LAC Co., Ltd. (3857)

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An IT services company strong in information security and large system development Shared Research Report

2015/8/4

LAC Co., Ltd. (3857)

Shared Research Inc. has produced this report by request from the company discussed in the report. The aim is to provide an “owner’s manual” to investors. We at Shared Research Inc. make every effort to provide an accurate, objective, and neutral analysis. In order to highlight any biases, we clearly attribute our data and findings. We will always present opinions from company management as such. Our views are ours where stated. We do not try to convince or influence, only inform. We appreciate your suggestions and feedback. Write to us at [email protected] or find us on Bloomberg.

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LAC Co., Ltd. (3857)

2015/8/4 Shared Research Report

Contents

Executive summary ... 3

Key financial data ... 4

Recent updates ... 5

Highlights ... 5

Trends and outlook ... 6

Quarterly trends ... 6

Full-year (FY03/16) outlook ... 10

Strategy ... 12

Business ... 14

Business description ... 14

Earnings overview by segment ... 17

Profitability analysis ... 26

Strengths and weaknesses... 30

Market and value chain ... 31

Historical performance ... 35

Balance sheet ... 46

Cash flow statement ... 48

News and topics ... 50

Other information ... 53

History ... 53

Major shareholders ... 54

Top management ... 54

Employees ... 54

Dividend payout ... 55

Company profile ... 56

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Executive summary

IT services: strong in security solutions and large system development

LAC Co., Ltd. is an IT services company focusing on security solutions and developing large systems. In October 2007, LAC was formed as a holding company following the merger of the former LAC (a security developer) and A&I System Co., Ltd. (a developer of big backbone systems for financial companies). LAC provides IT security services—consulting, managed security monitoring, and system development. It also sells IT system products and maintenance services. The company has two business segments: Security Solutions Services and System Integration Services.

Japan’s IT service industry has at least 10 companies with annual sales topping JPY100bn. NTT Data Corporation (TSE1: 9613) is the largest, with sales of more than JPY1tn. LAC, with annual sales of about JPY30bn, ranks between 25th and 30th in Japan’s IT industry. The former LAC began providing

information security services in 1995. LAC’s tech knowledge and brand recognition helped it become Japan’s second-largest internet security services provider after Trend Micro Inc. (TSE1: 4704) (based on the consolidated sales of listed companies offering internet security services as a core business).

Trends and outlook

For FY03/16, LAC forecasts consolidated sales of JPY35.8bn (+8.9% YoY), operating profit of JPY2.3bn (-1.2% YoY), recurring profit of JPY2.3bn (-0.6% YoY), and net income of JPY1.3bn (+5.1% YoY). Japan’s IT industry expects to benefit from the recovery in corporate earnings. The company expects an increase in demand for services that add security features to cloud, mobile, and big-data technologies. LAC forecasts increasing sales for both its Security Solutions Services and System Integration Services segments as a result.

The company on May 12 released a medium-term management plan that covers a period between FY03/16 through FY03/18. The management plan, called TRY2021 Stage 1, calls for FY03/18 sales of at least JPY50bn and a return on equity of 15% or more during the three-year period. The company also wants to move its stock listing from JASDAQ to the First Section of the Tokyo Stock Exchange by FY03/18.

Strengths and weaknesses

LAC’s strengths: stable customer base leading to steady sales; technological expertise gained from operating Japan’s biggest security operation center (the Japan Security Operation Center, or JSOC); a long track record as a brand trusted by major clients. Weaknesses: limited scale amid increasingly complex industry; lack of personnel experienced in IT security; and low profits from product sales.

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LAC Co., Ltd. (3857)

Key financial data

Income Statement FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16

(JPYmn) Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons. Cons.

Sales 21,899 32,538 32,215 33,413 31,596 32,577 33,087 32,850 35,770 YoY - 48.6% -1.0% 3.7% -5.4% 3.1% 1.6% -0.7% 8.9% Gross Profit 6,159 6,857 6,543 7,034 7,032 6,938 6,920 7,305 YoY - 11.3% -4.6% 7.5% 0.0% -1.3% -0.3% 5.6% GPM 28.1% 21.1% 20.3% 21.1% 22.3% 21.3% 20.9% 22.2% Operating Profit 1,771 906 675 1,490 1,895 1,998 2,100 2,329 2,300 YoY - -48.9% -25.5% 120.8% 27.2% 5.4% 5.1% 10.9% -1.2% OPM 8.1% 2.8% 2.1% 4.5% 6.0% 6.1% 6.3% 7.1% 6.4% Recurring Profit 1,706 706 407 1,301 1,673 1,850 1,991 2,264 2,250 YoY - -58.6% -42.3% 219.3% 28.6% 10.6% 7.6% 13.7% -0.6% RPM 7.8% 2.2% 1.3% 3.9% 5.3% 5.7% 6.0% 6.9% 6.3% Net Income 897 240 -413 851 661 913 1,007 1,256 1,320 YoY - -73.2% -271.9% -306.1% -22.4% 38.2% 10.4% 24.6% 5.1% Net Margin 4.1% 0.7% -1.3% 2.5% 2.1% 2.8% 3.0% 3.8% 3.7%

Per Share Data

Number of Shares ('000) 26,683 26,683 26,683 26,683 26,683 26,683 26,683 26,683 -EPS 33 9.12 -18.57 25.73 22.20 35.04 39.70 49.48 52.02 Dividend Per Share 6 9.00 10.00 10.00 10.00 12.00 13.00 16.00 16.00 Book Value Per Share 216 210.46 182.71 203.50 214.74 243.10 275.15 307.73

Balance Sheet (JPYmn)

Cash and Equivalents 2,723 2,463 2,376 2,985 3,003 3,560 3,713 4,803 Total Current Assets 7,387 11,534 11,087 10,564 10,825 12,269 10,556 12,573 Tangible Fixed Assets, net 924 1,095 950 1,242 1,169 1,027 882 1,291 Other Fixed Assets 1,606 3,937 5,098 3,547 2,900 1,888 1,658 1,301 Intangible Assets 1,546 5,612 4,915 4,790 4,505 4,067 3,263 2,460 Total Assets 11,463 22,177 22,050 20,143 19,400 19,251 16,360 17,625 Accounts Payable 1,099 2,642 3,274 1,931 2,053 2,055 1,501 1,579 Short-Term Debt 1,964 5,154 2,577 1,821 2,270 2,331 2,156 2,017 Total Current Liabilities 4,136 10,259 9,143 7,594 8,247 9,116 7,389 9,689 Long-Term Debt 1,502 6,293 6,079 4,782 4,304 3,773 1,817 -Total Fixed Liabilities 1,538 6,370 6,157 5,304 4,644 3,941 1,977 116 Total Liabilities 5,673 16,629 15,300 12,898 12,890 13,056 9,366 9,805 Net Assets 5,789 5,549 6,750 7,245 6,509 6,195 6,995 7,821 Interest-Bearing Debt 3,466 11,447 8,656 6,603 6,574 6,104 3,973 2,017

Cash Flow Statement (JPYmn)

Operating Cash Flow 1,975 978 2,493 2,245 2,356 3,082 3,003 3,736 Investment Cash Flow -48 -8,642 -1,249 963 -841 -437 -272 -289 Financing Cash Flow -190 7,413 -1,337 -2,586 -1,492 -2,123 -2,591 -2,385

Financial Ratios

ROA - 4.2% 1.8% 6.2% 8.5% 9.6% 11.2% 13.3%

ROE - 4.3% -6.7% 12.2% 9.6% 14.4% 15.3% 17.0% Equity Ratio 50.2% 25.0% 30.6% 35.9% 33.5% 32.0% 42.7% 44.3%

Source: Company data

Figures may differ from company materials due to differences in rounding methods.

LAC Holdings Co., Ltd. was established on October 1, 2007, but in the company’s consolidated financial statements for FY03/08, the acquisition of A&I System Co., Ltd. is deemed to have occurred on April 1, 2007. The former LAC (Little eArth Corporation Co., Ltd.) also changed its financial year end from December to March. As a result, FY03/08 covers a 15 month period from January 1, 2007 to March 31, 2008.

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LAC Co., Ltd. (3857)

Recent updates

Highlights

On August 4, 2015, LAC Co., Ltd. announced Q1 FY03/16 results; see the results section for details. On June 30, 2015, we updated our report on the company after interviews with company management. On June 5, 2015, the company announced it won the “Japan’s Managed Security Service Provider of the Year Award” awarded by US research firm Frost & Sullivan (link to press release).

On May 18, 2015, the company announced the progress of the establishment of joint venture Japan Current Co., Ltd.

The company announced the establishment of this joint venture with P.R.O. Co., Ltd. on April 23, 2015, but certain details were unconfirmed. The company has now finalized these details, including the date of establishment (May 25, 2015).

Japan Current will be a consolidated subsidiary of LAC, but the company does not expect any material impact on earnings results for FY03/16 from this action.

On May 12, 2015, the company announced earnings results for full-year FY03/15 and released a medium-term management plan through FY03/18.

For corporate releases and developments more than three months old, see the News and topics section.

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LAC Co., Ltd. (3857)

Trends and outlook

Quarterly trends

Quarterly Performance (JPYmn) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 % of FY 1H Est. Sales 7,321 7,838 8,096 9,595 7,932 48.5% 16,345 YoY 3.2% 3.5% -8.5% 0.3% 8.4% 7.8% Gross Profit 1,530 1,620 1,889 2,265 1,518 YoY 16.3% 14.0% -1.6% 0.1% -0.8% GPM 20.9% 20.7% 23.3% 23.6% 19.1% SG&A Expenses 1,171 1,285 1,166 1,354 1,359 YoY -1.2% 10.3% -5.3% 9.3% 16.1% SG&A-to-sales 16.0% 16.4% 14.4% 14.1% 17.1% Operating Profit 359 335 723 911 159 31.2% 510 YoY 175.8% 30.7% 5.1% -11.1% -55.8% -26.6% OPM 4.9% 4.3% 8.9% 9.5% 2.0% 3.1% Recurring Profit 340 323 719 883 90 19.2% 470 YoY 250.6% 41.0% 9.3% -12.4% -73.4% -29.1% RPM 4.6% 4.1% 8.9% 9.2% 1.1% 2.9% Net income 71 160 491 534 -20 230 YoY - 94.0% 35.9% -5.1% -0.2% Net Margin 1.0% 2.0% 6.1% 5.6% 1.4% Cumulative Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 % of FY FY Est. Sales 7,321 15,158 23,255 32,850 7,932 22.2% 35,770 YoY 3.2% 3.4% -1.1% -0.7% 8.4% 8.9% Gross Profit 1,530 3,150 5,040 7,305 1,518 YoY 16.3% 15.1% 8.2% 5.6% -0.8% GPM 20.9% 20.8% 21.7% 22.2% 19.1% SG&A Expenses 1,171 2,456 3,622 4,976 1,359 YoY -1.2% 4.5% 1.1% 3.2% 16.1% SG&A-to-sales 16.0% 16.2% 15.6% 15.1% 17.1% Operating Profit 359 695 1,418 2,329 159 6.9% 2,300 YoY 175.8% 79.6% 31.9% 10.9% -55.8% -1.2% OPM 4.9% 4.6% 6.1% 7.1% 2.0% 6.4% Recurring Profit 340 663 1,381 2,264 90 4.0% 2,250 YoY 250.6% 103.4% 40.5% 13.7% -73.4% -0.6% RPM 4.6% 4.4% 5.9% 6.9% 1.1% 6.3% Net income 71 230 721 1,256 -20 1,320 YoY - 178.1% 62.4% 24.6% 5.1% Net Margin 1.0% 1.5% 3.1% 3.8% 3.7% FY03/16 FY03/16 FY03/15

Source: Shared Reserch based on company data

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Segment earnings

Quarterly Performance by Segment

(JPYmn) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Sales

Security Solutions Services 1,188 1,433 1,530 2,074 1,490 1,874 1,774 2,501 1,537 Security Consulting Services 289 412 515 688 336 488 432 668 337 Security Assessment Services 178 241 247 476 181 282 255 576 230 Security Monitoring Services 539 589 554 648 626 752 676 799 651 Security Product Sales 33 42 62 109 161 178 223 225 117 Security Maintenance Services 147 150 150 154 185 173 188 233 199 System Integration Services 5,899 6,145 7,323 7,494 5,829 5,964 6,324 7,093 6,395 Development Services 2,923 3,094 3,164 3,976 3,159 3,484 3,536 4,037 3,665 Hardware and Software Sales 948 1,060 2,119 1,021 803 635 798 982 893 IT Maintenance Services 1,895 1,834 1,907 2,307 1,702 1,670 1,726 1,755 1,590 Solutions Services 133 156 134 189 164 175 263 320 245

Reseller Operations - - -

-Hardware and Software Sales - - -

-IT Maintenance Services - - -

-Solutions Services - - -

-Total 7,091 7,575 8,853 9,568 7,321 7,838 8,096 9,595 7,932

Cumulative Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

Sales

Security Solutions Services 1,188 2,621 4,151 6,225 1,490 3,364 5,138 7,639 1,537 Security Consulting Services 289 701 1,216 1,904 336 824 1,256 1,924 337 Security Assessment Services 178 419 666 1,142 181 463 718 1,294 230 Security Monitoring Services 539 1,128 1,682 2,330 626 1,378 2,054 2,853 651 Security Product Sales 33 75 137 246 161 339 562 787 117 Security Maintenance Services 147 297 447 601 185 358 546 779 199 System Integration Services 5,899 12,044 19,367 26,861 5,829 11,793 18,117 25,210 6,395 Development Services 2,923 6,017 9,181 13,157 3,159 6,643 10,179 14,216 3,665 Hardware and Software Sales 948 2,008 4,127 5,148 803 1,438 2,236 3,218 893 IT Maintenance Services 1,895 3,729 5,636 7,943 1,702 3,372 5,098 6,853 1,590 Solutions Services 133 289 423 612 164 339 602 922 245

Reseller Operations - - -

-Hardware and Software Sales - - -

-IT Maintenance Services - - -

-Solutions Services - - -

-Total 7,091 14,666 23,519 33,087 7,321 15,158 23,255 32,850 7,932 Operating Profit

Security Solutions Services 133 476 847 1,516 240 677 1,081 1,880 166 System Integration Services 407 710 1,462 2,268 553 977 1,728 2,370 566 Subtotal 540 1,186 2,308 3,784 793 1,654 2,809 4,250 732 Adjustments -410 -800 -1,233 -1,684 -434 -960 -1,392 -1,921 -573 Total 130 387 1,075 2,100 359 695 1,418 2,329 159

FY03/16

FY03/14 FY03/15

Source: Shared Reserch based on company data

Quarterly earnings: Sales tend to be higher in Q3 and Q4. Since fixed costs are steady, earnings for the

first two quarters (especially Q1) tend to be lower.

Q1 FY03/16 results

Industry environment

The IT service industry environment remained favorable as the ongoing recovery in the economy and the resulting growth in corporate earnings encouraged companies to continue spending on IT, especially in the area of data security, which has become an increasing important issue.

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Earnings overview

In Q1 FY03/16, LAC saw sales rise 8.4% YoY to JPY7.9bn. Although demand for IT maintenance services was generally weak, demand for other services was strong at System Integration Services segment as well as at the Security Solutions Services segment, and both segments saw positive top-line growth during the quarter. Notwithstanding, operating profit dropped 55.8% to JPY158mn, as personnel costs rose following a round of remedial pay increases and other expenses rose in conjunction with the development of new businesses and advances into new markets. Further depressed by losses at equity-method subsidiaries, recurring profit fell 73.4% to JPY90mn. At the net income level, LAC reported a loss of JPY20mn (versus a year-earlier profit of JPY70mn), as earnings were further depressed by the acquisition-related costs during the quarter and the inability to use deferred tax assets to cover the losses at certain subsidiaries that have been recognized for tax purposes.

Although higher personnel costs and spending to grow new and existing business prevented top-line growth from flowing through to the bottom line, both sales and earnings appear to have finished ahead of plan.

Security Solutions Services

Security Solutions Services Performance

(JPYmn) Q1 FY03/15 Q1 FY03/16 YoY

Sales 1,490 1,537 3.1%

Security Consulting Services 336 337 0.5% Security Assessment Services 181 230 27.4% Security Monitoring Services 626 651 3.9% Security Product Sales 161 117 -27.0% Security Maintenance Services 185 199 7.3%

Segment Profit 240 166 -31.1%

Segment Profit Margin 16.1% 10.8%

The Security Solutions Services segment logged Q1 sales of JPY1.5bn (+3.1% YoY) and operating profit of JPY166mn (-31.1%). Although top-line revenues increased as demand for professional security services grew following cyber-attacks targeting personal data, earnings finished the quarter down, hurt by remedial pay hikes and new hiring pushed personnel costs higher, expenses related to the acquisition of NetAgent, spending on enhanced security monitoring equipment and other investments that was planned for the quarter and carried out despite the resulting drop in earnings.

Within the Security Solutions Services segment, Security Consulting Services saw revenues rise 0.5% YoY to JPY337mn, as cyber-attacks targeting personal data spurred demand for a variety of data security services including consulting, training, and in-house consultants. Combining its existing service offerings with its technical expertise, the company moved to a new service model that provides monitoring services for databases to prevent unauthorized data leaks.

Security Assessment Services saw revenues rise 27.4% YoY to JPY230mn, as orders from both new and repeat projects increased amid growing demand for comprehensive audits of Web applications and platforms.

Security Monitoring Services saw revenues rise 3.9% YoY to JPY651mn, underpinned by growth in new orders and a steady migration of existing customers to the company's new data monitoring service aimed

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LAC Co., Ltd. (3857)

at preventing data leaks. Revenues from equipment installation services rose, though the change in the network environment of some customers resulted in fewer installations of security monitoring equipment. Security Product sales were down 27.0% YoY to JPY177mn. The sharp decline reflects difficult

comparisons with a year earlier, when sales of equipment for private security operation centers (PSOCs) were running especially high. Orders received during the quarter were actually up versus a year earlier. Security Maintenance Services saw revenues rise 7.3% YoY to JPY199mn, with growth in work orders from both new and existing customers.

System Integration Services

System Integration Services Performance

(JPYmn) Q1 FY03/15 Q1 FY03/16 YoY

Sales 5,829 6,395 9.7%

Development Services 3,159 3,665 16.0% Hardware and Software Sales 803 893 11.2% IT Maintenance Services 1,702 1,590 -6.6% Solutions Services 164 245 49.1% Segment Profit 553 566 2.3%

Segment Profit Margin 9.5% 8.9%

The System Integration Services segment logged Q1 sales of JPY6.4bn (+9.7% YoY) and operating profit of JPY566mn (+2.3% YoY). The operating environment remained favorable as the ongoing growth in corporate earnings encouraged companies to continue spending on IT, though demand for IT maintenance services was generally weak. System Development Services saw a rising order flow from mainstay customers in the finance industrial as well as from public sector institutions and companies outside the finance industry. Operating profit growth lagged the top-line but was still positive, as the top-line growth was still enough to offset the decline in margins on hardware and software sales as well as the increase in personnel costs stemming from remedial pay hikes, which had been included in the company's original budget.

Within the System Integration Services segment, System Development Services saw revenues rise 16.0% YoY to JPY3.6bn. Orders for next-generation backbone systems from major banks was the primary driver of the growth in orders from financial institutions, but LAC also won more orders from outside of the finance industry following the big project for a public sector institution that it began work on last fiscal year.

Hardware and Software sales rose 11.2% YoY to JPY893mn. After being hit hard by the company's decision last year to change in suppliers for a number of its major product lines, orders have started to show some signs of improvement.

IT Maintenance Service saw revenues decline 6.6% YoY to JP1.6bn, hurt by the drop in hardware and software sales last fiscal year and by delays in work orders on several current projects.

Solution Services saw revenues jump 49.1% YoY to JPY245mn. In addition to strong growth in new orders for systems work from local governments, the company also saw a jump in orders for its new solutions service offerings, especially for its new Application Performance Management (APM) solutions services.

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LAC Co., Ltd. (3857)

Full-year (FY03/16) outlook

FY03/16 Forecasts FY03/14

(JPYmn) FY Act. 1H Act. 2H Act. FY Act. 1H Est. 2H Est. FY Est.

Sales 33,087 15,158 17,692 32,850 16,345 19,425 35,770 YoY 1.6% 3.4% -4.0% -0.7% 7.8% 9.8% 8.9% CoGS 26,167 12,008 13,537 25,545 Gross Profit 6,920 3,150 4,155 7,305 GPM 20.9% 20.8% 23.5% 22.2% SG&A Expenses 4,820 2,456 2,521 4,976 SG&A-to-sales 14.6% 16.2% 14.2% 15.1% Operating Profit 2,100 695 1,634 2,329 510 1,790 2,300 YoY 5.1% 79.6% -4.6% 10.9% -26.6% 9.6% -1.2% OPM 6.3% 4.6% 9.2% 7.1% 3.1% 9.2% 6.4% Recurring Profit 1,991 663 1,602 2,264 470 1,780 2,250 YoY 7.6% 103.4% -3.8% 13.7% -29.1% 11.1% -0.6% RPM 6.0% 4.4% 9.1% 6.9% 2.9% 9.2% 6.3% Net Income 1,007 230 1,025 1,256 230 1,090 1,320 YoY 10.4% 178.1% 10.9% 24.6% -0.2% 6.3% 5.1% Net Margin 3.0% 1.5% 5.8% 3.8% 1.4% 5.6% 3.7%

FY03/16 FY03/15

Outlook for FY03/16

For FY03/16, LAC forecasts consolidated sales of JPY35.8bn (+8.9% YoY), operating profit of JPY2.3bn (-1.2% YoY), recurring profit of JPY2.3bn (-0.6% YoY), and net income of JPY1.3bn (+5.1% YoY). The company also plans to raise it FY03/16 dividend by JPY3.00 YoY to JPY16.00 (payout ratio 32.3%, DOE 5.5%).

Japan’s IT industry expects to benefit from the recovery in corporate earnings. The company expects an increase in demand for services that add security features to cloud, mobile, and big-data technologies. LAC forecasts increasing sales for both its Security Solutions Services and System Integration Services segments as a result.

The roughly JPY3bn YoY sales increase apparently breaks down to about a JPY2.0bn gain from existing businesses and a JPY1.0bn gain from new businesses. Among exiting businesses, the company expects solid growth from its security business. Meanwhile, as hardware sales turned sluggish during the previous year, hardware maintenance sales are expected to decline. That said, it expects to offset this decline with an increase in hardware sales towards the renewal period. The anticipated JPY1.0bn increase in sales from new businesses is due to contributions from sales of APM from Dynatrace (exclusive distribution contract signed in spring 2015) and products from recently consolidated subsidiary Netagent.

LAC has released a medium-term management plan that covers a three-year period starting FY03/16. In the initial year, the company will expand its existing operations as demand for online security rises and as major banks continue to increase their IT investments. LAC will also aggressively invest in new businesses to create new products and services. Therefore, the firm expects operating profit on par with the previous year due to an increase in internal and external personnel cost for product R&D, in addition to

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LAC Co., Ltd. (3857)

Segment Performance and Targets Sales

(JPYmn) FY03/14 FY03/15 FY03/16_Est. YoY FY03/14 FY03/15 FY03/16_Est. YoY FY03/14 FY03/15 FY03/16_Est.

Security Solutions Services 7,639 7,640 9,045 18.4% 1,515 1,880 2,255 20.0% 19.8% 24.6% 24.9%

Security Consulting Services 1,904 1,924 1,805 -6.2% - - -

-Security Assessment Services 1,142 1,294 1,340 3.6% - - -

-Security Monitoring Services 2,330 2,853 3,410 19.5% - - -

-Security Product Sales 246 787 1,715 117.9% - - -

-Security Maintenance Services 601 779 775 -0.5% - - -

-System Integration Services 25,210 25,210 26,725 6.0% 2,267 2,370 2,422 2.2% 9.0% 9.4% 9.1%

Development Services 13,157 14,216 14,730 3.6% - - -

-Hardware and Software Sales 5,148 3,218 4,475 39.1% - - -

-IT Maintenance Services 7,943 6,853 5,865 -14.4% - - -

-Solutions Services 612 922 1,655 79.5% - - -

-Shared Expenses, Adjustments -141 - - - -1,683 -1,921 -2,378 - - -

-Total 32,850 32,850 35,770 8.9% 2,100 2,329 2,300 -1.2% 6.4% 7.1% 6.4%

Operating Profit OPM

Historical forecast accuracy

Initial CE vs. Results FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15

(JPYmn) Parent Cons. Cons. Cons. Cons. Cons. Cons. Cons.

Sales (Initial CE) 21,900 22,000 42,700 33,000 33,500 35,000 34,000 34,300

Sales (Results) 21,899 32,538 32,215 33,413 31,596 32,577 33,087 32,850

Initial CE vs. Results 0.0% 47.9% -24.6% 1.3% -5.7% -6.9% -2.7% -4.2%

Operating Profit (Initial CE) 1,530 1,860 1,730 1,120 1,500 1,990 2,100 2,100

Operating Profit (Results) 1,771 906 675 1,490 1,895 1,998 2,100 2,329

Initial CE vs. Results 15.8% -51.3% -61.0% 33.0% 26.3% 0.4% 0.0% 10.9%

Recurring Profit (Initial CE) 1,450 1,810 1,400 900 1,235 1,740 1,950 2,010

Recurring Profit (Results) 1,706 706 407 1,301 1,673 1,850 1,991 2,264

Initial CE vs. Results 17.6% -61.0% -70.9% 44.6% 35.4% 6.3% 2.1% 12.7%

Net Profit (Initial CE) 700 910 870 450 470 870 1,000 1,070

Net Profit (Results) 897 240 -413 851 661 913 1,007 1,256

Initial CE vs. Results 28.2% -73.6% -147.5% 89.1% 40.6% 4.9% 0.7% 17.3% Source: Company data

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LAC Co., Ltd. (3857)

Strategy

The company on May 12, 2015 released TRY 2021 Stage 1, a medium-term management plan that covers a three-year period from FY03/16 through FY03/18. The first three years are positioned as three years of acceleration, during which investments will be made to prepare for the next growth stage, followed by three years of “rapid progress,” during which the company aims for even further growth.

LAC expects that the IT business environment will undergo major transformation by 2020, when Tokyo will host Olympic Games. Japan’s economy will probably reach its peak at that time. However, the company, in comping the medium-term management plan, has taken into consideration what is likely to unfold afterward. TRY 2021 Stage 1 will be crucial for the company as it seeks to enter the next stage of business expansion.

The medium-term management plan calls for the following goals: Sales: JPY50bn or more

Sales of at least JPY50bn for FY03/18 ROE: 15% or more

Return on equity of at least 15% during the period from FY03/16 through FY03/18 Stock listing on the TSE First Section

The company, which is traded on the JASDAQ market, wants to move its listing to the First Section of the Tokyo Stock Exchange by FY03/18. This will mark the company’s next stage of development.

According to the company, the only management targets it discloses are sales and ROE, as it wants to avoid becoming constrained by numerical targets to the point that development is delayed or set back. It is considering detailed numerical targets at each phase, while continuing to take on new challenges. Its target of reaching JPY50bn in sales (1.5x FY03/15) over next three years looks challenging. That said, striving to achieve this target is expected to force all employees to find the best way forward. Also, the target of ROE exceeding 15% means the company aims to maintain good ROE levels even while pursing acquisition opportunities.

According to the company, preparations for moving shares to the Tokyo Stock Exchange First Section are already underway. As such, its financial position is being enhanced to facilitate this listing.

The medium-term management plan also puts forth three themes: of “Challenge” (take on new challenges with an eye on the future), “Polish” (expand existing businesses), and “Foundation” (enrich the company’s foundation). The company has also raised the important points for each theme to promote structural reforms and realize future growth.

Challenge (take on new challenges to increase future possibilities)

The meaning of “Challenge” is to serve as the driving force for changing stages such as business reforms, strategic policies, and the launching of new businesses. LAC wants to strengthen its organizational foundation to expand businesses. For this purpose, the company will expand hiring and employee training. Human resources management is key to this endeavor. The company will at the same time gain further trust in the industry and enhance its name recognition.

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LAC Co., Ltd. (3857)

Priority Items in “Challenge”

Develop New Businesses (visible challenges)

Full-fledged Development of APM Business

In April 2015, the company entered into an exclusive distribution contract (Japan) with US-based Dynatrace LLC, the No. 1 APM solutions company in the world. APM (Application Performance Management) refers to overall management of applications for the smooth operation of various systems. According to the company, performance management is a valued part of business management in the US and the market is growing. LAC plans to capture a share of the Japanese market, which is likewise expected to grow, through its partnership with Dynatrace.

Develop LAC-brand Security Products

The International Criminal Police Organization (INTERPOL) is using the LAC Falcon®, an engine developed by LAC for analyzing correlations between cyber-attacks. LAC plans to further improve performance to raise the attractiveness of this product. The company also plans to develop new products by partnering with Netagent (information security company with particular focus on information leak prevention), which it made a subsidiary April 2015.

Develop O2O Solutions

In May 2015, LAC established a JV with P.R.O. Co., Ltd. (PRO), a company that builds smartphone-based websites and EC sites. LAC plans to provide various solutions services to meet diverse customer needs, starting with O2O, by combining its expertise cultivate through experience, a long track record, and its research in the information security development field with PRO’s planning / development skills and advertising base. Create Data Use Regulation Market

In January 2015, LAC and Benesse Holdings, Inc. (TSE1: 9783) established a joint special-function company to operate and maintain the Benesse group’s core information systems—the foundations for the Benesse group’s operations. The two partners plan to use this JV to realize a high level of security and operational efficiency. LAC is aiming for future horizontal development of business models realized through this JV.

Create Overseas Security Market

LAC is currently preparing systems to provide support for security in various overseas regions where major Japanese firms are setting up operations. Even when delivering high-quality Japanese products to markets overseas, there is often a mismatch between the selling price and the price overseas customers are willing to pay. So the firm will initially consider providing support to Japanese firms overseas. It has even dispatched personnel to Singapore and is collecting information.

Research Intelligence Information Bases

Research Advanced Technologies for IoT Age

LAC’s internal Cyber GRID Japan is conducting advanced research in the security field. The company sees a need to take into consideration security needs for a broader range of products amid growth of new networks linking home appliances and various other products. For this reason, LAC is participating in the Secure Drone Consortium with the aim of building secure cloud services and environments for the safe operation of drones (unmanned aircraft). The firm intends to pursue research in various fields with “security” as the key word.

Research Advanced Technologies (strategy for the future) Create New Markets (medium/long-term strategy)

Polish (further enhance advantages of existing businesses)

The meaning of “Polish” is to future develop business in order to meet needs and more intense

competition, and to have the capacity to support new challenges. LAC will solidify its existing businesses. For this, the company will maintain its efforts to improve customer satisfaction through continuous self-assessment and improvement. The company will expand its existing market share, make operations more efficient, and create a powerful operational base.

Priority Items in “Polish”

Expand existing services Increase delivery scale, full-fledge development of LAC Falcon, strengthen marketing functions

Raise customer/partner satisfaction Conduct satisfaction surveys, adopt PDCA cycle, strengthen cooperation/relationships with strategic partners Streamline service/business Automate some security services, shift to mobile/cloud services

Develop New Businesses (visible challenges)

Foundation (enrich the company’s foundation to support business growth)

The meaning of “Foundation” refers to raising the level of maturation for company functions such as corporate culture / working environments and financial / business systems. The company will tackle new challenges in order to keep growing. The company will invest in new businesses and create demand that does not currently exist. The focus is on new operations, new markets, and new technologies.

Priority Items in “Foundation”

Human resource development / strategic

personnel Develop highly skilled human resources, realize competitive compensation system, maintain strengthscompatible with increased job mobility Further enhancement of management base Bolster risk management, move shares to main market (Tokyo Stock Exchange – First Section), maintain a_{healthy financial base} Improve creditworthiness, name recognition Bolster brand power, enhance PR functions, continuously conduct education / CSR activities

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LAC Co., Ltd. (3857)

Business

Business description

IT services—strong in security and large-scale system development

LAC Co., Ltd.’s strong suits are IT security solutions and developing large-scale IT systems. It was established in October 2007 as a holding company following the merger of the former LAC (a security solutions firm) and A&I System Co., Ltd. (a systems developer). The former LAC operated Japan Security Operation Center (JSOC), Japan’s biggest network security monitoring center, while A&I System handled large-scale backbone systems for financial companies, personnel service firms, and information service companies. In August 2008, the company established IT Crew Co., Ltd. and took over the operations of NIWS Co. HQ Ltd. and NIWS, which had filed for bankruptcy protection. These operations became LAC’s now-defunct Reseller Operations segment (selling information system products and providing system engineering and maintenance services).

No. 2 in IT security, mid-ranked in IT industry

In Japan’s IT service industry, there are at least 10 companies that have annual sales exceeding JPY100bn. NTT Data Corporation (TSE1: 9613) is the largest with sales of more than JPY1tn. LAC, which has about JPY30bn in annual sales, ranks between 25th and 30th. The company that became LAC began providing IT security services in 1995, making it an industry forerunner. LAC’s security technology and trusted brand name has made it Japan’s second-biggest provider of internet security services after Trend Micro Inc. (TSE1: 4704) (based on the consolidated sales of listed companies offering internet security services as a core business).

LAC provides IT security services, such as consulting and operation monitoring, as well as system development. It sells IT system products and maintenance. The company has two business segments: Security Solutions Services and System Integration Services.

Reorganizes business into two segments to maximize synergy

Previously, the company had three segments: Security Solutions Services, System Integration Services, and Reseller Operations. The company eliminated the Reseller segment in Q1 FY03/15, reorganizing its segments into Security Solutions Services and System Integration Services in a bid to make IT solution operations a pillar of its business. Security Solutions Services has taken over operations of the previous LAC. System Integration Services was created from A&I System. These segments create synergy by promoting employee interactions and setting cross-selling targets.

Security Solution drives growth; System Integration provides steady sales stream

The company’s earnings deteriorated due to weak corporate IT investments after the global financial crisis of 2008, but began to recover in FY03/11. In the IT industry, information security is considered a growth area. Therefore, LAC positions the Security Solutions Services segment as a growth driver. The company gets the majority of its profit from the System Integration Services segment. The company expects a steady stream of sales from this segment, which mostly caters to financial companies, since 60% of segment sales comes from contract renewals. LAC will strengthen cooperation between the two segments as it seeks to distinguish itself from rivals and enjoy stable growth.

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LAC Co., Ltd. (3857)

LAC business model: benefitting from cooperation between segments

Red text indicates System Integration Services; black text indicates Security Solutions Services.

Consolidated operating profit and OPM

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 0 500 1,000 1,500 2,000 2,500

FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15

Operating Profit OPM (right axis) (JPYmn)

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LAC Co., Ltd. (3857)

Changes to segments

Old Segments New Segments

Security Solutions Services Security Solutions Services

Security Consulting Services Security Consulting Services Security Assessment Services Security Assessment Services Security Monitoring Services Security Monitoring Services

System Integration Services Security Product Sales

Development Services Security Maintenance Services

Reseller Operations

IT Maintenance Services

Security Product Maintenance

IT Maintenance Services SI Product Maintenance

Solutions Services Solutions Services

System Integration Services

Hardware and Software Sales

Security Products Development Services SI Products Hardware and Software Sales

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LAC Co., Ltd. (3857)

Earnings overview by segment

In FY03/15 the company reorganized its business into two segments from the previous three. The two segments after this consolidation are Security Solutions Services and System Integration Services. In FY03/15, Security Solutions Services accounted to 23% of all sales (19% in FY03/14, retroactively adjusted) and System Integration Services accounted for 77% of sales (81% in FY03/14). The break down in terms of profit was 44% for Security Solutions Services (40%) and 56% for System Integration Services (60%). System Integration Services makes the bigger contribution in terms of both sales and profits. However, profit margins are much bigger for the Security Solutions Services.

LAC reorganized its operations into the Security Solutions Services segment and System Integration Services segment in Q1 FY03/15. The company has not announced detailed segment data because FY03/15 is the new fiscal year under the reorganized segmentation. This section discusses the company’s earnings based on its previous segmentation.

Sales composition by segment

Profit composition by segment

29% 15% 14% 14% 14% 16% 16% 19% 23% 71% 43% 37% 34% 40% 39% 40% 81% 77% 41% 49% 51% 46% 45% 44% 0% 20% 40% 60% 80% 100%

FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 Reseller Operations System Integration Services Security Solutions Services

33% 32% _27% 21% 29% 35% 38% 40% 44% 67% 57% 71% 48% 59% 55% 50% 60% 56% 11% 2% 30% 12% 11% 12% 0% 20% 40% 60% 80% 100%

FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 Reseller Operations System Integration Services Security Solutions Services

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LAC Co., Ltd. (3857)

Profit margin composition by segment

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

Reseller Operations System Integration Services Security Solutions Services

That said, earnings based on the reorganized segments started from end-FY03/15. As such, this report provides figures for FY03/15 based on the reorganized segments, as well as figures for FY03/14 based both on the previous segmentation and retroactively adjusted for the new two-segment arrangement.

Security Solutions Services

Growth driver with a low sales composition ratio and high contribution to profit

Security Solutions Services New Segments

(JPYmn) FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/14 FY03/15

Orders 6,226 5,442 5,194 4,656 4,999 5,278 5,641 - -YoY - -12.6% -4.6% -10.4% 7.4% 5.6% 6.9% - -Outstanding Orders 1,141 1,600 2,366 2,264 2,081 1,684 1,948 - -YoY - 40.2% 47.9% -4.3% -8.1% -19.1% 15.6% - -Sales 6,247 5,025 4,454 4,795 4,519 5,153 5,338 6,226 7,640 YoY - -19.6% -11.4% 7.7% -5.7% 14.0% 3.6% - 22.7% Operating Profit 1,024 660 556 710 1,071 1,327 1,432 1,516 1,880 YoY - -35.6% -15.8% 27.8% 50.8% 23.9% 7.9% - 24.0% OPM 16.4% 13.1% 12.5% 14.8% 23.7% 25.8% 26.8% 24.3% 24.6% % of Total Sales 29% 15% 14% 14% 14% 16% 16% 19% 23% Operating Profit 33% 32% 27% 21% 29% 35% 38% 40% 44% Employees 224 298 322 332 302 318 346 -

-Sales per Employee 27.9 16.9 13.8 14.4 15.0 16.2 15.4 - -OP per Employee 4.6 2.2 1.7 2.1 3.5 4.2 4.1 - -Segment Assets 1,794 2,152 3,122 3,120 3,112 2,681 2,421 2,834 3,761

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LAC Co., Ltd. (3857)

Security Solutions Services provides information security services, such as consulting and operation monitoring, to help clients manage risk. In FY03/15 the segment comprised 23% and 44% of the company’s overall sales and operating profit, respectively. (Under the new segmentation, it comprised 19% and 40% of sales and operating profit in FY03/14.)

This segment may be broken down into Security Consulting Services, Security Assessment Services, and Security Monitoring Services. Under the new segmentation implemented in FY03/15, Security Product Sales and Security Maintenance Services have been added to this segment.

The company entered cyber security early. The company’s clients include Japanese government agencies and some of Japan’s largest corporations, which require advanced security protection. This segment’s sales and profitability, which temporarily declined after the economy stalled and IT investments fell, are now rising again amid growing demand for cyber security. This segment is the more profitable one, contributing more to company’s overall operating profit despite a low sales composition ratio. LAC labels the security business as a growth driver.

Recognizing LAC’s outstanding track record and business strategy as a security service provider in the Japanese market, leading US research firm Frost & Sullivan awarded the company its 2015 Frost & Sullivan Japan Managed Security Service Provider of the Year Award. The award is based on evaluations made in terms of market share, growth rate, business strategy, and cutting-edge innovations in the cyber security business. It is given to companies that drive the most excellent cyber security services. This marked the first time it was awarded to a company in Japan.

In explaining its selection of LAC for this award, Frost & Sullivan said the company is the market leader in Japan’s managed security services market, with a strong and stable performance. It noted that with a solid track record of more than 20 years, LAC has built a strong position in the market, earned respect and commendations from the Japanese government, government agencies as well as private companies, and Educational Institutions. It also pointed out that LAC is highly-regarded in the industry and plays a vital role as a Security Advisor to various government agencies. Such an award from a research firm in the US, one of the most advanced nations in the security field, should help underscore the technical prowess of LAC.

Security Solutions Services Sales Breakdown

(JPYmn) FY03/12 FY03/13 FY03/14 FY03/15 FY03/15 FY03/12 FY03/13 FY03/14 FY03/15 Old segments Old segments New segments New segments nts New segments Old segments Old segments New segments New segments

Security Solutions Services 4,481 5,146 6,225 7,639 22.7% 100% 100% 100% 100%

Security Consulting Services 1,725 2,103 1,904 1,924 1.1% 38% 41% 31% 25%

Security Assessment Services 877 946 1,142 1,294 13.3% 20% 18% 18% 17%

Security Monitoring Services 1,879 2,097 2,330 2,853 22.4% 42% 41% 37% 37%

Security Product Sales - - 246 787 219.9% - - 4% 10%

Security Maintenance Services - - 601 779 29.6% - - 10% 10%

Composition

Sales YoY

Security consulting service: 25% of segment sales in FY03/15 (31% in FY03/14)

This service may be divided into security consulting, emergency response/data leak investigation, and security training. Security consulting comprises 70–80% of sales. Emergency response/data leak investigation (Service name: Cyber 119), and security training services together generate between JPY200mn and JPY300mn in annual sales. These services could spark orders in other areas. They do not contribute much to sales but help the company maintain its competitiveness and brand equity.

Security consulting

In this service, the company develops IT security measures for clients; provides risk assessments; creates, adopts, operates information security policies; and audits information security measures. LAC dispatches

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LAC Co., Ltd. (3857)

employees to be stationed at clients’ offices if needed. This service covers a variety of projects, with each project bringing in between about JPY1mn to JPY50mn. The most common price range is between JPY2mn and JPY3mn. There are probably about 600 projects a year. Small-scale projects take about a week to complete, but large contracts may require as many as three years. Therefore, sales are recognized based on percentage of completion.

Emergency response/data leak investigation

In this service, the company provides emergency response operations to security threats (Cyber 119), helps clients recover data, examines for data leaks, and analyzes data leaks caused by unauthorized access and viruses. Cyber 119 is an emergency response service in which LAC’s information security experts quickly deal with client requests. According to the company, the center handles five to ten cases at any given time. LAC flagged that cybercrime has become more sophisticated in recent years. The number of attacks more than quadrupled during the past five years. As a result, the company has been receiving more inquiries about the service. Cyber 119 handled more than 300 cases in 2013. The company charges about JPY1mn per case. LAC stated that the company handles about 70–80% of big IT crime incidents reported in the media.

Cyber 119: number of cases (left) and types of cybercrime (right)

Source: Company data 0 50 100 150 200 250 300 2008 2009 2010 2011 2012 2013 38% 25% 17% 10% 6% 4% Unauthorized Access Data Theft Malware Others Spam E-mail Unauthorized ID Use Security training

At many companies, cyber security is handled by designated teams. However, they still need to purchase security products and services because of the complexity of cyber security. LAC Security Academy, staffed with instructors with specialized skills, provides training to employees in various departments of client companies, not just to IT security staff. This strengthens defenses company-wide.

Security Assessment Services: 17% of segment sales in FY03/15 (18% a year earlier)

In this service, the company provides diagnosis of security risks involving web applications, servers, network equipment, and databases. For example, the company examines clients’ websites to identify flaws. The company provides detailed analysis of security vulnerabilities and provides solutions. According to LAC, a typical project—from the start of the examination to the submission of reports—takes one to four weeks. The company handles 700

–

800 cases annually, with each project bringing in sales of between JPY1mn and JPY2mn. The company employs about 20 employees in Japan and 30 overseas for this service. The company is having difficulty handling orders due to a shortage of workers with the necessary specialized skills. As a result, despite the large market, the company is not seeking new customers. About 80% of clients are repeat customers, with the rest taking the initiative to search out the company.

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LAC Co., Ltd. (3857)

Security Monitoring Services: 37% of segment sales in FY03/15 (37% a year earlier)

In this service, the company operates the Japan Security Operation Center (JSOC), the biggest security monitoring center in Japan established in 2002. JSOC provides network monitoring to protect clients (including government agencies and some of Japan’s largest companies) against potential security threats. This service also helps clients build secure servers by providing them with products and services to keep security updated.

This is the mainstay service in the company’s Security Solutions Services segment. Network monitoring is conducted through monitoring censors installed at clients’ offices. Each monitoring censor generates sales of between JPY1mn and JPY2mn a year. The company employs about 100 employees for this service, with about 850 clients and 1,450 censors (September 30, 2014). This business generates steady earnings, as the service is based on a one-year contract which most clients renew to avoid the cost of switching services. The company contacts clients through their IT departments, and installs monitoring equipment when clients update their systems.

LAC began providing network security services in 1995, when the internet was still in its infancy, making it one of the first Japanese companies to realize the potential in this area. In 2002, the company established the Japan Security Operation Center (JSOC), one of the largest Japanese security operation centers. JSOC counts government agencies and major corporations among its clients. This places the company at the forefront of the information security industry and, according to the company, it has been called upon to propose national security measures to government agencies. JSOC brings together various security technologies to offer services that LAC considers to be some of the most advanced in its industry, and it boasts results on par with leading domestic information security providers.

Security Product Sales and Security Maintenance Services

In FY03/15, Security Product Sales accounted for 10% of segment sales (4% in FY03/14), while Security Maintenance Services also accounted for 10% of segment sales (10% in FY03/14).

Security Product Sales and Security Maintenance Services were moved to this segment from the Reseller Operations segment with the FY03/15 segment reorganization. Security Product Sales handles the sales associated with Security Solutions Services. Also, Security Maintenance Services is partially responsible for the maintenance of security-related services, with a focus on products sold by the company.

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LAC Co., Ltd. (3857)

System Integration Services

LAC’s biggest operations with steady sales; 60% of sales from contract renewals

System Integration Services New Segments

Orders 16,052 13,934 11,630 10,808 10,814 12,788 13,479 - -YoY - -13.2% -16.5% -7.1% 0.1% 18.3% 5.4% - -Outstanding Orders 2,569 2,470 2,145 1,538 1,764 2,433 2,755 - -YoY - -3.8% -13.2% -28.3% 14.7% 37.9% 13.2% - -Sales 15,653 14,201 12,009 11,603 13,068 12,726 13,227 27,002 25,456 YoY - -9.3% -15.4% -3.4% 12.6% -2.6% 3.9% - -5.7% Operating Profit 2,080 1,173 1,431 1,627 2,126 2,085 1,882 2,268 2,370 YoY - -43.6% 22.0% 13.7% 30.7% -1.9% -9.7% - 4.5% OPM 13.3% 8.3% 11.9% 14.0% 16.3% 16.4% 14.2% 8.4% 9.3% % of Total Sales 71% 43% 37% 34% 40% 39% 40% 81% 77% Operating Profit 67% 57% 71% 48% 59% 55% 50% 60% 56% Employees 755 842 833 774 738 713 700 -

-Sales per Employee 20.7 16.9 14.4 15.0 17.7 17.8 18.9 - -OP per Employee 2.8 1.4 1.7 2.1 2.9 2.9 2.7 - -Segment Assets 5,863 6,072 5,035 5,712 3,176 3,314 3,062 7,872 7,479

Old Segments

This segment handles system development for clients and provides system Solutions Services. For FY03/15, this segment contributed 77% and 56% of consolidated sales and operating profit, respectively (under the new segmentation, sales and operating profit composition ratios were 81% and 60%, respectively, for FY03/14).

The profit margin for this segment is lower than that for Security Solutions Services, but it contributes most to overall profits. Development services is the core of this segment. SI Product Sales Hardware and Software Sales, IT Maintenance Services, and Solutions Services were added under the new

segmentation. The result: sales and profit contributions increased.

This segment was built on operations of the former A&I System. LAC’s system integration operations have also been integrated into this segment. AI System, established in May 1987 by the former ABC (now FUJISOFT Inc. [TSE1: 9749]) and IBM Japan, Ltd., was a participant in major commercial banks’ online infrastructure development projects, as well as projects undertaken by the National Tax Agency, the Bank of Japan, the former Ministry of Posts and Telecommunications, and other public institutions. Thus, this segment has experience in backbone systems of financial institutions and government agencies.

Examples of the projects currently handled by this segment include ATM systems, online banking systems, and e-commerce websites for apparel retailers. Mostly catering to financial services, the segment generates 60% of its sales from contract renewals. This segment will strengthen its cooperation with the other segment. LAC sees this segment as a steady growth driver.

System Integration Services Sales Breakdown

FY03/12 FY03/13 FY03/14 FY03/15 FY03/15 FY03/12 FY03/13 FY03/14 FY03/15 Old segments Old segments New segments New segments nts New segments Old segments Old segments New segments New segments

System Integration Services 12,560 12,684 26,861 25,2100 -6.1% 100% 100% 100% 100%

Development Services 12,560 12,684 13,157 14,2160 8.0% 100% 100% 49% 56%

Hardware and Software Sales - - 5,148 3,2180 -37.5% - - 19% 13%

IT Maintenance Services - - 7,943 6,8530 -13.7% - - 30% 27%

Solutions Services - - 612 9220 50.7% - - 2% 4%

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LAC Co., Ltd. (3857)

Development services

For FY03/15, this segment contributed 56% of segment sales (49% in FY03/14)

In this service, the company designs and develops backbone systems for computers, as well as

customized development and maintenance of application systems. This department also creates websites and smartphone applications for online banking, shopping and part-time recruitment. Key clients include those that require reliable large-scale systems (banks, insurers, brokerages, government agencies) and recruitment companies. Development of mainframe platforms requires knowledge of a range of operating systems, including those for mainframe computers, as well as experience with development, operations, and maintenance.

Hardware/Software Sales and IT Maintenance Services

In FY03/15, Hardware/Software Sales accounted for 13% of segment sales (19% in FY03/14), while IT Maintenance Services accounted for 27% of segment sales (30% in FY03/14).

Hardware/Software Sales and IT Maintenance Services were moved to this segment from the Reseller Operations segment with the FY03/15 reorganization of segments. Hardware/Software Sales is

responsible for the sales of a wide range of information system products (hardware and software) related to servers and storage that are the foundations of systems supporting IT utilization. Meanwhile, IT Maintenance Services provides maintenance services for SI-related products (hardware and software) sold by the company. In addition, it provides a host of services from network base design and construction (including IT equipment installation) to equipment introduction and operation.

Solution Services: accounted for 4% of segment sales in FY03/15 (2% in FY03/14).

This service was moved to this segment from the Reseller Operations segment with the FY03/15 reorganization of segments. With a wealth of experience with Internet and intranet environments, this service provides various solutions services utilizing the latest IT technologies. It also provides various outsourcing services starting with data center cloud services.

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LAC Co., Ltd. (3857)

Reseller Operations (reference)

Low-margin products not very profitable; absorbed by other segments in FY03/15

Reseller Operations New Segments

Orders - 19,686 15,825 18,837 15,829 14,168 13,621 - -YoY - - -19.6% 19.0% -16.0% -10.5% -3.9% - -Outstanding Orders - 6,164 6,158 7,756 7,761 7,145 6,214 - -YoY - - -0.1% 26.0% 0.1% -7.9% -13.0% - -Sales - 13,522 15,843 17,373 14,745 14,786 14,658 0 0 YoY - - 17.2% 9.7% -15.1% 0.3% -0.9% - -Operating Profit - 231 40 1,020 435 407 470 0 0 YoY - - -82.5% 2428.7% -57.4% -6.5% 15.4% - -OPM - 1.7% 0.3% 5.9% 3.0% 2.8% 3.2% - -% of Total Sales - 41% 49% 51% 46% 45% 44% 0% 0% Operating Profit - 11% 2% 30% 12% 11% 12% 0% 0% Employees - 246 230 214 259 310 292 -

-Sales per Employee - 55.0 68.9 81.2 56.9 47.7 50.2 -

-OP per Employee - 0.9 0.2 4.8 1.7 1.3 1.6 -

-Segment Assets - 12,077 12,293 10,667 8,728 6,984 5,235 0 0

Old Segments

This previous segment, absorbed by the other two, used to sell products related to information systems and provided system engineering and maintenance services. The segment began as IT Crew Co., Ltd., which was established in August 2008 to take over businesses of NIWS Co. HQ Ltd. and NIWS after they filed for bankruptcy protection. For FY03/14, the segment contributed 44% to consolidated sales and 12% to operating profit. Despite a high sales composition ratio, profitability contribution was low because it relied heavily on equipment sales.

The segment provided Hardware and Software Services, as well as IT Maintenance Services and Solutions Services. However, the market for the segment’s products was shrinking, so the company abolished this segment in FY03/15, transferring operations to the Security Solutions Services and System Integration Services segments.

Reseller Operations Sales Breakdown

(JPYmn) FY03/12 FY03/13 FY03/14 FY03/13 FY03/14 FY03/12 FY03/13 FY03/14

Reseller Operations 14,551 14,746 14,551 1.3% -1.3% 100% 100% 100% Hardware and Software Sales 7,650 6,515 5,394 -14.8% -17.2% 53% 44% 37% IT Maintenance Services 6,274 7,585 8,544 20.9% 12.6% 43% 51% 59% Solutions Services 626 645 612 3.0% -5.1% 4% 4% 4%

YoY % of Total

Sales

Hardware and Software Sales: 37% of segment sales in FY03/14

The company sold hardware and software products to meet diverse client needs, such as servers, storage devices, and products related to Security Solutions Services. With the FY03/15 reorganization of segments, this section was split into two sections, with that handling sales of security-related products transferred to Security Solutions Services and that handling the sales of SI-related products transferred to Systems Integration Services.

IT Maintenance Services: 59% of segment sales in FY03/14

In these services, the company provided maintenance for products sold by the segment (hardware and software). It also offered a wide range of other services, such as the designing and building of network

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LAC Co., Ltd. (3857)

systems involving IT equipment construction work, and equipment installation and operation. With the FY03/15 reorganization of segments, this section was split into two sections, with that handling sales of security-related products transferred to Security Solutions Services and that handling the sales of SI-related products transferred to Systems Integration Services.

Solutions Services: 4% of segment sales in FY03/14

In these services, the company used to provide Solutions Services for internet and intranet operations. The department also operated a data center offering cloud and outsourcing services. This section was moved to Systems Integration Services with the FY03/15 reorganization of segments.

Major group companies (as of the end of March 2014)

The company’s subsidiaries are Cyber Security LAC Co., Ltd. (stake: 90.5%), LAC CHINA CORPORATION CO., LTD. (wholly owned; defunct), Software Service Inc. (wholly owned), Axis Co., Ltd. (wholly owned), and INetRely Corporation (wholly owned). For FY03/14, the parent company’s contributions to group sales and operating profit were about 91% and 87%, respectively.

Key subsidiaries

Business SegmenSubsidiary, Businesses

LAC China Corporation Co., Ltd. (website vulnerability assessment, collection and dissemination of information on vulnerabilities; defunct)

Cyber Security LAC Co., Ltd. (website vulnerability assessment, collection and dissemination of information on vulnerabilities) System Integration Software Service Inc. (services related to information systems)

Axis Co., Ltd. (operation, maintenance of data centers) INetRely Corporation (creates and manages IT system products)

Source: Company securities resport

Security Solutions S

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LAC Co., Ltd. (3857)

Profitability analysis

Profitability, SG&A Breakdown FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15

(JPYmn) Parent Cons. Cons. Cons. Cons. Cons. Cons. Cons.

Sales 21,899 32,538 32,215 33,413 31,596 32,577 33,087 32,850

YoY - 48.6% -1.0% 3.7% -5.4% 3.1% 1.6% -0.7%

Security Solutions Services 6,247 5,025 4,454 4,795 4,519 5,153 5,338 7,640

YoY - -19.6% -11.4% 7.7% -5.7% 14.0% 3.6% 22.7%

System Integration Services 15,653 14,201 12,009 11,603 13,068 12,726 13,227 25,456

YoY - -9.3% -15.4% -3.4% 12.6% -2.6% 3.9% -5.7% Reseller Operations 0 13,522 15,843 17,373 14,745 14,786 14,658 -YoY - - 17.2% 9.7% -15.1% 0.3% -0.9% -CoGS 15,740 25,682 25,672 26,380 24,563 25,639 26,167 25,545 YoY - 63.2% 0.0% 2.8% -6.9% 4.4% 2.1% -2.4% Gross Profit 6,159 6,857 6,543 7,034 7,032 6,938 6,920 7,305 YoY - 11.3% -4.6% 7.5% 0.0% -1.3% -0.3% 5.6% SG&A Expenses 4,388 5,951 5,869 5,544 5,137 4,940 4,820 4,976 YoY - 35.6% -1.4% -5.5% -7.3% -3.8% -2.4% 3.2%

Salaries, Allowances and Bonuses 1,680 2,609 2,525 2,269 2,042 2,144 2,091

-　YoY - 55.3% -3.2% -10.1% -10.0% 5.0% -2.5% -Retirement Benefits 31 94 128 118 117 101 88 -Rent 452 715 828 727 692 595 582 -Goodwill Amortization 0 599 752 746 654 460 459 -Others 2,224 1,933 1,634 1,683 1,633 1,639 1,600 -Operating Profit 1,771 906 675 1,490 1,895 1,998 2,100 2,329 YoY - -48.9% -25.5% 120.8% 27.2% 5.4% 5.1% 10.9%

R&D Expenses (included in manufacturing/SG&A) 91 82 41 48 47 49 51 0

Vs. Sales

CoGS 71.9% 78.9% 79.7% 78.9% 77.7% 78.7% 79.1% 77.8%

Gross Profit 28.1% 21.1% 20.3% 21.1% 22.3% 21.3% 20.9% 22.2%

SG&A Expenses 20.0% 18.3% 18.2% 16.6% 16.3% 15.2% 14.6% 15.1%

Operating Profit 8.1% 2.8% 2.1% 4.5% 6.0% 6.1% 6.3% 7.1%

Note: Segment sales are before internal eliminations.

Note: From FY03/15, there was a change in segmentation. The Dealer segment was split and merged into the other two segments. Segment YoY in FY03/15 is compared using retrospectively adjusted figures.

Improving OPM by controlling SG&A costs

LAC in August 2008 bought the operations of NIWS Co. HQ Ltd. and NIWS, which filed for bankruptcy protection, and began its Reseller Operations segment to sell information system related products and provide system engineering and maintenance services. As a result, sales for FY03/09 increased 48.6% YoY. However, the overall CoGS to sales ratio surged after the acquisition of the Reseller business, and gross profit margin declined in FY03/09. Operating profit margin also fell due to goodwill expenses that pushed up SG&A costs.

Soon after LAC took over the Reseller business, the global financial crisis hit in September 2008. The crisis significantly affected the company’s earnings results, owing to the considerable pain it inflicted on LAC’s main clients—financial institutions. The CoGS to sales ratio has mostly stabilized since FY03/10, despite sales being affected by sluggish corporate IT investments amid deteriorating business sentiment. LAC’s services are labor-intensive, so labor costs have a big impact on earnings. More than half of those

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involved in the company’s System Development Services in the System Integration Services segment are independent contractors, and the number of contractors are adjusted based on sales. LAC cut costs by consolidating administrative sections and relocating and consolidation of subsidiaries’ offices. As a result, SG&A expenses, such as salaries, bonuses, and rents, have been falling. The ratio of SG&A to sales is also improving. As a result, operating profit margin, which hit bottom during FY03/10, is now rising.

Comparison with competitors

LAC, Asgent, Cresco Performance New Segments

(JPYmn) FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/14 FY03/15

Sales

Security Solutions Services 6,247 5,025 4,454 4,795 4,519 5,153 5,338 6,226 7,640 Asgent 3,663 3,488 3,988 4,015 4,009 3,537 3,343 3,343 2,958 System Integration Services 15,653 14,201 12,009 11,603 13,068 12,726 13,227 27,002 25,456 Cresco 13,557 13,990 13,151 15,722 17,272 19,032 22,028 22,028 25,064 Reseller Operations - 13,522 15,843 17,373 14,745 14,786 14,658 - -LAC (consolidated) 21,899 32,538 32,215 33,413 31,596 32,577 33,087 33,087 32,850 Operating Profit (Segment Profit)

Security Solutions Services 644 482 369 445 828 1,040 1,162 1,200 1,436

Asgent 145 243 437 396 213 227 11 11 -158

System Integration Services 1,127 671 928 985 1,424 1,376 1,211 900 892 Cresco 680 660 272 824 1,031 1,243 1,430 1,430 2,013 Reseller Operations - -247 -623 59 -357 -417 -273 - -LAC (consolidated) 1,771 906 675 1,490 1,895 1,998 2,100 2,100 2,329 Operating Profit Margin

Security Solutions Services 10.3% 9.6% 8.3% 9.3% 18.3% 20.2% 21.8% 19.3% 18.8% Asgent 4.0% 7.0% 11.0% 9.9% 5.3% 6.4% 0.3% 0.3% -5.3% System Integration Services 7.2% 4.7% 7.7% 8.5% 10.9% 10.8% 9.2% 3.3% 3.5% Cresco 5.0% 4.7% 2.1% 5.2% 6.0% 6.5% 6.5% 6.5% 8.0% Reseller Operations - -1.8% -3.9% 0.3% -2.4% -2.8% -1.9% - -LAC (consolidated) 8.1% 2.8% 2.1% 4.5% 6.0% 6.1% 6.3% 6.3% 7.1%

Source: Company data, Asgent, Inc., Cresco, Ltd.

Company-wide expenses have been deducted from segment profits in proportion to sales.

Old Segments

The IT service industry encompasses a variety of business areas, with companies pursuing diverse operations; thus it is difficult to identify companies similar to LAC. It would be more appropriate to conduct segment-by-segment analysis. The size and scope of the company’s Security Solutions Services segment (FY03/15 sales of JPY7.6bn) may be comparable with Asgent, Inc. (JASDAQ: 4288), which has annual sales of about JPY3.0bn. The System Integration Services segment (sales of JPY25.5bn) could be compared with CRESCO, LTD. (TSE1: 4674), which has annual sales of JPY25bn.

Asgent posted an operating loss in FY03/15 on business launch delays. That said, LAC’s Security Solutions Serv