital investments to strengthen risk resilience. Specifically, we plan to invest mainly in (i)establishing new production facilities and upgrading production capacity and logistics networks, (ii)maintaining and upgrading production facilities, replacing aging facilities and improving the safety of facilities, (iii)streamlining and digitalization and (iv)research and development and environmental protection. Our Group has not made sufficient capital investments in Japan, which resulted in equipment problems caused by aging. Our Group plans to make capital investments for new facilities and renovations of factories and logistics centers, the construction of the Tokyo Office, and the digitalization of mission-critical operation systems. However, some projects will take several years to complete.
In Asia, capital investments are planned mainly in China to expand factories in order to improve production efficiency. The capital investment plan will be reviewed with flexibility according to the business environment. However, our Group’s businesses, financial position and performance may be adversely affected if these capital investments do not produce the expected benefits, such as the growth of production capacity and improvement of production efficiency, and result in an increase in depreciation expenses.
6. Laws and regulations
(1) Quality assurance of products and product liability
Our Group has a quality assurance system that includes strict design review procedures and strengthening quality control systems in order to improve the quality of products. In addition, products are covered by product liability insurance.
However, this insurance may not be sufficient to cover damages. There may be product defects, quality problems and associated property damage and casualties due to various factors, which may require a product recall, interruption or delay in manufacturing, or a large-scale recall. In addition, our Group may be subject to claims for damages based on product liability by a third party or subject to cancellation of orders or claims for damages or be required to improve quality control systems by customers. If these problems occur, our Group’s reputation may be adversely affected and our financial position and performance may be adversely affected due to a provision for product compensation (there was a provision for product compensation of 2,340 million yen in FY2017).
(2) Intellectual property
Our Group has regulations for the management of intellectual property. We recognize that intellectual property is an important asset, we accumulate and utilize intellectual property as management resources, and we respect the intellectual property of others. In addition, we have a system to protect intellectual property. For example, technical information that falls under the category of intellectual property is managed in accordance with the Information Management Regulations and stored in the dedicated technical information data base to prevent leakage.
Despite these measures, our Group’s financial position and performance may be affected if technical information that is categorized as intellectual property is leaked by a third party, including our employees (including retirees) and manufacturing and sales subcontractors, and if there is a dispute regarding intellectual property with a third party in the future.
(3) Compliance with environmental and other laws and regulations
Our Group conducts examinations of compliance with laws and regulations at various stages, including the selection of raw materials and product development activities. We also develop and supply marine-environment-friendly products and anti-viral products that contribute to solving social issues with an eye on tightening of regulations in the future. In addition, we comply with regulations for factory operations and establish reduction targets in order to lower our environmental impact. We also conduct procurement activities with our Group’s suppliers, taking into account our social responsibility.
However, laws and regulations involving the paint industry, such as laws and regulations concerning the environment, chemicals, and health and safety are frequently revised and tightened (including the introduction of the environmental tax in China.) If these regulations become stricter than expected, or if we are unable to comply with the regulations in time, our Group may incur additional expenses to respond to changes in laws and regulations. In addition, there is a risk that our Group’s manufacturing and sales activities or procurement activities will be restricted, or our Group may be imposed administrative punishment. If our Group is unable to comply with these regulations, we may be subjected to penalty or other dispositions from the regulatory authorities or obliged to pay the expenses for restoring to original conditions. These risks, if they happen, may adversely affect our Group’s financial position and performance.
(4) Compliance and litigation
The worldwide business operations of our Group are subject to laws and regulations in Japan and other countries. Our Group is committed to complying with these laws and regulations, which may require additional expenses. As a result, our Group’s financial position and performance may be adversely affected.
In addition, there is a risk of being subjected to measures or dispositions by regulatory authorities if our Group violates laws and regulations due to the inability to comply with laws and regulations as a result of changes in laws and regulations and legal interpretation and other reasons. Depending on the nature of these measures, our Group’s financial position and performance may be adversely affected.
Our Group is also at risk of litigation by consumers, business partners, employees and other parties regarding product liability, breach of contracts, labor issues and other issues in various countries and regions. Depending on the outcome of litigation and other actions, our Group may be ordered to pay substantial damages. As a result, our Group’s businesses, financial position, performance, brand image and reputation may be adversely affected.
7. Natural disasters and accidents
(1) Major natural disasters
Our Group places priority on measures to prevent and mitigate disasters, minimize the damage and losses from natural disasters, and build crisis management systems. In addition, we have started to rebuild our supply chains from the viewpoint of business continuity planning. However, if the cost of electricity increases due to the occurrence of a major natural disaster, in particular a powerful earthquake in the offshore Tonankai regions in Japan, triggering tsunami waves that exceeds our expectations, a major forest fire or flood caused by major typhoons for which global warming is belied to be one of the causes, or a cold wave, the procurement of raw materials, production activities and shipments of products will be restricted. If any of these events occur, we may become unable to supply products to customers and the financial position and performance of our Group may be affected.
(2) Fires and explosions
Our Group is constantly reinforcing our safety systems to prevent accidents involving the handling of hazardous substances and chemicals. We provide thorough safety education at factories and for workers handling hazardous substances. We are also switching to and improving water-based materials (non-hazardous substances) to improve the safety of our factories and other business sites. However, if a fire or explosion occurs, our Group’s financial position and performance may be adversely affected because we may be required to suspend operations temporarily or for other reasons.
(3) COVID-19 pandemic
The COVID-19 pandemic has been running rampant all over the world since around February 2020. The pandemic has had a significant affect the health of people and threatened the maintenance of medical systems and basic living of people in many countries of the world. As a result, economic activities have been greatly slowed down in many industries.
The COVID-19 pandemic may obstruct or restrict all or part of our Group’s business operations due to a decrease in production activities caused by closures, restrictions or voluntary reductions of operations at factories, other restrictions or voluntary reductions of operations, slowdowns in production at our Group due to shortages of employees and other reasons, or problems involving the procurement of raw materials and equipment and logistics operations for our products. In FY2020, our performance was adversely affected by a decline in production at customers in the industrial coatings business and the automotive coatings business. Therefore, our Group’s financial position and performance may be adversely affected if the global slowdown in economic activities lowers demand and prices of our products and if our Group is required to suspend operations temporarily due to the spread of COVID-19 infections among employees.
In order to cope with these risks, our Group has established a management system to stop and prevent the spread of infections. We have established the Coronavirus Emergency Headquarters, headed by the Representative Executive Officer and President. We have formulated three basic policies concerning the COVID-19 pandemic: (1) Taking actions with the highest priority on the health and safety of employees, such as using remote work, prohibiting business trips, and providing ventilation of offices and factories in accordance with the State of Emergency and the spread of infections, (2) Securing funds necessary to protect our Group’s businesses around the world, and (3) Implementing business continuity planning. Based on these basic policies, our Group is monitoring the status of production, sales, inventories, and logistics on a global level and implementing countermeasures through collaboration with our partner companies in Japan and other countries in order to minimize the impact of the COVID-19 pandemic. The outlook for the upcoming levels of infections and when this crisis will end are uncertain. Consequently, it is difficult at this time to provide a concrete forecast for the impact of the COVID-19 pandemic on our Group’s financial position and performance.
8. Climate change
(1) Long-term risk
To help fight climate change, our Group is developing and supplying environmentally friendly products in accordance with policies and laws and regulations related to climate change in Japan and other countries as well as with market demand. However, our Group’s automotive coatings business may be affected by global trends including stricter regulations based on the Japanese government’s policies to achieve a carbon-free society. In addition, there is a possibility that our Group will be required to pay higher taxes and incur other expenses associated with greenhouse gas emissions. If any of these events happen, our Group’s financial position and performance may be adversely affected.
(2) Short-term risk
Our Group’s products are used in a wide range of industries, including automobiles, construction, building materials, metal products, electrical machinery and ships. However, abnormal weather conditions such as typhoons and heavy rainfall that have been increasing in recent years due to climate change may cause significant damage in our Group, industries to which our Group supplies products, and industries from which our Group purchases raw materials. This damage may result in suspensions of production and shipments for a long time until the supplies recover. In addition, extreme weather such as a cool summer, warm winter and extended periods of rainfall can affect the industries that use our products. As a result, our Group’s financial position and performance may be adversely affected.
9. Other risks
(1) Information security
Our Group retains personal information and confidential information of business partners and other related parties that were obtained in the process of conducting business. In addition, our Group relies on information and IT systems for many business activities. Our Group is taking actions to prevent information leaks, such as by strengthening the management of confidential information and preventing IT system failures caused by virus infections and cyberattacks.
However, if important data are destroyed, altered or leaked or a system failure occurs due to a power interruption, disaster, software or equipment defect, or cyberattacks, or if these systems fail to function as expected, our Group’s businesses, financial position, performance, brand image and reputation may be adversely affected due to the suspension of our business operations and the provision of services, the loss of important data and expenses incurred to deal with these problems.
(2) Relationship with major shareholder
We completed the pay-in procedure for the issuance and sale of new shares through a third-party allotment to the Wuthelam Group (Wuthelam Holdings Limited (“Wuthelam”), its representative Mr. Goh Hup Jin (Wuthelam and Mr. Goh Hup Jin collectively, “Wuthelam and Mr. Goh”), Wuthelam’s subsidiaries, and companies substantively controlled by Wuthelam and Mr. Goh; the “Wuthelam Group”) on January 25, 2021. As a result, the Wuthelam Group has become the parent company of NPHD with a shareholding of 58.7% as of the date of filing of the Annual Securities Report. Consequently, the Wuthelam Group has a significant influence on matters which require special resolutions and ordinary resolutions at our General Meeting of Shareholders.
There are no agreements between our Group and the Wuthelam Group regarding the ownership and sale of our shares or the exercise of voting rights held by the Wuthelam Group, or any other agreements that may restrict our Group’s management. Mr. Goh Hup Jin, the representative of Wuthelam, serves concurrently as a Director of NPHD.
The interests of the Wuthelam Group with respect to our businesses and management policies may differ from the interests of NPHD and its minority shareholders. We recognize that the Wuthelam Group is in agreement with our management policy of pursuing the Maximization of Shareholder Value while protecting the interests of minority shareholders as a listed company, and will continue to hold our shares. However, the Wuthelam Group may increase or reduce its ownership of our shares in view of its financial position and other factors. If this happens, the market price of our shares may be affected.