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Financial Information:
Annual Report 2005
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Management’s
Discussion and Analysis of
Business Results and Financial Position |
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(3) Risk Management—Excerpt from
NSK’s
Yukashouken Houkokusho
(Securities Report)
Due to the nature of its operations, NSK is exposed to
various risks, some of which are listed below.
(Note: The following are risks that have been identified by the
Company as of June 29, 2005,
the date of our Annual
Meeting of Shareholders.)
1. Country, Region, and Industry Risks
NSK products are sold to customers in a wide variety of
industries in many countries and regions. Furthermore,
our production facilities and sales offices are located all
over the world. As a result, the NSK Group is exposed to
both the economic environments of these countries, as
well as the business environments surrounding our customers’ respective
industries. The deterioration of
economic conditions in relevant countries, regions and
industries may have an effect on the NSK Group’s ability
to deliver sustained earnings.
2. Market Risks
The competition NSK is facing is intensifying at a global
level, and the surrounding business environment is
changing at an accelerating rate. Low-cost bearings
produced by manufacturers from emerging countries
such as China have appeared in the standard ball bearing
market. This is one example of a market risk. In addition,
a delay in the overseas expansion of our
Automotive Products business could result in a loss of
business opportunities. However, we consistently review
our business policies to ensure that we have the right
strategies to provide sustained profitability.
3. Customer-specific Risks
NSK’s sales tend to center on certain industries. Nearly
half of our revenues are from sales of bearings and components
to the automotive industry. Sales of our precision
machinery and parts are weighted towards the
semiconductor production equipment and machine tool
sectors. Therefore, a demand down-cycle in these
industries would have a significant impact. To lessen this
impact, we are expanding bearing and precision machinery
sales to the general industrial machinery sector and
to the aftermarket, where the demand source is varied.
However, a dramatic drop in demand from such heavily
relied-upon industries would quite likely impact the NSK
Group’s overall financial performance and balance sheet.
4. Credit Risks
We believe most of NSK’s customers are comparatively
stable companies with fairly low credit risk. We have a
generally good turnover of accounts receivable. Nevertheless,
we have appropriated allowances for doubtful
accounts, and recognize the need to monitor the effects
economic down-cycles and intensifying competition may
have on the soundness of our customers’ capital base.
5. Business Alliance Risks
The NSK Group currently has a number of global business
alliances with the objective of efficiently using our
own and our partners’ management resources. Furthermore,
we aim to generate synergies in production,
research and development. Essentially, we endeavor to
maximize the advantages of our alliances. However,
disputes regarding issues such as management and
finance may prevent the joint venture from achieving
the expected benefits and results. As such, there may be
negative impacts on the overall financial performance
and balance sheet of the NSK Group.
6. Supplier Risks
To prevent over-dependence on a certain supplier, the
NSK Group has a basic policy of procuring materials and
components from multiple suppliers. Due to the nature
of some orders, however, there are cases where it is
technically impossible to divide an order between two or
more suppliers. In this case, quality problems or a
supplier’s lack of production capacity may make procuring
necessary materials or components impossible. Inevitably,
the supply to our customers would be disrupted. In
addition, when alternative materials and components are
sought, quality problems and cost increases may result.
In these cases, the NSK Group’s overall financial performance
and balance sheet may be affected.
7. Supply Instability and Rising Prices for Raw Materials
Global economic recovery and rising growth in demand
from China are leading to higher prices for steel, petroleum
and other key commodities, as well as acute shortfalls
in their production volume. In this context, the NSK
Group is also witnessing a rise in the cost of raw materials
used in its products. This trend comes amid concerns
over escalating prices for necessary materials and components,
and supply instability. The NSK Group is working
to reduce costs while passing on the higher cost of
raw materials to customers through product pricing.
Nevertheless, these efforts may fail to completely absorb
higher costs, which could have a negative impact on the
Company’s performance.
8. Quality Risks
NSK products are used in a wide number of industries. In
many cases, they are installed in areas requiring a high
level of precision and safety, such as automobiles, railway
vehicles, and aircraft. The NSK Group is acutely aware of
the importance of quality and has established a high-level
quality assurance system. However, the possibility
remains that an undetected critical defect could cause a
serious accident, resulting in a large liability claim. Such
an event would force a product recall, or force us to stop
manufacture of the relevant product. This, in turn, would
inconvenience our customers, who would then probably
demand some form of compensation, thus negatively
affecting the NSK Group’s reputation as well as overall
financial performance.
The NSK Group is covered by a global product liability
insurance policy. For certain products, the Company is
covered by a recall insurance plan. However, these insurance
plans do not necessarily cover all damages.
9. New Product Development Risks
Developing new products is an integral part of our business.
However, for a variety of reasons, newly developed
products may not be well-received by the market, or our
competitors may develop a product ahead of us. In order
to minimize these types of risks, we must constantly
maintain a pulse on the market.
10. Intellectual Property Rights and Risks
The NSK Group does not consider the shipment of products
to be the end of our research and development process.
The development cycle is considered complete
when our original technologies become part of our intellectual
property. We consider patents and intellectual
property rights extremely important in maintaining our
competitiveness. As such, we are applying for patents not
only in Japan, but also to authorities in relevant countries.
Because intellectual property rights are becoming so
important, any third party claim of invalidity or infringement
upon their intellectual property rights may impact
our financial performance.
11. Global Business Expansion Risks
The NSK Group has expanded globally to the point
where approximately half of our consolidated sales were
to overseas customers in fiscal 2004. We have production
sites in the U.S., Brazil, the U.K., Poland, Germany, China,
South Korea, Indonesia, Malaysia, Thailand, and India. We
also have sales offices all over the world. In expanding
business overseas, NSK faces risks such as the possibility
of being unable to recover invested capital as planned,
as well as risks associated with the consolidation and
elimination of production sites and those linked to withdrawal
from certain operations. There are also the inevitable
risks common with all business expansion overseas,
as listed below. Any of the following would certainly
affect the NSK Group’s ability to deliver sustained earnings,
and may adversely affect our financial position.
1) Unexpected changes in laws and regulations by local
governments
2) Changes in social, political, and economic conditions,
as well as the deterioration of public security
3) Problems in infrastructure, such as delays in transportation
and power shortages
4) Foreign currency limitations and rate fluctuations
5) Unfavorable changes in taxation policies
6) Adoption of transfer pricing taxation
7) Implementation of protectionist trade regulations
8) Credit risks arising from differences in commercial
practices
9) Changes in the labor market, including difficulty in
recruiting and retaining human resources
10) Outbreak of epidemics
12. Disaster and Terrorism Risks
Disasters such as earthquakes, floods, and fires, as well as
terrorist incidents and politically motivated social unrest
resulting in property damage and injury, are of great
concern to the NSK Group. If the Company or its customers
were to encounter such an event, this would have a
major impact on our production and sales activities.
Disaster and terrorism are two of the most important
issues management faces today. While NSK is not fully
insured for fires or natural disasters, we are taking every
possible step to prevent any of the aforementioned
events. However, it is extremely difficult to completely
eliminate these risks.
13. Compliance Risks
The NSK Group issued NSK’s Business Ethics Regulations to
ensure that laws and regulations are observed. We also
released NSK’s Code of Conduct Policies, which defines the
most important and basic rules that must be followed,
such as anti-trust laws and export regulations. These
documents are available on the Intranet and distributed
as necessary. In addition, executive officers and employees
learn these guidelines through educational programs,
in an effort to reduce noncompliance risks.
14. Legal Risks
As the NSK Group is a manufacturer, past and present
legal disputes have mainly been concerned with product
liability. Therefore, our chief legal risks should continue to
be product liability-related lawsuits, although we cannot
dismiss the possibility of other legal disputes.
15. Information Management
The NSK Group handles a substantial volume of sensitive
data and personal information in the course of its business
operations. The handling of this data is governed by an
information security policy that seeks to prevent the unauthorized
disclosure of sensitive information outside the
Group, or the use of such information for purposes other
than those for which consent has been gained. The Group
is taking steps to raise awareness and knowledge of this
policy and ensure its implementation. Nevertheless, unforeseen
circumstances could lead to the unauthorized
disclosure of sensitive information, resulting in damaging
the public’s trust in the NSK Group and causing the Group
to bear significant costs in response to the incident.
16. Environmental Risks
The NSK Group views actions to protect the natural environment
as one of its key management policies, and is
taking steps to upgrade its environmental management
systems. To date, NSK has never caused major damage to
the environment. However, if such were to occur, we
would face a variety of regulatory actions, including the
possibility of damage compensation, expenses for removing
the damage/pollutant, fines, and the effect of
production stoppages. Moreover, an incident of this kind
could damage the public’s trust in the NSK Group. The
possibility also exists that we would have to appropriate
a large amount of money to comply with new environmental
regulations. These would have a negative impact
on the NSK Group’s overall financial performance and
balance sheet.
17. Information Systems Risks
For many years now, the NSK Group has been promoting
the adoption of on-line systems to control production,
sales, and logistics. As a result, computers play a large
role in communication and routine duties, ranging from
the receipt of orders through to the delivery of products.
Any glitch in our computer systems from which an
extended period of time is needed to recover, can potentially
disrupt production and seriously affect our customers’
production plans. This in turn could result in
compensation liabilities, and damage our reputation in
the eyes of our customers. Moreover, disruptions arising
from the development and introduction of new
information systems in line with business expansion
could adversely impact the operations of the NSK Group.
18. Retainment of Human Resources
To maintain its competitive edge, the NSK Group must
recruit and retain talented human resources possessing
technical and other key skills. In Japan, some incongruity
has already emerged in the demographics of the Group’s
workforce, with a surge projected in the number of employees
nearing mandatory retirement. In the Group’s
core fields, the competition to secure outstanding human
resources has grown more intense. Failure by the
Group to secure and nurture these key human resources
would hamper the transfer of vital skills, which could
adversely impact NSK Group operations.
19. Labor Dispute Risks
The NSK Group has established a good, stable relationship
with its labor union. But, as our operations become
more globalized, rifts between the Company and the
union could develop. Differences in local labor practices
and regulations, changes in the economic environment,
and other unexpected circumstances could all result in
labor disputes that may disrupt business operations.
20. Foreign Exchange and Interest Rate Risks
The NSK Group currently has sales and production operations
in various locations around the world. Therefore, foreign
exchange fluctuations pose a risk to transactions and profits
from investments denominated in foreign currencies.
NSK is currently working on strengthening its balance
sheet position by reducing interest-bearing debts. However,
the NSK Group is still vulnerable to any increase in
interest rates. In order to reduce the negative impact of
foreign exchange and interest rate fluctuations, we are
trying to balance our foreign-based credit and debt. In
addition, we are using forward exchange contracts consistent
with internal guidelines to hedge foreign
exchange risks.
The financial statements of our overseas subsidiaries
and affiliates are indicated in local currencies. However,
when preparing consolidated financial statements, the
amounts are converted into yen. Therefore, even if the
results in local currencies do not change, the NSK
Group’s assets, liabilities, profits, and expenses are all
affected by foreign exchange fluctuations.
21. Retirement Benefit Liabilities
NSK Ltd. has adopted a defined-benefit pension plan.
This plan is also followed by the Company’s subsidiaries
in Japan, as well as a number of overseas subsidiaries
such as in the U.K.
The NSK Group’s retirement benefit expenses and
liabilities, including medical benefits for retirees, are
calculated using assumptions such as discount rates and
expected rate of return on plan assets. These assumptions,
returns on investments, share prices of the entrusted
stocks, and accounting policies could change.
Consequently, such changes may have a negative impact
on the NSK Group’s overall financial performance
and balance sheet.
In fiscal 2004, the NSK Group transferred part of its
current tax-qualified pension plan over to a defined-contribution
pension plan. This step was taken to reduce
the proportion of the pension plan accounted for by a
defined-benefit scheme. The aforementioned changes
and other factors, however, could nonetheless have an
adverse effect on the Group’s business results and financial
position.
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