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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED JULY 31, 1998 OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-27898
IDT CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 22-3415036
(I.R.S. Employer Identification No.)
(State or other jurisdiction of
incorporation and organization)
190 MAIN STREET
HACKENSACK, NEW JERSEY 07601
(Address of principal executive offices, including zip code)
(201) 928-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01 per share
(TITLE OF CLASS)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price of the Common Stock on October 27, 1998
of $16.625, as reported on the Nasdaq National Market, was approximately $370
million (assuming the conversion of all of the Company's shares of Class A
Common Stock into Common Stock). Shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common
Stock (assuming conversion of the Registrant's Class A Common Stock), have
been excluded from this computation, in that such persons may be deemed to be
affiliates of the Registrant. This determination of affiliate status is not
necessarily a conclusive determination for any other purpose.
As of October 27, 1998, the Registrant had outstanding 23,159,414 shares of
Common Stock, $.01 par value, and 10,144,396 shares of Class A Common Stock,
$.01 par value.
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INDEX
IDT CORPORATION
ANNUAL REPORT ON FORM 10-K
PAGE
NO.
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PART I
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 27
Item 3. Legal Proceedings............................................. 28
Item 4. Submission of Matters to a Vote of Security Holders........... 29
PART II
Market for Registrant's Common Equity and Related Stockholder
Item 5. Matters....................................................... 30
Item 6. Selected Financial Data....................................... 31
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 31
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.... 40
Item 8. Financial Statements and Supplementary Data................... 40
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 40
PART III
Item 10. Directors and Executive Officers of the Registrant............ 41
Item 11. Executive Compensation........................................ 41
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................... 41
Item 13. Certain Relationships and Related Transactions................ 41
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K...................................................... 42
SIGNATURES............................................................. 44
Index to Consolidated Financial Statements............................. F-1
2
PART I
ITEM 1. BUSINESS
SUMMARY
As used in this Annual Report, unless the context otherwise requires, the
terms "the Company" and "IDT" refer to IDT Corporation, a Delaware
corporation, its predecessor, International Discount Telecommunications,
Corp., a New York corporation ("IDT New York"), and their subsidiaries,
collectively. All information in this Annual Report gives effect to the 1995
reincorporation of the Company in Delaware. The Company's fiscal year ends on
July 31 of each calendar year. Each reference to a Fiscal Year in this Annual
Report refers to the Fiscal Year ending in the calendar year indicated (e.g.,
Fiscal 1998 refers to the Fiscal Year ended July 31, 1998).
IDT is a leading multinational carrier that provides its wholesale and
retail customers with integrated and competitively priced international and
domestic long distance telecommunications service, Internet access and,
through its Net2Phone products and services, Internet telephony services. IDT
delivers these services over a high-quality network consisting of 60 switches
in the U.S. and Europe and owned and leased capacity on 16 undersea fiber
optic cables. In addition, the Company obtains additional transmission
capacity from other carriers.
The Company delivers its international traffic worldwide pursuant to its
agreements with U.S.-based carriers, foreign carriers, and 17 of the companies
that are primarily responsible for providing telecommunications services in
particular countries (many of which are commonly referred to as "PTTs"). In
addition, IDT maintains a high-speed network that carries Internet traffic in
order to support both its Internet access services and its Internet telephony
services. The Company has grown considerably in recent years, generating
revenues of $57.7 million, $135.2 million and $335.4 million in Fiscal 1996,
Fiscal 1997 and Fiscal 1998, respectively.
As of October 1, 1998, the Company had approximately 110 wholesale customers
located in the U.S. and Europe. In addition, IDT offers retail long distance
services to individual and business customers in the U.S. and over 170 other
countries. Within the U.S., IDT provides dedicated and dial-up Internet access
services to approximately 75,000 retail customers. The Company's Net2Phone
service, which allows customers to make telephone calls from a multimedia PC
to any telephone, and the Company's Net2Phone Direct service, which enables
users to make phone-to-phone calls over the Internet, have been used by a
total of over 600,000 registered customers worldwide.
The Company operates a growing telecommunications network consisting of (i)
60 Excel and Nortel switches in the U.S. and Europe; (ii) 16 owned and leased
undersea fiber optic cables connecting the Company's U.S. facilities with its
international facilities and with the facilities of its foreign partners in
Europe, Latin America and Asia; and (iii) resale transmission capacity
obtained on a per-minute basis from other telephone carriers. The Company
monitors its network 24 hours a day, seven days a week through an automated
network operations center. The Company follows a disciplined, incremental
approach to expanding its network, adding new facilities when it determines
that such investments are justified by traffic volumes. The Company plans to
expand its global telecommunications network infrastructure in order to reduce
its operating costs, ensure the quality of its service and to expand its
customer base. IDT plans to install Company-owned switches in the U.K., the
Netherlands, Germany and France by the end of Fiscal 1999 and to continue to
pursue operating agreements with foreign carriers in order to terminate
traffic directly at favorable rates.
IDT also operates a domestic Internet network consisting of multiple leased
lines. IDT operates one of the nation's largest Internet access networks,
providing local dial-up access through more than 75 "points of presence" (or
"POPs"), owned by the Company, through which subscribers may access the
Internet. The Company's domestic Internet network also includes more than 375
additional POPs owned by local and regional Internet service providers, which
the Company refers to as its "Alliance Partners." This Internet network,
combined with the Company's telecommunications network, is also used to route
IDT's Internet telephony traffic.
3
The Company entered the telecommunications business by introducing its
international call reorigination business in 1990 to capitalize on the
opportunity created by the spread between U.S. and foreign-originated
international long distance telephone rates. IDT used the expertise derived
from, and the calling volume generated by, its call reorigination business to
enter the domestic long distance business in late 1993 by reselling long
distance services of other carriers to its domestic customers. As a value-
added service for its domestic long distance customers, the Company began
offering Internet access in early 1994, eventually offering dial-up and
dedicated Internet access to individuals and businesses as stand-alone
services. In 1995, IDT began reselling to other long distance carriers access
to the favorable telephone rates and special tariffs the Company receives as a
result of the calling volume generated by its call reorigination customers.
The Company began marketing its prepaid calling cards in January 1997.
IDT entered the Internet telephony market in August 1996 with its
introduction of Net2Phone, and expanded its Internet telephony offerings in
October 1997 with the introduction of its Net2Phone Direct service. In April
1998, the Company launched Click2Talk, an Internet telephony product which
allows customers to make calls to the toll-free numbers of e-commerce
companies anywhere in the world using a PC. In August 1998, the Company
introduced Click2CallMe, which allows consumers visiting e-commerce companies
to contact customer sales representatives from the websites of such companies
without charge.
The Company was founded in August 1990 and originally incorporated in New
York as "International Discount Telecommunications, Corp." The Company was
renamed IDT Corporation and reincorporated in Delaware in December 1995. The
Company's main offices are located at 190 Main Street, Hackensack, New Jersey
07601, its telephone number is (201) 928-1000. IDT's Internet address is
www.idt.net.
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This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Such forward-looking statements include,
among other things, the Company's plans to implement its growth strategy,
improve its financial performance, expand its infrastructure, develop new
products and services, expand its sales force, expand its customer base and
enter international markets. Such forward-looking statements also include the
Company's expectations concerning factors affecting the markets for its
products, such as changes in the U.S. and the international regulatory
environment and the demand for long-distance telecommunications, Internet
access and Internet telephony services. Actual results could differ from those
projected in any forward-looking statements for the reasons detailed in this
Annual Report. The forward-looking statements are made as of the date of this
Annual Report on Form 10-K, and the Company assumes no obligation to update
the forward-looking statements, or to update the reasons why actual results
could differ from those projected in the forward-looking statements. Investors
should consult all of the information set forth herein and the other
information set forth from time to time in the Company's Reports on Forms 10-Q
and 8-K.
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INDUSTRY
OVERVIEW
The international long distance industry, which principally consists of the
transmission of voice and data between countries, is undergoing a period of
fundamental change that has resulted, and is expected to continue to result,
in significant growth in usage of international telecommunications services.
According to industry sources, in 1996, the international long distance
telecommunications industry accounted for approximately $61.3 billion in
revenues and 70.0 billion minutes of use, an increase from approximately $23.9
billion in revenues and 19.1 billion minutes of use in 1987. Industry sources
have estimated that by 2000 this market may approach $85.7 billion in revenues
and 122.4 billion minutes of use, representing compound annual growth rates
from 1996 of 8.7% and 15.0%, respectively.
The Company believes that growth in international long distance services is
being driven by (i) the globalization of the world's economies and the
worldwide trend toward deregulation of the telecommunications sector; (ii)
declining prices arising from increased competition generated by privatization
and deregulation;
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(iii) increased worldwide telephone density and accessibility arising from
technological advances and greater investment in telecommunications
infrastructure, including the deployment of wireless networks; (iv) a wider
selection of products and services; and (v) the growth in the transmission of
data traffic via internal company networks and the Internet. The Company
believes that growth of traffic originated in markets outside the U.S. will be
higher than growth in traffic originated within the U.S. due to recent
deregulation in many foreign markets, relative economic growth rates and
increasing access to telecommunications facilities in emerging markets.
REGULATORY AND COMPETITIVE ENVIRONMENT
Consumer demand and competitive initiatives have acted as catalysts for
government deregulation, especially in developed countries. Deregulation
accelerated in the U.S. in 1984 with the divestiture by American Telephone &
Telegraph, Inc. ("AT&T") of the regional bell operating companies. Today,
there are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-
sized companies typically offer their customers a full range of services,
including international long distance. However, most of these carriers do not
have the critical mass of customers to receive volume discounts on
international traffic from the larger facilities-based carriers such as AT&T,
MCI WorldCom, Inc. ("MCI WorldCom") and Sprint Corporation ("Sprint"). In
addition, these companies have only a limited ability to invest in
international facilities. Alternative international carriers, such as the
Company, have capitalized on this demand for less expensive international
transmission facilities. These alternative international carriers are able to
take advantage of larger traffic volumes in order to obtain volume discounts
on international routes (resale traffic) and/or invest in facilities when the
volume of particular routes justifies such investments. As these emerging
international carriers have become established, they have also begun to carry
overflow traffic from the larger long distance providers that own overseas
transmission facilities.
Deregulation in the U.K. began in 1981 when Mercury, a subsidiary of Cable &
Wireless plc, was granted a license to operate a facilities-based network and
compete with British Telecommunications plc. Deregulation spread to other
European countries with the adoption of the "Directive on Competition in the
Markets for Telecommunication Services" in 1990. A series of subsequent
European Union directives, reports and actions have resulted in significant
but not complete deregulation of the telecommunications industries in most
European Union member states. Further deregulation of the European Union
telecommunications market is scheduled to occur in 2000 upon the
implementation of the European Union's Amending Directive to the
Interconnection Directive, which mandates the introduction of equal access and
carrier pre-selection by 2000. See "Regulation--European Regulation of
Telecommunications Services." A similar movement toward deregulation has
already taken place in Australia and New Zealand, and is also taking place in
Japan, Mexico, Hong Kong and other markets. Other governments have begun to
allow competition for value-added and other selected telecommunications
services and features, including data and facsimile services and certain
restricted voice services. Deregulation and privatization have also allowed
new long distance providers to emerge in other foreign markets. In many
countries, however, the rate of change and emergence of competition remain
slow, and the timing and extent of future deregulation is uncertain.
On February 15, 1997, the U.S. and 68 other countries signed the WTO
Agreement and agreed to open their telecommunications markets to competition
and foreign ownership starting in January 1998. These 69 countries represent
approximately 95% of worldwide telecommunications traffic. The Company
believes that the WTO Agreement will provide IDT with significant
opportunities to compete in markets in which it did not previously have
access, and to provide facilities-based services to and from these countries.
The Federal Communications Commission ("FCC") issued an order that
significantly reduces U.S. regulation of international services in order to
implement the U.S.'s commitments under the WTO Agreement. This order is
expected to increase opportunities for foreign carriers to compete in the U.S.
communications market, while increasing opportunities for U.S. carriers to
enter foreign markets and to develop alternative termination arrangements with
carriers that lack market power in other countries.
5
Deregulation has encouraged competition, which in turn has prompted carriers
to offer a wider selection of products and services at lower prices. The
Company believes that the lower prices for telecommunications services that
have resulted from increased competition have been more than offset by
decreases in the costs of providing such services and increases in
telecommunications usage. For example, based on FCC data for the period 1989
through 1995, per-minute settlement payments by U.S.-based carriers to foreign
PTTs fell 31.4%, from $0.70 per minute to $0.48 per minute. Over this same
period, however, per-minute international billed revenues fell only 13.7%,
from $1.02 in 1989 to $0.88 in 1995. The Company believes that as settlement
rates and capacity costs continue to decline, international long distance will
continue to provide opportunities to generate relatively high revenues and
per-minute gross profits.
INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. In the U.S., an international
long distance call typically originates on a local exchange carrier's network
and is switched to the caller's domestic long distance carrier. The domestic
long distance provider then carries the call to its own or to another
carrier's international gateway switch. From there it is carried to a
corresponding gateway switch operated in the country of destination by the
dominant carrier of that country and then is routed to the party being called
though that country's domestic telephone network.
International long distance providers can generally be categorized by the
extent, if any, of their ownership and use of their own switches and
transmission facilities. The largest U.S. carriers, AT&T, MCI WorldCom and
Sprint primarily utilize owned U.S. transmission facilities and have operating
agreements with, and own transmission facilities that carry traffic to, the
countries to which they provide service. A significantly larger group of long
distance providers own and operate their own switches and generally carry the
overflow traffic of other long distance providers. These carriers either rely
solely on resale agreements with other long distance carriers to terminate
traffic or use a combination of resale agreements and leased or owned
facilities in order to terminate their traffic, as discussed below.
Operating Agreements. Operating agreements provide for the termination of
traffic in, and return traffic from, the international long distance providers
that have rights in facilities in different countries at a negotiated
accounting rate. Under a traditional operating agreement, the international
long distance provider that originates more traffic compensates the other long
distance provider by paying an amount determined by multiplying the net
traffic imbalance by the latter's share of the accounting rate. Under a
typical operating agreement, each carrier has a right in its portion of the
transmission facilities between two countries. A carrier gains ownership
rights in a fiber optic cable by purchasing direct ownership in a particular
cable (usually prior to the time that the cable is placed in service), by
acquiring an "indefeasible right of use" in a previously installed cable, or
by leasing or obtaining capacity from another long distance provider that
either has direct ownership or an indefeasible right of use in the cable. In
situations where a long distance provider has sufficiently high traffic
volume, routing calls across an indefeasible right of use or leased cable
capacity is generally more cost-effective on a per-call basis than the use of
resale arrangements with other long distance providers. However, leased
capacity and acquisition of an indefeasible right of use requires a
substantial initial investment based on the amount of capacity acquired.
Transit Arrangements. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit agreements. Under
these arrangements, a long distance provider in an intermediate country
carries the traffic to the country of destination.
Switched Resale Arrangements. A switched resale arrangement typically
involves the wholesale purchase of termination services on a variable, per-
minute basis by one long distance provider from another. A single
international call may pass through the facilities of several long distance
resellers before it reaches the foreign facilities-based carrier that
ultimately terminates the call. Such resale, first permitted with the
deregulation of the U.S. market, enabled the emergence of alternative
international providers that relied, at least in part, on
6
transmission services acquired on a wholesale basis from other providers.
Resale arrangements set per-minute prices for different routes, which may be
guaranteed for a set time period or which may be subject to change. The resale
market for international transmission is constantly changing, as new long
distance resellers emerge, and as existing providers respond to fluctuating
costs and competitive pressures. In order to effectively manage costs when
utilizing resale arrangements, long distance providers need timely access to
changing market data and must quickly react to changes in costs through
pricing adjustments or routing decisions.
Alternative Transit/Termination Arrangements. As the international long
distance market began to deregulate, long distance providers developed
alternative transit/termination arrangements in an effort to decrease their
costs of terminating international traffic. Some of the more significant
arrangements include refiling, international simple resale and ownership of
switching facilities in foreign countries.
Refiling and transiting of traffic, which take advantage of disparities in
settlement rates between different countries, allow traffic to a destination
country to be treated as if it originated in another country that benefits
from lower settlement rates with the destination country, thereby resulting in
a lower overall termination cost. The difference between transit and refiling
is that, with respect to transit, the long distance provider in the
destination country has a direct relationship with the originating long
distance provider and is aware of the arrangement, while with refiling, it is
likely that the long distance provider in the destination country is not aware
of the country in which the traffic originated or of the originating carrier.
To date, the FCC has made no pronouncement as to whether refiling complies
with either U.S. regulations or the regulations of the International
Telecommunication Union.
Under international simple resale, a long distance provider completely
bypasses the accounting rate system by connecting an international leased
private line (i) to the public switched telephone network of two countries or
(ii) directly to the premises of a customer or partner in one country and the
public switched telephone network in the other country. While international
simple resale is currently only sanctioned by applicable regulatory
authorities on a limited number of routes, including U.S.-U.K., U.S.-Canada,
U.S.-Sweden, U.S.-New Zealand, U.S.-Australia, U.S.-Netherlands, U.K.-
worldwide, Canada-U.K. and U.S.-Japan, it is increasing in use and is expected
to expand significantly as deregulation of the international
telecommunications market continues. In addition, deregulation has made it
possible for U.S.-based long distance providers to establish their own
switching facilities in certain foreign countries, enabling them to terminate
traffic directly.
COMPETITIVE OPPORTUNITIES AND ADVANCES IN TELECOMMUNICATIONS TECHNOLOGY
The combination of a continually expanding global telecommunications market,
consumer demand for lower prices with improved quality and service, and
ongoing deregulation has created competitive opportunities in many countries.
Similarly, new technologies, including fiber optic cable and improvements in
digital compression, have improved quality and increased transmission
capacities and speed, with transmission costs decreasing as a result. In
addition, the growth of the Internet as a communications medium, and advances
in packet switching technology and Internet telephony are expected to have an
increasing impact on the international telecommunications market.
Advances in technology have created a variety of ways for telecommunications
carriers to provide customer access to their networks and services. These
include customer-paid local access, international and domestic toll-free
access, direct digital access through dedicated lines, equal access through
automated routing from the public switched telephone network, call
reorigination and Internet telephony. The type of access offered depends on
the proximity of switching facilities to the customer, the needs of the
customer, and the regulatory environment in which the carrier competes.
Overall, these changes have resulted in a trend towards bypassing traditional
international long distance operating agreements as international long
distance companies seek to operate more efficiently.
In a deregulated country such as the U.S., carriers can establish switching
facilities, own or lease fiber optic cable, enter into operating agreements
with foreign carriers and, accordingly, provide direct access service. In
7
markets that have not deregulated or are slow in implementing deregulation,
international long distance carriers have used advances in technology to
develop innovative alternative access methods, such as call reorigination. In
other countries, such as Hong Kong and Singapore, where deregulation has
commenced but has not been completed, carriers are permitted to offer data and
facsimile services, as well as limited voice services including those to
closed user groups, but are not yet permitted to offer full voice telephony.
As countries deregulate, the demand for alternative access methods typically
decreases because carriers are permitted to offer a wider range of facilities-
based services on a transparent basis.
The most common form of alternative international access, traditional call
reorigination, avoids the high international rates offered by the dominant
carrier in a particular regulated country by providing the user with a dial
tone from a deregulated country, typically the U.S. To place a call using
traditional call reorigination, a user dials a unique phone number to an
international carrier's switching center and then hangs up after it rings. The
user then receives an automated callback providing a dial tone from the U.S.
which enables the user to complete the call. Technical innovations, ranging
from inexpensive dialers to sophisticated in-country switching platforms, have
enabled telecommunications carriers to offer a "transparent" form of call
reorigination. The customer dials into the local switch, and then dials the
international number in the usual fashion, without the "hang-up" and
"callback," and the international call is automatically and rapidly processed.
The Company believes that as deregulation occurs and competition increases in
various markets around the world, the pricing advantage of traditional call
reorigination to most destinations relative to conventional international
direct dial service will diminish in those markets.
DEVELOPMENTS IN THE INTERNET INDUSTRY
Use of the Internet has grown rapidly since its initial commercialization in
the early 1990's. However, determining the precise number of Internet users is
extremely difficult because (i) the Internet does not have a single point of
control from which statistics may be recorded; (ii) computers are connected
and disconnected from the Internet on a continual basis; and (iii) a large
number of users may access the Internet through a single network. The
International Telecommunication Union estimates that there were approximately
120 million Internet users worldwide at the end of 1997 and that the number of
Internet users may increase to 300 million by 2001.
The Internet has evolved dramatically over the last several years as a
result of several trends affecting the computer and communications industries.
These trends include (i) the migration by organizations from proprietary
mainframe environments to open systems and distributed computing; (ii) the
emergence of low-cost, high-capacity telecommunications bandwidth; (iii) the
increased use of PCs in the home; (iv) the increased percentage of PCs that
are equipped with modems; (v) the growth of commercial on-line services; (vi)
the growth of information, entertainment and commercial applications; and
(vii) the increase in the number and variety of services available on the
Internet. Through an Internet connection, users can access commercial,
educational and governmental databases, software, graphics, newspapers,
magazines, library catalogs, industry newsletters, and other information.
Currently, the primary uses of the Internet include e-mail, Web browsing,
electronic commerce, file transfers, remote log-in, news, bulletin boards,
chat services and other on-line services.
In addition, during the last few years, several navigational and utility
tools have become available that have enabled easier access to the resources
of the Internet. Navigational software such as Netscape Navigator and
Microsoft's Internet Explorer, and search tools from such companies as Excite,
Inc. and InfoSeek, Inc., help users access information from the Internet.
As the volume of information available on organizations' computer systems
has increased and the use of data communications has grown as a preferred
means of day-to-day communications, organizations increasingly seek a number
of geographically dispersed access points to their own networks and to the
networks of other organizations. In the commercial sector, the number of
interconnections that businesses desire to establish with networks, customers,
suppliers and affiliates generally has made the development of proprietary
access systems on a case-by-case basis costly and time consuming. As a result,
many organizations seek reliable, high-speed
8
and cost-effective means of internetworking and increasingly rely on the
Internet. As reliance on the Internet for the transmission of data,
applications and electronic commerce continues to grow among organizations,
the Company believes that these organizations will require reliable,
geographically dispersed and competitively priced Internet access and
services.
INTERNET TELEPHONY
The Internet telephony industry began in 1995, when experienced Internet
users began to transfer voice messages from one personal computer to another.
In 1995, VocalTec Communications, Ltd. ("VocalTec") introduced software that
allowed personal computer users to place international calls via the Internet
to other personal computer users for the price of a local call. In its early
months, the growth of Internet telephony was constrained due to the poor sound
quality of the calls and because calls were mainly limited to those placed
from one personal computer to another.
The poor sound quality of Internet telephony was due to the fact that the
Internet was not created to provide for simultaneous voice traffic. Unlike
conventional voice communication circuits, in which the entire circuit is
reserved for a call, Internet telephony uses packet switching technology, in
which voice data is divided into discrete packets that are transmitted over
the Internet. These packets must travel through several routers in order to
reach their destination, which may cause misrouting, and delays in
transmission and reception. The limited capacity of the Internet has also
restrained the growth rate of Internet telephony.
However, as the industry has grown, substantial improvements have been made.
New software algorithms have substantially reduced delays. The use of private
networks or intranets to transmit calls as an alternative to the public
Internet has alleviated capacity problems. Another key development has been
the introduction of gateway servers, which connect packet-switched data
networks such as the Internet to circuit-switched public telephone networks.
Developments in hardware, software and networks are expected to continue to
improve the quality and viability of Internet telephony. In time, packet-
switched networks may become substantially less expensive to operate than
circuit-switched networks, because carriers can compress voice traffic and
place more calls on a single line.
The Internet telephony market has grown in terms of the number and size of
companies offering products. Established long distance providers such as AT&T,
Bell Atlantic Corporation ("Bell Atlantic") and Deutsche Telekom AG ("Deutsche
Telekom"), as well as other major companies such as Motorola, Inc.
("Motorola"), Microsoft Corporation ("Microsoft"), Intel Corporation ("Intel")
and Netscape Communications Corporation ("Netscape"), have all entered or plan
to enter the Internet telephony market, in certain cases by investing in
companies engaged in the development of Internet telephony products. In
addition, a number of large, well-capitalized companies such as Cisco Systems,
Inc. ("Cisco"), Lucent Technologies, Inc. ("Lucent"), Northern Telecom Limited
("Nortel") and Dialogic Corporation ("Dialogic") have announced their
intentions to offer server-based products that are expected to allow
communications over the Internet between parties using a multimedia PC and a
telephone and between two parties using telephones where both parties have
specialized servers at each end of the call. Current product offerings include
VocalTec's Internet Phone, QuarterDeck's WebPhone and Microsoft's NetMeeting.
Internet telephony provides customers with substantial savings compared to
conventional long distance calls, because the total cost of an Internet
telephone call is based on the local calls to and from the gateways of the
respective Internet service providers, thereby bypassing the international
settlements process. According to industry sources, the market for calls
carried by Internet telephony systems is expected to be approximately $30
million in 1998, and may increase to as much as $1.0 billion in 2002.
MARKET OPPORTUNITY
The market for international voice and data telecommunications is undergoing
fundamental change and has experienced significant growth as a result of: (i)
deregulation and privatization of telecommunications markets
9
worldwide; (ii) the convergence of traditional voice and packet switching
technology; and (iii) the growth of the Internet as a communications medium,
including Internet telephony.
Deregulation and Privatization of Telecommunications Markets
Worldwide. Significant legislation and agreements have been adopted since the
beginning of 1996 which are expected to lead to increased liberalization of
the majority of the world's telecommunication markets, including:
. the U.S. Telecommunications Act, signed in February 1996, which
establishes parameters for the implementation of full competition in the
U.S. domestic local and long distance markets;
. the European Union's Services Directive, adopted in 1990, which
abolishes exclusive rights for the provision of voice telephony services
throughout the European Union and the public switched telephone networks
of any member country of the European Union by January 1, 1998, subject
to extension by certain European Union member countries; and
. the WTO Agreement, signed in February 1997, which creates a framework
under which 69 countries have committed to liberalize their
telecommunications laws in order to permit increased competition and, in
most cases, foreign ownership in their telecommunications markets,
beginning in 1998.
The Company believes that these initiatives, as well as other proposed
legislation and agreements, will provide increased opportunities for emerging
competitive carriers such as IDT to provide telecommunications services in
targeted markets. Deregulation has encouraged competition, which in turn has
prompted carriers to offer a wider selection of services and reduce prices.
The industry's projections for substantially increased international minutes
of use and revenue by 2000 are based in part on the belief that reduced
pricing as a result of deregulation and competition will result in a
substantial increase in the demand for telecommunications services in most
markets.
Convergence of Traditional Voice and Packet Switching Technology.
Technological advancements have allowed the use of packet switching technology
for the transmission of voice telecommunications traffic, enabling a substantial
increase in network efficiency, as well as the use of the Internet for voice
communications. The use of the Internet as a voice communications medium
provides significant reductions in the cost of transmitting traffic, while
bypassing the cumbersome and expensive settlement process inherent in
international voice communications. The development of voice applications for
the Internet is part of a larger trend of convergence of standard voice and data
networks. Internet telephony services are expected to be one of the fastest
growth segments in the telecommunications industry. Industry sources have
estimated that the size of the total market may reach $1.0 billion by 2002. The
Company believes that the providers of packet switching technology will be able
to offer quality communications services at rates that are significantly less
than the rates currently charged for long distance calls.
In connection with these processes, in June 1998, the Company announced a
plan to market a corporate solution that will enable businesses to send both
voice and data traffic over the Company's Internet network, resulting in
substantially reduced costs for such users. The plan is designed to enable the
Company's business customers in designated U.S. markets to fully integrate all
communications services under one network. Using this plan, the Company's
business customers will be able to make phone calls, send faxes, and run
multiple applications on the Internet at high speeds through a single
connection at reduced rates.
THE IDT APPROACH
IDT's background as a leading alternative provider of wholesale and retail
international telecommunications services, combined with its experience as a
domestic Internet service provider and its leadership role in the field of
Internet telephony, position it to capitalize on continuing deregulation in
the international telecommunications marketplace and the convergence of voice
and data telecommunications technologies. The Company leverages its customer
base, existing carrier relationships and technology platforms to (i) develop
new, low-cost termination arrangements; (ii) offer new services such as
prepaid calling cards and Internet telephony to wholesale and retail customers
in target countries; and (iii) negotiate partnership arrangements with
existing and emerging carriers to market the Company's Internet telephony
services.
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STRATEGY
The Company's objective is to be a leading provider of high-quality, low-
cost international telecommunications services to wholesale and retail
customers in both the U.S. and abroad. Key elements of the Company's strategy
include:
Focus on International Telecommunications. The Company believes that the
international long distance market provides attractive opportunities due to
its higher revenue and gross profit per minute, and higher projected growth
rate compared to the domestic long distance market. The Company targets
international markets with high volumes of traffic, relatively high per-minute
rates and favorable prospects for deregulation and privatization. The Company
believes that the ongoing trend toward deregulation and privatization will
create new opportunities for the Company to increase its revenues and to
reduce its termination costs, while maintaining balanced growth in wholesale
and retail traffic.
Expand Switching and Transmission Facilities. The Company is continuing to
expand and enhance its network facilities by investing in switching and
transmission facilities where traffic volumes justify such investments.
Through Fiscal 1999, the Company intends to invest in (i) undersea cables
connecting the U.S. and Europe, the U.S. and Asia, and points within Europe;
(ii) switching facilities in the U.S., the U.K., France, Italy, Germany and
other European countries; and (iii) additional network compression equipment.
The Company believes that these investments will allow it to reduce the cost
of its services and to enhance its offerings, while maintaining its high
service quality.
Expand Service Offerings and Marketing Activities. The Company will continue
to develop value-added services and to market them on a wholesale and retail
basis in order to increase margins, optimize network utilization and improve
customer loyalty. IDT has historically used technology to capitalize on
regulatory opportunities and market niches by offering innovative value-added
services such as call reorigination, international prepaid calling cards and
Internet telephony. In addition, the Company intends to capitalize on its
strategic alliances and other relationships with U.S. and foreign companies in
order to expand its customer base.
Combine Voice Telecommunications and Internet Telephony Expertise. The
Company's knowledge of international voice telecommunications technology,
packet switching technology and Internet telephony provides the Company with a
significant competitive advantage as voice and Internet technologies converge.
The efficiencies of packet switching technology and the artificially high
costs of terminating international voice traffic resulting from the negotiated
rate which international long distance providers pay one another to terminate
traffic are expected to result in both high growth for Internet telephony and
the transmission of voice telecommunications using packet switching
technology. The Company expects that its leadership in Internet telephony and
its knowledge of voice telecommunications systems will enable it to partner
with foreign carriers seeking to provide inexpensive international termination
to their customers.
Pursue Strategic Alliances and International Agreements. The Company has
capitalized on its significant traffic volume and technological expertise to
negotiate favorable termination agreements with international carriers. The
Company intends to continue to seek new termination relationships with
established and emerging carriers to reduce its termination costs for
traditional international voice telephony, and to seek foreign partners for
the expansion of its Internet telephony offerings. To date, the Company has
entered into 17 agreements with carriers that provide for the termination of
its calls in 27 countries. In addition, the Company has negotiated partnership
arrangements with Daewoo Corporation and Naray Mobile Telecom Inc. in South
Korea and Marubeni Corporation in Japan to market its Internet telephony
services. The Company may also selectively pursue strategic acquisitions as
they become available.
Maintain Low Operating Costs and Improve Profitability. The Company seeks to
continue to improve its profitability by (i) maintaining a streamlined general
and administrative staff; (ii) leveraging its general and administrative staff
across its complementary telecommunications services businesses; (iii)
capitalizing on its wholesale traffic volumes to arrange cost-effective resale
and termination arrangements, while continuing to increase its sales of higher
margin retail international minutes; and (iv) investing in network
infrastructure and selling, general and administration expenses when such
investment is justified by traffic volumes.
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SERVICES
IDT provides its customers with integrated and competitively priced
international and domestic telecommunications, Internet access and Internet
telephony services.
TELECOMMUNICATIONS SERVICES
The Company's four primary telecommunications services are: (i) wholesale
carrier services; (ii) prepaid calling cards; (iii) international retail
services for individuals and businesses; and (iv) domestic long distance
services in the U.S. The Company generated revenues from its
telecommunications business of approximately $303.9 million during Fiscal
1998.
WHOLESALE CARRIER SERVICES
The Company sells its wholesale carrier services to other U.S. and
international carriers. In offering this service, the Company leverages the
rates that it is able to obtain through (i) its extensive relationships in the
long distance telecommunications industry; (ii) its ability to generate a high
volume of long distance call traffic; and (iii) the advantageous rates
negotiated with foreign PTTs and competitive carriers.
PREPAID CALLING CARDS
The Company sells prepaid debit and rechargeable calling cards providing
access to more than 230 countries and territories. The Company's rates are
between 10% and 50% less than the rates for international calls that are
charged by the major facilities-based carriers. The Company's debit cards are
marketed primarily to ethnic communities in the U.S. that generate high levels
of international traffic to specific countries where the Company has favorable
termination agreements. The Company's Colombianita and Colombiana cards offer
attractive rates to Colombia, the Company's Dominicall, Merengue and Discovery
cards offer attractive rates to the Dominican Republic and the Company's Mega
Mexico card offers attractive rates to Mexico. In addition, the Company's
Megatel and Metropolis cards provide favorable rates to a variety of
countries. The Company's New York Exclusive and New Jersey Exclusive cards are
distributed primarily in the New York and New Jersey area. The Company has
recently introduced new calling cards in specific states or geographic areas
which are marketed under the names California Exclusive, Connecticut
Exclusive, Georgia Exclusive, Massachusetts Exclusive, Rhode Island Exclusive,
Texas Exclusive and Washington-Virginia-Maryland Exclusive, and plans to
distribute calling cards in Illinois and Florida. The Company's rechargeable
cards permit users to place calls from 43 countries through international
toll-free services.
The Company's retail customers can use its calling cards at any touch tone
telephone by dialing an access number, followed by a personal identification
number (a "PIN") assigned to each prepaid calling card and the telephone
number the customer seeks to reach. The Company's switch completes the call,
and its debit card platform reduces the outstanding balance of the card during
the call. The Company offers prepaid calling cards that can be used to access
the Company's network by dialing a toll-free number or, in specific
metropolitan markets, local area calling cards that only require a local call.
The Company believes that many of its customers typically use its calling
cards as their primary means of making long distance calls due to (i)
attractive rates, (ii) reliable service, (iii) the ease of monitoring and
budgeting their long distance spending and (iv) the appealing variety of
calling cards offered by the Company to different market segments.
In May 1998, the Company completed its acquisition of InterExchange, Inc.
and its subsidiaries (collectively, "InterExchange"). Through InterExchange,
the Company operates one of the nation's largest international debit card
platforms. The platform provides the Company with a broad range of services
used to conduct its calling card operations, including billing, routing of
calls, and determining the amount of credit available on each outstanding
calling card.
INTERNATIONAL RETAIL SERVICES
The Company offers international retail services to customers outside of the
U.S., primarily through call reorigination. The Company also provides its call
reorigination customers with access to enhanced U.S.
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telecommunications service options at U.S. long distance rates. These options
include: voicemail, itemized billing, speed dial codes that allow customers
convenient access to the call reorigination service, personalized voice
prompts that allow customers to be called back at extensions where the party
being dialed must be requested by name, remote programmable service that
allows customers the flexibility of selecting the number called back instead
of receiving the call at a preprogrammed number, access to U.S. toll-free 888
and 800 numbers, and simplified billing that combines the cost of the call
back to the customer and the cost of the customer's outbound call from the
U.S. in one bill for convenient and orderly presentation. The Company markets
its call reorigination service to businesses and individuals.
As an alternative service, the Company provides international long distance
services to certain overseas customers, currently in the United Kingdom, via
standard international direct-dial network services. Through this service, the
Company offers a foreign customer the ability to place a direct call to an
international destination over the Company's leased network at competitive
rates without the need for call reorigination. In markets that are
deregulating, the Company's strategy is to migrate its call reorigination
customers to international direct-dial service, where operating environments
warrant. The Company expects to offer international direct-dial service in
France and Germany by the end of 1999.
DOMESTIC LONG DISTANCE SERVICES
The Company markets certain long distance services directly to retail
customers in the U.S. The Company's customers pay rates that are between 10%
and 50% less than the rates for domestic long distance service charged by the
major facilities-based carriers. The Company markets the long distance service
as a value-added bundled service with its dial-up Internet access, and offers
customers who maintain minimum monthly long distance billing levels rates that
are approximately 20% less than the rates for dial-up Internet access that are
charged by the major national Internet service providers.
INTERNET ACCESS
The Company's three primary Internet access and online services are: (i)
dial-up Internet access for individuals and businesses; (ii) direct-connect
dedicated Internet services for corporate customers; and (iii) the Genie
online entertainment and information services. The Company generated revenues
from its Internet access business of $20.0 million during Fiscal 1998.
DIAL-UP ACCESS SERVICES
The Company's dial-up service offers individuals unrestricted Internet
access with an easy-to-use point-and-click graphical user interface for a
fixed monthly fee. IDT provides its customers with access to a full range of
Internet applications, including e-mail functions, Web sites, Usenet news
groups, databases and public domain software, as well as a full graphics
package and browser software.
The Company provides its individual customers with several pricing options.
Currently, the Company offers Basic Internet service for $19.95 per month and
Premium Service for $29.95 per month. Each is a fully graphical account
bundled with an Internet browser, unlimited dial-up Internet access, and an e-
mail account. Premium Service customers are entitled to the Reuters news
service, a second e-mail address, eight megabytes of personal Web space
storage, and special customer support services. The Company also offers basic
Internet access accounts for $15.95 per month for customers who sign up for
IDT's long distance telephone service and maintain their monthly long distance
telephone billings at or above $40 per month. The Company offers free Basic
Internet accounts for those customers who sign up for IDT's long distance
telephone service and maintain their monthly telephone billings at or above
$150 per month. In addition, the Company offers an e-mail only account for
$7.95 per month.
The Company has entered into an agreement with Mail Call, Inc., pursuant to
which the Company's Internet subscribers are able to retrieve e-mail via
telephone, using text-to-speech technology. This service, which is called
"Mail Call," enables subscribers to hear their e-mail messages by calling to a
toll-free telephone number,
13
without the need for a computer. Subscribers to this service can choose to
listen to the text of each message (in English or Spanish), have a "hardcopy"
of the message sent to any fax machine in North America, or reply to the
message using one of several features. Mail Call also offers several
preference options, including six different voices with three pitches each, a
default fax phone number, a customized response, and several pattern matching
strings which can be used to filter and prioritize incoming e-mail messages.
DIRECT CONNECT DEDICATED SERVICES
The Company offers a variety of Internet access options and applications
specifically designed to address the unique needs of medium to large-sized
businesses. These corporate clients typically require high-speed dedicated
circuits because either they desire to put up a Web site, the nature of their
business requires the transfer of large data files, or it would be impractical
for them to maintain dial-up accounts for all their employees who require
Internet access. The Company currently charges clients using 56 kilobits per
second lines approximately $350 per month for direct connect service and
clients utilizing full T1's approximately $1,400 per month for direct connect
service.
GENIE SERVICES
In addition, the Company offers the Genie online service, giving subscribers
access to roundtables, bulletin boards and chat areas, individual and
multiplayer games, news, travel, entertainment, weather and other information
services. Currently, the Company markets the Genie content as an online
service available only to subscribers. The Company offers Internet access to
Genie online subscribers for an additional fee. In February 1998, the Company
entered into an agreement with Brother International to offer Genie as a
bundled value-added service to accompany desktop word processors and desktop
publishers.
INTERNET TELEPHONY
In August 1996, the Company began offering Net2Phone, the first commercial
telephone service to bridge calls between multimedia PCs and telephones via
the Internet, and to charge for this service on a per-minute basis. Upon
installation of the Net2Phone software, which is provided by the Company
primarily through the Internet without charge, a Net2Phone user receives an
account number, and chooses a personal identification number as an added
security feature. Once the Net2Phone software is installed, a user may place
toll-free "800" or "888" calls from anywhere in the world without incurring
any charges for such calls. Upon a user's prepayment for Net2Phone minutes,
the user may begin using Net2Phone to place telephone calls worldwide. In July
1997, Net2Phone was recognized as the "Product of the Week" by PC Magazine. In
Fiscal 1998, Net2Phone received the following awards and commendations:
SuperQuest Award for Excellence in IP Telephony, Frost & Sullivan Award for
Excellence in IP Telephony Market Engineering, CTI Editor's Choice Award, and
Best IP telephony card by Telecard World Magazine.
A user places a Net2Phone call after establishing a connection to the
Internet. The call is routed over the Internet, at no charge to the customer,
to the Company's telecommunications switches in the U.S. The call is then
routed in the same manner as other voice telephony calls, using the Company's
least-cost routing platform in order to increase the savings realized by
international callers. Net2Phone's voice quality has been enhanced through the
use of technology licensed from Lucent, and the software relating to Net2Phone
is available in seven different languages. For calls originating overseas, the
cost of placing and terminating the call with Net2Phone is up to 95% below the
rates generally charged by traditional foreign carriers to place and terminate
standard international telephone calls.
In October 1997, the Company introduced Net2Phone Direct, a commercial
telephone service that allows for international and domestic phone-to-phone
calling via the Internet using packet switching technology. Net2Phone Direct
enables phone-to-phone calling between two parties using telephones, while
using the Internet to transport the long-haul components of the call. Users of
Net2Phone Direct are able to call a local or toll-free access number, which
connects the call to the Internet. Through such use of the Internet, the
Company expects
14
to significantly reduce the cost of international and domestic calling by
extending the benefits of placing Internet telephone calls to customers with
access to a regular telephone without requiring the use of PCs or individual
Internet access. The Company also intends to develop a global network of
switches and servers, thereby expanding the Company's ability to provide
competitively priced Internet telephony solutions. The Company generated
revenues from its Internet telephony business of $11.5 million during Fiscal
1998.
IDT has entered into agreements with resellers in approximately five
countries worldwide, pursuant to which such parties purchase and house the
Net2Phone Direct servers in their country and resell Net2Phone Direct pin
numbers to end-users. IDT provides customer service and technical support for
Net2Phone and Net2Phone Direct customers in seven languages on a 24 hour per
day, 7 day per week basis.
SALES, MARKETING AND DISTRIBUTION
TELECOMMUNICATIONS
The Company primarily markets its international telecommunications services
through its direct wholesale carrier services sales staff. The staff primarily
relies on, and benefits from, (i) the Company's extensive relationships and
increasing international exposure and recognition throughout the long distance
industry for marketing its carrier services; (ii) the Company's substantial
traffic volumes, which enable the Company to negotiate for lower rates; and
(iii) favorable terminating rates negotiated with PTTs and foreign carriers.
The Company primarily markets its international call reorigination services
through its overseas network of independent sales representatives. The foreign
sales representatives, who are supervised by the Company's U.S.-based sales
managers, provide the Company with access to local business and residential
customers and new opportunities in the local markets they serve. The Company
pays its foreign sales representatives on a commission basis. As of October,
1998, the Company was represented by over 300 foreign sales representatives in
over 170 countries. The Company also has commenced direct sales efforts,
primarily through overseas advertising in international print media to
penetrate particular market segments that it does not currently serve.
The Company currently markets its prepaid debit cards to retail outlets
throughout the U.S. though Union Telecard Alliance, LLC ("Union"), a joint
venture company formed with Carlos Gomez, of which the Company owns 51% of the
outstanding equity interests. The agreement between IDT and Carlos Gomez
provides for the termination of the joint venture under certain circumstances.
In such a case occurring during the first two years of the joint venture, the
Company's equity interests in Union could be transferred to Mr. Gomez in
exchange for all (during the first year of the joint venture) or one-half
(during the second year of the joint venture) of the Company's purchase price
therefor. Beginning in the third year of the joint venture, the joint venture
would terminate through the purchase of one party's interest by the other. The
Company's rechargeable calling cards are distributed primarily through in-
flight magazines.
Union has entered into agreements with sub-distributors, located in Chicago,
Florida, New York, Ohio and Texas, whereby the sub-distributors have agreed to
market the prepaid calling cards of the Company in exchange for preferential
pricing, exclusive cards, extensions of credit, incentive bonuses and
technical support from the Company which is intended to assist each respective
partnership in the growth and development of its business. The exclusive
calling cards of the Company will be marketed by the corresponding partnership
in a given state.
INTERNET ACCESS
The Company established itself as a leading national provider of Internet
access services primarily through extensive broadcast and print advertising to
the consumer market. In Fiscal 1997, the Company refocused the marketing
efforts of its Internet access operations in order to lower the cost of
acquiring new customers. While the Company intends to continue various means
of broadcast advertising in select markets, the Company's sales and marketing
efforts now are focused primarily on increasing its Internet customer base
through (i) OEM transactions, including hardware, software and operating
system bundling, (ii) retail channel distribution agreements and (iii)
bundling Internet access with long distance telephone service. Additionally,
the Company has entered into agreements with other Internet service providers
to resell IDT's Internet access services. Through these strategies, the
Company believes that it will increase its exposure to the millions of
computer users who are potential customers of the Company's Internet access
services, while reducing its customer acquisition costs
15
as compared to traditional broadcast and print advertising. As of October 20,
1998, the Internet sales force consisted of approximately 25 salespersons. The
Company's Internet sales staff is closely supervised and undergoes customized
and ongoing training to ensure a high level of knowledge and service.
INTERNET TELEPHONY
The Company currently markets its Net2Phone Internet telephony services
primarily by distributing its Net2Phone software without charge via the
Internet and acquiring commercial Net2Phone customers through its prepaid
platform. IDT currently promotes its Net2Phone service through online and
Internet-based advertising venues, traditional print advertising in
international publications, and electronic media. In addition, the Company has
entered into agreements to bundle the required software for Net2Phone, as a
value-added component, with the software of other companies, and with other PC
and computer equipment. Such bundling agreements have included bundling
Net2Phone with a telephone handset product called Internet PhoneJACK(R)
developed by Quicknet Technologies, Inc.; this combination is marketed under
the name Net2Phone Pro. The Company has entered into agreements with Yahoo!
Inc., JABRA(R) Corporation, Broadcast.com, IBM Corporation, Packard Bell NEC
Europe, Excite, Inc. and Creative Technology Ltd. to bundle the required
software for Net2Phone with other software and computer equipment, and plans
to enter into additional bundling agreements with various computer
manufacturers and distributors of computer and telephone components.
The Company has entered into exclusive agreements with resellers in certain
countries, pursuant to which such resellers purchase bulk amounts of Net2Phone
minutes in advance, and resell such minutes to users in their own countries as
representative sellers of Net2Phone. The Company currently offers Net2Phone
Direct in over 62 cities in the U.S., and has entered into agreements with
Daewoo and Naray in South Korea and Marubeni in Japan to market Net2Phone
Direct in those countries. The Company also seeks to sell Net2Phone Direct
switch servers to additional third parties in strategic markets worldwide, and
to enter into agreements to resell the Click2CallMe service.
In April 1998, the Company began offering its Click2Talk Service, in which
an icon is placed on a customer's website. When an end-user of the website
that is equipped with an appropriately configured multimedia PC clicks on the
Click2Talk icon, the Net2Phone technology directly dials the customer's toll-
free customer service number.
In August 1998, the Company commenced offering the Click2CallMe service, in
which an icon is placed on a customer's website. When an end-user of the
website clicks on the Click2CallMe icon, IDT's callback and Net2Phone
technologies notify the customer, and then dials the end-user in order to
connect the customer and the end-user.
INTERNATIONAL SALES
In Fiscal 1996, 1997 and 1998, international customers accounted for
approximately 23%, 25% and 11% of the Company's total revenues, respectively.
See Note 9 to the Company's Consolidated Financial Statements. The Company
anticipates that revenues from international customers will continue to
account for a significant percentage of its total revenues.
BUNDLING OF SERVICE OFFERINGS
The Company bundles its Internet access services with its domestic long
distance telephone services. By bundling its long distance phone service with
its $15.95 per month discounted dial-up Internet access, the Company is
currently able to compete with many major national providers of Internet
access by offering rates that are on average 20% lower. By bundling its
Internet access services with its rechargeable calling cards, the Internet
access rates can be as much as 45% lower. At the same time, the Company
differentiates itself from its competitors in the Internet access market who
are unable to offer their customers significant savings on their monthly long
distance bills. The Company leverages its existing Internet sales force for
the sale of its bundled long distance and Internet access service.
16
MULTI-LEVEL MARKETING SYSTEM
In September 1998, the Company established a subsidiary, Nuestra Voz Direct
Inc., a Delaware corporation, though which the Company intends to market its
products and services by means of a multi-level marketing system. This system
will enable Nuestra Voz Direct's independent distributors to sell the
Company's products to consumers or other distributors. Distributors may also
develop their own distributor downline organizations by sponsoring other
distributors to do business in any market in which Nuestra Voz Direct
operates, entitling the sponsors to receive bonuses on sales within their
downline organizations. Nuestra Voz Direct initially plans to establish a
network of distributors that will direct their sales towards Spanish-speaking
residents of the U.S.
CUSTOMERS
TELECOMMUNICATIONS
As of October 1, 1998, the Company had approximately 110 wholesale customers
located in the U.S. and Europe. The Company supplements this wholesale
customer base by offering retail long distance services to individuals and
business customers in the U.S. and over 170 countries, including over 50,000
call reorigination customers. Since January 1997, the Company has sold over
18,000,000 prepaid calling cards and over 93,000 rechargeable debit cards.
INTERNET ACCESS
IDT is one of the nation's largest Internet service providers. As of October
20, 1998, the Company offered local dial-up access to approximately 75,000
retail customers, and provided dedicated access to approximately 350 medium
and large-sized businesses.
INTERNET TELEPHONY
As of October 20, 1998, the Company's Net2Phone service has been used by
over 500,000 registered customers worldwide. Total usage of Net2Phone
increased from approximately 1.5 million minutes in October 1997 to more than
five million minutes in October 1998. In addition, since its inception in
October 1997, approximately 99,000 customers have registered for the Company's
Net2Phone Direct service.
CUSTOMER SUPPORT AND BILLING
IDT believes that reliable, sophisticated and flexible billing and
information systems are essential to its ability to remain competitive in the
global telecommunications market. Accordingly, the Company has invested
substantial resources to develop and implement its proprietary management
information systems.
The Company's billing system enables the Company to (i) accurately analyze
its network traffic, revenues and margins by customer and by route on an
intra-day basis; (ii) validate carrier settlements; and (iii) monitor least
cost routing of customer traffic. The entire process is fully automated and
increases efficiencies by reducing the need for monitoring by the Company's
employees. The Company believes that the accuracy and efficiency of its
management information systems provide it with a significant strategic
advantage over other emerging carriers.
The Company has also developed a sophisticated real-time management
information system for its Internet telephony services. The Company is able to
monitor the length and quality of the calls that are placed over its Net2Phone
and Net2Phone Direct systems, thereby helping to ensure a high level of
service and more efficient routing of calls. In addition, this system helps
the Company prevent fraud, and assists in the customer management process by
automatically informing customers of new information, including system
upgrades.
The Company believes that its ability to provide adequate customer support
services is a crucial component of its ability to retain customers. The
Company has successfully focused on improving such service through
17
measures including the addition of support personnel and the monitoring of
customer waiting time. The customer support staff provides 24-hour technical
assistance in addition to general service assistance. Customer support
personnel communicate with subscribers via telephone, e-mail and fax. The
Company requires that each customer support staff member field a minimum
number of calls and e-mails each day. The Company also employs liaisons
between the customer support and technical staffs to ensure maximum
responsiveness to changing customer demands.
NETWORK INFRASTRUCTURE
The Company maintains an international telecommunications switching
infrastructure and U.S. domestic network, consisting of owned and leased lines
that enable it to provide an array of telecommunications, Internet access and
Internet telephony services to its customers worldwide. IDT believes it enjoys
competitive advantages by utilizing this network to carry both voice and
Internet traffic, resulting in the optimization of both its network
utilization and associated capital.
IDT's network is monitored 24 hours a day, seven days a week, and 365 days a
year by its network operations center. The entire network is centrally managed
from IDT's control center through the use of a standardized communications
protocol. In addition, two proprietary monitoring systems are used to manage
modem pools.
TELECOMMUNICATIONS NETWORK
PRIVATE LINE NETWORK
The Company operates a growing telephone network consisting of resold
international switched services, U.S. domestic dedicated leased fiber optic
lines, and Company-owned switch equipment in the U.S. which are interconnected
to major PTTs, emerging carriers and domestic interexchange carriers, local
exchange carriers and competitive local exchange carriers. IDT's major
switching facilities are located in Piscataway, N.J., Westfield, N.J., New
York, N.Y. and London, England. These varied locations serve to provide the
network with redundancy and diversity. All of these locations are linked with
the dominant local exchange carrier as well as at least one of the competitive
local exchange carriers, allowing the Company to interconnect with all major
interexchange carriers to switch traffic via the Company's leased private-line
DS3 network. Furthermore, all of the Company's locations are interconnected
via leased lines to enhance network reliability and redundancy as each
location interconnects with the various carriers. In September 1998, the
Company entered into a long-term agreement with Frontier Communications of the
West, Inc. ("Frontier") to obtain dedicated DS-1, DS-3, OC-3 and OC-12 circuit
capacity in the U.S. over Frontier's network. This agreement provides the
Company with additional network facilities that will enable it to expand the
range and reliability of its data and voice transmission services, and to
reduce its network costs.
In addition, the Company owns and leases switched services to connect its
U.S. and U.K. facilities. These services are used to originate traffic from
IDT's customer base in the U.K. and to terminate existing carrier and call
reorigination traffic to the U.K. The Company has 17 terminating agreements
that provide for the termination of traffic in 27 countries, including
agreements with companies based in Spain, the Dominican Republic, Italy,
Bangladesh, Cyprus and Chile. The Company also plans to obtain leased lines to
these destinations, which will result in reduced costs for termination to
these countries. The Company has also targeted countries such as the
Netherlands, Germany and France for network expansion due to the large number
of minutes the Company presently terminates and the size of the Company's
installed base of telecommunications customers in these countries.
SWITCHING PLATFORMS
The Company utilizes two major switching platforms. The Company uses its
Excel LNX switches for its application-based products such as call
reorigination, direct dial, call through, prepaid calling cards, and value-
added services such as voice prompts, speed dialing, voice mail and
conferencing. The Excel LNX is flexible
18
and programmable, and is designed to implement network-based intelligence
quickly and efficiently. The Company currently owns more than 50 Excel LNX
switches. The other platform is the Nortel DMS250-300, which serves as an
international gateway and generic carrier switch. The Company currently owns
two Nortel switches. The Company plans to install three more switching
platforms in Los Angeles, Miami and New Jersey during Fiscal 1999. All of the
Company's switches are modular, scaleable and equipped to signal in such
protocols as ISDN or SS7 so as to be compatible with either domestic or
foreign networks.
The Company plans to use other technologies, including Nortel ERS switches,
which allow for the dynamic allocation of voice and data traffic, to enable
the Company's Internet network to be used for the transmission of traditional
telephone minutes. If successfully developed, this leveraging of IDT's
Internet network could provide considerable cost efficiencies for transporting
a substantial portion of the Company's domestic voice traffic.
SOFTWARE
The Company's Excel LNX switch incorporates Company-developed software which
efficiently performs all the applications the Company requires to provide
value-added services, as well as billing and traffic analysis. The software
enables the Excel LNX to route all calls via the Company's least-cost routing
platform. Least-cost routing is a process by which the Company optimizes the
routing of calls over the least cost route on its switch for over 230
countries. In the event that traffic cannot be handled over the least cost
route due to capacity or network limitations, the least-cost routing system is
designed to transmit the traffic over the next least cost route. The least-
cost routing system analyzes several variables that may affect the cost of a
long distance call, including different suppliers, different time zones and
multiple choices of terminating carrier in each country. In some instances,
instead of routing a call directly between two overseas points, the least-cost
routing system may backhaul an overseas carrier's minutes using resold
switched services to the Company's U.S.-based switch in order to terminate the
traffic in a third country while taking advantage of the Company's competitive
U.S.-based international long distance rates. The least-cost routing system is
continually reviewed in light of rates available from different suppliers to
different countries to determine whether the Company should add new suppliers
to its switch to further reduce the cost of routing traffic to a specific
country and to maintain redundancy, diversity and quality within the switching
network.
INTERNET NETWORK
The Company operates a national Internet network comprised of a leased DS3
45 megabits per second backbone of high speed fiber optic lines connecting
eight major cities across the U.S., and leased dedicated T1 fiber optic lines
connecting smaller cities to the network. The network backbone uses state-of-
the-art routing platforms including Cisco Series 7000 routers and Nortel ERS
Magellan switches. The DS3 backbone connects traffic at four major Internet
"meet" points where the Company maintains switching and routing equipment and
has peering arrangements to exchange Internet traffic with over 50 other
Internet backbone providers. To minimize the potential detrimental effects of
single points of failure, the Company deploys a minimum of two dedicated
leased data lines to each backbone node and remotely positions secondary
servers for all configuration and authentication hosts. Multiple data segments
are used in high traffic areas to minimize packet loss and to reduce the
frequency of congestion in the network. Also, major IDT backbone nodes employ
routing switches for directing network traffic. To further enhance network
performance, the Company employs an "Open Shortest Path First" protocol, which
allows data traffic to be routed most efficiently.
The Company seeks to retain flexibility and to maximize its opportunities by
utilizing a continuously changing mix of routing alternatives. This
diversified approach is intended to enable the Company to take advantage of
the rapidly evolving Internet market in order to provide low-cost service to
its customers.
The Company utilizes the local dial-up switching infrastructure of several
Alliance Partners across the country to supplement the Company's owned and
operated local dial-up infrastructure. The Alliance Partners, which are
independently-owned Internet service providers, employ routing and modem
equipment which meet the Company's standards for providing dial-up access
services. The Company offers the Alliance Partners a
19
monthly fee for each customer account routed through their local access
networks. The Company also provides billing, advertising, marketing and
customer acquisition services, in exchange for which the Alliance Partners
provide local Internet access. The agreements with Alliance Partners generally
have one year terms and do not prohibit the Company from constructing its own
local installed POP where warranted.
The Company entered into an agreement with PSINet Inc. ("PSINet") in June
1996 to use PSINet as the primary Alliance Partner for the Company's dial-up
Internet access customers in areas where PSINet has POPs and where there are
no other Alliance Partners. The Company leases and operates a dedicated T3
connection to the PSINet network in order to maintain control of the Company's
provisioning of customers and to provide customers with access to electronic
mail and newsfeeds. Through the buildout of its own infrastructure and its
agreement to utilize the PSINet network as well the local networks of its
Alliance Partners, IDT now operates one of the nation's largest networks,
providing local dial-up Internet access through more than 450 POPs, of which
the Company owns more than 75 POPs.
RESEARCH AND DEVELOPMENT
The Company employs a technical staff that is devoted to the improvement and
enhancement of the Company's existing telecommunications and Internet products
and services, including switching technologies and the development of new
technologies and products, such as Net2Phone and Net2Phone Direct. The
Company's current research and development projects include the development of
switching and compression technologies that are designed to increase the
efficiency of the Company's telecommunications network. The Company believes
that the ability to adjust and improve existing technology and to develop new
technologies in response to, and in anticipation of, customers' changing
demands is necessary to compete in the rapidly changing telecommunications and
Internet industries. There can be no assurance that the Company will be able
to successfully develop new technologies or effectively respond to
technological changes or new industry standards or developments on a timely
basis, if at all.
COMPETITION
The markets in which the Company operates are extremely competitive and can
be significantly influenced by the marketing and pricing decisions of the
larger industry participants. The barriers to entry are not insurmountable in
any of the markets in which the Company competes. The Company expects
competition in these markets to intensify in the future.
TELECOMMUNICATIONS
The market for prepaid calling cards has become highly competitive. IDT
competes with both the larger established telecommunications companies as well
as with the smaller, emerging carriers in the prepaid calling card market.
Included among the Company's competitors are Star Telecommunications, Inc.,
RSL Communications, Ltd., SmarTalk Teleservices, Inc. and Pacific Gateway
Exchange, Inc. Furthermore, as the Company continues to expand its operations
into foreign markets it will compete with the dominant PTTs in those markets
With respect to its other telecommunication services, the Company competes
with (i) interexchange carriers and other long distance resellers and
providers, including large carriers such as AT&T, MCI WorldCom and Sprint;
(ii) foreign PTTs; (iii) other providers of international long distance
services such as STAR Telecommunications, Inc., Pacific Gateway Exchange,
Inc., RSL Communications Ltd. and Telegroup, Inc.; (iv) alliances that provide
wholesale carrier services, such as Global One (Sprint, Deutsche Telekom AG
and France Telecom S.A.) and Uniworld (AT&T, Unisource-Telecom Netherlands,
Telia AB, Swiss Telecom PTT and Telefonica de Espana S.A.); (v) new entrants
to the domestic long distance market such as the regional bell operating
companies in the U.S., who have announced plans to enter the U.S. interstate
long distance market pursuant to recent legislation conditionally authorizing
such entry, and utilities such as RWE Aktiengesellschaft in Germany; and (vi)
small long distance resellers. Moreover, some of the Company's competitors
have
20
announced business plans similar to the Company's regarding the expansion of
telecommunications networks into Europe. Many of the Company's competitors are
significantly larger and have substantially greater market presence, as well
as greater financial, technical, operational, marketing and other resources
and experience than the Company.
The Company competes for customers in the telecommunications markets
primarily based on price and, to a lesser extent, the type and quality of
service offered. Increased competition could force the Company to reduce its
prices and profit margins if its competitors are able to procure rates or
enter into service agreements that are comparable to or better than those the
Company obtains, or are able to offer other incentives to existing and
potential customers. Similarly, the Company has no control over the prices set
by its competitors in the long distance resale carrier-to-carrier market.
INTERNET ACCESS
The Company's current and prospective competitors in the Internet access
market include many large companies that have substantially greater market
presence, as well as greater financial, technical, operational, marketing and
other resources and experience than the Company. The Company's Internet access
business competes or expects to compete directly or indirectly with several
types of companies: (i) other national and regional commercial Internet
service providers, such as NETCOM On-Line Communication Services, Inc.
("NETCOM"); (ii) established online services companies that offer Internet
access, such as America Online, Inc. ("AOL"), CompServe Interactive Services,
Inc. ("CompuServe"), and Prodigy Communications Corporation ("Prodigy"); (iii)
computer software and technology companies such as Microsoft; (iv) national
long distance telecommunications carriers, such as AT&T, MCI WorldCom and
Sprint; (v) regional bell operating companies; (vi) cable television
operators, such as Comcast Corporation ("Comcast"), Tele-Communications, Inc.
("TCI") and Time Warner Inc. ("Time Warner"); (vii) nonprofit or educational
Internet service providers; (viii) newly-licensed providers of spectrum-based
wireless data services; and (ix) competitive local telephone service providers
such as AT&T, Teleport Communications Group Inc. ("TCG") and MCI WorldCom.
The Company believes that its ability to compete successfully in the
Internet access market depends upon a number of factors including: (i) market
presence; (ii) the adequacy of the Company's customer support services; (iii)
the capacity, reliability and security of its network infrastructure; (iv) the
ease of access to and navigation of the Internet; (v) the pricing policies of
its competitors and suppliers; (vi) regulatory price requirements for
interconnection to and use of existing local exchange networks by Internet
service providers; (vii) the timing of introductions of new products and
services by the Company and its competitors; (viii) the Company's ability to
support existing and emerging industry standards; and (ix) trends within the
industry as well as the general economy. There can be no assurance that the
Company will have the financial resources, technical expertise or marketing
and support capabilities to continue to compete successfully in the Internet
access market.
INTERNET TELEPHONY
The market for Internet telephony services is expected to be extremely
competitive. Most of the current Internet telephony products enable voice
communications over the Internet between two parties simultaneously connected
to the Internet via multimedia PCs, where both parties are using identical
Internet telephony software products. Current product offerings include
VocalTec's Internet Phone, QuarterDeck WebPhone and Microsoft's NetMeeting. In
addition, a number of large, well-capitalized companies such as Intel, Cisco,
Lucent, Nortel and Dialogic have announced their intentions to offer server-
based products that are expected to allow communications over the Internet
between parties using a multimedia PC and a telephone and between two parties
using telephones where both parties have specialized servers at each end of
the call. Several other companies, such as AT&T, Sprint and Qwest
Communications, have recently commenced offering or announced plans to offer
Internet telephony products and services. There can be no assurance that the
Company will be able
21
to successfully compete in the developing Internet telephony market, or that
other large companies will not enter the market as suppliers of Internet
telephony services or equipment. In addition, the Company's competitors may
introduce products that permit origination and termination of calls at a
telephone through the Internet.
REGULATION
TELECOMMUNICATIONS
As a multinational telecommunications company, the Company is subject to
varying degrees of regulation in each of the jurisdictions in which it
operates. As a non-dominant carrier lacking substantial power to influence
market prices in the U.S., the Company's provision of international and
domestic long distance telecommunications services in the U.S. is generally
subject to less regulation than a carrier that has such power. Despite recent
trends toward deregulation, some of the countries in which the company intends
to provide telecommunications services do not currently permit the Company to
provide public switched voice telecommunications services. In those countries
in which the Company operates that are not yet open to public switched voice
service competition, the Company provides services to closed user groups and a
variety of value-added services, as permitted by each country's laws.
Regulation of Domestic Telecommunications Services. In the U.S., provision
of the Company's services is subject to the provisions of the Communications
Act, as amended by the Telecommunications Act of 1996 (the "Telecommunications
Act") and the FCC regulations promulgated thereunder, as well as the
applicable laws and regulations of the various states administered by the
relevant state authorities. The recent trend in the U.S., for both federal and
state regulation of telecommunications service providers, has been in the
direction of reducing regulation. Nonetheless, the FCC and relevant state
authorities continue to regulate ownership of transmission facilities,
provision of services and the terms and conditions under which the Company's
services are provided. Non-dominant carriers, such as the Company, are
required by federal and state law and regulations to file tariffs listing the
rates, terms and conditions for the services they provide. In October 1996,
the FCC adopted an order (the "Detarriffing Order") which eliminated the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate services. The Detariffing
Order has been appealed to the U.S. Court of Appeals for the D.C. Circuit, and
a stay has been issued pending a decision on the merits of the appeal. It is
unclear when the Court will rule on the appeal.
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of
universal telephone service (the "Universal Service Order"). The Universal
Service Order requires all telecommunications carriers providing interstate
telecommunications services to contribute to universal support by contributing
to (i) a fund for schools and libraries, (ii) a fund for rural health care and
(iii) a fund for the development of regions characterized by high
telecommunications costs and low income levels (collectively, the "Universal
Service Funds"). These contributions became due beginning in 1998 for all
providers of interstate telecommunications services. Such contributions are
assessed based on certain defined intrastate, interstate and international end
user telecommunications revenues. Contribution factors vary quarterly, and
carriers, including the Company, are billed each month. Contribution factors
for 1998 have ranged from 3.19% to 3.14% for the high cost and low income fund
(interstate and international gross end user telecommunications revenues) and
0.72% and 0.76% for the schools, libraries and rural health care funds
(intrastate, interstate and international gross end user telecommunications
revenues), respectively. In addition, many state regulatory agencies have
instituted proceedings to revise state universal support mechanisms to make
them consistent with the requirements of the Telecommunications Act. As a
result, the Company will be subject to state, as well as federal, universal
service fund contribution requirements, which will vary from state to state.
Several parties have appealed the FCC's May 8th order, and these appeals have
been consolidated in the U.S. Court of Appeals for the Fifth Circuit. In
addition, a number of telecommunications companies have filed a petition for
stay with the FCC, which is currently pending.
Pursuant to the Universal Service Order, all carriers are required to submit
a Universal Service Fund worksheet in March and September of each year. The
Company has filed each of its Universal Service Fund
22
worksheets. The amounts remitted to the Universal Service Fund may be billed
to the Company's customers. If the Company does not bill these amounts to its
customers, its profit margins may be less than if it had elected to do so.
However, if the Company elects to bill these amounts to its customers,
customers may reduce their use of the Company's services, or elect to use the
services provided by the Company's competitors, which may have a material
adverse effect upon the Company's business, financial condition, or results of
operations.
The FCC recently instituted a rulemaking proceeding in which it is
determining whether to allow the regional bell operating companies to provide
advanced data services (certain of which are currently provided by the
Company) through a structurally separated and largely deregulated subsidiary.
Such companies are currently barred from providing such services, except under
certain limited circumstances. The proposed rulemaking would not permit the
provision of such services to cross the boundaries of the approximately 200
local telephone calling areas that were created in 1984 in connection with the
divestiture by AT&T of the regional bell operating companies. If the FCC
adopts such a rule, it could have a material adverse affect on the Company by
enabling the regional bell operating companies to more effectively compete
with the Company with respect to these services.
In addition to regulation by the FCC, the majority of the states require the
Company to register or apply for certification prior to initiating intrastate
interexchange telecommunications services. To date, the Company, together with
its subsidiaries, is authorized through certification, registration or on a
deregulated basis to provide intrastate interexchange telecommunications
services in 47 states. State issued certificates of authority to provide
intrastate interexchange telecommunications services can generally be
conditioned, modified, canceled, terminated or revoked by state regulatory
authorities for failure to comply with state law and/or the rules, regulations
and policies of the state regulatory authorities. Fines and other penalties
also may be imposed for such violations.
U.S. Regulation of International Telecommunications Services. International
common carriers, such as the Company, are required to obtain authority under
Section 214 of the Communications Act and file a tariff containing the rates,
terms and conditions applicable to their services prior to initiating their
international telecommunications services. The Company has obtained a global
Section 214 authority from the FCC to use, on a facilities and resale basis,
various transmission media for the provision of international switched and
private line services. Non-dominant international carriers such as the Company
must file their international tariffs and any revisions thereto with one day's
notice. Additionally, international telecommunications service providers are
required to file copies of their contracts with other carriers, including
foreign carrier agreements, with the FCC within 30 days of execution. The
FCC's rules also require that the Company file periodically a variety of
reports regarding the volume of its international traffic and revenues and use
of international facilities. In addition to the general common carrier
principles, and as discussed below, the Company is also required to conduct
its facilities-based international business in compliance with the FCC's
International Settlements Policy (the "IS Policy"), or an FCC approved
alternative settlement arrangement.
The Company's FCC authorizations also permit the Company to resell
international private lines interconnected to the PSTNs for the provision of
switched services in those countries that have been found by the FCC to offer
"equivalent opportunities" to U.S., carriers or to WTO member countries
without a finding of equivalency where certain settlement rate requirements
are met. To date, the FCC has approved interconnected international private
line resale to Canada, the U.K., Sweden, Australia, the Netherlands, New
Zealand, Germany, France, Belgium, Denmark, Luxembourg, Norway, Austria,
Switzerland, Italy, Japan and Hong Kong for facsimile and data services only.
The FCC currently imposes certain restrictions upon the use of the Company's
private lines between the U.S. and such approved countries. The Company may
not route traffic to or from the U.S. over a private line between the U.S. and
an "approved" country (such as the U.K.) if such traffic originates or
terminates in a third non-"approved" country at rates that are not publicly
available. Following implementation of the Full Competition Directive by
member states of the European Union (the "European Union"), and the WTO
Agreement by the signatories, the FCC may authorize the Company to originate
and terminate traffic over its private line between the U.S. and the U.K. and
(pursuant to ISR authority) over additional private lines to additional
countries.
23
The FCC administers a variety of international service regulations,
including the IS Policy. The IS Policy governs the permissible arrangements
between U.S. carriers and their foreign correspondents to settle the cost of
terminating traffic over each other's networks, the rates for such settlement
and permissible deviations from these policies. As a consequence of the
increasingly competitive global telecommunications market, the FCC has adopted
a number of policies that permit carriers to deviate from the IS Policy under
certain circumstances that promote competition. The FCC also requires carriers
such as the Company to report any affiliations, as defined by the Commission,
with foreign carriers.
The Company offers its call reorigination services pursuant to an FCC
authorization (the "Section 214 Switched Voice Authorization") under Section
214 of the Communications Act and certain relevant FCC decisions. The FCC has
determined that call reorigination services that use uncompleted call
signaling do not violate U.S. or international law, but has held that U.S.
companies providing such services must comply with the laws of the countries
in which they operate as a condition of such companies' Section 214 Switched
Voice Authorizations. The FCC reserves the right to condition, modify or
revoke any Section 214 Authorizations and impose fines for violations of the
Communications Act or the FCC's regulations, rules or policies promulgated
thereunder, or for violations of the clear and explicit telecommunications
laws of other countries that are unable to enforce their laws against call
reorigination using uncompleted call signaling. FCC policy provides that
foreign governments that satisfy certain conditions may request FCC assistance
in enforcing their laws against call reorigination providers based in the U.S.
that are violating the laws of these jurisdictions. 30 countries have formally
notified the FCC that call reorigination services violate their laws. The FCC
has held that it would consider enforcement action against companies based in
the U.S. engaged in call reorigination by means of uncompleted call signaling
in countries where this activity is expressly prohibited. The FCC has granted
a complaint by the Philippines Long Distance Company, Inc. and required U.S.
carriers to stop providing call reorigination to customers in the Philippines.
This decision is subject to petitions for reconsideration. There can be no
assurance that the FCC will not take further action in the future. Enforcement
action could include an order to cease providing call reorigination services
in such country, the imposition of one or more restrictions on the Company,
monetary fines or, in extreme circumstances, the revocation of the Company's
Section 214 Switched Voice Authorization, and could have a material adverse
effect on the Company's business, financial condition and results of
operations. The FCC is currently considering a petition filed by the
Telecommunications Resellers Association requesting that the FCC cease
enforcing foreign laws against call reorigination.
Regulatory requirements pertinent to the Company's operations will continue
to evolve as a result of the WTO Agreement, federal legislation, court
decisions, and new and revised policies of the FCC. In particular, the FCC
continues to refine its international service rules to promote competition,
reflect and encourage liberalization in foreign countries and reduce
international accounting rates toward cost. Indeed, the FCC recently adopted
new lower accounting rate benchmarks that became effective on January 1, 1998.
Under the FCC's new benchmarks, after a transition period of one to four years
depending on a country's income level, U.S. carriers may be required to pay
foreign carriers significantly lower rates for the termination of
international services. These rates range from a $0.15/minute benchmark for
upper income countries such as the U.K. to $0.23/minute for lower income
countries such as China. Moreover, the FCC has recently revised its Foreign
Carrier Entry Policy as part of its efforts to change its rules to implement
the WTO Agreement.
To date, the FCC has made no pronouncement as to whether refiling
arrangements are inconsistent with the regulations of the U.S. or the
International Telecommunication Union (the "ITU"), and a 1995 petition to the
FCC for declaratory ruling regarding Sprint's Fonaccess service was recently
withdrawn. Although it is possible that the FCC will determine that refiling
violates U.S. and/or international law and that such a finding could have a
material adverse effect on the Company's business, operating results and
financial condition, the FCC currently is not considering such issues in any
active proceeding.
European Regulation of Telecommunications Services. In Europe, the
regulation of the telecommunications industry is governed at a supranational
level by the European Union. The European Union's institutions, such as the
European Commission, are responsible for creating pan-European policies.
Through its legislation, the European Union has developed a regulatory
framework aimed at creating an open, competitive
24
telecommunications market. The European Union was established by the Treaty of
Rome and subsequent conventions and the European Commission and the Council of
Ministers of the European Union are authorized by such treaties to issue
European Union "directives." European Union member states are required to
implement these directives through national legislation. If an European Union
member state fails to adopt such directives, the European Commission may take
action, including referral to the European Court of Justice, to enforce the
directives.
In 1990, the European Union issued the Services Directive requiring each
European Union member state to abolish existing monopolies in
telecommunications services, with the exception of voice telephony. The
intended effect of the Services Directive was to permit the competitive
provision of all services, including value-added services and voice services
to closed user groups, other than public voice telephony. However, as a
consequence of local implementation of the Services Directive through the
adoption of national legislation, there are differing interpretations of the
definition of prohibited voice telephony and permitted value-added and closed
user group services. Voice services accessed by customers through leased lines
are permissible in all European Union member states. The European Commission
has generally taken a narrow view of the services classified as public voice
telephony, declaring that voice services may not be reserved to the ITOs if
(i) dedicated customer access is used to provide the service; (ii) the service
confers new value-added benefits on users; or (iii) calling is limited by a
service provider to a group having legal, economic or professional ties.
In March 1996, the European Union adopted the Full Competition Directive
containing two provisions which required European Union member states to allow
the creation of alternative telecommunications infrastructures by July 1,
1996, and which reaffirmed the obligation of European Union member states to
abolish the ITOs' monopolies in voice telephony by 1998. The Full Competition
Directive encouraged European Union member states to accelerate the
liberalization of voice telephony. Certain European Union countries were
allowed to delay the abolition of monopolies in public voice telephony based
on exemptions established in the Full Competition Directive. These countries
include Luxembourg (July 1998), Spain (December 1998), Portugal and Ireland
(January 2000) and Greece (January 2002). Subsequently, Ireland has decided to
liberalize its regulations as of an earlier date, January 1, 1999. The
European Commission has brought infringement proceedings against the following
countries for failure to comply with European Union Directives: Belgium,
Denmark, Greece, Italy, Luxembourg and Portugal.
In addition to the foregoing regulations, the European Union has adopted the
Interconnection Directive and the Licensing Directive. These measures attempt
to harmonize telecommunications regulations among the member states of the
European Union. The Interconnection Directive provides that ITOs are obliged
to interconnect with other operators requesting to do so, and to enter into
such arrangements on transparent, objective and non-discriminatory terms.
Disputes over interconnection rates, terms and conditions have arisen in
several member states, and there can be no guarantee that they will be
resolved in a manner that will not have a material adverse effect on the
Company's operations in Europe. The Licensing Directive provides for the
establishment of a national regulatory authority independent of the ITO in
each member state of the European Union, and provides that member states may
reject applications for licenses only upon certain narrowly-defined grounds.
Each European Union member state in which the Company currently conducts or
plans to conduct its business has a different regulatory regime, and such
differences have continued beyond January 1998. The requirements for the
Company to obtain necessary approvals vary considerably from one member state
to another and are likely to change as competition is permitted in new service
sectors. In addition, member states may require individual licenses for
reserved public telephony services and the creation of alternative
infrastructure, but not for data, value-added or closed user group services.
In connection with the growth of its European operations, the Company has
obtained a number of licenses to provide telecommunications services in
Europe. Through its U.K. subsidiary, IDT Global Limited ("IDT Global"), the
Company has obtained a license to provide international simple voice resale
services in the U.K., and a license to operate international
telecommunications facilities in the U.K. IDT Global has also obtained a
25
license to provide voice telephony services in Germany. In addition, IDT has
commenced the process of applying for the appropriate licenses and
registrations to provide voice telecommunications services in France and
Ireland.
IDT Global has been registered to provide voice telecommunications services
in The Netherlands. However, the Company has requested that the applicable
authorities of The Netherlands postpone the commencement date of the
registration until December 1998, in order to coincide with the time at which
the Company would be prepared to commence delivering such services in The
Netherlands. The Company cannot provide any assurances as to whether such
authorities would grant any additional requests by the Company to postpone
this registration. A decision by such authorities not to grant any such
postponement could substantially delay the Company's efforts to provide
telecommunications services in The Netherlands.
Other Overseas Markets. The Company is subject to the regulatory regimes in
each of the countries in which it conducts business. Local regulations range
from permissive to restrictive, depending upon the country. In the past, the
Company has experienced problems in certain countries and has, in certain
instances, modified or terminated its services to comply with local regulatory
requirements.
INTERNET ACCESS
Internet service providers are generally considered "enhanced service
providers" within the U.S. and are exempt from U.S. federal and state
regulations governing common carriers. Accordingly, the Company's provision of
Internet access services are currently exempt from tariffing, certification
and rate regulation. Nevertheless, regulations governing disclosure of
confidential communications, copyright, excise tax, and other requirements may
apply to the Company's provision of Internet access services. The Company
cannot predict the likelihood that state, federal or foreign governments will
impose additional regulation on the Company's Internet business, nor can it
predict the impact that future regulation will have on the Company's
operations.
The 1996 Telecommunications Act imposes criminal liability on persons
sending or displaying indecent material on an interactive computer service
such as the Internet in a manner available to minors. The 1996
Telecommunications Act also imposes criminal liability on an entity knowingly
permitting facilities under its control to be used for such activities.
Entities solely providing access to facilities not under their control are
exempted from liability, as are service providers that take good faith,
reasonable, effective and appropriate actions to restrict access by minors to
the prohibited communications. The constitutionality of these provisions has
been successfully challenged in federal appellate court, and their
interpretation and enforcement is uncertain. The Telecommunications Act may
chill the development of Internet content or have other adverse effects on
Internet service providers such as the Company. In addition, in light of the
uncertainty attached to interpretation and application of this law, there can
be no assurances that the Company would not have to modify its operations to
comply with the statute, including, among other things, prohibiting users from
maintaining home pages on the Web.
In December 1996, the FCC initiated a Notice of Inquiry regarding whether to
impose regulations or surcharges upon providers of Internet access and
Information Service. The Notice of Inquiry, and several ongoing FCC
proceedings, seek public comment as to whether to impose or to continue to
forebear from regulation of Internet and other packet-switched network service
providers. The Notice of Inquiry specifically identifies Internet telephony as
a subject for FCC consideration. In addition, in April 1998, the FCC issued a
Report to Congress on its implementation of the universal service provisions
of the Telecommunications Act. In its report, the FCC indicated that it would
reexamine its policy of not requiring Internet service providers to contribute
to the universal service mechanisms when they provide their own transmission
facilities and engage in data transport over those facilities in order to
provide an information service. Any such contribution would be related to the
Internet service provider's provision of telecommunications services itself.
The Company can not predict the outcome of any future proceedings that may
impact the Company's provision of Internet access or that may impose
additional requirements, regulations or charges upon IDT's provision of such
services.
INTERNET TELEPHONY
The use of the Internet to provide telephone service is a recent
development. Currently, the FCC is considering whether or not to impose
surcharges or additional regulations upon certain providers of Internet
26
telephony. In April 1998, the FCC issued its report to Congress concerning its
implementation of the universal service provisions of the Telecommunications
Act. In the report, the FCC indicated that it would examine the question of
whether certain forms of "phone-to-phone" Internet protocol telephony are
information services or telecommunications services. It noted that the FCC did
not have, as of the date of the report, an adequate record on which to make
any definitive pronouncements, but that the record before it suggested that
certain forms of phone-to-phone Internet telephony appear to have the same
functionality as non-Internet protocol telecommunications services and lack
the characteristics that would render them information services. If the FCC
were to determine that certain services are subject to FCC regulations as
telecommunications services, the FCC noted that it may find it reasonable to
require Internet service providers to make universal service contributions,
pay access charges or to be subject to traditional common carrier regulation.
In September 1998, two regional bell operating companies, BellSouth
Corporation and US West, Inc., advised companies providing Internet telephony
services that they will impose access charges on such traffic. It is not known
at present whether these companies will in fact impose such charges, and if
they do so, when such charges will take effect. In addition, while an effort
to impose such charges is subject to challenge, in light of the uncertainty of
the FCC's regulations with respect thereto. However, if the regional bell
operating companies successfully impose such charges, it would have a
materially adverse affect on the development of the Company's Internet
telephony business if such surcharges reduced the cost savings available to
users of Internet telephony services compared to the costs of traditional
telephone services.
To the Company's knowledge, there are currently no domestic and few foreign
laws or regulations that prohibit voice communications over the Internet.
Several efforts have been made to enact federal legislation that would either
regulate or exempt from regulation services provided over the Internet. State
public utility commissions may also retain jurisdiction to regulate the
provision of intrastate Internet telephony services, and could initiate
proceedings to do so. A number of countries that currently prohibit
competition in the provision of voice telephony have also prohibited Internet
telephony. Other countries permit but regulate Internet telephony. If
Congress, the FCC, state regulatory agencies, foreign governments or
supranational bodies begin to regulate Internet telephony, there can be no
assurances that any such regulation will not materially adversely affect the
Company's business, financial condition or results of operations.
INTELLECTUAL PROPERTY
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The Company relies
on a combination of patent, copyright, trademark and trade secret laws and
contractual restrictions to establish and protect its technology. The Company
does not currently have any issued patents or registered copyrights. The
Company's policy is to require its employees and consultants to execute
confidentiality agreements upon the commencement of their relationships with
the Company. These agreements provide that confidential information developed
or made known during the course of a relationship with the Company is to be
kept confidential and may not be disclosed to third parties except in specific
circumstances. There can be no assurance that the steps taken by the Company
will be adequate to prevent misappropriation of its technology or other
proprietary rights or that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's technology. In addition, there can be no assurance that licenses for
any intellectual property that might be required by the Company for it to
provide its services or products would be available on reasonable terms, if at
all.
The Company owns registered service marks for the mark IDT and design and
for the mark Net2Phone. In addition, the Company has applications pending with
respect to the registration of the service marks relating to its Internet
telephony business and trademarks relating to its prepaid calling card
business.
The Company has applied for a patent in connection with its development of
the systems and methodology comprising the technologies underlying Net2Phone.
There can be no assurance that the Company's competitors will not develop the
ability to provide similar or better services than that of Net2Phone. In
addition, there can be no assurance that the Company's patent application
relating to the systems and methodology comprising the technologies underlying
Net2Phone will result in any patent being issued or that, if issued, such
patent will
27
provide protection against competitive technology or that it will be held
valid and enforceable if challenged. There can be no assurance that the
Company's competitors would not be able to design around such patent or that
others will not obtain patents that the Company would need to license or
circumvent in order to exploit its patent.
In addition, the Company has entered into an agreement pursuant to which it
has received a non-exclusive license to utilize in certain European countries
the technologies covered by a European patent relating to the processing of
calls made with prepaid calling cards. Under the agreement, the Company is
entitled to receive royalties from companies selling prepaid calling cards in
Europe who acquire license rights under the patent or against which the patent
is successfully enforced. Under the patent agreement, the Company is permitted
to grant sublicenses with respect to prepaid calling cards in Europe, and
receive royalties from such sublicenses. The Company expects that this
arrangement will be attractive to European carriers because it will enable
them to fulfill demand for their services without raising their total costs,
and the Company believes that it will help to accelerate the growth of its
carrier business in Europe.
The Company has received correspondence from a company that claims to own a
registered U.S. trademark, which asserts that the Company's use of the mark
"Net2Phone" in connection with its Internet telephony services infringes the
relevant trademark, and requests that the Company cease and desist from using
the mark. The trademark in question does not purport to relate to Internet
telephony services, and no legal proceedings have been commenced against the
Company with respect to this matter.
EMPLOYEES
As of October 16, 1998, the Company had approximately 712 full-time
employees, including approximately 335 in technical support and customer
service, 100 in sales and marketing, 70 in its technical staff, 111 in general
operations and 96 in management and finance. The Company believes that its
relations with its employees are good. None of the Company's employees is
represented by a labor union or covered by a collective bargaining agreement
and the Company has never experienced a work stoppage.
ITEM 2. PROPERTIES
The Company's principal facilities total approximately 66,000 square feet
and are located in three buildings in Hackensack, New Jersey. The Company also
leases space (typically less than 500 square feet) in various geographic
locations to house the telecommunications equipment for each of its POPs. The
Company occupies one building under a lease which expires on June 30, 1999.
The Company leases this facility from an entity in which Howard S. Jonas, the
Company's Chairman and Chief Executive Officer, is the sole stockholder. The
Company occupies facilities in a second building pursuant to a lease which
expires on April 30, 2002 and occupies office space in a third building,
pursuant to a lease with an entity controlled by Mr. Jonas, which expires in
December 1998; the Company plans to renew the lease for an additional two year
term. The Company's 51% owned subsidiary, Union, occupies approximately 4,000
square feet of space pursuant to a ten year sublease agreement. The Company
recently entered into a three year lease agreement with Parkway Seventy
Associates in Lakewood, New Jersey for 3,500 square feet to house
telecommunications equipment and offices related to other telecommunications
services.
IDT's recently acquired subsidiary, InterExchange, occupies approximately
20,000 square feet of space at facilities located in Piscataway, New Jersey.
Prior to the Company's acquisition of InterExchange, InterExchange exercised
an option, pursuant to a lease agreement relating to such property, to
purchase the building and property which includes the currently leased
facilities. The purchase price has yet to be determined but is expected to be
between $6.0 million and $10.0 million. The parties are proceeding with an
appraisal process in order to determine the amount required to be paid.
ITEM 3. LEGAL PROCEEDINGS.
In December 1995, Surfers Unlimited, L.L.C. filed a breach of contract
action in the New Jersey Superior Court, Bergen County. The suit names a
subsidiary of the Company as defendant and seeks restitutional and
consequential damages in an unspecified amount for interference with
prospective business advantages, breach
28
of contract and improper use of confidential and proprietary information.
Howard S. Jonas, the Chairman and Chief Executive Officer of the Company, has
also been named as a defendant in the action. The Company's subsidiary has
filed a counterclaim based on interference with prospective business
advantages, breach of contract and improper use of confidential and
proprietary information. The suit is currently in the discovery phase, which
is scheduled to end in February 1999; a trial date has not been scheduled to
date.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey Superior Court, Bergen County. Howard S. Jonas,
the Chairman and Chief Executive Officer of the Company, has also been named
as a defendant in the action. The action claims that the Company has made
hiring and promotion decisions based upon the religious backgrounds of the
relevant individuals, in violation of federal and state law. The complaint
seeks compensatory and punitive damages in an unspecified amount and also
seeks statutory multiples of damages. All of the claims arising under federal
law were dismissed by the Court in New Jersey Superior Court, Bergen County,
leaving the plaintiffs with only the remedies available under state law.
Further, the Court granted the Company permission to file counterclaims
against all plaintiffs for the alleged unlawful taking of business records.
The Company filed such counterclaims in October 1998. Discovery is continuing
and a trial date is scheduled for February 16, 1999.
In June 1997, an uncertified class-action suit seeking compensatory damages
in an unspecified amount was brought against the Company in New York Supreme
Court, New York County. The suit concerns advertisements that are no longer
used by the Company, and advertising practices that were voluntarily
terminated by the Company following a prior investigation of the Company by
the Attorneys General of several states. A motion to dismiss is presently
pending before the Court.
In September 1997, DigiTEC 2000, Inc. ("DigiTEC") filed a complaint
(subsequently amended) in New York Supreme Court, New York County against the
Company alleging that in connection with its sale of prepaid calling cards,
the Company engaged in unfair competition and tortiously interfered with an
exclusive business relationship between DigiTEC and two co-defendants, CG Com,
Inc. and Mr. Carlos Gomez. The complaint seeks compensatory and consequential
damages in an unspecified amount and also seeks an unspecified amount of
punitive damages. The complaint also alleges that CG Com, Inc. and Mr. Gomez
owe DigiTEC more than $500,000. In November 1997, the Court denied DigiTEC's
motion for a preliminary injunction to bar CG Com, Inc. and Mr. Gomez from
distributing the Company's calling cards. DigiTEC has settled its claims
against CG Com, Inc. and Mr. Carlos Gomez, and therefore, the Company is the
only remaining defendant. DigiTEC and the Company have agreed in principle to
settle this action and are currently engaged in finalizing the settlement
agreement.
The Company filed a lawsuit against Mr. Glen Miller in August 1997 in the
New Jersey Superior Court, Bergen County. The action was based upon various
matters arising out of Mr. Miller's employment with IDT. Mr. Miller answered
the complaint and filed a counterclaim against the Company seeking
compensatory and punitive damages for breach of his employment contract and
breach of the covenant of good faith and fair dealing. Mr. Miller alleges that
the Company breached his employment agreement by failing to compensate him as
contemplated by his employment agreement, including by failing to deliver to
him 20,000 shares of the Company's Common Stock. Mr. Miller also filed a
third-party complaint against Howard Balter, the Chief Operating Officer of
the Company, and Jonathan Rand, the Company's former Director of Human
Resources, for fraudulent conduct and misrepresentation. The Company filed its
answer to Mr. Miller's counterclaim in December 1997. In January 1998, the
Court partially granted Mr. Miller's motion for summary judgment, awarding him
severance pay in the amount of approximately $50,000. The Company's motion for
leave to appeal this award has been denied, and the action is currently in the
discovery phase. A trial date has been scheduled for February 1999.
The Company is subject to other legal proceedings and claims which have
arisen in the ordinary course of its business and have not been finally
adjudicated. Although there can be no assurances in this regard, in the
opinion of the Company's management, such proceedings, as well as the
aforementioned actions, will not have a material adverse effect on results of
operations or the financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
29
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Common Stock has traded publicly on the Nasdaq National Market under the
symbol "IDTC" since March 15, 1996, the date of the Company's initial public
offering. The table below sets forth the high and low sales prices for the
Common Stock as reported by the Nasdaq National Market for the fiscal periods
indicated.
HIGH LOW
------ ------
FISCAL YEAR ENDED JULY 31, 1996
Third Quarter (from March 15, 1996)............................ $11.75 $ 6.75
Fourth Quarter................................................. 16.00 8.50
FISCAL YEAR ENDING JULY 31, 1997
First Quarter.................................................. $17.50 $10.25
Second Quarter................................................. 15.75 8.50
Third Quarter.................................................. 8.75 4.00
Fourth Quarter................................................. 9.25 5.25
FISCAL YEAR ENDING JULY 31, 1998
First Quarter.................................................. $22.13 $ 7.88
Second Quarter................................................. 25.25 15.50
Third Quarter.................................................. 38.13 25.56
Fourth Quarter................................................. 30.00 23.50
On October 27, 1998, the last sale price reported on the Nasdaq National
Market for the Common Stock was $16.625 per share. On the same date, there
were approximately 345 holders of record of the Common Stock. The aggregate
market value of the voting stock held by non-affiliates of the Registrant,
based on the closing price of the Common Stock on October 27, 1998, was
approximately $370 million. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common
Stock (assuming conversion of the Company's outstanding Class A Common Stock
into Common Stock) have been excluded from this computation in that such
persons may be deemed to be affiliates of the Company. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
The Company has never declared or paid any dividends on its Common Stock and
does not expect to pay dividends for the foreseeable future. The Company's
current policy is to retain all of its earnings to finance future growth. Any
future declaration of dividends will be subject to the discretion of the Board
of Directors of the Company. The availability of funds for the payment of
dividends by the Company is dependent on dividends the Company may receive
from its subsidiaries, which is subject to certain limitations under state
laws. In addition, the Indenture relating to the Company's Notes imposes
certain restrictions upon the Company's ability to declare dividends on its
Common Stock while the Notes are outstanding.
30
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for each of the
five years in the period ended July 31, 1998 has been derived from the
Company's consolidated financial statements, which have been audited by Ernst
& Young LLP, independent auditors. The selected consolidated financial data
should be read in conjunction with the Consolidated Financial Statements and
the Notes thereto and other financial information appearing elsewhere in this
Report.
YEAR ENDED JULY 31
----------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Telecommunications.......... $ 3,169 $10,789 $ 35,708 $ 99,937 $303,864
Internet.................... -- 875 21,986 32,895 20,001
Net2Phone................... -- -- -- 2,355 11,508
------- ------- -------- -------- --------
Total revenues............ 3,169 11,664 57,694 135,187 335,373
Costs and expenses:
Direct cost of revenues..... 990 7,544 36,438 92,214 240,860
Selling, general and
administrative............. 2,402 5,992 35,799 41,545 61,970
Acquired research and
development................ -- -- -- -- 25,000
Depreciation and
amortization............... 106 303 1,212 4,873 11,289
------- ------- -------- -------- --------
Total costs and expenses.. 3,498 13,839 73,449 138,632 339,119
Income (loss) from
operations................... (329) (2,175) (15,755) (3,445) (3,746)
Other, net(1)................. 31 30 112 (392) (425)
Income tax benefit.......... -- -- -- -- 1,671
Minority interests.......... -- -- -- -- (3,895)
------- ------- -------- -------- --------
Net income (loss)............. $ (298) $(2,145) $(15,643) $ (3,837) $ (6,395)
------- ------- -------- -------- --------
Net income (loss) per share--
basic and diluted............ $ (.02) $ (.13) $ (.86) $ (.18) $ (.22)
------- ------- -------- -------- --------
Weighted average number of
shares used in calculation
of net income (loss) per
share--basic and diluted..... 16,569 16,569 18,180 21,153 28,571
BALANCE SHEET DATA
Cash and cash equivalents..... $ 754 $ 232 $ 14,894 $ 7,674 $115,284
Working capital (deficit)..... 1,289 (884) 13,547 4,887 166,380
Total assets.................. 2,795 4,197 43,797 58,537 417,196
Long-term debt................ 5,241 101,834
Total stockholders' equity.... 2,062 911 26,843 25,259 238,748
- --------
(1) For Fiscal 1996 and Fiscal 1998, includes extraordinary losses on
retirement of debt of $233 and $132, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
IDT is a leading multinational carrier that provides its wholesale and
retail customers with integrated and competitively priced international and
domestic long distance telecommunications service, Internet access and,
through its Net2Phone products and services, Internet telephony services. IDT
delivers these services over a high-quality network consisting of 60 switches
in the U.S. and Europe and owned and leased capacity on 16 undersea fiber
optic cables. In addition, the Company obtains additional transmission
capacity from other carriers.
The Company delivers its international traffic worldwide pursuant to its
agreements with U.S.-based carriers, foreign carriers, and 17 of the companies
that are primarily responsible for providing telecommunications services in
particular countries (many of which are commonly referred to as "PTTs"). In
addition,
31
IDT maintains a high-speed network that carries Internet traffic in order to
support both its Internet access services and its Internet telephony services.
The Company has grown considerably in recent years, generating revenues of
$57.7 million, $135.2 million and $335.4 million in Fiscal 1996, Fiscal 1997
and Fiscal 1998, respectively.
The Company entered the international call reorigination business in 1990 to
capitalize on the opportunity created by the spread between U.S. and foreign-
originated international long distance telephone rates. IDT leveraged the
expertise derived from, and calling volume generated by, its call
reorigination business to enter the domestic long distance business in late
1993, by reselling long distance services of other carriers to IDT's domestic
customers. As a value-added service for its domestic long distance customers,
the Company began offering Internet access in early 1994, eventually offering
dial-up and dedicated Internet access to individuals and to businesses as
stand-alone services. In 1995, IDT began reselling to other long distance
carriers access to the favorable telephone rates and special tariffs the
Company receives as a result of the calling volume generated by its call
reorigination customers. IDT entered the Internet telephony market in August
1996 with its introduction of Net2Phone, and expanded its Internet telephony
offerings in October 1997 with the introduction of its Net2Phone Direct
service. The Company began marketing its prepaid calling cards in January
1997.
In May 1998, the Company acquired a 51% interest in Union, which distributes
the Company's prepaid calling cards in key markets nationwide. In May 1998,
the Company also acquired InterExchange, an operator of one of the largest
international prepaid calling card platforms in the United States. In
September 1998, the Company entered into a long-term agreement with Frontier
Communications of the West, Inc. ("Frontier") whereby Frontier will provide to
the Company nationwide network bandwidth capacity and maintenance services in
exchange for payments estimated at approximately $52.0 million during the term
of the agreement.
In Fiscal 1997, the Company began to place increased emphasis on its
international telecommunications operations and less emphasis on its Internet
access services. In Fiscal 1998, the Company focused its marketing efforts on
expanding the wholesale services offered to other carriers, developing and
increasing its retail prepaid calling card business and broadening its range
of Internet telephony services and products. As a result of these
developments, the Company's telecommunications revenues as a percentage of
total revenues increased from 73.9% for Fiscal 1997 to 90.6% for Fiscal 1998.
In addition, the Company's revenues from telecommunications operations
increased from $99.9 million during Fiscal 1997 to $303.9 million during
Fiscal 1998. Revenues from the Company's telecommunications operations are
derived primarily from the following activities: (i) prepaid calling cards;
(ii) wholesale carrier services to other long distance carriers; (iii)
international retail long distance services to individuals and businesses
worldwide (primarily provided through call reorigination services); and (iv)
domestic long distance services to individuals and businesses. The Company
generates revenues from the sale of its prepaid calling cards to distributors,
selling them to distributors at a discount to their face values of different
denominations, and recording the sales as deferred revenue until the card user
utilizes the calling time. Revenues from the Company's Internet operations are
derived primarily from providing Internet access services to individuals and
businesses. The Company's Net2Phone revenues are derived from the marketing of
Net2Phone and Net2Phone Direct services and equipment to individuals,
businesses and the Company's foreign partners.
While the Company's most significant customers vary from quarter to quarter,
the Company's five largest customers accounted for 20.8% of revenues in Fiscal
1997, and 26.2% of revenues in Fiscal 1998. Of this group, the customer
accounting for the most revenues during Fiscal 1997 (17.0% of revenues) and
Fiscal 1998 (40.7% of revenues), was an entity controlled by Carlos Gomez,
which ceased to be a customer of the Company when the Company acquired its
interest in Union in May 1998. This concentration of revenues increases the
risk of nonpayment by customers, and other carriers have experienced
significant write-offs related to the provision of wholesale carrier services
in situations in which large customers failed to pay their outstanding
balances. The Company performs ongoing credit evaluations of its customers,
but it generally does not require collateral to support accounts receivable
from its customers.
Direct cost of revenues for the Company's telecommunications services
include costs associated with the transmission and termination of
international and domestic long distance services. Historically, this expense
has
32
primarily been variable, based upon minutes of use, and consists mainly of
payments to other long distance carriers and, to a lesser extent,
customer/carrier interconnect charges, leased fiber circuit charges and switch
facility costs. The direct cost of revenues for Internet access and Net2Phone
services consists primarily of leased circuit and network costs and local
access costs. Direct cost of revenues for Internet services also include fees
paid to the Company's Alliance Partners.
The Company operates a growing facilities-based telecommunications network
consisting of (i) 60 switches in the U.S. and Europe; (ii) owned and leased
transmission capacity on 16 undersea fiber optic cables connecting the
Company's U.S. facilities with its international facilities, and with the
facilities of its foreign partners in Europe, Latin America and Asia; and
(iii) resale capacity obtained on a per-minute basis from other carriers. The
Company seeks to follow a disciplined strategy of establishing significant
traffic volumes prior to investing in fixed-cost facilities. As the Company
expands its network and the volume of its traffic, the cost of revenues will
increasingly consist of fixed costs associated with leased and owned lines, as
well as costs arising from the ownership and maintenance of its switches. The
Company expects that these factors will cause the direct cost of revenues to
decline as a percentage of revenues over time. The fixed nature of these costs
may also lead to larger fluctuations in gross margins, depending on the
minutes of traffic and associated revenues generated by the Company.
Selling expenses consist primarily of sales commissions paid to independent
agents and internal salespersons, which are the primary cost associated with
the acquisition of customers. General and administrative expenses include
salaries, benefits, and other corporate overhead costs. These costs have
increased in recent fiscal years due to the development and expansion of the
Company's operations and corporate infrastructure.
The Company's telecommunications revenues are generally associated with
lower selling, general and administrative expenses than the Company's Internet
revenues, and the Company's revenues from its wholesale sales of
telecommunications services have generally had lower selling, general and
administrative expenses than other types of telecommunications revenues. As a
result of these factors, and as a result of the increasing percentage of the
Company's revenues that are derived from telecommunications services and the
decreased emphasis placed on Internet access services, the Company's selling,
general and administrative expenses generally have declined as a percentage of
total revenues. However, as the Company expects its prepaid calling card and
Internet telephony businesses to grow, it is likely that selling, general and
administrative expenses will also grow as a percentage of revenues.
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items in the Company's statement of operations:
YEAR ENDED JULY
31
-------------------
1996 1997 1998
----- ----- -----
Revenues:................................................. 100.0% 100.0% 100.0%
Telecommunications...................................... 61.9 74.0 90.6
Internet................................................ 38.1 24.3 6.0
Net2Phone............................................... -- 1.7 3.4
Costs and expenses:
Direct cost of revenues................................. 63.2 68.2 71.8
Selling, general and administrative..................... 62.0 30.7 18.5
Acquired research and development....................... -- -- 7.4
Depreciation and amortization........................... 2.1 3.6 3.4
----- ----- -----
Total costs and expenses.............................. 127.3 102.5 101.1
----- ----- -----
Income (loss) from operations............................. (27.3) (2.5) (1.1)
Other (net)............................................... 0.6 (0.3) (0.1)
----- ----- -----
Income (loss) before taxes, minority interests and ex-
traordinary item..................................... (26.7) (2.8) (1.2)
33
FISCAL 1998 COMPARED TO FISCAL 1997
RESULTS OF OPERATIONS
Revenues. Revenues increased 148% from approximately $135.2 million in
Fiscal 1997 to approximately $335.4 million in Fiscal 1998. Telecommunications
revenues increased 204% from approximately $99.9 million in Fiscal 1997 to
approximately $303.9 million in Fiscal 1998. Internet access revenues
decreased 39.2% from approximately $32.9 million in Fiscal 1997 to
approximately $20.0 million in Fiscal 1998, reflecting the Company's decision
in Fiscal 1997 to de-emphasize its activities in this area. Internet telephony
revenues increased 388.5% from approximately $2.4 million in Fiscal 1997 to
approximately $11.5 million in Fiscal 1998.
Telecommunications revenues increased 204.0%, primarily as a result of a
244.7% increase in minutes of use, from approximately 233.8 million to
approximately 805.8 million, offset in part by a decline in revenue per minute
from $0.43 to $0.38. Telecommunications minutes increased primarily due to the
addition of wholesale carrier service clients, increased usage by existing
clients, and increased marketing and sales of the Company's prepaid calling
cards. The offsetting decline in revenue per minute resulted from variations
in the mix of telecommunications revenue. The addition of wholesale carrier
services clients and the increased use by existing clients resulted in an
increase in wholesale carrier services revenues of 157.8%, from approximately
$64.7 million in Fiscal 1997 to approximately $166.7 million in Fiscal 1998.
As a percentage of telecommunications revenues, wholesale carrier service
revenues decreased from approximately 64.8% to 54.9%, primarily due to the
significant increase in prepaid calling card revenues both in real dollars and
as a percentage of overall telecommunications revenues. Revenues from sales of
the Company's prepaid calling cards, which the Company began to market in
January 1997, increased from approximately $2.6 million in Fiscal 1997 to
approximately $108.1 million in Fiscal 1998. As a percentage of
telecommunications revenues, prepaid calling card revenues increased from
approximately 2.6% to approximately 35.6%. As a percentage of
telecommunications revenues, international retail services revenues decreased
from 27.3% to 7.5%.
As a percentage of total revenues, Internet access revenues decreased from
approximately 24.3% for Fiscal 1997 to approximately 6.0% for Fiscal 1998.
This decrease was due to the substantial increase in telecommunications
revenues as a percentage of total revenues, as well as a dollar decrease in
Internet access revenues due to a decrease in total dial-up subscribers.
Internet telephony revenues as a percentage of total revenues increased from
1.7% for Fiscal 1997 to 3.4% for Fiscal 1998. The increase in Internet
telephony revenues was primarily due to an increase in billed-minute usage,
and the sale of $1.5 million of equipment during Fiscal 1998.
Direct Cost of Revenues. The Company's direct cost of revenues increased by
161.2%, from approximately $92.2 million in Fiscal 1997 to approximately
$240.8 million in Fiscal 1998. As a percentage of total revenues, these costs
increased from 68.2% in Fiscal 1997 to 71.8% in Fiscal 1998. The dollar
increase is due primarily to increases in underlying carrier costs as the
Company's telecommunications minutes of use, and associated revenue, grew
substantially. As a percentage of total revenues, the increase in direct costs
reflects lower gross margins associated with wholesale carrier services as
compared with international retail and Internet access services.
Selling, General and Administrative. Selling, general and administrative
costs increased 49.0% from approximately $41.5 million in Fiscal 1997 to
approximately $61.9 million in Fiscal 1998. As a percentage of total revenues,
these costs decreased from 30.7% in Fiscal 1997 to 18.5% in Fiscal 1998. The
increase in these costs in dollar terms is due primarily to increased sales
and marketing efforts for retail services, specifically pre-paid calling cards
for the periods prior to the purchase of Union. As a percentage of total
revenues, the decrease was due primarily to the substantial increase in total
revenues for Fiscal 1998.
Depreciation and Amortization. Depreciation and amortization costs increased
131.7% from approximately $4.9 million in Fiscal 1997 to approximately $11.3
million in Fiscal 1998. As a percentage of revenues, these costs decreased
from 3.6% in Fiscal 1997 to 3.4% in Fiscal 1998. These costs increased in
absolute terms primarily as a result of the Company's higher fixed asset base
during Fiscal 1998 as compared
34
with Fiscal 1997 due to the Company's efforts to expand its telecommunications
network infrastructure, enhance its Internet network and expand its
facilities. The Company anticipates that depreciation and amortization costs
will continue to increase as the Company continues to implement its growth
strategy.
Income (loss) from Operations. The Company's loss from operations increased
8.0% from $3.4 million in Fiscal 1997 to $3.7 million in Fiscal 1998. Income
from operations for the Company's telecommunications business increased to
approximately $5.9 million in Fiscal 1998 from $5.7 million in Fiscal 1997.
The Company's loss from operations in Fiscal 1998 includes a one-time charge
of $25.0 million as a write-off of purchased in-process research and
development costs in connection with the Company's acquisition of
InterExchange. As a percentage of telecommunication revenues, income from
operations for the telecommunications business decreased to 2.0% in Fiscal
1998 from approximately 5.7% in Fiscal 1997. Income from telecommunications
operations excluding the one-time purchased in-process research and
development write-off, was approximately $30.9 million, which is 10.2% of
telecommunications revenues.
Loss from operations for the Company's Internet access business decreased to
approximately $7.0 million in Fiscal 1998 from approximately $8.1 million in
Fiscal 1997. The decreased loss of the Internet access segment is largely due
to the refocusing of the Company's marketing efforts from aggressive mass
marketing to new reseller programs.
Loss from operations of the Net2Phone division increased to approximately
$2.7 million for Fiscal 1998, compared to a loss of approximately $1.1 million
for Fiscal 1997. This change is due to the substantial increase in marketing
costs as the Company seeks to gain market share for its Internet telephony
products and services and expand its infrastructure.
Income Taxes. In the fourth quarter of Fiscal 1998, the Company recorded an
income tax benefit from the reversal of the previously established deferred
tax valuation allowance. The allowance was reversed as the realization of the
net deferred tax asset was more likely than not. A portion of the benefit that
related to the tax deduction upon the exercise of stock options was recorded
directly into additional paid in capital.
Acquired Research and Development. In May 1998, the Company completed its
acquisition of InterExchange. The Company's statement of operations for Fiscal
1998 reflects a non-recurring charge of $25.0 million, representing the
portion of the purchase price paid for InterExchange allocated to the in-
process research and development of alternative switching and compression
technologies.
In order to determine the amount of this charge, the Company allocated the
excess purchase price over the fair value of InterExchange's net tangible
assets acquired to identified intangible assets. In performing this
allocation, the Company considered, among other factors, the research and
development projects in-process as of the date of acquisition.
The Company intends to incur $1.0 to $1.5 million, related primarily to the
compensation of employees involved in the completion of these projects, to
develop the in-process technology into commercially viable products over the
next 12 months. Remaining development efforts are focused on software
development and testing, and completion of these projects will be necessary
before any revenues will be produced. The Company expects to begin to benefit
from the purchased in-process research and development in Fiscal 1999. If
these projects are not successfully developed, the Company may not realize the
value assigned to the in-process research and development projects.
FISCAL 1997 COMPARED TO FISCAL 1996
Revenues. Revenues increased 134.3% from approximately $57.7 million in
Fiscal 1996 to approximately $135.2 million in Fiscal 1997. Telecommunications
revenues increased 179.8% from approximately $35.7 million in Fiscal 1996 to
approximately $99.9 million in Fiscal 1997. Internet access revenues increased
49.5% from approximately $22.0 million in Fiscal 1996 to approximately $32.9
million in Fiscal 1997. The Company generated revenues of approximately $2.4
million from its Internet telephony services in Fiscal 1997 through its
Net2Phone service, which was launched in August 1996.
In Fiscal 1997, international telecommunications revenues constituted a
greater percentage of total revenues as compared to Fiscal 1996, due to the
Company's increased focus in that area as compared to its Internet access
services. The 179.9% increase in telecommunications revenues was due primarily
to a 169.3% increase in
35
telecommunications minutes of use from approximately 88 million minutes of use
to approximately 234 million minutes of use combined with an increase in
revenue per minute from $0.36 to $0.40. The increase in telecommunications
minutes of use was due to the addition of wholesale carrier services clients,
a substantial increase in international retail customers and migration of
existing customers to the Company's least cost routing switch platform. The
increase in telecommunications revenues per minute resulted from variations in
the mix of the Company's telecommunications revenues. As a percentage of
telecommunications revenues, international retail services revenues decreased
from approximately 36.8% to 27.3%. The addition of wholesale carrier services
clients resulted in an increase in wholesale carrier services revenues from
approximately $18.6 million in Fiscal 1996 to approximately $64.7 million in
Fiscal 1997. As a percentage of telecommunications revenues, wholesale carrier
services revenues increased from approximately 52.1% to 64.7%.
As a percentage of total revenues, Internet access revenues decreased from
approximately 38.1% in Fiscal 1996 to approximately 24.3% in Fiscal 1997. The
dollar increase in Internet access revenues was due primarily to the increase
in the dial-up subscribers base, and to a lesser degree increased revenues
from online services and dedicated customers from Fiscal 1996 to Fiscal 1997.
The decrease in Internet access revenue as a percentage of total revenue was
due to the increase of telecommunications revenue as compared to Internet
access revenue, consistent with the change in the focus of the Company's
operations. Internet access revenues also included approximately $3.4 million
of online service revenues for Fiscal 1996 and $1.2 million for Fiscal 1997.
The Company introduced Net2Phone in August 1996 and generated Internet
telephony revenues of approximately $2.4 million in Fiscal 1997.
Direct Cost of Revenues. The Company's direct cost of revenues increased by
153.3% from approximately $36.4 million in Fiscal 1996 to approximately $92.2
million in Fiscal 1997. As a percentage of total revenues, these costs
increased from 63.2% in Fiscal 1996 to 68.2% in Fiscal 1997. The dollar
increase is primarily due to increases in underlying carrier costs because the
Company's telecommunications minutes of use, and the associated revenue, grew
substantially. To a lesser extent, the increase is due to the increase in fees
paid to Alliance Partners and the costs of leased circuits and networks, and
of access lines and network connectivity to support subscriber growth in both
Internet access and international call reorigination.
Selling, General and Administrative. Selling, general and administrative
costs increased from approximately $35.8 million in Fiscal 1996 to
approximately $41.5 million in Fiscal 1997. As a percentage of total revenues,
these costs decreased from 62.0% in Fiscal 1996 to 30.7% in Fiscal 1997. The
decrease in selling, general and administrative costs as a percentage of total
revenues was primarily due to the shift of the focus of the Internet
division's marketing efforts from aggressive mass marketing to new reseller
programs which entail lower selling costs, together with the growth of the
Company's wholesale carrier services business.
Depreciation and Amortization. Depreciation and amortization costs increased
308.3% from approximately $1.2 million in Fiscal 1996 to approximately $4.9
million in Fiscal 1997. As a percentage of total revenues, these costs
increased from 2.1% in Fiscal 1996 to 3.6% in Fiscal 1997. These costs
increased in absolute terms and as a percentage of revenues primarily as a
result of the Company's higher fixed asset base during Fiscal 1997 as compared
with Fiscal 1996 due to the Company's installation of additional Company-owned
POPs, enhancement of its network infrastructure and expansion of its
facilities.
Income (loss) from Operations. Income from operations from the
telecommunications segment increased to approximately $5.7 million in Fiscal
1997 from $2.8 million in Fiscal 1996 and as a percentage of
telecommunications revenues decreased to 5.7% from 7.7%. The dollar increase
resulted primarily from increased revenue generated by the expansion of
operations. The decrease as a percentage of telecommunication revenues
resulted primarily from increased selling, general and administrative
expenses. Loss from operations for the Internet access segment decreased to
approximately $8.1 million in Fiscal 1997 from approximately $17.6 million in
Fiscal 1996. The loss from operations from the Internet access segment was
principally due to the initial costs of acquiring customers and increased
personnel and facilities costs to sustain growth. The decreased loss of the
Internet access segment is largely due to the refocusing of its marketing
efforts from aggressive mass
36
marketing to new reseller programs. The loss generated from the development
and marketing of Net2Phone was approximately $1.1 million and $660,000 for
Fiscal 1997 and 1996 respectively.
Income Taxes. The Company did not record an income tax benefit in Fiscal
1996 or 1997, because the realization of available tax losses was not
probable.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain quarterly financial data for the
eight quarters ended July 31, 1998. This quarterly information is unaudited,
has been prepared on the same basis as the annual financial statements and, in
the opinion of the Company's management, reflects all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation of the
information for periods presented. Operating results for any quarter are not
necessarily indicative of results for any future period.
IDT CORPORATION
CONSOLIDATED QUARTERLY INCOME STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OCTOBER 31, JANUARY 31, APRIL 30, JULY 31, OCTOBER 31, JANUARY 31, APRIL 30, JULY 31,
1996 1997 1997 1997 1997 1998 1998 1998
----------- ----------- --------- -------- ----------- ----------- --------- --------
Revenues:
Telecommunications..... $18,102 $21,939 $26,061 $33,835 $47,804 $63,050 $79,082 $113,928
Internet............... 10,137 9,074 7,555 6,129 4,850 5,194 5,211 4,746
Net2Phone.............. 79 392 836 1,049 2,097 2,709 2,819 3,883
------- ------- ------- ------- ------- ------- ------- --------
Total Revenues....... 28,318 31,405 34,452 41,013 54,751 70,953 87,112 122,557
Costs and Expenses:
Direct cost of
revenues.............. 18,013 20,862 23,681 29,659 40,861 51,449 59,505 89,045
Selling, general and
administrative........ 12,598 11,245 9,163 8,539 9,835 13,872 20,344 17,919
Acquired research and
development........... -- -- -- -- -- -- -- 25,000
Depreciation and
amortization.......... 963 1,083 1,317 1,510 1,745 2,042 2,765 4,737
------- ------- ------- ------- ------- ------- ------- --------
Total costs and
expenses............ 31,574 33,190 34,161 39,708 52,441 67,363 82,614 136,701
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) from
operations............. (3,256) (1,785) 291 1,305 2,310 3,590 4,498 (14,144)
Other (net)............. 150 (45) (130) (367) (347) (436) 337 154
------- ------- ------- ------- ------- ------- ------- --------
Income before taxes,
minority interests and
extraordinary item..... (3,106) (1,830) 161 938 1,963 3,154 4,835 (13,990)
Income tax benefit...... -- -- -- -- -- -- -- 1,671
Minority interests...... -- -- -- -- -- -- -- (3,896)
------- ------- ------- ------- ------- ------- ------- --------
Income (loss) before
extraordinary item..... (3,106) (1,830) 161 938 1,963 3,154 4,835 (16,215)
Extraordinary item...... -- -- -- -- -- -- -- (132)
------- ------- ------- ------- ------- ------- ------- --------
Net income (loss)....... $(3,106) $(1,830) $ 161 $ 938 $ 1,963 $ 3,154 $ 4,835 $(16,347)
======= ======= ======= ======= ======= ======= ======= ========
Net income (loss) per
share--basic........... $ (0.15) $ (0.09) $ 0.01 $ 0.04 $ 0.09 $ 0.14 $ 0.17 $ (0.51)
======= ======= ======= ======= ======= ======= ======= ========
Weighted average shares
outstanding--basic..... 20,841 20,873 21,258 21,648 21,999 23,330 28,881 32,359
======= ======= ======= ======= ======= ======= ======= ========
Net income (loss) per
share--diluted......... $ (0.15) $ (0.09) $ 0.01 $ 0.04 $ 0.08 $ 0.12 $ 0.15 $ (0.51)
======= ======= ======= ======= ======= ======= ======= ========
Weighted average shares
outstanding--diluted... 20,841 20,873 23,249 23,641 25,480 27,054 32,693 32,359
======= ======= ======= ======= ======= ======= ======= ========
37
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has satisfied its cash requirements through a
combination of cash flow from operating activities, sales of equity securities
and borrowings from third parties (including borrowings from certain of its
stockholders). In September 1997, the Company completed a $7.5 million private
placement of 3.0% convertible debentures. In March and April 1998, $6.5
million in aggregate principal amount of the convertible debentures were
converted into shares of the Company's Common Stock and in May 1998 the
Company redeemed the remaining $1.0 million in aggregate principal amount. In
February 1998, the Company sold 5,093,750 shares of its Common Stock, raising
net proceeds of approximately $119.8 million, after deducting underwriting
discounts, commissions and offering expenses, and including proceeds from the
exercise of stock options by certain selling stockholders. In February 1998,
the Company also issued $100.0 million aggregate principal amount of 8 3/4%
Senior Notes, and received net proceeds of approximately $96.4 million.
As of July 31, 1998, the Company had cash, cash equivalents and marketable
securities of $175.6 million, and working capital of approximately $166.4
million. The Company generated cash from operating activities of approximately
$30.6 million during Fiscal 1998, compared with negative cash flow from
operating activities of approximately $4.4 million during Fiscal 1997. The
improvement in cash flow was primarily due to improved operating results by
the Company in Fiscal 1998. Cash flow from operations varied significantly
from quarter to quarter, depending upon the timing of operating cash receipts
and payments, especially accounts receivable and accounts payable. Accounts
receivable (net of allowances) were approximately $17.1 million and $38.0
million at July 31, 1997 and July 31, 1998, respectively. Accounts receivable,
accounts payable and accrued expenses have increased from period to period as
the Company's businesses have grown. The Company's capital expenditures
increased from approximately $18.0 million in Fiscal 1997 to approximately
$59.3 million in Fiscal 1998, as the Company expanded its international and
domestic telecommunications network infrastructure. The Company financed a
portion of its capital expenditures through capital leases and notes payable.
The Company intends to, where appropriate, make strategic acquisitions to
increase its telecommunications customer base. The Company may also make
strategic acquisitions related to its Internet business. From time to time,
the Company evaluates potential acquisitions of companies, technologies,
products and customer accounts that complement the Company's businesses. In
November 1997, the Company purchased the outstanding capital stock of Rock
Enterprises, Inc. in exchange for 625,000 shares of the Company's Common
Stock. In April 1998, the Company purchased all of the issued and outstanding
capital stock of InterExchange and four related corporations acquired by
InterExchange immediately prior to the transaction, in exchange for 3,242,323
shares of the Company's Common Stock and $20.0 million in cash. In May 1998,
the Company entered into an agreement with Mr. Carlos Gomez, a distributor of
prepaid calling cards, pursuant to which the Company purchased a majority
interest in Union. Pursuant to the terms of the transaction, the Company
agreed to issue up to 200,000 shares of its Common Stock; 100,000 of such
shares were issued to Mr. Gomez in Fiscal 1998. Subject to the satisfaction of
certain performance criteria, up to an additional 100,000 of such shares will
be issued in Fiscal 1999.
As of July 31, 1998, the Company had made loans and advances in the
aggregate amount of approximately $24.4 million to other telecommunications
and Internet companies to help establish strategic relationships and
facilitate penetration into key markets. The Company may be a party to similar
transactions in the future.
In May 1998, the Company entered into an agreement with a telecommunications
company, Lermer Overseas Telecommunications, Inc. ("Lermer"), pursuant to
which the Company provided Lermer with a $25 million revolving credit facility
(the "Facility"). Loans can be drawn on the Facility through May 1999 and
cannot be reborrowed upon repayment. The Facility bears interest at the rate
of 5% per annum. The unpaid principal and accrued interest on the Facility are
payable in quarterly installments, as defined in the agreement, commencing on
February 1, 1999; this date may be delayed under certain circumstances. The
Facility must be fully repaid by April 30, 2004. As of October 1, 1998, the
outstanding principal balance on the Facility was approximately $12,600,000.
38
The Company believes that, based upon its present business plan, the
Company's existing cash resources and expected cash flow from operating
activities, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months. If the Company's
growth exceeds current expectations or if the Company acquires the business of
another company, the Company may need to raise additional capital from equity
or debt sources. There can be no assurance that the Company will be able to
raise such capital on favorable terms or at all.
YEAR 2000
The Company is conducting a review of its computer hardware and software to
ensure that its computer-related applications will not fail or create
erroneous results as a result of the use of two digits in various program date
fields (the "Year 2000 issue"). The Company's cost of addressing the Year 2000
issue is not expected to be material to its operations or financial position.
However, the consequences of an incomplete or untimely resolution of the Year
2000 issue could be expected to have a material adverse effect upon the
financial results of the Company; in the absence of such a resolution, the
ability of the Company to route its traffic in a cost effective manner, to
deliver a material portion of its services, to properly obtain payment for
such services, and/or to maintain accurate records of its business and
operations, could be substantially impaired until such issue is remediated.
The Company may become liable for substantial damages in the event that, as a
result of the Year 2000 issue, it fails to deliver any services that it has
contracted to provide. However, the Company expects that its Year 2000 issues
will be satisfactorily resolved before the year 2000.
IDT is conducting a comprehensive review of its computer systems to ensure
that all such systems are, or prior to the end of 1999 will be, Year 2000
compliant. The Company's plan for its Year 2000 project includes the following
phases: (i) conducting a comprehensive inventory of the Company's internal
systems, including information technology systems and non-information
technology systems (which include switching, billing and other platforms and
electrical systems) and the systems acquired or to be acquired by the Company
from third parties, (ii) assessing and prioritizing any required remediation,
(iii) remediating any problems by repairing or, if appropriate, replacing the
non-compliant systems, (iv) testing all remediated systems for Year 2000
compliance and (v) developing contingency plans that may be employed in the
event that any system used by the Company is unexpectedly affected by a
previously unanticipated problem relating to the Year 2000. The Company
currently expects to complete all of the phases of this process and that all
of its computer systems will be fully Year 2000 compliant before the end of
1999.
The Company has completed a number of acquisitions during its recent fiscal
years, and is in the process of integrating the systems of the acquired
businesses into its operations. Those systems are included in the Company's
Year 2000 review and remediation project. During the process of evaluating
businesses for any potential acquisition, and after any such acquisitions, the
Company will evaluate the extent of the Year 2000 problems associated with
such acquisitions and the cost and timing of remediation. No assurance can be
given, however, that the systems of any acquired business will be Year 2000
compliant when acquired or that they will be capable of timely remediation.
In addition to assessing its own systems, the Company is conducting an
external review of its customers and suppliers, and any other third parties
with which it does business, including equipment and systems providers and
other telecommunications service providers, to determine their vulnerability
to Year 2000 problems and any potential impact on the Company. In particular,
the Company may experience problems to the extent that other
telecommunications carriers whose services are resold by the Company or to
which the Company sends traffic for termination are not Year 2000 compliant.
The Company's ability to determine the ability of these third parties to
address issues relating to the Year 2000 problem is necessarily limited. To
the extent that a limited number of carriers experience disruptions in service
due to the Year 2000 issue, the Company believes that it will be able to
obtain service from alternate carriers. However, the Company's ability to
provide certain services to customers in selected geographic locations may be
limited. There can be no assurance that such problems will not have a material
adverse effect on the Company.
39
In addition, the Company is currently in the process of developing
contingency plans with regard to potential Year 2000 problems. The Company
believes that, in the event that one or more of its systems is impaired due to
unanticipated Year 2000 issues, its contingency plans will enable it to
temporarily conduct its operations on a temporarily modified basis until such
impaired system or systems is remediated. There can be no assurances that the
Company's suppliers and customers will achieve full Year 2000 compliance
before the end of 1999 or that the Company will develop or implement effective
contingency plans on a timely basis. A failure of the Company's computer
systems or the failure of the Company's suppliers or customers to effectively
upgrade their software and systems for transition to the year 2000 could have
a material adverse effect on the Company's business, financial conditions and
results of operations.
To date, the Company has incurred expenses of less than $1.0 million in
connection with its remediation of Year 2000 related issues. No assurance can
be given, however, that the systems of any acquired business will be Year 2000
compliant when acquired or that they will be capable of timely remediation.
The Company does not expect to incur significant costs to become Year 2000
compliant, although the Company's evaluation of the Year 2000 problem is not
yet complete and actual costs may be significantly higher. In particular, such
costs could be higher if certain suppliers of the Company fail to provide Year
2000 related updates to certain switching products purchased by the Company
without charge in the manner that is currently expected. Costs associated with
Year 2000 remediation are expensed by the Company when incurred.
EUROPEAN CURRENCY CONVERSION
Beginning in January 1999, a new currency called the "euro" is expected to
be introduced in certain Economic and Monetary Union ("EMU") countries.
Beginning in 2002, all EMU countries are expected to operate with the euro as
their single currency. Uncertainty exists as to the effect the euro currency
will have on the market for international telecommunications services.
Additionally, all of the final rules and regulations have not yet been defined
and finalized by the European Commission with regard to the euro currency. IDT
has not yet completed its assessment of the affect that the introduction of
the euro will have on its business, operations and sales.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The information set forth under the caption "Fair Value of Financial
Instruments" at page F-10 herein is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and supplementary data of the Company
and the report of independent auditors thereon set forth on pages F-1 through
F-21 herein are incorporated herein by reference.
Quarterly financial information set forth herein at page 31 is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
40
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting, which will be filed with
the Securities and Exchange Commission within 120 days after July 31, 1998, and
which is incorporated by reference herein.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting, which will be filed with
the Securities and Exchange Commission within 120 days after July 31, 1998, and
which, with the exception of the sections entitled "Report of the Compensation
Committee of the Board of Directors" and "Performance Graph of Common Stock,"
is incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting, which will be filed with
the Securities and Exchange Commission within 120 days after July 31, 1998, and
which is incorporated by reference herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item will be contained in the Company's
Proxy Statement for its Annual Stockholders Meeting, which will be filed with
the Securities and Exchange Commission within 120 days after July 31, 1998, and
which is incorporated by reference herein.
41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Report:
1 Financial Statements.
2. Financial Statement Schedules.
SCHEDULE
NO. DESCRIPTION
-------- -----------
I. Valuation and Qualifying Accounts
3. Exhibits.
3.01(1) Restated Certificate of Incorporation of the Registrant.
3.02(1) By-laws of the Registrant.
10.01(2) Employment Agreement between the Registrant and Howard S. Jonas.
10.02(2) Employment Agreement between the Registrant and Howard S. Balter.
10.03(3) Amended and Restated 1996 Stock Option and Incentive Plan of IDT
Corporation.
10.04(4) Form of Stock Option Agreement under the 1996 Stock Option and
Incentive Plan.
10.05(5) Form of Registration Rights Agreement between certain stockholders
and the Company.
10.06(1) Lease of 294 State Street.
10.07(6) Lease of 190 Main Street.
10.8(7) Form of Registration Rights Agreement between Howard S. Jonas and
the Registrant.
10.9(8) Employment Agreement between the Registrant and James Courter.
10.13(9) Agreement between Mr. Cliff Sobel and the Registrant.
10.14(9) Employment Agreement between the Registrant and Mr. Hal Brecher.
10.15(6) Employment Agreement between the Registrant and Mr. David Turock.
10.16(10) Indenture between the Registrant and U.S. Bank Trust National
Association, formerly known as First Trust National Association, as
Trustee.
10.17(10) Registration Rights Agreement between the Registrant, BT Alex. Brown
Incorporated, Hambrecht & Quist LLC, Jefferies & Company, Inc. and
Friedman, Billings, Ramsey & Co., Inc.
10.18(11) Agreement and Plan of Merger, dated April 7, 1998, by and among the
Registrant, ADM Corp., InterExchange, Inc., David Turock, Eric
Hecht, Richard Robbins, Bradley Turock, Wai Nam Tam, Mary Jo Altom
and Lisa Mikulynec.
10.21* Securities Purchase Agreement between the Registrant, Carlos Gomez
and Union Telecard Alliance, LLC.
21.01* Subsidiaries of the Registrant.
23.01* Consent of Ernst & Young LLP.
27.01* Financial Data Schedule.
- --------
*filed herewith
(1)Incorporated by reference to Form S-1 filed February 21, 1996 file no. 333-
00204.
(2)Incorporated by reference to Form S-1 filed January 9, 1996 file no. 333-
00204.
(3)Incorporated by reference to Form 14A, filed November 14, 1997.
(4)Incorporated by reference to Form S-8 filed January 14, 1996 file no. 333-
19727.
(5)Incorporated by reference to Form S-1 filed March 8, 1996 file no. 333-
00204.
(6)Incorporated by reference to Form 10-K/A for the fiscal year ended July 31,
1997 filed February 2, 1998.
(7)Incorporated by reference to Form S-1 filed March 14, 1996 file no. 333-
00204.
42
(8) Incorporated by reference to Form S-1 filed December 27, 1996 file no.
333-18901.
(9) Incorporated by reference to Form 10-K/A for the fiscal year ended July
31, 1997, filed October 29, 1997.
(10) Incorporated by reference to Form 10-Q filed March 17, 1998.
(11) Incorporated by reference to Form 8-K filed April 22, 1998.
(b) Reports on Form 8-K. The Registrant filed the following Current Reports
on Form 8-K during the fiscal year ended July 31, 1998:
On September 19, 1997, the Registrant filed a Current Report on Form 8-K
announcing the private placement of $7,500,000 in aggregate principal amount
of 3% Convertible Debentures.
On February 19, 1998, the Registrant filed a Current Report on Form 8-K
announcing the private placement of $100,000,000 in aggregate principal amount
of 8 3/4% Senior Notes due 2006.
On April 22, 1998, the Registrant filed a Current Report on Form 8-K
announcing the proposed merger of a wholly owned subsidiary of the Registrant
with and into InterExchange, Inc., a Delaware corporation, pursuant to an
Agreement and Plan of Merger, dated April 7, 1998.
On May 21, 1998, the Registrant filed a Current Report on Form 8-K providing
the Combined Financial Statements of InterExchange, Inc. and Combined
Affiliates as of December 31, 1997, 1996 and 1995 and for the three years
ended December 31, 1997 and the Unaudited Combined Financial Statements of
InterExchange, Inc. and Combined Affiliates as of March 31, 1998 and March 31,
1997 and for the three months ended March 31, 1998 and March 31, 1997. This
filing was amended on May 26, 1998 and September 27, 1998.
43
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS ANNUAL REPORT ON FORM
10-K TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
IDT Corporation
/s/ Howard S. Jonas
By __________________________________
HOWARD S. JONAS CHAIRMAN, CHIEF
EXECUTIVE OFFICER AND TREASURER
Date: October 28, 1998
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS ANNUAL
REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES
AND ON THE DATES INDICATED.
SIGNATURES TITLE DATE
/s/ Howard S. Jonas Chairman and Chief October 28,
- ------------------------------------- Executive Officer 1998
HOWARD S. JONAS (Principal Executive
Officer)
/s/ James A. Courter President and Director October 28,
- ------------------------------------- (Principal Executive 1998
JAMES A. COURTER Officer)
/s/ Howard S. Balter Chief Operating Officer October 28,
- ------------------------------------- and Director (Principal 1998
HOWARD S. BALTER Financial Officer)
/s/ Stephen R. Brown Chief Financial Officer October 28,
- ------------------------------------- (Principal Accounting 1998
STEPHEN R. BROWN Officer)
/s/ Marc E. Knoller Director October 28,
- ------------------------------------- 1998
MARC E. KNOLLER
/s/ Joyce J. Mason Director October 28,
- ------------------------------------- 1998
JOYCE J. MASON
/s/ Meyer A. Berman Director October 28,
- ------------------------------------- 1998
MEYER A. BERMAN
/s/ J. Warren Blaker Director October 28,
- ------------------------------------- 1998
J. WARREN BLAKER
/s/ Denis A. Bovin Director October 28,
- ------------------------------------- 1998
DENIS A. BOVIN
/s/ Hal Brecher Director October 28,
- ------------------------------------- 1998
HAL BRECHER
/s/ James Mellor Director October 28,
- ------------------------------------- 1998
JAMES MELLOR
/s/ Elmo R. Zumwalt Director October 28,
- ------------------------------------- 1998
ELMO R. ZUMWALT
IDT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors........................................... F-2
Consolidated Balance Sheets as of July 31, 1997 and 1998................. F-3
Consolidated Statements of Operations for the years ended July 31, 1996,
1997 and 1998........................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended July
31, 1996, 1997 and 1998................................................. F-5
Consolidated Statements of Cash Flows for the years ended July 31, 1996,
1997 and 1998........................................................... F-6
Notes to Consolidated Financial Statements............................... F-8
Financial Statement Schedule--Valuation and Qualifying Accounts.......... F-21
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
IDT Corporation
We have audited the accompanying consolidated balance sheets of IDT
Corporation (the "Company") as of July 31, 1997 and 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended July 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company
at July 31, 1997 and 1998 and the consolidated results of its operations and
its cash flows for each of the three years in the period ended July 31, 1998,
in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
ERNST & YOUNG LLP
New York, New York
September 28, 1998
F-2
IDT CORPORATION
CONSOLIDATED BALANCE SHEETS
JULY 31
--------------------------
1997 1998
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................ $ 7,674,313 $115,283,519
Marketable securities............................ - 60,308,768
Trade accounts and commissions receivable, net of
allowance for doubtful accounts of approximately
$3,190,000 at July 31, 1997 and $6,255,000 at
July 31, 1998................................... 17,128,890 38,037,974
Notes receivable--current portion................ 1,291,403 2,140,000
Other current assets............................. 2,922,750 12,096,803
------------ ------------
Total current assets............................... 29,017,356 227,867,064
Property and equipment, at cost, net............... 25,725,805 75,332,476
Notes receivable--long-term portion................ - 21,767,769
Goodwill, net...................................... 1,357,606 74,222,221
Deferred tax assets, net........................... - 10,750,000
Other assets....................................... 2,436,334 7,256,674
------------ ------------
Total assets....................................... $ 58,537,101 $417,196,204
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable........................... $ 16,957,656 $ 38,793,873
Accrued expenses................................. 721,142 3,499,301
Interest payable................................. - 3,942,577
Deferred revenue................................. 2,442,848 9,175,218
Notes payable--current portion................... 1,880,939 1,865,849
Capital lease obligation--current portion........ 1,531,971 3,989,375
Other current liabilities........................ 595,951 220,325
------------ ------------
Total current liabilities.......................... 24,130,507 61,486,518
Notes payable--long-term portion................... 5,241,088 101,833,892
Capital lease obligation--long-term portion........ 3,906,362 11,232,053
------------ ------------
Total liabilities.................................. 33,277,957 174,552,463
Minority interests................................. - 3,895,669
Commitments and contingencies......................
Stockholders' equity:
Preferred stock, $.01 par value; authorized
shares--10,000,000; no shares issued............ - -
Common stock, $.01 par value; authorized shares--
100,000,000; 10,636,000 and 22,848,866 shares
issued and outstanding in 1997 and 1998,
respectively.................................... 106,360 228,489
Class A stock, $.01 par value; authorized
shares--35,000,000; 11,174,330 and 10,255,668
shares issued and outstanding in 1997 and 1998,
respectively.................................... 111,743 102,557
Additional paid-in capital....................... 46,990,388 266,761,770
Accumulated deficit.............................. (21,949,347) (28,344,744)
------------ ------------
Total stockholders' equity......................... 25,259,144 238,748,072
------------ ------------
Total liabilities and stockholders' equity......... $ 58,537,101 $417,196,204
============ ============
See accompanying notes.
F-3
IDT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED JULY 31
----------------------------------------
1996 1997 1998
------------ ------------ ------------
Revenues............................. $ 57,693,880 $135,187,227 $335,372,915
Costs and expenses:
Direct cost of revenues............ 36,437,583 92,214,223 240,859,809
Selling, general and
administrative.................... 35,799,158 41,544,987 61,974,851
Acquired research and development.. -- -- 25,000,000
Depreciation and amortization...... 1,212,235 4,873,142 11,284,013
------------ ------------ ------------
Total costs and expenses............. 73,448,976 138,632,352 339,118,673
------------ ------------ ------------
Loss from operations................. (15,755,096) (3,445,125) (3,745,758)
Interest expense..................... (113,160) (862,954) (5,978,760)
Interest income...................... 458,464 436,112 5,582,951
Other................................ -- 35,197 103,215
------------ ------------ ------------
Loss before income taxes, minority
interests and extraordinary item.... (15,409,792) (3,836,770) (4,038,352)
Income tax benefit................... -- -- 1,671,000
Minority interests................... -- -- (3,895,669)
------------ ------------ ------------
Loss before extraordinary item....... (15,409,792) (3,836,770) (6,263,021)
Extraordinary loss on retirement of
debt, net of $89,000 income tax
benefit in 1998..................... (233,500) -- (132,376)
------------ ------------ ------------
Net loss............................. $(15,643,292) $ (3,836,770) $ (6,395,397)
============ ============ ============
Loss per share--basic and diluted:
Loss before extraordinary item..... $ (0.85) $ (0.18) $ (0.21)
Extraordinary loss on retirement of
debt.............................. (0.01) -- (0.01)
------------ ------------ ------------
Net loss............................. $ (0.86) $ (0.18) $ (0.22)
============ ============ ============
Weighted average number of shares
used in calculation of basic and
diluted loss per share.............. 18,180,023 21,152,927 28,571,421
============ ============ ============
See accompanying notes.
F-4
IDT CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK CLASS A STOCK ADDITIONAL TOTAL
------------------- -------------------- PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY
---------- -------- ---------- -------- ------------ ------------ -------------
Balance at July 31,
1995................... 4,491,900 $ 44,919 11,174,330 $111,743 $ 3,223,598 $ (2,469,285) $ 910,975
Compensation expense
recognized on issuance
of stock options...... -- -- -- -- 70,000 -- 70,000
Sale of common stock... 4,600,000 46,000 -- -- 41,458,993 -- 41,504,993
Exercise of warrants... 575,000 5,750 -- -- (5,750) -- --
Net loss for the year
ended July 31, 1996... -- -- -- -- -- (15,643,292) (15,643,292)
---------- -------- ---------- -------- ------------ ------------ ------------
Balance at July 31,
1996................... 9,666,900 96,669 11,174,330 111,743 44,746,841 (18,112,577) 26,842,676
Compensation expense
recognized on issuance
of stock options...... -- -- -- -- 41,213 -- 41,213
Exercise of stock
options............... 969,100 9,691 -- -- 2,202,334 -- 2,212,025
Net loss for the year
ended July 31, 1997... -- -- -- -- -- (3,836,770) (3,836,770)
---------- -------- ---------- -------- ------------ ------------ ------------
Balance at July 31,
1997................... 10,636,000 106,360 11,174,330 111,743 46,990,388 (21,949,347) 25,259,144
Exercise of options.... 1,615,366 16,154 -- -- 5,281,017 -- 5,297,171
Income tax benefit from
stock options
exercised............. -- -- -- -- 8,790,000 -- 8,790,000
Conversion of Class A
stock to common
stock................. 918,662 9,186 (918,662) (9,186) -- -- --
Issuance of common
stock in connection
with business
acquisitions.......... 3,967,323 39,673 -- -- 77,922,827 -- 77,962,500
Common stock issued
upon conversion of
notes payable......... 582,762 5,828 -- -- 8,648,685 -- 8,654,513
Exercise of warrants... 35,003 350 -- -- 530,258 -- 530,608
Sale of common stock... 5,093,750 50,938 -- -- 118,208,595 -- 118,259,533
Issuance of common
stock to employees by
shareholder........... -- -- -- -- 390,000 -- 390,000
Net loss for the year
ended July 31, 1998... -- -- -- -- -- (6,395,397) (6,395,397)
---------- -------- ---------- -------- ------------ ------------ ------------
Balance at July 31,
1998................... 22,848,866 $228,489 10,255,668 $102,557 $266,761,770 $(28,344,744) $238,748,072
========== ======== ========== ======== ============ ============ ============
See accompanying notes.
F-5
IDT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED JULY 31
---------------------------------------
1996 1997 1998
------------ ----------- ------------
OPERATING ACTIVITIES
Net loss.............................. $(15,643,292) $(3,836,770) $ (6,395,397)
Adjustments to reconcile net loss to
net cash provided
by (used in) operating activities:
Stock option expense................ 70,000 41,213 -
Amortization........................ - 97,056 1,570,176
Depreciation........................ 1,212,235 4,776,086 9,713,837
Accretion of notes receivable....... - - (130,000)
Acquired research and development
costs by issuance of
common stock....................... - - 25,000,000
Minority interests.................. - - 3,895,669
Deferred income taxes............... - - (1,960,000)
Issuance of common stock to
employees by shareholder........... - - 390,000
Changes in assets and liabilities:
Accounts receivable............... (9,468,047) (9,273,827) (20,909,084)
Due from Yovelle.................. (1,200,000) - -
Other current assets.............. (1,844,056) (937,660) (9,138,112)
Other assets...................... (492,630) (1,801,077) (1,359,248)
Notes receivable.................. (1,250,000) 2,861,003 485,810
Trade accounts payable............ 9,803,488 6,233,349 18,141,813
Accrued expenses.................. 2,918,366 (4,225,977) 878,017
Deferred revenue.................. 716,912 1,459,352 6,732,370
Interest payable.................. - - 4,063,120
Other current liabilities......... 234,648 173,946 (375,626)
------------ ----------- ------------
Net cash provided by (used in)
operating activities................. (14,942,376) (4,433,306) 30,603,345
INVESTING ACTIVITIES
Purchases of property and equipment... (11,895,452) (7,112,962) (41,332,835)
Issuance of notes receivable.......... - - (23,595,526)
Payments for the purchase of Yovelle,
net cash acquired.................... - 376,843 -
Payments for the purchase of the as-
sets of
International Computer Systems,
Inc.................................. - (2,250,000) -
Payment for the purchase of the assets
of PCIX, Inc......................... - (260,000) -
Payment for the purchase of
InterExchange, Inc................... - - (20,588,000)
Net purchases of marketable
securities........................... - - (60,308,768)
------------ ----------- ------------
Net cash used in investing
activities........................... (11,895,452) (9,246,119) (145,825,129)
F-6
IDT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED JULY 31
-------------------------------------
1996 1997 1998
----------- ---------- ------------
FINANCING ACTIVITIES
Payments on notes due to former
shareholder........................... $ (5,001) $ - $ -
Proceeds from notes payable from
shareholders, affiliates and outside
investors............................. 4,237,000 - -
Repayments from notes payable from
shareholders, affiliates and outside
investors............................. (4,237,000) - -
Proceeds from notes payable............ - 6,750,000 110,668,294
Payment of financing costs............. - - (3,561,070)
Exercise of warrants................... - - 530,608
Exercise of stock options.............. - 2,212,025 5,297,171
Repayment of capital lease
obligations........................... - (684,070) (2,665,084)
Repayments of notes payable............ - (1,817,973) (5,698,462)
Proceeds from sale of common stock..... 41,504,993 - 118,259,533
----------- ---------- ------------
Net cash provided by financing
activities............................ 41,499,992 6,459,982 222,830,990
----------- ---------- ------------
Net increase (decrease) in cash and
cash equivalents...................... 14,662,164 (7,219,443) 107,609,206
Cash and cash equivalents at beginning
of period............................. 231,592 14,893,756 7,674,313
----------- ---------- ------------
Cash and cash equivalents at end of
period................................ $14,893,756 $7,674,313 $115,283,519
=========== ========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash payments made for interest........ $ 113,000 $ 863,000 $ 2,036,000
=========== ========== ============
Cash payments made for income taxes.... - - -
=========== ========== ============
SUPPLEMENTAL SCHEDULE OF NON-CASH
OPERATING ACTIVITIES:
Conversion of carrier advances to notes
receivable............................ 1,250,000 - -
=========== ========== ============
Conversion of trade accounts and
commissions receivable................ 1,600,000 - -
=========== ========== ============
SUPPLEMENTAL SCHEDULE OF NON-CASH
FINANCING ACTIVITIES:
Accrued interest converted to equity... - - 121,000
=========== ========== ============
Purchase of fixed assets by capital
lease................................. - 6,122,000 12,448,000
=========== ========== ============
Notes payable converted to equity...... $ - $ - $ 8,534,000
=========== ========== ============
See accompanying notes.
F-7
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
IDT Corporation (the "Company") is a leading multinational
telecommunications carrier that provides a broad range of services to its
wholesale and retail customers worldwide. The Company provides its customers
with integrated international and domestic long distance, pre-paid calling
cards, Internet access and, through its Net2Phone product offerings, Internet
telephony services. The Company also sells pre-paid calling cards to
distributors.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include accounts of the
Company and all companies in which the Company has a controlling voting
interest. All significant intercompany balances and transactions have been
eliminated in consolidation.
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 amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
REVENUE RECOGNITION
Telecommunication, Internet telephony service, Internet subscription service
and debit card revenues are recognized as service is provided. Equipment sales
are recognized when installation is completed. Deferred revenues result from
advance billings for services.
DIRECT COST OF REVENUES
Direct cost of revenues consists primarily of telecommunication costs,
connectivity costs, and the cost of equipment sold to customers.
PROPERTY AND EQUIPMENT
Equipment, computer software, and furniture and fixtures are depreciated
using the straight-line method over the estimated useful lives of the assets,
which range from three to seven years. Leasehold improvements are depreciated
using the straight-line method over the term of the lease or estimated useful
life of the assets, whichever is shorter.
SUBSCRIBER ACQUISITION COSTS AND ADVERTISING
Subscriber acquisition costs, including sales commissions, license fees and
production and shipment of starter packages, are expensed as incurred.
The Company expenses the costs of advertising as incurred. For the years
ended July 31, 1996, 1997 and 1998, advertising expense totaled approximately
$8,520,000, $4,011,000, and $5,632,000, respectively.
SOFTWARE DEVELOPMENT COSTS
Costs for the internal development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established, at which time
F-8
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
any additional costs would be capitalized. To date, the Company has
essentially completed its software development concurrently with the
establishment of technological feasibility and, accordingly, costs capitalized
to date have not been material.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Cash and cash
equivalents are carried at cost which approximates market value. At July 31,
1998, the Company had 52% of its cash and cash equivalents in two financial
institutions.
MARKETABLE SECURITIES
Marketable securities consist of short-term debt securities carried at cost
which approximates market value and are considered to be available for sale.
GOODWILL
Goodwill is being amortized over 20 years using the straight-line method.
Accumulated amortization at July 31, 1997 and 1998 was approximately $34,000
and $882,000, respectively. The Company systematically reviews the
recoverability of its goodwill for each acquired entity to determine whether
an impairment may exist. Upon a determination that the carrying value of
goodwill will not be recovered from the undiscounted future cash flows of the
acquired business, the carrying value of such goodwill would be considered
impaired and will be reduced by a charge to operations in the amount of the
impairment.
INCOME TAXES
The Company accounts for income taxes on the liability method as required by
Statement of Financial Accounting Standards No. 109, Accounting for Income
Taxes. Under this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets
and liabilities.
EARNINGS PER SHARE
During fiscal 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, Earnings per Share, which replaced the calculation
of primary and fully diluted earnings per share with basic and diluted
earnings per share. Unlike primary earnings per share, basic earnings per
share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been restated to conform to the requirements of such
statement.
CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of cash, cash equivalents, marketable
securities, trade receivables and notes receivable. Concentrations of credit
risk with respect to trade receivables are limited due to the large number of
customers comprising the Company's customer base.
Management regularly monitors the creditworthiness of its customers and
believes that it has adequately provided for any exposure to potential credit
losses.
F-9
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments requires fair value disclosures about financial
instruments, whether or not recognized in the consolidated balance sheets, for
which it is practicable to estimate. The estimated fair value has been
determined using available market information or other appropriate valuation
methodologies. However, considerable judgment is required in interpreting
market data to develop estimates of fair value. Consequently, the estimates
are not necessarily indicative of the amounts that could be realized or would
be paid in a current market exchange.
The following methods and assumptions were used by the Company in estimating
the fair value of its financial instruments:
Notes receivable: For notes receivable which are short-term or have variable
interest rates, fair values are based on carrying values. The fair values of
notes receivable with fixed interest rates with long-term maturities are
estimated using discounted cash flow analysis, using interest rates currently
being offered for notes with similar terms to borrowers of similar credit
quality. The fair value of notes receivable at July 31, 1998 was approximately
$23,172,000.
Notes payable: For notes payable which are short-term or have variable
interest rates, fair values are based on carrying values. The fair values of
notes payable with fixed interest rates with long-term maturities are
estimated using discounted cash flow analysis using interest rates that are
currently being offered on similar instruments. The fair value of notes
payable at July 31, 1998 was approximately $98,700,000.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
SFAS No. 130, Reporting Comprehensive Income, was issued in June 1997. The
Company will be required to adopt the new standard for the year ending July
31, 1999, although early adoption is permitted. The primary objective of this
statement is to report and disclose a measure ("Comprehensive Income") of all
changes in equity of a company that result from transactions and other
economic events of the period other than transactions with owners. The Company
intends to adopt this statement in fiscal 1999 and does not anticipate that
the statement will have a significant impact on its financial statements.
SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, was issued in June 1997. The Company will be required to adopt
the new standard for the year ending July 31, 1999, although early adoption is
permitted. This statement requires use of the "management approach" model for
segment reporting. The management approach model is based on the way a
company's management organizes segments within the company for making
operating decisions and assessing performance. Reportable segments are based
on products and services, geography, legal structure, management structure, or
any other manner in which management disaggregates a company. The Company
intends to adopt this statement in fiscal 1999 and does not anticipate that
the adoption of the statement will have significant impact on the disclosures
in its financial statements.
STOCK BASED COMPENSATION
The Company applies the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. The Company accounts for stock
options using APB Opinion No. 25, Accounting for Stock Issued to Employees and
related interpretations.
RECLASSIFICATIONS
Certain prior year amounts in the consolidated statements of cash flows have
been reclassified to conform to the current year's presentation.
F-10
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. NOTES RECEIVABLE
In May 1998, the Company entered into an agreement with a telecommunications
company, pursuant to which the Company provided it with a $25,000,000
revolving credit facility (the "Facility"). Loans can be drawn on the Facility
through May 1999 and cannot be reborrowed upon repayment. The Facility bears
interest at the rate of 5% per annum. The unpaid principal and accrued
interest on the Facility are payable in quarterly installments, as defined in
the agreement, commencing on February 1, 1999 which under certain
circumstances may be delayed. The Facility must be fully repaid by April 30,
2004. As of July 31, 1998, the outstanding balance on such Facility of
approximately $12,600,000 is included in notes receivable.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
JULY 31
------------------------
1997 1998
----------- -----------
Equipment...................................... $24,945,687 $77,612,461
Computer software.............................. 4,618,931 10,027,335
Leasehold improvements......................... 1,115,822 1,930,769
Furniture and fixtures......................... 1,365,140 1,905,048
Building....................................... 109,525 -
----------- -----------
32,155,105 91,475,613
Less: accumulated depreciation and
amortization.................................. (6,429,300) (16,143,137)
----------- -----------
$25,725,805 $75,332,476
=========== ===========
Cost of property and equipment under capital leases aggregated approximately
$6,122,000 and $18,570,000 at July 31, 1997 and 1998, respectively. The
accumulated amortization related to these assets under capital leases was
approximately $441,000 and $2,885,000 at July 31, 1997 and 1998, respectively.
4. NOTES PAYABLE
Notes payable consists of the following:
JULY 31
-------------------------
1997 1998
----------- ------------
Senior notes (A)................................ $ - $100,000,000
Convertible promissory note (B)................. 2,159,000 -
Promissory note (C)............................. 1,901,000 1,195,000
Promissory note (D)............................. 1,683,000 1,159,000
Other........................................... 1,379,000 1,346,000
----------- ------------
7,122,000 103,700,000
Less: current portion........................... (1,881,000) (1,866,000)
----------- ------------
$5,241,000 $101,834,000
=========== ============
- --------
(A) On February 18, 1998, the Company completed an offering of $100,000,000 in
Senior Notes (the "Notes"). Such Notes bear interest, which is payable
semi-annually on February 15 and August 15, at 8.75% per annum, mature on
February 15, 2006 and are general unsecured obligations of the Company.
The Notes are redeemable at the option of the Company, in whole or in
part, at any time after February 15, 2002 at specified redemption prices.
In addition, prior to February 15, 2001, using the proceeds of certain
specified kinds of public equity offerings the Company may redeem up to
35% of the aggregate principal amount of the Notes at a redemption price
equal to 108.75% of the principal amount of the Notes so redeemed.
F-11
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(B) On October 14, 1996, the Company entered into a $2,250,000 convertible
promissory note with a financial institution. Such promissory note bore
interest at the rate of 11.00% per annum. Such promissory note and accrued
interest thereon was converted into 145,981 shares of the Company's common
stock in fiscal 1998.
(C) On August 14, 1996, the Company entered into a $2,500,000 promissory note
with a financing company. The note is payable in monthly installments
through September 1999 and bears interest, which is payable upon maturity,
at an effective rate of 16.3% per annum. The promissory note is
collateralized by certain equipment.
(D) On January 10, 1997, the Company entered into a $2,000,000 promissory note
with a financing company. The loan is payable in monthly installments of
principal and interest through January 2000 and bears interest at an
effective rate of approximately 18.6% per annum. Such interest rate is
adjusted on a monthly basis in accordance with changes in the interest
rate of three-year U.S. Treasury Securities. The promissory note is
collateralized by certain equipment.
On September 5, 1997, the Company completed a private placement of
$7,500,000 in convertible debentures. Such convertible debentures bore
interest at 3% per annum, which was payable upon their maturity on September
5, 2000. In April 1998, the holders of $6,500,000 in principal amount of the
convertible debentures elected to convert all outstanding principal and unpaid
accrued interest thereon into 436,781 shares of the Company's common stock.
The remaining $1,000,000 in principal amount of the convertible debentures and
all unpaid accrued interest thereon was repaid in June 1998. See Note 10.
On December 24, 1997, the Company entered into a loan and security agreement
(the "Loan") with a finance company to provide it with up to $10,000,000 in
financing. The Loan bore interest at the base rate, as defined, plus 2% per
annum and was repaid in full in February 1998, at which time the related
credit facility was terminated.
The future principal repayments of notes payable as of July 31, 1998 were
approximately as follows:
Year ending July 31:
1999................................. $ 1,866,000
2000................................. 1,269,000
2001................................. 310,000
2002................................. 240,000
2003................................. 15,000
Thereafter........................... 100,000,000
------------
Total payments....................... $103,700,000
============
5. RELATED PARTY TRANSACTIONS
The Company supplied telecommunications services to its customers under an
agreement wherein Lermer Overseas Telecommunications, Inc. ("Lermer") was the
carrier. Simon L. Lermer, who served as a director of the Company from
December 1992 to December 1995, is the sole shareholder of Lermer. Mr. Lermer
and Marc Knoller, a director of the Company, were the two directors of Lermer.
Under an agreement between Lermer and the Company, the Company provided Lermer
with marketing, technical support, billing and collection and rate procurement
services. Payments made to Lermer and the Company's revenues for such services
in fiscal 1996 were approximately $2,143,000. During fiscal 1996, the Company
obtained a license to supply telecommunications services directly to its
customers and the agreement with Mr. Lermer was terminated.
F-12
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities
consists of the following:
JULY 31
-----------------------
1997 1998
---------- ----------
Deferred tax assets:
Net operating loss carryforwards.................. $8,579,000 $ -
Bad debt reserve.................................. 1,280,000 2,577,000
Exercise of stock options......................... 434,000 8,790,000
Other............................................. - 1,263,000
---------- -----------
Deferred tax assets............................... 10,293,000 12,630,000
Deferred tax liability--depreciation.............. 999,000 1,880,000
---------- -----------
Net deferred tax assets........................... 9,294,000 10,750,000
Valuation allowance............................... (9,294,000) -
---------- -----------
Total deferred tax assets......................... $ - $10,750,000
========== ===========
In the fourth quarter of fiscal 1998, the Company recorded an income tax
benefit from the reversal of the previously established deferred tax valuation
allowance. The allowance was reversed as the realization of the net deferred
tax assets was more likely than not. A portion of the benefit that related to
the tax deduction upon the exercise of stock options was recorded directly
into additional paid-in capital.
The provision (benefit) for income taxes consists of the following for the
years ended July 31:
1996 1997 1998
---- ---- -----------
Current:
Federal $ - $ - $ -
State and local................................... - - 200,000
---- ---- -----------
- - 200,000
---- ---- -----------
Deferred:
Federal........................................... - - (1,519,000)
State and local................................... - - (441,000)
---- ---- -----------
- - (1,960,000)
---- ---- -----------
$ - $ - $(1,760,000)
==== ==== ===========
The income statement classification of the provision (benefit) for income
taxes consists of the following at July 31:
1996 1997 1998
---- ---- -----------
Income tax benefit attributable to continuing
operations...................................... - - $(1,671,000)
Income tax benefit attributable to extraordinary
loss............................................ - - (89,000)
---- ---- -----------
$ - $ - $(1,760,000)
==== ==== ===========
F-13
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The differences between income taxes expected at the U.S. federal statutory
income tax rate and income taxes provided are as follows:
YEARS ENDED JULY 31,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
Federal income tax at statutory
rate............................ $(5,394,000) $(1,343,000) $(1,373,000)
Purchased research and
development..................... -- -- 8,788,000
Change in valuation allowance.... 6,164,000 1,534,000 (9,294,000)
State and local income tax....... (915,000) (227,000) 328,000
Other, net....................... 145,000 36,000 (209,000)
----------- ----------- -----------
Income tax provision (benefit)... $ -- $ -- $(1,760,000)
=========== =========== ===========
7. STOCKHOLDERS' EQUITY
COMMON STOCK AND CLASS A STOCK
The rights of holders of common stock and holders of Class A stock are
identical except for voting and conversion rights and restrictions on
transferability. The holders of Class A stock are entitled to three votes per
share and the holders of common stock are entitled to one vote per share.
Class A stock is subject to certain limitations on transferability that do not
apply to the common stock. Each share of Class A stock may be converted into
one share of common stock at any time at the option of the holder.
WARRANTS
In May 1991, the Company repurchased 1,035,000 shares of its Common stock
for $80,000. In connection with the aforementioned stock repurchase, a former
stockholder received a warrant permitting him, in the event of certain sales
of the Company's common stock, as defined, to purchase shares of the Company's
common stock at a discount to the sale price. On January 1, 1996, in full
satisfaction of the previous agreement, the former stockholder was granted a
warrant to purchase 575,000 shares of the Company's common stock for an
aggregate purchase price of $1.00. This warrant was exercised in March 1996.
In July 1997, the Company issued warrants to purchase 35,906 shares of its
common stock at $8.34 per share and 63,098 shares of its common stock at
$6.958 per share to a leasing company in connection with a capital lease.
In September 1997, the Company issued warrants to purchase 75,000 shares of
the Company's common stock at $15.16 per share in connection with a private
placement of $7,500,000 of convertible debentures. The holders of these
warrants exercised warrants to purchase 35,000 shares of the Company's common
stock in fiscal 1998.
STOCK OPTIONS
Prior to March 15, 1996, the Company had an informal stock option program
whereby employees were granted options to purchase shares of common stock.
Under such program, options to purchase 2,158,770 shares of common stock were
granted.
On March 15, 1996, the Company adopted a stock option plan (the "Option
Plan") for officers, employees and non-employee directors to purchase up to
2,300,000 shares of the Company's common stock. In 1998, the
F-14
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
number of shares of common stock reserved for issuance under the Option Plan
was increased to 3,300,000. Generally, options become exercisable over vesting
periods up to six years and expire ten years from the date of grant.
During the years ended July 31, 1996 and 1997, the Company recorded
compensation expense relating to the granting of stock options of
approximately $70,000 and $41,000, respectively. On February 15, 1997, the
Company canceled 1,272,250 outstanding options with an exercise price of
$10.00 and granted new options with an exercise price at the market value on
that date of $7.75. On April 16, 1997, the Company canceled 603,500
outstanding options with an exercise price of $7.75 and granted new options
with an exercise price at the market value on that date of $4.375.
A summary of stock option activity under the Company's stock option plan is
as follows:
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
---------- --------------
Outstanding at July 31, 1995.................. 2,140,370 $ 0.41
Granted....................................... 1,363,150 9.92
---------- ------
Outstanding at July 31, 1996.................. 3,503,520 9.15
Granted....................................... 3,807,544 6.50
Exercised..................................... (969,100) 2.08
Canceled...................................... (1,875,750) 9.28
Forfeited..................................... (67,188) 4.47
---------- ------
Outstanding at July 31, 1997.................. 4,399,026 3.89
Granted....................................... 1,270,300 14.00
Exercised..................................... (1,615,366) 3.28
Forfeited..................................... (839,325) 5.00
---------- ------
Outstanding at July 31, 1998.................. 3,214,635 $ 7.90
========== ======
At July 31, 1998, 3,214,635 stock options were outstanding with exercise
prices ranging from $0.21 to $33.88. The weighted average exercise price and
remaining contractual life of such stock options were $7.90 and 8.3 years,
respectively.
At July 31, 1998, 1,837,851 stock options were exercisable at prices ranging
from $0.21 to $33.88 per share. The weighted average exercise price of such
stock options was $6.51. The weighted average fair value of options granted
was $3.21, $4.46, and $9.91 for the years ended July 31, 1996, 1997, and 1998,
respectively.
Pro forma information regarding net loss and loss per share is required by
SFAS 123, and has been determined as if the Company had accounted for employee
stock options under the fair value method provided by that statement. The fair
value of the stock options was estimated at the date of grant using the Black-
Scholes option pricing model with the following assumptions for vested and
non-vested options:
JULY 31
-----------------------
1996 1997 1998
------- ------- -------
ASSUMPTIONS
Average risk-free interest rate....................... 6.05% 6.11% 5.92%
Dividend yield........................................ - - -
Volatility factor of the expected market price of the
Company's common stock............................... 105% 89% 84%
Average life.......................................... 6 years 6 years 5 years
F-15
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of the
options under SFAS 123 is amortized to expense over the options' vesting
period. For the years ended July 31, 1996, 1997 and 1998, pro forma net loss
and pro forma net loss per share under SFAS 123 amounted to approximately
$18,107,000, $10,054,000 and $16,508,000, respectively, and $1.00, $0.48 and
$0.58, respectively.
8. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
In December 1995, Surfers Unlimited, L.L.C. filed a breach of contract
action in the New Jersey Superior Court, Bergen County. The suit names a
subsidiary of the Company as defendant and seeks restitutional and
consequential damages in an unspecified amount for interference with
prospective business advantages, breach of contract and improper use of
confidential and proprietary information. Howard S. Jonas, the Chairman and
Chief Executive Officer of the Company, has also been named as a defendant in
the action. The Company's subsidiary has filed a counterclaim based on
interference with prospective business advantages, breach of contract and
improper use of confidential and proprietary information. The suit is
currently in the discovery phase, which is scheduled to end in February 1999;
a trial date has not been scheduled to date.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey Superior Court, Bergen County. Howard S. Jonas,
the Chairman and Chief Executive Officer of the Company, has also been named
as a defendant in the action. The action claims that the Company has made
hiring and promotion decisions based upon the religious backgrounds of the
relevant individuals, in violation of federal and state law. The complaint
seeks compensatory and punitive damages in an unspecified amount and also
seeks statutory multiples of damages. All of the claims arising under federal
law were dismissed by the Court in New Jersey Superior Court, Bergen County,
leaving the plaintiffs with only the remedies available under state law.
Further, the Court granted the Company permission to file counterclaims
against all plaintiffs for the alleged unlawful taking of business records.
The Company filed such counterclaims in October 1998. Discovery is continuing
and a trial date is scheduled for February 16, 1999.
In June 1997, an uncertified class-action suit seeking compensatory damages
in an unspecified amount was brought against the Company in New York Supreme
Court, New York County. The suit concerns advertisements that are no longer
used by the Company, and advertising practices that were voluntarily
terminated by the Company following a prior investigation of the Company by
the Attorneys General of several states. A motion to dismiss is presently
pending before the Court.
In September 1997, DigiTEC 2000, Inc. ("DigiTEC") filed a complaint
(subsequently amended) in New York Supreme Court, New York County against the
Company alleging that in connection with its sale of prepaid calling cards,
the Company engaged in unfair competition and tortuously interfered with an
exclusive business relationship between DigiTEC and two co-defendants, CG Com,
Inc. and Mr. Carlos Gomez. The complaint seeks compensatory and consequential
damages in an unspecified amount and also seeks an unspecified amount of
punitive damages. The complaint also alleges that CG Com, Inc. and Mr. Gomez
owe DigiTEC more than $500,000. In November 1997, the Court denied DigiTEC's
motion for a preliminary injunction to bar CG Com,
F-16
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Inc. and Mr. Gomez from distributing the Company's calling cards. DigiTEC has
settled its claims against CG Com, Inc. and Mr. Carlos Gomez, and therefore,
the Company is the only remaining defendant. DigiTEC and the Company have
agreed in principle to settle this action and are currently engaged in
finalizing the settlement agreement.
The Company filed a lawsuit against Mr. Glen Miller in August 1997 in the
New Jersey Superior Court, Bergen County. The action was based upon various
matters arising out of Mr. Miller's employment with IDT. Mr. Miller answered
the complaint and filed a counterclaim against the Company seeking
compensatory and punitive damages for breach of his employment contract and
breach of the covenant of good faith and fair dealing. Mr. Miller alleges that
the Company breached his employment agreement by failing to compensate him as
contemplated by his employment agreement, including by failing to deliver to
him 20,000 shares of the Company's Common Stock. Mr. Miller also filed a
third-party complaint against Howard Balter, the Chief Operating Officer of
the Company, and Jonathan Rand, the Company's former Director of Human
Resources, for fraudulent conduct and misrepresentation. The Company filed its
answer to Mr. Miller's counterclaim in December 1997. In January 1998, the
Court partially granted Mr. Miller's motion for summary judgment, awarding him
severance pay in the amount of approximately $50,000. The Company's motion for
leave to appeal this award has been denied, and the action is currently in the
discovery phase. A trial date has been scheduled for February 1999.
The Company is subject to other legal proceedings and claims which have
arisen in the ordinary course of its business and have not been finally
adjudicated. Although there can be no assurances in this regard, in the
opinion of the Company's management, such proceedings, as well as the
aforementioned actions, will not have a material adverse effect on results of
operations or the financial condition of the Company.
OPERATING LEASES
The future minimum payments for all operating leases as of July 31, 1998
were approximately as follows:
Year ending July 31:
1999....................................... $ 1,184,000
2000....................................... 692,000
2001....................................... 242,000
2002....................................... 184,000
-----------
Total payments............................. $ 2,302,000
===========
Rental expense under operating leases was approximately $178,000, $388,000
and $1,225,000 for the years ended July 31, 1996, 1997 and 1998, respectively
CAPITAL LEASES
The future minimum payments for all capital leases as of July 31, 1998 were
approximately as follows:
Year ending July 31:
1999....................................... $ 5,339,000
2000....................................... 4,994,000
2001....................................... 3,164,000
2002....................................... 2,348,000
2003....................................... 1,294,000
Thereafter................................. 1,053,000
-----------
Total payments............................. 18,192,000
Less amount representing interest.......... (2,971,000)
Less current portion....................... (3,989,000)
-----------
Capital lease obligations--long-term
portion................................... $11,232,000
===========
F-17
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
COMMUNICATIONS SERVICES
The Company has an agreement with a supplier of telecommunications services
("Vendor") which began in August 1994 and continues monthly unless terminated
by one of the parties. Under such agreement, the Vendor bills and collects, on
behalf of the Company, for long distance telephone services provided to the
Company's customers. The Company is responsible for all uncollected
receivables. For the years ended July 31, 1996, 1997 and 1998, the Company
purchased approximately $3,900,000, $17,330,000 and $4,272,000 respectively,
of such services from the Vendor.
The Company has agreements with certain carriers to buy and sell
communications services. As of July 31, 1998, the Company had approximately
$71,000,000 in minimum purchase commitments related to such agreements.
DISTRIBUTION AGREEMENTS
The Company has distribution agreements under which it agrees to pay its
agents commissions for obtaining new Internet, pre-paid debit card, Internet
telephony and discount telecommunications customers. The agreements require
commissions upon activation of the customers.
9. CUSTOMER, GEOGRAPHICAL AREA AND SEGMENT INFORMATION
During the year ended July 31, 1996, one customer accounted for
approximately 19% of total revenues. No customer accounted for more than 10%
of revenues during the years ended July 31, 1997 and 1998.
Revenues from customers outside the United States represented approximately
23%, 25% and 11% of total revenues during the years ended July 31, 1996, 1997
and 1998, respectively. No single geographic area accounted for more than 10%
of total revenues.
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended July 31, 1996, 1997 and
1998 are as follows:
INTERNET
TELECOMMUNICATIONS ACCESS NET2PHONE TOTAL
------------------ -------- --------- --------
(IN THOUSANDS)
YEAR ENDED JULY 31, 1996
Revenues..................... $ 35,708 $21,986 $ - $ 57,694
Income (loss) from
operations.................. 2,756 (17,851) (660) (15,755)
Depreciation and
amortization................ 258 930 24 1,212
Total assets................. 22,907 20,570 320 43,797
Capital expenditures......... 1,358 10,335 202 11,895
YEAR ENDED JULY 31, 1997
Revenues..................... $ 99,937 $32,895 $ 2,355 $135,187
Income (loss) from
operations.................. 5,707 (8,092) (1,060) (3,445)
Depreciation and
amortization................ 1,128 3,562 183 4,873
Total assets................. 33,110 24,205 1,222 58,537
Capital expenditures......... 7,635 9,448 975 18,058
YEAR ENDED JULY 31, 1998
Revenues..................... $303,864 $20,001 $11,508 $335,373
Income (loss) from
operations.................. 5,934 (7,030) (2,650) (3,746)
Depreciation and
amortization................ 6,004 4,409 871 11,284
Total assets................. 367,131 36,415 13,650 417,196
Capital expenditures......... 51,970 1,113 6,238 59,321
F-18
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The income (loss) from operations for the telecommunications segment in
fiscal 1998 includes a $25,000,000 non-recurring expense for the write-off of
in-process research and development in connection with the acquisition of
InterExchange, Inc. which was allocated to acquired research and development.
10. EXTRAORDINARY ITEMS
During fiscal 1996, the Company borrowed an aggregate of $3,477,000 from
shareholders, affiliates and outside investors. The notes bore interest at 12%
per annum. The notes were repaid with a portion of the proceeds of the
Company's initial public offering. In connection with the repayment of such
notes, the Company incurred a prepayment penalty of $233,500.
During fiscal 1998, Company incurred a prepayment penalty, net of tax, of
approximately $132,000 related to repayment of $1,000,000 in aggregate
principal amount of convertible debentures. See Note 4. Such prepayment
penalties have been classified as extraordinary losses on retirement of debt
in the accompanying statement of operations.
11. ADDITIONAL FINANCIAL INFORMATION
Other current assets include advances to carriers of approximately
$1,982,000 and $3,712,000 at July 31, 1997 and 1998, respectively.
12. ACQUISITIONS
In August 1996, the Company completed the acquisition of the assets of PCIX,
Inc. ("PCIX"), a former alliance partner of the Company. The acquisition price
included a $690,000 promissory note, cash payments totaling $280,000,
forgiveness of $429,000 owed to the Company from PCIX, and the assumption of
$95,000 of other PCIX liabilities. The promissory note bore interest at 8.25%
per annum and was repaid in July 1998.
In October 1996, the Company completed the acquisition of the assets of
International Computer Systems, Inc., a former alliance partner of the
Company. The acquisition price included cash payments totaling $2,250,000 and
a $750,000 promissory note. Such promissory note is payable in 48 monthly
installments commencing on October 1, 1996 and bears interest at 10.00% per
annum.
In November 1997, the Company completed the acquisition of 100% of the
issued and outstanding common stock of Rock Enterprises, Inc. ("Rock"), a
former consultant of the Company, for an aggregate purchase price of
$5,312,500. The purchase price consists of 625,000 shares of the Company's
common stock. The Company issued 312,500 of such shares on the closing date of
the acquisition in November 1997. The remaining shares will be issued in equal
installments of 62,500 over the next five years on the anniversary of the
closing date. The Company is accounting for such acquisition using the
purchase method. Since Rock had no assets or liabilities, the entire purchase
price has been allocated to goodwill. The operations of Rock have been
included in the statement of operations as of the date of the acquisition.
In May 1998, the Company completed the acquisition of 51% of the issued and
outstanding stock of Union Telecard Alliance, Inc. ("Union"), a former debit
card reseller of the Company for an aggregate purchase price of $2,650,000.
The purchase price consists of 100,000 shares of the Company's common stock.
The purchase price can be increased by a maximum of 100,000 shares contingent
upon Union meeting certain operating criteria for the 12 month period
subsequent to the date of acquisition, as defined. The Company is accounting
for such acquisition using the purchase method. The entire purchase price has
been allocated to goodwill. The operations of Union have been included in the
statement of operations as of the date of the acquisition.
F-19
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In May 1998, the Company completed the acquisition of InterExchange, Inc.
("InterExchange"), a former debit card service platform provider of the
Company, for an aggregate purchase price of $90,588,000. The purchase price
consists of $20,000,000 in cash, 3,242,323 shares of the Company's common
stock and $588,000 in professional fees incurred in connection with the
acquisition. Some of such shares are currently held in escrow. The Company is
accounting for such acquisition using the purchase method. The operations of
Interexchange have been included in the statement of operations as of the date
of the acquisition.
The fair value of the assets acquired and liabilities assumed from
Interexchange at the date of acquisition is summarized as follows:
Current assets.............................................. $ 36,000
Property and equipment...................................... 5,539,000
Current liabilities......................................... (5,737,000)
In-process research and development......................... 25,000,000
Goodwill.................................................... 65,750,000
-----------
$90,588,000
===========
In connection with such acquisition, the Company immediately expensed the
amount allocated to in-process research and development of $25,000,000 in
accordance with generally accepted accounting principles, as technological
feasibility had not been established and the technology had no alternative
future use as of the date of the acquisition.
The pro forma unaudited consolidated results of operations assuming
consummation of the Interexchange acquisition as of the beginning of the
respective periods, are as follows:
YEAR ENDED JULY
31
------------------
1998 1997
-------- --------
(IN THOUSANDS)
Revenues............................................. $344,272 $144,937
Net loss before extraordinary item................... (5,762) (6,585)
Net loss............................................. (5,894) (6,585)
Loss per share--basic and diluted.................... (0.21) (0.27)
The pro forma unaudited consolidated results of operations in fiscal 1997
does not include a $25,000,000 non-recurring expense for the write-off of in-
process research and development in fiscal 1998.
F-20
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
IDT CORPORATION
FINANCIAL STATEMENT SCHEDULE--VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) OF PERIOD
----------- ---------- ---------- ------------- ----------
FISCAL 1996
Reserves deducted from accounts
receivable:
Allowance for doubtful
accounts.................... $ 250,000 $4,042,000 $(2,192,000) $2,100,000
FISCAL 1997
Reserves deducted from accounts
receivable:
Allowance for doubtful
accounts.................... $2,100,000 $4,592,000 $(3,502,000) $3,190,000
FISCAL 1998
Reserves deducted from accounts
receivable:
Allowance for doubtful
accounts.................... $3,190,000 $6,190,000 $(3,125,000) $6,255,000
- --------
(1) Uncollectible accounts written off, net of recoveries. Includes $122,000
in fully reserved accounts receivable received in conjunction with the
Company's acquisition of Yovelle Renaissance Corporation in 1996.
F-21