IIJ Announces First Six Months Financial Results for the Fiscal Year Ending March 31, 2017

TOKYO, Nov. 08, 2016 (GLOBE NEWSWIRE) — Internet Initiative Japan Inc. (“IIJ”) (NASDAQ:IIJI) (TSE:3774) today announced its consolidated financial results for the first six months of the fiscal year ending March 31, 2017 (“1H16”, from April 1, 2016 to September 30, 2016).¹

Overview of 1H16 Financial Results and Business Outlook

“As announced on November 4^th, we have revised down our financial targets for the fiscal year ending March 31, 2017, principally because our aggressive business investments and services developments have been taking longer than expected to start contributing to revenues accumulation. The revised annual revenue is JPY158.0 billion, JPY1.0 billion down from our initial target of JPY159.0 billion. The revised operating income is JPY5.0 billion, JPY2.3 billion down from our initial target of JPY7.3 billion,” said Eijiro Katsu, COO and President of IIJ.

“As we expect great market opportunities in the middle term with more advanced cloud usage, IoT type of network systems adoption and greater demand for security by many Japanese entities, consumer mobile service’s market explosion and so on, we’ve been making proactive business investments including the commencement of “IIJ GIO Infrastructure P2” and “IIJ Omnibus Services”² later last year. We’re also engaged in IoT service development³, continuous enhancement of security services⁴ and preparation for Full-MVNO⁵. As for IoT, we’re going to launch “IIJ IoT Service” which offers functions such as network, cloud and devise control elements required for IoT systems. With these required components, we’ve received several orders from local governments very large-scale multiple-year projects in which cloud, security, system and network are mostly outsourced and we expect recurring revenue growth should become strong the next year with these kinds of full-outsourcing trend,” said Katsu.

“In this first half, we continued to have strong year over year revenue growth rate of 13.5%. On the other hand, in addition to the current relatively high level of increasing costs due to the implementation of business expansion strategy, we saw SI gross margin deterioration as an additional factor impacting our operating income. The low SI gross margin was temporarily, we believe, by combination of factors such as low productivity of systems engineers,⁶ temporal profit deterioration due to the delay in offering　some functions of our foreign exchange system ASP service, low profitability in a certain construction project, and weaker than expected systems operation and maintenance revenue with the cancellation of certain relatively large projects from 1Q16. Although 1H16 total revenues slightly exceeded our initial target, we missed the operating income target and it decreased by 24.0% from 1H15,” continued Katsu.

“For the remaining half, we expect low productivity of systems engineers to improve based on the current SI projects situation. However, based on the current services order accumulation, we’d miss the revenue targets of new services such as “IIJ GIO Infrastructure P2” and “IIJ Omnibus Services” which should increase but not as strongly as our initial expectation. Since the depreciation for these new services have already begun, the revenue gap will directly impact our operating income. Because Japanese companies are conservative with their systems, especially with larger and mission-critical ones, the lead time, including clients’ internal judgments and preparation, takes longer than expected. And, some delays of our services developments would have some impacts as well. Another issue that would impact our operating income against our initial expectation is the cost related to mobile services. We increased leasing MVNO bandwidth largely during 2Q16 along with increasing traffic trend; therefore, this recurring type cost for MVNO infrastructure would exceed our initial expectation in 2H16. Although the excessive cost is not expected to become larger in 2H16 and the mobile services’ gross margin amount is expected to increase year over year, it would continue to impact our network services’ gross margin against our initial expectation. Regarding the details about our revision, please refer to our press release titled “IIJ Revises its First Half and Full-Year Financial Targets for FY2016,” said Katsu.⁷

“The income level for this fiscal year is to be weak. However, we believe our recent business developments for future sustainable growth should contribute to stronger revenue growth for the middle term which should ultimately lead to income growth. It’s inevitable that the role of IIJ to be larger and more critical along with the progression of IT usage such as IoT and BigData. We believe we’d be able to return to operating income growth the next fiscal year because SI deterioration is expected to be temporary, costs and revenues time-gap for new services would be diminished by the continuous revenue accumulation and mobile profitability to improve by gathering many more diversified mobile traffic⁸. Although the operating income is expected to be 1 or 1.5 years delayed from what we initially expected at the beginning of this fiscal year, we believe strong revenue would generate continuous operating margin improvement. Therefore, we decided the dividend targets to remain unchanged (annual dividend of JPY27.00 per share) and to implement share buyback of JPY1.5 billion,” concluded Koichi Suzuki, Founder, CEO and Chairman of IIJ.

¹ Unless otherwise stated, all financial figures discussed in this announcement are prepared in accordance with U.S. GAAP. All financial figures are unaudited and consolidated.

² “IIJ GIO Infrastructure P2” launched in November 2015 is our new cloud service platform to promote Japanese enterprises demand to migrate their core business platform to cloud. “IIJ Omnibus Service” launched in September 2015 incorporates SDN and NFV technologies, automatically offers several network elements. For details please refer to our pree releases titled “IIJ to Launch ‘IIJ GIO Infrastructure P2’ – A Next-generation Cloud Service” at http://www.iij.ad.jp/en/news/pressrelease/2015/0714.html and “IIJ to Launch ‘IIJ Omnibus Service’ – A New generation of Cloud Networking Services” at http://www.iij.ad.jp/en/news/pressrelease/2015/0715.html

³ “IIJ IoT Service” will be launched in November. For detail, please refer to our press release titled “IIJ to Launch the IIJ IoT Service, a New IoT Platform that Combines Networks with the Cloud” which can be found at http://www.iij.ad.jp/en/news/pressrelease/2016/0719.html

⁴ For example, we have launched consultation service to help companies implement CSIRT (Computer Security Incident Response Team) and expanded functions for our email security gateway service, recently.

⁵ For detail, please refer to our press release titled “IIJ Begins to Engage in a Full MVNO for Enhanced MVNO Business” which can be found at http://www.iij.ad.jp/en/news/pressrelease/2016/0830.html. Related FAQ is available at http://www.iij.ad.jp/en/ir/news/2016/pdf/20160830_fullMVNO_E.pdf

⁶ We had low productivity of systems engineers mainly because 1) of the projects already recognized as revenue in FY2015 (1Q16), 2) we assigned system engineers to handle several large projects while others were postponed (2Q16) , and 3) some prospective orders including cloud-related systems required pre-sales activities conducted by engineers (2Q16).

⁷ Please refer to our press release titled ”IIJ Revises its First Half and Full-Year Financial Targets for FY2016.”

⁸ As we purchase mobile network from NTT Docomo on the unit of bandwidth, once we gather various types of mobile traffic that should lead to improved utilization of network and thus profitability.

1H16 Financial Results Summary

We have omitted segment analysis because most of our revenues are dominated by network services and systems integration (SI) business.

1H16 Revenues and Income

Revenues

Total revenues were JPY74,123 million, up 13.5% YoY (JPY65,334 million for 1H15).

Network services revenue was JPY44,836 million, up 18.0% YoY (JPY38,000 million for 1H15).

Revenues for Internet connectivity services for enterprise were JPY10,577 million, up 26.6% YoY from JPY8,357 million for 1H15 mainly due to an increase in mobile related services revenues along with an expansion of MVNE business clients’ business volume.

Revenues for Internet connectivity services for consumers were JPY10,328 million, up 56.6% YoY from JPY6,596 million for 1H15, mainly due to revenue growth of “IIJmio High-speed Mobile/D services,” consumer mobile services which offer inexpensive data communication and voice services with SIM cards.

Revenues for WAN services revenues were JPY13,289 million, up 5.8% YoY compared to JPY12,558 million for 1H15.

Revenues for Outsourcing services revenues were JPY10,642 million, up 1.5% YoY from JPY10,489 million for 1H15.

*1. IP service revenues include revenues from the data center connectivity service.
*2. From 1Q16, the revenue from “IIJ Mobile MVNO Platform Service”, which is included in “IIJ Mobile service (Enterprise)”, is disclosed. “IIJ Mobile MVNO Platform Service” provides MVNO platform to our MVNE clients.
*3. From 1Q16, the revenue from “IIJmio High Speed Mobile Services”, which is included in “Internet connectivity services (Consumer)” provided by IIJ, is disclosed.

*1. Numbers in the table above show number of contracts except for “IIJ Mobile service (Enterprise),” “IIJ” and “hi-ho” which show number of subscriptions.

*2. From 1Q16, the number of subscription for “IIJ Mobile MVNO Platform Service”, which is included in “IIJ Mobile service (Enterprise)”, is disclosed.

*3. From 1Q16, the number of subscription for “IIJmio High Speed Mobile Service”, which is included in “Internet connectivity services (Consumer)” provided by IIJ, is disclosed.

*4. Regarding IP service, data center connectivity service and IIJ FiberAccess/F and IIJ DSL/F of Internet connectivity services (Enterprise), total contracted bandwidths are calculated by multiplying number of contracts by contracted bandwidths respectively.

SI revenues were JPY25,768 million, up 8.6% YoY (JPY23,725 million for 1H15).

Systems construction revenue, a one-time revenue, was JPY8,583 million, up 12.3% YoY. Systems operation and maintenance revenue, a recurring revenue, was JPY17,185 million, up 6.9% YoY, mainly due to an increase in private cloud services revenues although certain relatively large systems operation and maintenance projects were cancelled .

Orders received for SI and equipment sales totaled JPY34,516 million, up 20.1% YoY; orders received for systems construction and equipment sales were JPY13,321 million, up 0.4% YoY and orders received for systems operation and maintenance were JPY21,194 million, up 37.0% YoY.

Order backlog for SI and equipment sales as of September 30, 2016 amounted to JPY40,926 million, up 26.2% YoY; order backlog for systems construction and equipment sales was JPY9,349 million, up 7.2% YoY and order backlog for systems operation and maintenance was JPY31,577 million, up 33.2% YoY.

Equipment sales revenues were JPY1,467 million, down 10.5% YoY (JPY1,638 million for 1H15).

ATM operation business revenues were JPY2,052 million, up 4.2% YoY (JPY1,971 million for 1H15). As of September 30, 2016, 1,066 ATMs have been placed.

Cost and expense

Total cost of revenues was JPY62,275 million, up 16.1% YoY (JPY53,626 million for 1H15).

Cost of network services revenue was JPY36,715 million, up 20.4% YoY (JPY30,501 million for 1H15). The increase was mainly because outsourcing-related costs increased along with the increase in mobile-related revenue and circuit-related costs increased along with the increase in WAN services revenue. Gross margin was JPY8,120 million, up 8.3% YoY and gross margin ratio was 18.1% compared to 19.7% in 1H15.

Cost of SI revenues was JPY22,993 million, up 13.0% YoY (JPY20,341 million for 1H15). There were increases in outsourcing-related and purchasing-related along with the revenue increase, personnel-related costs and network operation related costs increased mainly with the service launch of “IIJ GIO Infrastructure P2”. Gross margin was JPY2,775 million, down 18.0% YoY and gross margin ratio was 10.8% compared to 14.3% in 1H15.

Cost of equipment sales revenues was JPY1,343 million, down 9.3% YoY (JPY1,480 million for 1H15). Gross margin was JPY124 million and gross margin ratio was 8.4% compared to 9.6% in 1H15.

Cost of ATM operation business revenues was JPY1,224 million, down 6.2% YoY (JPY1,304 million for 1H15). Gross margin was JPY829 million and gross margin ratio was 40.4% compared to 33.8% in 1H15.

SG&A and R&D expenses

SG&A and R&D expenses in total were JPY9,900 million, up 8.3% YoY (JPY9,145 million for 1H15).

Sales and marketing expenses were JPY5,636 million, up 9.1% YoY (JPY5,166 million for 1H15). There were increases in sales commission expenses and advertising expenses.

General and administrative expenses were JPY4,020 million, up 7.3% YoY (JPY3,747 million for 1H15). There were increases in office rent expenses, commission expenses and taxes and public dues.

Research and development expenses were JP244 million, up 5.3% YoY (JPY232 million for 1H15).

Operating income

Operating income was JPY1,948 million, down 24.0% YoY (JPY2,563 million for 1H15).

Other income (expenses)

Other income (expenses) was an income of JPY157 million (an income of JPY84 million for 1H15), mainly because of net gain on sales of other investments of JPY214 million, distribution from fund investment of JPY120 million (included in other-net, JPY115 million for 1H15), dividend income of JPY91 million from other investments (JPY74 million for 1H15), interest expense of JPY142 million (JPY112 million for 1H15) and foreign exchange losses of JPY106 million (JPY14 million for 1H15).

Income before income tax expenses

Income before income tax expenses was JPY2,105 million, down 20.5% YoY (JPY2,647 million for 1H15).

Net income

Income tax expense was JPY954 million (JPY1,040 million for 1H15).

Equity in net income of equity method investees was JPY42 million (JPY137 million for 1H15) mainly due to net income of Internet Multifeed Co.

As a result of the above, net income was JPY1,193 million, down 31.6% YoY (JPY1,744 million for 1H15).

Net income attributable to IIJ

Net income attributable to non-controlling interests was JPY85 million mainly related to net income of Trust Networks Inc. (JPY92 million for 1H15).

Net income attributable to IIJ was JPY1,108 million, down 33.0% YoY (JPY1,652 million for 1H15).

1H16 Balance Sheets and Cash Flows

Balance sheets

As of September 30, 2016, the balance of total assets was JPY123,113 million, increased by JPY5,278 million from the balance as of March 31, 2016 of JPY117,835 million.

As for current assets as of September 30, 2016, as compared to the respective balances as of March 31, 2016, prepaid expenses increased by JPY1,370 million and inventories increased by JPY704 million. As for noncurrent assets as of September 30, 2016, as compared to the respective balances as of March 31, 2016, property and equipment increased by JPY2,288 million and prepaid expenses-noncurrent increased by JPY781 million. As for liabilities as of September 30, 2016, as compared to the respective balance as of March 31, 2016, long-term borrowings increased by JPY3,000 million.

As for the balances of capital lease obligations as of September 30, 2016, as compared to the respective balances as of March 31, 2016, capital lease obligations-current portion increased by JPY328 million to JPY4,283 million and capital lease obligations-noncurrent increased by JPY1,119 million to JPY8,899 million.

As of September 30, 2016, the balance of other investments increased by JPY824 million to JPY6,772 million mainly due to change an increase in the fair value of available-for-sale securities. The breakdown of other investments were JPY4,570 million in available-for-sale securities, JPY1,124 million in nonmarketable equity securities and JPY1,078 million in investments in funds, including some through a trust.

As of September 30, 2016, the breakdown of major non-amortized intangible assets were JPY6,170 million in goodwill and JPY96 million in trademark. The balance of amortized intangible assets, which was customer relationships, was JPY3,227 million.

Total IIJ shareholders’ equity as of September 30, 2016 compared to the balance as of March 31, 2016, increased by JPY679 million to JPY65,524 million. IIJ shareholders’ equity ratio (total IIJ shareholders’ equity divided by total assets) as of September 30, 2016 was 53.2%.

Cash flows

Cash and cash equivalents as of September 30, 2016 were JPY19,668 million. (JPY20,098 million as of September 30, 2015.)

Net cash provided by operating activities for 1H16 was JPY4,073 million (net cash provided by operating activities of JPY6,080 million for 1H15.) There were net income of JPY1,193 million, depreciation and amortization of JPY5,284 million and net cash out flow of JPY2,747 million from changes in operating assets and liabilities (JPY584 for 1H15). There were an increase in prepaid expenses (including prepaid expenses-noncurrent) mainly along with an increase in maintenance for service facilities and systems integration projects.

Net cash used in investing activities for 1H16 was JPY3,896 million (net cash used in investing activities of JPY4,565 million for 1H15), mainly due to payments for purchase of property and equipment of JPY5,358 million (JPY5,321 million for 1H15) and proceeds from sales of property and equipment, which include sales and leaseback, of JPY1,209 million (JPY490 million for 1H15).

Net cash provided by financing activities for 1H16 was JPY155 million (net cash used in financing activities of JPY2,525 million for 1H15), mainly due to proceeds from long-term borrowings of JPY3,000 million, principal payments under capital leases of JPY2,314 million (JPY2,020 million for 1H15) and FY2015 year-end dividends payments of JPY505 million (JPY505 million for 1H15).

FY2016 Financial Targets

On November 4, 2016, we revised our financial targets for FY2016 which was announced on May 13, 2016. Please refer to our disclosure document titled “IIJ Revises its First Half and Full-Year Financial Targets for FY2016” for details.

Reconciliation of Non-GAAP Financial Measures

The following table summarizes the reconciliation of adjusted EBITDA to net income attributable to IIJ in our consolidated statements of income that are prepared in accordance with U.S. GAAP.

*1 Depreciation and amortization includes impairment loss on other intangible assets. (See IIJ’s consolidated financial statements for details)

Presentation

Presentation materials will be posted on our web site (http://www.iij.ad.jp/en/ir/) on November 8, 2016.

About Internet Initiative Japan Inc.

Founded in 1992, IIJ is one of Japan’s leading Internet-access and comprehensive network solutions providers. IIJ and its group companies provide total network solutions that mainly cater to high-end corporate customers. IIJ’s services include high-quality Internet connectivity services, systems integration, cloud computing services, security services and mobile services. Moreover, IIJ has built one of the largest Internet backbone networks in Japan that is connected to the United States, the United Kingdom and Asia. IIJ listed on the U.S. NASDAQ Stock Market in 1999 and on the First Section of the Tokyo Stock Exchange in 2006.

For inquiries, contact:

IIJ Investor Relations
Tel: +81-3-5205-6500 E-mail: [email protected] URL: http://www.iij.ad.jp/en/ir

Statements made in this press release regarding IIJ’s or management’s intentions, beliefs, expectations, or predictions for the future are forward-looking statements that are based on IIJ’s and managements’ current expectations, assumptions, estimates and projections about its business and the industry. These forward-looking statements, such as statements regarding FY2016 revenues and operating and net profitability, are subject to various risks, uncertainties and other factors that could cause IIJ’s actual results to differ materially from those contained in any forward-looking statement. These risks, uncertainties and other factors include: IIJ’s ability to maintain and increase revenues from higher-margin services such as systems integration and outsourcing services; the possibility that revenues from connectivity services may decline substantially as a result of competition and other factors; the ability to compete in a rapidly evolving and competitive marketplace; the impact on IIJ’s profits of fluctuations in costs such as backbone costs and subcontractor costs; the impact on IIJ’s profits of fluctuations in the price of available-for-sale securities; the impact of technological changes in its industry; IIJ’s ability to raise additional capital to cover its indebtedness; the possibility that NTT, IIJ’s largest shareholder, may decide to exercise substantial influence over IIJ; and other risks referred to from time to time in IIJ’s filings on Form 20-F of its annual report and other filings with the United States Securities and Exchange Commission.

Second Quarter FY2016 Consolidated Financial Results (3 months)

The following tables are highlight data of 2nd Quarter FY2016 (3 months) consolidated financial results (unaudited, for the three months ended September 30, 2016).

*1 IP service revenues include revenues from the data center connectivity service.
*2 From 1Q16, the revenue from “IIJ Mobile MVNO Platform Service”, which is included in “IIJ Mobile service (Enterprise)”, is disclosed. “IIJ Mobile MVNO Platform Service” provides MVNO platform to our MVNE clients.
*3 From 1Q16, the revenue from “IIJmio High Speed Mobile Services”, which is included in “Internet connectivity services (Consumer)” provided by IIJ, is disclosed.

Reconciliation of Non-GAAP Financial Measures (2nd Quarter FY2016 (3 months))

The following table summarizes the reconciliation of adjusted EBITDA to net income in our consolidated statements of income that are prepared in accordance with U.S. GAAP.

The following table summarizes the reconciliation of capital expenditures to the purchase of property and equipment in our consolidated statements of cash flows that are prepared and presented in accordance with U.S. GAAP.

Note: The following information is provided to disclose Internet Initiative Japan Inc. (“IIJ”) financial results (unaudited) for the six months ended September 30, 2016 (“1H16”) in the form defined by the Tokyo Stock Exchange.

Consolidated Financial Results for the Six Months ended September 30, 2016
[Under accounting principles generally accepted in the United States (“U.S. GAAP”)]

November 8, 2016
Company name: Internet Initiative Japan Inc.
Exchange listed: Tokyo Stock Exchange First Section
Stock code number: 3774
URL: http://www.iij.ad.jp/
Representative: Eijiro Katsu, President and Representative Director
Contact: Akihisa Watai, Managing Director and CFO
TEL: (03) 5205-6500
Scheduled date for filing of quarterly report (Shihanki -houkokusho) to Japan’s regulatory organization: November 14, 2016
Scheduled date for dividend payment: December 6, 2016
Supplemental material on annual results: Yes
Presentation on quarterly report: Yes (for institutional investors and analysts)

(Amounts of less than JPY one million are rounded)

1. Consolidated Financial Results for the Six Months ended September 30, 2016
(April 1, 2016 to September 30, 2016)

2. Dividends

(Note) Change from the latest released dividend forecasts: No.

3. Target of Consolidated Financial Results for the Fiscal Year Ending March 31, 2017

(Note1) Changes from the latest forecasts released: No

* Notes