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Below are the main factors that could impact IIJ Group’s results of operations, financial condition, and cash flow as well as investors’ decision making. Unless otherwise stated, the forward-looking statements described below are based on our expectations, assumptions, estimates and projections as of this document’s filing date. As the statements include uncertainties, actual results may differ from those contained or suggested herein.
*The following information was quoted from our English translation of our annual report "Yuka-shoken-houkokusho" for the fiscal year ended March 31, 2020 which was disclosed on June 30, 2020.
Our business is principally conducted in Japan and most of our revenues are from customers operating in Japan. For the fiscal year ended March 31, 2020, approximately 96% of our total revenues were from customers operating in Japan. If the Japanese economy deteriorates and that results in lower levels of network and systems related investment and expenditures, customers may respond to such conditions by prioritizing low prices over quality. We may experience severe price reduction pressure and/or cancellation of large accounts. Systems integration in particular tends to be very sensitive to the economic situation in Japan as well as demands for IT investments. Our results of operations and financial condition could be significantly impacted and we may not be able to maintain our current level of revenues and income and/or achieve our expected levels of revenues and income and so be unable to pay target cash dividends if customers’ demand does not expand as expected due, for example, to the economic situation or decreases in investment appetite, or if we fail to differentiate ourselves over service quality, or fail to keep up with rapidly
changing market trends which could lead to price competition and cancellation of contracts.
Our basic strategy is to provide reliable and value-added enterprise network services and systems integration together to mainly enterprises and central government agencies that use networks for their business by leveraging our technology related to Internet. We may not be able to exercise our business strategies according to plan if we fail to maintain our competitive technological advantage or develop and provide network services or systems integration that differentiates us from competitors.
Costs of enterprise network services mostly consist of circuit costs, depreciation costs, personnel costs, outsourcing costs, and office rent costs, which are not directly linked to revenue fluctuations. These costs tend to increase gradually along with new service development, facility expansion, or employee increase. We may not be able to cover the current network costs and/or an increase in such costs, which could result in profit decrease, if, for example, we experience cancellations (whole or partial) or severe pricing pressure for our enterprise network services as well as systems operation and maintenance, which are recurring services, by clients, especially large clients, or if revenue does not increase as planned. For the fiscal year ended March 31, 2020, WAN service revenue decreased JPY4.0 billion from the previous fiscal year as certain large clients connecting multiple sites through private connectivity switched to mobile services.
Costs of cloud computing services of which is recognized as systems operation and maintenance is mostly consisted of depreciation costs, license costs, personnel costs, outsourcing costs, and office rent costs. These upfront costs tend to increase due to expansions of service facilities, new service developments, and increases in personnel. We may not be able to cover the current cloud computing services’ costs and/or an increase in such costs, which could result in profit decrease, if we fail to accumulate cloud computing service revenues as planned, due, for example, to weak demand and/or slow migration to cloud, or if we experience cancellations (whole or partial) or severe pricing pressure.
As for consumer network services, compared to enterprise network services, its market trends rapidly change and revenue and income volatility tends to be large. Due to our limited brand recognition among consumers, in addition to direct sales, we leverage indirect sales channels such as sales partners and MVNE through which we provide our services to other MVNOs to grow consumer mobile services. We may not be able to maintain or expand our revenue and operating profit according to plan if, for example, we fail to acquire customers according to our plan, if we are forced to lower our prices due to competition, if the number of our sales partners and MVNE clients as well as their business transactions do not increase but decrease, if our creditability is damaged due to service problems, if we are faced with greater than expected amount of communication service costs such as interconnectivity charge and data communication charges and depreciation costs in order to maintain service quality, or if the unit price of interconnectivity charges by mobile carriers for mobile infrastructure does not decrease as much as expected and thus creates a gap between our estimates and the actual results.
Regarding IIJ Group’s SG&A expenses, personnel-related expenses, office rent expenses, sales commission expenses, commission expenses, advertising expenses and others have been increasing every year along with business developments. They could increase more than expected. Also, if gross profit of network services, systems integration, and ATM operation business do not increase or rather decrease, we may be faced with profit deterioration as increasing SG&A expenses cannot be absorbed.
We have been aggressively investing in new businesses, services and solution developments to further grow our business over the medium to long term. Such investments include an increase in human resources, acquisition of network equipment and capital expenditures including software development. As for the number of employees, we had 3,353 and 3,583 employees as of March 31, 2019 and 2020 respectively. The number of employees increased by 150 and 230 in the fiscal years ended March 31, 2019 and 2020 respectively. Capital expenditures, including assets acquired by finance leases, for the fiscal years ended March 31, 2019 and 2020 were JPY15,083 million and JPY15,150 million respectively. Depreciation and amortization for property and equipment (capital expenditure related depreciation and amortization) for the fiscal years ended March 2019 and 2020 were JPY13,867 million and JPY14,422 million respectively.
We started providing cloud services from December 2009 and have been continuously investing in data centers, servers, storage, network equipment, and software in order to meet customers’ demand, as well as to continuously enhance service functions. Along with our investment, costs such as depreciation and amortization have been increasing. Revenues for our cloud computing services for the fiscal years ended March 31, 2019 and 2020 were JPY20.1 billion and JPY23.6 billion, respectively. Capital expenditures related to domestic cloud computing services were JPY1.9 billion and JPY2.6 billion for the fiscal years ended March 31, 2019 and 2020 respectively.
In order to meet housing needs, including cloud computing service facilities that are expected to grow along with business expansion, as well as to integrate service facilities currently spread out across eastern Japan, we constructed our own system module type data center in Shiroi City, Chiba Prefecture and started operating its first phase data center facility from May 2019. Capital expenditures related to this data center facitilies were JPY2.1 billion and JPY2.0 billion for the fiscal years ended March 31, 2019 and 2020, respectively and the capital expenditures are expected to increase along with placement of system modules.
We have been providing mobile services to both enterprises and consumers from January 2008 by purchasing mobile network infrastructure mainly from NTT Docomo, as an MVNO. The total (sum of enterprise and consumer) mobile services revenues for the fiscal years ended March 31, 2019 and 2020 were JPY42.0 billion and JPY46.1 billion respectively. The total number of mobile service subscription was approximately 2.74 million and 3.03 million as of March 31, 2019 and March 31, 2020 respectively. Along with mobile services revenue growth and subscription growth, we need to increase the contracted mobile bandwidth we purchase from NTT Docomo and others. Along with our service launch of full MVNO services in March 2018, we had additional fixed cost for our network services, consisting mainly of depreciation costs for our Home Location Register (HLR) and Home Subscriber Server (HSS) systems, and the accumulation of monthly payments to NTT Docomo for network remodeling. Full MVNO service revenues for the fiscal year ended March 31, 2019 and 2020 were JPY0.7 billion and JPY1.4 billion. The revenue growth has been absorbing such fixed cost increase.
We have been enhancing our overseas business developments such as network services including cloud services and systems integration to meet mainly network and systems demands of Japanese companies heading overseas to seek business opportunities. As of the filing of this document, we have 10 overseas consolidated subsidiaries and two overseas equity method investees. In addition to the existing subsidiaries in Singapore, Thailand, China, Hong Kong, Indonesia and Vietnam, we may obtain more subsidiaries by establishing new companies and/or by co-working with local companies to seek greater business opportunities, as the need for IT is stronger in these regions compared to the United States and Europe. Our overseas business is smaller than our domestic business. Overseas business revenues for the fiscal years ended March 31, 2019 and 2020 were JPY7.7 billion and JPY8.5 billion, respectively. As for income, operating profit was JPY0.1 billion and JPY0.3 billion for the fiscal years ended March 31, 2019 and 2020, respectively. IIJ and IIJ-Global together had injected capital of JPY4,512 million into our overseas consolidated subsidiaries and equity method investees by the fiscal year ended March 31, 2020. Also, as of March 31, 2020, IIJ and IIJ-Global together had lent a total of JPY222 million to four of our overseas consolidated subsidiaries. We may establish overseas subsidiaries in other regions and add overseas offices by working together with local companies. The overseas business, compared to the domestic business, is exposed to various uncertainties including regulatory, economic, religious, cultural, geopolitical, and diplomatic risks. Although we strive to comply with the necessary regulations, failure to comply with foreign regulations such as the U.S. Foreign Corrupt Practices Act (“FCPA”) or failure to appropriately comply with local regulations due to inadequate internal control could impose a negative impact on our business.
Our consolidated subsidiary, Trust Networks is in charge of ATM operation business, which operates bank ATMs and the related network systems and receives a commission for each bank withdrawal transaction. Along with ATM placement, we continuously acquire ATMs as written in “PART 1. Information on the Company, Item 2. Business Overview, 2. Risk Factors, 3.Risk regarding our group operation (2) Risks regarding group management.” As for the fiscal year ending March 31, 2021, ATM operation business revenue and profit is expected to decrease because the number of placed ATMs to decrease due to certain clients’ matter and the number of ATM withdrawal transaction is expected to decrease year over year due to COVID-19 related store closure as well as request to refrain from going outside unless necessary.
We rely on telecommunications carriers such as NTT Communications and KDDI for our network backbone, NIPPON TELEGRAPH AND TELEPHONE EAST CORPORATION (“NTT East”), NIPPON TELEGRAPH AND TELEPHONE WEST CORPORATION (“NTT West”), and KDDI for local access lines for customers; and NTT Docomo and KDDI for mobile connectivity as an MVNO. We procure a significant portion of our network backbone and data center facilities pursuant to operating lease agreements with NTT Group, our largest provider of network infrastructure. For the fiscal year ended March 31, 2020, 48.6% of our domestic backbone cost was through NTT Communications and most of our mobile connectivity was through NTT Docomo.
We depend on third-party suppliers for the purchase of our network equipment, such as routers to be used for our network, mainly from certain U.S. companies. While we do not currently have any significant concerns over the equipment we procure from thirdparty vendors, if there arises any concerns such as security-related issue which make us difficult to use them, we may need to procure substitute equipment.
We lease most of our service facilities, such as data centers and office facilities, from third-party vendors. If costs of electricity suddenly increase and we are unable to renegotiate price increases with data center owners, if we fail to pass such price increases on to our customers, or if the supply of electricity becomes unstable or inadequate, we may be forced to pay additional costs to acquire electricity.
Although no such incident has occurred, if suppliers of telecommunication lines, network equipment, and service facilities for which we depend on third-party vendors are not provided, are faced with supply difficulties or fail to deliver within an appropriate period of time, we may experience service interruptions for long hours, or we may not be able to provide services. In such a case, our results of operations and our financial condition could be negatively impacted.
In order to maintain and improve the quality of our service offerings, we may need to increase investment in servers, network equipment, and software, or increase leasing volume of data communications, as well as infrastructure, beyond expectations. Although we believe we have been appropriately managing our service facilities, if we fail to appropriately manage our service facilities, leading to deterioration of service quality, or fail to differentiate our services from competitors, or if we need to make greater facility investment than expected or if we invest excessively, our results of operations and our financial condition may be significantly adversely impacted.
Interruptions, errors, or delays with respect to our backbone network or service facilitates may be caused by natural factors such as fires and earthquakes, power shortages, power losses or interruptions, errors or delays with carriers’ service facilities, or terrorism, which are beyond our control. Although we implement necessary measures to avoid serious security incidents, we may be prevented from providing our services due to cyber-attacks, computer viruses, human error, or unintentional or intentional interruption by Internet users. Although no such incident has occurred and our backbone and service facilities are designed with fault tolerance, if we damage our creditability or business opportunities due to failure to continuously provide services, our results of operations or financial condition may be significantly adversely impacted.
We store and manage confidential information related to mobile services and trade secrets obtained from customers in Japan and abroad. We pay attention to protecting the confidentiality of such information and take steps to ensure the security of our network, in accordance with the guidelines regulated by the Ministry of Internal Affairs and Communications as well as the Ministry of Economy, Trade, and Industry. If unauthorized access, human operation error, leakage, loss, alteration, or unauthorized utilization of customer information take place and if we fail to appropriately respond to such issues which would lead to a deterioration in our creditability or compensation for damages, our results of operations and our financial condition could be adversely impacted. Foreign countries have been enhancing their regulations regarding data protection of personal information including the General Data Protection Regulation (GDPR) in the European Union. Regarding GDPR, our consolidated subsidiary, IIJ Europe Limited, submitted its Binding Corporate Rules, internal rules defining the global policy regarding personal data protection within the IIJ Group, to the office of the UK’s Information Commissioner and has been working to receive approval. Although no such incidents has occurred, if we fail to comply with these foreign countries’ regulations unintentionally and are asked to pay a penalty, then this could ultimately result in an adverse effect on our business, financial condition and results of operations.
The telecommunications market, including the Internet, is characterized by rapidly changing technology, industry standards, customer needs, and competitive landscape regarding the frequent introduction of new products and new services. Under such conditions, our existing services may become less appealing. Although we focus on technology research and development to keep a competitive technological advantage, if we fail to obtain access to new or important technologies or to develop and introduce new services and enhancements that are compatible with changing industry technologies, standards, and customer requirements, or if more time and expenses are needed for research and development activities, our financial condition and results of operations could be significantly negatively impacted.
Pricing competition for network services, as well as systems integration, is severe. Thus, competitors enhance service development and marketing. If price competition becomes more extreme, revenue for network services and systems integration may not increase according to plan, profitability could deteriorate, or we may incur large costs or expenses. Such probability is always present, our results of operations as well as financial condition could be adversely impacted.
Network-related costs mostly consist of fixed type costs, such as circuit-related costs of backbone, network equipment-related costs, network operation costs for network operation centers, and personnel-related costs to conduct network operation. Volatility of these costs may impact our financial situation and results of operations negatively. If we experience rapid expansion of Internet traffic, if circuit-related costs increase due to an increase in unit price for backbone network, if we are required to procure a greater than expected volume of network capacity, if we fail to procure the necessary network capacity, or if we contract more network capacity than we actually require to service our customers, our financials and results of operations may be adversely impacted. Payment for international circuit and network equipment is made with foreign currency and Japanese yen-based payment is based on foreign currency.
In order to provide mobile services, we lease mobile infrastructure from mobile carriers such as NTT Docomo. We pay them interconnectivity fees, a wholesale telecommunication service charge, calculated based on the “Telecommunications Business Law” and the “Interconnection Rules for Category II Designated Telecommunications Facilities,” which are both administrated by the Ministry of Internal Affairs and Communications, multiplied by our leasing mobile bandwidth. The unit price of wholesale telecommunication service charge is revised annually and has been decreasing. Until the fiscal year ended March 31, 2020, the unit price used for the fiscal years ended March 31, 2019 and 2020 was fixed in March 2020 and we recognize difference between our estimated and actual figures as cost fluctuation when the unit price is fixed. Beginning from the fiscal year ending March 31, 2021, under the future cost method applied, we recognize interconnectivity fee based on mobile carriers’ predicted figures and when the unit charge is fixed, we may recognize difference between such predicted and actual figures. How much we pay to mobile carriers is to increase along with increases in subscriptions and mobile traffic. Our results of operations could be impacted if the unit price increases or does not decrease as much as expected or if we are required to lease greater than expected mobile bandwidth.
We use outsourced personnel. If the unit price of outsourced personnel increases, if we fail to appropriately manage outsourcing resources, if we fail to accumulate adequate revenue volumes to meet outsourcing costs, or if we fail to procure the necessary volume of outsourcing resources, our financial situation and results of operations may be negatively impacted.
The major competitors of our network services are major telecommunications carriers such as NTT Communications, KDDI Corporation and their affiliates. The major competitors of our systems integration business are system integrators such as NEC Corporation, Fujitsu Limited, NTT Data Corporation and their affiliates. Our competitors have advantages over us, including, but not limited to, substantially greater financial resources, larger pools of technology human resources, higher brand recognition, and larger customer bases. Our competitors may be better able to sustain downward pricing pressure, provide services that IIJ does not offer, and pursue competitive M&A transactions. The sales strategy and pricing strategy of our competitors may impact the market our group belongs to, and if we fail to effectively differentiate ourselves from competitors and fail to execute our business strategy as planned, our financial results and financial condition may be negatively impacted.
The major competitors of our cloud computing services are the companies listed above as well as global players such as Amazon Web Services, Inc. and MICROSOFT CORPORATION. These competitors may put additional business resources into cloud services and outsourcing related businesses. If we fail to successfully differentiate our services and solutions from those of our competitors, we may not be able to achieve expected future revenue and income, or we may not recoup our investment in cloud computing services, which may adversely affect our financial condition and results of operations.
The major competitors of our mobile services including MVNE and the consumer mobile business, are mobile carriers such as NTT Docomo, KDDI, Softbank Corp., their affiliates as well as MVNOs. Many of these competitors have higher brand recognition among consumers and greater financial resources, which enables them to implement more extensive and well-developed marketing and low-price strategies. Competition, including with new competitors entering the market, may become tougher. Under such circumstances, a failure to differentiate our services from those of competitors could impact our results of operations and our financial condition negatively.
Our group competitive landscape with NTT Group is discussed in later sections of this document under "Risks regarding relationships with NTT Group"
Force majeure such as natural disaster, blackout, terrorism, and pandemic infectious diseases may make it difficult for us to provide services reliably, may require us to recognize cost and/or investment more than expected, and may make it difficult to execute group strategy as planned. In such a case, our results of operation and financial condition could be significantly adversely impacted.
The expertise of IIJ’s as well as each group company’s management is very important in executing business. Also, reliable service offering depends on the continuous contributions of our engineers and other staff. The number of employees and personnel-related expenses have been increasing along with our business expansion. We need to procure the appropriate number of engineering, sales and business planning and administrative personnel at the appropriate timing. If we fail to acquire or retain the members of management or staff needed for business, if we fail to appropriately control personnel-related expenses due, for example, to greater than necessary recruitment, or personnel-related expenses increase more than expected due to the labor market climate, as well as regulation changes, our results of operations and financial condition may adversely impacted.
We aim to operate by bringing consolidated subsidiaries as well as equity method investees closer to create group synergy. In order to create close business relationships, our group directors and employees take concurrent positions as group company directors, and we also send employees to our group companies. As of this document’s filing date, we have 16 consolidated subsidiaries and nine equity method investees. Profit and loss of each consolidated subsidiary’s financial results are consolidated into our group consolidated financial statements, and each equity method investee’s financial results are recorded as share of profit (loss) of investments accounted for using the equity method. Due to each company’s business situation, the investment value of subsidiaries and associates held by us can fluctuate. If profit and loss of our subsidiaries and associates is unfavorable, or volume of loss is significant, our results of operations and our financial condition may be adversely impacted.
IIJ’s substantial investment in Crosswave, IIJ’s former equity method investee, became worthless due to Crosswave’s commencement of corporate reorganization proceedings in August 2003. As a result of this, we recorded losses on, equity in net loss of Crosswave, investment, restraint deposit and loan, of JPY12,667 million and JPY1,720 million for the fiscal years ended March 31, 2003 and 2004, respectively.
We bought IIJ Global, which mainly provides WAN services, from AT&T Japan LLC for JPY9,170 million and made it our consolidated subsidiary in October 2010. For the fiscal years ended March 31, 2019 and 2020, IIJ Global had JPY30,073 million and JPY26,103 million in revenues, respectively, and JPY713 million and JPY1,020 million in operating profit, respectively. Intangible assets as of March 31, 2020 related to IIJ Global were JPY3,336 million. If IIJ Global fails to accumulate expected future revenue and profit and is concluded to be lacking in value compared to its goodwill and intangible assets, we may incur an impairment loss on such assets.
Trust Networks Inc., our consolidated subsidiary established in July 2007, operates bank ATMs and related network systems and receives a commission for each bank withdrawal transaction. As of the filing date of this document, we have invested a total of JPY2,575 million (IIJ ownership 79.5%). ATM operation business segment revenue was JPY4,152 million and JPY4,081 million and operating profit was JPY1,623 million and JPY1,645 million for the fiscal years ended Mach 31, 2019 and 2020 respectively. Business operation might be difficult for Trust Network if the number of ATMs or users decreases, if the number of ATM transactions decreases, mainly due, for example, to a decrease in user appetite and store closure, or if it fails to maintain favorable relationships with related parties.
In December 2016, we established JOCDN Inc., which provides CDN services as a joint venture. Japan Broadcasting Corporation (NHK) and WOWOW Inc. became JOCDN’s shareholders through the third-party allotment in the fiscal year ended March 31, 2020. As of this document’s filing date, we have invested a total of JPY142 million (IIJ ownership: 16.8%).
In January 2018, we established DeCurret Inc., (“DeCurret “) which provides digital currency exchange and settlement services as a joint venture. In March 2019, DeCurret became a licensed crypto-asset exchange service provider, launched crypto-asset exchange services from April 2019 and leverage trading services from August. As of this document’s filing date, we have invested a total of JPY5,082 million (IIJ ownership: 41.6%). DeCurret is still in start-up phase and if their business does not expand as planned, their enterprise value may be damaged, record more than expected equity method investment loss, they may need additional capital injection and others. In such a case, IIJ Group’s results of operation and financial condition may be adversely impacted.
In order to continuously maintain or enhance group synergy, we may increase our ownership of group companies, provide financial support, give guarantees, or reorganize group structure. We may seek to establish new group companies or execute capital participation to launch new businesses. We may seek out capital transactions, including M&As, in order to expand our scale of business, customer base, and service line-ups. We may need to engage in capital funding or issue ordinary shares to execute capital strategies. Also if IIJ Group’s business operation is constrained due to certain regulations particular to the subsidiaries and/or affiliated companies, IIJ group’s results of operation and financial condition may be adversely impacted.
As for equity method investees over which we do not have total control, if their business strategies becomes different from ours and our consolidated subsidiaries, our business interests may differ from theirs. Thus, we may not be able to pursue group synergy.
Our capital transactions with NTT and NTT Communications include NTT participation in rights offerings to enhance our capital structure in January 1996, establishment of INTERNET MULTIFEED CO. with NTT in September 1997 (later, the shareholder became NTT Communications due to reorganization of NTT Group), and third-party allotment, mainly NTT and NTT Communications, in September 2003 in order to offset the commencement of corporate reorganization proceedings of Crosswave, our former equity method investee. NTT is our “other related company” and as of March 31, 2020. NTT and NTT Communications together own 26.9% of our voting rights.
As of this document’s filing date, our board of directors consists of 13 directors, including five outside directors, among whom Shinobu Umino worked for NTT. Mr. Umino is responsible for monitoring our business execution as our outside director, and there is no arrangement or business interest such as capital or business transactions, for him to work as our outside director.
We use services provided by NTT East and NTT West for a significant portion of access circuits, services provided by NTT Communications for a significant portion of IIJ’s domestic and international backbone circuits, and services provided by NTT Docomo for a significant portion of mobile communication lines and facilities to provide Internet connectivity services and other services to our customers. For the fiscal year ended March 31, 2020, the aggregated amount paid for these services was JPY36,228 million.
We have lease transactions with lease companies to procure facilities and as of March 31, 2020, we had JPY2,535 million of finance lease obligations with NTT Finance Inc.
The business relationship with NTT Group is within the ordinary course of business. There is no special arrangement due to NTT ownership of us.
Within NTT Group, there are NTT Communications, NTT Docomo, NTT DATA Corporation, NTT Security, NTT PC Communications and NTT Plala Inc., which provide network services as well as system integration services similar to ours.
While we recognize that our business may compete against these NTT Group companies for some projects, we operate our business independently from NTT Group, and there is no negotiation of any kind when it comes to competition against NTT Group.
Volume and timing of revenue and operating profit recognition depend on the economic situation in Japan; Japanese companies’ appetite for IT; the revenue accumulation status of network services revenue, which is recurring revenue; the number of systems integration projects and their profitability; profitability of cloud computing services and mobile services; overseas business developments; trends in the network-related costs for network services; differences between the actual and estimated rate of decrease in regard to unit price for mobile interconnectivity charges; trends in depreciation and amortization; absence and/or volume of impairment on tangible assets, goodwill, and intangible assets; and impact from capital transactions including M&As. Volume and timing of profit before tax and recognition of profit attributable to owners of the parent are related to the volume of finance income and finance costs, fluctuations in share of profit (loss) of investment accounted for using the equity method related to equity method investees, recognition of income tax expense including tax effect, and profit (loss) attributable to non-controlling interests,
in addition to fluctuations in operating profit. Therefore, our annual, semi-annual, and quarterly financial results may not work as guidelines for future earnings outlook.
Our financial results may differ from disclosed financial targets not only due to risk factors but also other factors. In fact, we timely revised and announced our disclosed financial targets for the fiscal years ended March 31, 2014, 2015, 2017, and 2020. Investments and increases in cost for development of new services and businesses could impose volatility on results of operations as the corresponding revenue volume and timing are difficult to predict and easy to change.
Revenue for systems integration is comprised of one-time revenue for systems construction, which includes equipment sales, and recurring revenue for systems operation and maintenance. Generally speaking, transactions regarding systems integration and equipment sales are concentrated at the end of March, which is a fiscal year-end month for many Japanese companies. Fluctuations in our quarterly revenue and profit heavily relate to systems integration, and the volume of revenue and profit tend to be the largest in the fourth quarter. Our results of operations, financial condition, and fluctuations of these may be impacted by our ability and the timing of when we recognize revenue and profit of systems integration, especially for the revenue recognition timing and profitability of large systems integration projects.
While we can expect to record recurring revenue for systems operation and maintenance, revenue and profitability of systems integration could fluctuate due, for example, to the number of new construction projects, as well as the terms and conditions of systems operation and maintenance contracts when renewed. The hardware portion of systems construction revenue may be replaced with cloud computing service along with the general trend of migration to cloud computing service-based systems from on-premise systems, which could cause our revenue volume to fluctuate. Large systems construction projects tend to require a longer time to completion, which is when revenue is recognized, and require more precise project management. Also, large construction projects tend to have lower profitability as competitive pricing is required to receive orders. Projects could become unprofitable if we fail to appropriately execute project management due, for example, to system problems, changes in system requirements, or unexpected utilization of engineers. We use outsourced personnel for systems integration. If the unit price for outsourced personnel increases, if we fail to manage outsourced resources, or if we fail to recognize adequate revenue to meet outsourcing costs, this could lead to failure to achieve appropriate profit levels and/or projects could become unprofitable. In these cases our results of operations and financial condition could be adversely affected. If we fail to appropriately procure the engineers or personnel, including outsourced resources assigned for software development, needed to complete systems integration projects, the revenue recognition timing may be delayed or orders may be cancelled. Also, if we fail to appropriately manage clients’ data, we may be sued.
We own network equipment; severs; construction, such as data centers; and assets such as software related to business mainly for network services and systems integration as well as back office systems and office facilities. We conduct impairment testing on these tangible and intangible assets if significant changes in business circumstances indicate that these may be recorded as impairment losses.
We may record intangible assets such as goodwill and assets related to customer relationships on our consolidated balance sheets through capital transactions such as M&As. As of March 31, 2020, the total balance of our goodwill on our consolidated balance sheets was JPY6,082 million. The intangible assets that are subject to amortization such as customer relationships was JPY1,969 million. On our consolidated balance sheets as of March 31, 2020, intangible assets in relation to IIJ-Global and IIJ Technology Inc. (“IIJ-Tech”), a former subsidiary of IIJ which was merged in April 2010, were JPY1,048 million and JPY922 million, respectively. Although we have never recorded impairment loss on goodwill and customer relationships, if significant changes in business circumstances indicate that they may be impaired, we may conduct impairment testing and record loss as a result.
We recognize that it is important for us to have more resources such as but not limited to, human resources, customers, application layer technology, and overseas business foundations, as well as to create synergistic effects to increase the scale of our business. The mergers and acquisitions transactions may not always be on good terms and conditions, bear the results we expect, or have synergistic effects. Although no such incident has occurred, we may incur a large loss of goodwill and exhaust time and our resources through mergers and acquisitions.
We invest in non-affiliated companies in order to further enhance our business relationships, in available-for-sale equity securities for fund management, and in funds which invest mainly in unlisted stocks. The breakdown of our investment securities held recorded on our consolidated balance sheets as other investments as of March 31, 2020 was JPY5,163 million of available-for-sale securities, JPY1,488 million of nonmarketable equity securities, and JPY2,348 million of investments in funds. We may continue to acquire new investment securities. The value of our investment securities held fluctuates due, for example, to market value, as well as business situation. The fluctuation of such fair value is recognized as either comprehensive income (loss) or profit (loss). As for available-for-sale-equities held, their fair values are measured as equity instruments through other comprehensive income, unrealized profit (loss) of holding available-for-sale-equities due to fluctuation of fair value or realized profit (loss) (post-tax effect) due to a sale that will not be recognized as profit (loss) on the consolidated statement of profit and loss. It is not certain that we will be able to sell our investment securities held on favorable terms. Our results of operations and financial condition may be adversely impacted by the price of such investment securities sold, as well as the timing
IIJ, as well as some IIJ Group companies, completed of telecommunication business notifications to the Ministry of Internal Affairs and Communications (MIC) and operates in accordance with the Telecommunications Business Act. If we are said to have failed to protect the privacy of communications within our business operation or to have improper business operation procedures, that could cause the Minister for Internal Affairs and Communications to order us to improve such business operation procedures.
As IIJ is a notified telecommunication business operator, compared to those operators who need to register with the MIC, supervision is relatively lax. However, the Telecommunications Business Act specifies that an operator that is designated by the Minister for Internal Affairs and Communications that provides reliable services to citizens may be given similar regulations to those required of registered telecommunications carriers. As of this document’s filing date, IIJ is not designated; however, the possibility of becoming designated in the near future has been increasing. After being designated, stronger supervision by regulators is expected, and if we fail to appropriately execute business matters, we could be ordered to improve our methods.
Additionally, in order to protect users, telecommunication business operators and their sales partners (brokers and other outsourcing resources) are subject to carry, for example, the obligation to explain important matters, the system to cancel initial contracts, and the obligation to observe sales partners’ operation, which are set forth by the Telecommunications Business Act. In addition to these, in order to create fare competition for mobile service market, there have been various regulations in placed in 2019 when offering mobile phones. If we or our sales partners are said to have improper business operations, we may be asked to disclose our names to the public and take measures to improve them.
If we are asked to take measures to improve our practices, our results of operation and financial condition could be adversely impacted because of costs needed to take such actions and/or damage on corporate image.
A number of regulations related to the usage of Internet already exist. However, arguments on the need for stricter regulations, including enhancement of measures against illegal and harmful information trading over Internet, stricter user identification, and protection of youth, have continuously been made. A regulation could be made requiring telecommunications operators to impose counter measures. Depending on such requirement, a large amount of cost or facility investment could be necessary to comply.
As Internet usage becomes diversified and related players become more complex, there have been cases where interpretation of privacy of communications, which is based on the existing regulations, imposes difficulties when trying to prevent infringement of the rights of third-party vendors. Although no such incident has occurred, we may fail to appropriately implement counter measures related to these issues and damage our creditability, or clients could stop making new investments as our understanding of regulations is unclear.
Regarding our consumer business, which comprise certain portion of our total business, in addition to the above mentioned Telecommunication Business Act, the business is subject to consumer protection related laws such as the Act against Unjustifiable Premiums and Misleading Representations. If we or sales partners fail to comply, our results of operations and financial condition could be adversely impacted because of fines from regulators, other than the MIC, demands for legal responsibility, or damage to corporate image.
Moreover, if regulations related to our business are newly enacted or enforced more strongly, flexibility and promptness in our business execution may be weakened or our service offerings may be constrained due to our clients’ usage of our offered services.
We have affiliated companies both in Japan and overseas. Although we strive to comply with each foreign country’s regulations,depending on counties, interpretation and operation of such regulations could be unclear, thus we may unintentionally fail to comply and be pointed out about it. In such a case, our results of operations and financial condition may be adversely impacted.
Also, among foreign country’s regulations, there are cases in which such compliance requirements are not limited within such country’s domain, but rather apply to the entire entity. For example, if we fail to comply with the FCPA and GDPR of EU, we could be ordered to pay fines as a penalty.
Although we strive not to infringe on third-party patents and other intellectual property, should we fail in those efforts, we may be faced with damage claims. Also, if a crucial part of our fundamental technology is understood to have a third-party patent, or in the future a third-party is given the patent to such technology, we may be required to pay license fees to the third-party with patent in order to execute our business.
We aggressively apply open source software when developing and operating services; however, terms and conditions for open source software impose some issues, such as unclarity surrounding licenses, which could cause unexpected restriction on application.
While we impose appropriate measures to protect our intellectual property and will do so continuously, it is difficult to completely remove risks of a third-party infringing on our intellectual property rights. In such a case, our results of operations and financial condition may be adversely impacted.
As of this document’s filing date, there are no cases pending which would have a significant financial impact on us; however, we cannot be certain that we will not be named as a defendant in a future lawsuit including damage claims due, for example, to service interruption; delays in completion or contractual nonconformity for systems integration; infringement of a third-party’s rights to intellectual property; leaks or defects of clients’ data, including personal information; improper attitudes towards clients; or improper treatment of employees or stocks.
If any judgment should be made against us in such a lawsuit, or should our creditability be damaged, our results of operations or financial condition could be adversely impacted.
As of March 31, 2020, our cash and cash equivalents were JPY38,672 million, increased by JPY6,714 million from the previous fiscal year end. Our bank borrowings as of March 31, 2020 were JPY27,750 million, increased by JPY1,000 million from the previous fiscal year end. Our finance lease obligation including current portion as of March 31, 2020 was JPY18,063 million, increased by JPY29 million. As of March 31, 2020, the balance of other financial liabilities related to operating lease recognized along with the adoption of IFRS 16 was JPY34,591 million.
Our investment in facilities has been increasing. We plan to continuously allocate more capital in the future for network facilities, cloud computing services-related facilities, investments and expenses needed for maintenance, updates and expansion of back office-related facilities, investments and expenses needed for service development as well as operation and business development, investments and expenses related to our own data center construction, expansion of office space along with human resources expansion, increases in operating capital along with business expansion, capital injections and/or loans for business expansion as a group, funds for M&A transactions, etc. We mainly use lease transactions when purchasing network equipment. Due to changes in the business climate, we may be faced with greater than expected funding needs for fund raising, including future lease transactions for our business operation. There is no guarantee that we can execute such transactions on favorable terms and conditions which could impose restrictions on our business development.
IIJ issued 4,700,000 new shares of common stock by way of a public offering in July 2013 and 700,000 new shares by way of a third-party allotment in connection with a secondary offering of shares by way of an over-allotment in August 2013. For future strategic mergers and acquisitions transactions and/or large-scale business investments, we may choose to raise additional funds from the issuance of equity shares of IIJ’s common stock or securities convertible into IIJ’s common stock, in which case existing shareholders may incur substantial dilution.
Stock compensation-type stock options are allocated to directors and executive directors of IIJ (excluding part-time and outside directors) as a substitution for the planned retirement allowance.
In June 2020, IIJ allocated restricted stocks compensation to directors and executive directors of IIJ (excluding part-time and outside directors) as a substation for a part of bonus. IIJ may allocate restricted stocks compensation in the future depending on earnings results.
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