Business Risks

The following is a list of major risks that management believes may have a material impact on the company's consolidated financial position, operating results, and cash flows, among other matters related to business and accounting conditions described in the Annual Securities Report. Note that the forward-looking statements in this document were determined by the Lacto Japan Group (“the Group”) as of February 28, 2022.

Having recognized the possibility of the occurrence of these risks, the Group intends to strive to avoid their occurrence and to respond in the event of their occurrence. However, the following information does not cover all risks and it is possible that the Group will be affected in the future by risks that cannot be predicted at present or risks that are not currently regarded as significant.

The Company has established the Risk Management Committee, which is composed of the Managing Director, directors, executive officers, the heads of business divisions, the head of the Corporate Staff Division, the head of the Accounting Department, the head of the Corporate Strategy & Planning Department, the head of the Internal Audit Office and the head of the Human Resources and General Affairs Department. The Committee reports to or provides advice to the Board of Directors regarding evaluation of risks faced by the Group, the determination of policies on risk countermeasures and the results of discussion.

(Impact of political and economic developments in major markets)

Political and economic developments in countries and regions such as Japan, Asia, North America, Europe, and Oceania, which are the key markets where the Group operates, may change the supply and demand balance of the products handled by the Group. If political and economic trends change the supply-demand balance of products handled, the Group's business performance may be affected through purchasing prices and sales prices.

(Impact of climate change)

The products handled by the Group, such as dairy ingredients, cheese and processed meat products, are derived from animals. Unlike industrial products, production volume is highly dependent on the climate and the environment, and the supply-demand balance for these products may be easily disrupted. In the dairy farming industry, climate change has a particularly large impact because rising temperatures lead to a decrease in milk production, and the quality of the feed crop resulting from drought and heavy rainfall also affects the volume of milk production. If supply-demand conditions ease internationally, due to such factors as an increase in production volume, the price competitiveness of imports versus domestic products will increase, and volume handled will tend to increase. Conversely, however, if production volume decreases due to abnormal weather or other factors and the supply-demand balance becomes tight, prices may rise steeply and volume handled may decrease. Moreover, in the event of extreme global warming, milk production in the dairy farming industry may decrease, which may affect the procurement of dairy raw materials and cheese. The above factors could adversely affect the Group’s business performance.

(Impact of environmental regulations)

The dairy farming and livestock industry is considered to be an environmentally burdensome industry, with high greenhouse gas emissions, including methane gas emissions from cattle, water and soil pollution from manure disposal, and deforestation caused by pasture development. In our business activities, where suppliers of the products we handle include the dairy farming and livestock industry, if various regulations are tightened to reduce environmental impact, such as further tightening of greenhouse gas emission regulations in line with the transition to a low-carbon society, the costs required to comply with the regulations may increase. Furthermore, an insufficient or delayed response to these issues in the dairy farming and livestock industry may impede the smooth business activities of the Group.

Such fluctuations in the business environment as described above may make it difficult to procure and sell the products we handle or may cause significant fluctuations in purchasing prices and sales prices, which may affect the Group's business performance. The Group will work to mitigate these risks by diversifying supply sources, promoting the development and procurement of alternative raw materials, working to build a sustainable dairy farming and livestock industry, and diversifying its business with food as its core.

Trade liberalization is progressing in Japan, with the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (TPP11) coming into force in December 2018, the EU-Japan Economic Partnership Agreement (Japan-EU EPA) coming into force in February 2019, and the US-Japan Trade Agreement coming into force in January 2020. For the Group, the progress of trade liberalization makes it difficult to utilize the overseas networks and know-how that we have built to deal with the high tariff barriers in Japan. On the other hand, factors such as the lowering or elimination of tariffs are likely to boost demand for imported products and increase the volume of products handled by the Group. Therefore, if trade agreements are revised or similar events occur, this could affect the Group’s business performance.

In carrying out business activities, the Group is subject to legal regulations in Japan, including the Food Sanitation Law and the Consumer Safety Act, as well as legal regulations in other countries in which we conduct business. Going forward, any revision or abolition of these regulations or the introduction of new legal regulations may result in additional costs to address them and may affect the business and business performance of the Group.

In addition, the Group has been granted various permits and licenses necessary for its business activities. However, if these permits and licenses are revoked due to a violation of laws and regulations or other factors, the business activities of the Group will be restricted, which may affect the business and business performance of the Group.

To respond to the above risks, we have established the Quality Assessment Office as a company organization to respond to and gather information on quality-related laws and regulations and we have a system in place to respond appropriately and promptly to new legal regulations.

The Group is implementing measures to reduce the risk of infection such as staggered work hours, the promotion of telecommuting and the active use of web meeting systems.

It is difficult to estimate accurately how far and how rapidly infectious diseases will spread or when they will be contained. However, if the state of infection deteriorates further and restrictions on business activities and behavior are strengthened due to demands by governments of various countries, the tendency to refrain from eating out and leisure may increase and demand for commercial dairy ingredients, cheese, meat products and other products may decrease. There could also be an impact on supply chains, including milk production, production of dairy ingredients and cheese, production of chilled and frozen pork, production of processed meat products, shipments of those products, marine transportation and delivery of cargo in various countries around the world that are supply sources.

The products that the Group handles comprise food ingredients and food products. The Group manufactures its own brand of commercial cheeses in Asia. In the unlikely event that a foreign material has been mixed in by our negligence or a malicious third party, if there is an error in the labeling of a raw material, or if a flavor or taste defect occurs due to the transportation or storage method, there is a possibility of receiving claims for a product recall or claims for compensation for damages respectively from the standpoint of a trading company that handles raw materials or the standpoint of a manufacturer. This may affect the business and business performance of the Group.

In manufacturing products, the Group makes its utmost efforts to ensure quality, including carrying out thorough safety management such as food defense.

The Group's competitors include major general trading companies that purchase and sell dairy ingredients and processed meat products and major food manufacturers. If these major companies take equity stakes in our suppliers or business partners or incorporate them in their corporate group, this may affect the business and business performance of the Group.

As a trading company, the Group conducts import and export transactions mainly in the United States, Europe and Asia. In addition, the financial statements of overseas consolidated subsidiaries are denominated in local currency, and there is a risk that net assets in the consolidated financial statements will fluctuate through foreign currency translation adjustments depending on the foreign exchange rate at the time of conversion into yen.

Moreover, most of the business transactions conducted by the Group conclude a purchase contract and a sales contract at the same time, and in principle, the selling price in yen to Japanese customers in import transactions is determined based on the exchange rate at the time of concluding the purchase contract. As a general rule, purchase contracts for import transactions are denominated in foreign currencies, but when concluding a purchase contract, we enter into a foreign exchange contract with a financial institution to avoid foreign exchange fluctuation risk. However, if the yen depreciates, the purchase amount converted into Japanese currency will increase, and the selling price will increase accordingly (increase in sales). If the yen appreciates, the reverse impact will occur (decrease in sales). In addition, if the exchange rate fluctuates sharply toward the end of the financial period, the cost of goods sold in the next financial period may be affected if the goods are held as inventory and sold in the following financial period after the purchase price is settled. Therefore, large foreign exchange fluctuations may affect the Group’s financial position, operating results and cash flow.

The Group’s main businesses, the Dairy Ingredients and Cheese Division, the Meat Products Division and the wholesale business in the Asian Business and Others segment, are structured as a trading company. As the business flow proceeds from purchasing to inventory to sales and to cash recovery, an increase in the scope of business operations is equivalent to an increase in working capital, and this may result in negative operating cash flows. Going forward, we will strive to secure profits by reforming our profit structure and generate our own funds by such means as improving the efficiency of working capital.

Under these circumstances, if it becomes difficult to procure funds due to such factors as a change in financial conditions and the Group is no longer able to execute investment plans or if funding costs increase due to a rise in market interest rates, this may affect the business performance and financial position of the Group. Note that the Company has signed a syndicated loan agreement with a commitment line with major financial institutions, and the agreement imposes financial covenants. If these covenants are infringed, the repayment of these borrowings could be demanded, which could affect the Group’s financial position.

The Group is focusing on acquiring and developing excellent human resources through new graduates and mid-career recruitment, as the most important management resource. However, in the event of the retirement of these human resources or if excellent human resources cannot be acquired in a timely manner due to the conditions in the human resources market, this may affect the business performance of the Group.

The Group handles various types of diverse information when conducting business activities. Under these circumstances, unexpected system failures or unauthorized access could result in the leakage, falsification, or loss of information, resulting in a loss of public trust and restrictions on a wide range of business activities, which could have a significant impact on the financial position, operating results, and cash flow of the Group.

To address the above risks, we have established an information security policy to protect information assets and comply with laws and regulations related to information security, and have implemented information security measures such as security training mainly in the Business Accounting Department. As regards the use of social networking services (SNS) by employees, we have clearly documented social media guidelines and thoroughly ensured that employees are familiar with them. Furthermore, owing to an increase in telework such as telecommuting, we have established regulations on methods of handling information and developed a secure network environment to accommodate this.