Net Sales and Other Operating Revenue
Honda's consolidated net sales and other operating revenue (hereafter "net sales") for fiscal 2006, ended March 31, 2006, amounted to ¥9,907.9 billion, up 14.5% from the previous fiscal year.
Of this amount, domestic net sales decreased by ¥5.1 billion, or 0.3%, to ¥1,694.0 billion, while overseas net sales increased by ¥1,263.0 billion, or 18.2% to ¥8,213.9 billion.

Operating Income
Operating income amounted to ¥868.9 billion, which was an increase of 37.7% from the previous fiscal year.
This was primarily due to positive currency effects caused by the depreciation of the Japanese yen, increased profit attributable to higher revenue, continuing cost reduction effects and gain on return of the substitutional portion of the Employees' Pension Funds to the Japanese government (herein referred to as "return"), which offset the negative impact of increased SG&A and R&D expenses.

Selling, General and Administrative Expenses/Research and Development Expenses
SG&A expenses for fiscal 2006 increased by ¥143.1 billion or 9.5%, to ¥1,656.3 billion, reflecting increased sales expenses and storage fee due to the increase of net sales and increased advertisement expenses.
R&D expenses increased by ¥42.6 billion or 9.1%, to ¥510.3 billion.

Income before Income Taxes and Equity in Income of Affiliates
Income before income taxes and equity in income of affiliates was up 24.0%, to ¥814.6 billion.
Other income & expenses, net decreased by ¥80.1 billion from the previous fiscal year, due mainly to decline in gains on derivative instruments.

Equity in Income of Affiliates
Equity in income of affiliates increased by 3.7%, to ¥99.6 billion.

Net Income
Net income amounted to ¥597.0 billion, an increase of 22.8%. The effective tax rate was 38.9%, an decrease by 1.7 percentage points from the previous fiscal year.
Basic net income per common share amounted to ¥648.67, compared with ¥520.68 in fiscal 2005.
The gain on "return" of ¥138.0 billion which was recorded in the fiscal year ended March 31, 2006, was included in the result of consolidated operating income and consolidated income before income taxes. Accordingly, the result of amount of the relevant income after tax that was recorded by the "return" was included in the consolidated net income for the fiscal year ended March 31, 2006.

Liquidity and Capital Resources
The policy of Honda is to support its business activities by maintaining sufficient capital resources, an ample level of liquidity and a sound balance sheet.
Honda's main business is the manufacture and sale of motorcycles, automobiles and power products. To support this business, it also provides retail financing and automobile leasing services for customers, as well as wholesale financing for dealers.
In its manufacturing and sales business, Honda requires operating capital mainly to purchase parts and materials required for production, as well as to control inventory of finished products and cover receivables from dealers. Honda also requires funds for capital expenditures, mainly to upgrade, rationalize and renew production facilities, as well as to expand and reinforce research and development and sales facilities.
Honda meets its operating capital requirements mainly through cash generated by operations. Honda funds its financial programs for customers and dealers primarily from corporate bonds, medium-term notes and commercial paper, as well as securitization of finance receivables. The year-end balance of liabilities associated with fund-raising by financial subsidiaries was ¥3,880.8 billion.

Cash Flows
Consolidated cash and cash equivalents at end of year amounted to ¥747.3 billion as of March 31, 2006, down ¥26.2 billion, or 3.4%, from a year earlier, owing to decreases from business subsidiaries.
Year-end cash and cash equivalents of business subsidiaries declined as net income and depreciation were outweighed by increases in purchases of production equipment and other tangible fixed assets. However, year-end cash and cash equivalents of finance subsidiaries increased, owing to an increase in their fund-raising activities associated with a rise in their receivables.
Net cash provided by operating activities amounted to ¥576.5 billion. Factors increasing cash flows included ¥597.0 billion in net income (including a ¥138.0 billion non-cash gain on the return of the substitutional portion of the employees' pension plan) and ¥262.2 billion in depreciation. By contrast, there was a ¥113.2 billion increase in trade accounts and notes receivable and a ¥109.6 billion increase in inventories.
Net cash used in investing activities totaled ¥672.7 billion. This was mainly due to ¥460.0 billion in capital expenditures associated with introducing new models, upgrading, streamlining and renewing production facilities, and the improvement of Sales and R&D facilities. Another factor was a ¥230.3 billion increase in acquisition (net) of finance subsidiaries' receivables associated with higher sales of automobiles in North America and elsewhere.
Net cash provided by financing activities was ¥24.0 billion. During the year, Honda raised ¥865.6 billion in long-term debt through the issue of bonds and medium-term notes to meet capital requirements associated with an increase in liabilities of finance subsidiaries, as well as to repay ¥568.3 billion in long-term debt. By contrast, there was a ¥124.9 billion decrease in short-term debt accompanying a decline in external liabilities in Europe. Honda also allocated ¥77.0 billion in payments for purchase of treasury stock and ¥71.0 billion in cash dividends paid.
The ¥747.3 billion in cash and cash equivalents at end of year corresponds to approximately 0.9 month of net sales, and Honda believes it has sufficient liquidity for its business operations. At the same time, Honda is aware of the possibility that various factors, such as recession-induced market contraction and financial and foreign exchange market volatility, may adversely affect liquidity.
For this reason, financial subsidiaries carry total short-term borrowings of ¥1,369.1 billion in the form of commercial paper issued regularly to replace debt. This serves as alternative liquidity for a back-up credit line equivalent to ¥701.0 billion. In addition, Honda currently has ample credit limits, extended by prominent international banks, that are not subject to contracts.
Honda believes it has adequate liquidity to meet its cash obligations for the near future at least for the year ending March 31, 2007.
Honda's short- and long-term debt securities are rated by credit rating agencies, such as Moody's Investors Service, Inc., and Standard & Poor's Rating Services. Based on major current ratings, which are shown below, Honda will be able to raise funds even if it requires more capital than its present level of liquidity would allow.
The following table shows the ratings of Honda's unsecured debt securities by Moody's and Standard & Poor's at the date of filing of this annual report.

The above ratings are based on information provided by Honda and other information deemed credible by the rating agencies. They are also based on the agencies' assessment of credit risk associated with designated securities issued by Honda. Each rating agency uses different standards for calculating Honda's credit rating, and also makes its own assessments. Ratings can be revised or nullified by agencies at any time. These ratings are not meant to serve as a recommendation for trading in or holding debt.

Off-Balance Sheet Arrangements
Special Purpose Entity
For the purpose of accelerating the receipt of cash related to our finance receivables, we periodically securitize and sell pools of these receivables. In these securitizations, we sell a portfolio of finance receivables to a special purpose entity, which is established for the limited purpose of buying and reselling finance receivables. We remain as a servicer of the finance receivables and are paid a servicing fee for our services. The special purpose entity transfers the receivables to a trust or bank conduit, which issues interest-bearing asset-backed securities or commercial paper, respectively, to investors. We retain certain subordinated interests in the sold receivables in the form of subordinated certificates, servicing assets and residual interests in certain cash reserves provided as credit enhancements for investors. We apply significant assumptions regarding prepayments, credit losses and average interest rates in estimating expected cash flows from the trust or bank conduit, which affect the recoverability of our retained interests in the sold finance receivables. We periodically evaluate these assumptions and adjust them, if appropriate, to reflect the performance of the finance receivables.

Guarantee
At March 31, 2006, we guaranteed ¥46.7 billion of employee bank loans for their housing costs. If an employee defaults on his/her loan payments, we are required to perform under the guarantee. The undiscounted maximum amount of our obligation to make future payments in the event of defaults is ¥46.7 billion. As of March 31, 2006, no amount was accrued for any estimated losses under the obligations, as it was probable that the employees would be able to make all scheduled payments.

Tabular Disclosure of Contractual Obligations
The following table shows our contractual obligations at March 31, 2006:

(*) Honda had commitments for purchases of property, plant and equipment at March 31, 2006.

At March 31, 2006, we had no material capital lease obligations or long-term liabilities reflected on our balance sheet under U.S. GAAP other than those set forth in the table above.

Capital Expenditures
Manufacturing-related capital expenditures in fiscal 2006 were applied to the expansion of manufacturing facilities, streamlining efforts, and the replacement of older equipment. Other expenditures included funds used to augment sales and R&D facilities.
Total capital expenditures for the year amounted to ¥457.8 billion, up ¥83.8 billion from the previous year. Spending by business segment is shown below.

In the motorcycle business, we made capital expenditures of ¥52.2 billion in the year ended March 31, 2006. Funds were allocated to the introduction of new models, as well as the improvement, streamlining and modernization of production facilities, and improvement of sales and R&D facilities.
In the automobile business, we made capital expenditures of ¥392.9 billion associated with introducing new models, improving, streamlining, and modernizing our production facilities, and improving our sales and R&D facilities in the year ended March 31, 2006.
In the financial services segment, capital expenditures amounted to ¥1.3 billion in the year ended March 31, 2006. Capital expenditures in power product and other businesses in the year ended March 31, 2006, totaling ¥11.3 billion, were deployed to upgrade, streamline, and modernize manufacturing facilities for power products, and to improve R&D facilities for power products.

Plans after Fiscal 2006
Honda plans to build a new auto plant capable of synchronous auto production—from the engine to the entire automobile—in Yorii-cho Oosato-gun, Saitama, Japan with an investment of approximately ¥70,000 million. The annual production capacity of this new auto plant will be approximately 200,000 units. This new auto plant plans to start operation in 2010, and when the new plant becomes operational, Honda's total annual production capacity in Japan will increase to 1.5 million units.
Honda plans to build a new R&D center in Sakura City, Tochigi, Japan with an investment of approximately ¥17,000 million.This new R&D facility will have multiple test courses, which reproduce various driving conditions including highspeed driving to urban-area driving.
Honda is aiming to begin operation of this new R&D facility in 2009.
Honda plans to build a new auto plant in the U.S., with an investment of approximately $550 million. The annual production capacity of this new plant will be approximately 200,000 units. This new auto plant plans to start operation in 2008, and when the new plant becomes operational, Honda's total annual production capacity in North America will increase to 1.6 million units.
Honda plans to build a new engine plant in Canada with an investment of approximately $140 million. The annual production capacity of this new plant will be approximately 200,000 units, and the products of this new plant will be supplied to the auto plant of Honda Canada Inc. This new plant should begin operation in 2008.
The planned amount of capital expenditures in fiscal 2007 is shown below.