Serverworks Co.,Ltd. Q2 FY2026 earnings call

• Overall performance • Multiple one-off special factors overlapped in the second quarter, leading to a large year-over-year profit decline and a downward revision to full-year guidance; management apologized to shareholders and investors for the negative surprise. • Excluding these one-off factors, the company met its initial earnings guidance, and core operating performance and order intake remain solid. Operating cash flow continues to perform strongly, and stable profit generation is expected from the next fiscal year onward. • Management took accountability: the CEO and two internal directors accepted pay cuts to clarify responsibility for the issues.

• Strategic and operational updates • The company obtained AWS MSSP Competency, which confirms its capability to deliver managed security services under its "Sabasock" security brand, aligning with growing customer demand for cloud infrastructure security. • G-gen exhibited at Google Cloud Next Tokyo 2025, won 2nd place in a customer acquisition contest, and has strong momentum in the generative AI space aligned with Google Cloud's growth in this area. • Both Serverworks and G-gen have published unique customer generative AI use cases; adoption of generative AI is growing in software development and enterprise internal document search, with increasing customer demand. • The company already met its initial full-year hiring target, and has implemented additional hiring. It is on track to reach a total group headcount of approximately 548 by year-end, and AWS certification acquisition by engineers is near the 1,500 target. • Lifetime customer value continues to build steadily, with cumulative revenue from long-term customers growing consistently. • The core business model has a 90%+ recurring revenue ratio, generating stable cash flow to support both growth investment and shareholder returns.

• Dividend initiation • The company is initiating its first ever dividend, with a planned 25 yen per share dividend for the FY2026 February term end. • The target dividend payout ratio is 20% to 30% on a consolidated basis, with a minimum 1.0% target for return on equity (DOE).

1. Cloud Integration (Serverworks): The segment saw steady growth and serves as a key leading indicator for future resale and MSP revenue growth. Excluding the impact of the unprofitable project, growth would have been even stronger. Revenue contribution is tied to the core business flow that feeds into recurring revenue streams.
2. Resale (AWS-focused, Serverworks): AWS account count grew strongly in the second quarter, recovering from a large cancellation in the first quarter. ARPU is well controlled as the company actively consults customers to keep usage costs at appropriate levels to drive long-term retention. USD-based AWS usage continues to grow steadily, reflecting ongoing expansion of the overall AWS market.
3. G-gen (Google Cloud-focused): G-gen reported an operating loss of 3.54 billion yen in the second quarter, driven by a large unprofitable project that absorbed most of the segment's resources. This resulted in slightly weak overall growth, though its resale business continues to grow steadily. Group-wide: Total group second quarter revenue hit 18.736 billion yen, an 8.4% increase year-over-year. Group operating profit was 90 million yen, with Serverworks standalone posting 508 million yen in operating profit, almost entirely offset by G-gen's loss.

• Full-year consolidated guidance was revised downward: full-year revenue is 6% lower than the prior forecast, primarily due to yen appreciation impacts. Net income is expected to be a negative 877 million yen, driven by the unprofitable projects and full goodwill amortization for G-gen.
• There are no changes to the medium-term management plan's operating profit and ordinary profit targets, as all negative impacts in the current fiscal year are primarily one-off.
• There is no expected negative impact on profits from the next fiscal year onward; in fact, full goodwill amortization will eliminate 108 million yen in annual amortization expense, creating a positive profit impact starting next fiscal year.
• The company maintains its target of 1.4 billion yen in operating profit for the next fiscal year, and continues to invest in required talent and resources to hit this target.
• The company will continue to advance its core growth strategy centered on Strategic Collaboration Agreements (SCA), with unchanged focus on the three priority growth areas: generative AI, security, and overseas expansion.
• The revised guidance uses an average exchange rate assumption of 146.2 yen, which reduces future sensitivity to exchange rate movements.

• Large unprofitable projects occurred at both Serverworks and G-gen in the quarter: Serverworks recorded a 106 million yen negative impact, while G-gen recorded a 414 million yen negative impact. The G-gen project will run until mid-2026, but all expected losses have already been conservatively recognized in the current period to avoid carrying losses into the next fiscal year.
• A security breach outside of the company's responsibility occurred at a customer's environment, leading to excess AWS resource usage and a confirmed 98 million yen extraordinary loss for the company. The company is currently negotiating recovery with the customer, and no further losses are expected beyond this amount, though the total loss could decrease if partial recovery is achieved.
• G-gen failed to meet the original business plan from when it (formerly Topgate) was acquired, requiring full immediate amortization of 742 million yen in goodwill and a write-down of deferred tax assets, leading to a 143 million yen reduction in accounting profit from corporate tax adjustments.
• Yen appreciation reduced revenue by 746 million yen and gross profit by 75 million yen in the quarter, creating moderate downward pressure on results.
• The company's existing process and risk management was insufficient for large new challenge projects and post-acquisition project oversight at G-gen, which allowed the unprofitable projects to occur.

Q: What steps are you taking to prevent large unprofitable projects from recurring, and is there ongoing risk of similar losses?

A: The G-gen loss stemmed from insufficient post-acquisition integration (PMI) when the acquired team took on a large project. Going forward, G-gen will pause large projects that exceed the company's risk capacity and return to the original strategy of accumulating smaller projects to build steady revenue, just as Serverworks did historically. Serverworks is building a process-dependent system, not people-dependent, by rolling out new business systems, workflows and guidelines, with the CEO directly leading company-wide implementation to prevent unplanned large losses.

Q: Why did you set the initial dividend at 25 yen per share, and can you sustain dividends going forward?

A: The company previously retained all earnings for growth investment, but it has now reached a scale with stable operating cash flow and 90%+ recurring revenue, so it can balance growth investment and shareholder returns. The 25 yen level was set based on the medium-term profit target and cash flow outlook, hitting the target range of a 20% payout ratio and 1.0% minimum DOE, while retaining enough capital for required growth investment. The policy is to maintain stable, continuous dividends, with the stable recurring revenue business serving as the source of dividend payments.

Q: What is the current contribution to earnings from generative AI and security, and what is your outlook for these areas?

A: The company is still in the investment stage for both segments, so material earnings contributions are not expected yet. However, generative AI project volume is already growing rapidly, with internal use cases (such as internal help desks) and customer-facing projects (such as call center support) increasing. For security, the company recently obtained AWS MSSP Competency, which formally validates its service capability. The next step is to scale go-to-market activities to grow this business segment.

Q: Why are you continuing aggressive hiring even with temporary weak current profitability, and how does this balance with future profits?

A: Hiring is aligned with the medium-term strategy of building a combined offering of cloud infrastructure, generative AI, and security, which are all growing demand areas. The current profit decline is purely from temporary one-off factors, and core order intake remains very strong. While hiring will push up near-term personnell costs, the added talent will increase per-employee added value and contribute to profit growth starting from the next fiscal year.

Q: Who bears responsibility for the customer security breach that led to the extraordinary loss, and will you recover the loss?

A: This breach is primarily the customer's responsibility, and the company's policy is to aim for full recovery of the 98 million yen loss. Management recognizes the customer may be facing a difficult situation, so it is negotiating in good faith to reach a practical recovery agreement that works for both parties.