Business Risks

Shinwa Co., Ltd. (“the Company”) and its subsidiaries (collectively, “the Group”) believe that the matters described below may have a material impact on the decision-making of investors. It should be noted that matters concerning the future in this section have been determined based on information available to the Group as of this writing. As such, the Group does not guarantee their realization, and this report is not to be taken as an exhaustive list of the risks associated with investment in the Company’s stock.

(1) Demand for System Scaffolding

The majority of end users of system scaffolding, one of the primary products of the Group, are scaffolding installers. Demand for construction work faced by scaffolding installers is likely to remain high for some time, but there is no denying that such end users may put off repurchasing for reasons including, but not limited to, a human power shortage at construction sites, overstocking of scaffolding materials, spread of next-generation scaffolding, and increases in the price of scaffolding materials due to rises in raw materials and plating prices. If these events were to trigger a softening of demand for system scaffolding either temporarily or over the medium- and long-term, the Group’s business performance could be adversely affected.

(2) Economic Trends in the Construction Market

The scaffolding equipment market in which the Group operates is significantly subject to the economic trends in the Japanese market, and demand from the housing and low- and mid-rise building construction market in particular. If the overall scaffolding equipment market is affected by changes in the Japanese economy in general or the economic climate of such market, the Group’s business activities and performance could be adversely affected.

(3) Competition with Other Companies

The wedge binding-type scaffolding, which the Group manufactures and sells, is exposed to constant price competition with other players who manufacture and sell scaffolding of a similar type. The Group has maintained a good relationship with its customers by consistently improving the quality of its products, which has earned us the leading position in the system scaffolding market in Japan*1. If competition intensifies as a result of a low-cost strategy by competitors (existing or new), the Group’s business activities and performance could be adversely affected.
*1 According to the “Survey Report on the Wedge Binding-Type and Next-Generation Scaffolding” (dated September 20, 2017, undisclosed), compiled by JMA Research Institute Inc. at the request of Shinwa Co., Ltd. Our wedge binding-type scaffolding had the leading market share on a shipment value basis in fiscal 2016.

(4) Fluctuations, etc. of Materials Prices

The Group’s products are made from selected, high-quality steel materials, such as pipes and coils, which are purchased from specialized trading companies and manufacturers in Japan and elsewhere. The prices of such materials fluctuate due to the rises and falls in the commodity market, foreign exchange rates, political situations, supply-demand gaps, and the like. The Group mitigates risks of performance fluctuations and supply bottlenecks resulting from potential price hikes by sourcing from multiple key vendors; however, there is no denying that prices may fluctuate going forward. A price increase in raw materials could adversely affect the Group’s business performance.

(5) A High Level of Borrowings

As a result of financing for a leveraged buyout (LBO), which was executed by River Holdings Co., Ltd. to purchase former Shinwa Co., Ltd.’s stock before the April 2015 merger, a large amount of borrowings was posted (borrowings outstanding: 6,180,249 thousand yen, or 29.2% of total assets) at the end of the fiscal year ended March 2019. Going forward, we will strive to compress our borrowings, but because they are funded with variable interest rates, if the interest rates rise, the Group’s operating results could be adversely affected. Also, should payment plans be altered due to a failure to achieve a business plan or should it become difficult to refinance the borrowings owing to confusion in the financial market, a change in lending policy on the part of financial institutions, or otherwise, the Group’s financial position could be adversely affected.

(6) Accelerated Payment of Borrowings

The Company has concluded a syndicated loan agreement with multiple financial institutions. Said agreement stipulates the following prohibitions and restrictive financial covenants.
1.The borrower shall not provide collateral to secure debts other than those stipulated in this agreement without the prior written consent of all of the lenders and agents.
2.The borrower shall not provide collateral to secure debts stipulated in this agreement for some lenders without the prior written consent of all of the lenders and agents, with the exception of this collateral agreement.
3.After accounts are settled for the fiscal year ended March 2019, the amount of total shareholders’ equity on the consolidated financial statements as of the last day of each fiscal year should be maintained at 75% or higher (65% or higher for Tranche D) of the amount of total shareholders’ equity in the consolidated financial statements as of the last day of the fiscal year ended March 2018.
4.After accounts are settled for the fiscal year ended March 2019, operating loss should not be reported in the consolidated profit and loss statement at the end of each fiscal year or the end of the second quarter for two consecutive years.

Said agreement stipulates the following asset-related restrictive covenants.
1.Entity conversion (as defined in Article 2, Paragraph xxvi, Companies Act (Act No. 86 of 2005, including subsequent revisions), merger, company split, share exchange, share transfer, or setting of self-settled trust
2.Assignment of all or part(s) of business or assets to a third party (including assignments for sales and leaseback)
3.Assignment of all or part(s) of business or assets of a third party
If any of these covenants is infringed upon, the Group may be forced to pay the borrowings in a lump sum, which could adversely affect the Group’s financial position.

(7) The High Percentage of Goodwill in Total Assets

The Group posted goodwill of 9,221,769 thousand yen under non-current assets at the end of the fiscal year ended March 2019, which accounts for as much as 43.6% of total assets. This goodwill arose when River Holdings Co., Ltd. and the former Shinwa Co., Ltd. merged in April 2015. Because we have adopted the International Financial Reporting Standards (IFRS), we do not have the annual depreciation burden, in principle. However, if a business from which goodwill is derived has lost its earnings power and posted an impairment loss, the Group’s business performance could be adversely affected. Based on the impairment test results, the value in use of the future cash flows (the recoverable amount) is believed to be higher than its book balance at the close of the year ended March 2019. Should the estimated future cash flows have decreased by 36.7% at the end of a given fiscal year or the pretax discount rate have risen by 4.62%, the recoverable amount will equal the book value.

(8) Recruitment and Development of Human Resources

It is essential that the Group has access to and develops talented personnel. If the Group fails to do so or if such individuals quit the company, the Group’s business operation, performance, and other parameters could be adversely affected.

(9) Management of Outsourcing Partners

The Group outsources parts of its product manufacturing processes. For product plating and outsourced production within our premises, we use one outsourcing partner each. For the sake of stable supply and pricing, we do our utmost not to depend on our limited number of outsourcing partners. However, should the supply from outsourcing partners upon whom we heavily depend become unstable for some reason, the Group’s operating results could be adversely affected. Also, an increase in outsourcing costs due to fluctuations in utilization of outsourcing partners’ factories and a hike in raw materials prices could each adversely affect the Group’s business performance.

(10) Quality Assurance

In the scaffolding equipment industry in which the Groups operates, there is no practice of determining a warranty period for merchandise and finished goods. Nevertheless, we are practically required to assure the quality of products that we provide under the Product Liability Act, the Industrial Safety and Health Act, the Ordinance on Industrial Safety and Health, and other laws and regulations. Furthermore, we recognize the need to work earnestly to assure the integrity of the products that we provide and offer after-sale service from the perspective of the corporate ethics of the Group. In preparation for the unlikely occurrence of a serious accident due to a defect in our products or for another reason, the Group purchases liability insurance to reduce such risks. However, should a major flaw or defect in the quality of the Group’s products cause a serious accident or other unforeseen circumstances, the Group’s social credibility and business performance could be adversely affected.

(11) Scaffolding and Construction Equipment Association of
Japan’s Certification System for the Group’s Products

The Group has its products certified and approved by the Scaffolding and Construction Equipment Association of Japan. The Association tests scaffolding and other temporary structures to see if their safety and specifications conform to their criteria, with the aim of contributing to the prevention of occupational accidents related to scaffolding and other temporary structures and the facilitation of on-site construction work. The Group takes infallible measures for quality control to prevent unforeseen circumstances from arising due to our products or during their manufacturing processes. However, should our products fail to pass or renew the certification by the Association, the Group’s business performance could be adversely affected.

(12) Concentration of Production Bases and Natural Disasters

The Group’s production bases are concentrated in Gifu Prefecture, with most of its products being produced at the Tsuchikura Plant, Gifu Prefecture, and its distribution centers are located in the Tokai region, including Gifu and Aichi Prefectures. Accordingly, should a natural disaster or another form of force majeure or in-plant accident that could affect the plant itself or threaten the livelihood of employees occur, production at the Tsuchikura Plant could be rendered stagnant, and the stable supply of products to business partners could be disrupted. There could also be significant delays in the delivery of products, as the main highways and ports in the Tokai region could be cut. Any such circumstances could cause the Group’s business performance to be adversely affected.

(13) Statutory Regulations

The Group’s Scaffolding Equipment Division and Logistics Equipment Division manufacture and sell scaffolding equipment and logistics equipment, respectively. In accordance with the Industrial Safety and Health Act, Ordinance on Industrial Safety and Health, and other laws and regulations, the Group ensures the occupational safety and well-being of its workers and strives to create a comfortable workplace environment by promoting measures based on a comprehensive plan for preventing occupational accidents involving its employees. This includes the establishment of danger prevention standards, clarification of a responsibility system, and facilitation of voluntary activities. If these statutory regulations are tightened or the level of social requirements for product safety is raised, both of which could result in the occurrence of additional expenses for capital expenditures or the like, the Group’s business performance could be adversely affected.

(14) Intellectual Property Rights

The Group puts its intellectual property rights under management by having the Product Development Department take care of research and development, applications for intellectual property, registration after application, and maintenance of registration status. To protect its intellectual property rights, when a salesperson is informed of an alleged infringement of the Group’s intellectual property rights, he/she reports it to the relevant departments to determine if the case constitutes an infringement. The Group has never been accused by a third party of an alleged infringement on their intellectual property rights. However, it is conceivable that intellectual property rights that the Group does not recognize have already been established or a third party could register a new intellectual property right in the Group’s business field. As such, it is extremely difficult to completely eliminate risks of such infringement. Should the Group be found to infringe on a third party’s intellectual property rights or the like, the Group’s business activities, performance, and/or operating results could be adversely affected owing to claims for damage, injunction requests, and payment for the use of another party’s intellectual property rights.

(15) Dependence on Information Technology

The Group makes extensive use of information technology for its mission-critical systems and the like for the entire range of operations from order receipt to shipment. To protect against cyber attacks from outside on its information systems via the internet and loss of critical data, the Group reduces associated risks by setting up a proper firewall and physically decentralizing data for backup. However, if a variety of failures in the Group’s information systems occurs due to unexpected program malfunctions, computer viruses, or cyber attacks from outside, or for another reason, the Group’s business activities and performance could be adversely affected as it would face business delays, loses important data, or incurs costs to deal with the situation(s).

(16) Stock Dilution as a Result of Exercise of Share Options

The Group has introduced an employee stock option plan, in which officers and employees are offered a share option as an incentive for enhancement of business performance and corporate value. The number of potential shares with regard to unexercised share options currently stands at 400,800, or 2.87% of the 13,988,800 outstanding shares. The exercise of such options would cause the Group’s stock value per share to be diluted.

Issues to be Addressed

In order to realize its management strategies over the medium- and long-term, the Group will address the following issues.

1. Creating Vitality for All the Employees of the Group

The Group upholds the basic philosophy (“Our Mission”), which includes “We offer our wholehearted support for our employees’ passion for realizing their ‘dreams and future visions.’” We also believe that, for the Group to sustain its growth, it is important that employees have dreams and be provided the chance to give full play to their potential as they seek to achieve them.

We strive to increase employee satisfaction and foster their vitality so that they can realize their dreams and future visions. To do so, the Group will remain committed to the development of a workplace environment in which diverse people can demonstrate their abilities to the fullest by undertaking a series of measures. These include improvement of transparency of personnel evaluation, development of infrastructure for sharing outcomes and information, investments in information technology for increasing operational efficiency and revitalization of communication, and enhancement of their awareness and willpower through branding.

2. Recruitment and Development of Talented Human Resources

In order for the Group to sustain its growth, we believe it imperative to recruit and develop talented human resources.

Accordingly, the Group will make greater efforts to recruit more outstanding human resources who will contribute to enhancement of product development and sales capabilities and the internal control structure.

We will also work to develop a system that stimulates employee growth as we develop a training program both in and outside of the company, build a personnel management system, and utilize external know-how.

3. Reinforcement of Corporate Governance

The Group believes that its corporate value will be enhanced continuously if it establishes a policy, structure, and operating method for compliance activities, deepens awareness of corporate social responsibilities, complies with applicable laws and regulations in the performance of everyday business, and acts in a manner that conforms with social ethics.

In order to treat all of our stakeholders with respect, enhance the soundness and transparency of the company, and increase shareholder value stably over a long term, the Group will establish an organizational structure that allows us to make prompt and rational decisions and increase efficiency of the execution of operations, thereby reinforcing our corporate governance.

We will also enhance the control structure at subsidiaries, thus reinforcing corporate governance of the entire Group.

4. Further Improvement of Product Quality

It is our belief that unless we continue to maintain and improve the quality of our products we cannot expect our customers to keep choosing our products.

With this in mind, we make it a rule to intensively verify quality at points of change, such as when changing personnel, equipment, and methods of manufacturing, while at the same time reflecting on previous quality problems at daily meetings to confirm the continuous implementation of countermeasures and consider additional measures, thereby boosting efforts to prevent recurrence of the same problems.

We will also ensure that not a single unit with less-than-satisfactory quality is manufactured, not only by verifying quality of products but also by enhancing the quality of manufacturing equipment through design, conducting periodic maintenance, and promptly handling and sharing information on detected defects using relevant processes.

5. Cost Reduction Efforts

The Group’s manufacturing and procurement departments are constantly seeking points for improvement to reduce costs, rather than continuing with conventional approaches.

Their approaches cover a broad scope, including costs of running and inspecting equipment, as well as shortening of processes. They aim for greater benefits by steadily carrying out diverse cost reduction activities. They will also focus on the reduction of procurement costs by ordering materials of appropriate size for higher yields and using multiple vendors whenever possible.

These efforts are reviewed periodically to assess their benefits and projected viability with a view toward establishing them as a consistent approach to cost reduction.