Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended July 31, 2004,

OR

Commission File Number: 1-16371

IDT CORPORATION

(Exact name of registrant as specified in its charter)

520 Broad Street

Newark, New Jersey 07102

(Address of principal executive offices, including zip code)

(973) 438-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  x    No  ¨

The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the closing price on January 30, 2004 (the last business day of the Registrant’s most recently completed second fiscal quarter) of the Class B common stock of $21.72 and of the common stock of $21.05, as reported on the New York Stock Exchange, was approximately $1.265 billion. Shares held by each officer and director and by each person who owns 5% or more of the outstanding common stock (assuming conversion of the Registrant’s Class A common stock) or Class B common stock have been excluded from this computation, in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

As of October 1, 2004, the Registrant had outstanding 67,554,116 shares of Class B common stock, $.01 par value, 9,816,988 shares of Class A common stock, $.01 par value, and 18,845,933 shares of common stock, $.01 par value. Excluded from these numbers are 1,608,290 shares of Class B common stock and 6,228,927 shares of common stock held by IDT Corporation.

Table of Contents

INDEX

IDT CORPORATION

ANNUAL REPORT ON FORM 10-K

Table of Contents

PART I

As used in this Annual Report, unless the context otherwise requires, the terms “the Company,” “IDT,” “we,” “us,” and “our” refer to IDT Corporation, a Delaware corporation, its predecessor, International Discount Telecommunications, Corp., a New York corporation, and its subsidiaries, collectively. Each reference to a fiscal year in this Annual Report refers to the fiscal year ending in the calendar year indicated (for example, fiscal 2004 refers to the fiscal year ended July 31, 2004).

Item 1. BUSINESS.

INTRODUCTION

We are a multinational telecommunications and entertainment company. Our primary telecommunications offerings are prepaid debit and rechargeable calling cards, wholesale carrier services and consumer local and long distance phone services. Our entertainment business is comprised of complementary operations and investments that enable us to acquire, develop, finance and produce animated entertainment programming and to distribute home entertainment content to the mass market. We also operate various media-related businesses including brochure distribution and radio operations.

We conduct our business primarily through the following four operating divisions:

IDT Telecom.  IDT Telecom is our largest division with revenues of $1.938 billion during fiscal 2004, representing 87% of our total consolidated revenues, and operating income of $78.4 million. IDT Telecom offers retail and wholesale telecommunications services. Our prepaid calling cards are our primary retail offering. In fiscal 2004, we expanded our consumer local and long distance phone services, and we introduced new retail products, such as “Global Access,” a calling card for cellular phone users who want to make international calls. In our prepaid calling card operations, we focus on traditionally underserved segments of the market. We offer wholesale services to other carriers, focusing on serving the world’s largest telecommunications providers. Our carrier customers include many of the largest telecommunications companies in the world.

We sell approximately 300 different prepaid and rechargeable calling cards in the United States, approximately 100 different calling cards abroad, providing telephone access to more than 230 countries and territories. Our prepaid calling cards are marketed primarily to targeted ethnic and immigrant communities in the United States, Europe and Latin America that generate high levels of international call volume. We sold approximately 373 million prepaid calling cards during fiscal 2004, generating $1.188 billion in revenues, or 53.6% of our total consolidated revenues for fiscal 2004, and 15.627 billion minutes of phone usage.

Through our prepaid solutions business we market customized retail calling cards, IDT-branded retail calling cards, promotional calling cards and corporate calling cards. Customers include Hess, ExxonMobil, Walgreens, Kroger and Sears. We are also developing new potential sources of revenue utilizing our global calling card platform and distribution network, including money transfer services, third-party advertising on calling card packaging and gift and loyalty calling card programs.

We market local and long distance phone services directly to consumers in the continental United States and in the United Kingdom. We have offered consumer long distance phone services in the United States since 1994, and, as of July 31, 2004, we had approximately 407,000 long distance customers. In August 2003, we launched bundled local and long distance phone service in the United States, marketed under the brand name America Unlimited, which we provided to approximately 280,000 customers in 13 states as of July 31, 2004. In the United Kingdom, we offer a bundled local and long distance phone service under the Toucan brand name. We launched this service in November 2003 and we had approximately 40,000 Toucan customers as of July 31, 2004.

Our wholesale services consist of carrying the telecommunications traffic of other telecommunications companies, which we refer to as “carrier’s carrier” services. In fiscal 2004, we carried 4.829 billion minutes, an increase of 25.3% over fiscal 2003, for approximately 450 other carriers.

In fiscal 2004, retail services constituted 72.9% of IDT Telecom’s revenues, with the remaining 27.1% attributable to wholesale services.

IDT Entertainment.  IDT Entertainment, which became a separate division in November 2003, operates our animation production and home entertainment distribution businesses. IDT Entertainment has recently become our second largest revenue-generating division, with fiscal 2004 revenues of $106.7 million (representing approximately 5% of our total revenues) and an operating loss of $0.6 million.

IDT Entertainment consists primarily of several animation studios and our home entertainment distribution operations. Through internally developed systems and acquired operations, we are able to acquire, develop, produce, finance and distribute animated properties for television, direct-to-video/DVD and theatrical release.

1

Table of Contents

We are currently in the early stages of production on several proprietary computer generated, or CG, animated feature films, including Yankee Irving, the last feature film directed by Christopher Reeve prior to his untimely death, and Starpoint Academy, based on a concept by Gene Roddenberry (creator of the Star Trek series).

Through our DPS Film Roman, Mainframe Entertainment, DKP Effects and Digital Production Solutions studios, we provide animation services primarily to third parties and also for our own projects. DPS Film Roman has been the animation studio for the Emmy Award winning television series, The Simpsons, for 13 years, and King of the Hill since its creation seven years ago. Mainframe Entertainment is a provider of CG animation for television and direct-to-video/DVD products such as the Spider-Man series on MTV and the Barbie DVD collection for Mattel. DKP Effects is a producer of 3-D animation and high-end, digital visual effects for feature films, television, video features and commercials.

We have purchased a minority equity interest in, and have entered into a joint venture with, Vanguard Animation, a CG animated feature film company founded by John Williams, an originating producer of the CG films Shrek and Shrek II. Vanguard’s initial production, Valiant, is the first in a series of four Vanguard-produced films to be distributed by Buena Vista International, Disney’s distribution arm. The joint venture enables us to co-produce and co-own future Vanguard properties distributed in theaters, direct-to-video/DVD and on television.

Our distribution operations, which are primarily conducted through our Anchor Bay Entertainment subsidiary, distribute videos and DVDs to mass merchants including Wal-Mart, Target, Blockbuster Video, Best Buy and Kmart, and other retail outlets. We have a significant presence in the children’s, horror and fitness genres. Anchor Bay’s library consists of approximately 3,500 owned or licensed titles, including the Thomas the Tank Engine series, which consistently ranks in the top 50 children’s video sales, the Halloween series and the Crunch fitness series.

In May 2004, we acquired Manga Entertainment, a company specializing in the production, distribution and worldwide marketing of anime for theatrical and home video/DVD releases and television broadcast. “Anime,” a form of animation developed in Japan, is derived from and styled after Japanese comic books. Manga Entertainment is one of the largest distributors of anime outside of Asia. Manga has rights to over 300 titles, including co-production of the animated sci-fi thriller Ghost in the Shell, the first and only Japanese animated film to reach No. 1 on the Billboard Top Video Sales Chart. Ghost in the Shell won awards at the 1997 World Animation Festival for Best Theatrical Film and for Best Director of a Theatrical Feature Film.

To increase our ownership of and access to brand name characters and content, we have completed several additional investments and joint ventures. We purchased a minority equity interest in Archie Comics Entertainment and have obtained the rights to co-develop and co-produce animated properties based upon selected Archie characters. We have made an investment in POW! Entertainment, a company founded by Stan Lee, the creator of Spider-Man, The Incredible Hulk and X-Men, and entered into a development agreement for six animated features based on new Stan Lee characters and ideas in which we will own all intellectual property rights. We have concluded a multi-faceted development, production and distribution agreement with Todd McFarlane Productions covering the production of animation and merchandise based on Spawn and other Todd McFarlane Productions intellectual properties.

IDT Capital.  IDT Capital, which was formerly called IDT Menlo Park and, before that, IDT Media, is our division responsible for developing, growing and, in some cases, operating our new or innovative business ideas. Many of these initiatives are in the media or communications areas. Currently, IDT Capital consists primarily of our brochure distribution and radio operations. CTM Brochure Distribution distributes travel brochures to over 10,000 racks in hotel lobbies and other tourist-related access points. Our radio operations consist of a radio station (WMET 1160AM) serving the Washington, D.C. metropolitan area. IDT Capital also operates several other developing operations, such as development and servicing of bond trading software.

Voice over IP.  Net2Phone, which operates our Voice over IP business, is a leading provider of Voice over Internet Protocol, or VoIP, communications services. Net2Phone delivers telephony solutions to businesses and consumers in over 200 countries, capitalizing on the growth, quality, flexibility and cost advantages of VoIP technologies. Net2Phone offers cable operators a fully outsourced telephony platform to deliver high-quality residential phone services to their subscribers, enabling them to compete with traditional phone companies. We have voting control of Net2Phone and an effective equity ownership of 17.6% as of July 31, 2004. Accordingly, we consolidate Net2Phone’s financial results with our own. Net2Phone’s common stock is publicly traded on the Nasdaq National Market under the symbol “NTOP.”

Our main offices are located at 520 Broad Street, Newark, New Jersey 07102. The telephone number at our headquarters is (973) 438-1000 and our Internet address is www.idt.net.

2

Table of Contents

We make available free of charge through the investor relations page of our Web site (www.idt.net/ir) our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and all beneficial ownership reports on Forms 3, 4 and 5 filed by directors, officers and beneficial owners of more than 10% of our equity as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission. We have adopted codes of business conduct and ethics for all of our employees, including our principal executive officer, principal financial officer and principal accounting officer. Copies of the codes of business conduct and ethics are available on our Web site.

Our Web site and the information contained therein or incorporated therein are not intended to be incorporated into this Annual Report on Form 10-K or our other filings with the Securities and Exchange Commission.

KEY EVENTS IN OUR HISTORY

We were founded in August 1990 and were originally incorporated in New York as International Discount Telecommunications, Corp. We were renamed IDT Corporation and reincorporated in Delaware in December 1995.

We entered the telecommunications business in 1990 by introducing our international call reorigination service to capitalize on the opportunity created by the large spread between U.S.-originated and foreign-originated international long distance telephone rates.

We used the calling volume and expertise derived from our call reorigination business to enter the consumer long distance business in late 1993 by reselling long distance services of other carriers to our customers. In 1995, we began reselling access to the favorable telephone rates we received as a result of our calling volume to other long distance carriers.

We completed an initial public offering of our common stock on March 15, 1996. Our common stock was quoted on the Nasdaq National Market until February 26, 2001, when it was listed on the New York Stock Exchange, where it now trades under the symbol “IDT.C.” On May 31, 2001, we distributed a stock dividend of one share of our Class B common stock for each outstanding share of our common stock, Class A common stock and Class B common stock. On June 1, 2001, our Class B common stock was listed on the New York Stock Exchange and now trades under the symbol “IDT.”

We entered the Internet telephony market in August 1996 with our introduction of PC2Phone, the first commercial service to connect voice calls between personal computers and telephones over the Internet.

We began marketing and selling prepaid calling cards in January 1997.

In August 1999, Net2Phone, our subsidiary that runs our Voice over IP operating division, completed an initial public offering of 6.2 million shares of its common stock, and in December 1999, Net2Phone completed another offering of 3.4 million shares of its common stock. In connection with the second offering, we sold 2.2 million shares of Net2Phone common stock for proceeds of $115.0 million.

In August 2000, we completed the sale of 14.9 million shares of Net2Phone common stock to AT&T for approximately $1.1 billion in cash.

In October 2001, we created a consortium, NTOP Holdings, LLC, which as of July 31, 2004 held approximately 28.9 million shares of Net2Phone’s Class A common stock representing approximately 38.2% of Net2Phone’s outstanding capital stock and approximately 55.3% of the voting power in Net2Phone. The consortium originally consisted of IDT, AT&T and Liberty Media. On October 29, 2002, AT&T sold its interests in the consortium to us and Liberty Media.

In November 2001, we organized a new venture, Digital Production Solutions, or DPS, an animation company which uses proprietary technology to operate a global animation studio linking animators throughout the world utilizing IDT Telecom’s infrastructure.

In January 2002, we sold 4.8% of IDT Telecom to Liberty Media Corporation for $30.0 million in cash.

In September 2002, we more than doubled the size of our domestic telecommunications backbone by acquiring indefeasible rights of use, or IRUs, and related equipment from the bankrupt estate of Star Telecommunications for $0.6 million.

In December 2002, we were selected as the exclusive prepaid calling card provider to Walgreens, the nation’s largest drugstore chain.

In May 2003, we acquired a controlling interest in Film Roman, an independent animation company known for its production work on animated television programs including The Simpsons and King of the Hill.

In June 2003, we sold 5.6% of our subsidiary that operated our entertainment and media businesses to Liberty Media for $25.0 million in cash.

3

Table of Contents

In July 2003, we purchased a minority stake in Vanguard Animation, a producer of CG animated feature films, and entered into a joint venture with Vanguard to co-produce and co-own other computer generated animated films, as well as computer generated animation projects for television exhibition and/or direct-to-video/DVD distribution.

DEVELOPMENTS IN FISCAL 2004

In August 2003, we successfully launched “IDT America Unlimited,” our flat rate, unlimited local and long distance calling plan, a service now available in 13 states.

Over the course of the fiscal year, our prepaid solutions business added new and well known names to its list of private label calling card clients, including Hess, Exxon Mobil and Sears.

Over the course of fiscal 2004, we also introduced calling cards under the carrier name “Entrix Telecom, Inc.,” or “Entrix”.

In November 2003, IDT began offering consumer phone services in the United Kingdom, under the “Toucan” brand name.

In November 2003, Net2Phone issued additional shares in an underwritten common stock offering. The offering, which was priced at $4.50 per share, included 11.5 million shares issued to the public, and an aggregate of 2.5 million shares purchased by IDT and Liberty Media. Net2Phone received net proceeds of $58.6 million from the offering (of which $5.6 million was received from IDT).

In November 2003, we also announced the creation of our IDT Entertainment division in an effort to expand our entertainment operations.

In December 2003, we completed the acquisition of a controlling interest in Mainframe Entertainment, a creator of CG animation for feature films, television and direct-to-video/DVD products.

In December 2003, we also completed the acquisition of Anchor Bay Entertainment, a leader in distribution of home entertainment products to the mass market.

In February 2004, IDT Europe and Connect Spot teamed up to launch “isimplify,” the world’s first prepaid rechargeable voice, data and WiFi card, allowing business travelers to use one calling card to make low cost calls around the world and to access a global network of WiFi hot spots.

In March 2004, we were selected as the online calling card provider for AOL Latino.

In March 2004, IDT Entertainment acquired DKP Effects, a producer of 3-D animation and high-end, digital visual effects for feature films, television, video features and commercials.

In May 2004, IDT Entertainment acquired a minority equity interest in POW! Entertainment headed by comic book direct-to-legend Stan Lee. In addition, IDT Entertainment acquired exclusive distribution rights for all POW! Entertainment animated DVD properties. The companies also announced that they will co-produce and co-develop a minimum of six animation projects for direct-to-DVD distribution and broadcast.

In May 2004, IDT Entertainment and Todd McFarlane Productions entered into a development, production, and distribution agreement to produce animated programming and merchandise based on Spawn and other original intellectual properties of Todd McFarlane Productions. Todd McFarlane Productions is best known for its multiple Emmy-winning Spawn franchise.

In May 2004, we acquired Manga Entertainment, which distributes anime programming from its extensive library of licensed titles.

In May 2004, we also announced the reorganization of our IDT Solutions operating division, which consists of Winstar Holdings. As of October 2004, IDT Solutions no longer provides retail switched communication services. The division currently provides communication services only to select governmental customers in 14 markets. We are exploring various options for further redeploy Winstar Holdings’ assets towards providing private line fixed wireless services, wholesale back-haul services and spectrum leasing, as well as other potential opportunities for the unique conglomeration of assets.

RECENT DEVELOPMENTS

In August 2004, we launched a telephone calling card-based advertising program with Pocket Billboards. The program places print advertising on IDT prepaid calling cards and features interactive audio messages that are linked to the calling card’s voice prompt directions.

In September 2004, Hasbro selected IDT Entertainment to produce two 3D animated direct-to-video movies based on WEEBLES, Hasbro’s Playskool division’s unique toy property. The series will be distributed worldwide by Paramount Home Entertainment.

4

Table of Contents

In September 2004, Mainframe Entertainment, an IDT Entertainment company, entered into an agreement with skateboarding legend Tony Hawk to produce a computer generated animated feature for direct-to-video release.

In September 2004, IDT Telecom entered into an agreement to provide international long distance phone services to Cablevision Systems Corporation’s Optimum Voice digital voice-over-cable customers.

In September 2004, IDT Entertainment and Emmy award winner Harry Connick Jr. entered into an agreement to co-produce The Happy Elf, a one-hour 3D animated holiday special based on Connick’s original children’s song from Harry for the Holidays, his Sony/Columbia Records’ top selling holiday CD for 2003.

IDT TELECOM

Overview

Our subsidiary, IDT Telecom, provides retail and wholesale telecommunications services and products, including prepaid, rechargeable and prepaid solutions (formerly referred to as private label) calling cards, consumer phone services and wholesale carrier services.

Our telecom division generated revenues of $1.938 billion during fiscal 2004, an 18.3% increase over the $1.639 billion of revenues generated during fiscal 2003. Our telecom division’s revenues represented 87.4% of our total consolidated revenues in fiscal 2004 as compared to 89.3% in fiscal 2003. During fiscal 2004, our retail telecommunications services and products (calling cards and consumer phone services) contributed 72.9% of our telecom division’s revenues, with the remaining 27.1% attributable to wholesale carrier services. Our telecom division’s operating income increased to $78.4 million in fiscal 2004, from $63.4 million in fiscal 2003.

In fiscal 2004, we recorded revenues of $1.188 billion from sales of calling cards worldwide, and provided 15.627 billion minutes of phone service to our calling card customers. We are one of the largest providers of calling cards in the United States, where we distribute cards primarily through Union Telecard Alliance, a joint venture of which we own 51%.

We provided consumer phone services to more than 670,000 residential customers and 15,000 business customers in the United States as of July 31, 2004. In addition, as of July 31, 2004, we had approximately 450 wholesale carrier customers (i.e., other telecommunications companies that purchase our telecommunications services to terminate their traffic) located primarily in North America and Europe.

We deliver our telecommunications services over our own network, consisting of switching centers and technical staff in the United States, the United Kingdom, Hong Kong, Peru and Argentina. This network comprises core carrier switching capabilities, a global softswitch (a software-based, as opposed to hardware-based, switching platform capable of delivering next-generation services) and Voice over IP (VoIP) network, and a highly scaleable Enhanced Services Platform.

IDT owns and operates seven core carrier switches located in the United States and the United Kingdom. In the United States, we have four Nortel GSP international gateway switches and one Nortel DMS domestic carrier switch. In London, we have two Nortel GSP international gateway switches serving the United Kingdom and Europe. An international gateway switch connects networks across international borders and translates voice and signaling protocols between those used in North America, in Europe and in other areas of the world so that the networks can communicate. Our global softswitch and VoIP network is a multi-service, distributed switching platform that provides domestic and international gateway switching capabilities, support for our enhanced services applications and VoIP gateway functionality. This platform is deployed worldwide in each of our operating regions and is interconnected over IDT’s internal VoIP backbone network.

IDT’s Enhanced Services Platform provides calling card, prepaid solutions and other products and services to retail customers in over 50 languages and currencies. This platform consists of proprietary applications and software deployed worldwide on more than 230 programmable switches and integrated over a distributed network of high availability servers, routers and databases.

IDT holds indefeasible rights of use (which are leases of fiber optic cables generally considered to be more akin to ownership rights than traditional leases and referred to as IRUs) providing long-term usage of capacity on six undersea fiber-optic systems. In addition, we lease capacity, which together operate on more than seventeen different cable systems worldwide. These undersea circuits connect our U.S. facilities with our international facilities and with third-party facilities in Europe, Latin America, Asia, the Caribbean, Canada, and Africa.

Industry Overview

The international telecommunications industry is intensely competitive and is subject to frequent regulatory changes that have altered and will continue to alter how the business is conducted. We believe that the dynamic nature of the industry

5

Table of Contents

creates growth and profit potential for entrepreneurial operators such as IDT that are willing to focus on specific segments of the market and react swiftly to changes and opportunities that arise. International telephone traffic has continued to increase throughout the global economic downturn, growing substantially year after year. The increase in international traffic is mainly due to a shift towards deregulation and opening to foreign operators in many of the world’s major telecommunications markets (including Eastern Europe, Latin America, and Asia). While minutes of use have increased, the price per minute of use has generally declined due to increased competition, deregulation and excess capacity. We believe that the growth of voice and data traffic originated outside of the United States will exceed the growth in voice and data traffic originated within the United States due to the deregulation of many foreign markets and increasing access to telecommunications facilities in emerging countries and regions. Many participants in the worldwide telecommunications industry have not been able to benefit from this growth in worldwide telecommunications traffic. Many of the incumbent carriers have experienced significant declines in their revenues and profitability due to the pricing declines. IDT Telecom has continued to grow its revenues by taking advantage of new opportunities created by the industry trends.

We believe that growth in international long distance telecommunications traffic will continue to be driven by:

The Telecommunications Act of 1996 has had a profound impact on the U.S. telecommunications industry by opening local markets to competition. This deregulation commenced at the same time that the Internet began to create new streams of data traffic. This resulted in the investment of a tremendous amount of capital designed to build converged networks and additional capacity to take advantage of the technological and regulatory changes and forecasts of increased demand. New competitors took advantage of the favorable capital market environment to raise substantial amounts of debt and equity to fund their business plans. The assumptions as to growth and pricing for telecommunications needs underlying these business plans turned out to be overly optimistic and many of these companies were unable to service their debt and sought bankruptcy protection or were sold or liquidated. Because we did not increase our leverage and did not participate in the network overbuild which was prevalent in the industry, we were not affected financially as greatly as other telecommunications companies by the downturn in the industry, the capital markets or the growth projections. Nevertheless, our revenues per minute were negatively affected as industry pricing dropped significantly, due primarily to the oversupply of capacity and significantly increased competition. We were also negatively affected by the financial difficulties or bankruptcies of some of our customers.

The Telecommunications Act of 1996 established a statutory framework for opening the local markets to competition, while at the same time allowing long distance service to be offered by the incumbent local exchange carries, known as ILECs, which generally are operated by the regional bell operating companies, or RBOCs. RBOCs can now offer long distance service because they have established, to the satisfaction of the FCC, that they have opened their local market to local telephone competition. We compete with the RBOCs for consumer phone service customers. However, the increased competition also creates opportunities, as most of the RBOCs lack international networks to support their new long distance businesses, and we expect that they will, therefore, rely heavily on carrier’s carriers, such as us, to carry and arrange for termination of their international telephone traffic.

The local phone service market continues to be dominated by the RBOCs. Currently, the RBOCs’ main competitors in this market are the dominant long distance providers that have entered the market for local service, competitive local exchange carriers, or CLECs, taking advantage of the FCC’s Unbundled Network Element-Platform, generally referred to as UNE-P, prescribed by the Telecommunications Act, and others such as cable companies, that use Voice over Internet Protocol, or VoIP, technology, to provide alternative access to customers. The RBOCs have seen their local business decline during each of the last four years due to competition from other providers of local phone service, increased use of cellular phones in place of traditional land lines and greater adoption of high speed Internet access services that replaces the phone line used for dial-up Internet access. However, the RBOCs have been able to offset some of these losses by providing wireless phone service, DSL Internet service, bundling long distance with their local phone service and, in some cases, cross-selling services with satellite TV providers. Cable companies, such as Comcast, Time Warner, and Cablevision, have had success in adding phone customers by bundling VoIP phone service with their cable television offerings and high speed Internet access.

6

Table of Contents

We compete in the consumer phone service market by utilizing the UNE-P platform to provide our bundled local and long phone distance service. UNE-P allows an operator to resell the RBOC’s phone service using the RBOCs’ equipment, at wholesale rates set by the FCC. The RBOCs are currently challenging these lease rates and the UNE-P structure itself, as discussed in more detail under the heading “Business—Regulation in the United States” below. The ultimate outcome and timing of any decision on UNE-P is uncertain, but we believe that there will continue to be an opportunity for IDT to provide local and long distance phone service, using either UNE-P or a combination of our own facilities and RBOC lines to access the customers’ premises.

The large long distance providers, such as AT&T, MCI, and Sprint, have been heavily affected by competition from the RBOCs in the long distance market. These providers have seen their revenues decline due to lower pricing brought on by the increased competition and subscriber losses to the new entrants. Long distance pricing has declined due to increased competition from flat-rate offerings from providers of bundled local and long distance, wireless, and VoIP phone service. In addition, they have lost subscribers to substitute products offered by the RBOCs, wireless operators, and cable companies. The long distance providers have attempted to move into the local market to try to offset some of these revenue declines but have met with limited success. Some long distance providers, faced with increased competition for their core business customers and the uncertainty surrounding the UNE-P regulations, have chosen to discontinue their attempt to attract new residential local customers. We believe that the withdrawal of our larger competitors from this market provides us with an opportunity to expand our customer base, which has traditionally been heavily weighted towards the residential segment of the local market.

The international long distance market, particularly in less developed regions, has not been affected to the same degree by the factors plaguing the domestic long distance market because many of these markets are in the early stages of deregulation and there is, therefore, less competition and fewer opportunities for product substitution. Prices have not declined to the same extent that they have in the U.S. market because most of the cost of the call remains in the termination. In many of these foreign markets there is still only one dominant provider of telephone services, usually a post, telephone or telegraph company which is either government owned or has recently been privatized, to provide this termination. We believe that prices in most foreign markets will decline as the factors that affected the U.S. market impact these markets as well, but we expect that the prices in these markets will remain substantially above those in the United States due to other factors that will limit the number of competitors and alternative products. While we have been affected by the general decline in pricing in the market, we have also been able to benefit from the deregulation of many foreign markets by expanding our current services and by offering service in new markets.

Business Strategy

Our approach to the dynamic worldwide telecommunications industry has allowed us to grow even as many companies have endured financial difficulties. Two key concepts of our approach are:

Throughout our history, we have sought to exploit profitable niches within the telecommunications industry. This included:

Our smart-build approach refers to the incremental approach we take to expand our network — we add new facilities only when we determine that such investments are justified by existing or imminent traffic volumes. Under this approach, we usually enter a new market by leasing fiber capacity. As traffic grows, we may install a switch to increase our overall capacity and lower our cost of carrying traffic. As traffic increases further, we analyze whether purchasing bandwidth, instead of leasing, would reduce our costs by routing calls over an owned network. If our volume continues to grow, we may deploy additional switching and/or fiber capacity. Only when we believe that we have the traffic volumes to justify the fixed cost involved with a switch or owned bandwidth do we consider such an investment. This approach enables us to focus on our network costs on a per minute basis.

7

Table of Contents

The following represent key elements of our strategy to compete and grow in the telecommunications market:

IDT Telecom’s Services

Our telecom division currently provides our customers with a variety of services, including:

Retail Telecommunications Services

Prepaid Debit and Rechargeable Calling Cards

We sell prepaid debit and rechargeable calling cards under the “IDT” and “Entrix” names providing telephone access to more than 230 countries and territories. We offer rates on our calling cards that we believe are generally well below the rates for international calls offered by most of the major “brand-name,” carriers such as AT&T, MCI and Sprint. We sell more than 300 different prepaid calling cards in the United States, and more than 85 different cards abroad, with specific cards featuring favorable rates to specific areas of the world.

Our prepaid calling cards are marketed primarily to the ethnic and immigrant communities in the United States, Europe, Asia and Latin America that tend to generate high levels of international traffic. We believe that recent immigrants and members of ethnic communities tend to be heavy users of international long distance telephone service because of their desire to keep in touch with family members and friends located in their country of origin. Specifically, a large portion of our U.S. and European calling card customers are from the Hispanic community. Therefore, a significant proportion (63.1% in fiscal 2004 and 58.4% in fiscal 2003) of our international prepaid calling card minutes are terminated in Latin America. We believe that many customers typically use our prepaid calling cards as their primary means of making long distance telephone calls due to competitive rates, reliable service, the ease of monitoring and budgeting their long distance spending and the appealing variety of prepaid calling cards that we offer to different market segments.

Our prepaid calling card business is particularly strong in the Northeastern United States because of our extensive distribution network and competitive rates to countries that immigrants in the Northeastern United States prefer to call, such as Colombia, Mexico and the Dominican Republic. With the expansion of operations in Arizona, California, Florida, Georgia,

8

Table of Contents

Texas and other parts of the United States, our prepaid calling card sales in the Northeastern United States now constitute a smaller percentage of our total prepaid calling card sales in the United States. In fiscal 2004, prepaid calling card sales in the Northeastern United States were approximately 43.0% of our total prepaid calling card sales in the United States, as compared to 53% in fiscal 2003. Supporting our expansion outside of the Northeastern United States, Union Telecard, our 51%-owned distribution arm, opened offices in California and North Carolina during fiscal 2004.

The following table lists some of the major prepaid calling cards that we sell in the United States:

In Europe, we market our prepaid calling cards in the United Kingdom, the Netherlands, Spain, Germany, Belgium, France, Italy, Sweden, Switzerland, Denmark, Norway, Portugal, Austria and Greece, seeking to capitalize on the opportunity presented by the recent surge in immigration from underdeveloped countries around the globe to Europe’s developed nations. We sell approximately 100 different prepaid calling cards in Europe, with some of the major cards listed below:

We believe that there is a significant untapped market for prepaid calling cards in Latin America, where certain countries serve as regional nexuses, attracting immigrants due to stronger job markets and opportunities. Immigrants from satellite countries share the needs of their U.S. counterparts for low-cost, prepaid calling solutions to maintain contact with relatives and friends in their countries of origin. In fiscal 2002, we began distributing prepaid calling cards in Latin America by selling calling cards in Argentina, and we now sell cards in Peru, Chile, Jamaica, and Uruguay as well. In fiscal 2004, we generated $7.1 million in revenue selling calling cards in Latin America.

During fiscal 2004, we sold approximately 373 million prepaid calling cards, excluding rechargeable calling cards, worldwide, a 22% increase from the 267 million prepaid calling cards sold in fiscal 2003. The sale of these calling cards in fiscal 2004 generated $1,171 million in revenue, as compared with $1,057 million in fiscal 2003, and resulted in the completion of 15.627 billion minutes of telephone usage, as compared with 12.606 billion minutes in fiscal 2003. During fiscal 2004, sales of prepaid calling cards accounted for 60.4% of our telecom division’s total consolidated revenues, as compared to 64.5% in fiscal 2003. During fiscal 2004, we sold 81.7% of our prepaid calling cards in the United States, with the remaining 17.3% sold abroad.

Our rechargeable calling cards, marketed to business travelers, are distributed primarily through in-flight magazines and permit users to place calls from over 55 countries through international toll-free services. Accounts are automatically recharged with a credit card that the customer provides at the time of initial card activation. In fiscal 2004, revenues attributable to rechargeable calling cards were $16.6 million, or 0.9% of our telecom division’s consolidated revenues.

Combined, our prepaid and rechargeable calling cards accounted for 61.3% of our telecom division’s consolidated revenues in fiscal 2004.

We believe that the following factors have contributed to the growth of our calling card services:

9

Table of Contents

Prepaid Solutions

Our Prepaid Solutions division markets a variety of calling cards and complementary offerings, including:

We are developing new potential sources of revenue, including placing third-party advertising on calling card packaging, offering gift calling cards, and loyalty calling cards. In addition, we are leveraging the technologies built for our point of sale activation services and our retail distribution channel to develop prepaid cards that can be accepted by banking networks (particularly internationally) for ATM withdrawals and by retail stores for debit purchases. Our prepaid solutions cards accounted for revenues of $37.9 million in fiscal 2004 or 2.0% of IDT Telecom revenues.

Consumer Phone Services

We market long distance phone services directly to consumers and businesses in the 48 contiguous U.S. states, and in Washington, D.C.

In August 2003, we launched our bundled local/long distance phone service in New York and New Jersey. We currently offer the bundled local/long distance phone service in 13 states and we plan to offer bundled service in at least 20 states by the end of fiscal 2005. Our bundled local/long distance service, offered to residential customers, includes unlimited local, regional toll and long distance calling with caller ID, speed dial, call waiting and 3-way calling. In most of the states we offer this service for $39.95 per month, plus applicable taxes and surcharges. We also offer a second bundled plan providing unlimited local service with caller ID and call waiting with IDT long distance included for as low as 5 cents a minute. With either plan, competitive international rates can be added on for an additional monthly fee.

10

Table of Contents

Our long-standing five cents per minute long distance service continues to be available in the continental United States with a monthly service fee. Our rates for international calls are often lower than those charged by the major international long distance carriers.

Consumer phone services accounted for 11.6% of our telecom division’s total consolidated revenues in fiscal 2004. As of July 31, 2004, we had approximately 280,000 active customers for our bundled local/long distance plan and 407,000 customers for our metered long distance plans. The highest concentrations are in large urban areas, with the greatest number of customers located in New York, New Jersey, Pennsylvania, California, and Florida.

In providing local phone service, we rely upon the use of local lines and other network elements leased from the ILECs. As mandated by the FCC’s UNE-P provisions, ILECs are required to allow access to their local networks to competitive phone companies. UNE-P has remained the subject of intense legal and lobbying efforts by the ILECs, who seek to have the FCC or the courts overturn this provision. During 2004, the FCC left standing those rules related to UNE-P. RBOCs are aggressively seeking significant revisions to the UNE-P rules and substantial increases in the UNE-P lease rates. We have evaluated a number of scenarios and are developing contingency plans depending on the outcome of any future decision.

We are party to resale agreements with AT&T and Global Crossing pursuant to which we resell long distance services to our consumer long distance and bundled plan customers. The AT&T agreement also provides that AT&T will originate calls from our long distance customers and that the types of calls specified (international, specific area codes, etc.) will be routed to their destination on our network. The agreement gives us the flexibility to select those calls to terminate on our own network at a lower cost to us. We believe that this flexibility can increase our gross margins and provide the opportunity to market new, more aggressive plans, particularly international plans, which will generate additional revenues.

Wholesale Carrier Services

Long distance telephone calls are generally originated by the local carrier of the customer placing the call. The local carrier switches the call to the customer’s long distance carrier. The call is then routed over the lines of the long distance carrier and in some instances one or more other carriers until it reaches its destination, where it is switched to the local carrier for termination at the telephone number called. Carriers, such as IDT Telecom, that transmit all or a portion of another carrier’s traffic are said to be acting as a “carrier’s carrier.”

By utilizing our flexible, least-cost traffic routing system and capitalizing on our aggressive purchasing strategies and extensive experience in provisioning circuits, we are able to provide major carriers and niche carriers alike with rates that we believe are often lower than those traditionally available through other carriers. The dramatically reduced pricing for telephone service prevalent in the last few years adds an incentive for carriers to seek the lowest wholesale rates. We are able to offer competitive rates to our carrier customers as a result of our ability to generate a high volume of international long distance telephone traffic (aided by the volumes generated by our calling card business) and our competitive rates negotiated with foreign state-owned or state sanctioned post, telephone or telegraph companies and other carriers. Wholesale carrier sales accounted for $524.5 million of our telecom division’s revenues in fiscal 2004, representing 27.1% of our telecom division’s consolidated revenues. In fiscal 2004, we carried 4.829 billion wholesale minutes, an increase of 25.3% over fiscal 2003 when we carried 3.854 billion wholesale minutes.

In fiscal 2004, we increased the number of our direct relationships with foreign state-owned or state sanctioned post, telephone or telegraph companies, from approximately 100 to more than 120. We believe that a direct connection from one of our switches to a foreign state-owned or state sanctioned post, telephone and telegraph company both increases the quality of a call and reduces cost, which enables us to generate more traffic with higher margins to that foreign locale. During fiscal 2005, we intend to continue to vigorously expand our existing direct relationships with foreign state-owned or state sanctioned post, telephone and telegraph companies. In particular, we plan to continue to approach some of the larger foreign state-owned or state sanctioned post, telephone and telegraph companies in Asia and Africa in order to establish new direct relationships.

With prices for bandwidth in decline for the last three years many carrier’s carriers have gone out of business or exited the market, allowing us to increase our market share. We believe that there will continue to be opportunities for financially sound carriers like us, to continue to increase market share at the expense of weaker rivals.

We have broadened our wholesale carrier service offerings to include a higher priced service in which we guarantee higher quality connections. This service meets a growing need for some of our wholesale customers. We believe that this service will help us grow our revenues and increase our gross profit margins.

During fiscal 2004, we broadened our wholesale customer base by increasing our customers from 350 in July 2003 to 448 a year later. In the fourth quarter of fiscal 2004, the top 15 wholesale carrier service customers accounted for 37.7% of the

11

Table of Contents

revenues for this division, versus 43% in the fourth quarter of fiscal 2003. Our most significant wholesale carrier customers are long distance carriers. While they may vary from period to period, our five largest wholesale carrier customers accounted for 6.5% of our total consolidated revenues in fiscal 2004, compared with 4.8% in fiscal 2003.

During fiscal 2004, wholesale carrier revenues from RBOCs increased 240% over fiscal 2003. The increase in our wholesale carrier revenues from the RBOCs has been offset, to a degree, by lost revenues on the retail side of our telecommunications business due to increased competition with RBOCs for our consumer phone service customers. We expect this trend to continue, particularly in states in which we do not yet offer our own bundled local/long distance service.

This concentration of revenues increases our risk associated with non-payment by a customer. This risk, in general, has become more acute for us since the early part of fiscal 2002 as several of our customers declared bankruptcy or faced financial difficulties. We perform ongoing credit evaluations of all of our wholesale carrier customers, but historically we have not required collateral to support accounts receivable from our customers. Since 2002 we have imposed stricter credit restrictions on some of our wholesale customer, resulting, in some cases, sharply curtailing or completely ceasing sales to certain of these customers.

Additionally, just as we carry traffic for other telecom companies, we may have other carriers carry traffic for us to certain destinations if we have no facilities in such destination or if other carriers charge less than it would cost us to carry that traffic on our network. Accordingly, in some cases in which we both buy from and sell to wholesale customers, we have the right to offset amounts we owe them for carrying our traffic against amounts they owe us for carrying their traffic. We endeavor to manage our relationships to ensure that we have no outstanding fees owed to us that cannot be offset. This mitigates the risk of nonpayment on these accounts.

Wholesale Carrier Market Strategy

We intend to become a multi-faceted wholesale telecom provider offering a portfolio of services and products to the most financially stable market participants through long-term contractual relationships. In order to reach this goal, we are seeking to:

IDT Europe

IDT Europe manages our telecom operations in Europe, Asia and South Africa. We maintain our corporate and carrier operations in London, England with our retail business headquartered in Dublin, Ireland. We also maintain Asian headquarters in Hong Kong and African headquarters in Johannesburg.

Our prepaid calling cards, typically sold under the IDT brand, are targeted primarily to immigrant and ethnic markets. IDT Europe markets a wide range of calling cards throughout Europe that feature competitive rates and high quality service to almost anywhere in the world. Because the European immigrant market is fragmented, we offer different cards to diverse communities. For instance, the top destinations for calls made from the United Kingdom are India and the Philippines, while the Netherlands has many ethnic Chinese and France is home to a large immigrant population of North African descent.

In the United Kingdom, we provide consumer local and long distance service under the Toucan brand name. We launched the Toucan service in November 2003 and it had approximately 40,000 customers as of July 31, 2004. We provide this local and long distance service as a reseller, except for international and U.K. mobile termination service, which we opportunistically choose to route to our own switches in the United Kingdom and then over our own network.

We also provide competitively priced wholesale carrier services to European telecom companies, including foreign state-owned or state sanctioned post, telephone or telegraph companies and Tier-1 carriers, new and emerging telephone companies, and value-added service providers.

Our European operations generated $365.9 million of revenues in fiscal 2004, a 22.0% increase over the $300.0 million of revenues generated during fiscal 2003. Our European operations’ revenues constituted 18.9% of our telecom division’s

12

Table of Contents

revenues in fiscal 2004, as compared to 18.3% in fiscal 2003. During fiscal 2004, prepaid calling cards constituted 43.7% of our European operations’ revenues, with 55.5% attributable to wholesale carrier business and the remaining 0.8% from consumer phone services.

Management of IDT Europe is also responsible for overseeing our Asian and African operations. For several years, we have had an office in Manila, Philippines. During fiscal 2003, we opened an office in Hong Kong and in Johannesburg, South Africa. In fiscal 2004, we opened a branch in Singapore. We are in the process of opening other branches in other parts of Asia. In fiscal 2004, IDT Telecom built out its Asia-Pacific gateway switching facility in Hong Kong. When the build out project is complete in fiscal 2005, IDT Telecom will possess the infrastructure necessary to pursue expansion of both wholesale carrier and retail calling card operations in the region. IDT Europe launched its Asian prepaid calling card business in Hong Kong in December 2003 and entered the Singapore market in August 2004.

Through our subsidiary, Corbina Telecom, a licensed full service telecommunications operator, we offer a broad range of services throughout the 24 largest industrial areas in the Russian market. Such services include fixed line telephony for domestic and long-distance voice, VoIP, lease line services, wholesale carrier services, Internet access (dial-up and broadband) and VPN. Corbina owns its own telecommunications network with over 700 kilometers of optic fiber in Moscow alone. Corbina also resells the services of the 2nd largest cellular operator in Russia under its own brand. Revenues generated by Corbina in fiscal 2004 were $46.2 million, an increase of 84.2% from $25.0 million in fiscal 2003. Corbina constituted 2.4% of IDT Telecom’s total revenues.

Customer Contact Services

We operate a call center business unit to manage the call center operations for IDT and outside clients. Prior to forming the business unit, IDT had a ten-year history of running call centers performing customer service for its own retail operations. In-house operations are located in Newark, New Jersey, Puerto Rico and London, England. The London office was opened to accommodate IDT’s European business. The Puerto Rico office takes advantage of that location’s lower wage levels and well-educated bilingual work force.

In the first quarter of fiscal 2003, we opened a call center in Jerusalem, Israel, which manages all our customer contact management services for outside clients. Israel draws immigrants from around the world, many of them well educated. However, like Puerto Rico, wage levels are low and unemployment is high. Our Jerusalem call center is staffed by people who are native speakers of English, French, Spanish, Dutch, Portuguese, Italian, and German. Initially staffed with 30 employees, the Jerusalem center worked only on IDT’s own customer service. The call center has grown to approximately 625 employees, and approximately 25% of its efforts are now devoted to outside clients. It has about 440 seats, and we plan to add approximately another 60 in fiscal 2005.

Projects for outside clients include fundraising and charitable solicitations, phone sales, subscription sales, customer service, client satisfaction surveys and information gathering. We are expanding our operations beyond customer service and sales to include employee assistance programs, call monitoring, coaching and other services that can take advantage of the human capital and cost advantages inherent in operating out of Jerusalem.

Sales, Marketing and Distribution

We market our prepaid calling cards primarily to retail outlets in the United States through an exclusive distribution agreement with Union Telecard, of which we own 51%. Union Telecard utilizes a network of more than 1,000 sub-distributors (ranging from large companies to sole proprietors) that sell to over 250,000 retail outlets throughout the United States. The vast majority of these retail outlets are convenience stores, newsstands and gas stations. We have appointed Union Telecard the exclusive distributor of our pre-paid phone cards in the 50 United States and Washington D.C., and the non-exclusive distributor in Puerto Rico, the Dominican Republic and the U.S. Virgin Islands. Subject to provisions for earlier termination, the distribution agreement continues through April 24, 2007.

We benefit from Union Telecard’s extensive distribution network, which provides us with an accurate assessment of the fast-changing requirements of our prepaid calling card customers. We work closely with Union Telecard’s management team, which we and our co-venturer appoint, in developing marketing and distribution strategies for our prepaid calling card products, including card design, pricing and expansion opportunities. Sales of our calling cards represented 98.2% of Union Telecard’s total revenues in fiscal 2004.

Union Telecard has entered into arrangements with certain major sub-distributors, located in Arizona, California, Illinois, Florida, New York, Ohio and Texas in which the sub-distributors have agreed to market our prepaid calling cards in exchange for preferential pricing, exclusive cards, extensions of credit, incentive bonuses and technical support from us.

13

Table of Contents

These incentives are intended to assist each respective sub-distributor in the growth and development of its business. Union Telecard holds equity interests in six of its ten largest sub-distributors.

During fiscal 2002, we implemented an enterprise software platform for our calling card business. This system enhances inventory and credit control, reduces costs, strengthens information flows across our organization, and enables customer support and tracking down to the consumer level. The system ties directly into our central database and seamlessly folds into enterprise level reporting. Furthermore, the system enables a dramatic increase in customer base, and therefore growth potential, with no significant change to existing personnel and procedures.

Our customized prepaid solutions calling cards and our IDT-branded calling cards are marketed to retail chains and outlets primarily through our own internal sales force, although from time to time we may utilize third-party agents or brokers to acquire accounts.

We market our consumer phone services primarily through direct television and print advertising in targeted markets. In the United Kingdom, we also use third-party sales agents to market our consumer phone services.

In Europe, we sell our prepaid calling cards through independent distributors, our rechargeable calling cards primarily through in-flight airline magazines, and our prepaid solutions prepaid calling cards directly to customers, using our own internal sales force.

Billing and Customer Support

We believe that reliable, sophisticated and flexible billing, information and customer service systems are essential to our ability to remain competitive in the global telecommunications market. Accordingly, we have invested substantial resources to develop and implement our proprietary management information systems.

Our billing system enables us to:

Our entire billing process is fully automated and increases efficiencies by reducing the need for monitoring by our employees.

Our customer support staff is located in our centers in Puerto Rico, Newark, New Jersey, London, England and Jerusalem, Israel, with the majority of calls handled by our staff in Puerto Rico. Customer service representatives communicate with subscribers via phone, fax and e-mail. They are trained to provide both technical and general service assistance, and are required to field a minimum number of calls and e-mails each day. Our quality control department monitors thousands of calls per day on a real time basis. We continuously train and retrain customer service representatives to ensure that they maintain a courteous attitude and remain knowledgeable about our service offerings. We also employ liaisons between our customer support and technical staffs to enhance responsiveness to changing customer demands.

Telecommunications Network Infrastructure

We maintain a global telecommunications switching and transmission infrastructure that enables us to provide an array of telecommunications, Internet access and Internet telephony services to our customers worldwide. Our network is monitored 24 hours a day, seven days a week, 365 days a year by our Network Operations Center.

We operate a growing telephone network consisting of domestic dedicated leased fiber-optic and copper lines and owned switch equipment in the United States, which are interconnected to major foreign state-owned or state sanctioned post, telephone or telegraph companies, emerging carriers and domestic interexchange carriers, local exchange carriers and competitive local exchange carriers.

We hold IRUs on six undersea fiber-optic systems. In addition, we lease capacity, which together operate on more than 17 different cable systems worldwide. These undersea circuits connect our U.S. facilities with our international facilities and with third-party facilities in Europe, Latin America, Asia, the Caribbean, Canada and Africa. We utilize other carriers’ networks in providing consumer long distance services.

Our largest switching facilities are located in the United States and the United Kingdom with smaller switching facilities being located in Peru, Argentina and Hong Kong. Our network is engineered with redundancy and diversity and our switching locations are chosen based on their access to key customers, carriers and market opportunities. All of our locations are

14

Table of Contents

interconnected via our extensive backbone of leased capacity to enhance network reliability and redundancy as each location interconnects with many different carriers.

In September 1998, we obtained from Frontier Communications (now a unit of Global Crossing) dedicated circuit capacity in the United States over Frontier’s network, connecting more than 120 metropolitan areas around the nation. These network facilities have enabled us to (i) expand the range and reliability of our data and voice transmission service, while reducing network costs, (ii) reduce 800-origination costs, and (iii) provide for origination and termination of wholesale carrier traffic in all major U.S. cities.

We are party to an agreement with Frontier whereby we enhanced our ability to provide presubscribed long distance and dedicated and toll-free services throughout the United States as well as casual calling long distance (the 10-10-xxx numbers) in selected areas of the United States.

In September 2002, we acquired certain IRUs and equipment from the estate of Star Telecommunications, which grant us long-term capacity on U.S. nationwide fiber networks operated by Qwest and Broadwing. With this network we can carry increased voice and data traffic into 13 major metropolitan cities in the United States, including Boston, New York City, Washington, D.C., Atlanta, Miami, Houston, Dallas, El Paso, Phoenix, San Diego, Los Angeles, San Francisco and Las Vegas.

Switching Platforms

Our telecom division uses three major telecommunications switching platforms. Excel (formerly a division of Lucent) switches are used for many application-based products such as prepaid calling cards, and value added services such as voice prompts, speed dialing, voice mail and conferencing. Excel switches are flexible and programmable, and are designed to implement network-based intelligence quickly and efficiently. As of October 1, 2004, we had deployed 226 Excel switches. Our telecom division also uses international gateway and domestic carrier switches manufactured by Nortel. As of October 1, 2004, we owned seven Nortel switches. Our telecom division has also deployed eight Sonus gateway switches interconnected over a VoIP backbone and controlled via a global softswitch. Our Sonus switches are extremely flexible and serve as international gateways as well as local interconnect switches. The Sonus platform also supports a SIP-based version of IDT’s Enhanced Services Platform which supplies prepaid calling card functionality in-country with the Sonus gateway switches. Our Sonus switches are deployed in New Jersey, California, Florida, Massachusetts, Peru, Argentina, London and Hong Kong. We are in the process of deploying a seventh Sonus gateway in England. All of our switches are modular, scaleable and equipped to signal in such protocols as ISDN (integrated services digital network) and C7/SS7 (a common channel signaling standard), so as to be compatible with multiple domestic and foreign networks.

Software

Our switches work in conjunction with our software platforms, many of which are proprietary, to run all of the applications that we require to provide value added services, as well as billing and traffic analysis. The software enables the switches to route all calls via our least-cost-routing system. Least-cost-routing is a process by which the routing of calls is optimized for over 230 countries and territories. In the event that traffic cannot be handled over the least-cost-route due to capacity or network limitations, the least-cost-routing system is designed to transmit the traffic over the next least-cost-route. Our least-cost-routing system analyzes several variables that may affect the cost of a call, including different suppliers, different time zones and multiple choices for terminating the call in each destination. Our least-cost-routing system is continuously updated to include the most favorable rates available from different suppliers to different destinations. By utilizing a least-cost-routing system, we are able to lower our costs and offer lower rates to our customers. This is of significant importance when serving a market that has become increasingly price-sensitive.

Research and Development

Our telecom division employs a technical staff that is devoted to the improvement and enhancement of its existing telecommunications products and services, as well as the development of new technologies, applications and products. We believe that the ability to adjust and improve existing technology and to develop new technologies in response to, and in anticipation of, customers’ changing demands is necessary to compete in the rapidly changing telecommunications industry.

IDT ENTERTAINMENT

IDT Entertainment operates our animation and entertainment distribution businesses and became a separate division in November 2003. IDT Entertainment has recently become our second largest division (based on revenues), with fiscal

15

Table of Contents

2004 revenues of $106.7 million and an operating loss of $0.6 million. We have several computer generated, or CG, animation projects currently in production or pre-production and we expect further revenue growth as these projects are commercialized.

IDT Entertainment consists primarily of several animation studios and our home entertainment distribution operations. Through internally developed systems and acquired operations, we acquire, develop, produce, finance and distribute animated properties for television, direct-to-video/DVD and theatrical release. We produce animated properties utilizing our internally developed, licensed and acquired intellectual property and we provide animation production services to third parties. We utilize our own studios and a network of affiliated animators around the world to produce our animated content. We have entered into several joint ventures and development arrangements to increase our access to brand name content.

Our distribution operations, which are primarily conducted through our Anchor Bay Entertainment subsidiary, distribute videos and DVDs to mass merchants including Wal-Mart, Target, Blockbuster Video, Best Buy and Kmart, and other retail outlets. We have a significant presence in the children’s, horror, fitness and anime genres.

Animation Industry Overview

Feature Films

The motion picture industry can be divided into two broad segments — animated and live-action films. The large majority of films theatrically released are live-action films. Animated films are either hand-drawn, stop-motion or computer generated. Hand-drawn films are the traditional two-dimensional films, such as Disney’s classic Snow White and the Seven Dwarfs. Stop-motion films involve animating three-dimensional models by making small adjustments to the model between each frame of film to simulate motion. CG animated films, such as the recent successes of the Shrek films, the Toy Story films and Finding Nemo, are made by creating and animating digital models and sets that have been built in a virtual world using complex computer programs.

The production of feature length animated films was reinvigorated in the 1990s when Disney Studios generated tremendous financial returns with the releases of Beauty and the Beast, Aladdin and The Lion King. As a result, several animation enterprises, including DreamWorks SKG, Blue Sky Studios and Pixar, were established with the intention of creating broad release animated feature films. Since 1995, there has been an increasing market acceptance for CG animation content, and CG animated films have significantly outperformed the average major studio release. Between 1995 and 2003, worldwide box office receipts for CG animated films totaled $4.2 billion. According to Kagan World Media between 1995 and 2002, on average, a CG animated film generated worldwide box office revenues of $340 million, compared to $64 million for non-CG animated films and $72 million for non-animated films. In addition, the genre has also generated significant revenue from ancillary sources, including video/DVD sales, merchandising and television.

Animated feature films have several differences from live-action films. They are typically shorter, which allows theaters to offer more show times per day, increasing the potential audience. Furthermore, animated films have sold, on average, considerably more home videos/DVDs per dollar of box office receipts than live action films, according to industry reports. However, the production costs of an animated film are generally higher than those of a live-action film. Currently production costs for animated films average approximately $72 million (according to imdb.com) for production, versus average costs for all films of approximately $64 million for live action films. Animators’ output is measured in seconds of finished animation per day, and anhy full-length feature film is a massive undertaking, requiring a large team of animators with a highly developed studio equipped with the latest animation hardware and software. Because of the historically significant production costs, animated films have generally been treated as event movies, on par with big-budget live-action films, and their promotional budgets have traditionally been comparable to those of big-budget live-action films.

Feature Film Life Cycle

Successful motion pictures may continue to play in theaters for six months or longer following their initial release. Concurrent with their release in the United States, motion pictures are generally released in Canada. Theatrical release in foreign markets other than Canada generally takes place several months after the U.S. release. The theatrical release of a film is often the most important component to its financial success, not in terms of revenue (since it generally accounts for only about a quarter of the total box office receipts), but because the publicity generated by a successful theatrical run facilitates launches and often drives success in other formats. After the initial theatrical release, distributors release movies in sequential release date windows, which are generally exclusive against other non-theatrical distribution channels. About six months after the U.S. release, studios sell home videos/DVDs for roughly six months. This accounts for about half of revenues, with about 60% of this revenue due to home video/DVD sales and 40% to rentals. When the exclusive home-video window closes, television generates about 15% of a feature film’s revenues, with an exclusive pay-per-view window, followed by

16

Table of Contents

premium cable, and then network television for one or two runs. After the broadcast premiere and usually the second run, the movie goes into syndication, generally on network and cable TV. This period lasts about five years. Studios often market merchandise and video games based upon the film simultaneously with the film’s release.

Other Formats

Direct-to-video/DVD is an important CG animation market. According to a Merrill Lynch Industry Update report released in 2003, this market has generated net margins in the range of 45%-66%. Because the smaller viewing screen is less demanding than the “big screen” used for theatrical releases, production times are much shorter and costs are considerably lower than for theatrically released films. According to Video Business, the home video industry totaled $22 billion in sales in 2003. DVD sales accounted for $16 billion, an increase of 41% from 2002. Currently, roughly 45% of U.S. households have a DVD player, and it is projected by the Merrill Lynch report to grow to over 75% by 2007.

There is increasing demand by the broadcast industry for CG animated content. In March 2004, UPN aired Game Over, the first ever CG animated prime time television series, which was produced by our own DKP Effects. DreamWorks has recently contracted with NBC to produce 13 episodes of a CG animated series entitled Father of the Pride for an estimated $2 million per episode. Traditionally, networks have paid approximately $200,000 for a “pre-school” style 2-D animated episode and approximately $450,000 for a CG animated episode. While the profit from a television series may be relatively modest, the awareness generated can drive significant merchandising and licensing revenues and profits. Prior to an episode being aired, a studio will seek to line up all merchandise and licensing contracts. Toys and clothing usually enter the consumer market either a week before or simultaneously with the airing of the series. Merchandise is ultimately where studios make the bulk of their revenue from broadcast properties.

Our Operations

IDT Entertainment intends to be a premier source of family-oriented animated entertainment available in theaters, for home viewing and on television. We are focused primarily on the acquisition, development and production of animated entertainment content and the mass distribution of animated (including 3D and 2D CG animated content) and live-action entertainment content both for third parties and, increasingly, utilizing our owned and licensed intellectual property. We are at various stages of development or production on several feature-length films, based on our owned or licensed content. We have consummated acquisitions and entered into joint ventures providing us access to well-known characters on which to base our projects. Through our various studios, we are producing a number of direct-to-video/DVD projects and animation properties for television release. Additionally, IDT Entertainment has a library of over 3,500 owned and licensed titles that it distributes to mass merchandising customers in the United States, Canada and the United Kingdom.

Our Approach

IDT Entertainment is pursuing a strategy designed to provide a stable base of licensing and distribution and production services work, coupled with the production of its own projects for direct-to-video/DVD and television, in addition to the riskier, but potentially more rewarding, undertaking of producing its own CG animated films for theatrical distribution. We have entered into joint ventures with owners of well-known intellectual property in order to achieve significant market appeal with relatively low marketing expenditures, because broad audiences are already familiar with the properties. We also provide production capacity to well-known producers, who add industry relationships and creative talent. We seek to be a low cost producer of high quality content, utilizing our extensive expertise in cost management and internally developed proprietary software. Our cost advantages arise from a combination of the following factors:

Production Methodology

Our GAS protocol is an internally developed, cost-effective production approach that we use to enable us to create animated content at a cost significantly lower than other high-quality CG animated productions. During production, we only utilize the highest cost, most exacting methodologies and personnel only on those elements that require such attention. Other

17

Table of Contents

elements are produced using personnel and tools that are sufficient for the application without sacrificing necessary quality. Our GAS protocol allows animators working at varied locations (including our hubs, our other studios and potentially outside locations) to work on the same production and same cell simultaneously. During production our animators build proprietary rigging tools and “plug-ins” which are then owned and available for use in future productions. One of our studios, DKP Effects, has developed technology that speeds up and simplifies the management and completion of complex animation projects by connecting all elements of production and accelerating real time changes.

Identifying and Approving Projects

Potential proprietary animation projects come from a wide range of sources. These ideas, called “treatments” in their preliminary form, along with others internally generated, are first presented to IDT Entertainment’s development and production department, which reviews each idea, and rejects the large majority. In addition to consideration of artistic merit and commercial potential, treatments are matched with the capacity and capabilities of IDT Entertainment’s production hubs. In the near term, we expect to “develop” fewer than 20 treatments in any year. Development of a treatment continues with the creation of preliminary artwork and the first draft of a script. The final decision to produce a project is made by management of IDT Entertainment and the studio or studios that are to work on the production. In reaching this decision, we consider not only the potential for the production itself, but also the expected market for merchandising and related sales opportunities. , which are particularly significant with respect to direct-to-video/DVD releases that involve well-known and developed properties. Our Anchor Bay and foreign sales distribution teams are actively involved in decisions at this preliminary stage due to their expertise in projecting video and DVD sales.

Distribution

We operate an extensive home entertainment distribution operations primarily through our Anchor Bay subsidiary. Anchor Bay has been involved in video and DVD distribution for over 15 years and has access to leading mass market retailers such as Wal-Mart, Best Buy and Blockbuster. Anchor Bay purchases certain content and obtain licenses covering DVD and videos. Anchor Bay supplements the content by designing and producing additional value-added features, such as interactive menus, critical commentaries, interviews with producers and talent, packaging and marketing materials. Anchor Bay’s library consists of over 3,500 owned or licensed titles with a particularly strong presence in the horror, children’s and fitness genres. Anchor Bay’s top selling titles in fiscal 2004 included:

In May 2004, we acquired Manga Entertainment, a film company specializing in the production, distribution and worldwide marketing of anime for home video/DVD releases, theatrical, and television broadcast. “Anime,” a form of animation developed in Japan, is derived from and styled after Japanese comic books. Over the last 10 years, Manga Entertainment has played an important role in establishing the market for anime in Europe and the United States. In 2003, the worldwide market for anime, including theatrical, broadcast television and direct to consumer products was estimated at over $2.0 billion. Manga Entertainment gained international acclaim with its co-production of the Japanese animated sci-fi thriller Ghost in the Shell, the first and only Japanese animated film to reach No. 1 on the Billboard Top Video Sales Chart. Ghost in the Shell won awards at The 1997 World Animation Festival for Best Theatrical Film and for Best Director of a Theatrical Feature Film. A new, related television series has been scheduled to air late 3rd quarter of the calendar year 2004 on the Cartoon Network. In the past seven years, the U.S. division of Manga Entertainment has released over 200 titles on DVD and VHS into U.S. retail and rental stores, with over 100 titles currently active. Manga Entertainment is one of the largest distributors of anime outside of Asia, with rights to over 300 titles. Manga Entertainment adds a new genre to the areas in which we have a leading distribution presence and is an important addition to our operations.

IDT Entertainment Sales, formed in June 2004, is responsible for the worldwide distribution of content from IDT Entertainment, as well as third-party producers, particularly programming to television broadcasters worldwide. IDT Entertainment Sales will be making its debut at MIPCOM, the International marketplace for entertainment content, in October with an impressive line up of projects, including the first look at IDT Entertainment’s development of product from the recently announced deals with Stan Lee’s POW! Entertainment, LLC and Todd McFarlane’s Spawn. In addition, IDT Entertainment Sales will unveil a preview of the new Inspector Gadget CG DVD feature, as well as a number of new properties from IDT Entertainment.

Proprietary Projects

We are in various stages of production of the following properties, among others:

18

Table of Contents

Production Services Projects

We, through our studios, provide animation and other production services on the following properties:

Our Studios

We own controlling and minority interests in the following companies. Each of these studios has its own expertise and independent operations allowing us to utilize their existing businesses and relationships to complement IDT Entertainment’s centralized operations. The diversity also allows us to send work to the most appropriate studio based on expertise, availability and special incentives (such as tax credits and governmental grants) that may be unique to a studio at a particular time.

Joint Ventures

We have completed several investments and joint ventures to secure access to brand name characters and content as well as distribution channels for family-friendly content.

We have a 5% equity interest in Archie Comics Entertainment, which is the entertainment and licensing arm of Archie Comic Publications. ACE has rights to characters including: Archie, Jughead, Veronica, Betty and their Riverdale friends, Sabrina the Teenage Witch, Josie and the Pussycats, Katy Keene, Cheryl Blossom, as well as super hero properties from the Mighty Crusaders library. Our interest in ACE provides us rights to co-develop and co-produce animated properties based upon selected Archie characters.

19

Table of Contents

Our investment in POW! Entertainment, founded by Stan Lee, the creator of Spider-Man, The Incredible Hulk and X-Men, provides us with a development agreement for six animated properties in which we will own all intellectual property rights to characters created for us by Mr. Lee. We own a minority interest in POW! and have exclusive distribution rights for all POW! animated direct-to-DVD properties. Pursuant to our agreement with POW!, Stan Lee will create original characters for new animated productions in a series entitled Stan Lee Presents.

We have concluded a multi-faceted development, production and distribution agreement with Todd McFarlane Productions covering the production of animation and merchandise based on Spawn and other Todd McFarlane Productions intellectual property. The initial project is intended to be the return of Todd McFarlane’s Spawn: The Animated Series. The first Spawn series aired on HBO from 1997 through 1999 and won two Emmy awards. Spawn, one of the world’s best-selling comic books with hundreds of millions sold worldwide, has also been the subject of a live action feature film released in 1997. Distributed by New Line Cinema, the movie version of Spawn has grossed nearly $90 million worldwide. According to the agreement, in addition to Spawn, Todd McFarlane will create two additional animated properties. All three projects include animated broadcast television series, DVDs, feature films, video games, apparel and action figures, as well as other consumer products. McFarlane Toys, one of the world’s premier toy manufacturers, is currently on its 25th figure line for Spawn action figures and merchandise.

IDT CAPITAL

Overview

IDT Capital, which was formerly called IDT Menlo Park and, prior to that, IDT Media, is our division that is responsible for developing, growing and, in some cases, operating our new or innovative business ideas. IDT Capital currently comprises the following primary business lines: brochure distribution, radio and bond trading software development and servicing. During fiscal 2004, IDT Capital generated an aggregate of $22.7 million in revenues, resulting in an operating loss of $21.2 million.

CTM Brochure Display

With over 2,000 clients and more than 10,000 display racks in over 25 states and provinces, CTM Brochure Display is a major distributor of travel and entertainment brochures in the Eastern United States and Canada. During fiscal 2004, CTM acquired an operation in Puerto Rico. CTM expects to grow by entering new sectors such as airport lounges and by pursuing acquisitions of additional companies in this market. CTM earns revenue through fees paid by travel and entertainment industry customers who pay CTM to distribute their brochures to hotel lobbies and other public venues. In fiscal 2004, CTM generated $15.7 million of revenue, resulting in operating income of $1.5 million.

Radio

In July 2002, we acquired WMET 1160 AM, a talk radio station serving the Washington, D.C. metropolitan area, the nation’s eighth-largest radio market. WMET covers the Washington D.C. metropolitan areas including the corridor from Baltimore, Maryland to Richmond, Virginia.. In fiscal 2004, WMET generated $0.2 million of revenue, resulting in an operating loss of $1.9 million compared to $0.2 million of revenue, resulting in an operating loss of $0.9 million in fiscal 2003.

Bond Trading Software Development and Servicing

Horizon Global Trading is a provider of comprehensive, real-time business solutions to the financial securities industry through a proprietary line of software products. It provides financial institutions with a one-stop solution for investing, trading, lending, clearing and processing securities. Horizon’s prestigious roster of clients includes institutions such as HSBC, JP Morgan Chase, Cantor Fitzgerald and Bank of Montreal. Horizon’s fully integrated product suite, BondFire, provides clients with true straight-through-processing capabilities, taking a trade from point of negotiation or execution all the way through to settlement. BondFire is designed to link seamlessly with clients’ proprietary systems for company wide general ledger reporting and other data processing. In fiscal 2004, Horizon generated $4.5 million of revenue, resulting in an operating profit of $0.1 million.

VOICE OVER IP

Overview

Our Voice over IP division consists of our stake in Net2Phone. Net2Phone is a separate public company whose common stock is quoted on the Nasdaq National Market under the symbol “NTOP.” Net2Phone is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended. On or about October 14, 2004, we expect that Net2Phone will file an Annual Report on Form 10-K with respect to its fiscal year ended July 31, 2004. Set forth below is a brief description of the business of Net2Phone. For further information with respect to Net2Phone, reference may be made to its Annual

20

Table of Contents

Report on Form 10-K and to prior and subsequent reports and other information filed by Net2Phone from time to time with the Securities and Exchange Commission. No such reports or information are incorporated into this report and such reports and information do not form a part of this report.

Net2Phone is a leading provider of Voice over Internet Protocol, or VoIP, telephony services. Since it began operations in 1995, Net2Phone has evolved from a pioneer in developing PC-to-telephone calling services over the Internet to a next generation provider of high-quality voice and enhanced telecommunication services throughout the world.

Net2Phone delivers VoIP services and products through two wholly owned subsidiaries — Net2Phone Global Services, or NGS, and Net2Phone Cable Telephony, or NCT. NGS delivers telephony solutions to businesses and consumers in over 200 countries, capitalizing on the growth, quality, flexibility and cost advantages of VoIP technologies. NCT offers cable operators a fully outsourced telephony platform to deliver high-quality residential phone services to their subscribers, empowering them to compete with traditional phone companies.

Ownership of Net2Phone Shares

NTOP Holdings holds an aggregate of 28.9 million shares of Net2Phone’s Class A common stock. As of July 31, 2004, this holding represented approximately 38.2% of Net2Phone’s outstanding equity and approximately 55.3% of the total voting power of Net2Phone’s outstanding equity. Currently, the members of NTOP Holdings consist of IDT and a subsidiary of Liberty Media. The membership interests held by each of the members are as follows:

Membership Interests in NTOP Holdings at July 31, 2004

The board of managers of NTOP Holdings is composed of five members appointed by the members owning a majority of the Class A-1 membership interests. Liberty Media has the right to designate one member of the board of managers. Because we own all of the Class A-1 membership interests, we have the right to appoint the entire board of managers, subject to Liberty Media’s right to designate one member. The board of managers directs the voting of all Net2Phone shares held by NTOP Holdings, thereby giving us effective control over the voting of the Net2Phone shares (but not their disposition, which requires consent of the members) held by NTOP Holdings. IDT is the managing member of NTOP Holdings.

The different classes of membership interests have different rights to receive operating and liquidating distributions. If NTOP Holdings were liquidated, the actual number of shares of Net2Phone Class A common stock each class of membership interest would be entitled to receive would vary based on the market price for Net2Phone’s common stock and other factors. As a result, the effective percentage of the Net2Phone Class A common stock held by each of the members of NTOP Holdings through NTOP Holdings (i.e. the number of shares each member would receive upon liquidation of NTOP Holdings) varies from time to time. The original members of NTOP Holdings were AT&T, Liberty Media and IDT. AT&T received 29 Class A units of NTOP Holdings. AT&T exercised its put rights and sold its units in NTOP Holdings to IDT and Liberty Media for a nominal amount, and AT&T is no longer a member of the NTOP Holdings.

In addition to the interest held through NTOP Holdings, as of July 31, 2004, IDT held 1.5 million shares of Net2Phone’s common stock directly. The following table illustrates the effective percentage of Net2Phone Class A common stock and common stock of each of the members of NTOP Holdings during the four quarters of fiscal 2004, based on the average daily closing price of Net2Phone’s common stock during such periods. The table includes shares of Net2Phone held directly by IDT. Liberty Media may also own Net2Phone shares directly, but they are not reflected in the table.

Effective Economic Ownership Percentages in Net2Phone of Members of NTOP Holdings

On October 29, 2003, IDT entered into a binding memorandum of understanding with Net2Phone, which requires Net2Phone to issue 6.9 million shares of Net2Phone Class A common stock to IDT at the time the parties execute definitive telecommunications services and related agreements. No definitive agreements have been executed as of October 14, 2004. The parties are continuing their efforts to establish detailed terms and conditions. Once issued, the shares will be held in escrow to secure IDT’s performance obligations under the agreements and are to be released to IDT in equal annual

21

Table of Contents

installments over five years, with the first release scheduled for October 29, 2004. The release of these 6.9 million shares will increase IDT’s aggregate equity investment and voting power of Net2Phone.

Net2Phone’s Business

NGS uses Net2Phone’s platform, centrally managed from our New Jersey headquarters, to deliver and support a variety of VoIP based telecommunications products and services to consumers, enterprises and telecommunications providers around the world. Net2Phone addresses the growing need for low-cost calling alternatives around the world by:

In fiscal 2003, Net2Phone began offering a suite of corporate solutions enabling small to medium sized businesses with branches and partners around the world to use a managed private data network, which Net2Phone calls its Private Voice Network, or PVN. The PVN allows these enterprises to access Net2Phone’s VoIP networks with regular telephones to significantly reduce their intra-company telecommunication costs.

Through its VoIP network, Net2Phone offer carriers a low-cost, high quality alternative for the transport and termination of voice and fax communications. Net2Phone generates revenue from carriers through the sale of access to the network via a VoIP interconnect, and through call termination charges.

NCT develops, integrates and manages an outsourced, customizable platform to provide cable operators with the tools they need to offer high-quality voice solutions over their current cable infrastructure. The solution complies with cable industry standards and we believe significantly reduces the costs and time-to-market associated with building a proprietary cable telephony service, thereby allowing cable operators to effectively compete with other established telephony providers. The service includes cable telephony business modeling, system integration, real-time service assurance with 24 x 7 network operations support, and the development and management of interconnects with local and long distance carriers to the public switched network. These tools are significantly enhanced by Net2Phone’s strategic relationships with us. We provide NCT with cost effective long distance termination and local connectivity throughout the United States. Using Net2Phone’s integrated system, cable operators can accelerate their time to market with an outsourced, scalable telephony solution, and can then sell their subscribers universal local and long distance service at very competitive calling rates.

In fiscal 2004, our Voice over IP segment, consisting of Net2Phone, generated $78.0 million in revenues and $21.9 million in loss from operations. Effective October 23, 2001, we reconsolidated our investment in Net2Phone into our financial statements.

COMPETITION

IDT Telecom

We believe that the principal competitive factor affecting our telecom business will be the price of our services. Additionally, our ability to compete will be dependent upon the quality and reliability of our services, customer service and innovation. Many of our current and potential competitors have greater name recognition and greater financial, marketing, personnel and other resources than we do, as well as other competitive advantages. We anticipate that price competition will remain intense in all of our telecom division’s market segments.

Calling Card Services

We believe our success in providing our calling card services is based on our ability to provide low rates and reliable service and to efficiently distribute our calling cards. The calling card industry is notable for its relative lack of regulation compared to the rest of the telecommunications industry, and for its ease of market entry. As calling rates continue to decrease and competition increases, we will be forced to rely on our service, quality and distribution efficiencies to remain competitive.

In the calling card market, we compete with other providers of calling cards, including established carriers and numerous small or regional operators, and with providers of alternative telecommunications services. Many of the largest telecommunications providers, including AT&T, MCI and Sprint, currently market prepaid calling cards, which in certain cases compete with our cards. In marketing prepaid calling cards to customers outside the United States, we compete with large foreign state-owned or state sanctioned post, telephone or telegraph companies. We believe that our distribution network,

22

Table of Contents

interconnect and termination agreements, network infrastructure and least cost routing system provide us with access to customers and the ability to offer low-cost, high quality services and are competitive advantages. However, as some of our competitors have significantly greater financial resources and name recognition, our ability to maintain or improve margins and/or to capture additional market share will be dependent upon our ability to continue to provide lower priced services.

Wholesale Carrier Services

The carrier business has numerous entities competing for the same customers, primarily on the basis of price and service quality. The financial difficulties, including bankruptcy, during the last three years of certain of our competitors, may present an opportunity for us to expand our carrier service business through decreased competition and/or low cost acquisition of the facilities or equipment of bankrupt or financially unstable carriers. However, financial difficulties within the industry may lead to greater competition as bankrupt carriers reorganize by shedding unprofitable lines of business and outstanding debt obligations, thus eliminating many of the financial burdens these carriers faced in their financially unstable condition. Regardless of the effects of bankruptcy and financial instability within the telecommunications industry, we expect this area to remain highly competitive due to the vast number of carriers and the amount of telecommunications network infrastructure that is available.

In the wholesale carrier service business, we compete with:

We believe that our extensive network of interconnect and termination agreements, as well as the significant volume of traffic to specific locations generated by our wholesale and calling card businesses, provide us with a competitive advantage and the ability to offer quality services at competitive prices.

Residential Telephone and Related Services

We offer consumer long distance service to residential and business subscribers in the United States. In several states we also offer consumers local and long distance service bundled at a flat monthly rate. The U.S. consumer phone service industry is characterized by intense competition, with numerous entities competing for a relatively static number of customers, leading to a high churn rate because customers frequently change providers in response to offers of lower rates or promotional incentives.

Our primary competitors in the long distance market include major long distance carriers such as AT&T, MCI and Sprint and the RBOCs. For the foreseeable future, we expect the RBOCs to increase their share of the long distance market, at the expense of the major long distance carriers.

The RBOCs remain our primary competitors in the local exchange market as well. Major long distance carriers such as AT&T and MCI also provide competitive local exchange service. Competing against the RBOCs is particularly challenging. Each of the RBOCs continues to enjoy a virtual monopoly as the ILEC in its respective territory and most of the RBOCs are well funded and enjoy high levels of name brand recognition, which represent significant resources in the battle for market share.

Many service providers, including us, offer “bundled” service, which includes local and long distance phone services, generally for a combined, flat monthly rate. Purchasing both local and long distance phone services from a single provider has become a major trend in the United States. According to the J.D. Power and Associates 2004 Residential Long Distance Telephone Service Study^SM, the share of households that bundled their local and long distance services with one carrier increased from 26% in 2002 to 51% in 2004. Some providers also include other services into their bundles, such as high-speed Internet access, either via a Digital Subscriber Line (DSL) or a cable modem; wireless telecommunications services and cable TV/satellite services. Our bundled offering currently includes only local and long distance services. However, we plan to make both high-speed Internet access and wireless services part of our bundled offering during fiscal 2005. We believe that it is imperative that we broaden the scope of our bundled services, and offer them at competitive rates, if we are to compete effectively.

Any changes in the UNE-P which increases the prices that we would have to pay to the RBOCs for access to their services could also impact our ability to offer services that are competitively priced with those offered by the RBOCs.

23

Table of Contents

Emerging Market Entrants

In all aspects of the telecommunications industry, we may face competition from an increasing number of market entrants such as electric utilities, cable television companies, fixed and mobile wireless system operators, and operators of private networks built for large end users. Electric utilities have existing assets and access to low cost capital that could allow them to enter a telecommunications market rapidly and accelerate network development. Cable television companies are also entering the telecommunications market by upgrading their networks with fiber optics and installing facilities to provide fully interactive transmission of broadband voice, video and data communications. New technology permits companies to provide voice telephone (or comparable) services over broadband Internet connections, allowing users of these Internet services to obtain communications services without subscribing to a conventional telephone line. Wireless companies have developed, and are deploying in the United States, wireless technology as a substitute for traditional wireline local telephones. Additionally, the World Trade Organization agreement on basic telecommunications services could increase the level of competition we face. Under this agreement, the United States and 68 other member states of the World Trade Organization are committed to opening their respective telecommunications markets, including permitting foreign companies to enter into basic telecommunications services markets. This development may increase the number of established foreign-based telecommunications carriers entering U.S. markets.

Entertainment

Television, motion picture and video production and distribution are highly competitive businesses. We face competition from companies within the entertainment business and from alternative forms of leisure entertainment, such as travel, sporting events, outdoor recreation and other cultural activities.

We will experience substantial competition with respect to CG animated film productions. Our CG animated films will compete directly with the CG animation producer/motion picture studio teams of Pixar, which is the CG animation leader-to-date, Disney, DreamWorks, and Blue Sky/Twentieth Century Fox, among others. Each of these entities plans to introduce at least one CG animated movie into the market in the next few years.

The intensity of competition in the animation industry is increasing with the entrance of large companies into the arena, including Sony and Lucasfilm. Due to the great success of Pixar’s films, many, if not all, of the major live action studios are attempting to become involved in the animated feature film arena. This has led to an increase in rivalry as advancements in digital imaging technology and animation techniques as well as the proven track record of CG animated films have shown that success is based on creating engaging stories, characters and worlds.

Because of the importance of the domestic theatrical market in determining revenue from other sources, our primary competition for both our planned theatrical films and our other filmed products comes from both animated and live-action films that are targeted at similar audiences and released into the domestic theatrical market at the same time as our films. At this level, in addition to competing for box office receipts, we compete with other film studios over optimal release dates and the number of motion picture screens on which our movies are exhibited. In addition, we compete with other films released into the international theatrical market and the worldwide home video/DVD and television markets. In addition, we compete and will continue to compete with other movie studios for the services of creative and technical personnel, particularly in the fields of animation and technical direction.

Our Anchor Bay and Manga distribution operations compete with the distribution divisions of major production companies, as well as with several other independent home video/DVD distribution companies, including GoodTimes Entertainment Limited, Lyrick Studios, Sony Wonder and VIZ Entertainment.

Regulation in the United States

Consumer Telecommunications Services

We offer consumer local exchange and long distance service (collectively, “telecommunications service”) to residential and business subscribers in the United States through our IDT America, Corp. (“IDTA”) affiliate. IDTA’s primary markets are the residential and small business markets. IDTA offers its service primarily through the unbundled network elements of the incumbent local exchange carriers.

IDTA and Entrix are certificated to provide facilities-based and/or resold long distance service in all 50 states, and IDTA also is certificated to provide facilities-based and resold local exchange service in 46 states. These certifications authorize us to provide calling card services under the IDT and Entrix names, and these certifications also authorize IDTA to provide telecommunications services. We are currently seeking authorization for IDTA to provide local exchange service in the remaining states. The local and long distance telecommunications services we provide are regulated by federal, state, and, to some extent, local government authorities. The FCC has jurisdiction over all telecommunications common carriers to the extent they provide interstate or international communications services. Each state regulatory commission has jurisdiction over the same carriers with respect to their provision of local and intrastate long distance communications services. Local

24

Table of Contents

governments often indirectly regulate aspects of our communications business by imposing zoning requirements, permit or right-of-way procedures or franchise fees. The FCC and the International Telecommunications Union, or ITU, set certain parameters on our domestic spectrum use. Significant changes to the regulations imposed by any of these regulators could have a material adverse effect on our business, operating results and financial condition.

In recent years, the regulation of the telecommunications industry has been in a state of flux as the U.S. Congress and various state legislatures have passed laws seeking to foster greater competition in telecommunications markets. Most significantly, the Telecommunications Act of 1996 pre-empted many of the barriers to competition in the U.S. telecommunications business that previously existed in state and local laws and regulations, and set basic standards for relationships between telecommunications providers. The Telecommunications Act requires ILECs to provide potential competitors with nondiscriminatory access to and interconnection with local networks, and to provide unbundled network elements at regulated prices. In addition, the Telecommunications Act allows the RBOCs, once certain thresholds are met, to enter the long distance market within their own local service regions.

The FCC and state utility commissions have adopted many new rules to implement the Telecommunications Act. Some states have also adopted state legislation to encourage competition. These changes, many of which are still being implemented, have created new opportunities and challenges for our competitors and us. The following summary of regulatory developments and legislation is intended to describe the most important, but not all, present and proposed international, federal, state and local regulations and legislation affecting the U.S. telecommunications industry. Some of these and other existing federal and state regulations are the subject of judicial proceedings and legislative and administrative proposals that could change, in varying degrees, the manner in which this industry operates. We cannot predict the outcome of any of these proceedings or their impact on the telecommunications industry at this time. Some of these future legislative, regulatory or judicial changes may have a material adverse impact on our business.

Regulation by the Federal Communications Commission — Domestic Telecommunications Services

The FCC has jurisdiction over all U.S. telecommunications common carriers to the extent they provide interstate or international communications services, including the use of local networks to originate or terminate such services. The FCC also has jurisdiction over certain issues relating to interconnection between providers of local exchange service. Our entry into the local exchange market ensures that, in the future, the FCC’s policies on the local exchange market will have a greater impact on us than they have had in previous years. The FCC’s current and future policies could have a material adverse effect on our business, operating results and financial condition.

Detariffing

In accordance with the FCC’s Detariffing Order, our rates, terms and conditions for international and domestic interstate services are no longer set forth in tariffs filed with the FCC, but are instead determined by contracts between us and our customers. Nonetheless, we remain subject to the FCC’s general requirements that rates must be just and reasonable, and not unreasonably discriminatory, and are also subject to the FCC’s jurisdiction over complaints regarding our services. The detariffing of domestic interstate and international services may pose additional risks for us because we will no longer have the benefit of the “filed rate doctrine.” This doctrine enabled us to bind our customers to the terms and conditions of the tariff without having each customer sign a written contract and enabled us to change rates and services on one day’s notice. Since the rates and terms of service are no longer tariffed, we may be subjected to increased risk of claims from customers involving terms of service and rates that could impact our financial operations.

Universal Service

In 1997, the FCC issued an order, referred to as the Universal Service Order, to implement the provisions of the Telecommunications Act relating to the preservation and advancement of universal telephone service. The Universal Service Order requires all telecommunications carriers providing interstate telecommunications services to periodically contribute to universal service support programs administered by the FCC, including subsidies for (i) telecommunications and information services for schools and libraries, (ii) telecommunications and information services for rural health care providers, (iii) the provision of basic telephone service in regions characterized by high telecommunications costs and low income levels, and (iv) interstate common line support (the “Universal Service Funds”). The periodic contribution requirements to the Universal Service Funds under the Universal Service Order are currently measured and assessed based on the total subsidy funding needs and each contributor’s percentage of the total of certain interstate and international end user telecommunications revenues reported to the FCC by all telecommunications carriers, which we measure and report in accordance with the legislative rules adopted by the FCC. The contribution rate factors are redetermined quarterly and carriers, including us, are billed for their contribution requirements each month based on projected interstate and international end-user telecommunications revenues, subject to periodic true up. Although the contribution obligations to the Universal Service Funds

25

Table of Contents

are imposed upon telecommunications carriers, such contributions may be passed through to consumers on an equitable and nondiscriminatory basis either as a component part of the rate charged for telecommunications services or as a separately invoiced line item. Since April 1, 2003, telecommunications carriers have been prohibited from using a separately invoiced line item identified as a recovery of contributions to the Universal Service Funds to bill amounts in excess of the rate of actual contributions to the Universal Service Funds. As a result, the ability of telecommunications carriers to recover administrative expenses and uncollectible receivables arising with respect to contributions to the Universal Service Funds has been curtailed. In addition to the FCC universal service support mechanisms, state regulatory agencies also operate parallel universal service support systems. Many state regulatory agencies have instituted proceedings to revise their universal support mechanisms to make them consistent with the requirements of the Telecommunications Act. As a result, we are subject to state, as well as federal, universal service support contribution requirements, which vary from state to state. As with any regulatory obligation, if a federal or state regulatory body determines that we have incorrectly calculated and/or remitted any universal service fund contribution, we could be subject to the assessment and collection of past due remittances as well as interest and penalties thereon. Furthermore, if the FCC determines that we have incorrectly calculated and overstated a separately invoiced line item identified as a recovery of contributions to the Universal Service Funds we could be required to repay any such over-collection and be subject to penalty.

There are three proposals currently being reviewed by the FCC that have the potential to significantly alter our contribution obligations under the Universal Service Order. The first FCC proposal relates to the universal service support mechanism established in 1999 for non-rural carriers based on forward-looking economic costs, which was challenged before the U.S. Court of Appeals for the Tenth Circuit. In July 2001 the Tenth Circuit remanded the matter to the FCC for reconsideration and additional review, and in February 2002, the FCC issued a notice of proposed rulemaking and order seeking additional comments. The second FCC proposal would fundamentally alter the basis upon which our Universal Service Fund contributions are determined and the means by which such contributions may be recovered from our customers, changing from a revenue percentage measurement to a connection (capacity) or telephone number (access) measurement. The FCC originally made this proposal in May 2001, February 2002 and December 2002, the FCC solicited more focused comments on this proposal, which could adversely affect our costs, our ability to separately list Universal Service Order contributions on end-user bills, and our ability to collect these fees from our customers, which would have a material adverse effect upon us. The third FCC proposal, which was made in February 2002, solicited comment on the FCC’s formal review of the universal service contribution requirements imposed on wireline and other broadband Internet access services and the impact that changes to those requirements would have on the contribution obligations of other telecommunications service providers, such as us.

Based on the foregoing, the application and effect of the Universal Service Fund requirements (and comparable state contribution requirements) on the telecommunications industry generally and on certain of our business activities cannot be definitively ascertained at this time. Furthermore, if our collection procedures result in over collection, we could be required to make reimbursements of such over collection and be subject to penalty, which could have a material adverse affect on our business, financial condition and results of operations.

The RBOCs’ Entry into the Long Distance Market

The Telecommunications Act permitted the RBOCs (Verizon, SBC, Qwest, and BellSouth) to provide long distance services in states outside of their local service regions beginning in 1996, and permits them to provide in-region long distance service upon demonstrating to the FCC that they have adhered to the Telecommunication Act’s Section 271 14-point competitive checklist. Since the passage of the Telecommunications Act, RBOCs have obtained FCC approval to offer long distance service in all of their in-region states.

Competition for long-distance services has increased as the RBOCs have entered the market over the past few years. Section 271 entry permits the RBOCs to offer a bundle of local, long-distance and enhanced services comparable to our services and therefore could increase competition and harm our business. In addition, RBOCs no longer have the incentive they had previously to rapidly implement the interconnection provisions of the Telecommunications Act in order to obtain in-region long distance authority. Although the RBOCs remain subject to a legal obligation to comply with those provisions, our ability to obtain adequate access to unbundled network elements and other facilities on a timely basis could be negatively affected, and therefore our business could be harmed.

Interconnection and Unbundled Network Elements

The Telecommunications Act requires ILECs to allow competitors to interconnect with their networks in a nondiscriminatory manner at any technically feasible point on their networks at cost-based prices, which are more favorable than past pricing based on the historic regulated costs of the ILEC. Since the FCC’s 1996 “Local Competition Order” CLECs have enjoyed

26

Table of Contents

the right to lease unbundled network elements at rates determined by state public utility commission employing the FCC’s TELRIC (Total Element Long Run Incremental Cost) forward looking, cost-based pricing model. The FCC recently commenced a rulemaking proceeding to comprehensively re-examine whether the TELRIC pricing model has resulted in unpredictable pricing inconsistent with appropriate economic signals; fails to adequately reflect the real-world attributes of the routing and topography of an incumbent LEC’s network; and may create disincentives to investment in facilities by understating forward-looking costs in pricing RBOC network facilities and/or overstating efficiency assumptions. Based on the foregoing, the application and effect of a revised TELRIC Pricing Model on the telecommunications industry generally and on certain of our business activities cannot be definitively ascertained at this time, although some of the proposals being considered by the FCC could have a material adverse affect on us if adopted.

The FCC released its Triennial Review Order in August 2003 making substantial changes in its rules governing availability of ILEC unbundled network elements to CLECs. The Order limited the FCC’s previous nationwide findings of impairment to high-capacity loops, switching, and dedicated transport elements. In March 2004, however, the United States Court of Appeals for the District of Columbia Circuit vacated many provisions of the FCC’s orders, and directed the FCC to further revise its unbundling criteria. Effective September 13. 2004, the FCC adopted interim rules that will preserve for a period of six months all network elements that were available as of the effective date of the Court of Appeals decision. If the FCC does not find continued impairment as to those elements before the expiration of the six-month period, however, those elements may no longer be available to us at current prices.

IDTA currently relies on access to ILEC facilities, including local switching, for the local component of its business plan. Although we expect that we would be able to obtain replacements for these network elements if the FCC does not find continued impairment, either from the ILECs or from third parties, the prices for the replacement services may be substantially higher than the network element prices. We may then have to reconfigure existing services and revise business plans for new markets; such changes in regulation may have a material adverse effect on our ability to compete profitably in some segments of the local exchange market. Also, any decision made by the FCC is likely to be subject to further court appeals, which may affect our business in ways that cannot now be anticipated.

Pursuant to the Local Competition Order, we negotiate each interconnection arrangement with the relevant ILEC, generally on a state-by-state basis. These agreements typically have terms of two or three years; accordingly, a substantial number of our interconnection agreements with ILECs will expire and require renegotiation in any given year. Each of these agreements provides for a holdover that continues the agreement on its current terms pending renegotiation. If the negotiation process does not result in interconnection terms that are acceptable to us, we can petition to arbitrate disputed issues or choose to “opt in” to another carrier’s agreement, thereby having our interconnection relationship governed under the same terms as those agreed to by the ILEC and another carrier.

Access Charges

As a long distance provider, we remit access fees directly to local exchange carriers or indirectly to our underlying long distance carriers for the origination and termination of our long distance telecommunications traffic. Generally, intrastate access charges are higher than interstate access charges. Therefore, to the degree access charges increase or a greater percentage of our long distance traffic is intrastate, our costs of providing long distance services will increase. As a local exchange provider, we bill access charges to long distance providers for the origination and termination of those providers’ long distance calls. Accordingly, as opposed to our long distance business, our local exchange business benefits from the receipt of intrastate and interstate long distance traffic. As an entity that both collects and remits access charges, we have implemented certain systems designed to ensure that we properly track and record the jurisdiction of our telecommunications traffic and remit or collect access charges accordingly. The result of any changes to the existing regulatory scheme for access charges or a determination that our systems inadequately or improperly record the jurisdiction of our telecommunications traffic could have a substantial and material adverse effect on our business.

The FCC has made major changes in the interstate access charge structure in recent years. On May 31, 2000, the FCC issued the so-called “CALLS Order” that lowers collective interstate access charges by local exchange carriers subject to price cap regulation by $3.2 billion and ends certain charges paid by interexchange carriers. This action has reduced access charges for interexchange carriers and resulted in increased price competition for long distance services.

Our costs of providing long distance services, and our revenues for providing local services, are also affected by changes in access charge rates imposed on CLECs. Pursuant to the FCC’s 2001 CLEC Access Charge Order lowering the rates CLECs can charge long distance carriers for origination and termination of calls over the local facilities, during 2004, our access rates were reduced to levels no higher than those of the ILEC in each area we serve. These rate reductions have affected our revenues and operating margins.

27

Table of Contents

In April 2001, the FCC released a Notice of Proposed Rulemaking in which it proposed a “fundamental re-examination of all currently regulated forms of intercarrier compensation.” The FCC proposed that carriers transport and terminate local traffic on a bill-and-keep basis, rather than per minute reciprocal compensation charges. The FCC regards the CALLS Order and the CLEC Access Charge Order as well as its reciprocal compensation rules to be “transitional intercarrier compensation regimes.” After completion of that transition in mid-2005, a new interstate intercarrier compensation regime based upon bill-and-keep or another alternative may be in place. Over the past year, several different industry groups have formed for the purpose of submitting access charge reform proposals to the FCC. While the FCC has not yet acted on these proposals, and it is not yet known when it will act, all .of the proposals would result in substantial reductions in access charge payments, and some would eliminate these payments entirely over a period of time. Because we both make payments to and receive payments from other carriers for exchange of local and long distance calls, at this time we cannot predict the effect that the FCC’s determination may have upon our business.

Reciprocal Compensation

Reciprocal compensation is the arrangement under which local telecommunications carriers compensate each other for terminating local calls made by their customers. The Telecommunications Act requires ILECs and CLECs to complete calls originated by competing carriers under reciprocal arrangements at prices based on a reasonable approximation of cost, or through the mutual exchange of traffic without explicit payments (called “bill and keep”). An issue has arisen regarding the treatment of local dial-up calls to Internet service providers, or ISPs, with regard to reciprocal compensation. Because the average length of these dial-up calls is much longer than that of voice calls, and the calls typically are routed in one direction to terminate at the ISP, the amount of traffic terminated by the ISP’s carrier, which is often a CLEC, can greatly exceed that of the Internet user’s carrier, which is typically the ILEC. This can represent significant revenues to the terminating CLEC. The FCC’s 2001 Intercarrier Compensation Order reclassified ILEC-terminated local traffic exceeding a 3-to-1 ratio relative to CLEC-terminated traffic as presumed ISP-bound traffic ineligible for reciprocal compensation. Beyond reciprocal compensation due for local traffic, the FCC established a transitional framework continuing the CLECs’ right to receive intercarrier compensation for ISP-bound traffic at diminishing rates reduced to $0.0007 per minute in 2003, with the number of minutes for which payment can be received in each state capped using a formula based on 2001 traffic. The D.C. Circuit Court of Appeals recently remanded (without vacating) the FCC’s classification of ISP-bound traffic as non-local, rejecting the FCC’s statutory basis for this classification but inviting an alternative rationale. Currently, carriers remain obliged to pay reciprocal compensation for local traffic and intercarrier compensation for ISP-bound traffic according to the Intercarrier Compensation Order. The FCC has not yet responded to the Court’s remand order, and it is not known when it will do so or whether this will result in any changes in its rules.

In light of the limited revenues we receive from reciprocal compensation for ISP traffic, we do not expect the resolution of this issue to have a material impact on our operations.

Slamming

A customer’s choice of a local or long distance telecommunications company is encoded in a customer record, which is used to route the customer’s calls so that the customer is served and billed by the desired company. A user may change service providers at any time, but the FCC and some states regulate this process and require that specific procedures be followed. When these procedures are not followed, particularly if the change is unauthorized or fraudulent, the process is known as “slamming.” Slamming has been addressed in detail by Congress in the Telecommunications Act, by some state legislatures, and by the FCC in recent orders. The FCC has levied substantial fines for slamming. The risk of financial damage, in the form of fines, penalties and legal fees and costs, and to business reputation from slamming is significant. Even one slamming complaint could cause extensive litigation expenses for us. We are also subject to state rules and regulations regarding slamming, cramming, and other consumer protection regulation. We have implemented internal procedures designed to ensure that our new subscribers are switched to us in accordance with state and Federal regulations. Because of the large volume of service orders processed by us, however, it is possible that some unauthorized carrier changes may be processed inadvertently, and we cannot assure that we will not be subject to slamming complaints.

Network Information

FCC rules protect the privacy of certain information about telecommunications customers that a telecommunications carrier such as IDT acquires by providing telecommunications services to such customers. Such protected information, known as Customer Proprietary Network Information, or CPNI, includes information related to the quantity, technological configuration, type, destination and the amount of use of a telecommunications service. The FCC’s original rules prevented a carrier from using CPNI acquired through one of its offerings of a telecommunications service to market certain other services without the express approval of the affected customer (a so-called “opt-in” approach). The U.S. Court of Appeals for the Tenth Circuit overturned a portion of the FCC’s rules regarding the use and protection of CPNI.

28

Table of Contents

In July 2002, the FCC reinstated most of its original rules in response to the Tenth Circuit decision, and revised its “opt-in” rules in a manner that limits our ability to use the CPNI of our subscribers without first engaging in extensive customer service processes and record keeping. These burdens could result in significant administrative expense to us in modifying internal customer systems to meet these requirements. IDT uses its subscribers’ CPNI in accordance with applicable regulatory requirements. However, if a federal or state regulatory body determines that we have implemented those guidelines incorrectly, we could be subject to fines or penalties.

Regulation of Internet Service Providers

To date the FCC has treated ISPs as “enhanced service providers” exempt from federal and state regulations governing common carriers, including the obligation to pay access charges and contributions to the Universal Service Fund. Nevertheless, regulations governing disclosure of confidential communications, copyright, excise tax and other requirements may apply to our Internet access services and future regulations may be imposed by state, federal or foreign governments. Also, Congress has passed a number of laws that concern the Internet, principally directed toward Internet users. Generally, these laws provide liability limitations for Internet service providers and hosting companies that do not knowingly engage in unlawful activity. We have guidelines in place to comply with this legislation and do not anticipate that compliance will have an adverse impact on us. Congress is actively considering a variety of Internet regulation bills, some of which, if signed into law, could impose obligations on us to police the Internet activities of our customers.

Similarly, where telecommunications service providers have offered enhanced services in addition to their telecommunications services, the FCC and state regulatory bodies have exempted the enhanced service component and its associated revenue from legacy telecommunications regulations, such as access charges and contributions to the Universal Service Fund. Some of the services we provide are characterized for regulatory purposes as enhanced services. The FCC recently ruled in response to a Petition for Declaratory Ruling (“Petition”) filed by AT&T that certain AT&T prepaid calling card services using Voice Over Internet Protocol transmission were telecommunications, not enhanced, service. The FCC’s decision states that Universal Service Fund contribution and access charges apply to AT&T’s prepaid calling cards. The FCC limited its decision to the facts presented by AT&T and did not address the regulatory classification of all enhanced services, including those offered by us. However, the FCC is considering other petitions relating to enhanced services, and it is possible that some of its decisions could result in determinations that we incorrectly characterized certain services as enhanced. In addition, the FCC’s pending review of intercarrier compensation policies (discussed under “Access Charges” above) could change the current status of enhanced service providers. The outcome of pending state proceedings as well as any future FCC proceedings could have a significant impact on our future provision of enhanced services. Additionally, if any of the proceedings outcomes are retroactively applied, we could be subject to fines, penalties or additional costs for services provided in the past.

Telephone Numbering

The FCC oversees the administration and the assignment of local telephone numbers, an important asset to voice carriers, by Neustar, Inc., in its capacity as North American Numbering Plan Administrator. Extensive FCC regulations govern telephone numbering, area code designation and dialing procedures, among other things. Since 1996, the FCC has permitted businesses and residential customers to retain their telephone numbers when changing local phone companies (referred to as Local Number Portability). The availability of local number portability is important to competitive carriers like IDTA, since customers may be less likely to switch to a competitive carrier if they cannot retain their existing telephone numbers.

Local exchange carriers must also have access to new telephone numbers if those carriers are to serve customers without pre-existing phone service. Presently, IDTA only offers local exchange service to subscribers with pre-existing phone service, however, we intend to offer local exchange service to subscribers that do not have pre-existing phone service. In order to accomplish this, we will be required to request blocks of telephone numbers and to distribute those telephone numbers within existing industry guidelines. If a sufficient amount of telephone numbers is not available to us in the market, our operations in that market may be adversely affected or we may be unable to enter that market until sufficient numbers become available. However, the recent failure of a number of CLECs and the implementation of guidelines that require more efficient distribution of telephone numbers seems to have reduced the demand for new blocks of telephone numbers and the resulting risk of depletion, at least in the short term.

Dial Around Compensation

The Telecommunications Act requires telecommunications companies to pay compensation to the owners of payphones for toll-free calls and certain other “dial-around” calls originating from payphones. The FCC increased the rate, beginning September 27, 2004, to $0.494 per completed call. As a result of the FCC’s decision, we increased our payphone sur - -

29

Table of Contents

charge. We have not yet been able to determine whether our increased liability to payphone owners and our increased rates will have a material adverse effect on our calling card business.

NASUCA Proceeding

On March 30, 2004, the National Association of State Utility Consumer Advocates (“NASUCA”) filed a Petition for Declaratory Ruling (“Petition”) with the FCC requesting the FCC declare that carriers are prohibited from imposing upon consumers line items unless those charges are expressly mandated by federal, state or local regulatory action. IDT imposes certain charges, such as our National Carrier Charge (“NCC”), upon subscribers that do not necessarily recover only charges that are “expressly mandated by state or local regulatory action.” Accordingly, if the FCC grants NASUCA’s Petition, we would have to cease imposition of certain charges or restructure our rates, which could have a material adverse effect on our business.

Taxes and Regulatory Fees

We are subject to numerous local, state and federal taxes and regulatory fees, including, but not limited to, the Federal excise tax, FCC universal service fund contributions and regulatory fees, and numerous public utility commission regulatory fees. We have procedures in place to ensure that we properly collect taxes and fees from our customers and remit such taxes and fees to the appropriate entity pursuant to applicable law and/or regulation. If our collection procedures prove to be insufficient or if a taxing or regulatory authority determines that our remittances were inadequate, we could be required to make additional payments, which could have a material adverse effect on our business.

On July 2, 2004, the IRS published an Advanced Notice of Proposed Rulemaking (“ANPRM”) seeking comment on several issues, including the application of the Federal Excise Tax to certain bundled telecommunications products as well as Internet telephony. We believe the outcome of this proceeding will be prospective only. However, if it is not, it could be determined that our collection procedures have been insufficient. Accordingly, if the IRS determined that our remittances were inadequate, we could be required to make additional payments, which could have a material adverse effect on our business.

Telemarketing

Through certain subsidiaries, we provide telemarketing services. Telemarketing is regulated by two Federal agencies, the FCC and the Federal Trade Commission (“FTC”), as well as individual state agencies. The FTC recently modified its Telemarketing Sales Rule (“TSR”), to impose new and revised regulations on telemarketers. Among these regulations was the creation of a national Do-Not-Call (“DNC”) registry. If an individual places his or her residential or mobile telephone number on the registry, telemarketers may not call the number, with limited exceptions, such as when a previous business relationship exists between the individual and the company on whose behalf the telemarketer calls. It is estimated that over 262 million telephone numbers have been registered. The FCC recently modified the Telephone Consumer Protection Act of 1991 (“TCPA”) to conform its regulations to those of the FTC. However, there are certain areas where the TPCA and the TSR differ, providing telemarketers with inconsistent guidelines. Telemarketers must also conform to state telemarketing guidelines, some of which vary from both the TSR and TPCA. Violation of the TSR, TCPA and/or state regulations may result in fines of up to $11,000 per violation. The effect of the increased and inconsistent regulations, penalties and a reduced consumer base may have a material adverse impact on our business. Additionally, the FTC and FCC’s decisions are the subject of judicial and regulatory proceedings that could further change, in varying degrees, the manner in which this industry operates. We cannot predict the outcome of any of these proceedings or their impact on the telemarketing industry at this time.

Financial Services

Through our IDT Financial Service LLC subsidiary, we provide certain money transmission services through stored value card products. These money transmission services are regulated under federal laws administered by the Department of Treasury and the Board of Governors of the Federal Reserve System and, on the state level, by the state agency which supervises banking institutions. Laws such as the Gramm-Leach-Bliley Act, the Bank Secrecy Act and the USA Patriot Act place considerable, precise obligations upon providers of such services. We believe that we have developed our products and internal systems to be in compliance with all applicable regulations. However, if a regulatory authority determines that our products and internal systems are deficient, we could be subject to large penalties or make costly alterations to our products and internal systems, which could have a material adverse effect on our business.

Internet Telephony

The use of the Internet and private IP networks to provide voice communications services is a relatively recent market development. Although the provision of such services is currently permitted by United States law and largely unregulated within the United States, several foreign governments have adopted laws and/or regulations that could restrict or prohibit the

30

Table of Contents

provision of voice communications services over the Internet or private IP networks. More aggressive regulation of the Internet in general, and Internet telephony providers and services specifically, may materially and adversely effect our business, financial condition, operating results and future prospects, particularly if increased numbers of governments impose regulations restricting the use and sale of IP telephony services. This additional regulation could have a material adverse effect on Net2Phone.

United States

In an April 10, 1998 Report to Congress, the Federal Communications Commission declined to conclude that IP telephony services constitute telecommunications services and instead indicated that it would undertake a subsequent examination of the question whether certain forms of phone-to-phone Internet telephony are information services or telecommunications services. The FCC indicated that, in the future, it would consider the extent to which phone-to-phone Internet telephony providers could be considered “telecommunications carriers” such that they could be subject to the regulations governing traditional telephone companies such as the imposition of access charges. The FCC stated that, although it did not have a sufficient record upon which to make a definitive ruling, the record suggested that, to the extent that certain forms of phone-to-phone IP telephony appear to possess the same characteristics as traditional telecommunications services and to the extent the providers of those services obtain the same circuit-switched access as obtained by interexchange carriers, the FCC may find it reasonable that they pay similar access charges. The FCC also recognized, however, that it would consider whether it should forbear from imposing any of the rules that would apply to phone-to-phone Internet telephony providers as “telecommunications carriers.”

Although the FCC currently exempts providers of other information and enhanced services from payment of interstate access charges, this decision may be reconsidered in the future. For instance, on April 19, 2001, in Docket No. CC 01-92, the FCC adopted a proposal to begin a fundamental examination of all forms of intercarrier compensation—the payments among telecommunications carriers resulting from their interconnecting networks. The FCC could adopt an intercarrier compensation mechanism and other regulations that could result in an increase in the cost of the local transmission facilities necessary to complete Net2Phone’s calls or a decrease in the costs of such facilities to traditional long distance telephone companies. An increase in Net2Phone’s rates as a result of new FCC regulations, could have a material adverse effect on Net2Phone’s ability to compete with long distance carriers.

In the past year, there have been several significant actions taken by the FCC regarding the regulatory status of Internet telephony. On February 19, 2004, the FCC granted pulver.com a declaratory ruling that its “Free World Dialup,” which facilitates point-to-point broadband Internet protocol voice communications, is neither telecommunications nor a telecommunications service as these terms are defined in section 153 of the Telecommunications Act of 1996. On April 21, 2004, the FCC denied a petition filed by AT&T seeking a declaratory ruling that would prevent incumbent local exchange carriers, or ILECs, from imposing traditional circuit-switched access charges on phone-to-phone IP services. The FCC ruled that AT&T’s particular phone-to-phone prepaid card service was a “telecommunications service” and therefore subject to access charges, although the ruling is limited to the type of service provided by AT&T and does not affect other types of IP voice services.

Most significantly, on March 10, 2004, the FCC released a Notice of Proposed Rulemaking (“NPRM”) regarding Internet Protocol-enabled (“IP-enabled”) services, including VoIP services. The NPRM seeks comment on ways in which the FCC might properly categorize IP-enabled services; whether the FCC has jurisdiction over such services, and, if so, whether that jurisdiction is exclusive; the appropriate statutory classification of the services falling into each category of IP-enabled service; and which regulations, if any, should apply to services falling into each category. The FCC could determine that certain types of Internet telephony should be regulated like basic interstate telecommunications services. Thus, Internet telephony would no longer be exempt from the access charge regime that permits local telephone companies to charge long distance carriers for the use of the local telephone networks to originate and terminate long-distance calls, generally on a per minute basis, which in turn could have a material adverse effect on the ability of Net2Phone to become a viable company in the cable telephony market.

The FCC could also conclude that Internet telephony providers should contribute to the Universal Service Fund, which provides support to ensure universal access to telephone service. The imposition of interstate access charges or universal service contributions would substantially increase Net2Phone costs of serving its customers in the U.S. The imposition of regulation and contribution requirements might also negatively affect the incentives for companies to continue to develop IP technologies to offer VoIP services. It is also possible that the FCC might adopt a regulatory framework that is unique to IP telephony providers or one where IP telephony providers are subject to reduced regulatory requirements. We cannot predict what regulations, if any the FCC will impose.

31

Table of Contents

Other aspects of our services may be subject to state or federal regulation, such as regulations relating to the confidentiality of data and communications, copyright issues, taxation of services, licensing, and 911 emergency access. For instance, in a rulemaking initiated in 2004, the FCC is considering whether providers of IP voice services should be required to design their systems to facilitate authorized wiretaps pursuant to the Communications Assistance to Law Enforcement Act. Also, in its rulemaking concerning IP-Enabled Services, the FCC is considering whether providers of these services should be required to offer access to 911 emergency services. Although Net2Phone’s cable telephony division typically does not currently offer 911 service, it is currently providing it to Liberty Cablevision of Puerto Rico. Net2Phone will continue to develop technologies that may be able to support emergency access and enhanced services. Similarly, changes in the legal and regulatory environment relating to the Internet connectivity market, including regulatory changes that affect telecommunications costs or that may increase the likelihood of competition from the regional Bell operating companies, or RBOCs, or other telecommunications companies, could increase Net2Phone’s costs of providing service.

In addition to the FCC, certain state governments and their regulatory authorities may assert jurisdiction over the provision of intra-state IP communications services where they believe that their telecommunications regulations are broad enough to cover regulation of IP services. Various state regulatory authorities have initiated proceedings to examine the regulatory status of Internet telephony services. While a majority of state commissions have not imposed traditional telecommunications regulatory requirements on IP telephony at this time, some states have issued rulings that may be interpreted differently. The New York State Public Service Commission (NYPSC) has ruled that a particular IP telephony service may be considered telecommunications service subject to access charges. On the other hand, the Florida Legislature passed a bill that exempts VoIP from regulation, although some local exchange companies have attempted to interpret the new law as leaving open the issue of access charges. On October 16, 2003, a Federal court in Minnesota issued a permanent injunction against the MNPUC preventing the MNPUC from imposing state regulations on another provider’s VoIP services offered over broadband connections. A similar, but temporary, injunction has been issued by a Federal court in New York against an NYPSC order seeking to regulate one company’s offering of VoIP services. Net2Phone has received letters from California, Washington, Wisconsin and Florida directing it to register as a telecommunications provider. Net2Phone has responded to these letters by asserting that it is an information service and not a telecommunications provider and, therefore, is not subject to regulation under their laws. There can be no assurance that the states will accept Net2Phone’s position. If the states require Net2Phone to register as a telecommunications provider, it may become subject to significant additional fees and charges. Ultimately, we believe the FCC’s decision in its IP-Enabled proceeding likely will prohibit individual states from implementing regulatory classifications and requirements inconsistent with the federal model. If the FCC does not prevent inconsistent state regulation of Internet telephony, we believe certain states will implement inconsistent regulatory classifications and requirements that will have a material adverse effect on the ability of Net2Phone to offer Internet telephony throughout the country. Ultimately, while we cannot predict what regulations, if any the FCC will impose, we believe FCC regulations may also have a material adverse effect on the ability of Net2Phone to offer Internet telephony.

Packet-Switched Voice Over Cable

The regulatory status of cable VoIP could be affected by the FCC and court decisions in the proceedings discussed above. Net2Phone’s ability to provide cable telephony services to cable operators may also be influenced by federal and state regulations specific to Internet over cable (also known as cable modern services). The FCC has deemed cable modem services to be unregulated information services that do not contain a separate telecommunications component. Additionally, the FCC has found that information services are interstate in nature thus falling out of the regulatory purview of the states. On October 6, 2003, the U.S. Court of Appeals for the Ninth Circuit issued its opinion in Brand X Internet Services v. FCC, reversing the FCC’s prior ruling that cable modem services do not contain a separate telecommunications component and remanded the issue back to the FCC for further proceedings consistent with the court’s decision. The court’s decision was based on procedural grounds. While the FCC has sought to appeal this decision to the U.S. Supreme Court, there is no assurance that the Court will accept the appeal, or if it does that it will rule in favor of the FCC on the merits. Until the challenges to the Ninth Circuit ruling are resolved, the regulatory status of cable modem services remains unchanged. We cannot predict what future actions the FCC may take in response to the Ninth Circuit decision if it is not reversed by the Supreme Court. In the meantime, uncertainty as to the regulatory treatment of cable facilities used to provide information services such as VoIP and as to whether states may attempt to impose any regulations on the telecommunications component of cable modem services may slow the development of these services.

The FCC is engaged in several other proceedings to examine the regulatory treatment of cable modem services and other broadband technologies such as DSL that may indirectly affect the market for Net2Phone’s cable telephony’s service. Although the FCC has maintained a pro-competitive regulatory policy for cable modem and broadband services, Net2Phone

32

Table of Contents

cannot predict the impact that market forces and regulatory developments might have on its business and operations related to Net2Phone’s cable telephony solution.

On the state and local levels, regulators may try to impose additional franchise fees and requirements on cable operators seeking to offer cable telephony within the state. While federal laws limit the extent of state and local regulation over cable networks used to offer telecommunications services, states may nevertheless attempt regulation. The FCC is also examining the role, if any, of state and local government authorities in regulating cable modem and broadband services in general. Where state and local regulators impose additional requirements on cable providers that offer voice or cable modem services, this may create disincentives to cable operators deploying these services and, in turn, materially decrease market demand for Net2Phone’s cable telephony solution.

As state governments, courts, and regulatory authorities continue to examine the regulatory status of Internet telephony services, they could render decisions or adopt regulations affecting providers of Internet telephony services or requiring such providers to pay intrastate access charges or to make contributions to universal service funding. Should the FCC determine to regulate IP services, states may, if not preempted by federal regulation, decide to follow the FCC’s lead and impose additional obligations as well. We cannot predict the actions that federal, state, and local regulators may take or what impact such actions would have on Net2Phone’s business.

International

The regulatory treatment of IP communications outside the United States varies significantly from country to country. Net2Phone operates on a global scale. The regulations we are subject to in many jurisdictions change from time to time, they may be difficult to obtain or it may be difficult to obtain accurate legal translations where official legal translations are unavailable. Additionally, in our experience, the enforcement of these regulations does not always track the letter of the law. Accordingly, although we devote considerable resources to maintaining compliance with these regulations, we cannot be certain that we are in compliance with all of the relevant regulations at any given point in time.

While some countries prohibit IP telecommunications, others have determined that IP services offer a viable alternative to traditional telecommunications services. As the Internet telephony market has expanded, regulators have begun to reconsider whether to regulate Internet telephony services. Some countries currently impose little or no regulation on Internet telephony services. For instance, on January 5, 2001, in the European Union (EU), the European Commission (EC) released a decision concluding that VoIP, in general, continues to fall outside the definition of voice telephony, except where the services satisfy all of four specific conditions. To date, the EC has not ruled that any particular type of VoIP service (such as computer-to-computer or phone-to-phone) satisfies all of these exception conditions. As a result, the EC directed Member States to permit providers to offer VoIP under data transmission general authorizations and without requiring compliance with more burdensome individual licenses and regulations applicable to traditional voice telephony. While the EC monitors and supervises the Member States of the EU subject to the principle of supremacy of EU law, the primary responsibility for implementing the provisions of specific EU legislation lies with the regulatory authorities of the Member States. Accordingly, although Member States are required to adhere to the EU laws, an individual country may decide that a particular VoIP service meets all of the conditions necessary to be regulated as traditional voice services. Net2Phone cannot guarantee that Member States will refrain from imposing additional regulations on our specific VoIP services.

Other countries, including those in which the governments prohibit or limit competition for traditional voice telephony services, generally do not permit Internet telephony services or strictly limit the terms under which those services may be provided. Still other countries regulate Internet telephony services like traditional voice telephony services, requiring Internet telephony companies to make universal service contributions and pay other taxes. While some countries subject IP telephony providers to reduced regulations, others have moved towards liberalization of the IP communications sector and have lifted bans on provision of IP telecommunications services. We cannot predict how a regulatory or policy change of a particular country might affect the provision of our services. We believe that while increased regulations and restrictions could materially threaten Net2Phone’s ability to provide services, the lifting of regulations in a country generally will enable Net2Phone to expand its services and presence in that country.

In some cases where access to some of our services has been blocked by government-controlled telecommunications companies, Net2Phone has tried to negotiate agreements with those governments to provide its services. Net2Phone intends to continue to do the same where similar situations may arise. No assurances can be given, however, that Net2Phone will be successful in such negotiations or that it will be able to provide alternative means of accessing its services that will not be blocked by foreign governments or government-controlled telecommunications companies. The varying and continually changing regulatory landscape of Internet telephony in the countries in which Net2Phone currently provides or may provide services may adversely and materially affect its business, financial condition and results of operations. We

33

Table of Contents

believe that Net2Phone’s experience negotiating this complicated and ever-changing regulatory environment gives it a competitive advantage over other, less experienced competitors attempting to access these international markets.

In addition, as Net2Phone expands into additional foreign countries, some countries may conclude that Net2Phone is required to qualify to do business in their country, that Net2Phone is otherwise subject to regulation, or that Net2Phone is prohibited from conducting our business in such countries. Our failure to qualify as a foreign corporation in certain jurisdictions, or to comply with foreign laws and regulations, may materially and adversely affect Net2Phone’s business.

Moreover, Net2Phone resellers in various foreign countries may be or may become subject to various regulatory requirements. We cannot be certain that Net2Phone’s resellers are currently in compliance with every regulatory or other legal requirement in their respective countries, or that they will be able to comply with existing or future requirements. Failure of Net2Phone’s resellers to comply with these requirements could materially and adversely affect its business, as Net2Phone may not be able to find other resellers for our products and services in these areas.

Regulation of the Internet

In addition to regulations addressing Internet telephony, cable modem, and broadband services, other regulatory issues relating to the Internet in general could affect Net2Phone’s ability to provide services. Congress has adopted legislation that regulates certain aspects of the Internet, including online content, user privacy, taxation, liability for third-party activities, and jurisdiction. In addition, a number of initiatives pending in Congress and state legislatures would prohibit or restrict advertising or sale of certain products and services on the Internet, which may have the effect of raising the cost of doing business on the Internet generally. The European Union has also enacted several directives relating to the Internet, one of which addresses online commerce. Recently, the European Union adopted a privacy directive that establishes certain requirements with respect to, among other things, the confidentiality, processing and retention of personally identifiable subscriber information and usage patterns. The potential effect, if any, of these data protection rules on the development of Net2Phone’s business remains uncertain.

Federal, state, local and foreign governmental organizations are considering other legislative and regulatory proposals that would regulate the Internet. We cannot predict whether new taxes will be imposed on Net2Phone’s services both nationally and internationally, and depending on the type of taxes imposed, whether and how Net2Phone’s services would be affected thereafter. Increased regulation of the Internet may decrease its growth and hinder technological development, which may negatively impact the cost of doing business via the Internet or otherwise materially adversely affect Net2Phone’s business, financial condition, and results of operations.

Regulation of Spectrum

The FCC regulates the grant, renewal and administration of spectrum licenses in the United States. The FCC and the International Telecommunications Union (ITU) also regulate a variety of spectrum interference, coordination, and power emission standards and authorizations. Winstar holds certain spectrum licenses and provides service over that spectrum. Some significant areas of regulation include:

Secondary Spectrum Markets: Spectrum Leasing

On May 15, 2003, the FCC adopted, and on October 6, 2003 released, rules designed, in part, to assist in creating a national secondary market in spectrum leasing. On July 8, 2004 the FCC adopted, and on September 2, 2004, the FCC released, a 2nd Report and Order, Order on Reconsideration, and Second Further Notice of Proposed Rulemaking to further streamline the rules governing secondary spectrum markets and to request further comments about additional future rule changes. Among other things, the FCC installed unprecedented “immediate approval” processes for certain de facto spectrum leases, in addition to certain license assignment and transfer protocols. The FCC also allowed eligible spectrum licensees to manage “private commons”. This essentially means that an eligible license holder, like Winstar, may lease the same spectrum to multiple users, provided those users are aware that the arrangement is non-exclusive. Additionally, the FCC provided for the inclusion of “smart” technologies into the leasing process. Essentially, this allows an eligible license holder to issues leases that account for dynamic technologies that allow splitting spectrum usage over frequency, space and time.

We are actively reviewing this proceeding. The FCC position remains that “explosive” demand exists for spectrum and that accordingly, it took the “landmark” step of opening up traditionally tightly regulated spectrum licenses to allow license holders to lease their spectrum to third parties. In the meantime, and in accordance with the new FCC rules, we continue to actively pursue commercial arrangements to provide spectrum services for third parties, including by engaging in spectrum leasing on favorable terms on the secondary market.

Renewal of 38 GHz and LMDS Licenses

Most of Winstar’s area-wide 39 GHz licenses possess a 10-year term expiring on October 18, 2010. Our remaining 39 GHz licenses expire at various times between November 2006 and March 2010. Winstar’s New York City LMDS license expires

34

Table of Contents

in February 2006. In other radio services, the FCC has historically renewed licenses as a matter of course. The FCC renewed 50 out of 85 licenses in the 39 GHz service in 2001 with the remaining 25 applications renewed in an FCC Memorandum & Order released November 28, 2003. The FCC’s stated policy for renewal of licenses in these bands is that licensees will have a renewal expectancy if they demonstrate substantial service during the initial license periods. We believe that our significant and continuing investment in the development of our national private line telecommunications business and infrastructure along with our ongoing spectrum lease operations demonstrates substantial service for our licenses and that the FCC will renew such licenses. However, the FCC’s application of substantial service criteria cannot be predicted and we cannot assure you that the FCC will renew all of our licenses. A failure by the FCC to renew our licenses in major markets could have a material adverse effect on those businesses.

37 GHz Auction Proceeding and 37GHz and 39 GHz Rule Amendment

On May 5, 2004, the FCC released a 3rd Notice of Proposed Rulemaking seeking comment on, among other things: 1) opening the 37.0-38.6 GHz (37 GHz) band to auction; and 2) establishing an appropriate coordination method to employ between both adjacent licensees and with the Federal government for both the 39 GHz and 37 GHz bands. The outcome of these proceedings may directly impact the rules under which spectrum licensees and leasees may operate their systems.

Proposals from Satellite Operators

We operate our spectrum services primarily in the 38.6 to 40.0 GHz (39 GHz) spectrum band. Several major U.S. satellite companies have made repeated proposals to the FCC to allow commercial satellite systems to operate within that band in the United States. In addition, in September 1999, the National Telecommunications and Information Administration, or NTIA, notified the FCC that the Department of Defense, or DoD, may wish to use the 39.5 to 40.0 GHz portion of the band for a future satellite system.

The FCC has designated the 39 GHz band for exclusive primary non-governmental use to terrestrial fixed services and has to date declined to propose rules that would accommodate the satellite companies’ desire to develop future systems utilizing this spectrum on a ubiquitous shared basis. Proceedings on this matter are still pending at the FCC. A number of satellite companies have recently withdrawn their applications for licensing in the 39 GHz band. We believe that this is the result of modifications to the FCC’s Space Station Licensing Rules and Policies. Some satellite companies’ applications for licenses remain pending. If satellite transmissions were allowed in the 39 GHz band as proposed by many of the satellite companies or the DoD, their transmissions could adversely affect our operations by creating interference or causing the FCC to limit our transmissions in some way.

Pursuant to an international agreement to which the United States is a signatory, the 39 GHz band is allocated on a co-primary basis to terrestrial fixed wireless and fixed satellite services. We are party to various international proceedings related to the use of 39 GHz and other spectrum inside and outside of the United States, including the World Radio Conference (WRC-2003), which was held in Geneva, Switzerland during the summer of 2003. The conference retained the satellite power limits in the International Radio Regulations and added a footnote to the table of power limits further clarifying that these limits shall not be exceeded. The Radio communications sub-committee (CITEL PCC II) of the Organization of American States (OAS) adopted a resolution at its February 2003 meeting that provides guidelines for “Power Flux Density (PFD) Limits in the Band 37.5-40.0 GHz for the Fixed Satellite Service.” This resolution recommends the same limits as the FCC and the Canadian regulatory body, Industry Canada, agreement to protect the fixed service in the band 37.5–40.0 GHz that further limits the power that can be produced by satellite systems in that band on their territories. The ITU continues to examine these issues, including at meetings scheduled for Fall 2004 and Spring 2005.

On December 5, 2003 the FCC issued a Second Report & Order in the V-band, which includes operations in the 36 to 51.4 GHz region, and thus encompassing the 38.6-40.0 GHz band that represents the majority of the Winstar spectrum holdings. In general, the FCC adopted key recommendations to protect the fixed service (FS) and either rejected or deferred making a decision on numerous, potentially harmful satellite industry proposals. Certain NATO-based protections for potential future government satellite systems remain. Satellite interference issues and decision-making continues to occur at the FCC and at the ITU. Winstar continues to use its interference simulator software and scientific personnel to study satellite interference matters and present the benefit of those studies to the FCC, the Department of Commerce, the State Department and the ITU.

Regulation of RF Emissions and RF Environments

The FCC regulates the health and safety effects of radio frequency, or RF, emissions by us and other wireless communications providers. Any FCC licensee whose emissions in an area exceed 5% of the total permissible emissions limit are responsible for ensuring that the site meets applicable health and safety requirements and must notify the FCC and obtain a waiver to operate. The wireless equipment we use is designed to operate at RF emission levels well below the FCC’s stan - -

35

Table of Contents

dard. However, if we operate in an area where other higher RF emitters are operating, we could be required to cooperate with, and contribute financially to, efforts intended to bring the site within applicable health and safety limits. In June 2003 the FCC opened a proceeding requesting comment on proposed changes to its RF Exposure rules. Winstar plans to actively participate in this proceeding. Certain foreign jurisdictions also regulate RF emissions to various degrees. The Occupational Health and Safety Act, or OSHA, requires certain RF monitoring and other measures in RF workplace environments. We believe our RF workplace policies comply with OSHA requirements. The FCC has recently issued a Notice of Proposed Rulemaking (NPRM) regarding “Exposure to Electromagnetic Fields” (ET Docket 03-137) which we are reviewing and which may result in additional protection requirements.

Regulation by the Federal Communications Commission — International Telecommunications Services

Section 214

In the United States, to the extent that we offer services as a carrier, we are required to obtain authority under Section 214 of the Telecommunications Act in order to provide telecommunications service that originates within the United States and terminates outside the United States. We have obtained the required Section 214 authorization from the FCC to provide U.S. international service. In addition, as a condition of our Section 214 authorization, we are subject to various reporting and filing requirements. Failure to comply with the FCC’s rules could result in fines, penalties, forfeitures or revocation of our FCC authorization, each of which could have a material adverse effect on our business, financial condition, and results of operation.

International Settlements

We must conduct our U.S.-originated international business in compliance with the FCC’s International Settlements Policy, the rules that establish the parameters by which U.S.-based carriers and their foreign correspondents settle the cost of terminating each other’s traffic over their respective networks. Under the FCC’s International Settlements Policy, absent approval from the FCC, international telecommunications service agreements with dominant foreign carriers must be non-discriminatory, provide for settlement rates usually equal to one-half of the accounting rate, and require proportionate share of return traffic.

In recent rule reforms, the FCC expressly exempted from the International Settlements Policy rules U.S. carrier arrangements with non-dominant foreign carriers as well as arrangements with any foreign carrier (dominant or non-dominant) on certain competitive routes where at least 50% of U.S.-billed traffic is terminated at settlement rates at least 25% below the FCC’s applicable benchmark settlement rates. There are currently 90 countries that are exempt from the International Settlements Policy, representing 46% of all U.S.-originated international traffic. For arrangements that will continue to be subject to the International Settlements Policy, the FCC imposes mandatory settlement rate benchmarks. These benchmarks are intended to reduce the rates that U.S. carriers pay foreign carriers to terminate traffic in their home countries. The FCC also prohibits a U.S. carrier that is affiliated with a foreign carrier from providing facilities-based switched or private line services to the foreign carrier’s home market unless and until the foreign carrier has implemented a settlement rate at or below the relevant benchmark. Certain confidential filing requirements still apply to dominant carrier arrangements. The FCC could find that we do not meet certain International Settlements Policy requirements with respect to certain of our foreign carrier agreements. Although the FCC generally has not issued penalties in this area, it has issued a Notice of Apparent Liability to a U.S. company for violations of the International Settlements Policy and it could, among other things, issue a cease and desist order, impose fines or allow the collection of damages if it finds that we are not in compliance with the International Settlements Policy. Any of these events could have a material adverse effect on our business, financial condition, or results of operation.

On March 30, 2004, the FCC released an Order that further liberalized its International Settlements Policy (“ISP”) and eliminated its International Simple Resale rules. The Order lessened the number of instances in which the ISP applies, effectively granting US and foreign carriers greater freedom to set rates and terms in their agreements. We believe further orders in the same proceeding will expand the decision to countries not covered by the Order. The Order also directed the FCC to initiate a Notice of Inquiry regarding the foreign mobile termination rates. Because the Order permits carriers to set rates based on negotiations rather than regulatory requirements, foreign carriers we negotiate with may be able to use the increased market freedom to negotiate lower rates. Accordingly, the FCC’s changes to its International Settlements Policy and other international policies could have a material adverse affect on our business, financial condition, or results of operation.

Callback

We offer our callback services pursuant to our Section 214 Authorization. The FCC has determined that callback services that use uncompleted call signaling do not violate U.S. or international law. However, U.S. companies providing such service must comply with the laws of the countries in which they provide callback services. According to an FCC study last

36

Table of Contents

updated in 2001, callback is not permitted in 36 countries. On March 28, 2003, the FCC issued an Order that eliminated the FCC’s comity-based prohibitions on call-back and the policy that allowed a foreign government or entity to make use of the enforcement mechanisms of the FCC to enforce foreign government prohibitions against U.S. carriers from offering uncompleted call-signaling abroad. The FCC determined that the policy is no longer necessary in today’s pro-competitive environment. The FCC also reaffirmed that callback using uncompleted call signaling violates neither U.S. domestic nor international law and found that elimination of the comity-based prohibitions and the policy that allowed foreign governments and entities to use Commission resources to enforce prohibitions on callback in a foreign country is consistent with international law.

The FCC’s Order does not, however, insulate IDT from proceedings initiated by foreign regulators in their respective countries to enforce their prohibitions against callback services. Regulatory requirements pertinent to our operations will continue to evolve as a result of the WTO Agreement and the policies and enforcement of international regulators.

Regulation by State Public Utility Commissions

To the extent that we provide telecommunications services that originate and terminate within the same state, including both local service and in-state long distance toll calls, we are subject to the jurisdiction of that state’s utility commission. As our local service business expands, we will offer more intrastate services and may become increasingly subject to state regulation. The Telecommunications Act maintains the authority of individual state utility commissions to impose their own regulation on rates, terms and conditions of intrastate services, so long as such regulation is not inconsistent with the requirements of federal law. For instance, states may require us to obtain a Certificate of Public Convenience and Necessity before commencing service in the state. IDTA is certificated to provide facilities-based and/or resold long distance service in all 50 states and facilities-based and resold local exchange service in 46 states. We are currently seeking authorization to provide local exchange service in the remaining states. No assurance can be made that the individual state regulatory authorities will approve these or additional certification requests in a timely manner. In addition to requiring certification, state regulatory authorities may impose tariff and filing requirements, consumer protection measures, and obligations to contribute to universal service and other funds. State commissions also have jurisdiction to approve negotiated rates, or establish rates through arbitration, for interconnection, including rates for unbundled network elements. Changes in those rates for unbundled network elements could have a substantial and material impact on our business.

We are subject to requirements in some states to obtain prior approval for, or notify the state commission of, any transfers of control, sales of assets, corporate reorganizations, issuances of stock or debt instruments and related transactions. Although we believe such authorizations could be obtained in due course, there can be no assurance that state commissions would grant us authority to complete any of these transactions, or that such authority will be granted on a timely basis.

We are also subject to state laws and regulations regarding slamming, cramming, and other consumer protection and disclosure regulations. These rules could substantially increase the cost of doing business in any particular state. State commissions have issued or proposed several substantial fines against competitive local exchange companies for slamming or cramming. The risk of financial damage, in the form of fines, penalties and legal fees and costs, and to business reputation from slamming is significant. Even one slamming complaint before a state commission could lead to extensive litigation expense. In addition, state law enforcement authorities may utilize their powers under state consumer protection laws against us in the event legal requirements in that state are not met.

Rates for intrastate switched access services, which we provide to long-distance companies to originate and terminate in-state toll calls, are subject to the jurisdiction of the state commissions in which the call originated and terminated. Such regulation by states could materially and adversely affect our revenues and business opportunities within that state.

The Telecommunications Act generally preempts state statutes and regulations that restrict the provision of competitive services. As a result of this preemption, we will be generally free to provide the full range of local, long distance, and data services in any state. While this action greatly increases our potential for growth, it also increases the amount of competition to which we may be subject. In addition, the cost of enforcing federal preemption against certain state policies and programs may be large and may cause considerable delay. In each jurisdiction where we operate, we anticipate that the ILEC will provide unbundled network elements in a manner similar to that provided in states where we currently operate. However, pricing and terms and conditions adopted by the ILEC in each of these states may preclude our ability to offer a competitively viable and profitable product within these and other states on a going forward basis.

As we enter new markets, we will be required to enter into interconnection agreements with ILECs on an individual state basis. To continue to provide service, we also need to renegotiate interconnection agreements with ILECs as they expire. Under the Telecommunications Act, we have the option of either negotiating the terms of such an agreement, or adopting

37

Table of Contents

the terms of an agreement negotiated by another carrier; but we cannot be certain that other agreements with suitable terms will be available for adoption in all cases. While current FCC rules and regulations require the incumbent provider to provide the network elements on an individual and combined basis necessary for us to provision end-user services, no assurance can be made that the ILECs will provide these components in a manner and at a price that will support competitive operations. If the incumbent providers do not readily provide network functionality in the manner required, we have regulatory and legal alternatives, including arbitration before state public service commissions, to force provision of services in a manner required to support our service offerings. However, if we are forced to litigate in order to obtain the combinations of network elements required to support our service, we are likely to incur significant incremental costs and delays in entering such markets. In addition, there is considerable legal uncertainty as to how interconnection agreements are to be enforced before state commissions and where appeals of state commission interconnection agreement determinations may be heard.

Regulation by Local Governments

FCC rules generally prohibit any state or local zoning law or regulation pertaining to the erection of fixed wireless antennae of the sizes currently used by Winstar by end users on their own property, except for reasonable safety or historic preservation laws. However, local governments retain residual authority to regulate aspects of our communications business by, among other things, imposing franchise fees for the use of certain public property or rights of way. The scope of local authority under the Telecommunications Act has been the subject of a number of disputes between carriers and local authorities and we anticipate the administrative proceedings and litigation relating to these disputes will continue.

Regulation by the Federal Communications Commission — Radio Broadcasting

One of our wholly owned subsidiaries holds certain assets, including authorizations from the FCC, relating to AM band radio station WMET, broadcasting on 1160 MHz and licensed to Gaithersburg, Maryland.

The radio broadcasting industry is subject to extensive and changing regulation of, among other things, program content, advertising content, technical operations and business and employment practices. The ownership, operation and sale of radio stations are subject to the jurisdiction of the FCC. Among other things, the FCC:

The FCC has the power to impose penalties for violations of its rules or the Communications Act of 1934, including the imposition of monetary forfeitures, the issuance of short-term licenses, the imposition of a condition on the renewal of a license, non-renewal of licenses and the revocation of operating authority. The following is a brief summary of some provisions of the Communications Act and of specific FCC regulations and policies. The summary is not a comprehensive listing of all of the regulations and policies affecting radio stations. For further information concerning the nature and extent of federal regulation of radio stations, you should refer to the Communications Act, FCC rules and public notices, and the rulings of the FCC and applicable courts.

FCC AM Radio Licenses

Radio stations operate pursuant to renewable broadcasting licenses that are ordinarily granted by the FCC for maximum terms of eight years. A station may continue to operate beyond the expiration date of its license if a timely filed license renewal application is pending. During the periods when renewal applications are pending, petitions to deny license renewals can be filed by interested parties, including members of the public. The FCC is required to hold hearings on a station’s renewal application if a substantial or material question of fact exists as to whether the station has served the public interest, convenience and necessity. If, as a result of an evidentiary hearing, the FCC determines that the licensee has failed to meet certain requirements and that no mitigating factors justify the imposition of a lesser sanction, then the FCC may deny a license renewal application. Historically, FCC licenses have generally been renewed. WMET’s FCC license expires on October 1, 2011. We have no reason to believe that our license for station WMET will not be renewed in the ordinary course, although there can be no assurance to that effect. The non-renewal of that license could have a material adverse effect on our radio business.

38

Table of Contents

Pursuant to FCC rules and regulations, many AM radio stations, including WMET, are authorized to operate only at a reduced power during the nighttime broadcasting hours, which results in reducing the radio station’s coverage during the nighttime hours of operation.

WMET currently is licensed to serve Gaithersburg, Maryland as a Class B AM station on 1160 MHz with 1 kilowatt of effective radiated power during the daytime hours and 0.5 kilowatt during the nighttime hours. However, the FCC has granted WMET program test authority to operate on 1160 MHz with 50 kilowatts of effective radiated power during the daytime hours and 1.5 kilowatts during the nighttime hours. That authority was granted to allow the station to operate on 1160 MHz at those higher power levels while an application for a new license to operate WMET at that frequency and at those power levels is pending before the FCC. We have been informed by the FCC that a number of residents of a community near WMET’s transmitting facilities have complained to the FCC about interference from the station affecting telephones and other electronic devices. We may be required under FCC rules to resolve certain of these interference complaints, and our failure to do so may result in the delay of the grant of our new license and the limitation of our ability to continue to broadcast under the current program test authority.

Transfers or Assignment of AM Radio License

The Telecommunications Act prohibits the assignment of broadcast licenses or the transfer of control of a broadcast licensee without the prior approval of the FCC. In determining whether to grant such approval, the FCC considers a number of factors pertaining to the licensee and proposed licensee, including:

If we determine that it is in our best interest to sell the WMET license to a third party, we will need to obtain the prior consent of the FCC before consummating the sale of the WMET FCC license.

INTERNATIONAL REGULATION

International Licensing for Telecommunications Services

In connection with the growth of our international operations, we have obtained licenses or are otherwise authorized to provide telecommunications services in various foreign countries. Through direct or indirect subsidiaries, we have obtained licenses or authorizations in Argentina, Austria, Belgium, Canada, Germany, Hong Kong, Italy, the Netherlands, Singapore, Spain, Sweden, the United Kingdom, Russia, Mexico and Peru.

European Regulation of Telecommunications Services

In Europe, the regulation of the telecommunications industry is governed by the European Union and to a large extent by the national law of the individual European Union Member States. The European Union’s institutions, such as the European Commission, are responsible for creating pan-European policies. Through legislation, the European Union has developed a regulatory framework aimed at creating an open, competitive telecommunications market. The European Union was established by the Treaty of Rome and subsequent conventions and the European Commission and the Council of Ministers of the European Union are authorized by such treaties to issue European Union “directives.” Membership of the European Union was increased from 15 to 25 Member States on 1 May 2004 with the addition of Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia (“the New Member States”). Member States are required to implement these directives through national legislation. If a Member State fails to adopt such directives, the European Commission may take action, including referral to the European Court of Justice, to enforce the directives. In practice, Member States have significant discretion regarding how to implement Directives into their national law system. For example, while the Authorization Directive provides Member States the required overall framework, the authorization schemes adopted by Member States have the potential to vary accordingly. Only in specific cases, the European Commission, in concert with the European Parliament and other relevant European Union institutions will render regulations or individual decisions on specific issues that become effective immediately without requiring Member States to adopt them on a country-by-country basis.

In March 1996, the European Union adopted the Full Competition Directive containing two provisions which required Member States to allow the creation of alternative telecommunications infrastructures by July 1, 1996, and which reaffirmed the obligation of Member States to abolish the incumbent telecommunications operator’s (“ITOs”) monopolies in voice telephony by 1998. Certain Member States, such as Greece, were allowed to delay the abolition of monopolies in public voice telephony based on exemptions established in the Full Competition Directive.

39

Table of Contents

In February 2002 the European Union adopted a new regulatory package for the regulation of electronic communications networks and services that replaces the old regime founded in the Full Competition Directive. The basis for the new regulatory framework is four major new EU Communications Directives that are intended to converge and harmonize communication regulation throughout the community. The four directives are: (a) Directive 2002/21/EC on a common regulatory framework for electronic communications networks and services (the Framework Directive); (b) Directive 2002/20/EC on the authorization of electronic communications networks and services (the Authorization Directive); (c) Directive 2002/19/EC on access to, and interconnection of, electronic communications networks and associated facilities (the Access Directive); and (d) Directive 2002/22/EC on universal service and users’ rights relating to electronic communications networks and services (the Universal Service Directive).

The Framework Directive provides the overall structure for the new regulatory regime and sets out fundamental rules and objectives that read across all the new directives. The Authorization Directive replaces the existing licensing regime and establishes a new system whereby any person will be generally authorized to provide communications services and/or networks without prior approval, save in cases where individual licenses or rights of use are needed to make the best use of limited resources (notably radio spectrum and telephone numbers). They may however have to notify the national regulatory authority (NRA) of what they are providing, and be required to comply with regulatory obligations developed by the NRA to apply to communications providers both generally and in certain limited circumstances. The Authorization Directive also imposes restrictions on the possible subject matter of the regulatory obligations that can be applied. Permissible matters for obligations which can be applied generally include consumer protection, standards and interoperability requirements, environmental and planning requirements, administrative charges, maintenance of the integrity of public networks and coordination with emergency services, etc. Permissible matters for obligations that can be applied specifically include ensuring access and interconnection, ensuring provision of universal service etc. The Access and Interconnection Directive sets out the terms on which providers may access each others’ networks and services with a view to providing publicly available electronic communications services. The Universal Service Directive defines a basic set of services that must be provided to end-users.

Member States were required to implement the terms of the new regulatory framework by July 25, 2003. Implementation of the terms of the new regulatory framework was also required of the New Member States by May 1, 2004. As described above, the discretion available to Member States as to the way in which the they implement directives is likely to result in different approaches being taken by individual Member States in certain areas. For example, while all Member States are generally required to abolish individual licenses, they have the discretion to decide whether to require that entities seeking to fall within the new authorization scheme need to notify their intention to provide relevant networks or services in advance of commencing activities. It may therefore become necessary for us to apply for additional general authorizations in individual Member States or otherwise to notify the local NRA of our activities, regardless of whether we held an appropriate license under the old regime. IDT is monitoring the implementation of the new regulatory regime in each Member State and intends to take appropriate action where necessary in order to remain compliant when each new regime comes into force. Under the new regulatory regime it may also become necessary for us to provide certain interconnection or other access services to other carriers, to provide for interception by state authorities, and to pay into universal service funds pursuant to national law.

Data Protection

European regulators and authorities have developed detailed provisions on data protection and privacy in the individual Member States. In particular, these provisions govern the collection, storage, transfer and access to personal data that are only harmonized to some extent by European Union directives. Compliance with national legal requirements may involve, for instance, the appointment of data protection officers by us and our subsidiaries, compliance with reporting requirements to national authorities, putting in place contracts governing the transfer to and processing by third parties of personal data (or the transfer to and processing of personal data by IDT), and notification requirements vis-à-vis individuals (e.g., obtaining an individual authorization before personal data are collected, stored or transferred). Recently, the United States and European Union agreed upon so-called “Safe Harbor Principles” to reconcile the differences between U.S. and European Union approaches to privacy and data protection regulation. Compliance with these principles on a voluntary basis will likely ensure that traffic data flowing from the European Union to the United States will not be interrupted and help minimize the risk of sanctions under national law. However, the “Safe Harbor Principles” will neither cover the collection and storage of data by facilities in Member States, nor regulate the data flow to and from third countries, which remains under the jurisdiction of each Member State’s national law. In addition, in such European countries where we are licensed as a voice telephony provider, specific data protection rules on issues relating to telecommunications services (e.g., billing, directory entrances, etc.) may apply.

40

Table of Contents

In addition, the European Union has adopted Directive 2002/58/EEC, a separate, complementary directive pertaining to the processing of personal data and the protection of privacy in the electronic communications sector. Member States were required to implement this Directive by 31 October 2003. This directive establishes certain requirements with respect to, among other things, the processing and retention of subscriber traffic and billing data, network security, subscriber rights to non-itemized bills, the presentation and restriction of calling and connected line identification, the use of internet “cookies” and regulations on direct marketing by electronic communications. It updated Directive 97/7/EC, which regulated a number of the same matters.

In addition, a number of European countries outside the European Union have adopted, or are in the process of adopting, data protection rules similar to those set forth in the European Union directives. The European Union also has enacted Directive 97/7/EC to protect consumers entering distance contracts. Distance contracts are generally contracts for goods or services where the contact between the supplier and the consumer takes place at a distance by means of communications technologies. This directive requires that the consumer be provided with certain information, such as the identity of the supplier, the arrangements for payment, delivery or performance, the existence of a right of withdrawal, and the cost of using the means of distance communication prior to entering the contract. Such information must be provided in a clear and comprehensible manner in any way appropriate to the means of distance communication used, with due regard to the principles of good faith in commercial transactions. While this directive has been effective since June 1997, all Member States were required to implement Directive 97/7/EC by June 4, 2000. To the extent that we enter into distance contracts, this directive may have a material adverse effect on our business, financial condition, operating results and future prospects.

The European Union has adopted the final version of Directive 2000/31/EC governing electronic commerce. Member States were required to implement this directive by 17 January 2002. The directive covers “Information Society services” or “any service normally provided for remuneration, at a distance, by electronic means and at the individual request of a recipient of services,” between the Member States. Information Society services generally includes both business-to-business services and business-to-consumer service. The directive establishes a general e-commerce legal framework covering service provider authorizations, commercial communications, electronic contracts, the liability of intermediary service providers, codes of conduct, out-of-court dispute settlements, court actions and cooperation between Member States. Increased regulation of the Internet or of transaction facilitation via the Internet by the European Union could have a material adverse effect on our business, financial condition, operating results and future prospects.

There will continue to be growth in transborder data flows between and among the various IDT companies and their affiliates. To enable us to comply with relevant European Union Data data protection laws while facilitating the movement of data between IDT companies in different countries, the relevant IDT group companies intend to enter into corporate protocols relating to the handling of data.

Other Overseas Markets

In numerous countries where we operate or plan to operate, local laws and regulations restrict or limit the ability of telecommunications companies to provide telecommunications services in competition with state-owned or state-sanctioned dominant carriers. In several countries where we do not have sufficient or established contractual relationships with the dominant carrier, we contract with licensed carriers who provide alternative telecommunications services in such countries. There can be no assurance that current or future regulatory, judicial, legislative, or political considerations will permit us to offer all or any of its products and services in such countries, that regulators or third parties will not raise material issues regarding our compliance with applicable laws or regulations, or that such regulatory, judicial, legislative, or political decisions will not have a material adverse effect on us. If we are unable to provide the services that we presently provide or intend to provide or to use our existing or contemplated transmission methods, or are subjected to adverse regulatory inquiry, investigation or action, such developments could have a material adverse effect on our business, financial condition, and results of operation.

The foregoing is not an exhaustive list of proceedings or issues that could materially affect our business. We cannot predict the outcome of these or any other proceedings before the courts, the FCC, legislative bodies, or state or local governments.

INTELLECTUAL PROPERTY

We regard our trademarks, service marks, copyrights, patents, trade secrets, proprietary technology and similar intellectual property as important strategic assets. Given the rapid pace of technological advancement, accelerating product life cycles, and an increasingly litigious environment, we have aligned our intellectual property strategy with our overall business strategy so as to maximize revenue, manage risk, minimize costs and use intellectual property for competitive advantage.

IDT owns, directly or through subsidiaries, 172 trademark and service mark registrations in the United States and additional registrations abroad. We actively police our brands and, when deemed appropriate, we have initiated litigation to protect our

41

Table of Contents

marks from infringers. We also have 144 trademark and service mark applications pending in the United States and abroad. We are also continuing an international filing program to register the mark “IDT,” and the IDT logo in various foreign countries. There can be no assurance that we will be able to secure registrations and maintain protection on our marks in all the countries where we deem it important to do so. We may encounter obstacles to our registration and use of the IDT marks in some countries.

We also rely on trade secret laws to protect our valuable proprietary technology and business methods. Where deemed appropriate, we have filed patent applications in an effort to protect our patentable intellectual property. IDT now has over 45 patent applications pending in the United States and abroad relating to various aspects of our business activities. We own 2 patents issued in the United States and 8 patents issued abroad.

Net2Phone

Net2Phone relies on a combination of patents, trademarks, domain name registrations and trade secret laws and contractual restrictions to enforce its intellectual property rights against others.

Net2Phone currently owns 27 patents issued in the United States and 28 foreign patents, plus over 30 other applications pending in both the United States and abroad. One of the patents expires on September 3, 2005.

The ability to make, use, sell or offer for sale Net2Phone’s products and services is important to its business. Net2Phone is aware that patents have been granted to others based on fundamental technologies in the Internet telephony area. It is possible that certain patent infringement claims might be asserted successfully against Net2Phone in the future. A party making an infringement claim could secure a substantial monetary award or obtain injunctive relief that could effectively block Net2Phone’s ability to provide services or products in the United States or abroad. If any of these risks materialize, Net2Phone could be forced to suspend operations, to pay significant amounts to defend its rights and/or secure an expensive license. A substantial amount of the attention of Net2Phone’s management may be diverted from our ongoing business. Moreover, because patent applications in the United States are not publicly disclosed when filed, third parties may have filed applications that, if issued as patents, could result in claims against Net2Phone in the future. These claims could materially adversely affect Net2Phone’s ability to operate and its financial condition and results of operations. Net2Phone may be able to use its patents against such claims, for example, if cross-licenses are warranted.

Net2Phone owns 44 registered trademarks in the United States and more than 100 foreign registered trademarks.

Net2Phone’s most important mark is NET2PHONE. Net2Phone has made a significant investment in protecting this mark, and Net2Phone believes it has achieved recognition in the United States and abroad. Net2Phone is currently engaged in an international filing program to file trademark applications for trademark registrations of the mark NET2PHONE in a number of foreign countries. We cannot give assurance that Net2Phone will be able to secure registration and maintain protection for NET2PHONE in all the countries where it deems it important to do so. Competitors of Net2Phone’s or other third parties may adopt marks similar to its mark NET2PHONE, thereby interfering with Net2Phone’s efforts to build brand identity and possibly leading to customer confusion.

Net2Phone has encountered trademark oppositions challenging its registration and use of the NET2PHONE mark in several countries. Net2Phone has also encountered refusals to registration from local trademark offices in several foreign countries, typically based on the asserted grounds that the mark is descriptive/non-distinctive or that it conflicts with a prior registered mark. In addition, in a limited number of situations, third parties have challenged Net2Phone’s marks. Net2Phone’s practice is to oppose vigorously such challenges, and Net2Phone have generally been successful.

Unlike patents, which have a limited duration, Net2Phone’s trademarks will continue to be registered so long as Net2Phone pays the required fees and Net2Phone does nothing to lose its rights, such as permit others to use the same mark.

Net2Phone and IDT

Net2Phone and IDT, respectively, have registered many Internet domain names that contain the term NET2PHONE or IDT. We cannot assure you that we will be successful in registering all of the domain names that we might want to have, either because of unwarranted expense, inability to register the domain due to registrar requirements that we cannot meet, or because of third parties who previously registered the relevant domain name. We have encountered several instances of third parties who have registered the term NET2PHONE or IDT within a domain name. We have generally had success in obtaining the transfer of those domains that we deemed important to our business from such third parties by agreement, institution of accepted domain name dispute resolution proceedings or other means. We cannot assure you that we will be

42

Table of Contents

successful in the future in obtaining all domain names that we deem important. Finally, there are many variations of the words NET2PHONE and IDT, and it is difficult, if not impossible, to register each variation, or to pursue all pirates who register such variations. Because we are in large part an Internet business, we may be materially and adversely affected by the unauthorized use of the word NET2PHONE or IDT, or of a substantially similar word, in a domain name owned by a third party.

All key employees of IDT and Net2Phone have signed confidentiality agreements, and it is our standard practice to require newly hired employees to execute confidentiality agreements. These agreements provide that the employee or consultant may not use or disclose confidential company information except as expressly permitted in connection with the performance of his or her duties for the company, or in other limited circumstances. These agreements also state that, to the extent rights in any invention conceived of by the employee or consultant while employed by us do not vest in the company automatically by operation of law, the employee or consultant is required to assign his or her rights to us. The steps taken by us may not, however, be adequate to prevent the misappropriation of our proprietary rights or technology.

IDT Entertainment

IDT Entertainment relies on licenses and ownership of the intellectual property contained in the content it develops and distributes. Protection of these rights is essential to IDT Entertainment’s success. Entertainment companies may be subject to claims that their productions infringe on the intellectual property rights of third parties with respect to previously developed entertainment content.

General

From time to time we may be subject to claims and legal proceedings from third parties in the ordinary course of business, including claims of alleged infringement of trademarks, service marks, copyrights, patents and other intellectual property rights. Certain of these proceedings are described under the heading “Legal Proceedings” below. In recent years, patent licensing and enforcement groups have been actively targeting industries, including the telecom industry. For example, we were approached by Ronald A. Katz Technology Licensing, L.P. who demanded that we obtain a license from it to a portfolio of patents, asserting that the patents were infringed by certain products and services offered by us. On January 21, 2004, we filed a complaint for declaratory relief in the United States District Court, District of New Jersey, against Ronald A. Katz Technology Licensing, L.P. asking the Court to find claims of the relevant patents invalid, unenforceable and not infringed by us. The defendant has until November 10, 2004 to respond. Meanwhile, settlement negotiations are ongoing.

Even if our products and processes are ultimately held not to infringe a third party’s intellectual property rights, resolving any such claims can be time-consuming and costly, and may divert management’s attention and resources away from our business. Such claims might also result in a preliminary injunction prohibiting certain commercial activities we consider important to our business, and, if later found to be meritorious, may result in a permanent injunction and the imposition of damages. Claims of intellectual property infringement might also require us to enter into costly license agreements. If any of these risks materialize we could be forced to suspend certain operations, to pay significant amounts to defend our right to continue to engage in the commercial activities complained of, and/or secure an expensive license. If we cannot or do not license the allegedly infringed rights or cannot substitute a non-infringing device or activity, or cannot obtain essentially equivalent rights from a licensed third party, our business could suffer. Moreover, because patent applications in the United States and elsewhere are not typically published for public inspection for at least eighteen (18) months from the date when they are filed, third parties may have filed applications that, if issued as patents, could result in claims against us in the future. Thus, there can be no assurances that any such claims, legal proceedings and/or license agreements would not have a material adverse effect on our business, operating results and financial condition.

Despite our efforts to protect our intellectual property, our intellectual property rights may ultimately not provide us with a significant competitive advantage. The protection of our intellectual property also may require the expenditure of significant financial and managerial resources and we may elect not to incur costs that are not outweighed by the potential benefits that may be realized. Effective trademark, service mark, copyright, patent and trade secrets protection may not be available, or we have decided for business reasons not to seek protection, in every jurisdiction in which our products and services are made available. Moreover, our intellectual proprietary rights could be challenged, invalidated or circumvented. Third parties that license proprietary rights from us may take actions that diminish the value of our proprietary rights, goodwill and/or reputation. Ultimately, the steps we take to protect our proprietary rights may not be adequate and third parties may infringe our trademarks, service marks, trade dress, copyrights, patents and otherwise misappropriate similar proprietary rights such as trade secrets. Moreover, given the rapid pace of technological change in the information technology industry, many of our products rely on key technologies developed by third parties, and we may not be able to obtain commercially reasonable licenses from these third parties.

43

Table of Contents

INTERNATIONAL SALES

In fiscal 2004, 2003 and 2002, revenue from customers located outside of the United States accounted for approximately 23%, 19% and 19% of our total revenues, respectively. We anticipate that revenues from international customers will continue to account for a significant percentage of our total revenues.

EMPLOYEES

As of October 1, 2004, we had a total of 4,434 employees, excluding employees of Net2Phone and Mainframe. As of October 1, 2004, Net2Phone had a total of 274 employees and Mainframe had 281 employees.

RISK FACTORS

Our business, operating results or financial condition could be materially adversely affected by any of the following risks as well as the other risks highlighted elsewhere in this document, particularly the discussions about regulation, competition and intellectual property. The trading price of our Class B common stock and common stock could decline due to any of these risks.

Risks Related to Our Telecommunications Businesses

Each of our telecommunications business lines is highly sensitive to declining prices, which may adversely affect our revenues and margins.

The worldwide telecommunications industry has been characterized in recent years by intense price competition, which has resulted in a significant decline in both our average per-minute price realizations and our average per-minute termination costs. Many of our competitors in both the retail telecommunications services (including prepaid calling cards, private label calling cards and consumer phone services) and wholesale carrier businesses have begun to aggressively price their services. This has led to continued erosion on pricing power, both in our retail and wholesale markets, and we have generally had to pass along our per minute cost savings to our customers, in the form of lower prices. Therefore, our telecommunications revenues have increased at a much slower rate. If this trend continues or increases, it could have a material adverse effect on the revenues and margins generated by our telecommunications business lines.

Because our prepaid calling cards generate the bulk of our revenue, our growth is substantially dependent upon continuing growth in that area, and we face significant competition.

During fiscal 2004, prepaid calling cards accounted for 60.4% of IDT Telecom’s total consolidated revenues, and we sold more than 325 million prepaid calling cards. We compete in the prepaid calling card market with many of the established facilities-based carriers, such as AT&T, MCI and Sprint. These companies are substantially larger and have greater technical, engineering, personnel and marketing resources, longer operating histories, greater name recognition and larger customer bases than we do. The resources of these competitors could significantly impact our ability to compete successfully.

We may not be able to obtain sufficient or cost-effective termination capacity to particular destinations to keep up with our growth.

Most of our telecommunications traffic is terminated through third-party providers. In order to keep pace with our growth of minutes of use, we may need to obtain additional termination capacity. We may not be able to obtain sufficient termination capacity from high-quality carriers to particular destinations or may have to pay significant amounts to obtain such capacity. This could result in our not being able to sustain growth in minutes of use or in higher costs per minute to particular destinations, which could adversely affect our revenues and margins.

Our customers, particularly our wholesale carrier customers, could experience financial difficulties which could adversely affect our revenues and profitability if we experience difficulties in collecting our receivables.

As a wholesale provider of international long distance services, we depend upon traffic from other long distance providers, and the collection of receivables from these customers. Since 2002, several of these customers have declared bankruptcy or otherwise faced financial difficulties. If continued weakness in the telecommunications industry reduces our ability to collect our accounts receivable from our major customers, particularly our wholesale carrier customers, our revenues may be substantially reduced. While our most significant customers vary from quarter to quarter, our five largest wholesale carrier customers accounted for 6.5% of our total consolidated revenues in fiscal 2004 compared with 4.8% in fiscal 2003. This concentration of revenues increases the risk of non-payment by customers, and we may experience significant write-offs related to the provision of wholesale carrier services if any of our large customers fail to pay their outstanding balances, which could adversely affect our revenues and profits.

44

Table of Contents

The termination of our carrier agreements with foreign partners or our inability to enter into carrier agreements in the future could materially and adversely affect our ability to compete in foreign countries, which could reduce our revenues and profits.

We rely upon our carrier agreements with foreign partners in order to provide our telecommunication services to our customers. These carrier agreements are for finite terms and, therefore, there can be no guarantee that these agreements will be renewed. Our ability to compete in foreign countries would be adversely affected if our carrier agreements with foreign partners were terminated or we were unable to enter into carrier agreements in the future to provide our telecommunications services to our customers, which could result in a reduction of our revenues and profits.

Our revenues and our growth will suffer if our distributors and sales representatives, particularly Union Telecard Alliance, LLC, fail to effectively market and distribute our prepaid calling card products and other services.

We rely on our distributors and representatives for marketing and distribution of our prepaid calling card products and other services. We hold a 51% ownership interest in Union Telecard Alliance, LLC, or UTA, which utilizes a network of more than 1,000 sub-distributors (ranging from large companies to sole proprietors) that sell to over 250,000 retail outlets throughout the United States to distribute our prepaid calling cards. In foreign countries, we are dependent upon our distributors and independent sales representatives, many of which also sell services or products of other companies. As a result, we cannot control whether these foreign distributors and sales representatives will devote sufficient efforts to selling our services. In addition, we may not succeed in finding capable retailers and sales representatives in new markets which we may enter. If our distributors or sales representatives fail to effectively market or distribute our prepaid calling card products and other services, our ability to generate revenues and grow our customer base could be substantially impaired.

Increased competition in the consumer and business telephone market, particularly from the regional bell operating companies, or RBOCs, and cable operators, could limit or reverse our growth in that area.

We offer long distance phone service to residential and business subscribers throughout the United States and we offer local service, bundled with long distance service, to residential subscribers in 13 states. The U.S. consumer phone service industry is characterized by numerous entities competing for a relatively static number of customers, leading to a high customer turnover rate because customers frequently change service providers in response to offers of lower rates or promotional incentives. Competition in the United States to provide phone services is intense. Our primary competitors include the Regional Bell Operating Companies, or RBOCs, as well as the major long distance carriers such as AT&T, MCI and Sprint. The four RBOCs are (i) BellSouth, (ii) SBC Communications (including former Ameritech, Pacific Bell, Southwestern Bell and Southern New England Telephone), (iii) Qwest (including former US West) and (iv) Verizon (including former NYNEX, Bell Atlantic and GTE). These are all substantial companies, and competing against them is extremely challenging. Each of the RBOCs continues to enjoy a virtual monopoly as the Incumbent Local Exchange Carrier, or ILEC, in its respective territory and the RBOCs are well funded. In a battle for market share, the RBOCs have considerable resources. Some of our competitors offer products and services available as part of their bundled service offerings, such as wireless services and high speed Internet access, that we do not presently offer. Our ability to compete in the bundled service market is dependent on our ability to have reasonably priced access to the facilities necessary to provide service at rates equal to or lower than those of our competitors. As of the date of this report, our right to continue to receive reasonably priced access to necessary facilities is being addressed at the United States Court of Appeals for the District of Columbia Circuit, the Federal Communications Commission and at various state public utility commissions. See “Regulatory Risks” below. If we do not receive favorable decisions in these forums, our ability to offer competitive bundled service offerings could be materially adversely affected.

We also compete in the consumer phone service market with cable operators. Cable operators present a significant and ever-increasing challenge to us, because (i) many cable operators market their cable telephony product as a VoIP service, so they do not charge certain “telecommunications” fees, such as the Subscriber Line Charge and the Federal Excise Tax, to subscribers, thus permitting the cable operators to provide their service at highly competitive rates, and (ii) cable operators offer television and high-speed Internet access along with their telephony product, providing a “one stop shopping” service. In addition, we are at a disadvantage vis-à-vis cable operators because cable operators have their own network and are not reliant on ILEC facilities to provide service and are not affected by regulatory uncertainty facing access to and the cost of ILEC facilities. We in particular face an additional competitive challenge because Cablevision and Time Warner — two cable operators that have been particularly aggressive in rolling out a cable telephony product — have clusters of cable franchises that overlap areas where a high percentage of our local telephony subscribers are located.

45

Table of Contents

Risks Related to IDT Entertainment

We rely on a few major customers in realizing our home entertainment distribution revenues and a reduction in our business with these customers could have an adverse effect on us.

A small number of retailers account for a significant percentage of our home entertainment distribution revenues. We do not have long-term agreements with any of these customers. We cannot assure you that we will continue to maintain favorable relationships with these customers or that they will not be adversely affected by economic conditions. If any of these customers reduces or cancels its relationship with us, it could have a material adverse effect on IDT Entertainment’s business, results of operations and financial condition.

A significant portion of our home entertainment distribution revenues comes from a small number of titles. A loss of our rights to these titles, or our failure to replace them when our rights expire, could significantly harm our home entertainment distribution business.

We depend on a limited number of titles for a significant portion of the revenues generated by our home entertainment distribution activities. In addition, many of the titles in our library are not presently distributed and generate substantially no revenue. If we were to lose access to our significant titles, or were unable to license new products, it could have a material adverse effect on our home entertainment distribution business’ results of operations and financial condition.

The success of IDT Entertainment may depend on audience acceptance of our CG animated feature films, which is extremely difficult to predict and therefore inherently risky.

We are spending an increasing amount of time and resources on the development of proprietary CG animated feature films and other CG animated content. We cannot predict the economic success of any of our proprietary products, because the revenue derived from the distribution of entertainment products depends primarily upon its acceptance by the public, which cannot be accurately predicted. If our films do not achieve audience acceptance, it could result in costs not being recouped or anticipated profits not being realized. If our feature films or other entertainment products are not as successful as we forecast, or if they do not recoup our investments in those properties, the operating results of IDT Entertainment could be adversely affected.

Animated films are expensive to produce and the uncertainties inherent in their production could result in the expenditure of significant amounts on films that are canceled or significantly delayed, which would adversely affect our revenues and financial condition.

The production, completion and distribution of animated feature films are subject to a number of uncertainties, including delays and increased expenditures due to creative problems, technical difficulties, talent availability, accidents, natural disasters or other events beyond our control. Because of these uncertainties, the projected costs of an animated feature film at the time it is set for production may increase, the date of completion may be substantially delayed or the film may be abandoned due to the exigencies of production. Delays in production may also result in a film not being ready for release at the intended time and postponement to a potentially less favorable time, which could result in lower gross receipts for that film. In extreme cases, a film in production may be abandoned or significantly modified (including as a result of creative changes) after substantial amounts have been spent, causing the write-off of expenses incurred with respect to the film.

Piracy, including digital and Internet piracy, may decrease revenue received from the exploitation of our entertainment products.

Intellectual property piracy is extensive in many parts of the world and is made easier by technological advances and the conversion of motion pictures into digital formats. The proliferation of unauthorized copies and piracy of our entertainment products could have an adverse affect on our business because these products reduce the revenue we receive from our production and distribution of legitimate products.

Risks Related to Net2Phone

Net2Phone has never been profitable.

Net2Phone has never generated profits from operations, except for fiscal 2003, which would not have been profitable if not for a litigation settlement. Net2Phone’s aggregate revenues from inception to July 31, 2004 were approximately $583.0 million, and its accumulated deficit was approximately $773.7 million as of that date. Net2Phone will need to generate significant additional revenue to achieve profitability. Net2Phone may not be able to do so. Even if it does achieve profitability, we cannot assure you that Net2Phone will be able to sustain or increase profitability on a quarterly or annual basis in the future.

46

Table of Contents

Net2Phone intends to pursue new streams of revenue, including from its cable telephony business, which it has not attempted to generate before and which may not be profitable.

In addition to its current revenue, Net2Phone is pursuing new revenue opportunities, particularly from its cable telephony business. In fiscal 2004, Net2Phone devoted, and will continue to devote, significant capital and resources to the development of its cable telephony business, and we cannot ensure when or if this investment will be profitable. Net2Phone’s business models for its cable telephony business have not been tested on a broad basis.

Net2Phone has not tested its cable telephony service on a large scale or with multiple operators in multiple jurisdictions. We cannot be sure that its service offering will be scalable to the extent necessary to serve a large customer base or that its services will deliver sufficient reliability or quality on a large scale basis, or at all. We cannot assure you that Net2Phone will obtain additional customers for its cable telephony business or that this business will be profitable.

Pricing pressures and increasing use of VoIP technology may lessen Net2Phone’s competitive pricing advantage.

Net2Phone’s success is based partly on its ability to provide discounted voice services by taking advantage of cost savings achieved by carrying voice traffic employing VoIP packet switched technologies, as compared to carrying calls over traditional circuit switched networks. In recent years, the price of telephone service has generally fallen. The price of telephone service may continue to fall for various reasons, including the adoption of VoIP technology by other communications carriers. Many carriers have adopted pricing plans such that the rates that they charge are not always substantially higher than the rates that Net2Phone charges for similar service. In addition, other providers of long distance services are offering unlimited or nearly unlimited use of some of their services for a competitive monthly rate. The overall effect of these developments may be to reduce the price of local and long distance calls to a point where VoIP providers such as Net2Phone no longer have a price advantage. Net2Phone would then have to rely on factors other than price to differentiate its product and service offerings, which it may not be able to do. If it is not able to do so, Net2Phone’s business, financial condition and results of operations may be materially and adversely affected.

Net2Phone has and plans to increasingly depend on its international operations, which subject it to unpredictable regulatory, economic and political situations.

Net2Phone’s customers based outside of the United States currently generate a majority of its revenue. A significant component of Net2Phone’s strategy is to continue to expand internationally. Net2Phone may not be successful in expanding into additional international markets. In addition to the uncertainty regarding Net2Phone’s ability to generate revenue from foreign operations and expand its international presence, there are certain risks inherent in doing business on an international basis, including:

For example, several of Net2Phone’s largest customers are based in the Middle East, Asia and Latin America and other areas of the world where there is the potential for significant political and economic instability. Net2Phone has experienced power supply problems, difficulty maintaining local customer support and difficulties dealing with local companies and governments in some of these regions. Moreover, developments in the Middle East, such as the continuation of hostilities involving the United States or others, could result in the disruption of Net2Phone’s business in the regions affected by the hostilities. These difficulties could materially and adversely affect Net2Phone’s business, financial condition and results of operations.

47

Table of Contents

Risk Related to Our Financial Performance and Growth Strategy

We have incurred significant losses since our inception, which could cause the trading price of our stock to decline.

We have incurred significant losses since inception. During fiscal 2004, we had a consolidated net loss of $95.7 million. If we are not able to achieve overall profitability or maintain any profitability that we do achieve, the trading price of our stock could be negatively affected.

Our growth strategy depends, in part, on our acquiring complementary businesses and assets and expanding our existing operations, which we may be unable to do.

Our growth strategy is based, in part, on our ability to acquire other telecommunications and complimentary businesses and assets. We are also seeking to acquire other businesses within our IDT Entertainment segment. The success of this acquisition strategy will depend, in part, on our ability to accomplish the following:

There can be no assurance that we will be successful in pursuing any or all of these steps. Our failure to implement our acquisition strategy could have an adverse effect on other aspects of our business strategy and our business in general. We may not be able to find appropriate acquisition candidates, acquire those candidates that we find or integrate acquired businesses effectively or profitably.

Our acquisition program and strategy may lead us to contemplate acquisitions of companies in bankruptcy, which entail additional risks and uncertainties. Such risks and uncertainties include, without limitation, that, before assets may be acquired, customers may leave in search of more stable providers and vendors may terminate key relationships. Also, assets are generally acquired on an “as is” basis, with no recourse to the seller if the assets are not as valuable as may be represented. Finally, while bankrupt companies may be acquired for comparatively little money, the cost of continuing the operations may significantly exceed expectations.

We have in the past used, and may continue to use, our capital stock as payment for all or a portion of the purchase price for acquisitions. If we issue significant amounts of our capital stock for such acquisitions, this could result in substantial dilution of the equity interests of our stockholders.

Intellectual Property and Regulatory Risks

Our revenue may be adversely affected if we fail to protect our proprietary technology or enhance or develop new technology.

We depend on proprietary technology and other intellectual property rights in our various business operations. We rely on a combination of patents, copyright and trade secret protection and nondisclosure agreements to establish and protect our proprietary rights. In addition, we also rely on licenses of third party intellectual property rights, particularly of entertainment content. Failure of our patents, copyrights and trade secret protection, non-disclosure agreements and other measures to provide protection of our technology, could enable our competitors to more effectively compete with us and have an adverse effect on our business, financial condition and results of operations.

In addition, we may be required to litigate in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition or results of operations.

Therefore, despite our efforts to protect our intellectual property, our intellectual property rights may ultimately not provide us with a significant competitive advantage. The protection of our intellectual property also may require the expenditure of significant financial and managerial resources and we may elect not to incur costs that are not outweighed by the potential benefits that may be realized. Effective trademark, service mark, copyright, patent and trade secrets protection may not be available in every jurisdiction in which our products and services are made available. Our intellectual proprietary rights could

48

Table of Contents

be challenged, invalidated or circumvented. Third parties that license proprietary rights from us may take actions that diminish the value of our proprietary rights, goodwill or reputation. Ultimately, the steps we take to protect our proprietary rights may not be adequate and third parties may infringe our trademarks, service marks, trade dress, copyrights, patents and otherwise misappropriate similar proprietary rights such as trade secrets. Moreover, given the rapid pace of technological change in the information technology industry, many of our products rely on key technologies developed by third parties, and we may not be able to obtain commercially reasonable licenses from these third parties.

We may be subject to claims of infringement of intellectual property rights of others.

From time to time we may be subject to claims and legal proceedings from third parties regarding alleged infringement of trademarks, copyrights, patents and other intellectual property rights. In recent years, patent licensing and enforcement groups that do not make or sell any products or offer any services have been actively targeting industries, including the telecom industry. For example, Ronald A. Katz Technology Licensing, L.P. has offered us a license to a portfolio of patents, claiming that the patents may be infringed by certain products and services offered by us. The patents purportedly relate to various aspects of telephone call processing. As of October 14, 2004, no legal proceedings have been instituted against us. If the Katz patents are valid, enforceable and apply to our business, we could be required to seek a license from Katz. Such license may not be available on terms we consider commercially reasonable and the potential for litigation exists.

Even if our products and processes are ultimately held not to infringe a third party’s intellectual property rights, resolving any such claims can be time-consuming and costly, and may divert management’s attention and resources away from our business. Such claims might also result in a preliminary injunction prohibiting certain commercial activities we consider important to our business, and, if later found to be meritorious, may result in a permanent injunction and the imposition of damages. Claims of intellectual property infringement might also require us to enter into costly license agreements. If any of these risks materialize we could be forced to suspend certain operations, to pay significant amounts to defend our right to continue to engage in the commercial activities complained of, and/or secure an expensive license. If we cannot or do not license the allegedly infringed rights or cannot substitute a non-infringing device or activity, or cannot obtain essentially equivalent rights from a licensed third party, our business could suffer. Moreover, because patent applications in the United States are not publicly disclosed when filed, third parties may have filed applications that, if issued as patents, could result in claims against us in the future. Thus, there can be no assurances that any such claims, legal proceedings and/or license agreements would not have a material adverse effect on our business, operating results and financial condition.

Federal, state, local and international government regulations may reduce our ability to provide services or make our business less profitable.

We are subject to varying degrees of regulation by federal, state, local and foreign regulators. The implementation, modification, interpretation and enforcement of these laws and regulations vary and can limit our ability to provide many of our services. Our ability to compete in our target markets depends, in part, upon favorable regulatory conditions and the favorable interpretations of existing laws and regulations. For example, on March 2, 2004, the United States Court of Appeals for the District of Columbia Circuit vacated several FCC rules. These rules preserved access to the UNE-P platform, which allowed competitors, like us, to lease local switches and lines from the ILECs at discounted rates for the small business and residential markets. In response to the DC Circuit Court’s action, on August 20, 2004, the FCC released an Order that preserved the status quo through February 2005 and implemented modest rate increases for the six months thereafter. However, this Order has been appealed to the DC Circuit Court, and the appeal is pending as of the date of this annual report. In response to this regulatory uncertainty, as well as the FCC’s recommendation that ILECs and CLECs negotiate rates and terms for access to the ILEC network, we have engaged in commercial negotiations with the ILECs so that we may continue to provide local exchange service. These negotiations are continuing and we cannot predict their outcome. However, it is likely that any changes to the current environment — whether imposed by a court, regulator or as a result of commercial negotiation — will result in a higher wholesale rate and/or reduced access to the ILECs’ network facilities and may impair our ability to offer local phone service by leasing local switches and lines through the UNE-P method.

We may become subject to increased price competition from other carriers due to federal regulatory changes in determining international settlement rates.

Revenues from international service reflect payments under agreements between us and foreign telecommunications administrations or private carriers, which are influenced by the guidelines of the international tariff and trade regulations and cover virtually all international calls to and from the United States. Various factors, including declining settlement rates, could affect the amount of net settlement payments from carriers to us in future years. These include increases in the proportion of outgoing as opposed to incoming calls. On March 30, 2004 and again on August 31, 2004, the FCC released Orders which

49

Table of Contents

removed FCC oversight of rates and settlements for numerous international routes. As a result, traffic we send or receive over these routes will be subject to rate competition, as opposed to the FCC’s rate and settlement policies. These Orders, as with any federal regulatory change to international telecommunications policy and/or settlement rates, may adversely affect our revenues.

Federal and state regulations may be passed that could harm Net2Phone’s business.

Net2Phone’s ability to provide voice services at competitive rates arises in part from the fact that VoIP services are not currently subject to the same regulation as traditional telephony. Because their services are not currently regulated to the same extent as traditional telephony, VoIP providers can currently avoid paying certain charges that traditional telephone companies must pay.

As of the date of this annual report, there is a Notice of Proposed Rulemaking (NPRM) pending before the FCC that seeks to address the appropriate regulatory treatment for VoIP services in general. The FCC may determine that at least some forms of voice communications that are presently treated as VoIP will be characterized as “telecommunications,” and thus be subject to the same fees, charges, taxes and regulations as traditional telecommunications services. These surcharges could include access charges payable to local exchange carriers to carry and terminate traffic, contributions to the universal service fund and other charges. Another significant issue that may be determined as a result of the NPRM is the role of the states in regulating VoIP. Certain state utility commissions, such as New York’s, have held that another provider’s in-state broadband VoIP service is a telecommunications service and, as such, is subject to the fees, charges, taxes and regulations as traditional in-state telecommunications services. It is unknown whether the FCC will preempt states from regulating in-state VoIP services. However, if the FCC determines that any of the VoIP services provided by Net2Phone should be treated as “telecommunications,” or if it does not preempt states from regulating in-state VoIP services our business, financial condition and results of operations could be materially and adversely affected.

In addition to the aforementioned proceedings, the FCC has a separate proceeding to consider whether, or to what degree, VoIP services should comply with the Communications Assistance for Law Enforcement Act (CALEA). If the FCC mandates technical changes to VoIP services to accommodate CALEA or other telecommunications rules and regulations, the requirements could also place a significant financial and/or technical burden on Net2Phone, to the degree it provides affected services. There are also several legislative proposals bills pending at the federal and state levels to change the regulatory status of VoIP. These legislative proposals and bills vary from maintaining VoIP free of traditional telecommunications regulation to regulating VoIP no differently than existing telecommunications services. We cannot predict which bills or legislative proposals will be adopted by federal and state legislatures. Ultimately, the imposition of any such additional fees, charges, taxes and regulations on VoIP services could materially increase our costs and may limit or eliminate the competitive pricing advantage VoIP currently enjoys.

Net2Phone’s ability to offer services outside the United States is subject to the local regulatory environment, which may be unfavorable, complicated and often uncertain.

Regulatory treatment of Internet telephony outside the United States varies from country to country. Net2Phone Global Services distributes its products and services through resellers that may be subject to telecommunications regulations in their home countries. The failure of these resellers to comply with these laws and regulations could reduce Net2Phone’s revenue and profitability. Because of Net2Phone’s relationship with resellers, some countries may assert that it is required to register as a telecommunications carrier in that country. In such case, Net2Phone’s failure to do so could subject it to fines, penalties, or service shut-downs. In addition, some countries are considering subjecting VoIP services to the regulations applied to traditional telephone companies. Regulatory developments such as these could have a material adverse effect on Net2Phone’s extensive international operations, from which it derived more than half of its revenue in fiscal 2004.

In many countries in which Net2Phone operates or its services are sold, the status of the laws that may relate to its services is unclear. Net2Phone cannot be certain that its customers, resellers, or other affiliates are currently in compliance with regulatory or other legal requirements in their respective countries, that they or we will be able to comply with existing or future requirements, and/or that they or we will continue in compliance with any requirements. Net2Phone’s failure or the failure of those with whom it transacts business to comply with these requirements could materially adversely affect its business, financial condition and results of operations.

50

Table of Contents

Risk Related to Our Capital Structure

Holders of our Class B common stock have significantly less voting power than holders of our Class A common stock and our common stock.

Holders of our Class B common stock are entitled to one-tenth of a vote per share on all matters on which our stockholders are entitled to vote, while holders of our Class A common stock are entitled to three votes per share and holders of our common stock are entitled to one vote per share. As a result, the ability of holders of our Class B common stock to influence the management of our Company is limited.

IDT is controlled by its principal stockholder, which limits the ability of other stockholders to affect the management of IDT.

Howard S. Jonas, our Chairman of the Board and founder, has voting power over 11,642,130 shares of our common stock (which includes 9,816,988 shares of our Class A common stock, which are convertible into shares of our common stock on a 1-for-1 basis) and 2,498,562 shares of our Class B common stock, representing 57.0% of the combined voting power of our outstanding capital stock, as of July 31, 2004. Mr. Jonas is able to control matters requiring approval by our stockholders, including the election of all of the directors and the approval of significant corporate matters, including any merger, consolidation or sale of all or substantially all of our assets. As a result, the ability of any of our other stockholders to influence the management of our company is limited.

Item 2. PROPERTIES.

Our headquarters are located in Newark, New Jersey pursuant to a 20 year lease entered into in November 1999 for facilities totaling approximately 484,000 square feet. Our headquarters house our executive offices, administrative, finance and marketing functions, carrier and customer service departments and our various developing operations and serve as the headquarters for each of our operating subsidiaries. We, along with a 20% partner, have purchased a 120,000 square foot building near our Newark headquarters which is leased out, and which would be convenient for the eventual expansion of our headquarters.

We also occupy space in both leased and owned properties in New Jersey and Los Angeles, California, primarily to house telecommunications equipment. In addition, we lease space (typically less than 500 square feet) in various other geographic locations to house the telecommunications equipment for each of our points of presence.”

We and our divisions and subsidiaries occupy office space in various locations to house headquarters and other activities.

We maintain our European headquarters in London, England (corporate and carrier operations) and Dublin, Ireland (retail operations). We also maintain various international office locations and telecommunications facilities, including in Buenos Aires, Argentina; London, England; Paris, France; Frankfurt and Hamburg, Germany; Rotterdam, Holland; Milan, Italy; Lisbon, Portugal; Moscow, Russia; Madrid, Spain; Lerum and Gothenburg, Sweden; San Juan, Puerto Rico; Santa Fe Colony, Mexico; Berchem, Belgium, Copenhagen, Denmark; Geneva, Switzerland, Prague, Czech Republic, Athens, Greece; Makati, Philippines; Johannesburg, South Africa; Lima, Peru and Hong Kong.

Digital Production Solutions and IDT Contact Services also lease space in two locations in Israel. We have entered into an agreement to purchase approximately 33,750 square meters of a building under construction in Jerusalem to house our call center operations in that location.

Net2Phone is based at our Newark, New Jersey headquarters and leases 69,525 square feet from IDT, pursuant to a lease that expires in May 2010. In addition, Net2Phone leases office and switch space in Brick and West Long Branch, New Jersey; Jerusalem, Israel and Singapore.

Item 3. LEGAL PROCEEDINGS.

On January 29, 2001, we filed a complaint against Telefonica S.A., Terra Networks, S.A., Terra Networks, U.S.A., Inc., and Lycos, Inc. in the United States District Court, District of New Jersey, relating to a joint venture we entered into with Terra Networks, S.A. in October 1999 and subsequently terminated in April 2000. The complaint asserted claims for, among other things, breaches of various contracts, breach of fiduciary duty, common law fraud, tortious interference with prospective economic advantage, and a securities fraud violation of Section 10(b)5 of the Securities Act against Terra Networks, S.A. We subsequently filed an amended complaint alleging a securities fraud violation of Section 20(a) of the Securities Act against two of the defendants, Terra Networks, S.A. and Terra Networks, U.S.A. We are seeking an amount to be determined at trial, or in the alternative, delivery of 250,000 marketable shares of Terra Networks, S.A. stock. Terra Networks, S.A. filed counterclaims against us for $3 million for breach of contract, securities fraud and unspecified punitive

51

Table of Contents

damages. We filed a motion to dismiss the securities fraud counterclaim, which is still pending. On September 13, 2002, Telefonica, S.A. renewed its motion to dismiss for lack of personal jurisdiction, which the Court previously denied. The Court has not yet ruled on that motion. IDT and all of the defendants, except Terra Networks, U.S.A., filed motions for summary judgment. On September 30, 2004, Terra Networks, S.A.’s motion for summary judgment was denied and Lycos’ motion for summary judgment was granted. As a result, Lycos is no longer a defendant in this case. Our motion for summary judgment and Telefonica S.A.’s motion for summary judgment are still pending.

On May 5, 2004, we filed a complaint in the Supreme Court of the State of New York, County of New York, seeking injunctive relief and damages against Tyco Group, S.A.R.L., Tyco Telecommunications (US) Inc. (f/k/a/ TyCom (US) Inc.), Tyco International, Ltd., Tyco International (US) Inc., and TyCom Ltd. We allege that the defendants breached a settlement agreement that they had entered into with us to resolve certain disputes and civil actions among the parties. We alleged that the defendants did not provide us, as required under the settlement agreement free of charge and for our exclusive use, a fifteen-year indefeasible right to use four wavelengths on the TyCom Global Network, a global undersea fiber optic network that TyCom Ltd. was deploying at that time. In June 2004, Tyco International (US) Inc. and Tyco Telecommunications (US) Inc. asserted several counterclaims against us, alleging that we breached the settlement agreement and are liable for damages for allegedly refusing to accept the defendant’s offer regarding the wavelengths referenced in the settlement agreement and for making a public statement that Tyco failed to provide us with the use of its wavelengths. In July 2004, we filed a motion to dismiss the counterclaims or, in the alternative, for summary judgment. In August 2004, the defendants cross-moved for summary judgment with respect to certain of their counterclaims. In addition, all defendants with the exception of Tyco Telecommunications (US) Inc. and Tyco Telecommunications, Ltd. (f/k/a TyCom Ltd.) cross-moved to dismiss the complaint.

IDT Telecom

We are a party in a legal matter before the United States District Court, District of New Jersey, involving several individual lawsuits, which were consolidated for coordinated pre-trial proceedings by the Multi-District Litigation Panel (collectively, the “MDL Action”). The MDL Action involves four separate complaints each seeking certification of a class consisting of consumers within the United States who purchased our calling cards and were allegedly charged fees that were not specifically disclosed on the card packaging prior to purchase. Two of the complaints specify damages of not less than $100 million. The parties engaged in discovery but then agreed to participate in court-supervised mediation and will attend another mediation session on October 25, 2004.

On or about April 22, 2003, we received a Petition filed by Powell Palmares in the District Court of Nueces County, Texas, 105th Judicial District seeking certification of a class of consumers in Texas who purchased or used “pre-paid phone cards” and were allegedly charged more for calls made to or from cellular telephone equipment. In his petition, the plaintiff names numerous other telecommunication companies as defendants. The damages sought have not yet been quantified.

On or about August 27, 2003, Aerotel, Ltd., Aerotel U.S.A., and Aerotel U.S.A., LLC filed a complaint against us in the United States District Court, Southern District of New York, alleging infringement of U.S. Patent No. 4,706,275, entitled “Telephone System,” which was issued on November 10, 1987 to Aerotel Ltd. as the assignee of Zvi Kamil. The complaint seeks (i) a permanent injunction against us; (ii) damages, together with prejudgment interest and costs; (iii) trebling of damages awarded under 35 U.S.C. 284; (iv) attorneys fees and costs; and (v) such other relief as the Court may deem just and proper. On October 31, 2003, we filed our answer to the complaint. On December 29, 2003, the Court granted our motion to stay the litigation pending a reexamination of certain claims of the asserted patent by the United States Patent and Trademark Office (the “USPTO”). On August 27, 2004, at our request, the USPTO agreed to conduct an additional reexamination and determined that a substantial new question of patentability issues was raised affecting claims 1-23 of the asserted patent.

On or about September 19, 2003, Irene Kieves served a complaint against us, which was filed in the Superior Court of New Jersey, Essex County alleging a violation of the New Jersey Consumer Fraud Act in connection with Universal Service Fund surcharges imposed on our long distance customers. The plaintiff is seeking certification of a class consisting of all persons who subscribed to IDT long distance service and paid any Universal Service Fund surcharge associated with such service at any time since January 1, 1998. The damages sought have not yet been quantified. On or about November 10, 2003, we filed our answer to the complaint and asserted a counterclaim for breach of contract. On or about September 28, 2004, plaintiff moved to dismiss our counterclaim.

On March 29, 2004, D. Michael Jewett (“Jewett”), a former employee whose employment we terminated less than seven months after he was first hired, filed a complaint against us in the United States District Court, District of New Jersey following his termination. The complaint alleges (i) violations of the New Jersey Anti-Racketeering Statute; (ii) violations of the New

52

Table of Contents

Jersey Conscientious Employee Protection Act; (iii) violations of the New Jersey Law Against Discrimination; (iv) Common Law Defamation; and (v) New Jersey Common Law Intentional Infliction of Emotional Distress. Jewett is seeking damages of $31 million, plus attorneys’ fees. We deny the allegations contained in the complaint. We intend to contest it vigorously and we have already moved to dismiss the complaint. We have also sought sanctions against Jewett’s attorney. Jewett sent a copy of his complaint to the United States Attorney’s Office because in his complaint, Jewett alleged, among other things, that improper payments were made to foreign officials in connection with an IDT Telecom contract. As a result, the Department of Justice, the Securities and Exchange Commission and the United States Attorney in Newark, New Jersey have initiated investigations with respect to this matter. The Company and the Audit Committee of our Board of Directors also initiated independent investigations, conducted by outside counsel, regarding certain of the matters raised in the Jewett complaint and in these investigations. Neither the Company’s nor the Audit Committee’s investigation has found any evidence that we made any such improper payments to foreign officials.

Net2Phone

Four substantially similar class-action lawsuits were filed in the United States District Court, Southern District of New York on behalf of all persons who acquired Net2Phone’s stock between July 29, 1999 and December 6, 2000. Net2Phone, certain of Net2Phone’s executive officers, directors and underwriters involved in our initial public offering were named as defendants in these complaints. The complaints allege, in part, that certain underwriters of Net2Phone’s initial public offering violated federal securities laws by failing to disclose that they had solicited and received undisclosed commissions and allocated shares in Net2Phone’s initial public offering to those investors in exchange for their agreement to purchase Net2Phone shares in the after-market at pre-determined prices. The complaints also allege that, whether or not Net2Phone and the named executives were aware of the underwriters’ arrangements, Net2Phone and the named executives have statutory liability under the federal securities laws for issuing a registration statement in connection with Net2Phone’s initial public offering that failed to disclose that these allegedly undisclosed arrangements existed. The suits against Net2Phone are substantially the same as suits asserting the same allegations that have been filed against several hundred other companies that closed their initial public offerings at or about the same time that Net2Phone did. Net2Phone has entered into a settlement agreement along with the majority of other issuer defendants. The settlement agreement is subject to the court’s approval. Under the terms of the proposed settlement agreement, Net2Phone is not conceding any liability and Net2Phone will not bear any of the expenses associated with the settlement, other than legal fees it may incur.

Previously Disclosed Legal Matters that were Settled, Dismissed or Otherwise Resolved

On or about February 19, 2002, six former employees of Teligent, Inc., on behalf of themselves and other similarly situated former employees of Teligent, served a class action complaint against Teligent and us for an alleged violation of the Worker Adjustment and Retraining Notification Act. We reached a settlement with the plaintiffs which requires us to make payments in an amount not to exceed $1.3 million in the aggregate. The parties are administering the court-approved settlement.

On or about July 25, 2002, PT-1 Communications, Inc. filed a complaint against us related to the agreement between the parties for the sale of PT-1’s calling card business to us. On May 10, 2004, the parties executed a settlement agreement pursuant to which we issued to PT-1 shares of our Class B common stock valued at $14.3 million. In addition, this court-approved settlement also dismissed the complaint filed by the Continuing Creditors’ Committee of Star Telecommunications against us.

On April 15, 2003, Network Communications of Indiana filed a four-count complaint against us, Winstar Holdings, LLC and Winstar Communications, LLC seeking $8.7 million in damages related to a contract dispute. On September 30, 2004, the Court granted our motion for summary judgment in its entirety and dismissed all counts of the complaint.

On February 15, 2000, Multi-Tech Systems, Inc. filed suit against Net2Phone and other companies alleging patent infringement related to the use of software for making phone calls over the Internet. On October 31, 2002, the Court entered a consent judgment dismissing Multi-Tech’s patent infringement claims. On October 4, 2004, the Supreme Court of the United States denied Multi-Tech’s petition for a Writ of Certiorari, which exhausted all of Multi-Tech’s appellate remedies in this case.

53

Table of Contents

In addition to the foregoing, we are subject to other legal proceedings that have arisen in the ordinary course of business and have not been finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of the legal proceedings to which we are a party, whether discussed in this Annual Report or otherwise, will have a material adverse effect on our results of operations, cash flows or our financial condition.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

54

Table of Contents

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY

Our Class B common stock trades on the New York Stock Exchange under the symbol “IDT” and our common stock trades on the New York Stock Exchange under the symbol “IDT.C”. Our common stock was quoted on the Nasdaq National Market under the symbol “IDTC” from March 15, 1996, the date of our initial public offering, through February 25, 2001. On February 26, 2001, we listed our common stock for trading on the New York Stock Exchange. In May 2001, our Board of Directors declared a stock dividend of one share of our Class B common stock for every one share of our common stock, Class A common stock and Class B common stock. On June 1, 2001, we listed our Class B common stock for trading on the New York Stock Exchange.

The table below sets forth the high and low sales prices for our Class B common stock as reported by the New York Stock Exchange for the fiscal periods indicated.

The table below sets forth the high and low sales prices for our common stock as reported by the New York Stock Exchange for the fiscal periods indicated.

On October 1, 2004, there were approximately 393 holders of record of our Class B common stock and approximately 325 holders of record of our common stock. This number does not include the number of persons whose shares are in nominee or in “street name” accounts through brokers.

We have never declared or paid any cash dividends on our common stock or Class B common stock and do not expect to pay cash dividends for the foreseeable future. Our current policy is to retain all of our earnings to finance future growth. Any future declaration of dividends will be subject to the discretion of our Board of Directors.

The information required by Item 201(d) of Regulation S-K will be contained in our Proxy Statement for our Annual Stockholders Meeting, which we will file with the Securities and Exchange Commission within 120 days after July 31, 2004, and which is incorporated by reference herein.

RECENT SALES OF UNREGISTERED SECURITIES

On June 10, 2004, we issued 666,667 shares of Class B common stock to Palm Entertainment Properties as consideration for our May 2004 acquisition, through our subsidiary IDT Entertainment, of Manga Entertainment.

55

Table of Contents

On June 16, 2004, we issued an additional 689 shares of Class B common stock to the stockholders of Approach Inc. as additional consideration for the acquisition of Approach, which was consummated in December 2003.

On July 22, 2004 we issued 754,617 shares of Class B common stock to PT-1 Communications in connection with the settlement of litigation. On October 4, 2004, we issued an additional 205,924 shares of Class B common stock to PT-1 Communications pursuant to the terms of the settlement agreement.

As previously disclosed in our Quarterly Report for the quarter ended October 31, 2003, we issued a warrant to Rad-Bynet Properties (1999) Ltd. as partial consideration for our acquisition of an interest in commercial property under construction. On July 14, 2004, we issued 229,001 shares of Class B common stock upon partial exercise of such warrant, and on September 1, 2004 we issued an additional 95,999 upon a further exercise of the warrant.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

This table provides information with respect to purchases by us of shares of its common stock during the fourth quarter.

56

Table of Contents

Item 6. SELECTED FINANCIAL DATA.

The selected consolidated financial data presented below for each of the fiscal years in the five-year period ended July 31, 2004 has been derived from our consolidated financial statements, which have been audited by Ernst & Young LLP, independent registered public accounting firm. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and other financial information appearing elsewhere in this Annual Report.

57

Table of Contents

* Effective fiscal 2004, we created a new reportable business segment, IDT Entertainment, to report the results of our animation and entertainment-related businesses. Prior to fiscal 2004, results for the assets and businesses that now constitute IDT Entertainment were consolidated with the IDT Capital segment results. To the extent possible, comparative historical results for IDT Entertainment and IDT Capital have been reclassified to conform to the current business segment presentation, although these results may not be indicative of the results that would have been achieved had the revised business segment structure been in effect during those periods. IDT Capital was formerly known as IDT Menlo Park and, before that, IDT Media.

** Since the acquisition of the Winstar assets by our subsidiary, Winstar Holdings (through which the IDT Solutions segment operates), in December 2001.

*** As a result of the sale of our majority stake in Net2Phone (our “Voice over IP” segment) to AT&T on August 11, 2000, we did not consolidate Net2Phone results in fiscal 2001. Therefore, we did not have any Voice over IP revenues and operating activities during fiscal 2001. Rather, we accounted for our investment in Net2Phone in fiscal 2001 under the equity method of accounting, with our pro-rata share of Net2Phone losses being recorded in “Equity in Loss of Affiliates.” Effective October 23, 2001, we reconsolidated our investment in Net2Phone. See note 2 to our consolidated financial statements included elsewhere in this Annual Report.

**** Consists of gains as a result of the Net2Phone common stock offering in fiscal 2004, our sale, to Liberty Media, of 5.6% of our subsidiary that operated our entertainment and media businesses in fiscal 2003 and gains on sales of Net2Phone Class A common stock in fiscal 2001 and fiscal 2000.

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.