Seiko Epson : Financial Strategies

Epson	CEO Message	Corporate Vision	Value Proposition	Financial	Value Creation	Sustainability	Value Creation	Fact Data	INDEX
Integrated Report 2021	Strategies	Strategy	Management	Platforms

CFO Message

Keeping Capital Costs Under Control

to Achieve Our Goals, Epson 25 Renewed

Tatsuaki Seki

Director, Managing Executive Officer

General Administrative Manager, Corporate Strategy and Management Control Division / Sustainability Promotion Office

CFO

Epson 25 Renewed presents a goal of future growth that emphasizes profitability, marking a departure from an excessive focus on revenue growth.

Accordingly, we have grouped our businesses into a growth area, mature area, and new area. In addition to executing strategies suited to each area, we will accelerate key environment, digital transformation, and co-creation strategies that span the areas. My role here is to ensure that we have the best possible financial strategy to support this effort.

New Performance Metrics to Keep Us On Course

To track the performance of investments under Epson 25 Renewed, we will use return on equity (ROE) as we have done in the past, but we will also use return on invested capital (ROIC). We once thought that inefficient investments were acceptable as long as they delivered revenue and profit. Recognizing our error, we now use ROIC to make sure we are spending our capital resources as efficiently as possible. Likewise, to track business performance over the medium and long term, we now use return on sales (ROS) instead of revenue. We stopped disclosing revenue because, given the uncertain business outlook, the assumptions underlying these forecasts could easily prove wrong. We consider a range of factors in addition to ROS, such as the performance and outlook in each business and whether we are on course to reach our goals. As announced in January 2021, we sold off our IC test handler business to Kanematsu. I doubt we could have made this decision if we had judged the business purely on revenue and profit. Keeping a close watch on capital efficiency will be particularly important for investments in co-creation (one of the key priorities).

Epson 25 Renewed sets the following goals for fiscal 2025: >11% ROIC, >13% ROE, and >10% ROS. These goals may seem daunting at first glance, but they are eminently achievable given that our existing investments are already bearing fruit. Key to success will be greater control over capital costs.

Consolidated
FY2020		FY2021	FY2023	FY2025
Financial Targets
	ROIC 1	5.6%		6.4%	8% or more	11% or more
	ROE 2	5.9%		8.5%	10% or more	13% or more
	ROS 3	6.2%		6.5%	8% or more	10% or more

1. ROIC = Profit for the year attributable to owners of the parent company / (equity attributable to owners of the parent company + interest-bearing liabilities)
2. ROE = Profit for the year attributable to owners of the parent company / equity attributable to owners of the parent company
   Equity attributable to owners of the parent company and interest-bearing liabilities are calculated using the average at the beginning and end of the period

ROS = Business profit / revenue3

23

Epson	CEO Message	Corporate Vision	Value Proposition	Financial	Value Creation	Sustainability	Value Creation	Fact Data	INDEX
Integrated Report 2021	Strategies	Strategy	Management	Platforms

CFO Message

Differentiated Investment Based on Contribution

to Growth and Earnings

A key aim of Epson 25 Renewed is to improve capital efficiency. We do this by managing our business portfolio in a way that creates efficient capital circulation. We are no stranger to portfolio management, but until now we have only looked at the outcomes and fiscal viability of existing investments and the areas where spending is heavy. Since Epson 25 Renewed has given us a clearer idea of our financial priorities, we can now allocate capital in a more differentiated and targeted manner.

Accordingly, we have grouped our businesses into the three areas based on growth and earnings. We prioritize spending on businesses in the new area that promise future growth and in the growth area. Meanwhile, we subject businesses in mature areas to a review to determine whether they are likely to deliver stable earnings or whether they need restructuring. Thus, in conjunction with the product lifecycle, we create a lifecycle for each business area by clarifying the position of the businesses, giving them the right budgets and goals, and then periodically reviewing them. We will consider, in addition to financial factors, business synergies and the social value the businesses produce. As well as tracking our overall ROIC, we will track business-specific ROIC to see how efficiently each business is performing. In this way, we are leveling-up portfolio management.

Setting Area-specific Goals to Improve Overall ROS

For each business area, we set goals appropriate to how the area is positioned.

In the growth area, we aim to expand the businesses by leveraging Epson's assets. For example, the businesses will switch from analog to digital and use our inkjet technology to innovate. We do aim to raise the revenue growth rate of these businesses (targeting a compound annual growth rate of >15%), but we will also consider profitability when allocating budgets.

In the mature area, we will track ROS as part of an effort to maintain or increase the profitability of these businesses. In home printing and microdevices, we have maintained our target of 15% ROS, as we expect steady growth in these businesses. For the projection and watch businesses, which require restructuring, we have set a target of >10% ROS. The watch business was hit somewhat by Covid, so it may take time to recover. The projection business has restored profitability thanks to progress in restructuring. We will keep making improvements in both businesses.

Our priority in the new area is to launch startups, and we have set a target of ¥10 billion. We particularly want to achieve our targets in the environmental category, one of the strategic priorities of Epson 25 Renewed.

Through these area-specific strategies, we hope to achieve a total ROS of >8% by fiscal 2023, and an ROS of >10% by fiscal 2025.

Efficient Fund Circulation Through Business Portfolio

High	New	Growth
	Sensing	Office printing
	Environmental business	Commercial & industrial printing
Company		Printhead sales
	Production systems
Growth	Mature	Mature
(Structural changes)	(Profitability maintenance)
Projection	Home printing
	Watches	Microdevices
	IC test handlers	Flow of funds
Low Low
Business transferred4	Profitability	High

4 Concluded a business transfer agreement with Kanematsu Corp. on Jan. 28, 2021

Clarify the role/importance of business areas according to product life cycles

Final decision made by also considering factors such as synergies between businesses and social value

Allocate funds and set targets according to business priority

Direction of Business Operations and Targets	FY2021-FY2023	from FY2025		Targets
	• Office printing									FY2020→FY2025 revenue
Growth	• Commercial & industrial	Growth strategies
printing		CAGR +15% or more
	• Printhead sales
	• Production systems
	• Projection									FY2020→FY2025 ROS improvement
	Structural changes
						+10 pt or more
Mature	• Watches
• Home printing	Profitability maintenance & improvement		Sustained ROS of
		15% or more
	• Microdevices
	• Sensing									FY2025 revenue
New	Business launch			Growth
• Environmental				¥ 10 billion or more
	business							strategies

Group ROS targets FY2023 8% or more FY202510% or more

24

Epson	CEO Message	Corporate Vision	Value Proposition	Financial	Value Creation	Sustainability	Value Creation	Fact Data	INDEX
Integrated Report 2021	Strategies	Strategy	Management	Platforms

CFO Message

Continuous and Stable Shareholder Returns Alongside

Targeted Investment in Future Growth

Regarding cash allocation, we have budgeted ¥320 billion in cash flows from operating activities for the three-year period starting fiscal 2021. Of this, we have earmarked ¥180 billion for growth capital expenditure. While prioritizing spending on the growth and new areas, we will also invest in environmental initiatives, in digital infrastructure for streamlining business processes and saving labor, and in an outward-looking digital transformation̶which will include using analytics to enhance the customer experience. The amount of expenditure will be less than what we have spent in the past. We completed a large spending program last year, and we have now created a product platform for the commercial and industrial sectors, which are set to grow.

As for shareholder returns, we remain committed to delivering a continuous and stable dividend, while repurchasing shares when necessary. Our benchmark for consolidated dividend payout ratio is 40%. We have also earmarked ¥70 billion to bolster our financial structure. To navigate these uncertain times, we need a shareholders'equity ratio of at least 50%, and to raise this to 55% in the longer term. In strengthening financial condition, we will consider a range of factors, including our financing needs.

Green Bond-funded Environmental Investments to Become

Carbon Negative and Underground Resource 5 Free

Environmental Vision 2050 (updated in March 2021) commits us to becoming carbon negative and underground resource free. As our cash allocation demonstrates, we are stepping up environmental initiatives. We will spend some ¥100 billion on these initiatives up to 2030. The initiatives include

3-year cumulative (FY2021-23)	Billions of yen

Investment

Approx. 180

Cash flows from

operating activities

Approx. 320 Shareholder returns Approx. 70

Strengthening

financial condition

Approx. 70

Investment to maintain competitiveness and improve productivity in mature areas Active investment, including in M&A, in new and growth areas, environment-related, digital infrastructure development, etc.

Dividends

Consolidated dividend payout ratio of approx. 40%

Share repurchase

Implement as needed, taking into account share price, financial situation, and other considerations

Repayment of interest-bearing liabilities, etc.

decarbonization, closed resource loop, and environmental technology development. To give an example, PaperLab uses Dry Fiber Technology to turn waste paper into new paper, but we want to use this technology to recycle paper into other materials too. In another example, we recently teamed up with Euglena and NEC to develop a biomass plastic called pararesin. Together with these partners, we founded Pararesin Japan Consortium to promote the biomass plastic.

As well as making our own production facilities sustainable, we want our products to achieve a high level of environmental performance. Accordingly, we have committed to ecologically sustainable finance. In July 2020, we issued our first green bond. We used some of the funds to top up our cash on hand, which we had spent on buildings and facilities covered in the green bond program. We also used some of the money to fund R&D and capital expenditure for inkjet printers. Almost all of our activities can be covered by green bonds. We will combine our efficient, compact and precision technologies with co-creation through open innovation to improve the environmental performance of our products and business activities and to reduce environmental impacts across the value chain.

5 Non-renewable resources such as oil and metals

25

Epson	CEO Message	Corporate Vision	Value Proposition	Financial	Value Creation	Sustainability	Value Creation	Fact Data	INDEX
Integrated Report 2021	Strategies	Strategy	Management	Platforms

Responding to TCFD

Recommendations

Climate change is greatly impacting society and Epson sees it as a significant societal problem. The goal of the Paris Agreement is to achieve decarbonization and limit the global average temperature to well below 2°C above pre-industrial levels and try to limit the temperature increase to 1.5°C. To achieve this, Epson is working to reduce total emissions in line with a 1.5°C scenario 1 by 2030. Furthermore, Epson coordinated the revision of Environmental Vision 2050 with the announcement of the Epson 25 Renewed Corporate Vision. To attain our goals of becoming carbon negative and underground resource free 2 by 2050, we are working to decarbonize and to close the resource loop. We are also providing products and services that reduce environmental impacts and developing environmental technologies.

Since Epson declared its support for the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) in October 2019, it has disclosed information (on governance, strategy, risk management, and metrics and targets) based on the TCFD framework so as to enable good communication with shareholders, investors, and a broad spectrum of other stakeholders. Epson has decided to disclose the level of financial impact in 2021 in a quantitative manner for the first time.

1 Target for reducing greenhouse gas emissions aligned with the criteria under the Science Based Targets initiative (SBTi)	2 Non-renewable resources such as oil and metals
Scenario Analysis Findings	Governance

We analyzed scenarios based on the TCFD framework to quantitatively assess the financial impact of climate-related risks and opportunities on Epson's strategy. In a 1.5°C scenario in which there is rapid decarbonization of society, we found that there is transitional risk of an increase in operating costs due to market changes, policies, and legislation, but we expect to limit the financial impact by strengthening products and services based on inkjet technology and paper recycling technology.

Epson will spend 100 billion yen over a period of 10 years ending in 2030 to accelerate decarbonization, close the resource loop, and develop environmental technology. The solution to climate-related risks aligns with the materialities we have set of achieving sustainability in a circular economy and advancing the frontiers of industry and will lead to opportunities for business expansion with Epson's low environmental impact products and services that save electricity and reduce waste. These products and services will help to mitigate customers'environmental impact and control climate change.

Based on the results of these analyses, Epson will continue to try to maximize its opportunities while addressing recognized risks in order to achieve decarbonization, which we believe is a rational goal both for society and for Epson.

On the other hand, even in a 4°C scenario in which global warming has advanced because the world failed to take additional measures, we found that the impact of physical risks on our domestic and overseas sites due to the damages arising from weather extremes would be small.

Main Climate Change Initiatives

Important matters related to climate change are supervised by the board of directors, which receives reports at least once a year after deliberations by the Sustainability Strategy Council, which formulates medium- to long-term strategy for the Epson Group's sustainability activities and reviews the status of implementation as the president's advisory body.

In addition, Seiko Epson's president and representative director, the individual who has the highest responsibility and authority for climate-related issues, delegates responsibility for climate-related issues to the Sustainability Director, who heads the Sustainability Promotion Office and manages and promotes climate change initiatives, including TCFD.

Promotion
Organization			Board Meeting
			President
							Sustainability Strategy Council
			Sustainability Officer (board director)			Sustainability Management Committee
			Sustainability	Promotion Office				Functional supervisory department
		Executive organizations				Functional supervisory department

	• Declared support for the TCFD		• Qualitatively disclosed the financial impact		• Revised Environmental Vision 2050 and set clear
		based on the disclosure recommendations of the		objectives, including becoming carbon negative
	recommendations
FY2019	FY2020	TCFD framework (2°C scenario)	FY2021	• Quantitatively disclosed the financial impact
• Studied risks of natural disasters caused by
		• Studied risks of natural disasters caused by		based on the disclosure recommendations of the
	climate change (2°C scenario and 4°C scenario)
		climate change (1.5°C scenario)		TCFD framework (1.5°C scenario)

26

Epson	CEO Message	Corporate Vision	Value Proposition	Financial	Value Creation	Sustainability	Value Creation	Fact Data	INDEX
Integrated Report 2021	Strategies	Strategy	Management	Platforms

Responding to TCFD

Recommendations

Strategy

Epson has determined that achieving sustainability in a circular economy and advancing the frontiers of industry are material matters in its value creation story. To achieve these, we will further reduce greenhouse gas (GHG) emissions by leveraging our efficient, compact, and precision technologies to drive innovation.

Scenario Analysis of	Epson identified and evaluated scenarios in the categories of transition risk, physical risk, and opportunity to
evaluate the importance of climate-related risks and opportunities. Six risks and opportunities were singled out
Climate-Related Risks	for evaluation. We evaluated the business impact and financial impact of each on the basis of the scenarios
corresponding to temperature increase of 1.5℃ presented by the Intergovernmental Panel on Climate Change
and Opportunities	(IPCC) and the International Energy Agency (IEA) as well as on the basis of internal and external information. The
	results of the evaluation of climate-related risks and opportunities based on this scenario analysis are as follows:

Climate-Related Risks and Opportunities in a 1.5°C Scenario

The results of evaluating climate-related risks and opportunities based on scenario analysis are as follows.

Scenario

Internal information

Causes

Financial information

Evaluation

・Revenue

・Expenses, etc.

of the importance

Event

of climate-related

risks

SBTs

・Scopes 1, 2, 3

Scenario

Effects

identification &

Business impact

evaluation

by impact category

(1.5°C)

Evaluation

of business impact

& examination

of countermeasures

Financial impact

(1.5°C)

External information

Climate change scenario

・IPCC

・IEA

Hazard information

・National & local government hazard maps ・International regional hazard information

External information

・Market trends

・Consumer trends

Category

Evaluated risks & opportunities

Actualization

Business impacts

•

We were unable to detect a strong relationship between climate change and the change in paper demand, but demand for printing and communication paper is

• Paper demand

Short-term

Impact

assumed to be on a declining trend. Even if that shift to paperless advances further due to changes in trends due to COVID-19 (such as the contraction of office printing

because of decentralization), we expect that the financial impact from the strengthening of products and services based on inkjet technology and paper recycling

Market

technology (reduction of printing costs, reduction of environmental impacts, increase of ease of printing, appeal using usefulness of paper information) will be limited.

Transition

changes

(Initiatives in Environmental Vision

•

"Decarbonization"of products and services as well as the supply

● Decarbonization

• Energy-saving facilities • Greenhouse gas removal

risks

Policy &

• Closed resource loop

toResponse

• Renewable energy use

laws and

chain and advanced initiatives in"resource recycling"are needed to

• Extend product service lives

2050)

• Supplier engagement

• Carbon-free logistics

regulations

• Decarbonization

Short-term

Impact

respond to"climate change"and"resource depletion,"which are

● Closed resource loop

• Minimize production losses

social issues shared globally.

• Effective use of resources

• Environmental technology

•

Scientific and specific solutions are necessary to develop

risks

Environmental technology development

environmental technologies linked with the rapid decrease of

●

development

environmental impacts.

• Dry fiber technology applications • Naturally derived (plastic-free) materials

• Damage to business sites due to

• Material recycling (metal, paper) • CO2

absorption technology

Physical

Acute

•

Based on the results of the latest FY2021 risk assessment for 36 sites (17 sites in Japan and 19 sites overseas), the changes in future operational risks due to

floods, etc.

Long-term

Impact

flooding (rivers overflowing) and high tides are limited.

risks

Chronic

• Damage to business sites due to

•

Short-term climate change risks to the supply chain will be addressed in line with our business continuity plans.

rising sea levels

Business

• For the growth areas of"Epson 25 Renewed,"a CAGR (compound annual

(Initiatives in"Environment Vision

Assumed

•

The need for environmentally friendly products and services will

growth rate) of 15% is expected for revenue growth by providing 1) office

Short-term

printing, commercial & industrial printing and printhead sales utilizing inkjet

Products

2050")

scenarios

increase due to the introduction of a carbon tax, soaring electricity

opportunities

technology to achieve a reduction of environmental impacts, increased work

• Customer environmental impact

prices, rising waste disposal costs, sustainable production amounts,

environmental impacts.

productivity and reduction of printing costs and 2) production systems with

mitigation

and reduced resource use.

expanded use of new production devices to achieve a reduction of

Opportunities

and

Business

• As effective solutions for combatting global warming and responding to the shift

services

Assumed

•

and the field of waste treatment and effective utilization of resources.

eliminating plastics (packing and molding materials), creating new

Market growth is expected in the field of combatting global warming

to a circular economy, generate revenue by upcycling (enhancing functionality),

• Environmental business

Short-term

scenarios

•

Due to the shift to a circular economy, market growth is expected for

opportunities

high-value-added materials and carrying out other measures through the

plastic and metal recycling.

plastic,Bio-based

of plastics) and recycling of raw materials (metal and paper recycling).

recycled plastics, high-performanceBio-based

establishment of technologies, such as applications of dry fiber technology,

including paper recycling, development of naturally derived materials (elimination

Actualization Short term: ≤ 10 years

Medium term: 10-50 years

Long term: > 50 years

Financial Impact

Small: ≤ 1 billion yen

Medium: 1-10 billion yen

Large: >10 billion yen

Financial impact

Small

Invest a total of approximately ¥100.0 billion by 2030

Small

Large

CAGR of 15% is

expected in growth

areas until 2025

Medium

27