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Enero Group LimitedAnnual Report 2006 Year ended March 31, 2006 O M R O N C o r p o r a t i o n A n n u a l R e p o r t 2 0 0 6 OMRON CORPORATION ANNUAL REPORT 2006 P R O F I L E The Omron Group creates and provides innovative devices and solutions in a broad range of fields including industry, society and lifestyle, through the use of its core competences of “sensing and control” to extract essential data from all manner of events. At the same time, it is strongly conscious of contributing to the building of a better society through its business activities. Along with being a turning point in our long-term management plan “Grand Design 2010 (GD2010)”, fiscal 2005 saw us set new records for sales and profits. In fiscal 2006, we will aim to accomplish the goals of the 2nd Stage of GD2010 (fiscal 2004 – fiscal 2007), changing gears for structural reform to put us on the offensive, and accelerating investment to build foundations for future growth. Discrete Information on People’s Intention and Thoughts People’s Biometric Data Environmental Information Discrete Information on People and Things Location of People and Things Sensing & Control Industry Society Lifestyle Sustainability Report 2006 For information on Omron’s sustainability initiatives, please refer to “Sustainability Report 2006”, a report on social and environmental activities to our stake- holders, including employees, clients and customers, shareholders, and the regional community. http://www.omron.com/corporate/csr/ Financial Fact Book 2006 For financial data from the past 10 years, please refer to “Fact Book 2006”. http://www.omron.com/ir/ir_factbook.html A Caution Concerning Forward-Looking Statements Statements in this annual report with respect to Omron’s plans, strategies and benefits, as well as other statements that are not historical facts, are forward-looking statements involving risks and uncertainties. Important factors that could cause actual results to differ materially from such statements include, but are not limited to, general economic conditions in Omron’s markets, which are primarily Japan, North America, Europe, Asia-Pacific and China; demand for, and competitive pricing pressure on, Omron’s products and services in the marketplace; Omron’s ability to continue to win accept- ance for its products and services in these highly competitive markets; and movements of currency exchange rates. Definition of Terms All references to “Omron” and “the Company” herein are to Omron Corporation; references to “the Omron Group” and “the Group” refer to Omron Corporation and consolidated subsidiaries and affiliates. H2 OMRON CORPORATION ANNUAL REPORT 2006 P R O D U C I N G W I N - W I N O U T C O M E S F O R A L L S TA K E H O L D E R S Contents 2 Grand Design 2010 (GD2010) 4 Ten-Year Financial Highlights 6 To Our Shareholders, Customers, and All Other Stakeholders 6 Message from the Chairman 7 Message from the President 11 Special Feature: Small but Global 15 Segment Information 16 Business Lineup (At a Glance) 18 20 Industrial Automation Business (IAB) Electronic Components Business (ECB) 22 Automotive Electronic Components Business (AEC) 24 Social Systems Business (SSB) 26 Healthcare Business (HCB) 28 Business Development Group and Other Businesses 29 Management Systems 30 32 34 Corporate Governance and Legal Compliance Corporate Social Responsibility Intellectual Property Strategy 36 Directors, Corporate Auditors and Executive Officers 37 Financial Section (including Business and Other Risks) 77 Global and Domestic Network 78 Corporate and Stock Information 79 Compass Determining the Direction of Omron’s Management —SINIC Theory 1 OMRON CORPORATION ANNUAL REPORT 2006 G R A N D D E S I G N 2 0 1 0 ( G D 2 0 1 0 ) O M R O N I S S T E A D I LY P R O G R E S S I N G T O W A R D S T H E E S TA B L I S H M E N T O F F O U N D AT I O N S F O R S U S TA I N A B L E G R O W T H LONG-TERM MAXIMIZATION OF CORPORATE VALUE In 2001, we established our long-term management plan “Grand Design 2010 (GD2010)” which has as its main goal the long-term maxi- mization of corporate value and indicates the direction to be pursued over the ten-year period from 2001. Furthermore, GD2010 is divided into three stages or medium-term management plans, each with its own theme. Currently, in the 2nd Stage, we are working under the theme of “Balancing Growth & Earnings” with the goal of “Doubling Total Business Value”. 1st Stage 2nd Stage 3rd Stage Theme Establishing a Profit Structure Balancing Growth & Earnings Achieving a Growth Structure FY 2001 FY 2004 FY 2007 FY 2010 Target ROE 10% Doubling Total Business Value Maintaining ROE above 10% The Goal of the 2nd Stage: Doubling Total Business Value ROE of 10% is indispensable if we are to compete globally. At the same time, we see it as a baseline for continuing business operations while making effec- tive use of capital markets. In the 1st Stage, we achieved our goal of maintaining ROE of 10%, and we are carrying out further reforms to build a busi- ness structure that can keep this level. 10.2 10.4 10.7 0.2 -5.1 ROE (%) 15 10 5 0 -5 -10 2 Under GD2010, we are aiming to become a corporation from which future growth, in the form of the long-term expansion of earnings based on a clear vision, can be expected. We are aiming for “Corporate Value-focused Manage- ment” which is highly rated in the capital market. To achieve these goals, we have defined corporate value as an estimate of present value, formed by using capital cost to discount the future free cash flow expected by the business units, for use as an internal management indicator, and are working to maximize corporate value. In particular, in the 2nd Stage of GD2010, where the pivotal role is shifted to investment for growth, the doubling of total business value (compared to levels in fiscal 2003) based on this internal definition, is our newest goal, and we are raising the level of corporate value in both existing and growth business areas. Doubling Total Business Value (Billions of yen) 1,200 1,000 800 600 400 200 130 210 600 720 730 240 870 250 New Tech Fields 950 Existing Businesses 01 02 03 04 05 (FY) 0 03 04 05 06 Plan (FY) 07 Target OMRON CORPORATION ANNUAL REPORT 2006 Increased Sales and Profits for the Fourth Consecutive Period We have established sales of more than ¥750 billion and operating income of greater than ¥75 billion for fiscal 2007 as management indi- cators to achieve the latest 2nd Stage goal of doubling total corporate value. In fiscal 2005, there was the extraordinary factor of a gain recorded on the return of pension assets to the government, but along with the fact that sales and profits increased for the fourth con- secutive period, operating income and net income both established new highs, and we were able to take another step closer to realizing our latest goal for the 2nd Stage. Corporate Performance (Billions of yen) 800 600 400 200 0 Net sales (left axis) Operating income (right axis) Operating income margin (right axis) (Billions of yen) (%) 12 9 95 96 97 98 99 00 01 02 03 04 05 06 Plan (FY) 07 Target 80 6 40 3 0 0 1st Stage 2nd Stage 3rd Stage Restructuring of Business Segments Management Restructuring 1) In order to establish pillars of business in the IAB, we are, above all, promot- ing the expansion of the ECB and AEC segments. 2) In Greater China—which stands out as a major consumer—we are focusing on expanding sales where major manufac- turers are building plants. In order to build a robust earnings structure, we are continuously working on business effi- ciency, and are aiming to achieve an SG&A expense ratio of 22% by fiscal 2007. Sales Breakdown by Segment IAB ECB AEC SSB HCB Other Sales Breakdown by Region Southeast Asia and Others Greater China Europe North America Japan (including exports) (%) 100 80 60 40 9.4 6.6 9.2 7.6 23.9 24.0 21.8 9.5 15.2 6.5 7.9 4.2 8.0 4.5 8.3 4.2 9.7 21.8 23.3 11.1 10.1 14.8 15.2 18.9 14.6 10.6 12.4 16.6 15.6 20 38.3 34.5 37.8 39.3 41.1 43.5 0 00 01 02 03 04 05 (FY) Note: In FY00, AEC was included in ECB. (%) 100 80 60 40 20 0 8.5 9.9 10.2 13.7 14.4 7.6 10.3 10.8 12.2 12.3 4.8 5.6 15.2 12.7 11.0 10.8 5.7 6.7 15.8 12.7 71.3 67.0 63.7 64.3 63.7 59.1 00 01 02 03 04 05 (FY) SG&A Expense Ratio (%) 26 25 24 23 22 21 20 25.3 25.3 24.3 24.1 23.8 22.1 00 01 02 03 04 05 (FY) Note: Until FY03, Greater China was included in Southeast Asia and Others. Greater China includes China, Hong Kong and Taiwan. Note: Excluding extraordinary factors of ATM business and response to hazardous chemical substance regulations in FY04 Excluding extraordinary factors of response to hazardous chemical substance regulations in FY05 IAB: Industrial Automation Business SSB: Social Systems Business ECB: Electronic Components Business HCB: Healthcare Business AEC: Automotive Electronic Components Business G D 2 0 1 0 3 OMRON CORPORATION ANNUAL REPORT 2006 T E N - Y E A R F I N A N C I A L H I G H L I G H T S OMRON Corporation and Subsidiaries Operating Results (for the year): Net sales Gross profit Selling, general and administrative expenses (Excluding research and development expenses) Research and development expenses Operating income EBITDA (Note 3) Net income Cash Flows (for the year): Net cash provided by operating activities Net cash used in investing activities Free cash flow (Note 4) Net cash used in financing activities Financial Position (at year-end): Total assets Total interest-bearing liabilities Total shareholders’ equity Per Share Data: Net income (Basic) Shareholders’ equity Cash dividends (Note 5) Ratios: Gross profit margin Operating income margin EBITDA margin Return on shareholders’ equity (ROE) Ratio of shareholders’ equity to total assets 2006/3 2005/3 2004/3 2003/3 ¥ 626,782 253,389 ¥ 608,588 249,771 ¥ 584,889 240,054 ¥ 535,073 207,660 152,675 50,501 62,128 92,953 35,763 51,699 (43,020) 8,679 (38,320) 144,219 49,441 56,111 84,753 30,176 61,076 (36,050) 25,026 (40,684) 142,157 46,494 51,403 79,065 26,811 80,687 (34,484) 46,203 (28,119) 135,112 40,235 32,313 61,989 511 41,854 (30,633) 11,221 (1,996) 589,061 3,813 362,937 585,429 24,759 305,810 592,273 56,687 274,710 567,399 71,260 251,610 151.1 1,548.1 30.0 126.5 1,284.8 24.0 40.4% 9.9% 14.8% 10.7% 61.6% 41.0% 9.2% 13.9% 10.4% 52.2% 110.7 1148.3 20.0 41.0% 8.8% 13.5% 10.2% 46.4% Net Sales and Operating Income Margin Net Income (Loss) and ROE (Billions of yen) 1,000 800 600 400 200 0 (%) 10 (Billions of yen) 40 8 6 4 2 0 30 20 10 0 -10 -20 97/3 98/3 99/3 00/3 01/3 02/3 03/3 04/3 05/3 06/3 97/3 98/3 99/3 00/3 01/3 02/3 03/3 04/3 05/3 06/3 Net sales (left axis) Operating income margin (right axis) Net income (loss) (left axis) ROE (right axis) Notes: 1. The U.S. dollar amounts represent translations of Japanese yen at the approximate exchange rate on March 31, 2006, of ¥117=$1. 2. About the above-mentioned financial data, the profit or loss (excluding the balance of obligation settled) recognized on the transfer of employee pension fund liabilities in March 31, 2006 is not included in any of “cost of sales”, “selling, general & administrative expenses” and “research and development expenses”, to enable an easy comparison with previous fiscal years. It is assumed that this profit or loss is allocated in one lump sum. 4 2.1 1036.0 10.0 38.8% 6.0% 11.6% 0.2% 44.3% (%) 20 15 10 5 0 -5 -10 OMRON CORPORATION ANNUAL REPORT 2006 2002/3 2001/3 2000/3 1999/3 1998/3 1997/3 2006/3 Millions of yen Thousands of U.S. dollars (Note 1) ¥ 533,964 180,535 ¥ 594,259 218,065 ¥ 555,358 196,447 ¥ 555,280 190,966 ¥ 611,795 224,350 ¥ 594,261 206,256 I I F N A N C A L H G H L G H T S I I 131,203 42,513 44,349 76,566 22,297 50,796 (32,365) 18,431 (24,582) 133,662 36,605 26,180 57,625 11,561 59,926 (34,180) 25,746 (23,785) 136,734 42,383 11,849 43,245 2,174 29,583 (29,011) 572 21,629 138,404 39,914 46,032 77,161 18,300 32,086 (17,631) 14,455 (23,637) 130,163 35,188 40,905 72,139 15,739 57,169 (29,398) 27,771 (37,857) 593,144 67,213 325,958 579,489 69,472 336,062 580,586 86,723 321,258 593,129 54,544 343,066 610,930 75,147 333,102 $ 5,357,111 2,165,718 1,304,915 431,632 531,009 794,470 305,667 441,872 (367,692) 74,179 (327,521) 5,034,710 32,590 3,102,026 87.4 1311.1 13.0 36.7% 7.5% 12.9% 6.7% 55.0% 45.0 1308.6 13.0 35.4% 4.7% 10.4% 3.5% 58.0% Yen U.S. dollars (Note 1) 8.3 1,249.5 13.0 71.4 1,308.9 13.0 60.1 1,270.9 13.0 1.29 13.23 0.26 34.4% 2.1% 7.8% 0.7% 55.3% 36.7% 7.5% 12.6% 5.4% 57.8% 34.7% 6.9% 12.1% 4.8% 54.5% Free Cash Flow Shareholders’ Equity and Ratio of Shareholders’ Equity to Total Assets (Billions of yen) 400 300 200 100 0 97/3 98/3 99/3 00/3 01/3 02/3 03/3 04/3 05/3 06/3 97/3 98/3 99/3 00/3 01/3 02/3 03/3 04/3 05/3 06/3 Shareholders’ equity (left axis) Ratio of shareholders’ equity to total assets (right axis) 3. EBITDA = Operating income + Depreciation and amortization. 4. Free cash flow = Net cash provided by operating activities – Net cash used in investing activities. 5. Cash dividends per share represent the amounts applicable to the respective year, including dividends to be paid after the end of the year. (%) 80 60 40 20 0 5 134,907 41,407 4,221 37,790 (15,773) 33,687 (40,121) (6,434) (12,056) 549,366 58,711 298,234 (63.5) 1201.2 13.0 33.8% 0.8% 7.1% (5.1%) 54.3% (Billions of yen) 50 40 30 20 10 0 -10 T O O U R S H A R E H O L D E R S , C U S T O M E R S , A N D A L L O T H E R S TA K E H O L D E R S OMRON CORPORATION ANNUAL REPORT 2006 M e s s a g e f r o m t h e C h a i r m a n In addition to the usual economic value that society demands from companies, the relative weight being placed on social value is increas- ing. Thus, the Omron Group—along with generating the centrifugal force or expansive power necessary for growth in ways such as global- ization, decentralization, and M&As—is using “The Omron Principles” as a source of centripetal force or cohesive power to raise the quality of its corporate governance, aiming for the long-term maximization of its corporate value while meeting the expectations of society. Yoshio Tateisi, Chairman of the BOD AN OPTIMUM PORTFOLIO MADE POSSIBLE BY A “SMALL BUT GLOBAL” APPROACH The Omron Group has grown to reach the scale of a major corporation, but in fact our company is a collection of 120 small business units organically intertwined and built around our core competence of “sensing and control”. The ability to recognize opportunity and the flexibility that comes with this “venture company” structure allows the entire Group to quickly build an optimum portfolio and remain on course toward growth despite whatever severe business circumstances might come along. In the future, even if our individual business units are small, we would like to be known as a “Small but Global” company with a strong worldwide presence. BALANCING THE CENTRIFUGAL AND CENTRIPETAL FORCES NEEDED FOR GROWTH Our Group is already at the point of operating in 33 countries around the world, which means half our business and half our employees can now be found overseas. In addition to this globalization, it can be said that both decentralization and M&As will provide the necessary centrifugal force that will drive future growth, but from the perspective of corporate governance, the diversification of values and standards of judgment brought about by this centrifugal force is, on occasion, problematic. Thus, in order to strongly bind this centrifugal force to sustainable growth for the entire Group, I believe that it is necessary to counter it with centripetal force, and we are finding this centripetal force in “The Omron Principles”. WORKING FOR THE BENEFIT OF SOCIETY “The Omron Principles” serve to announce our company’s mission and its methods of action to both those inside the Company and the public at large. These fundamental values are the foundation for decision-making and stan- dards of behavior. However, if they are going to be a source of centripetal force, “The Omron Principles” must also transcend personal and business interests. Therefore, last year, we formed a committee to examine “The Omron Principles”, and with the help of an employee survey, debated, from various points of view, such impor- tant questions as who owns the corporation and what corporate principles are globally acceptable. This resulted in our establishing “The Omron Principles”, the highest of which is “Working for the benefit of society”, which stems from the idea that companies get their start in business by leveraging various resources belonging to soci- ety. This way of thinking has been the basis of our management since the founding of our Group half a century ago. In order to further clarify this idea of “Working for the benefit of society” and ensure that it is passed down as an important value, we have established it anew as the kernel of “The Omron Principles”. CORPORATE GOVERNANCE POWERED BY “THE OMRON PRINCIPLES” The substance of the value that society demands from companies changes with the times. Nowadays, society not only demands the usual economic value, but also has strong expectations in terms of contributions to society and other forms of social value. Since Omron’s founding, the founder and his family have served as a source of cen- tripetal force; however, in this day and age, in order to achieve continuous growth on a global basis, “The Omron Principles” must become that source of centripetal force. Furthermore, I believe that the highest level of corporate governance can be achieved by having all employees, management included, share this value. Through corporate governance based on “The Omron Principles”, we will inherit and pass on our “innovation driven by social needs”, which contributes to society, and our “challenging ourselves to always do better” that comes from being a group of venture companies—two manifestations of our founding DNA. I want to continue as a company that is chosen for its future promise. July 2006 6 Yoshio Tateisi, Chairman of the BOD OMRON CORPORATION ANNUAL REPORT 2006 M e s s a g e f r o m t h e P r e s i d e n t Thanks to the support of our stakeholders in fiscal 2005, we were able to carry on from the previous term to once again achieve record sales and profits. To help lay the groundwork for making large strides in fis- cal 2007 toward the final goals contained in the 2nd Stage of our long-term management plan, we intend to make a bold investment in growth in fiscal 2006. M E S S A G E Hisao Sakuta, President and CEO RETROSPECTIVE ON FISCAL 2005 Business Environment The economy is gearing up for recovery In fiscal 2005, Japan’s economy finished a cycle of inventory adjustments for IT and digital- related products. An increase in capital investment on the back of major improvements in corporate profits, a recovery in consumer spending fed by improved employment and wages, as well as other events, moved business conditions a step closer toward real recovery. Overseas, the sharp rise in crude oil prices and the destructive impact of large- scale hurricanes raised concerns about the North American economy, but a favorable employment environment overcame both worries to produce positive results. In China, a moderate slowdown in consumer spending and capital investment failed to interrupt high levels of growth. Furthermore, in the European economy, growth in corporate production made possible by robust exports is evidence that conditions are moving toward recovery. Overview of Operating Results Four consecutive years of higher sales and profits Amidst a solid performance by the global economy, the Omron Group enjoyed new highs for operating income and net income above last year’s record numbers along with increased net sales and profits for the fourth consecutive term. For fiscal 2005, net sales increased 3.0% year on year to ¥626.8 billion, operating income rose 10.7% to ¥62.1 bil- lion and net income was up 18.5% to ¥35.8 billion. Operating income was 4.4% below the initial target, mainly because of variations in the product mix. Return on shareholders’ equi- ty (ROE), however, was kept above 10%, finishing at 10.7%. Net Sales and Operating Income ¥ 100M Net sales Operating income 5,340 5,351 5,849 6,086 6,268 42 01 323 02 514 03 561 621 04 05 (FY) The IAB, AEC, and HCB are the engines of growth Segment sales, aside from the Electronics Components Business (ECB), achieved strong results that came in above target. Nets sales of the Industrial Automation Business (IAB) rose 8.9% to ¥272.7 billion, backed by greater investment in products related to automobiles, semiconductors and digital consumer appliances which produced strong results in both domestic and overseas markets. In North America, IAB results were particularly striking, finishing 20% above initial targets. Sales in the Automotive Electronics Components Business (AEC) jumped 20.2% year on year to ¥77.6 billion, helped by the release of products able to meet demand for more environmentally friendly and safer automobiles in conjunction with new vehicle introductions by automakers who are Omron customers. In the Healthcare Business (HCB), the valuable acquisition of Colin Medical Technolo- gy and a strong sales performance by digital blood pressure monitors and body composition analyzers, both of which are mainstay products, generated sales of ¥61.1 billion, up 20.8% year on year. The Social Systems Business (SSB) also experienced strong sales, partly as a result of replacement demand for equipment adapted to commuter passes containing ICs, and large-scale projects tied to the opening of new train lines. On the other hand, the transfer of the information equipment business—which includes Automated Teller Machines (ATMs)—to an equity-method affiliate removed ¥27.0 billion from revenues, causing SSB net sales to decline 20.3% year on year to ¥91.8 billion. In the ECB business segment, sales fell 3.4% to ¥97.7 billion, partly because the slump in sales of backlights for LCDs was worse than expected. Breakdown of Change in Sales by Segment (FY05) ¥ 100M +224 Transfer of ATM business +130 +105 -34 -234 -9 IAB ECB AEC SSB HCB Other 7 OMRON CORPORATION ANNUAL REPORT 2006 Return of substitutional portion of pension fund gives operating income a lift In comparing operating income year on year, the transfer of the information equipment busi- ness (including ATMs) to an equity-method affiliate, compliance with Europe’s Restriction of Hazardous Substances (RoHS) in Electrical and Electronic Equipment Directive, and increased SG&A and R&D expenses represented minus factors worth ¥18.7 billion. Also, changes to the product mix squeezed ¥5.8 billion from earnings. On the positive side, the contributions of ¥14 billion from higher sales, ¥4.6 billion in foreign exchange gains and ¥11.9 billion from the return of substitutional portion of pension fund resulted in a year-on-year increase in net operating income of ¥6 billion. Financial Conditions The ratio of shareholders’ equity to total assets rises to 62% We have streamlined total assets to add more strength to the balance sheet. Based on an acceleration of investment in growth, fixed assets have increased by ¥7.3 billion, but interest- bearing liabilities have declined by ¥20.9 billion. At the same time, shareholders’ equity has gained ¥57.1 billion. In addition to higher net income, return of substitutional portion of pen- sion fund has reduced minimum pension liability adjustments, and unrealized gains on available-for-sale securities have increased. The overall result has been that the ratio of share- holders’ equity has risen 9 percentage points year on year to 62%. Operating income 561 04 FISCAL 2006 PLANS Keep Higher Sales and Profits on Track and Invest Aggressively In fiscal 2006, the Omron Group aims to keep the recent run of higher sales and profits on track and to register another year of record profits. Specifically, our forecast (as of April 2006) calls for net sales of ¥700 billion (11.7% increase over fiscal 2005), operating income of ¥63 billion (1.4% increase), and net income of ¥37.5 billion (4.9% increase). In line with the final goals of the 2nd Stage of the “GD2010” long-term management plan, “doubling of total business value (operat- ing results targets: net sales of ¥750 billion or more and operating income of ¥75 billion or more),” we are maintaining support for higher sales and profits in fiscal 2006 in view of the tar- gets we plan to hit in fiscal 2007, alongside of which we will carry out forward-looking R&D and invest in growth. Accordingly, we anticipate a temporary slowdown in operating income growth. * The operating results forecast does not account for the effects of M&As intended at present. Important Issues to Resolve in Fiscal 2006 Fiscal 2005 was another year of record profits, but leaving aside foreign exchange gains and return of substitutional portion of pension fund, two important issues have surfaced which need to be resolved; namely, (1) the decline in ECB sales and (2) deteriorating AEC prof- itability. As discussed below, we intend to take steps to resolve these issues in fiscal 2006. (1) ECB sales turnaround The decline in ECB sales in fiscal 2005 was caused mainly by the sluggish performance of back- lights for LCDs. One reason for this sluggishness is the inadequate supply arrangement for large-scale backlights used in flat panel TVs in Taiwan. In fiscal 2006, measures are already being taken to create a much better supply system. Another reason is that in the market for small- scale backlights for cellular phones, low-cost point light source backlights (a single LED serves as the light source) well suited to special applications have been hit by lower selling prices and by fierce competition with ultra bright multi-light source backlights (multiple LEDs serve as the light source). In response to this second problem, efforts are being made to boost sales in the expanding BRICs markets where point light source backlights can be more cost competitive. At the same time, we are in the process of offering a full line of backlight products based on our development of high-performance-oriented integrated 3-LED ultra-high brightness backlights and converting the Pioneer Precision Machinery acquisition (see pages 12 and 21) into an opportuni- ty to create a multi-light source backlight supply system. Based on these measures, we hope to make certain we can turn ECB sales and growth performance around in fiscal 2006. Breakdown of Change in Operating Income (FY05) ¥ 100M Exchange profit Transfer of ATM business +46 -40 -58 SG&A expenses Product mix Sales +140 +119 Substitutional portion of pension fund -112 -35 R&D expenses Operating income 621 05 (FY) ¥ 100M 750 Operating Income Continuation of investments for growth 621 630 561 514 03 04 05 06 Plan (FY) 07 Target Forecast of ECB Sales and Operating Income ¥ 100M Net sales approx. +50 Electronic components Sales 977 05 approx. +100 approx. +50 Amusement Backlights approx. +35 Sales Components for mobile phones, etc. 1,215 (FY) 06 Plan Opearting income +142 -60 Sales Operating income 112 05 -25 Added value ratio Manufacturing fixed costs -24 Operating income SG&A and R&D expenses 145 (FY) 06 Plan 8 * Excluding effects of M&As OMRON CORPORATION ANNUAL REPORT 2006 (2) Putting the AEC back into the black AEC sales have experienced substantial growth and are forecast to achieve a strong 17% jump in fiscal 2006. The problem, however, is profitability. Analyzing fiscal 2005 results, product profitability was in part hurt by a steep rise in raw material prices while the expense of quality improvements at factories in North America increased the cost burden. However, quality improvement costs were of a temporary nature. As for improvement of product profitability, which is a more substantial problem, we are sharing development and components with other business segments to improve cost competitiveness. In fiscal 2006, the AEC will continue to address problems in the ways described. If the benefits of higher sales are added to the picture, we believe we can turn the operating income per- formance from a ¥2 billion loss in fiscal 2005 into a ¥3 billion profit in the current term. Forecast of AEC Sales and Operating Income Net Sales +42 Europe +77 North America Sales 776 05 +17 -2 Japan China Asia M E S S A G E ¥ 100M Sales 910 (FY) 06 Plan MOVING TOWARD ACCOMPLISHING GD2010 2nd STAGE OBJECTIVES Accelerating Efforts to Hit our Targets in Fiscal 2007 Under our GD2010 plan, the theme of the 2nd Stage (which has fiscal 2007 as the final year) is striking a balance between profits and growth. Our strategies pivoting on growth are expanding sales in new business areas and Greater China. We also aim at “building a strong profit structure.” In regard to these important strategies, the sales plan for Greater China is running slightly behind schedule, but in the area of new business we expect to exceed our targets, and we are continuing to steadily build a strong profit structure. To ensure that we reach our fiscal 2007 goals, we are accelerating our business efforts in fiscal 2006. Strategies Pivoting on Growth (1) Pushing higher the goals for expanding new business In order to create new social needs, the Omron Group is investing aggressively in fostering important new business. The initial plan for the 2nd Stage of GD2010 called for lifting sales in the area of new business by ¥50 billion from ¥18 billion in fiscal 2003, but after adding ¥14 billion to the goal we have revised up our fiscal 2007 sales goal to ¥82 billion. Among the reasons for this revision are that customer interest in some products such as automated optical inspection (AOI) systems is growing as production lines in the manufacturing sector have a greater need for product quality improvements and safety assurances; backlights for LCDs are likely to return to the offensive after being flat in fiscal 2005; RFID tag systems have entered a period of full-scale growth; and that optical communications devices such as Stacked Polymer Optical IC/Advanced (SPICA) are now showing signs of growth. (2) Goals for expanding sales in Greater China remain unchanged Greater China is not only an important region for raising cost competitiveness, but it also has latent demand in such areas as automobiles, mobile phones, LCD TVs, health equip- ment and improvements to infrastructure. Given the Omron Group’s involvement in these areas, Greater China will again be an important market for driving growth. As mentioned earlier, the reason for the slowdown in our fiscal 2005 sales to Greater China was the sig- nificant impact of the delay in starting up LCD backlight supplies in Taiwan. The recent rise in interest rates is one of the uncertain factors in China’s economy, but based on the expanding reach of our sales distribution network in Greater China markets, our goal to achieve sales of US$1,330 million in fiscal 2007 (four times the fiscal 2003 sales figure) remains unchanged. Building a Strong Profit Structure Aiming to achieve a 4:3:1 profit structure To survive global competition and reach the goal of a strong profit structure, we aim to have in place a “4:3:1” profit structure by the end of fiscal 2007. The meaning of this three-part ratio is a profit structure which is based on a gross profit margin of 40%, an SG&A expense ratio of 30% (with an R&D expense ratio of 8%) and an operating income margin of 10%. In the interest of making this structure work, issues which concern Omron as a whole are being addressed, namely controlling SG&A expenses and lowering the ratio of fixed manufacturing costs mainly by shifting production to Greater China. In particular, in Operating Income +68 +8 -10 Added value ratio Operating loss -20 05 Sales -16 Operating income Manufacturing fixed costs SG&A and R&D expenses 30 (FY) 06 Plan Sales Growth in New Tech Fields ¥ 100M 180 03 288 04 343 05 820 569 06 Plan (FY) 07 Target Sales Growth in Greater China US$ M 325 03 411 04 412 05 1,330 676 06 Plan (FY) 07 Target Building a Strong Profit Structure Greater China production ratio SG&A expense ratio 24.1% 23.8% 24.3% 30% 22.0% 9% 03 12% 04 11% 05 06 Plan (FY) 07 Target * Excluding extraordinary factors of ATM business and response to hazardous chemical substance regulations in FY2004 * Excluding extraordinary factors of response to hazardous chemical substance regulations in FY2005 9 Double the Total Business Value ¥ 100M 8,500 9,400 6,000 11,100 12,000 03 04 05 06 Plan (FY) 07 Target Cash Dividends per Share ¥ 13 01 10 02 20 24 3030 03 04 05 (FY) OMRON CORPORATION ANNUAL REPORT 2006 the IAB, which has a big impact on earnings, we have raised our fiscal 2007 operating income margin goal to 20%, seeking a profit-loss structure with a ratio of gross profit to SG&A expenses (including R&D expenses) to operating income of 5:3:2, and continuing to strengthen our global competitiveness by restructuring our development and production system both in Japan and in China. MAXIMIZING CORPORATE VALUE AND RETURNING VALUE TO SHAREHOLDERS Plan to “Double Business Value” Moving Ahead Steadily The yardstick we use for evaluating the profitability and growth potential of the Omron Group is “total business value,” defined as the expected cash flow discounted by capital costs to arrive at the current value total, from which Omron’s indirect costs are deducted. Doubling the fiscal 2003 total business value is an especially important theme of the 2nd Stage of our GD2010 plan. In fiscal 2005, value creation came to ¥10 billion in existing business and ¥80 billion in growth areas, producing an estimated total business value of ¥940 billion. We are moving toward a target of ¥1.2 trillion in fiscal 2007, which leads me to conclude that the business value is increasing quite well. Three Consecutive Terms of Increased Dividend Payments At Omron, our priority is to increase medium- to long-term corporate value through using retained earnings to invest in growth. However, as for residual profits, bearing in mind the level of free cash flow, we have adopted a policy of returning value to shareholders based on a dividend payout ratio which corresponds to approximately 20% of our consolidated net income. Accordingly, on the basis of our fiscal 2005 results we have increased the divi- dend payment by ¥6, which is ¥30 annually (dividend payout ratio 19.8 %). Also, Omron has a dividend policy which is responsive to the expectations of our long-range sharehold- ers. Even in the event of a slide in our earnings performance, our policy is to stand by long-term stable dividends by supporting a minimum annual dividend payment of ¥10. STRENGTHENING GOVERNANCE AND COMPLIANCE The Omron Group is made up of 120 business units. As we navigate our way through efforts to accelerate growth, the post-M&A process of integrating different cultures, decentralization through widespread empowerment, and globalization of our business and workforce are all continuing to progress. In the face of these internal and external changes in the environment, we believe management transparency and universal compliance are extremely important. Thus, we are taking additional steps to improve Omron’s corporate governance and legal compliance systems. (See pages 30-31) CONCLUSION Fiscal 2006 is the year of the final important milestone on the way toward meeting the goals of the 2nd Stage in fiscal 2007. Careful consideration has been given to the choice between maintaining sound profit through a modest investment in growth or rapidly mov- ing in the direction of building a base for future growth possibly at the cost of some loss of profitability. However, I believe that current expectations with respect to Omron are toward our Company’s future growth potential as indicated by the rise in the Company’s share price in fiscal 2005. Thus, on the premise that fiscal 2006 stands ready to be another year of higher sales and record profits, we are making a bold investment in sustainable future growth, even though this may temporarily push up costs. As before, your continued support will be greatly appreciated. July 2006 10 Hisao Sakuta, President and CEO OMRON CORPORATION ANNUAL REPORT 2006 S P E C I A L F E AT U R E SMALL BUT GLOBAL Small but still aiming to be number one in the world Opening up niche areas where we can leverage our propri- etary technology and clinching the top share in those markets—this is the essence of the Omron Group’s growth strategy. When you look at niche markets individually, they are invariably small in scale, but we are seeking to maximize our overall corporate value by having each of our business units exhibit their globally competitive strengths in their respective markets. In this special feature, we will spotlight our backlight, safety and laser radar businesses as a few examples of niche areas which are particularly expected to experience growth on a global basis. I S P E C A L F E A T U R E 11 Aiming to Be No.1 in the World 01: LCD Backlights OMRON CORPORATION ANNUAL REPORT 2006 Realizing High Brightness, Low Weight, and Low Power Consumption Through Proprietary Photoregulation Technology High brightness, low weight and low power consumption are characteristics of small LCD backlights for mobile phones and digi- tal cameras which grasp user needs. Here, using our proprietary MLA technology*, we supply small LCD backlights which realize low power consumption and weight-reduc- tion (i.e., fewer parts) through a point light source system** which provides illumination from a single light source (LED). Aiming for a Tenfold Increase in Sales Across the Whole Product Lineup In addition, in August 2006, we acquired Pioneer Precision Machinery Corporation— a major manufacturer of small and medium multi-light source LCD backlights which dispose multiple LEDs—and renamed it Omron Precision Technology Co., Ltd. Through this acquisition, we have respond- ed to low-end to high-end needs in the area of small LCD backlights, through both point light source and multi-light source systems, and have gained the top market share*** in the world. In the future, we will take advantage of synergies between the two companies, and aim to raise our global market share to 35% in fiscal 2008. Target for Expanding the Backlight Business ¥ 100M 1,000 100 2005 Actual Results (FY) 2008 Target Building a Full Line of Small, Medium and Large Backlights Screen Size Large TAMA Fine Opto Co., Ltd. Medium Multi-Light Source Backlights Small Omron’s Existing Point Light Source Backlights Area of Omron Precision Technology Co., Ltd. Super High Brightness Multi-Light Source and Point Light Source Backlights Low-End High-End Function Application Liquid Crystal Televisions Desktop Monitors Notebook Computers Car Navigation Systems Game Consoles PDA Digital Camera Mobile Phones Together with TAMA Fine Opto Co., Ltd.—a manufacturer and marketer of large backlights for flat panel televisions, which we made a wholly owned subsidiary in May 2004—we will cover a whole range encompassing small, medium, and large backlights. Furthermore, sales of back- lights, which were ¥10 billion in fiscal 2005, will increase tenfold to nearly ¥100 billion in fiscal 2008. Moreover, the results from these acquisitions are not included in previously mentioned expectations of per- formance for fiscal 2006. *** Nearly 20% market share on a unit basis in the area of small LCD backlights (estimated by Omron). Strengthening Production Systems in Asia The major maker’s of LCDs are nearly all located in Asia. Therefore, we are produc- ing backlights in China and elsewhere in Asia in order to raise our cost competitive- ness and at the same time be in position to respond to local users. In terms of plan- ning and development too, we are, through our Hong Kong Design Center, preparing a system which can respond promptly to all demands. *MLA technology Proprietary technology which maximizes the efficiency of light use by reflecting light which diverges in all directions in a single direction using an MLA (microlens array) aggre- gating millions of microlenses on a single board **Point light source system LCDs display an image by projecting light emitted from an LED (light-emitting diode) onto a liquid crystal panel. For this reason, brightness can be increased by either increasing the number of LEDs—the light sources—or using the light emitted from LEDs more efficiently. A point light source system raises the efficiency of light use real- izing a two- to threefold increase in light efficiency and brightness over conventional methods which scatter light. 12 Aiming to Be No.1 in the World 02: The Safety Business OMRON CORPORATION ANNUAL REPORT 2006 The Market for Safety Equipment Is Expected to Grow by an Annual Rate of 15% With user needs diversifying and the life cycles of products becoming ever shorter, there is demand at production facilities for better manufacturing equipment and, at the same time, quicker production. It is in this setting that large numbers of skilled workers in Japan are reaching the age of retirement, and employment is diversifying to include temporary and part-time work- ers. Furthermore, with the shifting of production overseas, employment of inex- perienced local workers at new plants is also increasing. Thus, the shortage of skilled workers at production facilities is worsening, and not only the efficiency of production, but also the safety of workers has become a major concern. Under these conditions, in the next three years, we expect the market for safety equipment used in production facilities to grow at an annual pace of 15%, expanding to ¥35 bil- lion, ¥85 billion and ¥50 billion, in the United States, Europe, and Japan/Asia/Oceania respectively, for a total of ¥170 billion (esti- mated at ¥110 billion in fiscal 2005). Expanding Business on a Global Basis Through the Acquisition of STI In addition to safety equipment such as entry detectors, alarms, and emergency stop switches, we provide systems incor- porating such components. In fiscal 2005, sales of our safety equipment business reached ¥10 billion. We already boast the largest share of the market for safety equipment for the Japanese and Asian automobile and semiconductor industries. Furthermore, aiming for the No. 1 position globally, we agreed to buy the safety busi- ness of Scientific Technologies Incorporated, a major North American safety equipment maker. Sales of STI’s safety business were nearly ¥7.1 billion at the end of fiscal 2005, The Consulting Service Is also Developing Using the expertise that we have cultivat- ed at all stages of development—from planning and manufacturing to installation and maintenance—of all types of control equipment for production facilities, we are developing a consulting service which sup- ports the planning of equipment and machinery systems that make it possible to both raise efficiency and ensure safety. Especially for manufacturing companies, stopping all production lines in order to carry out safety inspections is very expen- sive, so we are focusing on supporting the construction of systems that permit the efficient assurance of safety by minimizing the interruption to production lines. and STI’s safety business has built a brand in a wide range of North American indus- tries and also holds patents for optical technology that complement our technolo- gy. Moreover, in terms of products, the areas in which each company excels differ; through the synergistic effects arising from integration, we expect the sum of both company’s sales of safety equipment to expand to ¥30 billion in fiscal 2008. Target for Expanding the Safety Business ¥ 100M STI Omron 71 100 300 2005 Actual Results (FY) 2008 Target Safety Light Curtains Safety Components Safety Switches Safety Light Curtains A sensor which emits beams of light to form a curtain. It detects dangerous objects based on the shape and size of objects which obstruct the light. Safety Components A shutdown sensor which acts as a mechanical guard. It con- firms the entry of people into hazardous areas and is used to build safety circuits. I S P E C A L F E A T U R E 13 Aiming to Be No.1 in the World 03: Laser Radar Sensors OMRON CORPORATION ANNUAL REPORT 2006 Greater Need for Safety and Security in the Automotive World Automobiles have evolved greatly, not only achieving superb drive and fuel efficiency, but also becoming more environmentally friendly. However, from the point of view of safety, the evolution of the car has only just begun. In Japan, the making mandato- ry of the wearing of seat belts and the spread of airbags have reduced the num- ber of people killed in car accidents. However, it still remains to put the brakes on the rising number of collisions between cars. The cause of most such collisions is slowness on the part of drivers to spot other vehicles as well as errors of judg- ment. Providing Laser Radar Systems to Major Automobile Makers Anticipating the safety needs of the auto- motive world, we have inherited the intention of our founder to “use our sens- ing technology to develop cars which don’t crash”, and, since 1990, we have been engaged in research on sensors which monitor the distance between vehicles. We have already developed, and are sup- plying to major automobile makers for use in new models, a laser radar which reduces rear-end collisions by measuring the distance between a car and the vehicle or other obstructions in front of it based on the time it takes for a laser projected at the vehicle in front to return. When too close, the system warns the driver by applying the breaks automatically. Further- more, our development pivots around laser radar, which is cheaper than milliwave radar. Thus we are promoting the develop- ment of products not just for luxury vehicles, but also for popular models. Developing Next Generation Sensors by Fusing Laser Radar and Image Sensing Technologies In addition, we are promoting the develop- ment of image sensing technology which uses High Dynamic Range Cameras (HDRC*). We expect that such image sen- sors will be applicable in various uses, one of which is a sensor fusion technology which combines laser radar with forward surveillance image sensors. This technolo- gy makes possible the discrimination of forward objects, which was difficult with laser radar alone. In brief, the car is able to tell whether the object in front is another car or a pedestrian, and based on that information, support the driver. This tech- nology will make a great contribution to the next generation development of safe automobiles. In this way, we are applying our proprietary image sensing technology, aiming to become the global leader in sen- sors that contribute to the ensuring of automobile safety. * High Dynamic Range Camera. Able to carry out sensing in a range of lighting conditions, from poor light, in which it would be difficult to see with the naked eye, to situations where the light is behind the object. Main Features of Laser Radar •High sensitivity: Able to detect vehicles under difficult condi- tions, such as in rainy weather or when the vehicle is dirty. •Two-dimensional scan: Has a wide angle of detection both horizontally and vertically, and does not lose sight of the vehi- cle in front, even when the vehicle moves up and down with the slope of the road. Main Features of Sensor Fusion •Distinguishing between vehicles and pedestrians: Based on the information from the laser radar image sensor, it is possible to per- ceive the characteristics of both vehicles and pedestri- ans, and thereby distinguish between them. 14 OMRON CORPORATION ANNUAL REPORT 2006 S E G M E N T I N F O R M AT I O N Contents 15 Segment Information 16 At a Glance 18 20 Industrial Automation Business (IAB) Electronic Components Business (ECB) 22 Automotive Electronic Components Business (AEC) 24 Social Systems Business (SSB) 26 Healthcare Business (HCB) 28 Business Development Group and Other Businesses S E G M E N T I N F O R M A T O N I 15 OMRON CORPORATION ANNUAL REPORT 2006 AT A G L A N C E Summary of Business and Market Position % of Net Sales I N D U S T R I A L A U T O M AT I O N B U S I N E S S ( I A B ) Top market share for high-precision sensors in Japan The IAB is Japan’s largest* manufacturer of control devices for factory automation (FA), and contributes to production in all manner of industries. Recently, the IAB has not just stayed with providing equipment and sys- tems, but is focusing on its solutions business for management themes such as quality improvement, work safety, and environmental friendliness, needs which are rapidly increasing at production facilities. * Market share data obtained from the Nippon Electric Control Equipment Industries Association (NECA). Domestic market share for high precision sensors is roughly 60%. E L E C T R O N I C C O M P O N E N T S B U S I N E S S ( E C B ) Aiming to be top in the LCD backlight business The ECB manufactures and sells semiconductor sensors using micromachining technology and entertainment equipment, among other things, centering on relays, switches and connectors for home electronics, communications, and indus- trial equipment. Recently, it is also concentrating on new growth businesses which can be expected to secure the top market share in the future, through such prod- ucts as LCD backlights which provide high brightness and low power consumption characteristics, for use in mobile phones and flat panel televisions. A U T O M O T I V E E L E C T R O N I C C O M P O N E N T S B U S I N E S S ( A E C ) Focusing on development of leading-edge products The AEC manufactures and sells a variety of components for automobiles such as controllers, sensors, switches and relays. In the rapidly advancing market for car electronics, it is focusing on the development of next-genera- tion, key components for which “peace of mind”, “safety”, and “environment” are keywords, and is already producing leading-edge prod- ucts such as laser radars (sensors for measuring the distance between cars). S O C I A L S Y S T E M S B U S I N E S S ( S S B ) Top market share for automated gates at stations The SSB provides a variety of systems which support social infrastructure, including systems for railways such as automated ticket gates and automat- ed ticket machines, and traffic control systems. Recently, as social needs related to security and safety have been rising quickly, the security business has been focusing on the provision of solutions related to room access con- trol and information access control. * The ATM business was transferred to Hitachi-Omron Terminal Solutions, Corp. (Hitachi: 55%, Omron: 45%) on October 1, 2004. H E A LT H C A R E B U S I N E S S ( H C B ) Top market share for digital home blood pressure monitors in Japan The HCB provides a wide range of health care equipment including blood pressure monitors, digital thermometers, pedometers and massage chairs. In particular, Omron’s digital home blood pressure monitors, which are a core product, boast 60% of the domestic market (according to a survey by a private research institute), and Omron is the top brand in the global market. Furthermore, along with developing new equipment for medical institutions, through our health care equipment, we are focusing on home medical care, which ties together home care and professional medical care. B U S I N E S S D E V E L O P M E N T G R O U P A N D O T H E R B U S I N E S S E S Exploration and development of new businesses The other businesses includes new businesses being explored and developed by the Business Development Group and other businesses not part of the above-described segments. Currently, the Business Development Group is carrying out the other part of the Omron Group’s growth strategy, and is focusing in particular on the RFID business and the service business for the remote monitoring of electricity. 43.5% 15.6% 12.4% 14.6% 9.7% 4.2% 16 OMRON CORPORATION ANNUAL REPORT 2006 Net Sales (100 millions of yen) Operating Income* (100 millions of yen) Main Products and Services Operating Income Margin (%) 2,727 2,503 2,296 414 419 16.5 15.4 342 14.9 Manufacturing and sales of control systems and equipment for factory automation and production machinery Sensing devices (Photoelectric/Proximity sensors, AOI, etc.), Control devices (Programmable logic controllers, Relays, Timers, etc.), Safety devices (Safety sensors, Safety switches, etc.) S E G M E N T I N F O R M A T O N I 2003 2004 2005 (FY) 2003 2004 2005 (FY) 1,011 977 890 146 161 16.4 15.9 112 2003 2004 2005 (FY) 2003 2004 2005 (FY) 11.5 588 646 776 1.7 10 (9) (1.4) (20) (2.6) 2003 2004 2005 (FY) 2003 2004 2005 (FY) 1,360 1,152 918 7.6 104 64 5.6 44 4.8 2003 2004 2005 (FY) 2003 2004 2005 (FY) 611 470 506 15.3 76 87 72 15.1 14.2 2003 2004 2005 (FY) 2003 2004 2005 (FY) 245 268 259 15.5 14.2 38 38 17 6.4 2003 2004 2005 (FY) 2003 2004 2005 (FY) Operating income Operating income margin (%) Operating income Operating income margin (%) Operating income Operating income margin (%) Operating income Operating income margin (%) Operating income Operating income margin (%) Operating income Operating income margin (%) Manufacturing and sales of electronic components for home appliances, communications, mobile phones, amusement components, OA Relays, Switches, Connectors, Sensors, Micro lens arrays, Customized ics, IC coins, Optical communications devices, etc. Manufacturing and sales of automotive electronic components Automotive relays, Sensors, Laser radars, Power window switches, Keyless entry systems, ECU, etc. Manufacturing and sales of equipment/modules, and provision of solutions and services in the fields of public transportation and traffic/road management Public transportation : Passenger gates, Ticket vending machines, etc. Traffic/Road management, Signal controllers, Road management systems, etc. Manufacturing and sales of home and professional healthcare equipment Digital blood pressure monitors, Digital thermometers, Pedometers, Body composition analyzers (Body-fat analyzers), Electronic pulse massagers, Massage chairs, Vital signs monitors, Inpatient blood pressure monitoring devices, Exhaled gas monitors, Central monitors, Vascular screening devices, etc. Business Development Group/Development of new businesses for achieving the Group growth strategy Entertainment business (Commercial game machines (Photo sticker machines), Cellular phone content distribution, Prizes for commercial game machines (Prize business), etc.), Personal computer peripherals (ADSL modems, Broadband routers, Uninterruptible power supplies, etc.), Wireless sensing business (Simple anti-theft devices for automobiles (Carmoni), Remote monitoring equipment, RFID business (IC tag, Reader/Writer, Antennae, etc.) * Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquar- ters expenses that are not apportionable. 17 OMRON CORPORATION ANNUAL REPORT 2006 I N D U S T R I A L A U T O M AT I O N B U S I N E S S ( I A B ) Manufacture and Sale of Control Equipment for Factory Automation IAB RESULTS AND PLANS Fiscal Year 2006 Plan Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization Capital expenditures 298.0 142.0 156.0 29.5 72.5 14.5 33.0 6.5 48.0 16.1% 20.0 11.0 2005 272.7 136.2 136.5 25.4 69.6 12.7 24.0 4.8 41.9 15.4% 18.5 8.7 10.2 Y o Y 108.9% 104.6% 113.6% 125.0% 106.1% 122.3% 122.9% 112.1% 101.2% (1.1 pt.) 110.9% 114.1% 116.3% 2004 250.3 130.2 120.1 20.3 65.6 10.4 19.5 4.3 41.4 Billions of yen 2003 229.6 117.1 112.5 19.6 60.7 13.6 18.4 0.3 34.2 16.5% 14.9% 16.7 7.6 8.8 145. 10.0 7.3 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not appor- tionable. Network-Ready Next-Generation Printed Circuit Board Inspection Equipment VT-RNS Series Network-Ready printed circuit board inspection equipment leveraging Omron's proprietary sensing and control technolo- gy, inspection technology cultivated over many years in the solder inspection equipment business, and IT. ZJ-FA10 Ionizer An advanced ionizer developed for high quality production. Generated ions are blown by fan, while sensing and control technology is used to optimize the ion balance. Safety Network Controller NE1A-SCPU01 The world’s first safety controller to incorporate the DeviceNet Safety interface. It realizes modularization and programmability of essential safety circuit functions, and ful- fills the world's highest safety standards. 18 OMRON CORPORATION ANNUAL REPORT 2006 The IAB, the driving force behind structural reform of the Omron Group’s overall profits, has an operating income margin goal of 20% by fiscal 2007. For this reason, along with bold investment in structural reforms, we are increasing added value through “technology” and “solutions” to respond to new need for improved “prod- uct quality”, “safety” and “environmental friendliness” in the manufacturing process. Fumio Tateisi Executive Vice President, Company President, Industrial Automation Company Review of Fiscal 2005 • Showing Strength in North America and China In addition to large-scale investment in the automobile industry, growing equipment demand in the semiconductor and digital con- sumer electronics industries following inventory adjustments set the stage for increased domestic needs related to “product quality”, “safety” and “environmental friendliness”, and strong performances in the Safety Network Controller and the Solution Service businesses. Overseas, in North America, sales rose sub- stantially owing to demand in both the automobile industry and oil and gas-related businesses. In China, sales increased substantially due to the strengthening of Omron’s sales force, centered on full- time sales staff, and its network of sales agents. Furthermore, in Europe, sales centering on inverters, servo motors and sensor equipment increased in Russia and in Eastern Europe. As a result, IAB net sales increased 8.9% year on year to ¥272.7 billion. Investments made to comply with the European RoHS* directive resulted in a 1.2% rise in operating income to ¥41.9 billion and a 1.1 percentage point fall in the operating income margin to 15.4%. *RoHS (Restriction of Hazardous Substances) THE MARKET ENVIRONMENT AND KEY STRATEGY • An Operating Income Margin Goal of 20% In fiscal 2006, aggressive investment by manufacturing industries, especially the automobile industry, and investment in equipment replacements among domestic small and medium-sized companies are likely to create a favorable business climate for the IAB. Further- more, as the level of performance of facilities increases, needs for improvements related to “product quality”, “safety” and “environ- mental friendliness” are strengthening, and we will undertake to expand our sales through proposing solutions. However, not only is the IAB currently seeking better profits, it is also accelerating efforts to serve as a core company which can realize an operating income margin of 20% by fiscal 2007. Specifically, over the three years from fiscal 2005 to fiscal 2007, Omron will invest a total of ¥10 bil- lion in IAB for a program of structural reforms aimed at reorganizing technology, development and production operations, all of which center on controller products, placing them in the same manufactur- ing plant, and shifting production to a Chinese subsidiary. From fiscal 2007, we expect to be in a position to reduce IAB fixed manu- facturing costs by more than ¥9 billion annually and at the same time increase development speeds while augmenting and strength- ening our base of manufacturing technology. MEASURES FOR ACCELERATING GROWTH • Strengthening the Safety Device Business In June 2006, Omron agreed to acquire the safety controller busi- ness of Scientific Technologies, Inc. (STI), a top maker of safety controller devices in North America for US$94 million. In the face of growing need for greater safety in manufacturing processes, we estimate that global annual sales in the safety device market reached approximately ¥110 billion at the end of fiscal 2005; thus we expect annual market growth of around 15%. STI’s business in North America includes a variety of industries, such as automo- biles, semiconductors, electronic devices, pharmaceuticals, cosmetics, and food. It is noted for its light curtains, which provide protection against illegal entry and accidents at manufacturing facilities, and its chemical plant safety sensors. In fiscal 2005, safety device sales were nearly ¥10 billion at Omron and roughly ¥7.1 billion at STI. In uniting the strengths of the two companies, Omron has set a combined safety device sales target of ¥30 bil- lion by fiscal 2008 and is aiming to become the No. 1 company in the world in the field of safety devices used in manufacturing plants. (See page 13 of “Special Feature”) • Full-Scale Entry into the Indian Market Omron has established a sales subsidiary in New Delhi, which opened for business in fiscal 2006. Production facilities in India are expanding, centering on the automobile industry, and we anticipate large growth in the market for control devices. Until now, Omron serviced its customers in India through a representative office affili- ated with a Singaporean sales company (OEP*). But in the absence of sales distribution rights, the activities of this office were restrict- ed to promoting OEP sales and customer support. Actual product deliveries were handled through authorized distributors or trading firms. By having established the sales subsidiary in India, Omron can more proactively tap into the potential of the Indian market, pro- viding a personalized level of customer support and responding to diverse demand for a full array of products such as sensors, compo- nents, PLCs**, motion controllers and inverters, as well as offering higher levels of technical support and better delivery service. * OMRON ASIAPACIFIC PTE LTD. **PLCs (Programmable Logic Controllers) are intelligent control devices used in production processes. PLCs control equipment efficiently by processing information from various control components such as sensors, timers, tem- perature regulators and switches. S E G M E N T I N F O R M A T O N I 19 OMRON CORPORATION ANNUAL REPORT 2006 E L E C T R O N I C C O M P O N E N T S B U S I N E S S ( E C B ) Manufacture and sale of electronic components for consumer appliances, telecommunications equipment, and industrial equipment ECB RESULTS AND PLANS Fiscal Year 2006 Plan 2005 Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization Capital expenditures 121.5 55.0 66.5 11.0 10.5 7.0 28.5 9.5 14.5 11.9% 9.0 12.0 97.7 45.0 52.7 9.9 12.5 6.3 14.5 9.5 11.2 11.5% 7.8 7.4 7.2 Y o Y 96.6% 86.9% 106.7% 104.3% 104.5% 112.3% 125.7% 88.1% 69.7% (4.4 pt.) 99.9% 127.6% 79.2% 2004 101.1 51.8 49.3 9.5 12.0 5.6 11.6 10.7 16.1 15.9% 7.9 5.8 9.1 Billions of yen 2003 89.0 47.5 41.5 10.5 10.4 5.0 9.1 6.6 14.6 16.4% 6.7 5.9 7.1 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not apportionable. LX4 Optical Interface Modules Divides an optical source into four waves and is used for optical communications in transmission equipment receiver modules. Developed by Aduro, Inc., prior to our acquisition of this company. Cellular Phone Ultra-Bright LCD Backlights Three integrated LEDs achieve high brightness of 20,000 cd (candles) per square meter. Enable extremely clear images and video. Ultra-small FPC Connectors 0.5 mm Pitch FPC (Flexible Printed Circuit) connectors used in a wide vari- ety of portable devices (cellular phones, portable music players, notebook PCs, etc.) and other products. 20 OMRON CORPORATION ANNUAL REPORT 2006 The ECB stands ready to become the driving force behind creating a new source of growth for the Omron Group. We are focused on the development of technology that distinguishes the Group from its competitors and on encouraging growth in new business areas like LCD backlights, optical communications devices and MEMS sensors. Soichi Yukawa Senior Managing Officer Company President, Electronic Components Company REVIEW OF FISCAL 2005 • Tough Fight for LCD Backlights Domestic sales were weak in the first half of the fiscal year. How- ever, in the second half of the year, particularly in the digital consumer electronics industry, the cycle of inventory adjustments came to an end, and demand recovered, benefiting from a big jump in FPC connector sales owing to brisk markets for flat-panel televisions and portable music players. Overseas, sales in China, a key region where we have strengthened our production capacity and marketing structure, grew significantly. In addition, European and American sales were also bullish owing to strengthened sales and marketing. On the other hand, sales in the LCD backlight business, which is a particular focus of the ECB segment, declined due to mounting price competition over small backlights for cellular phones and the late start of mass production of large backlights for flat-panel televisions. As a result, net sales in the ECB segment fell by 3.4% year on year to ¥97.7 billion. With high- er prices for crude oil and materials, operating income dropped 30.3% to ¥11.2 billion. The operating income margin declined 4.4 points to 11.5%. THE MARKET ENVIRONMENT AND KEY STRATEGY • Working towards a Rapid Recovery in LCD Backlights In fiscal 2006, we look for demand growth in the flat-panel televi- sion and cellular phone markets and for bullish industrial electronic component sales to hold steady. Given this anticipated environment, we will explore opportunities for our small-size LCD backlights in BRICs markets by leading with our energy-efficient products made using in-house technology. In response to the need for increasingly high performance-capable backlights for tel- evision-enabled mobile phones, we will try to put the sales back on track by creating a distribution supply system for ultra bright- type products. In regard to large-size LCD backlights, we are improving our supply system in parallel with the briskness of LCD television sales. Also, in August 2006 we will acquire Pioneer Pre- cision Machinery Corporation, a major backlight maker, to add Pioneer’s small-size (high-brightness, high-resolution) and medi- um-size backlight products to our lineup, aiming to raise total sales of the backlight business to ¥100 billion in fiscal 2008. China has been established as a key market, and our goal is consider- ably higher sales in China, which we intend to accomplish by strengthening production capacity and broadening our sales oper- ations. MEASURES FOR ACCELERATING GROWTH • Looking to Expand the Optical Communications Devices Business In December 2005, Omron acquired Aduro, Inc., a U.S.-based venture capital company for high-speed optical communications components, which we renamed Omron Network Products LLC. Given expectations of higher demand for even faster high-speed optical fiber networks and for transmission devices required for optical signal transmission & receiving modules, the ECB has developed a transmission-side multiplexer device which uses high precision lenses to compress multiple light wavelengths into one wavelength. This device will enable us to respond to the growth in the volume of communications data. On the other hand, Aduro, Inc., has developed a demultiplexer device which uses receiving- side optical signals. Based on this acquisition, the ECB is now able to supply transmission and receiving modules to the optical communications market. We believe these optical interface mod- ules and other products will help us reach our fiscal 2006 sales target of ¥1.9 billion in the optical communications device busi- ness, a better than ten-fold increase over our fiscal 2005 sales. • Expanding Our Lineup of LCD Backlight Products In August 2006, Omron acquired Pioneer Precision Machinery Corporation, a major maker of small and medium-size LCD back- lights, which we renamed OMRON PRECISION TECHNOLOGY Co., Ltd. Until now, the ECB has been focused on energy-efficient light source backlights for small-size LCDs used in such products as cellular phones and digital cameras. These LCDs are powered by our unique micro lens array technology to project light using one LED. At the same time, Pioneer Precision Machinery Corpora- tion is strong in high-resolution high-brightness multi-light source backlights and is also engaged in making medium-size LCD back- lights. Through our acquisition of this company, Omron is now in a position to provide a complete line-up of small, medium and large- size backlight products. Moreover, the small-size category will mainly consist of products that can meet the need for both ener- gy-efficient backlights used in ordinary equipment and high-resolution high-brightness-type backlights used in high-end equipment, aiming for a 35% share of the global market for small- size backlights by fiscal 2008. (See page 12 of “Special Feature”) S E G M E N T I N F O R M A T O N I 21 OMRON CORPORATION ANNUAL REPORT 2006 A U T O M O T I V E E L E C T R O N I C C O M P O N E N T S B U S I N E S S ( A E C ) Manufacture and sale of electronic components for automobiles AEC RESULTS AND PLANS Fiscal Year 2006 Plan 2005 Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization Capital expenditures 91.0 27.0 64.0 36.5 10.5 16.0 1.0 0 3.0 3.3% 7.0 9.0 77.6 27.2 50.4 28.8 6.2 15.1 0.1 0 (2.0) — 6.7 5.7 11.9 Y o Y 120.2% 104.8% 130.6% 136.9% 115.7% 127.6% — 15.7% — — 103.7% 175.2% 157.5% Billions of yen 2004 2003 64.6 26.0 38.6 21.0 5.4 11.9 0 0.3 (0.9) — 6.4 3.3 7.6 58.8 24.8 34.0 20.9 4.0 8.8 0 0.3 1.0 1.7% 5.2 3.0 9.0 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not appor- tionable. Automotive Laser Radar Measures the distance to the vehicle head using a sensitive wide-field laser and provides automatic braking. Automo- biles, bicycles and other obstacles are also detectable. Electric Power Steering Controllers Compared with conventional oil pressurization, electric (motorized) power steering leads to improved fuel efficiency. Consequently, adoption of electric power steering controllers is rapidly expanding in new automobile models. Automotive Relays High reliability and longevity are the important qualities required of automotive relays, which have a wide range of applications. In particular demand for automotive printed cir- cuit board relays for use in motor control is rapidly increasing. 22 OMRON CORPORATION ANNUAL REPORT 2006 As the trends of safety, comfort and environmental friendliness are leading to increasing high performance and greater use of electronic components in automo- biles, the AEC is utilizing its advanced “Sensing & Control” technology to both develop high value-added products and push forward with improvements to our cost structure, to keep ahead of the global competition. Hiroki Toyama Managing Officer Company President, Automotive Electronic Components Company REVIEW OF FISCAL 2005 • Achieved Higher Sales in all Areas, but Cost Increases Are Painful Although there was disparity in operating results among automo- tive manufacturers, global automobile production was generally quite strong in fiscal 2005. Based on the trend of building more environmentally friendly and safer automobiles, the AEC recorded increased sales of products developed in line with the introduction of new models by our customers. By region, sales in North Ameri- ca showed an especially impressive performance, rising 36.9% from the previous fiscal year on the back of newly released prod- ucts. In Asia, sales rose 27.6% year on year, benefiting from the strong sales of major customers. Moreover, with the help of high- er sales at a relay subsidiary we acquired in the previous fiscal year, sales in Europe also climbed. The total of overseas sales fin- ished ¥6.4 billion above the target we set at the beginning of the fiscal year. As a result, net sales in the AEC business rose 20.2% year on year to ¥77.6 billion. However, more severe price competi- tion and the cost of quality improvements in our North American production bases hurt earnings, causing the segment to suffer an operating loss of ¥2 billion, greater than the operating loss of ¥0.9 billion a year earlier. THE MARKET ENVIRONMENT AND KEY STRATEGY • The Key Issue Is to Improve Profitability Global automobile production is expected to continue to grow in fiscal 2006, driven mainly by expanded output in China, Eastern Europe and South America. In this context, the AEC new products are being adopted increasingly in the overseas and domestic development of new automobile models. Also, now that our pro- duction subsidiary in China has become fully operational, we are expecting AEC sales to rise 17.3% year on year in fiscal 2006, for the second consecutive year of double-digit growth. The key issue, however, is to improve profitability. In fiscal 2005, the cost of making improvements to quality in our North American produc- tion bases placed enormous pressure on profits, but in our view this was a one-time expenditure. As well, we believe that the steep rise in raw material prices can be offset through the select- ing of suppliers and better productivity. Lastly, we plan to take full advantage of Group synergies to address costs in a number of ways. For example, we are aiming to strengthen our cost competi- tiveness globally, promoting the expansion of our line-up of high value-added products such as automotive laser radars, boosting China-based production, sharing component suppliers with other companies in the group, and exploring ways to reduce research and development expenses. MEASURES FOR ACCELERATING GROWTH • Production Base in China Commences Operation Automobile production in China is currently estimated at five mil- lion units. According to forecasts, China’s annual automobile production will continue to grow at 10% annually in the years ahead. Some forecasts indicate that by 2007 or 2008 the number of automobiles produced in China annually will exceed Japan's total annual output of seven million units. For this reason, global automotive manufacturers are speeding up their timetables for localizing production in China. Given this situation, in January 2006 the AEC established a new plant in Guangzhou that produces key- less entry systems and power window switches with a view to meeting the procurement needs of the major automobile manu- facturers operating in China. Plans call for the Guangzhou plant to achieve sales of ¥5 billion in fiscal 2007. But in future we will posi- tion the Guangzhou plant as an important base for strengthening the AEC’s overall cost competitiveness, adjust the global supply structure, and aim to double or triple the plant’s production capaci- ty within three years. • New Automotive Laser Radar System in Development Given the strong interest in the development of Advanced Safety Vehicles (ASV), the AEC is already active in the area of car-follow- ing control systems and collision mitigation systems. It is supplying the major automobile makers with laser radars, for pre- cisely measuring the distance to the vehicle in front and the direction of movement of one’s own vehicle. The rapidly growing need to reduce accidents is also encouraging the AEC to further develop its laser radar technology and to move ahead with devel- opment of a fusion system incorporating a high dynamic range camera (See page 14 of “Special Feature”). The AEC segment is using its core “sensor technology” and “control technology” to develop high value-added products to meet the high-performance needs of safety vehicles and to be able to expand into new growth areas. S E G M E N T I N F O R M A T O N I 23 OMRON CORPORATION ANNUAL REPORT 2006 S O C I A L S Y S T E M S B U S I N E S S ( S S B ) Manufacturing and sales of railroad equipment, such as automated passenger gates, and traffic management systems plus services SSB RESULTS AND PLANS Fiscal Year 2006 Plan 2005 Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization Capital expenditures 99.0 95.0 4.0 0.5 0 0 0 3.5 6.0 6.1% 3.6 4.0 91.8 90.5 1.3 0.2 0 0 0 1.1 4.4 4.8% 4.0 2.4 4.3 Y o Y 79.7% 83.3% 20.3% 96.4% 0.0% — — 19.1% 68.9% (0.8 pt.) 74.8% 40.1% 104.3% 2004 115.2 108.6 6.6 0.2 0.4 0 0 6.0 6.4 5.6% 5.3 6.1 4.1 Billions of yen 2003 136.0 126.4 9.6 0.2 0.9 — 0.4 8.0 10.4 7.6% 7.6 6.6 3.2 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not appor- tionable. Non-contact IC specialized automated passenger gates A new style of automated passenger gates; antenna compo- nents attached to passenger gates instantly read information contained in a briefly flashed non-contact IC card and then allow passengers to pass through. Next-generation image sensors Sensors that can read motion differences in moving objects, differentiate multiple objects onscreen and perform precise tracking operations. In the road traffic control systems field, the movement to different directions of automobiles at inter- sections can be precisely measured. Security solutions Providing optimum solutions to such problems as the risk of private information leaks and preparing packages to protect “people, things, information, and environment” which are the assets of our customers.. 24 OMRON CORPORATION ANNUAL REPORT 2006 The SSB provides various systems that support society’s railroad and roadway infra- structure. Moreover, in recent years we have pursued the creation of new value by also putting our energies into a Security Solutions Business that can respond to the increasingly obvious social need for “security” and “safety.” Yutaka Takigawa Senior Managing Officer Company President, Social Systems Solutions Business Company REVIEW OF FISCAL 2005 • Above Target Net Sales and Profits In the railway station service systems business, demand for upgrad- ed and remodeled ticket sales machines in response to the issuance of new paper currency has ebbed. However, demand for upgraded and remodeled equipment to respond to the growing conversion of rail passes to an IC format and the existence of large-scale projects associated with the start-up of new railroad lines remain favorable. In the road traffic control systems business, fierce competition in the traffic control systems market is prolonging a severe business envi- ronment. In other business, new business, such as security solutions and IC cards & mobile solutions, generated increased net sales. Furthermore, in the related maintenance business, OA sys- tems and other IT-related business as well as the maintenance & repair of other company products business produced higher net sales. On an overall basis, the increase in demand was a positive outcome, but the impact of transferring the information equipment business, which includes ATMs, to an equity-method affiliate led to SSB net sales of 91.8 billion yen (down 20.3% YoY), operating income of 4.4 billion yen (down 31.1%) and an operating income margin of 4.8% (down 0.8%). THE MARKET ENVIRONMENT AND KEY STRATEGY • Pushing Structural Changes In FY 2006, we believe the railway station service systems busi- ness will benefit from growth in demand for upgraded and remodeled equipment that can respond to the continuous and full- scale adoption of IC cards and higher demand for IC card-compatible systems. However, in the road traffic control sys- tems business, we anticipate severe business conditions to remain owing to restrained public investment. In this context, the SSB is changing to a business structure necessary to maintain sta- ble growth by offering consistently high added-value total solutions including software and services. As a new business, in addition to strengthening our security solutions business and alongside the expansion of railway IC cards, we are aiming to establish an IC card and mobile solutions business in and around train stations. Furthermore, we are proactively expanding our sales activities in China, where infrastructure development is con- tinuing to accelerate. MEASURES FOR ACCELERATING GROWTH • Tapping into Demand for Social Infrastructure in China In June 2005, the SSB and a Chinese business partner jointly received an order for an Automatic Fare Collection (AFC) system for all 22 railway stations along Beijing’s newly constructed Sub- way Line #5. This AFC system applies contactless IC cards for all kinds of tickets and will be environmentally friendly by recycling single journey tickets, which are collected automatically at exit gates and reissued by ticket sales machines including Booking Office Machines and Ticket Vending Machines. Line #5 will begin operating with this AFC system in July 2007. These new subways are intended by Beijing City Government as a means of traffic management for the 2008 Beijing Olympics, and also as a solution against traffic congestion and associated environmental problems which are getting worse. The order is the result of steady market- ing we have conducted over more than two years. Omron intends to use this opportunity to further expand business in the Chinese market and establish the Omron brand name. • Developing Innovative Image Sensors in the Security Field Omron has developed innovative image sensors in cooperation with researchers at Tokyo University by applying technology based on the “Spatio-Temporal Markov Random Field” algorithm they created. These sensors read motion differences in moving objects, differentiate multiple objects onscreen and perform pre- cise tracking operations. For example, the sensors can be used to read the presence of two vehicles and then select one vehicle for tracking. Also, these sensors can be installed in traffic intersection cameras to help ease traffic congestion by adjusting traffic signals to the flow of vehicles. They can also be used at crosswalks to prolong the “Walk” signal for elderly pedestrians. Beyond high- ways and intersections, other uses for these new sensors are likely. We anticipate a wide range of demand from fields where high-level surveillance is required, such as anti-terrorism, and at airports, train stations and factories. S E G M E N T I N F O R M A T O N I 25 OMRON CORPORATION ANNUAL REPORT 2006 H E A LT H C A R E B U S I N E S S ( H C B ) Manufacture and sale of medical devices for home and institutional use HCB RESULTS AND PLANS Fiscal Year 2006 Plan 2005 Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* 66.5 33.5 33.0 16.0 11.0 1.5 4.0 0.5 8.5 61.1 30.3 30.8 15.4 10.6 1.6 2.9 0.2 8,7 Operating income margin* 12.8% 14.2% R&D expenses Depreciation and amortization Capital expenditures 4.0 2.0 3.4 1.1 1.5 Y o Y 120.8% 131.6% 111.7% 105.6% 119.4% 116.3% 114.1% 180.8% 113.5% (0.9 pt.) 124.5% 148.6% 71.4% Billions of yen 2004 2003 50.6 23.1 27.5 14.6 8.9 1.4 2.6 0.1 7.6 47.0 21.3 25.7 13.3 8.3 1.2 2.7 0.1 7.2 15.1% 15.3% 2.7 0.7 2.1 2.7 0.9 1.9 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not appor- tionable. “HEM-7020” Digital Blood Pressure Monitor A blood pressure monitor which has the ability to detect early morning hypertension, which is difficult to diagnose in hospital. An “early morning hypertension” mark lights up if the weekly average morning blood pressure exceeds the mean home blood pressure of 135/85mmHg. “HBF-362” Body Composition Analyzer A body composition analyzer which measures the percentage of subcutaneous fat and skeletal muscle in the torso, legs and arms. Also has the ability to compare various results against mean values for the same build, sex, and age. “Form” Blood Pressure and Pulse Wave Screening Device A blood pressure and pulse wave screening device which is capable of measuring vascular hardening, narrowing and blockage. It allows for easy checking of a patient's blood ves- sels in the space of a few minutes, enabling efficient treatment of lifestyle-related disease. 26 S E G M E N T I N F O R M A T O N I OMRON CORPORATION ANNUAL REPORT 2006 Omron Healthcare Co., Ltd. (HCB) is steadily expanding its business in response to growing global awareness to prevent lifestyle-related diseases. Our goal is to achieve further growth through our “Healthcare at Home” business, which plays a useful role at medical institutions in enabling preventive treatment of diseases based on bio-information and/or behavioral information recorded at home. Keiichiro Akahoshi Representative Director and Chief Executive Officer, Omron Healthcare Co., Ltd. REVIEW OF FISCAL 2005 • Favorable Domestic and Overseas Results In fiscal 2005, increased attention to personal health and growing awareness to prevent lifestyle-related diseases both in Japan and overseas resulted in higher sales in every region, of the sales of our mainstay product, digital blood pressure monitors. In the Japanese market, growing awareness of metabolic syndrome and interest in visceral fat helped produce strong sales of our body composition analyzers with scales. At the same time, in order to strengthen our business directed at medical institutions, in June 2005, we acquired Colin Medical Technology Corporation, a major medical device manufacturer, and renamed it OMRON COLIN Co., Ltd. (OHK). In overseas markets, business expansion in Russia with the launch of a new sales office there contributed to the high sales growth in Europe, while in Southeast Asia demand for our nebulizers increased. As a result, the HCB segment had net sales of ¥61.1 billion (up 20.8% YoY) and operating income of ¥8.7 bil- lion (up 13.5%). Costs ballooned with the acquisition of OHK, causing the operating income margin to fall 0.9 percentage points to 14.2%. THE MARKET ENVIRONMENT AND KEY STRATEGY • Focused on Product Development with the View of Expand- ing Market to Prevent Lifestyle-Related Diseases In Japan, promoting preventive medicine has been employed as one of the national policies to control medical costs. Under the guidance of national and local government authorities, efforts to address lifestyle-related disease prevention are being accelerated. Also, as societies become aging and the number of patients with lifestyle-related diseases increases, primarily in advanced coun- tries, we expect demand for our healthcare and medical equipment continuously to expand. Moreover, the idea has acquired general consensus among medical professionals that sharing bio-informa- tion measured at home leads effective and efficient medical treatment and supervision. Given these circumstances and views, HCB is improving its line-up of equipment useful for preventing lifestyle-related diseases, especially its “Cardiovascular Indices Monitoring Systems” designed to measure blood pressure and stiffness of arteries, while focusing the development of “Health- care at Home” products which measure daily bio-information at home to be utilized for preventive medicine MEASURES FOR ACCELERATING GROWTH • Acquisition of OHK Helps Strengthen and Expand Our Business Directed at Medical Institutions The acquisition of OHK represents our decision to greatly increase our presence in the “Preventive Medicine” business field; our restructuring of the business framework across the entire HCB group has been ongoing from the “Healthcare at Home” stand- point. Subsequent to the acquisition, OHK’s development division was merged into HCB in April 2006, to promote the development of new products—combining technologies of caradiovascular monitoring systems which have been strengths of both compa- nies—such as digital blood pressure monitors and vascular screening devices. Moreover, streamlining of business was enforced by merging the marketing division specializing in medical institutions into OHK. In fiscal 2006, we plan to invest about ¥0.7 billion in structural reforms in the HCB business to achieve even greater efficiency. Health Data Collected at Home is Used in Preventive Medicine at Medical Institutions Targeting the Market for Preventive Medicine HOME Blood pressure is measured at home Data is brought to the doctor Therapy/advice /follow-up HOSPITAL Measurement data is used in therapy Diagnosis (cid:127) Early morning hypertension (prescription of medication) (cid:127) Advice on lifestyle improvement (cid:127) Follow-up visits Health care Professionals Institutional use (cid:127)Vascular screening devices (cid:127)Hospital room monitors (cid:127)Operating room monitors Preventive Medicine business Consumers Home use (cid:127)Blood pressure monitors (cid:127)Body composition (fat) meters (cid:127)Pedometers Expansion of operating base through acquisition of OHK Growth through synergies between Omron and OHK Home Medical institutions Existing business area of Omron Healthcare 27 OMRON CORPORATION ANNUAL REPORT 2006 B U S I N E S S D E V E L O P M E N T G R O U P A N D O T H E R B U S I N E S S E S New business development and other business not covered by Group companies Tag Inlets A tiny film-like device with an IC chip embedded with an antenna. Generally, the device is used inside a tag or a label and stored data is read with a special reader. The Business Development Group carries out the Omron Group’s growth strategy. It seeks out and fosters new business opportunities and actively supports technologi- cal development and product commercialization. In particular, it is giving priority to the investment of management resources in the RFID business and the electric power remote monitoring service business. Kazunobu Amemiya Executive Officer Senior General Manager, Business Development Group IAB RESULTS AND PLANS Fiscal Year 2006 Plan 2005 Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization Capital expenditures 24.0 24.0 0 0 0 0 0 0 0.5 2.1% 11.9 7.0 25.9 25.6 0.3 0 0 0 0.2 0.1 1.7 6.4% 10.2 5.5 6.0 Y o Y 96.8% 97.0% 87.0% — — — 74.5% 80.2% 43.9% Billions of yen 2004 2003 26.8 26.4 0.4 0 0 0 0.3 0.1 3.8 24.5 24.0 0.5 0.1 0 0 0.4 0 3.8 (7.8 pt.) 14.2% 15.5% 97.1% 106.4% 104.0% 10.6 5.1 5.8 9.8 1.3 9.5 *Projections for FY2006 are based on an exchange rate of ¥110/US$ and ¥135/Euro. *The sales figures given indicate sales to external customers and exclude intersegment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as intersegment transactions and headquarters expenses that are not apportionable. REVIEW OF FISCAL 2005 • Entertainment Business, Computer Peripherals THE MARKET ENVIRONMENT AND KEY STRATEGY • Accelerating Development of the RFID Business and RFID Proved Positive in North America In the entertainment business, favorable results for cellular phone content distribution boosted sales, and in the computer peripherals business sales increased dramatically. Also, the Radio Frequency Identification (RFID) business, one of our focuses of business development, has entered an expansion phase on the back of rising domestic and overseas demand. However, in the wireless sensing business, easy-to-install vehi- cle anti-theft system sales were sluggish. As a result, Other Business net sales fell 3.2% year on year to ¥25.9 billion and operating income declined ¥2.1 billion to ¥1.7 billion. Given the recovery in operating results and other background fac- tors, we will try to boost sales of communications equipment, such as broadband routers, and backup power supplies in the computer peripherals business. In the area of new business, we are accelerating development of the RFID business in the North American market, where it has finally entered a phase of full-scale growth, and in the domestic market we are working to increase sales of electric power remote monitoring systems. However, we plan to streamline our product choices and businesses based on profitability and growth potential, and as a result Other Business net sales are expected to fall 7.5% year-on-year in fiscal 2006. MEASURES FOR ACCELERATING GROWTH • Expanding RFID Manufacturing Lines The RFID Business Development Division has built new Tag Inlet manufacturing lines in response to expected growth in demand for UHF-band IC Tag Inlets. As a result in fiscal 2006 we antici- pate a year-on-year doubling of sales in the RFID business. In the United States, suppliers dealing with Wal-Mart, the world’s largest retailer, are installing RFID systems, and in the domestic market, UHF-band RFID systems have been spreading since the use of UHF-band radio waves became possible in April 2005. Given these conditions, the Omron Group has developed an ultrasonic bonding technology, named JOMFUL, which address- es the most common problem with Tag Inlets, namely the poor connections of IC contact points. The technology features strong bonding capabilities and stable communication distance, and patents have been applied for in Japan, the US, Europe, South Korea and Taiwan. We are aiming at a global market share of 20% for UHF-band RFID systems within the next three years. 28 OMRON CORPORATION ANNUAL REPORT 2006 M A N A G E M E N T S Y S T E M S Contents 29 Management Systems 30 32 34 Corporate Governance and Legal Compliance Corporate Social Responsibility Intellectual Property Strategy 36 Directors, Corporate Auditors and Executive Officers M A N A G E M E N T S Y S T E M S 29 OMRON CORPORATION ANNUAL REPORT 2006 C O R P O R AT E G O V E R N A N C E A N D L E G A L C O M P L I A N C E As a global company, the Omron Group is dedicated to working harder than ever before to demonstrate accounta- bility to our stakeholders, increase management transparency and manage, as well as maintain support for, an appropriate governance system. Also, we remain focused on our goal of fostering a strong set of corporate ethics that go beyond the observance of laws and regula- tions and on promoting internal control such as an extensive compliance and corporate ethics program. CORPORATE GOVERNANCE STRUCTURE Basic Policies The major goal of the Omron Group which underlies all stakeholder expectations is “long-term maximization of corporate value”. Reaching this goal requires efficient and competitive management, which we strive to achieve by creating optimized systems of man- agement control and practicing sound corporate management. To achieve stronger corporate governance, we make a constant effort to put into practice three guiding perspectives: fulfilling manage- ment accountability, achieving management transparency and pursuing high business ethics. In keeping with this effort, the goal of our Group’s corporate governance is to earn the support of our stakeholders and achieve sustainable corporate growth by improv- ing our corporate competitiveness and by building a structure (an audit system) that functions to guarantee this outcome. Governance Structure In 1999, the Omron Group separated corporate management and business execution by introducing both a Managing Officer System and an Internal Company System. This move also represented an opportunity to encourage each business segment to focus on maxi- mizing their strengths in their own areas of business, to assign broader powers to the presidents of each internal company who have expertise in certain fields of business, to facilitate swift deci- sion-making, and to enhance productivity. It was also a moment to clarify roles and responsibilities and commit ourselves to a diverse set of management goals, including the profit of each company, and a performance-based compensation program for the purpose of real- izing shareholder value-based corporate value management. 1) Management and Monitoring Structure Omron operates with a small seven-member Board of Directors to increase efficiency and engage in more results-oriented delibera- tions. Our management monitoring functions are based on separating the duties of corporate management and business exe- cution. Both of these duties are the responsibility of the President & CEO, while corporate management duties are the responsibility of the Directors and business execution duties are the responsibil- ity of the Executive Officers. Furthermore, in order to enforce our management objectivity, we have separated the positions of Chairman of the Board of Directors and CEO and worked to strengthen management monitoring functions. In addition, the Chairman of the Board of Directors oversees business operations as a representative of the stakeholders without actually taking part in the execution of business. In regard to matters pertaining to the appointment, promotion, and remuneration of all Board Members (Directors, Auditors, and Managing Officers), we maintain objectivity and transparency through the Personnel Advisory Committee and the Remuneration Advisory Committee within the Board of Directors and by having our two outside Directors chair each of the committees. These committees are the venue for addressing personnel and remuner- ation matters relating to all Directors, and none reserves seats for the Chairman of the Board and the President. 2) Auditing Functions The Board of Corporate Auditors, which consists of four auditors (three of whom are outside corporate auditors), monitors gover- nance and management conditions as well as the daily activities of management, including those of the board of directors. Also, in undertaking its internal auditing function, the Audit Office, which functions directly under the President & CEO, periodically conducts Structure of Omron Corporate Governance Shareholders General Meeting Board of Auditors Board of Directors Board of Auditors Office Auditing Firm Executive Organization President & CEO Personnel Advisory Committee Compensation Advisory Committee Corporate Environmental Activity Committee Corporate Ethics & Conduct Committee Executive Council Audit Office CSR Management Headquarters Information Disclosure Committee Board of Directors This Board monitors execu- tive operations (President and Chief Executive Officer) and decides important business practices and strategies for matters such as company objectives and management strategy. The Board is chaired by the Chairman of the Board of Direc- tors, who monitors executive activities and represents stakeholders who do not hold execu- tive positions. Board of Auditors This Board consists of four auditors, of whom three are outside auditors. The Board checks expected governance and manage- ment conditions, and it monitors daily activities of management, including the Board of Directors. Personnel Advisory Committee This Commit- tee, formed of outside directors, receives guidance from the Chairman of the Board of Directors and from the President, sets election standards for the Board of Directors, Board of Auditors and executive officers, selects candi- dates, and evaluates current officers. Compensation Advisory Committee This Com- mittee, which consists of outside directors, receives guidance from the Chairman of the Board of Directors and from the President, decides on the compensation structure for the Board of Directors, board of auditors and execu- tive officers, sets evaluation standards, and evaluates current officers. Executive Council This Council determines and reviews important executive matters that are within the scope of authority of the President. Under the internal company system, decision- making is streamlined and operations made more efficient by transferring authority to the presidents of each company. Audit Office This Office periodically conducts internal audits of accounting, administration, business risks, and compliance for each head- quarters division and each company, and it offers concrete advice for monitoring and administra- tive improvement. 30 OMRON CORPORATION ANNUAL REPORT 2006 internal audits of accounting, administration, business risks, and compliance in each headquarters division and in each company. In addition to its checking functions, the Audit Office also offers spe- cific advice on ways of improving administrative functions. examples of problem situations along with judgment criteria to help guide appropriate reactions and (ii) the creation of a system by which all Directors and employees can proactively execute cor- porate ethics and compliance PDCA. Information Disclosure Committee Established In fiscal 2005, we responded to the needs of our shareholders and other stakeholders for more pro-active information disclosure by exploring the creation of our own unique and rigorous information disclosure standards in accordance with those stock exchange rules which require timely disclosure. In June 2006, the Informa- tion Disclosure Committee chaired by the President of Omron was established and a new system was created to monitor infor- mation disclosure activities for the entire Group. Based on these steps, we have moved to further upgrade the quality of our man- agement accountability. COMPLIANCE Basic Policies To insure that our corporate ethics are widely understood and established, the Group is taking four important actions: (1) active monitoring, (2) activating a PDCA cycle, (3) reinforcing compliance education and (4) rebuilding our compliance structure. Compliance Structure In 2003, the Group combined its risk management and compliance activities by establishing a Corporate Ethics & Business Conduct Committee chaired by Omron’s President. The general manager of each division and the president of each company participate in this committee to report on corporate ethics efforts for their respec- tive organizations in accordance with Omron’s corporate ethics and conduct framework and on the status of the response to each risk. Moreover, the Corporate Ethics & Business Conduct Commit- tee has established a whistleblower center called the “Corporate Ethics Hotline” (a call center was also opened at an outside law firm in fiscal 2005), which is situated within the Corporate General Affairs Division, to receive reports directly from employees and their families. Rebuilding Our Domestic and Overseas Compliance Structure In fiscal 2005, the compliance and risk management activities in the affiliated companies under the supervision of our companies were rebuilt in several ways. First, in September 2005, in order to organ- ize these activities, all domestic affiliated companies selected an individual to serve as a corporate ethics manager, and the members of that committee started to receive education and training. Sec- ond, in conducting monitoring and management training, we put a high priority on relatively small-size affiliated companies which have marketing functions and are facing severe market competition. At the same time, we are promoting (i) awareness of our Corpo- rate Ethics and Business Conduct Guidelines throughout the entire Group by starting to edit a “casebook” to provide specific In addition, we finished writing and publishing region-specific Corporate Ethics and Business Conduct Guidelines for four areas of the world in fiscal 2005. Also, the so called “legal monitoring” we first introduced in the North America region has also been introduced in China, and the Asia Pacific region. In these two regions, we have started to provide compliance training to desig- nated managers. In fiscal 2006, an education and training program for managers will be continued to ensure and strengthen compli- ance and we will institute monitoring in each global area. Risk Management Structure and Internal Control System The Omron Group is improving its internal control system as we believe that all risk arising from management and business opera- tions must be accurately assessed and controlled in order to appropriately manage operations, maintain stable growth and secure the required level of management resources. To achieve this end, Omron is putting into place a system of risk manage- ment for detecting, analyzing, countering and monitoring risk in each division and internal company. Moreover, the Corporate Gen- eral Affairs Division has oversight of risk management activities, and efforts are underway to identify and control risk throughout the Group. Structure of Omron Corporate Ethics Structure of Omron Corporate Ethics Corporate Ethics & Business Conduct Committee Committee Chair (President & CEO) Committee Secretariat Corporate Ethics Hotline Business Company Committee Members (Business Company Presidents) Corporate Committee Members (Head Office Administrative Division Managers) Corporate Ethics & Business Conduct Promotion Committee Specialized Committees Export Control Committee Business Companies’ Promotional Departments Administrative Divisions’ Promotional Departments Human Rights Committee Safety and Health Committee Central Disaster Prevention Committee For more information about our Corporate Governance and Legal Compliance programs, please refer to our Company Sustainability Report 2006 http://www.omron.com/corporate/csr/ M A N A G E M E N T S Y S T E M S 31 OMRON CORPORATION ANNUAL REPORT 2006 C O R P O R AT E S O C I A L R E S P O N S I B I L I T Y Ever since our founding, Omron has worked sincerely in the belief that the Company’s real purpose lies not only in seeking profits but also in serving society. Omron will, while upholding this corporate core value of “Working for the benefit of society”, work to meet the expectations of our stakeholders while fulfilling our social responsibility toward sustainable development in the “optimization society.” The Basic Philosophy of CSR: Working for the Benefit of Society Today, the criteria for evaluating a company are not only profitability and growth. Social value, as well, has been given greater impor- tance. A company’s social value means how a company fulfills its responsibility to society and how it contributes to a society’s sus- tainable development. On top of this change in society’s expectations toward corporations, the expansion and globalization of the Omron Group’s business and the subsequent diversification of our stakeholders* prompted us to review and reorganize the platform of our corporate philosophy, and we have restated it in the form of the new Omron Principles. This review process resulted in our re-acknowledgement of the importance of our corporate core value: ”Working for the benefit of society” which we have upheld since our founding. This is the very spirit behind our Corporate Motto: “At work for a better life, a better world for all.” Omron has been managed based upon this corporate core value for over 50 years. The Omron Group once again places this corporate core value at the center of the new Omron Principles and puts it into action with stronger conviction. We are convinced that it is the true fulfillment of CSR. Omron intends to continue its management responding to the expectations of our stakeholders, adhering to our belief that by meeting social needs we can earn the trust and respect of society as good corporate citizens. * Stakeholders: Omron considers that our stakeholders, those who are affect- ed by our actions, consist mainly of employees, business partners, customers, shareholders & investors, and society. CSR Management System The Omron Group has established “CSR Management Headquar- ters” under the direct control of the President and CEO, to assume planning and supervising functions related to CSR. Specific CSR activities, including environmental conservation, respect for human rights, promotion of appropriate labor standards, maintenance and improvement of corporate ethics, and corporate citizenship, are promoted through each specialized-function administrative division or internal business company. A CSR manager was assigned and a CSR management promotion system was set up at each internal business company. At present, the Omron Group has set out three CSR pillars of basic policy and four focused areas. In the future, the Omron Group plans to specify criteria for evaluating performance related to common corporate-wide CSR elements. Three Pillars of Omron’s CSR Activities [1] Contributing to a better society through business operations. Continuously offering advanced technologies, high-quality products and services through the cultivation of social needs. [2] Always demonstrating fairness and integrity in the promotion of corporate activities. By addressing a broad range of issues including legal com- pliance, corporate ethics, accountability and disclosure, we will promote more transparent corporate activities that maintain fairness and integrity. [3] Showing a commitment to addressing societal issues as a concerned party. We aim to address various issues such as those related to human rights, labor relations and the environment in a way that draws on Omron’s distinctive strengths. Four Focused Areas for CSR [1] Cultivating social needs through business operations. [2] Strengthening legal compliance and corporate ethics. [3] Addressing diversity issues through endeavors including extending support to people with disabilities and encour- aging women to take more active roles in the workplace. [4] Commitment to environmental conservation. 32 OMRON CORPORATION ANNUAL REPORT 2006 Commitment to Environmental Conservation Basic Thoughts About Environmental Management The Omron Group has positioned environmental issues as one of our important management objectives. We are of course working to reduce the burden of our activities on the environment and we also work to create products and technology that will help to pre- serve the environment. Our environmental management strives to bring together economy and ecology. M A N A G E M E N T S Y S T E M S Completion of Compliance with the RoHS Directive In fiscal 2005 our environmental conservation costs registered a year-on-year increase of ¥3.2 billion to ¥7.5 billion due to a ¥3.1 billion increase in research and development to comply with the RoHS (Restriction of Hazardous Substances) directive which took effect in July 2006 and other European regulatory requirements. With this investment we have eliminated hazardous substances from not only the product parts we purchase but also from our manufacturing processes. We have also built an environmental security system at the developmental and design stages of our operations. We successfully completed our process to comply with RoHS at the end of March 2006. 74 %: Product Ratio Certified as Eco-label Products The Omron Group has assessed products’ potential impact on the environment in order to assure that our products fully comply with environmental laws and regulations all over the world. The Omron Group defines those products that have met environmental tar- gets through these product assessments as “Eco-Products.” Those products that satisfy even higher standards of environmen- tal impact reduction are certified as “Eco-label products” and are eligible to bear Omron’s Eco-label. In fiscal 2005, 74% of the new product developments met the Eco-label Product environmental standard. Implementation of CSR Contributing to the “Optimization Society” “Seed-Innovation to Need-Impetus Cyclic Evolution (SINIC) theory (See page 79 for more information): science, technology and society have a cyclical relationship”, the predictive theory, developed by Omron’s founder Kazuma Tateisi, has served as a compass deter- mining the direction of Omron’s management. This theory predicted the “Optimization Society” where not only productivity but also new needs such as safety, security, environment and health are pursued. We believe that we are now in this new society. Omron, which has successfully anticipated and met the potential needs of society based on its SINIC theory, now promotes development and provi- sion of products and services contributing to the “Optimization Society.” Specifically this includes: safety sensors to prevent indus- trial accidents at manufacturing sites, laser radar systems to anticipate imminent danger and automatically activate brakes, and home medical care equipment to enable individuals to monitor and assess their daily health and to help them improve their lifestyles. Addressing Diversity Under the banner of fairness and impartiality and being free from gender and other discrimination, the Omron Group promotes its endeavors to address diversity issues through providing our diverse group of employees with opportunities to exercise their full potential at work. Specifically we provide female leadership training programs in order to bring out the abilities of our female employees. As a result we have improved our appointment ratio of female employees to positions of responsibility. The Omron Group has proactively promoted normalization* while working to improve the group-wide employment ratio of persons with disabil- ities since the establishment of a first-of-its-kind factory in Japan in 1972, Omron Taiyo Co., Ltd., which provides persons with dis- abilities with special considerations. In fiscal 2006, we plan to take advantage of our track record of experience in hiring the physically handicapped and other forms of know-how to begin a “Physically Handicapped Employment Support Business for the Physically Handicapped.” * Normalization: It is enshrined in the United Nations Declaration on the Rights of Disabled Persons: Bearing in mind the necessity of preventing physical and mental disabilities and of assisting disabled persons to develop their abilities in the most varied fields of activities and of promoting their integration as far as possible in normal life. Eco-label Product Developments in Fiscal 2005 Six RoHS banned substances eliminated HEM-5001 Digital Blood Pressure Monitor This upper arm-type blood pressure monitor allows a patient to share two years’ worth of home-measured blood pressure data with his doctor to assist in diagnosis. 30% less metal in use 3P5JX Vision Sensor for Intersections Installed at street corners, this sensor cap- tures the image of passing vehicles to control the traffic lights, thus helping alle- viate traffic jams. For more details about Omron’s implementation activities please see The Company Sustainability Report 2006. We believe it is important that we fulfill our responsibility to create dialog with more of our stakeholders, explaining thoughts regarding the expectations people hold for us, and having everyone understand our position. For more details regarding Omron’s CSR principles, plans and activity reports, please refer to The Company Sustainability Report 2006 available on our website. We would be happy to hear everyone’s frank opinions. http://www.omron.com/corporate/csr/ 33 OMRON CORPORATION ANNUAL REPORT 2006 I N T E L L E C T U A L P R O P E R T Y S T R AT E G Y The mission of the Omron Group is to be a pioneer among companies in the creation of social needs and the carrying out of continuous innovation. The proof of our accomplish- ments in these areas is our intellectual property portfolio, which is one of the most important resources available to management for determining growth potential, profitability and sustainability. The Basis of Our Intellectual Property Strategy The Omron Group is strengthening and strategically leveraging its intellectual property portfolio of patents, know-how, copyright and trademarks in order to maximize corporate value. From a company-wide perspective, the Group’s research and development scheme is structured so that the Advance Device Lab- oratory and Sensing & Control Laboratory, both belonging to our R&D Headquarters, undertake fundamental research and develop- ment while each Group company translates the two Laboratories’ work into application technologies and commercial products. Also, our R&D policy takes core technology as the starting point for creat- ing management-driven three to five-year growth scenarios. Executing a scenario involves bringing together three separate themes: Group growth strategy, business company growth strategy and core technology development. The first and second themes are handled jointly by the business companies and R&D Headquarters, while the third is handled solely by the R&D Headquarters. Furthermore, the sections involved in our management & busi- ness strategies, technology strategies, and intellectual property strategies all share common growth strategies, thereby building a structure which can generate technologies that become the core of our business growth, acquire potent intellectual property and translate intellectual property into actual business growth. With our R&D expense ratio set at a higher-than-normal level of 8%*, total R&D expenses amounted to ¥50.5 billion in fiscal 2005. The ratio of investment in basic technology development versus commercial product and business development was one to five. *Prior to losses resulting from the return of the substitute portion of the employee pension fund managed on behalf of the government Intellectual Property: Developing a Strategy and Business Growth Scenario Management/ Business Strategy Original technologies = maximization of corporate value by the power of intellectual property Shared Growth Strategy Intellectual Property Strategy Development of strong intellectual property and mitigation of risk Technology Strategy Strengthening our technical edge through the creation of core technologies Management Planning Office /Intellectual Property Dept. Intellectual property group for each segment Expansion of business Overall management Technology headquarters Development of core technologies Strengthening and Leveraging our Intellectual Property Portfolio Patents, know-how, copyrights, trademarks, etc. Group Structure Foundation of Intellectual Property Strategy 34 Measures to Enhance Our Intellectual Property Promoting Our Global Patenting Strategy Since the Omron Group started putting into practice its long-term vision GD2010 in 2001, we have accelerated our business develop- ment on a global basis and increased our overseas patent applications. In particular, we are striving to secure internationally recognized patent rights. In the United States, which is the world's superpower in terms of patents, we are strengthening acquisition of patents in order to increase our international competitiveness. In China, which is a country of strategic importance to us for production and marketing reasons, we are aggressively seeking patent rights as a way of supporting our business growth in that country. Planning to Open a Fundamental R&D Center in China In December 2006 the Omron Group plans to open an R&D center (a registered corporation) in Shanghai, China called the Omron Insti- tute of Sensing & Control Technology (Shanghai) Co., Ltd. It will begin with about 100 people tackling 30 different research themes, with the intention of doubling both the number of research person- nel and research themes by the end of fiscal 2007. Under current plans the institute will focus mainly on R&D in the areas of human facial recognition and image sensing of shapes and conditions of various objects. Until now individual Group companies have had their own commercial product development bases in China, but this is the first time that an incorporated institution is to be established for fundamental research. The institute will be located next to Shanghai Jiao Tong University, in an area with excellent research and education facilities, where highly capable graduate students and researchers are concentrated, many of whom have studied overseas. (Each year some 100,000 Chinese students who have studied advanced technology in Europe, US and Japan return to their homeland.) It will be a place where Chinese faculty, graduate students, other university-based researchers and Omron researchers can work side by side, putting the concept of “collabo- rative innovation” into practice and creating new value. R&D Organization R&D Organization CEO Advance Device Laboratory Sensing & Control Laboratory R&D Center Research and Development Headquarters Business Company SBU (Strategic Business Unit) Product Development Department OMRON CORPORATION ANNUAL REPORT 2006 Patents in the U.S.: Applications, Registrations and Rank Patent Applications in China (Number of Applications/Registrations) 200 178 169 163 (Total Number of Applications) 200 137 93 57 67 27 30 29 62 44 88 82 150 100 50 0 99 00 01 02 03 04 05 (FY) 150 100 50 0 162 160 150 105 38 6 99 13 00 01 02 03 04 05 (FY) Number of Applications Number of Registrations Number of Applications Managing Intellectual Property In recent years, particularly in China, many counterfeit Omron products have been found in circulation, causing damage to our corporate value. In response we have stationed company staff in Shanghai and have created a unique “Anti-Counterfeit Measures Manual” which has been distributed to local administrative authorities. Also, to eliminate counterfeits circulating in the Chinese mar- ket, we have carried out a public demonstration targeting counterfeit products. This involved mass destruction of large vol- umes of counterfeit products that had been discovered. The event was meant to express the Group's principles on intellectual property and our determination not to allow the manufacture and sale of counterfeit products, which was communicated through the media to people in China and abroad. Intellectual Property and R&D-related Data Number of patents Applied for Registered Number of patents R&D expenses (Billions of yen) Total IAB ECB AEC SSB HCB Business Development Group and Other Businesses R&D expenses ratio R&D staff (persons) Workers destroy counterfeit products as part of a campaign in Leqing, China. The items, which numbered in excess of 58,000, included proximi- ty switches and relays. FY2005 FY2004 FY2003 FY2002 1,509 705 4,538 50.5 18.5 7.8 6.7 4.0 3.4 10.2 8.1% 1,591 1,216 676 4,426 49.4 16.7 7.9 6.4 5.3 2.7 10.6 8.1% 1,384 1,170 580 4,154 46.5 14.5 6.7 5.2 7.6 2.7 9.8 7.9% 1,594 1,141 543 4,068 40.2 13.4 6.0 4.0 5.4 2.5 8.9 7.5% 1,378 M A N A G E M E N T S Y S T E M S 35 OMRON CORPORATION ANNUAL REPORT 2006 D I R E C T O R S , C O R P O R AT E A U D I T O R S A N D E X E C U T I V E O F F I C E R S As of June 22, 2006 (From the left) Director and Executive Vice President Tadao Tateisi, Director (external) Noriyuki Inoue, Director and Executive Vice President Shingo Akechi, President and CEO Hisao Sakuta, Chairman of the BOD Yoshio Tateisi, Senior Managing Director Tsukasa Yamashita, Director (external) Kakutaro Kitashiro DIRECTORS CORPORATE AUDITORS EXECUTIVE OFFICERS Chairman of the BOD Yoshio Tateisi President and CEO Hisao Sakuta Director and Executive Vice President Shingo Akechi Tadao Tateisi Senior Managing Director Tsukasa Yamashita Directors (external) Noriyuki Inoue Kakutaro Kitashiro Corporate Auditors Executive Vice President Executive Officers Tsutomu Ozako Fumio Tateisi Yoshisaburo Mogi (external) Yukio Kobayashi Hiroshi Fujiwara Yoshio Nakano (external) Senior Managing Officers Kazunobu Amemiya Hidero Chimori (external) Fujio Tokita Soichi Yukawa Hideo Higuchi Yutaka Fujiwara Yutaka Takigawa Tatsunosuke Goto Mike van Gendt Toshio Yamashita Roberto Maietti Managing Officers Koichi Imanaka Yoshinobu Morishita Takuji Yamamoto Yoshinori Suzuki Kuniyasu Kihira Toshio Ochiai Hiroki Toyama Kojiro Tobita Kuninori Hamaguchi 36 OMRON CORPORATION ANNUAL REPORT 2006 F I N A N C I A L S E C T I O N Contents 38 Financial Highlights 40 Six-year Summary 41 Fiscal 2005 Management’s Discussion and Analysis 46 Business and Other Risks 48 Consolidated Balance Sheets 50 Consolidated Statements of Income 51 Consolidated Statements of Comprehensive Income (Loss) 52 Consolidated Statements of Shareholders’ Equity 53 Consolidated Statements of Cash Flows 54 Notes to Consolidated Financial Statements 76 Independent Auditors’ Report I I F N A N C A L S E C T O N I 37 37 OMRON CORPORATION ANNUAL REPORT 2006 F I N A N C I A L H I G H L I G H T S OMRON Corporation and Subsidiaries Years ended March 31, 2006, 2005 and 2004 For the Year: Net Sales Income before Income Taxes, Minority Interests and Cumulative Effect of Accounting Change Income before Cumulative Effect of Accounting Change Net Income Per Share Data (yen and U.S. dollars): Income before Cumulative Effect of Accounting Change Basic Diluted Net Income Basic Diluted Cash Dividends (Note 1) Millions of yen (except per share data) 2006 2005 2004 Thousands of U.S. dollars (Note 2) (except per share data) 2006 ¥ 626,782 ¥ 608,588 ¥ 584,889 $ 5,357,111 64,352 36,964 35,763 52,548 30,176 30,176 47,984 26,811 26,811 550,017 315,932 305,667 ¥ 156.2 ¥ 126.5 ¥ 110.7 $ 156.1 124.8 107.5 151.1 151.1 30.0 126.5 124.8 24.0 110.7 107.5 20.0 1.34 1.33 1.29 1.29 0.26 Capital Expenditures (cash basis) Research and Development Expenses (Note 3) ¥ 40,560 ¥ 38,579 ¥ 38,115 $ 346,667 55,315 49,441 46,494 472,778 At Year End: Total Assets Total Shareholders’ Equity ¥ 589,061 ¥ 585,429 ¥ 592,273 $ 5,034,710 362,937 305,810 274,710 3,102,026 Notes: 1. Cash dividends per share represent the amounts applicable to the respective year, including dividends to be paid after the end of the year. 2. The U.S. dollar amounts represent translations of Japanese yen at the approximate exchange rate at March 31, 2006, of ¥117=$1. 3. A loss of ¥4,814 million ($41,145 thousand) in connection with the transfer of the substitutional portion of the benefit obligation and related plan assets is allocated to Research and Development Expenses for 2006. 38 OMRON CORPORATION ANNUAL REPORT 2006 Costs, expenses and income as percentages of net sales were as follows: Net sales Cost of sales Gross profit Selling, general and administrative expenses Research and development expenses Interest expenses (income), net Income before income taxes, minority interests and Cumulative effect of Accounting Change Income taxes Net income The increase or decrease in sales of each internal business company was as follows: Industrial Automation Business Electronic Components Business Automotive Electronic Components Business Social Systems Business Healthcare Business Other Businesses 2006 2005 2004 100.0% 100.0% 100.0% 62.1 37.9 25.8 8.8 (0.1) 10.3 4.4 5.7 59.0 41.0 23.7 8.1 (0.0) 8.6 3.6 5.0 59.0 41.0 24.3 7.9 0.1 8.2 3.5 4.6 2006 2005 2004 8.9% 9.0% 13.4% (3.4) 20.2 (20.3) 20.8 (3.2) 13.6 9.7 (15.3) 7.7 9.4 12.1 (1.1) 16.6 10.9 (29.5) Notes: 1. For 2004, Social Systems Business includes “Social Systems Solutions and Service Business Company” and “Advanced Module Business Company.” 2. For 2005, Social Systems Business includes “Social Systems Solutions and Service Business Company” and “Financial Systems Business Company.” The composition of net sales was as follows: Industrial Automation Business Electronic Components Business Automotive Electronic Components Business Social Systems Business Healthcare Business Other Businesses Note: The composition of net sales is based on the classifications reported in the Six-year Summary. 2006 2005 2004 43.5% 41.1% 39.3% 15.6 12.4 14.6 9.7 4.2 16.6 10.6 18.9 8.3 4.5 15.2 10.1 23.3 8.0 4.1 I I F N A N C A L S E C T O N I 39 OMRON CORPORATION ANNUAL REPORT 2006 S I X - Y E A R S U M M A R Y OMRON Corporation and Subsidiaries Years ended March 31 Net Sales (Note 2): Industrial Automation Business Electronic Components Business Automotive Electronic Components Business Social Systems Business Healthcare Business Other Businesses Costs and Expenses: Cost of sales Selling, general and administrative expenses Research and development expenses Subsidy from the government Interest expenses (income), net Foreign exchange loss, net Other expenses (income), net Income (Loss) before Income Taxes, Minority Interests and Cumulative Effect of Accounting Change Income Taxes Minority Interests Income (Loss) before Cumulative Effect of Accounting Change Net Income (Loss) Per Share Data (yen): Income (Loss) before Cumulative Effect of Accounting Change Basic Diluted Net Income (Loss) Basic Diluted Cash Dividends (Note 1) Capital Expenditures (cash basis) Total Assets Total Shareholders’ Equity Value indicators: Gross profit margin (%) Income (loss) before tax/Net sales (%) Return on sales (%) Return on assets (%) Return on equity (%) Inventory turnover (times) Price/earning ratio (times) Assets turnover (times) Debt/equity ratio (times) Interest coverage ratio (times) Millions of yen (except per share data) 2006 2005 2004 2003 2002 2001 ¥ 272,657 97,699 77,593 91,804 61,090 25,939 626,782 ¥ 250,329 101,127 64,558 115,205 50,583 26,786 608,588 ¥ 229,638 88,988 58,824 135,997 46,962 24,480 584,889 ¥ 202,518 79,365 59,480 116,652 42,331 34,727 535,073 ¥ 184,185 81,062 50,800 128,057 40,617 49,243 533,964 ¥ 227,691 129,444 — 141,928 39,327 55,869 594,259 389,368 161,310 55,315 (41,339) (609) 1,306 (2,921) 562,430 358,817 144,219 49,441 — (216) 75 3,704 556,040 344,835 142,157 46,494 — 317 1,254 1,848 536,905 327,413 135,112 40,235 — 348 575 26,658 530,341 353,429 134,907 41,407 — 223 1,506 27,865 559,337 376,194 131,203 42,513 — 111 1,389 2,812 554,222 64,352 27,238 150 52,548 22,108 264 47,984 20,762 411 4,732 3,936 285 (25,373) (9,348) 132 40,037 17,318 422 36,964 35,763 30,176 30,176 26,811 26,811 511 511 (16,157) (15,773) 22,297 22,297 ¥ ¥ 156.2 156.1 ¥ 126.5 124.8 ¥ 110.7 107.5 ¥ 2.1 2.1 ¥ (65.0) (65.0) 87.4 85.3 151.1 151.1 30.0 ¥ 40,560 589,061 362,937 126.5 124.8 24.0 ¥ 38,579 585,429 305,810 110.7 107.5 20.0 ¥ 38,115 592,273 274,710 2.1 2.1 10.0 ¥ 34,454 567,399 251,610 (63.5) (63.5) 13.0 ¥ 38,896 549,366 298,234 87.4 85.3 13.0 ¥ 37,583 593,144 325,958 37.9 10.3 5.7 11.0 10.7 5.43 22.2 1.07 0.623 71.43 41.0 8.6 5.0 8.9 10.4 5.17 18.5 1.03 0.914 53.36 41.0 8.2 4.6 8.3 10.2 4.73 23.3 1.01 1.156 43.27 38.8 0.9 0.1 0.8 0.2 4.36 900.8 0.96 1.255 23.59 33.8 (4.8) (3.0) (4.4) (5.1) 4.25 — 0.93 0.842 4.36 36.7 6.7 3.8 6.8 6.7 4.44 23.6 1.01 0.820 26.83 Notes: 1. Cash dividends per share represent the amounts applicable to the respective year, including dividends to be paid after the end of the year. 2. The Automotive Electronic Components Business has been classified separately from the Electronic Components Business effective from April 2003. Figures for 2003 and 2002 have been reclassified in accordance with the change. These same reclassifications could not be made to net sales amounts previously reported for 2001 because the necessary data is not readily available. 3. As of October 1, 2004, the ATM and other information equipment business that was included in the Social Systems Business was transferred to an affiliate accounted for using the equity method. 40 I I F N A N C A L S E C T O N I F I S C A L 2 0 0 5 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A LY S I S OMRON CORPORATION ANNUAL REPORT 2006 2. General Overview of Consolidated Results and Financial Conditions Given this macro environment, Group net sales increased 3.0 per- cent over the previous fiscal year. Operating income* and net income jumped 10.7 percent and 18.5 percent, the third consecu- tive term of record increases for both. Overall, sales and income in all categories rose for the fourth consecutive term. The higher earnings meant that return on equity (ROE) reached 10.7 percent, surpassing the target of 10 percent for the third consecutive term. Total assets increased by ¥3.6 billion in line with aggressive investment in future growth. On the other hand, the balance at the end of the term of interest-bearing debt was ¥3.8 billion (ver- sus ¥24.8 billion a year earlier). Also, higher net income con- tributed ¥57.1 billion to shareholders’ equity, resulting in a share- holders’ equity ratio of 61.6 percent (versus 52.2 percent a year earlier). * For the purpose of making comparisons with business results at other Japanese corporations, our Group operating income is calculated on the basis of adjustments to “selling, general & administrative expenses,” “research & development expenses” and “subsidy from the government related to the transfer of the substitutional portion of employee pension fund liabilities.” 1. The Macroeconomic Environment (1) Japan In fiscal 2005, the Japanese economy saw real GDP growth of 3.2 percent, the biggest growth in 15 years since 6.0 percent growth in 1990 (a bubble economy year) and the fourth consecu- tive year of growth. Also, the three “excesses” that have shack- led Japan’s recovery ever since the collapse of the bubble econo- my – facilities and equipment, employment and debt – have now been removed. In fact, for the first time in 14 years major corpo- rations and manufacturers experienced insufficient facilities and equipment and employment, a sign that the recovery is gaining steam. In the first half, IT and digital-related product inventory adjustments subsided and the economy apparently maneuvered past a temporary lull. Looking at the second half, big improve- ments in corporate earnings led to increased capital investment while better employment and income conditions meant con- sumer spending looked even more geared up for recovery. 2. Overseas In the United States, a sharp rise in crude oil prices, higher hous- ing prices and Hurricane Katrina constituted important negative factors, but also at work was a virtuous cycle of increased con- sumer spending, higher production and capital investment, improved employment and incomes, followed again by a con- sumer spending rise. The result was real GDP growth of 3.5 per- cent in fiscal 2005 (calendar year) versus 4.2 percent in fiscal 2004. In Europe, sluggish consumer spending in Germany, which had a highly negative effect, continued but solid exports to over- seas locations enabled EU25 real GDP growth of 1.6 percent (ver- sus 2.4 percent growth in fiscal 2004). In China, both consumer spending and capital investment slowed somewhat but strong export-led growth continued, bringing real GDP growth of 9.9 per- cent (versus 10.1 percent in fiscal 2004). As for the rest of Asia, the region generally witnessed economic expansion. Domestic Macroeconomic Environment (Source: Cabinet Office, Government of Japan) Real GDP Growth Rate Real Private Capital Investment Growth Rate Machinery Orders Growth Rate (Manufacturing) （%） 4.0 3.0 2.0 1.0 0 -1.0 -2.0 （%） 10.0 5.0 0 -5.0 -10.0 （%） 15.0 10.0 5.0 0 -5.0 -10.0 98 99 00 01 02 03 04 05 (FY) 98 99 00 01 02 03 04 05 (FY) 1Q 2Q 3Q FY04 4Q 1Q 4Q 2Q 3Q FY05 Note: Change from the previous year, seasonally adjusted Note: Change from the previous year, seasonally adjusted Note: Change from the previous quarter, seasonally adjusted 41 OMRON CORPORATION ANNUAL REPORT 2006 3. Review and Analysis of the Income Statement Note 1: The following business segment abbreviations are used in the dis- cussion that follows: Industrial Automation Business (IAB), Electronic Components Business (ECB), Automotive Electronic Components Business (AEC), Social Systems Business (SSB) and Healthcare Business (HCB). Note 2: Under U.S. accounting standards, the profit or loss (excluding subsidy from the government) recognized on the transfer of the substitutional portion of employee pension fund liabilities in fiscal year 2005 is includ- ed in the presentation of “cost of sales,” “selling, general & adminis- trative expenses” and “research & development expenses.” However, to enable an easy comparison with previous fiscal years, in the following analysis, it is assumed that this profit or loss together with the subsidy from the government is allocated in one lump sum to the transfer of the substitutional portion of employees’ pension fund. Sales Consolidated net sales, boosted by overseas sales results, increased 3.0 percent over the previous fiscal year to ¥626.8 bil- lion. Domestic sales, which were hurt by the transfer of the information equipment business (which includes ATMs) from the SSB segment to an equity affiliate, fell 3.1 percent to ¥354.9 billion. Overseas sales on an all-region basis rose 12.1 percent to ¥271.9 billion. By segment, the IAB, AEC and HCB recorded higher sales but the ECB and SSB and Other Businesses experi- enced declines. Cost of Sales and SG&A Expenses In line with the 3.0 percent year-over-year growth in sales, the cost of sales and SG&A expenses* increased by 4.1 percent and 5.9 percent, respectively. Despite attempts to lower manufactur- ing costs, a surge in raw material prices, changes in the product mix and other factors pushed the cost of sales margin higher by 0.6 points to 59.6 percent. Also, a greater cost burden brought on by quality improvements caused the SG&A expense ratio* to rise 0.6 points to 24.3 percent. R&D expenses rose to ¥50.5 billion (up ¥1.1 billion year over year) while the ratio of these expenses to net sales came to 8.1 percent. Our policy is to maintain an R&D expense ratio at the eight percent level in accordance with the Omron Group’s strate- gy of accelerating performance growth through further strength- ening the base of technology. * SG&A expenses include neither research & development expenses nor the transfer of employee pension fund liabilities. Return of substitutional portion of pension fund In regard to the return of substitutional portion of pension fund, the payment of an amount to be returned to the government (minimum actuarial liability) produced a payment portion pro- ceed of ¥11.9 billion (¥41.3 billion of the subsidy from the gov- ernment [profit], ¥8.9 billion from the derecognition of previous- ly accrued salary progression [profit] and ¥38.3 billion in settle- ment losses [loss]). Costs, Expenses and Income as Percentages of Net Sales (Based on the assumption that the all the profit from the transfer of the substitutional portion of employees’ pension fund was accounted for in a lump sum) Net sales Cost of sales Gross profit Selling, general and administrative expenses Research and development expenses Transfer of substitutional portion of employees’ pension fund Interest expense (income), net Net income before income taxes * Income taxes Net income FY2005 100.0% 59.6 40.4 24.3 8.1 (1.9) (0.1) 10.3 4.4 5.7 FY2004 100.0% 59.0 41.0 23.7 8.1 — (0.0) 8.6 3.6 5.0 FY2003 100.0% 59.0 41.0 24.3 7.9 — 0.1 8.2 3.5 4.6 * Net income before income taxes = The net of income and losses prior to income taxes, minority interests and the cumulative effect of accounting changes Net Sales & Net Income before Income Taxes (Billions of yen) 700 600 500 400 300 200 100 0 -100 (%) 30 20 10 0 SG&A Expenses Ratio & R&D Expenses Ratio Net Income (Loss) & ROE (Billions of yen) 40 30 20 10 0 -10 -20 (%) 20 15 10 5 0 -5 -10 01 02 03 04 05 (FY) 01 02 03 04 05 (FY) 01 02 03 04 05 (FY) Net sales Net income before income taxes SG&A expenses ratio R&D expenses ratio Net income (loss) [left axis] ROE [right axis] 42 OMRON CORPORATION ANNUAL REPORT 2006 Non-operating Income and Loss A net non-operating income of ¥2.2 billion was recorded, a sub- stantial improvement over the loss of ¥3.6 billion in the previous year. The income resulted primarily from booking ¥4.3 billion in sales of investment securities, which consisted of sales of stock- holdings mainly in financial institutions and returns on invest- ments in venture companies. Another important item was inter- est income (expenses), net, which went from ¥200 million in net income in the previous term to ¥600 million in fiscal 2005. Also, a foreign exchange loss of ¥1.3 billion was recorded (versus a loss of ¥800 million in the previous term). Net Income before Income Taxes, Net Income and Profit Distribution Due to the results noted above, net income before taxes* rose 22.5 percent over the previous year to ¥64.4 billion and net income rose 18.5 percent to ¥35.8 billion. Also, basic net income per share was ¥151.14 (¥126.52 in the previous year). Based on a profit distri- bution policy which includes a set consolidated net income divi- dend payout ratio of roughly 20 percent, an ordinary cash dividend of ¥18.0 per share was paid, which comes to ¥30.0 for the year when the interim cash dividend payment of ¥12.0 is included. Thus for the year the dividend payout ratio was 19.8 percent. * Net income before income taxes = The net of income and losses prior to income taxes, minority interests and the cumulative effect of accounting changes 4. Segment Information Note: Sales in the segment information column show sales to external cus- tomers, excluding intersegment transactions. Conversely, operating income shows operating income including internal profits, prior to the deduction of amounts such as intersegment transactions and head- quarters expenses that are not apportionable. The segment informa- tion is required under the Japanese Securities Exchange Law. The Composition of Net Sales by Business Segment IAB ECB AEC SSB HCB Other FY2005 FY2004 FY2003 43.5% 41.1% 39.3% 15.6 12.4 14.6 9.7 4.2 16.6 10.6 18.9 8.3 4.5 15.2 10.1 23.3 8.0 4.1 The Increase or Decrease in Sales by Business Segment IAB ECB AEC SSB HCB Other FY2005 FY2004 FY2003 8.9% 9.0% 13.4% (3.4) 20.2 (20.3) 20.8 (3.2) 13.6 9.7 (15.3) 7.7 9.4 12.1 (1.1) 16.6 10.9 (29.5) (1) By Business Segments • Industrial Automation Business (IAB) Sales in the IAB for the year increased 8.9 percent over the previ- ous year to ¥272.7 billion, helped by an economy on its way to recovery and visible corporate capital investment. Domestically, sales to the automobile industry, which continues to make large-scale capital investments, were higher and sales related to the semiconductor industry and digital consumer elec- tronics recovered. Also, rising concern in manufacturing facilities for product quality, safety and the environment led to higher sales in high-profile growth areas in the IAB segment, the safety business and the product quality solutions business. As a result, IAB domes- tic sales rose 4.6 percent year over year to ¥136.2 billion. In overseas markets, in North America sales to automobile-related industries increased and oil & gas-related sales also moved higher. In Europe, the new markets of Russia and Eastern Europe saw higher sales, driven mainly by inverters, servomotors and sensor equip- ment. In the Greater China and Southeast Asia, which continue to display high growth, sales were strong. In particular, sales increased substantially in China due to strengthening of Omron’s sales force, centered on full-time sales staff, and its network of sales agents. As a result, IAB overseas sales rose 13.6 percent to ¥136.5 billion. Operating income, however, weighed down by the cost of com- plying with the EU’s RoHS (Restriction of Hazardous Substances) directive, only managed to rise 1.2 percent over the previous year to ¥41.9 billion. • Electronic Components Business (ECB) Owing in part to intense competition in the market for cellular phone backlights, sales in the ECB fell 3.4 percent over the previ- ous year to ¥97.7 billion. In the domestic market, the first half demonstrated a generally weak sales performance, as inventory adjustments of industrial and consumer equipment had a dampening effect. As for the second half, an end to most inventory adjustments and higher demand for digital consumer electronic and mobile products (mainly flat-display televisions and portable music players) enabled FPC connectors and other products to turn toward recovery. Small-size backlights for cel- lular phones, however, ran into fierce competition from products sold by other companies. As a result, domestic sales in the ECB fell 13.1 percent over the previous year to ¥45.0 billion. Looking at overseas markets, in China the electronic compo- nents market continued to expand, led by digital consumer elec- tronic and mobile products, while relays, switches and other major products posted significant sales gains. In Europe, stronger sales and marketing in the IT and mobile growth markets provid- ed an upward push to sales. As a result, overseas sales in the ECB segment rose 6.7 percent to ¥52.7 billion. Operating income, however, fell 30.3 percent over the previous year to ¥11.2 billion in response to the lower sales and declines in profitability of major products. • Automotive Electronic Components Business (AEC) Sales in the AEC increased 20.2 percent over the previous year to ¥77.6 billion, due to a higher rate of electrical equipment installa- tion in vehicles and global growth in the number of vehicles pro- duced. In particular, new products were released, timed to coin- cide with new vehicle introductions, to customers all across the world to address needs related to safety and the environment, I I F N A N C A L S E C T O N I 43 OMRON CORPORATION ANNUAL REPORT 2006 two prominent themes in the auto industry. As a result, sales reg- istered gains in all regions of the world including Japan. Domestically, new products such as laser radars, electronic power steering controllers and door lock controllers were impor- tant, enabling sales to rise 4.8 percent to ¥27.2 billion. Overseas, the core overseas market for the AEC, North America, benefited from intensified production among client auto- mobile makers, leading to dramatic sales gains. In Europe, the fis- cal 2004 acquisition of a relay company provided the momentum for increased sales. As for Asia, expanded exports to North America by Korean auto makers produced a favorable sales per- formance. As a result, overseas sales in the AEC segment jumped 30.6 percent to ¥50.4 billion. Operating income, however, showed a loss of ¥2.0 billion (compared to a loss of ¥900 million in fiscal 2004). Contributing negative factors included higher research and development costs, cost increases brought on by quality upgrades at North American factories and lower prices for major products. • Social Systems Business (SSB) SSB sales fell 20.3 percent against a year earlier to ¥91.8 billion. The key factor was the transfer in fiscal 2004 of the financial equip- ment business to Hitachi-Omron Terminal Solutions, Corp., an equi- ty-method affiliate 55 percent held by Hitachi, Ltd. and 45 percent by Omron, which removed ¥27.0 billion from sales. In the train station management and approval systems business, demand decreased following demand in the previous term for modi- fying and upgrading ticketing machines in response to the issuance of new Japanese currency. On the other hand, there was new demand for machines which can read passenger-use IC cards as well as large-scale demand generated by the inauguration of new lines. In the Traffic and Road Management Systems business, the business environment turned more severe as a result of govern- ment administrative and budgetary pressures. In the Other area, the new security solutions and IC card mobile solutions businesses expanded. Also, in the Related Maintenance business, maintenance and repair sales generated by OA systems and other IT-related busi- nesses and by other company products jumped considerably higher. The end result was that in the SSB domestic sales fell 16.7 percent versus a year earlier to ¥90.5 billion while overseas sales dropped 79.7 percent to ¥1.3 billion. Operating income decreased 31.1 percent over the previous fiscal year to ¥4.4 billion on the back of the decrease in sales. • Healthcare Business (HCB) Sales in the HCB grew 20.8 percent over the previous fiscal year to ¥61.1 billion due to rising global consciousness about personal health issues and life-style related disease prevention. In the domestic market, given growing awareness of Metabolic Syndrome and rising concern about bodly fat, a stronger market- ing campaign focused mainly on TV advertising helped to boost sales of body composition monitors. Also, in June 2005 we strengthened our business directed at medical institutions by acquiring Colin Medical Technology Corporation (CMT), a major medical equipment maker of such products as bio-information monitoring devices. As a result, HCB domestic sales climbed 31.6 percent over the previous year to ¥30.3 billion. In overseas markets, a business expansion in Russia made pos- sible by the opening of a new marketing sales office in that country contributed greatly to higher sales in Europe. China saw growth in sales of digital blood pressure monitors while in Southeast Asia sales of nebulizers gained. As a result, the HCB had overseas sales of ¥30.8 billion, up 11.9 percent over the previous year. The acquisition of CMT added to the cost base, but this was offset by higher revenues and income. As a result, operating income increased 13.5 percent to ¥8.7 billion. • Business Development Group and Other Businesses Sales in this segment fell 3.2 percent over the previous year to ¥25.9 billion. In the entertainment business, photo sticker machines and other commercial game machines were weak but higher revenues were turned in by content delivery to cellular phones. In the PC peripherals business, broadband routers and backup power supplies recorded firm sales, aided by a recovery in corporate investment in IT. But in the wireless sensing business, revenues from personal automotive antitheft systems and soft- ware outsourcing declined. The RFID business, which is being positioned for important growth, enjoyed solid sales gains on the back of increased use of IC tags. As a result, domestic sales in this segment fell 3.0 percent to ¥25.6 billion and overseas sales dropped 13.0 percent to ¥300 million. Operating income decreased 56.1 percent over the previous year to ¥1.7 billion due in part to a greater R&D cost burden. (2) Review of Operations by Region In Japan, solid demand in the automobile industry helped the IAB and AEC, while increasing awareness of life-style related dis- eases benefited the HCB. All three segments recorded higher sales. On the other hand, the transfer of the financial equipment business from the SSB to an equity-method affiliate and the tougher competition faced by the ECB resulted in lower sales for both segments. As a result, sales in the Japanese market declined 3.1 percent from last year to ¥354.9 billion. In North America, similar to events in the Japanese market, sales in the IAB and AEC benefited from higher demand in the automobile industry. Also, the ECB and HCB used stronger sales and marketing operations to achieve better revenue performanc- es. As a result, sales in the North American market rose 21.5 per- cent against the previous year to ¥79.7 billion. Sales Breakdown, by Region 67.0% 12.3% 12.2% 8.5% 63.7% 12.7% 13.7% 9.9% 64.3% 11.0% 14.4% 10.2% 63.7% 10.8% 15.2% 10.3% 59.1% 12.7% 15.8% 12.4% (FY) 01 02 03 04 05 Japan North America Europe Asia and Other 44 I I F N A N C A L S E C T O N I OMRON CORPORATION ANNUAL REPORT 2006 In the European market, the IAB, HCB and AEC all recorded higher sales. The IAB and HCB continued to take advantage of emerging market opportunities in Russia and other areas, while the AEC was helped by last year’s acquisition of a relay company. Also, stronger marketing provided a boost to ECB sales. As a result, sales in the European market increased 7.3 percent over the previous year to ¥99.0 billion. In Greater China, because our major clients among auto-related and digital consumer electronic equipment makers are shifting their manufacturing operations to China, the IAB and ECB improved their supply systems in that country, which led directly to significantly higher sales. Also, the HCB achieved favorable sales growth. As a result, sales in Greater China rose 23.2 per- cent over the previous year to ¥41.7 billion. In Southeast Asia and other areas, digital consumer electronic inventory adjustments cycled through, allowing sales to recover in the IAB, ECB and AEC. The HCB witnessed higher sales mainly on the back of digital blood pressure monitors and nebulizers. As a result, sales in Southeast Asia jumped 22.2 percent over the previous year to ¥35.7 billion. 5. Explanation of Balance Sheets Assets and Liabilities Total assets at the end of this year rose ¥3.6 billion (0.6 percent) against a year earlier to ¥589.1 billion. The gain in assets was possible following a mix of repayment of interest bearing debt (which reduced debts by ¥20.9 billion ), an increase in accounts receivable (¥14.6 bil- lion added) and an increase in property, plant and equipment as part of active investment in growth opportunities (¥12.9 billion added). The total of year-end current liabilities, long-term liabilities and minority interests in subsidiaries fell ¥53.5 billion (19.1 percent) against a year earlier to ¥226.1 billion. A stable cash inflow eased repayment of corporate bonds and borrowings, leaving the total of interest-bearing debt at ¥3.8 billion (versus ¥24.6 billion at the previous year-end). In addition, the return of the substitute portion of the employee pension fund managed on behalf of the govern- ment reduced accrued retirement benefits by ¥44.9 billion (40.1 percent) to ¥67.0 billion. Furthermore, the year-end current ratio was 188 percent as against 182 percent a year earlier. Shareholders’ Equity Shareholders’ equity rose ¥571.1 billion (18.7 percent) year on year. The primary reasons for the increase were: the addition of ¥28.2 billion in other retained earnings made possible by higher net income; a reduction of ¥19.9 billion in minimum pension liabil- ity adjustments on account of the return of the substitute portion of the employee pension fund managed on behalf of the govern- ment (this means an increase in shareholders’ equity); and ¥8.8 billion in unrealized gains on available-for-sale securities and ¥9.2 billion in foreign currency translation adjustments. Treasury stock increased ¥9.6 billion as against the end of previous year to ¥32.8 billion. As a result, shareholders’ equity gained ¥57.1 billion and the ratio of shareholders’ equity to total assets increased to 61.6 percent from 52.2 percent at the end of the previous year. Also, the debt/equity ratio dropped steeply to 0.62 from 0.91 at the end of the previous year, a sign of the Group’s more improved finan- cial position. Net assets per share based on the number of shares outstanding at the end of the year were ¥1,548.07 compared to ¥1,284.81 at the end of the previous year. 6. Cash Flow Cash flow from operating activities was ¥51.7 billion, an inflow decrease of ¥9.4 billion over the previous year. While net income increased by ¥5.6 billion, accrued retirement benefits were lower (because of the return of the portion of the employee pension fund managed on behalf of the government) and tax payments were higher. Cash flow from investing activities saw an outflow increase of ¥7.0 billion over the previous year to ¥43.0 billion. The most important factor was future growth-oriented capital investment and M&A. Cash flow from financing activities saw an outflow of ¥38.3 bil- lion, down by ¥2.4 billion compared with the previous year. The main factor was that long-term loans which hit their repayment period declined by ¥19.2 billion against a year earlier, a result of repaid borrowings. Given the foregoing, cash and cash equivalents at the end of the year came to ¥52.3 billion, down ¥28.3 billion over the previ- ous year. Working Capital & Current Ratio Outstanding Interest-Bearing Debts & Debt/Equity Ratio Free Cash Flow (Billions of yen) 150 100 50 0 (%) 300 200 100 0 (Billions of yen) 80 60 40 20 0 (Times) 2.0 1.5 1.0 0.5 0 (Billions of yen) 50 40 30 20 10 0 -10 01 02 03 04 05 (FY) 01 02 03 04 05 (FY) 01 02 03 04 05 (FY) Working capital [left axis] Current ratio [right axis] Outstanding interest-bearing debts [left axis] Free cash flow Debt/equity ratio [right axis] 45 OMRON CORPORATION ANNUAL REPORT 2006 B U S I N E S S A N D O T H E R R I S K S The following risks may influence the Omron Group’s manage- ment results and financial condition (including share price), and Omron believes that these items may substantially affect investor decisions. Note that items referring to the future reflect the Omron Group’s forecasts and assumptions as of June 22, 2006, the date of publication of these materials. ratio due to factors such as production shifts. The Omron Group seeks to hedge against exchange rate risk in such ways as bal- ancing imports and exports denominated in foreign currencies. Exchange rate fluctuations, however, could have a negative impact on the Omron Group’s operating results and financial con- dition. (1) Economic Conditions The primary business of the Omron Group is consumer and com- merce electronic components used in the manufacture of control system equipment and other electrical and electronic equipment by the manufacturing sector and in capital investment related areas. Accordingly, demand for Omron Group products is affect- ed by economic conditions in these markets. Also, the Omron Group procures raw materials and semi-finished products in a wide variety of forms, and rapid increases in demand could result in supply shortages and/or sudden increases in prices that could halt production and/or cause sudden increases in costs. Both in Japan and overseas, therefore, market forces affecting suppliers to, and purchasers from, the Omron Group can result in the contraction of demand for our products, thereby possibly hav- ing a negative impact on the Group’s operating results and finan- cial condition. (2) Risks Accompanying Overseas Business Activities The Omron Group actively conducts business activities such as production and sales in overseas markets. The Group may be subject to operating difficulties in overseas countries related to possible social unrest due to factors including differences in cul- ture or religion, political turmoil and uncertainty in economic trends, differences in business customs in areas such as the structure of relationships with local businesses and collection of receivables, specific legal systems and investment regulations, changes in tax systems, labor shortages and problems in the labor-management relationship, epidemics, and terrorism, wars, and other political circumstances. These various risks associated with overseas operations may have a negative impact on the Omron Group’s operating results and financial condition. (3) Exchange Rate Fluctuation The Omron Group has 106 overseas affiliated companies and continues to reinforce its business operations in overseas mar- kets, such as China for which major market growth is anticipated in the future. The percentages of consolidated net sales account- ed for by overseas sales during the fiscal years ended March 31, 2005 and 2006 were 39.9 percent and 43.4 percent, respectively, and Omron expects further increases in the overseas operations (4) Product Defects The Omron Group is committed to the management philosophy of maximizing customer satisfaction, and implements the philoso- phy by providing the best quality products and services based on the Group’s motto of “quality first.” In particular, the Group has established strict quality control standards and built a quality con- trol system, and develops and manufactures its products accord- ingly. The Corporate General Affairs Division of the parent compa- ny conducts quality audits, and a Group-wide quality check sys- tem is in place for the ongoing improvement of the quality of the Group’s entire line of products and services. Nevertheless, there is no assurance that all of the Group’s products are without defects, and that recalls will not occur in the future. Large-scale recalls and/or product defects resulting in liability-related damages could impose huge costs, could severely influence evaluations of the Omron Group, and could result in reduced sales. Such events could exert a negative impact on the Group’s operating results and financial condition. In addition, to respond to an EU directive banning the use of lead, cadmium and certain other chemical substances in electric and electronic products in the European Union from July 2006, the Omron Group, in cooperation with its suppliers, is in the process of investigating the status of regulated chemical sub- stances in all of the components and materials the Group uses, and is accelerating efforts to switch to substitute components and materials that do not contain regulated chemical substances. Plans are proceeding smoothly to completely eliminate regulated substances from all the Group’s products throughout the world in order to make them “environmentally warranted products.” However, delays in the switchover beyond customer deadlines due to late response by some suppliers in providing substitute components and other factors could result in liability-related dam- ages or a violation of the EU directive, which could have a nega- tive impact on the Omron Group’s operating results and financial condition. (5) Research and Development Activities Based on a policy of securing a balance between growth and income, the Omron Group invests aggressively in R&D as part of its technology-centered business operations. As a result, the R&D expenses ratio is approximately 8 percent. 46 OMRON CORPORATION ANNUAL REPORT 2006 financial condition. Omron has always focused on managing its brands. Recently, however, it has discovered that several overseas businesses and organizations are using domain names similar to Omron’s. Omron has identified some of these and is responding with measures including issuing warning notices. However, it is difficult to identify and deal with all businesses and organizations using similar domain names, and there is a dan- ger that unethical business practices by such entities will damage the Group’s reputation. For its R&D and design, the Omron Group uses a dedicated system to conduct surveys of technologies in the public domain and those of other companies. However, because Group prod- ucts cover a diverse range of fields in which there are many patents and other intellectual property rights, and in which the number of new patents and intellectual property rights is con- stantly growing, the possibility exists that a third party could make a claim again the Group with respect to a specific product or part. The Omron Group is working to improve employee morale through measures such as revising its employee invention compensation policy in line with revisions to Japan’s Patent Law and introducing a new award system. However, disputes could arise with respect to the value of an invention with inventors who have retired from the Group. (8) Natural Disasters Because of the possibility of reduction of production capability, temporary disruption of distribution and sales routes, or other consequences of a natural disaster, fire or other calamity, includ- ing a large-scale earthquake in areas such as Tokai and Tounankai or directly below the Tokyo area, the Omron Group has identified the assumed risks and implemented the necessary safety measures and measures for continuation and early recov- ery of its businesses. However, the Omron Group’s operating bases are located in Japan and around the world, and it is impossible to avoid all risks due to a natural disaster, fire or other calamity. As a result, a natu- ral disaster, fire or other calamity could exert a negative impact on the Omron Group’s operating results and financial condition. The Omron Group strives to increase the new product contri- bution ratio by reflecting such considerations as market needs in its R&D themes and goals. However, factors such as delays in R&D or insufficient technological capabilities that result in a decrease in the R&D new product contribution ratio could have a negative impact on the Omron Group’s operating results and financial condition. (6) Information Leakage The Omron Group acquires information (including information on individuals) regarding the privacy and credit information of cus- tomers and other entities and other types of classified informa- tion through its business processes and important information in the course of business. The Omron Group is strengthening secu- rity to prevent external entry into its internal information systems and misappropriation by third parties, and a special committee has been established centering on the Corporate General Affairs Division. Steps are being taken to reinforce control over the infor- mation the Group handles, and to further improve employees’ information literacy. Unanticipated leakage of internal information, however, due for example to invasion of internal information systems using tech- nology exceeding implemented security levels, could exert a neg- ative impact on the Omron Group’s operating results and financial condition. (7) Risks Associated with Patent Rights and Other Intellectual Property Rights The Omron Group has accumulated technology and expertise allowing it to differentiate its products from those of its competi- tors. However, it is impossible to completely protect all of the Group’s intellectual property consisting of proprietary technology and expertise, due to legal restrictions in specific regions, includ- ing China, and conditions that allow only limited protection. At present, the Omron Group is working on intellectual property pro- tection against imitation products, through such measures as the placement of full-time personnel (including local staff) in Shanghai. However, it is possible that the Group will not be able to completely prevent third parties from using its intellectual prop- erty in the manufacture of imitation products. In China, skills in the methods needed to manufacture and sell imitations of the Omron Group’s products improve each year, and organizations that manufacture and market counterfeit prod- ucts have become extremely troublesome. The circulation of low-quality counterfeits that fraudulently use the Omron Group brand in Asia, including China, could damage trust in the Omron Group’s products and the Group’s brand image, and could exert a negative impact on the Omron Group’s operating results and I I F N A N C A L S E C T O N I 47 OMRON CORPORATION ANNUAL REPORT 2006 C O N S O L I D AT E D B A L A N C E S H E E T S OMRON Corporation and Subsidiaries March 31, 2006 and 2005 ASSETS Current Assets: Cash and cash equivalents Notes and accounts receivable - trade Allowance for doubtful receivables Inventories (Note 3) Deferred income taxes (Note 12) Other current assets Millions of yen Thousands of U.S. dollars (Note 2) 2006 2005 2006 ¥ 52,285 ¥ 80,619 $ 446,880 139,001 124,409 1,188,043 (2,653) 74,958 18,571 10,151 (2,757) 68,585 17,240 7,844 (22,675) 640,667 158,726 86,761 Total Current Assets 292,313 295,940 2,498,402 Property, Plant and Equipment: Land Buildings Machinery and equipment Construction in progress Total 46,571 117,414 159,254 8,180 43,794 110,367 143,111 5,946 398,043 1,003,538 1,361,145 69,915 331,419 303,218 2,832,641 Accumulated depreciation (163,802) (148,529) (1,400,017) Net Property, Plant and Equipment 167,617 154,689 1,432,624 Investments and Other Assets: Investments in and advances to affiliates Investment securities (Note 4) Leasehold deposits Deferred income taxes (Note 12) Other (Note 6) 16,135 62,477 8,553 15,892 26,074 17,343 49,764 8,595 41,499 17,599 137,906 533,991 73,103 135,829 222,855 Total Investments and Other Assets 129,131 134,800 1,103,684 Total See notes to consolidated financial statements. ¥ 589,061 ¥ 585,429 $ 5,034,710 48 OMRON CORPORATION ANNUAL REPORT 2006 LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities: Bank loans (Note 7) Notes and accounts payable - trade Accrued expenses Income taxes payable Other current liabilities (Note 12) Current portion of long-term debt (Note 7) Millions of yen Thousands of U.S. dollars (Note 2) 2006 2005 2006 ¥ 2,468 ¥ 12,424 $ 21,094 85,224 28,683 12,288 26,701 296 75,866 26,701 12,724 24,770 10,503 728,410 245,154 105,026 228,214 2,530 Total Current Liabilities 155,660 162,988 1,330,428 Long-Term Debt (Note 7) 1,049 1,832 8,966 Deferred Income Taxes (Note 12) 673 1,199 5,752 Termination and Retirement Benefits (Note 9) 67,046 111,988 573,043 Other Long-Term Liabilities 571 63 4,880 Minority Interests in Subsidiaries 1,125 1,549 9,615 Shareholders’ Equity (Note 10): Common stock, no par value: Authorized: 487,000,000 shares Issued: 249,121,372 shares Capital surplus Legal reserve Retained earnings Accumulated other comprehensive loss (Note 16) Treasury stock, at cost - 14,676,607 shares in 2006 and 64,100 64,100 547,863 98,724 8,082 227,791 (2,971) 98,726 7,649 199,551 (41,009) 843,795 69,077 1,946,931 (25,393) 11,101,591 shares in 2005 (32,789) (23,207) (280,247) Total Shareholders’ Equity 362,937 305,810 3,102,026 Total See notes to consolidated financial statements. ¥ 589,061 ¥ 585,429 $ 5,034,710 I I F N A N C A L S E C T O N I 49 OMRON CORPORATION ANNUAL REPORT 2006 C O N S O L I D AT E D S T AT E M E N T S O F I N C O M E OMRON Corporation and Subsidiaries Years ended March 31, 2006, 2005 and 2004 Net Sales Costs and Expenses: Cost of sales Selling, general and administrative expenses Research and development expenses Subsidy from the government (Note 9) Interest expense (income), net (Note 7) Foreign exchange loss, net Other expenses (income), net (Note 11) Millions of yen Thousands of U.S. dollars (Note 2) 2006 2005 2004 2006 ¥ 626,782 ¥ 608,588 ¥ 584,889 $ 5,357,111 389,368 358,817 344,835 3,327,932 161,310 55,315 (41,339) (609) 1,306 (2,921) 144,219 49,441 — (216) 75 3,704 142,157 46,494 — 317 1,254 1,848 1,378,718 472,778 (353,325) (5,205) 11,162 (24,966) Total 562,430 556,040 536,905 4,807,094 Income before Income Taxes, Minority Interests and Cumulative Effect of Accounting Change Income Taxes (Note 12) Income before Minority Interests and Cumulative Effect of Accounting Change Minority Interests Income before Cumulative Effect of Accounting Change Cumulative Effect of 64,352 27,238 52,548 22,108 47,984 20,762 550,017 232,803 37,114 150 30,440 264 27,222 411 317,214 1,282 36,964 30,176 26,811 315,932 Accounting Change, net of tax (Note 9) (1,201) — — (10,265) Net Income ¥ 35,763 ¥ 30,176 ¥ 26,811 $ 305,667 2006 Yen 2005 U.S. dollars (Note 2) 2004 2006 ¥ 156.2 ¥ 126.5 ¥ 110.7 $ 156.1 124.8 107.5 151.1 151.1 126.5 124.8 110.7 107.5 1.34 1.33 1.29 1.29 Per Share Data (Note 14): Income before Cumulative Effect of Accounting Change Basic Diluted Net Income Basic Diluted See notes to consolidated financial statements. 50 OMRON CORPORATION ANNUAL REPORT 2006 C O N S O L I D AT E D S T AT E M E N T S O F C O M P R E H E N S I V E I N C O M E ( L O S S ) OMRON Corporation and Subsidiaries Years ended March 31, 2006, 2005 and 2004 Net Income ¥ 35,763 ¥ 30,176 ¥ 26,811 $ 305,667 Millions of yen Thousands of U.S. dollars (Note 2) 2006 2005 2004 2006 Other Comprehensive Income (Loss), net of tax (Note 16): Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year Reclassification adjustment for the portion realized in net income Net change in foreign currency translation adjustments during the year 9,201 5,071 (6,680) 78,641 — — 462 — 9,201 5,071 (6,218) 78,641 Minimum pension liability adjustments 19,940 4,115 3,470 170,427 Unrealized gains on available-for-sale securities: Unrealized holding gains arising during the year Reclassification adjustment for losses on impairment realized in net income Reclassification adjustment for net gains on sales realized in net income 10,905 1,274 11,916 93,205 287 13 500 2,453 (2,430) (465) (613) (20,769) Net unrealized gains 8,762 822 11,803 74,889 Net gains (losses) on derivative instruments: Net gains (losses) on derivative instruments designated as cash flow hedges during the year (1,282) (1,004) 639 (10,957) Reclassification adjustment for net losses (gains) realized in net income Net gains (losses) 1,417 135 546 (458) (344) 12,111 295 1,154 Other Comprehensive Income 38,038 9,550 9,350 325,111 Comprehensive Income See notes to consolidated financial statements. ¥ 73,801 ¥ 39,726 ¥ 36,161 $ 630,778 I I F N A N C A L S E C T O N I 51 OMRON CORPORATION ANNUAL REPORT 2006 C O N S O L I D AT E D S T AT E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y OMRON Corporation and Subsidiaries Years ended March 31, 2006, 2005 and 2004 Conversion of convertible bonds 12,136 18 Millions of yen Number of common shares issued Common stock Capital surplus Legal reserve Retained earnings Accumulated other comprehensive income (loss) Treasury stock 249,109,236 ¥ 64,082 ¥ 98,705 ¥ 7,619 ¥ 153,134 ¥ (59,909) ¥ (12,021) (169) 26,811 (4,808) 169 (10) 9,350 (8,411) 168 249,109,236 64,082 98,705 7,450 175,296 (50,559) (20,264) 30,176 (5,713) (199) 199 9,550 3 19 (1) (9) (3,065) 16 1 105 249,121,372 64,100 98,726 7,649 199,551 (41,009) (23,207) 35,763 (7,078) (433) 433 1 (3) (12) 38,038 (10,075) 2 491 249,121,372 ¥ 64,100 ¥ 98,724 ¥ 8,082 ¥ 227,791 ¥ (2,971) ¥ (32,789) Thousands of U.S. dollars (Note 2) Common stock Capital surplus Legal reserve Retained earnings Accumulated other comprehensive income (loss) Treasury stock $ 547,863 $ 843,812 $ 65,376 $ 1,705,564 $ (350,504) $ (198,350) 305,667 (60,496) (3,701) 3,701 9 (26) (103) 325,111 (86,111) 17 4,197 $ 547,863 $ 843,795 $ 69,077 $ 1,946,931 $ (25,393) $ (280,247) Balance, April 1, 2003 Net income Cash dividends, ¥20 per share Reversal of legal reserve Other comprehensive income Acquisition of treasury stock Exercise of stock options Balance, March 31, 2004 Net income Cash dividends, ¥24 per share Transfer to legal reserve Other comprehensive income Acquisition of treasury stock Sale of treasury stock Exercise of stock options Balance, March 31, 2005 Net income Cash dividends, ¥30 per share Transfer to legal reserve Other comprehensive income Acquisition of treasury stock Sale of treasury stock Exercise of stock options Balance, March 31, 2006 Balance, March 31, 2005 Net income Cash dividends, $0.26 per share Transfer to legal reserve Other comprehensive income Acquisition of treasury stock Sale of treasury stock Exercise of stock options Balance, March 31, 2006 See notes to consolidated financial statements. 52 OMRON CORPORATION ANNUAL REPORT 2006 C O N S O L I D AT E D S T AT E M E N T S O F C A S H F L O W S OMRON Corporation and Subsidiaries Years ended March 31, 2006, 2005 and 2004 Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Net loss on sales and disposals of property, plant and equipment Loss on impairment of property, plant and equipment Net gain on sales of short-term investments and investment securities Loss on impairment of investment securities and other assets Bad debt expenses Subsidy from the government Termination and retirement benefits Deferred income taxes Minority interests Equity in loss (earnings) of affiliates Cumulative effect of accounting change Net loss (gain) on sales of business entities Changes in assets and liabilities: Notes and accounts receivable - trade, net Inventories Other assets Notes and accounts payable - trade Income taxes payable Accrued expenses and other current liabilities Other, net Total adjustments Net cash provided by operating activities Investing Activities: Proceeds from sales or maturities of short-term investments and investment securities Purchase of short-term investments and investment securities Capital expenditures Decrease in leasehold deposits Proceeds from sales of property, plant and equipment Acquisition of minority interests Decrease (increase) in investment in and loans to affiliates Proceeds from sale of business entities, net Payment for acquisition of business entities, net Net cash used in investing activities Financing Activities: Net repayments of short-term bank loans Proceeds from issuance of long-term debt Repayments of long-term debt Dividends paid by the Company Dividends paid to minority interests Acquisition of treasury stock Sale of treasury stock Exercise of stock options Net cash used in financing 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 the Year Cash and Cash Equivalents at End of the Year See notes to consolidated financial statements. Millions of yen Thousands of U.S. dollars (Note 2) 2006 2005 2004 2006 ¥ 35,763 ¥ 30,176 ¥ 26,811 $ 305,667 30,825 28,642 27,662 263,462 42 — (4,302) 757 — (41,339) 29,254 3,962 150 493 1,201 (194) (9,629) (2,098) (560) 7,079 (685) 1,411 (431) 15,936 51,699 918 614 (987) 366 140 — 1,956 1,715 264 1,483 — — (2,762) (1,964) 934 (4,908) 2,423 2,114 (48) 30,900 61,076 479 41 359 — (1,039) (36,769) 2,413 0 — 5,016 7,235 411 (92) — 494 (10,853) 4,105 891 10,976 6,015 (52) 174 53,876 80,687 6,470 — (353,325) 250,034 33,863 1,282 4,214 10,265 (1,658) (82,299) (17,932) (4,786) 60,504 (5,855) 12,060 (3,684) 136,205 441,872 6,830 1,867 1,894 58,376 (1,294) (40,560) 161 1,981 (200) 251 (544) (9,645) (43,020) (11,813) 318 (11,012) (6,190) (28) (10,075) 3 477 (38,320) (267) (38,579) 221 4,343 (515) (1,233) (1,111) (776) (36,050) (3,860) 1,924 (30,238) (5,611) (59) (2,954) 19 95 (40,684) (1,617) (38,115) 312 4,808 (1,738) — (365) 337 (34,484) (4,842) 1,011 (13,093) (2,792) (150) (8,411) — 158 (28,119) (11,060) (346,667) 1,376 16,932 (1,709) 2,145 (4,650) (82,436) (367,693) (100,966) 2,718 (94,120) (52,906) (239) (86,111) 26 4,077 (327,521) 1,307 1,218 (2,944) 11,171 (28,334) (14,440) 15,140 (242,171) 80,619 95,059 79,919 689,051 ¥ 52,285 ¥ 80,619 ¥ 95,059 $ 446,880 I I F N A N C A L S E C T O N I 53 OMRON CORPORATION ANNUAL REPORT 2006 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S T AT E M E N T S OMRON Corporation and Subsidiaries 1. Summary of Significant Accounting Policies Nature of Operations OMRON Corporation (the “Company”) is a multinational manu- facturer of automation components, equipment and systems with advanced computer, communications and control technolo- gies. The Company conducts business in over 30 countries around the world and strategically manages its worldwide oper- ations through 5 regional management centers in Japan, North America, Europe, Asia-Pacific and China. Products, classified by type and market, are organized into five business segments and one business development group, as described below. Industrial Automation Business manufactures and sells control components and systems including programmable logic controllers, sensors and switches used in automatic systems in industry. In the global market, the Company offers many servic- es, such as those involving labor-saving automation, environ- mental protection, safety improvement, and inspection- automization solutions for highly developed production systems. Electronic Components Business manufactures and sells electric and electronic components found in such consumer goods as home appliances as well as such business equipment as telephone systems, vending machines and office equipment. Automotive Electronic Components Business develops and produces automotive electronic components and other components for automobiles and automotive electronic compo- nents manufacturers throughout the world. Sosial Systems Business encompasses the sale of card authorization terminals mainly for the domestic markets. Passing gates, automated ticket machines, electronic panels and terminal displays for traffic information and monitoring pur- poses are also supplied for the domestic market. Healthcare Business sells blood pressure monitors, digital thermometers, body-fat monitors, nebulizers and infra-red therapy devices aimed at both the consumer and institutional markets. Business Development Group consists of businesses with high growth potential. The group provides the peripheral equip- ment used in office automation equipment, modems, terminal adapters, scanners and uninterrupted power supplies. Basis of Financial Statements The accompanying consolidated financial statements, stated in Japanese yen, include certain adjustments, not recorded on the books of account, to present these statements in accordance with accounting principles generally accepted in the United States of America, except for the omission of segment informa- tion required by Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Certain reclassifications have been made to amounts previously reported in order to con- form to 2006 classifications. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries (together the “Companies”). All significant intercompany accounts and transactions have been eliminated. Investments in which the Companies have a 20% to 50% interest (affiliates) are accounted for using the equity method. Use of Estimates The preparation of consolidated financial statements in conform- ity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and lia- bilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents Cash equivalents consist of highly liquid investments with origi- nal maturities of three months or less, including time deposits, commercial paper, securities purchased with resale agreements and money market instruments. Allowance for Doubtful Receivables An allowance for doubtful receivables is established in amounts considered to be appropriate based primarily upon the Companies’ past credit loss experience and an evaluation of potential losses in the receivables outstanding. Marketable Securities and Investments The Companies classify all of their marketable debt and equity securities as available-for-sale. Available-for-sale securities are carried at market value with the corresponding recognition of net unrealized holding gains and losses as a separate compo- nent of accumulated other comprehensive income, net of relat- ed taxes, until recognized. If necessary, individual securities classified as available-for-sale are reduced to fair value by a charge to income in the period in which the decline is deemed to be other than temporary. The Companies principally consider that an other-than-temporary impairment has occurred when the decline in fair value below the carrying value continues for over nine consecutive months. The Companies may also consider other factors, including their ability and intent to hold the appli- cable investment securities until maturity, and the severity of the decline in fair value. Other investments are stated at the lower of cost or estimat- ed net realizable value. The cost of securities sold is determined on the average cost basis. Inventories Inventories are stated at the lower of cost, determined by the first-in, first-out method, or market. 54 OMRON CORPORATION ANNUAL REPORT 2006 Property, Plant and Equipment Property, plant and equipment is stated at cost. Depreciation of property, plant and equipment has been computed principally on a declining balance method based upon the estimated useful lives of the assets. The estimated useful lives primarily range from 3 to 50 years for buildings and from 2 to 15 years for machinery and equipment. Goodwill and Other Intangible Assets The Company accounts for its goodwill and other intangible assets in accordance with SFAS No.142, "Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized, but instead tested for impairment at least annually. SFAS No.142 also requires recognized intangible assets be amortized over their respective estimated useful lives and reviewed for impairment. Any recognized intangible asset determined to have an indefinite useful life is not to be amortized, but instead tested for impair- ment until its life is determined to no longer be indefinite. Long-Lived Assets Long-lived assets 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 an asset to undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impair- ment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value. Assets to be disposed of other than by sale are considered held and used until disposed of. Assets to be disposed of by sale are reported at the lower of the carrying amount or fair value less costs to sell. Advertising Costs Advertising costs are charged to earnings as incurred. Advertising expense was ¥10,290 million ($ 87,949 thousand), ¥8,718 million and ¥8,391 million for the years ended March 31, 2006, 2005 and 2004, respectively. Shipping and Handling Charges Shipping and handling charges were ¥7,627 million ($ 65,188 thousand), ¥7,720 million and ¥8,061 million for the years ended March 31, 2006, 2005 and 2004, respectively, and are included in selling, general and administrative expenses in the consolidat- ed statements of income. Termination and Retirement Benefits Termination and retirement benefits are accounted for in accor- dance with SFAS No. 87, "Employers’ Accounting for Pensions” and are disclosed in accordance with SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The provision for termination and retirement benefits includes amounts for directors and corporate auditors of the Company. The Company and certain of its domestic subsidiaries previously used December 31 as the measurement date for projected benefit obligation and plan assets of the termination and retirement bene- fits. During the year ended March 31, 2006, the companies have changed the measurement date to March 31. The purpose of this change is to enable more timely reflection of factors, such as the effect of plan amendments and fluctuation of number of employ- ees in accounting for the termination and retirement benefits, in the projected benefit obligation and retirement benefit expense. A cumulative effect (net of tax) of this change was recognized in the consolidated statement of income for the year ended March 31, 2006, which reduced net income for the period by ¥1,201 million ($ 10,265 thousand). Income Taxes Deferred income taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabili- ties and their financial reporting amounts. Future tax benefits, such as net operating loss carryforwards and tax credit carryfor- wards, are recognized to the extent that such benefits are more likely than not to be realized. 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. Product Warranties A liability for the estimated warranty related cost is established at the time revenue is recognized and is included in other current lia- bilities. The liability is established using historical information includ- ing the nature, frequency, and average cost of warranty claims. Derivatives Derivative instruments and hedging activities are accounted for in accordance with SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities,” SFAS No.138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No.133,” and SFAS No.149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." These standards establish accounting and reporting standards for derivative instruments and for hedging activities, and require that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. For foreign exchange forward contracts and foreign currency options, on the date the derivative contract is entered into, the Companies designate the derivative as a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge or “for- eign currency” hedge). The Companies formally document all rela- tionships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all deriva- tives that are designated as cash flow or foreign currency hedges to specific assets and liabilities on the consolidated balance sheet or to specific firm commitments or forecasted transactions. Based on the Companies’ policy, all foreign exchange forward contracts I I F N A N C A L S E C T O N I 55 OMRON CORPORATION ANNUAL REPORT 2006 and foreign currency options entered into must be highly effective in offsetting changes in cash flows of hedged items. Changes in fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow or foreign currency hedge are recorded in other comprehensive income (loss), until earnings are affected by the variability in cash flows of the designated hedged item. Cash Dividends Cash dividends are reflected in the consolidated financial state- ments at proposed amounts in the year to which they are appli- cable, even though payment is not approved by shareholders until the annual general meeting of shareholders held early in the following fiscal year. Resulting dividends payable are includ- ed in Other current liabilities in the consolidated balance sheets. Revenue Recognition The Companies recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred and title and risk of Net Income as reported Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards Pro forma net income Net income per share (yen and U.S. dollars) Basic-as reported Basic-pro forma Diluted-as reported Diluted-pro forma loss has transferred, the sales price is fixed or determinable, and collectibility is probable. These criteria are met when products are received by customers or services are performed. Stock-Based Compensation The Companies account for stock-based awards to employees using the intrinsic value method in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees,” including related interpretations, and follow the disclosure only provision of SFAS No. 123, “Accounting for Stock Based Compensation.” At March 31, 2006, the Company had a stock-based employee compensation plan, which is described more fully in Note 10. No stock-based employee compensation cost is reflected in the results of operations, as all options granted under those plans had an exercise price exceeding the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and net income per share if the Company had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation. Millions of yen (except per share data) 2006 2005 2004 Thousands of U.S. dollars (except per share data) 2006 ¥ 35,763 ¥ 30,176 ¥ 26,811 $ 305,667 73 101 106 624 ¥ 35,690 ¥ 30,075 ¥ 26,705 $ 305,043 ¥ 151.1 ¥ 126.5 ¥ 110.7 $ 150.8 151.1 150.7 126.1 124.8 124.3 110.2 107.5 107.1 1.29 1.29 1.29 1.29 New Accounting Standards In May 2005, the FASB issued SFAS No.154 “Accounting Changes and Error Corrections, a replacement of APB Opinion No.20 and FASB Statement No.3.” SFAS No.154 replaces APB Opinion No.20, “Accounting Changes” and SFAS No.3 “Reporting Accounting Changes in Interim Financial Statements.” SFAS No.154 provides guidance on the accounting for and reporting of accounting changes and error corrections. SFAS No.154 establishes, unless impractica- ble, retrospective application as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS No.154 will be effective for accounting changes and cor- rections of errors made in fiscal year beginning after December 15, 2005. The Companies do not expect SFAS No.154 to have material effect on the consolidated financial statements. In November 2005, the FASB issued FSP FAS 115-1 and FAS 124- 1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”). FSP 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other- than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-tempo- rary impairments. FSP 115-1 will be applied to reporting periods begin- ning after December 15, 2005. The Companies do not expect FSP 115-1 to have material effect on the consolidated financial statements. 56 OMRON CORPORATION ANNUAL REPORT 2006 2. Translation into United States Dollars The consolidated financial statements are stated in Japanese yen, the currency of the country in which the Company is incorporated and operates. The translation of Japanese yen amounts into U.S. dollar amounts is included solely for convenience of the readers outside of Japan and has been made at the rate of ¥117 to $1, the approximate rate of exchange at March 31, 2006. Such trans- lation should not be construed as representations that the Japanese yen amounts could be converted into U.S. dollars at the above or any other rate. 3. Inventories Inventories at March 31 consisted of: Finished products Work-in-process Materials and supplies Total 4. Marketable Securities and Investments Millions of yen Thousands of U.S. dollars 2006 2005 2006 ¥ 40,613 ¥ 38,893 $ 347,120 14,286 20,059 10,882 18,810 122,103 171,444 ¥ 74,958 ¥ 68,585 $ 640,667 Available-for-sale securities are recorded at fair value, with unrealized gains and losses excluded from income and reported in other com- prehensive income (loss), net of tax. Cost, gross unrealized holding gains and losses and fair value of securities, excluding equity securi- ties with no readily determinable public market value, by major security type at March 31 were as follows: Available-for-sale securities Millions of yen 2006 2005 Cost (*) Gross unrealized gains Gross unrealized losses Fair value Cost (*) Gross unrealized gains Gross unrealized losses Fair value Debt securities Equity securities ¥ 1,067 ¥ 413 22,302 33,770 Total available-for-sale-securities ¥ 23,369 ¥ 34,183 ¥ — — ¥ — ¥ 1,480 ¥ 1,064 ¥ 237 ¥ — ¥ 1,301 56,072 24,600 19,584 (381) 43,803 ¥ 57,552 ¥ 25,664 ¥ 19,821 ¥ (381) ¥ 45,104 Thousands of U.S. dollars 2006 Cost (*) Gross unrealized gains Gross unrealized losses Fair value Debt securities Equity securities $ 9,120 $ 3,530 190,615 288,632 Total available-for-sale-securities $ 199,735 $ 292,162 $ — — $ — $ 12,650 479,247 $ 491,897 (*) Cost represents amortized cost for debt securities and acquisition cost for equity securities. I I F N A N C A L S E C T O N I 57 OMRON CORPORATION ANNUAL REPORT 2006 Maturities of debt securities as available-for-sale at March 31 were as follows: Millions of yen Thousands of U.S. dollars 2006 2005 2006 Cost Fair value Cost Fair value Cost Fair value Due after one year through five years ¥ 1,067 ¥ 1,480 ¥ 1,064 ¥ 1,301 $ 9,120 $ 12,650 Gross unrealized holding losses and fair value of certain available-for-sale, equity securities, aggregated by length of time that such securi- ties have been in a continuous unrealized loss position at March 31 were as follows: Millions of yen Thousands of U.S. dollars Less than 12 months 2006 2005 2006 Fair value ¥ — Gross unrealized holding losses ¥ — Fair value ¥ 3,671 Gross unrealized holding losses ¥ (381) Fair value $ — Gross unrealized holding losses $ — Equity securities There were no securities in unrealized loss position at March 31, 2006. and ¥847 million for the years ended March 31, 2006, 2005 and 2004, respectively. Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥4,925 million ($ 42,094 thou- sand) and ¥4,660 million at March 31, 2006 and 2005, respective- ly. Investments with an aggregate cost of ¥4,812 million ($ 41,128 thousand) were not evaluated for impairment because (a) the Companies did not estimate the fair value of those invest- ments as it was not practicable to estimate the fair value of the investment and (b) the Companies did not identify any events or changes in circumstances that might have had significant adverse effect on the fair value of those investments. Net unrealized holding gains (losses) on available-for-sale secu- rities, net of related taxes, increased by ¥8,762 million ($ 74,889 thousand) and by ¥822 million for the years ended March 31, 2006 and 2005, respectively. Proceeds from sales of available-for-sale securities were ¥6,511 million ($ 55,650 thousand), ¥1,638 million and ¥1,833 million for the years ended March 31, 2006, 2005 and 2004, respectively. Gross realized gains on sales were ¥4,119 million ($ 35,205 thousand), ¥788 million and ¥1,120 million for the years ended March 31, 2006, 2005 and 2004, respectively. Losses on impairment of available-for-sale securities recog- nized to reflect the decline in market value considered to be other than temporary were ¥487 million ($ 4,162 thousand), ¥22 million Gross realized losses on sales were ¥82 million for the year ended March 31, 2004. There were no gross realized losses on sales for the years ended March 31, 2006 and 2005. 5. Acquisition In June 2005, OMRON Healthcare Co., Ltd., a subsidiary of the Company, acquired 100% of the issued common stock of Colin Medical Technology Corporation (“CMT”) for cash in an aggre- gate amount of ¥8,943 million ($ 76,436 thousand). This acquisition was to expand healthcare business, to obtain synergies with CMT and to create preventive medicine market through the acquisition of CMT’s medical devices business for healthcare professionals. The consolidated financial statements for the year ended March 31, 2006 include the operating results of CMT from the date of acquisition. The estimated fair values of the assets acquired and liabilities assumed at the date of acquisi- tion were as follows: Current assets Property, plant and equipment Investments and other assets (*) Current liabilities Long term liabilities Net assets acquired (*) Investments and other assets include acquired goodwill of ¥6,554 million ($ 56,017 thousand). 58 Millions of yen Thousands of U.S. dollars ¥ 4,339 $ 37,085 996 6,747 (2,958) (181) 8,513 57,667 (25,282) (1,547) ¥ 8,943 $ 76,436 OMRON CORPORATION ANNUAL REPORT 2006 6. Goodwill and Other Intangible Assets The components of acquired intangible assets excluding goodwill at March 31, 2006 and 2005 were as follows: Intangible assets subject to amortization: Software Other Total Intangible assets subject to amortization: Software Other Total Millions of yen 2006 2005 Gross amount Accumulated amortization Gross amount Accumulated amortization ¥ 31,031 3,583 ¥ 34,614 ¥ 19,414 2,408 ¥ 21,822 ¥ 27,535 4,113 ¥ 31,648 ¥ 16,150 3,277 ¥ 19,427 Thousands of U.S. dollars 2006 Gross amount Accumulated amortization $ 265,222 $ 165,932 30,624 20,581 $ 295,846 $ 186,513 Intangible assets not subject to amortization at March 31, 2006 and 2005 were immaterial. Aggregate amortization expense related to intangible assets was ¥5,235 million ($ 44,744 thousand), ¥4,827 million and ¥4,625 million for the years ended March 31, 2006, 2005 and 2004, respectively. Estimated amortization expense for the next five years ending March 31 is as follows: Years ending March 31 2007 2008 2009 2010 2011 Millions of yen Thousands of U.S. dollars ¥ 4,301 $ 36,761 3,704 2,650 1,425 507 31,658 22,650 12,179 4,333 The carrying amount of goodwill at March 31, 2006 and changes in its carrying amount for the year ended March 31, 2006 were as fol- lows: Balance at April 1, 2005 Acquisition Foreign currency translation adjustments Balance at March 31, 2006 The changes in the carrying amount of goodwill for the year ended March 31, 2005 were immaterial. Millions of yen Thousands of U.S. dollars 2006 ¥ 1,314 7,633 38 $ 11,231 65,239 325 ¥ 8,985 $ 76,795 I I F N A N C A L S E C T O N I 59 OMRON CORPORATION ANNUAL REPORT 2006 7. Bank Loans and Long-Term Debt The weighted average annual interest rates of short-term bank loans at March 31, 2006 and 2005 were 3.7% and 1.0%, respectively. Long-term debt at March 31 consisted of the following: Unsecured debt: Loans from banks and other financial institutions, generally at 0.4% to 3.8% due on various dates through 2006 Other Total Less portion due within one year Long-term debt, less current portion The annual maturities of long-term debt outstanding at March 31, 2006 were as follows: Years ending March 31 2007 2008 2009 2010 2011 Thereafter Total Millions of yen Thousands of U.S. dollars 2006 2005 2006 ¥ — 1,345 1,345 296 ¥ 1,049 ¥ 10,779 1,556 12,335 10,503 ¥ 1,832 $ — 11,496 11,496 2,530 $ 8,966 Millions of yen Thousands of U.S. dollars ¥ 296 53 50 51 53 842 ¥ 1,345 $ 2,530 453 427 436 453 7,197 $ 11,496 As is customary in Japan, additional security must be given if requested by a lending bank, and banks have the right to offset cash deposited with them against any debt or obligation that becomes due and, in case of default and certain other specified events, against all debt payable to the banks. The Companies have never received any such requests. As is customary in Japan, the Company and domestic sub- sidiaries maintain deposit balances with banks with which they have short- or long-term borrowings. Such deposit balances are not legally or contractually restricted as to withdrawal. Total interest cost incurred and charged to expense for the years ended March 31, 2006, 2005 and 2004 amounted to ¥898 million ($ 7,675 thousand), ¥1,083 million and ¥1,217 million, respectively. 8. Leases The Companies do not have any material capital lease agree- ments. The Companies have operating lease agreements primarily involv- ing offices and equipment for varying periods. Leases that expire generally are expected to be renewed or replaced by other leas- es. At March 31, 2006, future minimum rental payments applica- ble to non-cancelable leases having initial or remaining non-cance- lable lease terms in excess of one year were as follows: Years ending March 31 2007 2008 2009 2010 2011 Thereafter Total Millions of yen Thousands of U.S. dollars ¥ 2,612 2,243 1,672 1,468 1,598 11,485 ¥ 21,078 $ 22,325 19,171 14,291 12,547 13,658 98,162 $ 180,154 Rental expense amounted to ¥11,862 million ($ 101,385 thousand), ¥11,151 million and ¥11,059 million for the years ended March 31, 2006, 2005 and 2004, respectively. 60 OMRON CORPORATION ANNUAL REPORT 2006 9. Termination and Retirement Benefits The Company and its domestic subsidiaries sponsor termination and retirement benefit plans which cover substantially all domes- tic employees. Benefits were based on the employee’s years of service, with some plans considering compensation and certain other factors. The Company, effective from April 2004, and its domestic subsidiaries, effective from April 2005, introduced an amended plan to establish a new formula for determining pension benefits including a "point-based benefits system," under which benefits are calculated based on accumulated points allocated to employees each year according to their job classification and per- formance. If the termination is involuntary, the employee is usual- ly entitled to greater payments than in the case of voluntary ter- mination. The Company and its domestic subsidiaries fund a portion of the obligations under these plans. The general funding policy is to contribute amounts computed in accordance with actuarial meth- ods acceptable under Japanese tax law. The Company and sub- stantially all domestic subsidiaries had a contributory termination and retirement plan which was interrelated with the Japanese government social welfare program and consisted of a substitu- tional potion requiring employee and employer contributions plus an additional portion established by the employers. Periodic pension benefits required under the substitutional por- tion were prescribed by the Japanese Ministry of Health, Labour and Welfare, commence at age 65 and continue until the death of the surviving spouse. Benefits under the additional portion were usually paid in a lump sum at the earlier of termination or retire- ment although periodic payments were available under certain conditions. In January 2003, Emerging Issues Task Force ("EITF") reached a final consensus on Issue 03-2, “Accounting for the Transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities.” EITF Issue 03-2 addresses accounting for a transfer to the Japanese government of a substi- tutional portion of an Employees’ Pension Fund plan. The process of separating the substitutional portion from the corporate portion occurs in four phases. EITF Issue 03-2 requires that the separation process should be accounted for upon com- pletion of the transfer to the government of the substitutional por- tion of the benefit obligation and related plan assets as the culmi- nation of a series of steps in a single settlement transaction. Under the consensus reached, at the time the assets are trans- ferred to the government in an amount sufficient to complete the separation process, the transaction is considered to be complete and the elimination of the entire substitutional portion of the ben- efit obligation would be accounted for as a settlement at that time. The difference between the obligation settled and the assets transferred to the government should be accounted for as a subsidy from the government. The Company received the Japanese government’s approval of exemption from the obligation for benefit related to future employee service on April 26, 2004 and past employee service on May 1, 2005 with respect to the substitutional portion of its termi- nation and retirement benefit plans. The substitutional portion of the benefit obligation and related plan assets were transferred to the government on September 29, 2005. The transfer resulted in the Company recording a subsidy from the government of ¥41,339 million ($ 353,325 thousand) representing the difference between the accumulated benefit obligation of the substitutional portion and the related plan assets. Additionally, the Company recorded a reduction in net periodic benefit cost related to the derecognition of previously accrued salary progression of ¥8,870 million ($ 75,812 thousand) and a settlement loss of ¥38,294 mil- lion ($ 327,299 thousand). The net amount of derecognition of previously accrued salary progression and settlement loss is allo- cated to cost of sales of ¥15,975 million ($ 136,539 thousand), selling, general and administrative expenses of ¥8,635 million ($ 73,803 thousand) and research and development expenses of ¥4,814 million ($ 41,145 thousand). I I F N A N C A L S E C T O N I 61 OMRON CORPORATION ANNUAL REPORT 2006 Obligations and Funded status The following table is the reconciliation of beginning and ending balances of the benefit obligations and the fair value of the plan assets at March 31: Change in benefit obligation: Benefit obligation at beginning of year Service cost, less employees’ contributions Interest cost Transfer of substitutional portion Effect of change in measurement date Plan amendments Actuarial loss (gain) Benefits paid Settlement paid Benefit obligation at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Transfer of substitutional portion Effect of change in measurement date Employers’ contributions Benefits paid Settlement paid Fair value of plan assets at end of year Funded status Unrecognized net actuarial loss Unrecognized prior service benefit Net amount recognized Amounts recognized in the consolidated balance sheets: Accrued liability Accumulated other comprehensive loss (gross of tax) Net amount recognized Accumulated benefit obligation at end of year Millions of yen Thousands of U.S. dollars 2006 2005 2006 ¥ 246,950 ¥ 259,647 $ 2,110,684 3,979 3,926 (91,963) 2,424 (7,745) 2,594 (3,659) (1,975) 5,822 5,022 — — (15,546) (3,428) (3,544) (1,023) 34,009 33,556 (786,009) 20,718 (66,197) 22,171 (31,274) (16,880) ¥ 154,531 ¥ 246,950 $ 1,320,778 121,121 7,668 (41,753) 1,496 5,573 (2,843) (1,975) 117,171 1,146 — — 6,348 (3,544) — 1,035,222 65,538 (356,863) 12,786 47,632 (24,299) (16,880) ¥ 89,287 ¥ 121,121 $ 763,136 (65,244) 62,151 (23,414) (125,829) 107,487 (17,812) (557,642) 531,205 (200,120) ¥ (26,507) ¥ (36,154) $ (226,557) ¥ (62,672) ¥ (107,278) $ (535,659) 36,165 71,124 309,102 ¥ (26,507) ¥ (36,154) $ (226,557) ¥ 151,959 ¥ 228,399 $ 1,298,795 Components of net Periodic Benefit Cost The expense recorded for the contributory termination and retirement plans included the following components for the years ended March 31: Service cost, less employees’ contributions Interest cost on projected benefit obligation Expected return on plan assets Amortization Settlement loss Derecognition of previously accrued salary progression Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 ¥ 3,979 ¥ 5,822 ¥ 7,981 $ 34,009 3,926 (3,620) 2,336 38,294 (8,870) 5,022 (4,301) 2,565 — — 4,968 (4,210) 3,530 — — 33,556 (30,940) 19,966 327,299 (75,812) Net periodic benefit cost ¥ 36,045 ¥ 9,108 ¥ 12,269 $ 308,078 62 OMRON CORPORATION ANNUAL REPORT 2006 The provisions of SFAS No. 87, “Employers’ Accounting for Pensions,” require the recognition of an additional minimum pension liability for each defined benefit plan to the extent that a plan’s accumulated benefit obligation exceeds the fair value of plan assets and accrued pension liabilities. The net change in the minimum pension liability is reflected as other comprehen- sive income, net of related tax effect. The unrecognized net actuarial loss and the prior service benefit are being amortized over 15 years. Measurement Date The Company and certain of its domestic subsidiaries previously used December 31 as the measurement date for projected bene- fit obligation and plan assets of the termination and retirement benefits. During the year ended March 31, 2006, the companies have changed the measurement date to March 31. The purpose of this change is to enable more timely reflection of factors, such as the effect of plan amendments and fluctuation of number of employees in accounting for the termination and retirement bene- fits, in the projected benefit obligation and retirement benefit expense. A cumulative effect (net of tax) of this change was recognized in the consolidated statement of income for the year ended March 31, 2006, which reduced net income for the period by ¥1,201 million ($ 10,265 thousand). Assumptions Weighted-average assumptions used to determine benefit obliga- tions at March 31, 2006 and 2005 are as follows: Discount rate Compensation increase rate 2006 2.0% 2.0 2005 2.0% 2.0 Weighted-average assumptions used to determine net periodic benefit cost for the years ended March 31, 2006, 2005 and 2004 are as follows: Discount rate Compensation increase rate Expected long-term rate of return on plan assets 2006 2.0% 2.0 3.0 2005 2.0% 2.0 3.0 2004 2.0% 2.0 3.0 The expected return on plan assets is determined by estimating the future rate of return on each category of plan assets considering actual historical returns and current economic trends and conditions. Plan assets The Company’s pension plan weighted-average asset allocation by asset category is as follows: Asset Category Cash Equity Securities Debt Securities Life insurance company general accounts Other Total 2006 0.1% 23.9% 46.1% 14.1% 15.8% 2005 20.0% 15.9% 42.4% 10.3% 11.4% 100.0% 100.0% The Company investment policies are designed to ensure ade- quate plan assets are available to provide future payments of pen- sion benefits to eligible participants. Taking into account the expect- ed long-term rate of return on plan assets, the Company formulates a model portfolio comprised of the optimal combination of equity and debt securities in order to produce a total return that will match the expected return on a mid-term to long-term basis. Target allocation of plan assets is 20% of equity securities, 66% of debt securities and life insurance company general account and 14% of other for both 2006 and 2005. The actual asset allocation as of March 31, 2005 did not meet the target allo- cation because the Companies held cash to be paid to the Japanese government in connection with the transfer of the sub- stitutional portion of the benefit obligation and related plan assets. The Company evaluates the gap between expected return and actual return of invested plan assets on an annual basis to deter- mine if such differences necessitate a revision in the model port- folio. The Company revises the model portfolio when and to the extent considered necessary to achieve the expected long-term rate of return on plan assets. Equity securities include common stock of the Company in the amounts of ¥11 million ($ 94 thousand) (0.01% of total domestic plan assets), and ¥10 million (0.01% of total domestic plan assets) at March 31, 2006, and December 31, 2004, respectively. I I F N A N C A L S E C T O N I 63 OMRON CORPORATION ANNUAL REPORT 2006 Cash Flows Contributions The Companies expect to contribute ¥5,478 million ($ 46,821 thousand) to its domestic termination and retirement benefit plans in the year ending March 31, 2007. The Company expects to contribute certain available-for-sale securities of ¥16,019 million ($ 136,915 thousand) to establish an employee retirement benefit trust in the year ending March 31, 2007. Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Years ending March 31 2007 2008 2009 2010 2011 2012-2016 Millions of yen Thousands of U.S. dollars ¥ 4,531 $ 38,726 5,547 6,108 6,525 6,448 47,410 52,205 55,769 55,111 34,649 296,145 Certain employees of European subsidiaries are covered by a defined benefit pension plan. The projected benefit obligation for the plan and related fair value of plan assets were ¥2,812 million ($24,034 thousand) and ¥2,020 million ($ 17,265 thousand), respectively, at March 31, 2006 and ¥1,979 million and ¥1,599 million, respectively, at March 31, 2005. The Companies also have unfunded noncontributory termina- tion plans administered by the Companies. These plans provide lump-sum termination benefits and are paid at the earlier of the employee’s termination or mandatory retirement age, except for payments to directors and corporate auditors which require approval by the shareholders before payment. The Companies record provisions for termination benefits sufficient to state the liability equal to the plans’ vested benefits, which exceed the plans’ accumulated benefit obligations. The aggregate liability for the termination plans excluding the funded contributory termination and retirement plan in Japan, as of March 31, 2006 and 2005 was ¥4,374 million ($ 37,384 thou- sand) and ¥4,710 million, respectively. The aggregate net periodic benefit cost for such plans for the years ended March 31, 2006, 2005 and 2004 was ¥618 million ($ 5,282 thousand), ¥1,241 mil- lion and ¥1,688 million, respectively. 10. Shareholders’ Equity Through May 1, 2006, Japanese companies are subject to the Commercial Code of Japan (the “Code”). The Code requires that all shares of common stock be issued with no par value and at least 50% of the issue price of new shares is required to be recorded as common stock and the remaining net proceeds are required to be presented as additional paid-in capital, which is included in capital surplus. The Code per- mits Japanese companies, upon approval of the Board of Directors, to issue shares to existing shareholders without con- sideration by way of a stock split. Such issuance of shares gener- ally does not give rise to changes within the shareholders’ accounts. The Code also provides that an amount of 10% or more of the aggregate amount of cash dividends and certain other appropria- tions of retained earnings associated with cash outlays applicable to each period (such as bonuses to directors) shall be appropriat- ed as a legal reserve until the total of such reserve and additional paid-in capital equals 25% of common stock. The amount of total legal reserve and additional paid-in capital that exceeds 25% of the common stock may be available for dividends by resolution of the shareholders after transferring such excess in accordance with the Code. In addition, the Code permits the transfer of a por- tion of additional paid-in capital and legal reserve to the common stock by resolution of the Board of Directors. The Code allows Japanese companies to purchase treasury stock and dispose of such treasury stock upon resolution of the Board of Directors. The aggregate purchased amount of treasury stock cannot exceed the amount available for future dividends plus the amount of common stock, additional paid-in capital or legal reserve that could be transferred to retained earnings or other capital surplus other than additional paid-in capital upon approval of such transfer at the annual general meeting of share- holders. In addition to the provision that requires an appropriation for a legal reserve in connection with the cash outlays, the Code also imposes certain limitations on the amount of capital surplus and retained earnings available for dividends. The amount of capital surplus and retained earnings available for dividends under the Code was ¥53,795 million ($ 459,786 thousand) as of March 31, 2006, based on the amount recorded in the parent company’s general books of account. Dividends are approved by the shareholders at a meeting held subsequent to the end of the fiscal year to which the dividends are applicable. Semiannual interim dividends may also be paid upon resolution of the Board of Directors, subject to certain limi- tations imposed by the Code. 64 OMRON CORPORATION ANNUAL REPORT 2006 On May 1, 2006, a new corporate law (the “Corporate Law”) became effective, which reformed and replaced the Code with various revisions that would, for the most part, be applicable to events or transactions which occur on or after May 1, 2006 and for the fiscal years ending on or after May 1, 2006. The significant changes in the Corporate Law that affect financial and accounting matters are summarized below; (a) Dividends Under the Corporate Law, companies can pay dividends at any time during the fiscal year in addition to the year-end dividend upon resolution at the shareholders meeting. For companies that meet certain criteria such as; (1) having the Board of Directors, (2) having independent auditors, (3) having the Board of Corporate Auditors, and (4) the term of service of the directors is prescribed as one year rather than two years of normal term by its articles of incorporation, the Board of Directors may declare dividends (except for dividends in kind) if the company has prescribed so in its articles of incorporation. equity account charged upon the payment of such dividends until the total of aggregate amount of legal reserve and additional paid- in capital equals 25% of the common stock. Under the Code, the aggregate amount of additional paid-in capital and legal reserve that exceeds 25% of the common stock may be made available for dividends by resolution of the shareholders. Under the Corporate Law, the total amount of additional paid-in capital and legal reserve may be reversed without limitation of such thresh- old. The Corporate Law also provides that common stock, legal reserve, additional paid-in capital, other capital surplus and retained earnings can be transferred among the accounts under certain conditions upon resolution of the shareholders. (c) Treasury stock and treasury stock acquisition rights The Corporate Law also provides for companies to purchase treasury stock and dispose of such treasury stock by resolution of the Board of Directors. The amount of treasury stock purchased cannot exceed the amount available for distribution to the share- holders which is determined by specific formula. The Corporate Law permits companies to distribute dividends- in-kind (non-cash assets) to shareholders subject to a certain limi- tation and additional requirements. Under the Corporate Law, stock acquisition rights, which were previously presented as a liability, are now presented as a sepa- rate component of shareholders’ equity. Semiannual interim dividends may also be paid once a year upon resolution by the Board of Directors if the articles of incor- poration of the company so stipulate. Under the Code, certain lim- itations were imposed on the amount of capital surplus and retained earnings available for dividends. The Corporate Law also provides certain limitations on the amounts available for dividends or the purchase of treasury stock. The limitation is defined as the amount available for distribution to the shareholders, but the amount of net assets after dividends must be maintained at no less than ¥3 million. (b) Increases / decreases and transfer of common stock, reserve and surplus The Corporate Law requires that an amount equal to 10% of divi- dends must be appropriated as a legal reserve or as additional paid-in capital (a component of capital surplus) depending on the The Corporate Law also provides that companies can purchase both treasury stock acquisition rights and treasury stock. Such treasury stock acquisition rights are presented as a separate com- ponent of shareholders’ equity or deducted directly from stock acquisition rights. Stock Options The Company has authorized the grant of options to purchase common stock of the Company to certain directors and executive officers of the Company under a fixed stock option plan. Under the above plan, the exercise price of each option exceeded the market price of the Company’s common stock on the date of grant and the options expire 5 years after the date of the grant. Generally, options become fully vested and exercisable after 2 years. A summary of the Company’s fixed stock option plan activity and related information is as follows: I I F N A N C A L S E C T O N I 65 OMRON CORPORATION ANNUAL REPORT 2006 Fixed options Options outstanding at April 1, 2003 Granted Exercised Options outstanding at March 31, 2004 Granted Exercised Exercised Expired Options outstanding at March 31, 2005 Granted Exercised Exercised Exercised Expired Options outstanding at March 31, 2006 Fixed options Options outstanding at March 31, 2005 Granted Exercised Exercised Exercised Expired Options outstanding at March 31, 2006 Options exercisable at March 31, 2004 Options exercisable at March 31, 2005 Options exercisable at March 31, 2006 Options exercisable at March 31, 2006 Yen Shares Weighted-average exercise price Weighted-average fair value of options granted during the year 971,000 204,000 (86,000) 1,089,000 219,000 (46,000) (5,000) (11,000) 1,246,000 213,000 (95,000) (117,000) (14,000) (260,000) 973,000 ¥ 2,294 2,435 1,839 2,357 2,580 1,839 1,913 1,839 2,421 2,550 2,306 1,913 2,435 2,936 ¥ 2,384 ¥ 736 ¥ 194 ¥ 415 U.S. dollars Shares Weighted-average exercise price 1,246,000 213,000 (95,000) (117,000) (14,000) (260,000) 973,000 $ 20.69 21.79 19.71 16.35 20.81 25.09 $ 20.38 Shares 609,000 823,000 541,000 Weighted-average fair value of options granted during the year $ 3.55 Yen Weighted-average exercise price ¥ 2,531 ¥ 2,376 ¥ 2,239 U.S. dollars Shares Weighted-average exercise price 541,000 $ 19.14 The following summarizes information about fixed stock options at March 31, 2006: Options outstanding Options exercisable Yen Range of exercise prices ¥ 2,306 1,913 2,435 2,580 2,550 ¥1,913 to ¥2,580 Shares 197,000 154,000 190,000 219,000 213,000 973,000 Weighted-average remaining contractual life 0.25 years 1.25 years 2.25 years 3.25 years 4.25 years 2.35 years Yen Weighted-average exercise price ¥ 2,306 1,913 2,435 2,580 2,550 ¥ 2,384 Shares 197,000 154,000 190,000 — — 541,000 Yen Weighted-average exercise price ¥ 2,306 1,913 2,435 — — ¥ 2,239 66 OMRON CORPORATION ANNUAL REPORT 2006 Options outstanding Options exercisable U.S. dollars Range of exercise prices $ 19.71 16.35 20.81 22.05 21.79 $16.35 to $22.05 Shares 197,000 154,000 190,000 219,000 213,000 973,000 Weighted-average remaining contractual life 0.25 years 1.25 years 2.25 years 3.25 years 4.25 years 2.35 years U.S. dollars Weighted-average exercise price $ 19.71 16.35 20.81 22.05 21.79 $ 20.38 Shares 197,000 154,000 190,000 — — U.S. dollars Weighted-average exercise price $ 19.71 16.35 20.81 — — 541,000 $ 19.14 The fair value of each option grant was estimated as of the grant date using the Black-Scholes option-pricing model with the following assumptions: Risk-free interest rate Volatility Dividend yield Expected life 2006 1.540% 23.0% 0.982% 2005 0.628% 10.0% 0.783% 2004 0.738% 45.0% 0.857% 3.5 years 3.5 years 3.5 years The Black-Scholes option valuation model used by the Company was developed for use in estimating the fair value of fully tradable options, which have no vesting restrictions and are fully transfer- able. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. It is management’s opinion that the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single meas- ure of the fair value of its stock options. 11. Other Expenses (Income), net Other expenses (income), net for the years ended March 31, 2006, 2005 and 2004 consisted of the following: Business restructuring expenses Equity in loss (earnings) of affiliates Loss on impairment of investment securities and other assets Net gain on sales of investment securities Net loss on sales and disposals of property, plant and equipment Loss on impairment of property, plant and equipment Net loss (gain) on sales of business entities Other, net Total 2006 ¥ 749 493 757 (4,302) 42 — (194) (466) Millions of yen 2005 ¥ 1,767 1,483 366 (987) 918 614 — (457) ¥ 2004 — (92) 2,413 (1,039) 479 41 494 (448) Thousands of U.S. dollars 2006 $ 6,402 4,214 6,470 (36,769) 359 — (1,658) (3,984) ¥ (2,921) ¥ 3,704 ¥ 1,848 $ (24,966) Certain land and buildings, principally idle assets in 2005, and dormitories in 2004, were deemed to be impaired and written down to fair value. I I F N A N C A L S E C T O N I 67 OMRON CORPORATION ANNUAL REPORT 2006 12. Income Taxes The provision for income taxes for the years ended March 31, 2006, 2005 and 2004 consisted of the following: Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 Current income tax expense Deferred income tax expenses, exclusive of the following Change in the valuation allowance Adjustments of deferred tax assets and liabilities for enacted changes in tax rates ¥ 23,276 3,947 15 — ¥ 20,393 ¥ 13,527 $ 198,932 2,160 (445) 7,135 (27) 33,735 136 — 127 — Total ¥ 27,238 ¥ 22,108 ¥ 20,762 $ 232,803 The Company and its domestic subsidiaries are subject to a num- ber of taxes based on income, which in the aggregate resulted in a normal tax rate of approximately 41.0% in 2006 and 2005, and 42.0% in 2004. An amendment to Japanese tax regulations was enacted into law on March 31, 2003. As a result of this amendment, the nor- mal income tax rate was reduced from 42.0% to 41.0% effective April 1, 2004. Deferred income tax assets and liabilities as of March 31, 2004 were measured at appropriate tax rates consider- ing the period the deferred tax asset or liability would be realized. The effect was an increase in the provision for income taxes of ¥127 million for the year ended March 31, 2004. The effective income tax rates of the Companies differ from the normal Japanese statutory rates as follows for the years ended March 31: Normal Japanese statutory rates Increase (decrease) in taxes resulting from: Permanently non-deductible items Tax credit for research and development expenses Losses of subsidiaries for which no tax benefit was provided Difference in subsidiaries’ tax rates Change in the valuation allowance Effects of enacted change in tax rates Other, net Effective tax rates 2006 41.0% 2005 41.0% 2004 42.0% 0.9 (3.5) 0.4 3.2 0.0 — 0.3 42.3 3.0 (3.4) 1.5 (0.9) 0.9 — 0.0 42.1 1.0 — 1.0 (0.6) (0.1) 0.3 (0.3) 43.3 68 I I F N A N C A L S E C T O N I OMRON CORPORATION ANNUAL REPORT 2006 The approximate effect of temporary differences and tax credit and loss carryforwards that gave rise to deferred tax balances at March 31, 2006 and 2005 were as follows: Inventory valuation Accrued bonuses and vacations Termination and retirement benefits Enterprise taxes Intercompany profits Marketable securities Property, plant and equipment Allowance for doubtful receivables Minimum pension liability adjustment Other temporary differences Tax credit carryforwards Operating loss carryforwards Subtotal Valuation allowance Total Inventory valuation Accrued bonuses and vacations Termination and retirement benefits Enterprise taxes Intercompany profits Marketable securities Property, plant and equipment Allowance for doubtful receivables Minimum pension liability adjustment Other temporary differences Tax credit carryforwards Operating loss carryforwards Subtotal Valuation allowance Total Millions of yen 2006 2005 Deferred tax assets Deferred tax liabilities Deferred tax assets Deferred tax liabilities ¥ 3,418 ¥ 5,165 11,534 1,292 3,293 — 808 814 14,827 9,998 4,536 3,089 — — — — — 13,998 — 19 — 3,869 — — ¥ 2,735 ¥ 5,206 9,493 1,329 2,790 — 1,410 3,005 29,161 12,267 4,411 4,714 — — — — — 7,954 — 42 — 3,814 — — ¥ 58,774 ¥ 17,886 ¥ 76,521 ¥ 11,810 (7,203) — (7,268) — ¥ 51,571 ¥ 17,886 ¥ 69,253 ¥ 11,810 Thousands of U.S. dollars 2006 Deferred tax assets Deferred tax liabilities $ 29,214 $ 44,145 98,581 11,043 28,145 — 6,906 6,957 126,726 85,453 38,769 26,402 — — — — — 119,641 — 162 — 33,068 — — $ 502,341 $ 152,871 (61,564) — $ 440,777 $ 152,871 The total valuation allowance decreased by ¥65 million ($ 555 thousand) in 2006 and increased by ¥150 million in 2005. As of March 31, 2006, certain subsidiaries had operating loss carryforwards approximating ¥7,837 million ($ 66,983 thousand) available for reduction of future taxable income, the majority of which expire by 2013. The Company has not provided for Japanese income taxes on unremitted earnings of certain foreign subsidiaries to the extent that they are believed to be indefinitely reinvested. The unremit- ted earnings of the foreign subsidiaries which are considered to be indefinitely reinvested and for which Japanese income taxes have not been provided were ¥55,311 million ($ 472,744 thou- sand) and ¥54,813 million at March 31, 2006 and 2005, respec- tively. Dividends received from domestic subsidiaries are expect- ed to be substantially free of tax. 69 OMRON CORPORATION ANNUAL REPORT 2006 13. Foreign Operations Net sales and total assets of foreign subsidiaries for the years ended March 31, 2006, 2005 and 2004 were as follows: Net sales Total assets 14. Per Share Data Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 ¥ 256,116 ¥ 209,038 ¥ 220,961 ¥ 178,038 ¥ 208,540 ¥ 162,630 $ 2,189,026 $ 1,786,650 The Company accounts for its net income per share in accor- dance with SFAS No. 128, "Earnings per Share.” Basic net income per share has been computed by dividing net income available to common shareholders by the weighted-average num- ber of common shares outstanding during each year. Diluted net income per share reflects the potential dilution of convertible bonds and stock options, and has been computed by the if-con- verted method for convertible bonds and by the treasury stock method for stock options. A reconciliation of the numerators and denominators of the basic and diluted net income per share computations is as follows: Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 Income before cumulative effect of accounting change ¥ 36,964 ¥ 30,176 ¥ 26,811 $ 315,932 Effect of dilutive securities: Convertible bonds, due September 2004 — 165 327 — Diluted income before cumulative effect of accounting change ¥ 36,964 ¥ 30,341 ¥ 27,138 $ 315,932 Net income Effect of dilutive securities: Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 ¥ 35,763 ¥ 30,176 ¥ 26,811 $ 305,667 Convertible bonds, due September 2004 Diluted income — 165 327 — ¥ 35,763 ¥ 30,341 ¥ 27,138 $ 305,667 Weighted average common shares outstanding 236,625,818 238,505,304 242,296,332 Dilutive effect of: Convertible bonds, due September 2004 Stock options Diluted common shares outstanding — 4,623,997 10,026,639 131,711 76,574 53,053 236,757,529 243,205,875 252,376,024 Number of shares 2006 2005 2004 70 OMRON CORPORATION ANNUAL REPORT 2006 15. Supplemental Information for Cash Flows Supplemental cash flow information for the years ended March 31, 2006, 2005 and 2004 was as follows: Interest paid Income taxes paid Non-cash investing and financing activities: Liabilities assumed in connection with capital expenditures Stock issued due to convertible bonds Transfer of assets and liabilities to joint venture 16. Other Comprehensive Income (Loss) Millions of yen 2006 2005 ¥ 898 23,843 ¥ 1,098 17,815 2004 ¥ 1,217 7,508 Thousands of U.S. dollars 2006 $ 7,675 203,786 3,220 — — 2,671 38 16,270 3,848 27,521 — — — — The change in each component of accumulated other comprehensive income (loss) for the years ended March 31, 2006, 2005 and 2004 was as follows: Foreign currency translation adjustments: Beginning balance Change for the year Ending balance Minimum pension liability adjustments: Beginning balance Change for the year Ending balance Unrealized gains (losses) on available-for-sale securities: Beginning balance Change for the year Ending balance Net gains (losses) on derivative instruments: Beginning balance Change for the year Ending balance Total accumulated other comprehensive loss: Beginning balance Change for the year Ending balance Millions of yen Thousands of U.S. dollars 2006 2005 2004 2006 ¥ (10,554) ¥ (15,625) ¥ (9,407) $ (90,205) 9,201 (1,353) (41,123) 19,940 (21,183) 10,909 8,762 19,671 (241) 135 (106) 5,071 (10,554) (45,238) 4,115 (41,123) 10,087 822 10,909 217 (458) (241) (6,218) (15,625) (48,708) 3,470 (45,238) (1,716) 11,803 10,087 (78) 295 217 78,641 (11,564) (351,478) 170,427 (181,051) 93,239 74,889 168,128 (2,060) 1,154 (906) (41,009) 38,038 (50,559) 9,550 (59,909) 9,350 (350,504) 325,111 ¥ (2,971) ¥ (41,009) ¥ (50,559) $ (25,393) I I F N A N C A L S E C T O N I 71 OMRON CORPORATION ANNUAL REPORT 2006 Tax effects allocated to each component of other comprehensive income (loss) and reclassification adjustments for the years ended March 31, 2006, 2005 and 2004 were as follows: Millions of yen 2006 Tax (expense) benefit Before-tax amount Net-of-tax amount Before-tax amount 2005 Tax (expense) benefit Net-of-tax amount Before-tax amount 2004 Tax (expense) benefit Net-of-tax amount Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year ¥ 9,458 ¥ (257) ¥ 9,201 ¥ 5,437 ¥ (366) ¥ 5,071 ¥ (6,875) ¥ 195 ¥ (6,680) Reclassification adjustment for the portion realized in net income — — — — — — 462 — 462 Net change in foreign currency translation adjustments during the year Minimum pension liability adjustments Unrealized gains (losses) on available-for-sale securities: Unrealized holding gains arising during the year Reclassification adjustment for losses on impairment realized in net income Reclassification adjustment for net gains on sales realized in net income Net unrealized gains Net gains (losses) on derivative instruments: Net gains (losses) on derivative instruments designated as cash flow hedges during the year Reclassification adjustment for net losses (gains) realized in net income Net gains (losses) on derivative instruments Other comprehensive income 9,458 33,797 (257) (13,857) 9,201 19,940 5,437 6,974 (366) (2,859) 5,071 4,115 (6,413) 5,880 195 (2,410) (6,218) 3,470 18,469 (7,564) 10,905 2,159 (885) 1,274 20,196 (8,280) 11,916 487 (200) 287 22 (9) 13 847 (347) 500 (4,119) 14,837 1,689 (6,075) (2,430) 8,762 (788) 1,393 323 (571) (465) 822 (1,038) 20,005 425 (8,202) (613) 11,803 (2,173) 891 (1,282) (1,702) 698 (1,004) 1,095 (456) 639 2,400 227 ¥ 58,319 (983) (92) ¥ (20,281) 1,417 135 ¥ 38,038 929 (773) ¥ 13,031 (383) 315 ¥ (3,481) 546 (458) ¥ 9,550 (592) 503 ¥ 19,975 248 (208) ¥ (10,625) (344) 295 ¥ 9,350 Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year Reclassification adjustment for the portion realized in net income Net change in foreign currency translation adjustments during the year Minimum pension liability adjustments Unrealized gains (losses) on available-for-sale securities: Thousands of U.S. dollars 2006 Before-tax amount Tax (expense) benefit Net-of-tax amount $ 80,838 — 80,838 288,863 $ (2,197) — (2,197) (118,436) $ 78,641 — 78,641 170,427 Unrealized holding gains arising during the year Reclassification adjustment for losses on impairment realized in net income Reclassification adjustment for net gains on sales realized in net income Net unrealized gains 157,855 4,162 (35,205) 126,812 (64,650) (1,709) 14,436 (51,923) 93,205 2,453 (20,769) 74,889 Net gains (losses) on derivative instruments: Net gains (losses) on derivative instruments designated as cash flow hedges during the year Reclassification adjustment for net losses (gains) realized in net income Net gains (losses) on derivative instruments Other comprehensive income (18,573) 20,513 1,940 $ 498,453 7,616 (8,402) (786) $ (173,343) (10,957) 12,111 1,154 $ 325,111 72 OMRON CORPORATION ANNUAL REPORT 2006 17. Financial Instruments and Risk Management Financial Instruments The following table presents the carrying amounts and estimated fair values as of March 31, 2006 and 2005, of the Companies’ financial instruments. Millions of yen 2006 2005 Carrying amount Fair value Carrying amount Fair value Nonderivatives: Long-term debt, including current portion ¥ (1,345) ¥ (1,345) ¥ (12,335) ¥ (12,356) Derivatives: Included in Other current assets (liabilities): Forward exchange contracts Foreign currency options (751) 36 (751) 36 (402) 51 (402) 51 Thousands of U.S. dollars 2006 Carrying amount Fair value Nonderivatives: Long-term debt, including current portion $ (11,496) $ (11,496) Derivatives: Included in Other current assets (liabilities): Forward exchange contracts Foreign currency options (6,419) 308 (6,419) 308 The following methods and assumptions were used to estimate the fair values of each class of financial instruments for which it is practicable to estimate that value: Nonderivatives (1) Cash and cash equivalents, notes and accounts receivable, bank loans and notes and accounts payable: The carrying amounts approximate fair values. (2) Investment securities (see Note 4): The fair values are estimated based on quoted market prices or dealer quotes for marketable securities or similar instru- ments. Certain equity securities included in investments have no readily determinable public market value, and it is not prac- ticable to estimate their fair values. (3) Long-term debt: The fair values are estimated using present value of discount- ed future cash flow analysis, based on the Companies’ current incremental issuing rates for similar types of arrangements. Derivatives The fair value of derivatives generally reflects the estimated amounts that the Companies would receive or pay to terminate the contracts at the reporting date, thereby taking into account the current unrealized gains or losses of open contracts. Dealer quotes are available for most of the Companies’ derivatives; oth- erwise, pricing or valuation models are applied to current market information to estimate fair value. The Companies do not use derivatives for trading purposes. Changes in the fair value of foreign exchange forward contracts and foreign currency options designated and qualifying as cash flow hedges are reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings through Foreign exchange loss, net in the same period as the hedged items affect earnings. Substantially all of the accu- mulated other comprehensive income (loss) in relation to foreign exchange forward contracts at March 31, 2006 is expected to be reclassified into earnings within twelve months. The effective portions of changes in the fair value of foreign exchange forward contracts and foreign currency options desig- nated as cash flow hedges and reported in accumulated other comprehensive income (loss), net of the related tax effect, are losses of ¥1,282 million ($ 10,958 thousand ) and ¥1,004 million for the years ended March 31, 2006 and 2005, respectively. The amounts, which were reclassified out of accumulated other com- prehensive income (loss) into Foreign exchange loss, net depend- ing on their nature, net of the related tax effect, are net gains of ¥1,417 million ($ 12,111 thousand ) and net gains of ¥546 million for the years ended March 31, 2006 and 2005, respectively. The amount of the hedging ineffectiveness is not material for the years ended March 31, 2006 and 2005. Foreign exchange forward contracts and foreign currency options: I I F N A N C A L S E C T O N I 73 OMRON CORPORATION ANNUAL REPORT 2006 The Companies enter into foreign exchange forward contracts and combined purchased and written foreign currency option con- tracts to hedge foreign currency transactions (primarily the U.S. dollar and the EURO) on a continuing basis for periods consistent with their committed exposure. The terms of the currency deriva- tives are typically less than 10 months. The credit exposure of for- eign exchange contracts are represented by the fair value of the contracts at the reporting date. Management considers the expo- sure to credit risk to be minimal since the counterparties are major financial institutions. The notional amounts of contracts to exchange foreign currency outstanding at March 31, 2006 and 2005 were as follows: Forward exchange contracts Foreign currency options Millions of yen 2006 ¥ 43,521 ¥ 2,100 2005 ¥ 37,680 ¥ 2,000 Thousands of U.S. dollars 2006 $ 371,974 $ 17,949 The Companies hedge certain exposures to fluctuations in foreign currency exchange rates that occur prior to conversion of foreign currency denominated monetary assets and liabilities into the functional currency. Prior to conversion to the functional currency, these assets and liabilities are translated at currency exchange rates in effect on the balance sheet date. The effects of changes in currency exchange rates are reported in earnings and included in Foreign exchange loss, net in the consolidated statements of income. Currency forward contracts and options designated as hedges of the monetary assets and liabilities are also marked to market rates with the resulting gains and losses reported in the consolidated statements of income. 18. Related Party Transaction The Company had an operating lease agreement for its Kyoto head office, including land and a building, with a private company owned by the family of the Company’s founder, which includes the Company’s chairman and representative director, a director, and certain managing officers. This lease agreement had an initial non-cancelable lease term to 2020 and required a monthly rental payment of ¥106 million ($ 906 thousand) and a security deposit of ¥2,600 million ($ 22,222 thousand) which is refundable when the agreement expires. However, the agreement with the private company was dissolved in March 2006, because the Kyoto head office was sold to an unrelated third party. During the years ended March 31, 2006, 2005 and 2004, the Company paid ¥1,166 million ($ 9,966 thousand), ¥1,272 million and ¥1,272 million, respectively, in rental expense and the security deposit to the pri- vate company at March 31, 2005 was ¥2,600 million, which was transferred to the third party at March 31, 2006. 19. Commitments and Contingent Liabilities The Company has commitments at March 31, 2006 of approxi- mately ¥714 million ($ 6,103 thousand) related to contracts for construction of a new building in Kusatsu city. The Company has commitments at March 31, 2006 of approxi- mately ¥9,109 million ($ 77,854 thousand) related to contracts for outsourcing computer services through 2008. The contracts require an annual service fee of ¥4,591 million ($ 39,239 thou- sand) for the year ending March 31, 2007. The annual service fee will gradually decrease each year during the contract term to ¥4,518 million ($ 38,615 thousand) for 2008. The contract is can- celable at any time subject to a penalty of 15% of aggregate serv- ice fees payable for the remaining term of the contract. The Company and certain of its subsidiaries are defendants in several pending lawsuits. However, based upon the information currently available to both the Company and its legal counsel, management of the Company believes that damages from such lawsuits, if any, would not have a material effect on the consoli- dated financial statements. Concentration of Credit Risk Financial instruments that potentially subject the Companies to concentrations of credit risk consist principally of short-term cash investments and trade receivables. The Companies place their short-term cash investments with high-credit-quality financial institutions. Concentrations of credit risk with respect to trade receivables, as approximately 75% of total sales are concentrated in Japan, are limited due to the large number of well-established customers and their dispersion across many industries. The Company normally requires customers to deposit funds to serve as security for ongoing credit sales. Guarantees The Company provides guarantees for bank loans of other com- panies. The guarantees for the other companies are made to ensure that those companies operate with less finance costs. The maximum payments in the event of default is ¥1,188 million ($ 10,154 thousand) at March 31, 2006. The carrying amounts of 74 OMRON CORPORATION ANNUAL REPORT 2006 the liabilities recognized under those guarantees at March 31, 2006 were immaterial. Bank loans of ¥679 million ($ 5,803 thousand) of an unaffiliated company were jointly and severally guaranteed by the Company and six other unaffiliated companies. According to an agreement between the seven companies, any loss on these guarantees are to be borne equally among the companies. Product Warranties The Companies issue contractual product warranties under which they generally guarantee the performance of products delivered and services rendered for a certain period or term. Changes in accrued product warranty cost for the years ended March 31, 2006 and 2005 are summarized as follows: Balance at beginning of year Addition Utilization Balance at end of year 20. Subsequent Events Millions of yen Thousands of U.S. dollars 2006 2005 2006 ¥ 2,309 ¥ 3,153 $ 19,735 1,586 (2,217) 2,683 (3,527) 13,556 (18,949) ¥ 1,678 ¥ 2,309 $ 14,342 (1) On April 26, 2006, the Company’s board of directors approved a resolution to establish an employee retirement benefit trust, and the Company made the contribution on April 28, 2006 of certain available-for-sale securities owned by the Company. As a result, in the year ending March 31, 2007, the Company will record a gain of ¥10,141 million ($ 86,675 thousand) from the contribu- tion of securities to the employee retirement benefit trust. (2) On April 26, 2006, the Company’s board of directors approved a resolution to sell the land and building making up its Tokyo head office (Minato-ku, Tokyo). As a result of the sale, the Company will record a loss of approximately ¥5,930 million ($ 50,684 thousand) in the year ending March 31, 2007. (3) On May 12, 2006, the Company’s board of directors approved a resolution, which is subject to approval at the general meet- ing of shareholders, outlining a plan to purchase the Company’s shares. The execution of the plan is at the Company’s discre- tion with a maximum aggregate purchase of ¥15,000 million ($ 128,205 thousand), or 4,200,000 shares, for the period up to the date of the June 2007 general meeting of shareholders. I I F N A N C A L S E C T O N I 75 Deloitte Touche Tohmatsu Nakanoshima Central Tower 2-2-7, Nakanoshima, Kita-ku Osaka-shi, Osaka 530-0005 Japan Tel: +81 6 4560 6000 Fax: +81 6 4560 6001 www.deloitte.com/jp I n d e p e n d e n t A u d i t o r s ’ R e p o r t To the Board of Directors and Shareholders of OMRON Corporation We have audited the accompanying consolidated balance sheets of OMRON Corporation and subsidiaries (the “Companies”) as of March 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income (loss), sharehold- ers’ equity, and cash flows for each of the three years in the period ended March 31, 2006, all expressed in Japanese yen. These financial statements are the responsibility of the Companies’ management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Certain information required by Statement of Financial Accounting Standards No.131, “Disclosures about Segments of an Enterprise and Related Information,” has not been presented in the accompanying consolidated financial statements. In our opinion, presentation concerning operating segments and other information is required for a complete presentation of the Company’s consolidated financial statements. In our opinion, except for the omission of segment information as discussed in the preceding paragraph, the consolidated finan- cial statements referred to above present fairly, in all material respects, the financial position of OMRON Corporation and sub- sidiaries as of March 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2006 in conformity with accounting principles generally accepted in the United States of America. As discussed in Notes 1 and 9 to the consolidated financial statements, the Company and certain of its domestic subsidiaries changed the measurement date for projected benefit obligation and plan assets of the termination and retirement benefits. As discussed in Note 20 to the consolidated financial statements, on April 26, 2006, the Company’s board of directors approved a resolution to establish an employee retirement benefit trust, and the Company made the contribution on April 28, 2006 of certain available-for-sale securities owned by the Company. As discussed in Note 20 to the consolidated financial statements, on April 26, 2006, the Company’s board of directors approved a resolution to sell the land and building making up its Tokyo head office. Our audits also comprehended the translation of Japanese yen amounts into United States dollar amounts and, in our opin- ion, such translation has been made in conformity with the basis stated in Note 2 to the consolidated financial statements. Such United States dollar amounts are presented solely for the convenience of readers outside Japan. Osaka, Japan June 9, 2006 76 OMRON CORPORATION ANNUAL REPORT 2006 G L O B A L A N D D O M E S T I C N E T W O R K Europe Subsidiaries: 36 Greater China Subsidiaries: 25 1 Affiliates: Japan Subsidiaries: 42 13 Affiliates: Asia-Pacific Subsidiaries: 18 3 Affiliates: North and South America Subsidiaries: 23 Regional Headquarters Headquarters Japan Kyoto Head Office North and South America OMRON Management Center of America, Inc. (Chicago) Tel: 81-75-344-7000 Fax: 81-75-344-7001 Tel: 1-847-884-0322 Fax: 1-847-884-1866 Tokyo Head Office Tel: 81-3-3436-7170 Fax: 81-3-3436-7180 Europe OMRON Europe B.V. (The Netherlands) Tel: 31-23-568-1300 Fax: 31-23-568-1388 Asia-Pacific OMRON Asia Pacific Pte. Ltd. (Singapore) Tel: 65-835-3011 Fax: 65-835-2711 Greater China OMRON (China) Co., Ltd. (Shanghai) Tel: 86-21-6841-2588 Fax: 86-21-6841-2788 Major Domestic Manufacturing, Marketing, and Research & Development Locations Manufacturing Mishima Systems Factory Marketing Osaki Office Research & Development Keihanna Technology Innovation Center Tel: 81-55-977-9000 Fax: 81-55-977-9080 Tel: 81-3-5435-2000 Fax: 81-3-5435-2030 Tel: 81-774-74-2000 Fax: 81-774-74-2001 Kusatsu Plant Nagoya Office Komaki Automotive Electronics Office Tel: 81-77-563-2181 Fax: 81-77-565-5588 Tel: 81-52-571-6461 Fax: 81-52-565-1910 Tel:81-568-78-6160 Fax: 81-568-78-6188 Ayabe Office Osaka Office Okayama Office Tel: 81-773-42-6611 Fax: 81-773-43-0661 Tel: 81-6-6347-5800 Fax: 81-6-6347-5900 Tel: 81-86-277-6111 Fax: 81-86-276-6013 Minakuchi Factory Fukuoka Office Tel: 81-748-62-6851 Fax: 81-748-62-6854 Tel: 81-92-414-3200 Fax: 81-92-414-3201 N E T W O R K 77 OMRON CORPORATION ANNUAL REPORT 2006 C O R P O R AT E A N D S T O C K I N F O R M AT I O N As of March 31, 2006 Date of Establishment May 10, 1933 Industrial Property Rights Number of patents: 2,455 (Japan) 2,083 (Overseas) Number of patents pending: 4,150 (Japan) 2,125 (Overseas) Common Stock Authorized: 487,000,000 shares Issued: 249,121,372 shares Number of shareholders: 28,111 Stock Listings Osaka Securities Exchange Tokyo Stock Exchange Nagoya Stock Exchange Frankfurt Stock Exchange Number of Employees (Consolidated) 27,408 Ticker Symbol Number 6645 Paid-in Capital ¥64,100 million Custodian of Register of Shareholders Mitsubishi UFJ Trust and Banking Corporation 1-4-5, Marunouchi, Chiyoda-ku, Tokyo 100-8212, Japan Common Stock Price Range/ Trading Volume (Osaka Securities Exchange) Depositary and Transfer Agent for American Depositary Receipts JPMorgan Chase Bank, N. A. 4 New York Plaza, New York, NY 10004, U. S. A. ADR Holder Contact: JPMorgan Service Center P. O. Box 3408 South Hackensack, NJ 07606-3408 TEL : 1-800-990-1135 FAX : 1-201-680-4604 General E-mail : adr@jpmorgan.com Homepage http://www.omron.co.jp (Japanese) http://www.omron.com (English) Ownership and Distribution of shares （％） 100 21.0% 21.5% 20.9% 30.9% 34.4% 39.7% 4.5% 0.5% 43.1% 4.3% 1.0% 38.9% 4.1% 0.9% 34.5% 80 60 40 20 0 (Yen) 40,000 30,000 20,000 10,000 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q ’03 ’04 ’05 (FY) FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 Price range of common stock [left axis] Adjusted average for Nikkei 225 stocks [right axis] Financial Institutions Securities Firms Other Corporations Foreign Institutions and Individuals Individuals and Others 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 Trading volume Yearly High and Low Prices FY1996 FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 High Low ¥ 2,380 ¥ 2,810 ¥ 2,220 ¥ 3,360 ¥ 3,180 ¥ 2,515 ¥ 2,080 ¥ 2,740 ¥ 2,880 ¥ 3,520 1,720 1,790 1,070 1,501 1,745 1,395 1,341 1,658 2,220 2,230 * Closing price of Osaka Securities Exchange 78 (Yen) 4,000 3,000 2,000 1,000 0 (Shares) 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 OMRON CORPORATION ANNUAL REPORT 2006 C O M PA S S D E T E R M I N I N G T H E D I R E C T I O N O F O M R O N ’ S M A N A G E M E N T — S I N I C T H E O R Y According to Omron’s SINIC theory, science, technology and society have a cyclical relationship, in which each area impacts and influences the others in two directions. In one direction, scientific breakthroughs yield new technologies that stimulate society to advance. In the other direction, the needs of society motivate technological developments and expectations for new scientific advancement. Both of these directions affect each other in a cyclical manner, encouraging society to evolve. SINIC DIAGRAM Seed-Innovation to Need-Impetus Cyclic Evolution A g r i cultura Society c i e t y o S Colle ctiv e i o n a l h n i c s r T d i t c e a T Handicraft Technics Handicraft S o cie t y Seed Technology Innovation Impetus Need Progress- oriented motivation Science Society Ancient Science a r y Prim S cie n c e ciety o S e itiv m i r P Primitive Technics imitive eligio r P R n I n d u T e c s t r i a l i z h n i e s c s d t S r o i a c l i i e z t a y t I n I n d u d s u t r i a l S o c i e t y i o n Renaiss Scie n c e a n c e M S c o i d e n e r c e n C o n t r o l S c i e n c e Seed Innovation Need Impetus Cyclic Evolution ciety o S al r u t a N s u o m o n ciety o S Auto ic g o l o h c y s p - a t e M i s c n h c e T s c i t e n o h c y s Meta-P T e c h n c s i M o d e r n M e c S h o a c n i e i z t y a t i o n A u t o m T a e c ti c h C n i c s o n tr ol C y b ern etics A S m uto o ciety ation pti m ization S o ciety O Cybernatio n Society ElectronicControl Technics n tr o l s o C n i c B i o l o g i c T e c h Bionetics Psycho-Biologic Technics h o n etics s y c P The future envisioned by Omron’s founder In 1970, Omron founder Kazuma Tateisi developed a unique future prediction method called “SINIC (Seed-Innovation to Need-Impetus Cyclic Evolution) Theory” and presented it at the International Future Research Conference. Since then, this theory has served as a com- pass determining the direction of Omron’s management. The SINIC Theory predicted that the traditional agricultural society would be followed by an industrialized society, which in turn would be broken down into five phases (handicraft society, industrialization society, mechanization society, automation society and information society). According to the SINIC Theory, a new society, called the “Optimization Society,” should follow the information society, the final phase of the industrialized society, around 2005. While our industrialized society has brought about great material wealth, it has also left many issues unsolved. Such issues include energy and resource depletion, growing industrial waste, food short- ages and human rights concerns. In the Optimization Society we envi- sion, these issues will be redressed and psychological fulfillment and quality of life will grow in importance as fundamental desires of human beings. At the same time, the pursuit of efficiency and material afflu- ence emphasized by the industrialized society will become relatively less important. This will in turn create a complete balance and harmo- nious relationship between individuals and society, between humans and the environment, and between people and machines. Omron in the Optimization Society Omron has successfully anticipated and met the potential needs of society based on its SINIC Theory, and has contributed to society through its busi- ness operations by drawing on its proprietary Sensing & Control technolo- gy, and combining this with its sophisticated device technology. The most representative developments that correctly addressed the issues of each era include automation control devices as well as public information and traffic control systems. The Optimization Society began around 2005, and Omron is striving to create the “best matching of machines to people” to ensure greater safety, security and environmental conservation. For machines that involve complicated procedures and require expert knowledge to operate, for example, our goal is to create machines that can adapt to the needs of each operator. Such machines will be able to choose functions tailored to each operator’s needs or detect various conditions, make expert judgments, and provide the operator with appropriate information necessary to deal with the current situation. Other examples include an automotive sensor that can detect the sur- rounding conditions, anticipate a potential crash, and alert the driver or automatically activate the brakes to assure driving safety. Instead of people trying to adapt themselves to the needs of machines, as they do today, machines capable of adapting to the needs of people are soon to be realized. Through the implementation of its corporate philosophy, Omron strives to continue its role as a pioneer in contributing to society in the soon-to-be-realized Optimization Society. 79 O M R O N C o r p o r a t i o n A n n u a l R e p o r t 2 0 0 6 100% Recycled-content level Shiokoji Horikawa, Shimogyo-ku, Kyoto 600-8530, Japan Phone: 81-75-344-7000 Fax: 81-75-344-7001 Homepage: http://www.omron.co.jp (Japanese) http://www.omron.com (English)
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