Business Risks

Below is a discussion of the most significant risks that could negatively impact the operating results, cash flow and financial position ("operating results, etc.") of Sumitomo Dainippon Pharma Group.
The Group is aware that these risks could occur, works to prevent and minimize them and will take appropriate measures if they occur.
Forward-looking matters statements in this discussion reflect the judgement of the Group as of March 31, 2020.
It is not an exhaustive discussion of all risks, and the Group could be impacted in the future by risks that are currently unpredictable or considered immaterial.

(1)Risk relating to research and development of new products

The Group works to research and develop highly original and globally viable products. However, product development may not proceed as planned or attain approval and market launch because of the growing difficulty of development of new drugs. It is also possible that some development projects, from the standpoint of efficacy, safety, etc., may be delayed or abandoned. Such cases involving research and development assets expected to become major products could have a significant and negative impact on the Group's operating results, etc.
While taking research and development risks into consideration, the Group concentrates research and development efforts on the three focus areas of Psychiatry & Neurology, Oncology, and Regenerative Medicine/Cell Therapy and is expanding its pipeline in those areas.
Moreover, through the establishment of a system for the global management of development, the Group formulates strategic development plans and implements efficient clinical development. The Company reviews research and development policy appropriately through a committee system for confirming the advantages and disadvantages of plan revisions in time with transitional stages of development and other methods to manage its portfolio properly.

(2)Risk relating to specific products comprising a large proportion of consolidated revenue

In the fiscal year 2019, the revenue in North America for atypical antipsychotic LATUDA®, which is a pillar of Group earnings, comprised 39% of Sumitomo Dainippon Pharma's consolidated revenue. If LATUDA® revenue falls due to the emergence of other strong competing products (including but not limited to the launch of competing products by manufacturers of branded prescription drugs as well as the sale of products that compete with LATUDA® by manufacturers of generic drugs), or through other unexpected events such as impacts on the supply chain, including raw material procurement, it could have a significant and negative effect on the Group's operating results, etc.
The Mid-term Business Plan 2022, the Group is working to establish growth engines. In addition to concentrating research and development efforts on the three focus areas of Psychiatry & Neurology, Oncology, and Regenerative Medicine/Cell Therapy, the Group aims to expand its pipeline, including the acquisition of late-stage development assets that can be expected to contribute early to revenue. The Group is also working to launch Frontier business aimed at the commercialization of healthcare solutions that provide new value to society with a focus on areas in which synergies with its pharmaceuticals business are expected. In its regional strategy, the Group is working to strengthen its business base with China as a third center in addition to the primary markets of Japan and North America.

(3)Risk relating to intellectual property rights

The Group utilizes a wide range of intellectual property during the course of its R&D activities. However, if the Group is unable to acquire a sufficient scope of rights to its technology, a competitor evades the Group's intellectual property rights, or there is an external leak of trade secrets, including know-how that is strictly managed by the Company, due to unexpected circumstances, the Group could be unable to secure its competitive advantage.
Furthermore, the Group's business is safeguarded by a large quantity of intellectual property. Consequently, if the Group's intellectual property were infringed by a third party, or if legal disputes pertaining to the validity and ownership of intellectual property rights were to arise, the Group could be unable to adequately maintain its competitive advantage. If such risks manifested, it could have a significant and negative impact on the Group's operating results, etc. On the other hand, the Group understands there are rights to lawfully use intellectual property rights required for business activities. Nevertheless, there is the possibility that it could infringe the intellectual property rights of a third party unknown to the Group.
The Group is building a patent portfolio that not only includes the core substance patents, but also related patents, such as applications, manufacturing methods, and formulations, to comprehensively safeguard its products and development assets. Furthermore, in order to advance commercialization in the Regenerative Medicine/Cell Therapy field, the Group is studying the issues involved in acquiring rights to its technologies in this field and taking measures to acquire such rights.

(4)Healthcare system reforms

The precipitous decline in Japan's birthrate and the rapid rise in the country's elderly population are the prime factors causing the financial state of Japan's healthcare insurance system to deteriorate. In this climate, measures continue to emerge aimed at curbing healthcare costs by price restraint of branded prescription drugs and promotion of generic drug use, while how to best reform the country's healthcare system continues to be debated. Moreover, in the U.S., the world's largest market for ethical pharmaceuticals, pressure from federal and state governments and public opinion to reduce the price of branded drugs is mounting year after year, and there is the possibility that system reforms aimed at controlling drug prices will be decided and introduced. In China also, there is the possibility that healthcare system changes will be implemented with the aim of controlling pharmaceutical expenses, including an expansion in centralized drug purchasing by public institutions. The direction that these healthcare system reforms might take could have a significant and negative impact on the Group's operating results, etc. As a pharmaceutical company, the Group will observe the system in each country and respond appropriately in accordance with such systems.

(5)Problems relating to adverse reactions

Pharmaceutical products are approved only after rigorous safety testing, at different stages of development, and rigorous reviews by the competent authorities in all the countries involved. These efforts notwithstanding, previously unreported adverse reactions are sometimes discovered only after a drug has already been marketed.
The appearance of such unexpected adverse reactions once a product of the Group has been sold could have a significant and negative impact on the Group's operating results, etc. The Group uses a database to centrally manage and evaluate safety information collected in Japan and overseas and formulates the necessary measures to ensure pharmaceutical safety and appropriate use, leading to the timely implementation of safety measures. These initiatives are implemented as pharmacovigilance activities in compliance with Japan's Act on Securing Quality, Efficacy and Safety of Products Including Pharmaceuticals and Medical Devices and Good Vigilance Practice (GVP).

(6)Risks relating to quality

The Group manufactures products based on strict quality control. Nevertheless, if a serious quality issue occurs, it could have a significant and negative impact on the Group's operating results, etc. as a result of product recalls, administrative penalties, and the loss of social trust. The manufacture, shipment and global distribution of the Group's products are conducted in accordance with laws and regulations related to pharmaceuticals and Good Manufacturing Practice (GMP), and undergo rigorous reviews and approval by the competent authorities including the Ministry of Health, Labour and Welfare in Japan, the Food and Drug Administration (FDA) in the U.S., and the European Medicines Agency (EMA) in Europe. Moreover, the Group has in place high levels of facility design and quality assurance systems that conform to strict global quality standards, including audits of overseas alliance partners and International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use (ICH) Guidelines.

(7)Prerequisites for primary business activities

The Group's core business is the ethical pharmaceuticals business. Accordingly, the Group requires licenses and other certifications to engage in R&D and the manufacture and sale of drugs pursuant to Japan's "Law on Securing Quality, Efficacy and Safety of Products including Pharmaceuticals and Medical Devices" and other laws and regulations related to pharmaceuticals. The Company has obtained licenses and other certifications, including Type 1 and Type 2 Pharmaceuticals Manufacturing and Sales Business licenses (both valid for five years). In addition, in order to engage in the ethical pharmaceuticals business in overseas countries, the Group also has obtained licenses as needed under laws and regulations related to pharmaceuticals of those countries. These licenses and other certifications will cease to be valid unless they complete procedures as stipulated by the applicable laws and regulations. These laws and regulations also stipulate that these licenses and certifications may be revoked and/or that the Group may be ordered to suspend part of or all of its operations for a fixed period of time or be subject to other measures in the event that the Group violates these laws and regulations. The Group currently has no knowledge of any facts that would warrant the revocation of its licenses or other certifications. However, an order to revoke the Group's licenses or other certifications could have a significant and negative impact on the Group's operating results, etc.
The Group has positioned promotion of compliance as the foundation for all business activities and strives to observe laws and regulations and corporate ethics. The Company has established Compliance Standards as a specific code of conduct for business activities. An Executive Officer in charge of Compliance has also been appointed to oversee compliance at the Company and at Group companies in Japan and overseas. The Executive Officer in charge of Compliance serves as chair of Compliance Committees at Group companies in Japan and Group companies overseas as well as the Compliance Committee of the Company and reports to the Board of Directors on the activities of each committee.

(8)Risk relating to litigation

There is always the possibility that a lawsuit may be brought in connection with the adverse effect of a pharmaceutical product, product liability, fair trade, etc., relating to the business activities of the Group. These lawsuits and other potential lawsuits involve inherent uncertainties. Depending on the development thereof, such lawsuits could have a significant and negative impact on the Group's operating results, etc.

(9)Closure or shutdown of a plant

The Group can envision scenarios in which the Group's plant is closed or shut down due to technical problems, stoppage of supply of raw materials, fire, earthquake, or any other disaster where the supply of products is delayed or halted. Such cases could have a significant and negative impact on the Group's operating results, etc. The Group's plants have prepared emergency response procedure manuals based on the Business Continuity Plan (BCP) and act in accordance with the manuals.

(10)Risk of impairment loss on non-financial assets

In order to achieve sustained growth, the Group engages in corporate acquisitions and in-licensing of development assets and records intangible assets, such as goodwill and in-process research and development, associated with these activities. In the event that the expected recoverable amount from acquisition or in-licensing is estimated to be lower than the book values of goodwill and intangible assets due to an expected decline in future profit, including suspension of development or failure to achieve the initial estimated profit, impairment loss will arise. Such cases could have a significant and negative impact on the Group's operating results, etc. The Group periodically assesses the values of such goodwill and intangible assets using impairment tests and applies the appropriate treatment.

(11)Risk relating to financial assets

The Group owns financial assets including the shares of other companies. When the market value or fair value of owned financial assets is lower than the book value, impairment loss or loss on sale arises. Such losses could have a significant and negative impact on the Group's operating results, etc. The Company will not acquire any new holdings of shares in other companies, except for corporate alliances, building and maintaining business relationships with key business partners, and other cases when necessary for business purposes. The Company also periodically assesses changes in the valuation of such financial assets using impairment tests and applies the necessary treatment.

(12)Impact of the financial market situation and foreign exchange fluctuations

The interest rate trend may increase interest expenses on borrowings, etc., and the deterioration of the financial market situation will cause retirement benefit obligations to increase. All these factors could have a significant and negative impact on the Group's operating results, etc.
Furthermore, foreign exchange fluctuations may have a material impact on foreign currency-denominated assets and the conversion of operating results of consolidated subsidiaries into yen. The Group enters into exchange contracts to avoid foreign exchange risk.

(13)Transactions with the parent company

The Company and its parent company, Sumitomo Chemical Co., Ltd., have concluded agreements for the leasing of land for research laboratories and plants, as well as for the purchase of raw materials used in the production of active pharmaceutical ingredients at these sites and other locations. These agreements involve prices that are determined based on discussions between the two parties with reference to general market prices. These agreements are customarily renewed every year. The Company also accepts employees on loan from the parent company. The Company's policy is to continue these transactions and other ties with the parent company. However, changes in these agreements, including changes in the transaction terms specified therein, could have a significant and negative impact on the Group's operating results, etc.
Important transactions that the Company conducts with its parent company are supervised appropriately through such means as obtaining the approval of a meeting of the Board of Directors attended by the independent directors in order to ensure fairness and rationality from the perspective of enhancing the Company's corporate value.

(14)Risk relating to overseas operation, large-scale disasters and infectious disease, etc.

The Group conducts overseas business activity mainly in the regions of North America and China. The risks such as change of local restrictions, worsening of diplomatic relations, and political uncertainties are inherent in these activities. In the event that the Group faces such risks, it could have a significant and negative impact on the Group's operating results, etc. In the event of facing a large-scale disaster or infectious disease pandemic, the Group may be unable to achieve business plans, and this could have a significant and negative impact on the Group's operating results, etc. To address risks that impact on business activities, the Company has formulated Risk Management Rule under which it is specified that the President oversees risk management as well as developing risk management systems for each risk. In the event of a large-scale disaster or infectious disease pandemic, the Company immediately establishes a headquarters for countermeasures to build systems for a company-wide response and has established production and supply systems with a priority on the supply of products as the mission of a pharmaceutical company.

(15)Risk relating to information management

Since the Group uses a variety of information systems, there is the possibility of business being interrupted by a system malfunction, computer virus, or the like.
Additionally, since the Group holds a large amount of confidential information that includes personal information, an external leak of the data could have a significant and negative impact on the Group's operating results, etc. resulting from compensation for damages, administrative sanctions, loss of social credibility, or the like. The Company has established in-house rules on the handling of records and information and IT security and continually provides education for employees in striving for the appropriate operation of these rules.

(16)Risk relating to environmental protection

The Group uses a variety of chemical substances in research and development and in the manufacture of products. In the event of a serious environmental problem, it could have a significant and negative impact on the Group's operating results, etc. due to shutdown of operations, administrative penalties, and loss of social trust, etc. Moreover, in the event that expenses related to environmental protection increase due to future strengthening of environmental laws and regulations, measures to address risk related to climate change, and additional obligations to reduce environmental impact, it could have a significant and negative impact on the Group's operating results, etc. The Group complies with various environmental laws and regulations when engaging in business activities, and plants in Japan have obtained ISO 14001 certification, which is the international standard for environmental management systems. In addition, the Group engages in green product development and green facility design as well as operating green logistics guidelines to continue addressing environmental protection throughout the product lifecycle.

 

There are risks other than those described above, and the risks listed here do not include all of the risks faced by the Group.