Risks Related to Advantest's Business
Advantest's business and results of operations are subject to significant demand volatility in the semiconductor industry
Advantest's business depends largely upon capital expenditures of semiconductor industrial, design and manufacturing companies, fabless semiconductor companies, foundries and test houses. These companies, in turn, determine their capital expenditures and investment levels largely based on current and anticipated market demand for semiconductors and products incorporating semiconductors. Such demand is influenced significantly by overall condition of the global economy. Historically, a reduction rate of capital expenditures of semiconductor manufacturers during downturns in the semiconductor industry, including investments in semiconductor test systems, has typically been much greater than a reduction rate of worldwide semiconductor sales. The semiconductor industry has been highly cyclical with recurring periods of excess inventory, which often have had a severe effect on the semiconductor industry's demand for semiconductor test systems, including those of Advantest.
The global semiconductor market increased by 21.6% in 2017 compared to 2016, due to vigorous growth in demand for a wide range of electronic equipment. In 2018, the semiconductor market increased by 13.7% compared to 2017, by continued high growth from the previous year despite the reduced growth in the second half of the year. In 2019, the semiconductor market decreased by 12.0% compared to 2018, due to the impact of slowdown in global economic growth caused by geopolitical risks such as trade friction between the United State and China.
Global sales of SoC semiconductors increased by 9.6% in 2017, due to solid growth in demand for automotive semiconductor and data center amid the development of advances in automotive electronics. In 2018, worldwide sales of SoC semiconductors increased by 7.3% compared to 2017, due to a strong demand from investments in further functional advancement of smartphones from 2017. In 2019, worldwide sales of SoC semiconductors decreased by 3.7% compared to 2018, due to remaining demand for test equipment for smartphone at a high level throughout the period, despite a decline of end-product demand and capital investment under this economic uncertainty.
In 2017, global sales of memory semiconductors increased by 61.5% compared to 2016, due to vigorous growth in demand for data center-related semiconductors, causing active capital investment in memory semiconductor manufactures. In 2018, worldwide sales of memory semiconductors increased by 27.4% compared to 2017, due to demand from continuous investment in data center from 2017. In 2019, worldwide sales of memory semiconductors decreased by 32.6% compared to 2018, due to an oversupply of memory semiconductors.
The significant volatility in demand for semiconductors is affected by various factors such as:
- the overall state of the global economy;
- trends in the semiconductor industry;
- levels of investment in communications infrastructure and trends of demand in communication devices such as smartphones and wearable devices;
- demand in personal data center, computer and server industries;
- consumer demand for digital consumer products such as TVs, game devices, VR (Virtual Reality) / AR (Augmented Reality) devices;
- trends in the industrial equipment market, including automotive, robotics and medical equipment;
In FY2017, Advantest worked to capture demand for test equipment for memory semiconductors and automotive semiconductors, both of which have shown remarkable growth, as well as to boost sales of peripheral devices for semiconductor testing. Advantest also took steps to increase production capacity in order to keep up with the steep increase in demand. As a result, Advantest's net sales in FY2017 increased by 32.9%, as compared to FY2016, to ¥207,223 million. Gross margin was below that of the last fiscal year due to factors such as a lower proportion of highly profitable products in Advantest's product mix, and the recording of write-down to inventories in nanotechnology. Nonetheless, net income attributable to owners of the parent was ¥18,103 million due to Advantest's efforts to improve operational efficiency. Advantest expanded its market share by demonstrating its strength as a manufacturer with the most comprehensive product portfolio in the semiconductor test equipment industry and capturing demand for new products from a broad range of customers. As a result, Advantest's net sales in FY2018 increased by 36.3%, as compared to FY2017, to ¥282,456 million. Net income attributable to owners of the parent was ¥56,993 million due to an one-off profit of ¥3.5 billion including ¥2,530 million associated with the transfer of a portion of the defined benefit pension plan for the employees of Advantest Corporation and its subsidiaries in Japan to a defined contribution pension plan. In current consolidated fiscal year, major semiconductor manufacturers have actively made efforts to improve semiconductor performance, stimulating demand for semiconductor test equipment. In particular, demand in test equipment for 5G, 4G smartphone semiconductors manufactured with advanced processes remained at a high level throughout the period. However, the memory tester market shrank significantly due to an oversupply of memory semiconductors. Advantest's net sales in FY2019 decreased by 2.3%, as compared to FY2018, to ¥275,894 million. Net income attributable to owners of the parent was ¥53,532 million due to an increase in selling, general and administrative expenses.
Advantest believes that its results are significantly affected by the significant volatility of demand in the semiconductor industry. If there is a significant downturn in the semiconductor industry, Advantest's financial condition and results of operations will be adversely affected including the write-down of inventories due to excess inventory.
To reduce the risk, Advantest is going to be flexible to meet fluctuations in demand by expanding its business into adjacent semiconductor value chain markets such as semiconductor design, evaluation processes and system level test processes. Additionally, Advantest is promoting the use of outsource manufacturing for productions while continuing to strengthen services for the development of a recurring business and new businesses.
Advantest's business is subject to economic, political and other risks associated with international operations and sales
Advantest's business is subject to risks associated with conducting business internationally because it manufactures and sells its products, and purchases parts and components from, around the world. In FY2019, 85.7% of Advantest's total net sales came from Asia (excluding Japan), a majority of which consisted of sales in Taiwan, the People's Republic of China ("China") and Korea, 6.7% from the Americas and 2.2% from Europe. Advantest anticipates that net sales from international operations will continue to represent a substantial portion of its total net sales. In addition, some of Advantest's distribution and support subsidiaries are located in the Americas, Europe, and Asian countries, including Taiwan, Singapore, Korea and China, and some of Advantest's suppliers and factories are also located overseas, such as Korea and Malaysia. Accordingly, Advantest's future results could be harmed by a variety of factors, including:
- risks with respect to a loss of demand for Advantest's products, inability to supply products and services, or a decline in supply capacity due to inability to procure parts due to import and export restrictions and distorted licensing systems in response to protectionist policies such as trade friction between the United States and China;
- political and economic instability, including economic and political disruptions, disputes, natural calamities, epidemics or other risks related to countries where Advantest procures its components and parts or manufactures and sells its products;
- risks with respect to disrupting the movement of people and the flow of goods and bringing the entire economy to a standstill caused by epidemics, including infections, spread throughout the world as the global economy develops;
- risks with respect to procurement due to the closure or reduced operation of suppliers' production facilities in specific regions and the limited means of transportation caused by the pandemic;
- risks with respect to social and political crises and issues resulting from, deterioration in the political, economic relationships, struggle for supremacy, terrorism, war or other conflicts between countries;
- potentially negative consequences from changes in tax laws or disagreement with National Tax Bureau;
- risks with respect to international taxation, including transfer pricing regulations;
- difficulty in staffing and managing widespread operations;
- differing protection of intellectual property;
- difficulties in collecting accounts receivable because of distance and different legal rules;
- risks with respect to decline in the quality of procurement and manufacturing where Advantest's suppliers or manufacturing facilities are located in countries that do not have developed infrastructures in mechanical processing and assembly;
- risks with respect to delays or stagnation in the manufacture and shipment of products by the shutdown of suppliers and production plants, the occurrence of major local disasters caused by global warming and climate change;
- risks with respect to increases in cost, delays in delivery or expenses in repairing products where low quality and counterfeit products are mixed into the supply chain;
To reduce the risk, Advantest will work to build a system that is less susceptible to economic and political trends by collecting information on overseas risks in a timely manner, further strengthening customers and suppliers relationships, expanding procurement locations and multipleproduction sites to be more flexible.
Advantest has assumed the following risks associated with the spread of the COVID-19
- Interruptions to business / reduced efficiency due to possible infection of employees of the Advantest Group, customers, and/or suppliers
Problems caused by long-term restrictions on movement and lockdowns around the world
- Declines in product supply capacity due to shortages of manufacturing personnel at the Advantest Group / subcontractors
- Decreased ability to provide customer support due to restrictions on movement
- Declines in product supply capacity due to global supply chain disruptions causing difficulties in the procurement of materials and components
- Decreases in end-product demand and spillover effects to the electronics industry as a whole, and a slowdown in the semiconductor and semiconductor manufacturing equipment markets
- Potential significant mid-term changes in the structure of the semiconductor industry resulting from changes in customer supply chains
- Changes in Advantest's business environment due to changes in human behavior and society in the post-COVID-19
To reduce the risk, Advantest's Risk Management Group , which is under the direct control of the president, conducts activities including (1) a implementation of measures that places the highest priority on the safety and health of employees, through telecommuting and banning of business trips, (2) online support for customers, (3) global understanding of production, sales, inventory and logistics conditions, (4) Business Continuity Plan in place if we have infected person, (5) interchange information of best practices and support material among group companies, and (6) cash management, in order to respond to a new coronavirus infection (COVID-19).
If Advantest does not introduce new products in a timely manner and at competitive prices, that meets customers technical requirements, existing products will become obsolete, which will affect its financial condition and results of operations
Advantest sells its products to several industries that are characterized by rapid technological changes, frequent introduction of new products and services, varying and unpredictable product lifecycles and evolving industry standards. Advantest anticipates that future demand for its products will be driven, in large part, by technological innovation in semiconductor technology, which creates new testing requirements that are not adequately addressed by currently installed semiconductor test systems. Customer needs in response to these technological innovations, and their needs for greater cost-effectiveness and efficiency to respond to the market environment, include:
- test solutions of SoC semiconductors that incorporate more advanced memory semiconductors, logic, analog and sensor circuits;
- test solutions of power semiconductors that control small and large motor drives;
- solutions for complex SOC devices incorporating heterogeneous chips in a single advanced package e.g. 3D integration through TSV (Through- Silicon Via) technology;
- solutions of parametric test for measuring and verifying electrical and timing characteristics for the characterization and monitoring of leading-edge semiconductor wafers.
- mechatronics-related products which transport devices faster, more accurately and more stably;
- test solutions of testing technologies that employ self-test circuit designs incorporated into semiconductor chips;
- test solutions of testing technologies that employ test circuit designs for device under test (DUT);
- test solutions of system level testing that guarantees performance of the final products;
- test solutions of testing temperatures for dynamic and delicate control of test environment;
- prompt response and quick repair in the event of failure;
- total solutions that allow customers to reduce their testing costs;
- solution by electron-beam metrology to enable reliable pattern critical dimension measurement or defect review on a leading-edge photomask;
- solution by electron-beam lithography to reduce turnaround time (TAT) of IC prototyping, and to enable small-volume production of high valued devices.
Advantest also believes demand for its products, including semiconductor and component test systems, is affected by the level of demand for personal computers, high-speed wireless and wireline data services, digital consumer products, advanced driver assistance system (ADAS) and communication devices, such as smartphones, wearable devices, and data center. It is likely that advances in technologies used in those products and services will require new testing systems. Without the timely introduction of semiconductor test systems which is capable of effectively testing and measuring equipment that use these new technologies, Advantest's products and services may become technologically obsolete over time.
A failure by Advantest to meet its customers' technical requirements at competitive prices or to deliver conforming equipment in a timely manner may result in its products being replaced by those of a competitor or an alternative technology solution. Furthermore, Advantest's inability to secure sufficient personnel appropriate for the business during a period of recovery or its inability to provide a product that meets requested performance criteria at an acceptable price when required by its customers would severely damage its reputation with such customers and may adversely affect future sales efforts with respect to such customers.
To reduce the risk, Advantest seeks to identify the next technological innovation, new products, and rapid creation of new markets by holding technology exchange events with leading customers and providing opportunities to exchange information on leading-edge solutions. In addition, Advantest conducts basic research on elemental technologies for the next generation, and production engineering from the initial stages of product development to prepare for mass production.
Advantest may not ensure management stability and sustainability if a succession plan of CEO and other personnel is not developed or does not function
Advantest formulates a succession plan of CEOs and other personnel by the Board of Directors, which plays a central role in formulating plans, after the Nomination and Compensation Committee deliberating. However, if the succession plan is not developed or does not work, management stability and sustainability may not be ensured.
To reduce the risk, Advantest recognizes the importance of succession planning, the Nomination and Compensation Committee is deliberating (1) required human resource requirements, (2) selection of candidates, (3) development of candidates over time, (4) identification of candidates by Nomination and Compensation Committee members and (5) selection of candidates.
Advantest's dependence on a sole source or a limited number of suppliers for its components and parts may prevent it from delivering its products on a timely basis or its failure to meet the demand for its products upon a sudden expansion of the markets may adversely affect its future market share and financial results
Advantest relies on suppliers to perform some of the assembly requirements for its products. In addition, many of the components used in Advantest's semiconductor and component test systems and mechatronics systems are produced by suppliers based on Advantest's specifications. Advantest's reliance on these suppliers may give it less control over the manufacturing process and exposes it to significant risks, especially inadequate manufacturing capacity, late delivery, substandard quality, lack of labor availability and high costs. In addition, Advantest depends on a sole source or a limited number of suppliers for a portion of its components and parts. Advantest does not maintain long-term supply agreements with most of its suppliers, and it purchases most of its components and parts through individual purchase orders. If a supplier becomes unable to provide components or parts in the volumes needed and at acceptable prices, or if a supplier withdraws from business thereby stopping production or sales of custom or general components and parts that Advantest uses or will use in the future, or a large scale natural disaster or electricity shortage occurs, Advantest would have to identify and procure acceptable replacements. Advantest may lose its capacity to supply test systems if it becomes unable to procure acceptable replacements. Suppliers have typically adjusted their production capacity through the reduction of production lines and personnel. Therefore, if the market for semiconductor and component test systems and mechatronics systems were to suddenly expand, Advantest would require significant increases in production capabilities including personnel, as well as materials, components and supplies from suppliers, in order to fully capitalize on such expansion. Furthermore, the markets for semiconductors and other specialized components have, in the past, experienced periods of inadequate supply to meet demand. Moreover, there may be a shortage of components if a large-scale natural disaster or electricity shortage occurs. The process of selecting suppliers and of identifying suitable replacement components and parts is lengthy and may result in Advantest being unable to deliver products meeting customer requirements in a timely manner. Advantest has, in the past, been unable to deliver its products according to production schedules primarily due to the inability of suppliers to supply components and parts based on Advantest's specifications and by other shortages in components and parts. Moreover, a deterioration in the financial position of Advantest's suppliers reflecting the decline in the economic environment or the failure of Advantest to adjust to large increases in demand for its products during the period of recovery in demand could result in Advantest losing one or more of its existing large-volume customers or losing the opportunity to establish a strong relationship with potential large-volume customers with which it currently does little or no business. Such failure may adversely affect Advantest's future market share and its financial results.
To reduce the risk, in accordance with for product design best practices, taking into account the latest technology, determined by Advantest internal working group. By doing so, Advantest is able to create and update a standard parts list of multiple potential suppliers, taking into account the parts lifecycle, while also looking to standardize parts and designs, and to build a systems which are not overly reliant on specific suppliers. In addition, it is important to consider various risks when selecting suppliers for components and parts. Furthermore, when selecting these suppliers, Advantest takes various risks into consideration and search for the best partners, and continuously evaluate and review them.
Advantest faces substantial competition in its businesses and, if Advantest does not maintain or expand its market share, its business may be harmed
Advantest faces substantial competition throughout the world. Advantest's primary competitors in the semiconductor and component test system market include, among others, Teradyne, Inc., Cohu, Inc., YIK Corp., UniTest Inc. and EXICON Ltd. In the mechatronics system related market, Advantest also competes with Cohu, Inc., TechWing, Inc., and Hon. Technologies, Inc. in test handler devices, and with TSE Co., Ltd., ESA Electronics Pte Ltd., TFE Inc. and TechWing, Inc. in device interfaces. Some of Advantest's competitors have greater financial and other resources than Advantest.
Advantest faces many challenges in its businesses, including increased pressure from customers to produce semiconductor and component test systems and mechatronics systems that reduce testing costs or from customers who have developed internal test solutions. For device interfaces, acquisition of vendors that supply core technical components by Advantest's competitors, or leakage of the manufacturing technology of printed circuit boards, may result in reduced testing costs by customers or difficulty by Advantest to realize its products' full performance.
To compete effectively and maintain and expand its market share, Advantest must continue to enhance its business processes to lower the cost of its products or introduce enhancements that lower overall testing costs. Advantest also expects its competitors to continue to introduce new products with improvements in price and performance, as well as increasing their customer service and support offerings, and Advantest expects new market participants to launch low-price testers. Significant increases in competition may weaken Advantest's earnings.
To reduce the risk, Advantest strives to understand customer needs, analyze the competitive landscape, and provide unique technologies and value-added solutions to ensure that our products remain competitiveness.
Advantest may not be able to meet the targets set in its strategies and mid/long-term management goals
The attainment of goals such as those in mid/long-term management goals are subject to various internal and external factors, including the general economic and market conditions in which Advantest and its customers operate, the level of competition, the level of corporate capital expenditure, the level of demand for Advantest's products and fluctuations in exchange rates. As a result, any strategies and mid/long-term management goals and targets (as amended from time to time) should not be treated as forecasts of future results. There can be no assurance that Advantest's strategies to accomplish mid/long-term management plans and implementation of such strategies will be successful, that the implementation of its strategies will have the intended effects, that the mid/long-term management goals or other targets (whether quantitative or qualitative, and as amended from time to time) will be met, or that such goals, targets and aims will not be changed in the future by Advantest's management.
To achieve these targets, Board of Directors and Board of Managing Directors and the Internal Control Committee conduct risk analysis to continuously verify scenarios of what changes will have an impact on performance.
Advantest has top tier customers that account for a significant part of the net sales and thus has risk of losing those customers or fluctuations in their investment. Additionally, Advantest may not be able to recover trade receivables if top tier customers experiences a deterioration in their financial position
Advantest's success depends on its continued ability to develop and manage relationships with its major customers. A small number of such major customers currently account for a significant portion of its net sales. Sales to Advantest's five largest customers accounted for approximately 37% in FY2018 and approximately 30% in FY2019. The success and loss of one or more of these major customers, changes in their capital expenditures or failure of their main products could materially harm Advantest's business. Furthermore, if Advantest's major customers experience deterioration in their financial position and are unable to fulfill their payment obligations to Advantest in accordance with the applicable terms, Advantest's business, results of operations and financial position may be adversely affected.
To reduce the risk, Advantest seeks to gain broad customer base by entering new markets and developing new customers and emerging market, while paying attention to operating efficiency.
Advantest's product lines are facing price pressure
Price pressure on Advantest's businesses is adversely affecting Advantest's operating margins. Irrespective of the trend in the demand for semiconductors, there is ongoing price pressure on semiconductors, which puts continuous pressure on the market price for products in the Semiconductor and Component Test System Segment and Mechatronics System Segment. During periods when there is rapid decrease in semiconductor prices, semiconductor manufacturers, foundries, and test houses, which are Advantest's customers, seek to increase their production capacities while minimizing their capital expenditures. In addition, increased competition in the market for digital consumer products, personal computers, mobile devices such as smartphones and wearable devices, data servers and automotive semiconductors have driven down prices of these goods, subsequently creating price pressure on Advantest's product lines. If prices of semiconductors continue to decline, customers may postpone capital expenditures on new equipment by remodeling or adapting the usage of existing equipment. In recent years, the number of customers adopting two-vendor systems has increased, and it making Advantest face further price pressure. If price pressure further increases in the future, Advantest's financial condition and results of operations may be adversely affected.
To reduce the risk, Advantest attempts to maintain product price at a level that satisfies their customers by providing our proprietary technologies and solutions of high value solution. At the same time, Advantest works continuously to improve profitability by reducing production costs.
Fluctuations in exchange rates could reduce Advantest's profitability
The majority of Advantest's net sales are derived from products sold to customers located outside of Japan. Of Advantest's FY2019 net sales, 94.6% were from products sold to overseas customers. Approximately 66% of Advantest's net sales in FY2019 were derived from currencies other than the Japanese yen, predominantly the U.S. dollar. If the Japanese yen becomes strong relative to foreign currencies (mostly the U.S. dollar), it may adversely affect Advantest's sales because it cannot necessarily pass on product price.
With respect to the Euro, if the Japanese yen weakens, there may be a negative impact on Advantest's profitability since there are currently more costs incurred in Euro than net sales derived in Euro.
In addition, significant fluctuations in the exchange rate between the Japanese yen and foreign currencies, especially the U.S. dollar, could require Advantest to lower its prices with respect to foreign sales of its products that are priced in Japanese yen, and reduce the Japanese yen equivalent amounts of its foreign sales for products that are based in U.S. dollars or other foreign currencies, thereby reducing its profitability overall. These fluctuations could also cause prospective customers to push out or delay orders because of the increased relative cost of Advantest's products. In the past, there have been significant fluctuations in the exchange rate between the Japanese yen and the foreign currencies in which Advantest's sales are denominated.
Furthermore, Advantest's consolidated financial statements for a particular period or for a particular date will be affected by changes in the prevailing exchange rates of the currencies in which subsidiaries of Advantest prepare their financial statements against the Japanese yen. Foreign exchange rate fluctuations may have an effect on those amounts not denominated in yen which are translated into yen for Advantest's consolidated financial statements, and depending on the direction of the foreign exchange fluctuation, it may have an adverse effect on Advantest's reported financial position, results of operations and net assets.
To reduce the risk, in addition to rebalancing currency holdings, Advantest strives to reduce the impact of currency fluctuations through the use of foreign exchange contracts and other financial instruments, and balance sheet management to ensure that foreign currency denominated assets and liabilities are offset.
Advantest may not recoup costs incurred in the development of new products
Enhancements to existing products and the development of new generations of products are, in most cases, costly processes. Furthermore, because the decision to purchase semiconductor and component test systems products and mechatronics systems generally involves a significant commitment of capital, the sale of this equipment typically involves a lengthy sales period and requires Advantest to expend substantial funds and sales efforts to secure the sale. Advantest's enhancements or new generations of products may not generate net sales in excess of development and sales costs if, for example, these new enhancements or products are quickly rendered obsolete by changing customer preferences, the introduction by Advantest's competitors of products embodying new technologies or features, the introduction by Advantest's customers of new products that require different testing functions or the failure of the market for Advantest's customer's products to grow at the rate, or to the levels, anticipated by Advantest. In some cases, Advantest must anticipate industry trends and develop products in advance of the commercialization of its customers' products. This requires Advantest to make significant investments in product development well before it determines the commercial viability of these innovations. If Advantest's customers fail to introduce their devices in a timely manner or the market rejects their devices, Advantest may not recover its investments in product development through sales in significant volume.
To reduce the risk, Advantest attempts to improve return on investment by developing product roadmaps that meet customer needs through technology exchange meetings, improving development efficiency through the creation of product platforms, and strengthening marketing through proactive evaluation of investment returns with ROIC and innovative product development.
The market for Advantest's major products is highly concentrated, and Advantest may not be able to increase sales of its products because of limited opportunities
The market for test systems for memory semiconductors in the Semiconductor and Component Test System Segment is highly concentrated, with a small number of large semiconductor manufacturers, foundries and test houses accounting for a large portion of total sales in the semiconductor and component test system industry. Advantest believes that this market concentration could become even more severe in the future as larger semiconductor device manufacturers, foundries and test houses acquire semiconductor market participants, and as corporate restructuring, such as elimination and consolidation of businesses, progresses. Advantest's ability to increase sales will depend in large part upon its ability to obtain or increase orders from large-volume customers. Furthermore, in the event there is an over-supply of semiconductor and component test system products on the second-hand market reflecting, among others, restructuring within the industry, or delay to meet the specific needs of Advantest's customers, Advantest faces an additional risk of losing its sales opportunities.
To reduce the risk, Advantest develops products for a variety of applications to strengthen customer partnerships and avoid missed opportunities. On the other hand, Advantest aims to expand its business domain by launching new businesses and M&A.
Goodwill and intangible assets resulting from Advantest business acquisitions could have a material adverse effect on Advantest's financial condition and results of operations due to significant impairment charge
If there is any indication of impairment for property, plant and equipment, goodwill and intangible assets, the assets are tested for impairment. Goodwill is tested for impairment both annually and when there is any indication of impairment. An impairment loss is recognized if the recoverable amount of an asset, cash-generating unit (CGU) or CGU group is less than its carrying amount. Especially, if goodwill and intangible assets resulting from acquisitions do not have the expected synergy effects, Advantest may be required to record a significant impairment charge, which could have a material adverse effect on Advantest's financial condition and results of operations.
To reduce the risk, when acquiring a business through M&A and other means, investments should be made taking into consideration the time it will take to recover the capital cost. Furthermore, after the acquisition, Advantest will be able to organically function in terms of strategy, sales network, management system, employee awareness and information systems. In order to achieve synergies, Advantest will execute Post Merger Integration (PMI) plan and aim to realize the effects as soon as possible.
If Advantest's main facilities for research and development, production or information technology systems for its businesses, or the facilities of its subcontractors and suppliers, were to experience catastrophic loss, its results of operations would be seriously harmed
Advantest's main facilities for research and development for its Semiconductor and Component Test Systems and Mechatronics System Segments production, as well as Advantest's service bases, are located in Gunma Prefecture, Saitama Prefecture and Miyagi Prefecture in Japan. In addition, the main system server and the network hub are maintained in system centers approved by the Information System Management System, or ISMS, and local network servers are located in certain operations offices in Japan.
Japan is a region that is susceptible to frequent earthquakes. If Advantest's facilities, particularly its semiconductor and component test system manufacturing factories, were to experience a catastrophic loss from, but not limited to, earthquakes or floods, it would materially disrupt Advantest's operations, delay production, shipments and revenue, and may result in large expenses to repair or replace the facilities. Advantest has insurance to cover most potential losses at its manufacturing facilities, other than those that result from earthquakes. However, this insurance may not be adequate to cover all possible losses. Similar disruptions to Advantest's business may occur if the facilities of Advantest's subcontractors and suppliers or if the facilities of Advantest's information system network were to experience a catastrophic loss.
Advantest has prepared itself for crises such as large-scale natural disasters, and each department of Advantest has documented its own disaster-response procedures and manuals. Furthermore, in order to prevent any disruption of its core businesses, or in case of suspension, to re-start the suspended businesses, including the recovery of important facilities, in the shortest possible time, Advantest formulated and implemented a "Business Continuity Plan". However, if such Business Continuity Plan is not effective, Advantest's core businesses could be disrupted at a time of crisis, such as large-scale natural disasters, and could take a substantial amount of time to recover.
To reduce the risk, Advantest has a developed a business continuity plan to ensure that business operations are not interfered with decentralizing production facilities and suppliers. Additionally, Advantest stores corporate records and data in a cloud system.
Advantest may not be able to recover its capital expenditures
Advantest continues to make capital expenditures. From FY2012 through FY2013, Advantest built a new factory in South Korea in order to increase its share of sales to major Korean customers. The factory began operating in May 2013. Advantest may not be able to recover the capital expenditures for such projects within the assumed timeframe, or at all, if it cannot achieve the assumed volume of sales due to customers cutting back on capital expenditures or if intense competition with competitors results in a reduction in unit prices. In such event, the asset would be subject to impairment, which may have an adverse impact on Advantest's profitability.
To reduce the risk, Advantest decides capital expenditures after the review of return on investment based upon capital cost. Advantest also continues to monitor the expected growth rate which is an investment effect, and continue to consider the optimal future investment decision.
Advantest's financial position and business result may be negatively affected by damage of credit or brand power
Advantest may experience damage of credit and brand power by a decline in the performance and reliability of a product or an act that violates laws or social ethics which may result in suspension of trading, sanctions or other social measures.
To reduce the risk, Advantest undertakes design review at the initial design stage and cross-references with the quality assurance division to provide products with high reliability. Advantest also established the Compliance Committee to maintain the credibility, and it performs activities to raise awareness of legal compliance that have been carried out.
Chemicals used by Advantest may become subject to more stringent regulations, and Advantest may be required to incur significant costs in adapting to new requirements
Advantest uses chemicals in the manufacturing of its products, the manufacture, processing and distribution of which are subject to environmental related laws, regulations and rules of Japanese governmental agencies, as well as by various industry organizations and other regulatory bodies in other countries. These regulatory bodies may strengthen existing regulations governing chemicals used by Advantest and may also begin to regulate other chemicals used by Advantest. While Advantest is taking measures to eliminate toxic substances included in parts used to manufacture its products, Advantest uses solder, which contains lead for mounting electronic parts and components for its products except for some of them, in order to ensure the reliability of its products as a matter of priority. Further, as a method to cool some of its semiconductor and component test systems and mechatronics systems, Advantest uses fluorinated liquid which use is not currently regulated by laws. Advantest believes that it is in compliance with regulations with respect to the use of chemicals by promoting environmental policies for its products with the focus on ensuring the safety and the reliability of its products; however, Advantest must be prepared to adapt to regulatory requirements in all relevant countries as requirements change. Advantest may be required to incur significant cost in adapting to new requirements. Any failure by Advantest to comply with applicable government or industry regulations could result in restrictions on its ability to carry on with or expand sales of its products.
To reduce the risk, Advantest seeks to find alternative technology as well as monitor environmental regulations for chemical materials.
Advantest is at risk of not being able to raise funds when necessary
As for the working capital requirements, Advantest shall appropriate the cash and deposits earned from its operating activities. In the event that it becomes necessary to raise funds due to an acquisition or a sudden downturn in economic conditions, it may issue bonds or borrow funds from financial institutions. In the event of financial market instability or a reduction in Advantest's credit rating due to a deterioration of creditworthiness, there is no guarantee that Advantest will be able to procure funds in a timely manner, which could affect the results of operations and financial position.
To reduce the risk, Advantest have built a strong financial position to withstand sharp demand fluctuations. Furthermore, Advantest maintains friendly relations with several financial institutions to enable the immediate borrowing of funds and the establishment of commitment lines when necessary.
Advantest could suffer significant liabilities, litigation costs or licensing expenses or be prevented from selling its products if it is infringing on the intellectual property of third parties
Advantest may be unknowingly infringing on the intellectual property rights of third parties and may be held responsible for that infringement. To date, Advantest has not been the subject of a material intellectual property claim. However, any future litigation regarding patents or other intellectual property infringement could be costly and time consuming and divert management and key personnel from Advantest's business operations. If Advantest loses a claim, it may be forced to pay significant damages, pay license fees, modify its products or processes, stop making products or stop using processes. A license could be very expensive to obtain or may not be available at all. Changing Advantest's products or processes to avoid infringing on the rights of third parties may be costly or impractical.
To reduce the risk, Advantest makes an effort to conduct research on intellectual property to not infringe on other companies' intellectual property throughout R&D stage and prior to product shipment.
Advantest may be unable to protect its proprietary rights due to the difficulty of Advantest gaining access to, and investigating, the products believed to infringe on Advantest's intellectual property rights
Advantest relies on patents, utility model rights, design rights, trademarks and copyrights obtained in various countries to actively protect its proprietary rights. For instance, with respect to the device interface market, Advantest has taken legal action based on its patent and utility model rights against manufacturers that sell replicas of Advantest's products and, in some instances, has obtained injunctions against sales of such replicas. Advantest's business could have a material adverse effect upon Advantest's market share and business results if Advantest is unable to protect its proprietary rights.
While, in general, it is difficult for Advantest to gain access to, and investigate, the products believed to infringe on its intellectual property rights. Therefore, Advantest cannot ensure that its intellectual property rights will provide meaningful protection of its proprietary rights.
Nevertheless, Advantest believes it is important to protect its intellectual property rights from third party infringement and will continue to monitor infringement of its intellectual property. Avantest will also communicate compliance to the customers.
The labor market is very competitive, and Advantest's business could have a material adverse effect upon Advantest's business operations and business results if Advantest is unable to hire and retain diverse technical experts and important staff for operations
In order to develop business in the rapidly changing electronics industry, Advantest needs to secure a diverse range of human resources who are familiar with R&D, manufacturing, marketing, sales and maintenance services and other technical experts. In addition, Advantest believes it is important to continuously develop and maintain human resources with management capabilities such as business strategy and organizational management.
Therefore, in addition to hiring new graduates, Advantest employs and secures a wide range of experienced personnel on a global basis, continuously review personnel systems and conduct employee education, as well as strive to establish and develop employees.
However, the competition for continuously hiring and retaining the necessary personnel is fierce. If Advantest does not proceed as planned or becomes less attractive to employees, it would result in the outflow of human resources due to the group's system becoming unattractive caused by a delay of improvements in the working environment. Thus, Advantest's business could have a material adverse effect upon Advantest's business operations and business results.
To reduce the risk, in addition to recruiting based on long-term view and job rotation upon a global basis, Advantest tries to stabilize the workforce by improving the working environment and improving engagement.
If Advantest is unable to promptly proceed with Digital Transformation of Core systems and processes on business, Advantest's business results could have a material adverse effect
Digital Transformation is an initiative to increase the competitiveness of companies with data and digital technologies. There are high expectations for digital transformation in a wide range of fields, including the utilization using IoT and artificial intelligence to revolutionize manufacturing floor, the creation of new value through the sharing of data between production facilities and logistics, and the response to changes in the business environment brought about by the COVID-19.
However, as proceeding with Digital Transformation if Advantest is unable to make full use of date due to the aging, complexity, and black-boxing of existing IT systems, or to keep resources for IT investment that utilizes new digital technology due to funds and human resources are dedicated the maintenance of existing systems, it loses competitiveness, the maintenance cost of the old system becomes high, or system problems and data loss occur by the retirement of system maintenance operation person in charge or the aging of the population, Advantest's business results could have a material adverse effect.
To reduce the risk, Advantest reviews IT systems and considers applications continuity and alternatives to new market technologies. Advantest is also working to expand the Digital Workplace (Workplaces created by digital technologies) concept worldwide and connect it to opportunities for organizations to innovate.
Damage, interference or interruption to Advantest's information technology networks and systems could hinder business continuity and lead to substantial costs or harm Advantest's reputation
Advantest relies on various information technology networks and systems, some of which are managed by third parties, to process, transmit and store electronic information, including confidential data, personal information and to carry out and support a variety of business activities, including manufacturing, research and development, supply chain management, sales and accounting. Advantest has the Information Security Committee to create policies on information security measures. The IT section builds and operates the information and technology network and system based on the above-mentioned policies. However, attacks by hackers or computer viruses, wrongful use of the information security system, careless use, accidents or disasters could undermine the defenses established by Advantest and disrupt business continuity, which could not only risk leakage or tampering of information but could also result in a legal claim, litigation, damages liability or an obligation to pay fines. If this were to occur, Advantest's reputation could be harmed, Advantest could incur substantial costs, and it may have a material adverse effect upon Advantest's financial condition and results of operation.
To reduce the risk, Advantest constantly monitors cyber-attacks to enhance their detection and establishes a CISRT (Computer Incident Security Response Team) system to promptly respond to accidents. At the same time, Advantest strives to improve employee awareness through regular information security education.
Product defects and any damages stemming from Advantest's product liability could harm Advantest's reputation among existing and potential customers and could have a material adverse effect upon Advantest's business results and financial condition
Advantest manufactures its products in accordance with internationally accepted quality control standards such as ISO 9001. However, Advantest cannot guarantee that there are no defects in its products. Advantest maintains product liability insurance, but cannot guarantee that such insurance will sufficiently cover the ultimate amount of damages with respect to Advantest's liabilities. Therefore, shipping stoppage and delivery delay due to quality defects of parts or manufacturing defects of products, large scale accidents due to product defects or any discovery of defects in its products could harm Advantest's reputation for not adequately addressing defects, could cause Advantest to incur higher costs, could result in claims for damages and could have a material adverse effect upon Advantest's business results and financial condition.
To reduce the risk, Advantest seeks to secure products reliability by checking with the quality assurance division.