Canon Annual Report 2008

Plain-text annual report

C A N O N A N N U A L R E P O R T 2 0 0 8 CANON ANNUAL REPORT 2008 Fiscal Year Ended December 31, 2008 CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan PUB. BEP018 0409SZ16.5 Printed in Japan This publication is printed on paper certiﬁ ed by the Forest Stewardship Council with ink that uses neither VOCs (Volatile Organic Compounds) nor mineral oil and realizes superior decomposability and deinkability. CORPORATE PROFILE Canon is engaged in the development, manufacture and sale of a growing lineup of copying machines, printers, cameras, optical and other products that meet a diverse range of customer needs. The Canon brand is well recognized and trusted throughout the world by the individuals, families, ofﬁ ces and industries that use Canon products. In 1996, Canon launched its Excellent Global Corporation Plan and has since delivered a series of strong performances. After this period of sustained growth, however, the Company is confronting an unprecedented downturn in worldwide ﬁ nan- cial and economic markets. Despite the onset of harsh operating condi- tions, Canon remains at the forefront of an industry that continues to experience the spread of globalization and broadband networks. Leverag- ing its strengths in cross-media imaging through advanced synergies among digital imaging equipment and technologies, Canon will reinforce its robust position in preparation for the next economic upturn. As a part of these endeavors, and in its efforts to fulﬁ ll its duties to investors and society, Canon will continue to emphasize good corporate governance and promote activities that contribute to the environment and society. CORPORATE PHILOSOPHY: Kyosei The corporate philosophy of Canon is kyosei. A concise deﬁ nition of this word would be “Living and working together for the common good,” but our deﬁ nition is broader: “All people, regardless of race, religion or culture, harmoniously living and working together into the future.” Unfortunately, the presence of imbalances in our world in such areas as trade, income levels and the environment hinders the achievement of kyosei. Addressing these imbalances is an ongoing mission, and Canon is doing its part by actively pursuing kyosei. True global companies must foster good relations, not only with their customers and the communities in which they operate, but also with nations and the environment. They must also bear the responsibility for the impact of their activities on society. For this reason, Canon’s goal is to contribute to global prosperity and people’s well-being, which will lead to continuing growth and bring the world closer to achieving kyosei. CORPORATE GOAL Canon is shifting its emphasis more toward improved management quality from sound growth, carrying out its medium- to long-term management plan, the Excellent Global Corporation Plan. This decision was made in light of the current worldwide ﬁ nancial crisis and unprec- edented downturn in the global economy. With the aim of attaining the status of being among the global top 100 companies in terms of key performance indicators, Canon is accelerating management quality improvement initiatives. CONTENTS FINANCIAL HIGHLIGHTS ............................. 1 TO OUR STOCKHOLDERS ............................ 2 MESSAGE FROM THE PRESIDENT ............... 6 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III .......................................... 8 CORPORATE GOVERNANCE ........................ 16 CORPORATE FUNCTIONS ............................ 20 RESEARCH & DEVELOPMENT PRODUCTION SALES & MARKETING CORPORATE SOCIAL RESPONSIBILITY PRODUCT GROUPS ...................................... 32 OFFICE IMAGING PRODUCTS COMPUTER PERIPHERALS CAMERAS OPTICAL AND OTHER PRODUCTS MAJOR CONSOLIDATED SUBSIDIARIES ..... 42 FINANCIAL SECTION .................................... 43 TRANSFER AND REGISTRAR’S OFFICE ....... 98 STOCKHOLDER INFORMATION .................. 98 Cover Photo: Equipped with Dual Flash Memory, this lightweight and compact video camcorder realizes reduced noise through Canon’s CMOS sensor and 1,920 x 1,080 Full HD high image quality. The dual memory allows users to enjoy capturing, viewing and saving images with ease. FINANCIAL HIGHLIGHTS Net sales Operating proﬁ t Income before income taxes and minority interests Net income Net income per share: -Basic -Diluted Total assets Millions of yen (except per share amounts) Thousands of U.S. dollars (except per share amounts) 2008 2007 Change (%) 2008 ¥ 4,094,161 ¥ 4,481,346 496,074 756,673 481,147 768,388 309,148 488,332 ¥ 246.21 ¥ 377.59 246.20 377.53 -8.6 -34.4 -37.4 -36.7 -34.8 -34.8 $ 44,990,780 5,451,363 5,287,330 3,397,231 $ 2.71 2.71 ¥ 3,969,934 ¥ 4,512,625 -12.0 $ 43,625,648 Stockholders’ equity ¥ 2,659,792 ¥ 2,922,336 -9.0 $ 29,228,484 Notes: 1. Canon’s consolidated ﬁ nancial statements are prepared in accordance with U.S. generally accepted accounting principles. 2. U.S. dollar amounts are translated from yen at the rate of JPY91=U.S.$1, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2008, solely for the convenience of the reader. Net Sales (Millions of yen) Net Income (Millions of yen) Net Income per Share (Yen) ROE / ROA (%) 5,000,000 500,000 Basic Diluted 400.00 4,000,000 3,000,000 666666 444444 333 , 111 1 1 1 8 888 8 8 444444 , 444 444 111 666666 1 11111 , , 444 444 999 9 9 9 000 0 0 0 ,, 444444 999 9 9 9 5 555 5 5 777777 , 666 666 555555 111 , 444444 111111 999 111111 , 444 444 4 4 333333 555 5 55 555 777 888 77 7 888 333333 777 666666 44444 4 , , , 333333 400,000 444444 444 4 4 4 3 333 3 3 , 333 3 3 3 4 444 4 4 333333 300,000 666666 999 9 9 9 000 0 0 0 , 444 444 4 4 4 8 888 8 8 333333 2222 2 2 3333 3 3 3333 33 , , 888888 555555 888 8 8 8 444 4 4 4 2222 2 2 3333 3 3 , 5555 5 5 555 5 5 5 444444 888 8 8 44 444 4 1 1111 , , , 999 999 000 0 0 0 333 3 3 3 2,000,000 200,000 1,000,000 100,000 300.00 200.00 100.00 0 0 0.00 333 555555 . 888888 555555 222222 5555 5 5 8888 8 8 . 7777 7 7 5555 5 5 222222 333333 66 6666 . 888888 8888 8 8 2222 2 2 666666 3333 33 . 888888 8888 8 8 2222 2 2 999999 555555 . 777777 7777 7 7 3333 3 3 333333 555555 . 777777 7777 7 7 3333 3 3 555555 99 9999 . . 111 4444 4 4 3333 3 3 444444 8888 88 . . 111 4444 4 4 3333 3 3 1111 1 1 2222 2 2 . 6666 6 6 4444 4 4 222222 000000 2222 22 . 666666 4444 4 4 2222 2 2 ROE ROA 16.8 16.0 16.3 16.5 10.6 10.8 10.1 11.1 7.3 20.0 15.0 10.0 5.0 0 04 05 06 07 08 04 05 06 07 08 04 05 06 07 08 04 05 06 07 08 1 TO OUR STOCKHOLDERS Bolstering Management Quality in the Face of Adversity In 2008, the world economy found itself facing an unprecedented crisis triggered primarily by the global recession following the collapse of Lehman Brothers in the United States. In 2009, the economic environment will continue to be extreme- ly harsh. Nevertheless, we view these drastic economic changes as an ideal opportunity to further restructure in order to bolster our overall management strength. In 2009, Canon will make a major change in course from sound growth to improved management quality while preparing to rapidly leap forward when the economic environment recovers. Improved management quality means that Canon will make decisions swiftly as needed so that we can rapidly move to the execution stage and increase the overall strength of the Company, even when market conditions suddenly turn turbulent. In other words, we will achieve real-time management. To that end, we will further strengthen our cash-ﬂ ow management and supply chain management (SCM) as we raise product competitiveness and proﬁ tability. Canon is boldly pushing forward its Excellent Global Corporation Plan with the aim of entering the ranks of the global top 100 companies in terms of key performance indicators. 2 3 Overview of Fiscal 2008 In the ﬁ rst half of 2008, energy and raw material prices skyrocketed, which had a major impact on corporate earn- ings. Moreover, during the severe economic recession that began in September, stock prices dropped precipitously due to the expanding ﬁ nancial crisis. At the same time, heavy yen buying in foreign exchange markets caused the already high yen to sharply appreciate. During 2008, the average ex- change rate of the yen was ¥103.23 against the dollar and ¥151.46 against the euro, appreciating approximately 14% and 7% year on year, respectively. Turning to each region, in the United States a grave situation has been created by the recession triggered by the subprime loan problem, with a sharp decline in new housing starts along with growing unemployment in the auto and ﬁ nancial industries—all leading economic indicators. In Europe, the ﬁ nancial crisis has also affected the real economy, leading to a decline in regional trade, which had been an engine of growth. In Japan as well, the ﬁ nancial crisis sent economic conditions into a rapid tailspin. Exports, a growth driver, plunged and production dropped substantially for most manufacturers. In Asia and emerging countries in other areas, economic growth abruptly declined due to decreased exports. Fiscal 2008 Performance Results As a result of the above-mentioned factors, Canon’s consoli- dated net sales declined 8.6% to ¥4,094.2 billion and net income dropped 36.7% to ¥309.1 billion compared with the previous ﬁ scal year. By product category, sales decreased 9.4% to ¥2,660.0 billion for business machines (includes ofﬁ ce imaging products and computer peripherals) and 9.6% to ¥1,042.0 billion for cameras. However, sales of optical and other products were largely in line with those of the previous ﬁ scal year at ¥392.2 billion. By operating region, in Europe sales fell 10.5% to ¥1,341.4 billion. Sales also decreased in the Americas, declining 13.6% to ¥1,154.6 billion. In Japan sales slipped 8.4% to ¥868.3 billion, and elsewhere in Asia and Oceania sales climbed 4.5% to ¥729.9 billion. Turning to operating expenses, Canon’s selling, general and administrative expenses declined 4.8% year on year to ¥1,067.9 billion. The Company’s R&D expenses increased 1.6% to ¥374.0 billion, or 9.1% of net sales. Even in a major economic downturn, Canon’s aggressive R&D spending was at a higher rate than in the previous ﬁ scal year. The gross proﬁ t ratio declined 2.8 percentage points to 47.3%. Net income per share, basic and diluted, came in at ¥246.21 and ¥246.20, respectively. As for returning proﬁ ts to stockholders, Canon empha- sizes the stable return of free cash ﬂ ow to stockholders, and intends to pay a full-year dividend per share of ¥110, the same amount as in the previous ﬁ scal year. Moreover, Canon purchased a total of ¥100 billion in treasury stock during ﬁ scal 2008. Management Policies for Fiscal 2009 We have deﬁ ned 2009 as the year to prepare for making our next leap forward. We will focus on surmounting the adversity caused by the economic crisis and promote measures and policies to improve the quality of management. First, Canon will thoroughly strengthen its SCM. To remain successful in the midst of major market changes, we must continue to expeditiously launch conpetitive new products. This cannot be achieved with only development and product planning capabilities. We will build a higher level of SCM through IT innovations that consolidate infor- mation on everything from development through sales, as well as through pull production, or the timely manufacture of products to meet the exact level of demand. Canon will promote a two-pronged production strategy of further developing cost-reducing technologies and build- ing a globally optimized production system based on local- ized production. With respect to the development of cost-reducing technologies, the Company will work to expand the scope of automation with the goal of establishing fully automated production systems. In addition to the assembly of toner and inkjet cartridges, We will continue to promote automation, even in the product body assembly process. We are develop- ing intelligent robots that can carry out highly precise and 4 sophisticated actions that will enable them to perform more complex assembly work. Canon promotes the in-house production of parts as a strategy for innovation and increasing proﬁ tability. In-house production leads to the accumulation of technological know- how as well as higher quality and lower costs. In 2008, the Company raised the ratio of in-house production of key parts, such as electrophotographic and optical parts, as well as metal molds. Canon’s globally optimized production system is a new production strategy that comprehensively considers such factors as consumer markets, employment conditions and transportation costs. Canon Virginia, Inc. in the United States has initiated the construction of a new plant in which we will build an integrated system that manufactures, sells, recovers and recycles toner cartridges. In order to launch businesses in a timely manner ahead of the market, it is essential that Canon possess the techno- logical capacity to develop technologies that will serve as seeds for promising future businesses. As a measure to strengthen the R&D system, in 2009 Canon established its Corporate R&D Headquarters. Along with the appointment of Dr. Toshiaki Ikoma as Executive Vice President and Chief Technical Ofﬁ cer, Canon has taken steps to consolidate its R&D Divisions and will fortify upstream technological re- search and speed up the promotion of new domains. As a result, we will achieve greater efﬁ ciency through the selec- tion and concentration of research themes, and investments in R&D will also contribute. In addition, Canon is strengthening and increasing the business autonomy of Group companies while fortifying its global sales system. Toward a Truly Excellent Global Company Finally, in order to become a truly excellent global company that sustains growth and continues to thrive for 100 or even 200 years, it is essential that we develop our management resources. Canon will pass on its DNA—respect for human dignity, an emphasis on technology, and an enterprising spirit—to the next generation of managers and implement practical human resource development training that will also apply to its executive ofﬁ cer system. Canon will also redouble its efforts to contribute to society. The presence of a truly excellent global company must be welcome—even in ﬁ elds outside of its direct business activities. Therefore, we will fulﬁ ll our social responsibilities as a good corporate citizen. One of those responsibilities is that of striking an opti- mal balance between business operations and environmental conservation. While Canon reexamines its business processes and thoroughly eliminates waste that affects the environment, the Company will enhance the environmental performance of its products and continuously innovate in a wide range of ﬁ elds, including materials and design. In addition, as a global company, Canon established the Canon Institute for Global Studies and the Canon Foundation in 2008 with the goal of contributing to the global community. These institutions analyze important issues pertaining to the world’s future, disseminate information, and broadly support groups and individuals involved in academic research, including in science and technology areas, as well as cultural research, business and education in the areas of technology. The economic crisis has had a major impact throughout the world and a great many uncertainties lie ahead. Neverthe- less, guided by the strategies of Phase III of our Excellent Global Corporation Plan, Canon will make a shift back to achieving increased revenue and earnings, speciﬁ cally, net sales of ¥3,700 billion or more and net income of ¥150 billion or more by ﬁ scal 2010, the ﬁ nal year of Phase III. Thereafter in the three-year period to ﬁ scal 2012, the Company will work diligently toward building a corporate structure that is capable of achieving the level of sales and proﬁ ts necessary to surpass its ﬁ scal 2008 performance based on current foreign currency exchange rates. I would like to thank everyone for their continued understanding and support. Chairman and CEO Canon Inc. 5 MESSAGE FROM THE PRESIDENT With speed and quality in mind, we will reorganize the Company into a ﬁ rm structure that completely eliminates inefﬁ ciencies Priority Goals for Fiscal 2009 In 2009, we are charting a major change of course from sound growth to improved management quality as we direct our energies over the year toward preparing for the Compa- ny’s next leap forward. Moreover, we have returned to the original intent of our Excellent Global Corporation Plan to achieve speed and quality with the realization that now is the time to start everything anew. Speciﬁ cally, we will pur- sue the following priority goals. Our ﬁ rst priority goal is the timely launch of highly competitive new products that excel in terms of functional- ity, design, ease-of-use, reliability and cost performance. The essence of competitiveness is innovation, beginning with the enhancement of the Company’s key components. Further- more, we consider “cross-media imaging” to be the guide- line for innovation. Drawing on the Company’s shared digital platforms of color management, wireless and user interface technologies, cross-media imaging enables a high level of collaboration among input and output devices and increases product synergies and added value. Our second priority goal is to lower the cost to sales ratio. We believe that achieving sustainable growth into the future requires the dedication of a considerable volume of resources to R&D and, consequently, the Company must maintain steady cash ﬂ ows. That is our main reason for working to establish optimal SCM. For this purpose, at the end of January 2009, Canon had already completed the introduction of a new, highly effective production information system to 20 produc- tion facilities, following its initial deployment at Oita Canon Inc. in 2003. This system not only centralizes production information for the entire Group, but also links technical information from the development side and information related to demand from sales and marketing. In addition to this system, in the future we will move forward with the establishment of an integrated system for managing product quality information as well as a next- generation logistics system that links information from the marketplace directly to production while handling the ship- ping, storage and transport of allocated products. We are carrying out innovation initiatives, including our pull produc- tion system, which allows us to efﬁ ciently respond to demand ﬂ uctuations. By unifying all the information through IT re- forms, Canon will further improve its management efﬁ ciency. The main advantage realized by centralizing informa- tion through these IT reforms is the ability to make progress in all business processes at the same time. Fully implement- ed, this unparalleled system will enable such results as timing the completion of product design to coincide with the completion of production equipment design, keeping inventories of goods in transit only and entirely eliminating the need for warehouses. The Company is determined to ultimately realize such a system of centralized information. Closely connected with these activities is our third priority goal of carrying out sweeping reforms to further raise quality. Problems with quality can cause considerable damage to a brand image and lead to a loss of public trust. Moreover, lack of quality during product design results in wasted materials and energy. With this in mind, the Com- pany has established new rules covering all product commer- cialization processes. In the event that any problem should arise, we will strictly adhere to the basic quality control principle of diligently facing and working to resolve it. This 6 approach will enable us to improve product quality. Our fourth priority goal is to cultivate the Company’s core businesses of the future. Canon is making steady progress in its development of displays, including organic light-emit- ting diode (OLED) displays and surface-conduction electron- emitter displays (SEDs). Furthermore, along with establishing device and process technologies for displays, we are bolster- ing our research and development efforts for the Company’s medical equipment. Our ﬁ nal priority goal is to strengthen the Group’s environmental management. Solving environmental prob- lems requires a fundamental reexamination of existing tech- nology—that is the wellspring of innovation. This brings new approaches to current technologies, and at the same time, greatly increases the possibility of uncovering a path leading to a paradigm shift in the industry. From this standpoint, Canon will continue working diligently to reduce environ- mental burdens with an eye to developing beneﬁ cial environ- mental technologies and thoroughly eliminating waste. We expect to face many hurdles in 2009 given the extent of the global economic crisis. Undaunted by the challenges ahead, the Group is unified in its commitment to pursuing speed and quality in all of its activities and to further improve its business structure by eliminating any inefficiencies. Tsuneji Uchida President and COO Canon Inc. 7 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III 8 Photo: The large-format imagePROGRAF inkjet printers have been adopted by the School of the Art Insti- tute of Chicago, earning high praise for combining professional-level photographic image quality and outstanding print speed. EXCELLENT GLOBAL CORPORATION PLAN—PHASE III 9 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III Canon will improve management quality in preparation for the next stage of growth In the face of an unprecedented global economic crisis, 2008 was a turbulent year of world economic collapse. Taking these conditions into account, Canon responded decisively and signiﬁ cantly changed the course of its Excellent Global Corporation Plan from sound growth to improved management quality. Having reconsidered our targets for ﬁ scal 2010, we are aiming for net sales of ¥3,700 billion or more and net income of ¥150 billion or more. Over the three years through ﬁ scal 2012, our objective is to establish a business structure that is capable of achieving the level of sales and proﬁ ts necessary to surpass our ﬁ scal 2008 performance based on current foreign currency exchange rates and to attain our original goal of joining the global top 100 companies in terms of key performance indicators. In 2009, Canon will undertake exhaustive efforts aimed at fully realizing SCM that eliminates all inefﬁ cient processes. The year will be a time to continue with steady investment in the devel- opment of high-value-added products while aggressively preparing for the next wave of growth. 10 Excellent Global Corporation Plan In 1996, Canon kicked off its medium- and long-term Excellent Global Corporation Plan, which is divided into a series of ﬁ ve- year terms with distinct strategies and targets under a single overarching vision: “In accordance with the philosophy of kyosei, Canon will continue contributing to society through technological innovation, aiming to be a corporation worthy of admira- tion and respect worldwide.” Phase I—Strengthening Financial Health In Phase I of the Excellent Global Corporation Plan, Canon set out to strengthen its ﬁ nancial health with reforms in all aspects of its business. The Company made all-out efforts to establish the policies of “total optimization” and “focus on proﬁ t” while carrying out the selection and concentration of business areas. Phase II—Becoming No. 1 in Core Businesses Having solidiﬁ ed its ﬁ nancial foundation in Phase I, Canon launched Phase II with the goal of becoming No. 1 globally in all its major areas of business. Placing strong emphasis on product competitiveness, the Company captured the top global market share for many of its core products. Sales and income grew steadily each year. 5 KEY STRATEGIES 1. Achieving the overwhelming No. 1 position worldwide in all current core businesses 2. Expanding business operations through diversiﬁ cation 3. Identifying new business domains and accumulating required technologies 4. Establishing new production systems to sustain international competitiveness 5. Nurturing truly autonomous individuals and promoting effective corporate reforms External Ratings (cid:129) Financial Times Global 500 (March 31, 2008 issue) Market value ranking: 110 (9th in the Technology Hardware & Equipment Category) (cid:129) FORTUNE Global 500 (July 21, 2008 issue) Revenues ranking: 189 (5th in the Computers, Ofﬁ ce Equipment category) Proﬁ ts ranking: 126 (5th in the Computers, Ofﬁ ce Equipment category) (cid:129) BusinessWeek “Best Global Brands” of 2008 (September 29, 2008 issue) Ranking: 36 (4th among all Japanese companies) FORTUNE Global 500 is a registered trademark of FORTUNE Magazine, a division of Time Inc. in the United States of America. 11 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III 1. Achieving the overwhelming No. 1 position worldwide in all current core businesses leveraging its Multifunction Embedded Application Platform (MEAP), which allows the customization of networked multifunctional devices (MFDs). In 2008, we surpassed the 100,000 mark for cumulative MEAP application licenses. Aiming to press ahead in 2009, the Company has further stepped up the development of its next-generation platforms for multifunction products with greatly enhanced systems and operability. In exposure equipment for LCDs, Canon maintained its No. 1 position in 2008, enhancing its sales of the MPAsp- H700 LCD exposure system for eighth- generation panels. Looking ahead, an important element for achieving the overwhelm- ing No. 1 position in the market is cross-media imaging, a concept that realizes high-level synergies among Canon’s input and output products as a means to meet the needs of our information society. EF lenses for EOS cameras enjoy wholehearted popularity as the telephoto lenses of choice for sports media on site at international soccer matches and other sporting events around the world. facility in Kawasaki, Japan, to develop and produce in-house semiconductor devices, including Complementary Metal Oxide Semiconductor (CMOS) sensors, which are key components of digital cameras. Also in cameras, Canon strength- ened its lineups and released digital single lens reﬂ ex (SLR) cameras for advanced amateurs. In addition, the Company worked to improve the perfor- mance and processing power of its DigitalImagingIC (DIGIC) imaging pro- cessors, another key component of digital cameras. In ofﬁ ce imaging products, Canon is Despite severe conditions in the global economy, in 2008 Canon held its No. 1 position for core products, including digital cameras, laser beam printers (LBPs), exposure equipment for LCDs and broadcasting lenses. To maintain the top position, the Company will work to differentiate its product technologies and release new prod- ucts to the marketplace with oppor- tune timing. Canon is strengthening the in- house development of its key compo- nents as a means to differentiate and accumulate its technologies, increase product quality and reduce costs. In 2008, the Company completed a new 12 strengthening its solutions business by In-house production of CMOS sensors 2. Expanding business operations through diversiﬁ cation Canon is accelerating the development of OLED displays for incorporation into its products. Canon pursues business diversiﬁ cation to ensure future business growth. We are currently placing priority on building up the display business, which is a key of cross- media imaging. In 2008, we acquired a capital stake in Hitachi Displays, Ltd., and strengthened operations centered on OLED displays and small- to medium-size LCDs. While focusing on efforts to further enhance the basic properties of the Com- pany’s unique SEDs, we are placing addi- tional weight on the establishment of technologies for mass production. Canon is also bolstering its digital radiography business with the develop- ment of digital radiography systems capable of viewing dynamic images and capturing static X-ray images, which will greatly improve diagnostic accuracy. Strengthening its position in the print-on-demand (POD) market, which it entered in 2007, Canon released several new products in the imagePRESS lineup in 2008. We will continue to enhance our POD lineups to consolidate our position in this market. Canon is also promoting the Group’s expansion of independent businesses. In 2008, Canon Finetech Inc., which devel- ops and manufactures ofﬁ ce MFDs and their peripherals, increased its equity in Nisca Corporation, a Japanese developer and manufacturer of peripheral devices for ofﬁ ce machines, with the aim of enabling the further expansion of the ofﬁ ce machine and peripheral business as well as accelerating the development of differentiated products. To this end, Nisca was included in Canon’s scope of consoli- dation as a wholly owned subsidiary. As a part of its business diversiﬁ ca- tion efforts, Canon U.S.A., Inc. is en- deavoring to commercialize molecular diagnostic equipment for the U.S. market, where gene diagnosis is a highly ad- vanced and rapidly growing ﬁ eld, through the application of its imaging and high- precision processing technologies. Canon has been focusing on its solu- tions business to provide optimal solutions to networked printing environments in ofﬁ ces. In particular, we are putting em- phasis on the area of security, applying our original MEAP to meet the characteristics of each region. In 2008, we acquired NEWCAL Industries, a California-based reseller of document and print solutions, to expand our solution business in the United States. In addition, Canon Marketing Japan Inc. established Canon IT Solutions Inc. with an eye to cultivating IT solutions as a core business. The popular digital color press imagePRESS contributes to greater printing efﬁ ciency in the POD market. The image in the print sample was designed by Europe Quality & Style Inc. N.Y. 13 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III 3. Identifying new business domains and accumulating required technologies Canon and Japan’s Kyoto University have teamed up to promote R&D of high sensitivity magnetic sensors. Canon pursues next-generation business domains with due consideration given to such factors as strong prospects for market growth, technological innovation potential, consistency with the Compa- ny’s core capabilities and the likelihood of the business positively impacting the Company’s prospects for sound growth. We have identiﬁ ed medical imaging as an important new business domain. As a key initiative, we have launched the Canon-Kyoto University Joint Research Project together with Kyoto University in Japan. With a commitment to developing next-generation diagnostic instruments capable of detecting disease at the earliest stages, the Company is applying its sensing and imaging technologies to research covering a broad range of areas, including new technologies and clinical applications, while continuing to carry out collaborative research. Industrial robotics is another next- generation business domain for Canon. The Company has already used robots to assemble toner and inkjet cartridges and is now working on developing intelligent robots that can carry out an even higher level of precise and sophisticated actions. 14 In other promising ﬁ elds, Canon is promoting R&D activities in such leading-edge technologies as nanotech- nology and biotechnology. Collaborative research into semiconductor devices for medical imaging with Stanford University 4. Establishing new production systems to sustain international competitiveness Canon is aggressively accumulating valuable technologies toward the estab- lishment of fully automated production systems that consistently realize high quality and improved productivity. In 2008, Canon improved the precision and efﬁ ciency of its automated toner cartridge production with the installation of new machinery at Oita Canon Materials Inc. The machinery is based on a concept of Canon automated production wherein the entire production process is optimized through the integration of development, manufacturing and engineering technologies. To decrease the environmental burden associated with transportation and to ﬂ exibly meet changes in global demand, Canon has begun a shift to localized production. In the United States, we are carrying out plans for large-scale expansion at Canon Virginia. The expansion will include a new toner cartridge manufacturing plant that will introduce high-speed automat- ed production systems, while also making feasible the efﬁ cient transport of Canon products. Canon is also taking further steps toward automated production by introducing automated machinery into sections of the assembly of inkjet print- ers and LBPs. Development of automation technology to ensure a fully automated production system 5. Nurturing truly autonomous individuals and promoting effective corporate reforms For Canon to become a company that ﬂ ourishes far into the future, it is vital that the Company’s corporate culture is passed down to new generations of employees. Therefore, we further strengthen the cultivation of manage- ment and general employees to pass on Canon’s accumulated corporate DNA— respect for human dignity, an emphasis on technology, and an enterprising spirit. Speciﬁ cally, Canon carries out various kinds of management training for managers and communicates the Canon corporate DNA. The Company’s executive ofﬁ cer system, introduced in 2008, provides opportunities for management to directly put their ideas into practice. In addition to corporate culture, we recognize the necessity of passing down competency in and knowledge of the Company’s highly advanced technolo- gies to future employees. From 2009, Canon will commence activities at Oita Manufacturing Training Center, Japan. Equipped with various manufacturing equipment, the center aims to nurture, through technical skills training, new generations of employees that will lead the manufacturing industry worldwide in the future. To realize our vision of being “a corporation worthy of admiration and respect worldwide,” we recognize that compliance must be thorough and rooted in all Group activities. With this in mind, we work continuously to strength- en compliance activities across the Group. Oita Manufacturing Training Center strengthens the technical skills of Canon Group employees. 15 CORPORATE GOVERNANCE Positioning itself for the future, Canon is bolstering corporate governance commensurate with business growth. Governance Structure (as of December 31, 2008) Canon Inc. General Meeting of Stockholders Board of Directors Chairman & CEO President & COO Executive Vice President & CFO Subsidiaries & Subsidiaries & Affiliates Affiliates Executive Committee Corporate Audit Center Headquarters Administrative Divisions Product Group Operations Board of Corporate Auditors Management Strategy Committee New Business Development Committee R&D Strategy Committee Corporate Ethics and Compliance Committee Marketing Subsidiaries & Affiliates Internal Control Committee Manufacturing Subsidiaries & Affiliates R&D Subsidiaries & Affiliates Disclosure Committee Global Legal Affairs Coordination Committee Directors & Corporate Auditors (as of December 31, 2008) Chairman & CEO Fujio Mitarai President & COO Tsuneji Uchida Executive Vice President & CFO Toshizo Tanaka Group Executive, Policy & Economy Research Headquarters Senior Managing Directors Nobuyoshi Tanaka Group Executive, Corporate Intellectual Property & Legal Headquarters Junji Ichikawa Chief Executive, Optical Products Operations Akiyoshi Moroe Group Executive, External Relations Headquarters Group Executive, General Affairs Headquarters Kunio Watanabe Group Executive, Corporate Planning Development Headquarters Deputy Group Executive, Policy & Economy Research Headquarters Managing Directors Yoroku Adachi President & CEO, Canon U.S.A., Inc. Yasuo Mitsuhashi Chief Executive, Peripheral Products Operations Tomonori Iwashita Group Executive, Environment Headquarters Group Executive, Quality Management Headquarters Masahiro Osawa Group Executive, Finance & Accounting Headquarters Shigeyuki Matsumoto Group Executive, Device Technology Development Headquarters Deputy Group Executive, Core Technology Development Headquarters Katsuichi Shimizu Chief Executive, Inkjet Products Operations Ryoichi Bamba President, Canon Europa N.V. President & CEO, Canon Europe Ltd. Toshio Homma Chief Executive, L Printer Products Operations Masaki Nakaoka Chief Executive, Ofﬁ ce Imaging Products Operations Haruhisa Honda Group Executive, Production Engineering Headquarters Directors Shunichi Uzawa Executive Vice President, Canon U.S.A., Inc. Toshiyuki Komatsu Deputy Group Executive, Corporate Planning Development Headquarters Tetsuro Tahara Group Executive, Global Manufacturing & Logistics Headquarters Seijiro Sekine Group Executive, Information & Communication Systems Headquarters Shunji Onda Group Executive, Global Procurement Headquarters Kazunori Fukuma President & CEO, SED Inc. Hideki Ozawa President & CEO, Canon (China) Co., Ltd. Masaya Maeda Chief Executive, Image Communication Products Operations Corporate Auditors Keijiro Yamazaki Kunihiro Nagata (Outside) Tadashi Ohe Yoshinobu Shimizu Minoru Shishikura 16 Basic Policy and Corporate Governance Structure Canon recognizes that strengthening management supervision functions and maintaining management transparency are vital to improving its corporate governance structure and raising corporate value. Canon’s basic governance structure comprises the General Meeting of Stockholders, the Board of Directors and the Board of Corporate Auditors. Furthermore, the Executive Committee and management committees are dedicated to addressing key issues. All of these bodies work together to ensure the appropriate man- agement of the Group through an independent internal auditing structure centered on the Corporate Audit Center and an informa- tion disclosure system for management activities. Board of Directors Important business matters are discussed and ratiﬁ ed during meetings of the Board of Directors and Executive Committee, which are attended, in principle, by all directors. As of December 31, 2008, the Board consisted of 25 directors. In order to realize a more streamlined and efﬁ cient management decision-making process, Canon has not adopted an outside director system. The main reason why directors are chosen from among Canon person- nel is that they have followed the same codes of behavior and have been subject to close scrutiny within the Group over many years. Executive Ofﬁ cer System On April 1, 2008, Canon adopted an executive ofﬁ cer system. Taking into consideration the growth in the scope of its scale of operations, Canon recognizes the need to bolster its management execution structure. The Company is endeavoring to realize more ﬂ exible and efﬁ cient management operations by maintaining an appropriately sized organization of directors and promoting capable human resources with accumulated execu- tive knowledge across speciﬁ c business areas. To this end, Canon will gradually increase the number of executive ofﬁ cers and further solidify its management systems. Executive ofﬁ cers are appointed and discharged by the Board of Directors and have a term of ofﬁ ce of one year. The number of executive ofﬁ cers was 10 as of April, 2009. Auditing System The Company has ﬁ ve corporate auditors, including three outside auditors who have no personal or business afﬁ liations with Canon. Auditors’ duties include attending meetings of the Board of Direc- tors, Executive Committee and various management committees, listening to business reports from directors, carefully examining Compliance training via e-learning is conducted for employees at Canon U.S.A. documents related to important decisions and conducting strict audits of the Group’s business and assets. Corporate auditors also work closely with accounting auditors and the Corporate Audit Center, which, with 58 members as of December 31, 2008, monitors compliance, risk management and internal control systems and provides assessments and recommendations. Internal Control Committee The Internal Control Committee, established in 2004, ensures the reliability of ﬁ nancial reporting. It also conducts reviews of the Group’s internal controls in order to gauge the true efﬁ ciency of business operations, supports compliance with all related laws and internal regulations and implements sound internal controls. In response to the Sarbanes-Oxley Act, including Section 404 that came into force during 2006, Canon continues to reinforce inter- nal control systems and implement all appropriate measures. In order to strengthen internal controls, Canon conducts comprehensive evaluations of internal controls across areas that include accounting, management oversight, legal compliance, IT systems and the promotion of corporate ethics. As of December 31, 2008, internal control over ﬁ nancial reporting has been as- sessed as effective by the management and the independent registered public accounting ﬁ rm. (Please refer to pages 95 and 97) Other Corporate Governance Committees Canon’s management committees are integral to its overall governance system. Key among these are the Corporate Ethics and Compliance Committee, which discusses and approves compliance and corporate ethics policies, and the Global Legal Affairs Coordination Committee, which analyzes trends in legal developments and works to raise the level of employee awareness regarding important legal issues facing the Group. 17 CORPORATE GOVERNANCE Compliance Shortly after its founding, Canon established the San-Ji, or “Three Selfs” spirit, namely “self-motivation,” or taking the initiative and being proactive in all things; “self-management,” or conducting oneself responsibly and being accountable for all one’s actions; and “self-awareness,” or understanding one’s situation and role in it. These principles remain the basis for em- ployee education and provide the platform for the Canon Group Code of Conduct. Canon recognizes personal information as an important form of information asset and does its utmost to protect it in order to fulﬁ ll its social responsibilities. With the aim of keeping its employees informed and aware, the Company conducts e- learning-based personal information protection education programs on an annual basis. Disclosure Canon makes every effort to disclose information on its man- agement and business strategies as well as its performance results to all stakeholders in an accurate, fair and timely man- ner. To this end, Canon holds regular brieﬁ ngs and posts the latest information on its Website together with a broad range of disclosure materials. Canon has established its own Disclo- sure Guidelines in addition to a Disclosure Committee that serves to ensure strict compliance with disclosure regulations prescribed by stock exchanges. With 44.2% of Canon’s shares owned by non-Japanese investors as of December 31, 2008, the Group goes to great lengths to promote close relations with non-Japanese institu- tional investors, maintaining investor relations bases in Europe and the United States and working to ensure that investors inside and outside Japan have access to the same information. Canon will continue to promote transparency and understand- ing of its activities by practicing thoroughgoing disclosure. 18 Signiﬁ cant Differences in Corporate Governance Prac- tices between Canon and U.S. Companies Listed on the NYSE Section 303A of the New York Stock Exchange (the “NYSE”) Listed Company Manual (the “Manual”) provides that compa- nies listed on the NYSE must comply with certain corporate governance standards. However, foreign private issuers whose shares have been listed on the NYSE, such as Canon Inc. (the “Company”), are permitted, with certain exceptions, to follow the laws and practice of their home country in place of the corporate governance practices stipulated under the Manual. In such circumstances, the foreign private issuer is required to disclose the signiﬁ cant differences between the corporate governance practices under Section 303A of the Manual and those required in Japan. A summary of these differences as they apply to the Company is provided below. 1. Directors Currently, the Company’s board of directors does not have any director who could be regarded as an “independent director” under the NYSE Corporate Governance Rules for U.S. listed companies. Unlike the NYSE Corporate Governance Rules, the Corporation Law of Japan (the “Corporation Law”) does not require Japanese companies with a board of corporate auditors such as the Company, to appoint independent directors as members of the board of directors. The NYSE Corporate Governance Rules require non-management directors of U.S. listed companies to meet at regularly scheduled executive sessions without the presence of management. Unlike the NYSE Corporate Governance Rules, however, the Corporation Law does not require companies to implement an internal corporate organ or committee comprised solely of independent directors. Thus, the Company’s board of directors currently does not include any non-management directors. 2. Committees Under the Corporation Law, the Company may choose to: (i) have an audit committee, nomination committee and compensation committee and abolish the post of corporate auditors; or (ii) have a board of corporate auditors. The Company has elected to have a board of corporate auditors, whose duties include monitoring and reviewing the manage- ment and reporting the results of these activities to the share- holders or board of directors of the Company. While the NYSE Corporate Governance Rules provide that U.S. listed companies must have an audit committee, nominating committee and compensation committee, each composed entirely of indepen- dent directors, the Corporation Law does not require companies to have speciﬁ ed committees, including those that are respon- sible for director nomination, corporate governance and execu- tive compensation. The Company’s board of directors nominates candidates for directorship and submits a proposal at the general meet- ing of shareholders for shareholder approval. Pursuant to the Corporation Law, the shareholders then vote to elect directors at the meeting. The Corporation Law requires that the total amount or calculation method of compensation for directors and corporate auditors be determined by a resolution of the general meeting of shareholders respectively, unless the amount or calculation method is provided under the Articles of Incorporation. As the Articles of Incorporation of the Company do not provide an amount or calculation method, the amount of compensation for the directors and corporate auditors of the Company is determined by a resolution of the general meeting of shareholders. The allotment of compensation for each director from the total amount of compensation is determined by the Company’s board of directors, and the allotment of compensation to each corporate auditor is determined by consultation among the Company’s corporate auditors. 3. Audit Committee The Company plans to avail itself of paragraph (c)(3) of Rule 10A-3 of the Security Exchange Act, which provides that a foreign private issuer which has established a board of corpo- rate auditors shall be exempt from the audit committee require- ments, subject to certain requirements which continue to be applicable under Rule 10A-3. Pursuant to the requirements of the Corporation Law, the shareholders elect the corporate auditors by resolution of a general meeting of shareholders. The Company currently has ﬁ ve corporate auditors, although the minimum number of corporate auditors required pursuant to the Corporation Law is three. Unlike the NYSE Corporate Governance Rules, Japanese laws and regulations, including the Corporation Law, do not require corporate auditors to be experts in accounting or to have any other area of expertise. Under the Corporation Law, a board of corporate auditors may determine the auditing policies and methods for investigating the business and assets of a Company, and may resolve other matters concerning the execution of the corporate auditor’s duties. The board of corpo- rate auditors prepares auditors’ reports and may veto a proposal for the nomination of corporate auditors and accounting auditors put forward by the board of directors. Under the Corporation Law, more than half of a company’s corporate auditors must be “outside” corporate auditors. These are individuals who are prohibited to have ever been a director, executive ofﬁ cer, manager, or employee of the Com- pany or its subsidiaries. The Company’s current corporate auditor system meets these requirements. Among the ﬁ ve members on the Company’s board of auditors, three are outside corporate auditors. The qualiﬁ cations for an “outside” corporate auditor under the Corporation Law are different from the audit committee independence requirement under the NYSE Corporate Governance Rules. 4. Shareholder Approval of Equity Compensation Plans The NYSE Corporate Governance Rules require that sharehold- ers be given the opportunity to vote on all equity compensation plans and any material revisions of such plans, with certain limited exceptions. Under the Corporation Law, a Company is required to obtain shareholder approval regarding the details of an equity-compensation plan. Stock acquisition rights to be issued to directors and corporate auditors are recognized as part of remuneration of directors and corporate auditors, and the issuance of stock acquisition rights must be approved by shareholders as part of their approval regarding remuneration of directors and corporate auditors. 19 CORPORATE FUNCTIONS 20 Photo: A Canon Hope elementary school, located in Xinglong, Hebei Province, northeast of Beijing, completed in November 2008. Canon supported the construction of schools including this school in China in 2008. RESEARCH & DEVELOPMENT ................... 22 PRODUCTION ............................................ 24 SALES & MARKETING ............................... 26 CORPORATE SOCIAL RESPONSIBILITY .... 28 21 RESEARCH & DEVELOPMENT Canon nurtures its technological strengths to ensure its future growth while developing and introducing new products to markets in a timely manner. Bolstering Product Competitiveness Canon continuously strengthens the development of its key components and devices to differentiate its products and further strengthen product com- petitiveness. In 2008, Canon released the DIGIC 4 imaging processor, which boasts even faster pro- cessing power for digital cameras and improved noise reduction. Another highlight of the year was the Company’s development of Liquid Crystal on Silicon (LCOS) reﬂ ective LCD panels, ideal for LCD projectors, which project high-resolution images free of lattice-like grid patterns. Canon has developed in-house all of the main parts for its LCD projectors. Canon is promoting cross-media imaging that enables advanced synergies among input devices like cameras or camcorders and output devices like dis- plays or printers. The achievement of such outstanding product collaboration is attributable to Canon’s long experience in developing leading-edge digital platform technologies shared across the Company, such as the high-accuracy color management system Kyuanos, system integration and telecommunication technolo- gies. Canon will continue to enhance these digital platform technologies as well as individual products to lead the digital imaging world. Raising Development Efﬁ ciency To speed up product development and reduce costs, Canon is constantly working to improve the efﬁ ciency DIGIC 4 imaging processor offers exceptionally fast signal processing for Canon’s digital cameras. Canon utilizes 3D-CAD for the development of ofﬁ ce network MFDs. * Source: U.S. Patent and Trademark Ofﬁ ce; Calculated based upon publicly disclosed weekly totals. 22 R&D Expenditure and Patents Despite harsh market conditions in 2008, Canon contin- ued to allocate a signiﬁ cant percentage of net sales to R&D. R&D expenditure amounted to ¥374.0 billion, and the ratio to net sales rose from 8.2% in ﬁ scal 2007 to 9.1% in ﬁ scal 2008. By business segment, ¥123.5 billion, or 33.0% of the total expenditure, was allocated to Business Machines; ¥45.5 billion, or 12.2%, to Cameras; ¥50.8 billion, or 13.6%, to Optical and Other Products; and ¥154.2 billion, or 41.2%, to basic R&D. Canon’s commitment to R&D has also contrib- uted to its leading position in intellectual property. In 2008, Canon was granted 2,114* patents in the United States, marking the 17th consecutive year it has placed among the top three. Cognizant that R&D is crucial to the next stage of growth, Canon will continue to place high priority on R&D expenditure. Strengthening Our R&D Infrastructure In January 2009, Canon improved its R&D manage- ment system by consolidating several research divisions into one headquarters to enhance efﬁ ciency and speed. We are also strengthening cooperation between product operations and R&D divisions while bolstering strategic investments and collaborative partnerships in an effort to further enhance technology development capabilities. of its development processes. In 2008, we contin- ued to promote our integrated IT systems based on a uniﬁ ed 3D-CAD system that facilitates the sharing of design information and links design through production to strengthen concurrent processes. The Company also started new initiatives to reduce failure costs that stem from design changes and to completely eliminate the need for proto- types. We will pursue innovations of our current virtual prototyping technologies, which include Digital Mockup and Computer-Aided Engineering. Efforts to improve product development quality were boosted by the 2008 completion of the Canon is actively advancing R&D on materials technolo- gies, including anti-reﬂ ection coatings for lenses. state-of-the-art Tamagawa measurement and testing facility, which can test for industry accreditation speciﬁ - cations such as noise and radio frequencies and ﬂ ame retardance. Located in Kawasaki, Japan, the laboratory will upgrade the Group’s measurement precision capabilities and compliance with public standards. Exploring Next-Generation Technologies Canon is strengthening its basic research in do- mains that offer considerable future potential. For materials technology in particular, the Company has been pursuing extensive research on numerous materials, including nanomaterials and various semiconductor materials, for the development of new devices and components. Canon will promote research into its capabilities in these areas and develop technologies that trigger paradigm shifts. To keep pace with global technology trends, Canon collaborates in advanced research with leading universities and institutes worldwide. In 2008, Canon announced plans for collaborative research with the University of Arizona’s College of Optical Sciences focusing on a broad range of technologies, including optical materials and measurement and medical-related applications. Measuring electro- magnetic waves emitted by printers: the Tamagawa measurement and testing facility contributes to enhancing the efﬁ ciency of testing operations and raising the level of precision measure- ment technology. 23 PRODUCTION Canon is raising the efﬁ ciency and quality of its production system to thoroughly improve supply chain management. Cell production of interchangeable lenses for SLR cameras at Oita Canon, Japan 24 Improving the Production System Based on Supply Chain Management Canon has been working to improve its SCM through various reform activities to meet market demands, supply products to the market in a timely manner and eliminate inefﬁ cient operations. We have developed a Uniﬁ ed Production Information System to standardize these reform activities and establish them throughout the Group. Initially intro- duced in 2003, the system has been implemented at 20 Group production sites as of January 31, 2009. The system integrates all production infor- mation and immediately links to information on design changes and ﬂ uctuations in market trends. Owing to dramatic economic shifts, the Com- pany was compelled to implement major reforms to its production strategies. We worked to increase the accuracy of our SCM to precisely respond to market demands while reducing stocks. We continue to adjust production volume through our ﬂ exible production At Canon’s new Kawasaki Ofﬁ ce, CMOS sensor production and automated technology development are conducted. system based on cell production and just-in-time production while endeavoring to reduce material costs through the optimum procurement of materials. Furthermore, Canon is now revamping its logistics network for global production and distribution. In another move, the Company began to implement a policy of localized production. To address such factors as the rising costs for transpor- tation and the reduction of environmental burdens related to transportation, the Company will carry out manufacturing at locations that can ensure the highest quality. These initiatives are initially being realized with the new establishment of a toner cartridge plant at Canon Virginia. Canon’s operations in the United States will come of age, encompassing all processes from production to sales, collection and recycling. Looking forward, Canon is considering the imple- mentation of localized production in Europe with an eye to optimizing production capacity in line with global market demands. Promoting In-House Production Canon pursues in-house production as a strategy for accumulating its technology and know-how, thereby enabling the Company to differentiate its products and raise product quality. In 2008, the Company promoted the in-house production of electrophotographic and optical key parts, as well as metal molds. The Company also established a new facility for the development and in-house production of semiconductor devices, including CMOS sensors, at the Kawasaki Ofﬁ ce in Kanagawa, Japan. Canon Workforce Development Center in Virginia. Canon collaborates with a local college to conduct technical training. Cell production for inkjet printers at Canon Vietnam Co., Ltd. In 2008, the new Tien-Son plant started operation. In February 2008, Canon entered into a compre- hensive alliance with Hitachi, Ltd., and Panasonic Corporation (then Matsushita Electric Industrial Co., Ltd.). The Company acquired a 24.9% stake in Hitachi Displays, a Hitachi subsidiary that manufac- tures small- and medium-sized LCD panels. With this acquisition, we are able to undertake the in- house production of LCD panels as key compo- nents for Canon products. Full Automation to Maintain International Competitiveness Canon pursues fully automated production as a means of boosting productivity. In 2008, new automation systems developed for toner cartridge production by Canon and Canon Machinery Inc. were installed and put into operation. Canon will start automated production of toner cartridges in Canon Virginia at the end of 2009. Canon is working toward expanding the scope of automation to other products. We have already started automated production for inkjet cartridges and expanded its operations in 2008. As a further step in this direction, the Company began introduc- ing automated machinery to certain sections of its assembly cells for inkjet printers and LBPs in 2008. In addition, to handle brisk demand for automated machinery, Canon Machinery built a plant in Shiga, Japan, in 2008, and expanded production with the aims of increasing productivity and reducing costs. 25 SALES & MARKETING Canon continues to bolster its sales and marketing activities in emerging economies as it works toward early market dominance. targeting a wide variety of markets, enhance sales activities that highlight Canon’s strengths in total imaging solutions that employ both input and output products. Europe In January 2009, Canon Europa N.V., in the Nether- lands, the operational headquarters for the Europe, Middle East and Africa region, began the process of transferring a number of strategic roles to Canon Europe Ltd. in the United Kingdom. Sales in Europe fell 10.5% year on year to ¥1,341.4 billion, representing 32.8% of Canon’s consolidated net sales. Economic conditions in Europe rapidly deceler- ated as a result of such factors as ﬁ nancial instabil- ity triggered by the subprime loan crisis and stag- nant consumer spending in response to rising prices. By region, year-on-year sales were down in most countries of Western Europe, including the United Kingdom, Germany and France. In Russia, although sales were strong in the ﬁ rst half of the ﬁ scal year, declining sales particularly in the fourth quarter resulted in an overall drop in sales year on year. On the other hand, sales in the Middle East increased compared with the previous ﬁ scal year. In 2008, we established Canon Eurasia A.S. in Turkey to access the Turkish and Israeli markets and began setting up a new locally based management organization in Russia to support business Canon U.S.A. is augmenting its marketing network by further bolstering its direct sales capabilities. Canon Communica- tion Space Shanghai was established to show the latest products and pro- mote face-to-face communication with customers in China. 26 The Americas Canon U.S.A., Inc. is the Company’s regional market- ing headquarters in North, Central and South America. As a whole, sales in the Americas amounted to ¥1,154.6 billion in ﬁ scal 2008, down 13.6% from the previous year. This represented 28.2% of Canon’s consolidated net sales. By region, North America was hit hard by the ﬁ nancial crisis, resulting in a decrease in sales compared with the previous ﬁ scal year. In Latin America, however, although the effects of the economic recession were felt from autumn, full- year sales were up year on year. In the United States, we consolidated three regional business solutions companies into the new Canon Business Solutions, Inc. and continued to bolster our direct sales and service network. In the POD market, we more than doubled sales of the imagePRESS C6000 and C7000VP series. In Latin America, sales rose and Canon continued to reinforce its sales and marketing infrastructure to keep pace with regional growth, particularly for sales and marketing subsidiaries in Argentina, Brazil and Chile, while taking into account currency ﬂ uctuations and risk management in each country. Looking forward, we will intensify sales promotions that cut across Company divisions and, development through improved customer service and the provision of business and consumer sup- port. In addition, we intend to boost investment in other emerging markets in the region, including the Ukraine and Kazakhstan. Asia and Oceania Canon (China) Co., Ltd. serves as the regional head- quarters for sales and marketing functions in Asia, excluding Japan and Korea; Canon Australia Pty. Ltd. for Oceania; and Canon Marketing Japan Inc. for Japan. In Japan, sales dropped 8.4% from the previous ﬁ scal year to ¥868.3 billion, representing 21.2% of Canon’s consolidated net sales. EOS Discovery seminars help spread the joy of photography among amateur enthusiasts and semi-pro photographers. Aiming to develop IT solutions into a core business, Canon Marketing Japan reorganized Group operations and established Canon IT Solu- tions Inc., which will be merged with Canon Net- work Communications Inc. in 2009. In Asia and Oceania, sales climbed 4.5% year on year to ¥729.9 billion, accounting for 17.8% of consolidated net sales. Canon continued to step up sales promotions in countries and regions recording strong growth, such as China, India and Vietnam. At the same time, we emphasized the value of customer contact points and set up new showrooms in cities such as Shanghai and Mumbai. Throughout Asia, we will continue to expand contact points to improve after-sale service and call centers in 2009. We will also implement sales and marketing initiatives into the new business areas of large-format printers, projectors and medical equipment. In China, we will focus on expanding business in second-tier cities and cultivating new customer segments. In Australia, Canon maintained strong market shares across all consumer product categories while strengthening its business solutions. Over 500 Canon imageRUNNERs have been installed in Fraport AG, the operator of Frankfurt Airport in Germany. 27 CORPORATE SOCIAL RESPONSIBILITY Canon continues to contribute to the realization of a sustainable society by applying technological innovations and reducing environmental burdens. Environmentally Conscious Products Canon continuously searches for new ways to enhance its products to be more environmentally conscious. In 2008, Canon and Toray Industries, Inc., succeeded in jointly developing a bio-based plastic—composed of more than 25% plant- derived material—that achieves the world’s highest level of ﬂ ame retardance for bio-based plastics. Canon intends to use the bio-based plastic in exterior plastic parts for its ofﬁ ce MFDs planned for release in 2009. Canon develops and applies energy-efﬁ cient technologies that reduce power consumption for its products while designing products and their packaging to cut down on the amount of material used. For example, power consumption for the inkjet printer PIXMA MP630/MP638 was reduced 30% compared with the previous MP610 model. Furthermore, package volume for the MP630/ MP638 was reduced 24% compared with the MP610, thereby increasing load efﬁ ciency per shipping container. For the PowerShot E1 compact digital camera, compared with the earlier PowerShot A560 model, we reduced the volume of the packaging box by 48% and the number of pages in the manual by 57% by including an additional manual in electronic format. Canon promotes modal shifts to reduce CO2 emissions related to product transportation. Canon U.S.A. held the Canon Forest Program, a nation- wide promotional campaign that plants a tree for every 10 Canon environmen- tally conscious products registered by customers. The campaign achieved its goal of 20,000 trees. i Canon’s Basic Approach to CSR Canon’s corporate philosophy is kyosei, concisely deﬁ ned as “Living and working together for the common good.” The Company promotes the practice of kyosei in its daily working operations and through its numerous environmental conserva- tion and social contribution activities all over the world. Aiming to become a truly excellent global corporation worthy of admiration and respect worldwide, we are working toward creating a sustainable society and environment with our customers, stockholders, employees and the local communities in which we operate. Environmental Activities Life Cycle Assessment Approach Canon’s environmental approach begins from the basic standpoint of life cycle assessment (LCA), a method for reducing environmental burdens through- out the entire product life cycle, from materials pro- curement through production, transport and usage to recycling. Even at the product design stage, we cut waste by reducing the number of material prototypes using digital mockups produced with 3D-CAD systems. By pursuing technological innovations and streamlin- ing operations, Canon aims to reduce environmental burdens at every stage of the product life cycle. 28 Environmental Activities at Operational Sites Canon practices thorough energy management at its operational bases, where it has introduced advanced energy-efficient equipment and de- vices and makes every effort to cut greenhouse gas emissions. Furthermore, the Company pro- motes the reduction or elimination of harmful chemical substances used in its production processes and is achieving significant reductions in the amount of resources used in these pro- duction processes. Canon has already achieved zero landfill waste at all of its global manufacturing sites. This goal was achieved in 2005 after the Com- pany launched a zero landfill waste campaign in 2001. Contributing to Society The following are a few examples of our longstand- ing commitment to fulﬁ lling our corporate social responsibility to assume a leading role as a good corporate citizen. The Canon Institute for Global Studies and the Canon Foundation At the end of 2008, we established both the Canon Institute for Global Studies and the Canon Foundation in Tokyo with the aim of contributing to the world’s development. The former will assess world trends from a global perspective as a political and economic think tank, publishing research in the areas of macro- economics, natural science, energy and the environ- ment, and diplomacy and defense. The Canon Foundation will support the activities of organizations and individuals engaged in research, business and education in the areas of science and technology as well as cultural pursuits. Canon Leadership Scholars Program In its commitment to developing the business leaders of tomorrow, Canon and Christopher Newport University located in Virginia, the United States, where Canon has a manufacturing company, created the Canon Leadership Scholars Program. Each year begin- ning in 2008, 25 students are awarded a scholarship of $5,000 over four years for a total of $20,000, and are offered opportunities to study abroad. Canon strives to reduce numerous environmental burdens at its operational sites through such meas- ures as this rooftop rainwater reuse system installed at Canon Belgium N.V./ S.A. that ﬁ lters rainwater through gravel on the roof. 29 Canon Hope Elementary Schools Canon places a priority on providing educational opportunities to nurture future generations. In Dalian, China, the Company began supporting “The Project Hope” in 1995, a program organized by the China Youth Development Foundation for supporting children who have difﬁ culty attending school. Since then, Canon has funded the construc- tion of schools and every year donates school supplies and equipment such as liquid-crystal projectors. In 2007, we extended the scope of support activities to cover the entire country while contributing to four more schools in 2008 and 2009. Canon employees donate to the project, and the Company has actively promoted exchanges with the schools, sending employee volunteers to give lessons on digital cameras. t The Tsuzuri Project Canon launched the Tsuzuri Project with Kyoto Culture Association (NPO) in 2007 with the goal of preserving and passing on important Japanese cultural properties using advanced digital technologies. The project employs Canon’s digital SLR cameras to photo- graph historical artifacts and its large-format inkjet printers to print out images. Skilled artisans can apply Canon supports research and educa- tional activities at Yellowstone National Park by providing equipment for use in recording research activities and the digitization of the park’s archives. WWF Conservation Partner Since becoming the ﬁ rst Conservation Partner of WWF, the global wildlife conservation organization, in 1998, Canon Europe has been supporting various WWF activities in Europe, the Middle East and Africa by providing them with equipment and supplies as well as technical assistance. Canon Europe helps WWF to digitize its superb image collection and to make it readily available online to its global network of WWF ofﬁ ces. There are currently more than 16,000 images available in the Photo Database. Canon Europe has been the ﬁ rst Conservation Partner of the WWF since 1998. © WWF-Canon / Yves-Jacques REY-MILLET 30 traditional techniques to the prints to produce works almost indistinguishable from the originals. In 2008, Canon applied its own high-precision color matching system to realize greatly shortened production times and the faithful reproduction of original colors. Between 2007 and March 2009, replicas of 10 historic items were completed and donated to associated temples and museums. Nurturing Diverse Human Resources To become a truly excellent global corporation, Canon is committed to creating fair worker-man- agement relations and using communication and education to motivate each employee to continue growing as an “excellent person.” Canon nurtures human resources and actively develops the abilities of its employees while provid- ing various certiﬁ cation programs and recognizing employee achievements. The Company also estab- lishes and actively supports training centers throughout the Group to raise the technical skills of employees and contribute to the expansion of employment opportunities in local communities. In 2008, Canon began construction of the Oita Manufacturing Training Center in Japan, to be Reproduction of Sesshu’s scroll, Landscapes of the Four Seasons: the combination of digital technologies and traditional techniques makes possible the faithful reproduction of original works. equipped with such manufacturing equipment as grinding machines for lens processing, plastic- molding machines and automation control equip- ment. The Company also constructed the Canon Workforce Development Center in Virginia, which is equipped with top-of-the-line facilities to provide technical skills training. Oita Canon teamed up with a social welfare corporation in Oita and established the joint company Canon Wind Inc. to promote the employ- ment of disabled people, especially those with mental disabilities. Established in 2008, Canon Wind is focusing efforts on supporting people with disabilities. 31 PRODUCT GROUPS Photo: A camera shop in Prague, Czech Republic. Canon is a popular brand in Eastern Europe. Business Machines OFFICE IMAGING PRODUCTS ... 34 Business Machines COMPUTER PERIPHERALS ... 36 (cid:129) Ofﬁ ce network digital multifunction devices (MFDs) (cid:129) Color network digital MFDs (cid:129) Ofﬁ ce copying machines (cid:129) Personal-use copying machines (cid:129) Full-color copying machines, etc. (cid:129) Laser beam printers (LBPs) (cid:129) Inkjet multifunction peripherals (cid:129) Single-function inkjet printers (cid:129) Image scanners, etc. 32 Business Machines BUSINESS INFORMATION PRODUCTS (cid:129) Computer information systems (cid:129) Document scanners (cid:129) Personal information products, etc. CAMERAS ... 38 OPTICAL AND OTHER PRODUCTS ... 40 (cid:129) Digital single lens reﬂ ex (SLR) cameras (cid:129) Compact digital cameras (cid:129) Interchangeable lenses (cid:129) Digital video camcorders, etc. (cid:129) Semiconductor-production equipment (cid:129) Mirror projection mask aligners for LCD panels (cid:129) Broadcasting equipment (cid:129) Medical equipment (cid:129) Large format printers (cid:129) Components, etc. 33 PRODUCT GROUPS OFFICE IMAGING PRODUCTS “ Canon will release new product lineups that offer highly advanced platforms in ofﬁ ce imaging.” Masaki Nakaoka Chief Executive, Ofﬁ ce Imaging Products Operations 27.3% Canon’s Ofﬁ ce Imaging Products busi- ness comprises four main categories: ofﬁ ce network multifunction devices (MFDs), MFDs for SOHOs, document solutions and commercial printers. In ofﬁ ce network MFDs, market demand was sluggish in 2008 owing to economic uncertainty. Nevertheless, Canon enjoyed increased unit sales of color models, particularly in the low-end range. The SOHO market remained steady overall, but sales of high-end models declined. In document solutions, the Company strengthened its proposal- style solutions that use its MEAP, which enables the customization of MFDs and the development of third-party applications. Numerous applications based on this platform have been released, including smart card authentication for business security. In commercial printers, shipments of the highly acclaimed imagePRESS C7000VP were strong amidst favorable market conditions. Canon has further strengthened its direct sales structure in the United States, which has seen successive reor- ganizations of sales channels in the same industry. In Europe, sales of color low-end models were favorable. In Asia, growth in emerging economies propelled unit sales. In the mature Japanese market, unit sales rose slightly owing to diligent efforts to promote sales, for example, of MFDs to convenience store chains. New markets in both Asia and Latin America also recorded strong unit sales, mainly for low-end monochrome products. We will work to release new prod- ucts that offer a new standard in ofﬁ ce information handling by incorporating a highly advanced platform. For SOHO use, we will introduce new stylish color models. In commercial printers, Canon will reinforce its lineups by expanding its monochrome lineup, especially medium- and light-production models. Further- more, to boost sales in markets hit hard by the global economic crisis, we will bolster our sales structures in North America and Europe. Innovative Products and Technology—V-Toner Clear Canon has developed the new and unique V-Toner Clear system, which it introduced with the imagePRESS C1+ in 2008. The system makes possible a visual texture treatment that greatly expands design capabilities. It works by applying clear toner to paper to control the degree of glossiness, enabling stunning effects such as metallic characters, spot matt/gloss coating and flood matt coating. The system also produces watermarks, an attractive option for customers looking to increase the security of their documents. With these features, V-Toner Clear allows for the production of a wide array of innovative printing solutions, providing added value for customers. 34 Color imageRUNNER C3480 (iR C3580 in some areas) imagePRESS C7000VP Fiscal 2008 Review Net sales in the Ofﬁ ce Imaging Prod- ucts business amounted to ¥1,119.5 billion, a decrease of 13.3% year on year. Unit sales also fell as the Com- pany’s performance in this business was impacted by the global economic downturn in the second half of the year and the appreciation of the yen. Sales of the Company’s ofﬁ ce network MFDs were slow due to the appreciation of the yen and restrained investment in ofﬁ ce equipment. Sales of its monochrome MFDs were down, reﬂ ecting low demand as the market continued to shift toward color products. Canon’s sales of color network MFDs showed robust growth in 2008, and the Company released several new models, including the Color imageRUNNER C3480/C3080 series (iR C3580/C3080 in some areas), which is targeted at small- to medium-sized ofﬁ ces and workgroups. In document solutions, the Com- pany’s eCopy solution* for simple and secure electronic distribution and the sharing of paper documents was well received in the United States. We also recorded solid unit sales of our E- maintenance service system, which uses networks to automatically detect problems involving the Company’s MFDs and notify a service base as necessary. The convenience of this service resulted in a high rate of system installations. In commercial printers, Canon expanded its business in the POD market with the release of its new imagePRESS C6000 digital press, designed to meet the needs of small- to medium-sized businesses. We also introduced the imagePRESS C1+ model featuring a clear toner system that offers new possibilities for graph- ics and design. Sales of the new model were particularly strong in Europe. * eCopy is a trademark of eCopy, Inc. Color imageRUNNER C3480 (iR C3580 in some areas) imagePRESS C1+ imagePRESS C6000 35 PRODUCT GROUPS COMPUTER PERIPHERALS “ Canon is dedicated to producing products that are superior in terms of image quality, speed, design and ease of use.” 35.5% Katsuichi Shimizu Chief Executive, Inkjet Products Operations In the latter half of 2008, the global economic downturn severely affected the inkjet printer market. However, unit sales of Canon inkjet printers increased year on year despite a drop in sales on a value basis due to the impact of the appreciation of the yen. Against the backdrop of economic recession, customers are extremely cautious when selecting products, limiting their choices to goods superior in terms of performance and value. To meet customer needs, Canon has returned to its roots as a manufacturer and devel- oped and released to the market “au- thentic” products that demonstrate an undying commitment to image quality, speed, design and ease of use—ele- ments that deﬁ ne any good printer. In recognition of these efforts, in 2008 Canon’s products swept the top three spots in the all-in-one printer category of a well-known American magazine for the second consecutive year. In 2008, we boosted unit sales by introducing powerful new printers and strengthening product lineups. The Company carried out reforms to core technologies, including proprietary FINE (Full-photolithography Inkjet Nozzle Engineering) technology for high-speed high-resolution printing and the Chroma- Life 100+ system for creating beautiful, long-lasting prints. In 2008, we devel- oped new inks and photo paper and expanded the range of color reproduction. Targeting SOHOs, we released the PIXMA MX7600 inkjet printer, that features Pigment Reaction (PgR) technology. Pursuing automation as a way to improve productivity and ensure product quality, in 2008 Canon inaugurated a new inkjet printer cartridge production plant at Oita Canon Materials in Japan and began introducing automated machinery in the assembly cell sections at its plant in Thailand. In 2009, we expect a severe global economic environment. To reduce the impact of declining printer prices and strengthen Canon’s presence in the global market, we will further strengthen our sales structure. Moreover, we will further differentiate our products by enhancing image quality and speed through FINE technology as well as by improving operability and design. Innovative Products and Technologies—Pigment Reaction (PgR) Technology Canon has rewritten the rules of inkjet printing with its revolutionary new PgR technology. This innovative ink system eliminates the problems sometimes associated with inkjet printing—print-through, print curling, ink bleeding—allowing high-deﬁ nition text, graphics and photographs to be printed on plain paper. PgR works by applying clear ink onto the paper when printing begins. Pigment inks are ejected on the clear ink coating, reacting with the clear ink to improve saturation, brightness and ink ﬁ xation. PgR also ensures that the ﬁ nal product will be long-lasting and water-fast. 1 2 Clear ink is applied to the paper. Pigment inks are ejected. 3 4 Pigment inks and clear ink react after pigment inks are placed. Saturation, brightness and ink ﬁ xation have improved. 36 LBP5975 PIXMA MP630 Fiscal 2008 Review Net sales in the Computer Peripherals business totaled ¥1,454.8 billion, a decrease of 5.4% year on year. In the market for laser beam printers (LBPs), demand was sluggish in the ﬁ rst half of the year and fell sharply in the second half. As a result, sales of LBPs were down 5.6% on a value basis and 6% on a unit basis year on year. However, unit sales of color LBPs rose slightly, and Canon bolstered its lineups and released low-end models for personal use and SOHOs. Turning to inkjet printers, although the world economy drastically deceler- ated in the second half of the year, Canon’s unit sales were up 3% year on year. However, sales of inkjet printers decreased 4.5% due to the sudden rise of the yen. Unit sales of the Company’s multifunction printers (MFPs) in- creased signiﬁ cantly, reﬂ ecting the continuing shift in market demand from single-function models to MFPs. In emerging economies, the Compa- ny’s sales of low-end models were favorable and we increased market share. Sales were especially strong for products targeting the home market, including the PIXMA MP620 MFP and the PIXMA iP2600 single-function printer. For the SOHO market, in 2008 Canon released the PIXMA MX7600 all-in-one inkjet printer featuring the Company’s original revolutionary new PgR technology. In addition, sales of consumables such as inkjet cartridges were strong. In scanners, although the market is shrinking due to the spread of MFPs, the Company recorded strong unit sales and solidiﬁ ed its No. 1 market position. In 2008, we released the new CanoScan LiDE 200, which contributed to the Company’s sales. This compact CIS (compact image sensor) scanner features a high resolu- tion of 4,800dpi and improved maxi- mum optical resolution compared with the previous model. LBP5050 (i-SENSYS LBP5050 in some areas) PIXMA MX7600 PIXMA iP2600 CanoScan LiDE 200 37 PRODUCT GROUPS CAMERAS “ Aiming to maintain its No. 1 position in the global market, Canon is introducing powerful new products that redeﬁ ne the picture-taking experience. ” Masaya Maeda Chief Executive, Image Communication Products Operations 25.4% In 2008, the Company held its No. 1 position for both digital SLR cameras and compact digital cameras in the four markets of North America, Europe, Japan and China. Canon increased unit sales and expanded its market share for digital SLR cameras on the back of continued demand, and reinforced its lineups for both low-end and mid-range models. In compact digital cameras, Canon increased unit sales despite stagnant market conditions. We worked to further enhance the functions of our compact digital cameras, equipping models with the new DIGIC 4 imaging pro - cessor and upgrading our Face Detec- tion Technology. Staying on top of the worldwide shift to HD, Canon introduced full HD camcorders to the market, winning high praise for their image quality and dual-ﬂ ash memory concept that enables recording the movie both to the internal memory and a removable SDHC card. Looking ahead, we will bolster product lineups for digital SLR and compact digital cameras, particularly for mid-range models. Canon will offer products that boast superior image quality based on its core competencies of optical technology, sensor technology and imaging processors while elevating the essential factors in capturing images, such as ease of use, miniaturization and design. From the beginning of 2009, we will aggressively launch attractive and powerful products across every product category, aiming to offer unprecedented levels of customer satisfaction. Canon will reinforce the in-house production of key components as a means of offering high-value-added products that are differentiated from those of its competi- tors and, at the same time, re-examine its systems for maintaining quality, including the service support structure for every category of user, from begin- ners and advanced amateurs to profes- sionals. Furthermore, the Company will continue efforts to promote cross-media imaging to realize advanced synergies between input and output products. Innovative Products and Technology—EOS 5D Mark II Digital SLR Camera In 2008, Canon released the EOS 5D Mark II digital SLR camera. Highly anticipated by customers, it features a newly developed 21.1- megapixel 35mm full-frame CMOS sensor that realizes less noise and a signiﬁ cantly expanded sensitivity range. The camera incorporates the DIGIC 4 imaging processor to enable the high-speed processing of the increased data generated by the high-pixel-count image sensor. The EOS 5D Mark II is the world’s ﬁ rst digital SLR capable of full HD (1,920 x 1,080 pixel) video capture. The Company applied its highly advanced imaging, photography and video capture tech- nologies to offer this function, signaling a new direction in digital SLR cameras. 38 PowerShot SD880 IS DIGITAL ELPH (DIGITAL IXUS 870 IS in some areas) VIXIA HF11 (HF11 in some areas) Fiscal 2008 Review Net sales in the Cameras business totaled ¥1,042.0 billion, a year-on- year decrease of 9.6%. Despite severe conditions in the economy, unit sales of Canon’s digital cameras increased approxi- mately 4%. The drop in sales is attribut- able to falling prices of digital cameras and the appreciation of the yen. In digital SLR cameras, Canon introduced new products to the market in both low-end and mid- range models. The Company enjoyed strong sales and worldwide popularity of the new EOS Digital Rebel XSi (EOS 450D in some areas), as well as for previous models, such as the ad- vanced-amateur model EOS 40D. Also in the advanced-amateur category, amid high expectations from custom- ers we released the EOS 5D Mark II, which features not only enhanced image quality but also full HD video capturing—effectively redeﬁ ning the digital SLR camera. In addition, unit sales in emerging markets expanded, led by the EOS Digital Rebel XS (EOS 1000D in some areas). In line with the overall growth in the sales of digital SLR cameras, unit sales of inter- changeable lenses also increased. In compact digital cameras, the market grew slightly in 2008 but demand plummeted toward the end of the year and prices continued to fall. Unit sales were up as the Com- pany strengthened its product lineup with 16 new models led by the stylish PowerShot SD1100 IS DIGITAL ELPH (DIGITAL IXUS 80 IS in some areas) and the PowerShot SD880 IS DIGITAL ELPH (DIGITAL IXUS 870 IS in some areas). In HD camcorders, we launched the VIXIA HF11 (HF11 in some areas) camcorder, which can record full HD images at 1,920 x 1,080 pixels to an internal ﬂ ash memory (32GB) and removable SDHC card. In LCD projectors, Canon intro- duced its top-of-the-line WUX10 projector in 2008. The Company equipped the wide-screen projector with its own WUXGA (1,920 x 1,200 pixel) LCOS panels and unique optical engine, AISYS, to deliver precise color reproduction and stunning resolution that surpasses that of 1080 full HDTV. EOS Digital Rebel XSi (EOS 450D in some areas) PowerShot SD1100 IS DIGITAL ELPH (DIGITAL IXUS 80 IS in some areas) VIXIA HF11 (HF11 in some areas) REALiS WUX10 (XEED WUX10 in some areas) 39 PRODUCT GROUPS OPTICAL AND OTHER PRODUCTS “ In 2009, we will work tirelessly toward accelerating our development capabilities to prepare for a turnaround in the economy.” 9.6% Junji Ichikawa Chief Executive, Optical Products Operations The market for semiconductor exposure equipment was impacted by severe eco- nomic conditions from the latter half of 2008. We responded by managing produc- tion capacity to meet demand and also made thorough efforts to reduce invento- ries while strengthening new product development to spur demand. In addition, Canon continued to advance its immersion technology for realizing the further minia- turization of semiconductors. This has served to lift the quality of its immersion ArF equipment to even higher levels. We also improved productivity by switching entirely to the production of steppers that cater to more competitive 300mm wafers. With regard to the market for expo- sure equipment for LCDs, conditions were favorable as capital investment by LCD manufacturers was on the upswing. We strengthened the MPAsp-H700 lineup of LCD exposure equipment for eighth-generation panels with continu- ous upgrades to meet various needs from LCD manufacturers. In 2009, we expect harsh conditions in the market for steppers, with declin- ing demand and further price reductions for semiconductor devices. To pursue advances in semiconductor miniaturiza- tion, Canon will bolster its immersion technology through the use of double patterning, a method that can signiﬁ - cantly increase resolution. We will carry out development in this area through 2011 as well as of new technologies that improve the throughput capacity of steppers that use KrF. In exposure equipment for LCDs, we expect a decline in capital investment from LCD manufacturers in 2009. Despite difﬁ cult conditions, we will work toward the development of the SP platform, which grew out of our H700 series, for our next-generation LCD exposure equipment. At the same time, we will endeavor to further improve optical performance. We regard 2009 as a signiﬁ cant year for thoroughly reinforcing the Company’s development capabilities. Canon aims to improve design quality to shorten equip- ment installation times so customers can start up operations quickly. The Company will also step up in-house production to further accumulate technological know- how and raise product quality. Innovative Product and Technology—Dynamic Imaging X-Ray Sensor In 2008, Canon succeeded in developing a portable ﬂ at-panel digital radiography (DR) system capable of viewing dynamic and capturing static X-ray images. Canon introduced the world’s ﬁ rst static-image DR system in 1998. Today, its wide lineup of systems for medical use includes portable sensors essential to emergency medicine. Canon’s newly developed prototype captures static X-ray images and enables “X-ray ﬂ uoroscopy,” allowing radiographers to see dynamic images of internal organs for optimal timing in capturing static images. Canon hopes that this new technology will contribute to widening the scope of medical diagnostic procedures and increas- ing the speed of diagnosis. 40 Canon’s dynamic imaging X-ray sensor attracted the interest of visitors to RSNA 2009. FPA-7000AS7 DIGISUPER 100 xs Fiscal 2008 Review Net sales of Optical and Other Prod- ucts slipped 0.2% compared with the previous ﬁ scal year to ¥392.2 billion. In the market for steppers, de- mand fell signiﬁ cantly. Nevertheless, Canon continued shipments of the FPA-7000AS5 dry ArF scanning stepper and the FPA-7000AS7 immer- sion lithography scanning stepper. Sales were also solid for the FPA- 5510iZ stepper, which won praise among customers for its high produc- tivity. Aiming to further expand its market presence, Canon launched the new FPA-5550iZ in November 2008. This 300mm-wafer-capable, high- throughput stepper achieves 50% higher throughput than the previous FPA-5510iZ model series. The market for LCD exposure equipment saw a rapid recovery in 2008, although the balance of supply and demand deteriorated. Canon recorded excellent sales of its MPA- 7800+ ﬁ fth-generation mirror projec- tion mask aligners, particularly in China. The Company also continued shipments of its acclaimed MPAsp- H700 LCD exposure equipment for eighth-generation panels. In digital radiography systems, Canon released the CXDI-60G, which features a detachable sensor cable for easy installation in multiple locations. The Company achieved strong sales growth especially in China for its CXDI series, particularly the 50G model. In broadcast and communications, Canon held on to its high market share as the shift to HDTV drove demand for upgraded equipment and did brisk business related to the holding of various events. Building on the continued success of Canon’s DIGISUPER 100AF and 86AF models, we launched the DIGISUPER 27AF HD studio lens featuring optical perfor- mance optimized for high-vision television and Auto Focus functions. In the large-format printer market, we strengthened the imagePROGRAF lineup with the release of the iPF720. Equipped with an 80GB hard drive, the printer is capable of handling multiple complex jobs and, in addition to producing posters, it can produce CAD drawings and GIS maps. MPAsp-H700 CXDI-60G DIGISUPER 27AF imagePROGRAF iPF720 41 MAJOR CONSOLIDATED SUBSIDIARIES MANUFACTURING Canon Electronics Inc. Canon Finetech Inc. Nisca Corporation Canon Semiconductor Equipment Inc. Canon Ecology Industry Inc. Canon Chemicals Inc. Canon Components, Inc. Canon Precision Inc. Oita Canon Inc. Nagahama Canon Inc. Oita Canon Materials Inc. Ueno Canon Materials Inc. Fukushima Canon Inc. Canon Optron, Inc. Canon Mold Co., Ltd. Canon Machinery Inc. Canon ANELVA Corporation SED Inc. Tokki Corporation Canon Virginia, Inc. Canon Giessen GmbH Canon Bretagne S.A.S. Canon Inc., Taiwan Canon Dalian Business Machines, Inc. Canon Zhuhai, Inc. Canon Zhongshan Business Machines Co., Ltd. Tianjin Canon Co., Ltd. Canon (Suzhou) Inc. Canon Opto (Malaysia) Sdn. Bhd. Canon Hi-Tech (Thailand) Ltd. Canon Engineering (Thailand) Ltd. Canon Vietnam Co., Ltd. Canon Electronic Business Machines (H.K.) Co., Ltd. Canon Imaging Systems Inc. RESEARCH & DEVELOPMENT Canon Development Americas, Inc. Canon Technology Europe Ltd. Canon Research Centre France S.A.S. Canon Information Systems Research Australia Pty. Ltd. Canon Information Technology (Beijing) Co., Ltd. Canon (Suzhou) System Software Inc. Canon i-tech Inc. 42 (As of December 31, 2008) MARKETING & OTHER Canon Marketing Japan Inc. Canon System and Support Inc. Canon IT Solutions Inc. Canon Software Inc. e-System Corporation Asia Paciﬁ c System Research Co., Ltd. Canon U.S.A., Inc. Canon Canada, Inc. Canon Mexicana, S. de R.L. de C.V. Canon Latin America, Inc. Canon do Brasil Industria e Comercio Limitada Canon Chile, S.A. Canon Panama, S.A. Canon Argentina, S.A. Canon Business Solutions, Inc. Canon Financial Services, Inc. Canon Information Technology Services, Inc. Canon Europa N.V. Canon Europe Ltd. Canon (UK) Ltd. Canon Deutschland GmbH Canon France S.A.S. Canon Italia S.p.A. Canon España S.A. Canon Nederland N.V. Canon Danmark A/S Canon Belgium N.V./S.A. Canon (Schweiz) AG Canon Gesellschaft m.b.H. Canon Svenska AB Canon Oy Canon North-East Oy Canon Norge A.S. Canon CEE GmbH Canon Eurasia A.S. Canon Portugal S.A. Canon Middle East FZ-LIC Canon South Africa Pty. Ltd. Canon Australia Pty. Ltd. Canon New Zealand Ltd. Canon Finance Australia Ltd. Canon (China) Co., Ltd. Canon Singapore Pte. Ltd. Canon Hongkong Co., Ltd. Canon Marketing (Malaysia) Sdn. Bhd. Canon Marketing (Philippines), Inc. Canon Marketing (Thailand) Co., Ltd. Canon India Pte. Ltd. Canon Korea Consumer Imaging Inc. Canon Semiconductor Engineering Korea Inc. Canon Semiconductor Equipment Taiwan Inc. Canon Engineering Hong Kong Co., Ltd. FINANCIAL SECTION TABLE OF Contents FINANCIAL OVERVIEW ..................................................................................... 44 TEN-YEAR FINANCIAL SUMMARY ................................................................... 62 CONSOLIDATED BALANCE SHEETS .................................................................. 64 CONSOLIDATED STATEMENTS OF INCOME ..................................................... 65 CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY ......................... 66 CONSOLIDATED STATEMENTS OF CASH FLOWS ............................................. 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .................................... 68 1 Basis of Presentation and Signiﬁ cant Accounting Policies 2 Basis of Financial Statement Translation ......................................... 72 3 Foreign Operations ............................................................................ 73 4 Investments 5 Trade Receivables .............................................................................. 75 6 Inventories 7 Property, Plant and Equipment 8 Finance Receivables and Operating Leases ...................................... 76 9 Acquisitions 10 Goodwill and Other Intangible Assets ............................................. 77 11 Short-Term Loans and Long-Term Debt ........................................... 78 12 Trade Payables 13 Employee Retirement and Severance Beneﬁ ts ............................... 79 14 Income Taxes ..................................................................................... 83 15 Common Stock .................................................................................. 85 16 Legal Reserve and Retained Earnings .............................................. 86 17 Other Comprehensive Income (Loss) 18 Stock-Based Compensation ................................................................ 88 19 Net Income per Share ....................................................................... 89 20 Derivatives and Hedging Activities 21 Commitments and Contingent Liabilities ........................................ 90 22 Disclosures about the Fair Value of Financial Instruments and Concentrations of Credit Risk ........................................................... 92 23 Fair Value Measurements ................................................................. 93 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING .......................................................................... 95 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ........... 96 43 FINANCIAL OVERVIEW GENERAL The following discussion and analysis provides information that management believes to be relevant to understanding Canon’s consolidated ﬁ nancial condition and results of operations. References in this discussion to the “Company” are to Canon Inc. and, unless otherwise indicated, references to the ﬁ nancial condition or operating results of “Canon” refer to Canon Inc. and its consolidated subsidiaries. OVERVIEW Canon is one of the world’s leading manufacturers of copying machines, laser beam printers, inkjet printers, cameras, steppers and aligners. Canon earns revenues primarily from the manufac- ture and sale of these products domestically and internationally. Canon’s basic management policy is to contribute to the prosperity and well-being of the world while endeavoring to become a truly excellent global corporate group targeting continued growth and development. Canon divides its businesses into three product groups: business machines, cameras, and optical and other products. The business machines product group has three sub-groups: ofﬁ ce imaging products, computer peripherals and business information products. Economic environment Looking back at the global economy in 2008, while the effects of the subprime loan crisis led to a slowdown that was felt in major countries from the beginning of the year, stock markets plunged and the real economy in these countries rapidly deterio- rated, especially toward the end of the year, as a result of increasing ﬁ nancial uncertainty triggered by the failures of major ﬁ nancial institutions in the United States. Furthermore, growth in Asia and other emerging economies slowed down sharply due to a decline in exports, and the sense of a severe recession of global proportions has gradually spread. As for foreign exchange markets, the unilateral yen buying that began in early autumn drove up the value of the yen against all other foreign currencies. Market environment As for the markets in which Canon operates amid these conditions, within the digital camera segment, demand for digital single-lens reﬂ ex (“SLR”) cameras continued to expand. While demand for compact digital cameras declined sharply toward the end of the year and prices continued to fall, the market staged healthy growth for the year. As for the ofﬁ ce imaging products market, sales of color network digital multifunction devices (“MFDs”) showed robust growth amid the shift toward color models in each region, although demand for monochrome models remained low. As for computer peripherals, in addition to a drop in demand for monochrome laser beam printers, sales of color-model printers, which had enjoyed sustained healthy expansion, remained rela- tively unchanged from the previous year. With regard to inkjet printers, although demand continued to shift from single-function to multifunction models, demand overall for the segment declined. Within the optical equipment segment, while the market for aligners, used to produce liquid crystal display (“LCD”) panels, realized a rapid recovery thanks to an increase in capital spending by LCD panel manufacturers, demand for steppers, utilized in 44 the production of semiconductors, fell signiﬁ cantly. The average value of the yen during the year was ¥103.23 to the U.S. dollar, a year-on-year appreciation of about 14%, and ¥151.46 to the euro, a year-on-year appreciation of approximately 7%. Summary of operations Amid these conditions, Canon’s consolidated net sales for the period was ¥4,094.2 billion (U.S.$44,991 million), a year-on-year decline of 8.6%, due to the effects of the substantial rise in value of the yen along with falling prices of such consumer products as digital cameras and inkjet printers, and reduced sales volumes due to decreased demand for network MFDs, laser beam printers, and other ofﬁ ce equipment. Income before income taxes and minority interests totaled ¥481.1 billion (U.S.$5,287 million), a decline of 37.4% from the year-ago period, while net income decreased 36.7% to ¥309.1 billion (U.S.$3,397 million). Key performance indicators The following are the key performance indicators (“KPIs”) that Canon uses in managing its business. The year-on-year changes in these KPIs are set forth in the table shown on page 45. Revenues As Canon pursues to become a truly excellent global company, one indicator upon which Canon’s management places strong emphasis is revenue. The following are some of the KPIs related to revenue that management considers to be important. Net sales is one such KPI. Canon derives net sales primarily from the sale of products and, to a much less extent, provision of services associated with its products. Sales vary depending on such factors as product demand, the number and size of transactions within the reporting period, product reputation for new products, and changes in sales prices. Other factors involved are market share and market environment. In addition, manage- ment considers the evaluation of net sales by product group to be important for the purpose of assessing Canon’s sales perfor- mance in various product groups taking into account recent market trends. Gross proﬁ t ratio (ratio of gross proﬁ t to net sales) is another KPI for Canon. Through its reforms in product development, Canon has been striving to shorten product development lead times in order to launch new, competitively priced products at a faster pace. Furthermore, Canon has achieved cost reductions through enhancement of efﬁ ciency in its production. Canon believes that these achievements have contributed to improving Canon’s gross proﬁ t ratio, and will continue pursuing the curtailment of product development lead times and reductions in production costs. Operating proﬁ t ratio (ratio of operating proﬁ t to net sales) and research and development (“R&D”) expense to net sales ratio are considered to be KPIs by Canon. Canon is focusing on two areas for improvement. Canon strives to control and reduce its selling, general and administrative expenses as its ﬁ rst key point. Secondly, Canon’s R&D policy is designed to maintain a high level of spending in core technology to sustain Canon’s leading position in its current ﬁ elds of business and to seek possibilities in other markets. Canon believes such investments will create the basis for future success in its business and operations. Cash ﬂ ow management Canon also places signiﬁ cant emphasis on cash ﬂ ow management. The following are the KPIs with regard to cash ﬂ ow management that Canon’s management believes to be important. Inventory turnover within days is a KPI because it measures the adequacy of supply chain management. Inventories have inherent risks of becoming obsolete, physically ruined or otherwise decreas- ing signiﬁ cantly in value, which may adversely affect Canon’s operating results. To mitigate these risks, management believes that it is crucial to continue reducing inventories and decrease production lead times in order to promptly collect related product expenses by strengthening supply chain management. Canon’s management seeks to meet its liquidity and capital requirements primarily with cash ﬂ ow from operations. Management also seeks debt-free operations. For a manufac- turing company like Canon, it generally takes considerable time to realize proﬁ t from a business as the process of R&D, manu- facturing and sales has to be followed for success. Therefore, management believes that it is important to have sufﬁ cient ﬁ nancial strength so that the Company does not have to rely on external funds. Canon has continued to reduce its dependency on external funds for capital investments in favor of generating the necessary funds from its own operations. Stockholders’ equity to total assets ratio (ratio of total stockholders’ equity to total assets) is another KPI for Canon. Canon believes that stockholders’ equity to total assets ratio measures its long-term sustainability. Canon also believes that achieving a high or rising stockholders’ equity ratio indicates that Canon has maintained a good status or further improved the constitution to fund debt obligations and other unexpected expenses. In the long-term, Canon will be able to maintain a high level of stable investments for its future operations and development. As Canon puts strong emphasis on its research and development activities, management believes that it is important to maintain a stable ﬁ nancial base and, accordingly, a high level of stockholders’ equity to total assets ratio. KEY PERFORMANCE INDICATORS Net sales (Millions of yen) Gross proﬁ t to net sales ratio R&D expense to net sales ratio Operating proﬁ t to net sales ratio Inventory turnover within days Debt to total assets ratio Stockholders’ equity to total assets ratio 2008 ¥4,094,161 47.3% 9.1% 12.1% 47 days 0.4% 67.0% 2007 ¥4,481,346 50.1% 8.2% 16.9% 44 days 0.6% 64.8% 2006 ¥4,156,759 49.6% 7.4% 17.0% 45 days 0.7% 66.0% 2005 ¥3,754,191 48.5% 7.6% 15.5% 47 days 0.8% 64.4% 2004 ¥3,467,853 49.4% 7.9% 15.7% 49 days 1.1% 61.6% Note: Inventory turnover within days; Inventory divided by net sales for the previous six months, multiplied by 182.5. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The consolidated ﬁ nancial statements are prepared in accor- dance with U.S. generally accepted accounting principles and based on the selection and application of signiﬁ cant accounting policies which require management to make signiﬁ cant estimates and assumptions. Canon believes that the following are the more critical judgment areas in the application of its accounting policies that currently affect its ﬁ nancial condition and results of operations. Revenue recognition Canon generates revenue principally through the sale of con- sumer products, equipment, supplies, and related services under separate contractual arrangements. Canon recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred and title and risk of loss have been transferred to the customer or services have been rendered, the sales price is ﬁ xed or determinable, and collectibility is probable. Revenue from sales of consumer products including ofﬁ ce imaging products, computer peripherals, business infor- mation products and cameras is recognized upon shipment or delivery, depending upon when title and risk of loss transfer to the customer. Revenue from sales of optical equipment, such as steppers and aligners that are sold with customer acceptance provisions related to their functionality, is recognized when the equipment is installed at the customer site and the speciﬁ c criteria of the equipment functionality are successfully tested and demonstrated by Canon. Service revenue is derived primarily from separately priced product maintenance contracts on equipment sold to customers and is measured at the stated amount of the contract and recognized as services are provided. Canon also offers separately priced product maintenance contracts for most ofﬁ ce imaging products, for which the customer typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service mainte- nance contracts is measured at the stated amount of the contract and recognized as services are provided and variable amounts are earned. Revenue from the sale of equipment under sales-type leases is recognized at the inception of the lease. Income on sales-type leases and direct-ﬁ nancing leases is recognized over the life of each respective lease using the interest method. Leases not qualifying as sales-type leases or direct-ﬁ nancing leases are accounted for as operating leases and related revenue is recog- nized ratably over the lease term. When equipment leases are 45 bundled with product maintenance contracts, revenue is ﬁ rst allocated considering the relative fair value of the lease and non-lease deliverables based upon the estimated relative fair values of each element. Lease deliverables generally include equipment, ﬁ nancing and executory costs, while non-lease deliverables generally consist of product maintenance contracts and supplies. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative fair value if such element meets the criteria for treatment as a separate unit of accounting as prescribed in the Emerging Issues Task Force (“EITF”) Issue No.00-21, “Revenue Arrangements with Multiple Deliverables.” Otherwise, revenue is deferred until the undelivered elements are fulﬁ lled and accounted for as a single unit of accounting. Canon records estimated reductions to sales at the time of sale for sales incentive programs including product discounts, customer promotions and volume-based rebates. Estimated reductions in sales are based upon historical trends and other known factors at the time of sale. In addition, Canon provides price protection to certain resellers of its products, and records reductions to sales for the estimated impact of price protection obligations when announced. Estimated product warranty costs are recorded at the time revenue is recognized and are included in selling, general and administrative expenses. Estimates for accrued product warranty costs are based on historical experience, and are affected by ongoing product failure rates, speciﬁ c product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. Allowance for doubtful receivables Allowance for doubtful receivables is determined using a com- bination of factors to ensure that Canon’s trade and ﬁ nancing receivables are not overstated due to uncollectibility. Canon maintains an allowance for doubtful receivables for all customers based on a variety of factors, including the length of time receiv- ables are past due, trends in overall weighted average risk rating of the total portfolio, macroeconomic conditions, signiﬁ cant one-time events and historical experience. Also, Canon records speciﬁ c reserves for individual accounts when Canon becomes aware of a customer’s inability to meet its ﬁ nancial obligations to Canon, such as in the case of bankruptcy ﬁ lings or deteriora- tion in the customer’s operating results or ﬁ nancial position. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. Valuation of inventories Inventories are stated at the lower of cost or market value. Cost is determined by the average method for domestic inventories and principally the ﬁ rst-in, ﬁ rst-out method for overseas inventories. Market value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the esti- mated costs necessary to make a sale. Canon routinely reviews its inventories for their salability and for indications of obsoles- cence to determine if inventories should be written-down to market value. Judgments and estimates must be made and used in connection with establishing such allowances in any accounting period. In estimating the market value of its inventories, Canon considers the age of the inventories and the likelihood of spoilage or changes in market demand for its inventories. Impairment of long-lived assets In accordance with Statement of Financial Accounting Standards No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, long-lived assets, such as property, plant and equipment, and acquired intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recov- erable. If the carrying amount of the asset exceeds its estimated undiscounted future cash ﬂ ows, an impairment charge is recog- nized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Determining the fair value of the asset involves the use of estimates and assumptions. These estimates and assumptions include future market condi- tions, net sales growth rate, gross margin and discount rate. Though Canon believes that the estimates and assumptions are reasonable, actual future results may differ from these estimates and assumptions. Property, plant and equipment Property, plant and equipment are stated at cost. Depreciation is calculated principally by the declining-balance method, except for certain assets which are depreciated by the straight-line method over the estimated useful lives of the assets. Income taxes Canon considers many factors when evaluating and estimating income tax uncertainties. These factors include an evaluation of the technical merits of the tax positions as well as the amounts and probabilities of the outcomes that could be realized upon settlement. The actual resolutions of those uncertainties will inevitably differ from those estimates, and such differences may be material to the ﬁ nancial statements. Valuation of deferred tax assets Canon currently has signiﬁ cant deferred tax assets, which are subject to periodic recoverability assessments. Realization of Canon’s deferred tax assets is principally dependent upon its achievement of projected future taxable income. Canon’s judg- ments regarding future proﬁ tability may change due to future market conditions, its ability to continue to successfully execute its operating restructuring activities and other factors. Any changes in these factors may require possible recognition of signiﬁ cant valuation allowances to reduce the net carrying value of these deferred tax asset balances. When Canon determines that certain deferred tax assets may not be recoverable, the amounts which may not be realized are charged to income tax expense and will adversely affect net income. Employee retirement and severance beneﬁ t plans Canon has signiﬁ cant employee retirement and severance beneﬁ t obligations that are recognized based on actuarial valuations. Inherent in these valuations are key assumptions, 46 including discount rates and expected return on plan assets. Management must consider current market conditions, including changes in interest rates, in selecting these assumptions. Other assumptions include assumed rate of increase in compensation levels, mortality rate, and withdrawal rate. Changes in these assumptions inherent in the valuation are reasonably likely to occur from period to period. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect future pension expenses. While management believes that the assumptions used are appropriate, the differences may affect employee retirement and severance beneﬁ t costs in the future. In preparing its ﬁ nancial statements for ﬁ scal 2008, Canon estimated a weighted-average discount rate of 2.5% for Japanese plans and 5.1% for foreign plans and a weighted-average expected long-term rate of return on plan assets of 3.7% for Japanese plans and 6.5% for foreign plans. In estimating the discount rate, Canon uses available information about rates of return on high-quality ﬁ xed-income governmental and corporate bonds currently available and expected to be available during the period to the maturity of the pension beneﬁ ts. Canon establishes the expected long-term rate of return on plan assets based on management’s expectations of the long-term return of the various plan asset categories in which it invests. Management develops expectations with respect to each plan asset category based on actual historical returns and its current expectations for future returns. Decreases in discount rates lead to increases in actuarial pension beneﬁ t obligations which, in turn, could lead to an increase in service cost and amortization cost through amortiza- tion of actuarial gain or loss, a decrease in interest cost, and vice versa. A decrease of 50 basis points in the discount rate increases the projected beneﬁ t obligation by approximately 9%. The net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and experience, are deferred until subsequent periods, as permitted by the Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions.” Decreases in expected returns on plan assets may increase net periodic beneﬁ t cost by decreasing expected return amounts, while differences between expected value and actual fair value of those assets could affect pension expense in the following years, and vice versa. For ﬁ scal 2009, a change of 50 basis points in the expected long-term rate of return on plan assets may cause a change of approximately ¥2,464 million in net periodic beneﬁ t cost. Canon multiplies management’s expected long-term rate of return on plan assets by the value of its plan assets, to arrive at the expected return on plan assets that is included in pension expense. Canon defers recognition of the difference between this expected return on plan assets and the actual return on plan assets. The net deferral affects the value of plan assets in future ﬁ scal years and, ultimately, future pension expense. In accordance with SFAS 158, “Employers’ Accounting for Deﬁ ned Beneﬁ t Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)”, Canon recognizes the funded status (i.e., the difference between the fair value of plan assets and the projected beneﬁ t obligations) of its pension plans in its consolidated balance sheets, with a corresponding adjustment to accumulated other comprehensive income (loss), net of tax. Effective January 1, 2007, the Company and certain of its domestic subsidiaries amended their funded deﬁ ned beneﬁ t pension plans. Under these funded deﬁ ned beneﬁ t pension plans, the lifetime pension beneﬁ t is based upon amounts payable during an initial period after retirement (the “guarantee period”) and the subsequent period lasting for the remainder of the retiree’s lifetime (the “post-guarantee period”). The Company and certain of its domestic subsidiaries amended these plans to increase the duration of this guarantee period from 15 years to 20 years to reﬂ ect an increase in the average lifespan of their employees, resulting in reduced amounts payable during each of the guarantee and post-guarantee periods. As a result of these changes, the projected beneﬁ t obligation decreased by ¥101,620 million as of January 1, 2007. In conjunction with these plan changes, the Company and certain of its domestic subsidiaries also have implemented an unfunded retirement and severance plan and a deﬁ ned contribution pension plan for certain future pension beneﬁ ts attributable to employees’ future services. CONSOLIDATED RESULTS OF OPERATIONS SUMMARY OF OPERATIONS Net sales Operating proﬁ t Income before income taxes and minority interests Net income Millions of yen 2008 ¥4,094,161 2007 2006 change change –8.6% ¥4,481,346 +7.8% ¥4,156,759 $44,990,780 5,451,363 5,287,330 3,397,231 756,673 +7.0 768,388 +6.8 488,332 +7.2 707,033 719,143 455,325 496,074 –34.4 481,147 –37.4 309,148 –36.7 Thousands of U.S. dollars 2008 47 Operating expenses The major components of operating expenses are payroll, R&D, advertising expenses and other marketing expenses. While R&D expenses increased slightly compared with the previous year, Group-wide cost reduction efforts contributed to a decline in total operating expenses of 3.2%. Operating proﬁ t Operating proﬁ t in ﬁ scal 2008 dropped 34.4% to a total of ¥496,074 million (U.S.$5,451 million) from ﬁ scal 2007, recording 12.1% to net sales. Other income (deductions) Other income (deductions) for ﬁ scal 2008 decreased by ¥26,642 million (U.S.$293 million) due to such factors as a reduction in interest income stemming from a decrease in cash surplus and a lower yield on investments, a decline in earnings on investments in afﬁ liates accounted for by the equity method, and write-downs of non-current marketable securities. Income before income taxes and minority interests Income before income taxes and minority interests in ﬁ scal 2008 was ¥481,147 million (U.S.$5,287 million), a decline of 37.4% from ﬁ scal 2007, and constituted 11.8% of net sales. Income taxes Provision for income taxes in ﬁ scal 2008 decreased by ¥103,470 million (U.S.$1,137 million) from ﬁ scal 2007, primarily as a result of the decline in income before income taxes and minority interests. The effective tax rate during ﬁ scal 2008 declined by 1.0% compared with ﬁ scal 2007. Net income As a result, net income in ﬁ scal 2008 decreased by 36.7% to ¥309,148 million (U.S.$3,397 million), which represents a 7.6% return on net sales. Sales Canon’s consolidated net sales in ﬁ scal 2008 totaled ¥4,094,161 million (U.S.$44,991 million). This represents an 8.6% decrease from the previous ﬁ scal year, reﬂ ecting the effects of the signiﬁ - cant appreciation of the yen coupled with declining prices of products such as digital cameras and inkjet printers, and reduced sales volumes stemming from decreased demand for network MFDs, laser beam printers, and other ofﬁ ce equipment. Overseas operations are signiﬁ cant to Canon’s operating results and generated approximately 76% of total net sales in ﬁ scal 2008. Such sales are denominated in the applicable local currency and are subject to ﬂ uctuations in the value of the yen to those currencies. Despite efforts to reduce the impact of currency ﬂ uctuations on operating results, including localization of manufacturing in some regions along with procuring parts and materials from overseas suppliers, Canon believes such ﬂ uctuations have had and will continue to have a signiﬁ cant effect on its results of operations. The average value of the yen in ﬁ scal 2008 was ¥103.23 to the U.S. dollar, and ¥151.46 to the euro, representing a signiﬁ - cant appreciation of about 14% to the U.S. dollar, and approxi- mately 7% appreciation against the euro, compared with the previous year. The effects of foreign exchange rate ﬂ uctuations negatively impacted net sales by approximately ¥299,500 million in 2008. This unfavorable impact was comprised of approximately ¥218,700 million for U.S. dollar denominated sales, ¥66,400 million for euro denominated sales and ¥14,400 million for other foreign currency denominated sales. Cost of sales Cost of sales principally reﬂ ects the cost of raw materials, parts and labor used by Canon in the manufacture of its products. A portion of the raw materials used by Canon is imported or includes imported materials. Many of these raw materials are subject to ﬂ uctuations in world market prices accompanied by ﬂ uctuations in exchange rates that may affect Canon’s cost of sales. Other components of cost of sales include depreciation expenses from plants, maintenance expenses, light and fuel expenses along with rent expenses. The ratio of cost of sales to net sales for ﬁ scal 2008, 2007 and 2006 was 52.7%, 49.9% and 50.4%, respectively. Gross proﬁ t Canon’s gross proﬁ t in ﬁ scal 2008 decreased by 13.8% to ¥1,938,008 million (U.S.$21,297 million) from ﬁ scal 2007. The gross proﬁ t ratio deteriorated by 2.8 points year on year to 47.3%. Despite the continued launch of new products and ongoing cost-reduction efforts, the deteriorated gross proﬁ t ratio was mainly the result of such factors as the sharp appreciation of the yen, falling product prices accompanied by the rise in prices of materials. 48 Product information Canon divides its businesses into three product groups: business machines, cameras and optical and other products. (cid:129) The business machines product group includes ofﬁ ce imaging products, computer peripherals and business information products. Ofﬁ ce imaging products mainly include ofﬁ ce network digital MFDs, color network digital MFDs, ofﬁ ce copying machines, personal-use copying machines and full-color copying machines. Computer peripherals mainly include laser beam printers, inkjet multifunction peripherals, single function inkjet printers and image scanners. Business information products mainly include computer information systems, document scanners and personal information products. (cid:129) The cameras product group mainly includes digital SLR cameras, compact digital cameras, interchangeable lenses and digital video camcorders. (cid:129) The optical and other products product group mainly includes semiconductor production equipment, mirror projection mask aligners for LCD panels, broadcasting equipment, medical equipment, large format printers and related components. Sales by product Canon’s sales by product group are summarized as follows: SALES BY PRODUCT Business machines: Ofﬁ ce imaging products Computer peripherals Business information products Cameras Optical and other products Total Return on Sales (%) Millions of yen 2008 change 2007 change 2006 Thousands of U.S.dollars 2008 1,454,768 ¥1,119,523 –13.3% ¥1,290,788 +8.8% ¥1,185,925 $12,302,451 15,986,462 –5.4 942,065 85,728 –20.1 29,230,978 –9.4 11,449,967 –9.6 –0.2 4,309,835 –8.6% ¥4,481,346 +7.8% ¥4,156,759 $44,990,780 1,537,511 +9.9 107,243 +0.5 2,935,542 +9.1 1,152,663 +10.6 –7.2 1,398,408 106,754 2,691,087 1,041,865 423,807 2,660,019 1,041,947 392,195 ¥4,094,161 393,141 Sales by Product (Millions of yen) Business Machines Office imaging products Computer peripherals Business information products Cameras Optical and other products 5,000,000 Sales by Region (Millions of yen) Japan Americas Europe Other areas 5,000,000 15 12 9 6 3 0 11.0 10.9 9.9 10.2 4,000,000 3,754,191 3,467,853 4,000,000 3,754,191 3,467,853 4,481,346 4,156,759 4,094,161 4,481,346 4,156,759 4,094,161 7.6 3,000,000 2,000,000 1,000,000 3,000,000 2,000,000 1,000,000 04 05 06 07 08 0 04 05 06 07 08 0 04 05 06 07 08 49 Sales of business machines, constituting 65.0% of consolidated net sales, decreased by 9.4% to ¥2,660,019 million (U.S.$29,231 million) in ﬁ scal 2008. In the business machines segment, as demand for network digital MFDs shifted toward color models for the ofﬁ ce imaging products category, the appreciation of the yen along with restrained investment in ofﬁ ce equipment due to concern over business performance led to ﬂ agging sales in major regions. Consequently, sales for the category declined by 13.3% to ¥1,119,523 million (U.S.$12,302 million) in ﬁ scal 2008. Color ofﬁ ce imaging products accounted for 37% in ﬁ scal 2008 and 35% in ﬁ scal 2007 of ofﬁ ce imaging products sales while monochrome ofﬁ ce imaging products accounted for 41% and 45% in ﬁ scal 2008 and 2007, respectively. Sales of facsimiles and information system business accounted for the residual 22% and 20% of ofﬁ ce imaging products sales in ﬁ scal 2008 and 2007, respectively. Sales of computer peripherals decreased by 5.4% in ﬁ scal 2008 to ¥1,454,768 million (U.S.$15,986 million). Laser beam printers sales suffered the signiﬁ cant impact of the strong yen along with reduced demand, resulting in a decrease in sales volume for monochrome models and slight increase for color models. As for inkjet printers, while sales volume for single- function models continued to drop, efforts focusing on expanded sales of multifunction business-use models resulted in an overall increase in sales volume. Sales of business information products decreased by 20.1%, to ¥85,728 million (U.S.$942 million) in ﬁ scal 2008 due to reduced personal computer sales in the Japanese domestic market. With regard to servers and personal computers, the decline in sales was caused by Canon’s change in marketing strategy from selling single products to a solutions business involving combinations of various products. Sales of cameras declined by 9.6% in ﬁ scal 2008, totaling ¥1,041,947 million (U.S.$11,450 million). The high-resolution, competitively priced EOS Digital Rebel XSi (EOS 450D) and advanced-amateur model EOS 40D enjoyed healthy sales, contributing to growth in sales volume for digital SLR cameras. Sales volume also increased for compact digital cameras despite stagnant market conditions as the company bolstered its product lineup with the introduction of 16 new models, including 6 new ELPH (IXUS)-series models and 10 PowerShot-series models. Consequently, unit sales of digital cameras increased by 4% year on year. Sales of cameras constituted 25.4% of consolidated net sales in ﬁ scal 2008. Sales of optical and other products decreased by 0.2% in ﬁ scal 2008, to ¥392,195 million (U.S.$4,310 million). Within this segment, while sales of aligners, used to produce LCD panels, gained momentum owing to a recovery in demand, sales of steppers, used in the production of semiconductors, remained stagnant due to deteriorating market conditions. Sales of optical and other products constituted 9.6% of consolidated net sales in ﬁ scal 2008. Sales by region A geographical analysis indicates that net sales in ﬁ scal 2008 decreased in each of the major regions. In Japan, sales of ofﬁ ce imaging products within the business machines segment dropped by 3.5% in ﬁ scal 2008 mainly due to weakened sales of monochrome models of network digital MFDs. Although sales of video camcorders recorded solid growth, overall sales of the cameras segment decreased by 8.7% led by reduced demand for compact digital cameras. Sales of optical and other products decreased by 22.8% mainly due to a reduced demand for steppers. As a result, net sales in the region decreased by 8.4% in ﬁ scal 2008 from ﬁ scal 2007. In the Americas, net sales decreased by 1.6% on a local currency basis in ﬁ scal 2008, mainly due to reduced sales of such products as monochrome network MFDs and compact digital cameras. On a yen basis, net sales in the Americas declined by 13.6% in ﬁ scal 2008 as the yen strengthened to the U.S. dollar rapidly and signiﬁ cantly. In Europe, net sales fell by 3.4% on a local currency basis in ﬁ scal 2008, mainly due to reduced sales of such products as compact digital cameras and laser beam printers. On a yen basis, net sales in Europe dropped by 10.5% in ﬁ scal 2008 resulting from the impact of the rapid appreciation of the yen to the euro. Sales in other areas increased by 4.5% on a yen basis in ﬁ scal 2008, reﬂ ecting the robust rise in sales of digital cameras and aligners. A summary of net sales by region is provided below: SALES BY REGION Japan Americas Europe Other areas Total Millions of yen 2008 ¥ 868,280 1,154,571 –13.6 1,341,400 –10.5 729,910 +4.5 ¥4,094,161 2007 2006 change change –8.4% ¥ 947,587 +1.6% ¥ 932,290 $ 9,541,538 12,687,593 14,740,659 8,020,990 –8.6% ¥4,481,346 +7.8% ¥4,156,759 $44,990,780 1,336,168 +4.1 1,499,286 +14.1 698,305 +11.5 1,283,646 1,314,305 626,518 Thousands of U.S.dollars 2008 Note: This summary of net sales by region of destination is determined by the location of the customer. 50 SEGMENT INFORMATION BY PRODUCT Millions of yen 2008 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Depreciation and amortization Increase in property, plant and equipment 2007 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Depreciation and amortization Increase in property, plant and equipment 2006 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Depreciation and amortization Increase in property, plant and equipment Thousands of U.S.dollars 2008 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Depreciation and amortization Increase in property, plant and equipment Business Machines Cameras Optical and Other Products Corporate and Eliminations Consolidated — 2,660,019 2,115,375 ¥ 2,660,019 ¥ 1,041,947 — 1,041,947 854,160 ¥ 544,644 ¥ 187,787 ¥ 1,487,885 ¥ 499,287 39,412 43,086 163,920 172,197 (235,690) (235,690) (44,823) ¥ 392,195 ¥ 235,690 627,885 673,375 — ¥ 4,094,161 — 4,094,161 3,598,087 ¥ (45,490) ¥ (190,867) ¥ 496,074 ¥ 495,095 ¥ 1,487,667 ¥ 3,969,934 341,337 88,017 361,988 68,542 49,988 78,163 ¥ 2,935,542 ¥ 1,152,663 — — 1,152,663 2,935,542 845,237 2,285,281 ¥ 650,261 ¥ 307,426 ¥ 1,762,167 ¥ 561,504 37,180 32,870 159,309 166,143 — 2,691,087 2,091,858 ¥ 2,691,087 ¥ 1,041,865 — 1,041,865 773,127 ¥ 599,229 ¥ 268,738 ¥ 1,617,198 ¥ 542,866 28,756 31,517 127,873 154,259 ¥ 393,141 238,659 631,800 610,720 ¥ 21,080 ¥ 544,734 69,843 78,449 ¥ 423,807 190,687 614,494 573,019 ¥ 41,475 ¥ 501,008 37,018 36,272 ¥ (238,659) (238,659) (16,565) — ¥ 4,481,346 — 4,481,346 3,724,673 ¥ (222,094) ¥ 756,673 ¥ 1,644,220 ¥ 4,512,625 341,694 428,549 75,362 151,087 ¥ (190,687) (190,687) 11,722 — ¥ 4,156,759 — 4,156,759 3,449,726 ¥ (202,409) ¥ 707,033 ¥ 1,860,843 ¥ 4,521,915 262,294 379,657 68,647 157,609 Business Machines Cameras Optical and Other Products Corporate and Eliminations Consolidated $ 29,230,978 $ 11,449,967 $ 4,309,835 $ — $ 44,990,780 — 2,590,000 (2,590,000) — — 6,899,835 (2,590,000) 44,990,780 29,230,978 11,449,967 23,245,879 9,386,374 (492,561) 39,539,417 7,399,725 $ 5,985,099 $ 2,063,593 $ (499,890) $ (2,097,439) $ 5,451,363 $ 16,350,385 $ 5,486,670 $ 5,440,604 $ 16,347,989 $ 43,625,648 549,318 3,750,956 1,801,319 858,934 3,977,890 1,892,275 967,220 753,209 433,099 473,472 Notes: 1. General corporate expenses of ¥190,698 million (U.S.$2,096 million), ¥221,979 million and ¥202,328 million in the years ended December 31, 2008, 2007 and 2006, respectively, are included in “Corporate and Eliminations.” 2. Corporate assets of ¥1,487,667 million (U.S.$16,348 million), ¥1,644,220 million and ¥1,860,933 million as of December 31, 2008, 2007 and 2006, respectively, which mainly consist of cash and cash equivalents, short-term investments, investments and corporate properties, are included in “Corporate and Eliminations.” 3. The segments are deﬁ ned under Japanese GAAP. In grouping of segment information by product, Japanese GAAP requires that consideration be given to similarities of product types and characteristics, manufacturing methods, sales markets, and other factors that are similar. 4. As noted in Note 1-(k) of the Notes to Consolidated Financial Statements, effective April 1, 2007, the Company and its domestic subsidiaries elected to change the declining-balance method of depreciating machinery and equipment. The change in depreciation methods caused an increase in depreciation expense by ¥29,148 million in the Business Machines segment, ¥6,451 million in the Cameras segment, ¥15,540 million in the Optical and Other Products segment and ¥12,634 million in Corporate and Eliminations. 51 SEGMENT INFORMATION BY GEOGRAPHIC AREA Millions of yen 2008 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses p Operating proﬁ t Assets g p 2007 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets 2006 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Thousands of U.S.dollars 2008 Net sales: Unafﬁ liated customers Intersegment Total Operating cost and expenses Operating proﬁ t Assets Japan Americas Europe Others Corporate and Eliminations Consolidated ¥ 998,676 ¥ 1,141,560 ¥ 1,337,147 ¥ 616,778 ¥ — ¥ 4,094,161 — (2,997,286) 2,318,521 4,094,161 (2,997,286) 3,317,197 3,598,087 (2,857,655) 2,757,356 40,300 ¥ (139,631) ¥ 496,074 ¥ 559,841 ¥ ¥ 1,908,675 ¥ 458,189 ¥ 477,571 ¥ 317,684 ¥ 807,815 ¥ 3,969,934 3,758 1,145,318 1,136,288 670,678 1,287,456 1,247,156 4,329 1,341,476 1,314,942 26,534 ¥ 9,030 ¥ ¥ 1,048,310 ¥ 1,329,479 ¥ 1,499,821 ¥ 603,736 ¥ 4,608 1,334,087 1,281,805 (3,327,199) 2,494,251 (3,327,199) 3,542,561 (3,100,082) 2,722,672 (227,117) ¥ 819,889 ¥ ¥ 2,715,294 ¥ 506,295 ¥ 732,579 ¥ 367,234 ¥ 191,223 824,844 1,428,580 1,378,306 3,496 1,503,317 1,441,972 52,282 ¥ 61,345 ¥ 50,274 ¥ — ¥ 4,481,346 — 4,481,346 3,724,673 ¥ 756,673 ¥ 4,512,625 ¥ 1,037,657 ¥ 1,277,867 ¥ 1,313,919 ¥ 527,316 ¥ 4,764 1,282,631 1,236,138 (3,111,850) 2,311,482 (3,111,850) 3,349,139 (2,893,377) 2,558,685 (218,473) ¥ 790,454 ¥ ¥ 2,644,116 ¥ 432,001 ¥ 682,381 ¥ 339,314 ¥ 424,103 792,018 1,319,334 1,275,817 3,586 1,317,505 1,272,463 46,493 ¥ 45,042 ¥ 43,517 ¥ — ¥ 4,156,759 — 4,156,759 3,449,726 ¥ 707,033 ¥ 4,521,915 Japan Americas Europe Others Corporate and Eliminations Consolidated 41,297 — $ 44,990,780 $ 10,974,462 $ 12,544,615 $ 14,693,923 $ 6,777,780 $ 25,478,252 — 36,452,714 12,585,912 14,741,495 14,147,868 (32,937,209) 44,990,780 30,300,615 12,486,681 14,449,913 13,705,011 (31,402,803) 39,539,417 $ 6,152,099 $ 442,857 $ (1,534,406) $ 5,451,363 $ 20,974,451 $ 5,035,044 $ 5,248,033 $ 3,491,033 $ 8,877,087 $ 43,625,648 47,572 7,370,088 (32,937,209) 291,582 $ 99,231 $ Notes: 1. General corporate expenses of ¥190,698 million (U.S.$2,096 million), ¥221,979 million and ¥202,328 million in the years ended December 31, 2008, 2007 and 2006, respectively, are included in “Corporate and Eliminations.” 2. Corporate assets of ¥1,487,667 million (U.S.$16,348 million), ¥1,644,220 million and ¥1,860,933 million as of December 31, 2008, 2007 and 2006, respectively, which mainly consist of cash and cash equivalents, short-term investments, investments and corporate properties, are included in “Corporate and Eliminations.” 3. Segment information by geographic area is determined by the location of the Company or its relevant subsidiary making the sale. The segments are deﬁ ned under Japanese GAAP. In grouping of segment information by geographic area, Japanese GAAP requires that consideration be given to geographic proximity, as well as similarities of economic activities, interrelationships of business activities and other similar factors. 52 Operating proﬁ t by product Operating proﬁ t for business machines in ﬁ scal 2008 decreased by ¥105,617 million (U.S.$1,161 million) to ¥544,644 million (U.S.$5,985 million). This decrease resulted primarily from the reduction in sales. Operating proﬁ t for cameras in ﬁ scal 2008 decreased by ¥119,639 million (U.S.$1,315 million) to ¥187,787 million (U.S.$2,064 million) as a result of the drop in sales value, coupled with the signiﬁ cant decline in the gross proﬁ t ratio stemming from falling prices and the effects of the strong yen. Operating proﬁ t for optical and other products in ﬁ scal 2008 decreased by ¥66,570 million (U.S.$732 million) to a loss of ¥45,490 million (U.S.$500 million) as a result of a signiﬁ cant increase in cost of sales and outlays due to such factors as the disposal of inventories, which was carried out in response to rising concerns that weak market sentiment may continue, the appreciation of the yen, along with an impairment charge for ﬁ xed assets equipped with current technologies. FOREIGN OPERATIONS AND FOREIGN CURRENCY TRANSACTIONS Canon’s marketing activities are performed by subsidiaries in various regions in local currencies, while the cost of sales is generally in yen. Given Canon’s current operating structure, appreciation of the yen has a negative impact on net sales and the gross proﬁ t ratio. To reduce the ﬁ nancial risks from changes in foreign exchange rates, Canon utilizes derivative ﬁ nancial instruments, which are comprised principally of forward currency exchange contracts. The return on foreign operation sales is usually lower than that from domestic operations because foreign operations consist mainly of marketing activities. Return on foreign operation sales is calculated by dividing net income of foreign subsidiaries, after factoring in consolidation adjustments between foreign subsidiaries, by net sales of foreign subsidiaries. Marketing activities are generally less proﬁ table than production activities, which are mainly conducted by the Company and its domestic subsidiaries. The returns on foreign operation sales in ﬁ scal 2008, 2007 and 2006 were 2.3%, 4.0% and 3.7%, respectively. This compares with returns of 7.6%, 10.9% and 11.0% on consolidated operations for the respective years. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents in ﬁ scal 2008 decreased by ¥265,267 million (U.S.$2,915 million) to ¥679,196 million (U.S.$7,464 million), compared with ¥944,463 million in ﬁ scal 2007 and ¥1,155,626 million in ﬁ scal 2006. Canon’s cash and cash equivalents are typically denominated both in Japanese yen and in U.S. dollar, with the remainder denominated in foreign currencies. Net cash provided by operating activities in ﬁ scal 2008 decreased by ¥222,585 million (U.S.$2,446 million) from the previous year to ¥616,684 million (U.S.$6,777 million), reﬂ ecting the decrease in sales and decreased cash proceeds from sales, combined with a decrease in net income. Cash ﬂ ow from operating activities consisted of the following key components: the major component of Canon’s cash inﬂ ow is cash received from customers, and the major components of Canon’s cash outﬂ ow are payments for parts and materials, selling, general and administrative expenses, and income taxes. For ﬁ scal 2008, cash inﬂ ow from cash received from customers decreased, due to the decrease in net sales. There were no signiﬁ cant changes in Canon’s collection rates. Cash outﬂ ow for payments for parts and materials also decreased, as a result of a decrease in net sales and cost reductions. Cost reductions reﬂ ect a decline in unit prices of parts and raw materials, as well as a streamlining of the process of using these parts and materials through promoting efﬁ ciency in operations. Cash outﬂ ow for payments for selling, general and administrative expenses increased despite cost-cutting efforts. Cash outﬂ ow for payments of income taxes decreased, due to the decrease in taxable income. Net cash used in investing activities in ﬁ scal 2008 was ¥472,480 million (U.S.$5,192 million), compared with ¥432,485 million in ﬁ scal 2007 and ¥460,805 million in ﬁ scal 2006, consisting primarily of purchases of ﬁ xed assets. The purchases of ﬁ xed assets which totaled ¥428,168 million (U.S.$4,705 mil- lion) in ﬁ scal 2008 were mainly concentrated to items relevant to reinforcing production and achieving cost reduction, along with the acquisition of shares of Hitachi Displays, Ltd. toward the launch of Canon’s display business. Canon deﬁ nes “free cash ﬂ ow” by deducting the cash ﬂ ows from investing activities from the cash ﬂ ows of operating activities. For ﬁ scal 2008, free cash ﬂ ow totaled ¥144,204 million (U.S.$1,585 million) as compared to ¥406,784 million for ﬁ scal 2007. Canon’s management recognizes that constant and 53 intensive investment in facilities and R&D is required to maintain and strengthen the competitiveness of its products. Canon’s management seeks to meet its capital requirements with cash ﬂ ow principally earned from its operations, therefore, our capital resources are primarily sourced from internally generated funds. Accordingly, Canon has included the information with regard to free cash ﬂ ow as its management frequently monitors this indicator, and believes that such indicator is beneﬁ cial to the understanding of investors. Furthermore, Canon’s management believes that this indicator is signiﬁ cant in understanding Canon’s current liquidity and the alternatives of use in ﬁ nancing activities because it takes into consideration its operating and investing activities. Canon refers to this indicator together with relevant U.S. GAAP ﬁ nancial measures shown in its consolidated state- ments of cash ﬂ ows and consolidated balance sheets for cash availability analysis. Net cash used in ﬁ nancing activities totaled ¥277,565 million (U.S.$3,050 million) in ﬁ scal 2008, mainly resulting from the ¥100,000 million (U.S.$1,099 million) purchase of treasury stock with the aim of improving capital efﬁ ciency and ensuring a ﬂ exible capital strategy in addition to the dividend payout of ¥145,000 million (U.S.$1,593 million). The Company paid dividends in ﬁ scal 2008 of ¥110.00 (U.S.$1.21) per share, the same dividend amount as the prior year on a local currency basis. Canon seeks to meet its capital requirements principally with cash ﬂ ow from operations although Canon expects net cash provided by operating activities in ﬁ scal 2009 is likely to decline. In response to this expectation, Canon is currently endeavoring to optimize the level of capital investments, by further raising the efﬁ ciency of its investments and focusing investments on selected material items. Consistent with this objective, Canon continued to reduce its reliance on external funding for capital investments in favor of relying upon internally generated cash ﬂ ows. This approach is supplemented with group-wide treasury and cash management activities undertaken at the parent company level. To the extent Canon relies on external funding for its liquidity and capital requirements, it generally has access to various funding sources, including the issuance of additional share capital, long- term debt or short-term loans. While Canon has been able to obtain funding from its traditional ﬁ nancing sources and from the capital markets, and believes it will continue to be able to do so in the future, there can be no assurance that adverse economic or other conditions will not affect Canon’s liquidity or long-term funding in the future. Short-term loans (including current portion of long-term debt) amounted to ¥5,540 million (U.S.$61 million) at December 31, 2008 compared to ¥18,317 million at December 31, 2007. Long-term debt (excluding current portion) amounted to ¥8,423 million (U.S.$93 million) at December 31, 2008 compared to ¥8,680 million at December 31, 2007. Canon’s long-term debt (excluding current portion) generally consists of lease obligations. In order to facilitate access to global capital markets, Canon obtains credit ratings from two rating agencies: Moody’s Investors Services, Inc. (“Moody’s”) and Standard and Poor’s Rating 54 Services (“S&P”). In addition, Canon maintains a rating from Rating and Investment Information, Inc. (“R&I”), a rating agency in Japan, for access to the Japanese capital market. As of February 27, 2009, Canon’s debt ratings are: Moody’s: Aa1 (long-term); S&P: AA (long-term), A-1+ (short-term); and R&I: AA+ (long-term). Canon does not have any rating down- grade triggers that would accelerate the maturity of a material amount of its debt. A downgrade in Canon’s credit ratings or outlook could, however, increase the cost of its borrowings. Increase in property, plant and equipment on an accrual basis in ﬁ scal 2008 amounted to ¥361,988 million (U.S.$3,978 million) compared with ¥428,549 million in ﬁ scal 2007 and ¥379,657 million in ﬁ scal 2006. In ﬁ scal 2008, increase in property, plant and equipment was mainly used to reinforce production and achieve cost reductions. For ﬁ scal 2009, Canon projects its increase in property, plant and equipment will be approximately ¥315,000 million (U.S.$3,462 million). Employer contributions to Canon’s worldwide deﬁ ned beneﬁ t pension plans were ¥23,033 million (U.S.$253 million) in ﬁ scal 2008, ¥21,720 million in ﬁ scal 2007, ¥44,981 million in ﬁ scal 2006. In addition, employer contributions to Canon’s worldwide deﬁ ned contribution pension plans were ¥10,840 million (U.S.$119 million) in ﬁ scal 2008, ¥10,262 million in ﬁ scal 2007, and ¥6,233 million in ﬁ scal 2006. Increase in Property, Plant and Equipment (Millions of yen) 500,000 400,000 300,000 200,000 100,000 0 428,549 383,784 379,657 361,988 318,730 04 05 06 07 08 OFF-BALANCE SHEET ARRANGEMENTS As part of its ongoing business, Canon does not participate in transactions that generate relationships with unconsolidated entities or ﬁ nancial partnerships, such as entities often referred to as structured ﬁ nance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Canon provides guarantees for bank loans of its employees, afﬁ liates and other companies. Canon would have to perform under a guarantee if the borrower defaults on a payment within the contract periods of 1 year to 30 years in the case of employees with housing loans, and of 1 year to 10 years in the case of afﬁ liates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default by all borrowers was ¥22,308 million (U.S.$245 million) at December 31, 2008. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees were insigniﬁ cant. Working capital in ﬁ scal 2008 decreased by ¥231,234 million (U.S.$2,541 million), to ¥1,120,848 million (U.S.$12,317 million), compared with ¥1,352,082 million in ﬁ scal 2007 and ¥1,619,042 million in ﬁ scal 2006. This decrease was primarily a result of a decrease in cash and cash equivalents. Canon believes its working capital will be sufﬁ cient for its requirements for the foreseeable future. Canon’s capital requirements are primarily dependent on management’s business plans regarding the levels and timing of purchases of ﬁ xed assets and investments. The working capital ratio (ratio of current assets to current liabilities) for ﬁ scal 2008 was 2.19 compared to 2.08 for ﬁ scal 2007 and 2.39 for ﬁ scal 2006. Return on assets (net income divided by the average of total assets) was 7.3% in ﬁ scal 2008, compared to 10.8% in ﬁ scal 2007 and 10.6% in ﬁ scal 2006. Return on stockholders’ equity (net income divided by the average of total stockholders’ equity) was 11.1% in ﬁ scal 2008 compared with 16.5% in ﬁ scal 2007 and 16.3% in ﬁ scal 2006. Debt to total assets ratio was 0.4%, 0.6% and 0.7% as of December 31, 2008, 2007 and 2006, respectively. Canon had short-term loans and long-term debt of ¥13,963 million (U.S.$153 million) as of December 31, 2008, ¥26,997 million as of December 31, 2007 and ¥31,151 million as of December 31, 2006. Working Capital Ratio Return on Stockholders’ Eqiuty (%) 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2.39 2.27 2.28 2.19 2.08 04 05 06 07 08 20 15 10 5 0 16.8 16.0 16.3 16.5 11.1 04 05 06 07 08 55 CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS The following summarizes Canon’s contractual obligations at December 31, 2008. Millions of yen Contractual obligations: Long-term debt: Capital lease obligations Other long-term debt Operating lease obligations Purchase commitments for: Property, plant and equipment Parts and raw materials Total Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period ¥ 13,648 95 52,049 74,909 60,281 ¥200,982 ¥ 5,313 7 15,221 74,909 60,281 ¥155,731 ¥ 7,388 27 18,946 — — ¥26,361 ¥ 924 33 9,107 — — ¥10,064 ¥ 23 28 8,775 — — ¥8,826 Note: The table does not include provisions for uncertain tax positions and related accrued interest and penalties, as the speciﬁ c timing of future payments related to these obligations cannot be projected with reasonable certainty. See Note 14, Income Taxes in the Notes to Consolidated Financial Statements for further details. Thousands of U.S.dollars Contractual obligations: Long-term debt: Capital lease obligations Other long-term debt Operating lease obligations Purchase commitments for: Property, plant and equipment Parts and raw materials Total Total Less than 1 year 1-3 years 3-5 years More than 5 years Payments due by period $ 149,978 1,044 571,967 $ 58,385 77 167,264 823,176 662,429 $2,208,594 823,176 662,429 $1,711,331 $ 81,187 297 208,198 — — $289,682 $ 10,154 362 100,077 — — $110,593 $ 252 308 96,428 — — $96,988 During ﬁ scal 2009, Canon expects to contribute ¥14,439 million (U.S.$159 million) to its Japanese deﬁ ned beneﬁ t pension plans and ¥3,485 million (U.S.$38 million) to its foreign deﬁ ned beneﬁ t pension plans. Canon’s management believes that current ﬁ nancial resources, cash generated from operations and Canon’s potential capacity for additional debt and/or equity ﬁ nancing will be sufﬁ cient to fund current and future capital requirements. Canon provides warranties of generally less than one year against defects in materials and workmanship on most of its consumer products. Estimated product warranty related costs are established at the time revenue is recognized and is included in selling, general and administrative expenses. Estimates for accrued product warranty cost are primarily based on historical experience, and are affected by ongoing product failure rates, speciﬁ c product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. As of December 31, 2008, accrued product warranty costs amounted to ¥17,372 million (U.S.$191 million). At December 31, 2008, commitments outstanding for the purchase of property, plant and equipment were approximately ¥74,909 million (U.S.$823 million), and commitments outstanding for the purchase of parts and raw materials were approximately ¥60,281 million (U.S.$662 million), both for use in the ordinary course of its business. Canon anticipates that funds needed to fulﬁ ll these commitments will be generated internally through operations. 56 Canon is developing and strengthening relationships with universities and other research institutes, such as Kyoto University, Tokyo Institute of Technology, Stanford University, the New Energy and Industrial Technology Development Organization and the National Institute of Advanced Industrial Science and Technology, to assist with fundamental research and to develop cutting-edge technologies. Canon has fully introduced 3D-CAD systems across the Canon group, boosting R&D efﬁ ciency to curtail product development times and costs. Moreover, Canon enhanced and evolved its simulation, measurement, and analysis technologies by establishing leading-edge facilities, including one of Japan’s highest-performance cluster computers. As such, Canon has succeeded in further reducing the need for prototypes, dramatically lowering costs and shortening product development lead times. Canon has R&D centers worldwide. Each R&D center is collaborating with other centers to achieve synergies, and is cultivating closer ties in ﬁ elds ranging from basic research to product development. Canon’s consolidated R&D expenditures were ¥374,025 million (U.S.$4,110 million) in ﬁ scal 2008, ¥368,261 million in ﬁ scal 2007 and ¥308,307 million in ﬁ scal 2006. The ratios of R&D expenditures to the consolidated total net sales for ﬁ scal 2008, 2007 and 2006 were 9.1%, 8.2% and 7.4%, respectively. Canon believes that new products protected by patents will not easily allow competitors to compete with it, and will give it an advantage in establishing standards in the market and industry. According to the United States patent annual list, which IFI CLAIMS® Patent Services released, Canon obtained the third greatest number of private sector patents in 2008. This achieve- ment marks Canon’s seventeenth consecutive year as one of the top three patent-receiving private-sector organizations. MARKET RISK EXPOSURE Canon is exposed to market risks, including changes in foreign currency exchange rates, interest rates and prices of marketable securities and investments. In order to hedge the risks of changes in foreign currency exchange rates, Canon uses derivative ﬁ nancial instruments. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES Canon is in the third year of the Excellent Global Corporation Plan, its 5-year (2006-2010) management plan. The slogan of the third phase (“Phase III”) is “Innovation & Sound Growth” and there are four core strategies: • Realize an overwhelming No.1 position worldwide in all current core businesses; • Expand operations through diversiﬁ cation; • Identify new business domains and accumulate necessary technological capabilities; and • Establish new production system to sustain global competitiveness. Canon is striving to implement the three R&D related strategies as follows: • Realize an overwhelming No.1 position worldwide in all current core businesses: Pursue development of new products which enable “cross-media imaging” by sophisti- cated functional synergy among the variety of Canon’s image handling products, beneﬁ ting from the proliferation of broad band communication environment. • Expand operations through diversiﬁ cation: Focus on developing various types of display, including Surface- conduction Electron-emitter Display (“SED”) and Organic Light-Emitting Diode displays (“OLED”). • Identify new business domains and accumulate necessary technological capabilities: Accumulate technological capability in each of the medical imaging sector, intelligent robot industry and safety technology domain. R&D Expenditure (Millions of yen) 400,000 368,261 374,025 308,307 286,476 300,000 275,300 200,000 100,000 0 04 05 06 07 08 57 Equity price risk Canon holds marketable securities included in current assets, which consist generally of highly-liquid and low-risk instruments. Investments included in noncurrent assets are held as long-term investments. Canon does not hold marketable securities and investments for trading purposes. Maturities and fair values of such marketable securities and investments with original maturities of more than three months were as follows at December 31, 2008. Available-for-sale securities Due within one year Due after one year through ﬁ ve years Due after ﬁ ve years through ten years Equity securities Millions of yen Thousands of U.S. dollars Cost ¥ 134 3,542 848 10,522 ¥15,046 Fair value 150 ¥ 3,426 811 12,218 ¥16,605 Cost $ 1,473 38,923 9,318 115,627 $165,341 Fair value $ 1,648 37,648 8,912 134,264 $182,472 Foreign currency exchange rate and interest rate risk Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative ﬁ nancial instruments are comprised principally of foreign currency exchange contracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign currency exchange rate risk by continually monitoring changes in the exposures and by evaluat- ing hedging opportunities. Canon does not hold or issue deriva- tive ﬁ nancial instruments for trading purposes. Canon is also exposed to credit-related losses in the event of non-performance by counterparties to derivative ﬁ nancial instruments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are internationally recognized ﬁ nancial institutions and selected by Canon taking into account their ﬁ nancial condition, and contracts are diversiﬁ ed across a number of major ﬁ nancial institutions. Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses foreign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dollars and euros into Japanese yen. These contracts are primarily used to hedge the foreign currency exposure of forecasted intercompany sales and intercompany trade receivables which are denominated in foreign currencies. In accordance with Canon’s policy, a speciﬁ c portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. The following table provides information about Canon’s major derivative ﬁ nancial instruments related to foreign currency exchange transactions existing at December 31, 2008. All of the foreign exchange contracts described in the following table have a contractual maturity date in 2009. U.S.$ Euro Others Total ¥179,239 8,391 ¥152,423 (1,390) ¥19,297 710 ¥350,959 7,711 ¥ 24,518 (9) ¥ 1,000 7 ¥ 9,729 2,129 ¥ 35,247 2,127 U.S.$ Euro Others Total $ 1,969,659 92,209 $ 1,674,978 (15,275) $ 212,055 7,802 $ 3,856,692 84,736 $ 269,429 (99) $ 10,989 77 $ 106,912 23,395 $ 387,330 23,373 Millions of yen Forwards to sell foreign currencies: Contract amounts Estimated fair value Forwards to buy foreign currencies: Contract amounts Estimated fair value Thousands of U.S. dollars Forwards to sell foreign currencies: Contract amounts Estimated fair value Forwards to buy foreign currencies: Contract amounts Estimated fair value 58 All of Canon’s long-term debt is ﬁ xed rate debt. Canon believes that fair value changes, and cash ﬂ ows resulting from reasonable near-term changes in interest rates would be immaterial. Accordingly, Canon considers interest rate risk is insigniﬁ cant. See also Note 11 of the Notes to Consolidated Financial Statements. Changes in the fair value of derivative ﬁ nancial instruments designated as cash ﬂ ow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassiﬁ ed into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all such amounts recorded in accumulated other comprehensive income (loss) at year-end are expected to be recognized in earnings over the next 12 months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign exchange contract for the period between the date that the forecasted intercompany sales occur and its maturity date are recognized in earnings and not considered hedge ineffectiveness. The amount of the hedging ineffectiveness was not material for the years ended December 31, 2008, 2007 and 2006. The amounts of net losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) was ¥3,701 million (U.S.$41 million), ¥6,883 million and ¥5,917 million for the years ended December 31, 2008, 2007 and 2006, respectively. Canon has entered into certain foreign currency exchange contracts to manage its foreign currency exposures. These foreign currency exchange contracts have not been designated as hedges. Accordingly, the changes in fair values of the contracts are recorded in earnings immediately. LOOKING FORWARD Regarding the global economy, given the combined effects of economic downturns in the leading industrialized countries and deceleration in emerging countries, it is expected that growth rates will decrease greatly and a strong sense of stagnation will continue. The business conditions for Canon are also expected to continue to be severe due to factors such as the trend of a strong yen in the foreign exchange markets. Much of the deterioration in market conditions for Canon’s three product groups occurred in the fourth quarter of ﬁ scal 2008 so that the full-year 2009 net sales volumes for Canon’s product groups are likely to decline further from ﬁ scal 2008 levels and continue to adversely affect Canon’s operating results. Canon expects net sales volumes to remain at suppressed levels in ﬁ scal 2010 and to continue to adversely affect ﬁ scal 2010 operating results. Under these conditions, Canon, in the fourth year of Phase III (2006 to 2010) of its “Excellent Global Corporation Plan”, will make the most of management reforms achieved to date and take all measures for future growth in order to achieve further improvements in management quality. In other words, Canon will respond swiftly to the present difﬁ cult business conditions and structure itself as a lean organization by using this year to prepare to take advantage of improved conditions in the future. Toward that goal, Canon’s key objectives will be, ﬁ rst of all, to achieve timely introductions of new products satisfactory to customers in every aspect of functionality, design, ease of use, reliability and cost performance, and to secure No. 1 market positions in each of its businesses. Next, amid a strong yen, massive ﬂ uctuations in raw material prices, falling product prices and conditions changing in other respects, Canon will work to lower its costs by, for example, pursuing production and procurement reform activities to an even greater degree and practicing prototype-less development. Furthermore, in the face of stagnant market conditions, Canon will improve the quality of products thoroughly by renewing its appreciation of product quality as the lifeblood of a manufacturer and taking to heart the supremacy of quality. Additionally, through collaboration with Hitachi Displays, Ltd., of which Canon acquired shares during the current term, Canon will concentrate on strengthening the display operation as a new core business. Canon also aims to add signiﬁ cant strength in new businesses by actively launching new products in the ﬁ eld of medical equipment and by pursuing other initiatives as well. With eyes focused on taking Canon to new heights, promot- ing its perpetual development and turning it into a truly excellent global company that continues to prosper, Canon will work to strengthen its unique core technology research system and develop management personnel, while also devoting even greater efforts to social contribution activities. Business machines segment Ofﬁ ce imaging products In the ofﬁ ce imaging products segment, it has become more important to provide added value in the form of networking, integration, color printing and multifunction models. Also, in addition to the stable market for mid-segment ofﬁ ce products, Canon expects that the market for higher-end models and low-end multifunction models will expand in the long term. The market for color network digital MFDs continued to grow, but sales of monochrome network digital MFDs decreased in 2008 due to the global economic downturn and the shifting market trend from monochrome to color models. In recent years, there has been a new printer-based multifunction printer (“MFP”) market emerging that has been created by printer vendors as they seek to enter the copier and MFD market. To maintain and enhance a competitive edge and to meet more sophisticated customer demands, Canon is strengthening its marketing capabilities by reinforcing its hardware and software product lineups and by improving functionality. In 2008, Canon strengthened the product lineups of its color digital devices as well as its monochrome machines and maintained its market share by executing business strategies in line with current market trends. 59 Computer peripheral products In the inkjet printer market, Canon expects a slowdown in market growth led by the global economic slowdown, and the shift from single-function printers (“SFPs”) to MFPs. To manage these trends, Canon has focused on selling mid-range to high-end models which enables large volume of printing, including the business-use multifunction models equipped with a facsimile function, and simultaneously has strengthened its lineup to entry models with the utmost effort to expand overall sales. Canon’s laser beam printer business had been maintaining a strong position in the market, which had consecutively displayed solid growth. However, the deterioration of the current global economy has led to a dramatic decline in the market as a whole, raising uncertainty in the market. Within the monochrome laser beam printer market, the reduced demand in emerging economies, which had been driving market expansion, was sig- niﬁ cant especially in Russia, in addition to the drop in developed countries. This situation has led to the shrinkage of the overall market. As for color laser beam printers, market growth reversed from expansion to a slight contraction. Amid this severe market conditions, Canon is accelerating the development of competitive, strategic products in all segments to introduce those products on a timely basis and prepare for the recovery of the global economy. Canon is also focused to shift from selling single-function models to multifunction models, as Canon expects continued growth in demand for multifunction models. The promotion of automated production of cartridges, along with in-house production of parts to ensure stable procurement, is concurrently in progress. Business information products As for document scanners, the adoption of internal information management systems by corporations, and other factors are driving a worldwide movement to digitize documents and Canon expects the market for low-priced, compact scanners to continue to expand. With regard to servers and personal com- puters, demand from corporate clients in the Japanese market held steady in ﬁ scal 2008, but a decline in sales was caused by Canon’s change in marketing strategy from selling single products to a solutions business involving combinations of various products. Cameras segment The digital camera market expanded in 2008, despite the slower growth starting in September 2008 due principally to the ﬁ nancial crisis. Developed markets such as the United States exhibited negative growth due to the ﬁ nancial crisis. However, markets in emerging countries such as China and Eastern Europe have continued to expand. The emergence of digital imaging systems such as PC-free direct printing systems has contributed to this growth by expanding digital imaging func- tionality through network connectivity. The improvement of the user-friendly image processing interfaces and software have also boosted growth. Currently, the overall market for digital cameras is stagnant due to the current economic crisis. However, digital cameras are popular among individuals and further expansion is expected once the economy recovers. Nevertheless, as with most other digital consumer electronics, the digital camera market is now confronted with a ﬁ erce price war and intensiﬁ ed technological competition in terms of picture quality and functionality. Proﬁ t margins have been shrinking overall in the industry, and Canon’s proﬁ t ratio has fallen due to the sharp economic downturn and ﬂ uctuations in the foreign exchange rates. Canon expects the market for compact digital cameras to expand in the medium term, thanks to growth in emerging market countries. However, industry proﬁ t margins are eroding due to falling prices and increased competition. Therefore, Canon seeks to continue cutting production costs while expanding sales volumes. Canon believes that it played a major role in the continued expansion of the digital SLR market in ﬁ scal 2008. Although the difﬁ cult global economic situation has resulted in slowed growth, this market is expected to continue to grow in the near term. The trend towards high ISO speeds has moved at a dramatic pace in this digital age. It has become possible with a digital SLR camera to easily take beautiful shots in dark places where shooting with ﬁ lm cameras is impossible. Also, movie functions were added to SLR cameras this year, marking the beginning of a new age for these products. These functions have expanded the possibilities for shooting, and by supporting new user needs, Canon believes it can develop the market even further. Canon expects the interchangeable lens market for SLRs to grow as a result of the market penetration in the digital SLR camera market. Canon aims to expand its sales and market share by introducing the most suitable products for the digital SLR camera users, including products with Canon’s Image Stabilizer capability. Diversiﬁ cation in the global video camcorder market has occurred with various new media appearing, such as DVDs, hard disks and ﬂ ash memories. However, starting in 2008, it became apparent that the trend is heading for ﬂ ash memories to become mainstream in the global video camcorder market and towards High Deﬁ nition (“HD”). Canon believes that these two trends will lead to higher picture quality from smaller video camcorders with longer battery life, and will likely support growth in the overall digital video market. Canon is working to expand sales of its powerful lineup of products that meet a wide range of user 60 Forward looking statements The foregoing discussion and other disclosure in this report contains forward-looking statements that reﬂ ect management’s current views with respect to certain future events and ﬁ nancial performance. Actual results may differ materially from those projected or implied in the forward-looking statements. Further, certain forward-looking statements are based upon assumptions of future events that may not prove to be accurate. The following important factors could cause actual results to differ materially from those projected or implied in any forward-looking statements: foreign currency exchange rate ﬂ uctuations; the uncertainty of Canon’s ability to implement its plans to localize production and other measures to reduce the impact of foreign currency exchange rate ﬂ uctuations; uncertainty as to economic conditions in Canon’s major markets; uncertainty of continued demand for Canon’s high-value-added products; uncertainty as to the recovery of computer and related markets; uncertainty of recovery in demand for Canon’s semiconductor production equipment; Canon’s ability to continue to develop products and to market products that incorporate new technology on a timely basis, are competitively priced, and achieve market acceptance; the possibility of losses resulting from foreign currency transactions designed to reduce ﬁ nancial risks from changes in foreign currency exchange rates; and inventory risk due to shifts in market demand. needs and that use high-quality HD imaging and dual ﬂ ash memory technologies. The business application projector market experienced the effects of the current global economic downturn beginning in the fourth quarter of 2008. Canon has reduced its unit and monetary projections for 2009. The economic slowdown has affected high value-added products ﬁ rst, and the effects have started to be observed in Canon’s high-resolution, high-brightness (high-luminosity), and high value-added products. Notwithstanding this trend, Canon continues to receive inquiries from system integrators and other imaging professionals, and is seeking to expand high value-added sales despite this current global economic downturn. Optical and other products segment In the semiconductor-production equipment industry, equipment manufacturers must provide high quality products corresponding to rapid technology progress. Canon will continue to focus on developing new products which adopt leading-edge technologies, such as immersion exposure technology and ultra precision processing and measurement technology. In the LCD production mask aligner market, Canon will seek to strengthen its technical capabilities to meet the recent trend toward larger glass-substrates due to the increasing demand for larger LCD televisions. In addition, Canon will continue to make distinctive products enabling high resolution and high productivity. In the TV lens market, demand for HDTV, which has grown in the United States and Japan, is now growing in Europe. In particular, there has been increased demand for lenses used for broadcasting sporting events and for producing dramas and documentaries in HDTV. Although Canon has observed a slow- down in demand for these TV lenses starting at the end of ﬁ scal 2008 due to the current global economic downturn, in the medium term, Canon still expects that digitization will drive worldwide replacement demand. At the same time, there have been signs of expanded HDTV applications by the media, starting with relatively inexpensive HDTV production, as the TV lens market structure shows signs of change. Canon already has signiﬁ cant market share worldwide for this class of lens and intends to continue to strengthen its market position in this market. The economic downturn has caused a decline in the large format printer market, accordingly, Canon’s sales fell below last year’s sales performance. Canon will continue to lower costs of production and improve inventory turnover by expanding its market share and achieving economics of scale that improve its proﬁ tability. 61 TEN-YEAR FINANCIAL SUMMARY Net sales: Domestic Overseas Total Percentage of previous year Net income Percentage of sales Advertising Research and development expenses Depreciation of property, plant and equipment Increase in property, plant and equipment Long-term debt, excluding current installments Stockholders’ equity Total assets Per share data: Income before cumulative effect of change in accounting principle: Basic Diluted Net income: Basic Diluted Cash dividends declared Stock price: High Low Millions of yen (except per share amounts) 2008 2007 2006 2005 ¥ 868,280 ¥ 947,587 ¥ 932,290 ¥ 856,205 2,897,986 3,754,191 108.3% 3,533,759 4,481,346 107.8% 3,225,881 4,094,161 91.4% 3,224,469 4,156,759 110.7% 309,148 7.6% 488,332 10.9% 455,325 11.0% 384,096 10.2% 112,810 374,025 304,622 361,988 132,429 368,261 309,815 428,549 116,809 308,307 235,804 379,657 106,250 286,476 205,727 383,784 ¥ 8,423 ¥ 8,680 ¥ 15,789 ¥ 2,659,792 3,969,934 2,922,336 4,512,625 2,986,606 4,521,915 27,082 2,604,682 4,043,553 ¥ 246.21 ¥ 246.20 377.59 ¥ 377.53 341.95 ¥ 341.84 288.63 288.36 246.21 246.20 110.00 5,820 2,215 377.59 377.53 110.00 7,450 5,190 341.95 341.84 83.33 6,780 4,567 288.63 288.36 66.67 4,780 3,460 Average number of common shares in thousands Number of employees 1,255,626 166,980 1,293,296 131,352 1,331,542 118,499 1,330,761 115,583 Common Stock Price Range (Tokyo Stock Exchange) (Yen) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 62 99 00 01 02 03 04 05 06 07 08 2004 2003 2002 2001 2000 1999 2008 Thousands of U.S. dollars (except per share amounts) ¥ 849,734 ¥ 801,400 ¥ 732,551 ¥ 827,288 ¥ 779,366 ¥ 718,513 1,812,383 2,530,896 92.5% 1,917,054 2,696,420 106.5% 2,207,577 2,940,128 101.1% 2,618,119 3,467,853 108.4% 2,396,672 3,198,072 108.8% 2,080,285 2,907,573 107.8% 343,344 9.9% 275,730 8.6% 190,737 6.5% 167,561 5.8% 134,088 5.0% 70,234 2.8% 111,770 275,300 174,397 318,730 100,278 259,140 168,636 210,038 71,725 233,669 158,469 198,702 66,837 218,616 147,286 207,674 67,840 194,552 144,043 170,986 67,544 177,922 155,682 200,386 ¥ 28,651 ¥ 59,260 ¥ 81,349 ¥ 2,209,896 3,587,021 1,865,545 3,182,148 1,591,950 2,942,706 95,526 ¥ 142,925 ¥ 165,277 1,202,003 1,298,914 2,587,532 2,832,125 1,458,476 2,844,756 ¥ 258.53 ¥ 257.85 209.21 ¥ 207.17 145.04 ¥ 143.20 124.71 ¥ 123.03 102.44 ¥ 101.01 258.53 257.85 43.33 3,880 3,273 209.21 207.17 33.33 4,140 2,607 145.04 143.20 20.00 3,500 2,413 127.53 125.80 16.67 3,553 2,100 102.44 101.01 14.00 3,747 2,267 53.77 53.00 53.77 53.00 11.33 2,800 1,447 1,328,048 108,257 1,317,974 102,567 1,315,074 97,802 1,313,940 93,620 1,308,909 86,673 1,306,049 81,009 $ 9,541,538 35,449,242 44,990,780 91.4% 3,397,231 7.6% 1,239,670 4,110,165 3,347,494 3,977,890 $ 92,560 29,228,484 43,625,648 $ 2.71 2.71 2.71 2.71 1.21 63.96 24.34 Notes: 1. U.S. dollar amounts are translated from yen at the rate of U.S.$1 = JPY91, the approximate exchange rate on the Tokyo Foreign Exchange Market as of December 30, 2008. 2. The Company made a three-for-two stock split on July 1, 2006. The average number of common shares and the per share data for the periods prior to the stock split have been adjusted to reﬂ ect the stock split. 63 CONSOLIDATED BALANCE SHEETS CANON INC. AND SUBSIDIARIES ASSETS Current assets: Cash and cash equivalents (Note 1) Short-term investments (Note 4) Trade receivables, net (Note 5) Inventories (Note 6) Prepaid expenses and other current assets (Notes 8 and 14) Total current assets Noncurrent receivables (Note 21) Investments (Note 4) Property, plant and equipment, net (Notes 7 and 8) Intangible assets (Notes 9 and 10) Other assets (Notes 8, 9, 10, 13 and 14) Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Short-term loans and current portion of long-term debt (Note 11) Trade payables (Note 12) Accrued income taxes (Note 14) Accrued expenses (Notes 13 and 21) Other current liabilities (Notes 7 and 14) Total current liabilities Long-term debt, excluding current installments (Note 11) Accrued pension and severance cost (Note 13) Other noncurrent liabilities (Note 14) Total liabilities Minority interests Commitments and contingent liabilities (Note 21) Stockholders’ equity: Common stock Authorized 3,000,000,000 shares; issued 1,333,763,464 shares in 2008 and 1,333,636,210 shares in 2007 (Note 15) Additional paid-in capital (Note 15) Legal reserve (Note 16) Retained earnings (Note 16) Accumulated other comprehensive income (loss) (Note 17) Treasury stock, at cost; 99,275,245 shares in 2008 and 72,588,428 shares in 2007 Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying notes to consolidated ﬁ nancial statements. December 31, 2008 and 2007 Millions of yen Thousands of U.S. dollars (Note 2) 2008 2007 2008 ¥ 679,196 7,651 595,422 506,919 275,660 2,064,848 14,752 88,825 1,357,186 119,140 325,183 ¥ 3,969,934 ¥ 5,540 406,746 69,961 277,117 184,636 944,000 8,423 110,784 55,745 1,118,952 191,190 ¥ 944,463 20,499 794,240 563,474 286,111 2,608,787 15,239 90,086 1,364,702 112,516 321,295 ¥ 4,512,625 ¥ 18,317 514,226 150,726 357,525 215,911 1,256,705 8,680 44,710 57,324 1,367,419 222,870 $ 7,463,692 84,077 6,543,099 5,570,538 3,029,231 22,690,637 162,110 976,099 14,914,132 1,309,231 3,573,439 $ 43,625,648 $ 60,879 4,469,736 768,802 3,045,242 2,028,967 10,373,626 92,560 1,217,407 612,583 12,296,176 2,100,988 174,762 403,790 53,706 2,876,576 (292,820) 174,698 402,991 46,017 2,720,146 34,670 1,920,462 4,437,253 590,176 31,610,725 (3,217,802) (556,222) 2,659,792 ¥ 3,969,934 (456,186) 2,922,336 ¥ 4,512,625 (6,112,330) 29,228,484 $ 43,625,648 64 CONSOLIDATED STATEMENTS OF INCOME CANON INC. AND SUBSIDIARIES Net sales Cost of sales (Notes 7, 10, 13 and 21) Gross proﬁ t Operating expenses (Notes 1, 7, 10, 13, 18 and 21): Selling, general and administrative expenses Research and development expenses Operating proﬁ t Other income (deductions): Interest and dividend income Interest expense Other, net (Notes 1, 4 and 20) Income before income taxes and minority interests Years ended December 31, 2008, 2007 and 2006 2008 ¥ 4,094,161 2,156,153 1,938,008 Millions of yen 2007 ¥ 4,481,346 2,234,365 2,246,981 2006 ¥ 4,156,759 2,096,279 2,060,480 Thousands of U.S. dollars (Note 2) 2008 $ 44,990,780 23,693,989 21,296,791 1,067,909 374,025 1,441,934 496,074 19,442 (837) (33,532) (14,927) 481,147 1,122,047 368,261 1,490,308 756,673 32,819 (1,471) (19,633) 11,715 768,388 1,045,140 308,307 1,353,447 707,033 27,153 (2,190) (12,853) 12,110 719,143 11,735,263 4,110,165 15,845,428 5,451,363 213,648 (9,198) (368,483) (164,033) 5,287,330 Income taxes (Note 14) Income before minority interests 160,788 320,359 264,258 504,130 248,233 470,910 1,766,901 3,520,429 Minority interests Net income 11,211 ¥ 309,148 15,798 ¥ 488,332 15,585 ¥ 455,325 123,198 $ 3,397,231 Yen U.S. dollars (Note 2) Net income per share (Note 19): Basic Diluted Cash dividends per share See accompanying notes to consolidated ﬁ nancial statements. ¥ 246.21 246.20 110.00 ¥ 377.59 377.53 110.00 ¥ 341.95 341.84 83.33 $ 2.71 2.71 1.21 65 CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY CANON INC. AND SUBSIDIARIES Millions of yen Accumulated other comprehensive income (loss) ¥ (28,212) Treasury stock (5,410) ¥ Common stock ¥ 174,438 165 Additional paid-in capital ¥ 403,246 264 Legal reserve ¥ 42,331 Retained earnings ¥ 2,018,289 1,269 (104,298) (1,269) 455,325 48,630 1,992 (489) (3,575) (15,628) 174,603 403,510 43,600 2,368,047 2,718 (462) (5,872) 95 (522) 2,417 (2,204) (131,612) (2,417) 488,332 (62) (1,778) 814 32,978 174,698 64 3 402,991 824 46,017 2,720,146 34,670 (450,314) (456,186) 7,689 (145,024) (7,689) 309,148 (258,764) (5,152) 2,342 (65,916) ¥ 174,762 (25) ¥ 403,790 ¥ 53,706 (5) ¥ 2,876,576 ¥ (292,820) (100,036) ¥ (556,222) $ 1,919,759 703 $ 4,428,473 9,055 Thousands of U.S. dollars (Note 2) $ 505,681 $ 29,891,714 $ 380,989 $ (5,013,034) 84,495 (1,593,670) (84,495) 3,397,231 (2,843,560) (56,615) 25,736 (724,352) $ 1,920,462 (275) $ 4,437,253 $ 590,176 (55) $ 31,610,725 $ (3,217,802) (1,099,296) $ (6,112,330) Total stockholders’ equity ¥ 2,604,682 429 (104,298) — 455,325 48,630 1,992 (489) (3,575) 501,883 (15,628) (462) 2,986,606 (2,204) (427) (131,612) — 488,332 (62) (1,778) 814 32,978 520,284 (450,311) 2,922,336 888 (145,024) — 309,148 (258,764) (5,152) 2,342 (65,916) (18,342) (100,066) ¥ 2,659,792 $ 32,113,582 9,758 (1,593,670) — 3,397,231 (2,843,560) (56,615) 25,736 (724,352) (201,560) (1,099,626) $ 29,228,484 Balance at December 31, 2005 Conversion of convertible debt and other Cash dividends Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 17): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Minimum pension liability adjustments Total comprehensive income Adjustment to initially apply SFAS 158, net of tax Repurchase of treasury stock, net Balance at December 31, 2006 Cumulative effect of a change in accounting principle - adoption of EITF 06-2, net of tax Conversion of convertible debt and other Cash dividends Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 17): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income Repurchase of treasury stock, net Balance at December 31, 2007 Conversion of convertible debt and other Cash dividends Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 17): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income Repurchase of treasury stock, net Balance at December 31, 2008 Balance at December 31, 2007 Conversion of convertible debt and other Cash dividends Transfer to legal reserve Comprehensive income: Net income Other comprehensive income (loss), net of tax (Note 17): Foreign currency translation adjustments Net unrealized gains and losses on securities Net gains and losses on derivative instruments Pension liability adjustments Total comprehensive income Repurchase of treasury stock, net Balance at December 31, 2008 See accompanying notes to consolidated ﬁ nancial statements. 66 CONSOLIDATED STATEMENTS OF CASH FLOWS CANON INC. AND SUBSIDIARIES Cash ﬂ ows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Loss on disposal of property, plant and equipment Deferred income taxes (Increase) decrease in trade receivables (Increase) decrease in inventories Increase (decrease) in trade payables Increase (decrease) in accrued income taxes Increase (decrease) in accrued expenses Decrease in accrued (prepaid) pension and severance cost Other, net Net cash provided by operating activities Cash ﬂ ows from investing activities: Purchases of ﬁ xed assets (Note 7) Proceeds from sale of ﬁ xed assets (Note 7) Purchases of available-for-sale securities Proceeds from sale and maturity of available-for-sale securities Proceeds from maturity of held-to-maturity securities (Increase) decrease in time deposits Acquisitions of subsidiaries, net of cash acquired Purchases of other investments Other, net Net cash used in investing activities Cash ﬂ ows from ﬁ nancing activities: Proceeds from issuance of long-term debt Repayments of long-term debt Decrease in short-term loans Dividends paid Repurchases of treasury stock, net Other, net Net cash used in ﬁ nancing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosure for cash ﬂ ow information: Cash paid during the year for: Interest Income taxes See accompanying notes to consolidated ﬁ nancial statements. Years ended December 31, 2008, 2007 and 2006 Millions of yen Thousands of U.S. dollars (Note 2) 2008 2007 2006 2008 ¥ 309,148 ¥ 488,332 ¥ 455,325 $ 3,397,231 341,337 11,811 (32,497) 83,521 49,547 (36,719) (77,340) (30,694) (12,128) 10,698 616,684 (428,168) 7,453 (7,307) 4,320 10,000 2,892 (5,999) (45,473) (10,198) (472,480) 6,841 (15,397) (2,643) (145,024) (100,066) (21,276) (277,565) 341,694 9,985 (35,021) (10,722) (26,643) 21,136 14,988 43,035 (15,387) 7,872 839,269 (474,285) 9,635 (2,281) 8,614 10,000 31,681 (15,675) (2,432) 2,258 (432,485) 2,635 (13,046) (358) (131,612) (450,311) (11,691) (604,383) 262,294 16,182 (6,945) (40,969) (5,542) (2,313) 22,657 36,165 (20,309) (21,304) 695,241 (424,862) 12,507 (7,768) 4,047 — (35,863) (2,485) (8,911) 2,530 (460,805) 1,053 (5,861) (828) (104,298) (462) 2,909 (107,487) 3,750,956 129,791 (357,110) 917,813 544,473 (403,505) (849,890) (337,297) (133,275) 117,560 6,776,747 (4,705,143) 81,901 (80,297) 47,473 109,890 31,780 (65,923) (499,703) (112,066) (5,192,088) 75,176 (169,198) (29,044) (1,593,670) (1,099,626) (233,803) (3,050,165) (131,906) (265,267) 944,463 ¥ 679,196 (13,564) (211,163) 1,155,626 ¥ 944,463 23,724 150,673 1,004,953 ¥ 1,155,626 (1,449,516) (2,915,022) 10,378,714 $ 7,463,692 ¥ 901 263,392 ¥ 1,476 273,888 ¥ 2,146 244,236 $ 9,901 2,894,418 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CANON INC. AND SUBSIDIARIES 1. Basis of Presentation and Signiﬁ cant Accounting Policies (a) Description of Business Canon Inc. (the “Company”) and subsidiaries (collectively “Canon”) is one of the world’s leading manufacturers in such ﬁ elds as ofﬁ ce imaging products, computer peripherals, business information products, cameras, and optical related products. Ofﬁ ce imaging products consist mainly of network multifunction devices and copying machines. Computer peripherals consist mainly of laser beam and inkjet printers. Business information products consist mainly of computer information systems, document scanners and calculators. Cameras consist mainly of digital single-lens reﬂ ex (“SLR”) cameras, compact digital cameras, interchangeable lenses and digital video camcorders. Optical and other products include semiconductor production equipment, mirror projection mask aligners for liquid crystal display (“LCD”) panels, broad- casting equipment, medical equipment and large format printers. Canon’s consolidated net sales for the years ended December 31, 2008, 2007 and 2006 were distributed as follows: ofﬁ ce imaging products 27%, 29% and 28%, computer peripherals 36%, 34% and 34%, business information products 2%, 2% and 3%, cameras 25%, 26% and 25%, and optical and other products 10%, 9% and 10%, respectively. Sales are made principally under the Canon brand name, almost entirely through sales subsidiaries. These subsidiaries are responsible for marketing and distribution, and primarily sell to retail dealers in their geographical area. Approximately 76%, 77% and 75% of consolidated net sales for the years ended December 31, 2008, 2007 and 2006 were generated outside Japan, with 28%, 30% and 31% in the Americas, 33%, 33% and 31% in Europe, and 15%, 14% and 13% in other areas, respectively. Canon sells laser beam printers on an OEM basis to Hewlett-Packard Company; such sales constituted approximately 23%, 22% and 22% of consolidated net sales for the years ended December 31, 2008, 2007 and 2006, respectively. Canon’s manufacturing operations are conducted primarily at 25 plants in Japan and 18 overseas plants which are located in countries or regions such as the United States, Germany, France, Taiwan, China, Malaysia, Thailand and Vietnam. (b) Basis of Presentation The Company and its domestic subsidiaries maintain their books of account in conformity with ﬁ nancial accounting standards of Japan. Foreign subsidiaries maintain their books of account in conformity with ﬁ nancial accounting standards of the countries of their domicile. Certain adjustments and reclassiﬁ cations have been incor- porated in the accompanying consolidated ﬁ nancial statements to conform with U.S. generally accepted accounting principles. These adjustments were not recorded in the statutory books of account. “Consolidation of Variable Interest Entities.” All signiﬁ cant intercompany balances and transactions have been eliminated. (d) Use of Estimates The preparation of the consolidated ﬁ nancial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated ﬁ nancial statements and the reported amounts of revenues and expenses during the period. Signiﬁ cant estimates and assumptions are reﬂ ected in valuation and disclosure of revenue recognition, allowance for doubtful receivables, valuation of inventories, impairment of long-lived assets, environmental liabilities, valuation of deferred tax assets, uncertain tax positions and employee retirement and severance beneﬁ t plans. Actual results could differ materially from those estimates. (e) Translation of Foreign Currencies Assets and liabilities of the Company’s subsidiaries located outside Japan with functional currencies other than Japanese yen are translated into Japanese yen at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the year. Gains and losses resulting from translation of ﬁ nancial statements are excluded from earnings and are reported in other comprehensive income (loss). Gains and losses resulting from foreign currency transactions, including foreign exchange contracts, and translation of assets and liabilities denominated in foreign currencies are included in other income (deductions) in the consolidated statements of income. Foreign currency exchange losses, net were ¥11,212 million ($123,209 thousand), ¥31,943 million and ¥25,804 million for the years ended December 31, 2008, 2007 and 2006, respectively. (f) Cash Equivalents All highly liquid investments acquired with original maturities of three months or less are considered to be cash equivalents. Certain debt securities with original maturities of less than three months classiﬁ ed as available-for-sale securities of ¥194,030 million ($2,132,198 thousand) and ¥164,610 million at December 31, 2008 and 2007, respectively, are included in cash and cash equivalents in the consolidated balance sheets. Additionally, certain debt securities with original maturities of less than three months classiﬁ ed as held-to-maturity securities of ¥997 million ($10,956 thousand) and ¥5,992 million at December 31, 2008 and 2007, respectively, are also included in cash and cash equivalents. Fair value for these securities approximates their cost. (c) Principles of Consolidation The consolidated ﬁ nancial statements include the accounts of the Company, its majority owned subsidiaries and those variable interest entities where the Company or its consolidated subsidiaries are the primary beneﬁ ciaries under Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised December 2003), (g) Investments Investments consist primarily of time deposits with original maturities of more than three months, debt and marketable equity securities, investments in afﬁ liated companies and non- marketable equity securities. Canon reports investments with maturities of less than one year as short-term investments. 68 Canon classiﬁ es investments in debt and marketable equity securities as available-for-sale or held-to-maturity securities. Canon does not hold any trading securities, which are bought and held primarily for the purpose of sale in the near term. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are reported as a separate component of other comprehensive income (loss) until realized. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Available-for-sale and held-to-maturity securities are regularly reviewed for other-than-temporary declines in carrying value based on criteria that include the length of time and the extent to which the market value has been less than cost, the ﬁ nancial condition and near-term prospects of the issuer and Canon’s intent and ability to retain the investment for a period of time sufﬁ cient to allow for any anticipated recovery in market value. When such a decline exists, Canon recognizes an impairment loss to the extent by which the cost basis of the investment exceeds the fair value of the investment. Fair value is determined based on quoted market prices, projected discounted cash ﬂ ows or other valuation techniques as appropriate. Realized gains and losses are determined on the average cost method and reﬂ ected in earnings. Investments in afﬁ liated companies over which Canon has the ability to exercise signiﬁ cant inﬂ uence, but does not hold a con- trolling ﬁ nancial interest, are accounted for by the equity method. Non-marketable equity securities in companies over which Canon does not have the ability to exercise signiﬁ cant inﬂ uence are stated at cost and reviewed periodically for impairment. (h) Allowance for Doubtful Receivables Allowance for doubtful trade and ﬁ nance receivables is maintained for all customers based on a combination of factors, including aging analysis, macroeconomic conditions, signiﬁ cant one-time events, and historical experience. An additional reserve for individual accounts is recorded when Canon becomes aware of a customer’s inability to meet its ﬁ nancial obligations, such as in the case of bankruptcy ﬁ lings. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. When all collection options are exhausted including legal recourse, the accounts or portions thereof are deemed to be uncollectable and charged against the allowance. (i) Inventories Inventories are stated at the lower of cost or market value. Cost is determined by the average method for domestic inventories and principally by the ﬁ rst-in, ﬁ rst-out method for overseas inventories. (j) Impairment of Long-Lived Assets Long-lived assets, such as property, plant and equipment, and acquired intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset and the estimated undiscounted future cash ﬂ ows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash ﬂ ows, an impairment charge is recog- nized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of by sale are reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. (k) Property, Plant and Equipment and Accounting Change Property, plant and equipment are stated at cost. Depreciation is calculated principally by the declining-balance method, except for certain assets which are depreciated by the straight-line method over the estimated useful lives of the assets. Effective April 1, 2007, the Company and its domestic subsidiaries elected to change the declining-balance method of depreciating machinery and equipment from the ﬁ xed-percentage- on-declining base application to the 250% declining-balance application. Estimated residual values were also reduced in conjunction with this change. The Company and its domestic subsidiaries believe that the 250% declining-balance application is preferable because it provides a better matching of the allocation of cost of machinery and equipment with associated revenues in light of increasingly short product life cycles. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No.3,” this change in depreciation methods represented a change in accounting estimate effected by a change in account- ing principle. Accordingly, the affects of the change have been accounted for prospectively beginning with the period of change and prior period results have not been restated. The change in depreciation methods caused an increase in depreciation expense by ¥63,773 million for the year ended December 31, 2007. Net income, basic net income per share and diluted net income per share decreased by ¥32,321 million, ¥24.99 and ¥24.99, respectively, for the year ended December 31, 2007. The depreciation period ranges from 3 years to 60 years for buildings and 1 year to 20 years for machinery and equipment. Assets leased to others under operating leases are stated at cost and depreciated to the estimated residual value of the assets by the straight-line method over the period ranging from 2 years to 5 years. (l) Goodwill and Other Intangible Assets Goodwill and other intangible assets with indeﬁ nite useful lives are not amortized, but are instead tested for impairment annually in the fourth quarter of each year, or more frequently if indicators of potential impairment exist. Intangible assets with ﬁ nite useful lives, consisting primarily of software and license fees, are amor- tized using the straight-line method over the estimated useful lives, which range from 3 years to 5 years for software and 5 years to 10 years for license fees. Certain costs incurred in connection with developing or obtaining internal use software are capitalized. These costs consist primarily of payments made to third parties and the salaries of employees working on such software develop- ment. Costs incurred in connection with developing internal use software are capitalized at the application development stage. 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES In addition, Canon develops or obtains certain software to be sold where related costs are capitalized after establishment of technological feasibility. (m) Environmental Liabilities Liabilities for environmental remediation and other environmental costs are accrued when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated. Such liabilities are adjusted as further information develops or circumstances change. Costs of future obligations are not discounted to their present values. (n) Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the ﬁ nancial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Canon records a valua- tion allowance to reduce the deferred tax assets to the amount that is more likely than not realizable. Canon recognizes the ﬁ nancial statement effects of tax positions when it is more likely than not, based on the technical merits, that the tax positions will be sustained upon examination by the tax authorities. Beneﬁ ts from tax positions that meet the more-likely-than-not recognition threshold are measured at the largest amount of beneﬁ t that is greater than 50 percent likely of being realized upon settlement. Interest and penalties accrued related to unrecognized tax beneﬁ ts are included in income taxes in the consolidated statements of income. (o) Issuance of Stock by Subsidiaries and Equity Investees The change in the Company’s proportionate share of a sub- sidiary’s or equity investee’s equity resulting from the issuance of stock by the subsidiary or equity investee is accounted for as an equity transaction. (p) Stock-Based Compensation Canon measures stock-based compensation cost at the grant date, based on the fair value of the award, and recognizes the cost on a straight-line basis over the requisite service period, which is the vesting period. (q) Net Income per Share Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during each year. Diluted net income per share includes the effect from potential issuances of common stock based on the assumptions that all convertible debentures were converted into common stock and all stock options were exercised. (r) Revenue Recognition Canon generates revenue principally through the sale of consumer products, equipment, supplies, and related services under separate contractual arrangements. Canon recognizes revenue when per- suasive evidence of an arrangement exists, delivery has occurred and title and risk of loss have been transferred to the customer or services have been rendered, the sales price is ﬁ xed or determinable, and collectibility is probable. Revenue from sales of consumer products including ofﬁ ce imaging products, computer peripherals, business information products and cameras is recognized upon shipment or delivery, depending upon when title and risk of loss transfer to the customer. Revenue from sales of optical equipment, such as steppers and aligners that are sold with customer acceptance provisions related to their functionality, is recognized when the equipment is installed at the customer site and the speciﬁ c criteria of the equipment functionality are successfully tested and demonstrated by Canon. Service revenue is derived primarily from separately priced product maintenance contracts on equipment sold to customers and is measured at the stated amount of the contract and recognized as services are provided. Canon also offers separately priced product maintenance contracts for most ofﬁ ce imaging products, for which the customer typically pays a stated base service fee plus a variable amount based on usage. Revenue from these service mainte- nance contracts is measured at the stated amount of the contract and recognized as services are provided and variable amounts are earned. Revenue from the sale of equipment under sales-type leases is recognized at the inception of the lease. Income on sales-type leases and direct-ﬁ nancing leases is recognized over the life of each respective lease using the interest method. Leases not qualify- ing as sales-type leases or direct-ﬁ nancing leases are accounted for as operating leases and related revenue is recognized ratably over the lease term. When equipment leases are bundled with product maintenance contracts, revenue is ﬁ rst allocated consid- ering the relative fair value of the lease and non-lease deliverables based upon the estimated relative fair values of each element. Lease deliverables generally include equipment, ﬁ nancing and executory costs, while non-lease deliverables generally consist of product maintenance contracts and supplies. For all other arrangements with multiple elements, Canon allocates revenue to each element based on its relative fair value if such element meets the criteria for treatment as a separate unit of accounting as prescribed in the Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” Otherwise, revenue is deferred until the undelivered elements are fulﬁ lled and accounted for as a single unit of accounting. Canon records estimated reductions to sales at the time of sale for sales incentive programs including product discounts, customer promotions and volume-based rebates. Estimated reductions in sales are based upon historical trends and other known factors at the time of sale. In addition, Canon provides 70 price protection to certain resellers of its products, and records reductions to sales for the estimated impact of price protection obligations when announced. Estimated product warranty costs are recorded at the time revenue is recognized and are included in selling, general and administrative expenses. Estimates for accrued product warranty costs are based on historical experience, and are affected by ongoing product failure rates, speciﬁ c product class failures outside of the baseline experience, material usage and service delivery costs incurred in correcting a product failure. Taxes collected from customers and remitted to governmental authorities are excluded from revenues in the consolidated statements of income. other comprehensive income (loss), until earnings are affected by the variability in cash ﬂ ows of the hedged item. Gains and losses from hedging ineffectiveness are included in other income (deductions). Gains and losses related to the components of hedging instruments excluded from the assessment of hedge effectiveness are included in other income (deductions). Canon also uses certain derivative ﬁ nancial instruments which are not designated as hedges. Canon records these derivative ﬁ nancial instruments in the consolidated balance sheets at fair value. The changes in fair values are immediately recorded in earnings. Canon classiﬁ es cash ﬂ ows from derivatives as cash ﬂ ows from operating activities in the consolidated statements of cash ﬂ ows. (s) Research and Development Costs Research and development costs are expensed as incurred. (t) Advertising Costs Advertising costs are expensed as incurred. Advertising expenses were ¥112,810 million ($1,239,670 thousand), ¥132,429 million and ¥116,809 million for the years ended December 31, 2008, 2007 and 2006, respectively. (u) Shipping and Handling Costs Shipping and handling costs totaled ¥62,128 million ($682,725 thousand), ¥63,708 million and ¥62,626 million for the years ended December 31, 2008, 2007 and 2006, respectively, and are included in selling, general and administrative expenses in the consolidated statements of income. (v) Derivative Financial Instruments All derivatives are recognized at fair value and are included in prepaid expenses and other current assets, or other current liabilities in the consolidated balance sheets. On the date the derivative contract is entered into, Canon designates the deriva- tive as either a hedge of the fair value of a recognized asset or liability or of an unrecognized ﬁ rm commitment (“fair value” hedge), or a hedge of a forecasted transaction or the variability of cash ﬂ ows to be received or paid related to a recognized asset or liability (“cash ﬂ ow” hedge). Canon formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. Canon also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the deriv- atives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash ﬂ ows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, Canon discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and qualiﬁ es as a fair-value hedge, along with the loss or gain on the hedged asset or liability or unrecognized ﬁ rm commitment of the hedged item that is attributable to the hedged risk, are recorded in earnings. Changes in the fair value of a derivative that is designated and qualiﬁ es as a cash-ﬂ ow hedge are recorded in (w) Guarantees Canon recognizes, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing guarantees. (x) New Accounting Standards In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 deﬁ nes fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement clariﬁ es how to measure fair value as permitted or required under other accounting pronouncements, but does not require any new fair value measurements. In February 2008, the FASB issued Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which delays the effective date of SFAS 157 for one year for certain nonﬁ nancial assets and liabilities. Canon adopted SFAS 157 in the ﬁ rst quarter beginning January 1, 2008 for all ﬁ nancial assets and liabilities that are recognized or disclosed at fair value in the ﬁ nancial statements. This adoption did not have a material impact on Canon’s consolidated results of operations and ﬁ nancial condition. The adoption of SFAS 157 for all nonﬁ nancial assets and liabilities beginning January 1, 2009 will not have a material impact on Canon’s consolidated results of operations and ﬁ nancial condition. See Note 23 for the disclosures required by SFAS 157. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 provides companies with an option to report selected ﬁ nancial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are recognized in earnings. SFAS 159 is effective for ﬁ scal years beginning after November 15, 2007 and was adopted by Canon in the ﬁ rst quarter beginning January 1, 2008. The adoption of SFAS 159 did not have an impact on Canon’s consolidated results of operations and ﬁ nancial condition as Canon did not elect to report ﬁ nancial assets and liabilities under the fair value option. In June 2007, the FASB ratiﬁ ed the consensus in EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Development Activities” (“EITF 07-3”). EITF 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and capitalized and recognized as an expense as the related goods are delivered or the related services are performed. EITF 07-3 is effective, on a prospective basis, for ﬁ scal years beginning after December 15, 2007 and was adopted by Canon in the ﬁ rst quarter beginning January 1, 2008. The adoption of EITF 07-3 did not have a material impact on Canon’s consolidated results of operations and ﬁ nancial condition. In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer rec- ognizes and measures in its ﬁ nancial statements the identiﬁ able assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired in a business combina- tion. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and ﬁ nancial effects of the business combination. SFAS 141R is effective for ﬁ scal years beginning on or after December 15, 2008 and is required to be adopted by Canon for any business combinations with an acquisition date on or after January 1, 2009. The impact of the adoption of SFAS 141R on Canon’s consolidated results of operations and ﬁ nancial condition will be largely dependent on the size and nature of the business combinations completed after the adoption of this statement. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for ﬁ scal years beginning on or after December 15, 2008 on a prospective basis, except for certain presentation and disclosure requirements, which will be applied retrospectively for all periods presented, and is required to be adopted by Canon in the ﬁ rst quarter beginning January 1, 2009. The adoption of SFAS 160 will impact the presentation of Canon’s consolidated balance sheets and consolidated statements of income; however, it will not have a material impact on Canon’s consolidated results of operations and ﬁ nancial condition. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amend- ment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends and expands the current disclosures required by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). SFAS 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its interpretations, and how derivative instruments and related hedged items affect an entity’s ﬁ nancial position, result of operations and cash ﬂ ows. SFAS 161 does not change the existing standards relative to recognition and measurement of derivative instruments and hedging activities. SFAS 161 is effective for ﬁ nancial statements issued for ﬁ scal years and interim periods beginning after November 15, 2008 and is required to be adopted by Canon in the ﬁ rst quarter beginning January 1, 2009. The adoption of SFAS 161 will not have an impact on Canon’s consolidated results of operations and ﬁ nancial condition. In December 2008, the FASB issued FSP FAS No. 132(R)-1, “Employers’ Disclosures about Postretirement Beneﬁ t Plan Assets” (“FSP 132R-1”). FSP 132R-1 requires additional disclosures about plan assets including investment allocation, fair value of major categories of plan assets, development of fair value measurements, and concentrations of risk. FSP 132R-1 is effective for ﬁ scal years ending after December 15, 2009 and is required to be adopted by Canon in the year ending December 31, 2009. Canon is currently evaluating the requirements of these additional disclo- sures, but does not expect the adoption of FSP 132R-1 to have an impact on Canon’s consolidated results of operations and ﬁ nancial condition. (y) Reclassiﬁ cation Time deposits with original maturities of more than three months and marketable securities, which were previously dis- closed separately in the consolidated balance sheets, have been reclassiﬁ ed to short-term investments to conform to the current year presentation. Intangible assets, which were previously included in other assets, have been reclassiﬁ ed to intangible assets in the consoli- dated balance sheets to conform to the current year presentation. 2. Basis of Financial Statement Translation The consolidated ﬁ nancial statements presented herein are expressed in Japanese yen and, solely for the convenience of the reader, have been translated into United States dollars at the rate of ¥91 = U.S.$1, the approximate exchange rate prevailing on the Tokyo Foreign Exchange Market on December 30, 2008. This translation should not be construed as a representation that the amounts shown could be converted into United States dollars at such rate. 72 3. Foreign Operations Amounts included in the consolidated ﬁ nancial statements relating to subsidiaries operating in foreign countries are summarized as follows: December 31: Total assets Net assets Years ended December 31: Net sales Net income Millions of yen 2008 2007 2006 Thousands of U.S. dollars 2008 ¥ 1,502,451 850,491 ¥ 2,077,268 1,024,150 ¥ 1,995,927 907,845 $ 16,510,451 9,346,055 ¥ 3,095,485 72,520 ¥ 3,433,036 136,560 ¥ 3,119,102 114,916 $ 34,016,318 796,923 4. Investments The cost, gross unrealized holding gains, gross unrealized holding losses and fair value for available-for-sale securities and held-to-maturity securities included in short-term investments and investments by major security type at December 31, 2008 and 2007 were as follows: December 31 Millions of yen 2008: Current: Available-for-sale: Government bonds Fund trusts Noncurrent: Available-for-sale: Government bonds Corporate debt securities Fund trusts Equity securities Millions of yen 2007: Current: Available-for-sale: Bank debt securities Held-to-maturity: Corporate debt securities Noncurrent: Available-for-sale: Government bonds Corporate debt securities Fund trusts Equity securities Gross unrealized holding gains Gross unrealized holding losses Cost Fair value ¥ ¥ 1 133 134 ¥ — ¥ — ¥ 16 16 — ¥ — ¥ ¥ 1 149 150 ¥ 431 1,593 2,366 10,522 ¥ 14,912 Cost ¥ — ¥ 27 40 2,532 ¥ 2,599 18 32 170 836 ¥ 1,056 Gross unrealized holding gains Gross unrealized holding losses ¥ 413 1,588 2,236 12,218 ¥ 16,455 Fair value ¥ 51 ¥ — ¥ — ¥ 51 10,115 ¥ 10,166 — ¥ — ¥ 496 3,183 3,573 12,666 ¥ 19,918 ¥ — 31 1,158 10,233 ¥ 11,422 — ¥ — ¥ 25 49 3 583 ¥ 660 10,115 ¥ 10,166 ¥ 471 3,165 4,728 22,316 ¥ 30,680 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Thousands of U.S. dollars 2008: Current: Available-for-sale: Government bonds Fund trusts Noncurrent: Available-for-sale: Government bonds Corporate debt securities Fund trusts Equity securities Gross unrealized holding gains Gross unrealized holding losses Cost Fair value $ 11 1,462 $ 1,473 $ — $ — $ 11 1,637 $ — $ 1,648 — 175 175 $ $ 4,736 17,505 26,000 115,627 $ 163,868 $ — $ 297 440 27,824 $ 28,561 198 352 1,868 9,187 $ 11,605 $ 4,538 17,450 24,572 134,264 $ 180,824 Maturities of available-for-sale debt securities and fund trusts included in short-term investments and investments in the accompanying consolidated balance sheets were as follows at December 31, 2008: Available-for-sale securities Due within one year Due after one year through ﬁ ve years Due after ﬁ ve years through ten years Millions of yen Cost ¥ 134 3,542 848 ¥ 4,524 Fair value ¥ 150 3,426 811 ¥ 4,387 Thousands of U.S. dollars Cost $ 1,473 38,923 9,318 $ 49,714 Fair value $ 1,648 37,648 8,912 $ 48,208 The gross realized gains were ¥116 million ($1,275 thousand), ¥1,512 million and ¥674 million for the years ended December 31, 2008, 2007 and 2006, respectively. The gross realized losses, including write-downs for impairments that were other than temporary, were ¥7,868 million ($86,462 thousand) for the year ended December 31, 2008, and were not signiﬁ cant for the years ended December 31, 2007 and 2006. At December 31, 2008, substantially all of the available-for- sale securities with unrealized losses had been in a continuous unrealized loss position for less than 12 months. Time deposits with original maturities of more than three months are ¥7,430 million ($81,648 thousand) and ¥10,333 million at December 31, 2008 and 2007, respectively, and are included in short-term investments in the accompanying consolidated balance sheets. Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥10,684 million ($117,407 thousand) and ¥14,017 million at December 31, 2008 and 2007, respectively. Investments with an aggregate cost of ¥10,572 million ($116,176 thousand) were not evaluated for impairment because (a) Canon did not estimate the fair value of those investments as it was not practicable to estimate the fair value of the investments and (b) Canon did not identify any events or changes in circumstances that might have had signiﬁ cant adverse effects on the fair value of those investments. Investments in afﬁ liated companies accounted for by the equity method amounted to ¥59,428 million ($653,055 thousand) and ¥42,817 million at December 31, 2008 and 2007, respectively. Canon’s share of the net earnings (losses) in afﬁ liated companies accounted for by the equity method, included in other income (deductions), was a loss of ¥20,047 million ($220,297 thousand) for the year ended December 31, 2008, and earnings of ¥5,634 million and ¥4,237 million for the years ended December 31, 2007 and 2006, respectively. 74 5. Trade Receivables Trade receivables are summarized as follows: December 31 Notes Accounts Less allowance for doubtful receivables 6. Inventories Inventories are summarized as follows: December 31 Finished goods Work in process Raw materials Millions of yen 2008 ¥ 20,303 584,437 604,740 (9,318) ¥ 595,422 2007 ¥ 23,632 785,155 808,787 (14,547) ¥ 794,240 Thousands of U.S. dollars 2008 $ 223,110 6,422,385 6,645,495 (102,396) $ 6,543,099 Millions of yen 2008 ¥ 316,533 171,511 18,875 ¥ 506,919 2007 ¥ 366,845 175,704 20,925 ¥ 563,474 Thousands of U.S. dollars 2008 $ 3,478,385 1,884,736 207,417 $ 5,570,538 7. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation and are summarized as follows: December 31 Land Buildings Machinery and equipment Construction in progress Less accumulated depreciation Millions of yen 2008 ¥ 247,602 1,268,388 1,395,451 81,346 2,992,787 (1,635,601) ¥ 1,357,186 2007 ¥ 249,959 1,198,519 1,406,849 103,749 2,959,076 (1,594,374) ¥ 1,364,702 Thousands of U.S. dollars 2008 $ 2,720,901 13,938,330 15,334,626 893,912 32,887,769 (17,973,637) $ 14,914,132 Depreciation expense for the years ended December 31, 2008, 2007 and 2006 was ¥304,622 million ($3,347,494 thousand), ¥309,815 million and ¥235,804 million, respectively. Amounts due for purchases of property, plant and equipment were ¥98,398 million ($1,081,297 thousand) and ¥120,823 million at December 31, 2008 and 2007, respectively, and are included in other current liabilities in the accompanying consolidated balance sheets. Fixed assets presented in the consolidated state- ments of cash ﬂ ows includes property, plant and equipment and intangible assets. Canon recognized impairment losses of ¥11,164 million ($122,681 thousand) related primarily to property, plant and equipment of its semiconductor production equipment business during the year ended December 31, 2008. As a result of declining demand in the semiconductor manufacturing industry and diminished proﬁ tability of the semiconductor production equipment business, Canon evaluated the ongoing value of the related long-lived assets and estimated that the carrying amounts would not be recoverable from the future cash ﬂ ows. The fair value of the property, plant and equipment was based on the estimated discounted future cash ﬂ ows expected to be generated from the use of them. The impairment losses are included in selling, general and administrative expenses in the consolidated statements of income. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 8. Finance Receivables and Operating Leases Finance receivables represent ﬁ nancing leases which consist of sales-type leases and direct-ﬁ nancing leases resulting from the marketing of Canon’s and complementary third-party products. These receivables typically have terms ranging from 1 year to 7 years. The components of the ﬁ nance receivables, which are included in prepaid expenses and other current assets, and other assets in the accompanying consolidated balance sheets, are as follows: December 31 Total minimum lease payments receivable Unguaranteed residual values Executory costs Unearned income Less allowance for doubtful receivables Less current portion Millions of yen 2008 ¥ 198,611 16,310 (1,729) (26,658) 186,534 (8,268) 178,266 (59,608) ¥ 118,658 2007 ¥ 229,229 17,036 (2,960) (27,756) 215,549 (8,590) 206,959 (72,776) ¥ 134,183 Thousands of U.S. dollars 2008 $ 2,182,538 179,231 (19,000) (292,945) 2,049,824 (90,857) 1,958,967 (655,033) $ 1,303,934 The cost of equipment leased to customers under operating leases included in property, plant and equipment, net at December 31, 2008 and 2007 was ¥50,388 million ($553,714 thousand) and ¥63,190 million, respectively. Accumulated depreciation on equipment under operating leases at December 31, 2008 and 2007 was ¥37,284 million ($409,714 thousand) and ¥48,818 million, respectively. The following is a schedule by year of the future minimum lease payments to be received under ﬁ nancing leases and non-cancelable operating leases at December 31, 2008. Year ending December 31: Millions of yen Thousands of U.S. dollars 2009 2010 2011 2012 2013 Thereafter Financing leases ¥ 76,599 57,305 38,152 19,024 6,743 788 ¥ 198,611 Operating leases ¥ 4,225 1,585 832 390 54 7 ¥ 7,093 Financing leases $ 841,747 629,725 419,253 209,055 74,099 8,659 $ 2,182,538 Operating leases $ 46,429 17,417 9,143 4,286 593 77 $ 77,945 9. Acquisitions In 2007, the Company and one of its subsidiaries acquired two companies for a total cost of ¥26,387 million. One company, which was acquired with cash, is engaged in developing, manufacturing, selling and providing services for equipment used in the manufacture of organic EL display panels and thin-ﬁ lm solar cells. The other company, which was acquired with cash and share exchange by the subsidiary of the Company, is engaged in providing architecture, management and maintenance services for information systems. In connection with those transactions, Canon recognized goodwill of ¥7,556 million, which is included in other assets, and intangible assets of ¥7,131 million, which are included in intangible assets in the accompanying consolidated balance sheets. Intangible assets consist primarily of manufacturing technology, trademarks, patents, customer contracts and related customer relationships, and are subject to a weighted average amortization period of approximately 13 years as of the date of acquisition. Canon acquired businesses other than those described above during the years ended December 31, 2008, 2007 and 2006 that were not material to its consolidated ﬁ nancial statements. Canon has included the results of operations of these trans- actions prospectively from the respective dates of transactions. Canon has not presented pro forma results of operations of the acquired businesses because the results are not material to its consolidated results of operations on either an individual or an aggregate basis. 76 10. Goodwill and Other Intangible Assets Intangible assets developed or acquired during the year ended December 31, 2008 totaled ¥47,050 million ($517,033 thou- sand), which are subject to amortization and primarily consist of software of ¥38,986 million ($428,418 thousand), which is mainly for internal use, and license fees of ¥2,217 million ($24,363 thousand), in addition to those recorded from December 31 Millions of yen Software License fees Other Thousands of U.S. dollars Software License fees Other acquired businesses. The weighted average amortization period for software, license fees and intangible assets in total is approximately 4 years, 7 years and 4 years, respectively. The components of intangible assets subject to amortization at December 31, 2008 and 2007 were as follows: 2008 2007 Gross carrying amount ¥ 187,920 21,537 34,341 ¥ 243,798 Accumulated amortization ¥ 103,535 11,104 10,925 ¥ 125,564 Gross carrying amount ¥ 174,645 22,825 31,488 ¥ 228,958 Accumulated amortization ¥ 96,445 11,697 9,241 ¥ 117,383 2008 Gross carrying amount $ 2,065,055 236,670 377,374 $ 2,679,099 Accumulated amortization $ 1,137,747 122,022 120,055 $ 1,379,824 Aggregate amortization expense for the years ended December 31, 2008, 2007 and 2006 was ¥36,715 million ($403,462 thousand), ¥31,879 million and ¥26,490 million, respectively. Estimated amortization expense for intangible assets currently held for the next ﬁ ve years ending December 31 is ¥35,010 million ($384,725 thousand) in 2009, ¥27,402 million ($301,121 thousand) in 2010, ¥16,455 million ($180,824 thousand) in 2011, ¥9,030 million ($99,231 thousand) in 2012, and ¥6,016 million ($66,110 thousand) in 2013. Intangible assets not subject to amortization other than goodwill at December 31, 2008 and 2007 were not signiﬁ cant. The changes in the carrying amount of goodwill, which is included in other assets in the consolidated balance sheets, for the years ended December 31, 2008 and 2007 were as follows: Years ended December 31 Balance at beginning of year Goodwill acquired during the year Translation adjustments and other Balance at end of year Millions of yen 2008 ¥ 56,783 4,975 (11,004) ¥ 50,754 2007 ¥ 40,801 13,573 2,409 ¥ 56,783 Thousands of U.S. dollars 2008 $ 623,989 54,670 (120,923) $ 557,736 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 11. Short-Term Loans and Long-Term Debt Short-term loans consisting of bank borrowings at December 31, 2008 and 2007 were ¥220 million ($2,417 thousand) and ¥2,888 million, respectively. The weighted average interest rates on short-term loans outstanding at December 31, 2008 and 2007 were 6.21% and 3.16%, respectively. Long-term debt consisted of the following: December 31 Loans, principally from banks, maturing in installments through 2017; bearing weighted average interest of 2.93% and 1.80% at December 31, 2008 and 2007, respectively 2.27% Japanese yen notes, due 2008 1.30% Japanese yen convertible debentures, due 2008 Capital lease obligations Less current portion Millions of yen 2008 2007 ¥ 95 — — 13,648 13,743 (5,320) ¥ 8,423 ¥ 2,993 10,000 128 10,988 24,109 (15,429) ¥ 8,680 Thousands of U.S. dollars 2008 $ 1,044 — — 149,978 151,022 (58,462) $ 92,560 The aggregate annual maturities of long-term debt outstanding at December 31, 2008 were as follows: Year ending December 31: 2009 2010 2011 2012 2013 Thereafter Millions of yen ¥ 5,320 4,410 3,005 822 135 51 ¥ 13,743 Thousands of U.S. dollars $ 58,462 48,462 33,022 9,033 1,483 560 $ 151,022 12. Trade Payables Trade payables are summarized as follows: December 31 Notes Accounts Both short-term and long-term bank loans are made under general agreements which provide that security and guarantees for present and future indebtedness will be given upon request of the bank, and that the bank shall have the right to offset cash deposits against obligations that have become due or, in the event of default, against all obligations due to the bank. Millions of yen 2008 ¥ 14,544 392,202 ¥ 406,746 2007 ¥ 17,088 497,138 ¥ 514,226 Thousands of U.S. dollars 2008 $ 159,824 4,309,912 $ 4,469,736 78 13. Employee Retirement and Severance Beneﬁ ts The Company and certain of its subsidiaries have contributory and noncontributory deﬁ ned beneﬁ t pension plans covering substantially all of their employees. Beneﬁ ts payable under the plans are based on employee earnings and years of service. Certain foreign subsidiaries also have deﬁ ned contribution pension plans covering substantially all of their employees. Effective January 1, 2007, the Company and certain of its domestic subsidiaries amended their funded deﬁ ned beneﬁ t pension plans. Under these funded deﬁ ned beneﬁ t pension plans, the lifetime pension beneﬁ t is based upon amounts payable during an initial period after retirement (the “guarantee period”) and the subsequent period lasting for the remainder of the retiree’s lifetime (the “post-guarantee period”). The Company and certain of its domestic subsidiaries amended these plans to increase the duration of this guarantee period from 15 years to 20 years to reﬂ ect an increase in the average lifespan of their employees, resulting in reduced amounts payable during each of the guarantee and post-guarantee periods. As a result of these changes, the projected beneﬁ t obligation decreased by ¥101,620 million. In conjunction with these plan changes, the Company and certain of its domestic subsidiaries also have implemented an unfunded retirement and severance plan and a deﬁ ned contribution pension plan for certain future pension beneﬁ ts attributable to employees’ future services. The amounts of cost recognized for the deﬁ ned contribution pension plans of the Company and certain of its subsidiaries for the years ended December 31, 2008, 2007 and 2006 were ¥10,840 million ($119,121 thousand), ¥10,262 million and ¥6,233 million, respectively. Obligations and funded status Reconciliations of beginning and ending balances of the beneﬁ t obligations and the fair value of the plan assets are as follows: December 31 Japanese plans Foreign plans Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Change in beneﬁ t obligations: Beneﬁ t obligations at beginning of year ¥ 493,478 ¥ 578,086 $ 5,422,835 228,418 Service cost Interest cost 134,648 Plan participants’ contributions Amendments Actuarial (gain) loss Beneﬁ ts paid Acquisition Foreign currency exchange rate changes g g Beneﬁ t obligations at end of year 20,786 12,253 — (204) 10,160 (14,488) — — 521,985 20,161 11,888 — 2,474 — 493,478 (101,620) (4,623) (12,888) (2,242) 111,649 (159,209) 5,736,099 g y — — 3,141 4,991 1,460 (86) (4,521) (2,210) ¥ 113,833 ¥ 110,505 $ 1,250,912 34,516 4,016 54,846 4,947 16,044 1,613 (945) — (49,681) (24,286) — (419,120) 862,286 (778) 113,833 (38,140) 78,468 (3,293) (3,177) — — — Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Plan participants’ contributions Beneﬁ ts paid Acquisition Foreign currency exchange rate changes Fair value of plan assets at end of year Funded status at end of year 511,450 (81,981) 14,716 — 520,476 (15,796) 17,510 — 5,620,330 (900,890) 161,714 — (12,498) (157,308) (14,315) — — 1,758 — 4,723,846 511,450 ¥ (92,115) ¥ 17,972 $ (1,012,253) 429,870 — — 92,908 (8,453) 8,317 1,460 (1,556) — (29,680) 62,996 87,173 2,283 4,210 1,613 (2,242) — (129) 92,908 1,020,967 (92,890) 91,396 16,044 (17,099) — (326,154) 692,264 $ (170,022) ¥ (15,472) ¥ (20,925) 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Amounts recognized in the consolidated balance sheets at December 31, 2008 and 2007 are as follows: December 31 Japanese plans Foreign plans Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Other assets Accrued expenses Accrued pension and severance cost ¥ 806 — (92,921) ¥ (92,115) ¥ 41,567 $ 8,857 — — (23,595) (1,021,110) ¥ 17,972 $ (1,012,253) ¥ 2,461 ¥ 347 $ 27,044 (769) (157) (196,297) (21,115) $ (170,022) ¥ (15,472) ¥ (20,925) (70) (17,863) Amounts recognized in accumulated other comprehensive income (loss) at December 31, 2008 and 2007 are as follows: December 31 Japanese plans Foreign plans Millions of yen 2007 Thousands of U.S. dollars 2008 Actuarial loss Prior service credit Net transition obligation 2008 ¥ 251,731 (168,904) 2,166 ¥ 84,993 (182,073) ¥ 146,937 $ 2,766,275 (1,856,088) 23,802 $ 933,989 ¥ (32,248) 2,888 Millions of yen 2008 2007 ¥ 15,650 ¥ 16,905 (768) — (953) — ¥ 14,882 ¥ 15,952 Thousands of U.S. dollars 2008 $ 171,978 (8,440) — $ 163,538 The accumulated beneﬁ t obligation for all deﬁ ned beneﬁ t plans was as follows: December 31 Japanese plans Foreign plans Accumulated beneﬁ t obligation 2008 ¥ 493,559 Millions of yen 2007 Thousands of U.S. dollars 2008 Millions of yen 2008 2007 ¥ 471,146 $ 5,423,725 ¥ 71,627 ¥ 104,275 Thousands of U.S. dollars 2008 $ 787,110 The projected beneﬁ t obligations and the fair value of plan assets for the pension plans with projected beneﬁ t obligations in excess of plan assets, and the accumulated beneﬁ t obligations and the fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets are as follows: December 31 Japanese plans Foreign plans Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Millions of yen 2008 2007 Thousands of U.S. dollars 2008 Plans with projected beneﬁ t obligations in excess of plan assets: Projected beneﬁ t obligations Fair value of plan assets ¥ 516,646 423,725 ¥ 179,455 $ 5,677,429 4,656,319 155,860 ¥ 77,083 ¥ 113,790 92,518 59,150 $ 847,066 650,000 Plans with accumulated beneﬁ t obligations in excess of plan assets: Accumulated beneﬁ t obligations Fair value of plan assets ¥ 485,436 420,341 ¥ 46,789 $ 5,334,462 4,619,132 29,599 ¥ 69,471 ¥ 104,119 92,401 59,089 $ 763,418 649,330 80 Components of net periodic beneﬁ t cost and other amounts recognized in other comprehensive income (loss) Net periodic beneﬁ t cost for Canon’s employee retirement and severance deﬁ ned beneﬁ t plans for the years ended December 31, 2008, 2007 and 2006 consisted of the following components: Years ended December 31 Japanese plans Foreign plans Service cost Interest cost Expected return on plan assets Amortization of net transition obligation Amortization of prior service credit Amortization of actuarial loss 2008 Millions of yen 2007 ¥ 20,786 ¥ 20,161 ¥ 23,916 11,888 13,411 12,253 (21,148) (21,705) (19,721) 2006 Thousands of U.S. dollars 2008 $ 228,418 134,648 (216,714) 2008 Millions of yen 2007 ¥ 3,141 ¥ 4,016 ¥ 3,483 3,898 4,947 4,991 (4,494) (5,427) (5,519) 2006 Thousands of U.S. dollars 2008 $ 34,516 54,846 (60,648) 722 722 345 7,934 — — — — (13,479) (7,436) (13,373) 7,068 4,868 3,377 ¥ 7,735 ¥ 3,012 ¥ 11,908 (146,956) 77,670 $ 85,000 (113) (86) (271) 898 402 887 ¥ 3,240 ¥ 4,337 ¥ 3,176 (2,978) 9,868 $ 35,604 Other changes in plan assets and beneﬁ t obligations recog- nized in other comprehensive income (loss) for the years ended December 31, 2008 and 2007 were summarized as follows: Years ended December 31 Japanese plans Foreign plans Current year actuarial (gain) loss Amortization of actuarial loss Prior service credit due to amendments Amortization of prior service credit Amortization of net transition obligation Thousands of U.S. dollars 2008 Millions of yen 2008 2007 ¥ 111,862 ¥ 32,321 $ 1,229,253 (77,670) (2,242) 146,956 (7,934) $ 1,288,363 (4,868) (101,620) 13,479 (722) ¥ 117,241 ¥ (61,410) (7,068) (204) 13,373 (722) Millions of yen 2008 ¥ 9,451 (898) (86) 271 — ¥ 8,738 2007 ¥ (149) (887) — 86 — ¥ (950) Thousands of U.S. dollars 2008 $ 103,857 (9,868) (945) 2,978 — $ 96,022 The estimated net transition obligation, prior service credit and actuarial loss for the deﬁ ned beneﬁ t pension plans that will be amortized from accumulated other comprehensive income (loss) into net periodic beneﬁ t cost over the next year are summarized as follows: Japanese plans Foreign plans ¥ Millions of yen 722 (13,514) 13,249 Thousands of U.S. dollars $ 7,934 (148,505) 145,593 Millions of yen ¥ — (117) 1,122 Thousands of U.S. dollars $ — (1,286) 12,330 Net transition obligation Prior service credit Actuarial loss Assumptions Weighted-average assumptions used to determine beneﬁ t obligations are as follows: December 31 Discount rate Assumed rate of increase in future compensation levels Japanese plans Foreign plans 2008 2.4% 3.0% 2007 2.5% 2.9% 2008 5.3% 3.1% 2007 5.1% 3.1% 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Weighted-average assumptions used to determine net periodic beneﬁ t cost are as follows: Years ended December 31 Japanese plans Foreign plans Discount rate Assumed rate of increase in future compensation levels Expected long-term rate of return on plan assets 2008 2.5% 2.9% 3.7% 2007 2.5% 2.9% 3.9% 2006 2.5% 2.9% 4.5% 2008 5.1% 3.1% 6.5% 2007 4.5% 2.9% 6.0% 2006 4.8% 2.6% 6.4% Canon determines the expected long-term rate of return based on the expected long-term return of the various asset categories in which it invests. Canon considers the current expectations for future returns and the actual historical returns of each plan asset category. Plan assets The weighted-average asset allocations of Canon’s beneﬁ t plans at December 31, 2008 and 2007 and target asset allocation by asset category are as follows: December 31 Asset category: Equity securities Debt securities Cash Life insurance company general accounts Other Japanese plans Foreign plans 2008 2007 Target allocation 2008 2007 Target allocation 22.7% 52.0 0.6 23.8 0.9 33.6% 45.2 1.1 19.5 0.6 100.0% 100.0% 100.0% 31.9% 46.7 0.1 20.4 0.9 43.3% 42.5 1.3 — 12.9 52.4% 33.8 — — 13.8 100.0% 100.0% 100.0% 30.3% 59.9 1.6 — 8.2 Canon’s investment policies are designed to ensure adequate plan assets are available to provide future payments of pension beneﬁ ts to eligible participants. Taking into account the expected long-term rate of return on plan assets, Canon formulates a “model” portfolio comprised of the optimal combination of equity securities and debt securities. Plan assets are invested in individual equity and debt securities using the guidelines of the “model” portfolio in order to produce a total return that will match the expected return on a mid-term to long-term basis. Canon evaluates the gap between expected return and actual return of invested plan assets on an annual basis to determine if such differences necessitate a revision in the formulation of the “model” portfolio. Canon revises the “model” portfolio when and to the extent considered necessary to achieve the expected long-term rate of return on plan assets. The plan’s equity securities include common stock of the Company and certain of its subsidiaries in the amounts of ¥485 million ($5,330 thousand) and ¥1,257 million at December 31, 2008 and 2007, respectively. Contributions Canon expects to contribute ¥14,439 million ($158,670 thousand) to its Japanese deﬁ ned beneﬁ t pension plans and ¥3,485 million ($38,297 thousand) to its foreign deﬁ ned beneﬁ t pension plans for the year ending December 31, 2009. Estimated future beneﬁ t payments The following beneﬁ t payments, which reﬂ ect expected future service, as appropriate, are expected to be paid: Year ending December 31: Japanese plans Foreign plans 2009 2010 2011 2012 2013 2014—2018 82 Millions of yen ¥ 11,779 12,849 14,506 15,700 16,918 105,706 Thousands of U.S. dollars $ 129,440 141,198 159,407 172,527 185,912 1,161,604 Millions of yen ¥ 1,566 1,733 1,784 1,902 1,851 12,483 Thousands of U.S. dollars $ 17,209 19,044 19,604 20,901 20,341 137,176 14. Income Taxes Domestic and foreign components of income before income taxes and minority interests, and the current and deferred Years ended December 31 2008: Income before income taxes and minority interests Income taxes: Current Deferred 2007: Income before income taxes and minority interests Income taxes: Current Deferred 2006: Income before income taxes and minority interests Income taxes: Current Deferred 2008: Income before income taxes and minority interests Income taxes: Current Deferred income tax expense (beneﬁ t) attributable to such income are summarized as follows: Japanese ¥ 382,299 ¥ 168,428 (34,073) ¥ 134,355 Millions of yen Foreign ¥ 98,848 ¥ 24,857 1,576 ¥ 26,433 Total ¥ 481,147 ¥ 193,285 (32,497) ¥ 160,788 ¥ 575,017 ¥ 193,371 ¥ 768,388 ¥ 238,921 (31,930) ¥ 206,991 ¥ 60,358 (3,091) ¥ 57,267 ¥ 299,279 (35,021) ¥ 264,258 ¥ 556,759 ¥ 162,384 ¥ 719,143 ¥ 201,022 (73) ¥ 200,949 ¥ 54,156 (6,872) ¥ 47,284 ¥ 255,178 (6,945) ¥ 248,233 Thousands of U.S. dollars Japanese $ 4,201,088 Foreign $ 1,086,242 Total $ 5,287,330 $ 1,850,857 (374,428) $ 1,476,429 $ 273,154 17,318 $ 290,472 $ 2,124,011 (357,110) $ 1,766,901 The Company and its domestic subsidiaries are subject to a number of income taxes, which, in the aggregate, represent a statutory income tax rate of approximately 40% for the years ended December 31, 2008, 2007 and 2006. A reconciliation of the Japanese statutory income tax rate and the effective income tax rate as a percentage of income before income taxes and minority interests is as follows: Years ended December 31 Japanese statutory income tax rate Increase (reduction) in income taxes resulting from: Expenses not deductible for tax purposes Income of foreign subsidiaries taxed at lower than Japanese statutory tax rate Tax credit for research and development expenses Other Effective income tax rate 2008 40.0% 0.5 (2.6) (4.6) 0.1 33.4% 2007 40.0% 0.3 (2.8) (4.5) 1.4 34.4% 2006 40.0% 0.3 (2.1) (4.1) 0.4 34.5% 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Net deferred income tax assets and liabilities are included in the accompanying consolidated balance sheets under the following captions: December 31 Prepaid expenses and other current assets Other assets Other current liabilities Other noncurrent liabilities The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are presented below: December 31 Deferred tax assets: Inventories Accrued business tax Accrued pension and severance cost Research and development—costs capitalized for tax purposes Property, plant and equipment Accrued expenses Net operating losses carried forward Other Less valuation allowance Total deferred tax assets Deferred tax liabilities: Undistributed earnings of foreign subsidiaries Net unrealized gains on securities Tax deductible reserve Financing lease revenue Prepaid pension and severance cost Other Total deferred tax liabilities Net deferred tax assets Millions of yen 2008 ¥ 96,613 130,378 (2,491) (29,075) ¥ 195,425 2007 ¥ 79,846 68,178 (4,506) (28,157) ¥ 115,361 Thousands of U.S. dollars 2008 $ 1,061,681 1,432,725 (27,374) (319,505) $ 2,147,527 Millions of yen 2008 2007 ¥ 36,817 5,183 51,713 41,661 58,682 27,748 6,745 44,894 273,443 (10,817) 262,626 (10,407) (607) (8,119) (31,035) (2,644) (14,389) (67,201) ¥ 195,425 ¥ 17,359 11,555 16,336 42,434 53,487 27,903 4,080 34,448 207,602 (9,327) 198,275 (13,566) (4,440) (8,574) (26,892) (10,604) (18,838) (82,914) ¥ 115,361 Thousands of U.S. dollars 2008 $ 404,582 56,956 568,275 457,813 644,857 304,923 74,121 493,341 3,004,868 (118,868) 2,886,000 (114,363) (6,670) (89,220) (341,044) (29,055) (158,121) (738,473) $ 2,147,527 The net changes in the total valuation allowance were increases of ¥1,490 million ($16,374 thousand), ¥2,827 million and ¥3,155 million for the years ended December 31, 2008, 2007 and 2006, respectively. Based upon the level of historical taxable income and projections for future taxable income over the periods which the net deductible temporary differences are expected to reverse, management believes it is more likely than not that Canon will realize the beneﬁ ts of these deferred tax assets, net of the existing valuation allowance, at December 31, 2008. At December 31, 2008, Canon had net operating losses which can be carried forward for income tax purposes of ¥18,322 million ($201,341 thousand) to reduce future taxable income. Periods available to reduce future taxable income vary in each tax jurisdiction and generally range from one year to ten years as follows: 84 Within one year After one year through ﬁ ve years After ﬁ ve years through ten years Indeﬁ nite period Total Millions of yen 233 ¥ 2,945 10,293 4,851 ¥ 18,322 Thousands of U.S. dollars $ 2,560 32,363 113,110 53,308 $ 201,341 Income taxes have not been accrued on undistributed earnings of domestic subsidiaries as the tax law provides a means by which the dividends from a domestic subsidiary can be received tax free. Canon has not recognized deferred tax liabilities of ¥37,208 million ($408,879 thousand) for a portion of undistributed earnings of foreign subsidiaries that arose for the year ended December 31, 2008 and prior years because Canon currently does not expect to have such amounts distributed or paid as dividends to the Company in the foreseeable future. Deferred tax liabilities will be recognized when Canon expects that it will realize those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. At December 31, 2008, such undistributed earnings of these subsidiaries were ¥728,410 million ($8,004,505 thousand). Effective January 1, 2007, Canon adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an inter- pretation of FASB Statement No. 109”. A reconciliation of the beginning and ending amount of unrecognized tax beneﬁ ts is as follows: Years ended December 31 Balance at beginning of year Additions for tax positions of the current year Additions for tax positions of prior years Reductions for tax positions of prior years Lapse of the applicable statute of limitations Settlements with tax authorities Other Balance at end of year Millions of yen 2008 ¥ 15,791 8,700 1,354 (8,512) — (1,208) (3,436) ¥ 12,689 2007 ¥ 16,087 994 1,902 (1,340) (1,311) (322) (219) ¥ 15,791 Thousands of U.S. dollars 2008 $ 173,527 95,604 14,879 (93,538) — (13,274) (37,758) $ 139,440 The total amounts of unrecognized tax beneﬁ ts that would reduce the effective tax rate, if recognized, are ¥4,405 million ($48,407 thousand) and ¥8,278 million at December 31, 2008 and 2007, respectively. Although Canon believes its estimates and assumptions of unrecognized tax beneﬁ ts are reasonable, uncertainty regarding the ﬁ nal determination of tax audit settlements and any related litigation could affect the effective tax rate in the future period. Based on each of the items of which Canon is aware at December 31, 2008, no signiﬁ cant changes to the unrecognized tax beneﬁ ts are expected within the next twelve months. Canon recognizes interest and penalties accrued related to unrecognized tax beneﬁ ts in income taxes. Both interest and penalties accrued at December 31, 2008 and 2007, and interest and penalties included in income taxes for the years ended December 31, 2008 and 2007 are not material. Canon ﬁ les income tax returns in Japan and various foreign tax jurisdictions. In Japan, Canon is no longer subject to regular income tax examinations by the tax authority for years before 2006. While there has been no speciﬁ c indication by the tax authority that Canon will be subject to a transfer pricing examination in the near future, the tax authority could conduct a transfer pricing examination for years after 2001. In other major foreign tax jurisdictions, including the United States and Netherlands, Canon is no longer subject to income tax examinations by tax authorities for years before 2004 with few exceptions. The tax authorities are currently conducting income tax examinations of Canon’s income tax returns for years after 2005 in Japan and for certain years after 2003 in major foreign tax jurisdictions. 15. Common Stock For the years ended December 31, 2008, 2007 and 2006, the Company issued 127,254 shares, 190,380 shares and 331,661 shares of common stock, respectively, in connection with the conversion of convertible debt. In accordance with the Corporation Law of Japan, conversion into common stock of convertible debt is accounted for by crediting one-half or more of the conversion price to the common stock account and the remainder to the additional paid-in capital account. 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 16. Legal Reserve and Retained Earnings The Corporation Law of Japan provides that an amount equal to 10% of distributions from retained earnings paid by the Company and its Japanese subsidiaries be appropriated as a legal reserve. No further appropriations are required when the total amount of the additional paid-in capital and the legal reserve equals 25% of their respective stated capital. The Corporation Law of Japan also provides that additional paid-in capital and legal reserve are available for appropriations by the resolution of the stockholders. Certain foreign subsidiaries are also required to appropriate their earnings to legal reserves under the laws of the respective countries. Cash dividends and appropriations to the legal reserve charged to retained earnings for the years ended December 31, 2008, 2007 and 2006 represent dividends paid out during those years and the related appropriations to the legal reserve. Retained earnings at December 31, 2008 do not reﬂ ect current year-end dividends in the amount of ¥67,897 million ($746,121 thousand) which will be payable in March 2009 upon approval by the stockholders. The amount available for dividends under the Corporation Law of Japan is based on the amount recorded in the Company’s nonconsolidated books of account in accordance with ﬁ nancial accounting standards of Japan. Such amount was ¥1,363,838 million ($14,987,231 thousand) at December 31, 2008. Retained earnings at December 31, 2008 included Canon’s equity in undistributed earnings of afﬁ liated companies accounted for by the equity method in the amount of ¥17,745 million ($195,000 thousand). 17. Other Comprehensive Income (Loss) Changes in accumulated other comprehensive income (loss) are as follows: Years ended December 31 Millions of yen 2008 2007 2006 Thousands of U.S. dollars 2008 Foreign currency translation adjustments: Balance at beginning of year Adjustments for the year Balance at end of year Net unrealized gains and losses on securities: Balance at beginning of year Adjustments for the year Balance at end of year Net gains and losses on derivative instruments: Balance at beginning of year Adjustments for the year Balance at end of year Minimum pension liability adjustments: Balance at beginning of year Adjustments for the year Adjustment to initially apply SFAS 158 Balance at end of year Pension liability adjustments: Balance at beginning of year Adjustments for the year Adjustment to initially apply SFAS 158 Balance at end of year Total accumulated other comprehensive income (loss): Balance at beginning of year Adjustments for the year Adjustment to initially apply SFAS 158 Balance at end of year 86 ¥ 22,796 (258,764) (235,968) ¥ 22,858 (62) 22,796 ¥ (25,772) 48,630 22,858 $ 250,505 (2,843,560) (2,593,055) 6,287 (5,152) 1,135 (849) 2,342 1,493 — — — — 6,436 (65,916) — (59,480) 34,670 (327,490) — ¥ (292,820) 8,065 (1,778) 6,287 (1,663) 814 (849) — — — — (26,542) 32,978 — 6,436 2,718 31,952 — ¥ 34,670 6,073 1,992 8,065 (1,174) (489) (1,663) (7,339) (3,575) 10,914 — — — (26,542) (26,542) 69,088 (56,615) 12,473 (9,329) 25,736 16,407 — — — — 70,725 (724,352) — (653,627) (28,212) 46,558 (15,628) ¥ 2,718 380,989 (3,598,791) — $ (3,217,802) Tax effects allocated to each component of other com- prehensive income (loss) and reclassiﬁ cation adjustments are as follows: Years ended December 31 2008: Foreign currency translation adjustments Net unrealized gains and losses on securities: Before-tax amount Millions of yen Tax (expense) or beneﬁ t Net-of-tax amount ¥ (264,657) ¥ 5,893 ¥ (258,764) Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year (15,957) 7,374 (8,583) Net gains and losses on derivative instruments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) 23,131 (19,229) 3,902 (106,937) (4,556) (111,493) ¥ (380,831) 43,595 1,982 45,577 ¥ 53,341 6,532 (3,101) 3,431 (9,248) 7,688 (1,560) (9,425) 4,273 (5,152) 13,883 (11,541) 2,342 (63,342) (2,574) (65,916) ¥ (327,490) 2007: Foreign currency translation adjustments Net unrealized gains and losses on securities: ¥ (370) ¥ 308 ¥ (62) Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Net gains and losses on derivative instruments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) (7,237) (293) (7,530) 590 772 1,362 3,037 2,715 5,752 (236) (312) (548) (4,200) 2,422 (1,778) 354 460 814 62,768 (5,766) 57,002 ¥ 50,464 (26,502) 2,478 (24,024) ¥ (18,512) 36,266 (3,288) 32,978 ¥ 31,952 2006: Foreign currency translation adjustments Net unrealized gains and losses on securities: ¥ 49,518 ¥ (888) ¥ 48,630 Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year 3,708 (388) 3,320 (1,502) 174 (1,328) Net gains and losses on derivative instruments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Minimum pension liability adjustments Other comprehensive income (loss) (7,126) 6,309 (817) (4,391) ¥ 47,630 2,858 (2,530) 328 816 ¥ (1,072) 2,206 (214) 1,992 (4,268) 3,779 (489) (3,575) ¥ 46,558 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES 2008: Foreign currency translation adjustments Net unrealized gains and losses on securities: Thousands of U.S. dollars Before-tax amount Tax (expense) or beneﬁ t Net-of-tax amount $ (2,908,318) $ 64,758 $ (2,843,560) Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year (175,351) 81,033 (94,318) Net gains and losses on derivative instruments: Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Pension liability adjustments: 254,187 (211,308) 42,879 Amount arising during the year Reclassiﬁ cation adjustments for gains and losses realized in net income Net change during the year Other comprehensive income (loss) (1,175,132) (50,066) (1,225,198) $ (4,184,955) 71,780 (34,077) 37,703 (101,627) 84,484 (17,143) (103,571) 46,956 (56,615) 152,560 (126,824) 25,736 479,066 21,780 500,846 $ 586,164 (696,066) (28,286) (724,352) $ (3,598,791) 18. Stock-Based Compensation On May 1, 2008, based on the approval of the stockholders, the Company granted stock options to its directors, executive ofﬁ cers and certain employees to acquire 592,000 shares of common stock. These option awards vest after two years of continuous service beginning on the grant date and have a four year con- tractual term. The grant date fair value of each option granted was ¥1,247 ($13.70). The compensation cost recognized for these stock options for the year ended December 31, 2008 was ¥246 million ($2,703 thousand) and is included in selling, general and administrative expenses in the consolidated statements of income. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions presented below: Expected term of option (in years) Expected volatility Dividend yield Risk-free interest rate 4.0 37.39% 2.10% 0.95% A summary of option activity under the stock option plan as of and for the year ended December 31, 2008 is presented below: Outstanding at January 1, 2008 Granted Forfeited Outstanding at December 31, 2008 Weighted-average exercise price Weighted- average remaining contractual term Aggregate intrinsic value Yen U.S. dollars Year Millions of yen Thousands of U.S. dollars — ¥5,502 — ¥5,502 — $60.46 — $60.46 3.3 ¥ — $ — Shares — 592,000 — 592,000 At December 31, 2008, all option awards were nonvested, but expected to be vested, and there was ¥492 million ($5,407 thousand) of total unrecognized compensation cost related to nonvested stock option. That cost is expected to be recognized over 1.33 years. 88 19. Net Income per Share A reconciliation of the numerators and denominators of basic and diluted net income per share computations is as follows: Years ended December 31 Net income Effect of dilutive securities: 1.30% Japanese yen convertible debentures, due 2008 Diluted net income Average common shares outstanding Effect of dilutive securities: 1.30% Japanese yen convertible debentures, due 2008 Diluted common shares outstanding Net income per share: Basic Diluted 2008 ¥ 309,148 Millions of yen 2007 ¥ 488,332 2006 ¥ 455,325 Thousands of U.S. dollars 2008 $ 3,397,231 2 ¥ 309,150 4 ¥ 488,336 8 ¥ 455,333 22 $ 3,397,253 1,255,626,490 1,293,295,680 1,331,542,074 Number of shares 79,929 474,796 1,255,706,419 1,293,517,431 1,332,016,870 221,751 Yen ¥377.59 377.53 ¥246.21 246.20 ¥341.95 341.84 U.S. dollars $2.71 2.71 The computation of diluted net income per share for the year ended December 31, 2008 excludes outstanding stock options because the effect would be anti-dilutive. 20. Derivatives and Hedging Activities Risk management policy Canon operates internationally, exposing it to the risk of changes in foreign currency exchange rates. Derivative ﬁ nancial instruments are comprised principally of foreign exchange contracts utilized by the Company and certain of its subsidiaries to reduce the risk. Canon assesses foreign currency exchange rate risk by continually monitoring changes in the exposures and by evaluating hedging opportunities. Canon does not hold or issue derivative ﬁ nancial instruments for trading purposes. Canon is also exposed to credit- related losses in the event of non-performance by counterparties to derivative ﬁ nancial instruments, but it is not expected that any counterparties will fail to meet their obligations. Most of the counterparties are internationally recognized ﬁ nancial institutions and selected by Canon taking into account their ﬁ nancial condition, and contracts are diversiﬁ ed across a number of major ﬁ nancial institutions. Foreign currency exchange rate risk management Canon’s international operations expose Canon to the risk of changes in foreign currency exchange rates. Canon uses foreign exchange contracts to manage certain foreign currency exchange exposures principally from the exchange of U.S. dollars and euros into Japanese yen. These contracts are primarily used to hedge the foreign currency exposure of forecasted intercompany sales and intercompany trade receivables which are denominated in foreign currencies. In accordance with Canon’s policy, a speciﬁ c portion of foreign currency exposure resulting from forecasted intercompany sales are hedged using foreign exchange contracts which principally mature within three months. 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Cash ﬂ ow hedge Changes in the fair value of derivative ﬁ nancial instruments designated as cash ﬂ ow hedges, including foreign exchange contracts associated with forecasted intercompany sales, are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassiﬁ ed into earnings through other income (deductions) in the same period as the hedged items affect earnings. Substantially all amounts recorded in accumulated other comprehensive income (loss) at year-end are expected to be recognized in earnings over the next 12 months. Canon excludes the time value component from the assessment of hedge effectiveness. Changes in the fair value of a foreign exchange contract for the period between the date that the forecasted intercompany sales occur and its maturity date are recognized in earnings and not considered hedge ineffectiveness. The amount of the hedging ineffectiveness was not material for the years ended December 31, 2008, 2007 and 2006. The amount of net gains or losses excluded from the assessment of hedge effectiveness (time value component) which was recorded in other income (deductions) was net losses of ¥3,701 million ($40,670 thousand), ¥6,883 million and ¥5,917 million for the years ended December 31, 2008, 2007 and 2006, respectively. Derivatives not designated as hedges Canon has entered into certain foreign exchange contracts to manage its foreign currency exposures. These foreign exchange contracts have not been designated as hedges. Accordingly, the changes in fair value of the contracts are recorded in earnings immediately. Contract amounts of foreign exchange contracts at December 31, 2008 and 2007 are set forth below: December 31 To sell foreign currencies To buy foreign currencies Millions of yen 2008 ¥ 350,959 35,247 2007 ¥ 697,240 46,897 Thousands of U.S. dollars 2008 $ 3,856,692 387,330 21. Commitments and Contingent Liabilities Commitments At December 31, 2008, commitments outstanding for the purchase of property, plant and equipment approximated ¥74,909 million ($823,176 thousand), and commitments outstanding for the purchase of parts and raw materials approximated ¥60,281 million ($662,429 thousand). Canon occupies sales ofﬁ ces and other facilities under lease arrangements accounted for as operating leases. Deposits made under such arrangements aggregated ¥14,223 million ($156,297 thousand) and ¥14,440 million at December 31, 2008 and 2007, respectively, and are included in noncurrent receivables in the accompanying consolidated balance sheets. Rental expenses under the operating lease arrangements amounted to ¥41,169 million ($452,407 thousand), ¥36,900 million and ¥36,157 million for the years ended December 31, 2008, 2007 and 2006, respectively. Future minimum lease payments required under noncancelable operating leases that have initial or remaining lease terms in excess of one year at December 31, 2008 are as follows: Millions of yen ¥ 14,726 11,127 7,090 5,105 3,348 8,440 ¥ 49,836 Thousands of U.S. dollars $ 161,824 122,275 77,912 56,099 36,791 92,747 $ 547,648 Year ending December 31: 2009 2010 2011 2012 2013 Thereafter Total future minimum lease payments 90 Guarantees Canon provides guarantees for bank loans of its employees, afﬁ liates and other companies. The guarantees for the employees are principally made for their housing loans. The guarantees of loans of its afﬁ liates and other companies are made to ensure that those companies operate with less ﬁ nancial risk. For each guarantee provided, Canon would have to perform under a guarantee if the borrower defaults on a payment within the contract periods of 1 year to 30 years, in the case of employees with housing loans, and of 1 year to 10 years, in the case of afﬁ liates and other companies. The maximum amount of undiscounted payments Canon would have had to make in the event of default is ¥22,308 million ($245,143 thousand) at December 31, 2008. The carrying amounts of the liabilities recognized for Canon’s obligations as a guarantor under those guarantees at December 31, 2008 were not signiﬁ cant. Canon also issues contractual product warranties under which it generally guarantees the performance of products delivered and services rendered for a certain period or term. Changes in accrued product warranty cost for the years ended December 31, 2008 and 2007 are summarized as follows: Years ended December 31 Balance at beginning of year Addition Utilization Other Balance at end of year Millions of yen 2008 ¥ 20,138 30,644 (26,846) (6,564) ¥ 17,372 2007 ¥ 18,144 31,053 (26,199) (2,860) ¥ 20,138 Thousands of U.S. dollars 2008 $ 221,297 336,747 (295,011) (72,132) $ 190,901 Legal proceedings In October 2003, a lawsuit was ﬁ led by a former employee against the Company at the Tokyo District Court in Japan. The lawsuit alleges that the former employee is entitled to ¥45,872 million ($504,088 thousand) as reasonable remuneration for an invention related to certain technology used by the Company, and the former employee has sued for a partial payment of ¥1,000 million ($10,989 thousand) and interest thereon. On January 30, 2007, the Tokyo District Court of Japan ordered the Company to pay the former employee approximately ¥33.5 million ($368 thousand) and interest thereon. On the same day, the Company appealed the decision. On February 26, 2009, the Intellectual Property High Court of Japan issued a judgment in the appellate court review and ordered the Company to pay the former employee approximately ¥69.6 million ($765 thousand), consisting of reasonable remuneration of approximately ¥56.3 million ($619 thousand) and interest thereon. On March 12, 2009, the Company appealed the decision to the Supreme Court. In Germany, Verwertungsgesellschaft Wort (“VG Wort”), a collecting agency representing certain copyright holders, has ﬁ led a series of lawsuits seeking to impose copyright levies upon digital products such as PCs and printers, that allegedly enable the reproduction of copyrighted materials, against the companies importing and distributing these digital products. In May 2004, VG Wort ﬁ led a civil lawsuit against Hewlett-Packard GmbH seeking levies on multi-function printers sold in Germany during the period from 1997 through 2001. This is an industry test case under which Hewlett-Packard GmbH represents other companies sharing common interests, and Canon has undertaken to be bound by the ﬁ nal decision of this court case. In 2008, the Federal Supreme Court delivered its short judgment in favor of VG Wort, whereby the court decided that, for MFPs sold during the period from 1997 through 2001, the same full tariff as applicable to photocopier (EUR38.35 to EUR 613.56 per unit, depending on the printing speed and color printing capability) should be applied. Hewlett-Packard GmbH ﬁ led a claim with the Federal Constitutional Court challenging the judgment of the Federal Supreme Court in August 2008. For the multi-function printers sold during the period from 2002 through 2007, VG Wort made a request for arbitration with Canon before an arbitration court in January 2007, and the arbitration court delivered their settlement proposal in December 2008. However, VG Wort rejected such settlement proposals in January 2009. VG Wort is now able to transfer this case to a court of appeals. With regard to single-function printers, VG Wort ﬁ led a separate lawsuit in January 2006 against Canon seeking payment of copyright levies, and the court of ﬁ rst instance in Düsseldorf ruled in favor of the claim by VG Wort in November 2006. Canon lodged an appeal against such decision in December 2006 before the court of appeals in Düsseldorf. Following a dicision by the same court of appeals in Düsseldorf on January 23, 2007 in relation to a similar court case seeking copyright levies on single-function printers of Epson Deutschland GmbH, Xerox GmbH and Kyocera Mita Deutschland GmbH, whereby the court rejected such alleged levies, in its judgment of November 13, 2007, the court of appeals rejected VG Wort’s claim against Canon. VG Wort appealed further against said decision of the court of appeals before the Federal Supreme Court. In December 2007, for a similar Hewlett-Packard GmbH case relating to single-function printers, the Federal Supreme Court delivered its judgment in favor of Hewlett-Packard GmbH and dismissed VG Wort’s claim. VG Wort has already ﬁ led a constitutional complaint with the Federal Constitutional Court against said judgment of the Federal Supreme Court. Canon, other companies and the industry associations have expressed opposition to such extension of the levy scope. Based on industry opposition to the extension 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES of levies to digital products, Canon’s assessments of the ﬁ nal conclusion of these court cases including the amount of levies to be imposed and the associated ﬁ nancial impact on Canon remains uncertain. In, 2007, an amendment of German copyright law was carried out, and a new law has been effective from January 1, 2008 for both multi-function printers and single-function printers. The new law sets forth that the scope and tariff of copyright levies will be agreed between industry and the collect- ing society. Industry and the collecting society, based on the requirement under the new law, reached an agreement in December 2008. This agreement is applicable retroactively from January 1, 2008 and will remain effective through end of 2010. Accordingly, there is no longer any uncertainty with respect to levies for sales of printers on and after January 1, 2008. In April 2005, a lawsuit was ﬁ led by Nano-Proprietary Inc., currently Applied Nanotech Holdings, Inc., (“NPI”) against the Company and Canon U.S.A., Inc. in the United States District Court of Texas alleging that SED Inc., a joint venture company established by the Company and Toshiba Corporation, was not regarded as a “subsidiary” under the Patent License Agreement between the Company and NPI and the extension of the license to SED Inc. constituted a breach of the agreement. NPI also alleged that Canon committed fraud in executing such agreement, and requested rescission of the agreement and compensatory damages. In November 2006, the Court denied Canon’s motion for a summary judgment that SED Inc. was a subsidiary of the Company. In January 2007, the Company purchased all the shares of SED Inc. owned by Toshiba Corporation, making SED Inc. a 100% owned subsidiary of the Company. However, on February 22, 2007, the Court issued a summary judgment stating that SED Inc. (before the above stock purchase) was not a subsidiary of the Company, that the Company had materially breached the patent license agreement and that NPI was allowed to terminate that agreement. Thereafter, a trial was held from April 30 to May 3, 2007, in Austin, Texas. NPI’s fraud claims against Canon were withdrawn by NPI and the jury returned a verdict that NPI had sustained no damages. All claims against Canon U.S.A., Inc. were also withdrawn by NPI. On May 15, 2007, Canon ﬁ led a notice of appeal to the United States Court of Appeals for the Fifth Circuit (“Appeals Court”), appealing the District Court’s prior ruling that Canon had breached the patent license agreement and allowing NPI to terminate that agreement. On June 4, 2007, NPI also ﬁ led a notice of appeal, appealing the District Court’s determination that NPI had sustained no damages. On July 25, 2008, the Appeals Court reversed the District Court’s judgment and found that termination of the patent license agreement was ineffective and that the 100% owned SED Inc. is a subsidiary of Canon. The Appeal Court also afﬁ rmed the District Court’s judgment denying damages to NPI. NPI petitioned for rehearing of the judgment, but the Appeals Court denied the petition. Since NPI did not appeal to the Supreme Court within the required time limit, the Fifth Circuit’s judgment is deﬁ nitive and conclusive in favor of Canon. Canon is involved in various claims and legal actions, including those noted above, arising in the ordinary course of business. In accordance with SFAS No. 5, “Accounting for Contingencies,” Canon has recorded provisions for liabilities when it is probable that liabilities have been incurred and the amount of loss can be reasonably estimated. Canon reviews these provisions at least quarterly and adjusts these provisions to reﬂ ect the impact of the negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Based on its experience, Canon believes that any damage amounts claimed in the speciﬁ c matters discussed above are not a meaningful indicator of Canon’s potential liability. In the opinion of management, the ultimate disposition of the above mentioned matters will not have a material adverse effect on Canon’s consolidated ﬁ nancial position, results of operations, or cash ﬂ ows. However, litigation is inherently unpredictable. While Canon believes that it has valid defenses with respect to legal matters pending against it, it is possible that Canon’s consolidated ﬁ nancial position, results of operations, or cash ﬂ ows could be materially affected in any particular period by the unfavorable resolution of one or more of these matters. 22. Disclosures about the Fair Value of Financial Instruments and Concentrations of Credit Risk Fair value of ﬁ nancial instruments The estimated fair values of Canon’s ﬁ nancial instruments at December 31, 2008 and 2007 are set forth below. The following summary excludes cash and cash equivalents, trade receivables, ﬁ nance receivables, noncurrent receivables, short-term loans, trade payables and accrued expenses for which fair values approximate their carrying amounts. The summary also excludes investments which are disclosed in Note 4. December 31 Millions of yen Thousand of U.S. dollars Long-term debt, including current installments ¥ (13,743) ¥ (13,727) Foreign exchange contracts: ¥ (24,109) ¥ (24,714) $ (151,022) $ (150,846) 2008 2007 2008 Carrying amount Estimated fair value Carrying amount Estimated fair value Carrying amount Estimated fair value Assets Liabilities 92 10,516 (678) 10,516 (678) 806 (12,335) 806 (12,335) 115,560 (7,451) 115,560 (7,451) The following methods and assumptions are used to estimate the fair value in the above table. Long-term debt The fair values of Canon’s long-term debt instruments are based on the quoted price in the most active market or the present value of future cash ﬂ ows associated with each instrument discounted using Canon’s current borrowing rate for similar debt instruments of comparable maturity. Foreign exchange contracts The fair values of foreign exchange contracts, all of which are used for purposes other than trading, are estimated by obtaining quotes from counterparties or third parties. Limitations Fair value estimates are made at a speciﬁ c point in time, based on relevant market information and information about the ﬁ nancial instruments. These estimates are subjective in nature and involve uncertainties and matters of signiﬁ cant judgment and therefore cannot be determined with precision. Changes in assumptions could signiﬁ cantly affect the estimates. Concentrations of credit risk At December 31, 2008 and 2007, one customer accounted for approximately 19% and 16% of consolidated trade receivables, respectively. Although Canon does not expect that the customer will fail to meet its obligations, Canon is potentially exposed to concentrations of credit risk if the customer failed to perform according to the terms of the contracts. 23. Fair Value Measurements SFAS 157 deﬁ nes fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. SFAS 157 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value as follows: that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 — Inputs are derived from valuation techniques in which one or more signiﬁ cant inputs or value drivers are unobservable, which reﬂ ect the reporting entity’s own assumptions about the assumptions that market participants would use in establishing a price. Level 1 — Inputs are quoted prices in active markets for identical assets or liabilities. Level 2 — Inputs are quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs Assets and Liabilities Measured at Fair Value on a Recurring Basis The following table presents Canon’s assets and liabilities that are measured at fair value on a recurring basis at December 31, 2008 consistent with the fair value hierarchy provisions of SFAS No. 157. Assets: Cash and cash equivalents Investments Derivatives Total assets Liabilities: Derivatives Total liabilities Level 1 Level 2 Level 3 Total Millions of yen ¥ — 14,108 — ¥ 14,108 ¥ 194,030 981 10,516 ¥ 205,527 ¥ — 1,516 — ¥ 1,516 ¥ 194,030 16,605 10,516 ¥ 221,151 ¥ — ¥ — ¥ ¥ 678 678 ¥ — ¥ — ¥ ¥ 678 678 93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CANON INC. AND SUBSIDIARIES Thousands of U.S. dollars Level 1 Level 2 Level 3 Total Assets: Cash and cash equivalents Investments Derivatives Total assets Liabilities: Derivatives Total liabilities $ 155,033 $ 155,033 — $ 2,132,198 10,780 115,560 $ 2,258,538 — $ — $ 2,132,198 182,472 115,560 $ 2,430,230 16,659 — $ 16,659 $ $ — $ — $ 7,451 7,451 $ — $ $ — $ 7,451 7,451 Level 1 investments are comprised principally of equity securities, which are valued using an unadjusted quoted market price in active markets with sufﬁ cient volume and frequency of transactions. Level 2 cash and cash equivalents are valued using quoted prices for identical assets in markets that are not active. Level 3 investments are comprised of corporate debt securities, which are valued based on unobservable inputs as the market for the assets was not active at the measurement date. Derivative ﬁ nancial instruments are comprised of foreign exchange contracts. Level 2 derivatives are valued using quotes obtained from counterparties or third parties, which are periodi- cally validated by pricing models using observable market inputs, such as foreign currency exchange rates and interest rates. The following table presents the changes in Level 3 assets measured on a recurring basis, consisting solely of corporate debt securities, for the year ended December 31, 2008. Balance at beginning of year Total gains or losses (realized or unrealized): Included in earnings Included in other comprehensive income (loss) Purchases, issuances, and settlements Balance at end of year All gains and losses included in earnings are related to corporate debt securities still held at December 31, 2008, and are reported in “Other, net” in the consolidated statements of income. Millions of yen ¥ 1,889 (559) (8) 194 ¥ 1,516 Thousands of U.S. dollars $ 20,758 (6,143) (88) 2,132 $ 16,659 Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Non-marketable equity securities with a carrying amount of ¥513 million ($5,638 thousand) were written down to their fair value of ¥112 million ($1,231 thousand), resulting in an other- than-temporary impairment charge of ¥401 million ($4,407 thousand), which was included in earnings for the year ended December 31, 2008. All impaired non-marketable equity securities were classiﬁ ed as Level 3 instruments, as Canon uses unobservable inputs to value these investments. 94 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Canon is responsible for establishing and maintaining adequate internal control over ﬁ nancial reporting. Internal control over ﬁ nancial reporting is deﬁ ned in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 , as amended, as a process designed by, or under the supervision of, the company’s principal executive and principal ﬁ nancial ofﬁ cers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the preparation of ﬁ nancial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reﬂ ect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Canon’s management assessed the effectiveness of internal control over ﬁ nancial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (the “COSO criteria”). Based on its assessment, management concluded that, as of December 31, 2008, Canon’s internal control over ﬁ nancial reporting was effective based on the COSO criteria. Canon’s independent registered public accounting ﬁ rm, Ernst & Young ShinNihon LLC, has issued an audit report on the effectiveness of our internal control over ﬁ nancial reporting. 95 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of Canon Inc. We have audited the accompanying consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash ﬂ ows for each of the three years in the period ended December 31, 2008, all expressed in Japanese yen. These ﬁ nancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁ nancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁ nancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁ nancial statements. An audit also includes assessing the accounting principles used and signiﬁ cant estimates made by management, as well as evaluating the overall ﬁ nancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The Company’s consolidated ﬁ nancial statements do not disclose segment information required by Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” In our opinion, disclosure of segment information is required by U.S. generally accepted accounting principles. In our opinion, except for the omission of segment information as discussed in the preceding paragraph, the ﬁ nancial statements referred to above present fairly, in all material respects, the consolidated ﬁ nancial position of Canon Inc. and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash ﬂ ows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated ﬁ nancial statements, in 2007 the Company changed its method of accounting for depreciation. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Canon Inc.’s internal control over ﬁ nancial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009 expressed an unqualiﬁ ed opinion thereon. We have also recomputed the translation of the consolidated ﬁ nancial statements as of and for the year ended December 31, 2008 into United States dollars. In our opinion, the consolidated ﬁ nancial statements expressed in Japanese yen have been translated into United States dollars on the basis described in Note 2. 96 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of Canon Inc. We have audited Canon Inc.’s internal control over ﬁ nancial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Canon Inc.’s management is responsible for maintaining effective internal control over ﬁ nancial reporting, and for its assessment of the effectiveness of internal control over ﬁ nancial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over ﬁ nancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁ nancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁ nancial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over ﬁ nancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁ nancial reporting and the preparation of ﬁ nancial statements for external purposes in accordance with generally accepted account- ing principles. A company’s internal control over ﬁ nancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂ ect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁ nancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regard- ing prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the ﬁ nancial statements. Because of its inherent limitations, internal control over ﬁ nancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Canon Inc. maintained, in all material respects, effective internal control over ﬁ nancial reporting as of December 31, 2008, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Canon Inc. and subsidiaries as of December 31, 2008 and 2007, and the related con- solidated statements of income, stockholders’ equity, and cash ﬂ ows for each of the three years in the period ended December 31, 2008, all expressed in Japanese yen, and our report thereon dated March 16, 2009 stated that, except for the omission of segment information required by Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the ﬁ nancial statements referred to above present fairly, in all material respects, the consolidated ﬁ nancial position of Canon Inc. and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash ﬂ ows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. 97 TRANSFER AND REGISTRAR’S OFFICE STOCKHOLDER INFORMATION Canon Inc. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan Stock Exchange Listings: Tokyo, Osaka, Nagoya, Fukuoka, Sapporo and New York stock exchanges Manager of the Register of Stockholders Mizuho Trust & Banking Co., Ltd. 2-1, Yaesu 1-chome, Chuo-ku, Tokyo 103-8670, Japan Depositary and Agent with Respect to American Depositary Receipts for Common Shares JPMorgan Chase Bank, N.A. 4 New York Plaza, New York, N.Y. 10004, U.S.A. American Depositary Receipts are traded on the New York Stock Exchange (CAJ). Stockholders’ Annual General Meeting: March 27, 2009, in Tokyo Further Information: For publications or information, please contact the External Relations Headquarters, Canon Inc., Tokyo, or access Canon’s Website at www.canon.com 98 CORPORATE PROFILE Canon is engaged in the development, manufacture and sale of a growing lineup of copying machines, printers, cameras, optical and other products that meet a diverse range of customer needs. The Canon brand is well recognized and trusted throughout the world by the individuals, families, ofﬁ ces and industries that use Canon products. In 1996, Canon launched its Excellent Global Corporation Plan and has since delivered a series of strong performances. After this period of sustained growth, however, the Company is confronting an unprecedented downturn in worldwide ﬁ nan- cial and economic markets. Despite the onset of harsh operating condi- tions, Canon remains at the forefront of an industry that continues to experience the spread of globalization and broadband networks. Leverag- ing its strengths in cross-media imaging through advanced synergies among digital imaging equipment and technologies, Canon will reinforce its robust position in preparation for the next economic upturn. As a part of these endeavors, and in its efforts to fulﬁ ll its duties to investors and society, Canon will continue to emphasize good corporate governance and promote activities that contribute to the environment and society. CORPORATE PHILOSOPHY: Kyosei The corporate philosophy of Canon is kyosei. A concise deﬁ nition of this word would be “Living and working together for the common good,” but our deﬁ nition is broader: “All people, regardless of race, religion or culture, harmoniously living and working together into the future.” Unfortunately, the presence of imbalances in our world in such areas as trade, income levels and the environment hinders the achievement of kyosei. Addressing these imbalances is an ongoing mission, and Canon is doing its part by actively pursuing kyosei. True global companies must foster good relations, not only with their customers and the communities in which they operate, but also with nations and the environment. They must also bear the responsibility for the impact of their activities on society. For this reason, Canon’s goal is to contribute to global prosperity and people’s well-being, which will lead to continuing growth and bring the world closer to achieving kyosei. CORPORATE GOAL Canon is shifting its emphasis more toward improved management quality from sound growth, carrying out its medium- to long-term management plan, the Excellent Global Corporation Plan. This decision was made in light of the current worldwide ﬁ nancial crisis and unprec- edented downturn in the global economy. With the aim of attaining the status of being among the global top 100 companies in terms of key performance indicators, Canon is accelerating management quality improvement initiatives. CONTENTS FINANCIAL HIGHLIGHTS ............................. 1 TO OUR STOCKHOLDERS ............................ 2 MESSAGE FROM THE PRESIDENT ............... 6 EXCELLENT GLOBAL CORPORATION PLAN—PHASE III .......................................... 8 CORPORATE GOVERNANCE ........................ 16 CORPORATE FUNCTIONS ............................ 20 RESEARCH & DEVELOPMENT PRODUCTION SALES & MARKETING CORPORATE SOCIAL RESPONSIBILITY PRODUCT GROUPS ...................................... 32 OFFICE IMAGING PRODUCTS COMPUTER PERIPHERALS CAMERAS OPTICAL AND OTHER PRODUCTS MAJOR CONSOLIDATED SUBSIDIARIES ..... 42 FINANCIAL SECTION .................................... 43 TRANSFER AND REGISTRAR’S OFFICE ....... 98 STOCKHOLDER INFORMATION .................. 98 Cover Photo: Equipped with Dual Flash Memory, this lightweight and compact video camcorder realizes reduced noise through Canon’s CMOS sensor and 1,920 x 1,080 Full HD high image quality. The dual memory allows users to enjoy capturing, viewing and saving images with ease. C A N O N A N N U A L R E P O R T 2 0 0 8 CANON ANNUAL REPORT 2008 Fiscal Year Ended December 31, 2008 CANON INC. 30-2, Shimomaruko 3-chome, Ohta-ku, Tokyo 146-8501, Japan PUB. BEP018 0409SZ16.5 Printed in Japan This publication is printed on paper certiﬁ ed by the Forest Stewardship Council with ink that uses neither VOCs (Volatile Organic Compounds) nor mineral oil and realizes superior decomposability and deinkability.

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