UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 000–27127

iBasis, Inc.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or
organization)

04-3332534

(I.R.S. Employer Identification No.)

20 Second Avenue, Burlington, MA 01803

(Address of executive offices, including zip code)

(781) 505–7500

(Registrant’s telephone number, including area code)

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of July 30, 2004, there were 46,786,877 shares of the Registrant’s Common Stock, par value $0.001 per share, outstanding.

iBASIS, INC.
Index

PART I — FINANCIAL INFORMATION
Item 1 —	Condensed Consolidated Financial Statements	3
	Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003 (unaudited)	3
	Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2004 and 2003 (unaudited)	4
	Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2004 and 2003 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 (unaudited)	6
	Condensed Notes to Consolidated Financial Statements (unaudited)	7
Item 2 —	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3 —	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4 —	Controls and Procedures	37
PART II — OTHER INFORMATION		37
Item 1 —	Legal Proceedings	37
Item 4 —	Submission of Matters to a Vote of Security Holders	39
Item 6 —	Exhibits and Reports on Form 8-K	39
	Signature	41

Part I – Financial Information

iBasis, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

	June 30, 2004			December 31, 2003
	(in thousands, except per share data)

Assets
Cash and cash equivalents	$	18,217		$	17,270
Accounts receivable, net of allowance for doubtful accounts of $3,132 and $3,128, respectively	25,692			21,767
Prepaid expenses and other current assets	2,875			5,295
Total current assets	46,784			44,332

Property and equipment, at cost:
Network equipment	67,990			67,441
Equipment under capital lease	9,558			9,558
Computer software	8,763			8,387
Leasehold improvements	6,437			6,414
Furniture and fixtures	1,065			1,062
	93,813			92,862
Less: Accumulated depreciation and amortization	(81,996		)	(75,687		)
Property and equipment, net	11,817			17,175

Deferred debt financing costs, net	191			326
Long term investment in non-marketable security	—			5,000
Other assets	358			705
Total assets	$	59,150		$	67,538
Liabilities and Stockholders’ Deficit
Accounts payable	$	24,510		$	19,902
Accrued expenses	13,875			18,652
Deferred revenue	3,421			417
Current portion of long-term debt	4,023			2,097
Total current liabilities	45,829			41,068

Long term debt, net of current portion	66,285			65,829
Other long term liabilities	1,200			2,749

Stockholders’ deficit:
Common stock, $0.001 par value, authorized – 170,000 and 85,000 shares, respectively; issued – 46,656 and 45,913 shares, respectively;	48			46
Treasury stock; 1,135,113 shares at cost	(341		)	(341		)
Additional paid-in capital	373,590			370,393
Accumulated deficit	(427,461		)	(412,206		)
Total stockholders’ deficit	(54,164		)	(42,108		)
Total liabilities and stockholders’ deficit	$	59,150		$	67,538

The accompanying notes are an integral part of these condensed consolidated financial statements.

iBasis, Inc.
Condensed Consolidated Statements of Operations
(unaudited)

	Three Months Ended June 30,
	2004			2003
	(in thousands, except per share data)
Net revenue	$	61,175		$	39,119
Costs and operating expenses:
Data communications and telecommunications (excluding depreciation and amortization)	52,066			33,370
Research and development	3,542			3,442
Selling and marketing	2,131			1,903
General and administrative	3,266			2,820
Depreciation and amortization	2,787			5,749
Non-cash stock-based compensation	—			28
Total cost and operating expenses	63,792			47,312

Loss from operations	(2,617		)	(8,193		)

Interest income	14			41
Interest expense	(809		)	(971		)
Gain on bond exchanges	—			3,716
Other expenses, net	(66		)	(98		)
Refinancing transaction costs	(1,954		)	—
Refinancing related interest expense	(481		)	—

Net loss	$	(5,913	)	$	(5,505	)

Basic and diluted net loss per share:
Basic	$	(0.13	)	$	(0.12	)
Diluted	$	(0.13	)	$	(0.12	)

Weighted average common shares outstanding:
Basic	46,287			44,652
Diluted	46,287			44,652

The accompanying notes are an integral part of these condensed consolidated financial statements.

iBasis, Inc.
Condensed Consolidated Statements of Operations
(unaudited)

	Six Months Ended June 30,
	2004			2003
	(in thousands, except per share data)
Net revenue	$	118,183		$	80,960
Costs and operating expenses:
Data communications and telecommunications (excluding depreciation and amortization)	100,656			68,297
Research and development	7,080			7,125
Selling and marketing	4,132			3,896
General and administrative	6,219			5,329
Depreciation and amortization	6,311			11,862
Non-cash stock-based compensation	—			57
Total cost and operating expenses	124,398			96,566

Loss from operations	(6,215		)	(15,606		)

Interest income	28			111
Interest expense	(1,548		)	(2,398		)
Gain on bond exchanges	—			16,615
Other expenses, net	(85		)	(195		)
Loss on long-term non-marketable security	(5,000		)	—
Refinancing transaction costs	(1,954		)	—
Refinancing related interest expense	(481		)	—

Net loss	$	(15,255	)	$	(1,473	)

Basic and diluted net loss per share:
Basic	$	(0.33	)	$	(0.03	)
Diluted	$	(0.33	)	$	(0.03	)

Weighted average common shares outstanding:
Basic	45,674			44,651
Diluted	45,674			44,651

The accompanying notes are an integral part of these condensed consolidated financial statements.

iBasis, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)

	Six Months Ended June 30,
	2004			2003
	(in thousands)
Cash flows from operating activities:
Loss from continuing operations	$	(15,255	)	$	(1,473	)
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on bond exchanges	—			(16,615		)
Depreciation and amortization	6,311			11,862
Amortization of deferred debt financing costs	135			198
Amortization of deferred compensation	—			57
Bad debt expense	—			300
Impairment of investment in long-term non-marketable security	5,000			—
Fair value of warrant issued	2,140
Changes in assets and liabilities
Accounts receivable	(3,925		)	4,075
Prepaid expenses and other current assets	(188		)	661
Other assets	347			53
Accounts payable	4,608			(309		)
Accrued expenses	(2,998		)	(2,183		)
Deferred revenue	3,004			—
Other long term liabilities	(1,549		)	(391		)
Net cash used in continuing operating activities	(2,370		)	(3,765		)

Cash flows from investing activities:
Purchases of property and equipment	(953		)	(2,146		)
Adjustments to proceeds from sale of Speech Solutions Business	—			(736		)
Proceeds from earn-out receivable related to sale of Speech Solutions Business	1,108			—
Proceeds from receipt of escrow receivable related to sale of Speech Solutions Business	1,500			—
Net cash provided by (used in) investing activities	1,655			(2,882		)

Cash flows from financing activities:
Bank borrowings	4,600			4,600
Payments of bank borrowings	(4,600		)	(4,600		)
Proceeds from issuance of 8% Secured Convertible Notes	29,000			—
Prepayment of 11½% Senior Secured Notes	(25,175		)	—
Payments of principal on capital lease obligations	(1,443		)	(3,599		)
Refinancing transaction costs	(1,779		)	(861		)
Proceeds from exercise of warrants	961			—
Proceeds from exercises of common stock options	98			5
Net cash provided by (used in) financing activities	1,662			(4,455		)

Net increase (decrease) in cash and cash equivalents	947			(11,102		)
Cash and cash equivalents, beginning of period	17,270			32,316
Cash and cash equivalents, end of period	$	18,217		$	21,214

Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	6,341		$	3,098

Supplemental disclosure of non-cash investing and financing activities:
Refinancing of 5¾% Convertible Subordinated Notes and 11½% Senior Secured Notes:
Fair value of warrant issued	$	2,140		$	—
Reduction of accrued interest on 11½% Senior Secured Notes	$	(1,659	)	$	—
Investment banking services paid in shares of common stock	$	175		$	—
Exchange of 5¾% Convertible Subordinated Notes for 11½% Senior Secured Notes:
Face value of 5¾% Convertible Subordinated Notes surrendered	$	—		$	50,350

Face value of 11½% Senior Secured Notes issued	$	—		$	25,175

Future interest payments on 11½% Senior Secured Notes	$	—		$	5,527

Fair value of warrants issued	$	—		$	1,375

Reduction in deferred financing costs	$	—		$	723

The accompanying notes are an integral part of these condensed consolidated financial statements.

iBasis, Inc.
Condensed Notes to Consolidated Financial Statements

(1) Business, Management Plans and Presentation

Business

We are an international telecommunications carrier that utilizes the Internet to provide economical international telecommunications services. Our continuing operations consist primarily of our Voice-Over-Internet-Protocol, or (“VoIP”), business. We offer wholesale services through our worldwide network to carriers, telephony resellers and others around the world by operating through various service agreements with local service providers in the United States, Europe, Asia, the Middle East, Latin America, Africa and Australia. During the third quarter of 2003, we introduced our retail prepaid calling card services and have marketed such services primarily to ethnic communities within major domestic markets through distributors.

Beginning in the second quarter of 2004, our recently created operating segment, retail prepaid calling card services and other enhanced services (“Retail”) became a reportable business segment, in addition to our international wholesale VoIP telecommunications services. Since we introduced our retail prepaid calling card services, revenue from our Retail business had been less than 10% of total revenue. In the second quarter of 2004, revenue from our Retail business exceeded 10% of total net revenue.

We have a history of operating losses and, as of June 30, 2004, our accumulated deficit was $427.5 million and our stockholders’ deficit was $54.2 million. We used $2.4 million and $3.2 million in cash from operations in the six months ended June 30, 2004 and the year ended December 31, 2003, respectively. These results are primarily attributable to the expenditures necessary to build our network and develop and expand our market.

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer (the “Exchange Offer”), pursuant to which $37.3 million of our outstanding 5¾% Convertible Subordinated Notes due in March 2005 (“Existing Notes”), representing approximately 98% of the total amount of Existing Notes outstanding, were tendered for the same principal amount of new 6¾% Convertible Subordinated Notes due in June 2009 (“New Subordinated Notes”). Approximately $0.9 million of the Existing Notes remain outstanding after the Exchange Offer. Simultaneously with the Exchange Offer, we prepaid all $25.2 million of our 11½% Senior Secured Notes due in January 2005 (“Existing Senior Notes”) for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock, at $1.85 per share (the “Warrants”). We issued $29.0 million of new 8% Secured Convertible Notes due in June 2007 of which $25.2 million was used to prepay the Existing Senior Notes. The new Secured Notes are convertible into shares of common stock at $1.85 per share.

Management Plans

We continue to expand our market share in VoIP telecommunications services by expanding our customer base and by introducing cost-effective solutions for our customers to interconnect with our network. During the first quarter of 2004, we introduced our DirectVoIP service which eliminates the need for certain switches for our customers to interconnect to our network, thus reducing capital equipment costs for both us and our customers. Our strategy is to continue the deployment of our retail prepaid calling card services which leverage our international VoIP network with our real time back office systems, and have the potential to deliver higher margins and improve cash flow. In addition, we continue to increase the traffic we terminate to mobile phones, which generally delivers higher average revenue per minute and margins than typical fixed-line traffic. We also continue to control operating expenses and capital expenditures, as well as to monitor and manage accounts payable and accounts receivable, and restructure existing debt to enhance cash flow.

Our plans include:

• expanding our market share for our retail prepaid calling card services;

• increasing revenues generated through mobile phone terminations;

• increasing our customer base by introducing cost-effective solutions to interconnect with our network;

• use of our switchless architecture, which eliminates the need for costly telecommunication switches and other equipment;

and

• aggressive management of credit risk.

From 2001 to date, we took a series of actions to reduce operating expenses, restructure operations, reduce outstanding debt

and provide additional liquidity. Such actions primarily included:

• reductions in workforce and consolidation of Internet Central Offices. As a result of our restructuring programs and our continued focus on controlling expenses, our research and development, selling and marketing and general and administrative expenses, in total, declined to $28.6 million in 2003 from $53.2 million in 2002;

• sale of our previous messaging business and the assets associated with our previous Speech Solutions Business;

• settlement of certain capital lease obligations;

• repurchase of a portion of our 5¾% Convertible Subordinated Notes for cash;

• exhange of a portion of our 5¾% Convertible Subordinated Notes for 11½% Senior Secured Notes and warrants to purchase common stock;

• establishment of a new credit facility with a bank; and

• completing our refinancing plan, pursuant to which $37.3 million (98% of the total outstanding) of our 5¾% Convertible Subordinated Notes due in March 2005 were tendered for the same principal amount of our new 6¾% Convertible Subordinated Notes due in June 2009 and we issued $29.0 million of 8% Secured Convertible Notes due in June 2007 to finance the prepayment of all $25.2 million of our 11½% Senior Secured Notes due in January 2005.

Presentation

The unaudited condensed consolidated financial statements presented herein have been prepared by us and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair presentation. Interim results are not necessarily indicative of results for a full year.

The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to those rules and regulations, but we believe that the disclosures are adequate to make the information presented not misleading. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and notes in our Annual Report on Form 10-K for the year ended December 31, 2003.

(2) Stock Based Compensation

We account for stock-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” using the intrinsic-value method as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 encourages, but does not require, the recognition of compensation expense for the fair value of stock options and other equity instruments issued to employees and non-employee directors.

At June 30, 2004, we had one stock-based employee compensation plan. The following table illustrates the effect on net income or net loss, and net income or net loss per share, if we had applied the fair value recognition provisions of SFAS No. 123.

	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands, except per share data)	2004			2003			2004			2003

Net loss:
As reported	$	(5,913	)	$	(5,505	)	$	(15,255	)	$	(1,473	)

Deduct: Stock-based employee compensation expense included in reported net loss	—			28			—			57
Add: Total stock-based employee expense included in reported net under fair value based method for all awards	(852		)	(139		)	(1,640		)	(282		)
Pro forma	$	(6,765	)	$	(5,616	)	$	(16,895	)	$	(1,698	)

Basic and diluted net loss per share:
As reported	$	(0.13	)	$	(0.12	)	$	(0.33	)	$	(0.03	)
Pro forma	$	(0.15	)	$	(0.13	)	$	(0.37	)	$	(0.04	)

We estimate the fair value of our stock-based awards to employees using the Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model required the input of highly subjective assumptions including the expected stock price volatility. Because stock-based awards to employees 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 our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of stock-based awards to employees. The fair value of stock-based awards to employees was estimated assuming no expected dividends and the following weighted average assumptions.

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Risk free interest rate	3.50		%	3.00		%	3.25		%	3.00		%
Dividend yield	0.00		%	0.00		%	0.00		%	0.00		%
Expected life	5 years			5 years			5 years			5 years
Volatility	137		%	128		%	138		%	128		%
Fair value of options granted	$	1.14		$	1.21		$	1.32		$	1.19

(3) Business Segment Information

Beginning in the second quarter of 2004, our recently created operating segment, retail prepaid calling card services and other enhanced services (“Retail”) became a reportable business segment, in addition to our international wholesale VoIP telecommunications services (“Wholesale”). Since we introduced our retail prepaid calling card services, revenue from our Retail business had been less than 10% of total revenue. In the second quarter of 2004, revenue from our Retail business exceeded 10% of total net revenue.

Our Wholesale business consists of international telecommunications services we provide using VoIP. We offer wholesale services through our worldwide network to carriers, telephony resellers and others around the world by operating through various service agreements with local service providers in United States, Europe, Asia, the Middle East, Latin America, Africa and Australia.

Our Retail business consists of our retail prepaid calling card services and other enhanced services. To date, we have marketed our retail prepaid calling card services primarily to ethnic communities within major domestic markets through distributors. Revenue from our retail prepaid calling card services were 83% and 74% of our total Retail revenue in the three and six months ended June 30, 2004, respectively. We expect that revenue from our retail prepaid calling card services will continue to be an increasingly large percentage of our total Retail revenue in the future. Our other enhanced services primarily consist of revenue derived from the outsourcing of our retail prepaid calling card platform.

Our executive management team uses net revenue and gross margin, which is net revenue less data communications and telecommunications costs, as the basis for measuring profit or loss and making decisions on our Wholesale and Retail businesses. We do not allocate our research and development expenses, selling and marketing expenses, general and administrative expenses and depreciation and amortization between Wholesale and Retail.

Operating results, excluding interest income and expense, other income and expense, and refinancing related charges, for our two business segments are as follows:

	Three Months Ended June 30, 2004
	(In thousands)
	Wholesale		Retail		Total
Net revenue	$	53,522	$	7,653	$	61,175
Data communications and telecommunication (excluding depreciation and amortization)	45,771		6,295		52,066
Gross margin	$	7,751	$	1,358	9,109

Research and development expenses					3,542
Selling and marketing expenses					2,131
General and administrative expenses					3,266
Depreciation and amortization					2,787
Loss from operations					$	(2,617	)

	Six Months Ended June 30, 2004
	(In thousands)
	Wholesale		Retail		Total
Net revenue	$	106,694	$	11,489	$	118,183
Data communications and telecommunication (excluding depreciation and amortization)	91,450		9,206		100,656
Gross margin	$	15,244	$	2,283	17,527

Research and development expenses					7,080
Selling and marketing expenses					4,132
General and administrative expenses					6,219
Depreciation and amortization					6,311
Loss from operations					$	(6,215	)

	As of June 30, 2004
	(In thousands)
	Wholesale		Retail		Total
Segment assets	$	22,514	$	3,178	$	25,692

Non-segment assets					33,188

Total assets					59,150

(4) Discontinued Operations

Loss from discontinued operations. On July 15, 2002 we completed the sale of substantially all the assets of our Speech Solutions Business for $18.5 million in cash ($1.5 million of this amount was held in escrow until March 2004). The loss from discontinued operations has been recorded under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets.” In the fourth quarter of 2003, we recognized additional consideration of $1.3 million for an earn-out payment based on the achievement of certain 2003 revenue-based milestones associated with this business. The cash payment associated with the earn-out was $1.1 million and was received in February 2004. In addition, in March 2004, we received the balance that had been held in escrow from the sale of this business since July 2002. We received $1.5 million in cash associated with this escrow balance. There are no further payments to be made to us relating to the sale of our former Speech Solutions Business.

(5) Long-term investment in non-marketable security

Our long-term investment in a non-marketable security represents an equity investment in a privately-held company that was made in 2000 in connection with a round of financing with other third-party investors. As our investment does not permit us to exert significant influence or control over the entity in which we have invested, the recorded amount represents our cost of the investment less any adjustments we make when we determine that an investment’s carrying value is other than temporarily impaired.

The process of assessing whether the equity investment’s net realizable value is less than its carrying cost requires a significant amount of judgment due to the lack of a mature and stable public market for investments of this type. In making this judgment, we carefully considered the investee’s most recent financial results, cash position, recent cash flow data, projected cash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data, the current investing

environment, management or ownership changes, and competition. This valuation process is based primarily on information that we request, receive and discuss with the investees’ management on a quarterly basis. Such evaluation is performed on a quarterly basis.

Based on our evaluation for the quarter ended March 31, 2004, we determined that our investment in this privately-held company has been other than temporarily impaired and, as a result, we recorded a $5.0 million non-cash charge to continuing operations for the first quarter of 2004. Our decision was based on our evaluation of the company’s current cash position and recent operating results, as well as the perceived inability of the company to obtain additional financing at a level, and in a timely manner, to support its continued operations.

(6) Accrued Restructuring Costs

During 2001 and 2002, the Company announced a restructuring plan to better align the organization with its corporate strategy and recorded a charge to its Statements of Operations in those periods in accordance with the criteria set forth in EITF 94-3 and SEC Staff Accounting Bulletin 100. The restructuring included the write-off of property and equipment, the termination of certain contractual obligations, exiting certain leased facilities and the reduction in the Company’s workforce resulting in employee benefit costs.

As of June 30, 2004, the accrued restructuring costs consisted of costs accrued for certain leased facilities obligations. A summary of the accrued restructuring costs for the three months ended June 30, 2004 is as follows:

	(In thousands)
2001 Restructuring Charge:	Leased Facility Obligations
	(In thousands)
Accrual as of December 31, 2003	$	181
Payment of termination of contractual obligations	113

Accrual as of June 30, 2004	$	68

2002 Restructuring Charge:	Leased Facility Obligations		Employee Severance Costs		Total
	(In thousands)
Accrual as of December 31, 2003	$	2,051	$	25	$	2,076
Payment of termination of contractual obligations	294		25		319

Accrual as of June 30, 2004	$	1,757	$	—	$	1,757

(7) Long-Term Debt

Long-term debt consists of the following:

	June 30, 2004		December 31, 2003
	(In thousands)
5¾% Convertible Subordinated Notes, due in March, 2005	$	895	$	38,180
6¾% Convertible Subordinated Notes, due in June, 2009	37,285		—
11½% Senior Secured Notes, due in January, 2005	—		25,175
8% Secured Convertible Notes due in June, 2007	29,000		—
Capital lease obligations	828		2,271
Revolving line of credit	2,300		2,300
Total long term debt	70,308		67,926

Less-current portion	4,023		2,097

Long term debt, net of current portion	$	66,285	$	65,829

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer, pursuant to which $37.3 million of our 5¾% Convertible Subordinated Notes due in March 2005, representing approximately 98% of the total amount outstanding, were tendered for the same principal amount of new 6¾% Convertible Subordinated Notes due in June 2009. Approximately $0.9 million of the 5¾% Convertible Subordinated Notes due in March 2005 remain outstanding after the exchange offer. Simultaneously with the exchange offer, we prepaid all $25.2 million of our 11½% Senior Secured Notes due in January 2005 for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock at $1.85 per share. We issued $29.0 million of new 8% Secured Convertible Notes due in June 2007, of which $25.2 million was used to prepay the 11½% Senior Secured Notes due in January 2005. The 8% Secured Convertible Notes due in June 2007 are convertible into shares of common stock at $1.85 per share.

In December 2003, we amended and extended our revolving line of credit with our bank. The new $15.0 million revolving line of credit replaced two secured lines of credit that totaled $15.0 million. The revolving line of credit bears interest at the bank’s prime rate plus 1%, matures on January 5, 2005 and is collateralized by substantially all of our assets. Borrowings under the revolving line of credit are on a formula basis and are limited to eligible accounts receivable. The revolving line of credit requires us to comply with various non-financial covenants and financial covenants, including minimum profitability. As of June 30, 2004, we had $2.3 million in borrowings and unused borrowing capacity of $3.0 million, based on our borrowing formula, under the revolving line of credit.

At June 30, 2004, we had outstanding letters of credit totaling $1.6 million.

(8) Gain on Exchanges of 5¾% Convertible Subordinated Notes

During the year ended December 31, 2003, we entered into agreements with principal holders of our 5¾% Convertible Subordinated Notes which resulted in the retirement of $50.4 million of such notes in exchange for new debt instruments at 50% of the face value of the retired notes. Under the terms of the agreement, the holders of the retired notes received $25.2 million of 11½% Senior Secured Notes and warrants to purchase 4,915,416 shares of our common stock. Each warrant has an initial exercise price of $0.65 per share and is exercisable over a five-year term. The 11½% Senior Secured Notes mature on January 15, 2005 and share in a

second priority lien on our assets and are subordinated to our revolving line of credit with our bank.

In accordance with SFAS No. 15, “Accounting by Debtors and Creditors Regarding Troubled Debt Restructuring,” we recorded a gain on the exchange of approximately $3.7 million and $16.6 million during the three months and six months ended June 30, 2003, respectively. SFAS No. 15 requires that the gain on the exchange be recorded net of the accrual for future interest payments on the 11½% Senior Secured Notes, the fair value of the warrants issued, the reduction of the net book value of the deferred financing costs originally capitalized with the issuance of our 5¾% Convertible Subordinated Notes and any other fees or costs.

The gain recognized for the debt exchanges that occurred in the three and six months ended June 30, 2003 was calculated as follows:

		Three Months Ended June 30, 2003			Six Months Ended June 30, 2003
		(In thousands)
Face value of surrendered 5¾% Convertible Subordinated Notes		$	12,200		$	50,350
Less:	Face value of issued 11½% Senior Secured Notes	(6,100		)	(25,175		)
	Future interest payments on 11½% Senior Secured Notes	(1,140		)	(5,527		)
	Fair value of warrants issued	(833		)	(1,375		)
	Reduction of deferred debt financing costs	(154		)	(723		)
	Professional fees	(257		)	(935		)
	Gain	$	3,716		$	16,615

(9) Net (Loss) Income Per Share

Basic and diluted net loss per common share is determined by dividing net loss by the weighted average common shares outstanding during the period. Basic net loss per share and diluted net loss per share are the same, as outstanding stock options, shares issuable upon conversion of the 6¾% Convertible Subordinated Notes, shares issuable upon conversion of the remaining 5¾% Convertible Subordinated Notes, shares issuable upon conversion of the 8% Secured Convertible Notes, and warrants to purchase common shares are anti-dilutive. Basic net income per common share is determined by dividing net income by the weighted average common shares outstanding during the period. Diluted net income per common share is determined by dividing the net income by the weighted average common shares, which includes weighted average common shares outstanding and weighted average outstanding stock options, shares issuable upon conversion of the 6¾% Convertible Subordinated Notes, shares issuable upon conversion of the remaining 5 ¾% Convertible Subordinated Notes, shares issuable upon conversion of the 8% Secured Convertible Notes and warrants to purchase common shares.

The following common shares have been excluded from the computation of basic net income or loss for the periods presented:

	Six Months Ended June 30,
	2004	2003
	(In thousands)
Outstanding stock options	6,171	4,060
Shares to be issued upon conversion of 5¾% Convertible Subordinated Notes	10	443
Shares to be issued upon conversion of 6¾% Convertible Subordinated Notes	20,154	—
Shares to be issued upon conversion of 8% Secured Convertible Notes	15,676	—
Warrants to purchase shares, issued in connection with the 11½% Senior Secured Notes	3,437	4,915
Warrants to purchase common shares, issued in connection with prepayment of 11½% Senior Secured Notes	5,176	—
Shares to be issued as partial compensation for investment banking services	110	—
Total shares excluded	50,734	9,418

(10) Contingencies

In addition to litigation that we have initiated or responded to in the ordinary course of business, we are currently party to the following potentially material legal proceedings:

Beginning July 11, 2001, we were served with several class action complaints that were filed in the United States District Court for the Southern District of New York against us and several of our officers, directors, and former officers and directors, as well as against the investment banking firms that underwrote our November 10, 1999 initial public offering of the common stock and our March 9, 2000 secondary offering of the common stock. The complaints were filed on behalf of persons who purchased the common stock during different time periods, all beginning on or after November 10, 1999 and ending on or before December 6, 2000.

The complaints are similar to each other and to hundreds of other complaints filed against other issuers and their underwriters, and allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 primarily based on the assertion that there was undisclosed compensation received by our underwriters in connection with our public offerings and that there were understandings with customers to make purchases in the aftermarket. The plaintiffs have sought an undetermined amount of monetary damages in relation to these claims. On September 4, 2001, the cases against us were consolidated. On October 9, 2002, the individual defendants were dismissed from the litigation by stipulation and without prejudice.

that we and the individual defendants have meritorious defenses to the claims made in the complaints, in deciding to pursue settlement, we considered, among other factors, the substantial costs and the diversion of our management’s attention and resources that would be required by litigation.

Pursuant to the terms of the proposed settlement, in exchange for a termination and release of all claims against us and the individual defendants and certain protections against third-party claims, we will assign to the plaintiffs certain claims we may have as an issuer against the underwriters, and our insurance carriers, along with the insurance carriers of the other issuers, will ensure a floor of $1 billion for any underwriter-plaintiff settlement. Although the financial effect of the settlement on us will not be material, our insurance carriers’ exposure in this connection will range from zero to a few hundred thousand dollars, and will be reduced proportionately by any amounts recovered by plaintiffs directly from the underwriters.

We cannot assure you that the settlement which has been finalized will be accepted by the court, or that we will be fully covered by collateral or related claims from underwriters, and that we would be successful in resulting litigation. In addition, even though we have insurance and contractual protections that could cover some or all of the potential damages in these cases, or amounts that we might have to pay in settlement of these cases, an adverse resolution of one or more of these lawsuits could have a material adverse affect on our financial position and results of operations in the period in which the lawsuits are resolved. We are not presently able to estimate potential losses, if any, related to the lawsuits.

We are also party to suits for collection, related commercial disputes, claims from carriers and foreign service partners over reconciliation of payments for circuits, Internet bandwidth and/or access to the public switched telephone network, and claims from estates of bankrupt companies alleging that we received preferential payments from such companies prior to their bankruptcy filings. We intend to prosecute vigorously claims that we have brought and employ all available defenses in contesting claims against us. Nevertheless, in deciding whether to pursue settlement, we will consider, among other factors, the substantial costs and the diversion of management’s attention and resources that would be required in litigation. In light of such costs, we have settled various and in some cases similar matters on what we believe have been favorable terms which did not have a material impact our financial position, results of operations, or cash flows. The results or failure of any suit may have a material adverse affect on our business.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are an international telecommunications carrier that utilizes the Internet to provide economical international telecommunications services. Our continuing operations consist primarily of our Voice-Over-Internet-Protocol (“VoIP”) business. We offer wholesale services through our worldwide network to carriers, telephony resellers and others around the world by operating through various service agreements with local service providers in the United States, Europe, Asia, the Middle East, Latin America, Africa and Australia.

During 2003, many major telecommunications carriers announced plans to deploy VoIP technology in their networks, to migrate their traffic to VoIP, and to introduce VoIP-based services to their retail customers. In addition, new providers of retail telephony services based on VoIP emerged during 2003. We believe this trend may have a positive impact on our business in the future by lowering the level of capital investment required for our network and potentially positioning us to receive a larger volume of international traffic in the future. Telephone calls that enter The iBasis Network as traditional PSTN (TDM) calls must be converted into Internet protocol (IP) for transport through our VoIP infrastructure and over the public Internet. In contrast, telephone calls that enter our network already in the form of IP do not require conversion from traditional PSTN to IP through a VoIP gateway. Thus, VoIP-based traffic we receive require a lower capital investment in our network. These major carriers have initially focused their VoIP plans on their U.S. networks, rather than their international network. We believe that it may be more economical for these major carriers to send their VoIP-based international traffic to our network rather than making the capital investment necessary in their international network infrastructure. Many of the new providers of VoIP-based telephony services do not have an international infrastructure in place and, similarly, we believe it may be more economical for these emerging carriers to send their VoIP-based international traffic to us.

During the third quarter of 2003, we introduced our retail prepaid calling card services and have marketed such services primarily to ethnic communities within major domestic markets through distributors. Our entry into the retail prepaid calling card business is based on our strategy to leverage our existing international VoIP network with additional services that have the potential to deliver higher margins than our wholesale international telecommunications services. In addition, the retail prepaid calling card business typically has a faster cash collection cycle than wholesale international telecommunication services. Beginning in the second quarter of 2004, our recently created operating segment, retail prepaid calling card services and other enhanced services (“Retail”) became a reportable business segment, in addition to our international wholesale VoIP telecommunications services. Since we introduced our retail prepaid calling card services, revenue from our Retail business had been less than 10% of total revenue. In the second quarter of 2004, revenue from our Retail business exceeded 10% of our total net revenue.

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer (the “Exchange Offer”), pursuant to which $37.3 million of our outstanding 5 3/4% Convertible Subordinated Notes due in March 2005 (“Existing Notes”), representing approximately 98% of the total amount of Existing Notes outstanding, were tendered for the same principal amount of new 6 3/4% Convertible Subordinated Notes due in June 2009 (“New Subordinated Notes”). Approximately $0.9 million of the Existing Notes remain outstanding after the Exchange Offer. Simultaneously with the Exchange Offer, we prepaid all $25.2 million of our 11 1/2% Senior Secured Notes due in January 2005 (“Existing Senior Notes”) for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock at $1.85 per share (the “Warrants”). We issued $29.0 million of new 8% Secured Convertible Notes due in June 2007 of which $25.2 million was used to prepay the Existing Senior Notes. The new Secured Notes are convertible into shares of common stock at $1.85 per share.

Management Plans

We continue to expand our market share in VoIP telecommunications services by expanding our customer base and by introducing cost-effective solutions for our customers to interconnect with our network. During the first quarter of 2004, we introduced our DirectVoIP service which eliminates the need for certain switches for our customers to interconnect to our network, thus reducing capital equipment costs for both us and our customers. Our strategy is to continue the deployment of our retail prepaid calling card services which leverage our international VoIP network with our real time back office systems, and have the potential to deliver higher margins and improve cash flow. In addition, we continue to increase the traffic we terminate to mobile phones, which generally delivers higher average revenue per minute and margins than typical fixed-line traffic. We also continue to control operating expenses and capital expenditures, as well as to monitor and manage accounts payable and accounts receivable and restructure existing debt to enhance cash flow.

Our plans include:

• expanding our market share for our retail prepaid calling card services;

• increasing revenues generated through mobile phone terminations;

• increasing our customer base by introducing cost-effective solutions to interconnect with our network;

• use of our switchless architecture, which eliminates the need for costly telecommunications switches and other equipment; and

• aggressive management of credit risk.

From 2001 to date, we took a series of actions to reduce operating expenses, restructure operations, reduce outstanding debt and provide additional liquidity. Such actions primarily included:

• reductions in workforce and consolidation of Internet Central Offices. As a result of our restructuring programs and our continued focus on controlling expenses, our research and development; selling and marketing and general and administrative expenses, in total, declined to $28.6 million in 2003 from $53.2 million in 2002;

• sale of our previous messaging business and the assets associated with our previous Speech Solutions Business;

• settlement of certain capital lease obligations;

• repurchase of a portion of our 5¾% Convertible Subordinated Notes for cash;

• exchange of a portion of our 5¾% Convertible Subordinated Notes for 11½% Senior Secured Notes and warrants to purchase common stock;

• establishment of a new credit facility with a bank; and

The following discussion and analysis of our financial condition and results of operations for the three months and six months ended June 30, 2004 and 2003 should be read in conjunction with the unaudited condensed consolidated financial statements and footnotes for the three months and six months ended June 30, 2004 included herein, and the year ended December 31, 2003, included in our Annual Report on Form 10-K.

Critical Accounting Policies

Revenue Recognition.

For our wholesale business, our revenue transactions are derived from the resale of international minutes of calling time. We recognize revenue in the period the service is provided, net of revenue reserves for potential billing disputes. Such disputes can result from disagreements with customers regarding the duration, destination or rates charged for each call. For our retail prepaid calling card business, revenue is deferred upon activation of the cards and is recognized as the prepaid calling card balances are reduced based upon minute usage and service charges. Revenue from both the resale of minutes as well as the usage of the prepaid calling cards is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable and collectibility is reasonably assured.

Increased competition from other providers of telephony services and greater expansion into new markets, such as prepaid calling services could materially adversely affect revenue in future periods. The loss of a major customer could have a material adverse affect on our business, financial condition, operating results and future prospects.

Accounts Receivable. We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. We have been able to mitigate our credit risk by using reciprocal arrangements with customers, who are also iBasis suppliers, to offset our outstanding receivables. A majority of our accounts receivable are from international carriers. A significant change in the liquidity or financial position of our customers, or a change in the telecommunications industry, could have a material adverse impact on the collectibility of our accounts receivables and our future operating results.

Impairment of Long Lived Assets. Our long lived assets consist primarily of property and equipment. We have assessed the realizability of these assets and determined that there was no asset impairment as of June 30, 2004 for these assets. Any future impairment would not impact cash flow but would result in an additional charge in our statement of operations.

Long term investment in non-marketable security. Our long-term investment in a non-marketable security represents an equity investment in a privately-held company that was made in connection with a round of financing with other third-party investors. As our investment does not permit us to exert significant influence or control over the entity in which we have invested, the recorded amount represents our cost of the investment less any adjustments we make when we determine that an investment’s carrying value is other-than-temporarily impaired.

The process of assessing whether the equity investment’s net realizable value is less than its carrying cost requires a significant amount of judgment due to the lack of a mature and stable public market for investments of this type. In making this judgment, we carefully consider the investee’s most recent financial results, cash position, recent cash flow data, projected cash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data, the current investing environment, management or ownership changes, and competition. This valuation process is based primarily on information that we request, receive and discuss with the investees’ management on a quarterly basis.

We consider our equity investment to be other than temporarily impaired if, as of the end of any quarter, we believe that the carrying value of the investment is greater than the estimated fair value. Such evaluation is performed on a quarterly basis.

Based on our evaluation for the quarter ended March 31, 2004, we determined that our investment in this privately-held company has been other than temporarily impaired and, as a result, we recorded a $5.0 million non-cash charge to continuing operations in the first quarter of 2004. Since March 31, 2004, based on our on-going monitoring of this privately-held company, we continue to believe that our investment has been other than temporarily impaired.

Restructuring Charges. During 2002 and 2001, we recorded significant charges to operations in connection with our restructuring programs. The related reserves reflect estimates, including those pertaining to severance costs and facility exit costs. We assess the reserve requirements to complete each restructuring program at the end of each reporting period. Actual experience may be different from these estimates. We had no restructuring charges in 2003, or the three and six months ended June 30, 2004.

Results from Continuing Operations

The following table sets forth for the periods indicated the principal items included in the Consolidated Statement of Operations as a percentage of net revenue.

	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Net revenue	100.0	%	100.0	%	100.0	%	100.0	%
Costs and operating expenses:
Datacommunications and telecommunications	85.1		85.3		85.2		84.3
Research and development	5.8		8.8		6.0		8.8
Selling and marketing	3.5		4.8		3.5		4.8
General and administrative	5.3		7.2		5.3		6.6
Depreciation and amortization	4.6		14.7		5.3		14.7
Non-cash stock-based compensation	—		0.1		—		0.1
Total costs and operating expenses	104.3		120.9		105.3		119.3

Loss from operations	(4.3	)	(20.9	)	(5.3	)	(19.3	)

Interest income	0.0		0.1		0.0		0.1
Interest expense	(1.3	)	(2.5	)	(1.3	)	(2.9	)
Gain on bond exchanges	—		9.5		—		20.5
Loss on long-term non-marketable security	—		—		(4.2	)	—
Other expenses, net	(0.1	)	(0.3	)	(0.1	)	(0.2	)
Debt refinancing charges:
Transaction costs	(3.2	)	—		(1.6	)	—
Additional interest expense, net	(0.8	)	—		(0.4	)	—

Net (loss) income	(9.7	)%	(14.1	)%	(12.9	)%	(1.8	)%

Three Months Ended June 30, 2004 Compared to June 30, 2003

Net revenue. Our primary source of revenue is the fees that we charge customers for completing voice and fax calls over our network. Revenue is dependent on the volume of voice and fax traffic carried over the network, which is measured in minutes. We charge our customers fees, per minute of traffic, that are dependent on the length and destination of the call and recognize this revenue in the period in which the call is completed. Our average revenue per minute is based upon our total net revenue divided by the number of minutes of traffic over our network for the applicable period. Average revenue per minute is a key telecommunications industry financial measurement. We believe this measurement is useful in understanding our financial performance, as well as industry trends. Although the long distance telecommunications industry has been experiencing declining prices in recent years, due to the effects of deregulation and increased competition, our average revenue per minute can fluctuate from period to period as a result of shifts in traffic over our network to higher priced, lower priced, destinations.

Net revenue increased by approximately $22.1 million, or 56%, to $61.2 million for 2004 from $39.1 million for 2003. Traffic carried over our network increased 30% to just over 1.1 billion minutes for 2004 from 854 million minutes for 2003 and our average revenue per minute was 5.5 cents in 2004 compared to 4.6 cents per minute in 2003. Revenues from our wholesale telecommunications services increased $15.3 million, or 40%, to $53.5 million for 2004 from $38.2 million in 2003. Revenues for our retail prepaid calling card services and other enhanced services, were $7.7 million in 2004 compared to $0.9 million in 2003. This increase reflects the rapid growth we have achieved with our retail prepaid calling card services, which we introduced in the third quarter of 2003.

Data communications and telecommunications costs. Data communications and telecommunications expenses are composed primarily of termination and circuit costs. Termination costs are paid to local service providers to terminate voice and fax calls received from our network. Terminating costs are negotiated with the local service provider. Should competition cause a decrease in the prices we charge our customers and, as a result, a decrease in our profit margins, our contracts, in some cases, provide us with the flexibility to renegotiate the per-minute termination fees. Circuit costs include charges for Internet access at our Internet Central Offices, fees for the connections between our Internet Central Offices and our customers and/or service provider partners, facilities charges for overseas Internet access and phone lines to the primary telecommunications carriers in particular countries, and charges for the limited number of dedicated international private line circuits we use.

Data communications and telecommunications expenses increased by $18.7 million, or 56%, to $52.1 million for 2004 from $33.4 million for 2003. Data communications and telecommunications expenses were $45.8 million and $6.3 million for our Wholesale and Retail business segments, respectively. The increase in data communications and telecommunications expense primarily reflects the increase in traffic, as discussed above. The largest component of this expense, termination costs, increased to $50.8 million for 2004 from $32.0 million for 2003 while circuit costs decreased slightly to $1.3 million for 2004 from $1.4 million for 2003. As a percentage of net revenues, data

communications and telecommunications expenses decreased to 85.1% for 2004 from 85.3% in 2003. We expect data communications and telecommunications expenses to decrease as a percentage of net revenue to continue to decrease over the balance of 2004 as we further increase utilization and efficiency of our network and achieve economies of scale and we increase our revenues from our higher-margin retail prepaid calling card services.

Research and development expenses. Research and development expenses include the expenses associated with developing, operating, supporting and expanding our international and domestic network, expenses for improving and operating our global network operations centers, salaries, and payroll taxes and benefits paid for employees directly involved in the development and operation of our global network operations centers and the rest of our network. Also included in this category are research and development expenses that consist primarily of expenses incurred in enhancing, developing, updating and supporting our network and our proprietary software applications.

Research and development expenses increased by $0.1 million to $3.5 million for 2004 from $3.4 million for 2003. The small increase in research and development expenses is due to expenditures related to the support of The iBasis Network. As a percentage of net revenue, research and development expenses decreased to 5.8% for 2004 from 8.8% for 2003. We expect that research and development expenses will remain relatively level and continue to decrease as a percentage of net revenue over the balance of 2004.

Selling and marketing expenses. Selling and marketing expenses include expenses relating to the salaries, payroll taxes, benefits and commissions that we pay for sales personnel and the expenses associated with the development and implementation of our promotion and marketing campaigns.

Selling and marketing expenses increased by $0.2 million, to $2.1 million in 2004, from $1.9 million in 2003. The slight increase in expenses primarily relates to sales incentive compensation on the higher level of revenues. As a percentage of net revenue, selling and marketing expenses decreased to 3.5% for 2004 from 4.8% for 2003. We anticipate that selling and marketing expenses will remain relatively level and will continue to decrease as a percentage of net revenue over the balance of 2004.

General and administrative expenses. General and administrative expenses include salary, payroll tax and benefit expenses and related costs for general corporate functions, including executive management, finance and administration, legal and regulatory, facilities, information technology and human resources.

General and administrative expenses increased by $0.5 million to $3.3 million for 2004 from $2.8 million for 2003. The increase in expenses relates to costs associated with complying with the Sarbanes-Oxley Act of $0.1 million and the effect of foreign currency fluctuations of $0.4 million. As a percentage of net revenue, general and administrative expenses decreased to 5.3% for 2004 from 7.2% for 2003. We expect general and administrative expenses to remain relatively level and decrease as a percentage of net revenue over the balance of 2004.

Depreciation and amortization expenses. Depreciation and amortization expenses decreased by $2.9 million to $2.8 million for 2004 from $5.7 million for 2003. This decrease was primarily due to the end of the useful life of certain networking equipment. As a percentage of net revenue, depreciation and amortization expenses decreased to 4.6% for 2004 from 14.7% for 2003. We expect depreciation and amortization expenses to continue to decrease over the balance of 2004, both in absolute dollars and as a percentage of net revenue.

Non-cash stock-based compensation. Non-cash stock-based compensation represents compensation expense incurred in connection with the grant of stock options to our employees with exercise prices less than the fair value of our common stock at the respective dates of grant. Such grants were made prior to our initial public stock offering and are being expensed over the vesting periods of the options granted. Non-cash stock-based

compensation was $28,000 in 2003. There was no non-cash stock-based compensation expense in 2004 as these options became fully vested in 2003.

Interest income. Interest income was $14,000 and $41,000 for 2004 and 2003, respectively. The decrease in interest income reflects our lower average cash balance in 2004.

Interest expense. Interest expense is primarily composed of interest expense paid on the Existing Notes and various capital lease agreements financing certain hardware and software components of our network. Interest expense decreased by $0.2 million to $0.8 million in 2004 from $1.0 million in 2003. This decrease primarily relates to the bond exchanges in 2003, which reduced our debt level by $25.2 million, as well as reduced interest expense relating to a lower level of capital lease obligations. As a result of the completion of the refinancing of our debt in June 2004, interest expense in the future will include interest on the New Secured Notes. All of the interest associated with the Existing Senior Notes, which were prepaid in full as part of the refinancing, had been charged to the gain on bond exchanges in 2003. As a result, we expect that interest expense will increase by approximately $0.6 million per quarter over the balance of 2004.

Gain on bond exchanges. In 2003, we recognized a gain of $3.7 million in connection with the early extinguishment of $12.2 million of the Existing Notes.

Other expenses, net. Other expenses, net were $66,000 and $98,000 in 2004 and 2003, respectively, and relate mostly to state excise and franchise taxes.

Refinancing transaction costs. Transaction costs relating to the refinancing of our debt in June 2004 were $1.9 million. These costs consisted primarily of investment banking services, legal and audit fees.

Refinancing related interest expense. We issued warrants to purchase a total of 5.2 million shares of our common stock, at $1.85 per share, to the holders of the Existing Senior Notes as partial consideration for the prepayment of these notes. The fair value of $2.1 million for these warrants has been charged to the statement of operations as additional interest expense. Future interest on the Existing Senior Notes of $1.6 million, that had originally been charged to the gain on bond exchanges in 2003 and will not be paid as a result of the prepayment of these notes, was recorded as a reduction to the additional interest expense associated with the refinancing.

Income taxes. We have not recorded an income tax benefit for the losses associated with our operating losses in 2004 and 2003 as we believe that it is more likely than not that these benefits will not be realized.

Net loss. Net loss was $5.9 million in 2004 compared to a net loss of $5.5 million in 2003. Excluding refinancing charges of $2.4 million, the loss in 2004 was $3.5 million. Excluding the gain on bond exchanges of $3.7 million, the loss in 2003 was $9.2 million. The reduction in the net loss in 2004 compared to 2003 of $5.7 million, excluding refinancing charges and gain on bond exchanges, primarily relates to the proportionately lower level of costs and operating expenses on the higher level of revenues year-to-year.

Six Months Ended June 30, 2004 Compared to June 30, 2003

Net revenue. Net revenue increased by approximately $37.2 million, or 46%, to $118.2 million for 2004 from $81.0 million for 2003. Traffic carried over our network increased 29% to just over 2.1 billion minutes for 2004 from 1.6 billion minutes for 2003 and our average revenue per minute was 5.5 cents in 2004 compared to 4.9 cents per minute in 2003. Revenues from our wholesale telecommunications services increased $27.4 million, or 35%, to $106.7 million for 2004 from $79.3 million in 2003. Revenues for our retail prepaid calling card services and other enhanced services, were $11.5 million in 2004 compared to $1.7 million in 2003. This increase reflects the rapid growth we have achieved with our retail prepaid calling card services,

which we introduced in the third quarter of 2003.

Data communications and telecommunication costs. Data communications and telecommunications expenses increased by $32.4 million, or 47%, to $100.7 million for 2004 from $68.3 million for 2003. Data communications and telecommunications expenses were $91.5 million and $9.2 million for our Wholesale and Retail business segments, respectively. The increase in data communications and telecommunications expense primarily reflects the increase in traffic, as discussed above. The largest component of this expense, termination costs, increased to $98.1 million for 2004 from $65.7 million for 2003 while circuit costs remained level at $2.6 million for 2004 and 2003. As a percentage of net revenues, data communications and telecommunications expenses increased to 85.2% for 2004 from 84.3% in 2003.

Research and development expenses. Research and development expenses were approximately the same at $7.1 million for 2004 and 2003. As a percentage of net revenue, research and development expenses decreased to 6.0% for 2004 from 8.8% for 2003.

Selling and marketing expenses. Selling and marketing expenses increased by $0.2 million, to $4.1 million in 2004, from $3.9 million in 2003. The slight increase in expenses primarily relates to sales incentive compensation on the higher level of revenues. As a percentage of net revenue, selling and marketing expenses decreased to 3.5% for 2004 from 4.8% for 2003.

General and administrative expenses. General and administrative expenses increased by $0.9 million to $6.2 million for 2004 from $5.3 million for 2003. The increase in expenses relates to costs associated with complying with the Sarbanes-Oxley Act of $0.1 million and the effect of foreign currency fluctuations of $0.4 million. As a percentage of net revenue, general and administrative expenses decreased to 5.3% for 2004 from 6.6% for 2003.

Depreciation and amortization expenses. Depreciation and amortization expenses decreased by $5.6 million to $6.3 million for 2004 from $11.9 million for 2003. This decrease was primarily due to the end of the useful life of certain networking equipment. As a percentage of net revenue, depreciation and amortization expenses decreased to 5.3% for 2004 from 14.7% for 2003.

Interest income. Interest income was $28,000 and $111,000 for 2004 and 2003, respectively. The decrease in interest income reflects our lower average cash balance in 2004.

Gain on bond exchanges. In 2003, we recognized a gain of $16.6 million in connection with the early extinguishment of $50.4 million of the Existing Notes.

Net loss. Net loss was $15.3 million in 2004 compared to a net loss of $1.5 million in 2003. Excluding refinancing charges of $2.4 million and the loss on a long-term non-marketable security, the loss in 2004 was $7.8 million. Excluding the gain on bond exchanges of $16.6 million, the loss in 2003 was $18.1 million. The reduction in the net loss in 2004 compared to 2003 of $10.3 million, excluding refinancing charges, loss on a non-marketable security and gain on bond exchanges, primarily relates to the proportionately lower level of costs and operating expenses on the higher level of revenues year-to-year.

Liquidity and Capital Resources

Our principal capital and liquidity needs historically have related to the development of our network infrastructure, our sales and marketing activities, research and development expenses, and general capital needs. Our capital needs have been met, in large part, from the net proceeds from our public offerings of common stock and the issuance of our Existing Notes. In addition, we have also historically met our capital needs through vendor capital leases and other equipment financings. We expect to continue to utilize equipment financing in the future to partially fund our capital equipment needs.

Net cash used in continuing operating activities for the six months ended June 30, 2004 declined to $2.4 million from $3.8 million for the same period in 2003. For the three months ended June 30, 2004, operating activities provided $0.4 million in cash. Cash used in continuing operating activities for both six month periods was primarily related to the cash necessary to fund our operating losses. In addition, the reduction in cash used in operating activities in 2004 was also a result of strong collections of accounts receivable which reduced our days sales outstanding.

Net cash provided by investing activities was $1.7 million for the six months ended June 30, 2004 compared to cash used of $2.9 million for the same period in 2003. The cash provided by investing activities in 2004 relates to $1.1 million in proceeds from an earn-out receivable and $1.5 million in proceeds from an escrow payment relating the sale of our Speech Solutions Business, net of purchases of property and equipment of $1.0 million. The cash used in investing activities in 2003 relates to purchases of equipment of $2.1 million and $0.7 million relating to an adjustment to the proceeds from the sale of our former Speech Solutions Business.

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an Exchange Offer, pursuant to which $37.3 million of our outstanding Existing Notes, representing approximately 98% of the total amount of Existing Notes outstanding, were tendered for the same principal amount of New Subordinated Notes. Approximately $0.9 million of the Existing Notes remain outstanding after the Exchange Offer. Simultaneously with the Exchange Offer, we prepaid all $25.2 million of our Existing Senior Notes for cash equal to the principal amount plus accrued but unpaid interest and the issuance of Warrants exercisable for an aggregate of 5,176,065 shares of our common stock at $1.85 per share. We issued $29.0 million of New 8% Secured Convertible Notes due in June 2007 of which $25.2 million was used to prepay the Existing Senior Notes. The New Secured Notes are convertible into shares of common stock at $1.85 per share. As a result of the refinancing, we have extended the maturity of $62.5 million in debt from the first quarter of 2005 until 2007 and 2009. This refinancing will also reduce our future annual cash interest payments by $0.2 million.

Net cash provided by financing activities was $1.7 million for the six months ended June 30, 2004 compared to cash used in financing activities of $4.5 million for 2003. Cash provided by financing activities in 2004 included an additional $3.8 million in proceeds from the issuance of the New Secured Notes net of the amount used to finance the prepayment of the Existing Senior Notes. The additional net proceeds from the New Secured Notes helped finance $1.8 million in transaction costs. In addition, we received proceeds of $1.0 million from the holders of the Existing Senior Notes who exercised previously issued warrants for 1.5 million shares during the three months ended June 30, 2004. Principal payments on capital lease obligations were $1.4 million in 2004.

At June 30, 2004 and December 31, 2003, we had $2.3 million in borrowings under our bank line of credit. At June 30, 2004, we had unused borrowing capacity of $3.0 million and we had outstanding letters of credit of $1.6 million.

Cash used in financing activities in 2003 was a result of $3.6 million for principal payments on capital lease obligations and $0.9 million for professional fees paid on the exchange of bonds in 2003.

In June 2004, our stockholders approved an increase in the level of our authorized common stock from 85 million shares to 170 million shares.

We anticipate that the June 30, 2004 balance of $18.2 million in cash and cash equivalents, together with cash flow from operations, will be sufficient to fund our operations and debt service requirements for the next twelve months. However, in the event we fail to execute on our plan, we experience events described in “Risk Factors”, or that circumstances currently unknown or unforeseen by us arise, we may not succeed in re-capitalizing the Company, or be able to obtain additional funding to allow us to meet our debt obligations.

Under accounting principles generally accepted in the U.S., certain obligations and commitments are not required to be included in the consolidated balance sheets and statements of operations. These obligations and commitments, while entered into in the normal course of business, may have a material impact on liquidity. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

The following table summarizes our future contractual obligations as of June 30, 2004 and displays our future contractual obligations:

	Payment Due Dates
	Total		Less than 1 Year		1 to 2 Years		2 to 3 Years		3 to 5 Years		After 5 Years
	(In thousands)
6¾% Convertible Subordinated Notes due 2009	$	37,285	$	—	$	—	$	—	$	37,285	$	—
5¾% Convertible Subordinated Notes due 2005	895		895		—		—		—		—
8% Secured Convertible Notes due 2007	29,000		—		—		29,000		—		—
Capital lease obligations	828		828		—		—		—		—
Revolving line of credit	2,300		2,300		—		—		—		—
Operating leases	10,606		3,120		1,732		1,709		3,677		368

Total	$	80,914	$	7,143	$	1,732	$	30,709	$	40,962	$	368

Factors That May Affect Future Results and Financial Condition

RISK FACTORS

Any investment in our securities involves a high degree of risk. You should carefully consider the risks described below, which we believe are all the material risks to our business, together with the information contained elsewhere in this report, before you make a decision to invest in our company.

Risks Related to Our Company

A failure to obtain necessary additional capital in the future could jeopardize our operations.

We will need additional capital in the future to fund our operations, finance investments in equipment and corporate infrastructure, expand our network, increase the range of services we offer and respond to competitive pressures and perceived opportunities. We have had a history of negative cash flows from operations. For the six months ended June 30, 2004 and for all of 2003, our negative cash flow from continuing operations was $2.4 million and $3.2 million, respectively. Cash flow from operations and cash on hand may not be sufficient to cover our operating expenses, working capital, interest on and repayment of our debt and capital investment needs. We may not be able to obtain additional financing on terms acceptable to us, if at all. If we raise additional funds by selling equity securities, the relative equity ownership of our existing investors could be diluted or the new investors could obtain terms more favorable than previous investors. A failure to obtain additional funding could prevent us from making expenditures that are needed to allow us to grow or maintain our operations.

Our financial condition, and the restrictive covenants contained in our credit facility may limit our ability to borrow additional funds or raise additional equity as may be required to fund our future operations.

We incurred significant losses from continuing operations of $15.3 million for the six months ended June 30, 2004 and $10.9 million for the year ended December 31, 2003. Our accumulated deficit, and stockholders’ deficit was approximately $427.5 million and $54.2 million, respectively, as of June 30, 2004. Moreover, the terms of our $15 million revolving credit facility and our debt exchange may limit our ability to, among other things:

• incur additional debt;

• retire or exchange outstanding debt;

• pay cash dividends, redeem, retire or repurchase our stock or change our capital structure;

• acquire assets or businesses or make investments in other entities;

• enter into certain transactions with affiliates;

• merge or consolidate with other entities;

• sell or otherwise dispose of assets or use the proceeds from any asset sale or other disposition; and

• create additional liens on our assets; or

• issue certain types of redeemable preferred stock.

Our available cash, and the remaining borrowing capacity under our credit facility may not be sufficient to fund our operating and capital expenditure requirements in the foreseeable future. Our ability to borrow additional funds or raise additional equity is limited by the terms of our outstanding debt and/or our financial condition.

Additionally, events such as our inability to continue to reduce our loss from continuing operations, could adversely affect our liquidity and our ability to attract additional funding as required.

We may not be able to pay our debt and other obligations and our assets may be seized as a result.

We may not generate the cash flow required to pay our liabilities as they become due. Following the completion of the Exchange Offer and refinancing of our Existing Senior Notes, our outstanding debt included approximately $0.9 million of the Existing Notes due in March 2005, $37.3 million of the New Subordinated Notes due in June 2009, and $29.0 million of New Secured Notes due in June 2007. We must pay interest on all of the Existing Notes, the New Subordinated Notes and the New Secured Notes twice a year. If our cash flow is inadequate to meet our obligations, we will default on the notes. Any default of the Existing Notes, the New Subordinated Notes or the New Secured Notes could allow our note holders to seize our assets or try to force us into bankruptcy.

Additionally, as of June 30, 2004, we had an outstanding balance of $2.3 million on our bank revolving line of credit totaling $15.0 million, and had approximately $1.6 million of outstanding letters of credit issued under this agreement. If we fail to pay our liabilities under this credit line, the bank may enforce all available remedies and seize our assets or receivables, to satisfy any amounts owed.

We may be unable to repay or repurchase the new secured notes, existing notes or new subordinated notes upon a repurchase event and be forced into bankruptcy.

The holders of the New Secured Notes may require us to repurchase or prepay all of the outstanding New Secured Notes upon a “repurchase event.” A repurchase event under the New Secured Notes includes a change of control under certain circumstances or a termination of listing of our common stock on a U.S. national securities exchange or trading on an established over-the-counter trading market in the U.S. In addition, upon the receipt of proceeds of certain asset sales by us that generate proceeds in excess of $10,000,000 (or if an event of default exists, regardless of the amount) that is not invested or used to reduce existing indebtedness and does not result in a change of control, we are required to use the proceeds from the asset sale to prepay or repurchase the New Secured Notes. We may not have sufficient cash reserves to repurchase the New Secured Notes at such time, which would cause an event of default under the New Secured Note Indenture and under our other debt obligations.

The holders of the Existing Notes and New Subordinated Notes may require us to repurchase all or any portion of the outstanding Existing Notes or New Subordinated Notes upon a “repurchase event.” A repurchase event under the Existing Notes and New Subordinated Notes includes a change in control under certain circumstances or a termination of listing of our common stock on a U.S. national securities exchange or trading on an established over-the-counter trading market in the U.S. We may not have sufficient cash reserves to repurchase the Existing Notes or New Subordinated Notes at such time, which would cause an event of default under the Existing Note Indenture or the New Subordinated Note Indenture and under our other debt obligations and may force us to declare bankruptcy.

Investor interest in the Common Stock may be negatively affected by our continued trading on the Over-the-Counter Bulletin Board.

On November 13, 2002, we received a determination from Nasdaq that shares of our common stock would no longer trade on the Nasdaq National Market because we failed to meet certain minimum listing requirements. Our common stock began trading on the NASD-operated Over-the-Counter Bulletin Board on November 14, 2002. The Over-the-Counter Bulletin Board market is generally considered to be less efficient and not as liquid as the Nasdaq National Market. Trading in this market may decrease the market value and liquidity of our

common stock, which could materially and adversely affect our ability to attract additional investment to finance our operations.

Provisions of our governing documents and Delaware law could also discourage acquisition proposals or delay a change in control.

Our certificate of incorporation and by-laws contain anti-takeover provisions, including those listed below, that could make it more difficult for a third party to acquire control of our company, even if that change in control would be beneficial to stockholders:

• our board of directors has the authority to issue Common Stock and preferred stock, and to determine the price, rights and preferences of any new series of preferred stock, without stockholder approval;

• our board of directors is divided into three classes, each serving three-year terms;

• our stockholders need a supermajority of votes to amend key provisions of our certificate of incorporation and by-laws;

• there are limitations on who can call special meetings of stockholders;

• our stockholders may not take action by written consent; and

• our stockholders must provide specified advance notice to nominate directors or submit stockholder proposals.

In addition, provisions of Delaware law and our stock option plan may also discourage, delay or prevent a change of control of our company or unsolicited acquisition proposals.

International governmental regulation and legal uncertainties and other laws could limit our ability to provide our services, make them more expensive, or subject us to legal or criminal liability.

A number of countries currently prohibit or limit competition in the provision of traditional voice telephony services. In some of those countries, licensed telephony carriers as well as government regulators have questioned our legal authority and/or the legal authority of our service partners or affiliated entities and employees to offer our services. We may face similar questions in additional countries. Our failure to qualify as a properly licensed service provider, or to comply with other foreign laws and regulations, could materially adversely affect our business, financial condition and results of operations, including subjecting us or our employees to taxes and criminal or other penalties and/or by precluding us from, or limiting us in, enforcing contracts in such jurisdictions.

It is also possible that countries may apply to our activities laws otherwise relating to services provided over the Internet, including laws governing:

• sales and other taxes, including payroll-withholding applications;

• user privacy;

• pricing controls and termination costs;

• characteristics and quality of products and services;

• qualification to do business;

• consumer protection;

• cross-border commerce, including laws that would impose tariffs, duties and other import restrictions;

• copyright, trademark and patent infringement; and

• claims based on the nature and content of Internet materials, including defamation, negligence and the failure to meet necessary obligations.

If foreign governments or other bodies begin to impose related restrictions on Internet telephony or our other

services or otherwise enforce criminal or other laws against us, our affiliates or employees, such activities could have a material adverse effect on our ability to attain and maintain profitability.

The telecommunications industry is subject to domestic governmental regulation and legal uncertainties and other laws that could materially increase our costs and prevent us from executing our business plan.

We are not licensed to offer traditional telecommunications services in any U.S. state and we have not filed tariffs for any service at the Federal Communications Commission (FCC) or at any state regulatory commission.

Nonetheless, aspects of our operations may currently be, or become, subject to state or federal regulations governing licensing, universal service funding, access charges, advertising, disclosure of confidential communications or other information, excise taxes, transactions restricted by U.S. embargo and other reporting or compliance requirements.

While the FCC to date has maintained an informal policy that information service providers, including Internet telephony providers, are not telecommunications carriers for regulatory purposes, various entities have challenged this idea, before the FCC and at various state government agencies. The FCC recently ruled against AT&T, finding that certain traffic AT&T carried in part utilizing an Internet protocol format was nonetheless regulated telecommunications for which terminating access charges were due. The FCC has also held hearings and announced a Notice of Proposed Rulemaking on IP-enabled services. Adverse rulings or rulemakings could subject us to licensing requirements and additional fees and subsidies.

The IRS and the U.S. Department of Treasury have issued a notice of proposed rulemaking suggesting that VoIP calls may be subject to a 3% federal excise tax.

We have offered our prepaid international calling card services on a wholesale basis to international carrier customers, and others, some of which provide these services to end-user customers, enabling them to call internationally over The iBasis Network from the U.S. We have also made arrangements to participate in the selling and marketing of such cards on a retail basis. Although the calling cards are not primarily marketed for domestic interstate or intrastate use, we have not blocked the ability to place such calls or required our wholesale customers or distributors to show evidence of their compliance with U.S. and state regulations. As a result, there may be incidental domestic use of the cards. Domestic calling may employ transport and switching that is not connected to the Internet and, therefore, may not enjoy the lighter regulation to which our Internet-based services are subject. Because we provide services that are primarily wholesale and/or international, we do not believe that we are subject to federal or state telecommunications regulation for the possible uses of these services described here and, accordingly, we have not obtained state licenses, filed state or federal tariffs, posted bonds, or undertaken other possible compliance steps. Under current standards or as-yet undetermined rules, the FCC and state regulatory authorities may not agree with our position. If they do not, we could become subject to regulation at the federal and state level for these services, and could become subject to licensing and bonding requirements, and federal and state fees and taxes, including universal service contributions and other subsidies, and other laws, all of which could materially affect our business.

We are also subject to federal and state laws and regulations regarding consumer protection and disclosure regulations. These rules could substantially increase the cost of doing business domestically and in any particular state. Law enforcement authorities may utilize their powers under consumer protection laws against us in the event we do not meet legal requirements in that jurisdiction.

The Telecommunications Act of 1996 requires that payphone service providers be compensated for all completed calls originating from payphones in the United States. When calling cards are used, the FCC’s prior rules required the first switch-based carrier to compensate the payphone service provider, but newly adopted rules require the last switched-based carrier to do so, and further require that all carriers in the call chain implement a call-tracking system, utilize it to identify such calls, provide an independent audit of the adequacy of such system, and provide a report on these matters to the FCC and others in the call chain. We maintain that as an international Internet telephony provider, we sell an information service. We therefore are not a “carrier” for regulatory purposes and, in any case, our Internet-based systems do not rely on traditional long distance switches. Thus, there is a good faith legal basis for concluding that our services are not subject to payphone

compensation requirements. Nonetheless, we have indirectly paid, and intend to continue paying, payphone service providers as part of our prepaid calling card business. To date, we have reimbursed certain of our toll-free access vendors - facilities-based long distance carriers from which we have received payphone calls that could be construed to be compensable under the payphone compensation rules - who have indeed paid payphone compensation for such calls. In the future, we intend to contract with a clearinghouse to remit funds directly to payphone service providers for calls originating from payphones utilizing our prepaid calling cards. For all other types of traffic related to our wholesale transport business, we believe that we are not responsible for payphone compensation, but rather that the carrier that precedes us is.

In addition to specific telecommunications regulation, we are subject to other laws. As an example, the Office of Foreign Asset Control of the U.S. Department of the Treasury, or OFAC, administers the United States’ sanctions against certain countries. OFAC rules restrict many business transactions with such countries and, in some cases, require that licenses be obtained for such transactions. We may currently, or in the future, transmit telecommunications between the U.S. and countries subject to U.S. sanctions regulations and undertake other transactions related to those services. We have undertaken such activities via our network or through various reciprocal traffic exchange agreements to which we are a party. We have received licenses from OFAC to send traffic to some countries and, if necessary, will remain in contact with OFAC with regard to other transactions. Failure to obtain proper authority could expose us to legal and criminal liability.

Risks Related to Our Operations

We may never achieve sustained profitability and the market price of our Common Stock may fall.

Our revenue and results of operations have fluctuated and will continue to fluctuate significantly from quarter to quarter in the future due to a number of factors, some of which are not in our control, including, among others:

• the amount of traffic we are able to sell to our customers, and their decisions on whether to route traffic over our network;

• increased competitive pricing pressure in the international long distance market;

• the percentage of traffic that we are able to carry over the Internet rather than over the more costly traditional public-switched telephone network;

• loss of arbitrage opportunities resulting from declines in international settlement rates or tariffs;

• our ability to negotiate lower termination fees charged by our local providers if our pricing deteriorates;

• our continuing ability to negotiate competitive costs to interconnect our network with those of other carriers and Internet backbone providers;

• capital expenditures required to expand or upgrade our network;

• changes in call volume among the countries to which we complete calls;

• the portion of our total traffic that we carry over more attractive routes could fall, independent of route-specific price, cost or volume changes;

• technical difficulties or failures of our network systems or third party delays in expansion or provisioning system problems;

• our ability to manage distribution arrangements and provision of retail offerings, including card printing, marketing, usage tracking, web-based offerings and customer service requirements, and resolution of associated disputes;

• our ability to manage our traffic on a constant basis so that routes are profitable;

• our ability to collect from our customers; and

• currency fluctuations and restrictions in countries where we operate.

Because of these factors, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. It is possible that, in future periods, our results of operations will be significantly lower than the estimates of public market analysts, investors or our own estimates. Such a discrepancy could cause the price of the Common Stock to decline significantly and prevent us from achieving

profitability.

We may never generate sufficient revenue to attain profitability if telecommunications carriers and other communications service providers or others are reluctant to use our services or do not use our services, including any new services, in sufficient volume.

If the market for Internet telephony and new services does not develop as we expect, or develops more slowly than expected, our business, financial condition and results of operations will be materially and adversely affected.

Our customers may be reluctant to use our Internet telephony services for a number of reasons, including:

• perceptions that the quality of voice transmitted over the Internet is low;

• perceptions that Internet telephony is unreliable;

• our inability to deliver traffic over the Internet with significant cost advantages;

• development of their own capacity on routes served by us;

• an increase in termination costs of international calls.

The growth of our core business depends on carriers and other communications service providers generating an increased volume of international voice and fax traffic and selecting our network to carry at least some of this traffic. Similarly, the growth of any retail services we offer depends on these factors as well as acceptance in the market of the brands that we service, including their respective rates, terms and conditions. If the volume of international voice and fax traffic and associated or other retail services fail to increase, or decrease, and these parties or other customers do not employ our network or otherwise use our services, our ability to become profitable will be materially and adversely affected.

We may not be able to collect amounts due to us from our customers and we may have to disgorge amounts already paid.

Some of our customers have closed their businesses or filed for bankruptcy owing us millions of dollars for services we have provided to them in the past. Despite our efforts to collect these overdue funds, we may never be paid. The bankruptcy court may require us to continue to provide services to these companies during their reorganizations. Other customers may discontinue their use of our services at any time and without notice, or delay payments that are owed to us. Additionally, we may have difficulty in collecting amounts from them. Although we have internal credit risk policies to identify companies with poor credit histories, we may not effectively manage these policies and provided services to companies that refuse to pay. The risk is even greater in foreign countries, where the legal and collection systems available may not be adequate or impartial for us to enforce the payment provisions of our contracts. Our cash reserves will be reduced and our results of operations will be materially adversely affected if we are unable to collect amounts from our customers.

We have received claims including lawsuits from estates of bankrupt companies alleging that we received preferential payments prior to bankruptcy filing. We may be required to return amounts received from bankrupt estates. We intend to employ all available defenses in contesting such claims or, in the alternative settle such claims. The results of any suit or settlement may have a material adverse affect on our business.

We may increase costs and risks in our business by relying on third parties.

Vendors. We rely upon third-party vendors to provide us with the equipment, software, circuits, and other facilities that we use to provide our services. For example, we purchase a substantial portion of our Internet telephony equipment from Cisco Systems. We may be forced to try to renegotiate terms with vendors for products or services that have become obsolete. Some vendors may be unwilling to renegotiate such contracts, which could affect our ability to continue to provide services and consequently render us unable to generate sufficient revenues to become profitable.

Parties that Maintain Phone and Data Lines and Other Telecommunications Services. Our business model

depends on the availability of the Internet and traditional telephone networks to transmit voice and fax calls. Third parties maintain and own these networks, other components that comprise the Internet, and business relationships that allow telephone calls to be terminated over the public switched telephone network. Some of these third parties are telephone companies. They may increase their charges for using these lines at any time and thereby decrease our profitability. They may also fail to maintain their lines properly, fail to maintain the ability to terminate calls, or otherwise disrupt our ability to provide service to our customers. Any such failure that leads to a material disruption of our ability to complete calls or provide other services could discourage our customers from using our network, which could have the effect of delaying or preventing our ability to become profitable.

Local Communications Service Providers. We maintain relationships with local communications service providers in many countries, some of whom own the equipment that translates calls from traditional voice networks to the Internet, and vice versa. We rely upon these third parties both to provide lines over which we complete calls and to increase their capacity when necessary as the volume of our traffic increases. There is a risk that these third parties may be slow, or fail, to provide lines, which would affect our ability to complete calls to those destinations. We may not be able to continue our relationships with these local service providers on acceptable terms, if at all. Because we rely upon entering into relationships with local service providers to expand into additional countries, we may not be able to increase the number of countries to which we provide service. Finally, any technical difficulties that these providers suffer, or difficulties in their relationships with companies that manage the public switched telephone network, could affect our ability to transmit calls to the countries that those providers help serve.

Strategic Relationships. We depend in part on our strategic relationships to expand our distribution channels and develop and market our services. In particular, we depend on our joint marketing and product development efforts with Cisco Systems to achieve market acceptance and brand recognition in certain markets. Strategic relationship partners may choose not to renew existing arrangements on commercially acceptable terms, if at all. In general, if we lose these key strategic relationships, or if we fail to maintain or develop new relationships in the future, our ability to expand the scope and capacity of our network and services provided, and to maintain state-of-the-art technology, would be materially adversely affected.

Distributors of prepaid calling cards to retail outlets. We make arrangements with distributors to market and sell prepaid calling cards to retail outlets. In some cases, we rely on these distributors to print cards, prepare marketing material, activate accounts, track usage and other data, and remit payments collected from retailers. There is a risk that distributors will not properly perform these responsibilities, comply with legal requirements, or pay us monies when due. We may not have adequate contractual or credit protections against these risks. There is also a risk that we will be ineffective in our efforts to implement new systems, customer care and disclosure policies, and certain technical and business processes. The result of any attendant difficulties may have a material impact on our business.

We may not be able to succeed in the intensely competitive market for our various services.

We compete in our wholesale business principally on quality of service and price. In recent years, prices for long distance telephone services have been declining as a result of deregulation and increased competition. We face competition from major telecommunications carriers, such as AT&T, British Telecom, Deutsche Telekom, MCI WorldCom and Qwest Communications, as well as new emerging carriers. We also compete with Internet protocol and other Internet telephony service providers who route traffic to destinations worldwide. Also, Internet telephony service providers that presently focus on retail customers may in the future enter the wholesale market and compete with us. If we can not offer competitive prices and quality of service our business could be materially adversely affected.

We may not be able to succeed in the intensely competitive market for prepaid calling services.

The market for prepaid calling services is extremely competitive. Hundreds of providers offer calling card products and services. We have just recently begun offering prepaid calling card services and have little prior experience in this business and no established distribution channel for these services. If we do not successfully

establish a distribution channel and enter geographic markets in which our rates, fees, surcharges, country services, and our other products and service characteristics, can successfully compete, our business could be materially adversely affected.

We are subject to downward pricing pressures and a continuing need to renegotiate overseas rates, which could delay or prevent our profitability.

As a result of numerous factors, including increased competition and global deregulation of telecommunications services, prices for international long distance calls have been decreasing. This downward trend of prices to end-users has caused us to lower the prices we charge communications service providers and calling card distributors for call completion on our network. If this downward pricing pressure continues, we may not be able to offer Internet telephony services at costs lower than, or competitive with, the traditional voice network services with which we compete. Moreover, in order for us to lower our prices, we have to renegotiate rates with our overseas local service providers who complete calls for us. We may not be able to renegotiate these terms favorably enough, or fast enough, to allow us to continue to offer services in a particular country on a cost-effective basis. The continued downward pressure on prices and our failure to renegotiate favorable terms in a particular country could have a material adverse effect on our ability to operate our network and Internet telephony business profitably.

A variety of risks associated with our international operations could materially adversely affect our business.

Because we provide many of our services internationally, we are subject to additional risks related to operating in foreign countries. In particular, in order to provide services and operate facilities in some countries, we have established subsidiaries or other legal entities or have forged relationships with service partners or entities set up by our employees. Associated risks include:

• unexpected changes in tariffs, trade barriers and regulatory requirements relating to Internet access or Internet telephony;

• economic weakness, including inflation, or political instability in particular foreign economies and markets;

• difficulty in collecting accounts receivable;

• tax, consumer protection, telecommunications, and other laws;

• compliance with tax, employment, securities, immigration, labor and other laws for employees living and traveling, or conducting business, abroad, which may subject them or us to criminal or civil penalties;

• foreign taxes including withholding of payroll taxes;

• foreign currency fluctuations, which could result in increased operating expenses and reduced revenues;

• political or economic instability;

• exposure to liability under the Foreign Corrupt Practices Act;

• other obligations or restrictions, including, but not limited to, criminal penalties incident to doing business or operating a subsidiary or other entity in another country;

• the personal safety of our employees and their families who at times have received threats of, or who may in any case be subject to, violence, and who may not be adequately protected by legal authorities or other means, and

• inadequate insurance coverage to address these risks.

These and other risks associated with our international operations may materially adversely affect our ability to attain or maintain profitable operations.

If we are not able to keep up with rapid technological change in a cost-effective way, the relative quality of our services could suffer.

The technology upon which our services depend is changing rapidly. Significant technological changes could render the hardware and software that we use obsolete, and competitors may begin to offer new services that we

are unable to offer. If we are unable to respond successfully to these developments or do not respond in a cost-effective way, we may not be able to offer competitive services.

We may not be able to expand and upgrade our network adequately and cost-effectively to accommodate any future growth.

Our Internet telephony business requires that we handle a large number of international calls simultaneously. As we expand our operations, we expect to handle significantly more calls. If we do not expand and upgrade our hardware and software quickly enough, we will not have sufficient capacity to handle the increased traffic and growth in our operating performance would suffer as a result. Even with such expansion, we may be unable to manage new deployments or utilize them in a cost-effective manner. In addition to lost growth opportunities, any such failure could adversely affect customer confidence in The iBasis Network and could result in us losing business outright.

We depend on our current personnel and may have difficulty attracting and retaining the skilled employees we need to execute our business plan.

We depend heavily on our key management. Our future success will depend, in large part, on the continued service of our key management and technical personnel, including Ofer Gneezy, our President and Chief Executive Officer, Gordon VanderBrug, our Executive Vice President, Richard Tennant, our Chief Financial Officer, Paul Floyd, our Senior Vice President of Research & Development, Engineering, and Operations, and Dan Powdermaker, our Senior Vice President of Worldwide Sales. If any of these individuals or others we employ are unable or unwilling to continue in their present positions, our business, financial condition and results of operations could suffer. We do not carry key person life insurance on our personnel. While each of the individuals named above has entered into an employment agreement with us, these agreements do not ensure their continued employment with us.

We will need to retain skilled personnel to execute our plans. Our future success will also depend on our ability to attract, retain and motivate highly skilled employees, particularly engineering and technical personnel. Past workforce reductions have resulted in reallocations of employee duties that could result in employee and contractor uncertainty and dissatisfaction. Reductions in our workforce or restrictions on salary increases or payment of bonuses may make it difficult to motivate and retain employees and contractors, which could affect our ability to deliver our services in a timely fashion and otherwise negatively affect our business.

If we are unable to protect our intellectual property, our competitive position would be adversely affected.

We rely on patent, trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our intellectual property. Unauthorized third parties may copy our services or reverse engineer or obtain and use information that we regard as proprietary. End-user license provisions protecting against unauthorized use, copying, transfer and disclosure of any licensed program may be unenforceable under the laws of certain jurisdictions and foreign countries. We may seek to patent certain processes or equipment in the future. We do not know if any of our patent applications will be issued with the scope of the claims we seek, if at all. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. Our means of protecting our proprietary rights in the United States or abroad may not be adequate and third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. If we fail to protect our intellectual property and proprietary rights, our business, financial condition and results of operations would suffer.

We believe that we do not infringe upon the proprietary rights of any third party. It is possible, however, that such a claim might be asserted successfully against us in the future. Our ability to provide our services depends on our freedom to operate. That is, we must ensure that we do not infringe upon the proprietary rights of others or have licensed all such rights. A party making an infringement claim could secure a substantial monetary award or obtain injunctive relief that could effectively block our ability to provide services in the United States

or abroad.

We have received letters and other notices claiming that certain of our products and services may infringe patents or other intellectual property of other parties. To date, none of these has resulted in a material restriction on any use of our intellectual property or has had a material adverse impact on our business. We may be unaware of intellectual property rights of others that may, or may be claimed, to cover our technology. Current or future claims could result in costly litigation and divert the attention of management and key personnel from other business issues. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements to the extent necessary for the conduct of our business. However, we may be unable to obtain royalty or license agreements on terms acceptable to us or at all. We also may be subject to significant damages or an injunction against use of our proprietary or licenses systems. A successful claim of patent or other intellectual property infringement against us could materially adversely affect our business and profitability.

We rely on a variety of technologies, primarily software, which is licensed from third parties.

Continued use of this technology by us requires that we purchase new or additional licenses from third parties. We may not be able to obtain those third-party licenses needed for our business or that the third party technology licenses that we do have will continue to be available to us on commercially reasonable terms or at all. The loss or inability to maintain or obtain upgrades to any of these technology licenses could result in delays or breakdowns in our ability to continue developing and providing our services or to enhance and upgrade our services.

We may undertake strategic acquisitions or dispositions that could damage our ability to attain or maintain profitability.

We may acquire additional businesses and technologies that complement or augment our existing businesses, services and technologies. We may need to raise additional funds through public or private debt or equity financing to acquire any businesses, which may result in dilution for stockholders and the incurrence of indebtedness. We may not be able to operate acquired businesses profitably or otherwise implement our growth strategy successfully.

We may need to sell existing assets or businesses in the future to generate cash or focus our efforts in making our core business, Internet telephony, profitable. As with many companies in the telecommunications sector that experienced rapid growth in recent years, we may need to reach profitability in one market before entering another. In the future, we may need to sell assets to cut costs or generate liquidity.

Risks Related to the Internet and Internet Telephony Industry

If the Internet does not continue to grow as a medium for voice and fax communications, our business will suffer.

Historically, the sound quality of calls placed over the Internet was poor. As the Internet telephony industry has grown, sound quality has improved, but the technology may require further refinement. Additionally, as a result of the Internet’s capacity constraints, callers could experience delays, errors in transmissions or other interruptions in service. Transmitting telephone calls over the Internet, and other uses of the Internet, must also be accepted by customers as an alternative to traditional services. As the Internet telephony market is evolving, predicting the size of these markets and their growth rate is difficult. If our market fails to continue to develop, then we will be unable to grow our customer base and our results of operations will be materially adversely affected.

If the Internet infrastructure is not adequately maintained, we may be unable to maintain the quality of our services and provide them in a timely and consistent manner.

Our future success will depend upon the maintenance of the Internet infrastructure, including a reliable network backbone with the necessary speed, data capacity and security for providing reliability and timely Internet access and services. To the extent that the Internet continues to experience increased numbers of users, frequency of use or bandwidth requirements, the Internet may become congested and be unable to support the demands placed on it and its performance or reliability may decline thereby impairing our ability to complete calls and provide other services using the Internet at consistently high quality. The Internet has experienced a variety of outages and other delays as a result of failures of portions of its infrastructure or otherwise. Future outages or delays could adversely affect our ability to complete calls and provide other services. Moreover, critical issues concerning the commercial use of the Internet, including security, cost, ease of use and access, intellectual property ownership and other legal liability issues, remain unresolved and could materially and adversely affect both the growth of Internet usage generally and our business in particular. Finally, important opportunities to increase traffic on The iBasis Network will not be realized if the underlying infrastructure of the Internet does not continue to be expanded to more locations worldwide.

Our ability to provide our services using the Internet may be adversely affected by computer vandalism.

If the overall performance of the Internet is seriously downgraded by website attacks or other acts of computer vandalism or virus infection, our ability to deliver our communication services over the Internet could be adversely impacted, which could cause us to have to increase the amount of traffic we have to carry over alternative networks, including the more costly public-switched telephone network. In addition, traditional business interruption insurance may not cover losses we could incur because of any such disruption of the Internet. While some insurers are beginning to offer products purporting to cover these losses, we do not have any of this insurance at this time.

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q, including without limitation Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 194, as amended (the Exchange Act). We intend the forward-looking statements to be covered by the safe harbor for forward-looking statements in such sections of the Exchange Act. These forward-looking statements include, without limitation, statements about our market opportunity, strategies, competition, expected activities, expected profitability and investments as we pursue our business plan, and the adequacy of our available cash resources. These forward-looking statements are usually accompanied by words such as “believe,” “anticipate,” “plan,” “seek,” “expect,” “intend” and similar expressions. The forward-looking information is based on various factors and was derived using numerous assumptions.

Forward-looking statements necessarily involve risks and uncertainties, and our actual results could differ materially from those anticipated in the forward-looking statements due to a number of factors, including those set forth below under “Risk Factors” and elsewhere in this report. The factors set forth below under “Risk Factors” and other cautionary statements made in this Prospectus should be read and understood as being applicable to all related forward-looking statements wherever they appear in this report. The forward-looking statements contained in this report represent our judgment as of the date of this report. We caution readers not to place undue reliance on such statements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk exposure is related to interest rates and foreign currency exchange rates. To date, we have not engaged in trading market risk sensitive instruments or purchasing hedging instruments, whether interest rate, foreign currency exchange, commodity price or equity price risk. We have not purchased options or entered into swaps or forward or futures contracts.

Our investments in commercial paper and debt instruments are subject to interest rate risk, but due to the short-term nature of these investments, changes in interest rates would not have a material impact on their value at June 30, 2004. Our primary interest rate risk is the risk on borrowings under our line of credit agreements, which are subject to interest rates based on the bank’s prime rate. A change in the applicable interest rates would also affect the rate at which we could borrow funds or finance equipment purchases. All other debt, including capital lease obligations, are fixed rate debt. A 10% change in interest rates would not have a material impact on interest expense associated with our line of credit agreement. In addition, a 10% change in interest rates would not significantly impact the fair value of the New Notes or New Secured Notes.

We conduct our business in various regions of the world, but most of our revenues are denominated in U.S. dollars with the remaining being generally denominated in Euros or British pounds sterling. Although most of our costs are U.S. dollar denominated, some of our costs are in Euros or British pounds sterling which partially offsets our risk from revenues denominated in these currencies.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, (the “Exchange Act”) as of the end of the period covered by this quarterly report. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and are operating in an effective manner.

(b) Changes in internal control over financial reporting. There were no significant changes in our internal controls over financial reporting during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II — Other Information

Item 1. Legal Proceedings

In addition to litigation that we have initiated or responded to in the ordinary course of business, we are currently party to the following potentially material legal proceedings:

primarily based on the assertion that there was undisclosed compensation received by our underwriters in connection with our public offerings and that there were understandings with customers to make purchases in the aftermarket. The plaintiffs have sought an undetermined amount of monetary damages in relation to these claims. On September 4, 2001, the cases against us were consolidated. On October 9, 2002, the individual defendants were dismissed from the litigation by stipulation and without prejudice.

On June 11, 2004, we and the individual defendants, as well as many other issuers named as defendants in the class action proceeding, entered into an agreement-in-principle to settle this matter, and on June 14, 2004, this settlement was presented to the court. A motion for preliminary approval of the settlement was filed on June 25, 2004 and is pending. Once the court preliminarily approves the settlement and notice has been mailed, there will be an objection period, followed by a hearing for final approval of the settlement. Although we believe that we and the individual defendants have meritorious defenses to the claims made in the complaints, in deciding to pursue settlement, we considered, among other factors, the substantial costs and the diversion of our management’s attention and resources that would be required by litigation.

Item 2. Changes in Securities, Use of proceeds and Issuer Purchases of Equity Securities

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer (the “Exchange Offer”), pursuant to which $37.3 million of our outstanding 5¾% Convertible Subordinated Notes due in March 2005 (“Existing Notes”), representing approximately 98% of the total amount of Existing Notes outstanding, were tendered for the same principal amount of new 6¾% Convertible Subordinated Notes due in June 2009 (“New Subordinated Notes”). Approximately $0.9 million of the Existing Notes remain outstanding after the Exchange Offer. Simultaneously with the Exchange Offer, we prepaid all $25.2 million of our 11½% Senior Secured Notes due in January 2005 (“Existing Senior Notes”) for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock, $0.001 par value per share (“common stock”), at $1.85 per share (the “Warrants”). We issued $29.0 million of New Secured Notes, of which $25.2 million was used to prepay the Existing Senior Notes. The New Secured Notes are convertible into shares of common stock at

$1.85 per share.

Item 4. Submission of Matters to a Vote of Security Holders

At the Company’s Annual Meeting of Shareholders held on May 24, 2004, shareholders re-elected Mr. W. Frank King and Mr. Charles Skibo as Class 2 Directors to serve until the Company’s 2007 Annual Meeting of Shareholders. The shareholders also ratified and appointed Deloitte & Touche LLP as independent auditors for the Company.

The results of the shareholder vote is as follows:

Election of Class 2 Directors:

	FOR	WITHHELD
W. Frank King	40,746,026 shares	815,941 shares
Charles Skibo	40,403,443 shares	1,158,524 shares

Appointment of Deloitte & Touche LLP as independent auditors:

FOR: 41,196,152 shares

AGAINST: 335,132 shares

ABSTAIN: 30,683 shares

At a Special Meeting of Shareholders held on June 18, 2004, shareholders approved an increase in theauthorized number of shares of common stock of the Company from 85 million common shares to 170 million common shares.

The results of the shareholder vote is as follows:

FOR: 42,394,756 shares

AGAINST: 1,506,209 shares

ABSTAIN: 84,811 shares

Item 6 - Exhibits and Reports on Form 8-K

(a)	Exhibits:

	31.1	Certificate of iBasis, Inc. Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certificate of iBasis, Inc. Chief Financial Officer pursuant to Section 302 of the Sarbanes-

		Oxley Act of 2002.

	32.1	Certificate of iBasis, Inc. Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	32.2	Certificate of iBasis, Inc. Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)	Reports on Form 8-K:
	On April 28, 2004, the Company filed a Form 8-K related to the press release regarding results for the three months ended March 31, 2004.

SIGNATURE

Pursuant to the requirements 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.

	iBasis, Inc.


August 5, 2004	By:	/s/ Richard Tennant
		Richard Tennant
		Vice President and Chief Financial Officer
		(Authorized Officer and
		Principal Accounting Officer)

Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended June 30, 2004

OR

For the transition period from to

Commission file number: 000–27127

iBASIS, INC. Index

Condensed Consolidated Balance Sheets

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Critical Accounting Policies

Liquidity and Capital Resources

Factors That May Affect Future Results and Financial Condition

RISK FACTORS

Risks Related to Our Company

Risks Related to Our Operations

Risks Related to the Internet and Internet Telephony Industry

Item 4. Controls and Procedures

Part II — Other Information

Item 1. Legal Proceedings

Item 4. Submission of Matters to a Vote of Security Holders

The results of the shareholder vote is as follows:

Election of Class 2 Directors:

FOR

WITHHELD

W. Frank King

40,746,026 shares

815,941 shares

Charles Skibo

40,403,443 shares

1,158,524 shares

Appointment of Deloitte & Touche LLP as independent auditors:

FOR: 41,196,152 shares

AGAINST: 335,132 shares

ABSTAIN: 30,683 shares

At a Special Meeting of Shareholders held on June 18, 2004, shareholders approved an increase in theauthorized number of shares of common stock of the Company from 85 million common shares to 170 million common shares.

The results of the shareholder vote is as follows:

FOR: 42,394,756 shares

AGAINST: 1,506,209 shares

ABSTAIN: 84,811 shares

Item 6 - Exhibits and Reports on Form 8-K

SIGNATURE

iBASIS, INC.
Index