As filed with the Securities and Exchange Commission on September 29, 2009

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 20-F

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

OR

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

For the fiscal year ended March 31, 2009

OR

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

For the transition period from _____ to _____

OR

o		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 _____

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)

Jinbocho Mitsui Bldg., 1-105 Kanda Jinbo-cho, Chiyoda-ku, Tokyo 101-0051, Japan
(Address of Principal Executive Offices)

Yuko Kazama, +81-3-5259-6500, +81-3-5205-6395,
Jinbocho Mitsui Bldg., 1-105 Kanda Jinbo-cho, Chiyoda-ku, Tokyo 101-0051, 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, 2009, 206,478 shares of common stock were outstanding, including 15,990 shares represented by an aggregate of 6,396,000 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 o   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 o   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 o

     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 o   No o

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

          þ U.S. GAAP

          o International Financial Reporting Standards as issued by the International Accounting Standards Board

          o 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 o   Item 18 o

     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 o   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			12
Item 5. Operating and Financial Review and Prospects			27
Item 6. Directors, Senior Management and Employees			50
Item 7. Major Shareholders and Related Party Transactions			54
Item 8. Financial Information			55
Item 9. The Offer and Listing			56
Item 10. Additional Information			57
Item 11. Quantitative and Qualitative Disclosures about Market Risk			66
Item 12. Description of Securities Other than Equity Securities			66
PART II			67
Item 13. Defaults, Dividend Arrearages and Delinquencies			67
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds			67
Item 15. Controls and Procedures			67
Item 16A.Audit Committee Financial Expert			69
Item 16B.Code of Ethics			69
Item 16C.Principal Accountant Fees and Services			69
Item 16D.Exemptions from the Listing Standards for Audit Committees			7 0
Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers			71
Item 16F.Change in Registrant’s Certifying Accountant			71
Item 16G.Corporate Governance			71
PART III			72
Item 17. Financial Statements			72
Item 18. Financial Statements			72
Item 19. Exhibits			73
EX-1.1 Articles of Incorporation, as amended (English translation)
EX-1.2 Share Handling Regulations, as amended (English translation)
EX-4.6 Agreement on Limited Liability, dated June 27, 2008 and June 26, 2009,between Internet Initiative Japan Inc. and outside directors and outside company auditors
EX-12.1 Certification of the principal executive officer required by 17 C.F.R. 240. 13a-14(a)
EX-12.2 Certification of the principal financial officer required by 17 C.F.R. 240. 13a-14(a)
EX-13.1 Certification of the chief executive officer required by 18 U.S.C. Section 1350
EX-13.2 Certification of the chief financial officer required by 18 U.S.C. Section 1350

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 and affiliated companies may not produce the returns that we expect or may adversely affect our results of operations and financial condition.

     As used in this annual report, references to “IIJ” 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.

PART I

Item 1. Identity of Directors, Senior Management and Advisers.

     Not required.

Item 2. Offer Statistics and Expected Timetable.

     Not applicable.

Item 3. Key Information.

A. Selected Financial Data.

     You should read the selected consolidated financial data below 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. The consolidated statement of operations data and per share and American Depositary Shares (“ADS”) data below for the fiscal years ended March 31, 2005, 2006, 2007, 2008 and 2009, the consolidated balance sheet data below as of March 31, 2005, 2006, 2007, 2008 and 2009 and consolidated statements of cash flows for the fiscal years ended March 31, 2005, 2006, 2007, 2008 and 2009 under operating data below are derived from our audited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), and audited by Deloitte Touche Tohmatsu, an independent registered public accounting firm.

		As of and for the fiscal year ended March 31,
		2005				2006				2007				2008				2009				2009
		(millions of yen, except per share and ADS data)																				(thousands of
																						U.S. dollars,
																						except per
																						share and ADS
																						data(1))
Statement of Operations Data:
REVENUES:
Connectivity and outsourcing services (2):
Connectivity services (corporate use)		¥	11,994			¥	11,179			¥	11,239			¥	12,149			¥	13,142			$	132,551
Connectivity services (home use)			2,316				2,120				1,969				5,430				6,538				65,934
Outsourcing services			8,174				9,924				11,145				13,724				15,396				155,278
Total			22,484				23,223				24,353				31,303				35,076				353,763
Systems integration (3):
Systems construction			7,598				12,296				16,660				18,021				14,658				147,841
Systems operation and maintenance			8,256				11,209				13,867				15,993				18,989				191,514
Total			15,854				23,505				30,527				34,014				33,647				339,355
Equipment sales			3,365				3,085				2,175				1,514				985				9,930
ATM operation business (4)			—				—				—				4				23				237
Total revenues			41,703				49,813				57,055				66,835				69,731				703,285
COST AND EXPENSES:
Cost of connectivity and outsourcing services			19,484				20,078				20,545				26,040				29,318				295,690
Cost of systems integration			12,200				18,120				23,529				25,526				25,543				257,617
Cost of equipment sales			3,111				2,818				1,894				1,300				863				8,704
Cost of ATM operation business (4)			—				—				—				17				422				4,259
Total cost			34,795				41,016				45,968				52,883				56,146				566,270
Sales and marketing			2,795				3,080				3,439				4,329				4,631				46,703
General and administrative			2,666				3,147				3,971				4,624				5,622				56,701
Research and development			199				159				177				240				415				4,187
Total cost and expenses			40,455				47,402				53,555				62,076				66,814				673,861
OPERATING INCOME			1,248				2,411				3,500				4,759				2,917				29,424
OTHER INCOME (EXPENSES):
Interest income			13				13				23				63				45				455
Interest expense			(686	)			(437	)			(397	)			(438	)			(408	)			(4,117	)
Other — net			2,573				3,392				1,923				(22	)			(520	)			(5,243	)
Other income (expenses) — net			1,900				2,968				1,549				(397	)			(883	)			(8,905	)
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT), MINORITY INTERESTS IN (EARNINGS) LOSSES OF SUBSIDIARIES AND EQUITY IN NET INCOME (LOSS) OF EQUITY METHOD INVESTEES			3,148				5,379				5,049				4,362				2,034				20,519
INCOME TAX EXPENSE (BENEFIT)			100				257				(804	)			(861	)			1,002				10,113
MINORITY INTERESTS IN (EARNINGS) LOSSES OF SUBSIDIARIES			(109	)			(354	)			(233	)			97				352				3,555
EQUITY IN NET INCOME (LOSS) OF EQUITY METHOD INVESTEES			(33	)			(14	)			(210	)			(143	)			35				354
NET INCOME		¥	2,906			¥	4,754			¥	5,410			¥	5,177			¥	1,419			$	14,315

		As of and for the fiscal year ended March 31,
		2005				2006				2007				2008				2009				2009
		(millions of yen, except per share and ADS data)																				(thousands of
																						U.S. dollars,
																						except per
																						share and ADS
																						data(1))
Per Share and ADS Data (5):
Basic net income per share		¥	15,172			¥	24,301			¥	26,519			¥	25,100			¥	6,918			$	70
Diluted net income per share			15,172				24,258				26,487				25,072				6,917				70
Basic net income per ADS equivalent			37.93				60.75				66.30				62.75				17.29				0.17
Diluted net income per ADS equivalent			37.93				60.65				66.22				62.68				17.29				0.17
Cash dividends declared per share:
Japanese Yen			—				—			¥	1,500			¥	1,750			¥	2,000
U.S. Dollars			—				—			$	12.76			$	17.53			$	20.17
Basic weighted average number of shares			191,559				195,613				203,992				206,240				205,165
Diluted weighted average number of shares			191,559				195,955				204,244				206,465				205,195
Basic weighted average number of ADS equivalents (thousands)			76,624				78,245				81,597				82,496				82,066
Diluted weighted average number of ADS equivalents (thousands)			76,624				78,382				81,698				82,586				82,078
Balance Sheet Data:
Cash and cash equivalents		¥	5,286			¥	13,727			¥	13,555			¥	11,471			¥	10,188			$	102,751
Total assets			37,116				50,705				47,693				55,703				52,301				527,496
Short-term borrowings			4,725				4,555				6,050				9,150				7,350				74,130
Current portion of long-term borrowings, including capital lease obligations			5,511				4,994				3,243				3,456				3,272				33,003
Long-term borrowings, including capital lease obligations			5,869				5,271				4,318				4,738				4,866				49,078
Common stock			13,765				16,834				16,834				16,834				16,834				169,782
Total shareholders’ equity			11,615				20,222				20,112				24,981				25,169				253,849
Operating Data:
Capital expenditures, including capitalized leases (6)		¥	5,011			¥	4,762			¥	3,953			¥	6,078			¥	7,006			$	70,660
Operating margin ratio (7)			3.0	%			4.8	%			6.1	%			7.1	%			4.2	%
Net cash provided by (used in):
Operating activities		¥	5,238			¥	6,559			¥	7,402			¥	4,538			¥	8,631			$	87,049
Investing activities			1,974				1,805				(3,014	)			(5,444	)			(3,328	)			(33,566	)
Financing activities			(14,213	)			39				(4,560	)			(1,152	)			(6,573	)			(66,297	)

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,
		2005				2006				2007				2008				2009
										(millions of yen)
Capital expenditures:
Acquisition of assets by entering into capital leases		¥	4,434			¥	3,843			¥	2,665			¥	4,222			¥	4,015
Purchases of property and equipment			577				919				1,288				1,856				2,991
Total capital expenditures		¥	5,011			¥	4,762			¥	3,953			¥	6,078			¥	7,006

Exchange Rates

     Fluctuations in exchange rates between the Japanese yen and the U.S. dollar and other currencies 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 ¥99.15 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 31, 2009, the date of our most recent consolidated balance sheet contained in this annual report. 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:

		High				Low				Average(2)				Period-end
Fiscal year ended March 31, (1)
2005		¥	114.30			¥	102.26			¥	107.28			¥	107.22
2006			120.93				104.41				113.67				117.48
2007			121.81				110.07				116.55				117.56
2008			124.09				96.88				113.61				99.85
2009			110.48				87.80				100.85				99.15
Calendar year 2009
January		¥	94.20			¥	87.80			¥	90.12			¥	89.83
February			98.55				89.09				92.92				97.74
March			99.34				93.85				97.86				99.15
April			100.71				96.49				98.92				98.76
May			99.24				94.45				96.64				95.55
June			98.56				95.19				96.58				96.42
July			96.41				92.33				94.30				94.54
August			97.65				92.82				94.90				92.82
September (through September 25, 2009)			93.09				89.83				91.54				89.83

     The noon buying rate on September 25, 2009 was ¥89.83 per $1.00.

B. Capitalization and Indebtedness.

     Not required.

C. Reasons for the Offer and Use of Proceeds.

     Not applicable.

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 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. If the Japanese economy deteriorates or does not improve, and it results in significantly lower levels of network-related investment and expenditures, and corporate customers respond to conditions by prioritizing low prices over quality, or we experience cancellation of large accounts, it may become difficult to maintain our current level of revenues or achieve our expected revenues and profits, particularly in network systems construction.

     In addition to factors related to general economic conditions in Japan, we may not be able to maintain our current level of revenues and profits or achieve our expected levels of revenues and profits due to several other factors, including, but not limited to:

	•		a decrease in revenues from our connectivity services because of lower unit prices per bandwidth and cancellation of large accounts, due, for example, to severe price competition,
	•		lower revenue growth and lower margins if we fail to successfully differentiate our services from those of our competitors, if corporate customers put off or stop placing orders with us, if the number of systems construction projects decreases, or if the average revenues for each projects decreases,
	•		an increase in backbone costs due to increased volume of Internet traffic and tightened demands for leasing backbone lines, or a decline in the profitability of connectivity services if we contract for more capacity than we actually require to serve our customers,
	•		an increase in expenses for network infrastructure, research and development, back-office systems and other similar investments which we may be forced to make in the future in order to remain competitive, or an increase in expenses relating to the leasing of additional equipment and an increase in amortization and depreciation,
	•		failure to control personnel and outsourcing costs, especially in our systems integration, if personnel and outsourcing costs increase, or we fail to manage outsourcing resource effectively or fail to cover outsourcing costs by raising enough revenues from outsourced projects,
	•		an increase in SG&A costs, such as personnel expenses, advertising expenses and office rent expenses, in conjunction with our expected or planned or continued business expansion,
	•		the recording of an impairment loss as a result of an impairment test on the non-amortized intangible assets such as goodwill that are recorded related to any mergers and acquisitions,
	•		a decline in the value and trading volume of our holding of available-for-sale securities from which we expect gains on sale,
	•		an impairment losses on available-for-sale securities, nonmarketable equity securities and funds,
	•		the amount and timing of the recognition of deferred tax benefits or expenses resulting from a release or an increase of valuation allowance against deferred income tax assets related to tax operating loss carryforwards and other temporary differences, and
	•		a negative effect on our revenues and profits if newly established consolidated subsidiaries cannot achieve our expected levels of revenues or manage costs and expenses in a timely and adequate manner.

     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 connectivity and outsourcing services are major telecommunications carriers such as NTT Communications Corporation (“NTT Communications”) and KDDI Corporation (“KDDI”). Price competition for Internet connectivity services is still severe. For outsourcing services, price competition may also increase. 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 IBM Japan, Ltd., 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 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.

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

	•		substantially greater financial resources,
	•		more extensive and well-developed marketing and sales networks,
	•		higher brand recognition among consumers,
	•		larger customer bases, and
	•		more diversified operations which allow profits from some operations to support operations with lower profitability, such as network services, for which we are a competitor.

     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.

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

     In the past, we have invested in our group companies to expand our businesses and generate new businesses. As of August 2009, we have ten consolidated subsidiaries and four equity method investees. The financial performance of our consolidated subsidiaries affects our financial condition and results of operations directly and the financial performance of our equity method investees affects our financial condition and results of operations to the extent of our pro rata portion of 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 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, guarantees or additional equity investments in such companies. We may lose all or part of our investment in such companies if their value decreases as a result of their financial performance or if they go bankrupt. If our interests differ from those of other investors in entities over which we do not exercise control, we may not be able to enjoy synergies with the investees and it may adversely affect our financial condition and results of operations.

     In the fiscal years ended March 31, 2008 and 2009, IIJ has established four new subsidiaries; GDX Japan Inc. (“GDX”), Trust Networks Inc. (“Trust Networks”), On-Demand Solutions Inc. (“ODS”) and IIJ Innovation Institute Inc. (“IIJ-II”) to further expand our businesses. For these four new subsidiaries, IIJ has invested a total of ¥2.2 billion as of August 31, 2009. As they are in their early stages of business, there are no assurance whether they will be able to start their businesses as planned or if their businesses start up take longer than expected, we may need to provide them with additional financial support. If they cannot achieve our expected levels of revenues or manage costs and expenses in a timely and adequate manner or if they go bankrupt, it may adversely affect our financial condition and results of operations.

     Trust Networks, IIJ’s consolidated subsidiary established in July 2007, operates automated teller machines (“ATMs”) and its network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of 10 ATMs operations and as of June 2009, it operates 26 ATMs placed in Japanese pinball shops (PACHINKO parlor). Trust Networks expects to introduce around 8,000 ATMs in four to five years from the fiscal year ending March 31, 2010. As of August 2009, IIJ has invested total of ¥1.3 billion in Trust Networks (73.8% share ownership). The ATM operation business, which is conducted by Trust Networks, is still in the course of its business start up and for the fiscal year ended March 31, 2009, it had ¥23 million of revenues and ¥399 million of gross loss. If Trust Networks is not able to introduce ATMs in accordance with its plan, or does not record ATMs’ withdrawing transactions as anticipated or incur unexpected additional costs, its business start up may take longer than planned and its losses would widen and it may not be able to achieve its future expected revenue and profit or it may become difficult to continue its business which may adversely affect our financial conditions and results of operations. If Trust Networks fails to secure lease arrangements for its ATMs, it would require additional cash to operate its business. If the placement of ATMs increases, our capital expenditures including capitalized leases may increase due to the leasing or purchasing of ATMs.

     IIJ’s substantial investment in Crosswave Communications Inc. (“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. In February 2006, IIJ invested ¥0.8 billion in Internet Revolution Inc. (“i-revo”), a joint venture that IIJ established with Konami Corporation, and i-revo is IIJ’s equity method investee. After the investment through the fiscal year ended March 31, 2009, we recorded total equity in net loss of i-revo of ¥0.7 billion.

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, have a tendency to fluctuate from time to time compared to monthly recurring revenues from connectivity and outsourcing services and systems operation and maintenance due to the budget systems in Japan, of which many ends in March. If corporate investments decreases or if we fail to meet customer demands due to lack of sufficient number of qualified engineers or lack of sufficient task-management capabilities 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 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 in turn have an adverse impact on our reputation, results of operations and financial condition.

     Generally, systems construction projects are more difficult to be effectively controlled as they become larger in scale and if we fail to control costs such as personnel and outsourcing costs or to retain adequate personnel for the projects, or if we fail to calculate the necessary timeframe or the manpower to complete a project and the costs exceed the payment received from our customers, our results of operations and financial condition related to systems integration may be adversely affected.

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, 2009, the total balance of our intangible assets was approximately ¥5.8 billion, of which ¥5.5 billion was non-amortized intangible assets: ¥4.3 billion related to IIJ-Technology Inc. (“IIJ-Tech”), ¥0.4 billion related to hi-ho Inc. (“hi-ho”), ¥0.3 billion related to Net Care Inc. (“Net Care”), ¥0.2 billion related to IIJ Financial Systems Inc. (“IIJ-FS”), and ¥0.2 billion related to Trust Networks. Amortized intangible assets related to hi-ho as of March 31, 2009 was ¥0.2 billion. The amount of our intangible assets may increase if we conduct mergers, acquisitions or investments in affiliates in the future. We conduct an impairment test by each of our reporting unit and if the business operations for each of our reporting unit 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 such as goodwill. The realization of any impairment losses on intangible assets may result in material adverse effects on our financial condition and results of operations.

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 from our engineering, research and development, and other personnel. As our business grows, we need to hire additional engineering, research and development, and other personnel. In particular, in order to continue to increase our revenues from outsourcing services and systems integration, we require more sales and engineering personnel to achieve our expectations. We are not sure that we will be able to retain or attract such personnel and control human resources costs adequately. Competition for qualified engineering, research and development personnel is intense in the telecommunications 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 agreement. 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 network may be caused by human errors 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, human error, computer viruses and other similar events. Much of our computer and networking equipment and the lines that make up our network backbones are concentrated in a few locations that are in earthquake-prone areas. Any disruption, outages, or 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 confidence in our business, any or all of which could have a material adverse effect on our business, financial condition and results of operations.

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 care in protecting the confidentiality of such information and take steps to ensure the security of our network, in accordance with the law protecting personal information that came into effect in April 2005 and the requirements set by the Ministry of Internal Affairs and Communications (“MIC”), and the Ministry of Economy, Trade and Industry. However, our network, like all Information Technology systems, is vulnerable to external attack from computer viruses, hackers 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. The realization of these or similar risks may have a material adverse effect on our business, financial condition and result of operations.

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 and as the volume of information transferred 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. 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:

	•		rapid technological change, including the shift to new technology-based networks such as IPv6,
	•		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.

     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 better able 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, particularly Mr. Koichi Suzuki, 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 IIJ’s president, chief executive officer and representative director, as well as the president and chief executive officer and representative director of IIJ’s major subsidiaries. We rely in particular on his expertise in the operation of our businesses and on his relationships with our shareholders, the shareholders of the IIJ Group companies, our business partners and our employees. None of our executive officers, including Mr. Suzuki, is bound by an employment or noncompetition agreement.

The amounts and timing of recognition of deferred tax benefits or expenses related to tax operating loss carryforwards may adversely affect our financial results.

     As of March 31, 2009, we had tax operating loss carryforwards related to corporate tax of ¥10.1 billion. The loss carryforwards are available to offset future taxable income and a large portion of tax operating loss carryforwards will expire in the period ending March 31, 2011 (see Note 10 to our consolidated financial statements). We recorded ¥0.6 billion of deferred tax expenses for the fiscal year ended March 31, 2009. As of March 31, 2009, we had deferred tax asset (current) of ¥0.8 billion and deferred tax asset (noncurrent) of ¥2.3 billion, respectively, which will result in deferred tax expense in the future. 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 release or an increase of valuation allowance against deferred income tax assets related to tax operating loss carryforwards and other temporary differences would result in the decrease or increase in deferred tax expense which may affect our financial condition and results of operations.

Fluctuations in the stock prices of companies or impairment losses on stocks of companies in which we have invested may significantly influence our financial condition.

     We have invested in non-affiliated companies in order to further 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. We recorded net impairment losses of ¥0.5 billion on nonmarketable and available-for-sale equity securities in the fiscal year ended March 31, 2009. The book value of available-for-sale securities was ¥0.7 billion, nonmarketable equity securities was ¥0.9 billion and funds was ¥0.4 billion as of March 31, 2009, respectively. We may acquire additional securities of non-affiliated companies. However, the book value can decline significantly due to changes in the financial condition of non-affiliated companies, general economic conditions in Japan or fluctuations in the Japanese stock markets. Fluctuations in the value of securities in which we have invested may affect our financial results. In addition, should we choose to sell all or a portion of these shares, it is not certain that we will be able to do so on favorable terms.

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 30.0% of IIJ’s outstanding voting shares as of March 31, 2009. As IIJ’s largest shareholder, NTT may be able to exercise substantial influence over us. As of June 26, 2009, IIJ had one outside director, Mr. Takashi Hiroi, from NTT among IIJ’s 14 directors. While we intend to conduct our day-to-day operations independently of NTT and its group 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 interests, which may not be in our interest or that of 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 and Nippon Telegraph and Telephone East Corporation (“NTT East”) and Nippon Telegraph Telephone West Corporation (“NTT West”) and KDDI for local access lines for our customers. We procure significant portions of our network backbone and data center facilities pursuant to operating lease agreements with NTT Communications, our largest provider of network infrastructure. For the fiscal year ended March 31, 2009, 69.2% in costs for our domestic network backbone was for NTT Communications. For us to provide broadband mobile data communications as a Mobile Virtual Network Operator (“MVNO”), we depend on mobile network operators. 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 like routers that are used in our network. We acquire certain components from limited sources, typically from Cisco Systems, Inc. (“Cisco”) and Juniper Networks, Inc. (“Juniper Networks”). 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. As a result of the amendment in April 2004 of the Telecommunication Business Law and deregulation including elimination of the regulatory distinction between carriers providing telecommunications services through networks owned by other telecommunication carriers and carriers which own or have long-term leases for the networks through which they offer telecommunication services, competition may increase. Recently, the MIC has been considering adapting laws and regulations to control actions that hurt public order over the Internet. Furthermore, 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”.

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 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 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 may raise additional funds in the future to raise additional working capital and for other financial needs. IIJ issued 12,500 new shares of IIJ’s common stock along with IIJ’s listing on the Mothers market of the Tokyo Stock Exchange in December 2005, after conducting a 1 to 5 split of our shares of common stock in October 2005. On May 11, 2007, IIJ issued 2,178 shares of common stock to make IIJ’s two consolidated subsidiaries wholly-owned through share exchanges. If IIJ choose to raise such funds from the issuance of equity shares of IIJ’s common stock or securities convertible into IIJ’s common stock, existing shareholders may incur substantial dilution.

Item 4. Information on the Company.

A. History and Development of the Company.

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

     IIJ began its operations in July 1993, making IIJ one of the first commercial providers in Japan to offer Internet connectivity services. In February 1994, IIJ acquired a Type II Telecommunications license, which enables IIJ to operate IIJ’s own international backbone networks. The main services that IIJ and the Group offers are Internet connectivity services, outsourcing services, systems integration and equipment sales. The Group offers our services and solutions directly to our customers and also work closely together as a Group in providing total network solutions to our customers. In addition, the Group entered the ATM operation business through our consolidated subsidiary, Trust Networks, which we established in July 2007. 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 Tokyo Stock Exchange (“TSE”). In connection with the listing, IIJ issued 12,500 new shares of common stock for an amount of ¥6.0 billion. As IIJ conducted a 1 to 5 split of IIJ’s shares of common stock on October 11, 2005, the total number of IIJ’s issued shares of common stock increased to 204,300. On December 14, 2006, IIJ moved to the First Section of the TSE for IIJ’s listing in Japan, without the issuance of new shares. On May 11, 2007, IIJ made IIJ-Tech and Net Care our 100% owned consolidated subsidiaries through share exchanges. In regard to this, IIJ issued 2,178 new shares of common stock and as a result, the total number of IIJ’s issued shares of common stock increased to 206,478.

     IIJ’s head office is located at Jinbo-cho Mitsui Bldg., 1-105 Kanda Jinbo-cho, Chiyoda-ku, Tokyo 101-0051, Japan, and IIJ’s telephone number at that location is (813) 5259-6500. IIJ’s agent in the United States is IIJ America Inc. (“IIJ America”), 1211 Avenue of the Americas, Suite 2900, New York, New York 10036 and the telephone number at that location is (212) 440-8080. IIJ has a web site that you may access at http://www.iij.ad.jp/en/. Information contained on IIJ’s web site 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.

B. Business Overview.

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

     We offer, together with other companies or independently, a variety of services to our customers, mainly corporate and governmental organizations, as total network solutions through a single source. Our primary services are our connectivity services, outsourcing services, systems integration and equipment sales. Our connectivity services includes full-spec IP service with bandwidth ranging from 64 kbps up to 10 Gbps, low-cost broadband services such as optical and/or ADSL lines which are mainly used to connect branch offices, and mobile access services. 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, and data center-related outsourcing services. Our systems integration includes systems construction and systems operation and maintenance. Systems construction are tailored to meet each of our customers’ requirements, which include consulting, project planning, systems design and construction of network systems, and sales of equipment and software purchased from third parties. Systems operation and maintenance revenues include systems construction-related maintenance, monitoring and other operating services. We aim to be the leading supplier of total network solutions in Japan.

     In addition, we entered the ATM operation business through our consolidated subsidiary, Trust Networks, which was established in July 2007. Trust Networks operates ATMs and its network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of 10 ATMs operations. As of June 30, 2009, Trust Networks operates 26 ATMs and aims to introduce around 8,000 ATMs in four to five years from the fiscal year ending March 31, 2010.

     Starting from the fiscal year ended March 31, 2009, we have disclosed revenues and costs for the ATM operation business for fiscal years ended March 31, 2008 and 2009 because the amount of losses related to their business has become materially large.

     Currently, we have two segments: Network services and systems integration business and ATM operation business. Network services and systems integration business is comprised of: connectivity and outsourcing services, systems integration and equipment sales.

     The table below provides a breakdown of the total revenues and percentage by services among our services 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)
		2007								2008								2009
Connectivity services			13,208				23.2	%			17,579				26.3	%			19,680				28.2	%
Outsourcing services			11,145				19.5	%			13,724				20.5	%			15,396				22.1	%
Systems construction			16,660				29.2	%			18,021				27.0	%			14,658				21.0	%
Systems operation and maintenance			13,867				24.3	%			15,993				23.9	%			18,989				27.3	%
Equipment sales			2,175				3.8	%			1,514				2.3	%			985				1.4	%
ATM operation business			—				—				4				0.0	%			23				0.0	%
Total revenues:			57,055				100.0	%			66,835				100.0	%			69,731				100.0	%

Connectivity Services

     We offer two categories of Internet connectivity services: connectivity services for corporate use and connectivity services for home use. Connectivity services for corporate use are based mainly on dedicated local-line connections provided by telecommunications carriers between our backbone and customers. Connectivity services for home use mainly require customers to connect to our points of presence (“POPs”) through the publicly-switched telephone network or variety of broadband access services, such as ADSL and optical lines. The last-one mile access such as dedicated access, ADSL, fiber optic, Ethernet and others are provided by large telecommunications carriers such as NTT East and West, NTT DoCoMo, Inc. (“NTT Docomo”) and others.

     Starting from fiscal year ended March 31, 2009, we have launched a broadband mobile data communication service as a mobile virtual network operator. Such new service provides inexpensive high-speed, high-capacity last-one mile access, and we will continue to introduce new variations to our Internet connectivity service to accommodate such developments.

     The following table shows the number of our connectivity service subscribers as of the dates indicated:

		As of March 31,
		2005				2006				2007				2008				2009
Connectivity services (corporate use) (1):
IP Service (-99 Mbps)			749				739				751				855				938
IP Service (100 Mbps — 999 Mbps)			90				117				161				201				225
IP Service (1 Gbps —)			24				40				63				70				94
IIJ Data Center Connectivity Service			231				247				282				288				298
IIJ FiberAccess/F and IIJ DSL/F (Broadband Services)			9,873				13,297				16,418				23,539				26,023
Others (1)			2,423				1,760				1,618				3,002				21,224
Total connectivity service (corporate use) contracts			13,390				16,200				19,293				27,955				48,802
Connectivity services (home use) :
Under IIJ Brand			65,921				60,525				55,907				51,051				46,901
hi-ho			—				—				—				189,700				179,786
OEM (2)			625,908				568,307				476,483				232,515				216,725
Total connectivity service (home use contracts)			691,829				628,832				532,390				473,266				443,412

(1)		Includes IIJ Mobile Service.
(2)		OEM services provided to other service providers.

Connectivity Services for Corporate Use

     Our lineup of connectivity services for corporate use includes: IP Service, IIJ Data Center Connectivity Service, IIJ FiberAccess/F and IIJ DSL/F (Broadband Services), dial-up services and IIJ Mobile service.

	•		IP Service and Data Center Connectivity Service. Our IP Service and Data Center Connectivity is a full-scale, high-speed access service that connects 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. As of August 2009, we offer service at speeds ranging from 64 kbps to 10 Gbps.
			We believe that as business customers continue to increase their use of the Internet as their business tool and increasingly rely on the Internet, our Internet connectivity service will continue to be the foundation of our total network solutions offerings.
			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 provide 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 outage or disruption.

	•		IIJ FiberAccess/F and IIJ DSL/F (Broadband Services). IIJ FiberAccess/F and IIJ DSL/F are broadband Internet connectivity services that uses “FLET’S” services for fiber optic access and ADSL access provided by NTT East and 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.
	•		Dial-up Access Services. We offer a variety of dial-up access services for corporate use. 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. Our main dial-up access services are our IIJ Dial-up Advanced, Enterprise Dial-up IP Service and IIJ Dial-up Standard.
	•		IIJ Mobile Service. This service, launched in January 2008, provides wireless broadband Internet connectivity exclusively for corporate customers as a MVNO. We use the wireless networks of NTT DoCoMo and EMOBILE (“EMOBILE Ltd.”) for mobile access network.
	•		Other Internet connectivity services. We offer, other than the services mentioned above, IIJ ISDN/F and IIJ Line Management/F service, which the former provides dedicated Internet access for ISDN lines and the latter the procurement of “FLET’S” services on behalf of customers.

Connectivity Services for Home Use

     We offer connectivity services for home use such as IIJ4U, IIJmio, and hi-ho. IIJmio has a variety of Internet connectivity services, such as IIJmio DSL/DF Service, IIJmio FiberAccess/DF Service, IIJmio DSL/SF Service, IIJmio FiberAccess/DC Service, IIJmio FiberAccess/SF Service and IIJmio MobileAccess Service, depending on the type of local access. Connectivity services for home use under the hi-ho brand, which we acquired in June 2007, are similar to IIJ4U. We also offer OEM services for other network operators. In December 2008, IIJmio and hi-ho introduced wireless broadband Internet connectivity service.

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 and data center-related outsourcing services.

     We believe that business customers will increasingly rely on outsourcing services for costs reduction, improve productivity and to rely on the outside expertise for a reliable network-related operation. Therefore, we will continue our efforts on improving our services with new features and enhancing the line ups by creating new services with our Internet expertise on a timely manner.

     Our outsourcing services include:

	•		Security-related outsourcing services. We offer services that protect customers’ internal network systems from unauthorized access and secure remote connections to the internal networks such as, IIJ DDoS Solution Service, IIJ Security Scan Service, IIJ Managed IPS Service, IIJ Managed Firewall Service and IIJ Secure Remote Access. We were the first ISP in Japan to provide firewall services, which we introduced in 1994.
	•		Network-related outsourcing services. We offer Internet-VPN and router rental services such as, IIJ Internet-LAN Service, IIJ SMFsx Service, IIJ Managed VPN PRO Service, SEIL Rental Service and Managed Router Service. IIJ SMFsx Service is based on the patent 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. Currently, the main service line ups are, IIJ Secure MX Service, IIJ Secure Web Gateway Service, IIJ Document Exchange Service, IIJ Download Site Service, IIJ URL Filtering Service, IIJ DNS Service and Streaming Service.
	•		Data center-related services. We offer, IIJ data center facility services, IIJ data center connectivity 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, and have earthquake-resistant construction and high-speed Internet connectivity with IIJ backbones. We also offer basic monitoring and maintenance services for the equipment. This service enhances reliability because 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.
	•		Other services. Other than the above, we offer customer support and help desk solutions, IP Phone service and other services.

Systems Integration

     Our systems integration consists of systems construction and systems operation and maintenance. Systems construction are 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,
	•		outsourcing 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,
	•		online brokerage systems for securities firms,
	•		outsourcing of websites for online businesses,
	•		re-construction of overall corporate network systems suited to increased traffic data,
	•		voice over IP systems to transmit voice among customer branch offices over the Internet,
	•		construction of wireless local area networks (“LAN”), and
	•		consultation on corporate network security.

     In the 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 network systems construction phase, we procure equipment such as servers and manage application development and software programming tasks which are, depending on the size of the project, outsourced to third parties. Network systems constructions are generally provided together with our connectivity and outsourcing services.

     In the operation phase, by utilizing data center facilities directly linked to our network, we provide a range of outsourcing 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 equipments, we take care of the customer’s entire computing environment, as well as 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 also provide our customers with basic, easy-to-order systems integration, which we refer to as IBPS, 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 connectivity and outsourcing services and systems integration, we sell third-party equipment to meet the one-stop needs of our customers together with our in-house developed router, the “SEIL Series”.

     SEIL Series. Our high-end in-house developed router, the “SEIL Series” was first released in October 2001. Currently there are; SEIL/B1, SEIL/X, SEIL/Turbo, SEIL/Plus, SEIL/128. With the SMF feature, which provides auto-configuration features, it enables customers to create a VPN network by simply connecting the network into SEIL WAN interface.

ATM Operation Business

     The ATM operation business is conducted by our consolidated subsidiary, Trust Networks which operates ATMs and its network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of 10 ATMs operations and as of June 30, 2009, it operates 26 ATMs placed in Japanese pinball shops (PACHINKO parlor). Trust Networks aims to introduce around 8,000 ATMs in four to five years from the fiscal year ending March 31, 2010.

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. The Internet network that we have created extends throughout Japan and to the United States.

     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 advanced Internet 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 extended throughout Japan and to the United States. 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 August 2009, the total capacity between Japan and the United States was 40.8Gbps.

     We lease high-capacity, high-speed digital transmission lines in Japan from various carriers. The table below shows our backbone cost.

Backbone Cost

		For the fiscal year ended March 31,
		2005				2006				2007				2008				2009
Backbone cost (thousand yen)		¥	3,550,885			¥	3,516,322			¥	3,515,934			¥	3,469,717			¥	3,692,286

Network equipment

     We use advanced equipment in our network. Our primary routers in our network are Cisco and Juniper Networks 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 and dial-up access routers to Cisco 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 August 2009, we operate 11 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 the 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.

Internet Data Centers.

     As of August 2009, we operate 15 Internet data centers in Japan which we use to offer our outsourcing data center services, five in Tokyo, two in Yokohama, and one each in Saitama, Osaka, Sapporo, Sendai, Kawaguchi, Nagoya, Kyoto and Fukuoka. These data centers are specifically designed for application hosting, co-location services and high capacity access to our networks. These data centers are mainly leased from NTT Communications, ITOCHU Techno-Solutions Corporation, and KDDI.

     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.

Network operations center and technical and customer support.

     Our NOC in Tokyo operates 24 hours a day and 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.

Our Group Companies

     We offer our services directly and with our group companies. As of August 2009, we had ten consolidated subsidiaries and four equity method investees, which all, except for IIJ-A and i-Heart Inc. (“i-Heart”), are incorporated under the laws of Japan. IIJ-A is incorporated under the laws of the state of California and the United States of America, and i-Heart is incorporated under the laws of Republic of Korea. The financial results of our consolidated subsidiaries shown in this section are prepared under generally accepted accounting principles in Japan, except for IIJ-A. 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. However, our group companies specialize in different aspects of the Internet and networking. Our customers’ main point of contact is IIJ itself. We then draw upon the resources and special capabilities of the group companies to offer total Internet solutions.

     The ATM operation business is conducted by Trust Networks.

     The table below sets out our group companies, including our subsidiaries and equity method investees and our direct and indirect ownership of each of them as of August 2009:

		Jurisdiction of				Proportion of ownership
Company Name		Incorporation				and voting interest
Consolidated Subsidiaries:
IIJ Technology Inc.		Japan					100.0	%
Net Care, Inc.		Japan					100.0	%
IIJ Financial Systems Inc.		Japan					100.0	%
Net Chart Japan Inc.		Japan					100.0	%
hi-ho Inc.		Japan					100.0	%
On-Demand Solutions Incorporated		Japan					100.0	%
IIJ Innovation Institute Inc.		Japan					100.0	%
Trust Networks Inc.		Japan					73.8	%
GDX Japan Inc.		Japan					60.2	%
IIJ America Inc.			U.S.A.				100.0	%
Equity method investees:
Taihei Computer Co., Ltd.		Japan					45.0	%
Internet Multifeed Co.		Japan					31.0	%
Internet Revolution Inc.		Japan					30.0	%
i-Heart Inc.		Republic of Korea					28.6	%

IIJ Technology Inc.

     IIJ-Tech is an important element in our provision of total network solutions to our customers. IIJ-Tech provides systems construction and systems operation and maintenance. IIJ-Tech assists customers in consultation, network and system design, project management and implementation of network systems such as web systems and e-mail systems for ISP’s.

     In May 2007, IIJ made IIJ-Tech wholly-owned through a share exchange. Before the share exchange, IIJ’s ownership in IIJ-Tech increased to 95.2% as of April 2007 through the purchase of IIJ-Tech shares from IIJ-Tech’s minority shareholders.

     IIJ-Tech had revenues of ¥25.5 billion and operating income of ¥0.8 billion for the fiscal year ended March 31, 2009. As of March 31, 2009, IIJ-Tech had 461 full-time employees, 17 of whom were seconded from IIJ.

Net Care, Inc.

     Net Care provides a broad array of support services, from monitoring and troubleshooting to network operations, Data Center operations and an end-user help desk.

     In May 2007, IIJ made Net Care a wholly-owned subsidiary through a share exchange. Before the share exchange, IIJ’s ownership in Net Care increased to 92.5% as of April 2007 through the purchase of Net Care shares from Net Care’s minority shareholders.

     Net Care had revenues of ¥3.9 billion and operating income of ¥0.3 billion for the fiscal year ended March 31, 2009. As of March 2009, Net Care had 286 employees, 11 of whom were seconded from IIJ.

IIJ Financial Systems Inc.

     IIJ-FS is a company wholly-owned by IIJ-Tech, whose business was acquired from Yamatane Co., Ltd. in October 2004. IIJ-FS provides systems integration for securities trading systems.

     IIJ-FS became IIJ’s wholly-owned consolidated subsidiary through indirect ownership due to the fact that it is wholly-owned by IIJ-Tech and IIJ-Tech became IIJ’s wholly-owned subsidiary in May 2007.

     IIJ-FS had revenues of ¥5.6 billion and operating income of ¥0.8 billion for the fiscal year ended March 31, 2009. As of March 31, 2009, IIJ-FS had 87 employees.

Net Chart Japan Inc.

     Netchart Japan Inc. (“NCJ”) was established in August 2006 as a company wholly-owned by IIJ. NCJ commenced its business operations after it succeeded the business operations of Net Chart Japan Corporation in October 2006. 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.

     NCJ had revenues of ¥1.5 billion and operating loss of ¥14 million for the fiscal year ended March 31, 2009. As of March 31, 2009, NCJ had 43 employees.

hi-ho Inc.

     hi-ho is a company wholly-owned by IIJ. In June 2007, IIJ acquired 100% of the equity of hi-ho from Panasonic Network Services Inc. (“PNS”) to take over PNS’s Internet service business for personal users and its solution business for corporate customers. A portion of the solution business for corporate customers were transferred to IIJ-Tech in April 2008. IIJ had additionally invested ¥0.3 billion as of March 2009.

     hi-ho had revenues of ¥5.2 billion and operating income of ¥26 million for the fiscal year ended March 31, 2009. As of March 31, 2009, hi-ho had 32 employees, 10 of whom were seconded from IIJ.

On-Demand Solutions Incorporated

     In April 2008, IIJ invested ¥130 million in and established ODS as our wholly-owned consolidated subsidiary to provide print-on-demand and related services.

IIJ Innovation Institute Inc.

     In June 2008, IIJ invested ¥100 million in and established IIJ-II as our wholly-owned consolidated subsidiary, which engages in research and development of Internet-related basic technology development and its business incubation. Additional ¥50 million was invested as of March 2009. On July 1, 2009, IIJ Research Laboratory was transferred into IIJ-II to strengthen the Group research and development by reclassifying the Group research and development organization.

Trust Networks Inc.

     In July 2007, IIJ invested ¥15 million in Trust Networks. In October 2007, IIJ additionally invested ¥485 million in to Trust Networks and as a result, Trust Networks became our consolidated subsidiary. IIJ had additionally invested ¥975 million from April 2008 to August 2009.

     Trust Networks operates ATMs and its network systems and receives a commission for each bank withdrawal transaction when a customer uses its serviced ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of ATMs operations. As of June 30, 2009, Trust Networks operated 26 ATMs .

     Trust Networks recorded revenue of ¥23 million and operating loss of ¥715 million for the fiscal year ended March 31, 2009. As of March 31, 2009, Trust Networks had 10 employees, five of whom were seconded from us.

GDX Japan Inc.

     In April 2007, IIJ and GDX Network, Inc., a company incorporated in the United States, established a joint venture company, GDX, to provide a message exchange network service in Japan. IIJ invested ¥300 million in GDX and GDX became our consolidated subsidiary. IIJ had additionally invested ¥115 million from April 2008 to August 2009.

     GDX recorded operating loss of ¥175 million for the fiscal year ended March 31, 2009.

IIJ America Inc.

     IIJ-A is a U.S.-based ISP, catering mostly to U.S.-based operations of Japanese companies.

     Reflecting the fact that IIJ-Tech, IIJ-A’s minority shareholder with 8.7% ownership, became wholly-owned by us on May 11, 2007, IIJ-A became our wholly-owned consolidated subsidiary.

     IIJ-A had revenues of $12 million and operating income of $0.07 million for the fiscal year ended December 31, 2008. As of March 31, 2009, IIJ-A had 28 employees, five of whom were seconded from IIJ.

Taihei Computer Co., Ltd.

     In July 2007, IIJ invested ¥235 million in Taihei Computer Co., Ltd., (“TCC”), one of the subsidiaries of Hirata Corporation, which manages customer loyalty reward program systems. As a result of this investment, TCC became our equity method investee with a 45.0% ownership.

Internet Multifeed Co.

     Internet Multifeed Co. (“Multifeed”) provides the location and facilities for directly connecting high-speed Internet backbones with content servers to make distribution on the Internet more efficient. Its technology was developed jointly with the NTT Group. Multifeed launched a new IX (Internet eXchange — where major ISPs exchange network traffic) service named JPNAP Tokyo 1 in Tokyo in May 2001 and expanded the service to Osaka in December 2001. Multifeed launched a new IX service named JPNAP Tokyo II in Tokyo in April 2008. We account Multifeed as an equity method investee with a 31.0% ownership.

Internet Revolution Inc.

     In February 2006, IIJ and Konami Corporation established a joint venture company, i-revo, to operate comprehensive sites. IIJ invested ¥750 million in i-revo. We account i-revo as an equity method investee with a 30.0% ownership.

i-Heart Inc.

     In May 2000, we entered into the i-Heart joint venture with South Korean companies with a total investment by us of ¥89 million. i-Heart is our equity method investee (28.6% ownership).

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 years.

		For the fiscal year ended March 31,
		2007				2008				2009
		(millions of yen)
Capital expenditures, including capitalized leases (1)		¥	3,953			¥	6,078			¥	7,006

     Most of our capital expenditures relate to the expansion and improvement of our existing network, including the installation of the routers and servers necessary to offer services on our network. Capital expenditures, including capitalized leases for fiscal year ended March 31, 2009 were ¥7.0 billion, larger than the previous fiscal years largely because of the upgrade in backbone routers, which comes once in every four or five years and new investments for back-office systems.

     We believe that our expected capital expenditures, including capitalized leases, for the fiscal year ending March 31, 2010 related to our network services and systems integration business will be lower than the amount for the fiscal year ended March 31, 2009. If the ATM operation business start up in accordance with its plan, additional capital expenditures, including capitalized leases related to the placement of ATMs are expected. In total, we expect that our capital expenditures, including capitalized leases, for the fiscal year ended March 31, 2010 to slightly increase from the amount from the previous fiscal year.

     We recorded losses on disposal of property and equipment of ¥151 million, ¥72 million and ¥443 million for the fiscal years ended March 31, 2007, 2008 and 2009, respectively. The losses for the fiscal year ended March 31, 2007 and 2008 were mainly due to disposal of software such as for back-office systems, and network equipment related to the closing of a network operation center. The losses for the fiscal year ended March 31, 2009 increased as there were disposal of network equipment and software due to the cancellation from a certain large customer and the discontinuance in some services.

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 headquarter is in Tokyo. In addition, we have ten branch or sales offices in Osaka, Nagoya, Fukuoka, Sapporo, Sendai, Toyama, Hiroshima, Yokohama, Toyota and Okinawa in order to cover the major metropolitan areas in which the majority of large Japanese companies operate. As of March 31, 2009, we had 298 people working in sales and marketing.

     IIJ organizes its sales personnel into four distinct, separate departments: the Sales Department, the Marketing Planning and Development Division, the Operation Management and Coordination Division, and Strategic Sales.

     Also, its Sales Department is divided into seven divisions:

	•		Five divisions focus on its total network solutions and work with large corporate clients, including financial institutions, manufacturers, retail companies and others. In order to provide total network solutions, personnel in its sales divisions work closely with other IIJ Group companies such as IIJ-Tech as well as with other non-IIJ Group companies.
	•		One division focuses on total network solutions and works with governmental institutions, and universities and other schools.
	•		One division focuses on developing and strengthening partnerships with sales agents, including large telecommunications carriers and systems integrators to expand our marketing reach.

     In addition, IIJ has sales personnel in the branch or sales offices indicated above.

     IIJ’s Marketing Planning and Development Division mainly makes and conducts promotion plans on IIJ’s products and services. IIJ’s Operation Management and Coordination Division handles administrative issues. Strategic Sales is responsible for the planning and management on the sales figures, processes and other information.

Customers

     We had approximately 6,500 business and other institutional customers and approximately 440,000 individuals, which includes individuals subscribing to OEM services, as of March 31, 2009. Our main customers continue to be major corporations, including ISPs.

Research and Development

Research and Development Organization

     Our research and development are conducted by IIJ Research Laboratory, IIJ-II and other departments.

     IIJ Research Laboratory. IIJ Research Laboratory was established as a research organization of IIJ in April 1998 to engage in the research and development of new basic network technologies. Through our IIJ Research Laboratory, we participate in various research and development activities in cooperation with organizations from the private and academic sectors to promote the deployment and implementation of IPv6. IIJ Research Laboratory is also engaged in the research and development activities related to e-mail technologies and network traffic analysis. On July 1, 2009, IIJ Research Laboratory was transferred into IIJ-II to reorganize and strengthen the Group’s research and development capabilities.

     Other Departments. Other departments, such as the Service Business Department, Network Service Department and SEIL Business Unit 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.

     IIJ Innovation Institute. IIJ established IIJ-II in June 2008 as a wholly-owned subsidiary, which engages in research and development of Internet-related basic technology development and its business incubation. IIJ-II is currently focusing on the research and development of the “Distributed and Parallel Processing Platform” for very large data sets. IIJ Research Laboratory was transferred into IIJ-II to reorganize and strengthen the Group’s research and development capabilities on July 1, 2009.

Research and Development Strategy

     Our primary research and development objective is to continue to develop innovative services, applications and products that will 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 the 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 basic technology since the establishment of IIJ Research Laboratory in 1998. In June 2008, IIJ-II which engages in research and development of Internet-related basic technology development and its business incubation was established. 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:

	•		continued improvement of our SEIL router and SMF, systems which we developed specifically to be integrated into IIJ’s network-related services,
	•		research and development of the latest e-mail implementation technologies and spam countermeasures,
	•		research and development of IPv6-based mobile communications technology,
	•		research relating to the methodology of configuration of routers and other servers,
	•		research relating to the technology for next generation IP networks,
	•		research relating to the behavior of Internet routing systems,
	•		research of the Internet traffic monitoring and management,
	•		research and development of the Distributed and Parallel Processing Platform for very large data sets,
	•		research and analysis of the characteristics of the captured malware and spam mails, and,
	•		development relating to proprietary video distribution server software specifically designed for digital television.

     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, 2007, 2008 and 2009, our research and development expenses were ¥177 million, ¥240 million and ¥415 million, respectively, most of which was personnel expense. The level of research and development expenditures is low in relation to our total costs primarily because we do not engages 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 other suppliers, such as Check Point Software Technologies Ltd., WatchGuard Technologies, Inc., Trend Micro Incorporated, RSA Security Inc., NRI Secure Technologies, Ltd., MX Logic, Inc and Adobe Systems Software Ireland Limited.

     We have purchased licenses from the companies 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 countries. As of August 31, 2009, 42 registrations had been granted, with four pending application.

Patents

     We have applied for patent registrations in relation to our technology in Japan and the United States. As of August 31, 2009, six registrations had been granted, with five pending applications. The latest acquired patent is for a system to centrally administer communications equipment and other devices on WAN and other closed networks developed by IIJ and implemented in one of our competitive services, SMF.

Legal Proceedings

     We are involved in normal claims and other legal proceedings in the ordinary course of business. Except as noted below, 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.

     In December 2001, a class action complaint alleging violations of the federal securities laws was filed against the Company, naming the Company, certain of its officers and directors as defendants, and underwriters of the Company’s initial public offering. Similar complaints have been filed against over 300 other issuers that have had initial public offerings since 1998 and such actions have been included in a single coordinated proceeding in the Southern District of New York. An amended complaint was filed on April 24, 2002 alleging, among other things, that the underwriters of the Company’s initial public offering violated the securities laws (i) by failing to disclose in the offering’s registration statement certain alleged compensation arrangements entered into with the underwriters’ clients, such as undisclosed commissions or tie in agreements to purchase stock in the after market, and (ii) by engaging in manipulative practices to artificially inflate the price of the Company’s stock in the after market subsequent to the initial public offering. On July 15, 2002, the Company joined in an ‘omnibus’ motion to dismiss the amended complaint filed by the issuers and individuals named in the various coordinated cases. On February 19, 2003, the Court ruled on the motions to dismiss. The Court granted the Company’s motion to dismiss the claims against it under Rule 10b-5 promulgated under the Exchange Act due to the insufficiency of the allegations against the Company. The motions to dismiss the claims under Section 11 of the Securities Act were denied for virtually all of the defendants in the consolidated cases, including the Company. In June 2003, the Company conditionally approved a proposed partial settlement with the plaintiffs in this matter. The Company, along with the settling issuer defendants, filed a motion seeking the court’s preliminary approval of the settlement. The settlement would have provided, among other things, a release of the Company and of the individual officer and director defendants for the alleged wrongful conduct in the amended complaint in exchange for a guarantee from the Company’s insurers regarding recovery from the underwriter defendants and other non-monetary consideration from the Company. While the partial settlement was pending approval, the plaintiffs continued to litigate against the underwriter defendants. The District Court directed that the litigation proceed with a number of “focus cases” rather than all of the 310 cases that had been consolidated. The Company’s case is not one of these focus cases.

     On October 13, 2004, the District Court certified the focus cases as class actions in the ongoing litigation. The underwriter defendants appealed that ruling, and on December 5, 2006, the Court of Appeals for the Second Circuit reversed the District Court’s class certification decision. On April 6, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing, and on May 18, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing en banc. In light of the Second Circuit opinion, liaison counsel for all issuer defendants, including the Company, informed the District Court that the settlement could not be approved, because the defined settlement class, like the litigation class, could not be certified. On June 25, 2007, the District Court entered an order terminating the proposed settlement. On August 14, 2007, the plaintiffs filed their second consolidated amended complaints against the six focus cases and on September 27, 2007, again moved for class certification. On November 12, 2007, certain of the defendants in the focus cases moved to dismiss the second consolidated amended class action complaints. On March 26, 2008, the District Court denied the motions to dismiss except as to Section 11 claims raised by those plaintiffs who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period. The motion for class certification was withdrawn without prejudice on October 10, 2008. On February 25, 2009, liaison counsel for the plaintiffs informed the District Court that a settlement had been agreed to in principle, subject to formal approval by the parties, and preliminary and final approval by the District Court. On April 2, 2009, a stipulation and agreement of settlement among the plaintiffs, issuer defendants and underwriter defendants was submitted to the District Court for preliminary approval. If the District Court grants the motion for preliminary approval, notice will be given to all class members of the settlement, a fairness hearing will be held and if the District Court determines that the settlement is fair to the class members, the settlement will be approved. There can be no assurance that this proposed settlement will be approved and implemented in its current form, or at all. Due to the inherent uncertainties of litigation and because the settlement approval process is at a preliminary stage, the ultimate outcome of the matter is uncertain.

Regulation 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. The summary of the regulations under the current Telecommunications Business Law is as follows:

     The Telecommunications Business Law applies to the telecommunications business, except for the telecommunications business exempt under the Telecommunications Business Law (“Exempted Business”)⁽¹⁾. The term “telecommunications business” is defined under the Telecommunications Business Law as the 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 within the definition of telecommunications business, not Exempted Business, and therefore is subject to the Telecommunications Business Law.

	(i)		the telecommunications business which exclusively provides telecommunications services to a single person (except one being a telecommunications carrier);
	(ii)		the 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 there of is also to be established, or with telecommunications facilities which are below the standards stipulated in the ministerial ordinance of the MIC; and
	(iii)		the telecommunications business installing no telecommunications circuit facilities 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 being handled by a person who operates the telecommunications business listed above.

Start-up of Services

	•		Registration
			Registration with the Minister of the MIC is required for a telecommunications business which meets the following two requirements established by the ministerial ordinance of the MIC: (i) areas of installation of terminal-related transmission facilities are limited to a single municipality (city, town or village) and (ii) areas of installation of relay-related transmission facilities are limited to a single prefecture.
	•		Notification

Notification to the MIC is required for a telecommunications business for which the requirement of the registration does not apply. Our business is subject to this notification requirement ⁽¹⁾.

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 Basic Telecommunications Services (universal services specified by the ministerial ordinance of the MIC, i.e., 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 other than 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 personal life and property in case of natural disaster, calls to police agencies regarding crimes, and calls to the fire brigade (“Emergency Exception”)
	•		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 the facilities which meet the criteria specified by the ministerial ordinance of the MIC as being the 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 other than 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 will be 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 or Category II Designated Telecommunications Facilities described below.
	•		Approval from the Minister of the MIC required for Category I Designated Telecommunications Facilities.
	•		Prior notification to the Minister of the MIC required for Category II Designated Telecommunications Facilities (i.e., the facilities which meet the criteria provided by the ministerial ordinance of the MIC as being the mobile telecommunications facilities used for the 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 installs telecommunications circuit facilities must 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 conformity with the technical standards provided in the ministerial ordinance of the MIC. Such telecommunications carriers shall confirm that its telecommunications facilities are in compliance with the technical standards specified in the ministerial ordinance of the MIC.

	•		A telecommunications carrier that provides Basic Telecommunications Services must maintain its telecommunications facilities for provision of Basic Telecommunications Services in conformity with the technical standards provided in the ministerial ordinance of the MIC.
	•		Telecommunications carriers that install telecommunications circuit facilities or provide Basic Telecommunications Services must establish their own administrative rules in accordance with the ministerial ordinance of the MIC in order to secure the reliable and stable provision of telecommunications services. These administrative rules must regulate the operation and manipulation of telecommunications facilities and the safeguarding, inspecting and testing regarding the construction, maintenance and administration of telecommunications facilities, etc. as provided for by the ministerial ordinance of the MIC. Such administrative rules must be submitted to the Minister of the MIC prior to the commencement of operations, and changes must be submitted to the Minister of the MIC once after they are implemented without delay.

          Order to Improve Business Activities

•

The Minister of the MIC may, if it is deemed that 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 the authorization on the entire or a part of the relevant telecommunications business by the Minister of the MIC.

          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 in “Our Group Companies” above.

D. Property, Plants and Equipment.

     The information required by this item is in “ — Network” above and in Note 6 “Property and Equipment” and Note 8 “Leases” to our consolidated financial statements included in this annual report on Form-20F.

Item 4A. Unresolved Staff Comments

     None.

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 are a provider of a comprehensive range of Internet connectivity services and network solution services 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 have expanded the Group business to outsourcing services and systems integration along with the expansion of usage of the Internet by customers.

     Our primary sources of revenue are connectivity services, outsourcing services, systems integration and equipment sales. Connectivity services consist of connectivity services for corporate use and connectivity services for home use. For outsourcing services, we provide services such as network security services, mail and web server hosting services, managed router services and Internet data center services. 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. For equipment sales, we provide equipment as part of our provision of total network.

     In addition, we entered the ATM operation business through our consolidated subsidiary, Trust Networks, which was established in July 2007. Trust Networks operates ATMs and its network systems to provide ATMs service and receives a commission for each bank withdrawal transaction when a customer uses their ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of 10 ATMs operations. As of June 30, 2009, Trust Networks operates 26 ATMs placed in PACHINKO parlor. Trust Networks aims to introduce around 8,000 ATMs in four to five years from the fiscal year ending March 31, 2010.

     Starting from the fiscal year ended March 31, 2009, we have disclosed revenues and costs for the ATM operation business for fiscal years ended March 31, 2008 and 2009 because the amount of losses related to these business has become material.

     Currently, we have two segments: Network services and systems integration business and ATM operation business. Network services and systems integration business is comprised of: Connectivity and outsourcing services, Systems integration and Equipment sales.

     Net revenue of network services and systems integration business and ATM operation business before elimination of intersegment revenues were ¥70.0 billion and ¥23 million, respectively, of our total net revenue in the fiscal year ended March 31, 2009. Our consolidated net revenue for the fiscal year ended March 31, 2009 was ¥69.7 billion.

     Substantially all of our revenues are from our customers in Japan, and we are the main point of contact for customers for the various services we provide.

     We refer to our subsidiaries and certain affiliates as our group companies, and we have invested heavily in and exercise significant influence over these companies. For the fiscal year ended March 31, 2009, we consolidated the results of operations of ten subsidiaries included among our group companies — IIJ-Tech, IIJ-A, Net Care, IIJ-FS, NCJ, hi-ho, Trust Networks, GDX, IIJ-II and ODS. We account for our investments in the affiliated companies by the equity method. 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”.

          Results of Operations

     As an aid to understanding our operating results, the following tables show items from our statement of income for the periods indicated in millions of yen (or thousands of U.S. dollars) 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,
		2007								2008								2009
		(millions of yen except for percentage data)																								(thousands
																										of U.S.
																										dollars(1))
REVENUES:
Connectivity and outsourcing services:
Connectivity services (corporate use)		¥	11,239				19.7	%		¥	12,149				18.2	%		¥	13,142				18.8	%		$	132,551
Connectivity services (home use)			1,969				3.5				5,430				8.1				6,538				9.4				65,934
Outsourcing services (2)			11,145				19.5				13,724				20.5				15,396				22.1				155,278
Total			24,353				42.7				31,303				46.8				35,076				50.3				353,763
Systems integration: (3)
Systems construction			16,660				29.2				18,021				27.0				14,658				21.0				147,841
Systems operation and maintenance			13,867				24.3				15,993				23.9				18,989				27.3				191,514
Total			30,527				53.5				34,014				50.9				33,647				48.3				339,355
Equipment sales			2,175				3.8				1,514				2.3				985				1.4				9,930
ATM operation business (4)			—				—				4				0.0				23				0.0				237
Total revenues			57,055				100.0				66,835				100.0				69,731				100.0				703,285
COST AND EXPENSES:
Cost of connectivity and outsourcing services:
Backbone cost			3,516				6.2				3,470				5.2				3,692				5.3				37,239
Local access line cost (5)			4,616				8.1				7,102				10.6				8,113				11.6				81,828
Other connectivity cost			331				0.6				370				0.6				473				0.7				4,771
Depreciation and amortization			2,639				4.6				2,928				4.4				3,468				5.0				34,982
Other			9,443				16.5				12,170				18.2				13,572				19.5				136,870
Total cost of connectivity and outsourcing services			20,545				36.0				26,040				39.0				29,318				42.1				295,690
Cost of systems integration:
Cost of equipment sales related to systems integration			4,206				7.3				4,409				6.6				4,931				7.0				49,733
Other			19,323				33.9				21,117				31.6				20,612				29.6				207,884
Total cost of systems integration			23,529				41.2				25,526				38.2				25,543				36.6				257,617
Cost of equipment sales			1,894				3.4				1,300				1.9				863				1.2				8,704
Cost of ATM operation business (4)			—				—				17				0.0				422				0.6				4,259
Total cost			45,968				80.6				52,883				79.1				56,146				80.5				566,270
Sales and marketing			3,439				6.0				4,329				6.5				4,631				6.6				46,703
General and administrative			3,971				7.0				4,624				6.9				5,622				8.1				56,701
Research and development			177				0.3				240				0.4				415				0.6				4,187
Total cost and expenses			53,555				93.9				62,076				92.9				66,814				95.8				673,861
OPERATING INCOME			3,500				6.1				4,759				7.1				2,917				4.2				29,424
OTHER INCOME (EXPENSES):
Interest income			23				0.0				63				0.1				45				0.1				455
Interest expense			(397	)			(0.7	)			(438	)			(0.6	)			(408	)			(0.6	)			(4,117	)
Foreign exchange gains (losses)			(0	)			(0.0	)			2				0.0				(29	)			(0.0	)			(288	)
Net gains on sales of other investments			3,230				5.7				218				0.3				16				0.0				158
Losses on write-down of other investments			(1,363	)			(2.4	)			(289	)			(0.4	)			(524	)			(0.8	)			(5,288	)
Other — net			56				0.1				47				0.0				17				0.0				175
Other income (expenses) — net			1,549				2.7				(397	)			(0.6	)			(883	)			(1.3	)			(8,905	)
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE (BENEFIT), MINORITY INTERESTS IN EARNINGS (LOSSES) OF SUBSIDIARIES AND EQUITY IN NET INCOME (LOSS) OF EQUITY METHOD INVESTEES			5,049				8.8	%			4,362				6.5	%			2,034				2.9				20,519
INCOME TAX EXPENSE (BENEFIT)			(804	)			(1.4	)%			(861	)			(1.3	)%			1,002				1.4				10,113
MINORITY INTERESTS IN (EARNINGS) LOSSES OF SUBSIDIARIES			(233	)			(0.4	)			97				0.1				352				0.5				3,555
EQUITY IN NET INCOME (LOSS) OF EQUITY METHOD INVESTEES			(210	)			(0.3	)			(143	)			(0.2	)			35				0.0				354
NET INCOME		¥	5,410				9.5	%		¥	5,177				7.7	%		¥	1,419				2.0	%		$	14,315

Year Ended March 31, 2009 Compared to the Year Ended March 31, 2008

Total revenues

     Our total revenues increased 4.3% to ¥69.7 billion for the fiscal year ended March 31, 2009 from ¥66.8 billion for the previous fiscal year. These increases were primarily due to an increase in monthly recurring revenues from connectivity and outsourcing services and systems operation and maintenance of systems integration revenues.

     Connectivity and outsourcing services revenues. Revenues from connectivity services and outsourcing services, which comprise our connectivity services for corporate use, connectivity services for home use, outsourcing services increased by 12.1% to ¥35.1 billion for the fiscal year ended March 31, 2009 from ¥31.3 billion for the previous fiscal year.

	•		Connectivity services for corporate use. Revenues from connectivity services for corporate use increased by 8.2% to ¥13.1 billion for the fiscal year ended March 31, 2009 from ¥12.1 billion for the previous fiscal year. IP service revenues, the service mainly used for corporate headquarters and data centers, increased by 2.8% for the fiscal year ended March 31, 2009 compared to the previous year and broadband services increased by 8.7% for the fiscal year ended March 31, 2009 as a result of steady demands for network expansion and the shift to higher bandwidths. Contracts of over 1 Gbps increased to 94 contracts compared to 70 contracts at the end of March 2008, especially among content business operators and ISPs. IIJ Mobile service, a mobile data communication services for corporate use are performing well, contributing to revenue growth.
	•		Connectivity services for home use. Despite the decrease in revenues from IIJ4U and OEM, revenues from connectivity services for home use increased by 20.4% to ¥6.5 billion for the fiscal year ended March 31, 2009 from ¥5.4 billion for the previous fiscal year. This significant increase was mainly due to additional revenues incurred by hi-ho, which we acquired in June 2007, of ¥5.0 billion (12 months) for the fiscal year ended March 31, 2009 compared to ¥3.8 billion for the fiscal year ended March 31, 2008 (10 months).
	•		Outsourcing services. Our outsourcing services revenues increased by 12.2% to ¥15.4 billion for the fiscal year ended March 31, 2009 from ¥13.7 billion for the previous fiscal year. This increase was mainly due to a steady increase in revenues from services such as security-related and e-mail related outsourcing services for anti-spam protection, data center services and network related solutions. The steady increase in outsourcing services revenues was affected by an increase in demand for outsourcing services by corporate customers.

     Systems integration revenues. Our revenues from systems integration, which include equipment sales related to systems integration, decreased by 1.1% to ¥33.6 billion for the fiscal year ended March 31, 2009 from ¥34.0 billion for the previous fiscal year. The decrease was due to a decrease in systems construction revenues of 18.7% for the fiscal year ended March 31, 2009 compared to the previous fiscal year, offsetting the increase in recurring revenues from systems operation and maintenance of 18.7% for the fiscal year ended March 31, 2009 compared to the previous fiscal year. Systems construction revenues were significantly affected by the weak Japanese economy, resulting in many large projects getting delayed or postponed. The order backlog for systems integration and equipment sales as of March 31, 2009 was ¥14.9 billion, a decrease of 6.5% compared to March 31, 2008. The order backlog for systems construction including equipment sales as of March 31, 2009 decreased by 39.9% to ¥2.9 billion and the order backlog for systems operation and maintenance increased by 7.7% to ¥12.0 billion compared to the amount as of March 31, 2008, respectively.

     Equipment sales revenues. Our equipment sales decreased by 35.0% to ¥1.0 billion for the fiscal year ended March 31, 2009 from ¥1.5 billion for the previous fiscal year. Equipment sales revenues has been decreasing year by year because we have been focusing on providing systems construction that have higher margin to our corporate customers instead of providing equipment sales which has a relatively lower margin.

     ATM Operation Business revenues. Our revenues from the ATM operation business were ¥23 million for the fiscal year ended March 31, 2009 compared to ¥4 million for the previous fiscal year. The ATM operation business is conducted by our consolidated subsidiary, Trust Networks which operates ATMs and its network systems to provide ATMs service. It receives commission for each bank withdrawal transaction when customers use their serviced ATMs. During the fiscal year ended March 31, 2009, Trust Networks completed its field test of 10 ATMs operations.

Total cost of revenues

     Our total cost of revenues increased by 6.2% to ¥56.1 billion for the fiscal year ended March 31, 2009 from ¥52.9 billion for the previous fiscal year. The increase was mainly due to the cost of connectivity and outsourcing services revenues and the additional cost related to ATM operation business.

     Cost of connectivity and outsourcing services revenues. Our cost of connectivity and outsourcing services revenues increased by 12.6% to ¥29.3 billion for the fiscal year ended March 31, 2009 from ¥26.0 billion for the previous fiscal year. The increase was largely due to the increase in network operation related costs including upgrade of large backbone routers which comes once in every four to five years and the additional cost incurred by hi-ho of ¥4.5 billion (12 months) for the fiscal year ended March 31, 2009 compared to ¥4.0 billion for the fiscal year ended March 31, 2008 (10 months). Backbone costs for the fiscal year ended March 31, 2009 increased by 6.4% to ¥3.7 billion from ¥3.5 billion for the previous fiscal year. Local access line costs for the fiscal year ended March 31, 2009 increased by 14.2% to ¥8.1 billion from ¥7.1 billion for the previous fiscal year. Additionally, costs related to GDX and ODS, newly established subsidiaries to engage in new business developments, were ¥162 million for the fiscal year ended March 31, 2009 and ¥26 million for the previous fiscal year. The gross margin ratio in connectivity and outsourcing services revenues, which is the ratio of (1) the amount obtained by subtracting cost of connectivity and outsourcing services revenues from connectivity and outsourcing services revenues to (2) connectivity and outsourcing services revenues, decreased to 16.4% for the fiscal year ended March 31, 2009 from 16.8% for the previous fiscal year.

     Cost of systems integration revenues. Our cost of systems integration revenues were ¥25.5 billion for the fiscal year ended March 31, 2009, nearly the same amount as the previous fiscal year. While purchasing costs largely decreased along with the decrease in systems construction revenues, outsourcing and personnel related and network operation related costs increased compared to the previous fiscal year. The gross margin ratio in systems integration revenues, which is the ratio of (1) the amount obtained by subtracting cost of systems integration revenues from systems integration revenues to (2) systems integration revenues, decreased to 24.1% for the fiscal year ended March 31, 2009 from 25.0% for the previous fiscal year.

     Cost of equipment sales. Our cost of equipment sales decreased by 33.6% to ¥0.9 billion for the fiscal year ended March 31, 2009 from ¥1.3 billion for the previous fiscal year. The decrease is primary due to the decrease in equipment sales revenues. The gross margin ratio, as the figure subtracting cost of equipment sales from equipment sales revenues to equipment sales revenues, in equipment sales decreased to 12.3% for the fiscal year ended March 31, 2009 from 14.2% for the previous fiscal year.

     Cost of ATM Operation Business. Cost of the ATM operation business was ¥422 million for the fiscal year ended March 31, 2009 compared to ¥17 million for the previous fiscal year. Gross margin was a loss of ¥399 million for the fiscal year ended March 31, 2009 compared to ¥13 million for the previous fiscal year. Cost of ATM operation business increased as Trust Networks placed 10 ATMs as a testing phase during the fiscal year ended March 31, 2009.

Total costs and expenses

     Total costs and expenses, which include total cost of revenues, sales and marketing expenses, general and administrative expenses and research and development expenses, increased by 7.6% to ¥66.8 billion for the fiscal year ended March 31, 2009 from ¥62.1 billion for the previous fiscal year. The increase in total costs and expenses was primarily a result of an increase in the cost of connectivity and outsourcing services, including the additional cost related to hi-ho services, the new subsidiaries: GDX and ODS, the additional cost related to ATM operation business, and the increase in sales and marketing expenses, general and administrative expenses and research and development expenses including expenses related to new subsidiaries such as IIJ-II.

     Sales and marketing. Sales and marketing expenses increased by 7.0% to ¥4.6 billion for the fiscal year ended March 31, 2009 from ¥4.3 billion for the previous fiscal year. The increase was mainly due to the increase in personnel related expenses of ¥0.4 billion and the additional expenses related to hi-ho of 12 months.

     General and administrative. General and administrative expenses increased by 21.6% to ¥5.6 billion for the fiscal year ended March 31, 2009 from ¥4.6 billion for the previous fiscal year. The increase was mainly due to the increase in expenses related to four new subsidiaries and personnel related expenses. There were also losses of ¥0.4 billion in the fourth quarter of the fiscal year including disposal of property and equipment for our services and disposal of software such as for back-office systems.

     Research and development. Research and development expenses increased by 72.7% to ¥415 million for the fiscal year ended March 31, 2009 from ¥240 million for the previous fiscal year. The increase was primary due to an increase in personnel expenses related to research and development. IIJ established IIJ-II in June 2008 which engages in research and development of Internet-related basic technology development.

Operating income

     As a result of the foregoing factor, operating income decreased by 38.7% to ¥2.9 billion for the fiscal year ended March 31, 2009 from ¥4.8 billion for the previous fiscal year as gross margin for systems construction decreased while there were operating losses for four new subsidiaries of ¥1.3 billion including the loss from Trust Networks of ¥0.7 billion.

Other income (expenses)-net

     Other expenses-net of ¥0.9 billion was recorded for the fiscal year ended March 31, 2009, compared to net other expense of ¥0.4 billion for the previous fiscal year. There were net impairment losses of ¥0.5 billion on nonmarketable and available-for-sale equity securities.

     Interest income. Interest income was ¥45 million for the fiscal year ended March 31, 2009, compared to ¥63 million for the previous fiscal year. The decrease mainly resulted from the drop in the interest rate in Japan.

     Interest expense. Interest expense, comprised of interest expense in respect of bank borrowings and capital lease obligations, amounted to ¥408 million for the fiscal year ended March 31, 2009 compared to ¥438 million for the previous fiscal year. The decrease was mainly due to the decrease in bank borrowings.

     Foreign exchange gains (losses). Foreign exchange losses amounted to ¥29 million for the fiscal year ended March 31, 2009 compared to gains of ¥1 million for the previous fiscal year.

     Net gains on sales of other investments. For the fiscal year ended March 31, 2009, we recorded net gains on sales of other investments of ¥16 million, which resulted from the sale of certain nonmarketable and available-for-sale security, compared to net gains of ¥218 million for the previous fiscal year.

     Losses on write-down of other investments. For the fiscal year ended March 31, 2009, we recorded losses on write-down of other investments of ¥524 million from nonmarketable, available-for-sale securities and others compared to losses of ¥289 million for the previous fiscal year.

     Other-net. For the fiscal year ended March 31, 2009, we recorded other income of ¥17 million, most of which is dividend income, compared to income of ¥47 million, most of which is also dividend income, for the previous fiscal year.

Income from operations before income tax expense (benefit), minority interests in losses of subsidiaries and equity in net income (loss) of equity method investees

     We recorded income from operations before income tax expense, minority interests in losses of subsidiaries and equity in net income of equity method investees of ¥2.0 billion for the fiscal year ended March 31, 2009 compared to income from operations before income tax benefit, minority interests in losses of subsidiaries and equity in net loss of equity method investees of ¥4.4 billion for the previous fiscal year. The decrease primarily reflects the decrease in operating income and the increase in net impairment loss on equity securities.

Income tax expense (benefit)

     For the fiscal year ended March 31, 2009, we recorded an income tax expense of ¥1.0 billion compared to income tax benefit of ¥0.9 billion for the previous fiscal year. The income tax expense for the fiscal year ended March 31, 2009 was mainly due to deferred tax expenses of ¥0.6 billion whereas there was deferred tax benefit of ¥1.7 billion for the previous fiscal year, resulting from the release of valuation allowance against deferred income tax assets related to tax operating loss carryforwards and other temporary differences. We started the consolidated tax declaration for the fiscal year ended March 31, 2009.

Minority interests in (earnings) losses of subsidiaries

     For the fiscal year ended March 31, 2009, minority interests in losses of subsidiaries was ¥352 million compared to minority interests in losses ¥97 million for the previous fiscal year, mainly related to GDX and Trust Networks.

Equity in net income (loss) of equity method investees

     Equity in net income of equity method investees was ¥35 million for the fiscal year ended March 31, 2009 compared to equity in net losses of ¥143 million for the previous fiscal year. While equity in net income of equity method investees was recorded in Multifeed, equity in net loss of equity method investees was mainly recorded in i-revo.

Net income

     Net income for the fiscal year ended March 31, 2009 was ¥1.4 billion compared with ¥5.2 billion for the previous fiscal year. The decrease primarily reflects the decrease in operating income of ¥1.8 billion compared to the previous year affected by the decrease in gross margin from systems construction, impairment losses on nonmarketable and available-for-sale equity securities of ¥0.5 billion compared to net gains of ¥0.2 billion for the previous fiscal year and income tax expense of ¥1.0 billion compared to recording of an income tax benefit of ¥0.9 billion for the previous fiscal year. There were also additional operating losses related to four new subsidiaries of ¥1.3 billion for the fiscal year ended March 31, 2009 compared to ¥0.2 billion for the previous fiscal year.

Year Ended March 31, 2008 Compared to the Year Ended March 31, 2007

Total revenues

     Our total revenues increased 17.1% to ¥66.8 billion for the fiscal year ended March 31, 2008 from ¥57.1 billion for the previous fiscal year. These increases were primarily due to an increase in monthly recurring revenues from connectivity and outsourcing services and systems operation and maintenance of systems integration revenues.

     Connectivity and outsourcing services revenues. Revenues from connectivity services and outsourcing services, which comprise our connectivity services for corporate use, connectivity services for home use and outsourcing services, increased by 28.5% to ¥31.3 billion for the fiscal year ended March 31, 2008 from ¥24.4 billion for the previous fiscal year.

	•		Connectivity services for corporate use. Revenues from connectivity services for corporate use increased by 8.1% to ¥12.1 billion for the fiscal year ended March 31, 2008 from ¥11.2 billion for the previous fiscal year. The increase was mainly due to an increase in revenues from IP services, the service mainly used for corporate headquarters and data centers, along with the shift to higher bandwidth, and an increase in revenues from broadband services along with the expansion of broadband utilization in the corporate internal network.
	•		Connectivity services for home use. Despite the decrease in revenues from IIJ4U and OEM, revenues from connectivity services for home use increased by 175.8% to ¥5.4 billion for the fiscal year ended March 31, 2008 from ¥2.0 billion for the previous fiscal year. This significant increase was mainly due to additional revenues for the fiscal year ended March 31, 2008 of ¥3.8 billion from hi-ho, which we acquired in June 2007.
	•		Outsourcing services. Our outsourcing services revenues increased by 23.1% to ¥13.7 billion for the fiscal year ended March 31, 2008 from ¥11.1 billion for the previous fiscal year. This increase was mainly due to a steady increase in revenues from services such as security and e-mail related services for anti-spam protection, data center services, network related solutions, customer support and Wide-are Ethernet services. The steady increase in outsourcing services revenues is affected by an increase in demand for outsourcing services by corporate customers.

     Systems integration revenues. Our revenues from systems integration, which include equipment sales related to systems integration, increased by 11.4% to ¥34.0 billion for the fiscal year ended March 31, 2008 from ¥30.5 billion for the previous fiscal year. The increase was due to an increase in systems construction, a one-time revenues, and a continuous increase in recurring revenues from systems operation and maintenance. The order backlog for systems integration and equipment sales as of March 31, 2008 was ¥15.9 billion, an increase of 68.0% compared to March 31, 2007. The order backlog for systems construction including equipment sales increased by 35.3% to ¥4.8 billion and the operation and maintenance of the systems increased by 87.3% to ¥11.1 billion compared to the amount as of March 31, 2007.

     Equipment sales revenues. Our equipment sales decreased by 30.3% to ¥1.5 billion for the fiscal year ended March 31, 2008 from ¥2.2 billion for the previous fiscal year. Equipment sales revenues has been decreasing year by year because we have been focusing on providing systems construction that have higher margin to our corporate customers instead of providing equipment sales which has a relatively lower margin.

     ATM Operation Business revenues. We entered the ATM operation business through our consolidated subsidiary, Trust Networks, which was established in July 2007. During the fiscal year ended March 31, 2008, it was under planning and preparation for business launch and revenues from the ATM operation business were ¥4 million for the fiscal year ended March 31, 2008,

Total cost of revenues

     Our total cost of revenues increased by 15.0% to ¥52.9 billion for the fiscal year ended March 31, 2008 from ¥46.0 billion for the previous fiscal year. The increase was mainly because the cost of connectivity and outsourcing services revenues and the cost of systems integration revenues increased compared to the previous fiscal year corresponding with the increase in connectivity and outsourcing services revenues and systems integration revenues, respectively.