Management s Discussion and Analysis of Financial Position and Operating Results

Transcription

1 Management s Discussion and Analysis of Financial Position and Operating Results Dentsu Inc. and Consolidated Subsidiaries As of June 28, 212 Any forward-looking statements in the following discussion and analysis are based on the judgment of management as of the date that Dentsu Inc. (hereinafter Dentsu or the Company ) filed its securities report for the fiscal year ended March 31, 212 with regulatory authorities. Significant Accounting Policies and Estimates The consolidated financial statements covering the Company and its consolidated subsidiaries are prepared on the basis of generally accepted accounting principles in Japan. Overview Dentsu and the group of companies it leads (hereinafter the Dentsu Group or the Group ) derive most of their revenue from promotional and communication services, notably advertising services in the four traditional mass media (newspapers, magazines, radio and television) and related creative services, including the planning and production of advertising. The Group s activities also include: promotional services; billboard, transit and other out-of home (OOH) media advertising; advertising and related services encompassing interactive media, such as the Internet and mobile devices, as well as satellite media; and other services, such as sports and entertainment marketting, event planning and execution, public relations, public affairs, direct marketing, market research and e-solution services. In the fiscal year ended March 31, 212 (hereinafter the fiscal year under review ), advertising sales to clients accounted for approximately 97% of net sales. Invoices to advertisers for advertising services constituted most of this amount. Sales in the Information Services segment came primarily from the information processing services and the consulting business of Information Services International-Dentsu, Ltd., a Dentsu subsidiary. The Group is particularly active in Japan but is developing a worldwide network that includes the rest of Asia as well as Europe and the Americas. In the fiscal year under review, overseas sales accounted for approximately 14.% of net sales. In the preparation of these consolidated financial statements, management must disclose the amounts of the reported asset and liability figures as well as those of off balance sheet transactions such as contingent liabilities, as of the date the accounts are closed. Management must also estimate the impact of these figures on the Group s financial position and operating results during the reporting period. Management continuously evaluates forecasts and assumptions regarding such items as allowance for doubtful accounts, investments and corporate taxes, as well as financing activities, retirement benefits, contingencies and litigation. Management bases its estimates and assumptions on the rational consideration of several factors, given past performance and conditions. These results underpin assumptions regarding asset and liability book values and reported revenue and expense figures. However, uncertainties are inherent in such results and estimates may vary from actual results. The significant accounting policies described below are those that management considers to have specific potential to affect the financial position and operating results of the Group. Such policies may also include important assumptions and estimates used in creating the Company s consolidated financial statements and therefore have a material impact on these statements. Revenue Recognition Consolidated revenue consists primarily of commissions received from media companies for the placement of advertising into different media formats and payments received from advertisers and other clients for providing services, such as assistance in the production of advertising, including MD&A - 1/12

2 creative, and various content-related services. Commission revenue is recognized when the media placement appears. Other revenue is recognized when the service is complete; an estimate of the value can be reasonably determined and the potential for economic benefit is high. Figure 2: Ad Planning and Creative Development Transactions Outsourcing costs Outsourcing costs Advertisers Dentsu Inc. and its Group companies Business partners Compensation (Fees) Dentsu Group companies receive commissions from media companies for the sale of media time and/or space to Allowance for Doubtful Accounts advertisers. In Japan, advertising companies generally purchase media time and/or space from media companies at the request of advertisers and resell the purchased time and/or space to the advertisers at the same prices as those charged by the media companies. The commissions received for the placement of advertising are typically a percentage of the price advertisers pay for the media time and/or space. An amount is recorded as allowance for doubtful accounts, based on estimated losses that might occur if expected amounts from clients become uncollectible. If the financial position of advertisers or other clients deteriorates and their ability to pay decreases, this allowance may have to be raised. This percentage is generally negotiated between the relevant Group company and media company. In practice, Impairment Losses on Investments however, prevailing industry custom dictates that the commission portion be netted against payment due to the media company with the balance paid to that company. In the Dentsu Group, the entire price charged to the advertiser for media time and/or space is recorded as net sales and the amount paid to the media company is recorded as cost of sales. (Please refer to Figure 1.) Figure 1: Ad Space and Time Slot Transactions Advertising rates Advertising rates Advertisers Dentsu Inc. and its Group companies Media companies Commissions To ensure continuous growth into the future, the Group pursues investments in new businesses and overseas businesses, and undertakes investment opportunities with partners. These investments include shares in publicly listed companies with high price-variability as well as shares in unlisted companies with difficult-to-determine share values. In the event that a decline in the value of an investment is determined to be something other than temporary, an impairment loss is recorded on that investment. If market conditions worsen or the performance of an investment target deteriorates, unrecoverable investment or losses not reflected in current book values may arise, requiring the Revenue from the production of advertising and other booking of valuation losses. advertising services consists of payments made by advertisers and other clients to the relevant Group company as Deferred Tax Assets compensation for such services. Payments for these services are generally negotiated as a markup on the prices charged to the Group companies for services provided by third parties and/or Dentsu subsidiaries. In some cases, the Group companies may also agree to a fixed fee or other compensation arrangements. (Please refer to Figure 2.) The Group books consolidated deferred tax assets, based on future taxable income and ongoing tax planning that emphasizes cautious and highly implementable approaches. However, if management decides that some or all of these deferred tax assets are unrecoverable, these assets may MD&A - 2/12

3 have to be recorded as expenses for the period when such a decision is made. Provision for Retirement Benefits large orders in the previous fiscal year. Nevertheless, sales of the enterprise solution business, enterprise solution engineering and communication IT grew, boosting segment sales over the previous fiscal year. The Other Business segment posted sales of 18. billion Retirement benefit costs and obligations are recorded on the basis of pension actuarial calculations. These calculations are dependent upon such factors as the discount rate, future compensation levels, employee turnover, mortality rates based on recent statistical values, and expected rates of investment return on pension plan assets. If the actual values of these factors stray from their forecast values, or if the assumptions that underlie these values change, regulatory requirements obligate the Company and relevant consolidated subsidiaries to record the cumulative impact of these changes going forward. In all likelihood, the Company will be impacted by the recognition of such costs or by the recording of such liabilities in the future, on a consolidated basis. Operating Results for the Fiscal Year under Review Net Sales and Gross Profit Consolidated net sales for the fiscal year under review reached 1,893. billion yen (up 3.3% from the previous fiscal year). Of this amount, the Advertising segment contributed 1,833.7 billion yen (up 3.4%), largely due to a year-on-year increase in sales by overseas consolidated subsidiaries in the United States and throughout Asia. Sales in the Information Services segment amounted to 63.8 billion yen (up 6.%). This segment hinges on Information Services International-Dentsu, Ltd., which is involved primarily in the provision of IT solutions, such as information system configuration. During the fiscal year under review, the segment experienced a drop in sales of financial solutions, reflecting a reversal from the robust demand for yen (down 22.8%). This considerable year-on-year decrease in sales reflects sluggish environment-related business activities. The Overseas segment contributed billion yen (up 23.3%). Consolidated sales rose considerably, owing to a substantial increase in sales in the United States and throughout Asia. As a result, the Group posted consolidated gross profit of billion yen (up 4.8%) for the fiscal year under review. Both the consolidated net sales and gross profit figures exceeded those of the previous fiscal year. Selling, General and Administrative Expenses Consolidated selling, general and administrative (SG&A) expenses for the fiscal year under review came to 28.8 billion yen (up 5.3% from the previous fiscal year). Depreciation, amortization of goodwill, provision of allowance for doubtful accounts and other SG&A expenses decreased. However, certain expenses, mainly salaries and allowances and welfare expenses, increased, leading to a higher consolidated amount compared with the previous fiscal year. Salaries and allowances accounted for 45.7% (up.7 percentage point) of gross profit. Operating Income, Non-Operating Income & Expenses and Net Income As the increased amount of gross profit was greater than that of SG&A expenses for the fiscal year under review, operating income came to 51.9 billion yen (up 2.% from the previous fiscal year). Non-operating income amounted to 15.8 billion yen (up MD&A - 3/12

4 (Years ended March 31) (Billions of yen) Net Sales (Billions of yen) Gross Profit 2,5 5 2, 4 1,5 3 1, (Billions of yen) Operating Income and Operating Margin (%) (Billions of yen) Net Income (Loss) and Return on Equity (ROE) (%) Operating Income Operating Margin Net Income (Loss) Return on Equity (ROE) 63.6%), reflecting an increase in equity in the earnings of Factors Affecting Operating Results affiliated companies. Non-operating expenses came to 5. billion yen (down 22.6%), due to decreases such as foreign Revenue exchange loss, which led to a non-operating balance of 1.8 billion yen (up 236.5%) and income before income taxes and minority interests came to 58.4 billion yen (up 65.2% from the previous fiscal year). Net income, from which income taxes current, income taxes deferred, and minority interests in income were deducted from the above, reached 29.5 billion yen (up 36.7%). Consolidated revenue comes primarily from advertising services in the four traditional mass media formats and advertising-related services, mainly interactive media and OOH media, as well as related creative services. Commissions from media companies on the sale of media time and/or space represent the largest contribution to revenue, with the MD&A - 4/12

5 key revenue source being commissions for advertising time and/or space through the four traditional mass media formats. The main factors affecting revenue from advertising in these traditional mass media formats are described below: Domestic advertising expenditures, which fluctuate with new industry realities such as general economic conditions, technological innovations, deregulation and heightened competition The Group s competitive position vis-à-vis other advertising companies in Japan Rates charged by media companies for media time and/or space Changing advertiser needs for advertising across different media There is a strong correlation between the state of the Japanese economy and increases in domestic advertising spending. Therefore, management applies nominal gross domestic product (GDP) growth as a point of reference when gauging trends in advertising spending. In the fiscal year under review, the direction of the Japanese economy remained uncertain despite continuing signs of a rally in production activity, which had stalled due to consequences associated with the Great East Japan Earthquake, fears of economic slowdowns overseas, highly fluctuating exchange rates and skyrocketing oil prices. In this operating environment, 211 Advertising Expenditures in Japan prepared by Dentsu for calendar 211 revealed that domestic advertising spending totaled 5,79.6 billion yen (down 2.3% from calendar 21). This marked the fourth consecutive year of decline. By media, advertising expenditures in the four traditional mass media categories fell from the 21 level (down 2.6%), and promotional media also declined (down 4.6%). However, satellite media advertising showed double-digit growth (up 13.6%), thanks to wider use of televisions compatible with terrestrial and broadcast and commercial satellite relayed programming. Also, the debut of new approaches, such as social media applications, sustained the upward trend in Internet advertising (up 4.1%). The Internet is firmly in second place, behind television, as the medium garnering the most contact time in homes across Japan. As the media environment evolves, the needs of advertisers become increasingly sophisticated. Advertisers are particularly interested in effective and efficient media planning that integrates the Internet, mobile and other interactive media with the traditional mass media formats. Increasingly, they seek verification of advertising effectiveness. To accurately address these client needs, the Dentsu Group strives to provide Integrated Communication Design solutions. Recent trends indicate heightened appreciation for integrated services that cover a broad spectrum of media domains as well as tools that verify cost efficiency and advertising effectiveness. This will undoubtedly result in an increase in the number of transactions between advertisers and full-service advertising companies. The Group frequently provides promotional services and other advertising services in combination with advertising in the four traditional mass media. For example, in promotional services, clients typically combine advertising campaigns in traditional mass media with point-of-purchase (POP) displays, promotional events and other approaches to encourage consumers to buy the client company s products or subscribe to its services. Demand for traditional mass media advertising may fluctuate independently of demand for combined services, but the factors that influence one type of advertising will impact the other types as well. The Group also secures revenue from services related to entertainment and sports marketing. These services include the production, marketing and establishment of marketing tie-ins for, and the selling or brokering of, sponsorship, broadcasting and other rights to such content as movies, sports events, music and other forms of entertainment. A breakdown of revenue from such services shows net proceeds or commissions on the purchase and sale of content- MD&A - 5/12

6 (Years ended March 31) (Billions of yen) Total Assets and Return on Assets (ROA) (%) (Billions of yen) Total Shareholders Equity and Equity Ratio (%) 1, , Total Assets Return on Assets (ROA) Total Shareholders Equity Equity Ratio related rights, returns on rights or interests in content owned as well as payments for services. Revenues may vary, depending on such factors as the location and timing of the entertainment and sports events, the terms under which companies under the Group umbrella acquire the rights, the level of consumer demand for, or interest in, the associated content, and the level of demand for these rights, especially by advertisers and broadcasters. of Group companies vis-à-vis other advertising companies, as well as market practices regarding remuneration for services, and shifts in demand among clients for advertising in different media. Exchange rate fluctuations between the yen the reporting currency for the Company s consolidated books and the currencies of other countries in which the Group operates may also have an effect on revenue from overseas advertising services. In addition, the Group earns revenue from solutions services, including customer relationship management (CRM), Selling, General and Administrative Expenses e-marketing and system configuration. Revenue from these services is not only affected by factors that impact advertising services but also investment trends pertaining to system development. The Group also obtains revenue from advertising services outside Japan. The issues that influence revenue domestically do not differ all that much from issues that impact revenue generated outside the country. But trends in revenue may differ among the countries in which the Group operates, based on such factors as the business climate in each country, developments in specific industries, the competitive position The largest component of SG&A expenses is employees salaries and allowances, including bonuses. Other significant components of SG&A expenses include the provision for retirement benefits, business consignment expenses, borrowing costs and welfare benefit expenses. In the fiscal year ended March 31, 23, Dentsu introduced a remuneration system linking a portion of employee compensation to the Company s financial performance to make personnel expenses more flexible. However, personnel costs may increase in the future, as the Company develops its human resources. MD&A - 6/12

7 Factors that affect the provision for retirement benefits include changes in the value of pension plan assets, the number of Group employees, the level of employee compensation and the terms of the pension and retirement plans. in the global arena and the digital domain, the Group will provide its clients with quality solutions. At the same time, the Group will address other priorities, such as the establishment of new business models, and integrate all these factors to further increase business opportunities. Depreciation costs incurred in connection with the consolidation of Dentsu s offices into the new Head Office building in Shiodome in November 22 peaked in the fiscal year ended March 31, 24, and continue to decline. Depreciation costs are partially offset by rental income from tenants in the Head Office building and an adjacent building. Current Status of Management Strategies and Outlook The unprecedented Great East Japan Earthquake that occurred in March 211 and the subsequent accident at the Fukushima Daiichi Nuclear Power Plant precipitated a slump in corporations communications activities and consumer confidence, adversely affecting the Japanese advertising market. However, the Dentsu Group is moving steadily forward with various measures based on its medium-term management plan, Dentsu Innovation 213, which has guided the Group since July 29. For Dentsu to accomplish the targets set in Dentsu Innovation 213 and to achieve sustainable growth in the long term, with the challenging operating environment likely to persist, it is essential that the Group fully meet its stated business objectives while at the same time establish itself as the most preferred partner for its clients by contributing to their growth. Never satisfied with the status quo, the Group will embrace change as its ally and pursue Good Innovation. By connecting the diverse values brought forth as it moves steadily forward, the Group will address various new projects with the aim of becoming a business group that delivers greater synergy to society at large. By incorporating technology-driven new consumer insights as well as the latest communication methods practiced Analysis of Capital Resources and Cash Liquidity Assets, Liabilities and Net Assets As of March 31, 212, total assets stood at 1,21.8 billion yen, an increase of 68.5 billion yen compared with the end of March 211, owing to increases in cash and deposits as well as notes and accounts receivable trade. Total liabilities amounted to 645. billion yen, 23.8 billion yen higher than at the end of the previous fiscal year as an increase in notes and accounts payable trade exceeded a decrease in the amount of loans payable. Buoyed by net income of 29.5 billion yen, net assets totaled billion yen, or 44.7 billion yen more than at March 31, 211. Cash Flows As of March 31, 212, cash and cash equivalents (hereinafter cash ) increased to billion yen from the billion yen posted at the end of the preceding fiscal year. As net cash provided by operating activities and net cash provided by investing activities exceeded net cash used in financing activities, cash at the end of the fiscal year under review increased by 44.2 billion yen from the previous fiscal year. Net cash provided by operating activities amounted to 26.3 billion yen compared with 72.9 billion yen in the previous fiscal year. Net cash provided by operating activities decreased by a total of 46.5 billion yen compared with the previous fiscal year even though income before income taxes and minority interests was higher year on year, mainly because of a significant increase in notes and accounts receivable trade MD&A - 7/12

8 Net cash provided by investing activities amounted to 45.9 billion yen, a reversal from the 1.8 billion yen in net cash used in investing activities in the previous fiscal year. The reason for the 47.7 billion yen change reflects a considerable increase in proceeds from sales of investment securities. The Japanese rating agency Rating and Investment Information, Inc. (R&I) has assigned a rating of AA to Dentsu s long-term debt and a rating of a-1+ to its short-term debt. Management Issues and Future Policies Net cash used in financing activities amounted to 27.3 billion yen compared with 29.3 billion yen in the previous fiscal year. The 2. billion yen change is primarily due to an increase in short-term loans payable and a decrease in repayments of lease obligations. Capital Requirements The Group s principal working capital requirements are payments for the purchase of advertising time and/or space and the production of advertisements, as well as personnel costs and other SG&A expenses. In recent years, capital requirements have increased for investments in the digital and global domains in the course of exploring different advertising opportunities. Financial Policy The Group satisfies working capital requirements from internal reserves, short-term borrowings and the issuance of commercial paper. Constant efforts on a Group-wide basis to improve current assets foster a positive working capital position (current assets minus current liabilities) on a consolidated basis. In the previous fiscal year and the fiscal year under review, consolidated working capital exceeded billion yen and 197. billion yen, respectively. The domestic economy suffered major blows due to the sudden global economic slowdown in 28, triggered by the U.S. financial crisis, and then resulting from the impact of the Great East Japan Earthquake that occurred in March 211 and the subsequent accident at the Fukushima Daiichi Nuclear Power Plant. The situation has made the management issues that the Group s clients are facing even more complex. Meanwhile, the business environment surrounding the Group is changing, fueled by new consumer behavior and the emergence of new communication methods such as social media. Amid this transformation, management believes it is vital for Dentsu to establish its position as the best partner for its clients by being committed to their growth while fully meeting the business objectives stated in the medium-term management plan. To that end, the Group will further advance its transformation to a creativity-driven organization, one that is not bound by conventional advertising agency practices, by making the most of its three core competencies: marketing intelligence, the consumer insight capability which led to Dentsu s reputation as the company that understands consumers best ; creativity, the ability to generate competitive ideas; and the Group network, which facilitates optimization of the expertise and diversity of its individual members. The Group will continue to evolve with its clients while growing its profitability. To ensure short-term liquidity, a 4 billion yen commitment line was established with a syndicate of banks for Group use. To improve cash management, a Group-wide finance system is in place that enables almost all domestic consolidated subsidiaries that require funding to borrow funds acquired for this purpose from other domestic consolidated subsidiaries with excess cash. Operating and Other Risks The operating results, share price and financial position of Dentsu, and by extension, the Dentsu Group are subject to various risks, as described below. Any forward-looking statements in the following discussion MD&A - 8/12

9 are based on the judgment of management as of the date of filing the securities report. Overall Industry-related Risk Risk related to fluctuations in the economic and business environments The financial results of the Dentsu Group and other companies in the advertising industry are highly susceptible to changes in the market and business conditions because many advertisers adjust their spending in response to changes in these conditions. Management believes that the development of an Internet-based advertising method should contribute to expanding the overall advertising market by raising synergies between advertising in the four traditional mass media and Internet advertising. Already, the Dentsu Group has secured a leading position not only in advertising in the four traditional mass media but also in Internet advertising, and is seeking to explore and expand further business opportunities. However, if the Group cannot cope appropriately with changes in the media structure, financial results could be adversely affected. Management has taken steps, such as diversifying the types of services the Group provides, to reduce exposure to the impact of fluctuations in the economic and business environments. Nonetheless, since net sales in Japan account for 86.% of the Dentsu Group s consolidated net sales, the Group s financial results may be influenced by domestic macroeconomic trends and fluctuations in the operating environment of key domestic industry sectors that have significant advertising expenditures. In addition, changes in overseas business conditions, namely, an economic slowdown and exchange rate fluctuations, may also influence domestic business conditions. The Great East Japan Earthquake that occurred in March 211 adversely affected the Japanese economy. Going forward, the economic environment is likely to undergo significant changes, for various reasons, and it is difficult at the present time to accurately gauge the effects of such changes on the Dentsu Group s operations. Risk related to structural changes in the media According to 211 Advertising Expenditures in Japan (issued by Dentsu), Internet advertising expenditures have continued to grow since the first survey in 1996 and have reached a level surpassing the amounts allocated to newspaper, magazine and radio advertising three of the four traditional mass media (newspapers, magazines, radio and television). Risk related to common business practices The common practice in Japan is for advertising agencies to purchase time and/or space from media companies on their own behalf, rather than on behalf of advertisers. Accordingly, Dentsu Group companies are liable for payment to media companies regardless of whether they receive payment from their advertiser clients. This practice exposes the Group to the risk of default should a client s business fail. The nature of the advertising business is such that sudden changes in advertising proposals and actual advertisements are frequent. The Dentsu Group strives to preclude problems related to work for clients by encouraging the conclusion of basic written contracts with them, but unforeseen incidents or disputes with clients might arise. Overseas, especially in Europe and the Americas, relationships between advertisers and advertising agencies are usually exclusive within a particular industry. In Japan, however, these relationships are typically less exclusive. Accordingly, the Dentsu Group, like other advertising agencies in Japan, handles multiple clients in a single industry. If the practice in Japan were to change in favor of exclusive relationships, however, and if the Dentsu Group s efforts to respond to this change were ineffective, its financial results could be adversely affected. MD&A - 9/12

10 Competition-related Risk Risk related to competition among advertising agencies Competition among Japan s advertising agencies is intense. Reorganization and mergers among domestic companies and the entry into the market of multinational advertising companies could alter the structure of Japan s advertising industry. Going forward, the Dentsu Group s financial results could be adversely affected by increased competition to secure clients if the Group is unable to respond appropriately to changes in the structure of the industry or standard business practices prompted by the entry of multinational advertising companies. Risk related to competition from new market entries and from adjacent industries The rapid expansion and diversification of the advertising field is giving rise to competition from an increasing number of companies in adjacent industries, including general trading and consulting companies. Fields related to Internet advertising and social networking services (SNS) are also seeing a sharp increase in the number of new market entrants companies with which the Dentsu Group competes in the development and expansion of new businesses. If the Group is unable to respond appropriately to client needs in such business domains from either a service or a cost perspective, or if the entrance of new companies into these new markets suddenly causes rapid changes in customary advertising business practices, the Dentsu Group s financial results could be adversely affected. Risk Related to Advertisers and Media Companies Dentsu has formed business ties with major advertisers in Japan and has maintained stable, long-term relationships with a large majority of its current clients. In the fiscal year under review, net sales to the Company s top ten clients (in terms of billings) accounted for approximately 2% of total net sales. Dentsu has established a solid foundation for business development through the operations and sales activities of Japan s mass media companies. This underpins the Company s ability to coordinate issues with advertisers and media companies and facilitate transactions. However, if the Company is unable to provide services that match the needs of existing or new advertisers or media companies, business relationships may be ended, accounts may shrink and the terms of business may change. This could adversely affect the Group s financial results. In recent years, advertisers have become increasingly keen to consolidate their media service activities with one advertising agency to boost advertising efficiency and reduce costs. As a result, a decrease in the profitability of advertising in the mass media can be seen. If this trend persists, the Dentsu Group s financial results could be adversely affected. Risk Related to Efforts to Reinforce Domestic Service Capabilities Risk related to the development of systems and databases The Dentsu Group is currently involved in research and development on computer systems and databases that verify the effectiveness of clients advertising activities and marketing budgets. Through these efforts, management seeks to bring latent demand to the surface and increase the Group s share of the domestic advertising market. However, it is unclear when the results of these efforts will be marketable and put to practical use. Moreover, even if that time comes, the Group s R&D activities may not produce the desired services, especially if the needs of clients have changed significantly or technological difficulties preclude widespread use. Risk related to investments in media and Internet advertising businesses To reinforce its position in the media markets, the Dentsu Group has made investments in the four traditional mass media, MD&A - 1/12

11 out-of-home (OOH) media (billboard, transit and other OOH media) and satellite media (broadcast and communication satellite), as well as in related research and business development programs. However, if demand for media advertising becomes stagnant or competition in the media advertising market intensifies, profits and business results might not be commensurate with investments in R&D and commercialization. In the Internet advertising domain, as advertising methods diversify and demands from clients expand, the Dentsu Group has been actively establishing alliances with leading, specialized agencies as well as investing in specialized companies and technologies. These moves support the Group s efforts to further promote and propose cross-media campaigns that are aimed at creating effective synergies among multiple media and creatives that are in sync with target consumers behavior patterns. Another prominent advertising method on which the Group is focusing is search engine advertising, in which an advertiser s ad appears on the PC/mobile phone display when a consumer searches for a keyword that has been purchased by the advertiser on the Internet. However, if the Group s responses fail to adequately address the rapid progress in technologies and services associated with the Internet advertising domain, the business results might not be commensurate with initial expectations at the time of investment. Risk related to expansion of the promotion business The importance of promotional activities has been rising for advertisers, and the market is expanding. Taking advantage of this opportunity, the Dentsu Group has established several specialized companies in promotion-related fields such as POP marketing, flyer production, direct business and client access in order to expand future promotion business. However, if demand for these services falls short of expectations, or if the Group is unable to maintain competitiveness against other solutions providers, the Group s investments might not expand business as planned. Risk Related to Content Business The Dentsu Group actively invests in the acquisition of rights to, and in the production of, films, television programs, sports events and music, and generates profits from the production, distribution, sale and licensing of films and other content as well as from the sale of sponsorships, broadcasting rights and content-related advertising. However, projects may extend over several fiscal years and require a considerable amount of acquisition costs and financial commitment. In addition, media that provide content have been diversifying in recent years. Moreover, the success of the Group s content business depends on general public reaction, which can be difficult to predict. Therefore, if these business efforts do not develop as planned or do not realize the benefits expected, the Group s financial results might be adversely affected. Risk Related to Global Businesses The Dentsu Group conducts its business activities outside Japan through its own network and through alliances with other companies. In the fiscal year under review, sales in markets outside Japan accounted for approximately 14.% of the Group s consolidated net sales. Management recognizes that building a global business portfolio is essential to the Group s future growth and is thus working to expand operations through such approaches as M&A involving local companies in overseas markets. However, the development of a stronger overseas presence may require considerable financial investment, and competition among advertising companies has intensified. Therefore, if the Group s overseas businesses fail to progress or are unsuccessful, financial results might be adversely affected. The BRIC nations and Asian countries where the advertising market has shown remarkable growth are the primary targets of the Dentsu Group s focus on expanding operations through its original network. These markets, however, MD&A - 11/12

12 remain underdeveloped in terms of the advertising business. If political and economic conditions, legal restrictions, business practices and other factors in these regions do not develop as predicted, the Group s financial results might be adversely affected. Risk Related to Maintaining and Developing Human Resources The growth potential and competitive edge of the Dentsu Group are highly dependent upon attracting, keeping and developing excellent human resources. Therefore, companies under the Group umbrella strive to bring in the necessary talent by hiring a stable number of new graduates and by recruiting mid-career professionals with expertise and experience that will make an immediate impact. At the same time, the Group endeavors to promote development by offering training opportunities according to the position and ability of each individual. However, these efforts could be sidetracked for all sorts of reasons, making it difficult to attract exceptional people or keep them within the Group. If this were to occur, the Group s growth potential and its competitive edge might be adversely affected. Risk Related to Legal or Regulatory Changes are introduced, or if existing laws and regulations are reinterpreted. Members of the Group handle personal and other advertiser information in the course of doing business. The Dentsu Group s information security system is certified to international standards, and the utmost care is given to safeguarding information entrusted to the Group. However, in the unlikely event of an information leak or other such incident occurring, the Group s credibility could be severely compromised. This could adversely affect its financial results. Risk of Litigation The Dentsu Group could become involved in litigation brought against it directly or indirectly in association with the execution of business by members of the Group, including claims by clients, organizations, consumers or owners of intellectual property. The Group was involved in litigation brought by several entities which were operating a live music club as a partnership business, and is being asked to pay subcontracting and lease fees with regard to a fictitious order made by an ex-dentsu employee who misused the name of the Company and the partnership. Advertising companies in Japan, including those under the Dentsu Group umbrella, are subject to a number of laws and regulations, including the Act against Delay in Payment of Subcontract Proceeds, Etc. to Subcontractors and the Act on the Protection of Personal Information. At the current time, management does not anticipate that these laws and regulations will have any material impact on the Group s business. However, the financial results of the Dentsu Group and other advertising companies could be adversely affected if existing laws or regulations governing the advertising activities of advertisers or the format or content of advertisements are strengthened, if new laws or regulations MD&A - 12/12