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Risk Factors

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The NEC Group has a company-wide cross-sectional risk management system to accurately comprehend and to respond appropriately to both internal and external risks related to NEC Group’s businesses.
Specifically, NEC Corporation (hereinafter “the Company”) established the Risk Control and Compliance Committee and discusses a risk management policy, policies with regard to selection of and response to “Priority Risks” that requires countermeasures across the NEC Group, as well as measures to address risks that require company-wide management due to fluctuations in risk environment during the fiscal year, and other important matters related to company-wide risk management, then reports them to the Executive Committee and the Board of Directors on a regular basis.
The Company also conducted risk assessment, evaluated each risk with common standards such as magnitude of impact and urgency, based upon the exhaustive list of risks that are deemed necessary for the NEC Group to recognize, and prepared a risk map that visualizes the priority of such risks.
Further, on April 1, 2023, the Company newly established Chief Risk Officer (CRO) to monitor and address company-wide risks centrally and cross-functionally and strengthen its structure to manage possibilities to make losses. The CRO chairs the Risk Control and Compliance Committee and takes a lead the company-wide risk management by detecting and analyzing various / complicated risks in social and business environment changing day by day, and evaluating impacts, while prioritizing countermeasures with the risk map and closely collaborating with other chief officers managing each risk.

The NEC Group’s business is subject to various risks. NEC’s Group’s management recognizes that the NEC Group’s financial condition, results of operations, and cash flow status could be materially affected by the primary risks described below, among matters related to the NEC Group’s business and management status. The forward-looking statements in this section are based on the judgement of the NEC Group as of the end of the fiscal year ended March 31, 2023.

(1) Risks related to economic conditions and financial markets

a. Influence of economic conditions

The NEC Group’s business is dependent, to a significant extent, on the Japanese market. The NEC Group's consolidated revenue to customers in Japan accounted for 73.0% of its total revenue in the fiscal year ended March 31, 2023. The future deterioration of economic conditions in Japan or the financial condition or performance of the NEC Group’s customer base in Japan could have a material adverse effect on the results of operations and the financial position of the NEC Group.

Moreover, the NEC Group’s business is also influenced by the economic conditions of countries and regions including Asia, the United States and Europe, in which the NEC Group operates its business. Geopolitical issues and trade conflicts worldwide, including trade tensions between the United States and China, have recently contributed to increasing uncertainties in global markets, and increases in protectionist trade policies more generally may also contribute to slower global macroeconomic growth. Epidemics such as virus outbreaks, including the outbreak of COVID-19 and other infections described below in “d. Impact of the outbreak of novel coronavirus (COVID-19) and other infections ” as well as perpetuation of current situation between Russia and Ukraine, may also negatively affect economic conditions in the global economy. When aforementioned geopolitical issues and trade conflicts become apparent in regions and countries in which NEC Group operates its business, they may also adversely affect the NEC Group’s business.
In addition, shifts in the policy or budgetary focus of national or local governments in Japan or internationally for economic or other reasons may also adversely affect the NEC Group’s business.

Uncertainties in the economy make it difficult to forecast future levels of economic activity. Because the components of the NEC Group’s planning and forecasting depend upon estimates of economic activity in the markets that the NEC Group serves, the prevailing economic uncertainty in Japan and overseas makes it more difficult than usual to estimate its future income and required expenditures. If the NEC Group is mistaken in its planning and forecasting, there is a possibility that the NEC Group will not be able to appropriately respond to the changing market conditions.

b. Fluctuations in foreign currency exchange and interest rate

The NEC Group is exposed to risks of foreign currency exchange rate fluctuations particularly for the Japanese yen against the U.S. dollar and euro. The NEC Group’s consolidated financial statements, which are presented in Japanese yen, are affected by fluctuations in foreign exchange rates. Changes in exchange rates affect the yen value of the NEC Group’s equity investments and monetary assets and liabilities arising from business transactions in foreign currencies. They also affect the costs and revenue of products or services that are denominated in foreign currencies. As of March 31, 2023, the NEC Group’s net exposure of operating receivables and payables and forward currency contracts amounts to 213 million USD, and had Japanese yen weakened by 1% toward U.S. Dollar on the same day, profit before income taxes would have been 284 million JPY more than the actual result. The NEC Group uses various measures to reduce, or hedge against, foreign currency exchange risks, such as offsetting of foreign currency-denominated operating receivables and payables, forward currency exchange contracts, and currency options. Despite these measures, however, foreign exchange rate fluctuations may hurt the NEC Group’s business, results of operations and financial condition. Depending on the movements of particular foreign exchange rates, the NEC Group may be adversely affected at a time when the same currency movements are benefiting some of its competitors.

The NEC Group is also exposed to risks of interest rate fluctuations, which may affect its overall operational costs and the amount of its financial assets and liabilities, in particular, the burden of long-term debt. As of March 31, 2023, the NEC Group had 200 million JPY of long-term borrowings subject to floating interest rates. Despite measures undertaken by the NEC Group to hedge a portion of its exposure against interest rate fluctuations, such as interest rate swaps, such fluctuations may increase the NEC Group’s operational costs, reduce the value of its financial assets, or increase the value of its liabilities.

c. Volatile nature of markets

The NEC Group is exposed to the risk that broader changes and trends in the ICT industry, both in Japan and overseas, may affect demand for the products and services that it provides. Demand for the NEC Group’s products and services can be negatively affected by a slump in ICT market conditions, as well as obsolescence of existing products and services, excess inventories, and a decline in the NEC Group’s cost competitiveness. The volatile nature of the relevant markets means that even if they recover, there may be future recurrences of downturns with similar or more adverse effects on the NEC Group’s results of operations.

d. Impact of the outbreak of novel coronavirus (COVID-19) and other infections

The outbreak or spread of COVID-19 and other infections may result in social, economic, financial and labor instability in the countries in which the NEC Group, its suppliers, and its customers operate. The extent to which the infection will ultimately impact the NEC Group’s operations and those of its suppliers and customers will depend on the duration of the pandemic and governmental countermeasures in each country including prevention of infection and countermeasures for the spread of disease such as travel restrictions and requests to people to refrain from going outside, which are highly uncertain and cannot be predicted with confidence. As the NEC Group’s corporate customers as well as its Japanese national and local government customers focus on addressing the various difficulties such as the spread of the infection, etc., they may become more constrained in their ability to engage the NEC Group’s services and purchase its products at the levels that were anticipated prior to the crisis. Regarding COVID-19, although signs of economic recovery could be expected in Japan due to easing of economic activities restriction that were applied due to the pandemic, the adverse impact could still remain with no guarantee on the economy in Japan being recovered as expected, with circumstances and future developments which the NEC Group is unable to control such as spread of infections including new variant of COVID-19, effect of vaccines and immunization rate movements and state of medical care system in Japan.

To date, under the ‘Smart Work 2.0’ that enhances smart workstyle, the NEC Group has transitioned a significant subset of its employee population to a remote work environment partly in an effort to mitigate the spread of the COVID-19, which may exacerbate certain risks to its business, including increased risk of cybersecurity attacks and increased risk of unauthorized dissemination of personal information or confidential information about the NEC Group, its customers or other third-parties, in addition to which internal control systems may not function effectively at the same level as before the outbreak of COVID-19 infections. Although the NEC Group has not closed any of its production facilities and has not yet experienced significant disruptions in its supply chain, the spread of pandemic and countermeasures taken by various governments could result in facility closures by its customers or suppliers, general business shutdowns and financial difficulties. The pandemic could also result in increased prices, delays or difficulty in obtaining such components and raw materials. The NEC Group cannot presently predict the overall scope or duration of business disruptions as a result of the outbreak or spread of infections including COVID-19.

Depending on the overall duration and severity of the impact of the outbreak or spread of infection including COVID-19, the NEC Group may be required to recognize material impairments of its assets, including, but not limited to, goodwill, intangible assets and right-of-use assets. Additionally, declines in the value of the NEC Group’s equity holdings in various major companies could negatively impact its financial condition. The NEC Group’s equity instruments designated as measured at fair value through other comprehensive income was 140.7 billion JPY as of March 2023, and there is a possibility that this value will decrease due to the impact of the spread of the COVID-19 pandemic.

The NEC Group is unable to estimate with certainty the overall impact to its business, results of operations and financial condition due to the outbreak or spread of infection including COVID-19 pandemic and any associated protective or preventative measures.

(2) Risks related to the NEC Group’s Management Policy

a. Mid-term management plan

In May 2021, the NEC Group launched “Mid-term Management Plan 2025” with the fiscal year ending March 31, 2026 as its final year, with the principles of integrated promotion of 1) Purpose (Basis of NEC), 2) strategies and 3) culture, to maximize its corporate value.
The NEC Group is carrying out initiatives to realize its Mid-term Management Plan. However, whether NEC Group could carry out initiatives to realize its Mid-term Management Plan or not depends on various factors discussed in more details in this "Risk Factors" such as sizes of markets where NEC Group aims to expand its businesses such as digital government, digital finance and 5G might not grow as expected, growth speed of aforementioned markets might be slower than expected, market share in the aforementioned markets could not be obtained as much as expected by NEC Group, or expected positive impact could not be realized even with strategic expenses incorporated in the “Mid-term Management Plan 2025” spent. Such aforementioned initiatives may not be carried out according to the plan, and NEC Group may be unable to achieve the goals stated in its mid-term management plan within the planned timeframe, or at all, due to various factors discussed in more details in "Risk Factors".

b. Finance and profit fluctuations

The NEC Group’s results of operations for any quarter or year are not necessarily indicative of results to be expected in future periods. The NEC Group’s results of operations have historically been, and will continue to be, subject to quarterly and yearly fluctuations as a result of a number of factors, including:

  • the introduction and market acceptance of new technologies, products, and services;
  • delay or failure in development or commercialization of technologies or infrastructures to support them;
  • generational technology upgrades, expiration of support services contracts for widely used software products, and technology investment cycles;
  • variations in product costs, and the mix of products sold;
  • seasonality of purchasing cycles of customers;
  • the size and timing of customer orders, which in turn will often depend upon the success of customers’ businesses or specific products or services;
  • the impact of acquired businesses and technologies;
  • the ability to generate expected synergies by acquisition of companies; and
  • fixed costs.

There are other trends and factors beyond the NEC Group’s control that may affect its results of operations and make it difficult to predict results of operations for a particular period. These include:

  • adverse changes in the market conditions for the products and services that the NEC Group offers;
  • changes in conditions in the broader markets for ICT infrastructure and in the Japanese and global economies generally;
  • Unexpected market environment changes caused by technological breakthrough by competitors;
  • governmental decisions regarding the development and deployment of ICT and communications infrastructure, including the size and timing of governmental expenditures in these areas;
  • the size and timing of capital expenditures and ICT spending by its customers;
  • inventory management practices of its customers;
  • changes in laws, governmental regulation or policy affecting the ICT industry;
  • adverse changes in the public and private equity and debt markets, and the ability of its customers and suppliers to obtain financing or to fund capital expenditures; and
  • adverse changes in the credit conditions of its customers and suppliers.

These trends and factors could have a material adverse effect on the NEC Group's business, results of operations and financial condition.

c. Acquisitions, other business combinations and reorganizations and business withdrawals

The NEC Group has completed acquisitions and other business combinations and reorganizations in order to expand its business and strengthen its competitiveness. For example, the NEC Group acquired Northgate Public Services Limited (currently NEC Software Solutions UK) in the United Kingdom in January 2018, KMD Holding ApS in Denmark in February 2019, and Avaloq Group AG in December 2020. NEC Group continues to seek appropriate opportunities for acquisitions and other business combinations and reorganizations as part of its growth strategy under “Mid-term Management Plan 2025”. However, the NEC Group may be unable to find appropriate target companies with strengths that match the objectives of its inorganic growth strategy, and even if it is able to find such appropriate target companies, the NEC Group faces risks that could adversely affect its ability to achieve its strategic goals. For example,

  • The NEC Group may be unable to realize the growth opportunities, improvement of its financial position, investment effect, synergy effect and other expected benefits by these acquisitions, business combinations and reorganizations in the expected time period or at all;
  • The planned transactions may not be completed as scheduled or at all due to legal or regulatory requirements or contractual and other conditions to which such transactions are subject;
  • Unanticipated problems could also arise in the integration process, including unanticipated restructuring or integration expenses and liabilities, as well as delays or other difficulties in coordinating, consolidating and integrating personnel, information and management systems, and customer products and services, particularly in markets outside Japan;
  • Issues may arise for the entities to be acquired, such as in maintaining of its management which is necessary for continuing and growing of its business or in transformation of its operations in order to start operations as part of NEC Group in mid-to long-term perspective;
  • The acquired, integrated, or reorganized entities may not be able to retain existing customers and strategic partners to the extent that they wish to diversify their suppliers for cost and risk management and other purposes;
  • The acquired, integrated or reorganized entities may require additional financial support from the NEC Group;
  • The diversion of management and key employees’ attention may leave the NEC Group unable to focus on increasing revenues and minimizing costs in its existing businesses;
  • The goodwill and other intangible assets arising from the acquisitions and business reorganizations are subject to impairment charges;
  • NEC Group’s investments in the acquired, integrated or reorganized entities are subject to valuation and other losses; and
  • The transactions may result in other unanticipated adverse consequences.

Any of the foregoing and other risks may adversely affect the NEC Group’s business, results of operations, financial condition and stock price.

NEC Group has also exited from or scaled down certain businesses that are, not compatible with its strategies, or generating only low profitability. However, there is no guarantee that NEC Group could exit or scale down with favorable conditions for NEC Group as they depend on market environment or intentions of possible buyers. In case exit or scaling down could not be executed in order to realize its business strategies with conditions in NEC Group’s favor, it could adversely impact NEC Group’s operations and business results.

d. Alliance with strategic partners

The NEC Group has entered into a number of long-term strategic alliances with leading industry participants, both to develop new technologies and products and to manufacture existing and new products. In June 2020, the Company agreed with Rakuten Mobile, Inc. to jointly develop a fully virtualized standalone 5G core network. The Company, in the same month, agreed with Nippon Telegraph and Telephone Corporation ("NTT Corporation") on a capital and business alliance aimed at joint research, development and global expansion of 5G and various ICT products. Furthermore, in July 2021, Microsoft Corporation of the United States and the NEC Group concluded a contract to expand their strategic partnership with the aim of introducing the cloud to customers and accelerating DX through mutual utilization of technology and knowledge. If the NEC Group’s strategic partners encounter financial or other business difficulties, if their strategic objectives change or if they no longer perceive the NEC Group to be an attractive alliance partner, they may no longer desire or be able to participate in the NEC Group’s alliances. The NEC Group’s business could be hurt if the NEC Group is unable to continue one or more of its alliances. In addition, as a result of such strategic alliances, the NEC Group may become dependent on its alliance partners for product lines using co-developed technologies and an Open RAN which is jointly developed with NTT Group and Rakuten Mobile, Inc., leaving the NEC Group with less flexibility in expanding or diversifying its product and service offerings.

NEC Group’s competitors may form strategic alliances with the aim of enhancing their competitiveness and developing new technologies in areas where NEC Group also operates. Competitive landscape changes caused by such successful alliances of competitors, such as their developed technologies gaining status as market standards and as a result, the standards promoted by NEC Group or by its strategic alliances are unable to be so, could result in a failure of NEC Group’s strategic alliance.

The NEC Group participates in various projects where the NEC Group and various other companies provide services and products that are integrated into systems to meet customer requirements. If a strategic partner is unable to continue its role in the partnership due to bankruptcy or other reasons, or if any of the services or products that companies other than the NEC Group provide cause the integrated systems to malfunction, fail to meet customer requirements, or give rise to some other defect or problem, the NEC Group’s reputation and business could be significantly harmed.

e. Expansion of global business

The NEC Group’s strategies include expanding its business in markets outside Japan, including the promotion of “Digital Government/Digital Finance Business” and “Global 5G Business”. Of these, effect of “Digital Government/Digital Finance Business” will be evaluated by how successfully and appropriately the integration of acquired companies outside of Japan including Northgate Public Services Limited in the United Kingdom purchased in January 2018, KMD Holding ApS in Denmark in February 2019, and Avaloq Group AG in Switzerland in December 2020 could be achieved. As the NEC Group expands business, it will be exposed to risks that are unique to particular regions or markets. The NEC Group’s efforts to penetrate new markets or offer new products and services may not succeed if the profitability or market growth of planned products and services develops more slowly than expected, if its new products and services are not well accepted among customers, if the profitability of opportunities is undermined by competitive pressures or regulatory limitations, or if its planned acquisitions, investments or capital alliances are not approved by regulators. The NEC Group may also lack sufficient knowledge or understanding of local business practices or legal and regulatory requirements. Moreover, depending on the market, the NEC Group may encounter difficulties in finding suitable business, joint venture and alliance partners. Furthermore, in many of these markets, the NEC Group faces entry barriers such as the existence of long-standing relationships between its potential customers and their local suppliers, and regulations to protect domestic businesses. In addition, pursuing international growth opportunities may require the NEC Group to make significant investments long before it realizes returns on the investments, if any, even though there is no guarantee that such significant investment brings expected degree of profit growth. Increased investments may result in expenses growing at a faster rate than revenues.
The NEC Group’s overseas projects and investments could be adversely affected by:

  • exchange controls;
  • restrictions on foreign investment or the repatriation of income or invested capital;
  • nationalization of local industries;
  • changes in export or import restrictions including those on 5G related technologies;
  • regulations in foreign markets, including with respect to licenses and permits that may be required from local authorities;
  • changes in the tax system or rate of taxation in the countries where the NEC Group does business; and
  • economic, social, political and geopolitical risks, currently seen as international affairs between Russia and Ukraine.

In addition, difficulties in foreign financial markets and economies could adversely affect demand from customers in the affected markets.
Because of these factors, the NEC Group may not succeed in expanding its business in international markets, and its business growth prospects, results of operations and financial condition could be materially and adversely affected.

(3) Risks related to the NEC Group’s business and operations

a. Technological advances and response to customer needs

The markets for the products and services that the NEC Group offers are characterized by rapidly changing technology, evolving technical standards, changes in customer preferences, and the frequent introduction of new products and services. The development and commercialization of new technologies and the introduction of new products and services will often make existing products and services obsolete or unmarketable. The NEC Group’s competitiveness in the future will depend at least in part on its ability to:

  • keep pace with rapid technological developments and maintain technological leadership, primarily in the fields of AI, IoT, biometrics and cybersecurity technology;
  • enhance existing products and services;
  • develop and manufacture innovative products that meet customers’ needs in a timely and cost-effective manner;
  • utilize or adjust to new products, services, and technologies;
  • attract and retain highly capable technical and engineering personnel;
  • accurately assess the demand for, and perceived market acceptance of, new products and services that the NEC Group develops;
  • Commercialize NEC Group’s own developed technologies;
  • avoid delays in developing or shipping new products;
  • address increasingly sophisticated customer requirements; and
  • have the NEC Group’s products integrated into its customers' products and systems.

The aforementioned NEC Group’s ability is based on maintenance of appropriate R&D structure that could cope with technological developments and accumulated knowledge of its results from the past. Lack of necessary resources such as fund, personnel or others could result in failure of such maintenance, and could result in inability to cope with technological developments. This could lead to NEC Group’s losing its competitiveness in the future.

The NEC Group may not be successful in identifying and marketing product and service enhancements, or offering and supporting new products and services, in response to rapid changes in technologies and customer preferences. Additionally, future technological changes may not advance in accordance with historical trends or predicted courses or timetables, and may differ from current forecasts. If the NEC Group fails to adequately monitor and address these technological changes and changes in customer preferences or accurately anticipate the direction of such changes, its business, results of operations and financial condition will be significantly harmed. In addition, the NEC Group may encounter difficulties in incorporating its technologies into its products in accordance with its customers' expectations, which may adversely affect its relationships with its customers, its reputation and revenues.

The NEC Group seeks to form and enhance alliances and partnerships with other companies to develop and commercialize technologies that will become industry standards for the products and services that it currently provides and plans to provide in the future. The NEC Group spends significant financial, human and other resources on developing and commercializing such technologies. For example, NEC Group’s capital and business alliance with Nippon Telegraph and Telephone Corporation ("NTT Corporation") aimed at joint research and development of Open architecture such as O-RAN, however, competition is fierce among other players in this O-RAN system. The NEC Group may not, however, succeed in developing or commercializing such standard-setting technologies if its competitors’ technologies are accepted as industry standards. In such a case, the NEC Group’s competitive position, reputation, results of operations and financial condition could be adversely affected.

b. Intense competition

To intense competition in many of the markets in which it operates. Competition places significant pressure on the NEC Group’s ability to maintain gross margins and is particularly acute during market slowdowns. The entry of additional competitors into the markets in which the NEC Group operates increases the risk that its products and services will become subject to intense price competition. Some of the NEC Group’s competitors mainly in Asian countries may have an advantage of lower production cost than the NEC Group does and may be able to compete for customers more effectively than it can in terms of price. There is also the risk that the NEC Group’s competitors in the future may include multinational corporations with extensive financial resources. Multinational corporations such as these may invest significant resources into strategic pricing and research and development, and may undertake large-scale hiring of personnel. In recent years, the time between the introduction of a new product developed by the NEC Group and the production of the same or a comparable product by its competitors has become shorter. This has increased the risk that the products the NEC Group offers will become subject to intense price competition sooner than in the past.
The NEC Group has many competitors in Japan and other countries, ranging from large multinational corporations to a number of relatively small, rapidly growing, and highly specialized companies. Unlike many of the NEC Group’s competitors, however, it operates in many businesses and competes with companies that specialize in one or more of its product or service lines. As a result, even if the NEC Group has more combined resources than its specialized competitors, it may not be able to fund or invest in some of its businesses as much as its competitors can and it may not be able to respond to change or take advantage of market opportunities as quickly or as well as they can.
In addition, even though NEC Group may have spent enormous amount of cash on certain area of R&D, personnel or other resources, there is no guarantee that profitability nor competitiveness will achieve growth for NEC Group. As a result, the spent cash and so forth could adversely impact NEC Group’s operations and business performance. Sizes of competitors and factors that differentiate from others in terms of competitiveness depends on each industry and market. In 5G related technological field, for example, NEC Group’s competitiveness toward competitors depends on whether the platform, of which technologies and standards are developed, designed and promoted by NEC Group only or jointly with strategical partners, could obtain dominant position in the market or not, since aforementioned competitors in this field contains large-sized multinational corporations that could afford considerable amount of resources. For Digital Government and Digital Finance, on the other hand, NEC Group’s market share and its competitors differ in each country or region in which NEC Group operates, therefore, appropriate measures are necessary to be taken to address situations in each country or region accordingly in order to maintain NEC Group’s competitiveness. Since NEC Group conducts its business in various fields, in case NEC Group cannot effectively execute its strategies in a manner that is appropriate for each business field, NEC Group’s operations and business performance could be adversely impacted.
The NEC Group’s participation in competitive bidding or proposal processes for government and other large projects with demanding price and other requirements can place further downward pressure on its profitability. In order to maintain or improve profitability while meeting such demanding requirements, the NEC Group continuously strives to increase its revenue by offering and delivering innovative and unique value to customers and to reduce its costs and expenses through optimization of development and manufacturing operations, business process improvements and other measures. However, these measures may be insufficient to enable the NEC Group to maintain or improve its operating profit margin on such projects.
The NEC Group sells products and services to some of its current and potential competitors. For example, the NEC Group receives orders from, and provides solutions to, competitors that further integrate or otherwise use its solutions for large projects for which such competitors are engaged as the primary solutions provider. If these competitors cease to use the NEC Group's solutions for such large projects for competitive or other reasons, the NEC Group’s business could be harmed.

c. Dependence on certain key customers

A substantial portion of the NEC Group’s business portfolio consists of projects for government entities and certain large network and other infrastructure companies, such as the NTT group. Fluctuations in demand for such projects, particularly large-scale projects, or the NEC Group’s potential inability to secure such projects through the applicable bidding processes, may have a significant impact on its revenue. Furthermore, government entities may reduce contract amounts or terminate contracts for funding, policy or other reasons. Similarly, corporate customers may reduce their level of capital expenditures, shift their investment focus or otherwise reduce their business with the NEC Group for business, financial or other reasons.
The NEC Group is also subject to the risk that regulatory restrictions may prevent it from participating in the bidding or proposal processes that are required for obtaining contracts with government entities. For example, in 2016 and 2017, the NEC Group was subject to a nomination stop from a significant number of Japanese government agencies and local governments after receiving notification from the Japanese Fair Trade Commission that it had violated the Japanese Act on Prohibition of Private Monopolization and Maintenance of Fair Trade, and thereby became temporarily ineligible to participate in the bidding process for projects. The NEC Group has worked to strengthen its internal control systems with a view to preventing regulatory violations; however, even if these measures are thoroughly implemented, the NEC Group is unable to completely eliminate the possibility of regulatory violations. Furthermore, if the number of projects for government entities decreases due to changes in demand, government policy, and regulations, the NEC Group’s business, results of operations, and financial condition could be adversely affected.

d. Development of new business

The process of developing new products and services entails many risks. The development and manufacturing processes can be lengthy and costly and require the NEC Group to commit significant resources well in advance of actually selling or providing the product or service. For example, in 2019, the NEC Group acquired OncoImmunity AS (currently, NEC Oncolmmunity AS) with a view to making a full-scale entry to the AI-driven drug discovery business. Because the NEC Group has limited experience with drug development, it anticipates that this initiative may not become profitable for an extended period and is still subject to the risk of failure. Additionally, new technologies may be launched and standards may change while new products or services are in the development stage, rendering them obsolete or uncompetitive before their introduction. Newly developed products or services may also contain undetected defects or errors that may be discovered after their introduction and distribution, resulting in liability for losses incurred by customers due to such errors and reputational harm to the NEC Group or the product or service. These could significantly and adversely affect the NEC Group’s business, results of operations and financial condition.

e. Defects in products and services

The NEC Group faces risks arising from defects in its products and services. Defects in products and services provided by the NEC Group could cause serious losses to its customers, including public institutions, as well as to a large population of end users. Many of its products and services are used in customers’ “mission critical” operations requiring high degree of reliability, where the NEC Group could be liable for damages incurred by its customers due to defects in product or service, or delays in their provision. Negative publicity concerning these problems could also make it more difficult to convince customers to buy the NEC Group’s products and services, and the NEC Group could also be liable for recall costs. In particular, although products and services generally related to ICT solutions are exposed to customary risks of technology failure or computer viruses, many of the NEC Group’s products and services are used in infrastructure that is directly related to the protection of human life, such as systems for fire rescue services, and it may be exposed to more serious liability. Products and services that use innovative technologies such as biometrics authentication technology may also be exposed to risks that are difficult to foresee. Any reputational harm and regulatory sanctions that arise from these could harm the NEC Group’s ability to sell its products and services. Furthermore, such factors may result in unprofitable projects.
In order to prevent the defects of products and services or unprofitable projects, the NEC Group takes thorough measures to control risks in projects such as system development projects from the beginning of business negotiation, through understanding of customer’s confirmed system requirements or technical difficulties, and quality control measures on hardware and software of which systems consist. However, it is difficult to prevent them completely. The defects of its products or services or unprofitable projects could hurt the NEC Group’s business, results of operations and financial condition.

f. Material Procurement of components, etc.

The NEC Group’s business operations depend on obtaining deliveries of components, equipment, and other supplies in a timely manner. In some cases, the NEC Group purchases on a just-in-time basis. Because the components that the NEC Group purchases are often complex or specialized, it may be difficult for the NEC Group to substitute one supplier for another or one product for another. Some products are available only from a limited number of suppliers or a single supplier. Many industries, some of which NEC’s main clients belong to, may be adversely impacted by geopolitical risks and economic disputes among nations including trade conflicts between the U.S. and China, etc. Accordingly, NEC Group’s operations may also be adversely impacted and possibly resulting in NEC Group’s delay of products and service deliveries. Although the NEC Group believes that supplies of the components, equipment, and other supplies that the NEC Group uses are currently adequate, shortages in critical components could occur and the procurement cost of replacement parts increase, due to a delay or an interruption in supply, a change in regulatory trends, an increase in industry demand, or tariffs and other trade restrictions, which could adversely affect the NEC Group’s production capacity and efficiency. In addition, a financial market disruption could pose liquidity or solvency risks for the NEC Group’s suppliers, which could reduce its sources of supply or disrupt its supply chain. In addition, if the NEC Group procures components, equipment or other supplies include defects that could adversely affect the reliability and reputation of the NEC Group’s products, or if it could not obtain adequate delivery of these supplies in a timely manner and at an acceptable price, the NEC Group’s business, results of operations, and financial condition could be adversely affected.

g. Intellectual property rights

The NEC Group depends on its proprietary technology, and its ability to obtain patents and other intellectual property rights covering its products, services, business models, and design and manufacturing processes. The applications for patents and the maintenance of registered patents can be a time and cost consuming process. The NEC Group’s patents could be challenged, invalidated, or circumvented. The fact that the NEC Group holds many patents or other intellectual property rights does not ensure that the rights granted under them will provide competitive advantages to the NEC Group. For example, the protection afforded by the NEC Group’s intellectual property rights may be undermined by rapid changes in technologies in the industries in which the NEC Group operates. Similarly, there can be no assurance that claims allowed on any future patents will be broad enough to protect the NEC Group’s technology. Effective patent, copyright, and trade secret protection may be unavailable or limited in some countries, and the NEC Group’s trade secrets may be vulnerable to disclosure or misappropriation by employees, former employees, contractors, and other persons. Further, pirated products of inferior quality infringing the NEC Group’s intellectual property rights may damage its brand and adversely affect sales of its products. Litigation, which could consume financial and management resources, may be necessary to enforce the NEC Group’s patents or other intellectual property rights.

h. Intellectual property licenses owned by third parties

Many of the NEC Group’s products are designed to include software or other intellectual property licenses from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of the NEC Group’s products, the NEC Group believes that, based upon experience and industry’s standard practices, these licenses can be obtained on commercially reasonable terms in principle. There can be no assurance that the NEC Group will be able to obtain, on commercially reasonable terms or at all, from third parties the licenses that the NEC Group will need. In such a case, the NEC Group may be required to limit or cease operations that make use of such licenses, which could adversely affect its business, results of operations and financial condition.

i. Risks related to customers’ financial difficulties

The NEC Group sometimes provides vendor financing to its customers or offer customers extended payment terms or other forms of financing to assist their purchase of the NEC Group’s products and services. If the NEC Group is unable to provide or facilitate such payment arrangements or other forms of financing to its customers on terms acceptable to them or at all, due to financial difficulties or otherwise, the NEC Group’s results of operations could be adversely affected. In addition, many of the NEC Group’s customers purchase products and services from the NEC Group on payment terms that provide for deferred payment. If the NEC Group’s customers for whom it has extended payment terms or provided other financing terms, or from whom it has substantial accounts receivable, encounter financial difficulties or inability to access credit from others, and are unable to make payments on time, the NEC Group's business, results of operations and financial condition could be adversely affected.

j. Retention of personnel

The NEC Group must compete for talented employees to develop its products, services and solutions that are acceptable to society, and its competition for these potential employees includes multinational technology companies with considerable resources. Accordingly, the NEC Group’s human resources organization focuses significant efforts on attracting and retaining individuals needed in divisions that are driving the NEC Group’s business, such as growth fields of the mid-term management plan. For this reason, recruitment and personnel costs may increase in the future. Changes in technology and industry trends may increase the need to recruit diverse human resources who are highly socially literate and have various values, abilities and backgrounds, as well as skills that differ from the conventional skillset. Specifically, recent trends in digitization and automation have resulted in increased demand for talent with skills in AI, machine learning, data science, and statistical analysis, and the NEC Group foresees fiercer competition from such talent. Furthermore, the recruitment of talent with these kinds of skills may require a different approach from the conventional recruitment method.
If the NEC Group experiences a substantial loss of, or an inability to attract and retain, talented personnel, or if it is unable to ensure the diversity of talent, it may experience difficulty in meeting its business objectives. This could leave the NEC Group unable to provide products, services, and solutions acceptable to society as a Social Value Innovator.

k. Financing

The NEC Group's primary sources of funds are cash flows from operations, borrowings from banks and other institutional lenders, and funding from the capital markets, such as offerings of commercial paper and other debt securities. A decline in the NEC Group’s credit profile could result in a downgrade in its credit ratings and result in increases in its interest expenses, having an adverse impact on its ability to access the commercial paper market or other debt markets. This could have an adverse effect on the NEC Group's liquidity, business, and financial condition. Because the NEC Group maintains a relatively high level of leverage, its operations may be particularly affected in the event that it encounters difficulties in raising funds through debt.
A failure of one or more of the NEC Group’s major lenders, a decision by one or more of them to stop lending to the NEC Group or instability in the capital markets could have an adverse impact on the NEC Group’s access to funding and funding cost. If the NEC Group fails to obtain external financing on terms acceptable to it, or at all, or to generate sufficient cash flows from its operations or sales of its assets, when necessary, the NEC Group will be unable to fulfill its obligations, and its business, results of operations, and financial condition will be materially adversely affected. In addition, to the extent the NEC Group finances its activities with additional debt, the NEC Group may become subject to financial and other covenants that may restrict its ability to pursue its growth strategy. NEC Group’s basic policy is not to hold listed shares for purpose other than investment, however, for shares of which NEC Group considers necessary to hold in terms of business collaborations as well as maintaining amicable business relationships to achieve healthy state of business, NEC Group decides to hold for purpose other than investment, as an exception. Even though such shares are decided to be held by NEC Group, necessity and the cost of capital such as return of investments to be obtained of each shares will be comprehensively assessed, and the rationale of holding of such shares is verified by the board of directors’ meeting based on the criteria which the Company set forth. In case holding of the share is considered irrational, NEC Group sells such shares accordingly. NEC Group has sold its strategically-held shares for the fiscal year ended March 2023. The sale of such shares has contributed 19.2 billion JPY to NEC Group’s free cash flow. NEC Group still owns approximately 140.7 billion JPY worth of strategically-held shares (including unlisted shares). Of this, listed shares which has share prices in the market consists 33%. No specific goal is set in terms of sales timeline of such strategically-held shares, however, given economic environment changes both in Japan and abroad, as well as stock market’s supply and demand fluctuations and the companies of those shares’ business performance deteriorations, share prices of those shares may drop. In case this happens, NEC Group may not be able to sell those shares at desirable times, therefore could result in failing to gain free cash flow by selling those strategically-held shares.

(4) Risks related to internal control, legal proceedings, laws and governmental policies

a. Internal control

The NEC Group is taking action to guarantee the accuracy of its financial reporting by strengthening its internal controls with expanding documentation of the business process and implementing stronger internal auditing. However, even effective internal control systems can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. For example, the inherent limitations of internal control systems include fraud, human error, or circumvention of controls, such as through collusion among multiple employees. In addition, the systems may not be able to effectively deal with changes in the business environment unforeseen at the time that the systems were implemented or with non-routine transactions. The NEC Group’s established business processes may not function effectively, and fraudulent acts, such as false financial reporting or embezzlement, or inadvertent mistakes may occur. Such events may require restatement of financial information and could adversely affect the NEC Group’s financial condition or results of operations. The NEC Group’s reputation in the financial markets may also be damaged as a result of these events and occur much of additional costs in order to correct these events. In addition, if any administrative or judicial sanction is issued against the NEC Group as a result of these events, it may lose business opportunities.

If the NEC Group identifies a material weakness in its internal control systems, the NEC Group may incur significant additional costs for remedying such weakness. Despite the efforts by the NEC Group to continually improve and standardize its business processes from the perspective of ensuring effective operations and enhancing efficiency, it is difficult to design and establish common business processes since the NEC Group operates in a diverse range of countries and regions, using varying business processes, particularly when it acquires and integrates into the NEC Group a company that is engaged in an unfamiliar business or that operates in an unfamiliar market to the NEC Group. Consequently, the efforts by the NEC Group to further improve and standardize its business processes may continue to occupy significant management and human resources and the NEC Group may incur considerable financial costs.

b. Legal proceedings

From time to time, the NEC Group companies are involved in various lawsuits and legal proceedings, including intellectual property infringement claims. Due to the existence of a large number of intellectual property rights in the fields in which the NEC Group operates and the rapid rate of issuance of new intellectual property rights, it is difficult to completely judge in advance whether a product or any of its services may infringe upon the intellectual property rights of others. Whether or not intellectual property infringement claims against the NEC Group companies have merit, significant financial and management resources may be required to defend the NEC Group from such claims. If an intellectual property infringement claim by a third party is successful and the NEC Group could not obtain a license of technology which is subject of the infringement claim or any substitution thereof, it could have an adverse effect on the NEC Group’s business, results of operations and financial condition.

The NEC Group may also from time to time be involved in various lawsuits and legal proceedings concerning such laws as business laws, antitrust laws, anticorruption laws, product liability laws, environmental laws, and laws regulating various industries..
It is difficult to foresee the results of legal actions and proceedings currently involving the NEC Group or of those which may arise in the future, and an adverse result in these matters could have a significant negative effect on the NEC Group’s business, results of operations and financial condition. In addition, any legal or administrative proceedings which the NEC Group is subject to could require management resources such as financial and human resources, including senior management, and the extend of such requirements is similarly difficult to predict. Such resources may be difficult for the NEC Group to acquire in a timely manner, and depending on the level of requirement, it could have a severe impact on the NEC Group’s ability to conduct operations. Furthermore, if the NEC Group violates legal or regulatory requirements, it may be required to pay fines or penalties, government agencies, local governments, and intergovernmental organizations could suspend or debar the NEC Group as a contractor or prevent it from participating in bidding or proposal processes, and the NEC Group could not operate its businesses which requires certain licenses in accordance with various industrial laws and regulations due to the revocation of licenses by the authorities, etc. which could have a material adverse impact on the NEG Group’s business, results of operation, financial condition, and reputation.

c. Laws and governmental policies

In many of the countries in which the NEC Group operates, its business is subject to various risks associated with unexpected regulatory changes, uncertainty in the application of laws and governmental policies and uncertainty relating to legal liabilities. Substantial changes in the regulatory or legal environments, including the economic, trade, tax, defense, labor, spending, privacy and other policies of the governments of Japan and other jurisdictions in which the NEC Group operates could oblige it to change its businesses or otherwise adversely affect its business, results of operations and financial condition.
For example, European Data Protection Supervisor announced implementation of new regulations concerning biometrics and AI technologies in April 2021. In case countries or regions in the EU implemented this regulation or related changes to their existing regulations, NEC Group’s business operations may be adversely impacted. The regulatory authorities of each country may restrict or prohibit transactions with countries subject to economic sanctions, certain persons or entities, and such regulations may change dramatically within a short period. The NEC Group’s existing compliance program may not be effective at preventing violations of such regulations, and the occurrence of such violations could have an adverse effect on the NEC Group’s social credibility, business, results of operations and financial condition.

d. Environmental laws and regulations

The NEC Group's operations are subject to many environmental laws and regulations governing, among other things, air emissions, wastewater discharges, the use and handling of hazardous substances, waste disposal, chemical substances in products, product recycling, soil and ground water contamination and global warming. The NEC Group faces risks of environmental liability arising from its current, historical, and future manufacturing activities. The NEC Group’s failure to comply with current and future environmental laws and regulations, or the identification of contamination for which it is liable, could subject the NEC Group to substantial costs, including fines, clean-up costs, third-party property damage or personal injury claims and require significant investments to upgrade its facilities and equipment. Moreover, the future occurrence of new environmental issues, enactment of more stringent regulatory requirements such as implementation of carbon pricing which requires a company financial obligations in accordance with its amount of greenhouse gas emissions or other unanticipated events could give rise to adverse publicity, restrict the NEC Group’s operations, affect the design or marketability of its products or otherwise cause it to incur material environmental costs, adversely affecting its results of operations and financial condition.
The NEC Group endeavors to comply with laws and government policies. It has established self-management norms, formulated guidelines on climate change mitigation measures from a long-term perspective up to 2050 and conducts business operations in an appropriate manner and environmental auditing in accordance with its internal environmental policies. In September 2022, the NEC Group participated in “The Climate Pledge” that is committed to be carbon neutral across its supply chain by year 2040 to enhance its countermeasures for reducing CO2 emissions. But these measures and participation in such an initiative may not be effective at avoiding potential liabilities arising from its current, historical and future business activities. Moreover, costs associated with future additional and stricter environmental compliance or remediation obligations as well as the case in which such targets for carbon neutrality could not be met, could adversely affect the NEC Group’s business, results of operations and financial condition, as well as the reputation and brand value of the NEC Group.

e. Tax practice

The NEC Group’s effective tax rate could be adversely affected by: earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; changes in the valuation of the NEC Group’s deferred tax assets and liabilities; transfer pricing adjustments; tax effects of nondeductible compensation; or changes in tax laws, regulations, accounting principles or interpretation thereof in the various jurisdictions in which the NEC Group operates. Any significant increase in the NEC Group’s future effective tax rates could reduce net income for future periods.

The NEC Group currently carries deferred tax assets resulting from tax loss carry forwards and deductible temporary differences, both of which will reduce its taxable income in the future. However, the deferred tax assets may only be realized against taxable income. The amount of the NEC Group’s deferred tax assets that is considered realizable could be reduced from time to time if estimates of future taxable income from its operations and tax planning strategies during the carry forward period are lower than forecasted, due to deterioration in market conditions or other circumstances. In addition, the amount of the NEC Group’s deferred tax assets could be reduced due to changes in tax laws, regulations or accounting principles related to future deductions of income tax rates. Any such reduction will adversely affect the NEC Group’s income for the period of the adjustment.

Furthermore, the NEC Group is subject to continuous audits and examination of its income tax returns by tax authorities of various jurisdictions. The NEC Group regularly assesses the likelihood of adverse outcomes resulting from these audits and examinations to determine the adequacy of its accrued income taxes. There can be no assurance that the outcomes of these audits and examinations will not have an adverse effect on the NEC Group’s business, results of operations and financial condition.

f. Information management

The NEC Group collects, stores, uses, transfers, and performs other processes with a voluminous amount of personal information, including “My Number” social security and tax number information, as well as confidential information in the regular course of its business. There have been many cases where such information and records in the possession of corporations and institutions were leaked, improperly accessed or exposed by a cyberattack. If personal or confidential information in the NEC Group’s possession about its customers or employees is leaked, improperly accessed or exposed by a cyberattack and subsequently misused, it may be subject to liability and regulatory action, and its reputation and brand value may be damaged. In particular, the increasingly sophisticated nature of cyberattacks, as well as the increasing scale and complexity of the business and infrastructure that can be targeted, make it possible that certain threats and vulnerabilities in systems related to information management will not be detected or mitigated in a timely manner. In addition, unauthorized access and cyberattack risk depends on the products, services and systems not only of the NEC Group, but also of its customers, contractors, suppliers, business partners and other third parties. These products, services and systems are also used by customers in highly regulated industries, such as financial and healthcare services, as well as government agencies that engage in the area of fundamental social infrastructure which incorporates national defense. The NEC Group’s products, services and systems may be used in customers’ critical operations, and may involve the handling of sensitive data.
The NEC Group is required to handle personal information in compliance with Japan’s Act on the Protection of Personal Information, the European Union’s General Data Protection Regulation (GDPR) and other legal or regulatory requirements. The NEC Group may have to provide compensation for economic loss and emotional distress arising out of a failure to protect such information, or may be subject to large penalties imposed by regulatory authorities. The cost and operational consequences of implementing further data protection measures could be significant. In addition, if customers using the NEC Group’s products, services and systems have been unable to protect their information, it could adversely affect the NEC Group’s reputation and business.
Furthermore, the NEC Group aims to grow by promoting “Digital Government/Digital Finance Business”, using biometrics and AI technologies, among others. Various human rights issues that need to be addressed along with development of such technologies have recently been discussed. Given the increasing pace of development of these advanced technologies and the rising interest in related human rights issues, the scope of regulation around data projection and privacy protection is expanding and growing increasingly complex in individual countries and regions. Regulations for the use of biometrics and AI technologies will likely be more stringent on a continual basis. There are increasing risks for NEC Group or its customers to whom NEC Group provides its services to be subject to governmental investigations or sanctions by regulatory authorities as well as litigations from third parties, and the use of such advanced technologies could be ceased or considerably restricted in certain countries or regions, which could lead to the NEC Group’s losing business opportunities that could be brought by utilization of aforementioned advanced technology.

g. Human rights

In the countries and regions where the NEC Group operates, there is growing interest in how corporations respond to issues related to human rights and occupational safety and health, and the relevant laws and regulations are changing. Human rights issues caused by racial discrimination and political uncertainty remain in certain regions and it has been deemed necessary to address such issues by working together with business partners. The NEC Group has identified “New Technology such as AI and Human Rights”, “Human Right Violation Risks Arising from Geopolitical Situation and Impact of Conflicts”, “Occupational Conditions in the Supply Chain” and “Safety and Health of Employees” as prominent human rights issues and has taken measures to address such issues. However, in the event that the NEC Group’s business offices and/or supply chain is unable to appropriately respond to these issues, the NEC Group may not only receive administrative punishment or suspension of business from clients, but may also be faced with criticism from a range of stakeholders, including local residents, clients, consumers, shareholders, investors and human rights organizations, and it may cause the reputation and brand value of the NEC Group to be damaged, which could have an adverse impact on the NEG Group’s business and financial condition.

(5) Other Risks

a. Natural and fire disasters

Natural disasters such as earthquakes and typhoons, abnormal weather (e.g. concentrated downpours, floods, droughts, water shortages) due to climate change, fire, prevalence of highly virulent and fatal disease throughout the world (pandemic), armed hostilities, terrorism and other incidents, whether in Japan or any other country in which the NEC Group operates, could cause damage or disruption to the NEC Group, its suppliers or customers. NEC Group Headquarters building, in particular, may be damaged significantly by earthquake directly under the metropolitan area, and accordingly, NEC Group’s business operations may suffer tremendously from adverse impact. These events could also create economic inactivity either in or outside Japan, fluctuation of foreign exchange or interest rates, political or economic instability, deterioration of public safety or public unrest, any of which could harm the NEC Group’s business. In addition to various measures of disaster mitigation in place, the NEC Group has adopted a group-wide business continuity plan outlining countermeasures and recovery procedures to be taken in response to emergency, and has conducted training and learning programs. Despite the NEC Group’s efforts, natural disasters could disrupt social infrastructure such as electricity, gas and water supply, communication or transportation in affected areas, and could have a material adverse effect on NEC Group’s business by causing human damages, disruptions of manufacturing, procurement and logistics, or occurrences of environmental and quality issues. Moreover, the spread of unknown infectious diseases to which human has no immunity, such as the outbreak of infections including COVID-19 described above in “(1) risks related to economic conditions and financial markets d. Impact of the outbreak of novel coronavirus (COVID-19) and other infections,” could affect adversely the NEC Group’s operations by increasing risks for inability to secure human resources and deterioration of working environment, as well as by reducing customer demand or disrupting its suppliers' operations in the infected areas.

b. Impairment of goodwill

The NEC Group has recorded significant goodwill as a result of its acquisitions of Northgate Public Services Limited in the United Kingdom in 2018, KMD Holding ApS in Denmark in 2019, and Avaloq Group AG in Switzerland in 2020, etc., amount of which is 355.6 billion JPY in the fiscal year ended March 31, 2023, and it may also record additional goodwill as a result of further acquisitions in the future.
The NEC Group’s consolidated financial statements are prepared in accordance with IFRS, which requires testing cash generating units, or CGUs, to which goodwill has been allocated for impairment at least once annually, regardless of any indication of impairment. In addition, whenever it is recognized that there is a sign of impairment, it is necessary to perform an impairment test to determine whether the carrying amount of a CGU exceeds the recoverable amount. The recoverable amount of a CGU is the higher of its fair value less costs of disposal and its value in use. In determining the value in use, estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. If the carrying amount of a CGU with goodwill is found to exceed its recoverable amount as a result of testing, an impairment loss is recognized. Any impairment loss is processed by reducing the carrying amount of goodwill allocated to the CGU, which could adversely affect the NEC Group’s results of operations and financial condition.

c. Defined benefit pension plan obligations

The NEC Group, except some subsidiaries, have shifted from defined benefit pension plans (DB) to defined contribution pension plans (DC) for the portion funded after October 1, 2020. However, for the portion funded until September 30, 2020, the NEC Group may still face adverse effects on its financial condition and results of operations due to increases in defined benefit pension plan obligations arising from changes in the market value of equity securities and other pension assets and a decline in returns on pension assets. Changes in actuarial assumptions such as discount rates on which the calculation of projected defined benefit pension plan obligations are based may have an adverse effect on the NEC Group’s financial condition and its results of operations. For example, there is a possibility of defined benefit pension plan obligations and/or defined benefit pension plan expenses increasing in the event of a future reduction in discount rates or prior service costs resulting from a change in the system.