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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, 1999, 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
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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 29, 1999
of $22.875, as reported on the Nasdaq National Market, was approximately $547
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 29, 1999, the Registrant had outstanding 24,100,383 shares of
Common Stock, $.01 par value, and 10,029,758 shares of Class A Common Stock,
$.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information in the Registrant's definitive Proxy Statement for its
1999 Annual Meeting of Stockholders, which will be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after July 31, 1999, is incorporated by reference in Part III (Items 10, 11,
12 and 13) of this Form 10-K.
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INDEX
IDT CORPORATION
ANNUAL REPORT ON FORM 10-K
Page No.
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PART I
Item 1. Business............................................... 1
Item 2. Properties............................................. 32
Item 3. Legal Proceedings...................................... 32
Item 4. Submission of Matters to a Vote of Security Holders.... 33
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.................................... 34
Item 6. Selected Financial Data................................ 35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 36
Item 7A. Quantitative and Qualitative Disclosures about Market
Risks.................................................. 46
Item 8. Financial Statements and Supplementary Data............ 46
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant..... 47
Item 11. Executive Compensation................................. 47
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................. 47
Item 13. Certain Relationships and Related Transactions......... 47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K............................................... 48
SIGNATURES.......................................................... 50
Index to Consolidated Financial Statements.......................... F-1
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 1999 refers
to the Fiscal Year ended July 31, 1999).
IDT Corporation is a leading facilities-based emerging multinational carrier
that provides a broad range of telecommunications services to wholesale and
retail customers worldwide. The company offers integrated and competitively
priced international and domestic long distance telecommunications service and
Internet access. The Company's majority-owned Net2Phone, Inc. ("Net2Phone")
(NASDAQ: NTOP) subsidiary offers a variety of Internet telephony products and
services. The Company's telecommunications services include wholesale carrier
services, prepaid calling cards, international retail services and domestic
long distance services. The Company has grown considerably in recent years,
generating revenues of $135.2 million, $335.4 million and $732.2 million in
Fiscal 1997, Fiscal 1998 and Fiscal 1999, respectively.
IDT delivers its telecommunications services over a high-quality network
consisting of 70 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 23 of the companies that are primarily
responsible for providing telecommunications services in particular countries
(many of which are commonly referred to as "Post, Telephone and Telegraphs," or
"PTTs"). In addition, IDT maintains a high-speed network that carries Internet
traffic in order to support both its Internet access services and Net2Phone's
Internet telephony services.
As of October 1, 1999, the Company had approximately 125 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 worldwide. Within
the U.S., IDT provides dedicated and dial-up Internet access services to
approximately 65,000 retail customers. Net2Phone's Web-based Internet telephony
services, which allow customers to make telephone calls from a multimedia PC to
any telephone, and the Net2Phone Direct service, which enables users to make
phone-to-phone calls over the Internet, have been used by a total of over 1.8
million registered customers worldwide.
The Company operates a growing telecommunications network consisting of (i)
70 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 plans to expand its global telecommunications network
infrastructure, in order to allow the Company to route a greater percentage of
its international long distance traffic over owned lines. Routing calls over
owned lines, rather than leased lines, will help the Company to reduce its
operating costs, ensure the quality of its service and expand its customer
base. However, the Company follows a disciplined, incremental approach to
expanding its network, adding new facilities only when it determines that such
investments are justified by traffic volumes. Generally, IDT enters new markets
by leasing fiber capacity. As traffic grows, the Company typically invests in
bandwith to realize cost savings from routing calls over an owned network. As
traffic
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increases further, the Company may install a switch to increase overall
capacity. If volume continues to grow, the Company may deploy additional
switching and/or fiber capacity. IDT installed company-owned switches in the
U.K. and the Netherlands in Fiscal 1999. The company plans to install and/or
upgrade facilities in France, Italy, Spain, Germany and Austria by the end of
Fiscal 2000, 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's Internet access networks provide local dial-up access through 33
"points of presence" (or "POPs") owned by the Company, through which
subscribers may access the Internet. The Company's domestic Internet network
also includes about 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 Net2Phone's Internet telephony traffic.
History
The Company was founded in August 1990 and was 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.
The Company entered the telecommunications business by introducing its
international call reorigination service in 1990 to capitalize on the
opportunity created by the large spread between U.S. and foreign-originated
international long distance telephone rates. Long distance calling costs in
certain highly regulated international markets are often prohibitive. The
Company's call reorigination service enables customers to access a U.S. dial
tone from overseas and place international calls that are reoriginated in the
U.S. The customer benefits from more favorable U.S. outbound long distance
rates and superior transmission quality. 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 PC2Phone, the first commercial telephone service to connect
calls between personal computers and telephones over the Internet. The Company
expanded its Internet telephony offerings in September 1997 with the
introduction of Net2Phone Direct, a service that enables users to make
international and domestic calls over the Internet using standard telephones.
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 Web sites of such companies
without charge.
Offerings of Net2Phone
On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock (the "Initial Public Offering"), yielding
$85.3 million in net proceeds, to be used for development and maintenance of
strategic Internet relationships, advertising and promotion, research and
development, the upgrading and expansion of its network and general corporate
purposes, including working capital.
Prior to the Initial Public Offering, Net2Phone was a 90%-owned direct
subsidiary of the Company. As such, Net2Phone received various services
provided by the Company, including administration (accounting, human
resources, legal), customer support, telecommunications and joint marketing.
The Company also provided Net2Phone with a number of its executives and
employees. The Company has historically allocated a portion of its overhead
costs related to those services it provided to Net2Phone. None of these
services were provided to Net2Phone pursuant to any written agreement between
the Company and Net2Phone.
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After the Initial Public Offering, the Company owned 56.2% of the capital
stock of Net2Phone. The Company owns Class A stock that has twice the voting
power of Net2Phone's common stock. Therefore, after the Initial Public
Offering, the Company controlled 64.0% of Net2Phone's vote.
In connection with Net2Phone's Initial Public offering, the Company entered
into several agreements with Net2Phone, including an assignment agreement, a
separation agreement, an IDT services agreement, a Net2Phone services
agreement, a tax sharing and indemnification agreement, a joint marketing
agreement and an Internet/telecommunications agreement.
On November 4, 1999 Net2Phone filed a registration statement with the
Securities and Exchange Commission for the sale of 6,300,000 shares of common
stock (the "November Offering"). Of the 6,300,000 shares to be sold in the
November Offering, 3,400,000 shares are being sold by Net2Phone. The Company
will be selling 2,200,000 shares, with the remaining 700,000 shares to be sold
by other selling stockholders. The underwriters have also been granted an
option for a period of 30 days to purchase up to 900,000 additional shares of
common stock from other selling stockholders to cover over-allotments, if any.
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. 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.
Industry
Overview
The international long distance industry, which principally consists of the
transmission of voice and data between countries, is undergoing a period of
rapid, fundamental change that has resulted, and is expected to continue to
result, in significant growth in the usage of international telecommunications
services. According to industry sources, in 1997, the international long
distance telecommunications industry accounted for approximately 81.8 billion
minutes of use, an increase of 14% from 71.7 billion minutes of use in 1996,
and up from approximately 24.6 billion minutes of use in 1988. The
international long distance telecommunications industry generated revenues of
approximately $67.0 billion in 1997. Industry sources have estimated that by
2001 this market may approach $98.0 billion in revenues and 143.2 billion
minutes of use, representing compound annual growth rates from 1997 of 10.0%
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; (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.
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Globalization: The increased globalization of commerce, trade and travel has
stimulated demand for international long distance services, which in turn has
spurred the continuing deregulation and privatization of telecommunications
markets, which have traditionally been served by state-owned monopoly
providers. In the U.S., demand for international long distance services has
been boosted by a continued surge of immigrants to the U.S. These immigrants
often seek a way to make inexpensive international calls to their friends and
relatives back in their country of origin, using any telephone, without
needing to demonstrate a credit history. The debit calling card remains the
preferred vehicle for fulfilling these needs. The company believes that it is
currently the top provider of international debit card calling time from the
U.S., putting it in position to benefit from this trend.
Declining prices: The reduction of outbound international long distance
rates, resulting from the increased competition generated by deregulation and
privatization, continues to make international calling available to a much
larger customer base. This, in turn, has stimulated increased traffic volumes.
Increased teledensity: Stimulated by economic growth and development,
government initiatives and technological advances, the number of telephone
lines around the world has increased dramatically, and is expected to lead to
greater demand for international telecommunications services.
Wider selection of products and services: The proliferation of
communications devices, including cellular telephones, facsimile machines,
pagers, data communications devices and communications equipment has led to a
general increase in the use of telecommunications services. In addition, a
growing number of products and services are available to an increasing portion
of the world's population. This availability is driving the increasing demand
for these services on both a singular and bundled basis, requiring carriers to
offer a wide array of voice and data products and services.
Growth of data traffic: The increased availability of higher-quality and
higher-capacity bandwith has enabled international long distance carriers to
improve service quality and provide a wider array of data services, while also
lowering costs. The demand for data services, including Internet based demand,
has increased rapidly, and is expected to continue to increase at a robust
pace in the foreseeable future.
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 ("BT"). 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
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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 the opportunities for U.S. carriers to
enter foreign markets and to develop alternative termination arrangements with
carriers that lack market power in other countries.
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
through that country's domestic telephone network.
International long distance providers can generally be categorized by the
extent of their ownership and use of switches and transmission facilities. The
largest U.S. carriers, AT&T, MCI WorldCom and Sprint primarily utilize owned
U.S. transmission facilities and tend to use other international long distance
providers to reach niche markets where they do not own a network, to take
advantage of lower prices, and to carry their overflow traffic. Since no
carrier has transmission facilities that cover the more than 200 countries to
which major long distance providers offer service, a significantly larger
group of long distance providers has emerged, which own and operate their own
switches but 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. Almost all international calls are carried under the complex
accounting rate system, a framework
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for originating, carrying and terminating calls that has been in place since
just after World War II. Within each country, the regulatory authority
negotiates rates with a foreign PTT. These accounting rates tend to be
artificially inflated, with no relation to the actual costs of carrying
traffic.
Under a traditional operating agreement, the international long distance
provider that originates more traffic compensates the long distance provider
in the other country by paying an amount determined by multiplying the net
traffic imbalance (the difference between minutes sent and minutes received)
by the settlement rate, which is generally one-half 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" (IRU), in a
previously installed cable, or by leasing or obtaining capacity from another
long distance provider that either has direct ownership or IRU rights 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 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 extremely dynamic in nature, 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
6
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
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, 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
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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. International Data Corporation ("IDC") estimates that the number of
Internet users worldwide will increase from approximately 69 million in 1997
to 320 million in 2002, representing a compound annual growth rate of 36%.
Forrester Research projects that revenue from Internet access services in the
U.S. will grow from $6.5 billion in 1998, to $21.8 billion in 2002, a compound
annual growth rate of 35%.
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; (vii)
the increase in the number and variety of services available on the Internet;
and (viii) the widening acceptance of Internet-based transactions
("e-commerce") as reliable and more convenient substitutes for transactions
conducted through more traditional means. 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@Home Corp., InfoSeek Corp. and Lycos, 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 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 fast, 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.
8
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.
Internet telephony has emerged as a low cost alternative to traditional long
distance calls. IDC projects that the Internet telephony market will grow
rapidly to over $23.4 billion in 2003, from approximately $1.1 billion in 1998
and that Internet telephony will account for nearly 11% of domestic and
international long distance voice traffic by 2002.
Internet telephone calls are less expensive than traditional international
long distance calls primarily because these calls are carried over the
Internet or a proprietary network and therefore bypass a significant portion
of international long distance tariffs. The technology by which Internet phone
calls are made is also more cost-effective than the technology by which
traditional long distance calls are made. IDC projects that commerce over the
Internet will grow to approximately $1.3 trillion in 2003.
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 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 over both the near term and long term 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.
9
Traditional international long distance calls use a technology called "circuit
switching," which carries the calls over international voice telephone
networks. Circuit switching requires a dedicated connection between the caller
and the recipient which must stay open for the duration of the call. On the
other hand, packet switching technology breaks voice and fax calls into
separate data packets, sends them over the Internet, then reassembles them in
their original form for delivery to the recipient. This technology allows data
packets representing multiple conversations to be carried over the same line,
and is therefore inherently more efficient than is circuit switching
technology. In addition, 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.
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.
Strategy
The Company's objective is to enhance its current position as as a leading
facilities-based provider of high-quality, low-cost 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. During
Fiscal 2000, 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)
facilities in the U.S., the U.K., France, Italy, Spain, Germany, Austria 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.
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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 in some cases to use its
relationship with Net2Phone for additional low cost termination. To date, the
Company has entered into approximately 65 agreements with carriers that
provide for the favorably priced termination of its calls in over 40
countries.
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.
Services
IDT provides its customers with integrated and competitively priced
international and domestic telecommunications, Internet access and through its
majority-owned Net2Phone subsidiary, 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 $684.6 million during Fiscal
1999, up from $303.9 million during Fiscal 1998. Telecommunications revenues
represented 93.5% and 90.6%, respectively, of IDT's total consolidated
revenues in Fiscal 1999 and Fiscal 1998.
Wholesale Carrier Services
The Company sells its wholesale carrier services to other U.S. and
international carriers, utilizing flexible and least-cost traffic routing and
based on its expertise in navigating the complex accounting rate system. In
this way, the Company acts as a "carrier's carrier," providing the numerous
entrants in the retail market with rates that are much lower than those
previously offered by the more established carriers. The Company is able to
offer competitive rates to its carrier customers as a result of (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.
During Fiscal 1999, wholesale carrier sales represented 39.5% of IDT's total
consolidated revenues.
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. Recent immigrants and members of the ethnic
communities are heavy users of international long distance, given their desire
to keep in touch with family members and friends back home. The Company also
markets cards in the U.K., France and the Netherlands, seeking to capitalize
on the opportunity presented by the recent surge in immigration from under-
developed countries to Europe's developed nations. During Fiscal 1999, sales
of prepaid calling cards accounted for 49.7% of IDT's total consolidated
revenues.
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The Company offers both IDT-branded and non- IDT-branded prepaid calling
cards, with favorable rates to specific areas of the world. The cards are sold
in several different dollar denominations, most commonly $5, $10 and $20. The
table below lists the IDT phone cards sold by the Company:
California Exclusive Illinois Exclusive New York Exclusive
Carolina Exclusive Long Island Exclusive Nosso Brazil Card
Centro Americard M&M Card Pepe Colombianita
China Card Mass Exclusive Pepe Megatel
Colombiana Card Mega Mexico Card Puerto Rico Exclusive
Colombianita Card Megatel Card Rhode Island Exclusive
Connecticut Exclusive Megatel Vending Texas Exclusive
Discovery Card Metropolis Card Vending Georgia
Dominicall Card Merengue Card Exclusive
Florida Exclusive New Jersey Exclusive Vending Washington
Georgia Exclusive New York Alliance Exclusive
Washington Alliance
Washington Exclusive
The Company's rechargeable cards, distributed primarily through in-flight
magazines, permit users to place calls from 43 countries through international
toll-free services.
The Company's retail customers can use its calling cards at a 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.
IDT expanded its domestic debit card platform through its acquisition of
InterExchange and its subsidiaries (collectively, "InterExchange"), completed
in May 1998. 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.
As part of IDT's rapid expansion in the prepaid calling card market, the
Company has initiated marketing private label phone cards. Private label cards
serve as lucrative promotional items and can also be used to help generate
brand name awareness. In December 1998, IDT signed an exclusive multi-year
supply and distribution agreement with M&M/MARS's "M&M's(R)" Chocolate
Candies, one of the largest confectionary brands in the world, to provide
specifically-branded, private label phone cards. Through a strategic marketing
relationship, "M&M's(R)" cards will be available to retailers currently
carrying "M&M's(R)" Chocolate Candies. The phone cards feature the likenesses
and the voices of the "M&M's(R)" Brand Characters currently featured in
"M&M's(R)" advertising. IDT handles the entire call process of these phone
cards, including call routing, authorization, prepaid platform and billing of
the "M&M's(R)" cards.
In February 1999, the Company launched Debitalk, its first prepaid callback
phone card, which allows people around the world to bypass the high costs of
placing international calls from countries outside of the United States.
Debitalk allows users to place phone calls from anywhere in the world using a
touch-tone telephone with a pre-programmed callback number. Users dial their
access number, allow the phone to ring once, hang up, wait for the ring back,
listen to their real-time account balance, and dial their destination number.
There are no credit cards, invoices or bad debt associated with Debitalk as
the callback services are prepaid.
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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. 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. International retail
services accounted for 2.9% of IDT's total consolidated revenues in Fiscal
1999.
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 retail service in several European
nations by the end of Fiscal 2000.
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 also 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.
Domestic long distance services accounted for 1.4% of the Company's total
consolidated revenues in Fiscal 1999.
In September 1999, the Company announced a new domestic long distance plan
featuring a flat rate of 5 cents per minute with a $3.95 monthly fee. The 5
cents per minute rate applies to all calls, 24 hours a day, 7 days a week. IDT
also plans to offer rates as low as 3.5 cents per minute for customers who
also subscribe to IDT's dial-up Internet service. The Company believes that it
is now the lowest cost domestic long distance provider in the country.
Internet Services
In 1994, the Company began offering dial-up and dedicated Internet access to
individuals as a value-added service for its domestic long distance customers,
and to businesses as a stand-alone service. IDT's Internet access network,
which consists of multiple leased lines, offers 33 (POPs) owned by the
Company, and approximately 375 POPs owned by local and regional Internet
service providers, through which subscribers may access the Internet. 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. Internet access accounted for 2.3% of
IDT's total consolidated revenues in Fiscal 1999.
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.
13
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 Service 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 Service 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 a
toll-free telephone number, 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.
In August 1999, the Company teamed up with iPass, to offer to its retail and
business customers roaming Internet access in over 150 countries using iPass'
vast worldwide network of 4,000 POPs. Internet roaming is available
immediately to the Company's customers, who can download the iPass connection
software at the Company's Web site. Instead of having to pay for long-distance
calls to connect back to IDT's service while outside the United States, the
Company's customers can now access the Internet locally in virtually every
major city throughout the world. The roaming Internet service also improves
the connection quality for users who often experience noisy or dropped
connections with Internet connections via international calls.
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 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 of their employees who require
Internet access.
In March 1999, the Company formed a Dedicated Internet Group for the primary
purpose of selling Dedicated Internet Access, Digital Subscriber Lines
("DSL"), Web Hosting and Design and Colocation to business clients. The
Dedicated Internet Group is currently staffed by 20 employees and revenues
have increased from $4,000 in new sales in April 1999 to over $100,000 in
September 1999. The Company currently charges clients using 56 kilobits per
second ("56K") lines approximately $350 per month for direct connect service
and clients utilizing full T1's approximately $1,400 per month for direct
connect service. For clients with higher bandwith needs, IDT offers a tiered
T3 service starting at $3,000 per month.
In June 1999, IDT began offering Internet access through DSL. DSL uses
standard telephone lines to provide access to the Internet at speeds many
times faster than standard 56K modem connections, at a lower cost than a
dedicated leased line. IDT offers DSL service to its customers at monthly
rates ranging from $125 to $499, depending on line speed and the length of the
contract, with four months of free Internet access included in the package.
The Company views the DSL market as largely untapped given the 38,000 to
40,000 nationally installed DSL lines and the potential market of well over
five million DSL subscribers.
14
Genie Services
The Company also 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.
Telefonica Agreement
In October 1999, IDT entered into a joint venture agreement with Terra
Networks, S.A. (formerly known as Telefonica Interactiva, S.A.) pursuant to
which the parties formed two limited liability companies to provide Internet
services and products for customers in the United States, mainly targeting and
focusing on the Hispanic population in the United States. One company was
formed to provide Internet access to customers in the target market, and IDT
contributed its dial-up Internet access customers, its managerial resources
and facilities and its portfolio of current and future products for Internet
access to the new company in exchange for a 49% ownership interest. The other
company was formed to develop and manage an Internet portal that will provide
content-based Internet services, electronic commerce offerings and other
Internet services to customers in the target market. IDT will assist in
developing relationships with content producers and content providers and will
sell advertising on this new company's portal in exchange for a 10% ownership
interest. Terra Networks has agreed to fund the first $30 million of expenses
for the ISP joint venture, subject to the completion of certain performance
criteria.
IDT/Westmintech Joint Venture
In September 1999, Chattle, Inc., a wholly owned subsidiary of IDT, entered
into a joint venture with Westmintech Company, L.L.C. ("Westmintech") in the
form of a Delaware limited liability company named Worldwide Intercom, L.L.C.
("Worldwide Intercom") to provide high speed voice and data services,
including without limitation local and long distance telephone service
(dedicated and 1+), cable television service (cable and/or fiber optic), on
line service with direct Internet access and Internet access services (DSL,
dedicated and dial up) and various other Internet services and other
technology related to the foregoing existing and yet to be developed, to the
tenants of commercial and residential properties worldwide. Westmintech is
owned in part and controlled by Charles Kushner or an entity which he
controls. Mr. Kushner owns in part and controls directly or indirectly various
multifamily, retail and commercial properties throughout New York and New
Jersey. Chattle, Inc. owns 75% of Worldwide Intercom and Westmintech owns the
remaining 25%.
Under the terms of the joint venture agreement, IDT will license to
Worldwide Intercom intellectual property, technical know-how, and patent,
copyright and trademark rights relating to the provision of Worldwide
Intercom's services. IDT will also provide Worldwide Intercom with back office
support for its services, and will arrange for the installation, activation,
maintenance, repair and service of the hardware and wiring necessary to
provide Worldwide Intercom's services. The initial term of the agreement is
for a period of one year and shall be automatically renewable for additional
one year periods.
Net2Dine.com
In August 1999, the Company launched Net2Dine.com, an Internet directory
designed for restaurant owners and consumers which currently lists over
112,000 restaurants in the United States. Net2Dine.com attracts restaurants to
its Web site by offering a free restaurant listing as well as value-added
products that increase a restaurant's presence on the Internet. For $10 a
month, a restaurant may subscribe to Net2Dine.com's Webpage Plan. Every
subscribing restaurant receives its own mini Webpage which is built into
Net2Dine.com's Web site, complete with Click2Reserve on-line reservations.
Each Webpage provides detailed information about the restaurant, including its
credit card policy, specials, reservations requirements and other relevant
information.
The Company intends to pursue and/or develop other opportunities in the
Internet business, with a focus on identifying and exploiting niche market
opportunities, specifically in markets where the Company can leverage one or
more of its existing strengths.
15
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 Net2Phone
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
Fiscal 1999, Net2Phone received the following awards and commendations:
. Net2Phone Direct was named Internet Telephony Magazine's 1998 Product of
the Year
. Net2Phone was named CTI Magazine's 1998 Product of the Year
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 Technologies, Inc., 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 enables international and domestic phone-to-phone calls
to be made 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 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 net revenues from its Internet telephony business of about $30.7
million during Fiscal 1999.
IDT has entered into agreements with resellers in several foreign countries,
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
16
commission basis. As of October 1999, the Company was represented by over 300
foreign sales representatives worldwide. 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 of which the Company owns 51% of the outstanding equity
interests. Union is one of the largest distributors of prepaid calling cards
in the nation, selling through over 100,000 retail outlets throughout the
United States. In July 1999, the Company entered into an agreement with All
Americas Cable & Radio ("AACR"), a long distance carrier based in the
Dominican Republic, in which the Company will distribute prepaid calling cards
in the Dominican Republic on behalf of AACR. As part of its plan to expand its
territory beyond the U.S., the Company has begun to establish a distribution
network in the Dominican Republic to replicate its calling card distribution
network in the United States. Union also plans to begin distributing prepaid
cards in Puerto Rico and parts of Central America.
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
sub-distributor 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.
In addition to selling IDT's prepaid calling cards, Union sells prepaid
calling cards of other companies. This allows Union to operate as a "one-stop
shop" for the widest possible range of prepaid phone cards, enabling Union to
enhance its sales to the retail outlets it currently serves.
IDT also sells rechargeable calling cards, which are distributed primarily
through in-flight magazines.
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 as compared to
traditional broadcast and print advertising. As of October 20, 1999, the
Internet sales force consisted of approximately 45 employees. 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
Net2Phone markets its Internet telephony services primarily by distributing
its products without charge via the Internet and acquiring commercial
Net2Phone customers through its prepaid platform. Net2Phone promotes its
service through online and Internet-based advertising venues, traditional
print advertising in international publications, and electronic media. In
addition, Net2Phone has 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. Net2Phone has entered into strategic
marketing and distribution relationships with leading
17
Internet companies, including Yahoo!, Infospace.com, Snap.com, Excite@Home and
ZD Net. Net2Phone has also entered into arrangements with leading computer
equipment and software companies, such as IBM, Compaq and Packard Bell-NEC
Europe to include its software with these companies' products.
Net2Phone has 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. Net2Phone 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. Net2Phone 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, Net2Phone began offering its Click2Talk Service, in which an
icon is placed on a customer's Web site. When an end-user of the Web site 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 began offering the Click2CallMe service, in
which an icon is placed on a customer's Web site. When an end-user of the Web
site 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.
In February 1999, Net2Phone launched easysurf.com (www.ezsurf.com) the first
web shopping portal powered by Internet telephony. Easysurf.com allows
visitors to learn about online merchants' services and to communicate with
them through direct voice interaction. Easysurf.com gives users added
convenience by listing useful information for key online retailers, including
payment and shipping options and return policies. Easysurf.com enables voice
communications with over 300 Web sites, and educates users by providing them
with essential information needed to buy products online.
In July 1999, Net2Phone entered into an exclusive, four-year distribution
and marketing agreement with ICQ, a subsidiary of America Online, to provide
Internet telephony services to users of ICQ's instant messaging service. ICQ
will embed Net2Phone's Internet telephony software into ICQ's Instant
Messenger software on an exclusive basis, allowing ICQ users to make PC-to-
phone and PC-to-PC calls and to receive phone-to-PC calls.
International Sales
In Fiscal 1997, 1998 and 1999, international customers accounted for
approximately 25%, 11% and 13% 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. Additionally, the Company is able to leverage its existing
Internet sales force for the sale of its bundled long distance and Internet
access service.
Customers
Telecommunications
As of October 1, 1999, the Company had approximately 125 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 worldwide, including over 50,000 call
reorigination customers. The Company sold over 50,000,000 prepaid calling
cards during Fiscal 1999.
18
Internet Access
As of October 20, 1999, the Company offered local dial-up access to
approximately 65,000 retail customers, provided dedicated access to nearly 500
medium and large-sized businesses, and offered Web hosting services to almost
2,000 customers.
Internet Telephony
As of July 31, 1999, Net2Phone served over 325,000 active customers who made
an average of approximately 60 minutes of calls per month, and handled over 20
million minutes of use per month. Approximately 69% of Net2Phone's customers
as of July 31, 1999, were based outside of the United States. As of October
10, 1999, Net2Phone had installed the Click2Talk service on approximately 176
commercial Web sites.
Billing and Customer Support
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's majority-owned Net2Phone subsidiary has also developed a
sophisticated real-time management information system for its Internet
telephony services. This system allows Net2Phone 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 Net2Phone 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 a number of
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.
19
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., Newark,
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 $32 million, 20 year IRU
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, connecting more than 120 metropolitan areas around the
nation. These network facilities will enable the Company to expand the range
and reliability of its data and voice transmission service, while reducing
network costs. IDT will be able to offer nationwide dial-up long distance and
dial-around (10xxx) services, reduce 800-origination costs and provide for
origination and termination of carrier traffic in all major U.S. cities.
In October 1999, the Company entered into an agreement with Frontier whereby
IDT will enhance its ability to provide presubscribed long distance (1+) and
dedicated and toll-free services throughout the United States as well as
casual calling (10xxx) in selected areas of the country. The additional
capacity will significantly enhance IDT's ability to provide long distance
dial up services.
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 about 65 operating and
terminating agreements that provide for the termination of traffic in over 40
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.
International Telecommunications Acquisitions & Agreements
In January 1999, the Company signed agreements with France Telecom, Deutsche
Telkom, Swisscom N.A. and Telefonica de Espana, four major telecommunications
companies based in Europe, to establish a direct fiber-optic connection
between the companies for international long distance service. The agreement
establishes direct channels between the companies' international switching
points and the Company's facilities in the United States and United Kingdom.
The Company has already established a presence in the United Kingdom with its
facilities-based switch, and has purchased more than 12,000 kilometers of
undersea cable connecting the United States, Canada and the United Kingdom.
In February 1999, the Company acquired Orion Telekom BV, a Netherlands based
provider of telecommunications services. Through this acquisition, the Company
procured a contractual relationship with Royal KPN NV ("KPN") the leading
phone company in the Netherlands, and associated physical interconnections, an
installed Alcatel S12 switch, an operating license in Holland and a facility
in Rotterdam. The Company's voice licensing in the Netherlands coupled with
the interconnection available through KPN has enabled the Company to offer
wholesale and retail carrier services in the Dutch market.
20
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 and programmable, and is designed to
implement network-based intelligence quickly and efficiently. The Company
currently owns 65 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 four Nortel switches. The Company plans to upgrade its
switching platforms in Los Angeles, Miami and New Jersey during Fiscal 2000.
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. By utilizing a least-cost routing system, the Company is able to
minimize its costs, and offer lower rates to its customers.
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.
21
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 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 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's network now provides local dial-up Internet access
through more than 400 POPs, of which the Company owns 33.
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. 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.
In connection with the Company's acquisition of InterExchange in May 1998,
the Company acquired InterExchange's in-process research and development
relating to alternative switching and compression technologies. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-- Fiscal 1998 Compared to Fiscal 1997--Acquired Research and
Development." To the extent that the Company succeeds in completing the
development of such alternative switching technologies, the Company believes
that it will be able to substantially reduce its investments in connection
with the acquisition and installment of additional switching equipment, and
that it will be able to install such equipment in substantially less time. In
addition, if the Company succeeds in developing such compression technologies,
the Company believes that it will be able to manage voice compression more
effectively across its network and provide significant cost efficiencies in
routing telephone traffic via fiber optic cables and satellite transmission.
No assurances can be given that the Company will succeed in developing either
of such technologies within a time frame that will enable it to capitalize
upon its investment, or 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. In the
prepaid calling card market, the Company competes with other providers of
prepaid calling cards and with providers of telecommunications services in
general. Many of the largest telecommunications providers, including AT&T, MCI
WorldCom and Sprint, currently market prepaid calling cards, which in certain
cases, compete with the prepaid calling cards
22
sold by the Company. These companies are substantially larger and have greater
financial, technical, engineering, personnel and marketing resources, longer
operating histories, greater name recognition and larger customer bases than
the Company. The Company also competes with smaller, emerging carriers in the
prepaid calling card market, including Star Telecommunications, Inc., RSL
Communications, Ltd., and Pacific Gateway Exchange, Inc. In marketing prepaid
calling cards to customers outside the U.S. market, the Company competes with
the large PTTs, such as British Telecommunications (BT) in the U.K. The
Company believes that additional competitors are likely to enter the prepaid
calling card market (including Internet-based service providers and other
telecommunications companies) during the next several years.
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 Viatel, 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 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"), and Earthlink Network, Inc. ("Earthlink"); (ii) established online
services companies that offer Internet access, such as America Online, Inc.
("AOL"), CompuServe 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
Liberty Media Group ("Liberty Media") 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 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
23
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 long distance telephony market and, in particular, the Internet
telephony market, is highly competitive. Net2Phone's competitors include AT&T,
MCI WorldCom and Sprint in the United States and foreign telecommunications
carriers. During the past several years, a number of companies have introduced
services that make Internet telephony services available to businesses and
consumers. In addition to Net2Phone, AT&T Jens (a Japanese affiliate of AT&T),
ICG Communications, IPVoice.com, ITXC, OzEmail (which was acquired by MCI
WorldCom), RSL Communications (through its Delta Three subsidiary), I-Link and
iBasis (formerly known as VIP Calling) provide a range of voice-over-the-
Internet services. These companies offer PC-to-phone or phone-to-phone
services that are similar to the services Net2Phone offers. Some, such as AT&T
Jens and OzEmail, offer these services within limited geographic areas.
Additionally, a number of companies have recently introduced Web-based voice
mail services and voice-chat services to Internet users.
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") 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 "Detariffing 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
24
certain defined interstate and international end user telecommunications
revenues. Contribution factors vary quarterly, and carriers, including the
Company, are billed each month. 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.
In July 1999, the United States Court of Appeals for the Fifth Circuit
released its decision reviewing the FCC's Universal Service Order. This
decision will have a significant impact on carrier's obligations to make
payments to the FCC's Universal Service Funds. The Court found that the FCC
cannot include intrastate revenues in the calculation of universal service
contributions. Local exchange carriers' revenues are largely intrastate and
their interstate revenues are primarily from other carriers and not subject to
universal service assessment. Therefore, the contributions required to be made
by these carriers will be sharply reduced, placing an even greater burden on
interexchange carriers, including the Company, to fund the universal service
program. The Court also reversed the FCC's decision to include the
international revenues of interstate carriers in the universal service
contribution base.
In implementing the Court's decision, the FCC has amended its universal
service fund rules and removed intrastate-end user telecommunications revenues
from the assessment base for the schools and libraries and rural health care
support mechanisms. The FCC will assess contributions to the universal service
program using a single contribution factor based on interstate and
international end-user telecommunications revenues. The proposed contribution
factor for November and December 1999 is 5.8% of interstate and international
end-user telecommunications revenues. This increase in the universal service
contribution factor may significantly increase the Company's contribution to
the FCC's Universal Service Fund.
Pursuant to the Universal Service Order, all carriers are required to submit
a Universal Service Fund worksheet in March and September of each year.
Starting April 1, 2000, carriers will be required to annually file a single
telecommunications reporting worksheet for the FCC's Universal Service Fund,
Telecommunications Relay Services, Local Number Portability, and North
American Numbering Plan programs. 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.
On September 29, 1999, Bell Atlantic-New York ("BANY") filed with the FCC
its Section 271 application for authority to provide interLATA interexchange
service to customers in New York. The FCC has ninety days to review BANY's
Section 271. Southwestern Bell Telephone Company ("SWBT") has received the
Texas Public Utilities Commission's approval of its Section 271 application to
provide interLATA interexchange service to customers in Texas and will soon
file its Section 271 application with the FCC. If the FCC subsequently
approves BANY's and SWBT's Section 271 applications, interexchange carriers,
such as the Company, will be subjected to increased competition from these
companies in the New York and Texas markets for interexchange services. As a
result, the Company may face increased pressure to reduce its rates for
interexchange services which may have an adverse impact on the Company's
revenues. In addition, it is likely that Bell Atlantic, SWBT, US West, and
Bell South will shortly file Section 271 applications in additional states,
which if granted, would further increase competition in the provision of
interexchange services and result in downward price pressures for such
services in these states.
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 permit the
provision of such services to cross the boundaries of the approximately 200
local telephone calling
25
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 49 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. Under the FCC's revised rules, international telecommunications
service providers are only required to file copies of their contracts with
dominant foreign carriers, and these contracts may be filed with the FCC on a
confidential basis. 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 public switched telephone
networks ("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
the provision of switched services over private lines, interconnected to the
public switched network, between the United States and the following
countries: Canada, the U.K., Sweden, Australia, the Netherlands, New Zealand,
Germany, France, Belgium, Denmark, Luxembourg, Norway, Austria, Switzerland,
Italy, Japan, Hong Kong, Ireland, Spain, Iceland, Finland, and Israel. 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, 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.
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.
In May 1999, the FCC issued an order exempting competitive carriers and
specified competitive routes from the IS Policy. Specifically, the FCC's May
1999 Order eliminated the IS Policy for arrangements with non-dominant foreign
carriers (i.e., those that lack market power) and for arrangements with any
carrier, dominant or
26
non-dominant, on routes deemed "competitive" by the FCC. The FCC has
determined that the following international routes qualify for relief from the
FCC's IS Policy and associated filing requirements: Canada, Denmark, France,
Germany, Hong Kong, Ireland, Italy, The Netherlands, Norway, Sweden, and the
U.K. Historically, the Company's exemption from the IS Policy has been a chief
factor enabling it to offer competitive international long distance services.
Under the FCC's May 1999 order, providers of traditional telephone services
will have increased flexibility to enter into more economically efficient
arrangements with foreign correspondent carriers, which could, over time,
decrease the competitive price advantage of the Company's international
services, and make these services less attractive to our customers.
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. Thirty 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. In connection with this process,
the FCC 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 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 is not currently 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
27
European Union has developed a regulatory framework aimed at creating an open,
competitive 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, which required
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 decided to
liberalize its regulations as of an earlier date, December 1, 1998. 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.,
28
and a license to operate domestic and international telecommunications
facilities in the U.K. IDT Global has also obtained a license to provide voice
telephony services in Frankurt, Germany. In addition, through its Dutch
holding subsidiary, IDT Europe BV, the Company has obtained a nationwide voice
license in France. In addition, the same subsidiary holds a General
Telecommunications License in Ireland.
In February 1999, the Company acquired Orion Telekom BV, a Netherlands based
provider of telecommunications services. Included in the purchase was Orion's
Netherlands voice license. Orion, (now known as IDT Netherlands BV) is a
wholly-owned subsidiary of IDT Europe BV, a wholly-owned subsidiary of the
Company. In Austria, a voice license has been obtained for Strategic
Telecommunications Belgium.
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 Telecommunications Act of 1996 contained provisions imposing criminal
liability on: (1) persons sending or displaying indecent material on an
interactive computer service such as the Internet in a manner available to
minors and (2) entities knowingly permitting facilities under their control to
be used for such activities. These provisions were held to be unconstitutional
by the U.S. Supreme Court in 1997. In 1998, Congress passed the Child Online
Protection Act ("COPA") which imposes criminal liability and civil liability
on any person who by means of the World Wide Web, makes any communication for
commercial purposes available to minors that includes material that is harmful
to minors. COPA was enacted to prevent minors' access to indecent material on
the Internet by criminalizing certain communications to minors and imposing a
"filtering" requirement on Internet service providers ("ISPs"). The sections
of COPA that impose criminal and civil liability for the dissemination of
harmful material to minors have been stayed by the U.S. District Court for the
Eastern District of Pennsylvania pending a trial on their constitutionality.
However, the "filtering" requirement in COPA has not been stayed, and ISPs
must notify users of existing measures (e.g. hardware, software, and filtering
devices) that may assist the users in limiting minors' access to harmful
material. Subsequent enforcement of the liability provisions of COPA
restricting minors' access to harmful material may chill the development of
Internet content or have other adverse effects on ISPs such as the Company. In
addition, in light of the uncertainty attached to the enforcement of the law,
there can be no assurances that the Company would not have to modify its
operations to comply with COPA, including, among other things, prohibiting
users from maintaining home pages on the Web that contain material deemed
harmful to minors.
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
29
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
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 advised Internet
telephony providers that these companies would impose access charges on
Internet telephony traffic. One of these bell operating companies also
petitioned the FCC for a declaratory ruling that providers of interstate
Internet telephony must pay federal access charges and petitioned the public
utilities commissions of Nebraska and Colorado for similar rulings concerning
payment of access charges for intrastate telephone calls. The regional bell
operating company involved in the Colorado proceeding has requested the
dismissal of its petition. The Nebraska Public Service Commission ("PSC") has
dismissed the regional bell operating company's complaint but plans to hold a
public hearing and seek comment on the following issues: (1) whether its
preliminary finding that traffic to ISPs is "local" in nature; (2) how
carriers should compensate each other for calls placed to ISPs; (3) whether
interexchange carriers providing Internet telephony must pay intrastate access
charges; and (4) whether ISPs and providers of Internet telephony should
contribute to the state universal service fund. The outcome of the Nebraska
and FCC proceedings is uncertain. If the FCC or the Nebraska PSC decide that
access charges may be levied against Internet telephony providers, the
Company's majority-owned Net2Phone subsidiary would have to pay interstate
access charges and intrastate access charges in Nebraska. Moreover, if the
Nebraska PSC subjects ISPs or Internet telephony providers to state universal
service fund contributions, Net2Phone's revenues would be impacted. Should
additional state public utility commissions make similar rulings, Net2Phone
may not be able to operate profitably in any state that assesses access or
universal charges against it.
In September 1999, the FCC initiated a notice of inquiry regarding voice
over Internet telephony (both computer to computer and phone to phone Internet
telephony) seeking comment on the availability of Internet telephony, the
extent it has begun to replace traditional telecommunications services, the
percentage of disabled persons who utilize Internet telephony, and whether it
falls under the purview of Section 255 of the Telecommunications Act. Section
255 of the Telecommunications Act requires a provider of telecommunications
service to ensure that its service is accessible and usable by persons with
disabilities, if readily achievable. Should the FCC subsequently decide to
adopt rules subjecting Internet Telephony to the requirements of Section 255,
it may materially impact the Company's operations by requiring the Company to
ensure that its Internet telephony services are compatible with
telecommunications devices used by the disabled.
To the Company's knowledge, there are currently no domestic 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
30
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.
In connection with the initial public offering of Net2Phone, IDT assigned
various pending federal service mark applications and three service mark
registrations to Net2Phone on May 7, 1999. IDT also assigned its interest in
three United States patent applications relating to the technology underlying
the Net2Phone services as well as pending foreign counterpart applications.
The Company owns registered service marks for the mark IDT, IDT and antenna
design, Colombianita, Dominicall and Megatel. In addition, the Company has
applications pending with respect to the registration of service marks
relating to its various operations, including, Click2Reserve, Click2Take,
Columbiana, Cyberspace Kids, Debit Talk, Gifts for Gab, Global America, Global
Call, IP Central Office, LA Universal, Mega Mexico, Mexicall, Net2Dine.com,
Nuestra Voz and Virtual Dime. IDT aggressively protects its intellectual
property and continues to build its portfolio of service marks.
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.
Employees
As of October 20, 1999, the Company and its subsidiaries had a total of
approximately 1,271 employees, including 373 in technical support and customer
service, 125 in sales and marketing, 115 in technical staff, 115 in general
operations and 100 in management and finance. The Company also had a total of
35 employees in Europe. Union Telecard Alliance, LLC, in which the Company has
a 51% interest, employed 75 persons. The Company's majority-owned Net2Phone
subsidiary had 333 full-time employees as of October 20, 1999.
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.
31
Item 2. PROPERTIES.
The Company's principal facilities total approximately 66,000 square feet
and are primarily located in two buildings in Hackensack, New Jersey. The
Company occupies facilities in one building pursuant to a lease which expires
on April 30, 2002 and occupies office space in a second building, pursuant to
a lease with an entity controlled by Howard S. Jonas, the Company's Chairman
and Chief Executive Officer, which expired in December 1998; however, the
Company renewed the lease for an additional two year term. The Company also
leases additional office space totaling approximately 6,000 square feet in two
separate buildings located in Hackensack, New Jersey. The Company's 51% owned
subsidiary, Union, occupies approximately 4,000 square feet of space pursuant
to a ten year sublease agreement.
On March 25, 1999, IDT entered into a 10 year lease agreement for
approximately 12,000 square feet in Newark, New Jersey and on July 12, 1999,
IDT entered into a 10 year lease agreement for approximately 6,000 square feet
of space in Los Angeles, California, both primarily to house
telecommunications equipment. In addition, IDT leases space (typically less
than 500 square feet) in various other geographic locations to house the
telecommunications equipment for each of its POPs.
On April 20, 1999, IDT's subsidiary, 225 Old NB Road, Inc., purchased the
building leased by IDT and its subsidiary, InterExchange, located in
Piscataway, New Jersey, consisting of approximately 65,295 square feet, of
which IDT and InterExchange occupy approximately 40,057 square feet. The
balance of the building is sublet to third parties.
In support of its international expansion efforts, the Company maintains
various international office locations, including in London, England; Paris,
France; Santa Fe Colony, Mexico; and Rotterdam, the Netherlands.
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 of contract and improper use of
confidential and proprietary information. Howard S. Jonas 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. In September 1999, the Company's subsidiary, Howard S. Jonas and
Surfers Unlimited L.L.C. entered into a confidential settlement agreement.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey Superior Court, Bergen County. Howard S. Jonas
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 settlement conference has been scheduled for
November 10, 1999.
In August 1998, a subsidiary of the Company, InterExchange, Inc. ("IX"),
filed a complaint in the New Jersey Superior Court, Middlesex County, against
PT-1 Communications, Inc. ("PT-1"). The action has been removed to the U.S.
District Court for the District of New Jersey. The action arises from a
contract in which IX
32
and PT-1 agreed that PT-1 would route its traffic from prepaid calling cards
through IX's debit card platform. In the action, IX claimed that PT-1 breached
its contract with IX by failing to make required payments under the contract,
and claimed compensatory damages in the amount of $8.5 million. In February
1999, PT-1 filed an answer and counterclaim and third party complaint against
IX, the Company, and certain of their officers, including Howard S. Jonas. PT-
1 alleges that IX is not entitled to these payments in that IX had breached
the agreement, and that, following IX's 1998 merger agreement with the
Company, in which IX become a wholly-owned subsidiary of the Company, IX
violated its covenant in the agreement that it would not compete with PT-1.
PT-1 also alleges, among other things, that the Company and Mr. Jonas
tortiously interfered with the contract between IX and PT-1, and that they
conspired with IX and its personnel to obtain confidential information
relating to PT-1. PT-1 seeks compensatory damages and punitive damages. In May
1999, the Company and Howard S. Jonas filed an answer to PT-1's third party
complaint and IX filed a motion for leave to amend their complaint to add Star
Telecommunications and Samer Tawfik as additional defendants and to include
the additional claims of tortious interference and fraud in the inducement.
The Company and individual plaintiffs David Turock, Eric Hecht, Bradley Turock
and Richard Robbins have sought leave to amend their counterclaims to include
Star Telecommunications as an additional defendant for failure to permit
plaintiff to execute certain stock warrants to purchase PT-1 stock. The Court
has issued an order which provides that PT-1 may not allege a specific amount
of damages although the order does not forbid PT-1 from claiming damages in
general. Discovery is continuing and a trial date has not been scheduled.
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.
33
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 been quoted 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, 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
Fiscal Year ended July 31, 1999..................................
First Quarter.................................................... $28.50 $11.88
Second Quarter................................................... 21.88 9.50
Third Quarter.................................................... 35.00 11.69
Fourth Quarter................................................... 30.38 18.00
On October 29, 1999, the last sale price reported on the Nasdaq National
Market for the Common Stock was $22.875 per share. On the same date, there were
approximately 390 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 29, 1999, was approximately
$547 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 Senior Notes imposes certain
restrictions upon the Company's ability to declare dividends on its Common
Stock while the Notes are outstanding.
34
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, 1999 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
-----------------------------------------------
1995 1996 1997 1998 1999
------- -------- -------- -------- --------
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Telecommunications........ $10,789 $ 35,708 $ 99,937 $303,864 $684,572
Internet.................. 875 21,986 32,895 20,001 16,934
Net2Phone................. -- -- 2,355 11,508 30,678
------- -------- -------- -------- --------
Total revenues.......... 11,664 57,694 135,187 335,373 732,184
Costs and expenses:
Direct cost of revenues..... 7,544 36,438 92,214 240,860 575,050
Selling, general and
administrative............. 5,992 35,799 41,545 61,975 128,500
Acquired research and
development................ -- -- -- 25,000 --
Depreciation and
amortization............... 303 1,212 4,873 11,284 26,254
------- -------- -------- -------- --------
Total costs and
expenses............... 13,839 73,449 138,632 339,119 729,804
Income (loss) from
operations................. (2,175) (15,755) (3,445) (3,746) 2,380
Other, net(1)............... 30 112 (392) (425) 15,078
Income tax provision
(benefit).................. -- -- -- (1,671) 17,850
Minority interests.......... -- -- -- 3,895 (3,309)
------- -------- -------- -------- --------
Net income (loss)............. (2,145) (15,643) (3,837) (6,395) 2,917
Subsidiary redeemable
preferred stock dividends.... -- -- -- -- 26,298
------- -------- -------- -------- --------
Net loss available to common
stockholders................. $(2,145) $(15,643) $ (3,837) $ (6,395) $(23,381)
======= ======== ======== ======== ========
Net loss per share-basic and
diluted...................... $ (.13) $ (.86) $ (.18) $ (.22) $ (.70)
======= ======== ======== ======== ========
Weighted average number of
shares used in calculation of
net loss per share-basic..... 16,569 18,180 21,153 28,571 33,530
======= ======== ======== ======== ========
Balance Sheet Data:
Cash and cash equivalents... $ 232 $ 14,894 $ 7,674 $115,284 $ 52,903
Working capital (deficit)... (884) 13,547 4,887 166,380 179,415
Total assets................ 4,197 43,797 58,537 417,196 515,336
Long-term debt.............. -- -- 5,241 101,834 112,973
Total stockholders' equity.. 911 26,843 25,259 238,748 253,405
- --------
(1) For Fiscal 1996, Fiscal 1998 and Fiscal 1999 includes extraordinary losses
on retirement of debt, net of income taxes, of $233, $132 and $3,270
respectively.
35
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Overview
General
IDT is a leading facilities-based emerging 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 majority-owned Net2Phone subsidiary, Internet
telephony products and services. IDT delivers these services over a high-
quality network consisting of 70 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 23 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 $135.2 million, $335.4 million and $732.2 million in Fiscal 1997,
Fiscal 1998 and Fiscal 1999, respectively.
History
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 Telecard Alliance,
LLC 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.
Revenues
Beginning 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 and Fiscal 1999, 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 90.6% for Fiscal 1998 to 93.5% for
Fiscal 1999. In addition, the Company's revenues from telecommunications
operations increased from $303.9 million during Fiscal 1998 to $684.6 million
during Fiscal 1999. Revenues from the Company's telecommunications operations
are derived primarily from the following activities: (i) domestic and
international 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
36
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 majority-owned subsidiary Net2Phone's revenues are
derived from the marketing of Net2Phone and Net2Phone Direct services and
equipment to individuals, businesses and the Company's foreign partners.
Concentration of Customers
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, 26.2% of revenues in Fiscal 1998 and 10.9% of revenues in Fiscal 1999.
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.
Costs and Expenses
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 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 includes fees
paid to the Company's Alliance Partners.
The Company operates a growing facilities-based telecommunications network
consisting of (i) 70 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
fixed nature of these costs may lead to larger fluctuations in gross margins,
depending on the minutes of traffic and associated revenues generated by the
Company. The Company also expects that these factors will cause the direct
cost of revenues to decline as a percentage of revenues over time. However,
the improvement in gross margins which would result from an expansion in the
Company's network could be partially offset by pricing pressures caused by
intense competition, which would have a negative impact on margins.
Selling expenses consist primarily of sales commissions paid to independent
agents and internal salespersons and advertising costs, which are the primary
cost associated with the acquisition of customers. General and administrative
expenses include salaries, benefits, professional fees 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 are 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 have 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.
37
Initial Public Offering of Net2Phone
On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock (the "Initial Public Offering"), yielding
$85.3 million in net proceeds. After the Initial Public Offering, the Company
owned 56.2% of the capital stock of Net2Phone. The Company owns Class A stock
that has twice the voting power of Net2Phone's Common Stock. Therefore, after
the Initial Public Offering, the Company controlled 64.0% of Net2Phone's vote.
Subsequent Events
Telefonica Agreement
In October 1999, IDT entered into a joint venture agreement with Terra
Networks, S.A. (formerly known as Telefonica Interactiva, S.A.) pursuant to
which the parties formed two limited liability companies to provide Internet
services and products for customers in the United States, mainly targeting and
focusing on the Hispanic population in the United States. One company was
formed to provide Internet access to customers in the target market, and IDT
contributed its dial-up Internet access customers, its managerial resources
and facilities and its portfolio of current and future products for Internet
access to the new company in exchange for a 49% ownership interest. The other
company was formed to develop and manage an Internet portal that will provide
content-based Internet services, electronic commerce offerings and other
Internet services to customers in the target market. IDT will assist in
developing relationships with content producers and content providers and will
sell advertising on this new company's portal in exchange for a 10% ownership
interest. Terra Networks has agreed to fund the first $30 million of expenses
for the ISP joint venture, subject to the completion of certain performance
criteria.
IDT/Westmintech Joint Venture
In September 1999, a subsidiary of the Company entered into an agreement to
form a joint venture with Westmintech Company, L.L.C., to provide high speed
voice and data services, including without limitation local and long distance
telephone service (dedicated and 1+), cable television service (cable and/or
fiber optic), on line service with direct Internet access and Internet access
services (DSL, dedicated and dial up) and various other Internet services and
other technology to the tenants of commercial and residential properties
worldwide. The Company will have a 75% ownership interest in the joint
venture.
Results of Operations
The following table sets forth the percentage of revenues represented by
certain items in the Company's statement of operations (revenues and costs and
expenses are presented net of intercompany transactions):
Year Ended July
31
-------------------
1997 1998 1999
----- ----- -----
Revenues:
Telecommunications..................................... 74.0 90.6 93.5
Internet............................................... 24.3 6.0 2.3
Net2Phone.............................................. 1.7 3.4 4.2
----- ----- -----
100.0% 100.0% 100.0%
Costs and expenses:
Direct cost of revenues................................ 68.2 71.8 78.5
Selling, general and administrative.................... 30.7 18.5 17.6
Acquired research and development...................... -- 7.4 --
Depreciation and amortization.......................... 3.6 3.4 3.6
----- ----- -----
Total costs and expenses............................. 102.5 101.1 99.7
----- ----- -----
Income (loss) from operations............................ (2.5) (1.1) 0.3
Other (net).............................................. (0.3) (0.1) 2.5
----- ----- -----
Income (loss) before income taxes, minority interests and
extraordinary items .................................... (2.8) (1.2) 2.8
===== ===== =====
38
Fiscal 1999 Compared to Fiscal 1998
Results of Operations
Revenues. Revenues increased 118.3% from approximately $335.4 million in
Fiscal 1998 to approximately $732.2 million in Fiscal 1999. Telecommunications
revenues increased 125.3% from approximately $303.9 million in Fiscal 1998 to
approximately $684.6 million in Fiscal 1999. Internet access revenues
decreased 15.3% from approximately $20.0 million in Fiscal 1998 to
approximately $16.9 million in Fiscal 1999. Internet telephony revenues
increased 166.6% from approximately $11.5 million in Fiscal 1998 to
approximately $30.7 million in Fiscal 1999.
Telecommunications revenues increased 125.3%, primarily as a result of a
247.5% increase in minutes of use, from approximately 805.8 million to
approximately 2.8 billion. 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 addition of wholesale carrier services clients and the increased use
by existing clients resulted in an increase in wholesale carrier services
revenues of 73.4%, from approximately $166.7 million in Fiscal 1998 to
approximately $289.0 million in Fiscal 1999. As a percentage of
telecommunications revenues, wholesale carrier service revenues decreased from
approximately 54.9% to 42.2%, 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 prepaid calling
cards increased 236.7% from approximately $108.1 million in Fiscal 1998 to
approximately $364.0 million in Fiscal 1999. As a percentage of
telecommunications revenues, prepaid calling card revenues increased from
approximately 35.6% to approximately 53.2%. As a percentage of
telecommunications revenues, international retail services revenues decreased
from 7.5% to 3.0%.
As a percentage of total revenues, Internet access revenues decreased from
approximately 6.0% for Fiscal 1998 to approximately 2.3% for Fiscal 1999. 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
3.4% for Fiscal 1998 to 4.2% for Fiscal 1999. The increase in Internet
telephony revenues was primarily due to an increase in billed-minute usage
resulting from increased marketing of Net2Phone's Internet telephony products
and services.
Direct Cost of Revenues. The Company's direct cost of revenues increased by
138.7% from approximately $240.9 million in Fiscal 1998 to approximately
$575.0 million in Fiscal 1999. As a percentage of total revenues, these costs
increased from 71.8% in Fiscal 1998 to 78.5% in Fiscal 1999. The dollar
increase is due primarily to increases in underlying carrier and connectivity
costs, as the Company's telecommunications minutes of use, and associated
revenues, grew substantially. As a percentage of total revenues, the increase
in direct costs reflects lower gross margins associated with wholesale carrier
services and prepaid calling card services as compared with international
retail and Internet access services. Gross margins were also adversely
affected by network constraints as demand for usage outpaced the rate of
deployment of additional network capacity.
Selling, General and Administrative. Selling, general and administrative
costs increased 107.3% from approximately $62.0 million in Fiscal 1998 to
approximately $128.5 million in Fiscal 1999. As a percentage of total
revenues, these costs decreased from 18.5% in Fiscal 1998 to 17.6% in Fiscal
1999. The increase in these costs in dollar terms is due primarily to
increased sales and marketing efforts for retail services, including prepaid
calling cards, domestic and international long distance, Net2Phone and
Net2Phone Direct, as well as increased salaries, facilities costs and
professional fees related to the expansion of the Company's infrastructure to
handle its rapid sales growth. Included in salaries is $16.0 million of non-
cash compensation as a result of option grants made by our majority-owned
Net2Phone subsidiary in the fourth quarter of Fiscal 1999.
Depreciation and Amortization. Depreciation and amortization costs increased
131.6% from approximately $11.3 million in Fiscal 1998 to approximately $26.3
million in Fiscal 1999. As a percentage of revenues, these costs increased
from 3.4% in Fiscal 1998 to 3.6% in Fiscal 1999. These costs increased in
39
absolute terms primarily as a result of the Company's higher fixed asset base
during Fiscal 1999 as compared with Fiscal 1998 reflecting 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 add to its asset base allowing it to implement its growth
strategy.
Income (loss) from Operations. The Company's income from operations was $2.4
million in Fiscal 1999 compared to a loss from operations of $3.7 million in
Fiscal 1998. Income from operations for the Company's telecommunications
business increased to approximately $35.0 million in Fiscal 1999 from $5.9
million in Fiscal 1998. 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 increased to 5.1%
in Fiscal 1999 from approximately 2.0% in Fiscal 1998. Fiscal 1998 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 increased to
approximately $8.2 million in Fiscal 1999 from approximately $7.0 million in
Fiscal 1998. The increased loss is primarily due to decreased revenues
resulting from a decrease in total dial-up subscribers.
Loss from operations of the majority owned Net2Phone subsidiary increased to
approximately $24.4 million for Fiscal 1999, compared to a loss of
approximately $2.7 million for Fiscal 1998. This increase is due primarily to
the non-cash compensation charge of $16.0 million described above, coupled
with a substantial increase in both sales and marketing expenses as well as
general and administrative expenses incurred as Net2Phone expanded
distribution relationships, corporate infrastructure and human resources.
Income Taxes. The Company recorded income tax expense of $17.9 million
attributable to continuing operations in Fiscal 1999. An income tax benefit of
$4.3 million upon the exercise of stock options was recorded directly into
additional paid-in capital in Fiscal 1999. In Fiscal 1998, the Company
recorded an income tax benefit of $1.9 million 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. The Company did not incur any expense
related to acquired research and development during Fiscal 1999. 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.
Subsidiary Redeemable Preferred Stock Dividends. On May 13, 1999, Net2Phone
designated 3,150,000 shares of its preferred stock as Series A ("Series A
Stock") and sold 3,140,000 of such shares to unrelated third parties in a
private placement transaction for aggregate gross proceeds of $31,400,000.
The Series A Stock contained beneficial conversion features. The total value
of the beneficial conversion features approximated $75 million. For accounting
purposes the value of the beneficial conversion features was limited to the
amount of proceeds allocated to the Series A Stock. The Company recorded an
increase in net loss available to common stockholders on the date of issuance
of the Series A Stock in the amount of approximately $26.3 million
representing their allocable share of the amount attributable to the
beneficial conversion feature. Each share of Series A Stock was converted into
three shares of Net2Phone Class A Common Stock at the time of Net2Phone's
Initial Public Offering.
40
Fiscal 1998 Compared to Fiscal 1997
Revenues. Revenues increased 148.1% from approximately $135.2 million in
Fiscal 1997 to approximately $335.4 million in Fiscal 1998. Telecommunications
revenues increased 204.0% 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 388.6% 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 $240.9
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 $62.0 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 primarily due to increased sales
and marketing efforts for retail services, specifically pre-paid calling cards
for the periods prior to the purchase of Union Telecard Alliance, LLC. As a
percentage of total revenues, the decrease was primarily due 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 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.
41
Income (loss) from Operations. The Company's loss from operations increased
8.7% 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. Fiscal 1998 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.
42
Quarterly Results of Operations
The following tables set forth certain quarterly financial data for the
eight quarters ended July 31, 1999. 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)
Oct. 31, Jan. 31, April 30, July 31, Oct. 31, Jan. 31, April 30, July 31,
1997 1998 1998 1998 1998 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
Revenues:
Telecommunications..... $47,804 $63,050 $79,082 $113,928 $123,708 $149,239 $179,190 $232,435
Internet............... 4,850 5,194 5,211 4,746 4,269 4,312 4,217 4,136
Net2Phone.............. 2,097 2,709 2,819 3,883 5,301 7,190 8,344 9,843
------- ------- ------- -------- -------- -------- -------- --------
Total revenues......... 54,751 70,953 87,112 122,557 133,278 160,741 191,751 246,414
Costs and expenses:
Direct cost of
revenues.............. 40,861 51,449 59,505 89,045 101,074 126,592 150,183 197,201
Selling, general and
administrative........ 9,835 13,872 20,344 17,919 17,056 23,750 29,966 57,728
Acquired research and
development........... -- -- -- 25,000 -- -- -- --
Depreciation and
amortization.......... 1,745 2,042 2,765 4,737 5,439 6,296 6,902 7,617
------- ------- ------- -------- -------- -------- -------- --------
Total costs and
expenses.............. 52,441 67,363 82,614 136,701 123,569 156,638 187,051 262,546
------- ------- ------- -------- -------- -------- -------- --------
Income (loss) from
operations............. 2,310 3,590 4,498 (14,144) 9,709 4,103 4,700 (16,132)
Other (net)............. (347) (436) 337 154 205 (62) (153) 18,358
------- ------- ------- -------- -------- -------- -------- --------
Income (loss) before
taxes, minority
interests and
extraordinary item..... 1,963 3,154 4,835 (13,990) 9,914 4,041 4,547 2,226
Income tax provision
(benefit).............. -- -- -- (1,671) 3,399 1,426 2,071 10,954
Minority interests...... -- -- -- 3,896 1,623 562 420 (5,914)
------- ------- ------- -------- -------- -------- -------- --------
Income (loss) before
extraordinary item..... 1,963 3,154 4,835 (16,215) 4,892 2,053 2,056 (2,814)
Extraordinary item, net
of income taxes........ -- -- -- (132) -- -- -- (3,270)
------- ------- ------- -------- -------- -------- -------- --------
Net income (loss)....... 1,963 3,154 4,835 (16,347) 4,892 2,053 2,056 (6,084)
Subsidiary redeemable
preferred stock
dividends.............. -- -- -- -- -- -- -- 26,298
------- ------- ------- -------- -------- -------- -------- --------
Net income (loss)
available to common
stockholders........... $ 1,963 $ 3,154 $ 4,835 $(16,347) $ 4,892 $ 2,053 $ 2,056 $(32,382)
======= ======= ======= ======== ======== ======== ======== ========
Net income (loss) per
share--basic........... $ 0.09 $ 0.14 $ 0.17 $ (0.51) $ 0.15 $ 0.06 $ 0.06 $ (0.96)
======= ======= ======= ======== ======== ======== ======== ========
Weighted average shares
outstanding--basic..... 21,999 23,330 28,881 32,359 33,200 33,332 33,649 33,919
======= ======= ======= ======== ======== ======== ======== ========
Net income (loss) per
share--diluted......... $ 0.08 $ 0.12 $ 0.15 $ (0.51) $ 0.14 $ 0.06 $ 0.06 $ (0.96)
======= ======= ======= ======== ======== ======== ======== ========
Weighted average shares
outstanding--diluted... 25,480 27,054 32,693 32,359 35,702 35,344 35,731 33,919
======= ======= ======= ======== ======== ======== ======== ========
43
Liquidity and Capital Resources
General
Historically, the Company has satisfied its cash requirements through a
combination of cash flow from operating activities, sales of equity and debt
securities and borrowings from third parties. The Company received
approximately $10.7 million upon the exercise of stock options and warrants in
Fiscal 1999.
In May 1999, The Company entered into a credit agreement with Lehman
Commercial Paper Inc., CIBC World Markets Corp., Bankers Trust Company and a
Syndicate of lenders. These institutions have provided us with a $160 million
credit facility that includes term loans in an aggregate amount of up to
$135 million and revolving loans in an amount of up to $25 million and an
additional uncommitted amount of up to $100 million. Bankers Trust Company
serves as administrative agent for the facility. The Company used the proceeds
from the initial borrowings under the credit facility of $108.1 million to
purchase more than 99% of its outstanding 8.75% Senior Notes due 2006,
together with accrued and unpaid interest, that were tendered in connection
with its tender offer for these securities. The amount of $75.0 million of the
initial borrowings currently bears interest at a rate of 8.75% per annum and
the remaining $33.1 million of the initial borrowings currently bears interest
at a rate of 8.25% per annum.
As of July 31, 1999, the Company had cash, cash equivalents and marketable
securities of $130.8 million and working capital of approximately $179.4
million. The Company generated negative cash flow from operating activities of
approximately $18.3 million during Fiscal 1999, compared with positive cash
flow from operating activities of approximately $30.6 million during Fiscal
1998. The Company's cash flow from operations varies significantly from year
to year, depending upon the timing of operating cash receipts and payments,
especially accounts receivable and accounts payable. Accounts receivable (net
of allowances) were approximately $38.0 million and $106.1 million at July 31,
1998 and July 31, 1999, 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 $59.3 million in Fiscal 1998 to approximately $60.0 million in
Fiscal 1999, 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 experiences intense competition in its telecommunications
business. The long distance telecommunications industry has been characterized
by declines in both per-minute revenues and per-minute costs. In the past,
these factors have tended to generally offset each other. However, as per-
minute pricing continues to erode, gross margins could come under increasing
pressure. The Company's long-term strategy involves terminating a larger
proportion of minutes on the Company's own network, thus lowering costs and
preserving margins even in a weaker price environment. However, in the short
term, the demand for usage might outpace the rate of deployment of additional
network capacity. As such, there can be no assurance that the Company will be
able to maintain its gross margins at the current level, in the face of lower
per-minute revenues.
In addition, the Company will need to make significant capital expenditures
in order to expand its network capacity. If the Company is unable to raise
sufficient capital to meet its spending requirements, the Company's network
expansion, and the associated margin improvement, would be delayed.
Net2Phone Financings
In May 1999, a group of strategic investors purchased from Net2Phone, in the
aggregate, 3,140,000 shares of Net2Phone Series A Preferred Stock convertible
into 9,420,000 shares of common stock and warrants to purchase up to 180,000
shares of Net2Phone common stock, for a net aggregate purchase price of $29.9
million. Additionally, Net2Phone issued a warrant to purchase 92,400 shares of
its common stock to Hambrecht & Quist as part of its fee as placement agent
with respect to this transaction. In August 1999, Net2Phone completed its
Initial Public Offering of 6.2 million shares, receiving approximately $85.3
million in net proceeds. At that time the Series A Preferred Stock was
converted into Class A Common Stock. The Company owned 56.2% of the capital
stock of Net2Phone after the Initial Public Offering.
44
Other Sources and Uses of Resources
The Company intends to, where appropriate, make strategic acquisitions to
increase its telecommunications customer base. Net2Phone may also make
strategic acquisitions related to its Internet telephony business. From time
to time, the Company evaluates potential acquisitions of companies,
technologies, products and customer accounts that complement its businesses.
As of July 31, 1999, the Company had made loans and advances in the
aggregate amount of approximately $34.5 million, of which $21.2 million was
still outstanding as of July 31, 1999, to other telecommunications and
Internet companies to help establish strategic relationships and facilitate
penetration into key markets. Of that amount $20.0 million had been repaid as
of October 28, 1999, including the entire outstanding balance of a loan made
to Lermer Overseas Telecommunications, Inc. The Company may be a party to
similar transactions in the future.
The Company believes that, based upon its present business plan, the
Company's existing cash resources, and expected cash flow from operating
activities and borrowings under its credit facility, will be sufficient to
meet its currently anticipated 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 or assets
of another company, or if the Company's cash flow from operations after the
end of such period is insufficient to meet its working capital and capital
expenditure requirements, the Company will 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. If the Company is
unable to obtain such additional capital, the Company may be required to
reduce the scope of its anticipated expansion, which could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Year 2000
The Year 2000 issue affects Company's installed computer systems, network
systems and software applications due to the fact that many computers and
applications define dates by the last two digits of the year and "00" may not
be properly recognized by such programs as the Year 2000. The Company has
dedicated the resources it deems appropriate to address and correct potential
Year 2000 problems.
The Company has established a Year 2000 compliance committee (the
"Committee"). The Committee's objectives are to eliminate any possible
disruptions in services and operations that may result from the date change in
the Year 2000. The Committee has developed a plan to identify and repair any
systems that may be affected by the Year 2000. The plan consists of (1)
identifying and inventorying all systems; (2) assessing and testing the
systems for Year 2000 compliance; (3) modifying, upgrading or replacing any
non-compliant systems; and (4) testing the corrected systems to ensure
compliance.
The Committee has implemented this plan throughout the Company and, in
addition to reviewing its own systems, the Company has initiated inquiries and
submitted requests to its third-party vendors and service providers to obtain
information regarding their compliance with the Year 2000.
Inventory, assessment, remediation and testing of software applications and
hardware systems, including network systems, is substantially complete. The
Company will complete the modification, updating or replacement of any systems
that to its knowledge are not Year 2000 compliant by the end of November 1999.
Testing of the corrected systems has been implemented and will continue on an
ongoing basis through October 2000 due to the date October 10, 2000, which is
the first occurrence of a date requiring the use of eight digits to define the
date. Additional testing will be conducted, as deemed necessary by management.
In particular, the Company has focused on the testing and remediation of its
switching facilities to ensure that its network operations through which it
provides communications services to its customers are not disrupted by the
Year 2000. The Company believes that its own network systems are Year 2000
compliant due to the nature and extent of the testing the Company has
conducted and continues to implement on such systems.
The greatest risk to the Company's ability to provide communications
services is the failure of third party service providers to be Year 2000
compliant. While many other carriers and Internet providers have plans to
45
independently become Year 2000 compliant, there is the risk that some
(particularly smaller carriers and providers) will not address or properly
resolve Year 2000 issues. If this were to occur, the Company would be affected
only to the same degree as other carriers and Internet providers in the
communications industry.
In providing telecommunications services, the Company connects directly and
indirectly with thousands of other carriers through switches of the Company
and other carriers. The Company has obtained written assurances and
information from its primary vendors and providers regarding their year 2000
compliance and, to the best of the Company's knowledge based on such
assurances and information, the Company believes there is not a significant
risk that the Company's provision of telecommunication services will be
materially impacted. In addition, it is unlikely that a network failure of a
smaller carrier would have a significant impact on the Company's ability to
provide telecommunications services, however, fully addressing any of these
risks is beyond the Company's control. In addition, the Company is unable to
fully assess the degree to which the manufacturers of switches and similar
equipment have assessed and remediated their equipment and software since most
are manufactured and maintained by independent third parties. However, most
switches are manufactured by manufacturers with a wide range of customers,
therefore, such manufacturers would have a vested interest in ensuring Year
2000 compliance and prompt remediation of any Year 2000 issues.
To date, the Company has incurred expenses of less than $1.0 million in
connection with its remediation of Year 2000 related issues. The Company
constantly monitors its progress of the Year 2000 plan and anticipates that it
will resolve any outstanding internal issues before the end of 1999.
Contingency plans will be developed and implemented before the end of 1999 for
critical systems on an as needed basis should the Company identify any areas
for which such plans are appropriate.
European Currency Conversion
In January 1999, a new currency called the "euro" was introduced in certain
Economic and Monetary Union ("EMU") countries. The EMU countries adopted the
euro as their common legal currency, and through January 1, 2002, both the
existing national currency of the respective EMU country and the euro will be
accepted as legal currency. 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's management does not anticipate, based
on currently available information, that the euro will have a material adverse
impact on the Company's 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-9 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-24 herein are incorporated herein by reference.
Quarterly financial information set forth herein at page 41 is incorporated
herein by reference.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
46
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, 1999,
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, 1999,
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, 1999,
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, 1999,
and which is incorporated by reference herein.
47
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
Exhibit
Number Description
------- -----------
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.
1996 Stock Option and Incentive Plan, as amended and restated, of
10.02(10) the Registrant.
Form of Stock Option Agreement under the 1996 Stock Option and
10.03(3) Incentive Plan.
Form of Registration Rights Agreement between certain stockholders
10.04(4) and the Registrant.
10.05(1) Lease of 294 State Street.
10.06(5) Lease of 190 Main Street.
Form of Registration Rights Agreement between Howard S. Jonas and
10.7(6) the Registrant.
10.8(11) Employment Agreement between the Registrant and James Courter.
10.9(7) Agreement between Cliff Sobel and the Registrant.
10.10(11) Employment Agreement between the Registrant and Hal Brecher.
10.11(11) Employment Agreement between the Registrant and Howard S. Jonas.
10.12(8) 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.
10.13(9) Securities Purchase Agreement between the Registrant, Carlos Gomez
and Union Telecard Alliance, LLC.
10.14(11) Credit Agreement, dated as of May 10, 1999, by and among the
Registrant, various lenders party thereto, Lehman Commercial Paper
Inc., CIBC World Markets Corp. and Bankers Trust Company.
10.15(11) Pledge Agreement, dated as of May 10, 1999, by and among the
Registrant, certain subsidiaries of the Registrant and Bankers Trust
Company, as Collateral Agent.
10.16(11) Security Agreement, dated as of May 10, 1999, by and among the
Registrant, certain subsidiaries of the Registrant and Bankers Trust
Company, as Collateral Agent.
10.17(11) Subsidiaries Guaranty, dated as of May 10, 1999, by and among the
Registrant, certain subsidiaries of the Registrant and Bankers Trust
Company, as Collateral Agent.
10.18(11) Loan Agreement between the Registrant and Stephen Brown.
10.19* Internet/Telecommunications Agreement, dated as of May 7, 1999, by
and between Registrant and Net2Phone, Inc.
10.20* Joint Marketing Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.21* IDT Services Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.22* Net2Phone Services Agreement, dated as of May 7, 1999, by and
between Registrant and Net2Phone, Inc.
10.23* Assignment Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
48
Exhibit
Number Description
------- -----------
10.24* Tax Sharing and Indemnification Agreement, dated as of May 7, 1999, by
and between Registrant and Net2Phone, Inc.
10.25* Separation Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.26* Co-location and Facilities Management Services Agreement, dated as of
May 20, 1999, by and between Registrant and Net2Phone, Inc.
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 S-8 filed January 14, 1996 file no.
333-19727.
(4) Incorporated by reference to Form S-1 filed March 8, 1996 file no. 333-
00204.
(5) Incorporated by reference to Form 10-K for the fiscal year ended July 31,
1997, filed October 29, 1997.
(6) Incorporated by reference to Form S-1 filed March 14, 1996 file no. 333-
00204.
(7) Incorporated by reference to Form 10-K/A for the fiscal year ended July
31, 1997, filed February 2, 1998.
(8) Incorporated by reference to Form 8-K filed April 22, 1998.
(9) Incorporated by reference to Form 10-K/A for the fiscal year ended July
31, 1998, filed December 4, 1998.
(10) Incorporated by reference to Form 10-Q for the fiscal quarter ended
January 31, 1999, filed March 17, 1999.
(11) Incorporated by reference to Form 10-Q for the fiscal quarter ended April
30, 1999, filed June 14, 1999.
(b) Reports on Form 8-K. The Registrant filed the following Current Reports
on Form 8-K during the fiscal year ended July 31, 1999:
On September 29, 1998, the Registrant filed a Current Report on Form 8-K to
amend and refile Exhibit 23.1 to Amendment No. 1 to the Registrant's Current
Report on Form 8-K which was filed with the Commission on May 26, 1998.
49
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
By: /s/ Howard S. Jonas
----------------------------------
Howard S. Jonas
Chairman, Chief Executive Officer
and Treasurer
Date: November 4, 1999
Pursuant to the requirements of the Securities Act of 1933, this Annual
Report on Form 10-K has been signed by the following persons on this 4th day
of November 1999 in the capacities and on the dates indicated.
Signature Titles
--------- ------
/s/ Howard S. Jonas Chairman and Chief
______________________________________ Executive Officer
Howard S. Jonas (Principal Executive
Officer)
/s/ James A. Courter President and Director
______________________________________
James A. Courter
/s/ Hal Brecher Chief Operating Officer
______________________________________ and Director
Hal Brecher
/s/ Stephen R. Brown Chief Financial Officer
______________________________________ (Principal Accounting
Stephen R. Brown Officer)
/s/ Moshe Kaganoff Director
______________________________________
Moshe Kaganoff
/s/ Marc E. Knoller Director
______________________________________
Marc E. Knoller
/s/ Joyce J. Mason Director
______________________________________
Joyce J. Mason
/s/ Geoffrey Rochwarger Director
______________________________________
Geoffrey Rochwarger
/s/ Meyer A. Berman Director
______________________________________
Meyer A. Berman
50
Signature Titles
--------- ------
/s/ J. Warren Blaker Director
______________________________________
J. Warren Blaker
/s/ Denis A. Bovin Director
______________________________________
Denis A. Bovin
/s/ Irving Goldstein Director
______________________________________
Irving Goldstein
Director
______________________________________
Elmo R. Zumwalt
51
IDT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors........................................... F-2
Consolidated Balance Sheets as of July 31, 1998 and 1999................. F-3
Consolidated Statements of Operations for the years ended July 31, 1997,
1998 and 1999........................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended July
31, 1997, 1998 and 1999................................................. F-5
Consolidated Statements of Cash Flows for the years ended July 31, 1997,
1998 and 1999........................................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Financial Statement Schedule--Valuation and Qualifying Accounts.......... F-24
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, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended July 31, 1999. 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, 1998 and 1999 and the consolidated results of its operations and
its cash flows for each of the three years in the period ended July 31, 1999,
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
October 1, 1999
F-2
IDT CORPORATION
CONSOLIDATED BALANCE SHEETS
July 31
--------------------------
1998 1999
------------ ------------
Assets
Current assets:
Cash and cash equivalents........................ $115,283,519 $ 52,903,479
Marketable securities............................ 60,308,768 77,869,655
Trade accounts and commissions receivable, net of
allowance for doubtful accounts of approximately
$6,255,000 at July 31, 1998 and $7,643,000 at
July 31, 1999................................... 38,037,974 106,146,127
Notes receivable--current portion................ 2,140,000 18,967,967
Other current assets............................. 12,096,803 36,311,052
------------ ------------
Total current assets........................... 227,867,064 292,198,280
Property, plant and equipment, at cost, net........ 75,332,476 114,122,923
Trademark, net..................................... -- 4,791,667
Notes receivable--long-term portion................ 21,767,769 2,187,071
Goodwill, net...................................... 74,222,221 74,880,499
Deferred tax assets, net........................... 10,750,000 1,309,000
Other assets....................................... 7,256,674 25,846,814
------------ ------------
Total assets................................... $417,196,204 $515,336,254
============ ============
Liabilities and stockholders' equity
Current liabilities:
Trade accounts payable........................... $ 38,793,873 $ 79,475,136
Accrued expenses................................. 3,499,301 5,354,710
Interest payable................................. 3,942,577 1,564,741
Deferred revenue................................. 9,175,218 13,209,663
Notes payable--current portion................... 1,865,849 4,752,780
Capital lease obligations--current portion....... 3,989,375 6,029,273
Other current liabilities........................ 220,325 2,397,234
------------ ------------
Total current liabilities...................... 61,486,518 112,783,537
Notes payable--long-term portion................... 101,833,892 112,973,330
Capital lease obligations--long-term portion....... 11,232,053 15,742,218
------------ ------------
Total liabilities.............................. 174,552,463 241,499,085
Minority interests................................. 3,895,669 20,431,834
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; 22,848,866 and 23,982,854 shares
issued and outstanding in 1998 and 1999,
respectively.................................... 228,489 239,829
Class A stock, $.01 par value; authorized
shares--35,000,000; 10,255,668 and 10,029,758
shares issued and outstanding in 1998 and 1999,
respectively.................................... 102,557 100,298
Loans to stockholders............................ -- (251,207)
Additional paid-in capital....................... 266,761,770 278,744,508
Accumulated deficit.............................. (28,344,744) (25,428,093)
------------ ------------
Total stockholders' equity..................... 238,748,072 253,405,335
------------ ------------
Total liabilities and stockholders' equity..... $417,196,204 $515,336,254
============ ============
See accompanying notes.
F-3
IDT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended July 31
----------------------------------------
1997 1998 1999
------------ ------------ ------------
Revenue............................. $135,187,227 $335,372,915 $732,183,855
Costs and expenses:
Direct cost of revenue............ 92,214,223 240,859,809 575,049,683
Selling, general and
administrative................... 41,544,987 61,974,851 128,499,715
Acquired research and
development...................... -- 25,000,000 --
Depreciation and amortization..... 4,873,142 11,284,013 26,254,086
------------ ------------ ------------
Total costs and expenses............ 138,632,352 339,118,673 729,803,484
------------ ------------ ------------
Income (loss) from operations....... (3,445,125) (3,745,758) 2,380,371
Interest expense.................... (862,954) (5,978,760) (11,318,964)
Interest income..................... 436,112 5,582,951 10,090,332
Other............................... 35,197 103,215 19,576,147
------------ ------------ ------------
Income (loss) before income taxes,
minority interests and
extraordinary items................ (3,836,770) (4,038,352) 20,727,886
Provision (benefit) for income
taxes.............................. -- (1,671,000) 17,850,000
Minority interests.................. -- 3,895,669 (3,308,552)
------------ ------------ ------------
Income (loss) before extraordinary
items.............................. (3,836,770) (6,263,021) 6,186,438
Extraordinary loss on retirement of
debt, net of income taxes.......... -- (132,376) (3,269,787)
------------ ------------ ------------
Net income (loss)................... (3,836,770) (6,395,397) 2,916,651
Subsidiary redeemable preferred
stock dividends.................... -- -- 26,297,426
------------ ------------ ------------
Net loss available to common
stockholders....................... $ (3,836,770) $ (6,395,397) $(23,380,775)
============ ============ ============
Loss per share:
Loss before extraordinary items:
Basic and diluted................. $ (0.18) $ (0.21) $ (0.60)
Extraordinary loss on retirement of
debt, net of income taxes:
Basic and diluted................. $ -- $ (0.01) $ (0.10)
------------ ------------ ------------
Net loss............................ $ (0.18) $ (0.22) $ (0.70)
============ ============ ============
Weighted average number of shares
used in calculation of basic loss
per share.......................... 21,152,927 28,571,421 33,529,930
============ ============ ============
See accompanying notes.
F-4
IDT CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Class A Stock Additional Total
------------------- -------------------- Paid-In Loans to Accumulated Stockholders'
Shares Amount Shares Amount Capital Stockholders Deficit Equity
---------- -------- ---------- -------- ------------ ------------ ------------ -------------
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 stock
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
related party......... -- -- -- -- 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
Exercise of stock
options............... 696,840 6,968 -- -- 4,075,118 (251,207) -- 3,830,879
Income tax benefit from
stock options
exercised............. -- -- -- -- 4,257,973 -- -- 4,257,973
Conversion of Class A
stock to common
stock................. 225,910 2,259 (225,910) (2,259) -- -- -- --
Issuance of common
stock in connection
with business
acquisitions.......... 100,000 1,000 -- -- 2,849,000 -- -- 2,850,000
Exercise of warrants... 111,238 1,113 -- -- 922,801 -- -- 923,914
Costs associated with
stock registration.... -- -- -- -- (122,154) -- -- (122,154)
Net income for the year
ended July 31, 1999... -- -- -- -- -- -- 2,916,651 2,916,651
---------- -------- ---------- -------- ------------ --------- ------------ ------------
Balance at July 31,
1999................... 23,982,854 $239,829 10,029,758 $100,298 $278,744,508 $(251,207) $(25,428,093) $253,405,335
========== ======== ========== ======== ============ ========= ============ ============
See accompanying notes.
F-5
IDT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended July 31
----------------------------------------
1997 1998 1999
----------- ------------- ------------
Operating activities
Net income (loss).................... $(3,836,770) $ (6,395,397) $ 2,916,651
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Amortization........................ 97,056 1,570,176 5,047,868
Depreciation........................ 4,776,086 9,713,837 21,206,218
Extraordinary loss on retirement of
debt before taxes.................. -- 132,376 5,359,787
Gain on sale of subsidiary stock.... -- -- (21,611,297)
Amortization of deferred
compensation....................... -- -- 15,734,418
Acquired research and development
costs by issuance of common stock.. -- 25,000,000 --
Minority interests.................. -- 3,895,669 (3,308,552)
Deferred income taxes............... -- (1,960,000) 9,441,000
Issuance of common stock to
employees by related party......... -- 390,000 --
Changes in assets and liabilities:
Accounts receivable................ (9,273,827) (20,909,084) (68,108,153)
Other current assets............... (937,660) (9,138,112) (24,214,249)
Other assets....................... (1,801,077) (1,359,248) (6,770,740)
Notes receivable................... 2,861,003 485,810 --
Trade accounts payable............. 6,233,349 18,141,813 39,056,078
Accrued expenses................... (4,225,977) 878,017 1,290,649
Deferred revenue................... 1,459,352 6,732,370 4,034,445
Interest payable................... -- 4,063,120 (2,377,836)
Other current liabilities.......... 173,946 (375,626) 2,176,909
Other.............................. 41,213 (262,376) 1,830,450
----------- ------------- ------------
Net cash provided by (used in)
operating activities................ (4,433,306) 30,603,345 (18,296,354)
Investing activities
Purchases of property, plant and
equipment........................... (7,112,962) (41,332,835) (48,097,692)
Purchase of trademark................ -- -- (5,000,000)
Issuance of notes receivable......... -- (23,595,526) (13,423,462)
Investments and acquisitions......... (2,133,157) -- (10,735,031)
Collection of notes receivable....... -- -- 14,040,147
Payments for the purchase of
InterExchange, Inc.................. -- (20,588,000) --
Net purchases of marketable
securities.......................... -- (60,308,768) (17,560,887)
----------- ------------- ------------
Net cash used in investing
activities.......................... (9,246,119) (145,825,129) (80,776,925)
Financing activities
Proceeds from issuance of Series A
Preferred stock and warrants by
Net2Phone........................... -- -- 29,900,000
Proceeds from exercise of stock
options for Net2Phone............... -- -- 1,334,000
Proceeds from exercise of warrants
for Net2Phone....................... -- -- 437,870
Payment of debt issuance costs....... -- -- (4,475,029)
Distribution to minority
shareholder......................... -- -- (6,079,274)
Proceeds from borrowings............. 6,750,000 110,668,294 115,945,551
Payment of financing costs........... -- (3,561,070) --
Proceeds from exercise of warrants... -- 530,608 923,914
Proceeds from exercise of stock
options............................. 2,212,025 5,297,171 7,966,698
Repayment of capital lease
obligations......................... (684,070) (2,665,084) (5,348,909)
Repayments of borrowings............. (1,817,973) (5,698,462) (103,911,582)
Proceeds from sale of common stock... -- 118,259,533 --
----------- ------------- ------------
Net cash provided by financing
activities.......................... 6,459,982 222,830,990 36,693,239
----------- ------------- ------------
Net increase (decrease) in cash...... (7,219,443) 107,609,206 (62,380,040)
Cash and cash equivalents at
beginning of period................. 14,893,756 7,674,313 115,283,519
----------- ------------- ------------
Cash and cash equivalents at end of
period.............................. $ 7,674,313 $ 115,283,519 $ 52,903,479
=========== ============= ============
Supplemental disclosure of cash flow
information:
Cash payments made for interest...... $ 863,000 $ 2,036,000 $ 13,483,000
=========== ============= ============
Cash payments made for income taxes.. $ -- $ -- $ 235,000
=========== ============= ============
Supplemental schedule of non-cash
activities:
Accrued interest converted to
equity.............................. $ -- $ 121,000 $ --
=========== ============= ============
Purchase of fixed assets by capital
lease............................... $ 6,122,000 $ 12,448,000 $ 11,899,000
=========== ============= ============
Notes payable converted to equity.... $ -- $ 8,534,000 $ --
=========== ============= ============
See accompanying notes.
F-6
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 31, 1999
1. Summary of Significant Accounting Policies
Description of Business
IDT Corporation ("IDT" or the "Company") is a multinational
telecommunications carrier that provides a broad range of services to its
wholesale and retail customers world wide. The Company provides its customers
with integrated international and domestic long distance, pre-paid calling
cards, Internet access, and through Net2Phone, Inc. ("Net2Phone"), a majority-
owned subsidiary, Internet telephony services. The Company also sells pre-paid
calling cards to distributors.
Basis of Consolidation and Accounting for Investments
The consolidated financial statements include the accounts of IDT and all
companies in which IDT has a controlling voting interest ("subsidiaries"), as
if IDT and its subsidiaries were a single company. Significant intercompany
accounts and transactions between the consolidated companies have been
eliminated.
Investments in companies in which IDT has significant influence, but less
than a controlling voting interest, are accounted for using the equity method.
Investments in companies in which IDT does not have a controlling interest or
an ownership and voting interest so large as to exert significant influence
are accounted for at market value if the investments are publicly traded and
there are no resale restrictions, or at cost, if the sale of a publicly-traded
investment is restricted or if the investment is not publicly traded.
The effect of any changes in IDT's ownership interests resulting from the
issuance of equity capital by consolidated subsidiaries or equity investees to
unaffiliated parties is included in other income.
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. Pre-payments for services are
deferred and recognized as revenue as the services are provided.
Direct Cost of Revenue
Direct cost of revenue consists primarily of telecommunication costs,
connectivity costs, and the cost of equipment sold to customers. Direct cost
of revenue excludes depreciation and amortization.
Property, Plant and Equipment
Equipment 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. Computer software is amortized using the straight-line
method over the shorter of five years or the term of the related agreement.
Buildings are depreciated using the straight-line method over the estimated
useful life of the assets of 30 years.
Trademark
Costs associated with obtaining the right to use trademarks owned by third
parties are capitalized and amortized on a straight-line basis over the term
of the trademark license.
F-7
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. Typically,
Net2Phone purchases banner advertising on other companies' web sites pursuant
to contracts which have one to three year terms and may include the guarantee
of (i) a minimum number of impressions, (ii) the number of times that an
advertisement appears in pages displayed to users of the web site, or (iii) a
minimum amount of revenue that will be recognized by Net2Phone from customers
directed to Net2Phone's web site as a direct result of the advertisement.
Net2Phone recognizes expense with respect to such advertising ratably over the
period in which the advertisement is displayed. In addition, some agreements
require additional payments as additional impressions are delivered. Such
payments are expensed when the impressions are delivered.
In one case, Net2Phone entered into an agreement with no specified term of
years. In this case, the Company amortizes as expense the lessor of (i) the
number of impressions to date/minimum guaranteed impressions, or (ii) revenue
to date/minimum guaranteed revenue as a percentage of the total payments.
For the years ended July 31, 1997, 1998 and 1999, advertising expense
totaled approximately $4,011,000, $5,632,000, and $10,454,000, 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 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, it has commenced capitalizing these costs.
Software development costs are the Company's only research and development
expenditures. For the years ended July 31, 1997, 1998 and 1999, research and
development costs totaled approximately $473,000, $481,000 and $757,000,
respectively.
Capitalized Internal Use Software Costs
The Company capitalizes certain costs incurred in connection with developing
or obtaining internal use software. These costs consist of payments made to
third parties and the salaries of employees working on such software
development. At July 31, 1998 and 1999, the Company has capitalized $2,198,000
and $4,065,000, respectively, of internal use software costs as computer
software.
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,
1999, the Company has 79% of its cash and cash equivalents in three financial
institutions.
Marketable Securities
Marketable securities consist of short-term debt securities which are
considered to be held to maturity, and are carried at amortized cost which
approximates fair value.
F-8
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Goodwill
Goodwill is being amortized over 20 years using the straight-line method.
Accumulated amortization at July 31, 1998 and 1999 was approximately $882,000
and $4,699,000 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. 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 (Loss) Per Share
Basic earnings (loss) per share is computed by dividing the net income
(loss) applicable to common shares by the weighted average of common shares
outstanding during the period. Diluted earnings (loss) per share adjusts basic
earnings (loss) per share for the effects of convertible securities, stock
options, warrants and other potentially dilutive financial instruments, only
in the periods in which such effect is dilutive.
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. At July 31, 1999, the
Company has 90% of its notes receivable with one company, and 11% of its
accounts receivable balance with one company.
International customers account for a significant amount of the Company's
total revenues. Therefore, the Company is subject to risks associated with
international operations, including changes in exchange rates, difficulty in
accounts receivable collection and longer payment cycles.
Management regularly monitors the creditworthiness of its domestic and
international customers and believes that it has adequately provided for any
exposure to potential credit losses.
Fair Value of Financial Instruments
The estimated fair value of financial instruments 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
F-9
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
notes with similar terms to borrowers of similar credit quality. The fair
value of notes receivable at July 31, 1998 and 1999 approximates
$23,172,000 and $17,082,000, respectively.
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 approximates $98,700,000. The fair value of the
notes payable at July 31, 1999 approximate their carrying value, due to
their variable rate of interest.
Segment Disclosures
The Company uses 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.
Stock Based Compensation
The Company accounts for stock options issued to employees using the
intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25"). Compensation expense
for stock options issued to employees is measured as the excess of the quoted
market price of the Company's stock at the date of grant over the amount an
employee must pay to acquire the stock.
The Company applies the disclosure-only provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation, with respect to stock options issued to the Company's employees.
In March 1999, the Financial Accounting Standards Board issued an exposure
draft of an interpretation on APB 25 containing proposed rules designed to
clarify its application. The proposed rules included in the exposure draft are
expected to be formally issued prior to December 31, 1999 and become effective
at the time they are issued. The proposed rules would generally be applicable
to events that occur after December 15, 1998. Consequently, if the exposure
draft is enacted in the form currently proposed, the new rules would apply to
all stock options granted by the Company in fiscal 1999.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133").
This statement establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments embedded
in other contracts) be recorded on the balance sheet as either an asset or
liability measured at its fair value. This statement requires that changes in
the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Special accounting for qualifying
hedges allows derivative's gains and losses to offset related results on the
hedge item in the income statement, and requires a company to formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. This statement is effective for fiscal years beginning after
June 15, 2000 and cannot be applied retroactively. The Company believes that
the adoption of this standard will not have a material effect on the Company's
consolidated results of operation or financial position due to their limited
use of derivative instruments.
F-10
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Notes Receivable
In May 1998, the Company entered into an agreement with a telecommunication
company to provide it with a $25,000,000 revolving credit facility (the
"Facility"). The Facility bore interest at a rate of 5% per annum. The unpaid
principal and accrued interest on the Facility were payable in quarterly
installments, as defined in the agreement, which payments commenced on February
1, 1999. As of July 31, 1998 and 1999, the outstanding balance on the Facility
of approximately $12,600,000 and $19,000,000, respectively, are included in
notes receivable. In October 1999, the Facility's remaining principal balance
was repaid in full.
3. Property, Plant and Equipment
Property, plant and equipment consists of the following:
July 31
-------------------------
1998 1999
----------- ------------
Equipment........................................ $77,612,461 $100,145,353
Computer software................................ 10,027,335 38,916,589
Leasehold improvements........................... 1,930,769 3,650,936
Furniture and fixtures........................... 1,905,048 2,447,210
Land and building................................ -- 6,312,190
----------- ------------
91,475,613 151,472,278
Less accumulated depreciation and amortization... (16,143,137) (37,349,355)
----------- ------------
Property, plant and equipment, net............... $75,332,476 $114,122,923
=========== ============
Fixed assets under capital leases aggregate approximately $18,570,000 and
$30,469,000 at July 31, 1998 and 1999, respectively. The accumulated
amortization related to these assets under capital leases is approximately
$2,885,000 and $8,266,000 at July 31, 1998 and 1999, respectively.
4. Notes Payable
Notes payable consists of the following:
July 31
--------------------------
1998 1999
------------ ------------
Senior Notes (A)................................. $100,000,000 $ 380,000
Senior Credit facilities (B)..................... -- 108,146,000
Promissory note (C).............................. -- 7,367,000
Other............................................ 3,700,000 1,833,000
------------ ------------
103,700,000 117,726,000
Less notes payable--current portion.............. (1,866,000) (4,753,000)
------------ ------------
Notes payable--long-term portion................. $101,834,000 $112,973,000
============ ============
F-11
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(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
semiannually on February 15 and August 15, at 8.75% per annum, mature on
February 15, 2006 and are general unsecured obligations of the Company. On
May 10, 1999, the Company repaid $99,620,000 of the principal balance
together with accrued interest at a redemption price equal to 102% of the
repaid principal balance. The Company recorded a pre-tax extraordinary
loss in connection with the repayment of $5,359,787 during the year ended
July 31, 1999.
(B) On May 10, 1999, the Company obtained a Senior Secured Credit Facility
("Credit Facility") from a consortium of financial institutions. The
Credit Facility, as amended, consists of a $25,000,000 revolving line of
credit, maturing on May 9, 2003, a $60,000,000 multi-draw term loan,
payable in equal quarterly principal payments commencing February 2001,
and ending May 9, 2003, and a $75,000,000 single-draw term loan, requiring
payments of 1% of the principal balance for the first four years, and the
remaining principal balance in four equal quarterly payments thereafter.
The Credit Facility bears interest at base rates, as defined, plus 2.50%
to 3.50%. The Credit Facility is collateralized by 100% of the capital
stock of IDT's domestic subsidiaries, and other assets. At July 31, 1999,
$25,000,000 of the revolving line of credit, and $26,854,000 of the
$60,000,000 multi-draw term loan remain unused.
(C) On May 6, 1999, the Company entered into a $7,800,000 promissory note with
a financing company. The note is payable in 36 monthly installments
commencing on June 1, 1999, and bears an adjustable interest rate indexed
to the one month LIBOR rate. The promissory note is collateralized by
certain equipment of the Company.
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 convertible debentures and all unpaid accrued
interest thereon were repaid in June 1998.
Annual future principal repayments of long-term debt for the five years
subsequent to July 31, 1999 consist of $4,753,000 due in fiscal 2000,
$13,612,000 due in fiscal 2001, $16,287,000 due in fiscal 2002, $28,506,000
due in fiscal 2003, $54,188,000 due in fiscal 2004 and $380,000 due
thereafter.
5. Related Party Transactions
In connection with the incorporation of Net2Phone in October 1997, Net2Phone
and the Company entered into a separation agreement in May 1999 whereby the
transactions and agreements necessary to govern the relationship between the
two companies to effect their separation were determined.
During the periods prior to the signing of the aforementioned agreements,
service costs were generally allocated based upon a percentage of total
revenue earned or payroll expense incurred by Net2Phone. Such allocated costs
approximate the amounts that would have been charged under the intercompany
agreements if they had been in effect during such periods.
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
----------------------
1998 1999
----------- ----------
Deferred tax assets:
Bad debt reserve................................... $ 2,577,000 $3,045,000
Exercise of stock options.......................... 8,790,000 7,926,000
Other.............................................. 1,263,000 1,743,000
----------- ----------
Deferred tax assets.................................. 12,630,000 12,714,000
----------- ----------
Deferred tax liabilities:
Depreciation....................................... 1,880,000 2,760,000
Gain on sale of subsidiary stock................... -- 8,645,000
----------- ----------
Deferred tax liabilities............................. 1,880,000 11,405,000
----------- ----------
Net deferred tax assets.......................... $10,750,000 $1,309,000
=========== ==========
No valuation allowance on the net deferred tax assets has been established
as the realization of such net deferred tax assets is considered to be more
likely than not.
At July 31, 1999, based upon tax returns filed and to be filed, the Company
had net operating loss carryforwards for federal income tax purposes of
approximately $20 million attributable to the exercise of stock options
expiring in the years 2018 through 2019. These net operating loss
carryforwards may be limited in their use in the event of significant changes
in the Company's ownership.
The provision (benefit) for income taxes consists of the following for the
years ended July 31:
1997 1998 1999
---- ----------- -----------
Current:
Federal...................................... $-- $ -- $ 400,000
State and local.............................. -- 200,000 --
---- ----------- -----------
-- 200,000 400,000
---- ----------- -----------
Deferred:
Federal...................................... -- (1,519,000) 14,300,000
State and local.............................. -- (441,000) 1,060,000
---- ----------- -----------
-- (1,960,000) 15,360,000
---- ----------- -----------
$-- $(1,760,000) $15,760,000
==== =========== ===========
The income statement classification of the provision (benefit) for income
taxes consists of the following at July 31:
1997 1998 1999
---- ----------- -----------
Income tax provision (benefit) attributable
to continuing operations.................. $-- $(1,671,000) $17,850,000
Income tax benefit attributable to
extraordinary loss........................ -- (89,000) (2,090,000)
---- ----------- -----------
$-- $(1,760,000) $15,760,000
==== =========== ===========
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 provides are as follows:
1997 1998 1999
----------- ----------- -----------
Federal income tax at statutory
rate............................... $(1,343,000) $(1,373,000) $ 7,255,000
Purchased research and development.. -- 8,788,000 --
Change in valuation allowance....... 1,534,000 (9,294,000) --
Losses for which no benefit
provided........................... -- -- 6,110,000
Non-deductible expenses............. -- -- 1,673,000
State and local income tax.......... (227,000) 328,000 692,000
Other, net.......................... 36,000 (209,000) 30,000
----------- ----------- -----------
$ -- $(1,760,000) $15,760,000
=========== =========== ===========
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 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 $6.96
per share to a leasing company in connection with a capital lease. During the
years ended July 31, 1998 and 1999, all of such warrants were exercised.
In September 1997, the Company issued warrants to purchase 75,000 shares of
the Company's common stock at $15.16 per share to placement agents in
connection with a private placement of $7,500,000 in convertible debentures.
The holders of these warrants exercised warrants to purchase 35,003 and 12,234
shares, respectively, of the Company's common stock in Fiscal 1998 and 1999.
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 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.
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.
F-14
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, 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
Granted........................................... 1,136,241 15.21
Exercised......................................... (696,840) 5.86
Canceled.......................................... (58,000) 14.85
Forfeited......................................... (8,070) 8.27
---------- -------
Outstanding at July 31, 1999...................... 3,587,966 $ 10.50
========== =======
The following table summarizes the status of stock options outstanding and
exercisable at July 31, 1999:
Stock Options Outstanding
---------------------------------
Weighted- Number of
Number Remaining Stock
Range of of Contractual Options
Exercise Prices Options Life Exercisable
--------------- --------- ----------- -----------
$ 0.21 - $ 0.21............................ 376,550 5.0 376,550
$ 0.41 - $ 0.41............................ 8,816 5.7 8,816
$ 0.83 - $ 0.83............................ 40,500 5.0 40,500
$ 1.65 - $ 1.65............................ 15,000 5.7 15,000
$ 4.38 - $ 6.50............................ 568,700 7.5 543,699
$ 6.88 - $10.00............................ 1,034,900 7.6 660,400
$11.25 - $15.44............................ 939,750 9.4 157,625
$17.00 - $24.25............................ 429,750 8.6 184,833
$26.25 - $34.00............................ 174,000 8.6 173,000
--------- ---------
3,587,966 2,160,423
========= =========
The weighted average fair value of options granted was $3.21, $4.46, and
$9.26 for the years ended July 31, 1997, 1998, and 1999, 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
employees' 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.
F-15
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
July 31
-----------------------
1997 1998 1999
------- ------- -------
Assumptions
Average risk-free interest rate.................... 6.11% 5.92% 4.67%
Dividend yield..................................... -- -- --
Volatility factor of the expected market price of
the Company's common stock........................ 89% 84% 84%
Average life....................................... 6 years 5 years 5 years
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, 1997, 1998 and 1999, pro forma net loss
and pro forma net loss per share under SFAS 123 amounted to approximately
$(10,054,000), $(16,508,000) and $(32,175,000) respectively, and $(0.48)
$(0.58), and $(0.96), respectively.
Net2Phone Stock Options
In the fourth quarter of fiscal 1999, Net2Phone granted options to purchase
8,811,500 shares of its common stock at exercise prices ranging from $3.33 to
$15.00 per share to its employees and employees of IDT. In connection with the
exercise of such options, Net2Phone extended $3,149,900 of recourse loans to
its employees. In order to obtain the loans, optionees agreed to the
cancellation of 23,382 outstanding options.
Deferred compensation resulting from Net2Phone's issuance of stock options
of approximately $44.1 million is being charged to expense over the vesting
period of the stock options as follows: fiscal 1999, $16.0 million; fiscal
2000, $10.4 million; fiscal 2001, $10.4 million; and fiscal 2002, $7.3
million.
Public Offering
On February 3, 1998, the Company completed a public offering of 5,093,750
shares of its common stock for $24.875 a share. The Company realized net
proceeds of approximately $118.3 million from this offering.
On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock (the "Initial Public Offering") at a
price of $15.00 per share, resulting in net proceeds of approximately $85.3
million. In connection with the Initial Public Offering, the Company's
ownership percentage in Net2Phone decreased to approximately 56.2%. In
connection with the Initial Public Offering, the Company recorded a gain on
sale of stock by a subsidiary of approximately $21,611,000. Such gain is
included in other income at July 31, 1999.
Net2Phone Series A Stock
On May 13, 1999, Net2Phone designated 3,150,000 shares of its preferred
stock as Series A ("Series A Stock") and sold 3,140,000 of such shares to
unrelated third parties in a private placement transaction for aggregate gross
proceeds of $31,400,000.
F-16
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Series A Stock contained beneficial conversion features. The total value
of the beneficial conversion feature approximated $75 million. For accounting
purposes the value of the beneficial conversion feature was limited to the
amount of proceeds allocated to the Series A Stock. The Company recorded an
increase in net loss available to common stockholders on the date of issuance
of the Series A Stock in the amount of approximately $26.3 million
representing their allocable share of the amount attributable to the
beneficial conversion feature.
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. In September 1999,
the Company's subsidiary, Howard S. Jonas and Surfers Unlimited L.L.C. entered
into a confidential settlement agreement.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey Superior Court, Bergen County. Howard S. Jonas
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 settlement conference has been scheduled for
November 10, 1999.
In August 1998, a subsidiary of the Company, InterExchange, Inc. ("IX"),
filed a complaint in the New Jersey Superior Court, Middlesex County, against
PT-1 Communications, Inc. ("PT-1"). The action has been removed to the U.S.
District Court for the District of New Jersey. The action arises from a
contract in which IX and PT-1 agreed that PT-1 would route its traffic from
prepaid calling cards through IX's debit card platform. In the action, IX
claimed that PT-1 breached its contract with IX by failing to make required
payments under the contract, and claimed compensatory damages in the amount of
$8.5 million. In February 1999, PT-1 filed an answer and counterclaim and
third party complaint against IX, the Company, and certain of their officers,
including Howard S. Jonas. PT-1 alleges that IX is not entitled to these
payments in that IX had breached the agreement, and that, following IX's 1998
merger agreement with the Company, in which IX become a wholly-owned
subsidiary of the Company, IX violated its covenant in the agreement that it
would not compete with PT-1. PT-1 also alleges, among other things, that the
Company and Mr. Jonas tortiously interfered with the contract between IX and
PT-1, and that they conspired with IX and its personnel to obtain confidential
information relating to PT-1. PT-1 seeks compensatory damages and punitive
damages. In May 1999, the Company and Howard S. Jonas filed an answer to PT-
1's third party complaint and IX filed a motion for leave to amend their
complaint to add Star Telecommunications and Samer Tawfik as additional
defendants and to include the additional claims of tortious interference and
fraud in the inducement. The Company and individual plaintiffs David Turock,
Eric Hecht, Bradley Turock and Richard Robbins have sought leave to amend
their counterclaims to include Star Telecommunications as an additional
defendant for failure to permit plaintiff to execute certain stock warrants to
purchase PT-1 stock. The Court has issued an order which provides that PT-1
may not allege a specific amount of damages although the order does not forbid
PT-1 from claiming damages in general. Discovery is continuing and a trial
date has not been scheduled.
F-17
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. In the opinion of management, settlement of these and the
aforementioned actions when ultimately concluded will not have a material
adverse effect on results of operations, cash flows or the financial condition
of the Company.
Lease Obligations
The future minimum payments for all capital and operating leases as of July
31, 1999 are approximately as follows:
Operating Capital
Leases Leases
Year ending July 31: ----------- -----------
2000................................................ $ 5,561,000 $ 7,328,000
2001................................................ 5,112,000 5,498,000
2002................................................ 4,838,000 4,682,000
2003................................................ 3,994,000 4,159,000
2004................................................ 2,239,000 1,414,000
Thereafter.......................................... 3,370,000 --
----------- -----------
Total payments...................................... $25,114,000 23,081,000
===========
Less amount representing interest................... (1,310,000)
Less current portion................................ (6,029,000)
-----------
Capital lease obligations--long-term portion........ $15,742,000
===========
Rental expense under operating leases was approximately $388,000, $1,225,000
and $2,821,000 for the years ended July 31, 1997, 1998 and 1999, respectively.
Commitments
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, 1997, 1998 and 1999, the Company
purchased approximately $5,271,000, $5,997,000 and $10,214,000 respectively,
of such services from the Vendor.
The Company has entered into agreements with certain carriers to buy and
sell communications services. At July 31, 1999, the Company's minimum purchase
commitments related to such agreements consist of $27,154,000 in Fiscal 2000,
$14,888,000 in Fiscal 2001, $3,713,000 in Fiscal 2002, $2,485,000 in Fiscal
2003, and $1,440,000 in Fiscal 2004.
In September 1998, the Company entered into a 20 year agreement with a
carrier to provide the Company with nationwide bandwidth capacity and
maintenance services in exchange for total payments estimated at $32.0
million.
On January 31, 1999, the Company entered into a series of agreements with a
third party. The agreements call for the bundling of the Company's Internet
telephony products with the third party's Internet browser, the purchase of
software from the third party and the use of the third party's trademark. The
agreements require the Company to pay the third party (i) $5,000,000 for the
use of the trademark, (ii) $8,000,000 for the purchase of software and (iii)
commissions on revenues generated from customers that the Company obtains from
the
F-18
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
bundling of products. Through July 31, 1999, the Company had paid $1,500,000
and accrued $3,500,000 for the right to use the trademark and $8,000,000 for
certain software. The Company has capitalized the costs of the right to use
the trademark and the software costs and will amortize them over the term of
the bundling agreement, which expires two years after the release of the
bundled product.
On February 8, 1998, the Company entered into an agreement with an Internet
company to develop a link between its Internet site and that of the Company
and advertise Company products on such site. The agreement is effective for
fifteen months upon the completion of the link and automatically extends for
an additional one year unless terminated by either party. Pursuant to such
agreement, the Company has made payments of $3.3 million through July 31, 1999
for the design, development, installation and implementation of the link as
well as the placement of Company advertisements on the Internet company's
site, of which $750,000 attributable to the establishment of such link was
deferred and is being amortized over the term of the agreement and
$2.4 million attributable to monthly payments for advertising and the
maintenance of the link was expensed monthly as incurred. As of July 31, 1999,
the Company was required to make an additional payment of $150,000 in fiscal
1999 and pay certain future commissions, as defined, based upon revenue earned
and usage of the link.
On February 19, 1999, the Company entered into an agreement under which an
international computer company is to provide connections to its global
network. These connections will allow worldwide transport of the Company's IP
traffic. The agreement is effective for 63 months upon availability of the
connections. Pursuant to such agreement, the Company has made payments of $1
million through July 31, 1999 which have been reflected on the balance sheets
as other current assets. As of July 31, 1999, the Company is required to make
an additional payment of $1 million when the connections are available and pay
fees for additional connections and usage. The $2 million of prepayments will
be amortized over the term of the agreement beginning at the time the
connections are available for use.
The Company entered into an agreement with Snap, an Internet portal service
of NBC and CNET, on May 17, 1999. Snap will display links to the Company's Web
site and services on its Snap.com Web site. In addition, the Company is Snap's
preferred provider of PC-to-phone services during the two-year term of this
agreement. Snap also will deliver a preset minimum number of impressions on
its site and agreed to give the Company the right to advertise on its Snap.com
Web site, subject to certain conditions. In exchange, the Company agreed to
pay Snap a one-time fee, a percentage of revenue generated through their site
and bonus payments for customers delivered by Snap of $2,000,000 after meeting
certain quotas. The Company will amortize the up front payment over the term
of the agreement
The Company signed an agreement with NBC on June 25, 1999 to purchase $1.5
million in television advertising on the NBC television network. The Company
also has the right to purchase additional spots to be telecast prior to June
30, 2000. The cost of the advertising will be expensed as the spots are shown.
On July 15, 1999, the Company entered into a four-year distribution and
marketing agreement with ICQ, a subsidiary of America Online. Under this
agreement, ICQ has agreed to co-brand and promote the Company's Internet
telephony services in the U.S. and in 19 other countries, embed customized
versions of the Company's software to allow ICQ customers to make PC-to-phone
and PC-to-PC calls and to receive phone-to-PC calls, share revenue from
advertisements and sponsorships sold by ICQ on the Company's software that is
embedded in ICQ's Instant Messenger software, and promote the Company's
services on some of ICQ's Web sites. The Company agreed to pay ICQ a fee of
$7.5 million, $4.0 million of which was paid at signing and the remainder of
which was paid in September 1999. The Company also agreed to pay ICQ a share
of minutes-based revenue generated through ICQ and to award ICQ a performance
bonus on the basis of the total revenue derived under the agreement, and to
promote ICQ on the Company's Web sites.
F-19
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In connection with the Company's distribution and marketing agreement with
ICQ, the Company issued a warrant to America Online to purchase up to 3% of
Net2Phone's outstanding capital stock on a fully-diluted basis. This warrant
will vest in 1% increments upon the achievement of each of three incremental
thresholds of revenue generated under the agreement during the first four
years that the warrant is outstanding. The per share exercise price under the
warrant will be equal to the lesser of 80% of the price per share in
Net2Phone's initial public offering, or $450 million divided by the number of
the Company's fully-diluted shares on the initial exercise date. The warrant
may be exercised for a period of five years from the date of issuance.
Distribution Agreements
The Company has entered into distribution agreements under which it has
agreed to pay its agents commissions for obtaining new Internet, debit card,
Internet telephony and discount telecommunications customers. The agreements
require commissions upon activation of the customers.
9. Business Segment Information
Based principally on products and services provided, the Company has
identified four reportable business segments: Wholesale Telecommunications
Services, Retail Telecommunications Services, Internet Services and Internet
Telephony. The operating results of these business segments are
distinguishable, are regularly reviewed by Company management and are integral
to their decision making process.
The Wholesale Telecommunications Services business segment is comprised of
wholesale carrier services sold to other U.S. and international carriers. The
Retail Telecommunications Services business segment includes prepaid calling
cards, international retail services and domestic long distance services. The
Internet Services business segment includes dial-up access services, direct
connect dedicated service, Genie online services and Net2Dine.com. The
Internet Telephony business segment reflects the results of the Company's
majority-owned subsidiary, Net2Phone, prior to the elimination of minority
interests.
F-20
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company evaluates the performance of its business segments based
primarily on operating income after depreciation and amortization but prior to
interest expense and income taxes; all corporate overhead is allocated to the
business segments based on time and usage studies. Operating results and other
financial data presented for the principal business segments of the Company
for the years ended July 31, 1997, 1998 and 1999 are as follows ($ in
thousands):
Wholesale Retail
Telecommunications Telecommunications Internet Internet
Services Services Services Telephony Total
------------------ ------------------ -------- --------- --------
Year ended July 31, 1997
Total segment revenue... $ 65,389 $ 35,283 $33,435 $ 2,652 $136,759
Less: revenues between
segments............... (735) -- (540) (297) (1,572)
-------- -------- ------- -------- --------
Total unaffiliated
revenue................ 64,654 35,283 32,895 2,355 135,187
Income (loss) from
operations............. 3,444 2,263 (8,092) (1,060) (3,445)
Depreciation and
amortization........... 730 398 3,562 183 4,873
Total assets............ 21,626 11,790 24,205 916 58,537
Year ended July 31, 1998
Total segment revenue... $170,240 $137,159 $20,721 $ 12,006 $340,126
Less: revenues between
segments............... (3,535) -- (720) (498) (4,753)
-------- -------- ------- -------- --------
Total unaffiliated
revenue................ 166,705 137,159 20,001 11,508 335,373
Income (loss) from
operations............. 6,715 (781) (7,030) (2,650) (3,746)
Depreciation and
amortization........... 3,294 2,710 4,409 871 11,284
Total assets............ 205,083 168,723 36,415 6,975 417,196
Year ended July 31, 1999
Total segment revenue... $301,413 $395,542 $17,882 $ 33,256 $748,093
Less: revenues between
segments............... (12,383) -- (948) (2,578) (15,909)
-------- -------- ------- -------- --------
Total unaffiliated
revenue................ 289,030 395,542 16,934 30,678 732,184
Income (loss) from
operations............. 18,660 16,325 (8,197) (24,408) 2,380
Depreciation and
amortization........... 8,056 11,233 4,699 2,266 26,254
Total assets............ 275,090 166,372 23,057 50,817 515,336
The income (loss) from operations for the Wholesale Telecommunications
Services and Retail Telecommunications Services business segments for fiscal
1998 includes their pro-rata portion of 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. ("InterExchange") which was allocated
to acquired research and development.
Revenue from customers located outside of the United States represented
approximately 25%, 11% and 13% of total revenue for the years ended July 31,
1997, 1998 and 1999, respectively, with no single foreign geographic area
representing more than 10% of total revenues for any period presented. Long-
lived assets held outside of the United States totaled approximately $9.9
million and $24.9 million as of July 31, 1998 and 1999, respectively. Long-
lived assets held outside of the United States were insignificant as of July
31, 1997.
10. Additional Financial Information
Trade accounts payable includes approximately $23,724,000 and $57,336,000
due to Telecommunication carriers at July 31, 1998 and 1999, respectively.
11. Acquisitions
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
F-21
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 since 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 consisted of 100,000 shares of the Company's common stock.
Pursuant to the acquisition agreement, the Company issued an additional
100,000 shares of the Company's common stock valued at $2,850,000 in April
1999. Such issuance was based upon Union meeting certain operating criteria
for the 12 month period subsequent to the date of acquisition, as defined. The
Company accounted for such acquisition using the purchase method. Since Union
had no assets or liabilities, the entire purchase price has been allocated to
goodwill. The operations of Union have been included in the statement of
operations since the date of the acquisition.
In May 1998, the Company completed the acquisition of Interexchange, Inc., 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. Such shares are
in escrow and 648,465 shares were released six months after the closing with
the remaining 2,593,858 shares to be released in equal installments every 12
months thereafter for the next four years. The Company is accounting for such
acquisition using the purchase method.
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........................................... (7,357,000)
Acquired research and development............................. 25,000,000
Goodwill...................................................... 67,370,000
-----------
$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.
F-22
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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:
July 31
--------------------------
1997 1998
------------ ------------
Revenues....................................... $144,937,000 $344,272,000
Net loss before extraordinary item............. (6,585,000) (5,762,000)
Net loss....................................... (6,585,000) (5,894,000)
Loss per share................................. (0.27) (0.21)
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.
13. Subsequent Events
Telefonica Agreement
In October 1999, IDT entered into a joint venture agreement with Terra
Networks, S.A. (formerly known as Telefonica Interactiva, S.A.) pursuant to
which the parties formed two limited liability companies to provide Internet
services and products for customers in the United States, mainly targeting and
focusing on the Hispanic population in the United States. One company was
formed to provide Internet access to customers in the target market, and IDT
contributed its dial-up Internet access customers, its managerial resources
and facilities and its portfolio of current and future products for Internet
access to the new company in exchange for a 49% ownership interest. The other
company was formed to develop and manage an Internet portal that will provide
content-based Internet services, electronic commerce offerings and other
Internet services to customers in the target market. IDT will assist in
developing relationships with content producers and content providers and will
sell advertising on this new company's portal in exchange for a 10% ownership
interest. Terra Networks has agreed to fund the first $30 million of expenses
for the ISP joint venture, subject to the completion of certain performance
criteria.
IDT/Westmintech Joint Venture
In September 1999, a subsidiary of the Company entered into an agreement to
form a joint venture with Westmintech Company, L.L.C., to provide high speed
voice and data services, including without limitation local and long distance
telephone service (dedicated and 1+), cable television service (cable and/or
fiber optic), on line service with direct Internet access and Internet access
services and various other Internet services (DSL, dedicated and dial up) and
various other Internet services and other technology to the tenants of
commercial and residential properties worldwide. The Company will have a 75%
ownership interest in the joint venture.
F-23
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
----------- ---------- ---------- -------------- ----------
1997
Reserves deducted from
accounts receivable:
Allowance for doubtful
accounts................... $2,100,000 $4,592,000 $(3,502,000) $3,190,000
1998
Reserves deducted from
accounts receivable:
Allowance for doubtful
accounts................... $3,190,000 $6,190,000 $(3,125,000) $6,255,000
1999
Reserves deducted from
accounts receivable:
Allowance for doubtful
accounts................... $6,255,000 $5,558,000 $(4,170,000) $7,643,000
- --------
(1) Uncollectible accounts written off, net of recoveries.
F-24