Pivoting Its Business Model Under an "Every Employee an AI Instructor" Banner; Targeting JPY 10B Operating Income Through AI Frontier Lab and the CI/CS Integration

Summary

The License & Products (L&P) business drove last fiscal year's results, and both revenue and profit hit record highs. However, operating income fell short of the plan that had been revised upward mid-year. Management attributed the miss to delivery delays in product sales and a decision to prioritize groundwork on AI projects. This fiscal year, the company is merging its Cloud Integration (CI) and Cloud Services (CS) businesses to accelerate the shift toward an engineering services model. It aims to lift margins on three levers: billable headcount, utilization rate, and project pricing. Upfront investment in people, including a higher starting salary, comes first, and management has laid out a path to its FY9/28 operating income target.

Key Points (Earnings Takeaways and Growth Actions)

• Management Strategy and Market View
  • Management believes AI adoption has moved beyond initial deployment into operational implementation and value creation. Demand is strong for rebuilding data and cloud platforms and for adoption support.
  • The company uses itself as a showcase and builds hands-on experience internally. Management stressed that every employee should be confident enough to coach customers as an AI instructor.
  • Management expects demand for SIers that work directly with end-user companies as prime contractors to keep growing in the AI era. It acknowledged that its own organizational build-out is still insufficient.
  • In manufacturing and financial services, Japanese headquarters show strong demand for unified, centrally managed global IT environments. Global enterprise license agreements represent a sizeable opportunity.
• Current Business Progress and Drivers
  • The 0.8pt decline in CI segment margin reflects upfront investment in training and in internal AI and security infrastructure.
  • CS margin improvement came from efficiency gains as AI and automation were applied to systems already in place.
  • The operating income shortfall stemmed partly from project slippage caused by delivery delays in product sales. The company also shifted AI projects to an AI-driven development approach and prioritized preparation, which weighed on results.
  • L&P uses global enterprise agreements as an entry point to expand into ancillary products and cross-selling. Recurring revenue from consumption-based services such as Azure is also growing.
• Key Strategic Initiatives and Changes
  • From 1Q FY9/27, CI and CS will be combined into an Engineering Services business. The new two-segment structure reflects the fact that the line between system build and maintenance has disappeared.
  • The company is consolidating its top internal talent into AI Frontier Lab. The lab will serve as the core for everything from deal pursuit to SME (subject matter expert) support on advanced projects and talent development.
  • The starting salary has been raised to JPY 300,000, and overall pay levels are being reviewed. Salary revisions are expected to account for roughly 60% of the SG&A increase.
  • The company already covers nearly all 100 companies in the TOPIX Core30 and Large70. It is expanding capacity to meet requests for broader support and to win new customers.

Outlook and Strategy

• The FY9/27 plan calls for revenue of JPY 235B (+7.5%) and operating income of JPY 10.0B (+14.6%). Revenue, operating income, and recurring profit are all expected to hit record highs for a sixth consecutive year.
• Higher billable headcount, utilization, and pricing are expected to lift gross profit margin to 10.9% (+1.4pt). Gross margin improvement should add JPY 1.84B, while SG&A is projected to rise by JPY 3.56B.
• Earnings are expected to be more 2H-weighted than in prior years. This reflects front-loaded costs from the organizational build-out and the pace at which AI projects are accumulating.
• The Engineering Services business is targeting revenue of JPY 65B (+18.0%) and segment profit of JPY 11.40B (+21.0%). Customer referrals from L&P and an end-to-end support model are the key growth drivers.
• Net income is planned at JPY 6.30B (-10.1%). The effective tax rate will normalize as benefits from wage-increase tax incentives and similar measures fall away. The annual dividend will be maintained at JPY 50 (interim JPY 25, year-end JPY 25), implying a payout ratio of 37.8%.
• The company will continue to pursue business expansion and stronger earnings power toward its FY9/28 operating income target of JPY 12B.

Positive Factors

• Microsoft E7 bundles Microsoft 365 with security and AI into a single package. Management sees it as a definitive architectural answer and cited it as a driver of L&P revenue growth.
• Subsidiary NextScape is leading AI-driven development for physical AI. Management said customers have told them the work could only be done by NextScape and JBS.
• The company won a global tenant consolidation project at a global manufacturer with more than 100 group companies in Japan and overseas. It plans to extend its scope to supporting core system upgrades.
• For DENSO, the company supported the multi-agent AI system DAIKU from concept through operation. The case has been published, showing search times cut by roughly half.
• Management views AI and security as inseparable. It described cybersecurity as a never-ending source of demand and a driver of business scale.
• A low attrition rate means aggressive hiring and training translate readily into higher billable headcount.

Concerns and Risks

• The FY9/27 L&P plan calls for segment profit of JPY 3.30B (-2.4%) and a 1.9% margin. With inflation pushing up product prices, the company will prioritize fair pricing over profit.
• Revenue growth is planned to slow from last year. The company expects demand that L&P had been absorbing at a rapid pace to settle down.
• Higher working capital from L&P expansion pushed operating CF to JPY -2.2B. Accounts receivable rose by JPY 23.8B and short-term borrowings by JPY 9.3B, and the equity ratio fell from 36.4% to 29.9%.
• Factoring in higher interest rates, the FY9/27 plan assumes non-operating income/expenses of JPY -0.50B, versus JPY +0.29B last year.
• Supply delays in product sales were one reason for last year's shortfall. Projects remain at risk of slipping depending on hardware availability.
• Front-loaded personnel costs and a 2H-weighted plan may make 1H profit progress difficult to read.

Performance Highlights

FY9/26 revenue was JPY 218.5B (+26.6%), operating income JPY 8.72B (+14.9%), and net income JPY 7.00B (+24.5%), all record highs. Operating income reached 95.9% of the revised plan, while recurring profit of JPY 9.01B and net income came in line with plan (100.1% achievement). Gross profit margin was 9.5% (-0.9pt), reflecting a higher mix of low-margin L&P.

Segment Results

• EBITDA: JPY 9,881M (+13.0% YoY)
• ROE: 24.5% (+1.9pt YoY, our estimate)
• Core Operating CF: JPY 8B (+19.4% YoY, our estimate)
• Consolidated Headcount: 3,029 (+6.7% YoY, our estimate)
• Of Which Engineers: 2,378 (+10.9% YoY, our estimate)
• Attrition Rate: 6.1% (-0.7pt YoY, our estimate)
• Business Partner Ratio: 42% (+3pt YoY, our estimate)
• 4Q Revenue: JPY 50,703M (+25.3% YoY, our estimate)
• 4Q Operating Income: JPY 1,831M (+13.2% YoY, our estimate)

Q&A List

• Q

  For FY9/27 revenue and profit, do you expect any change in the 1H/2H split compared with FY9/26?

  A

  As explained at the outset, we are strengthening our organization, so costs will be front-loaded. In addition, looking at how projects are building up in FY9/27, led by AI-related demand, we currently expect a heavier 2H weighting than in the past.

• Q

  SI-centric IT services vendors, including your company, are all performing well. Some argue, however, that further AI adoption and greater in-sourcing by users call their very existence into question. What do you see as the purpose and role of IT services vendors going forward?

  A

  (President Makita) It is true that today's AI can cover a large portion of IT services. Programming and virtually everything else can be handled by AI. Against that backdrop, we deliver work and services directly to end-user companies as a prime contractor. Achieving digital transformation requires understanding customers' operations and embedding deeply with them to deliver services. That need naturally includes guidance on how to use AI, so IT and digital professionals must embed themselves ever more deeply within customers. SIers in that position remain busy, and demand is unquestionably growing. As an SIer that coaches customers directly, we feel we still need to strengthen significantly, and we plan to keep building out our organization.(Senior Managing Director Uesaka) As you point out, AI advances are changing the role and approach of SIers. The conversation is also shifting constantly. It moved from the need to use AI properly to how to manage token volumes as pricing shifted from SaaS to consumption-based models. Right after that, the focus turned to how well AI talent can leverage AI. Some now argue that tokens are like overtime pay and should be used freely if they generate value. We have moved beyond simply using LLMs; as technology evolves, customers' options are widening, and the question is how well we can guide those choices. We feel the need to move a step ahead and pass the results on to customers is, if anything, increasing. By learning ourselves and moving first, we become a showcase, and we sense that delivering this to customers will be needed for some time. One more point, on security. Many Japanese customers have an ingrained mindset of leaving systems untouched and locked down once built. We need to start by helping them build mechanisms that let them update in a timely manner and apply patches quickly without relying on extended special support. We must be able to provide a culture suited to the current era. We believe customers will fall into confusion unless we can lead them from a higher vantage point and ahead of the curve, and we intend to fulfill that role.

• Q

  What caused last year's operating income to fall short of plan?

  A

  There were several factors. In terms of major changes, the first was delays in product sales. We could only move projects forward once hardware availability was secured, so customer schedules did not proceed as planned. Distribution conditions had a not-insignificant impact. The second factor relates to AI. We switched to executing the projects we were pursuing through AI-driven development, and prioritized solidifying our footing over launching at scale. Taking the time to prepare properly as a step toward higher-difficulty work led to the slight shortfall.

• Q

  For the License & Products business, what is behind your expectation of higher revenue but lower profit this year?

  A

  One reason revenue is growing is our current focus on security and IT. Microsoft E7 packages the existing Microsoft 365 world tightly with security and AI. Having considered various architectures, I personally see it as a definitive answer, and we believe we can deliver its value to customers. That is the background to revenue growth. On the other hand, these products also involve elements such as token volumes, and the products themselves are affected by inflation. Considering customers' budgets, we will make careful judgments to offer them at fair prices. Rather than simply maximizing profit, we will determine appropriate pricing for licenses. Using that as a starting point and combining it with engineering services, we aim to raise overall operating income.

• Q

  SG&A is expected to rise by about JPY 3.6B YoY in FY9/27. How much of that do you expect to come from organizational expansion versus salary revisions?

  A

  Roughly 60% of the increase is salary revisions, and you can consider the rest to be organizational expansion.

• Q

  What net increase in employees do you expect YoY?

  A

  It is hard to give a precise figure because of mid-career hiring, but we are looking at a net increase of roughly 6% to 7% of total headcount.

• Q

  Is hiring focused on sales?

  A

  Hiring is overwhelmingly engineers.

• Q

  Revenue growth this year appears to be slowing compared with the past two years. What is behind this?

  A

  The License & Products segment has been the largest revenue driver, and we have been handling a rapid flow of requests from customers. We expect this demand to settle somewhat as the path for using AI becomes clearer. We intend to offer customers a balanced combination of engineering services and License & Products. As a result, revenue growth will be 7.5% versus last year. Rather than landing a large deal all at once and then chasing another the following year, we expect stable revenue this year. We see that as one factor.

• Q

  The recent wave of cyberattacks would seem to represent a major business opportunity for you. Is that the case?

  A

  Rather than a business opportunity, security is an area where customers are genuinely struggling. Addressing cyberattacks in particular is a never-ending effort. Alongside developing our engineers, we will provide best practices to customers. Demand is certainly rising, and we are expanding capacity. However, our priority is supporting customers properly rather than profiting from the situation. AI and security go hand in hand, and it is true that security will become a larger part of our business. But in our current conversations with customers, what we feel more strongly is not opportunity but a sense of urgency that failing to respond properly would be dangerous.