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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, 1997 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-27898
IDT CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 22-3415036
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation and organization)
294 STATE STREET
HACKENSACK, NEW JERSEY 07601
(Address of principal executive offices, including zip code)
(201) 928-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
(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 28, 1997
of $18.00, as reported on the Nasdaq National Market, was approximately $160
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 have been excluded
from this computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of October 28, 1997 the Registrant had outstanding 11,788,321 shares of
Common Stock, $.01 par value, and 10,410,371 shares of Class A Common Stock,
$.01 par value.
INDEX
IDT CORPORATION
ANNUAL REPORT ON FORM 10-K
PAGE NO.
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PART I
Item 1. BUSINESS................................................................................... 1
RISK FACTORS............................................................................... 18
Item 2. PROPERTIES................................................................................. 30
Item 3. LEGAL PROCEEDINGS.......................................................................... 31
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................ 31
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...................... 32
Item 6. SELECTED FINANCIAL DATA.................................................................... 33
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...... 34
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................ 41
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE....... 41
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................... 42
Item 11. EXECUTIVE COMPENSATION..................................................................... 44
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................. 51
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................. 52
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................... 53
SIGNATURES.............................................................................................. 55
PART I
ITEM 1. BUSINESS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE "RISK FACTORS" SECTION OF ITEM 1. THE TERM "FISCAL YEAR," AS SET FORTH
HEREIN, REFERS TO THE TWELVE- MONTH PERIOD ENDING ON JULY 31 OF THE INDICATED
YEAR.
IDT Corporation ("IDT" or the "Company") is an international
telecommunications company which offers a broad range of integrated and
competitively priced long-distance telephone, Internet access and Internet
telephony services in the U.S. and abroad. The Company is an innovator in the
international telecommunications industry with its August 1996 introduction of
Net2Phone--the first commercial telephone service to bridge live calls between
personal computers and telephones via the Internet. The Company operates a
telecommunications network of switches and leased lines with interconnections to
other domestic and foreign carriers. As a result of industry deregulation,
increasing traffic volume, and an installed base of international customers, the
Company continues to build an international telecommunications infrastructure of
Company-owned switches and leased lines. As of July 31, 1997, IDT provides
international and domestic long-distance telephone services to over 60,000
individuals, businesses, and other telephone carriers in more than 130
countries. The Company has grown considerably in recent years, generating
revenues of $135.2 million for Fiscal 1997, versus revenues of $57.7 million for
Fiscal 1996 and revenues of $11.7 million for Fiscal 1995.
The Company operates a growing facilities-based telecommunications network
consisting of Company-owned switches in the United States and the United
Kingdom, dedicated leased fiber optic lines between the United States and United
Kingdom, and interconnections with interexchange carriers ("IXCs"), local
exchange carriers ("LECs") and government-owned postal, telegraph and telephone
monopolies ("PTTs") around the world. The Company has considerably grown its
international long distance customer base and routes a sufficient number of
international long distance minutes to cost-justify further network expansion.
The Company plans to expand its global telecommunications switching
infrastructure in order to reduce its operating costs and to broaden its
potential customer base. IDT plans to install Company-owned switches in France,
Germany and Italy by the end of fiscal 1998 and continues to pursue operating
agreements with overseas carriers to enable the Company to terminate traffic
directly to foreign carriers at advantageous rates. IDT also operates a national
Internet network comprised of multiple leased DS3 lines creating a 45 mbps high
speed backbone, together with leased T1 lines connecting approximately 75
Company-owned points of presence ("POPs") to the Company's Internet backbone.
Supplemented by its alliance partners, including PSINet Inc. ("PSI"), IDT now
operates one of the nation's largest Internet networks, which connects over 450
POPs owned by the Company and its Internet alliance partners. Through this
network, the Company provides dial-up and dedicated Internet access and on-line
service to approximately 85,000 individuals and business customers.
The Company is in the process of integrating its telecommunications and
Internet networks by enabling portions of the domestic Internet backbone to be
used for the transmission of both traditional and Internet telephony. If
successfully implemented, this leveraging of the available capacity over IDT's
Internet network could provide considerable economic efficiencies for
transporting much of the Company's domestic voice traffic. The Company believes
that the planned expansion of its international telecommunications network and
the integration of its networks through combined voice and data services, could
allow the Company to realize certain efficiencies and position itself among
those global telecommunications companies offering full service solutions and
employing innovative and converging technologies, which will enable it to
provide competitively priced international communications services.
The Company entered the international call reorigination business in 1990 to
capitalize on the opportunity created by the spread between U.S. and
foreign-originated international long-distance rates.
1
IDT leveraged the expertise derived from, and calling volume generated by, its
call reorigination business to enter the domestic long-distance business in late
1993, by reselling long-distance telecommunications services of other carriers
to IDT's domestic customers. As a value-added service for its domestic long-
distance customers, the Company began offering Internet access in early 1994,
eventually offering dial-up and dedicated Internet access to individuals and
businesses as stand-alone services. Throughout 1994, the Company focused on
developing and marketing its Internet services and offerings. In 1995, IDT began
reselling to other long-distance carriers access to the favorable international
and domestic long-distance telephone rates the Company obtains as a result of
its significant calling volume generated by its call reorigination customers. In
early 1996, the Company focused on the convergence between the
telecommunications circuit-switch and Internet packet-switch network by
developing its proprietary Internet telephony products. In August 1996, IDT
released a commercial version of it Net2Phone software enabling users to call
any phone in the world via the Internet using a multimedia PC.
The Company was founded in August 1990 and originally incorporated in New
York as "International Discount Telecommunications Corp." The Company was
renamed IDT Corporation and incorporated in the State of Delaware in December
1995. The Company's principal offices are located at 294 State Street,
Hackensack, New Jersey 07601, its main telephone number is (201) 928-1000 and
its website address is www.idt.net.
SERVICES
IDT offers its customers a wide array of domestic and international
telecommunications, Internet and Internet telephony services.
TELECOMMUNICATIONS SERVICES
The Company's four primary telecommunications services are: (i) carrier
services (wholesale international long distance provided to other carriers) (ii)
international long-distance services for individuals and businesses via call
reorigination services and international direct-dial services; (iii) marketing
to individuals and businesses of domestic long-distance services provided by
WorldCom, Inc. ("WorldCom"); and (iv) prepaid calling cards. IDT provides
international and domestic long-distance telephone service to over 60,000
customers in 130 countries worldwide, including over 25,000 international call
reorigination customers, and over 30,000 domestic long-distance services
customers.
INTERNATIONAL CARRIER SALES
The Company resells its competitive long-distance domestic and international
rates to third party IXCs and Competitive Access Providers ("CAPs"). In offering
this service, the Company leverages the rates that it is able to obtain through
(i) its extensive relationships in the long-distance telecommunications
industry, (ii) its inclusion in special tariffs written for a number of large
call reorigination clients, (iii) its ability to generate a high volume of
long-distance call traffic, and (iv) from advantageous rates negotiated with
foreign PTTs and competitive carriers. The Company enhances its ability to
resell such rates by using its least-cost routing ("LCR") platform to minimize
the per-minute resale cost to the third party IXC. Service is provided by
routing the IXC customer's minutes through the Company's LCR switching platform,
enabling the carrier customer to benefit from the competitive rates offered by
the Company. In some instances, instead of routing a call directly between two
overseas points, the Company may "back-haul" an overseas carrier's minutes using
resold switched services to the Company's U.S.-based switch in order to
terminate the traffic in a third country while taking advantage of the Company's
competitive U.S.-based international long distance rates.
INTERNATIONAL LONG-DISTANCE SERVICES
CALL REORIGINATION. The Company offers customers outside of the United
States international call reorigination services. Through this service, the
Company enables customers to access a U.S. dial tone
2
from overseas and place international calls that are reoriginated in the U.S.,
thereby benefiting from attractive U.S. outbound long-distance rates,
transmission quality, and enhanced services. In a typical call reorigination
scenario, an overseas customer dials a U.S. phone number and after one ring,
contact is made and the customer hangs up, with no charge for the inbound call.
The Company's switch then calls back a pre-set number and provides a U.S. dial
tone for the customer to connect and complete the call.
The Company also provides its call reorigination customers with access to
enhanced U.S. telecommunications service options at U.S. long-distance rates.
These options include: voicemail; itemized billing; speed dial codes that allow
customers convenient access to the call reorigination service; personalized
voice prompts that allow customers to be called back at extensions where the
party being dialed must be requested by name; remote programmable service that
allows customers the flexibility of selecting the number called back instead of
receiving the call at a pre-programmed number; access to U.S. toll-free 888 and
800 numbers; and one-leg billing that combines the cost of the call back to the
customer and the cost of the customer's outbound call from the United States in
one item for convenience and orderly presentation. The Company primarily markets
its call reorigination service to fixed site businesses and individuals. As of
July 31, 1997, the Company had more than 25,000 international call reorigination
customers in 120 countries.
INTERNATIONAL DIRECT-DIAL. As an alternative service, the Company provides
international long-distance services to certain overseas customers, currently in
the United Kingdom, via standard international direct-dial network services.
Through this service, the Company offers a foreign customer the ability to place
a direct call to an international destination over the Company's leased network
at competitive rates without the need for call reorigination. In those markets
that are deregulating, the Company's strategy is to migrate its call
reorigination customers to international direct-dial service, where the
operating environments warrant. The Company expects to offer international
direct dial service in France and Germany by the end of Fiscal 1998. However,
there can be no assurance that the Company will be able to offer this service in
these countries.
DOMESTIC LONG-DISTANCE SERVICES
The Company markets certain long-distance services directly to customers in
the United States. Under an agreement with a leading facilities-based U.S.
long-distance carrier, the Company resells domestic and international
long-distance services directly to U.S. retail customers at competitive rates.
The Company's customers save, on average, 10--50% off the rates for domestic
long-distance service charged by the major facilities-based carriers. The
Company markets the long-distance service as a value-added bundled service with
its dial-up Internet access, and offers customers who maintain minimum monthly
long-distance billing levels of $40 savings of approximately 20% off the rates
for dial-up Internet access that are charged by the major national Internet
service providers.
PREPAID CALLING CARDS
The Company also markets prepaid calling cards providing access to more than
230 countries and territories and international call origination and
termination. The Company's debit cards provide payment convenience and are
rechargeable. The Company's customers save on average 10-50% off the rates for
international calls that are charged by the major facilities-based carriers.
INTERNET TELEPHONY
In August 1996, the Company began offering the first commercial telephone
service to bridge live calls between personal computers and regular telephones
via the Internet, and to charge for this service on a per minute basis. Through
the Company's Net2Phone service, which is based upon its proprietary technology,
customers can place calls from multimedia computers and have the calls terminate
at regular telephones. Upon installation of the Net2Phone software, which is
provided by the Company without
3
charge, a Net2Phone user receives a unique account number, and chooses his or
her own 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. Upon a user's payment for Net2Phone "minutes," which
are currently required to be purchased in advance, the user may begin using
Net2Phone to place telephone calls worldwide.
All telephone calls made with Net2Phone are routed over the Company's
telecommunications switches. The Company takes advantage of its existing LCR
platform to increase the savings realized by international callers using
Net2Phone. For calls originating overseas, the cost of placing and terminating
the call with Net2Phone is up to 95% below the rates generally charged by
traditional foreign carriers to place and terminate standard international
telephone calls.
Net2Phone is currently used by over 300,000 customers in over 180 countries.
Total usage of Net2Phone increased from approximately 220,000 minutes in October
1996 to approximately 9 million minutes in October 1997. More than 5,000,000
calls have been placed worldwide through Net2Phone subscribers since its launch.
In July 1997, Net2Phone was recognized as the "Product of the Week" by PC
Magazine.
In October 1997, the Company released for beta testing in Cleveland, Ohio,
and Portland, Oregon, Net2Phone Direct, a commercial telephone service that
allows for international phone-to-phone calling via the Internet using packet
switching technology. The Company expects to shortly introduce Net2Phone Direct
for beta testing in the cities of Charlotte, South Carolina, and Cincinnati,
Ohio, and has entered into agreements to provide Net2Phone Direct service in
South Korea. Net2Phone Direct enables phone-to-phone calling between two parties
using regular telephones while using the Internet to transport the long-haul
components of the call. Users of Net2Phone Direct are able to call a local or
toll-free access number, which connects the call to an outbound switch server,
which connects the call to the Internet. Through such use of the Internet, the
Company expects to reduce significantly the cost of international calling while
extending the benefits of placing Internet telephone calls to customers with
access to a regular telephone without requiring the use of personal computers or
individual Internet access. The Company also has announced its intention to
develop a global network of switches and servers, thereby expanding the
Company's reach for providing competitively priced Internet telephony solutions.
The Company believes that any delays in the deployment of Net2Phone and
Net2Phone Direct switches and servers could delay final product introduction.
There can be no assurance that Net2Phone or Net2Phone Direct will gain market
acceptance for the technology or for the quality of the completed call, or that
the Company's competitors will not develop the ability to provide similar or
better services. The Company believes that Internet telephony applications are
an important emerging niche in the Internet industry and that other companies
will enter the market to offer additional Internet telephony products. The
Company believes that Net2Phone and Net2Phone Direct expand the role of the
Internet as a communications medium and allow substantial long-distance
telecommunications savings. However, because of the Company's extensive
experience in both the Internet access and telecommunications industries, the
Company believes that it is well-positioned to gain a competitive advantage in
offering personal computer-to-telephone and telephone-to-telephone Internet
telephony solutions.
INTERNET AND ON-LINE SERVICES
The Company's three primary Internet and on-line services are: (i) dial-up
Internet access for individuals and businesses; (ii) direct-connect dedicated
Internet services for corporate customers; and (iii) the Genie on-line
entertainment and information services. IDT has become one of the nation's
largest Internet access providers, providing local dial-up access to 85,000
customers and providing dedicated access to approximately 400 corporate
customers as of July 31, 1997. Through the build-out of its own infrastructure
and the recent agreement to utilize the PSI network as well the local networks
of its alliance
4
partners, IDT now operates one of the nation's largest networks providing local
dial-up Internet access through over 450 POPs, of which the Company owns
approximately 75 POPs.
DIAL-UP ACCESS SERVICES
The Company markets a dial-up service that allows individuals to obtain
unrestricted Internet access with an easy-to-use point-and-click graphical user
interface for a fixed monthly fee. IDT provides its customers with access to a
full range of Internet applications, including e-mail functions, Web sites,
USENET news groups, databases and public domain software, as well as a full
graphics package and browser software.
The Company provides its individual customer base with various pricing
options. Currently, the Company offers Basic Accounts for $19.95 per month, and
Premium Accounts for $29.95 per month. Each is a fully graphical SLIPP/PPP
account bundled with an Internet browser, unlimited dial-up Internet access, and
an e-mail account. Premium Account customers are entitled to the Reuters news
service, a second e-mail address, 8MB of personal Web space storage, and special
customer support services. The Company also offers basic Internet access
accounts for $15.95 per month for those customers who sign up for IDT's
long-distance telephone service and maintain their monthly long-distance
telephone billings at or above $40 per month. The Company offers free Basic
Accounts for those customers who sign up for IDT's long-distance telephone
service and maintain their monthly telephone billings at or above $150 per
month.
DIRECT-CONNECT DEDICATED SERVICES
The Company offers a variety of Internet access options and applications
specifically designed to address the unique needs of corporations, as well as
business professionals. These direct-connect clients typically require
high-speed dedicated circuits because either they desire to put up a Web site,
the nature of their business requires the transfer of large data files, or it
would be impractical for them to maintan dial-up accounts for all their
employees who require Internet access. IDT employs both frame relay technology
and dedicated connections to connect its clients' computers to the Internet
through local area networks ("LANs") and both 56Kbps and T1 lines. Currently,
the Company maintains a corporate client base comprised principally of
medium-sized to large businesses. The Company currently charges clients using
56Kbps lines approximately $350 per month for direct-connect service and clients
utilizing full T1s approximately $1,400 per month for direct connect service. As
of July 31, 1997, the Company had 400 direct connect subscribers.
GENIE SERVICES
In addition, the Company offers the legacy Genie on-line service, giving
subscribers access to roundtables, bulletin boards and chat areas, individual
and multi-player games, and premium news, travel, entertainment, weather and
other information services. Currently, the Company markets the Genie content as
an on-line service available only to subscribers. The Company offers Internet
access to Genie on-line subscribers for an additional fee, and intends to offer
the basic Genie Interactive service as a value-added service for the Company's
premium Internet access customers.
NETWORK INFRASTRUCTURE
The Company maintains an international telecommunications switching
infrastructure and U.S. domestic network of leased lines that enable it to
provide an array of telecommunications, Internet and Internet telephony services
to its customers. IDT believes it enjoys competitive advantages by utilizing
this network to carry both voice and Internet traffic, resulting in the
optimization of both its network utilization and associated capital.
5
TELECOMMUNICATIONS NETWORK
PRIVATE LINE NETWORK
The Company operates a growing telephone network consisting of resold
international switched services, U.S. domestic dedicated leased fiber optic
lines, and Company-owned switch equipment in the United States which are
interconnected to major international and domestic IXCs, LECs and Competitive
Local Exchange Carriers. IDT's major switching facilities are located in
Piscattaway, NJ, Westfield, NJ, New York, NY and London. 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 LECs, allowing the Company to interconnect with all
major IXCs to switch traffic via the Company's leased private line DS3 network.
Furthermore, all of the Company's locations are interconnected via leased lines
to enhance network reliability and redundancy as each location interconnects
with the various carriers from diverse POPs.
In addition, the Company obtains switched services to connect its U.S.
facilities and London. These services are used for the origination of traffic
from IDT's customer base in the United Kingdom and to terminate existing carrier
and call reorigination traffic to the United Kingdom. The Company has recently
signed terminating agreements to the Dominican Republic, Italy, Bangladesh,
Cyprus and Peru, in addition to other countries and plans to obtain leased lines
to these destinations which will result in reduced costs for termination to
these countries. The Company has also targeted countries such as France, Italy
and Germany for network expansion due to the large number of minutes the Company
presently terminates to these countries and the Company's installed base of
telecommunications customers in these countries.
SWITCHING PLATFORMS
The Company utilizes two major switching platforms for different tasks. The
Excel LNX is a smart switch which the Company uses for its application-based
products such as callback, direct dial, call through, debit cards, calling
cards, and value added services such as voice prompts, speed dialing, voice mail
and conferencing. The other platform is the Northern Telecom DMS250-300, which
serves as an international gateway and generic carrier switch.
The Company also plans to use certain technologies, such as Northern Telecom
ERS switches, which allow for the dynamic allocation of voice and data traffic,
to enable the Company's Internet network to be used for the transmission of
traditional telephone minutes. If successfully developed, this leveraging of
IDT's Internet network could provide considerable economic efficiencies for
transporting much of the Company's domestic voice traffic.
The Company's Excel LNX switch incorporates Company-developed software which
efficiently performs all the applications the Company requires to provide
value-added services as well as billing and traffic analysis. The software
enables the Excel to route all calls via the Company's LCR platform. LCR is a
process by which the Company optimizes the routing of calls over the least cost
route on its switch for over 230 countries. In the event that traffic cannot be
handled over the least cost route due to overflow, the LCR system is designed to
transmit the traffic over the next least cost route. The LCR system analyzes the
following variables that may effect the cost of a long distance call: different
suppliers, different time zones and multiple choices of terminating carrier per
country. The LCR system is continually reviewed in light of rates available from
different suppliers to different countries to determine whether the Company
should add new suppliers to its switch to further reduce the cost of routing
traffic to a specific country and to maintain redundancy, diversity and quality
within the switching network. The Excel is flexible and programmable, designed
to implement network-based intelligence quickly and efficiently. All the
Company's switches are modular, scaleable and equipped to signal in such
protocols as ISDN or SS7 so as to be compatible with either domestic or foreign
networks.
6
INTERNET NETWORK
IDT operates a national Internet "network" comprised of a leased DS3 45 mbps
backbone of high speed fiber optic lines connecting eight major cities across
the United States, 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 Northern Telecom ERS Magellan
switches. The DS3 backbone drains traffic at four major Internet "meet" points
where the Company maintains switching and routing equipment and has peering
arrangements to exchange Internet traffic with over twenty other Internet
backbone providers. To minimize the potential detrimental effects of single
points of failure, the Company deploys a minimum of two dedicated leased data
lines to each backbone node and remotely positions secondary servers for all
configuration and authentication hosts. Multiple data segments are used in high
traffic areas to minimize packet loss and to reduce the frequency of
"bottlenecks" in the network. Also, major IDT backbone nodes employ routing
switches for directing network traffic. To further enhance network performance,
the "Open Shortest Path First" protocol is employed to optimally configure
Internet routing tables and to allow data traffic to be routed most efficiently.
The Company seeks to retain flexibility and to maximize its opportunities by
utilizing a continuously changing mix of routing alternatives. This diversified
approach is intended to enable the Company to take advantage of the rapidly
evolving Internet market in order to provide low cost service to its customers.
The Company utilizes the local dial-up switching infrastructure of several
alliance partners across the country to supplement the Company's owned and
operated local dial up infrastructure. The alliance partners, which are
independently-owned Internet Service Providers ("ISPs"), employ routing and
modem equipment which meet the Company's standards for providing dial-up access
services. The Company offers the alliance partners a monthly fee for each
customer account funneled through their local access networks. The Company also
provides the billing, advertising, marketing and customer acquisition services,
in exchange for which the alliance partners provide local Internet access. The
agreements with alliance partners generally have one year terms and do not
prohibit the Company from constructing its own local installed POP where
warranted. Finally, the Company entered into an agreement with PSI in June 1996
to use PSI as the primary alliance partner for the Company's dial-up Internet
access customers in areas where PSI has POPs and where there are no pre-existing
alliance partners. The Company leases and operates a dedicated T3 connection to
the PSI network in order to maintain control of the Company's provisioning of
customers and to provide customers with access to electronic mail and newsfeeds.
The Company's Internet network includes over 405 POPs owned by PSI and the
alliance partners, and approximately 75 Company-owned POPs.
IDT's network is monitored on a 24 hours a day, 7 days a week, and 365 days
a year basis by its network operations center. The entire network is centrally
managed from IDT's control center through the use of a standardized
communications protocol. In addition, two proprietary monitoring systems are
used to manage modem pools.
RESEARCH AND DEVELOPMENT
The Company employs a technical staff that is devoted to the improvement and
enhancement of the Company's existing Internet and telecommunications products
and services, including switching technologies and the development of new
technologies and products, such as Net2Phone and Net2Phone Direct. The Company
believes that the ability to adjust and improve existing technology and to
develop new technologies in response to, and in anticipation of, customers'
changing demands is necessary to compete in the rapidly changing Internet and
telecommunications industries. There can be no assurance that the Company will
be able to successfully develop new technologies or effectively respond to
technological changes or new industry standards or developments on a timely
basis, if at all. See "Risk Factors-Rapid Technological Development; Proprietary
Rights."
7
SALES, MARKETING AND DISTRIBUTION
The Company's overall marketing strategy is to leverage its promotional and
advertising resources to sell the Company's full range of telecommunications and
Internet services. By marketing its telephone and Internet services as bundled
and integrated solutions, the Company believes it can gain a competitive
advantage while enhancing its international recognition as a comprehensive
provider of competitively priced communications services. The Company has
changed its customer acquisition strategy from direct sales via heavy
advertising to a wholesale, OEM approach. While this has slowed the growth of
its customer base, the Company has been able to successfully lower its costs of
acquiring new subscribers.
TELECOMMUNICATIONS
The Company primarily markets its international call reorigination services
through its overseas network of independent sales representatives. The foreign
sales representatives, who are supervised by the Company's U.S.-based sales
managers, provide the Company with access to local business clientele and
residential customers and continually emerging opportunities in the local
markets they serve. The Company pays its foreign sales representatives on a
commission basis. As of July 31, 1997, the Company was represented by 200
foreign sales representatives in 70 countries. In recent months, the Company
also has commenced direct sales efforts, primarily through overseas advertising
in international print media, to penetrate particular market segments not
currently served.
The Company's internal international carrier sales staff obtains and
remarkets competitive rates to other IXCs. The staff primarily relies on, and
benefits from, (i) the Company's extensive relationships within and increasing
international exposure and recognition throughout the long-distance industry for
marketing its carrier services, (ii) the Company's self-perpetuating
telecommunications model which should enable the Company to negotiate for lower
rates, and (iii) favorable terminating rates negotiated with foreign PTTs and
carriers.
INTERNET
The Company established itself as a leading national provider of Internet
access services primarily through extensive broadcast print advertising to the
consumer market. During Fiscal 1997 the Company has refocused the marketing
efforts of its Internet operations. While the Company intends to continue
various means of broadcast advertising in select markets, the Company's sales
and marketing efforts now are focused primarily on increasing its Internet
customer base through (i) OEM transactions, including hardware, software and
operating system bundling, (ii) retail channel distribution agreements and (iii)
bundling Internet access with long-distance telephone service. By applying the
above strategies, the Company believes it will increase its exposure to the
millions of computer users who are potential customers of the Company's Internet
access services, while reducing its customer acquisition costs as compared to
traditional broadcast and print advertising. As of July 31, 1997, the Internet
sales force consisted of approximately 25 salespersons. The Company's Internet
sales staff is closely supervised and undergoes customized and ongoing training
to ensure the highest level of knowledge and service.
INTERNET/LONG-DISTANCE BUNDLING
The Company bundles its Internet access services with its domestic
long-distance telephone services in order to maximize the Company's marketing
efforts for its Internet services while allowing for the acquisition of
telephone customers. By bundling its long-distance phone service with its $15.95
per month discounted dial-up Internet access, the Company is currently able to
compete with many major national providers of Internet access by offering rates
that are, on average 20% lower, and at the same time differentiate itself from
its competitors in the Internet access market who are unable to offer their
customers significant savings on their monthly long-distance bills. The Company
leverages its existing inbound Internet telesales group for the sale of its
bundled long-distance and Internet access service.
8
INTERNET TELEPHONY
The Company is currently marketing its Net2Phone Internet telephony solution
by distributing its Net2Phone software for free via the Internet and acquiring
commercial Net2Phone customers through its pre-paid, virtual debit-card system.
IDT currently promotes its Net2Phone service through on-line and Internet-based
advertising venues, traditional print advertising in international publications,
and electronic media. In addition, the Company has entered into agreements to
bundle the required software for Net2Phone, as a value-added component, with the
software of other companies, and with other PC and computer equipment. The
Company has entered into exclusive agreements with resellers in certain
countries, pursuant to which such resellers purchase millions of Net2Phone
"minutes" in advance, and have resold such minutes to users in thier own
countries as direct sellers of Net2Phone. The Company is also seeking to sell
its Net2Phone Direct switch servers to third parties in strategic markets
world-wide by leveraging its existing international network of independent sales
representatives.
CUSTOMER SUPPORT AND BILLING
The Company provides customer support for its call reorigination customers
to deal with both technical questions and billing issues. The customer support
staff focuses on responding rapidly to customers and is generally capable of
activating call reorigination service for new customers in 24 to 48 hours from
the time of subscription.
The Company believes that, in order to successfully compete in the
international call reorigination business, effective billing and collection
procedures and policies are necessary because the geographic dispersal of call
reorigination clients creates the potential for billing and collection
difficulties. Call reorigination customers have the option of either providing
the Company with a credit card or giving a security deposit or advance payment.
The Company reviews all account usage on a daily basis, regardless of the
payment mechanism. The Company charges credit card customers throughout the
month, whenever accumulated usage equals $250 dollars, and provides detailed
billing statements once a month. For cash customers, the Company generally
accepts either a two-month deposit or a prepayment. Via the daily monitoring
system, the Company attempts to prevent such customers from exceeding their
balance on hand at the Company. If a charge or credit card is declined or if the
customer has inadequate funds on deposit, the Company suspends the account to
minimize the Company's exposure to unauthorized usage. In addition, the Company
is developing a real-time billing platform for its call reorigination customers.
The Company expects this service to both provide more efficient customer service
and allow the Company to further limit its exposure to bad debt.
The Company believes that its ability to provide adequate customer support
services is a crucial component of its ability to retain customers. While the
Company has experienced difficulty in the provision of support services in the
past, it has successfully focused on improving such service through measures
including the addition of support personnel and the monitoring of customer
waiting time. The customer support staff provides 24-hour technical assistance
in addition to general service assistance. Customer support personnel
communicate with subscribers via telephone, e-mail and fax. The Company requires
that each customer support staff member field a minimum number of calls and
e-mails each day. The Company also employs liaisons between the customer support
and technical staffs to ensure maximum responsiveness to changing customer
demands.
9
COMPETITION
The markets in which the Company operates are extremely competitive and can
be significantly influenced by the marketing and pricing decisions of the larger
industry participants. Their barriers to entry are not insurmountable in either
the Internet access or any of the telecommunications markets in which the
Company competes. The Company expects competition in these markets to intensify
in the future.
TELECOMMUNICATIONS
Currently, the Company competes with (i) IXCs engaged in the provision of
long-distance access and other long-distance resellers and providers including
large carriers such as AT&T Corp. ("AT&T"), MCI Communications Corp. ("MCI"),
Sprint Corp. ("Sprint"), and WorldCom, (ii) foreign PTTs, (iii) other marketers
of international long-distance and call reorigination services such as Viatel,
Inc., Kallback, and RSL Communications, Ltd., (iv) wholesale providers of
international long distance services such as Pacific Gateway Exchange, Inc., (v)
alliances for providing wholesale carrier services such as "Global One" (Sprint,
Deutsche Telekom AG, and France Telecom S.A.) and "Concert" (British Telecom Plc
and MCI), and Uniworld (AT&T and Unisource--Telecom Netherlands, Telia AB, Swiss
Telecom PTT and Telefonica de Espana S.A.), (vi) new entrants to the long
distance market such as the regional bell operations companies ("RBOCs") in the
United States, who have entered or have announced plans to enter the U.S. intra
and interstate long-distance market pursuant to recent legislation authorizing
such entry, and utilities such as RWE AG in Germany, and (vii) small resellers
and facility-based IXCs. Moreover, some of the Company's competitors have
announced business plans similar to the Company's regarding the expansion of
telecommunications networks into Europe. Many of the Company's competitors are
significantly larger and have substantially greater market presence as well as
financial, technical, operational, marketing and other resources and experience
than the Company.
Because of their close ties to their national regulatory authorities,
foreign PTTs and newly-privatized versions thereof can directly pressure the
Company in their home countries by influencing regulatory authorities to outlaw
the provision of call reorigination services or by blocking access to the call
reorigination services the Company markets. There can be no assurance that such
behavior will not have a material adverse effect on the Company's business,
financial condition or results of operations. With the increasing privatization
of international telecommunications in foreign countries, it is also possible
that new foreign service providers, with close ties to their national regulatory
authorities and customer bases, will enter the call reorigination services
market in competition with the Company, or that PTTs will become deregulated and
gain the pricing flexibility to compete more effectively with the Company. The
ability of a deregulated PTT to compete on the basis of greater size and
resources and long-standing relationships with customers in its own country
could have a material adverse effect on the Company's business, financial
condition or results of operations.
The large U.S. long-distance carriers have, in the past, been reluctant to
compete directly with the PTTs by entering the international call reorigination
business and attempting to capture significant market share of the domestic
customers of the incumbent foreign PTTs. However, there can be no assurance that
other large carriers will not enter the call reorigination industry. Because of
their ability to compete on the basis of superior financial and technical
resources, the entry of AT&T or any other large U.S. long-distance carrier into
the international call reorigination business could have a material adverse
effect on the Company's business, financial condition or results of operations.
Also, the FCC's approval of call reorigination services where no foreign country
proscribes it is likely to stimulate additional entry by small carriers who
might target the same customer base as the Company does, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
Competition for customers in the telecommunication markets the Company
competes in is primarily on the basis of price and, to a lesser extent, on the
basis of the type and quality of service offered. Increased competition could
force the Company to reduce its prices and profit margins if the Company's
10
competitors are able to procure rates or enter into service agreements
comparable to or better than those the Company obtains, or to offer other
incentives to existing and potential customers. Similarly, the Company has no
control over the prices set by its competitors in the long-distance resale
carrier-to-carrier market. The Company could also face significant pricing
pressure if it experiences a decrease in its market share of international
long-distance traffic, as the Company's ability to obtain favorable rates and
tariffs depends, in large part, on the volume of international long-distance
call traffic the Company can generate for third-party IXCs. There is no
guarantee that the Company will be able to maintain the volume of domestic and
international long-distance traffic necessary to obtain favorable rates and
tariffs. Although the Company has no reason to believe that its competitors will
pursue directly aggressive pricing policies that could adversely affect the
Company, there can be no assurance that such price competition will not occur or
that the Company will be able to compete successfully in the future. In
addition, the Company is aware that its ability to market its carrier services
depends upon the existence of spreads between the rates offered by the Company
and those offered by the IXCs with whom it competes as well as those from whom
it obtains service. A decrease in such spreads could have a material adverse
effect on the Company's business, financial condition or results of operations.
INTERNET ACCESS
The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, operational, marketing and other resources and experience than the
Company. The Company's Internet access business competes or expects to compete
directly or indirectly with the following categories of companies: (i) other
national and regional commercial Internet access providers, such as Netcom
On-Line Communications Services, Inc. ("NETCOM") and PSI; (ii) established
on-line services companies that offer Internet access, such as America Online,
Inc. ("AOL"), CompuServe Corp. ("CompuServe") and Prodigy Services Company
("Prodigy"); (iii) software and technology companies such as Microsoft
Corporation ("Microsoft"); (iv) national long-distance telecommunications
carriers, such as AT&T, MCI, and Sprint; (v) RBOCs; (vi) cable television
operators, such as Comcast Corporation ("Comcast"), Tele-Communications, Inc.
("TCI") and Time Warner Inc. ("Time Warner"); (vii) nonprofit or educational
Internet service providers; (viii) newly licensed providers of spectrum-based
wireless data services; and (ix) competitive local telephone service providers
such as Teleport Communications Group ("TCG") and Metropolitan Fiber Systems
("MFS").
Many of the established on-line services companies and telecommunications
companies, such as AT&T and the RBOCs, have begun to offer or announced plans to
offer expanded Internet access services. The Company expects that all of the
major on-line services companies will eventually compete fully in the Internet
access market. In addition, the Company believes that new competitors, including
large computer hardware and software, cable, media, wireless, and wireline
telecommunications companies such as the RBOCs, will enter the Internet access
market, resulting in even greater competition for the Company. The ability of
these competitors or others to bundle services and products not offered by the
Company with Internet access services could place the Company at a significant
competitive disadvantage. In addition, certain of the Company's competitors that
are telecommunications companies may be able to offer customers reduced
communications charges in connection with their Internet access services or
other incentives, reducing the overall cost of their Internet access services
and increasing price pressures on the Company. This price competition could
reduce the average selling price of the Company's services. In addition,
increased competition for new subscribers could result in increased sales and
marketing expenses and related subscriber acquisition costs, which could
materially adversely affect the Company's profitability. There can be no
assurance that the Company will be able to offset the effects of any such price
reductions or incentives with an increase in the number of its customers, higher
revenue from enhanced services, cost reductions or otherwise.
Competition is also expected to increase in overseas markets, where Internet
access services have only recently been introduced. There can be no assurance
that the Company will be able to increase its presence
11
in the overseas markets it presently serves, or to enter other overseas markets.
There can be no assurance that the Company will be able to obtain the capital
required to finance such continued expansion. In addition, there can be no
assurance that the Company will be able to obtain the permits and operating
licenses required for it to operate, hire and train employees or market, sell
and deliver services in foreign countries. Further, entry into foreign markets
will result in competition from companies that may have long-standing
relationships with or possess a better understanding of their local markets,
regulatory authorities, customers and suppliers. There can be no assurance that
the Company can obtain similar levels of local knowledge, and failure to obtain
that knowledge could place the Company at a significant competitive
disadvantage. To the extent the ability to provide access to locations and
services overseas becomes a competitive advantage in the Internet access
industry, failure of the Company to penetrate overseas markets or to increase
its presence in the overseas markets it presently serves may result in the
Company being at a competitive disadvantage relative to other Internet access
providers.
The Company believes that its ability to compete successfully in the
Internet access market depends upon a number of factors, including: market
presence; the adequacy of the Company's customer support services; the capacity,
reliability and security of its network infrastructure; the ease of access to
and navigation of the Internet; the pricing policies of its competitors and
suppliers; regulatory price requirements for interconnection to and use of
existing local exchange networks by Internet services; the timing of
introductions of new products and services by the Company and its competitors;
the Company's ability to support existing and emerging industry standards; and
trends within the industry as well as the general economy. There can be no
assurance that the Company will have the financial resources, technical
expertise or marketing and support capabilities to continue to compete
successfully in the Internet access market.
INTERNET TELEPHONY
Numerous companies have entered the Internet telephony market in the past
year and a half and have established their Internet telephony products in the
marketplace before the Company's August 1996 introduction of its Net2Phone
service and imminent release of Net2Phone Direct. Most of the current Internet
telephony products enable voice communications over the Internet between two
parties simultaneously connected to the Internet via multimedia-equipped
personal computers, where both parties are using identical Internet telephony
software products. These products include Internet Phone form VocalTec Ltd.
("VocalTec"), WebPhone from QuarterDeck Corporation ("QuarterDeck") and
NetMeeting from Microsoft. Recently, Intel Corporation announced a new
technology aimed at standardizing and improving the compatibility of the various
Internet telephony software products, enabling customers of different Internet
telephony software products to communicate with one another over the Internet.
Furthermore, a number of companies including Dialogic Corp. ("Dialogic") and
Northern Telecom Limited ("Northern Telecom") have developed or announced their
intentions to offer server-based products which are expected to allow
communications over the Internet between parties using a personal computer and
regular telephone and between two parties using telephones where both parties
have these specialized servers at both ends of the call. While the Company's
Net2Phone and Net2Phone Direct services differ from the above mentioned products
in that they allow PC-to-telephone and phone-to-phone communications over the
Internet, with the Internet transmission service connected to the public
switched telephone network at centralized switching platforms owned by the
Company, and where users of the service are billed on a per-minute basis, there
can be no assurance that the Company will be able to successfully compete in the
developing Internet telephony market. Although Internet telephony continues to
be an area of intense focus from various Internet software providers,
traditional telephone service companies and telephone equipment manufacturers,
there can be no assurance that Internet telephony will gain market acceptance or
prove to be a viable alternative to traditional telephone service. Many
international telephone callers, accustomed to the convenience and quality of
phone-to-phone international calling via traditional circuit switch telephone
networks, may not switch to Internet telephony services notwithstanding the
potential cost savings.
12
REGULATION
TELECOMMUNICATIONS
As a multinational telecommunications company, the Company is subject to
varying degrees of regulation in each of the jurisdictions in which it operates.
As a non-dominant carrier in the United States, the Company's provision of
international and national long distance telecommunications services is
generally regulated on a streamlined basis. 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 not yet
open to switched voice service competition, the Company provides services to
closed user groups ("CUGs") and a variety of value-added services as permitted
by each country's laws.
REGULATION OF DOMESTIC TELECOMMUNICATIONS SERVICES. In the United States,
provision of the Company's services is subject to the provisions of the
Communications Act, as amended by the Telecommunications Act of 1996 and the FCC
regulations promulgated thereunder, as well as the applicable laws and
regulations of the various states administered by the relevant state PSCs. The
recent trend in the United States, for both federal and state regulation of
telecommunications service providers, has been in the direction of reducing
regulation. Nonetheless, the FCC and relevant state PSCs 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. On March 21, 1997, the FCC initiated a proceeding in
which it proposed to eliminate the requirement that non-dominant interstate
carriers such as the Company maintain tariffs on file with the FCC for domestic
interstate services. The FCC's proposed rules are pursuant to authority granted
to the FCC in the Telecommunications Act to "forbear" from regulating any
telecommunications service provider if the FCC determines that the public
interest will be served. The FCC subsequently adopted its proposal and
eliminated the requirement that interstate carriers file domestic tariffs. That
decision has been appealed to the Federal Court of Appeals for the 8th Circuit
and a stay has been issued pending a decision on the merits of the appeal. It is
unclear when the Court will rule on the appeal.
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of universal
telephone service (the "Universal Service Order"). The Universal Service Order
requires all telecommunications carriers providing interstate telecommunications
services to contribute to universal support by contributing to a fund (the
"Universal Service Fund"). Universal service contributions will be assessed
based on intrastate, interstate, and international "end-user" gross
telecommunications revenues effective January 1, 1998. All carriers were
required to submit a Universal Service Fund Worksheet in September 1997. The
Company has filed its Universal Service Fund worksheet. Although the FCC has not
yet determined the contribution assessment rate, the Company estimates the
assessment could be as much as 4.5% or more of such revenues for the calendar
year 1998, and would increase in subsequent years.
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 is certified to
provide intrastate interexchange telecommunications services in 43 states. State
issued certificates of authority to provide intrastate interexchange
telecommunications services can generally be conditioned, modified, canceled,
terminated, or revoked by state regulatory authorities for failure to comply
with state law and/or the rules, regulations and policies of the state
regulatory authorities. Fines and other penalties also may be imposed for such
violations.
U.S. REGULATION OF INTERNATIONAL TELECOMMUNICATIONS SERVICES. International
common carriers, such as the Company, are required to obtain authority under
Section 214 of the Communications Act and file a tariff containing the rates,
terms and conditions applicable to their services prior to initiating their
international telecommunications services. The Company has obtained a "global"
Section 214 authority
13
from the FCC to use, on a facilities and resale basis, various transmission
media for the provision of international switched and private line services.
Non-dominant international carriers such as the Company must file their
international tariffs and any revisions thereto with one day's notice.
Additionally, international telecommunications service providers are required to
file copies of their contracts with other carriers, including foreign carrier
agreements, with the FCC within 30 days of execution. The FCC's rules also
require that the Company file periodically a variety of reports regarding the
volume of its international traffic and revenues and use of international
facilities. In addition to the general common carrier principles, and as
discussed below, the Company is also required to conduct its facilities-based
international business in compliance with the FCC's International Settlements
Policy ("ISP"), or an FCC approved alternative accounting rate arrangement.
The Company's FCC authorizations also permit the Company to resell
international private lines interconnected to the PSTNs for the provision of
switched services in those countries that have been found by the FCC to offer
"equivalent opportunities" to U.S. carriers. To date, the FCC has found that
only Canada, the United Kingdom, Sweden and New Zealand offer such
opportunities. The FCC currently imposes certain restrictions upon the use of
the Company's private lines between the United States and "equivalent"
countries. The Company may not route traffic to or from the United States over a
private line between the United States and an "equivalent" country (I.E., the
united Kingdom) if such traffic originates or terminates in a third country, if
the third country has not been found by the FCC to offer "equivalent" resale
opportunities. Following implementation of the Full Competition Directive by EU
member states, and the World Trade Organization ("WTO") Agreement by the
signatories, the FCC may authorize the Company to originate and terminate
traffic over its private line between the United States and the United Kingdom
and (pursuant to ISR authority) over additional private lines to additional
member states if the FCC finds that such additional member states provide
equivalent resale opportunities or that such authority would otherwise promote
competition. The FCC has also recently proposed to permit U.S. carriers to
provide ISR to WTO member countries without a finding of equivalency.
With regard to international services, the FCC administers a variety of
international service regulations, including the International Settlements
Policy ("ISP"). The ISP governs the permissible arrangements between U.S.
carriers and their foreign correspondents to settle the cost of terminating
traffic over each other's networks, the rates for such settlement and
permissible deviations from these policies. As a consequence of the increasingly
competitive global telecommunications market, the FCC has adopted a number of
policies that permit carriers to deviate from the ISP under certain
circumstances that promote competition. The FCC also requires carriers such as
the Company to report any affiliations, as defined by the Commission, with
foreign carriers.
Regulatory requirements pertinent to the Company's operations will continue
to evolve as a result of the WTO Agreement, federal legislation, court
decisions, and new and revised policies of the FCC. In particular, the FCC
continues to refine its international service rules to promote competition,
reflect and encourage liberalization in foreign countries and reduce
international accounting rates toward cost. Indeed, the FCC recently adopted new
lower accounting rate "benchmarks" that become effective in January 1, 1998.
Under the FCC's new benchmarks, after a transition period of one to four years
depending on a country's income level, U.S. carriers will be required to pay
foreign carriers significantly lower rates for the termination of international
services. These rates range from $.15/minute benchmark for upper income
countries such as the United Kingdom to $.23/minute for lower income countries
such as China. Moreover, the FCC recently initiated a proceeding proposing to
revise its Foreign Carrier Entry Policy as part of its efforts to change its
rules to implement the WTO Agreement. In addition, the FCC is currently
considering whether to limit or prohibit the practice whereby a carrier routes,
through its facilities in a third country, traffic originating from one country
and destined for another country. The FCC has permitted third country calling
where all countries involved consent to the routing arrangements (referred to as
"transiting"). Under certain arrangements referred to as "refiling," the carrier
in the destination country does not consent to receiving traffic from the
originating country and does not realize
14
the traffic it receives from the third country is actually originating from a
different country. The FCC to date has made no pronouncement as to whether
refiling arrangements are inconsistent with U.S. or ITU regulations, although it
is considering these issues in connection with MCI's 1995 petition to the FCC
for declaratory ruling regarding Sprint's FONACCESS service. It is possible that
the FCC will determine that refiling violates U.S. and/or international law.
EUROPEAN REGULATION OF TELECOMMUNICATIONS SERVICES. In Europe, the
regulation of the telecommunications industry is governed at a supra-national
level by the EU (consisting of the following member states: Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the
Netherlands, Portugal, Spain, Sweden, and the United Kingdom), which is
responsible for creating pan-European policies and, through legislation, has
developed a regulatory framework to ensure an open, competitive
telecommunications market. The EU was established by the Treaty of Rome and
subsequent conventions and is authorized by such treaties to issue EU
"directives." EU member states are required to implement these directives
through national legislation. If an EU member state fails to adopt such
directives, the European Commission may take action, including referral to the
European Court of Justice, to enforce the directives.
In 1990, the EU issued the Services Directive requiring each EU member state
to abolish existing monopolies in telecommunications services, with the
exception of voice telephony. The intended effect of the Services Directive was
to permit the competitive provision of all services other than voice telephony,
including value-added services and voice services to CUGs. However, as a
consequence of local implementation of the Services Directive through the
adoption of national legislation, there are differing interpretations of the
definition of prohibited voice telephony and permitted value-added and CUG
services. Voice services accessed by customers through leased lines are
permissible in all EU member states. The European Commission has generally taken
a narrow view of the services classified as voice telephony, declaring that
voice services may not be reserved to the ITOs if (i) dedicated customer access
is used to provide the service, (ii) the service confers new value-added
benefits on users (such as alternative billing methods) or (iii) calling is
limited by a service provider to a group having legal, economic or professional
ties.
In March 1996, the EU adopted the Full Competition Directive containing two
provisions which required EU member states to allow the creation of alternative
telecommunications infrastructures by July 1, 1996, and which reaffirmed the
obligation of EU member states to abolish the ITOs' monopolies in voice
telephony by 1998. The Full Competition Directive encouraged EU member states to
accelerate liberalization of voice telephony. To date, Sweden, Finland, Denmark
and the United Kingdom have liberalized facilities-based services to all routes.
Certain EU countries may delay the abolition of the Voice Telephony monopoly
based on exemptions established in the Full Competition Directive. These
countries include Spain (1998), Portugal and Ireland (January 1, 2000) and
Greece (2003).
Each EU member state in which the Company currently conducts or plans to
conduct its business has a different regulatory regime and such differences are
expected to continue beyond January 1998. The requirements for the Company to
obtain necessary approvals vary considerably from country to country and are
likely to change as competition is permitted in new service sectors.
OTHER OVERSEAS MARKETS.
The Company is subject to the regulatory regimes in each of the countries in
which it conducts business. Local regulations range from permissive to
restrictive, depending upon the country. In the past, the Company has
experienced problems in certain countries and has, in certain instances,
modified or terminated its services to comply with local regulatory
requirements.
15
INTERNET
Internet access providers are generally considered "enhanced service
providers" and are exempt from federal and state regulations governing common
carriers. Accordingly, the Company's provisioning of Internet services are
currently exempt from tariffing, certification, and rate regulation.
Nevertheless, regulations governing disclosure of confidential communications,
copyright, excise tax, as well as other requirements may apply to IDT's
provision of Internet services. The Company cannot predict the likelihood that
state, federal or foreign governments will impose additional regulation on the
Company's Internet business, nor can it predict the impact that future
regulation will have on the Company's operations.
The 1996 Telecommunications Act imposes criminal liability on persons
sending or displaying in a manner available to minors indecent material on an
interactive computer service such as the Internet. The 1996 Telecommunications
Act also imposes criminal liability on an entity knowingly permitting facilities
under its control to be used for such activities. Entities solely providing
access to facilities not under their control are exempted from liability, as are
service providers that take good faith, reasonable, effective and appropriate
actions to restrict access by minors to the prohibited communications. The
constitutionality of these provisions has been successfully challenged in
federal appellate court, and the interpretation and enforcement of them is
uncertain. The Act may decrease demand for Internet access, chill the
development of Internet content, or have other adverse effects on Internet
access providers such as the Company. In addition, in light of the uncertainty
attached to interpretation and application of this law, there can be no
assurances that the Company would not have to modify its operations to comply
with the statute, including prohibiting users from maintaining home pages on the
WWW, and increasing its control over the GENIE INTERACTIVE content.
In December 1997, the FCC initiated a Notice of Inquiry ("NOI") regarding
whether to impose regulation or surcharges upon providers of Internet access and
Information Service ("Internet NOI"). The Internet NOI seeks public comment upon
whether to impose or continue to forebear from regulation of Internet and other
packet-switched network service providers. The Internet NOI specifically
identifies Internet telephony as a subject for FCC consideration. The Company
can not predict the outcome of the FCC proceeding or the impact of any
additional regulations or charges the FCC may impose on IDT's Internet and
Internet telephony businesses.
INTERNET TELEPHONY
The Company knows of no domestic or foreign laws that prohibit voice
communications over the Internet. As identified above, the FCC is currently
considering whether or not to impose surcharges or additional regulation upon
providers of Internet telephony. In addition, several efforts have been made to
enact federal legislation that would either regulate or exempt from regulation
services provided over the Internet. State public utility commissions may also
retain jurisdiction to regulate the provision of intrastate Internet telephone
services and could initiate proceedings to regulate Internet telephony. If a
foreign government, Congress, the FCC, or a state utility commission regulate
Internet telephony, there can be no assurances that any such regulation will not
materially adversely affect the Company's business, financial condition or
results of operation.
INTELLECTUAL PROPERTY
The Company's success and ability to compete is dependent in part upon its
technology, although the Company believes that its success is more dependent
upon its technical expertise than its proprietary rights. The Company relies on
a combination of patent, copyright, trademark and trade secret laws and
contractual restrictions to establish and protect its technology. The Company
does not have any issued patents or registered copyrights, although it has
registered trademarks in connection with the Genie services and other pending
applications for a patent and certain trademarks. The Company requires
16
employees and consultants to execute confidentiality agreements upon the
commencement of their relationships with the Company. These agreements provide
that confidential information developed or made known during the course of a
relationship with the Company is to be kept confidential and may not be
disclosed to third parties except in specific circumstances. There can be no
assurance that the steps taken by the Company will be adequate to prevent
misappropriation of its technology or other proprietary rights or that the
Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology. In addition,
there can be no assurance that licenses for any intellectual property that might
be required by the Company for it to provide its services or products would be
available on reasonable terms, if at all.
The Company owns a trademark registrations for the mark GENIE. The Company
has also registered the service mark IDT and its logo. In addition, the Company
has applications pending with respect to the registration of the service marks
IDT, NET2PHONE, N2P, AMTALK, Amtalk design, and NET2FAX. In addition, the
Company has applied for a patent in connection with its development of the
systems and methodology comprising the technologies underlying Net2Phone. There
can be no assurance that the Company's competitors will not develop the ability
to provide similar or better services than that of Net2Phone. In addition, there
can be no assurance that the Company's patent application relating to the
systems and methodology comprising the technologies underlying Net2Phone will
result in any patent being issued or that, if issued, any patent will provide
protection against competitive technology or will be held valid and enforceable
if challenged, or that the Company's competitors would not be able to design
around such patent; nor can there be any assurance that others will not obtain
patents that the Company would need to license or circumvent to practice its
patent. See "Risk Factors-Dependence on Technological Development."
EMPLOYEES
As of July 31, 1997, the Company had approximately 360 full-time employees,
including approximately 120 in technical support and customer service, 75 in
sales and marketing, 50 in its technical staff, 75 in general operations and 40
in management and finance. The Company believes that its relations with its
employees are good. None of the Company's employees is represented by a labor
union or covered by a collective bargaining agreement and the Company has never
experienced a work stoppage.
17
RISK FACTORS
FORWARD-LOOKING STATEMENTS. THIS REPORT ON FORM 10-K CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. SUCH
FORWARD-LOOKING STATEMENTS INCLUDE, AMONG OTHER THINGS, THE COMPANY'S PLANS TO
IMPLEMENT ITS GROWTH STRATEGY, IMPROVE ITS FINANCIAL PERFORMANCE, EXPAND ITS
INFRASTRUCTURE, DEVELOP NEW PRODUCTS AND SERVICES, EXPAND ITS SALES FORCE,
EXPAND ITS CUSTOMER BASE AND ENTER INTERNATIONAL MARKETS. SUCH FORWARD-LOOKING
STATEMENTS ALSO INCLUDE THE COMPANY'S EXPECTATIONS CONCERNING FACTORS AFFECTING
THE MARKETS FOR ITS PRODUCTS, SUCH AS DEMAND FOR LONG-DISTANCE
TELECOMMUNICATIONS, INTERNET ACCESS AND ON-LINE AND INTERNET TELEPHONY SERVICES.
ACTUAL RESULTS COULD DIFFER FROM THOSE PROJECTED IN ANY FORWARD-LOOKING
STATEMENTS FOR THE REASONS DETAILED IN THE "RISK FACTORS" BELOW AS WELL AS IN
OTHER SECTIONS OF THIS REPORT ON FORM 10-K. THE FORWARD-LOOKING STATEMENTS ARE
MADE AS OF THE DATE OF THIS 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 THE RISK FACTORS AND THE OTHER INFORMATION
SET FORTH FROM TIME TO TIME IN THE COMPANY'S REPORTS ON FORM 10-Q, 8-K, 10-K AND
ANNUAL REPORT TO STOCKHOLDERS.
LIMITED OPERATING HISTORY; OPERATING LOSSES; FLUCTUATIONS IN OPERATING RESULTS
The Company commenced operations in August 1990 as one of the first
providers of international call reorigination, or call-back services and entered
the Internet access business in February 1994. Accordingly, the Company has only
a limited operating history upon which an evaluation of it and its prospects can
be based. Although the Company has experienced substantial revenue growth since
its incorporation, it has incurred losses of approximately $300,000, $2.1
million, $15.6 and $3.8 million in Fiscal 1994, Fiscal 1995, Fiscal 1996, and
Fiscal 1997 respectively. As of July 31, 1997, the Company had an accumulated
deficit of approximately $21.9 million. The Company's current focus is on
expanding its network infrastructure to achieve economies of scale, improve
network performance, and enable the Company to expand its geographic reach for
potential telecommunications and Internet subscribers. Consequently, the Company
continues to make capital expenditures and incur additional operating costs to
hire additional personnel and increase its expenses related to product
development, marketing, network infrastructure, technical resources and customer
support. The pursuit of such objectives can be expected to have an adverse
impact on the Company's profit margins for at least the near-term and until the
Company can increase its customer bases sufficiently to recover the costs of
such expansions. In addition, an acceleration in the growth of the Company's
subscriber bases or changes in usage patterns among subscribers may also
increase the Company's costs as a percentage of revenues. There can be no
assurance that revenue growth will continue or that the Company will be
profitable in Fiscal 1998 or will at any time in the future achieve or sustain
profitability.
The Company's quarterly operating results have fluctuated in the past as the
Company's business has evolved, and may fluctuate significantly in the future as
a result of a variety of factors, some of which are outside of the Company's
control. These factors include general economic conditions, acceptance and use
of the Internet, user demand for long-distance telecommunications services,
capital expenditures and other costs relating to the expansion of operations,
the timing and costs of any acquisitions of technologies or businesses,
government regulation, the timing of new product announcements by the Company or
its competitors, changes in pricing strategies by the Company or its
competitors, changes in the mix of services sold by the Company market
availability and acceptance of new and enhanced versions of the Company's or its
competitors' products and services and the rates of new subscriber acquisition
and retention. These factors could also have a material adverse effect on the
Company's business, financial condition or results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Quarterly Results of Operations."
RISKS OF EXPANSION AND IMPLEMENTATION OF GROWTH STRATEGY
The Company's rapid growth and expansion into new businesses have placed,
and may continue to place, a strain on the Company's management, administrative,
operational, financial and technical
18
resources and increased demands on its systems and controls. Demands on the
Company's network resources and technical staff and resources have grown rapidly
with the Company's expanding customer bases, and the Company has in the past
experienced difficulties satisfying the demand for its services. The Company has
experienced delays in shipping the Company's software, resulting in billing
subscribers in advance of software receipt, and from time to time, subscribers
have experienced significant delays both in accessing the Internet through the
Company's modems and in contacting, and in receiving responses from, the
Company's customer and technical support personnel. In certain situations, these
events have created customer relations issues for the Company and resulted in
cancellations of subscriptions. There can be no assurance that the Company's
improved technical staff and resources will be adequate to facilitate the
Company's growth. A failure to effectively provide customer and technical
support services will affect adversely the Company's ability to attract and
maintain its customer base. The Company expects to experience continued strain
on its operational systems as it develops, operates and maintains its network.
Expected increases in the Company's telecommunications customer and Internet
subscriber bases will produce increased demands on its sales, marketing and
administrative resources, its engineering and technical resources, and its
customer and technical support resources, as well as on its switching and
routing capabilities and network infrastructure. As of July 31, 1996 and July
31, 1997, the Company had approximately 462 and 360 employees, respectively. The
Company believes that it will need, both in the short-term and the long-term, to
hire additional sales and marketing and technical personnel as well as qualified
administrative and management personnel in its accounting and finance areas to
manage its financial control systems. Although the Company has hired additional
personnel and upgraded certain of its systems, there can be no assurance that
the Company's administrative, operating and financial control systems,
infrastructure, personnel and facilities will be adequate to support the
Company's future operations or to maintain and effectively adapt to future
growth.
There can be no assurance that the Company will be able to install
additional POPs, or expand its telecommunications infrastructure, add services,
expand its customer bases and geographical markets or implement the other
features of its business strategy at the rate or to the extent presently
planned. There can be no assurance that IDT's business strategy will be
successful. The Company's ability to continue to grow may be affected by various
factors, many of which are not within the Company's control, including U.S. and
foreign regulation of the telecommunications and Internet industries,
competition and technological developments. Part of the Company's growth
strategy is dependent upon the continued deregulation of foreign
telecommunications markets. There can be no assurance that such deregulation
will occur when or to the extent anticipated. The effect of foreign deregulation
on the Company is also uncertain. While the Company expects that deregulation
will give rise to new opportunities, the increase in competition expected to
result from deregulation could cause the Company's call reorigination business
to suffer and could have other material adverse effects on the business,
financial condition or results of operations of the Company. The inability to
continue to upgrade the networking systems or the operating and financial
control systems, the inability to recruit and hire necessary personnel or the
emergence of unexpected expansion difficulties could have a material adverse
effect on the Company's business, financial condition or results of operations.
INCREASING COMPETITION
The markets in which the Company operates are extremely competitive and can
be significantly influenced by the marketing and pricing decisions of the larger
industry participants. There are no substantial barriers to entry in either the
Internet access or any of the telecommunications markets in which the Company
competes. The Company expects competition in these markets to intensify in the
future.
TELECOMMUNICATIONS
Currently, the Company competes with (i) IXCs engaged in the provision of
long-distance access and other long-distance resellers and providers including
large carriers such as AT&T, MCI, Sprint, and
19
WorldCom, (ii) foreign PTTs, (iii) other marketers of international
long-distance and call reorigination services such as Viatel, Kallback, and RSL
Communications, (iv) wholesale providers of international long distance services
such as Pacific Gateway, (v) alliances for providing wholesale carrier services
such as "Global One" (Sprint, Deutsche Telekom, and France Telecom), "Concert"
(British Telecom and MCI) and Uniworld (AT&T and Unisource--Telecom Netherlands,
Telia AB, Swiss Telecom PTT and Telefonica de Espana S.A.), (vi) new entrants to
the long distance market such as the RBOCs in the United States, who have
entered or have announced plans to enter the U.S. interstate long-distance
market pursuant to recent legislation authorizing such entry, and utilities such
as RWE in Germany, and (vii) small resellers and facility-based IXCs. Moreover,
some of the Company's competitors have announced business plans similar to the
Company's regarding the expansion of telecommunications networks into Europe.
Many of the Company's competitors are significantly larger and have
substantially greater market presence and financial, technical, operational,
marketing and other resources and experience than the Company.
Because of their close ties to their national regulatory authorities,
foreign government-owned PTTs may directly pressure the Company in their home
countries by influencing regulatory authorities to outlaw the provision of call
reorigination services or by blocking access to the call reorigination services
the Company markets. Similar pressure can be applied by newly-privatized former
PTTs and other home country competitors in nations that have eliminated
government ownership of the PTT. Although the Company has not suffered a
material adverse effect due to anti-competitive behavior on the part of the PTTs
(or former PTTs) to date, there can be no assurance that such behavior will not
in the future cause a material adverse effect on the Company's business,
financial condition or results of operations. With the increasing privatization
of international telecommunications in foreign countries, PTTs may increasingly
become deregulated and free to compete more effectively with the Company at
competitive rates. Deregulation in foreign countries also could result in
competition from other service providers with large, established customer bases
and close ties to governmental authorities in their home countries. Deregulation
and increased competition in foreign markets could cause prices for direct-dial
international calls to decrease so much that customers are no longer willing to
use the Company's international call reorigination services. The ability of a
deregulated PTT or another home country service provider to compete on the basis
of greater size and resources, pricing flexibility and long-standing
relationships with customers in its own country could have a material adverse
effect on the Company's business, financial condition or results of operations.
The large U.S. long-distance carriers have, in the past, been reluctant to
compete directly with the PTTs by entering the international call reorigination
business and attempting to capture significant market share of the domestic
customers of the incumbent overseas PTTs. However, there can be no assurance
that other large carriers will not enter the call reorigination industry.
Because of their ability to compete on the basis of superior financial and
technical resources, the entry of AT&T or any other large U.S. long-distance
carrier into the international call reorigination business could have a material
adverse effect on the Company's business, financial condition or results of
operations. Also, the FCC's approval of call reorigination services where no
foreign country proscribes it is likely to stimulate additional entry by small
carriers who might target the same customer base as the Company does, which
could have a material adverse effect on the Company's business, financial
condition or results of operations.
Competition for customers in the telecommunication markets the Company
competes in is primarily on the basis of price and, to a lesser extent, on the
basis of the type and quality of service offered. Increased competition could
force the Company to reduce its prices and profit margins if the Company's
competitors are able to procure rates or enter into service agreements
comparable to or better than those the Company obtains or markets or are able to
offer other incentives to existing and potential customers. Similarly, the
Company has no control over the prices set by its competitors in the
long-distance resale market. The Company could also face significant pricing
pressure if it experiences a decrease in its market share of international
long-distance traffic because the Company's ability to obtain favorable rates
and tariffs from its carrier suppliers depends, in large part, on the Company's
total volume of long-distance traffic. There is no guarantee that the Company
will be able to maintain the volume of domestic and
20
international long-distance traffic necessary to obtain favorable rates and
tariffs. The Company is aware that its ability to market its long-distance
resale services depends upon the existence of spreads between the rates offered
by the Company and those offered by the IXCs with whom it competes as well as
those from whom it obtains service. A decrease in such spreads or price
competition in the Company's markets could have a material adverse effect on the
Company's business, financial condition or results of operations. See "Risk
Factors--Dependence on Others" and "Business-Competition."
INTERNET ACCESS
The Company's current and prospective competitors include many large
companies that have substantially greater market presence as well as financial,
technical, operational, marketing and other resources and experience than the
Company. The Company's Internet access business competes or expects to compete
directly or indirectly with the following categories of companies: (i) other
national and regional commercial Internet access providers, such as NETCOM and
PSI; (ii) established on-line services companies that currently offer or are
expected to offer Internet access, such as AOL, CompuServe, and Prodigy; (iii)
computer hardware and software and other technology companies, such as
Microsoft; (iv) national long-distance telecommunications carriers, such as
AT&T, MCI, and Sprint; (v) RBOCs; (vi) cable television system operators, such
as Comcast, TCI, and Time Warner; (vii) nonprofit or educational ISPs; and
(viii) newly-licensed providers of spectrum-based wireless data services. See
"Business-Competition."
Many of the established on-line services companies and telecommunications
companies, such as AT&T and the RBOCs, have begun to offer or announced plans to
offer expanded Internet access services. The Company expects that all of the
major on-line services companies will eventually compete fully in the Internet
access market. In addition, the Company believes that new competitors, including
large computer hardware and software, cable, media, wireless, and wireline
telecommunications companies, will enter the Internet access market, resulting
in even greater competition for the Company. The ability of these competitors or
others to bundle with Internet access services other services and products not
offered by the Company could place the Company at a significant competitive
disadvantage. In addition, certain of the Company's competitors that are
telecommunications companies may be able to provide customers with reduced
communications costs in connection with their Internet access services or other
incentives, reducing the overall cost of their Internet access solution and
significantly increasing price pressures on the Company. This price competition
could result in significant reductions in the average selling price of the
Company's services. In addition, increased competition for new subscribers could
result in increased sales and marketing expenses and related subscriber
acquisition costs, which could materially adversely affect the Company's
profitability. There can be no assurance that the Company will be able to offset
the effects of any such price reductions or incentives with an increase in the
number of its customers, higher revenue from enhanced services, cost reductions
or otherwise.
Moreover, the Company uses LEC networks to connect its Internet customers to
its POPs. Under current federal and state regulations, the Company and its
Internet customers pay no charges for this use of the LECs' networks other than
the flat-rated, monthly service charges that apply to basic telephone service.
LECs have asked the FCC to change its rules and require Internet access
providers to pay additional, per minute charges for their use of local networks.
Per minute access charges could significantly increase the Company's costs of
doing business and could, therefore, have a material adverse effect on the
Company's competitive position and on its business, financial condition or
results of operations. The FCC is currently considering whether to propose such
rule changes.
Competition is also expected to focus increasingly on overseas markets,
where Internet access services are just beginning to be introduced. The Company
does not currently plan to increase its Internet access services outside the
United States. To the extent the ability to provide access to locations and
services overseas becomes a competitive advantage in the Internet access
industry, failure of the Company to penetrate overseas markets or to increase
its presence in the few overseas markets it presently serves may result in the
Company being at a competitive disadvantage relative to other Internet access
providers.
21
The Company believes that its ability to compete successfully in the
Internet access market depends upon a number of factors, including: market
presence; the adequacy of the Company's customer support services; the capacity,
reliability and security of its network infrastructure; the ease of access to
and navigation of the Internet; the pricing policies of its competitors and
suppliers; regulatory price requirements for interconnection to and use of
existing local exchange networks by Internet services; the timing of
introductions of new products and services by the Company and its competitors;
the Company's ability to support existing and emerging industry standards; and
trends within the industry as well as the general economy. There can be no
assurance that the Company will have the financial resources, technical
expertise or marketing and support capabilities to continue to compete
successfully in the Internet access market.
INTERNET TELEPHONY
In August 1996, the Company began offering the first commercial telephone
service to bridge live calls between personal computers and regular telephones
via the Internet, and to charge on a per minute basis. Through the Company's
Net2Phone service, customers can place calls from sound-equipped computers and
have the calls terminate at regular telephones, with no requirement of
specialized equipment at the receiving telephone.
Numerous companies have entered the Internet telephony market in the past
year and a half and have established their Internet telephony products in the
marketplace before the Company's introduction of its Net2Phone service. Most of
the current Internet telephony products enable voice communications over the
Internet between two parties simultaneously connected to the Internet via
multimedia-equipped personal computers, where both parties are using identical
Internet telephony software products. These products include Internet Phone from
VocalTec, WebPhone from QuarterDeck and NetMeeting from Microsoft. Recently,
Intel Corporation announced a new technology aimed at standardizing and
improving the compatibility of the various Internet telephony software products,
enabling customers of different Internet telephony software products to
communicate with one another over the Internet. Furthermore, a number of
companies including Northern Telecom and Dialogic have announced server-based
products and switches which are expected to allow communications over the
Internet between parties using a personal computer and regular telephone and
between two parties using telephones where both parties have these specialized
servers at both ends of the call. There can be no assurance that other large
companies will not enter the market as suppliers of Internet telephony services
or equipment or that the Company's competitors in this market will not introduce
Internet telephony products that permit termination of the call at a standard
telephone as does Net2Phone. There can be no assurances that the Company will be
able to successfully compete in the developing Internet telephony market.
Although Internet telephony continues to be an area of intense focus of various
Internet software providers, traditional telephone service companies and
telephone equipment manufacturers, there can be no assurance that Internet
telephony will gain market acceptance or prove to be a viable alternative to
traditional telephone service. Many international telephone callers, accustomed
to the convenience and quality of phone-to-phone international calling, may not
switch to Internet telephony services notwithstanding the potential cost
savings.
DEPENDENCE ON OTHERS
The Company is dependent on third-party suppliers of network transmission
services for many of its services and generally does not have long-term
contracts with its suppliers. Certain of these suppliers are or may become
competitors of the Company, and such suppliers generally are not subject to
restrictions upon their ability to compete with the Company. To the extent that
any of these suppliers raise their rates or change their pricing structure, the
Company may be adversely affected. Also, the Company faces the risk that there
will be a disruption in the service provided by these suppliers, and can give no
assurance that there will not be a significant disruption in such service in the
future, causing a disruption in the services provided by the Company to its
customers. The Company is dependent upon WorldCom and MFS
22
Communications Company, Inc. ("MFS") which are the primary providers to the
Company of leased-line network capacity and data communications facilities, and
lease to the Company physical space for switches, modems and other equipment. If
these suppliers are unable to expand their networks or unwilling to provide or
expand their current level of service to the Company in the future, the
Company's operations could be adversely affected. The Company is also dependent
upon the LECs and MFS to provide telecommunications services to the Company's
customers. Although certain leased data communications services are currently
available from several alternative suppliers, including, for example, AT&T, MCI,
and Sprint, there can be no assurance that the Company could obtain substitute
services from other suppliers at reasonable or comparable terms and prices or in
a timely fashion.
The Company's ability to compete in the long-distance telecommunications
market depends, in part, on its ability to procure advantageous rates from other
IXCs, and on the ability of such IXCs to carry the calls the Company routes to
their networks. If the Company, as a result of a termination of its relationship
with an IXC or an IXC's inability to carry traffic routed to it, routed the
traffic to another IXC providing service at a less advantageous rate, or with
lesser quality, there could be an adverse effect on the Company's profit margins
and network service quality. Such harm to the Company's profit margins and
service quality could in turn have an adverse effect on the Company's results of
operations and its ability to prevent subscription cancellation. Similarly, if
the facility-based providers whose services the Company resells were unable to
sell such services to the Company, there could be a material adverse effect on
the Company's business, financial condition, or results of operations.
IDT also depends on other companies to provide Internet access in areas not
serviced by the Company's POPs. The Company depends upon the continued viability
and financial stability of PSI, other alliance partners and other suppliers as
well as on the performance of their networks. If a material number of such
networks were to suffer operational problems or failure, or were unable to
expand to satisfy customer demand, there could be a material adverse effect on
the Company. The Company has from time to time experienced delays in the timely
connection of customer accounts to the Internet by suppliers other than PSI. If
a material number of suppliers other than PSI fail to serve accounts on a timely
basis or are unable to serve accounts generated by the Company's growth, there
could be a loss of customers which may have a material adverse effect on the
Company's business, financial condition or results of operations.
The Company currently is dependent on software licensed from Netscape
Communications Corp. ("Netscape") for the front end software for its Internet
access services. Under its non-exclusive agreement with Netscape (the "Netscape
Agreement"), the Company can use and reproduce certain Netscape products, and
distribute such products to distributors and end users in conjunction with IDT
configuration software. The Company has experienced difficulty in integrating
third party software into the Company's Internet software. The occurrence of
operating difficulties in connection with Netscape software could deter
customers from using the Company's Internet services. If another software
manufacturer challenges Netscape's market position and the Company is unable to
provide such software to its customers or the Company continues to experience
difficulty integrating Netscape software into the Company's Internet services,
there could be a material adverse effect on the Company's business, financial
condition or results of operations.
The Company is dependent on certain third-party suppliers of equipment and
hardware components, including, for example, Northern Telecom, Excel
Communications, Inc., and Ascend Communications, Inc. A failure by a supplier to
deliver quality services or products on a timely basis, or the inability to
develop alternative sources if and as required, could result in delays which
could have a material adverse effect on the Company.
In addition, the Company is dependent on its independent sales
representatives, particularly in key foreign markets. Most of the Company's
independent sales representatives also sell services or products of other
companies. There can be no assurance that the Company's sales representatives
will devote sufficient efforts to promoting and selling the Company's services.
23
DEPENDENCE ON KEY PERSONNEL
The Company is highly dependent on the technical and management skills of
its key employees, including technical, sales, marketing, financial and
executive personnel, and on its ability to identify, hire and retain qualified
personnel. Competition for such personnel is intense and there can be no
assurance that the Company will be able to retain existing personnel or identify
or hire additional personnel. In particular, the Company is highly dependent on
the services of Howard S. Jonas, its Chief Executive Officer, Chairman of the
Board and founder, and Howard S. Balter, its Chief Operating Officer and Vice
Chairman of the Board. The loss of either Mr. Jonas's or Mr. Balter's services
could have a material adverse effect on the Company's business, financial
condition or results of operations.
RAPID TECHNOLOGICAL DEVELOPMENT; PROPRIETARY RIGHTS
The markets the Company services are characterized by rapidly changing
technology, evolving industry standards, emerging competition and the frequent
introduction of new services, software and other products. The Company's success
is dependent in part upon its ability to enhance existing products, software and
services and to develop new products, software and services that meet changing
customer requirements on a timely and cost-effective basis. There can be no
assurance that the Company can successfully identify new opportunities and
develop and bring new products, software and services to market in a timely and
cost-effective manner, or that products, software, services or technologies
developed by others will not render the Company's products, software, services
or technologies noncompetitive or obsolete. In addition, there can be no
assurance that products, software or service developments or enhancements
introduced by the Company will achieve or sustain market acceptance or be able
to effectively address the compatibility and inoperability issues raised by
technological changes or new industry standards.
There can be no assurance that the Company's patent application relating to
the systems and methodology comprising the technologies underlying Net2Phone
will result in any patent being issued or that, if issued, any patent will
provide adequate protection against competitive technology or will be held valid
and enforceable if challenged, or that the Company's competitors would not be
able to design around any such patent; nor can there be any assurance that
others will not obtain patents that the Company would need to license or
circumvent in order to exploit the Company's patent.
The Company is also at risk to fundamental changes in the technologies for
delivering telephone, Internet telephony and Internet access and content
provision services. For example, although Internet services currently are
accessed primarily by computers through telephone lines, several companies have
recently introduced, on an experimental basis, delivery of Internet access
services through cable television lines. If the Internet becomes accessible by
other methods or if there are advancements in the delivery of telephone
services, the Company will need to develop new technology or modify its existing
technology to accommodate these developments. The Company's pursuit of these
technological advances may require substantial time and expense, and there can
be no assurance that the Company will succeed in adapting its businesses to
alternate access devices, conduits or other technological developments.
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and contractual restrictions to establish and protect its
technology. The Company does not currently have any issued patents or registered
copyrights, although it has registered trademarks in connection with the Genie
services and other pending applications for certain trademarks. The Company has
a policy to require employees and consultants to execute confidentiality and
technology ownership agreements upon the commencement of their relationships
with the Company. There can be no assurance that the steps taken by the Company
will be adequate to prevent misappropriation of its technology or other
proprietary rights, or that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's technology. There can be no assurance that the Company's trademark
applications will result in any trademark registrations, or that, if registered,
any registered trademark will be held valid and enforceable if challenged. In
addition, there can be no assurance that licenses for any
24
intellectual property that might be required for the Company's services or
products would be available on reasonable terms if at all. See
"Business-Intellectual Property."
Although the Company does not believe that its products infringe the
proprietary rights of any third parties, and no third parties have asserted
patent infringement or other such claims against the Company, there can be no
assurance that third parties will not assert such claims against the Company in
the future or that any such claims will not be successful. The Company is aware
that patents have been granted recently to others on fundamental technologies in
the communications, multimedia and Internet telephony areas, and patents may
issue which relate to fundamental technologies incorporated in the Company's
services and products. Since patent applications in the United States are not
publicly disclosed until the patent issues, applications may have been filed
which, if issued as patents, could relate to the Company's services. The Company
could incur substantial costs and diversion of management resources in defending
or pursuing any claims relating to proprietary rights, which could have a
material adverse effect on the Company's business, financial condition or
results of operations. Furthermore, parties making such claims could secure a
judgment awarding substantial damages, as well as injunctive or other equitable
relief which could effectively block the Company's ability to provide services
in the United States or abroad. Such a judgment could have a material adverse
effect on the Company's business, financial condition or results of operations.
RISKS OF NETWORK FAILURE
The success of the Company is largely dependent on its ability to deliver
high quality, uninterrupted access to the Internet and low-cost, uninterrupted
domestic and international long-distance telephone services. Any system or
network failure that causes interruptions in the Company's operations could have
a material adverse effect on the business, financial condition or results of
operations of the Company. The Company has experienced failures relating to
individual POPs and the Company's subscribers have experienced difficulties in
accessing, and maintaining connection to, the Internet. The Company at times has
experienced failures of its call reorigination switching equipment, which
temporarily prevented customers from using IDT's call reorigination services.
The Company's operations are dependent on its ability to successfully expand its
network and integrate new and emerging technologies and equipment into its
network, which are likely to increase the risk of system failure and to cause
unforeseen strain upon the network. The Company's operations also are dependent
on the Company's protection of its hardware and other equipment from damage from
natural disasters such as fires, floods, hurricanes, and earthquakes, or other
sources of power loss, telecommunications failures or similar occurrences. The
Company maintains a substantial portion of its Internet accounts, electronic
mail services, and other systems essential to the Company's service offerings at
its primary operational facilities in Hackensack, New Jersey. Significant or
prolonged system failures, such as were experienced in 1996 by AOL and NETCOM,
or difficulties for subscribers in accessing, and maintaining connection with
the Internet could damage the reputation of the Company and result in the loss
of subscribers. Similarly, significant or prolonged telephone network failures,
or difficulties for customers in completing long-distance telephone calls could
damage the reputation of the Company and result in the loss of customers. Such
damage or losses could have a material adverse effect on the Company's ability
to obtain new subscribers and customers, and on the Company's business,
financial condition or results of operation.
25
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
In Fiscal 1995, 1996, and 1997, international customers accounted for
approximately 56%, 23%, and 25%, respectively, of the Company's total revenues.
The Company anticipates that revenues from international customers will continue
to account for a significant percentage of its total revenues. In addition, part
of the Company's growth strategy is to develop a network switching
infrastructure in foreign countries. Therefore, a significant portion of the
Company's total revenues as well as a portion of its equipment and other
property will be subject to risks associated with international operations,
including unexpected changes in legal and regulatory requirements, changes in
tariffs, exchange rates and other barriers, political and economic instability,
difficulties in accounts receivable collection, longer payment cycles,
difficulties in establishing, maintaining and managing independent foreign sales
organizations, difficulties in staffing and managing international operations,
difficulties in maintaining and repairing equipment abroad, difficulties in
protecting the Company's intellectual property overseas, possible confiscation
of property and equipment, potentially adverse tax consequences and the
regulation of Internet access providers and telecommunications companies by
foreign jurisdictions. Although the Company's sales to date have generally been
denominated in U.S. dollars, the value of the U.S. dollar in relation to foreign
currencies may also adversely affect the Company's sales to international
customers as well as the cost of procuring, installing and maintaining equipment
abroad. To the extent the Company expands its international operations or
changes its pricing practices to denominate prices in foreign currencies, the
Company will be exposed to increased risks of currency fluctuation as the
Company does not, and has no plans to, engage in hedging activities designed to
manage currency fluctuations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business-Sales and
Marketing."
NEW AND UNCERTAIN MARKETS
Many of the overseas markets in which the Company currently markets
long-distance telephone services are undergoing dramatic changes as a result of
privatization and deregulation. The European Union has mandated competitive
markets for the European telecommunications industry by January 1998 and the
various European countries are at different stages of opening their
telecommunications markets. As a result of privatization and deregulation, a new
competitive environment is emerging in which major European telephone companies,
media companies and utilities are entering the telecommunications market and
forming new alliances which are radically changing the landscape for domestic
and international telephone services. Open markets for telecommunications
services are expected to evolve in other parts of the world as well. While the
Company is focused on exploiting the imbalances brought about by the often
fragmented nature of deregulation, the Company is entering new and often unknown
markets and, therefore, is unable to predict how such deregulating markets will
evolve. There can be no assurance that changes in the marketplace and new
strategic alliances among companies with greater resources than the Company will
not adversely affect the Company's ability to continue to offer and to sell call
reorigination services, its efforts to increase its overseas telecommunications
customer base or its ability to recover the cost of building out its
international telecommunications switching infrastructure.
The markets for Internet connectivity, telephony and content services and
related software products are relatively new, current and future competitors are
likely to introduce competing Internet connectivity and/or on-line services and
products. Therefore, it is difficult to predict the rate at which these markets
will grow or at which new or increased competition will result in market
saturation. If demand for Internet services fails to grow, grows more slowly
than anticipated, or becomes saturated with competitors, the Company's business,
operating results and financial condition could be adversely affected. Although
the Company intends to support emerging standards in the market for Internet
connectivity, there can be no assurance that industry standards will emerge or
if they become established, that the Company will be able to conform to these
new standards in a timely fashion and maintain a competitive position in the
market. See "Business-Research and Development."
26
SECURITY RISKS
Despite the implementation of network security measures by the Company, such
as limiting physical and network access to its routers, its Internet access
systems and Genie entertainment and information services are vulnerable to
computer viruses, break-ins and similar disruptive problems caused by its
customers or other Internet users. Such problems caused by third parties could
lead to interruption, delays or cessation in service to the Company's Internet
customers. Furthermore, such inappropriate use of the Internet by third parties
could also potentially jeopardize the security of confidential information
stored in the computer systems of the Company's customers and other parties
connected to the Internet, which may deter potential subscribers. Persistent
security problems continue to plague public and private data networks. Recent
break-ins reported in the press and otherwise have reached computers connected
to the Internet at major corporations and Internet access providers and have
involved the theft of information, including incidents in which hackers bypassed
firewalls by posing as trusted computers. Alleviating problems caused by
computer viruses, break-ins or other problems caused by third parties may
require significant expenditures of capital and resources by the Company, which
could have a material adverse effect on the Company. Until more comprehensive
security technologies are developed, the security and privacy concerns of
existing and potential customers may inhibit the growth of the Internet service
industry in general and the Company's customer base and revenues in particular.
Moreover, if the Company experiences a breach of network security or privacy,
there can be no assurance that the Company's customers will not assert or
threaten claims against the Company based on or arising out of such breach, or
that any such claims will not be upheld, which could have a material adverse
effect on the Company's business, financial condition or results of operations.
POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH NETWORK
Internet access and content providers face potential liability of uncertain
scope for the actions of subscribers and others using their systems, including
liability for infringement of intellectual property
rights, rights of publicity, defamation, libel and criminal activity under the
laws of the U.S. and foreign jurisdictions. For example, an action against
Prodigy alleging libel and negligence in connection with an electronic message
posted by a Prodigy subscriber through Prodigy's Internet access system
attempted to impose liability upon Internet service providers for information,
messages and other materials disseminated across and through their systems.
Prodigy lost a summary judgment motion related to the scope of its potential
liability exposure. While the parties subsequently settled their dispute, the
court refused to vacate its opinion on the summary judgment motion, which still
stands as precedent. Another action is currently pending against NETCOM relating
to NETCOM's potential liability for vicarious copyright infringement arising out
of electronic messages posted by a subscriber. NETCOM lost a summary judgment
motion related to the scope of its potential vicarious copyright liability
exposure, but this case has yet to come to trial. Recently, a Hong Kong court
permitted a local company to sue a California Internet provider for copyright
violation based on content included by a subscriber on a Web site.
The Company carries errors and omissions insurance. However, such insurance
may not be adequate to compensate the Company for all liability that may be
imposed. Any imposition of liability in excess of the Company's coverage could
have a material adverse effect on the Company. In addition, recent legislative
enactments and pending legislative proposals aimed at limiting the use of the
Internet to transmit indecent or pornographic materials could, depending upon
their interpretation and application, result in significant potential liability
to Internet access and service providers including the Company, as well as
additional costs and technological challenges in complying with any statutory or
regulatory requirements imposed by such legislation. For example, the
Communications Decency Act of 1996 (amending 47 U.S.C. 223), which is part of
the 1996 Telecommunications Act, became effective on February 8, 1996. The 1996
Telecommunications Act would impose criminal liability on persons sending or
displaying in a manner available to minors indecent material on an interactive
computer service such as the Internet, and on an entity knowingly permitting
facilities under its control to be used for such activities.
27
While the constitutionality of these provisions has been successfully challenged
in federal appellate court, there can be no assurance as to the final result
regarding the constitutionality of the 1996 Telecommunications Act, or as to the
scope and content of any substitute legislation or other legislation in the U.S.
or foreign jurisdictions restricting the type of content being provided over the
Internet. In addition, CompuServe faced action by German authorities in response
to which CompuServe temporarily restricted the scope of the Internet access it
provides to all subscribers, both in the U.S. and internationally; and a number
of countries are considering content restrictions based on such factors as
political or religious views expressed, and pornography or indecency. The
acquisition of the Genie on-line service and the launch of Genie Interactive
service has increased the Company's exposure to such legislation, and to libel
and defamation suits, primarily because of the increased level of content being
provided by or through the Company.
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
The Company believes that it must continue to enhance and expand its network
and build out its telecommunications network infrastructure in order to maintain
its competitive position and continue to meet the increasing demands for service
quality, availability and competitive pricing. The Company's ability to grow
depends, in part, on its ability to expand its operations through the
establishment of new installed POPs, each of which requires significant advance
capital equipment expenditures, as well as advance expenditures and commitments
for owned and leased telephone company facilities and circuits and advertising.
The Company believes that, based upon its present business plan, its existing
cash resources and expected cash flow from operating activities will be
sufficient to meet its currently anticipated working capital and capital
expenditure requirements through at least Fiscal 1998. If the Company's growth
exceeds current expectations or if the Company's cash flow from operations after
Fiscal 1998 is insufficient to meet its working capital and capital expenditure
requirements, the Company will need to raise additional capital from equity or
debt sources, and the Company is currently considering alternative means to
raise capital. There can be no assurance that the Company will be able to raise
such capital on favorable terms or at all. If the Company is unable to obtain
such additional capital, the Company may be required to reduce the scope of its
anticipated expansion, which could have a material adverse effect on the
Company's business, financial condition or results of operations and its ability
to compete. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
GOVERNMENT REGULATORY POLICY RISKS
TELECOMMUNICATIONS
United States domestic interstate long-distance telecommunications services
are subject to limited regulation by the FCC. Intrastate long-distance services
are regulated by state commissions, which have varying requirements.
International call reorigination services are subject to regulation by both U.S.
and foreign regulators. The FCC requires international call reorigination
providers such as the Company to provide service in a manner not in violation of
the laws of the countries in which they operate. Local laws and regulations
differ among the jurisdictions in which the Company operates, and the
interpretation and enforcement of such laws and regulations vary and are often
based on the informal views of the local government ministries which, in some
cases, are subject to influence by the local PTTs. Accordingly, in certain of
the Company's principal existing and target markets, there are laws and
regulations that either prohibit or limit, or could be used to prohibit or
limit, certain of the Company's services. There can be no assurance that the
Company has accurately predicted or will accurately predict the interpretation
of foreign laws and regulations or regulatory and enforcement trends or will be
found to be in compliance with all such laws and regulations. Failure to
accurately predict the enforcement of applicable laws and regulations in
particular jurisdictions, or incorrect interpretation of applicable laws and
regulations, could cause the Company to lose, or be unable to obtain, regulatory
approvals necessary for it to provide services
28
in such jurisdictions and could result in monetary penalties imposed against the
Company that could be significant. If the FCC finds that the Company has not
provided services "in a manner that is consistent with the laws of the countries
in which [it] operates," the FCC could impose a variety of sanctions, including
fines or the revocation of the Company's Section 214 License to provide
international service to U.S. points. There can be no assurance that the
Company's international services will continue to be permitted in its current
and proposed markets. Depending upon the countries involved, there could be a
material adverse effect on the Company's business, financial condition or
results of operations if the Company's services are prohibited. Furthermore, if
the FCC or state regulators found that the Company was engaging in activities
that required certain licenses which the Company currently does not hold, or
that required compliance with tariffing or other regulatory requirements which
the Company has not satisfied, the FCC or state regulators could impose
financial penalties or prohibit service, which could have a material adverse
effect on the Company's business, financial condition or results of operations.
See "Business-Regulation."
The 1996 Telecommunications Act and the WTO Agreement substantially altered
the regulatory framework for the telecommunications industry for domestic and
international telecommunications services. The 1996 Telecommunications Act and
the WTO Agreement will require the FCC to conduct a variety of rulemakings to
implement various requirements. The Company cannot predict the ultimate effects
of the WTO Agreement or the 1996 Act upon the Company's business other than to
note that the Company will not be required to contribute to the FCC's Universal
Service fund and such contributions could be as much as 4.5% or more of such
revenues for the calendar year 1998, and would increase in subsequent years.
INTERNET
Internet access providers are generally considered "enhanced service
providers" and are exempt from federal and state regulations governing common
carriers. Accordingly, the company's provisioning of Internet services are
currently exempt from tariffing, certification, and rate regulation.
Nevertheless, regulations governing disclosure of confidential communications,
copyright, excise tax, as well as other requirements may apply to IDT's
provision of Internet services. The Company cannot predict the likelihood that
state, federal or foreign governments will impose additional regulation on the
Company's Internet business, nor can it predict the impact that future
regulation will have on the Company's operations.
The 1996 Telecommunications Act would impose criminal liability on persons
sending or displaying in a manner available to minors indecent material on an
interactive computer service such as the Internet, and on an entity knowingly
permitting facilities under its control to be used for such activities. Entities
solely providing access to facilities not under their control are exempted from
liability, as are service providers that take good faith, reasonable, effective
and appropriate actions to restrict access by minors to the prohibited
communications. However, the Genie on-line service and GENIE INTERACTIVE are not
likely to fall within such exception. The constitutionality of these provisions
has been successfully challenged in federal appellate court, and the
interpretation and enforcement of them are uncertain. This legislation, as well
as lawsuits against Internet service providers, may decrease demand for Internet
access, chill the development of Internet content, or have other adverse effects
on Internet access and content providers such as the Company. In addition, in
light of the uncertainty attached to interpretation and application of this law,
there can be no assurance that the Company would not have to modify its
operations to comply with the statute, including prohibiting users from
maintaining home pages on the Web, and increasing its control over the GENIE
INTERACTIVE content. See "Risk Factors--Potential Liability for Information
Disseminated Through Network."
29
INTERNET TELEPHONY
The Company knows of no domestic or foreign laws that prohibit voice
communications over the Internet. As identified above, the FCC is currently
considering whether or not to impose surcharges or additional regulation upon
providers of Internet telephony. In addition, several efforts have been made to
enact federal legislation that would either regulate or exempt from regulation
services provided over the Internet. State public utility commissions may also
retain jurisdiction to regulate the provision of intrastate Internet telephone
services and could initiate proceedings to regulate Internet telephony. If a
foreign government, Congress, the FCC, or a state utility commission regulate
Internet telephony, there can be no assurances that any such regulation will not
materially adversely affect the Company's business, financial condition or
results of operation.
CONTROL BY PRINCIPAL STOCKHOLDER
Howard S. Jonas, the Company's Chief Executive Officer, Chairman of the
Board and founder, owns beneficially all of the Company's outstanding shares of
Class A Stock and thereby holds more than 50% of the combined voting power of
the Company's outstanding capital stock. As a result, Mr. Jonas is able to
control matters requiring approval by the stockholders of the Company, including
the election of all of the directors and the approval of significant corporate
matters, including any merger, consolidation or sale of all or substantially all
of the Company's assets. See "Security Ownership of Certain Beneficial Owners
and Management."
VOLATILITY OF STOCK PRICE
Since the initial public offering of the Company's Common Stock in March
1996, the market price of the Company's Common Stock has fluctuated
significantly, and it is likely that the price of the Company's Common Stock
will fluctuate in the future. Factors such as variations in the Company's
revenue, earnings and cash flow from quarter-to-quarter and announcements of new
service offerings, technological innovations or price reductions by the Company,
its competitors or providers of alternative services could cause the market
price of the Common Stock to fluctuate substantially. In addition, the stock
markets recently have experienced significant price and volume fluctuations that
particularly have affected companies in the technology sector and resulted in
changes in the market price of the stocks of many companies, which have not been
directly related to the operating performance of those companies. Such broad
market fluctuations may adversely affect the market price of the Common Stock in
the future.
ANTITAKEOVER PROVISIONS
The Company's restated certificate of incorporation (the "Certificate of
Incorporation") contains certain provisions that may discourage bids for the
Company, including disparate voting rights and a provision providing for
classification of the Company's Board of Directors. This could limit the price
that certain investors might be willing to pay in the future for shares of
Common Stock. See "Description of Capital Stock."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock eligible for sale
into the public market could adversely affect the market price for the Common
Stock.
ITEM 2. PROPERTIES
The Company's principal facilities total approximately 35,300 square feet
and are located in three buildings in Hackensack, New Jersey. The Company also
leases space (typically less than 500 square feet) in various geographic
locations to house the telecommunications equipment for each of its POPs. The
Company occupies one building under a lease which expires on June 30, 1999. The
Company leases this
30
facility from an entity in which Howard S. Jonas, the Company's Chairman and
Chief Executive Officer, is the sole stockholder. The Company occupies
facilities in a second building pursuant to a lease which expires on September
30, 1998 and facilities in a third building, which the Company also leases from
an entity controlled by Mr. Jonas, which expires in December 1998. See "Certain
Relationships and Related Transactions."
ITEM 3. LEGAL PROCEEDINGS.
On December 29, 1995, Surfers Unlimited, L.L.C. ("Surfers") filed a breach
of contract action in the New Jersey Superior Court, Bergen County. The suit
names a subsidiary of the Company as defendant and seeks restitutional and
consequential damages in an unspecified amount for interference with prospective
business advantages, breach of contract and improper use of confidential and
proprietary information. Howard Jonas, the Chairman and Chief Executive Officer
of the Company, has also been named as a defendant in the action. The suit is
currently in the discovery phase and a trial is tentatively scheduled for
February 1998.
The Company was served with a third party complaint in a pending action
between The New York Times Company and Independent Media Services, Inc. ("IMS").
In the third party complaint, IMS alleges non-payment of media services fees and
print advertisement fees. The claim against the Company is for approximately
$300,000. Settlement discussions have taken place, however, the Company does not
believe that a settlement of this matter is imminent. The lawsuit is currently
in the discovery phase and a trial date has not yet been set. The Company does
not believe that the outcome of this matter will have a material adverse effect
upon the business of the Company.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey entitled INNELLA V. IDT CORP. Howard Jonas, the
Chairman and Chief Executive Officer of the Company, has also been named as a
defendant in the action. The action claims that the Company has made hiring and
promotion decisions based upon the religious backgrounds of the relevant
individuals. The case is in the preliminary stages of discovery, however, the
Company does not believe that this action will have a material adverse effect
upon its business.
In June 1997, an uncertified class-action suit was brought against IDT in
New York. The suit concerns advertisements that are no longer used by the
Company, and advertising practices that were voluntarily terminated by the
Company following a prior investigation of the Company by the Attorneys General
of several states. The case is currently in preliminary stages of discovery,
however, the Company does not believe that this action will have a material
adverse effect upon its business.
In September 1997, DigiTEC 2000, Inc. ("DigiTEC") filed a complaint against
the Company alleging that in connection with its sale of pre-paid calling cards,
the Company tortiously interfered with a business relationship between DigiTEC
and two co-defendants, CG Com, Inc. and Carlos Gomez. DigiTEC has filed a motion
for a preliminary injunction that would bar the Company from selling its prepaid
calling cards through these co-defendants. The Court has not yet ruled upon
DigiTEC's motion and the case is currently in preliminary stages of discovery.
However, the Company believes that the outcome of this matter will not have a
material adverse effect upon its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
31
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Common Stock has traded publicly on the Nasdaq National Market under the
symbol "IDTC" since March 15, 1996, the date of the Company's initial public
offering. The table below sets forth the high and low sales prices for the
Common Stock as reported by the Nasdaq National Market for the fiscal periods
indicated.
HIGH LOW
--------- ---------
FISCAL YEAR ENDED JULY 31, 1996
Third Quarter (from March 15, 1996).......................................................... $ 11.75 $ 6.75
Fourth Quarter............................................................................... 16.00 8.50
FISCAL YEAR ENDING JULY 31, 1997
First Quarter................................................................................ $ 17.50 $ 10.25
Second Quarter............................................................................... 15.75 8.50
Third Quarter................................................................................ 8.75 4.00
Fourth Quarter............................................................................... 9.25 5.25
FISCAL YEAR ENDING JULY 31, 1998
First Quarter (through October 28, 1997)..................................................... $ 21.25 $ 7.875
On October 28, 1997, the last sale price reported on the Nasdaq National
Market for the Common Stock was $18.00 per share. On the same date, there were
approximately 69 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 28, 1997, was approximately $160
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 have been excluded
from this computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The Company has never declared or paid any dividends on its Common Stock and
does not expect to pay dividends for the foreseeable future. The Company's
current policy is to retain all of its earnings to finance future growth. Any
future declaration of dividends will be subject to the discretion of the Board
of Directors of the Company. The availability of funds for the payment of
dividends by the Company is dependent on dividends the Company may receive from
its subsidiaries, which is subject to certain limitations under state laws.
32
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, 1997 has been derived from the Company's
consolidated financial statements, which have been audited by Ernst & Young LLP,
independent auditors. The selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and the Notes thereto and
other financial information appearing elsewhere in this Report.
YEAR ENDED JULY 31,
-------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Telecommunications................................... $ 1,675 $ 3,169 $ 10,789 $ 35,708 $ 99,936
Internet............................................. -- -- 875 21,986 32,895
Net2Phone............................................ -- -- -- -- 2,356
--------- --------- --------- ---------- ----------
Total revenues..................................... 1,675 3,169 11,664 57,694 135,187
Costs and expenses:
Direct cost of revenues.............................. 272 990 7,544 36,438 92,214
Selling, general and administrative.................. 1,019 2,402 5,992 35,799 41,545
Depreciation and amortization........................ 79 106 303 1,212 4,873
--------- --------- --------- ---------- ----------
Total costs and expenses........................... 1,370 3,498 13,839 73,449 138,632
--------- --------- --------- ---------- ----------
Income (loss) from operations.......................... 305 (329) (2,175) (15,755) (3,445)
Other, net(1).......................................... (3) 31 30 112 (392)
--------- --------- --------- ---------- ----------
Net income (loss).................................. $ 302 $ (298) $ (2,145) $ (15,643) (3,837)
--------- --------- --------- ---------- ----------
--------- --------- --------- ---------- ----------
Net income (loss) per share............................ $ .02 $ (.02) $ (.13) $ (.86) $ (.18)
--------- --------- --------- ---------- ----------
--------- --------- --------- ---------- ----------
Weighted average number of shares used in calculation
of net income (loss) per share....................... 16,569 16,569 16,569 18,180 21,153
--------- --------- --------- ---------- ----------
--------- --------- --------- ---------- ----------
BALANCE SHEET DATA
Cash and cash equivalents....................... $ 302 $ 754 $ 232 $ 14,894 $ 7,674
Working capital (deficit)....................... 826 1,289 (884) 13,547 4,887
Total assets.................................... 1,302 2,795 4,197 43,797 58,537
Total stockholders' equity...................... 1,045 2,062 911 26,843 25,259
- ------------------------
(1) For the year ended July 31, 1996, includes an extraordinary loss on
retirement of debt of $233.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE "RISK FACTORS" SECTION OF ITEM 1.
OVERVIEW
IDT is an international telecommunications company offering a broad range of
competitively priced long-distance telephone, and Internet access services in
the U.S. abroad. IDT recently began offering Internet telephony services.
Revenues from the Company's telecommunications operations are derived
primarily from the following activities: (i) international long-distance call
reorigination services; (ii) resale of long-distance minutes to other
long-distance carriers; (iii) marketing to individuals and businesses of
domestic long-distance services provided by WorldCom; and (iv) marketing to
individuals and businesses of prepaid calling cards. Beginning in Fiscal 1997,
the Company's focus has increasingly shifted towards its international
telecommunication operations, and away from its sales of Internet access.
Revenues from the Company's Internet operations are primarily derived from
providing Internet access services to individuals and businesses.
The Company's Internet access service revenues depend primarily on the
number of subscribers to the Company's services and the types of accounts
subscribed for. In February 1997, the Company shifted its dial-up division's
marketing efforts from aggressive mass marketing to new reseller programs which
entailed significantly lower selling costs and resulted in a lower customer
acquisition rate.
The Company's ability to achieve revenue growth and profitability is
dependent upon its ability to acquire and retain customers. The Company's
ability to improve operating margins will also depend in part on its ability to
retain its customers and there can be no assurances that the Company's
investments in telecommunications infrastructure, customer support capabilities
and software releases will improve customer retention. The Company's strategies
and commitments have required substantial up-front expenditures for additional
personnel, marketing, facilities, infrastructure, product development and
capital equipment and have and may continue to adversely affect short-term
operating results. There can be no assurance that revenue growth will continue
or that the Company will in the future achieve or sustain profitability or
positive cash flow from operations on either a quarterly or annual basis.
34
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items in the Company's statement of operations:
YEAR ENDED JULY 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
Revenues:............................................................................. 100.0% 100.0% 100.0%
Telecommunications.................................................................. 92.5 61.9 74.0
Internet............................................................................ 7.5 38.1 24.3
Net2Phone........................................................................... -- -- 1.7
Costs and expenses:
Direct cost of revenues............................................................. 64.7 63.2 68.2
Selling, general and administrative................................................. 51.4 62.0 30.7
Depreciation and amortization....................................................... 2.5 2.1 3.6
--------- --------- ---------
Total costs and expenses........................................................ 118.6 127.3 102.5
--------- --------- ---------
Income (loss) from operations......................................................... (18.6) (27.3) (2.5)
--------- --------- ---------
Other (net)........................................................................... 0.2 0.6 (0.3)
--------- --------- ---------
Income before taxes and extraordinary item...................................... (18.4)% (26.7)% (2.8)%
Income Taxes.......................................................................... 0.0 0.0 0.0
--------- --------- ---------
Income (loss) before extraordinary item............................................... (18.4) (26.7) (2.8)
Extraordinary loss on retirement debt................................................. 0.0 (0.4) (0.0)
--------- --------- ---------
Net income (loss)..................................................................... (18.4)% (27.1)% (2.8)%
--------- --------- ---------
--------- --------- ---------
FISCAL 1997 COMPARED TO FISCAL 1996
REVENUES. Revenues increased 134.3% from approximately $57.7 million in
Fiscal 1996 to approximately $135.2 million in Fiscal 1997. The composition of
the Company's revenues increasingly consisted of revenues from its international
telecommuniations operations, as its focus increasingly concentrated in that
area, as opposed to its Internet services. Revenues from the Company's
telecommunications operations increased 179.9% from approximately $35.7 million
in Fiscal 1996 to approximately $99.9 million in Fiscal 1997. Revenues from
Internet operations increased 49.6% from $22.0 million in Fiscal 1996 to
approximately $32.9 million in Fiscal 1997. Revenues from Internet telephony
operations increased from $0 in fiscal 1996 to approximately $2.4 million in
Fiscal 1997. The increase in telecommunications revenues was due primarily to an
165.9% increase in rebilled long-distance minutes of use from approximately 88
million minutes of use to approximately 234 million minutes of use. The increase
in rebilled long-distance minutes of use was due to a substantial increase in
international call reorigination customers, migration of existing customers to
the Company's least cost routing switch platform and the addition of
carrier-to-carrier services clients. During this period, the number of
international call reorigination customers increased 40% from approximately
19,600 at July 31, 1996 to 27,422 customers at July 31, 1997. As a percentage of
telecommunications revenues and overall revenues in Fiscal 1996 and 1997,
callback revenues decreased from approximately 36.8% to 27.3% and 9.7% to 47.4%,
respectively. The addition of wholesale carrier clients resulted in an increase
in carrier-to-carrier services revenues from approximately $18.6 million in
Fiscal 1996 to approximately $64.7 million in Fiscal 1997. As a percentage of
telecommunications revenues and overall revenues, carrier-to-carrier services
revenues increased from approximately 52.1% to 64.7% and 32.3% to 47.8%,
respectively. As a percentage of total revenues, Internet revenues decreased
from approximately 38.1% in Fiscal 1996 to approximately 24.3% in Fiscal 1997.
The increase in Internet revenues in dollar terms was due primarily to the
increase in the dial-up subscribers base, and to a lesser degree increased
revenues from on-line services and dedicated customers from Fiscal 1996 to
Fiscal 1997.
35
The decrease in Internet revenue as a percentage of total revenue was due to the
increase of telecommunications revenue as compared to Internet revenue,
consistent with the change in the focus of the Company's operations. Internet
revenues also included approximately $3.4 million of online service revenues for
Fiscal 1996 and $1.2 million for Fiscal 1997. Internet telephony revenues as a
percentage of overall revenues increased from 0.0% in Fiscal 1996 to 1.7% in
Fiscal 1997.
DIRECT COST OF REVENUES. Direct cost of revenues consists primarily of the
costs paid to carriers for the transmission and termination of switched minutes
through IDT's facilities, and to a lesser extent, fees paid to alliance
partners, leased circuits and network costs, local access costs, Internet
connectivity costs, and switch maintenance costs. The Company's direct cost of
revenues increased by 153.1% from approximately $36.4 million in Fiscal 1996 to
approximately $92.2 million in Fiscal 1997. As a percentage of revenues, these
costs increased from 63.2% to 68.2% in Fiscal 1996 and 1997, respectively. The
increase in absolute dollars is primarily due to increases in underlying carrier
costs as the Company's telecommunications minutes of use, and the associated
revenue, grew substantially. To a lesser extent, the increase is due to the
increase in fees paid to alliance partners and the costs of leased circuits and
networks and of access lines and network connectivity to support subscriber
growth in both Internet access and international call reorigination. The Company
expects that direct cost of revenues will continue to increase in absolute
dollar terms as the Company expands its telecommunications and Internet
subscriber bases.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
costs increased from approximately $35.8 million in Fiscal 1996 to approximately
$41.5 million in Fiscal 1997. As a percentage of revenues, these costs decreased
from 62.1% to 30.7% in Fiscal 1996 and 1997, respectively. The decrease in
selling, general and administrative costs as a percentage of revenues was
primarily due to the shift of the focus of the Internet division's marketing
efforts from aggressive mass marketing to new reseller programs which entail
significantly lower selling costs. The Company anticipates selling, general and
administrative costs will increase as the Company implements its growth
strategy, but will decrease as a percentage of total revenues.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs
increased 302.0% from approximately $1.2 million in Fiscal 1996 to approximately
$4.9 million in Fiscal 1997. As a percentage of revenues, these costs increased
from 2.1% to 3.6 % in Fiscal 1996 and 1997, respectively. These costs increased
in absolute terms and as a percentage of revenues primarily as a result of the
Company's higher fixed asset base during Fiscal 1997 as compared with Fiscal
1996 due to the Company's installation of additional Company-owned POPs,
enhancement of its network infrastructure and expansion of its facilities. The
Company anticipates that its depreciation and amortization costs will continue
to increase as the Company continues to implement its growth strategy.
INCOME (LOSS) FROM OPERATIONS. Income from operations for the
telecommunications segment increased to approximately $5.7 million in Fiscal
1997 from $2.8 million in Fiscal 1996 and as a percentage of telecommunications
revenues decreased to 5.7% from 7.7%. The increase in dollars resulted
principally from increased revenue generated by the expansion of operations. The
decrease as a percentage of telecommunication revenues resulted from increased
selling general and administrative expenses as well as the increased percentage
of long-distance arbitrage revenues which typically carry lower margins. Loss
from operations for the Internet access segment decreased to approximately $8.1
million in Fiscal 1997 from approximately $17.6 million in Fiscal 1996. The loss
from operations from the Internet access segment was principally due to the
initial costs of acquiring customers and increased personnel and facilities
costs to sustain growth. The decreased loss of the Internet access segment is
largely due to the refocusing of its marketing efforts from aggressive mass
marketing to new reseller programs. The loss generated from the development and
marketing of Net2Phone was approximately $1.1 million and $660,000 for Fiscal
1997 and 1996 respectively.
INCOME TAXES. The Company records income taxes in accordance with Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). The Company did not
36
record an income tax benefit in Fiscal 1996 or 1997, as the realization of
available tax losses was not probable. As of July 31, 1997, the Company had
Federal net operating loss carryforwards of approximately $21.0 million. The
amount of these carryforwards that can be used in any given year may be limited
in the event of certain changes in the ownership of the Company. The Company
does not believe that the prior ownership changes will significantly limit the
Company's ability to use its net operating loss carryforwards.
FISCAL 1996 COMPARED TO FISCAL 1995
REVENUES. Revenues increased 390% from approximately $11.7 million in
Fiscal 1995 to approximately $57.7 million in Fiscal 1996. Revenues from the
Company's telecommunications operations increased 230% from approximately $10.8
million in Fiscal 1995 to approximately $35.7 million in Fiscal 1996. Revenues
from Internet operations increased from $875,000 in Fiscal 1995 to approximately
$22 million in Fiscal 1996, a 24-fold increase. The increase in
telecommunications revenues was due primarily to an eight fold increase in
rebilled long-distance minutes of use, from approximately 11 million minutes of
use to nearly 88 million minutes of use. The increase in rebilled long-distance
minutes of use was due to a substantial increase in international call
reorigination customers, migration of existing customers to the Company's least
cost routing switch platform and the addition of carrier-to-carrier services
clients. During this period, the number of international call reorigination
customers increased 208% from approximately 6,358 at July 31, 1995 to 19,582
customers at July 31, 1996. As a percentage of telecommunications revenues and
overall revenues in Fiscal 1995 and 1996, callback revenues decreased from
approximately 31.8% to 36.5% and 51.6% to 22.2%, respectively. The addition of
wholesale carrier clients resulted in an increase in carrier-to-carrier services
revenues from approximately $1.1 million in Fiscal 1995 to approximately $18.6
million in Fiscal 1996. As a percentage of telecommunications revenues and
overall revenues, carrier-to-carrier services revenues increased from
approximately 10.3% to 52.1% and 12.1% to 55.8%, respectively. As a percentage
of total revenues, Internet revenues increased from approximately 7.5% in Fiscal
1995 to approximately 38.1% in Fiscal 1996. The increase in Internet revenues
both in dollar terms and as a percentage of revenues was due primarily to a 12
fold increase in dial-up subscribers from 10,839 as of July 31, 1995 to
approximately 142,700 as of July 31, 1996.
DIRECT COST OF REVENUES. Direct cost of revenues consists primarily of the
costs paid to carriers for the transmission and termination of switched minutes
through IDT's facilities, and to a lesser extent, fees paid to alliance
partners, leased circuits and network costs, local access costs, Internet
connectivity costs, and switch maintenance costs. The Company's direct cost of
revenues increased by 383% from approximately $7.5 million in Fiscal 1995 to
approximately $36.4 million in Fiscal 1996. As a percentage of revenues, these
costs decreased from 64.7% to 63.2% in Fiscal 1995 and 1996, respectively. The
increase in absolute dollars is primarily due to increases in underlying carrier
costs as the Company's telecommunications minutes of use, and associated
revenue, grew substantially. To a lesser extent, the increase is due to the
increase in fees paid to alliance partners and the costs of leased circuits and
networks and of access lines and network connectivity to support subscriber
growth in both Internet access and international call reorigination. The Company
expects that direct cost of revenues will continue to increase in absolute
dollar terms as the Company expands its telecommunications and Internet
subscriber bases.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
costs increased 497% from approximately $6.0 million in Fiscal 1995 to
approximately $35.8 million in Fiscal 1996. As a percentage of revenues, these
costs increased from 51.4% to 62.1% in Fiscal 1995 and 1996, respectively. The
increase in these costs both in dollar terms and as a percentage of revenues was
due primarily to the addition of sales, marketing and technical and customer
support personnel hired to support the growth of the Company's Internet access
business, the increased advertising to attract Internet dial-up subscribers, the
increased license fees paid to Netscape under the Netscape Agreement, and costs
incurred in developing and marketing Net2Phone. During Fiscal 1995, the Company
recorded a non-cash compensation expense of approximately $1.0 million as
compared to $70,000 in Fiscal 1996 due to the grant of options to employees
37
and consultants. The Company anticipates selling, general and administrative
costs will continue to increase as the Company implements its growth strategy.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization costs
increased 299% from approximately $304,000 in Fiscal 1995 to approximately $1.2
million in Fiscal 1996. As a percentage of revenues, these costs decreased from
2.6% to 2.1% in Fiscal 1995 and Fiscal 1996, respectively. These costs increased
in absolute terms primarily as a result of the Company's higher fixed asset base
during Fiscal 1996 as compared with Fiscal 1995 due to the Company's aggressive
efforts to install additional Company-owned POPs, enhance its network
infrastructure and expand its facilities. The Company anticipates depreciation
and amortization costs will continue to increase as the Company continues to
implement its growth strategy.
INCOME (LOSS) FROM OPERATIONS. Income from operations for the
telecommunications segment increased to approximately $2.8 million in Fiscal
1996 from $830,000 in Fiscal 1995 and as a percentage of telecommunications
revenues to 7.72% from 7.69%. The increase resulted principally from increased
volume. Loss from operations for the Internet access segment increased to $17.9
million in Fiscal 1996 from approximately $3 million in Fiscal 1995 and as a
percentage of Internet revenues to 81.2% from 443%. The loss from operations
from the Internet access segment was principally due to the initial costs of
acquiring customers, increased personnel and facilities costs to sustain growth
and substantial marketing expenses to create customer awareness. The increased
loss of the Internet access segment is largely due to the growth in Internet
customer base as the initial costs of acquiring customers exceeds the initial
revenue received from such customers. The customer base increased 12-fold from
10,839 to 142,700 customers during Fiscal 1996. The loss generated from the
development and marketing of Net2Phone was approximately $660,000 for the year
ended July 31, 1996.
INCOME TAXES. The Company records income taxes in accordance with SFAS 109.
The Company did not record an income tax benefit in the periods ended July 31,
1995 or 1996, as the realization of available tax losses was not assured.
38
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain quarterly financial data for the
eight quarters ended July 31, 1997. This quarterly information is unaudited, has
been prepared on the same basis as the annual financial statements and, in the
opinion of the Company's management, reflects all adjustments (consisting only
of normal recurring adjustments) necessary for a fair presentation of the
information for periods presented. Operating results for any quarter are not
necessarily indicative of results for any future period.
IDT CORPORATION
CONSOLIDATED QUARTERLY INCOME STATEMENT (IN $,000'S)
10-31-95 01-31-96 04-30-96 07-31-96 10-31-96 01-31-97
----------- ----------- ----------- ----------- ----------- -----------
Revenues:
Telecommunications........................ 4,808 5,852 11,338 13,710 18,101 21,939
Internet.................................. 1,793 3,862 6,888 9,442 10,137 9,074
Net2Phone................................. -- -- -- -- 79 392
----------- ----------- ----------- ----------- ----------- -----------
Total Revenues.......................... 6,601 9,714 18,226 23,153 28,317 31,405
Costs and Expenses
Direct Costs.............................. 4,173 5,926 12,289 14,050 18,013 20,862
Selling, General & Administrative......... 3,953 8,506 10,135 13,205 12,598 11,245
Depreciation and Amortization............. 131 175 264 642 963 1,083
----------- ----------- ----------- ----------- ----------- -----------
Total Costs & Expenses.................. 8,257 14,607 22,688 27,897 31,574 33,190
----------- ----------- ----------- ----------- ----------- -----------
Income From Operations...................... (1,656) (4,893) (4,462) (4,744) (3,257) (1,785)
Interest (Net).............................. 3 (32) 59 316 150 (45)
----------- ----------- ----------- ----------- ----------- -----------
Income (Loss) Before Taxes.................. (1,653) (4,925) (4,403) (4,428) (3,107) (1,830)
Taxes....................................... 0 0 0 0 0 0
----------- ----------- ----------- ----------- ----------- -----------
Net Income (Loss) Before Extraordinary
Item...................................... (1,653) (4,925) (4,403) (4,428) (3,107) (1,830)
Extraordinary Item.......................... 0 0 (234) 0 0 0
----------- ----------- ----------- ----------- ----------- -----------
Net Income (Loss)........................... (1,653) (4,925) (4,637) (4,428) (3,107) (1,830)
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Weighted Average Shares Outstanding......... 16,569 16,569 18,705 20,841 20,841 20,873
Net Income (Loss) Per Share................. ($ 0.10) ($ 0.30) ($ 0.25) ($ 0.21) ($ 0.15) ($ 0.09)
04-30-97 07-31-97
----------- -----------
Revenues:
Telecommunications........................ 26,061 33,835
Internet.................................. 7,555 6,129
Net2Phone................................. 836 1,049
----------- -----------
Total Revenues.......................... 34,452 41,013
Costs and Expenses
Direct Costs.............................. 23,681 29,659
Selling, General & Administrative......... 9,163 8,539
Depreciation and Amortization............. 1,317 1,510
----------- -----------
Total Costs & Expenses.................. 34,161 39,707
----------- -----------
Income From Operations...................... 291 1,306
Interest (Net).............................. (130) (367)
----------- -----------
Income (Loss) Before Taxes.................. 161 939
Taxes....................................... 0 0
----------- -----------
Net Income (Loss) Before Extraordinary
Item...................................... 161 939
Extraordinary Item.......................... 0 0
----------- -----------
Net Income (Loss)........................... 161 939
----------- -----------
----------- -----------
Weighted Average Shares Outstanding......... 23,249 23,641
Net Income (Loss) Per Share................. $ 0.01 $ 0.04
IDT CORPORATION
CONSOLIDATED QUARTERLY INCOME STATEMENT (IN %)
10-31-95 01-31-96 04-30-96 07-31-96 10-31-96 01-31-97
----------- ----------- ----------- ----------- ----------- -----------
Revenues:
Telecommunications...................... 72.8% 60.2% 62.2% 59.2% 63.9% 69.9%
Internet................................ 27.2% 39.8% 37.8% 40.8% 35.8% 28.9%
Net2Phone............................... -- -- -- -- 0.3% 1.2%
----------- ----------- ----------- ----------- ----------- -----------
Total Revenues........................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and Expenses
Direct Costs............................ 63.2% 61.0% 67.4% 60.7% 63.6% 66.4%
Selling, General & Administrative....... 58.9% 87.6% 55.6% 57.0% 44.5% 35.8%
Depreciation and Amortization........... 2.0% 1.8% 1.5% 2.8% 3.4% 3.5%
----------- ----------- ----------- ----------- ----------- -----------
Total Costs & Expenses................ 125.1% 150.4% 124.5% 120.5% 111.5% 105.7%
----------- ----------- ----------- ----------- ----------- -----------
Income From Operations...................... -25.1% -50.4% -24.5% -20.5% -11.5% -5.7%
Interest (Net).............................. 0.1% -0.3% 1.0% 1.4% 0.5% -0.1%
----------- ----------- ----------- ----------- ----------- -----------
Income (Loss) Before Taxes.................. -25.0% -50.7% -25.5% -19.1% -11.0% -5.8%
Taxes....................................... 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
----------- ----------- ----------- ----------- ----------- -----------
Net Income (Loss) Before Extraordinary
Item...................................... -25.0% -50.7% -25.5% -19.1% -11.0% -5.8%
Extraordinary Item.......................... 0.0% 0.0% -1.3% 0.0% 0.0% 0.0%
----------- ----------- ----------- ----------- ----------- -----------
Net Income (Loss)........................... -25.0% -50.7% -26.8% -19.1% -11.0% -5.8%
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
04-30-97 07-31-97
----------- -----------
Revenues:
Telecommunications...................... 75.7% 82.5%
Internet................................ 21.9% 14.9%
Net2Phone............................... 2.4% 2.6%
----------- -----------
Total Revenues........................ 100.0% 100.0%
Costs and Expenses
Direct Costs............................ 68.8% 72.3%
Selling, General & Administrative....... 26.6% 20.8%
Depreciation and Amortization........... 3.8% 3.7%
----------- -----------
Total Costs & Expenses................ 99.2% 96.8%
----------- -----------
Income From Operations...................... 0.8% 3.2%
Interest (Net).............................. -0.4% -0.9%
----------- -----------
Income (Loss) Before Taxes.................. 0.5% 2.3%
Taxes....................................... 0.0% 0.0%
----------- -----------
Net Income (Loss) Before Extraordinary
Item...................................... 0.5% 2.3%
Extraordinary Item.......................... 0.0% 0.0%
----------- -----------
Net Income (Loss)........................... 0.5% 2.3%
----------- -----------
----------- -----------
39
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has satisfied its cash requirements principally
through a combination of cash flow from operations, sales of equity securities
and borrowings from third parties (including its stockholders). In March 1996,
the Company completed an initial public offering of 4,600,000 shares of Common
Stock for $10 per share. The Company realized approximately $41.5 million from
this offering. A portion of the proceeds were used to repay $3,477,000, the
principal amount of short-term notes previously issued during Fiscal 1996. In
September 1997, the Company completed a $7,500,000 private placement of 3%
convertible debentures with a group of institutional investors, which are
redeemable for shares of the Company's Common Stock. The Company also obtained
in September 1997 a $6,000,000 line of credit from Transamerica Technology
Finance, a subsidiary of Transamerica Corporation, which is secured by the
Company's carrier receivables. The Company also received approximately $2.2
million on the exercise of stock options in Fiscal 1997. As of July 31, 1997,
the Company had cash and cash equivalents of $7.7 million and working capital of
approximately $4.9 million.
The Company generated negative cash flow from operating activities of
approximately $4.4 million during Fiscal 1997, compared to a negative cash flow
from operating activities of approximately $14.9 million during Fiscal 1996. The
changes in operating cash flows from Fiscal 1996 to Fiscal 1997 were primarily
due to the decrease in the net loss, and increases in accounts receivable and
prepaid and other assets in relation to accounts payable and other current
liabilities. Cash flow from operations varied significantly from quarter to
quarter, depending upon the timing of operating cash receipts and payments,
especially accounts receivable and accounts payable. Accounts receivable (net of
allowances) were approximately $11.5 million and $17.1 million at July 31, 1996
and 1997, respectively. Accounts receivable, accounts payable and accrued
expenses have increased from period to period as the Company's businesses have
grown.
The Company's capital expenditures increased from approximately $11.9
million in Fiscal 1996 to approximately $18.0 million in Fiscal 1997, primarily
as a result of purchases of equipment to support expansion of the Company's
domestic and international network infrastructure, and expansion of the
Company's facilities. The Company financed a large portion of its capital
expenditures in Fiscal 1997 through capital leases. Payments on purchases of
fixed assets decreased from approximately $11.9 million in Fiscal 1996 to
approximately $7.1 million in Fiscal 1997. The Company is upgrading and
expanding its existing domestic and international network.
The Company experiences intense competition in both its telecommunications
and Internet access businesses. If additional competition were to lead to
significant price reductions, the Company's cash flows from operations would be
materially adversely affected.
The Company intends to, where appropriate, make strategic acquisitions to
increase its telecommunications customer base. The Company may also make
strategic acquisitions related to its Internet business. From time to time, the
Company evaluates potential acquisitions of companies, technologies, products
and customer accounts that complement the Company's businesses. In Fiscal 1997,
the Company purchased the equipment and networks of two of its alliance partners
for approximately $4.4 million. The purchase price includes cash of $2,250,000,
which was financed by a four year note, assumption of trade liabilities of
approximately $280,000 (excluding $429,000 due to the Company), and the issuance
of promissory notes totaling approximately $1,440,000 of which $690,000 is a two
year note at 8.25% interest per annum, and $750,000 is a four year note at 10%
per annum. No additional acquisitions are currently contemplated.
The Company believes that the cash on hand, together with cash flow from its
operating activities and cash available from its private placement of
convertible subordinated debentures and from its line of credit, will be
sufficient to fund the Company's existing operations through Fiscal 1998. The
Company intends to continue its strategy of rapid growth, primarily through the
expansion of its domestic and international networks, as well as by pursuing
other growth opportunities, such as acquisitions of complementary entities or
businesses. The Company is currently reviewing various alternatives for
obtaining
40
additional financing to fund this strategy. The proceeds from such financing are
anticipated to be used to expand the Company's operations, fund the Company's
growth and enable the Company to undertake additional strategic initiatives.
There can be no assurance that the Company will be able to raise additional
capital on acceptable terms or at all. If the Company is unable to obtain such
additional capital, the Company may have to curtail its expansion of operations,
growth and other strategic initiatives, which could adversely affect the
company's business, financial condition and results of operations and its
ability to compete.
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-20 herein are incorporated herein by reference.
Quarterly financial information set forth at page 39 herein is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
NAME AGE POSITION
- ----------------------------------- --------- ----------------------------------------------------------------------
Howard S. Jonas.................... 41 Chief Executive Officer, Chairman of the Board and Treasurer
Howard S. Balter................... 36 Chief Operating Officer and Vice Chairman of the Board
James Courter...................... 56 President and Director
Stephen R. Brown................... 41 Chief Financial Officer
Joyce J. Mason..................... 38 Secretary and Director
Marc E. Knoller.................... 36 Vice President and Director
Hal Brecher........................ 34 Executive Vice President of Operations and Director
Meyer A. Berman.................... 63 Director
J. Warren Blaker................... 63 Director
Bert W. Wasserman.................. 64 Director
James R. Mellor.................... 67 Director
Elmo Zumwalt....................... 76 Director
HOWARD S. JONAS founded IDT in August 1990 and has served as Chairman of the
Board and Treasurer since its inception and as Chief Executive Officer since
December 1991. He served as President of the Company from December 1991 through
September 1996. Mr. Jonas is also the founder and has been President of Jonas
Publishing Corp. ("Jonas Publishing"), a publisher of trade directories, since
its inception in 1979. Mr. Jonas received a B.A. in Economics from Harvard
University.
HOWARD S. BALTER has served as Chief Operating Officer of the Company since
1993 and served as the Company's Chief Financial Officer from 1993 to May 1995.
Mr. Balter has been a director of the Company since December 1995 and became
Vice Chairman of the Board in October 1996. From 1985 to 1993, Mr. Balter
operated his own real estate development firm. Mr. Balter holds a B.A. in
Mathematics and Computers from Yeshiva University and attended New York
University School of Business.
JAMES COURTER joined the Company as President in October 1996 and has been a
director of the Company since March 1996. Mr. Courter has been a senior partner
in the New Jersey law firm of Courter, Kobert, Laufer & Cohen since 1972. He was
also a partner in the Washington, D.C. law firm of Verner, Liipfert, Bernhard,
McPherson & Hand from January 1994 to September 1996. Mr. Courter was a member
of the U.S. House of Representatives for 12 years, retiring in January 1991.
From 1991 to 1994, Mr. Courter was Chairman of the President's Defense Base
Closure and Realignment Commission. Mr. Courter also serves on the Board of
Directors of Envirogen, Inc. He received a B.A. from Colgate University and a
J.D. from Duke University Law School.
STEPHEN R. BROWN joined the Company as its Chief Financial Officer in May
1995. From 1985 to May 1995, Mr. Brown operated his own public accounting
practice servicing medium-sized corporations as well as high net worth
individuals. Mr. Brown received a B.A. in Economics from Yeshiva University and
a B.B.A. in Business and Accounting from Baruch College.
JOYCE J. MASON has been a director of the Company since March 1996. Ms.
Mason has served as Secretary of the Company since its inception and as a
director of the Company's predecessor since its inception to March 1996. Ms.
Mason has been in private legal practice since August 1990. Ms. Mason received a
B.A. from the City University of New York and a J.D. from New York Law School.
Ms. Mason is Mr. Jonas's sister.
42
MARC E. KNOLLER has been a director of the Company since March 1996. Mr.
Knoller joined the Company as its Vice President in March 1991 and also served
as a director of its predecessor since such time. From 1988 until March 1991,
Mr. Knoller was director of national sales for Jonas Publishing. Mr. Knoller
received a B.B.A. from Baruch College.
HAL BRECHER has served as the Company's Executive Vice President of
Operations since he joined the Company in November 1996, and became a director
of the Company in April 1997. Prior to joining the Company, Mr. Brecher was the
Executive Vice President of a direct marketing firm. He holds a B.S. in Computer
Science from Brooklyn College, and an M.B.A. from the Wharton School of the
University of Pennsylvania.
MEYER A. BERMAN has been a director of the Company since March 1996. Mr.
Berman founded M.A. Berman Co. in 1981, a broker-dealer that services high net
worth individuals and institutions, and has served as its President from its
inception. Prior to such time Mr. Berman held various positions in the stock
brokerage business.
J. WARREN BLAKER has been a director of the Company since March 1996. Dr.
Blaker has been Professor of Physics and Director of the Center for Lightwave
Science and Technology at Fairleigh Dickinson University since 1987. Prior to
such time he worked in various capacities in the optics industry, including
serving as Chief Executive Officer of University Optical Products, Inc., a
wholly-owned subsidiary of University Patents, Inc., from 1982 to 1985. Dr.
Blaker received a B.S. from Wilkes University and a Ph.D. from the Massachusetts
Institute of Technology.
BERT W. WASSERMAN has been a director of the Company since March 1996. Mr.
Wasserman was Executive Vice President and Chief Financial Officer of Time
Warner Inc. from January 1990 to December 1994 and was also a director of Time
Warner from January 1990 to March 1993. Mr. Wasserman was a member of the Office
of the President and was also a director of Warner Communications, Inc. ("Warner
Communications") from 1981 to 1990, when that company merged to form Time
Warner, and had served Warner Communications in various capacities beginning in
1966. Mr. Wasserman serves as a member of various boards, including: several
investment companies in the Dreyfus Family of Funds; Lillian Vernon Corp., a
catalog seller of home products; Winstar Communications, Inc., a wireless
communications company; and Mountasia Entertainment International, Inc., an
operator of family recreation centers. Mr. Wasserman is a graduate of Baruch
College and Brooklyn Law School.
JAMES R. MELLOR joined the Company as a director in August, 1997. Since
1981, Mr. Mellor had been working for General Dynamics Corporation, a leader in
nuclear submarines, surface combatant ships and combat systems. From 1994 until
1997, Mr. Mellor served as CEO of General Dynamics Corporation. Before joining
General Dynamics, Mr. Mellor served as President and Chief Operating Officer of
AM International, Inc., now Multigraphics, Inc. Prior to that, Mr. Mellor spent
18 years with Litton Industries in a variety of engineering and management
positions, including Executive Vice President in charge of Litton's Defense
Group from 1973 to 1977.
ELMO R. ZUMWALT, JR. became a director of the Company in February 1997. He
is a retired United States Navy Admiral and served as Chief of Naval Operation
and a member of the Joint Chiefs of Staff from 1970 to 1974. He has been
President of Admiral Zumwalt & Consultants, Inc., a Washington-based consulting
firm, since prior to 1991. Admiral Zumwalt is a director of Magellan Aerospace
Corporation, Dallas Semiconductor Corporation and NL Industries Inc. He is also
a member of the President's Foreign Intelligence Advisory Board, Chairman of the
International Consortium for Research on the Health Effects of Radiation,
Chairman of the Morrow Foundation and Chairman of the Ethics and Public Policy
Center.
In addition to the directors identified above, Denis A. Bovin was elected to
serve as a director in September 1997 and is currently expected to take office
before the third quarter of Fiscal 1998. Mr. Bovin currently serves as Vice
Chairman of Investment Banking and Senior Managing Director of Bear Stearns
43
& Co. Prior to joining Bear Stearns, Mr. Bovin spent close to two decades in the
Investment Banking Corporate Coverage and Capital Markets divisions as well as
the Communications and Technology Group of Salomon Brothers, Inc.
Each director holds office until that director's successor has been duly
elected and qualified. The Company's Board of Directors is divided into three
classes with Messrs. Blaker, Courter, Knoller and Zumwalt constituting Class I,
Messrs. Balter, Berman, Wasserman and Brecher constituting Class II and Messrs.
Jonas, Mellor and Ms. Mason constituting Class III. Upon the expiration of the
term of each class of directors, directors comprising such class of directors
will be elected for a three-year term at the next succeeding annual meeting of
stockholders. Executive officers of the Company are elected by the Board of
Directors on an annual basis and serve until their successors are duly elected
and qualified.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has established a Compensation Committee, which
currently consists of Messrs. Berman, Mellor and Blaker, and an Audit Committee
consisting of Messrs. Berman, Blaker and Wasserman. The Compensation Committee
will make recommendations concerning the salaries and incentive compensation of
employees of and consultants to the Company and will administer the Company's
Plan (as defined below). The Audit Committee will be responsible for reviewing
the results and scope of audits and other services provided by the Company's
independent auditors.
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION OF DIRECTORS
Each non-employee director received as of March 15, 1996 options exercisable
for 10,000 shares of Common Stock, and each director appointed to the Board of
Directors after such date received options to purchase 10,000 shares of the
Company's Common Stock upon his or her appointment. However, Elmo Zumwalt
received options to purchase 16,000 shares of the Company's Common Stock upon
his appointment to the Company's Board of Directors in Fiscal 1997. In addition,
each continuing non-employee director of the Company will annually receive
grants of options exercisable for 10,000 shares of Common Stock.
EXECUTIVE COMPENSATION
The following table sets forth certain information for the Company's last
completed fiscal year concerning the compensation of the Company's Chief
Executive Officer and the Company's most highly compensated executive officers
(whose salary and bonus exceeded $100,000), other than the Chief Executive
Officer, who were serving as executive officers as of July 31, 1997 (the "Named
Executive Officers").
44
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------------- -------------------
OTHER SECURITIES
ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR(1) SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#)
- -------------------------------------- ----------- ----------- ----------- ----------------------- -------------------
Howard S. Jonas....................... 1997 153,846 0 0 0
Chairman of The Board, 1996 65,000 0 0 0
Chief Executive Officer,
President and Treasurer
Howard S. Balter...................... 1997 200,251 14,000 0 0
Chief Operating Officer and 1996 175,000 64,000 0 0
Vice Chairman
James Courter......................... 1997 169,230 0 0 300,000
President
Stephen R. Brown...................... 1997 122,855 15,000 0 27,500
Chief Financial Officer 1996 68,125 12,500 0 0
Hal Brecher........................... 1997 129,731 15,000 0 150,000
Executive Vice President of
Operations
ALL OTHER
NAME AND PRINCIPAL POSITION COMPENSATION ($)
- -------------------------------------- -----------------------
Howard S. Jonas....................... 0
Chairman of The Board, 0
Chief Executive Officer,
President and Treasurer
Howard S. Balter...................... 0
Chief Operating Officer and 0
Vice Chairman
James Courter......................... 0
President
Stephen R. Brown...................... 0
Chief Financial Officer 0
Hal Brecher........................... 0
Executive Vice President of
Operations
- ------------------------
(1) Information with respect to Fiscal 1995 is not presented because the Company
was not a reporting Company pursuant to the Securities Exchange Act of 1934,
as amended, prior to Fiscal 1996. James Courter joined the Company as
President in October 1996. Hal Brecher joined the Company as Vice President
of Operations in November 1996.
STOCK OPTIONS GRANTED IN LAST FISCAL YEAR
PERCENT OF
NUMBER OF TOTAL OPTIONS RATES OF STOCK
SHARES GRANTED TO PRICE APPRICIATION
UNDERLYING EMPLOYEES IN EXERCISE DATE OF FOR OPTION TERM
NAME OPTIONS(#) FISCAL YEAR(%) PRICE($)(1) EXPIRATION 5%($) 10%($)
- --------------------------------------- ----------- ----------------- ------------------- ----------- --------- ----------
James Courter.......................... 300,000 31.5 4.375 10/29/06 825,300 2,091,900
Stephen R. Brown....................... 20,000 2.1 4.375 8/14/06 55,020 139,460
Stephen R. Brown....................... 7,500 0.8 5.250 5/1/07 24,765 62,753
Hal Brecher............................ 75,000 8.1 4.375 10/29/06 206,325 522,975
Hal Brecher............................ 75,000 8.1 5.250 5/1/07 247,650 627,525
- ------------------------
(1) See "Ten-Year Option Repricings" below for additional information regarding
the exercise price of certain stock options.
45
OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END VALUES
The following table provides certain information concerning the number of
shares of Common Stock underlying unexercised stock options held by each of the
Named Executive Officers and the value of such officers' unexercised stock
options at July 31, 1997. 222,000 stock options were exercised by the Named
Executive Officers during Fiscal 1997.
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED VALUE FISCAL YEAR-END(#) FISCAL YEAR-END ($)(1)
ON REALIZED -------------------------- -------------------------
NAME EXERCISE (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------------------- ------------ ----------- ----------- ------------- ---------- -------------
Howard S. Jonas......................... 0 0 0 0 0 0
Howard S. Balter........................ 207,000 1,470,686 345,920 0 2,825,475 0
James A. Courter........................ 0 0 85,000 225,000 306,300 900,000
Stephen R. Brown........................ 15,000 137,520 67,420 15,000 485,250 55,625
Hal Brecher............................. 0 0 25,000 125,000 100,000 384,375
- ------------------------
(1) The closing price of the Common Stock on July 31, 1997, as reported by the
Nasdaq National Market, was $8.375 per share.
TEN-YEAR OPTION REPRICINGS
The following table summarizes the Company's cancellation and reissuance of
certain stock options granted to the Named Executive Officers during Fiscal
1997:
MARKET PRICE LENGTH OF ORIGINAL
NUMBER OF OF STOCK AT EXERCISE PRICE OPTION TERM
SECURITIES TIME OF AT TIME OF NEW REMAINING AT DATE
UNDERLYING REPRICING OR REPRICING OR EXERCISE OF REPRICING OR
NAME DATE OPTION(#) AMENDMENT($) AMENDMENT($) PRICE($) AMENDMENT
- ----------------------------- ------------ ----------- --------------- --------------- ----------- --------------------
Stephen R. Brown........... Feb. 1997 20,000 7.75 10.00 7.75 9 years, 9 months
Stephen R. Brown........... April 1997 20,000 4.375 7.75 4.375 9 years, 7 months
Jim Courter................ Feb. 1997 300,000 7.75 10.00 7.75 9 years, 9 months
Jim Courter................ Feb. 1997 10,000 7.75 10.00 7.75 9 years, 1 month
Jim Courter................ April 1997 300,000 4.375 7.75 4.375 9 years, 7 months
Hal Brecher................ Feb. 1997 75,000 10.00 7.75 7.75 9 years, 9 months
Hal Brecher................ April 1997 75,000 7.75 4.375 7.75 9 years, 7 months
In each of February 1997 and May 1997, the Compensation Committee of the
Company's Board of Directors determined that it was in the best interests of the
Company to cancel a broad range of the outstanding stock options that Company
had previously issued to many of its executive officers and other employees, and
to reissue stock options with substantially equal terms, but with a lower
exercise price that would reflect the market price of the Company's common stock
as of the date of such reissuance. Acordingly, in February 1997, outstanding
stock options previously granted to employees at all levels of the Company were
canceled and reissued. In May 1997, stock options held by members of the
Company's middle and senior management were so canceled and reissued. In each
case, the new options were issued with an exercise price equal to fair market
value on the date of reissuance.
In February 1997, the reissuance of the Company's outstanding options was
intended primarily to raise the morale of the Company's employees. The Company's
Internet-related business had produced lackluster results during the first and
second quarter of Fiscal 1997, and the Company reduced the scope of its
Internet-related operations during that period. In addition, the market price of
the Company's
46
Common Stock had fallen beneath the exercise price of many outstanding stock
options, further reducing morale. Under these circumstances, the Compensation
Committee determined that it was in the best interests of the Company to reissue
such outstanding options with an exercise price equal to the prevailing market
price of $7.75 per share.
In April 1997, the Compensation Committee elected to reissue outstanding
options, in this case, to members of the Company's mid-level and senior
employees, in order to reward such individuals for their performance during the
period described above. The Compensation Committee determined that the relevant
officers and employees had made diligent, serious and fairly successful efforts
to improve the Company's performance, as indicated by the fact that in March
1997, the Company had its first profitable month since its initial public
offering. Under these circumstances, the Compensation Committee decided to
reward the responsible officers and employees by reissuing certain outstanding
stock options with an exercise price equal to the then-prevailing market price
of $4.375 per share.
By: The Compensation Committee of the Board of Directors
Meyer A. Berman, James R. Mellor and J. Warren Blaker
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Messrs. Jonas,
Balter, Brecher and Courter. Mr. Jonas's employment agreement, dated as of
January 1, 1996, provides for a base salary of a minimum of $200,000, which may
be increased, but not decreased, during the term of the agreement. The Company
may terminate Mr. Jonas's employment only for cause (as defined in the
agreement). If the agreement is terminated without cause, the Company is
obligated to pay to Mr. Jonas an amount equal to twice his base salary as then
in effect. The agreement has a three year term, but is automatically extendable
for one year periods unless the Board of Directors or Mr. Jonas notifies the
other, within ninety days of the anniversary of such period, that the agreement
will not be extended. Pursuant to the agreement, Mr. Jonas has agreed to not
compete with the Company for a period of one year following termination of the
agreement.
Mr. Balter's employment agreement, dated as of January 1, 1996, provides for
a base salary of a minimum of $175,000, which may be increased, but not
decreased, during the term of the agreement. The Company may terminate Mr.
Balter's employment only for cause (as defined in the agreement). If the
agreement is terminated without cause, the Company is obligated to pay to Mr.
Balter an amount equal to twice his base salary as then in effect. The agreement
has a three year term, but is automatically extendable for one year periods
unless the Board of Directors or Mr. Balter notifies the other, within 90 days
of the anniversary of such period, that the agreement will not be extended.
Pursuant to the agreement, Mr. Balter has agreed to not compete with the Company
for a period of one year following termination of the agreement.
Mr. Courter's employment agreement, dated as of September 4, 1996, provides
for a base salary of a minimum of $200,000, which may be increased, but not
decreased, during the term of the agreement. The Company may terminate Mr.
Courter's employment only for cause (as defined in the agreement). If the
agreement is terminated without cause, the Company is obligated to pay to Mr.
Courter an amount equal to twice his base salary as then in effect. The
agreement has a three year term but is automatically extendable for one year
periods unless the Board of Directors or Mr. Courter notifies the other, within
ninety days of the anniversary of such period, that the agreement will not be
extended. Pursuant to the agreement, Mr. Courter has agreed to not compete with
the Company for a period of one year following termination of the agreement.
Mr. Hal Brecher is employed as the Company's Executive Vice President of
Operations pursuant to a three year employment contract that was executed in
October 1996. Mr. Brecher's agreement provides for a base salary of $160,000,
which may be increased, but not decreased, during the term of the agreement. In
47
the event of termination, Mr. Brecher will receive three months' salary and
benefits. In addition 12,500 shares of non vested options will vest upon the
termination of his employment with the Company.
EMPLOYEE STOCK OPTION PROGRAM
The Company had an informal stock option program whereby selected key
employees were granted options to purchase shares of Common Stock. The primary
purpose of this program was to provide long-term incentives to the Company's key
employees and to further align their interests with those of the Company.
Options granted under such program have a term of ten years and are subject to
all other reasonable terms and conditions as the Company deems necessary and
appropriate. The selection of the participants and the determination of the
number of options to be granted to each participant were made by the Company's
Board of Directors. Under such program, options to purchase an aggregate of
2,158,770 shares of Common Stock have been granted, of which 1,392,582 were
outstanding as of July 1997. See "Certain Relationships and Related
Transactions." The Company does not anticipate that any additional options will
be granted under this program.
1996 STOCK OPTION AND INCENTIVE PLAN
The Company has adopted the IDT Corporation 1996 Stock Option and Incentive
Plan (the "Plan"). Pursuant to the Plan, key employees, directors and
consultants of the Company are eligible to receive awards of stock options,
stock appreciation rights, limited stock appreciation rights and restricted
stock. Options granted under the Plan may be "incentive stock options" ("ISOs"),
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), or nonqualified stock options ("NQSOs"). Stock
appreciation rights ("SARs") and limited stock appreciation rights ("LSARs") may
be granted simultaneously with the grant of an option or (in the case of NQSOs),
at any time during the term of the Plan. Restricted stock may be granted in
addition to or in lieu of any other award granted under the Plan. The Company
has authorized 2,300,000 shares of Common Stock for issuance of awards under the
Plan (subject to antidilution and similar adjustments), of which 2,277,544 of
such options were granted as of July 1997, and of which 2,031,544 such options
were outstanding as of such date.
The Plan is administered by the Compensation Committee (the "Committee")
appointed by the Board of Directors of the Company (the "Board"). Subject to the
provisions of the Plan, the Committee will determine the type of award, when and
to whom awards will be granted, the number of shares covered by each award and
the terms, provisions and kind of consideration payable (if any), with respect
to awards. The Committee may interpret the Plan and may at any time adopt such
rules and regulations for the Plan as it deems advisable.
In determining the persons to whom awards shall be granted and the number of
shares covered by each award, the Committee shall take into account the duties
of the respective persons, their present and potential contribution to the
success of the Company and such other factors as the Committee shall deem
relevant.
An option may be granted on such terms and conditions as the Committee may
approve, and generally may be exercised for a period of up to 10 years from the
date of grant. Generally, ISOs will be granted with an exercise price equal to
the "Fair Market Value" (as defined in the Plan) on the date of grant. In the
case of ISOs, certain limitations will apply with respect to the aggregate value
of option shares which can become exercisable for the first time during any one
calendar year, and certain additional limitations will apply to ISOs granted to
"Ten Percent Stockholders" (as defined in the Plan) of the Company. The
Committee may provide for the payment of the option price in cash, by delivery
of Common Stock or Class A Stock having a Fair Market Value equal to such option
price, by a combination thereof or by any other method. Options granted under
the Plan will become exercisable at such times and under such conditions as the
Committee shall determine, subject to acceleration of the exercisability of
options in the event of, among other things, a "Change in Control" (as defined
in the Plan).
48
The Plan provides for automatic formula option grants to eligible
non-employee directors of the Company. Options to purchase 10,000 shares of
Common Stock were granted to each non-employee director upon the consummation of
the Company's initial public offering in March 1996 and options to purchase
10,000 shares of Common Stock will be granted to each new non-employee director
upon such director's initial election and qualification for the Board. In
addition, options to purchase 10,000 shares of Common Stock will be granted
annually to each non-employee director on the day of each annual stockholder
meeting. Each option will have an exercise price equal to the Fair Market Value
of a share of Common Stock on the date of grant. All such options granted to
non-employee directors will be immediately exercisable. All options held by
non-employee directors, to the extent not exercised, expire on the earliest of
(i) the tenth anniversary of the date of grant, (ii) one year following the
optionee's termination of his directorship on account of death or disability or
(iii) three months following the optionee's termination of his directorship with
the Company for any other reason.
The Plan also permits the Committee to grant SARs and/or LSARs with respect
to all or any portion of the shares of Common Stock covered by options.
Generally, SARs may be exercised only at such time as the related option is
exercisable and LSARs may be exercised only during the 90 days immediately
following an "Acceleration Date" (as defined in the Plan) except that, in the
case of an "Insider" (as defined in the Plan), (i) an SAR and an LSAR must be
held for at least six months before it becomes exercisable and (ii) an LSAR must
automatically be paid out in cash. LSARs will be exercisable only if, and to the
extent, that the option to which the LSARs relate is then exercisable, and if
such option is an ISO, only to the extent the Fair Market Value per share of
Common Stock exceeds the option price.
Upon exercise of an SAR, a grantee will receive for each share for which an
SAR is exercised, an amount in cash or Common Stock, as determined by the
Committee, equal to the excess, if any, of (i) the Fair Market Value of a share
of Common Stock on the date the SAR is exercised over (ii) the exercise price
per share of the option to which the SAR relates.
Upon exercise of an LSAR, a grantee will receive for each share for which an
LSAR is exercised, an amount in cash equal to the excess, if any, of (i) the
greater of (x) the highest Fair Market Value of a share of Common Stock during
the 90-day period ending on the date the LSAR is exercised, and (y) whichever of
the following is applicable: (1) the highest per share price paid in any tender
or exchange offer which is in effect at any time during the 90 days ending on
the date of exercise of the LSAR; (2) the fixed or formula price for the
acquisition of shares of Common Stock in a merger in which the Company will not
continue as the surviving corporation, or upon a consolidation, or a sale,
exchange or disposition of all or substantially all of the Company's assets,
approved by the Company's stockholders (if such price is determinable on the
date of exercise); and (3) the highest price per share of Common Stock shown on
Schedule 13D, or any amendment thereto, filed by the holder of the specified
percentage of Common Stock, the acquisition of which gives rise to the
exercisability of the LSAR over (ii) the exercise price per share of the option
to which the LSAR relates. In no event, however, may the holder of an LSAR
granted in connection with an ISO receive an amount in excess of the maximum
amount which will enable the option to continue to qualify as an ISO.
When an SAR or LSAR is exercised, the option to which it relates will cease
to be exercisable to the extent of the number of shares with respect to which
the SAR or LSAR is exercised, but will be deemed to have been exercised for
purposes of determining the number of shares available for the future grant of
awards under the Plan.
The Plan further provides for the granting of restricted stock awards, which
are awards of Common Stock which may not be disposed of, except by will or the
laws of descent and distribution, for such period as the Committee determines
(the "restricted period"). The Committee may also impose such other conditions
and restrictions, if any, on the shares as it deems appropriate, including the
satisfaction of performance criteria. All restrictions affecting the awarded
shares lapse in the event of a Change in Control.
49
During the restricted period, the grantee will be entitled to receive
dividends with respect to, and to vote the shares awarded to him. If, during the
restricted period, the grantee's service with the Company terminates for any
reason, any shares remaining subject to restrictions will be forfeited. The
Committee has the authority to cancel any or all outstanding restrictions prior
to the end of the restricted period, including cancellation of restrictions in
connection with certain types of termination of service.
The Board may at any time and from time to time suspend, amend, modify or
terminate the Plan; provided however, that, to the extent required by Rule 16b-3
("Rule 16b-3") promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), or any other law, regulation or stock exchange rule, no
such change shall be effective without the requisite approval of the Company's
stockholders. In addition, no such change may adversely affect any award
previously granted, except with the written consent of the grantee.
No awards may be granted under the Plan after ten years after its adoption.
401(K) PLAN
The Company has established a plan in September 1996, pursuant to Section
401(k) of the Internal Revenue Code of 1986, as amended (the "401(k) Plan"), for
non-union employees. The non-union employees of the Company and its subsidiaries
are eligible to participate in the 401(k) Plan after completion of one year of
employment with the Company. Under the 401(k) Plan, eligible employees may elect
to defer a portion of their salary each year (subject to limits imposed by the
Internal Revenue Service). The portion deferred will be paid by the Company to
the trustee under the 401(k) Plan. The Company makes a matching contribution to
the 401(k) Plan each month on behalf of each participant in an amount equal to
20% of such participant's salary deferral contribution. Matching contributions
become vested under the 401(k) Plan at a rate of 20% for each full year of
employment. Matching contributions do not begin vesting until the second year of
employment.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During Fiscal 1997, the Compensation committee was comprised of Messrs.
Berman, Blaker and Mellor and the Audit committee was comprised of Messrs.
Berman, Blaker and Wasserman. Each of the members of the Compensation Committee
and the Audit Committee were not employees of the Company during such period.
50
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information regarding the beneficial
ownership of Common Stock (and Class A Stock, assuming conversion of all shares
of Class A Stock into Common Stock) as of September 30, 1997 by (i) each person
known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock (and Class A Stock, on an as-converted
basis), (ii) each of the Company's directors and the Named Executive Officers
and, (iii) all directors and officers of the Company as a group. Unless
otherwise noted in the footnotes to the table, the persons named in the table
have sole voting and investing power with respect to all shares (or Class A
Stock) of Common Stock indicated as being beneficially owned by them.
NAME AND ADDRESS OF NUMBER OF PERCENTAGE OF
BENEFICIAL OWNER SHARES OWNERSHIP
- ------------------------------------------------------------------------------------- ------------ ---------------
Howard S. Jonas(1)................................................................... 10,992,301 48.0
294 State Street
Hackensack, NJ 97068
The Equitable Companies, Inc.(2)..................................................... 1,209,700 5.3
787 Seventh Avenue
New York, NY 10019
Putnam Investments, Inc.(3).......................................................... 1,154,113 5.0
One P.O. Box Square
Boston, MA 02109
Howard S. Balter(4).................................................................. 552,920 2.4
James Courter(5)..................................................................... 317,000 1.4
Joyce J. Mason(6).................................................................... 41,533 *
Meyer A. Berman(7)................................................................... 123,500 *
J. Warren Blaker(8).................................................................. 20,000 *
Bert W. Wasserman(8)................................................................. 45,000 *
Mark E. Knoller(8)................................................................... 230,000 *
James Mellor(8)...................................................................... 10,000 *
Stephen R. Brown(8).................................................................. 57,420 *
Hal Brecher(8)....................................................................... 82,500 *
Elmo Zumwalt(8)...................................................................... 16,000 *
All directors and officers as a group
(12 persons)....................................................................... 12,488,194 54.5
- ------------------------
* Less than 1%.
(1) Shares of Class A Stock which are convertible on a share-for-share basis
into Common Stock at the option of the holder. 10,434 of these shares of
Class A Stock are owned of record by the Jonas Family Limited Partnership,
over which Mr. Jonas exercises the power to vote and the power to dispose.
(2) Includes 161,200 shares beneficially owned by The Equitable Life Assurance
Society of the United States, a subsidiary of The Equity Companies
Incorporated, and 873,500 shares beneficially owned by the Alliance Capital
Management L.P., also a subsidiary of The Equitable Companies Incorporated.
(3) Includes 1,154,113 shares held by Putnam Investment Managements, Inc. as the
wholly-owned investment adviser of Putnam Investments, Inc. 817,940 of these
shares are held by the Putnam Voyager Fund. The investment adviser has
dispository power over the shares in each of the funds, but the investment
trustee has voting power over the shares in each fund.
(4) Includes 345,920 shares beneficially owned pursuant to stock options
exercisable within 60 days.
(5) Includes 85,000 shares beneficially owned pursuant to stock options
exercisable within 60 days.
(6) Includes 40,200 shares beneficially owned pursuant to stock options
exercisable within 60 days.
(7) Includes 20,000 shares beneficially owned pursuant to stock options
exercisable within 60 days.
(8) Common Stock beneficially owned pursuant to stock options exercisable within
60 days.
51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The Company currently leases one of its three headquarters facilities in
Hackensack, New Jersey from a corporation which is wholly-owned by Howard Jonas,
the Company's Chief Executive Officer and Chairman of the Board of Directors.
Aggregate lease payments under such lease were $24,000 for each of Fiscal 1995
and 1996 and $69,000 for Fiscal 1997. In addition, the Company leases one floor
in an office building which is owned by an entity controlled by Mr. Jonas;
pursuant to the lease, which expires in December 1998, the Company pays a
monthly rental fee of $5,200.
For information regarding grants of options to the Company's directors and
executive offices, see "Executive Compensation."
The Company has not and will not extend or guarantee loans to officers or
directors of the Company, unless such loans are approved by a majority of the
directors and a majority of the independent, disinterested, outside directors of
the Company, are for bona fide business purposes and may be reasonably expected
to benefit the Company.
James Courter, the President and a Director of the Company, was a partner of
the law firm of Verner, Liipfert, Bernhard, McPherson & Hand until September
1996. The firm has served as counsel to the Company since January 1996. Mr.
Courter is a partner of the law firm Courter, Kobert, Laufer & Cohen which has
served as counsel to the Company since July 1996. Fees paid to each of the firms
by the Company were less than 5% of the firms' gross revenues for each fiscal
year in which they represented the Company.
52
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 NO. DESCRIPTION
- ------------ ---------------------------------------------------------------------------------
3.01(1) Restated Certificate of Incorporation of the Registrant.
3.02(1) By-laws of the Registrant.
4.01(2) Specimen Certificates for shares of the Registrant's Common Stock and Class A
Stock.
4.02(1) Description of Capital Stock (contained in the Certificate of Incorporation of
the Registrant, filed as Exhibit 3.01).
10.01(3) Employment Agreement between the Registrant and Howard S. Jonas.
10.02(3) Employment Agreement between the Registrant and Howard S. Balter.
10.04(4) Amended and Restated 1996 Stock Option and Incentive Plan of IDT Corporation.
10.05(5) Network Service Provider Agreement between Netscape Communications Corporation
and the Registrant.
10.06(3) Marketing Services and Independent Contractor Services Agreement between Lermer
Overseas Telecommunications, Inc. and the Registrant.
10.07(6) Rebiller Service Agreement between WorldCom, Inc. (formerly LDDS Communications,
Inc.) and the Registrant.
10.08(2) Form of Registration Rights Agreement between the Company's stockholders and the
Company.
10.09(1) Lease of 294 State Street.
10.11(7) Form of Registration Rights Agreement between Howard S. Jonas and the Registrant.
10.12(8) Employment Agreement between the Registrant and James Courter.
10.13(5) Access Agreement between PSINet Inc. and the Registrant.
10.14(5) Restated Sales Agreement between International Computer Systems, Inc. and the
Registrant.
10.15(4) Form of Stock Option Agreement under the 1996 Stock Option and Incentive Plan.
10.16(9) Form of Debenture between the Registrant, RGC International Investors, LDC,
Pangaea Fund Ltd., Special Situations Private Equity Fund, L.P. and Halifax
Fund L.P.
10.17(9) Securities Purchase Agreement among the Registrant, RGC International Investors,
LDC, Pangaea Fund Ltd., Special Situations Private Equity Fund, L.P. and
Halifax Fund L.P.
53
EXHIBIT NO. DESCRIPTION
- ------------ ---------------------------------------------------------------------------------
10.18(9) Registration Rights Agreement among the Registrant, RGC International Investors,
LDC, Pangaea Fund Ltd., Special Situations Private Equity Fund, L.P. and
Halifax Fund L.P.
10.19* Warrants (No. 1 and No. 2) for the Purchase of Common Stock between the
Registrant and Prime Leasing, Inc.
10.20* Stock Purchase Agreement between the Registrant and Mr. David Turock
10.21+ Agreement between Mr. Cliff Sobel and the Registrant.
10.22* Employment Agreement between the Registrant and Mr. Hal Brecher.
21.01* Subsidiaries of the Registrant.
23.01* Consent of Ernst & Young LLP.
27.01* Financial Data Schedule.
- ------------------------
* filed herewith
+ to be filed by amendment
(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 March 8, 1996 file No. 333-00204
(3) incorporated by reference to Form S-1 filed January 9, 1996, file No. 333-00204
(4) incorporated by reference to Form S-8 filed January 14, 1996, file No. 333-19727
(5) incorporated by reference to Form 10-K for the fiscal year ended July 31, 1996 filed
October 29, as amended November 21, 1996 file No. 000-27898
(6) incorporated by reference to Form S-1 filed January 22, 1996 file No. 333-00204
(7) incorporated by reference to Form S-1 filed March 14, 1996 file No. 333-00204
(8) incorporated by reference to Form S-1 filed December 27, 1996 file No. 333-18901
(9) incorporated by reference to Form 8-K filed September 19, 1997 file No. 000-27898
(b) Reports on Form 8-K. The Registrant filed one report on Form 8-K during the
fiscal year ended July 31, 1997, on September 19, 1997, relating to the
Company's issuance of $7,500,000 aggregate principal amount of convertible
subordinated debentures.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report 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 29, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ HOWARD S. JONAS Chairman, Chief Executive October 29, 1997
- ------------------------------ Officer and
Howard S. Jonas Treasurer
(Principal Executive
Officer)
/s/ JAMES A. COURTER President and Director October 29, 1997
- ------------------------------ (Principal Executive
James A. Courter Officer)
/s/ HOWARD S. BALTER Chief Operating Officer October 29, 1997
- ------------------------------ (Principal Financial
Howard S. Balter Officer)
/s/ STEPHEN R. BROWN Chief Financial Officer October 29, 1997
- ------------------------------ (Principal Accounting
Stephen R. Brown Officer)
/s/ MEYER A. BERMAN Director October 29, 1997
- ------------------------------
Meyer A. Berman
Director October 29, 1997
- ------------------------------
J. Warren Blaker
/s/ BERT W. WASSERMAN Director October 29, 1997
- ------------------------------
Bert W. Wasserman
/s/ MARK E. KNOLLER Director October 29, 1997
- ------------------------------
Mark E. Knoller
/s/ ELMO R. ZUMWALT, JR. Director October 29, 1997
- ------------------------------
Elmo R. Zumwalt, Jr.
/s/ JAMES MELLOR Director October 29, 1997
- ------------------------------
James Mellor
/s/ HAL BRECHER Director October 29, 1997
- ------------------------------
Hal Brecher
/s/ JOYCE MASON Director October 29, 1997
- ------------------------------
Joyce Mason
55
IDT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors....................................................... F-2
Consolidated Balance Sheets as of July 31, 1996 and 1997............................. F-3
Consolidated Statements of Operations for the years ended July 31, 1995, 1996 and
1997............................................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended July 31, 1995,
1996 and 1997...................................................................... F-5
Consolidated Statements of Cash Flows for the years ended July 31, 1995, 1996 and
1997............................................................................... F-6
Notes to Consolidated Financial Statements........................................... F-7
Financial Statement Schedule--Valuation and Qualifying Accounts...................... F-21
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
IDT Corporation
We have audited the accompanying consolidated balance sheets of IDT
Corporation as of July 31, 1996 and 1997, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended July 31, 1997. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company at
July 31, 1996 and 1997 and the consolidated results of its operations and its
cash flows for each of the three years in the period ended July 31, 1997, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
ERNST & YOUNG LLP
New York, New York
September 25, 1997
F-2
IDT CORPORATION
CONSOLIDATED BALANCE SHEETS
JULY 31
----------------------------
1996 1997
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 14,893,756 $ 7,674,313
Trade accounts and commissions receivable, net of allowance for doubtfulaccounts
of approximately $2,100,000 at July 31, 1996 and $3,190,000 at July 31, 1997... 11,497,565 17,128,890
Notes receivable................................................................. 925,000 1,291,403
Due from Yovelle................................................................. 1,200,000 --
Other current assets............................................................. 1,985,090 2,922,750
------------- -------------
Total current assets............................................................... 30,501,411 29,017,356
Property and equipment, at cost, net............................................... 12,453,330 25,725,805
Note receivable.................................................................... 325,000 --
Goodwill, net...................................................................... -- 1,357,606
Other assets....................................................................... 517,630 2,436,334
------------- -------------
Total assets....................................................................... $ 43,797,371 $ 58,537,101
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable........................................................... $ 10,602,075 $ 16,957,656
Accrued expenses................................................................. 4,947,119 721,142
Deferred revenue................................................................. 983,496 2,442,848
Notes payable--current portion................................................... -- 1,880,939
Capital lease obligations--current portion....................................... -- 1,531,971
Other current liabilities........................................................ 422,005 595,951
------------- -------------
Total current liabilities.......................................................... 16,954,695 24,130,507
Notes payable--long-term portion................................................... -- 5,241,088
Capital lease obligations--long-term portion....................................... -- 3,906,362
------------- -------------
Total liabilities.................................................................. 16,954,695 33,277,957
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;
9,666,900 and X10,636,000 shares issued and outstanding in 1996 and 1997,
respectively................................................................... 96,669 106,360
Class A stock, $.01 par value; authorized shares--35,000,000;
11,174,330 shares issued and outstanding....................................... 111,743 111,743
Additional paid-in capital....................................................... 44,746,841 46,990,388
Accumulated deficit.............................................................. (18,112,577) (21,949,347)
------------- -------------
Total stockholders' equity......................................................... 26,842,676 25,259,144
------------- -------------
Total liabilities and stockholders' equity......................................... $ 43,797,371 $ 58,537,101
------------- -------------
------------- -------------
See accompanying notes.
F-3
IDT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED JULY 31
---------------------------------------------
1995 1996 1997
------------- -------------- --------------
Revenues.......................................................... $ 11,664,434 $ 57,693,880 $ 135,187,227
Costs and expenses:
Direct cost of revenues......................................... 7,543,923 36,437,583 92,214,223
Selling, general and administrative............................. 5,991,520 35,799,158 41,544,987
Depreciation and amortization................................... 303,619 1,212,235 4,873,142
------------- -------------- --------------
Total costs and expenses.......................................... 13,839,062 73,448,976 138,632,352
------------- -------------- --------------
Loss from operations.............................................. (2,174,628) (15,755,096) (3,445,125)
Interest expense.................................................. -- (113,160) (862,954)
Interest income................................................... 15,129 458,464 436,112
Other............................................................. 14,950 -- 35,197
------------- -------------- --------------
Loss before income taxes and extraordinary item................... (2,144,549) (15,409,792) (3,836,770)
Income taxes...................................................... -- -- --
------------- -------------- --------------
Loss before extraordinary item.................................... (2,144,549) (15,409,792) (3,836,770)
Extraordinary loss on retirement of debt.......................... -- (233,500) --
------------- -------------- --------------
Net loss.......................................................... $ (2,144,549) $ (15,643,292) $ (3,836,770)
------------- -------------- --------------
------------- -------------- --------------
Loss per share:
Loss before extraordinary item.................................... $ (0.13) $ (0.85) $ (0.18)
Extraordinary loss on retirement of debt.......................... -- (0.01) --
------------- -------------- --------------
Net loss.......................................................... $ (0.13) $ (0.86) $ (0.18)
------------- -------------- --------------
------------- -------------- --------------
Weighted average number of shares used in calculation of loss per
share........................................................... 16,569,292 18,180,023 21,152,927
------------- -------------- --------------
------------- -------------- --------------
See accompanying notes.
F-4
IDT CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK CLASS A STOCK ADDITIONAL STOCK
---------------------- ---------------------- PAID-IN SUBSCRIPTION (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT)
----------- --------- ----------- --------- ------------ ------------ -------------
Balance at July 31, 1994........ 4,491,900 $ 44,919 11,174,330 $ 111,743 $ 2,254,938 $ (25,000) $ (324,736)
Compensation expense
recognized on issuance of
stock options............... -- -- -- -- 968,660 -- --
Services rendered in exchange
for subscription
receivable.................. -- -- -- -- -- 25,000 --
Net loss for the year ended
July 31, 1995............... -- -- -- -- -- -- (2,144,549)
----------- --------- ----------- --------- ------------ ------------ -------------
Balance at July 31, 1995........ 4,491,900 44,919 11,174,330 111,743 3,223,598 -- (2,469,285)
Compensation expense
recognized on issuance of
stock options............... -- -- -- -- 70,000 -- --
Sale of common stock.......... 4,600,000 46,000 -- -- 41,458,993 -- --
Exercise of warrants.......... 575,000 5,750 -- -- (5,750) -- --
Net loss for the year ended
July 31, 1996............... -- -- -- -- -- -- (15,643,292)
----------- --------- ----------- --------- ------------ ------------ -------------
Balance at July 31, 1996........ 9,666,900 96,669 11,174,330 111,743 44,746,841 -- (18,112,577)
Compensation expense
recognized on issuance of
stock options............... -- -- -- -- 41,213 -- --
Exercise of stock options..... 969,100 9,691 -- -- 2,202,334 -- --
Net loss for the year ended
July 31, 1997............... -- -- -- -- -- -- (3,836,770)
----------- --------- ----------- --------- ------------ ------------ -------------
Balance at July 31, 1997........ 10,636,000 $ 106,360 11,174,330 $ 111,743 $ 46,990,388 $ -- $ (21,949,347)
----------- --------- ----------- --------- ------------ ------------ -------------
----------- --------- ----------- --------- ------------ ------------ -------------
See accompanying notes.
F-5
IDT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED JULY 31
1995 1996 1997
------------- -------------- -------------
OPERATING ACTIVITIES
Net loss............................................................ $ (2,144,549) $ (15,643,292) $ (3,836,770)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Stock option expense............................................ 968,660 70,000 41,213
Depreciation and amortization................................... 303,619 1,212,235 4,873,142
Services rendered in exchange for subscription receivable....... 25,000 -- --
Changes in assets and liabilities:
Accounts receivable........................................... (1,104,087) (9,468,047) (9,273,827)
Due from Yovelle.............................................. -- (1,200,000) --
Other current assets.......................................... (97,357) (1,844,056) (937,660)
Other assets.................................................. -- (492,630) (1,801,077)
Advances receivable........................................... -- (1,250,000) 2,861,003
Trade accounts payable........................................ 417,662 9,803,488 6,233,349
Accrued expenses.............................................. 1,731,696 2,918,366 (4,225,977)
Deferred revenue.............................................. 242,921 716,912 1,459,352
Other current liabilities..................................... 177,810 234,648 173,946
------------- -------------- -------------
Net cash provided by (used in) operating activities................. 521,375 (14,942,376) (4,433,306)
INVESTING ACTIVITIES
Purchases of property and equipment................................. (1,325,518) (11,895,452) (7,112,962)
Payments for the purchase of Yovelle, net cash acquired............. -- -- 376,843
Payments for the purchase of the assets of International Computer
Systems, Inc...................................................... -- -- (2,250,000)
Payment for the purchase of the assets of PCIX, Inc................. -- -- (260,000)
Proceeds from the sale of short-term investments.................... 297,974 -- --
------------- -------------- -------------
Net cash used in investing activities............................... (1,027,544) (11,895,452) (9,246,119)
FINANCING ACTIVITIES
Payments on notes due to former shareholder......................... (16,669) (5,001) --
Proceeds from notes payable from shareholders, affiliates and
outside investors................................................. -- 4,237,000 --
Repayments of notes payable from shareholders, affiliates and
outside investors................................................. -- (4,237,000) --
Proceeds from notes payable......................................... -- -- 6,750,000
Exercise of stock options........................................... -- -- 2,212,025
Repayment of capital lease obligations.............................. -- -- (684,070)
Repayments of notes payable......................................... -- -- (1,817,973)
Proceeds from sale of common stock.................................. -- 41,504,993 --
------------- -------------- -------------
Net cash provided by (used in) financing activities................. (16,669) 41,499,992 6,459,982
------------- -------------- -------------
Net increase (decrease) in cash..................................... (522,838) 14,662,164 (7,219,443)
Cash and cash equivalents at beginning of period.................... 754,430 231,592 14,893,756
------------- -------------- -------------
Cash and cash equivalents at end of period.......................... $ 231,592 $ 14,893,756 $ 7,674,313
------------- -------------- -------------
------------- -------------- -------------
SEE ACCOMPANYING NOTES.
F-6
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
IDT Corporation (the "Company") provides telecommunication, Internet
connectivity and Internet telephony services to customers in the United States
and abroad.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results inevitably will differ from those estimates.
REVENUE RECOGNITION
Monthly subscription service revenue is recognized over the period services are
provided. Telecommunication, Internet telephony service, and debit card revenues
are recognized as service is provided. Equipment sales are recognized when
installation is completed. Deferred revenues result from advance billings for
services.
DIRECT COST OF REVENUES
Direct cost of revenues consists primarily of telecommunication costs,
connectivity costs, and the cost of equipment sold to customers.
PROPERTY AND EQUIPMENT
Equipment, software, and furniture and fixtures are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from five to seven years. Leasehold improvements are amortized using the
straight-line method over the term of the lease or estimated useful life of the
assets, whichever is shorter.
SUBSCRIBER ACQUISITION COSTS AND ADVERTISING
Subscriber acquisition costs including sales commissions, license fees and
production and shipment of starter packages are expensed as incurred.
The Company expenses the costs of advertising as incurred. For the years ended
July 31, 1995, 1996 and 1997, advertising expense totaled approximately
$581,000, $8,520,000 and $4,011,000, respectively.
F-7
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE DEVELOPMENT COSTS
Costs for the internal development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established, at which time any additional
costs would be capitalized. To date, the Company has essentially completed its
software development concurrently with the establishment of technological
feasibility and, accordingly, no such costs have been capitalized to date.
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, 1997, the
Company has substantially all of its cash and cash equivalents deposited with
one financial institution.
GOODWILL
Goodwill is amortized over 20 years using the straight-line method. Accumulated
amortization of Goodwill at July 31, 1997 was $34,307. The Company
systematically reviews the recoverability of its goodwill for each acquired
entity to determine whether an impairment may exist. Upon a determination that
the carrying value of goodwill will not be recovered from the undiscounted
future cash flows of the acquired business, the carrying value of such goodwill
would be considered impaired and will be reduced by a charge to operations in
the amount of the impairment.
INCOME TAXES
The Company accounts for income taxes on the liability method as required by
Statement of Financial Accounting Standards ("SFAS") No. 109, ACCOUNTING FOR
INCOME TAXES. Under this method, deferred tax assets and liabilities are
determined based on differences between the financial reporting and tax bases of
assets and liabilities.
NET INCOME (LOSS) PER SHARE
Except as noted below, net income (loss) per common share is computed using the
weighted average number of Common and Class A shares outstanding and dilutive
common stock equivalent shares from stock options. Stock options and warrants
are included as share equivalents using the treasury stock method. For all
periods prior to the Company's initial public offering, the net income (loss)
per share amounts were computed in accordance with rules and practices of the
Securities and Exchange Commission that require common stock, common stock
options and common stock warrants issued at a price substantially below the
proposed public offering price and within a twelve-month period prior to an
initial public offering of common stock to be treated as common stock
equivalents outstanding for all periods prior to the initial public offering.
CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash, cash equivalents and trade receivables.
Concentrations of credit risk with respect to
F-8
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
trade receivables are limited due to the large number of customers comprising
the Company's customer base.
International customers account for a significant portion 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.
IMPACT OF RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In March 1997, the Financial Accounting Standards Board issued SFAS No. 128,
EARNINGS PER SHARE, which is not effective until the second quarter of the
Company's fiscal 1998. This new standard requires dual presentation of basic and
diluted earnings per share ("EPS") on the face of the statement of operations
and requires a reconciliation of the numerators and denominators of basic and
diluted EPS calculations. The results would not materially differ from earnings
per share as presented.
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, was issued in June 1997. The
Company will be required to adopt the new standard for the year ending July 31,
1999, although early adoption is permitted. The primary objective of this
statement is to report and disclose a measure ("Comprehensive Income") of all
changes in equity of a company that result from transactions and other economic
events of the period other than transactions with owners. The Company intends to
adopt this statement in fiscal 1999 and does not anticipate that the statement
will have a significant impact on its financial statements .
SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, was issued in June 1997. The Company will be required to adopt the
new standard for the year ending July 31, 1999, although early adoption is
permitted. This statement requires use of the "management approach" model for
segment reporting. The management approach model is based on the way a company's
management organizes segments within the company for making operating decisions
and assessing performance. Reportable segments are based on products and
services, geography, legal structure, management structure, or any other manner
in which management disaggregates a company. The Company intends to adopt this
statement in fiscal 1999 and does not anticipate that the adoption of the
statement will have a significant impact on its financial statements.
STOCK BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. The Company applies APB Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES and related interpretations in
accounting for stock options.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
F-9
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. NOTES RECEIVABLE
Prior to July 31, 1996, the Company advanced $1,250,000 to one of its carriers.
The Company also had trade receivables of approximately $1,600,000 due from such
carrier at July 31, 1996. The Company converted the advance and trade
receivables, plus accrued interest thereon, into a promissory note bearing
interest at a rate of 13% per annum and payable in 12 monthly installments
commencing on November 15, 1996. The promissory note is secured by the carrier's
equipment. At July 31, 1996 and 1997, the outstanding balance of such promissory
note was $1,250,000 and $486,000, respectively.
On January 1, 1997, the Company converted a $1,996,000 trade receivable balance
from a carrier into a loan. At July 31, 1997, the outstanding balance of such
loan was approximately $805,000. The Company expects the outstanding loan
balance will be satisfied through services provided to the Company by the
carrier.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
JULY 31
----------------------------
1996 1997
------------- -------------
Equipment...................................................... $ 10,661,941 $ 24,945,687
Computer software.............................................. 1,971,018 4,618,931
Leasehold improvements......................................... 296,718 1,115,822
Furniture and fixtures......................................... 1,176,867 1,365,140
Building....................................................... -- 109,525
------------- -------------
14,106,544 32,155,105
Less accumulated depreciation and amortization................. (1,653,214) (6,429,300)
------------- -------------
Net property and equipment..................................... $ 12,453,330 $ 25,725,805
------------- -------------
------------- -------------
Fixed assets under capital leases aggregate $6,122,403 at July 31, 1997. The
accumulated amortization related to these assets under capital leases was
$440,552 at July 31, 1997.
F-10
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. NOTES PAYABLE
Notes payable consist of:
JULY 31
------------------------
1996 1997
---------- ------------
Convertible promissory note (A)...................................................... $ -- $ 2,159,000
Promissory note (B).................................................................. -- 1,901,000
Acquisition note payable (C)......................................................... -- 689,000
Acquisition note payable (D)......................................................... -- 690,000
Promissory note (E).................................................................. -- 1,683,000
---------- ------------
--........ 7,122,000
Less current portion................................................................. -- (1,881,000)
---------- ------------
Note payable--long-term portion...................................................... $ -- $ 5,241,000
---------- ------------
---------- ------------
- ------------------------
(A) On October 14, 1996, the Company entered into a $2,250,000 promissory note
with a commercial bank. The promissory note is payable in monthly payments
of interest only commencing on November 15 for a period of six months at a
rate of 11.00% per annum, and thereafter, in equal monthly payments of
principal and interest at a rate of 14.00% per annum. The promissory note is
convertible to the Company's Common stock at the option of the Company based
upon the prevailing market price of the Company's common stock on the date
of conversion. The promissory note is collateralized by certain equipment.
(B) On August 14, 1996, the Company entered into a $2,500,000 promissory note
with a financing company. The promissory note is payable in 36 monthly
installments commencing on September 1, 1996 and bears interest at an
effective rate at 16.30% per annum. The promissory note is collateralized by
certain equipment.
(C) In October 1996, as partial payment for the acquisition of an Internet
service provider, the Company issued a $750,000 note. The note is payable in
48 monthly installments and bears interest at 10.00% per annum.
(D) In August 1996, as partial payment for the acquisition of an Internet
service provider, the Company issued the $690,000 note. The note is payable
on August 15, 1998 and bears interest at 8.25% per annum.
(E) On January 10, 1997, the Company entered into a $2,000,000 promissory note
with a financing company. The loan is payable in 36 monthly installments and
bears interest at 18.58% per annum. Such interest rate is adjusted on a
monthly basis in accordance with changes in the interest rate of three-year
U.S. Treasury Securities. The promissory note is collateralized by certain
equipment.
F-11
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. NOTES PAYABLE (CONTINUED)
On July 31, 1997, the estimated fair value of the notes payable described
above was approximately the same as the carrying amount. Required annual
principal payments of notes payable as of July 31, 1997 are as follows:
Year ending July
31:............. 1998..... $1,827,000
1999..... 2,799,000
2000..... 1,682,000
2001..... 649,000
2002..... 165,000
---------
$7,122,000
---------
---------
5. RELATED PARTY TRANSACTIONS
The Company currently leases office space from a corporation which is
wholly-owned by an officer/ stockholder. Aggregate lease payments under such
lease, which expires on June 30, 1997, were $24,000, $24,000 and $69,000 for the
years ended July 31, 1995, 1996 and 1997, respectively.
The Company has been provided professional services by directors and/or
relatives of officers/directors. The Company incurred approximately $37,000,
$197,000 and $245,000 for such services for the years ended July 31, 1995, 1996
and 1997, respectively.
During 1996, the Company received $760,000 in non-interest bearing advances from
a company which is wholly-owned by an officer/shareholder of the Company. Such
advances were repaid during 1996.
The Company supplied telecommunications services to its customers under an
agreement wherein Lermer Overseas Telecommunications, Inc. ("Lermer") was the
carrier. Simon L. Lermer, who served as a director of the Company from December
1992 to December 1995, is the sole shareholder of Lermer. Mr. Lermer and Marc
Knoller, a director of the Company, are the two directors of Lermer. Under an
agreement between Lermer and the Company, the Company provides Lermer with
marketing, technical support, billing and collection and rate procurement
services. Payments made to Lermer in 1995 and 1996 were approximately $2,417,000
and $2,143,000, respectively. The Company's revenues for such services amounted
to approximately $6,016,000 and $13,024,000 for the years ended July 31, 1995
and 1996, respectively. During fiscal 1996, the Company obtained a license to
supply telecommunications services directly to its customers and the agreement
with Mr. Lermer was terminated.
F-12
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities are
as follows:
JULY 31
----------------------------
1996 1997
------------- -------------
Deferred tax assets:
Net operating loss carryforwards.............................. $ 7,257,000 $ 8,579,000
Bad debt reserve.............................................. 844,000 1,280,000
Employee benefits............................................. 418,000 434,000
------------- -------------
Deferred tax assets............................................. 8,519,000 10,293,000
Deferred tax liability--depreciation............................ 759,000 999,000
------------- -------------
Net deferred tax assets......................................... 7,760,000 9,294,000
Valuation allowance............................................. (7,760,000) (9,294,000)
------------- -------------
Total deferred tax assets....................................... $ -- $ --
------------- -------------
------------- -------------
The Company has provided a full valuation allowance on net deferred tax assets
since realization of these benefits cannot be reasonably assured.
At July 31, 1997, based upon tax returns filed and to be filed, the Company had
net operating loss carryforwards for federal income tax purposes of
approximately $21,000,000 expiring in the years 2009 through 2012. These net
operating loss carryforwards may be limited in their use in the event of
significant changes in the Company's ownership.
7. STOCKHOLDERS' EQUITY
COMMON STOCK AND CLASS A STOCK
The rights of holders of Common stock and holders of Class A stock are identical
except for voting and conversion rights and restrictions on transferability. The
holders of Class A stock are entitled to three votes per share and the holders
of Common stock are entitled to one vote per share. Class A stock is subject to
certain limitations on transferability that do not apply to the Common stock.
Each share of Class A stock may be converted into one share of Common stock, at
any time at the option of the holder.
WARRANTS
In May 1991, the Company repurchased 1,035,000 shares of its Common stock for
$80,000. In connection with the aforementioned stock repurchase, the former
stockholder received a warrant permitting him, in the event of certain sales of
the Company's Common stock, as defined, to purchase shares of the Company's
Common stock at a discount to the sale price. On January 1, 1996, in full
satisfaction of the previous agreement, the former stockholder was granted a
warrant to purchase 575,000 shares of the Company's Common stock for an
aggregate purchase price of $1.00. This warrant was exercised in March 1996.
In July 1997, the Company issued warrants to purchase 63,908 shares of its
common stock at $6.958 per share to a leasing company in connection with a
capital lease.
F-13
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS
Prior to March 15, 1996, the Company had an informal stock option program
whereby employees were granted options to purchase shares of the Company's
Common stock. Under such program, options to purchase 2,158,770 shares of Common
stock were granted. On March 15, 1996, the Company adopted a stock option plan
for officers, employees and non-employee directors to purchase up to 2,300,000
shares of the Company's Common stock. Generally, options become exercisable over
vesting periods up to six years and expire ten years from the date of grant.
During the years ended July 31, 1995, 1996 and 1997, the Company recorded
compensation expense related to the granting of stock options of approximately
$969,000, $70,000 and $41,000, respectively. On February 15, 1997, the Company
canceled 1,272,250 outstanding options with an exercise price of $10 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 plans is as
follows:
WEIGHTED
NUMBER AVERAGE
OF EXERCISE
SHARES PRICE
----------- ---------
Outstanding at July 31, 1994........................................................... -- $ --
Granted................................................................................ 2,140,370 0.41
----------- ---------
Outstanding at July 31, 1995........................................................... 2,140,370 0.41
Granted................................................................................ 1,363,150 9.92
----------- ---------
Outstanding at July 31, 1996........................................................... 3,503,520 9.15
Granted................................................................................ 3,807,544 6.50
Exercised.............................................................................. (969,100) 2.08
Canceled............................................................................... (1,875,750) 9.28
Forfeited.............................................................................. (67,188) 4.47
----------- ---------
Outstanding at July 31, 1997........................................................... 4,399,026 $ 3.89
----------- ---------
----------- ---------
At July 31, 1997, 2,235,646 stock options were exercisable at prices ranging
from $.41 to $10.00. The weighted average exercise price and remaining term of
such stock options was $2.41 and 8.3 years, respectively. The weighted average
fair value of an option granted during the year was $3.21 and $4.46 for the
years ended July 31, 1996 and 1997, respectively.
Pro forma information regarding net loss and net 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
F-14
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
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
--------------------
ASSUMPTIONS 1996 1997
- ------------------------------------------------------------------------- --------- ---------
Risk-free interest rate.................................................. 6.05% 6.11%
Dividend yield........................................................... -- --
Volatility factor of the expected market price of the Company's common
stock.................................................................. 105% 89%
Estimated life........................................................... 6 years 6 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, 1996 and 1997, pro forma net loss and pro forma net loss
per share under SFAS 123 amounted to approximately $18,106,932 and $10,054,043,
respectively, and $1.00 and $.48, respectively.
INITIAL PUBLIC OFFERING
On March 15, 1996, the Company completed an initial public offering of 4,600,000
shares of its common stock for $10 per share. The Company realized net proceeds
of approximately $41.5 million from this offering. A portion of the proceeds
from this offering was used to repay $3,477,000 of short-term notes previously
issued during fiscal 1996.
8. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On December 29, 1995, Surfers Unlimited, L.L.C. filed a breach of contract
action in the New Jersey Superior Court. The suit names a subsidiary of the
Company as defendant and seeks damages in an unspecified amount for interference
with prospective business advantages, breach of contract and improper use of
confidential and proprietary information. The Company has filed a counterclaim.
The suit is currently in the discovery phase and a trial is tentatively
scheduled for February 1998.
In January 1997, six former employees alleging employment discrimination
commenced a suit in New Jersey entitled INNELLA, ET AL V. IDT CORP., ET AL. The
suit claims that the Company has made hiring and promotion decisions based on
religious background. The case is in the very early stages of discovery.
In June 1997, an uncertified class-action suit was bought against IDT in New
York. The suit concerns advertisements no longer in use by IDT, and advertising
practices that were voluntarily terminated by the
F-15
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company following a prior investigation by the Attorneys General of several
states. The case is in the preliminary stages of discovery.
In September 1997, DigiTEC 2000, Inc. ("DigiTEC") filed a complaint against
the Company alleging that in connection with its sale of prepaid calling cards,
the Company tortiously interfered with a business relationship between DigiTEC
and two codefendants, CG Com, Inc. and Carlos Gomez. DigiTEC has filed a motion
for a preliminary injunction that would bar the Company from selling its prepaid
calling cards through these co-defendants. The Court has not yet ruled upon
DigiTEC's motion and the case is currently in preliminary 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. In
the opinion of management, settlement of these and the aforementioned actions
when ultimately concluded will not have a material adverse effect on results of
operations, cash flows or the financial condition of the Company.
LICENSE FEES
In connection with the provision of Internet access, the Company provides
certain customers with Internet software licensed from a third party. In the
prior year, the Company agreed to pay royalties based upon end users. In May
1996, such agreement was amended, except for moneys due under the original
agreement. Under the terms of the amended agreement, which expires in May 1998,
the Company has agreed to pay minimum royalties based upon end users and annual
service fees of approximately $1,850,000 and $300,000, respectively. For the
years ended July 31, 1995, 1996 and 1997, total licensing fees amounted to
$30,000, $1,098,000 and $234,000, respectively.
LEASES
The future minimum payments for capital and operating leases as of July 31, 1997
are as follows:
CAPITAL OPERATING
LEASES LEASES
------------- ------------
1998............................................................................... $ 2,216,000 $ 1,038,000
1999............................................................................... 1,912,000 945,000
2000............................................................................... 1,740,000 456,000
2001............................................................................... 735,000 83,000
2002............................................................................... 540,000 52,000
------------- ------------
Total payments..................................................................... 7,143,000 $ 2,574,000
------------- ------------
------------
Less amounts representing interest................................................. (1,705,000)
Current portion.................................................................... (1,532,000)
-------------
Capital lease obligations-long-term portion........................................ $ 3,906,000
-------------
-------------
Rental expense under operating leases was approximately $30,000, $178,000 and
$388,000 for the years ended July 31, 1995, 1996 and 1997, respectively.
F-16
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
COMMUNICATIONS SERVICES
The Company has an agreement with a supplier of telecommunications services
("Vendor") which began in August 1994 and continues monthly unless terminated by
one of the parties. Under such agreement, the Vendor bills and collects, on
behalf of the Company, for long distance telephone services provided to the
Company's customers. The Company is responsible for all uncollected receivables.
For the year ended July 31, 1996 and 1997, the Company purchased approximately
$3,900,000 and $17,330,000, respectively, of such services from the Vendor.
The Company has entered into agreements with certain carriers to buy and sell
communications services. As of July 31, 1997, the Company has approximately
$30,000,000 in minimum purchase commitments related to such agreements.
DISTRIBUTION AGREEMENTS
The Company has entered into distribution agreements under which it has agreed
to pay its agents commissions for obtaining new Internet and discount
telecommunications customers. The agreements require commissions upon activation
of the customers.
9. CUSTOMER, GEOGRAPHICAL AREA AND SEGMENT INFORMATION
During the year ended July 31, 1996, one customer accounted for approximately
19% of total revenues. No customer accounted for more than 10% of revenues
during the year ended July 31, 1995 or 1997.
Revenues from customers outside the United States represented approximately 56%,
23% and 25% of total revenues during the years ended July 31, 1995, 1996 and
1997, respectively. No single geographic area accounted for more than 10% of
total revenues.
F-17
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. CUSTOMER, GEOGRAPHICAL AREA AND SEGMENT INFORMATION (CONTINUED)
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended July 31, 1995, 1996 and
1997.
INTERNET TELE-
ACCESS COMMUNICATIONS NET2PHONE TOTAL
---------- --------------- ----------- ----------
($ IN THOUSANDS)
YEAR ENDED JULY 31, 1995
Revenues..................................................... $ 875 $ 10,789 $ -- $ 11,664
Income (loss) from operations................................ (3,005) 830 -- (2,175)
Depreciation and amortization................................ 187 117 -- 304
Total assets................................................. 869 3,328 -- 4,197
Capital expenditures......................................... 893 433 -- 1,326
YEAR ENDED JULY 31, 1996
Revenues..................................................... $ 21,986 $ 35,708 $ -- $ 57,694
Income (loss) from operations................................ (17,851) 2,756 (660) (15,755)
Depreciation and amortization................................ 930 258 24 1,212
Total assets................................................. 20,570 22,907 320 43,797
Capital expenditures......................................... 10,335 1,358 202 11,895
YEAR ENDED JULY 31, 1997
Revenues..................................................... $ 32,895 $ 99,937 $ 2,355 $ 135,187
Income (loss) from operations................................ (8,092) 5,707 (1,060) (3,445)
Depreciation and amortization................................ 3,562 1,128 183 4,873
Total assets................................................. 24,205 33,110 1,222 58,537
Capital expenditures......................................... 9,448 7,635 975 18,058
10. NOTES AND ADVANCES PAYABLE
During fiscal 1996, the Company borrowed an aggregate of $3,477,000 from
shareholders, affiliates and outside investors. The notes bore interest at 12%
per annum. The notes were repaid with the proceeds of the Company's initial
public offering. In connection with the repayment of such notes, the Company
incurred a prepayment penalty of $233,500. Such prepayment penalty has been
classified as an extraordinary loss on retirement of debt in the accompanying
statement of operations.
11. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as follows:
YEAR ENDED JULY 31
---------------------------------
1995 1996 1997
--------- ---------- ----------
Cash payments made for interest............................. $ -- $ 113,000 $ 863,000
Cash payments made for income taxes......................... 56,000 -- --
F-18
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. ADDITIONAL FINANCIAL INFORMATION (CONTINUED)
Other current assets include advances to carriers of approximately $1,499,000
and $1,982,000 at July 31, 1996 and 1997, respectively. Accounts payable
includes approximately $5,840,000 and 14,541,000 due to telecommunication
carries at July 31, 1996 and 1997, respectively.
12. CONSULTING AND LICENSING AGREEMENT
The Company possesses the exclusive right to make the services of Genie,
including its multi-player games and information services, accessible over the
Internet and the World Wide Web, pursuant to its agreement with Yovelle
Renaissance Corporation ("Yovelle," and such agreement, the "Yovelle
Agreement"). Yovelle purchased the Genie service from GE Information Services,
Inc. in January 1996. Pursuant to the Yovelle Agreement, the Company provided
certain management consulting and other services to Yovelle and paid Yovelle
certain online content product costs and licensing fees, in exchange for the
right to make Genie's online offerings available over the Internet (including
the World Wide Web) exclusively through the Company. The Yovelle Agreement was
to expire in February 1998, and was renewable thereafter. The Company's Chief
Executive Officer and Chairman of the Board of Directors, loaned $500,000 to
Yovelle and received a promissory note in consideration therefor which bore
interest at a rate of 12% per annum and was due in June 1996.
During the year ended July 31, 1996, revenue under the Yovelle Agreement
amounted to $1,200,000.
In August 1996, the Company purchased all of the issued and outstanding stock of
Yovelle for $200,000. The purchase price is comprised of $100,000 in cash and a
non-interest bearing promissory note for $100,000, payable on or before December
31, 1996 which was paid.
13. ACQUISITIONS
In August 1996, the Company completed the acquisition of the assets of PCIX,
Inc. ("PCIX"), a former alliance partner of the Company. The acquisition price
included a $690,000 promissory note, cash payments totaling $280,300,
forgiveness of $428,800 owed to the Company from PCIX, and the assumption of
$95,400 of other PCIX liabilities. The promissory note is payable on August 16,
1998 and bears interest at 8.25% per annum.
In October 1996, the Company completed the acquisition of the assets of
International Computer Systems, Inc., a former alliance partner of the Company.
The acquisition price included cash payments totaling $2,250,000 and a $750,000
promissory note. Such promissory note is payable in 48 monthly installments
commencing on October 1, 1996 and bears interest at 10.00% per annum.
14. SUBSEQUENT EVENTS
CONVERTIBLE DEBENTURES
On September 5, 1997 the Company entered into a Securities Purchase Agreement
(the "Agreement") with a group of institutional investors (the "Investors")
pursuant to which the Investors purchased Convertible Debentures totaling
$7,500,000 (the "Debentures"). The Debentures carry an interest rate of 3.00%
per annum.
The Debentures, including the principal amount and all unpaid accrued interest,
are convertible into the Company's Common stock at the option of the Investors
at a conversion price equal to the lower of $15.16
F-19
IDT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. SUBSEQUENT EVENTS (CONTINUED)
per share or the lowest closing price on any one trading day during the twelve
consecutive trading day period preceding the date that notice of conversion is
given to the Company. Any principal amount or unpaid accrued interest
outstanding on September 5, 2000 will be automatically converted into shares of
the Company's Common stock.
ACQUISITION OF ROCK ENTERPRISES, INC.
In September 1997, the Company purchased all of the issued and outstanding stock
of Rock Enterprises, Inc., a telecom engineering firm owned by an employee of
the Company, in exchange for shares of the Company's Common stock valued at
$5,000,000 to be issued over several years.
NOTES PAYABLE
In August 1997, the Company entered into a revolving credit agreement (the
"Credit Agreement") with Transamerica Business Credit Corporation which provides
for borrowings of up to $6,000,000. Loans outstanding under the Credit Agreement
bear interest at the prime rate plus 2.00% per annum and are secured by all
personal property of the Company, excluding equipment. The Credit Agreement has
a term of one year and is automatically renewable for additional terms of one
year each unless sixty-days written notice of termination is given by either
party.
F-20
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
- -------------------------------------------------------- ------------ ------------ ------------- ------------
1995:
Reserves deducted from accounts receivable:
Allowance for doubtful accounts..................... $ 5,000 $ 439,891 $ (194,891) $ 250,000
1996:
Reserves deducted from accounts receivable:
Allowance for doubtful accounts..................... $ 250,000 $ 4,042,070 $(2,192,070) $ 2,100,000
1997:
Reserves deducted from accounts receivable:
Allowance for doubtful accounts..................... $ 2,100,000 $ 4,592,241 $(3,502,241) $ 3,190,000
- ------------------------
(1) Uncollectible accounts written off, net of recoveries. Includes $121,816 in
fully reserved accounts receivable received in conjunction with the
Company's acquisition of Yovelle.
F-21