Form 20-F (1b/4)

Toyota Motor Corporation 24 June 2005 Table of Contents The following table sets forth information, as of March 31, 2005, with respect to Toyota's principal facilities and organizations, all of which are owned by Toyota or its subsidiaries. However, small portions, all under approximately 20%, of some facilities are on leased premises. Facility or Subsidiary Name Location Floor Principal ------------------- ------ Space Products or (thousand Functions square meters) Japan Toyota Head Office and Technical Center Toyota City, Aichi Pref. 1,190 Research and Development Tahara Plant Tahara City, Aichi Pref. 1,160 Automobiles Motomachi Plant Toyota City, Aichi Pref. 850 Automobiles Takaoka Plant Toyota City, Aichi Pref. 710 Automobiles Tsutsumi Plant Toyota City, Aichi Pref. 610 Automobiles Kamigo Plant Toyota City, Aichi Pref. 550 Automobile parts Honsha Plant Toyota City, Aichi Pref. 520 Automobiles Kinu-ura Plant Hekinan City, Aichi Pref. 380 Automobile parts Myochi Plant Miyoshi-cho, Aichi Pref. 280 Automobile parts Higashi-Fuji Technical Center Susono City, Shizuoka Pref. 270 Research and Development Daihatsu Motors Co., Ltd. Ikeda City, Osaka, etc. 970 Automobiles Hino Motors, Ltd. Hino City, Tokyo, etc. 920 Automobiles Toyota Auto Body Co., Ltd. Kariya City, Aichi Pref., etc. 890 Automobiles Toyota Motor Kyushu, Inc. Miyata-cho, Fukuoka Pref. 350 Automobiles Kanto Auto Works, Ltd. Susono City, Shizuoka Pref., 310 Automobiles etc. Outside Japan Toyota Motor Sales, U.S.A., Inc. California, U.S.A. 870 Sales facilities Toyota Motor Manufacturing, Kentucky, Inc. Kentucky, U.S.A. 700 Automobiles Toyota Motor Manufacturing, Indiana, Inc. Indiana, U.S.A. 360 Automobiles Toyota Motor Manufacturing (UK) Limited Derbyshire, UK 300 Automobiles Toyota Motor Manufacturing Canada, Inc. Ontario, Canada 280 Automobiles Toyota is constantly engaged in upgrading, modernizing and revamping the operations of its manufacturing facilities, based on its assessment of market needs and prospects. As market conditions and Toyota's business objectives evolve, Toyota adjusts its capacity and utilization by opening, closing, expanding or downsizing production facilities accordingly. As a result, Toyota believes it is difficult and it would require unreasonable effort to track the exact productive capacity and the extent of utilization of each of its manufacturing facilities with a reasonable degree of accuracy. Toyota believes that its manufacturing facilities are generally all operating within normal operating capacity and not substantially below capacity. As of March 31, 2005, property, plant and equipment having a net book value of approximately Y112,885 million was pledged as collateral securing indebtedness incurred by Toyota's consolidated subsidiaries. Toyota believes that there does not exist any material environmental issues that may affect the company's utilization of its assets. Toyota considers all its principal manufacturing facilities and other significant properties to be in good condition and adequate to meet the needs of its operations. See '- Business Overview - Capital Expenditures and Divestitures' for a description of Toyota's material plans to construct, expand or improve facilities. 41 -------------------------------------------------------------------------------- Table of Contents ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 5.A OPERATING RESULTS All financial information discussed in this section is derived from Toyota's consolidated financial statements that appear elsewhere in this annual report on Form 20-F. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Overview The business segments of Toyota Motor Corporation ('the parent company') and its subsidiaries (collectively, 'Toyota') include automotive operations, financial services operations and all other operations. Automotive operations is Toyota's most significant business segment, accounting for 90% of Toyota's total revenues before the elimination of intersegment revenues and 86% of Toyota's total operating income before the elimination of intersegment revenues and costs for the year ended March 31, 2005. The operating income from automotive operations as a percentage of total operating income decreased by 4% due to an increase in operating income from the financial services operations. Toyota's primary markets based on vehicle unit sales for the year ended March 31, 2005 were: Japan (32%), North America (31%) and Europe (13%). Automotive Market Environment The worldwide automotive market is highly competitive and volatile. The demand for automobiles is affected by a number of factors including social, political and general economic conditions; introduction of new vehicles and technologies; and costs incurred by customers to purchase and operate vehicles. These factors can cause consumer demand to vary substantially from year to year in different geographic markets and for different types of automobiles. The following table sets forth Toyota's consolidated vehicle unit sales by geographical market for the past three fiscal years. (Thousands of Units) Year Ended March 31, 2003 2004 2005 Japan 2,217 2,303 2,381 North America 1,982 2,103 2,271 Europe 776 898 979 All Other Markets 1,138 1,415 1,777 Oversea total 3,896 4,416 5,027 Total 6,113 6,719 7,408 Toyota's consolidated unit sales in Japan increased during both fiscal 2004 and 2005 as compared to the prior year as the result of the active introduction of new products that met customer needs and the strong sales efforts of domestic dealers despite a decline in the overall domestic market in each of those years. In addition, overseas vehicle unit sales increased in North America, Europe and all other markets due to extensive product offerings that catered to regional needs during fiscal 2004 and 2005. Toyota's share of total vehicle unit sales in each market is influenced by the quality, price, design, performance, safety, reliability, economy and utility of Toyota's vehicles compared with those offered by other manufacturers. The timely introduction of new or redesigned vehicles is also an important factor in satisfying customer demand. Toyota's ability to satisfy changing customer preferences can affect its revenues and earnings significantly. 42 -------------------------------------------------------------------------------- Table of Contents The profitability of Toyota's automotive operations is affected by many factors. These factors include: â€¢ vehicle unit sales volumes, â€¢ the mix of vehicle models and options sold, â€¢ the level of parts and service sales, â€¢ the levels of price discounts and other sales incentives and marketing costs, â€¢ the cost of customer warranty claims and other customer satisfaction actions, â€¢ the cost of research and development and other fixed costs, â€¢ the ability to control costs, â€¢ the efficient use of production capacity, and â€¢ changes in the value of the Japanese yen and other currencies in which Toyota does business. Changes in laws, regulations, policies and other governmental actions can also materially impact the profitability of Toyota's automotive operations. These laws, regulations and policies include those attributed to environmental matters and vehicle safety, fuel economy and emissions that can add significantly to the cost of vehicles. The European Union has approved a directive that requires manufacturers to be financially responsible for taking back end-of-life vehicles and to take measures to ensure that adequate used vehicle disposal facilities are established and that hazardous materials and recyclable parts are removed from vehicles prior to scrapping. Please see '- Legislation Regarding End-of-Life Vehicles' and 'Information on the Company - Business Overview - Governmental Regulation, Environmental and Safety Standards' and note 23 to the consolidated financial statements for a more detailed discussion of these laws, regulations and policies. Many governments also regulate local content, impose tariffs and other trade barriers, and enact price or exchange controls which can limit an automaker's operations and can make the repatriation of profits unpredictable. Changes in these laws, regulations, policies and other governmental actions may affect the production, licensing, distribution or sale of Toyota's products, cost of products or applicable tax rates. Toyota is currently one of the defendants in purported national class actions alleging violations of the U.S. Sherman Antitrust Act. For a more detailed description of these proceeding, see note 23 to the consolidated financial statements. The worldwide automotive industry is in a period of globalization and consolidation, which may continue for the foreseeable future. As a result, the competitive environment in which Toyota operates is likely to intensify. Toyota believes it has the resources, strategies and technologies in place to compete effectively in the industry as an independent company for the foreseeable future. In November 2002, Toyota acquired an additional ownership interest in Toyota South Africa Motor Company ('Toyota South Africa'). As a result, Toyota's ownership interest in Toyota South Africa increased by 39.3% to 75.0% and Toyota's consolidated financial statements include the accounts of Toyota South Africa from the end of fiscal 2003. Prior to the acquisition of the additional ownership interest, Toyota South Africa was accounted for using the equity method. Toyota South Africa is primarily engaged in the manufacturing and sale of Toyota vehicles and related parts. Fiscal 2004 is the first full year that Toyota's consolidated financial statements include the operating results of Toyota South Africa. In May 2003, Toyota acquired additional ownership interests in Toyota Auto Body Co., Ltd. ('Toyota Auto Body') and Kanto Auto Works, Ltd (' Kanto Auto Works'). As a result, Toyota's ownership interests in Toyota Auto Body and Kanto Auto Works increased by 2.94% and 1.14% to 50.21% and 50.57%, respectively, and Toyota's consolidated financial statements include the accounts of Toyota Auto Body and Kanto Auto Works from fiscal 2004. Prior to the acquisition of the additional ownership interests, Toyota Auto Body and Kanto Auto Works were accounted for using the equity method. Toyota Auto Body and Kanto Auto Works are primarily engaged in the manufacturing and sale of Toyota vehicles and related parts. In September 2003, Toyota acquired an additional ownership interest in P.T. Toyota Motor Manufacturing Indonesia ('TMMIN'). As a result, Toyota's ownership interests in TMMIN increased by 46.00% to 95.00% and Toyota's consolidated financial statements include the accounts of TMMIN from the end of fiscal 2004. Prior to the acquisition of the additional ownership interest, TMMIN was accounted 43 -------------------------------------------------------------------------------- Table of Contents for using the equity method. TMMIN is primarily engaged in the manufacturing and sale of Toyota vehicles and related parts. Fiscal 2005 is the first full year that Toyota's consolidated financial statements include the operating results of TMMIN. In October 2004, Araco Corporation ('Araco') spun off its automotive manufacturing business that was merged into Toyota Auto Body, while the remaining operations of Araco were merged with Takanichi Co., Ltd. ('Takanichi') and Toyoda Boshoku Corporation to become Toyota Boshoku Corporation ('Toyota Boshoku'). As a result, Toyota's ownership interests in Toyota Boshoku increased to 49.63% and Toyota Boshoku is accounted for using the equity method from the latter half of fiscal 2005. Prior to the merger, Araco and Takanichi were consolidated subsidiaries of Toyota and included their financial results in Toyota's consolidated financial statements. Toyota Boshoku is primarily engaged in the development, manufacturing and sales of all automotive interior system and filter parts. Financial Services Operations The worldwide automobile financial services industry is highly competitive. The market for automobile financing has grown as more consumers are financing their purchases, primarily in North America and Europe. As competition increases, margins on financing transactions may decrease and market share may also decline as customers obtain financing for Toyota vehicles from alternative sources. Toyota's financial services operations mainly include loans and leasing programs for customers and dealers. Toyota believes that its ability to provide financing to its customers is an important value added service, therefore Toyota intends to continue to expand its network of finance subsidiaries in order to offer financial services in more countries. Toyota's competitors for retail financing and retail leasing include commercial banks, credit unions, and other finance companies. Meanwhile, commercial banks and other captive automobile finance companies also provide competition for Toyota's wholesale financing activities. Toyota's financial assets increased during fiscal 2005 resulting primarily from the continued expansion of its financial services operations in North America. The following table provides information regarding Toyota's finance receivables and operating leases as of March 31, 2004 and 2005. Yen in millions March 31, 2004 2005 Finance Receivables Retail Y 3,643,998 Y 4,780,250 Finance leases 912,622 758,632 Wholesale and other dealer loans 1,680,907 1,773,440 6,237,527 7,312,322 Unearned income (298,153 ) (233,417 ) Allowance for credit losses (87,462 ) (91,829 ) Finance receivables, net 5,851,912 6,987,076 Less - Current portion (2,622,939 ) (3,010,135 ) Noncurrent finance receivables, net Y 3,228,973 Y 3,976,941 Operating Leases Vehicles Y 1,387,404 Y 1,736,238 Equipment 106,376 92,459 1,493,780 1,828,697 Less - Accumulated depreciation (375,861 ) (424,609 ) Vehicles and equipment on operating leases, net Y 1,117,919 Y 1,404,088 44 -------------------------------------------------------------------------------- Table of Contents Toyota has continued to originate leases to finance new Toyota vehicles. These leasing activities are subject to residual value risk. Residual value risk arises when the lessee of a vehicle does not exercise the option to purchase the vehicle at the end of the lease. The number of vehicles returned at the end of leases has decreased in recent years. Approximately 50% of vehicles leased by Toyota Motor Credit Corporation, Toyota's financing subsidiary located in the United States, were returned at the end of the applicable lease periods during fiscal 2003 and 2004, compared to a decrease in the return rate to approximately 40% in fiscal 2005 due to a narrowing spread between contractual residual values and end of lease market values. To avoid a loss on a vehicle returned to Toyota at the end of its lease, Toyota must resell or re-lease the vehicle at or above the residual value of the vehicle. If Toyota is unable to recover the residual value of the vehicle, it will incur a loss at the end of the lease, which may offset a portion of the earnings on the lease. To the extent that sales incentives remain an integral part of sales promotions (reducing new vehicle prices and cost of ownership), resale prices of used vehicles and, correspondingly, the fair value of Toyota's leased vehicles could be subject to downward pressure. During fiscal 2004 and 2005, losses have decreased mainly due to a decrease in the number of vehicles returned. See discussion in the Critical Accounting Estimates section regarding 'Investment in Operating Leases' and note 2 to consolidated financial statements regarding the allowance for residual values losses. Toyota maintains an overall risk management strategy to mitigate its exposure to fluctuations in interest rates and currency exchange rates. Toyota enters into interest rate swap agreements and cross currency interest rate swap agreements to convert its fixed-rate debt to variable-rate functional currency debt. Toyota formally documents relationships between the derivative instrument and the hedged item, as well as its risk-management strategy for undertaking hedge transactions. If Toyota elects fair value hedge accounting, derivative instruments are designated with specific liabilities on Toyota's consolidated balance sheet, and the fair value quarterly change component of each derivative instrument and hedged item is included in the assessment of hedge effectiveness. Most interest rate swap agreements are executed as an integral part of specific debt transactions, achieving designated hedges. Toyota uses cross currency interest rate swap agreements to entirely hedge exposure to currency exchange rate fluctuations on principal and/or interest payments and to manage its exposure to interest rate fluctuations. Certain derivative instruments are entered into to hedge interest rate risk from an economic perspective and are not designated to specific assets or liabilities on Toyota's consolidated balance sheet. Accordingly, unrealized gains or losses related to derivatives that are not designated to specific assets and liabilities on Toyota's consolidated balance sheet are recognized currently. As a result, earnings are impacted by these non-designated derivatives. The impact of recognizing these realized and unrealized gains and losses attributed to non-designated derivatives resulted in a loss, gain and gain to net income for fiscal 2003, 2004 and 2005, respectively. Toyota does not use any derivative instruments for trading purposes. See discussion in the Critical Accounting Estimates section regarding 'Derivatives and Other Contracts at Fair Value', and further discussion in the Market Risk Disclosures section. In addition, aggregated funding costs can affect the profitability of Toyota's financial services operations. Funding costs are affected by a number of factors, some of which are not in Toyota's control. These factors include general economic conditions, prevailing interest rates and Toyota's financial strength. Funding costs decreased during fiscal 2004 as a result of lower interest rates primarily in the United States and increased during fiscal 2005 as a result of higher interest rates and an increase in borrowings, primarily in the United States. Toyota launched its credit card business in Japan at the beginning of fiscal 2002. As of March 31, 2004, Toyota had 4.2 million cardholders, an increase of 0.6 million cardholders compared with March 31, 2003, and as of March 31, 2005, Toyota had 4.7 million cardholders, an increase of 0.5 million cardholders compared with March 31, 2004. Corresponding to the increase in cardholders, the credit card receivables at March 31, 2004 increased by Y21.8 billion from March 31, 2003 to Y117.2 billion. The credit card receivables at March 31, 2005 increased by Y27.0 billion from March 31, 2004 to Y144.2 billion. Other Business Operations Toyota's other business operations consist of housing including the manufacture and sale of prefabricated homes; information technology related businesses including information technology and telecommunications, intelligent transport systems, GAZOO; marine, biotechnology and afforestation. 45 -------------------------------------------------------------------------------- Table of Contents Toyota does not expect its other business operations to materially contribute to Toyota's consolidated results of operations. Currency Fluctuations Toyota is sensitive to fluctuations in foreign currency exchange rates. In addition to the Japanese yen, Toyota is principally exposed to fluctuations in the value of the U.S. dollar and the euro, and to a lesser extent the British pound and the Australian dollar. Toyota's consolidated financial statements, which are presented in Japanese yen, are affected by foreign currency exchange fluctuations through both translation risk and transaction risk. Changes in foreign currency exchange rates may positively or negatively affect Toyota's revenues, operating costs and expenses, gross margins, operating income, net income and retained earnings. Translation risk is the risk that Toyota's consolidated financial statements for a particular period or for a particular date will be affected by changes in the prevailing exchange rates of the currencies in those countries in which Toyota does business compared with the Japanese yen. Even though the fluctuations of currency exchange rates to the Japanese yen can be substantial, and, therefore, significantly impact comparisons with prior periods and amongst the various geographic markets, the translation effect is a reporting consideration and does not reflect Toyota's underlying results of operations. Toyota does not hedge against translation risk. Transaction risk is the risk that the currency structure of Toyota's costs and liabilities will deviate from the currency structure of sales proceeds and assets. Transaction risk relates primarily to sales proceeds from Toyota's non-domestic operations from vehicles produced in Japan. Toyota believes that the location of its production facilities in different parts of the world has significantly reduced the level of transaction risk. As part of its globalization strategy, Toyota has continued to localize production by constructing production facilities in the major markets in which it sells its vehicles. In calendar 2003 and 2004, Toyota produced 60.9% and 62.9% of Toyota's non-domestic sales outside Japan, respectively. In North America, 61.7% and 63.7% of vehicles sold in calendar 2003 and 2004 were produced locally, respectively. In Europe, 52.6% and 56.7% of vehicles sold in calendar 2003 and 2004 were produced locally, respectively. Localizing production enables Toyota to purchase many of the supplies and resources used in the production process, which allows for a better match of local currency revenues with local currency expenses. Toyota also enters into foreign currency transactions and other hedging instruments to address a portion of its transaction risk. This has reduced, but not eliminated, the effects of foreign currency exchange rate fluctuations, which in some years can be significant. See notes 20 and 21 to the consolidated financial statements for additional information regarding the extent of Toyota's use of derivative financial instruments to hedge foreign currency exchange rate risks. Generally, a weakening of the Japanese yen against other currencies has a positive effect on Toyota's revenues, operating income and net income. A strengthening of the Japanese yen against other currencies has the opposite effect. The Japanese yen has on average been stronger against the U.S. dollar during fiscal 2004 and 2005. At the end of fiscal 2004 and 2005, the Japanese yen was stronger and weaker, respectively, against the U.S. dollar in comparison to the end of the prior fiscal year. As compared to the euro, the Japanese yen has on average been weaker during fiscal 2004 and 2005. At the end of fiscal 2004 and 2005, the Japanese yen was stronger and weaker, respectively, against the euro compared to the end of the prior fiscal year. See further discussion in the Market Risk Disclosures section regarding 'Foreign Currency Exchange Rate Risk'. During fiscal 2004 and 2005, the average value of the yen fluctuated against the major currencies including the U.S. dollar and euro compared with the average value of the previous fiscal year, respectively, as noted above. The operating results excluding the impact of currency fluctuations described in the 'Results of Operations - Fiscal 2005 Compared with Fiscal 2004' and the 'Results of Operations - Fiscal 2004 Compared with Fiscal 2003' show results of net revenues obtained by applying the yen's average exchange rate in the 46 -------------------------------------------------------------------------------- Table of Contents previous fiscal year to the local currency-denominated net revenues for fiscal 2004 and 2005, respectively, as if the value of the yen had remained constant for the comparable periods. Results excluding the impact of currency fluctuations year-on-year are not on the same basis as Toyota's consolidated financial statements and do not conform with U.S.GAAP. Furthermore, Toyota does not believe that these measures are a substitute for U.S.GAAP measures. However, Toyota believes that such results excluding the impact of currency fluctuations year-on-year provide additional useful information to investors regarding the operating performance on a local currency basis. Segmentation Toyota's most significant business segment is its automotive operations. Toyota carries out its automotive operations as a global competitor in the worldwide automotive market. Toyota's management allocates resources to, and assesses the performance of, its automotive operations as a single business segment on a worldwide basis. Toyota does not manage any subset of its automotive operations, such as domestic or overseas operations or parts, as separate management units. The management of the automotive operations is aligned on a functional basis with managers having oversight responsibility for the major operating functions within the segment. Management assesses financial and non-financial data such as units of sale, units of production, market share information, vehicle model plans and plant location costs to allocate resources within the automotive operations. Geographical Breakdown The following table sets forth Toyota's net revenues from external customers in each geographical market for the past three fiscal years. Yen in millions For the years ended March 31, 2003 2004 2005 Japan Y 6,621,054 Y 7,167,704 Y 7,408,136 North America 5,929,803 5,910,422 6,187,624 Europe 1,514,683 2,018,969 2,305,450 All Other Markets 1,436,013 2,197,665 2,650,316 Results of Operations - Fiscal 2005 Compared with Fiscal 2004 Net Revenues Toyota had net revenues for fiscal 2005 of Y18,551.5 billion, an increase of Y 1,256.8 billion, or 7.3%, compared with the prior year. This increase principally reflects the impact of increased vehicle unit sales, increased parts and service sales and increased financings. These increases were partially offset by the impact of fluctuations in foreign currency translation rates particularly against the U.S. dollar. Eliminating the difference in the yen value used for translation purposes, net revenues would have been approximately Y18,846.1 billion during fiscal 2005, a 9.0% increase compared with the prior year. Toyota's net revenues include net revenues from sales of products which increased during fiscal 2005 by 7.3% from the prior year to Y17,790.8 billion and net revenues from financing operations which increased 6.1% in fiscal 2005 compared with the prior year to Y760.7 billion. Eliminating the difference in the yen value used for translation purposes, net revenues from sales of products would have been approximately Y18,062.8 billion, a 9.0% increase, while net revenues from financing operations would have increased approximately 9.3% during fiscal 2005 compared to the prior year to Y783.3 billion. Geographically, net revenues for fiscal 2005 increased by 3.4% in Japan, 4.7% in North America, 14.2% in Europe and 20.6% in all other markets compared with the prior year. Eliminating the difference in the yen value used for translation purposes, net revenues in fiscal 2005 would have increased by 3.4% in Japan, 10.0% in North America, 12.2% in Europe and 21.5% in all other markets compared with the prior year. 47 -------------------------------------------------------------------------------- Table of Contents The following is a discussion of net revenues for each of Toyota's business segments. The net revenue amounts discussed are amounts before the elimination of intersegment revenues. Automotive Operations Segment Net revenues from Toyota's automotive operations, which constitute the largest percentage of Toyota's net revenues, increased in fiscal 2005 by Y1,139.7 billion, or 7.1% compared with the prior year to Y17,113.5 billion. The increase resulted primarily from the approximate Y1,300.0 billion impact attributed to combined net impact of vehicle unit sales growth and changes in sales mix and the impact of increased parts and service sales. These overall increases were partially offset by unfavorable currency fluctuations totaling Y270.0 billion. Eliminating the difference in the yen value used for translation purposes, automotive operations net revenues would have been approximately Y17,383.5 billion in fiscal 2005, an 8.8% increase compared to the prior year. In fiscal 2005, net revenues in Japan were favorably impacted primarily attributed to vehicle unit sales growth in both the domestic and export markets, which was partially offset by changes in sales mix compared to fiscal 2004. Net revenues in North America were favorably impacted by vehicle unit sales growth, but were partially offset by the impact of foreign currency fluctuations during fiscal 2005. Net revenues in Europe were favorably impacted primarily by vehicle unit sales growth and foreign currency translation rates fluctuations during fiscal 2005. Net revenues in all other markets were favorably impacted, primarily attributed to vehicle unit sales growth due to IMV (Innovative International Multi-Purpose Vehicle), which was launched in fiscal 2004. Financial Services Operations Segment Net revenues in fiscal 2005 for Toyota's financial services operations increased by Y44.3 billion or 6.0% compared to the prior year to Y781.2 billion. This increase resulted primarily from the impact of a higher volume of financings and the impact of adjustments made by a sales financing subsidiary in the United States for the correction of errors relating to prior periods (see note 24 to the consolidated financial statements), but was partially offset by the impact of unfavorable foreign currency fluctuations during fiscal 2005. Eliminating the difference in the yen value used for translation purposes, financial services operations net revenues would have been approximately Y803.7 billion during fiscal 2005, a 9.1% increase compared with the prior year. All Other Operations Segment Net revenues for Toyota's other businesses increased by Y134.1 billion, or 15.0%, to Y1,030.3 billion during fiscal 2005 compared with the prior year. This increase primarily relates to increased production volume and sales attributed to the housing business. Operating Costs and Expenses Operating costs and expenses increased by Y1,251.5 billion, or 8.0%, to Y 16,879.3 billion during fiscal 2005 compared with the prior year. The increase resulted primarily from the approximate Y1,100.0 billion impact on costs of products attributed to combined net impact of vehicle unit sales growth and changes in sales mix, a Y72.9 billion increase in research and development expenses, a Y59.8 billion decrease in net gain on the transfer to the government of the substitutional portion of certain employee pension funds in Japan, increased expenses in expanding business operations and increased costs related to the corresponding increase in parts and service sales. These increases were partially offset by approximately Y160.0 billion of cost reduction efforts in fiscal 2005. In 2001, the Corporate Defined Benefit Pension Plan Law was enacted and allowed a company to transfer the substitutional portion of the obligation to the government. The parent company and certain subsidiaries in Japan applied for an exemption from the payment of benefits related to future employee services with respect to the substitutional portion of their employee pension funds and obtained approval from the Minister of Health, Labor, and Welfare. These companies also applied for approval for the separation of the benefit obligations of 48 -------------------------------------------------------------------------------- Table of Contents the substitutional portion which relates to past employee services. After approval was obtained, the parent company and certain subsidiaries in Japan completed the transfers of the government-specified portion of plan assets relating to the substitutional portion in fiscal 2004. Several additional subsidiaries in Japan also completed the transfers of the government-specified portion of plan assets in fiscal 2005. The gains and losses relating to these transfers were treated in accordance with the Emerging Issues Task Force ('EITF ') No.03-02, Accounting for the transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities. In connection with these transfers, for fiscal 2004 and 2005, settlement losses relating to the transfer of the substitutional portion was Y213.9 billion and Y 74.3 billion, respectively and is reflected in cost of products sold (Y190.1 billion and Y65.9 billion, respectively) and selling, general and administrative expenses (Y23.8 billion and Y8.4 billion, respectively). In addition, the government subsidy representing the difference between the benefit obligations of the substitutional portion and the government-specified portion of plan assets of Y320.9 billion for fiscal 2004 and Y121.5 billion for fiscal 2005, respectively, which were both transferred to the government, reduced selling, general and administrative expenses. The net impact of these items was a reduction of operating expenses by Y47.2 billion during fiscal 2005, which increased by Y59.8 billion compared to a reduction of operating expenses by Y 107.0 billion during fiscal 2004. See note 19 to the consolidated financial statements. Continued cost reduction efforts reduced costs and expenses in fiscal 2005 by approximately Y160.0 billion over what would have otherwise been incurred. These cost reduction efforts relate to ongoing value engineering and value analysis activities, the use of common parts that result in a reduction of part types and other manufacturing initiatives designed to reduce the costs of vehicle production. Cost of products sold increased by Y993.9 billion, or 7.4%, to Y14,500.2 billion during fiscal 2005 compared with the prior year. This increase (before the elimination of intersegment amounts) reflects an increase of Y881.6 billion, or 6.8%, for the automotive operations and an increase of Y112.5 billion, or 14.8%, for the all other operations segment. The increase in cost of products sold for the automotive operations is primarily attributed to the net impact of increased vehicle unit sales and changes in sales mix, the impact of increased parts and service sales, and the impact of the increase in research and development expenses, which were partially offset by the impact of continued cost reduction efforts, the impact of decrease in the settlement losses relating to the transfer to the government of the substitutional portion and the impact of foreign currency fluctuations during fiscal 2005 The increase in cost of products sold for all other operations primarily related to the increase in net revenues. Cost of financing operations increased by Y5.7 billion, or 1.6%, to Y369.8 billion during fiscal 2005 compared with the prior year. The increase resulted primarily from the impact of increased interest expenses caused primarily by higher interest rates and an increase in borrowings attributed to business expansion in the United States, that was partially offset by the impact of an increase in net gains on derivative financial instruments that are not designated as hedges and are marked-to-market at the end of each period. Selling, general and administrative expenses increased by Y251.9 billion, or 14.3%, to Y2,009.2 billion during fiscal 2005 compared with the prior year. This increase (before the elimination of intersegment amounts) reflects an increase of Y324.5 billion, or 21.8%, for the automotive operations, a decrease of Y20.9 billion, or 9.3%, for the financial services operations and an increase of Y3.0 billion, or 2.5%, for all other operations segment. The increase for the automotive operations consisted primarily of the impact from the reduction of gains attributed to the transfer of the substitutional portion of certain employee pension funds to the government and the impact of increased expenses in expanding business operations, which were partially offset by the impact of unfavorable currency fluctuations. The decrease for the financial services operations reflects lower provisions for credit losses specifically in North America due to an improvement in the delinquent loan collection rate and the favorable impact of fluctuations in foreign currency translation rates. Research and development expenses (included in cost of products sales and selling, general and administrative expenses) increased by Y72.9 billion, or 10.7%, to Y755.1 billion during fiscal 2005 compared with the prior year. This increase primarily relates to expenditures attributed to the development of 49 -------------------------------------------------------------------------------- Table of Contents environmentally conscious technologies including hybrid and fuel cell battery technology, aggressive developments in advanced technologies relating to collision safety and vehicle stability controls and the impact of expanding new models to promote Toyota's strength in a competitive global market to further build up competitive strength in future. Operating Income Toyota's operating income increased by Y5.3 billion, or 0.3%, to Y1,672.1 billion during fiscal 2005 compared with the prior year. Operating income was favorably affected by the combined net impact of vehicle unit sales growth and changes in sales mix, the impact of increased parts and service sales, continued cost reduction efforts, growth in the financial services operations and improvements in all other operations. These increases were partially offset by a reduction in the net gains on the transfer to the government of the substitutional portion of certain employee pension funds, increases in research and development expenses, the impact of business expansion and the unfavorable impact due to currency fluctuations. As a result, operating income decreased to 9.0% for fiscal 2005 compared to 9.6% in the prior year. During fiscal 2005, operating income (before the elimination of intersegment profits) by significant geographies resulted in a decreased of Y120.9 billion, or 10.9%, in Japan, and increases of Y56.5 billion, or 14.5%, in North America, Y36.0 billion, or 49.8% in Europe and Y44.3 billion, or 45.7% in all other markets compared with the prior year. The decrease in Japan relates primarily to the impact of a decrease in the net gains on the transfer to the government of the substitutional portion of certain employee funds, increases in research and development expenses and unfavorable currency fluctuations. The decrease was partially offset by the combined net impact of vehicle unit sales growth in both of the domestic and export markets and changes in sales mix and continued cost reduction efforts. The increase in North America relates primarily to the increase in production volume and vehicle unit sales, the impact of cost reduction efforts in the manufacturing operations, increases in the asset base of the financial services operations, and lower provisions for credit losses and the allowance for residual value losses which were partially offset by an increase in expenses attributed to business expansion in North America and the impact of currency fluctuations. The increase in the European market operating income relates mainly to the impact of cost reduction efforts in the manufacturing operations, an increase in production volume and vehicle unit sales and the favorable impact of currency fluctuations, which were partially offset by increases in expenses attributed to expansion of operations. The increase in all other markets relates primarily to the impact of the increase in production volume and vehicle unit sales mainly attributed to the IMV project. The following is a discussion of operating income for each of Toyota's business segments. The operating income amounts discussed are before the elimination of intersegment profits. Automotive Operations Segment Operating income from Toyota's automotive operations decreased by Y66.5 billion, or 4.4%, to Y1,452.5 billion during fiscal 2005 compared with the prior year. Operating income was unfavorably affected by the impact of the reduction in net gains attributed to the transfer to the government of the substitutional portion of certain employee pension funds, the increase in research and development expenses, the increase in expenses corresponding to business expansion and currency fluctuations. These decreases were partially offset by the increase in vehicle unit sales, the increase in parts and service sales, and the impact of continued cost reduction efforts. Financial Services Operations Segment Operating income from Toyota's financial services operations increased by Y54.8 billion, or 37.6%, to Y200.8 billion during fiscal 2005 compared with the prior year. This increase was primarily due to an increase in the finance receivables asset base, the impact of adjustments made by a sales financing subsidiary for the 50 -------------------------------------------------------------------------------- Table of Contents correction of errors relating to prior periods (see note 24 to the consolidated financial statements), the impact of lower provisions for credit losses and the allowance for residual value losses in the United States. These increases were partially offset by the impact of fluctuations in foreign currency translation rates. All Other Operations Segment Operating income from Toyota's other businesses increased by Y18.5 billion, or 121.3% to Y33.7 billion during fiscal 2005. This increase primarily relates to increased production volume and sales attributed to the housing business. Other Income and Expenses Interest and dividend income increased by Y11.9 billion, or 21.4%, to Y67.5 billion during fiscal 2005 compared with the prior year due to an increase in investment securities in the United States subsidiary. Interest expense decreased by Y1.8 billion, or 8.5%, to Y18.9 billion during fiscal 2005 compared with the prior year due to a decrease in borrowings in the automotive operations segment. Foreign exchange gains, net decreased by Y16.7 billion, or 43.9%, to Y21.4 billion during fiscal 2005 compared with the prior year. Foreign exchange gains and losses include the differences between the value of foreign currency denominated sales translated at prevailing exchange rates and the value of the sales amounts settled during the year, including those settled using forward foreign currency exchange contracts. Other income, net decreased by Y13.3 billion, or 51.7%, to Y12.4 billion during fiscal 2005 due to an increase in donations paid to educational institutions. Income Taxes The provision for income taxes decreased Y23.4 billion in fiscal 2005 compared with the prior year primarily due to the decrease in income before income taxes. In addition, the provision decreased as a result of the reduction in the effective tax rate for fiscal 2005, which decreased to 37.5% from 38.6% for the prior year mainly attributed to the reduction in the statutory tax rate in Japan. Minority Interest in Consolidated Subsidiaries and Equity in Earnings of Affiliated Companies Minority interest in consolidated subsidiaries increased by Y22.3 billion to Y 64.9 billion during fiscal 2005 compared with the prior year. This increase was mainly due to favorable operating results at consolidated subsidiaries. Equity in earnings of affiliated companies during fiscal 2005 increased by Y19.2 billion to Y139.4 billion compared with the prior year due to an increase in net income attributable to favorable operations at the affiliated companies, which were partially offset by the decrease in the net gain on the transfer to the government of the substitutional portion of an employee pension fund of affiliated companies in Japan. Net Income Toyota's net income increased by Y9.2 billion, or 0.8%, to Y1,171.2 billion during fiscal 2005 compared with the prior year. Other Comprehensive Income and Loss Other comprehensive income decreased by Y275.8 billion to Y123.9 billion for fiscal 2005 compared with the prior year. This change resulted primarily from a decrease in unrealized holding gains on securities during 51 -------------------------------------------------------------------------------- Table of Contents fiscal 2005 of Y38.4 billion compared with unrealized holding gains of Y329.7 billion in the prior year reflected by the recovery of the Japanese stock exchange market and the lower gain adjustment in the minimum pension liability component during fiscal 2005 of Y9.8 billion compared to a Y273.3 billion gain adjustment in the prior year due to the transfer to the government of the substitutional portion of employee pension funds of primarily the parent company. These declines in the other comprehensive income were partially offset by the foreign currency translation adjustments, which resulted in a Y75.7 billion of gains in fiscal 2005 compared with losses of Y203.3 billion in the prior year. Results of Operations - Fiscal 2004 Compared with Fiscal 2003 Net Revenues Toyota had net revenues for fiscal 2004 of Y17,294.7 billion, an increase of Y 1,793.2 billion, or 11.6%, compared with the prior year. This increase principally reflects the impact of increased vehicle unit sales, the consolidation of the results of subsidiaries previously accounted for on the equity basis, increased parts and service sales and the impact of increased financings. These increases were partially offset by the impact of fluctuations in foreign currency translation rates particularly against the U.S. dollar. Eliminating the difference in the yen value used for translation purposes, net revenues would have been approximately Y17,554.3 billion during fiscal 2004, a 13.2% increase compared with the prior year. Toyota's net revenues include net revenues from sales of products which increased during fiscal 2004 by 12.1% to Y 16,578.0 billion compared to the prior year and net revenues from financing operations which increased during fiscal 2004 by 1.3% to Y716.7 billion compared with the prior year. Eliminating the difference in the yen value used for translation purposes, net revenues from sales of products would have been approximately Y16,809.1 billion, a 13.6% increase, and net revenues from financing operations would have been approximately Y745.2 billion, a 5.3% increase, during fiscal 2004 compared with the prior year. Net revenues for fiscal 2004 increased by 8.3% in Japan, 33.3% in Europe and 53.0% in all other markets and decreased by 0.3% in North America compared with the prior year. Eliminating the difference in the yen value used for translation purposes, net revenues would have increased by 8.3% in Japan, 7.1% in North America, 25.3% in Europe and 48.9% in all other markets compared with the prior year. The following is a discussion of net revenues for each of Toyota's business segments. The net revenue amounts discussed are amounts before the elimination of intersegment revenues. Automotive Operations Segment Net revenues from Toyota's automotive operations constitute the largest percentage of Toyota's net revenues and increased by Y1,662.3 billion, or 11.6%, to Y15,973.8 billion during fiscal 2004 compared with the prior year. The increase resulted primarily from the approximately Y1,300.0 billion impact attributed to increased vehicle unit sales, the Y420.0 billion impact attributed to the consolidation of the results of subsidiaries previously accounted for on the equity basis, as discussed in note 5 to the consolidated financial statements, and increased parts and service sales. These increases were partially offset by the Y230.0 billion impact of foreign currency translation rates fluctuations. Eliminating the difference in the yen value used for translation purposes, automotive operations revenues would have been approximately Y16,205.2 billion during fiscal 2004, a 13.2% increase compared to the prior year. Net revenues in Japan were favorably impacted by vehicle unit sales growth in both of the domestic and export markets, that were offset by lower average unit sales prices resulting from the continuing market shift in Japan to lower priced vehicles during fiscal 2004. Net revenues in North America were favorably impacted by vehicle unit sales growth, but were partially offset by the negative impact of foreign currency fluctuations during fiscal 2004. Net revenues in Europe were favorably impacted by combined net impact of vehicle unit sales growth and changes in sales mix, and foreign currency translation rate fluctuations during fiscal 2004. Net revenues in all other markets were favorably impacted by vehicle unit sales growth, but were partially offset by the lower average unit sales price. 52 -------------------------------------------------------------------------------- Table of Contents Financial Services Operations Segment Net revenues for Toyota's financial services operations increased by Y12.0 billion, or 1.6%, to Y736.9 billion during fiscal 2004 compared with the prior year. This increase resulted primarily from the impact of a higher volume of financings and the impact of expansion of the credit card business in Japan that was partially offset by the impact of foreign currency translation rates fluctuations during fiscal 2004. Eliminating the difference in the yen value used for translation purposes, financial services operations net revenues would have been approximately Y765.0 billion during fiscal 2004, a 5.5% increase compared with the prior year. All Other Operations Segment Net revenues for Toyota's other businesses increased by Y101.0 billion, or 12.7%, to Y896.2 billion during fiscal 2004 compared with the prior year. This increase resulted primarily from the impact of increased production volume and sales from the housing business. Operating Costs and Expenses Operating costs and expenses increased by Y1,398.0 billion, or 9.8%, to Y 15,627.9 billion during fiscal 2004 compared with the prior year. The increase is comprised of approximately Y1,000.0 billion, primarily from the impact on cost of products attributed to increased vehicle unit sales, a Y470.0 billion impact from the consolidation of the results of subsidiaries previously accounted for on the equity basis, a Y110.0 billion impact of increase in labor costs, and the impact of increased parts and service sales. These increases were partially offset by the approximate Y230.0 billion impact of cost reduction efforts and a Y107.0 billion net gain on the transfer of the substitutional portion of certain employee pension funds in Japan. In 2001, the Corporate Defined Benefit Pension Plan Law was enacted and allowed a company to transfer the substitutional portion of the obligation to the government. The parent company and certain subsidiaries in Japan applied for an exemption from the payment of benefits related to future employee services with respect to the substitutional portion of their employee pension funds and obtained approval from the Minister of Health, Labor, and Welfare. These companies also applied for approval for the separation of the benefit obligations of the substitutional portion which relates to past employee services. After approval was obtained, the parent company and certain subsidiaries completed the transfer of the government-specified portion of plan assets relating to the substitutional portion in fiscal 2004. In accordance with the Emerging Issues Task Force ('EITF') No. 03-02, Accounting for the transfer to the Japanese Government of the Substitutional Portion of Employee Pension Fund Liabilities, settlement losses relating to the transfer of the substitutional portion was Y213.9 billion and is reflected in cost of products sold (Y190.1 billion) and selling, general and administrative expenses (Y23.8 billion) for fiscal 2004. In addition, the government subsidy representing the difference between the benefit obligations of the substitutional portion and the government-specified portion of plan assets of Y320.9 billion transferred to the government reduced selling, general and administrative expenses. The net impact of these items was a reduction of operating expenses by Y107.0 billion during fiscal 2004. See note 19 to the consolidated financial statements. Continued cost reduction efforts reduced costs and expenses for fiscal 2004 by approximately Y230.0 billion over what would have otherwise been incurred. These cost reduction efforts relate to ongoing value engineering and value analysis activities, the use of common parts that results in a reduction of part types and other manufacturing initiatives designed to reduce the costs of vehicle production. Cost of products sold increased by Y1,592.1 billion, or 13.4%, to Y13,506.3 billion during fiscal 2004 compared with the prior year. This increase (before the elimination of intersegment amounts) reflects an increase of Y1,485.3 billion, or 12.9%, for the automotive operations and an increase of Y92.5 billion, or 13.8%, for the all other operations segment. The increase in cost of products sold for the automotive operations is primarily due to the combined net impact of increased vehicle unit sales and changes in sales mix, the consolidation of the results of subsidiaries previously accounted for on the equity basis, the impact of increased parts and service sales, the 53 -------------------------------------------------------------------------------- Table of Contents increase in research and development expenses and settlement loss on transfer of the substitutional portion of the employee pension fund that was partially offset by the impact of continued cost reduction efforts and the impact of foreign currency translation rates fluctuations during fiscal 2004. Cost of financing operations decreased by Y59.7 billion, or 14.1%, to Y364.2 billion during fiscal 2004 compared with the prior year. The decrease resulted primarily from the impact of gains on derivative financial instruments that are not designated as hedges and are marked-to-market at the end of each period, the impact of decreased interest expenses caused primarily by lower interest rates in the United States and the impact of fluctuations in foreign currency translation rates. The cost of all other operations increased Y90.3 billion, or 11.4% during fiscal 2004 compared to the prior year. The increase results from the increase in net revenues from Toyota's other businesses. Selling, general and administrative expenses (after the elimination of intersegment amounts) decreased by Y134.4 billion, or 7.1%, to Y1,757.4 billion during fiscal 2004 compared with the prior year. This decrease (before the elimination of intersegment amounts) reflects a decrease of Y95.0 billion, or 6.0%, for the automotive operations, a decrease of Y43.7 billion, or 16.3%, for the financial services operations and a decrease of Y2.3 billion, or 1.9%, for the other operations segment. The decrease for the automotive operations consisted primarily of the impact of continued cost reduction efforts, the impact of fluctuations in foreign currency translation rates and the government subsidy relating to the transfer of the substitutional portion of certain employee pension funds that was partially offset by the impact of increased labor costs arising from the expansion of operations overseas and increases in advertising costs. The decrease for the financial services operations results from lower provisions for credit losses especially in North America due to an improvement in the delinquent loan collection rate and the impact of fluctuations in foreign currency translation rates. Research and development expenses (included in cost of products sales and selling, general and administrative expenses) increased by Y13.8 billion, or 2.1%, to Y682.2 billion during fiscal 2004 compared with the prior year, as a result of the impact of research related to anticipatory, advanced and environmental technologies with a central focus on the development of a fuel cell battery and the impact of expanding new models to promote Toyota's strength in a competitive global market for the future. Operating Income Toyota's operating income increased by Y395.2 billion, or 31.1%, to Y1,666.8 billion during fiscal 2004 compared with the prior year. Operating income was favorably affected primarily by vehicle unit sales growth, the impact of increased parts and service sales, continued cost reduction efforts, net gains on the transfer of the substitutional portion of certain employee pension funds and the consolidation of the results of subsidiaries previously accounted for on the equity basis. These increases were partially offset by increases in labor costs and advertising costs. As a result, operating income as a percentage of revenue increased to 9.6% for fiscal 2005 compared to 8.2% in the prior years. During fiscal 2004, operating income (before the elimination of intersegment profits) increased by Y163.8 billion, or 17.4%, in Japan, Y111.0 billion, or 39.6%, in North America, Y64.2 billion, or 772.7% in Europe and Y51.3 billion, or 112.4% in all other markets compared with the prior year. The increase in Japan relates primarily to the impact of increased production volume and vehicle unit sales, continued cost reduction efforts, the impact of the net gains on the transfer of the substitutional portion of certain employee funds and the consolidation of the results of subsidiaries previously accounted for on the equity basis. These increases were partially offset by the impact of fluctuations in foreign currency translation rates against Toyota's non-domestic sales produced in Japan. The increase in North America relates primarily to the increase in production volume and vehicle unit sales, the impact of cost reduction efforts of manufacturing companies, lower provisions for credit losses and the impact of unrealized gains on interest rate swaps held by sales financing subsidiaries, that were partially offset by the negative impact of the exchange rate of the yen against the U.S. dollar. The increase in the European market relates mainly to the impact of cost reduction efforts of manufacturing companies, an 54 -------------------------------------------------------------------------------- Table of Contents increase in production volume and vehicle unit sales, the impact of changes in sales mix and a favorable exchange rate of the yen against the Euro, that was partially offset by the increase in labor costs due to the expansion of operations. The increase in other markets relates primarily to the impact of the increase in production volume and vehicle unit sales mainly in Asia and a general improvement in other markets. The following is a discussion of operating income for each of Toyota's business segments. The operating income amounts discussed are before the elimination of intersegment profits. Automotive Operations Segment Operating income from Toyota's automotive operations increased by Y272.1 billion, or 21.8%, to Y1,519.0 billion during fiscal 2004 compared with the prior year. Operating income was favorably affected primarily by the increase in vehicle unit sales, the increase in parts and service sales, the impact of continued cost reduction efforts, net gains on the transfer of the substitutional portion of certain employee pension funds, the consolidation of the results of subsidiaries previously accounted for on the equity basis, and the favorable exchange rate fluctuations of the yen against the euro. These increases were partially offset by increases in labor costs and advertising expenses, and the unfavorable exchange rate fluctuations of the yen against the U.S. dollar. Financial Services Operations Segment Operating income from Toyota's financial services operations increased by Y115.7 billion, or 381.4%, to Y146.0 billion during fiscal 2004 compared with the prior year. This increase was primarily due to the impact of gains on derivative financial instruments, lower provisions for credit losses, an increase in the finance receivables asset base, the decrease in interest expenses attributed to lower interest rates on borrowings in the United States and the increase in the number of credit cards issued in Japan. These increases were partially offset by the unfavorable fluctuations in the U.S. dollar exchange rate against the yen. All Other Operations Segment Operating income from Toyota's other businesses increased by Y10.7 billion, or 236.7% to Y15.2 billion during fiscal 2004. This increase primarily relates to increased revenue from the prefabricated housing business. Other Income and Expenses Interest and dividend income increased by Y3.0 billion, or 5.6%, to Y55.6 billion during fiscal 2004 compared with the prior year due to an increase in investment securities in the United States subsidiary, which was partially offset by lower interest rates in the United States. Interest expense decreased by Y9.8 billion, or 32.0%, to Y20.7 billion during fiscal 2004 compared with the prior year due to a decrease in borrowings in the automotive segment and lower interest rates in the United States. Foreign exchange gain, net increased by Y2.6 billion, or 7.3%, to Y38.2 billion during fiscal 2004 compared with the prior year. Foreign exchange gain and loss include the differences between the value of foreign currency denominated sales translated at prevailing exchange rates and the value of the sales amounts settled during the year, including those settled using forward foreign currency exchange contracts. Other gain and loss changed to a gain of Y25.8 billion from a loss of Y102.8 billion in the prior year. During fiscal 2003, there were losses of Y111.3 billion relating to other-than temporary impairments on investment securities. During fiscal 2004, there were no material impairments on investment securities primarily attributed to the more favorable stock market conditions in Japan. 55 -------------------------------------------------------------------------------- Table of Contents Income Taxes Provision for income taxes increased by Y164.3 billion during fiscal 2004 compared with the prior year, primarily as a result of the increase in income before income taxes and an increased provision for taxes on undistributed earnings of affiliated companies accounted for by the equity method. The effective tax rate for fiscal 2004 decreased to 38.6% from 42.1% for the prior year due to the reduction in valuation allowances and an increase in certain tax credits. Minority Interest in Consolidated Subsidiaries and Equity in Earnings of Affiliated Companies Minority interest in consolidated subsidiaries increased by Y31.1 billion to Y 42.6 billion during fiscal 2004 compared with the prior year. This increase was mainly due to the consolidation of the results of subsidiaries previously accounted for on the equity basis. Equity in earnings of affiliated companies during fiscal 2004 increased by Y67.4 billion to Y120.2 billion compared with the prior year due to an increase in net income as a result of favorable operations at most of the affiliated companies, a net gain on the transfer of the substitutional portion of an employee pension fund of an affiliate company in Japan, partially offset by the acquisition and consolidation of certain affiliate companies. Net Income Toyota's net income increased by Y411.1 billion, or 54.8%, to Y1,162.0 billion during fiscal 2004 compared with the prior year. Other Comprehensive Income and Loss Other comprehensive income and loss increased by Y736.6 billion to an income of Y399.7 billion during fiscal 2004 compared with the prior year. This change resulted primarily from an increase in unrealized holding gains on securities during fiscal 2004 of Y329.7 billion compared with unrealized holding losses of Y26.5 billion in the prior year due to favorable market conditions in Japan and minimum pension liability adjustments during fiscal 2004, which resulted in a Y 273.3 billion gain adjustment compared with a Y171.9 billion loss adjustment in the prior year due to the transfer of the substitutional portion of certain employee pension funds, an increase in cash contributions to the plans, and the increase in the market value of assets of the plans, offset by an increase in the losses for foreign currency translation adjustments during fiscal 2004 of Y 203.3 billion compared with a losses of Y139.3 billion in the prior year. Related Party Transactions Toyota does not have any significant related party transactions other than transactions with affiliated companies in the ordinary course of business as described in note 12 to the consolidated financial statements. Legislation Regarding End-of-Life Vehicles In September 2000, the European Union approved a directive that requires member states to promulgate regulations implement the following by April 21, 2002: â€¢ manufacturers shall bear all or a significant part of the costs for taking back end-of-life vehicles put on the market after July 1, 2002 and dismantling and recycling those vehicles. Beginning January 1, 2007, this requirement will also be applicable to vehicles put on the market before July 1, 2002; â€¢ manufacturers may not use certain hazardous materials in vehicles sold after July 2003; â€¢ vehicles type-approved and put on the market from three years after the amendment of the directive on type-approval shall be re-usable and/or recyclable to a minimum of 85% by weight per vehicle and shall be re-usable and/or recoverable to a minimum of 95% by weight per vehicle; and 56 -------------------------------------------------------------------------------- Table of Contents â€¢ end-of-life vehicles must meet actual re-use of 80% and re-use as material or energy of 85%, respectively, of vehicle weight by 2006, rising respectively to 85% and 95% by 2015. See note 23 to the consolidated financial statements for further discussion. Recent Accounting Pronouncements in the United States In November 2004, FASB issued FAS No. 151, Inventory Costs - an amendment of ARB No. 43, Chapter 4 ('FAS 151'). FAS 151 amends the guidance in ARB No. 43, Chapter 4, 'Inventory Pricing,' to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that '. . . under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. . . .'. FAS 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of 'so abnormal.' In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. FAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management does not expect this statement to have a material impact on Toyota's consolidated financial statements. In December 2004, the Financial Accounting Standards Board ('FASB') issued FAS No. 123(R), Share-Based Payment (revised 2004) ('FAS 123(R)'). FAS 123(R) is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation (' FAS 123'), supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees ('APB 25'), and its related implementation guidance. FAS 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. FAS 123(R) also requires a public entity to initially measure the cost of employee services received in exchange for an award of liability instruments based on its current fair value; the fair value of that award will be remeasured subsequently at each reporting date through the settlement date. Changes in fair value will be recognized as compensation cost over that period. Although Toyota is required to implement the standard as of the beginning of the first interim or annual period that begins after June 15, 2005 under Statement No. 123(R), the Securities and Exchange Commission has amended the compliance date and Toyota is required to adopt the Standard at the beginning of its next fiscal year, instead of the next reporting period, that begins after June 15, 2005. Management does not expect this statement to have a material impact on Toyota's consolidated financial statements. In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29 ('FAS 153'). The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion; however, included certain exceptions to that principle. FAS 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. 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. FAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Management does not expect this statement to have a material impact on Toyota's consolidated financial statements. In March 2005, FASB issued the FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143 ('FIN 47'). This Interpretation clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 requires a company to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the 57 -------------------------------------------------------------------------------- Table of Contents conditional asset retirement obligation should be recognized when incurred. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. Management does not expect this statement to have a material impact on Toyota's consolidated financial statements. In May 2005, FASB issued FAS No. 154, Accounting Changes and Error Corrections - a replacement of APB No. 20 and FAS No. 3 ('FAS 154'). FAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. FAS 154 applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement when the pronouncement does not include specific transition provisions. APB Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 requires retrospective application to prior periods' financial statements of changes in accounting principle. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The impact of applying FAS 154 will depend on the change, if any, that Toyota may identify and record in future period. Critical Accounting Estimates The consolidated financial statements of Toyota are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Toyota believes that of its significant accounting policies, the following may involve a higher degree of judgments, estimates and complexity: Product Warranty Toyota generally warrants its products against certain manufacturing and other defects. Product warranties are provided for specific periods of time and/or usage of the product and vary depending upon the nature of the product, the geographic location of the sale and other factors. All product warranties are consistent with commercial practices. Toyota provides a provision for estimated product warranty costs as a component of cost of sales at the time the related sale is recognized. The accrued warranty costs represent management's best estimate at the time of sale of the total costs that Toyota will incur to repair or replace product parts that fail while still under warranty. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on repair costs. The amount of warranty costs accrued also contains an estimate of warranty claim recoveries to be received from suppliers. The foregoing evaluations are inherently uncertain, as they require material estimates and some products' warranties extend for several years. Consequently, actual warranty costs will differ from the estimated amounts and could require additional warranty provisions. If these factors require a significant increase in Toyota's accrued estimated warranty costs, it would negatively affect future operating results of the automotive operations. Allowance for Doubtful Accounts and Credit Losses Natures of estimates and assumptions Sales financing and finance lease receivables consist of retail installment sales contracts secured by passenger cars and commercial vehicles. Collectibility risks include consumer and dealer insolvencies and insufficient collateral values (less costs to sell) to realize the full carrying values of these receivables. As a matter of policy, Toyota maintains an allowance for doubtful accounts and credit losses representing Toyota management's estimate of the amount of asset impairment in the portfolios of finance, trade and other receivables. Toyota determines the allowance for doubtful accounts and credit losses based on a systematic, ongoing review and evaluation performed as part of the credit-risk evaluation process, historical loss experience, the size and composition of the portfolios, current economic events and conditions, the estimated fair value and 58 -------------------------------------------------------------------------------- Table of Contents adequacy of collateral and other pertinent factors. This evaluation is inherently judgmental and requires material estimates, including the amounts and timing of future cash flows expected to be received, which may be susceptible to significant change. Although management considers the allowance for doubtful accounts and credit losses to be adequate based on information currently available, additional provisions may be necessary due to (i) changes in management estimates and assumptions about asset impairments, (ii) information that indicates changes in expected future cash flows, or (iii) changes in economic and other events and conditions. To the extent that sales incentives remain an integral part of sales promotion with the effect of reducing new vehicle prices, resale prices of used vehicles and, correspondingly, the collateral value of Toyota's sales financing and finance lease receivables could experience further downward pressure. If these factors require a significant increase in Toyota's allowance for doubtful accounts and credit losses, it could negatively affect future operating results of the financial services operations. The level of credit losses, which impacts larger on Toyota's results of operations, is influenced primarily by two factors, which are frequency of occurrence and loss severity. For evaluation purposes, exposures to credit loss are segmented into the two primary categories of 'consumer' and 'dealer'. Toyota's consumer portfolio consists of smaller balance homogenous retail finance receivables and lease earning assets. Dealer portfolio consists of wholesale and other dealer financing. The overall allowance for credit losses is evaluated at least quarterly, considering a variety of assumptions and factors to determine whether reserves are considered adequate to cover probable losses. Sensitivity analysis The level of credit losses, which could significantly impact Toyota's results of operations, is influenced primarily by two factors: frequency of occurrence and loss severity. The overall allowance for credit losses is evaluated at least quarterly, considering a variety of assumptions and factors to determine whether reserves are considered adequate to cover probable losses. The following table illustrates the effect of an assumed change in expected loss severity, which we believe is one of the key critical estimates for determining the allowance for credit losses, assuming all other assumptions are held consistent. The table below represents the impact on the allowance for credit losses in Toyota's financial services operations as any change impacts most significantly on the financial services operations. Yen in millions Effect on the allowance for credit losses as of March 31, 2005 10 percent increase in expected loss severity Y 4,081 Investment in Operating Leases Natures of estimates and assumptions Vehicles on operating leases, where Toyota is the lessor, is valued at acquisition cost and depreciated over its estimated useful life using the straight-line method to its estimated residual value. Toyota utilizes industry published information and its own historical experience to determine estimated residual values for these vehicles. Toyota evaluates the recoverability of the carrying values of its leased vehicles for impairment when there are indications of declines in residual values, and if impaired, Toyota recognizes an allowance for its residual values. In addition, to the extent that sales incentives remain an integral part of sales promotion with the effect of reducing new vehicle prices, resale prices of used vehicles and, correspondingly, the fair value of Toyota's leased vehicles could be subject to downward pressure. If resale prices of used vehicles decline, future operating results of the financial services operations are likely to be adversely affected by incremental charges to reduce estimated residual values. Throughout the life of the lease, management performs periodic evaluations of estimated end-of-term market values to determine whether estimates used in the determination of the contractual residual value are still considered reasonable. Factors affecting the estimated residual value at lease maturity include, but are not limited to, new vehicle incentive programs, new vehicle pricing, used vehicle supply, projected vehicle return rates, and projected loss severity. The vehicle return rate represents the number of leased vehicles returned at contract maturity and sold by Toyota during the period as a percentage of the number of lease contracts that, as 59 -------------------------------------------------------------------------------- Table of Contents of their origination dates, were scheduled to mature in the same period. A higher rate of vehicle returns exposes Toyota to higher potential losses incurred at lease termination. Loss severity is the extent to which the end-of-term market value of a lease is less than its carrying value at lease end. Sensitivity analysis The following table illustrates the effect of an assumed change in the vehicle return rate, which we believe is one of the critical estimates, in determining the allowance for residual value, holding all other assumptions constant. The following table represents the impact on the allowance for residual values in Toyota's financial services operations as those changes impact most significantly on financing operations. Yen in millions Effect on the allowance for residual value as of March 31, 2005 5 percent increase in vehicle return rate Y 1,074 Impairment of Long-Lived Assets Toyota periodically reviews the carrying value of its long-lived assets held and used and assets to be disposed of, including goodwill and other intangible assets, when events and circumstances warrant such a review. This review is performed using estimates of future cash flows. If the carrying value of a long-lived asset is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. Management believes that the estimates of future cash flows and fair values are reasonable; however, changes in estimates of such cash flows and fair values would affect the evaluations and negatively affect future operating results of the automotive operations. Pension Costs and Obligations Natures of estimates and assumptions Pension costs and obligations are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, benefits earned, interest costs, expected rate of return on plan assets, mortality rates and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligations in future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect Toyota's pension costs and obligations. Sensitivity analysis The following table illustrates the effect of assumed changes in discount rates and the expected rate of return on plan assets, which we believe are critical estimates in determining pension costs and obligations, assuming all other assumptions are consistent. Yen in millions Effect on Effect on pre-tax PBO income as of for the March 31, year 2005 ending March 31, 2006 Discount rates 0.5% decrease Y (10,496 ) Y 128,713 0.5% increase 8,814 (110,883 ) Expected rate of return on plan assets 0.5% decrease Y (4,673 ) 0.5% increase 4,673 60 -------------------------------------------------------------------------------- Table of Contents Derivatives and Other Contracts at Fair Value Toyota uses derivatives in the normal course of business to manage its exposure to foreign currency exchange rates and interest rates. The accounting is complex and continues to evolve. In addition, there are the significant judgments and estimates involved in the estimating of fair value in the absence of quoted market values. These estimates are based upon valuation methodologies deemed appropriate in the circumstances; however, the use of different assumptions may have a material effect on the estimated fair value amounts. Marketable securities Toyota's accounting policy is to record a write-down of such investments to realizable value when a decline in fair value below the carrying value is other-than-temporary. In determining if a decline in value is other-than-temporary, Toyota considers the length of time and the extent to which the fair value has been less than the carrying value, the financial condition and prospects of the company and Toyota's ability and intent to retain its investment in the company for a period of time sufficient to allow for any anticipated recovery in market value. 5.B LIQUIDITY AND CAPITAL RESOURCES Historically, Toyota has funded its capital expenditures and research and development activities primarily through cash generated by operations. Toyota expects to sufficiently fund its capital expenditures and research and development activities in fiscal 2006 primarily through cash and cash equivalents on hand and increases in cash and cash equivalents from operating activities. See 'Information on the Company - Business Overview - Capital Expenditures and Divestitures' for information regarding Toyota's material capital expenditures and divestitures for fiscal 2003, 2004 and 2005 and information concerning Toyota's principal capital expenditures and divestitures currently in progress. Toyota funds its financing programs for customers and dealers, including loans and leasing programs, from both operating cash flows and borrowings by its finance subsidiaries. Toyota seeks to expand its ability to raise funds locally in markets throughout the world by expanding its network of finance subsidiaries. During fiscal 2005, Toyota changed its presentation of cash flows attributed to origination and collection activities of finance receivables relating to the sales of inventory in its consolidated statement of cash flows from investing activities to operating activities. This change in presentation was based on concerns raised by the staff of the Division of the Corporation Finance of the United States Securities and Exchange Commission. To conform the prior years' statements of cash flows to the new presentation adopted in fiscal 2005, Toyota reclassified similar amounts reported for these items in fiscal 2003 and 2004. 61 -------------------------------------------------------------------------------- Table of Contents The following table sets forth a reconciliation of Toyota's current year presentation of cash flows attributed to finance receivables compared to the presentation of cash flows reported in prior periods. Yen in millions For the years ended March 31, 2003 2004 Net cash provided by operating activities Y 2,085,047 Y 2,283,023 - As previously reported Amount reclassified from investing activities (144,959 ) (96,289 ) Net cash provided by operating activities Y 1,940,088 Y 2,186,734 - After reclassified Net cash used in investing activities Y (2,146,407 ) Y (2,312,784 ) - As previously reported Amount reclassified to operating activities 144,959 96,289 Net cash used in investing activities Y (2,001,448 ) Y (2,216,495 ) - After reclassified Net cash outflows from finance receivables relating to the sale of inventories reported in operating activities in the consolidated statement of cash flows for the year ended March 31, 2005 were Y55.9 billion. See note 4 and 7 to the consolidated financial statements. Net cash provided by operating activities was Y2,370.9 billion for fiscal 2005, compared with Y2,186.7 billion for the prior year. The increase in net cash provided by operating activities resulted primarily from increased operating cash flows attributed to the growth in business of the financial services operations. Net cash used in investing activities was Y3,061.1 billion for fiscal 2005, compared with Y2,216.4 billion for the prior year. The increase in net cash used in investing activities resulted primarily from the decrease in sales, redemptions and maturities of marketable securities and security investments and an increase in additions of equipment leased to others, which was partially offset by decrease in additions to finance receivables. Net cash provided by financing activities was Y419.3 billion for fiscal 2005, compared with Y242.2 billion for the prior year. The increase in net cash provided by financing activities resulted primarily from an increase in long-term debt and a decrease in purchases of common stock, which was partially offset by increased payments of short-term borrowings. Total capital expenditures for property, plant and equipment, excluding vehicles and equipment on operating leases, were Y1,068.2 billion during fiscal 2005, an increase of 13.0% over the Y945.8 billion in total capital expenditures for the prior year. The increase in capital expenditures resulted primarily from the impact of increased capital expenditures in domestic subsidiaries and overseas capital expenditures for IMV. Total expenditures for vehicles and equipment on operating leases were Y854.9 billion during fiscal 2005, an increase of 57.5% over the Y542.7 billion in expenditures in the prior year. The change resulted primarily from increased operating lease assets in finance subsidiaries in North America and Europe. Toyota expects investments in property, plant and equipment, excluding vehicles leased to others, to approximate Y1,250.0 billion during fiscal 2006. Toyota's expected capital expenditures include approximately Y770.0 billion in Japan, Y 220.0 billion in North America, Y110.0 billion in Europe and Y150.0 billion in all other areas, respectively. Based on currently available information, Toyota does not expect environmental matters to have a material impact on its financial position, results of operations, liquidity or cash flows during fiscal 2006. However, there 62 -------------------------------------------------------------------------------- Table of Contents exists a substantial amount of uncertainty with respect to Toyota's obligations under current and future environment regulations as described in 'Information on the Company - Business Overview - Governmental Regulations, Environment and Safety Standards'. Cash and cash equivalents were Y1,483.7 billion at March 31, 2005. Most of Toyota's cash and cash equivalents are held in Japanese yen and the U.S. dollars. In addition, time deposits were Y63.6 billion and marketable securities were Y543.1 billion at March 31, 2005. Liquid assets, which Toyota defines as cash and cash equivalents, time deposits, marketable debt securities and its investment in monetary trust funds, increased during fiscal 2005 by Y353.8 billion, or 10.2%, to Y3,810.0 billion. Trade accounts and notes receivable, net increased during fiscal 2005 by Y84.7 billion, or 5.5%, to Y1,616.3 billion, reflecting the impact of increased revenues and the impact of the change in foreign currency translation rates. Inventories increased during fiscal 2005 by Y223.4 billion, or 20.6%, to Y 1,306.7 billion, reflecting the impact of increased volumes and the impact of the change in foreign currency translation rates. Total finance receivables, net increased during fiscal 2005 by Y1,135.1 billion, or 19.4%, to Y6,987.0 billion. The change resulted from the increase in retail financings due to the increase in vehicle unit sales, the increase in wholesale and other dealer loans, including real estate loans and working capital financings provided to dealers and a decrease in securitizations of finance receivables in finance subsidiaries in North America. These increases were partially offset by the decrease in finance leases. As of March 31, 2005, finance receivables were geographically distributed as follows: in North America 64.0%, in Japan 15.7%, in Europe 10.3% and in all other markets 10.0%. Toyota maintains programs to sell finance receivables through special purpose entities and obtained proceeds from securitization transactions, net of purchased and retained interests totaling Y48.9 billion during fiscal 2005. Marketable securities and other securities investments, including those included in current assets, increased during fiscal 2005 by Y556.8 billion, or 20.7%, to Y3,247.2 billion, primarily reflecting the increase of U.S. treasury notes held by a manufacturing subsidiary in North America and Japanese government bonds held by the parent company. Property, plant and equipment increased during fiscal 2005 by Y440.9 billion, or 8.2%, reflecting an increase in capital expenditures and the impact of changes in foreign currency translation rates, which was partially offset by the depreciation charges during the year. Accounts payable increased during fiscal 2005 by Y147.4 billion, or 8.6%, reflecting the increased product volumes and the impact of changes in foreign currency translation rates. Accrued expenses increased during fiscal 2005 by Y156.1 billion, or 13.8%, reflecting the increase in expenses due to the expansion of the business. Income taxes payable increased during fiscal 2005 by Y40.3 billion, or 15.9%, principally as a result of the increase in taxable income especially in subsidiaries in North America and Asia. Toyota's total borrowings increased during fiscal 2005 by Y986.1 billion, or 13.0%. Toyota's short-term borrowings consist of loans with a weighted-average fixed interest rate of 1.58% and commercial paper with a weighted-average fixed interest rate of 2.81%. Short-term borrowings increased during fiscal 2005 by Y 192.8 billion, or 8.8%, to Y2,381.8 billion. Toyota's long-term debt consists of unsecured and secured loans, medium-term notes, unsecured notes and long-term capital lease obligations ranging from 0.01% to 27.00%, with maturity dates ranging from 2005 to 2035. Toyota's long-term debt also consists of notes payable related to securitized finance receivables structured as collateralized borrowings. The current portion of long-term debt increased 63 -------------------------------------------------------------------------------- Table of Contents during fiscal 2005 by Y25.7 billion, or 2.3%, to Y1,150.9 billion and the non-current portion increased by Y767.6 billion, or 18.1%, to Y5,014.9 billion. The increase in total borrowings reflects the expansion of the financial services operations. At March 31, 2005, approximately 38% of long-term debt was denominated in U.S. dollars, 27% in Japanese yen, 17% in euros and 18% in other currencies. Toyota hedges fixed rate exposure by entering into interest rate swaps. There are no material seasonal variations in Toyota's borrowings requirements. As of March 31, 2005, Toyota's total interest bearing debt was 94.5% of total shareholders' equity, compared to 92.5% as of March 31, 2004. Toyota's long-term debt was rated 'AAA' by Standard & Poor's Ratings Group, 'Aaa ' by Moody's Investors Services and 'AAA' by Rating and Investment Information, Inc. as of March 31, 2005. These ratings represent the highest long-term debt ratings published by each of the respective rating agencies. A credit rating is not a recommendation to buy, sell or hold securities. A credit rating may be subject to withdrawal or revision at any time. Each rating should be evaluated separately of any other rating. Toyota's treasury policy is to maintain controls on all exposures, to adhere to stringent counterparty credit standards, and to actively monitor marketplace exposures. Toyota centralized, and is pursuing global efficiency of, its financial services operations through Toyota Financial Services Corporation. The key element of Toyota's financial policy is maintaining a strong financial position that will allow Toyota to fund its research and development initiatives, capital expenditures and financing operations on a cost effective basis even if earnings experience short-term fluctuations. Toyota believes that it maintains sufficient liquidity for its present requirements and that by maintaining their high credit ratings, it will continue to be able to access funds from external sources in large amounts and at relatively low costs. Toyota's ability to maintain its high credit ratings is subject to a number of factors, some of which are not within Toyota's control. These factors include general economic conditions in Japan and the other major markets in which Toyota does business, as well as Toyota's successful implementation of its business strategy. Toyota's unfunded pension liabilities decreased during fiscal 2005 by Y325.2 billion, or 38.7% to Y516.0 billion. The unfunded pension liabilities relate primarily to the parent company and its Japanese subsidiaries. The unfunded amounts will be funded through future cash contributions by Toyota and its employees or in some cases will be funded on the retirement date of each covered employee. The unfunded pension liabilities decreased in fiscal 2005 compared to the prior year due to the transfer to the government of the substitutional portion of certain employee pension funds in some of Toyota's subsidiaries, cash contributions to the plans and the increase in the market value of assets of the plans. See note 19 to the consolidated financial statements. 5.C RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES Toyota's research and development activities focus on the environment, vehicle safety, information technology and product development. Toyota's environmental research and development activities focus on: â€¢ Developing light weight and more fuel-efficient engines and transmissions. These technologies include the direct injection four-stroke gasoline engine, the nitrous oxide storage reduction catalytic system and the common rail direct injection diesel engine. â€¢ Developing alternative fuel powering systems for commercial sale. This includes developing hybrid vehicles such as the Prius and fuel-cell vehicles. The next-generation Prius that Toyota introduced in September 2003 features a new hybrid system combining decreased environmental impact with increased power and performance. Toyota also began limited sales of a fuel cell hybrid vehicle in Japan and the United States in December 2002. In June 2005, Toyota's new fuel cell hybrid passenger vehicle became the first vehicle in Japan to acquire vehicle type certification under the Road Vehicles Act, as amended and enacted on March 31, 2005, by Japan's Ministry of Land, Infrastructure and Transport (MLIT). Other Toyota efforts in this area include the development of vehicles fueled by compressed natural gas and other alternative fuel vehicles. Toyota has formed a research and development alliance with General Motors Corporation to develop future power systems. 64 -------------------------------------------------------------------------------- Table of Contents â€¢ Recycling of vehicle parts through the development of recycling technologies. Work in this area includes developing uses for shredder residue, the recycling of nickel-metal hydride batteries and the development of vehicles constructed with a high proportion of recyclable parts. Toyota's work in the area of vehicle safety is focused on the development of technologies designed to prevent accidents in the first instance, as well as the development of technologies that protect passengers and reduce the damage on impact in the event of an accident. Safety technologies in development include: â€¢ research on protecting diverse passengers, including senior citizens, â€¢ autonomous driving support systems, including frontal crash-prevention support systems, and â€¢ data exchange driving-support systems using advanced communication technologies. To expand the frontiers of safety technology in automobiles, Toyota completed in 1995 its first prototype Advanced Safety Vehicle, the ASV-1. In 2000, Toyota created a successor prototype, the ASV-2. The ASV-2 incorporates emerging technologies, such as an autonomous safety support system that uses CCD stereo cameras to recognize obstacles in traffic lanes and an infrastructure-harmonized safety support system to warn the driver of pedestrian crossings. In 2002, Toyota conducted road testing of the ASV-3, a prototype based on further improved infrastructure-harmonized system. With the February 2003 introduction of the Harrier models in Japan, Toyota became the first car manufacturer to implement a pre-collision safety system in its automobiles. This advanced system consists of pre-collision sensors that use millimeter wave radar to detect an imminent crash, seat belts that tighten their hold on passengers during the early stage of crash detection and a brake assist system that utilizes power-assisted braking to minimize the speed on impact. In February 2004, Toyota introduced the pre-collision safety system for the first time in the United States by equipping the LS430 with the above features and suspension control features that control nose dives when apply the brakes. Toyota plans to further continue its focus on developing practical applications for its advanced safety technologies. Toyota's product development program uses a series of methods which are generally intended to promote timely and appropriate responses to changing market demand. These methods include: â€¢ reducing the number of vehicle platforms, â€¢ sharing parts and components among multiple vehicles, â€¢ shortening the time for development and production preparation by the simultaneous study of design and production engineering processes, and â€¢ using computers for production design and its evaluation. In September 2002, Toyota and Nissan Motor Co. entered into an agreement setting forth the basic terms of technical cooperation and other long-term projects involving hybrid systems between the parties. This agreement, which aims for a long-term business relationship of 10 years or longer, calls for Toyota to supply state-of-the-art hybrid system components to Nissan. In addition, with the aim of promoting technical cooperation, both companies agreed to exchange information on hybrid systems that both Toyota and Nissan are currently developing independently, and to discuss the joint development of related components. In March 2004, Toyota and Ford Motor Company announced that they have entered into licensing agreements for patents related to hybrid systems and emissions purification. Pursuant to the agreements, Toyota will license to Ford Motor Corporation patents related to hybrid system control technology. Further, both companies agreed to a cross-licensing arrangement of emission purification technology patents for lean-burn engines. Toyota's research and development expenditures were approximately Y755 billion in fiscal 2005, Y682 billion in fiscal 2004 and Y668 billion in fiscal 2003. Worldwide, approximately 28,000 employees are involved in Toyota's research and development activities. 65 -------------------------------------------------------------------------------- Table of Contents Toyota does not consider any one group of patents or licenses to be so important that their expiration or termination would materially affect Toyota's business. For a further discussion of Toyota's intellectual property, see 'Information on the Company - Business Overview - Intellectual Property'. 5.D TREND INFORMATION For a discussion of the trends that affect Toyota's business and operating results, see '- Operating Results' and '- Liquidity and Capital Resources'. 5.E OFF-BALANCE SHEET ARRANGEMENTS Securitization Funding Toyota uses its securitization program as part of its funding for its financial services operations. Toyota believes that the securitizations are an important element of its financial services operations as it provides a cost-effective funding source. Securitization of receivables allows Toyota to access a highly liquid and efficient capital market while providing Toyota with an alternative source of funding and investor diversification. See note 7 to the consolidated financial statements with respect to the impact on the balance sheet, income statement, and cash flows of these securitizations. Toyota's securitization program involves a two-step transaction. Toyota sells discrete pools of retail finance receivables to a wholly-owned, bankruptcy remote special purpose entity ('SPE'), which in turn transfers the receivables to a qualified special purpose entity ('QSPE' or 'securitization trust') in exchange for the proceeds from securities issued by the securitization trust. Once the receivables are transferred to the QSPE, the receivables are no longer assets of Toyota and, therefore, no longer appear in Toyota's consolidated balance sheet. These securities are secured by collections on the sold receivables and structured into senior and subordinated classes. The following flow chart diagrams a typical securitization transaction: Toyota's use of SPEs in securitizations is consistent with conventional practices in the securitization markets. The sale to the SPE isolates the sold receivables from other creditors of Toyota for the benefit of securitization investors and, assuming accounting requirements are satisfied, the sold receivables are accounted for as a sale. 66 -------------------------------------------------------------------------------- Table of Contents While Toyota retains subordinated interests, investors in securitizations have no recourse to Toyota, any cash reserve funds, or any amounts available or funded under the revolving liquidity notes discussed below. Toyota does not guarantee any securities issued by the securitization trust. Each SPE has a limited purpose and may only be used to purchase and sell the receivables. The individual securitization trusts have a limited duration and generally terminate when investors holding the asset-backed securities have been paid all amounts owed to them. The SPE retains an interest in the securitization trust. The retained interest includes subordinated securities issued by the securitization trust and interest-only strips representing the right to receive any excess interest. The retained interests are subordinated and serve as credit enhancements for the more senior securities issued by the securitization trust. The retained interests are held by the SPE as restricted assets and are not available to satisfy any obligations of Toyota. If forecasted future cash flows result in an other-than-temporary decline in the fair value of the retained interests, then an impairment loss is recognized to the extent that the fair value is less than the carrying amount. Such losses would be included in the consolidated statement of income. These retained interests as well as senior securities purchased by Toyota are reflected in the consolidated balance sheet for accounting purposes. Various other forms of credit enhancements are provided to reduce the risk of loss for senior classes of securities. These credit enhancements may include the following: Cash reserve funds or restricted cash A portion of the proceeds from the sale of asset-backed securities may be held by the securitization trust in segregated reserve funds and may be used to pay principal and interest to investors if collections on the sold receivables are insufficient. In the event a trust experiences charge-offs or delinquencies above specified levels, additional excess amounts from collections on receivables held by the securitization trusts will be added to such reserve funds. Revolving liquidity notes In certain securitization structures, revolving liquidity notes ('RLN') are used in lieu of deposits to a cash reserve fund. The securitization trust may draw upon the RLN to cover any shortfall in interest and principal payments to investors. Toyota funds any draws, and the terms of the RLN obligate the securitization trust to repay amounts drawn plus accrued interest. Repayments of principal and interest due under the RLN are subordinated to principal and interest payments on the asset-backed securities and, in some circumstances, to deposits into a reserve account. If collections are insufficient to repay amounts outstanding under a RLN, Toyota will recognize a loss for the outstanding amounts. Toyota must fund the entire amount available under the RLN if Toyota's short-term unsecured debt rating is downgraded below P-1 or A-1 by Moody's or S&P, respectively. Management believes the likelihood of Toyota incurring such losses or Toyota's short-term credit rating being downgraded is remote. There were no outstanding amounts drawn on the RLN's at March 31, 2004 and 2005. The RLN had no material fair value as of March 31, 2004 and 2005. Toyota has not recognized a liability for the RLN because it does not expect to be required to fund any amounts under the RLN. Toyota may enter into a swap agreement with the securitization trust under which the securitization trust is obligated to pay Toyota a fixed rate of interest on payment dates in exchange for receiving amounts equal to the floating rate of interest payable on the asset backed securities. This arrangement enables the securitization trust to issue securities bearing interest on a basis different from that of the receivables held. Toyota continues to service the sold receivables for a servicing fee. Toyota's servicing duties include collecting payments on receivables and submitting them to the trustee for distribution to the certificate holders. While servicing the sold receivables for the securitization trusts, Toyota applies the same servicing policies and procedures that are applied to the owned receivables and maintains a normal relationship with the financing customers. Other significant provisions relating to securitizations are described below. 67 -------------------------------------------------------------------------------- Table of Contents Receivable Repurchase Obligations Toyota makes certain representations and warranties to the SPE, and the SPE makes corresponding representations and warranties to the securitization trust, relating to receivables sold in a securitization. Toyota and the SPE may be required to repurchase any receivables in the event of a breach of a representation and warranty relating to the receivable that materially and adversely affects the interest of the SPE, or securitization trust, as applicable. In addition, Toyota, as servicer of the receivables, may be required to repurchase any receivable in the event of a breach of a covenant by the servicer with respect to the receivable that materially and adversely affects the interest of the securitization trust or of an extension or modification of a receivable as to which Toyota, as servicer, does not commit to make advances to fund reductions in interest payments. The repurchase price is generally the outstanding principal balance of the receivable and accrued interest. These provisions are customary for securitization transactions. Advancing Requirements As the servicer, Toyota is required to advance certain shortfalls in obligor payments to the securitization trust to the extent it believes the advance will be recovered from future collections of that receivable. Generally, the securitization trust is required to reimburse Toyota for these advances from collections on all receivables before making other required payments. These provisions are customary for securitization transactions. Lending Commitments Credit facilities with credit card holders Toyota's financial services operation issues credit cards to customers. As customary for credit card businesses, Toyota maintains credit facilities with holders of credit cards issued by Toyota. These facilities are used upon each holders' requests up to the limits established on an individual holder basis. Although loans made to customers through this facility are not secured, for the purposes of minimizing credit risks and of appropriately establishing credit limits for each individual credit card holder, Toyota employs its own risk management policy which includes an analysis of information provided by financial institutions in alliance with Toyota. Toyota periodically reviews and revises, as appropriate, these credit limits. Outstanding credit facilities with credit card holders were Y1,885.8 billion as of March 31, 2005. Credit facilities with dealers Toyota's financial services operation maintains credit facilities with dealers. These credit facilities may be used for business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. These loans are typically collateralized with liens on real estate, vehicle inventory, and/or other dealership assets, as appropriate. Toyota obtains a personal guarantee from the dealer or corporate guarantee from the dealership when deemed prudent. Although the loans are typically collateralized or guaranteed, the value of the underlying collateral or guarantees may not be sufficient to cover Toyota's exposure under such agreements. Toyota prices the credit facilities according to the risks assumed in entering into the credit facility. Toyota's financial services operation also provides financing to various multi-franchise dealer organizations, referred to as dealer groups, often as part of a lending consortium, for wholesale inventory financing, business acquisitions, facilities refurbishment, real estate purchases, and working capital requirements. Toyota's outstanding credit facilities with dealers totaled Y1,169.5 billion as of March 31, 2005. Guarantees Toyota enters into certain guarantee contracts with its dealers to guarantee customers' payments of their installment payables that arise from installment contracts between customers and Toyota dealers, as and when requested by Toyota dealers. Guarantee periods are set to match the maturity of installment payments, and at March 31, 2005 range from one month to 35 years; however, they are generally shorter than the useful lives of products sold. Toyota is required to execute its guarantee primarily when customers are unable to make required payments. 68 -------------------------------------------------------------------------------- Table of Contents The maximum potential amount of future payments as of March 31, 2005 is Y1,139.6 billion. Liabilities for these guarantees of Y3.7 billion have been provided as of March 31, 2005. Under these guarantee contracts, Toyota is entitled to recover any amounts paid by it from the customers whose obligations it guaranteed. 5.F TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS For information regarding debt obligations, capital lease obligations, operating leases, and other obligations, including amounts maturing in each of the next five years, see notes 13, 22 and 23 to the consolidated financial statements. In addition, as part of Toyota's normal business practices, Toyota enters into long-term arrangements with suppliers for purchases of certain raw materials, components and services. These arrangements may contain fixed/minimum quantity purchase requirements. Toyota enters into such arrangements to facilitate an adequate supply of these materials and services. The following tables summarize Toyota's contractual obligations and commercial commitments as of March 31, 2005: Yen in millions Payments Due by Period Total Less than 1 to 3 3 to 5 5 years 1 year and years years after Contractual Obligations: Short-term borrowings (note 13) Loans Y 789,801 Y 789,801 Commercial paper 1,592,026 1,592,026 Long-term debt * (note 13) 6,094,565 1,133,876 Y 2,486,313 Y 1,546,951 Y 927,425 Capital lease obligations (note 13) 71,280 17,044 24,988 9,493 19,755 Non-cancelable operating lease obligations (note 43,151 8,649 12,010 7,837 14,655 22) Commitments for the purchase of property, plant 87,617 80,026 7,591 - - and other assets (note 23) Total Y 8,678,440 Y 3,621,422 Y 2,530,902 Y 1,564,281 Y 961,835 -------- * 'Long-term debt' represents future principal payments. Toyota expects to contribute Y83,862 million to its pension plan in the year ending March 31, 2006. Yen in millions Amount of Commitment Expiration Per Period Total Less than 1 to 3 3 to 5 5 years Amounts and Committed 1 year years years after Commercial Commitments: Maximum potential exposure to guarantees given in Y 1,139,638 Y 372,904 Y 515,551 Y 196,283 Y 54,900 the ordinary course of business (note 23) Total Commercial Commitments Y 1,139,638 Y 372,904 Y 515,551 Y 196,283 Y 54,900 5.G SAFE HARBOR All information that is not historical in nature disclosed under 'Item 5. Operating and Financial Review and Prospects - Off-Balance Sheet Arrangements' and '- Tabular Disclosure of Contractual Obligations' is deemed to be a forward-looking statement. See 'Cautionary Statement with Respect to Forward-Looking Statements' for additional information. 69 -------------------------------------------------------------------------------- Table of Contents ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 6.A DIRECTORS AND SENIOR MANAGEMENT In June 2003, Toyota implemented a comprehensive reorganization of its senior management structure. As part of this reorganization, Toyota introduced a streamlined board of directors and established the new position of non-board managing officer. At the June 2005 general meeting of shareholders, 26 directors were appointed to serve on the board of directors. Senior Managing Directors not only serve as members of the board to participate in the management of Toyota but also serve as the highest authorities in their respective areas of supervision and oversee the daily operations of specific fields/divisions in conjunction with non-board managing officers. This allows Senior Managing Directors to serve as a conduit between management and daily operations. The 48 non-board managing officers generally have responsibility for Toyota's daily operations in specific fields/divisions and report to the designated Senior Managing Director, and are appointed for one-year terms. Toyota believes that this new management system has enhanced its global competitiveness by promoting timely, hands-on decision-making for day-to-day operational matters. Toyota has seven corporate auditors, four of whom are outside corporate auditors. Name Age Title Date First --- -- --- Elected to Board or as Auditor ----------- Hiroshi Okuda 72 Chairman of the Board July 1982 Fujio Cho 68 Vice Chairman of the Board September 1988 Katsuhiro Nakagawa 63 Vice Chairman of the Board June 2001 Katsuaki Watanabe 63 President, Member of the Board September 1992 Tokuichi Uranishi 63 Executive Vice President, Member of the Board June 1996 Kazuo Okamoto 61 Executive Vice President, Member of the Board June 1996 Kyoji Sasazu 61 Executive Vice President, Member of the Board June 1997 Mitsuo Kinoshita 59 Executive Vice President, Member of the Board June 1997 Yoshimi Inaba 59 Executive Vice President, Member of the Board June 1997 Takeshi Uchiyamada 58 Executive Vice President, Member of the Board June 1998 Masatami Takimoto 59 Executive Vice President, Member of the Board June 1999 Akio Toyoda 49 Executive Vice President, Member of the Board June 2000 Tetsuo Hattori 58 Senior Managing Director, Member of the Board June 1999 Yukitoshi Funo 58 Senior Managing Director, Member of the Board June 2000 Takeshi Suzuki 57 Senior Managing Director, Member of the Board June 2000 Atsushi Niimi 57 Senior Managing Director, Member of the Board June 2000 Hajime Wakayama 59 Senior Managing Director, Member of the Board June 2001 Hiroshi Takada 58 Senior Managing Director, Member of the Board June 2001 Teiji Tachibana 58 Senior Managing Director, Member of the Board June 2001 Shinichi Sasaki 58 Senior Managing Director, Member of the Board June 2001 Shin Kanada 57 Senior Managing Director, Member of the Board June 2001 Akira Okabe 57 Senior Managing Director, Member of the Board June 2001 Yoshio Shirai 57 Senior Managing Director, Member of the Board June 2001 Yoichiro Ichimaru 56 Senior Managing Director, Member of the Board June 2001 Shoji Ikawa 55 Senior Managing Director, Member of the Board June 2001 Shoichiro Toyoda 80 Honorary Chairman, Member of the Board July 1952 Hideaki Miyahara 62 Corporate Auditor June 2000 Yoshiro Hayashi 56 Corporate Auditor June 2003 Chiaki Yamaguchi 55 Corporate Auditor June 2003 Yasutaka Okamura 76 Corporate Auditor June 1997 Hiromu Okabe 68 Corporate Auditor June 2002 Yoichi Kaya 71 Corporate Auditor June 2003 Tadashi Ishikawa 63 Corporate Auditor June 2003 The term of each director listed above expires in June 2006. 70 -------------------------------------------------------------------------------- Table of Contents Biographies Hiroshi Okuda was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1982 and as has served the Chairman of the Board since 1999. Mr. Okuda served as the President, Member of the Board of Toyota from 1995 to 1999. Mr. Okuda also serves as a Director of KDDI Corporation. Mr. Okuda joined Toyota in 1955. Fujio Cho was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1988 and has served as the Vice Chairman of the Board since 2005. Mr. Cho served as the President, Member of the Board of Toyota from 1999 to 2005, an Executive Vice President, Member of the Board from 1998 to 1999, and as the President of Toyota Motor Manufacturing, U.S.A., Inc. from 1988 to 1994. Mr. Cho also serves as a Director of Aioi Insurance Co., Ltd and as a Director of Central Japan Railway Company. Mr. Cho joined Toyota in 1960. Katsuhiro Nakagawa was appointed as a Managing Director, Member of the Board of Toyota Motor Corporation in 2001 and has served as the Vice Chairman of the Board since 2004. Mr. Nakagawa served as an Executive Vice President, Member of the Board between 2003 and 2004. Mr. Nakagawa served as the Executive Advisor of The Tokio Marine and Fire Insurance Co., Ltd. between 1998 and 2001. Mr. Nakagawa was the Vice Minister for International Affairs at the former Japanese Ministry of International Trade and Industry before joining The Tokio Marine and Fire Insurance Co., Ltd. Mr. Nakagawa joined Toyota in 2001. Katsuaki Watanabe was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1992 and has served as the President, Member of the Board since 2005. Mr. Watanabe also serves as a Director of Mitsubishi Securities Co., Ltd. Mr. Watanabe joined Toyota in 1964. Tokuichi Uranishi was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1996 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Uranishi has also served as the President of Toyota Motor Europe since 2004. Mr. Uranishi joined Toyota in 1966. Kazuo Okamoto was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1996 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Okamoto also serves as a Director of Toyota Boshoku Corporation. Mr. Okamoto joined Toyota in 1967. Kyoji Sasazu was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1997 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Sasazu joined Toyota in 1967. Mitsuo Kinoshita was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1997 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Kinoshita also serves as a Vice Chairman of Gamagori Marine Development Co., Ltd. Mr. Kinoshita joined Toyota in 1968. Yoshimi Inaba was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1997 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Inaba served as the President of Toyota Motor Sales, U.S.A., Inc. between 1999 and 2003. Mr. Inaba joined Toyota in 1968. Takeshi Uchiyamada was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1998 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Uchiyamada also serves as a Director of Koyo Seiko Co., Ltd. Mr. Uchiyamada joined Toyota in 1969. Masatami Takimoto was appointed as a Director, Member of the Board of Toyota Motor Corporation in 1999 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Takimoto joined Toyota in 1970. Akio Toyoda was appointed as a Director, Member of the Board of Toyota Motor Corporation in 2000 and has served as an Executive Vice President, Member of the Board since 2005. Mr. Toyoda also serves as the Chairman of Toyota FAW (Tianjin) Dies Co., Ltd and as a Director of New United Motor Manufacturing, Inc. Mr. Toyoda joined Toyota in 1984. 71 -------------------------------------------------------------------------------- Table of Contents Tetsuo Hattori has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2004. Mr. Hattori has also served as the Chief Vehicle Engineering Officer of Toyota since 2004 and as the Chief Quality Officer since 2005. Mr. Hattori served as a Director, Member of the Board from 1999 to 2003 and as a Managing Officer from 2003 to 2004. Mr. Hattori joined Toyota in 1971. Yukitoshi Funo has served as a Senior Managing Director, Member of the Board since 2005. Mr. Funo has also served as the Chief Americas Operations Officer since 2005 and as the President of Toyota Motor Sales, U.S.A., Inc. since 2003. Mr. Funo served as a Director, Member of the Board from 2000 to 2003, as a Managing Officer from 2003 to 2004 and as a Director from 2004 to 2005. Mr. Funo joined Toyota in 1970. Takeshi Suzuki has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2004. Mr. Suzuki has also served as the Chief Finance and Accounting Officer since 2004 and as the Chief Information Systems Officer since 2005. Mr. Suzuki served as a Director, Member of the Board from 2000 to 2003 and as a Managing Officer from 2003 to 2004. Mr. Suzuki joined Toyota in 1970. Atsushi Niimi has served as a Senior Managing Director, Member of the Board since 2005. Mr. Niimi has served as the Chief Production Control & Logistics Officer and as the Chief Manufacturing Officer since 2005. Mr. Niimi has also served as the President of Toyota Motor Manufacturing North America, Inc. since 2002. Mr. Niimi served as a Director, Member of the Board from 2000 to 2003, as a Managing Officer from 2003 to 2004 and as a Director from 2004 to 2005. Mr. Niimi joined Toyota in 1971. Hajime Wakayama has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Wakayama has also served as the Chief Business Development Officer and as the Chief Purchasing Officer since 2005. Mr. Wakayama served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Wakayama joined Toyota in 1969. Hiroshi Takada has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Takada has also served as the Chief Overseas Planning Officer since 2005. Mr. Takada served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Takada joined Toyota in 1969. Teiji Tachibana has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Tachibana has also served as the Chief General Administration & Human Resources Officer and as the Chief Housing (Housing Company) Officer since 2005. Mr. Tachibana served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Tachibana joined Toyota in 1969. Shinichi Sasaki has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Sasaki served as a Director, Member of the Board from 2000 to 2003 and as a Managing Officer from 2003 to 2004. Mr. Sasaki has also served as the President of Toyota Motor Engineering & Manufacturing Europe S.A./N.V. Mr. Sasaki joined Toyota in 1970. Shin Kanada has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Kanada has also served as the Chief Government & Public Affairs Officer since 2005. Mr. Kanada served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Kanada joined Toyota in 1970. Akira Okabe has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Okabe has also served as the Chief Asia, Oceania & Middle East Operations Officer since 2005. Mr. Okabe served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Okabe joined Toyota in 1971. 72 -------------------------------------------------------------------------------- Table of Contents Yoshio Shirai has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Shirai has also served as the Chief Technical Administration Officer and as the Chief Product Development Officer since 2005. Mr. Shirai served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Shirai joined Toyota in 1973. Yoichiro Ichimaru has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Ichimaru has also served as the Chief Domestic Sales Operations Officer and as the Chief Customer Service Operations Officer since 2005. Mr. Ichimaru served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Ichimaru joined Toyota in 1971. Shoji Ikawa has served as a Senior Managing Director, Member of the Board of Toyota Motor Corporation since 2005. Mr. Suzuki has also served as the Chief Production Engineering Officer since 2005. Mr. Ikawa served as a Director, Member of the Board from 2001 to 2003 and as a Managing Officer from 2003 to 2005. Mr. Ikawa joined Toyota in 1975. Shoichiro Toyoda has served as a Director, Member of the Board of Toyota Motor Corporation since 1952. Dr. Toyoda is currently the Honorary Chairman of the Board of Toyota Motor Corporation. Dr. Toyoda joined Toyota in 1952. Hideaki Miyahara has served as a Corporate Auditor of Toyota Motor Corporation since 2000. Mr. Miyahara served as a Director, Member of the Board of Toyota from 1996 to 1999 and as a Managing Director, Member of the Board from 1999 to 2000. Mr. Miyahara joined Toyota in 1965. Yoshiro Hayashi has served as a Corporate Auditor of Toyota Motor Corporation since 2003. Mr. Hayashi also served as the General Manager of Toyota's TQM Promotion Division from 1999 to 2003. Mr. Hayashi joined Toyota in 1974. Chiaki Yamaguchi has served as a Corporate Auditor of Toyota Motor Corporation since 2003. Mr. Yamaguchi also served as the Senior Managing Director of Toyota Finance Corporation from 2001 to 2003. Mr. Yamaguchi joined Toyota in 1972. Yasutaka Okamura has served as a Corporate Auditor of Toyota Motor Corporation since 1997. Mr. Okamura is the President of International Civil and Commercial Law Centre Foundation. Mr. Okamura has been registered as a practicing lawyer since 1994. Hiromu Okabe has served as a Corporate Auditor of Toyota Motor Corporation since 2002. Mr. Okabe is the Chairman of the Board of Denso Corporation. Yoichi Kaya has served as a Corporate Auditor of Toyota Motor Corporation since 2003. Mr. Kaya is the Assistant Director of the Research Institute of Innovative Technology for the Earth. Tadashi Ishikawa has served as a Corporate Auditor of Toyota Motor Corporation since 2003. Mr. Ishikawa is the Chairman of Toyota Industries Corporation. Akio Toyoda is Shoichiro Toyoda's son. There are no other family relationships between directors and/or corporate auditors. None of the persons listed above was selected as a director, corporate auditor or member of senior management pursuant to an arrangement or understanding with Toyota's major shareholders, customers, suppliers or others. 73 -------------------------------------------------------------------------------- Table of Contents 6.B COMPENSATION OF DIRECTORS AND CORPORATE AUDITORS The aggregate amount of remuneration, including bonuses but excluding stock options, paid to all directors and corporate auditors as a group by Toyota for services in all capacities during fiscal 2005 was approximately Y1,997 million. Directors and corporate auditors of Toyota Motor Corporation receive year-end bonuses, the aggregate amount of which is approved at Toyota Motor Corporation's annual general meeting of shareholders and is based on Toyota Motor Corporation's financial performance for the fiscal year. The amounts of the bonuses paid to individual directors and corporate auditors are then determined at a meeting of Toyota Motor Corporation's board of directors and the meeting of corporate auditors. Toyota Motor Corporation also granted to its directors 4,600 stock acquisition rights to purchase up to 460,000 shares of common stock during fiscal 2005 under its stock option plan. For a detailed description of the stock options and the stock option plan, see '- Share Ownership'. In accordance with customary Japanese business practice, when a director or corporate auditor of Toyota Motor Corporation retires, a proposal to pay a lump sum retirement allowance is submitted to a general meeting of shareholders for approval. The amount of the retirement allowance for a director or corporate auditor generally reflects one's position at the time of retirement, the length of one's service as a director or corporate auditor and one's contribution to Toyota Motor Corporation's performance. No reserves are accumulated for payment of these allowances. During fiscal 2005, Toyota paid retirement allowances aggregating approximately Y1,049 million to retiring directors and corporate auditors. 6.C BOARD PRACTICES Toyota's articles of incorporation provide for a board of directors of not more than 30 members and for not more than seven corporate auditors. Shareholders elect the directors and corporate auditors at general meetings of shareholders. The normal term of office of a director is one year and of a corporate auditor is four years. Directors and corporate auditors may serve any number of consecutive terms. The board of directors may elect one Chairman of the Board, one President and one or more Vice Chairmen of the Board, Executive Vice Presidents and Senior Managing Directors. The board of directors elects, pursuant to its resolutions, one or more Representative Directors. Each Representative Director represents Toyota generally in the conduct of its affairs. The board of directors has the ultimate responsibility for the administration of Toyota's affairs. None of Toyota's directors is party to a service contract with Toyota or any of its subsidiaries that provides for benefits upon termination of employment. Under Japan's Commercial Code, and the Law concerning Exceptional Measures to the Commercial Code with respect to Auditing, etc. of Joint Stock Corporations (the 'Special Exception Law'), Toyota must have at least three corporate auditors. At least one must be a person who has not been a Director, executive officer, general manager or employee of Toyota or any of its subsidiaries during the five-year period prior to his or her election as a corporate auditor. After the conclusion of the ordinary general meeting of shareholders to be held in June 2006, at least half of the corporate auditors will be required to be persons who have not been a Director, executive officer, general manager of employee of Toyota or any of its subsidiaries at any time prior to their election as corporate auditors. The corporate auditors may not at the same time be directors, executive officers, general managers or employees of Toyota or any of its subsidiaries. Together, these corporate auditors form a board of corporate auditors. The corporate auditors have the duty to examine the financial statements and business reports which are submitted by the board of directors to the general meeting of shareholders. The corporate auditors also supervise the administration of Toyota's affairs by the directors. Corporate auditors are not required to be, and Toyota's corporate auditors are not, certified public accountants. They are required to participate in meetings of the board of directors but are not entitled to vote. Toyota does not have a remuneration committee. 74 -------------------------------------------------------------------------------- Table of Contents Significant Differences in Corporate Governance Practices between Toyota and U.S. Companies Listed on the NYSE Pursuant to home country practices exemptions granted by the New York Stock Exchange (the 'NYSE'), Toyota is permitted to follow certain corporate governance practices complying with Japanese laws, regulations and stock exchange rules in lieu of NYSE's listing standards. The Securities and Exchange Commission (the 'SEC') approved changes to the NYSE's listing standards related to corporate governance practices of listed companies (the 'NYSE Corporate Governance Rules') in November 2003, as further amended in November 2004. Toyota is exempt from the approved changes, except for requirements that (a) Toyota's board of corporate auditors satisfies the requirements of Rule 10A-3 under the Securities Exchange Act of 1934, as amended (the 'Exchange Act'), (b) Toyota must disclose significant differences in its corporate governance practices as compared to those followed by domestic companies under the NYSE listing standards, (c) Toyota's principal executive officer must notify the NYSE of material non-compliance with (a) and (b), and (d) Toyota must submit annual and interim written affirmations to the NYSE. Toyota's corporate governance practices and those followed by domestic companies under the NYSE Corporate Governance Rules have the following significant differences: 1. Directors. Toyota currently does not have any directors who will be deemed as an 'independent director' as required under the NYSE Corporate Governance Rules for U.S. listed companies. Unlike the NYSE Corporate Governance Rules, the Commercial Code of Japan (the 'Code') and the Law concerning Exceptional Measures to the Commercial Code with respect to Auditing, etc. of Joint Stock Corporations (the 'Special Exception Law') do not require Japanese companies with a board of corporate auditors such as Toyota to have any independent directors on its board of directors. While the NYSE Corporate Governance Rules require that the non-management directors of each listed company meet at regularly scheduled executive sessions without management, Toyota currently has no non-management director on its board of directors. Unlike the NYSE Corporate Governance Rules, the Code and the Special Exception Law do not require, and accordingly Toyota does not have, an internal corporate organ or committee comprised solely of independent directors. 2. Committees. Under the Code and the Special Exception Law, Toyota has elected to structure its corporate governance system as a company with corporate auditors, who are under a statutory duty to monitor, review and report on the management of the affairs of Toyota. Toyota, as with other Japanese companies with a board of corporate auditors, but unlike U.S. listed companies subject to the NYSE Corporate Governance Rules, does not have specified committees, including those that are responsible for director nomination, corporate governance and executive compensation. Pursuant to the Code, Toyota's board of directors nominates and submits a proposal for the appointment of directors for shareholder approval. The shareholders vote on such nomination at the general meeting of shareholders. The Code requires that the respective total amount of remuneration to be paid to all directors and all corporate auditors must be determined by a resolution of the general meeting of shareholders, unless their remuneration is provided for in the Articles of Incorporation. The distribution of remuneration among each director is broadly delegated to the board of directors and the distribution of remuneration among each corporate auditor is determined by consultation among the corporate auditors. 3. Audit Committee. Toyota plans to avail itself of paragraph (c)(3) of Rule 10A-3 of the Exchange Act, which provides a general exemption from the audit committee requirements to a foreign private issuer with a board of corporate auditors, subject to certain requirements which continue to be applicable under Rule 10A-3. Pursuant to the requirements of the Code and the Special Exception Law, Toyota elects its corporate auditors through a resolution adopted at a general meeting of shareholders. Toyota currently has seven corporate auditors, which exceeds the minimum number of corporate auditors required pursuant to the Code and the Special Exception Law. Unlike the NYSE Corporate Governance Rules, the Code and the Special Exception Law, among others, do not require corporate auditors to establish an expertise in accounting nor are they required to present other special knowledge and experience. Under the Special Exception Law, the board of corporate auditors may determine the 75 -------------------------------------------------------------------------------- Table of Contents auditing policies and methods of investigating the conditions of Toyota's business and assets, and may resolve other matters concerning the execution of the corporate auditor's duties. The board of corporate auditors also prepares auditors' reports and gives consent to proposals of the nomination of corporate auditors and accounting auditors. Toyota currently has four outside corporate auditors under the Special Exception Law. Under the Special Exception Law, at least one of the corporate auditors of Toyota must be an 'outside' corporate auditor, which is such person who was not a director, executive officer, manager, or employee of Toyota or its subsidiaries during the five-year period prior to such corporate auditor's election. Such qualifications for an 'outside' corporate auditor are different from the audit committee independence requirement under the NYSE Corporate Governance Rules. 4. Corporate Governance Guidelines. Unlike the NYSE Corporate Governance Rules, Toyota is not required to adopt or disclose corporate governance guidelines under Japanese laws and regulations, including the Code and the Securities and Exchange Law of Japan or stock exchange rules. However, Toyota is required to disclose policies and the present status of its corporate governance in its annual securities report and certain other disclosure documents in accordance with the regulations under the Japanese Securities and Exchange Law and stock exchange rules in respect of timely disclosure. 5. Code of Business Conduct and Ethics. Unlike the NYSE Corporate Governance Rules, under Japanese laws and regulations including the Code and the Securities and Exchange Law of Japan, or stock exchange rules, Toyota is not required to adopt a code of business conduct and ethics for directors, officers and employees. Accordingly, Toyota is not required to adopt and disclose waivers of the code of business conduct and ethics for these individuals. However, Toyota maintains guidelines and internal regulations such as 'Guiding Principles at the Company' and 'Code of Conduct for the Company Employees' and has also established a code of ethics pursuant to Section 406 of the Sarbanes-Oxley Act. Please see 'Code of Ethics' for additional information. 6. Shareholder Approval of Equity Compensation Plans. Unlike the NYSE Corporate Governance Rules, under which material revisions to equity-compensation plans of listed companies are subject to shareholder approval, pursuant to the Code, if Toyota desires to adopt an equity-compensation plan under which stock acquisition rights are granted on specially favorable terms to the recipient (except where such rights are granted to all of its shareholders on a pro-rata basis at the same time), then Toyota must obtain approval by super-majority (as defined in the Code) at the general meeting of shareholders. Such approval is applicable only to stock acquisition rights to be granted within one year from the date of the approval. 6.D EMPLOYEES The total number of Toyota employees, on a consolidated basis, as reported in Toyota's annual Japanese securities report filed with the director of the Kanto Local Finance Bureau was 265,753 at March 31, 2005, 264,410 at March 31, 2004 and 264,096 at March 31, 2003. The following tables set forth a breakdown of persons employed by business segment and by geographic location at March 31, 2005. Segment Number of Location Number of ----- Employees ----- Employees ------- ------- Automotive 231,914 Japan 171,087 Financial services 6,843 North America 31,543 All other 21,845 Europe 18,554 Unallocated 5,151 Other foreign countries 44,569 Total company 265,753 Total company 265,753 As a result of Toyota's business plan to further localize its global operations, the number of Toyota's employees in the countries in which Toyota operates has generally been growing over the last several years. Most regular employees of Toyota Motor Corporation and its consolidated subsidiaries in Japan, other than management, are required to become members of the labor unions that comprise the FEDERATION OF ALL TOYOTA WORKERS' UNIONS. Approximately 89% of Toyota Motor Corporation's regular employees in Japan are members of this union. 76 -------------------------------------------------------------------------------- Table of Contents In Japan, basic wages and other working conditions are negotiated annually. In addition, in accordance with Japanese national custom, each employee is also paid a semiannual bonus. Bonuses are negotiated at the time of wage negotiations and are based on Toyota's financial results, prospects and other factors. The average wage increases per employee, excluding bonuses, in Japan have been approximately 1.9% per year for the past five fiscal years. In general, Toyota considers its labor relations with all of its workers to be good. However, Toyota is currently a party to, and otherwise from time to time experiences, labor disputes in some of the countries in which it operates. Toyota does not expect any disputes to which it is currently a party to materially affect Toyota's consolidated financial position. Toyota's average number of temporary employees on a consolidated basis was 59,481 during fiscal 2005. 6.E SHARE OWNERSHIP The following table sets forth information with respect to the number of shares of Toyota's common stock held by each director and corporate auditor as of June 2005. Name Number of --- Shares Hiroshi Okuda 64,963 Fujio Cho 29,105 Katsuhiro Nakagawa 18,000 Katsuaki Watanabe 12,171 Tokuichi Uranishi 19,333 Kazuo Okamoto 13,264 Kyoji Sasazu 14,092 Mitsuo Kinoshita 15,070 Yoshimi Inaba 15,000 Takeshi Uchiyamada 20,464 Masatami Takimoto 14,100 Akio Toyoda 2,533,891 Tetsuo Hattori 5,526 Yukitoshi Funo 5,248 Takeshi Suzuki 7,076 Atsushi Niimi 7,038 Hajime Wakayama 8,635 Hiroshi Takada 9,050 Teiji Tachibana 10,200 Shinichi Sasaki 8,010 Shin Kanada 9,578 Akira Okabe 12,000 Yoshio Shirai 11,000 Yoichiro Ichimaru 9,568 Shoji Ikawa 16,236 Shoichiro Toyoda 13,140,193 Hideaki Miyahara 19,600 Yoshiro Hayashi 5,000 Chiaki Yamaguchi 5,000 Yasutaka Okamura - Hiromu Okabe - Yoichi Kaya - Tadashi Ishikawa 3,000 Total 16,061,411 77 -------------------------------------------------------------------------------- Table of Contents Each of the persons listed above owns less than one percent of the issued and outstanding shares of common stock of Toyota. The shares listed above do not include options that are exercisable for shares of Toyota's common stock. For a description of these options, see '- Stock Options' below. None of Toyota's shares of common stock entitles the holder to any preferential voting rights. Stock Options Toyota has enacted stock option plans in each of the past five years. The plans for which stock options or stock acquisition rights are currently exercisable or will become exercisable in the future were approved by Toyota's shareholders in June of 2001, 2002, 2003, 2004 and 2005. Under the plan enacted in 2001, Toyota issued options to purchase up to 1,361,000 shares of common stock to its directors and 408 other employees that held the two highest ranks at Toyota at the time the plan was approved. Under the plan enacted in 2002, Toyota issued stock acquisition rights, which are rights introduced as of April 2002 pursuant to the amendment to the Commercial Code, to purchase up to 1,876,000 shares of common stock to its directors and 496 officers and employees, including directors, officers and employees of its subsidiaries and one Toyota affiliate. Under the 2003 plan, Toyota issued stock acquisition rights to purchase up to 1,958,000 shares of common stock to its directors and 565 officers and employees, including directors, officers and employees of its subsidiaries and one Toyota affiliate. Under the 2004 plan, Toyota issued stock acquisition rights to purchase up to 2,021,000 shares of common stock to its directors and 582 officers and employees, including directors, officers and employees of its subsidiaries and one Toyota affiliate. Under the 2005 plan, Toyota is authorized to issue stock acquisition rights to purchase up to 2,104,000 shares of common stock to its directors and 596 officers and employees, including directors, officers and employees of its subsidiaries and one Toyota affiliate. Pursuant to the provisions of each plan enacted prior to 2002, options may be exercised during a two-year period that starts two years from the date first granted at an exercise price of 1.025 times the closing price of Toyota's common stock on the Tokyo Stock Exchange on the date of grant. Each plan provides that each director will be granted no more than 15,000 and no less than 5,000 options and the year 2001 plan provides that each eligible employee will be granted 2,000 options. Each option represents one share of common stock of Toyota. Pursuant to the provisions of the 2002, 2003, 2004 and 2005 plans, stock acquisition rights may be exercised during a four-year period that starts two years from the date first granted at an exercise price of 1.025 times the closing price of Toyota's common stock on the Tokyo Stock Exchange on the date of grant. The 2002 plan provides that each director will be granted no more than 200 and no less than 100 stock acquisition rights, and each eligible officer or employee will be granted no more than 100 and no less than 20 stock acquisition rights. Each of the 2003, 2004 and 2005 plan provides that each director will be granted no more than 200 and no less than 150 stock acquisition rights, and each eligible officer or employee will be granted no more than 100 and no less than 20 stock acquisition rights. For each of the 2002, 2003, 2004 and 2005 plan, one hundred shares will be issued or delivered upon the exercise of each stock acquisition right. The options are granted as of August 1 of each year for each plan, except for the 2004 plan, which options were granted as of August 2, 2004. Each plan further provides that an option holder who retires while one's options are still exercisable retains the right to exercise one's options until the earlier of: (i) six months after one's retirement, or (ii) four years (six years under the 2002 plan) after the date the options were first granted. Under the 2003, 2004 and 2005 plan, an option holder who retires while one's options are still exercisable retains the right to exercise his shares until six years after the date the options were first granted. An option holder's right to purchase common stock under each plan lapses automatically upon one's death. During 2001, Toyota adopted an incentive plan with terms similar to its stock option plans described above. Under the plan, 58 directors, officers and employees of Toyota subsidiaries and one Toyota affiliate, each located outside Japan, are eligible to receive 2,000 options. 78 -------------------------------------------------------------------------------- Table of Contents The following table summarizes information for options and the incentive plan outstanding and exercisable at March 31, 2005: Outstanding Exercisable Exercise Price range Number of Weighted- Weighted- Weighted- Number Weighted- Weighted- -------------- shares average average average of average average exercise exercise remaining shares exercise exercise price price life price price (Yen) (Yen) (Dollars) (Years) (Yen) (Dollars) Y2,958 - 4,000 2,538,900 Y 3,067 $ 29 4.02 785,900 Y 2,958 $ 28 Y4,001 - 4,541 2,961,400 Y 4,432 $ 41 3.72 954,400 Y 4,203 $ 39 Toyota also has an employee stock ownership association in Japan for employees and full time and part time company advisors. Members of the employee stock ownership association set aside certain amounts from their monthly salary and bonuses to purchase Toyota's common stock through the employee stock ownership association. As of March 31, 2005, the employee stock ownership association held 13,678,957 shares of Toyota's common stock. 79 -------------------------------------------------------------------------------- Table of Contents ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 7.A MAJOR SHAREHOLDERS As of March 31, 2005, 3,268,078,939 shares (excluding treasury shares) of Toyota's common stock were outstanding. Beneficial ownership of Toyota's common stock in the table below was prepared from publicly available records of the filings made by Toyota's shareholders regarding their ownership of Toyota's common stock under the Securities and Exchange Law of Japan. Under the Securities and Exchange Law of Japan, any person who becomes, beneficially and solely or jointly, a holder, including, but not limited to, a deemed holder who manages shares for another holder pursuant to a discretionary investment agreement, of more than 5% of the shares with voting rights of a company listed on a Japanese stock exchange (including ADSs representing such shares) must file a report concerning the shareholding with the Director of the relevant local finance bureau. A similar report must be filed, with certain exceptions, if the percentage of shares held by a holder, solely or jointly, of more than 5% of the total issued shares of a company increases or decreases by 1% or more, or if any change to a material matter set forth in any previously filed reports occurs. Based on publicly available information, the following table sets forth the beneficial ownership of holders of more than 5% of Toyota's common stock as of the dates indicated in the reports described below. Name of Beneficial Owner Number of Percentage ------------------ Shares of Shares Outstanding Toyota Industries Corporation 187,115,312 5.18 The number of shares owned by Toyota Industries Corporation (formerly, Toyoda Automatic Loom Works, Ltd.) is based on a report filed under the Securities and Exchange Law of Japan stating that Toyota Industries Corporation held or was deemed to hold beneficially, as of November 13, 1995, 187,115,312 shares of Toyota's common stock. Based on information made publicly available on or after January 1, 2002, the following table describes transactions resulting in a 1% or greater change in the percentage ownership held by major beneficial owners of Toyota's common stock. Name of Shareholder Date of Shares Percentage Number of Shares Percentage -------------- Transaction Owned of Shares Shares Owned of Shares Prior to Issued Changed After the Issued Transaction Transaction UFJ Bank Limited* and its joint January 31, 332,317,558 9.10 (38,857,900 ) 293,459,658 8.04 holders 2002 Sumitomo Mitsui Banking Corporation October 31, 186,315,239 5.06 (67,881,090 ) 118,434,149 3.28 and its joint holder 2002 UFJ Bank Limited and its joint April 30, 255,060,258 7.07 (37,924,800 ) 217,135,458 6.01 holders 2003 -------- * The shares owned by UFJ Bank Limited and its joint holders have decreased from 180,931,065 shares (5.01%) to 167,075,565 shares (4.63%) as of July 31, 2004, and as a result UFJ Bank Limited is no longer classified under the major beneficial shareholders. According to The Bank of New York, depositary for Toyota's ADSs, as of March 31, 2005, 70,203,808 shares of Toyota's common stock were held in the form of ADRs and there were 1,798 ADR holders of record in the United States. According to Toyota's register of shareholders, as of March 31, 2005, there were 352,029 holders of common stock of record worldwide. As of March 31, 2005, there were 291 record holders of Toyota's common stock with addresses in the United States, whose shareholdings represented approximately 10.0% of the issued common stock on that date. Because some of these shares were held by brokers or other nominees, the number of record holders with addresses in the United States might not fully show the number of beneficial owners in the United States. 80 -------------------------------------------------------------------------------- Table of Contents None of Toyota's shares of common stock entitles the holder to any preferential voting rights. To the extent known to Toyota, Toyota is not owned or controlled, directly or indirectly, by another corporation, any foreign government or any natural or legal person. Toyota knows of no arrangements the operation of which may at a later time result in a change of control. 7.B RELATED PARTY TRANSACTIONS Business Relationships Toyota purchases materials, supplies and services from numerous suppliers throughout the world in the ordinary course of business, including Toyota's equity-method affiliates and those firms with which certain members of Toyota's board of directors are affiliated. Toyota purchased materials, supplies and services from these affiliated entities in the amount of Y2,923.3 billion in fiscal 2005. Toyota also sells its products and services to Toyota's equity-method affiliates and firms with which certain members of Toyota's board of directors are affiliated. Toyota sold products and services to these affiliated entities in the amount of Y1,150.5 billion in fiscal 2005. Toyota believes all of these purchase and sale transactions were arm's-length transactions. See note 12 of Toyota's consolidated financial statements for additional information regarding Toyota's investments in and transactions with affiliated companies. Loans Toyota regularly has trade accounts and other receivables payable by, and accounts payable to, Toyota's equity-method affiliates and firms with which certain members of Toyota's board of directors are affiliated. Toyota had outstanding trade accounts and other receivables payable by these affiliated entities in the amount of Y179.5 billion as of March 31, 2005. Toyota had accounts payable to these affiliated entities in the amount of Y463.9 billion as of March 31, 2005. Toyota held convertible debt securities issued by an equity-method affiliate in the amount of Y11.1 billion at fair value as of March 31, 2005. The debt securities have interest rate of 1.05%. The maturity of these debt securities is one year. Toyota, from time to time, provides short- to medium-term loans to its affiliates, as well as loans under a loan program established by certain subsidiaries to assist their executives and directors with the purchase of homes. As of March 31, 2005, an aggregate amount of Y8.1 billion in loans was outstanding to its equity-method affiliates. As of March 31, 2005, an aggregate amount of Y46.6 billion in loans was outstanding to those of its affiliates not accounted for under the equity method, which are 20% to 50% owned by Toyota. As of March 31, 2005, the largest loan outstanding to any such equity-method affiliate was a loan of Y3.8 billion at a variable rate. Toyota believes that each of these loans was entered into in the ordinary course of business. 7.C INTERESTS OF EXPERTS AND COUNSEL Not applicable. 81 -------------------------------------------------------------------------------- Table of Contents ITEM 8. FINANCIAL INFORMATION 8.A CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION 1-3. Consolidated Financial Statements. Toyota's audited consolidated financial statements are included under 'Item 18 - Financial Statements'. Except for Toyota's consolidated financial statements included under Item 18, no other information in this annual report has been audited by Toyota's auditors. 4. Not applicable. 5. Not applicable. 6. Export Sales. See 'Operating and Financial Review and Prospects - Operating Results - Overview - Geographical Breakdown'. 7. Legal and Arbitration Proceedings. See 'Information on the Company - Business Overview - Legal Proceedings'. 8. Dividend Policy. See 'Selected Financial Data - Dividends'. 8.B SIGNIFICANT CHANGES Except as disclosed in this annual report, there have been no significant changes since the date of Toyota's latest annual financial statements. 82 -------------------------------------------------------------------------------- Table of Contents ITEM 9. THE OFFER AND LISTING 9.A LISTING DETAILS The following table sets forth for the periods shown the reported high and low sales prices of the common stock on the Tokyo Stock Exchange and the ADSs on the New York Stock Exchange. Tokyo Stock New York Stock Exchange Exchange Price per Share Price per ADS High Low High Low Fiscal Year Ending March 31, ------------------------- 2001 Y 5,800 Y 3,370 $ 108.25 $ 58.20 2002 4,450 2,665 71.50 46.60 2003 3,790 2,625 57.45 44.40 2004 3,990 2,455 75.88 41.17 2005 4,520 3,730 82.94 65.65 Financial Quarter Ending --------------------- June 30, 2003 3,180 2,455 53.75 41.17 September 30, 2003 3,920 2,975 67.52 49.65 December 31, 2003 3,720 3,130 69.75 57.75 March 31, 2004 3,990 3,390 75.88 64.52 June 30, 2004 4,440 3,730 81.95 65.65 September 30, 2004 4,520 4,030 82.94 73.30 December 31, 2004 4,320 3,780 81.87 73.42 March 31, 2005 4,220 3,940 82.27 73.93 Month Ending ------------- December 31, 2004 4,170 3,780 81.87 73.42 January 31, 2005 4,220 3,960 82.27 77.05 February 28, 2005 4,200 3,990 80.40 76.82 March 31, 2005 4,150 3,940 79.50 73.93 April 30, 2005 4,150 3,790 76.81 71.54 May 31, 2005 3,950 3,790 75.25 71.00 9.B PLAN OF DISTRIBUTION Not applicable. 9.C MARKETS The primary trading market for Toyota's common stock is the Tokyo Stock Exchange. The common stock is also listed on the Nagoya Stock Exchange and three other regional stock exchanges in Japan. Since September 29, 1999, American Depositary Shares, each equal to two shares of Toyota's common stock and evidenced by American Depositary Receipts, have been traded and listed on the New York Stock Exchange through a sponsored ADR facility operated by The Bank of New York, as depositary. Prior to that time, Toyota's ADSs were listed on the Nasdaq SmallCap Market through five unsponsored ADR facilities. Toyota's common stock is also listed on the London Stock Exchange. 9.D SELLING SHAREHOLDERS Not applicable. 9.E DILUTION Not applicable. 9.F EXPENSES OF THE ISSUE Not applicable. 83 -------------------------------------------------------------------------------- Table of Contents ITEM 10. ADDITIONAL INFORMATION 10.A SHARE CAPITAL Not applicable. 10.B MEMORANDUM AND ARTICLES OF ASSOCIATION Except as otherwise stated, set forth below is information relating to Toyota's common stock, including brief summaries of the relevant provisions of Toyota's articles of incorporation and share handling regulations, as currently in effect, and of the Commercial Code of Japan and related legislation. A bill to modernize and make overall amendments to the Commercial Code by replacing the current provisions with regard to corporations with the new company law (the 'New Company Law') was submitted to the Diet on March 22, 2005. Once enacted, the proposed New Company Law will come into effect within one year and half after its promulgation, and currently, it is expected that it will take effect in April 2006. The proposed legislation is subject to discussion, revision and approval by the Diet. General Toyota's authorized share capital as of March 31, 2004 is 9,740,185,400 shares, of which 3,609,997,492 shares were issued. Under the Commercial Code, shares must be registered and are transferable generally by delivery of share certificates. In order to assert shareholders' rights against Toyota, a shareholder must have its name and address registered on Toyota's register of shareholders, in accordance with Toyota's share handling regulations. The registered beneficial holder of deposited shares underlying the ADSs is the depositary for the ADSs. Accordingly, holders of ADSs will not be able directly to assert shareholders' rights. A holder of shares may choose, at its discretion, to participate in the central clearing system for share certificates under the Law Concerning Central Clearing of Share Certificates and Other Securities of Japan. Participating shareholders must deposit certificates representing all of the shares to be included in this clearing system with Japan Securities Depository Center, Inc. If a holder is not a participating institution in the Securities Center, it must participate through a participating institution, such as a securities company or bank having a clearing account with the Securities Center. All shares deposited with the Securities Center will be registered in the name of the Securities Center on Toyota's register of shareholders. Each participating shareholder will in turn be registered on Toyota's register of beneficial shareholders and be treated in the same way as shareholders registered on Toyota's register of shareholders. For the purpose of transferring deposited shares, delivery of share certificates is not required. Entry of the share transfer in the books maintained by the Securities Center for participating institutions, or in the book maintained by a participating institution for its customers, has the same effect as delivery of share certificates. The registered beneficial owners may exercise the rights attached to the shares, such as voting rights, and will receive dividends (if any) and notices to shareholders directly from Toyota. The shares held by a person as a registered shareholder and those held by the same person as a registered beneficial owner are aggregated for these purposes. Beneficial owners may at any time withdraw their shares from deposit and receive share certificates. A new law to establish a new central clearing system for shares of listed companies and to eliminate the issuance and use of certificates for such shares was promulgated in June 2004 and the relevant part of the law will come into effect within five years of the date of the promulgation. On the effective date, a new central clearing system will be established and the shares of all Japanese companies listed on any Japanese stock exchange, including the shares of Common Stock of Toyota, will be subject to the new central clearing system. On the same day, all existing share certificates will become null and void and the companies are not required to withdraw those share certificates from shareholders. The transfer of such shares will be effected through entry in the books maintained under the new central clearing system. 84 -------------------------------------------------------------------------------- More to follow This information is provided by RNS The company news service from the London Stock Exchange

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