Constant Change Constant Change t o s h i b a t o s h i b a Annual Report 2006 • Financial Review Annual Report 2006 • Financial Review c o r p o r a t i o n c o r p o r a t i o n Management’s Discussion and Analysis Eleven-year Summary Toshiba Corporation and Subsidiaries Years ended March 31 Net sales Cost of sales Selling, general and administrative expenses (Note 1) Operating income (loss) (Note 2) Income (loss) before income taxes and minority interest Income taxes Net income (loss) Per share of common stock: Net income (loss) (Note 3) —Basic —Diluted Cash dividends Total assets Shareholders’ equity Capital expenditures (Property, plant and equipment) Depreciation (Property, plant and equipment) R&D expenditures Number of employees 2006 ¥6,343,506 4,659,795 1,443,101 240,610 178,177 90,142 78,186 ¥24.32 22.44 6.50 ¥4,727,113 1,002,165 338,800 228,637 372,447 172,000 2005 ¥5,836,139 4,296,572 1,384,760 154,807 111,232 55,944 46,041 ¥14.32 13.53 5.00 ¥4,571,412 815,507 318,394 215,844 348,010 165,000 2004 ¥5,579,506 4,075,336 1,329,584 174,586 135,770 102,237 28,825 ¥8.96 8.96 3.00 ¥4,462,200 754,990 227,273 223,946 336,714 161,000 2003 ¥5,655,778 4,146,460 1,393,776 115,542 55,705 48,532 18,503 ¥5.75 5.75 3.00 ¥5,238,936 571,064 230,512 237,888 331,494 166,000 Notes: 1) ¥4,085 million, ¥4,836 million and ¥48,945 million of “Subsidy received on return of substitutional portion of Employees’ Pension Fund Plan, net of settlement loss of ¥5,045 million in 2006, ¥7,992 million in 2005 and ¥188,106 million in 2004” are classified as a reduction of selling, general and administrative expenses for the fiscal years ended March 31, 2006, 2005 and 2004, respectively. 2) Operating income (loss) has been determined under financial reporting practices generally accepted in Japan and is defined as net sales less cost of sales and selling, general and admin- istrative expenses. 3) Basic net income per share (EPS) is computed based on the weighted-average number of shares of common stock outstanding during each period. Diluted EPS assumes the dilution that could occur if convertible bonds were converted or stock acquisition rights were exercised to issue common stock, unless their inclusion would have an antidilutive effect. 4) Beginning with the fiscal year ended March 31, 2001, Toshiba has adopted Statement of Financial Accounting Standards (SFAS) No. 115,“Accounting for Certain Investments in Debt and Equity Securities.” Prior-period data for the fiscal years ended from March 31, 1996 through 2000 has been restated to conform with SFAS No. 115. 5) Beginning with the fiscal year ended March 31, 1998, revenues and expenses from financial services, real estate leasing and sales, and other operations are reported as operating activi- ties whereas they were reported as non-operating activities in prior periods. Prior-period data for the fiscal years ended from March 31, 1996 and 1997 has been reclassified to conform with the current classification. 6) Beginning with the fiscal year ended March 31, 2006, equity in earnings (losses) of affiliates has been included in income (loss) before income taxes and minority interest. Prior-period data for the fiscal years ended from March 31, 1996 through 2005 has been reclassified to conform with the current classification. Millions of yen, except per share amounts 2002 ¥5,394,033 4,070,130 1,437,478 (113,575) (374,247) (113,915) (254,017) ¥(78.91) (78.91) — ¥5,407,782 705,314 348,235 311,208 326,170 176,000 2001 ¥5,951,357 4,323,525 1,395,699 232,133 197,453 96,145 96,168 ¥29.88 29.71 10.00 ¥5,724,564 1,047,925 269,545 308,294 327,915 188,000 2000 ¥5,749,372 4,254,444 1,393,959 100,969 (39,161) (4,530) (32,903) ¥(10.22) (10.22) 3.00 ¥5,780,006 1,060,099 298,512 329,630 334,398 191,000 1999 ¥5,300,902 3,890,622 1,379,797 30,483 13,187 20,901 (9,095) ¥(2.83) (2.83) 6.00 ¥6,101,929 1,128,753 375,464 309,836 316,703 198,000 1998 ¥5,458,498 3,960,158 1,416,046 82,294 30,641 17,313 14,723 ¥ 4.57 4.57 10.00 ¥6,166,323 1,305,946 339,584 291,418 322,928 186,000 1997 ¥5,521,887 3,932,585 1,391,471 197,831 139,980 71,593 67,077 ¥20.84 20.06 10.00 ¥5,933,205 1,388,827 341,020 252,732 332,555 186,000 1996 ¥5,192,244 3,647,624 1,282,053 262,567 195,191 102,965 90,388 ¥28.08 26.85 10.00 ¥5,743,009 1,384,582 308,653 261,985 314,774 186,000 2 3 2. Management’s Discussion and Analysis 14. Consolidated Balance Sheets 16. Consolidated Statements of Income 17. Consolidated Statements of Shareholders’ Equity 18. Consolidated Statements of Cash Flows 19. Notes to Consolidated Financial Statements 39. Report of Independent Auditors Management’s Discussion and Analysis SCOPE OF CONSOLIDATION As of the end of March 2006, Toshiba Group comprised Toshiba Corporation and 368 consolidated subsidiaries and its principal operations were in the Digital Products, Electronic Devices, Social Infrastructure and Home Appliances business domains. 94 consolidated subsidiaries were involved in Digital Products, 45 in Electronic Devices, 122 in Social Infrastructure, 56 in Home Appliances and 51 in Others. The consolidated subsidiaries listed on the first Section of Tokyo Stock Exchange are Toshiba TEC Corporation and Toshiba Plant Systems & Services Corporation. 111 were affiliates accounted for by the equity method. The number of consolidated subsidiaries was 29 more than at the end of March 2005. RESULTS OF OPERATIONS NET SALES AND NET INCOME (LOSS) The Japanese economy recovered in this period as capital expenditures increased on solid corporate profitability, though con- cerns remained about unemployment. Overseas, economic expansion continued in the US on improved employment rates and higher consumption, and Europe saw gradual recovery. In Asia, China and other countries continued their economic expansion. Toshiba Group aims for high growth in its Digital Products and Electronic Devices business domains. In Social Infrastructure domain, the Group seeks to secure stable growth and profits, mainly through expansion of its international business. Toshiba’s consolidated sales in FY 2005 were ¥6,343.5 billion (US$54,218.0 million), ¥507.4 billion higher than in the previous fiscal year. Consolidated operating income increased by ¥85.8 billion from the same period a year earlier to ¥240.6 billion (US$2,056.5 million). All business segments posted healthy business results, recording year-on-year increases in sales and operating income, as a result of business development based on the overall Group strategy of achieving high growth with steady profitability. Income before income taxes and minority interest was ¥178.2 billion (US$1,522.9 million), a ¥67.0 billion increase from the previous year. Net income increased by ¥32.2 billion from the previous year to ¥78.2 billion (US$668.3 million). Basic earnings per share also increased by ¥10.00 to ¥24.32 (US$0.21) from a year ago. (Note) From FY2005, income (loss) before income taxes and minority interest includes equity in earnings of affiliates, which was not included until FY2004. The impact of this change is plus ¥0.6 billion for FY2004 and minus ¥4.5 billion for FY2005. NET SALES BY REGION Year ended March 31 Japan Asia North America Europe Others Net Sales 2006 ¥3,382,143 1,144,568 945,137 699,584 172,074 ¥6,343,506 Millions of yen 2005 ¥3,259,853 949,208 811,641 615,283 200,154 ¥5,836,139 2004 ¥3,399,903 829,914 710,108 517,235 122,346 ¥5,579,506 (Note) These figures are based on geographic location of the market in which sales were recorded, and therefore differ from the segment sales reported on p.8, which are based on the location of the distribution source. Japan Sales increased by ¥122.3 billion compared to the previous year to ¥3,382.1 billion, reflecting the dissolution of a joint ven- ture accounted for under the equity method in the power transmission and distribution business with Mitsubishi Electric Corporation, and the transfer of the business back to the parent. Asia Sales increased by ¥195.4 billion from the year earlier period to ¥1,144.6 billion, with the storage devices, semiconductor business, LCD business recording revenue increases. North America and Europe Sales were ¥945.1 billion in North America and ¥699.6 billion in Europe, primarily on higher revenues in the semiconductor business and the PC business. Others Sales declined by ¥28.1 billion compared to the previous year to ¥172.1 billion. DIVIDEND Toshiba will pay 3.5 yen per share as a year-end dividend. Combined with the 3 yen interim dividend, the total full-term divi- dend will be 6.5 yen per share, an increase of 1.5 yen per share from the previous year. Payment of the year-end dividend will start on June 2, 2006. RESULTS BY INDUSTRY SEGMENT Year ended March 31 Digital Products Electronic Devices Social Infrastructure Home Appliances Others Eliminations Total Net Sales Billions of yen — 2,536.5 1,388.1 1,882.3 687.5 379.8 –530.7 6,343.5 Change (%) 14% 6% 7% 4% 2% — 9% Operating Income (loss) — 20.9 123.3 76.5 2.7 18.0 –0.8 240.6 Change +13.6 +30.8 +27.9 +6.0 +8.2 –0.7 +85.8 4 5 DIGITAL PRODUCTS Consolidated net sales of Digital Products increased by ¥312.3 billion or 14% to ¥2,536.5 billion (US$21,679.9 million). The Personal Computers business saw sales increase from a year ago on overseas sales growth, mainly in the US and Europe. The Digital Media Network business saw sales increase on higher sales of storage devices. The Mobile Phones business also increased sales, as new products, mainly high-end models, met a positive response in the Japanese market. The Retail Information and Office Document Processing Systems business also increased sales. Consolidated operating income of Digital Products was ¥20.9 billion (US$178.3 million), an improvement of ¥13.6 bil- lion from a year earlier, as a result of improved operating income in the Mobile Phones business and storage devices, despite adverse impacts from exchange rate fluctuations, and price erosion in such products as DVD recorders. ELECTRONIC DEVICES Electronic Devices increased consolidated net sales by ¥80.9 billion to ¥1,388.1 billion (US$11,864.0 million). The Semiconductor business saw increased sales against the previous year on strong sales of memories, mainly NAND flash memory. Sales in the LCD business were comparable with FY2004, as overseas sales increased despite significant price ero- sion. The Display Devices & Components business reported a significant sales decline, reflecting the cessation of production of some cathode-ray-tube related products. Consolidated operating income in Electronic Devices was ¥123.3 billion (US$1,053.7 million), an increase of ¥30.8 bil- lion. The Semiconductor business increased its operating income. The LCD business remained profitable through cost reduction programs, though on decreased operating income due to price erosion. SOCIAL INFRASTRUCTURE Social Infrastructure saw consolidated net sales of ¥1,882.3 billion (US$16,087.7 million), ¥117.0 billion higher than for the previous year. Sales in the Medical Systems business rose from a year earlier, on strong sales of multi-slice CT scan systems mainly in the US. The Industrial and Power Systems & Services business saw a sales increase from FY2004, reflecting the transition of the power transmission and distribution businesses to the parent from a dissolved joint venture. The Social Network & Infrastructure Systems business also increased its sales against the previous year, as a result of higher sales of broadcasting systems, while the IT Solutions business saw a slight decline in sales, due to decreased orders for the public sec- tor. Sales in the Elevator business were flat compared to the previous year, as sluggish domestic sales undermined higher overseas sales. Consolidated operating income in Social Infrastructure was ¥76.5 billion (US$654.3 million), a ¥27.9 billion increase from the year earlier period. The Medical Systems, IT Solutions, Industrial and Power Systems & Services, and Social Network & Infrastructure Systems businesses improved their performance from the previous year, while the Elevator busi- ness saw a decline in operating income. Management’s Discussion and Analysis HOME APPLIANCES Consolidated net sales in Home Appliances increased by ¥26.5 billion from the previous year to ¥687.5 billion (US$5,876.1 million) on higher sales of washing machines and backlights for LCDs. The segment posted profit of ¥2.7 billion (US$23.2 million), an improvement of ¥6.0 billion from the year earlier period. OTHERS Consolidated net sales of Others increased by ¥8.2 billion to ¥379.8 billion (US$3,245.8 million). Operating income in Others was ¥18.0 billion (US$153.5 million), a ¥8.2 billion increase from the year earlier period. Segment information is based on Japanese accounting standards. INDUSTRY SEGMENTS Year ended March 31 Sales: Digital Products Unaffiliated customers Intersegment Total Electronic Devices Unaffiliated customers Intersegment Total Social Infrastructure Unaffiliated customers Intersegment Total Home Appliances Unaffiliated customers Intersegment Total Others Unaffiliated customers Intersegment Total Eliminations Consolidated 2006 Millions of yen 2005 2004 Thousands of U.S. dollars 2006 ¥ 2,459,270 77,278 2,536,548 ¥ 2,156,495 67,690 2,224,185 ¥ 1,939,717 69,678 2,009,395 $ 21,019,401 660,496 21,679,897 1,301,665 86,419 1,388,084 1,815,115 67,146 1,882,261 669,058 18,448 687,506 1,215,802 91,361 1,307,163 1,707,211 58,091 1,765,302 642,285 18,760 661,045 1,174,934 108,654 1,283,588 1,654,959 59,177 1,714,136 616,807 20,475 637,282 11,125,342 738,624 11,863,966 15,513,803 573,898 16,087,701 5,718,445 157,675 5,876,120 98,398 281,357 379,755 (530,648) ¥ 6,343,506 114,346 257,276 371,622 (493,178) ¥ 5,836,139 193,089 279,655 472,744 (537,639) ¥ 5,579,506 841,008 2,404,761 3,245,769 (4,535,453) $ 54,218,000 Year ended March 31 Operating income (loss): Digital Products Electronic Devices Social Infrastructure Home Appliances Others Eliminations Consolidated Identifiable assets: Digital Products Electronic Devices Social Infrastructure Home Appliances Others Corporate and Eliminations Consolidated Depreciation and amortization: Digital Products Electronic Devices Social Infrastructure Home Appliances Others Corporate Consolidated Impairment of long–lived assets: Digital Products Electronic Devices Social Infrastructure Home Appliances Others Corporate Consolidated Capital expenditures: Digital Products Electronic Devices Social Infrastructure Home Appliances Others Corporate Consolidated 2006 Millions of yen 2005 2004 Thousands of U.S. dollars 2006 ¥ ¥ 20,864 123,287 76,553 2,710 17,964 (768) 240,610 ¥ 1,092,075 1,323,693 1,577,973 400,825 442,389 (109,842) ¥ 4,727,113 ¥ 32,071 148,016 34,982 16,654 22,494 — ¥ 254,217 ¥ ¥ 7,126 2,861 444 116 1,427 — 11,974 ¥ 44,209 239,480 44,034 27,428 7,733 — 362,884 ¥ ¥ 7,266 92,512 48,581 (3,332) 9,863 (83) ¥ 154,807 ¥ 966,105 1,270,970 1,493,170 390,171 515,371 (64,375) ¥ 4,571,412 ¥ 32,559 132,662 34,588 18,056 23,497 — ¥ 241,362 ¥ ¥ — 1,088 — — — — 1,088 ¥ 36,478 239,361 36,571 22,024 8,073 — ¥ 342,507 ¥ (23,810) $ 178,325 1,053,735 117,002 654,299 58,637 23,162 3,474 153,539 18,845 (6,564) 438 $ 2,056,496 ¥ 174,586 ¥ 872,559 1,241,464 1,529,197 371,850 479,399 (32,269) ¥ 4,462,200 $ 9,333,974 11,313,615 13,486,949 3,425,855 3,781,103 (938,821) $ 40,402,675 ¥ 35,499 112,466 37,657 18,786 44,423 — ¥ 248,831 $ 274,111 1,265,094 298,992 142,342 192,256 — $ 2,172,795 ¥ — $ 10,018 — — — — ¥ 10,018 60,906 24,453 3,795 991 12,197 — $ 102,342 ¥ 48,556 136,162 27,629 19,330 23,009 — ¥ 254,686 $ 377,855 2,046,838 376,359 234,427 66,094 — $ 3,101,573 6 7 Management’s Discussion and Analysis GEOGRAPHIC SEGMENTS Year ended March 31 Sales: Japan Unaffiliated customers Intersegment Total Asia Unaffiliated customers Intersegment Total North America Unaffiliated customers Intersegment Total Europe Unaffiliated customers Intersegment Total Others Unaffiliated customers Intersegment Total Eliminations Consolidated Operating income (loss): Japan Asia North America Europe Others Eliminations Consolidated Identifiable assets: Japan Asia North America Europe Others Corporate and Eliminations Consolidated 2006 Millions of yen 2005 2004 Thousands of U.S. dollars 2006 ¥ 3,787,378 1,677,041 5,464,419 ¥ 3,651,995 1,363,317 5,015,312 ¥ 3,747,371 1,188,508 4,935,879 $ 32,370,752 14,333,684 46,704,436 980,360 541,060 1,521,420 863,732 24,769 888,501 634,245 24,489 658,734 77,791 1,454 79,245 (2,268,813) ¥ 6,343,506 ¥ 191,949 22,063 18,107 6,145 2,075 271 ¥ 240,610 ¥ 3,790,544 750,481 254,649 241,598 30,379 (340,538) ¥ 4,727,113 806,794 548,344 1,355,138 744,223 21,067 765,290 568,211 28,706 596,917 64,916 1,292 66,208 (1,962,726) ¥ 5,836,139 ¥ 112,765 20,485 15,639 5,105 900 (87) ¥ 154,807 617,973 568,220 1,186,193 8,379,145 4,624,445 13,003,590 667,663 19,220 686,883 488,785 15,619 504,404 7,382,324 211,701 7,594,025 5,420,897 209,308 5,630,205 57,714 2,035 59,749 (1,793,602) ¥ 5,579,506 664,880 12,428 677,308 (19,391,564) $ 54,218,000 ¥ 148,729 13,368 6,599 3,875 756 1,259 174,586 ¥ $ 1,640,590 188,572 154,761 52,521 17,735 2,317 $ 2,056,496 ¥ 3,577,949 641,258 223,435 204,146 29,386 (104,762) ¥ 4,571,412 ¥ 3,589,596 513,932 180,086 210,935 28,111 (60,460) ¥ 4,462,200 $ 32,397,812 6,414,367 2,176,487 2,064,940 259,650 (2,910,581) $ 40,402,675 RESEARCH AND DEVELOPMENT The Group, inspired by the three concepts of “surprise and sensation”, “safety and security” and “comfort”, is dedicated to the creation of cutting-edge, high value-added technologies able to overcome commoditization. Wide-ranging research projects promote the development of differentiated technologies and proprietary knowledge in new materials, products and systems, and further the development of manufacturing technology. In the core business segments of Digital Products, Electronic Devices and Social Infrastructure, research and development draws on the Group’s technological strengths to develop engines for future growth to a strategic product map. Efforts are also made to achieve cross functional business synergies, such as those between the Digital Products segment and Electronic Devices segment to promote the concept of “Toshiba as a Visual Brand”. The Group’s overall R&D expenditure reached ¥372.4 billion in the fiscal year ended March 31, 2006. Expenditures for each business segment were as follows: Digital Products Electronic Devices Social Infrastructure Home Appliances Others CAPITAL EXPENDITURES Billions of yen 108.3 174.5 70.9 17.7 1.0 8 9 CAPITAL EXPENDITURE OVERVIEW The Group’s basis strategy stresses “concentration of management resources in growing fields.” In the term under review, overall plant and equipment investments (including intangible assets) reached ¥362.9 billion, with the majority from the Electronic Devices and Digital Products segments. Additional investments totaling ¥186.1 billion were made by Flash Vision, Ltd., Flash Partners, Ltd. and SED Inc., all affiliates accounted for by the equity method. In the Electronic Devices segment, capital investments of ¥239.5 billion were directed at increasing capacity and promoting development of Semiconductor products and in raising output of LCDs. Major projects completed by the Group in this fis- cal year included the construction of an advanced System LSI facility at Oita and the construction and physical infrastruc- ture for a NAND flash memory facility at Yokkaichi. Projects currently underway in the segment include a further facility for NAND flash memory at Yokkaichi Works, a new production line for System LSI and other devices at Iwate Toshiba Electronics Co., Ltd., and a new plant and manufacturing equipment for low temperature polysilicon LCD at Toshiba Matsushita Display Technology Co., Ltd. In the Digital Products segment, capital investments totaling ¥44.2 billion were channeled into development and manufac- turing of new products, including PCs, imaging products and HDDs. In the Social Infrastructure segment, capital investments of ¥44.1 billion were made in areas that included system develop- ment and updating infrastructure equipment. In the Home Appliances segment, ¥27.4 billion was increased for to develop- ment of new models and manufacturing. The major investment was in new plant and equipment for manufacturing cold cathode fluorescent lamps at Harison Engineering (Korea) Co., Ltd. Capital expenditures in the Others segment totaled ¥7.7 billion. PLANS FOR CONSTRUCTING NEW FACILITIES AND RETIRING EXISTING FACILITIES Group capital expenditures are planned from a three-year perspective, with consideration for manufacturing plans, demand forecasts, and return on investment. Each segment develops its own plan, while Toshiba corporate provides oversight and adjustment to prevent unnecessary duplication of investment. In the year under review, investment in new facilities and equipment upgrades, including intangible assets, totaled ¥644.0 billion. This figure includes ¥300.5 billion invested by Toshiba through three affiliates accounted for by the equity method, Flash Vision, Ltd., Flash Partners, Ltd. and SED Inc. Management’s Discussion and Analysis FINANCIAL POSITION AND CASH FLOWS Total assets increased by ¥155.7 billion from the end of March 2005 to ¥4,727.1 billion (US$40,402.7 million), mainly as a result of increased notes and accounts receivable, reflecting higher sales. Shareholders’ equity increased by ¥186.7 billion from the end of March 2005 to ¥1,002.2 billion (US$8,565.5 million), on significant improvement in net income and improved accumulated other comprehensive loss. Total debt decreased by ¥193.9 billion from the end of March 2005 to ¥917.5 billion (US$7,842.0 million), falling well below ¥1,000 billion. Free cash flow was plus ¥198.0 billion, an improvement of ¥135.6 billion from the year-earlier period. As a result of the foregoing, the debt-to-equity ratio as of the end of March 2006 was 92%, below 100% and a 44-point improvement from the end of March 2005. The shareholder’s equity ratio improved by 3.4 points from the end of March 2005 to 21.2%, and ROE improved by 2.7 points to 8.6%. CASH FLOWS In the fiscal year under review, net cash provided by operating activities amounted to ¥501.4 billion, an increase of ¥195.9 bil- lion from the previous fiscal year. Net cash used in investing activities totaled ¥303.4 billion, up ¥60.3 billion from the previous fiscal year. This was due to costs incurred from the transfer of the power transmission and distribution business, and to increased capital investments in the semiconductor business. Net cash used in financing activities increased ¥143.0 billion to ¥235.3 billion during the fiscal year under review, due to the repayment of debts towards reducing interest bearing debt. The effect of exchange rate movements was to increase cash by ¥13.2 billion. After accounting for the aforementioned and other factors, cash and cash equivalents at the fiscal year-end decreased by ¥24.1 billion to ¥270.9 billion. PRINCIPAL SUBSIDIARIES AND AFFILIATED COMPANIES As of March 31, 2006 Subsidiaries: Japan Toshiba Building Co., Ltd. Toshiba Elevator and Building Systems Corporation Toshiba Medical Systems Corporation Toshiba Plant Systems & Services Corporation Toshiba TEC Corporation U.S.A. Toshiba America Information Systems, Inc. Toshiba America, Inc. 100 80 100 69 52 100 100 Percentage held by the Group Affiliated Companies: Japan MT Picture Display Co., Ltd. Toshiba Ceramics Co., Ltd. Toshiba Machine Co., Ltd. 36 41 34 RISK FACTORS RELATING TO THE TOSHIBA GROUP AND ITS BUSINESS The Group’s business areas of energy and electronics require highly advanced technology. At the same time, the Group faces fierce global competition. Therefore, appropriate risk management is indispensable. Major risk factors related to the Group are described below. The actual occurrence of any of those risk factors may adversely affect the Group’s results and financial condition. In order to promote full disclosure to investors, this also may cover risk in the wider aspect. The Group recognizes these risks and makes every effort to manage them and to minimize any impact. These risks include potential risks for future, that the Group judged as risk as of the end of March 2006. (1) Acquisitions and others The Group entered into an agreement in February 2006 to acquire Westinghouse at a cost of US$5.4 billion. As a result, a substantial amount of goodwill may be recorded in the Company’s consolidated balance sheets, pursuant to with US general- ly accepted accounting principles (US GAAP). The Company believes this goodwill is appropriate, reflecting Westinghouse’s future capabilities for profit generation and the synergy to be obtained from combining Westinghouse and Toshiba Group. However, it is a significant task for the Group to maintain and raise the value of the goodwill continuously. (2) Reliance on Electronic Devices business The Group is highly reliant on its Electronic Devices business segment in operating income. If the results of the segment are weak, the Group may be unable to offset them with any profits it may make from other business segments. (3) Business environment of Digital Products business The market for the Digital Product segment is intensely competitive, with many competitors manufacturing and selling products similar to those offered by the Group. In addition, demand for products in this segment can be volatile. In times of decreased consumer spending, demand for the Group’s products can be low, while times of rapid increases in demand may result in shortages of parts and components, hampering the Group’s ability to supply products to the market in a timely manner. The segment makes every effort to monitor the demand situation, however if demand fluctuates rapidly, price ero- sion and increases may occur in the prices of components. Furthermore, some products in this segment are dependent on particular customers. (4) Business environment of Electronic Devices business The market for the Electronic Devices segment is highly cyclical in demand, a situation usually referred to as the “silicon cycle”. In addition, competition to develop and market new products is severe. The segment makes every effort to monitor shifts in the market, but if the market faces a downturn, if the Group fails to market new products in a timely manner, or if there is a rapid introduction of new technology, the Group’s current products may become obsolete. In addition, this business segment requires significant levels of capital expenditure. While efforts are made to invest in stages by watching the demand situation carefully, unpredicted market change may make production capacity for particular products available at a time when demand for those products is on the wane, creating saturation. (5) Business environment of Social Infrastructure business A significant portion of net sales in the Social Infrastructure segment is attributable to government and local municipality expenditure on public works and private capital expenditure. The segment monitors the trend in these capital expenditures, and makes best efforts to cultivate new business and customers, in order to avoid undue impact from any fluctuation in the trend, however, reductions and delays in public works spending, as well as low levels of private capital expenditure, can adversely affect the segment business. Furthermore, the business of this segment involves supply of products and services in relation to large-scale projects. Delays, changes in plans, stoppages, natural and other disasters, and other factors beyond the control of the segment and that affect the progress of such projects may adversely affect the segment’s business operations. (6) Lawsuits The Group undertakes global business operation, and is investigated by authorities and involved in disputes, including law- suits, in several regions. Due to differences in judicial systems it is difficult to rule out the possibility that the Group may be subject to a judicial order requiring payment of an amount far exceeding normal expectations, a factor that results in signifi- cant difficulty in estimating potential exposure. Judgments or decisions unfavorable to the Group may impact on Group operations. Lexar Media, Inc. filed suit against the Company and its US subsidiary, Toshiba America Electronic Components, Inc. alleging misappropriation of NAND flash-related trade secrets and related misconduct. In December 2005, the Superior Court of the State of California (the court of first instance) granted a new trial on damages, vacating a March 2005 jury award from the 10 11 Management’s Discussion and Analysis original trial that totaled approximately US$465 million. Both the Company and its US subsidiary and Lexar Media filed notices of appeal to the higher court on portions of the Superior Court’s decision, and the case is now pending before the Court of Appeal of the State of California. The Group will pursue all available legal avenues to arrive at a just outcome in this matter. (7) Development of new products It is critically important for the Group to offer the market viable and innovative new products and services. The Group identifies strategic products that will drive future profits, and defines strategic products to support the timely introduction of successive products. However due to the rapid pace of technological innovation, the introduction of new technologies and products that replace current products, and changes in technology standards, the introduction to market of optimum new products, including SED, may be delayed, and new products that are brought to market, such as HD DVD players, may be accepted by the market for a shorter period than anticipated. In addition, if the Group fails to assure sufficient funding and resources for continuous product development, it may affect the Group’s ability to develop new products and services and to introduce them to the market. (8) Investments in new business The Group invests in companies involved in new business, including Mobile Broadcasting, as well as developing its own new business opportunities. Many technological issues need to be resolved and new demand effectively discovered and captured before a new line of business can become successful, and as such its progress and success are uncertain. If any new business in which the Group invests or which the Group attempts to develop does not progress as planned, the Group may not recover the funds and resources it has spent, and this may adversely affect the Group. (9) Success of joint ventures and other business alliances A key strategy of the Group in many of its businesses is the formation of joint ventures and business alliances optimized for each business, in every area of the business, including research and development, production and marketing. If the Group experiences differences with a partner in a joint venture or business alliance, in respect of financing, technological manage- ment, product development or management strategies, such joint ventures or business alliances may be terminated. (10) Global environment The Group undertakes global business operations. Any changes in political, economic and social conditions, legal or regulatory changes and exchange rate fluctuations in any region, may impact on market demand and the Group’s business operations. As the Group expands overseas production, particularly in Asia, any occurrence of terrorism or an epidemic illness, such as avian flu, could have a significant adverse effect on Group results. (11) Natural disasters Most of the Group’s Japanese production facilities are located in the Keihin region, part of the capital region, while key semi- conductor production facilities are located in Kyushu, Tokai, Hanshin and Tohoku. While the Group promotes measures such as earthquake-resistant buildings at production facilities, large-scale disasters, such as earthquakes or typhoons in regions with production sites could damage or destroy production capabilities, cause operational and transportation inter- ruptions, and affect production capabilities significantly. (12) Measures against counterfeit products While the Group protects and seeks to enhance the value of the “Toshiba” brand, there are lesser-quality counterfeit prod- ucts worldwide created by third parties, which may dilute the value of the “Toshiba” brand. Distribution of those ‘copycat’ products may decrease the Group’s net sales. (13) Product quality claims While the Group has instituted measures to manufacture its products in accordance with appropriate quality-control stan- dards, there can be no assurance that each of its products is free of defects or that they will not result in a large-scale recall, lawsuits or other claims relating to product quality. (14) Information securities The Group keeps and manages various personal information obtained in the process of business operations. The Group also keeps various trade secrets regarding the Group’s technology, marketing and other business operations. While the Group makes every effort to manage this information properly, an unanticipated leak of such information, obtained and used illegal- ly by a third party, could occur, and recovery may be costly. Additionally, the role of information systems in the Group is critical to carry out business activities. While the Group makes every effort to assure stable operation of its information systems, it is possible that their functionality could be impaired or destroyed by computer viruses, disaster, terrorism, software or hardware failures, and other factors. (15) Procurement of components and materials It is important for the Group’s business activities to obtain materials, components, and other procured goods in a timely and proper manner. Procured goods include products whose suppliers are limited due to the product’s particularity, and that are difficult to replace. In cases of delay or other problems in receiving supply of such components and materials, shortages may occur or procurement costs may rise. Also, it is necessary to procure components and materials at competitive costs and to optimize the entire supply chain, including suppliers, in order for the Group to bring competitive products to market. Any failure by the Group to achieve proper cooperation with key suppliers may impact on the Group’s competitiveness. Any case of defective components and materials may also have an adverse effect on the reliability and reputation of the Group and Toshiba brand products. (16) Securing human resources Success of the Group’s businesses depends in large part on securing excellent human resources in every business area and process, including product development, production, marketing and business management. Competition to secure human resources is intensifying, as the number of qualified personnel in each area and process is limited, and demand for human resources is increas- ing as the economy recovers. Due to this, the Group may fail to retain existing employees or to obtain new human resources. (17) Compliance and internal control The Group is active in various businesses in various regions worldwide, and its business activities are subject to laws and reg- ulations in each country or region. The Group puts in place appropriate internal control systems from perspectives that include assuring management effectiveness and efficiency, assuring the reliability of business and financial reports, compli- ance with laws and regulations, and risk management, and operates within those systems. However, by their nature, such internal control systems may themselves have limitations, and it is not possible to guarantee that they will fully achieve their objectives. Due to these inherent limitations, we cannot guarantee that there will never be any violation of laws and regula- tions. Changes in laws and regulations or changes in interpretations of laws and regulations by the authorities may also cause difficulty in achieving compliance with laws and regulations, or may result in increased compliance costs. (18) Strategic concentrated investment The Group makes strategic investments that concentrate on specific business areas, including NAND flash memory, nuclear power and SED. While it is essential to allocate limited management resources to strategic, high growth areas and businesses in which the Group enjoys competitiveness, in order to secure and maintain the Group’s advantages, the strategic businesses in which such investments are made may not generate profit commensurate with the investments. (19) Protection of intellectual property rights The Group makes every effort to secure intellectual property rights. However, in some regions, it may not be possible to secure sufficient protection. Also, the Group may use intellectual property from third parties, for which the Group has acquired permission for use. It could be possible that the Group fails to receive such third-party permission for an essential intellectual property, or receives permission only on unfavorable terms. It is also possible that the Group will have to file suit in order to protect its intellectual property rights, or that a suit for breach of intellectual property rights may be brought against the Group. Such lawsuits may require time, costs and other management resources, and, depending on the decision in such a lawsuit, it may become impossible for the Group to use an important technology, or the Group may become liable for significant damages. (20) Environment In the Group’s global business activities, various environmental laws, including laws on air pollution, water pollution, toxic sub- stances, waste disposal, and product recycling, are in force around the world. While the Group pays careful attention to those laws and regulations, it may be possible that the Group discovers a legal or social liability for the environment, regardless of whether it is at fault or not, in past, present or future business activities. It may also be possible that, in future, the Group will be required to remove environmental hazards including toxic substances, as a result of the introduction of more demanding environmental regulations. (21) Employee retirement benefit costs and obligations The amount of the Group’s employee retirement benefit costs and obligations are calculated on assumptions used in the rele- vant actuarial calculations. Those assumptions may change due to adverse economic or other factors, or returns on plan assets may be lower than anticipated. (22) Financing environment The Group has substantial amounts of interest-bearing debt for financing, highly susceptible to the market environment, including interest rate and supply and demand of funds. Changes in these factors may have an adverse effect on the Group’s funding activities. 12 13 Consolidated Balance Sheets Toshiba Corporation and Subsidiaries As of March 31, 2006 and 2005 Assets Current assets: Cash and cash equivalents Notes and accounts receivable, trade: Notes (Note 5) Accounts (Note 5) Allowance for doubtful notes and accounts Inventories (Note 6) Deferred tax assets (Note 16) Prepaid expenses and other current assets Total current assets Long-term receivables and investments: Long-term receivables (Note 5) Investments in and advances to affiliates (Note 7) Marketable securities and other investments (Note 4) Property, plant and equipment (Notes 9, 15, 20 and 21): Land Buildings Machinery and equipment Construction in progress Less—Accumulated depreciation Deferred tax assets (Note 16) Other assets (Notes 8 and 11) The accompanying notes are an integral part of these statements. Millions of yen 2006 2005 Thousands of U.S. dollars (Note 3) 2006 ¥ 270,921 ¥ 295,003 $ 2,315,564 101,208 1,181,943 (28,671) 664,922 146,655 309,638 2,646,616 18,883 228,402 240,456 487,741 161,503 1,084,433 2,402,752 64,345 3,713,033 (2,536,483) 1,176,550 95,207 1,052,288 (26,599) 649,998 131,144 277,278 2,474,319 865,026 10,102,077 (245,051) 5,683,094 1,253,461 2,646,479 22,620,650 19,090 193,266 194,191 406,547 161,393 1,952,154 2,055,179 4,168,726 169,464 1,064,760 2,349,258 60,547 3,644,029 (2,479,846) 1,164,183 1,380,368 9,268,658 20,536,342 549,957 31,735,325 (21,679,342) 10,055,983 237,334 178,872 348,713 177,650 2,028,496 1,528,820 ¥ 4,727,113 ¥ 4,571,412 $ 40,402,675 Liabilities and shareholders’ equity Current liabilities: Short-term borrowings (Note 9) Current portion of long-term debt (Notes 9 and 19) Notes payable, trade Accounts payable, trade Accounts payable, other and accrued expenses (Note 25) Accrued income and other taxes Advance payments received Other current liabilities (Notes 21 and 23) Total current liabilities Long-term liabilities: Long-term debt (Notes 9, 10 and 19) Accrued pension and severance costs (Note 11) Other liabilities (Note 21) Millions of yen 2006 2005 ¥ 142,530 163,558 63,574 1,037,048 411,220 48,725 144,362 397,953 2,408,970 ¥ 197,765 230,285 67,291 906,248 349,009 46,561 134,326 335,358 2,266,843 Thousands of U.S. dollars (Note 3) 2006 $ 1,218,205 1,397,932 543,367 8,863,658 3,514,701 416,453 1,233,863 3,401,308 20,589,487 611,430 474,198 72,025 1,157,653 683,396 581,598 79,361 1,344,355 5,225,898 4,052,974 615,598 9,894,470 Minority interest in consolidated subsidiaries 158,325 144,707 1,353,205 Shareholders’ equity (Note 17): Common stock: Authorized—10,000,000,000 shares Issued: 2006 and 2005—3,219,027,165 shares Additional paid-in capital Retained earnings Accumulated other comprehensive loss Treasury stock, at cost: 2006—4,429,347 shares 2005—3,558,726 shares Commitments and contingent liabilities (Notes 22, 23 and 24) 14 15 274,926 285,743 570,080 (126,509) (2,075) — 1,002,165 274,926 285,736 511,185 (254,753) — (1,587) 815,507 2,349,795 2,442,248 4,872,479 (1,081,274) (17,735) — 8,565,513 ¥ 4,727,113 ¥ 4,571,412 $ 40,402,675 Consolidated Statements of Income Toshiba Corporation and Subsidiaries For the years ended March 31, 2006 and 2005 Sales and other income: Net sales Subsidy received on return of substitutional portion of Employees’ Pension Fund Plan, net of settlement loss of ¥5,045 million ($43,120 thousand) in 2006 and ¥7,992 million in 2005 (Note 11) Interest and dividends Equity in earnings of affiliates (Note 7) Other income (Notes 4, 5 and 14) Costs and expenses: Cost of sales (Notes 8, 12, 15, 20 and 25) Selling, general and administrative (Notes 8, 12, 13 and 20) Interest Equity in losses of affiliates (Note 7) Other expense (Notes 4, 5, 14 and 15) Millions of yen 2006 2005 Thousands of U.S. dollars (Note 3) 2006 ¥ 6,343,506 ¥ 5,836,139 $ 54,218,000 4,085 13,485 — 49,605 6,410,681 4,659,795 1,447,186 24,601 4,452 96,470 6,232,504 4,836 10,564 665 58,156 5,910,360 4,296,572 1,389,596 21,749 — 91,211 5,799,128 34,915 115,256 — 423,974 54,792,145 39,827,308 12,369,111 210,265 38,051 824,530 53,269,265 Income before income taxes and minority interest 178,177 111,232 1,522,880 Income taxes (Note 16): Current Deferred 57,051 33,091 90,142 50,419 5,525 55,944 487,615 282,829 770,444 Income before minority interest 88,035 55,288 752,436 Minority interest in income of consolidated subsidiaries 9,849 9,247 84,180 Net income ¥ 78,186 ¥ 46,041 $ 668,256 Basic net income per share (Note 18) Diluted net income per share (Note 18) Cash dividends per share (Note 17) The accompanying notes are an integral part of these statements. Yen ¥ 24.32 ¥ 22.44 ¥ 14.32 ¥ 13.53 U.S. dollars (Note 3) 0.21 $ $ 0.19 ¥ 6.50 ¥ 5.00 $ 0.06 Consolidated Statements of Shareholders’ Equity Toshiba Corporation and Subsidiaries For the years ended March 31, 2006 and 2005 Balance at March 31, 2004 Comprehensive income (loss): Common stock ¥ 274,926 Additional paid-in capital ¥ 285,736 Millions of yen Retained earnings ¥ 481,227 ¥ 46,041 Accumulated other comprehensive loss Treasury stock (285,894) ¥ (1,005) ¥ 754,990 Total 6,654 10,441 14,968 (922) (16,083) 274,926 285,736 511,185 (254,753) (582) (1,587) 78,186 23,767 36,830 67,964 (317) (19,291) 7 (488) 46,041 6,654 10,441 14,968 (922) 77,182 (16,083) (582) 815,507 78,186 23,767 36,830 67,964 (317) 206,430 (19,291) (481) 16 17 ¥ 274,926 ¥ 285,743 ¥ 570,080 ¥ (126,509) ¥ (2,075) ¥1,002,165 Common stock Additional paid-in capital Thousands of U.S. dollars (Note 3) Retained earnings Accumulated other comprehensive loss Treasury stock Total $2,349,795 $2,442,188 $4,369,102 $ (2,177,376) $(13,564) $6,970,145 668,256 668,256 203,137 314,786 580,889 (2,710) 1,764,358 (164,879) (4,111) $2,349,795 $2,442,248 $4,872,479 $ (1,081,274) $(17,735) $8,565,513 203,137 314,786 580,889 (2,710) (164,879) (4,171) 60 Net income Other comprehensive income (loss), net of tax (Note 17): Unrealized gains on securities (Note 4) Foreign currency translation adjustments Minimum pension liability adjustment (Note 11) Unrealized losses on derivative instruments Comprehensive income Dividends Purchase of treasury stock, net, at cost Balance at March 31, 2005 Comprehensive income (loss): Net income Other comprehensive income (loss), net of tax (Note 17): Unrealized gains on securities (Note 4) Foreign currency translation adjustments Minimum pension liability adjustment (Note 11) Unrealized losses on derivative instruments Comprehensive income Dividends Purchase of treasury stock, net, at cost Balance at March 31, 2006 Balance at March 31, 2005 Comprehensive income (loss): Net income Other comprehensive income (loss), net of tax (Note 17): Unrealized gains on securities (Note 4) Foreign currency translation adjustments Minimum pension liability adjustment (Note 11) Unrealized losses on derivative instruments Comprehensive income Dividends Purchase of treasury stock, net, at cost Balance at March 31, 2006 The accompanying notes are an integral part of these statements. Consolidated Statements of Cash Flows Toshiba Corporation and Subsidiaries For the years ended March 31, 2006 and 2005 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities— Depreciation and amortization Provisions for pension and severance costs, less payments Deferred income tax provision Equity in (earnings) losses of affiliates, net of dividends Loss from sales, disposal and impairment of property, plant and equipment, net Gain from sales and impairment of securities and other investments, net Minority interest in income of consolidated subsidiaries Increase in notes and accounts receivable, trade Increase in finance receivables, net (Increase) decrease in inventories Increase in other current assets (Increase) decrease in long-term receivables Increase in long-term finance receivables, net Increase in notes and accounts payable, trade Increase in accrued income and other taxes Decrease in advance payments received Increase in accounts payable and other liabilities Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of property, plant and equipment Proceeds from sale of securities Acquisition of property, plant and equipment Purchase of securities Increase in investments in affiliates Purchase of business from an affiliate Increase in other assets and other Net cash used in investing activities Cash flows from financing activities Proceeds from long-term debt Repayment of long-term debt Decrease in short-term borrowings, net Dividends paid Repurchase of subsidiary common stock Purchase of treasury stock, net Other 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 year Cash and cash equivalents at end of year Supplemental disclosure of cash flow information Cash paid during the year for— Interest Income taxes Purchase of business from an affiliate— Assets acquired Liabilities assumed The accompanying notes are an integral part of these statements. Millions of yen 2006 2005 Thousands of U.S. dollars (Note 3) 2006 ¥ 78,186 ¥ 46,041 $ 668,256 254,217 4,809 33,091 20,023 241,362 2,641 5,525 5,816 2,172,795 41,102 282,829 171,137 19,807 7,592 169,291 (1,737) 9,849 (84,846) — 31,927 (15,540) (1,574) — 90,482 816 (7,121) 69,037 501,426 81,503 12,379 (316,702) (14,940) (20,872) (25,700) (19,053) (303,385) 108,393 (250,884) (60,638) (22,808) (86) (481) (8,794) (235,298) 13,175 (24,082) 295,003 ¥ 270,921 (4,241) 9,247 (67,678) (2,245) (10,107) (17,695) 3,928 (1,682) 82,427 9,722 (51,263) 46,143 305,533 42,094 34,138 (271,635) (12,397) (7,051) — (28,255) (243,106) 251,563 (211,280) (105,416) (17,104) (634) (586) (8,867) (92,324) 5,623 (24,274) 319,277 ¥ 295,003 (14,846) 84,180 (725,179) — 272,880 (132,821) (13,453) — 773,350 6,974 (60,863) 590,060 4,285,692 696,607 105,803 (2,706,855) (127,692) (178,393) (219,658) (162,846) (2,593,034) 926,436 (2,144,308) (518,273) (194,940) (735) (4,111) (75,163) (2,011,094) 112,607 (205,829) 2,521,393 $ 2,315,564 ¥ 24,538 62,925 ¥ 21,761 38,539 $ 209,726 537,821 70,383 34,556 — — 601,564 295,350 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 1. DESCRIPTION OF BUSINESS Toshiba Corporation and its subsidiaries (collectively, the “Company”) are engaged in research and development, manufactur- ing and sales of high-technology electronic and energy products, which span (1)Digital Products, (2)Electronic Devices, (3)Social Infrastructure, (4)Home Appliances, and (5)Others. For the year ended March 31, 2006, sales of Digital Products represented the most significant portion of the Company’s total sales or approximately 37 percent. Social Infrastructure repre- sented approximately 27 percent, Electronic Devices approximately 20 percent, and Home Appliances approximately 10 per- cent of the Company’s total sales. The Company’s products were manufactured and marketed throughout the world with approximately 53 percent of its sales in Japan and the remainder in Asia, North America, Europe and other parts of the world. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PREPARATION OF FINANCIAL STATEMENTS Toshiba Corporation and its domestic subsidiaries maintain their records and prepare their financial statements in accor- dance with accounting principles generally accepted in Japan, and its foreign subsidiaries in conformity with those of the countries of their domicile. Certain adjustments and reclassifications have been incorporated in the accompanying consolidated financial statements to conform with accounting principles generally accepted in the United States. These adjustments were not recorded in the statutory books of account. BASIS OF CONSOLIDATION AND INVESTMENTS IN AFFILIATES The consolidated financial statements of the Company include the accounts of Toshiba Corporation, its majority-owned sub- sidiaries and all variable interest entities (“VIEs”) for which the Company is the primary beneficiary under Financial Accounting Standards Board (“FASB”) Interpretation No.46 as revised in December 2003, Consolidation of Variable Interest Entities, an Interpretation of ARB No.51 (“FIN 46R”). All significant intercompany transactions and accounts are eliminated in consolidation. Investments in affiliates in which the ability to exercise significant influence exists are accounted for under the equity method of accounting. The Company eliminates unrealized intercompany profits in determining its equity in the current net earnings (losses) of such companies. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabili- ties, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. The Company has identified significant areas where it believes assumptions and estimates are particularly critical to the consolidated financial statements. These are determination of impairment on long-lived tangible and intangible assets and goodwill, realization of deferred tax assets, pension accounting assumptions and other valuation allowances and reserves. Actual results could differ from those estimates. CASH EQUIVALENTS All highly liquid investments with original maturities of 3 months or less at the date of purchase are considered to be cash equivalents. FOREIGN CURRENCY TRANSLATION The assets and liabilities of foreign consolidated subsidiaries and affiliates that operate in a local currency environment are translated into Japanese yen at applicable current exchange rates at year end. Income and expense items are translated at aver- age exchange rates prevailing during the year. The effects of these translation adjustments are included in accumulated other comprehensive income (loss) and reported as a component of shareholders’ equity. Exchange gains and losses resulting from foreign currency transactions and translation of assets and liabilities denominated in foreign currencies are included in other income or other expense in the consolidated statements of income. ALLOWANCE FOR UNCOLLECTIBLE RECEIVABLES An allowance for uncollectible trade receivables is recorded based on a combination of the write-off history, aging analysis, and an evaluation of any specific known troubled accounts. When all collection options are exhausted including legal recourse, the accounts or portions thereof are deemed to be uncollectible and charged against the allowance. An allowance for uncollectible finance receivables has been provided based on past loss experience and the estimation of value of the underlying collateral. MARKETABLE SECURITIES AND OTHER INVESTMENTS The Company classifies all of its marketable securities as available-for-sale which are reported at fair value, with unrealized gains and loss- es included in accumulated other comprehensive income (loss), net of taxes. Other investments without quoted market prices are stated at cost. Realized gains or losses on the sale of securities are based on the average cost of a particular security held at the time of sale. Marketable securities and other investment securities are regularly reviewed for other-than-temporary declines in carrying amount based on criteria that include the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer and the Company’s intent and ability to retain marketable securities and investment securities for a period of time sufficient to allow for any anticipated recovery in market value. When such a 18 19 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 decline exists, the Company recognizes an impairment loss to the extent of such decline. INVENTORIES Raw materials, finished products and work in process for products are stated at the lower of cost or market, cost being deter- mined principally by the average method. Finished products and work in process for contract items are stated at the lower of cost or estimated realizable value, cost being determined by accumulated production costs. In accordance with general industry practice, items with long manufacturing periods are included among inventories even when not realizable within one year. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, including significant renewals and additions, are carried at cost. Maintenance and repairs, including minor renewals and betterments, are expensed as incurred. Depreciation for property, plant and equipment is computed generally by the declining-balance method at rates based on the following estimated useful lives of the assets: buildings, 3 to 50 years; machinery and equipment, 2 to 20 years. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets, other than goodwill and intangible assets with indefinite useful lives, are evaluated for impairment using an estimate of undiscounted cash flows whenever events or changes in circumstances indicate that the carrying amount of such asset may not be recoverable. If the estimate of undiscounted cash flow is less than the carrying amount of the asset, an impair- ment loss is recorded based on the fair value of the asset. Fair value is determined primarily by using the anticipated cash flows discounted at a rate commensurate with the risk involved. For assets held for sale, an impairment loss is further increased by costs to sell. Long-lived assets to be disposed of other than by sale are considered held and used until disposed of. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and intangible assets with indefinite useful lives are not amortized, but instead are tested for impairment at least annually. Intangible assets with finite useful lives, consisting primarily of software and license fees, are amortized using the straight-line method over their respective contractual periods or estimated useful lives. ENVIRONMENTAL LIABILITIES Liabilities for environmental remediation and other environmental costs are accrued when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated, based on current law and existing technologies. Such liabilities are adjust- ed as further information develops or circumstances change. Costs of future obligations are not discounted to their present values. INCOME TAXES The provision for income taxes is computed based on the pre-tax income included in the consolidated statements of income. Deferred income taxes are recorded to reflect the expected future tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, and are measured by applying currently enacted tax laws. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the change is enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. ACCRUED PENSION AND SEVERANCE COSTS The Company has various retirement benefit plans covering substantially all employees. Current service costs of the retire- ment benefit plans are accrued in the period. The unrecognized net obligation existing at initial application of Statement of Financial Accounting Standards (“SFAS”) No. 87, Employers’ Accounting for Pensions, and prior service costs resulting from amendments to the plans are amortized over the average remaining service period of employees expected to receive benefits. Unrecognized actuarial losses that exceed 10 percent of the greater of the projected benefit obligation or the fair value of plan assets are also amortized over the average remaining service period of employees expected to receive benefits. ADDITIONAL PAID-IN CAPITAL Under the Japanese Commercial Code, the entire amount of the issue price of shares is required to be accounted for in the common stock account although a company in Japan may, by a resolution of its board of directors, account for an amount not exceeding one-half of the issue price of the shares as additional paid-in capital. ISSUANCE OF STOCK BY A SUBSIDIARY When a subsidiary issues stock to an unrelated third party, the Company’s ownership interest in the subsidiary decreases; however, if the price per share is more or less than the Company’s average carrying amount per share, the Company is required to adjust the carry- ing amount of its investment in the subsidiary. The Company accounts for such adjustments as gains or losses in income for the year in which the change in ownership interest occurs rather than as a capital transaction with a charge or credit to additional paid-in capital. NET INCOME PER SHARE Basic net income per share (“EPS”) is computed based on the weighted-average number of shares of common stock out- standing during each period. Diluted EPS assumes the dilution that could occur if stock acquisition rights were exercised to issue common stock, unless their inclusion would have an antidilutive effect. REVENUE RECOGNITION Revenue of mass-produced standard products, such as digital products and electronic devices, is recognized when there is persuasive evidence of an arrangement, the product has been delivered, the sales price is fixed or determinable, and collectibil- ity is reasonably assured. Mass-produced standard products are considered delivered to customers once they have been shipped, and the title and risk of loss have transferred. Revenue from services, such as maintenance service for plant and other systems, that are priced and sold separately from the equipment is recognized ratable over the contract term or as the services are provided. Revenue from the development of custom software products is recognized when the software product has been delivered and accepted by the customer. Revenue related to equipment that requires installation is recognized upon the completion of the installation of the equipment. Revenue under long-term contracts is recorded under the percentage of completion method. To measure the extent of progress toward completion, the Company generally compares the costs incurred to date to estimated total costs to complete based upon the most recent available information. A provision for contract losses is recorded in its entirety when the loss first becomes evident. Revenue from the sales of equipment under sales-type leases is recognized at the inception of the lease. Interest on sales-type leases and direct financing leases is recognized to produce a constant periodic rate of return on the net investment in the lease. Leases not qualifying as sales-type lease or direct financing lease are accounted for as operating leases and related revenues are recognized over the lease term. Revenue from arrangements with multiple elements, which may include any combination of products, equipment, installment and maintenance, is allocated to each element based on its relative fair value if such element meets the criteria for treatment as a separate unit of accounting as prescribed in the Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables. Otherwise, revenue is deferred until the undelivered elements are fulfilled as a single unit of accounting. SHIPPING AND HANDLING COSTS The Company includes shipping and handling costs which totaled ¥85,951 million ($734,624 thousand) and ¥84,136 million for the years ended March 31, 2006 and 2005, respectively in selling, general and administrative expenses. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses a variety of derivative financial instruments, which include forward exchange contracts, interest rate swap agreements, currency swap agreements, and currency options for the purpose of currency exchange rate and interest rate risk management. Refer to Note 19 for descriptions of these financial instruments. The Company recognizes all derivative financial instruments, such as forward exchange contracts, interest rate swap agreements, cur- rency swap agreements, and currency options in the consolidated financial statements at fair value regardless of the purpose or intent for holding the derivative financial instruments. Changes in the fair value of derivative financial instruments are either recognized periodi- cally in income or in shareholders’ equity as a component of accumulated other comprehensive income (loss) depending on whether the derivative financial instruments qualify for hedge accounting, and if so, whether they qualify as a fair value hedge or a cash flow hedge. Changes in fair value of derivative financial instruments accounted for as fair value hedges are recorded in income along with the portion of the change in the fair value of the hedged item that relates to the hedged risk. Changes in fair value of derivative financial instruments accounted for as cash flow hedges, to the extent they are effective as a hedge, are recorded in accumulated other comprehensive income (loss), net of tax. Changes in the fair value of derivative financial instruments not qualifying as a hedge are reported in income. SALES OF RECEIVABLES The Company enters into transactions to sell certain trade notes receivable and trade accounts receivable. The Company may retain certain interests in these transactions. Gain or loss on the sale of receivables is computed based on the allocated carrying amount of the receivables sold. Retained interests are recorded at the allocated carrying amount of the assets based on their relative fair values at the date of sale. The Company estimates fair value based on the present value of future expect- ed cash flows less credit losses. GUARANTEES The Company recognizes, at the inception of a guarantee, a liability for the fair value of the obligation it has undertaken in issuing guarantees for guarantees issued or modified after December 31, 2002 in accordance with the FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees. RECENT PRONOUNCEMENTS In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facili- ty expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effec- tive for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the fiscal year beginning April 1, 2006. The adoption of SFAS 151 did not have a material impact on its results of operations and financial condition of the Company. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 20 21 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 (“SFAS 153”). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for the fiscal peri- ods beginning after June 15, 2005 and is required to be adopted by the Company in the fiscal year beginning April 1, 2006. The adoption of SFAS 153 did not have a material impact on its results of operations and financial condition of the Company. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154’’). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and provides guidance on the accounting for and reporting of accounting changes and error corrections. SFAS 154 establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 did not have a material impact on its results of operations and financial condition of the Company. RECLASSIFICATIONS Certain reclassifications to the prior year’s consolidated financial statements and related footnote amounts have been made to conform to the presentation for the current year. 3. U.S. DOLLAR AMOUNTS U.S. dollar amounts are included solely for convenience of readers. These translations should not be construed as a representation that the yen could be converted into U.S. dollars at this rate or any other rates. The amounts shown in U.S. dollars are not intended to be computed in accordance with generally accepted accounting principles in the United States for the translation of foreign currency amounts. The rate of ¥117=U.S.$1, the approximate current rate of exchange at March 31, 2006, has been used throughout for the purpose of presentation of the U.S. dollar amounts in the accompanying consolidated financial statements. 4. MARKETABLE SECURITIES AND OTHER INVESTMENTS The aggregate cost, gross unrealized holding gains and losses, and aggregate fair value for marketable equity securities and debt securities classified as available-for-sale securities by security type at March 31, 2006 and 2005 are as follows: March 31, 2006: Equity securities Debt securities March 31, 2005: Equity securities Debt securities March 31, 2006: Equity securities Debt securities Cost 54,160 1,191 55,351 53,802 284 54,086 ¥ ¥ ¥ ¥ Millions of yen Gross unrealized holding gains Gross unrealized holding losses Fair value ¥ 99,096 0 ¥ 99,096 ¥ 57,117 0 ¥ 57,117 ¥ ¥ ¥ ¥ 726 0 726 920 0 920 ¥ 152,530 1,191 ¥ 153,721 ¥ ¥ 109,999 284 110,283 Cost Gross unrealized holding gains Gross unrealized holding losses Fair value Thousands of U.S. dollars $ 462,906 10,179 $ 473,085 $ 846,974 0 $ 846,974 $ $ 6,205 0 6,205 $ 1,303,675 10,179 $ 1,313,854 At March 31, 2006, debt securities mainly consisted of corporate debt securities. Contractual maturities of debt securities classified as available-for-sale at March 31, 2006 are as follows: March 31, 2006: Due within one year Due after one year Millions of yen Cost ¥ ¥ 3 1,188 1,191 Fair value ¥ ¥ 3 1,188 1,191 Thousands of U.S. dollars Cost Fair value $ 25 10,154 $ 10,179 $ $ 25 10,154 10,179 The proceeds from sales of available-for-sale securities for the years ended March 31, 2006 and 2005 were ¥7,513 million ($64,214 thousand) and ¥11,367 million, respectively. The gross realized gains on those sales for the years ended March 31, 2006 and 2005 were ¥5,676 million ($48,513 thousand) and ¥4,980 million, respectively. The gross realized losses on those sales for the years ended March 31, 2006 and 2005 were ¥7 million ($60 thousand) and ¥107 million, respectively. Included in other expense are charges of ¥4,984 million ($42,598 thousand) and ¥4,892 million related to other-than-tempo- rary declines in the marketable and non-marketable equity securities for the years ended March 31, 2006 and 2005, respectively. At March 31, 2006, the cost and fair value of available-for-sale securities in an unrealized loss position over 12 consecutive months were not significant. Aggregate cost of non-marketable equity securities accounted for under the cost method totaled ¥83,708 million ($715,453 thousand) and ¥80,894 million at March 31, 2006 and 2005, respectively. At March 31, 2006, investments with an aggregate cost of ¥79,492 million ($679,419 thousand) were not evaluated for impairment because (a)the Company did not estimate the fair values of those investments as it was not practicable to estimate the fair value of the investment and (b)the Company did not identify any events or changes in circumstances that might have had significant adverse effects on the fair values of those investments. 5. SECURITIZATIONS The Company has transferred certain trade notes receivable and trade accounts receivable under several securitization pro- grams. These securitization transactions are accounted for as a sale in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement 125, because the Company has relinquished control of the receivables. Accordingly, the receivables sold under these facilities are excluded from the accompanying consolidated balance sheets. Upon the sale of receivables, the Company holds subordinated retained interests for certain trade notes receivable and trade accounts receivable. A portion of these receivables, where the Company holds subordinated retained interests, is not taken off the balance sheet and is recorded at their fair value. Such carrying amount is adjusted to reflect the portion that is not expected to be collectible. As of March 31, 2006 and 2005, the fair values of retained interests were ¥53,756 million ($459,453 thousand) and ¥41,303 million, respectively. The Company recognized losses of ¥2,242 million ($19,162 thou- sand) and ¥1,861 million on the securitizations of receivables for the years ended March 31, 2006 and 2005, respectively. Subsequent to sale, the Company retains collection and administrative responsibilities for the receivables. Servicing fees received by the Company approximate the prevailing market rate. Related servicing assets or liabilities are immaterial to the Company’s financial position. The table below summarizes certain cash flows received from and paid to special purpose entities (“SPEs”) on the above 22 23 securitization transactions. Year ended March 31 Proceeds from new securitizations Servicing fees received Cash flows received on retained interests Purchases of delinquent and foreclosed receivables Millions of yen 2006 ¥ 1,019,315 564 135,667 — 2005 ¥ 979,748 514 75,788 0 Thousands of U.S. dollars 2006 $ 8,712,094 4,821 1,159,547 — At March 31, 2006, the assumed weighted-average life and residual cash flow discount rate used to compute the fair value of retained interests were 0.20 years and 2.17 percent, respectively. Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 Quantitative information about delinquencies, net credit losses, and components of securitized receivables as of and for the years ended March 31, 2006 and 2005 are as follows: Accounts receivable Notes receivable Total managed portfolio Securitized receivables Total receivables Accounts receivable Notes receivable Total managed portfolio Securitized receivables Total receivables 6. INVENTORIES Inventories consist of the following: March 31 Finished products Work in process: Long-term contracts Other Raw materials Total principal amount of receivables March 31, Millions of yen Amount 90 days or more past due 2006 2005 ¥1,383,192 ¥ 1,236,396 185,558 1,421,954 (255,369) ¥1,302,034 ¥ 1,166,585 190,455 1,573,647 (271,613) 2006 ¥ 48,672 26 ¥ 48,698 2005 ¥ 26,151 95 ¥ 26,246 Total principal amount of receivables March 31, 2006 Thousands of U.S. dollars Amount 90 days or more past due $ 11,822,154 1,627,821 13,449,975 (2,321,479) $ 11,128,496 $ 416,000 222 $ 416,222 Net credit losses Year ended March 31, 2005 ¥ 3,798 269 ¥ 4,067 2006 ¥ 4,734 358 ¥ 5,092 Net credit losses Year ended March 31, 2006 $ 40,461 3,060 $ 43,521 Millions of yen 2006 ¥ 275,231 100,081 181,297 108,313 ¥ 664,922 2005 ¥ 262,893 81,321 197,949 107,835 ¥ 649,998 Thousands of U.S. dollars 2006 $ 2,352,402 855,393 1,549,547 925,752 $ 5,683,094 7. INVESTMENTS IN AND ADVANCES TO AFFILIATES The Company’s significant investments in affiliated companies accounted for by the equity method together with the per- centage of the Company’s ownership of voting shares at March 31, 2006 were: MT Picture Display Co., Ltd. (35.5%); Topcon Corporation (35.5%); Toshiba Ceramics Co., Ltd. (41.4%); Toshiba Machine Co., Ltd. (33.9%); Toshiba Finance Corporation (“TFC”) (35.0%); Toshiba Mitsubishi-Electric Industrial Systems Corporation (50.0%); and Semp Toshiba Amazonas S.A. (40.0%). Of the affiliates which were accounted for by the equity method, the investments in common stock of the listed companies (5 companies) were carried at ¥68,377 million ($584,419 thousand) and ¥58,322 million at March 31, 2006 and 2005, respec- tively. The Company’s investments in these companies had market values of ¥207,340 million ($1,772,137 thousand) and ¥106,000 million at March 31, 2006 and 2005, respectively, based on quoted market prices at those dates. Summarized financial information of the affiliates accounted for by the equity method is shown below: March 31 Current assets Other assets including property, plant and equipment Total assets Current liabilities Long-term liabilities Shareholders’ equity Total liabilities and shareholders’ equity Year ended March 31 Sales Net income (loss) Millions of yen 2006 ¥ 1,143,036 1,074,125 ¥ 2,217,161 ¥ 1,079,690 475,319 662,152 ¥ 2,217,161 2005 ¥ 1,110,233 866,937 ¥ 1,977,170 ¥ 954,607 404,432 618,131 ¥ 1,977,170 Millions of yen 2006 ¥ 1,596,139 (25,737) 2005 ¥ 1,619,823 5,344 Thousands of U.S. dollars 2006 $ 9,769,538 9,180,556 $ 18,950,094 $ 9,228,120 4,062,555 5,659,419 $ 18,950,094 Thousands of U.S. dollars 2006 $ 13,642,214 (219,974) A summary of transactions and balances with the affiliates accounted for by the equity method is presented below: Year ended March 31 Sales Purchases Dividends March 31 Notes and accounts receivable, trade Other receivables Long-term loans receivable Notes and accounts payable, trade Other payables Capital lease obligations Millions of yen 2006 ¥ 110,336 96,835 13,526 2005 ¥ 99,408 115,074 8,819 Millions of yen 2006 ¥ 26,804 11,238 7,300 136,236 62,717 33,886 2005 ¥ 30,805 8,751 5,950 113,606 30,035 46,102 Thousands of U.S. dollars 2006 $ 943,043 827,650 115,607 Thousands of U.S. dollars 2006 $ 229,094 96,051 62,393 1,164,410 536,043 289,624 24 25 8. GOODWILL AND OTHER INTANGIBLE ASSETS The Company tested goodwill for impairment under SFAS No.142, Goodwill and Other Intangible Assets, applying a fair value- based test and has concluded that there was no impairment as of March 31, 2006 and 2005. The components of acquired intangible assets excluding goodwill at March 31, 2006 and 2005 are as follows: March 31, 2006 Other intangible assets subject to amortization: Software Technical license fees Other Total Other intangible assets not subject to amortization Gross carrying amount ¥ 146,913 43,531 17,774 ¥ 208,218 Millions of yen Accumulated amortization ¥ 84,847 22,764 13,571 ¥ 121,182 Net carrying amount ¥ 62,066 20,767 4,203 87,036 4,444 ¥ 91,480 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 March 31, 2005 Other intangible assets subject to amortization: Software Technical license fees Other Total Other intangible assets not subject to amortization March 31, 2006 Other intangible assets subject to amortization: Software Technical license fees Other Total Other intangible assets not subject to amortization Gross carrying amount ¥ 123,215 47,371 13,966 ¥ 184,552 Millions of yen Accumulated amortization ¥ 65,328 22,632 8,596 ¥ 96,556 Net carrying amount ¥ 57,887 24,739 5,370 87,996 4,260 ¥ 92,256 Gross carrying amount Thousands of U.S. dollars Accumulated amortization Net carrying amount $ 1,255,667 372,060 151,914 $ 1,779,641 $ 725,188 194,564 115,992 $ 1,035,744 $ 530,479 177,496 35,922 743,897 37,983 $ 781,880 Intangible assets acquired during the year ended March 31, 2006 primarily consisted of software of ¥24,039 million ($205,462 thousand).The weighted-average amortization period of software for the year ended March 31, 2006 was approxi- mately 5.0 years. The weighted-average amortization periods for other intangible assets were approximately 5.3 years and 5.7 years for the years ended March 31, 2006 and 2005, respectively. Amortization expenses of other intangible assets subject to amortization for the years ended March 31, 2006 and 2005 were ¥32,303 million ($276,094 thousand) and ¥25,898 million, respectively. The future amortization expense for each of the next 5 years relating to intangible assets currently recorded in the consoli- dated balance sheets at March 31, 2006 is estimated as follows: Year ending March 31 2007 2008 2009 2010 2011 Millions of yen ¥ 29,533 21,735 14,832 8,532 4,377 Thousands of U.S. dollars $ 252,419 185,769 126,769 72,923 37,410 Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. The changes in the carrying amount of goodwill for the years ended March 31, 2006 and 2005 are as follows: Year ended March 31 Balance at beginning of year Goodwill acquired during the year Foreign currency translation adjustments Balance at end of year Millions of yen 2006 ¥ 20,249 2,575 1,367 ¥ 24,191 2005 ¥ 17,702 2,033 514 ¥ 20,249 Thousands of U.S. dollars 2006 $ 173,068 22,009 11,684 $ 206,761 As of March 31, 2006, all carrying amount of goodwill was allocated to the Digital Products Segment. 9. SHORT-TERM BORROWINGS AND LONG-TERM DEBT Short-term borrowings at March 31, 2006 and 2005 consist of the following: March 31 Loans, principally from banks, including bank overdrafts, with weighted-average interest rate of 4.79% at March 31, 2006 and 2.10% at March 31, 2005: Secured Unsecured Euro yen medium-term notes of a subsidiary, with weighted-average interest rate of 0.13% at March 31, 2006 and 0.10% at March 31, 2005 (swapped for floating rate (LIBOR, etc.) Euro obligations) Euro medium-term note of a subsidiary, with interest rate of 2.69% at March 31, 2006 and 2.22% at March 31, 2005 Millions of yen 2006 2005 Thousands of U.S. dollars 2006 ¥ — 108,440 ¥ 354 162,876 $ — 926,837 29,968 32,442 256,137 4,122 ¥ 142,530 2,093 ¥ 197,765 35,231 $ 1,218,205 Substantially all of the short-term borrowings are with banks which have written basic agreements with the Company to the effect that, with respect to all present or future loans with such banks, the Company shall provide collateral (including sums on deposit with such banks) or guarantors immediately upon the bank’s request and that any collateral furnished pursuant to such agreements or otherwise will be applicable to all indebtedness to such banks. At March 31, 2006, the Company had unused committed lines of credit from short-term financing arrangements aggregating ¥259,795 million ($2,220,470 thousand), of which ¥18,795 million ($160,641 thousand) was in support of the Company’s commer- cial paper. The lines of credit expire on various dates from April 2006 through March 2007. Under the agreements, the Company is required to pay commitment fees ranging from 0.065 percent to 0.120 percent on the unused portion of the lines of credit. 26 27 Long-term debt at March 31, 2006 and 2005 consist of the following: March 31 Loans, principally from banks and insurance companies, due 2006 to 2029 with weighted-average interest rate of 0.91% at March 31, 2006 and due 2005 to 2032 with weighted-average interest rate of 0.69% at March 31, 2005: Secured Unsecured Unsecured yen bonds, due 2006 to 2008 with interest ranging from 0.40% to 3.025% at March 31, 2006 and due 2005 to 2008 with interest ranging from 0.40% to 3.025% at March 31, 2005 Zero Coupon Convertible Bonds with stock acquisition rights: Due 2009 convertible currently at ¥587 per share Due 2011 convertible currently at ¥542 per share Euro yen medium-term notes, due 2007 to 2008 with interest ranging from 0.56% to 2.34% at March 31, 2006 and due 2005 to 2008 with interest ranging from 0.47% to 2.34% at March 31, 2005 (swapped for floating rate (LIBOR, etc.) Yen obligations) Euro yen medium-term notes of subsidiaries, due 2006 to 2015 with interest ranging from 0.07% to 2.71% at March 31, 2006 and due 2005 to 2014 with interest ranging from 0.09% to 3.55% at March 31, 2005 (swapped for floating rate (LIBOR, etc.) U.S. dollar, Yen or Euro obligations) Capital lease obligations Less—Portion due within one year Millions of yen 2006 2005 Thousands of U.S. dollars 2006 ¥ 5,383 285,019 ¥ 7,127 287,698 $ 46,009 2,436,060 245,522 359,230 2,098,479 50,000 100,000 50,000 100,000 427,350 854,701 3,000 8,000 25,641 52,178 33,886 774,988 (163,558) ¥ 611,430 55,524 46,102 913,681 (230,285) ¥ 683,396 445,966 289,624 6,623,830 (1,397,932) $ 5,225,898 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 Certain of the secured loan agreements contain provisions, which permit the lenders to require additional collateral. Substantially all of the unsecured loan agreements permit the lenders to require collateral or guarantors for such loans. Certain of the secured and unsecured loan agreements require prior approval by the banks and trustees before any distribu- tions (including cash dividends) may be made from current or retained earnings. Assets pledged as collateral for long-term debt at March 31, 2006 were property, plant and equipment with a book value of ¥14,353 million ($122,675 thousand). The aggregate annual maturities of long-term debt, excluding those of capital lease obligations are as follows: Year ending March 31 2007 2008 2009 2010 2011 Thereafter Millions of yen ¥ 150,197 89,818 115,588 174,536 72,558 138,405 ¥ 741,102 Thousands of U.S. dollars $ 1,283,735 767,675 987,932 1,491,761 620,154 1,182,949 $ 6,334,206 10. ISSUANCE OF CONTINGENTLY CONVERTIBLE BOND In July, 2004, Toshiba Corporation issued ¥50,000 million Zero Coupon Convertible Bonds due 2009 (the “2009 Bonds”) and ¥100,000 million Zero Coupon Convertible Bonds due 2011 (the “2011 Bonds”). The bonds include stock acquisition rights which entitle bondholders to acquire common stock under certain circum- stances, and are exercisable on and after August 4, 2004 up to, and including, July 7, 2009 (in the case of the 2009 Bonds) and up to, and including, July 7, 2011 (in the case of the 2011 Bonds). The initial conversion prices are ¥587 per share (in the case of the 2009 Bonds) and ¥542 (in the case of the 2011 Bonds), subject to adjustment for certain events such as a stock split, consolidation of stock or issuance of stock at a consideration per share which is less than the current market price. (Conditions allowing exercise of stock acquisition rights) The period prior to (but not including) July 21, 2008 (in the case of the 2009 Bonds) or July 21, 2010 (in the case of the 2011 Bonds) In the case that as of the last trading day of any calendar quarter, the closing price of the shares for any 20 trading days in a period of 30 consecutive trading days ending on the last trading day of such quarter is more than 120% of the conversion price in effect on each such trading day. The period on or after July 21, 2008 (in the case of the 2009 Bonds) or July 21, 2010 (in the case of the 2011 Bonds) At any time after the closing price of the shares on at least one trading day is more than 120% of the conversion price in effect on each such trading day. The additional 85,178,875 shares and 184,501,845 shares relating to the potential conversion of the 2009 Bonds and the 2011 Bonds were included in the diluted net income per share calculations for the year ended March 31, 2006 and 2005. 11. ACCRUED PENSION AND SEVERANCE COSTS All employees who retire or are terminated are usually entitled to lump-sum severance indemnities or pension benefits deter- mined by reference to their current basic rate of pay, length of service and conditions under which their employment termi- nates. The obligation for the severance indemnity benefit is provided for through accruals, funding of tax-qualified non-con- tributory pension plans and the corporate pension plan. The Company had Employees’ Pension Fund (“EPF”) Plans, which were contributory defined benefit pension plans under the Japanese Welfare Pension Insurance Law (“JWPIL”). These plans were composed of a substitutional portion which was the obligation related to the government-defined benefit prescribed by JWPIL, and a corporate portion based on a contributory defined benefit arrangement established at the discretion of Toshiba Corporation and these subsidiaries. Among the EPF Plans that the Company participated in, certain subsidiaries’ EPF Plans were reorganized and became cor- porate pension plans under the Japanese Defined Benefit Corporate Pension Law during the year ended March 31, 2006 and 2005. The Toshiba EPF plan was reorganized and became corporate pension plans during the year ended March 31, 2004. Certain subsidiaries in Japan have tax-qualified non-contributory pension plans which cover all or a part of the indemnities payable to qualified employees at the time of termination. The funding policy for the plans is to contribute amounts required to maintain sufficient plan assets to provide for accrued benefits, subject to the limitation on deductibility imposed by Japanese income tax laws. The Company uses a March 31 measurement date for the majority of its plans. The changes in the benefit obligation and plan assets and reconciliations of net amount recognized to funded status and accrued pension and severance costs for the years ended March 31, 2006 and 2005 are as follows: March 31 Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Plan participants’ contributions Plan amendments Actuarial loss Benefits paid Return of substitutional portion to the government Foreign currency exchange impact Benefit obligation at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Plan participants’ contributions Benefits paid Return of substitutional portion to the government Foreign currency exchange impact Fair value of plan assets at end of year Funded status Unrecognized actuarial loss Unrecognized net obligation at transition Unrecognized prior service cost Net amount recognized Amounts recognized in the consolidated balance sheets consist of: Prepaid pension cost Accrued pension and severance costs Accumulated other comprehensive loss, pre-tax Net amount recognized Accumulated benefit obligation at end of year Millions of yen 2006 2005 ¥ 1,296,805 46,403 32,244 2,329 (5,278) 57,557 (61,357) (20,637) 1,702 ¥ 1,349,768 ¥ 647,836 152,106 55,007 2,329 (37,052) (10,541) 1,616 ¥ 811,301 ¥ 538,467 (397,246) — 59,590 ¥ 200,811 ¥ (3,849) 474,198 (269,538) ¥ 200,811 ¥ 1,285,079 ¥ 1,290,504 44,106 33,134 2,932 2,110 22,024 (69,032) (29,767) 794 ¥ 1,296,805 ¥ ¥ ¥ ¥ 617,832 26,028 54,223 2,932 (38,794) (15,019) 634 647,836 648,969 (499,433) (12,495) 57,737 194,778 ¥ (2,672) 581,598 (384,148) ¥ 194,778 ¥ 1,229,014 Thousands of U.S. dollars 2006 $ 11,083,804 396,607 275,590 19,906 (45,111) 491,940 (524,419) (176,385) 14,547 $ 11,536,479 $ 5,537,060 1,300,051 470,146 19,906 (316,684) (90,094) 13,812 $ 6,934,197 $ 4,602,282 (3,395,265) — 509,316 $ 1,716,333 $ (32,897) 4,052,974 (2,303,744) $ 1,716,333 $ 10,983,581 28 29 The components of the net periodic pension and severance cost for the years ended March 31, 2006 and 2005 are as follows: Year ended March 31 Service cost—benefits earned during the year Interest cost on projected benefit obligation Expected return on plan assets Amortization of unrecognized net obligation at transition Amortization of prior service cost Recognized actuarial loss Settlement loss Net periodic pension and severance cost Millions of yen 2006 ¥ 46,403 32,244 (21,504) 12,495 (3,455) 23,575 5,045 ¥ 94,803 2005 ¥ 44,106 33,134 (18,637) 12,025 (3,584) 24,894 7,992 ¥ 99,930 Thousands of U.S. dollars 2006 $ 396,607 275,590 (183,795) 106,795 (29,530) 201,495 43,120 $ 810,282 The Company expects to contribute ¥57,947 million ($495,274 thousand) to its defined benefit plans in the year ending March 31, 2007. Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 The following benefit payments are expected to be paid: Year ending March 31 2007 2008 2009 2010 2011 2012—2016 Millions of yen ¥ 64,272 67,579 69,782 74,278 78,565 402,754 Thousands of U.S. dollars $ 549,333 577,598 596,427 634,855 671,496 3,442,342 In January 2003, the Emerging Issue Task Force reached a consensus on Issue No. 03-2 (“EITF 03-2”), Accounting for the Transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities, which addresses accounting for a transfer to the Japanese government of a substitutional portion of EPF Plans. EITF 03-2 requires employers to account for the entire process at completion of the transfer to the Japanese government of the substitutional portion of the benefit obli- gation and the related plan assets, as a single settlement transaction. Upon the approval from the Japanese government, with the transfer to the Japanese government from the assets of the pension plans in the years ended March 31, 2006 and 2005, certain subsidiaries were relieved of all obligations under substi- tutional portion of the plan. As a result, the Company recorded a gain of ¥4,085 million ($34,915 thousand) and ¥4,836 million for the years ended March 31, 2006 and 2005, respectively. The subsidies of ¥9,130 million ($78,035 thousand) for the year ended March 31, 2006 and ¥12,828 million for the year ended March 31, 2005 from the government were calculated as the difference between the obligation settled and the assets transferred determined pursuant to the government formula, less derecognized amounts of previously accrued salary progression at the time of settlement of ¥966 million ($8,256 thousand) and ¥1,920 million for the years ended March 31, 2006 and 2005, respectively. Weighted-average assumptions used to determine benefit obligations as of March 31, 2006 and 2005 and net periodic pension and severance cost for the years then ended are as follows: March 31 Discount rate Rate of compensation increase Year ended March 31 Discount rate Expected long-term rate of return on plan assets Rate of compensation increase 2006 2.5% 3.0% 2006 2.6% 4.0% 3.0% 2005 2.6% 3.0% 2005 2.7% 4.0% 3.0% The Company determines the expected long-term rate of return in consideration of the target allocation of the plan assets, the current expectation of long-term returns on the assets and actual returns on plan assets. The Company’s pension and severance plan asset allocations at March 31, 2006 and 2005, by asset category are as follows: March 31 Asset category Equity securities Debt securities Life insurance company general accounts Other Total The other category includes hedge funds. 2006 58% 24% 3% 15% 100% 2005 52% 26% 6% 16% 100% The Company’s investment policies and strategies are to assure adequate plan assets to provide for future payments of pen- sion and severance benefits to participants, with reasonable risks. The Company designs the basic target allocation of the plan assets to mirror the best portfolio based on estimation of mid-term and long-term return on the investments. The Company periodically reviews the actual return on the investments and adjusts the portfolio to achieve the assumed long- term rate of return on the investments. The Company targets its investments in equity securities at 40 percent or more of total investments, and investments in equity and debt securities at 75 percent or more of total investments. 12. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred and amounted to ¥372,447 million ($3,183,308 thousand) and ¥348,010 million for the years ended March 31, 2006 and 2005, respectively. 13. ADVERTISING COSTS Advertising costs are expensed as incurred. Advertising costs amounted to ¥49,839 million ($425,974 thousand) and ¥41,494 million for the years ended March 31, 2006 and 2005, respectively. 14. FOREIGN EXCHANGE GAINS AND LOSSES For the years ended March 31, 2006 and 2005, the net foreign exchange impacts were ¥3,434 million ($29,350 thousand) loss and ¥1,772 million gain respectively. 15. IMPAIRMENT OF LONG-LIVED ASSETS Due to general price erosion, severe market competition and others, the Company recorded impairment charges of ¥11,974 million ($102,342 thousand) related primarily to the manufacturing facilities of the Digital Products division and the Electronic Devices division for the year ended March 31, 2006, and ¥1,088 million related to the manufacturing facilities of the Electronic Devices division for the year ended March 31, 2005. These impairment charges are included under the caption cost of sales and other expense in the accompanying consolidated statements of income. 30 31 16. INCOME TAXES The Company is subject to a number of different income taxes which, in the aggregate, result in an effective statutory tax rate in Japan of approximately 40.7 percent for the years ended March 31, 2006 and 2005. A reconciliation between the reported income tax expense and the amount computed by multiplying the income before income taxes and minority interest by the applicable statutory tax rate is as follows: Year ended March 31 Expected income tax expense Increase (decrease) in taxes resulting from: Dividends Non-deductible expenses for tax purposes Net changes in valuation allowance Tax rate difference relating to foreign subsidiaries Deferred tax liabilities on undistributed earnings of foreign subsidiaries Other Income tax expense Millions of yen 2006 ¥ 72,518 7,771 4,437 3,416 (6,384) 6,587 1,797 ¥ 90,142 2005 ¥ 45,271 9,849 4,363 8,117 (7,057) (207) (4,392) ¥ 55,944 Thousands of U.S. dollars 2006 $ 619,812 66,419 37,923 29,196 (54,564) 56,299 15,359 $ 770,444 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 The significant components of deferred tax assets and deferred tax liabilities as of March 31, 2006 and 2005 are as follows: March 31 Gross deferred tax assets: Inventories Accrued pension and severance costs Tax loss carryforwards Minimum pension liability adjustment Accrued bonus Depreciation and amortization Other Valuation allowance for deferred tax assets Deferred tax assets March 31 Gross deferred tax liabilities: Retained earnings appropriated for tax allowable reserves Unrealized gains on securities Gain on securities contributed to employee retirement benefit trusts Other Deferred tax liabilities Net deferred tax assets Millions of yen 2006 2005 ¥ 23,878 116,586 62,849 109,702 44,899 31,208 158,082 547,204 (80,947) ¥ 466,257 ¥ 21,565 112,275 123,788 156,348 42,300 30,781 130,596 617,653 (88,818) ¥ 528,835 Millions of yen 2006 2005 ¥ (21,114) (41,258) (17,381) (18,302) (98,055) ¥ 368,202 ¥ (18,887) (23,410) (17,381) (13,402) (73,080) ¥ 455,755 Thousands of U.S. dollars 2006 $ 204,085 996,462 537,171 937,624 383,752 266,735 1,351,128 4,676,957 (691,854) $ 3,985,103 Thousands of U.S. dollars 2006 $ (180,462) (352,632) (148,556) (156,427) (838,077) $ 3,147,026 The net changes in the total valuation allowance for the years ended March 31, 2006 and 2005 were a decrease of ¥7,871 mil- lion ($67,274 thousand) and an increase of ¥7,521 million, respectively. The Company’s tax loss carryforwards for each of the corporate and local taxes at March 31, 2006 amounted to ¥90,074 million ($769,863 thousand) and ¥321,961 million ($2,751,803 thousand), respectively, the majority of which will expire during the period from 2007 through 2013. The Company utilized tax loss carryforwards of ¥168,371 million ($1,439,068 thousand) and ¥93,811 million ($801,803 thousand) to reduce current corporate and local taxes, respectively, during the year ended March 31, 2006. Realization of tax loss carryforwards and other deferred tax assets is dependent on the Company generating sufficient tax- able income prior to their expiration or the Company exercising certain available tax strategies. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets, less the valuation allowance, will be realized. The amount of such net deferred tax assets considered realizable, however, could be reduced in the near term if esti- mates of future taxable income during the carryforward period are reduced. Deferred income tax liabilities have not been provided on undistributed earnings of foreign subsidiaries deemed indefinite- ly reinvested in foreign operations. As of March 31, 2006 and 2005, the undistributed earnings of the foreign subsidiaries not subject to deferred tax liabilities were ¥105,029 million ($897,684 thousand), and ¥124,375 million, respectively. It is not practicable to estimate the amount of the deferred income tax liabilities on such earnings. 17. SHAREHOLDERS’ EQUITY RETAINED EARNINGS Retained earnings at March 31, 2006 and 2005 included a legal reserve of ¥14,950 million ($127,778 thousand) and ¥13,980 million, respectively. The Japanese Commercial Code provides that an amount equal to at least 10 percent of cash dividends and other distributions from retained earnings paid by Toshiba Corporation and its Japanese subsidiaries be appropriated as a legal reserve. No further appropriations are required when the total amount of the additional paid-in capital and the legal reserve equals 25 percent of their respective stated capital. The Japanese Commercial Code also provides that to the extent that the sum of the additional paid-in capital and the legal reserve exceeds 25 percent of the stated capital, the amount of the excess, if any, is available for appropriations. The amount of retained earnings available for dividends is based on Toshiba Corporation’s retained earnings determined in accordance with generally accepted accounting principles in Japan and the Japanese Commercial Code. Retained earnings at March 31, 2006 do not reflect current year-end dividends of ¥11,251 million ($96,162 thousand) which will be paid from June 2, 2006. Retained earnings at March 31, 2006 included the Company’s equity in undistributed earnings of affiliated companies accounted for by the equity method in the amount of ¥5,291 million ($45,222 thousand). ACCUMULATED OTHER COMPREHENSIVE LOSS An analysis of the changes in accumulated other comprehensive loss, net of tax, for the years ended March 31, 2006 and 2005 is shown below: March 31 Unrealized gains on securities: Balance at beginning of year Current year change Balance at end of year Foreign currency translation adjustments: Balance at beginning of year Current year change Balance at end of year Minimum pension liability adjustment: Balance at beginning of year Current year change Balance at end of year Unrealized gains (losses) on derivative instruments: Balance at beginning of year Current year change Balance at end of year Total accumulated other comprehensive loss: Balance at beginning of year Current year change Balance at end of year Millions of yen 2006 2005 Thousands of U.S. dollars 2006 ¥ 33,479 23,767 ¥ 57,246 ¥ 26,825 6,654 ¥ 33,479 $ 286,145 203,137 $ 489,282 ¥ (68,849) 36,830 ¥ (32,019) ¥ ¥ (79,290) 10,441 (68,849) $ (588,453) 314,786 $ (273,667) ¥ (219,315) 67,964 ¥ (151,351) ¥ (234,283) 14,968 ¥ (219,315) $ (1,874,487) 580,889 $ (1,293,598) ¥ ¥ (68) (317) (385) ¥ ¥ 854 (922) (68) $ $ (581) (2,710) (3,291) ¥ (254,753) 128,244 ¥ (126,509) ¥ (285,894) 31,141 ¥ (254,753) $ (2,177,376) 1,096,102 $ (1,081,274) 32 33 Tax effects allocated to each component of other comprehensive income (loss) for the years ended March 31, 2006 and 2005 are shown below: Pre-tax amount Millions of yen Tax benefit (expense) Net-of-tax amount For the year ended March 31, 2006: Unrealized gains on securities: Unrealized holding gains arising during year Less: reclassification adjustment for gains included in net income ¥ 44,230 (4,198) ¥ (17,973) 1,708 ¥ 26,257 (2,490) Foreign currency translation adjustments: Currency translation adjustments arising during year Less: reclassification adjustment for gains included in net income Minimum pension liability adjustment Unrealized losses on derivative instruments: Unrealized losses arising during year Less: reclassification adjustment for losses included in net income Other comprehensive income (loss) For the year ended March 31, 2005: Unrealized gains on securities: 31,811 (15) 114,610 5,034 — (46,646) 36,845 (15) 67,964 (4,437) 3,914 ¥ 185,915 1,800 (1,594) ¥ (57,671) (2,637) 2,320 ¥ 128,244 Unrealized holding gains arising during year Less: reclassification adjustment for gains included in net income ¥ 15,989 (4,783) ¥ (6,499) 1,947 ¥ 9,490 (2,836) Foreign currency translation adjustments: Currency translation adjustments arising during year Less: reclassification adjustment for losses included in net income Minimum pension liability adjustment Unrealized losses on derivative instruments: 12,470 162 25,242 (2,191) — (10,274) 10,279 162 14,968 Unrealized losses arising during year Less: reclassification adjustment for losses included in net income Other comprehensive income (loss) (5,927) 4,374 47,527 ¥ 2,411 (1,780) ¥ (16,386) (3,516) 2,594 ¥ 31,141 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 For the year ended March 31, 2006: Unrealized gains on securities: Unrealized holding gains arising during year Less: reclassification adjustment for gains included in net income $ 378,034 (35,880) $ (153,615) 14,598 $ 224,419 (21,282) Pre-tax amount Thousands of U.S. dollars Tax benefit (expense) Net-of-tax amount Foreign currency translation adjustments: Currency translation adjustments arising during year Less: reclassification adjustment for gains included in net income Minimum pension liability adjustment Unrealized losses on derivative instruments: Unrealized losses arising during year Less: reclassification adjustment for losses included in net income Other comprehensive income (loss) 18. NET INCOME PER SHARE 271,889 (128) 979,572 43,025 — (398,683) 314,914 (128) 580,889 (37,923) 33,453 $ 1,589,017 15,384 (13,624) $ (492,915) (22,539) 19,829 $ 1,096,102 A reconciliation of the numerators and denominators between basic and diluted net income per share for the years ended March 31, 2006 and 2005 is as follows: Year ended March 31 Net income available to common shareholders Net income effect of dilutive convertible debentures Net income available to common shareholders and assumed conversions Year ended March 31 Weighted-average number of shares of common stock outstanding for the year Incremental shares from assumed conversions of dilutive convertible debentures Weighted-average number of shares of diluted common stock outstanding for the year Year ended March 31 Net income per share of common stock: —Basic —Diluted 19. FINANCIAL INSTRUMENTS Thousands of U.S. dollars 2006 $ 668,256 — $ 668,256 Millions of yen 2006 ¥ 78,186 — ¥ 78,186 2005 ¥ 46,041 — ¥ 46,041 Thousands of shares 2006 2005 3,215,045 3,216,215 269,681 186,702 3,484,726 3,402,917 Yen 2006 2005 U.S. dollars 2006 ¥ 24.32 22.44 ¥ 14.32 13.53 $ 0.21 0.19 (1)DERIVATIVE FINANCIAL INSTRUMENTS The Company operates internationally, giving rise to exposure to market risks from fluctuations in foreign currency exchange and interest rates. In the normal course of its risk management efforts, the Company employs a variety of derivative financial instru- ments, which are consisted principally of forward exchange contracts, interest rate swap agreements, currency swap agreements, and currency options to reduce its exposures. The Company has policies and procedures for risk management and the approval, reporting and monitoring of derivative financial instruments. The Company’s policies prohibit holding or issuing derivative finan- cial instruments for trading purposes. The counterparties to the Company’s derivative transactions are financial institutions of high credit standing. The Company does not anticipate any credit loss from nonperformance by the counterparties to forward exchange contracts, interest rate swap agreements, currency swap agreements and currency options. The Company has entered into forward exchange contracts with financial institutions as hedges against fluctuations in foreign currency exchange rates on monetary assets and liabilities denominated in foreign currencies. The forward exchange contracts related to accounts receivable and payable, and commitments on future trade transactions denominated in foreign currencies, mature primarily within a few months of the balance sheet date. Interest rate swap agreements, currency swap agreements and currency options are used to limit the Company’s exposure to loss- es in relation to underlying debt instruments and accounts receivable and payable denominated in foreign currencies resulting from adverse fluctuations in foreign currency exchange and interest rates. These agreements mature during the period 2006 to 2015. Forward exchange contracts, interest rate swap agreements, currency swap agreements and currency options are designated as either fair value hedges or cash flow hedges depending on accounts receivable and payable denominated in foreign currencies or commitments on future trade transactions and the interest rate characteristics of the underlying debt as discussed below. Fair Value Hedge Strategy The forward exchange contracts and currency swap agreements utilized by the Company effectively reduce fluctuation in fair value of accounts receivable and payable denominated in foreign currencies. The interest rate swap agreements utilized by the Company effectively convert a portion of its fixed-rate debt to a floating-rate basis. Cash Flow Hedge Strategy The forward exchange contracts and currency options utilized by the Company effectively reduce fluctuation in cash flow from commitments on future trade transactions denominated in foreign currencies for the next 18 months. The interest rate swap agreements utilized by the Company effectively convert a portion of its floating-rate debt to a fixed- rate basis for the next 10 years. The Company expects to reclassify ¥708 million ($6,051 thousand) of net losses on derivative financial instruments from accumulated other comprehensive income (loss) to earnings during the next 12 months due to the collection of accounts receivable denominated in foreign currencies and the payments of accounts payable denominated in foreign currencies and variable interest associated with the floating-rate debts. At March 31, 2006, there were no significant gains or losses on derivative financial instruments or portions thereof that were either ineffective as hedges, excluded from assessment of hedge effectiveness, or where the underlying risk did not occur. The Company’s forward exchange contract amounts, the aggregate notional principal amounts of interest rate swap agree- ments, currency swap agreements, and currency options outstanding at March 31, 2006 and 2005 are summarized below: 34 35 March 31 Forward exchange contracts: To sell foreign currencies To buy foreign currencies Interest rate swap agreements Currency swap agreements Currency options Millions of yen 2006 2005 ¥ 125,684 41,332 164,050 146,652 218,679 ¥ 132,673 36,702 119,250 139,208 34,816 Thousands of U.S. dollars 2006 $ 1,074,222 353,265 1,402,137 1,253,436 1,869,051 (2)FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Company’s financial instruments at March 31, 2006 and 2005 are summarized as follows: March 31 Nonderivatives: Liabilities: 2006 2005 Millions of yen Carrying amount Estimated fair value Carrying amount Estimated fair value Long-term debt, including current portion ¥ (741,102) ¥ (793,470) ¥ (867,579) ¥ (875,132) Derivative financial instruments: Forward exchange contracts Interest rate swap agreements Currency swap agreements Currency options (989) (1,161) 153 (810) (989) (1,161) 153 (810) 944 (285) 1,182 164 944 (285) 1,182 164 Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 March 31 Nonderivatives: Liabilities: Thousands of U.S. dollars 2006 Carrying amount Estimated fair value Long-term debt, including current portion $ (6,334,206) $ (6,781,795) Derivative financial instruments: Forward exchange contracts Interest rate swap agreements Currency swap agreements Currency options (8,453) (9,923) 1,308 (6,923) (8,453) (9,923) 1,308 (6,923) The above table excludes the financial instruments for which fair values approximate their carrying amounts and those relat- ed to leasing activities. The table also excludes marketable securities and other investments which are disclosed in Note 4. In assessing the fair value of these financial instruments, the Company uses a variety of methods and assumptions, which are based on estimates of market conditions and risks existing at that time. For certain instruments, including cash and cash equivalents, notes and accounts receivable-trade, short-term borrowings, notes payable-trade, accounts payable-trade and accounts payable-other and accrued expenses, it is assumed that the carrying amount approximated fair value for the majority of these instruments because of their short maturities. Quoted market prices are used for a part of marketable securities and other investments. For long-term debt, fair value is estimated using market quotes, or where market quotes are not available, using estimated discounted future cash flows. Other techniques, such as estimated discounted value of future cash flows, and replacement cost, are used to determine fair value for the remaining financial instruments. These estimated fair values are not necessarily indicative of the amounts that could be realized in a current market exchange. 20. LEASES LESSEE The Company leases manufacturing equipment, office and warehouse space, and certain other assets under operating leases. Rent expenses under such leases for the years ended March 31, 2006 and 2005 were ¥84,047 million ($718,350 thousand) and ¥82,174 million, respectively. The Company also leases certain machinery and equipment which are accounted for as capital leases from TFC and Toshiba Medical Finance Co., Ltd., affiliates of the Company. The costs under capital leases as of March 31, 2006 and 2005 were approximately ¥70,700 million ($604,274 thousand) and ¥91,000 million, respectively. Accumulated amortization of the machinery and equipment under capital leases as of March 31, 2006 and 2005 were approximately ¥36,800 million ($314,530 thousand) and ¥45,000 million, respectively. Minimum lease payments for the Company’s capital and non-cancelable operating leases as of March 31, 2006 are as follows: Year ending March 31 2007 2008 2009 2010 2011 Thereafter Total minimum lease payments Executory costs Amounts representing interest Present value of net minimum lease payments Less—current portion Millions of yen Thousands of U.S. dollars Capital leases ¥ 14,992 9,947 6,674 3,822 1,507 366 37,308 (1,698) (1,724) 33,886 (13,361) ¥ 20,525 Operating leases ¥ 24,536 17,742 14,979 10,340 2,148 4,603 ¥ 74,348 Operating leases $ 209,709 151,641 128,026 88,376 18,359 39,342 $ 635,453 Capital leases $ 128,137 85,017 57,043 32,667 12,880 3,128 318,872 (14,513) (14,735) 289,624 (114,197) $ 175,427 LESSOR The Company is also a lessor to office buildings and other assets under operating leases. Future minimum lease payments to be received under the Company’s non-cancelable operating leases as of March 31, 2006 are as follows: Year ending March 31 2007 2008 2009 2010 2011 Thereafter Millions of yen ¥ 846 847 729 723 727 6,203 ¥ 10,075 Thousands of U.S. dollars $ 7,231 7,239 6,231 6,179 6,214 53,017 $ 86,111 21. CONSOLIDATION OF VIEs The Company leases certain manufacturing equipment from a VIE. The Company consolidates the VIE in accordance with FIN 46R. As a result, at March 31, 2006, the Company recorded machinery and equipment of ¥20,119 million ($171,957 thousand), and other current liabilities and other liabilities of ¥23,784 million ($203,282 thousand). At March 31, 2005, the Company recorded machinery and equipment of ¥27,288 million, and other current liabilities and other liabilities of ¥29,021 million, respectively. The creditors of the VIE do not have recourse to the general credit of the Company. 22. COMMITMENTS AND CONTINGENT LIABILITIES Commitments outstanding at March 31, 2006 for the purchase of property, plant and equipment approximated ¥23,067 mil- lion ($197,154 thousand). At March 31, 2006, contingent liabilities, other than guarantees disclosed in Note 23, approximated ¥6,704 million ($57,299 thousand) principally for recourse obligations related to notes receivable transferred. Toshiba Corporation has entered into a definitive Purchase and Sale Agreement with British Nuclear Fuels plc and its subsidiary, under which Toshiba Corporation will acquire BNFL USA Group Inc. and Westinghouse Electric UK Limited (collectively “Westinghouse” hereafter) at a cost of US$5.4 billion. Although Toshiba Corporation expects to have several minority investors who wish to participate in this opportunity, it will retain ownership of more than 51% of Westinghouse voting shares. The closing of the acquisition is subject to certain procedures, including, without limitation, obtaining regulatory approvals from relevant governmental authorities. Toshiba Corporation has sufficient capital resources and borrowing capacity to fund this acquisition. The Company will account for this acquisition under the purchase method of accounting in accordance with SFAS No.141, Business Combinations. The Company expects to record on its consolidated balance sheet a substantial amount of goodwill as a result of this acquisition. The Company believes this goodwill is appropriate, reflecting Westinghouse’s future capabilities for profit generation and the synergy to be obtained from combining Westinghouse and the Company. 36 37 23. GUARANTEES GUARANTEES OF UNCONSOLIDATED AFFILIATES AND THIRD PARTY DEBT The Company guarantees debt as well as certain financial obligations of unconsolidated affiliates and third parties to support the sale of the Company’s products and services. Expiration dates vary from 2006 to 2017 or terminate on payment and/or cancellation of the obligation. A payment by the Company would be triggered by the failure of the guaranteed party to fulfill its obligation under the guarantee. The maximum potential payments under these guarantees were ¥96,569 million ($825,376 thousand) as of March 31, 2006. GUARANTEES OF EMPLOYEES’ HOUSING LOANS The Company guarantees housing loans of its employees. The term of the guarantees is equal to the term of the related loans which range from 5 to 25 years. A payment would be triggered by failure of the guaranteed party to fulfill its obligation covered by the guar- antee. The maximum potential payments under these guarantees were ¥20,609 million ($176,145 thousand) as of March 31, 2006. However, the Company expects that the majority of such payments would be reimbursed through the Company’s insurance policy. GUARANTEES OF TRANSFERRED CORPORATE BONDS The Company entered into a sale and assumption agreement with an SPE during 2001. As a result, the Company was released from being a primary obligor for ¥20,178 million of the Company’s corporate bonds, which mature on various dates through 2008, and became secondarily liable for these obligations. The maximum potential payment by the Company as a Notes to Consolidated Financial Statements Toshiba Corporation and Subsidiaries March 31, 2006 secondary obligor was ¥8,078 million ($69,043 thousand) at March 31, 2006. RESIDUAL VALUE GUARANTEES UNDER SALE AND LEASEBACK TRANSACTIONS The Company has entered into several sale and leaseback transactions in which certain manufacturing equipment was sold and leased back. The Company may be required to make payments for residual value guarantees in connection with these transac- tions. The operating leases will expire on various dates through December 2010. The maximum potential payments by the Company for such residual value guarantees were ¥15,717 million ($134,333 thousand) at March 31, 2006. GUARANTEES OF DEFAULTED NOTES AND ACCOUNTS RECEIVABLE The Company has transferred trade notes receivable and trade accounts receivable under several securitization programs. Upon certain sales of trade notes and accounts receivable, the Company holds a repurchase obligation, which the Company is required to perform upon default of the trade notes and accounts receivable. The trade notes and accounts receivable generally mature within 3 months. The maximum potential payment for such repurchase obligation was ¥12,144 million ($103,795 thousand) as of March 31, 2006. The carrying amounts of the liabilities for the Company’s obligations under the guarantees described above at March 31, 2006 were not significant. WARRANTY Estimated warranty costs are accrued for at the time the product is sold to a customer. Estimates for warranty costs are made based primarily on historical warranty claim experience. The following is a reconciliation of the product warranty accrual: March 31 Balance at beginning of year Warranties issued Settlements made Foreign currency translation adjustments Balance at end of year 24. LEGAL PROCEEDINGS Millions of yen 2006 ¥ 25,075 36,659 (30,512) 1,680 ¥ 32,902 2005 ¥ 19,938 31,568 (27,211) 780 ¥ 25,075 Thousands of U.S. dollars 2006 $ 214,316 313,325 (260,786) 14,359 $ 281,214 In November 2002, a lawsuit was filed by Lexar Media, Inc. against Toshiba Corporation and one of its subsidiaries, Toshiba America Electronic Components, Inc. at the California Superior Court (County of Santa Clara) alleging claims for trade secret misappropriation related to NAND flash memory. In December 2005, the Court ruled on the Company’s post-trial motions and granted a new trial on damages issues, vacating the judgement based on a March 2005 jury award that totaled approximately US$465 million. Both the Company and Lexar Media filed notices of appeal and the case is now pending before the California Court of Appeal. In addition, the Company is a defendant in other pending lawsuits alleging patent infringement, breaches of contract and warranties and other matters. The Company’s management believes that there are meritorious defenses to all of these actions. Based on the information currently available to both the Company and its legal counsel, management believes that damages from such lawsuits, if any, would not have a material adverse effect on the financial position or the results of operations of the Company. 25. ENVIRONMENTAL LIABILITIES The Japanese environmental regulation, “Law Concerning Special Measure against poly chlorinated biphenyl (PCB) waste” requires PCB waste holders dispose of all PCB waste by July 2016. The Company accrued ¥10,615 million ($90,726 thou- sand) and ¥10,156 million at March 31, 2006 and 2005, respectively, for environmental remediation and restoration costs for products or equipment with PCB which some Toshiba operations in Japan have retained. The costs recorded during the year are included as cost of sales in the accompanying consolidated statements of income. The accrual will be adjusted as assessment and remediation efforts progress or as additional technical or legal information available. Management is of opinion that the ultimate costs in excess of the amount accrued, if any, would not have a material adverse effect on the financial position or the results of operations of the Company. Report of Independent Auditors The Board of Directors and Shareholders of Toshiba Corporation We have audited the accompanying consolidated balance sheets of Toshiba Corporation and subsidiaries (the “Company”) as of March 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equi- ty, and cash flows for the years then ended, all expressed in Japanese yen. These financial statements are the respon- sibility 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. 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for design- ing 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 state- ments, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. 38 39 The Company’s consolidated financial statements do not disclose segment information required by Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” In our opinion, disclosure of segment information is required by accounting principles generally accepted in the United States. In our opinion, except for the omission of segment information discussed in the preceding paragraph, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at March 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. We have also reviewed the translation of the financial statements mentioned above into United States dollars on the basis described in Note 3. In our opinion, such statements have been translated on such basis. April 26, 2006 This report was printed on recycled paper with soy-based ink. Printed in Japan