Company Quick10K Filing
Quick10K
Internet Initiative Japan
20-F 2018-03-31 Annual: 2018-03-31
20-F 2017-03-31 Annual: 2017-03-31
20-F 2016-03-31 Annual: 2016-03-31
20-F 2016-03-31 Annual: 2016-03-31
YNDX Yandex 12,220
LN Line 8,397
SWCH Switch 4,062
SVMK SVMK 2,251
EB Eventbrite 1,460
MODN Model N 878
RUBI Rubicon Project 527
SYNC Synacor 77
INAP Internap 72
MOXC Moxian 20
IIJI 2018-03-31
Item 17 ¨ Item 18 ¨
Part I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Change in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Item 16H. Mine Safety Disclosure
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
EX-4.5 exh_45.htm
EX-12.1 exh_121.htm
EX-12.2 exh_122.htm
EX-13.1 exh_131.htm
EX-13.2 exh_132.htm

Internet Initiative Japan Earnings 2018-03-31

IIJI 20F Annual Report

Balance SheetIncome StatementCash Flow

20-F 1 f20f_062918p.htm FORM 20-F

As filed with the Securities and Exchange Commission on June 29, 2018

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 20-F

¨REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2018

OR

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

OR

¨SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report           

Commission file number: 0-30204

Kabushiki Kaisha Internet Initiative

(Exact Name of Registrant as Specified in Its Charter)

Internet Initiative Japan Inc.

(Translation of Registrant’s Name Into English)

Japan

(Jurisdiction of Incorporation or Organization)

Iidabashi Grand Bloom, 2-10-2 Fujimi, Chiyoda-ku, Tokyo 102-0071 Japan

(Address of Principal Executive Offices)

Natsuko Kiyoshi, +81-3-5205-6500, +81-3-5205-6441,

Iidabashi Grand Bloom, 2-10-2 Fujimi, Chiyoda-ku, Tokyo 102-0071 Japan

(Name, Telephone, Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

  Title of Each Class   Name of Each Exchange On Which Registered  
  Common Stock The NASDAQ Stock Market  

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

As of March 31, 2018, 46,713,800 shares of common stock were outstanding, including 811,425 shares represented by an aggregate of 1,622,850 American Depositary Shares.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No þ

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes ¨ No þ

Note—Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ Accelerated Filer ¨   Non-Accelerated Filer ¨ Emerging growth company ¨

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ¨

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP þ International Financial Reporting Standards as issued by the International Accounting Standards Board ¨ Other ¨ 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 ¨ Item 18 ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No þ

 

 

 

TABLE OF CONTENTS

PART I 2
Item 1. Identity of Directors, Senior Management and Advisers 2
Item 2. Offer Statistics and Expected Timetable 2
Item 3. Key Information 2
Item 4. Information on the Company 23
Item 5. Operating and Financial Review and Prospects 48
Item 6. Directors, Senior Management and Employees 86
Item 7. Major Shareholders and Related Party Transactions 96
Item 8. Financial Information 98
Item 9. The Offer and Listing 99
Item 10. Additional Information 101
Item 11. Quantitative and Qualitative Disclosures about Market Risk 114
Item 12. Description of Securities Other than Equity Securities 115
PART II 116
Item 13. Defaults, Dividend Arrearages and Delinquencies 116
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds 116
Item 15. Controls and Procedures 116
Item 16A. Audit Committee Financial Expert 120
Item 16B. Code of Ethics 120
Item 16C. Principal Accountant Fees and Services 120
Item 16D. Exemptions from the Listing Standards for Audit Committees 121
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers 122
Item 16F. Change in Registrant's Certifying Accountant 122
Item 16G. Corporate Governance 122
Item 16H. Mine Safety Disclosure 123
PART III 124
Item 17. Financial Statements 124
Item 18. Financial Statements 124
Item 19. Exhibits 124

 

 

 

 

Cautionary Note Regarding Forward-Looking Statements

This annual report contains forward-looking statements about us and our industry that are based on our current expectations, assumptions, estimates and projections. These forward-looking statements are subject to various risks and uncertainties. These statements discuss future expectations, identify strategies, discuss market trends, contain projections of results of our operations and our financial condition, and state other forward-looking information. Known and unknown risks, uncertainties and other factors could cause our actual results to differ materially from those contained in or suggested by any forward-looking statement. We cannot provide any assurance that our expectations, projections, anticipated estimates or other information expressed in these forward-looking statements will turn out to be correct. We do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Important risks and factors that could cause our actual results to differ materially from our forward-looking statements are generally provided in Item 3.D. “Risk Factors” and elsewhere in this annual report on Form 20-F and include, without limitation:

·that we may not be able to achieve or sustain profitability in the near future,
·that we may not be able to compete effectively against competitors which have greater financial, marketing and other resources, and
·that our investments in our subsidiaries, affiliated companies, new business and service developments may not produce the returns we expect or may adversely affect our results of operations and financial condition adversely.

 

 

 

 

 

 

 

 

 

 

 1 

 

As used in this annual report, references to “IIJ” are to Internet Initiative Japan Inc. and references to “the Company,” “the Group,” “we,” “our,” “our group” and “us” are to Internet Initiative Japan Inc. and its subsidiaries except as the context otherwise requires.

 

References in this annual report to “yen” or “¥” are to Japanese yen and references to “U.S. dollars” or “$” are to United States dollars.

 

PART I

Item 1. Identity of Directors, Senior Management and Advisers

 

Not applicable.

 

Item 2. Offer Statistics and Expected Timetable

 

Not applicable.

 

Item 3. Key Information

 

A.  Selected Financial Data

 

The following tables include selected historical financial data as of and for each of the fiscal years ended March 31, 2014, 2015, 2016, 2017, and 2018. The data in the table is derived from our audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and audited by Deloitte Touche Tohmatsu LLC, an independent registered public accounting firm. You should read the selected consolidated financial data together with Item 5. “Operating and Financial Review and Prospects” of this annual report on Form 20-F and our consolidated financial statements and the notes to our consolidated financial statements beginning on page F-1. 

 2 

 

   As of and for the fiscal year ended March 31,
   2014  2015  2016  2017  2018
   (millions of yen, except per share and ADS data)
Statement of Income Data:               
REVENUES:               
Network services:                         
Internet connectivity services (enterprise)   ¥16,585   ¥16,350   ¥17,597   ¥22,634   ¥27,944 
Internet connectivity services (consumer)    6,025    8,222    15,256    21,735    24,761 
WAN services    25,006    24,326    25,177    26,460    29,295 
Outsourcing services    19,670    20,108    21,266    22,167    26,119 
Total    67,286    69,006    79,296    92,996    108,119 
Systems integration:                          
Systems construction    18,673    20,437    21,145    22,626    22,528 
Systems operation and maintenance    23,796    27,800    33,043    35,123    37,903 
Total    42,469    48,237    54,188    57,749    60,431 
Equipment sales    1,690    2,167    3,275    2,994    3,470 
ATM operation business    2,827    3,640    3,889    4,050    4,031 
Total revenues    114,272    123,050    140,648    157,789    176,051 
                          
COSTS AND EXPENSES:                         
Cost of network services    53,046    54,932    64,239    76,387    88,698 
Cost of systems integration    36,510    41,562    46,226    50,992    53,612 
Cost of equipment sales    1,527    1,932    2,969    2,735    3,142 
Cost of ATM operation business   2,123    2,552    2,559    2,428    2,366 
Total costs    93,206    100,978    115,993    132,542    147,818 
Sales and marketing    8,548    9,188    10,589    11,432    12,688 
General and administrative    6,374    7,368    7,471    8,215    8,296 
Research and development    421    441    455    466    487 
Total costs and expenses    108,549    117,975    134,508    152,655    169,289 
OPERATING INCOME    5,723    5,075    6,140    5,134    6,762 
                          
OTHER INCOME (EXPENSES):                         
Dividend income    51    63    93    118    243 
Interest income    27    23    28    35    31 
Interest expense    (256)   (238)   (241)   (304)   (375)
Net gain on sales of other investments    108    41    24    217    1,068 
Other — net    622    175    149    227    111 
Other income — net   552    64    53    293    1,078 
                          
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE AND EQUITY IN NET INCOME OF EQUITY METHOD
INVESTEES
   6,275    5,139    6,193    5,427    7,840 
INCOME TAX EXPENSE    1,795    1,897    2,183    2,225    2,696 
EQUITY IN NET INCOME OF EQUITY METHOD INVESTEES   204    155    180    130    135 
NET INCOME    4,684    3,397    4,190    3,332    5,279 
LESS: NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS    (242)   (75)   (152)   (165)   (170)
NET INCOME ATTRIBUTABLE TO INTERNET INITIATIVE JAPAN INC.   ¥4,442   ¥3,322   ¥4,038   ¥3,167   ¥5,109 

 

 3 

 

 

   As of and for the fiscal year ended March 31,
   2014  2015  2016  2017  2018
   (millions of yen, except per share and ADS data)
    
Per Share and ADS Data:                         
Basic net income attributable to IIJ per common share   ¥100.26   ¥72.31   ¥87.88   ¥69.36   ¥113.37 
Diluted net income attributable to IIJ per common share    100.14    72.20    87.71    69.18    112.99 
Basic net income attributable to IIJ per ADS equivalent    50.13    36.16    43.94    34.68    56.69 
Diluted net income attributable to IIJ per ADS equivalent    50.07    36.10    43.86    34.59    56.50 
                          
Cash dividends declared per share:                         
Japanese Yen   ¥22.00   ¥22.00   ¥22.00   ¥27.00   ¥27.00 
U.S. Dollars (1)   $0.21   $0.18   $0.20   $0.24   $0.24 
Basic weighted-average number of shares    44,306,680    45,942,291    45,950,098    45,652,981    45,062,878 
Diluted weighted-average number of shares    44,361,083    46,014,737    46,043,383    45,772,470    45,215,686 
Basic weighted-average number of ADS equivalents (thousands)    88,613    91,885    91,900    91,306    90,126 
Diluted weighted-average number of ADS equivalents (thousands)    88,722    92,029    92,087    91,545    90,431 
                          
Balance Sheet Data:                         
Cash and cash equivalents   ¥22,421   ¥21,094   ¥19,569   ¥21,959   ¥21,403 
Total assets    103,867    108,705    117,835    137,395    153,449 
Short-term borrowings    9,400    9,250    9,250    9,250    9,250 
Long-term borrowings, including capital lease obligations:                         
Current portion    4,733    3,522    3,954    4,819    5,656 
Noncurrent portion    4,603    4,340    7,779    18,885    26,421 
Common stock   25,497    25,500    25,509    25,509    25,512 
Total IIJ shareholders’ equity    59,912    62,504    64,845    66,742    73,270 
                          
Operating Data:                         
Capital expenditures, including capitalized leases (2)   ¥12,560   ¥11,835   ¥14,812   ¥16,531   ¥20,828 
                          
Operating margin ratio (3)    5.0%   4.1%   4.4%   3.3%   3.8%
                          
Net cash provided by (used in):                         
Operating activities   ¥8,787   ¥12,912   ¥12,052   ¥7,368   ¥13,262 
Investing activities    (10,203)   (8,073)   (8,377)   (7,376)   (13,037)
Financing activities    11,382    (6,283)   (5,201)   2,492    748 
                          

_________________

(1)The dividends per share were translated into U.S. dollars at the relevant record date.
(2)Further information regarding capital expenditures, including capitalized leases and a reconciliation to the most directly comparable U.S. GAAP financial measure can be found in the following page.
(3)Operating income as a percentage of total revenues.

 

 4 

 

Reconciliations of the Disclosed Non-GAAP Financial Measures to the Most Directly Comparable GAAP Financial Measures

 

Capital expenditures

 

We define capital expenditures as purchases of property and equipment plus acquisition of assets by entering into capital leases. We have included the information concerning capital expenditures because our management monitors our capital expenditure budgets and believes that it is useful to investors to know the trends of our capital expenditures and analyze and compare companies on the basis of such investments. Capital expenditures, as we have defined it, may not be comparable to similarly titled measures used by other companies.

 

The following table summarizes the reconciliation of capital expenditures to purchases of property and equipment and acquisition of assets by entering into capital leases as reported in our consolidated statements of cash flows prepared and presented in accordance with U.S. GAAP.

 

   For the fiscal year ended March 31,
   2014  2015  2016  2017  2018
   (millions of yen)
Capital expenditures:                         
Acquisition of assets by entering into capital leases(1)   ¥3,436   ¥3,678   ¥6,118   ¥8,302   ¥7,109 
Purchases of property and equipment(2)    9,124    8,157    8,694    8,229    13,719 
Total capital expenditures   ¥12,560   ¥11,835   ¥14,812   ¥16,531   ¥20,828 

_____________________

(1)Regarding the acquisition of assets by entering into capital leases for the fiscal year ended March 31, 2016, sales-type leases are excluded from purchase of property and equipment disclosed in our consolidated financial statement of cash flows.
(2)Regarding the purchases of property and equipment for the fiscal years ended March 31, 2016, 2017, and 2018, sales-leaseback transactions are excluded from purchases of property and equipment disclosed in our consolidated financial statements of cash flows.

 

 

 5 
 

 

 

Exchange Rates

 

Fluctuations in exchange rates between the Japanese yen and the U.S. dollar will affect the U.S. dollar and other currency equivalent of the yen price of IIJ shares and the U.S. dollar amounts received on conversion of any cash dividends, which in turn will affect the U.S. dollar price of IIJ ADSs. We have translated some Japanese yen amounts presented in this annual report into U.S. dollars solely for your convenience. Unless otherwise noted, the rate used for the translations was ¥106.20 per U.S. $1.00, which was the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York prevailing as of March 30, 2018. Translations do not imply that the yen amounts actually represent, or have been or could be converted into, equivalent amounts in U.S. dollars.

 

The following table presents the noon buying rates for Japanese yen per U.S. $1.00 in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York:

 

Fiscal year ended March 31, (1)  High  Low  Average(2)  Period-end
2014  ¥105.25   ¥92.96   ¥100.46   ¥102.98 
2015   121.50    101.26    110.78    119.96 
2016   125.58    111.30    120.13    112.42 
2017   118.32    100.07    108.31    111.41 
2018   114.25    104.83    110.70    106.20 
                     
Calendar year 2018                    
January   ¥113.18   ¥108.38   ¥110.87   ¥109.31 
February    110.40    106.10    107.97    106.62 
March    106.91    104.83    106.05    106.20 
April    109.33    105.99    107.66    109.28 
May    111.08    108.62    109.69    108.73 
June (through June 22, 2018)    110.58    109.45    110.02    109.98 

_____________________

(1)Exchange rate refers to the foreign exchange rate as set forth in the H.10 statistical release and historical data of the Board of Governors of the Federal Reserve System.
(2)For fiscal years, calculated from the average of the exchange rates on the last day of each month during the period. For calendar year months, calculated based on the average of daily exchange rates.

 

The noon buying rate on June 22, 2018 was ¥109.98 per $1.00.

 

 

A.Capitalization and Indebtedness

 

Not required.

 

 

B.Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

 

 6 
 

 

D.Risk Factors

 

You should carefully consider the following information, together with the other information contained in this annual report on Form 20-F, including our consolidated financial statements and the related notes, before making an investment decision. Any risks described below could result in a material adverse effect on our business, financial condition or results of operations.

 

We may not maintain our current level of revenues and profits or achieve our expected revenues and profits in the future.

 

Our business is principally conducted in Japan and most of our revenues are from customers operating in Japan. For the fiscal year ended March 31, 2018, approximately 97% of our total revenues were from customers operating in Japan. If the Japanese economy deteriorates and that results in significantly lower levels of network and systems related investment and expenditures, customers may respond to such conditions by prioritizing low prices over quality, or we may experience severe price reduction pressure and/or cancellation of large accounts. Such conditions may also make it difficult to maintain our current level of revenues and income, or achieve our expected revenues and income, or payout our target dividends.

 

In addition to factors related to general economic conditions in Japan, we may not be able to maintain our current level of revenues and income or achieve our expected levels of revenues and income. In fact, we revised our disclosed financial targets downward for the fiscal years ended March 31, 2014, 2015, and 2017 due to several factors unrelated to general economic conditions in Japan. Operating income for the fiscal year ended March 31, 2017 decreased from that of fiscal year ended March 31, 2016. Factors that may prevent us from maintaining our current level of revenues and income or achieving our expected levels of revenues and income include but are not limited to the following:

 

·a decrease or weaker than expected growth in our network services revenues which include Internet connectivity services for enterprise, Internet connectivity services for consumers, Wide Area Network (“WAN”) services, and outsourcing services if, for example, we fail to develop and offer competitive services and solutions in a timely manner, if our service line-ups become obsolete, if we fail to keep up with rapidly changing market trends, especially for the consumer market, if service prices fall dramatically due, for example, to tough competition regarding customer acquisition, especially for our mobile services for consumers which are provided through direct sales, sales partnerships, and Mobile Virtual Network Enabler (“MVNE”) strategy, or if we experience cancellations or usage reductions, especially in large accounts, due, for example, to corporate customers’ demand to cut costs or a decrease in customers’ needs for network usage for enterprise services,

 

·a decrease or weaker than expected growth in our systems construction revenues and lower margins if, for example, we fail to successfully differentiate our technical skills from those of our competitors, if corporate customers put off placing orders with us, if we fail to hire adequate employees or acquire outsourcing resources to complete systems projects appropriately, if we fail to effectively manage and assign outsourcing resources, if we have serious troubles or problems in certain projects which may become unprofitable or incur losses, especially for large-scale projects, or if we pursue unprofitable construction projects in order to, for example, gain greater business opportunities and to acquire continuous systems operation and maintenance profit in the future. Our systems construction revenues may decrease due to the continuing trend of cloud computing services replacing conventional on-site hardware,

 

·a decrease or weaker than expected growth in our systems operation and maintenance revenues and lower margins if, for example, the number and the size of systems construction projects which contain continuous systems operation and maintenance decrease or do not significantly increase, if our cloud computing services revenues do not grow as anticipated, or if we fail to effectively manage and assign outsourcing resources, or if we have serious troubles or problems in certain projects which may become unprofitable or incur losses. Also, we may have cancellations or reductions in current systems operation and maintenance revenues due, for example, to severe price reduction requirements, especially for large-scale projects, or due to customers’ intention to reduce or eliminate their systems,

 

 7 
 

 

·an inability to achieve anticipated revenue and income growth for our cloud computing services, in which we have been continuously investing in facilities such as some portion of our data centers, servers, storages, software and other equipment as well as service developments if, for example, the cloud computing market in Japan does not expand as large as we expect or takes a longer time to expand than we expect, if we fail to successfully differentiate our services from those of our increasing number of competitors, including global players, if we have serious system troubles and interruptions with our cloud computing services that damage our credibility or cause customers to question the reliability of our services, if market prices for the services fall dramatically, if we experience cancellations of large contracts or reduction of usage, or if Japanese companies strongly maintain their current systems and fail to adopt cloud computing services to the extent currently anticipated. We decided to build our own data center in order to meet the future data center capacity demand as well as integrate our data center racks that are currently widely dispersed among Eastern Japan area’s data centers. We plan to place module-based data center, rather than a traditional building-based data center. For more discussion on the risks related to our cloud computing services, please refer to other parts of “Risk Factors” including “Our investment in our new business and service developments may not produce the returns we expect or may affect our results of operations and financial condition adversely.

 

·an inability to achieve anticipated revenue and income growth for our mobile services for both enterprise and consumer, in which we have been expanding our service infrastructure by increasing the purchasing volume of mobile bandwidth mainly from NTT DoCoMo Inc. (“NTT Docomo”), enhancing marketing activities, including increasing related advertisement expenses, if, for example, the Japanese inexpensive LTE Subscriber Identity Module (“SIM”) card market does not expand as we expect or takes a longer time to expand than we expect, if we experience severe customer acquisition and/or price competition, if Mobile Network Operators (“MNOs”) and their affiliated companies which currently dominate the Japanese consumer mobile market further implement low price strategies, if we fail to successfully differentiate our services from those of an increasing number of competitors, if we fail to carry out our marketing strategy and are left with significant increases in selling, general and administrative (“SG&A”) expenses, if we fail to maintain appropriate relationships with our sales partners, if we face troubles in providing services which damage our credibility, if we are faced with heavy concentrations of mobile traffic at certain hours which requires us to purchase greater than our expected volume of bandwidth thus resulting in cost increases, or if we experience an unexpected level of wholesale telecommunication services charge changes by MNOs, such as NTT Docomo. We launched full-Mobile Virtual Network Operator (“MVNO”) services in March 2018 and plan to expand our service line-up. In light of the service launch, our network services’ fixed type cost is expected to increase by approximately ¥0.1 billion per month, consisting mainly of depreciation cost for HLR (Home Location Register) and HSS (Home Subscriber Server) systems constructed by us, and the accumulation of monthly payments to NTT Docomo for its network remodeling which will not be recognized as our capital expenditures but will be included in our monthly payments to NTT Docomo. For more discussion on the risks related to our mobile business, please refer to other parts of “Risk Factors” including “Our investment in our new business and service developments may not produce the returns we expect or may affect our results of operations and financial condition adversely.

 

 8 
 

 

·an inability to achieve anticipated revenue and income growth for our overseas business, in which we have been investing in overseas subsidiaries, facilities and increasing staff, if, for example, we fail to offer competitive services and solutions, if our domestic customers reduce their overseas business and/or refrain from operating overseas business, if we fail to develop a customer base overseas, if we fail to attract and attain qualified personnel overseas, if we fail to provide our services as reliably as we provide them in the domestic market, if we fail to successfully work with business partners abroad, or if we fail to adequately control overseas subsidiaries and comply with necessary regulations. We may expand our presence overseas by, for example, increasing overseas subsidiaries or participating in more joint ventures with local companies. For more discussion on the risks related to our overseas business, please refer to other parts of “Risk Factors” including “Our investment in our new business and service developments may not produce the returns we expect or may affect our results of operations and financial condition adversely.

 

·a decline in the profitability of network services if, for example, we invest in and contract more network capacity, including service facilities, than we actually require to serve our customers, if we experience unexpected increases or smaller-than-expected decreases in prices such as for electricity, leasing lines for our Internet backbone and interconnectivity bandwidth for MVNO infrastructure. These unexpected price fluctuations could be due, for example, to a shortage in electricity, an increase in Internet traffic volume and general demand for the infrastructure. There may also be price increases for international leasing lines and network equipment for service facilities, including cloud computing services, due, for example, to the weaker Japanese yen,

 

·slower and/or weaker than expected revenues growth against significant investments in business such as back-office systems, research and development, and other similar expenses and investments which we may be forced to make in the future in order to remain competitive or support business growth, and an unexpected level of increase in depreciation and amortization, loss on disposal, or loss due to obsolescence. We may continuously reinforce our back-office operations by making necessary investments to support revenue growth,

 

·an unexpected level of increase in personnel and outsourcing costs as well as related operating costs and expenses including office rent expenses if, for example, we fail to manage personnel and outsourcing resources effectively, if we experience a shortage of human resources in the market, or if we face pressure to raise individual salaries by a large amount due, for example, to Japanese labor market situation. As for our overall personnel costs, they continuously increase year over year as we acquire new employees in addition to the regular annual pay raise for existing employees. We may fail to raise enough revenue to cover the increase in these costs and expenses.

 

·an unexpected level of increase in SG&A expenses, such as personnel-related expenses, office rent-related expenses, sales commission expenses, and advertising expenses,

 

·the recording of an impairment loss on current and future intangible assets, which are recognized in relation to any mergers and acquisitions, that are subject to amortization, such as customer relationships, and/or are not subject to amortization, such as goodwill, as a result of an impairment test,

 

·the recording of an impairment loss and/or a retirement on tangible assets, software, network, service facilities and others if they fail to generate future cash flow as expected,

 

 9 
 

 

·the recording of impairment losses on nonmarketable equity securities and funds,

 

·the recording of unrealized gains and/or losses in other income (expenses) due to fluctuation of share prices for our available-for-sale equity securities following the revision of U.S. GAAP. Unrealized gains or losses on holding available-for-sale equity securities as recorded on our consolidated balance sheet as of March 31, 2018 were measured based on closing prices of March 30, 2018, the final day of trading in the fiscal year ended March 31, 2018 and were reclassed from accumulated other comprehensive income to retained earnings at the beginning of the fiscal year ending March 31, 2019. For future periods, fluctuations of unrealized gains or losses due to fluctuation of stock prices will be recognized in other income (expenses) in every quarter under the U.S. GAAP.

 

We are considering to voluntarily adopt International Financial Reporting Standards (“IFRS”) from the filing of our annual report for the fiscal year ending March 31, 2019. Until then, we plan to continue preparing our consolidated financial statements disclosed in earnings press release as well as in the Convocation Notice for the 27th Ordinary General Meeting for Shareholders under U.S. GAAP. Because of different accounting principles, especially on different processing on unrealized gains or losses on holdings available-for-sale equity securities, our consolidated financial statements disclosed in the annual report, which might be prepared under IFRS, might differ from our consolidated financial statements disclosed in earnings press release as well as in the Convocation Notice for the 27th Ordinary General Meeting for Shareholders, which will be prepared under the U.S. GAAP.

 

·the recording of foreign exchange gain and/or loss such as for our U.S. dollars and British pounds denominated bank deposits, other overseas assets, and liabilities related to our overseas business,

 

·the decline in the value and trading volume of our holding of available-for-sale securities from which we expect gains on sale,

 

·a negative effect on our revenues and profits if our consolidated subsidiaries and/or equity method investees including newly established ones, such as DeCurret Inc. (“DeCurret”) which is to provide cryptocurrency exchange and settlement business as well as JOCDN Inc. (“JOCDN”) which provides contents distribution network (“CDN”) services, cannot achieve our expected levels of revenues or manage costs and expenses in a timely and adequate manner,

 

·a negative effect on our credibility, corporate image, or revenues and profits if we are unable to provide our services without interruption to customers due, for example, to power supply shortage, and

 

·a negative effect on our revenues and profits if new business areas to which we are to emphasize business investment such as content distribution, Machine to Machine (“M2M”), Internet of Things (“IoT”), health care and further development of overseas business cannot achieve our expected level of revenues or manage costs and expenses in a timely and adequate manner.

 

We disclosed our middle term plan for the period from the fiscal year ended March 31, 2017 to the fiscal year ending March 31, 2021 in our earnings results for the fiscal year ended March 31, 2016, which was filed as Form 6-K on May 13, 2016. The middle term plan was made based on our current expectation about, for example, the related markets and economic situations. The plan, especially regarding our target for the fiscal year ending March 31, 2021, is not made by accumulating each revenue line or operating cost item. We are not certain that we will be able to achieve our middle term plan due to such risks as weaker or slower than expected market expansion or a failure to execute growth strategies effectively. Please see Item 5, “Operating and Financial Review and Prospects” for more detailed information concerning our operations and other results.

 

We may not be able to compete effectively, especially against competitors with greater financial, marketing and other resources.

 

The major competitors of our network services are major telecommunications carriers such as NTT Communications Corporation (“NTT Communications”) and KDDI Corporation (“KDDI”). Price competition for Internet connectivity services, outsourcing services, and WAN services has been severe. This competition may adversely affect our revenues and profitability and may make it difficult for us to retain existing customers or attract new customers. The major competitors of our systems integration business are systems integrators, such as NEC Corporation, Fujitsu Limited, NTT Data Corporation and their affiliates. Our major competitors have the financial resources to reduce prices in an effort to gain market share. There is strong competition among systems integrators that may adversely affect our revenues and profitability. Even though the NTT Group, which is comprised of companies such as Nippon Telegraph and Telephone Corporation (“NTT”) and NTT Communications, is IIJ's largest shareholder, we plan to continue to operate the Company separately and independently from the NTT Group, and will therefore continue to compete with the NTT Group.

 

 10 
 

 

We anticipate that cloud computing services for enterprise should become widely used in Japan in the middle-to long-term. In addition to the competitors listed above, global players such as Amazon Web Services, Inc. and MICROSOFT CORPORATION have been aggressively expanding their business and may put additional business resources into the cloud computing business which may lead to strong competition, including price competition, in Japan. If we fail to successfully differentiate our services and solutions from these competitors, we may not be able to achieve expected future revenues and income, or we may not recoup our investments in cloud computing services, which may adversely affect our financial condition and results of operations.

 

As for our consumer business, especially our mobile services for consumers, in which we offer inexpensive LTE SIM cards through an MVNO scheme, we may not be able to achieve expected future revenues and income due, for example, to severe competition for pricing and customer acquisition, as a growing number of competitors and companies with greater financial resources enter the market, a failure to differentiate our services from competitors, our limited brand recognition among consumers and a lack of experience in providing services to consumers. Moreover, we may increase marketing expenses in order to improve our limited brand recognition among consumers. The major competitors of consumer mobile services business are NTT Docomo, KDDI, SoftBank Group Corp. (“SoftBank”), their affiliated companies, and MVNOs including NTT Communications Furthermore, additional new competitors may emerge and the competitive landscape may change.

 

We are enhancing our indirect sales channels with partnership programs, although currently our sales channels with respect to small and medium enterprises and the consumer market are not as strong as those of our established and well recognized larger competitors.

 

Our competitors have advantages over us, including, but not limited to:

 

·substantially greater financial resources, more extensive and well-developed marketing and sales networks,
·a larger pool of technology human resources including application development engineers,
·higher brand recognition among consumers and corporate customers,
·larger customer bases, and
·more diversified operations which allow profits from some operations to support operations with lower profitability.

 

With these advantages, our competitors may be better able to:

 

·sustain downward pricing pressure, including pressure on low-price Internet connectivity services offered to corporate customers, which are our target customers,
·develop, market and sell their services,
·adapt quickly to new and changing technologies,
·obtain new customers, and
·aggressively pursue mergers and acquisitions to enlarge their customer base and market share.

 

 11 
 

 

Our investment in our new business and service developments may not produce the returns we expect or may adversely affect our results of operations and financial condition.

 

We have been investing in new business, service and solution developments to further grow our business. Such investments include, for example, an increase in human resources and capital expenditures. As for the number of our employees, we had 2,980, 3,104 and 3,203 employees as of March 31, 2016, 2017, and 2018 respectively. Capital expenditures, including capitalized leases, depreciation and amortization expenses for property and equipment, and working capital are increasing along with our business expansion efforts. Capital expenditures, including capitalized leases, for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥14.8 billion, ¥16.5 billion and ¥20.8 billion, respectively. Capital expenditure in the fiscal year ended March 31, 2018 include approximately ¥1.2 billion for the acquisition of land for our own new data center of as well as approximately ¥3 billion of capital expenditures for cloud service facility in Western Japan for usage from the fiscal year ending March 31, 2019. Depreciation and amortization expenses for property and equipment for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥9.5 billion, ¥10.5 billion and ¥12.0 billion respectively. If our investment returns are not realized in the future, our investments may become obsolete, which may adversely affect our financial condition and results of operations. Our recent enhanced business investments could lead to a greater uncertainty in our financial outlook.

 

We are investing heavily in our cloud computing services and infrastructure as the cloud computing services market in Japan is anticipated to grow over the middle term. Revenues for our cloud computing services for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥14.1 billion, ¥15.7 billion and ¥17.9 billion, respectively. The capital expenditures, including capitalized leases, related to our domestic cloud computing services for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥4.4 billion, ¥3.6 billion and ¥7.9 billion, respectively. Capital expenditures during the fiscal year ended March 31, 2018 include approximately ¥3 billion of capital expenditures for a cloud service facility in Western Japan for usage from the fiscal year ending March 31, 2019. As we expand our cloud computing services capabilities in order to meet the increasing demand, we will need to acquire more servers, network equipment and data center facilities, as well as human resources. Along with our business investments for cloud computing services, related costs such as depreciation and amortization are increasing significantly compared to cloud-related revenue. We anticipate that we can leverage our strong customer base and our engineering skills to further expand our cloud computing related services; however, if the expansion of the cloud computing market does not proceed at its expected pace or takes longer than expected, if we face troubles in providing cloud computing services which damage our credibility or lead customers to question the reliability of our services, if we fail in our marketing strategy and fail to introduce cloud service line-ups that are superior to our competitors and promote business enterprises’ cloud usage, if we invest more than customers demand, if severe price competition occurs, or if we should need more human resources and incur unexpected additional costs, we may not be able to achieve the returns or benefits we expect or we may need to increase the amount of our investments.

 

 12 
 

 

We have been providing mobile services from January 2008 by purchasing NTT Docomo’s mobile network infrastructure as an MVNO. The total (sum of enterprise and consumer) mobile services revenues were ¥15.6 billion, ¥26.7 billion and ¥35.3 billion for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. The total number of our mobile services subscriptions was approximately 1,228 thousand, 1,856 thousand and 2,345 thousand as of March 31, 2016, 2017, and 2018, respectively. This increase is mainly due to growth in mobile services for consumers in which we offer inexpensive LTE SIM cards through MVNE scheme. Currently, most Japanese mobile phone consumers are contracted with mobile network carriers such as NTT Docomo, KDDI, and Softbank. We anticipate that the inexpensive LTE SIM card market in Japan should expand in the middle term because a small portion of Japanese mobile phone users are contracted with inexpensive LTE SIM card services. We may not be able to achieve our anticipated level of business growth if, for example, the market does not expand as currently anticipated, if MNOs and their affiliated companies implement strategies in order to maintain their customer base by dramatically lowering their pricing or offering comprehensive bundled services to make it harder for consumers to switch contracts to other providers, if price competition becomes severe, if we fail to differentiate our services from our competitors, if changes in regulation adversely affect our business, if we significantly damage our reputation or decrease customer trust by failing to offer reliable connectivity or cause serious systems or network troubles or if we fail to maintain or develop appropriate relationships with sales partners, if we face unfavorable changes in business conditions with these sales partners, including sales commission terms, or if we mismanage our marketing expenses, we may not be able to achieve our expected levels of business growth and could negatively impact our profit level. In fact, the affiliated companies of KDDI and Softbank in particular are aggressively promoting their consumer mobile services. Because business enterprise has been our main customer domain, IIJ is not well known among consumers. Therefore, we rely on our partnerships for sales channels, including prominent consumer retailers who have nationwide stores in order to have face-to-face sales counters, as well as MVNE strategy, through which we provide our MVNO infrastructure to corporate customers so that they can incorporate it into their own services, in order to generate subscriptions. The cost structure of mobile services imposes uncertainty on our financial outlook. Our mobile infrastructure purchasing volume from NTT Docomo has been increasing along with the growing subscriptions of our mobile services for consumers. We pay NTT Docomo a wholesale telecommunication service charge, which is a flat-rate charge per Mbps and the same charge currently has been applied to all of NTT Docomo’s MVNOs. The charge is calculated annually and it is mainly based on NTT Docomo’s mobile data communication infrastructure volume and its related costs, in accordance with the law and the guidelines administrated by the Ministry of Internal Affairs and Communications (“MIC”). The charge that was applied to our purchasing volume from NTT Docomo during the fiscal year ended March 31, 2018 was based on NTT Docomo’s mobile data communication infrastructure volume and related costs for the fiscal year ended March 31, 2017. The charge was fixed and notified to MVNOs purchasing volume from NTT Docomo, including us, in March 2018. The charge has been applied to not only our purchasing volume during the fiscal year ended March 31, 2018, but also during the fiscal year ended March 31, 2017. NTT Docomo’s unit price of wholesale telecommunication volume was revised in March 2018 for a decrease of 18.2% year over year, compared to 14.1% decrease in the previous year. This relatively large decrease seems to be mainly due to NTT Docomo’s cost decrease related to their change in depreciation method from declining-balance to straight line method from their fiscal year ended March 31, 2017. We need to apply our own estimated charge from the beginning of a fiscal year and calculate quarterly financial results based on our own estimated charge until the charge is finalized, generally in March. If there is a gap between our estimated charge decrease rate and the actual revised charge decrease rate, we will record increased costs if the actual revised charge decrease is smaller than our estimated charge decrease rate and will record decreased costs if the actual revised charge decrease is larger than our estimated charge decrease rate. As the volume we purchase from NTT Docomo increases, the uncertainty regarding our financial outlook, especially income, could also increase. We may make large-scale investments to enhance our mobile service line-ups in the future. For more discussion on mobile services’ structure, please refer to Item 5.D “Trend Information.”

 

We anticipate to increase our investment in the bank automated teller machine (“ATM”) operation business by increasing the number of ATMs we place. If our ATM operation business does not proceed as planned, we may lose all or part of our investment in this business which may adversely affect our financial condition and results of operations. For more detailed risks pertaining to our ATM operation business, please refer to the risk described in “Our investments in our subsidiaries and equity method investees may not produce the returns we expect or may affect our results of operations and financial condition adversely.”

 

 13 
 

 

The size of Japanese domestic economy is expected to be limited, though its IT investment should continue to increase, over the long run mainly due to the declining Japanese population and along with that many Japanese companies heading overseas to seek opportunities. Under such circumstances, we have been enhancing our overseas business developments mainly to expand our customer base and to meet the range of Information Technology (“IT”) network needs of our Japanese customers operating abroad since the fiscal year ended March 31, 2012. Revenues from our overseas business for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥5.3 billion, ¥6.4 billion and ¥6.1 billion, respectively. Although our overseas revenue is still relatively small, if, for example, we fail to offer competitive services and solutions, if we fail to develop customer base for our overseas business, if we fail to acquire enough qualified personnel, or if we invest and contract more network capacity and service facilities than we actually need to serve our customers, due, for example, to our lack of experience in operating overseas business, our limited brand recognition overseas, and change in our domestic customers’ overseas business expansion strategy and refrain from operating overseas business, we may not be able to achieve our expected levels of revenues and profits. Overseas business expansion may impact our domestic business if, for example, we assign many engineers and other resources for our overseas business that our domestic business is left with insufficient resources to complete projects. Overseas business operating expenses and costs may increase due, for example, to commencement of cloud computing services, opening of new overseas subsidiaries, increasing employees, and investing in network facilities. Additionally, we may encounter difficulties in planning and managing operations due to unfavorable political or economic factors, such as geopolitical, cultural and religious conflicts, non-compliance with expected business conduct, local regulations and taxation laws, and a lack of adequate infrastructure. Moreover, changes in local regulations, policies, taxation laws, local regulations, business or investment permit approval requirements, foreign exchange controls, or the nationalization of assets or restrictions on the repatriation of returns from foreign investments in major markets and regions may affect our operating results. Also, a failure to maintain adequate controls to comply with regulations such as the U.S. Foreign Corrupt Practices Act (“FCPA”) may harm our reputation and adversely affect our financial results and business operation.

 

Along with our business expansion, our capital expenditures, our working capital and our interest-bearing liabilities are also increasing. Our bank borrowings (total of short- and long- term borrowings) were ¥9.3 billion, ¥17.8 billion and ¥24.8 billion as of March 31, 2016, 2017, and 2018, respectively. Our capital lease obligations (current and noncurrent) were ¥11.7 billion, ¥15.2 billion and ¥16.6 billion as of March 31, 2016, 2017, and 2018, respectively. Cash and cash equivalents were ¥19.6 billion, ¥22.0 billion and ¥21.4 billion as of March 31, 2016, 2017, and 2018, respectively.

 

Other than the above, we will continue to invest in the development of new businesses and services to enhance our current businesses and services such as IoT-related business, the content distribution business, the health care business and other businesses. However, there is no assurance that we can achieve the returns or benefits from the development of those businesses and services and this may adversely affect our financial condition and results of operations.

 

Our investments in our subsidiaries and equity method investees may not produce the returns we expect or may adversely affect our results of operations and financial condition.

 

In the past, we have invested in our group companies to expand our businesses and generate new businesses. As of June 29, 2018, we have sixteen consolidated subsidiaries and eight equity method investees. The financial performance of our consolidated subsidiaries directly affects our financial condition and results of operations and the financial performance of our equity method investees affects our financial condition and results of operations through our pro rata interest in our equity method investments. There can be no assurance that we will be able to maintain or enhance the value or the performance of such companies in which we have invested in or may invest in the future, or that we will achieve the returns or benefits from these investments. We may consider further reorganization of our group companies and there is no guarantee that we will be able to achieve the benefits that we expect from such reorganization. We may provide additional financial support in the form of loans, additional equity investments, guarantees, or leases in such companies. We may lose all or part of our investment relating to such companies if their value decreases as a result of their financial performance or if they go bankrupt, as in the case of our former equity-method investee, Crosswave Communications Inc. (“Crosswave”) in 2003. If our interests differ from those of other investors in entities over which we do not exercise control, we may not be able to realize synergies with the investees and it may adversely affect our financial condition and results of operations.

 

 14 
 

 

IIJ’s substantial investment in Crosswave, IIJ’s former equity method investee, became worthless due to Crosswave’s commencement of corporate reorganization proceedings. In August 2003, Crosswave filed a voluntary petition for the commencement of corporate reorganization proceedings in Japan, and as a result of IIJ’s equity method net loss and an impairment loss taken in respect of IIJ’s investment in Crosswave, our net loss for the fiscal year ended March 31, 2003 was ¥15.6 billion, the highest net loss that we have ever experienced.

 

We established a joint venture, DeCurret, in January 2018 with eighteen Japanese companies. DeCurret plans to launch cryptocurrency exchange and settlement services. DeCurret is our equity method investee based on our 35% ownership into which we have injected a total of ¥1.8 billion in capital as of June 29, 2018. DeCurret’s planned cryptocurrency operations are subject to a significant amount of risk, including but not limited, to the followings:

 

·uncertainty about the legal and regulatory status of blockchain technology in general and cryptocurrencies in particular, including the application of money-laundering of financial crimes laws to cryptocurrency exchanges and settlement providers;
·uncertainty about the security of blockchain and cryptocurrency exchange and settlement services from hacking, cyberattacks, or bad actors;
·fluctuation in cryptocurrency markets, including potential market manipulation by participants in cryptocurrency markets;
·the ability to appropriately respond in a timely manner to changes in technology;
·uncertainty about the competitive landscape as well as the success in our marketing strategy as increasing number of cryptocurrency exchange service providers emerge;

·the extent to which blockchain technology and cryptocurrencies as a form of payment will maintain or achieve widespread adoption, and which cryptocurrencies will achieve such adoption; and
·changes in regulation or restriction with regards to registration for cryptocurrency exchange and settlement business by the Japanese government. In Japan, in order to operate cryptocurrency related business such as exchange, registration by Japan’s Financial Service Agency is required, and DeCurret has neither received nor fixed timing of such registration as of June 29, 2018.

 

Adverse consequences arising from any of these risks could harm DeCurret’s brand name and reputation, cause significant decreases in demand for cryptocurrency-related services, or require DeCurret to make large, unexpected expenditures for technological infrastructure or equipment or incur legal fees or pay damages, fees or penalties arising from lawsuits, and regulatory administrative proceedings and/or we may incur unexpected level of equity in net loss if DeCurret fails to achieve anticipated business performance. We may inject additional capital into and/or lend money to DeCurret. These could, in turn, harm our investment in DeCurret and/or harm our brand name and reputation.

 

We established a joint venture, JOCDN, in December 2016 with fifteen major Japanese broadcasting companies to provide CDN services. JOCDN is our equity method investee based on our 20% ownership into which we have injected a total of ¥0.1 billion in capital as of June 29, 2018. If JOCDN cannot achieve our expected levels of revenues and profits, manage costs and expenses in a timely and adequate manner or incur unexpected expenses, it may adversely affect our financial condition and results of operations.

 

 15 
 

 

IIJ Global Solutions Inc. (“IIJ-Global”), which became our 100% owned consolidated subsidiary on September 1, 2010 after acquiring its stock from AT&T Japan LLC (“AT&T Japan”) for ¥9.2 billion, mainly provides WAN services. For the fiscal years ended March 31, 2017 and 2018, IIJ-Global had ¥28.0 billion and ¥29.0 billion in revenues, respectively, and ¥0.6 billion and ¥0.5 billion in operating income, respectively. If IIJ-Global cannot achieve our expected levels of revenues and profits, manage costs and expenses in a timely and adequate manner or incurs unexpected expenses, it may adversely affect our financial condition and results of operations. Intangible assets as of March 31, 2018 related to IIJ-Global were ¥3.8 billion, and if our network service division and/or IIJ-Global cannot achieve its future expected revenue and profit, we may incur a substantial impairment loss on its intangible assets, which may adversely affect our financial condition and results of operations. Related to the acquisition of IIJ-Global, IIJ-Global entered into a Solutions Engagement Agreement with IBM Japan Ltd. (“IBM Japan”), IIJ-Global’s largest sales partner. This agreement, which establishes the basis for a procurement relationship between IIJ-Global and IBM Japan, contains an indemnification for IIJ-Global to perform services, functions, responsibilities and other actions in the same way as when the company was a part of AT&T Japan. Failure to perform in this manner may adversely affect our financial condition and results of operations. Furthermore, IIJ-Global and the Company may damage their relationship with IBM Japan, which may indirectly have an adverse impact on our financial condition and results of operations.

 

Trust Networks Inc. (“Trust Networks”), IIJ's consolidated subsidiary which was established in July 2007, is in charge of the ATM operation business. Trust Networks operates ATMs and the related network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. As of March 31, 2018, 1,096 ATMs were placed in locations such as Japanese pinball shops (“pachinko parlors”). As of March 31, 2018, IIJ has invested a total of ¥2.6 billion in Trust Networks (79.5% share ownership). For the fiscal years ended March 31, 2017 and 2018, the ATM operation business had ¥4.1 billion and ¥4.0 billion in revenues, respectively, and ¥1.4 billion and ¥1.5 billion in operating income, respectively. If Trust Networks is not able to introduce ATMs in accordance with its plan due, for example, to a longer than expected negotiation period with interested parties including banks, if it does not record ATM withdrawal transactions as anticipated due, for example, to a decrease in the number of pinball players as a result of a declining Japanese population or a decrease in consumer demand prompted by an increase in the Japanese consumption tax rate, if it incurs unexpected additional costs, or if we face unfavorable regulation and/or business condition changes, it may not be able to achieve its future expected revenue and profit, which may adversely affect our financial condition and results of operations. If the number of serviced ATMs increases, our capital expenditures including capitalized leases may increase due to the leasing or purchasing of ATMs.

 

As of June 29, 2018, we have ten overseas subsidiaries including IIJ America Inc. (“IIJ-America”) and IIJ Europe Limited (“IIJ-Europe”). During the fiscal year ended March 31, 2017, we established subsidiaries in Vietnam, IIJ Global Solutions Vietnam Company Limited (“IIJ-Global Vietnam”), and in Thailand, IIJ (Thailand) Co., Ltd. (“IIJ-Thailand”), which cooperates with Leap Solutions Asia Co., Ltd. in Thailand. In addition to the existing subsidiaries in China, Singapore, Thailand, Indonesia, Vietnam, and Hong Kong, we may establish more subsidiaries in Asia to seek greater business opportunities as the need for IT increases in the region compared to the United States and Europe, where IT-related markets are already established. However, there is no assurance that we will be able to receive the returns we expect from investing due, for example, to our lack of experience in operating businesses in emerging countries, a failure in offering services that meet local needs, shrinking IT needs and changes in the political and diplomatic situation. During the period from the fiscal year ended March 31, 2016 to the fiscal year ended March 31, 2018, IIJ and IIJ-GS together injected capital of ¥1.0 billion in the aggregate to six of our ten overseas subsidiaries. As of March 31, 2018, IIJ and IIJ-GS together lent a total of ¥0.3 billion to four of our overseas subsidiaries. As for our overseas equity method investees, during the period from the fiscal year ended March 31, 2016 to the fiscal year ended March 31, 2018, we injected capital of ¥0.4 billion to our equity method investees. We may continue to inject additional capital into and/or lend money to the existing and/or new affiliated companies.

 

 16 
 

 

If our systems integration revenues fluctuate or if we fail to execute our systems construction projects in a timely or satisfactory manner, our results of operations and financial condition may be adversely affected.

 

Systems construction revenues, a one-time revenue that is a part of systems integration revenues, have a tendency to fluctuate from time to time compared to monthly recurring revenues of network services and systems operation and maintenance due to the budget systems in Japan, of which many end in March. If corporate investments decrease, or if we fail to meet customer demands due to a lack of a sufficient number of qualified engineers to execute the projects in a professional manner, corporate customers may put off or stop placing orders with us and we may not be able to record systems construction revenues and operating profit as expected. If we fail to effectively manage and assign our resources such as outsourcing resources, or to execute the projects as contracted, our recognition of revenues may be delayed or lost altogether, we could be held liable for damages or we could be sued, which could have an adverse impact on our reputation, results of operations and financial condition.

 

Generally, gross margin of systems construction is low compared to that of systems operation and maintenance, and gross margin for large scale systems construction projects may become even lower due, for example, to price competition in acquiring such construction projects. It is more difficult to effectively control systems construction projects as they become larger in scale, and we have seen an increase in the number of large scale systems construction projects in recent years. Our results of operations and financial condition related to systems integration may be adversely affected if, for example, we fail to control costs such as personnel and outsourcing costs or retain adequate personnel for projects, or if we fail to calculate the necessary timeframe or the manpower to complete a project and the costs exceed the payments received from our customers.

 

We may have an impairment loss as a result of an impairment test on the intangible assets that are recorded related to mergers and acquisitions.

 

As of March 31, 2018, the total balance of our intangible assets was approximately ¥8.8 billion, of which ¥6.1 billion was intangible assets not subject to amortization such as goodwill and ¥2.7 billion was intangible assets subject to amortization such as customer relationships. Intangible assets in relation to IIJ-Global and IIJ Technology Inc. (“IIJ-Tech”), former subsidiaries of IIJ, were ¥3.8 billion and ¥3.9 billion, respectively, as of March 31, 2018. The amount of our intangible assets may increase if we conduct mergers, acquisitions or investments in affiliates in the future. We conduct impairment testing of goodwill and indefinite-lived intangible assets annually on March 31 or more frequently if events or changes in circumstances indicate that an asset might be impaired. We conduct impairment testing of definite-lived intangible assets whenever events or changes in circumstances indicate that the assets might be impaired. If the business operations are adversely affected by factors such as significant adverse changes in their business climate and others, we may have an impairment loss as a result of an impairment test on intangible assets. The recognition of any impairment losses on intangible assets may result in material adverse effects on our financial condition and results of operations.

 

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If we fail to attract and retain qualified personnel, we may not be able to achieve our expected business growth.

 

Our network, services, products and technologies are complex, and as a result, we depend heavily on the continued service of our engineering, research and development, and other personnel, and, as our business grows, we need to hire more of such employees. In particular, in order to continue to increase our revenues from outsourcing services and systems integration, we require more sales and engineering personnel. We are not sure whether we will be able to retain or attract such personnel and control human resources costs adequately. Competition for hiring qualified engineering, research and development personnel is intense in the IT service industry in Japan, and there is a limited number of personnel with the necessary knowledge and experience we require. None of our employees are bound by any employment or noncompetition agreements. The realization of any or all of these risks may result in a failure to achieve our expected business growth.

 

Our business may be adversely affected if our network suffers interruptions, errors or delays.

 

Interruptions, errors or delays with respect to our backbone network or service facilities may be caused by human errors, interruptions, errors or delays with carriers’ service facility, or natural factors, many of which are beyond our control, including, but not limited to, damage from fire, earthquakes or other natural disasters, power loss, sabotage, computer hackers, cyber-attack, human error, computer viruses, and other similar events.

 

Much of our computer, networking equipment, and the lines that make up our backbone network are concentrated in a few locations that are in earthquake-prone areas. Any disruption, outages, delays, or other difficulties experienced by any of our technological and information systems and networks could result in a decrease in new or existing accounts, loss or exposure of confidential information, reduction in revenues and profits, costly repairs or upgrades, reputational damage, and decreased consumer and corporate customer trust in our business, any or all of which could have a material adverse effect on our business, financial condition, and results of operations.

 

Should we experience further unforeseeable incidents such as the disruption of social infrastructure or power shortages and other impacts due to inoperable or damaged nuclear power plants, our backbone network and service facilities could fail and, as a result, we may suffer direct and indirect damages, which may adversely affect our financial condition and results of operations.

 

We rely heavily on the security of our internal IT systems. Moreover, as a comprehensive network service provider, we offer services and/or construct systems to protect some portion of the IT systems of our clients from cyberattacks, information leaks and other unfavorable incidents. We are required to continuously evaluate and enhance our security measures, including systems designed to block unauthorized access, and have made expenditures for these purposes in recent years. We have not had significant cybersecurity incidents, but if we fail to protect our service facilities and our clients, the credibility of our network and customer satisfaction could decrease significantly, although we are continuously enhancing security measures including systems to block unauthorized access.

 

If we fail to keep and manage our confidential customer information, we could be subject to lawsuits, incur expenses associated with our security systems, or suffer damage to our reputation.

 

We keep and manage confidential information and trade secrets obtained from our customers. We exercise much care in protecting the confidentiality of such obtained information and take steps to ensure the security of our network, in accordance with the Personalized Information Protection Law protecting personal information that came into effect in April 2005 and the requirements set by the MIC, and the Ministry of Economy, Trade and Industry. In October 2016, IIJ-Europe submitted its Binding Corporate Rules (BCR) to the UK’s Information Commissioner’s Office (which has yet to complete its examination of the BCR) and in preparation for a new regulation governing data protection, the General Data Protection Regulation (“GDPR”), which became effective in the European Union (“EU”) on May 25, 2018. The submitted internal rules define the global policy regarding personal data protection within the IIJ Group. These rules confirm that the IIJ Group complies with the applicable and prospective EU data protection rules. If we fail to comply with the GDPR unintentionally and are asked to pay a penalty, then this could ultimately result in an adverse effect on our business, financial condition, and results of operations. Our network, like all IT systems, is vulnerable to external attack from computer viruses, hackers, cyber-attack, or other such sources. In addition, despite internal controls, misconduct by an employee could result in the improper use or disclosure of confidential information. If any material leak of such information were to occur, we could be subject to lawsuits for damages from our customers, incur expenses associated with repairing or upgrading our security systems, and suffer damages to our reputation that could result in a severe decline in new customers as well as an increase in service cancellations. As our consumer mobile business grows, we are dealing with an increasing number of consumers. Our corporate image and credibility could be negatively impacted, if, for example, we or our sales partners fail to comply with related laws such as consumer-protection laws, or if we fail to securely protect our consumers’ individual information. Such failure could ultimately result in an adverse effect on our business, financial condition and results of operations.

 

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Business growth and a rapidly changing operating environment may strain our limited resources.

 

We have limited operational, administrative and financial resources which could be inadequate to sustain the growth we want to achieve. As the number of our customers and their Internet usage increases, as traffic patterns change, as the volume of information transferred increases, and as the need for our cloud computing-related service increases, we will need to increase expenditures for our network and other facilities, including data center facilities in the future, in order to adapt our services and to maintain and improve the quality of our services. If we are unable to manage our growth and expansion adequately, the quality of our services could deteriorate and our business may suffer. If data center facilities do not meet our expectations, the quality of our service could deteriorate and our business may suffer. We may also need to increase office rent expenditures along with our business expansion. If we are unable to prepare our network and other facilities in a timely manner to meet our customers’ demand or our business expansion, we may miss growth opportunities or may be obliged to bear higher costs to prepare our network and other facilities.

 

If we fail to keep up with the rapid technological changes in our industry, our services may become obsolete and we may lose customers.

 

Our markets are characterized by, but not limited to:

 

·rapid technological changes, including the shift to new technology-based networks such as IPv6, cloud computing, Software Defined Network (“SDN”), Network Functions Virtualization (“NFV”), IoT, and Big Data,
·frequent new product and service introductions,
·continually changing customer requirements, and
·evolving industry standards.

 

If we fail to obtain access to new or important technologies or to develop and introduce new services and enhancements that are compatible with changing industry technologies and standards and customer requirements, we may lose customers.

 

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Our pursuit of necessary technological advances may require substantial time and expense. Many of our competitors have greater financial and other resources than we do and, therefore, may be more equipped to meet the time and expense demands of achieving technological advances. Additionally, this may allow our competitors to respond more quickly to new and emerging technologies and standards or invest more heavily in upgrading or replacing equipment to take advantage of new technologies and standards.

 

We depend on our executive officers, and if we lose the service of our executive officers, our business and our relationships with our customers, major shareholders of IIJ and other IIJ Group companies and our employees could suffer.

 

Our future success depends on the continued service of our executive officers, particularly Mr. Koichi Suzuki, who is a founder, Chairman, Chief Executive Officer and representative director of IIJ and Mr. Eijiro Katsu, who is President, Chief Operating Officer and representative director. We rely in particular on their expertise in the operation of our businesses and on their relationships with the shareholders of IIJ, our customers, our business partners, and our employees. None of our executive officers, including Mr. Suzuki and Mr. Katsu, are bound by an employment or noncompetition agreement.

 

We may continuously pursue mergers and acquisitions transactions which may not be effective.

 

We recognize that it is important for us to have more business resources such as, but not limited to, human resources, customer base, application layer technology, and others, in the middle term. We may continuously pursue mergers and acquisitions transactions to scale up our business. The mergers and acquisitions transactions may not always be on good terms and conditions, bear the results we expect, or have synergistic effect, and we may incur a large loss of goodwill. We may also exhaust time and our resources through mergers and acquisitions.

 

As a result, those transactions may strain our financial resources and may adversely affect our financial condition and results of operations or we will not be able to have enough business resources to scale up due to a failure to engage in adequate mergers and acquisitions transactions.

 

Fluctuations in the stock prices of companies or losses on companies in which we have invested may adversely affect our financial condition.

 

We have invested in non-affiliated companies in order to further expand our business relationships with those companies. We have also invested in available-for-sale equity securities and in funds which invest mainly in unlisted stocks. The carrying amount of available-for-sale securities was ¥9.3 billion, nonmarketable equity securities was ¥1.0 billion, and investments in funds was ¥1.1 billion as of March 31, 2018. Until the end of the fiscal year ended March 31, 2018, available-for sale equity securities were tested for other-than temporary impairment under U.S. GAAP, with impairment losses of ¥31 million recorded for the fiscal year ended March 31, 2017. Unrealized gains on holding available-for-sale equity securities of ¥7.5 billion were measured based on closing prices of March 30, 2018, the final day of trading in the fiscal year ended March 31, 2018. Due to the revision to U.S. GAAP relating to available-for-sale equity securities, the net of tax amount of unrealized gains of ¥5.1 billion were reclassified to retained earnings at the beginning of the fiscal year ending March 31, 2019. Changes in unrealized gains or losses due to fluctuations of stock prices will be recognized in other income (expenses) in every quarter, beginning with our consolidated statements of income from the first quarter of the fiscal year ending March 31, 2019. Therefore, fluctuations of stock prices may impact our consolidated statements of income. In addition, should we choose to sell all or a portion of these securities or funds, it is not certain that we will be able to do so on favorable terms.

 

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NTT, IIJ's largest shareholder, could exercise substantial influence over us in a manner which may not necessarily be in our interest or that of our other shareholders.

 

NTT and its affiliates owned 26.9% of IIJ's outstanding voting shares as of March 31, 2018. As IIJ's largest shareholder, NTT may be able to exercise substantial influence over us. As of June 29, 2018, IIJ has 13 directors including five outside directors among whom Shinobu Umino worked for NTT until 2002. While we intend to conduct our day-to-day operations independently from NTT and its affiliate companies and believe that NTT also plans for us to operate independently, NTT may decide to exercise substantial influence over us in a manner which could impair our ability to operate independently. Furthermore, NTT may take actions that are in its best interest, which may not be in our interest or that of our other shareholders.

 

We rely greatly on other telecommunications carriers and other suppliers, and could be affected by disruptions in service or delays in the delivery of their products and services.

 

We rely on telecommunications carriers such as NTT Communications and KDDI for a significant portion of our network backbone, Nippon Telegraph and Telephone East Corporation (“NTT East”), Nippon Telegraph Telephone West Corporation (“NTT West”), and KDDI for local access lines for our customers, and NTT Docomo and KDDI for mobile connectivity as an MVNO. We procure significant portions of our network backbone and data center facilities pursuant to operating lease agreements with NTT Group, our largest provider of network infrastructure. For the fiscal year ended March 31, 2018, we have spent ¥35.2 billion in the aggregate for international and domestic backbone, local access lines, mobile connectivity, and lines for WAN services to NTT Group. Also, as of March 31, 2018, we had ¥3.1 billion of lease obligations with NTT FINANCE CORPORATION (“NTT FINANCE”). We are subject to potential disruptions in these telecommunications services and, in the event of such disruption, we may have no means of replacing these services, on a timely basis or at all.

 

We also depend on third-party suppliers of hardware components such as routers, servers, and software that are used in our network. We purchase certain components from limited sources, typically from Cisco Systems, Inc. (“Cisco”), Juniper Networks, Inc. (“Juniper”), Hewlett-Packard Company, IBM Japan, NEC, Fujitsu and VMware Inc. A failure by one of our suppliers to deliver quality products on a timely basis, or the inability to develop alternative sources if and as required, may delay our ability to expand the capacity and scope of our network.

 

Any problems experienced by our telecommunications carriers and other suppliers could have a material adverse effect on our business, financial condition, and results of operations.

 

Regulatory matters and new legislation could impact our ability to conduct our business.

 

The licensing, construction, and operation of telecommunications systems and services in Japan are subject to regulation and supervision by the MIC. We operate pursuant to licenses and approvals that have been granted by the MIC.

 

Our licenses have an unlimited duration, but are subject to revocation by the MIC if we violate any telecommunications laws and regulations in a manner that is deemed to harm the public interest, if we or any of our directors are sentenced to a fine or any more severe penalty under the telecommunications laws, if we employ a director who was previously sentenced to a fine or more severe penalty thereunder, or if we have had a license revoked in the past.

 

Existing and future governmental regulation may substantially affect the way in which we conduct our business. These regulations may increase the cost of doing business or may restrict the way in which we offer products and services. We cannot predict future regulatory changes which may affect our business. Any changes in laws, such as those described above, or regulations or MIC policy affecting our business activities and those of our competitors could adversely affect our financial condition or results of operations. For more information, see Item 4. “Business Overview — Regulation of the Telecommunications Industry in Japan.”

 

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We may be named as defendants in litigation, which could have an adverse impact on our business, financial condition, and results of operations.

 

We are involved in normal claims and other legal proceedings in the ordinary course of our business. We believe that there are no cases currently pending which would have a significant financial impact on us, but we cannot be certain that we will not be named as a defendant in a future lawsuit. Any judgment against us in such a lawsuit, or in any future legal proceeding, could have an adverse effect on our business, financial condition, and results of operations.

 

In the event that we need to raise capital, we may issue additional shares of IIJ's common stock or securities convertible into IIJ's common stock, which may cause shareholders to incur substantial dilution.

 

IIJ issued 4,700,000 new shares of common stock by way of a public offering in July 2013 and 700,000 new shares by way of a third-party allotment in connection with a secondary offering of shares by way of an over-allotment in August 2013. For future strategic mergers and acquisitions transactions and/or large scale business investments, we may choose to raise additional funds from the issuance of equity shares of IIJ’s common stock or securities convertible into IIJ’s common stock, in which case existing shareholders may incur substantial dilution.

 

Prior to the above public offering, IIJ issued 2,500,000 new shares of IIJ's common stock along with IIJ's listing on the Mothers market of the Tokyo Stock Exchange (“TSE”) in December 2005. On May 11, 2007, IIJ issued 435,600 shares of common stock to make IIJ's two consolidated subsidiaries wholly-owned through share exchanges. The above figures are retroactively adjusted to reflect the 1:5 stock split in October 2005 and the 1:200 stock split in October 2012.

 

 

 

 

 

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Item 4. Information on the Company

 

A.History and Development of the Company

 

IIJ is incorporated under the Corporation Law of Japan as a joint stock corporation under the name Internet Initiative Japan Inc. IIJ was incorporated in December 1992 and operates under the laws of Japan.

 

IIJ began its operations in July 1993 as one of the first commercial Internet service providers (“ISP”) in Japan to offer Internet connectivity services for both enterprises and consumers. With the emergence of many other commercial ISPs, price competition for Internet connectivity services became severe. Rather than falling into price competition, we strategically shifted our business model towards providing value-added total network solutions to enterprise businesses that tend to choose quality and reliability over price, by fully leveraging our engineering skills to differentiate ourselves from our competitors. Currently, our main business focuses on providing Internet connectivity services, WAN services, outsourcing services, systems integration, and equipment sales as total network solutions to mainly Japanese corporate clients and governmental organizations. The Group works closely together as a group in providing total network solutions directly to its customers. With our expertise in Internet related technology, our revenues have been expanding along with our customers’ needs for broader bandwidth for Internet connectivity services and for professional IT support for their network systems.

 

For descriptions and the history of the Group, see “Our Group Companies” in Item 4.B.

 

IIJ became a public company in August 1999 with IIJ's initial public offering of ADSs on the NASDAQ National Market. On December 2, 2005, IIJ listed on the Mothers market of the TSE. On December 14, 2006, IIJ moved to the First Section of the TSE for IIJ's listing in Japan. On October 1, 2012, IIJ conducted a 1 to 200 split of IIJ's shares of common stock and the total number of IIJ's issued shares of common stock increased to 41,295,600. IIJ issued 4,700,000 new shares of IIJ’s common stock by way of a public offering in July 2013 and 700,000 new shares by way of a third-party allotment in connection with a secondary offering of shares by way of an over-allotment in August 2013.

 

As for major business combinations, on May 11, 2007, IIJ made IIJ-Tech and Net Care, Inc. (“Netcare”) our 100% owned consolidated subsidiaries through share exchanges. Netcare renamed itself to IIJ Engineering Inc. (“IIJ-EG”) in October 2014. We merged IIJ-Tech on April 1, 2010. On September 1, 2010, IIJ made IIJ-Global its 100% owned consolidated subsidiary by acquiring the stock of IIJ-Global from AT&T Japan for ¥9.2 billion by our own cash and bank borrowings.

 

Please also see Note 2 “Business Combination and Transfer” to our consolidated financial statements included in this annual report on Form-20F.

 

IIJ's head office is located at Iidabashi Grand Bloom, 2-10-2 Fujimi, Chiyoda-ku, Tokyo 102-0071, Japan, and IIJ's telephone number at that location is +81-3-5205-6500. IIJ's agent in the United States is IIJ-America, located at 55 East 59th Street, Suite 18C New York, NY 10022 and the telephone number at that location is (212) 440-8080. IIJ has a website that you may access at http://www.iij.ad.jp/en/. Information contained on IIJ's website does not constitute part of this annual report on Form 20-F.

 

For a discussion of capital expenditures and divestitures currently in progress and those for the past three years, see “Capital Expenditures” in Item 4.B.

 

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B.Business Overview

 

The Group offers a comprehensive range of Internet connectivity services, WAN services, outsourcing services, systems integration, and equipment sales to our customers mainly in Japan. We believe we provide efficient and reliable services and solutions to our customers on one of the most reliable Internet backbone networks available in Japan. Our services are based upon high-quality Internet related networking technology tailored to meet specific needs and demands of our customers.

 

Our Internet connectivity services include full-spec IP services with bandwidth ranging from 64 kbps up to over 10 Gbps, low-cost broadband services such as optical and/or ADSL lines which are mainly used to connect branch offices, and mobile data communications services for enterprise and consumers. Our WAN services provide closed-network services, mainly operated by IIJ-Global. Our outsourcing services include security-related outsourcing services that protect our customer network systems from unauthorized access and secure remote connections to internal networks, network-related outsourcing services such as router rental and Virtual Private Network (“VPN”), server-related outsourcing services such as web server hosting and e-mail security service, data center-related outsourcing services, and our public cloud computing service IIJ GIO/Hosting Package and IIJ GIO P2 Public Resource. Our systems integration includes systems construction and systems operation and maintenance. Systems construction is tailored to meet each of our customers’ requirements, which include consulting, project planning, systems design and development of network systems, and sales of equipment and software purchased from third parties. Systems operation and maintenance revenues include system related maintenance, monitoring, and other operating services, and our private cloud computing services such as IIJ GIO/Component and IIJ GIO P2 Private Resource. We aim to be the leading supplier of total network solutions in Japan.

 

We started to provide our mobile access services for enterprise as an MVNO in January 2008. From February 2012, we also started to offer our mobile services to consumers which became popular in recent years because of their cost-effectiveness; accordingly, mobile services for consumers are one of our strong growth drivers.

 

From December 2009, we began proving our cloud computing services under the service name “IIJ GIO.” We invest in infrastructures, such as servers, network equipment, virtualization software, and data center facilities for IIJ GIO, and provide them to users as an Infrastructure as a Service (“IaaS”) platform service for a monthly fee, basically. At the beginning, IIJ GIO consisted mainly of two types, (1) IIJ GIO/Hosting Package and (2) IIJ GIO/Component. IIJ GIO/Hosting Package is a line-up of services for an all-in-one non-customizable packaged cloud computing service and IIJ GIO/Component is a line-up of services for a semi-customizable cloud computing service. The cloud computing service in Japan is still in its start-up phase and it is anticipated that the market in Japan should grow in the middle term. In November 2015, we launched a new service platform “IIJ GIO Infrastructure P2” for our cloud services. The service provides reliable public cloud infrastructure with increased processing performance as well as private cloud infrastructure.

 

As of June 29, 2018, we have ten overseas subsidiaries in the United States, the United Kingdom, Germany, China, Singapore, Hong Kong, Thailand, Indonesia, and Vietnam. We have been enhancing our overseas business primarily to fulfill the broad range of IT network related needs of our Japanese customers who are headed abroad to expand their overseas business. As of June 29, 2018, we provide cloud computing services in the United States, the United Kingdom, China, Singapore, Indonesia, Thailand and Vietnam.

 

In addition, we conduct our ATM operation business through our consolidated subsidiary, Trust Networks, which was established in July 2007. Trust Networks operates ATMs and ATM network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. As of March 31, 2018, 1,096 ATMs were placed.

 

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Currently, we have two business segments: a network services and systems integration business segment and an ATM operation business segment. Our network services and systems integration business segment is comprised of Internet connectivity services for enterprise and consumers, WAN services, outsourcing services, systems integration, and equipment sales.

 

The table below provides a breakdown of the total revenues and percentage by service over the past three fiscal years. Most of our revenues are generated in Japan and are denominated in Japanese yen.

 

   For the fiscal year ended March 31
(millions of yen, except for percentage data)
   2016  2017  2018
Internet connectivity services   ¥32,853    23.4%  ¥44,369    28.1%  ¥52,705    29.9%
WAN services    25,177    17.9    26,460    16.8    29,295    16.7 
Outsourcing services    21,266    15.1    22,167    14.0    26,119    14.8 
Systems construction    21,145    15.0    22,626    14.3    22,528    12.8 
Systems operation and maintenance    33,043    23.5    35,123    22.3    37,903    21.5 
Equipment sales    3,275    2.3    2,994    1.9    3,470    2.0 
ATM operation business    3,889    2.8    4,050    2.6    4,031    2.3 
Total revenues:   ¥140,648    100.0%  ¥157,789    100.0%  ¥176,051    100.0%

 

 

 

 

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Internet Connectivity Services

 

We offer two categories of Internet connectivity services: Internet connectivity services for enterprise and Internet connectivity services for consumers. Internet connectivity services for enterprise are based on dedicated local-line connections and high-speed wireless data connections provided by telecommunications carriers between our backbone and customers. Internet connectivity services for consumers mainly require customers to connect to our points of presence (“POPs”) through the publicly-switched telephone network or a variety of broadband access services, such as ADSL and optical lines as well as wireless mobile data communications. High-speed, high-capacity last-one mile access such as dedicated access, ADSL, fiber optic, Ethernet, 3G mobile, LTE mobile, and others are provided by large telecommunications carriers such as NTT East, NTT West, NTT Docomo, and others. A variety of choices for last-one mile access are provided to our customers independently or together with other network solution line-ups to fulfill their specific and individual needs for tailored total network solutions. The following table shows the number of our Internet connectivity service contracts as of the dates indicated:

 

   As of March 31,
   2014  2015  2016  2017  2018
Internet connectivity services (enterprise):                         
IP Service (1Gbps –)    271    340    367    437    468 
IP Service (100Mbps – 999Mbps)    448    504    532    591    658 
IP Service (-99Mbps)    847    763    690    658    614 
IIJ Data Center Connectivity Service    288    278    270    253    241 
IIJ FiberAccess/F and IIJ DSL/F (broadband services)    56,384    62,926    75,932    72,605    72,630 
IIJ Mobile Service (enterprise)    127,057    187,429    431,030    857,903    1,339,586 
IIJ Mobile MVNO Platform Service    32,253    67,434    250,757    582,250    824,731 
Others    1,293    1,309    1,246    1,049    585 
Total Internet connectivity service (enterprise) subscriptions   186,588    253,549    510,067    933,496    1,414,782 
                          
Internet connectivity services (consumer):                          
IIJ    468,344    734,311    1,084,295    1,275,875    1,363,531 
IIJmio Mobile Service    181,439    430,253    747,395    951,249    1,005,092 
hi-ho    158,233    157,208    146,305    133,384     
Total Internet connectivity service (consumer) subscriptions   626,577    891,519    1,230,600    1,409,259    1,363,531 

_____________________

*1. Numbers in the table show number of contracts except for “IIJ Mobile service,” “IIJ,” and “hi-ho” which show number of subscriptions.
*2. From Form 20-F for the fiscal year ended March 31, 2017, the following changes are made to the table:
  (1) The number of subscriptions for “IIJ Mobile MVNO Platform Service”, which was included in “IIJ Mobile service (Enterprise),” is disclosed.
  (2) The number of subscriptions for “IIJmio Mobile Service” (formerly known as “IIJmio High Speed Mobile Service”), which was included in “Internet connectivity services (consumer)” provided by IIJ, is disclosed.
*3. On December 31, 2017, we sold all the shares of common stock of our wholly-owned subsidiary hi-ho. Accordingly, hi-ho’s subscription for “Internet connectivity services (consumer)” decreased to zero, hi-ho’s mobile service subscriptions of 14,735 was reclassed to “IIJ Mobile MVNO Platform Service” and a part of hi-ho’s subscriptions (other than mobile service subscription) of 47,683 is included in our subscriptions for “Internet connectivity services (consumer)” on December 31, 2017.

 

 

Internet Connectivity Services for Enterprise

 

Our lineup of Internet connectivity services for enterprise includes: IP service, IIJ data center connectivity service, IIJ FiberAccess/F and IIJ DSL/F (broadband services), dial-up services, and IIJ mobile service.

 

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IP Service and IIJ Data Center Connectivity Service. Our IP service and data center connectivity service are full-scale, high-speed internet access services that connect the customer’s network to our backbone with dedicated access lines. The services are used mainly for corporate headquarters or data centers, where reliable network service is indispensable. The customer chooses the level of service it needs based upon its bandwidth requirements. We currently offer service at speeds ranging from 64kbps to over 10Gbps. Subscribers pay a monthly fee for the leased local access line from the customer’s location to one of our POPs. The amount of this fee varies depending on the carrier, the distance between the customer’s site and our POPs and its contracted bandwidth. We collect the local access fee from the customer and pay the amount to the carrier. While we prepare and arrange the leased access lines on behalf of customers under our name, the usage fee collected from the customer and paid to the carriers is recorded gross in our consolidated financial statements. For our IP service, we offer Service Level Agreements (“SLA”) to our customers to better define the quality of services our customers receive. We were the first ISP in Japan to introduce this type of agreement. We are able to offer these SLA due to our high quality and reliable network. Our SLA provides customers with credit against the amount invoiced for the services if our service quality fails to meet the prescribed standards. Subscribers to our IP Service receive technical support 24 hours a day and seven days a week. We guarantee the performance of the following elements under our SLA:

 

·100% availability of our network,
·the maximum average latency, or time necessary to transmit a signal, between designated POPs, and
·prompt notification of outages and/or disruptions.

 

We believe that business customers will continue to increase their use of the Internet and increasingly rely on the Internet as a business tool.

 

IIJ FiberAccess/F and IIJ DSL/F (Broadband Services). IIJ FiberAccess/F and IIJ DSL/F are broadband Internet connectivity services that use “FLET’S” services for fiber optic access and ADSL access provided by NTT East, NTT West, and others, allowing service on a best-efforts basis. The services are used mainly to connect branch offices and headquarters. We support this service by providing guarantees of latency rates under SLA.

 

IIJ Mobile Service. This service provides wireless 3G and LTE Internet connectivity services to enterprise customers as an MVNO. We use the wireless networks of NTT Docomo and KDDI, which we added to our service-lineups from April 2015. We offer mobile services based on our MVNO infrastructure to meet corporate customers’ needs. Such needs include remote access solutions, which are wireless solutions that allow employees working outside of an office to access work-related files, and other needs including M2M connectivity and MVNO platform services.

 

Dial-up Access Services. We offer a variety of dial-up access services. Our dial-up services allow employees that are out of the office or frequent travelers to access the Internet or their own internal networks through one of our POPs or through our roaming access points. When accessing their internal network, for security purposes, it is usually accessed using the VPN function that is provided by our outsourcing services or systems integration.

 

Other Internet Connectivity Services. In addition to the services mentioned above, we also offer services such as IIJ ISDN/F which provides Internet access for ISDN lines, IIJ Line Management/F service that procures “FLET'S” services on behalf of customers and “LaIT” (pronounced “light”) service, a brand that offers high-quality services at reasonable prices to small and medium enterprises. The main sales channels for LaIT are through direct sales via online sign-up or through sales partners.

 

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Internet Connectivity Services for Consumers

 

We offer internet connectivity services for consumers under the brand names IIJmio. We also offer OEM services for other network operators. For Internet connectivity services, there are a variety of different service line-ups depending on the type of local access, such as ADSL, fiber optic, WiMAX, 3G, and LTE wireless data communication.

 

In February 2012, we launched LTE mobile data communications services for consumers in which we offer inexpensive LTE SIM cards to consumers by purchasing NTT Docomo’s mobile infrastructure as an MVNO. We provide the service from the same MVNO infrastructure from which we provide mobile data communications services to enterprises which we launched in January 2008. We mainly offer data communications services in a postpaid scheme with a minimum contract period of one month. The minimum basic monthly charge is ¥900 with bundled high-speed data volume of 3GB which can be shared among up to two SIM cards. The maximum basic monthly charge is ¥2,560 with bundled high-speed data volume of 12GB which can be shared among up to ten SIM cards. As an option, we offer 20GB and 30GB data usage for a monthly charge of ¥3,100 and ¥5,000, respectively. If a customer exceeds the bundled high-speed data volume, the consumer can purchase what we call a “coupon card” which is charged with either 500MB or 2GB high-speed data volume for ¥1,500 and ¥3,000, respectively. We started offering voice function as an optional service with a monthly charge of ¥700 and ¥20 for every 30 seconds for domestic telephone charge from April 2014. We started to accept Mobile Number Portability (“MNP”) transactions from April 2014. We also offer LTE SIM cards through prepaid schemes not only for domestic customers but also for foreigners visiting Japan. “Japan Travel SIM powered by IIJmio” (“JTS”) is the service name and the card includes either 1GB of high speed data for 30 days or 2GB of high-speed data for a three-month period for approximately ¥2,000 and ¥3,500, respectively, depending on the sales channel. From August 2016, we started to offer mobile data communications services for consumers by purchasing KDDI service’s mobile infrastructure.

 

WAN Services

 

We offer WAN services, a closed network service mainly using dedicated lines, wide-area Ethernet services, and IP-VPN services to corporate customers. WAN services offer dedicated, reliable, secure connections that allow our customers to better control the traffic over the wide-area networks. While IIJ had been providing WAN services to its corporate customers, the WAN business became a larger portion of the consolidated base business following the acquisition of IIJ Global on September 1, 2010.

 

Outsourcing Services

 

Our customers are increasingly seeking additional network-related services, in addition to Internet connectivity. We provide our customers with a broad range of outsourcing services such as security-related, network-related, server-related, data center-related, and public cloud computing services of IIJ GIO/Hosting Package, a line-up of services for an all-in-one non-customizable hosting package cloud computing service, and IIJ GIO P2 Public Resource, higher-performance a line up-of services for public cloud computing services.

 

We believe that business customers will increasingly rely on outsourcing services for cost reduction, improving productivity, and ensuring reliable network-related operations. Therefore, we will continue our efforts to improve our services by adding new features and enhancing line-ups through new services by utilizing our Internet expertise in a timely manner.

 

 

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Our outsourcing services include:

 

Security-related Outsourcing Services. We offer services that protect customers’ internal network systems from unauthorized, illegal access, such as firewall services and security scan services. We also provide secure remote connections to the internal networks. We were the first ISP in Japan to provide firewall services, which we introduced in 1994. In March, 2017, we started to offer IIJ C-SOC service, which provides one-stop security support for security incident correspondence by implementing a customer-dedicated analysis platform that is linked to our security operation center.

 

Network-related Outsourcing Services. We offer various types of Internet-VPN services and router rental services such as IIJ Internet-LAN Service, IIJ SMFsx Service and IIJ Managed VPN PRO Service. IIJ SMFsx Service is based on patented technology, the SEIL Management Framework (“SMF”) which enables centralized management of network-configuration, administration and maintenance, reducing both configuration and maintenance time and costs for large-scale network construction.

 

Server-related Outsourcing Services. We offer services such as web hosting, e-mail hosting, document storage and streaming services.

 

Data center-related Services. We offer IIJ data center facility services and management and monitoring services. Our Internet data center facility services are co-location services which allow companies to house their servers and routers off-site on our premises. Our Internet data center facilities are leased from third parties such as NTT Communications and are equipped with robust security systems, 24-hours-a-day non-stop power supplies and fire extinguishing systems, earthquake-resistant construction, and high-speed Internet connectivity utilizing IIJ backbones. We also offer basic monitoring and maintenance services for the equipment. This service enhances reliability as we provide 24-hours-a-day monitoring and have specialized maintenance personnel and facilities. We offer management and monitoring services tailored to our customers’ requirements.

 

Public cloud computing Services. IIJ GIO/Hosting Package, a line-up of services for non-customizable packaged cloud computing service, and IIJ GIO P2 Public Resource, higher-performance a line up-of services for public cloud computing services, are our public cloud computing services name.

 

Other Services. In addition to the above, we offer customer support and help desk solutions, an IP Phone service, and other services.

 

Systems Integration

 

Our systems integration consists of systems construction and systems operation and maintenance. Systems construction is tailored to meet each of our customers’ requirements, which include consulting, project planning, systems design and development of network systems. Our systems construction mainly focuses on Internet business systems and Intranet and Extranet corporate information systems. We have built a strong record in various business fields.

 

Examples of systems construction are:

 

·connecting over a hundred locations such as gas stations, bank branches and retail shops via Internet-VPN, transmission of data over the Internet with an encryption feature and our proprietary SEIL Series routers, SMF, SACM(1), and a service adapter "SA-W series,”(2)

 

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·construction of large scale e-mail servers or systems to detect or delete e-mails with viruses or spam or record all e-mails incoming to and outgoing from customers,
·construction of websites for online businesses, such as on-line game providers,
·re-construction of overall corporate network systems to accommodate increased traffic data,
·construction of voice-over IP systems to transmit voice to customer branch offices over the Internet,
·construction of wireless local area networks, and
·consultation on corporate network security.
(1)SACM (Service Adapter Control Manager) is a management service platform for OEMs to provide automatic connection and a comprehensive management mechanism of IIJ’s proprietary next-generation network management system, SMFv2.
(2)SA-W series is a service adaptor developed for SACM.

 

In the consulting and planning phase of a systems construction project, we form special project management teams for the project. We analyze and design the customer’s network and systems with three engineering focuses: reliability, flexibility, and extendibility.

 

In the phase of systems design and development of network systems, we procure equipment such as servers or use IIJ GIO/Component services or IIJ GIO P2 Private Resource as a component of the system and manage application development and software programming tasks which are, depending on the size of the project, outsourced to third parties. Systems construction is generally provided together with our network services.

 

In the operation and maintenance phase, by utilizing data center facilities, IIJ GIO/Component services and IIJ GIO P2 Private Resource directly linked to our network, we provide a range of operation and maintenance services, which take maximum advantage of the Internet system, network operation and management know-how of the IIJ Group companies. Rather than simply looking after the customer’s servers and network equipment, we take care of the customer’s entire computing environment, as well as implement custom-designed monitoring systems and provide around-the-clock operation and management services. These outsourcing services enable customers to free themselves from the burden of operating the network systems, which demands professional operation and maintenance to ensure prompt and flexible responses to unexpected system problems.

 

We develop, provide, and make investment for our own systems construction and software development for a cloud-based foreign exchange (“FX”) platform which we mainly provide to financial institutions such as securities brokers and FX trading companies who pay monthly fees primarily based on the volume of transactions.

 

We have provided our customers with basic and easy-to-order systems integration services, including provision of network resources such as network equipment, data storage systems, network monitoring, and systems operation management, on demand and on a monthly basis, therefore enabling our customers to launch their internal network system securely and cost effectively.

 

Equipment Sales

 

In addition to the network services and systems integration, we sell third-party equipment, such as routers, mobile devices including iPads and other equipment to meet the one-stop needs of our customers together with our in-house developed router, the “SEIL Series.”

 

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SEIL Series. In August 1998, we introduced our first SEIL Series router, a high-end in-house developed router, which was compatible with ISDN. As of June 29, 2018, IIJ sells SEIL/X1, SEIL/BPV4 and SEIL/x86. With the SMF feature, which provides auto-configuration features, it enables customers to create a VPN network simply by connecting the network to SEIL WAN interface.

 

ATM Operation Business

 

Our ATM operation business is conducted by our consolidated subsidiary, Trust Networks, which operates ATMs and related network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. As of March 31, 2018, 1,096 ATMs were placed in places such as Japanese pachinko parlors.

 

Network

 

Our network is one of our most important assets. We have developed and currently operate a high-capacity network that has been designed to provide reliable, high-speed, high-quality Internet connectivity services. Our Internet network extends throughout Japan, and to the United States, the United Kingdom, Singapore, and Hong Kong.

 

We are able to achieve and maintain high speeds through our advanced network architecture, routing technology and load balancing that optimize traffic on our multiple Internet connections.

 

The primary components of our network are:

 

·our backbone, which includes leased lines and network equipment, such as routers,
·POPs in major metropolitan areas in Japan,
·Internet data centers, and
·a network operations center (“NOC”).

 

Backbone

 

Leased lines

 

Our network is anchored by our extensive Internet backbone that extends throughout Japan, and to the United States, the United Kingdom, Singapore, and Hong Kong. We use our expertise in developing and operating our network to organize and connect these leased lines to form a backbone that has substantial transmission capacity. As of June 29, 2018, the total capacity between Japan and the United States was 500Gbps.

 

The physical lines that comprise our backbone are an assembly of numerous physical lines that are procured from various carriers. The lines which we lease are high-capacity, high-speed digital transmission lines. The topology of the backbone network, in principal, is a mesh topology with redundancy, therefore the connection is secured and IIJ’s service will not be interrupted even if either one of the numerous physical lines fails.

 

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The table below lists the total number of contracts comprising IIJ’s backbone network as of March 31, 2017 and March 31, 2018. Each contract represents one physical line. The largest contract accounts for only approximately 2.9% of the total contracted amount.

 

Total Number of Contracts Comprising IIJ's Backbone Network

 

   As of March 31, 2017  As of March 31, 2018
Number of Contracts comprising IIJ’s backbone network          
NTT Group    74    69 
KDDI    47    50 
Others    45    48 
Total    166    167 

 

If IIJ is unable to renew any of its contracts with either of the companies listed above, IIJ can continue with its business by procuring additional physical line services from other telecommunications carriers that offer the best terms or charges in the ordinary course of business. There are over ten additional telecommunications carriers that we can procure physical lines from. A majority of the contracts that comprise IIJ’s backbone network are one-year renewable contracts and IIJ can renew or upgrade its existing contracts or replace them with other telecommunications carrier services if they can be replaced with better terms in the ordinary course of business.

 

Accordingly, IIJ is not substantially dependent on a particular contract with either NTT or KDDI, nor is the amount of a particular contract substantially large. Further, IIJ is neither substantially dependent on a certain arrangement or relationship with a particular carrier or carriers because IIJ has the ability to replace its existing contracts with others under fair terms.

 

The table below shows our backbone cost related to leased lines.

 

Backbone Cost related to Leased Lines

 

   For the fiscal year ended March 31,
(millions of yen)
   2014  2015  2016  2017  2018
Backbone cost   ¥3,762   ¥3,741   ¥3,636   ¥3,414   ¥3,316 

 

 

Network equipment

 

We use advanced equipment in our network. Our primary routers in our network are Cisco and Juniper routers. The size of our routers varies depending on the number of customers and volume of traffic served by our POPs. At each POP we connect our dedicated line to Cisco or Juniper backbone routers which then transmit and receive information throughout our network. We primarily lease our network equipment under capital lease arrangements.

 

Points of Presence

 

POPs are the main points at which our customers connect to our backbone. We provide Internet connectivity from our POPs to commercial and residential customers through leased lines and dial-up connections over local exchange facilities. As of June 29, 2018, we operate 29 primary POPs for dedicated access and one universal POP for nationwide dial-up access in Japan. The universal POP can be accessed from anywhere in Japan with a minimum local telephone charge.

 

Many of our POPs are located in the same facilities where other major carriers and ISPs have their POPs, in facilities of various carriers in Japan like NTT Communications and KDDI. We mainly lease the physical space. We maintain our routers and other networking equipment at these POPs. Our POPs are in, or in close proximity to, the same buildings in which the switches and routers of these carriers and ISPs are located enabling quick and easy interconnection of our equipment with theirs.

 

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Internet Data Centers

 

As of June 29, 2018, we operate 27 Internet data centers, 21 in Japan and six abroad; seven in Tokyo, three in Osaka, two each in Yokohama, Nagoya, and Fukuoka, and one each in Saitama, Sapporo, Sendai, Kyoto, Matsue, New York, San Jose, Los Angeles, London, Shanghai, and Singapore. These data centers are specifically designed for application hosting, IIJ GIO and IIJ GIO Infrastructure P2 services, co-location services and high capacity access to our networks. Excluding the container-based module type data center in Matsue, our data centers are leased. In Japan, they are mainly leased from NTT Communications, ITOCHU Techno-Solutions Corporation, Mitsubishi Corporation, and KDDI. The container-based module type data center in Matsue is directly owned and operated by us.

 

These data centers have 24-hours-a-day, seven-days-a-week operations and security and are equipped with uninterruptible power supplies and backup generators, anti-seismic damage precautions, fire suppression equipment, and other features to optimize our ability to offer high-quality services through these data centers.

 

The container-based module type data center in Matsue is specifically designed for the use of our cloud computing service IIJ GIO which uses outside-air-cooling, a first in Japan. The main features of the Matsue container-based module type data center are its cost efficiency and its short construction period of approximately two to three months to add one container-based module, which allows it to start small and expand along with the rise in demand, unlike building type data centers where you need to build the whole capacity at once regardless of the demand. The second module type data center site in Matsue opened in December 2013 and can host up to 48 container-based modules, 24 container-based modules per site.

 

 

Network operations center and technical and customer support

 

Our NOC in Tokyo operates 24-hours-a-day, seven-days-a-week. From our NOC, we monitor the status of our network, the traffic on the network, the network equipment and components, and many other aspects of our network including our customers’ dedicated access lines leased from carriers. From our NOC, we monitor our networks to ensure that we meet our commitments under our SLA.

 

 

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Our Group Companies

 

We offer our services directly and with our group companies. As of June 29, 2018, we had sixteen consolidated subsidiaries and eight equity method investees. Our group companies work closely together in providing total network solutions to our customers. We collaborate on the development of various services and products and market our services and products together as a group and offer as a group our total network solutions. Our ATM operation business is conducted by Trust Networks.

 

The table below sets out our group companies, including our major subsidiaries and equity method investees and our direct and indirect ownership of each of them as of March 31, 2018:

 

Company Name  Jurisdiction of
Incorporation
  Percentage of ownership
Consolidated Subsidiaries:          
IIJ Global Solutions Inc.    Japan    100.0%
IIJ Engineering Inc.    Japan    100.0%
Trust Networks Inc.    Japan    79.5%(1)
IIJ Innovation Institute Inc.    Japan    100.0%
Net Chart Japan Inc.    Japan    100.0%
RYUKOSHA NETWARE Inc.    Japan    100.0%
IIJ America Inc.    U.S.A.    100.0%
IIJ Europe Limited    U.K.    100.0%
IIJ Global Solutions China Inc.    China    100.0%(2)
IIJ Global Solutions Singapore Pte. Ltd.    Singapore    100.0%(3)
 and six other subsidiaries(4)          
Equity method investees:          
DeCurret Inc.    Japan    35.0%
INTERNET MULTIFEED CO.    Japan    34.0%
Trinity Inc.    Japan    33.8%
Internet Revolution Inc.    Japan    30.0%
JOCDN Inc.    Japan    20.0%
PT Biznet Gio Nusantara    Indonesia    40.0%
Leap Solutions Asia co. Ltd.    Thailand    40.0%
 and one other equity method investee(5)          

_____________________

(1)We owned an 80.6% voting interest. The difference is due to the treasury stock owned by Trust Networks Inc.
(2)IIJ Global Solutions China Inc. was a 100% owned subsidiary of IIJ Global Solutions Inc.
(3)IIJ owned a 50.4% voting interest directly and a 49.6% indirectly through IIJ-Global.
(4)The six other subsidiaries were IIJ Deutschland GmbH, IIJ Global Solutions Hong Kong Ltd., IIJ-Global Solutions (Thailand) Co., Ltd., IIJ-Thailand, PT. IIJ Global Solutions Indonesia, and IIJ-Global Vietnam. On December 31, 2017, we sold all the shares of common stock of our wholly-owned subsidiary hi-ho.
(5)The one other equity method investee was KIS, Inc.

 

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IIJ Global Solutions Inc.

On September 1, 2010, IIJ acquired 100% of the equity of IIJ-Global from AT&T Japan for the amount of ¥9.2 billion. IIJ-Global is incorporated under the laws of Japan. IIJ-Global provides mainly domestic network outsourcing service businesses, such as WAN services. To fulfill the demands of our Japanese clients that are headed abroad to expand their overseas business, together with IIJ, IIJ-Global has been enhancing its business abroad in Asian countries such as China, Singapore and Thailand. As of March 31, 2018, IIJ-Global had 380 employees, 5 of whom were seconded from IIJ.

 

IIJ Engineering Inc.

IIJ Engineering Inc. (“IIJ-EG”), whose name has been changed from Net Care, Inc. as of October 1, 2014, provides a broad array of support services, from monitoring and troubleshooting to network operations and data center operations. As of March 31, 2018, IIJ-EG had 433 employees, 6 of whom were seconded from IIJ.

 

Trust Networks Inc.

Trust Networks Inc. (“Trust Networks”) was established in July 2007. Trust Networks operates bank ATMs and its network systems, and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. As of March 31, 2018, Trust Networks had 1,096 ATMs in operation. As of March 31, 2018, Trust Networks had ten employees, seven of whom were seconded from IIJ.

 

IIJ Innovation Institute Inc.

IIJ Innovation Institute Inc. (“IIJ-II”) mainly engages in research and development of basic Internet-related technology. On July 1, 2009, IIJ Research Laboratory, one of the research departments of IIJ, was transferred to IIJ-II to strengthen the Group research and development by reclassifying the Group research and development organization. As of March 31, 2018, IIJ-II had 15 employees, all of whom were seconded from IIJ.

 

Net Chart Japan Inc.

Net Chart Japan Inc. (“NCJ”) provides network construction services that are mainly related to Local Area Networks, such as installation and configuration of equipment, wiring following network installation, and installation and operation support for applications. As of March 31, 2018, NCJ had 90 employees.

 

RYUKOSHA NETWARE Inc.

RYUKOSHA NETWARE Inc. (“RYUKOSHA”) engages in human resources outsourcing, including systems operation and service support. RYUKOSHA became IIJ’s wholly owned subsidiary as of December 1, 2014. As of March 31, 2018, RYUKOSHA had 313 employees.

 

IIJ America Inc.

IIJ America Inc. (“IIJ-America”) is a U.S.-based ISP that also provides cloud computing services and offers systems integration solutions, catering primarily to the U.S.-based operations of Japanese companies. As of March 31, 2018, IIJ-America had 44 employees, five of whom were seconded from IIJ.

 

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IIJ Europe Limited

IIJ Europe Limited (“IIJ-Europe”) offers systems integration, Internet connectivity services, and cloud computing services primarily to Japanese companies operating in Europe. As of March 31, 2018, IIJ-Europe had 50 employees, four of whom were seconded from IIJ.

 

IIJ Global Solutions China Inc.

IIJ-Global Solutions China Inc. (“IIJ-Global China”) is a China-based systems integrator and cloud computing services provider catering primarily to China-based operations of Japanese companies. As of March 31, 2018, IIJ-Global China had 22 employees.

 

IIJ Global Solutions Singapore Pte. Ltd.

IIJ-Global Solutions Singapore Pte. Ltd. (“IIJ-Global Singapore”) is a Singapore-based systems integrator and cloud computing services provider catering primarily to Singapore-based operations of Japanese companies. As of March 31, 2018, IIJ-Global Singapore had 14 employees, two of whom were seconded from IIJ.

 

DeCurret Inc.

In January 2018, we established DeCurret Inc. which is a joint venture with various Japanese companies to provide cryptocurrency exchange and settlement services. As of March 31, 2018, DeCurret is our equity method investee, in which we have a 35.0% ownership interest. The shareholders of DeCurret include Nomura Holdings, Inc., ITOCHU Corporation, East Japan Railway Company, QTnet, Inc., BIC CAMERA INC., K-Opticom Corporation, Mitsui Sumitomo Insurance Company, Limited, Sompo Holdings, Inc., Sumitomo Mitsui Banking Corporation, The Dai-ichi Life Insurance Company, Limited, Mitsui Fudosan Co., Ltd., Daiwa Securities Group Inc., MUFG Bank, Ltd., Tokio Marine & Nichido Fire Insurance Co., Ltd., ITOCHU Techno-Solutions Corporation, Nippon Life Insurance Company, DENTSU INC., and YAMATO HOLDINGS CO., LTD.

 

INTERNET MULTIFEED CO.

INTERNET MULTIFEED CO. (“Multifeed”) provides high-speed Internet eXchange (“IX” — where major ISPs exchange network traffic) service. Its technology was developed jointly with the NTT Group. Multifeed operates IXs named JPNAP. As of March 31, 2018, Multifeed is our equity method investee, in which we have a 34.0% ownership interest.

 

Trinity Inc.

Trinity Inc. (“Trinity”) is one of the subsidiaries of Hirata Corporation, which manages customer loyalty reward program systems. As of March 31, 2018, Trinity is our equity method investee, in which we have a 33.8% ownership interest.

 

Internet Revolution Inc.

In February 2006, IIJ and Konami Corporation established a joint venture company, Internet Revolution Inc. (“i-revo”) initially to operate a portal website. i-revo now provides operation of the gaming platform used by the Konami Group. As of March 31, 2018, i-revo is our equity method investee, in which we have a 30.0% ownership interest.

 

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JOCDN Inc.

In December 2016, IIJ and Nippon Television Network Corporation, one of the major Japanese broadcasting companies, established a joint venture company, JOCDN to provide a content delivery platform specialized for video distribution within Japan. In April 2017, TV Asahi Holdings Corporation, Tokyo Broadcasting System Holdings, Inc., TV TOKYO Holdings Corporation, Fuji Television Network, Inc., MBS Media Holdings, Inc., Asahi Broadcasting Corporation, Television Osaka, Inc., Kansai Telecasting Corporation, Yomiuri Telecasting Corporation, Tokai Television Broadcasting Co., Ltd., Chukyo TV. Broadcasting Co., Ltd., Chubu-Nippon Broadcasting Co., Ltd., Nagoya Broadcasting Network Co., Ltd., and Aichi Television Broadcasting Co., Ltd., became shareholders of JOCDN. As of March 31, 2018, JOCDN is our equity method investee, in which we have a 20.0% ownership interest.

 

PT Biznet Gio Nusantara

In January 2015, IIJ and Biznet Networks, a major communications services company in Indonesia, established a joint venture company, PT Biznet Gio Nusantara (“PT Biznet GIO”), to offer public and private cloud computing services mainly to local companies in Indonesia. As of March 31, 2018, PT Biznet GIO is our equity method investee, in which we have a 40.0% ownership interest.

 

Leap Solutions Asia co. Ltd.

In February 2016, IIJ and T.C.C. Technology Co., Ltd., a leading data center and IT infrastructure service provider in Thailand, established a joint venture company, Leap Solutions Asia co. Ltd., to provide full-scale cloud computing services in Thailand. As of March 31, 2018, Leap Solutions Asia Co. Ltd., is our equity method investee, in which we have a 40.0% ownership interest.

 

 

 

 

 

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Capital Expenditures

 

The table below shows our capital expenditures, which we define as amounts paid for purchases of property and equipment plus acquisition of assets by entering into capital leases, for the last three fiscal years.

 

   For the fiscal year ended March 31,
   2016  2017  2018
   (millions of yen)
Capital expenditures, including capitalized leases (1)  ¥14,812   ¥16,531   ¥20,828 

_____________________

(1)Further information regarding capital expenditures, including capitalized leases and a reconciliation to the most directly comparable U.S. GAAP financial measure, can be found in Item 3.A., “Selected Financial Data— Reconciliations of the Disclosed Non-GAAP Financial Measures to the Most Directly Comparable GAAP Financial Measures.”

 

Most of our capital expenditures, which are funded largely by cash generated from operations, proceeds from bank borrowings, proceeds from issuance of common stock, and leases, relate primarily to the development, expansion, improvement, and maintenance of our network and service infrastructures and of our own internal back-office systems. The investments are mostly for routers, servers, network equipment, containers for our container type data centers, and other facilities necessary to offer services related to our network and software developments. Capital expenditures for the fiscal year ended March 31, 2018 increased compared with the previous fiscal year mainly because increase in capital expenditures related to cloud computing service and purchase of land for new data center construction.

 

We estimate that our expected capital expenditures, including capitalized leases, for the fiscal year ending March 31, 2019 related to our network services and systems integration business will be slightly smaller than the amount for the fiscal year ended March 31, 2018. As capital expenditures related to cloud computing service will decrease, expenditures related to data center construction will increase.

 

Seasonality

 

See Item 5.D., “Trend Information — Factors Affecting Our Future Financial Results — Systems integration revenues, including related equipment sales revenues.”

 

Sales and Marketing

 

Our sales headquarters are located in Tokyo. In addition, we have eight branches, Osaka, Nagoya, Fukuoka, Sapporo, Sendai, Yokohama, Toyama, and Hiroshima and three offices in Niigata, Toyota, and Okinawa in order to cover the major metropolitan areas in which the majority of large Japanese companies operate. As of March 31, 2018, we had 553 employees, on a consolidated basis, working in sales and marketing. The Business Unit, where our domestic sales and marketing employees are assigned, is divided into 13 divisions:

 

·Enterprise Business Divisions 1 and 2 focus on selling total network solutions and work with large corporate clients, including manufacturers and retail companies.

 

·Financial Systems Business Division focuses on selling total network solutions and work with financial institutions.

 

·Government, Public & Educational Organization Business Division focuses on selling total network solutions and works with governmental institutions, universities, and other schools.

 

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·Global Business Division is in charge of the planning and administration of overseas business development.

 

·Service Product Business Division focuses on promoting the sales of our focused services such as IIJ GIO and IIJ GIO Infrastructure P2 services, security-related services, IP services, mobile services, and corporate network solutions including IIJ Omnibus Services, and also focuses on enhancing partner business.

 

·West Japan Business Division focuses on developing and strengthening partnerships with customers in the western Japan area. Sales personnel in branch and sales offices are part of this division.

 

·Central Japan Business Division focuses on developing and strengthening partnerships with customers in the central Japan area such as Nagoya. Sales personnel in branch and sales offices are part of this division

 

·East Japan Business Division focuses on developing and strengthening partnerships with customers in the eastern Japan area except for the Kanto area. Sales personnel in branch and sales offices are part of this division.

 

·Enterprise Business System Development Division 1 and 2 are comprised of pre-sales engineers who focus on meeting specific IT needs of corporations by, for example, integrating network services and systems integration.

 

·Outsourcing Division focuses on promoting business enterprises to outsource their IT systems by offering needed services and/or operating systems for them.

 

·Business Unit Management Division is in charge of back-office operations such as those related to processing sales orders for business divisions.

 

 

Customers

 

As of March 31, 2018, we had approximately 11,000 business and other institutional customers which is approximately 10% increase from the previous year end of approximately 10,000 customers. As of March 31, 2018, we had approximately 2.0 million individuals which include individual customers subscribing to our mobile, “IIJ Mobile MVNO-Platform services” under which we provide our mobile services to other consumer MVNOs, and OEM services. Our main customers continue to be major corporations, including ISPs.

 

Research and Development

 

Research and Development Organization

 

Our research and development activities are conducted by IIJ Innovation Institute (“IIJ-II”) and IIJ’s internal organizations in charge of technology.

 

IIJ Innovation Institute. IIJ established IIJ-II in June 2008 as a wholly-owned subsidiary, which engages in research and development of basic Internet-related technology development. In July 2009, IIJ Research Laboratory, which was established as a research organization of IIJ in April 1998 to engage in new basic network technologies, was transferred to IIJ-II to reorganize and strengthen the Group's research and development capabilities. IIJ-II is currently participating in various research and development activities in cooperation with organizations from the private and academic sectors. IIJ-II is engaged in research and development activities related to cloud computing, network traffic measurement and analysis, the development of operational technology for Internet routing, and Internet security among various other activities.

 

 39 
 

 

IIJ’s internal organizations in charge of technology. IIJ’s internal organizations such as the Service Product Business Division, the Service Infrastructure Division, the Network Division, the Cloud Division, and the MVNO Division, play an important role in the research and development of technologies to be applied to our services and solutions, collect information, evaluate new technology, and conduct business expansion.

 

 

Research and Development Strategy

 

Our primary research and development objective is to continue to develop innovative services, applications, and products that meet the current and future demands of our customers, and to continue to be at the forefront of the Internet industry in Japan. Many of our engineers are regularly engaged in research and development activities related to the development of new services, applications, and products. These engineers have continued to develop innovative services, applications, and products, many of which have set the standard for the Internet industry in Japan. They also work very closely with our sales and marketing personnel and technical engineers to ensure that the innovative services, applications and products will meet the demands of our customers.

 

Our second research and development objective is to continue participating in or otherwise closely monitor new products, developments, and initiatives of manufacturers and standards-setting and research groups. We have also engaged in the research and development of new Internet-related basic technology since 1998. Through these efforts, we seek to ensure that we have timely and effective access to new technologies, and that we implement these technologies effectively.

 

In furtherance of these objectives, our research and development efforts currently are focused on a variety of projects, including:

 

·research and development of the basic technologies for cloud computing-related technology including Software-Defined Networking (“SDN”) and Network Function Virtualization (“NFV”),
·research and development of methodology to solve the technical problems of the current cloud computing systems,
·research and development of the basic technologies for a storage system for a wide area data center operation to enable flexible location and relocation of virtual machines,
·research and development of methodology to construct a virtualized large-scale data center with an assembly of small-scale data centers,
·research and development of electric feeding methodology with high efficiency, and adoption to a next generation container-based module type data center,
·development and commercialization of a cloud-based Power Metering System (PMS) Service Platform, a system platform for providing services that make use of a smart meter,
·research of Internet traffic monitoring and management,
·research relating to the behavior of Internet routing systems,
·research and development of IPv6-based communication technology,
·continuous improvement of our SEIL router (an in-house developed service adaptor) and SMF, systems which we developed specifically to be integrated into IIJ’s network-related services,
·research relating to the methodology of the configuration of routers and other servers, and
·research and development of the Distributed and Parallel Processing Platform for very large data sets.

 

 40 
 

 

Our research and development expenses averaged less than 1.0% of total revenues for the past three consecutive years. For the fiscal years ended March 31, 2016, 2017, and 2018, our research and development expenses were ¥455 million, ¥466 million and ¥487 million, respectively, most of which were for personnel expenses. The level of research and development expenditures is low in relation to our total costs primarily because we do not engage in extensive research and development of new technologies and products that require large investments. Rather, as noted above, we are intensively engaged in research and development related to our ongoing business. We focus on monitoring developments in the industry and in developing new and innovative services and applications by utilizing and enhancing existing technologies and products.

 

Because the rate of change in technology relevant to our business is so rapid, we believe that the sophistication and experience of our research and development personnel is an important part of our success.

 

 

Proprietary Rights

 

Although we believe that our success is more dependent upon our technical, marketing, and customer service expertise than our proprietary rights, we rely on a combination of trademark and contractual restrictions to establish and protect our technology.

 

Licenses

 

For us to provide certain services to our customers, we have, as a licensee, entered into license agreements with suppliers including Trend Micro Incorporated, RSA Security Inc., NRI Secure Technologies, Ltd., McAfee, Inc. (Intel Security), Microsoft Japan Co., Ltd., Adobe Systems Software Ireland Limited, and Oracle Corporation Japan.

 

We have purchased licenses from these suppliers in accordance with customer demands for our services.

 

Trademarks

 

We have applied for trademark registrations of our corporate name, “Internet Initiative Japan Inc.” and certain other corporate and product names in Japan, the United States and certain European and Asian countries.

 

Patents

 

We have applied for patent registrations in relation to our technology in Japan and the United States. As of June 29, 2018, eleven registrations had been granted, with two pending applications. The latest acquired patent is for technology to cool telecommunication equipment utilizing the chimney effect in a data center.

 

Legal Proceedings

 

We are involved in normal claims and other legal proceedings in the ordinary course of business. We are not involved in any litigation or other legal proceedings that, if determined adversely to us, we believe would individually or in the aggregate have a material adverse effect on us or our operations.

 

 

 

 41 
 

 

Regulations of the Telecommunications Industry in Japan

 

The MIC regulates the Japanese telecommunications industry. Telecommunications carriers, including us, are regulated by the MIC primarily under the Telecommunications Business Law.

 

The Telecommunications Business Law

 

The Telecommunications Business Law, which became effective in 1985, was established for the purpose of privatization and deregulation in the telecommunications business. After several amendments, the Telecommunications Business Law was considerably amended in July 2003, and the amended Telecommunications Business Law became effective as of April 2004. Further, an amendment to the Telecommunications Business Law was enacted on June 3rd, 2014 and the amended Telecommunications Business Law became effective on June 1, 2015. From here on, “Telecommunications Business Law” refers to the latest amended Telecommunications Business Law. A summary of the regulations under the current Telecommunications Business Law is as follows:

 

The Telecommunications Business Law applies to the telecommunications business, except for telecommunications business that is exempted under the Telecommunications Business Law (“Exempted Business”). (1) The term “telecommunications business” is defined under the Telecommunications Business Law as a business providing telecommunications services in order to meet the demand of others. (2) The term “telecommunications services” is defined under the Telecommunications Business Law as intermediating communications of others through the use of telecommunications facilities, or any other acts of providing telecommunications facilities for the use of communications of others. Our business falls under the definition of a telecommunications business, but not an Exempted Business, and, therefore, is subject to the Telecommunications Business Law.

_____________________

(1)An Exempted Business is a business related to facilities supplying broadcast services, wire radio broadcasting, wire broadcast telephone services, wire television broadcasting services, or the acceptance of applications for the use of cable television broadcasting facilities.
(2)The provisions of this Law shall not apply to the telecommunications businesses listed in the following items:
(i)a telecommunications business which exclusively provides telecommunications services to a single person (except one being a telecommunications carrier);
(ii)a telecommunications business which provides telecommunications services with telecommunications facilities, a part of which is to be established on the same premises (including the areas regarded as the same premises) or in the same building where any other part thereof is also to be established, or with telecommunications facilities which meet the standards stipulated in the ministerial ordinance of the MIC; and
(iii)a telecommunications business which does not install telecommunications circuit facilities but which provides telecommunications services other than the telecommunications services which intermediate communications of others by using telecommunications facilities;

 

Provided that the provisions of Article 3 and Article 4 of the Telecommunications Business Law apply to communications handled by a person who operates the telecommunications business listed above.

 

Start-up of Services

 

·Registration/Notification

Registration with the Minister of the MIC is required for start-up telecommunications businesses that intend to provide telecommunications services. However, for telecommunications businesses which meet either of the following two requirements, only a notification to the Minister of the MIC is required: (i) the scale of the telecommunications circuit facilities which are to be installed and the scope of the area covered thereby do not exceed a certain threshold established by the ministerial ordinance of the MIC (i.e., areas of installation of terminal-related transmission facilities are limited to a single municipality (city, town or village) and areas of installation of relay-related transmission facilities are limited to a single prefecture) or (ii) the telecommunications circuit facilities to be installed fall within a certain category of radio facilities as set forth in the Radio Act (i.e., radio facilities which conduct radio communications (except for basic broadcasting) as well as basic broadcasting). Our business is subject to this latter notification requirement.

 

 42 
 

 

Terms and Conditions of Provision of Services and Charge

 

·Our business is unregulated, in general, as IIJ does not fall under either Basic Telecommunications Services or Designated Telecommunications Services described below.

 

·Prior notification to the Minister of the MIC is required for the Basic Telecommunications Services (i.e., universal services specified by the ministerial ordinance of the MIC such as analog or public fixed telephone services, analog or public remote island telephone services, and analog or public emergency call telephone services). Providing these telecommunications services in a manner other than that pursuant to the terms and conditions and charges notified to the Minister of the MIC is prohibited, provided that the charges may be discounted or waived pursuant to the exception criteria provided under the ministerial ordinance of the MIC (i.e., an emergency call for the safety of ships and airplanes, an emergency call for the safety of life and property in case of natural disaster, calls to police agencies regarding crimes, and calls to the fire brigade).

 

·Prior notification to the Minister of the MIC is required for Designated Telecommunications Services (i.e., services provided through Category I Designated Telecommunications Facilities and which meet the criteria provided by the ministerial ordinance of the MIC as the services for which the guarantee of the terms and conditions and charges are necessary for the protection of users, such as the basic fee). “Category I Designated Telecommunications Facilities” are facilities which meet the criteria specified by the ministerial ordinance of the MIC as being fixed telecommunications facilities used for the services which are offered to a substantial percentage of users in a given area, and which are currently only the facilities of NTT East and NTT West. Providing these telecommunications services in a manner other than that pursuant to the terms and conditions and charges notified to the Minister of the MIC is prohibited, unless the telecommunications carrier and the user agree otherwise, provided that the charges may be discounted or waived in emergency cases, for emergency calls for injured persons in a ship, and for use by a police agency, fire brigade, and broadcasting companies.

 

·The Minister of the MIC at least once a year notifies the telecommunications carrier providing the Specific Designated Telecommunications Services specified by the ministerial ordinance of the MIC (i.e., Designated Telecommunications Services other than voice services, except for telephone and general digital services and data transmission services) the price cap regarding such services. The telecommunications carriers are required to obtain approval from the Minister of the MIC if a proposed change in charges exceeds the price cap.

 

Articles of Interconnection Agreements

 

·Our business is unregulated, in general, as IIJ does not fall under either Category I Designated Telecommunications Facilities, described above, or Category II Designated Telecommunications Facilities described below.

 

·Approval from the Minister of the MIC is required for Category I Designated Telecommunications Facilities.

 

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·Prior notification to the Minister of the MIC is required for Category II Designated Telecommunications Facilities (i.e., facilities which meet the criteria provided by the ministerial ordinance of the MIC as being mobile telecommunications facilities used for services which are offered to a substantial percentage of users in a given area, and which are currently NTT Docomo, Okinawa Cellular, and KDDI).

 

Telecommunications Facilities of Carriers

 

·A telecommunications carrier that any of the following items applies to shall maintain its telecommunications facilities (except telecommunications facilities stipulated in the ministerial ordinance of the MIC as those having a minor influence on the users' benefit in the cases of damage or failure thereof) in compliance with the technical standards specified in the applicable ministerial ordinance of the MIC.

 

(1)a telecommunications carrier that installs telecommunications circuit facilities

 

(2)a telecommunications carrier that provides Universal Telecommunications Services

 

(3)a telecommunications carrier (excluding those falling under 2 above) that both of the following items apply to and that is designated by the Minister of the MIC as a telecommunications carrier that shall maintain its telecommunications facilities properly (“Carrier without Circuit Facilities”):

 

·having more than one million users at the end of the previous fiscal year; and

 

·charging service fees as compensation for providing telecommunications services.

 

Such telecommunications carriers shall confirm themselves that said telecommunications facilities are in compliance with the technical standards specified in the applicable ministerial ordinance of the MIC.

 

·Telecommunications carriers that install telecommunications circuit facilities, that provide Universal Telecommunications Services, or that are Carriers without Circuit Facilities shall establish their own administrative rules governing said telecommunications facilities in accordance with the ministerial ordinance of the MIC in order to ensure the reliable and stable provision of telecommunications services. These administrative rules shall provide the necessary rules with which said telecommunications carriers shall comply with respect to the policy, the structure and the method of the administration of the telecommunication facilities, and the appointment of the general administrator of the telecommunication facilities in accordance with the ministerial ordinance of the MIC. Telecommunications carriers that install telecommunications circuit facilities and telecommunications carriers that provide Universal Telecommunications Services shall submit such administrative rules to the Minister of the MIC prior to the commencement of operations, and Carriers without Circuit Facilities must submit them within three months after the date they are designated as Carriers without Circuit Facilities by the Minister of the MIC as above. When these telecommunications carriers amend their administrative rules, they shall submit a notification in respect of the amended matters to the Minister of the MIC without delay.

 

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·Although the regulations described above currently do not apply to us, there is a possibility that we will be designated as a Carrier without Circuit Facilities in the future depending on the increase of the number of users of our telecommunications services.

 

Protection of Users

 

·Telecommunications carriers, as well as business operators that are entrusted by telecommunications carriers with acting as an intermediary in entering into contracts relating to telecommunications services, are required to explain, in accordance with the ministerial ordinance of the MIC, to users (except for users who are telecommunications carriers) an outline of charges and other terms and conditions of their services when entering into certain contracts with such users relating to telecommunications services as specified in the Telecommunications Business Law.

 

·Telecommunications carriers shall, when the said contracts are validly established, prepare documents containing items as specified in the ministerial ordinance of the MIC and deliver such documents to the users. Telecommunications carriers may, by obtaining the approval of the users, provide the users with the said documents by electromagnetic means in lieu of the delivery of them, in accordance with the ministerial ordinance of the MIC.

 

·Telecommunications carriers are required, when a user offers to cancel a contract relating to telecommunications services as specified under the Telecommunications Business Law, within a certain period after the receipt of the said cancellation document, to accept cancellation of the contract without demanding that the user pay any compensation, cancellation fees, or other similar fees (except for charges for the telecommunications services provided before the cancellation and other charges as specified in the ministerial ordinance of the MIC).

 

·When telecommunications carriers entrust a business operator with acting as an intermediary in entering into contracts relating to telecommunications services and/or performing other business activities incidental thereto, telecommunications carriers shall exercise supervision and necessary measures over them in order to ensure the proper and secure execution of such entrusted business, in accordance with the ministerial ordinance of the MIC.

 

Order to Improve Business Activities

 

·The Minister of the MIC may, if it is deemed that certain business activities of a telecommunications carrier fall under inappropriate cases set forth in the Telecommunications Business Law, insofar as it is necessary to ensure the users’ benefit or the public interest, order the telecommunications carrier to take actions to improve operations methods or other measures.

 

Right of Way Privilege for Authorized Carriers

 

·A telecommunications carrier which is engaged, or intends to engage, in the telecommunications business by installing telecommunications circuit facilities and which wishes to have the privileged use of land or other public utilities for circuit facilities deployment, must obtain authorization for the entire or a part of the relevant telecommunications business from the Minister of the MIC.

 

 45 
 

 

Merger, Business Transfer, or Divestiture of Carriers

 

·Post facto notification to the Minister of the MIC without delay is required.

 

Business Suspension, Abolition, or Dissolution of Carriers

 

·Post facto notification to the Minister of the MIC without delay is required. Prior announcement of withdrawals to service users is required in accordance with ministerial ordinances of the MIC.

 

Foreign Capital Participation

 

·Prior notification is required under the Foreign Exchange and Foreign Trade Law for the acquisition of shares of telecommunications carriers to which registration for start-up services is applicable. This is not applicable to purchasers of ADSs. The one-third foreign ownership restriction is applicable only to NTT East and NTT West.

 

C.Organizational Structure

 

The information required by this item is included in “Our Group Companies” above.

 

D.Property, Plant and Equipment

 

Property and equipment recorded on our consolidated balance sheet as of March 31, 2017 and March 31, 2018 consisted of the following:

 

   As of March 31
   2017  2018
   (millions of yen)
Data communications equipment   ¥15,014   ¥18,544 
Office and other equipment    2,875    2,523 
Land    538    2,039 
Buildings    1,663    2,151 
Leasehold improvements    4,062    4,182 
Capitalized software    33,336    36,625 
Assets under capital leases, primarily data communications equipment    32,854    35,821 
Total    90,342    101,885 
           
Less accumulated depreciation and amortization    (50,567)   (55,471)
Property and equipment-net   ¥39,775   ¥46,414 

 

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Our fixed assets consist mainly of (i) data communications equipment necessary to offer services on our network, such as routers, servers, and other network equipment, which are mainly acquired under capital leases and (ii) software, such as that for back-office systems, virtualization software and others for cloud computing services, FX service application software, and others. Most of our property and equipment are located in Japan. The above-mentioned property and equipment consists of many relatively small assets. As of March 31, 2018, we did not own any buildings or facilities such as factories. As of March 31, 2018 we owned the properties related to the container-based module type data center in Matsue which is directly owned and operated by us. We bought land for our new container-based module type data center in Chiba. Other than the above assets recorded on our consolidated balance sheet, we use operating leased assets such as backbone lines, local access line, office premises, and network operation centers. There are no known environmental issues that may affect our utilization of our property and equipment.

 

Please also see “Network” above and Note 7 “Property and Equipment” and Note 9 “Leases” to our consolidated financial statements included in this annual report on Form 20-F.

 

Item 4A. Unresolved Staff Comments

 

None.

 

 

 

 

 

 

 

 

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Item 5. Operating and Financial Review and Prospects

 

A.Operating Results

 

You should read the following discussion of our financial condition and results of operations together with Item 3.A. of this annual report on Form 20-F and our consolidated financial statements and the notes to those financial statements beginning on page F-1 of this annual report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of factors including but not limited to those in Item 3.D. of this annual report on Form 20-F.

 

Overview

 

The Group is a provider of a comprehensive range of network services and systems integration mainly in Japan. IIJ was founded in December 1992 and began offering Internet connectivity services commercially in July 1993. IIJ was one of the first commercial ISPs in Japan and has expanded the Group business to outsourcing services, WAN services and systems integration along with the expansion of usage of Internet by customers.

 

Our primary sources of revenue are Internet connectivity services, outsourcing services, WAN services, systems integration, equipment sales, and the ATM operation business. Internet connectivity services consist of Internet connectivity services for enterprise and Internet connectivity services for consumers. For WAN services, which are mainly provided by IIJ-Global, we offer closed network services using connectivity such as Ethernet, IP-VPN and dedicated lines. For outsourcing services, we provide services such as network security services, mail and web server hosting services, managed router services, Internet data center services and cloud computing services such as IIJ GIO/Hosting Package. For systems integration, we provide systems construction such as consulting, project planning, systems design and development of network systems to meet each of our customers’ requirements and systems operation and maintenance. IIJ GIO/Component is provided as a part of systems operation and maintenance. For equipment sales, we sell equipment as part of our provision of total network solutions.

 

We entered into the ATM operation business through our subsidiary, Trust Networks, which was established in July 2007. Trust Networks operates ATMs and its network systems to provide ATM service and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. As of March 31, 2018, 1,096 ATMs were placed in places such as Japanese pachinko parlors.

 

Currently, we have two business segments: the network services and systems integration business and the ATM operation business. Our network services and systems integration business is comprised of Internet connectivity services, WAN services, outsourcing services, systems integration and equipment sales.

 

For the fiscal year ended March 31, 2018, net revenues of network services and systems integration business and ATM operation business before elimination of intersegment revenues were ¥172.4 billion and ¥4.0 billion, respectively. Our consolidated net revenue for the fiscal year ended March 31, 2018 was ¥176.1 billion.

 

Most of our revenues are from customers operating in Japan.

 

We refer to our subsidiaries and equity method investees as our group companies, and we have invested heavily in and exercise significant influence over these companies. For the fiscal year ended March 31, 2018, we consolidated all of our seventeen subsidiaries. In addition, we had nine equity method investees. For descriptions and the history of our group companies, see “Our Group Companies” in Item 4.B.

 

For a discussion of factors affecting our future financial results, see “Item 5.D. Trend Information.”

 

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Results of Operations

 

As an aid to understanding our operating results, the following tables show items from our statements of income for the periods indicated in millions of yen and as a percentage of total revenues. For further discussion about segment reporting, please see “Segment Information” later in this section.

 

   Fiscal year ended March 31,
   2016  2017  2018
   (millions of yen except for percentage data)
REVENUES:                              
Network services:                              
Internet connectivity services (enterprise)   ¥17,597    12.5%  ¥22,634    14.3%  ¥27,944    15.9%
Internet connectivity services (consumer)    15,256    10.9    21,735    13.8    24,761    14.1 
WAN services    25,177    17.9    26,460    16.8    29,295    16.6 
Outsourcing services    21,266    15.1    22,167    14.0    26,119    14.8 
Total    79,296    56.4    92,996    58.9    108,119    61.4 
Systems integration:                              
Systems construction    21,145    15.0    22,626    14.3    22,528    12.8 
Systems operation and maintenance    33,043    23.5    35,123    22.3    37,903    21.5 
Total    54,188    38.5    57,749    36.6    60,431    34.3 
Equipment sales    3,275    2.3    2,994    1.9    3,470    2.0 
ATM operation business    3,889    2.8    4,050    2.6    4,031    2.3 
Total revenues    140,648    100.0    157,789    100.0    176,051    100.0 
                               
COSTS AND EXPENSES:                              
Cost of network services:                              
Backbone cost    3,636    2.6    3,414    2.2    3,316    1.9 
Local access line cost    22,913    16.3    24,625    15.6    27,490    15.6 
Other connectivity cost    454    0.3    482    0.3    585    0.3 
Depreciation and amortization    4,458    3.2    5,048    3.2    5,922    3.4 
Other    32,778    23.3    42,818    27.1    51,385    29.2 
Total cost of network services    64,239    45.7    76,387    48.4    88,698    50.4 
Cost of systems integration:                              
Cost of equipment sales related to systems integration    7,919    5.6    7,902    5.0    6,835    3.9 
Other    38,307    27.3    43,090    27.3    46,778    26.6 
Total cost of systems integration    46,226    32.9    50,992    32.3    53,612    30.5 
Cost of equipment sales    2,969    2.1    2,735    1.7    3,142    1.8 
Cost of ATM operation business    2,559    1.8    2,428    1.5    2,366    1.3 
Total costs    115,993    82.5    132,542    84.0    147,818    84.0 
Sales and marketing    10,589    7.5    11,432    7.2    12,688    7.2 
General and administrative    7,471    5.3    8,215    5.2    8,296    4.7 
Research and development    455    0.3    466    0.3    487    0.3 
Total costs and expenses    134,508    95.6    152,655    96.7    169,289    96.2 
OPERATING INCOME    6,140    4.4    5,134    3.3    6,762    3.8 
OTHER INCOME (EXPENSES):                              
Dividend income    93    0.0    118    0.1    243    0.1 
Interest income    28    0.0    35    0.0    31    0.0 
Interest expense    (241)   (0.0)   (304)   (0.2)   (375)   (0.2)
Foreign exchange loss, net    (71)   (0.0)   (45)   (0.0)   (16)   (0.0)
Net gain on sales of other investments    24    0.0    217    0.1    1,068    0.7 
Loss on sales of an investment in equity method investee    -    -    (12)   (0.0)   -    - 
Impairment of other investments   (15)   (0.0)   (31)   (0.0)   (110)   (0.0)
Other—net   235    0.0    315    0.2    237    0.1 
Other income — net    53    0.0    293    0.2    1,078    0.7 
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE AND EQUITY IN NET INCOME OF EQUITY METHOD INVESTEES—(FORWARD)    6,193    4.4%   5,427    3.4%   7,840    4.5%
                               
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE AND EQUITY IN NET INCOME OF EQUITY METHOD INVESTEES—(FORWARD)    6,193    4.4    5,427    3.4    7,840    4.5 
INCOME TAX EXPENSE    2,183    1.5    2,225    1.4    2,696    1.5 
EQUITY IN NET INCOME OF EQUITY METHOD INVESTEES    180    0.1    130    0.1    135    0.0 
NET INCOME    4,190    3.0    3,332    2.1    5,279    3.0 
LESS: NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS    (152)   (0.1)   (165)   (0.1)   (170)   (0.1)
NET INCOME ATTRIBUTABLE TO INTERNET INITIATIVE JAPAN INC.   ¥4,038    2.9%  ¥3,167    2.0%  ¥5,109    2.9%

_________________

 

 

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The Fiscal Year Ended March 31, 2018 Compared to the Fiscal Year Ended March 31, 2017

 

Total Revenues

 

For the fiscal year ended March 31, 2018, our total revenues were ¥176.1 billion, an increase of 11.6% compared to ¥157.8 billion for the previous fiscal year, mainly due to the increase in mobile services which are recognized as Internet connectivity services for enterprise and consumers revenues and the increase in security related services revenue which are accounted as Outsourcing services revenues.

 

Network Services Revenues

 

For the fiscal year ended March 31, 2018, revenues from network services, which comprise our Internet connectivity services for enterprises, Internet connectivity services for consumers, WAN services and outsourcing services, increased by 16.3% to ¥108.1 billion from ¥93.0 billion for the previous fiscal year.

 

Internet Connectivity Services for Enterprise. Revenues for Internet connectivity services for enterprise depend on customers’ bandwidth usage, the number of contracts, and pricing for connectivity services. For the fiscal year ended March 31, 2018, revenues increased by 23.5% to ¥27.9 billion from ¥22.6 billion for the previous fiscal year. For the fiscal year ended March 31, 2018, IP connectivity service revenue increased by 3.4% to ¥10.1 billion from ¥9.8 billion for the previous fiscal year. For the fiscal year ended March 31, 2018, mobile services for enterprise revenue increased by 52.4% to ¥14.6 billion from ¥9.6 billion for the previous fiscal year. The increase was mainly due to increases in mobile-related services revenues along with an expansion of MVNE clients’ business transactions. We expect MVNE services to contribute to the continued growth of mobile services revenues along with rapid MVNO market expansion.

 

Internet Connectivity Services for Consumers. Revenues for Internet connectivity services for consumers depend on the number of service contracts and pricing. For the fiscal year ended March 31, 2018, revenues increased by 13.9% to ¥24.8 billion from ¥21.7 billion for the previous fiscal year. On December 31, 2017, IIJ sold all the shares of common stock it owned of hi-ho and revenues from hi-ho brand services after December 31, 2017 were not consolidated. Due to this, for the fiscal year ended March 31, 2018, revenues from hi-ho brand services decreased by 37.5% from the previous fiscal year, while the revenues from IIJ brand services increased by 19.4% from the previous fiscal year. The increase in IIJ brand services was mainly due to the increase in mobile services for consumers, in which we offer inexpensive data communication and voice services through SIM cards. The increase in revenues from our mobile services for consumers covered the decrease in revenues from our network service by hi-ho. Subscriptions to our mobile services for consumers were 1,005 thousand as of March 31, 2018 compared to 951 thousand for the previous fiscal year end. For the fiscal year ending March 31, 2019, we anticipate mobile services for consumers to continue to grow and contribute to our revenue growth.

 

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WAN Services. The WAN services that we offer are closed network services using connectivity such as Ethernet, IP-VPN and dedicated access lines, and are mainly provided by IIJ-Global and IIJ. Revenues for WAN services depend on the number of contracted lines for WAN services and the customers’ bandwidth usage. For the fiscal year ended March 31, 2018, revenues from WAN services increased by 10.7% to ¥29.3 billion from ¥26.5 billion for the previous fiscal year as we continued to accumulate orders from enterprise customers. For the fiscal year ending March 31, 2019, we do not expect WAN services revenue to grow, as a large-scale project connecting multiple locations will migrate to mobile connection.

 

Outsourcing Services. For outsourcing services, we are currently offering security-related, network-related, server-related, and data center-related outsourcing services, as well as public cloud computing services. Examples of our outsourcing services include, among others, firewall services, email-related services including a sandbox function, web hosting services, Distributed Denial of Service (“DDoS”) attack protection services, Internet-VPN services, router rental services, Security Operations Center (“SOC”) services and virtual desktop services, which are provided mainly to our Internet connectivity customers. Our revenues depend on our ability to cross-sell our existing outsourcing services, add new features to existing outsourcing services and introduce new services. For the fiscal year ended March 31, 2018, our outsourcing services revenues increased by 17.8% to ¥26.1 billion from ¥22.2 billion for the previous fiscal year. The increase was mainly due to an increase in security-related services revenues. We anticipate that outsourcing services revenues should continue to grow mainly due to increasing demands for security-related services by corporate customers.

 

Systems Integration Revenues

 

Generally speaking, while Japanese customers, especially blue-chip companies, use ready-made network services to build their network systems, they also require customization to meet their individual needs. To meet such needs, we believe that it is important as a total network solution provider to provide systems construction together with network services. Therefore, we have been focusing on providing systems construction to our corporate customers. Systems construction is mainly IP-related network construction such as VPN networks and IP-based server system construction such as web server and email server systems. Systems construction can be significantly affected by prevailing economic conditions, as corporations usually reduce their ICT-related investments during economic down times unless such investments are deemed critical.

 

For the fiscal year ended March 31, 2018, our revenues from systems integration, which include equipment sales related to systems integration, increased by 4.6% to ¥60.4 billion from ¥57.7 billion for the previous fiscal year. Systems construction revenue, a one-time revenue, was ¥22.5 billion, approximately flat from the previous fiscal year, with our continued receipt of orders for system construction projects. Systems operation and maintenance revenue, a recurring revenue, increased by 7.9% compared to the previous fiscal year. The increase was mainly due to continued accumulation of systems operation orders as well as an increase in private cloud computing services’ revenues. As of March 31, 2018, order backlog for systems construction and equipment sales was ¥7.0 billion, a decrease of 2.6% compared to the previous fiscal year end. As of March 31, 2018, order backlog for systems operation and maintenance was ¥39.6 billion, an increase of 15.4% compared to the previous fiscal year end.

 

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For the fiscal year ending March 31, 2019, systems construction revenues are expected to slightly increase from the fiscal year ended March 31, 2018. Systems integration revenues can fluctuate significantly in accordance with the absence or addition of large orders. For systems operation and maintenance revenues, a recurring type revenue, we anticipate that revenues should increase compared to the fiscal year ended March 31, 2018 with the accumulation of contracts, including contracts for our cloud computing services, as well as some of our construction projects migrating to the operation and maintenance phases.

 

Equipment Sales Revenues

 

For equipment sales, we sell third-party equipment to meet the one-stop needs of our customers. For the fiscal year ended March 31, 2018, equipment sales revenues increased by 15.9% to ¥3.5 billion from ¥3.0 billion for the previous fiscal year. Revenues increased mainly due to fluctuations in sales of devices such as mobile devices.

 

ATM Operation Business Revenues

 

Trust Networks, our subsidiary which operates this business, receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. For the fiscal year ended March 31, 2018, ATM operation business revenues decreased by 0.5% to ¥4.0 billion from ¥4.1 billion for the previous fiscal year. ATM operation business revenues are generated based on the number of placed ATMs and daily transactions. For the fiscal year ending March 31, 2019, we do not expect the revenue to largely increase as we do not expect to place large number of additional ATM placements.

 

 

Total Cost of Revenues

 

For the fiscal year ended March 31, 2018, our total cost of revenues increased by 11.5% to ¥147.8 billion from ¥132.5 billion for the previous fiscal year.

 

Cost of Network Services. For the fiscal year ended March 31, 2018, cost of network services increased by 16.1% to ¥88.7 billion from ¥76.4 billion for the previous fiscal year. For the fiscal year ended March 31, 2018, the gross margin ratio for network services revenues, which is the ratio of (1) the amount obtained by subtracting the cost of network services from network services revenues to (2) network services revenues, increased to 18.0% from 17.9% for the previous fiscal year. The increase was mainly due to the overall increase in fixed-type costs, such as an increase in outsourcing-related costs with our mobile infrastructure enhancement associated with our mobile-related revenue increase, an increase in circuit-related costs associated with our WAN services revenue increase, and an increase in network operation-related costs.

 

Cost of Systems Integration. For the fiscal year ended March 31, 2018, cost of systems integration increased by 5.1% to ¥53.6 billion from ¥51.0 billion for the previous fiscal year. For the fiscal year ended March 31, 2018, the gross margin ratio for systems integration, which is the ratio of (1) the amount obtained by subtracting the cost of systems integration revenues from systems integration revenues to (2) systems integration revenues, decreased to 11.3% from 11.7% for the previous fiscal year. The decrease was mainly due to increases in initial installation costs related to a large-scale services integration project.

 

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Cost of Equipment Sales. For the fiscal year ended March 31, 2018, cost of equipment sales increased by 14.9% to ¥3.1 billion from ¥2.7 billion for the previous fiscal year. The increase was primarily due to the increase in equipment sales revenues. For the fiscal year ended March 31, 2018, the gross margin ratio for equipment sales, which is the ratio of (1) the amount obtained by subtracting the cost of equipment sales from equipment sales revenues to (2) equipment sales revenues, increased to 9.5% from 8.7% for the previous fiscal year.

 

Cost of the ATM Operation Business. For the fiscal year ended March 31, 2018, cost of the ATM operation business was ¥2.4 billion, at the same level as that of the fiscal year. For the fiscal year ended March 31, 2018, the gross margin was ¥1.7 billion compared to ¥1.6 billion for the previous fiscal year. For the fiscal year ended March 31, 2018, the gross margin ratio for ATM operation business revenues, which is the ratio of (1) the amount obtained by subtracting the cost of ATM operation business from the ATM operation business revenues to (2) ATM operation business revenues, increased to 41.3% from 40.1% for the previous fiscal year mainly due to the improvement of per ATM utilization. As of March 31, 2018, 1,096 ATMs were placed.

 

 

Total Costs and Expenses

 

For the fiscal year ended March 31, 2018, total costs and expenses, which includes total cost of revenues, sales and marketing expenses, general and administrative expenses and research and development expenses, increased by 10.9% to ¥169.3 billion from ¥152.7 billion for the previous fiscal year.

 

Sales and Marketing. For the fiscal year ended March 31, 2018, sales and marketing expenses increased by 11.0% to ¥12.7 billion from ¥11.4 billion for the previous fiscal year. The increase was mainly due to increases in advertising expenses, personnel-related expenses, and sales commission expenses

 

General and Administrative. For the fiscal year ended March 31, 2018, general and administrative expenses increased by 1.0% to ¥8.3 billion from ¥8.2 billion for the previous fiscal year. The increase was mainly due to an increase in personnel-related expenses.

 

Research and Development. For the fiscal year ended March 31, 2018, research and development expenses increased by 4.5% to ¥0.5 billion from the previous fiscal year.

 

 

Operating Income

 

As a result of the foregoing factors, operating income for the fiscal year ended March 31, 2018 increased by 31.7% to ¥6.8 billion from ¥5.1 billion for the previous fiscal year.

 

 

Other Income (Expenses)-Net

 

For the fiscal year ended March 31, 2018, we recorded other income-net of ¥1,078 million compared to other income-net of ¥293 million for the previous fiscal year.

 

Dividend Income. For the fiscal year ended March 31, 2018, dividend income was ¥243 million compared to ¥118 million for the previous fiscal year.

 

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Interest Income. For the fiscal year ended March 31, 2018, interest income was ¥31 million compared to ¥35 million for the previous fiscal year.

 

Interest Expense. For the fiscal year ended March 31, 2018, interest expense, comprising interest expense related to borrowings and capital lease obligations, amounted to ¥375 million compared to ¥304 million for the previous fiscal year.

 

Foreign Exchange (Loss)-Net. For the fiscal year ended March 31, 2018, net foreign exchange loss amounted to ¥16 million compared to the loss of ¥45 million for the previous fiscal year. Foreign exchange loss was mainly the result of the Japanese yen becoming stronger against foreign currencies, including the U.S. dollar and the British pound in the fiscal year ended March 31, 2018.

 

Net Gain on Sales of Other Investments. For the fiscal year ended March 31, 2018, we recorded a net gain on sales of other investments of ¥1,068 million compared to the net gain of ¥217 million for the previous fiscal year. Unrealized gains on holding available-for-sale equity securities of ¥7.5 billion were measured based on closing prices of March 30, 2018, the final day of trading in the fiscal year ended March 31, 2018. Due to the revision to U.S. GAAP relating to available-for-sale equity securities, the net of tax amount of unrealized gains of ¥5.1 billion were reclassified to retained earnings at the beginning of the fiscal year ending March 31, 2019. Changes in unrealized gains or losses due to fluctuations of stock prices will be recognized in other income (expenses) in every quarter beginning with our consolidated statements of income from the first quarter of the fiscal year ending March 31, 2019. Therefore, fluctuations of stock prices may impact our consolidated statements of income.

 

Loss on sales of an investment in equity method investee. For the fiscal year ended March 31, 2018, we recorded no loss on sales of an investment in equity method investee, as compared to a loss of ¥12 million in the previous fiscal year.

 

Impairment of Other Investments. For the fiscal year ended March 31, 2018, we recorded an impairment loss on other investments of ¥110 million compared to a loss of ¥31 million for the previous fiscal year.

 

Other-Net. For the fiscal years ended March 31, 2017 and 2018, we recorded other income of ¥315 million and ¥237 million, respectively.

 

Income from Operations before Income Tax Expense and Equity in Net Income of Equity Method Investees

 

For the fiscal year ended March 31, 2018, we recorded income from operations before income tax expense and equity in net income of equity method investees of ¥7.8 billion compared to ¥5.4 billion for the previous fiscal year. The increase primarily reflects the increase in operating income and a net gain on sales of other investments described above.

 

Income Tax Expense

 

For the fiscal year ended March 31, 2018, we recorded income tax expense of ¥2.7 billion compared to income tax expense of ¥2.2 billion for the previous fiscal year.

 

Equity in Net Income of Equity Method Investees

 

For the fiscal year ended March 31, 2018, equity in net income of equity method investees was ¥135 million compared to ¥130 million for the previous fiscal year. The increase was mainly due to an increase in our share of net income related to Multifeed.

 

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Net income attributable to noncontrolling interests

 

For the fiscal year ended March 31, 2018, net income attributable to noncontrolling interests was ¥170 million compared to ¥165 million for the previous fiscal year. The increase was mainly due to net income of Trust Networks Inc.

 

Net income attributable to IIJ

 

For the fiscal year ended March 31, 2018, net income attributable to IIJ was ¥5.1 billion, compared to ¥3.2 billion for the previous fiscal year. The increase primarily reflects the decrease in operating income and a net gain on sales of other investments.

 

 

The Fiscal Year Ended March 31, 2017 Compared to the Fiscal Year Ended March 31, 2016

 

Total Revenues

 

For the fiscal year ended March 31, 2017, our total revenues were ¥157.8 billion, an increase of 12.2% compared to ¥140.6 billion for the previous fiscal year, mainly due to the increase in mobile services which are recognized as Internet connectivity services for enterprise and consumers revenues and the increase in system integration revenues.

 

Network Services Revenues

 

For the fiscal year ended March 31, 2017, revenues from network services, which comprise our Internet connectivity services for enterprises, Internet connectivity services for consumers, WAN services and outsourcing services, increased by 17.3% to ¥93.0 billion from ¥79.3 billion for the previous fiscal year.

 

Internet Connectivity Services for Enterprise. Revenues for Internet connectivity services for enterprise depend on customers’ bandwidth usage, the number of contracts, and pricing for connectivity services. For the fiscal year ended March 31, 2017, revenues increased by 28.6% to ¥22.6 billion from ¥17.6 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, IP connectivity service revenue increased by 1.0% to ¥9.8 billion from ¥9.7 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, mobile services for enterprise revenue increased by 109.5% to ¥9.6 billion from ¥4.6 billion for the previous fiscal year. The increase was mainly due to the increase in mobile-related services revenues along with an expansion of MVNE business clients’ business transactions. We expect MVNE solution services to contribute to the continued growth of mobile services revenues along with rapid MVNO market expansion.

 

Internet Connectivity Services for Consumers. Revenues for Internet connectivity services for consumers depend on the number of service contracts and pricing. For the fiscal year ended March 31, 2017, revenues increased by 42.5% to ¥21.7 billion from ¥15.3 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, the revenues from hi-ho brand services decreased by 17.2% from the previous fiscal year, while the revenues from IIJ brand services increased by 54.4% from the previous fiscal year. The increase in IIJ brand services was mainly due to the increase in mobile services for consumers, in which we offer inexpensive data communication and voice services through SIM cards. The increase in revenues from our mobile services for consumers covered the decrease in revenues from our network service by hi-ho. Subscriptions to our mobile services for consumers were 951 thousand as of March 31, 2017 compared to 747 thousand for the previous fiscal year end.

 

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WAN Services. The WAN services that we offer are closed network services using connectivity such as Ethernet, IP-VPN and dedicated access lines, and are mainly provided by IIJ-Global and IIJ. Revenues for WAN services depend on the number of contracted lines for WAN services and the customers’ bandwidth usage. For the fiscal year ended March 31, 2017, revenues from WAN services increased by 5.1% to ¥26.5 billion from ¥25.2 billion for the previous fiscal year as we continued to accumulate orders from enterprise customers.

 

Outsourcing Services. For outsourcing services, we are currently offering security-related, network-related, server-related, and data center-related outsourcing services, as well as public cloud computing services. Examples of our outsourcing services include, among others, firewall services, email-related services including a sandbox function, web hosting services, Distributed Denial of Service (“DDoS”) attack protection services, Internet-VPN services and router rental services, which are provided mainly to our Internet connectivity customers. Our revenues depend on our ability to cross-sell our existing outsourcing services, add new features to existing outsourcing services and introduce new services. For the fiscal year ended March 31, 2017, our outsourcing services revenues increased by 4.2% to ¥22.2 billion from ¥21.3 billion for the previous fiscal year. The increase was mainly due to an increase in security-related services revenues. We anticipate that outsourcing services revenues should continue to grow mainly due to increasing demands for security-related services by corporate customers.

 

Systems Integration Revenues

 

Generally speaking, while Japanese customers, especially blue-chip companies, use ready-made network services to build their network systems, they also require customization to meet their individual needs. To meet such needs, we believe that it is important as a total network solution provider to provide systems construction together with network services. Therefore, we have been focusing on providing systems construction to our corporate customers. Systems construction is mainly IP-related network construction such as VPN networks and IP-based server system construction such as web server and email server systems. Systems construction can be significantly affected by prevailing economic conditions, as corporations usually reduce their ICT-related investments during economic down times unless such investments are deemed critical.

 

For the fiscal year ended March 31, 2017, our revenues from systems integration, which include equipment sales related to systems integration, increased by 6.6% to ¥57.7 billion from ¥54.2 billion for the previous fiscal year. Systems construction revenue, a one-time revenue, increased by 7.0% compared to the previous fiscal year. The increase was mainly due to an increase in systems construction projects and the execution of several large-scale projects, including the exportation of a container data center module which generated approximately ¥1.2 billion in revenue. Systems operation and maintenance revenue, a recurring revenue, increased by 6.3% compared to the previous fiscal year. The increase was mainly due to an increase in private cloud computing services revenues and an increase in operation and maintenance revenues which had been shifted from systems construction projects. As of March 31, 2017, order backlog for systems construction and equipment sales was ¥7.2 billion, an increase of 18.1% compared to the previous fiscal year end. As of March 31, 2017, order backlog for systems operation and maintenance was ¥34.3 billion, an increase of 24.5% compared to the previous fiscal year end.

 

Equipment Sales Revenues

 

For equipment sales, we sell third-party equipment to meet the one-stop needs of our customers. For the fiscal year ended March 31, 2017, equipment sales revenues decreased by 8.6% to ¥3.0 billion from ¥3.3 billion for the previous fiscal year. Revenues decreased mainly due to fluctuations in sales of devices such as mobile devices.

 

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ATM Operation Business Revenues

 

Trust Networks, our subsidiary which operates this business, receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. For the fiscal year ended March 31, 2017, ATM operation business revenues increased by 4.1% to ¥4.1 billion from ¥3.9 billion for the previous fiscal year. Revenues mainly increased in conjunction with an increase in daily transactions.

 

 

Total Cost of Revenues

 

For the fiscal year ended March 31, 2017, our total cost of revenues increased by 14.3% to ¥132.5 billion from ¥116.0 billion for the previous fiscal year.

 

Cost of Network Services. For the fiscal year ended March 31, 2017, cost of network services increased by 18.9% to ¥76.4 billion from ¥64.2 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, the gross margin ratio for network services revenues, which is the ratio of (1) the amount obtained by subtracting the cost of network services from network services revenues to (2) network services revenues, decreased to 17.9% from 19.0% for the previous fiscal year. The decrease was mainly because of the overall increase in fixed-type costs, such as an increase in outsourcing-related costs with our mobile infrastructure enhancement associated with our mobile-related revenue increase, an increase in circuit-related costs associated with our WAN services revenue increase, and an increase in network operation-related costs.

 

Cost of Systems Integration. For the fiscal year ended March 31, 2017, cost of systems integration increased by 10.3% to ¥51.0 billion from ¥46.2 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, the gross margin ratio for systems integration, which is the ratio of (1) the amount obtained by subtracting the cost of systems integration revenues from systems integration revenues to (2) systems integration revenues, decreased to 11.7% from 14.7% for the previous fiscal year. The decrease was mainly due to profit deterioration resulting from low productivity of systems engineers and the delay in offering some functions of our ASP-type foreign exchange systems which led to the delay in revenue recognition while cost was recognized.

 

Cost of Equipment Sales. For the fiscal year ended March 31, 2017, cost of equipment sales decreased by 7.9% to ¥2.7 billion from ¥3.0 billion for the previous fiscal year. The decrease was primarily due to the decrease in equipment sales revenues. For the fiscal year ended March 31, 2017, the gross margin ratio for equipment sales, which is the ratio of (1) the amount obtained by subtracting the cost of equipment sales from equipment sales revenues to (2) equipment sales revenues, decreased to 8.7% from 9.4% for the previous fiscal year.

 

Cost of the ATM Operation Business. For the fiscal year ended March 31, 2017, cost of the ATM operation business was ¥2.4 billion compared to ¥2.6 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, the gross margin was ¥1.6 billion compared to ¥1.3 billion for the previous fiscal year. For the fiscal year ended March 31, 2017, the gross margin ratio for ATM operation business revenues, which is the ratio of (1) the amount obtained by subtracting the cost of ATM operation business from the ATM operation business revenues to (2) ATM operation business revenues, increased to 40.1% from 34.2% for the previous fiscal year mainly due to the improvement of per ATM utilization. As of March 31, 2017, 1,066 ATMs were placed.

 

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Total Costs and Expenses

 

For the fiscal year ended March 31, 2017, total costs and expenses, which includes total cost of revenues, sales and marketing expenses, general and administrative expenses and research and development expenses, increased by 13.5% to ¥152.7 billion from ¥134.5 billion for the previous fiscal year.

 

Sales and Marketing. For the fiscal year ended March 31, 2017, sales and marketing expenses increased by 8.0% to ¥11.4 billion from ¥10.6 billion for the previous fiscal year. The increase was mainly due to increases in sales commission expenses of mobile-related services and advertising expenses.

 

General and Administrative. For the fiscal year ended March 31, 2017, general and administrative expenses increased by 10.0% to ¥8.2 billion from ¥7.5 billion for the previous fiscal year. The increase was mainly due to the increase in office rent expenses, commission expenses, and taxes and public dues.

 

Research and Development. For the fiscal year ended March 31, 2017, research and development expenses increased by 2.4% to ¥0.5 billion from ¥0.5 billion for the previous fiscal year.

 

 

Operating Income

 

As a result of the foregoing factors, operating income for the fiscal year ended March 31, 2017 decreased by 16.4% to ¥5.1 billion from ¥6.1 billion for the previous fiscal year.

 

 

Other Income (Expenses)-Net

 

For the fiscal year ended March 31, 2017, we recorded other income-net of ¥293 million compared to other income-net of ¥53 million for the previous fiscal year.

 

Dividend Income. For the fiscal year ended March 31, 2017, dividend income was ¥118 million compared to ¥93 million for the previous fiscal year.

 

Interest Income. For the fiscal year ended March 31, 2017, interest income was ¥35 million compared to ¥28 million for the previous fiscal year.

 

Interest Expense. For the fiscal year ended March 31, 2017, interest expense, comprising interest expense related to borrowings and capital lease obligations, amounted to ¥304 million compared to ¥241 million for the previous fiscal year.

 

Foreign Exchange (Loss) -Net. For the fiscal year ended March 31, 2017, net foreign exchange loss amounted to ¥45 million compared to the loss of ¥71 million for the previous fiscal year. Foreign exchange loss was mainly the result of the Japanese yen becoming stronger against foreign currencies, including the U.S. dollar and the British pound in the fiscal year ended March 31, 2017.

 

Net Gain on Sales of Other Investments. For the fiscal year ended March 31, 2017, we recorded a net gain on sales of other investments of ¥217 million compared to the net gain of ¥24 million for the previous fiscal year.

 

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Loss on sales of an investment in equity method investee. For the fiscal year ended March 31, 2017, we recorded loss on sales of an investment in equity method investee of ¥12 million as a result of selling all of our ownership interest in e-CORPORATION.

 

Impairment of Other Investments. For the fiscal year ended March 31, 2017, we recorded an impairment loss on other investments of ¥31 million compared to the loss of ¥15 million for the previous fiscal year.

 

Other-Net. For the fiscal years ended March 31, 2016 and 2017, we recorded other income of ¥235 million and ¥315 million, respectively.

 

Income from Operations before Income Tax Expense and Equity in Net Income of Equity Method Investees

 

For the fiscal year ended March 31, 2017, we recorded income from operations before income tax expense and equity in net income of equity method investees of ¥5.4 billion compared to ¥6.2 billion for the previous fiscal year. The decrease primarily reflects the decrease in operating income.

 

Income Tax Expense

 

For the fiscal year ended March 31, 2017, we recorded income tax expense of ¥2.2 billion compared to income tax expense of ¥2.2 billion for the previous fiscal year.

 

Equity in Net Income of Equity Method Investees

 

For the fiscal year ended March 31, 2017, equity in net income of equity method investees was ¥130 million compared to ¥180 million for the previous fiscal year. The decrease was mainly due to a decrease in our share of net income related to Multifeed.

 

Net income attributable to noncontrolling interests

 

For the fiscal year ended March 31, 2017, net income attributable to noncontrolling interests was ¥165 million compared to ¥152 million for the previous fiscal year. The increase was mainly due to net income of Trust Networks Inc.

 

Net income attributable to IIJ

 

For the fiscal year ended March 31, 2017, net income attributable to IIJ was ¥3.2 billion, compared to ¥4.0 billion for the previous fiscal year. The decrease primarily reflects the decrease in operating income.

 

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Segment Reporting

 

Currently, we have two business segments: a network services and systems integration business segment and an ATM operation business segment. The network services and systems integration business segment is comprised of Internet connectivity services, WAN services, outsourcing services, systems integration and equipment sales.

 

The following table presents net revenues and operating income for the fiscal years ended March 31, 2016, 2017, and 2018, respectively, by segment.

 

Business Segment Summary:

 

   Fiscal year ended March 31,
   2016  2017  2018
   (millions of yen)
Revenues:               
Network services and systems integration business  ¥137,142   ¥154,126   ¥172,370 
ATM operation business   3,889    4,050    4,031 
Elimination   (383)   (387)   (350)
Total   140,648    157,789    176,051 
Operating income:               
Network services and systems integration business   5,128    3,854    5,430 
ATM operation business   1,149    1,438    1,510 
Elimination   (137)   (157)   (178)
Total  ¥6,140   ¥5,134   ¥6,762 

 

 

The Fiscal Year Ended March 31, 2018 Compared to the Fiscal Year Ended March 31, 2017

 

Network services and Systems Integration Business Segment

 

Net revenues from our network services and systems integration business segment, before elimination of intersegment revenues, increased by 11.8% to ¥172.4 billion for the fiscal year ended March 31, 2018 compared to ¥154.1 billion for the previous fiscal year. The increase in revenues was mainly due to the increase in mobile-related services both for enterprise and consumers, outsourcing services, WAN services and systems operation. Operating costs and expenses of our network services and systems integration business for the fiscal year ended March 31, 2018 increased by 11.1% to ¥166.9 billion compared to ¥150.3 billion for the previous fiscal year, mainly due to the increases in costs of network services and systems integration. As a result, operating income of our network services and systems integration business for the fiscal year ended March 31, 2018 increased to ¥5.4 billion compared to ¥3.9 billion for the previous fiscal year.

 

ATM Operation Business Segment

 

Net revenues from our ATM operation business segment, before elimination of intersegment revenues, decreased by 0.5% to ¥4.0 billion for the fiscal year ended March 31, 2018 compared to ¥4.1 billion for the previous fiscal year. Operating costs and expense of our ATM operation business for the fiscal year ended March 31, 2018 were ¥2.5 billion compared to ¥2.6 billion for the previous fiscal year. As a result, operating income of our ATM operation business for the fiscal year ended March 31, 2018 was ¥1.5 billion compared to operating income of ¥1.4 billion for the previous fiscal year.

 

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The Fiscal Year Ended March 31, 2017 Compared to the Fiscal Year Ended March 31, 2016

 

Network services and Systems Integration Business Segment

 

Net revenues from our network services and systems integration business segment, before elimination of intersegment revenues, increased by 12.4% to ¥154.1 billion for the fiscal year ended March 31, 2017 compared to ¥137.1 billion for the previous fiscal year. The increase in revenues was mainly due to the increase in mobile-related services both for enterprise and consumers, WAN services, systems integration and outsourcing services. Operating costs and expenses of our network services and systems integration business for the fiscal year ended March 31, 2017 increased by 13.9% to ¥150.3 billion compared to ¥132.0 billion for the previous fiscal year, mainly due to the increases in costs of network services and systems integration, and SG&A expenses. As a result, operating income of our network services and systems integration business for the fiscal year ended March 31, 2017 decreased to ¥3.9 billion compared to ¥5.1 billion for the previous fiscal year.

 

ATM Operation Business Segment

 

Net revenues from our ATM operation business segment, before elimination of intersegment revenues, increased by 4.1% to ¥4.1 billion for the fiscal year ended March 31, 2017 compared to ¥3.9 billion for the previous fiscal year. Operating costs and expense of our ATM operation business for the fiscal year ended March 31, 2017 were ¥2.6 billion compared to ¥2.7 billion for the previous fiscal year. As a result, operating income of our ATM operation business for the fiscal year ended March 31, 2017 was ¥1.4 billion compared to operating income of ¥1.1 billion for the previous fiscal year.

 

 

 

 

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Application of Critical Accounting Policies

 

In reviewing our consolidated financial statements (“financial statements”), you should consider the sensitivity of our reported financial condition and results of operations to changes in the conditions and assumptions underlying the estimates and judgments made by our management in applying critical accounting policies.

 

The preparation of the financial statements requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. Actual results may differ from these estimates, judgments and assumptions. Note 1 to our consolidated financial statements includes a summary of the significant accounting policies used in the preparation of our financial statements. Certain accounting policies are particularly critical because of their significance to our reported results and because of the possibility that future events may differ significantly from the conditions and assumptions underlying the estimates used and judgments made by our management in preparing our financial statements.

 

We have discussed the development and selection of critical accounting policies and estimates with our Disclosure Committee, and the Disclosure Committee has reviewed the disclosure relating to these, which are included in this “Operating and Financial Review and Prospects.” For all of these policies, we caution that future events rarely develop exactly as forecasted, and even the best estimates may require adjustment.

 

Revenue recognition

 

Network service revenues consist of Internet connectivity services, WAN services and outsourcing services.

 

Revenues from Internet connectivity services consist of Internet connectivity services for enterprise and Internet connectivity for consumers. Internet connectivity services for enterprise represent dedicated Internet access type services, such as IP services and Data Center Connectivity services, broadband Internet connectivity services that use fiber optic and ADSL access, such as IIJ FiberAccess/F Service and IIJ DSL/F Service and wireless broadband Internet connectivity services, such as IIJ Mobile Service. Internet connectivity services for consumers are provided under IIJ brands such as IIJmio, hi-ho brand and others, and consist of dial-up services, optical based or ADSL based broadband services and wireless broadband Internet connectivity services. WAN services are closed network services for enterprise customers which mainly use dedicated lines. Outsourcing service revenues consist principally of sales of various Internet access-related services such as security-related services, network related services, server related services, data center related services, cloud computing services and others. The term of these contracts is generally one month or one year. All of these services revenues are billed and recognized monthly on a straight-line basis. Initial setup fees received in connection with network services revenues are deferred and recognized over the estimated average period of the subscription for each service.

 

System integration revenue involves one or more of the following deliverables:

 

·System construction services―include all or some of the following elements depending on arrangements to meet each of our customer's requirements: consulting, project planning, system design, and development of network systems. These services also include the installation of software as well as configuration and installation of hardware.
·Software―we resell third-party software such as Oracle and Windows to our customers, which are installed by us during the system development process.

 

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·Hardware―we also resell third-party hardware, primarily servers, switches and routers, which we install during the system development process. The hardware is generic hardware that is often sold by third-party manufacturers and resellers.
·Monitoring and operating services―we monitor our customer's network activity and Internet connectivity to detect and report problems. We also provide constant data backup services.
·Hardware and software maintenance services―we repair or replace any malfunctioning parts of hardware. We examine software faults and provide suitable solutions to customers.

 

The system construction services are generally delivered over a three-month period. All hardware and software are delivered and installed during this period. Customers are required to pay a specified fixed fee that is not payable until after the system construction has been completed and accepted by our customers.

 

Monitoring, operating and hardware and software maintenance services generally commence once our customers have accepted the systems, and contract periods are generally from one to five years. Our contracts include a stated annual fee for these services.

 

For multiple-element arrangements that include system construction services, hardware, software essential to the hardware product’s functionality and undelivered non-software services (e.g., monitoring and operating services), the Company allocates revenue to all deliverables based on their relative selling prices. The Company uses a hierarchy to determine the selling price to be used for allocating revenue to the deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of the selling price (“TPE”) and (iii) best estimate of the selling price (“ESP”). The allocation of revenue is based mainly on the Company’s ESPs except for certain undelivered non-software services for which VSOE has been established. The Company’s process for determining its ESP for deliverables includes various factors that may vary depending on the circumstances and specific characteristics related to each deliverable. In developing the ESP, the Company considers customer demand, the existence and effect of competitors, general profit margin realized in the marketplace, volume of the transactions, the Company’s internal costs of providing the deliverables, the profit objectives including targeted and historical margins realized on similar sales to similar customers and the historical pricing practices.

 

The method used to account for each unit and the period over which each unit of accounting is recognized are as follows:

 

·Revenue allocated to system construction services is accounted for using contract accounting. System construction service revenues, which are generally completed within three months, are recognized based on the completed-contract method in compliance with Accounting Standards Codification (“ASC”) 605-35-25-92 because the Company is unable to bill customers and the title to the constructed network system is not transferred to the customers unless they are satisfied with and accept the completed systems.
·Revenue related to the hardware and software essential to the hardware product’s functionality is not recognized until the customer acceptance is received because title to the hardware and software do not transfer to our customers until formal acceptance is received.
·Revenue related to undelivered non-software services (monitoring, operating and hardware maintenance services) is recognized on a straight-line basis over the contract period.

 

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The Company also enters into multiple-element arrangements for system integration services that include software not essential to the hardware product’s functionality and software-related services and account for them in accordance with ASC 985-605, “Software-Revenue Recognition.” The Company has been able to establish VSOE of fair value of the software-related services based on separate renewal contracts of the services that are consistently priced within a narrow range. The Company allocates revenue to such services based on VSOE and recognizes the revenues on a straight-line basis over the contract period. The Company allocates the residual amount to the software.

 

Equipment sales revenues are recognized when equipment is delivered and accepted by the customer.

 

The Company evaluates whether it is appropriate to record the gross amount of revenues and related costs or the net amount earned in reporting system construction services and equipment sales, depending on whether the Company functions as the principal or agent.

 

The ATM operation business revenues consist primarily of commissions for each withdrawing transaction with the use of ATMs. The ATM commission collected from each withdrawal is aggregated every month and recognized as ATM operation revenues.

 

Revenue is recognized net of consumption tax collected from customers and subsequently remitted to governmental authorities.

 

Useful lives of property and equipment

 

Property and equipment, net recorded on our balance sheet was ¥46.4 billion at March 31, 2018, representing 30.2% of our total assets. Property and equipment are recorded at cost. Depreciation and amortization of property and equipment, including capitalized software and capital leases, are computed principally using the straight-line method based on either the estimated useful lives of the assets or the lease period, whichever is shorter. Our depreciation and amortization expenses for property and equipment for the fiscal years ended March 31, 2016, 2017 and 2018 were ¥9.5 billion, ¥10.5 billion and ¥12.0 billion, respectively.

 

We estimate the useful lives of property and equipment in order to determine the amount of depreciation and amortization expense to be recorded in each fiscal year. We determine the useful lives of our assets at the time the assets are acquired and base our determinations on expected use, experience with similar assets, established laws and regulations as well as taking into account anticipated technological or other changes. Estimated useful lives by major asset classes at March 31, 2018, were as follows:

 

Item   Range of useful lives 
Data communications, office and other equipment    2 to 20 years 
Buildings    20 years 
Leasehold improvements    4 to 20 years 
Capitalized software    5 to 7 years 
Capital leases    4 to 6 years 

 

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If technological or other changes were to occur more rapidly or in a different form than anticipated or new laws or regulations are enacted or the intended use changes, the useful lives assigned to these assets may need to be shortened, or we may need to sell or write off the assets, resulting in recognition of increased depreciation and amortization or losses in future periods. Our losses on disposal of property and equipment for the fiscal years ended March 31, 2016, 2017, and 2018 were ¥66 million, ¥171 million and ¥112 million, respectively.

 

A one-year change in the useful life of these assets would have increased or decreased depreciation expense by approximately ¥6.2 billion and ¥3.9 billion, respectively.

 

Ordinary maintenance and repairs are charged to income as incurred. Major replacements and improvements are capitalized. When properties are retired or otherwise disposed of, the property and related accumulated depreciation accounts are relieved of the applicable amounts and any differences are included in operating cost and expenses.

 

Goodwill and intangible assets

 

Goodwill and intangible assets that are deemed to have indefinite useful lives are not amortized, but are subject to impairment testing. Impairment testing is performed annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performs annual impairment tests on March 31. If the carrying amount of a reporting unit exceeds its fair value, the Company then performs the second step of the goodwill impairment test to measure the amount of impairment loss, if any.

 

No impairment of goodwill was recognized during the years ended March 31, 2016, 2017 and 2018.

 

The Company recorded ¥11 million and ¥81 million of loss on impairment of the trademark right related to hi-ho in “General and administrative” expenses in the Company’s consolidated statements of income for the years ended March 31, 2016 and 2017, respectively. Because of the recent decrease in revenues of hi-ho, the Company recognized that the trademark might be impaired. The carrying value of the trademark exceeded its fair value and the impairment loss was recognized in an amount equal to the excess of the carrying amount of the trademark over the fair value of the trademark. The fair value of the trademark was calculated using the relief-from-royalty method. The amount of loss was included in the network service and system integration business segment.

 

Intangible assets with finite useful lives, consisting of customer relationships, are amortized using a non-straight-line basis based on the pattern of expected future economic benefit over the estimated useful lives, which range from 10 to 19 years. We estimate the useful lives of the intangible assets, considering the customer attrition rate related to the customer relationships, results of contract update, new technology or economic situation. If the attrition rate increases beyond expectation or rapid technological advances render the existing technology obsolete, we may need to re-evaluate the remaining useful lives, or recognize impairment losses on the customer relationships.

 

On December 31, 2017, we sold all of the company’s shares of hi-ho, which provided Internet connectivity services for consumers, to a third party. Hi-ho was included in the network service and systems integration business segment. We recognized a gain of ¥45 million on the sale of the hi-ho shares, in addition, goodwill and trademark decreased by ¥87 million and ¥15 million, respectively, for the year ended March 31, 2018. The gain on the sale was recorded in “General and administrative” expenses in our consolidated statements of income.

 

Impairment of long-lived assets

 

Long-lived assets consist principally of property and equipment, including those items leased under capital leases and amortized intangible assets. We perform an impairment review for our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. This analysis is separate from our analysis of the useful lives of our assets, but it is affected by some similar factors. Factors that we consider important which could trigger an impairment review include, but are not limited to, the impact of the following trends or conditions:

 

·significant decline in the market value of an asset,

 

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·current period operating cash flow loss,

 

·introduction of competing technologies or services,

 

·significant underperformance of expected or historical cash flows,

 

·significant or continuing decline in subscribers,

 

·changes in the manner or use of an asset,

 

·disruptions in the use of network equipment under capital lease arrangements, and

 

·other negative industry or economic trends.

 

When we determine that the carrying amount of specific assets may not be recoverable based on the existence or occurrence of one or more of the above or other factors, we estimate the future cash inflows and outflows expected to be generated by the assets over their expected useful lives. We estimate the sum of expected undiscounted future cash flows based upon historical trends adjusted to reflect our best estimate of future market and operating conditions. If the sum of the expected undiscounted future net cash flows is less than the carrying value of the assets, we record an impairment loss based on the fair values of the assets. Such fair values may be based on established markets, independent appraisals and valuations or discounted cash flows. If actual market and operating conditions under which assets are used are less favorable or shorter than those projected by management, resulting in reduced cash flows, additional impairment for assets may be required.

 

Allowance for doubtful accounts and uncollectible contractual prepayments

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. As of March 31, 2017 and 2018, we maintained allowances for doubtful accounts of ¥185 million and ¥185 million, respectively. Management specifically analyzes accounts and loans receivable including historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowances for doubtful accounts. If the financial condition of our customers or debtors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

Deferred tax assets

 

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. As of March 31, 2018, certain subsidiaries not subject to consolidation tax filing had tax operating loss carryforwards, which were composed of ¥707 million in the United States of America and ¥1,180 million in other countries. The tax operating loss carryforwards are available to offset future taxable income and will expire as shown in Note 12 of our consolidated financial statements. The net operating loss carryforwards in the United States of America will expire in the period ending from December 31, 2021 to 2037. With the exception of ¥251 million with no expiration period, the net operating loss carryforwards in other countries will expire in the period ending from December 31, 2018 to 2022. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, if there are changes in circumstances that causes a change in judgment about the realizability of the related deferred tax asset in future years, a decrease of or an increase in valuation allowance against deferred tax assets related to tax operating loss carryforwards and other temporary differences would result in the decrease or increase in deferred tax expense.

 

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Valuation of investments

 

We have investments in securities, and the valuation of such investments and funds requires us to make judgments using information that is generally uncertain at the time, such as assumptions regarding future financial conditions and cash flows. As of March 31, 2018, we had available-for-sale securities of ¥9.3 billion and cost method investments of ¥2.1 billion.

 

We review the fair value of available-for-sale securities on a regular basis to determine if the fair value of any individual security has declined below its cost and if such decline is other-than-temporary. If the decline in value is judged to be other-than-temporary, the cost basis of the investment is written down to fair value. Other-than-temporary declines in value are determined taking into consideration the extent of decline in fair value, the length of time that the decline in fair value below cost has existed, the financial condition and near-term prospects of the issuer and IIJ’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value and events that might accelerate the recognition of impairment. For debt securities for which the declines are deemed to be other-than-temporary and there is no intent to sell and it is not more likely than not that we will be required to sell the securities before the recovery of the amortized cost basis, impairments are separated into the amount related to credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income (loss). For debt securities for which the declines are deemed to be other-than-temporary and there is an intent to sell or it is more likely than not that we will be required to sell the securities before the recovery of the amortized cost basis, impairments in their entirety are recognized in earnings. For equity securities for which the declines are deemed to be other-than-temporary, the resulting realized loss is recognized in earnings in the period in which the decline is deemed to be other-than-temporary.

 

Non-marketable equity securities are carried at cost as the fair value is not readily determinable. When we evaluate whether non-marketable equity securities are impaired or not, we evaluate first whether an event or change in circumstances has occurred in the period that may have significant adverse effect on the fair value of the securities (an impairment indicator). We use such impairment indicators as follows:

 

·A significant deterioration in the earnings performance or business prospects of the investee.
·A significant adverse change in the regulatory, economic, or technological environment of the investee.
·A significant adverse change in the general market condition of either the geographic area or the industry in which the investee operates.
·A recent example of the new issuance of a security, in which the issue price is less than our cost.

 

We estimate the fair value of the non-marketable equity securities when an impairment indicator is present. The fair value is determined as a result of considering various unobservable inputs which are available to us, including expectation of future income of the investees, net asset value of the investees, and material unrealized losses to be considered in the assets and liabilities held by the investees. We recognize impairment of non-marketable equity securities when the fair value is below the carrying amount and the decline in fair value is considered to be other-than-temporary.

 

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Our unrealized loss on investments in marketable equity securities as of March 31, 2018 relates to Japanese companies (three issuers) in the financial, heavy and shipping industries. The fair value of each investment is between 2.8% and 8.6% less than its cost. The duration of the unrealized loss position was primarily less than two months. We evaluated the near-term prospects of the issuer and the analyst reports in relation to the severity and duration of impairment. Based on that evaluation and our ability and intent to hold the investments for a reasonable period of time sufficient for a recovery of fair value, we do not consider the investments to be other-than-temporarily impaired as of March 31, 2018.

 

Impairment of investments in certain marketable equity securities and nonmarketable equity securities, including funds, included in “Other income (expenses)” in our consolidated statements of income, were recognized to reflect the decline in value considered to be other-than-temporary. We recognized an impairment loss of ¥31 million on marketable equity securities for the year ended March 31, 2017, and ¥110 million on nonmarketable equity securities for the year ended March 31, 2018.

 

In addition to investments in securities, we also have investments in equities for which we have significant influence over the investee’s operations and financial positions and are accounted for by the equity method. For other-than-temporary declines in the value of such investments below the carrying amount, the investment is reduced to fair value and an impairment loss is recognized.

 

Pension benefits costs

 

Employee pension benefit costs and obligations are dependent on certain assumptions including discount rate, retirement rate and rate of increase in compensation levels, which are based upon current statistical data, as well as the expected long-term rate of return on plan assets and other factors. Specifically, the discount rate and expected long-term rate of return on assets are two critical assumptions in the determination of periodic pension cost and pension liabilities. Assumptions are evaluated at least annually and when events occur or circumstances change which could have a significant effect on these critical assumptions. In accordance with U.S. GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods. Therefore, actual results generally affect recognized expenses and the recorded obligations for pensions in future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect our pension obligations and future expenses.

 

We used a discount rate of 0.8% for the projected benefit obligation as of March 31, 2018. The discount rate was determined by using the market yield of high-quality fixed income securities reflecting the estimated timing of benefit payments.

 

We used an expected long-term rate of return on pension plan assets of 2.9% as of March 31, 2018. To determine the expected long-term rate of return on pension plan assets, we consider a combination of historical returns and prospective return assumptions derived from the pension trust funds’ managing company. The actual return on the pension plan assets for the year ended March 31, 2018 was 3.6%.

 

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The following table illustrates the sensitivity to a change in the discount rate and the expected return on pension plan assets, while holding all other assumptions constant, for our pension plan as of March 31, 2018.

 

Change in Assumption  Pre-Tax PBO  Pension Expense  Equity (Net of Tax)
   (millions of yen)
50 basis point increase/decrease in discount rate   (535)/581    (36)/65    24/(44) 
50 basis point increase/decrease in expected return on assets       (21)/21    –/(14) 
                

 

Stock Based Compensation

 

The Company measures and records the compensation cost from stock compensation-type stock options based on the fair value. The fair value of the stock option is measured on the date of grant using the Black-Scholes option-pricing model, and amortized over the requisite service period. The compensation cost is mainly included in “General and administrative” expense.

 

 

 

 

 

 

 

 

 

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New Accounting Guidance

 

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” which applies to inventory that is measured using the first-in, first-out method (“FIFO”) or average cost methods. Under the updated guidance, an entity should measure inventory within the scope of the guidance at the lower of cost or net realizable value, which is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory that is measured using the last-in, first-out method (“LIFO”). This ASU is effective for annual and interim periods beginning after December 15, 2016 and should be applied prospectively with early adoption permitted at the beginning of an interim or annual reporting period. The Company adopted this ASU in the first quarter beginning April 1, 2017. The adoption of this ASU did not have a material impact on the Company’s financial position or results of operations.

 

In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes (Topic 740)” which changes how deferred taxes are classified on our balance sheets. This ASU requires all deferred tax assets and liabilities to be classified as non-current. This ASU is effective for annual and interim periods beginning after December 15. 2016, with early adoption permitted. The Company adopted this ASU in the first quarter beginning April 1, 2017 with prospective application. Prior periods were not retrospectively adjusted. Current deferred tax assets and liabilities included in the consolidated balance sheets as of March 31, 2017 are ¥1,298,469 thousand and ¥108,994 thousand, respectively.

 

Accounting Guidance Issued But Not Adopted as of March 31, 2018

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. This guidance also requires an entity to improve disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

ASU 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date,” which was issued in August 2015, revised the effective date for ASU 2014-09 to annual and interim periods beginning after December 15, 2017, with early adoption permitted, but not earlier than the original effective date of annual and interim periods beginning after December 15, 2016, for public entities.

 

In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)," which is an amendment to the ASU 2014-09 on assessing whether an entity is a principal or an agent in a revenue transaction. This amendment addresses implementation issues that were discussed by the Revenue Recognition Transition Resource Group ("TRG") to clarify the principal versus agent assessment and provide for a more consistent application. This new standard has the same effective date and transition requirements as ASU 2014-09. The guidance permits two methods of adoption. The Company currently plans to adopt the standard using the“modified retrospective method.” Under that method, the Company will apply the rules to all contracts existing as of April 1, 2018, recognizing in beginning retained earnings an adjustment for the cumulative effect of the change and providing additional disclosures comparing results to previous accounting standards.

 

The Company expects revenue recognition for its broad portfolio of hardware, software and services to remain largely unchanged. However, the guidance is expected to change the allocation of contract revenues between various services and equipment and the timing of revenue recognition for certain nonrefundable upfront fees.

 

Although the Company expenses sales commissions as incurred, the requirements in the new standard to capitalize certain in-scope sales commissions will not result in a significant change to the Company’s results. However, the requirement to defer such incremental contract acquisition costs and recognize them over the contract period or expected customer life will result in the recognition of a deferred charge on the Company’s balance sheets.

 

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The Company is in the process of finalizing the assessment of the impact of adopting this guidance and expects that the adoption will not have a material impact on the Company’s results of operations and financial position.

 

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," which amends the guidance in U.S. GAAP on the classification and measurement of financial instruments. Changes to the current guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the ASU clarifies guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The new standard is effective for fiscal years and interim periods beginning after December 15, 2017, and upon adoption, an entity should apply the amendments by means of a cumulative effect adjustment to the balance sheet at the beginning of the first reporting period in which the guidance is effective. Early adoption is not permitted, except for the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. The Company anticipates that the adoption of this guidance will increase the volatility of the Company’s other income (expenses), resulting from the remeasurement of the Company’s equity securities.

 

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)," which requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The new guidance requires that a lessee recognizes assets and liabilities for leases with lease terms of more than twelve months and the recognition, presentation and measurement in the financial statements will depend on its classification as a finance or operating lease. In addition, the new guidance will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. Lessor accounting remains largely unchanged from current U.S. GAAP, but does contain some targeted improvements to align with the new revenue recognition guidance issued in 2014. ASU 2016-02 is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018, using a modified retrospective approach, and early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.

 

In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments," which addresses the diversity of practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows with respect to eight specific cash flow issues. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently evaluating the impact of adopting this guidance.

 

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B. Liquidity and Capital Resources

 

Liquidity and Capital Requirements

 

Our principal capital and liquidity needs in recent years have been for capital expenditures for the development, expansion and maintenance of our network infrastructure, lease payments, payment for acquisition of a land, payment of principal and interest on outstanding borrowings, investments in group companies and other working capital. In our opinion, our working capital is sufficient for our present requirements.

 

Capital Expenditures. Most of our capital expenditures relate primarily to the development, expansion and maintenance of our network and service infrastructures, our internal back-office systems, and software development. The investments are mostly for routers, servers, network equipment, container-type data centers, other facilities necessary to offer services on our network and software. The table below shows our capital expenditures, which we define as amounts paid for purchases of property and equipment plus acquisition of assets by entering into capital leases, for the last three fiscal years. Capital expenditures for the fiscal year ended March 31, 2018 were larger than the fiscal years ended March 31, 2016 and 2017, mainly because there were increases in capital expenditures, including capitalized leases for facilities and equipment related to service developments, such as for security and mobile services, and back-office related capital expenditures in the fiscal year ended March 31, 2018 compared to the fiscal years ended March 31, 2016 and 2017.

 

   For the fiscal year ended March 31,
   2016  2017  2018
   (millions of yen)
Capital expenditures, including capitalized leases (*)   ¥14,812   ¥16,531   ¥20,828 

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(*)Further information regarding capital expenditures, including capitalized leases and a reconciliation to the most directly comparable U.S. GAAP financial measure, can be found in Item 3.A., “Selected Financial Data— Reconciliation of the Disclosed Non-GAAP Financial Measures to the Most Directly Comparable GAAP Financial Measures.”

 

 

We expect that our capital expenditures, including capitalized leases, for the fiscal year ending March 31, 2019 related to our network services and systems integration business will be slightly smaller than the amount for the fiscal year ended March 31, 2018. While the capital expenditure for the fiscal year ended March 31, 2018 includes approximately ¥1.2 billion for the acquisition of land for our own new data center as well as approximately ¥3 billion of capital expenditures for cloud service facility in Western Japan for usage from the fiscal year ending March 31, 2019, we plan to start constructing our own data center capital expenditures attributed to which in the fiscal year ending March 31, 2019 are estimated to be approximately ¥3.0 billion. The usual expansion and improvement of our existing network and service development is expended to be essentially unchanged from the fiscal year ended March 31, 2018.

 

We recorded a loss on disposal of property and equipment of ¥66 million, ¥171 million, and ¥112 million for the fiscal years ended March 31, 2016, 2017, and 2018, respectively.

 

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Lease payments. We have operating lease agreements with telecommunications carriers and others for the use of connectivity lines, including local access lines that customers use to connect to our network. The leases for domestic and international backbone connectivity are generally non-cancelable for a minimum one-year lease period. We also lease our office premises, for which refundable lease deposits are capitalized as guarantee deposits, certain office equipment under non-cancelable operating leases, and its network operation centers under non-cancelable operating leases which expire on various dates through the year 2023. Lease expenses related to the backbone lines for the fiscal years ended March 31, 2016, 2017, and 2018 amounted to ¥3.6 billion, ¥3.4 billion and ¥3.3 billion, respectively. Lease expenses for local access lines, which are mainly attributable to Internet connectivity services and WAN services, for the fiscal years ended March 31, 2016, 2017, and 2018 amounted to ¥23.0 billion, ¥24.8 billion and ¥27.6 billion, respectively. Other lease expenses for the fiscal years ended March 31, 2016, 2017, and 2018 amounted to ¥6.9 billion, ¥7.1 billion and ¥7.6 billion, respectively.

 

We conduct our connectivity and other services, including cloud computing services by using data communications and other equipment leased under capital lease arrangements.

 

We sold ATM and data communications equipment procured from a third-party vendor, which amounted to ¥3.6 billion and ¥3.2 billion, to the leasing company for the years ended March 31, 2017 and 2018, respectively, and concurrently entered into capital lease arrangements to lease the equipment back, which resulted in total lease payments of ¥3.6 billion due by March 2022 and ¥3.1 billion due by March 2023, related to the lease contracts entered into during the year ended March 31, 2017 and 2018, respectively.

 

The fair value of the assets upon execution of the capital lease agreements and accumulated depreciation amounted to ¥32.9 billion and ¥19.7 billion as of March 31, 2017 and ¥35.8 billion and ¥21.3 billion as of March 31, 2018, respectively.

 

As of March 31, 2018, the future lease payments under non-cancelable operating leases, including the aforementioned non-cancelable connectivity lease agreements (but excluding dedicated access lines which we charge outright to customers), and capital leases were as follows:

 

      Payments due by period
                   (millions of yen)
   Total contractual
amount
  Less than 1 year  1 to 3 years  3 to 5 years  More than
5 years
Connectivity lines operating leases   ¥849   ¥586   ¥263         
Other operating leases    5,642    3,467    1,689   ¥365   ¥121 
Capital leases    17,056    5,885    8,630    2,541     
Total minimum lease payments (1)   ¥23,547   ¥9,938   ¥10,582   ¥2,906   ¥121 

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(1)See Note 9 “Leases” to our consolidated financial statements included in this annual report on Form 20-F.

 

Payments of principal and interest on outstanding borrowings. We require cash for payments of interest and principal on our outstanding borrowings.

 

Short-term borrowings. As of March 31, 2018, our short-term borrowings consisting of bank overdrafts were ¥9.3 billion. The weighted-average interest rate of our short-term borrowings at March 31, 2018 was 0.411%. Our short-term borrowings as of March 31, 2018 stayed the same as the balance of March 31, 2017. Our unused balance under our bank overdraft agreements, uncommitted, was ¥10.5 billion in short-term borrowings as of March 31, 2018.

 

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Long-term borrowings. As of March 31, 2018, we had ¥15.5 billion of outstanding long-term borrowings, all of which were non-current portions and which consisted of unsecured, fixed interest rate loans from banks of ¥15.5 billion with a weighted-average interest rate of 0.488%.

 

Annual maturities of long-term borrowings outstanding as of March 31, 2018 were as follows:

 

Fiscal year ending March 31  Millions of yen
2020  ¥1,500 
2021   1,830 
2022   5,170 
2023   1,500 
2024   2,000 
2025   3,500 
Total   ¥15,500 

 

Collateral for borrowings. Substantially all of our short-term and long-term borrowings are made under agreements which, as is customary in Japan, provide that under certain conditions the banks may require us to provide collateral or guarantees with respect to the borrowings. We did not provide banks with any collateral for outstanding loans as of March 31, 2017 and 2018. Our primary banking relationships are with Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho Bank, Ltd., Sumitomo Mitsui Banking Corporation and Mitsubishi UFJ Trust and Banking Corporation. The banks are also shareholders and customers of ours.

 

Investments in current and former group companies. In the past, we have made substantial investments in current and former group companies. We may need to provide additional investment in our group companies to enhance or maintain our business synergy with our affiliated companies in the future. See Item 4.B., “Our Group Companies” for information on investment in equity method investees.

 

Working capital needs. Our principal working capital requirements are for payments for our domestic and international backbone, local access lines, mobile bandwidth, network equipment, software and systems integration. We also require working capital requirements for personnel expenses, office rents and other operating expenses.

 

Capital Resources

 

We seek to manage our capital resources and liquidity to provide sufficient funds for current and future financial obligations. We have traditionally met our capital and liquidity requirements through cash flows from operating activities, long-term and short-term borrowings from financial institutions, capital leases and issuances of equity securities. As of March 31, 2018, we had cash and cash equivalents of ¥21.4 billion.

 

Short-term and long-term borrowings. Short-term and long-term borrowings provide us with an important source for maintaining an adequate level of working capital, acquisition of fixed assets and investments. We plan to refinance our short-term borrowings or use the unused balance outstanding of ¥10.5 billion, uncommitted, as of March 31, 2018 under the bank overdraft agreement for maintaining adequate level of working capital, acquisition of fixed assets and investments. See — “Payments of principal and interest on outstanding borrowings” above.

 

Cash flows from operating activities. We generated ¥13.3 billion by operating activities for the year ended March 31, 2018. See — “Cash Flows” below.

 

Capital leases. Capital leases also provide us with an important source of financing. See Note 9 “Leases” to our consolidated financial statements included in this annual report on Form 20-F.

 

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Cash Flows

 

We had cash and cash equivalents of ¥21.4 billion at March 31, 2018 compared to ¥22.0 billion at March 31, 2017.

 

The following table presents information about our cash flows during the fiscal years ended March 31, 2016, 2017 and 2018:

 

   Fiscal year ended March 31,
   2016  2017  2018
   (millions of yen)
Net cash provided by operating activities   ¥12,051   ¥7,368   ¥13,261 
Net cash used in investing activities    (8,377)   (7,376)   (13,037)
Net cash provided by (used in) financing activities    (5,201)   2,492    (748)
Effect of exchange rate changes on cash and cash equivalents    2    (94)   (32)
Net increase (decrease) in cash and cash equivalents    (1,525)   2,390    (556)
Cash and cash equivalents at beginning of the year    21,094    19,569    21,959 
Cash and cash equivalents at end of the year   ¥19,569   ¥21,959   ¥21,403 

 

 

The Fiscal Year Ended March 31, 2018 Compared to the Fiscal Year Ended March 31,2017

 

Net cash provided by operating activities for the fiscal year ended March 31, 2018 was ¥13.3 billion, an increase of ¥5.9 billion from ¥7.4 billion for the previous fiscal year. Net income for the fiscal year ended March 31, 2018 increased by ¥1.9 billion from the previous fiscal year. As adjustments to reconcile net income to net cash provided by operating activities, depreciation and amortization increased by ¥1.5 billion from the previous fiscal year resulting from our recent years’ business investment enhancements, and net gain on sales of other investments for the fiscal year ended March 31, 2018 increased by ¥0.9 billion from the previous fiscal year. The net changes in operating assets and liabilities resulted in a positive impact of ¥3.5 billion compared to the previous fiscal year. The positive impact mainly included the following: a decrease of prepaid expenses of ¥2.0 billion; a decrease in inventories of ¥1.9 billion; an increase in income taxes payable and accrued expenses of ¥1.4 billion in total; an increase in accounts receivable of ¥1.1 billion; and a decrease of deferred income (current and non-current) of ¥1.0 billion, compared to the previous year.

 

Net cash used in investing activities for the fiscal year ended March 31, 2018 was ¥13.0 billion, an increase of ¥5.6 billion from ¥7.4 billion for the previous fiscal year. The change mainly resulted from the following factors: an increase in payment for property and equipment of ¥5.1 billion; an increase of investment in equity method investees of ¥1.9 billion; and an increase of proceeds from available-for-sale securities of ¥1.2 billion, compared to each for the previous fiscal year.

 

Net cash used in financing activities for the fiscal year ended March 31, 2018 was ¥0.7 billion, a decrease of ¥3.2 billion from net cash provided by financing activities of ¥2.5 billion for the previous fiscal year. The change mainly resulted from the following factors: a decrease in net proceeds from borrowings of ¥1.7 billion; an increase in principal payments under capital leases of ¥0.9 billion; and an increase in payments of long-term accounts payable of ¥0.5 billion, compared to each for the previous fiscal year.

 

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The Fiscal Year Ended March 31, 2017 Compared to the Fiscal Year Ended March 31, 2016

 

Net cash provided by operating activities for the fiscal year ended March 31, 2017 was ¥7.4 billion, a decrease of ¥4.7 billion from ¥12.1 billion for the previous fiscal year. Net income for the fiscal year ended March 31, 2017 decreased by ¥0.9 billion from the previous fiscal year, and depreciation and amortization increased by ¥1.0 billion from the previous fiscal year, which is due to our recent years’ business investment enhancements. However, the net changes in operating assets and liabilities resulted in a negative impact of ¥4.6 billion compared to the previous fiscal year. The negative impact mainly included the following: an increase in accounts receivable of ¥2.2 billion; an increase in prepaid expenses of ¥1.8 billion related to the payment for systems integration projects and the payment of licensing fees along with revenue growth and service development, compared to the previous year.

 

Net cash used in investing activities for the fiscal year ended March 31, 2017 was ¥7.4 billion, a decrease of ¥1.0 billion from ¥8.4 billion for the previous fiscal year. The decrease mainly reflects the following factors: an increase in proceeds from sales of property and equipment of ¥0.5 billion; a decrease in payments for purchase of property and equipment of ¥0.3 billion; and a decrease in payments of guarantee deposits of ¥0.3 billion due to expansion of our office space in the previous year.

 

Net cash provided by financing activities for the fiscal year ended March 31, 2017 was ¥2.5 billion, an increase of ¥7.7 billion from net cash used in financing activities of ¥5.2 billion for the previous fiscal year. The change mainly resulted from an increase in proceeds from long-term borrowings of ¥8.5 billion, and an increase in proceeds from resulting from long-term accounts payable of ¥1.5 billion, offset by an increase in payments for purchase of treasury stock of ¥1.5 billion and an increase in principal payments under capital leases of ¥0.6 billion.

 

 

Contingencies

 

We did not have any material contingent liabilities as of March 31, 2018.

 

 

C. Research and Development, Patents and Licenses, etc.

 

See the information in Item 4.B., “Business Overview — Research and Development Strategy.”

 

 

D. Trend Information

 

Factors Affecting Our Future Financial Results

 

We expect that the following are the most significant factors likely to affect our financial results and those of our consolidated subsidiaries. You should also consult Item 3.D. “Risk Factors” and the other portions of this annual report on Form 20-F for additional factors affecting our financial results.

 

Revenues

 

We have two business segments: a network services and systems integration business segment and an ATM operation business segment. The network services and systems integration business segment is comprised of Internet connectivity services, WAN services, outsourcing services, systems integration and equipment sales.

 

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Network services revenues

 

Network services revenues consist of our revenues from Internet connectivity services for enterprise, Internet connectivity services for consumers, WAN services and outsourcing services. Our network services revenues accounted for 56.4%, 58.9% and 61.4% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018 respectively. As our Internet connectivity services for enterprise and WAN services customers are more likely to use our outsourcing services or systems integration along with their needs for comprehensive network expands, Internet connectivity services for enterprise and WAN services are important for the growth of our outsourcing services or systems integration business.

 

Internet connectivity services for enterprise

 

Our revenues from Internet connectivity services for enterprise accounted for 12.5%, 14.3% and 15.9% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018 respectively. Revenues from Internet connectivity services for enterprise basically depend on the size of our customer base, the average contracted bandwidth and the unit price of our services. The market for Internet connectivity services for enterprise generally follows the trends written below:

 

Increase in contracted bandwidth. Total contracted bandwidth for Internet connectivity services for enterprise customers increased to 3,117.7Gbps as of March 31, 2018 from 2,773.3Gbps for the previous fiscal year end. The number of IP service contracts for the bandwidth over 100 Mbps increased to 1,126 for the fiscal year ended March 31, 2018 from 1,028 for the previous fiscal year end. This increase is mainly due to an increase in customers' demand for broader bandwidth for their Internet connectivity. The total contracted bandwidth for Internet connectivity services for enterprise is calculated by adding the contracted bandwidth for each of the following services: IP services, IIJ data center connectivity services and broadband services. Although we do not expect revenue per contract to grow largely in the fiscal year ending March 31, 2019 due to continuing competition, we believe that customer demand for broader bandwidth should continue as the use of broadband by corporate customers expands. We expect Internet traffic generated by CDN services to increase in the fiscal year ending March 31, 2019 as our equity method investee, JOCDN starts to provide CDN services to a large content provider and continue to provide CDN services to major Japanese broadcasting companies. We also try to acquire new customers and increase the bandwidth of existing customers as well as maintain the quality of our services to differentiate them from those of our competitors.

 

Increasing demand for mobile data communications services. Demand for our mobile data communications service for enterprise called IIJ Mobile Service, which is provided under an MVNO scheme, has increased since its introduction in January 2008. IIJ Mobile Service’s subscriptions increased to 1,339,586 as of March 31, 2018 from 857,903 for the previous fiscal year end. The increase is mainly due to subscription accumulation through our MVNE clients as well as M2M and IoT type projects. We target corporate customers who are security conscious and looking for data communication services with strong security features such as VPN access and private access. Demands related to M2M connectivity and IoT are expected to increase. To capture the demand, we have developed related service line-ups.

 

Increasing demands for MVNE transaction. We started “IIJ Mobile MVNO Platform Services” under which we operate as MVNE by providing our MVNO service platform to corporate customers so that they can incorporate MVNO services in their businesses. The related subscriptions, which are included in IIJ Mobile Services subscriptions, increased to approximately 825 thousand as of March 31, 2018 from approximately 582 thousand for the previous fiscal year end. MVNE revenue accounted for 28.5% and 38.9% of our Internet connectivity services for enterprise for the fiscal years ended March 31, 2017 and 2018, respectively. The number of MVNE clients as of March 31, 2018 was 137, which includes 85 cable TV operators nationwide, an increase of 13 clients from the previous fiscal year end. Most of the clients are cable television operators which sell our inexpensive SIM cards together with their services such as ISP services to individual households all over Japan.

 

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Continuous demand for broadband services. Demand for broadband services such as IIJ FiberAccess/F, IIJ DSL/F and IIJ DSL/A is steady as the services are used to connect corporate branches and remote offices. For access lines, the services use optical lines with a maximum speed of 1Gbps. The number of contracts for our broadband services was 72,630 as of March 31, 2018 compared to 72,605 for the previous fiscal year end. We expect demand for broadband services should contribute to an increase in our outsourcing services and systems integration revenues as usage and implementation of these connectivity services increase the demand for outsourcing services such as security services and network systems integration.

 

Although we do not expect prices of Internet connectivity services for enterprise to increase in the fiscal year ending March 31, 2018, we anticipate that corporate customers’ demand for broader bandwidth and mobile data communications services should contribute to our revenue growth as the use of broadband and mobile data communications by corporate customers expands, especially our MVNO-platform services which enables companies to offer MVNO services. We also plan to focus on acquiring new customers as well as increasing the bandwidth of existing customers by maintaining the quality of our services to differentiate them from those of our competitors.

 

Internet Connectivity services for consumers

 

Our revenues from Internet connectivity services for consumers accounted for 10.8%, 13.8% and 14.1% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. Revenues from Internet connectivity services for consumers mainly depend on the size of our customer base and pricing. The size of our customer base depends primarily on the popularity of services under our brand name, our sales partners as well as the attractiveness of our service offerings which is measured primarily by pricing, the quality of service, and our ability to attract new customers. Internet connectivity services for consumers’ subscriptions decreased to 1,363,531 as of March 31, 2018 from 1,409,259 for the previous fiscal year end. The decrease is mainly because we sold all shares of hi-ho, our former consolidated subsidiary whose main business was fixed line Internet connectivity services for consumers, on December 31, 2017. Our mobile services for consumers contributed to the increase in the number of subscriptions.

 

Increasing demands for mobile services for consumers. From February 2012, we started to provide mobile services to consumers by using our MVNO service infrastructure, which was formerly provided only to corporate customers. The revenue from this service increased to ¥20.7 billion for the fiscal year ended March 31, 2018 from ¥17.1 billion for the previous fiscal year. The subscriptions for this service increased to 1,005 thousand as of March 31, 2018 from 951 thousand for the previous fiscal year end. We offer inexpensive LTE SIM cards which are inserted to individual smart phones and portable devices. We started to offer voice call function in April 2014 with an expectation that it would generate more subscriptions. From October 2014, we started to provide prepaid SIM cards to foreign tourists visiting Japan. These SIM cards are sold at convenience stores, major electronics retail stores, department stores, and airports. Since the inexpensive LTE SIM card market is relatively new in Japan, we are uncertain about the extent of how much the market will expand and the timeframe of that expansion. According to the report published by the MIC, 7.1% of the total Japanese mobile subscriptions were using inexpensive SIM card services as of December 31, 2017. We anticipate our mobile-related revenue to increase largely for a while along with the market expansion. Our revenue can fluctuate as consumer market trends tend to change rapidly.

 

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General trends of Internet connectivity services for consumers. We offer our Internet connectivity services for consumers not only directly, but also through sales partners including Excite Japan Co., Ltd. and so on. These service providers sell Internet connectivity services to consumers under their own name but they are using our Internet network infrastructure to provide such services. From March 2015, we started to offer “IIJmio Hikari,” which is a bundled service packaging optical fiber broadband service with ISP services. IIJmio Hikari is replacing our conventional Internet connectivity services for consumers. We also offer our mobile services for consumers as an optional service for IIJmio Hikari with some monthly charge discount.

 

WAN services

 

Our revenues from WAN services accounted for 17.9%, 16.8% and 16.6% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. Demand for WAN services is relatively stable with continuous use by certain large clients who use the services to connect corporate mission critical systems. Such transaction volume tends to be large and unit prices tend to be higher than our other network services. Therefore, revenues can fluctuate significantly with the absence or addition of such large orders. Accordingly, future revenue is difficult to forecast.

 

Outsourcing Services

 

Our revenues from outsourcing services accounted for 15.1%, 14.0% and 14.8% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. Outsourcing services consist of network-related services, server-related services, security-related services, data center-related facility services and operation and management services, and some services of our cloud computing services. For the fiscal year ended March 31, 2018, outsourcing services revenues increased to ¥26.1 billion from ¥22.2 billion for the fiscal year ended March 31, 2017 mainly because security-related service revenue grew by 26.2% from the previous fiscal year. The increase in demand for security services is due to an increasing number of Japanese enterprises becoming security conscious about their IT systems triggered by the number of recent security incidents, such as targeted and DDoS attacks on Japanese business enterprises and public sector entities. The demands for DDoS protection services, firewall services with a sandbox function and virtual desktop services in particular are increasing. We expect that corporate customers will continue to increase their use of the Internet as a business tool and will increasingly rely on an expanding range of outsourcing services to enhance productivity, reduce costs and improve service reliability. We believe our public cloud computing services will contribute to the revenue growth for the middle-to long-term although we also expect the current weak growth pace to continue for a while.

 

Systems integration revenues, including related equipment sales revenues

 

Our systems integration revenue consists of systems construction and systems operation and maintenance.

 

Systems construction, which is a one-time revenue, accounted for 15.0%, 14.3% and 12.8% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. Systems construction revenues, including related equipment sales revenues for the fiscal year ended March 31, 2018 was essentially unchanged from the previous fiscal year because system engineers resources were concentrated on a particularly large project, which led to a weak sales activity and order accumulation for the latter half of the fiscal year, and in the fiscal year ended March 31, 2017.

 

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Systems operation and maintenance, which is a monthly recurring revenue, accounted for 23.5%, 22.3% and 21.5% for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. Revenue for our private-type cloud computing services is included in the systems operation and maintenance revenues. Systems operation and maintenance revenues for the fiscal year ended March 31, 2018 increased by 7.9% compared to the previous fiscal year mainly because many of the accumulated systems construction projects have been shifted to the operation. Excluding the revenue growth from our private-type cloud computing services, systems operation and maintenance revenues increased by 4.8% compared to the previous fiscal year. For the fiscal year ended March 31, 2018, we recognized 86.4% of our cloud computing service revenues in systems operation and maintenance and 13.6% was recognized in outsourcing services.

 

For the fiscal year ended March 31, 2018, our cloud computing services revenues were ¥17.9 billion, an increase of approximately ¥2.3 billion from the previous fiscal year, and for the fiscal year ending March 31, 2019, we target approximately ¥20.0 billion in revenue. In November 2015, we launched “IIJ GIO Infrastructure P2,” targeting Japanese enterprises that seek to migrate their core business platform systems to the cloud by offering a reliable public cloud computing infrastructure with increased processing performance, as well as a private cloud computing infrastructure.

 

For the fiscal year ending March 31, 2019, we should continue to see a strong appetite for IT investments along with favorable market situations. As systems integration revenues can fluctuate significantly in accordance with the absence or addition of large orders, they are accordingly difficult to forecast. For systems operation and maintenance revenues, we anticipate that we can increase them from the increase in systems construction revenue which should migrate to systems operation and maintenance as well as accumulation of our cloud computing services orders. In the middle-to long-term, we anticipate that Japanese companies should increase IT-related investments for their network systems when the general economic situation and the business results of the Japanese companies recover. While we anticipate the cloud computing market to continue to expand in Japan, our cloud computing services might replace hardware revenues, which are a part of systems construction revenues, which could result in a decrease in systems construction revenues in the middle-to long-term.

 

Equipment sales revenues

 

Our equipment sales revenues consist primarily of sales of networking and other related equipment as requested by our customers, other than that provided in connection with our systems integration services. We are seeing an increase in portable devices and smartphone orders along with increasing needs for mobile services for both enterprise and consumer. Our equipment sales revenues accounted for 2.3%, 1.9% and 2.0% of our total revenues for the fiscal years ended March 31, 2016, 2017, and 2018, respectively.

 

ATM Operation Business revenues

 

The ATM operation business revenues consist primarily of commission fees for each withdrawal transaction with the use of ATMs. ATM commission fees collected from each withdrawal are aggregated every month and recognized as ATM operation business revenues. The number of daily withdrawing transactions for the fiscal year ended March 31, 2018 stayed almost the same as the previous fiscal year. Our ATM operation business revenues and its percentage of our total revenue was ¥3.9 billion, ¥4.1 billion and ¥4.0 billion and 2.8%, 2.6% and 2.3% for the fiscal years ended March 31, 2016, 2017, and 2018, respectively. The number of placed ATMs as of March 31, 2018 was 1,096, an increase of 30 ATMs from the previous fiscal year end. We may see a continuous decrease in the number of daily transaction due, for example, to a decrease in the number of pachinko players as the Japanese population declines or to a decrease in consumer demand prompted by an increase in the Japanese consumption tax rate.

 

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Additional factors affecting revenues

 

A number of other factors may affect demand for our services and in turn our revenues, including overall increases in the business usage of Internet and network solutions and our range of service offerings.

 

Increase in business usage: Our revenues will be affected by the extent and speed with which businesses in Japan utilize Internet and network solutions to their full potential, including, for example, electronic transactions between businesses and wider ranges of devices accessing the Internet. Such services require high-quality and high-capacity connectivity services for both businesses and individuals. Such services also require total network solutions including various Internet connectivity services, systems integration and other outsourcing services which we believe we are well positioned to provide. The degree of business usage will also depend upon a variety of factors including:

 

·technological advances, reliability of security systems and users’ familiarity with and confidence in new technologies,
·the rate at which Japanese companies in certain industries significantly increases their Internet usage, and
·corporate budgets for information technologies, including Internet-related items.

 

Range of service offerings: To increase our revenues from business users, we provide a wide variety of services and continue to introduce new services. For Internet connectivity services, we have introduced LTE services as an addition to our mobile services. For cloud computing services, in November 2015, we launched a new service platform “IIJ GIO Infrastructure P2” which offers reliable public cloud infrastructure with increased processing performance and private cloud infrastructure. For network services for enterprise, from July 2015, we started to offer “IIJ Omnibus Service” which incorporates SDN and NFV technologies to offer several network elements automatically. We anticipate these steps will allow us to sell a greater variety of services to our high-end corporate users and to meet Japanese enterprises’ IT needs. However, we will still be strongly dependent on the Japanese economy and on Japanese companies and their information technology budgets. We expect Internet usage to continue to grow in Japan and that businesses will continue to diversify their uses of the Internet. Our ability to develop and offer a broad range of services to meet our customers’ demands will significantly influence our future revenues.

 

Synergies between network services and systems integration: Most of our systems integration customers come from our Internet connectivity services customers, and we expect these relationships to continue. As part of our systems integration business, we offer solution services for corporate information network systems, consultation, project planning, system design and systems/operation outsourcing or Internet VPN solution services which combine the FLET’S Internet connectivity or mobile connectivity services with SEIL, adopted by customers who have multiple locations, such as branches, offices and factories. Cloud computing services and security-related services are also provided together with connectivity and systems integration services. The ability to introduce a wide range of services, including solutions necessary to build corporate information network systems, like disaster recovery services and Internet VPN, Voice over IP (“VoIP”), SEIL, private mobile access solutions, SEIL/SMF and wireless LAN service, is an important competitive factor.

 

Synergies between the Group companies: The Group works together as a team to provide network solutions to our customers, mainly corporate and governmental organizations.

 

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Overseas business: The Group is enhancing its overseas operations mainly to fulfill the broad range of IT network related needs of our Japanese customers that are headed abroad to expand their overseas business. As a group, we aim to expand our cloud computing related services and overseas business by leveraging our customer base and our engineering skills. However, our overseas business portion is still relatively small. For the fiscal year ended March 31, 2018, our overseas revenue, which is mainly recognized in systems integration revenue, was approximately ¥6.1 billion, compared to approximately ¥6.4 billion of the previous year, and we recorded positive operating income, compared to an operating loss of approximately ¥0.2 billion of the previous year. For the fiscal year ending March 31, 2019, we target overseas business revenue of approximately ¥7.0 billion and operating income of approximately ¥0.1 billion.

 

Costs and expenses

 

Costs and expenses include cost of network services revenues, cost of systems integration revenues, cost of equipment sales revenues, cost of ATM operation business revenues, sales and marketing expenses, general and administrative expenses and research and development expenses.

 

Cost of network services revenues

 

Our primary cost of network services revenues is the leasing fees that we pay for the leased lines which comprise our network and for the dedicated local access lines that our subscribers use to connect with our network. Other primary components of our costs are leasing fees that we pay for MVNO service infrastructure, depreciation and amortization of capital leases for network equipment, personnel and other costs for technical and customer support staff and network operation center related costs. Most of our network equipment is leased rather than purchased to take advantage of the financing provided by a capital lease arrangement.

 

We have made continuous investments in past years to develop and expand our network along with our business expansion. For the fiscal year ended March 31, 2018, our leased lines and other connectivity costs were ¥31.4 billion or 29.0% of our total network services revenues. For the previous fiscal year, these costs were ¥28.5 billion or 30.7% of total our network services revenues.

 

·Backbone cost: Backbone cost for the fiscal year ended March 31, 2018 was ¥3.3 billion, a slight decrease compared to the fiscal year ended March 31, 2017. We do not expect our backbone costs to significantly increase.

 

·Dedicated local access line costs: We collect dedicated local access line fees from subscribers and pay these fees over to the carriers. Dedicated local access line costs for the fiscal year ended March 31, 2018 were ¥27.5 billion compared to ¥24.6 billion for the fiscal year ended March 31, 2017. Other connectivity costs were ¥0.6 billion for the fiscal year ended March 31, 2018, compared to ¥0.5 billion for the previous fiscal year.

 

Depreciation and amortization cost related to network service revenues increased by ¥0.9 billion to ¥5.9 billion for the fiscal year ended March 31, 2018 from ¥5.0 billion for the fiscal year ended March 31, 2017 along with the increase in capital expenditures related to network service revenues. Along with the increase in capital expenditures, we expect depreciation and amortization to increase.

 

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The cost of mobile services revenues, most of which is recognized as outsourcing-related costs of network services revenues, has been increasing along with the rapid increase in consumer mobile and MVNE subscriptions. We have been purchasing NTT Docomo’s mobile infrastructure to provide our mobile services and we have been increasing our purchasing volume in order to offer reliable connectivity to our customers, both enterprise and consumer. For the fiscal year ended March 31, 2018, outsourcing-related costs increased by ¥6.2 billion from the previous year mainly due to an increase in purchasing volume of mobile-related service facility including mobile bandwidth from NTT Docomo along with an increase in consumer mobile service subscriptions. NTT Docomo charges a “wholesale telecommunications service charge” to all MVNOs purchasing volume from NTT Docomo, including us. NTT Docomo calculates the unit price in accordance with the “Telecommunications Business Law” and the “Guidelines related to Operation of the Institution for Category II Designated Telecommunications Facilities,” which are both administrated by the MIC. The unit price is a flat-rate per Mbps and is calculated based mainly on NTT Docomo’s actual cost related to its mobile data communication business. In recent years, such unit price decreased by 41.2%, 56.6%, 23.5%, 16.9%, 14.1% and 18.2% annually in the fiscal years 2011, 2012, 2013, 2014, 2015 and 2016 respectively. The corresponding unit price per 10Mbps is approximately ¥2.8 million, approximately ¥1.2 million, approximately ¥0.9 million, approximately ¥0.8 million, approximately ¥0.7 million, and approximately ¥0.6 million in the fiscal years 2011, 2012, 2013, 2014, 2015 and 2016 respectively. As for the unit price fixed in March 2018, the rate of decrease was relative large which is mainly due to NTT Docomo’s cost and we assume that this may have been due to their change in depreciation method from declining-balance to straight line. Amounts we pay to NTT Docomo for our mobile services have been increasing along with the purchasing volume increase, while the unit price itself continues to decrease.

 

Costs of systems integration revenues and equipment sales

 

The cost of our systems integration revenues and equipment sales consists of purchasing costs, personnel-related costs, outsourcing-related costs, network operation-related costs and other costs. Purchasing costs increase or decrease in tandem with systems construction revenues and equipment sales revenues. Personnel and outsourcing-related costs are mainly costs of engineering staff. Network operation-related costs are costs such as depreciation and amortization of capital leases for system-related equipment, including facilities and equipment mainly for cloud computing services. The main determinant of whether our gross margin will increase or decrease depends on whether we can secure profit for each systems integration project, whether we are able to adequately control the man-hour for each systems integration project as initially estimated, maintain the productivity of outsourcing personnel, especially system engineers, maintain the profitability of our cloud computing services and whether we are able to achieve enough revenue that covers our total costs. For the fiscal year ending March 31, 2019, as we do not expect systems construction revenue to significantly increase, we expect the costs of systems integration revenues to also not increase significantly. We should continue to focus on controlling personnel and outsourcing costs adequately as well as carefully consider the timing of increasing facilities and equipment for our cloud computing services as they require a large upfront investment.

 

Costs of ATM Operation Business

 

The cost of our ATM operation business consists primarily of per-ATM cost such as ATM depreciation, maintenance and network cost, systems development costs, and outsourcing related costs. For the fiscal year ended March 31, 2018, the ATM operation business recorded approximately ¥2.4 billion in costs.

 

Sales and marketing

 

Our sales and marketing expenses consist primarily of personnel expenses related to sales and marketing activities, general advertising expenses and sales commission. Our sales and marketing expenses should increase to the extent that we expand our operations, hire additional employees and increase our sales and marketing activities such as promotion of our cloud services and mobile services for consumers. As for the fiscal year ending March 31, 2019, we expect sales commission expenses for our sales channels should increase but not as much as the fiscal year ended March 31, 2018 along with revenue outlook for our mobile services for consumers. Sales and marketing expenses were ¥12.7 billion for the fiscal year ended March 31, 2018, compared to ¥11.4 billion for the previous fiscal year. For the fiscal year ending March 31, 2019, we do not expect any major changes for both sales and marketing expenses and general advertising expenses.

 

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General and administrative

 

Our general and administrative expenses primarily include expenses associated with our management, accounting, finance and administrative functions, including personnel expenses. Our general and administrative expenses will increase to the extent that we grow our business and hire new employees. We expect general and administrative expenses to increase in the fiscal year ending March 31, 2019 in accordance with our business growth.

 

Research and development

 

Our research and development expenses include primarily expenses associated with personnel expenses related to research and development activities. Our research and development expenses will increase to the extent that we expand our research and development activities. We expect the research and development expenses to slightly increase for the fiscal year ending March 31, 2019.

 

Other income (expenses)

 

Our other income and expenses include interest income and expenses and other primary items such as foreign exchange gains or losses, net gain on other investments and impairment losses on other investments.

 

Interest expense: Most of our interest expense is from capital leases and bank borrowings. Interest income and interest expenses are also affected by the fluctuation of market interest rates and our total amount of outstanding borrowings. As we had the proceeds of long term bank borrowing of ¥7.0 billion in the fiscal year ended March 31, 2018, we expect the interest expense to increase. If we increase capital leases or borrowings in order to finance further development of our backbone, data centers and for other investments, interest expenses will increase.

 

Foreign exchange gain or loss: Attributed to the stronger Japanese yen against foreign currencies including the U.S. dollar and the British pound, we recognized foreign currency loss of ¥16 million for the fiscal year ended March 31, 2018. The assets held by us which are exposed to foreign currency exchange risk are mainly the U.S. dollar and British pound denominated bank deposits.

 

Net gain or loss on other investments: We hold other investments comprised of available-for-sale securities, nonmarketable equity securities and funds. Gain or loss on other investments are mostly raised from available-for-sale securities and fund investments. Fluctuations in the fair value of other investments may affect our financial results upon the sale. For the fiscal year ended March 31, 2018, we had net gain on sales of other investments of ¥1,068 million. Unrealized gains on holding available-for-sale equity securities of ¥7.5 billion were measured based on closing prices of March 30, 2018, the final day of trading in the fiscal year ended March 31, 2018. Due to the revision to U.S. GAAP relating to available-for-sale equity securities, the net of tax amount of unrealized gains of ¥5.1 billion were reclassified to retained earnings at the beginning of the fiscal year ending March 31, 2019. Changes in unrealized gains or losses due to fluctuations of stock prices will be recognized in other income (expenses) in every quarter, beginning with our consolidated statements of income from the first quarter of the fiscal year ending March 31, 2019. Therefore, fluctuations of stock prices may impact our consolidated statements of income.

 

Impairment of other investments: We hold other investments comprised of available-for-sale securities, nonmarketable equity securities and funds. If the fair value of other investments becomes lower than its costs and such decline in fair value is evaluated as other-than-temporary, we will be required to recognize an impairment loss on investment. For the fiscal year ended March 31, 2018, we had impairment loss of other investments of ¥110 million.

 

E.Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements as is defined for purposes of Item 5.E. of Form 20-F.

 

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F.Tabular Disclosure of Contractual Obligations

 

The following table shows our material contractual payment obligations under our agreements as of March 31, 2018:

 

   Payments due by period (millions of yen)
Contractual Obligations  Total  less than 1 year  1 to 3 years  3 to 5 years  more than 5 years
Long-term debt obligations   ¥15,500       ¥8,500   ¥3,500   ¥3,500 
Capital lease obligations    17,056   ¥5,885    8,630    2,541     
Operating lease obligations    6,490    4,052    1,952    365    121 
Total (1) (2)   ¥39,046   ¥9,937   ¥19,082   ¥6,406   ¥3,621 

_____

(1)The table above does not include short term borrowings. For short term borrowings, see Item 5.B “Liquidity and Capital Resource” and Note 11 “Borrowings” to our consolidated financial statements included in this annual report on Form 20-F.
(2)The table above does not include obligations for interest payments on debt as such payments are not material. For interest payments regarding capital lease, see Note 9 “Leases” to our consolidated financial statements included in this annual report on Form 20-F.

 

G.Safe Harbor

 

This annual report contains forward-looking statements about us and our industry that are based on our current expectations, assumptions, estimates and projections. These forward-looking statements are subject to various risks and uncertainties. These statements discuss future expectations, identify strategies, discuss market trends, contain projections of results of our operations and our financial condition, and state other forward-looking information. Known and unknown risks, uncertainties and other factors could cause our actual results to differ materially from those contained in or suggested by any forward-looking statement. We cannot provide any assurance that our expectations, projections, anticipated estimates or other information expressed in these forward-looking statements will turn out to be correct. We do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Important risks and factors that could cause our actual results to differ materially from our forward-looking statements are generally provided in Item 3.D. “Risk Factors” and elsewhere in this annual report on Form 20-F and include, without limitation:

 

·that we may not be able to achieve or sustain profitability in the near future, that we may not be able to compete effectively against competitors which have greater financial, marketing and other resources, and that our investments in our subsidiaries, affiliated companies, new business and service developments may not produce the returns that we expect or may adversely affect our results of operations and financial condition.

 

 

 

 

 

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Item 6. Directors, Senior Management and Employees

 

A.Directors and Senior Management

 

As of June 29, 2018, the Company's Board of Directors consists of thirteen directors, including five outside directors. The Company's Board of Company Auditors consists of four company auditors, three of whom are outside company auditors, including an attorney from a Japanese law firm and a certified public accountant. Further, the Company has an internal auditing office consisting of three members.

 

Additionally, we introduced an executive officer system in 2010 with the aim of further enhancing our corporate governance by separating its decision making, supervisory function and business execution function.

 

There is no family relationship between any director or executive officer and any other director or executive officer. The following table provides information about our directors and company auditors as of June 29, 2018.

 

Name  Position  Date of birth  Current term
expires
  Initial
appointment date
  Number of
Shares
Owned (1)
  Percentage of
Shares Owned (1)
Koichi Suzuki  Chairman,
Chief Executive Officer and Representative Director
   Sep. 3, 1946   June 2019  Dec. 1992   1,826,676 (2)   3.91%(2)
Eijiro Katsu  President,
Chief Operating Officer and Representative Director
   June 19, 1950   June 2019  June 2013   26,176    0.06%
Hideshi Hojo  Senior Managing Director   Dec. 22, 1957   June 2019  June 2000   26,037    0.06%
Takeshi Kikuchi  Senior Managing Director   Apr. 27, 1959   June 2020  June 2010   59,841    0.13%
Akihisa Watai  Managing Director,
Chief Financial Officer and Chief Accounting Officer
   Sep. 30, 1965   June 2020  June 2004   12,868    0.03%
Tadashi Kawashima  Managing Director   Feb. 27,1963   June 2019  June 2015   1,537    0.00%
Junichi Shimagami  Director   Apr. 17,1967   June 2019  June 2015 (3)  9,368    0.02%
Yasurou Tanahashi  Director   Jan. 4, 1941   June 2020  June 2004   0     
Shingo Oda  Director   Nov. 8, 1944   June 2020  June 2008   0     
Toshinori Iwasawa  Director   May 8, 1962   June 2019  June 2013   1,241    0.00%
Tadashi Okamura  Director   July 26,1938   June 2019  June 2015   0     
Shinobu Umino  Director   Aug. 4, 1952   June 2020  June 2018   0     
Takashi Tsukamoto  Director   Aug. 2, 1950   June 2019  June 2017   0     
Kazuhiro Ohira  Company Auditor   Dec. 26, 1957   June 2020  June 2010   0     
Masako Tanaka  Company Auditor   Apr. 4, 1958   June 2022  June 2018   173,236    0.02%
Yasuhiro Akatsuka  Company Auditor   Feb. 10, 1947   June 2020  June 2016   0     
Takashi Michishita  Company Auditor   Feb. 1, 1969   June 2020  June 2016   0     

_________

(1)The number of IIJ shares owned as of June 29, 2018.
(2)Mr. Koichi Suzuki jointly owns IIJ stocks through his wholly owned private company called KS Holdings which holds 1.73% of the total company outstanding shares as of March 31, 2018.
(3)Mr. Junichi Shimagami was a director of the company from June 2007 to March 2010.
* In March 2018, one of our outside directors, Hiroki Watanabe, resigned for personal reasons.

 

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Koichi Suzuki is one of the founders of IIJ and has approximately 30 years of experience in the computer and communications industries. He was appointed as president, representative director and Chief Executive Officer in April 1994. In June 2013, he became our chairman, representative director, and Chief Executive Officer. In addition, Mr. Suzuki is chairman of IIJ-America and JOCDN , and president of IIJ-EG and Multifeed. He also serves as a director of IIJ-Global, Trinity, DeCurret and IIJ-II. From December 1992 to April 1994, Mr. Suzuki was a director of IIJ. Prior to joining us, Mr. Suzuki was employed at Japan Management Association where he served as a general manager.

 

Eijiro Katsu joined IIJ in November 2012 and was appointed as president, representative director and Chief Operating Officer in June 2013. He also serves as a director of DeCurret. Prior to joining IIJ, he worked at the Ministry of Finance in Japan and serviced as Vice Minister from July 2010 to August 2012.

 

Hideshi Hojo joined IIJ in 1996. He has served as a senior managing director of IIJ since June 2006. Mr. Hojo is also a director of i-revo and NCJ. Since April 2014, he has been in charge of the Asian business development. From February 1998 to June 2000, Mr. Hojo acted as general manager of the Sales Division, from June 2000 to June 2002 as a director and from June 2002 to 2006 as a managing director. Prior to joining us, Mr. Hojo had 16 years of experience in the field of sales working for the Itochu Group.

 

Takeshi Kikuchi was appointed as a senior managing director of IIJ in June 2010 and is serving as a division director in charge of a Business Unit (Sales Divisions). Mr. Kikuchi joined Itochu Corporation in April 1983 and was temporarily seconded to IIJ from April 1996. In July 1999, Mr. Kikuchi joined IIJ-Tech and was president of IIJ-Tech from October 2005 to March 2010.

 

Akihisa Watai was appointed as a managing director of IIJ in June 2010 and is serving as division director of the Finance Division. Mr. Watai has served as chief financial officer and chief accounting officer since June 2004. In addition, Mr. Watai is a director of NCJ, Trinity, Trust Networks, RYUKOSHA and DeCurret, and a company auditor of i-revo, IIJ-Global and IIJ-II. From June 2004 to March 2010, Mr. Watai served as director of IIJ. Mr. Watai joined The Sumitomo Bank, Limited (currently Sumitomo Mitsui Banking Corporation) in April 1989 and was temporarily seconded to IIJ from August 1996. In February 2000, Mr. Watai joined IIJ permanently and has been general manager of the Finance Division from April 2004 to March 2016.

 

Tadashi Kawashima has served as a managing director of IIJ since June 2015 and is serving as deputy executive division director in charge of Business Unit (Sales Divisions). Mr. Kawashima joined NTT DATA Corporation in July 1988 and served as Senior Specialist of Public and Financial IT Service Company. Mr. Kawashima served as President and Representative Director of NTT Data Tokai Corporation from June 2013 to June 2015.

 

Junichi Shimagami has served as a director and Chief Technology Officer of IIJ since June 2015 and is serving as division director in charge of Technology Unit (Technology Divisions) since April 2016. Mr. Shimagami is also a director of Multifeed. Mr. Shimagami served as a director of the Company from June 2007 to March 2010. Mr. Shimagami joined us in 1996. Prior to joining us, Mr. Shimagami worked at Nomura Research Institute, Ltd., which he joined in April 1990.

 

Yasurou Tanahashi has served as an outside director of IIJ since June 2004. Mr. Tanahashi served as an advisor of NS Solutions Corporation, an affiliated company of Nippon Steel Corporation from June 2007 to June 2009. Mr. Tanahashi had been president and representative director of NS Solutions Corporation since April 2000 and had been chairman of NS Solutions Corporation since April 2003.

 

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Shingo Oda has served as an outside director of IIJ since June 2008. From May 2005 to November 2007, Mr. Oda was president and representative director of Hewlett-Packard Japan, Ltd. From February 2002 to May 2005, Mr. Oda was vice president and representative director of Hewlett-Packard Japan, Ltd.

 

Toshinori Iwasawa was appointed as a director of IIJ in June 2013. Mr. Iwasawa has been president and representative director of IIJ-Global since September 2010. Prior to joining IIJ-Global, he was a representative director at AT&T Japan LLC. and worked for IBM Japan from 1985.

 

Tadashi Okamura has served as an outside director of IIJ since June 2015. Mr. Okamura joined Toshiba Corporation in April 1962, and served as Chief Executive Officer of Toshiba Corporation from June 2000 to June 2005 and as Chairman of Toshiba Corporation from June 2005 to June 2009. Mr. Okamura has been serving as an adviser to the Board of Toshiba Corporation since June 2009 and became an honorary advisor to Toshiba Corporation in June 2016.

 

Takashi Tsukamoto has served as an outside director of IIJ since June 2017. Mr. Tsukamoto joined Dai-Ichi Kangyo Bank, Ltd. (Currently Mizuho Bank, Ltd.) in April 1974 and served as Chairman of Mizuho Financial Group, Inc. from June 2011 to March 2014 and as a senior adviser of Mizuho Financial Group, Inc. from April 2014 to March 2017. He became an honorary advisor to Mizuho Financial Group, Inc. in April 2017.

 

Shinobu Umino was appointed as an outside director of IIJ in June 2018. Mr. Umino joined NTT in April 1975 and served as Representative Director and President of NTT COMWARE Corporation from June 2012 to June 2017,and he has been a Chief Executive Adviser of of NTT COMWARE Corporation since June 2017.

 

Kazuhiro Ohira has been a company auditor of IIJ since June 2010. Mr. Ohira is a company auditor of Trust Networks, NCJ, IIJ-Global, Trinity and RYUKOSHA. Mr. Ohira was General Manager of International Business Management Dept. of Dai-Ichi Life Insurance Company, Ltd.

 

Masako Tanaka was appointed as an auditor of IIJ in June 2018. Ms. Tanaka joined us in December, 1992 and has worked as general manager of administrative department as well as human resources department.

 

Yasuhiro Akatsuka has been an outside company auditor of IIJ since June 2016. Mr. Akatsuka is a Japanese Certified Public Accountant and joined Deloitte Haskins & Sells (currently Deloitte Touche Tohmatsu LLC) in November 1972. Mr. Akatsuka left Deloitte Touche Tohmatsu LLC in September 2011 and has been serving as senior technical staff of The Japanese Institute of Certified Public Accountants.

 

Takashi Michishita has been an outside company auditor of IIJ since June 2016. Mr. Michishita admitted to the Tokyo Bar Association and joined Asahi Law Office (currently Nishimura & Asahi LPC) in April 1994. Mr. Michishita has been a partner at Nishimura & Asahi LPC since July 2007.

 

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The following table provides information about our executive officers as of June 29, 2018.

 

Name  Position and Major Responsibility
Naoshi Yoneyama  Senior Managing Executive Officer
Division Director of Corporate Planning Division
Masayoshi Tobita  Managing Executive Officer
Division Director of Administrative Division
Kiyoshi Ishida  Managing Executive Officer
Division Director of Network Division
Makoto Ajisaka  Managing Executive Officer
Division Director of Service Product Business Division
Yoshikazu Yamai  Managing Executive Officer
Division Director of Service Infrastructure Division
Koichi Maruyama  Managing Executive Officer
Division Director of Global Business Division
Masakazu Tachikui  Managing Executive Officer
Division Director of Cloud Division
Yasumitsu Iizuka  Executive Officer
In charge of Global Business Division (President and CEO of IIJ America Inc.)
Seiji Okita  Executive Officer
Division Director of Outsourcing Division
Masami Kawamata  Executive Officer
General Manager of Accounting Department
Akira Sumiya  Executive Officer
General Manager of Compliance Department

_________

* Senior Executive Officer, Kazuhiro Tokita was appointed as the President and CEO of DeCurret, an equity method investee of IIJ, on April 1, 2018.

 

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B.Compensation

 

The aggregate compensation to IIJ’s directors and company auditors during the fiscal year ended March 31, 2018 was as follows:

 

      Breakdown of Compensation (in millions of yen)   
Position  Total
Compensation
  Base Salary  Stock Option  Liability for
Retirement
Benefit
  Others  Number of
Persons
Directors *  ¥290   ¥253   ¥36       ¥1    9 
Company Auditor **   12    12                1 
Outside Directors/Outside Company Auditors   35    34            1    8 

_________

(1)Starting with its annual securities report for the year ended March 31, 2010 filed with the Ministry of Finance, a Japanese listed company is required to disclose the individual compensation of any director, executive officer or corporate auditor if it is ¥100 million or more. For fiscal year ended March 31, 2018, there was no director, executive officer or corporate auditor who received compensation of over ¥100 million.
(2)Upper limits on compensation for directors and company auditors are determined at a general meeting of shareholders of the Company. Within the upper limit approved by the shareholders' meeting, the Board of Company Auditors will determine the amount of compensation for each company auditor.
(3)Please see Item 6.E. “Share Ownership” for more detailed information concerning our stock options.

* Excluding Outside Directors

** Excluding Outside Company Auditors

 

The retirement benefit plan for full-time directors of IIJ was abolished in June 2011. We recorded a liability for retirement benefits for full-time directors of ¥400 million, which would be required if they retire as of March 31, 2018. For a description of our stock option and warrant issuances to directors and employees, see Item 6.E.

 

The retirement benefit plan for full-time company auditors was abolished in June 2016. We recorded a liability for retirement benefits of ¥8 million for full-time company auditors, which would be required to settle the obligation if they retire as of March 31, 2018. For a description of our stock option and warrant issuances to directors and employees, see Item 6.E.

 

C.Board Practices

 

From here on, “Corporation Law” refers to the amended Corporation Law.

 

In accordance with the Corporation Law and our Articles of Incorporation, our directors are elected at a general meeting of shareholders and our Board of Directors consists of a minimum of three and a maximum of 14 directors. While the normal term of office of a director is two years, a director may serve any number of consecutive terms. We do not have audit or remuneration committees, as is the standard practice in Japan. We do not have any service contracts with any of our directors providing for benefits upon termination of their employment.

 

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We have a Board of Company Auditors as well as an accounting auditor who is an independent certified public accountant or an auditing corporation. In accordance with the Corporation Law and our Articles of Incorporation, our Board of Company Auditors consists of a minimum of three company auditors, of whom at least half must be from outside of the company, and company auditors are elected at a general meeting of shareholders. Currently, three of our four company auditors are outside company auditors. While the normal term of office of a company auditor is four years, a company auditor may serve any number of consecutive terms. Our company auditors are under a statutory duty to supervise the execution of duties by the directors, to investigate proposals and documents to be submitted by the Board of Directors to the general meetings of shareholders and report their opinions thereon to the shareholders, if necessary. They are required to attend meetings of the Board of Directors and to express their opinions if necessary, but they are not entitled to vote. Each of our company auditors also have a statutory duty to audit business reports and examine the audit report on our financial statements prepared by our accounting auditor, and provide a report thereon to the entire Board of Company Auditors, which must, in turn, submit its audit report to the Board of Directors and/or the general meetings of shareholders. The Board of Company Auditors will also determine matters relating to the duties of company auditors, such as audit policy and methods of investigation of our affairs.

 

Following the requirements of the Corporation Law, we require a director to obtain the approval of the Board of Directors in order for such director to accept a transfer of a product or any other asset of IIJ, to transfer a product or any other asset of such director to IIJ, to receive a loan from IIJ, or to effect any other transaction with IIJ, for himself or a third-party.

 

If we issue common shares or other shares, stock acquisition rights or bonds with stock acquisition rights under the Corporation Law, it is necessary for the Board of Directors to determine the conditions of issuance. Additionally, (i) if the company issues such securities to persons other than shareholders (in the case of common shares or other shares) at a specially favorable issue price or (in the case of stock acquisition rights or bonds with stock acquisition rights) on specially favorable conditions, even if there are provisions related thereto in the Articles of Incorporation, some matters related to such issuance are to be resolved by a special resolution of a shareholders’ meeting and (ii) if the company issues such securities to persons other than shareholders whereby the persons will hold more than 50% of the voting rights of all shareholders, the company is to provide notice (including public notice) to its shareholders in advance and if shareholders who hold 10% or more of the voting rights of all shareholders provide notice to the company to dissent from such issuance of securities, an approval by a resolution of a general meeting of shareholders is generally required before the payment date for such issuance or transfer pursuant to the Corporation Law.

 

The rights of ADR holders, including their rights relating to corporate governance practices, are provided in the deposit agreement which is an exhibit to this annual report.

 

Limitation of Liabilities of some outside Directors and Auditors

 

As of June 29, 2018, we have entered into an agreement with five of our outside directors, Mr. Shingo Oda, Mr. Tadashi Okamura, Mr. Yasurou Tanahashi, Mr. Takashi Tsukamoto and Mr. Shinobu Umino, and two of our outside company auditors, Mr. Yasuhiro Akatsuka and Mr. Takashi Michishita that limits their liabilities to us for damages suffered by us due to their acts taken in good faith and without gross negligence, amounting to ¥10 million or the aggregate of the amounts set forth in Article 427 paragraph 1 of the Corporation Law, whichever is higher. Under the former Corporation Law, we were allowed to enter into such agreements only with outside directors, outside auditors, accounting advisors and accounting auditors, but under the Corporation Law, which amended the range of directors and company auditors that are allowed to be a party to such agreements, we are allowed to enter with all directors (excluding those who are executive directors and who serve in certain other roles in corporate governance, hereinafter referred to as “non-executive directors”) and all company auditors. However, we have decided not to enter into such agreements with non-executive directors and company auditors other than our outside directors and outside auditors above. For further discussion, see Item 10.C. Material Contracts and Exhibit 4.5 of this annual report.

 

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D.Employees

 

As of March 31, 2018, we had 3,203 employees, including employees of our consolidated subsidiaries, and we had 3,104 employees as of March 31, 2017 and 2,980 employees as of March 31, 2016. The following table shows the breakdown of the employees by main category of activity.

 

   For the fiscal year ended March 31,
   2016  2017  2018
   (number of employees)
Engineering    2,121    2,221    2,273 
Sales    516    532    553 
Administration    343    351    377 

 

We have never experienced any labor disputes and consider our labor relations to be good. To our knowledge, none of our employees are members of any union.

 

 

 

 

 

 

 

 

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E.Share Ownership

 

The information on share ownership required by this item is in Item 6.A. “Directors and Senior Management” above.

 

Stock Option Plan

 

Stock compensation–type stock option. A stock compensation-type stock option is a stock acquisition right entitling its holder to acquire shares upon the exercise of a stock acquisition right at an exercise price of one yen (¥1) per share. Stock compensation-type stock options are allocated to directors and executive officers as a substitution for the retirement allowance planned for them and to further motivate and incentivize them to enhance IIJ’s middle- to long-term business performance and corporate value. On May 26, 2011, IIJ’s board of directors resolved to introduce stock compensation–type stock options for executive officers of IIJ. On June 28, 2011, IIJ’s ordinary general meeting of shareholders approved the introduction of stock compensation type stock options for directors of IIJ.

 

  1st Series (issued in July 2011) 2nd Series (issued in July 2012)
(1)
Total number of Stock Acquisition Rights:
138 rights 130 rights
(2)
Class and total number of shares underlying the Stock Acquisition Rights:
27,600 shares of the Company’s common stock
(The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares. This number is adjusted from 1 share to 200 shares due to the effect of the stock split conducted on October 1, 2012)
26,000 shares of the Company’s common stock
(The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares. This number is adjusted from 1 share to 200 shares due to the effect of the stock split conducted on October 1, 2012)
(3)
Amount to be paid in exchange for the Stock Acquisition Rights:
¥259,344 per option
 (The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
¥318,562 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
(4)
Exercise period of stock acquisition rights:
From July 15, 2011 to July 14, 2041 From July 14, 2012 to July 13, 2042
(5)
Position and number of persons to be allotted the stock acquisition rights and the number of stock acquisition rights to be allotted:

- Directors (excluding Part-time and Outside Directors) of IIJ: 6 Directors, 89 rights

- Executive Officers of IIJ: 8 Executive Officers, 49 rights

- Directors (excluding Part-time and Outside Directors) of IIJ: 6 Directors, 74 rights

- Executive Officers of IIJ: 11 Executive Officers, 56 rights

     
  3rd Series (issued in July 2013) 4th Series (issued in July 2014)

(1)

Total number of Stock Acquisition Rights:

89 rights 128 rights

(2)

Class and total number of shares underlying the Stock Acquisition Rights:

17,800 shares of the Company’s common stock (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares) 25,600 shares of the Company’s common stock (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares)

(3)

Amount to be paid in exchange for the Stock Acquisition Rights:

¥647,000 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
¥422,600 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)

(4)

Exercise period of stock acquisition rights:

From July 12, 2013 to July 11, 2043 From July 11, 2014 to July 10, 2044

(5)

Position and number of persons to be allotted the stock acquisition rights and the number of stock acquisition rights to be allotted:

- Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 60 rights

- Executive Officers of IIJ: 10 Executive Officers, 29 rights

- Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 88 rights

- Executive Officers of IIJ: 10 Executive Officers, 40 rights

 

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  5th Series (issued in July 2015) 6th Series (issued in July 2016)
(1)
Total number of Stock Acquisition Rights:
151 rights 162 rights
(2)
Class and total number of shares underlying the Stock Acquisition Rights:
30,200 shares of the Company’s common stock (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares) 32,400 shares of the Company’s common stock (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares)
(3)
Amount to be paid in exchange for the Stock Acquisition Rights:
¥369,200 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
¥360,000 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
(4)
Exercise period of stock acquisition rights:
From July 14, 2015 to July 13, 2045 From July 12, 2016 to July 11, 2046
(5)
Position and number of persons to be allotted the stock acquisition rights and the number of stock acquisition rights to be allotted:

- Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 100 rights

- Executive Officers of IIJ: 11 Executive Officers, 51 rights

- Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 105 rights

- Executive Officers of IIJ: 12 Executive Officers, 57 rights

 
  7th Series (issued in July 2017)
(1)
Total number of Stock Acquisition Rights:
169 rights
(2)
Class and total number of shares underlying the Stock Acquisition Rights:
33,800 shares of the Company’s common stock (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares)
(3)
Amount to be paid in exchange for the Stock Acquisition Rights:
¥337,200 per option.
(The fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model)
(4)
Exercise period of stock acquisition rights:
From July 15, 2017 to July 14, 2047
(5)
Position and number of persons to be allotted the stock acquisition rights and the number of stock acquisition rights to be allotted:

- Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 114 rights

- Executive Officers of IIJ: 11 Executive Officers, 55 rights

 

8th Series (To be issued in July 2018)

(1)Maximum number of Stock Acquisition Rights to be determined on July 13, 2018: 234 rights
(2)Class of shares underlying the Stock Acquisition Rights, the Company’s common stock and the total number of shares underlying the Stock Acquisition Rights to be determined accordingly with the number of stock acquisition rights to be allotted (The number of shares to be issued or transferred for each Stock Acquisition Rights shall be 200 shares)
(3)Amount to be paid in exchange for the Stock Acquisition Rights is to be determined on July 13, 2018 based on the fair value of stock acquisition rights used to recognize compensation expense was estimated using the Black-Scholes option-pricing model.
(4)Exercise period of stock acquisition rights: From July 14, 2018 to July 13, 2048.
(5)Position and number of persons to be allotted the stock acquisition rights and the maximum number of stock acquisition rights to be allotted:
(i)Directors (excluding Part-time and Outside Directors) of IIJ: 7 Directors, 157 rights
(ii)Executive Officers of IIJ: 11 Executive Officers, 77 rights

 

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Class and total number of shares to be acquired by exercising stock acquisition rights outstanding, as of March 31, 2018, is as follows:

 

  1st Series 2nd Series 3rd Series 4th Series 5th Series 6th Series 7th Series
Issued in July 2011 July 2012 July 2013 July 2014 July 2015 July 2016 July 2017
Outstanding: Class

Common

stock

Common

stock

Common

stock

Common

stock

Common

stock

Common

stock

Common

Stock

Outstanding:
Total number of shares to be acquired
21,400 shares 20,800 shares 15,600 shares 22,600 shares 29,400 shares 31,600 shares 33,800 shares

 

Employee Stock Purchase Plan

 

The Group Employee Stock Purchase Plan, which was implemented in December 1995, provides designated employees with the opportunity to purchase shares at market value. Incentive payment is given to designated employees. Shares are basically held in the name of the group employee stock purchase program until employees leave the association, due to resignation or retirement. The representative of the employee shareholders' association exercises voting rights in accordance with the instructions of each employee shareholder. As of March 31, 2018, the association holds 501,500 shares of common stock, or 1.07% of our outstanding shares.

 

 

Director Stock Purchase Plan

 

The Director Stock Purchase Plan was implemented in November 2007. On April 1, 2010, the plan was amended in connection with the introduction of the Executive Officer System. The plan provides designated directors and executive officers of IIJ and its wholly-owned subsidiaries in Japan with the opportunity to purchase IIJ common shares at market value, every month, with a fixed amount of their own money through a designated security broker.

 

 

 

 

 

 

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Item 7. Major Shareholders and Related Party Transactions

 

A.Major Shareholders

 

The following table shows information regarding beneficial ownership of our common stock as of March 31, 2018 by each shareholder known by us to own beneficially more than 5% of our common stock and all directors and executive officers as a group. We are not required by Japanese law to disclose beneficial ownership of our common stock. As explained in “Reporting Requirements of Shareholders—Report of Substantial Shareholdings” in Item 10.B. of this annual report on Form 20-F, any person who becomes, beneficially and solely or jointly, a holder of more than 5% of our outstanding common stock must file a report with the relevant local finance bureau of the Ministry of Finance. The information in this table is based upon our shareholders of record and reports filed with the Financial Services Agency and the SEC.

 

   Outstanding Voting Shares
as of March 31, 2018(4)
   Number  Percentage
Nippon Telegraph and Telephone Corporation and affiliates (1)    12,135,000    26.9%
Koichi Suzuki(2)    2,635,300    5.8 
Directors, executive officers and company auditor as a group(3)    2,914,700    6.5 

 

__________ 

(1)Includes NTT, which owned 10,095,000 shares, or 22.4% of our outstanding voting shares and 21.6% of our total issued shares, and NTT Communications, which owned 2,040,000 shares, or 4.5% of our outstanding voting shares and 4.4% of our total issued shares.
(2)Mr. Koichi Suzuki directly held 4.0% of our outstanding voting shares and 1.8% indirectly through his wholly owned private company called KS Holdings.
(3)Includes Koichi Suzuki’s holdings which are also separately set forth above and 31,500 shares owned by Mr. Tokita who resigned executive officer on March 31, 2018. No other director or executive officer except for Koichi Suzuki was a beneficial owner of more than 5%.
(4)As of March 31, 2018, the Company held 1,650,909 shares of the Company as treasury stock.

 

 

Our major shareholders have the same voting rights as other holders of our common stock.

 

According to our register of shareholders, as of March 31, 2018, there were 9,590 holders of common stock of record worldwide. As of March 31, 2018, The Bank of New York Mellon, depositary for our ADSs, held 1.7% of the outstanding common stock on that date. According to The Bank of New York Mellon, as of March 31, 2018, there were 1,565 ADR holders of record with addresses in the United States. Because some of these shares were held by brokers or other nominees, the number of record holders with addresses in the United States might not fully show the number of beneficial owners in the United States. Of the 46,713,800 shares of common stock outstanding as of March 31, 2018, shares were held in the form of 1,622,850 ADSs. As of March 31, 2018, the Company held 1,650,909 shares of the Company as treasury stock.

 

To the knowledge of the Company, it is not directly or indirectly owned or controlled by any other corporation, by any government, or by any other natural or legal person or persons severally or jointly. As far as is known to the Company, there are no arrangements, the operation of which may at a subsequent date, result in a change in control of IIJ.

 

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B.Related Party Transactions

 

NTT-affiliated Companies. The Company entered into a number of different types of transactions with NTT and its subsidiaries including purchases of wireline telecommunication services for the Company’s offices and capital lease arrangements. On an ongoing basis in the ordinary course of business, for the Company’s connectivity and outsourcing services, the Company purchases international and domestic backbone services, local access lines, rental rack space in data centers and mobile services from NTT and its subsidiaries. The Company sells to NTT and its subsidiaries its services, systems integration services and monitoring services for their data centers. For the fiscal year ended March 31, 2018, we have spent ¥35.2 billion in the aggregate for international and domestic backbone, local access line, mobile connectivity costs, lines for WAN services and co-location costs to NTT and its subsidiaries such as NTT Communications, NTT East, NTT West and NTT Docomo. As of March 31, 2018, we had ¥3.1 billion of lease obligations with NTT FINANCE.

 

All the transactions entered into with NTT and its affiliates are entered in the ordinary course of business. Mr. Kawashima, one of our directors, was an employee of NTT DATA Corporation and was Representative Director of NTT DATA TOKAI Corporation. Mr. Umino, one of our outside directors, was an employee of NTT, Senior Vice President of NTT DATA Corporation, Senior Executive Vice President of NTT Communications, President and Representative Director of NTT COMWARE Corporation, and is currently Chief Executive Adviser of NTT COMWARE Corporation. There is no shareholders’ agreement in place with NTT, its affiliates or any other party for the appointment of any of our directors.

 

Transactions with equity method affiliates. In the ordinary course of business, we have various sales, purchases and other transactions with affiliate companies which we own 20% to 50% of and are accounted for by the equity method. Account balances and transactions with such affiliate companies as of and for the fiscal year ended March 31, 2018 are presented as follows:

 

   millions of yen
Accounts receivable   ¥183 
Accounts payable    98 
Revenues    864 
Costs and Expenses    1,107 

 

Transactions with Outside Directors and Auditors. We entered into a Limitation of Liability Agreement with Mr. Yasuhiro Akatsuka and Mr. Takashi Michishita as outside company auditors on June 24, 2016,with Mr. Tadashi Okamura and Mr. Takashi Tsukamoto as outside directors on June 28, 2017 and with Mr. Yasurou Tanahashi, Mr. Shingo Oda and Mr. Shinobu Umino as outside directors on June 28, 2018, respectively, pursuant to which their liability for damages sustained by us as a result of their actions is limited to an aggregate of ¥10 million. For further discussion, see Item 10.C. Material Contracts and Exhibit 4.5 of this annual report.

 

See Note 22 “Related Party Transactions” and Note 6 “Investments in Equity Method Investees” to our consolidated financial statements, included in this annual report on Form 20-F.

 

 

C.Interests of Experts and Counsel

 

Not applicable.

 

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Item 8. Financial Information

 

A. Consolidated Statements and Other Financial Information

 

Financial Statements

 

The consolidated financial statements required by this item begin on page F-1.

 

Legal or Arbitration Proceedings

 

The information on legal or arbitration proceedings required by this item is in Item 4.B.

 

Dividend Policy

 

Our basic dividend policy is that we pay dividends to our shareholders continuously and in a stable manner while considering the need to have retained earnings for the enhancement of financial position, middle-to long-term business expansion, future business investment and other goals. Under Japanese law, a company is required to have retained earnings, without accumulated deficit, in order to be able to conduct certain types of capital-related transactions such as payments of dividends in general. The ordinary general meeting of shareholders held in June 2006 approved the elimination of accumulated deficit through the reduction of additional-paid in capital and common stock in our non-consolidated financial statements under generally accepted accounting principles in Japan. For the fiscal year ended March 31, 2018, IIJ paid total cash dividend of ¥27.0 per share of common stock.

 

B. Significant Changes

 

Except as otherwise disclosed in this annual report on Form 20-F, there has been no significant change in our financial condition since March 31, 2018, the date of our last audited financial statements.

 

 

 

 

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Item 9. The Offer and Listing

 

A.Offer and Listing Details

 

ADSs representing our common stock have been quoted on the NASDAQ market since August 4, 1999 under the symbol “IIJI” and were transferred from the NASDAQ Global Market to the NASDAQ Global Select Market on June 11, 2007. The current ADS/share ratio is 2 ADSs per 1 share of our common stock. Our shares of common stock had been quoted on the Mothers market of the TSE since December 2, 2005 under the stock code number “3774” and were transferred to the First Section of the TSE on December 14, 2006.

 

The following table shows, for the periods indicated, the high and low price of our ADSs and shares of common stock on the TSE for the periods indicated:

 

   NASDAQ (1)
(per ADS)
  TSE (1) (2)
(per share of common stock)
Fiscal year ended/ending March 31,  High  Low  High  Low
2014    21.21    8.71    4,365    1,797 
2015    12.95    7.56    2,700    1,802 
2016