Omron Corporation
Annual Report 2007

Plain-text annual report

Annual Report 2007 Year ended March 31, 2007 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 7 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) P R O F I L E Omron’s core sensing & control technology is creating new value through accurate read- ings of needed information in all circumstances. Through this, Omron provides products and services that support safety, security, environment and health in a variety of areas including industry, society, and in lifestyles. Contents Business Domains of OMRON Grand Design 2010 (GD2010) Ten-Year Financial Highlights To Our Stakeholders Message from the Chairman Message from the President 2 4 6 8 8 10 Special Feature: Growing Stronger and Expanding Omron’s Reach through M&A 32 Corporate Governance, Compliance, and Risk Management 36 Corporate Social Responsibility (CSR) Directors, Corporate Auditors and Executive Officers Interview with the President — Seven Important Questions 12 Financial Section (U.S. GAAP) Omron at a Glance Industrial Automation Business (IAB) Electronic Components Business (ECB) Automotive Electronic Components Business (AEC) Social Systems Business (SSB) Healthcare Business (HCB) Business Development Group and Other Businesses Intellectual Property Strategy 18 20 22 24 26 28 30 31 Fiscal 2006 Management’s Discussion and Analysis Business and Other Risks Consolidated Financial Statements Notes to Consolidated Financial Statements Independent Auditors’ Report Global and Domestic Network Corporate and Stock Information Compass Determining the Direction of Omron’s Management— SINIC Theory 40 42 43 45 50 52 58 80 81 82 83 Sustainability Report 2007 Sustainability Report 2007 For information on Omron’s sustainability initiatives, please refer to “Sustainability Report 2007”, a report on social and environmental activities to our stake- holders, including employees, clients and customers, shareholders, and regional communities. http://www.omron.com/corporate/csr/ FINANCIAL FACT BOOK 2007 Financial Fact Book 2007 For financial data from the past 10 years, please refer to “Fact Book 2007”. 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 for- ward-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 acceptance 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 and consolidated subsidiaries and affiliates. A B E T T E R W O R L D F O R A L L PHILOSOPHY T H R O U G H S E N S I N G & C O N T R O L G R A N D D E S I G N 2 0 1 0 ( G D 2 0 1 0 ) 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 maximization of corporate value and indicates the direction to be pursued over the ten-year period from 2001. Furthermore, we divided GD2010 into three stages or medium-term management plans, each with its own theme and target, and are aiming for sustainable growth. 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 WA 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 L O N G - T E R M M A N A G E M E N T P L A N G R A N D D E S I G N 2 0 1 0 ( G D 2 0 1 0 ) 1st Stage 2nd Stage 3rd Stage Theme Establishing a Profit Structure Balancing Growth & Earnings Achieving a Growth Structure Target ROE 10% Doubling Total Business Value 2nd Stage Management Policies In the 2nd Stage of GD2010, the 4 years of fiscal 2004 through fiscal 2007, we set a management target of doubling total corporate value over 2003 levels and set a theme of balancing growth and earnings. That is, based on policies of ensuring profitability through reforms in management struc- ture and ensuring growth through expanding business segments, the more than 100 business units of the Omron Group are working to double total corporate value. 4 B u s i n e s s D o m a i n s o f O M R O N T H E B E S T M A T C H I N G O F M A C H I N E S T O P E O P L E S e n s i n g & C o n t r o l T e c h n o l o g y In sensing & control, machines sense information just as humans do with their five senses (sight, hearing, smell, taste, and touch), and similarly control a process by handling the information with intuition, producing output in a convenient form. Not simply through humans and not simply through machines, through coopera- tion between human and machine Omron aims for the best matching of machines to people via its sensing & control technology. INDUSTRIAL AUTOMATION BUSINESS (IAB) ELECTRONIC COMPONENTS BUSINESS (ECB) Others 4% HCB 9% AUTOMOTIVE ELECTRONIC COMPONENTS BUSINESS (AEC) SOCIAL SYSTEMS BUSINESS (SSB) HEALTHCARE BUSINESS (HCB) SSB 14% AEC 13% S e n s i n g & C o n t r o l IAB 41% ECB 19% Note: % of Net Sales BUSINESS DEVELOPMENT GROUP AND OTHER BUSINESSES Net Sales ¥736.7 billion (FY2006) Industry Electronic components Automobiles Society Lifestyle RFID IAB Control Equipment for Factory Automation Programmable logic controllers (PLC) Production line control Safety light curtain Sensing if fingers, arms, or other parts of the body are present in dangerous areas ECB Electronic components for home appliances, communications, mobile device, etc. 計測センサ LCD Backlights AEC Automotive electronic components Smart entry Releasing a lock with electromagnetic waves Power window switches SSB Social systems HCB Healthcare and medical equipment Traffic management systems Automatic gate Home use Digital blood pressure monitor Body composition analyzer Visual sensors Detecting defects in product exteriors or in print AOI (Automated optical inspection) Electronic components for home appliances Relays Switches Laser radars Detecting distance between your car and objects in front Automotive relays Providing traffic light and congestion information for city streets Next-generation image sensors Measurement image for traffic volume at an intersection Medical use Blood pressure and pulse wave screening device A B E T T E R W O R L D F O R A L L PHILOSOPHY T H R O U G H S E N S I N G & C O N T R O L G R A N D D E S I G N 2 0 1 0 ( G D 2 0 1 0 ) 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 maximization of corporate value and indicates the direction to be pursued over the ten-year period from 2001. Furthermore, we divided GD2010 into three stages or medium-term management plans, each with its own theme and target, and are aiming for sustainable growth. 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 WA 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 L O N G - T E R M M A N A G E M E N T P L A N G R A N D D E S I G N 2 0 1 0 ( G D 2 0 1 0 ) 1st Stage 2nd Stage 3rd Stage Theme Establishing a Profit Structure Balancing Growth & Earnings Achieving a Growth Structure Target ROE 10% Doubling Total Business Value 2nd Stage Management Policies In the 2nd Stage of GD2010, the 4 years of fiscal 2004 through fiscal 2007, we set a management target of doubling total corporate value over 2003 levels and set a theme of balancing growth and earnings. That is, based on policies of ensuring profitability through reforms in management struc- ture and ensuring growth through expanding business segments, the more than 100 business units of the Omron Group are working to double total corporate value. 4 Corporate Performance (%) 12 8 4 0 Operating income margin (right axis) (Billions of yen) 800 (Billions of yen) 600 400 200 0 80 40 0 95 96 97 98 99 00 01 02 03 04 05 06 (FY) 07 (plan) Net sales (left axis) Operating income (right axis) 1st Stage 2nd Stage 3rd Stage Increased Sales and Profits for the Fifth 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 last 2nd Stage goal of doubling total business value. In fiscal 2006 we actively invested in strengthening our profitabili- ty base. As a result, despite one-time increases in costs the fruits of restructuring began to be seen, and the fifth consecutive term of higher sales and profits was realized. Also, for fiscal 2007, the effects of M&A activities has brought sales of ¥800 billion within sight. Restructuring of Business Segments 1) In order to establish ECB and AEC as pillars of busi- ness of the same scale as IAB, we are, above all, pro- moting the expansion of the two segments. 2) In Greater China—which stands out as a major con- sumer—we are focusing on expanding sales where major manufacturers are building plants. Sales Breakdown by Segment Sales Breakdown by Region (%) 100 80 60 40 20 0 01 IAB SSB 02 ECB HCB 3.8 8.9 14.4 12.6 18.8 41.5 03 04 05 06 (FY) (%) 100 80 60 40 20 0 5.5 9.5 15.8 13.3 55.9 01 02 03 04 05 06 (FY) AEC Others Japan (including exports) Greater China North America Southeast Asia and Others Europe Operational Restructuring In order to build a robust earnings structure, we are continuously working on business efficiency, and are aiming to achieve an SG&A expense ratio of 22% by fiscal 2007. SG&A Expense Ratio (%) 25.3 25.3 22.8 24.3 24.1 23.8 22.8 22.0 Note: Until FY03, Greater China was included in Southeast Asia and Others. Greater China includes China, Hong Kong and Taiwan. Note: Excluding extraordinary factors in the ATM business and the response to hazardous chemical substance regulations in FY04. Also excluding extraordinary factors in response to hazardous chemical substance regulations in FY05 00 01 02 03 04 05 06 (FY) 07 (Target) 26 25 24 23 22 21 20 5 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 (loss) 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 Millions of yen FY2006 FY2005 FY2004 FY2003 ¥ 736,651 284,199 ¥ 626,782 253,389 ¥ 608,588 249,771 ¥ 584,889 240,054 168,135 52,028 64,036 97,959 38,280 40,539 (47,075) (6,536) (4,697) 630,337 21,813 382,822 Yen 165.0 1,660.7 34.0 38.6% 8.7% 13.3% 10.3% 60.7% 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) 589,061 3,813 362,937 585,429 24,759 305,810 592,273 56,687 274,710 151.1 1,548.1 30.0 126.5 1,284.8 24.0 110.7 1,148.3 20.0 40.4% 9.9% 14.8% 10.7% 61.6% 41.0% 9.2% 13.9% 10.4% 52.2% 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 (%) 10 800 600 400 200 0 8 6 4 2 0 97 98 99 00 01 02 03 04 05 06 (FY) 40 30 20 10 0 -10 -20 (Billions of yen) (%) 20 15 10 5 0 -5 -10 (FY) 97 98 99 00 01 02 03 04 05 06 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, 2007, of ¥118=$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. 6 FY2002 FY2001 FY2000 FY1999 FY1998 FY1997 FY2006 Thousands of U.S. dollars (Note 1) ¥ 535,073 207,660 ¥ 533,964 180,535 ¥ 594,259 218,065 ¥ 555,358 196,447 ¥ 555,280 190,966 ¥ 611,795 224,350 $ 6,242,805 2,408,466 135,112 40,235 32,313 61,989 511 41,854 (30,633) 11,221 (1,996) 134,907 41,407 4,221 37,790 (15,773) 33,687 (40,121) (6,434) (12,056) 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) 567,399 71,260 251,610 549,366 58,711 298,234 593,144 67,213 325,958 579,489 69,472 336,062 580,586 86,723 321,258 593,129 54,544 343,066 2.1 1,036.0 10.0 (63.5) 1,201.2 13.0 87.4 1,311.1 13.0 45.0 1,308.6 13.0 8.3 1,249.5 13.0 71.4 1,308.9 13.0 38.8% 6.0% 11.6% 0.2% 44.3% 33.8% 0.8% 7.1% (5.1%) 54.3% 36.7% 7.5% 12.9% 6.7% 55.0% 35.4% 4.7% 10.4% 3.5% 58.0% 34.4% 2.1% 7.8% 0.7% 55.3% 36.7% 7.5% 12.6% 5.4% 57.8% 1,424,873 440,915 542,678 830,161 324,407 343,551 (398,941) (55,390) (39,805) 5,341,840 184,856 3,244,254 U.S. dollars (Note 1) 1.40 14.07 0.29 Free Cash Flow (Billions of yen) Shareholders’ Equity and Ratio of Shareholders’ Equity to Total Assets (Billions of yen) (%) 50 40 30 20 10 0 -10 97 98 99 00 01 02 03 04 05 06 (FY) 400 300 200 100 0 97 98 99 00 01 02 03 04 05 06 80 60 40 20 0 (FY) 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. Shareholders’ Equity Ratio of Shareholders’ Equity to Total Assets 7 T O O U R S TA K E H O L D E R S M E S S A G E F R O M T H E C H A I R M A N The Omron Group responded flexibly to changing market conditions in fiscal 2006 and, in addition to reporting that we were able to steadily increase our corporate value, I want to thank all of our stakeholders who supported that growth. I would like to explain how the Omron Group will achieve sustainable growth in the future, the vision we must aim for, our mission to respond to the changing times, and the grounding force required for global management. A Corporation Contributing to the 21st Century Earth that Incorporates the Dynamism of Asian Growth In June 2007, we opened our first R&D center over- seas, the Omron R&D Collaborative Innovation Center, in Shanghai, China. The center will be the second R&D base for our global operations together with the Keihanna Technology Innovation Center in Japan, and its purpose is to enhance the development of our core sensing and control technologies. The Omron Group has positioned China as its most important area of focus in our 10 year long-term corporate vision, “Grand Design 2010” (GD2010), launched in fiscal 2001. In particular, in the 2nd Stage of GD2010, which began in fiscal 2004, we concentrated capital investment in China, which culminated in fiscal 2007 with the open- ing of the R&D center in Shanghai. The center estab- lishes a functional coherence for our operations from R&D through manufacturing, sales and after-sales service in the Chinese market, which is currently a driver for the world economy. Over the next two decades, we plan to incorporate the dynamism of the Asian market into our current U.S. and European operations. Ultimately, we aim to be rec- ognized as a truly 21st century company that contributes to the healthy development of society on a global basis. 8 Safety, Security, Environment and Health are Global Social Needs Further Growth through Governance with Corporate Principles as a Grounding Force Safety, Security, environment and health are funda- The values that society requires of a company change mental elements in the creation of sustainable society. with the times, and now they are not only emphasizing This has been true in the already advanced countries, economic values such as profitability and growth, but and remains equally essential in China, India, and the also social value. At the same time, social values vary other rapidly emerging nations of Asia. between countries and regions. However, I believe that In many respects, this growth resembles Japan’s pas- our corporate principles, which are characterized by our sage through industrial development (see “SINIC Theory”, core value of working for the benefit of society set at on P83) on its way to becoming an economic power. the founding of the Omron Group and our corporate Therefore, we believe the Japanese companies that are motto since 1959 of “At work for a better life, a better benefiting from the development of the Asian markets world for all,” will be recognized as common values by have an obligation as members of Asian society to use stakeholders in all countries and regions. their accumulated technology and know-how to help solve In the future the Omron Group will continue enforcing the modern issues that arise as these countries seek sus- its corporate principles and aim for diligent corporate tainability. The Omron Group follows the management governance powered by the grounding force of these principle of “working for the benefit of society” and is principles. As we take up the challenge to creatively creatively helping resolve problems faced by Asian socie- approach and resolve the new social needs in building ty through our corporate DNA of “innovation driven by sustainable society for the 21st century, we will imple- social needs*” and “challenging ourselves to always do ment corporate social responsibility (CSR) through our better.” This may be our most important corporate mis- business as though our existence itself represents the sion, and I believe this is also where we will find many fulfillment of CSR and aim to be a company chosen for its business opportunities for Omron’s future growth. future promise. * Discover latent social needs, and be the first to provide products and services to build a better society July 2007 Yoshio Tateisi, Chairman of the BOD 9 T O O U R S TA K E H O L D E R S M E S S A G E F R O M T H E P R E S I D E N T Looking to the future, we have restructured our business portfolio and reformed our operational structure to create a more robust profit structure. As a result, we achieved record profits for the fourth consecutive year in fiscal 2006. We are now devoting our efforts to achieving our 2nd Stage goal of operating income of ¥75 billion, and addressing remaining issues as we shift our focus to the 3rd Stage theme of GD2010: establishing a growth structure for the future of the Omron Group. Structural Reforms Aimed at Both Growth and Profit My role at the helm of Omron Group management is to steer our company on a course that will enable us to maximize the corporate value of the Group over the long term. In 2001, we launched the 10-year long-term corpo- rate plan Grand Design 2010 (GD2010) with three distinct stages of development and targets. Our medium-term objec- tive during the 2nd Stage (fiscal 2004-2007) is to double the Omron Group’s total business value in terms of both growth and profit from the level in fiscal 2003. The specific targets for the 2nd stage are net sales of ¥750 billion and an operating income of ¥75 billion. To achieve our growth objectives, we have clearly identified target growth markets and fundamental technology that can give us competitive superiority. We aim to raise business value by 1) expanding sales in China and 2) creating value in new areas centered on core technologies as part of our business segment reforms to set the foundation of our competitive edge in the future. We are also establishing more efficient profit structures for our businesses as part of our operational structure reforms to realize more robust profit structures. Fiscal 2006: The Fifth Consecutive Year of Sales Growth and Increased Profits, the Fourth Consecutive Year of Increased Dividends These business policies enabled us to raise both sales and profit for a fifth consecutive year. Net sales for fiscal 2006 exceeded our initial forecast of ¥700 billion, reaching ¥736.7 billion (up 17.5% over the previous year) due in part to the contribution of large-scale M&As. Operating income reached ¥64 billion (up 3.1% over the previous year, or 27.5% excluding the previous year gains from the return of the ¥11.9 billion substitutional portion of the employee pen- sion fund), also surpassing our initial projection, and net income was ¥38.2 billion (up 7.0% over the previous year). As a result, return on equity (ROE) rose to 10.3%, and we again fulfilled the company target of ROE of 10% or above. 10 In view of these solid results, we raised the annual div- idend for the fourth consecutive year by ¥4, to ¥34 per share, in accordance with our basic policy for a payout ratio of around 20% of consolidated net income (see page 17 for Omron’s capital policy). Maximizing Corporate Value with a Long-term Vision Although the outlook for the economic environment in fiscal 2007 holds unclear elements such as steep rises in the prices of raw materials, we anticipate further positive out- comes from structural reforms and contributions from M&A activities to date. We are targeting net sales of ¥800 billion (up 8.6% over the previous period) and operating income of ¥75 billion. Meeting these targets will raise consolidated earnings per share (EPS) to about ¥200 (net profit of ¥46 billion), which is roughly double the level of the ¥110 con- solidated EPS in fiscal 2003. We are also aware that if we fail to keep business and investment on an even keel by opting to pursue immediate gains that can have the potential to stunt our future growth, or if we shy away from promising challenges simply for the sake of cutting costs, we will fall behind the times and dimin- ish as a company. With this in mind, we are aiming to strike a balance between growth and earnings in the 2nd Stage of GD2010. Looking back at the three-year period of the 2nd Stage, the Group has become even stronger than we could have anticipated. In terms of earnings, productivity in IAB has improved significantly following the reorganization of our global production and development bases. SSB has also achieved positive outcomes through cost cutting measures based on selection and concentration. ECB also has achieved growth through expansion of the liquid crystal backlight busi- ness, and HCB has improved its position by making a full- fledged entry into the supply market for medical institutions and private medical practices. Despite concerns over steep rises in raw material prices, AEC also lifted its productivity through management efforts and returned to profitability in the second half of fiscal 2006. While disparities in profitabil- ity and growth exist among the business units, our man- agement strategy of maintaining an effective balance of growth and earnings is producing steady overall results for the Omron Group. Fiscal 2007 will bring us another important step closer to our goal. However, the 2nd stage of the GD2010 is just one part of establishing a foundation on which to transform the Omron Group into a sustainable value creation company. I am committed to doing my utmost to guide the company toward maximizing corporate value over the long term based on GD2010 by promoting optimal distribution of limited management resources (people, goods, money). The Omron Group strives to meet the tasks cut out for us, and I would like to ask all of you to give even greater support and cooperation in the days ahead. July 2007 Hisao Sakuta, President and CEO 11 I N T E R V I E W W I T H T H E P R E S I D E N T — S E V E N I M P O R TA N T Q U E S T I O N S What do you consider to be the main factors in achieving this? Q.1 In fiscal 2006 the Omron Group again set a new record high in profits. A.If you look at consolidated net sales for fiscal ufacturer, and STI (consolidated as of September 2006), a leading North American safety equipment manufacturer. Contributing to the increase in net sales and the improve- ment in the product mix were IAB, which increased its sales in Europe and the United States, and SSB, which benefited from demand for IC cards by railway companies upgrading station services to accommodate wider use of electronic tickets. At HCB, there was also steady growth in sales of blood pressure monitors in Russia & Eastern Europe and Asia. On the other hand, while ECB did show an improve- ment in earnings, the sharp fall in the prices of large-size backlights, which has been a driving force in sales, had a severe impact on results, and unavoidably ECB’s contribution to the product mix in terms of profitability deteriorated. In the latter half of the year, AEC began to show a dramatic recovery in performance but failed to return to the black for the full year. At ECB and AEC, the high component ratio of relay and switch products, which were directly affected by the negative effects of price rises in raw materials such as sil- ver and copper, also put pressure on profits. In comparison with the previous year, prices of silver increased 60% and copper 80%, so an austere earnings environment persist- ed for the entire year. However, we managed to overcome the negative effects of the rises in raw material prices, absorb the non-recurrence of gains from the return of the substitutional portion of the employee pension of the pre- vious year and secure an increase in profits. On the whole, fiscal 2006 was a solid year. 2006, you will see that our core IAB operation achieved double-digit growth and that SSB also demonstrated noteworthy expansion. In addition, our M&A activities and the positive effects of yen exchange rates were factors contributing to favorable performance in fiscal 2006, and overall we were able to achieve year-on-year growth of 17.5% in net sales to ¥736.7 billion. At the same time, consolidated operating income rose 3.1% over the previous year to ¥64 billion. While the growth in operating income looks low in comparison with growth in net sales, this is because the operating income for fiscal 2005 included gains of ¥11.9 billion resulting from the return of the sub- stitutional portion of the employee pension fund, an anomaly of that period. If we exclude the effects of these gains, the actual increase in operating income rises to 27.5%. In terms of growth in consolidated operating income, on the positive side there was an increase in net sales and an improvement in the product mix, as well as the effects of M&As and the depreciation of the yen. At the same time, there were also negative factors working against us, name- ly steep rises in the cost of raw materials such as silver and copper, increases in manufacturing fixed costs, and an increase in selling, general and administrative expenses. Research and development expenses also rose during the period. The effects of M&As during the fiscal year under review were for the most part derived from the acquisition of Pioneer Precision Machinery Corporation (consolidated as of August 2006), a multi-light source LCD backlight man- 12 comment on conditions at AEC at present and what you are planning for future measures to rebuild the segment? Q.2 For the past three years, AEC has remained in the red. Could you please A.In the automobile industry the development of China. In addition, we revised our logistics network infra- structure and shifted operations from local production to production in what we deemed to be optimal locations. As a result of these measures, the operating income of AEC improved dramatically in the second half of fiscal 2006 and returned to the black. new vehicles has been centered on the themes of safety and the environment, and the number of electronic devices used in vehicles is increasing. Following this trend, the introduction of AEC products in new vehi- cles is also increasing. As a result, net sales for AEC in fiscal 2006 rose significantly to ¥93.3 billion (up 20.3% over the previous year). Despite a rapid recovery in operating income during the second half of the fiscal year, operating income for the full year finished in the red with a deficit of ¥1.2 bil- lion (the first half was ¥2 billion in the red, the second half was ¥0.8 billion in the black). There were two main factors inhibiting performance at AEC. One was the squeeze on profits caused by surges in raw material prices such as silver and copper, and the other was the delay in improvement in production efficiency at production bases in North America in both the previous year and the first half of fiscal 2006. In North America, orders have been increasing over the past year, but production plants were unable to cope with increases in production volume and were unable to fulfill their supply quotas in fis- cal 2006. Consequently, production plants in Japan had to cover their shortfall, and the products then had to be air freighted. This abnormal situation not only resulted in unnec- essary transport costs and production costs but also result- ed in productivity at North American plants falling below projections and a significant rise in fixed production expens- es. Added to these was the negative effect of the appreci- ation of the Canadian dollar on results. To address this situation, AEC put in place emergency measures to improve earnings. Specifically, we reviewed product values and the possibilities of changing over to alternative materials, based on value analysis (VA) and value engineering (VE), and we undertook efforts to revise prices of relays where profitability had been seriously impaired by the surges in silver and copper prices. Furthermore, as for the production framework, we also transferred production of some of our products from North America to Japan and Furthermore, to broaden the application of relays to other areas, such as general consumer electronics and commu- nications equipment, we launched the Relay Business Improvement Project: a company-wide initiative under my direct control that involved IAB as well as ECB. We have also been promoting improvement in productivity not only in North America but in other areas as well. As a result, AEC’s operating income is gradually head- ing in the direction of improvement in fiscal 2007, and we are expecting a profit of ¥1.4 billion for the full year. However, in contrast to AEC’s sales target of ¥100 billion, the level of operating income is still far too low. I am determined to do everything within my power, in cooperation with the entire Omron Group and AEC, in order to improve income in a way that will result in lifting the operating income margin in excess of capital cost (about 6%). 13 Can you please comment on the current situation there and your forecast for the future? Q.3 Sales for Greater China are trailing behind initial projections noticeably. A.We at the Omron Group stated that we will lift IAB’s business in Greater China consists largely of the com- ponent business, which is conducted through local distrib- utors. We have been working on developing sales chan- nels over the past several years and although we have been able to retain a number of sales distributors and sales staff above levels called for in our initial plan, the skill level of distributors and sales staff who provide support for distrib- utors is still an issue that requires attention. On the other hand, skills which can be honed through experience are improving on a daily basis, and now we are beginning to see results from this improvement. Our customer base is expanding and we are deepening our business relations with them. Therefore, although we are trailing behind our ini- tial sales plan by about one year, we believe that we can top US$1,000 million in sales during fiscal 2007 and we will be able to reach US$1,330 million in fiscal 2008. sales in Greater China to US$1,330 million in fis- cal 2007 and we undertook strategic investment accordingly. In fiscal 2006, net sales for Greater China includ- ing the contribution of ECB, which acquired Omron Precision Technology Co., Ltd. (formerly Pioneer Precision Machinery Corporation), increased about 1.8-fold to US$726 million from the previous fiscal year. This surpassed our initial pro- jection of US$676 million for fiscal 2006, but is falling far short of our medium-term plan target. However, in our exist- ing businesses at present, we believe that we can expect growth of about 30%, and we are still planning on sales of just over US$1,000 million for fiscal 2007. Sales aren’t growing as planned at IAB, which is posi- tioned as our engine of growth. This is the main factor that is keeping us from achieving our sales plan in Greater China. 14 you please comment on anticipated results for fiscal 2007 and the basis of your expectations? Q.4 This year is the final year of the 2nd Stage of GD2010. In that light, can A.In fiscal 2007 we are anticipating net sales of ¥800 billion (up 8.6% over the previous year), operat- ing income of ¥75 billion (up 17.1%), income before taxes of ¥72 billion (up 8.6%), and net income of ¥46 billion (up 20.2%), marking the sixth consecutive year of growth in sales and profits. On that basis we will be able to meet our initial targets for the 2nd Stage of GD2010. Thanks to ongoing capital investment, we expect demand for products of Group businesses to continue grow- ing, albeit modestly, both in Japan and overseas. This includes demand for factory automation control devices, electronic components for digital consumer products and automotive electronic devices to meet safety and environ- mental requirements. In this environment, we expect a combined increase of ¥76 billion in net sales (up ¥63.3 billion year on year for the Group overall) for IAB, which acquired a safety equipment manufacturing company, and ECB, which acquired a man- ufacturer of small-size backlights. We can also expect growth in sales for HCB in blood pressure monitors in Europe and Asia as well as an increase in sales of lifestyle disease prevention devices for private medical practices, and we are anticipating growth of 10% or more over the previous fiscal year. In addition to growth in these busi- nesses, we also anticipate steady growth for AEC with the increasing number of electronic devices being fitted in new model cars. On the other hand, we expect sales for SSB to contract by ¥15.9 billion due to the completion of invest- ment associated with the installation of IC card equipment at stations of major railway companies. In other businesses, we are expecting a contraction of ¥11.3 billion in sales due to the transfer of our entertainment business to a newly established company in an arrangement where the man- agement team of that business is comprised of the principal investors. As for operating income (up ¥11 billion year on year for the Group overall), despite an environment where negative elements such as prevailing high prices for raw materials and the increasing severity of price competition are putting pressure on profits, productivity in China, which is essential to strengthening our earning power, is set to increase further. We believe that achieving overall operating income of ¥75 billion for the Omron Group is well within our reach due to a number of factors: 1) we expect an increase of ¥16.1 billion in operating income in IAB, where we have taken decisive action to increase sales and revamp our earnings structure, 2) we have achieved a turnaround in AEC, which, with the help of emergency profit improvement measures, will post a surplus for the full year in fiscal 2007, and 3) there has been further improvement in the operating income margin of SSB due to structural reforms in fixed expenses. 15 income (up 33.1% year on year) in IAB as the main force driving growth in results for fiscal 2007, but can you give some specific details of the possibilities for achieving that? Q.5 I understand that you are looking at a significant increase in operating A.In fiscal 2007, we are expecting total operating As a result of IAB’s efforts to increase sales since fiscal 2004, and the initiatives I just mentioned to control pro- duction and selling, general and administrative (SG&A) expenses, we expect to achieve for the most part (operating margin will be 19%) our commitment of establishing an earnings structure based on a ratio of 5:3:2, representing gross profit, SG&A expenses (including R&D expenses), and operating income respectively. This is, in fact, the most important IAB company theme of the 2nd Stage of GD2010. We plan to generate about half of the ¥16.1 billion increase in operating income expected in fiscal 2007 through structural reforms in fixed expenses, and the remaining half from an increase in volume. In sales for fis- cal 2007, we expect a ¥34 billion increase year on year, largely in Japan and Greater China. At home in Japan, we will promote aggressive sales for resolving customer issues in areas such as quality, safety and the environment, and in those areas we will focus particular attention on the auto- motive, semiconductor, flat panel display and liquid crys- tal areas with a view to growing our applications business. In Greater China, on the other hand, we will concentrate on expanding our business operations in AOI (automated optical inspection) and PLC (programmable logic controllers) by reinforcing our sales framework, boosting productivity and launching new products. income of ¥97.4 billion (including inter-segment income of ¥22.4 billion) for all business segments and we anticipate that IAB will generate ¥64.6 billion of that amount. Therefore, it is no exaggeration to say that the IAB will be the leader in determining whether we will reach our con- solidated operating income target of ¥75 billion for fiscal 2007. During the 2nd Stage of GD2010, our long-term man- agement plan, IAB, which is the core business of the Omron Group, undertook decisive measures on a large scale, implementing sweeping structural reforms in its operations. Specifically, over the past three years we have consolidated three of our plants in China (Shanghai) into one plant. In Japan we also streamlined operations by consolidating our development and production operations in Mishima and Okayama into our plant at Kusatsu. In addition, by transferring production of general-pur- pose products to China, we also expect to achieve a 30% improvement in productivity in that area in comparison with the start of the 2nd Stage of GD2010. These initiatives in streamlining and reform have significantly cut our manu- facturing fixed costs. Furthermore, we were able to com- plete spending to accommodate RoHS requirements (restric- tions of hazardous substances in electric and electronic devices) by the end of the previous fiscal year, and this will result in cost reduction from fiscal 2007 onwards. * Figures for the profit structure plan are based on management of IAB itself. The share of operating expenses is approximately 1 percentage point lower than figures released due to the way in which operating expenses for headquarters are allocated. 16 your view on profit distribution? Q.6 Could you please explain A.Our company policy on profit distribution is that securing internal capital resources is necessary in order to maximize corporate value over the long term. This includes investments in R&D and capital investments. At the same time, I recognize that distributing profits every year to our shareholders in a stable, uninter- rupted manner insofar as possible is an obligation we have to our shareholders. In particular, to live up to the expecta- tions of our shareholders who hold the shares of our com- pany over the long term, we are committed to providing long-term, stable profit distribution of a certain level even at times when our profits may fall. In fiscal 2006, against its target payout ratio of about 20% of consolidated net income, we provided a dividend of ¥34 per share (dividend payout of 20.6%), which was ¥4 above the dividend of the previous year. For annual dividends in fiscal 2007 and thereafter, Omron has clearly stated that it will aim to provide a minimum of 20% of consolidated net income as the payout ratio instead of the somewhat ambiguous standard of “about 20%”. In addition to this, to enhance stable, uninterrupted profit dis- tributions, we will also introduce from fiscal 2007 onwards indicators such as dividends on equity (DOE), which is return on equity (ROE) multiplied by the payout ratio. In specific terms, this means that Omron will strive to maintain a pay- out ratio of at least 20% and provide profit distributions with a near-term DOE target of 2%. Of course, we also intend to provide dividends to shareholders as much as pos- sible from surpluses remaining after securing internal capi- tal resources required for growth investment. In addition, we also have plans to provide return to shareholders flexibly through the repurchase of common shares using surplus funds retained over the long term. In fact, the total return ratio, which is share buybacks and dividends combined, has been maintained at the high level of close to 50% for the past few years. about Omron’s capital policy? Q.7 Can you please tell us A.In fiscal 2006, accounts receivable and invento- ries increased slightly as a result of M&A activi- ties and the effect of currency exchange rates. This combined with efforts to increase capital efficiency on a global basis and reduce cash has brought the equity ratio to the current level of 60.7%, demonstrating our sound financial position. Effectively debt-free, we consider our capital cost to be in the vicinity of 6 percent, so we believe that there is capacity for us to increase our interest-bearing liabilities a lit- tle. On the other hand, if we increase interest-bearing liabili- ties recklessly, we risk lowering our credit rating, so we have no intention to borrow more than necessary. In terms of our financial strategy for the immediate future, we intend to maintain the basic position of borrowing the amount we need at the time we need it. Although inter- est rates are edging upwards, we do not feel that there is a need for us to secure funds in advance. However, we are considering using borrowings from the perspective of finan- cial leverage effects*. If we increase borrowings and lower our capital cost to the 5 percentile level, and maintain at least an A credit rating, we estimate that we will be able to borrow about ¥150 billion. Furthermore, we would like to undertake investment for future growth through M&A by using our treasury stock effectively. During fiscal 2007, as investment necessary for maximizing our corporate value over the long term, we plan to spend ¥56.5 billion on R&D expenses (up ¥4.5 billion year on year) and ¥45 billion on capital expenditure (up ¥600 million year on year), which is in excess of depreciation (¥35 billion). * Financial leverage effects If there is an earnings opportunity for increasing profit above debt costs (interest expenses), increasing financial leverage (total capital ÷ share- holders’ equity), in other words utilizing borrowing, will have the effect of raising ROE. 17 O M R O N AT A G L A N C E % of Net Sales / Operating Income by Segment Segment Net Sales (Billions of yen) % of Net Sales IAB 41% ECB 19% AEC 13% SSB 14% HCB 9% Business Development Group And Other Businesses 4% Operating Income by Segment* (Billions of yen) 90 80 70 60 50 40 30 20 10 0 2004 IAB SSB 2005 2006 (FY) ECB HCB AEC Others 18 INDUSTRIAL AUTOMATION BUSINESS (IAB) ELECTRONIC COMPONENTS BUSINESS (ECB) AUTOMOTIVE ELECTRONIC COMPONENTS BUSINESS (AEC) (FY) 305.6 305.6 250.3 250.3 272.7 272.7 2004 2005 2006 138.4 101.1 97.7 2004 2005 2006 77.6 64.6 93.3 2004 2005 2006 SOCIAL SYSTEMS 115.2 105.9 91.8 BUSINESS (SSB) HEALTHCARE BUSINESS (HCB) BUSINESS DEVELOPMENT GROUP AND OTHER BUSINESSES 2004 2005 2006 61.1 65.7 50.6 2004 2005 2006 26.8 25.9 27.8 2004 2005 2006 Operating Income* (Billions of yen) Operating Income Margin (%) (FY) 41.4 16.5% 41.9 15.4% 48.5 15.9% 2004 2005 2006 16.1 15.9% 11.2 11.5% 2004 2005 13.1 9.5% 2006 -0.9 -2.0 -1.2 -1.4% -1.3% -2.6% 2004 2005 2006 8.1 7.6% 4.4 4.8% 2005 2006 8.7 8.7 6.4 5.6% 2004 7.6 15.1% 14.2% 2004 2005 14.2% 3.8 2004 6.4% 1.7 2005 13.2% 2006 8.7% 2.4 2006 Overview and Market Position Main Products and Services Top market share for high-precision sensors in Japan IAB is Japan’s largest* manufacturer of control devices for factory automa- tion (FA), and contributes to production in all manner of industries. Recently, IAB has not just provided equipment and systems, but is focusing on its solutions business for management themes such as quality improvement, work safety, and environmental friendliness-needs which are rapidly increas- ing at production facilities. * Market share data obtained from the Nippon Electric Control Equipment Industries Association (NECA). Domestic market share is roughly 40%. Manufacturing and sales of control sys- tems and equipment for factory automa- tion and production machinery Sensing devices (photoelectric/proximity sen- sors, automated optical inspection systems, etc.), control devices (programmable logic con- trollers, temperature controllers, relays, timers, etc.), safety devices (safety sensors, safety switches, etc.) Aiming to be top in the LCD backlight business ECB manufactures and sells semiconductor sensors using micromachining technology and electronic components for amusement equipment, among other things, centering on relays, switches and connectors for home elec- tronics, communications, and industrial equipment. In the business for liquid crystal backlights used in displays for mobile phones and in flat panel displays, ECB holds top global share for small-sized backlights, and has product offer- ings in all size ranges, from small to mid and large-sized backlights. Manufacturing and sales of electronic components for home appliances, com- munications, mobile phones, amusement equipment, office automation equipment Relays, switches, connectors, sensors, micro lens arrays, customized ICs, IC coins, optical commu- nications devices, etc. Focusing on development of leading-edge products 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-generation, key com- ponents for which safety, security, and environment are keywords, and is already producing leading-edge products such as laser radars (sensors for measuring the distance between cars). Manufacturing and sales of automotive electronic components Automotive relays, sensors, laser radars, power window switches, keyless entry systems, elec- tronic control units, etc. Top market share for automated gates at stations in Japan SSB provides a variety of systems which support social infrastructure, includ- ing systems for railways such as automated ticket gates and automated ticket machines, and traffic control systems for road networks. Recently, as social needs related to safety and security have been rising quickly, the security business has been focusing on the provision of solutions related to room access control and information access control. * The ATM business was transferred to Hitachi-Omron Terminal Solutions, Corp. (Hitachi: 55%, Omron: 45%) on October 1, 2004. Manufacturing and sales of equip- ment/modules, and provision of solutions and services for the fields of public trans- portation and traffic/road management Public transportation : passenger gates, ticket vending machines, fare adjustment machines, etc. traffic/road management, traffic signal controllers, road management systems, etc. Top market share for digital home blood pressure monitors in Japan HCB provides a wide range of health care equipment including blood pres- sure monitors, digital thermometers and pedometers. In particular, Omron’s digital home blood pressure monitors, which are a core product, boast 50% of the domestic market (according to a survey by a private research institute), and Omron is becoming 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. Manufacturing and sales of home and professional healthcare equipment Digital blood pressure monitors, digital ther- mometers, nebulizers, pedometers, body compo- sition analyzers (body-fat analyzers), electronic pulse massagers, vital signs monitors, inpatient blood pressure monitoring devices, exhaled gas monitors, central monitors, vascular screening devices, etc. Exploration and development of new businesses Other businesses include 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 car- rying out part of the Omron Group’s growth strategy, and is focusing in par- ticular on the RFID business and the service business for the remote moni- toring of electricity. Business Development Development/Promotion of new busi- nesses for achieving the Group growth strategy Personal computer peripherals (modems, broad- band routers, back-up power supplies, etc.), wire- less sensing business (remote monitoring equip- ment, etc.), RFID business (IC tags, reader/writ- ers, antennae, etc.) * Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. 19 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 ) Manufacturing and sales of control systems for factory automation Fumio Tateisi, Executive Vice President Company President, Industrial Automation Company As the driving force behind structural reform of the Omron Group’s overall profits, IAB has been aiming for an operating income margin of 20% for fiscal 2007 and is currently devoting efforts to the final stages of realizing that goal. At the same time, we are focusing our attention on the application business as an area that will contribute to promoting product quality, safety and environmental friendliness, aspects of management that companies are intent on improving at the production site. MARKET ENVIRONMENT AND KEY STRATEGY Strengthening Abilities in Aggressive Sales in the AOI (automated optical inspection) system and the Safety Components Businesses In fiscal 2007 the business environment in the domestic market for IAB is expected to continue to be strong on capital expenditure in the automobile industry as well as the semi- conductor and electronic components industry. In the over- seas market, steady capital expenditure is also anticipated in the United States and Europe, and further growth is expected in emerging markets such as India and Russia. On the other hand, the trend to shift production bases overseas will accelerate as companies the world over strive to produce goods at lower cost and with greater production effi- ciency. Irrespective of the technical expertise of local staff, achieving quality of the same level at every production base at all times is essential if companies hope to increase their cor- porate competitiveness. At the same time, securing the safety of inexperienced local workers and putting in place production systems that are underpinned by principles affirming a com- mitment to global environmental protection have also become important corporate social responsibilities. In that respect, IAB has been developing its application business to respond to management issues in product quality, safety and environ- mental friendliness through technology that we have cultivated over the years at the actual production site, and we will estab- lish a sound revenue base by further developing ways in which we can serve our customers in this area. BUSINESS RESULTS AND FISCAL 2007 OUTLOOK Completion of the 5:3:2 Earnings Structure and Outlook for a Significant Increase in Profit IAB finished fiscal 2006 with net sales of ¥305.6 billion (up 12.1% year on year), and operating income of ¥48.5 billion (up 15.7%). In Japan the safety components and application busi- nesses steadily progressed. Semiconductor and digital home electronics-related capital expenditure also remained strong, driv- ing up sales for our mainstay FA (factory automation) control devices. In overseas markets, sales of control devices for oil and gas-related businesses in the United States were strong. Moreover, a leading US manufacturer of safety devices, Scientific Technologies Incorporated (current OSTI), which became a con- solidated subsidiary of IAB in September 2006, also made a con- tribution to sales (approximately ¥7.0 billion). In Europe, sales of inverters and servo motors also showed growth. In fiscal 2007 we are expecting net sales of ¥339.5 billion (up 11.1% over the current year), and operating income of ¥64.6 billion (up 33.1%). As our final goal in the current medium-term business plan, we at IAB made a commitment to establishing an earnings structure based on a ratio of 5:3:2* for gross profit; selling, general and administrative SG&A expenses (including R&D expenses); and operating income respectively, and we 20 IAB RESULTS AND PLANS Fiscal Year Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization* Capital expenditures 2007 Plan 339.5 154.5 185.0 38.3 85.8 16.2 38.0 6.6 64.6 19.0% 21.0 13.0 2006 305.6 140.8 164.8 34.8 81.3 14.0 28.8 5.8 48.5 15.9% 18.1 11.2 13.7 YoY 112.1% 103.4% 120.7% 137.2% 116.8% 110.1% 120.2% 120.3% 115.7% +0.5% pt. 98.1% 109.9% 137.2% 2005 272.7 136.2 136.5 25.4 69.6 12.7 24.0 4.8 41.9 15.4% 18.5 10.2 10.0 2004 250.3 130.2 120.1 20.3 65.6 10.4 19.5 4.3 41.4 16.5% 16.7 7.6 8.8 Billions of yen 2003 229.6 117.1 112.5 19.6 60.7 13.6 18.4 0.3 34.2 14.9% 14.5 10.0 7.3 * Projections for FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. * Projections for depreciation and amortization are not publically released. Portable Multilogger ZR-RX Series An electronic device for storing data of measurement results recorded by various sensors, it can be connected to a PC and convert data into graphs or send it via e-mail in abnormal situ- ations. In addition to contributing to ISO compatibility measures and traceability, the device, at one third of the market price for devices of this type price, represents the highest cost-per- formance in the market. Safety Laser Scanner OS3101 Utilizing reflected laser light, this is a non-contact sensor for detecting the presence of a human body. A system that achieves both safety and productivity, it has two possible settings: one for shutting down machines and one for monitoring and warning of the proximity of workers to machines. High Speed Accuracy Measurement Devices Enabling high-speed and accurate measurement of the line width and overlap of TFT substrates in the LCD array fabrication process, these devices warn of and prevent the incidence of defective products. With proprietary technology and algorithms for image processing, this device achieves high-accuracy meas- urement of 0.1 nanometer repeatable accuracy and measuring speed of 1 item per second. are giving top priority to finalizing that structure during the current fiscal year. At the same time, we have strengthened our sales framework for China, which is about one year behind schedule in terms of sales, and we plan to widen and deepen our sales activities by expanding our market of AOI instruments. As a result, we expect to boost growth in sales in the Chinese mar- ket by 30% or more (See P14 for details). * Figures for the profit structure plan are based on management of IAB itself. The share of operating expenses is approximately 1 percentage point lower than figures released due to the way in which operating expenses for headquarters are allocated. MEASURES FOR ACCELERATING GROWTH Completion of the BRICs Market Sales Network with IAB’s Full-fledged Entry into the Russian Market In October 2006 Omron established OEE-RUS in Moscow, Russia as a sales company under the control of IAB and com- menced operations. This marked the first full-fledged entry of a Japanese maker of FA control devices in the Russian market. With the establishment of OEE-RUS, we have put in place a framework where we can look after the needs of our cus- tomers quickly provide them with close support. We already have sales companies in Brazil, India, and China, so the estab- lishment and operation of the new sales company for control devices in Russia marks the completion of our sales network in the BRICs markets which are expected to grow further. During fiscal 2007 we expect sales amounting to 20 million euros (approximately ¥2.7 billion) and by 2010 we plan to increase sales to 50 million euros, which represents an approximate five-fold increase in sales from the fiscal 2005. Expanding the Scope of Business through Laser Fine Processing Technology In June 2007 Omron acquired a 95% stake from principal shareholders in Laser Front Technologies, Inc. (LFT), an inde- pendent developer and manufacturer of laser fine processing devices, spun off from NEC Corp., and made it a consolidated subsidiary under the name Omron Laser Front Co., Ltd. With the integration of LFT’s laser processing business and IAB’s testing and measuring business units, IAB will be able to pro- vide total quality solutions across all production processes where progress in fine processing is accelerating at a rapid pace. Moreover, using LFT’s technical capabilities in areas such as liquid crystals, semiconductors, and electronic com- ponents, and IAB’s full advantage of the merits of having a broad customer base that encompasses all manufacturing industries worldwide, and we plan to develop our operational base further (see the special feature on P33). 21 I I N D U S T R A L A U T O M A T I O N B U S N E S S I ( I A B ) 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, mobile devices, telecommunica- tions and industrial equipment, and amusement devices Soichi Yukawa, Senior Managing Officer Company President, Electronic Components Company At ECB we are aggressively moving into new growth domains in efforts to expand and extend the reach of our business. We are now doing this by offering innovative products that make the most of new technologies in areas such as liquid crystal backlights, input devices, and face recognition sensing to enhance the performance of mobile telephones and digital devices, which are rapidly growing industries. MARKET ENVIRONMENT AND KEY STRATEGY Increasing Profitability and Promoting the Development of New Business Areas In fiscal 2007 we expect to see further growth in the elec- tronic components market for digital consumer appliances and mobile devices. This growth will be driven largely by replace- ment sales and the growing popularity of products like flat screen TVs and mobile telephones featuring more electronic components accompanying technical innovation. Electronic components for industrial use can also look forward to a year of sound performance, with the help of robust capital investment plans by companies. However, intensifying competition on a global scale is putting further downward pressure on prices. In the backlight business for liquid crystal displays in particular, the selling prices for liquid crystal displays both for TVs and mobile devices are falling at a rapid pace. Meanwhile, the man- ufacturing costs of our mainstay relay products are being pushed up significantly by costs for raw materials due to soar- ing conditions in the silver and copper markets. As a measure to boost earnings in this challenging environment, particularly in small-size backlights for mobile devices where there is strong pressure to lower costs, we integrated our product strategies for point light source lights for the low end of the market and multiple light source lights for the high end of the market, which had previously been promoted on two separate tracks, and we have been devoting efforts to improving efficiency in develop- ment costs and enhancing our product power. We have also established a Business Strengthening Project which we are deploying across the ECB company as we promote sweeping measures to improve productivity. As a new initiative, we are presently strengthening and expanding our line of semiconductor-related products through our new company Omron Semiconductors Co., Ltd., a whol- ly-owned subsidiary established at the end of 2006. Semiconductor business assets transferred from Seiko Epson Corp. form the foundation of this subsidiary, and in fiscal 2007 we plan sales of approximately ¥3 billion (see the special feature on P33). Moreover, in our optical fiber communications com- ponents business, which is beginning to show promising signs of growth, we will promote the global development of the fiber- to-the-home (FTTH) market. BUSINESS RESULTS AND OUTLOOK FOR FISCAL 2007 Outlook for Double-digit Growth in Sales and Profit despite Concerns over Pressure on Earnings In fiscal 2006, ECB recorded net sales of ¥138.4 billion (up 41.6% year on year), and operating income of ¥13.1 billion (up 16.9%). In the domestic market, demand for semiconduc- tor and equipment related products is moving at a favorable pace. In addition, the round of inventory adjustments for digital consumer electronics which was underway during the second half of the previous year has come to an end, and our main- stay products, such as switches and relays for printed sub- strates as well as connectors, made steady progress. Overseas 22 ECB RESULTS AND PLANS Fiscal Year Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization* Capital expenditures 2007 Plan 180.5 75.5 105.0 12.2 12.6 9.3 61.2 9.7 15.3 8.5% 10.0 15.0 2006 138.4 58.8 79.6 11.0 12.0 8.6 35.7 12.4 13.1 9.5% 8.1 9.0 12.8 YoY 141.6% 130.5% 151.1% 110.9% 96.2% 136.5% 245.4% 130.8% 116.9% (2.0% pt.) 103.5% 108.0% 181.4% 2005 97.7 45.0 52.7 9.9 12.5 6.3 14.5 9.5 11.2 11.5% 7.8 8.4 7.1 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 FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. * Projections for depreciation and amortization are not publically released. MEMS Microphone Chip Measuring only 1.2 x 1.3 x 0.4mm, a super miniature micro- phone chip developed using the latest MEMS* technology and is among the smallest microphone chips in the world. Combination Jog Switch A customized jog device that contributes significantly in the area of design, the switch enables the fabrication of more com- pact and flatter mobile devices. OKAO Vision Facial Image Sensing Software with a range of functions such as exposure correc- tion in cameras, brightness correction in photo printing, and personal identify verification of the owners of mobile phones, OKAO recognizes with high accuracy facial images and can estimate age and determine sex. * MEMS (Micro Electro Mechanical System) Using semiconductor processes, production technology for precise structures and devices. in the Chinese market, one of our priority areas, we are cap- turing demand for products for consumer electronics and mobile devices and we increased our sales significantly. In addition, the backlight business of Pioneer Precision Machinery Corporation (currently Omron Precision Technology Co., Ltd., hereafter “OPT”), which became a consolidated subsidiary in August 2006, also made contributions to sales (approximately ¥26 billion, for eight months). Also, the optic communications business of NHK Spring Co., Ltd., was transferred to Omron in November 2006, and we have made efforts to beef up that business (see the special feature on P35). In fiscal 2007 we are expecting net sales of ¥180.5 billion (up 30.5% over the current period) and an operating income of ¥15.3 billion (up 16.8%). Raw material prices such as copper and silver remain high and will continue to place pressure on earnings, but we expect the demand environment to remain favorable. In terms of anticipated performance for specific prod- ucts, we expect an increase in demand for flexible printed circuit connectors for mobile devices, combination jog switches, and hinges. In addition, we anticipate an increase in demand for relays for communications equipment in Europe and the United States. Furthermore, OPT will contribute to earnings for the full year for small to medium-size backlights, and we can also expect a rise in demand for large-size backlights as the popularity of large flat-screen TVs accelerates. MEASURES FOR ACCELERATING GROWTH Strengthening Existing Areas and the Backlight Business through Expansion of Our Facilities in China At ECB we are making plans to put in place a cost structure that will enable us to stand up to strong competition inside and outside China. At the same time, we are currently undertaking ini- tiatives to strengthen our existing business (relays, switches, and connectors) in China and to boost our production capacity in backlights so that we can remain in close contact with major local manufacturers to respond to their requests promptly. As part of this initiative, we have already started construction on the third phase of our production subsidiary OMZ, which was established as a core base for our existing business areas in June 2006, and we plan to establish a framework for accom- modating a double-digit increase in demand by 2010. In the back- light business, following on from the start of operations of a new large-scale liquid crystal backlight plant in Changshu, Jiangsu Province in December 2006, we commenced operations in April 2007 at a second plant of an existing production subsidiary for small-size liquid crystal backlights with a monthly production capacity of 8,000,000 units, in the province. I E L E C T R O N C C O M P O N E N T S B U S N E S S I ( E C B ) 23 AUTOMOTIVE ELECTRONIC COMPONENTS BUSINESS (AEC) Manufacture and sale of electronic components for automobiles Yoshinori Suzuki, Managing Officer Company President, Automotive Electronic Components Company As automobiles make greater use of electronic components and become more sophisticated, the Automotive Electronic Components Company (AEC) is increasing sales steadily under the principle of meeting society's need for more secure, safe and environmentally friendly products. With regard to the challenge of increasing profitability, positive results are being seen gradually in tandem with a fundamental reform of our cost structure. Our goal is to expand our business while maintaining a balance between growth and profits. MARKET ENVIRONMENT AND KEY STRATEGY Promoting Our High Value-Added Module Business In 2006, Japan’s automobile production reached the world's top spot, surpassing domestic output in the United States for the first time in 13 years since 1993. Even though Japan's domestic automobile market is reaching maturity, pro- duction increased in 2006 mainly as a result of the growing pop- ularity of Japan's fuel-efficient automobiles worldwide against the backdrop of a surge in gasoline prices, triggering a rapid increase in production of vehicles for export. Automobile pro- duction is forecast to continue growing steadily on a global basis, driven by the demand in Asia which is enjoying remarkable economic growth. Japan’s automobile manufacturers are responding by moving aggressively to build factories in emerg- ing countries, focusing particularly on China, prioritizing on local- ized production and procurement as well as enhanced cost com- petitiveness. At the same time, intensifying competition to develop a new generation of automobiles based on the themes of environmentally friendliness, improved safety and comfort has set the stage for car electronics demand to expand. AEC expects the above trend will continue in the automobile industry for the time being. We are taking advantage of the demand for car electronic components driven by increased awareness for automobile safety and environmental conservation by develop- ing our business for tire pressure monitoring systems and other high-performance component modules, while operating our fac- tories in China to their full potential to meet local procurement needs. Nevertheless, profitability has become an increasingly significant challenge due to downward pressure on electronic component prices and surges in raw material costs caused by soaring silver and copper market prices. BUSINESS RESULTS AND OUTLOOK FOR FISCAL 2007 Profitability Improvements Will Put Fiscal 2007 into the Black In fiscal 2006, AEC recorded net sales of ¥93.3 billion (up 20.3% year on year) and an operating loss of ¥1.2 billion. Despite the small increase in domestic automobile production, expanded use of AEC products in new automobile models over- seas enabled sales to exceed expectations made at the begin- ning of the fiscal year. Particularly noteworthy was North America, where our new products such as wireless control equipment and power window switches enjoyed higher sales, even though the auto sales performance of our main customers was disappointing. Also, our manufacturing subsidiary in China, which began full operation in January 2006, made an enor- mous contribution to AEC's total sales growth. Earnings, how- ever, were another matter. Although value analysis/value engi- neering-based cost reductions, the relocation of some compo- nent production and other emergency measures designed to improve profitability did help earnings recover in the second 24 AEC RESULTS AND PLANS Billions of yen Fiscal Year Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization* Capital expenditures 2007 Plan 100.0 25.5 74.5 41.9 12.8 17.3 2.4 0 1.4 1.4% 8.0 6.0 2006 93.3 26.1 67.2 37.9 9.8 16.2 1.4 2.0 (1.2) — 7.1 8.1 8.9 YoY 120.3% 95.7% 133.5% 131.5% 157.9% 106.8% 1032.4% — — — 106.9% 116.9% 79.6% 2005 77.6 27.2 50.4 28.8 6.2 15.1 0.1 0 (2.0) — 6.7 7.0 11.2 2004 64.6 26.0 38.6 21.0 5.4 11.9 0 0.3 (0.9) — 6.4 3.3 7.6 2003 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 FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. * Projections for depreciation and amortization are not publically released. Laser Radar Measures the distance to the vehicle up ahead using a sensitive wide-field laser to contribute to realizing a driving control sys- tem. In addition to automobiles, bicycles and other objects are also detectable. Smart Entry Portable devices that transmit signals to automatically lock and unlock doors. It also features enhanced security func- tions for authorizing engine start-up, increasing the owner’s peace of mind. Electric Power Steering Controller Compared with conventional oil pressurization, electric (motor- ized) power steering leads to improved fuel efficiency. Consequently, adoption of electric power steering controllers is rapidly expanding in new automobile models. half, delayed productivity improvements at our North American manufacturing facility, higher raw material costs and other fac- tors resulted in our third consecutive year of operating losses. Our fiscal 2007 full-term forecast looks for net sales of ¥100 billion (up 7.2% year on year) and a return to the black with operating income of ¥1.4 billion. Despite potential risk fac- tors such as poor performance among the Big Three in North America and slumping sales of new cars in the Japanese mar- ket, we anticipate a rise in automobile production in China, India, Central and Eastern Europe, South America and other new markets. Moreover, we expect stronger demand for such strategic products as laser radars, tire pressure monitoring sys- tems and electric power steering controllers in light of expand- ed use of AEC products in new models scheduled to be launched by Japanese and non-Japanese automobile manu- facturers. As for earnings prospects, AEC’s own efforts to improve its manufacturing efficiency should of course help, as will working with IAB and ECB to share product platforms for relays and other products and lower R&D costs. In taking these steps we are determined to return to profitability. (See P13 for profitability recovery initiatives) MEASURES FOR ACCELERATING GROWTH Greater TPMS Marketing in North America in Response to New Safety Requirements In 2000 inadequate tire pressure was pointed out to be one of the causes of a series of automobile tire failure acci- dents in the United States. As a result, automobile safety leg- islation, known as the TREAD Law*, was passed that requires all automobiles sold in the United States from September 2007 to be equipped with a TPMS** device to warn of inadequate tire pressure. TPMS is an alarm system that uses a wireless central processing unit with a high-frequency receiver to receive information from sensors attached to each of the four wheels of an automobile. The driver of an automobile receives data on tire pressure and internal temperature of the tire and will be alerted to an abnormal condition. AEC has already intro- duced products for TPMS systems using electronic frequency sensing technology to the North American market from fiscal 2005, based on which it will expand the business to promote installation in new model vehicles. * TREAD Law: Transportation Recall Enhancement, Accountability and Document Act **TPMS: Tire Pressure Monitoring System 25 I A U T O M O T I V E E L E C T R O N C C O M P O N E N T S B U S N E S S I ( A E C ) S O C I A L S Y S T E M S B U S I N E S S ( S S B ) Providing solutions and services for realizing a secure, safe, and comfortable social environment Yutaka Takigawa, Senior Managing Officer Company President, Social Systems Solutions Business Company In response to today’s growing needs for security, safety and comfort, SSB is promoting expansion of new business areas by providing solutions that capitalize on the strengths of the Omron Group in services ranging from image sensing, IC card technology, and system construction to system maintenance and management. MARKET ENVIRONMENT AND KEY STRATEGY BUSINESS RESULTS AND OUTLOOK FOR FISCAL 2007 Stepping up Efforts to Address Society’s Needs in Security, Safety, and Comfort Amid calls for tighter measures to address increasing inci- dents and accidents in society and growing concern regarding corporate social responsibility and internal control in the wake of a series of corporate scandals, the demand for services to pro- mote a safer, more secure society where people can live with greater peace of mind is set to increase. Likewise, as values in our society become increasingly diverse, new services to address individual needs in pursuit of more comfortable and convenient lifestyles have emerged one after another. In this environment of dramatic changes in social needs, SSB cannot expect significant further growth in its railway and roadway infrastructure services which have been its mainstay to date. The widespread use of IC cards has resulted in the need for fewer ticket vending machines, and government agencies are restraining investment in infrastructure. To counter this we will foster image sensing and IC technologies which we have devel- oped to date by positioning them as core technologies that will serve as the mainstay of future growth in new business aimed at providing wide-ranging solutions centered on the themes of security, safety, comfort, and convenience. Also, we will continue efforts to transform our business manage- ment and change business processes in our existing busi- nesses to strengthen our business structure. Efforts to Secure Profit amid a Significant Decline in Sales In fiscal 2006, SSB recorded net sales of ¥105.9 billion (up 15.4% year on year), and operating income of ¥8.1 billion (up 82.0%). In the railroad infrastructure business, new and replacement demand for automated passenger gates and auto- matic ticket vending machines was a major driving force in sales as the nationwide transition to IC card use by railways in Japan continued. Sales in the IC card mobile solutions busi- ness also grew accompanying an increase in demand for cred- it authorization terminals. Sales also increased in the new serv- ices segment due to demand for security against the leaking of information at production sites. On the other hand, sales in the roadway infrastructure business tapered considerably. Despite efforts to promote traffic-load measuring systems, there were few major contracts. In terms of profits, because of the decrease in fixed expenses and other costs due to the changeover in operations, increases in income exceeded the sales increases considerably. During fiscal 2007, we expect net sales of ¥90 billion (down 15.0% year on year) and operating income of ¥7.3 billion (down 9.6%). The cycle of demand accompanying the introduction of IC cards for transport tickets will come to an end, and sales are expected to fall off considerably. On the other hand, we expect an increase in demand for new 26 SSB RESULTS AND PLANS Fiscal Year Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization* Capital expenditures 2007 Plan 90.0 87.5 2.5 1.0 0 0 0 1.5 7.3 8.1% 3.5 1.8 2006 105.9 101.8 4.1 5 0 0 0 3.6 8.1 7.6% 5.1 3.3 3.9 YoY 115.4% 112.6% 308.8% 262.1% — — — 317.9% 182.0% +2.8% pt. 128.3% 101.9% 91.6% 2005 91.8 90.5 1.3 0.2 0 0 0 1.1 4.4 4.8% 3.9 3.2 4.3 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 FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. * Projections for depreciation and amortization are not publically released. Non-contact IC Specialized Automated Passenger Gates The latest in automated passenger gates, antenna components attached to passenger gates instantly read information con- tained in a non-contact IC card held briefly over the machine and then allow passengers to pass through Real-time Security Management Systems Quantifying the continually changing risk of important assets in a building, this system contributes to security and safety through its ability to profile risks in real time by making risk “visible”. Next-generation Image Sensors Sensors that can read differences in the movement of moving objects, separate images of overlapping objects on screen and perform precise tracking operations, these sensors are already used in the area of road traffic control systems. At present these sensors are being developed for application in security and safety solutions where they will be used for sensing the movement of people and objects. Launch of the ID Management Solutions Business In March 2007, SSB integrated its security solutions busi- ness and IC card mobile solutions business, and launched its ID management solutions business. This business will contribute to increasing the value of cities and local areas by gathering and analyzing ID information of individual people and objects and providing solutions that will promote security & safety, and comfort & convenience. In fiscal 2007, we plan to devote efforts to improving security in cities and local areas through the pro- vision of a range of security packages and improving the con- venience of IC cards in areas such as micro-payment and point club services. business in the area of security for ID keys using facial recognition to control, for example, persons entering and leaving production sites. In this environment we will devote our efforts to further boosting the operating income margin and curbing the decrease in profits as sales taper off. To achieve this, we aim to reduce fixed expenses by continuing to change the way we manage operations and through the efficient management of SG&A and R&D expenses. MEASURES FOR ACCELERATING GROWTH Development of New Security Systems In a three-company joint project withTakenaka Corporation, a major construction company, and Secure Planning Co., Ltd., a company specializing in anti-crime consulting, Omron devel- oped a real-time security management system in November 2006. This system enables supervisors in buildings to identify risk in real time and implement appropriate, optimal risk meas- ures by quantifying external and internal risks as they change by the moment based on information such as the location of impor- tant assets and the status of people in nearby areas obtained through cameras and sensors stationed in different locations in the building. SSB plans to expand this new system not only into plants and offices but also commercial facilities and schools to contribute to improving the safety and security of cities. 27 I S O C A L S Y S T E M S B U S N E S S I ( S S B ) 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 medical institutions. Keiichiro Akahoshi Representative Director and Chief Executive Officer, Omron Healthcare Co., Ltd. Omron Healthcare Co., Ltd. (HCB) is enjoying steady growth amid a market that is expanding with rising global awareness of disease prevention. Our goal is to increase the size of our business through the promotion of our “Healthcare @ Home” business, which aims at preventive treatment via home healthcare management and by sharing related data with medical institutions. Our goal is also to increase our business through our creation of health & medical equipment and services in a wide range of areas. MARKET ENVIRONMENT AND KEY STRATEGY BUSINESS RESULTS AND OUTLOOK FOR FISCAL 2007 Acceleration of Growth in Our Global Business as Awareness of Lifestyle-related Disease Prevention Rises In Japan, for health-insured individuals aged 40-74 a spec- ified array of physical examinations and health guidance will be made mandatory from fiscal 2008, with the prevention of lifestyle-related disease listed as one of the national measures to slash medical expenditures. As a result, the Japanese are becoming more aware of lifestyle-related disease prevention. As a research survey conducted by HCB in January 2007 shows, public awareness of metabolic syndrome* has skyrocketed in just one year, from 3% to 74%. Given this background, we believe the Japan market for lifestyle-related disease prevention for medical institutions and individuals will see further growth. Also, because of the aging of populations, particularly in advanced countries, and rising living standards in emerging countries, the issue of lifestyle-related disease measures is being pushed to the national level in various countries, and global demand for health and medical equipment is expanding. In the face of these developments, based on the concept of Healthcare @ Home, HCB is creating useful prod- ucts that can help prevent and treat lifestyle-related diseases while promoting a differentiation strategy underpinned by bio- information sensing technology and high-quality products. * Metabolic syndrome: A condition characterized by obesity caused by fat collected on internal organs that can combine with such risk factors as high blood pressure, diabetes and lipid abnormality to easily trigger heart attacks and seizures. Growth in Body Composition Analyzers in Japan and Blood Pressure Monitors Overseas In fiscal 2006, HCB realized net sales of ¥65.7 billion (up 7.6% year on year) and operating income of ¥8.7 billion (up 0.4%). In the Japan market, in addition to greater personal health awareness triggered by increased public familiarity with metabolic syndrome, faster efforts by local governments and companies for meeting the obligation of a specified array of physical examinations and health guidance were favorable fac- tors. In overseas markets, sales in Russia, Eastern Europe and China rose, led by products such as blood pressure monitors. On a global basis however, price competition is becoming more severe. As for our earnings performance, an approximately ¥0.7 billion investment in business restructuring in connection with our acquisition of Omron Colin (formerly Colin Medical Technology Corporation) was a temporary factor weighing down operating income. In fiscal 2007, we forecast net sales of ¥73.5 billion (up 11.8% year on year) and operating income of ¥9.5 billion (up 9.4%). In particular, we look for continued strong growth in blood pressure monitor sales in China and Russia and body composition analyzer sales in Japan. At the same time, our equipment for medical institutions business is coming up against hospital management efficiency measures driven by 28 HCB RESULTS AND PLANS Fiscal Year Net sales* Domestic Overseas North America Europe Asia China Direct exports Operating income* Operating income margin* R&D expenses Depreciation and amortization* Capital expenditures 2007 Plan 73.5 37.5 36.0 14.3 14.4 2.0 4.6 0.7 9.5 12.9% 4.5 2.1 2006 65.7 32.8 32.9 13.8 13.1 2.1 3.6 0.3 8.7 13.2% 3.9 1.0 1.5 YoY 107.6% 108.2% 107.0% 89.8% 124.3% 127.0% 123.8% 106.8% 100.4% (1.0% pt.) 115.5% 93.5% 94.7% 2005 61.1 30.3 30.8 15.4 10.6 1.6 2.9 0.2 8.7 14.2% 3.3 1.1 1.6 2004 50.6 23.1 27.5 14.6 8.9 1.4 2.6 0.1 7.6 15.1% 2.7 0.7 2.1 Billions of yen 2003 47.0 21.3 25.7 13.3 8.3 1.2 2.7 0.1 7.2 15.3% 2.7 0.9 1.9 * Projections for FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indicates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. * Projections for depreciation and amortization are not publically released. HEM-7020 Digital Blood Pressure Monitor A blood pressure monitor with detection functions for early morning high blood pressure, which is difficult for Hospitals to detect. If weekly average readings for morning readings sur- pass the standard level of 135/85mmHg, a warning icon appears on display early morning high blood pressure. HBF-361 Body Composition Analyzer A body composition analyzer which measures visceral fat level and percentage of subcutaneous fat. Visceral fat level can be measured down to a unit of 0.5 and the result can be compared with the mean values for people in the same age group. “Form” Blood Pressure and Pulse Wave Screening Device A blood pressure and pulse detection device that can deter- mine hardness of blood vessels as well as constriction and blockage. In just a few minutes, patients can quickly and easi- ly have their blood ves- sels checked and thus receive efficient care for lifestyle-related diseases. New Factory in Vietnam In response to rising global demand for home-use blood pressure monitors, HCB has invested about ¥0.6 billion in con- struction of a new factory in Vietnam, which will begin pro- duction in December 2007. At present, HCB has a roughly 50% global share of home-use blood pressure monitors, of which some 97% is manufactured at our factory in China. However, the aging of populations in advanced countries and the rising number of lifestyle-related disease patients in emerging coun- tries suggest that demand for home-use blood pressure mon- itors is likely to experience further growth. the need to contain medical costs and other unfavorable devel- opments. However, it is expected that demand for equipment for lifestyle-related diseases such as vascular screening devices will continue to grow. MEASURES FOR ACCELERATING GROWTH Tie-up with GE Yokogawa in Bio-Information Monitoring In April 2007, HCB formed an alliance with GE Yokogawa Medical Systems of the General Electric (GE) Group to acquire exclusive sales rights to GE's bio-information monitors* sold in the Japan market and to jointly develop products in the diag- nostic, prevention and home medical fields. In the bio-infor- mation monitoring business, HCB has been involved in devel- oping products for general hospital wards, while GE Yokogawa has provided high-performance products mainly for use in oper- ating rooms and intensive care units. By tying up with GE Yokogawa, HCB is expanding its business through the creation of a sales structure that can supply a wide variety of products, from those for general hospital wards to operating rooms and intensive care units in need of high-performance equipment. Furthermore, going forward we will jointly develop products for markets worldwide with GE. * Bio-information monitoring devices monitor a patient's condition by meas- uring and recording blood pressure, pulse and other forms of bio-infor- mation, as well as perform electrocardiograms. 29 H E A L T H C A R E B U S N E S S I ( H C B ) BUSINESS DEVELOPMENT GROUP AND OTHER BUSINESSES RESULTS AND PLANS Billions of yen Fiscal Year Net sales* Domestic Overseas Operating income* Operating income margin* R&D expenses Depreciation and amortization* 2007 Plan 16.5 16.0 0.5 (0.6) — 9.5 2006 27.8 27.7 0.1 2.4 8.7% 9.7 YoY 106.9% 107.8% 35.0% 144.8% +2.3%pt. 95.1% 2005 25.9 25.7 0.2 1.7 6.4% 10.2 2004 26.8 26.4 0.4 3.8 14.2% 10.6 2003 24.5 24.0 0.5 3.8 15.5% 9.8 Capital expenditures 125.4% 51.7% * Projections for FY2007 are based on exchange rates of ¥115/US$ and ¥150/Euro. * The sales figures given indicate sales to external customers and exclude inter-segment transactions. Operating income indi- cates income including internal income prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. 1.3 3.6 1.3 9.5 1.0 7.0 5.1 5.8 7.1 Remote Monitoring Equipment A terminal for measuring energy consump- tion at business facilities that can be installed easily without requiring any wiring work with the adoption of a mobile communication net- work and specified low-power consumption radio transmission. The terminal can provide detailed measurement data at low cost. * Projections for depreciation and amortization are not publically released. BUSINESS DEVELOPMENT GROUP AND OTHER BUSINESSES Seeking Out and Fostering New Business Opportunities Kazunobu Amemiya, Executive Officer Senior General Manager, Business Development Group The Business Development Group is contributing to the building of a basis for the Omron Group’s growth by seeking out and fostering new business opportunities and also supporting technological development and product commercialization. In particular, we are focusing on the steadily-growing energy management and RFID businesses and stepping up efforts toward their further growth. MARKET ENVIRONMENT AND KEY STRATEGY Placing High Expectations on the RFID System and Energy Monitoring Businesses We have our eyes on people’s growing awareness of environmental protection and energy-saving. Accordingly, we are accelerating efforts to identify the potential of the com- mercialization of energy monitoring equipment and related serv- ices, which should not only support corporate clients’ promotion of energy-saving efforts but also contribute to their cost-cut- ting efforts. We will also take advantage of the full-scale growth in demand for RFID*-related equipment to provide the global marketplace with products suitable for UHF and HF radio bands. Further, we will seek to create new businesses in the fields of safety, security, environment and health by making full use of the Omron Group’s core competence. * RFID: Radio Frequency Identification BUSINESS RESULTS AND FISCAL 2007 OUTLOOK Photo Sticker Machines, Energy Monitoring Business Turn in Strong Performance In fiscal 2006, we saw net sales of ¥27.8 billion (up 6.9% year on year) and operating income of ¥2.4 billion (up 44.8%). Among existing businesses, the mainstay photo sticker machines performed strongly in the entertainment business, with the membership of the mobile site linked to these machines also growing smoothly. In the computer peripherals business, sales increased for uninterruptible power supply equipment. Among businesses with particular emphasis for growth, we started shipments of UHF-band RFID equipment to the Asian market, following the U.S. and Japanese markets, and sales of the newly launched energy monitoring business also grew steadily. In fiscal 2007, however, despite an expected expansion of the RFID and energy monitoring businesses, we are forecasting an operating loss of ¥0.6 billion on net sales of ¥16.5 billion (down 40.5% year on year), as the sale of the entertainment business will lead to a corresponding decline in both sales and operating income and as we continue to invest in the search for new business opportunities. MEASURES FOR ACCELERATING GROWTH Expansion of the Energy Monitoring Business We are putting extra effort into the energy monitoring business as a new business area. In this business, we utilize wireless technology to measure energy consumption of air-con- ditioning and other equipment, as well as room temperature and humidity, at manufacturing plants and distribution centers, process the measurement results into data useful in energy- saving efforts and feed these data into personal computers of client companies or into mobile phones of individuals. We launched the business in fiscal 2006 to provide both equipment and services to corporate clients who can expect both energy- saving and cost-cutting benefits. We will seek to double fiscal 2007 sales for the business from the fiscal 2006 level, and at the same time expand the scope of energy measurement and enhance the range of data services provided. I B U S 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 N E S S E S I 30 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 Intellectual property relating to technology and know-how is one of the Omron Group’s most vital management resources for ensuring its sustainable growth. Acting as our mentor in technology, the Intellectual Property Center strategically links research and development with business and plays an essential role as a corporate concierge in converting technology into profit. Patent Applications and Approvals in the United States Patent Applications in China 200 150 137 178 169 163 157 132 88 82 62 44 100 93 50 0 29 01 Applications 162 160 150 142 200 150 100 50 38 105 02 Approvals 03 04 05 06 (FY) 0 01 02 03 04 05 06 (FY) Applications Omron’s Research and Development Scheme and Strategy for Intellectual Property Focusing on sensing and control as core competencies, the Advance Device Laboratory and Sensing & Control Laboratory are responsible for the development of fundamental technology while the companies of the Omron Group engage in the devel- opment of applied technology and product development. In the context of this research and development scheme, the Intellectual Property Center not only serves as an interme- diary between business and technology but also contributes to the Group by creating the differentiating value that in the future will set Omron apart from other manufacturers in the industry. In specific terms, the Center comprehensively man- ages intellectual content from the development of fundamental technology to the development of applied technology and determines the direction of strategic development with a view to providing integrated support for both R&D and the business units. Through the Intellectual Property Center, we will predict and assess value in terms of the differentiating value that will be created in the future, synergies between technologies, and the accumulation of know-how, and we will promote the acqui- sition of rights for these projects, including business models from the research and development stages to their catego- rization as business models, aiming at maximization of corporate value. Stepping up Patent Applications in the United States and China and Commencing Application Procedures in India Since the Omron Group put in place its long-term man- agement vision GD2010 in 2001, we have accelerated our busi- ness development globally and have increased our number of overseas patent applications. With our sights set on securing patents that will enhance our competitive edge internationally, we are stepping up efforts to acquire patents in the United States. Likewise, we have also been promoting the acquisi- tion of patents in China, which is positioned as one of our pri- ority strategic areas. In India too, despite existing inadequa- cies in legislation to protect intellectual property rights, we have not only investigated legal conditions but have actually begun to file applications for patents with a vision for the future. Promoting the Acquisition of Patents on a Global Scale To coincide with our plans as a global corporation, we will continue to promote collaborative innovation with local universities and local development in various regions of the world. In China, as we move ahead with research and devel- opment locally at the Omron Institute of Sensing & Control Technology (ORS) in Shanghai and at Omron (Shanghai) Co., Ltd., the need for us to apply for patents locally in accordance with the Chinese legal system is increasing in recent years. To facilitate the acquisition of patents, we have appointed spe- cialist staff in both China and North America to provide local support at every stage from consultation concerning inven- tions to the filing of patent applications. Intellectual Property and R&D-related Data Fiscal Year Number of patents Applications Approvals Total patents R&D expenses (Billions of yen) R&D expenses ratio R&D staff (persons) 2006 2005 2004 2003 2002 1,300 836 5,206 52.0 7.1% 1,630 1,509 705 4,538 50.5 8.1% 1,591 1,216 676 4,426 49.4 8.1% 1,384 1,170 580 4,154 46.5 7.9% 1,594 1,141 543 4,068 40.2 7.5% 1,378 31 SPECIAL FEATURE: GROWING STRONGER AND EXPANDING OMRON’S REACH THROUGH M&A Because we live in a rapidly changing world, we at Omron understand that it is essential for us to always be seek- ing out promising fields, areas, and technologies for our growth, rapidly reorganize and recombine our busi- ness areas to accommodate selection and concentration of management resources, and grow our business. As a powerful means of executing this strategy, we carefully consider the possibilities of M&A and proceed accord- ingly. In this special feature, we present the strengthening and expanding of our businesses through M&A in six case studies explaining initiatives to create synergies with existing businesses and to break into new growth areas in the 2nd Stage of GD2010 from the perspective of long-term maximization of corporate value. Case 1: Aiming to be the global No. 1 company in safety equipment for the production site. In addition to the need to pursue productivity at production sites, there is a rapidly growing need to establish greater safe- ty. Positioning the safety equipment business specializing in safety at production sites as its top area of priority, the Industrial Automation Business (IAB) has focused its efforts on strength- ening its expertise in system solutions and consulting in safety design know-how in addition to the manufacture of its wide- ranging product lineup of safety equipment from components to networks. As a result of its efforts, IAB has the largest share of the safety equipment market for the Japanese and Asian automobile and semiconductor industries. Aiming for ambitious growth to further enhance our posi- tion in the market, we acquired the safety equipment business division of Scientific Technologies, Inc. a top manufacturer of safety equipment in North America, in June 2006, and estab- lished Omron Scientific Technologies, Inc (OSTI). OSTI has strengths in safety equipment such as powerful, long-distance safety light curtains and laser scanners and in North America also boasts high technical expertise and brand power in the food, pharmaceutical, and cosmetics industries as well as in the automobile, semiconductor, and electronic machinery indus- tries. Therefore, IAB plans to add OSTI’s safety devices to its product lineup and to expand their application. Moreover, the integration of IAB’s sensing and control technologies and OSTI’s basic patents for optical application technology and superior know-how in creating powerful devices will boost IAB’s ability to respond to advanced safety needs by reinforcing its expertise and pace of development. As a result of these efforts, IAB’s safety equipment busi- ness in fiscal 2008 is anticipating sales of ¥30 billion, which represents a three-fold increase in sales from fiscal 2005. Safety Laser Scanner Programmable Terminal Safety Mat Safety Light Curtain Guard Lock Safety-door Switch Safety Network Controller Target for Expanding the Safety Business of Omron Billions of yen 10.0 2005 15.1 2006 22.0 2007 plan 30.0 2008 Target (FY) * OSTI has been in the scope of consolidation since September 2006 32 Case 2: Total quality support at the production site through precision laser processing technologies In June 2007, Omron entered into a business and capi- tal alliance with LaserFront Technologies Co., Ltd. (LFT), a development and manufacturing company of precision laser processing equipment that became independent of NEC Corp. and that recorded net sales of ¥10.3 billion in fiscal 2006, and officially changed its name to OMRON LASERFRONT Inc. (See P21). This company is the first in the world to commercialize the use of solid lasers and possesses technological expertise of the highest standard in both laser oscillators and laser process technology that utilizes the oscillators in manufacturing. The company in particular boasts top global share for laser CVD repair systems* for LCD panels. Through this capital alliance, IAB added to its product line- up various products used in manufacturing and repair process- es such as laser repair devices, laser markers** and laser welders which utilize precision laser processing technologies owned by LFT. Furthermore, IAB plans to expand the domain of its quality solution business by providing solutions for yield improvement and traceability systems in all areas of produc- tion processes including machining, assembly, inspection, measuring, and repair. * CVD repair systems for LCD displays: these systems improve the yield in LCD mass production by using laser irradiation on defective areas occur- ring in the metal wiring pattern on LCD substrates in processes for LCD displays. Products are repaired through thin film pattern cuts, fusion join- ing, and connection of spaces between wiring with laser CVD film. Laser CVD (chemical vapor deposition) is a coating method based on the for- mation of a membrane through chemical and physical reactions of raw material gas on a laser irradiated surface achieved by irradiating laser beams on a substrate placed in the gas. **Laser markers: devices which directly engrave characters such as let- ters and symbols on a surface by altering, fusing, or evaporating a part of the material surface through laser irradiation. One example of such devices is two-dimensional bar-code printing equipment. Production Process Material Processing Assembly Inspection / Measurement Repair (processing) Shipment Information (Traceability) Laser welding Laser trimmer Film-thickness sensor, LCD / overlay measurement LCD repair Laser marker Two dimension code reader/RFID Precision laser processing technologies Integration Sensing & control technologies Case 3: Full-fledged entry into the proprietary development and production of Omron semiconductors Following the transfer of assets of the semiconductor business of Seiko Epson Corporation and its consolidated sub- sidiary Yasu Semiconductor Corporation to ECB at the end of fiscal 2006, OMRON Semiconductors Co., Ltd. (OSC) was established as a wholly-owned subsidiary and commenced operation in April 2007. The new company started with the commissioned manufacturing of nonvolatile memory and logic ICs employing an 8-inch CMOS (complementary metal oxide semiconductor) production line. As OSC gradually expands its production lineup to include proprietary semiconductor ele- ments and other products, it is aiming for sales of ¥3 billion in fiscal 2007 and more than ¥5 billion in fiscal 2010. The Omron Group has been involved in the development, production and marketing of custom ICs that offer functionality and cost performance not found in general-purpose semicon- ductors as well as MEMS (micro electro mechanical systems)* products such as flow sensors and pressure sensors that utilize semiconductor processes in their manufacture. The acquisi- tion of OSC will facilitate further development of products that utilize semiconductors within our Group as we push ahead with plans to fully strengthen and expand our semiconductor- related business. * MEMS (micro electro mechanical systems) are electronic device sys- tems consisting of minute parts fabricated using semiconductor micro- fabrication technology where photographic technology is applied. Specifically, the method of production involves applying photographic sensitive material over a silicon wafer and printing an electronic circuit pattern through irradiation and then scraping off unwanted parts of the sur- face by etching and other methods. 33 Case 4: Expanding business in optical communication devices world wide Acquisition of NHK Spring’s optical communication parts business for the FTTH market Acquisition of Aduro, an American venture company and manufacturer of high-speed communication parts Led by advanced countries, the introduction of FTTH (fiber- to-the-home), a high-capacity, super-fast continuous connec- tion network environment using a fiber optic cable connection, is rapidly progressing. In tune with this trend, ECB has focused its attention on lowering the cost of optical waveguides* used in optical splitters, which are key devices in FTTH. To achieve this, ECB put SPICA** (replication polymer optical waveguide) technology to practical use. Although as a technology SPICA is slightly inferior in quality in comparison with fused silica, which has become the standard, it enables simplification of production significantly through production based on replication. Along the same lines, Omron acquired the optical com- munication parts business for the FTTH market of NHK SPRING Co., Ltd. in November 2006 to enhance the quality of optical waveguides and to accelerate the acquisition of a solid cus- tomer base. This business has become the top supplier in North America after commercializing high-performance quartz opti- cal waveguides utilizing precision processing and coating tech- nologies. This acquisition not only enabled ECB to secure a sound customer base in North America but also, the integration of ECB’s cost-cutting technology and NHK Spring’s high per- formance technology has placed ECB in a prime position for promoting business expansion in the rapidly growing global FTTH market. is attracting attention. To As the need for high volume data transmission at data centers and offices and ultra high-speed transmission to transmit full high-definition television images increases, electronic transmission is becoming increasingly inadequate in responding to the growing demands for transmission at greater speed and distance. As an answer to these needs, optical transmission include responding to such needs in ECB’s business domain, in December 2005 Omron acquired Aduro, a US venture company known for its strengths in optical transmission and reception modules which combine optical wavelength multiplexing from/to electronic conversion technology (CWDM-TOSA/ROSA***). With this acquisition as a launching point, ECB has developed small and high-speed TOSA and ROSA by integrating its own micro lens technology and Aduro’s TOSA and ROSA technologies. ECB has been making progress toward developing the market including extension of electric cable and integration into transmission devices and video devices. Furthermore, in the future ECB will actively provide optimal solutions by integrating its own technology and the technologies acquired through M&A in the globally expanding optical high-speed communications market. technology and optical * Optical waveguide: a component used to branch out optical signals sent through optical fiber. It transmits, divaricates, branches, and controls opti- cal signals without leaking them in the circuitry of information communi- cation devices. **SPICA: Stacked Polymer Optical IC / Advanced *** CWDM-TOSA/ROSA CWDM: Coarse Wavelength Division Multiplexer (multiplexes and trans- mits 400 to 1600nm wavelengths). TOSA: Transmitter Optical Sub-Assembly (transmission module) ROSA: Receiver Optical Sub-Assembly (reception module) FFTH System Structure Relay station OLT(*) Fiber optics ONU ONU(**) Application in fiber optic network monitoring and as an optical switch for redundancy changeovers Receipt by a fiber optic splitter (1/8 & 1/32 type) *OLT (optical line terminal): transmission device to connect the backbone network and FTTH **ONU (optical network unit): receiver set in the home of fiber optic subscribers 34 Fiber optic splitters for FTTH Case 5: Rising to the world’s top position in LCD backlight production Using proprietary optical control technology that utilizes microlens array* (MLA) technology, ECB developed and com- mercialized small LCD backlight units for mobile phones that provide illumination from a single light source (LED). At the same time, with our sights set on making backlights a future core business, our aim is to ensure the soundness of growth potential in the LCD backlight business by broadening the busi- ness domain. To do this, in May 2004 we acquired the large-size LCD backlight business from Tama Electric Co., Ltd., which is a wholly-owned subsidiary of KOA Corp., and we made it a wholly-owned subsidiary of Omron under the name of Tama Fine Opto Co., Ltd. This acquisition was followed by the acquisition of Pioneer Precision Machinery Corporation, which deals with small and medium multi-light source LCD backlights with multiple placed LEDs, in August 2006 as a wholly-owned subsidiary and renamed it Omron Precision Technology Co., Ltd. Through the acquisition of these two companies, Omron is able to meet the diverse needs of customers from low-end to high-end users in the area of point-source and multi-light source systems, and offers products meeting backlight needs in all areas including medium and large backlights, making Omron one of the world’s leading companies in LCD backlights** * MLA technology: Omron’s proprietary technology which maximizes the efficiency of light use by reflecting light that normally diverges in all direc- tions in a single direction using a microlens array (MLA), aggregating mil- lions of microlenses on a single board. **According to Omron estimates, we have the world’s top share of slight- ly more than 20% in the area of small LCD backlights in terms of the number of units. Building a Full Line of Small, Medium and Large Backlights Screen Size Large Medium TAMA Fine Opto Co., Ltd. Omron Precision Technology Co., Ltd. Omron Small LED point light source backlights (low-power consumption /low-cost) LED multi-light source backlights (high brightness /high-definition) Low-End High-End Application Liquid Crystal Televisions Car Navigation Systems Game Consoles PDAs Digital Cameras Mobile Phones Function Case 6: Providing a wide range of products for use in the home to medical institutions In June 2005, Omron Healthcare (HCB) acquired Colin Medical Technology Corporation (fiscal 2004 net sales: ¥8.6 bil- lion), a leading medical device manufacturer. This acquisition expanded HCB’s product line and created a framework which enables us to provide health care products for both home and institutional use in every area of lifestyle-related disease pre- vention. In addition to health and medical care devices for home use such as blood pressure monitors, body composition ana- lyzers, and thermometers, HCB’s business domain now includes a range of instruments for measuring biological information including inpatient vital sign monitors and screening devices to detect vascular hardening for medical institution use. As societies, particularly in advanced countries, continue aging, the number of persons with lifestyle-related illnesses, such as hypertension and diabetes, is on the rise and coun- tries are beginning to promote preventive medicine as a nation- al policy measure. With its recent acquisition, HCB will strength- en its business for medical institutions with a view to growing its business for preventive medical care, an area which is expected to grow into a vibrant market in the future. Health and Medical Care Devices for Home Use Products for Medical Institutions Digital blood pressure monitors Body composition analyzers Inpatient blood pressure monitoring devices Exhaled gas monitors Operating room Hospital ward Central monitors Examination Full automatic blood pressure monitors Vascular screening devices Thermometers Electrocardiograph Nebulizers Strengthening the operational base for the medical institution business through the acquisition of Colin Medical Technology 35 CORPORATE GOVERNANCE, COMPLIANCE, AND RISK MANAGEMENT As a global company, Omron is committed to demonstrating accountability to our stakeholders, increasing management transparency and maintaining & managing an appropriate governance system. In efforts to firmly establish corporate ethics of a high standard, we will continue to strengthen our compliance system and promote the establishment of a risk management framework that will support ongoing improvement in sustainable corporate value. Corporate Governance Basic Policies Omron believes that pursuing long-term maximization of corporate value holds the key to fulfilling all stakeholders’ expectations. Reaching this goal requires efficient and com- petitive management which we strive to achieve by creating an optimal management, structure and conducting fair and appro- priate business operations. To achieve stronger corporate gov- ernance, we will concentrate our efforts on putting three guid- ing perspectives into practice continually: fulfilling manage- ment accountability, achieving management transparency and pursuing high business ethics. Implementation Status of Corporate Governance In addition to strengthening management monitoring func- tions, Omron separates management oversight and business exe- cution to quickly respond to changes in the business environment. To facilitate business operations, Omron has adopted an exec- utive officer system. Aiming to strengthen operations of each business area, an internal company system was introduced, with the president of each internal business company empow- ered by more authority to realize quicker decision-making and more streamlined operations. Also, the goals between the President & CEO and exec- utive officers, and the top management of each division com- pany have been clarified, along with thorough promotion of management commitments and a performance-based com- pensation program for meeting various goals including those Corporate Governance Structure for profitability at each division company. These initiatives have been put in place to put into practice corporate value manage- ment based on shareholder value. At the same time, we are taking preventive action against risk by putting in place a system that will identify various forms of risk with the potential to impede ongoing improvement in sustainable corporate value both internally and externally, and that will manage the risk of loss and prevent acts of staff which could be in breach of the law. Basic Structure • Management and Monitoring Structure Omron has reduced the number of board members to seven to increase its efficiency and deepen deliberations. Our management monitoring functions are based on separating the duties of corporate management and business execution. The President & CEO is the only director who serves concurrently both in corporate management and business execution, while other directors are distanced from day to day business execution. Furthermore, in order to enforce our management objec- tivity, we have separated the positions of Chairman of the Board of Directors and President & CEO, and worked to strengthen management monitoring functions. In addition, the Chairman of the Board of Directors oversees business opera- tions as a representative of stakeholders by not taking part in the execution of business. In regard to matters of the appoint- Board of Directors (BOD) The BOD decides important business matters such as company objectives and management strategies, while overseeing the business practices of the President & CEO. Board of Corporate Auditors This board verifies the effectiveness of the cor- porate governance system and its imple- mentation, while also monitoring the day- to-day operations of executives including directors. The board consists of four cor- porate auditors, three of whom are out- side auditors. Personnel Advisory Committee This committee, chaired by an outside director, sets election standards for directors, cor- porate auditors and executive officers, selects candidates, and evaluates current executives. Shareholders Meeting Board of Corporate Auditors Board of Directors Chair: Chairman of the Board Board of Corporate Auditors Office Personnel Advisory Committee Independent Auditing Firm Compensation Advisory Committee CEO Selection Advisory Commitee Executive Organization President & CEO Corporate Environmental Activitiy Committee Corporate Ethics & Business Conduct Committee Executive Council Corporate Auditors Office Information Disclosure Committee Compensation Advisory Committee Also chaired by an outside director, this committee determines the compensa- tion structure for directors, corporate auditors and executive officers, sets evaluation standards, and evaluates current executives. CEO Selection Advisory Committee This committee, chaired by an outside director, is dedicated to nomination of the President. It deliberates on selec- tion of the new President for the next term and a succession plan in prepara- tion for contingencies. Executive Council This council deter- mines and reviews important business operation matters that are within the scope of authority of the President. Information Disclosure Committee In June 2006, Omron set forth an informa- tion disclosure policy and standards that are more exacting than the Tokyo Stock Exchange rules. Established in June 2006, and chaired by the President, the committee monitors information disclosure activities of the entire Group. 36 ment, promotion, and compensation of all officers (directors, auditors, and managing officers), we maintain objectivity and transparency through the Personnel Advisory Committee and the Compensation 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 compensation matters relating to all officers, without the presence of the Chairman of the Board and the President & CEO. • Auditing Functions The Board of Corporate Auditors, consisting of four audi- tors (including three outside corporate auditors), monitors gov- ernance and management conditions as well as the daily activ- ities of the Board of Directors and other management. Also, in undertaking its internal auditing function, the Audit Office, which functions directly under the President & CEO, periodically conducts internal audits of accounting, administration, busi- ness risks, and compliance in each headquarters division and in each division company. In addition to its auditing functions, the Audit Office also offers specific advice on ways of improving administrative functions. Comments from Outside Directors Main Activities of Outside Directors The outside directors attend monthly Board meetings and directors’ liaison meetings (arranged as forums for free dis- cussion and sharing information on management strategies following Board meetings), as well as technology liaison meet- ings for narrowing down specific technical themes. They provide appropriate advice and recommendations as necessary. Serving as chairman of the Personnel Advisory Committee, the Compensation Advisory Committee, and the President & CEO Selection Advisory Committee, the outside directors also con- tribute to the soundness of management. In accordance with the selection standards for outside directors, Mr. Noriyuki Inoue and Mr. Kazuhiko Toyama have been appointed as Omron’s two outside directors. Mr. Inoue has been selected for his extensive experience in corporate management and broad insight while Mr. Toyama has been selected as a management specialist on the basis of his long years of experience in the management of several companies. Omron looks forward to benefiting from the experience and wisdom of the two outside directors in the management of the company. For the fourth consecutive year, Omron has set a record in perform- ance. This is proof of the high regard Omron’s customers have for its superb expertise in technology. It is also an achievement made possible through growth resulting from Omron’s ambitious M&A strategies and a broadening of the company’s business domain. As a person involved in corporate management at the top-level, I am committed to working tirelessly for our shareholders and investors by considering what they expect of Omron in light of my own experience. At a time when there are strong demands placed on CSR management, I understand that it is my duty to engage in management keeping in mind our stakeholders including our shareholders and investors and to provide advice and monitoring for Omron’s management team from an independent perspective. In this capacity, I am determined to fulfill my responsibilities as an outside director with the aim of improving shareholder value. Noriyuki Inoue The true purpose of governance is to improve intrinsic corporate value, in other words, to make a company consistently well-regarded by socie- ty over a long period of time, thereby maintaining and increasing the earnings of the company’s business. As a COO of the Industrial Revitalization Corporation of Japan over the past four years, I have engaged directly in corporate revitalization as an authority in corporate governance. I also had first hand experience working with the Kanebo affair*. That experience made me again realize that corporate gover- nance in Japan - and the world for that matter - had come to a turning point in many respects. It is clear that governance can no longer be seen simply as an extension of the authority of shareholders or a refuge of mutual checking within a village society; these are no longer accepted as answers. Many excellent companies in advanced countries including Japan today are those which promote the concentration of knowledge and establish their compet- itive superiority on the basis of human capital and knowledge capital. I see Omron as a com- pany in that category and think that it should remain that way in the future. In that context, I think we must consider how governance at Omron should be. Keeping this fundamental issue in mind, I am determined to devote my energy and efforts to contributing to Omron as a director involved in corporate governance to enhance the true corporate value of Omron. In these efforts, I would like to ask for the support of Omron’s stakeholders. Kazuhiko Toyama * Kanebo affair: an accounting scandal at Kanebo, a maker of cosmetics and other products, after which the Industrial Revitalization Corporation of Japan became involved in the company’s revitalization Joined Daikin Industries, Ltd. Appointed Director, Daikin Industries, Ltd. Appointed Managing Director, Daikin Industries, Ltd. Appointed Senior Managing Director, Daikin Industries, Ltd. Appointed President and Representative Director, Daikin Industries, Ltd. Appointed President and Representative Chairman of the Board, Daikin Industries, Ltd. Appointed President and Representative Director, Daikin Industries, Ltd. Appointed CEO and Representative Chairman, Daikin Industries, Ltd. (current position) Appointed Director, OMRON Corporation (current posi- tion) Personal History March 1957 February 1979 February 1985 June 1989 June 1994 May 1995 June 1996 June 2002 June 2003 Personal History April 1985 March 1986 April 1986 March 1993 April 2000 April 2001 March 2003 April 2003 March 2007 April 2007 June 2007 Joined The Boston Consulting Group K.K. Resigned from The Boston Consulting Group K.K. Established Corporate Directions, Inc. Appointed Director, Corporate Directions, Inc. Appointed Executive Managing Director, Corporate Directions, Inc. Appointed President and Representative Director of Corporate Directions, Inc. Resigned from Corporate Directions, Inc. Appointed Executive Managing Director and COO, Industrial Revitalization Corporation of Japan Industrial Revitalization Corporation of Japan is dissolved Appointed CEO & Representative Director, Industrial Growth Platform, Inc. (current position) Appointed Director, OMRON Corporation (current position) 37 Initiatives in Governance in Fiscal 2006 • Directors’ Term Shortened to One Year In efforts to further clarify the responsibilities of the man- agement team toward our shareholders and to enable rapid response to changes in the management environment, a res- olution was passed to shorten the term of office for directors from two years to one year from fiscal 2007 onward. • Establishment of the President & CEO Selection Advisory Committee In December 2006 the President & CEO Selection Advisory Committee was established to further enhance trans- parency and objectivity in the replacement of presidents. • Establishment of the Information Disclosure Committee In June 2006, in response to the requests of increasingly discerning stakeholders to further disclose information, Omron established information disclosure policies and disclosure stan- dards which are more rigorous than the timely disclosure stan- dards of the stock exchanges. Based on these standards, we established the Information Disclosure Committee chaired by the President & CEO to monitor the information disclosure activities of the entire Group. • Improvement of the Framework for an Internal Control System We also put in place a structure for assessing and report- ing on internal control relating to financial reports (in accor- dance with the Financial Instruments and Exchange Law) two years ahead of requirement to enable us to submit confirmation by the President & CEO to the Financial Services Agency. Furthermore, the Board of Directors passed a resolution regarding a structure for ensuring that the execution of the directors’ duties conforms to the law and to the Articles of Incorporation as well as a framework for establishing appropri- ateness in other company business. We are making efforts to put this framework in place. Compliance and Risk Management Basic Policies • Compliance Omron has set a high standard in corporate ethics which goes beyond simple observance of laws and regulations. In efforts to ensure that our corporate ethics are thoroughly under- stood and well established in work practices throughout the company, we have been focusing our compliance activities on four important areas: (1) monitoring, (2) implementing the PDCA (plan do check act) cycle, (3) reinforcing compliance education and (4) rebuilding our compliance structure. • Risk Management Omron is improving its internal control system as we believe that all risk arising from management and business operations must be accurately assessed and controlled in order to appropriately manage operations, maintain stable growth and protect management resources. To achieve this end, Omron is putting into place a system of risk management for detecting, analyzing, countering and monitoring risk in each headquarters division and division company. Moreover, over- sight of risk management activities has been placed in the Corporate Resources Innovation Headquarters, and efforts are underway to promote and improve our risk management sys- tem and identify and control risk throughout the Group. Basic Framework In 2003, Omron combined its risk management and compliance activities by establishing the Corporate Ethics & Business Conduct Committee chaired by the President & CEO. The General Manager of each headquarters division and the President of each division company participate in this committee to report on corporate ethics efforts for their respective organizations in accordance with their corporate ethics and conduct framework and on the status of the response to risks. Moreover, the Corporate Resources Innovation Headquarters has established the Corporate Ethics Hotline (a call center was also opened at an outside law firm in fiscal 2005), a whistleblower center to receive reports directly from employees and their families. Also, Omron has also appointed officers or managers in its Group companies to promote risk management and compli- ance throughout the Group and is conducting training for these officers every year in efforts to promote and thoroughly famil- iarize staff in the Omron Group with risk management. Structure of Omron Corporate Ethics Corporate Ethics & Business Conduct Committee Committee Chair (President & CEO) Committee Secretariat Business Company Committee Members (Business Company Presidents) Corporate Committee Members (Head office Administrative Division Managers) Corporate Ethics & Business Conduct Promotion Committee Specialized Committees Corporate Ethics Hotline Export Control Committee Human Rights Committee Safety and Health Committee Central Disaster Prevention Committee Business Companies Promotional Departments Administrative Divisions’ Promotional Departments Information Security Management Committee 38 Efforts in Fiscal 2006 • Compliance In fiscal 2006, we undertook compliance monitoring at 11 Omron Group companies in Japan and overseas, including newly acquired companies, to confirm that laws and regula- tions are being observed. In all domestic companies, we reviewed compliance activities on the basis of the PDCA cycle in efforts to strengthen compliance. Also, at all of our domestic Group companies, in addition to conducting compliance training for directors, management, specialist personnel, and regular and temporary staff, we also held training sessions for new employees and staff transferring from other companies. In addition, we introduced e-learning as a new method of training and in fiscal 2007 we plan to broaden its application as we con- tinue to focus our efforts on ways of promoting compliance throughout the Group. • Risk Management To establish an enduring information security system, we undertook a company-wide review of the status of security in domestic Group operations. With an understanding of our obli- gation to fulfill our social responsibility to our stakeholders by appropriately managing confidential and personal information to safeguard it against leaking or unauthorized use, we undertook a sweeping review of our rules for information management and commenced the construction of an integrated system for managing both confidential information and personal informa- tion. In fiscal 2007 we intend to implement comprehensive measures to guarantee security in information management at Group companies in Japan and we will also commence a review of rules for information management in our overseas Group companies. Promoting corporate ethics and compliance in four regions outside of Japan At the Omron Group, a total of 32,456 people are working in Japan and four regions around the world. To demonstrate fairness and integrity in all corporate activities and individual employees’ behavior throughout the world, Omron is promoting compliance and risk management at each region through distribution of the Corporate Ethics Guidelines and monitoring of compliance status. In fiscal 2007, Omron will publish regional versions of the CSR Practice Guidelines, which are based on and upgraded from the Corporate Ethics Guidelines. Continued promotion of compliance training and monitoring is also planned. North America Compliance officers are in place at each North American Group company. In fiscal 2006, compliance monitoring for Group companies contin- ued, while awareness of the whistleblower hotline was enhanced, resulting in 11 hot- line contacts received. Blake Thatcher Bill Abbott Europe Under the leadership of Omron Europe’s Risk Management Committee, compliance audit- ing and manager training have been con- ducted on a regular basis to strengthen com- pliance. Establishment of a contact channel to work in collaboration with the committee is now underway along with the improve- ment of the compliance promotion system. Managers in charge of regulatory matters were assigned to ensure strict observance of environmental and other regulations. Patrick Duregger China Compliance and maintenance of ethical standards are among the key CSR issues for Omron in Greater China. In fiscal 2006, corporate ethics officers were assigned at each Group company, and the first promotion confer- ence was held in Shanghai. In addition to manager train- ing, compliance monitoring continued with a focus on observing compliance with three important laws, related to customs, bribery and operations falling outside each company’s authorized scope of business. Fumihiro Matsuzaki Dai Ogihara Asia-Pacific Taking into consideration the language and cultural diversity in the region, the Corporate Ethics Guidelines have been translated into five different languages*. Efforts are focused on education, training and monitoring with the aim of strengthening understanding of corporate ethics and compliance among all employees through the distribution of guidelines and creation of a system to ensure strict legal observance. *Thai, Indonesian, Vietnamese, Malay and Tamil 39 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 ( C S R ) Since the founding of our Company, Omron has held the belief that a company exists to serve society, and that only when this is accomplished should a company earn profits and enjoy sustainable growth. We take pride in being a company under- pinned by the corporate core value of working for the benefit of society and we are committed to fulfilling our corporate social responsibility for the sustainable development of society as we live up to the expectations of all of our stakeholders. The Basic Philosophy of CSR — Working for the Benefit of Society Companies today are judged not only on the basis of their profitability and growth. How a company fulfills its responsibility to society and how it contributes to promoting sustainable devel- opment have also come to be considered important criteria in judging a company. In addition to the change in the company’s raison d’être, the expansion and globalization of Omron’s busi- ness and the subsequent diversification of our stakeholders* prompted us to review and reorganize the platform of our cor- porate philosophy, and we have rearranged it in the form of the new Omron Principles announced in May 2006. This review process resulted in our reaffirmation 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 established in 1959: “At work for a better life, a better world for all,” Omron has been managed on the basis of this corporate core value since its formulation. The Omron Group once again places this corporate core value at the center of the new Omron Principles and puts it into action with even stronger conviction. We are convinced that serving society is the true fulfillment of a company’s CSR. Omron intends to continue its management in conformity with the belief that only companies that add value and meet social needs can earn trust and respect from society as good corporate citizens, and thus successfully continue to exist as businesses. As society’s needs become more diversified and wide-ranging, and the social responsibilities that companies assume become even more multifaceted and evolving, it is crucial that companies meet society’s expectations. Disseminating and instilling The Omron Principles in All Staff at Omron The Omron Principles take on real meaning only when each and every employee of the company can describe them in his or her own words and put them into practice. This is because our people are the driving force for all of our corporate activities. Therefore, in 2006 when we announced the new Omron Principles, we distributed a booklet entitled the “Introduction to The Omron Principles” to all staff worldwide. However, our efforts did not stop at simply distributing these booklets. We also prepared two action guidelines and distributed these to all staff in the Omron Group in Japan. The first set of guidelines, CSR Practice Guidelines, specify the Group’s basic policy for addressing important CSR issues, which is a reflection of current worldwide trends, as well as define what all Omron Group direc- tors and employees should or should not adopt in conformance with this policy. The second booklet is “Implementing the Guiding Principles for Action,” which stipulates the key points of prac- tices for Omron Group directors and employees to put Guiding Principles for Action into practice in day-to-day operations. Following the distribution of the booklets, discussions at workplace meetings were held throughout the Omron Group in Japan on three occasions in May, July and December to January. The third meeting on the theme of the CSR Practice Guidelines evoked particularly meaningful discussion because a total of 42 briefings were given for all managerial class people in Japan before the meeting. * Stakeholders: Omron considers as its stakeholders employees and poten- tial employees, business partners, customers, shareholders & investors, and society (in other words, all those interested parties who are affected by Omron’s activities). 40 CSR Management System It is Omron’s firm belief that alignment of CSR with its busi- ness strategy and embedding it into its business operations is absolutely essential. In efforts to enhance the effectiveness and thoroughness of Omron’s CSR-oriented management by ensuring that CSR is more fully integrated into the business strategy, we established the CSR Management Department, within the Corporate Strategic Planning Headquarters, as a body under the direct control of the President & CEO. The CSR Management Department is responsible for the planning and general control of CSR within the company. Specific CSR activities, which include environmental conserva- tion, respect for human rights, promotion of appropriate labor standards, compliance and corporate ethics, and community relations, have been put into practice by assigning a CSR Manager at each internal business company. In addition, the CSR Promotion Committee coordinates CSR across the vari- ous divisions at headquarters. Under this committee there are also working groups which take up to various CSR themes and issues. Under this system, during the current second stage of GD2010, the Omron Group is promoting CSR activities built on three pillars, with particu- lar focus on four key issues. CSR Management Structure Internal Business Companies President & CEO President of Business Companies BC CSR Managers Business Divisions Japanese Affiliated Companies Overseas Affiliated Companies CSR Promotion Committee *1 Working Groups *1 CSR Promotion Committee: consists of administrative divisions, with the CSR Management Department at the center. *2 Head Office Administrative Divisions: Corporate Resources Innovation Headquarters, Business Process Innovation Headquarters, Monozukuri Innovation Headquarters, etc. Corporate Strategic Planning Headquarters CSR Management Department Head Office Administrative Divisions *2 Basic CSR policy — Three pillars (1) Contribute to a better society through business operations. Continuously offer advanced technologies, high-quality products, and services by stimulating innovation driven by social needs. (2) Always demonstrate fairness and integrity in the promotion of corporate activities. Promote more transparent corporate activities that maintain fairness and integrity not only through strict compliance with laws, regula- tions, and social rules but also through increased accountability. (3) Show a commitment to addressing societal issues as a con- cerned party. Address issues such as human rights, environment, diversity, and community relations in a way that draws on Omron‘s distinctive strengths. CSR activities — Four focus areas (1) Promoting innovation driven by social needs through business operations (2) Strengthening legal compliance and corporate ethics (3) Addressing diversity issues (4) Committing to environmental conservation Practicing CSR Four Focus Areas for CSR Resolving security issues in manufacturing operations was one example of our initiatives in the four focus areas of CSR in fiscal 2006. In addition, we also provided a system for improving quality management and traceability in food pro- duction sites. In promoting diversity in the work place, we made efforts to improve the employment rate of the disabled and increased the overall employment ratio of the disabled at Omron as of June 2006 to 2.04% (compared with 1.78% in June 2005), coming close to meeting 2.3%, which is a high level in manufacturing industries and is our goal. To promote greater participation of women in the workplace, albeit on a small scale, we have been conducting ongoing training of female leaders and, as a result, the ratio of women in man- agement is steadily increasing. We have also steadily imple- mented programs in compliance and environmental initiatives. Promoting CSR Activities in China Since 1979 when the company initiated technological exchange with China, Omron has built strong associations with the country. Beginning in 2001 Omron, based on the GD2010 plan, specified China as the most important strategic region and aggressively expanded business in the region. At present, more than 13,000 Chinese employees are working in Greater China, with the scale of production and sales expanding annu- ally. The results have been annual expansion in the economical, environmental and social impact of Omron’s businesses in China. Against this backdrop, we decided to give priority to our CSR activities in China that contribute to promoting harmo- nious social relations in areas where Omron has a presence, and initiate activities accordingly. Our principal activities conducted in China during fiscal 2006 included: (1) assignment of corporate ethics officers in each affiliated company, (2) employment of and support to peo- ple with disabilities, (3) the inclusion of additional CSR items in contract negotiations with 136 suppliers in Greater China and the signing of contracts with 75% of these, (4) group envi- ronmental audits (internal audits) at plants of two affiliated com- panies, and (5) the establishment of the Omron Education Fund. Tackling Environmental Issues The Omron Group has positioned environmental issues as one of its important management objectives. We have for- mulated action plans for the Group companies and headquarters divisions accordingly and we evaluate their implementation in terms of products, business places, and violation of environ- mental laws or regulations according to our Group environ- mental auditing standards, ranking companies and headquar- ters divisions from A to C. The assessment results are then reflected in the following year’s annual plan, and companies and headquarters divisions with a C rank are obliged to under- take additional investment in environmental protection in spe- cific environmental areas to promote improvement. In fiscal 2006, there were companies which were unable to reach their targets in curbing CO2, waste, and use of paper accompanying an increase in production. During fiscal 2007, we will focus our efforts on appropriate measures to address areas where goals have not yet been reached and to promote energy-saving meas- ures in distribution under the tighter provisions of the revised Law Concerning the Rational Use of Energy. For more details about Omron’s CSR activities, please see our Sustainability Report 2007. We would like to engage in dialog with as many of our stakeholders as possible. Taking the time to explain to you Omron’s views in response to your expectations of us and gaining your understanding of our activities and plans is, we believe, very important in fulfilling our role as a responsible and account- able corporate citizen. If you would like to learn more about Omron’s CSR principles, plans, and reports of activities to date, we would like to invite you to take a look at our report “Sustainability Report 2007” available on our website. We would appreciate hearing your opinions. http://www.omron.com/corporate/csr/ 41 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 21, 2007 DIRECTORS (7 persons), CORPORATE AUDITORS (4 persons) Chairman of the BOD Yoshio Tateisi President and CEO Hisao Sakuta Director and Executive Vice President Shingo Akechi Director and Executive Vice President Tadao Tateisi Senior Managing Director Tsukasa Yamashita Director (external) Noriyuki Inoue Director (external) Kazuhiko Toyama Corporate Auditor Tsutomu Ozako EXECUTIVE OFFICERS (24 persons) Executive Vice President Fumio Tateisi Senior Managing Officers Soichi Yukawa Yutaka Takigawa Managing Officers Koichi Imanaka Yoshinobu Morishita Takuji Yamamoto Yoshinori Suzuki Yukio Kobayashi Hideo Higuchi Toshio Ochiai Masaki Kobayashi Hiroki Toyama Kojiro Tobita Executive Officers Kazunobu Amemiya Yutaka Fujiwara Tatsunosuke Goto Mike van Gendt Toshio Yamashita Roberto Maietti Yoshisaburo Mogi Hiroshi Miyagawa Koichi Tada Kiichiro Kondo Shigeki Fujimoto Corporate Auditor (external) Satoshi Ando Corporate Auditor (external) Yoshio Nakano Corporate Auditor (external) Hidero Chimori 42 F I N A N C I A L S E C T I O N ( U . S . G A A P ) Contents Financial Highlights Six-year Summary Fiscal 2006 Management’s Discussion and Analysis Business and Other Risks Consolidated Balance Sheets Consolidated Statements of Income 43 44 45 50 52 54 Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Shareholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Independent Auditors’ Report 55 56 57 58 80 Notes: Financial Highlights, Six-year Financial Summary, Fiscal 2004 Management’s Discussion and Analysis (including Business and Other Risks) are unaudited. F I N A N C I A L H I G H L I G H T S OMRON Corporation and Subsidiaries For the year: Net sales Income before income taxes, minority interests, equity in loss of affiliates 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) Thousands of U.S. dollars (Note 2) (except per share data) FY2006 FY2005 FY2004 FY2006 ¥ 736,651 ¥626,782 ¥608,588 $ 6,242,805 66,288 38,280 38,280 64,845 36,964 35,763 54,031 30,176 30,176 561,763 324,407 324,407 ¥ 165.0 ¥ 156.2 ¥ 126.5 $ 164.9 156.1 124.8 165.0 164.9 34.0 151.1 151.1 30.0 126.5 124.8 24.0 1.40 1.40 1.40 1.40 0.29 Capital expenditures (cash basis) Research and development expenses (Note 3) ¥ 44,689 ¥ 40,560 52,028 55,315 ¥ 38,579 49,441 $ 378,720 440,915 At year end: Total assets Total shareholders’ equity ¥ 630,337 ¥589,061 382,822 362,937 ¥585,429 305,810 $ 5,341,840 3,244,254 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, 2007, of ¥118=$1. 3. A loss of ¥4,814 million 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 FY2005. 43 S I X - Y E A R S U M M A R Y OMRON Corporation and Subsidiaries Net sales (Note 2 and 3): 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 Other expenses (income), net Income (loss) before income taxes, Minority interests, equity in loss (earnings) of affiliates and cumulative effect of accounting change Income taxes Minority interests Equity in loss (earnings) of affiliates 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 (%) Equity ratio (%) Inventory turnover (times) Price/earning ratio (times) Assets turnover (times) Debt/equity ratio (times) Interest coverage ratio (times) FY2006 FY2005 FY2004 FY2003 FY2002 FY2001 Millions of yen (except per share data) ¥ 305,568 138,352 93,321 105,944 65,726 27,740 736,651 ¥ 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 34,727 535,073 452,452 168,135 52,028 — (2,252) 670,363 389,368 161,310 55,315 (41,339) (2,717) 561,937 358,817 144,219 49,441 — 2,080 554,557 344,835 142,157 46,494 — 3,511 536,997 327,413 135,112 40,235 — 27,522 530,282 ¥ 184,185 81,062 50,800 128,057 40,617 49,243 533,964 353,429 134,907 41,407 — 29,669 559,412 66,288 26,418 238 1,352 64,845 27,238 150 493 38,280 38,280 36,964 35,763 54,031 22,108 264 1,483 30,176 30,176 47,892 20,762 411 (92) 26,811 26,811 4,791 3,936 285 59 511 511 (25,448) (9,348) 132 (75) (16,157) (15,773) ¥ ¥ ¥ 165.0 164.9 156.2 156.1 ¥ 126.5 124.8 ¥ 110.7 107.5 ¥ 2.1 2.1 ¥ (65.0) (65.0) 165.0 164.9 34.0 44,689 630,337 382,822 151.1 151.1 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 38.6 9.0 5.2 10.9 10.3 60.7 5.35 19.1 1.21 0.647 59.60 37.9 10.3 5.7 11.0 10.7 61.6 5.43 22.2 1.07 0.623 71.43 41.0 8.9 5.0 9.2 10.4 52.2 5.17 18.5 1.03 0.914 53.36 41.0 8.2 4.6 8.3 10.2 46.4 4.73 23.3 1.01 1.156 43.27 38.8 0.9 0.1 0.9 0.2 44.3 4.36 900.8 0.96 1.255 23.59 33.8 (4.8) (3.0) (4.5) (5.1) 54.3 4.25 — 0.93 0.842 4.36 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 FY2002 and FY2001 have been reclassified in accordance with the change. 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. 44 F I S C A L 2 0 0 6 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 Market Environment Note: The macro indicators may be changed in subsequent revisions. The figures presented are the newest data as of the end of June 2007. 1. Macroeconomic Environment The Japanese economy improved steadily as corporate prof- its improved and capital investment increased, in addition to which there were improvements in employment and income situations. While there were concerns for the U.S. economy such as adjust- ments in the housing sector, it held firm supported by capital investment and consumer spending. The European economy also did well overall where improved corporate earnings led to increased capital investment and as consumer spending recov- ered. As Asian economies continued to expand led by exports, in particular China maintained its high rate of growth. Furthermore, India has shown remarkable economic growth. Growth rates of real GDP for each country (calendar year basis) 2000 2001 2002 2003 2004 2005 2006 Japan 2.9 0.2 0.3 1.4 2.7 1.9 2.2 U.S. 3.7 0.8 1.6 2.5 3.9 3.2 3.3 Canada 5.2 1.8 2.9 1.9 3.1 3.1 2.8 Germany 3.2 1.2 0.0 -0.2 1.3 0.9 2.8 France 4.0 1.8 1.1 1.1 2.3 1.7 2.2 U.K. 3.8 2.4 2.1 2.7 3.3 1.9 2.8 Italy 3.8 1.7 0.3 0.1 1.0 0.2 1.9 Russia 10.0 5.1 4.7 7.3 7.2 6.4 6.7 China 8.4 8.3 9.1 10.0 10.1 10.4 10.7 Korea 8.5 3.8 7.0 3.1 4.7 4.2 5.0 India 4.4 5.8 3.8 8.5 7.5 8.8 9.4 Brazil 4.3 1.3 2.7 1.1 5.7 2.9 3.7 Source: Cabinet Office “Overseas Economic Data” June 2007, etc. Domestic Macroeconomic Environment Real Private Capital Investment Growth Rate (%) 10.0 5.0 0 -5.0 -10.0 Machinery Orders Growth Rate (Manufacturing) Indices of Electronic Parts and Devices (Seasonally adjusted indices, 2000 average =100) (Billions of yen) 1,600 1,500 1,400 1,300 (%) 10.0 180 5.0 140 0 100 -5.0 60 97 98 99 00 01 02 03 04 05 06 (FY) Note: Change from the previous year, seasonally adjusted Source: Cabinet Office, Government of Japan Q1 Q2 Q3 2005 Q4 Q1 Q2 Q3 2006 Q4 (FY) Orders (left axis) Change from the previous quarter (right axis) Note: Seasonally adjusted Source: Cabinet Office, Government of Japan 00 01 02 03 04 05 06 (FY) Shipments Productions Inventory Source: Ministry of Economy, Trade and Industry 2. Market Trends Affecting the Omron Group The market environment surrounding the Omron Group was favorable for the main product area of factory automation control equipment supported by demand for capital investment, and was solid for business and consumer equipment for IT and digital related products as the electronic parts industry recovered. Growth con- tinued for automotive electronics as the needs remained high for car electronics in the safety and environmental areas. Furthermore, as railroad companies all over Japan increased reciprocal use of IC cards, demand for updating equipment in rail- way stations increased. Rising costs for raw materials such as copper and silver were factors putting pressure on profits. Silver and Copper Prices (Yen/kg) 60,000 50,000 40,000 30,000 20,000 10,000 0 03 04 05 06 (FY) Silver (left axis) Copper (right axis) (Yen/kg) 1,200 1,000 800 600 400 200 0 45 General Overview of Consolidated Results and Financial Condition In this market environment the Company experienced real growth in its existing businesses, and with a proactive implementation of a growth strategy including M&A activities, as well as the depreciation of the yen, Group sales grew 17.5 percent over the previous fiscal year. In addition, income before income taxes, minority interests, equity in loss of affiliates and cumulative effect of accounting change, (“net income before income taxes” hereafter) and net income increased by 2.2 percent and 7.0 percent, respectively so that the Company has achieved increases in both sales and profits for five consecutive years, and both sales and profits were at record highs. Total assets increased 7.0 percent over the previous fiscal year due to the assets of acquired companies. Meanwhile, share- holders’ equity increased 5.5 percent over the previous fiscal year, and the shareholders’ equity ratio was 60.7 percent, compared to 61.6 percent at the end of the previous fiscal year. Return on equity (ROE) was 10.3 percent due to the increase in net income, and the Group has cleared its goal of maintaining a level of 10 percent for four consecutive years. Review and Analysis of the Income Statement Note 1: The following business segment abbreviations are used in the discussion 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/ loss (excluding adjustment of income returned) recognized on the transfer of the substitutional portion of employee pension funds in fiscal year 2006 is included in the presentation of “cost of sales,” “selling, general & administrative 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 adjustment of income returned is allocated in one lump sum to the gain on transfer of the substitutional portion of the employees’ pension fund. Sales Consolidated net sales, generally boosted by growth in existing businesses, the depreciation of the yen, and the acquisitions of OSTI and OPT (refer to Note 5 on page 63) increased 17.5 percent over the previous year to ¥736.7 billion. All segments recorded increased revenues, and in particular the acquisition of OPT con- tributed to ECB, and sales for SSB grew significantly due to the boost from demand for improvement and replacement of equip- ment in railway stations throughout Japan to accommodate the implementation of IC cards for boarding passes. In addition, revenues increased in all regions, with net sales up by 9.3 percent over the previous fiscal year in Japan, and by 28.2 percent overseas (overseas sales comprised 47.3 percent of total sales). In particular sales in the region that the Group places the most importance on, Greater China, posted remarkable growth over the previous fiscal year at 66.4 percent. OSTI: Omron Scientific Technologies, Inc. Business lines: Capital: Development, manufacturing, sales, consulting, and service of safety equipment US$10,000 (wholly owned by OMRON MANAGEMENT CENTER OF AMERICA INCORPORATED) Date shares acquired: September 12, 2006 Location: Employees: Sales: Fremont, California, U.S.A. 320 $52,141,000 (for the year ended December, 2005) OPT: Omron Precision Technology Co., Ltd. Business lines: Sales composition in fiscal 2005 was 85 percent small liquid crystal backlighting and 15 percent rubber and metal molding ¥448 million (wholly owned by Omron Corporation) Capital: Date shares acquired: August 1, 2006 Location: Employees: Sales: Saitama Prefecture about 270 (as of July 1, 2006, non-consolidated) ¥36.4 billion (for the year ended March 2006) Cost of Sales and SG&A Expenses Other Expenses (Income) * See Note 11 on page 72 In line with the overall growth in sales, the cost of sales and SG&A expenses increased 21.2 percent and 10.1 percent, respectively. The cost of sales margin rose 1.8 percentage points over the previous year due to the effect of soaring prices for copper, silver and other raw materials. As a result of efforts to achieve the target revenue structure for the 2nd Stage of GD2010, the SG&A expense ratio was reduced by 1.5 percentage points from the previous fiscal year. Meanwhile, R&D expenses rose ¥1.5 billion over the previous fiscal year to ¥52.0 billion. However, the R&D expense ratio fell by 1 per- centage point from the previous fiscal year to 7.1 percent as net sales increased. Furthermore, the Group will not change its policy of active investment in R&D, but will strive for more efficient operations and we estimate that in fiscal 2007 the R&D expense ratio will be maintained at the same level of 7.1 percent. Note: SG&A expenses include neither research & development expenses nor the profits from transfer of employee pension funds. The net amount of other expenses (income) was a net gain of ¥2.3 billion. While gains from sales of investment securities declined by ¥3.3 billion from the previous fiscal year, and there was a loss of ¥5.9 billion from the sale of property at the Tokyo head office, there was a gain on the contribution of securities to retirement benefit trusts of ¥10.1 billion, which covered the losses. Net Income before Income Taxes, Net Income and Profit Distribution Due to the results noted above, net income before income taxes increased by ¥1.4 billion (2.2 percent) over the previous year to ¥66.3 billion, and net income increased ¥2.5 billion (7.0 percent) over the same period to ¥38.3 billion. In addition, basic net income per share was ¥165.0 (¥151.1 in the previous year). Based on our profit distribution policy (see page 17), an annual dividend of ¥34 per share was paid (¥4 higher than in the previous fiscal year). 46 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 expenses (income), net Income before income taxes, minority interests, equity in loss of affiliates and cumulative effect of accounting change Income taxes Income before cumulative effect of accounting change Cumulative effect of accounting change Net income Net Sales & Net Income before Income Taxes (Billions of yen) 800 (Billions of yen) 160 Net Income & ROE (Billions of yen) 50 600 400 200 0 120 80 40 0 40 30 20 10 0 FY2006 100.0% 61.4 38.6 22.8 7.1 — (0.1) 9.0 3.6 5.2 — 5.2 (%) 12.5 10.0 7.5 5.0 2.5 0 FY2005 100.0% 62.1 37.9 25.8 8.8 — (0.1) 59.6* 40.4* 24.3* 8.1* (1.9)* 10.3 4.4 5.9 (0.2) 5.7 Dividends per Share FY2004 100.0% 59.0 41.0 23.7 8.1 — (0.0) 8.9 3.6 5.0 — 5.0 (Yen) 40 30 20 10 0 34 30 24 20 10 02 03 04 05 06 (FY) 02 03 04 05 06 (FY) 02 03 04 05 06 (FY) Net sales (left axis) Net income before income taxes (right axis) Net income (left axis) ROE (right axis) Segment Information *Prepared in accordance with Japanese Securities Exchange Law Note 1: Disclosure of operating income Sales in the segment information column show sales to external customers, excluding inter-segment transactions. Conversely, operating income shows operating income including internal profits, prior to the deduction of amounts such as inter-segment transactions and headquarters expenses that are not apportionable. Note 2: The comparison with the previous fiscal year is calculated based on a comparison of the results for the current fiscal year and the profit/loss for the previous fiscal year before the transfer of the substitutional portion of the employee pension funds. * Please refer to pages 20 to 30 for details on the business results, prospects for fiscal 2007 and strategy of each segment. 1. Conditions by Business Segments IAB enjoyed good orders, and OSTI, which became a subsidiary in September 2006, contributed so that net sales increased 12.1 per- cent over the previous fiscal year to ¥305.6 billon, and operating income increased 15.7 percent over the same period to ¥48.5 billion. In addition to existing ECB businesses, OPT, which became a subsidiary in August 2006, contributed so that net sales increased 41.6 percent over the previous fiscal year to ¥138.4 billion, and operating income increased 16.9 percent over the same period to ¥13.1 billion. Net sales in AEC grew 20.3 percent from the previous fis- cal year to ¥93.3 billion based on the need for car electronics to provide for safety and concern for the environment. However, due to soaring raw material prices and the delay in improvements in productivity at North American facilities, the Company recorded an operating loss of ¥1.2 billion (the operat- Growth in Net Sales by Business Segment FY2006 FY2005 FY2004 IAB ECB AEC SSB HCB Other 12.1% 41.6 20.3 15.4 7.6 6.9 8.9% (3.4) 20.2 (20.3) 20.8 (3.2) 9.0% 13.6 9.7 (15.3) 7.7 9.4 Note: For FY2004, Social Systems Business includes “Social Systems Solutions and Service Business Company” and “Financial Systems Business Company.” 47 ing loss in the previous fiscal year was ¥2.0 billion). Composition of Net Sales by Business Segment As railway boarding passes shifted to using IC cards across Japan, there was demand to improve or replace automated passenger gate and automatic ticket vendors, and SSB net sales increased 15.4 percent over the previous fiscal year to ¥105.9 billion. Meanwhile the effects of structural reform began to emerge and operating income increased 82.0 percent over the same period to ¥8.1 billion. HCB was boosted by a worldwide movement to prevent lifestyle related illness and recorded a 7.6 percent increase in net sales over the previous fiscal year to ¥65.7 billion. However, oper- ating income recorded only an 0.4 percent increase over the same period to ¥8.7 billion, due to the inclusion of expenses for restruc- turing the business and price competition on a global scale. Other business was primarily in the Business Development Group, which searches for and fosters new businesses, and is in charge of fostering and strengthening businesses that are 2. Review of Sales by Region Japan Net sales grew solidly in IAB and ECB as capital investment in semiconductors and digital household appliances continued to be high. Also, net sales in SSB grew significantly on demand for improvements and replacement to the railway station equipment as railway boarding passes using IC cards were introduced nationwide. Meanwhile, AEC net sales remained level with the previous fiscal year as the domestic market for sales of new automobiles matured. As a result, total net sales in Japan increased 11.2 percent over the previous fiscal year to ¥412.1 billion, and operating income increased by 17.7 percent over the same period to ¥62.3 billion. North America Net sales in IAB and ECB grew solidly as capital investment remained firm. Also, net sales in AEC grew with the launch of new products in wireless control equipment, power window switches and others. As a result, net sales in North America increased 23.0 percent over the previous fiscal year to ¥98.0 bil- lion, but operating income decreased 27.1 percent over the same period to ¥300 million. Europe As capital investment in Europe increased along with improved earnings at European corporations, net sales at IAB grew, center- ing on inverters and servomotors. Also, AEC and HCB performed solidly. As a result, net sales in Europe increased 17.6 percent over the previous fiscal year to ¥116.4 billion, and operating income increased 40.8 percent over the same period to ¥10.3 billion. Financial Condition Assets Total assets rose ¥41.2 billion (7.0 percent) from the previ- ous fiscal year to ¥630.3 billion. Trade notes and accounts receivable both increased ¥36.7 billion from the previous fiscal year along with the increase in net sales due to improved busi- ness results and acquisitions (refer to Note 5 on page 63), and inventory increased ¥19.2 billion in the same period. Meanwhile, land was reduced by ¥18.3 billion from the previ- ous fiscal year due to a loss from the sale of land and buildings of the Tokyo head office, and investment securities were reduced ¥15.7 billion by such factors as establishment of a retirement benefits trust. IAB ECB AEC SSB HCB Other FY2006 FY2005 FY2004 41.5% 43.5% 41.1% 18.8 12.7 14.4 8.9 3.7 15.6 12.4 14.6 9.7 4.2 16.6 10.6 18.9 8.3 4.5 Note: The composition of net sales is based on the classifications reported in the Six-year Summary. not handled by division companies. The total net sales for other segments increased 6.9 percent over the previous fiscal year to ¥27.7 billion, and operating income increased 44.8 percent in the same period to ¥2.4 billion. Greater China As a result of actively investing in strengthening our marketing in China, where high growth is expected, IAB’s net sales grew signifi- cantly. Also, the sales of the subsidiary of OPT contributed greatly to ECB. As a result, net sales in Greater China increased 66.4 per- cent over the previous fiscal year to ¥69.4 billion, and operating income increased 44.5 percent in the same period to ¥1.5 billion. Southeast Asia and Others IAB and ECB performed solidly as export led economies expanded. As a result, net sales in Southeast Asia increased 14.0 percent over the previous fiscal year to ¥40.7 billion, and operating income increased 7.2 percent in the same period to ¥4.0 billion. Sales Breakdown, by Region (%) 100 80 60 40 20 0 4.8% 5.6% 15.2% 10.8% 5.7% 6.7% 15.8% 12.7% 5.5% 9.4% 15.8% 13.3% 63.7% 59.1% 55.9% North America Japan Europe Greater China Southeast Asia and Others 04 05 06 (FY) Liabilities and Shareholders’ Equity The total of current liabilities, long-term liabilities and minority interests increased ¥21.4 billion (9.5 percent) from the previous fis- cal year to ¥247.5 billion. The major factors behind the increase were an increase in short-term liabilities by ¥17.4 billion from the previous fiscal year to ¥19.9 billion, and increases in other current liabilities and deferred income taxes (refer to Note 12 on page 72). In addition, interest bearing debt outstanding increased ¥18.0 billion from the previous fiscal year due to the effects of M&A activities (refer to Note 7 on page 64), to ¥21.8 billion. However, accrued retirement benefits (refer to Note 9 on page 66) decreased ¥14.3 billion (21.4 percent) from the previous fiscal year. Shareholders’ equity rose ¥19.9 billion from the previous 48 fiscal year (5.5 percent) to ¥382.8 billion. While net income was ¥38.3 billion and foreign currency translation adjustments increased ¥7.9 billion, treasury stock increased ¥10.6 billion (a decrease in shareholders’ equity). As a result the shareholders’ equity ratio fell 0.9 percentage points from the previous fiscal year to 60.7 percent, and the debt/equity ratio rose from 0.623 to 0.647 over the same period. In addition, net assets per share based on the number of shares outstanding at the end of the year was ¥1,660.68, compared to ¥1,548.07 at the end of the previous fiscal year. Working Capital & Current Ratio (Billions of yen) 200 150 100 50 0 Outstanding Interest-Bearing Debts & Debt/Equity Ratio (Billions of yen) 80 (Times) 2.0 60 40 20 0 1.5 1.0 0.5 0 (%) 200 175 150 125 100 02 03 04 05 06 (FY) Working capital (left axis) Current ratio (right axis) 02 03 04 05 06 (FY) Outstanding interest-bearing debts (left axis) Debt/equity ratio (right axis) Cash Flows Cash and cash equivalents at the end of the year came to ¥43.0 billion, down ¥9.3 billion from the previous year. The sit- uation regarding cash flows was as follows. Cash Flow from Operating Activities Cash flow from operating activities was ¥40.5 billion, an inflow decrease of ¥11.2 billion from the previous year. Although we recorded the contribution of the establishment of an employee retirement benefit trust, and accounts receivable and inventories increased, net income was ¥38.3 billion and depreciation and amortization, a non-cash item, also increased. Cash Flow from Investing Activities Cash flow from investing activities saw a net outflow of ¥47.1 billion, an increase of ¥4.1 billion over the previous year. While inflow increased due to the sale of the land and build- ings belonging to the Tokyo head office, our active investment in growth opportunities and our acquisitions of OSTI and OPT led to increased expenditure overall. Overview of Capital Expenditures In the fiscal year under review most of our capital expenditures were for buildings and structures, machinery and equipment, and molds for IAB, ECB, and AEC. Total capital expenditures (including investments in intangible fixed assets and long-term prepaid expens- es) were ¥44.4 billion, an 8.1 percent increase over the previous year. Looking at the results by region, capital expenditures were higher in all areas than in the previous year and in particular we made a large number of forward-looking investments in China, which is expected to achieve higher growth. Capital expenditures by business segment were as follows. Total capital expenditures in IAB and ECB, business segments in which we are accelerating investments for growth, were cen- tered on enhancements to manufacturing facilities and increased 37.2 percent to ¥13.7 billion, and 81.4 percent to ¥12.8 billion, Cash Flow from Financing Activities Cash flow from financing activities saw a net outflow of ¥4.7 bil- lion (an improvement of ¥33.6 billion over the previous year due to the impact of our repayment of borrowings in the previous year). Although short-term debt increased, our acquisition of treasury stock and payment of dividends led to a net outflow overall. Free Cash Flow (Billions of yen) 50 40 30 20 10 0 -10 02 03 04 05 06 (FY) respectively. On the other hand, in AEC capital expenditures were centered on enhancements to manufacturing facilities and declined 20.4 percent to ¥8.9 billion. In SSB capital expenditures were centered on upgrading manufacturing facilities and decreased 8.4 percent to ¥3.9 billion. In HCB capital expendi- tures were centered on enhancements to sales and administra- tive capacity and decreased 5.3 percent to ¥1.5 billion. Lastly in other businesses capital expenditures decreased 48.3 percent to ¥3.6 billion. Total capital expenditures for fiscal 2007 are expected to be ¥45.0 billion, 1.2 percent higher than in fiscal 2006. 49 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, 2007. shifts. The Omron Group seeks to hedge against exchange rate risk in such ways as balancing 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 condition. (1) Economic Conditions The primary business of the Omron Group is consumer and com- mercial electronic components used in the manufacture of elec- trical and electronic equipment, as well as control system equip- ment used by manufacturing sectors and in capital investment related areas. Accordingly, demand for Omron Group products is affected 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 affect- ing suppliers to, and purchasers from, the Omron Group can result in the contraction of demand for our products, thereby possibly having a negative impact on the Group’s operating results and financial 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 regula- tions, changes in tax systems, labor shortages and problems in the labor-management relationship, epidemics, and terrorism, wars, and other political circumstances. These 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 121 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 percentage of consolidated net sales account- ed for by overseas sales during the fiscal year ended March 31, 2007 was 47.3 percent, and Omron expects further increases in the overseas operations ratio due to factors such as production (4) Product Defects Based on its core corporate value of “working for the benefit of society,” the Omron Group has declared maximum customer satisfaction to be one of its management philosophies and imple- ments it 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 control system, and develops and manufactures its prod- ucts accordingly. A Group-wide quality check system 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 lia- bility-related damages could impose huge costs, severely influ- ence evaluations of the Omron Group, and 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 elec- tric 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 with a view to completely eliminating regulated substances from all the Group’s products throughout the world in order to make them environmentally friendly products. However, delays in the switchover beyond customer deadlines due to a late response by suppliers in providing substitute components and other factors could result in liability-related damages or a violation of the EU directive, which could have a negative 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 remains at approximately 7 percent. The Omron Group strives to increase the new product con- 50 tribution 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 personal information and classified information of customers through its business processes and acquires important information in the course of business. The Omron Group is taking steps to reinforce control over the infor- mation the Group handles and to further improve employees’ information literacy, with the goal of preventing external entry into its internal information systems and misappropriation by third parties resulting from theft or loss of that information. Unanticipated leakage of internal information, however, due for example to invasion of internal information systems using technology exceeding implemented security levels, could exert a negative 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 com- petitors. However, it is impossible to completely protect all of the Group’s intellectual property consisting of proprietary tech- nology and expertise, due to legal restrictions in specific regions, including China, and conditions that allow only limited protec- tion. At present, the Omron Group is working on intellectual property protection 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 property 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 activities. 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, although Omron is monitoring the registration of illegal domain names on a global level and on a daily basis, it is dif- ficult to identify and deal with all businesses and organizations registering and using similar domain names, and there is a danger that such entities will resort to unethical business practices such as the use of identical or similar domain names which could dam- age the Group’s reputation. This is not limited to the problem of imitation products and domain names; when exercising our intel- lectual property rights, including the granting or assigning of licens- es for the intellectual property of the Omron Group, disputes could arise with third parties, such as oppositional tactics from the party which is subject to the exercise of rights. 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 against 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 com- pensation 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, and this could exert a negative impact on the Omron Group’s operating results and financial condition. (8) Natural Disasters Because of the possibility of reduction of production capability, temporary disruption of distribution and sales routes, or other con- sequences of a natural disaster, fire or other calamity, including a large-scale earthquake in areas such as Tokai and Tonankai or directly below the Tokyo area, the Omron Group has identified risks and implemented the necessary safety measures and meas- ures for continuation and early recovery 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 nat- ural disaster, fire or other calamity could exert a negative impact on the Omron Group’s operating results and financial condition. 51 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, 2007 and 2006 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) 2007 2006 2007 ¥ 42,995 ¥ 52,285 $ 364,364 175,700 139,001 1,488,983 (2,297) 94,109 19,985 11,567 (2,653) 74,958 18,571 10,151 (19,466) 797,534 169,364 98,026 Total current assets 342,059 292,313 2,898,806 Property, plant and equipment: Land Buildings Machinery and equipment Construction in progress 28,271 125,227 175,398 6,389 46,571 117,414 159,254 8,180 239,585 1,061,246 1,486,423 54,144 Total 335,285 331,419 2,841,398 Accumulated depreciation (175,970) (163,802) (1,491,271) Net property, plant and equipment 159,315 167,617 1,350,127 Investments and other assets: Investments in and advances to affiliates Investment securities (Note 4) Leasehold deposits Deferred income taxes (Note 12) Other (Note 6) 16,677 46,770 8,650 17,293 39,573 16,135 62,477 8,553 15,892 26,074 141,331 396,356 73,305 146,551 335,364 Total investments and other assets 128,963 129,131 1,092,907 Total See notes to consolidated financial statements. ¥ 630,337 ¥ 589,061 $ 5,341,840 52 LIABILITIES AND SHAREHOLDERS’ EQUITY 2007 2006 2007 Millions of yen Thousands of U.S. dollars (Note 2) Current liabilities: Short-term debt (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) ¥ 19,868 ¥ 2,468 $ 168,373 91,543 32,548 11,467 33,170 264 85,224 28,683 12,288 26,701 296 775,788 275,831 97,178 281,102 2,237 Total current liabilities 188,860 155,660 1,600,509 Long-term debt (Note 7) 1,681 1,049 14,246 Deferred income taxes (Note 12) 2,006 673 17,000 Termination and retirement benefits (Note 9) 52,700 67,046 446,611 Other long-term liabilities 830 571 7,034 Minority interests in subsidiaries 1,438 1,125 12,186 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 – 18,599,842 shares in 2007 and 64,100 64,100 543,220 98,828 8,256 258,057 (3,013) 98,724 8,082 227,791 (2,971) 837,525 69,966 2,186,924 (25,534) 14,676,607 shares in 2006 (43,406) (32,789) (367,847) Total shareholders’ equity 382,822 362,937 3,244,254 Total See notes to consolidated financial statements. ¥ 630,337 ¥ 589,061 $ 5,341,840 53 C O N S O L I D AT E D S TAT E M E N T S O F I N C O M E OMRON Corporation and Subsidiaries Years ended March 31, 2007, 2006 and 2005 Net sales Costs and expenses: Cost of sales Selling, general and administrative expenses Research and development expenses Subsidy from the government (Note 9) Other expenses (income), net (Note 11) Millions of yen Thousands of U.S. dollars (Note 2) 2007 2006 2005 2007 ¥ 736,651 ¥ 626,782 ¥ 608,588 $ 6,242,805 452,452 168,135 52,028 — (2,252) 389,368 161,310 55,315 (41,339) (2,717) 358,817 144,219 49,441 — 2,080 3,834,339 1,424,873 440,915 — (19,085) Total 670,363 561,937 554,557 5,681,042 Income before income taxes, minority interests, equity in loss of affiliates and cumulative effect of accounting change 66,288 64,845 54,031 561,763 Income taxes (Note 12) 26,418 27,238 22,108 223,881 Income before minority interests, equity in loss of affiliates and cumulative effect of accounting change 39,870 37,607 31,923 337,882 Minority interests 238 150 264 2,017 Equity in loss of affiliates Income before cumulative effect of accounting change 1,352 38,280 493 36,964 1,483 30,176 11,458 324,407 Cumulative effect of accounting change, net of tax (Note 9) — (1,201) — — Net income ¥ 38,280 ¥ 35,763 ¥ 30,176 $ 324,407 Per share data (Note 14): Income before cumulative effect of accounting change Basic Diluted Net income Basic Diluted See notes to consolidated financial statements. 2007 Yen 2006 U.S. dollars (Note 2) 2005 2007 ¥ 165.0 164.9 ¥ 156.2 156.1 ¥ 126.5 124.8 $ 1.40 1.40 165.0 164.9 151.1 151.1 126.5 124.8 1.40 1.40 54 CONSOLIDATED STATEMENTS OF C O M P R E HE N S I V E IN C O ME ( L OSS) OMRON Corporation and Subsidiaries Years ended March 31, 2007, 2006 and 2005 Millions of yen Thousands of U.S. dollars (Note 2) 2007 2006 2005 2007 ¥ 38,280 ¥ 35,763 ¥ 30,176 $ 324,407 Net income Other comprehensive income (loss), net of tax (Note 16): Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year 7,907 9,201 5,071 67,008 Reclassification adjustment for the portion realized in net income Net change in foreign currency translation adjustments during the year 6 — — 51 7,913 9,201 5,071 67,059 Minimum pension liability adjustments 1,658 19,940 4,115 14,051 Unrealized gains (losses) on available-for-sale securities: Unrealized holding gains (losses) arising during the year (560) 10,905 1,274 (4,746) Reclassification adjustment for losses on impairment realized in net income Reclassification adjustment for net gains on sales realized in net income Reclassification adjustment for net gains on contribution of 85 287 13 720 (475) (2,430) (465) (4,025) securities to retirement benefit trust realized in net income (5,983) — — (50,703) Net unrealized gains (losses) (6,933) 8,762 822 (58,754) Net gains (losses) on derivative instruments: Net losses on derivative instruments designated as cash flow hedges during the year Reclassification adjustment for net losses realized in net income Net gains (losses) (1,208) (1,282) (1,004) (10,237) 1,172 1,417 (36) 135 546 (458) 9,932 (305) Other comprehensive income 2,602 38,038 9,550 22,051 Comprehensive income ¥ 40,882 ¥ 73,801 ¥ 39,726 $ 346,458 See notes to consolidated financial statements. 55 C O N S O L I D AT E D S TAT 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, 2007, 2006 and 2005 Number of common shares issued Common stock Capital surplus Legal reserve Retained earnings Accumulated other comprehensive income (loss) Treasury stock Millions of yen Balance, April 1, 2004 249,109,236 ¥ 64,082 ¥ 98,705 ¥ 7,450 ¥ 175,296 ¥ (50,559) ¥ (20,264) Net income Cash dividends, ¥24 per share Transfer to legal reserve Other comprehensive income Acquisition of treasury stock Sale of treasury stock Conversion of convertible bonds 12,136 18 Exercise of stock options 30,176 (5,713) (199) 199 3 19 (1) 9,550 (3,065) 16 1 105 (9) Balance, March 31, 2005 249,121,372 64,100 98,726 7,649 199,551 (41,009) (23,207) 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 35,763 (7,078) (433) 433 1 (3) (12) 38,038 (10,075) 2 491 Balance, March 31, 2006 249,121,372 64,100 98,724 8,082 227,791 (2,971) (32,789) Net income Cash dividends, ¥34 per share Transfer to legal reserve Other comprehensive income Adjustment to initially apply SFAS No.158 (Note 9) Acquisition of treasury stock Sale of treasury stock Exercise of stock options Grant of stock options 38,280 (7,839) (174) 174 2,602 (2,644) (1) (11,204) 2 585 1 10 93 Balance, March 31, 2007 249,121,372 ¥ 64,100 ¥ 98,828 ¥ 8,256 ¥ 258,057 ¥ (3,013) ¥ (43,406) Thousands of U.S. dollars (Note 2) Common stock Capital surplus Legal reserve Retained earnings Accumulated other comprehensive income (loss) Treasury stock Balance, March 31, 2006 $ 543,220 $ 836,644 $ 68,491 $ 1,930,432 $ (25,178) $ (277,873) Net income Cash dividends, $0.29 per share Transfer to legal reserve Other comprehensive income Adjustment to initially apply SFAS No.158 (Note 9) Acquisition of treasury stock Sale of treasury stock Exercise of stock options Grant of stock options 324,407 (66,432) (1,475) 1,475 22,051 (22,407) (8) (94,949) 17 4,958 8 85 788 Balance, March 31, 2007 $ 543,220 $ 837,525 $ 69,966 $ 2,186,924 $ (25,534) $ (367,847) See notes to consolidated financial statements. 56 C O N S O L I D AT E D S TAT 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, 2007, 2006 and 2005 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 investment securities Loss on impairment of investment securities and other assets Bad debt expenses Subsidy from the government Gain on contribution of securities to retirement benefit trust Termination and retirement benefits Deferred income taxes Minority interests Equity in loss of affiliates Cumulative effect of accounting change Net 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 investment securities Purchase of investment securities Capital expenditures Decrease (increase) 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 borrowings (repayments) of short-term debt 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 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) 2007 2006 2005 2007 ¥ 38,280 ¥ 35,763 ¥ 30,176 $ 324,407 33,923 30,825 28,642 287,483 6,445 1,441 (954) 682 — — (10,141) (1,403) 3,887 238 1,352 — — (19,773) (13,955) 2,248 (5,674) (2,244) 6,480 (293) 2,259 40,539 1,643 (2,108) (44,689) (9) 17,930 (15) (1,189) — (18,638) (47,075) 13,812 242 (455) (7,680) (9) (11,204) 3 594 (4,697) 1,943 (9,290) 52,285 ¥ 42,995 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 6,830 (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) 1,307 (28,334) 80,619 ¥ 52,285 918 614 (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 1,867 (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) 1,218 (14,440) 95,059 ¥ 80,619 54,619 12,212 (8,085) 5,780 — — (85,941) (11,890) 32,941 2,017 11,458 — — (167,568) (118,263) 19,051 (48,085) (19,017) 54,915 (2,483) 19,144 343,551 13,923 (17,865) (378,720) (76) 151,949 (127) (10,076) — (157,949) (398,941) 117,051 2,051 (3,856) (65,085) (76) (94,949) 25 5,034 (39,805) 16,466 (78,729) 443,093 $ 364,364 57 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 TAT 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 tech- nologies. 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-automiza- tion 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 com- ponents for automobiles and automotive electronic components manufacturers throughout the world. Social Systems Solutions 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 purposes 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 information 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 conform to 2007 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 con- formity with accounting principles generally accepted in the United States of America requires management to make esti- mates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and lia- bilities 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 clas- sified 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 con- secutive months. The Companies may also consider other fac- tors, including their ability and intent to hold the applicable invest- ment securities until maturity, and the severity of the decline in fair value. Other investments are stated at the lower of cost or esti- mated net realizable value. The cost of securities sold is deter- mined on the average cost basis. Inventories Inventories are stated at the lower of cost, determined by the first-in, first-out method, or market. 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. 58 Goodwill and Other Intangible Assets The Companies account 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 impairment 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 impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value. Assets to be disposed of other than by sale are considered held and used until disposed of. Assets to be dis- posed 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 ¥10,315 million ($87,415 thousand), ¥10,290 million and ¥8,718 million for the years ended March 31, 2007, 2006 and 2005, respectively. Shipping and Handling Charges Shipping and handling charges were ¥8,851 million ($75,008 thousand), ¥7,627 million and ¥7,720 million for the years ended March 31, 2007, 2006 and 2005, respectively, and are included in selling, general and administrative expenses in the consolidat- ed statements of income. Termination and retirement benefits Deferred income taxes (Investments and other assets) Accumulated other comprehensive loss Termination and retirement benefits Deferred income taxes (Investments and other assets) Accumulated other comprehensive loss Termination and Retirement Benefits Termination and retirement benefits are accounted for in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” based on the fiscal year-end fair value of plan assets and the projected benefit obligations of employees, and are disclosed in accordance with SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” and SFAS No. 158. 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 pre- viously used December 31 as the measurement date for pro- jected benefit obligation and plan assets of the termination and retirement benefits. During the year ended March 31, 2006, the companies changed the measurement date to March 31. The purpose of this change was 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 benefits, in the projected benefit obligation and retire- ment benefit expense. A cumulative effect (net of tax) of this change was recog- nized in the consolidated statement of income for the year ended March 31, 2006, which reduced net income for the period by ¥1,201 million. On March 31, 2007, the Companies adopted the recognition and disclosure provisions of SFAS No. 158. SFAS No. 158 required the Companies to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of their pension plans in the March 31, 2007 consolidated balance sheet, with a corresponding adjustment to accumulated other comprehensive income (loss) as pension liability adjustments. Before adoption of SFAS No. 158, an additional minimum pension liability was recognized based on a plan’s accumulated benefit obligation (projected benefit obligation, less future compensation increase), pursuant to SFAS No. 87. The incremental effects of adopting the provisions of SFAS No. 158 on the accompanying consolidated balance sheet at March 31, 2007 are presented in the following table. Before Application of SFAS No.158 Millions of yen Adjustments After Application of SFAS No.158 ¥ (48,219) ¥ (4,481) ¥ (52,700) 15,456 (369) 1,837 (2,644) 17,293 (3,013) Thousands of U.S. dollars Before Application of SFAS No.158 Adjustments After Application of SFAS No.158 $ (408,635) $ (37,975) $ (446,610) 130,983 (3,127) 15,568 (22,407) 146,551 (25,534) 59 Income Taxes Deferred income taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabil- ities 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. The Company and certain domestic subsidiaries compute current income taxes based on the consolidated taxable income as permitted by Japanese tax regulations for the year beginning after April 1, 2006. Product Warranties A liability for the estimated warranty related cost is established at the time revenue is recognized and is included in other current liabilities. The liability is established using historical information including 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 “foreign currency” hedge). The Companies formally document all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for under- taking various hedge transactions. This process includes linking all derivatives that are designated as cash flow or foreign cur- rency hedges to specific assets and liabilities on the consolidat- ed balance sheet or to specific firm commitments or forecasted transactions. Based on the Companies’ policy, all foreign exchange forward contracts 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 curren- cy 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 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 applied revised SFAS No. 123, “Share Based Payment,” and recognized a stock-based compensation cost measured by the fair value method. For the years ended March 31, 2006 and 2005, the Companies applied APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and recognized a stock-based compensation cost measured by the intrinsic value method. The following table illustrates the effect on net income and net income per share if the Companies had applied the fair value method to stock-based compensation cost. 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) Basic - as reported Basic - pro forma Diluted - as reported Diluted - pro forma 60 Millions of yen (except per share data) 2006 2005 ¥ 35,763 ¥ 30,176 73 101 ¥ 35,690 ¥ 30,075 ¥ 151.1 ¥ 126.5 150.8 151.1 150.7 126.1 124.8 124.3 New Accounting Standards In June 2006, the FASB ratified the Emerging Issue Task Force (“EITF”) consensus on EITF Issue 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43.” EITF Issue 06-2 provides guidance for an accrual of compensated absences that require a minimum serv- ice period but have no increase in the benefit even with addi- tional years of service. EITF Issue 06-2 is effective for fiscal years beginning after December 15, 2006. The adoption of EITF Issue 06-2 will not have a material impact on the Companies’ consoli- dated financial statements. In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes, an inter- pretation of FASB Statement No.109”. FIN No. 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Companies do not expect the adoption of FIN No. 48 will have a material impact on the Companies’ consolidated finan- cial statements. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, estab- lishes a framework for measuring fair value, and expands dis- closures about fair value measurements. SFAS No. 157 is effec- tive for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157 will not have a material impact on the Companies’ consolidated financial statements. 2. Translation into United States Dollars In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires plan sponsors of defined benefit pension and other postretirement benefit plans (collectively, “postretirement benefit plans”) to recognize the funded status of their postretirement benefit plans in the con- solidated balance sheet, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end con- solidated balance sheet, and provide additional disclosures. On March 31, 2007, the Company adopted the recognition and dis- closure provisions of SFAS No. 158. The effect of adopting SFAS No. 158 on the Company’s financial condition at March 31, 2007 has been included in the accompanying consolidated financial statements. SFAS No. 158’s provisions regarding the change in the measurement date of postretirement benefit plans did not have a material impact on the Company’s consolidated results of operations and financial condition as the Company already uses a measurement date of March 31 for the majority of its plans. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 will not have a material impact on the Companies’ con- solidated financial statements. The consolidated financial statements are stated in Japanese yen, the currency of the country in which the Company is incor- porated 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 ¥118 to $1, the approximate rate of exchange at March 31, 2007. Such translation 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 Millions of yen Thousands of U.S. dollars 2007 2006 2007 ¥ 53,331 ¥ 40,613 $ 451,958 14,043 26,735 14,286 20,059 119,008 226,568 ¥ 94,109 ¥ 74,958 $ 797,534 61 4. Marketable Securities and Investments Available-for-sale securities are recorded at fair value, with unrealized gains and losses excluded from income and reported in other comprehensive income (loss), net of tax. Cost, gross unrealized holding gains and losses and fair value of securities, excluding equi- ty securities with no readily determinable public market value, by major security type at March 31 were as follows: 2007 2006 Millions of yen Cost (*) Gross unrealized gains Gross unrealized losses Fair value Cost (*) Gross unrealized gains Gross unrealized losses Fair value Available-for-sale securities： Debt securities ¥ 2,559 Equity securities 16,063 Total available-for-sale ¥ 510 22,351 ¥ — (12) ¥ 3,069 ¥ 1,067 ¥ 413 38,402 22,302 33,770 ¥ — — ¥ 1,480 56,072 securities ¥ 18,622 ¥ 22,861 ¥ (12) ¥ 41,471 ¥ 23,369 ¥ 34,183 ¥ — ¥ 57,552 Thousands of U.S. dollars 2007 Cost (*) Gross unrealized gains Gross unrealized losses Fair value Available-for-sale securities： Debt securities $ 21,686 $ 4,322 $ — $ 26,008 Equity securities 136,127 189,415 (101) 325,441 Total available-for-sale securities $ 157,813 $ 193,737 $ (101) $ 351,449 (*) Cost represents amortized cost for debt securities and acquisition cost for equity securities. Maturities of debt securities classified as available-for-sale at March 31 were as follows: Millions of yen Thousands of U.S. dollars 2007 2006 2007 Cost Fair value Cost Fair value Cost Fair value Due after one year through five years Due over five years ¥ 1,059 ¥ 1,500 ¥ 1,569 ¥ 1,500 ¥ 1,067 ¥ — ¥ 1,480 ¥ — $ 8,974 $ 12,712 $ 13,296 $ 12,712 Gross unrealized holding losses and fair value of certain available-for-sale, equity securities, aggregated by length of time that such secu- rities have been in a continuous unrealized loss position at March 31 were as follows: Millions of yen Thousands of U.S. dollars 2007 2006 2007 Fair value Gross unrealized holding losses Fair value Gross unrealized holding losses Fair value Gross unrealized holding losses Less than 12 months Equity securities ¥ 312 ¥ (12) ¥ — ¥ — $ 2,644 $ (101) Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥5,299 million ($44,907 thousand) and ¥4,925 million at March 31, 2007 and 2006, respectively. Investments with an aggregate cost of ¥5,279 million ($44,737 thousand) were not evaluated for impairment because (a) the Companies did not estimate the fair value of those investments as it was not practicable to do so and (b) the Companies did not iden- tify any events or changes in circumstances that might have had a significant adverse effect on the fair value of those investments. Losses on impairment of available-for-sale securities recog- nized to reflect declines in market value considered to be other than temporary were ¥144 million ($1,220 thousand), ¥487 million 62 and ¥22 million for the years ended March 31, 2007, 2006 and 2005, respectively. Proceeds from sales of available-for-sale securities were ¥976 million ($8,271 thousand), ¥6,511 million and ¥1,638 million for the years ended March 31, 2007, 2006 and 2005, respectively. Gross realized gains on sales were ¥805 million ($6,822 thou- sand), ¥4,119 million and ¥788 million for the years ended March 31, 2007, 2006 and 2005, respectively. There were no gross realized losses on sales for the years ended March 31, 2007, 2006 and 2005. The fair value of available-for-sale securities contributed to a retirement benefit trust was ¥16,019 million ($135,754 thou- sand) and the gain on contribution was ¥10,141 million ($85,941 thousand) for the year ended March 31, 2007. 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 (now OMRON Colin Co., Ltd., “OHK”) for cash in the aggregate amount of ¥8,943 million. This acquisition was to expand healthcare business, to obtain synergies with OHK and to create preventive medicine market through the acquisition of OHK’s medical devices business for healthcare professionals. The consolidated financial statements for the year ended March 31, 2006 include the operating results of OHK from the date of acquisition. The estimated fair values of the assets acquired and liabilities assumed at the date of acqui- sition were as follows: In September 2006, OMRON Management Center of America, Inc., a subsidiary of the Company, acquired 100% of the issued common stock of Scientific Technologies Incorporated (now OMRON Scientific Technologies Incorporated, “OSTI”) for cash in the aggregate amount of ¥11,667 million ($98,873 thou- sand). This acquisition was to fulfill line-up of safety equipment, expand safety business and create cutting-edge equipment. The consolidated financial statements for the year ended March 31, 2007 include the operating results of OSTI from the date of acquisition. The estimated fair values of the assets acquired and liabilities assumed at the date of acquisition were as follows: Current assets Property, plant and equipment Investments and other assets (*) Current liabilities Long term liabilities Net assets acquired Millions of yen ¥ 4,339 996 6,747 (2,958) (181) ¥ 8,943 Millions of yen Thousands of U.S. dollars Current assets ¥ 2,463 $ 20,873 Property, plant and equipment 458 Investments and other assets (*) 11,360 Current liabilities Long term liabilities (795) (1,819) 3,881 96,271 (6,737) (15,415) (*) Investments and other assets include acquired goodwill of ¥6,554 million. Net assets acquired ¥ 11,667 $ 98,873 (*) Investments and other assets include acquired goodwill of ¥7,044 million ($59,695 thousand). In August 2006, the Company acquired 100% of the issued com- mon stock of Pioneer Precision Machinery Corporation (now OMRON Precision Technology Co., Ltd., “OPT”) for cash in the aggregate amount of ¥7,721 million ($65,432 thousand). This acquisition was to expand and strengthen LCD backlights business from small-size to large-size. The consolidated financial statements for the year ended March 31, 2007 include the operating results of OPT from the date of acquisition. The estimated fair values of the assets acquired and liabilities assumed at the date of acquisition were as follows: Millions of yen Thousands of U.S. dollars Current assets ¥ 18,299 $ 155,076 Property, plant and equipment Investments and other assets (*) Current liabilities Long term liabilities 3,788 3,855 (16,284) (1,937) 32,101 32,670 (138,000) (16,415) Net assets acquired ¥ 7,721 $ 65,432 (*) Investments and other assets include acquired goodwill of ¥2,179 million ($18,466 thousand). 63 6. Goodwill and Other Intangible Assets The components of acquired intangible assets excluding goodwill at March 31, 2007 and 2006 were as follows: Millions of yen 2007 2006 Thousands of U.S. dollars 2007 Gross amount Accumulated amortization Gross amount Accumulated amortization Gross amount Accumulated amortization Intangible assets subject to amortization: Software Other Total ¥ 37,141 4,895 ¥ 42,036 ¥ 21,426 2,897 ¥ 24,323 ¥ 31,031 3,583 ¥ 34,614 ¥ 19,414 2,408 ¥ 21,822 $ 314,754 41,483 $ 356,237 $ 181,576 24,551 $ 206,127 Aggregate amortization expense related to intangible assets was ¥5,867 million ($49,720 thousand), ¥5,235 million and ¥4,827 million for the years ended March 31, 2007, 2006 and 2005, respectively. Estimated amortization expense for the next five years ending March 31 is as follows: Years ending March 31 2008 2009 2010 2011 2012 Millions of yen Thousands of U.S. dollars ¥ 6,335 5,132 3,482 1,900 793 $ 53,686 43,492 29,508 16,102 6,720 Intangible assets not subject to amortization at March 31, 2007 and 2006 were immaterial. The carrying amount of goodwill at March 31, 2007 and 2006 and changes in its carrying amount for the years ended March 31, 2007 and 2006 were as follows: Balance at beginning of year Acquisition Foreign currency translation adjustments and other Balance at end of year 7. Short-Term Debt and Long-Term Debt Short-term debt at March 31 consisted of the following: Millions of yen 2007 ¥ 8,895 10,080 46 ¥ 19,021 2006 ¥ 1,314 7,633 38 ¥ 8,895 Thousands of U.S. dollars 2007 $ 75,381 85,424 390 $ 161,195 Millions of yen Thousands of U.S. dollars 2007 2006 2007 Commercial Paper The weighted average annual interest rates ¥ 16,000 ¥ — $ 135,593 2006 2007 — 0.8% Unsecured debt: The weighted average annual interest rates 3,868 2,468 32,780 2006 2007 Total 3.7% 5.0% 64 ¥ 19,868 ¥ 2,468 $ 168,373 Long-term debt at March 31 consisted of the following: Unsecured debt: The weighted average annual interest rates ¥ 120 ¥ — $ 1,017 Millions of yen Thousands of U.S. dollars 2007 2006 2007 2006 2007 Other Total — 5.4% Less portion due within one year Long-term debt, less current portion 1,825 1,945 264 ¥ 1,681 1,345 1,345 296 ¥ 1,049 15,466 16,483 2,237 $ 14,246 The annual maturities of long-term debt outstanding at March 31, 2007 were as follows: Years ending March 31 2008 2009 2010 2011 2012 Thereafter Total Millions of yen Thousands of U.S. dollars ¥ 264 492 69 60 62 998 ¥ 1,945 $ 2,237 4,169 585 508 525 8,459 $ 16,483 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 also customary in Japan, the Company and domestic subsidiaries maintain deposit balances with banks with which they have short- or long-term debt. 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, 2007, 2006 and 2005 amounted to ¥1,116 million ($9,458 thousand), ¥898 million and ¥1,083 million, respec- tively. 8. Leases The Companies do not have any material capital lease agree- ments. The Companies have operating lease agreements primarily involving offices and equipment for varying periods. Leases that expire generally are expected to be renewed or replaced by other leases. At March 31, 2007, future minimum rental payments applicable to non-cancelable leases having initial or remaining non-cancelable lease terms in excess of one year were as follows: Years ending March 31 2008 2009 2010 2011 2012 Thereafter Total Millions of yen Thousands of U.S. dollars ¥ 2,908 2,388 1,780 1,560 1,367 10,579 ¥ 20,582 $ 24,644 20,237 15,085 13,220 11,585 89,653 $ 174,424 Rental expense amounted to ¥12,758 million ($108,119 thousand), ¥11,862 million and ¥11,151 million for the years ended March 31, 2007, 2006 and 2005, respectively. 65 9. Termination and Retirement Benefits The Company and its domestic subsidiaries sponsor termina- tion and retirement benefit plans which cover substantially all domestic 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 deter- mining pension benefits including a “point-based benefits sys- tem,” under which benefits are calculated based on accumulat- ed points allocated to employees each year according to their job classification and performance. If the termination is involun- tary, the employee is usually entitled to greater payments than in the case of voluntary termination. 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 methods acceptable under Japanese tax law. The Company and substantially all domestic subsidiaries had a contributory termi- nation and retirement plan which was interrelated with the Japanese government social welfare program and consisted of a substitutional potion requiring employee and employer contri- butions plus an additional portion established by the employers. Periodic pension benefits required under the substitutional portion 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 termi- nation or retirement although periodic payments were available under certain conditions. In January 2003, 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 substitutional 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 completion of the transfer to the government of the sub- stitutional portion of the benefit obligation and related plan assets as the culmination of a series of steps in a single settlement transaction. Under the consensus reached, at the time the assets are transferred 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 benefit 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 termination and retirement benefit plans. The substitutional por- tion of the benefit obligation and related plan assets were trans- ferred to the government on September 29, 2005. The transfer resulted in the Company recording a subsidy from the govern- ment of ¥41,339 million 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 derecog- nition of previously accrued salary progression of ¥8,870 million and a settlement loss of ¥38,294 million. The net amount of derecognition of previously accrued salary progression and set- tlement loss is allocated to cost of sales of ¥15,975 million, sell- ing, general and administrative expenses of ¥8,635 million and research and development expenses of ¥4,814 million. On March 31, 2007, the Companies adopted the recogni- tion and disclosure provisions of SFAS No. 158. SFAS No. 158 required the Companies to recognize the funded status (i.e., the difference between the fair value of plan assets and the pro- jected benefit obligations) of their pension plans in the March 31, 2007 consolidated balance sheet, with a corresponding adjustment to accumulated other comprehensive income (loss) as pension liability adjustments. Before adoption of SFAS No. 158, an additional minimum pension liability was recognized based on a plan’s accumulated benefit obligation (projected ben- efit obligation, less future compensation increase), pursuant to SFAS No. 87. The effects of adopting the provisions of SFAS No. 158 on the accompanying consolidated balance sheets at March 31, 2007 are presented in Note 1. Summary of Significant Accounting Policies. 66 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: Millions of yen Thousands of U.S. dollars 2007 2006 2007 ¥ 154,531 ¥ 246,950 $ 1,309,585 3,954 3,091 — — — (2,521) (3,477) (1,049) 3,979 3,926 (91,963) 2,424 (7,745) 2,594 (3,659) (1,975) 33,508 26,195 — — — (21,364) (29,466) (8,890) ¥ 154,529 ¥ 154,531 $ 1,309,568 Fair value of plan assets at beginning of year ¥ 89,287 ¥ 121,121 Actual return on plan assets Transfer of substitutional portion Effect of change in measurement date Employers’ contributions Benefits paid Settlement paid 2,894 — — 5,110 (2,780) (1,049) 7,668 (41,753) 1,496 5,573 (2,843) (1,975) 756,670 24,525 — — 43,305 (23,559) (8,890) Fair value of plan assets at end of year Fair value of assets in retirement benefit trust at beginning of year Actual return on assets in retirement benefit trust Employers‘ contributions Fair value of assets in retirement benefit trust at end of year Funded status at end of year ¥ 93,462 ¥ 89,287 $ 792,051 ¥ — (2,269) 16,019 ¥ 13,750 ¥ ¥ — — — — $ — (19,229) 135,754 116,525 ¥ (47,317) ¥ (65,244) $ (400,992) Amounts recognized in the consolidated balance sheet at March 31, 2007 consist of: Millions of yen Thousands of U.S. dollars The funded status at March 31, 2006, reconciled to the net amount recognized in the consolidated balance sheet at that date, is summarized as follows: Termination and retirement benefit ¥ (47,317) $ (400,992) Amounts recognized in accumulated other comprehensive income (loss) at March 31, 2007 consist of: Funded status Unrecognized net actuarial loss Unrecognized prior service benefit Net amount recognized Millions of yen ¥ (65,244) 62,151 (23,414) ¥ (26,507) Net actuarial loss Prior service cost Millions of yen Thousands of U.S. dollars ¥ 59,950 $ 508,051 (21,561) (182,720) ¥ 38,389 $ 325,331 Amounts recognized in the consolidated balance sheet at March 31, 2006 consist of: Termination and retirement benefit Accumulated other comprehensive loss (gross of tax) Net amount recognized Millions of yen ¥ (62,672) 36,165 ¥ (26,507) 67 The accumulated benefit obligation at March 31 was as follows: Accumulated benefit obligation Millions of yen Thousands of U.S. dollars 2007 2006 2007 ¥ 150,045 ¥ 151,959 $ 1,271,568 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 2007 2006 2005 2007 ¥ 3,954 ¥ 3,979 ¥ 5,822 $ 33,508 3,091 (3,411) 612 — — 3,926 (3,620) 2,336 38,294 (8,870) 5,022 (4,301) 2,565 — — 26,195 (28,907) 5,186 — — Net periodic benefit cost ¥ 4,246 ¥ 36,045 ¥ 9,108 $ 35,982 The unrecognized net actuarial loss and the prior service benefit are being amortized over 15 years. The estimated net actuarial loss and prior service benefit that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost for the year ending March 31, 2008 are summarized to the right: Net actuarial loss Prior service cost Millions of yen ¥ 2,479 (1,853) Thousands of U.S. dollars $ 21,008 (15,703) Measurement Date The Company and certain of its domestic subsidiaries use March 31 as the measurement date for projected benefit obligation and plan assets of the termination and retirement benefits. During the year ended March 31, 2006, the companies changed the measurement date from December 31 to March 31. The purpose of this change was 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 benefits, in the projected benefit obligation and retire- ment benefit expense. A cumulative effect (net of tax) of this change was recog- nized in the consolidated statement of income for the year ended March 31, 2006, which reduced net income for the period by ¥1,201 million. Assumptions Weighted-average assumptions used to determine benefit obligations at March 31, 2007 and 2006 are as follows: Discount rate Compensation increase rate 2007 2.0% 2.0% 2006 2.0% 2.0% 68 Weighted-average assumptions used to termination and retirement benefit cost for the years ended March 31, 2007, 2006 and 2005 are as follows: Discount rate Compensation increase rate Expected long-term rate of return on plan assets 2007 2.0% 2.0% 3.0% 2006 2.0% 2.0% 3.0% 2005 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 (except for assets in retirement benefit trust) by asset category is as follows: Asset Category Cash Equity Securities Debt Securities Life insurance company general accounts Other Total 2007 2006 0.0% 21.1% 48.8% 13.8% 16.3% 0.1% 23.9% 46.1% 14.1% 15.8% 100.0% 100.0% The assets in the retirement benefit trust at March 31, 2007 consisted of 99.7% equity securities and 0.3% other. The Company investment policies are designed to ensure that adequate plan assets are available to provide future pay- ments of pension benefits to eligible participants. Taking into account the expected long-term rate of return on plan assets, the Company formulates a model portfolio comprised of the opti- mal combination of equity and debt securities in order to pro- duce a total return that will match the expected return on a mid- term to long-term basis. Target allocation of plan assets is 20% equity securities, 66% debt securities and life insurance company general account and 14% other for both 2007 and 2006. The Company evaluates the gap between expected return and actual return of invested plan assets on an annual basis to determine if such differences necessitate a revision in the model portfolio. The Company revises the model portfolio to the extent considered necessary to achieve the expected long-term rate of return on plan assets. Equity securities include a common stock of the Company in the amounts of ¥1 million ($10 thousand) (0.00% of total domes- tic plan assets), and ¥11 million (0.01% of total domestic plan assets) at March 31, 2007, and 2006, respectively. Cash Flows Contributions The Companies expect to contribute ¥5,178 million ($43,881 thousand) to their domestic termination and retirement benefit plans in the year ending March 31, 2008. Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Years ending March 31 2008 2009 2010 2011 2012 2013 — 2017 Millions of yen Thousands of U.S. dollars ¥ 4,492 $ 38,068 5,698 6,532 6,883 6,629 48,288 55,356 58,331 56,178 34,340 291,017 69 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 ¥2,687 million ($22,771 thousand) and ¥2,555 million ($21,653 thou- sand), respectively, at March 31, 2007 and ¥2,812 million and ¥2,020 million, respectively, at March 31, 2006. The Companies also have unfunded noncontributory termi- nation plans administered by the Companies. These plans provide lump-sum termination benefits 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 10. Shareholders’ Equity. 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, 2007 and 2006 was ¥5,383 million ($45,619 thousand) and ¥4,374 million, respectively. The aggregate net periodic benefit cost for such plans for the years ended March 31, 2007, 2006 and 2005 was ¥1,167 million ($9,890 thousand), ¥618 million and ¥1,241 million, respectively. Japanese companies are subjected to the Corporate Low. separate component of shareholders’ equity. The Corporate Law requires that all shares of common stock be issued with no par value and at least 50% of amount paid of the issue price of new shares is required to be recorded as com- mon stock and the remaining net proceeds are required to be presented as additional paid-in capital, which is included in capi- tal surplus. The Corporate Law permits Japanese companies, upon approval of the Board of Directors, to issue shares to exist- ing shareholders without consideration by way of a stock split. Such issuance of shares generally does not give rise to changes within the shareholders’ accounts. The Corporate Law also requires that an amount equal to 10% of dividends must be appropriated as a legal reserve or as additional paid-in capital (a component of capital surplus) depend- ing on the 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 Corporate Law, the total amount of additional paid-in capital and legal reserve may be reversed without limitation of such threshold. 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. 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 pur- chased cannot exceed the amount available for distribution to the shareholders which is determined by specific formula. Under the Corporate Law, stock acquisition rights, which were previously presented as a liability, are now presented as a The Corporate Law also provides that companies can pur- chase both treasury stock acquisition rights and treasury stock. Such treasury stock acquisition rights are presented as a separate component of shareholders’ equity or deducted directly from stock acquisition rights. Under the Corporate Law, companies can pay dividends at any time during the fiscal year in addition to the year-end divi- dend 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 pre- scribed so in its articles of incorporation. The Corporate Law permits companies to distribute divi- dends-in-kind (non-cash assets) to shareholders subject to a cer- tain limitation and additional requirements. 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 Corporate Law, certain limitations 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 div- idends 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. 70 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: Fixed options Options outstanding at April 1, 2004 Granted Exercised Expired Options outstanding at March 31, 2005 Granted Exercised Expired Options outstanding at March 31, 2006 Granted Exercised Expired Options outstanding at March 31, 2007 Options exercisable at March 31, 2007 Fixed options Options outstanding at March 31, 2006 Granted Exercised Expired Options outstanding at March 31, 2007 Options exercisable at March 31, 2007 yen Weighted-average exercise price Weighted-average fair value of options granted during the year ¥ 194 ¥ 415 ¥ 539 ¥ 2,357 2,580 1,846 1,839 ¥ 2,421 2,550 2,111 2,936 ¥ 2,384 3,031 2,284 2,306 ¥ 2,570 ¥ 2,369 U.S. dollar Weighted-average exercise price Weighted-average fair value of options granted during the year $ 4.57 $ 20.20 25.69 19.36 19.54 $ 21.78 $ 20.08 Shares 1,089,000 219,000 (51,000) (11,000) 1,246,000 213,000 (226,000) (260,000) 973,000 217,000 (260,000) (25,000) 905,000 475,000 Shares 973,000 217,000 (260,000) (25,000) 905,000 475,000 The following summarizes information about fixed stock options at March 31, 2007: Shares Weighted-average remaining contractual life Yen Range of exercise prices Weighted-average exercise price Options outstanding 905,000 2.54 years ¥ 1,913 Options exercisable 475,000 1.44 years to ¥ 3,031 ¥ 1,913 to U.S. dollars $ 16.21 to $ 25.69 $ 16.21 to Yen ¥ 2,570 U.S. dollars $ 21.78 ¥ 2,369 $ 20.08 ¥ 2,580 $ 21.86 71 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 2007 1.540% 28.0% 1.068% 3.5years 2006 1.540% 23.0% 0.982% 3.5years 2005 0.628% 10.0% 0.783% 3.5years 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 trans- ferable. 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. Stock-based compensation cost recognized for the year ended March 31, 2007 was ¥93 million ($788 thousand). As of March 31, 2007, total compensation cost related to nonvested options and not yet recognized was ¥84 million ($712 thousand), and the weighted-average period over which it is expected to be recognized is 1.12 years. Cash received from options exer- cised under the plan for the year ended March 31, 2007 was ¥594 million ($5,034 thousand). When options are exercised, the Company will grant the Company’s treasury stock. 11. Other Expenses (Income), net Other expenses (income), net for the years ended March 31, 2007, 2006 and 2005 consisted of the following: Millions of yen Thousands of U.S. dollars 2007 2006 2005 2007 Net loss on sales and disposals of property, plant and equipment ¥ 6,445 ¥ Loss on impairment of property, plant and equipment Business restructuring expenses Loss on impairment of investment securities and other assets Net gain on sales of investment securities 1,441 713 682 (954) Gain on contribution of securities to retirement benefit trust (10,141) 42 — 749 757 (4,302) — (194) (609) 1,306 (466) ¥ 918 $ 54,619 614 1,767 366 (987) — — (216) 75 (457) 12,212 6,042 5,780 (8,085) (85,941) — (6,178) 9,203 (6,737) — (729) 1,086 (795) ¥ (2,252) ¥ (2,717) ¥ 2,080 $ (19,085) Net gain on sales of business entities Interest income, net Foreign exchange loss, net Other, net Total Certain land and buildings, principally idle assets, were deemed to be impaired and written down to fair value for the year ended March 31, 2005. Also certain manufacturing assets of Automotive Electronic Components Business were deemed to be impaired and written down to fair value for the year ended March 31, 2007. The fair value was measured by discounted cash flows expected to be generated by the assets. 72 12. Income Taxes The provision for income taxes for the years ended March 31, 2007, 2006 and 2005 consisted of the following: Current income tax expense Deferred income tax expenses, exclusive of the following Change in the valuation allowance Total Millions of yen Thousands of U.S. dollars 2007 2006 2005 2007 ¥ 22,531 ¥ 23,276 ¥ 20,393 $ 190,941 3,521 366 3,947 15 2,160 (445) 29,839 3,101 ¥ 26,418 ¥ 27,238 ¥ 22,108 $ 223,881 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 2007, 2006 and 2005. 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 Other, net Effective tax rates 2007 41.0% 0.6 (4.0) 3.7 (2.0) 0.6 0.0 39.9 2006 41.0% 2005 41.0% 0.9 (3.5) 0.4 3.2 0.0 0.0 42.0 3.0 (3.4) 1.5 (0.9) 0.9 (1.2) 40.9 The approximate effect of temporary differences and tax credit and loss carry forwards that gave rise to deferred tax balances at March 31, 2007 and 2006 were as follows: Millions of yen 2007 2006 Thousands of U.S. dollars 2007 Deferred tax assets Deferred tax liabilities Deferred tax assets Deferred tax liabilities Deferred tax assets Deferred tax liabilities Inventory valuation ¥ 3,776 ¥ Accrued bonuses and vacations Termination and retirement benefits Enterprise taxes Intercompany profits Marketable securities Property, plant and equipment 5,779 6,279 756 3,970 — 958 Allowance for doubtful receivables 1,088 Minimum pension liability adjustment Pension liability adjustment Other temporary differences Tax credit carryforwards Operating loss carryforwards — 15,739 9,363 4,997 3,469 — — — — — 9,214 — — — — 3,056 — — ¥ 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 — — $ 32,000 $ 48,975 53,212 6,407 33,644 — 8,119 9,220 — 133,381 79,347 42,347 29,398 — — — — — 78,085 — — — — 25,898 — — Subtotal ¥ 56,174 ¥ 12,270 ¥ 58,774 ¥ 17,886 $ 476,050 $ 103,983 Valuation allowance (8,826) — (7,203) — (74,797) — Total ¥ 47,348 ¥ 12,270 ¥ 51,571 ¥ 17,886 $ 401,253 $ 103,983 73 The total valuation allowance increased by ¥1,623 million ($13,754 thousand) in 2007 and decreased by ¥65 million in 2006. As of March 31, 2007, certain subsidiaries had operating loss carryforwards approximating ¥9,776 million ($82,847 thousand) available for reduction of future taxable income, the majority of which expire by 2014. 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 accu- mulated unremitted earnings of the foreign subsidiaries which are considered to be indefinitely reinvested and for which Japanese income taxes have not been provided were ¥55,211 million ($467,890 thousand) and ¥55,311 million at March 31, 2007 and 2006, respectively. Dividends received from domestic subsidiaries are expected to be substantially free of tax. 13. Foreign Operations Net sales and total assets of foreign subsidiaries for the years ended March 31, 2007, 2006 and 2005 were as follows: Net sales Total assets 14. Per Share Data Millions of yen Thousands of U.S. dollars 2007 2006 2005 2007 ¥ 324,509 ¥ 263,900 ¥ 256,116 ¥ 209,038 ¥ 220,961 ¥ 178,038 $ 2,750,076 $ 2,236,441 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 2007 2006 2005 2007 Income before cumulative effect of accounting change ¥ 38,280 ¥ 36,964 ¥ 30,176 $ 324,407 Effect of dilutive securities: Convertible bonds, due September 2004 — — 165 — Diluted income before cumulative effect of accounting change ¥ 38,280 ¥ 36,964 ¥ 30,341 $ 324,407 Net income Effect of dilutive securities: Millions of yen Thousands of U.S. dollars 2007 2006 2005 2007 ¥ 38,280 ¥ 35,763 ¥ 30,176 $ 324,407 Convertible bonds, due September 2004 — — 165 — Diluted income ¥ 38,280 ¥ 35,763 ¥ 30,341 $ 324,407 Weighted average common shares outstanding 232,059,070 236,625,818 238,505,304 2007 2006 2005 Dilutive effect of: Convertible bonds, due September 2004 Stock options Diluted common shares outstanding — — 4,623,997 153,918 131,711 76,574 232,212,988 236,757,529 243,205,875 74 15. Supplemental Information for Cash Flows Supplemental cash flow information for the years ended March 31, 2007, 2006 and 2005 was as follows: Interest paid Income taxes paid Non-cash investing and financing activities: Liabilities assumed in connection with capital expenditures Fair value of securities contributed to retirement benefit trust Stock issued due to convertible bonds Transfer of assets and liabilities to joint venture 16. Other Comprehensive Income (Loss) Millions of yen 2006 ¥ 898 23,843 3,220 — — — 2005 ¥ 1,098 17,815 2,671 — 38 16,270 2007 ¥ 1,130 24,591 2,977 16,019 — — Thousands of U.S. dollars 2007 $ 9,576 208,398 25,229 135,754 — — The change in each component of accumulated other comprehensive income (loss) for the years ended March 31, 2007, 2006 and 2005 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 Adjustment to initially apply SFAS No. 158 Ending balance Pension liability adjustments: Beginning balance Adjustment to initially apply SFAS No. 158 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 Adjustment to initially apply SFAS No. 158 Ending balance Millions of yen Thousands of U.S. dollars 2007 2006 2005 2007 ¥ (1,353) ¥ (10,554) ¥ (15,625) $ (11,466) 7,913 6,560 (21,183) 1,658 19,525 — — (22,169) (22,169) 19,671 (6,933) 12,738 (106) (36) (142) (2,971) 2,602 (2,644) 9,201 (1,353) (41,123) 19,940 — 5,071 (10,554) 67,059 55,593 (45,238) (179,517) 4,115 — 14,051 165,466 (21,183) (41,123) — — — 10,909 8,762 19,671 (241) 135 (106) (41,009) 38,038 — — — — 10,087 822 10,909 217 (458) (241) (50,559) 9,550 — — — (187,873) (187,873) 166,703 (58,754) 107,949 (898) (305) (1,203) (25,178) 22,051 (22,407) ¥ (3,013) ¥ (2,971) ¥ (41,009) $ (25,534) 75 Tax effects allocated to each component of other comprehensive income (loss) and reclassification adjustments for the years ended March 31, 2007, 2006 and 2005 were as follows: 2007 Tax (expense) benefit Before-tax amount Net-of-tax amount Before-tax amount Millions of yen 2006 Tax (expense) benefit Net-of-tax amount Before-tax amount 2005 Tax (expense) benefit Net-of-tax amount Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year ¥ 8,248 ¥ (341) ¥ 7,907 ¥ 9,458 ¥ (257) ¥ 9,201 ¥ 5,437 ¥ (366) ¥ 5,071 Reclassification adjustment for the portion realized in net income 6 — 6 — — — — — — Net change in foreign currency translation adjustments during the year Minimum pension liability adjustments 8,254 2,811 (341) (1,153) 7,913 1,658 9,458 (257) 9,201 5,437 (366) 33,797 (13,857) 19,940 6,974 (2,859) 5,071 4,115 Unrealized gains (losses) on available-for-sale securities: Unrealized holding gains (losses) arising during the year (949) 389 (560) 18,469 (7,564) 10,905 2,159 (885) 1,274 Reclassification adjustment for losses on impairment realized in net income 144 (59) 85 487 (200) 287 22 (9) 13 Reclassification adjustment for net gains on sales realized in net income (805) 330 (475) (4,119) 1,689 (2,430) (788) 323 (465) Reclassification adjustment for net gains on contribution of securities to retirement benefit trust realized in net income Net unrealized gains (losses) Net gains (losses) on derivative instruments: Net gains (losses) on derivative instruments designated as cash flow (10,141) (11,751) 4,158 4,818 (5,983) — — — — — (6,933) 14,837 (6,075) 8,762 1,393 (571) — 822 hedges during the year (2,047) 839 (1,208) (2,173) 891 (1,282) (1,702) 698 (1,004) Reclassification adjustment for net losses (gains) realized in net income 1,986 (814) 1,172 2,400 (983) 1,417 929 (383) 546 Net gains (losses) on derivative instruments (61) 25 (36) 227 (92) 135 (773) 315 (458) Other comprehensive income ¥ (747) ¥ 3,349 ¥ 2,602 ¥58,319 ¥(20,281) ¥38,038 ¥13,031 ¥(3,481) ¥ 9,550 76 Thousands of U.S. dollars 2007 Before-tax amount Tax (expense) benefit Net-of-tax amount Foreign currency translation adjustments: Foreign currency translation adjustments arising during the year $ 69,898 $ (2,890) $ 67,008 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: Unrealized holding gains (losses) 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 Reclassification adjustment for net gains on contribution of securities to retirement benefit trust realized in net income Net unrealized gains (losses) 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 51 69,949 23,822 (8,042) 1,220 (6,822) — (2,890) (9,771) 3,296 (500) 2,797 51 67,059 14,051 (4,746) 720 (4,025) (85,941) (99,585) 35,238 40,831 (50,703) (58,754) (17,347) 16,830 (517) 7,110 (6,898) 212 (10,237) 9,932 (305) $ (6,331) $ 28,382 $ 22,051 17. Financial Instrumentsand Risk Management Fair Value of Financial Instruments The following table presents the carrying amounts and estimated fair values as of March 31, 2007 and 2006, of the Companies’ financial instruments. Nonderivatives: Long-term debt, including current portion ¥ (1,945) ¥ (1,945) ¥ (1,345) ¥ (1,345) Millions of yen 2007 2006 Carrying amount Fair value Carrying amount Fair value Derivatives: Included in other current assets (liabilities): Forward exchange contracts Foreign currency options (286) 47 (286) 47 (751) 36 (751) 36 Thousands of U.S. dollars 2007 Carrying amount Fair value Nonderivatives: Long-term debt, including current portion $ (16,483) $ (16,483) Derivatives: Included in other current assets (liabilities): Forward exchange contracts Foreign currency options (2,424) 398 (2,424) 398 77 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, short-term debt and notes and accounts payable: The carry- ing 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 practicable to estimate their fair values. (3) Long-term debt: The fair values are estimated using present value of discounted 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. Derivatives and Hedging Activities 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 other expenses (income), net in the same period as the hedged items affect earnings. Substantially all of the accumulated other comprehensive income (loss) in relation to foreign exchange for- ward contracts at March 31, 2007 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 des- ignated as cash flow hedges and reported in accumulated other comprehensive income (loss), net of the related tax effect, are losses of ¥1,208 million ($10,237 thousand) and ¥1,282 million for the years ended March 31, 2007 and 2006, respectively. The amounts, which were reclassified out of accumulated other com- prehensive income (loss) into other expenses (income), net depending on their nature, net of the related tax effect, are net gains of ¥1,172 million ($9,932 thousand) and net gains of ¥1,417 million for the years ended March 31, 2007 and 2006, respec- tively. The amount of the hedging ineffectiveness is not materi- al for the years ended March 31, 2007 and 2006. Foreign exchange forward contracts and foreign currency options: The Companies enter into foreign exchange forward con- tracts and combined purchased and written foreign currency option contracts 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 cur- rency derivatives are typically less than 10 months. The credit exposure of foreign exchange contracts are represented by the fair value of the contracts at the reporting date. Management considers the exposure to credit risk to be minimal since the counterparties are major financial institutions. The notional amounts of contracts to exchange foreign cur- rency outstanding at March 31, 2007 and 2006 were as follows: Forward exchange contracts Foreign currency options Millions of yen 2007 ¥ 59,596 ¥ 2,100 2006 ¥ 43,521 ¥ 2,100 Thousands of U.S. dollars 2007 $ 505,051 $ 17,797 The Companies hedge certain exposures to fluctuations in foreign currency exchange rates that occur prior to conversion of for- eign currency denominated monetary assets and liabilities into the functional currency. Prior to conversion to the functional curren- cy, 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 other expenses (income), 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 Until the year ended March 31, 2006, the Company had an oper- ating 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 offi- cers. This lease agreement had an initial non-cancelable lease term to 2020 and required a monthly rental payment of ¥106 million and a security deposit of ¥2,600 million which is refund- able 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 and 2005, the Company paid ¥1,166 million and ¥1,272 million, respectively, in rental expense and the security deposit to the private company was transferred to the third party at March 31, 2006. 78 19. Commitments and Contingent Liabilities The Company has commitments at March 31, 2007 of approxi- mately ¥29,517 million ($250,144 thousand) related to contracts for outsourcing computer services through 2013. The contracts require an annual service fee of ¥6,031 million ($51,110 thou- sand) for the year ending March 31, 2007. The annual service fee will gradually decrease each year during the contract term to ¥4,657 million ($39,466 thousand) for 2013. The contract is can- celable at any time subject to a penalty of 15% of aggregate service 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 consol- idated 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 56% of total sales are concen- trated in Japan, are limited due to the large number of well- Balance at beginning of year Addition Utilization Balance at end of year 20. Subsequent Events established customers and their dispersion across many indus- tries. 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 ¥1,026 million ($8,695 thousand) at March 31, 2007. The carrying amounts of the liabilities recognized under those guarantees at March 31, 2007 were immaterial. Bank loans of ¥574 million ($4,864 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, 2007 and 2006 are summarized as follows: Millions of yen Thousands of U.S. dollars 2007 2006 2007 ¥ 1,678 ¥ 2,309 $ 14,220 2,082 (1,570) 1,586 (2,217) 17,644 (13,305) ¥ 2,190 ¥ 1,678 $ 18,559 1) In April 2007, OMRON Entertainment Co., Ltd., a subsidiary of the Company, had transferred all of its business to third party. As a result of this business transfer, the Company will record a gain (pre tax base) of approximately ¥5,200 million ($44,068 thousand) in the year ending March 31, 2008. (2) On May 16, 2007, 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 discretion with a maximum aggregate purchase of ¥10,000 million ($84,746 thousand), or 3,000,000 shares, for the period up to the date of the June 2008 general meet- ing of shareholders. 79 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 Stockholders of OMRON Corporation We have audited the accompanying consolidated balance sheets of OMRON Corporation and subsidiaries (the "Company") as of March 31, 2007 and 2006, and the related consolidated statements of income, comprehensive income (loss), shareholders’ equity, and cash flows for each of the three years in the period ended March 31, 2007, all expressed in Japanese yen. These financial statements are the responsibility of the Company's 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 stan- dards 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 opin- ion, 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 financial statements referred to above present fairly, in all material respects, the financial position of OMRON Corporation and subsidiaries as of March 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2007, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 20 to the financial statements, in April 2007, OMRON Entertainments Co., Ltd., a subsidiary of the Company, had transferred all of its business to a third party. Our audits also comprehended the translation of Japanese yen amounts into United States dollar amounts and, in our opinion, 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 8, 2007 80 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: 39 Greater China Subsidiaries: 27 Affiliates: 3 Japan Subsidiaries: 47 Affiliates: 13 Asia-Pacific Subsidiaries: 21 5 Affiliates: North America Subsidiaries: 26 Regional Headquarters Headquarters Japan Kyoto Head Office North 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: 81-3-3436-7011 Fax: 81-3-3436-7035 Europe OMRON Europe B.V. (The Netherlands) Tel: 31-23-568-1300 Fax: 31-23-568-1391 Asia-Pacific OMRON Asia Pacific Pte. Ltd. (Singapore) Tel: 65-835-3011 Fax: 65-835-2711 Greater China OMRON (China) Co., Ltd. (Shanghai) Tel: 86-21-5888-1666 Fax: 86-21-5888-7633/7933 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 81 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, 2007 Head Office Shiokoji Horikawa, Shimogyo-ku, Kyoto 600-8530, Japan Phone: 81-75-344-7000 Fax: 81-75-344-7001 Tokyo Head Office 3-4-10, Toranomon, Minato-ku, Tokyo 105-0001, Japan Phone: 81-3-3436-7170 Fax: 81-3-3436-7180 Date of Establishment May 10, 1933 Industrial Property Rights Number of patents: 2,350 (Japan) 2,481 (Overseas) Number of patents pending: 3,778 (Japan) 2,236 (Overseas) Number of Employees (Consolidated) 32,456 Paid-in Capital ¥64,100 million Common Stock Authorized: 487,000,000 shares Issued: 249,121,372 shares Number of shareholders: 29,190 Stock Listings Osaka Securities Exchange Tokyo Stock Exchange Nagoya Stock Exchange Frankfurt Stock Exchange Ticker Symbol Number 6645 Common Stock Price Range/ Trading Volume (Osaka Securities Exchange) Custodian of Register of Shareholders Mitsubishi UFJ Trust and Banking Corporation 1-4-5, Marunouchi, Chiyoda-ku, Tokyo 100-8212, Japan 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 21.5% 20.9% 22.0% 80 60 40 20 0 34.4% 39.7% 42.9% 4.3% 1.0% 38.9% 4.1% 0.9% 4.0% 0.8% 34.5% 30.4% (Yen) 40,000 30,000 20,000 10,000 0 (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 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 ’04 ’05 ’06 (FY) FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 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 1Q 2Q 2Q 3Q 4Q 3Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q 1Q 1Q 2Q 2Q 3Q 3Q 4Q 4Q FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 Trading volume Yearly High and Low Prices FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 High Low ¥ 2,810 ¥ 2,220 ¥ 3,360 ¥ 3,180 ¥ 2,515 ¥ 2,080 ¥ 2,740 ¥ 2,880 ¥ 3,520 ¥ 3,570 1,790 1,070 1,501 1,745 1,395 1,341 1,658 2,220 2,230 2,625 * Closing price of Osaka Securities Exchange 82 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 affluence emphasized by the industrialized society will become rela- tively less important. This will in turn create a complete balance and harmonious 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 socie- ty based on its SINIC Theory, and has contributed to society through its business operations by drawing on its proprietary Sensing & Control tech- nology, 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 peo- ple” 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 cur- rent situation. Other examples include an automotive sensor that can detect the surrounding 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. 83 Annual Report 2007 Year ended March 31, 2007 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 7 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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