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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED JULY 31, 1999, OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
Commission File Number: 0-27898
IDT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3415036
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
190 Main Street
Hackensack, New Jersey 07601
(Address of principal executive offices, including zip code)
(201) 928-1000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01 per share
(Title of class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price of the Common Stock on October 29, 1999
of $22.875, as reported on the Nasdaq National Market, was approximately $547
million (assuming the conversion of all of the Company's shares of Class A
Common Stock into Common Stock). Shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common
Stock (assuming conversion of the Registrant's Class A Common Stock) have been
excluded from this computation, in that such persons may be deemed to be
affiliates of the Registrant. This determination of affiliate status is not
necessarily a conclusive determination for any other purpose.
As of October 29, 1999, the Registrant had outstanding 24,100,383 shares of
Common Stock, $.01 par value, and 10,029,758 shares of Class A Common Stock,
$.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information in the Registrant's definitive Proxy Statement for its
1999 Annual Meeting of Stockholders, which will be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after July 31, 1999, is incorporated by reference in Part III (Items 10, 11,
12 and 13) of this Form 10-K.
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INDEX
IDT CORPORATION
ANNUAL REPORT ON FORM 10-K
Page No.
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PART I
Item 1. Business............................................... 1
Item 2. Properties............................................. 32
Item 3. Legal Proceedings...................................... 32
Item 4. Submission of Matters to a Vote of Security Holders.... 33
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.................................... 34
Item 6. Selected Financial Data................................ 35
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 36
Item 7A. Quantitative and Qualitative Disclosures about Market
Risks.................................................. 46
Item 8. Financial Statements and Supplementary Data............ 46
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant..... 47
Item 11. Executive Compensation................................. 47
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................. 47
Item 13. Certain Relationships and Related Transactions......... 47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K............................................... 48
SIGNATURES.......................................................... 50
Index to Consolidated Financial Statements.......................... F-1
PART I
Item 1. BUSINESS.
Summary
As used in this Annual Report, unless the context otherwise requires, the
terms "the Company" and "IDT" refer to IDT Corporation, a Delaware corporation,
its predecessor, International Discount Telecommunications, Corp., a New York
corporation ("IDT New York"), and their subsidiaries, collectively. All
information in this Annual Report gives effect to the 1995 reincorporation of
the Company in Delaware. The Company's fiscal year ends on July 31 of each
calendar year. Each reference to a Fiscal Year in this Annual Report refers to
the Fiscal Year ending in the calendar year indicated (e.g., Fiscal 1999 refers
to the Fiscal Year ended July 31, 1999).
IDT Corporation is a leading facilities-based emerging multinational carrier
that provides a broad range of telecommunications services to wholesale and
retail customers worldwide. The company offers integrated and competitively
priced international and domestic long distance telecommunications service and
Internet access. The Company's majority-owned Net2Phone, Inc. ("Net2Phone")
(NASDAQ: NTOP) subsidiary offers a variety of Internet telephony products and
services. The Company's telecommunications services include wholesale carrier
services, prepaid calling cards, international retail services and domestic
long distance services. The Company has grown considerably in recent years,
generating revenues of $135.2 million, $335.4 million and $732.2 million in
Fiscal 1997, Fiscal 1998 and Fiscal 1999, respectively.
IDT delivers its telecommunications services over a high-quality network
consisting of 70 switches in the U.S. and Europe and owned and leased capacity
on 16 undersea fiber optic cables. In addition, the Company obtains additional
transmission capacity from other carriers. The Company delivers its
international traffic worldwide pursuant to its agreements with U.S.-based
carriers, foreign carriers, and 23 of the companies that are primarily
responsible for providing telecommunications services in particular countries
(many of which are commonly referred to as "Post, Telephone and Telegraphs," or
"PTTs"). In addition, IDT maintains a high-speed network that carries Internet
traffic in order to support both its Internet access services and Net2Phone's
Internet telephony services.
As of October 1, 1999, the Company had approximately 125 wholesale customers
located in the U.S. and Europe. In addition, IDT offers retail long distance
services to individual and business customers in the U.S. and worldwide. Within
the U.S., IDT provides dedicated and dial-up Internet access services to
approximately 65,000 retail customers. Net2Phone's Web-based Internet telephony
services, which allow customers to make telephone calls from a multimedia PC to
any telephone, and the Net2Phone Direct service, which enables users to make
phone-to-phone calls over the Internet, have been used by a total of over 1.8
million registered customers worldwide.
The Company operates a growing telecommunications network consisting of (i)
70 Excel and Nortel switches in the U.S. and Europe; (ii) 16 owned and leased
undersea fiber optic cables connecting the Company's U.S. facilities with its
international facilities and with the facilities of its foreign partners in
Europe, Latin America and Asia; and (iii) resale transmission capacity obtained
on a per-minute basis from other telephone carriers. The Company monitors its
network 24 hours a day, seven days a week through an automated network
operations center.
The Company plans to expand its global telecommunications network
infrastructure, in order to allow the Company to route a greater percentage of
its international long distance traffic over owned lines. Routing calls over
owned lines, rather than leased lines, will help the Company to reduce its
operating costs, ensure the quality of its service and expand its customer
base. However, the Company follows a disciplined, incremental approach to
expanding its network, adding new facilities only when it determines that such
investments are justified by traffic volumes. Generally, IDT enters new markets
by leasing fiber capacity. As traffic grows, the Company typically invests in
bandwith to realize cost savings from routing calls over an owned network. As
traffic
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increases further, the Company may install a switch to increase overall
capacity. If volume continues to grow, the Company may deploy additional
switching and/or fiber capacity. IDT installed company-owned switches in the
U.K. and the Netherlands in Fiscal 1999. The company plans to install and/or
upgrade facilities in France, Italy, Spain, Germany and Austria by the end of
Fiscal 2000, and to continue to pursue operating agreements with foreign
carriers in order to terminate traffic directly at favorable rates.
IDT also operates a domestic Internet network consisting of multiple leased
lines. IDT's Internet access networks provide local dial-up access through 33
"points of presence" (or "POPs") owned by the Company, through which
subscribers may access the Internet. The Company's domestic Internet network
also includes about 375 additional POPs owned by local and regional Internet
service providers, which the Company refers to as its "Alliance Partners,".
This Internet network, combined with the Company's telecommunications network,
is also used to route Net2Phone's Internet telephony traffic.
History
The Company was founded in August 1990 and was originally incorporated in
New York as "International Discount Telecommunications Corp." The Company was
renamed IDT Corporation and reincorporated in Delaware in December 1995. The
Company's main offices are located at 190 Main Street, Hackensack, New Jersey
07601; its telephone number is (201) 928-1000. IDT's Internet address is
www.idt.net.
The Company entered the telecommunications business by introducing its
international call reorigination service in 1990 to capitalize on the
opportunity created by the large spread between U.S. and foreign-originated
international long distance telephone rates. Long distance calling costs in
certain highly regulated international markets are often prohibitive. The
Company's call reorigination service enables customers to access a U.S. dial
tone from overseas and place international calls that are reoriginated in the
U.S. The customer benefits from more favorable U.S. outbound long distance
rates and superior transmission quality. IDT used the expertise derived from,
and the calling volume generated by, its call reorigination business to enter
the domestic long distance business in late 1993 by reselling long distance
services of other carriers to its domestic customers. As a value-added service
for its domestic long distance customers, the Company began offering Internet
access in early 1994, eventually offering dial-up and dedicated Internet
access to individuals and businesses as stand-alone services. In 1995, IDT
began reselling to other long distance carriers access to the favorable
telephone rates and special tariffs the Company receives as a result of the
calling volume generated by its call reorigination customers. The Company
began marketing its prepaid calling cards in January 1997.
IDT entered the Internet telephony market in August 1996 with its
introduction of PC2Phone, the first commercial telephone service to connect
calls between personal computers and telephones over the Internet. The Company
expanded its Internet telephony offerings in September 1997 with the
introduction of Net2Phone Direct, a service that enables users to make
international and domestic calls over the Internet using standard telephones.
In April 1998, the Company launched Click2Talk, an Internet telephony product
which allows customers to make calls to the toll-free numbers of e-commerce
companies anywhere in the world using a PC. In August 1998, the Company
introduced Click2CallMe, which allows consumers visiting e-commerce companies
to contact customer sales representatives from the Web sites of such companies
without charge.
Offerings of Net2Phone
On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock (the "Initial Public Offering"), yielding
$85.3 million in net proceeds, to be used for development and maintenance of
strategic Internet relationships, advertising and promotion, research and
development, the upgrading and expansion of its network and general corporate
purposes, including working capital.
Prior to the Initial Public Offering, Net2Phone was a 90%-owned direct
subsidiary of the Company. As such, Net2Phone received various services
provided by the Company, including administration (accounting, human
resources, legal), customer support, telecommunications and joint marketing.
The Company also provided Net2Phone with a number of its executives and
employees. The Company has historically allocated a portion of its overhead
costs related to those services it provided to Net2Phone. None of these
services were provided to Net2Phone pursuant to any written agreement between
the Company and Net2Phone.
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After the Initial Public Offering, the Company owned 56.2% of the capital
stock of Net2Phone. The Company owns Class A stock that has twice the voting
power of Net2Phone's common stock. Therefore, after the Initial Public
Offering, the Company controlled 64.0% of Net2Phone's vote.
In connection with Net2Phone's Initial Public offering, the Company entered
into several agreements with Net2Phone, including an assignment agreement, a
separation agreement, an IDT services agreement, a Net2Phone services
agreement, a tax sharing and indemnification agreement, a joint marketing
agreement and an Internet/telecommunications agreement.
On November 4, 1999 Net2Phone filed a registration statement with the
Securities and Exchange Commission for the sale of 6,300,000 shares of common
stock (the "November Offering"). Of the 6,300,000 shares to be sold in the
November Offering, 3,400,000 shares are being sold by Net2Phone. The Company
will be selling 2,200,000 shares, with the remaining 700,000 shares to be sold
by other selling stockholders. The underwriters have also been granted an
option for a period of 30 days to purchase up to 900,000 additional shares of
common stock from other selling stockholders to cover over-allotments, if any.
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934. Such forward-looking statements include,
among other things, the Company's plans to implement its growth strategy,
improve its financial performance, expand its infrastructure, develop new
products and services, expand its sales force, expand its customer base and
enter international markets. Such forward-looking statements also include the
Company's expectations concerning factors affecting the markets for its
products, such as changes in the U.S. and the international regulatory
environment and the demand for long-distance telecommunications, Internet
access and Internet telephony services. Actual results could differ from those
projected in any forward-looking statements. The forward-looking statements
are made as of the date of this Annual Report on Form 10-K, and the Company
assumes no obligation to update the forward-looking statements, or to update
the reasons why actual results could differ from those projected in the
forward-looking statements. Investors should consult all of the information
set forth herein and the other information set forth from time to time in the
Company's Reports on Forms 10-Q and 8-K.
Industry
Overview
The international long distance industry, which principally consists of the
transmission of voice and data between countries, is undergoing a period of
rapid, fundamental change that has resulted, and is expected to continue to
result, in significant growth in the usage of international telecommunications
services. According to industry sources, in 1997, the international long
distance telecommunications industry accounted for approximately 81.8 billion
minutes of use, an increase of 14% from 71.7 billion minutes of use in 1996,
and up from approximately 24.6 billion minutes of use in 1988. The
international long distance telecommunications industry generated revenues of
approximately $67.0 billion in 1997. Industry sources have estimated that by
2001 this market may approach $98.0 billion in revenues and 143.2 billion
minutes of use, representing compound annual growth rates from 1997 of 10.0%
and 15.0%, respectively.
The Company believes that growth in international long distance services is
being driven by (i) the globalization of the world's economies and the
worldwide trend toward deregulation of the telecommunications sector; (ii)
declining prices arising from increased competition generated by privatization
and deregulation; (iii) increased worldwide telephone density and
accessibility arising from technological advances and greater investment in
telecommunications infrastructure, including the deployment of wireless
networks; (iv) a wider selection of products and services; and (v) the growth
in the transmission of data traffic via internal company networks and the
Internet. The Company believes that growth of traffic originated in markets
outside the U.S. will be higher than growth in traffic originated within the
U.S. due to recent deregulation in many foreign markets, relative economic
growth rates and increasing access to telecommunications facilities in
emerging markets.
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Globalization: The increased globalization of commerce, trade and travel has
stimulated demand for international long distance services, which in turn has
spurred the continuing deregulation and privatization of telecommunications
markets, which have traditionally been served by state-owned monopoly
providers. In the U.S., demand for international long distance services has
been boosted by a continued surge of immigrants to the U.S. These immigrants
often seek a way to make inexpensive international calls to their friends and
relatives back in their country of origin, using any telephone, without
needing to demonstrate a credit history. The debit calling card remains the
preferred vehicle for fulfilling these needs. The company believes that it is
currently the top provider of international debit card calling time from the
U.S., putting it in position to benefit from this trend.
Declining prices: The reduction of outbound international long distance
rates, resulting from the increased competition generated by deregulation and
privatization, continues to make international calling available to a much
larger customer base. This, in turn, has stimulated increased traffic volumes.
Increased teledensity: Stimulated by economic growth and development,
government initiatives and technological advances, the number of telephone
lines around the world has increased dramatically, and is expected to lead to
greater demand for international telecommunications services.
Wider selection of products and services: The proliferation of
communications devices, including cellular telephones, facsimile machines,
pagers, data communications devices and communications equipment has led to a
general increase in the use of telecommunications services. In addition, a
growing number of products and services are available to an increasing portion
of the world's population. This availability is driving the increasing demand
for these services on both a singular and bundled basis, requiring carriers to
offer a wide array of voice and data products and services.
Growth of data traffic: The increased availability of higher-quality and
higher-capacity bandwith has enabled international long distance carriers to
improve service quality and provide a wider array of data services, while also
lowering costs. The demand for data services, including Internet based demand,
has increased rapidly, and is expected to continue to increase at a robust
pace in the foreseeable future.
Regulatory and Competitive Environment
Consumer demand and competitive initiatives have acted as catalysts for
government deregulation, especially in developed countries. Deregulation
accelerated in the U.S. in 1984 with the divestiture by American Telephone &
Telegraph, Inc. ("AT&T") of the regional bell operating companies. Today,
there are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-
sized companies typically offer their customers a full range of services,
including international long distance. However, most of these carriers do not
have the critical mass of customers to receive volume discounts on
international traffic from the larger facilities-based carriers such as AT&T,
MCI WorldCom, Inc. ("MCI WorldCom") and Sprint Corporation ("Sprint"). In
addition, these companies have only a limited ability to invest in
international facilities. Alternative international carriers, such as the
Company, have capitalized on this demand for less expensive international
transmission facilities. These alternative international carriers are able to
take advantage of larger traffic volumes in order to obtain volume discounts
on international routes (resale traffic) and/or invest in facilities when the
volume of particular routes justifies such investments. As these emerging
international carriers have become established, they have also begun to carry
overflow traffic from the larger long distance providers that own overseas
transmission facilities.
Deregulation in the U.K. began in 1981 when Mercury, a subsidiary of Cable &
Wireless plc, was granted a license to operate a facilities-based network and
compete with British Telecommunications plc ("BT"). Deregulation spread to
other European countries with the adoption of the "Directive on Competition in
the Markets for Telecommunication Services" in 1990. A series of subsequent
European Union directives, reports and actions have resulted in significant
but not complete deregulation of the telecommunications industries in most
European Union member states. Further deregulation of the European Union
telecommunications market is scheduled to occur in 2000 upon the
implementation of the European Union's "Amending Directive to the
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Interconnection Directive," which mandates the introduction of equal access
and carrier pre-selection by 2000. See "Regulation--European Regulation of
Telecommunications Services." A similar movement toward deregulation has
already taken place in Australia and New Zealand, and is also taking place in
Japan, Mexico, Hong Kong and other markets. Other governments have begun to
allow competition for value-added and other selected telecommunications
services and features, including data and facsimile services and certain
restricted voice services. Deregulation and privatization have also allowed
new long distance providers to emerge in other foreign markets. In many
countries, however, the rate of change and emergence of competition remain
slow, and the timing and extent of future deregulation is uncertain.
On February 15, 1997, the U.S. and 68 other countries signed the WTO
Agreement and agreed to open their telecommunications markets to competition
and foreign ownership starting in January 1998. These 69 countries represent
approximately 95% of worldwide telecommunications traffic. The Company
believes that the WTO Agreement will provide IDT with significant
opportunities to compete in markets in which it did not previously have
access, and to provide facilities-based services to and from these countries.
The Federal Communications Commission ("FCC") issued an order that
significantly reduces U.S. regulation of international services in order to
implement the U.S.'s commitments under the WTO Agreement. This order is
expected to increase opportunities for foreign carriers to compete in the U.S.
communications market, while increasing the opportunities for U.S. carriers to
enter foreign markets and to develop alternative termination arrangements with
carriers that lack market power in other countries.
Deregulation has encouraged competition, which in turn has prompted carriers
to offer a wider selection of products and services at lower prices. The
Company believes that the lower prices for telecommunications services that
have resulted from increased competition have been more than offset by
decreases in the costs of providing such services and increases in
telecommunications usage. For example, based on FCC data for the period 1989
through 1995, per-minute settlement payments by U.S.-based carriers to foreign
PTTs fell 31.4%, from $0.70 per minute to $0.48 per minute. Over this same
period, however, per-minute international billed revenues fell only 13.7%,
from $1.02 in 1989 to $0.88 in 1995. The Company believes that as settlement
rates and capacity costs continue to decline, international long distance will
continue to provide opportunities to generate relatively high revenues and
per-minute gross profits.
International Switched Long Distance Services
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. In the U.S., an international
long distance call typically originates on a local exchange carrier's network
and is switched to the caller's domestic long distance carrier. The domestic
long distance provider then carries the call to its own or to another
carrier's international gateway switch. From there it is carried to a
corresponding gateway switch operated in the country of destination by the
dominant carrier of that country and then is routed to the party being called
through that country's domestic telephone network.
International long distance providers can generally be categorized by the
extent of their ownership and use of switches and transmission facilities. The
largest U.S. carriers, AT&T, MCI WorldCom and Sprint primarily utilize owned
U.S. transmission facilities and tend to use other international long distance
providers to reach niche markets where they do not own a network, to take
advantage of lower prices, and to carry their overflow traffic. Since no
carrier has transmission facilities that cover the more than 200 countries to
which major long distance providers offer service, a significantly larger
group of long distance providers has emerged, which own and operate their own
switches but either rely solely on resale agreements with other long distance
carriers to terminate traffic or use a combination of resale agreements and
leased or owned facilities in order to terminate their traffic, as discussed
below.
Operating Agreements. Operating agreements provide for the termination of
traffic in, and return traffic from, the international long distance providers
that have rights in facilities in different countries at a negotiated
accounting rate. Almost all international calls are carried under the complex
accounting rate system, a framework
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for originating, carrying and terminating calls that has been in place since
just after World War II. Within each country, the regulatory authority
negotiates rates with a foreign PTT. These accounting rates tend to be
artificially inflated, with no relation to the actual costs of carrying
traffic.
Under a traditional operating agreement, the international long distance
provider that originates more traffic compensates the long distance provider
in the other country by paying an amount determined by multiplying the net
traffic imbalance (the difference between minutes sent and minutes received)
by the settlement rate, which is generally one-half the accounting rate. Under
a typical operating agreement, each carrier has a right in its portion of the
transmission facilities between two countries.
A carrier gains ownership rights in a fiber optic cable by purchasing direct
ownership in a particular cable (usually prior to the time that the cable is
placed in service) by acquiring an "indefeasible right of use" (IRU), in a
previously installed cable, or by leasing or obtaining capacity from another
long distance provider that either has direct ownership or IRU rights in the
cable. In situations where a long distance provider has sufficiently high
traffic volume, routing calls across an indefeasible right of use or leased
cable capacity is generally more cost-effective on a per-call basis than the
use of resale arrangements with other long distance providers. However, leased
capacity and acquisition of an indefeasible right of use requires a
substantial initial investment based on the amount of capacity acquired.
Transit Arrangements. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit agreements. Under
these arrangements, a long distance provider in an intermediate country
carries the traffic to the country of destination.
Switched Resale Arrangements. A switched resale arrangement typically
involves the wholesale purchase of termination services on a variable, per-
minute basis by one long distance provider from another. A single
international call may pass through the facilities of several long distance
resellers before it reaches the foreign facilities-based carrier that
ultimately terminates the call. Such resale, first permitted with the
deregulation of the U.S. market, enabled the emergence of alternative
international providers that relied, at least in part, on transmission
services acquired on a wholesale basis from other providers. Resale
arrangements set per-minute prices for different routes, which may be
guaranteed for a set time period or which may be subject to change. The resale
market for international transmission is extremely dynamic in nature, as new
long distance resellers emerge, and as existing providers respond to
fluctuating costs and competitive pressures. In order to effectively manage
costs when utilizing resale arrangements, long distance providers need timely
access to changing market data and must quickly react to changes in costs
through pricing adjustments or routing decisions.
Alternative Transit/Termination Arrangements. As the international long
distance market began to deregulate, long distance providers developed
alternative transit/termination arrangements in an effort to decrease their
costs of terminating international traffic. Some of the more significant
arrangements include refiling, international simple resale and ownership of
switching facilities in foreign countries.
Refiling and transiting of traffic, which take advantage of disparities in
settlement rates between different countries, allow traffic to a destination
country to be treated as if it originated in another country that benefits
from lower settlement rates with the destination country, thereby resulting in
a lower overall termination cost. The difference between transit and refiling
is that, with respect to transit, the long distance provider in the
destination country has a direct relationship with the originating long
distance provider and is aware of the arrangement, while with refiling, it is
likely that the long distance provider in the destination country is not aware
of the country in which the traffic originated or of the originating carrier.
To date, the FCC has made no pronouncement as to whether refiling complies
with either U.S. regulations or the regulations of the International
Telecommunication Union.
Under international simple resale, a long distance provider completely
bypasses the accounting rate system by connecting an international leased
private line (i) to the public switched telephone network of two countries
6
or (ii) directly to the premises of a customer or partner in one country and
the public switched telephone network in the other country. While
international simple resale is currently only sanctioned by applicable
regulatory authorities on a limited number of routes, including U.S.-U.K.,
U.S.-Canada, U.S.-Sweden, U.S.-New Zealand, U.S.-Australia, U.S.-Netherlands,
U.K.-worldwide, Canada-U.K. and U.S.-Japan, it is increasing in use and is
expected to expand significantly as deregulation of the international
telecommunications market continues. In addition, deregulation has made it
possible for U.S.-based long distance providers to establish their own
switching facilities in certain foreign countries, enabling them to terminate
traffic directly.
Competitive Opportunities and Advances in Telecommunications Technology
The combination of a continually expanding global telecommunications market,
consumer demand for lower prices with improved quality and service, and
ongoing deregulation has created competitive opportunities in many countries.
Similarly, new technologies, including fiber optic cable and improvements in
digital compression, have improved quality and increased transmission
capacities and speed, with transmission costs decreasing as a result. In
addition, the growth of the Internet as a communications medium, and advances
in packet switching technology and Internet telephony are expected to have an
increasing impact on the international telecommunications market.
Advances in technology have created a variety of ways for telecommunications
carriers to provide customer access to their networks and services. These
include customer-paid local access, international and domestic toll-free
access, direct digital access through dedicated lines, equal access through
automated routing from the public switched telephone network, call
reorigination and Internet telephony. The type of access offered depends on
the proximity of switching facilities to the customer, the needs of the
customer, and the regulatory environment in which the carrier competes.
Overall, these changes have resulted in a trend towards bypassing traditional
international long distance operating agreements as international long
distance companies seek to operate more efficiently.
In a deregulated country such as the U.S., carriers can establish switching
facilities, own or lease fiber optic cable, enter into operating agreements
with foreign carriers and, accordingly, provide direct access service. In
markets that have not deregulated or are slow in implementing deregulation,
international long distance carriers have used advances in technology to
develop innovative alternative access methods, such as call reorigination. In
other countries, where deregulation has commenced but has not been completed,
carriers are permitted to offer data and facsimile services, as well as
limited voice services including those to closed user groups, but are not yet
permitted to offer full voice telephony. As countries deregulate, the demand
for alternative access methods typically decreases because carriers are
permitted to offer a wider range of facilities-based services on a transparent
basis.
The most common form of alternative international access, traditional call
reorigination, avoids the high international rates offered by the dominant
carrier in a particular regulated country by providing the user with a dial
tone from a deregulated country, typically the U.S. To place a call using
traditional call reorigination, a user dials a unique phone number to an
international carrier's switching center and then hangs up after it rings. The
user then receives an automated callback providing a dial tone from the U.S.
which enables the user to complete the call. Technical innovations, ranging
from inexpensive dialers to sophisticated in-country switching platforms, have
enabled telecommunications carriers to offer a "transparent" form of call
reorigination. The customer dials into the local switch, and then dials the
international number in the usual fashion, without the "hang-up" and
"callback," and the international call is automatically and rapidly processed.
The Company believes that as deregulation occurs and competition increases in
various markets around the world, the pricing advantage of traditional call
reorigination to most destinations relative to conventional international
direct dial service will diminish in those markets.
Developments in the Internet Industry
Use of the Internet has grown rapidly since its initial commercialization in
the early 1990's. However, determining the precise number of Internet users is
extremely difficult because (i) the Internet does not have a
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single point of control from which statistics may be recorded; (ii) computers
are connected and disconnected from the Internet on a continual basis; and
(iii) a large number of users may access the Internet through a single
network. International Data Corporation ("IDC") estimates that the number of
Internet users worldwide will increase from approximately 69 million in 1997
to 320 million in 2002, representing a compound annual growth rate of 36%.
Forrester Research projects that revenue from Internet access services in the
U.S. will grow from $6.5 billion in 1998, to $21.8 billion in 2002, a compound
annual growth rate of 35%.
The Internet has evolved dramatically over the last several years as a
result of several trends affecting the computer and communications industries.
These trends include (i) the migration by organizations from proprietary
mainframe environments to open systems and distributed computing; (ii) the
emergence of low-cost, high-capacity telecommunications bandwidth; (iii) the
increased use of PCs in the home; (iv) the increased percentage of PCs that
are equipped with modems; (v) the growth of commercial on-line services; (vi)
the growth of information, entertainment and commercial applications; (vii)
the increase in the number and variety of services available on the Internet;
and (viii) the widening acceptance of Internet-based transactions
("e-commerce") as reliable and more convenient substitutes for transactions
conducted through more traditional means. Through an Internet connection,
users can access commercial, educational and governmental databases, software,
graphics, newspapers, magazines, library catalogs, industry newsletters, and
other information. Currently, the primary uses of the Internet include e-mail,
Web browsing, electronic commerce, file transfers, remote log-in, news,
bulletin boards, chat services and other on-line services.
In addition, during the last few years, several navigational and utility
tools have become available that have enabled easier access to the resources
of the Internet. Navigational software such as Netscape Navigator and
Microsoft's Internet Explorer, and search tools from such companies as
Excite@Home Corp., InfoSeek Corp. and Lycos, Inc. help users access
information from the Internet.
As the volume of information available on organizations' computer systems
has increased and the use of data communications has grown as a preferred
means of day-to-day communications, organizations increasingly seek a number
of geographically dispersed access points to their own networks and to the
networks of other organizations. In the commercial sector, the number of
interconnections that businesses desire to establish with networks, customers,
suppliers and affiliates generally has made the development of proprietary
access systems on a case-by-case basis costly and time consuming. As a result,
many organizations seek reliable, high-speed and cost-effective means of
internetworking and increasingly rely on the Internet. As reliance on the
Internet for the transmission of data, applications and electronic commerce
continues to grow among organizations, the Company believes that these
organizations will require fast, reliable, geographically dispersed and
competitively priced Internet access and services.
Internet Telephony
The Internet telephony industry began in 1995, when experienced Internet
users began to transfer voice messages from one personal computer to another.
In 1995, VocalTec Communications, Ltd. ("VocalTec") introduced software that
allowed personal computer users to place international calls via the Internet
to other personal computer users for the price of a local call. In its early
months, the growth of Internet telephony was constrained due to the poor sound
quality of the calls and because calls were mainly limited to those placed
from one personal computer to another.
The poor sound quality of Internet telephony was due to the fact that the
Internet was not created to provide for simultaneous voice traffic. Unlike
conventional voice communication circuits, in which the entire circuit is
reserved for a call, Internet telephony uses packet switching technology, in
which voice data is divided into discrete packets that are transmitted over
the Internet. These packets must travel through several routers in order to
reach their destination, which may cause misrouting, and delays in
transmission and reception. The limited capacity of the Internet has also
restrained the growth rate of Internet telephony.
8
However, as the industry has grown, substantial improvements have been made.
New software algorithms have substantially reduced delays. The use of private
networks or intranets to transmit calls as an alternative to the public
Internet has alleviated capacity problems. Another key development has been
the introduction of gateway servers, which connect packet-switched data
networks such as the Internet to circuit-switched public telephone networks.
Developments in hardware, software and networks are expected to continue to
improve the quality and viability of Internet telephony. In time, packet-
switched networks may become substantially less expensive to operate than
circuit-switched networks, because carriers can compress voice traffic and
place more calls on a single line.
Internet telephony has emerged as a low cost alternative to traditional long
distance calls. IDC projects that the Internet telephony market will grow
rapidly to over $23.4 billion in 2003, from approximately $1.1 billion in 1998
and that Internet telephony will account for nearly 11% of domestic and
international long distance voice traffic by 2002.
Internet telephone calls are less expensive than traditional international
long distance calls primarily because these calls are carried over the
Internet or a proprietary network and therefore bypass a significant portion
of international long distance tariffs. The technology by which Internet phone
calls are made is also more cost-effective than the technology by which
traditional long distance calls are made. IDC projects that commerce over the
Internet will grow to approximately $1.3 trillion in 2003.
Market Opportunity
The market for international voice and data telecommunications is undergoing
fundamental change and has experienced significant growth as a result of: (i)
deregulation and privatization of telecommunications markets worldwide; (ii)
the convergence of traditional voice and packet switching technology; and
(iii) the growth of the Internet as a communications medium, including
Internet telephony.
Deregulation and Privatization of Telecommunications Markets
Worldwide. Significant legislation and agreements have been adopted since the
beginning of 1996 which are expected to lead to increased liberalization of
the majority of the world's telecommunication markets, including:
. the U.S. Telecommunications Act, signed in February 1996, which
establishes parameters for the implementation of full competition in the
U.S. domestic local and long distance markets;
. the European Union's Services Directive, adopted in 1990, which
abolishes exclusive rights for the provision of voice telephony services
throughout the European Union and the public switched telephone networks
of any member country of the European Union by January 1, 1998, subject
to extension by certain European Union member countries; and
. the WTO Agreement, signed in February 1997, which creates a framework
under which 69 countries have committed to liberalize their
telecommunications laws in order to permit increased competition and, in
most cases, foreign ownership in their telecommunications markets,
beginning in 1998.
The Company believes that these initiatives, as well as other proposed
legislation and agreements, will provide increased opportunities for emerging
competitive carriers such as IDT to provide telecommunications services in
targeted markets. Deregulation has encouraged competition, which in turn has
prompted carriers to offer a wider selection of services and reduce prices.
The industry's projections for substantially increased international minutes
of use and revenue over both the near term and long term are based in part on
the belief that reduced pricing as a result of deregulation and competition
will result in a substantial increase in the demand for telecommunications
services in most markets.
Convergence of Traditional Voice and Packet Switching
Technology. Technological advancements have allowed the use of "packet
switching" technology for the transmission of voice telecommunications
traffic, enabling a substantial increase in network efficiency, as well as the
use of the Internet for voice communications.
9
Traditional international long distance calls use a technology called "circuit
switching," which carries the calls over international voice telephone
networks. Circuit switching requires a dedicated connection between the caller
and the recipient which must stay open for the duration of the call. On the
other hand, packet switching technology breaks voice and fax calls into
separate data packets, sends them over the Internet, then reassembles them in
their original form for delivery to the recipient. This technology allows data
packets representing multiple conversations to be carried over the same line,
and is therefore inherently more efficient than is circuit switching
technology. In addition, the use of the Internet as a voice communications
medium provides significant reductions in the cost of transmitting traffic,
while bypassing the cumbersome and expensive settlement process inherent in
international voice communications. The development of voice applications for
the Internet is part of a larger trend of convergence of standard voice and
data networks. Internet telephony services are expected to be one of the
fastest growth segments in the telecommunications industry.
The IDT Approach
IDT's background as a leading alternative provider of wholesale and retail
international telecommunications services, combined with its experience as a
domestic Internet service provider and its leadership role in the field of
Internet telephony, position it to capitalize on continuing deregulation in
the international telecommunications marketplace and the convergence of voice
and data telecommunications technologies. The Company leverages its customer
base, existing carrier relationships and technology platforms to (i) develop
new, low-cost termination arrangements; (ii) offer new services such as
prepaid calling cards and Internet telephony to wholesale and retail customers
in target countries; and (iii) negotiate partnership arrangements with
existing and emerging carriers to market the Company's Internet telephony
services.
Strategy
The Company's objective is to enhance its current position as as a leading
facilities-based provider of high-quality, low-cost telecommunications
services to wholesale and retail customers in both the U.S. and abroad. Key
elements of the Company's strategy include:
Focus on International Telecommunications. The Company believes that the
international long distance market provides attractive opportunities due to
its higher revenue and gross profit per minute, and higher projected growth
rate compared to the domestic long distance market. The Company targets
international markets with high volumes of traffic, relatively high per-minute
rates and favorable prospects for deregulation and privatization. The Company
believes that the ongoing trend toward deregulation and privatization will
create new opportunities for the Company to increase its revenues and to
reduce its termination costs, while maintaining balanced growth in wholesale
and retail traffic.
Expand Switching and Transmission Facilities. The Company is continuing to
expand and enhance its network facilities by investing in switching and
transmission facilities where traffic volumes justify such investments. During
Fiscal 2000, the Company intends to invest in (i) undersea cables connecting
the U.S. and Europe, the U.S. and Asia, and points within Europe; (ii)
facilities in the U.S., the U.K., France, Italy, Spain, Germany, Austria and
other European countries; and (iii) additional network compression equipment.
The Company believes that these investments will allow it to reduce the cost
of its services and to enhance its offerings, while maintaining its high
service quality.
Expand Service Offerings and Marketing Activities. The Company will continue
to develop value-added services and to market them on a wholesale and retail
basis in order to increase margins, optimize network utilization and improve
customer loyalty. IDT has historically used technology to capitalize on
regulatory opportunities and market niches by offering innovative value-added
services such as call reorigination, international prepaid calling cards and
Internet telephony. In addition, the Company intends to capitalize on its
strategic alliances and other relationships with U.S. and foreign companies in
order to expand its customer base.
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Pursue Strategic Alliances and International Agreements. The Company has
capitalized on its significant traffic volume and technological expertise to
negotiate favorable termination agreements with international carriers. The
Company intends to continue to seek new termination relationships with
established and emerging carriers to reduce its termination costs for
traditional international voice telephony, and in some cases to use its
relationship with Net2Phone for additional low cost termination. To date, the
Company has entered into approximately 65 agreements with carriers that
provide for the favorably priced termination of its calls in over 40
countries.
Maintain Low Operating Costs and Improve Profitability. The Company seeks to
continue to improve its profitability by (i) maintaining a streamlined general
and administrative staff; (ii) leveraging its general and administrative staff
across its complementary telecommunications services businesses; (iii)
capitalizing on its wholesale traffic volumes to arrange cost-effective resale
and termination arrangements, while continuing to increase its sales of higher
margin retail international minutes; and (iv) investing in network
infrastructure and selling, general and administration expenses when such
investment is justified by traffic volumes.
Services
IDT provides its customers with integrated and competitively priced
international and domestic telecommunications, Internet access and through its
majority-owned Net2Phone subsidiary, Internet telephony services.
Telecommunications Services
The Company's four primary telecommunications services are: (i) wholesale
carrier services; (ii) prepaid calling cards; (iii) international retail
services for individuals and businesses; and (iv) domestic long distance
services in the U.S. The Company generated revenues from its
telecommunications business of approximately $684.6 million during Fiscal
1999, up from $303.9 million during Fiscal 1998. Telecommunications revenues
represented 93.5% and 90.6%, respectively, of IDT's total consolidated
revenues in Fiscal 1999 and Fiscal 1998.
Wholesale Carrier Services
The Company sells its wholesale carrier services to other U.S. and
international carriers, utilizing flexible and least-cost traffic routing and
based on its expertise in navigating the complex accounting rate system. In
this way, the Company acts as a "carrier's carrier," providing the numerous
entrants in the retail market with rates that are much lower than those
previously offered by the more established carriers. The Company is able to
offer competitive rates to its carrier customers as a result of (i) its
extensive relationships in the long distance telecommunications industry; (ii)
its ability to generate a high volume of long distance call traffic; and (iii)
the advantageous rates negotiated with foreign PTTs and competitive carriers.
During Fiscal 1999, wholesale carrier sales represented 39.5% of IDT's total
consolidated revenues.
Prepaid Calling Cards
The Company sells prepaid debit and rechargeable calling cards providing
access to more than 230 countries and territories. The Company's rates are
between 10% and 50% less than the rates for international calls that are
charged by the major facilities-based carriers. The Company's debit cards are
marketed primarily to ethnic communities in the U.S. that generate high levels
of international traffic to specific countries where the Company has favorable
termination agreements. Recent immigrants and members of the ethnic
communities are heavy users of international long distance, given their desire
to keep in touch with family members and friends back home. The Company also
markets cards in the U.K., France and the Netherlands, seeking to capitalize
on the opportunity presented by the recent surge in immigration from under-
developed countries to Europe's developed nations. During Fiscal 1999, sales
of prepaid calling cards accounted for 49.7% of IDT's total consolidated
revenues.
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The Company offers both IDT-branded and non- IDT-branded prepaid calling
cards, with favorable rates to specific areas of the world. The cards are sold
in several different dollar denominations, most commonly $5, $10 and $20. The
table below lists the IDT phone cards sold by the Company:
California Exclusive Illinois Exclusive New York Exclusive
Carolina Exclusive Long Island Exclusive Nosso Brazil Card
Centro Americard M&M Card Pepe Colombianita
China Card Mass Exclusive Pepe Megatel
Colombiana Card Mega Mexico Card Puerto Rico Exclusive
Colombianita Card Megatel Card Rhode Island Exclusive
Connecticut Exclusive Megatel Vending Texas Exclusive
Discovery Card Metropolis Card Vending Georgia
Dominicall Card Merengue Card Exclusive
Florida Exclusive New Jersey Exclusive Vending Washington
Georgia Exclusive New York Alliance Exclusive
Washington Alliance
Washington Exclusive
The Company's rechargeable cards, distributed primarily through in-flight
magazines, permit users to place calls from 43 countries through international
toll-free services.
The Company's retail customers can use its calling cards at a touch tone
telephone by dialing an access number, followed by a personal identification
number (a "PIN") assigned to each prepaid calling card and the telephone
number the customer seeks to reach. The Company's switch completes the call,
and its debit card platform reduces the outstanding balance of the card during
the call. The Company offers prepaid calling cards that can be used to access
the Company's network by dialing a toll-free number or, in specific
metropolitan markets, local area calling cards that only require a local call.
The Company believes that many of its customers typically use its calling
cards as their primary means of making long distance calls due to (i)
attractive rates, (ii) reliable service, (iii) the ease of monitoring and
budgeting their long distance spending and (iv) the appealing variety of
calling cards offered by the Company to different market segments.
IDT expanded its domestic debit card platform through its acquisition of
InterExchange and its subsidiaries (collectively, "InterExchange"), completed
in May 1998. Through InterExchange, the Company operates one of the nation's
largest international debit card platforms. The platform provides the Company
with a broad range of services used to conduct its calling card operations,
including billing, routing of calls, and determining the amount of credit
available on each outstanding calling card.
As part of IDT's rapid expansion in the prepaid calling card market, the
Company has initiated marketing private label phone cards. Private label cards
serve as lucrative promotional items and can also be used to help generate
brand name awareness. In December 1998, IDT signed an exclusive multi-year
supply and distribution agreement with M&M/MARS's "M&M's(R)" Chocolate
Candies, one of the largest confectionary brands in the world, to provide
specifically-branded, private label phone cards. Through a strategic marketing
relationship, "M&M's(R)" cards will be available to retailers currently
carrying "M&M's(R)" Chocolate Candies. The phone cards feature the likenesses
and the voices of the "M&M's(R)" Brand Characters currently featured in
"M&M's(R)" advertising. IDT handles the entire call process of these phone
cards, including call routing, authorization, prepaid platform and billing of
the "M&M's(R)" cards.
In February 1999, the Company launched Debitalk, its first prepaid callback
phone card, which allows people around the world to bypass the high costs of
placing international calls from countries outside of the United States.
Debitalk allows users to place phone calls from anywhere in the world using a
touch-tone telephone with a pre-programmed callback number. Users dial their
access number, allow the phone to ring once, hang up, wait for the ring back,
listen to their real-time account balance, and dial their destination number.
There are no credit cards, invoices or bad debt associated with Debitalk as
the callback services are prepaid.
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International Retail Services
The Company offers international retail services to customers outside of the
U.S., primarily through call reorigination. The Company also provides its call
reorigination customers with access to enhanced U.S. telecommunications
service options at U.S. long distance rates. These options include: voicemail,
itemized billing, speed dial codes that allow customers convenient access to
the call reorigination service, personalized voice prompts that allow
customers to be called back at extensions where the party being dialed must be
requested by name, remote programmable service that allows customers the
flexibility of selecting the number called back instead of receiving the call
at a preprogrammed number, access to U.S. toll-free 888 and 800 numbers, and
simplified billing that combines the cost of the call back to the customer and
the cost of the customer's outbound call from the U.S. in one bill for
convenient and orderly presentation. The Company markets its call
reorigination service to businesses and individuals. International retail
services accounted for 2.9% of IDT's total consolidated revenues in Fiscal
1999.
As an alternative service, the Company provides international long distance
services to certain overseas customers, currently in the United Kingdom, via
standard international direct-dial network services. Through this service, the
Company offers a foreign customer the ability to place a direct call to an
international destination over the Company's leased network at competitive
rates without the need for call reorigination. In markets that are
deregulating, the Company's strategy is to migrate its call reorigination
customers to international direct-dial service, where operating environments
warrant. The Company expects to offer retail service in several European
nations by the end of Fiscal 2000.
Domestic Long Distance Services
The Company markets certain long distance services directly to retail
customers in the U.S. The Company's customers pay rates that are between 10%
and 50% less than the rates for domestic long distance service charged by the
major facilities-based carriers. The Company also markets the long distance
service as a value-added bundled service with its dial-up Internet access, and
offers customers who maintain minimum monthly long distance billing levels
rates that are approximately 20% less than the rates for dial-up Internet
access that are charged by the major national Internet service providers.
Domestic long distance services accounted for 1.4% of the Company's total
consolidated revenues in Fiscal 1999.
In September 1999, the Company announced a new domestic long distance plan
featuring a flat rate of 5 cents per minute with a $3.95 monthly fee. The 5
cents per minute rate applies to all calls, 24 hours a day, 7 days a week. IDT
also plans to offer rates as low as 3.5 cents per minute for customers who
also subscribe to IDT's dial-up Internet service. The Company believes that it
is now the lowest cost domestic long distance provider in the country.
Internet Services
In 1994, the Company began offering dial-up and dedicated Internet access to
individuals as a value-added service for its domestic long distance customers,
and to businesses as a stand-alone service. IDT's Internet access network,
which consists of multiple leased lines, offers 33 (POPs) owned by the
Company, and approximately 375 POPs owned by local and regional Internet
service providers, through which subscribers may access the Internet. The
Company's three primary Internet access and online services are: (i) dial-up
Internet access for individuals and businesses; (ii) direct-connect dedicated
Internet services for corporate customers; and (iii) the Genie online
entertainment and information services. Internet access accounted for 2.3% of
IDT's total consolidated revenues in Fiscal 1999.
Dial-Up Access Services
The Company's dial-up service offers individuals unrestricted Internet
access with an easy-to-use point-and-click graphical user interface for a
fixed monthly fee. IDT provides its customers with access to a full range of
Internet applications, including e-mail functions, Web sites, Usenet news
groups, databases and public domain software, as well as a full graphics
package and browser software.
13
The Company provides its individual customers with several pricing options.
Currently, the Company offers Basic Internet Service for $19.95 per month and
Premium Service for $29.95 per month. Each is a fully graphical account
bundled with an Internet browser, unlimited dial-up Internet access, and an e-
mail account. Premium Service customers are entitled to the Reuters news
service, a second e-mail address, eight megabytes of personal Web space
storage, and special customer support services. The Company also offers Basic
Internet Service access accounts for $15.95 per month for customers who sign
up for IDT's long distance telephone service and maintain their monthly long
distance telephone billings at or above $40 per month. The Company offers free
Basic Internet Service accounts for those customers who sign up for IDT's long
distance telephone service and maintain their monthly telephone billings at or
above $150 per month. In addition, the Company offers an e-mail only account
for $7.95 per month.
The Company has entered into an agreement with Mail Call, Inc., pursuant to
which the Company's Internet subscribers are able to retrieve e-mail via
telephone, using text-to-speech technology. This service, which is called
"Mail Call," enables subscribers to hear their e-mail messages by calling a
toll-free telephone number, without the need for a computer. Subscribers to
this service can choose to listen to the text of each message (in English or
Spanish), have a "hardcopy" of the message sent to any fax machine in North
America, or reply to the message using one of several features. Mail Call also
offers several preference options, including six different voices with three
pitches each, a default fax phone number, a customized response, and several
pattern matching strings which can be used to filter and prioritize incoming
e-mail messages.
In August 1999, the Company teamed up with iPass, to offer to its retail and
business customers roaming Internet access in over 150 countries using iPass'
vast worldwide network of 4,000 POPs. Internet roaming is available
immediately to the Company's customers, who can download the iPass connection
software at the Company's Web site. Instead of having to pay for long-distance
calls to connect back to IDT's service while outside the United States, the
Company's customers can now access the Internet locally in virtually every
major city throughout the world. The roaming Internet service also improves
the connection quality for users who often experience noisy or dropped
connections with Internet connections via international calls.
Direct Connect Dedicated Services
The Company offers a variety of Internet access options and applications
specifically designed to address the unique needs of medium to large-sized
businesses. These corporate clients typically require high-speed dedicated
circuits because they desire to put up a Web site, the nature of their
business requires the transfer of large data files, or it would be impractical
for them to maintain dial-up accounts for all of their employees who require
Internet access.
In March 1999, the Company formed a Dedicated Internet Group for the primary
purpose of selling Dedicated Internet Access, Digital Subscriber Lines
("DSL"), Web Hosting and Design and Colocation to business clients. The
Dedicated Internet Group is currently staffed by 20 employees and revenues
have increased from $4,000 in new sales in April 1999 to over $100,000 in
September 1999. The Company currently charges clients using 56 kilobits per
second ("56K") lines approximately $350 per month for direct connect service
and clients utilizing full T1's approximately $1,400 per month for direct
connect service. For clients with higher bandwith needs, IDT offers a tiered
T3 service starting at $3,000 per month.
In June 1999, IDT began offering Internet access through DSL. DSL uses
standard telephone lines to provide access to the Internet at speeds many
times faster than standard 56K modem connections, at a lower cost than a
dedicated leased line. IDT offers DSL service to its customers at monthly
rates ranging from $125 to $499, depending on line speed and the length of the
contract, with four months of free Internet access included in the package.
The Company views the DSL market as largely untapped given the 38,000 to
40,000 nationally installed DSL lines and the potential market of well over
five million DSL subscribers.
14
Genie Services
The Company also offers the Genie online service, giving subscribers access
to roundtables, bulletin boards and chat areas, individual and multiplayer
games, news, travel, entertainment, weather and other information services.
Currently, the Company markets the Genie content as an online service
available only to subscribers. The Company offers Internet access to Genie
online subscribers for an additional fee.
Telefonica Agreement
In October 1999, IDT entered into a joint venture agreement with Terra
Networks, S.A. (formerly known as Telefonica Interactiva, S.A.) pursuant to
which the parties formed two limited liability companies to provide Internet
services and products for customers in the United States, mainly targeting and
focusing on the Hispanic population in the United States. One company was
formed to provide Internet access to customers in the target market, and IDT
contributed its dial-up Internet access customers, its managerial resources
and facilities and its portfolio of current and future products for Internet
access to the new company in exchange for a 49% ownership interest. The other
company was formed to develop and manage an Internet portal that will provide
content-based Internet services, electronic commerce offerings and other
Internet services to customers in the target market. IDT will assist in
developing relationships with content producers and content providers and will
sell advertising on this new company's portal in exchange for a 10% ownership
interest. Terra Networks has agreed to fund the first $30 million of expenses
for the ISP joint venture, subject to the completion of certain performance
criteria.
IDT/Westmintech Joint Venture
In September 1999, Chattle, Inc., a wholly owned subsidiary of IDT, entered
into a joint venture with Westmintech Company, L.L.C. ("Westmintech") in the
form of a Delaware limited liability company named Worldwide Intercom, L.L.C.
("Worldwide Intercom") to provide high speed voice and data services,
including without limitation local and long distance telephone service
(dedicated and 1+), cable television service (cable and/or fiber optic), on
line service with direct Internet access and Internet access services (DSL,
dedicated and dial up) and various other Internet services and other
technology related to the foregoing existing and yet to be developed, to the
tenants of commercial and residential properties worldwide. Westmintech is
owned in part and controlled by Charles Kushner or an entity which he
controls. Mr. Kushner owns in part and controls directly or indirectly various
multifamily, retail and commercial properties throughout New York and New
Jersey. Chattle, Inc. owns 75% of Worldwide Intercom and Westmintech owns the
remaining 25%.
Under the terms of the joint venture agreement, IDT will license to
Worldwide Intercom intellectual property, technical know-how, and patent,
copyright and trademark rights relating to the provision of Worldwide
Intercom's services. IDT will also provide Worldwide Intercom with back office
support for its services, and will arrange for the installation, activation,
maintenance, repair and service of the hardware and wiring necessary to
provide Worldwide Intercom's services. The initial term of the agreement is
for a period of one year and shall be automatically renewable for additional
one year periods.
Net2Dine.com
In August 1999, the Company launched Net2Dine.com, an Internet directory
designed for restaurant owners and consumers which currently lists over
112,000 restaurants in the United States. Net2Dine.com attracts restaurants to
its Web site by offering a free restaurant listing as well as value-added
products that increase a restaurant's presence on the Internet. For $10 a
month, a restaurant may subscribe to Net2Dine.com's Webpage Plan. Every
subscribing restaurant receives its own mini Webpage which is built into
Net2Dine.com's Web site, complete with Click2Reserve on-line reservations.
Each Webpage provides detailed information about the restaurant, including its
credit card policy, specials, reservations requirements and other relevant
information.
The Company intends to pursue and/or develop other opportunities in the
Internet business, with a focus on identifying and exploiting niche market
opportunities, specifically in markets where the Company can leverage one or
more of its existing strengths.
15
Internet Telephony
In August 1996, the Company began offering Net2Phone, the first commercial
telephone service to bridge calls between multimedia PCs and telephones via
the Internet, and to charge for this service on a per-minute basis. Upon
installation of the Net2Phone software, which is provided by Net2Phone
primarily through the Internet without charge, a Net2Phone user receives an
account number, and chooses a personal identification number as an added
security feature. Once the Net2Phone software is installed, a user may place
toll-free "800" or "888" calls from anywhere in the world without incurring
any charges for such calls. Upon a user's prepayment for Net2Phone minutes,
the user may begin using Net2Phone to place telephone calls worldwide. In
Fiscal 1999, Net2Phone received the following awards and commendations:
. Net2Phone Direct was named Internet Telephony Magazine's 1998 Product of
the Year
. Net2Phone was named CTI Magazine's 1998 Product of the Year
A user places a Net2Phone call after establishing a connection to the
Internet. The call is routed over the Internet, at no charge to the customer,
to the Company's telecommunications switches in the U.S. The call is then
routed in the same manner as other voice telephony calls, using the Company's
least-cost routing platform in order to increase the savings realized by
international callers. Net2Phone's voice quality has been enhanced through the
use of technology licensed from Lucent Technologies, Inc., and the software
relating to Net2Phone is available in seven different languages. For calls
originating overseas, the cost of placing and terminating the call with
Net2Phone is up to 95% below the rates generally charged by traditional
foreign carriers to place and terminate standard international telephone
calls.
In October 1997, the Company introduced Net2Phone Direct, a commercial
telephone service that enables international and domestic phone-to-phone calls
to be made via the Internet using packet switching technology. Net2Phone
Direct enables phone-to-phone calling between two parties using telephones,
while using the Internet to transport the long-haul components of the call.
Users of Net2Phone Direct are able to call a local or toll-free access number,
which connects the call to the Internet. Through such use of the Internet, the
Company expects to significantly reduce the cost of international and domestic
calling by extending the benefits of placing Internet telephone calls to
customers with access to a regular telephone without requiring the use of PCs
or individual Internet access. The Company also intends to develop a global
network of switches and servers, thereby expanding the Company's ability to
provide competitively priced Internet telephony solutions. The Company
generated net revenues from its Internet telephony business of about $30.7
million during Fiscal 1999.
IDT has entered into agreements with resellers in several foreign countries,
pursuant to which such parties purchase and house the Net2Phone Direct servers
in their country and resell Net2Phone Direct pin numbers to end-users. IDT
provides customer service and technical support for Net2Phone and Net2Phone
Direct customers in seven languages on a 24 hour per day, 7 day per week
basis.
Sales, Marketing and Distribution
Telecommunications
The Company primarily markets its international telecommunications services
through its direct wholesale carrier services sales staff. The staff primarily
relies on, and benefits from, (i) the Company's extensive relationships and
increasing international exposure and recognition throughout the long distance
industry for marketing its carrier services; (ii) the Company's substantial
traffic volumes, which enable the Company to negotiate for lower rates; and
(iii) favorable terminating rates negotiated with PTTs and foreign carriers.
The Company primarily markets its international call reorigination services
through its overseas network of independent sales representatives. The foreign
sales representatives, who are supervised by the Company's U.S.-based sales
managers, provide the Company with access to local business and residential
customers and new opportunities in the local markets they serve. The Company
pays its foreign sales representatives on a
16
commission basis. As of October 1999, the Company was represented by over 300
foreign sales representatives worldwide. The Company also has commenced direct
sales efforts, primarily through overseas advertising in international print
media to penetrate particular market segments that it does not currently
serve.
The Company currently markets its prepaid debit cards to retail outlets
throughout the U.S. though Union Telecard Alliance, LLC ("Union"), a joint
venture company of which the Company owns 51% of the outstanding equity
interests. Union is one of the largest distributors of prepaid calling cards
in the nation, selling through over 100,000 retail outlets throughout the
United States. In July 1999, the Company entered into an agreement with All
Americas Cable & Radio ("AACR"), a long distance carrier based in the
Dominican Republic, in which the Company will distribute prepaid calling cards
in the Dominican Republic on behalf of AACR. As part of its plan to expand its
territory beyond the U.S., the Company has begun to establish a distribution
network in the Dominican Republic to replicate its calling card distribution
network in the United States. Union also plans to begin distributing prepaid
cards in Puerto Rico and parts of Central America.
Union has entered into agreements with sub-distributors, located in Chicago,
Florida, New York, Ohio and Texas, whereby the sub-distributors have agreed to
market the prepaid calling cards of the Company in exchange for preferential
pricing, exclusive cards, extensions of credit, incentive bonuses and
technical support from the Company which is intended to assist each respective
sub-distributor in the growth and development of its business. The exclusive
calling cards of the Company will be marketed by the corresponding partnership
in a given state.
In addition to selling IDT's prepaid calling cards, Union sells prepaid
calling cards of other companies. This allows Union to operate as a "one-stop
shop" for the widest possible range of prepaid phone cards, enabling Union to
enhance its sales to the retail outlets it currently serves.
IDT also sells rechargeable calling cards, which are distributed primarily
through in-flight magazines.
Internet Access
The Company established itself as a leading national provider of Internet
access services primarily through extensive broadcast and print advertising to
the consumer market. In Fiscal 1997, the Company refocused the marketing
efforts of its Internet access operations in order to lower the cost of
acquiring new customers. While the Company intends to continue various means
of broadcast advertising in select markets, the Company's sales and marketing
efforts now are focused primarily on increasing its Internet customer base
through (i) OEM transactions, including hardware, software and operating
system bundling, (ii) retail channel distribution agreements and (iii)
bundling Internet access with long distance telephone service. Additionally,
the Company has entered into agreements with other Internet service providers
to resell IDT's Internet access services. Through these strategies, the
Company believes that it will increase its exposure to the millions of
computer users who are potential customers of the Company's Internet access
services, while reducing its customer acquisition costs as compared to
traditional broadcast and print advertising. As of October 20, 1999, the
Internet sales force consisted of approximately 45 employees. The Company's
Internet sales staff is closely supervised and undergoes customized and
ongoing training to ensure a high level of knowledge and service.
Internet Telephony
Net2Phone markets its Internet telephony services primarily by distributing
its products without charge via the Internet and acquiring commercial
Net2Phone customers through its prepaid platform. Net2Phone promotes its
service through online and Internet-based advertising venues, traditional
print advertising in international publications, and electronic media. In
addition, Net2Phone has agreements to bundle the required software for
Net2Phone, as a value-added component, with the software of other companies,
and with other PC and computer equipment. Such bundling agreements have
included bundling Net2Phone with a telephone handset product called Internet
PhoneJACK(R) developed by Quicknet Technologies, Inc.; this combination is
marketed under the name Net2Phone Pro. Net2Phone has entered into strategic
marketing and distribution relationships with leading
17
Internet companies, including Yahoo!, Infospace.com, Snap.com, Excite@Home and
ZD Net. Net2Phone has also entered into arrangements with leading computer
equipment and software companies, such as IBM, Compaq and Packard Bell-NEC
Europe to include its software with these companies' products.
Net2Phone has agreements with resellers in certain countries, pursuant to
which such resellers purchase bulk amounts of Net2Phone minutes in advance,
and resell such minutes to users in their own countries as representative
sellers of Net2Phone. Net2Phone currently offers Net2Phone Direct in over 62
cities in the U.S., and has entered into agreements with Daewoo and Naray in
South Korea and Marubeni in Japan to market Net2Phone Direct in those
countries. Net2Phone also seeks to sell Net2Phone Direct switch servers to
additional third parties in strategic markets worldwide, and to enter into
agreements to resell the Click2CallMe service.
In April 1998, Net2Phone began offering its Click2Talk Service, in which an
icon is placed on a customer's Web site. When an end-user of the Web site that
is equipped with an appropriately configured multimedia PC clicks on the
Click2Talk icon, the Net2Phone technology directly dials the customer's toll-
free customer service number.
In August 1998, the Company began offering the Click2CallMe service, in
which an icon is placed on a customer's Web site. When an end-user of the Web
site clicks on the Click2CallMe icon, IDT's callback and Net2Phone
technologies notify the customer, and then dials the end-user in order to
connect the customer and the end-user.
In February 1999, Net2Phone launched easysurf.com (www.ezsurf.com) the first
web shopping portal powered by Internet telephony. Easysurf.com allows
visitors to learn about online merchants' services and to communicate with
them through direct voice interaction. Easysurf.com gives users added
convenience by listing useful information for key online retailers, including
payment and shipping options and return policies. Easysurf.com enables voice
communications with over 300 Web sites, and educates users by providing them
with essential information needed to buy products online.
In July 1999, Net2Phone entered into an exclusive, four-year distribution
and marketing agreement with ICQ, a subsidiary of America Online, to provide
Internet telephony services to users of ICQ's instant messaging service. ICQ
will embed Net2Phone's Internet telephony software into ICQ's Instant
Messenger software on an exclusive basis, allowing ICQ users to make PC-to-
phone and PC-to-PC calls and to receive phone-to-PC calls.
International Sales
In Fiscal 1997, 1998 and 1999, international customers accounted for
approximately 25%, 11% and 13% of the Company's total revenues, respectively.
See Note 9 to the Company's Consolidated Financial Statements. The Company
anticipates that revenues from international customers will continue to
account for a significant percentage of its total revenues.
Bundling of Service Offerings
The Company bundles its Internet access services with its domestic long
distance telephone services. By bundling its long distance phone service with
its $15.95 per month discounted dial-up Internet access, the Company is
currently able to compete with many major national providers of Internet
access by offering rates that are on average 20% lower. By bundling its
Internet access services with its rechargeable calling cards, the Internet
access rates can be as much as 45% lower. At the same time, the Company
differentiates itself from its competitors in the Internet access market who
are unable to offer their customers significant savings on their monthly long
distance bills. Additionally, the Company is able to leverage its existing
Internet sales force for the sale of its bundled long distance and Internet
access service.
Customers
Telecommunications
As of October 1, 1999, the Company had approximately 125 wholesale customers
located in the U.S. and Europe. The Company supplements this wholesale
customer base by offering retail long distance services to individuals and
business customers in the U.S. and worldwide, including over 50,000 call
reorigination customers. The Company sold over 50,000,000 prepaid calling
cards during Fiscal 1999.
18
Internet Access
As of October 20, 1999, the Company offered local dial-up access to
approximately 65,000 retail customers, provided dedicated access to nearly 500
medium and large-sized businesses, and offered Web hosting services to almost
2,000 customers.
Internet Telephony
As of July 31, 1999, Net2Phone served over 325,000 active customers who made
an average of approximately 60 minutes of calls per month, and handled over 20
million minutes of use per month. Approximately 69% of Net2Phone's customers
as of July 31, 1999, were based outside of the United States. As of October
10, 1999, Net2Phone had installed the Click2Talk service on approximately 176
commercial Web sites.
Billing and Customer Support
IDT believes that reliable, sophisticated and flexible billing and
information systems are essential to its ability to remain competitive in the
global telecommunications market. Accordingly, the Company has invested
substantial resources to develop and implement its proprietary management
information systems.
The Company's billing system enables the Company to (i) accurately analyze
its network traffic, revenues and margins by customer and by route on an
intra-day basis; (ii) validate carrier settlements; and (iii) monitor least
cost routing of customer traffic. The entire process is fully automated and
increases efficiencies by reducing the need for monitoring by the Company's
employees. The Company believes that the accuracy and efficiency of its
management information systems provide it with a significant strategic
advantage over other emerging carriers.
The Company's majority-owned Net2Phone subsidiary has also developed a
sophisticated real-time management information system for its Internet
telephony services. This system allows Net2Phone to monitor the length and
quality of the calls that are placed over its Net2Phone and Net2Phone Direct
systems, thereby helping to ensure a high level of service and more efficient
routing of calls. In addition, this system helps Net2Phone prevent fraud, and
assists in the customer management process by automatically informing
customers of new information, including system upgrades.
The Company believes that its ability to provide adequate customer support
services is a crucial component of its ability to retain customers. The
Company has successfully focused on improving such service through a number of
measures, including the addition of support personnel and the monitoring of
customer waiting time. The customer support staff provides 24-hour technical
assistance in addition to general service assistance. Customer support
personnel communicate with subscribers via telephone, e-mail and fax. The
Company requires that each customer support staff member field a minimum
number of calls and e-mails each day. The Company also employs liaisons
between the customer support and technical staffs to ensure maximum
responsiveness to changing customer demands.
Network Infrastructure
The Company maintains an international telecommunications switching
infrastructure and U.S. domestic network, consisting of owned and leased lines
that enable it to provide an array of telecommunications, Internet access and
Internet telephony services to its customers worldwide. IDT believes it enjoys
competitive advantages by utilizing this network to carry both voice and
Internet traffic, resulting in the optimization of both its network
utilization and associated capital.
IDT's network is monitored 24 hours a day, seven days a week, and 365 days a
year by its network operations center. The entire network is centrally managed
from IDT's control center through the use of a standardized communications
protocol. In addition, two proprietary monitoring systems are used to manage
modem pools.
19
Telecommunications Network
Private Line Network
The Company operates a growing telephone network consisting of resold
international switched services, U.S. domestic dedicated leased fiber optic
lines, and Company-owned switch equipment in the U.S. which are interconnected
to major PTTs, emerging carriers and domestic interexchange carriers, local
exchange carriers and competitive local exchange carriers. IDT's major
switching facilities are located in Piscataway, N.J., Westfield, N.J., Newark,
N.J., New York, N.Y. and London, England. These varied locations serve to
provide the network with redundancy and diversity. All of these locations are
linked with the dominant local exchange carrier as well as at least one of the
competitive local exchange carriers, allowing the Company to interconnect with
all major interexchange carriers to switch traffic via the Company's leased
private-line DS3 network. Furthermore, all of the Company's locations are
interconnected via leased lines to enhance network reliability and redundancy
as each location interconnects with the various carriers.
In September 1998, the Company entered into a $32 million, 20 year IRU
agreement with Frontier Communications of the West, Inc. ("Frontier") to
obtain dedicated DS-1, DS-3, OC-3 and OC-12 circuit capacity in the U.S. over
Frontier's network, connecting more than 120 metropolitan areas around the
nation. These network facilities will enable the Company to expand the range
and reliability of its data and voice transmission service, while reducing
network costs. IDT will be able to offer nationwide dial-up long distance and
dial-around (10xxx) services, reduce 800-origination costs and provide for
origination and termination of carrier traffic in all major U.S. cities.
In October 1999, the Company entered into an agreement with Frontier whereby
IDT will enhance its ability to provide presubscribed long distance (1+) and
dedicated and toll-free services throughout the United States as well as
casual calling (10xxx) in selected areas of the country. The additional
capacity will significantly enhance IDT's ability to provide long distance
dial up services.
In addition, the Company owns and leases switched services to connect its
U.S. and U.K. facilities. These services are used to originate traffic from
IDT's customer base in the U.K. and to terminate existing carrier and call
reorigination traffic to the U.K. The Company has about 65 operating and
terminating agreements that provide for the termination of traffic in over 40
countries, including agreements with companies based in Spain, the Dominican
Republic, Italy, Bangladesh, Cyprus and Chile. The Company also plans to
obtain leased lines to these destinations, which will result in reduced costs
for termination to these countries. The Company has also targeted countries
such as the Netherlands, Germany and France for network expansion due to the
large number of minutes the Company presently terminates and the size of the
Company's installed base of telecommunications customers in these countries.
International Telecommunications Acquisitions & Agreements
In January 1999, the Company signed agreements with France Telecom, Deutsche
Telkom, Swisscom N.A. and Telefonica de Espana, four major telecommunications
companies based in Europe, to establish a direct fiber-optic connection
between the companies for international long distance service. The agreement
establishes direct channels between the companies' international switching
points and the Company's facilities in the United States and United Kingdom.
The Company has already established a presence in the United Kingdom with its
facilities-based switch, and has purchased more than 12,000 kilometers of
undersea cable connecting the United States, Canada and the United Kingdom.
In February 1999, the Company acquired Orion Telekom BV, a Netherlands based
provider of telecommunications services. Through this acquisition, the Company
procured a contractual relationship with Royal KPN NV ("KPN") the leading
phone company in the Netherlands, and associated physical interconnections, an
installed Alcatel S12 switch, an operating license in Holland and a facility
in Rotterdam. The Company's voice licensing in the Netherlands coupled with
the interconnection available through KPN has enabled the Company to offer
wholesale and retail carrier services in the Dutch market.
20
Switching Platforms
The Company utilizes two major switching platforms. The Company uses its
Excel LNX switches for its application-based products such as call
reorigination, direct dial, call through, prepaid calling cards, and value-
added services such as voice prompts, speed dialing, voice mail and
conferencing. The Excel LNX is flexible and programmable, and is designed to
implement network-based intelligence quickly and efficiently. The Company
currently owns 65 Excel LNX switches. The other platform is the Nortel DMS250-
300, which serves as an international gateway and generic carrier switch. The
Company currently owns four Nortel switches. The Company plans to upgrade its
switching platforms in Los Angeles, Miami and New Jersey during Fiscal 2000.
All of the Company's switches are modular, scaleable and equipped to signal in
such protocols as ISDN or SS7 so as to be compatible with either domestic or
foreign networks.
The Company plans to use other technologies, including Nortel ERS switches,
which allow for the dynamic allocation of voice and data traffic, to enable
the Company's Internet network to be used for the transmission of traditional
telephone minutes. If successfully developed, this leveraging of IDT's
Internet network could provide considerable cost efficiencies for transporting
a substantial portion of the Company's domestic voice traffic.
Software
The Company's Excel LNX switch incorporates Company-developed software which
efficiently performs all the applications the Company requires to provide
value-added services, as well as billing and traffic analysis. The software
enables the Excel LNX to route all calls via the Company's least-cost routing
platform. Least-cost routing is a process by which the Company optimizes the
routing of calls over the least-cost route on its switch for over 230
countries. In the event that traffic cannot be handled over the least-cost
route due to capacity or network limitations, the least-cost routing system is
designed to transmit the traffic over the next least-cost route. The least-
cost routing system analyzes several variables that may affect the cost of a
long distance call, including different suppliers, different time zones and
multiple choices of terminating carrier in each country. In some instances,
instead of routing a call directly between two overseas points, the least-cost
routing system may backhaul an overseas carrier's minutes using resold
switched services to the Company's U.S.-based switch in order to terminate the
traffic in a third country while taking advantage of the Company's competitive
U.S.-based international long distance rates. The least-cost routing system is
continually reviewed in light of rates available from different suppliers to
different countries to determine whether the Company should add new suppliers
to its switch to further reduce the cost of routing traffic to a specific
country and to maintain redundancy, diversity and quality within the switching
network. By utilizing a least-cost routing system, the Company is able to
minimize its costs, and offer lower rates to its customers.
Internet Network
The Company operates a national Internet network comprised of a leased DS3
45 megabits per second backbone of high speed fiber optic lines connecting
eight major cities across the U.S., and leased dedicated T1 fiber optic lines
connecting smaller cities to the network. The network backbone uses state-of-
the-art routing platforms including Cisco Series 7000 routers and Nortel ERS
Magellan switches. The DS3 backbone connects traffic at four major Internet
"meet" points where the Company maintains switching and routing equipment and
has peering arrangements to exchange Internet traffic with over 50 other
Internet backbone providers. To minimize the potential detrimental effects of
single points of failure, the Company deploys a minimum of two dedicated
leased data lines to each backbone node and remotely positions secondary
servers for all configuration and authentication hosts. Multiple data segments
are used in high traffic areas to minimize packet loss and to reduce the
frequency of congestion in the network. Also, major IDT backbone nodes employ
routing switches for directing network traffic. To further enhance network
performance, the Company employs an "Open Shortest Path First" protocol, which
allows data traffic to be routed most efficiently.
The Company seeks to retain flexibility and to maximize its opportunities by
utilizing a continuously changing mix of routing alternatives. This
diversified approach is intended to enable the Company to take advantage of
the rapidly evolving Internet market in order to provide low-cost service to
its customers.
21
The Company utilizes the local dial-up switching infrastructure of several
Alliance Partners across the country to supplement the Company's owned and
operated local dial-up infrastructure. The Alliance Partners, which are
independently-owned Internet service providers, employ routing and modem
equipment which meet the Company's standards for providing dial-up access
services. The Company offers the Alliance Partners a monthly fee for each
customer account routed through their local access networks. The Company also
provides billing, advertising, marketing and customer acquisition services, in
exchange for which the Alliance Partners provide local Internet access. The
agreements with Alliance Partners generally have one year terms and do not
prohibit the Company from constructing its own local installed POP where
warranted.
The Company entered into an agreement with PSINet Inc. ("PSINet") in 1996 to
use PSINet as the primary Alliance Partner for the Company's dial-up Internet
access customers in areas where PSINet has POPs and where there are no other
Alliance Partners. The Company leases and operates a dedicated T3 connection
to the PSINet network in order to maintain control of the Company's
provisioning of customers and to provide customers with access to electronic
mail and newsfeeds. Through the buildout of its own infrastructure and its
agreement to utilize the PSINet network as well the local networks of its
Alliance Partners, IDT's network now provides local dial-up Internet access
through more than 400 POPs, of which the Company owns 33.
Research and Development
The Company employs a technical staff that is devoted to the improvement and
enhancement of the Company's existing telecommunications and Internet products
and services, including switching technologies and the development of new
technologies and products. The Company believes that the ability to adjust and
improve existing technology and to develop new technologies in response to,
and in anticipation of, customers' changing demands is necessary to compete in
the rapidly changing telecommunications and Internet industries. There can be
no assurance that the Company will be able to successfully develop new
technologies or effectively respond to technological changes or new industry
standards or developments on a timely basis, if at all.
In connection with the Company's acquisition of InterExchange in May 1998,
the Company acquired InterExchange's in-process research and development
relating to alternative switching and compression technologies. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-- Fiscal 1998 Compared to Fiscal 1997--Acquired Research and
Development." To the extent that the Company succeeds in completing the
development of such alternative switching technologies, the Company believes
that it will be able to substantially reduce its investments in connection
with the acquisition and installment of additional switching equipment, and
that it will be able to install such equipment in substantially less time. In
addition, if the Company succeeds in developing such compression technologies,
the Company believes that it will be able to manage voice compression more
effectively across its network and provide significant cost efficiencies in
routing telephone traffic via fiber optic cables and satellite transmission.
No assurances can be given that the Company will succeed in developing either
of such technologies within a time frame that will enable it to capitalize
upon its investment, or at all.
Competition
The markets in which the Company operates are extremely competitive and can
be significantly influenced by the marketing and pricing decisions of the
larger industry participants. The barriers to entry are not insurmountable in
any of the markets in which the Company competes. The Company expects
competition in these markets to intensify in the future.
Telecommunications
The market for prepaid calling cards has become highly competitive. In the
prepaid calling card market, the Company competes with other providers of
prepaid calling cards and with providers of telecommunications services in
general. Many of the largest telecommunications providers, including AT&T, MCI
WorldCom and Sprint, currently market prepaid calling cards, which in certain
cases, compete with the prepaid calling cards
22
sold by the Company. These companies are substantially larger and have greater
financial, technical, engineering, personnel and marketing resources, longer
operating histories, greater name recognition and larger customer bases than
the Company. The Company also competes with smaller, emerging carriers in the
prepaid calling card market, including Star Telecommunications, Inc., RSL
Communications, Ltd., and Pacific Gateway Exchange, Inc. In marketing prepaid
calling cards to customers outside the U.S. market, the Company competes with
the large PTTs, such as British Telecommunications (BT) in the U.K. The
Company believes that additional competitors are likely to enter the prepaid
calling card market (including Internet-based service providers and other
telecommunications companies) during the next several years.
With respect to its other telecommunication services, the Company competes
with (i) interexchange carriers and other long distance resellers and
providers, including large carriers such as AT&T, MCI WorldCom and Sprint;
(ii) foreign PTTs; (iii) other providers of international long distance
services such as STAR Telecommunications, Inc., Pacific Gateway Exchange,
Inc., RSL Communications Ltd. and Viatel, Inc.; (iv) alliances that provide
wholesale carrier services, such as Global One (Sprint, Deutsche Telekom AG
and France Telecom S.A.) and Uniworld (AT&T, Unisource-Telecom Netherlands,
Telia AB, Swiss Telecom PTT and Telefonica de Espana S.A.); (v) new entrants
to the domestic long distance market such as the regional bell operating
companies in the U.S., who have announced plans to enter the U.S. interstate
long distance market pursuant to recent legislation conditionally authorizing
such entry, and utilities such as RWE Aktiengesellschaft in Germany; and (vi)
small long distance resellers. Moreover, some of the Company's competitors
have announced business plans similar to the Company's regarding the expansion
of telecommunications networks into Europe. Many of the Company's competitors
are significantly larger and have substantially greater market presence, as
well as greater financial, technical, operational, marketing and other
resources and experience than the Company.
The Company competes for customers in the telecommunications markets
primarily based on price and, to a lesser extent, the type and quality of
service offered. Increased competition could force the Company to reduce its
prices and profit margins if its competitors are able to procure rates or
enter into service agreements that are comparable to or better than those the
Company obtains, or are able to offer other incentives to existing and
potential customers. Similarly, the Company has no control over the prices set
by its competitors in the long distance resale carrier-to-carrier market.
Internet Access
The Company's current and prospective competitors in the Internet access
market include many large companies that have substantially greater market
presence, as well as greater financial, technical, operational, marketing and
other resources and experience than the Company. The Company's Internet access
business competes or expects to compete directly or indirectly with several
types of companies: (i) other national and regional commercial Internet
service providers, such as NETCOM On-Line Communication Services, Inc.
("NETCOM"), and Earthlink Network, Inc. ("Earthlink"); (ii) established online
services companies that offer Internet access, such as America Online, Inc.
("AOL"), CompuServe Interactive Services, Inc. ("CompuServe") and Prodigy
Communications Corporation ("Prodigy"); (iii) computer software and technology
companies such as Microsoft; (iv) national long distance telecommunications
carriers, such as AT&T, MCI WorldCom and Sprint; (v) regional bell operating
companies; (vi) cable television operators, such as Comcast Corporation
Liberty Media Group ("Liberty Media") and Time Warner Inc. ("Time Warner");
(vii) nonprofit or educational Internet service providers; (viii) newly-
licensed providers of spectrum-based wireless data services; and (ix)
competitive local telephone service providers such as AT&T and MCI WorldCom.
The Company believes that its ability to compete successfully in the
Internet access market depends upon a number of factors including: (i) market
presence; (ii) the adequacy of the Company's customer support services; (iii)
the capacity, reliability and security of its network infrastructure; (iv) the
ease of access to and navigation of the Internet; (v) the pricing policies of
its competitors and suppliers; (vi) regulatory price requirements for
interconnection to and use of existing local exchange networks by Internet
service providers; (vii) the timing of
23
introductions of new products and services by the Company and its competitors;
(viii) the Company's ability to support existing and emerging industry
standards; and (ix) trends within the industry as well as the general economy.
There can be no assurance that the Company will have the financial resources,
technical expertise or marketing and support capabilities to continue to
compete successfully in the Internet access market.
Internet Telephony
The long distance telephony market and, in particular, the Internet
telephony market, is highly competitive. Net2Phone's competitors include AT&T,
MCI WorldCom and Sprint in the United States and foreign telecommunications
carriers. During the past several years, a number of companies have introduced
services that make Internet telephony services available to businesses and
consumers. In addition to Net2Phone, AT&T Jens (a Japanese affiliate of AT&T),
ICG Communications, IPVoice.com, ITXC, OzEmail (which was acquired by MCI
WorldCom), RSL Communications (through its Delta Three subsidiary), I-Link and
iBasis (formerly known as VIP Calling) provide a range of voice-over-the-
Internet services. These companies offer PC-to-phone or phone-to-phone
services that are similar to the services Net2Phone offers. Some, such as AT&T
Jens and OzEmail, offer these services within limited geographic areas.
Additionally, a number of companies have recently introduced Web-based voice
mail services and voice-chat services to Internet users.
Regulation
Telecommunications
As a multinational telecommunications company, the Company is subject to
varying degrees of regulation in each of the jurisdictions in which it
operates. As a non-dominant carrier lacking substantial power to influence
market prices in the U.S., the Company's provision of international and
domestic long distance telecommunications services in the U.S. is generally
subject to less regulation than a carrier that has such power. Despite recent
trends toward deregulation, some of the countries in which the Company intends
to provide telecommunications services do not currently permit the Company to
provide public switched voice telecommunications services. In those countries
in which the Company operates that are not yet open to public switched voice
service competition, the Company provides services to closed user groups and a
variety of value-added services, as permitted by each country's laws.
Regulation of Domestic Telecommunications Services. In the U.S., provision
of the Company's services is subject to the provisions of the Communications
Act, as amended by the Telecommunications Act of 1996 (the "Telecommunications
Act") regulations promulgated thereunder, as well as the applicable laws and
regulations of the various states administered by the relevant state
authorities. The recent trend in the U.S., for both federal and state
regulation of telecommunications service providers, has been in the direction
of reducing regulation. Nonetheless, the FCC and relevant state authorities
continue to regulate ownership of transmission facilities, provision of
services and the terms and conditions under which the Company's services are
provided. Non-dominant carriers, such as the Company, are required by federal
and state law and regulations to file tariffs listing the rates, terms and
conditions for the services they provide. In October 1996, the FCC adopted an
order (the "Detariffing Order") which eliminated the requirement that non-
dominant interstate carriers such as the Company maintain tariffs on file with
the FCC for domestic interstate services. The Detariffing Order has been
appealed to the U.S. Court of Appeals for the D.C. Circuit, and a stay has
been issued pending a decision on the merits of the appeal. It is unclear when
the Court will rule on the appeal.
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of
universal telephone service (the "Universal Service Order"). The Universal
Service Order requires all telecommunications carriers providing interstate
telecommunications services to contribute to universal support by contributing
to (i) a fund for schools and libraries, (ii) a fund for rural health care and
(iii) a fund for the development of regions characterized by high
telecommunications costs and low income levels (collectively, the "Universal
Service Funds"). These contributions became due beginning in 1998 for all
providers of interstate telecommunications services. Such contributions are
assessed based on
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certain defined interstate and international end user telecommunications
revenues. Contribution factors vary quarterly, and carriers, including the
Company, are billed each month. In addition, many state regulatory agencies
have instituted proceedings to revise state universal support mechanisms to
make them consistent with the requirements of the Telecommunications Act. As a
result, the Company will be subject to state, as well as federal, universal
service fund contribution requirements, which will vary from state to state.
In July 1999, the United States Court of Appeals for the Fifth Circuit
released its decision reviewing the FCC's Universal Service Order. This
decision will have a significant impact on carrier's obligations to make
payments to the FCC's Universal Service Funds. The Court found that the FCC
cannot include intrastate revenues in the calculation of universal service
contributions. Local exchange carriers' revenues are largely intrastate and
their interstate revenues are primarily from other carriers and not subject to
universal service assessment. Therefore, the contributions required to be made
by these carriers will be sharply reduced, placing an even greater burden on
interexchange carriers, including the Company, to fund the universal service
program. The Court also reversed the FCC's decision to include the
international revenues of interstate carriers in the universal service
contribution base.
In implementing the Court's decision, the FCC has amended its universal
service fund rules and removed intrastate-end user telecommunications revenues
from the assessment base for the schools and libraries and rural health care
support mechanisms. The FCC will assess contributions to the universal service
program using a single contribution factor based on interstate and
international end-user telecommunications revenues. The proposed contribution
factor for November and December 1999 is 5.8% of interstate and international
end-user telecommunications revenues. This increase in the universal service
contribution factor may significantly increase the Company's contribution to
the FCC's Universal Service Fund.
Pursuant to the Universal Service Order, all carriers are required to submit
a Universal Service Fund worksheet in March and September of each year.
Starting April 1, 2000, carriers will be required to annually file a single
telecommunications reporting worksheet for the FCC's Universal Service Fund,
Telecommunications Relay Services, Local Number Portability, and North
American Numbering Plan programs. The amounts remitted to the Universal
Service Fund may be billed to the Company's customers. If the Company does not
bill these amounts to its customers, its profit margins may be less than if it
had elected to do so. However, if the Company elects to bill these amounts to
its customers, customers may reduce their use of the Company's services, or
elect to use the services provided by the Company's competitors, which may
have a material adverse effect upon the Company's business, financial
condition, or results of operations.
On September 29, 1999, Bell Atlantic-New York ("BANY") filed with the FCC
its Section 271 application for authority to provide interLATA interexchange
service to customers in New York. The FCC has ninety days to review BANY's
Section 271. Southwestern Bell Telephone Company ("SWBT") has received the
Texas Public Utilities Commission's approval of its Section 271 application to
provide interLATA interexchange service to customers in Texas and will soon
file its Section 271 application with the FCC. If the FCC subsequently
approves BANY's and SWBT's Section 271 applications, interexchange carriers,
such as the Company, will be subjected to increased competition from these
companies in the New York and Texas markets for interexchange services. As a
result, the Company may face increased pressure to reduce its rates for
interexchange services which may have an adverse impact on the Company's
revenues. In addition, it is likely that Bell Atlantic, SWBT, US West, and
Bell South will shortly file Section 271 applications in additional states,
which if granted, would further increase competition in the provision of
interexchange services and result in downward price pressures for such
services in these states.
The FCC recently instituted a rulemaking proceeding in which it is
determining whether to allow the regional bell operating companies to provide
advanced data services (certain of which are currently provided by the
Company) through a structurally separated and largely deregulated subsidiary.
Such companies are currently barred from providing such services, except under
certain limited circumstances. The proposed rulemaking would permit the
provision of such services to cross the boundaries of the approximately 200
local telephone calling
25
areas that were created in 1984 in connection with the divestiture by AT&T of
the regional bell operating companies. If the FCC adopts such a rule, it could
have a material adverse affect on the Company by enabling the regional bell
operating companies to more effectively compete with the Company with respect
to these services.
In add