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Operating Risks

A wide variety of economic, political, and social factors in countries throughout the world have the potential to impact negatively the NYK Group's mainstay shipping and integrated logistics operations, as well as its cruise and other businesses. Indicated below are some of the risks that could affect the group's operating performance, share price, and financial conditions. The items described in the text below represent the group's judgment of potential future events as of March 31, 2011.

  1. A major shipping accident
    Based on the basic philosophy “Bringing value to life.”, the NYK Group operates and controls vessels throughout the world. We recognize the safe operation of vessels and preservation of the environment as our top operational imperatives. To ensure operational safety, we have implemented our own safety management system, NAV9000, to pursue environmental management certification. We have established the Environmental Safety Measures Promotion Council, which is chaired by the president of NYK, to periodically review safety measures for shipping and other operations. This structure is designed to guarantee steady improvements in the group's safety levels and to ensure appropriate responses in the event of an emergency. Nevertheless, a major unforeseen accident, such as an oil spill or some other type of environmental contamination, injury to or death of a crew member or passenger, damage to or loss of a vessel, or a safetyrelated incident such as an act of piracy or terrorism could delay or halt cargo transport; nullify transport agreements or render them uncollectible; result in administrative fines, lawsuits, penalties, or trade restrictions; prompt higher insurance premiums; or cause damage to the group's reputation and relationships with customers. The materialization of such risks or the inability to cover them with insurance could impact the operating performance and financial condition of the NYK Group.

  2. Changes in the overall shipping and freight markets
    The NYK Group endeavors to generate stable operating revenue that is not affected by overall changes in the shipping market. However, such factors as general economic fluctuations, a falloff in international freight demand, increasingly severe competition, or changes in the balance of shipping supply and demand could cause a substantial decline in shipping revenues or vessel rental income. Such a situation could impact the operating performance and financial condition of the NYK Group.

    Furthermore, recent imbalances in shipping supply and demand are causing major fluctuations in freight rates. This disparity between capacity and demand is forecast to continue affecting the shipping industry in the future, which could significantly impact the NYK Group's revenues. The value of the NYK Group's vessels might also be affected.

    Factors that affect shipping industry demand include the following.

    • Global and regional economic conditions
    • Trends in the demand for and consumption of the energy resources, raw materials, and products that the NYK Group transports
    • The globalization of production
    • Inventory levels
    • Changes in marine and other transport methods, as well as the development of alternative methods
    • International trade development, global and regional political trends and economic conditions
    • Environmental development and other legislative trends

    Moreover, excess shipping capacity could affect the financial condition and operating performance of the NYK Group.

    Factors that affect shipping supply include the following.

    • The number and capacities of new vessels
    • Scrap prices for used vessels
    • Congestion or closure of ports and canals
    • The number of vessels out of service due to periodic maintenance or idling
    • V essel reductions owing to changes in or expanded provisions for environmental legislation or other regulations that could limit the useful life of vessels

    Falling market rates for chartered freight and declines in the value of the NYK Group's vessels as a result of oversupply could impact the operating performance and financial condition of the NYK Group.

    The NYK Group sources part of its fleet through the construction and ownership of new vessels. Long-term fixed costs to the NYK Group related to new vessel construction include depreciation and amortization, interest on loans, and ship operation and maintenance costs. Some of the vessels in the NYK Group's fleet are provided as long-term charter vessels, for which the group has agreed to pay charter fees over the charter period. However, shipping demand and freight rates can vary significantly in short periods of time. The NYK Group places orders for the construction of new vessels or enters into long-term charter contracts based on its forecasts of demand trends and the number of vessels needed to satisfy this demand. If vessel utilization rates do not exceed a certain level or if market freight rates fall dramatically after entering into short-term agreements, the NYK Group may be unable to generate revenue from transportation sufficient to cover its costs. This situation could affect the NYK Group's business, operating performance, and financial position.

  3. Impacts of competition with other companies
    In addition to Japanese marine transport operators, the NYK Group competes with international shipping companies operating throughout the globe, and the competitive situation is growing more intense. If the NYK Group becomes unable to maintain its competitive position in any of the sectors in which it operates, the NYK Group's business, operating performance, and financial condition could be affected.

  4. Fluctuations in currency exchange rates
    Many of the NYK Group's operations are denominated in foreign currencies, creating the possibility of losses resulting from exchange rate fluctuations. To match the currencies in which it generates revenue and pays expenses, the NYK Group conducts hedging transactions, including foreign exchange contracts and currency swaps, to minimize the effects of exchange rate fluctuations. When preparing consolidated financial statements, the NYK Group converts the financial statements of its overseas consolidated subsidiaries into yen. As a result, fluctuations in currency exchange rates could affect the operating performance and financial condition of the NYK Group.

  5. Changes in fuel prices
    The NYK Group regularly purchases bunker oil for use as fuel for the vessels and aircraft it uses to transport cargo throughout the world. Bunker oil prices account for a substantial portion of the costs the NYK Group incurs in the liner trade, bulk shipping, and air cargo transportation businesses. Bunker oil prices and purchase availability are subject to global crude oil supply and demand, foreign exchange market fluctuations, changes involving OPEC and other crude oil producing countries, the state of environmental legislation, competition, and changes in myriad other factors, and forecasting the changes in all of these conditions is difficult. The NYK Group seeks to minimize the impact of such factors on its operating performance by purchasing bunker oil from diverse regions, using derivative transactions to hedge against fuel price fluctuations, and economizing on fuel consumption. Even so, these measures have limited effect, and there is no guarantee that they will be sufficient to protect the group against price fluctuations and supply shortages. Furthermore, low-sulfur fuel regulations that are slated for future expansion and enhancement call for vessels to use fuels that are more expensive. The NYK Group typically is unable to pass on all the costs of bunker fuel price increases to customers through rate hikes or fuel surcharges. Consequently, a rise in fuel costs could affect the NYK Group's business, operating performance, and financial position.

  6. Changes in regional economic conditions affecting global operational developments
    As the NYK Group's sphere of operations includes Japan, North America, Europe, Asia, the Middle East, and other regions, economic conditions in each of these areas can influence the group's operations. We gather information ourselves and employ outside consultants to minimize and, where possible, avoid such risks. Nevertheless, these changes could affect the operating performance and financial condition of the NYK Group. Some potential risks are described below.

    1. Disadvantageous political or economic factors
    2. Government regulations, such as operational or investment permissions, taxes, foreign exchange controls, monopolies, or commercial limitations
    3. Joint operations or tie-ups with other companies
    4. Social upheaval, such as wars, riots, terrorist acts, piracy, infectious diseases, strikes, and computer viruses
    5. Earthquakes, tsunamis, typhoons, and other natural disasters
    6. Difficulty in situating or managing personnel involved in international operations
    7. Standards of liability that differ from those in Japan and legal systems that are difficult to predict

    These factors have the potential to negatively affect the NYK Group's operations in certain international markets, which in turn could have a negative impact on the business of the NYK Group.

    Through its containership business, the NYK Group is a member of the Grand Alliance — a strategic alliance that also includes three overseas marine transport companies. The NYK Group considers the alliance necessary to ensure the efficiency of its containership operations and the ability to maintain a global network. At the same time, it is difficult to maintain the same safety and service standards and management directions and procedures across alliance activities, and the alliance could be dissolved or members could withdraw from the alliance, which presents the risk that the alliance may not deliver the anticipated results. If it is unable to respond appropriately to such factors, the NYK Group's business, operating performance, and financial condition could be affected.

    The NYK Group's business depends on having sufficient marine crew members. High-quality crew members are particularly vital to the safe operation of vessels. The majority of the NYK Group's crew members are citizens of Asian countries other than Japan, particularly the Philippines. The NYK Group employs various methods to secure quality crew members, such as providing education and training and recruiting in other countries, but there is no guarantee that the group will always be able to employ enough crew members that have the necessary skills at an appropriate price. For instance, for several years before the financial crisis hit, shipping demand was high, and personnel costs for crew members skyrocketed. If the NYK Group becomes unable to employ a sufficient number of crew members for a reasonable price, its business, operating performance, and financial condition could be affected. In addition, roughly 70% of the NYK Group's current crew members are Philippine nationals, and war or other political factors could adversely affect the NYK Group's business. Furthermore, some NYK Group employees, including crew members, belong to labor unions. Any employee strikes, work stoppages, or acts of sabotage could impact the NYK Group's business, financial condition, and operating performance. Third-party strikes or work stoppages by employees outside the NYK Group could also impact the NYK Group's business, operating performance, and financial condition.

    The NYK Group is affected by the risk of conflicts throughout the world, including the Middle East. Some of the vessels the NYK Group owns or charters operate in the Straits of Malacca and Singapore, an area of frequent pirate attacks, and the Gulf of Aden, the Arabian Sea, and Indian Ocean, where Somali pirates are active. The areas in which acts of terrorism and piracy occur are expanding, and the frequency of attacks is increasing. Terrorist or pirate attacks, or political instability or conflict, could impact the NYK Group's business, operating performance, and financial condition. The exclusion of regions in which NYK Group vessels operate from coverage by standard war risks insurance (certain areas are already so designated) could impact insurance premiums and claim payments.

  7. Impacts of incidents arising during system development or operation
    The smooth operation of its fundamental IT systems is essential to the operations of the NYK Group. In the event that an earthquake, fire, or other calamity affects the stable operation of these systems or causes them to go down, the group will make every effort to get these systems back online promptly. However, if these systems remain down for more than a certain period of time, the provision of information to customers and our business operations could be affected. Such incidents could impact the NYK Group's operating performance and financial condition.

  8. Stronger legislation on environmental preservation, safety, and security
    In each of the regions in which it operates, the NYK Group is obliged to observe international law regarding the safe operation of its vessels and the prevention of marine accidents. The group also must comply with regional legislation and other requirements concerning environmental protection, import-export, taxation, and foreign exchange.

    The NYK Group recognizes the importance of environmental preservation activities and measures to ensure the stability and safety of its distribution supply chain, while developing and expanding its global operations. Increasingly stringent public regulations to preserve the environment include moves toward double-hull construction, which reduces the danger of oil spills in the event of an oil tanker collision; standards to reduce CO2, SOx, and NOx emissions; and the use of electronically controlled engines.

    The costs required to respond to increasingly stringent legislative measures or social expectations on environmental preservation — including the prevention of global warming, atmospheric pollution, and the preservation of biodiversity, as well as safety and security, could affect the operating performance and financial condition of the NYK Group. In the event that compliance with legislation or other regulations in certain regions becomes problematic, this situation could limit the NYK Group's operations in that region, which could impact the group's operating performance.

  9. Air cargo transportation business
    The 747-8F aircraft that the NYK Group has ordered from Boeing are presently scheduled for delivery in or after fiscal 2011. However, the delivery of these 14 aircraft could be delayed, which could result in losses for the NYK Group. Conversely, even if these aircraft do become available, the NYK Group may not be able to deploy all of them if the air cargo transportation market enters a downturn. In that situation, the group could face losses unless it takes aircraft out of service or leases or sells them.

    As with its marine transport business, the NYK Group's air cargo transportation business faces various potential risks, outlined below. These factors could impact the NYK Group's operating performance and financial condition.

    • Aircraft accidents
    • The promotion of environmental legislation or other regulations
    • A downturn in air freight rates owing to increasingly stringent competition or a drop-off in demand
    • Fluctuations in aircraft fuel prices
    • Currency exchange fluctuations
    • Insufficient insurance coverage
    • Takeoff / landing slots granted by legislation or competent authorities
    • IT system malfunctions
    • Fixed-cost inflexibility
    • Acts of terrorism, political unrest, and natural disaster
  10. Relations with business partners
    The NYK Group's Dry Bulk Carrier Division and Tanker Division place importance on long-term contracts with business partners, particularly for large vessels. These long-term agreements help stabilize the group's business in the face of market fluctuations by fixing freight rates, carrying volumes, and rate adjustment conditions. If business conditions for some of the business partners with which the NYK Group maintains long-term agreements were to deteriorate, these business partners may become unable to continue fulfilling all terms of the agreements that are in place. Furthermore, the NYK Group may find itself unable to procure third-party charter vessels that would enable it to fulfill the terms of the long-term agreements it has made. If charter companies become unable to fulfill the terms of their agreements with the NYK Group before their charter period has ended, the NYK Group could suffer losses due to an inability to procure alternative vessels. Such circumstances could impact the NYK Group's business, operating performance, and financial condition. Also, although long-term agreements provide some insulation against market fluctuations, in an upward-trending market the NYK Group may become unable to pass on rising market prices immediately by demanding higher freight rates.

    Important business partners of the NYK Group include leading Japanese automakers, paper manufacturers, electronics manufacturers, steelmakers, and public utilities, as well as U.S.-based retailers. The scale of its transactions with important business partners could shrink, or the NYK Group could lose an important business partner. Such a situation could impact the NYK Group's financial condition.

  11. Operational restructuring
    The NYK Group has restructured its operations when necessary. Future operational restructuring activities, if implemented, could affect the operating performance and financial condition of the NYK Group.

  12. Medium-term management plan
    In March 2011 the NYK Group formulated “More Than Shipping 2013,” a new three-year medium-term management plan. Nevertheless, progress under this medium-term management plan could be affected by a variety of factors, and the plan's achievement is not necessarily guaranteed.

  13. Investment plans
    Although the NYK Group's plans include investment in the expansion of its fleet of vessels and aircraft, fluctuations including market conditions and government regulations could prevent these plans from progressing as initially intended. Such changes could affect the operating performance and financial condition of the NYK Group.

    The NYK Group spends a substantial amount of money on capital investments in new vessels. Large-scale shipbuilding plans are subject to delays and may be affected by shipyard labor disputes, management difficulties, or other factors that affect the shipyard itself. Cargo transport demand could slacken just as new vessels are delivered, or demand could increase while vessel delivery is delayed beyond expected dates. Such situations could impact the business, operating performance, and financial condition of the NYK Group.

  14. Fluctuations in interest rates
    To meet funding requirements for capital investment, such as in vessels, aircraft, and transportation-related facilities, and for working capital, the NYK Group uses internal funds as well as funds procured from external sources. Currently, a portion of the external funds are procured at floating interest rates. The group seeks to minimize the effect of interest rate changes by moving toward fixed interest rates on the basis of its assumptions about the interest rate environment. However, certain changes in interest rates could impact the operating performance and financial condition of the NYK Group, and affect the future cost of procuring funds.

  15. Disposal of vessels
    Changes in shipping supply and demand conditions, as well as technical developments and advances, cause physical limitations on the use of vessels as they become outdated or no longer comply with safety and other legal requirements. In such cases, the NYK Group may dispose of its vessels or aircraft, or cancel certain charter contracts for vessels to be chartered. Such activities could affect the operating performance and financial condition of the NYK Group.

    The NYK Group typically sells fully depreciated vessels and aircraft. However, there is no guarantee that the NYK Group will be able to sell such vessels and aircraft under attractive conditions or, indeed, be able to sell them at all. The group also may face a growing need to sell superannuated vessels or aircraft during times of economic stagnation or when market prices on vessels and aircraft are falling. If the NYK Group were compelled to sell vessels or aircraft that were not fully depreciated for prices below their book values, it could be forced to record a loss on their sale and retirement. Furthermore, if markets fail to recover from their current malaise or deteriorate further, the group may suffer valuation losses on its vessels, aircraft, and other assets.

  16. Valuation losses on investment securities
    The NYK Group uses the current value method to evaluate its holdings of investment securities that have explicit market values, taking as the market value the average market price during the one-month period preceding the end of the fiscal year. As a result, changes in stock market conditions could affect the operating performance and financial condition of the NYK Group.

  17. Retirement benefits plan
    The NYK Group's defined benefit plans include a defined benefit pension plan law, a qualified retirement benefits plan, an employees' pension fund plan, and a temporary retirement fund plan. Legally, the NYK Group was required to change from a defined benefit pension plan law to a different type of plan by the end of March 2012. As of April 1, 2007, a defined benefit pension plan law is applied. Changes in the pension plan, the investment of pension assets, or the assumptions underlying the accounting for retirement benefits could affect the operating performance and financial condition of the NYK Group.

  18. Evaluation of prospects for recovery of deferred tax assets
    The NYK Group performs an evaluation based on estimated future taxable income to determine the likelihood of recovering deferred tax assets. If we decide that part of or all deferred tax assets cannot be recovered because of a decline in estimated future taxable income or a revision in a nation's tax system, including a change in the statutory tax rate, we will reduce deferred tax assets and post a corresponding expense for taxes in the fiscal period when this decision was made.

    These expenses could affect the operating performance and financial condition of the NYK Group.

  19. Litigation
    The NYK Group is engaged in the ocean cargo transport, global logistics, cruise, air cargo transportation and other businesses. There is a risk of litigation concerning all of these business activities. Depending on the outcome, litigation could affect the operating performance and financial condition of the NYK Group. Two examples of ongoing litigation are provided below.

    1. Nippon Cargo Airlines Co. Ltd.
      Major airline companies around the world are being investigated by South Korean authorities as part of a probe into price-cartel activity regarding air cargo transport services, and NYK Group consolidated subsidiary Nippon Cargo Airlines Co. Ltd. (NCA), is cooperating with these investigations.

      NCA had been served with a written notification from the Korea Fair Trade Commission (KFTC) that a fine was to be imposed for violations of Korea's Monopoly Regulation and Fair Trade Act. After carefully reviewing the contents and considering its response to the KFTC's notification, NCA determined that it could not accept the finding of the KFTC, and in December 2010 filed a lawsuit against the KFTC with the Seoul High Court in Korea seeking to have the KFTC's decision reversed.

      In the United States, NCA is a defendant in a class action lawsuit demanding an unspecified payment to compensate for damages caused by an alleged price-fixing cartel. As it is difficult to reasonably estimate the outcome of this lawsuit, no provision has been set aside.

    2. Yusen Logistics Co. Ltd. (former name: Yusen Air & Sea Service Co. Ltd.)
      In April 2008, the Japan Fair Trade Commission began investigating consolidated subsidiary Yusen Logistics Co. Ltd. (YLK) and other major users in Japan of international air cargo services for alleged violations of the Anti-Monopoly Act involving freight rates and fuel surcharges. In March 2009, the commission issued a cease-and-desist order and surcharge payment order. Following an examination and confirmation of these orders and the careful consideration of a response, YLK concluded that these orders cannot be accepted. Consequently, the board of directors of YLK approved a resolution at an extraordinary meeting held in April 2009 to file an application with the Fair Trade Commission to initiate a hearing regarding this matter. In July 2009, the company received notice concerning the initiation of hearing procedures. The hearing procedures concluded on the date of the sixth hearing (July 2, 2010), but as of March 31, 2011, a decision had yet to be rendered.

      Despite taking this action, as of March 31, 2011, YLK had established an anti-monopoly law allowance equal to the surcharge that the Japan Fair Trade Commission has ordered this company to pay.

The specific items described above are some of the ongoing risks that the NYK Group faces in its everyday operations, and are not intended to encompass all potential risks.