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 on March 30, 2022.
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 FY2021, we established the Basic Policy on Global Risk Management that was enforced on January 1, 2022 in order to enhance risk management across the Nippon Paint Group globally. We also established a global risk management system based on autonomous risk management through self-inspections by group of subsidiaries classified by region or business (the Partner Company Groups).
Specifically, we held meetings of the Risk Management Committee in the Japan segment that monitored the development and operation of risk management systems at our partner companies in Japan and discussed actions to appropriately manage significant categories of risk involving the entire Group in Japan. In addition, subcommittees of the Risk Management Committee took concrete actions to enhance credit management, information management, export control, business continuity planning and other matters. In addition, the heads of the Partner Company Groups are charged with global risk management under the direct supervision of the Directors, Representative Executive Officers & Co-Presidents (the Co-Presidents).
The Audit Department conducts risk management surveys by collecting and analyzing risk information at important Group companies in Japan and other countries. The Audit Department reports the survey results to the Audit Committee and the Directors, Representative Executive Officers & Co-Presidents, and gives feedback to important Group companies in Japan and other countries in order to share information about issues and discuss policies for managing risks. In this manner, the Audit Department performs the internal audit function by monitoring the effectiveness of our Group’s risk management system (internal control system).
2. Risk Related to Business Operations
(1) Risk of changes in our markets
Our Group manufactures and sells paint and paint-related products for use in a broad range of industries including construction, automobiles, metal products, construction materials, electrical machinery, and ships mainly in Asia including China, as well as in Japan, Oceania, the Americas and Europe. As a result, our Group’s performance may be affected by changes in the economic conditions and financial market conditions in countries and regions around the world where our Group conducts manufacturing and sales activities. Uncertainties in the business environment, such as disruptions of supply chains and changes in paint demand and raw material market conditions, have increased in recent years due to the pandemic, geopolitical issues and natural disasters and other factors around the world. Asia, in particular China, is an important region for our operations. As a result, our Group’s business operations are vulnerable to changes in the economic conditions and political climate in China. A greater than expected deterioration and stricter than expected regulations of the real estate market may impact our Group’s business operations.
Our goal is sustainable growth by taking actions across the Group, such as expanding into new geographic markets through M&A, creating new demand through the development and sale of anti-viral products and environmentally friendly products, strengthening brands in every region, monitoring moves of suppliers, and enhancing the entire Group’s supply and procurement capabilities. If the business environment deteriorates beyond the expectations of our Group, the financial position and performance of our Group may be adversely affected.
(2) Risk related to selling prices
Our Group determines selling prices by taking into consideration raw material prices, customer needs, moves of competitors and other factors. Our Group takes actions to reduce vulnerability to fluctuations in raw material prices such as by negotiating selling price revisions whenever necessary while monitoring raw material prices, diversifying and strategically selecting suppliers, and evaluating and using alternative materials that are less vulnerable to changes in raw material prices. However, there is no guarantee that we will be able to reduce the impact of raw material price increases on our earnings. We are also taking actions to maintain and increase our competitive advantage by selling technically-advanced products, reinforcing support for sales channels, and establishing new channels. However, we may not be able to pass on raw material price increases to customers or there may be a delay in passing on prices due to competition and other factors. If any of these risk events happen, our Group’s profit margins may decline and there may be an adverse effect on the financial position and performance of our Group.
(3) Risk related to overseas business activities
Our Group is aggressively expanding overseas businesses and operates as multinational corporate group. In FY2021, overseas sales (after elimination of intersegment transactions) accounted for approximately 84% 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 using the average exchange rate during the period or the exchange rate at the end of the period. As a result, changes in exchange rates of currencies 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. 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, an appreciation of the currency at a manufacturing or sales 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 and regions in which our Group conducts business activities, 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 environmental protection, product liability, occupational health and safety, labor-management relations, foreign investment regulations, foreign currency regulations, national security, consumer protection, competition policies, 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 risks related to differences in business practices, local working conditions including the possibility of labor disputes, and securing excellent management teams, engineers, and other human resources, in addition to the risks described in (a) through (c) above. We delegate significant authority to Group partner companies based on our management policy of respecting the independence and autonomy of these companies. This makes it possible for our Group to retain and recruit people who are well versed in local markets and to conduct business operations that reflect laws and regulations, working conditions, and business practices in each country and region. However, there is no guarantee that we will be able to identify and respond quickly and appropriately to all risks. These risks, if they happen, may adversely affect our Group’s financial position and performance. 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, our Group’s financial position and performance may be adversely affected.
(4) Risks related to raw materials
(a) Procurement of raw materials
The COVID-19 pandemic that began in early 2020 has created significant risk concerning our Group’s procurement of raw materials and the impact of the pandemic remains strong even after two years.
The pandemic has severely impacted the global economy. In the first half of FY2020, economic activities slowed down worldwide due to a rapid spread of the pandemic. As a result, companies significantly reduced capacity utilization in order to control inventories. Subsequently production activities gradually resumed, starting with European companies, and there were shortages of distribution inventories of raw materials in the first half of FY2021. The recovery of the Japanese market was around six months behind Western markets. As a result, we had to resume procurement activities on a full scale when supply and demand were out of balance globally. Due to this situation, we ran out of available capacity in the supply chain in the second half of FY2021. Although some people expect that the mismatch in supply and demand will ease to some extent in FY2022, there is a possibility that the supply and demand balance of raw materials will remain tight.
Some manufacturers of raw materials have not been able to maintain sufficient production to meet demand due to suspensions of production activities, employees’ absence from work because of the pandemic, and the unavailability of crude raw materials due to suspensions of production activities for upstream raw materials. In addition, the supply and demand imbalance increased as many companies were forced to suspend production activities occasionally due to various factors, such as fires, equipment failures and a severe cold wave that hit North America in February 2021.
In addition, the supply of raw materials tightened due to the accumulation (uneven distribution) of shipping containers in the U.S. and a decrease in operating rate of cargo ships because of a sharp economic recovery from the pandemic and the trade imbalance between the U.S. and China. As a result, we have been unable to procure raw materials in a timely manner. 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 complex and far-reaching negative effects on economic activities that started with the pandemic. 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 will not 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 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. Crude oil prices are affected by various factors that are intertwined, such as OPEC production volumes and natural gas market conditions, as well as geopolitical risks including the Ukraine crisis, civil unrest in Kazakhstan, political uncertainty in the Middle East and Russia, monetary policy in the U.S., the US-China trade conflict, the rebound of shale oil production, the pricing policy of oil producers in the Middle East that takes into account exchange rate fluctuations, and the decline in gasoline demand due to increasing sales of electric vehicles. In addition, there is a possibility that raw material demand will change suddenly and drastically due to continuing impacts of a further spread and continuation of the pandemic on economic activities of countries around the world. Furthermore, global disruptions of supply chains, centered on ocean freight, will raise the cost of transporting raw materials. 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 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
Recruiting, appointing, and retaining people with diverse professional skills, including for the management teams of our Group’s major operating regions, are essential for the achievement of the growth strategy in the Medium-Term Plan.
In Japan, where the percentage of employees reaching the mandatory retirement age is expected to increase, we need to strengthen our workforce by recruiting and training people. With a relative shortage of labor in Japan compared to other countries and our priority on expanding global operations, it is becoming increasingly important to develop and retain a diverse team of talented people.
Asia, which is our Group’s largest market, is characterized by a higher mobility of labor and a higher job turnover than in Japan. There is a possibility that recruiting people and increasing our pool of talent will reduce the wage level. However, a higher job turnover tends to increase personnel expenses. Furthermore, this may interfere with the accumulation of expertise and technological capabilities and reduce operational efficiency and productivity in the long term. If we fail to execute our human resources strategy, encounter an unexpectedly large number of resignations, or have difficulties finding successors for current management teams in a timely manner, our organizational strength will decrease. This may cause a decrease in organizational strength, including valuable expertise, and interfere with our ability to compete and execute strategies.
Under these circumstances, there are three major risks related to securing 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
If we are unable to hire young people and people with specialized skills as planned at the right timing; 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, our development and production activities will be delayed and we may face the risk of outflows of the results of research programs and our technologies.
To deal with these risks, our Group is working to recruit people with outstanding capabilities by visiting universities and graduate schools in Japan and other countries to hold recruitment events and by providing internship programs. We are reinforcing employee training programs to enhance cultivation of people and developing comfortable working environments for diverse employees.
In addition, we are expanding mid-career recruitment activities, such as by conducting recruitment activities at academic conferences. Furthermore, we established fair evaluation and treatment systems based on the target management system in order to improve employee engagement, retain employees, and develop an environment where we can improve employees’ skills and allow employees to reach their full potential. If we are unable to get the expected results despite these activities, 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 enhanced the reemployment system for retirees and are systematically developing successors. In addition, we have started a personnel system that allows employees to continue working for a longer time. 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.
If we are unable to pass down skills properly despite these actions, the financial position and performance of our Group may be adversely affected.
(c) Retention of employees
Asia, which is our Group’s largest market, generally has a higher mobility in the labor market than in Japan. Outflows of competent employees may hinder the long-term growth of our Group’s know-how and technological capabilities and reduce our operational efficiency and productivity. In addition, if we are unable to secure succeeding management teams in a timely manner, there is a possibility that valuable management know-how and other expertise will not be succeeded, which may reduce our organizational capability and interfere with the effective execution of competitiveness and strategies. We have been taking actions to deal with these risks.
For instance, our Group is making the corporate brand more powerful and enhancing our Group’s appeal through various public relations activities, such as making the SDGs and ESG the priorities of management. Our Group is also increasing employee retention by fostering the sense of unity and reinforcing employee engagement. In addition, our Group is securing human resources and skills and developing management talent by stepping up initiatives for the borderless utilization of employees, including employees at our overseas partner companies, by leveraging the strengths of our global networks.
If we are unable to achieve the expected results despite these actions, 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 Maximization of Shareholder Value (MSV). For instance, we acquired DuluxGroup Limited and Betek Boya ve Kimya Sanayi Anonim Sirketi in 2019 to make them wholly-owned subsidiaries and completed the full integration of the Asia JVs and the acquisition of the Indonesia business in January 2021. 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 economies of scale and other reasons.
To address these risks, our Group acquired Cromology Holding SAS (Cromology), which manufactures and sells decorative paints and other paint products in Europe, on January 20, 2022. Our Group expects that this acquisition will enable us to expand our decorative paints business in the major European markets, utilize excellent management teams, and acquire opportunities for our Group’s global business growth and DuluxGroup’s decorative paints business. However, there is no guarantee that these benefits will be realized as expected. Our Group concluded an agreement regarding the acquisition proposal for DP JUB delniska druzba pooblascenka d.d., which was announced on October 29, 2021. The acquisition of this company is subject to the approval of the regulatory authorities of countries and regions concerned. If we fail to satisfy these conditions, there is a possibility that the acquisition will be delayed or the acquisition will not be completed as initially planned. In addition, the acquisition of these companies will make our Group more exposed to the impact of changes in the global business environment, such as a decline in demand in the paint and paint-related segments due to the pandemic, raw material price inflation, disruptions of supply chains and other factors.
(7) Customer needs and preferences
Our Group’s businesses depend on the continuation of demand for our Group’s brands and products in countries and regions around the world. 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 achieve sustainable growth, our Group needs to accurately understand the preferences and needs of customers and consumers and develop and sell attractive products from the standpoint of both innovations for existing products and the creation of new products. This involves various factors, such as our capabilities to develop and produce innovative products that meet the expectations of customers and consumers and the effectiveness of marketing activities, such as sales, advertising, and product life cycle management.
To target demand created by the pandemic, we supply anti-viral and anti-bacterial products such as PROTECTON brand anti-viral and anti-bacterial paint products 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 product requires more expenses and time than expected.
(8) Shrinking demand for our Group’s products due to technological innovation
Our Group is using coating technologies to bring color, comfort and security to various scenes of people’s lives. As stated in our Group’s Purpose, "enriching our living world through the power of Science + Imagination," our Group has focused for many years on using our technological strengths to develop products that solve social issues. Advanced technical expertise is essential for creating innovation to tackle social issues and meet customer needs, as well as for becoming more competitive, such as by maintaining a stable supply of products. Our Group is strengthening collaboration involving the comprehensive strengths of our engineers in Japan and overseas and our external networks. In addition, we are accurately identifying the needs of customers and consumers and changes in demand in markets around the world with the goal of continuing to create novel and innovative solutions for society. However, there is a risk that our Group is unable to develop new technologies and products in a timely manner due to the speed of technology progress. There is also a risk of a competitor developing and selling a revolutionary new product with capabilities that far exceed our Group’s existing technologies. If our Group is unable to achieve expected results as a result of any of these events, our Group’s market share may decline in Japan and other countries. Then, the financial position and performance of our Group may be adversely affected.
Our Group is facing more fundamental downside risk mainly involving customers in the automotive coatings business due to technological innovation and developments aimed to eliminate and reduce the use of paint and coatings products. For instance, automobile manufacturers and material engineering companies are developing various technologies as alternative to paint on automobiles, such as decorative films, from the viewpoint of reducing costs and environmental impacts. As one step to accomplish these goals, we announced on July 1, 2021 that Nippon Paint Automotive Coatings Co., Ltd. will expand into coating technology for automotive decorative films. We are developing various technologies and applications of decorative films through initiatives such as a joint project with Toyota Motor Corporation. If these alternatives for paint become mainstream products due to technological innovation, coupled with government policies for carbon neutral initiatives, there is a possibility that demand for paint products will decline or we will be required to make large investments to switch to alternative products. If this happens, our Group’ financial position and performance may be adversely affected.
Our Group is engaged in intense competition in the paint and paint-related businesses with companies in Japan and other countries. If competition increases in these businesses, our Group’s market share and profit margins may be adversely affected due to factors such as the loss of a regional customer or a major global customer or a decline in our pricing power. In addition, integration between customers in some businesses, such as the automotive coatings and industrial coatings businesses, may adversely affect our prices and profit margins. The paint and coatings business can benefit from economies of scale in raw material procurement, production processes, supply chains, logistics, R&D activities, and regulatory compliance. As a result, paint manufacturers can significantly benefit from integration. Just as our Group has been expanding operations through overseas M&A in recent years, other major global paint manufacturers have been reinforcing and expanding their positions in the industry. We believe this trend will continue. If competitors’ operations become larger than our Group’s as a result of integration, there is no guarantee that we will be able to effectively compete in terms of capital, technological strengths, financing capability, and other matters. Our Group’s financial position and performance may be adversely affected if our market share decreases or downward pressure on prices increases as a result of the larger size of competitors.
(10) R&D activities
Our Group invests considerable resources to conduct R&D activities to provide products and services to solve various social issues by strengthening the collaboration between the comprehensive strengths of our engineers in Japan and overseas and our external networks with the goal of maximizing the appeal of paint and coatings through our technological capabilities. We are currently focusing on the development of technologies for new products that solve social issues in four fields: Infectious disease risk reduction, Contribute to a smart/remote society, Reduce environmental burdens, and Control social costs. We believe these initiatives are consistent with changes in social environments and responses to future products, untapped market opportunities, and technological progress in many industries. However, if our Group’s continuous investments in R&D activities are unable to generate earnings commensurate with these investments or to create profitable products or if the market structure changes significantly, our Group’s businesses, financial position and performance may be adversely affected.
(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, if 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, our Group’s businesses, financial position and performance may be adversely affected. 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 major markets such as Asia including China, Australia, and Japan. We believe our Group’s brands have a high recognition among customers and consumers. Our Group continuously uses our resources for brand building to maintain and improve our brand recognition. However, our Group’s brand value may be damaged by complaints and harmful rumors regarding problems related to the safety or quality of our products, accidents, misconduct, invasion of privacy, scandals by management or employees, and other events that may be beyond our control. These complaints and harmful rumors, even if a part or all of them are unfounded, may damage the social reputation of our Group’s businesses. If consumers’ trust in our Group or our Group’s products is damaged due to these events, consumers’ demand for our Group’s products and our Group’s brand value may decline significantly, which will adversely affect our Group’s businesses, financial position and performance.
3. Risk 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 our partner companies which joined our Group through M&A. Our Group has also established sustainability and M&A strategies with the goal of achieving sustainable growth and improving our operating profit margin. However, as exemplified by the raw material price inflation and disruptions of logistics networks taking place currently after a year has passed since the announcement of the new Medium-Term Plan, 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.
4. Risks Related to Financial Position
(1) Impairment of goodwill and other intangible assets
Our Group recognizes goodwill and other intangible assets resulting from M&A transactions on the Consolidated Statement of Financial Position. Goodwill and other intangible assets as of the end of FY2021 amounted to 652,682 million yen and 300,200 million yen, respectively.
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.
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, may be affected by changes in economic conditions. Therefore, there is a possibility of a significant revision to impairment losses related to goodwill and intangible assets for which the useful life cannot be determined in future years. If such revisions are made, our Group’s financial position and performance may be adversely affected.
(2) Interest-bearing debt and financing
Our Group uses loans from financial institutions and bonds to procure funds. Loans and bonds (excluding those scheduled to be repaid or redeemed within one year) were 457,919 million yen at the end of FY2021.
Most of our Group’s long-term loans have fixed interest rates, but some of the bonds and loans denominated in foreign currencies have floating interest rates. These bonds and loans denominated in foreign currencies are hedged by derivatives such as interest rate swaps and interest rate currency swaps. However, if interest rates rise or exchange rates fluctuate in the future, interest expenses may increase, which could adversely affect our Group’s businesses, financial position and performance.
In addition, out Group’s 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
To accomplish our goals of MSV and sustainable growth, our Group needs to continuously make capital investments to increase production capacity and improve productivity. We will continue to make investments to seize business opportunities, improve the quality of our products, and reinforce our risk management systems and profit margin. Specifically, we will prioritize investments in logistics transformation in supply chains including digital transformation technologies, maintaining and upgrading aging production facilities, securing workplace safety, streamlining and information technology, R&D activities and environmental protection. Our Group will implement capital investment plans with flexibility in line with changes in the business environment, but capital investments may not yield sufficient returns. Our Group’s financial position and performance may be adversely affected due to an increase in capital investment or depreciation or other reasons.
5. 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.
(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 in particular in China and Europe. 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.
6. Natural disasters and accidents
(1) Major natural disasters
Our Group is headquartered in Japan and conducts business activities in Asia, which is historically vulnerable to natural disasters and bad weather. As a result, our Group places priority on measures to prevent and mitigate disasters to minimize the damage and losses from natural disasters and to build crisis management systems. In addition, we have started to build digital supply chains that utilize digital tools and methods to enable remote working and reduce complicated work and to rebuild 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 warmings is believed 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
There is a risk of explosions, fires, and emissions and releases of toxic and harmful substances due to the characteristics of our business activities. 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 significantly affected 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 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. Our performance has been 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. Our Group’s operations are geographically spread out and different regions have been subjected to the impact of the pandemic on different areas. Therefore, our Group is monitoring the status of production, sales, inventories, and logistics on a global level and implementing countermeasures in order to minimize the impact of the 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 pandemic on our Group’s financial position and performance.
7. Climate change
(1) Long-term risk
Our Group may be physically affected by geographically widespread natural disasters and abnormal weather in regions including part of Asia. 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 to help fight climate change. In addition, our Group has established targets for reducing greenhouse gas emissions from production processes and is taking concrete actions for reducing these emissions. However, our Group’s businesses may be affected by stricter regulations based on the Japanese government’s policies to achieve a carbon-free society, as well as by global trends such as substantial targets for the reduction of greenhouse gas emissions from production processes of automobile manufacturers and other sources. 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.
8. Other risks
(1) Information security
Our Group relies on information and IT systems for conducting business transactions accurately and efficiently, providing information to management teams and preparing financial statements.
Our Group has established backup procedures and disaster recovery measures, as well as information security guidelines, in order to securely store personal information and ensure compliance with security procedures. However, there is a possibility that our systems may be damaged by an earthquake or other natural disaster, equipment or communication failures, computer viruses, cyberattacks, or other unforeseeable events. There is a possibility of cyber security incidents caused by intentional attacks or unintentional events at our Group. For instance, there is a possibility that our internal systems are compromised by computer viruses, unauthorized access, malware, and other cyberattacks; or our business execution capability may be damaged due to leakage or deletion of confidential information.
These incidents include unauthorized access to our systems, computer viruses, and malicious codes, malware, ransomware, phishing, human errors, and other events that cause security violations, leakage of confidential information, or outflows of assets. These problems affecting our systems may lead to the suspension our business operations, expenses incurred to deal with these problems, the leakage of customer information or confidential information, violations of laws, and system failures that occur despite security measures and backup and disaster recovery systems. Any of these events may have a negative effect on our Group’s social credibility, financial position, and performance.
(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 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 and may remain in office in the future.
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. NPHD transferred its automotive coatings businesses in Europe and India and decorative paints business in India to the Wuthelam Group as part of its business transactions with the Wuthelam Group in August 2021. As a result, a continuous commercial relationship has been established between our Group and the Wuthelam Group regarding these businesses based on a management service agreement and buy-back option. Consequently, there is no guarantee that no conflict of interest will occur between our Group and the Wuthelam Group.
We recognize that the Wuthelam Group is in agreement with our management policy of pursuing MSV 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.
(3) Risk of non-compliance with listing maintenance criteria for the Prime Market of Tokyo Stock Exchange (TSE)
Following TSE’s transition to new market segments on April 4, 2022, NPHD has met the criteria for maintaining a listing on the Prime Market. One of the criteria for maintaining this listing is a free float ratio of 35% or more, which is calculated based on TSE’s regulations. NPHD’s free float ratio was less than 35% as of December 31, 2021, as a result of the issuance of new shares through a third-party allotment to the Wuthelam Group on January 21, 2021. The shareholder composition as of the end of December 31, 2022 will be used to calculate the free float ratio for maintaining the Prime Market listing in 2023. We will take various actions where necessary, including the secondary offering of shares held by financial institutions in January 2022 and application of special provisions regarding specified free float shares. However, there is a possibility that we will not be able to meet these criteria despite our efforts. If this happens, NPHD will not be able to maintain its Prime Market listing, which may adversely affect our stock price or liquidity of our stock.