Dentsu : Q1 FY2022 Summary of Questions and Answers（135KB）

Financial Results for the First Quarter of Fiscal 2022

Summary of Questions and Answers

Date: May 16, 2022 (Monday)

Hosts:

Hiroshi Igarashi, Representative Director, President & CEO, Dentsu Group Inc.

Yushin Soga, Representative Director, Executive Vice President & CFO, Dentsu Group Inc. Norihiro Kuretani, Executive Officer, Dentsu Group Inc. and CEO, Dentsu Japan Network

Wendy Clark, Director & Executive Officer, Dentsu Group Inc. and Global CEO, Dentsu International Nick Priday, Director & Executive Officer, D-CFO, Dentsu Group Inc. and CFO, Dentsu International

[Guidance]

1. Is the guidance for the organic growth rate upgraded due to the fact that Q1 was a better-than- expected results or do you have aggressive views for the forecast of Q2 and onwards? The conflict in Ukraine, the China lockdown, and increased raw material costs are likely to put pressure on the performance of Japanese companies. Even if you take these factors into consideration, do you still expect a strong performance from Q2 and onwards?

1. We upgraded the guidance not only considering that Q1 results exceeded our forecast, but also in consideration of the forecast of the rest of the period of the fiscal year. We have included the risks which may lead to negative impacts that could arise from the Russia-Ukraine conflict and the consequences of higher input costs, inflation, and supply-chain disruptions.
   So, it's not just purely based on the results from Q1, but based on Q1, we have an expectation for the performance in Q2, Q3, and Q4. But there are additional factors that are more negative in nature in risk, but all these were put together to come up with updated group guidance for this occasion.

1. Global mega-agencies, including the Dentsu Group, tend to take quite an aggressive outlook. Is this not only the expansion of the advertising market, but also the expansion of businesses such as your Customer Transformation & Technology ("CT&T"), and the change in the business structure of advertising agencies is driving the organic growth of the market? I would like to ask about the tread

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not just for Dentsu Group, but about the industry trends.

A: In Japan, there are no agency groups that have expanded to domains like CT&T.

The core business of CT&T in Dentsu International ("DI") is Merkle, and if you take apart the performance for Q1, Merkle achieved the strongest quarter over the past four years. It was also the fourth consecutive quarter of double-digit growth for Merkle, indicating that we are starting to see the CT&T/CXM capabilities perform in line with our expectations. There is no doubt that CXM is a structural growth area in the industry and DI is expanding in this area steadily. CXM is now over one- third of DI's net revenue and was 36% in Q1.

We've just seen all the right indicators. Our pipeline and both our pitch performance for Q1 this year versus Q1 last year is a stronger performance and show a steady and improved trajectory. And so, we feel very positive about that.

If you just look at it on a compounded basis versus 2019, now CXM is up 18% versus the pre- pandemic level. You've seen the acceleration of that. I think if you look at a microcosm using our US market, as Igarashi-san said, our second-largest market, you see double-digit growth from CXM, and you see strong mid-digit performance from Media and Creative.

That really makes up the complexion and the blend moving forward that we believe gets us the right cyclical resilience and structural growth delivery. So that sort of represents what we see in the market moving forward. Thank you.

1. Given the weak stock market outlook due to uncertainty over the macro environment, what is the background to the upgrade of the organic growth guidance? In the context of dialogue with clients, what is the client saying about their budget?

1. We have been under structural reforms for two years, and in the process have transformed to an extremely robust profit structure that can respond to the changes in the macro environment. This is firmly reflected in Q1 performance. On the other hand, we recognize that the CT&T area is the area where the client's budget is expanding as we hear in daily dialogue with our clients. Unlike the marketing/communication domain, which is more sensitive to the macro environment, clients tell us that CT&T is an area they will continue to invest. Towards the second half of this fiscal year, we will face a headwind in the macro-environment, but even under such situation, we believe that we are able to continue to grow our business, toward the target of expanding the CT&T domain. This is the background of our upgrade.

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At the overseas business, we are in constant conversation with our clients, and these are times when we need to be partnering and understanding their challenges. By customer industry, there is an uptrend in technology, finance, CPG, and pharmaceuticals. Automobiles are also growing in the United States. The approach we take to establish our forecast is to report what we see and hear from our clients. While Media may be more sensitive to market conditions, the CXM area continues to be structurally growing having investment from clients over the long term.

1. With regards to the fiscal year guidance, comparing to the comments on the high growth rate in CXM, and considering that the guidance implies a decline in domestic margins for the remaining nine months, are you being overly conservative?

1. You may feel we are conservative comparing to the guidance announced by the European and US peer groups but based on our experience of communication with the market in the past, we are not announcing a simple outlook, but have announced guidance as a commitment with sufficient confidence. Therefore, we are confident that this upgraded guidance will be fully achieved. On the other hand, there are risks, including macroeconomic factors. Therefore, considering the remaining period, we refrain from providing a further upgraded guidance at this timing. We will review the full- year outlook in mid-August, when announcing Q2 results, and we will consider further upgrading if necessary at the timing.

I mentioned earlier that growth rate of CXM was double-digit, but I would like to note that this is not the growth rate of the total CXM business, but the Q1 growth rate of CXM in US. As you know, we have had a continued drag on the business from Creative, and we are underway of restoration since the joining of Fred Lebron six months ago. We will make announcements at an event in Cannes next month.

With regards to the outlook for domestic margins, as the CT&T domain is progressing very well, we are trying to accelerate the recruitment of talents in this domain and expect an increase in hiring costs.

[M&A]

1. What is the budget for M&A for this fiscal year?
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1. In the medium-term management plan ("MTMP") updated in February this year, we explained our approach for capital allocation. We announced that we will invest 250 billion yen to 300 billion yen by 2024 to strengthen the CT&T domain and target 50% of net revenue in the group over the next few years. This plan remains unchanged. Currently our M&A pipeline is active. However, since each project has different stages and has confidentiality, we will refrain from providing how much M&A is planned for the current fiscal year. Again, please note there is no change in our plan to proceed with business transformation at this point in time.

1. What is Dentsu Group's advantage in acquiring leading companies in an extremely competitive M&A environment.

1. Firstly, in overseas the competitiveness in M&A has become intense as many agencies and consultancy firms eek to expand capabilities beyond pure advertising into technology, implementation, and integration. I would like highlight that, our track record is strong with our return on investment being significantly higher than our weighted average cost of capital. In terms of the competitive nature of the environment, we are not afraid to walk away from deals if we think the price is too high, and we have done that on many occasions. We need to be disciplined in terms of our approach. One of our strengths in M&A is that we can leverage from the acquisition of Merkle, and this is an advantage when the focus of our acquisition efforts is on CXM. In addition, we think it's not only the ability to access CXM and better growth going forward but also the ability to continue to transform our operations via offshore delivery centers, which many of our recent acquisitions have brought for us.

With regards to our advantage of M&A in Japan, the use of a client base of more than 6,000 companies is commonly cited in recent M&A. In addition, clients are resonating with us trying to improve the quality of service through the integrated model of "Integrated Growth Partner". More specifically, we have a very good understanding of the demand side, and we are able to utilize this expertise in consultation for businesses, as well as for system establishment. Furthermore, from the perspectives of recruitment and retention of talent, amidst the high mobility within the industry, inflows have increased significantly over outflows from the Dentsu Group, and this integrated model and empathy to the corporate culture, as well as the provision of new opportunities for our people's learning, can be said that it is highly appreciated.

1. Disciplined M&A is good, but how would that relate to the share buyback going forward? 4

1. When we updated the MTMP in February this year, we announced that we will invest between 250 billion yen and 300 billion yen in M&A over the three-year period until 2024 to increase the CT&T ratio to 50% over the next few years. By doing this, we want to achieve structural change. Only a few months have passed since this announcement. We are also in the process of buying back its shares, announced in February. Therefore, I think it's too early to talk about additional share buyback at this timing. While looking at the progress made in the MTMP, we will flexibly consider about the shareholder returns as well.

[Overseas Business]

1. With regards to the margin of the overseas business, can I ask about the background of the slight decline in Q1 and the outlook for the future.

1. We achieved a historically high margin in Q1 of last year and it was the first time we achieved a double-digit margin percentage in Q1 for DI. We came very close to that same level of margin in Q1 of 2022 just been fractionally behind it. If we exclude the impact of our Russian business which has suffered in Q1, our margin would have been up against the prior year by 10 basis points. As we shift more of our business to CT&T, we are recognizing more profitability earlier in the year. Over the long term, margins are expected to improve due to the benefits progress in business transformation, business simplification, and efficiency achieved by offshoring. In 2021, DI achieved 15% margin, one year ahead of schedule. In 2022, we are confident that we will achieve the margin as guided, and at the same time, reinvest in people and talent attraction and retention.

1. What is the outlook for the rest of this year for international pitch activities?

1. The pipeline is just right around $5 billion at the moment, and this is roughly 72% offensive for DI. We saw our top 20 clients grow by 15% in Q1, enabling us to expand our existing relationships with our biggest clients, clients like Microsoft, P&G, GM, and others. We have a 70% conversion rate locally. Although these pitches do not become bigger headlines like large pitches, it is important for us, who operate in a wide range of countries around the world, to win local market pitches. So far this year, our media conversions is approximately $600 million and is on track. The current pitch pipeline is good, and I am very confident about the rest of the period.

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