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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JULY 31, 2000
COMMISSION FILE NUMBER: 000-26763
NET2PHONE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-3559037
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
520 BROAD STREET 07102
NEWARK, NEW JERSEY (ZIP CODE)
(ADDRESS OF REGISTRANT'S PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (973) 412-2800
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 registrant's common stock held by
non-affiliates of the registrant on October 24, 2000, was approximately $499.7
million. On such date, the last sale price of registrant's common stock was
$19.375 per share. Solely for the purposes of this calculation, shares
beneficially owned by directors and officers of the registrant and persons
owning 5 percent or more of the registrant's common stock (including the Class A
common stock) have been excluded, in that such persons may be deemed to be
affiliates of the registrant. Such exclusion should not be deemed a
determination or admission by registrant that such individuals or entities are,
in fact, affiliates of registrant. This calculation includes shares of the
registrant's Class A common stock, which may be converted at the option of the
holder into shares of the registrant's common stock on a one-to-one basis at any
time.
The number of shares outstanding of each of the registrant's classes of
common stock, as of October 24, 2000, was 27,057,646 shares of common stock and
33,625,000 shares of Class A common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the 2000 Annual Meeting of
Stockholders are incorporated by reference into Part III.
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NET2PHONE, INC.
2000 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
NUMBER
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PART I.
ITEM 1. BUSINESS.................................................... 2
ITEM 2. PROPERTIES.................................................. 29
ITEM 3. LEGAL PROCEEDINGS........................................... 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 30
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................... 30
ITEM 6. SELECTED FINANCIAL DATA..................................... 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK........................................................ 50
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................... 51
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 51
ITEM 11. EXECUTIVE COMPENSATION...................................... 51
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................. 51
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K......................................................... 51
SIGNATURES............................................................... 54
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS............................... F-1
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PART I.
ITEM 1. BUSINESS
GENERAL DESCRIPTION OF BUSINESS
Net2Phone is a global leader in delivering voice and enhanced services over
Internet Protocol networks. We began operations in November 1995, launched our
first product in July 1996 and were incorporated in Delaware as a subsidiary of
IDT Corporation in October 1997. Net2Phone enables individuals and businesses to
place low-cost, high-quality calls from their computers, telephones and fax
machines to computers, telephones and fax machines worldwide via the public
Internet and private IP networks.
Through our consumer, enterprise, and carrier businesses, we have
strengthened our position as a leading platform for the migration of voice
traffic onto the Internet and over Internet Protocol networks -- the IP
telephony company of the future. At the same time, we have established strategic
partnerships with leading companies to further extend our reach into the
marketplace.
For example, our current strategic investors include AT&T Corp. (which,
through a subsidiary, acquired a 39 percent voting stake in Net2Phone in August
2000), IDT, SOFTBANK, Yahoo! Inc., America Online Inc. and GE Capital Equity
Investments, Inc./NBC.
We have developed a sophisticated software application that enables use of
our Web-based Internet telephony services. We promote our services through
direct sales and marketing and through strategic partners and international
resellers. Our software is currently available in ten languages (English,
Spanish, Japanese, French, Dutch, Portuguese, Italian, German, Swedish and
Chinese).
Our company is divided into six core product lines: (1) PC-based consumer
services, (2) phone-based consumer services, (3) enterprise solutions, (4)
carrier services, (5) broadband, and (6) YAP (Your Alternative Phone). All units
are supported by our marketing, operations, and networks divisions. By
delivering voice and enhanced services to IP networks through each of these
business units as well as our strategic partners, we hope to achieve ubiquity
throughout the marketplace.
Our consumer services enable low-cost, high-quality calls over the Internet
servicing over one million active users around the world. Our enterprise unit
now enables businesses nationwide to plug into our IP network to make clear
phone calls at reduced costs as well as layer enhanced services on the network.
We provide carriers and ISPs around the world with access to our IP network to
route calls worldwide. Our broadband division is capitalizing on the
opportunities in gaining high-speed "last mile" access into consumers' homes and
businesses, layering voice and enhanced services to provide phone and enhanced
services over broadband lines using our network. Our YAP division drives
consumer and business usage of our services by marketing devices designed to
make Internet calling easy.
Through our distribution efforts, we have voice enabled over 90% of the
instant messaging market. In July 2000, we teamed up with Microsoft to integrate
our PC-based client software into the latest version of MSN Messenger Service
3.0. The MSN Messenger Service 3.0, released in July, includes a new "Call"
button which allows users to place PC-to-PC or PC-to-phone calls to any of their
online buddies using our software and technology.
Additionally, in October 2000, we announced that we will provide our
voice-optimized IP network for voice transit to the Yahoo!(R) properties. Under
the terms of the agreement, Yahoo! will use our voice-over-IP network for its
newest suite of voice services, including its voice-enabled instant messenger
and voice portal. Launched in October 2000, Yahoo! by Phone provides telephone
and voice access to popular Yahoo! content, voice-mail and e-mail.
ICQ, a subsidiary of America Online, began offering our services
exclusively to their instant messaging users earlier this year. Our software has
been integrated into ICQ's 2000b Instant Messenger since
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September 2000, and we have been marketing a co-branded pre-paid calling card
with ICQ since September 1999, allowing users to place calls from the United
States and 19 other countries to anywhere in the world. Additionally, we have
been marketing a co-branded pre-paid calling card with AOL Instant Messenger
(AIM) since January 2000. We also have an agreement with American Online to
integrate our PC-to-phone services into their Instant Messenger.
In addition, we are leveraging the strengths of our voice-over-IP
technology through high-margin agreements with major players in the Internet and
communications arena. We are forging wholesale software licensing agreements
with large traditional telephone companies seeking to migrate voice traffic on
the Internet and IP networks.
In September 2000, we formed Adir Technologies, Inc., as a subsidiary of
Net2Phone, to which we contributed certain assets and which has been funded by
investments from Cisco Systems, Inc., SOFTBANK and IDT, to develop and market
network management software for voice-over-IP and other packet-based multimedia
networks. By creating Adir, we will commercialize our proprietary network
management software that we have exclusively been using since 1995. We believe
that Adir will provide a new, high-margin, line of business with minimal capital
expenditure without adversely affecting our existing core services business.
Adir currently intends to market its products to telecommunications, Internet,
wireless, next generation and broadband service providers and enterprises
worldwide.
In January 1999, Netscape agreed to integrate our PC-to-phone software on
an exclusive basis into future versions of Netscape's Internet browser released
during the term of our agreement, including the Netscape Communicator products.
Netscape also agreed to include a Net2Phone icon on the Netscape Navigator
Personal Toolbar. Netscape launched its first beta version of Netscape 6.0
Browser in January 2000 and the second beta version of Netscape 6.0 Browser in
April 2000.
In addition, we have forged ahead in making Internet telephony more readily
available to consumers by entering into arrangements with leading computer
equipment and software companies, such as IBM and Compaq, to include our
software with their products.
Throughout our development, we have proven our ability to scale to demand,
as an increasing number of individuals and businesses have recognized the real
benefits of voice-over-IP technology. In fiscal 1999, we served 325,000
customers and routed 750,000 minutes per day. As of July 2000, we served more
than 1,179,000 customers and have successfully routed more than 5,000,000
minutes per day.
Our total assets increased from $916,000 at July 31, 1997, to $7.0 million
at July 31, 1998, $50.8 million at July 31, 1999, and $411.7 million at July 31,
2000. Our revenue has grown substantially, increasing from approximately $2.7
million in fiscal 1997, approximately $12.0 million in fiscal 1998,
approximately $33.3 million in fiscal 1999, and approximately $72.4 million in
fiscal 2000. Our net loss increased from approximately $1.7 million in fiscal
1997, to $3.5 million in fiscal 1998, to $53.9 million in fiscal 1999, and
$118.3 million in fiscal 2000.
On December 1, 1999, we completed a secondary public offering of 7,245,000
shares of common stock at a price of $55.00 per share. Selling stockholders sold
3,845,000 shares, and we sold 3,400,000 shares of common stock. Our proceeds
from the offering, after deducting underwriting discounts and commissions and
offering expenses, were approximately $177.4 million.
On August 11, 2000, we completed a sale of 4,000,000 shares of Class A
common stock to a subsidiary of AT&T for an aggregate purchase price of
$300,000,000.
INDUSTRY SEGMENTS
We report only in one industry segment. See "Notes to Financial
Statements -- Note 2."
INDUSTRY BACKGROUND
The Internet is experiencing substantial growth as a global medium for
communications and commerce. International Data Corporation estimates that the
number of Internet users worldwide will grow from
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approximately 349 million in 2000 to 766 million by the end of 2005. People are
increasingly using the Internet as a communications medium. A study by Jupiter,
a market research firm, estimated that 432 billion e-mail messages will be sent
in the U.S. in 2003. Instant text communication through online "chat" rooms is
also gaining widespread acceptance.
Emergence of Internet Telephony
TeleGeography, a market research firm, estimates that the international
long distance market will grow to $73.2 billion in 2002. Despite the large size
of this market and the number of minutes of calls made, traditional
international long distance calls are still relatively expensive for the
consumer. We believe that this creates a significant opportunity for us to use
the technology by which Internet phone calls are made to gain market share.
The technology by which Internet phone calls are made is more
cost-effective than the technology by which traditional long distance calls are
made. Internet telephony, therefore, is emerging as a low cost alternative to
traditional long distance calls. International Data Corporation projects that
the Internet telephony market will grow rapidly to over $11.9 billion in 2003,
from approximately $100 million in 1998.
We use a technology called "packet-switching" to break voice and fax calls
into discrete data packets, route them over the Internet or our network and
reassemble them into their original form for delivery to the recipient.
Traditional international long distance calls, in contrast, are made using a
technology called "circuit switching" which carries these calls over
international voice telephone networks. These networks are typically owned by
governments or carriers who charge a tariff for their use. Circuit switching
requires a dedicated connection between the caller and the recipient that must
remain open for the duration of the call. As a result, circuit-switching
technology is inherently less efficient than packet-switching technology, which
allows data packets representing multiple conversations to be carried over the
same line. This greater efficiency creates network cost savings that can be
passed on to the consumer in the form of lower long distance rates.
Integration of Voice into the Web
We believe that Internet telephony offers significant benefits to consumers
and businesses beyond international long distance cost savings. The technologies
that enable Internet telephony can be applied to integrate live voice
capabilities into the Web. We believe that this integration can enhance the
potential for the Internet to become the preferred medium for both
communications and commerce. For example, the integration of voice into the Web
would supplement existing text-based modes of Internet communication such as
email and online chat by adding a live, secure, low-cost or free voice
alternative. We believe that this is attractive both to consumers and
businesses.
In addition, voice-enabling the Web would give Internet shoppers the
ability to speak directly with customer service representatives of online
retailers in order to ask questions and alleviate concerns about online
security. This may increase the probability that a sale is made and may give
online retailers a key competitive advantage by providing them with
opportunities to sell higher margin and additional products to these customers.
Voice-enabling a commercial Web site may also give online retailers the ability
to provide more responsive customer support and service.
Integrating live voice capabilities into the Web would also enable Internet
companies to offer enhanced communications services, such as providing Internet
users with a central source for retrieving voice-mail, e-mail, faxes and pages.
We believe this would allow these companies to attract more users to their sites
and to increase the amount of time these users spend on their sites. This
increased usage will allow these Internet companies to attract advertisers and
secure higher advertising rates, thereby increasing revenue.
Limitations of Existing Internet Telephony Solutions
The growth of Internet telephony has been limited to date due to poor sound
quality attributable to technological issues such as delays in packet
transmission and network capacity limitations. However, recent improvements in
packet-switching technology, new software algorithms and improved hardware have
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substantially reduced delays in packet transmissions. In addition, the use of
private networks to transmit calls as an alternative to the public Internet is
helping to alleviate network capacity constraints. Finally, the emergence of
new, lower cost Internet access technologies, such as high-speed modems, are
addressing local Internet access issues.
Several large long distance carriers, including Sprint and Cable and
Wireless, have announced Internet telephony service offerings. However, many of
these service offerings have not been deployed on a large scale. Many also
require users to purchase other telecommunications services or allow only
domestic calling. Smaller Internet telephony service providers also offer
low-cost Internet telephony services from PC-to-phone and from phone-to-phone.
These services, however, are available only in limited geographic areas and
require payment by credit card which may preclude many international customers
from signing up for these services. We also believe that existing Internet
telephony service providers rely upon technologies and systems that lack
large-scale billing, network management and monitoring systems, and customer
service capabilities required for the integration of voice communication into
the Web.
In addition, many companies currently provide Internet telephony software
and services that allow Internet telephone calls to be made between personal
computers. However, most of these companies require both the initiator and the
recipient of the call to have the same software installed on their personal
computers and to be online at the same time.
THE NET2PHONE SOLUTION
Net2Phone delivers high-quality voice-over-IP telephony services and
voice-enabling Web applications to consumers, small and medium businesses,
enterprises, international telecommunications operators, resellers, and
broadband providers. Our solution provides many benefits to our customers,
including:
- Low Cost. Our PC-to-phone software is distributed free of charge, and
our services allow our customers to make telephone calls often at a
fraction of the cost of traditional long distance service. We do not
currently charge customers for PC-to-phone calls within the U.S. or PC-to
PC calls anywhere in the world. Our low cost phone-to-phone service is
available in over forty countries.
- High Voice Quality. We offer high voice quality through our proprietary
packet-switching technologies, which reduces packet loss and delay, route
packets efficiently and perform quality enhancing functions, such as echo
cancellation. We intend to continue to enhance the voice quality of our
services as our customer base and business grow. Furthermore, the
proliferation of broadband services such as DSL and cable will further
enhance the quality and reach of our service.
- Ease of Use and Access. Our services are designed to be convenient and
easy to access from anywhere in the world. To make a call using our
Web-based services, a customer need only install our free software on a
sound-enabled personal computer, register and be connected to the
Internet. No additional telephone lines or special equipment are
required. Our phone-to-phone service is also easy to use and requires a
customer only to register and dial a toll-free or local access number
from any telephone or fax machine.
- Reliable Service. Our network is reliable because of its technologically
advanced design. This design allows us to expand our network and add
capacity by adding switches to the existing network. Our system also
provides seamless service and high-quality voice transmission through our
ability to reroute packets if problems arise. We believe that our ability
to provide reliable service is essential to voice-enable the Web.
- Scalability. Our services platform is a flexible solution that can be
readily integrated at low cost and in large scale into existing systems.
Our system integrates quickly and seamlessly into the platforms of
various communications service providers such as ISPs, portals,
telecommunications companies, broadband providers, enterprises and
instant messenger platforms and can be scaled to handle thousands of
calls simultaneously.
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- Ease of Payment and Online Account Access. Once registered, our
customers are able to make toll-free calls. In addition, they can make
toll calls by opening a prepaid account using credit cards, wire
transfers or checks. Acceptance of payment in multiple forms enables
international customers who may not necessarily have credit cards to use
our services. Our customers can access their accounts via the Internet in
order to view their call history and account balances, and to increase
their prepaid amounts.
- Customer Support. We offer live customer support 24 hours a day, 7 days
a week in multiple languages. Our customer support center can be accessed
at no charge either by calling our toll-free number, where available, or
by using our Web-based Internet telephony service. Our integrated
customer billing software and call management system provide our customer
support staff with immediate access to user accounts, calling patterns
and billing history to help us provide better, more responsive customer
support.
- Voice-Enabled Online Retailing. Our services enable users to speak with
sales or customer service representatives of online retailers and other
Web-based businesses while visiting their Web sites. This provides
customers an opportunity to ask questions of and to provide credit card
information directly to a customer service representative if they are
concerned about Internet security, thereby increasing the likelihood of
consummating an online sale. In addition, our services allow our
customers outside of the United States and Canada to access telephone
numbers that might otherwise be inaccessible to them through their local
carriers. For example, users of our services in other countries may call
United States, Canadian, UK, or Australian numbers at no charge. The
ability to communicate with international customers in this manner
provides United States, Canadian, UK, and Australian-based online
retailers and other Web-based businesses with cost effective access to an
expansive international customer base.
STRATEGY
Our mission is to deliver quality voice and enhanced services to IP
networks worldwide. We intend to leverage our leadership position in the
Internet telephony market to make our communications services readily available
and to develop and market enhanced services. Our strategy includes the following
key elements:
- Drive Usage through Resellers and Strategic Partners. We promote our
services through direct sales and marketing and through Tier-1
relationships with leading ISPs, telecommunications companies, hardware,
software, and content companies. We intend to build on our significant
relationships with partners such as AOL, AT&T, Yahoo! and Microsoft, and
to add more partners and resellers to drive usage of our Internet
telephony services. We also intend to partner with large
telecommunications companies, such as we did with AT&T, to enable them to
offer our Internet telephony services under their brand.
- Pursue Multiple Sources of Revenue. In addition to our minutes-based
revenue, we are generating new Web-based revenue opportunities from
banner (with our Net2Phone domestic PC-telephone service, Yahoo! Instant
Messenger, and MSN Instant Messenger offerings) and audio advertising, as
well as sponsorship opportunities on our PC-to-phone software client.
Furthermore, our subsidiary, Adir Technologies, will commercialize our
existing network management software. Adir will market its products to
telecommunications, Internet, wireless, next generation and broadband
service providers and enterprises worldwide. We also intend to explore
the availability of revenue-sharing opportunities with online retailers.
- Enhance Brand Recognition. We have established strong brand identity in
the Internet telephony market in large part due to the high-quality of
our services and our marketing efforts with strategic partners, such as
Microsoft, Yahoo! and AOL. We intend to continue to implement online and
offline worldwide advertising and sales campaigns to increase brand
awareness. In addition, we intend to enhance our brand recognition by
cooperatively marketing our Internet telephony services with leading
computer hardware and software companies and ISPs.
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- Make Our Software Readily Available Worldwide. We have entered into
strategic distribution relationships with leading computer equipment and
software companies to expand the availability of our software. For
example, our software is embedded in Netscape's Internet browser, and a
Net2Phone icon is prominently positioned next to AOL's Instant Messenger
icon on the Netscape Navigator Personal Tool Bar. In addition, customized
versions of some of our Internet telephony services have been integrated
into ICQ's instant messaging software and distributed by ICQ. Our
software is included with IBM's Internet services and may be pre-loaded
on computers sold by Compaq internationally. Panasonic recently shipped
the first dual-band cordless telephones with one-touch access to the
Net2Phone Internet telephony network. We intend to build upon these
relationships and enter into new distribution relationships with other
leading companies in order to enhance the distribution of our software
worldwide.
- Expand and Enhance Products and Services. We have committed significant
resources to expand our network, enhance our existing product and service
offerings and develop and market additional products and services in
order to continue to provide customers with high-quality Internet
telephony services. For example, we plan to introduce new products and
services, including:
- Phone-to-PC, which will allow calls from a traditional telephone to an
internet ready multimedia personal computer;
- Internet call waiting, which enables users who are online to receive
phone calls and voice messages on their PCs;
- speech-enabled address books, which are linked to Net2Phone accounts
but can be synchronized with a number of contact management programs;
- voice-enabled chat, which will allow two participants in an online chat
room discussion to establish direct voice communication with each other
while maintaining anonymity;
- online commerce applications, which will provide customer service
representatives of online retailers with real-time access to a caller's
profile and enable them to 'push' specific content onto a caller's
personal computer screen in order to better assist the caller in
answering their inquiries;
- customer payment applications, which will allow customers to pay for
online commerce transactions by debiting their Net2Phone account; and
- video conferencing between two or more personal computer users over the
Internet.
STRATEGIC RELATIONSHIPS
We have entered into strategic distribution, integration and advertising
relationships with leading Internet and computer hardware and software
companies. These relationships are sometimes secured by toehold or other
strategic investments. In addition, these relationships typically include
arrangements under which we share with our strategic partners a portion of the
revenue they bring to us. We believe that these relationships are important
because they provide incentive to our partners and allow us to leverage the
strong brand names and distribution channels of these companies to market our
products and services. Our strategic partners include:
AT&T
On August 11, 2000, a subsidiary of AT&T Corp. completed its $1.4 billion
investment in us, which we believe will facilitate our objective of becoming the
global standard for Internet telephony. The AT&T subsidiary purchased four
million newly-issued shares of our Class A common stock from us for an aggregate
purchase price of $300,000,000 and 14.9 million shares of our Class A common
stock from IDT for an aggregate purchase price of $1.1 billion. Following the
consummation of these transactions, the AT&T subsidiary owns approximately 32
percent of our outstanding capital stock, but controls 39 percent of the
aggregate voting power of our capital stock because it holds Class A common
stock with two votes per share. In connection with the transaction, we agreed
with AT&T to cooperate in the development of new Internet
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voice applications for cable telephony and the business communications market.
AT&T and IDT were also granted a license to deploy our present and future
technologies on terms, conditions and pricing to be negotiated that are no less
favorable than those granted to other licensees of Net2Phone. John C. Petrillo,
Executive Vice President of Corporate Strategy and Business Development for
AT&T, and Richard R. Roscitt, President of AT&T Business Services, joined our
board of directors following the closing of the transaction, and AT&T has a
right to appoint a third director.
We believe that this transaction facilitates our objectives for the
following reasons:
- AT&T, which is among the world's premier voice, video and data
communications companies, now has a strong incentive to work with us to
develop and distribute our Internet telephony services and products.
- Companies focused on providing Internet-related services and products
will view us as a "neutral" provider of Internet telephony, which should
enhance our ability to enter into strategic alliances with competing
companies, building on our important alliances with America Online,
Yahoo! and other top Internet companies.
- This transaction positions us at the nexus of the convergence of
communications technologies and gives us an edge over our competitors in
managing the rapidly changing technological and market landscape.
Microsoft
On June 2, 2000, we entered into a three year agreement with Microsoft to
integrate our Internet telephony products and services into Microsoft's MSN
Messenger. Under this agreement, Microsoft agreed to include the "Powered by
Net2Phone" branding on the dial-up window through which users access Net2Phone
from MSN Messenger. The revenue generated from the sale of advertising that will
appear on this integrated product will be split between Microsoft and us. In
addition to the integration of our Internet telephony products and services into
MSN Messenger, Microsoft has the right under this agreement to include our
software in any of Microsoft's other products. We are responsible for providing
the software that allows Microsoft's users to access our service, as well as
providing PC-to-phone and PC-to-PC service to Microsoft's MSN Messenger users.
This integrated product has already been released to the public.
Yahoo!
In 1998, we signed an agreement with Yahoo!, which was recently renewed
through 2000, that integrated our Web-based Internet telephony service into the
Yahoo! People Search online telephone directory. As a result of this
integration, an Internet user who performs a search on Yahoo! People Search can,
after installing our software, simply click on a displayed telephone number to
initiate a call to that number. Under this agreement, we also have the right to
have our banner advertising appear when an Internet user performs a word or
category search for "Internet Telephony" or related phrases on Yahoo!
Additionally, our PC-to-phone service is integrated into the Yahoo! Yellow Pages
online directory.
On July 24, 2000, we entered into a three-year exclusive services and
marketing agreement whereby Yahoo! has agreed to embed our Internet telephony
software into the future versions of its Yahoo! Messenger software client and to
use our network to carry traffic to and from its voice portal. Additionally, in
October 2000, we announced that we will provide our voice-optimized IP network
for voice transit throughout the Yahoo!(R) network of properties. Under the
terms of the agreement, Yahoo! will use our voice-over-IP network for its newest
suite of voice services. Launched in October 2000, Yahoo! by Phone provides
telephone and voice access to popular Yahoo! content, voice-mail and e-mail.
Yahoo! has also agreed to do the following:
- market and promote the combined Net2Phone Yahoo! services pursuant to a
joint media plan;
- market and promote a co-branded Net2Phone calling card;
- allow us to market our products and services to users of the Yahoo! voice
portal; and
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- share advertising revenue with us from the voice portal.
Under the terms of this agreement, we are obligated to pay Yahoo! fees in
consideration for our exclusivity throughout the Yahoo! network of properties,
as well as commit to certain advertising media buys pursuant to the joint media
plan.
On March 31, 2000, Yahoo! Inc. purchased an equity interest in us. Under
the terms of the agreement, we entered into a stock swap with Yahoo! with the
objective of securing our strategic relationship in accordance with which we
issued and sold Yahoo! approximately 2.8 million shares of our common stock in
exchange for approximately 806,000 shares of Yahoo! common stock.
ICQ/AIM
In July 1999, we entered into an exclusive four-year distribution and
marketing agreement with ICQ, a subsidiary of America Online. ICQ began offering
our services exclusively to their instant messaging users earlier this year. Our
software has been fully integrated into ICQ's 2000b Instant Messenger since
September 2000, and we have been marketing a co-branded pre-paid calling card
with ICQ since September 1999, allowing users to place calls from the United
States and 19 other countries to anywhere in the world. Additionally, we have
been marketing a co-branded pre-paid calling card with AOL Instant Messenger
(AIM) since January 2000. We also have an agreement with AOL to integrate our PC
to Phone services into their Instant Messenger. Under this agreement, ICQ has
agreed to:
- co-brand and promote our phone-to-phone Internet telephony services in
the United States and in 19 other countries;
- integrate customized versions of some of our Internet telephony services
on an exclusive basis into ICQ's instant messaging software to allow ICQ
customers to make PC-to-phone and PC-to-PC calls and to receive
phone-to-PC calls;
- share revenue from some advertisements and sponsorships relating to
Internet telephony that are sold by ICQ within its instant messaging
software; and
- promote our services on some of ICQ's Web sites.
All of our Internet telephony services that ICQ promotes under our
agreement are co-branded under both of our labels.
priceline.com
In November 1999, we entered into agreements with priceline.com, an
Internet commerce service that allows users to name their own price to purchase
goods and services over the Internet. Under the terms of the agreement, we offer
our international and domestic phone-to-phone services as a premier provider
through priceline.com, enabling priceline.com customers to name their own price
to purchase blocks of phone-to-phone minutes.
Our phone-to-phone products are offered for sale through several live
services on priceline.com. The "Name Your Own Price for Long Distance" service,
launched in March 2000, allows customers to make calls from their home phones
without having to enter an account number, once they have purchased a block of
phone-to-phone minutes from priceline.com. Customers may make offers for blocks
of calling time in the following manner:
- domestic time blocks -- customers can name their own price for blocks of
domestic long distance phone-to-phone minutes;
- international time blocks -- customers can name their own price for
blocks of international long distance phone-to-phone minutes to a
specified country;
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- priceline.com's "Call Anywhere" program -- customers can name their own
price for blocks of phone-to-phone minutes that can be used to call
multiple designated locations; the actual amount of time purchased will
vary per location.
In May 2000, we launched a second service with priceline.com, called "Offer
by Phone." The "Offer by Phone" service enables customers to offer to purchase
phone-to-phone services from us on a per-call basis. We are the exclusive
provider of the Offer by Phone service.
In August 2000, we launched a third service with priceline.com that allows
university students to name their own price for blocks of calling time. This
university service is different from the original "Name Your Own Price for Long
Distance" service because customers are able to make calls from behind a college
PBX so they can use the service from their dorm rooms.
Future Net2Phone/priceline.com services under separate agreements include
launching the "Name Your Own Price for Long Distance" service in various
European countries, beginning with the United Kingdom by December 2000.
Netscape
Netscape has agreed to embed our PC-to-phone software on an exclusive basis
in future versions of Netscape's Internet browser released during the term of
our agreement, including the Netscape Communicator products. Netscape also has
agreed to do the following:
- place a Net2Phone icon on the Netscape Navigator Personal Toolbar
immediately to the right of the AOL Instant Messenger icon, which allows
Netscape users to use our Web-based Internet telephony services from
anywhere on the Web simply by clicking on our icon;
- integrate our services into, and display our services on, the Netscape
Netcenter site, including Netscape's Contacts section and Address Book
section, which allows Netscape users to make calls using our services
simply by clicking on a displayed telephone number; and
- include the software for our Web-based Internet telephony services in
Netscape's suite of online plug-in software and Netscape Smart Update
programs (both domestically and when available internationally) for
downloading by Netscape users from centralized locations on Netscape's
Web site.
We also have the right to place a specified number of banner and other
advertisements on Web pages of our choice on Netscape's domestic and
international Web sites. The two-year term of our exclusive agreement with
Netscape commences with the beta release of the next version of Netscape's
Internet browser. In January 1999, Netscape agreed to integrate our PC-to-phone
software on an exclusive basis into future versions of Netscape's Internet
browser released during the term of our agreement, including the Netscape
Communicator products. Netscape also agreed to include a Net2Phone icon on the
Netscape Navigator Personal Toolbar. Netscape launched its first beta version of
Netscape 6.0 Browser in January 2000 and the second beta version of Netscape 6.0
Browser in April 2000.
Adir Technologies, Inc./Investment by Cisco Systems, Inc., SOFTBANK and IDT
We created Adir Technologies, Inc. as a new subsidiary to develop and
market network management software for voice-over-IP and other packet-based
multimedia networks. The new company plans to offer our industry-leading
voice-over-IP network management software to telecommunications, Internet,
wireless, next generation and broadband service providers and enterprises
worldwide. The software platform we contributed to Adir was originally created
in our research and development laboratory in Lakewood, NJ in 1995 when we
rolled out the first service to bridge voice communications with a PC using the
Internet, and it has been enhanced since then.
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In September 2000, we announced that Cisco Systems, Inc. had purchased a
minority equity interest in Adir. In connection with Cisco's investment, the
companies agreed to a relationship in which Cisco will jointly market Adir's
network management platform to its voice-over-IP customers, offering
communications providers and enterprises compelling new choices in voice-over-IP
solutions. Through this relationship, we expect to realize a substantial new
source of revenue from software licensing fees. Adir's existing network
management software provides a broad view of the health, capacity and
utilization of a packet-based network, including specific functionality such as
real-time advanced call management, rating, routing, and authentication. These
components are essential for managing traditional circuit-switched networks but
have been missing in voice-over-IP networks until now. Adir's technology can
help provide a much greater quality of service by providing advanced tools for
fault detection, notification and diagnosis of network equipment from the voice
network service perspective. Adir has received additional funding for its
operations from investments by SOFTBANK and IDT.
Aplio S.A.
On July 7, 2000, we acquired all of the outstanding capital stock of Aplio,
S.A., a company located in Sarcelles France, which is a leading integrator of
voice-over-IP technologies. Aplio's technology enables voice-over devices to
access our network, including designs for chips, boards, and casings that all
specialize in voice-over software for devices. Aplio's technology will further
enable us to support a wide range of business and consumer products to optimize
the Net2Phone network and our growing communications services. Consideration
consisted of $2.9 million in cash at closing and 582,749 shares of our common
stock which were valued at $35.50 per share, promissory notes aggregating $6.5
million, $1.1 million in acquisition related costs and $4.8 million in cash to
be paid within eighteen months of the closing of the transaction. In addition,
we are required to pay two contingent cash payments of $2,778,230 on July 7,
2001 and July 7, 2002. These contingent payments are dependent on certain
individuals continuing their employment with us. We may also be required to
repurchase the shares of common stock issued to the selling shareholders on or
prior to January 31, 2002, or a per share purchase price of $36.947.
Other Strategic Relationships
We also have entered into other important strategic relationships with
leading Internet and computer hardware and software companies, including:
- Compaq. Our software is featured as a download from a special Compaq Web
site accessible directly from the Compaq-branded keyboard, may be
pre-installed on Compaq-branded computers distributed internationally and
may be included with their other products. We announced in October 2000,
that Compaq will bundle our YAP Phones with new Compaq Presario
computers, which will be available online at www.compaq.com.
- Snap.com. Promotions for our services and a link to our Web site will be
prominently displayed on the Snap.com Web site, and we are their
preferred provider of PC-to-phone services.
- SpeechWorks International, Inc. In June 2000, we entered into a letter
of intent with SpeechWorks International, Inc. under which SpeechWorks
agreed to grant us a software license, provide professional services and
pursue joint marketing and promotional efforts. We also agreed to
purchase 321,027 shares of SpeechWorks common stock in a private
placement concurrent with SpeechWorks' initial public offering.
- Webley Systems, Inc. Webley Systems, Inc. provides unified messaging
services and related personal communications features, which consist of
the integration of information, telecommunications and Internet services
that include interactive, voice-activated, directional management of
inbound and outbound calls, e-mail, fax-mail, voice-mail, conference
calling and call answering, delivered over its advanced computer
telephony platform. In June 2000, we entered into an exclusive four year
distribution and marketing agreement with Webley Systems, Inc. Under this
agreement, we have the right to integrate co-branded versions of Webley's
products with our Internet telephony products and services in order to
create a unified communication and messaging platform that will enable
users to
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send and receive voice mail, faxes, e-mail and telephone calls over the
Internet. We will share revenue from the combined products and services
with Webley. On April 5, 2000, we acquired a small, strategic stake in
Webley Systems, Inc. We invested $7,500,000 in a convertible Series B
Preferred Stock, accruing dividends at 5 percent per annum. We have the
right to designate one member to Webley's board of directors.
- WebEx Communications, Inc. WebEx Communications, Inc. provides
real-time, interactive multimedia communications services for websites.
These services allow end-users to conduct meetings and share software
applications, documents, presentations and other content on the Internet
using a standard Web browser. Telephone calls and web-based audio and
video services can also be controlled within a WebEx meeting using
standard devices such as telephones, computer web-cameras and
microphones. In January, 2000 we purchased 240,000 shares of Series A
Preferred Stock for $3.00 per share from an existing stockholder of
WebEx, and in March, 2000 we purchased 14,600 shares of Series D
Preferred Stock for $12.50 per share for a total investment of $902,500.
Upon the consummation of the initial public offering of WebEx in July
2000, the shares of both the Series A and the Series D Preferred Stock
were converted on a one for one basis into common stock of WebEx.
- WebDialogs, Inc. WebDialogs, Inc. is a privately held provider of live,
voice and Web-based customer interaction solutions that bring live human
interaction and collaboration to Web experiences, facilitating closer
relationships with customers, prospects and partners and better customer
service online. On January 28, 2000 we invested $10 million for 1,696,667
shares of Series D Preferred Stock of WebDialogs at $5.893 per share.
This investment represents a minority interest in WebDialogs. Cumulative
dividends on the Series D Preferred Stock accrue quarterly at 6 percent
per annum. The Series D Preferred Stock is convertible into common stock
at an initial conversion ratio of one for one and is subject to
antidilution protection. We have the right to designate one member to
WebDialog's board of directors.
- Go2Net. In October 1999, we entered into an exclusive three-year
distribution and marketing agreement with Go2Net, a network of branded,
technology and community-driven Web sites. Under this agreement, Go2Net
has agreed to integrate co-branded versions of our Internet telephony
products and services into the Go2Net Network.
- eCal Corporation. eCal is a leading provider of Internet-based
scheduling and communications services. Its technology uses the
collaborative powers of the Internet to simplify the management of
time-dependent information and events. In March, 2000, we invested $2.0
million for 181,818 shares of Series G Preferred Stock of eCal
Corporation at $11.00 per share. No dividends accrue on the Series G
Preferred Stock. The Series G Preferred Stock is convertible into common
stock at an initial conversion ratio of one for one and is subject to
antidilution protection.
PRODUCTS AND SERVICES
Our services enable our customers to make low-cost, high-quality phone
calls over our own voice optimized IP network and the Internet using their
personal computers or traditional telephones. Our principal current product and
service offerings are described in the table below.
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- ----------------------------------------------------------------------------------------------------
PRODUCT/SERVICE DESCRIPTION BENEFITS
- ----------------------------------------------------------------------------------------------------
CONSUMER SERVICES
- ----------------------------------------------------------------------------------------------------
BASIC CONSUMER - Enables customer to make - International long distance
Telephony Services calls over traditional rates are typically
PHONE-TO-PHONE telephones and fax machines substantially lower than
- Fax2Fax routed over the Internet. the rate charged by
- Net2Phone Direct Calling Customers must dial a traditional long distance
Cards local or domestic carriers for calls
PC TO PHONE toll-free access number to originating in the United
- PC-to-Phone access the Net2Phone States and up to 95% lower
- PC-to-Fax network. for calls originating
- PC-to-PC outside the United States.
- Voice Email - Customers are charged for
toll and long distance calls - User does not need to
on a per-minute basis for purchase expensive hardware
phone-to-phone. We do not or software.
currently charge a fee for
PC-to-phone calls within - High voice quality.
the United States.
- We do not currently charge
- Services are available in customers for PC-to-Phone
the United States and in many and PC-to-PC calls to the
international locations. US and Canada, from
anywhere in the US and
- We market Phone-to-Phone Canada and PC to PC calls
under the brand "Net2Phone from anywhere to anywhere.
Direct."
- Faxes are transmitted
- Enables customers to make without delay and users
calls and send faxes over receive immediate delivery
the Internet using their confirmations.
personal computers.
- PC to Phone services are
- Customers must install our available to any Internet
software on their personal user with a sound-equipped
computers, register with us personal computer.
and be online in order to
make calls. - Online real time billing.
- Auto recharge &
registration via web.
- ----------------------------------------------------------------------------------------------------
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- ----------------------------------------------------------------------------------------------------
PRODUCT/SERVICE BENEFITS DESCRIPTION BENEFITS
- ----------------------------------------------------------------------------------------------------
CONSUMER SERVICES
- ----------------------------------------------------------------------------------------------------
YAP GEAR (YOUR ALTERNATIVE - Headset allows you to place - YAP Headset, ISA, and
PHONE) hands-free calls over the Phone: We do not currently
- YAP Headset Internet. charge for PC-to-PC calling,
and we offer low-cost PC-to-
- YAP Hotline ISA - Hotline ISA allows you to Phone calling, convenient
use your regular phone to Phone-to-Phone calling with
- YAP Jack place cost-saving calls Universal PIN, award-winning
over the Internet. software with easy to use
- YAP MultiMax GUI.
- Jack enables you to place
- YAP Phone cost- saving Internet calls - YAP Jack: Use your regular
without a computer. Simply phone, place low-cost Phone-
- YAP Time plug your regular phone into to-Phone calls, call any
the YAP Jack and connect it other phone, no computer
to your wall jack. necessary, and includes
integrated v.90 modem.
- MultiMax connects multiple
phones and faxes to make - YAP MultiMax: Calls any
high quality calls over the phone or fax anywhere in
Internet. the world at reduced rates,
accepts six standard
- The YAP Phone allows you to phones, faxes or a PBX
use an actual phone handset system for simultaneous
to place cost-saving calls calling.
over the Internet. Simply
install the Net2Phone - YAP Phone: We do not
Software and plug the YAP currently charge for PC-to
Phone into the USB port on PC calling and we offer
your computer. low-cost PC-to-Phone
calling, convenient
- YAP Time allows you to Phone-to-Phone calling with
place calls over the Internet Universal PIN, plug and
anytime. Use your universal play USB interface, and
account number from you PC award-winning software with
and also carry it as a easy to use GUI.
calling card to access low
Internet calling rates. - YAP Time: Call from any PC
or phone to any other
phone.
- Creates user friendly
experience.
- ----------------------------------------------------------------------------------------------------
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- ----------------------------------------------------------------------------------------------------
BUSINESS SERVICES DESCRIPTION BENEFITS
- ----------------------------------------------------------------------------------------------------
WEB-BASED INTERNET TELEPHONY - When browsing Web sites - Services are available to
SERVICES that have a Click2Talk icon, any Internet user with a
- Click2Talk customers may initiate calls sound- equipped personal
to the business or site computer.
- Click2CallMe owner from anywhere in the
world. Click2Talk - Facilitates online commerce
- ClickTogether voice-enables web sites by providing live voice
with Net2Pone's new JAVA contact between online
engine and allows end users retailers and Internet
to call a company whose site shoppers.
they are browsing with one
simple click. As of - Customers do not require
10/2000, over 30,000 sites multiple telephone lines
have registered for and need not log off the
Click2Talk. Internet to initiate a
call.
- ClickTogether is a complete
voice-led collaboration - United States, Canadian,
solution for web sites. UK, and Australian toll-free
Features include: Customer numbers can be accessed
call initiation via web from anywhere in the world.
callback (PSTN) and Voice We currently do not charge
Over IP (voice-over-IP), for calls to any Click2Talk
Co-Browsing and URL Page enabled site within the US,
Push, Form Sharing, Canada, UK or Australia.
Multimedia Whiteboarding,
Chat, File Transfer, Screen - Customers are able to
Snapshot Transfer, Call initiate a phone call from a
Queuing, Call Transfer and web site (either PSTN or
Detailed Summary/Status voice-over- IP) and
reports. collaborate with an agent
in real time.
- Assists enterprises in the
CRM field.
- ----------------------------------------------------------------------------------------------------
ENTERPRISE SALES - Enables clients to make - International long distance
Voice-over-IP Long Distance calls over a privately rates are typically 50% to
Domestic/International managed voice-over-IP 70% lower than the rate
managed network. charged by traditional long
distance carriers for calls
- Installation of Gateway on originating in the United
client site. States and 20% to 30% on
domestic long distance.
- Marketed as Net2Phone
Enterprise Sales. - The enterprise provides all
costs for installation.
- Value added services:
Collaborative browsing - High voice quality.
- Net2Phone fax services can
be used for Enterprise
clients as well. They are
transmitted without delay
and users receive immediate
delivery and confirmations.
- ----------------------------------------------------------------------------------------------------
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- ----------------------------------------------------------------------------------------------------
BROADBAND AND CARRIER DESCRIPTION BENEFITS
- ----------------------------------------------------------------------------------------------------
Net2Phone Broadband - Net2Phone's Broadband is an Customer Benefits:
end-to-end carrier grade IP - Inbound and outbound low
telephony service offering cost calling
clear voice and real time - Up to 95% savings on
fax. international calls
- No charge for network calls
- Net2Phone Broadband offers - Unified messaging features
an always-on persistent IP - Speech recognition features
dial tone over next - Bundled bill with cable
generation access networks operator
(Cable, DSL, Satellite and - Option for virtual local
Wireless) providing end calling numbers
users with a high quality - No secondary line charges
and low cost alternative or
secondary line phone Broadband Service Provider
service at home and work. (BSP) Benefits:
- Low up-front capital
- Net2Phone's Softswitch is - Quicker deployment than
designed to provide circuit switch
enhanced services and - Scaleable platform
applications over Net2Phone - Managed IP network
IP network allowing end - Full service provider
users to personalize their - Integrated billing system
dial tone, thus having access - Customer service in 14
to a host of speech languages
recognized services such as
an address book voice dialer
and real-time web data over
their phone.
- ----------------------------------------------------------------------------------------------------
INTERNATIONAL CARRIER - Enables ITO (International - Generates cost savings
SERVICES Telecommunications thanks to Net2Phone's highly
Operator) to route calls competitive rates.
destined to the U.S. and
beyond via Net2Phone's - Offers the ability to
managed voice-over-IP reduce costs by avoiding
Network. capital- intensive network
build outs.
- Provides ITO with access to
destinations where it has - Facilitates the use of
no direct connections. Net2Phone's next generation
of value added
- Gives ITO additional Internet-based
capacity on demand for communications services.
traffic surges.
- ----------------------------------------------------------------------------------------------------
SALES, MARKETING AND DISTRIBUTION
We promote our services through online and Internet-based advertising
venues and traditional direct response print advertising in domestic and
international publications. Another way we sell our services internationally is
by entering into agreements with resellers in other countries. We sell these
resellers bulk amounts of minutes of use of our products and services to be
resold in the resellers' respective countries. To facilitate distribution and
attract users in foreign countries, we have developed our software in ten
languages (English, Spanish, Japanese, French, Dutch, Portuguese, Italian,
German, Swedish and Chinese) and intend to increase the number of languages as
our distribution broadens. We also market through loyalty programs to existing
customers and through e-mail customer acquisition programs.
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We have entered into strategic partnerships with leading Internet and
computer hardware and software companies, including IBM and Compaq so that our
software is included with our partners' products and services and distributed
domestically and internationally. We distribute our software through the
Internet, strategic partnerships and international resellers. Our software is
currently embedded in the beta version of the Netscape browser. Our software is
distributed in ICQ's Instant Messenger, and MSN and Yahoo! instant messengers.
Customers can also download our software at no charge from our Web site and
through links on other Web sites, including Yahoo!'s People Search.
In April 2000, we announced the introduction of a line of innovative
hardware solutions designed to enable a wide range of users to make Internet
phone calls easily. The new hardware line is called "YAP -- Your Alternative
Phone," and is sold worldwide to consumers and enterprises through retail
superstores such as CompUSA and Microcenter and resellers such as Ingram Micro
and VARs this year and supported by marketing and advertising campaigns.
Our International Carrier Division is offering International
Telecommunication Operators (ITO) access to its managed voice-over-IP network.
By establishing direct facilities with ITOs in strategic markets, Net2Phone
allows access to routes worldwide and facilitates the use of our next generation
of value added Internet-based communications services.
We distribute Net2Phone Broadband products and services through strategic
partnerships with broadband service providers and original equipment
manufacturers. Service providers bundle our voice offerings with their
high-speed data services to deliver the ultimate converged communications bundle
to their end users. Original equipment manufactures embed our software into
customer premise equipment (CPE) to offer feature rich, telephony enabled
devices to their customers. Finally, broadband customers may order and provision
services online, directly from us.
Broadband products and services will be promoted via our partners' sales
and marketing channels as well as by us. Cooperative marketing arrangements with
partners include launch event sponsorships, advertising agreements and product
collateral in and on device packaging. To facilitate distribution and attract
partnership interest, we advertise in leading broadband trade publications and
demonstrate service offerings at broadband industry trade shows.
We directly market enterprise products and services to Fortune 1000 and
mid-market companies that fit our qualification criteria. We qualify prospects
by calling volumes and patterns (minimum minutes per month of domestic long
distance and international calls). Our unique value proposition to the market is
high quality calls based on our voice-optimized-IP network and our technology
which enables Internet telephony utilizing existing infrastructure. We have
shown cost savings on domestic long distance and International calls. Our
gateway technology enables both off-net termination of calls as well as
establishing on-net calling for global organizations.
As of October 2000, we have agreements in place with 25 Fortune 500
companies and seven mid-market companies. Our prospects for the immediate future
indicate that our sales will increase.
CUSTOMER SERVICE
As part of our goal to attract and retain customers, we offer live customer
support in multiple languages. As of July 31, 2000, we had approximately 289
employees in technical support and customer service who offer customer service
support 24 hours a day. Customer services can be reached from anywhere in the
world currently using either our toll-free number, where available, or our
Web-based Internet telephony services. The customer support staff provides
technical assistance, as well as general service assistance, for all of our
products and services. We also offer customer support via e-mail and fax. Our
integrated customer billing software and call management system provide our
customer support staff with immediate access to user accounts, calling patterns
and billing history, thereby enhancing the quality of service provided to our
customers. In addition, our international resellers typically provide their own
front-line customer support. We have also signed agreements with international
call centers and two other domestic centers.
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TECHNOLOGY
PC-to-Phone Software
Our PC2Phone software has won various industry awards. The installation
process is wrapped in the industry-standard "Install Shield" product. During
installation, the Net2Phone "wizard" verifies that the user's microphone and
speakers are properly set for Internet telephony. The software also links to a
service registration web site that allows the customer to quickly register for
paid time with the product. Our software has a preferences dialog to enable
customization. These preferences allow the user to customize specific
properties, access and modify customer account information, program and use
speed dialing and verify rates.
Our PC2Phone software has gone through various new releases, each improving
upon our Internet telephony capabilities. The software is a Windows-compliant,
32-bit application written in a high-level PC language. The code is extendible
allowing us to add new functionality, yet is relatively compact. The software is
broken into two pieces: an Application Interface Engine and an Internet
telephony calling engine.
The software is flexible and customizable. The user interface supports
custom interface "skins" for modifying the user interface. The software supports
voice email by allowing users to record and play sound files and delivering them
as voice email attachments. The software includes a PC Fax printer driver to
allow faxing from the PC desktop through the Net2Phone network. The software
includes support for displaying advertisements on various sections of the user
interface. The newest version of our software will support Buddy Lists for
building online calling communities. We expect this to be released in December
2000.
We also have developed a software development kit allowing other companies
to integrate their products with our PC2Phone software. For example, our
Internet telephony calling engine is the core technology used in Microsoft's MSN
Messenger product, AOL's ICQ product, Yahoo!'s Pager product, and AOL's AIM
product. This integration enables Internet telephony service to be deployed
throughout the world through robust Internet software distribution channels.
We are developing a version of our PC2Phone software for modern Apple
Macintosh systems such as the iMac. We expect this to be released in December
2000.
Call Management System
To maintain our leadership position in the Internet telephony market, we
believe that reliable and flexible billing, information management, monitoring
and control systems are critical. Accordingly, we have invested substantial
resources to develop and implement our sophisticated real-time call management
information system. Key elements of this system include:
- Customer Provisioning. The system provides automated online customer
registration and customer registration through call centers and
resellers. It also provides online credit card authorization and batch
billing capabilities that streamline customer registration. A special
remote access application program allows other people access to our
database, enabling sophisticated partners to remotely service customers
through our system, and to tie our system directly to their own business
systems. This remote capability includes remote account management and
continuous real-time call detail and billing information. Additionally,
the system makes customer account records readily available to call
center representatives in the event of customer billing problems.
- Customer Access. Our system allows customers to access their billing
records independently online without the need to contact customer service
representatives.
- Fraud Control. Fraud detection and prevention features include caller
authentication, prevention of multiple simultaneous calls using the same
account, PIN code verification and call duration timers. We also generate
reports on suspicious calling patterns to detect caller registration
fraud. We routinely scan for fraudulent content before credit card
purchases are allowed.
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- Network Security. We use firewalls to prevent attacks on our network and
also sophisticated techniques to safeguard sensitive database
information. We also encrypt call requests and portions of the call to
prevent "network sniffers" from unauthorized access to data.
- Call Routing. Our network management system identifies and routes calls
to the most efficiently priced carrier. The system also automatically
routes calls around links or servers that are experiencing problems, have
failed or have been manually taken out of service for maintenance or
upgrades. This system provides remote administration facilities for
maintaining routing tables and system monitoring.
- Monitoring. The management system provides for real-time monitoring of
all call information. We are able to track potential problems such as too
many short calls on a server or a low call completion percentage. The
system also provides remote management that allows partners to monitor
and manage their own accounts.
- Reliability. We maintain three separate network operations centers in
Hackensack, New Jersey, Piscataway, New Jersey and Newark, New Jersey.
These facilities house redundant equipment and have the ability to track
calls simultaneously. This redundant system gives our network a high
degree of reliability, enabling each network operations center to serve
as a back-up to the other.
- Detailed Call Records. The management software maintains detailed
records for each call, including the account number of the caller, the
caller's phone number, access number used, the point at which the call
enters and exits our network, the account owner, the calling party, the
server/service phone number, the number of the called party, a running
account balance and rate and billing information, including surcharges.
THE NET2PHONE NETWORK
Through an agreement with IDT, we lease capacity on an Internet network
comprised of leased high-speed fiber optic lines connecting 8 major cities
across the United States and leased high-speed fiber optic lines connecting
smaller cities to the network. The network backbone uses state-of-the-art
hardware including Cisco Series 7000 routers and Nortel Passport switches. Our
high-speed backbone connects traffic at 4 major public Internet exchange points
and is also facilitated by a growing number of private peering or exchange
points with other networks. Through peering arrangements, we exchange Internet
traffic with 25 other Internet backbone providers at these points. We operate
IDT's network, one of the largest Internet access networks, providing local
dial-up access through 36 locations. Our Internet network also includes more
than 700 additional network access locations owned by local and regional
Internet service providers.
We are able to provide service in areas where we do not have dial-up
equipment by using call-forwarding technology to expand our coverage areas by
increasing the total number of local access numbers. We have been consolidating
multiple access points into central "Super Point of Presence" locations. For
example, one Super Point of Presence in New Jersey can supply local access for
the entire state of New Jersey.
We seek to retain flexibility by using dynamic call routing alternatives.
This approach is intended to enable us to take advantage of the rapidly evolving
Internet market to provide low-cost service to our customers. Accordingly, our
network employs an "Open Shortest Path First" protocol that promotes efficient
routing of traffic. Additionally, we have placed redundant hardware for
reliability in high traffic areas to minimize loss of data packets. Each network
data exchange point employs hardware to direct network traffic and a minimum of
two dedicated leased data lines to increase reliability.
We manage our network hardware remotely. It is compatible with a variety of
local network systems around the world. We believe our Internet telephony
network can currently support approximately 12,000 simultaneous calls. We
believe our systems are scalable to 4 times their current capacity through the
purchase and installation of certain additional hardware. To date, the highest
number of simultaneous calls serviced by our network was approximately 9000 on
October 15, 2000.
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THE NETWORK OPERATIONS CENTER
Our Network Operations Center, located in Hackensack, New Jersey and
Newark, New Jersey, employs a staff of 70 people. There are 2 groups that work
within the network operations center, the network analysis group and the
Internet telephony monitoring group. Both groups have 24 hours per day, 7 days
per week coverage to respond quickly to any issues.
The network analysis group works around the clock monitoring network
issues, handling customer requests, repairing outages and solving security
problems. Our monitoring group oversees a nationwide real-time network analysis
map, which notifies our staff of network errors. They also use software we
developed to monitor our hardware around the world. This group can dynamically
turn on or turn off equipment and re-route Internet telephony traffic, as
necessary.
There is also a complete voice engineering group, network engineering group
and t-circuit provisioning group, to augment our operational abilities.
CUSTOMERS
We have a diverse, global customer base. As of July 31, 2000, approximately
38 percent of our customers were based outside of the United States. As of July
31, 2000, we served over 1,179,000 active customers who had used our services
during the preceding 3 months. Additionally, as of July 31, 2000, we had signed
agreements with 7 International Telecommunications Operators. As of August 2000,
we had two agreements with DSL providers. As of October 2000, we have Enterprise
agreements in place with 25 Fortune 500 companies and mid-market companies. In
addition, as of October 10, 2000, we had installed the Click2Talk service on
approximately 30,000 commercial Web sites.
COMPETITION
Long Distance Market
The long distance telephony market and, in particular, the Internet
telephony market, is competitive. There are several large and numerous small
competitors, and we expect to face continuing competition based on price and
service offerings from existing competitors and new market entrants in the
future. The principal competitive factors in the market include price, quality
of service, breadth of geographic presence, customer service, reliability,
network capacity and the availability of enhanced communications services. Our
competitors include MCI WorldCom and Sprint in the United States and foreign
telecommunications carriers. Although we have forged a strategic partnership
with AT&T, to some extent AT&T still provides competing services.
Some of our competitors may have greater financial, technical and marketing
resources, larger customer bases, longer operating histories, greater name
recognition and more established relationships in the industry than we have. As
a result, certain of these competitors may be able to adopt more aggressive
pricing policies, which could hinder our ability to market our Internet
telephony services. One of our competitive advantages is the ability to route
calls through Internet service providers, which allows us to bypass the
international settlement process and realize substantial savings compared to
traditional telephone service. Any change in the regulation of an Internet
service provider could force us to increase prices and offer rates that are
comparable to traditional telephone call providers.
Web-Based Internet Telephony Services
As consumers and telecommunications companies have come to understand the
benefits that may be obtained from transmitting voice over the Internet, a
substantial number of companies have emerged to provide voice over the Internet.
In addition, companies currently in related markets have begun to provide voice
over the Internet services or adapt their products to enable voice over the
Internet services. These related companies may potentially migrate into the
Internet telephony market as direct competitors.
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- Internet Telephony Service Providers. 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 us, AT&T
Jens (a Japanese affiliate of AT&T), deltathree.com (a subsidiary of RSL
Communications), I-Link, iBasis (formerly known as VIP Calling), ICG
Communications, IPVoice.com, ITXC and OzEmail (which was acquired by MCI
WorldCom), HearMe, Phonefree, and Dialpad 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 we offer. Some
companies, including 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.
- Software/Hardware Providers. Many companies produce software and other
computer equipment that may be installed on a user's computer to permit
voice communications over the Internet. These products generally require
each user to have compatible software and hardware equipment and rely on
the public Internet for the transmission of traffic, which often results
in reduced quality of communications. Representative companies include
VocalTec and Netspeak. We believe VocalTec's software and hardware are
unable to handle large numbers of simultaneous calls and that Netspeak
focuses on delivering solutions targeted at traditional call centers that
require significant customization.
- Telecommunications Companies. A number of telecommunications companies,
including AT&T, Deutsche Telekom, MCI WorldCom and Qwest, may currently
maintain, or may in the future maintain, packet-switched networks to
route the voice traffic of other telecommunications companies. These
companies, which tend to be large entities with substantial resources,
generally have large budgets available for research and development and
therefore may enhance the quality and acceptance of the transmission of
voice over the Internet. However, many of these companies are new to the
Internet telephony market and may not build brand recognition among
consumers for these services. These companies also may not have the range
of product and service offerings that is necessary to independently
provide a broad set of voice-enabled Web services.
- Network Hardware Manufacturers. Several of the world's major providers
of telecommunications equipment, such as Alcatel, Cisco, Lucent, Northern
Telecom and Dialogic (which was acquired by Intel) have developed or plan
to develop network equipment to use in connection with the provision of
voice over the Web services, including routers, servers and related
hardware and software. By developing this equipment, these manufacturers
may exert substantial influence over the technology that enables
transmission of voice over the Web, and they may develop products that
facilitate the quality and timely roll-out of these networks. However,
these companies are dependent upon the operators of Internet telephony
networks to purchase and install their equipment into their networks.
They are also dependent upon the developers of hardware and software to
market their systems to end users. Cisco currently manufactures Internet
telephony equipment for low to medium scale networking but does not
manufacture high-end Internet telephony equipment for large networks. In
September 2000, we created Adir Technologies, a separate company to which
we contributed certain assets and which has been funded by Cisco Systems,
SOFTBANK and IDT to focus on IP network management software. By creating
Adir, we will commercialize our network management software. Adir
currently intends to market its products to service providers and
telecommunications companies, as well as equipment manufacturers looking
to migrate voice traffic to IP networks. Lucent has co-developed with
VocalTec a set of industry standards that have been adopted by major
competitors and is currently marketing Internet telephony hardware,
including servers that allow the transmission of calls and faxes over the
Internet. Lucent also offers related support products, such as billing
centers and "Internet call centers," which allow Internet access and
conversation with a customer support agent on a single line.
- Voice-Enabled Online Commerce Providers. Several providers apply
Internet telephony technologies in connection with e-commerce
transactions. These providers compete with services of ours such as
Click2Talk by integrating voice communications into commercial Web sites.
These competitors include HearMe, Lipstream and USA Global Link, which
introduced its Instant Call service in 1998, a
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system that permits voice communications between a customer on the Web
and customer service representatives. In addition, AT&T's Inter@active
Communications group of services integrates voice into the Web, including
AT&T Chat'N Talk, a voice-enabled chat service, and Click2Dial
Conferencing Services, which initiates and manages conference calls.
RESEARCH AND DEVELOPMENT
Strategic Research and Development
At our research and development centers in Lakewood, New Jersey and Newark,
New Jersey, we employ 30 engineers, whose specialties include software,
hardware, switching, Internet security, voice compression, protocols, Web
applications, PC development, interactive voice response systems, VoiceXML,
speech recognition, speech applications, broadband technologies, engineering
real-time online transactions, billing network and call management. This staff
is devoted to the improvement and enhancement of our existing product and
service offerings, as well as to the development of new products and services.
Current research and development activities include the following:
- enhancements to our PC-to-phone software to increase functionality;
- encapsulation of our PC-to-phone software as an OEM engine product;
- porting of our PC-to-phone software to other operating system platforms;
- enhancements to our call processing platform to increase scalability and
performance;
- enhancements to our billing platforms to increase scalability and
performance;
- development of a calling application platform to host interactive voice
response and VoiceXML applications;
- development of speech enabled calling applications;
- multiprotocol voice-over-IP support to embrace multiple voice-over-IP
calling devices and platforms; and
- protocol support for IP calling software, devices and broadband
initiatives.
Our future success will depend, in part, on our ability to improve existing
technology and develop new products and services that incorporate leading
technology.
Costs for the internal development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established, at which time any additional
costs would be capitalized. As we have completed our software development
concurrently with the establishment of technological feasibility, we have begun
capitalizing these costs. Software development costs are our only research and
development expenditures. For the years ended July 31, 2000, 1999 and 1998,
research and development costs totaled approximately $4,692,000, $757,000 and
$481,000, respectively.
REGULATION
Regulation of Internet Telephony
The use of the Internet to provide telephone service is a relatively recent
market development. The Federal Communications Commission (FCC) currently does
not impose surcharges or traditional common carrier regulation upon providers of
Internet telephony.
On April 10, 1998, the FCC issued a report to Congress concerning the
implementation of the universal service provisions of the Telecommunications
Act. In the report, the FCC indicated that it would undertake a subsequent
examination of the question whether certain forms of phone-to-phone Internet
telephony are information services or telecommunications services. The FCC noted
that although it did not have, as of the
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date of the report, an adequate record on which to make a definitive
pronouncement, the record suggested that certain forms of phone-to-phone
Internet telephony appear to have the same functionality as non-Internet
telecommunications services and lack the characteristics that would render them
information services. The FCC indicated that it would weigh the extent to which
phone-to-phone Internet telephony providers could be considered
"telecommunications carriers" such that they would be subject to universal
service contribution requirements. The FCC also indicated, however, that it
would consider whether it should forbear from imposing any of the rules that
would apply to phone-to-phone Internet telephony providers as
"telecommunications carriers."
If the FCC were to determine that certain Internet telephony services are
subject to FCC regulation as telecommunications services, it may require
providers of Internet telephony services to make universal service
contributions, pay access charges, or be subject to traditional common carrier
regulation. It is also possible that PC-to-phone and phone-to-phone services may
be regulated by the FCC differently. To date, however, the FCC has not initiated
a proceeding to examine these issues.
In September 1999, the FCC released a Notice of Inquiry that requested
comment on the regulatory status of Internet telephony for purposes of
considering the access to telecommunications afforded to persons with
disabilities. The FCC requested, in part, that comments address whether Internet
telephony service generally, and phone-to-phone service in particular, may be
regulated as a basic telecommunications service. To date, the Commission has not
issued any policy directive or adopted any regulations addressing these issues.
The FCC also sets the access charges on traditional telephony traffic. In
May 2000, the Commission adopted a proposal set forth by a coalition of
traditional telephone companies that lowered the accessed charges paid by long
distance companies and reduced, and in some cases eliminated, a number of
implicit subsidies within the access charge regime that are passed-through to
end-user customers. When implemented, this proposal could reduce the cost of
traditional long distance telephone calls, thereby decreasing our competitive
pricing advantage.
Although the FCC to date has determined that providers of Internet services
should not be required to pay interstate access charges, it may reconsider this
decision. The FCC could determine, for instance, that certain types of Internet
telephony should be regulated like basic interstate telecommunications services.
Thus, Internet telephony would no longer be exempt from the access charge regime
that permits local telephone companies to charge long-distance companies for the
use of the local telephone network to originate and terminate long-distance
calls, generally on a per minute basis. Similarly, the FCC could conclude that
Internet telephony providers should contribute to the Universal Service Fund,
which provides support to ensure universal access to telephone service. The
imposition of access charges or universal service contributions may increase our
costs of serving dial-up customers.
Changes in the legal and regulatory environment relating to the Internet
connectivity market, including regulatory changes that affect telecommunications
costs or that may increase the likelihood of competition from the regional Bell
operating companies or other telecommunications companies, could increase our
costs of providing service. For example, the FCC determined on a preliminary
basis that subscriber calls to Internet service providers should be classified
for jurisdictional purposes as interstate calls. This determination could affect
a telephone carrier's costs for provision of service to these providers by
eliminating the payment of reciprocal compensation to carriers terminating calls
to these providers. The FCC is currently considering mechanisms to achieve
cost-based compensation for the termination of calls made to Internet services
providers. Meanwhile, state agencies are making specific determinations based
upon the contractual relationships governing traditional telecommunications
carriers regarding whether carriers are entitled to reciprocal compensation on
Internet bound calls. If new compensation mechanisms increase carriers' costs of
terminating calls to Internet service providers or if some states rule that
compensation is not due for such calls, then the affected carriers could
compensate by increasing the price of service to Internet service providers,
thereby raising the cost of Internet access to consumers.
In September 2000, the FCC released a Notice of Inquiry to address what
regulation, if any, should apply to providers of high-speed Internet access
services, including cable modem services and xDSL based services.
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If the FCC were to limit the Internet service providers that are permitted to
offer services through cable modems or xDSL based services, then it could limit
the availability of certain types of Internet services. Similarly, if the FCC
were to impose traditional common carrier regulations upon providers of cable
Internet access services, then the consumer cost of Internet access could
increase, thus affecting the entire market for Internet services.
Access to our services may also be limited in foreign countries where laws
and regulations otherwise do not prohibit voice communication over the Internet.
For example, access to some of our services has been blocked in certain
countries by government-controlled telecommunications companies, thus preventing
our customers from originating certain types of calls in these countries. In
such cases, we have and will continue to negotiate agreements to continue to
provide our services, and we intend to do the same as similar situations arise.
No assurances, however, can be given that we will be successful in such
negotiations or that we will be able to provide alternative means of access to
our service that will not be blocked by government-controlled telecommunications
companies.
The European Commission recently requested public comment in order to
review a 1998 notice by the Commission of the Status of Voice on the Internet
under European Community law. In doing so, the European Commission stated that
it "intends to confirm that Internet telephony still continues to fall outside
the definition of voice telephony." If the Commission were to determine
otherwise, however, it could impose regulatory restrictions upon Internet
telephony, which could have material adverse effects upon our business,
financial condition, and results of operations.
The International Telecommunications Union (ITU) has announced the third
World Telecommunications Policy Forum, to be held in March 2001, to address the
economic, policy, and regulatory implications of Internet telephony for member
nations and, in particular, developing nations. If the ITU World Policy Forum
encouraged member nations to adopt regulatory programs that restrict or prohibit
the provision of voice communications over the Internet, our business, financial
condition, and results of operations could be materially adversely affected.
To our knowledge, there are currently no domestic and few foreign laws or
regulations that prohibit voice communications over the Internet. A number of
countries that currently prohibit competition in the provision of voice
telephony have also prohibited Internet telephony. Other countries permit but
regulate Internet telephony. If Congress, the FCC, state regulatory agencies, or
foreign governments begin to regulate the Internet telephony industry, such
regulation may materially adversely affect our business, financial condition, or
results of operations.
Regulation of the Internet
Congress has adopted legislation that regulates certain aspects of the
Internet, including online content, user privacy, taxation, access charges,
liability for third-party activities, and jurisdiction. In addition, a number of
initiatives pending in Congress and state legislatures would prohibit or
restrict advertising or sale of certain products and services on the Internet,
which may have the effect of raising the cost of doing business on the Internet
generally. The European Union has also enacted several directives relating to
the Internet, one of which addresses online commerce. In addition, federal,
state, local and foreign governmental organizations are considering other
legislative and regulatory proposals that would regulate the Internet. Increased
regulation of the Internet may decrease its growth, which may negatively impact
the cost of doing business via the Internet or otherwise materially adversely
affect our business, results of operations, and financial condition.
Additionally, the FTC has proposed regulations regarding the collection and
use of personal identifying information obtained from individuals when accessing
Web sites, with particular emphasis on access by minors. These regulations may
include requirements that companies establish certain procedures to disclose and
notify users of privacy and security policies, obtain consent from users for
certain collection and use of information and provide users with the ability to
access, correct and delete personal information stored by the company. These
regulations may also include enforcement and redress provisions. There can be no
assurance that we will adopt policies that conform with any regulations adopted
by the FTC. Moreover, even in the absence of those regulations, the FTC has
begun investigations into the privacy practices of companies that
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collect information on the Internet. One investigation resulted in a consent
decree pursuant to which an Internet company agreed to establish programs to
implement the principles noted above. We may become subject to a similar
investigation, or the FTC's regulatory and enforcement efforts may adversely
affect the ability to collect demographic and personal information from users,
which could have an adverse effect on our ability to provide highly targeted
opportunities for advertisers and electronic commerce marketers. Any of these
developments would materially adversely affect our business, results of
operations and financial condition.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. Under the directive, citizens of the
European Union are guaranteed rights to access their data, rights to know where
the data originated, rights to have inaccurate data rectified, rights to
recourse in the event of unlawful processing and rights to withhold permission
to use their data for direct marketing. The directive could, among other things,
affect United States companies that collect information over the Internet from
individuals in European Union member countries and may impose restrictions that
are more stringent than current Internet privacy standards in the United States.
In particular, companies with offices located in European Union countries will
not be allowed to send personal information to countries that do not maintain
adequate standards of privacy. The directive does not, however, define what
standards of privacy are adequate. As a result, the directive may adversely
affect the activities of entities such as us that engage in data collection from
users in European Union member countries.
In October 2000, the World Telecommunications Standardization Assembly, an
international standards-setting body, issued a proposal under which U.S.
providers of Internet backbone services would be required to compensate foreign
telecommunications providers for the costs of carrying Internet traffic
generated in the United States. If adopted, the proposal would require Internet
backbone providers to enter into reciprocal agreements to compensate each other
for the costs of carrying each others' Internet traffic. Such a requirement
could result in an increase in the price of Internet access and other services.
If Congress, the FCC, state regulatory agencies, or foreign governments
begin to regulate markets for all types of Internet services, such regulation
could increase the cost of Internet services and, therefore, could affect our
business, financial condition, or results of operations.
INTELLECTUAL PROPERTY
Our performance and ability to compete depend in part, on our proprietary
and licensed technology. We rely on a combination of patent, copyright,
trademark and trade secret laws and contractual restrictions to establish and
protect our technology. Our employees are bound by confidentiality agreements.
These agreements provide that confidential information developed by or with an
employee or consultant, or disclosed to such person during his or her
relationship with us, may not be disclosed to any third party except in certain
specified circumstances. These agreements also require our employees to assign
their rights to any inventions to us. The steps taken by us may not, however, be
adequate to prevent the misappropriation of our proprietary rights or
technology. In addition, our competitors may independently develop technologies
that are substantially equivalent or superior to our technology.
We currently have 5 U.S. patent applications pending; none have been issued
to date. We have been granted patents in Taiwan and Singapore for "Method and
apparatus for transmitting and routing voice telephone calls over a
packet-switched computer network." We own eighteen (18) registered trademarks in
the United States and 3 foreign registered trademarks. We are currently engaged
in a worldwide program to file trademark applications throughout the world for
our "net2phone" and "Y@P/YAP" marks.
There can be no assurance that we will be able to secure significant
protection for all of our marks world wide. Competitors of ours or others may
adopt product or service marks similar to our marks, or try to prevent us from
using our marks, thereby impeding our ability to build brand identity and
possibly leading to customer confusion. Trademark oppositions have been filed
against us challenging our registration of the mark NET2PHONE in Argentina,
Chile, Colombia, Guatemala, Paraguay, Peru and Venezuela which we are
prosecuting.
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To the extent trademark rights are acquired through registration in
countries outside the United States, we may not be able to protect our marks or
assure that we are not infringing other parties' marks in those countries.
Moreover, although we have taken steps to commence the registration of
"net2phone" as a domain name with the various international registries, we
cannot be assured that this will be successful in all locations.
We have been assigned the rights to patent applications claiming a number
of the technologies underlying our products and services. Our two United States
utility patent applications have been rejected, but we are continuing to pursue
patent protection for the claimed subject material. There can be no assurance
that the applications will result in the issuance of patents or that, if issued,
such patents would adequately protect us against competitive technology or that
they would be held valid and enforceable against a challenge. In addition, it is
possible that our competitors may be able to design around any such patents.
Also, our competitors may obtain patents that we would need to license or
circumvent in order to make, use, sell or offer for sale the technology.
We have received correspondence from a company, NetPhone Inc., in 1996
claiming that our use of the mark "Net2Phone" in connection with Internet
telephony services infringes that company's "NetPhone" registered trademark and
requesting that we cease and desist from using the "Net2Phone" mark. We
responded by denying any infringement. No legal proceedings have been commenced
against us with respect to this matter. There can be no assurance that the
existence of this entity's claim, will not materially adversely affect our
business.
We have also received correspondence from a company, Wireless Application
Protocol Forum Ltd., in June 2000, claiming that our use of the trademarks, Y@P,
Y@P GEAR and Y@P TIME infringes on that company's use of the W@P mark. They have
requested that we cease and desist using the Y@P marks. We have responded by
denying any infringement. No legal proceedings have been commenced against us
with respect to this matter. There can be no assurance that the existence of
this entity's claim or its business will not materially affect our business.
We are also aware of several other parties that use marks that are the same
or similar to marks that we use, though in some instances, to the best of our
knowledge, these parties are not in the same business as we are. There can be no
assurance that the companies that notified us or other companies with marks
similar to our marks will not bring suit to prevent us from using the
"Net2Phone" mark or other marks. Defending or losing any litigation relating to
intellectual property rights could materially adversely affect our business,
results of operations and financial condition.
We believe that we do not infringe upon the patent rights of any third
party. However, on February 15, 2000, Multi-Tech Systems, Inc. filed suit
against us and other companies in the United States Federal District Court in
Minneapolis, Minnesota. In its press release, Multi-Tech stated that "the
defendant companies are infringing because they are providing the end users with
the software necessary to simultaneously transmit voice and data on their
computers in the form of making a phone call over the Internet." We intend to
defend the lawsuit vigorously. We have filed an answer and the litigation is in
the early stages of discovery. We believe that the Multi-Tech claims are without
merit. However, should a judge issue an injunction against us requiring that we
cease distributing its software or providing its software-based services, such
an injunction could have a material adverse effect on our business operations,
financial condition, results of operations and cash flows.
It is possible that other patent infringement claims might be asserted
successfully against us in the future. Our ability to make, use, sell or offer
for sale our products and services depends on our freedom to operate. That is,
we must ensure that we do not infringe upon the patents of others or have
licensed all such rights. We are aware that patents have recently been granted
to others based on fundamental technologies in the Internet telephony area. In
addition, we are aware of at least one other patent application involving
potentially similar technologies to our own which if issued could materially
adversely affect our business. Because patent applications in the Unites States
are not publicly disclosed until issued, other applications may have been filed
which, if issued as patents, could relate to our services and products. However,
foreign patent applications do publish before issuance.
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We are aware of several such publications that relate to Internet
telephony. One such published application claims as an inventor a previous
consultant to IDT and has been assigned to another company. Issuance of a patent
or patents from this application could materially adversely affect our ability
to operate.
A party making an infringement claim could secure a substantial monetary
award or obtain injunctive relief that could effectively block our ability to
provide services or products in the United States or abroad. If any of these
risks materialize, we could be forced to suspend operations, to pay significant
amounts to defend our rights, and a substantial amount of the attention of our
management may be diverted from our ongoing business, each of which could
materially adversely affect our ability to operate.
We rely on a variety of technology, primarily software, that we license
from third parties. Most of this technology was purchased or licensed on our
behalf by IDT. Continued use of this technology by us may require that we
purchase new or additional licenses from third parties or obtain consents from
third parties to assign the applicable licenses from IDT. There can be no
assurances that we can obtain those third party licenses needed for our business
or that the third party technology licenses that we do have will continue to be
available to us on commercially reasonable terms or at all. The loss or
inability to maintain or obtain upgrades to any of these technology licenses
could result in delays or breakdowns in our ability to continue developing and
providing our products and services or to enhance and upgrade our products and
services.
EMPLOYEES
As of July 31, 2000, we had approximately 541 full-time and 45 part-time
employees, including approximately 289 in technical support and customer
service, 160 in marketing and sales, 35 in management and finance, 40 in
operations, and 62 in research and development. Our employees are not
represented by a union, and we consider our employee relations to be good. We
have never experienced a work stoppage.
REVENUES AND ASSETS BY GEOGRAPHIC AREA
For the year ended July 31, 2000, 34%, or $24.6 million of our revenue was
derived from international customers, and 66%, or $47.8 million from customers
in the United States. All our long-lived assets are located in the United
States, with the exception of our recently acquired Aplio assets which are
primarily located in Sarcelles, France.
We face certain risks inherent in doing business on an international basis,
including:
- changing regulatory requirements, which vary widely from country to
country;
- action by foreign governments or foreign telecommunications companies to
limit access to our services;
- increased bad debt and subscription fraud;
- legal uncertainty regarding liability, tariffs and other trade barriers;
- political instability; and
- potentially adverse tax consequences.
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EXECUTIVE OFFICERS
The following are the executive officers of Net2Phone as of October 19,
2000:
EXECUTIVE
NAME AGE OFFICER SINCE PRESENT OFFICE
- ---- --- ------------- -----------------------------
Howard S. Balter.................... 38 1999 Chief Executive Officer
David Greenblatt.................... 48 1999