the independent marketing arm of Canon Inc. wholesaling and retailing a broad range of products

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2 PROFILE (which will be renamed Canon Marketing Japan Inc. on April 1, 2006), is the independent marketing arm of Canon Inc. wholesaling and retailing a broad range of products developed and manufactured by Canon. The Canon Sales Group comprises the parent company Canon Sales and its 16 consolidated subsidiaries. Its operations are concentrated in the following business segments: Business Solutions, Consumer Equipment and Industrial Equipment. The Group seeks to boost revenue and income through more efficient operations. It therefore makes concerted efforts to expand high-revenue businesses and reduce costs through superior inventory and logistical systems. Equally important, the Group is firmly committed to strict compliance and effective, customer-oriented management. Canon U.S.A., Inc. Business Solutions Canon System & Support Inc. OAL Inc. Canon B.M. Tokyo Inc. Canon B.M. Kanagawa Inc. Canon B.M. Osaka Inc. Canon Europe Ltd. Canon Inc. Information Technology (IT) Business Canon Software Inc. Canon Software Technology & Research Inc. Canon Software America Inc. Canon System Solutions Inc. Canon Control System (SHANGHAI) Inc. Canon Network Communications Inc. Canon Supercomputing S.I. Inc. Slti Solution Service Inc. Canon (China) Co., Ltd. Facility Management Canon Facility Management Inc. * Mail-Order and Mobile Sales Canon Trading Inc. Canon Australia Pty. Ltd. Customer Support Canon Response Service Inc. Sales of Ophthalmic Instruments Canon Staar Co., Inc. * ** ** Nonconsolidated To be renamed Canon Business Support Inc. on April 1, 2006 (As of December 31, 2005) Disclaimer Regarding Forward-Looking Statements This annual report contains forward-looking statements about the performance and management plans of, based on management s assumptions in light of current information. The following factors may therefore influence actual results. These factors include consumer trends in Japan as well as other major global markets, private capital expenditures, currency fluctuations, notably against the U.S. dollar, materials prices and political turmoil in certain countries and regions. Photo Credit Cover photograph of broadcasting equipment courtesy of J.League Photos Inc.

3 CONTENTS TO OUR SHAREHOLDERS 2 A message to our shareholders by Haruo Murase, the president and CEO of Canon Sales, combining a review of the Company s record-setting consolidated net sales, operating income and net income with a description of future goals and financial targets. NEW COMPANY NAME/LONG-TERM AND MEDIUM-TERM MANAGEMENT PLANS 4 The section explains our reasons for renaming the Company on April 1, We also provide an outline of the Long-Term Management Plan (Fiscal 2006 Fiscal 2010) and the Medium-Term Management Plan (Fiscal 2006 Fiscal 2008) a plan for implementing the broader strategies of the former. REVIEW OF OPERATIONS 8 At a Glance 8 Business Solutions 10 Consumer Equipment 14 Industrial Equipment 18 CORPORATE GOVERNANCE 21 A guide to the corporate governance structure of Canon Sales, including a summary of its internal controls system, which is based on the internal controls standards established by Canon Inc. the New York Stock Exchange (NYSE)-listed company at the center of the global Canon Group. FINANCIAL SECTION 23 BOARD OF DIRECTORS AND CORPORATE AUDITORS/CORPORATE INFORMATION 43 Annual Report

4 TO OUR SHAREHOLDERS To Our Shareholders As president and CEO of, I would like to express my deepest gratitude to all of our shareholders for their solid support to date. I am proud to present this annual report outlining the achievements in fiscal 2005, ended December 31, Record Net Sales, Operating Income and Net Income In recent years, Canon Sales and its consolidated subsidiaries have striven to evolve as an organization that creates added value. This has entailed substantial changes to the structure of our business and operations. During fiscal 2005, in the Business Solutions segment, we reinforced our software businesses and focused on improving our ability to provide top-class solutions. Segment income increased, reflecting stronger sales of maintenance services and cartridges due to the continued shift from monochrome to color equipment in the areas of business-use multifunctional products (MFPs) and laser-beam printers (LBPs). Every member of the Group forged ahead with efforts to promote IT services businesses, including information security and consulting services. In the Consumer Equipment segment, we maintained top share of the digital camera market, and enjoyed solid sales growth of interchangeable lenses. We also recorded significantly higher sales of ink-jet MFPs as the market for MFPs continued to evolve. Despite increasingly severe competition, segment sales expanded steadily, reflecting the strength of our varied lineup, which enabled us to promote new approaches to digital photography. In the Industrial Equipment segment, we retained top share of the wafer imaging equipment market in terms of shipments. This achievement was attributable to a concerted drive to increase customer satisfaction, which countered the effects of reduced capital spending. Companywide efforts to reorganize inventory and logistical systems ensured a significant reduction in other expenses. Owing to the above, consolidated net sales edged up 0.8%, to billion, operating income increased 1.5%, to 29.7 billion, and net income climbed 24.2%, to 15.4 billion all setting new records for the Company. To reward shareholders for their contribution to these outstanding results, we decided to pay a bonus dividend by increasing the year-end cash dividends per share to 15.00, 2.00 higher than our initial 2 Annual Report 2005

5 forecast. Combined with an interim cash dividend of 13.00, this brought full-term cash dividends to 28.00, up 6.00 from the previous fiscal year-end. Company Name Change and Long-Term Management Plan In fiscal 2006, Canon Inc. launched the Excellent Global Corporation Plan, Phase 3, which will guide its operations until the end of fiscal Canon Sales and its consolidated subsidiaries have therefore formulated the Long-Term Management Plan, a five-year plan timed to run concurrently with Canon s global plan. The new plan will enable us to plot the course of our business from a long-term perspective and accelerate the pace of management reform. On April 1, 2006, the Company name will be changed to Canon Marketing Japan Inc. (abbreviated to Canon MJ) to mark this significant turning point. The new name will better reflect the focus of our business as we intensify and broaden our comprehensive range of frontline marketing activities. These include ensuring twoway communication with customers through a variety of channels; offering customer-oriented solutions and support; and contributing to the development of products tailored to market needs. While stepping up efforts in such activities, we will continue to promote profitable growth, ensure strict compliance and improve the quality of our management. For fiscal 2006, we forecast consolidated net sales of billion, up nearly 6%, operating income of 30.5 billion, a rise of approximately 3% and net income of 16.9 billion, a gain of roughly 10%. On May 8, 2006, we will reduce our minimum trading unit of stock from 1,000 to 100 shares to enable a broader range of investors to become shareholders. In these and all our endeavors, we look forward to the continued loyal support and understanding of our shareholders, investors and other stakeholders. March 2006 Haruo Murase President and CEO Annual Report

6 NEW COMPANY NAME (Canon MJ) On April 1, 2006, Canon Sales will change its name to Canon Marketing Japan Inc. In recent years, Canon Sales has sought to evolve as a company centered on IT solutions. At the same time, we have made substantial management changes and promoted added-value businesses. Feedback from within Canon Sales as well as from outside the Company has suggested the current name no longer reflects the true nature of our business. In light of this, we approved the name change, timed to coincide with the start of the Long-Term Management Plan. We will do our best to promote and expand business activities implied by the new name. 4 Annual Report 2005

7 LONG-TERM MANAGEMENT PLAN (Fiscal 2006 Fiscal 2010) Mission and Vision Mission: As a member of the worldwide Canon Group, Canon Marketing Japan seeks to ensure consistently innovative marketing activities and encourage greater creativity in each individual, at work and in the community, by providing products and services of the highest value. Vision: Adopt a global perspective and strengthen our position as a topflight customer-oriented corporate group In fiscal 2006, Canon Inc. launched the Excellent Global Corporation Plan, Phase 3, which will guide its operations until the end of fiscal As the Japanese marketing arm of the worldwide Canon Group, Canon Sales and its subsidiaries initiated the Long-Term Management Plan, a five-year management plan timed to run concurrently with Canon s global plan. Ensuring better two-way communication with customers has become an increasingly important challenge for companies wishing to accurately identify market trends. In line with our corporate vision, we will align our operations more closely with those of our customers to provide the most suitable, tailor-made solutions. Financial Goals for Fiscal 2010 Fiscal 2006 Fiscal 2008 Medium-Term Management Plan See page 6 Fiscal 2010 Net sales: 1,100 billion Ordinary income margin: Over 5.0% Net income per share: Over In our Long-Term Management Plan, we are targeting net sales of 1,100 billion for fiscal More importantly, we aim to raise our ordinary income margin above 5.0%. Our top priority is to improve profit margins and income through sales expansion. Another goal for fiscal 2010 is to push net income per share above Annual Report

8 MEDIUM-TERM MANAGEMENT PLAN (Fiscal 2006 Fiscal 2008) Consolidated Net Sales, Operating Income and Net Income (Billions of yen) 1, Net Sales (Left scale) Operating Income (Right scale) Net Income (Right scale) Consolidated Segment Sales (Billions of yen) 1, IT Solutions Business Solutions Document Business IT Solutions Consumer Equipment Industrial Equipment Document Business Projected Projected Financial Goals The Medium-Term Management Plan is a three-year management plan that will guide our efforts as we implement the broader strategies of the Long-Term Management Plan. For fiscal 2008, we are targeting net sales of billion, operating income of 41.0 billion and operating margin of 4.2% in line with our Long-Term Management Plan goals. During the period under review, we reorganized the Business Solutions segment into two categories for accounting purposes: Document Business comprising business-use equipment and maintenance services and IT Solutions encompassing IT services and IT products. The subcategory IT products includes servers, network equipment and other IT-related equipment. We expect revenue to improve steadily in every segment. In particular, we are aiming for double-digit increases in IT Solutions an area with the sharpest growth rate. Expand highly profitable businesses Develop IT Solutions into a core business Expand operations and increase our competitive strengths in the Document Business category Reinforce our position as the No. 1 digital photography company Strengthen and expand operations in the Industrial Equipment segment Key Strategy No. 1: Promote Profitable Growth We aim to promote profitable growth by expanding highly profitable businesses. The strategy has four parts. First, we seek to develop IT Solutions into a core business (please refer to Key Strategy No. 3). Second, we are committed to expanding operations and increasing our competitive strengths in the Document Business category. This will entail promoting the shift from monochrome to color MFPs and LBPs and cultivating markets for print-on-demand (POD) equipment and high-speed business-use equipment with advanced features. At the same time, we will strive to provide better, distinctive solutions by capitalizing on our strengths in documentrelated software. We will also take various measures to boost profitability, including a drive to enhance systems for remote maintenance of MFPs. Reinforcing our position as the No. 1 digital photography company is the third part of Key Strategy No. 1. To this end, we will reinforce our digital photography-related business, which encompasses sales of digital cameras, interchangeable lenses, digital camcorders, ink-jet printers and cartridges. In addition, we will continue to promote an approach to digital photography whereby users enjoy every aspect of the creative process from taking a photograph to printing the final image. We will also endeavor to cultivate the photography studio market, where digital equipment is becoming more common, by capitalizing on our lineup encompassing digital-photography products, projectors and larger-format printers. The fourth part of the strategy is to strengthen and expand operations in the Industrial Equipment segment by reinforcing our semiconductor production equipment business. This area covers wafer imaging equipment for semiconductors, lithography equipment for semiconductor and liquid crystal display (LCD) manufacturers, and imported semiconductor production equipment. At the same time, we will pursue the full-scale expansion of our medical solutions business. Key Strategy No. 2: Become the No. 1 Company in Our Mainstay Product Categories Our goal is to become the top company in terms of market share in our mainstay product categories. In addition, we aim to be No. 1 when judged by the criteria of customer satisfaction and quality of maintenance/ 6 Annual Report 2005

9 support services and software solutions. As the box below indicates, we plan to reinforce our position in product categories where we are already ahead of our competitors. In the near future, we aim to secure the lead in areas where we have yet to become No. 1. In addition to securing top market share, we aim to be No. 1 in terms of customer satisfaction and the quality of our maintenance/support services and software solutions. Reinforce our top market share in: plain-paper copiers (PPCs), LBPs, compact digital cameras, digital SLR cameras, wafer imaging equipment and television camera lenses In the short-term, seize the largest market share for: color MFPs, color LBPs, ink-jet printers, and lithography equipment for semiconductor and LCD manufacturers Key Strategy No. 3: Develop IT Solutions into a Core Business Future efforts to expand IT Solutions sales will center on IT services, which are divided into the following four areas. Software: Information-related, backbone system, infrastructure software and business software Project-based services: Consulting, system integration, network integration and engineering IT outsourcing: Internet service provider (ISP), application service provider (ASP), Internet Data Center (idc) and other outsourcing services Professional support services: Various services, including a comprehensive range of installation and maintenance services and training IT Solutions Sales Targets (Billions of yen) IT Services 112% IT Products 116% 114% Projected Our competitive advantage in the area of IT services owes itself to the clearly defined roles of our Group companies, which develop different areas of excellence by capitalizing on quality products and a well-trained workforce. The Group also benefits from having a diverse customer base, including small and medium-sized enterprises (SMEs) and large corporations. Our goal is to provide a broader range of solutions in this area. We will therefore maximize the integrated capabilities of the Group and make concerted efforts to expand operations, utilizing mergers, acquisitions and business alliances when necessary. Key Strategy No. 4: Improve Management Quality and Reduce Operational Costs The first part of this strategy focuses on promoting management reform. In April 2005, we launched FOCUS-1, a Groupwide management reform initiative to ensure better, customer-oriented management. As part of the initiative, we have implemented a management quality program centered on self-assessments using criteria set by the Japan Quality Award Council. Responding better to customer needs is the second part of our strategy. To facilitate even better responses, we will reorganize our services-based businesses and develop next-generation customer relationship management (CRM) systems. The third part of the strategy is to maximize the use of shared services within the Group. Under the shared services system, the support functions of each Group company are transferred to one specialized company serving the whole Group. We will ensure efficient and high-quality operations by switching to this system. Canon Facility Management Inc., the subsidiary providing shared services, will be renamed Canon Business Support Inc. on April 1, Promote management reform Respond better to customer needs Maximize the use of shared services within the Group Annual Report

10 REVIEW OF OPERATIONS At a Glance Percentage of Net Sales Business Solutions 57.9% Consumer Equipment 30.9% Industrial Equipment 11.2% 8 Annual Report 2005

11 Business Solutions Sales of Canon s business-use equipment and supplies Maintenance/support services and software solutions Document solutions and backbone system solutions Sales 475,882 Millions of yen Consumer Equipment Wholesale of Canon s personal-use equipment and supplies Sales 254,277 Millions of yen Industrial Equipment Sales of Canon s semiconductor production equipment and medical equipment Sales of ophthalmic instruments Import-centered sales of equipment produced by companies other than Canon Sales 91,789 Millions of yen Annual Report

12 Main Products Business-use multifunctional products (MFPs) Laser-beam printers (LBPs) Document software IT services Service and support Financial Highlights Sales (Billions of yen) Projected 10 Annual Report 2005

13 Business-use Multifunctional Products In fiscal 2005, the business-use multifunctional product (MFP) market was characterized by firm sales of color MFPs but weaker sales of monochrome models, reflecting the continuing trend toward color equipment. The total number of shipments for the industry remained unchanged. In the color MFP market, makers have continued to launch new products. At the lower end of the market, the shift to color equipment accelerated significantly. As a result, color models accounted for nearly 40% of MFPs sold in fiscal We estimate that Canon products accounted for 20% of the total business-use MFP market in terms of shipments. Laser-Beam Printers Although shipments fell in the monochrome laser-beam printer (LBP) market, sales by value held steady, reflecting strong demand for the installation of optional products proposed as part of LBP systems. The color LBP market expanded, with high-speed models becoming increasingly common. Our calculations show that we secured a 27% share of total shipments in the LBP market in fiscal IT Solutions Software The introduction of the e-document Law (Law Concerning Application of Information and Telecommunication Technology in Storage of Written Documents by Private Businesses) and other laws has stimulated demand in the software market, especially for document management software. Most companies are proposing integrated solutions to enhance operational efficiency and security. In this market, it is becoming increasingly important to respond effectively to the particular needs of each client. Information Services: The market for Enterprise Content Management (ECM) services, which enable customers to maintain high levels of compliance, is expected to grow rapidly. This is also the case with the market for Corporate Performance Management (CPM) services. Backbone Systems: The overall market for backbone systems is expected to remain firm, owing to strong demand from mediumsize companies purchasing mid-range enterprise resource planning (ERP) systems. This demand should compensate for a decline in orders from large corporations that have already installed high-end ERP systems and are now in the downward phase of their investment cycle. Network Systems: We expect slow but steady growth in demand from database users with system construction needs. Although unit prices for server systems have fallen, demand has increased for products with high levels of reliability, availability and serviceability (RAS). This is attributable to greater network usage, as IT systems rely more on web-based applications. Annual Report

14 REVIEW OF OPERATIONS Business Solutions Business-use Multifunctional Products In fiscal 2005, we remained committed to our basic policy of ensuring stable income and sales growth. Accordingly, we continued to promote the shift from monochrome to color equipment in every market segment and persisted in our efforts to expand our share of the high-speed MFP market by persuading customers to switch to high-end equipment. In the area of color MFPs, new launches in our Color imagerunner series included the ir C3170 and ir C2570 standard models introduced in May In November, we commenced sales of the ir C6870 and ir C5870 models featuring our proprietary Java-based Multifunctional Embedded Application Platform (MEAP). Such lineup enhancements strengthened our marketing capabilities and ensured year-on-year sales increases that exceeded the industry average. ir C6870 In the area of monochrome MFPs, efforts to expand sales through launches of such models as the standard ir 2230F and the high-speed ir 5570 and ir 6570 enabled us to maintain sales at fiscal 2004 levels, despite the continuing shift to color equipment. We also introduced the high-speed ir 7105i in an effort to bolster sales to large offices and other users with high-volume printing needs. Laser-Beam Printers June 2006 saw the launches of the Satera LBP5900 and LBP5600 color printers, which mainly target business-use customers and feature A3-size capabilities. In October 2006, we commenced sales of the Satera LBP5000, a compact A4 printer. Sales of color LBPs rose considerably and color toner cartridge sales improved steadily. Other Products In other products, three new large-format printers sold well, owing to specifications that met the requirements of professionals printing signs and posters. We also established a reputation for top Satera LBP5000 quality in the ultra-high resolution liquid crystal projector market, where sales of the SX50, a Super Extended Graphics Array Plus (SXGA+) projector, remained brisk. Maintenance Services Sales of maintenance services for color MFPs grew steadily as did sales of Canon Service Pack, a package of maintenance services for various types of hardware. To improve the efficiency of our services, we encouraged customers to install NET EYE, a remote web-based maintenance system, and organized our city-based sales forces into specialized teams. IT Solutions We enjoyed firm sales growth in information-security products and related consulting services, as a result of the Law on the Protection of Personal Information, effective since April The MEAPrelated business expanded considerably, owing to the launch of more than 30 applications and our efforts to tailor solutions to increasingly diverse customer needs. During the fiscal year, we proposed 12 Annual Report 2005

15 REVIEW OF OPERATIONS Business Solutions distinctive solutions, including integrated circuit (IC) card authorization systems and Anyplace Print for MEAP, which allows output from various printers while maintaining information security. By targeting large corporations that place a high premium on information security, we achieved considerable success in this area. Our reporting solutions business, centering on electronic forms and documentation systems, expanded steadily, supported by substantial sales increases for such products as Report Viewer and imageware Form Manager. Group Companies Canon Software Inc. In fiscal 2005, Canon Software received a greater number of orders for large-scale software development projects, including quality control systems. Packaged software such as Web-CADDY/J, used for creating workflow systems, and Web Performer, a web application development tool, made solid improvements, compared with sales of the previous fiscal year. Canon System Solutions Inc. Canon System Solutions recorded solid sales from system integration and other IT services, including migration the reconstruction of backbone systems by transferring programs and data. The subsidiary s security solutions business, which centers on its proprietary GUARDIAN series, also performed well. Canon Network Communications Inc. Canon Network Communications enjoyed favorable sales in its network systems business focusing on local area network (LAN) installation, database construction and application development. The subsidiary also generated substantially higher sales from its Internet Data Center (idc), which monitors and manages customers systems 24 hours a day all year round. Canon System & Support Inc. Canon System & Support registered strong sales of equipment and maintenance services and steady sales in its solutions business, which caters to small and medium-sized enterprises (SMEs). Reflecting the above, in the Business Solutions segment, consolidated sales edged up 0.5%, to 475,882 million, and nonconsolidated sales slipped 0.1%, to 385,387 million. Annual Report

16 Main Products Compact digital cameras Digital single-lens reflex (SLR) cameras Video cameras Ink-jet printers Personal-use MFPs Personal-use faxes Scanners Calculators and electronic dictionaries Financial Highlights Sales (Billions of yen) Projected 14 Annual Report 2005

17 Compact Digital Cameras In fiscal 2005, the compact digital camera market shrank in terms of shipments and sales value, reflecting greater ownership of such products and longer replacement cycles. Customers replacing old models accounted for the majority of purchases. Women and middle-aged people represented a greater proportion of first-time purchases. Recently, average unit prices of new models have fallen between 10% and 15% within a month of launch. This downward trend is expected to continue. The best-selling products in this product category are slim and lightweight with large displays and occupy approximately 80% of the market. Products featuring blur reduction technology to minimize the effects of camera shake and sudden subject movements have proved popular. Our estimates indicate that Canon Sales secured a 19% share of this market in terms of total shipments in fiscal Digital Single-Lens Reflex Cameras The digital single-lens reflex (SLR) camera market grew by 50%, compared with the previous fiscal year. During fiscal 2005, competition intensified following the launches of new models by each digital SLR maker. Consumer electronics makers announced agreements with camera producers to jointly develop new digital SLRs a move that will also exert pressure on other companies. These partnerships bring together Sony Corporation and Konica Minolta Holdings, Inc.; Matsushita Electric Industrial Co., Ltd., and Olympus Corporation; and Samsung Techwin Co., Ltd., of the Samsung Group and PENTAX Corporation. According to our calculations, our share of total shipments in this market was 57% in fiscal Digital Camcorders In fiscal 2005, the digital camcorder market underwent considerable change, characterized by shorter product cycles and increasingly diverse forms of recording media. As a consequence, best-selling models represented less of the market. Sales of high-resolution camcorders grew as products with resolution less than one mega pixel lost market share. In the area of high-end camcorders, makers are stepping up efforts to introduce camcorders with hard disk drives (HDDs). Ink-Jet Printers and Personal-use MFPs During the period under review, the ink-jet printer market began to grow, after recovering from its sluggish condition in fiscal Manufacturers made considerable efforts to promote personal-use MFPs among their lineups. As a result, ink-jet printers accounted for a smaller portion of this product category as the shift to MFPs accelerated. Reflecting this trend, MFPs represented over 50% of this market. The supplies market expanded steadily, supported by increased photo printer sales. Other Products Personal-use Copiers Personal-use copier shipments increased in the first half of fiscal 2005 the first year-on-year improvement in five years but declined in the second half, resulting in a slight decrease for the whole term. Personal-use Faxes Sales of personal-use faxes were level with fiscal 2004 in terms of shipments but decreased by value, owing to falling prices. This reflected a fullscale shift toward multifunctional color equipment, as makers launched MFPs combining telephone functions and ink-jet engines. Scanners In fiscal 2005, the scanner market remained sluggish with shipments falling approximately 30%. Makers have increasingly sought to promote devices with functions for converting photographs and printed documents into portable document format (PDF) files. Calculators and Electronic Dictionaries Sales in this product category were on a par with the previous fiscal year in terms of shipments and value. Electronic dictionaries for exam preparation and other models containing Chinese dictionaries have dominated the electronic dictionary market. Annual Report

18 REVIEW OF OPERATIONS Consumer Equipment Compact Digital Cameras In fiscal 2005, we strove to expand sales by launching six new models in both the IXY DIGITAL and PowerShot series. In the IXY DIGITAL series, we implemented full-fledged advertising campaigns to raise awareness of our products enhanced features and reinforce the brand. We also opened the IXY DIGITAL Special Page web site as a new channel for communicating with our customers and IXY DIGITAL 700 introducing interesting topics. As part of our distribution strategy, we held workshops and events to announce launches in retail stores. In addition, we cultivated new distribution channels, including general merchandising stores and home centers. These efforts enabled us to maintain sales at last year s level and secure top share of the compact digital camera market for the third consecutive year. Digital Single-Lens Reflex Cameras Our goal in this market was to boost sales of entry-level digital SLR cameras a key growth area. We therefore launched the EOS Kiss Digital N and promoted the WE NEED KISS campaign, primarily focusing on families. In the advanced amateur category, we strove hard to encourage customers to switch from film to digital cameras, introducing the EOS 5D in September During the fiscal year, we endeavored to expand sales routes via large consumer electronics chains. To stimulate demand, we organized various activities throughout Japan. These included events where visitors took EOS 5D photographs and produced prints using Canon cameras; EOS Dojo training courses for store personnel; and EOS Zemi workshops for users. Such efforts earned us an overwhelmingly large share of the market, despite an increasingly competitive environment. Furthermore, strong sales of SLR cameras were accompanied by a considerable improvement in sales of interchangeable lenses. Digital Camcorders During the period under review, we aimed to increase our market share and sales by launching eight digital camcorders and promoting Shashin DV cameras, which realize image quality sufficient for both still shots and video. Our lineup of DVD camcorders was enhanced by the addition of two new models, the DC20 and DC10. We also commenced sales of the XL H1, a lightweight and affordable highdefinition (HD) camcorder for users involved in broadcasting or television/video production. DC20 PIXUS MP950 Ink-Jet Printers and Personal-use MFPs In October 2005, we reinforced our lineup by replacing many models in the PIXUS series. To increase sales, we launched the ip4200 a product targeted at the largest portion of the market and two other ink-jet printers. We also introduced four personal-use MFPs, including the flagship MP950 a high-resolution model with a new design and the MP500, appealing to the average user. As a result, we achieved a solid overall performance in this area, benefiting from a substantial improvement in MFP sales. Moreover, sales of ink cartridges, photo paper and other supplies were strong, reflecting a greater number of ink-jet printers and personal-use MFPs in use and the growing preference for printing photographs at home. Sales of compact photo printers rose significantly, 16 Annual Report 2005

19 REVIEW OF OPERATIONS Consumer Equipment owing to a drive to expand sales, which included the launch of three new SELPHY models in September Through these efforts, we have driven the market expansion for personal-use equipment that is capable of high-quality photo prints using ink-jet or dye-sublimation printing technology. Other Products Overall sales of personal-use copiers were firm. Our personal-use scanners secured top share of the market for the sixth consecutive year. Sales of ink films for personal-use faxes were roughly double those in the previous fiscal year. Sales of electronic dictionaries improved steadily, reflecting efforts to boost revenue by targeting students preparing for examinations and Chinese language learners. As a result, in the Consumer Equipment segment, consolidated sales rose 6.4%, to 254,277 million, and nonconsolidated sales increased 6.4%, to 253,239 million. wordtank V90 Annual Report

20 Main Products Lithography equipment for semiconductor manufacturers Lithography equipment for LCD manufacturers Other semiconductor production equipment Broadcasting equipment Network cameras Video recorders Medical equipment Financial Highlights Sales (Billions of yen) Projected 18 Annual Report 2005

21 Lithography Equipment for Semiconductor Manufacturers During the period under review, predictions of a dramatic slowdown in demand proved false, owing to persistently strong domestic capital investment in semiconductor equipment. Although shipments of wafer imaging equipment slipped slightly, high-priced products accounted for a greater proportion of the market. As a result, the total value of such sales remained unchanged, compared with the previous fiscal year. The market has become polarized between companies that are investing aggressively and those that are not. This situation is likely to become more pronounced. Lithography Equipment for LCD Manufacturers In fiscal 2005, the market for liquid crystal display (LCD) and plasma televisions and other digital consumer electronics continued to grow steadily. However, there is a growing disparity between the investments of manufacturers recording high profits and those that are not. Medical Equipment Following revisions to the Pharmaceutical Affairs Law in April 2005, vendors seeking licenses to sell certain medical equipment must undergo an evaluation process. Previously, these vendors only needed to apply to the appropriate authorities before obtaining licenses. New safety regulations for medical equipment that requires high levels of care have ensured better maintenance standards. Broadcasting Lenses and Closed Circuit Televisions In the broadcasting lens market, broadcasters have continued to replace older equipment with high-definition television (HDTV) cameras as preparation for terrestrial digital broadcasting shifts into full gear. Another significant trend in this area is the increased production of surveillance camera lenses by manufacturers that have traditionally focused on LCD projectors and digital camera lenses. Annual Report

22 REVIEW OF OPERATIONS Industrial Equipment Lithography Equipment for Semiconductor Manufacturers In this area of our business, we strove to increase customer satisfaction levels by developing a better support system tailored to user needs. At the same time, we made concerted efforts in our sales activities to secure repeat orders. To cultivate business from new customers, we bolstered sales of two new products: the FPA-5500iZa, an i-line stepper, and the FPA-6000ES6a, a krypton fluoride (KrF) step-and-scan system. Reflecting the above factors, we maintained top share of the Japanese market in terms of units sold, but sales of argon fluoride (ArF) step-and-scan systems weakened. Lithography Equipment for LCD Manufacturers FPA-6000ES6a During the period under review, we sought to tap demand from LCD panel manufacturers, whose businesses have expanded rapidly. To this end, we intensified various business activities, including negotiations with senior executives of such companies, and stepped up marketing efforts, proposing equipment with specifications that meet the requirements of each customer. Other Semiconductor-related Equipment Overall sales in this category declined, reflecting weaker demand. Medical Equipment Digital Radiography Systems In fiscal 2005, we endeavored to expand sales of the CXDI series of digital radiography systems by establishing a firm presence in the medical clinic segment of the market. CXDI-50G Intraocular Lenses During the period under review, we recorded firm sales of intraocular lenses and commenced operations with new original equipment manufacturer (OEM) partners. Broadcasting Lenses Our efforts in this area focused on portable HD lenses and network controllable pan/tilt/zoom (P/T/Z) systems. These products mainly targeted private broadcasting companies acquiring HD equipment. Reflecting the factors above, consolidated and nonconsolidated sales in the Industrial Equipment segment fell 10.9%, to 91,789 million. HJ22ex7.6B 20 Annual Report 2005

23 CORPORATE GOVERNANCE Annual General Meeting for Shareholders Appointment/Dismissal Appointment/Dismissal Appointment/Dismissal 17 Directors Audits 4 Corporate Auditors Cooperation Board of Directors President and CEO Board of Corporate Auditors Management Committee Auditing of Accounts Auditing Company Internal Auditors Office Corporate Ethics and Compliance Committee Disclosure Committee Internal Audits Internal Controls Evaluation Committee Information Security Committee Group Companies Staff Managers Advice Lawyers/ Licensed Tax Accountants (As of March 29, 2006) Board of Directors We seek to promote swift, streamlined decision making through our 17-member Board of Directors. There are no outside directors and each director s term is limited to one year. Under the guidance of the Board of Directors, we are developing a management system that will enable prompt responses to changes in the operating environment. We decide important matters after vigorous discussion at meetings of the Board of Directors, usually held monthly, and meetings of the Management Committee, attended by Canon Sales directors and the CEOs of main subsidiaries. Board of Corporate Auditors The Board of Corporate Auditors designates responsibilities among auditors and sets auditing policy. The four corporate auditors, including three outside corporate auditors, conduct thorough audits in line with this policy. The corporate auditors participate in Board of Director meetings, receive business reports from directors and other senior management, examine documents relating to resolutions and other important matters, and monitor the operations and financial condition of the Group. Internal Controls On March 1, 2004, Canon Inc. the New York Stock Exchange (NYSE)-listed company at the center of the global Canon Group established an Internal Controls Evaluation Project. This step was taken in response to the Sarbanes Oxley Act, a U.S. law designed to improve corporate governance. During fiscal 2004, as the Japan-based marketing arm of the Canon Group, we completed our own version of the Internal Controls Evaluation Project, applying the same standards. On January 1, 2005, we established the Internal Controls Evaluation Committee, chaired by the President and CEO, and appointed internal controls officers in each division of Canon Sales and the main Group companies. We plan to continue implementing the internal controls system throughout the whole Group. Annual Report

24 22 Annual Report 2005

25 FINANCIAL SECTION CONTENTS Six-Year Consolidated Financial Summary Financial Review Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Auditors Annual Report

26 SIX-YEAR CONSOLIDATED FINANCIAL SUMMARY and Consolidated Subsidiaries Years ended December 31 Thousands of Millions of yen U.S. dollars (Note 1) For the year: Net sales , , , , , ,917 $6,965,661 Cost of sales , , , , , ,199 4,670,890 Gross profit , , , , , ,718 2,294,771 Selling, general and administrative expenses , , , , , ,206 2,042,881 Operating income... 29,723 29,274 16,987 10,885 19,397 20, ,890 Income (loss) before income taxes and minority interests... 27,086 20,186 20,438 6,873 (63,280) 15, ,542 Income taxes (credit)... 11,366 7,666 13,219 3,361 (28,407) 7,966 96,322 Net income (loss)... 15,358 12,364 7,043 3,436 (32,831) 6, ,153 At year-end: Total assets , , , , , ,958 4,350,297 Total stockholders equity , , , , , ,959 2,095,288 Yen U.S. dollars (Note 1) Per share of common stock: Net income (loss) (Note 2)... )( )( , )(222.96,(217.39) 0, $,(0.86. Cash dividends (Notes 3 and 4) Stockholders equity... 1, , , , , , Notes: 1. The accompanying financial figures have been presented in U.S. dollars by translating all Japanese yen amounts at 118 to US$1, the prevailing exchange rate as of December 31, Net income (loss) per share is based on the weighted average number of shares of common stock outstanding during the respective fiscal years. 3. Cash dividends per share are the amounts applicable to the respective fiscal years, including dividends to be paid after the end of the year. 4. Year-end cash dividends for the year ended December 31, 2005, include a 2.00 bonus dividend reflecting record-high consolidated net sales, operating income and net income. 24 Annual Report 2005

27 FINANCIAL REVIEW Results of Operations Sales Consolidated net sales edged up 0.8% in fiscal 2005, ended December 31, 2005, to billion, owing to stronger sales of such products as color MFPs, digital SLR cameras and maintenance services, which countered a decline in sales of semiconductor production equipment. Business Solutions sales increased 0.5%, to billion, reflecting steady sales of LBP toner cartridges and improved sales of color MFP maintenance services. Consumer Equipment sales amounted to billion, up 6.4%, reflecting the performance of compact digital cameras, which achieved top market share for the third consecutive year, and stronger sales of digital SLR cameras. Industrial Equipment sales declined 10.9%, to 91.8 billion, as a consequence of shrinking demand, despite improvements to the customer support system and a substantial volume of orders from new clients. Earnings Operating income once again reached record levels, advancing 1.5%, to 29.7 billion. This achievement was attributable to higher gross profit due to stronger net sales, which countered rising advertising and sales promotion expenses and higher performance-based remuneration a consequence of better business results. Net income also achieved an all-time high of 15.4 billion, up 24.2%, reflecting a significant reduction in loss on disposal and devaluation of inventories, and the elimination of two other negative factors: expenses related to redemption of bonds and loss on impairment of fixed assets. Net income per share was , compared with in fiscal Cash dividends per share applicable to the year were 28.00, up Financial Position Total assets of Canon Sales as of December 31, 2005, grew 6.4%, to billion. Significant factors in this total were an increase in cash and cash equivalents, a gain in notes and accounts receivable and a rise in investments in securities due to a buoyant stock market. The sum of total current liabilities and total long-term liabilities rose 6.9%, to billion, primarily reflecting higher notes and accounts payable and greater accrued income taxes. Reflecting the above, total stockholders equity amounted to billion, up 5.6%. Return on equity (ROE) was 6.4%, compared with 5.4% in fiscal Stockholders equity ratio was 48.2%, down from 48.5% the previous fiscal year. Stockholders equity per share reached 1,650.52, compared with 1, a year earlier. Cash Flows Cash and cash equivalents at end of year were billion, 16.7 billion higher than at the beginning of the period, owing mainly to income before income taxes and minority interests of 27.1 billion. Net cash provided by operating activities totaled 37.0 billion, compared with 22.1 billion in fiscal Important items in this result included income before income taxes and minority interests of 27.1 billion; depreciation and amortization of 11.1 billion; increase in notes and accounts payable of 9.7 billion; and 10.7 billion in income taxes paid. Net cash used in investing activities amounted to 17.9 billion, compared with 8.0 billion in the previous fiscal year. Key contributing factors were payments for purchases of property and equipment of 10.3 billion and payments for purchases of investments in securities of 5.4 billion. Net cash used in financing activities totaled 4.3 billion, compared with 39.0 billion a year earlier, primarily reflecting 4.1 billion in dividends paid. Return on Sales (ROS) Working Capital Total Stockholders Equity and Return on Equity (ROE) (Billions of yen) (%) (Billions of yen) (Times) (Billions of yen) (%) Net Sales ROS Total Current Assets Total Current Liabilities Current Ratio Total Stockholders Equity ROE Annual Report

28 CONSOLIDATED BALANCE SHEETS and Consolidated Subsidiaries December 31, 2005 and 2004 Thousands of Millions of yen U.S. dollars (Note 1) ASSETS Current assets: Cash and cash equivalents (Note 3) , ,844 $1,978,847 Notes and accounts receivable , ,360 1,447,644 Inventories (Note 4)... 56,667 56, ,229 Deferred tax assets (Note 7)... 7,302 5,731 61,882 Other current assets... 12,059 7, ,195 Allowance for doubtful receivables... (255) (298) (2,161) Total current assets , ,224 3,068,636 Property and equipment (Note 8): Land... 40,864 40, ,305 Buildings and structures... 72,235 70, ,161 Machinery Vehicles Furniture and fixtures... 19,276 19, ,356 Rental assets... 17,373 15, ,229 Construction in progress Total , ,741 1,269,220 Accumulated depreciation... (47,391) (43,815) (401,618) Net property and equipment , , ,602 Intangible assets: Software... 4,517 5,009 38,280 Utilization rights ,093 Other intangible assets Total intangible assets... 4,898 5,399 41,508 Investments and other assets: Investments in securities (Notes 3 and 9)... 12,248 4, ,797 Long-term loans receivable Lease deposits... 8,714 9,286 73,847 Deferred tax assets (Note 7)... 20,787 23, ,161 Other investments... 3,306 3,402 28,017 Allowance for doubtful receivables... (1,107) (1,336) (9,381) Total investments and other assets... 43,961 38, ,551 Total assets , ,337 $4,350,297 See accompanying notes to consolidated financial statements. 26 Annual Report 2005

29 Thousands of Millions of yen U.S. dollars (Note 1) LIABILITIES AND STOCKHOLDERS EQUITY Current liabilities: Notes and accounts payable , ,186 $1,287,593 Accrued income taxes... 7,592 5,343 64,339 Accrued consumption tax payable... 2,822 3,872 23,915 Accrued expenses... 30,401 29, ,636 Reserves... 4,476 4,676 37,932 Other current liabilities... 15,074 10, ,746 Total current liabilities , ,812 1,799,161 Long-term liabilities: Deferred tax liabilities (Note 7) ,593 Liability for employees retirement benefits (Note 5).. 45,520 44, ,763 Liability for directors and corporate auditors retirement benefits (Note 2) ,331 Consolidation differences... 1,391 1,928 11,788 Other long-term liabilities... 2,389 2,242 20,246 Total long-term liabilities... 50,117 49, ,721 Minority interests... 3,673 2,726 31,127 Contingent liabilities (Note 10) Stockholders equity (Notes 6 and 11): Common stock: Authorized 299,500,000 shares; Issued 150,523,896 shares in 2005 and ,303 73, ,212 Capital surplus... 82,525 82, ,364 Retained earnings... 90,324 78, ,458 Net unrealized gain on available-for-sale securities... 2, ,703 Foreign currency translation adjustments... 8 (24) 68 Treasury stock... (1,123) (920) (9,517) Total stockholders equity , ,158 2,095,288 Total liabilities and stockholders equity , ,337 $4,350,297 Annual Report