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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________
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, 2000, 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)
520 Broad Street
Newark, New Jersey 07102
(Address of principal executive offices, including zip code)
(973) 438-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01 per share
(Title of class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price of the Common Stock on October 27, 2000
of $30.813, as reported on the Nasdaq National Market, was approximately $683
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 Registrant's 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 Registrant. This determination of affiliate status is not necessarily a
conclusive determination for any other purpose.
As of October 27, 2000, the Registrant had outstanding 26,104,722 shares of
Common Stock, $.01 par value, and 9,970,233 shares of Class A Common Stock,
$.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information in the Registrant's definitive Proxy Statement for its
2000 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, 2000 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.
--------
PART I.................................................................................................. 1
Item 1. BUSINESS.................................................................................. 1
Item 2. PROPERTIES................................................................................ 1
Item 3. LEGAL PROCEEDINGS......................................................................... 31
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................... 32
PART II................................................................................................. 33
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..................... 33
Item 6. SELECTED FINANCIAL DATA................................................................... 34
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..... 35
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS............................... 49
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................... 49
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...... 49
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................ 50
Item 11. EXECUTIVE COMPENSATION.................................................................... 50
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................ 50
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................ 50
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......................... 51
SIGNATURES.............................................................................................. 54
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," "IDT," "We," and "Our" 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 2000 refers
to the Fiscal Year ended July 31, 2000).
IDT Corporation is a leading facilities-based emerging multinational
carrier that provides a broad range of telecommunications services to wholesale
and retail customers worldwide. In addition, our IDT Ventures division is
developing several innovative telecom and Internet-related businesses. Also,
through our wholly-owned IDT Investments subsidiary, we have equity interests in
other technology companies, including our former subsidiary, Net2Phone, Inc.
("Net2Phone") (NASDAQ: NTOP), which offers a variety of Internet telephony
products and services. We have grown considerably in recent years, generating
revenues of $335.4 million, $732.2 million and $1,093.9 million in Fiscal 1998,
Fiscal 1999 and Fiscal 2000, respectively.
IDT's telecommunications services include wholesale carrier services, and
retail services, including prepaid calling cards, domestic long distance
services and international retail services. IDT delivers its telecommunications
services over a high-quality network consisting of over 100 switches in the U.S.
and Europe and owned and leased capacity on 16 undersea fiber optic cables,
connecting our U.S. facilities with our international facilities and with the
facilities of our foreign partners in Europe, Latin America and Asia. We monitor
our network 24 hours a day, seven days a week through an automated network
operations center. In addition, we obtain transmission capacity from other
carriers. We deliver our international traffic worldwide pursuant to our
agreements with U.S.-based carriers, foreign carriers, and more than 20 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").
As of October 1, 2000, we had approximately 165 wholesale customers located
in the U.S. and Europe. In addition, IDT offers retail long distance services to
over 150,000 individual and business customers in the U.S. and worldwide.
Minutes of use for our telecommunications business have grown from 809.5 million
minutes in Fiscal 1998 to 2,777.8 million minutes in Fiscal 1999 to 4,252.0
million minutes in Fiscal 2000.
We plan to further expand our global telecommunications network
infrastructure, in order to allow us to route a greater percentage of our
international long distance traffic over owned lines. Routing calls over owned
lines, rather than leased lines, will help us to reduce our operating costs,
ensure the quality of our service and expand our customer base. However, we
follow a disciplined, incremental approach to expanding our network, adding new
facilities only when we determine that such investments are justified by traffic
volumes. Under this "smart build" approach, IDT enters new markets by leasing
fiber capacity. As traffic grows, we may install a switch to increase overall
capacity. As traffic increases further, we typically invest in bandwidth to
realize cost savings from routing calls over an owned network. If volume
continues to grow, we may deploy additional switching and/or fiber capacity. IDT
installed company-owned switches in Newark, New Jersey and in London, England in
Fiscal 2000. We plan to install and/or upgrade facilities in Newark and
Piscataway, New Jersey; London, England; Amsterdam and Rotterdam, Holland; and
Brussels, Belgium by the end of Fiscal 2001, and to continue to pursue operating
agreements with foreign carriers in order to terminate traffic directly at
favorable rates.
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, including statements that contain the words
"believes," "anticipates," "expects," "plans," "intends" and similar words and
phrases. Such forward-looking statements include, among other things, the
Company's plans to reorganize, 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
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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.
Forward-looking statements are based on management's current views and
assumptions and involve known and unknown risks that could cause actual results,
performance or events to differ materially from those expressed or implied in
those statements. These risks include, but are not limited to, the following
risks:
. each of our business lines is highly sensitive to declining prices;
. competition in our core businesses could substantially reduce our
revenues and our profits;
. we may not be able to grow our operations in the future if we cannot
raise enough capital;
. our revenues and profits will not increase if we are unable to
continue to expand our telecommunications business;
. our expenses will increase substantially if we expand our network at a
rate that is faster or slower than the growth of our
telecommunications traffic;
. our operations would be impaired if we are unable to obtain the
products and services of the telecommunications companies that we are
dependent upon;
. termination of our carrier agreements with foreign partners or our
inability to enter into carrier agreements in the future could
materially and adversely affect our ability to compete in foreign
countries;
. our revenues and our growth will suffer if our retailers and sales
representatives fail to effectively market and distribute our products
and services;
. we may not be able to integrate our joint ventures, direct investments
and acquisitions successfully with our existing business;
. rapid technological change and frequent new product introductions in
our markets could render our products and services obsolete;
. our growth may be limited if we cannot effectively manage our
international operations;
. our business will not grow without increased use of the Internet;
. our revenues will be impaired if we experience difficulties in
collecting our receivables;
. we will not be profitable if we do not receive attractive rates from
other carriers for our long distance traffic;
. federal, state and international government regulation may reduce our
ability to provide services, or make our business less profitable and
we may become subject to increased costs of operations due to
uncertainty over the amount of payphone surcharges and Federal
Universal Service Fund obligations;
. we may become subject to increased price competition from other
carriers due to federal regulatory changes in determining
international settlement rates;
. European regulation of telecommunications services may not continue to
evolve towards streamlined regulation;
. telecommunications regulations of other countries may restrict our
operations;
. government regulation of Internet access may increase our costs of
operations and we may become subject to Internet access charges;
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. we may be subject to liability for information disseminated over our
Internet network;
. the infringement or duplication of our proprietary technology could
increase our competition and we could incur substantial costs in
defending or pursuing any claims relating to proprietary rights;
. network construction delays and system disruptions or failures could
prevent us from providing our services, cause us to lose customers and
adversely affect our business;
. our quarterly operating results are subject to variation, which could
cause us not to meet the expectations of securities analysts, and
should not be relied upon as an accurate indicator of our overall
performance;
. if we are unable to attract and retain qualified management and
technical personnel, we may not remain profitable; and
. IDT is controlled by its principal stockholder, which limits the
ability of other stockholders to affect the management of IDT.
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 filed with the Securities and
Exchange Commission pursuant to the Securities Act of 1933 and the Securities
Exchange Act of 1934, including the Company's reports on Forms 10-Q and 8-K.
History
The Company was founded in August 1990 and was originally incorporated in
New York as "International Discount Telecommunications Corp." Our company was
renamed IDT Corporation and reincorporated in Delaware in December 1995. Our
main offices are located at 520 Broad Street, Newark, New Jersey 07102; our
headquarters telephone number is (973) 438-1000. IDT's Internet address is
www.idt.net.
IDT 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. Our 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. We used the expertise derived from, and the calling volume
generated by, our call reorigination business to enter the domestic long
distance business in late 1993 by reselling long distance services of other
carriers to our domestic customers. As a value-added service for our domestic
long distance customers, we 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, we began reselling to other long
distance carriers access to the favorable telephone rates and special tariffs we
receive as a result of the calling volume generated by our call reorigination
customers. We began marketing 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. We expanded
our 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, we
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, we introduced Click2CallMe, which allows
consumers visiting e-commerce companies to contact customer sales
representatives from the Web sites of such companies without charge.
On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock, yielding $85.3 million in net proceeds. In
December 1999, we sold 2,200,000 Net2Phone shares, in connection with
Net2Phone's secondary offering. In August 2000, we completed the sale of
14,900,000 shares of Net2Phone to AT&T, receiving approximately $1.1 billion in
cash proceeds. We currently still hold approximately 10,000,000
3
shares of Class A Net2Phone common stock. As part of our transaction with AT&T,
we have granted AT&T the right of first refusal to purchase our remaining
Net2Phone shares. After August 11, 2000, we will no longer consolidate the
results of operation of Net2Phone.
Corporate Reorganization
In October 2000, we announced plans to reorganize the Company, creating
separate divisions designed to reflect our various businesses and their unique
strategies. Upon completing this reorganization, which is subject to regulatory
approval, receipt of counterparty consents and completion of various
administrative requirements, IDT Corporation will be a holding company,
consisting primarily of two main subsidiaries: IDT Telecom and IDT Ventures and
Investments. Each of these divisions will be described in greater detail below.
We believe that the reorganization may result in several benefits to IDT
and its shareholders. These advantages include:
. Giving IDT greater flexibility in managing and financing new and
existing business operations
. Enhancing our ability to create separate, publicly-traded companies
through potential initial public offerings (IPOs) of stock
. Giving IDT greater flexibility to expand in the future through
acquisitions of companies, which may be strategically advantageous to
our long-term growth
. Facilitating the formation of joint ventures or other strategic
alliances along business lines
. Furthering our objective of operating our telecom business on a more
self-sufficient, independent economic basis
. Facilitating improved delineation of administrative and other
responsibilities within our corporate structure
. Enhancing management focus, by permitting a designated group of
executive employees to concentrate their efforts on the concerns of
the consolidated enterprise as a whole while allowing management of
the principal subsidiaries to focus on business unit-specific
objectives
. Permitting us to further link executive compensation to the
performance of the different business units, thereby providing for
better management accountability
IDT Telecom
IDT's Telecom division provides competitively-priced wholesale and retail
telecommunications services to customers around the world. Services offered
include wholesale carrier services, prepaid calling cards, domestic long
distance services and international retail services. Our telecom division seeks
to take advantage of numerous market opportunities -- presented by an ever-
evolving worldwide telecommunications industry -- to profitably grow its
business.
The International Long Distance Market
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, WorldCom, Inc. and Sprint Corporation primarily
utilize owned U.S. transmission facilities and tend to use other international
long distance providers to
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reach niche markets where they do not own a network, to take advantage of lower
prices, and to carry their overflow traffic. Since no single carrier has
transmission facilities that cover each of 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.
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, WorldCom and
Sprint. In addition, these companies have only a limited ability to invest in
international facilities. Alternative international carriers, such as us, 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.
Telecommunications Market Opportunities
The international communications industry is undergoing a period of rapid
technological and regulatory changes that have resulted in several market
opportunities for emerging telecommunications services providers, such as IDT.
Recent years have witnessed rapid growth in the usage of international
telecommunications services, the proliferation of carriers providing such
services, a shift towards deregulation in many of the world's major
telecommunications markets and the development of new technologies.
According to industry sources, in 1998, the international long distance
telecommunications industry accounted for approximately 93 billion minutes of
use, an increase of 12% from 83 billion minutes of use in 1997, and up from
approximately 34 billion minutes of use in 1990. Industry sources have estimated
that by 2002 this market may approach 160 billion in revenues, representing
compound annual growth rates from 1998 of approximately 15%.
We believe that growth in international long distance services is being
driven by:
. the globalization of the world's economies and the worldwide trend
toward deregulation of the telecommunications sector
. declining prices arising from increased competition generated by
privatization and deregulation
. increased worldwide telephone density in both traditional wireline and
wireless telephones
. the emergence of new technologies, which have resulted in higher
quality and lower costs
. a wider selection of products and services
. the growth in the transmission of data traffic
We anticipate that growth of voice and data traffic originated in markets
outside the U.S. will be higher than growth in voice and data traffic originated
within the U.S. due to recent deregulation in many foreign markets, relative
long-term economic growth rates and increasing access to telecommunications
facilities in emerging markets.
Deregulation and Competition
Consumer demand and competitive initiatives have acted as catalysts for
government deregulation, especially in developed countries. 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:
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. 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 every 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.
We believe 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. In fact, this price elasticity of demand has already been
witnessed on a large scale worldwide.
The competitive opportunities have affected the deregulated, deregulating
and regulated markets in different ways. In a fully deregulated country, such as
the U.S. or the U.K., carriers can establish switching facilities, own or lease
fiber optic cable, enter into operating agreements with foreign carriers and,
accordingly, provide direct access service. However, new carrier entrants to a
deregulated market are usually not in a position to build their own
infrastructure. They generally prefer not to purchase services from incumbent
carriers and current competitors, whose incentives are to make the entrants'
access as restrictive and expensive as possible. These circumstances create a
demand for a carrier's carrier -- a firm that is capable of constructing its own
long distance network with a primary focus on serving other companies who market
their services directly to consumers. A carrier's carrier builds an
international telecommunications network to serve entrants in the retail market
and often offers rates that are much lower than the incumbent carrier offers to
entrants.
In markets that have not been deregulated, or are slow in implementing
deregulation, there are typically two or three competing carriers, including the
national monopoly. In such markets, a carrier's carrier will sell minutes to,
and buy minutes from, the competitive carriers, who seek minutes volume as well
as lower costs in order to enable them to compete. In addition, the carrier's
carrier will also continue to offer similar services to the national monopoly.
In markets that are fully regulated, such as various countries in the
Middle East, Asia and Africa, the regulated telephone monopoly or incumbent
carrier sets prices based on the accounting rate system, a framework 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. However,
even monopolists providing services in closed markets find that operating their
own network is unduly expensive, and given the low prices available relative to
those offered in their bilateral agreements, the most cost effective solution in
many situations is to employ a carrier's carrier. Unlike the monopolist, the
carrier's carrier can fill its network with calls originating in many countries
without being bound by accounting rates.
Teledensity
A major trend in the worldwide telecommunications industry in recent years
has been increased teledensity, or the measure of telephone lines per units of
population. Teledensity rates vary widely across different regions and
countries, with a relatively strong relationship between a country's per capita
income and its teledensity, as richer countries tend to have higher teledensity
rates than do their poorer counterparts. The following table highlights the
"teledensity gap" which exists between the world's more developed and less
developed countries and regions.
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---------------------------------------------
Country or Region Teledensity
---------------------------------------------
Africa 2.4%
---------------------------------------------
Americas (including U.S.) 32.8%
---------------------------------------------
Asia 8.0%
---------------------------------------------
Europe 38.1%
---------------------------------------------
Oceania 41.1%
---------------------------------------------
United States 66.1%
---------------------------------------------
World 14.9%
---------------------------------------------
However, it appears as though the "teledensity gap" may be narrowing. Many
governments of developing nations have begun to view increased teledensity as a
potential driver for economic growth, and have been focusing on improving
telephone line penetration in their countries. As a result, teledensity rates
around the world have been rising, and are expected to continue to increase over
the foreseeable future. As more people around the world gain access to
telephones, international long distance minutes will increase.
IDT believes that it is particularly well-positioned to benefit from the
anticipated improvements in teledensity rates in areas such as Africa, Asia and
Latin America. Our wholesale business focuses on these relatively high revenue-
per-minute telecommunications markets. In addition, our prepaid calling cards
are marketed primarily to the ethnic, immigrant communities in the U.S., Europe
and Latin America. Therefore, a significant proportion of our international
debit card minutes go to regions such as Africa, Asia and Latin America, as our
customers call their friends and families in their native countries. We estimate
that over 50% of our international wholesale and debit card minutes go to these
regions. As teledensity rates in these areas continue to increase, we believe
that demand for calling time to these countries will also rise, fueling further
growth in our prepaid calling card business.
New Technologies
New technologies, including the development of next-generation 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 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 advances
have resulted in a trend towards bypassing traditional international long
distance agreements between national monopolies and the proliferation of voice
and data service providers.
Furthermore, 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. 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 traditional 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.
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Increasing Importance of Data Services
As the world continues to transition to information-based economies, and
the telecommunications and Internet industries continue to converge, the
transmission of data will take on a more important role in the business of
telecommunications carriers such as IDT. Although we believe that transmission
of "voice minutes" will continue to increase, we anticipate that more of our
business in the future will involve the transmission of "data minutes."
Currently, data is the major driver behind the industry's projections of future
demand, and the basis for the enormous amount of bandwidth that is being
installed around the globe. Industry sources have estimated that due to
increased demand for data services, the global volume of data traffic is
increasing by more than 100% per year. This explosion in demand for data
services is being fueled by several factors, including:
. Increasing use of the Internet and corporate Intranets
. Continued personal computer penetration
. The emergence, and rapid acceptance, of e-commerce as a substitute for
more traditional transactions
. Growing demand for other Internet-related services, such as web
hosting
As with the voice minutes market, we believe that the growth in the data
services market will be greater overseas than in the U.S., owing to the
significantly lower relative levels of Internet use, PC penetration and
corporate Intranet and web hosting activities outside the U.S. This indicates
greater potential upside in these international markets.
The growth in data transmission presents us with opportunities to both
expand our business with our existing customers, and to reach a new customer
base. We will be able to add a data element to the services we currently provide
our existing telecommunications customers, offering services such as Internet
telephony, remote Internet access, web-hosting, and co-location and data center
services. We will also be able to offer services to a broad, new customer base
for IDT, including Internet Service Providers (ISPs) and Application Service
Providers, as we carry their data minutes over our network.
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 the various opportunities
presented by today's telecommunications industry. Our objective is to enhance
our current position 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. The following goals represent key elements of our strategy:
Focus on International Telecommunications. We believe 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. We target international markets
with high volumes of traffic, relatively high per-minute rates and favorable
prospects for deregulation and privatization. We believe that the ongoing trend
toward deregulation and privatization will create new opportunities for us to
increase our revenues and to reduce our termination costs, while maintaining
balanced growth in wholesale and retail traffic.
Expand Switching and Transmission Facilities. We are continuing to expand
and enhance our network facilities by investing in switching and transmission
facilities where traffic volumes justify such investments. During Fiscal 2001 we
intend to invest in:
. undersea cables connecting the U.S., Europe, South America and Asia
. terrestrial fiber capacity within the U.S. and Europe
. gateway switches and facilities in the U.S., the U.K., the Netherlands
and other European countries
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. additional network compression equipment.
We believe that these investments will allow us to broaden the scope of our
telecommunications activities and to reduce the cost of our services, while
maintaining our high service quality.
Expand Service Offerings and Marketing Activities. We intend to 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. Our wholesale business will attempt to offer a more complete suite of
value-added carrier services to both its existing customer base and to new
customers. Within our retail division, we will continue to seek profitable
niches within the telecommunications markets, adding higher-margin retail
businesses, such as residential long distance and wireless products and
services, to our existing sales mix.
Pursue Strategic Alliances and International Agreements. We intend to
capitalize on our strategic alliances and other relationships with U.S. and
foreign companies in order to expand our customer base. We have traditionally
been able to capitalize on our significant traffic volume and technological
expertise to negotiate favorable termination agreements with international
carriers. We intend to continue to seek new termination relationships with
established and emerging carriers to reduce our termination costs for
traditional international voice telephony, and in some cases to use our
relationship with Net2Phone for additional low cost termination. To date, we
have entered into approximately 65 agreements with carriers that provide for the
favorably priced termination of its calls worldwide.
As part of the transaction in which we sold 14.9 million of our Net2Phone
shares to AT&T, we have announced that we would pursue operating agreements with
AT&T and/or its international affiliates.
Telecommunications Services
IDT provides its wholesale and retail customers with integrated and
competitively priced international and domestic telecommunications services. Our
four primary telecommunications services are: wholesale carrier services,
prepaid calling cards, domestic long distance services in the U.S., and
international retail services. We generated revenues from our telecommunications
business of approximately $1,023.0 million during Fiscal 2000, up from $684.6
million during Fiscal 1999. Telecommunications revenues represented 93.5% of
IDT's total consolidated revenues in both Fiscal 2000 and Fiscal 1999.
Wholesale Carrier Services
We sell our wholesale carrier services to other U.S. and international
carriers, utilizing flexible and least-cost traffic routing and based on our
expertise in navigating the complex accounting rate system. In this way, we act
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. We are able to offer competitive rates to our carrier
customers as a result of our extensive relationships in the long distance
telecommunications industry, our ability to generate a high volume of long
distance call traffic and the advantageous rates negotiated with foreign PTTs
and competitive carriers. As of October 1, 2000, we had approximately 165
wholesale customers located in the U.S. and Europe, with wholesale carrier sales
representing 47.6% of IDT's total consolidated revenues in Fiscal 2000.
The wholesale carrier business is currently undergoing a transformation, as
intense competition has led to significant price declines and margin pressure.
In this environment, several less efficient operators, who generally do not
possess the critical mass necessary to succeed, are finding it increasingly
difficult to compete. We anticipate that this trend will continue in the coming
years, as some competitors leave the industry, and the more financially sound
players, including IDT, gain market share at the expense of the weaker
competitors. In the short-term however, we anticipate that we will continue to
be faced with a challenging operating environment for wholesale carrier
services, characterized by continued margin pressure.
9
Competitive Advantages
We believe that we have several competitive advantages in the wholesale
carrier business, including the following:
. Strong existing relationships with national monopolies and other leading
carriers, which, we believe, allow us to negotiate advantageous rates.
. Our prepaid card business, which generates a high volume of long distance
call traffic. Because we can bring new minutes to the national monopoly,
rather than simply taking minutes from another carrier with whom it might
already have an agreement, we are favored by national monopolies.
. Superior switching, routing and customer service technology. Our backbone
network has demonstrated its superior quality in several tests. Our back
office technology allows us to generate real-time information, allowing for
better cost analysis and customer service and facilitating strict quality
controls.
. Our ability to offer "value-added carrier services," such as giving
carriers remote access to our debit card platform. This enables us to offer
additional "turnkey" capabilities to carrier customers and positions us as
a "total outsourcing provider" of carrier services, something that our pure
wholesale competitors cannot offer.
. Our status as an independent wholesale carrier that does not compete for
the core retail customers sought by our carrier customers.
. Our ability to rapidly react to changing price environments, which has
allowed us to take advantage of attractive rates more quickly than have our
competitors.
. Our early-entrant status in several regulated markets, which, we believe,
will provide an advantage when these markets deregulate.
. Our careful attention to cost control, efficiency and the maintenance of
lower general overhead expenses.
Wholesale Carrier Strategies
We have strategies tailored to different markets: regulated markets,
deregulated markets and markets that are currently deregulating.
In deregulated countries, we offer new market entrants, who are generally not
in the position to build their own infrastructure, carrier services at rates
that are typically lower than the incumbent carrier is offering. In such
countries, we also establish and expand our arbitrage operations by taking
advantage of the competitive environment to buy minutes at a lower rate and then
sell them at a higher rate. In markets that are fully regulated, our strategy is
to establish a relationship with the national monopoly and enter into agreements
to carry and terminate its minutes. We can typically offer the national
monopolies lower prices than those offered in their existing bilateral
agreements. In markets that are undergoing the deregulation process, there are
typically two or three competing carriers, including the national monopoly. In
these markets, our strategy involves selling minutes to, and buying minutes
from, the competitive carriers, who seek minutes volume as well as lower costs
in order to compete. We also continue to offer similar services to the national
monopoly.
These different strategies, for the three types of markets, are part of our
overall strategy for the deregulating world. As a country moves from regulated
to fully deregulated status, our strategy for that country shifts to take
advantage of the opportunities presented at any given time. By first entering a
market when it is regulated and establishing relationships with the national
monopoly, we obtain early entrant status, which prepares us to compete more
effectively as the market deregulates. By the time the market opens for
competition, we have acquired a thorough knowledge of the market (in terms of
potential minutes generated, most frequently called routes, culture, etc.),
which we believe is a competitive advantage for both our wholesale carrier and
retail operations.
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Retail Telecommunications
Prepaid Calling Cards
We sell prepaid debit and rechargeable calling cards providing access to more
than 230 countries and territories. Our rates are up to 50% lower than the rates
for international calls that are charged by the major facilities-based carriers.
We market debit cards primarily to ethnic communities in the U.S. that generate
high levels of international traffic to specific countries where we have
favorable termination agreements. Recent immigrants and members of the ethnic
communities tend to be heavy users of international long distance, given their
desire to keep in touch with family members and friends back home. Our business
is particularly strong in the Northeast U.S., aided by our extensive
distribution network and attractive rates to areas such as Colombia, Mexico and
the Dominican Republic. We have also been rapidly expanding our operations in
California, Florida, Illinois, Texas and other parts of the U.S. Outside the
U.S., we market cards in the U.K., France, Germany, Italy, Spain and the
Netherlands, seeking to capitalize on the opportunity presented by the recent
surge in immigration from under-developed countries around the globe to Europe's
developed nations. We have also recently begun to sell cards in Latin America.
We sold over 50,000,000 prepaid calling cards during Fiscal 2000. During Fiscal
2000, sales of prepaid calling cards accounted for 43.6% of IDT's total
consolidated revenues.
We offer 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 major IDT phone cards we sell:
Asimon Florida Exclusive New York Alliance
Blackstone America Florida Friend New York Exclusive
California Exclusive Georgia Exclusive Pennsylvania Exclusive
Carribean Friend Illinois Exclusive Pepe Colombianita
Carolina Exclusive Kababayan Pepe Megatel
Centro Americard Long Island Exclusive Puerto Rico Exclusive
China Card M&M Card Rhode Island Exclusive
Circle Line Mass Exclusive South Seas
Colombianita Card Massachusetts Talk Tele Talk
Connecticut Exclusive Mega Mexico Card Texas Exclusive
Cumbia 800 Megatel Card Union Phone Card
Dominicall Card Megatel Vending Union Phone Vending
Eastern Europe Metropolis Vending Exclusive
Easy Pass IDT Merengue Card Virtual Internet Card
Easytalk LA Michigan Exclusive Walter Mercado Phone
Easy Talk NJ New Jersey Alliance Washington Alliance
Flat Rate Nickel 2001 New Jersey Exclusive Washington Exclusive
Our rechargeable cards, distributed primarily through in-flight magazines,
permit users to place calls from over 40 countries through international toll-
free services.
Our retail customers can use our 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. Our switch completes the call, and our debit card
platform reduces the outstanding balance of the card during the call. We offer
prepaid calling cards that can be used to access our network by dialing a toll-
free number or, in specific metropolitan markets, local area calling cards that
only require a local call. We believe that many of our customers typically use
our calling cards as their primary means of making long distance calls due to
attractive rates, reliable service, the ease of monitoring and budgeting their
long distance spending and the appealing variety of calling cards we offer 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, we operate one of the nation's largest
international debit card platforms. The platform provides us with a broad range
of services used to conduct our calling card operations, including billing,
routing of calls, and determining the amount of credit available on each
outstanding calling card.
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As part of our rapid expansion in the prepaid calling card market, we have
started marketing private label phone cards. Private label cards serve as
lucrative promotional items and can also be used to help generate brand name
awareness. We have launched several co-branded cards in partnership with
consumer product companies, including the Coca-Cola Company in the Dominican
Republic.
Competitive Advantages
We believe that we possess the following advantages over our competition in
the prepaid calling card industry:
. Our status as a carrier's carrier allows us to offer calling time over more
routes to the countries that are in demand in the retail marketplace, at
attractive prices.
. Our debit platform, which we believe to be the most advanced in the
industry, enables us to process a large number of cards simultaneously and
to provide multi-lingual and multi-currency cards.
. Our expertise, market savvy and distribution channel, which covers over
100,000 retail outlets.
. Our understanding of, and commitment to, the ethnic prepaid calling card
market.
. We are able to provide low rates and at the same time maintain our margins
by taking a disciplined approach to advertising and because we enjoy low
overhead and low headcount. We believe that as our carrier business builds
out its network, our prepaid business' cost per minute will decline,
helping margins.
Domestic Long Distance Services
IDT markets certain long distance services directly to retail customers in the
U.S. Introduced in February 2000, our calling plan features a flat rate of five
cents per minute for all state-to-state calls within the continental United
States, 24 hours a day, seven days a week. We also offer a free IDT Calling
Card, with no monthly fees or per-call surcharges, featuring a domestic rate of
ten cents per minute. Our rates for international calls are also extremely
competitive, well below those charged by the major facilities-based carriers. In
April 2000, we began to more aggressively market our domestic long distance
services, by expanding the existing TV ad campaign to additional markets and
introducing new marketing channels, including print advertisements, direct mail,
online advertising and partnerships.
As of October 1, 2000, we had over 150,000 domestic long distance customers.
Domestic long distance services accounted for 1.3% of our total consolidated
revenues in Fiscal 2000. As we continue to make significant expenditures to
market this service, resulting in customer growth, we anticipate that domestic
long distance services will begin to account for an increasing proportion of our
total revenues in future periods.
International Retail Services
We offer international retail services to customers outside of the U.S.,
primarily through call reorigination. We also provide our 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. We market our call reorigination service to
businesses and individuals. International retail services accounted for 1.0% of
IDT's total consolidated revenues in Fiscal 2000.
Internet Services
In 1994, IDT began offering Internet access to individuals and businesses. We
currently offer a variety of both dial-up and direct-connect dedicated Internet
services. IDT's Internet access network, which consists of multiple leased
lines, offers approximately 200 points-of-access through approximately 35
points-of-presence (POPs) owned
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by IDT. In addition, we offer approximately 2,300 points-of-access through POPs
owned by local and regional ISPs, called Alliance Partners, through which
subscribers may access the Internet. As of October 1, 2000, IDT offered local
dial-up access to approximately over 20,000 retail customers, provided dedicated
access to nearly 350 medium and large-sized businesses, offered Web hosting
services to approximately 2,000 customers and provided Digital Subscriber Line
(DSL) services to 800 customers. Internet services accounted for 1.2% of IDT's
total consolidated revenues in Fiscal 2000.
In recent years, our Internet business has pursued a targeted niche strategy,
seeking to offer products and services to markets where we would not be required
to incur the significant customer acquisition costs generally associated with
"mass market" Internet service providers. Consequently, our Internet strategy
shifted several times through Fiscal Years 1999 and 2000, as we attempted to
profitably exploit market opportunities in the Internet industry. Most recently,
we offered free Internet access and other services through our Free-At-Last.com
subsidiary. However, in October 2000, we announced that we were transitioning
our FreeAtLast.com Internet service from a free service to a subscription plan.
In addition, as part of our joint venture agreements with Terra Networks, and
the subsequent exchange of our interests in these ventures for Terra Networks
stock, we have given most of our dial-up customers to Terra Networks. We are
currently considering several options for our Internet business, and we expect
to continue to scale back our operations in this area.
Sales, Marketing and Distribution
We primarily market our international telecommunications services through our
direct wholesale carrier services sales staff. The staff primarily relies on,
and benefits from (i) IDT's extensive relationships and increasing international
exposure and recognition throughout the long distance industry for marketing its
carrier services; (ii) our substantial traffic volumes, which enable us to
negotiate for lower rates; and (iii) favorable terminating rates negotiated with
PTTs and foreign carriers.
We primarily market our international call reorigination services through our
overseas network of independent sales representatives. The foreign sales
representatives, who are supervised by our U.S.-based sales managers, provide us
with access to local business and residential customers and new opportunities in
the local markets they serve. We pay our foreign sales representatives on a
commission basis. As of October 2000, we were represented by over 300 foreign
sales representatives worldwide. We have also commenced direct sales efforts,
primarily through overseas advertising in international print media to penetrate
particular market segments that we do not currently serve.
We currently market our prepaid debit cards to retail outlets throughout the
U.S. through Union Telecard Alliance, LLC ("Union"), a joint venture company
of which we own 51% of the outstanding equity interests. Union is one of the
largest distributors of prepaid calling cards in the nation, utilizing a network
of over 600 sub-distributors who sell through over 100,000 retail outlets
throughout the United States. In July 1999, we entered into an agreement with
All Americas Cable & Radio ("AACR"), a long distance carrier based in the
Dominican Republic, in which we will distribute prepaid calling cards in the
Dominican Republic on behalf of AACR. As part of our plan to expand our
territory beyond the U.S., we have begun to establish a distribution network in
the Dominican Republic to replicate our calling card distribution network in the
United States. In May 2000, Union began distributing prepaid cards in Puerto
Rico, and plans to begin distributing cards in parts of Central America during
Fiscal 2001.
Union has entered into agreements with sub-distributors, located in Illinois,
Florida, New York, Ohio and Texas, whereby the sub-distributors have agreed to
market the our prepaid calling cards in exchange for preferential pricing,
exclusive cards, extensions of credit, incentive bonuses and technical support
from us, which is intended to assist each respective sub-distributor in the
growth and development of its business. Our exclusive calling cards 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.
13
We have significantly increased our marketing expenditures for our domestic
long distance services, in conjunction with the announcement of our new flat-
rate, five-cents-a-minute calling plan. The advertising campaign for these
services is mostly driven by direct television advertising in targeted markets,
and is supplemented with a direct mail program. Our goal is to continue spending
on marketing and advertising to build our domestic long distance customer base,
with a primary focus on keeping cost-per-customer acquired at or below our
targeted levels.
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, we have invested substantial resources
to develop and implement our proprietary management information systems.
Our billing system enables us to:
. accurately analyze our network traffic, revenues and margins by customer
and by route on an intra-day basis;
. validate carrier settlements; and
. monitor least cost routing of customer traffic.
The entire process is fully automated and increases efficiencies by reducing
the need for monitoring by our employees. We believe that the accuracy and
efficiency of our management information systems provide us with a significant
strategic advantage over other emerging carriers.
We believe that our ability to provide adequate customer support services is a
crucial component of our ability to retain customers. We have 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. We require that each customer support
staff member field a minimum number of calls and e-mails each day. We also
employ liaisons between the customer support and technical staffs to ensure
maximum responsiveness to changing customer demands.
Network Infrastructure
We maintain an international telecommunications switching infrastructure and
U.S. domestic network, consisting of owned and leased lines that enable us to
provide an array of telecommunications, Internet access and Internet telephony
services to our customers worldwide. 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, we use two proprietary
monitoring systems to manage modem pools.
Telecommunications Network
Private Line Network
We operate a growing telephone network consisting of U.S. domestic dedicated
leased fiber optic and copper lines, and IDT-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. Our major switching facilities are located in Piscataway, N.J.;
Newark, N.J.; New York, N.Y.; London, England and Rotterdam, Holland. 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 us to
interconnect with all major interexchange carriers to switch traffic via our
leased private-line DS3 network. Furthermore, all of our locations are
interconnected via leased lines to enhance network reliability and redundancy as
each location interconnects with the various carriers.
14
In September 1998, we entered into a $32 million, 20 year Indefeasible Right
of Use (IRU) agreement with Frontier Communications (now a unit of Global
Crossing Ltd.) 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 have enabled us to expand the range
and reliability of our data and voice transmission service, while reducing
network costs. IDT is 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, we entered into an agreement with Frontier whereby we
enhanced our 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 has
significantly enhanced our ability to provide long distance dial up services.
In addition, we own and lease switched services to connect our 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. We have about 65 operating and terminating agreements that
provide for the termination of traffic worldwide, including agreements with
companies based in Spain, the Dominican Republic, Italy, Bangladesh, Cyprus and
Chile. We also plan to obtain leased lines to these destinations, which will
result in reduced costs for termination to these countries. We have also
targeted countries such as the Netherlands, Germany and France for network
expansion due to the large number of minutes we presently terminate and the size
of our installed base of telecommunications customers in these countries.
International Telecommunications Acquisitions & Agreements
In January 1999, we 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 our
facilities in the United States and United Kingdom. We have already established
a presence in the United Kingdom with its facilities-based switch, and have
purchased more than 12,000 kilometers of undersea cable connecting the United
States, Canada and the United Kingdom.
In February 1999, we acquired Orion Telekom B.V., now known as IDT Netherlands
B.V., a Netherlands based provider of telecommunications services. Through this
acquisition, we procured an Interconnect/Access agreement 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. Our voice licensing in the Netherlands
coupled with the interconnection available through KPN has enabled us to offer
wholesale and retail carrier services in the Dutch market.
Switching Platforms
We utilize two major switching platforms. We use our Lucent switches for our
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 Lucent switches (such as the
LNX) are flexible and programmable, and are designed to implement network-based
intelligence quickly and efficiently. We currently own and/or lease 113 Lucent
switches. The other platform is the Nortel DMS250-300/GSP, which serves as an
international gateway and generic carrier switch. We currently own four Nortel
switches. A third platform, the Alcatel, is used at our switching facility in
the Netherlands. We plan to upgrade our switching platforms in New Jersey,
London and Amsterdam during Fiscal 2001. All of our 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.
Software
Our Lucent switches incorporate Company-developed software which efficiently
performs all the applications we require to provide value-added services, as
well as billing and traffic analysis. The software enables the Lucent switches
to route all calls via our least-cost routing platform. Least-cost routing is a
process by which we optimize the routing of calls over the least-cost route on
our switches 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
15
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 a carrier's minutes using resold switched services to another of our
U.S.-based switches in order to terminate the traffic in a third country while
taking advantage of our competitive 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 we 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, we are able to
minimize our costs, and offer lower rates to our customers. This is of
significant importance when serving a market which has become increasingly
price-sensitive.
Internet Network
We operate 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 we maintain 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, we deploy 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, we employ an "Open Shortest
Path First" protocol, which allows data traffic to be routed most efficiently.
We seek to retain flexibility and to maximize our opportunities by utilizing a
continuously changing mix of routing alternatives. This diversified approach is
intended to enable us to take advantage of the rapidly evolving Internet market
in order to provide low-cost service to our customers.
We utilize the local dial-up switching infrastructure of several Alliance
Partners across the country to supplement our owned and operated local dial-up
infrastructure. The Alliance Partners, which are independently-owned Internet
service providers, employ routing and modem equipment which meet our standards
for providing dial-up access services. We offer the Alliance Partners a monthly
fee for each customer account routed through their local access networks. We
also provide 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 us from constructing our own local installed POP where warranted.
Research and Development
We employ a technical staff that is devoted to the improvement and enhancement
of our existing telecommunications and Internet products and services, including
switching technologies and the development of new technologies and products. We
believe 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 we
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. For the years ended July 31, 1998, 1999 and 2000, research and
development costs totaled approximately $481,000, $757,000 and $4,692,000,
respectively.
In connection with IDT's acquisition of InterExchange in May 1998, we acquired
InterExchange's in-process research and development relating to alternative
switching and compression technologies. IDT has chosen to discontinue the
acquired research and development projects in favor of utilizing advanced vendor
technologies.
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Competition
The markets in which we operate 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 we compete. We expect competition in these markets to
intensify in the future.
The market for prepaid calling cards has become highly competitive. In the
prepaid calling card market, we compete with other providers of prepaid calling
cards and with providers of telecommunications services in general. Many of the
largest telecommunications providers, including AT&T, WorldCom and Sprint
currently market prepaid calling cards, which in certain cases, compete with the
prepaid calling cards we sell. 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 does the Company. We also compete with smaller, emerging carriers in the
prepaid calling card market, including RSL Communications, Ltd., Viatel, Inc.,
Primus Telecommunications and PT-1 Communications. In marketing prepaid calling
cards to customers outside the U.S. market, we compete with the large PTTs, such
as British Telecommunications (BT) in the U.K. We believe 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, we compete with:
. interexchange carriers and other long distance resellers and providers,
including large carriers such as AT&T, WorldCom, Inc. and Sprint
. foreign PTTs
. other providers of international long distance services such as Pacific
Gateway Exchange, Primus Telecommunications, RSL Communications Ltd.,
Viatel, Inc., and World Access, Inc.
. alliances between large multinational carriers that provide wholesale
carrier services
. 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
. small long distance resellers.
Moreover, some of our competitors have announced business plans similar to
ours regarding the expansion of telecommunications networks into Europe and
Latin America. Many of our 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.
We compete 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 us to reduce our prices and profit margins if
our competitors are able to procure rates or enter into service agreements that
are comparable to or better than those we obtain, or are able to offer other
incentives to existing and potential customers. Similarly, we have no control
over the prices set by our competitors in the long distance resale carrier-to-
carrier market.
IDT Ventures
Our IDT Ventures division was formed to develop several new innovative
telecommunications and Internet-related businesses, with a focus on identifying
and exploiting niche market opportunities, specifically in markets where we can
leverage one or more of our existing strengths.
The IDT Approach
The goal of IDT Ventures is to remain on the cutting-edge of technology and
business development. The formation of venture businesses is both analytical and
visionary in nature. Our high-level executive development
17
team draws on its substantial experience in the high-technology and
telecommunications fields to identify existing yet overlooked opportunities,
while at the same time anticipating and evaluating future demand for certain new
technologies, products and services. Once a promising venture is identified, and
the project proceeds from concept to development, our development team allocates
the financial and human resources necessary to move the project through the
development stage. In order to ensure proper management focus on each potential
new business, we provide each venture with a dedicated management team, seeking
individuals whose skill-sets and experience most closely match those needed for
each particular venture.
Although these new ventures will benefit at the outset from IDT's financial
strength, which will allow us to fund these businesses in their early stages, we
will require these businesses to demonstrate their ability to become profitable
and obtain independent financing at a relatively early stage. In general, the
long-term plan for these ventures businesses, once they have reached critical
mass, is to separate them as independent financial entities, as in the case of
our former subsidiary, Net2Phone. In this way, IDT Ventures hopes to build
businesses which can eventually become stand-alone companies. Currently, the
Ventures division consists primarily of TV.TV and IDT Wireless.
TV.TV
In September 2000, we announced the formal creation of TV.TV, a new venture
designed to deliver high quality online video content, as well as television and
entertainment services to the emerging broadband market. TV.TV (also known as
"Genie" while in its development stage) will provide free television on demand
supported by targeted advertising, pay-per-view events, subscription services
and e-commerce revenues.
TV.TV is constructing its own private broadband network, to enable it to
deliver content at quality that exceeds that available through the public
Internet. TV.TV will co-locate its servers at cable head-ends and DSL
aggregation points, connecting broadband users to its network. TV.TV's platform
is neutral, as it can be accessed through cable modems, DSL, digital cable set
top boxes, or even wireless services.
TV.TV is currently developing proprietary technology for a range of advanced
security solutions, including encryption, digital fingerprinting and
watermarking that protect content against piracy and unlicensed use or
duplication. By converting film and other programming content into an encrypted,
digital format that can be streamed on the Web, the TV.TV platform offers a
secure, turnkey solution for moving entertainment properties onto the Internet,
where they can be accessed by a diverse, geographically dispersed and growing
online audience.
TV.TV is due to be operational in multiple pilot markets by the end of
calendar 2000. The service will be launched in a market-by-market rollout,
beginning with New York City, San Jose, CA and Billings, MT, to customers with a
high-speed, broadband connection to the Internet.
IDT Wireless
In response to the numerous opportunities offered by the rapidly growing
wireless industry, IDT formed its IDT Wireless division in March 2000 to develop
and offer competitively priced paging and cellular products. These products will
feature IDT's "calling-party-pays" technology, which eliminates the fees that
subscribers are currently forced to pay for incoming pages and calls in the U.S.
In June 2000, IDT launched its FREEWAY pagers, featuring the calling-party-
pays technology. With Freeway Pagers, users pay a one-time purchase price for
the pager, with no need to pay again for service. FREEWAY pagers are available
through the same extensive retail distribution network that currently sells IDT
Prepaid Calling Cards, as well as many national and regional retail chain
stores. The FREEWAY numeric pager has a suggested retail price of $49.95, while
the FREEWAY text model has a suggested retail price of $79.95. With the FREEWAY
numeric pager, the calling party is charged 35 cents for each page. The FREEWAY
text messaging pager lets a calling party send a text message of up to 120
characters for a 50 cents charge.
Also in June 2000, we announced the launch of our branded wireless program,
including prepaid wireless mobile phone service, with enhanced features, such as
Voicemail, Caller ID and Call Waiting. IDT's network services are provided on
the Sprint PCS(K) Nationwide wireless Network. Under IDT's Private Label
Services arrangement with Sprint PCS, IDT customers have access to PCS service
anywhere on the Sprint PCS Nationwide
18
Network, serving more than 300 major metropolitan areas. Customers can purchase
wireless minutes, as needed, in amounts ranging from $25 to $200. IDT's prepaid
wireless service is initially being offered in retail outlets in the New York
Metropolitan area, with distribution to be phased in nationwide.
In addition, IDT plans to license its technology to other cellular providers,
creating an additional business and source of revenue from its "calling party
pays" technology.
Brix Communications
In September 1999, IDT formed Brix Communications to provide diversified
telecommunications and Internet services to tenants of commercial buildings and
residential multifamily properties. Brix offers high speed voice and data
services, including 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. Brix's strategy involves entering into a
partnership with a property owner, under which Brix provides the building-wide
infrastructure upgrade at no cost to the landlord, in return for allowing Brix
to offer its Internet, telecommunications and video services to tenants. We are
currently exploring our options for the Brix Communications subsidiary,
including, but not limited to, the possible sale of Brix Communications to
another company.
IDT Investments
IDT Investments represents IDT's equity investments in other
telecommunications or Internet-related companies. This division seeks to
leverage our extensive industry knowledge and relationships to identify
promising investment opportunities. Because of IDT's experience in, and
knowledge of, the worldwide telecommunications and Internet industries, we
believe that we are well qualified to assess the value of the investments with
which we are frequently presented. Like our IDT Ventures unit, IDT Investment's
goal is to identify opportunities in the telecommunications and Internet fields
which can be exploited through the use of superior technology. Unlike IDT
Ventures, however, IDT Investments seeks to accomplish this goal through its
minority investments in other entities. We anticipate that our investments will
often involve companies with whom we have existing business relationships,
although the scope of our investment program will not necessarily be limited to
those entities. Our primary investments include our holdings in Net2Phone, our
former subsidiary; Terra Networks, and 2AM Inc.
Net2Phone
IDT now owns approximately 10,000,000 shares the Class A Common Stock of
Net2Phone (NASDAQ: NTOP). Originally formed by IDT in 1996, Net2Phone is the
world's leading provider of Internet telephony products and services. Net2Phone
routes millions of minutes over the Internet every month. According to
International Data Corporation, Net2Phone is the industry leader in IP (Internet
Protocol) telephony minutes routed, with nearly 40% market share.
Net2Phone offers a variety of products and services, including:
. Net2Phone: Software for PC-to-phone service, which now includes free PC-to-
PC calling, PC-to-fax service and free voice E-mail.
. Net2Phone Direct: Low cost phone-to-phone and fax-to-fax service over
Net2Phone's IP telephony network. Net2Phone also offers the Net2Phone
Direct Prepaid Calling Card, allowing users to place phone calls via the
Internet to another phone.
. Voice Enabled E-Commerce Solutions, such as Click2Talk, Click2Callme and
Click Together.
. Yap (Your Alternative Phone): Net2Phone's retail line of hardware solutions
designed to enable users to easily make Internet phone calls.
When IDT launched Net2Phone in 1996, it became 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
19
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.
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
our telecommunications switches in the U.S. The call is then routed in the same
manner as other voice telephony calls, using our 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 substantially below the rates
generally charged by traditional foreign carriers to place and terminate
standard international telephone calls.
In September 2000, Net2Phone announced the formation of a new company, Adir
Technologies, designed to develop and market network management software for
Voice over IP (VoIP) and other packet-based multimedia networks. Net2Phone also
announced that Cisco Systems (NASDAQ: CSCO) has purchased a minority equity
interest in Adir Technologies. Cisco will jointly market Adir's network
management platform to its VoIP customers. IDT has invested $7.0 million in Adir
Technologies, in return for a minority equity interest.
In August 1999, Net2Phone completed an initial public offering of 6,210,000
shares of its Common Stock. Prior to the Initial Public Offering, Net2Phone was
a 90%-owned direct subsidiary of IDT. After the Initial Public Offering, IDT
owned 56.2% of the capital stock of Net2Phone. IDT owns Class A stock that has
twice the voting power of Net2Phone's common stock. Therefore, after the Initial
Public Offering, we controlled 64.0% of Net2Phone's vote.
In connection with Net2Phone's Initial Public offering, we 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.
In December 1999, Net2Phone sold an additional 6,300,000 shares of common
stock (the "Secondary Offering"). Of the 6,300,000 shares sold in the
Secondary Offering, 2,200,000 shares were sold by IDT. After the Secondary
Offering, we had a 48.3% ownership interest and a 57.3% voting interest in
Net2Phone.
In August 2000, we sold 14,900,000 of our Net2Phone shares to AT&T Corp., for
a purchase price of $75.00 per share, for total cash consideration of
approximately $1.1 billion. In addition, AT&T purchased an additional 4,000,000
newly-issued Net2Phone shares, also at a price of $75.00 per share, paying
proceeds of approximately $300 million to Net2Phone. After completing these
transactions, AT&T held 31.8% of Net2Phone's outstanding stock, and a 38.8%
voting interest. IDT held 16.8% of Net2Phone's outstanding stock, and a 20.5%
voting interest.
Terra Networks
As of October 30, 2000, IDT owned 2,070,000 shares of Terra Networks, the
Internet subsidiary of Telefonica, S.A. of Spain. Terra provides Internet access
and local language interactive content and services to the Spanish and
Portuguese-speaking world, including the Hispanic communities in the United
States.
In October 1999, IDT entered into a joint venture agreement with Terra
Networks 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, Terra Networks Access Services, was formed to provide Internet
access to customers in the target market, while the other company, Terra
Networks Interactive Services, 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. At the
time of the agreement, IDT owned 49% of Terra Networks Access Services and 10%
of Terra Networks Interactive Services. In addition, IDT participated in Terra
Networks' U.S. initial public offering (IPO) in November, 1999, purchasing
1,156,682 Terra Networks shares for approximately $15.5 million.
20
In May 2000, IDT announced that it was exchanging its ownership interests in
Terra Networks Access Services and Terra Networks Interactive Services for
3,750,000 additional Terra shares. Upon the completion of the transaction, Terra
Networks held 100% ownership of both Terra Networks Access Services and Terra
Networks Interactive Services. IDT was also released from the "lock-up"
provision restricting it from disposing of its Terra Networks shares. Under the
terms of the new agreement, IDT was granted authorization to dispose of its
Terra stock, at a maximum rate of 75,000 Terra shares per day, not to exceed
500,000 per month. Through October 1, 2000, we have sold 2,836,682 Terra shares,
generating proceeds of approximately $111.6 million.
2AM Inc.
IDT holds a 25% equity interest in privately-held 2AM, Inc. 2AM has three core
business divisions: 2AM Game Club, TVAD2NET and 2AM Development Ltd. 2AM Game
Club has created an international Internet community competing in multi-player
games with accompanying chat. These games, each of which can involve a large
number of players, permit 2AM to display advertising banners, for which it
receives revenue. TVAD2NET has developed software that permits, in a process
that does not disturb the user, full motion video advertisements to be slowly
sent over a low bandwidth connection onto a computer's hard drive. Because this
technology does not slow down the applications running on the computer, the user
experiences the advertisements as only a 15 to 30 second video commercial
interruption. 2AM Development Ltd. is developing various technologies, including
technology that allows individuals to be linked as they surf the Internet
together.
Regulatory Environment
Deregulation in the U.S. and International Telecommunications Markets
Deregulation accelerated in the U.S. in 1984 with the divestiture by American
Telephone & Telegraph, Inc. ("AT&T") of the regional bell operating companies.
This gave rise to an influx of competitive telecommunications companies. Today,
there are over 500 U.S. long distance companies. 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 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.
Deregulation has encouraged competition, which in turn has prompted carriers
to offer a wider selection of products and services at lower prices. We believe
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. We believe 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.
21
Government Regulation of the Telecommunications Industry
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.
In February 1997, the United States and 68 other countries signed the World
Trade Organization Agreement on Basic Telecommunications Services ("WTO
Agreement") to facilitate competition in basic telecommunications services.
Pursuant to the WTO Agreement, signatories committed to varying degrees and
within varying time frames to provide competitive telecommunications providers
access to their domestic and international markets, reduce or eliminate foreign
ownership restrictions, and establish regulatory regimes that foster
telecommunications competition. The WTO Agreement became effective on February
5, 1998. Although the Company believes that the WTO Agreement could provide us
with significant opportunities to compete in markets that were not previously
accessible, it could also provide opportunities for our competitors. There can
be no assurance that the pro-competitive effects of the WTO Agreement will not
have a material adverse effect on the Company's business, financial condition,
and results of operation or that members of the WTO will implement the terms of
the WTO Agreement.
Regulation of U.S. Domestic Telecommunications Services. In the U.S.,
provision of the Company's services is subject to the provisions of the
Communications Act of 1934, as amended by the Telecommunications Act of 1996
(the "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 was upheld on appeal by
the U.S. Court of Appeals for the D.C. Circuit and will require the Company to
withdraw its FCC interstate interexchange service tariff by January 31, 2001.
After that time, the Company will be required to maintain its services and rates
on the Company's website. The detariffing of services poses additional risk for
the Company because it will no longer have the benefit of the "filed rate
doctrine" which enables the Company to bind its customers to the terms and
conditions of the tariff without having each customer sign a written contract
and enables the Company to change rates and services on one day's notice. The
Company may be subjected to increased risk of claims from customers involving
terms of service and rates that could impact the Company's financial operations.
On May 8, 1997, the FCC issued an order to implement the provisions of the Act
relating to the preservation and advancement of universal telephone service (the
"Universal Service Order"). The Universal Service Order requires all
telecommunications carriers providing interstate telecommunications services to
contribute to universal support by contributing to (i) a fund for schools and
libraries, (ii) a fund for rural health care and (iii) a fund for the
development of regions characterized by high telecommunications costs and low
income levels (collectively, the "Universal Service Funds"). These
contributions became due beginning in 1998 for all providers of interstate
telecommunications services. Such contributions are assessed based on certain
defined 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 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.
22
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 the
fourth quarter of 2000 is 5.6688% 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. In
addition, carriers are 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.
The FCC has approved Verizon's (formerly Bell Atlantic-New York) Section 271
application for authority to provide interLATA interexchange service to
customers in New York and Southwestern Bell Telephone Company's ("SWBT")
Section 271 application to provide interLATA interexchange service to customers
in Texas. Because the FCC has approved these 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. Verizon recently filed a Section 271 application to
provide interLATA interexchange services in Massachusetts and Verizon, SWBT, US
West, and Bell South have announced that they intend to 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 Company's costs of providing long distance services will be affected by
changes in access charge rates imposed by regional bell operating companies on
long distance carriers for origination and termination of calls over the local
facilities. The FCC has made major changes in the interstate access charge
structure. On May 31, 2000, the FCC issued an Order adopting the access charge
reform measures based on a proposal from an industry coalition referred to as
CALLS that included some major interexchange carriers, most regional bell
operating companies, and GTE. This proposal lowers collective interstate access
charges by local exchange carriers subject to price cap regulation by $3.2
billion and ends certain charges paid by interexchange carriers. As part of the
proposal, AT&T and Sprint agreed to pass through access charge savings to
customers. The FCC Order is currently the subject of motions for reconsideration
as well as an appeal to the D.C. Circuit Court of Appeals. If upheld, access
charges will decrease for interexchange carriers and Company may face increased
competition to lower its prices for long distance 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 48 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.
23
U.S. Regulation of International Telecommunications Services. In the United
States, to the extent that the Company offers services as a carrier, the Company
is required to obtain authority under Section 214 of the Act, in order to
provide international telecommunications service that originates or terminates
in the United States. U.S. international carriers also are required to file and
maintain international tariffs with the FCC specifying the rates, terms and
conditions of their services. The Company has obtained the required Section 214
authorization from the FCC to provide U.S. international service and has filed
an international tariff. In addition, as a condition of the Company's Section
214 authorization, the Company is subject to various reporting and filing
requirements. However, the FCC recently issued a Notice of Proposed Rulemaking
proposing to detariff international services and to further streamline contract
filing requirements. Failure to comply with the FCC's rules could result in
fines, penalties, forfeitures or revocation of the Company's FCC authorization,
each of which could have a material adverse effect on our business, financial
condition, and results of operation.
The Company must conduct its U.S. international business in compliance with
the FCC's International Settlements Policy, the rules that establish the
parameters by which U.S.-based carriers and their foreign correspondents settle
the cost of terminating each other's traffic over their respective networks.
Under the FCC's International Settlements Policy, absent approval from the FCC,
international telecommunications service agreements with dominant foreign
carriers must be non-discriminatory, provide for settlement rates equal to one-
half of the accounting rate, and require proportionate share of return traffic.
In recent rule reforms, the FCC expressly exempted from the International
Settlements Policy rules, U.S. carrier arrangements with non-dominant foreign
carriers as well as arrangements with any foreign carrier (dominant or non-
dominant) on certain competitive routes where at least 50% of U.S.-billed
traffic is terminated at settlement rates at least 25% below the FCC's
applicable benchmark settlement rates. These routes currently include: Canada,
Denmark, France, Germany, Hong Kong, Ireland, Italy, the Netherlands, Norway,
Sweden and the United Kingdom. For arrangements that will continue to be subject
to the International Settlements Policy, the FCC imposes mandatory settlement
rate benchmarks. These benchmarks are intended to reduce the rates that U.S.
carriers pay foreign carriers to terminate traffic in their home countries. The
FCC also prohibits a U.S. carrier affiliated with a foreign carrier from
providing facilities-based switched or private line services to the foreign
carrier's home market unless and until the foreign carrier has implemented a
settlement rate at or below the relevant benchmark. Certain confidential filing
requirements still apply to dominant carrier arrangements.
The FCC's new rules declined to expand the scope of the International Simple
Resale ("ISR") policy, which permits U.S. carriers to provide international
switched services over private lines interconnected to the public switched
telecommunications network on the current FCC-authorized routes. The FCC will
continue to maintain the distinction between routes it approves for ISR and
routes on which it removes the International Settlements Policy. Even though the
FCC dramatically scaled back the application of the International Settlements
Policy, the FCC's ISR policy still requires FCC approval to provide ISR services
in an arrangement with a foreign dominant carrier on non-competitive routes.
To the extent that the International Settlements Policy still applies, the FCC
could find that the Company does not meet certain International Settlements
Policy requirements with respect to certain of our foreign carrier agreements.
Although the FCC generally has not issued penalties in this area, it has issued
a Notice of Apparent Liability to a U.S. company for violations of the
International Settlements Policy and it could, among other things, issue a cease
and desist order, impose fines or allow the collection of damages if it finds
that we are not in compliance with the International Settlements Policy. Any of
these events could have a material adverse effect on the Company's business,
financial condition, or results of operation.
The Company offers its callback services pursuant to its Section 214
Authorization. The FCC has determined that callback services that use
uncompleted call signaling do not violate U.S. or international law, but 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
Authorizations. The FCC reserves the right to condition, modify or revoke any
Section 214 Authorizations and impose fines for violations of the 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 callback services using uncompleted call
signaling. FCC policy provides that foreign governments that satisfy certain
conditions may request FCC assistance in enforcing their laws against callback
providers based in the U.S. that are violating the laws of these jurisdictions.
Thirty countries have formally notified the FCC that callback services violate
their laws. The FCC has held that it would consider enforcement
24
action against companies based in the U.S. engaged in callback services by means
of uncompleted call signaling in countries where this activity is expressly
prohibited. In fact, the FCC granted a complaint by the Philippines Long
Distance Telephone Company and required U.S. carriers to stop providing callback
services to customers in the Philippines. A petition filed by the
Telecommunications Resellers Association in 1998 requesting that the FCC cease
enforcing foreign laws against callback services is still pending. 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 callback 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 Authorization, and could have a material adverse effect on the
Company's business, financial condition and results of operations.
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 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.
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.
European Regulation of Telecommunications Services. In Europe, the regulation
of the telecommunications industry is governed at a supranational level by the
European Union and to a large extent by the national law of the individual
European Union Member States. The European Union's institutions, such as the
European Commission, are responsible for creating pan-European policies. Through
its legislation, the European Union has developed a regulatory framework aimed
at creating an open, competitive 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 a 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 practice, Member States have significant
discretion regarding how to implement Directives into their national law system.
For example, while the Licensing Directive provides Member States the required
overall framework, the licensing regimes adopted by Member States vary
accordingly. Only in specific cases, the European Commission, in concert with
the European Parliament and other relevant European Union institutions will
render regulations or individual decisions on specific issues that become
effective immediately without requiring Member States to adopt them on a
country-by-country basis.
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 incumbent telecommunications operator's ("ITOs") monopolies in voice
telephony by 1998. Certain European Union countries, such as Greece (January
2002), were allowed to delay the abolition of monopolies in public voice
telephony based on exemptions established in the Full Competition Directive.
Under current European Union law, 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. The
European Union presently is in the process of reviewing its telecommunications
regulatory regime and has introduced legislative proposals that would direct the
Member States to reform their laws regarding licensing, interconnection,
universal service, unbundling of local loops, data protection, and
harmonization. The European Commission presently is considering these
legislative proposals which, if adopted, could impact the Company's operations.
In addition to the foregoing regulations, the European Union has adopted the
Interconnection Directive and the Licensing Directive that attempt to harmonize
telecommunications regulations among the Member States. The Interconnection
Directive provides that ITOs are obliged to interconnect with requesting
operators, and to enter into interconnection 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. In
25
addition, the Licensing Directive provides for the establishment of a national
regulatory authority independent of the ITO in each Member State, and provides
that Member States may reject applications for licenses only upon certain
narrowly-defined grounds. The Interconnection Directive and the Licensing
Directive are currently under review. Under the pending legislative proposals,
these Directives might no longer differentiate between Voice and Data services.
Consequently, the Company, or its Net2Phone subsidiary, could be required to
apply for additional individual licenses or general authorizations in the
individual Member States. It may also become necessary for the Company to
provide certain interconnection services to other carriers, to provide for
interception by state authorities, and to pay into universal service funds
pursuant to national law.
In connection with the growth of its European operations, the Company has
obtained a number of licenses to provide telecommunications services in Europe.
Through its U.K. subsidiary, IDT Global Limited ("IDT Global"), the Company
has obtained a license to provide international simple voice resale services in
the U.K., and a license to operate domestic and international telecommunications
facilities in the U.K. IDT Global has also obtained a license to provide voice
telephony services in Frankfurt, 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. In Belgium, a notification of carrier
services was filed and approved on behalf of IDT Europe BVBA, and IDT Europe BV
was granted authorization for the provision of telecommunications operations in
Sweden. IDT and its affiliates are currently in the process of applying for and
obtaining additional licenses in connection with the continued growth of its
European operations.
Data Protection: European regulators and authorities have developed detailed
provisions on data protection and privacy in the individual Member States. In
particular, these provisions govern the collection, storage, transfer and access
to personal data that are only harmonized to some extent by European Union
directives. Compliance with national legal requirements may involve, for
instance, the appointment of data protection officers by the Company and its
subsidiaries, compliance with reporting requirements to national authorities,
and notification requirements vis-a-vis individuals -- e.g., obtaining an
individual authorization before personal data are collected, stored or
transferred. Recently, the United States and European Union agreed upon so-
called "Safe Harbor Principles" to reconcile the differences between U.S. and
European Union approaches to privacy and data protection regulation. Compliance
with these principles on a voluntary basis will likely ensure that traffic data
flowing from the European Union to the United States will not be interrupted and
help minimize the risk of sanctions under national law. However, the "Safe
Harbor Principles" will neither cover the collection and storage of data by
facilities in European Union Member States, nor regulate the data flow to and
from third countries, which remains under the jurisdiction of each member
state's national law. In addition, in such European countries where the Company
is licensed as a voice telephony provider, specific data protection rules on
issues relating to telecommunications services -- e.g., billing, directory
entrances, etc. -- may apply.
In addition, the European Union has adopted Directive 97/7/EC, a separate,
complementary directive pertaining to privacy and the processing of personal
data in the telecommunications sector. This directive establishes certain
requirements with respect to, among other things, the processing and retention
of subscriber traffic and billing data, subscriber rights to non-itemized bills,
and the presentation and restriction of calling and connected line
identification. In addition, a number of European countries outside the European
Union have adopted, or are in the process of adopting, data protection rules
similar to those set forth in the European Union directives. The European Union
also has enacted Directive 97/7/EC to protect consumers entering distance
contracts. Distance contracts are generally contracts for goods and services
where the contact between the supplier and the consumer takes place at a
distance by means of communications technologies. This directive requires that
the consumer be provided with certain information, such as the identity of the
supplier, the arrangements for payment, delivery or performance, the existence
of a right of withdrawal, and the cost of using the means of distance
communication prior to entering the contract. Such information must be provided
in a clear and comprehensible manner in any way appropriate to the means of
distance communication used, with due regard to the principles of good faith in
commercial transactions. While this directive has been effective since June
1997, all Member States are required to implement Directive 97/7/EC by June 4,
2000. To the extent that the Company enters into distance contracts, this
directive may have a material adverse effect on our business, financial
condition, operating results and future prospects.
The European Union has adopted the final version of Directive 2000/31/EC
governing electronic commerce. The directive covers "Information Society
services" or "any service normally provided for remuneration, at a
26
distance, by electronic means and at the individual request of a recipient of
services," between the Member States. Information Society services generally
include both business-to-business services and business-to-consumer service. The
directive establishes a general e-commerce legal framework covering service
provider authorizations, commercial communications, electronic contracts, the
liability of intermediary service providers, codes of conduct, out-of-court
dispute settlements, court actions and cooperation between Member States.
Increased regulation of the Internet or of transaction facilitation via the
Internet by the European Union could have a material adverse effect on our
business, financial condition, operating results and future prospects.
Other Overseas Markets. In numerous countries where the Company operates or
plans to operate, local laws and regulations may limit the ability of
telecommunications companies to provide telecommunications services in
competition with state-owned or state-sanctioned monopoly carriers. There can be
no assurance that current or future regulatory, judicial, legislative, or
political considerations will permit the Company to offer all or any of its
products and services in such countries, that regulators or third parties will
not raise material issues regarding the Company's compliance with applicable
laws or regulations, or that such regulatory, judicial, legislative, or
political decisions will not have a material adverse effect on the Company. If
the Company is unable to provide the services that we presently provide or
intend to provide or to use our existing or contemplated transmission methods,
or because the Company is subjected to adverse regulatory inquiry, investigation
or action, or for any other reason related to regulatory compliance or lack
thereof, such developments could have a material adverse effect on the Company's
business, financial condition, and results of operation.
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 Act 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. On June 22,2000, this stay was
upheld on appeal by the U.S. Court of Appeals for the Third Circuit. 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 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
27
provide an information service. Any such contribution would be related to the
Internet service provider's provision of telecommunications services itself. The
Company can not predict the outcome of any future proceedings that may impact
the Company's provision of Internet access or that may impose additional
requirements, regulations or charges upon the Company's provision of such
services.
On September 28, 2000, the FCC issued a Notice of Inquiry on the issue of
cable open access. The FCC has asked the public to comment on the proper
regulatory classification for cable modem Internet access and whether the FCC
has the authority to impose an open access requirement on cable Internet
providers. It is not clear whether the FCC will actually make any decision in
this proceeding or merely collect information from interested parties. However,
should the FCC decide that cable providers must open their systems to rival
Internet service providers, the Company along with other Internet service
providers would have access to cable providers networks to provide high-speed
Internet access.
Internet Protocol Telephony
The use of the Internet to provide telephone service is a recent development.
Although the FCC has determined that information service providers, including
Internet protocol ("IP") telephony providers, are not telecommunications
carriers, the Company cannot be certain that the FCC will continue to maintain
this position. On April 10, 1998, the FCC issued a report to Congress discussing
its implementation of universal service provisions contained in the Act. In its
report, the FCC indicated that it would examine whether phone-to-phone IP
telephony should be classified as an information service or as a
telecommunications service. The two are treated differently in several respects,
with information services being unregulated and not subject to universal service
contribution obligations. The FCC indicated that it did not have, as of the date
of the report, an adequate record upon which to make a definitive ruling.
However, the FCC noted that the record suggested that certain forms of phone-to-
phone IP telephony appear to have the same functionality as non-IP
telecommunications services and lack the characteristics that would render them
information services. If the FCC were to determine that certain IP telephony
services are subject to FCC regulations as telecommunications services, the FCC
stated that it might find it reasonable to require IP service providers to make
universal service contributions, pay access charges, or to be subject to
traditional common carrier regulation.
Incumbent telephone operators have also commenced efforts to collect access
charges from IP telephony providers. In September 1998, two regional Bell
operating companies advised IP telephony providers that they would impose access
charges on Internet telephony traffic. On April 5, 1999, Qwest (formerly US
West) filed a petition with the FCC asking the FCC to find that IP telephony
services are telecommunications services, not enhanced or information services,
and therefore should be subject to access charge and universal service
obligations. Qwest did not press the matter and, to date, the FCC has not issued
a public notice requesting comment on the petition. If the FCC does ultimately
determine that IP telephony is subject to the FCC's access charge and universal
service regimes, such a ruling would likely substantially increase the costs of
providing Internet telephony in the U.S.
The FCC is in the process of collecting additional information regarding IP
telephony services. On September 29, 1999, the FCC released a notice of inquiry
seeking information on whether IP telephony services should be made accessible
to the disabled under Section 255 of the Act, which applies to
"telecommunications services." Multiple parties filed comments in this
proceeding opposing the classification of IP telephony as a telecommunications
service. To date, the FCC has not issued a decision in this docket. In addition,
on October 22, 1999, the FCC released a notice of proposed rulemaking to collect
information on the status of local telephone service competition and the
deployment of advanced telecommunications capability. The FCC recognized that,
while it does not regulate IP telephony services, IP telephony may become an
important substitute for circuit-switched telephony and should be included in
evaluating local competition. Also, the FCC asked whether it should undertake a
more specific determination of the extent to which IP telephony is being used to
provide telephony services. This proceeding is also pending.
If the FCC determines that IP telephony is subject to regulation as a
telecommunications service, it may subject providers of Internet telephony
services to traditional common carrier regulation and require them to make
universal service contributions and pay access charges to terminate long
distance traffic. In addition, it is possible that IP telephony providers may
become subject to the Communications Assistance for Law Enforcement Act
("CALEA"), which requires telecommunications common carriers to modify their
networks to allow law enforcement authorities
28
to perform electronic surveillance. It is also possible that the FCC will adopt
a regulatory framework for IP telephony providers different than that applied to
traditional common carriers. Moreover, Congressional dissatisfaction with the
FCC's conclusions regarding IP telephony could result in legislation requiring
the FCC to impose greater or lesser regulation. Any change in the existing
regulation of IP telephony by the FCC or Congress could result in a material
adverse effect on the Company's business, financial condition, operation results
and future prospects.
In addition to the FCC and Congress, state regulatory authorities and
legislators may also assert jurisdiction and regulate the provision of
intrastate IP telephony services. Regional "bell" operating companies have made
several attempts to collect state access charges from IP telephony providers. In
particular, Qwest petitioned Colorado and Nebraska for a ruling that IP
telephony providers must pay access charges for intrastate calls. The proceeding
was dismissed in Colorado, and a decision was never reached in Nebraska. In
recent interconnection arbitration decisions, Colorado and North Carolina
declined to classify IP telephony as switched access traffic subject to
intrastate switched access charges. However, a recent Florida interconnection
arbitration decision expressly included phone-to-phone IP telephony in the
definition of switched access traffic subject to intrastate switched access
charges. Should state public utility commissions regulate IP telephony
providers, the Company, and its subsidiaries, may not be able to operate
profitably in any state that assesses access or universal service charges
against it.
The European Commission principally follows the FCC's "hands-off" approach to
the regulation of voice over IP telephony. The European Commission has recently
launched a public consultation on a review of the status of voice over IP within
the European Union. The outcome of this consultation is still uncertain, but
there are recent indications that some national European regulators within the
European Union are inclined to give up their current "hands-off" approach and to
require voice over IP providers to obtain individual voice licenses. The Company
cannot predict the likely outcome of this consultation, but it is possible that
the provision of voice over IP telephony may require licensing in the future
which could impact the Company's, and its Net2Phone subsidiary's, business and
financial operations.
To the Company's knowledge, there are currently no domestic laws or
regulations that prohibit voice over IP telephony. Several efforts have been
made to enact federal legislation that would either regulate or exempt from
regulation services provided using IP technology. State public utility
commissions may also retain jurisdiction to regulate the provision of intrastate
IP 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 IP telephony. Other countries permit but regulate
IP telephony. If Congress, the FCC, state regulatory agencies, foreign
governments or supranational bodies begin to regulate IP 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
Although IDT believes that its success ultimately is more dependent upon its
technical expertise than its proprietary rights, we regard our trademarks,
service marks, copyrights, patents, trade secrets, proprietary technology and
similar intellectual property as very important to our success. Given the rapid
pace of technological advancement, accelerating product life cycles, and an
increasingly litigious environment, our intellectual property are strategic
assets. We have aligned our intellectual property strategy with our overall
business strategy so as to maximize revenue, manage risk, minimize costs and use
intellectual property for competitive advantage.
We own US trademarks and service mark registrations on Colombianita, Debit
Talk, Dominicall, Genie, IDT, IDT and antenna design, La Universal, and Megatel.
We also own trademark and service mark registrations overseas on Imperial
Telecard and Genie. In addition, the Company has applications pending for the
registration of service marks relating to its various operations, including, but
not limited to, Beep2Talk, Clic Aqui, Click2Reserve, Click2Take, Columbiana,
Cyberspace Kids, EZ Road, FreeAtLast, FreeAtLast.Com, Gifts for Gab, Global
America, Global Call, HealInc, Internet Industry & Design, IP Central Office, La
Linea Latina, LogInData, Mega Mexico, Mexicall, Net2Dine.com, No One Does It For
Less, NuBill, NuBill.Com, NuPage, NuSserve, Skipid, Nuestra Voz, The Wonder of
Broadband, Traveler SOS, TV.TV, TV.TV Broadband Network, Virtual Dime, Webony,
Webony.com, and ZeroDinero. We have filed provisional patents in the US and
internationally and plan to file other patent applications in the future.
29
The Company also 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.
Our intellectual property may not provide significant competitive advantages.
Because of the rapid pace of technological change in the information technology
industry, many of our products rely on key technologies developed by third
parties, and we may not be able to obtain licenses from these third parties. The
protection of our intellectual property also may require the expenditure of
significant financial and managerial resources. Effective trademark, service
mark, copyright, patent and trade secret protection may not be available in
every country in which our products and services are made available. Moreover,
any of our intellectual proprietary rights could be challenged, invalidated or
circumvented. Third parties that license our proprietary rights may take actions
that diminish the value of our proprietary rights or reputation. Ultimately, the
steps we take to protect our proprietary rights may not be adequate and third
parties may infringe or misappropriate our trademarks, servicemarks, trade
dress, copyrights, patents and similar proprietary rights.
From time to time the Company may be subject to legal proceedings and claims
from licensors and third parties in the ordinary course of business, including
claims of alleged infringement of trademarks, copyrights and other intellectual
property rights. Even if our products are not infringing third parties'
intellectual property rights, the claims can be time-consuming and costly to
defend and divert management's attention and resources away from our business.
Claims of intellectual property infringement might also require us to enter into
costly royalty or license agreements. If we cannot or do not license the
infringed technology or substitute similar technology from another source, our
business could suffer. Such claims, whether or not meritorious, may result in
injunctions against us or the imposition of damages that we must pay.
Finally, any of our Web sites may feature interactive areas that allow
customers to post materials, or that feature third party content acquired from
licensors. It is possible that a third party claim could be made against us for
infringement based on the materials posted on our Web sites. If we become liable
for information posted on our Web site by subscribers or licensors, we could be
adversely impacted and may be forced to discontinue certain services or content.
International Sales
In Fiscal 1998, 1999 and 2000, international customers accounted for
approximately 11%, 13% and 17% of our total revenues, respectively. See Note 11
of the Notes to the Company's Consolidated Financial Statements. We anticipate
that revenues from international customers will continue to account for a
significant percentage of our total revenues.
Employees
As of October 1, 2000, IDT and its subsidiaries had a total of approximately
1,280 employees, including 506 in technical support and customer service, 158 in
sales and marketing, 256 in technical staff, 268 in general operations and 92 in
management and finance. We also had a total of 150 employees in Europe. Union
Telecard Alliance, LLC, in which we have a 51% interest, employed 61 persons.
We believe that our relations with our employees are good. None of our
employees is represented by a labor union or covered by a collective bargaining
agreement, and we have never experienced a work stoppage.
30
Item 2. PROPERTIES.
IDT moved its headquarters in November 1999 from Hackensack, New Jersey to
Newark, New Jersey in a strategic move intended to expand its operations as well
as maximize its presence in the rapidly developing metropolitan area of Newark.
IDT entered into a twenty year lease with 520 Broad Street Associates L.L.C. for
facilities amounting to approximately 484,000 square feet. IDT's headquarters
house its executive offices, administrative, finance and marketing functions,
carrier and customer service departments and its various developing operations.
We continue to occupy facilities in one building located in Hackensack, New
Jersey, pursuant to a lease which expires on April 30, 2002. We also lease
additional office space totaling approximately 6,000 square feet in two separate
buildings located in Hackensack, New Jersey.
IDT additionally occupies approximately 12,000 square feet in Newark, New
Jersey and 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.
225 Old NB Road, Inc., a wholly owned subsidiary of IDT, purchased the
building located at 225 Old New Brunswick Road located in Piscataway, New
Jersey, and IDT and its wholly owned subsidiary, InterExchange presently occupy
approximately 44,000 square feet of the 65,295 square feet in the building. The
balance of the building is sublet to third parties.
Union Telecard Alliance, our 51% owned subsidiary, occupies approximately
4,000 square feet of space in Queens, New York, pursuant to a ten year sublease
agreement.
In support of our international expansion efforts, we maintain our European
headquarters in Brussels, Belgium. We also maintain various international office
locations and telecommunications facilities, including in London, England;
Paris, France; Frankfurt, Germany; Rotterdam, Holland; Dublin, Ireland; Milan,
Italy; Madrid, Spain; Gothenburg, Sweden; San Juan, Puerto Rico; and Santa Fe
Colony, Mexico.
Item 3. LEGAL PROCEEDINGS.
In October 1999, Union commenced an action against DigiTEC 2000, Inc.
("DigiTEC") and TecNet, Inc. ("TecNet") in the Supreme Court of the State of New
York, County of New York, alleging damages of approximately $725,000 based upon,
among other things, non-payment for prepaid calling cards. DigiTEC and TecNET
have answered the complaint and DigiTEC has asserted a third-party claim against
IDT seeking damages of $2.5 million dollars based upon IDT's alleged breach of a
settlement agreement between IDT and DigiTEC which had resolved a prior
litigation between those parties. The court adjourned the return date without
assigning a specific return date for IDT to answer the Third-Party Complaint,
subject to DigiTEC's right to make a written thirty day demand for an Answer.
This action is currently in the early stages of discovery.
In February 2000, IDT Europe B.V.B.A., a subsidiary of IDT, filed a Complaint
against Tyco Group S.A.R.L. ("Tyco") and Tyco Submarine Systems, Ltd. ("TSSL")
in the United States District Court, Newark, New Jersey, alleging breach of
implied covenant of good faith and fair dealing and breach of contract for
breaching a Memorandum of Understanding and Instruction to Proceed entered into
on November 9, 1999. IDT sought to enjoin and restrain Tyco and TSSL from
undertaking contrary business activity inconsistent with the Memorandum of
Understanding and Instruction to Proceed and sought compensatory, consequential
and punitive damages. On March 24, 2000, Tyco filed an answer and a motion to
dismiss the action for lack of subject matter jurisdiction and Tyco, TSSL, Tyco
International Ltd., Tyco International (US) Inc., and Tycom Ltd. filed suit
against IDT Europe B.V.B.A. and IDT in the Supreme Court for New York county.
The suit alleges breach of contract and tortious interference with prospective
business relations and seeks declaratory and/or injunctive relief. The
plaintiffs are seeking compensatory damages in an undefined amount and punitive
damages in the amount of $3 billion. On April 13, 2000, IDT filed a motion to
dismiss the action for lack of personal jurisdiction and failure to state a
claim, on which a hearing was scheduled for June 19, 2000. On June 7, 1999, the
United States District Court in Newark, New Jersey dismissed IDT's complaint for
lack of federal court jurisdiction. On June 14, 2000, IDT filed a substantially
similar action in the New Jersey state court.
31
On October 10, 2000, IDT reached a full and final settlement with Tyco of all
pending claims brought against one another and their respective affiliates. The
settlement agreement is the subject of a confidentiality agreement among the
parties and only the following disclosure by IDT is permitted under the terms of
that agreement.
Under the terms of the settlement, Tycom Ltd. ("TyCom") granted to IDT Europe
B.V.B.A. ("IDT Europe"), free of charge, certain exclusive rights to use
capacity on the transatlantic and transpacific segments of TyCom's global
undersea fiber optic network (the "TyCom Global Network") which TyCom is
currently deploying. The settlement agreement provides for IDT Europe to obtain
exclusive indefeasible rights to use 2 (two) 10 Gb/s wavelengths on the
transatlantic segment and 2 (two) 10 Gb/s wavelengths on the transpacific
segment for fifteen years from the applicable Handover Dates (as described
below). TyCom previously announced that it expects the TyCom transatlantic
network to be ready for service in September of 2001 and the TyCom transpacific
network to be ready for service in the second quarter of 2002, the respective
"Ready for Service Dates." Under the terms of the settlement agreement, the
Handover Dates for the wavelengths on the transatlantic segment are six months
(for the first wavelength) and 18 months (for the second wavelength),
respectively, after the Ready for Service Date of the TyCom transatlantic
network and the Handover Dates for the wavelengths on the transpacific segment
are six months (for the first wavelength) and 18 months (for the second
wavelength), respectively, after the Ready for Service Date of the TyCom
transpacific network. Operation, administration and maintenance for the
wavelengths used by IDT will be provided by TyCom for a fifteen year period
after the relevant Handover Date, free of charge. TyCom has also granted IDT
certain rights to resell any unused capacity on the wavelengths through TyCom as
its sole and exclusive agent. In addition, IDT will also have the option,
exercisable at least annually, to convert the available capacity on its
wavelengths to available equivalent capacity on another portion of the Tycom
Global Network.
In February 2000, Multi-Tech Systems, Inc. ("Multi-Tech") filed suit against
Net2Phone and other companies in the United States Federal District Court in
Minneapolis, Minnesota. In its press release, Multi-Tech stated that "the
defendant companies are infringing because they are providing the end users with
the software necessary to simultaneously transmit voice and data on their
computers in the form of making a phone call over the Internet." Net2Phone
intends to defend the lawsuit vigorously. Net2Phone believes that the Multi-
Tech claims are without merit. However, should a judge issue an injunction
against Net2Phone requiring that Net2Phone cease distributing its software or
providing its software-based services, such an injunction could have an adverse
effect on Net2Phone's business. Net2Phone has filed an answer and this action is
currently in the early stages of discovery.
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.
32
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 our 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, 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
Fiscal Year ended July 31, 2000
First Quarter................................ $32.50 $13.50
Second Quarter............................... 27.00 18.50
Third Quarter................................ 45.00 20.19
Fourth Quarter............................... 41.00 27.06
On October 27, 2000, the last sale price reported on the NASDAQ National
Market for the Common Stock was $30.813 per share. On the same date, there were
approximately 350 holders of record of the Common Stock. The aggregate market
value of the voting stock held by non-affiliates of the Registrant, based on the
closing price of the Common Stock on October 27, 2000, was approximately $683
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.
We have never declared or paid any dividends on our Common Stock and do not
expect to pay dividends for the foreseeable future. Our current policy is to
retain all of our earnings to finance future growth. Any future declaration of
dividends will be subject to the discretion of the Board of Directors of the
Company.
Sales of Restricted Securities
In June 2000, we sold to Liberty Media Group 3,728,949 shares of our Common
Stock for an aggregate price of approximately $128.6 million.
33
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, 2000 has been derived from our 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
--------------------------------------------------------------------
1996 1997 1998 1999 2000
------------ ------------ ------------ ------------ ------------
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Telecommunications.................................. $ 35,708 $ 99,937 $ 303,864 $ 684,572 $ 1,023,030
Internet............................................ 21,986 32,895 20,001 16,934 13,168
Net2Phone........................................... -- 2,355 11,508 30,678 56,075
Ventures............................................ -- -- -- -- 1,638
------------ ------------ ------------ ------------ ------------
Total revenues..................................... 57,694 135,187 335,373 732,184 1,093,911
Costs and expenses:
Direct cost of revenues............................. 36,438 92,214 240,860 575,050 918,256
Selling, general and administrative................. 35,799 41,545 61,975 128,500 343,702
Acquired research and development................... -- -- 17,900 -- --
Depreciation and amortization....................... 1,212 4,873 13,810 36,360 48,564
------------ ------------ ------------ ------------ ------------
Total costs and expenses........................... 73,449 138,632 334,545 739,910 1,310,522
Income (loss) from operations....................... (15,755) (3,445) 828 (7,726) (216,611)
Other, net(1)....................................... 112 (392) (425) (6,534) 609,504
Income tax provision (benefit)...................... -- -- (2,524) 7,253 218,403
Minority interests.................................. -- -- 3,896 (3,309) (59,336)
------------ ------------ ------------ ------------ ------------
Net income (loss)..................................... (15,643) (3,837) (969) (18,204) 231,931
Subsidiary redeemable preferred stock dividends....... -- -- -- 26,297 --
------------ ------------ ------------ ------------ ------------
Net income (loss) available to common stockholders.... $ (15,643) $ (3,837) $ (969) $ (44,501) $ 230,850
============ ============ ============ ============ ============
Net income (loss) per share-basic..................... $ (0.86) $ (0.18) $ (0.03) $ (1.33) $ 6.60
============ ============ ============ ============ ============
Weighted average number of shares used in calculation
of net loss per share-basic.......................... 18,180 21,153 28,571 33,530 34,966
============ ============ ============ ============ ============
Net income (loss) per share-diluted................... $ (0.86) $ (0.18) $ (0.03) $ (1.33) $ 6.14
============ ============ ============ ============ ============
Weighted average number of shares used in calculation
of net loss per share-diluted........................ 18,180 21,153 28,571 33,530 37,617
============ ============ ============ ============ ============
Balance Sheet Data:
Cash and cash equivalents............................ $ 14,894 $ 7,674 $ 115,284 $ 52,903 $ 162,879
Working capital (deficit)............................ 13,547 4,887 166,381 179,415 347,930
Total assets......................................... 43,797 58,537 461,240 559,871 1,219,055
Long-term debt....................................... -- 5,241 101,834 112,973 12,174
Total stockholders' equity........................... 26,843 25,259 282,792 276,329 468,188
__________
(1) For Fiscal 1996, Fiscal 1998, Fiscal 1999 and Fiscal 2000 includes
extraordinary losses on retirement of debt, net of income taxes, of $233,
$132, $3,270 and $2,976, respectively.
34
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
a broad range of telecommunications services to wholesale and retail customers
worldwide. In addition, our IDT Ventures division is developing several
innovative telecom and Internet-related businesses. Also, through our wholly-
owned IDT Investments subsidiary, we have equity interests in other technology
companies, including our former subsidiary, Net2Phone, Inc. ("Net2Phone")
(NASDAQ: NTOP), which offers a variety of Internet telephony products and
services. We have grown considerably in recent years, generating revenues of
$335.4 million, $732.2 million and $1,093.9 million in Fiscal 1998, Fiscal 1999
and Fiscal 2000, respectively.
IDT's telecommunications services include wholesale carrier services, prepaid
calling cards, domestic long distance services and international retail
services. IDT delivers its telecommunications services over a high-quality
network consisting of over 100 switches in the U.S. and Europe and owned and
leased capacity on 16 undersea fiber optic cables, connecting our U.S.
facilities with our international facilities and with the facilities of our
foreign partners in Europe, Latin America and Asia. In addition, we obtain
transmission capacity from other carriers. We deliver our international traffic
worldwide pursuant to our agreements with U.S.-based carriers, foreign carriers,
and more than 20 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").
As of October 1, 2000, we had approximately 165 wholesale customers located in
the U.S. and Europe. In addition, IDT offers retail long distance services to
over 150,000 individual and business customers in the U.S. and worldwide.
Minutes of use for our telecommunications business have grown from 809.5 million
minutes in Fiscal 1998 to 2,777.8 million minutes in Fiscal 1999 to 4,252.0
million minutes in Fiscal 2000.
History
IDT 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. We leveraged the
expertise derived from, and calling volume generated by, our call reorigination
business to enter the domestic long distance business in late 1993, by reselling
long distance services of other carriers to our domestic customers. As a value-
added service for our domestic long distance customers, we 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, we began reselling to other long distance carriers access to the favorable
telephone rates and special tariffs we receive as a result of the calling volume
generated by our call reorigination customers.
We began marketing our prepaid calling cards in January 1997. In May 1998, we
acquired a 51% interest in Union Telecard Alliance, LLC which distributes our
prepaid calling cards in key markets nationwide. In May 1998, we also acquired
InterExchange, an operator of one of the largest international prepaid calling
card platforms in the United States.
IDT entered the Internet telephony market in August 1996 with its introduction
of Net2Phone, and expanded its Internet telephony offerings throughout Fiscal
Years 1998 and 1999. On August 3, 1999, Net2Phone completed an initial public
offering of 6,210,000 shares of its Common Stock, yielding $85.3 million in net
proceeds. In December 1999, we sold 2,200,000 Net2Phone shares, in connection
with Net2Phone's secondary offering. In August 2000, we completed the sale of
14,900,000 shares of Net2Phone to AT&T, receiving approximately $1.1 billion in
cash proceeds. We currently still hold approximately 10,000,000 shares of Class
A Net2Phone common stock.
Outlook
In recent years, we have derived the majority of our revenues from our core
telecommunications businesses, consisting primarily of wholesale carrier
services and retail prepaid calling cards. These businesses have also
35
accounted for the bulk of our operating expenses as well. Since the fourth
quarter of Fiscal 1998, we have conducted wholesale carrier and prepaid calling
card operations in Europe. As we build our European telecommunications
operations, we expect to experience weaker gross margins and to incur
significant sales and marketing expenses, which will have a negative impact on
overall profitability over the next two to four quarters.
We are also developing various new telecom and Internet related businesses.
During Fiscal 2000, we incurred approximately $27.8 million in development costs
for these business ventures, which provided us with revenues of approximately
$2.1 million. We anticipate that we will continue to incur significant costs
related to these and other new ventures. The timing, and magnitude, of any
revenues and/or operating profits to be realized from these new businesses
remains uncertain.
Within the wholesale carrier and prepaid calling card business segments, we
have experienced intense competition, which has served, over time, to reduce our
average per-minute price realizations. In addition, this environment has led
some of our competitors to de-emphasize their wholesale carrier and/or prepaid
calling card operations, in order to focus on higher margin telecommunications
businesses. We remain strongly committed to our wholesale carrier and prepaid
calling card businesses. However, we have experienced pricing and margin
pressure in recent quarters. We anticipate that we will continue to experience
pricing and margin pressure in both our wholesale and retail businesses for at
least the next few quarters.
Revenues
Beginning in Fiscal 1997, we began to place increased emphasis on our
international telecommunications operations and less emphasis on our Internet
access services. In Fiscal 1998 and Fiscal 1999, we focused our marketing
efforts on expanding the wholesale services offered to other carriers,
developing and increasing our retail prepaid calling card business and
broadening our range of Internet telephony services and products. As a result of
these developments, our revenues from telecommunications operations increased
from $684.6 million during Fiscal 1999 to $1,023.0 million during Fiscal 2000.
Telecommunications revenues as a percentage of total revenues were 93.5% for
both Fiscal 2000 and Fiscal 1999. Revenues from our telecommunications
operations are derived primarily from the following activities:
. wholesale telecommunications services, provided to other long distance
carriers
. retail telecommunications services, including:
. domestic and international prepaid calling cards
. international retail long distance services to individuals and
businesses worldwide (primarily provided through call reorigination
services)
. domestic long distance services to individuals and businesses.
We generate revenues from the sale of our prepaid calling cards to
distributors, selling them to distributors at a discount to their face values of
different denominations, and recording the sales as deferred revenue until the
card user utilizes the calling time. Revenues from our Internet operations are
derived from providing dial-up and dedicated Internet access services to
individuals and businesses, as well as from web hosting activities. Net2Phone's
revenues are derived from the marketing of various Internet telephony services
and equipment to individuals and businesses.
Concentration of Customers
While our most significant customers vary from quarter to quarter, our five
largest customers accounted for 26.2% of revenues in Fiscal 1998, 10.9% of
revenues in Fiscal 1999 and 18.8% of revenues in Fiscal 2000. 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. This risk has, in general, become more acute in recent
quarters for participants in the emerging telecommunications industry, as
several customers are facing financial difficulties, and now pose increased
credit risks. We perform ongoing credit evaluations of our customers, but we
generally do not
36
require collateral to support accounts receivable from our customers. In light
of the deteriorating credit quality of some of our customers, however, we have
begun to impose stricter credit restrictions on some customers.
Costs and Expenses
Direct cost of revenues for our 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 our Alliance Partners.
We operate a growing facilities-based telecommunications network consisting of
over 100 switches in the U.S. and Europe; as well as owned and leased
transmission capacity on 16 undersea fiber optic cables connecting our U.S.
facilities with our international facilities, and with the facilities of our
foreign partners in Europe, Latin America and Asia. We also obtain transmission
capacity on a per-minute basis from other carriers. We have traditionally
followed a disciplined strategy of establishing significant traffic volumes
prior to investing in fixed-cost facilities. As we expand our network and
traffic volumes, 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 our switches. The fixed nature of these costs may
lead to larger fluctuations in gross margins, depending on the minutes of
traffic and associated revenues we generate. We also expect that these factors
will cause the direct cost of revenues to decline as a percentage of revenues
over time. However, in the short term, we anticipate that the improvement in
gross margins which would otherwise result from an expansion in our network will
be largely offset by pricing pressures caused by intense competition. Such
pricing pressure would consequently 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
costs 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 our operations and corporate infrastructure. As we
continue to expand both the scale and geographic scope of our telecommunications
activities, and continue to incur expenditures related to new business ventures
which are beyond the scope of our exiting core businesses, we anticipate that
selling, general and administrative expenses will continue to increase
significantly.
Our Internet and Ventures revenues are generally associated with higher
selling, general and administrative expenses than are our telecommunications
revenues. Within our telecommunications division, retail revenues generally have
higher selling, general and administrative expenses than have our wholesale
sales of telecommunications services. Within our group of retail
telecommunications businesses, revenues from our domestic long distance business
are generally associated with much higher selling, general and administrative
expenses than are our revenues from prepaid calling card sales. Despite the
expected de-emphasis on Internet revenues going forward, as we develop our
Ventures businesses, we expect to incur -- in the short and intermediate term --
selling, general and administrative expenses that are much higher, in terms of
percentage of revenues than those incurred by our telecommunications businesses.
With domestic long distance expected to account for a larger proportion of
overall telecommunications revenues, and with Ventures businesses expected to
exhibit faster revenue growth than will our telecommunications business, we
anticipate that our selling, general and administrative expenses will increase
as a percentage of total revenues.
Net2Phone Offerings and Transactions
In August 1999, Net2Phone completed an initial public offering of 6,210,000
shares of its Common Stock. Prior to the Initial Public Offering, Net2Phone was
a 90%-owned direct subsidiary of IDT. After the Initial Public Offering, IDT
owned 56.2% of the capital stock of Net2Phone. IDT owns Class A stock that has
twice the voting power of Net2Phone's common stock. Therefore, after the Initial
Public Offering, we controlled 64.0% of Net2Phone's vote.
37
In December 1999, Net2Phone sold an additional 6,300,000 shares of common
stock (the "Secondary Offering"). Of the 6,300,000 shares sold in the
Secondary Offering, 2,200,000 shares were sold by IDT. After the Secondary
Offering, we had a 48.0% ownership interest and a 57.3% voting interest in
Net2Phone.
In August 2000, we sold 14,900,000 of our Net2Phone shares to AT&T Corp., for
a purchase price of $75.00 per share, for total cash consideration of
approximately $1.1 billion. In addition, AT&T purchased an additional 4,000,000
newly-issued Net2Phone shares, also at a price of $75.00 per share, paying
proceeds of approximately $300 million to Net2Phone. After completing these
transactions, AT&T held 31.8% of Net2Phone's outstanding stock, and a 38.8%
voting interest. IDT held 16.8% of Net2Phone's outstanding stock, and a 20.5%
voting interest.
Significant Transactions
Liberty Media Investment
In June 2000, Liberty Media Group (NYSE: LMG.A, LMG.B) purchased approximately
9.9% of the equity of IDT. Under the terms of the transaction, we issued and
sold to Liberty Media 3,728,949 shares of IDT Common Stock at a price of $34.50
per share, resulting in total cash consideration of approximately $128.6
million. In addition to this investment, Liberty Media has the right to nominate
a director for election to IDT's Board of Directors.
The newly issued shares purchased by Liberty Media are exchangeable for shares
of a new class of common stock, Class B Common Stock. This new class of shares
is expected to be created within one year following the closing and to be quoted
on the NASDAQ National Market. The Class B Common Stock will carry 1/10 of a
vote per share and otherwise will have the same rights as IDT's outstanding
Common Stock. Liberty Media has agreed not to sell its IDT shares for a period
of one year after the closing of the sale, and will receive certain registration
rights with respect to such shares.
Telefonica/Terra Networks Transactions
In October 1999, IDT entered into a joint venture agreement with Terra
Networks (formerly a subsidiary of Telefonica S.A., and 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, Terra Networks Access Services, was formed to provide
Internet access to customers in the target market, while the other company,
Terra Networks Interactive Services, 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. At the time of the agreement, IDT owned 49% of Terra Networks Access
Services and 10% of Terra Networks Interactive Services. In addition, IDT
participated in Terra Networks' U.S. initial public offering in November 1999,
purchasing 1,156,682 Terra Networks shares for approximately $15.5 million.
In May 2000, IDT announced that it was exchanging its ownership interests in
Terra Networks Access Services and Terra Networks Interactive Services for
3,750,000 additional Terra shares. Upon the completion of the transaction, Terra
Networks held 100% ownership of both Terra Networks Access Services and Terra
Networks Interactive Services. IDT was also released from the "lock-up"
provision restricting it from disposing of its Terra Networks shares. Under the
terms of the new agreement, IDT was granted authorization to dispose of its
Terra stock, at a maximum rate of 75,000 Terra shares per day, not to exceed
500,000 per month.
Stock Buyback Program
In May 2000, we announced that our Board of Directors had authorized the
repurchase of up to five million shares of our common stock. In July 2000, we
announced that our Board of Directors had authorized an increase in the share
repurchase program to 10 million shares. In October 2000, we announced that our
Board of Directors had authorized a further increase in the share repurchase
program, to 12.5 million shares. Through October 1, 2000, we had repurchased
5,118,755 shares, for an aggregate purchase price of approximately $178.2
million.
38
Subsequent Events
On October 10, 2000, IDT reached a full and final settlement with Tyco of all
pending claims brought against one another and their respective affiliates. The
settlement agreement is the subject of a confidentiality agreement among the
parties and only the following disclosure by IDT is permitted under the terms of
that agreement.
Under the terms of the settlement, Tycom Ltd. ("TyCom") granted to IDT Europe
B.V.B.A. ("IDT Europe"), free of charge, certain exclusive rights to use
capacity on the transatlantic and transpacific segments of TyCom's global
undersea fiber optic network (the "TyCom Global Network") which TyCom is
currently deploying. The settlement agreement provides for IDT Europe to obtain
exclusive indefeasible rights to use 2 (two) 10 Gb/s wavelengths on the
transatlantic segment and 2 (two) 10 Gb/s wavelengths on the transpacific
segment for fifteen years from the applicable Handover Dates (as described
below). TyCom previously announced that it expects the TyCom transatlantic
network to be ready for service in September of 2001 and the TyCom transpacific
network to be ready for service in the second quarter of 2002, the respective
"Ready for Service Dates." Under the terms of the settlement agreement, the
Handover Dates for the wavelengths on the transatlantic segment are six months
(for the first wavelength) and 18 months (for the second wavelength),
respectively, after the Ready for Service Date of the TyCom transatlantic
network and the Handover Dates for the wavelengths on the transpacific segment
are six months (for the first wavelength) and 18 months (for the second
wavelength), respectively, after the Ready for Service Date of the TyCom
transpacific network. Operation, administration and maintenance for the
wavelengths used by IDT will be provided by TyCom for a fifteen year period
after the relevant Handover Date, free of charge. TyCom has also granted IDT
certain rights to resell any unused capacity on the wavelengths through TyCom as
its sole and exclusive agent. In addition, IDT will also have the option,
exercisable at least annually, to convert the available capacity on its
wavelengths to available equivalent capacity on another portion of the Tycom
Global Network.
Results of Operations
The following table sets forth the percentage of revenues represented by
certain items in our statement of operations (revenues and costs and expenses
are presented net of intercompany transactions):
Year Ended July 31,
----------------------------------
1998 1999 2000
---------- --------- ----------
Revenues:
Telecommunications........................................................... 90.6 93.5 93.6
Internet..................................................................... 6.0 2.3 1.2
Net2Phone.................................................................... 3.4 4.2 5.1
Ventures..................................................................... 0.0 0.0 0.1
---------- --------- ----------
100.0% 100.0% 100.0%
Costs and expenses:
Direct cost of revenues...................................................... 71.8 78.5 83.9
Selling, general and administrative.......................................... 18.5 17.6 31.5
Acquired research and development............................................ 5.3 -- --
Depreciation and amortization................................................ 4.1 5.0 4.4
---------- --------- ----------
Total costs and expenses.................................................. 99.7 101.1 119.8
---------- --------- ----------
Income (loss) from operations.................................................... 0.3 (1.1) (19.8)
Interest and Other (net)......................................................... (0.1) (0.9) 55.7
---------- --------- ----------
Income (loss) before income taxes, minority interests and extraordinary items.... 0.2 2.0 35.9
========== ========= ==========
Fiscal 2000 Compared to Fiscal 1999
Results of Operations
Revenues. Revenues increased 49.4%, from approximately $732.2 million in
Fiscal 1999 to approximately $1,093.9 million in Fiscal 2000. Telecommunications
revenues increased 49.4% from approximately $684.6 million in Fiscal 1999 to
approximately $1,023.0 million in Fiscal 2000. Internet access revenues
decreased 22.2% from
39
approximately $16.9 million in Fiscal 1999 to approximately $13.2 million in
Fiscal 2000. Internet telephony revenues increased 82.8% from approximately
$30.7 million in Fiscal 1999 to approximately $56.1 million in Fiscal 2000.
Revenues from Ventures businesses amounted to approximately $1.6 million in
Fiscal 2000. No revenues were recorded from these businesses during Fiscal 1999.
Telecommunications revenues increased 49.4%, primarily as a result of a 53.1%
increase in minutes of use, from approximately 2.8 billion to approximately 4.3
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 our prepaid calling cards. The addition of
wholesale carrier services clients and increased use by existing clients
resulted in an increase in wholesale carrier services revenues of 80.1%, from
approximately $289.0 million in Fiscal 1999 to approximately $520.5 million in
Fiscal 2000. As a percentage of telecommunications revenues, wholesale carrier
service revenues increased from approximately 42.2% to 50.9%, as wholesale
revenues grew at a faster rate than did revenues for prepaid calling cards and
other retail telecommunications businesses. Revenues from sales of prepaid
calling cards increased 31.0% from approximately $364.0 million in Fiscal 1999
to approximately $477.0 million in Fiscal 2000. As a percentage of
telecommunications revenues, prepaid calling card revenues decreased from
approximately 53.2% to approximately 46.6%. As a percentage of
telecommunications revenues, international retail services revenues decreased
from 3.0% to 1.0%, while domestic long distance revenues decreased from 1.5% to
1.3%.
As a percentage of total revenues, Internet access revenues decreased from
approximately 2.3% for Fiscal 1999 to approximately 1.2% for Fiscal 2000. This
decrease was due to a dollar decrease in Internet access revenues due to a
decrease in total dial-up subscribers, as well as the substantial increase in
telecommunications revenues as a percentage of total revenues. Internet
telephony revenues as a percentage of total revenues increased from 4.2% for
Fiscal 1999 to 5.1% for Fiscal 2000. 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. Our direct cost of revenues increased by 59.7% from
approximately $575.0 million in Fiscal 1999 to approximately $918.3 million in
Fiscal 2000. As a percentage of total revenues, these costs increased from 78.5%
in Fiscal 1999 to 83.9% in Fiscal 2000. The dollar increase is due primarily to
increases in underlying carrier and connectivity costs, as our
telecommunications minutes of use, and associated revenues, grew substantially.
As a percentage of total revenues, the increase in direct costs reflects a
change in the revenue mix, in which we experienced lower gross margins
associated with wholesale carrier services as compared with retail
telecommunications services and Internet access services. In addition, within
the retail telecommunications division, the increase in direct costs reflects
lower gross margins associated with prepaid calling card services as compared
with international retail and domestic long distance services. Within our major
telecommunications business lines, gross margins were lower for both wholesale
carrier services and prepaid calling cards, reflecting an increasingly
competitive operating environment, which has resulted in price and gross margin
erosion throughout the industry. We anticipate that this pricing pressure will
continue in the short term, before the competitive environment eases in the
intermediate term, as several competitors exit the industry. Gross margins were
also adversely affected by network constraints as demand for usage outpaced the
rate of deployment of additional network capacity. This caused us to carry
incremental minutes using transmission capacity obtained on a per-minute basis
from other carriers. These minutes are generally associated with lower gross
margins than are minutes carried over our own network. Slightly offsetting these
factors was the increase in Internet telephony revenues as a percentage of total
revenues. These revenues are generally associated with higher gross margins than
are telecommunications revenues.
Selling, General and Administrative. Selling, general and administrative
costs increased 167.5%, from approximately $128.5 million in Fiscal 1999 to
approximately $343.7 million in Fiscal 2000. As a percentage of total revenues,
these costs increased from 17.6% in Fiscal 1999 to 31.4% in Fiscal 2000. The
increase in these costs in dollar terms is due primarily to increased sales and
marketing efforts for retail services, particularly for domestic and
international prepaid calling cards, the aggressive expansion of the domestic
long distance business and for Net2Phone. Increased salaries, facilities costs
and professional fees related to the expansion of our domestic and European
telecommunications business as well as Net2Phone's businesses also contributed
to the rise in overall selling, general and administrative costs. In addition,
we incurred approximately $27.8 million in selling, general and administrative
expenses related to the formation and development of our various Ventures
businesses, including IDT Wireless, FreeAtLast.com, TV.TV and Brix
Communications. To a lesser extent, the increase in selling, general and
administrative expense was also attributable to an increase in bad debt expense,
due to financial difficulties encountered by some of our customers.
40
We anticipate that selling, general and administrative expenses will continue to
increase in dollar terms in the future, and will continue to be equivalent to a
significant percentage to total revenues, as we expand both our core
telecommunications business and our new Ventures businesses. Over the next few
quarters, as we move our different Ventures businesses through their respective
development stages, we anticipate that selling, general and administrative
expenses for our Ventures division could exceed, in dollar terms, the revenues
generated from this division.
Included in salaries is non-cash compensation as a result of option grants
made by Net2Phone. This amounted to $16.0 million and $41.0 million,
respectively, in Fiscal Years 1999 and 2000.
Depreciation and Amortization. Depreciation and amortization costs increased
33.6% from approximately $36.4 million in Fiscal 1999 to approximately $48.6
million in Fiscal 2000. As a percentage of revenues, these costs decreased from
5.0% in Fiscal 1999 to 4.4% in Fiscal 2000. These costs increased in absolute
terms due primarily to our higher fixed asset base during Fiscal 2000 as
compared with Fiscal 1999, reflecting our efforts to expand our
telecommunications network infrastructure and our facilities. We anticipate that
depreciation and amortization costs will continue to increase as we continue to
add to our asset base, particularly in our telecommunications division, allowing
us to implement our growth strategy.
Income (loss) from Operations. Our loss from operations was $216.6 million in
Fiscal 2000, compared to a loss from operations of $7.7 million in Fiscal 1999.
Our telecommunications business recorded a loss from operations of $45.3 million
in Fiscal 2000, compared to income from operations of approximately $24.9
million in Fiscal 1999, reflecting weaker margins for both our wholesale carrier
and prepaid calling card businesses, and substantially higher selling, general
and administrative expenses, as described above.
Loss from operations for our Internet access business increased to
approximately $18.1 million in Fiscal 2000 from approximately $8.2 million in
Fiscal 1999. The increased loss is due to lower revenues resulting from a
decrease in total dial-up subscribers, significantly lower gross margins and a
22% increase in operating expenses. The rise in operating expenses is due in
large part to expenses incurred in connection with the formation of the Internet
access joint venture with Terra Networks. This joint venture has since been
discontinued.
Loss from operations from our Ventures division, which is developing several
new telecom and Internet-related businesses, was approximately $27.3 million in
Fiscal 2000, reflecting start-up, marketing and development costs.
Loss from operations for Net2Phone increased to approximately $125.9 million
for Fiscal 2000, compared to a loss of approximately $24.4 million for Fiscal
1999. This increase is due primarily to 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.
Interest and Other Income (Expense) - net. Interest and Other Income net
amounted to approximately $609.5 million in Fiscal 2000, compared to net
interest and other expense of approximately $3.3 million in Fiscal 1999.
Included in other income for Fiscal 2000 is $142.3 million in gains recognized
by us under Staff Accounting Bulletin No. 51 in conjunction with Net2Phone's
sale of shares in its initial public offering and concurrent conversion of
Net2Phone's series A stock to Class A Stock in August 1999 and secondary
offering in December 1999, a realized gain of $105.8 million on our sale of 2.2
million Net2Phone shares as part of Net2Phone's Secondary Offering and
approximately $102.3 million on Net2Phone's sale of approximately 2.8 million
shares for approximately 806,000 shares of Yahoo, Inc. (NASDAQ: YHOO) and other
equity transactions. Also included in other income was a gain of approximately
$231.0 million related to the sale of our interests in two Internet joint
ventures with Terra Networks in exchange for Terra Networks stock, and a gain of
approximately $24.9 million on the sale of some of our Terra Networks shares in
the fourth quarter of Fiscal 2000.
Income Taxes. We recorded income tax expense of approximately $218.4 million
attributable to continuing operations in Fiscal 2000, versus income tax expense
of approximately $7.3 in Fiscal 1999. An income tax benefit of $10.3 million
upon the exercise of stock options was recorded directly into additional paid-in
capital in Fiscal 2000.
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.
41
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. We 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. Upon
completion of Net2Phone's initial public offering and concurrent conversion of
Series A Stock into Class A Common stock, we recorded a pretax gain of
approximately $65,587,000 in the first quarter of Fiscal 2000. Deferred taxes of
approximately $26.2 million have been provided on the gain.
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 our 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. Our 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 our
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
42
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 our infrastructure to handle our 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
164% from approximately $13.8 million in Fiscal 1998 to approximately $36.4
million in Fiscal 1999. As a percentage of revenues, these costs increased from
4.1% in Fiscal 1998 to 5.0% in Fiscal 1999. These costs increased in absolute
terms primarily as a result of amortization of goodwill and other intangible
assets that resulted from our acquisition of InterExchange in the fourth quarter
of fiscal 1998 and our higher fixed asset base during Fiscal 1999 as compared
with Fiscal 1998 reflecting our efforts to expand our telecommunications network
infrastructure, enhance our Internet network and expand our facilities. We
anticipate that depreciation and amortization costs will continue to increase as
we continue to add to our asset base allowing us to implement our growth
strategy.
Income (loss) from Operations. Our loss from operations was $7.7 million in
Fiscal 1999 compared to income from operations of $0.8 million in Fiscal 1998.
Income from operations for our telecommunications business increased to
approximately $24.9 million in Fiscal 1999 from $10.5 million in Fiscal 1998.
Our loss from operations in Fiscal 1998 includes a one-time charge of $17.9
million as a write-off of purchased in-process research and development costs in
connection with our acquisition of InterExchange. As a percentage of
telecommunication revenues, income from operations for the telecommunications
business increased to 3.6% in Fiscal 1999 from approximately 3.5% in Fiscal
1998. Fiscal 1998 income from telecommunications operations excluding the one-
time purchased in-process research and development write-off, was approximately
$28.4 million, which is 9.3% of telecommunications revenues.
Loss from operations for our 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 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. We recorded income tax expense of $7.3 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, we 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 In-Process Research and Development. We did not incur any expense
related to acquired in-process research and development during Fiscal 1999. Our
statement of operations for Fiscal 1998 reflects a non-recurring charge of $17.9
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. Neither of these projects has been successfully
completed at this time, and both projects have been terminated. Currently, we
are not contemplating any additional acquisitions of in-process research and
development.
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. We 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
43
Series A Stock was converted into three shares of Net2Phone Class A Common Stock
at the time of Net2Phone's initial public offering. Upon completion of
Net2Phone's initial public offering and concurrent conversion of Series A
Preferred Stock into Class A Common stock, we recorded a pretax gain of
approximately $65,587,000 in the first quarter of Fiscal 2000. Deferred taxes of
approximately $26.2 million have been provided on the gain.
44
Quarterly Results of Operations
The following tables set forth certain quarterly financial data for the eight
quarters ended July 31, 2000. This quarterly information is unaudited, has been
prepared on the same basis as the annual financial statements and, in the
opinion of our 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,
1998 1999 1999 1999 1999 2000 2000 2000
-------- -------- -------- -------- -------- -------- -------- --------
Revenues:
Telecommunications................... $123,708 $149,239 $179,190 $232,435 $268,492 $260,581 $245,775 $ 248,182
Internet............................. 4,269 4,312 4,217 4,136 3,547 3,001 3,298 3,322
Net2Phone............................ 5,301 7,190 8,344 9,843 11,382 11,937 13,887 18,869
Ventures............................. -- -- -- -- -- -- 150 1,489
-------- -------- -------- -------- -------- -------- -------- ---------
Total revenues...................... 133,278 160,741 191,751 246,414 283,421 275,519 263,110 271,862
Costs and expenses:
Direct cost of revenues.............. 101,074 126,592 150,183 197,201 230,199 220,785 210,634 256,639
Selling, general and Administrative.. 17,056 23,750 29,966 57,728 48,617 56,720 71,345 167,019
Depreciation and Amortization........ 7,965 8,823 9,428 10,144 9,926 10,449 11,624 16,565
-------- -------- -------- -------- -------- -------- -------- ---------
Total costs and expenses............ 126,095 159,165 189,577 265,073 288,742 287,954 293,603 440,223
-------- -------- -------- -------- -------- -------- -------- ---------
Income (loss) from Operations......... 7,183 1,576 2,174 (18,659) (5,321) (12,435) (30,493) (168,361)
Interest and Other (net).............. 205 (62) (153) (3,254) 65,161 183,116 236,946 124,280
-------- -------- -------- -------- -------- -------- -------- ---------
Income (loss) before taxes, minority
interests and extraordinary item..... 7,388 1,514 2,021 (21,913) 59,840 170,681 206,453 (44,082)
Income tax provision (benefit)........ 2,547 574 1,219 2,913 26,706 74,877 88,350 28,471
Minority interests.................... 1,623 562 420 (5,914) (2,597) (5,516) (7,879) (43,344)
-------- -------- -------- -------- -------- -------- -------- ---------
Income (loss) before extraordinary
item................................. 3,218 378 382 (18,912) 35,731 101,320 125,982 (29,208)
Extraordinary item, net of income
taxes................................ -- -- -- (3,270) -- (2,976) -- --
-------- -------- -------- -------- -------- -------- -------- ---------
Net income (loss)..................... 3,218 378 382 (22,182) 35,731 98,344 125,982 (29,208)
Subsidiary redeemable preferred stock
dividends............................ -- -- -- 26,297 -- -- -- --
-------- -------- -------- -------- -------- -------- -------- ---------
Net income (loss) available to common
stockholders......................... $ 3,218 $ 378 $ 382 $(48,479) $ 35,731 $ 98,344 $125,982 $ (29,208)
======== ======== ======== ======== ======== ======== ======== =========
Net income (loss) per share-basic..... $ 0.10 $ 0.01 $ 0.01 $ (1.43) $1.05 $2.88 $ 3.65 $ (0.83)
======== ======== ======== ======== ======== ======== ======== =========
Weighted average shares
outstanding-basic.................... 33,200 33,332 33,649 33,919 34,065 34,132 34,540 35,262
======== ======== ======== ======== ======== ======== ======== =========
Net income (loss) per share-diluted... $ 0.09 $ 0.01 $ 0.01 $ (1.43) $ 0.98 $ 2.70 $ 3.32 $ (0.83)
======== ======== ======== ======== ======== ======== ======== =========
Weighted average shares
outstanding-diluted.................. 35,702 35,344 35,731 33,919 36,602 36,439 37,996 35,262
======== ======== ======== ======== ======== ======== ======== =========
45
Liquidity and Capital Resources
General
Historically, we have satisfied our cash requirements through a combination of
cash flow from operating activities, sales of equity and debt securities and
borrowings from third parties. The Company, including Net2Phone, received
approximately $22.8 million upon the exercise of stock options and warrants in
Fiscal 2000.
In May 1999, we entered into a credit agreement with a syndicate of lenders
whereby these institutions committed to provide a $160 million credit facility.
We used the proceeds from the initial borrowings under the credit facility of
$108.1 million to purchase more than 99% of our outstanding 8.75% Senior Notes
due 2006, together with accrued and unpaid interest. During the quarter ended
January 31, 2000, we paid off the outstanding indebtedness under the credit
facility of $108.1 million, plus fees and accrued and unpaid interest, using
part of the proceeds from its sale of Net2Phone shares in Net2Phone's December
1999 Secondary Offering and the credit facility terminated.
As of July 31, 2000, we had cash, cash equivalents and marketable securities
of approximately $393.0 million and working capital of approximately $347.9
million. We generated negative cash flow from operating activities of
approximately $77.1 million during the fiscal year ended July 31, 2000, compared
with negative cash flow from operating activities of approximately $18.3 million
during the fiscal year ended July 31, 1999. Our cash flow from operations varies
significantly from quarter to quarter, depending upon the timing of operating
cash receipts and payments, especially accounts receivable and accounts payable.
Accounts receivable, accounts payable and accrued expenses have increased from
period to period as our businesses have grown.
Our capital expenditures were approximately $101.2 million for the fiscal year
ended July 31, 2000, compared to approximately $48.1 million for the fiscal year
ended July 31, 1999, as we expanded our international and domestic
telecommunications network infrastructure. We financed a portion of our capital
expenditures through capital leases and notes payable.
We experience intense competition in our 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, since the mid-point of Fiscal 2000, as
per-minute pricing continued to erode, gross margins have come under increasing
pressure. Our long term strategy involves terminating a larger proportion of
minutes on our own network, thereby lowering costs and preserving margins even
in a weaker price environment. However, in the short term, the demand for usage
has outpaced the rate of deployment of additional network capacity. In fact, it
has become commonplace within the industry for companies to experience delays in
network build-out programs. As such, there can be no assurance that we will be
able to maintain our gross margins at the current level, in the face of lower
per-minute revenues.
During Fiscal 2000, we launched our Ventures division, which incurred
significant start-up, development, marketing and promotional costs. As we move
our Ventures businesses through their respective development stages, we
anticipate that selling, general and administrative expenses for our Ventures
division will exceed the revenues generated by this division for the foreseeable
future.
We will need to make significant capital expenditures in order to expand our
network capacity. If we are unable to raise sufficient capital to meet our
spending requirements, our network expansion, and the anticipated margin
improvement, would be delayed.
Changes in Other Assets, Accounts Receivable, Allowance for Doubtful Accounts
and Deferred Revenue
Other current assets increased from $22.8 million at July 31, 1999 to $53.3
million at July 31, 2000, due to increases in contract deposits, inventories and
prepaid expenses at Net2Phone. The average age of our accounts receivable, as
measured by number of days sales outstanding, has been increasing due to a
significant increase in sales to relatively more credit-worthy carriers and
distributors of prepaid calling cards. These customers tend to demand, and we
are willing to grant, extended payment terms.
46
Due to the wide range of collection terms, future trends with respect to days
sales outstanding are generally dependent upon the proportion of total sales
made to carriers, who are often offered extended payment terms of up to 90 days,
and prepaid calling card distributors, who generally receive terms of up to 30
days. Therefore, the trends in days sales outstanding will depend, in large
part, on the mix of wholesale (carrier) versus retail (debit card distributor)
customers. In addition, as we are willing to extend longer payment terms to more
credit-worthy customers, an increase in customers belonging to the highest
credit classes, as a percentage of total customers, could also lead to an
increase in days sales outstanding. However, as the foregoing is difficult to
predict, it is not possible at this time to determine whether or not the recent
upward trend in days sales outstanding will continue.
The allowance for doubtful accounts as a percentage of accounts receivable
increased from 6.7% at July 31, 1999, to 14.3% at July 31, 2000. The increase in
the allowance for doubtful accounts as a percentage of accounts receivable
reflects the deteriorating credit quality of a portion of our existing customer
base. Although, as mentioned above, we anticipate that our customer base will
continue its transition towards a more credit-worthy group, some of our existing
accounts receivable are still related to sales made to less credit-worthy
customers.
Deferred revenue as a percentage of total revenue varies from period to period
dependent upon the mix and the timing of revenue. Subsequent to the end of
Fiscal 2000, we began to experience a significant increase in the sale of our
prepaid calling cards, due to increased marketing efforts and decreased
competition in our target markets. This will result in increased deferred
revenue.
Net2Phone Financings
In May 1999, a group of strategic investors purchased from Net2Phone, in the
aggregate, 3,140,000 shares of Net2Phone Series A 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 Stock was converted into Class A Common
Stock. We recognized pre-tax gains of approximately $65.6 million as a result of
these transactions.
In December 1999, Net2Phone completed a Secondary Offering of 6.3 million
shares, receiving approximately $177.4 million in net proceeds. As part of the
Secondary Offering, we sold 2.2 million Net2Phone shares, yielding approximately
$115.4 million in net proceeds. Subsequent to the sale of these shares, we used
approximately $108.1 million of the proceeds to pay off the outstanding balance
of our bank credit facility.
In connection with Net2Phone's distribution and marketing agreement with ICQ,
a subsidiary of America Online, Net2Phone issued to America Online a warrant 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 exercise price under the
terms of the warrant will be equal to the lesser of $12.00 per share or $450
million divided by the number of Net2Phone's fully-diluted shares on the initial
exercise date. The warrants are accounted for in accordance with the provisions
of EITF 96-18, "Accounting for Equity Investments that are Issued to Other than
Employees for Acquiring or in Conjunction with Selling Goods or Services." Due
to the uncertainty of reaching the performance measures stipulated in the
warrant agreement, we have not recorded any expense relating to the issuance of
the warrant. Upon determination that the achievement of the revenue thresholds
is probable, we will value the warrant and expense it over the remaining period
until the performance criteria is met. The three revenue thresholds are $10
million, $50 million and $75 million and the term of the distribution and
marketing agreement is four years. If the three incremental thresholds had been
met on July 31, 2000, we would have expensed approximately $25.3 million.
In November 1999, the warrant was amended to include the right to purchase an
additional 0.5% of Net2Phone's outstanding capital stock on a fully-diluted
basis at an exercise price of $60.46 per share upon the achievement of $100
million in revenue.
47
Significant Transactions
In August 2000, a consortium led by AT&T Corporation purchased 14.9 million of
our approximately 24.9 million shares of Net2Phone Class A Common Stock, for a
purchase price of $75 per share. In addition, Net2Phone sold four million of its
shares to AT&T for a purchase price of $75 per share. Net proceeds to IDT from
these transactions was $1.1 billion in cash proceeds.
In addition, we received the right, at our option, to sell to AT&T 2,040,817
shares of our Class B Common Stock for total cash consideration of $75.0
million. In August 2000, we announced that we had notified AT&T of our intent to
exercise this option.
In June 2000, Liberty Media Group completed the purchase of approximately 9.9%
of the equity of IDT. Under the terms of the agreement, IDT issued and sold to
Liberty Media 3,728,949 shares of IDT's Common Stock, exchangeable for shares of
Class B Common Stock, at a price of $34.50 per share, resulting in total cash
consideration of approximately $128.6 million.
On April 30, 2000, we sold our interests in two joint ventures with Terra
Networks for the right to receive 3,750,000 Terra ordinary shares. We recognized
a pre-tax gain of approximately $231.0 million in connection with this
transaction for the quarter ended April 30, 2000.
Stock Buyback Program
In May 2000, we announced that our Board of Directors had authorized the
repurchase of up to five million shares of our common stock. In July 2000, we
announced that our Board of Directors had authorized an increase in the share
repurchase program to 10 million shares. In October 2000, we announced that our
Board of Directors had authorized a further increase in the share repurchase
program to 12.5 million shares. Through October 20, 2000, we had repurchased
5,118,755 shares, for an aggregate purchase price of approximately $178.2
million.
Acquisitions of In-Process Research & Development
Our purchase of InterExchange, Inc. in April 1998 involved the acquisition of
two significant in-process research and development projects relating to switch
technology. Neither one of these projects has been successfully completed at
this time, and both projects have been terminated. Currently, we are not
contemplating any additional acquisitions of in-process research and
development.
Other Sources and Uses of Resources
We intend to, where appropriate, make strategic acquisitions to expand our
telecommunications division. These acquisitions could include, but are not
limited to, acquisitions of telecommunications equipment, telecommunications
network capacity, customer bases or other assets. We may also make strategic
acquisitions related to any of our new venture businesses. From time to time, we
evaluate potential acquisitions of companies, technologies, products and
customer accounts that complement our businesses.
We believe that, based upon our present business plan, and as a result of the
cash proceeds generated by the recently completed sale of the majority of our
Net2Phone sales to AT&T, our existing cash resources will be sufficient to meet
our currently anticipated working capital and capital expenditure requirements
and to fund any potential operating cash flow deficits for at least the next
twelve months. If our growth exceeds current expectations or if we acquire the
business or assets of another company, we may need to raise additional capital
from equity or debt sources. There can be no assurance that we will be able to
raise such capital on favorable terms or at all. If we are unable to obtain such
additional capital, we may be required to reduce the scope of our anticipated
expansion or acquisitions, which could have a material adverse effect on our
business, financial condition or results of operations.
48
European Currency Conversion
In January 1999, a new currency called the euro was introduced in certain
Economic and Monetary Union, or 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 our operations and sales.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
The information set forth under the caption "Fair Value of Financial
Instruments" at page F-10 herein is incorporated herein by reference.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and supplementary data of the Company
and the report of independent auditors thereon set forth on pages F-1 through
F-27 herein are incorporated herein by reference.
Quarterly financial information set forth herein at page 45 is incorporated
herein by reference.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
49
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, 2000, 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, 2000, 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, 2000, 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, 2000, and
which is incorporated by reference herein.
50
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.
10.02(10) 1996 Stock Option and Incentive Plan, as amended and restated, of
the Registrant.
10.03(3) Form of Stock Option Agreement under the 1996 Stock Option and
Incentive Plan.
10.04(4) Form of Registration Rights Agreement between certain stockholders
and the Registrant.
10.05(1) Lease of 294 State Street.
10.06(5) Lease of 190 Main Street.
10.7(6) Form of Registration Rights Agreement between Howard S. Jonas and
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(12) Internet/Telecommunications Agreement, dated as of May 7, 1999, by
and between Registrant and Net2Phone, Inc.
10.20(12) Joint Marketing Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.21(12) IDT Services Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.22(12) Net2Phone Services Agreement, dated as of May 7, 1999, by and
between Registrant and Net2Phone, Inc.
10.23(12) Assignment Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
51
Exhibit
Number Description
- ------ -----------
10.24(12) Tax Sharing and Indemnification Agreement, dated as of May 7, 1999,
by and between Registrant and Net2Phone, Inc.
10.25(12) Separation Agreement, dated as of May 7, 1999, by and between
Registrant and Net2Phone, Inc.
10.26(12) Co-location and Facilities Management Services Agreement, dated as
of May 20, 1999, by and between Registrant and Net2Phone, Inc.
10.27(13) Lease of 520 Broad Street, Newark, New Jersey.
10.28(13) Amendment to Lease of 520 Broad Street, Newark, New Jersey.
10.29(14) Option Agreement, dated as of March 3, 2000, between IDT Corporation
and AT&T Corp.
10.30(15) Amendment to Option Agreement, dated as of April 5, 2000 between IDT
Corporation and AT&T Corp.
10.31(14) Subscription Agreement, dated as of March 24, 2000, between IDT
Corporation and Liberty Media Corporation.
10.32(15) Amendment to Subscription Agreement, dated as of May 26, 2000,
between IDT Corporation and Liberty Media Corporation.
10.33(14) Letter Agreement, dated as of March 28, 2000, between IDT
Corporation, AT&T Corp. and Net2Phone, Inc.
10.34(14) Letter Agreement, dated as of March 30, 2000, between IDT
Corporation, AT&T Corp. and Net2Phone, Inc.
10.35(16) Conversion, Termination and Release Agreement, dated as of April 30,
2000, between IDT Corporation, Terra Networks, S.A., Terra Networks
USA, Inc., Terra Networks Access Services USA LLC and Terra Networks
Interactive Services USA LLC.
21.01* Subsidiaries of the Registrant
23.01* Consent of Ernst & Young LLP.
27.01* Financial Data Schedule.
__________
* filed herewith
(1) Incorporated by reference to Form S-1 filed February 21, 1996 file no. 333-
00204.
(2) Incorporated by reference to Form S-1 filed January 9, 1996 file no. 333-
00204.
(3) Incorporated by reference to Form 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.
(12) Incorporated by reference to Form 10-K for the fiscal year ended July 31,
1999, filed November 4, 1999.
(13) Incorporated by reference to Form 10-Q for the fiscal quarter ended January
31, 2000, filed March 16, 2000.
(14) Incorporated by reference to Form 8-K filed March 31, 2000.
(15) Incorporated by reference to Schedule 14C filed June 12, 2000.
(16) Incorporated by reference to Form 10-Q for the fiscal quarter ended April
30, 2000, filed June 14, 2000.
52
(16) Incorporated by reference to Form 10-Q for the fiscal quarter ended April
30, 2000, filed June 14, 2000.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on March 31, 2000,
announcing that on March 28, 2000, the Company entered into an agreement with
AT&T, whereby AT&T, through a newly formed business entity, would purchase 14.9
million shares of Class A Common Stock, par value $0.01 per share, of Net2Phone,
Inc. at a price of $75 per share.
The Company also announced that on March 3, 2000 it entered into an
agreement with AT&T in which the Company granted an option to AT&T, for a period
of 180 days, to purchase 2,040,817 shares of Class B Common Stock of the Company
for an aggregate purchase price of approximately $75,000,000.
The Company also announced that on March 24, 2000 it entered into an
agreement with Liberty Media Corporation pursuant to which Liberty Media
Corporation agreed to purchase approximately 9.9% of the Company's Common Stock
for an aggregate purchase price of approximately $130,000,000.
53
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: October 27, 2000
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 27th day of
October, 2000 in the capacities indicated.
Signature Titles
--------- ------
/s/ Howard S. Jonas Chairman and Chief Executive Officer
- ------------------------------ (Principal Executive Officer)
Howard S. Jonas
/s/ James A. Courter Vice Chairman and President
- ------------------------------ (Principal Executive Officer)
James A. Courter
/s/ Hal Brecher Chief Operating Officer and Director
- ------------------------------
Hal Brecher
/s/ Stephen R. Brown Chief Financial Officer and Director
- ------------------------------ (Principal Financial and Accounting Officer)
Stephen R. Brown
/s/ Joyce J. Mason Director
- ------------------------------
Joyce J. Mason
/s/ Marc E. Knoller Director
- ------------------------------
Marc E. Knoller
/s/ Moshe Kaganoff Director
- ------------------------------
Moshe Kaganoff
/s/ Geoffrey Rochwarger Director
- ------------------------------
Geoffrey Rochwarger
/s/ Meyer A. Berman Director
- ------------------------------
Meyer A. Berman
/s/ J. Warren Blaker Director
- ------------------------------
J. Warren Blaker
54
Signature Titles
--------- ------
/s/ Denis A. Bovin Director
- ------------------------------
Denis A. Bovin
/s/ Saul K. Fenster Director
- ------------------------------
Saul K. Fenster
/s/ William Arthur Owens Director
- ------------------------------
William Arthur Owens
/s/ William F. Weld Director
- ------------------------------
William F. Weld
55
IDT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors.............................................................................. F-2
Consolidated Balance Sheets as of July 31, 1999 and 2000.................................................... F-3
Consolidated Statements of Operations for the years ended July 31, 1998, 1999 and 2000...................... F-4
Consolidated Statements of Stockholders' Equity for the years ended July 31, 1998, 1999 and 2000............ F-5
Consolidated Statements of Cash Flows for the years ended July 31, 1998, 1999 and 2000...................... F-6
Notes to Consolidated Financial Statements.................................................................. F-7
Financial Statement Schedule--Valuation and Qualifying Accounts............................................. F-27
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, 1999 and 2000, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended July 31, 2000. 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 auditing standards generally
accepted in the United States. 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, 1999 and 2000 and the consolidated results of its operations and its
cash flows for each of the three years in the period ended July 31, 2000, in
conformity with accounting principles generally accepted in the United States.
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 24, 2000
F-2
IDT CORPORATION
CONSOLIDATED BALANCE SHEETS
July 31
-------------------------------
1999 2000
------------ ---------------
Assets
Current assets:
Cash and cash equivalents..................................................................... $ 52,903,479 $ 162,879,042
Marketable securities......................................................................... 77,869,655 230,159,597
Trade accounts and commissions receivable, net of allowance for doubtful accounts
of approximately $7,643,000 at July 31, 1999 and $26,771,000 at July 31, 2000................ 106,146,127 160,994,911
Notes receivable--current portion............................................................. 18,967,967 3,630,000
Deposits...................................................................................... 4,646,906 17,760,610
Inventory..................................................................................... 8,838,671 13,120,993
Other current assets.......................................................................... 22,825,475 53,347,819
------------ ---------------
Total current assets........................................................................ 292,198,280 641,892,972
Property, plant and equipment, at cost, net.................................................... 114,122,923 225,638,279
Trademark, net of accumulated amortization of $ 208,000 at July 31, 1999 and
$814,576 at July 31, 2000..................................................................... 4,791,667 10,985,424
Notes receivable--long-term portion............................................................ 2,187,071 8,001,284
Intangible assets, net......................................................................... 117,366,124 162,232,640
Marketable securities.......................................................................... -- 132,277,504
Deferred tax assets, net....................................................................... 3,358,500 --
Investments.................................................................................... 12,306,507 29,318,383
Other assets................................................................................... 13,540,307 8,708,871
------------ ---------------
Total assets................................................................................ $559,871,379 $1,219,055,357
============ ===============
Liabilities and stockholders' equity
Current liabilities:
Trade accounts payable........................................................................ $ 79,475,136 $ 161,873,530
Accrued expenses.............................................................................. 5,354,710 36,436,486
Interest payable.............................................................................. 1,564,741 15,213
Deferred revenue.............................................................................. 13,209,663 48,571,880
Notes payable--current portion................................................................ 4,752,780 22,604,067
Capital lease obligations--current portion.................................................... 6,029,273 13,539,647
Other current liabilities..................................................................... 2,397,234 10,922,579
------------ ---------------
Total current liabilities................................................................... 112,783,537 293,963,402
Deferred tax liabilities....................................................................... -- 168,772,000
Notes payable--long-term portion............................................................... 112,973,330 12,174,113
Capital lease obligations--long-term portion................................................... 15,742,218 43,940,097
Other liabilities.............................................................................. -- 708,908
------------ ---------------
Total liabilities......................................................................... 241,499,085 519,558,520
Minority interests............................................................................. 42,043,131 231,308,958
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; 23,982,854 and
25,959,256 shares issued and outstanding 1999 and 2000, respectively......................... 239,829 259,593
Class A stock, $.01 par value; authorized shares--35,000,000; 10,029,758 and
9,970,233 shares issued and outstanding 1999 and 2000, respectively.......................... 100,298 99,703
Loans to stockholders........................................................................ (251,207) (251,207)
Additional paid-in capital................................................................... 317,362,508 371,005,060
Accumulated other comprehensive income....................................................... -- (92,653,041)
Retained earnings/(deficit).................................................................. (41,122,265) 189,727,771
------------ ---------------
Total stockholders' equity................................................................ 276,329,163 468,187,879
------------ ---------------
Total liabilities and stockholders' equity................................................ $559,871,379 1,219,055,357
============ ===============
See accompanying notes.
F-3
IDT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended July 31,
--------------------------------------------------
1998 1999 2000
------------ ------------ --------------
Revenue................................................................... $335,372,915 $732,183,855 $1,093,911,855
Costs and expenses:
Direct cost of revenue.................................................. 240,859,809 575,049,683 918,256,364
Selling, general and administrative..................................... 61,974,851 128,499,715 343,701,929
Acquired research and development....................................... 17,900,000 -- --
Depreciation and amortization........................................... 13,810,488 36,359,986 48,564,344
------------ ------------ --------------
Total costs and expenses.................................................. 334,545,148 739,909,384 1,310,522,637
------------ ------------ --------------
Income (loss) from operations............................................. 827,767 (7,725,529) (216,610,782)
Interest expense.......................................................... (5,978,760) (11,318,964) (8,259,515)
Interest income........................................................... 5,582,951 10,090,332 15,490,449
Equity loss............................................................... -- -- (6,289,004)
Gain on sales of investments.............................................. -- -- 231,032,051
Gain on sales of subsidiary stock ........................................ -- -- 350,343,786
Other..................................................................... 103,215 (2,035,150) 27,186,305
------------ ------------ --------------
Income (loss) before income taxes, minority interests and
extraordinary items..................................................... 535,173 (10,989,311) 392,893,290
Provision (benefit) for income taxes...................................... (2,523,500) 7,253,000 218,403,383
Minority interests........................................................ 3,895,669 (3,308,552) (59,335,974)
------------ ------------ --------------
Income (loss) before extraordinary items.................................. (836,996) (14,933,759) 233,825,881
Extraordinary loss on retirement of debt, net of income taxes............. (132,376) (3,269,787) (2,975,845)
------------ ------------ --------------
Net income (loss)......................................................... (969,372) (18,203,546) 230,850,036
Subsidiary redeemable preferred stock dividends........................... -- 26,297,426 --
------------ ------------ --------------
Net loss available to common stockholders................................. $ (969,372) $(44,500,972) $ 230,850,036
============ ============ ==============
Net income (loss) per share:
Net income (loss) before extraordinary items:
Basic................................................................... ($0.02) ($1.23) $ 6.69
Diluted................................................................. ($0.02) ($1.23) $ 6.22
Extraordinary loss on retirement of debt, net of
income taxes:
Basic..................................................................... ($0.01) ($0.10) ($0.09)
Diluted................................................................... ($0.01) ($0.10) ($0.08)
Net income (loss)
Basic..................................................................... ($0.03) ($1.33) ($6.60)
Diluted................................................................... ($0.03) ($1.33) ($6.14)
Weighted average number of shares used in
calculation of net income (loss) per share:
Basic..................................................................... 28,571,421 33,529,930 34,966,400
Diluted................................................................... 28,571,421 33,529,930 37,619,351
See accompanying notes.
F-4
IDT CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Class A Stock Additional
--------------------- -----------------------
Paid-In Loans to
Shares Amount Shares Amount Capital Stockholders
----------- -------- ---------- --------- ------------- ------------
Balance at July 31, 1997................................ 10,636,000 $106,360 11,174,330 $111,743 $ 46,990,388 --
Exercise of stock options............................. 1,615,366 16,154 -- -- 5,281,017 --
Income tax benefit from stock
options exercised.................................... -- -- -- -- 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 -- -- 116,540,827 --
Common stock issued upon conversion of notes
payable.............................................. 582,762 5,828 -- -- 8,648,685 --
Exercise of warrants.................................. 35,003 350 -- -- 530,258 --
Sale of common stock.................................. 5,093,750 50,938 -- -- 118,208,595 --
Issuance of common stock to employees by related
party................................................ -- -- -- -- 390,000 --
Net loss for the year ended July 31, 1998............. -- -- -- -- -- --
----------- -------- ---------- --------- ------------- ------------
Balance at July 31, 1998................................ 22,848,866 228,489 10,255,668 102,557 305,379,770 --
Exercise of stock options............................. 696,840 6,968 -- -- 4,075,118 (251,207)
Income tax benefit from stock options exercised....... -- -- -- -- 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 --
Exercise of warrants.................................. 111,238 1,113 -- -- 922,801 --
Costs associated with stock registration.............. -- -- -- -- (122,154) --
Net loss for the year ended July 31, 1999............. -- -- -- -- -- --
----------- -------- ---------- --------- ------------- ------------
Balance at July 31, 1999................................ 23,982,854 239,829 10,029,758 100,298 317,362,508 (251,207)
Exercise of stock options............................. 1,310,700 13,107 14,521,413
Income tax benefit from stock options exercised....... 10,346,394
Conversion of Class A stock to common stock........... 59,525 595 (59,525) (595)
Exercise of warrants.................................. 19,963 200 117,504
Issuance of common stock.............................. 3,728,949 37,289 128,611,451
Change in Unrealized gain(loss)
in available for sale securities
Foreign currency translation adjustment
Repurchase of common stock............................ (3,142,735) (31,427) (101,855,987)
Modification of stock options......................... 984,564
Stock option given to partnership..................... 917,213
----------- -------- ---------- --------- ------------- ------------
Net income for the year ended July 31, 2000
Balance at July 31, 2000................................ 25,959,256 259,593 9,970,233 99,703 371,005,060 (251,207)
=========== ======== ========== ========= ============= ============
Accumulated
Retained Other Total
Earnings Comprehensive Stockholders'
(Deficit) Income Equity
------------- --------------- --------------
Balance at July 31, 1997....................... $(21,949,347) -- $ 25,259,144
Exercise of stock options.................... -- -- 5,297,171
Income tax benefit from stock
options exercised........................... -- -- 8,790,000
Conversion of Class A stock to
common stock................................ -- -- --
Issuance of common stock in
connection with business
acquisitions................................ -- -- 116,580,500
Common stock issued upon
conversion of notes payable................. -- -- 8,654,513
Exercise of warrants......................... -- -- 530,608
Sale of common stock......................... -- -- 118,259,533
Issuance of common stock to
employees by related party.................. -- -- 390,000
Net loss for the year ended July
31, 1998.................................... (969,372) -- (969,372)
------------- --------------- --------------
Balance at July 31, 1998....................... (22,918,719) -- 282,792,097
Exercise of stock options.................... -- -- 3,830,879
Income tax benefit from stock
options exercised........................... -- -- 4,257,973
Conversion of Class A stock to
common stock................................ -- -- --
Issuance of common stock in
connection with business
acquisitions................................ -- -- 2,850,000
Exercise of warrants......................... -- -- 923,914
Costs associated with stock
registration................................ -- -- (122,154)
Net loss for the year ended July
31, 1999.................................... (18,203,546) -- (18,203,546)
------------- --------------- --------------
Balance at July 31, 1999....................... (41,122,265) -- 276,329,163
Exercise of stock options.................... 14,534,520
Income tax benefit from stock
options exercised........................... 10,346,394
Conversion of Class A stock to
common stock Exercise of warrants........... 117,704
Issuance of common stock..................... 128,648,740
Change in Unrealized gain(loss)
in available for sale securities............ (94,044,241) (94,044,241)
Foreign currency translation
adjustment.................................. 1,391,200 1,391,200
Repurchase of common stock................... (101,887,414)
Modification of stock options................ 984,564
Stock option given to partnership............ 917,213
Net income for the year ended
July 31, 2000............................... 230,850,036 230,850,036 230,850,036
---------------
Comprehensive Income......................... -- 138,196,995 --
------------- --------------- --------------
Balance at July 31, 2000....................... $189,727,771 $(92,653,041) $468,187,879
============= =============== ==============
See accompanying notes.
F-5
IDT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended July 31
----------------------------------------------
1998 1999 2000
------------- ------------- ---------------
Operating activities
Net income (loss).............................................................. $ (969,372) $ (18,203,546) $ 230,850,036
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Amortization............................................................... 4,096,651 15,153,768 16,285,633
Depreciation............................................................... 9,713,837 21,206,218 32,278,711
Extraordinary loss on retirement of debt before taxes...................... 132,376 5,359,787 4,870,452
Amortization of deferred compensation...................................... -- 15,734,418 42,917,133
Other stock option compensation expense.................................... -- -- --
Acquired research and development costs by issuance of common stock........ 17,900,000 -- --
Minority interests......................................................... 3,895,669 (3,308,552) (59,335,974)
Deferred income taxes...................................................... (2,812,500) (1,156,000) 216,903,000
Issuance of common stock to employees by related party..................... 390,000 -- --
Gain on derivative instrument.............................................. -- -- (516,610)
Gain on sale of investment................................................. -- -- (231,032,051)
Gain on sales of subsidiary................................................ -- -- (350,343,786)
Net realized gains from sales of marketable securities and investments..... -- -- (29,476,446)
Changes in assets and liabilities:
Accounts receivable.................................................. (20,909,084) (68,108,153) (52,643,463)
Other current assets................................................. (9,138,112) (24,214,249) (40,718,219)
Other assets......................................................... (1,359,248) (6,770,740) 12,524,075
Notes receivable..................................................... 485,810 -- --
Trade accounts payable............................................... 18,141,813 39,056,078 81,262,113
Accrued expenses..................................................... 878,017 1,290,649 29,735,880
Deferred revenue..................................................... 6,732,370 4,034,445 34,025,765
Interest payable..................................................... 4,063,120 (2,377,836) (1,549,528)
Other current liabilities............................................ (375,626) 2,176,909 (12,357,263)
Other................................................................ (262,376) 1,830,450 (749,209)
------------- ------------- --------------
Net cash provided by (used in) operating activities............................ 30,603,345 (18,296,354) (77,069,751)
Investing activities
Purchases of property, plant and equipment..................................... (41,332,835) (48,097,692) (101,192,121)
Purchase of trademark.......................................................... -- (5,000,000) --
Issuance of notes receivable................................................... (23,595,526) (13,423,462) --
Investments and acquisitions................................................... -- (10,735,031) (38,802,726)
Collection of notes receivable................................................. -- 14,040,147 9,523,754
Payments for the purchase of InterExchange, Inc................................ (20,588,000) -- --
Net purchases of marketable securities......................................... (60,308,768) (17,560,887) (7,058,853)
Proceeds from sale of subsidiary, net.......................................... -- -- 115,434,000
------------- ------------- --------------
Net cash used in investing activities.......................................... (145,825,129) (80,776,925) (22,095,946)
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 8,172,042
Proceeds from exercise of warrants for Net2Phone............................... -- 437,870 --
Payment of debt issuance costs................................................. -- (4,475,029) --
Distribution to minority shareholder........................................... -- (6,079,274) (3,179,288)
Proceeds from borrowings....................................................... 110,668,294 115,945,551 13,897,620
Payment of financing costs..................................................... (3,561,070) -- --
Proceeds from exercise of warrants............................................. 530,608 923,914 117,704
Proceeds from exercise of stock options........................................ 5,297,171 7,966,698 14,534,520
Repayment of capital lease obligations......................................... (2,665,084) (5,348,909) (9,833,000)
Repayments of borrowings....................................................... (5,698,462) (103,911,582) (108,145,550)
Proceeds from sale of common stock............................................. 118,259,533 -- 128,648,740
Proceeds from offerings of common stock by Net2Phone........................... -- -- 261,188,837
Collection of loans to stockholders by Net2Phone............................... -- -- 627,049
Proceeds from minority investment in subsidiary................................ -- -- 5,000,000
Payments to repurchase common stock............................................ -- -- (101,887,414)
------------- ------------- --------------
Net cash provided by financing activities...................................... 222,830,990 36,693,239 209,141,260
------------- ------------- --------------
Net increase (decrease) in cash................................................ 107,609,206 (62,380,040) 109,975,563
Cash and cash equivalents at beginning of year................................. 7,674,313 115,283,519 52,903,479
------------- ------------- --------------
Cash and cash equivalents at end of year....................................... $ 115,283,519 $ 52,903,479 $ 162,879,042
============= ============= ==============
Supplemental disclosure of cash flow information:
============= ============= ==============
Cash payments made for interest................................................ $ 2,036,000 $ 13,483,000 $ 10,073,542
============= ============= ==============
Cash payments made for income taxes............................................ $ -- $ 235,000 $ 1,050,000
============= ============= ==============
Supplemental schedule of non-cash activities:
Accrued interest converted to equity........................................... $ 121,000 $ -- $ --
============= ============= ==============
Purchase of fixed assets by capital lease...................................... $ 12,448,000 $ 11,899,000 $ 45,541,253
============= ============= ==============
Notes payable converted to equity.............................................. $ 8,534,000 $ -- $ --
============= ============= ==============
See accompanying notes.
F-6
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 31, 2000
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, prepaid calling cards,
Internet access, and through Net2Phone, Inc. ("Net2Phone"), a majority-owned
subsidiary, Internet telephony services. The Company also sells prepaid 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 gain on sales of subsidiary stock.
Reclassifications
Certain prior year amounts have been reclassified to conform to current
year presentation.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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. Prepayments for services
are deferred and recognized as revenue as the services are provided.
Sales of equipment with software necessary to provide the Company's
services are accounted for in accordance with the American Institute of
Certified Public Accountants' Statement of Position of 97-2, Software Revenue
Recognition. Revenue on such sales is recognized when such products are
delivered, collection of payments are assured and there are no significant
future obligations.
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.
F-7
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property, Plant and Equipment
All property, plant and equipment is 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 the over the term of the lease or estimated useful life of the assets,
whichever is shorter. Computer software is amortized over the shorter of five
years or the term of the related agreement. Buildings are depreciated over the
estimated 30 year useful lives.
Trademark and Patents
Costs associated with obtaining the right to use trademarks and patents
owned by third parties are capitalized and amortized on a straight-line basis
over the term of the trademark licenses and patents.
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 that 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 banner advertising 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.
Thus, additional 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, 1998, 1999 and 2000, advertising expense
totaled approximately $5,632,000, $10,454,000 and $46,722,000, respectively.
In addition, for the quarter ended July 31, 2000, the Company incurred
approximately $28 million of costs to terminate advertising arrangements. These
termination costs are included in selling, general and administrative expenses
in the accompanying consolidated statements of operations.
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 are capitalized. For the years ended July 31, 1998, 1999 and 2000,
research and development costs totaled approximately $481,000, $757,000 and
$4,692,000, 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, 1999 and 2000, the Company has capitalized $4,065,000
and $8,593,000, respectively, of internal use software costs as computer
software.
F-8
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Long-Lived Assets
In accordance with SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, the Company reviews the
impairment of long-lived assets and certain identifiable intangibles whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The analysis of the recoverability utilizes undiscounted
cash flows. The measurement of the loss, if any, will be calculated as the
amount by which the carrying amount of the asset exceeds the fair value.
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 and 2000, the Company has 79% and 66%, respectively, of its cash and cash
equivalents in three financial institutions.
Marketable Securities
Marketable securities consist of equity securities and U.S. Government
Agency Obligations and commercial paper. Certain debt securities held by
Net2Phone, with original maturities of greater than three months at the time of
purchase are classified as held to maturity and are carried at amortized
cost. Interest on these securities is included in interest income as earned.
During fiscal 2000, IDT sold approximately $55,000,000 of held-to-
maturity securities prior to their maturity dates and recorded a loss of
approximately $1,200,000. The securities were sold to fund certain transactions.
In connection with these sales, marketable securities with a cost basis of
approximately $22,000,000 were reclassified as available-for-sale and through
July 31, 2000, unrealized losses of approximately $850,000 have been included in
accumulated other comprehensive income at July 31, 2000.
Inventory
Inventories are stated at the lower of cost or market. Cost is computed on
a specific identification basis.
Goodwill and Other Intangible Assets
Goodwill is amortized over 5 to 20 years using the straight-line method.
Other intangible assets consists of core programming technology and assembled
workforce which are amortized over 32 to 35 months, and 48 to 54 months,
respectively. The Company systematically reviews the recoverability of its
acquired intangible assets for each acquired entity to determine whether an
impairment may exist. Upon a determination that the carrying value of acquired
intangible assets will not be recovered from the undiscounted future cash flows
of the acquired business, the carrying value of such acquired intangible assets
would be considered impaired and would 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.
F-9
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. At July 31, 2000, the Company has 43% of
its notes receivable with two companies and 9% of the of its accounts
receivable 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
offered for notes with similar terms to borrowers of similar credit quality. The
fair values of notes receivable at July 31, 1999 and 2000 approximates
$17,082,000 and $11,631,000, 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 values of the notes payable at
July 31, 1999 and July 31, 2000 approximate carrying values, due to their
variable rates 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 employees 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.
F-10
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB No. 25. The Interpretation, was adopted
prospectively as of July 1, 2000.
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.
2. Marketable Securities
The following is a summary of the marketable securities at July 31, 2000:
Gross
Carrying Unrealized Gross Unrealized
Amount Gains Losses Fair Value
Short term:
Held-to-maturity securities
U.S. Government Agency
Obligations $ 9,500,000 $1,775 ($12,500) $ 9,489,275
Commercial paper 49,642,518 17 (45,568) 49,596,967
------------ ------ --------- ------------
59,142,518 1,792 (58,068) $ 59,086,242
------------ ------ --------- ------------
Available-for-sale securities
U.S. Government Agency
Obligations 23,096,425 -- -- 23,096,425
Terra common stock 147,920,654 -- -- 147,920,654
------------ ------ --------- ------------
230,159,597 1,792 (58,068) 230,103,321
------------ ------ --------- -------------
Long term:
Held-to-maturity securities
U.S. Government Agency
Obligations 5,000,000 -- (21,200) 4,978,800
------
Commercial paper 17,942,877 -- (37,877) 17,905,000
------------ ------ --------- ------------
22,942,877 -- (59,077) 22,883,800
------------ ------ --------- ------------
Available-for-sale securities
WebEx common stock 5,331,518 5,331,518
Yahoo! common stock 104,003,109 -- -- 104,003,109
------------ ------ --------- ------------
132,277,504 -- (59,077) 132,218,427
------------ ------ --------- ------------
$362,437,101 $1,792 ($117,145) $362,321,748
============ ====== ========= ============
F-11
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. 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, 1999, the outstanding balance on the Facility of
approximately $19,000,000 was included in notes receivable. In October 1999, the
Facility's remaining principal balance was repaid in full.
4. Property, Plant and Equipment
Property, plant and equipment consists of the following:
July 31
------------------------------
1999 2000
------------ ------------
Equipment............................................. $100,145,353 $238,767,013
Computer software..................................... 38,916,589 32,215,814
Leasehold improvements................................ 3,650,936 11,918,145
Furniture and fixtures................................ 2,447,210 10,624,846
Land and building..................................... 6,312,190 6,326,874
------------------------------
151,472,278 299,852,692
Less accumulated depreciation and amortization........ (37,349,355) (74,214,413)
------------ ------------
Property, plant and equipment, net.................... $114,122,923 $225,638,279
============ ============
Fixed assets under capital leases aggregate approximately $30,469,000 and
$71,835,000 at July 31, 1999 and 2000, respectively. The accumulated
amortization related to these assets under capital leases is approximately
$8,266,000 and $17,756,000 at July 31, 1999 and 2000, respectively.
5. Intangible Assets
Intangible assets consist of the following at July 31:
1999 2000
------------------------------
Core technology and patents .................................. $ 21,200,000 $ 35,100,000
Assembled workforce........................................... 2,300,000 3,317,000
Goodwill...................................................... 110,822,000 156,639,000
------------------------------
134,322,000 195,056,000
------------------------------
Accumulated amortization..................................... (16,956,000) (32,823,000)
------------------------------
$117,366,000 $162,233,000
============ ============
F-12
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Notes Payable
Notes payable consists of the following:
July 31
----------------------------
1999 2000
------------ ------------
Senior Notes (A)..................... $ 380,000 $ 380,000
Senior Credit facilities (B)......... 108,146,000 --
Promissory note (C).................. 7,367,000 4,768,000
Promissory notes (D)................. -- 16,942,000
Promissory notes (E)................. -- 4,800,000
Promissory notes (E)................. -- 6,537,000
Other................................ 1,833,000 1,351,000
------------ ------------
117,726,000 34,778,000
------------ ------------
Less notes payable--current portion.. (4,753,000) (22,604,000)
------------ ------------
Notes payable--long-term portion..... $112,973,000 $ 12,174,000
============ ============
(A) On February 18, 1998, the Company completed an offering of $100,000,000 in
Senior Notes (the "Notes"). Such Notes bear interest, which is payable
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, consisted 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 bore interest at base rates, as defined, plus 2.50% to 3.50%. The
Credit Facility was 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 remained unused. During the second quarter ended January 31,
2000, the Company repaid all of the outstanding principal balance together
with accrued interest. The Company recorded a pre-tax extraordinary loss in
connection with the repayment of $4,870,452 during the year ended July 31,
2000.
(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.
(D) On June 30, 2000, the Company completed the acquisition of a 100% interest
in CTM Brochure Display, Inc. ("CTM"), a brochure distribution company. In
connection with the acquisition, the Company issued promissory notes to the
former shareholders in the aggregate amount of $16,942,000. The notes bear
interest at the rate of 9.50% per annum. The principal balance on the
notes, together with accrued interest, are payable in equal monthly
installments through June 30, 2001.
(E) The promissory notes were issued in connection with Net2Phone's Aplio
acquisition (Note (13)) and bear interest at an annual rate of 6.53%. The
Company is required to pay $1,961,235 of the notes on March 31, 2001 and the
remaining principal balance of $4,576,215 plus all accrued and unpaid
interest on January 31, 2002. In addition Net2Phone is required to pay
the former Aplio shareholders $4.8 million over 18 months from the date of
sale.
F-13
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, 2000 consist of $22,604,000 due in fiscal 2001,
$11,829,000 due in fiscal 2002, and $345,000 due in fiscal 2003.
7. 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 under which 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. These allocated costs
approximate the amounts that would have been charged under the intercompany
agreements if they had been in effect during such periods.
8. Income Taxes
Significant components of the Company's deferred tax assets and liabilities
consists of the following:
July 31,
----------------------------
1999 2000
----------- -------------
Deferred tax assets:
Unrealized losses on securities................. $ - $ 34,484,000
Bad debt reserve................................ 3,045,000 5,331,000
Exercise of stock options....................... 7,926,000 3,277,000
Reserves........................................ - 4,500,000
Other ......................................... 285,000 289,000
----------- -------------
Deferred tax assets................................... 11,256,000 47,881,000
Deferred tax liabilities:
Gain on sales of subsidiary stock............... - (97,830,000)
Partnership..................................... - (92,413,000)
Depreciation.................................... (2,760,000) (14,466,000)
Identifiable intangibles........................ (5,137,500) (1,728,000)
Other........................................... (10,216,000)
----------- -------------
Deferred tax liabilities.............................. (7,897,500) (216,653,000)
----------- -------------
Net deferred tax assets (liabilities).... $ 3,358,500 $(168,772,000)
=========== =============
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.
F-14
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision (benefit) for income taxes consists of the following for the
years ended July 31:
1998 1999 2000
----------- ---------- ------------
Current:
Federal............................... $ -- $ 400,000 $ --
State and local and foreign ......... 200,000 -- --
----------- ---------- ------------
200,000 400,000 (395,000)
----------- ---------- ------------
Deferred:
Federal............................... (2,207,000) 3,768,000 175,191,000
State and local....................... (605,500) 995,000 41,712,000
----------- ---------- ------------
(2,812,500) 4,763,000 216,903,000
----------- ---------- ------------
$(2,612,500) $5,163,000 $216,508,000
----------- ---------- ------------
The income statement classification of the provision (benefit) for income
taxes consists of the following at July 31:
1998 1999 2000
Income tax provision (benefit) attributable to $(2,523,500) $ 7,253,000 $218,403,000
continuing operations........................................
Income tax benefit attributable to extraordinary loss......... (89,000) (2,090,000) (1,895,000)
----------- ----------- ------------
$(2,612,500) $ 5,163,000 $216,508,000
=========== =========== ============
The differences between income taxes expected at the U.S. federal statutory
income tax rate and income taxes provides are as follows:
1998 1999 2000
----------- ----------- ------------
Federal income tax at statutory rate............ $ 281,000 $(3,842,000) $137,513,000
Purchased research and development.............. 6,240,000 -- --
Change in valuation allowance................... (9,294,000) -- --
Losses for which no benefit provided............ -- 6,110,000 32,703,000
Non-deductible expenses......................... -- 2,226,000 17,625,000
State and local and foreign income tax.......... 369,500 647,000 28,612,000
Other, net...................................... (209,000) 22,000 55,000
----------- ----------- ------------
$(2,612,500) $ 5,163,000 $216,508,000
=========== =========== ============
9. 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.
F-15
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. During
the year ended July 31, 2000 all of the remaining warrants were exercised.
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
this informal program, options to purchase 2,158,770 shares of Common stock were
granted.
The Company adopted a stock option plan as amended (the "Option Plan") for
officers, employees and non-employee directors to purchase up to 6,300,000
shares of the Company's common stock. In September 2000, the Board of Directors
of the Company approved an amendment to the Option Plan to reserve for issuance
3,000,000 shares of Class B stock. Class B stock will have 1/10 the voting
rights of the Company's common shares. 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.
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, 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
Granted.............................. 4,425,543 19.96
Exercised............................ (1,310,700) 11.09
Canceled............................. (47,500) 17.72
Forfeited............................ (15,750) 21.85
----------- --------------
Outstanding at July 31, 2000......... 6,639,559 $16.61
=========== ==============
F-16
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes the status of stock options outstanding and
exercisable at July 31, 2000:
Stock Options Outstanding
---------------------------------------
Weighted- Number of
Range of Remaining Stock
-------- Number Contractual Options
Exercise Prices of Options Life Exercisable
--------------- ---------- ----------- -----------
$ 0.21 - $ 0.21....... 292,150 4.0 292,150
$ 0.41 - $ 0.41....... 8,816 4.7 8,816
$ 0.83 - $ 0.83....... 40,500 4.0 40,500
$ 1.65 - $ 1.65....... 15,000 4.7 15,000
$ 4.38 - $ 5.25....... 389,200 6.6 389,200
$ 6.88 - $10.00....... 610,825 6.5 464,325
$11.25 - $16.00....... 1,631,633 8.5 419,903
$17.44 - $24.25....... 3,000,185 9.3 198,449
$26.25 - $37.02....... 651,250 9.1 195,000
--------- ---------
6,639,559 2,023,343
========= =========
The weighted average fair value of options granted was $4.46, $9.26 and $14.84
for the years ended July 31, 1998, 1999, and 2000, 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.
July 31
-----------------------------
1998 1999 2000
------ ------- -------
Assumptions
Average risk-free interest rate..................................... 5.92% 4.67% 6.49%
Dividend yield...................................................... -- -- --
Volatility factor of the expected market price of the Company's
common stock..................................................... 84% 84% 81%
Average life........................................................ 5 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, 1998, 1999 and 2000, pro forma net income (loss) and pro
forma net income (loss) income per share under SFAS 123 amounted to
approximately $(11,082,000), $(53,295,000) and $214,285,657, respectively, and
$(0.39), $(1.59) and $6.12, respectively.
During the year ended July 31, 2000, the Company modified stock options
granted for certain employees of the Company to accelerate or extend their
terms. Accordingly, the Company recorded additional compensation expense of
approximately $985,000.
F-17
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 these 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.
During the quarter ended July 31, 2000, stock options issued to certain
officers and employees of Net2Phone were accelerated in accordance with the
original stock option awards and as a result Net2Phone recorded approximately
$12.5 million in compensation charges as a result of the acceleration. During
the quarter ended July 31, 2000, stock options issued to certain officers and
employees of IDT were modified and as a result, Net2Phone recorded $18.3 million
in compensation charges.
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.
Public Offerings and Other Transactions
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 $115.4 million from this offering.
On August 3, 1999, Net2Phone completed an initial public offering of 6,210,000
shares of common stock at an initial public offering price of $15.00 per share,
resulting in net proceeds of approximately $85.3 million. Upon completion of the
initial public offering, 3,140,000 shares of Net2Phone Series A Preferred Stock
were converted into 9,420,000 shares of Net2Phone Class A Stock. As a result of
the initial public offering and concurrent conversion of Series A Stock to Class
A stock, the Company's ownership percentage in Net2Phone decreased from
approximately 90.0% to approximately 56.2%. In connection with such offering,
the Company recorded a gain on sale of stock by a subsidiary of approximately
$65,464,000. Such gain is included in gain on sales of subsidiary stock for the
year ended July 31, 2000.
In December 1999, the Net2Phone completed a secondary offering of 6,300,000
shares of common stock at a price of $55.00 per share. In connection with the
offering, IDT also sold 2,200,000 share of Net2Phone common stock at $55.00 per
share. Proceeds to the Company, after deducting underwriting discounts and
commissions and offering expenses were approximately $292.8 million. The
Company's ownership percentage in Net2Phone before and after these transactions
decreased from 56.4% to 47.97%. The Company recorded gains on sales of stock by
a subsidiary of approximately $182,594,000 in connection with these offerings.
Such gains are included in gain on sales of subsidiary stock for the year ended
July 31, 2000.
In March 2000, the Company acquired 806,452 shares of Yahoo! Inc. in exchange
for 2,777,778 shares of the Net2Phone common stock at a then equivalent market
value of approximately $150,000,000. In connection with the transaction, the
Company recorded a gain on sale of subsidiary stock of $102,286,000.
Stock Buyback Program
During the year ended July 31, 2000 the Board of Directors of the Company
authorized the repurchase of up to ten million shares of the Company's common
stock. As of July 31, 2000, the Company had repurchased and retired
approximately 3.1 million shares of common stock for an aggregate consideration
of approximately $101.9 million.
F-18
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Liberty Media Transaction
On March 27, 2000, Liberty Media Group agreed to purchase approximately 9.9%
of the equity of IDT, equal to approximately 3,775,000 shares of IDT's common
stock exchangeable for shares of Class B common stock. On June 6, 2000, Liberty
Media Group completed the purchase of 3,728,949 shares of IDT's common stock at
$34.50 per share, resulting in aggregate cash consideration of approximately
$128.6 million. Liberty Media also has the right to nominate a director for
election to the IDT Board of Directors.
Terra Networks Transaction
In October 1999, IDT entered into a joint venture agreement with Terra
Networks, S.A. ("Terra") pursuant to which the two parties formed two limited
liability companies to provide Internet services and products to customers in
the United States. One company was formed to provide internet access to
customers and the other company was formed to develop and manage an internet
portal that will provide content-based Internet services. IDT's 49% interest in
the Internet access company was accounted for using the equity method of
accounting. The equity method was used since IDT had significant influence, but
less than a controlling voting interest. IDT's 10% interest in the Internet
portal company was accounted for at cost. The cost method was used since IDT did
not have a controlling voting interest, or an ownership or voting interest so
large as to exert significant influence, and the venture was not publicly
traded. On April 30, 2000, the Company sold its interests in the two joint
ventures for the right to receive 3,750,000 shares of Terra common stock. The
Company recognized a pre-tax gain of approximately $231.0 million in connection
with this transaction for the year ended July 31, 2000.
10. Commitments and Contingencies
Legal Proceedings
In October 1999, Union commenced an action against DigiTEC 2000, Inc.
("DigiTEC") and TecNet, Inc. ("TecNet") in the Supreme Court of the State of New
York, County of New York, alleging damages of approximately $725,000 based upon,
among other things, non-payment for prepaid calling cards. DigiTEC and TecNET
have answered the complaint and DigiTEC has asserted a third-party claim against
IDT seeking damages of $2.5 million dollars based upon IDT's alleged breach of a
settlement agreement between IDT and DigiTEC which had resolved a prior
litigation between those parties. The court adjourned the return date without
assigning a specific return date for IDT to answer the Third-Party Complaint,
subject to DigiTEC's right to make a written thirty day demand for an Answer.
This action is currently in the early stages of discovery.
In February 2000, IDT Europe B.V.B.A., a subsidiary of IDT, filed a Complaint
against Tyco Group S.A.R.L. ("Tyco") and Tyco Submarine Systems, Ltd. ("TSSL")
in the United States District Court, Newark, New Jersey, alleging breach of
implied covenant of good faith and fair dealing and breach of contract for
breaching a Memorandum of Understanding and Instruction to Proceed entered into
on November 9, 1999. IDT sought to enjoin and restrain Tyco and TSSL from
undertaking contrary business activity inconsistent with the Memorandum of
Understanding and Instruction to Proceed and sought compensatory, consequential
and punitive damages. On March 24, 2000, Tyco filed an answer and a motion to
dismiss the action for lack of subject matter jurisdiction and Tyco, TSSL, Tyco
International Ltd., Tyco International (US) Inc., and Tycom Ltd. filed suit
against IDT Europe B.V.B.A. and IDT in the Supreme Court for New York county.
The suit alleges breach of contract and tortious interference with prospective
business relations and seeks declaratory and/or injunctive relief. The
plaintiffs are seeking compensatory damages in an undefined amount and punitive
damages in the amount of $3 billion. On April 13, 2000, IDT filed a motion to
dismiss the action for lack of personal jurisdiction and failure to state a
claim, on which a hearing was scheduled for June 19, 2000. On June 7, 1999, the
United States District Court in Newark, New Jersey dismissed IDT's complaint for
lack of federal court jurisdiction. On June 14, 2000, IDT filed a substantially
similar action in the New Jersey state court.
F-19
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On October 10, 2000, IDT reached a full and final settlement with Tyco of all
pending claims brought against one another and their respective affiliates. The
settlement agreement is the subject of a confidentiality agreement among the
parties and only the following disclosure by IDT is permitted under the terms of
that agreement.
Under the terms of the settlement, Tycom Ltd. ("TyCom") granted to IDT Europe
B.V.B.A. ("IDT Europe"), free of charge, certain exclusive rights to use
capacity on the transatlantic and transpacific segments of TyCom's global
undersea fiber optic network (the "TyCom Global Network") which TyCom is
currently deploying. The settlement agreement provides for IDT Europe to obtain
exclusive indefeasible rights to use 2 (two) 10 Gb/s wavelengths on the
transatlantic segment and 2 (two) 10 Gb/s wavelengths on the transpacific
segment for fifteen years from the applicable Handover Dates (as described
below). TyCom previously announced that it expects the TyCom transatlantic
network to be ready for service in September of 2001 and the TyCom transpacific
network to be ready for service in the second quarter of 2002, the respective
"Ready for Service Dates." Under the terms of the settlement agreement, the
Handover Dates for the wavelengths on the transatlantic segment are six months
(for the first wavelength) and 18 months (for the second wavelength),
respectively, after the Ready for Service Date of the TyCom transatlantic
network and the Handover Dates for the wavelengths on the transpacific segment
are six months (for the first wavelength) and 18 months (for the second
wavelength), respectively, after the Ready for Service Date of the TyCom
transpacific network. Operation, administration and maintenance for the
wavelengths used by IDT will be provided by TyCom for a fifteen year period
after the relevant Handover Date, free of charge. TyCom has also granted IDT
certain rights to resell any unused capacity on the wavelengths through TyCom as
its sole and exclusive agent. In addition, IDT will also have the option,
exercisable at least annually, to convert the available capacity on its
wavelengths to available equivalent capacity on another portion of the Tycom
Global Network.
In February 2000, Multi-Tech Systems, Inc. ("Multi-Tech") filed suit against
Net2Phone and other companies in the United States Federal District Court in
Minneapolis, Minnesota. In its press release, Multi-Tech stated that "the
defendant companies are infringing because they are providing the end users with
the software necessary to simultaneously transmit voice and data on their
computers in the form of making a phone call over the Internet." Net2Phone
intends to defend the lawsuit vigorously. Net2Phone believes that the Multi-
Tech claims are without merit. However, should a judge issue an injunction
against Net2Phone requiring that Net2Phone cease distributing its software or
providing its software-based services, such an injunction could have an adverse
effect on Net2Phone's business. Net2Phone has filed an answer and this action is
currently in the early stages of discovery.
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.
Lease Obligations
The future minimum payments for all capital and operating leases as of July
31, 2000 are approximately as follows:
Year ending July 31: Operating Capital
Leases Leases
------------ ------------
2001............................................ $ 9,215,000 $ 16,646,000
2002............................................ 8,471,000 16,595,000
2003............................................ 7,772,000 14,182,000
2004............................................ 7,539,000 11,071,000
2005............................................ 7,233,000 6,233,000
Thereafter...................................... 112,628,000 --
------------ ------------
Total payments.................................. $152,858,000 64,727,000
============
Less amount representing interest............... (7,247,000)
Less current portion............................ (13,540,000)
------------
Capital lease obligations--long-term portion.... $ 43,940,000
============
Rental expense under operating leases was approximately $1,225,000, $2,821,000
and $6,857,000 for the years ended July 31, 1998, 1999 and 2000, respectively.
Commitments
For the years ended July 31, 1998 and 1999, the Company had an agreement with
a supplier of telecommunications services ("Vendor") which began in August
1994. Under such agreement, the Vendor bills
F-20
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. The Company purchased approximately $5,997,000 and
$10,214,000 during 1998 and 1999, 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, 2000, the Company's minimum purchase
commitments related to such agreements consist of $3,127,000 in Fiscal 2001,
$1,771,000 in Fiscal 2002, $500,000 in Fiscal 2003, and $194,000 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.
Net2Phone has entered into various marketing and distribution agreements under
which it is obligated to make upfront and future payments. At July 31, 2000
$12,162,000 of prepayments are included in contract deposits. Future minimum
payments under the agreements are:
Fiscal 2001 $12,643,000
Fiscal 2002 7,036,000
Fiscal 2003 1,860,000
-----------
$21,539,000
===========
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.
The warrants are accounted for in accordance with the provisions of EITF 96-
18, "Accounting for Equity Investments that are Issued to Other than Employees
for Acquiring or in Conjunction with Selling Goods or Services." Due to the
uncertainty of reaching performance measures stipulated in the warrant
agreement, the Company has not recorded any expense relating to the issuance of
the warrant. Upon determination that the achievement of the revenue thresholds
is probable, the Company will value the warrant and expense it over the
remaining period until the performance criteria is met. The three revenue
thresholds are $10 million, $50 million and $75 million and the term of the
distribution and marketing agreement is four years. If the three incremental
thresholds had been met on July 31, 2000, the Company would have expensed
approximately $25.3 million.
11. Business Segment Information
Based principally on products and services provided, the Company has
identified four reportable business segments: Wholesale Telecommunications
Services, Retail Telecommunications Services, Internet Services and Internet
Telephony. The operating results of these business segments are distinguishable,
are regularly reviewed by Company management and are integral to their decision
making process.
The Wholesale Telecommunications Services business segment is comprised of
wholesale carrier services sold to other U.S. and international carriers. The
Retail Telecommunications Services business segment includes prepaid calling
cards, international retail services and domestic long distance services. The
Internet Services business segment includes dial-up access services and direct
connect dedicated service. The Internet Telephony business segment reflects the
results of the Company's majority-owned subsidiary, Net2Phone, prior to the
elimination of minority interests. The Ventures business segment, new for the
current fiscal year, includes new industries explored by the Company such as IDT
Wireless and TV.TV.
F-21
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company evaluates the performance of its business segments based primarily
on operating income after depreciation and amortization but prior to interest
expense and income taxes; all corporate overhead is allocated to the business
segments based on time and usage studies. Operating results and other financial
data presented for the principal business segments of the Company for the years
ended July 31, 1998, 1999 and 2000 are as follows ($ in thousands):
Wholesale Retail
Telecommunications Telecommunications Internet Internet
Services Services Services Telephony Ventures Total
------------------ ------------------ ---------- ----------- ---------- ----------
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....... 9,460 1,048 (7,030) (2,650) 828
Depreciation and amortization....... 4,810 3,721 4,409 871 13,811
Total assets........................ 230,998 186,000 36,415 7,827 461,240
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....... 12,596 12,283 (8,197) (24,408) (7,726)
Depreciation and amortization....... 14,120 15,275 4,699 2,266 36,360
Total assets........................ 294,941 179,607 23,057 62,266 559,871
Year ended July 31, 2000
Total segment revenue............... $ 549,213 $504,594 $ 13,768 $ 72,401 $ 1,638 $1,141,614
Less: revenues between segments..... (28,695) (2,082) (600) (16,326) -- (47,703)
----------- ---------- --------- --------- -------- ----------
Total unaffiliated revenue.......... 520,518 502,512 13,168 56,075 1,638 1,093,911
Income (loss) from operations....... (11,458) (33,877) (18,112) (125,865) (27,298) (216,610)
Depreciation and amortization....... 18,407 17,771 5,285 6,804 297 48,564
Total assets........................ 431,659 358,656 13,145 403,202 12,393 1,219,055
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 $17.9 million non-recurring expense
for the write-off of in-process research and development in connection with the
acquisition of InterExchange, Inc. which was allocated to acquired research and
development.
Revenue from customers located outside of the United States represented
approximately 11%, 13% and 17% of total revenue for the years ended July 31,
1998, 1999 and 2000, respectively, with no single foreign geographic area
representing more than 10% of total revenues for any period presented. Revenues
are attributed to countries based on the location of the customer. Long-lived
assets held outside of the United States totaled approximately $24.9 million and
$24.4 million as of July 31, 1999 and 2000, respectively.
F-22
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Additional Financial Information
Trade accounts payable includes approximately $57,336,000 and $96,215,000 due
to Telecommunication carriers at July 31, 1999 and 2000, respectively.
13. 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 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 were issued in May 1998. 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 the result of Union's net income exceeding $2.4 million in the one
year period following the completion of the acquisition. There is no other
contingent consideration. The Company accounted for the acquisition using the
purchase method and consolidates its 51% interest in Union. The operations of
Union have been included in the statement of operations since the date of the
acquisition. Union had no assets or liabilities. The Company acquired Union as
it gave IDT the ability to immediately enter the rapidly growing market for
prepaid calling cards geared to specific ethnic markets. The initial entry into
this market allowed the Company to become a significant participant in the
market and be dominant in certain segments. Therefore, the entire purchase price
has been allocated to goodwill.
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 $129,206,000. 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. The common stock
was valued based on a price per share of $33.50, which is the average price of
the Company's common stock a few days before and after the acquisition was
announced. 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)
Assembled workforce............................................ 2,300,000
Core technology................................................ 21,200,000
Acquired research and development.............................. 17,900,000
Goodwill....................................................... 98,988,000
Deferred Tax Liability on identifiable intangible assets....... (9,400,000)
------------
$129,206,000
============
In connection with the acquisition of InterExchange, Inc., the Company
immediately expensed the amount allocated to in-process research and development
of $17.9 million 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-23
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
CTM Brochure Display, Inc. Acquisition
On June 30, 2000, the Company acquired a 100% interest in CTM Brochure
Display, Inc. ("CTM"), a brochure distribution company, for an aggregate
purchase price of approximately $23,800,000. The purchase price consisted
primarily of $5.1 million in cash, $16.9 million in notes payable to the former
owners and the liquidation of $1,400,000 of CTM's bank debt. In connection with
the transaction, the Company recorded goodwill of $23,000,000 which is being
amortized over 20 years and tax liabilities of $3,000,000. The acquisition was
accounted for as a purchase, and accordingly, the net assets and results of
operations of the acquired business have been included in the consolidated
financial statements from the date of acquisition.
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 consolidates its
75% ownership interest in the joint venture.
Aplio Acquisition
On July 7, 2000, Net2Phone acquired all of the outstanding capital stock of
Aplio, S.A ("Aplio") a company located in France with technology that enables
VoIP devices. Consideration consisted of $2.9 million in cash at closing and
582,749 shares of Net2Phone's common stock which were valued at $35.50 per
share, promissory notes aggregating $6.5 million, $1.1 million in acquisition
related costs and $4.8 million in cash to be paid within eighteen months of the
closing of the transaction. In addition, Net2Phone is required to pay two
contingent cash payments of $2,778,230 on July 7, 2001 and July 7, 2002. These
contingent payments are dependent on certain individuals continuing their
employment with Net2Phone and will be recorded as expense if and when they
become due.
Net2Phone may also be required to repurchase the shares of common stock issued
to the selling shareholders on or prior to January 31, 2002 for a per share
purchase price of $36.947.
As collateral for the $4.8 million payment, Net2Phone has placed 152,390
shares of its common stock in escrow. The aggregate purchase price of $36.0
million plus the fair value of net liabilities assumed of $2.7 million totaled
approximately $38.7 million which was preliminarily allocated as follows:
approximately $17.5 million to goodwill, $13.9 million to technology, $2.3
million to trademark, $4.5 million to patents and $500,000 to workforce. The
acquisition was accounted for as a purchase, and accordingly, the net assets and
results of operations of the acquired business have been included in the
consolidated financial statements from July 7, 2000, the date of acquisition.
14. Subsequent Events
AT&T transaction
On March 28, 2000, IDT entered into an agreement with AT&T Corporation
("AT&T") which closed on August 11, 2000 pursuant to which IDT sold AT&T 14.9
million shares of Class A Common Stock, par value $0.01 per share, of Net2Phone
("Class A Stock"), at a price of $75 per share. In addition, AT&T purchased four
million newly-issued shares of Class A Stock from Net2Phone at a price of $75
per share. Following these transactions, AT&T had a 39% voting stake and a
32% economic stake in Net2Phone for a total cash investment of approximately
$1.4 billion. These transactions reduce IDT's voting stake in Net2Phone from its
current 56% to 21% and its economic stake in Net2Phone from its current 45% to
17%. Accordingly, IDT has deconsolidated Net2Phone effective August 11, 2000 and
accounts for it using the equity method. In addition, AT&T and IDT have reached
an agreement that gives
F-24
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
AT&T the right of first refusal to purchase IDT's remaining stake of 10 million
shares of Class A Stock. If this right is exercised, AT&T will have a 60% voting
interest and a 49% economic interest in Net2Phone. AT&T will also receive the
option to convert IDT's remaining 10 million shares of Class A Stock into shares
of Common Stock, par value $0.01 per share, of Net2Phone ("Common Stock").
Shares of Class A Stock have two votes per share, while shares of Common Stock
have one vote per share.
On March 3, 2000, AT&T entered into an agreement with IDT granting IDT an
option, for a period of 180 days, to cause AT&T to purchase 2,040,817 shares of
Class B Common Stock of IDT, at a price of $36.75 per share for an aggregate
purchase price of approximately $75,000,000. The option is exercisable from
April 2, 2000 until the earlier of (i) 180 days following March 3, 2000 and (ii)
the date IDT sells at least 12,500,000 shares of Class A Stock, $0.01 par value,
of Net2Phone to a current holder of shares of such Class A Stock of Net2Phone.
The Class B Common Stock will carry 1/10 of a vote per share. For a period of 18
months, if AT&T buys shares of Class A Stock from another holder of shares of
Class A Stock, IDT will have the option to cause AT&T to purchase up to 5
million additional shares of its Class A Stock on the same terms and conditions.
AT&T and IDT have agreed to enter into various definitive commercial
arrangements for a period of three years. AT&T has the right to nominate three
members to the Board of Directors of Net2Phone. Until August 1, 2003 AT&T and
IDT will agree to vote their shares in favor of mutually acceptable nominees to
the Board of Directors of Net2Phone. Net2Phone also granted each of AT&T and IDT
a license to use Net2Phone's technologies in their own communications services.
Effective August 11, 2000 IDT will no longer consolidate Net2Phone. Summary
financial information for Net2Phone as of July 31, 2000 is as follow:
Current assets $156,023,000
Total assets $411,728,000
Working Capital $106,372,000
Revenue $72,401,000
Operating loss $(128,512,694)
15. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
Year ended July 31
2000 1999 1998
-------------- -------------- --------------
Numerator:
Net Loss
Subsidiary preferred stock dividends 230,850,036 (18,203,546) (969,372)
Net Loss available for common stockholders -- (26,297,426) --
-------------- ------------- -------------
Denominator: 230,850,036 44,500,972 (969,372)
============== ============= =============
Weighted average shares outstanding - basic 34,966,400 33,529,930 28,571,421
Effect of stock options 2,652,952 -- --
-------------- -------------- --------------
Weighted average shares outstanding - diluted 37,619,351 33,529,930 28,571,421
============== ============= =============
Basic earnings (loss) per share $6.60 ($1.33) ($0.03)
Diluted earnings (loss) per share $6.14 ($1.33) ($0.03)
The following securities have been excluded from the dilutive
per share computation as they are antidilutive
Year ended July 31
2000 1999 1998
-------------- -------------- --------------
Stock options 449,500 3,587,966 3,214,635
F-25
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16.
Net2Phone subsidiary stock sales
During the course of the year ended July 31, 2000, the Company recognized
approximately $350.3 million in gains, included in gain on sales of subsidiary
stock, related to Net2Phone subsidiary stock sales as follows:
On August 3, 1999, Net2Phone, Inc. a majority owned subsidiary, completed an
initial public offering of 6,210,000 shares of its common stock at a price of
$15 per share, resulting in net proceeds of approximately $85.3 million. Upon
completion of the initial public offering, 3,140,000 shares of Net2Phone Series
A Preferred Stock were converted into 9,420,000 shares of Net2Phone Class A
Stock. As a result of the initial public offering and concurrent conversion of
Series A Stock to Class A Stock, IDT's ownership percentage in Net2Phone
decreased from 90.0% to approximately 56.2%. This resulted in the Company
recording a gain on the sale of stock by a subsidiary of approximately $65.5
million. Deferred taxes of $26.2 million have been provided on the gain.
A $76.8 million pre-tax gain was recognized in December 1999 (second quarter
of fiscal 2000) in connection with Net2Phone's secondary offering of 6.3 million
shares of its common stock, at a price of $55.00 per share for net proceeds to
Net2Phone of approximately $177.4 million. Deferred taxes of approximately $30.7
million have been provided for this gain.
A $105.8 million pre-tax gain was recognized in December 1999 (second quarter
of fiscal 2000) in connection with IDT's sale of 2,200,000 shares of common
stock of Net2Phone in Net2Phone's secondary, at a price of $55.00 per share for
net proceeds of approximately $115.4 million. IDT's ownership interest before
and after this transaction and the secondary (which occurred at the same time)
was 56.24% and 47.97%, respectively.
A $102.3 million pretax gain was recognized in fiscal 2000 in connection with
Net2Phone's exchange of its stock for Yahoo common stock and the exercise of
stock options.
F-26
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
- ---------------------------------------------------- ----------- ------------- --------------- --------------
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
2000
Reserves deducted from accounts receivable:
Allowance for doubtful accounts.................... $7,643,000 $20,154,000 $ (1,025,000) $26,771,000
__________
(1) Uncollectible accounts written off, net of recoveries.
F-27