##### Table of Contents



As filed with the Securities and Exchange Commission on July 6, 2007
   UNITED STATESSECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 20-F
 (Mark One)o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (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, 2007
 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
 Commission file number: 0-30204
 Kabushiki Kaisha Internet Initiative
  Internet Initiative Japan Inc.
  Japan
 Jinbocho Mitsui Bldg.
1-105 Kanda Jinbo-cho
Chiyoda-ku, Tokyo 101-0051, Japan
  Title of Each Class
    
    Name of Each Exchange On Which RegisteredCommon Stock
    
    The NASDAQ Stock Market
 Common Stock, no par value
 None
  As of March 31, 2007, 204,300 shares of common stock were outstanding, including 27,409 shares
represented by an aggregate of 10,963,600 American Depositary Shares.
  o þ
  o þ
 
  þ o
  o þ o
  o þ
  o þ




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##### 



TABLE OF CONTENTS
 PART I
    
    
    2Item 1. Identity of Directors, Senior Management and Advisers.
    
    
    2Item 2. Offer Statistics and Expected Timetable.
    
    
    2Item 3. Key Information.
    
    
    2Item 4. Information on the Company.
    
    
    14Item 4A. Unresolved Staff Comments.
    
    
    41Item 5. Operating and Financial Review and Prospects.
    
    
    41Item 6. Directors, Senior Management and Employees.
    
    
    66Item 7. Major Shareholders and Related Party Transactions.
    
    
    72Item 8. Financial Information.
    
    
    74Item 9. The Offer and Listing.
    
    
    75Item 10. Additional Information.
    
    
    76Item 11. Quantitative and Qualitative Disclosures about Market Risk.
    
    
    87Item 12. Description of Securities Other than Equity Securities.
    
    
    88PART II
    
    
    88Item 13. Defaults, Dividend Arrearages and Delinquencies.
    
    
    88Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.
    
    
    89Item 15T. Controls and Procedures.
    
    
    89Item 16A. Audit Committee Financial Expert.
    
    
    90Item 16B. Code of Ethics.
    
    
    91Item 16C. Principal Accountant Fees and Services.
    
    
    91Item 16D. Exemptions from the Listing Standards for Audit Committees.
    
    
    92Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers.
    
    
    93PART III
    
    
    93Item 17. Financial Statements.
    
    
    93Item 18. Financial Statements.
    
    
    93Item 19. Exhibits.
    
    
    93EX-1.1 ARTICLES OF INCORPORATION, AS AMENDEDEX-4.24 AGREEMENT ON LIMITED LIABILITY, DATED JUNE 28, 2006 AND JUNE 26, 2007, BETWEEN INTERNET INITIATIVE JAPAN INC. AND OUTSIDE DIRECTORS AND OUTSIDE COMPANY AUDITORSEX-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 1350EX-13.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER REQUIRED BY 18 U.S.C. SECTION 1350
  i




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Cautionary Note Regarding Forward-Looking Statements
   
    
    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 we may not be able to attract and retain qualified personnel.
 1




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##### Table of Contents



As used in this annual report, references to IIJ, the Company, 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.
  
 Item 2.
    
    Offer Statistics and Expected Timetable.
  
 Item 3.
    
    Key Information.
 A.
    
    Selected Financial Data.
  2




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##### Table of Contents



As of and for the fiscal year ended March 31,2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2007(millions of yen, except per share and ADS data)
    
    
    (thousands ofU.S. dollars,except pershare and ADSdata(1))Statement of Operations Data:REVENUES:Connectivity and value-added
services:Dedicated access
    
    ¥
    13,815
    
    
    ¥
    12,862
    
    
    ¥
    11,373
    
    
    ¥
    10,625
    
    
    ¥
    10,792
    
    
    $
    91,797Dial-up access
    
    
    3,155
    
    
    
    3,088
    
    
    
    2,937
    
    
    
    2,674
    
    
    
    2,416
    
    
    
    20,554Value-added services
    
    
    3,603
    
    
    
    4,296
    
    
    
    5,005
    
    
    
    6,250
    
    
    
    7,416
    
    
    
    63,079Other
    
    
    1,726
    
    
    
    2,118
    
    
    
    3,169
    
    
    
    3,674
    
    
    
    3,729
    
    
    
    31,725Total
    
    
    22,299
    
    
    
    22,364
    
    
    
    22,484
    
    
    
    23,223
    
    
    
    24,353
    
    
    
    207,155Systems integration
    
    
    15,013
    
    
    
    11,848
    
    
    
    15,854
    
    
    
    23,505
    
    
    
    30,527
    
    
    
    259,672Equipment sales
    
    
    6,706
    
    
    
    4,567
    
    
    
    3,365
    
    
    
    3,085
    
    
    
    2,175
    
    
    
    18,496Total revenues
    
    
    44,018
    
    
    
    38,779
    
    
    
    41,703
    
    
    
    49,813
    
    
    
    57,055
    
    
    
    485,323COST AND EXPENSES:Cost of connectivity and
value-added services
    
    
    20,387
    
    
    
    20,047
    
    
    
    19,484
    
    
    
    20,078
    
    
    
    20,545
    
    
    
    174,765Cost of systems integration
    
    
    13,090
    
    
    
    9,852
    
    
    
    12,200
    
    
    
    18,120
    
    
    
    23,529
    
    
    
    200,145Cost of equipment sales
    
    
    6,417
    
    
    
    4,346
    
    
    
    3,111
    
    
    
    2,818
    
    
    
    1,894
    
    
    
    16,104Total cost
    
    
    39,894
    
    
    
    34,245
    
    
    
    34,795
    
    
    
    41,016
    
    
    
    45,968
    
    
    
    391,014Sales and marketing
    
    
    3,176
    
    
    
    3,528
    
    
    
    2,795
    
    
    
    3,080
    
    
    
    3,439
    
    
    
    29,251General and administrative
    
    
    2,205
    
    
    
    2,098
    
    
    
    2,666
    
    
    
    3,147
    
    
    
    3,971
    
    
    
    33,776Research and development
    
    
    414
    
    
    
    358
    
    
    
    199
    
    
    
    159
    
    
    
    177
    
    
    
    1,508Total cost and expenses
    
    
    45,689
    
    
    
    40,229
    
    
    
    40,455
    
    
    
    47,402
    
    
    
    53,555
    
    
    
    455,549OPERATING INCOME (LOSS)
    
    
    (1,671
    )
    
    
    (1,450
    )
    
    
    1,248
    
    
    
    2,411
    
    
    
    3,500
    
    
    
    29,774OTHER INCOME (EXPENSES):Interest income
    
    
    67
    
    
    
    38
    
    
    
    13
    
    
    
    13
    
    
    
    23
    
    
    
    196Interest expense
    
    
    (733
    )
    
    
    (702
    )
    
    
    (686
    )
    
    
    (437
    )
    
    
    (397
    )
    
    
    (3,381
    )Other  net
    
    
    (603
    )
    
    
    1,646
    
    
    
    2,573
    
    
    
    3,392
    
    
    
    1,923
    
    
    
    16,356Other income
(expenses)  net
    
    
    (1,269
    )
    
    
    982
    
    
    
    1,900
    
    
    
    2,968
    
    
    
    1,549
    
    
    
    13,171INCOME (LOSS) FROM OPERATIONS BEFORE
INCOME TAX EXPENSE (BENEFIT),
MINORITY INTERESTS AND EQUITY IN NET
LOSS OF EQUITY METHOD INVESTEES
    
    
    (2,940
    )
    
    
    (468
    )
    
    
    3,148
    
    
    
    5,379
    
    
    
    5,049
    
    
    
    42,945INCOME TAX EXPENSE (BENEFIT)
    
    
    23
    
    
    
    33
    
    
    
    100
    
    
    
    257
    
    
    
    (804
    )
    
    
    (6,839
    )MINORITY INTERESTS IN (EARNINGS)
LOSSES OF SUBSIDIARIES
    
    
    153
    
    
    
    236
    
    
    
    (109
    )
    
    
    (354
    )
    
    
    (233
    )
    
    
    (1,979
    )EQUITY IN NET LOSS OF EQUITY METHOD
INVESTEES:(2)Equity method net loss
    
    
    (5,625
    )
    
    
    (286
    )
    
    
    (33
    )
    
    
    (14
    )
    
    
    (210
    )
    
    
    (1,788
    )Impairment loss on
investment, advance and
deposits for Crosswave
    
    
    (7,153
    )
    
    
    (1,720
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 3




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As of and for the fiscal year ended March 31,2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007
    
    
    2007(millions of yen, except per share and ADS data)
    
    
    (thousands ofU.S. dollars,except pershare and ADSdata(1))Total equity in net
loss of equity method
investees
    
    ¥
    (12,778
    )
    
    ¥
    (2,006
    )
    
    ¥
    (33
    )
    
    ¥
    (14
    )
    
    ¥
    (210
    )
    
    $
    (1,788
    )NET INCOME (LOSS)
    
    ¥
    (15,588
    )
    
    ¥
    (2,271
    )
    
    ¥
    2,906
    
    
    ¥
    4,754
    
    
    ¥
    5,410
    
    
    $
    46,017Per Share and ADS Data(3):Basic net income (loss) per share
    
    ¥
    (138,689
    )
    
    ¥
    (14,321
    )
    
    ¥
    15,172
    
    
    ¥
    24,301
    
    
    ¥
    26,519
    
    
    $
    226Diluted net income (loss) per share
    
    
    (138,689
    )
    
    
    (14,321
    )
    
    
    15,172
    
    
    
    24,258
    
    
    
    26,487
    
    
    
    225Basic net income (loss) per ADS
equivalent
    
    
    (346.72
    )
    
    
    (35.80
    )
    
    
    37.93
    
    
    
    60.75
    
    
    
    66.30
    
    
    
    0.57Diluted net income (loss) per ADS
equivalent
    
    
    (346.72
    )
    
    
    (35.80
    )
    
    
    37.93
    
    
    
    60.65
    
    
    
    66.22
    
    
    
    0.56Basic weighted average number of
shares
    
    
    112,400
    
    
    
    158,554
    
    
    
    191,559
    
    
    
    195,613
    
    
    
    203,992Diluted weighted average number of
shares
    
    
    112,400
    
    
    
    158,554
    
    
    
    191,559
    
    
    
    195,955
    
    
    
    204,244Basic weighted average number of ADS
equivalents (thousands)
    
    
    44,960
    
    
    
    63,422
    
    
    
    76,624
    
    
    
    78,245
    
    
    
    81,597Diluted weighted average number of
ADS equivalents (thousands)
    
    
    44,960
    
    
    
    63,422
    
    
    
    76,624
    
    
    
    78,382
    
    
    
    81,698Balance Sheet Data:Cash and cash equivalent
    
    ¥
    3,588
    
    
    ¥
    12,284
    
    
    ¥
    5,286
    
    
    ¥
    13,727
    
    
    ¥
    13,555
    
    
    $
    115,299Total assets
    
    
    32,064
    
    
    
    42,737
    
    
    
    37,116
    
    
    
    50,705
    
    
    
    47,693
    
    
    
    405,691Short-term borrowings
    
    
    4,824
    
    
    
    6,564
    
    
    
    4,725
    
    
    
    4,555
    
    
    
    6,050
    
    
    
    51,463Current portion of long-term
borrowings, including capital lease
obligations
    
    
    4,660
    
    
    
    3,936
    
    
    
    5,511
    
    
    
    4,994
    
    
    
    3,243
    
    
    
    27,588Long-term borrowings, including
capital lease obligations
    
    
    7,092
    
    
    
    5,188
    
    
    
    5,869
    
    
    
    5,271
    
    
    
    4,318
    
    
    
    36,733Convertible notes(4)
    
    
    15,000
    
    
    
    11,832
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock
    
    
    7,082
    
    
    
    13,765
    
    
    
    13,765
    
    
    
    16,834
    
    
    
    16,834
    
    
    
    143,194Total shareholders equity (capital
deficiency)
    
    
    (10,004
    )
    
    
    6,214
    
    
    
    11,615
    
    
    
    20,222
    
    
    
    20,112
    
    
    
    171,079Operating Data:Capital expenditures, including
capitalized leases(5)
    
    ¥
    4,893
    
    
    ¥
    3,523
    
    
    ¥
    5,011
    
    
    ¥
    4,762
    
    
    ¥
    3,953
    
    
    $
    33,622Operating margin ratio(6)
    
    
    (3.8
    )%
    
    
    (3.7
    )%
    
    
    3.0
    %
    
    
    4.8
    %
    
    
    6.1
    %Net cash provided by (used in):Operating activities
    
    ¥
    1,582
    
    
    ¥
    1,923
    
    
    ¥
    5,238
    
    
    ¥
    6,559
    
    
    ¥
    7,402
    
    
    $
    62,959Investing activities
    
    
    (7,878
    )
    
    
    (852
    )
    
    
    1,974
    
    
    
    1,805
    
    
    
    (3,014
    )
    
    
    (25,635
    )Financing activities
    
    
    (872
    )
    
    
    7,669
    
    
    
    (14,213
    )
    
    
    39
    
    
    
    (4,560
    )
    
    
    (38,786
    )
 
 (1)
    
    The U.S. dollar amounts represent translations of yen amounts at the rate of ¥117.56 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, 2007.(2)
    
    Of total equity method net loss of ¥5,625 million for the fiscal year ended March 31, 2003,
¥5,514 million was based on unaudited financial information made publicly available by
Crosswave Communications Inc. (Crosswave) and the impairment loss on investment and deposits
for Crosswave was determined to be the amount required to reduce 4




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the carrying amount of investment in and deposits for Crosswave at March 31, 2003 to zero. The
audit report of Deloitte Touche Tohmatsu in respect of our financial statements as of and for
the fiscal year ended March 31, 2003 was qualified as to the effects of such adjustments, if
any, as might have been determined to be necessary if sufficient evidence regarding the equity
method loss, the impairment loss on investment, advance to and deposits for Crosswave and the
related summary information of Crosswave for the year ended March 31, 2003 was available. As
described elsewhere in this annual report, Crosswave filed a voluntary petition for corporate
reorganization proceedings in Japan in August 2003 and has not prepared audited financial
statements for the year ended March 31, 2003 or other sufficient evidence of its results of
operations to permit the independent registered public accounting firm to issue an audit report
on our financial statements as of and for the year ended March 31, 2003 without such
qualification.(3)
    
    We conducted a 1 to 5 stock split effective on October 11, 2005. The per share data is
calculated based on the assumption that the stock split was made at the beginning of the
fiscal year ended March 31, 2003. We did not declare any dividends during the five year period
presented. On June 26, 2007, our shareholders approved the payment of a cash dividend to
shareholders of record as of March 31, 2007 of ¥1,500 per share, an aggregate amount of ¥306
million.(4)
    
    In April 2000, we issued 1.75 percent unsecured convertible yen notes due March 2005 in the
aggregate principal amount of ¥15,000 million. In November 2003 and June 2004, we repurchased
and cancelled a portion of the aforementioned notes, in the aggregate principal amount of
¥3,168 million and ¥744 million, respectively. We redeemed the remainder of the unsecured
convertible notes in March 2005.(5)
    
    Further information regarding capital expenditures, including capitalized leases and a
reconciliation to the most directly comparable U.S. GAAP financial measure can be found below.(6)
    
    Operating income (loss) as a percentage of total revenues. Reconciliations of the Disclosed Non-GAAP Financial Measures to the Most Directly Comparable GAAP Financial Measures
 Capital expenditures
   For the fiscal year ended March 31,2003
    
    
    2004
    
    
    2005
    
    
    2006
    
    
    2007(millions of yen)Capital expenditures:Acquisition of assets by entering into capital leases
    
    ¥
    3,578
    
    
    ¥
    1,866
    
    
    ¥
    4,434
    
    
    ¥
    3,843
    
    
    ¥
    2,665Purchases of property and equipment
    
    
    1,315
    
    
    
    1,657
    
    
    
    577
    
    
    
    919
    
    
    
    1,288Total capital expenditures
    
    ¥
    4,893
    
    
    ¥
    3,523
    
    
    ¥
    5,011
    
    
    ¥
    4,762
    
    
    ¥
    3,953
 Exchange Rates
  5




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High
    
    Low
    
    Average(1)
    
    Period-endFiscal year ended March 31,2003
    
    ¥
    133.40
    
    
    ¥
    115.71
    
    
    ¥
    121.10
    
    
    ¥
    118.072004
    
    
    120.55
    
    
    
    104.18
    
    
    
    112.75
    
    
    
    104.182005
    
    
    114.30
    
    
    
    102.26
    
    
    
    107.28
    
    
    
    107.222006
    
    
    120.93
    
    
    
    104.41
    
    
    
    113.67
    
    
    
    117.482007
    
    
    121.81
    
    
    
    110.07
    
    
    
    116.55
    
    
    
    117.56Calendar year 2007January
    
    ¥
    121.81
    
    
    ¥
    118.49
    
    
    ¥
    120.45
    
    
    ¥
    121.02February
    
    
    121.77
    
    
    
    118.33
    
    
    
    120.50
    
    
    
    118.33March
    
    
    118.15
    
    
    
    116.01
    
    
    
    117.26
    
    
    
    117.56April
    
    
    119.84
    
    
    
    117.69
    
    
    
    118.93
    
    
    
    119.44May
    
    
    121.79
    
    
    
    119.77
    
    
    
    120.77
    
    
    
    121.76June
    
    
    124.09
    
    
    
    121.08
    
    
    
    122.69
    
    
    
    123.39July (through July 3, 2007)
    
    
    122.40
    
    
    
    122.32
    
    
    
    122.36
    
    
    
    122.40
 
 (1)
    
    For fiscal years, calculated from the average of the exchange rates on the last day of each
month during the period. For calendar year months, calculated based on the average of daily
exchange rates.  B.
    
    Capitalization and Indebtedness.
  C.
    
    Reasons for the Offer and Use of Proceeds.
  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 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.
  6




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##### Table of Contents




    
    a decrease in revenues from our Internet connectivity services because of lower
unit prices per bandwidth and cancellation of large accounts especially due to severe
price competition,
    
    lower revenue growth and lower margins in our growing value-added services and
systems integration, if we fail to successfully differentiate our services from those
of our competitors, or experience a significant decrease in systems integration
revenues from period to period due to the cancellation of one or more large projects
or changes in the number of projects resulting from a seasonal fluctuation in the
systems integration business in Japan,
    
    an increase in backbone costs due to increased volume of Internet traffic and
demand for leasing backbone lines, or a decline in the profitability of connectivity
services if we contract for more capacity than we actually utilize to serve our
customers,
    
    an increase in expenses for network infrastructure, research and development and
other similar investments which we may be forced to make in the future in order to
remain competitive, or increased expenses relating to the leasing of additional
equipment,
    
    an increase in outsourcing costs, especially in our systems integration, if
outsourcing costs increase, or we fail to manage outsourcing projects effectively or
fail to cover outsourcing costs by raising enough revenues from outsourced projects,
    
    an increase in SG&A costs, such as personnel expenses and advertising 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 is 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 or impairment losses on
stocks of
companies,
    
    an increase of equity in net loss of equity method investees affected by an
increase of net loss of our equity method investees, and
    
    an amount and timing of 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 others.
  7




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##### Table of Contents



We may not be able to compete effectively, especially against competitors with greater financial, marketing and other resources.
   
    
    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 the network services, for which we are a
competitor.
  
    
    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.
 If we fail to attract and retain qualified personnel, we may not be able to achieve our expected business growth.
  8




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Our business may be adversely affected if our network suffers interruptions, errors or delays.
  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.
  Business growth and a rapidly changing operating environment may strain our limited resources.
  If we fail to keep up with the rapid technological changes in our industry, our services may become
obsolete and we may lose customers.
  
    
    rapid technological change,
    
    frequent new product and service introductions,
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##### Table of Contents




    
    continually changing customer requirements, and
    
    evolving industry 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 the customers, major
shareholders of IIJ and other IIJ Group companies and our employees could suffer.
  Our investments in our subsidiaries and affiliated companies may not produce the returns we expect
and may require additional funding.
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We may have an impairment loss as a result of an impairment test on the non-amortized intangible
assets that is recorded related to mergers and acquisitions.
  The amounts and timing of recognition of deferred tax benefits or expenses related to tax operating
loss carryforwards may adversely affect our financial results.
  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.
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NTT, our 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.
  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.
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The risks inherent in international markets and other risks associated with our international
business may adversely affect our future international expansion and our financial results.
  
    
    the impact of economic conditions outside Japan,
    
    unexpected changes in or delays resulting from regulatory requirements,
    
    the rate of the development of the Internet industry in countries in Asia,
    
    political and economic instability, and
    
    potential unsatisfactory financial returns from our investments in Asia, including
the data center businesses in which we have invested in South Korea.
  If we fail to execute our systems integration projects in a timely or satisfactory manner or if we
fail to manage customer data in a professional manner, we could be sued and our reputation could
suffer.
  Regulatory matters and new legislation could impact our ability to conduct our business.
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We may be named as defendants in litigation, which could have an adverse impact on our business,
financial condition and results of operations.
  In the event we need to raise capital, we may sell additional shares of our common stock or
securities convertible into our common stock, which may cause shareholders to incur substantial
dilution.
  
 Item 4.  Information on the Company.
 A.
    
    History and Development of the Company.
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B.
    
    Business Overview.
  15




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##### Table of Contents



For the fiscal year ended March 31,2005
    
    2006
    
    2007Connectivity services
    
    
    34.3
    %
    
    
    26.7
    %
    
    
    23.1
    %Value-added services
    
    
    12.0
    %
    
    
    12.5
    %
    
    
    13.0
    %Systems integration
    
    
    38.0
    %
    
    
    47.2
    %
    
    
    53.5
    %
   Total network solutions
   
    
    our Internet connectivity services,
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##### Table of Contents




    
    our line-up of value-added services, including security, network and server-related
outsourcing,
    
    our Internet data center services,
    
    our systems integration, including ongoing consulting, systems design,
construction, operation and management, and
    
    other network and application services that our group companies provide.
  Internet Connectivity Services
   As of March 31,2003
    
    2004
    
    2005
    
    2006
    
    2007Dedicated access service contracts:IP service:Low Bandwidth (64 kbps  768 kbps)
    
    
    147
    
    
    
    93
    
    
    
    89
    
    
    
    85
    
    
    
    64Medium Bandwidth (1 Mbps  99 Mbps)
    
    
    473
    
    
    
    565
    
    
    
    660
    
    
    
    654
    
    
    
    687High Bandwidth (100 Mbps )
    
    
    43
    
    
    
    80
    
    
    
    114
    
    
    
    157
    
    
    
    224Total IP Service
    
    
    663
    
    
    
    738
    
    
    
    863
    
    
    
    896
    
    
    
    975IIJ T1 Standard and IIJ Economy
    
    
    939
    
    
    
    504
    
    
    
    276
    
    
    
    109
    
    
    
    45IIJ Data Center Connectivity Service
    
    
    156
    
    
    
    196
    
    
    
    231
    
    
    
    247
    
    
    
    282IIJ FiberAccess/F and IIJ DSL/F
(Broadband Services)
    
    
    3,550
    
    
    
    5,788
    
    
    
    9,873
    
    
    
    13,297
    
    
    
    16,418Total dedicated access service contracts
    
    
    5,308
    
    
    
    7,226
    
    
    
    11,243
    
    
    
    14,549
    
    
    
    17,720Dial-up access service contracts:Under IIJ Brand
    
    
    86,183
    
    
    
    75,136
    
    
    
    68,068
    
    
    
    62,176
    
    
    
    57,480OEM
    
    
    443,601
    
    
    
    620,731
    
    
    
    625,908
    
    
    
    568,307
    
    
    
    476,483Total dial-up access service contracts
    
    
    529,784
    
    
    
    695,867
    
    
    
    693,976
    
    
    
    630,483
    
    
    
    533,963
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##### Table of Contents



PricingService Type
    
    Summary Description
    
    (excluding consumption tax)Dedicated access servicesIP Service
    
    Full-scale
dedicated line
service with
high-speed access
for businesses and
other network
operators with
demanding bandwidth
requirements.
    
    Setup and monthly fees
vary according to carrier,
line speed, line type and
distance involved.IIJ T1 Standard
    
    Packaged dedicated
line service
offering 1.5 Mbps
connection (no
longer promoted).
    
    Initial setup fee of
¥50,000. Monthly access
fee of ¥117,000 for up to
8 IP addresses and
¥167,000 for up to 16 IP
addresses.IIJ Economy
    
    Service for
dedicated line
access to the
Internet with
inexpensive monthly
fees primarily for
small- and
medium-sized
businesses and
local and regional
offices of
corporate groups
(no longer
promoted).
    
    Initial setup fee of
¥40,000. Monthly access
fees of ¥38,000 for 64
kbps service and ¥45,000
for 128 kbps service.IIJ Data Center Connectivity Service
    
    Full-scale
dedicated line
service for
customers hosted in
IIJ Data Centers,
with asymmetrical
speeds of upstream
(from the Internet
to data center) and
downstream (from
the data center to
the Internet)
transmissions.
    
    Initial setup fee of
¥100,000. Monthly fees
range from ¥400,000 to
¥10,000,000, depending on
the speed of upstream
transmissions.IIJ FiberAccess/F
    
    Service for
dedicated line
Internet-access
using optical lines
at speeds of up to
10 Mbps or 100
Mbps, targeted
primarily at small-
and medium-sized
enterprises
requiring
high-capacity,
high-speed
transmissions.
Optical fiber
access is limited
to FLETS lines
provided by NTT
East and West.
    
    Initial setup fee of
¥50,000. Monthly fees
range from ¥14,000 to
¥190,000, depending on the
speed of connection and
the number of IP addresses
allocated. Monthly fees do
not include optical line
charges, which are paid
directly by the customer
to the optical line
provider.IIJ DSL/F
    
    Service for
dedicated line
Internet-access
using ADSL lines at
speeds of up to 47
Mbps, targeted
primarily at small-
and medium-sized
offices and home
offices. ADSL
access is limited
to FLETS lines
provided by NTT
East and West.
    
    Initial setup fee of
¥30,000. Monthly fees
range from ¥9,800 to
¥49,800, depending on the
number of allocated IP
addresses. Monthly charges
do not include ADSL
charges, which are paid
directly by the customer
to the ADSL service
provider.IIJ DSL/A
    
    Service for
dedicated line
Internet-access
using ADSL lines at
speeds of up to 47
Mbps, targeted
primarily at small-
and medium-sized
offices and home
offices. ADSL
access is limited
to ADSL services
provided by ACCA
Networks, Co., Ltd.
    
    Initial setup fee of
¥75,000. Monthly fees
range from ¥12,000 to
¥52,000, depending on the
number of allocated IP
addresses. Monthly charges
do not include ADSL
charges, which are paid
directly by the customer
to the ADSL service
provider.
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##### Table of Contents



PricingService Type
    
    Summary Description
    
    (excluding consumption tax)(ACCA Networks)IIJ ISDN/F
    
    Service for
dedicated line
Internet-access
using ISDN lines at
speeds of up to 64
kbps, targeted
primarily at small-
and medium-sized
offices and home
offices where ADSL
lines are not
available. ISDN
access is limited
to FLETS lines
provided by NTT
East and West.
    
    Initial setup fee of
¥5,000. Monthly fees range
from ¥4,800 to ¥6,800,
depending on the number of
allocated IP addresses.
Monthly charges do not
include ISDN charges,
which are paid directly by
customers to ISDN
providers.IIJ Line Management/F
    
    Service for us to
prepare optical
fiber or ADSL
access provided by
NTT East and West
for IIJ
FiberAccess/F, IIJ
DSL/F and IIJ
ISDN/F on behalf of
customers. We
provide customer
support functions
for the access
lines.
    
    Initial setup fee range
from ¥5,000 to ¥43,400.
Monthly fees range from
¥2,300 to ¥44,700,
depending on the optional
services.Dial-up access servicesIIJ Dial-up Standard
    
    Service for
corporate users
permitting
simultaneous
Internet-access
from several
dial-up lines under
a single contract.
    
    Initial setup fee of
¥5,000. Monthly basic fee
of ¥2,000 plus access
charges of ¥10 per minute.Enterprise Dial-up IP Service
    
    Service for
corporate users
offering multiple
dial-up accounts at
a fixed monthly
fee.
    
    Initial setup fee of
¥20,000. Monthly basic
fees range from ¥3,000 to
¥4,900 per account
depending on the number of
accounts.IIJ Dial-up Advanced
    
    Service for
corporate users
offering bundled
low-cost dial-up
accounts.
    
    Initial setup fee of
¥5,000. Monthly basic fee
of ¥10,000 for the first
50 e-mail accounts
including the first two
hours access per account,
plus ¥5 per minute after
two hours.IIJ4U
    
    Service for
individual users,
which includes
Internet-access and
5 megabytes of disk
space for personal
Web pages and
e-mail account
options for
multiple users.
Various access
options such as
ISDN, ADSL and
optical fiber
access are
available.
    
    This service does not
charge an initial setup
fee. Monthly service fee
of ¥800 for the first
eight hours and a charge
of ¥5 per minute, with a
ceiling of ¥4,100.IIJmioDSL/DF Service
    
    Service for
individual users
offering Internet
connectivity over
ADSL at speeds of
up to 47 Mbps. ADSL
access is limited
to FLETS lines
provided by NTT
East and West. The
IP address is
changed every time
a connection
    
    No initial setup fee.
Monthly charge is ¥1,400.
Monthly charges do not
include ADSL charges,
which are paid directly by
the customer to NTT East
and West.
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##### Table of Contents



PricingService Type
    
    Summary Description
    
    (excluding consumption tax)is made.IIJmioFiberAccess/DF Service
    
    Service for
individual users
offering Internet
connectivity over
optical fiber
network at maximum
10 Mbps or 100
Mbps. Optical fiber
access is limited
to FLETS lines
provided by NTT
East and West. The
IP address is
changed every time
a connection is
made.
    
    No initial setup fee.
Monthly charges range from
¥2,000 to ¥7,000. Monthly
charges do not include
optical fiber access
charges, which are paid
directly by the customer
to NTT East and West.IIJmioDSL/SF Service
    
    Service for
individual users
offering Internet
connectivity over
ADSL at speeds of
up to 47 Mbps. ADSL
access is limited
to FLETS lines
provided by NTT
East and West. A
fixed IP address is
provided with this
service.
    
    No initial setup fee. The
monthly charge is ¥4,800.
Monthly charges do not
include ADSL charges,
which are paid directly by
the customer to NTT East
and West.IIJmioFiberAccess/DC Service
    
    Service for
individual users
offering Internet
connectivity over
optical fiber
network at speeds
of up to 50 Mbps or
100 Mbps. Optical
fiber access is
limited to Access
Commufa lines
provided by Chubu
Telecommunications
Co., Inc.
    
    No initial setup fee. The
monthly charge is
¥2,000. Monthly
charges do not include
optical fiber access
charges, which are paid
directly by the customer
to Chubu
Telecommunications Co.,
Inc.IIJmioFiberAccess/SF Service
    
    Service for
individual users
offering Internet
connectivity over
optical fiber
network at speeds
of up to 10 Mbps or
100 Mbps. Optical
fiber access is
limited to FLETS
lines provided by
NTT East and West.
A fixed IP address
is provided with
this service.
    
    No initial setup fee. The
monthly charges range from
¥8,000 to ¥12,000,
depending on the type of
access line. The monthly
charges do not include
optical fiber access
charges, which are paid
directly by the customer
to NTT East and West.IIJmioMobileAccess Service
    
    Service for
individual users
offering mobile
Internet
connectivity
through several
data communications
services provided
by mobile
telecommunication
companies.
    
    No initial setup fee. The
monthly charge is ¥300 and
does not include service
charges to IIJs access
points, which are paid
directly by the customer
to the mobile
telecommunication
companies.
 Dedicated Access Services
  IP Service.
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##### Table of Contents




    
    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 T1 Standard.
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##### Table of Contents



IIJ Economy.
 IIJ Data Center Connectivity Service.
 IIJ FiberAccess/F.
 IIJ DSL/F and IIJ DSL/A.
 IIJ ISDN/F.
 IIJ Line Management/F.
 Dial-up Access Services
  22




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##### Table of Contents



mio mio mio mio mio mio
 Value-Added Services
    
    
    Security-related outsourcing services.As of July 3, 2007, we offer six main
security-related outsourcing services (described below) that protect customers
internal networks from unauthorized access and secure remote connections to internal
networks. We were the first ISP in Japan to provide firewall services, which we
introduced in 1994.IIJ DDoS Solution Service. In October 2005, we began offering IIJ DDoS
Solution Service to protect customers internal networks from distributed denial of
service (DDoS) attacks, a type of unauthorized access from Internet. The fee depends
on the type of service that we provide and the initial fee starts at ¥650,000 and the
monthly fee starts at ¥498,000.IIJ Security Scan Service. In March 2002, we began offering IIJ Security
Scan Service, a package of services targeting small- and medium-sized enterprises to
identify security weaknesses in order to prevent illicit access from external networks
and to avert virus infection of in-house servers. It is available in two forms: regular
monthly scans and one-time spot checks. The form of service can be selected to meet the
specific needs of the customer, such as checks for protocol and network configuration
or for vulnerability to specific illegal network intrusion. The service was developed
with NRI Secure Technologies Ltd., a Japanese security assessment and auditing
solutions provider. For the regular monthly scan service, the initial charge is ¥5,000.
The monthly charge for scanning is ¥25,000 for one IP address, and ¥24,000 will be
added for every additional IP address. For the spot scan service, the basic charge for
scanning one IP address is ¥30,000, and ¥29,000 will be added for every additional IP
address.IIJ Network Intrusion Detection Service. In April 2001, we began offering
IIJ Network Intrusion Detection Service, which offers around-the-clock, non-stop
network monitoring and
intrusion-detection capabilities, as well as packet information for analyzing
detected illicit accesses. The initial cost for the service is ¥300,000, and the
monthly fee starts from ¥300,000, depending on the customers traffic volume.
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##### Table of Contents



IIJ Managed IPS Service. In July 2006, we began offering IIJ Managed IPS
Service, which offers around-the-clock, non-stop monitoring of a companys network
using an intrusion prevention system (IPS) to detect unauthorized access on such
companys network in real time and terminate such authorized access. The initial cost
for the service is ¥900,000 and the minimum monthly fee starts from ¥380,000.IIJ Managed Firewall Service. In October 2006, we began offering IIJ
Managed Firewall Service, which offers around-the-clock, non-stop monitoring of
firewalls with Service Level Agreements, real-time reporting and an anomaly detection
system. The initial cost for the service is ¥100,000 and the minimum monthly fee starts
from ¥50,000. The service replaced our previous firewall services, such as IIJ Security
Premium, IIJ Security Standard and IIJ Security Lite.IIJ Secure Remote Access. IIJ Secure Remote Access is a packaged service
combining the IIJ Dial-up Advanced with ID Gateway, which controls remote access to
in-house servers protected by firewalls. In addition to the 50 dial-up accounts covered
by the base rate, the service ensures a secure remote environment by controlling
accessible servers and utilization protocols for each dial-up account. In May 2002, IIJ
Secure Remote Access was upgraded by adding a remote VPN function. The upgrade enables
remote users to transmit and receive data with encryption, offering a secure enterprise
network environment with a greater variety of access options, such as connections from
overseas via local ISPs. In June 2005, IIJ Secure Remote Access was upgraded by adding
an Authentication Service Link Option, which enables customers to use a greater variety
of authentication methods.
    
    Network-related outsourcing services.As of July 3, 2007, we offer seven main
network-related outsourcing services (described below), including provision,
monitoring and maintenance of network equipment and VPN to connect customers branch
and remote offices.IIJ Internet-LAN Service. IIJ Internet-LAN Service is a service which
provides connectivity among a companys branch and remote offices. With this service,
customers can use functions provided by Wide-area Ethernet over the Internet.IIJ SMF sx Service. IIJ SMF sx Service is a centralized network management
system developed by IIJ based on the SEIL Management Framework (SMF). This system
enables centralized management of network configuration, administration, and
maintenance. We received patent approval in March 2006 for SMF. When a customer at a
remote site connects a router to the circuit, the router is automatically configured
and connected to the network. System integrators utilizing this technology can reduce
configuration and maintenance costs at the remote site.IIJ Managed VPN PRO Service. IIJ Managed VPN PRO Service is a service
which provides connectivity among a companys branch and remote offices, utilizing SEIL
Series or other routers.IIJ VPN Standard. IIJ VPN Standard is a service which provides Internet
VPN connectivity among a companys branch and remote offices based on encryption
technology. We no longer promote this service because we provide similar functions with
other services.SEIL Rental
Service. SEIL Rental Service is a service through which we
rent the SEIL Series, a product developed by IIJ. There are several products depending
on the Wide Area Network (WAN) Interface. Optional services such as fixed format
configuration and on-site maintenance are provided.
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##### Table of Contents



Managed Router Service.Managed Router Service provides customers with
router equipment together with maintenance, operation and administration of routers. We
provide SEIL Series routers or CISCO routers depending on customer requirements.IIJ NetLightning. IIJ NetLightning is a service based on Netli, Inc.s
technology that improves web application performance. By utilizing this service, end
users can access customer websites faster, without any settings, and customers can
thereby reduce the cost of placing mirror sites. We no longer promote this service.
    
    Server-related outsourcing services.As of July 3, 2007, we offer 14 main
server-related outsourcing services (described below), including provision of e-mail
and web services and operation and management of e-mail systems.IIJ Mail Gateway Service. In November 2002, we renovated IIJ Mail Gateway
Service to expand the service from large corporate customers to other corporate
segments. The service has three options. The first one is virus protection to check the
viruses on incoming and outgoing e-mails. The second one is audit to detect the keyword
set in advance on the outgoing e-mails. The third one is antispam to check spam for
incoming e-mails, which we started to provide in October 2004. Customers can take all
or a selection of the options. The initial cost is ¥10,000, and the monthly fee ranges
from ¥30,000 to ¥70,000 for the first 50 e-mail accounts and an additional fee per
account after the first 50 e-mail accounts ranges from ¥200 to ¥850.IIJ Post Office Service. IIJ Post Office Service is an e-mail operation
outsourcing service performed by our e-mail server, enabling a customer to allocate and
maintain a number of e-mail accounts under its own domain name for its employees,
members or other relevant users. The customer can administer e-mail accounts online
through our customer support Web interface. In December 2002, we added a virus checking
option for incoming and outgoing e-mails and an audit option to check the content of
outgoing e-mails and suspend the ones containing keywords specified in advance. In
addition, we added a spam checking option which we started to provide in October 2004
for no additional charge to customers contracting the virus checking option or an
audit option.IIJ Mail Box Service. IIJ Mail Box Service is also an e-mail operation
outsourcing service performed by our e-mail server. Unlike IIJ Post Office Service,
customers do not have to obtain their own domain names. A customer can administer
e-mail accounts online through our customer support Web interface.E-mail distribution services. We offer other e-mail outsourcing services,
such as services for e-mail distribution to large numbers of e-mail addresses and
mailing list functions.IIJ Secure MX Service. In September 2006, we started offering IIJ Secure
MX Service which is an Application Service Provider type of service that operates
through an IIJ gateway server established between a customers e-mail system and the
Internet. The service offers comprehensive e-mail security functions including
anti-spam, sender authentication, e-mail transmission route encryption, and full-text
e-mail storage. IIJ support engineers provide 24-
hour, 365-day monitoring of redundant gateway servers located at the data center,
ensuring a safe and stable e-mail environment.IIJ Web Standard Service. The IIJ Web Standard allows customers to use
their own domain names while providing them with up to 200 megabytes of web hosting
space. By limiting specifications, the pricing of the service is kept to a minimum
¥5,000 per month. Additionally, careful traffic management of the storage space ensures
a high-performance web-server
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##### Table of Contents



environment for users is ensured. This service mainly
targets small- and medium-sized enterprises.Web hosting services. We offer other web hosting services, such as
customized web hosting services and functions to distribute computer files using our
ftp servers.IIJ Download Site Service. IIJ Download Site Service is a hosting service
dedicated to high-volume content downloads from the Internet. The service started on a
trial basis in November 2001, and the full-fledged service was launched in February
2002. A dedicated hosting server and dedicated bandwidth are established for each
contract to ensure constant stable performance. With disk capacity of 500 megabytes per
contract on our hosting servers, access is provided at a maximum transmission bandwidth
per contract of up to 80 Mbps. The initial charge for the service is ¥50,000. The
monthly charge ranges between ¥60,000 and ¥340,000, depending upon the bandwidth. In
April 2003, we added the option of 1 Gbps maximum transmission speed for an additional
fee.IIJ URL Filtering Service. IIJ URL Filtering Service is a service enabled
by the use of IIJs proxy server which blocks access to websites deemed inappropriate.
The initial cost for the service is ¥30,000, and the monthly fee is ¥40,000 as a basic
fee plus an additional fee depending on the number of users in the customers internal
network.IIJ SSL Certificate Management Service. In April 2007, we began offering
IIJ SSL Certificate Management Service which offers a proxy registration service that
performs all actions necessary to acquire and use Secure Socket Layer certificates. The
initial cost for the service is ¥50,000, and the additional fee to acquire the
certificate ranges from ¥75,000 to ¥240,000 depending on which certificate is acquired
and the length of the period for which the certificate is valid.IIJ Document Exchange Service. This service is an online storage service
with which customers can upload files onto IIJs storage server and share them with
authorized users. The initial cost is ¥40,000 and the monthly fee is ¥20,000, which
includes 1GB of disk space and 50 accounts. The fee for each additional set of 10
accounts is ¥3,000, and each 1GB of additional disk space is ¥10,000 per month.IIJ DNS Service. We offer domain name related services that consist of
domain name administration services and domain name server outsourcing services. Domain
names such as .jp, .com, .net and .org are available.Streaming services. We offer Internet streaming services for live
broadcasts over the Internet, as well as streaming server hosting services.IIJmio Safety Mail Service. IIJmioSafety Mail Service, launched in
December 2001, is a standard e-mail service with an anti-virus function for individual
users. The service employs the InterScan VirusWall developed by Trend Micro
Incorporated, and features POP/SMTP over SSL which provides secure e-mail transmission
by encrypting the e-mail transmission
between the users and our mail server, in addition to SMTP authentication, which
ensures a higher level of encryption and authorization than what is currently available
for general use. In February 2005, we started to provide spam check function without an
additional charge. There is no initial charge for IIJmioSafety Mail Service and the
monthly charge is ¥500.
    
    Internet data center services.Our Internet data center services include three
primary services which are typically bundled together for our customers: IIJ data
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##### Table of Contents



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.
    
    Customer support and help desk solutions.We provide comprehensive customer support
and help desk solutions that include network monitoring and trouble-shooting services.
Most of our customer support services are provided as an integral part of other
services we sell.
    
    IP Phone.We began IP Phone service for individual users of IIJ4U and IIJmioin May
2003, and for corporate users who are using IIJs Internet connectivity services
through NTT FLETS network in December 2003. The telephone service is provided via NTT
FLETS network and customers can make telephone calls with other users connected to
NTT FLETS network or legacy telephones by interconnection with the Publicly Switched
Telephone Network, the legacy telephone network.
 Systems Integration
   
    
    connecting over a hundred locations such as gas stations, bank branches and
retail shops via Internet-VPN, transmission of data over the Internet with an
encryption feature and our proprietary SEIL Series routers and SMF,
    
    outsourcing of large scale e-mail servers or systems to detect or delete
e-mails with viruses or spam or record all of 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 Internet,
    
    construction of wireless local area network (LAN), and
    
    consultation on corporate network security.
 27




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##### Table of Contents



Equipment Sales
  SEIL Series.
  Network
   28




---



##### Table of Contents




    
    our backbone, which includes leased lines and network equipment, such as advanced
Internet routers,
    
    Points of Presence (POPs) in major metropolitan areas in Japan,
    
    Internet data centers, and
    
    a network operations center (NOC).
 Backbone
 Leased lines
   Backbone Cost
 For the fiscal year ended March 31,2003
    
    2004
    
    2005
    
    2006
    
    2007Backbone cost (thousand yen)
    
    ¥
    5,235,517
    
    
    ¥
    4,719,638
    
    
    ¥
    3,550,885
    
    
    ¥
    3,516,322
    
    
    ¥
    3,515,934
 Network upgrades
  Network equipment
  Points of Presence .
  29




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##### Table of Contents



Internet Data Centers.
   Network operations center and technical and customer support.
 Our Group Companies
   Proportion of ownershipCompany Name
    
    and voting interestIIJ Technology Inc.
    
    
    100.0
    %IIJ America Inc.
    
    
    100.0
    %Net Care, Inc.
    
    
    100.0
    %IIJ Financial Systems Inc.
    
    
    100.0
    %Net Chart Japan Inc.
    
    
    100.0
    %hi-ho, Inc.
    
    
    100.0
    %GDX Japan, K.K
    
    
    51.0
    %Internet Multifeed Co.
    
    
    30.0
    %Internet Revolution Inc.
    
    
    30.0
    %Taihei Computer Co., Ltd.
    
    
    45.0
    %
 30




---



##### Table of Contents



IIJ Technology Inc.
     IIJ America Inc.
    Net Care, Inc.
     31




---



##### Table of Contents



IIJ Financial Systems Inc.
    Net Chart Japan Inc.
   hi-ho Inc.
  GDX Japan, K.K.
  Internet Multifeed Co.
   Internet Revolution Inc.
  32




---



##### Table of Contents



Taihei Computer Co., Ltd.
  Capital Expenditures
  For the fiscal year ended March 31,2005
    
    2006
    
    2007(millions of yen)Capital
expenditures,
including capitalized
leases(1)
    
    ¥
    5,011
    
    
    ¥
    4,762
    
    
    ¥
    3,953
 
 (1)
    
    Further information regarding capital expenditures, including capitalized leases and a
reconciliation to the most directly comparable U.S. GAAP financial measure, can be found in Item
3.A., Selected Financial Data Reconciliations of the Disclosed Non-GAAP Financial Measures to
the Most Directly Comparable GAAP Financial Measures.   Seasonality
  Sales and Marketing
   33




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##### Table of Contents




    
    Three divisions focus on our total network solutions and work with large corporate
clients, including telecommunications carriers and ISPs, financial institutions,
manufacturers, government institutions, universities and other schools, or focus on
the expansion of sales agents for our services and network equipment. In order to
provide total network solutions, personnel in our sales divisions work closely with
other IIJ Group companies such as IIJ-Tech as well as with other important service
providers.
    
    One division focuses on total network solutions and works with governmental
institutions.
  Customers
  Research and Development
    Research and Development Organization
  34




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##### Table of Contents



IIJ Research Laboratory.
 Applied Research and Development Department.
 Research and Development Strategy
  
    
    continued improvement of our SEIL router and SMF, systems
which we developed specifically to be integrated into IIJs network-related services,
    
    research relating to the methodology of configuration of routers and other servers,
    
    research relating to behavior of Internet routing systems,
    
    software development for management of border gateway protocol, or BGP, which is
protocol that allows routers to exchange routing information on the TCP/IP network,
    
    research for Internet traffic monitoring and management,
    
    development of software and evaluation of hardware relating to improving the
operations of routers located on our customers premises, and
    
    research and development of IPSec, which is a secure version of IP that provides
secure communication channels over the Internet.
  Proprietary Rights
  35




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##### Table of Contents



Licenses
   Trademarks
  Patents
  Legal Proceedings
   36




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##### Table of Contents



Regulation of the Telecommunications Industry in Japan
  The Telecommunications Business Law
  
    
    the elimination of the classification of Type I Carriers and Type II Carriers;
    
    deregulation of regulations on charges and terms and conditions for providing
services by Carriers; and
    
    the introduction of certain terminal-equipment-suppliers declaration system
regarding technical standard conformity.
   37




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(Before Amendment)
 Type I Carriers
    
    Type II CarriersSpecial Type II
    
    General Type IIStart-up of services
    
    Permission from MIC required
    
    Registration with MIC required
    
    Notification to MIC requiredRates and charges
    
    Notification* to MIC required
    
    Notification to MIC required
    
    UnregulatedShare acquisition
by foreign
investors
    
    Unregulated**
    
    Unregulated
    
    Unregulated
 
 *
    
    Type I Carriers which operate Category I Designated Telecommunications Facilities are
required to receive MIC approval for their Interconnection charges.**
    
    Prior notification is required under the Foreign Exchange and Foreign Trade Law. This is not
applicable to purchasers of ADSs. A one-third foreign ownership restriction is applicable only
to NTT (which was changed from a 20% foreign ownership restriction on November 30, 2001). (After Amendment)
 Telecommunications CarriersRegistration required
    
    Registration exemptedStart-up of services
    
    Registration with MIC required*
    
    Notification to MIC required****Rates and charges
    
    Notification to MIC required**
    
    UnregulatedShare acquisition
by foreign
investors
    
    Unregulated***
    
    Unregulated
  
 *
    
    Applicable to telecommunications carriers which install certain large scale circuit
facilities unless an exemption applies as designated by the applicable ministerial ordinance
of MIC from the viewpoint of the scale of the telecommunications circuit facilities and the
scope of areas where such telecommunications circuit facilities are installed.**
    
    Applicable to universal services and services which have the control power over the market
provided by the telecommunications carriers which install what is called the bottle-neck
facilities.Telecommunications carriers which operate Category I Designated Telecommunications Facilities
are required to receive MIC approval for their Interconnection terms and charges.***
    
    Prior notification is required under the Foreign Exchange and Foreign Trade Law for
acquisition of shares of telecommunications carriers to which registration for start-up
services is applicable. This is not applicable to purchasers of ADSs. A one-third foreign
ownership restriction is applicable only to NTT. 38




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##### Table of Contents



****
    
    Currently, carriers which meet the following two requirements established by the ministerial
ordinance of MIC are exempted from registration with MIC: (i) areas of installation of
terminal-related transmission facilities are limited to only within a single municipal (city,
town or village) and (ii) areas of installation of relay-related transmission facilities are
limited to only within a single prefecture. Regulations of telecommunications carriers
  Start-up of Services
 
    
    Carriers with registrationRegistration with the MIC required for telecommunications carriers which exceed
criteria established by MICs ordinance in relation to the scale of the
telecommunications circuit facilities and the scope of areas where such
telecommunications circuit facilities are installed.
    
    Other CarriersNotification to the MIC required for telecommunications carriers other than the above.
We do business under this category.
 Charges and Tariffs
 
    
    Unregulated, in general. The requirement that standard terms and conditions be
applied equally to all users was repealed.
    
    Prior notification to the MIC required for Basic Telecommunications Services
(universal services such as basic fee, local call and emergency telecommunication
service) and Designated Telecommunications Services (i.e., services which have the
controlling power over the market provided by the telecommunications carriers which
install what is called the bottle-neck facilities). Among the Designated
Telecommunications Services, the telecommunications services to be specified by MIC at
least once a year will be subject to price cap regulations, under which carriers will
be required to obtain approval from the MIC if a proposed change of charge exceeds the
price cap. Providing these telecommunications services other than pursuant to the
terms and conditions notified to the MIC is prohibited, unless minor exceptions apply.
 Articles of Interconnection Agreements
 
    
    Unregulated, in general.
    
    Approval from the MIC required for Category I Designated Telecommunications Facilities.
    
    Prior notification to the MIC required for Category II Designated
Telecommunications Facilities.
 Telecommunications Facilities of Carriers.
 
    
    A telecommunications carrier that owns telecommunications circuit facilities must
maintain its telecommunications facilities (except telecommunications facilities
stipulated in MICs ordinances as those having a minor influence on the users benefit in the cases of damage or
 39




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##### Table of Contents



failure thereof) in conformity with the technical standards
provided in the applicable MICs ordinances. Such Carriers shall confirm itself that
said telecommunications facilities are in compliance with such technical standards
specified in the applicable MICs ordinances.
    
    A telecommunications carrier that provides Basic Telecommunications Services must
maintain their telecommunications facilities for provision of their Basic
Telecommunications Services in conformity with the technical standards provided in the applicable MICs
ordinances.
    
    Telecommunications Carriers that own telecommunications circuit facilities or
provide Basic Telecommunications Services must establish their own administrative
rules in accordance with MICs ordinances 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
MIC. Such administrative rules must be submitted to the MIC prior to the commencement
of operations, and changes must be submitted to the MIC after they are implemented
without delay.
 Order to Improve Business Activities
 
    
    The Minister for MIC may, if it is deemed that business activities of a
telecommunications carrier falls under the inappropriate items set forth in the
Telecommunications Business Law, insofar as necessary to ensure the users benefit or
the public interest, order said telecommunications carrier to take actions to improve
operations methods or other measures.
 Right of Way Privilege for Authorized Carriers
 
    
    Authorization on the entire or a part of a carriers telecommunications business by
MIC for the privileged use of land or other public utilities for circuit facilities
deployment is required. Right of Way privilege is available to carriers irrespective
of registration.
 Merger, Business Transfer or Divestiture of Carriers
 
    
    Post facto notification to MIC without delay is required.
 Business Suspension, Abolition or Dissolution of Carriers
 
    
    Post facto notification to MIC without delay is required. Prior announcement of
withdrawals to service users is required in accordance with MICs ordinance.
 Foreign Capital Participation
 
    
    Unregulated. Prior notification is required under the Foreign Exchange and Foreign
Trade Law for 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.
 C. Organizational Structure.
  40




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##### Table of Contents



D. Property, Plants and Equipment.
  
 Item 4A. Unresolved Staff Comments
  
 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
       41




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42




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Results of Operations
  Fiscal year ended March 31,2005
    
    
    2006
    
    
    2007(millions of yen except for percentage data)
    
    
    (thousandsof U.S.dollars)REVENUES:Connectivity and value-added services:Dedicated access
    
    ¥
    11,373
    
    
    
    27.3
    %
    
    ¥
    10,625
    
    
    
    21.3
    %
    
    ¥
    10,792
    
    
    
    18.9
    %
    
    $
    91,797Dial-up access
    
    
    2,937
    
    
    
    7.0
    
    
    
    2,674
    
    
    
    5.4
    
    
    
    2,416
    
    
    
    4.2
    
    
    
    20,554Value-added services
    
    
    5,005
    
    
    
    12.0
    
    
    
    6,250
    
    
    
    12.5
    
    
    
    7,416
    
    
    
    13.0
    
    
    
    63,079Other
    
    
    3,169
    
    
    
    7.6
    
    
    
    3,674
    
    
    
    7.4
    
    
    
    3,729
    
    
    
    6.6
    
    
    
    31,725Total
    
    
    22,484
    
    
    
    53.9
    
    
    
    23,223
    
    
    
    46.6
    
    
    
    24,353
    
    
    
    42.7
    
    
    
    207,155Systems integration
    
    
    15,854
    
    
    
    38.0
    
    
    
    23,505
    
    
    
    47.2
    
    
    
    30,527
    
    
    
    53.5
    
    
    
    259,672Equipment sales
    
    
    3,365
    
    
    
    8.1
    
    
    
    3,085
    
    
    
    6.2
    
    
    
    2,175
    
    
    
    3.8
    
    
    
    18,496Total revenues
    
    
    41,703
    
    
    
    100.0
    
    
    
    49,813
    
    
    
    100.0
    
    
    
    57,055
    
    
    
    100.0
    
    
    
    485,323COST AND EXPENSES:Cost of connectivity and value-added
services:Backbone cost
    
    
    3,551
    
    
    
    8.5
    
    
    
    3,516
    
    
    
    7.0
    
    
    
    3,516
    
    
    
    6.2
    
    
    
    29,908Local access line cost
    
    
    4,040
    
    
    
    9.7
    
    
    
    4,558
    
    
    
    9.2
    
    
    
    4,616
    
    
    
    8.1
    
    
    
    39,269Other connectivity cost
    
    
    1,361
    
    
    
    3.3
    
    
    
    815
    
    
    
    1.6
    
    
    
    331
    
    
    
    0.6
    
    
    
    2,813Depreciation and amortization
    
    
    2,938
    
    
    
    7.0
    
    
    
    2,721
    
    
    
    5.5
    
    
    
    2,639
    
    
    
    4.6
    
    
    
    22.450Other
    
    
    7,594
    
    
    
    18.2
    
    
    
    8,468
    
    
    
    17.0
    
    
    
    9,443
    
    
    
    16.5
    
    
    
    80,325Total cost of connectivity and
value-added services
    
    
    19,484
    
    
    
    46.7
    
    
    
    20,078
    
    
    
    40.3
    
    
    
    20,545
    
    
    
    36.0
    
    
    
    174,765Cost of systems integration:Cost of equipment sales related to
systems integration
    
    
    1,759
    
    
    
    4.2
    
    
    
    3,591
    
    
    
    7.2
    
    
    
    4,206
    
    
    
    7.3
    
    
    
    35,774Other
    
    
    10,441
    
    
    
    25.0
    
    
    
    14,529
    
    
    
    29.2
    
    
    
    19,323
    
    
    
    33.9
    
    
    
    164,371Total cost of systems integration
    
    
    12,200
    
    
    
    29.2
    
    
    
    18,120
    
    
    
    36.4
    
    
    
    23,529
    
    
    
    41.2
    
    
    
    200,145Cost of equipment sales
    
    
    3,111
    
    
    
    7.5
    
    
    
    2,818
    
    
    
    5.7
    
    
    
    1,894
    
    
    
    3.4
    
    
    
    16,104Total cost
    
    
    34,795
    
    
    
    83.4
    
    
    
    41,016
    
    
    
    82.4
    
    
    
    45,968
    
    
    
    80.6
    
    
    
    391,014Sales and marketing
    
    
    2,795
    
    
    
    6.7
    
    
    
    3,080
    
    
    
    6.2
    
    
    
    3,439
    
    
    
    6.0
    
    
    
    29,251General and administrative
    
    
    2,666
    
    
    
    6.4
    
    
    
    3,147
    
    
    
    6.3
    
    
    
    3,971
    
    
    
    7.0
    
    
    
    33,776Research and development
    
    
    199
    
    
    
    0.5
    
    
    
    159
    
    
    
    0.3
    
    
    
    177
    
    
    
    0.3
    
    
    
    1,508Total cost and expenses
    
    
    40,455
    
    
    
    97.0
    
    
    
    47,402
    
    
    
    95.2
    
    
    
    53,555
    
    
    
    93.9
    
    
    
    455,549OPERATING INCOME
    
    
    1,248
    
    
    
    3.0
    
    
    
    2,411
    
    
    
    4.8
    
    
    
    3,500
    
    
    
    6.1
    
    
    
    29,774OTHER INCOME (EXPENSES):Interest income
    
    
    13
    
    
    
    0.0
    
    
    
    13
    
    
    
    0.0
    
    
    
    23
    
    
    
    0.0
    
    
    
    196Interest expense
    
    
    (686
    )
    
    
    (1.6
    )
    
    
    (437
    )
    
    
    (0.9
    )
    
    
    (397
    )
    
    
    (0.7
    )
    
    
    (3,381
    )Foreign exchange gains (losses)
    
    
    6
    
    
    
    0.0
    
    
    
    3
    
    
    
    0.0
    
    
    
    0
    
    
    
    (0.0
    )
    
    
    (3
    )Net gain on other investments
    
    
    2,439
    
    
    
    5.9
    
    
    
    3,198
    
    
    
    6.5
    
    
    
    1,867
    
    
    
    3.3
    
    
    
    15,877Other  net
    
    
    128
    
    
    
    0.3
    
    
    
    191
    
    
    
    0.4
    
    
    
    56
    
    
    
    0.1
    
    
    
    482Other income  net
    
    
    1,900
    
    
    
    4.6
    
    
    
    2,968
    
    
    
    6.0
    
    
    
    1,549
    
    
    
    2.7
    
    
    
    13,171INCOME FROM OPERATIONS BEFORE INCOME TAX
EXPENSE (BENEFIT), MINORITY INTERESTS AND
EQUITY IN NET LOSS OF EQUITY METHOD
INVESTEES
    
    ¥
    3,148
    
    
    
    7.6
    %
    
    ¥
    5,379
    
    
    
    10.8
    %
    
    ¥
    5,049
    
    
    
    8.8
    %
    
    $
    42,945INCOME TAX EXPENSE (BENEFIT)
    
    ¥
    100
    
    
    
    0.2
    %
    
    ¥
    257
    
    
    
    0.5
    %
    
    ¥
    (804
    )
    
    
    (1.4
    )%
    
    $
    (6,839
    )MINORITY INTERESTS IN EARNINGS OF
SUBSIDIARIES
    
    
    (109
    )
    
    
    (0.3
    )
    
    
    (354
    )
    
    
    (0.7
    )
    
    
    (233
    )
    
    
    (0.4
    )
    
    
    (1,979
    )EQUITY IN NET LOSS OF EQUITY METHOD
INVESTEES
    
    
    (33
    )
    
    
    (0.1
    )
    
    
    (14
    )
    
    
    (0.0
    )
    
    
    (210
    )
    
    
    (0.3
    )
    
    
    (1,788
    )
 43




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##### Table of Contents



Fiscal year ended March 31,2005
    
    
    2006
    
    
    2007(millions of yen except for percentage data)
    
    
    (thousandsof U.S.dollars)NET INCOME
    
    ¥
    2,906
    
    
    
    7.0
    %
    
    ¥
    4,754
    
    
    
    9.6
    %
    
    ¥
    5,410
    
    
    
    9.5
    %
    
    $
    46,017
 Year Ended March 31, 2007 Compared to the Year Ended March 31, 2006
 Total revenues
  Connectivity and value-added services revenues.
 
    
    Dedicated access.Revenues from dedicated access services increased 1.6% to ¥10.8
billion for the fiscal year ended March 31, 2007 from ¥10.6 billion for the previous
fiscal year. The increase was mainly due to an increase in revenues from broadband
services along with the expansion of broadband utilization in the corporate internal
network and an increase in revenues from IP Services, the services mainly used for
corporate headquarters and data centers, along with customers shift to higher speeds.
    
    Dial-up access.Revenues from dial-up access services decreased 9.6% to ¥2.4
billion for the fiscal year ended March 31, 2007 from ¥2.7 billion for the previous
fiscal year. This decrease was primarily the result of declining revenues from
services for individuals such as IIJ4U Service, as well as the discontinuance of
services of certain large customers to which we provided our services as OEM.
    
    Value-added services.Our value-added services revenues increased 18.7% to ¥7.4
billion for the fiscal year ended March 31, 2007 from ¥6.2 billion for the previous
fiscal year. This increase was mainly due to a steady increase in revenues from
solutions such as data center services, security and e-mail related outsourcing
services and network related solutions such as SEIL and SEIL Management Framework,
along with projects to connect customers multiple operational sites. The steady
increase is affected by an increase in demand for outsourcing services by corporate
customers.
    
    Other.Other revenues, which included rental fees for network equipment, customer
support service, and sale of Wide-area Ethernet services, amounted to ¥3.7 billion for
the fiscal year ended March 31, 2007, a 1.5% increase from the previous fiscal year.
 Systems integration revenues.
 44




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##### Table of Contents



Equipment sales.
 Total cost of revenues
  Cost of connectivity and value-added services revenues
 Cost of systems integration revenues.
 Cost of equipment sales.
 Total costs and expenses
  Sales and marketing.
 General and administrative.
 45




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##### Table of Contents



Research and development.
 Operating income
  Other income net
  Interest income.
 Interest expense.
 Foreign exchange gains (losses).
 Net gain on other investments.
 Other-net.
 Income from operations before income tax expense (benefit), minority interests and equity in net
loss of equity method investees
  Income tax expense (benefit)
  46




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##### Table of Contents



Minority interests in earnings of subsidiaries
  Equity in net loss of equity method investees
  Net income
  Year Ended March 31, 2006 Compared to the Year Ended March 31, 2005
 Total revenues
  Connectivity and value-added services revenues.
 
    
    Dedicated access.Revenues from dedicated access services decreased 6.6% to ¥10.6
billion for the fiscal year ended March 31, 2006 from ¥11.4 billion for the previous
fiscal year. This decrease reflected a decrease of revenues of ¥468 million from the
interconnection of the Companys network with AIH, our former equity method investee,
which resulted from the consolidation of AIHs revenues following the merger of AIH
into the Company. The decrease is also due to the decline in unit price per bandwidth.
    
    Dial-up access.Revenues from dial-up access services decreased 9.0% to ¥2.7
billion for the fiscal year ended March 31, 2006 from ¥2.9 billion for the previous
fiscal year. This decrease was primarily the result of declining revenues from
services for individuals such as IIJ4U Service. The revenues from IIJ4U decreased by
¥0.1 billion from the previous fiscal year.
    
    Value-added services.Our value-added services revenues increased 24.9% to ¥6.2
billion for the fiscal year ended March 31, 2006 from ¥5.0 billion for the previous
fiscal year. This increase was mainly due to a steady increase in revenues from
solutions such as data center services, security and e-mail related outsourcing
services and network related solutions such as SEIL and SEIL Management Framework,
along with projects to connect customers multiple operational sites. The steady
increase is affected by an increase in demand for outsourcing services by corporate
customers.
 47




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##### Table of Contents




    
    Other.Other revenues, which included rental fees for network equipment, customer
support service, and sale of Wide-area Ethernet services, amounted to ¥3.7 billion for
the fiscal year ended March 31, 2006, a 15.9% increase from the previous fiscal year.
The increase was mainly due to a continuous increase in sales of Wide-area Ethernet
services which increased by 43.8% compared to the previous fiscal year.
 Systems integration revenues.
 Equipment sales.
 Total cost of revenues
  Cost of connectivity and value-added services revenues
 Cost of systems integration revenues.
 Cost of equipment sales.
 Total costs and expenses
  48




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##### Table of Contents



Sales and marketing.
 General and administrative.
 Research
and development.
 Operating income
  Other income (expenses) net
  Interest income.
 Interest expense.
 Foreign exchange gains.
 Net gain on other investments.
 Other-net.
 Income from operations before income tax expense, minority interests and equity in net loss of
equity method investees
  49




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##### Table of Contents



Income tax expense
  Minority interests in earnings of subsidiaries
  Equity in net loss of equity method investees
  Net income
  Application of Critical Accounting Policies
    Revenue recognition
  50




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##### Table of Contents




    
    The delivered item(s) has value to the client on a stand-alone basis,
 
    
    There is objective and reliable evidence of the fair value of the undelivered item(s), and
    
    If the arrangement includes a general right of return relative to the
delivered item(s), delivery or performance of the undelivered item(s) is considered
probable and substantially in the control of the company.
    Useful lives of property and equipment
  51




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##### Table of Contents



Item
    
    Useful LivesData communications, office and other equipment
    
    
    2 to 15 yearsLeasehold improvements
    
    
    3 to 15 yearsPurchased software
    
    
    5 yearsCapitalized leases
    
    
    4 to 7 years
     Impairment of long-lived assets
  
    
    significant decline in the market value of an asset,
    
    current period operating cash flow loss,
 52




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
    
    introduction of competing technologies or services,
    
    significant underperformance of expected or historical cash flows,
    
    significant or continuing decline in subscribers,
    
    changes in the manner or use of an asset,
    
    disruptions in the use of network equipment under capital lease arrangements, and
    
    other negative industry or economic trends.
  Allowance for doubtful accounts and uncollectible contractual prepayments
  Deferred tax assets
  53




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##### Table of Contents



Valuation of investments
  
    
    the length of time and the extent to which the market value has been less than
cost,
    
    the financial condition and near-term prospects of the issuer, including any
specific events which may influence the operations of the issuer such as changes in
technology that may impair the earnings potential of the investment, and
    
    our intent and ability to retain the investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in market value. If a decline in
value occurs and is deemed to be other-than-temporary, an impairment loss will be
recorded to write-down the carrying value of the investment to fair value. If, after
taking into account these considerations, the decline is judged to be other than
temporary, the cost basis of the individual security is written down to a new cost
basis and the amount of the write-down is accounted for as a realized loss.
    Pension benefits costs
  54




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Change in Assumption
    
    Pre-Tax PBO
    
    Pension Expense
    
    Equity (Net of Tax)(millions of yen)50 basis point increase/decrease in discount rate
    
    (135)/150
    
    (22)/27
    
    13/(16)50 basis point increase/decrease in expected return on assets
    
    
    
    (5)/ 5
    
     / (3)
 New Accounting Standards
     55




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##### Table of Contents



B.
    
    Liquidity and Capital Resources.
 Liquidity and Capital Requirements
  Capital expenditures.
 For the fiscal year ended March 31,2005
    
    
    2006
    
    
    2007(millions of yen)Capital expenditures, including
capitalized leases(1)
    
    ¥
    5,011
    
    
    ¥
    4,762
    
    
    ¥
    3,953
 
 (1)
    
    Further information regarding capital expenditures, including capitalized leases and a
reconciliation to the most directly comparable U.S. GAAP financial measure, can be found in Item
3.A., Selected Financial Data Reconciliation of the Disclosed Non-GAAP Financial Measures to
the Most Directly Comparable GAAP Financial Measures.   56




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Lease payments.
    Payment due by period(millions of yen)Totalcontractual
    
    
    Less than
    
    
    
    
    
    
    
    
    More thanamount
    
    
    1 year
    
    
    1 to 3 years
    
    
    4 to 5 years
    
    
    5 yearsConnectivity lines operating leases
    
    ¥
    134
    
    
    ¥
    39
    
    
    ¥
    76
    
    
    ¥
    19
    
    
    ¥
    Other operating leases
    
    
    2,226
    
    
    
    1,468
    
    
    
    680
    
    
    
    38
    
    
    
    40Capital leases
    
    
    7,700
    
    
    
    3,202
    
    
    
    3,808
    
    
    
    683
    
    
    
    7Total minimum lease payments(1)
    
    ¥
    10,060
    
    
    ¥
    4,709
    
    
    ¥
    4,564
    
    
    ¥
    740
    
    
    ¥
    47
 
 (1)
    
    See note 7 to our consolidated financial statements included in this annual report. Payments of principal and interest on outstanding borrowings.
   57




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Investments in current and former group companies.
 Working capital needs.
 Capital Resources
  Short-term and long-term Borrowings.
 Cash flows from operating activities.
 Capital Leases.
 58




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##### Table of Contents



Issuances of Equity Securities.
 Cash Flows
   Fiscal year ended March 31,2005
    
    
    2006
    
    
    2007(millions of yen)Net cash provided by operating activities
    
    ¥
    5,238
    
    
    ¥
    6,559
    
    
    ¥
    7,402Net cash provided by (used in) investing activities
    
    
    1,974
    
    
    
    1,805
    
    
    
    (3,014
    )Net cash provided by (used in) financing activities
    
    
    (14,212
    )
    
    
    39
    
    
    
    (4,560
    )Effect of exchange rate changes on cash
    
    
    2
    
    
    
    38
    
    
    
    (0
    )Net increase (decrease) in cash
    
    
    (6,998
    )
    
    
    8,441
    
    
    
    (172
    )Cash at beginning of the year
    
    
    12,284
    
    
    
    5,286
    
    
    
    13,727Cash at end of the year
    
    ¥
    5,286
    
    
    ¥
    13,727
    
    
    ¥
    13,555
 Year Ended March 31, 2007 as Compared to the Year Ended March 31, 2006
    59




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Year Ended March 31, 2006 as Compared to the Year Ended March 31, 2005
    Contingencies
  C. Research and Development, Patents and Licenses, etc.
  D. Trend Information.
 Factors Affecting Our Future Financial Results
  60




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Revenues
  Connectivity and value-added services revenues
  Dedicated access services
  
    
    Increased contracted bandwidth.Total contracted bandwidth for dedicated access
services including Internet Data Center Connectivity Services increased to 323.5 Gbps
for the fiscal year ended March 31, 2007 from 194.9 Gbps for the previous fiscal year.
The number of IP Service contracts for the bandwidth over 100Mbps increased to 224 for
the fiscal year ended March 31, 2007 from 157 for the fiscal year ended March 31,
2006. This increase is mainly due to an increase in customers demand for higher
bandwidth for their Internet connectivity. The average revenues per contract for IP
Service was approximately ¥0.6 million at the end of March 2007, compared to the
revenues per contract of ¥0.6 million at the end of March 2006. Though we do not
expect that revenue per contract come to a growing trend for the fiscal year ending
March 31, 2008 due to the continuing competition, we believe that customer demand for
higher bandwidth will continue as the use of broadband by corporate customers expands,
and we will try to acquire new customers and increase the bandwidth of existing
customers as well as maintain the quality of our services and differentiate them from
those of our competitors.
    
    Increased demand for broadband services.Demand for broadband services, IIJ
FiberAccess/F, IIJ DSL/F and IIJ DSL/A are increasing rapidly as the services are
coming to be used to connect corporate branches and remote offices. The services uses
ADSL lines at maximum 47 Mbps speed or optical lines at maximum 10 Mbps or 100 Mbps as
access lines. The number of contracts for IIJ FiberAccess/F and IIJ DSL/F increased to
16,418 for the fiscal year ended March 31, 2007 from 13,297 for the fiscal year ended
March 31, 2006. We also expect that it will also contribute to the increase of
value-added services and systems integration revenues as usage and implementation of
these connectivity services will increase the demand for value-added services such as
security services and network systems integration.
 61




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Dial-up access services
   Value-added services revenues
   Other
  Systems integration revenues, including related equipment sales revenues
   62




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Other equipment sales revenues
  Additional factors affecting revenues
  
    
    Increase in business usage.Our revenues will be affected by the extent and speed
with which businesses in Japan exploit the Internet and network solutions to their
full potential, including, for example, electronic transactions between businesses and
expanding the range of devices that access the Internet. Such services require
high-quality and high-capacity connectivity services for both businesses and
individuals. Such services also require provision of total network solutions including
various Internet connectivity services, systems integration and other value-added
services which we believe we are well positioned to provide. The degree of business
usage will also depend upon a variety of factors including:
 
    
    technological advances, reliability of security systems and users familiarity
with and confidence in new technologies,
    
    the rate at which Japanese companies in certain industries significantly
increase their Internet usage, particularly the financial, manufacturing and
retail segments, and
    
    corporate budgets for expenditures for information technologies, including
Internet-related items.
 
    
    Range of service offerings.To increase our revenues from business users, we have
increased the access and connectivity options to include fiber optic lines and ADSL
lines. We have also completed our multi-site Internet data centers and expanded our
service offerings to include systems management and monitoring. We believe these steps
will allow us to sell a greater variety of services to our high-end corporate users
and to capture a greater amount of the current growth and demand. However, we will
still be strongly dependent on increasing acceptance of our services by large Japanese
companies and by increases in their Information Technology budgets. We expect Internet
usage to continue to grow rapidly in Japan and that businesses will continue to
diversify their uses of the Internet. Our ability to offer a broad range of services
to meet our customers demands will significantly influence our future revenues.
    
    Synergies between connectivity services, value-added services and systems
integration.Most of our systems integration customers become Internet connectivity
service customers as well, and we expect these relationships to continue. As part of
our systems integration business, we offer solution services for corporate information
network systems, consulting, project planning, system design and systems/operation
outsourcing or Internet VPN solution services which combines the FLETS Internet
connectivity services with the SEIL, adopted by customers who have multiple locations,
such as branches, offices and factories. The number of contracts
 63




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concerning these
services is steadily increasing and we seek to enlarge these network integration
services with relatively high gross margin services. The ability to introduce a wide
range of services, including solutions necessary to build corporate
information network systems, like disaster recovery services and Internet VPN, Voice
over IP (VoIP), SEIL and the network service operating system SMF, wireless LAN, is an
important competitive factor.
 Costs and expenses
  Cost of connectivity and value-added services revenues
   
    
    Backbone cost.Backbone cost for the fiscal year ended March 31, 2007 was ¥3.5
billion, almost the same as the fiscal year ended March 31, 2006. We do not expect
that our backbone cost will increase significantly as compared with recent fiscal
years.
    
    Dedicated local access line costs.We collect dedicated local access line fees from
subscribers and pay these fees over to the carriers. Dedicated local access line costs
for the fiscal year ended March 31, 2007 were ¥4.6 billion, almost the same as the
fiscal year ended March 31, 2006. Other connectivity costs were ¥0.3 billion for the
fiscal year ended March 31, 2007 compared to ¥0.8 billion for the previous fiscal
year.
  Costs of systems integration revenues and equipment sales
  64




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Sales and marketing
  General and administrative
  Research and development
  Other income (expenses)
  
    
    Interest expense.Most of our interest expense is from bank borrowing and capital
leases. Interest income and interest expenses are also affected by the fluctuation of
market interest rates and our total amount of outstanding borrowings. As we increase
capital leases or borrowings in order to finance further development of our backbone
and data centers and for other investments, interest expenses will also increase.
    
    Impairment losses.We also hold other investments, including available-for-sale
securities. The book value of other investments are affected by the fluctuation in the
market price or the decrease in fair values of non-marketable investments. If a
decrease below cost in the market
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price or fair value of an investment is judged to be
other than temporary, we will have impairment losses on other investments.
    
    Gain on sale of other investments.Gain on sales of other investment is mostly
raised from a sale of available-for-sale securities. We expect that we will continue a
sale of available-for-sale securities to raise the gain for the fiscal year ending
March 31, 2008.
 E. Off-Balance Sheet Arrangements.
  F. Tabular Disclosure of Contractual Obligations.
  Payments due by period (in million of yen)moreless than
    
    
    
    
    
    
    
    
    thanContractual Obligations
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsLong-term debt obligations
    
    ¥
    290
    
    
    ¥
    290
    
    
    ¥
    
    
    
    ¥
    
    
    
    ¥
    Capital lease obligations
    
    
    7,700
    
    
    
    3,202
    
    
    
    3,808
    
    
    
    683
    
    
    
    7Operating lease obligations
    
    
    2,360
    
    
    
    1,507
    
    
    
    757
    
    
    
    56
    
    
    
    40Total (1) (2)
    
    ¥
    10,350
    
    
    ¥
    4,999
    
    
    ¥
    4,565
    
    
    ¥
    739
    
    
    ¥
    47
 
 (1)
    
    In addition to the above, we plan to contribute ¥173 million to our pension plan for the
fiscal year ending March 31, 2008. On January 17, 2007, we
made an agreement for
investing in funds which invest in unlisted stocks mainly in Europe, Asia and Israel, with an
investment advisory company. We committed to provide $5 million for the fund at its request in
the future several years. We provided $140 thousand for the fiscal year ended March 31, 2007.
(Please refer to Note 14 to our consolidated financial statements). In June 2007, we acquired
100% of the equity of hi-ho, Inc. from Panasonic Network Services Inc. (PNS) to take over
PNSs Internet service business for personal users and its solution business for its corporate
customers for ¥1,200 million.(2)
    
    The table above does not include obligations for interest payments on debt. 
 Item 6. Directors, Senior Management and Employees.
 A. Directors and Senior Management.
  Initial date ofappointment asdirector,
    
    Number of IIJexecutive officer
    
    shares ownedCurrent term

    
    or company
    
    as of July 3,Name
    
    Position
    
    Date of birth
    
    expires
    
    auditor
    
    2007Koichi Suzuki
    
    President, Chief
Executive Officer and
Representative Director
    
    Sep. 3, 1946
    
    June 2009
    
    Dec. 1992
    
    
    12,783Toshiya Asaba
    
    Executive Vice President
    
    June 12, 1962
    
    June 2009
    
    June 1999
    
    
    *Yoshiaki Hisamoto
    
    Executive Vice President
    
    Dec. 14, 1954
    
    June 2008
    
    June 2006
    
    
    Hideshi Hojo
    
    Senior Managing Director
    
    Dec. 22, 1957
    
    June 2009
    
    June 2000
    
    
    *
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Initial date ofappointment asdirector,
    
    Number of IIJexecutive officer
    
    shares ownedCurrent term
    
    or company
    
    as of July 3,Name
    
    Position
    
    Date of birth
    
    expires
    
    auditor
    
    2007Takamichi Miyoshi
    
    Director
    
    May 5, 1963
    
    June 2008
    
    June 2002
    
    
    *Akihisa Watai
    
    Director, Chief
Financial Officer and
Chief Accounting
Officer
    
    Sep. 30, 1965
    
    June 2008
    
    June 2004
    
    
    *Hiroyuki Hisashima
    
    Director
    
    Oct. 11, 1959
    
    June 2009
    
    June 2005
    
    
    *Kazuhiro Tokita
    
    Director
    
    Apr. 25, 1969
    
    June 2009
    
    June 2005
    
    
    *Junichi Shimagami
    
    Director
    
    Apr. 17, 1967
    
    June 2009
    
    June 2007
    
    
    *Yasurou Tanahashi
    
    Director
    
    Jan. 4, 1941
    
    June 2008
    
    June 2004
    
    
    Takashi Hiroi
    
    Director
    
    Feb. 13, 1963
    
    June 2008
    
    June 2004
    
    
    Yoshifumi Nishikawa
    
    Director
    
    Aug. 3, 1938
    
    June 2009
    
    June 2005
    
    
    Junnosuke Furukawa
    
    Director
    
    Dec. 5, 1935
    
    June 2009
    
    June 2005
    
    
    Senji Yamamoto
    
    Director
    
    Apr. 14, 1946
    
    June 2008
    
    June 2006
    
    
    Junichi Tate
    
    Company Auditor
    
    Nov. 6, 1949
    
    June 2008
    
    June 2006
    
    
    Masaki Okada
    
    Company Auditor
    
    Jan. 9, 1959
    
    June 2008
    
    June 2004
    
    
    Masaaki Koizumi
    
    Company Auditor
    
    Oct. 4, 1964
    
    June 2008
    
    June 2004
    
    
    Hirofumi Takahashi
    
    Company Auditor
    
    Sep. 1, 1939
    
    June 2009
    
    June 2005
    
    
    *
 
 *
    
    Owns less than 1% of outstanding shares of IIJs common stock. Koichi Suzuki
 Toshiya Asaba
 Yoshiaki Hisamoto
 Hideshi Hojo
 67




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##### Table of Contents



Takamichi Miyoshi
 Akihisa Watai
 Hiroyuki Hisashima
 Kazuhiro Tokita
 Junichi Shimagami
 Yasurou Tanahashi
 Takashi Hiroi
 Yoshifumi Nishikawa
 Junnosuke Furukawa
 Senji Yamamoto
 68




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##### Table of Contents



Junichi Tate
 Masaki Okada
 Masaaki Koizumi
 Hirofumi Takahashi
 B. Compensation.
  C. Board Practices.
    69




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1 3
  70




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D. Employees.
    E. Share Ownership.
  71




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Stock Option Plan
 
    
    June 2001 Stock Option Plan. In June 2001, we implemented a stock option plan under
which 395 options to acquire a total of 1,975 shares or 790,000 ADS equivalents, or
approximately 1.8% of total outstanding shares on that date, were granted to 44
directors and employees on August 2, 2001. The option exercise price for the shares
was determined by setting the price 5% above the 30-days average of the closing market
prices beginning 45 days prior to the date of the grant which was ¥403,661 per share
and has been adjusted to ¥334,448 as a result of issuances of common shares. The
options are exercisable at various times from two years to ten years from the date of
grant.
    
    April 2000 Stock Option Plan. In April 2000, we implemented a stock option plan
under which our directors and employees were granted 295 options to acquire a total of
1,475 shares or 590,000 ADS equivalents, or approximately 1.2% of total outstanding
shares on that date. The options were granted to 34 directors and employees on May 31,
2000. The option exercise price was determined by setting the price at 5% above the
30-day moving average of closing market prices beginning 45 days prior to the date of
grant, which was ¥2,611,112 per share and has been subsequently adjusted to ¥2,163,418
as a result of issuances of common shares. The options are exercisable at various
times from two years to ten years from the date of grant.
    
    March 2001 Warrant Issuance. On March 31, 2001, certain directors of IIJ were
provided with 375 warrants exercisable for shares of common stock of IIJ-Tech. Each
warrant is exercisable for one share of common stock up to seven or eight years from
the date of grant at an exercise price of ¥300,000 and was purchased for 1% of the
exercise price.
  Employee Stock Purchase Plan
  
 Item 7. Major Shareholders and Related Party Transactions.
 A. Major Shareholders.
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Shares of common stock outstanding,beneficially owned as of March 31, 2007Number
    
    PercentageNippon Telegraph and Telephone Corporation and affiliates (1)
    
    
    60,675
    
    
    
    29.7
    %Koichi Suzuki
    
    
    12,532
    
    
    
    6.1Itochu Corporation
    
    
    10,430
    
    
    
    5.1Directors and executive officers as a group (2)
    
    
    13,317
    
    
    
    6.5
 
 (1)
    
    Includes Nippon Telegraph and Telephone Corporation (NTT), which owns 50,475 shares, or
24.7%, and NTT Communications Corporation (NTT Communications), which owns 10,200 shares, or
5.0%.(2)
    
    Includes Koichi Suzukis holding which is also separately set forth above. No other director
or executive officer is a beneficial owner of more than 5%.   B. Related Party Transactions.
 NTT-affiliated Companies.
 Transactions with equity method affiliates.
 millions of yenAccounts receivable
    
    ¥
    44Accounts payable
    
    
    16Revenues
    
    
    482Costs and expenses
    
    
    173
  73




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##### Table of Contents




    
    any enterprise that directly or indirectly controls, is controlled by, or is in common
control with us or any of our subsidiaries,
    
    any director, officer, company auditor or family member of any of the preceding or any
enterprise over which such person directly or indirectly is able to exercise significant
influence,
    
    any individual shareholder directly or indirectly having significant influence over
us or any of our subsidiaries or a family member of such individual or any enterprise
over which such person directly or indirectly is able to exercise significant influence,
or their respective family members or enterprises over which they exercise significant
influence, or
    
    any unconsolidated enterprise in which we have a significant influence or which has a
significant influence over us.
 C. Interests of Experts and Counsel.
  
 Item 8. Financial Information.
 A. Consolidated Statements and Other Financial Information.
 Financial Statements
  Legal or Arbitration Proceedings
  Dividend Policy
  B. Significant Changes.
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Item 9. The Offer and Listing.
 A. Offer and Listing Details.
   Nasdaq(1)
    
    TSE(1) (2)(per ADS)
    
    (per share of common stock)Fiscal year ended/ending March 31,
    
    High
    
    Low
    
    High
    
    Low2003
    
    $
    7.34
    
    
    $
    1.802004
    
    
    14.10
    
    
    
    1.412005
    
    
    6.24
    
    
    
    2.112006
    
    
    14.88
    
    
    
    3.04
    
    
    ¥
    584,000
    
    
    ¥
    409,000First Quarter
    
    
    13.93
    
    
    
    3.04Second Quarter
    
    
    11.12
    
    
    
    7.31Third Quarter
    
    
    14.88
    
    
    
    8.45
    
    
    
    548,000
    
    
    
    484,000Fourth Quarter
    
    
    12.99
    
    
    
    8.67
    
    
    
    584,000
    
    
    
    409,0002007
    
    
    10.65
    
    
    
    6.41
    
    
    
    517,000
    
    
    
    296,000First Quarter
    
    
    10.65
    
    
    
    6.41
    
    
    
    517,000
    
    
    
    296,000Second Quarter
    
    
    8.85
    
    
    
    6.83
    
    
    
    425,000
    
    
    
    315,000Third Quarter
    
    
    9.63
    
    
    
    7.33
    
    
    
    431,000
    
    
    
    358,000Fourth Quarter
    
    
    10.38
    
    
    
    8.33
    
    
    
    516,000
    
    
    
    402,0002008First Quarter
    
    
    9.98
    
    
    
    7.45
    
    
    
    473,000
    
    
    
    351,000MonthJanuary 2007
    
    
    9.32
    
    
    
    8.33
    
    
    
    455,000
    
    
    
    402,000February 2007
    
    
    10.38
    
    
    
    9.15
    
    
    
    516,000
    
    
    
    441,000March 2007
    
    
    10.20
    
    
    
    8.98
    
    
    
    477,000
    
    
    
    417,000April 2007
    
    
    9.98
    
    
    
    8.66
    
    
    
    473,000
    
    
    
    407,000May 2007
    
    
    9.08
    
    
    
    7.45
    
    
    
    438,000
    
    
    
    351,000June 2007
    
    
    9.14
    
    
    
    8.21
    
    
    
    440,000
    
    
    
    397,000
 
 (1)
    
    Price data are based on prices throughout the sessions for each corresponding period at each
stock exchange.(2)
    
    The high and low price of our shares of common stock on the TSE for the fiscal year ended
March 31, 2006 and the third quarter of the fiscal year ended March 31, 2006 show the high and
low price for the period on and after December 2, 2005, when we listed on the Mothers market
of the TSE. B. Plan of Distribution.
  75




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C. Markets.
  D. Selling Shareholders.
  E. Dilution.
  F. Expenses of the issue.
  
 Item 10. Additional Information.
 A. Share Capital.
  B. Memorandum and Articles of Association.
 Objects and Purposes in Our Articles of Incorporation
  
    
    Telecommunications business under the Telecommunications Business Law,
    
    Processing, mediation and provision of information and contents by using
telecommunications networks,
    
    Agency for the management business such as the management of networks and the
management of information and telecommunications systems,
    
    Planning, consulting service, development, operation and maintenance of or for
information and telecommunications systems,
    
    Development, sales, lease and maintenance of computer software,
    
    Development, sales, lease and maintenance of telecommunications machinery and
equipment,
    
    Telecommunications construction,
    
    Agency for non-life insurance,
 76




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##### Table of Contents




    
    Research, study, education and training related to the foregoing, and
    
    Any and all businesses incidental or related to the foregoing.
 Provisions Regarding Our Directors
      Rights of Shareholders of our Common Stock
  
    
    the right to receive dividends when the payment of dividends has been approved at a
shareholders meeting, with this right lapsing three full years after the due date for
payment according to a provision in the Articles,
    
    the right to receive interim dividends as provided for in the Articles, with this
right lapsing three full years after the due date for payment according to a provision
in the Articles,
    
    the right to vote at a shareholders meeting (cumulative voting is not allowed
under the Articles),
    
    the right to receive surplus in the event of liquidation, and
    
    the right to require us to purchase shares when a shareholder opposes resolutions
including (i) the transfer of all or material part of the business, (ii) an amendment
of the Articles to establish a restriction on share transfer, (iii) a share exchange
or share transfer to establish a holding company, (iv) split of the company or (v)
merger, all of which must be consummated by a two-thirds affirmative vote of the
voting rights of the shareholders at a shareholders meeting at which shareholders
having not less than one-third of the total number of voting rights held by all
shareholders who can exercise their voting rights are in attendance.
 77




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
    
    a reduction of the stated capital,
    
    amendment of our Articles of Incorporation (except amendments that the Board of
Directors are authorized to make under the Corporation Law of Japan),
    
    establishment of a 100% parent-subsidiary relationship through a share exchange or
share transfer requiring shareholders approval,
    
    a dissolution, merger or consolidation requiring shareholders approval,
    
    a company split requiring shareholders approval,
    
    a transfer of the whole or an important part of our business,
    
    the taking over of the whole of the business of any other corporation requiring
shareholders approval, and
    
    issuance of new shares at a specially favorable price, or issuance of stock
acquisition rights or bonds with stock acquisition rights with specially favorable
conditions to persons other than shareholders.
   
    
    short-form share transfer (only in respect of the shareholders of the company to be
a 100% parent company by the short-form share transfer),
    
    short-form company split into an existing company (only in respect of the
shareholders of the exiting company that takes over the target business of the split
company), and
 78




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##### Table of Contents




    
    short-form absorption (only in respect of the shareholders of the exiting company
that absorbs the target company by the short-form absorption).
  
    
    dissolution, and
    
    commencement of reorganization proceedings as provided for in the Company
Reorganization Law of Japan.
  
    
    demand the convening of a general meeting of shareholders,
    
    apply to a competent court for removal of a director or company auditor,
    
    apply to a competent court for removal of a liquidator, and
    
    apply to a competent court for an order to inspect our business and assets in a
special liquidation proceeding.
  
    
    examine our accounting books and documents and make copies of them, and
    
    apply to a competent court for appointment of an inspector to inspect our operation
or financial condition.
    
    
    us to institute an action to enforce the liability of one of our directors or
company auditors,
    
    us to institute an action to recover from a recipient the benefit of a proprietary
nature given in relation to exercising the right of a shareholder, and
    
    a director on our behalf for the cessation of an illegal or ultra vires action.
  79




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##### Table of Contents



Restrictions on Holders of our Common Stock
      C. Material Contracts.
  Limitation of Liability Agreements dated, June 28, 2006 and June 26, 2007, between Internet
Initiative Japan Inc. and outside directors and outside company auditors.
 80




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##### Table of Contents



D. Exchange Controls.
  E. Taxation.
 Japanese Taxation
  
    
    the overall tax consequences of the ownership and disposition of shares or ADSs,
including specifically the tax consequences under Japanese law,
    
    the laws of the jurisdiction of which they are resident, and
    
    any tax treaty between Japan and their country of residence, by consulting their
own tax advisers.
    
    
    a corporation that has owned, directly or indirectly through one or more residents
of either Japan or the U.S., more than 50% of the voting shares of the paying
corporation for the period of twelve months ending on the date on which entitlement to
the dividends is determined and which meets additional requirements, or
 81




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##### Table of Contents




    
    a pension fund, provided that such dividends are not derived from the carrying on
of a business, directly or indirectly, by such pension fund.
  The Prior Treaty
    
    
    
    The Treaty10% or more of the voting shares
    
    10%
    
    More than 50% of the voting shares
    
    0%10% to 50% of the voting shares
    
    5%Others
    
    15%
    
    Others
    
    10%
       82




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##### Table of Contents



United States Taxation
  
    
    tax-exempt entities,
    
    life insurance companies,
    
    dealers in securities,
    
    traders in securities that elect to use a mark-to-market method of accounting for
securities holdings,
    
    investors liable for alternative minimum tax,
    
    investors that actually or constructively own 10% or more of the voting stock of IIJ,
    
    investors that hold shares or ADSs as part of a straddle or a hedging or conversion
transaction, or
    
    investors whose functional currency is not the U.S. dollar.
   
    
    a citizen or resident of the United States,
    
    a domestic corporation,
    
    an estate whose income is subject to United States federal income tax regardless of
its source, or
    
    a trust if a United States court can exercise primary supervision over the trusts
administration and one or more United States persons are authorized to control all
substantial decisions of the trust.
   83




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Taxation of Dividends
      84




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##### Table of Contents



Taxation of Capital Gains
  PFIC Rules
   
    
    at least 75% of our gross income for the taxable year is passive income, or
    
    at least 50% of the value, determined on the basis of a quarterly average, of our
assets is attributable to assets that produce or are held for the production of
passive income.
    
    
    any gain you realize on the sale or other disposition of your shares or ADSs, and
    
    any excess distribution that we make to you (generally, any distributions to you
during a single taxable year that are greater than 125% of the average annual
distributions received by you in respect of the shares or ADSs during the three
preceding taxable years or, if shorter, your holding period for the shares or ADSs).
  
    
    the gain or excess distribution will be allocated ratably over your holding period
for the shares or ADSs,
 85




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##### Table of Contents




    
    the amount allocated to the taxable year in which you realized the gain or excess
distribution will be taxed as ordinary income,
    
    the amount allocated to each prior year, with certain exceptions, will be taxed at
the highest tax rate in effect for that year, and
    
    the interest charge generally applicable to underpayments of tax will be imposed in
respect of the tax attributable to each such year.
     F. Dividends and Paying Agents.
  G. Statement by Experts.
  H. Documents on Display.
  86




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##### Table of Contents



1-800-SEC-0330 1-105 http://www.iij.ad.jp/.
 I. Subsidiary Information.
  
 Item 11. Quantitative and Qualitative Disclosures about Market Risk.
  Interest Rate Risk
  Expected maturity dateFairvalueorGainMarch 31, 2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    2012
    
    Total
    
    (loss)(millions of yen)Long-term debt obligations:Fixed rate long-term borrowings and
installment payable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Average interest rate
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %Variable rate long-term borrowings
    
    
    290
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    290
    
    
    
    290Average interest rate
    
    
    1.997
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.997
    %Interest rate swap contracts Notional amount  variable to fixed:
    
    
    250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    250Average pay rate
    
    
    1.670
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.670
    %Average receive rate
    
    
    1.706
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.706
    %
 Expected maturity dateFairvalue orGainMarch 31, 2006
    
    2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    Total
    
    (loss)(millions of yen)Long-term debt obligations:Fixed rate long-term borrowings and
installment payable
    
    
    756
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    756
    
    
    
    756
 87




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##### Table of Contents



Expected maturity dateFairvalue orGainMarch 31, 2006
    
    2007
    
    2008
    
    2009
    
    2010
    
    2011
    
    Total
    
    (loss)(millions of yen)Average interest rate
    
    
    1.883
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.883
    %Variable rate long-term borrowings
    
    
    1,234
    
    
    
    290
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,524
    
    
    
    1,524Average interest rate
    
    
    1.413
    %
    
    
    1.440
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.418
    %Interest rate swap contracts Notional amount  variable to fixed:
    
    
    900
    
    
    
    250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,150
    
    
    
    (4
    )Average pay rate
    
    
    1.812
    %
    
    
    1.670
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.781
    %Average receive rate
    
    
    1.166
    %
    
    
    1.150
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1.162
    %
  Equity Price Risk
  Foreign Currency Exchange Rate Risk
  
 Item 12.
Description of Securities Other than Equity Securities.
  
 PART II
 
 Item 13.
Defaults, Dividend Arrearages and Delinquencies.
  88




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Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds.
  
 Item 15T.
Controls and Procedures.
 Disclosure Controls and Procedures
    Managements Report on Internal Control Over Financial Reporting
   
    
    pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of our assets,
    
    provide reasonable assurance that transactions are recorded as necessary to
permit preparation of our financial statements in accordance with accounting
principles generally accepted in the United States of America, and that our receipts
and expenditures are being made only in accordance with authorizations of our
management and directors, and
    
    provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a material
effect on our financial statements.
  89




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Changes in Internal Control Over Financial Reporting
  
 Item 16A.
Audit Committee Financial Expert
          90




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##### Table of Contents



Item 16B.
Code of Ethics.
   
 Item 16C.
Principal Accountant Fees and Services.
 Independent Auditor Fees and Services
  Fiscal year ended March 31,2006
    
    2007(millions of yen)Audit fees (1)
    
    
    80
    
    
    
    85Audit-related fees (2)
    
    
    -
    
    
    
    -Tax fees (3)
    
    
    -
    
    
    
    15All other fees (4)
    
    
    4
    
    
    
    -Total fees
    
    
    84
    
    
    
    100
 (1)
    
    These are the aggregate fees billed for the fiscal year for professional services rendered by
Deloitte Touche Tohmatsu for the audit of our annual financial statements and services that
are normally provided in connection with statutory and regulatory filings or engagements for
those fiscal years.(2)
    
    These are the aggregate fees billed for the fiscal year for assurance and related services by
Deloitte Touche Tohmatsu that are reasonably related to the performance of the audit or review
of our financial statements other than 91




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##### Table of Contents



those reported under Audit Fees above. These services
include internal control reviews and consultation concerning financial accounting and
reporting standards.(3)
    
    These are the aggregate fees billed for the fiscal year for professional services rendered by
Deloitte Touche Tohmatsu for tax compliance, tax advice and tax planning.(4)
    
    These are the aggregate fees for the fiscal year for all other products and services provided
by Deloitte Touche Tohmatsu including consultation services related to the Privacy Mark System
being instituted by The Japan Information Processing Development Center. Board of Company Auditors Pre-Approval Policies and Procedures
   
 Item 16D.
Exemptions from the Listing Standards for Audit Committees.
  
    
    The Board of Company Auditors must be established, and its members must be
selected, pursuant to Japanese law expressly requiring such a board for Japanese
companies that elect to have a corporate governance system with company auditors,
    
    Japanese law must and does require the Board of Company Auditors to be separate
from the Board of Directors,
    
    None of the members of the Board of Company Auditors may be elected by management,
and none of the listed companys executive officers may be a member of the Board of
Company Auditors,
    
    Japanese law must and does set forth standards for the independence of the members
of the Board of Company Auditors from the listed company or its management, and
    
    The Board of Company Auditors, in accordance with Japanese law or the registrants
governing documents, must be responsible, to the extent permitted by Japanese law, for
the appointment, retention and oversight of the work of any registered public
accounting firm engaged (including, to the extent permitted by Japanese law, the
resolution of disagreements between management and the auditor regarding financial
reporting) for the purpose of preparing or issuing an audit report or performing other
audit, review or attest services for the listed
 92




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company, including its principal
accountant which audits its consolidated financial statements included in its annual
reports on Form 20-F.
  
    
    The Board of Company Auditors must establish procedures for (i) the receipt,
retention and treatment of complaints received by us regarding accounting, internal
accounting controls, or auditing matters, and (ii) the confidential, anonymous
submission by our employees of concerns regarding questionable accounting or auditing
matters,
    
    The Board of Company Auditors must have the authority to engage independent counsel
and other advisers, as it determines necessary to carry out its duties, and
    
    The listed company must provide for appropriate funding, as determined by its Board
of Company Auditors, for payment of (i) compensation to any registered public
accounting firm engaged for the purpose of preparing or issuing an audit report or
performing other audit, review or attest services for us, (ii) compensation to any
advisers employed by the Board of Company Auditors, and (iii) ordinary administrative
expenses of the Board of Company Auditors that are necessary or appropriate in
carrying out its duties.
  
 Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers.
  
 PART III
 
 Item 17.
Financial Statements.
  
 Item 18.
Financial Statements.
  
 Item 19.
Exhibits.
 1.1
    
    Articles of Incorporation, as amended (English translation)1.2
    
    Share Handling Regulations, as amended (English translation)*1.3
    
    Regulations of the Board of Directors, as amended (English translation)**1.4
    
    Regulations of the Board of Company Auditors, as amended (English translation)***2.1
    
    Specimen Common Stock Certificate****2.2
    
    Bylaws of the IIJ Employee Shareholders Association (with English translation)****2.3
    
    Form of Deposit Agreement among IIJ, The Bank of New York as depositary and all owners and
holders from time to time of American Depositary Receipts, including the form of American
Depositary Receipt*****4.1
    
    Basic Agreement to Delegate Services, dated April 1, 1997, between Internet Initiative
Japan Inc.
 93




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##### Table of Contents



and IIJ Technology Inc. (with English translation)****4.2
    
    Shareholders Agreement Relating to the Establishment of INTERNET MULTIFEED CO., dated
August 20, 1997, between Nippon Telegraph and Telephone Corporation and the Registrant
(with English translation)****4.3
    
    Basic Agreement to Delegate Services, dated April 1, 1998, between Internet Initiative
Japan Inc. and Net Care, Inc. (with English translation)****4.4
    
    Lease Agreement, dated March 14, 2003, between Internet Initiative Japan Inc. and Mitsui
Fudosan Co., Ltd. (English translation)**4.5
    
    Sublease Agreements, dated March 15, 2003, between Internet Initiative Japan Inc., IIJ
Technology Inc. and Net Care, Inc. (English translations)**4.6
    
    Joint Venture Agreement, dated January 19, 2006, between Internet Initiative Japan Inc.
and Konami Corporation (English translation)*4.20
    
    Subscription Agreement, dated September 16, 2003, between Internet Initiative Japan Inc.
and Nippon Telegraph and Telephone Corporation (English translation)**4.21
    
    Service Agreement, dated March 25, 2004, between Internet Initiative Japan Inc. and IIJ
America Inc.******4.24
    
    Agreement on Limited Liability, dated June 28, 2006 and June 26, 2007, between Internet
Initiative Japan Inc. and outside directors and outside company auditors*******8.1
    
    List of Significant Subsidiaries (See Our Group Companies in Item 4.B. of this Form 20-F)11.1
    
    Internet Initiative Japan Code of Conduct*12.1
    
    Certification of the principal executive officer required by 17 C.F.R. 240. 13a-14(a)12.2
    
    Certification of the principal financial officer required by 17 C.F.R. 240. 13a-14(a)13.1
    
    Certification of the chief executive officer required by 18 U.S.C. Section 135013.2
    
    Certification of the chief financial officer required by 18 U.S.C. Section 135014.1
    
    Selected unaudited financial statement data as of and for the year ended March 31, 2003 of
Crosswave Communications Inc.**
 
 (*)
    
    Incorporated by reference to the corresponding exhibit to our annual report on Form 20-F
(File No. 0-30204) filed on July 11, 2006.(**)
    
    Incorporated by reference to the corresponding exhibit to our annual report on Form 20-F
(File No. 0-30204) filed on September 30, 2003.(***)
    
    Incorporated by reference to the corresponding exhibit to our annual report on Form 20-F
(File No. 0-30204) filed on August 3, 2005.(****)
    
    Incorporated by reference to the corresponding exhibit to our Form F-1 Registration
Statement (File No. 333-10584) declared effective on August 3, 1999.(*****)
    
    Incorporated by reference to the Registration Statement on Form F-6 (File No. 333-110862)
filed on December 2, 2003.(******)
    
    Incorporated by reference to the corresponding exhibit to our annual report on Form 20-F
(File No. 0-30204) filed on July 23, 2004.(*******)
    
    We and each of Mr. Yasurou Tanahashi and Mr. Takashi Hiroi as our outside directors and
each of Mr. Masaki Okada and Mr. Masaaki Koizumi as our outside company auditors entered into
an Agreement on Limited Liability, dated June 28, 2006. We entered into an Agreement on
Limited Liability, dated June 26, 2007, with each of Mr. Yoshifumi Nishikawa and Mr. Junnosuke
Furukawa as our outside directors.  94




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SIGNATURE
  Internet Initiative Japan Inc.By:
    /s/ Koichi SuzukiName:
    Koichi SuzukiTitle:
    President, Chief Executive Officer
and Representative Director  95




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 Index to Consolidated Financial Statements
 PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheets as of March 31, 2006 and 2007
    
    
    F-3Consolidated Statements of Income
for Each of the Three Years in the Period Ended March 31, 2007
    
    
    F-5Consolidated Statements of Shareholders Equity
for Each of the Three Years in the Period Ended March 31, 2007
    
    
    F-7Consolidated Statements of Cash Flows
for Each of the Three Years in the Period Ended March 31, 2007
    
    
    F-8Notes to Consolidated Financial Statements
    
    
    F-11
 F-1




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Report of Independent Registered Public Accounting Firm
 
     
 F-2




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 
 Consolidated Balance Sheets  March 31, 2006 and 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)ASSETS
    
    2006
    
    
    2007
    
    
    2007CURRENT ASSETS:Cash (Note 15)
    
    ¥
    13,727,021
    
    
    ¥
    13,554,544
    
    
    $
    115,299Short-term investment
    
    
    
    
    
    
    12,093
    
    
    
    103Accounts receivable, net of allowance for doubtful accounts of
¥23,411 thousand and ¥32,489 thousand ($276 thousand) at March
31, 2006 and 2007, respectively (Notes 3, 4 and 17)
    
    
    11,962,304
    
    
    
    9,675,725
    
    
    
    82,305Inventories
    
    
    851,857
    
    
    
    1,111,086
    
    
    
    9,451Prepaid expenses
    
    
    1,031,325
    
    
    
    1,053,270
    
    
    
    8,959Other current assets, net of allowance for doubtful accounts
of ¥33,250 thousand and ¥4,570 thousand ($39 thousand)
at March 31, 2006 and 2007, respectively (Notes 3, 7 and 9)
    
    
    214,121
    
    
    
    930,571
    
    
    
    7,916Total current assets
    
    
    27,786,628
    
    
    
    26,337,289
    
    
    
    224,033INVESTMENTS IN AND ADVANCES TO
EQUITY METHOD INVESTEES, net of loan loss valuation
allowance of ¥16,701 thousand ($142 thousand) at March
31, 2006 and 2007 (Notes 3 and 4)
    
    
    1,162,971
    
    
    
    858,490
    
    
    
    7,302OTHER INVESTMENTS (Notes 2, 8, 14 and 15)
    
    
    8,020,705
    
    
    
    2,841,741
    
    
    
    24,173PROPERTY AND EQUIPMENTNet (Notes 5 and 7)
    
    
    10,299,496
    
    
    
    9,832,396
    
    
    
    83,637INTANGIBLE ASSETSNet (Note 6)
    
    
    632,594
    
    
    
    2,876,894
    
    
    
    24,472GUARANTEE DEPOSITS (Notes 7, 8 and 15)
    
    
    1,549,653
    
    
    
    1,686,141
    
    
    
    14,343OTHER ASSETS, net of allowance for doubtful accounts of
¥40,980 thousand and ¥69,050 thousand ($587 thousand) at March
31, 2006 and 2007, respectively (Notes 3, 7, 9, 10 and 15)
    
    
    1,252,942
    
    
    
    3,260,053
    
    
    
    27,731TOTAL
    
    ¥
    50,704,989
    
    
    ¥
    47,693,004
    
    
    $
    405,691
 F-3




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 Consolidated Balance Sheets
March 31, 2006 and 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)LIABILITIES AND SHAREHOLDERS' EQUITY
    
    2006
    
    
    2007
    
    
    2007CURRENT LIABILITIES:Short-term borrowings (Note 8)
    
    ¥
    4,555,000
    
    
    ¥
    6,050,000
    
    
    $
    51,463Long-term borrowingscurrent portion
(Notes 8 and 15)
    
    
    1,989,963
    
    
    
    290,000
    
    
    
    2,467Payable under securities loan agreement (Note 8)
    
    
    999,600
    
    
    
    
    
    
    
    Capital lease obligationscurrent portion (Note 7)
    
    
    3,003,914
    
    
    
    2,953,173
    
    
    
    25,121Accounts payable (Notes 4 and 17)
    
    
    10,107,942
    
    
    
    8,464,835
    
    
    
    72,004Accrued expenses
    
    
    540,027
    
    
    
    897,355
    
    
    
    7,633Accrued retirement and pension costs-current (Note 10)
    
    
    
    
    
    
    8,428
    
    
    
    72Other current liabilities
    
    
    1,702,208
    
    
    
    2,469,058
    
    
    
    21,002Total current liabilities
    
    
    22,898,654
    
    
    
    21,132,849
    
    
    
    179,762LONG-TERM BORROWINGS (Notes 8 and 15)
    
    
    290,000
    
    
    
    
    
    
    
    CAPITAL LEASE OBLIGATIONSNoncurrent (Note 7)
    
    
    4,980,659
    
    
    
    4,318,309
    
    
    
    36,733ACCRUED RETIREMENT AND PENSION COSTS
Noncurrent (Note 10)
    
    
    223,332
    
    
    
    750,042
    
    
    
    6,380OTHER NONCURRENT LIABILITIES (Notes 9 and 10)
    
    
    827,086
    
    
    
    564,618
    
    
    
    4,803Total liabilities
    
    
    29,219,731
    
    
    
    26,765,818
    
    
    
    227,678MINORITY INTEREST
    
    
    1,263,320
    
    
    
    815,182
    
    
    
    6,934COMMITMENTS AND CONTINGENCIES (Note 14)SHAREHOLDERS EQUITY (Notes 10, 11 and 12):Common stockauthorized, 377,600 shares;
issued and outstanding, 204,300 shares at March 31, 2006
and 2007
    
    
    16,833,847
    
    
    
    16,833,847
    
    
    
    143,194Additional paid-in capital
    
    
    26,599,217
    
    
    
    26,599,217
    
    
    
    226,261Accumulated deficit
    
    
    (29,680,482
    )
    
    
    (24,270,769
    )
    
    
    (206,454
    )Accumulated other comprehensive income
    
    
    6,553,594
    
    
    
    949,709
    
    
    
    8,078Treasury stock777 shares held by an equity
method investee at March 31, 2006
    
    
    (84,238
    )
    
    
    
    
    
    
    Total shareholders equity
    
    
    20,221,938
    
    
    
    20,112,004
    
    
    
    171,079TOTAL
    
    ¥
    50,704,989
    
    
    ¥
    47,693,004
    
    
    $
    405,691
  F-4




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 
 Consolidated Statements of Income  Three Years in the Period Ended March 31, 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007REVENUES (Notes 4 and 17):Connectivity and value-added services:Dedicated access
    
    ¥
    11,372,701
    
    
    ¥
    10,625,268
    
    
    ¥
    10,791,703
    
    
    $
    91,797Dial-up access
    
    
    2,936,973
    
    
    
    2,673,808
    
    
    
    2,416,307
    
    
    
    20,554Value-added services
    
    
    5,004,730
    
    
    
    6,249,891
    
    
    
    7,415,533
    
    
    
    63,079Other
    
    
    3,169,413
    
    
    
    3,673,872
    
    
    
    3,729,633
    
    
    
    31,725Total
    
    
    22,483,817
    
    
    
    23,222,839
    
    
    
    24,353,176
    
    
    
    207,155Systems integration
    
    
    15,853,824
    
    
    
    23,504,537
    
    
    
    30,527,081
    
    
    
    259,672Equipment sales
    
    
    3,364,926
    
    
    
    3,085,208
    
    
    
    2,174,324
    
    
    
    18,496Total revenues
    
    
    41,702,567
    
    
    
    49,812,584
    
    
    
    57,054,581
    
    
    
    485,323COST AND EXPENSES (Notes 4 and 17):Cost of connectivity and value-added
services
    
    
    19,483,890
    
    
    
    20,077,990
    
    
    
    20,545,358
    
    
    
    174,765Cost of systems integration
    
    
    12,200,137
    
    
    
    18,120,418
    
    
    
    23,529,045
    
    
    
    200,145Cost of equipment sales
    
    
    3,111,369
    
    
    
    2,818,036
    
    
    
    1,893,216
    
    
    
    16,104Total cost
    
    
    34,795,396
    
    
    
    41,016,444
    
    
    
    45,967,619
    
    
    
    391,014Sales and marketing (Note 16)
    
    
    2,794,561
    
    
    
    3,079,526
    
    
    
    3,438,725
    
    
    
    29,251General and administrative (Note 6)
    
    
    2,665,980
    
    
    
    3,147,315
    
    
    
    3,970,692
    
    
    
    33,776Research and development
    
    
    198,979
    
    
    
    158,155
    
    
    
    177,273
    
    
    
    1,508Total cost and expenses
    
    
    40,454,916
    
    
    
    47,401,440
    
    
    
    53,554,309
    
    
    
    455,549OPERATING INCOME
    
    
    1,247,651
    
    
    
    2,411,144
    
    
    
    3,500,272
    
    
    
    29,774OTHER INCOME (EXPENSES):Interest income
    
    
    12,877
    
    
    
    13,099
    
    
    
    23,037
    
    
    
    196Interest expense
    
    
    (685,857
    )
    
    
    (437,364
    )
    
    
    (397,439
    )
    
    
    (3,381
    )Foreign exchange gains (losses)
    
    
    5,958
    
    
    
    3,470
    
    
    
    (297
    )
    
    
    (3
    )Net gain on other investments (Note 2)
    
    
    2,439,330
    
    
    
    3,197,690
    
    
    
    1,866,510
    
    
    
    15,877Gain arising
from issuance of common stock by equity method investee
    
    
    25,933
    
    
    
    
    
    
    
    
    
    
    
    Othernet
    
    
    102,616
    
    
    
    190,520
    
    
    
    56,605
    
    
    
    482Other incomenet
    
    
    1,900,857
    
    
    
    2,967,415
    
    
    
    1,548,416
    
    
    
    13,171INCOME FROM OPERATIONS BEFORE INCOME TAX
EXPENSE (BENEFIT), MINORITY INTERESTS
AND EQUITY IN NET LOSS OF EQUITY METHOD
INVESTEES
    
    
    3,148,508
    
    
    
    5,378,559
    
    
    
    5,048,688
    
    
    
    42,945INCOME TAX EXPENSE (BENEFIT) (Note 9)
    
    
    99,870
    
    
    
    257,360
    
    
    
    (803,943
    )
    
    
    (6,839
    )MINORITY INTERESTS IN EARNINGS
OF SUBSIDIARIES
    
    
    (109,161
    )
    
    
    (353,883
    )
    
    
    (232,719
    )
    
    
    (1,979
    )FORWARD
    
    ¥
    2,939,477
    
    
    ¥
    4,767,316
    
    
    ¥
    5,619,912
    
    
    $
    47,805
  F-5




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 Consolidated Statements of Income  Three Years in the Period Ended March 31, 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007FORWARD
    
    ¥
    2,939,477
    
    
    ¥
    4,767,316
    
    
    ¥
    5,619,912
    
    
    $
    47,805EQUITY IN NET LOSS OF EQUITY
METHOD INVESTEES (Note 4):
    
    
    (33,208
    )
    
    
    (13,746
    )
    
    
    (210,199
    )
    
    
    (1,788
    )NET INCOME
    
    ¥
    2,906,269
    
    
    ¥
    4,753,570
    
    
    ¥
    5,409,713
    
    
    $
    46,017NET INCOME PER SHARE (Note 13):BASIC WEIGHTED-AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING
    
    
    191,559
    
    
    
    195,613
    
    
    
    203,992DILUTED WEIGHTED-AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING
    
    
    191,559
    
    
    
    195,955
    
    
    
    204,244
 Yen
    
    
    U.S. DollarsBASIC NET INCOME
PER COMMON SHARE
    
    ¥
    15,172
    
    
    ¥
    24,301
    
    
    ¥
    26,519
    
    
    $
    226DILUTED NET INCOME
PER COMMON SHARE
    
    ¥
    15,172
    
    
    ¥
    24,258
    
    
    ¥
    26,487
    
    
    $
    225
   F-6




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 
 Consolidated Statements of Shareholders Equity
Three Years in the Period Ended March 31, 2007
 Thousands of YenShares of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    AccumulatedCommon Stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    OtherOutstanding
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    Comprehensive(Including
    
    
    Common
    
    
    Paid-in
    
    
    Accumulated
    
    
    Income
    
    
    TreasuryTreasury Stock)
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    (Notes 10 and 12)
    
    
    Stock
    
    
    TotalBALANCE, APRIL 1, 2004
    
    
    191,800
    
    
    ¥
    13,765,372
    
    
    ¥
    23,637,628
    
    
    ¥
    (37,340,321
    )
    
    ¥
    6,195,449
    
    
    ¥
    (44,000
    )
    
    ¥
    6,214,128Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,906,269
    
    
    
    
    
    
    
    
    
    
    
    2,906,269Other comprehensive income, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,494,676
    
    
    
    
    
    
    
    2,494,676Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,400,945BALANCE, MARCH 31, 2005
    
    
    191,800
    
    
    
    13,765,372
    
    
    
    23,637,628
    
    
    
    (34,434,052
    )
    
    
    8,690,125
    
    
    
    (44,000
    )
    
    
    11,615,073Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,753,570
    
    
    
    
    
    
    
    
    
    
    
    4,753,570Other comprehensive loss, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,136,531
    )
    
    
    
    
    
    
    (2,136,531
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,617,039Issuance of common stock, net of
issuance cost
    
    
    12,500
    
    
    
    3,068,475
    
    
    
    2,961,589
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,030,064Purchase of common stock by an equity
method investee
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (40,238
    )
    
    
    (40,238
    )BALANCE, MARCH 31, 2006
    
    
    204,300
    
    
    
    16,883,847
    
    
    
    26,599,217
    
    
    
    (29,680,482
    )
    
    
    6,553,594
    
    
    
    (84,238
    )
    
    
    20,221,938Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,409,713
    
    
    
    
    
    
    
    
    
    
    
    5,409,713Other comprehensive loss, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,492,154
    )
    
    
    
    
    
    
    (5,492,154
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (82,441
    )Adjustment to initially apply
SFAS158, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (111,731
    )
    
    
    
    
    
    
    (111,731
    )Dissolution of reciprocal interests
due to sale of investment in an
equity method investee
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84,238
    
    
    
    84,238BALANCE, MARCH 31, 2007
    
    
    204,300
    
    
    ¥
    16,833,847
    
    
    ¥
    26,599,217
    
    
    ¥
    (24,270,769
    )
    
    ¥
    949,709
    
    
    ¥
    
    
    
    ¥
    20,112,004
 Thousands of U.S. Dollars (Note 1)AccumulatedOtherAdditional
    
    
    
    
    
    
    ComprehensiveCommon
    
    
    Paid-in
    
    
    Accumulated
    
    
    Income
    
    
    TreasuryStock
    
    
    Capital
    
    
    Deficit
    
    
    (Notes 10 and 12)
    
    
    Stock
    
    
    TotalBALANCE, MARCH 31, 2006
    
    
    
    
    
    $
    143,194
    
    
    $
    226,261
    
    
    $
    (252,471
    )
    
    $
    55,747
    
    
    $
    (717
    )
    
    $
    172,014Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46,017
    
    
    
    
    
    
    
    
    
    
    
    46,017Other comprehensive loss, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (46,718
    )
    
    
    
    
    
    
    (46,718
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (701
    )Adjustment to initially apply SFAS158, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (951
    )
    
    
    
    
    
    
    (951
    )Dissolution of reciprocal interests due to sale
of investment in an equity method investee
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    717
    
    
    
    717BALANCE, MARCH 31, 2007
    
    
    
    
    
    $
    143,194
    
    
    $
    226,261
    
    
    $
    (206,454
    )
    
    $
    8,078
    
    
    $
    
    
    
    $
    171,079
  F-7




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 
 Consolidated Statements of Cash Flows  Three Years in the Period Ended March 31, 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007OPERATING ACTIVITIES:Net income
    
    ¥
    2,906,269
    
    
    ¥
    4,753,570
    
    
    ¥
    5,409,713
    
    
    $
    46,017Adjustments to reconcile net income
to net cash provided by
operating activities:Depreciation and amortization
    
    
    4,193,093
    
    
    
    4,209,037
    
    
    
    4,228,048
    
    
    
    35,965Provision for retirement and
pension costs, less payments
    
    
    70,659
    
    
    
    76,095
    
    
    
    382,682
    
    
    
    3,255Provision for (reversal of) allowance for
doubtful accounts and advances
    
    
    24,781
    
    
    
    (12,009
    )
    
    
    12,232
    
    
    
    104Loss on disposal of property and
equipment
    
    
    143,887
    
    
    
    118,855
    
    
    
    150,731
    
    
    
    1,282Loss on disposal and impairment of telephone rights
    
    
    99,075
    
    
    
    2,040
    
    
    
    
    
    
    
    Net gain on other investments
    
    
    (2,439,330
    )
    
    
    (3,197,690
    )
    
    
    (1,866,510
    )
    
    
    (15,877
    )Foreign exchange losses (gains)
    
    
    (15,466
    )
    
    
    (7,825
    )
    
    
    2,226
    
    
    
    19Gain arising from issuance of common stock by equity method investee
    
    
    (25,933
    )
    
    
    
    
    
    
    
    
    
    
    Loss on retirement of convertible notes
    
    
    5,195
    
    
    
    
    
    
    
    
    
    
    
    Equity in net loss of equity method
investees
    
    
    33,208
    
    
    
    13,746
    
    
    
    210,199
    
    
    
    1,788Minority interests in earnings of
subsidiaries
    
    
    109,161
    
    
    
    353,883
    
    
    
    232,719
    
    
    
    1,979Deferred income tax benefit
    
    
    (11,023
    )
    
    
    (230,841
    )
    
    
    (1,494,685
    )
    
    
    (12,714
    )Others
    
    
    79,247
    
    
    
    18,490
    
    
    
    622
    
    
    
    5Changes in operating assets and
liabilities net of effects from
acquisition of business and a company:Decrease (increase) in accounts
receivable
    
    
    1,607,692
    
    
    
    (4,460,173
    )
    
    
    2,376,126
    
    
    
    20,212Decrease (increase) in
inventories, prepaid expenses and
other current and noncurrent assets
    
    
    228,358
    
    
    
    (1,390,398
    )
    
    
    (1,235,003
    )
    
    
    (10,505
    )Increase (decrease) in accounts payable
    
    
    (2,307,729
    )
    
    
    4,975,623
    
    
    
    (1,872,969
    )
    
    
    (15,932
    )Increase in income taxes payable
    
    
    97,913
    
    
    
    334,854
    
    
    
    312,292
    
    
    
    2,656Increase in accrued
expenses and other current
and noncurrent liabilities
    
    
    439,440
    
    
    
    1,001,567
    
    
    
    553,084
    
    
    
    4,705Net cash provided by
operating
activities(Forward)
    
    ¥
    5,238,497
    
    
    ¥
    6,558,824
    
    
    ¥
    7,401,507
    
    
    $
    62,959
  F-8




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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 Consolidated Statements of Cash Flows  Three Years in the Period Ended March 31, 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007Net cash provided by
operating activities(Forward)
    
    ¥
    5,238,497
    
    
    ¥
    6,558,824
    
    
    ¥
    7,401,507
    
    
    $
    62,959INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (577,133
    )
    
    
    (919,366
    )
    
    
    (1,287,906
    )
    
    
    (10,955
    )Purchase of available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    (802,662
    )
    
    
    (6,828
    )Purchase of short-term and other investments
    
    
    (12,566
    )
    
    
    (674,569
    )
    
    
    (1,794,358
    )
    
    
    (15,263
    )Investment in an equity method investee
    
    
    
    
    
    
    (750,000
    )
    
    
    
    
    
    
    Purchase of subsidiary stock
from minority shareholders
    
    
    (61,680
    )
    
    
    (192,142
    )
    
    
    (3,077,764
    )
    
    
    (26,180
    )Proceeds from sales of available-for-sale securities
    
    
    2,614,768
    
    
    
    3,240,805
    
    
    
    3,883,915
    
    
    
    33,038Proceeds from sales and redemption of
short-term and other investments
    
    
    361,249
    
    
    
    372,434
    
    
    
    110,446
    
    
    
    939Proceeds from sales of investment in an equity
method investee
    
    
    
    
    
    
    
    
    
    
    185,900
    
    
    
    1,581Payments of guarantee deposits
    
    
    (48,683
    )
    
    
    (62,074
    )
    
    
    (146,172
    )
    
    
    (1,243
    )Refund of guarantee deposits
    
    
    71,850
    
    
    
    568,869
    
    
    
    27,761
    
    
    
    236Payment for refundable insurance policies
    
    
    (25,231
    )
    
    
    (25,917
    )
    
    
    (38,273
    )
    
    
    (326
    )Refund from insurance policies
    
    
    18,348
    
    
    
    6,301
    
    
    
    4,969
    
    
    
    42Acquisition of a newly controlled company, net of
cash acquired
    
    
    
    
    
    
    229,457
    
    
    
    
    
    
    
    Acquisition of business
    
    
    (375,123
    )
    
    
    
    
    
    
    (74,751
    )
    
    
    (636
    )Other
    
    
    8,204
    
    
    
    11,052
    
    
    
    (4,716
    )
    
    
    (40
    )Net cash provided by (used in)
investing activities
    
    
    1,974,003
    
    
    
    1,804,850
    
    
    
    (3,013,611
    )
    
    
    (25,635
    )FINANCING ACTIVITIES:Proceeds from issuance of short-term
borrowings with initial maturities over three
months and long-term borrowings
    
    
    2,250,000
    
    
    
    1,000,000
    
    
    
    10,500,000
    
    
    
    89,316Repayments of short-term borrowings with
initial maturities over three months and
long-term borrowings
    
    
    (1,840,246
    )
    
    
    (2,986,056
    )
    
    
    (7,639,963
    )
    
    
    (64,988
    )Proceeds from securities loan agreement
    
    
    2,546,320
    
    
    
    4,897,040
    
    
    
    1,057,680
    
    
    
    8,997Repayments of securities loan agreement
    
    
    (816,800
    )
    
    
    (5,626,960
    )
    
    
    (2,057,280
    )
    
    
    (17,500
    )Principal payments under capital leases
    
    
    (2,867,625
    )
    
    
    (3,105,519
    )
    
    
    (3,259,875
    )
    
    
    (27,729
    )Net decrease in short-term borrowings
    
    
    (1,839,460
    )
    
    
    (169,633
    )
    
    
    (3,355,000
    )
    
    
    (28,538
    )Repurchase of convertible notes
    
    
    (745,488
    )
    
    
    
    
    
    
    
    
    
    
    Redemption of convertible notes
    
    
    (11,088,000
    )
    
    
    
    
    
    
    
    
    
    
    Proceeds from issuance of common stock,
net of issuance cost
    
    
    
    
    
    
    6,030,064
    
    
    
    
    
    
    
    Proceeds from issuance of subsidiary
stock to minority shareholders
    
    
    188,632
    
    
    
    
    
    
    
    194,679
    
    
    
    1,656Net cash provided by (used in)
financing activities(Forward)
    
    ¥
    (14,212,667
    )
    
    ¥
    38,936
    
    
    ¥
    (4,559,759
    )
    
    $
    (38,786
    )
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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 Consolidated
Statements of Cash Flows
Three Years in the Period Ended March 31, 2007
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007Net cash provided by (used in)
financing activities(Forward)
    
    ¥
    (14,212,667
    )
    
    ¥
    38,936
    
    
    ¥
    (4,559,759
    )
    
    $
    (38,786
    )EFFECT OF EXCHANGE RATE
CHANGES ON CASH
    
    
    2,405
    
    
    
    37,934
    
    
    
    (614
    )
    
    
    (5
    )NET INCREASE (DECREASE) IN CASH
    
    
    (6,997,762
    )
    
    
    8,440,544
    
    
    
    (172,477
    )
    
    
    (1,467
    )CASH, BEGINNING OF YEAR
    
    
    12,284,239
    
    
    
    5,286,477
    
    
    
    13,727,021
    
    
    
    116,766CASH, END OF YEAR
    
    ¥
    5,286,477
    
    
    ¥
    13,727,021
    
    
    ¥
    13,554,544
    
    
    $
    115,299
 Thousands ofU.S. DollarsThousands of Yen
    
    
    (Note 1)2005
    
    
    2006
    
    
    2007
    
    
    2007ADDITIONAL CASH FLOW
INFORMATION:Interest paid
    
    ¥
    613,817
    
    
    ¥
    426,692
    
    
    ¥
    383,461
    
    
    $
    3,262Income taxes paid
    
    
    29,227
    
    
    
    148,101
    
    
    
    347,826
    
    
    
    2,959NONCASH INVESTING AND
FINANCING ACTIVITIES:Acquisition of assets by
entering into capital leases
    
    
    4,433,906
    
    
    
    3,842,952
    
    
    
    2,664,706
    
    
    
    22,667Exchange of common stock
investment due to merger:Market value of common
shares acquired
    
    
    37,950
    
    
    
    7,390
    
    
    
    Cost of investment
    
    
    2,500
    
    
    
    2,584
    
    
    
    Acquisition of business and a company:Assets acquired
    
    
    1,202,007
    
    
    
    843,485
    
    
    
    236,307
    
    
    
    2,010Cash paid
    
    
    (375,123
    )
    
    
    (733,589
    )
    
    
    (74,751
    )
    
    
    (636
    )Liabilities assumed
    
    
    826,884
    
    
    
    109,896
    
    
    
    161,556
    
    
    
    1,374
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##### Table of Contents



Internet Initiative Japan Inc. and Subsidiaries
 
 Notes to Consolidated Financial Statements
 1.
    
    DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESInternet Initiative Japan Inc. (IIJ, a Japanese corporation) was founded in December 1992 to
develop and operate Internet access services and other Internet-related services in Japan and
is 29.7 percent jointly owned by Nippon Telegraph and Telephone Corporation (NTT) and its
subsidiary as of March 31, 2007. IIJ and subsidiaries (collectively, the Company) provide
Internet access services throughout Japan and into the United States of America and the rest
of Asia. The Company also provides Internet systems design and integration representing
principally sales of Internet network systems and equipment and miscellaneous Internet
access-related services.The Company manages its business and measures results based on a single Internet-related
services industry segment. Substantially all revenues are from customers operating in Japan.Certain Significant Risks and UncertaintiesThe Company relies on telecommunications carriers for significant portion of network backbone,
and regional NTT subsidiaries, electric power companies and their affiliates for local
connections to customers. Currently, NTT Communications, a wholly owned subsidiary of NTT, is
the largest provider of network infrastructure. The Company believes that its use of multiple
carriers and suppliers significantly mitigates concentrations of credit risk. However, any
disruption of telecommunication services could have an adverse effect on operating results.Financial instruments that potentially subject the Company to concentrations of credit risk
consist principally of cash investments, accounts receivable and guarantee deposits. The
Companys management believes that the risks associated with accounts receivable is mitigated
by the large number of customers comprising its customer base.Summary of Significant Accounting PoliciesBasis of PresentationIIJ maintains its records in accordance with generally accepted
accounting principles in Japan. Certain adjustments and reclassifications have been
incorporated in the accompanying consolidated financial statements to conform to generally
accepted accounting principles in the United States of America (U.S. GAAP). These
adjustments were not recorded in the statutory accounts.Certain reclassifications have been made to prior periods to conform to the current year
presentation.Translation into U.S. DollarsIIJ maintains its accounts in Japanese yen, the currency of the
country in which it is incorporated and principally operates. The U.S. dollar amounts
included herein represent a translation using the noon buying rate in New York City for cable
transfers in yen as certified for customs purposes by the Federal Reserve Bank of New York at
March 31, 2007 of ¥ 117.56 = $1, solely for the convenience of the reader. The translation
should not be construed as a representation that the yen amounts have been, could have been,
or could in the future be converted into U.S. dollars.ConsolidationThe consolidated financial statements include the accounts of IIJ and all of
its subsidiaries, Net Care, Inc. (Net Care), IIJ Technology Inc. (IIJ-Tech), IIJ Media
Communications Inc. (MC), which was merged with IIJ on October 1, 2005, IIJ America, Inc.
(IIJ-A), Netchart Japan Inc. (NCJ), which was established on August 10, 2006 and IIJ
Financial Systems Inc. (IIJ-FS), which all, except for IIJ America, have fiscal years ending
March 31. IIJ Americas fiscal year end is December 31 and such date was used for purposes of
preparing the consolidated financial statements as it is not practicable for the subsidiary to
report its financial results as of March 31. There were no significant events that occurred
during the intervening period that would require adjustment to or disclosure in the
accompanying consolidated financial statements. Intercompany transactions and balances have
been eliminated in consolidation.Investments in companies over which IIJ has significant influence but not control are
accounted for by the equity method. For other than a temporary decline in the value of
investments in equity method investees below the carrying amount, the investment is reduced to fair value and an impairment loss is
recognized.
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A subsidiary or equity method investee may issue its shares to third parties at amounts per
share in excess of or less than the Companys average per share carrying value. With respect
to such transactions, the resulting gains or losses arising from the change in ownership are
recorded in income for the year in which such shares are issued.Use of EstimatesThe preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Significant estimates and assumptions used are
primarily in the areas of evaluation of cost method investments, valuation allowances for
deferred tax assets, allowance for doubtful accounts, determination of pension benefit costs
and obligations, estimated useful lives of fixed assets and impairment of long-lived assets.
Actual results could differ from those estimates.Revenue RecognitionRevenues from customer connectivity services consist principally of
dedicated Internet access services and dial-up Internet access services. Dedicated Internet
access services represent full-line IP services and standard-level IP services (IIJ
FiberAccess/F Service). Dial-up Internet access services are provided to both enterprises and
individuals (IIJ4U). The term of these contracts is one year for dedicated Internet access
services and generally one month for dial-up Internet access services. All these services are
billed and recognized monthly on a straight-line basis.Value-added service revenues consist principally of sales of various Internet access-related
services such as firewalls services. Value-added services also include monthly fees from data
center services such as housing, monitoring and security services. Other revenues under
connectivity and value-added services consist principally of Wide-area Ethernet services and
call-center customer support. The terms of these services are generally for one year and
revenues are recognized on a straight-line basis during the service period.Initial set up fees received in connection with connectivity services and value-added services
are deferred and recognized over the contract period.Systems integration revenues consist principally of the development of Internet network
systems and related maintenance, monitoring and other operating services. The development of
the Internet network systems includes planning, systems design, and construction services, and
equipment and software purchased from third parties. Systems integration service is subject to
the Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. For deliverables in multiple-element arrangements, the guidance below is
applied for separability and allocation. A multiple-element arrangement is separated into more
than one unit of accounting if all of the following criteria are met:
 
    
    The delivered item(s) has value to the client on a stand-alone basis;
 
    
    There is objective and reliable evidence of the fair value of the undelivered item(s); and
 
    
    If the arrangement includes a general right of return relative to the delivered
item(s), delivery or performance of the undelivered item(s) is considered probable and
substantially in the control of the company.
 If these criteria are not met, the arrangement is accounted for as one unit of
accounting which would result in revenue being recognized on a straight-line basis or being deferred until the earlier of when
such criteria are met or when the last undelivered element is delivered. If these criteria are met for each element and there is
objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration
is allocated to the separate units of accounting based on each units relative fair value.The period for the development of the systems is less than one year and revenues are
recognized when network systems and equipment are delivered and accepted by the customer. When
the equipment or system is delivered prior to other elements of the arrangement, revenue is
deferred until other service elements are completed and accepted by the customer because the
customer may return all of the equipment or system in the event that the Company does not
complete other service elements. Maintenance, monitoring and operating service revenues are
recognized ratably over the separate contract period, which is generally for one year.Equipment sales are reported on a gross or net basis in accordance with EITF Issue No. 99-19
Reporting Revenue Gross as a Principal versus Net as an Agent. Revenues are recognized when
equipment is delivered and accepted by the customer. Title to equipment passes when equipment is accepted by the
customer.
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Allowance for Doubtful AccountsAn allowance for doubtful accounts is established in amounts
considered to be appropriate based primarily upon the Companys past credit loss experience
and an evaluation of potential losses in the receivables outstanding.Other InvestmentsIn accordance with Statement of Financial Accounting Standards (SFAS) No.
115, Accounting for Certain Investments in Debt and Equity Securities, the Company
classifies its marketable equity securities as available-for-sale securities, which are
accounted for at fair value with unrealized gains and losses excluded from earnings and
reported in accumulated other comprehensive income (loss). The cost of securities sold is
determined based on average cost.The Company reviews the fair value of available-for-sale securities on a regular basis to
determine if the fair value of any individual security has declined below its cost and if such
decline is other than temporary. If the decline in value is judged to be other than
temporary, the cost basis of the investment is written down to fair value. Other than
temporary declines in value are determined taking into consideration the extent of decline in
fair value, the length of time that the decline in fair value below cost has existed and
events that might accelerate the recognition of impairment. The resulting realized loss is
included in the consolidated statements of income in the period in which the decline is deemed
to be other than temporary.Non-marketable equity securities are carried at cost as fair value is not readily
determinable. If the value of a security is estimated to have declined and such decline is
judged to be other than temporary, the security is written down to the fair value.
Determination of impairment is based on the consideration of such factors as operating
results, business plans and change in the regulatory, economic or technological environment of
the investees. For purposes of computing an impairment loss, fair value is determined as the
Companys interest in the net assets of investees.InventoriesInventories consist mainly of network equipment purchased for resale and
work-in-process for development of Internet network systems. Network equipment purchased for
resale is stated at the lower of cost, which is determined by the average-cost method, or
market. Work-in-process for development of network systems is stated at the lower of actual
production costs, including overhead cost, or market. Inventories are reviewed periodically
and items considered to be slow-moving or obsolete are written down to their estimated net
realizable value.LeasesCapital leases, which meet specific criteria noted in SFAS No.13, Accounting for
Leases, are capitalized at the inception of the lease at the present value of the minimum
lease payments. All other leases are accounted for as operating leases. Lease payments for
capital leases are apportioned to interest expense and a reduction of the lease liability so
as to achieve a constant rate of interest on the remaining balance of the liability. Operating
lease payments are recognized as an expense on a straight-line basis over the lease term.Property and EquipmentProperty and equipment are recorded at cost. Depreciation and
amortization of property and equipment, including purchased software and capital leases, are
computed principally using the straight-line method based on either the estimated useful lives
of assets or the lease period, whichever is shorter.The useful lives for depreciation and amortization by major asset classes are as follows:
 Range ofUseful LivesData communications, office and other equipment
    
    2 to 15 yearsLeasehold improvements
    
    
    3 to 15 yearsPurchased software
    
    5 yearsCapital leases
    
    
    4 to 7 years
 Impairment of Long-lived AssetsLong-lived assets consist principally of property and
equipment, including those items leased under capital leases. The Company evaluates the
impairment of long-lived assets whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. There were no impairment
losses for long-lived assets for the three years in the period ended March 31, 2007.
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##### Table of Contents



Goodwill and Intangible AssetsIn accordance with SFAS No. 142, Goodwill and Other
Intangible Assets, goodwill (including equity-method goodwill) and intangible assets that are
deemed to have indefinite useful lives are not amortized, but are subject to impairment
testing. Impairment testing is performed annually or more frequently if events or changes in
circumstances indicate that the asset might be impaired. The Company performs annual
impairment tests on March 31.
 Pension and severance indemnities plansThe Company has pension plans and /or severance
indemnities plans. The cost of the pension plans and severance indemnities plans are accrued
based on amounts determined using actuarial methods.On September 29, 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB statements No. 87, 88, 106 and 132(R) (SFAS No. 158). SFAS No. 158
requires an employer that sponsors one or more defined benefit pension plans or other
postretirement plans to 1) recognize the funded status of a plan, measured as the difference
between plan assets at fair value and the benefit obligation, in balance sheet; 2) recognize
in shareholders equity as a component of accumulated other comprehensive income, net of tax,
the gains and losses and prior service costs or credits that arise during the period but are
not yet recognized as components of net periodic benefit cost; 3) measure defined benefit plan
assets and obligations as of the date of the employers fiscal year-end balance sheet; and 4)
disclose in the notes to the financial statements additional information about the effects on
net periodic benefit cost for the next fiscal year that arise from delayed recognition of the
gains or losses, prior service costs or credits, and transition asset or obligation. The
Company adopted SFAS No. 158 effective March 31, 2007. The adoption of SFAS No. 158 resulted
in a decrease in total shareholder equity of ¥111,731 thousand ($950 thousand) as of March
31, 2007. For further information regarding the impact of the
adoption of SFAS No. 158, refer to
Note 10.Income TaxesThe provision for income taxes is based on earnings before income taxes and
includes the effects of temporary differences between assets and liabilities recognized for
financial reporting purposes and income tax purposes and operating loss carryforwards.
Valuation allowances are provided against deferred tax assets when it is more likely than not
that a tax benefit will not be realized.Foreign Currency TranslationForeign currency financial statements have been translated in
accordance with SFAS No. 52, Foreign Currency Translation. Pursuant to this statement, the
assets and liabilities of a foreign subsidiary and an equity method investee are translated
into Japanese yen at the respective year-end exchange rates. All income and expense accounts
are translated at average rates of exchange. The resulting translation adjustments are
included in accumulated other comprehensive income.Foreign currency assets and liabilities, which consist substantially of cash denominated in
U.S. dollars, are stated at the amount as computed by using year-end exchange rates and the
resulting transaction gain or loss is recognized in earnings.Derivative Financial InstrumentsAll derivatives are recorded at fair value as either asset
or liabilities in the balance sheet in accordance with SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 138 and No. 149
(collectively, SFAS No. 133). In accordance with SFAS No. 133, the Company designated
interest swap contracts as a hedge of the variability of cash flows to be paid related to
interest on floating rate borrowings (cash flow hedge) and the effective portion of the
derivatives gain or loss is initially reported as a component of other comprehensive income
and subsequently reclassified into earnings when the underlying transaction affects earnings.
The ineffective portion of the gain or loss is reported in earning immediately. The Company
enters into contracts to hedge interest rate risks and does not enter into contracts or
utilize derivatives for trading purposes.Stock-based CompensationOn April 1, 2006, the Company adopted SFAS No. 123R, Share-Based
Payment and the related interpretations, which requires compensation expense for stock options
and other share-based payments to be measured and recorded based on the instruments fair
value, by using the modified prospective application method. SFAS No. 123R requires
recognizing expenses for share-based payments granted prior to the adoption date equal to the
fair value of unvested amounts over the remaining requisite service period. The portion of
these share-based payments fair value attributable to vested awards prior to the adoption of
SFAS No. 123R is never recognized. As all existing granted stock-based awards of the Company
have vested, the adoption of SFAS No. 123R did not have any impact on the Companys
consolidated financial position or results of operations.Prior to April 1, 2006, the Company accounted for stock-based compensation using the intrinsic
value method prescribed in Accounting Principle Board Opinion (APB) No. 25, Accounting for
Stock Issued to Employers and related interpretations.
 F-14




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##### Table of Contents



Research and DevelopmentResearch and development costs are expensed as incurred.AdvertisingAdvertising costs are expensed as incurred and are recorded in Sales and
marketing.Basic and Diluted Net Income per Common ShareBasic net income per common share is computed
by dividing net income by the weighted-average number of shares of common stock outstanding
during the year. Diluted net income per common share reflects the potential dilutive effect
of stock options and convertible bonds.Other Comprehensive Income (Loss)Other comprehensive income (loss) consists of translation
adjustments resulting from the translation of financial statements of a foreign subsidiary,
unrealized gains or losses on available-for-sale securities and gains or losses on cash flow
hedging derivative instruments.Segment Reporting SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for reporting information about operating segments.
Operating segments are defined as components of an enterprise that engage in business
activities from which it may earn revenues and incur expense and for which separate financial
information is available that is evaluated regularly by the chief operation decision maker in
deciding how to allocate resources and in assessing performance.The Company provides a comprehensive range of network solutions to meet its customers needs
by cross-selling a variety of services, including Internet connectivity services, value-added
services, systems integration and sales of network-related equipment. The Companys chief
operating decision maker, who is the Companys Chief Executive Officer, regularly reviews the
revenue and cost of sales on a consolidated basis and makes decisions regarding how to
allocate resources and assess performance based on a single operating unit.New Accounting StandardsIn June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FASB statement No. 109 (FIN No. 48) which clarifies the accounting for
uncertainty in income tax recognized in an enterprises financial statements in accordance
with SFAS No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. This interpretation also
provides guidance on derecognition, classification, interest, and penalties, accounting in
interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006. The adoption of FIN No. 48 will not have a material effect
upon the Companys financial position or results of operations.In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements which defines
fair value, establishes a framework for measuring fair value in generally accepted accounting
principles, and expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value measurements and is
effective for fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact of adopting this Statement.In September 2006, the Securities and Exchange Commission (SEC) staff published Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements (SAB No. 108). SAB No. 108
provides guidance on the consideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a materiality assessment. SAB No.
108 requires quantification of the effects of financial statements errors on each of the
balance sheets and statements of income and the related financial statements disclosures. The
Company adopted SAB No. 108 effective March 31, 2007. The adoption of SAB No. 108 did not have
a material effect upon the Companys financial position or results of operations.In February 2007, the FASB issued SFAS No.
159, The Fair Value Option for Financial
Assets and Financial Liabilities, which
permits entities to choose to measure many
financial instruments and certain other
items at fair value. This Statements
objective is to improve financial
reporting by providing entities with the
opportunity to mitigate volatility in
reported earnings caused by measuring
related assets and liabilities differently
without having to apply complex hedge
accounting provisions. SFAS No. 159 is
effective for fiscal years beginning after
November 15, 2007. The Company is
currently evaluating the impact of
adopting this Statement.
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##### Table of Contents



2.
    
    OTHER INVESTMENTSPursuant to SFAS No. 115, all of the Companys marketable equity securities were classified as
available-for-sale securities. Information regarding the securities classified as
available-for-sale at March 31, 2006 and 2007 is as follows:
 Thousands of YenUnrealized
    
    
    Unrealized
    
    
    FairMarch 31, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueAvailable-for-saleEquity
securities
    
    ¥
    222,807
    
    
    ¥
    6,552,623
    
    
    ¥
    42
    
    
    ¥
    6,775,388March 31, 2007Available-for-saleEquity
securities
    
    ¥
    252,988
    
    
    ¥
    1,057,288
    
    
    ¥
    12,582
    
    
    ¥
    1,297,694
 Thousands of U.S. DollarsUnrealized
    
    
    Unrealized
    
    
    FairMarch 31, 2007
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueAvailable-for-saleEquity
securities
    
    $
    2,153
    
    
    $
    8,993
    
    
    $
    107
    
    
    $
    11,039
 The following table provides the fair value and gross unrealized losses of the Companys
investments, which have been deemed to be temporarily impaired, aggregated by investment
category and length of time that individual securities have been in a continuous unrealized
loss position, as of March 31, 2006 and 2007:
 Thousands of YenLess than12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedMarch 31, 2006
    
    Value
    
    
    Losses
    
    
    Value
    
    
    Losses
    
    
    Value
    
    
    LossesAvailable-for-saleEquity
securities
    
    ¥
    1,338
    
    
    ¥
    42
    
    
    ¥
    
    
    
    ¥
    
    
    
    ¥
    1,338
    
    
    ¥
    42March 31, 2007Available-for-saleEquity
securities
    
    ¥
    37,398
    
    
    ¥
    12,582
    
    
    ¥
    
    
    
    ¥
    
    
    
    ¥
    37,398
    
    
    ¥
    12,582
 Thousands of U.S. DollarsLess than12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedMarch 31, 2007
    
    Value
    
    
    Losses
    
    
    Value
    
    
    Losses
    
    
    Value
    
    
    LossesAvailable-for-saleEquity
securities
    
    $
    318
    
    
    $
    107
    
    
    $
    
    
    
    $
    
    
    
    $
    318
    
    
    $
    107
 The Company regularly reviews all of the Companys investments to determine if any are
other-than-temporarily impaired. The analysis includes reviewing industry analyst reports, sector credit
ratings and volatility of the securitys market price.The Companys unrealized loss on investments in marketable equity security relates to a
management company which owns and operates golf courses and a Japanese commercial bank. The
fair value of each investment is 26% and 25% less than its cost, respectively. The duration of
the unrealized loss position was less than 6 months. Based on the Companys ability and intent
to hold the investment for a reasonable period of time sufficient for a recovery of fair
value, the Company does not consider the investment to be other-than-temporarily impaired at
March 31, 2007.
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##### Table of Contents



Proceeds from the sale of available-for-sale securities were ¥2,614,768 thousand, ¥3,240,805
thousand and ¥3,883,915 thousand ($33,038 thousand) for the years ended March 31, 2005, 2006
and 2007, respectively. Gross realized gains of ¥2,477,607 thousand, ¥3,222,397 thousand and
¥3,242,257 thousand ($27,580 thousand) were included in other income (expenses) for the year
ended March 31, 2005, 2006 and 2007, respectively, and gross realized losses of ¥12,358
thousand ($105 thousand) were included in other income (expenses) for the year ended March 31,
2007.The aggregate cost of the Companys cost method investments totaled ¥1,245,317 thousand and ¥
1,544,047 thousand ($13,134 thousand) at March 31, 2006 and 2007, respectively.Losses on write-down of investments in certain marketable and nonmarketable equity securities,
included in other income (expenses), were recognized to reflect the decline in value
considered to be other than temporary, which were ¥34,151 thousand and ¥118,076 thousand,
respectively, for the year ended March 31, 2005. Such losses in certain nonmarketable equity
securities, included in other income (expenses), were ¥29,513 thousand and ¥1,363,389 thousand
($11,598 thousand) for the years ended March 31, 2006 and 2007, respectively.Gains on exchange of securities of ¥35,450 thousand and ¥ 4,806 thousand, included in other
income (expenses), for the year ended March 31, 2005 and 2006, respectively, represented
non-monetary gains from the exchange of marketable common shares in a merger transaction.In Japan, there is a market in which participants lend and borrow debt and equity
securities without collateral from financial institutions under agreements known as lending
and borrowing debt and equity securities contracts. Under the agreement, the Company loans
equity securities without collateral. The Company has loaned ¥324,000 thousand and ¥218,000
thousand ($1,854 thousand) of available-for-sale securities to the financial institution as of
March 31, 2006 and 2007, respectively.
 3.
    
    ALLOWANCE FOR DOUBTFUL ACCOUNTS AND ADVANCESAn analysis of the allowance for doubtful accounts and advances for the years ended March 31,
2005, 2006 and 2007 is as follows:
 Thousands of YenProvision for(Reversal of)Balance at
    
    
    
    
    
    
    DoubtfulBeginning of
    
    
    Credits
    
    
    Accounts and
    
    
    
    
    
    
    Balance atYear
    
    
    Charged Off
    
    
    Advances
    
    
    Reclassification
    
    
    End of YearYear ended March 31, 2005
    
    ¥
    492,605
    
    
    ¥
    (68,516
    )
    
    ¥
    24,781
    
    
    
    
    
    
    ¥
    448,870Year ended March 31, 2006
    
    ¥
    448,870
    
    
    ¥
    (357,519
    )
    
    ¥
    (12,009
    )
    
    ¥
    35,000
    
    
    ¥
    114,342Year ended March 31, 2007
    
    ¥
    114,342
    
    
    ¥
    (3,764
    )
    
    ¥
    12,232
    
    
    ¥
    
    
    
    ¥
    122,810
 Thousands of U.S.dollarsReversal ofBalance at
    
    
    
    
    
    
    DoubtfulBeginning of
    
    
    Credits
    
    
    Accounts and
    
    
    
    
    
    
    Balance atYear
    
    
    Charged Off
    
    
    Advances
    
    
    Reclassification
    
    
    End of YearYear ended March 31, 2007
    
    $
    973
    
    
    $
    (33
    )
    
    $
    104
    
    
    $
    
    
    
    $
    1,044
 The credits charged off for the year ended March 31, 2006 included the reversal of allowance
for doubtful accounts of Crosswave, the former equity method investee, amounted to ¥345,994
thousand due to the final distribution of remaining assets of Crosswave under the corporate
reorganization proceedings.
 F-17




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##### Table of Contents



4.
    
    INVESTMENTS IN AND ADVANCES TO EQUITY METHOD INVESTEESIIJ utilizes various companies in Japan and neighboring countries to form and operate its
Internet business. Businesses operated by its equity method investees include connectivity
services in Asian countries (Asia Internet Holding Co., Ltd., AIH) through September 2005,
Web page design services (atom Co., Ltd., atom) through March 2007, multifeed technology
services and location facilities for connecting high-speed Internet backbones (Internet
Multifeed Co., Multifeed), data center services in Asian countries ( i-Heart Inc., i-Heart
and Ayalaport Makati Inc., Ayalaport through June, 2004) and comprehensive portal sites
operations (Internet Revolution Inc., i-revo).Since July 2004, Ayalaport is no longer accounted for under equity method due to dilution of
the Companys ownership and loss of ability to exercise significant influence.AIH was no longer an equity method investee after October 1, 2005 since AIH was merged with
IIJ.On March 28, 2007, IIJ sold all its shares in atom for ¥185,900 thousand ($1,581 thousand)
with a gain of ¥252 thousand ($2 thousand). IIJ accounted for atom as an equity method
investee through March 2007. It was not an equity method investee as of March 31, 2007.The aggregate amounts of balances and transactions of the Company with these equity method
investees as of March 31, 2006 and 2007, and for each of the three years in the period ended
March 31, 2007 are summarized as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Accounts receivable
    
    ¥
    
    
    
    ¥
    253,208
    
    
    ¥
    43,628
    
    
    $
    371Accounts payable
    
    
    
    
    
    
    17,084
    
    
    
    15,808
    
    
    
    134Revenues
    
    
    1,245,361
    
    
    
    1,286,275
    
    
    
    481,850
    
    
    
    4,080Costs and expenses
    
    
    1,145,834
    
    
    
    656,184
    
    
    
    172,971
    
    
    
    1,471
 During each of the three years in the period ended March 31, 2007, the Company did not receive
any dividends from its equity method investees.The Companys investments in and advances to these equity method investees and respective
ownership percentage at March 31, 2006 and 2007 consisted of the following:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    
    
    
    
    2007
    
    
    2007Multifeed
    
    
    29.44
    %
    
    ¥
    317,144
    
    
    
    29.72
    %
    
    ¥
    461,750
    
    
    $
    3,928atom
    
    
    40.00
    
    
    
    116,974
    
    
    
    
    
    
    
    
    
    
    
    i-revo
    
    
    30.00
    
    
    
    676,795
    
    
    
    30.00
    
    
    
    328,435
    
    
    
    2,793Other
    
    
    
    
    
    
    52,058
    
    
    
    
    
    
    
    68,305
    
    
    
    581Total
    
    
    
    
    
    ¥
    1,162,971
    
    
    
    
    
    
    ¥
    858,490
    
    
    $
    7,302
 Advances of ¥34,545 thousand ($294 thousand ) to i-Heart, net of loan loss valuation allowance
were included in the Other balances as of March 31, 2006 and 2007.
 F-18




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##### Table of Contents



5.
    
    PROPERTY AND EQUIPMENT
 Property and equipment as of March 31, 2006 and 2007 consisted of the following:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Data communications equipment
    
    ¥
    781,605
    
    
    ¥
    807,528
    
    
    $
    6,869Office and other equipment
    
    
    718,362
    
    
    
    782,666
    
    
    
    6,657Leasehold improvements
    
    
    780,143
    
    
    
    802,220
    
    
    
    6,824Purchased software
    
    
    5,425,819
    
    
    
    6,202,794
    
    
    
    52,763Assets under capital leases, primarily data
communications equipment
    
    
    14,458,667
    
    
    
    13,000,872
    
    
    
    110,589Total
    
    
    22,164,596
    
    
    
    21,596,080
    
    
    
    183,702Less accumulated depreciation
and amortization
    
    
    (11,865,100
    )
    
    
    (11,763,684
    )
    
    
    (100,065
    )Property and equipmentnet
    
    ¥
    10,299,496
    
    
    ¥
    9,832,396
    
    
    $
    83,637
 6.
    
    GOODWILL AND INTANGIBLE ASSETS
 The components of intangible assets as of March 31, 2006 and 2007 are as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Non-amortized intangible assets:Telephone rights
    
    ¥
    12,555
    
    
    ¥
    12,534
    
    
    $
    107Customer relationship
    
    
    113,360
    
    
    
    1,477,412
    
    
    
    12,567Backlog
    
    
    
    
    
    
    696
    
    
    
    6Goodwill
    
    
    506,679
    
    
    
    1,386,252
    
    
    
    11,792Total intangible assets
    
    ¥
    632,594
    
    
    ¥
    2,876,894
    
    
    $
    24,472
 During the years ended March 31, 2005 and 2006, the Company recorded disposal losses of
¥73,271 thousand and ¥2,040 thousand, respectively, on telephone rights, which were not used
by the Company upon cancellation of the contracts for the usage of telephone circuits for
dial-up access services and the disposal loss was included in general and administrative
expenses.
 NTT reduced the price of telephone rights by 50 percent after March 1, 2005 and the
Company recorded an impairment loss of ¥25,804 thousand on telephone rights based on the new
purchase price. The impairment loss was included in general and administrative expenses for
the year ended March 31, 2005.
 Goodwill of ¥73,444 thousand and ¥879,573 thousand ($7,482 thousand) was recorded for the
years ended March 31, 2006 and 2007, respectively.
 On October 1, 2004, IIJ-FS, a 100 percent owned subsidiary of IIJ-Tech, which was a 69 percent
owned subsidiary of IIJ at October 1, 2004, purchased the securities systems development and
operation business from Yamatane Co.,Ltd (Yamatane) in order to initiate a business
relationship with Yamatanes customer base. The primary factor that contributed to the
recognition of goodwill was an assembled workforce. The results of operations of this business
are included in the statement of income of the Company from October 1, 2004. The cash paid for
this business was ¥375,123 thousand including incremental costs directly related to the
transaction. The Company acquired an order backlog of ¥6,254 thousand, customer relationships
valued at ¥113,360 thousand and recorded goodwill of ¥251,127 thousand in the transaction.
The backlog became fully amortized during the year ended March 31, 2005. The pro forma impact
of the acquisition of the business operations of Yamatane on consolidated revenues and net
income of the Company, assuming the acquisition had been completed at the beginning of the
year ended March 31, 2005, would have been an increase to consolidated revenues of ¥1.2
billion and an increase to net income of ¥56 million in the year ended March 31, 2005.
 F-19




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##### Table of Contents



IIJ established NCJ, a 100 percent owned subsidiary in August, 2006. NCJ purchased the
systems integration and network engineering business from Netchart Japan Corporation on
October 1, 2006 and then started its business. The results of operations of this business are
included in the statement of income of the Company from October 1, 2006. The cash paid for
this business was ¥74,752 thousand ($636 thousand). The factor that contributed to the
recognition of goodwill was an assembled workforce. The Company acquired an order backlog of
¥874 thousand ($7 thousand), customer relationships valued at ¥34,065 thousand ($290 thousand)
and recorded goodwill of ¥1,349 thousand ($11 thousand) in the transaction. The backlog became
fully amortized during the year ended March 31, 2007. The pro forma impact of the acquisition
of the business on consolidated revenues and net income of the Company, assuming the
acquisition had been completed at the beginning of the year ended March 31, 2006 and the year
ended March 31, 2007, would have been an increase to consolidated revenues of ¥1.2 billion
($10 million) and ¥0.5 billion ($4 million), respectively, and a decrease to net income of ¥25
million ($215 thousand) and ¥77 million ($656 thousand), respectively.
 On March 30, 2007, IIJ purchased the shares of IIJ-Tech from its minority shareholders for
¥2,725,205 thousand ($23,181 thousand) by cash, in order to acquire the additional interests
in IIJ-Tech. The Company acquired an order backlog of ¥696 thousand ($6 thousand), customer
relationships valued at ¥1,329,987 thousand ($11,313 thousand) and recorded goodwill of
¥751,266 thousand ($6,390 thousand) in the transaction. The backlog will be fully amortized
during the year ending March 31, 2008.
 No impairment on goodwill was recognized during the years ended March 31, 2005, 2006 and
2007.
 7.
    
    LEASES
 The Company enters into, in the normal course of business, various leases for domestic and
international backbone services, office premises, network operation centers and data communications and
other equipment. Certain leases that meet one or more of the criteria set forth in the
provision of SFAS No. 13, Accounting for leases have been classified as capital leases and
the others have been classified as operating leases.
 A portion of the Companys sales result from multi-year lease agreements, under which the
company leased some network equipment to customers. The leases are classified as sale-type
leases which the Company accounts for in accordance with SFAS No. 13.
 Operating LeasesThe Company has operating lease agreements with telecommunications carriers
and others for the use of connectivity lines, including local access lines that customers use
to connect to IIJs network. The leases for domestic backbone connectivity are generally
non-cancelable for a minimum one-year lease period. The leases for international backbone
connectivity during one-year lease period are substantially non-cancelable. The Company also
leases its office premises, for which refundable lease deposits are capitalized as guarantee
deposits, and certain office equipment under non-cancelable operating leases which expire on
various dates through the year 2009 and also leases its network operation centers under
non-cancelable operating leases.
 Refundable guarantee deposits as of March 31, 2006 and 2007 consist of as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Head office
    
    ¥
    1,185,307
    
    
    ¥
    1,185,307
    
    
    $
    10,083Sales and subsidiaries offices
    
    
    308,494
    
    
    
    438,211
    
    
    
    3,727Others
    
    
    55,852
    
    
    
    62,623
    
    
    
    533Total refundable guarantee deposits
    
    ¥
    1,549,653
    
    
    ¥
    1,686,141
    
    
    $
    14,343
 Lease expenses related to backbone lines for the years ended March 31, 2005, 2006 and 2007
amounted to ¥3,550,885 thousand, ¥3,516,322 thousand and ¥3,515,934 thousand ($29,908
thousand), respectively. Lease expenses for local access lines for the years ended March 31,
2005, 2006 and 2007, which are only attributable to dedicated access revenues, amounted to
¥4,040,192 thousand, ¥4,558,382 thousand and ¥4,616,413 thousand ($39,269 thousand),
respectively. Other lease expenses for the years ended March 31, 2005, 2006 and 2007 amounted
to ¥3,303,717 thousand, ¥3,653,766 thousand and ¥4,381,951 thousand ($37,274 thousand),
respectively.
 The Company has subleased a part of its office premises. Lease expenses mentioned above have been
reduced by sublease revenues totaling ¥406,451 thousand, ¥435,224 thousand and ¥22,034
thousand ($187 thousand) for the years ended March 31, 2005, 2006 and 2007, respectively.
 F-20




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##### Table of Contents



Capital LeasesThe Company conducts its connectivity and other services by using data
communications and other equipment leased under capital lease arrangements. The fair values of
the assets upon execution of the capital lease agreements and accumulated depreciation amounted
to ¥14,458,667 thousand and ¥6,819,503 thousand at March 31, 2006 and ¥ 13,000,872 thousand
($110,589 thousand) and ¥6,101,574 thousand ($51,902 thousand) at March 31, 2007, respectively.
 As of March 31, 2007, future lease payments under non-cancelable operating leases, including the
aforementioned non-cancelable connectivity lease agreements (but excluding dedicated access
lines which the Company charges outright to customers), and capital leases were as follows:
 Thousands of Yen
    
    
    Thousands of U.S. DollarsConnectivity
    
    
    
    
    
    
    
    
    
    
    ConnectivityLines
    
    
    Other
    
    
    
    
    
    
    Lines
    
    
    OtherOperating
    
    
    Operating
    
    
    Capital
    
    
    Operating
    
    
    Operating
    
    
    CapitalLeases
    
    
    Leases
    
    
    Leases
    
    
    Leases
    
    
    Leases
    
    
    LeasesYear ending March 31:2008
    
    ¥
    38,520
    
    
    ¥
    1,468,267
    
    
    ¥
    3,201,825
    
    
    $
    328
    
    
    $
    12,490
    
    
    $
    27,2362009
    
    
    38,520
    
    
    
    516,252
    
    
    
    2,465,381
    
    
    
    328
    
    
    
    4,391
    
    
    
    20,9712010
    
    
    38,520
    
    
    
    163,681
    
    
    
    1,342,670
    
    
    
    328
    
    
    
    1,392
    
    
    
    11,4212011
    
    
    19,051
    
    
    
    21,541
    
    
    
    593,936
    
    
    
    161
    
    
    
    183
    
    
    
    5,0522012
    
    
    
    
    
    
    15,970
    
    
    
    89,425
    
    
    
    
    
    
    
    136
    
    
    
    7612013 and thereafter
    
    
    
    
    
    
    40,112
    
    
    
    6,623
    
    
    
    
    
    
    
    341
    
    
    
    56Total minimum lease payments
    
    ¥
    134,611
    
    
    ¥
    2,225,823
    
    
    ¥
    7,699,860
    
    
    $
    1,145
    
    
    $
    18,933
    
    
    $
    65,497Less amounts representing interest
    
    
    
    
    
    
    
    
    
    
    428,378
    
    
    
    
    
    
    
    
    
    
    
    3,643Present value of net minimum capital
lease payments
    
    
    
    
    
    
    
    
    
    
    7,271,482
    
    
    
    
    
    
    
    
    
    
    
    61,854Less current portion
    
    
    
    
    
    
    
    
    
    
    2,953,173
    
    
    
    
    
    
    
    
    
    
    
    25,121Noncurrent portion
    
    
    
    
    
    
    
    
    
    ¥
    4,318,309
    
    
    
    
    
    
    
    
    
    
    $
    36,733
 Sales-type LeasesThe Company has some sales-type lease agreements with customers. The Company
recognize revenues on sales-type leases when the assets under lease are delivered to and
accepted by the customers. The revenue recognized is calculated at the net present value of the
future payment amounts. Interest income in sales-type leases is recognized in other income using
the interest method.
 The components of the net investment in sales-type leases as of March 31, 2007 were as follows:
 Thousands of
Yen
    
    
    Thousands ofU.S. Dollars2007
    
    
    2007Year ending March 31:2008
    
    ¥
    348,188
    
    
    $
    2,9612009
    
    
    359,780
    
    
    
    3,0602010
    
    
    239,781
    
    
    
    2,0402011
    
    
    239,781
    
    
    
    2,0402012
    
    
    19,982
    
    
    
    170Total minimum lease payments to be received*
    
    ¥
    1,207,512
    
    
    $
    10,271Estimated residual value of leased property (unguaranteed)
    
    
    215,917
    
    
    
    1,837Less unearned income
    
    
    68,599
    
    
    
    583Net investment in sales-type leases
    
    
    1,354,830
    
    
    
    11,525Less current portion
    
    
    320,530
    
    
    
    2,727Non-current net investment in sales-type leases
    
    ¥
    1,034,300
    
    
    $
    8,798
 
 *
    
    Estimated executory costs, including profit thereon, of ¥263,245 thousand ($2,239 thousand)
were excluded from total minimum lease payments to be received. F-21




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##### Table of Contents



8.
    
    BORROWINGS
 Short-term borrowings at March 31, 2006 and 2007 consist of bank overdrafts. Short-term
borrowings bear fixed and variable-rate interest and their weighted average rates at March 31, 2006 and
2007 were 1.375 percent and 1.141 percent, respectively.
 Long-term borrowings as of March 31, 2006 and 2007 consisted of the following:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Unsecured long-term loans payable to
banks, maturing at various dates
through calendar 2007.
Interest is payable at a variable rate.Weighted average interest rates were 2.206
percent
and 3.815 percent at March 31, 2006 and 2007,
respectively.
    
    ¥
    374,000
    
    
    ¥
    40,000
    
    
    $
    340Unsecured long-term loans payable to
banks, maturing in calendar 2006.Weighted average interest rates were 1.710
percent
at March 31, 2006
    
    
    600,000
    
    
    
    
    
    
    
    Unsecured long-term loans payable to
banks, maturing at various dates through calendar
2007. Interest is payable at a variable
rate based on TIBOR which was 0.133 percent and
0.706 percent as of March 31, 2006 and 2007,
respectively.
Weighted average interest rates were 1.130 percent
and 1.706 percent at March 31, 2006 and 2007,
respectively.
    
    
    1,150,000
    
    
    
    250,000
    
    
    
    2,127Long-term installment loans payable at
various dates through calendar 2007.Interest rates were 2.55 percent
at March 31, 2006.
    
    
    155,963
    
    
    
    
    
    
    
    Total
    
    
    2,279,963
    
    
    
    290,000
    
    
    
    2,467Less current portion
    
    
    (1,989,963
    )
    
    
    (290,000
    )
    
    
    (2,467
    )Long-term borrowings, less current
portion
    
    ¥
    290,000
    
    
    ¥
    
    
    
    $
    
 The Company entered into interest rate swap contracts to manage its interest rate exposure
resulting in a fixed interest rate for a portion of its long-term debt. The effective
weighted average interest rates for ¥1,150,000 thousand and ¥250,000 thousand ($2,127
thousand) of the long-term loan outstanding at March 31, 2006 and 2007 after giving effect to
such swap agreements were 1.781 percent and 1.670 percent per annum, respectively.
 On March 14, 2003, the Company entered into a long-term installment loan agreement with a
leasing company to finance the payment for rental deposits given to other lessor for its new
head office. The principal of the loan was ¥155,963 thousand at March 31, 2006 and the loan
was secured by a first priority pledge against a claim for the guarantee deposits. The Company
fully paid off the long-term installment loan in March 2007.
 Substantially all short-term and long-term bank borrowings are made under agreements which, as
is customary in Japan, provide that under certain conditions the bank may require the borrower
to provide collateral (or additional collateral) or guarantor with respect to the borrowings
and that the bank may treat any collateral, whether furnished as security for short-term or
long-term loans or otherwise, as collateral for all indebtedness to such bank. Also,
provisions of certain loan agreements grant certain rights of possession to the lenders in the
event of default. The Company did not provide banks with any collateral for outstanding loans
as of March 31, 2007.
 F-22




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##### Table of Contents



The Company entered into bank overdraft agreements with certain Japanese banks for which the
unused balance outstanding as of March 31, 2007 was ¥13,370,000 thousand ($113,729 thousand).
 Since August 2004, the Company had been a party to a securities loan agreement with a
Japanese financial institution. The Company loaned available-for-sale securities to the
financial institution and received cash in return in the transaction. These transactions were
accounted for as secured borrowings and the cash received was recorded as payable under the
securities loan agreement and securities lent were recorded as other investments. The
agreement required the Company to provide certain marketable securities as collateral at the
commencement of the transaction. The Company was required to make a partial repayment or
receive additional borrowings depending on the market value of securities pledged. The
Company paid the interest on the payables at a variable rate, which was 0.37 percent and 0.76
percent as of March 31, 2006 and March 27, 2007,
respectively. On March 27, 2007, the Company paid off the
loan and took the available-for-sale securities loaned back since the agreement expired on
that date.
 9.
    
    INCOME TAXES
 Income taxes imposed by the national, prefectural and municipal governments of Japan resulted
in a normal statutory rate of approximately 41 percent for the years ended March 31, 2005,
2006 and 2007.
 The reserve for tax contingencies related to the denial of the use of tax operating loss
carryforwards by IIJ America, a U.S. subsidiary, was ¥197,753 thousand as of March 31, 2006.
 In September 2006, IIJ America filed an application with the Internal Revenue Service (IRS)
for the Bilateral Advance Pricing Agreement Request (BAPA), relating to the terms of transactions
with IIJ and the use of the tax operating loss carryforwards in its taxation. IIJ America reversed
the reserve for the potential penalty relating to the past use of the tax operating loss
carryforwards of ¥108,782 thousand ($925 thousand) after filing the application with the IRS,
leaving a remaining balance of ¥102,310 thousand ($870 thousand) as of March 31, 2007. The Company
believed that IRS would not impose tax penalty if the Company applied the BAPA. This is
managements best estimate of the potential liability for tax contingencies.
 F-23




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##### Table of Contents



Income from operations before income tax expense (benefit), minority interests and equity
in net loss of equity method investees and income tax expense for the years ended March 31,
2005, 2006, and 2007 consists of the following components:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Income from operations before income tax
expense (benefit), minority interests and equity in net loss
of equity method investees:Domestic
    
    ¥
    3,168,974
    
    
    ¥
    5,316,535
    
    
    ¥
    5,055,155
    
    
    $
    43,000Foreign
    
    
    (20,466
    )
    
    
    62,024
    
    
    
    (6,467
    )
    
    
    (55
    )Total
    
    ¥
    3,148,508
    
    
    ¥
    5,378,559
    
    
    ¥
    5,048,688
    
    
    $
    42,945Income taxescurrent:Domestic
    
    ¥
    110,893
    
    
    ¥
    289,376
    
    
    ¥
    798,922
    
    
    $
    6,796Foreign
    
    
    0
    
    
    
    198,825
    
    
    
    (108,180
    )
    
    
    (920
    )Total
    
    ¥
    110,893
    
    
    ¥
    488,201
    
    
    ¥
    690,742
    
    
    $
    5,876Income taxesdeferred:Domestic
    
    ¥
    (11,023
    )
    
    ¥
    (230,841
    )
    
    ¥
    (1,494,685
    )
    
    $
    (12,714
    )Foreign
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    ¥
    (11,023
    )
    
    ¥
    (230,841
    )
    
    ¥
    (1,494,685
    )
    
    $
    (12,714
    )
 Net deferred income tax assets and liabilities are reflected on the consolidated balance sheets
as of March 31, 2006 and 2007 as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Current AssetsOther current assets
    
    ¥
    138,938
    
    
    ¥
    427,079
    
    
    $
    3,633Noncurrent AssetsOther assets
    
    
    193,681
    
    
    
    1,392,144
    
    
    
    11,842Noncurrent liabilitiesOther noncurrent liabilities
    
    
    (83,127
    )
    
    
    (40,652
    )
    
    
    (346
    )Total
    
    ¥
    249,492
    
    
    ¥
    1,778,571
    
    
    $
    15,129
 The approximate effect of temporary differences and carryforwards giving rise to deferred tax
balances at March 31, 2006 and 2007 was as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Deferred
    
    
    Deferred
    
    
    Deferred
    
    
    Deferred
    
    
    Deferred
    
    
    DeferredTax
    
    
    Tax
    
    
    Tax
    
    
    Tax
    
    
    Tax
    
    
    TaxAssets
    
    
    Liabilities
    
    
    Assets
    
    
    Liabilities
    
    
    Assets
    
    
    LiabilitiesUnrealized gains on
available-for-sale securities
    
    ¥
    
    
    
    ¥
    2,686,560
    
    
    ¥
    
    
    
    ¥
    487,242
    
    
    $
    
    
    
    $
    4,145Capital leases
    
    
    84,345
    
    
    
    
    
    
    
    87,994
    
    
    
    
    
    
    
    749
    
    
    
    Accrued expenses
    
    
    161,902
    
    
    
    
    
    
    
    301,322
    
    
    
    
    
    
    
    2,563
    
    
    
    Retirement and pension cost
    
    
    89,705
    
    
    
    
    
    
    
    311,558
    
    
    
    
    
    
    
    2,650
    
    
    
    Stock issuance cost
    
    
    29,212
    
    
    
    
    
    
    
    14,606
    
    
    
    
    
    
    
    124
    
    
    
    Allowance for doubtful accounts
    
    
    16,333
    
    
    
    
    
    
    
    10,874
    
    
    
    
    
    
    
    92
    
    
    
    Depreciation
    
    
    25,070
    
    
    
    
    
    
    
    18,362
    
    
    
    
    
    
    
    156
    
    
    
    Net loss on other investment
    
    
    127,115
    
    
    
    
    
    
    
    632,365
    
    
    
    
    
    
    
    5,379
    
    
    
    Operating loss carryforward
    
    
    9,602,271
    
    
    
    
    
    
    
    7,461,360
    
    
    
    
    
    
    
    63,469
    
    
    
    Other
    
    
    121,659
    
    
    
    150,129
    
    
    
    119,776
    
    
    
    128,890
    
    
    
    1,019
    
    
    
    1,096Total
    
    
    10,257,612
    
    
    
    2,836,689
    
    
    
    8,958,217
    
    
    
    616,132
    
    
    
    76,201
    
    
    
    5,241Valuation allowance
    
    
    (7,171,431
    )
    
    
    
    
    
    
    (6,563,514
    )
    
    
    
    
    
    
    (55,831
    )
    
    
    Total
    
    ¥
    3,086,181
    
    
    ¥
    2,836,689
    
    
    ¥
    2,394,703
    
    
    ¥
    616,132
    
    
    $
    20,370
    
    
    $
    5,241
 As of March 31, 2006 and 2007, the valuation allowance for deferred tax assets has been provided
at amounts which are not considered more likely than not to be realized. The net changes in the
valuation allowance for deferred tax assets were a decrease of ¥2,224,170 thousand, a decrease
of ¥1,244,326 thousand and a decrease of ¥607,917 thousand ($5,171 thousand) for the years ended
March 31, 2005, 2006 and 2007, respectively.
 F-24




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##### Table of Contents



As of March 31, 2007, IIJ and IIJ America had tax operating loss carryforwards of ¥17,083,252
thousand ($145,315 thousand) and $8,855 thousand, respectively. These loss carryforwards are
available to offset future taxable income, and will expire in the period ending March 31, 2012
in Japan and December 31, 2026 in the United States of America as follows:
 Year Ending
    
    
    
    
    
    Thousands ofMarch 31
    
    Thousands of Yen
    
    
    U.S. Dollars2008
    
    ¥
    
    
    
    $
    2009
    
    
    
    
    
    
    2010
    
    
    9,314,732
    
    
    
    79,2342011
    
    
    7,353,136
    
    
    
    62,5482012 and thereafter
    
    
    1,456,411
    
    
    
    12,388Total
    
    ¥
    18,124,279
    
    
    $
    154,170
 A reconciliation between the amount of reported income taxes and the amount of income taxes
computed using the normal statutory rate for each of the three years in the period ended March
31, 2007 is as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Amount computed by using
normal Japanese statutory
tax rate
    
    ¥
    1,290,888
    
    
    ¥
    2,205,209
    
    
    ¥
    2,069,962
    
    
    $
    17,608Increase (decrease) in taxes
resulting from:Expenses not deductible for
tax purpose
    
    
    34,820
    
    
    
    38,653
    
    
    
    60,340
    
    
    
    513Provision for (reversal of) reserve
for tax contingencies
    
    
    
    
    
    
    197,753
    
    
    
    (108,782
    )
    
    
    (925
    )Inhabitant tax-per capital
    
    
    23,410
    
    
    
    25,085
    
    
    
    25,141
    
    
    
    214Realization of tax benefit of
operating loss carryforwards
    
    
    (1,426,755
    )
    
    
    (439,256
    )
    
    
    (2,163,531
    )
    
    
    (18,404
    )Other change in valuation allowance
    
    
    261,380
    
    
    
    (1,933,379
    )
    
    
    (717,049
    )
    
    
    (6,099
    )Expiration of operating loss
carryforwards
    
    
    
    
    
    
    149,750
    
    
    
    
    
    
    
    Othernet
    
    
    (83,873
    )
    
    
    13,545
    
    
    
    29,976
    
    
    
    254Income tax expense (benefit)
as reported
    
    ¥
    99,870
    
    
    ¥
    257,360
    
    
    ¥
    (803,943
    )
    
    $
    (6,839
    )
 F-25




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##### Table of Contents



10.
    
    RETIREMENT AND PENSION PLANSIIJ and certain subsidiaries have unfunded retirement benefit and noncontributory defined
benefit pension plans which together cover substantially all of their employees who are not
directors and also participate in a contributory multi-employer pension plan, the Japan
Computer Information Service Employees Pension Fund (the Multi-Employer Plan), covering
substantially all of their employees.Approximately 70 percent of the employees benefits from IIJs severance indemnity plan was
transferred in May 1997 to its newly established noncontributory defined benefits pension
plan. The following information regarding net periodic pension cost and accrued pension cost
also includes the 30 percent of severance benefits not transferred to the noncontributory
plan. Under the severance and pension plans, all of IIJs employees are entitled, upon
voluntary retirement with 15 years or more service, or upon mandatory retirement at age 60, to
a 10-year period of annuity payments (or lump-sum severance indemnities) based on the rate of
pay at the time of retirement, length of service and certain other factors. IIJs employees
who do not meet these conditions are entitled to lump-sum severance indemnities.As stipulated by the Japanese Welfare Pension Insurance Law, the Multi-Employer Plan is
composed of a substitutional portion of Japanese Pension Insurance and a multi-employers
portion of a contributory defined benefit pension plan. The benefits for the substitutional
portion are based on a standard remuneration schedule under the Welfare Pension Insurance Law
and the length of participation. The multi-employers portion of the benefits is based on the
employees length of service. However, assets contributed by an employer including IIJ are
not segregated in a separate account or restricted to provide benefits only to employees of
that employer. The net pension cost under the Multi-Employer Plan is recognized when
contributions become due.The Company adopted SFAS No.158 effective March 31, 2007. The following table provides a
breakdown of the incremental effect of applying this statement on individual line items in the
consolidated balance sheet at March 31, 2007:
 Thousands of YenBefore
    
    
    
    
    
    AfterApplication of
    
    
    
    
    
    Application ofSFAS 158
    
    
    Adjustments
    
    
    SFAS 158Other assets
    
    ¥
    3,224,576
    
    
    ¥
    35,477
    
    
    ¥
    3,260,053Total Assets
    
    ¥
    47,657,527
    
    
    ¥
    35,477
    
    
    ¥
    47,693,004Other noncurrent liabilities
    
    ¥
    563,062
    
    
    ¥
    1,556
    
    
    ¥
    564,618Accrued retirement
and pension costs-current
    
    
    
    
    
    
    8,428
    
    
    
    8,428Accrued retirement
and pension costs-noncurrent
    
    
    606,014
    
    
    
    144,028
    
    
    
    750,042Minority interest
    
    
    821,986
    
    
    
    (6,804
    )
    
    
    815,182Accumulated other comprehensive
income
    
    
    1,061,440
    
    
    
    (111,731
    )
    
    
    949,709Total Liabilities and Shareholders
Equity
    
    ¥
    47,657,527
    
    
    ¥
    35,477
    
    
    ¥
    47,693,004
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##### Table of Contents



Thousands of U.S. DollarsBefore
    
    
    
    
    
    AfterApplication of
    
    
    
    
    
    Application ofSFAS 158
    
    
    Adjustments
    
    
    SFAS 158Other assets
    
    $
    27,429
    
    
    $
    302
    
    
    $
    27,731Total Assets
    
    $
    405,389
    
    
    $
    302
    
    
    $
    405,691Other noncurrent liabilities
    
    $
    4,790
    
    
    $
    13
    
    
    $
    4,803Accrued retirement
and pension costs-current
    
    
    
    
    
    
    72
    
    
    
    72Accrued retirement
and pension costs-noncurrent
    
    
    5,155
    
    
    
    1,225
    
    
    
    6,380Minority interest
    
    
    6,992
    
    
    
    (58
    )
    
    
    6,934Accumulated other comprehensive
income
    
    
    9,028
    
    
    
    (950
    )
    
    
    8,078Total Liabilities and Shareholders
Equity
    
    $
    405,389
    
    
    $
    302
    
    
    $
    405,691
 Net periodic pension cost for the years ended March 31, 2005, 2006 and 2007 included the
following components:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Service cost
    
    ¥
    221,132
    
    
    ¥
    240,765
    
    
    ¥
    257,960
    
    
    $
    2,194Interest cost
    
    
    14,944
    
    
    
    20,524
    
    
    
    26,589
    
    
    
    226Expected return on plan assets
    
    
    (13,129
    )
    
    
    (16,736
    )
    
    
    (26,942
    )
    
    
    (228
    )Amortization of transition
obligation
    
    
    402
    
    
    
    402
    
    
    
    402
    
    
    
    3Recognized net actuarial loss
    
    
    8,262
    
    
    
    1,904
    
    
    
    2,505
    
    
    
    21Net periodic pension cost
    
    ¥
    231,611
    
    
    ¥
    246,859
    
    
    ¥
    260,514
    
    
    $
    2,216
 The change in benefit obligation and plan assets for the years ended March 31, 2006 and 2007
and the amounts recognized in the consolidated balance sheets as of March 31, 2006 and 2007
are as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Change in benefit obligation:Benefit obligation at beginning of year
    
    ¥
    1,140,240
    
    
    ¥
    1 ,329,452
    
    
    $
    11,309Service cost
    
    
    240,765
    
    
    
    257,960
    
    
    
    2,194Interest cost
    
    
    20,524
    
    
    
    26,589
    
    
    
    226Actuarial loss (gain)
    
    
    (31,171
    )
    
    
    45,597
    
    
    
    388Benefit paid
    
    
    (40,906
    )
    
    
    (24,012
    )
    
    
    (204
    )Benefit obligation at end of year
    
    ¥
    1,329,452
    
    
    ¥
    1,635,586
    
    
    $
    13,913Change in plan assets:Fair value of plan assets at beginning
of year
    
    ¥
    796,946
    
    
    ¥
    997,856
    
    
    $
    8,488Actual return on plan assets
    
    
    68,185
    
    
    
    32,233
    
    
    
    274Employer contribution
    
    
    155,191
    
    
    
    173,160
    
    
    
    1,473Benefits paid
    
    
    (22,466
    )
    
    
    (14,691
    )
    
    
    (125
    )Refund of surplus in plan assets
    
    
    
    
    
    
    (110,862
    )
    
    
    (943
    )Fair value of plan assets at end of year
    
    ¥
    997,856
    
    
    ¥
    1,077,696
    
    
    $
    9,167Funded status at end of year
    
    
    (331,596
    )
    
    ¥
    (557,890
    )
    
    $
    (4,746
    )Unrecognized actuarial loss
    
    
    111,009
    
    
    
    
    
    
    
    Unrecognized transition obligation
    
    
    4,016
    
    
    
    
    
    
    
    Net amount recognized
    
    ¥
    (216,571
    )
    
    
    
    
    
    
    
 F-27




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##### Table of Contents



On October 25, 2006, the surplus amount of ¥110,862 thousand in plan assets was refunded
as a result of the excess of actual return on plan assets compared with the expected return.Amounts recognized in the consolidated balance sheets as of
March 31, 2006 and 2007 consist of:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Prepaid pension costs
    
    ¥
    3,891
    
    

    ¥
    
    
    

    $
    Accrued retirement and pension costs-current
    
    
    
    
    
    
    (8,428
    )
    
    
    (72
    )Accrued retirement and pension costs-non current
    
    
    (220,462
    )
    
    
    (549,462
    )
    
    
    (4,674
    )Net amount recognized
    
    ¥
    (216,571
    )
    
    ¥
    (557,890
    )
    
    $
    (4,746
    )
 The accumulated benefit obligation for the Companys defined benefit pension plans as of March
31, 2006 and 2007 was ¥750,900 thousand and ¥937,733 thousand ($7,977 thousand), respectively.The aggregate projected benefit obligation and aggregate fair value of plan assets for plans
with projected benefit obligations in excess of plan assets were ¥1,329,452 thousand and
¥997,856 thousand at March 31, 2006 and ¥1,635,586 thousand ($13,913 thousand) and ¥1,077,696
thousand ($9,167 thousand) at March 31, 2007. The aggregate accumulated benefit obligation of
plans with no plan assets were ¥153,402 thousand and ¥220,779 thousand ($1,878 thousand) at
March 31, 2006 and 2007, respectively.Amounts recognized in accumulated other comprehensive income at March 31, 2007 consist of:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2007
    
    
    2007Net actuarial loss
    
    ¥
    148,842
    
    
    $
    1,266Obligation at transition
    
    
    3,614
    
    
    
    31¥
    152,456
    
    

    $
    1,297
 The estimated net actuarial loss and obligation at transition for the defined benefit pension
plans that will be amortized from accumulated other comprehensive income into net periodic
pension cost in the fiscal year ending March 31, 2008 are ¥ 3,699 thousand ($31 thousand) and
¥ 402 thousand ($3 thousand), respectively.The Company uses a March 31 measurement date for all its plans.Actuarial assumptions as of March 31:
 BenefitObligations
    
    Net Periodic Costs2006
    
    2007
    
    2005
    
    2006
    
    2007Discount rate
    
    
    2.0
    %
    
    
    1.9
    %
    
    
    1.6
    %
    
    
    1.8
    %
    
    
    2.0
    %Expected long-term rate of return
on plan assets
    
    
    
    
    
    
    
    
    
    
    2.0
    
    
    
    2.1
    
    
    
    2.7Rate of increase in compensation
    
    
    3.4
    
    
    
    3.5
    
    
    
    3.25
    
    
    
    3.4
    
    
    
    3.4
 F-28




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##### Table of Contents



The Company sets the discount rate assumption annually at March 31 to reflect the market yield
of Japanese Government Bonds matched against the average remaining service period of employees.The basis for determining the long-term rate of returns is a combination of historical returns
and prospective return assumptions derived from pension trust funds managing company.IIJs funding policies with respect to the noncontributory plan are generally to contribute
amounts considered tax deductible under applicable income tax regulations. Plan assets
including life insurance pooled investment portfolios consist of Japanese Government bonds,
other debt securities and marketable equity securities. Life insurance pooled investment portfolios are managed by an insurance company and guarantee a
minimum rate of return.The Companys investment strategy for the plan assets is to manage the assets in order to pay
retirement benefits to plan participants while minimizing cash contributions from the Company
over the life of the plans. This is accomplished by preserving capital through diversification
in equity and debt securities based on portfolio determined by the insurance company
forecasting macroeconomics in order to maximize long-term rate of return, while considering the
liquidity need of the plans.The projected allocation of the plan assets managed by the insurance company is developed in
consideration of the expected long-term investment returns for each category of the plan
assets. Approximately 63.0%, 35.0%, and 2.0% of the plan assets excluding pooled investment
portfolios will be allocated to debt securities, equity securities and other financial
instruments, respectively, to moderate the level of volatility in pension plan asset returns
and reduce risks. 50% of the employers contribution to the plan during the year ending March
31, 2008 will be allocated to life insurance pooled investment portfolios and other 50% will be
allocated to the forementioned investments.The Companys pension plan asset allocations as of March 31, 2006 and 2007 by asset category
are as follows:
 2006
    
    2007Asset category:Equity securities
    
    
    22.4
    %
    
    
    (35.9
    )%
    
    
    21.9
    %
    
    
    (35.7
    )%Debt securities
    
    
    38.8
    
    
    
    (62.1
    )
    
    
    38.1
    
    
    
    (62.3
    )Life insurance pooled investment portfolios
    
    
    37.6
    
    
    
    (
    )
    
    
    38.8
    
    
    
    (
    )Other
    
    
    1.2
    
    
    
    (2.0
    )
    
    
    1.2
    
    
    
    (2.0
    )Total
    
    
    100.0
    %
    
    
    (100.0
    )%*
    
    
    100.0
    %
    
    
    (100.0
    )%*
 
 *
    
    The percentages in parentheses represent the Companys plan asset allocation excluding life
insurance pooled investment portfolios. The unrecognized net loss and the unrecognized net obligation at the date of initial
application are being amortized over 14 years and 21 years, respectively.Contributions due and paid during the years ended March 31, 2005, 2006 and 2007 under the
Multi-Employer Plan, including its substitutional portion, amounted to ¥466,543 thousand,
¥451,312 thousand and ¥ 522,269 thousand ($ 4,443 thousand), respectively.IIJ expects to contribute ¥173,159 thousand ($1,473 thousand) to its pension plan in the year
ending March 31, 2008.
 F-29




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##### Table of Contents



The following benefit payments, which reflect expected future service, as appropriate,
are expected to be paid.
 Year Ending
    
    
    
    
    Thousands ofMarch 31
    
    Thousands of yen
    
    
    U.S. Dollars2008
    
    ¥
    45,670
    
    
    $
    3882009
    
    
    42,607
    
    
    
    3622010
    
    
    50,068
    
    
    
    4262011
    
    
    57,829
    
    
    
    4922012
    
    
    64,179
    
    
    
    5462013  2017
    
    
    410,823
    
    
    
    3,495Total
    
    ¥
    671,176
    
    
    $
    5,709
 The amount of retirement benefits for retiring directors and company auditors must be approved
by the shareholders. IIJ established a retirement plan for full-time company auditors in
March, 2006 and a retirement plan for full-time directors in March 2007. The Company recorded a
liability for the retirement benefits for full-time company auditors of ¥2,870 thousand and a liability for retirement benefit for
full-time directors and company auditors of ¥200,580 thousand ($1,706 thousand), which would
be required if they retire at March 31, 2006 and 2007, respectively.There were no other benefits approved or paid to retired directors and company auditors for
each of three years in the period ended March 31, 2007, except a benefit of ¥4,010 thousand
paid to a retired director in July 2005 and ¥3,000 thousand ($26 thousand) paid to a retired
auditor in July 2006, respectively.
 F-30




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##### Table of Contents



11.
    
    SHAREHOLDERS EQUITY
 On and after May 1, 2006, Japanese companies are subject to a new corporation law (the
Corporation Law) which reformed and replaced the Commercial Code of Japan (the Code) with
various revisions that are, for the most part, applicable to events or transactions occurring
on or after May 1, 2006 and for the fiscal years ending on or after May 1, 2006. The
significant changes brought about by the Corporation Law that affect financial matters are
summarized below:
 (a) Dividends
Under the Corporation Law, companies can pay dividends at any time during the fiscal year in
addition to the year-end dividend in accordance with an approval of a shareholders meeting.
For companies that meet certain criteria such as: (1) having a Board of Directors, (2) having
independent auditors, (3) having a Board of Company Auditors, and (4) having a term of
service for directors prescribed as one year rather than two years as the normal term by its
articles of incorporation, the Board of Directors may declare dividends (except for dividends
in kind) if the company has prescribed so in its articles of incorporation. However, IIJ
cannot do so because it does not meet the criteria
(4) above.
The Corporation Law permits companies to distribute dividends in kind to shareholders subject
to a certain limitation and additional requirements. Semiannual interim dividends may also be
paid once a year upon resolution of the Board of Directors if the articles of incorporation of
the company so stipulate. The Corporation Law provides certain limitations on the amounts
available for dividends or the purchase of treasury stock. The limitation is defined as the
amount available for distribution to the shareholders, but the amount of net assets after
dividends must be maintained as at least ¥3 million.
 (b) Increases / decreases and transfer of common stock, reserve and surplus
The Corporation Law requires that an amount equal to 10% of dividends must be appropriated as
legal reserve (a component of retained earnings) or as additional paid-in capital (a component
of capital surplus) depending on the equity account charged upon the payment of such dividends
until the total of aggregate amount of legal reserve and additional paid-in capital equals 25%
of common stock. Under the Corporation Law, the total amount of additional paid-in capital and
legal reserve may be reversed without limitation. The Corporation Law also provides that
common stock, legal reserve, additional paid-in capital, and other capital surplus and
retained earnings can be transferred among the accounts under certain conditions upon
resolution of shareholders.
 (c) Treasury stock and treasury stock acquisition rights
The Corporation Law also provides for companies to purchase treasury stock and dispose of such
treasury stock by resolution of the Board of Directors. The amount of treasury stock purchased
cannot exceed the amount available for distribution to the shareholders which is determined by
specific formula. The Corporation Law also provides that companies can purchase both treasury stock acquisition
rights and treasury stock.
 At the 14th Ordinary General Shareholders Meeting held on June 28, 2006, IIJs
shareholders approved the reductions of additional paid-in capital of ¥21,980,395 thousand
($186,972 thousand) and common stock of ¥2,539,222 thousand ($21,599 thousand) to eliminate
the accumulated deficit for purpose of reporting under the Corporation Law in its
non-consolidated financial statements. The effective date was August 4, 2006.
 The amount of retained earnings available for dividends under the Corporation Law is based on
the amount of retained earnings recorded in IIJs general books of account with accepted
Japanese accounting practices. The adjustments included in the accompanying consolidated
financial statements for U.S.GAAP purposes but not recorded in the general books of account
have no effect on the determination of retained earnings available for dividends under the
Corporation Law. Retained earnings shown in IIJs general books of account amounted to
¥4,876,947 thousand ($41,485 thousand) at March 31, 2007.
 In December, 2005, IIJ completed a public offering of 12,500 new shares (equivalent to
5,000,000 ADSs) of common stock by a firm-commitment underwriting at an offering price of
¥534,022 (an issue value of ¥490,955) per share on the Mothers market of the Tokyo Stock
Exchange. The net proceeds to IIJ from the public offering, after deducting stock issuance
costs, were ¥6,030,064 thousand. Stock issuance costs of ¥106,873 thousand were deducted from
additional paid-in capital.
 In December, 2006, IIJs listing was transferred to the First Section of the Tokyo Stock
Exchange without the issuance of new shares.
 F-31




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##### Table of Contents



Stock Option PlansIn May 2000, IIJ granted 295 options to 34 directors and employees. The
options vested fully on April 8, 2002 and are exercisable for eight years from that date. In
August 2001, IIJ granted 395 options to 44 directors and employees. The options became fully
vested on June 28, 2003 and are exercisable for eight years from that date. No options are
available for additional grant as of March 31, 2007. No compensation expense has been
recognized in the consolidated statements of income pursuant to APB No. 25, because the
exercise price was greater than the market price on the dates of grant.
 In March 2000, subsidiary IIJ-Tech issued bonds with 2,000 detachable warrants in the amount
of ¥600,000 thousand. The bonds were repurchased in April 2000 and warrants to purchase the
subsidiarys 775 common shares at an exercise price of ¥300,000 per share based on fair market
value were immediately purchased by certain officers and employees of IIJ and the subsidiary.
One thousand warrants were purchased by IIJ. Warrants were exercisable upon issuance. On
March 29, 2006, 1,000 of the warrants of IIJ-Tech expired. The exercise price was revised to ¥250,326 ($2,131 thousand) per share as of
March 31, 2006, due to the effects of issuances of new shares during the year ended March 31,
2006.
 In March, 2007, 770 of the warrants were exercised at the above-mentioned exercise price. The
remaining 230 warrants expired on March 29, 2007.
 The following table summarizes the transactions of IIJs stock option plans for the year in
the period ended March 31, 2007:
 Thousands of YenWeighted AverageNumber of

    
    

    Number of

    
    
    Exercise Price perOptions
    
    
    Shares
    
    
    Common SharesUnexercised options outstandingMarch 31, 2006
    
    
    530
    
    
    
    2,650
    
    
    ¥
    1,007Options granted
    
    
    
    
    
    
    
    
    
    
    Options exercised
    
    
    
    
    
    
    
    
    
    
    Options forfeited
    
    
    15
    
    
    
    75
    
    
    
    944Unexercised options outstandingMarch 31, 2007
    
    
    515
    
    
    
    2,575
    
    
    ¥
    1,009
 Due to the effect of the stock split in October 2005, grantees of options can purchase
five shares by exercising one option.
 F-32




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##### Table of Contents



Summarized information about stock options outstanding as of March 31, 2007 is as follows:
 Outstanding
    
    ExercisableNumber of SharesExercise Price
    
    Underlying
    
    Remaining Life
    
    Number of Shares
    
    Total Intrinsic Value(Thousands of Yen)
    
    Options
    
    (in Years)
    
    Underlying Options
    
    (Thousands of Yen)¥2,163
    
    
    
    950
    
    
    
    3.0
    
    
    
    950
    
    
    
    334
    
    
    
    1,625
    
    
    
    4.3
    
    
    
    1,625
    
    
    ¥
    218,647
 12.
    
    OTHER COMPREHENSIVE INCOME
 The change in each component of other comprehensive income (loss) for the years ended March
31, 2005, 2006 and 2007 is as follows:
 Thousands of YenBefore Tax
    
    
    Tax (Expense)
    
    
    Net of TaxAmount
    
    
    or Benefit
    
    
    AmountYear ended March 31, 2005:Foreign currency translation adjustments
    
    ¥
    (25,858
    )
    
    ¥
    
    
    
    ¥
    (25,858
    )Unrealized holding gain (loss) on
securities:Amount arising during the period
    
    
    4,989,951
    
    
    
    (2,045,880
    )
    
    
    2,944,071Less: Reclassification adjustments for
gains included in net income
    
    
    (2,478,906
    )
    
    
    1,016,351
    
    
    
    (1,462,555
    )Release in deferred tax asset valuation
allowance*
    
    
    
    
    
    
    1,029,529
    
    
    
    1,029,529Net unrealized holding gain (loss) during
the period
    
    
    2,511,045
    
    
    
    
    
    
    
    2,511,045Gain on cash flow hedging derivative
instruments:Amount arising during the period
    
    
    (3,521
    )
    
    
    
    
    
    
    (3,521
    )Less: Reclassification adjustments for
losses included in net income
    
    
    13,010
    
    
    
    
    
    
    
    13,010Net gain on cash flow hedging derivative
instruments
    
    
    9,489
    
    
    
    
    
    
    
    9,489Other comprehensive income (loss)
    
    ¥
    2,494,676
    
    
    ¥
    
    
    
    ¥
    2,494,676Year ended March 31, 2006:Foreign currency translation adjustments
    
    ¥
    38,331
    
    
    ¥
    
    
    
    ¥
    38,331Unrealized holding gain (loss) on
securities:Amount arising during the period
    
    
    1,046,874
    
    
    
    (429,218
    )
    
    
    617,656Less: Reclassification adjustments for
gains included in net income
    
    
    (3,227,203
    )
    
    
    1,323,153
    
    
    
    (1,904,050
    )Increase in deferred tax asset valuation
allowance*
    
    
    
    
    
    
    (893,935
    )
    
    
    (893,935
    )Net unrealized holding gain (loss) during
the period
    
    
    (2,180,329
    )
    
    
    
    
    
    
    (2,180,329
    )Gain on cash flow hedging derivative
instruments:Amount arising during the period
    
    
    (4,541
    )
    
    
    
    
    
    
    (4,541
    )Less: Reclassification adjustments for
losses included in net income
    
    
    10,008
    
    
    
    
    
    
    
    10,008Net gain on cash flow hedging derivative
instruments
    
    
    5,467
    
    
    
    
    
    
    
    5,467Other comprehensive income (loss)
    
    ¥
    (2,136,531
    )
    
    ¥
    
    
    
    ¥
    (2,136,531
    )
 F-33




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##### Table of Contents



Thousands of YenBefore Tax
    
    
    Tax (Expense)
    
    
    Net of TaxAmount
    
    
    or Benefit
    
    
    AmountYear ended March 31, 2007:Foreign currency translation adjustments
    
    ¥
    11,653
    
    
    ¥
    
    
    
    ¥
    11,653Unrealized holding gain (loss) on
securities:Amount arising during the period
    
    
    (2,277,976
    )
    
    
    933,970
    
    
    
    (1,344,006
    )Less: Reclassification adjustments for
gains included in net income
    
    
    (3,229,899
    )
    
    
    1,324,259
    
    
    
    (1,905,640
    )Increase in deferred tax asset valuation
allowance*
    
    
    
    
    
    
    (2,258,229
    )
    
    
    (2,258,229
    )Net unrealized holding gain (loss) during
the period
    
    
    (5,507,875
    )
    
    
    
    
    
    
    (5,507,875
    )Gain on cash flow hedging derivative
instruments:Amount arising during the period
    
    
    (708
    )
    
    
    
    
    
    
    (708
    )Less: Reclassification adjustments for
losses included in net income
    
    
    4,776
    
    
    
    
    
    
    
    4,776Net gain on cash flow hedging derivative
instruments
    
    
    4,068
    
    
    
    
    
    
    
    4,068Other comprehensive income (loss)
    
    ¥
    (5,492,154
    )
    
    ¥
    
    
    
    ¥
    (5,492,154
    )
 Thousands of U.S. DollarsBefore Tax
    
    
    Tax (Expense)
    
    
    Net of TaxAmount
    
    
    or Benefit
    
    
    AmountYear ended March 31, 2007:Foreign currency translation adjustments
    
    $
    99
    
    
    $
    
    
    
    $
    99Unrealized holding gain (loss) on
securities:Amount arising during the period
    
    
    (19,377
    )
    
    
    7,945
    
    
    
    (11,432
    )Less: Reclassification adjustments for
gains included in net income
    
    
    (27,475
    )
    
    
    11,265
    
    
    
    (16,210
    )Increase in deferred tax asset valuation
allowance*
    
    
    
    
    
    
    (19,210
    )
    
    
    (19,210
    )Net unrealized holding gain (loss) during
the period
    
    
    (46,852
    )
    
    
    
    
    
    
    (46,852
    )Gain on cash flow hedging derivative
instruments:Amount arising during the period
    
    
    (6
    )
    
    
    
    
    
    
    (6
    )Less: Reclassification adjustments for
losses included in net income
    
    
    41
    
    
    
    
    
    
    
    41Net gain on cash flow hedging derivative
instruments
    
    
    35
    
    
    
    
    
    
    
    35Other comprehensive income (loss)
    
    $
    (46,718
    )
    
    $
    
    
    
    $
    (46,718
    )
 
 *
    
    The release (increase) in the deferred tax asset valuation allowance has resulted from
unrealized gains
and (losses) on available-for-sale securities, respectively. F-34




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##### Table of Contents



The components of accumulated other comprehensive income (loss) at March 31, 2006 and 2007 are
as follows:
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2006
    
    
    2007
    
    
    2007Foreign currency translation adjustments
    
    ¥
    5,036
    
    
    ¥
    16,689
    
    
    $
    142Unrealized holding gain on securities
    
    
    6,552,581
    
    
    
    1,044,706
    
    
    
    8,886Gain (loss) on cash flow hedging
derivative instruments
    
    
    (4,023
    )
    
    
    45
    
    
    
    0Pension liability adjustments
    
    
    
    
    
    
    (111,731
    )
    
    
    (950
    )¥
    6,553,594
    
    
    ¥
    949,709
    
    
    $
    8,078
 13.
    
    BASIC AND DILUTED NET INCOME PER COMMON SHARE
 Basic and diluted net income per common share computation for three years ended March 31,
2005, 2006 and 2007 is as follows.
 Thousands ofThousands of Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Numerator:Net income-basic and diluted
    
    ¥
    2,906,269
    
    
    ¥
    4,753,570
    
    
    ¥
    5,409,713
    
    
    $
    46,017
 Number of shares2005
    
    
    2006
    
    
    2007Denominator:Weighted-average common shares
outstanding-basic
    
    
    191,559
    
    
    
    195,613
    
    
    
    203,992Dilutive effect of stock options
    
    
    
    
    
    
    342
    
    
    
    252Weighted-average common shares
outstanding-diluted
    
    
    191,559
    
    
    
    195,955
    
    
    
    204,244
 Yen
    
    
    U.S. Dollars2005
    
    
    2006
    
    
    2007
    
    
    2007Basic net income per common share
    
    ¥
    15,172
    
    
    ¥
    24,301
    
    
    ¥
    26,519
    
    
    $
    226Diluted net income per common
share
    
    ¥
    15,172
    
    
    ¥
    24,258
    
    
    ¥
    26,487
    
    
    $
    225
 For the year ended March 31, 2005, potentially dilutive shares have been excluded from
the computation of diluted net income because the exercise prices of the options were greater
than the average market price of the common shares and the effect of conversion of the
convertible notes would be antidilutive.
 For the years ended March 31, 2006 and 2007, potentially dilutive shares have been excluded
from the computation of diluted net income because the exercise prices of the options were
greater than the average market price of the common shares.
 Diluted net income per share does not include the effects of the following potential common shares:
 Year ended March 312005
    
    2006
    
    2007Shares issuable under stock options
    
    
    2,725
    
    
    
    975
    
    
    
    950
 F-35




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##### Table of Contents



14.
    
    COMMITMENTS AND CONTINGENT LIABILITIESIn December 2001, a class action complaint alleging violations of the federal securities
laws was filed against the Company, naming IIJ, certain of its officers and directors as
defendants, and underwriters of IIJ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 coordinate 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 IIJ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 IIJ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
as to 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. IIJ, 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. The plaintiffs have continued to litigate
against the underwriter defendants. The District Court directed that the litigation proceed
within a number of focus cases rather than in all of the 310 cases that have 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 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 this settlement cannot be approved, because the defined settlement
class, like the litigation class, cannot be certified. The Company
cannot predict whether the Company
will be able to renegotiate a settlement that complies with the Second Circuits mandate. Due
to the inherent uncertainties of litigation, the Company cannot predict the ultimate outcome
of the matter.In addition to the foregoing, the Company is a party to other suits and claims that arise
in the normal course of business. The negative adverse outcome of such suits and claims would
not have a significant impact on the financial statements.On May 29, 2006, IIJ made an agreement for investing in funds which invest in unlisted stocks
mainly in the United States of America, with an investment advisory company. IIJ committed to
provide $5 million for the fund at its request in future several years. IIJ provided $608
thousand for the year ended March 31, 2007. On January 17, 2007, IIJ made another agreement
for investing in funds which invest in unlisted stocks mainly in Europe, Asia and Israel, with
an investment advisory company. IIJ committed to provide $5 million for the fund at its
request in future several years. IIJ provided $140 thousand for the year ended March 31, 2007.On March 29, 2007, IIJ made a contract with Panasonic Network Services Inc. to acquire 100% of
the shares of hi-ho, Inc., which provides internet service under the hi-ho brand and the
solution business to corporate customers. IIJ purchased the shares for ¥1.2 billion ($10
million) with a closing date of June 1, 2007 in the agreement.
 15.
    
    DERIVATIVE AND OTHER FINANCIAL INSTRUMENTSInterest Rate Swap AgreementThe Company is exposed to changes in interest rates that are
associated with long-term bank borrowings. The Companys policy on managing the interest rate
risk is to hedge the exposure to variability in future cash flows of floating rate interest
payments on the long-term bank borrowings. In order to reduce cash flow risk exposures on
floating rate borrowings, the Company utilizes interest rate swap agreements to convert a
floating rate borrowing to a fixed rate borrowing.
 F-36




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##### Table of Contents



The Company is also exposed to credit-related losses in the event of non-performance by
counterparties to interest rate swaps, but it is not expected that any counterparties will fail to meet their
obligations, because counterparties are internationally recognized financial institutions.Changes in fair value of interest rate swaps designated as hedging instrument are reported in
accumulated other comprehensive income during the years ended March 31, 2005, 2006 and 2007.
These amounts subsequently are reclassified into interest expense as a yield adjustment in the
same period in which the hedged bank borrowings affect earnings. The term, notional amount
and repricing date of interest rate swaps exactly match those of the long-term borrowings.
The swap terms are at the market, so they have zero value at inception. Thus, there was no
ineffectiveness recognized in earnings for the years ended March 31, 2005, 2006 and 2007.
For the years ended March 31, 2005, 2006 and 2007, net derivative losses of ¥13,010 thousand,
¥10,008 thousand and ¥ 4,776 thousand ($41 thousand), respectively, were reclassified to
interest expense.¥45 thousand ($0.4 thousand) of accumulated other comprehensive gain related to the interest
rate swaps are expected to be reclassified as an adjustment to interest expense as a yield
adjustment of the hedged bank borrowings within the next 12 months.Fair ValueIn the normal course of business, the Company invests in financial assets and
incurs financial liabilities. To estimate the fair value of those financial assets,
liabilities and derivatives, the Company used quoted market prices to the extent that they
were available. Where a quoted market price is not available, the Company estimates fair
value using primarily the discounted cash flow method. For certain financial assets and
liabilities, such as trade receivables and trade payables, which are expected to be collected
and settled within one year, the Company assumed that the carrying amount approximates fair
value due to their short maturities. For guarantee deposits, which are fully refunded at the
end of lease contracts, the remaining noncancellable lease terms are principally within two
years and the Company assumed that the carrying amount approximates fair value. Investment for
which it is not practicable to estimate fair value primarily consists of investments in a
number of unaffiliated and unlisted smaller sized companies and the estimate of their fair
values cannot be made without incurring excessive costs. Refundable insurance policies are
carried at cash surrender value. The carrying amounts or notional amounts and fair value of
financial instruments are summarized below:
 Thousands ofThousands of Yen
    
    U.S. Dollars2006
    
    2007
    
    2007Carrying
    
    Fair
    
    Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    Value
    
    Amount
    
    ValueOther
investments
for which it is:Practicable to
estimate
fair value
    
    ¥
    6,775,388
    
    
    ¥
    6,775,388
    
    
    ¥
    1,297,694
    
    
    ¥
    1,297,694
    
    
    $
    11,039
    
    
    $
    11,039Not practicable
    
    
    1,245,317
    
    
    
    
    
    
    
    1,544,047
    
    
    
    
    
    
    
    13,134
    
    
    
    Noncurrent
refundable
insurance
policies
(other assets)
    
    
    82,252
    
    
    
    82,252
    
    
    
    115,555
    
    
    
    115,555
    
    
    
    983
    
    
    
    983Long-term
borrowings and
installment
payable,
including
current
portion
    
    
    2,279,963
    
    
    
    2,279,963
    
    
    
    290,000
    
    
    
    290,000
    
    
    
    2,467
    
    
    
    2,467Interest rate
swap contracts*
    
    
    (4,023
    )
    
    
    (4,023
    )
    
    
    45
    
    
    
    45
    
    
    
    0
    
    
    
    0
 
 *
    
    Notional amount was ¥1,150,000 thousand and ¥250,000 thousand ($2,127 thousand) as of March 31, 2006 and 2007, respectively. F-37




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##### Table of Contents



Cash at March 31, 2006 and 2007 includes U.S. dollar denominated current bank deposits of
¥442,169 thousand and ¥372,934 thousand ($3,172 thousand), respectively.
 16.
    
    ADVERTISING EXPENSESAdvertising expenses incurred during the years ended March 31, 2005, 2006 and 2007 related
primarily to advertisements in magazines, journals and newspapers and amounted to ¥151,226
thousand, ¥223,696 thousand and ¥337,768 thousand ($2,873 thousand), respectively.
 17.
    
    RELATED PARTY TRANSACTIONSNTT and its subsidiary owned 29.7 percent of IIJs outstanding common shares as of March 31,
2007.The Company entered into a number of different types of transactions with NTT and its
subsidiaries including purchases of wireline telecommunication services for the Companys
offices. For the Companys connectivity and value added services, the Company purchases
international and domestic backbone services, local access lines and rental rack space in data
centers from NTT and its subsidiaries. The Company sells to NTT and its subsidiaries its
services including OEM services, system integration services and monitoring services for their
data centers.The amounts of balances as of March 31, 2006 and 2007 and transactions of the Company with NTT
and its subsidiaries for the each of the three years in the period ended March 31, 2007, are
summarized as follows.
 Thousands ofThousands of Yen
    
    U.S. Dollars2005
    
    2006
    
    2007
    
    2007Accounts receivable
    
    ¥
    
    
    
    ¥
    366,648
    
    
    ¥
    318,069
    
    
    $
    2,706Accounts payable
    
    
    
    
    
    
    710,322
    
    
    
    664,938
    
    
    
    5,656Revenues
    
    
    1,413,379
    
    
    
    1,394,791
    
    
    
    1,308,843
    
    
    
    11,133Costs and expenses
    
    
    7,672,480
    
    
    
    8,075,542
    
    
    
    7,725,572
    
    
    
    65,716
 As for equity method investees, refer to Note 4,
INVESTMENTS IN AND ADVANCES TO EQUITY METHOD INVESTEES.
 18.
    
    SUBSEQUENT EVENTSOn April 5, 2007, the boards of directors of IIJ, IIJ-Tech and Net Care resolved that IIJ
would make these two consolidated subsidiaries 100% owned through share exchanges and on May, 11, 2007, each of
the companies, including IIJ-FS, a wholly owned subsidiary of IIJ-Tech, became a wholly owned subsidiary of IIJ under an agreement for the share exchanges. In this connection, IIJ issued new 2,178
shares of common stock to the shareholders of these subsidiaries upon the provision of the exchanges of the shares in the
agreement.Prior to the share exchanges, IIJ purchased the shares of IIJ-Tech and Net Care from their minority
shareholders for ¥1,635 million ($14 million) and ¥340 million ($3 million), respectively, resulting
to increases in IIJs interests in IIJ-Tech and Net Care to 95.2% and 92.5%, respectively, as of April 5, 2007.On June 1, 2007, IIJ purchased all shares of hi-ho, Inc. (hi-ho) for ¥1,200 million ($10 million), which was
a wholly owned subsidiary of Panasonic Network Services Inc. (PNS) and is operating the ISP business
provided by PNS under the hi-ho service brand and the solution business to corporate customers, based on
a resolution of the board of directors of IIJ made on March 29, 2007.On June 26, 2007, IIJs shareholders approved the payment of cash dividend to shareholders of record at
March 31, 2007 of ¥1,500 ($13) per share or in the aggregate amount of ¥306,450 thousand ($2,607 thousand).
  F-38