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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JULY 31, 2001, OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
Commission File Number: 0-27898
IDT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 22-3415036
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification Number)
organization)
520 Broad Street
Newark, New Jersey 07102
(Address of principal executive offices, including
zip code)
(973) 438-1000
(Registrant's telephone number, including area code)
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
Class B Common Stock, par value
$.01 per share (Title of class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing price on October 26, 2001 of the Common
Stock of $11.50 and of the Class B Common Stock of $9.35 was approximately
$240,978,400.80 million and $264,078,996.50 million, respectively, as reported
on the New York Stock Exchange. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
(assuming conversion of the Registrant's Class A Common Stock) have been
excluded from this computation, in that such persons may be deemed to be
affiliates of the Registrant. This determination of affiliate status is not
necessarily a conclusive determination for any other purpose.
As of October 26, 2001, the Registrant had outstanding 23,212,753 shares of
Common Stock, $.01 par value, 9,816,988 shares of Class A Common Stock, $.01 par
value, and 47,263,289 shares of Class B Common Stock, $.01 par value. As of
October 26, 2001, 5,390,163 shares of Common Stock and 4,019,063 shares of
Class B Common Stock were held by IDT Telecom, Inc.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information in the Registrant's definitive Proxy Statement for its
2001 Annual Meeting of Stockholders, which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
July 31, 2001, is incorporated by reference in Part III (Items 10, 11, 12 and
13) of this Form 10-K.
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INDEX
IDT CORPORATION
ANNUAL REPORT ON FORM 10-K
Page No.
PART I
Item 1. Business.............................................................1
Item 2. Properties..........................................................29
Item 3. Legal Proceedings...................................................30
Item 4. Submission Of Matters To A Vote Of Security Holders.................31
PART II
Item 5. Market For Registrant's Common Equity And Related
Stockholder Matters.................................................32
Item 6. Selected Financial Data.............................................33
Item 7. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations...............................................34
Item 7A. Quantitative And Qualitative Disclosures About Market Risks.........47
Item 8. Financial Statements And Supplementary Data.........................47
Item 9. Changes In And Disagreements With Accountants On Accounting And
Financial Disclosure................................................48
PART III
Item 10. Directors And Executive Officers Of The Registrant..................49
Item 11. Executive Compensation..............................................49
Item 12. Security Ownership Of Certain Beneficial Owners And Management......49
Item 13. Certain Relationships And Related Transactions......................49
PART IV
Item 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K....50
SIGNATURES....................................................................53
Index to Consolidated Financial Statements...................................F-1
PART I
Item 1. BUSINESS.
Summary
As used in this Annual Report, unless the context otherwise requires, the
terms "the Company," "IDT," "We," and "Our" refer to IDT Corporation, a Delaware
corporation, its predecessor, International Discount Telecommunications, Corp.,
a New York corporation ("IDT New York"), and their subsidiaries, collectively.
All information in this Annual Report gives effect to the 1995 reincorporation
of the Company in Delaware. The Company's fiscal year ends on July 31 of each
calendar year. Each reference to a Fiscal Year in this Annual Report refers to
the Fiscal Year ending in the calendar year indicated (e.g., Fiscal 2001 refers
to the Fiscal Year ended July 31, 2001).
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including statements that contain the words
"believes," "anticipates," "expects," "plans," "intends" and similar words and
phrases. Such forward-looking statements include, among other things, the
Company's plans to implement its growth strategy, improve its financial
performance, expand its infrastructure, develop new products and services,
expand its sales force, expand its customer base and enter international
markets. Such forward-looking statements also include the Company's expectations
concerning factors affecting the markets for its products, such as changes in
the U.S. and the international regulatory environment and the demand for
long-distance telecommunications. Actual results could differ from those
projected in any forward-looking statements.
Forward-looking statements are based on management's current views and
assumptions and involve known and unknown risks that could cause actual results,
performance or events to differ materially from those expressed or implied in
those statements. These risks include, but are not limited to, the following
risks:
o each of our business lines is highly sensitive to declining prices;
o competition in our core businesses could substantially reduce our
revenues and our profits;
o our revenues and profits will not increase if we are unable to
continue to expand our telecommunications business;
o our expenses will fluctuate substantially if we expand our network at
a rate that is faster or slower than the growth of our
telecommunications traffic;
o our operations will be impaired if we are unable to obtain the
products and services of the telecommunications companies that we are
dependent upon, or if such products or services are impaired or
disrupted by terrorist attack or natural disaster;
o termination of our carrier agreements with foreign partners or our
inability to enter into carrier agreements in the future could
materially and adversely affect our ability to compete in foreign
countries;
o our revenues and our growth will suffer if our retailers and sales
representatives fail to effectively market and distribute our products
and services;
o rapid technological change and frequent new product introductions in
our markets could render our products and services obsolete;
o our growth may be limited if we cannot effectively manage our
international operations;
o continuing impact on the New York area or overall U.S. economy
stemming from the September 11 terror attacks could have an adverse
effect upon our business;
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o unexpected fluctuations in the relative values of foreign currencies
against the U.S. Dollar could have a materially adverse impact on our
gross margin performance;
o our profitability will be impaired if we experience difficulties in
collecting our receivables;
o we will not be profitable if we do not receive attractive rates from
other carriers for our long distance traffic;
o federal, state and local excise taxes, and international government
regulation may reduce our ability to provide services, or make our
business less profitable and we may become subject to increased costs
of operations due to uncertainty over the amount of payphone
surcharges and Federal Universal Service Fund obligations;
o we may become subject to increased price competition from other
carriers due to federal regulatory changes in determining
international settlement rates;
o European regulation of telecommunications services may not continue to
evolve towards streamlined regulation;
o telecommunications regulations of other countries may restrict our
operations;
o we may be subject to liability for information disseminated over our
Internet network;
o the infringement or duplication of our proprietary technology could
increase our competition and we could incur substantial costs in
defending or pursuing any claims relating to proprietary rights;
o network construction or upgrade delays and system disruptions or
failures could prevent us from providing our services, cause us to
lose customers and adversely affect our business;
o our quarterly operating results are subject to variation, which could
cause us not to meet the expectations of securities analysts, and
should not be relied upon as an accurate indicator of our overall
performance;
o we may infringe on third party intellectual property rights and could
become involved in costly intellectual property litigation;
o if we are unable to attract and retain qualified management and
technical personnel, future quarterly results may be impaired; and
o IDT is controlled by its principal stockholder, which limits the
ability of other stockholders to affect the management of IDT.
The forward-looking statements are made as of the date of this Annual
Report on Form 10-K, and the Company assumes no obligation to update the
forward-looking statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements. Investors should
consult all of the information set forth herein and the other information set
forth from time to time in the Company's Reports filed with the Securities and
Exchange Commission pursuant to the Securities Exchange Act of 1934, including
the Company's reports on Forms 10-Q and 8-K.
IDT Corporation is a leading facilities-based emerging multinational
carrier that provides a broad range of telecommunications services to retail and
wholesale customers worldwide. Though IDT is already an established player in
the telecommunications field, we continue to grow considerably, generating
revenues of $0.7 billion, $1.1 billion and $1.2 billion in Fiscal 1999, Fiscal
2000 and Fiscal 2001, respectively. During Fiscal 2001, we concluded a
restructuring elevating IDT Corporation to a holding company with operations
conducted through two main subsidiaries: IDT Telecom, Inc. and IDT Ventures,
Inc.
IDT's telecommunications services, conducted by our IDT Telecom, Inc.
subsidiary, consists of retail services, including prepaid and rechargeable
calling cards and domestic long distance services, as well as wholesale carrier
services. IDT delivers its telecommunications services over a high-quality
network consisting of over 150 switches in the U.S. and Europe and owned and
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leased capacity on 14 undersea fiber-optic cables, connecting our U.S.
facilities with our international facilities and with the facilities of our
foreign partners in Europe, Latin America and Asia. We monitor our network 24
hours a day, seven days a week through an automated network operations center.
In addition, we obtain transmission capacity from other carriers. We deliver our
international traffic worldwide pursuant to our agreements with U.S.-based
carriers, 19 of the top 25 global carriers, and more than 20 of the companies
that are primarily responsible for providing telecommunications services in
particular countries (commonly referred to as "Post, Telephone and Telegraphs,"
or "PTTs").
IDT offers retail long distance services to over 300,000 individual and
business customers in the U.S. and worldwide. In addition, as of October 1,
2001, we had approximately 185 wholesale customers located in the U.S. and
Europe. Minutes of use for our telecommunications business have grown from 2.8
billion minutes in Fiscal 1999 to 4.3 billion minutes in Fiscal 2000 to 7.0
billion minutes in Fiscal 2001.
We plan to further expand our global telecommunications network
infrastructure, in order to allow us to route a greater percentage of our
international long distance traffic over owned lines. Routing calls over owned
lines, rather than leased lines, will help us reduce our operating costs, ensure
the quality of our service and expand our customer base. However, we follow a
disciplined, incremental approach to expanding our network, adding new
facilities only when we determine that such investments are justified by traffic
volumes. Under this "smart build" approach, IDT enters new markets by leasing
fiber capacity. As traffic grows, we may install a switch to increase overall
capacity. As traffic increases further, we typically invest in bandwidth to
realize cost savings from routing calls over an owned network. If volume
continues to grow, we may deploy additional switching and/or fiber capacity. IDT
installed and/or upgraded company-owned switches in Newark and Piscataway, New
Jersey and in London, England in Fiscal 2001. We plan to further upgrade
facilities in Newark and Piscataway, New Jersey and in London, England by the
end of Fiscal 2002, and to continue to pursue operating agreements with foreign
carriers in order to terminate traffic directly at favorable rates.
History
The Company was founded in August 1990 and was originally incorporated in
New York as "International Discount Telecommunications Corp." Our company was
renamed IDT Corporation and reincorporated in Delaware in December 1995. Our
main offices are located at 520 Broad Street, Newark, New Jersey 07102; our
headquarters telephone number is (973) 438-1000. IDT's Internet address is
www.idt.net.
IDT entered the telecommunications business by introducing its
international call reorigination service in 1990 to capitalize on the
opportunity created by the large spread between U.S. and foreign-originated
international long distance telephone rates. Long distance calling costs in
certain highly regulated international markets are often prohibitive. Our call
reorigination service enables customers to access a U.S. dial tone from overseas
and place international calls that are reoriginated in the U.S. The customer
benefits from more favorable U.S. outbound long distance rates and superior
transmission quality. We used the calling volume and expertise derived from our
call reorigination business to enter the domestic long distance business in late
1993 by reselling long distance services of other carriers to our domestic
customers. As a value-added service for our domestic long distance customers, we
began offering Internet access in early 1994, eventually offering dial-up and
dedicated Internet access to individuals and businesses as stand-alone services.
In 1995, we began reselling to other long distance carriers access to the
favorable telephone rates and special tariffs we receive as a result of the
calling volume generated by our call reorigination customers. We began marketing
prepaid calling cards in January 1997.
IDT entered the Internet telephony market in August 1996 with its
introduction of PC2Phone, the first commercial telephone service to connect
calls between personal computers and telephones over the Internet. We expanded
our Internet telephony offerings in September 1997 with the introduction of
Net2Phone Direct, a service that enables users to make international and
domestic calls over the Internet using standard telephones. In April 1998, we
launched Click2Talk, an Internet telephony product that allows customers to make
calls to the toll-free numbers of e-commerce companies anywhere in the world
using a PC. In August 1998, we introduced Click2CallMe, which allows consumers
visiting e-commerce companies to contact customer sales representatives from the
Web sites of such companies without charge.
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On August 3, 1999, Net2Phone completed an initial public offering of
6,210,000 shares of its Common Stock, yielding $85.3 million in net proceeds. In
December 1999, we sold 2,200,000 Net2Phone shares in connection with Net2Phone's
secondary offering. In August 2000, we completed the sale of 14,900,000 shares
of Net2Phone to AT&T, receiving approximately $1.1 billion in cash proceeds.
On October 23, 2001 IDT entered into an agreement to lead a consortium that
would concentrate ownership of approximately 49% (60% of the voting power) of
Net2Phone. The consortium consists of IDT, Liberty Media, and AT&T, resulting in
significant economic stakes in Net2Phone for all three parties. As part of the
agreement, IDT and AT&T contributed their shares of Net2Phone (approximately
10.0 million and 18.9 million shares, respectively) to a newly formed LLC.
Liberty then acquired a substantial portion of the LLC's units from AT&T, while
IDT increased its stake and AT&T retained a significant interest. The LLC now
holds an aggregate of 28.9 million shares of Net2Phone's Class A Common Stock.
IDT will be the managing member of the LLC.
Corporate Reorganization
Subsequent to Fiscal 2001, we completed the corporate reorganization
announced in October 2000 by segregating our assets into separate subsidiaries
and divisions designed to reflect our various businesses and their unique
strategies. Pursuant to the restructuring, all IDT operations are now conducted
principally through two first-tier wholly owned subsidiaries:
(1) IDT Telecom, Inc. IDT Telecom, Inc. ("Telecom"), which serves as a
holding company for the principal telecommunications services of IDT.
(2) IDT Ventures, Inc. IDT Ventures, Inc. ("Ventures"), which will conduct
the new venture related activities of IDT.
On the Telecom side, IDT Domestic Telecom, Inc. ("Domestic Telecom"), a
newly formed, wholly-owned, domestic subsidiary of Telecom, holds a federal
telecommunications carrier license and will conduct the telecommunications
business of IDT as an operating corporation. Domestic Telecom is the company
that engages in the provision of international wholesale services to other
telecommunications companies through the sale of telecommunications services as
a carrier's carrier, and also provides international long-distance services and
domestic long-distance services to individuals and businesses.
As a further key element to our restructuring, we formed IDT Telecom, LLC
("Telecom LLC"), a Delaware limited liability company. Telecom LLC also holds a
federal telecommunications carrier license, and conducts the procurement
function of IDT by purchasing wholesale carrier services in the
telecommunications market. Telecom LLC now enters into contracts with
third-party carriers for the provision of telecommunications services.
Additionally, we have formed IDT International Telecom, Inc.,
("International Telecom") a wholly-owned subsidiary of Telecom, incorporated
under the laws of the State of Delaware, in order to perform a portion of our
international telecommunications services.
On the Ventures side, we expect the corporate structure to be more fluid
and flexible, as we form appropriate corporate entities to embody emerging
business lines. We will discuss the businesses of Telecom and Ventures in
further detail below.
Inherent in the strategic planning of the reorganization was our belief in
the need to: (a) preserve our key competitive advantage in the
telecommunications field by better positioning ourselves to obtain preferential
rates for telecommunications services in the competitive marketplace; and (b)
better position ourselves on the Ventures side to take advantage of new market
opportunities.
We believe that the reorganization may result in several benefits to IDT
and its shareholders. These advantages include:
o Isolating various functions within the telecommunications operations
to allow us to more readily assess operating efficiencies and
streamline our operations
o Shifting responsibilities of various teams and working groups in
isolated functions as necessary to allow each group to attain maximum
performance through a defined focus
o Giving us greater flexibility in managing and financing new and
existing business ventures
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o Giving us greater flexibility to expand in the future through
acquisitions of companies that may be strategically advantageous to
our long-term growth
o Facilitating payment structures for the purchase of services that will
allow us to benefit from leveraging our cash pool to achieve more
favorable pricing.
o Enhancing the operational efficiency and overall autonomy of our newly
formed divisions.
IDT Telecom
IDT's Telecom division provides competitively priced retail and wholesale
telecommunications services to customers around the world. Services offered
include prepaid and rechargeable calling cards, domestic long distance services,
and wholesale carrier services. Our telecom division seeks to take advantage of
numerous market opportunities -- presented by an ever-evolving worldwide
telecommunications industry -- to profitably grow its business.
The International Long Distance Market
International switched long distance services are provided through
switching and transmission facilities that automatically route calls to circuits
based upon a predetermined set of routing criteria. In the U.S., an
international long distance call typically originates on a local exchange
carrier's network and is switched to the caller's domestic long distance
carrier. The domestic long distance provider then carries the call to its own or
to another carrier's international gateway switch. From there it is carried to a
corresponding gateway switch operated in the country of destination by the
dominant carrier of that country and then is routed to the party being called
through that country's domestic telephone network.
International long distance providers can generally be categorized by the
extent of their ownership and use of switches and transmission facilities. The
largest U.S. carriers, AT&T, WorldCom, Inc. and Sprint Corporation primarily
utilize owned U.S. transmission facilities and tend to use other international
long distance providers to reach niche markets where they do not own a network,
to take advantage of lower prices, and to carry their overflow traffic. Since no
single carrier has transmission facilities that cover each of the more than 200
countries to which major long distance providers offer service, a significantly
larger group of long distance providers has emerged, which own and operate their
own switches but either rely solely on resale agreements with other long
distance carriers to terminate traffic or use a combination of resale agreements
and leased or owned facilities in order to terminate their traffic.
The long distance market today differs greatly from the market landscape of
a mere 18 months ago. Three factors have combined to reshape the international
long distance market: 1) the liquidation of many of the most aggressive,
cut-rate small and medium-sized players in the telecommunications industry; 2)
the downturn in the stock market that has sapped investor patience for
long-term, heavily financed infrastructure plans favored by some of the largest
carriers; and 3) the increasingly aggressive attempts by the Regional Bell
Operating Companies ("RBOCs" or "Baby Bells") to penetrate the long distance
market.
One: Demise of the emerging multinational carriers. For several years, a
cycle of steep rate cutting was fueled by new entrants in the telecommunications
market. Equipped with limited capitalization and customer base, these emerging
companies immediately charted a risky course: selling cut-rate
telecommunications at cost or at times even below, in the hopes that they could
build a customer base, record revenue (if little profit), and attract further
infusions of capital from the financial markets. Established, well-funded
companies, IDT among them, were forced to match these rates in order to maintain
market share, even if it meant drastically trimming profits on certain routes or
even forfeiting them altogether. Ultimately, however, these companies failed in
implementing this business model. The course from low rates to significant
revenue to financial viability proved too much for most of the companies that
braved it. Numerous cut-rate switched service arbitrageurs have folded in the
last year. In IDT's class of seven "emerging multinational carriers," only IDT
remains. This has already resulted in the end of the rate wars and even some
stabilization of domestic long distance rates. At this time, only a limited
number of carriers remain - and IDT stands out from the field as one of the
lowest-cost providers, bearing a strong record of proven stability and little
risk of short-term financial difficulties.
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Two: Ebbing investor patience with long-term, debt-financed build-outs. In
the wake of "dotcoms" with incendiary burn rates and only nebulous forecasts of
profits in the distant future, it appears that the market has grown intolerant
of nearly any plan with a number of years of heavy investment to be followed
only later by returns. This holds true even for the most well-established,
well-financed of companies, those that have already proven their long-term
viability and reliability. This change in attitude among investors caught
several large telecoms off guard - telecoms that were already in the process of
piecing together cable, internet, local and long distance "one-stop" portfolios
of telecommunications and media services. Having already spent billions of
dollars on acquiring and upgrading component pieces of this portfolio, these
telecoms find themselves suddenly faced with a market which is unwilling to
grant them the additional five years and ten billion dollars it will take to
fully complete their integration strategy. Faced with extreme pressure to cut
debt, these large telecoms have abandoned their integration plans, often
splitting the company along business lines. Consumer long distance, viewed by
many such companies as the weakest link, often ranks lowest on their scale of
priorities, allowing IDT ample opportunity to pick up additional business. The
general trend of economizing in these companies works to IDT's benefit as IDT
least-cost routing is increasingly sought by these companies in order to control
costs. Moreover, IDT has come to serve as a model for these larger companies for
mobility and low-cost infrastructure build-outs.
Three: The relentless march of the Baby Bells. While their competitors are
flooded with debt overruns and issues of integration and restructuring, the Baby
Bells have taken advantage of a relaxed regulatory scheme to make a grab at a
significant slice of the long distance market. Since 1996, the FCC has allowed
Baby Bells to provide long distance as well as local telephone service if they
can successfully establish that they have opened up their local footprint to
competition. Currently, Baby Bells in several regions are engaged in an all-out
assault against the traditional long-distance providers. This too is a positive
development for IDT, since the RBOCs, lacking the international network
possessed by most existing long distance providers, can be expected to rely more
heavily on carrier's carriers to terminate international telephone traffic. As a
premier carrier's carrier, IDT stands to benefit from incursions by the RBOCs
into the long distance market.
Telecommunications Market Opportunities
The international communications industry is undergoing a period of rapid
technological and regulatory changes that have resulted in several market
opportunities for emerging telecommunications services providers, such as IDT.
Recent years have witnessed rapid growth in the usage of international
telecommunications services, the proliferation of carriers providing such
services, a shift towards deregulation in many of the world's major
telecommunications markets and the development of new technologies.
According to industry sources, in 1999, the international long distance
telecommunications industry accounted for approximately 108 billion minutes of
use, an increase of 15% from 93 billion minutes of use in 1998. Industry sources
have estimated that by 2003 this market may approach 190 billion in revenues,
representing compound annual growth rates from 1999 of approximately 15%.
We believe that growth in international long distance services is being
driven by:
o the globalization of the world's economies and the worldwide trend
toward deregulation of the telecommunications sector
o declining prices arising from increased competition generated by
privatization and deregulation
o increased worldwide telephone density in both traditional wireline and
wireless telephones
o the emergence of new technologies, which have resulted in higher
quality and lower costs
o a wider selection of products and services
o the growth in the transmission of data traffic
We anticipate that growth of voice and data traffic originated in markets
outside the U.S. will be higher than growth in voice and data traffic originated
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within the U.S. due to recent deregulation in many foreign markets, relative
long-term economic growth rates and increasing access to telecommunications
facilities in emerging markets.
Deregulation and Competition
Consumer demand and competitive initiatives have acted as catalysts for
government deregulation, especially in developed countries. Significant
legislation and agreements have been adopted since the beginning of 1996 which
are expected to lead to increased liberalization of the majority of the world's
telecommunication markets, including:
o the U.S. Telecommunications Act, signed in February 1996, which
establishes parameters for the implementation of full competition in
the U.S. domestic local and long distance markets;
o the European Union's Services Directive, adopted in 1990, which
abolishes exclusive rights for the provision of voice telephony
services throughout the European Union and the public switched
telephone networks of every member country of the European Union by
January 1, 1998, subject to extension by certain European Union member
countries; and
o the WTO Agreement, signed in February 1997, which creates a framework
under which 69 countries have committed to liberalize their
telecommunications laws in order to permit increased competition and,
in most cases, foreign ownership in their telecommunications markets,
beginning in 1998.
We believe that these initiatives, as well as other proposed legislation
and agreements, will provide increased opportunities for emerging competitive
carriers such as IDT to provide telecommunications services in targeted markets.
Deregulation has encouraged competition, which in turn has prompted
carriers to offer a wider selection of services and reduce prices. The
industry's projections for substantially increased international minutes of use
and revenue over both the near term and long term are based in part on the
belief that reduced pricing as a result of deregulation and competition will
result in a substantial increase in the demand for telecommunications services
in most markets. In fact, this price elasticity of demand has already been
witnessed on a large scale worldwide.
The competitive opportunities have affected the deregulated, deregulating
and regulated markets in different ways. In a fully deregulated country, such as
the U.S. or the U.K., carriers can establish switching facilities, own or lease
fiber-optic cable, enter into operating agreements with foreign carriers and,
accordingly, provide direct access service. However, new carrier entrants to a
deregulated market are usually not in a position to build their own
infrastructure. They generally prefer not to purchase services from incumbent
carriers and current competitors, whose incentives are to make the entrants'
access as restrictive and expensive as possible. These circumstances create a
demand for a carrier's carrier - a firm that is capable of constructing its own
long distance network with a primary focus on serving other companies who market
their services directly to consumers. A carrier's carrier builds an
international telecommunications network to serve entrants in the retail market
and often offers rates that are much lower than the incumbent carrier offers to
entrants.
In markets that have not been deregulated, or are slow in implementing
deregulation, there are typically two or three competing carriers, including the
national monopoly. In such markets, a carrier's carrier will sell minutes to,
and buy minutes from, the competitive carriers, who seek minutes volume as well
as lower costs in order to enable them to compete. In addition, the carrier's
carrier will also continue to offer similar services to the national monopoly.
In markets that are fully regulated, such as various countries in the
Middle East, Asia and Africa, the regulated telephone monopoly or incumbent
carrier sets prices based on the accounting rate system, a framework for
originating, carrying and terminating calls that has been in place since just
after World War II. Within each country, the regulatory authority negotiates
rates with a foreign PTT. These accounting rates tend to be artificially
inflated, with no relation to the actual costs of carrying traffic. However,
even monopolists providing services in closed markets find that operating their
own network is unduly expensive, and given the low prices available relative to
those offered in their bilateral agreements, the most cost effective solution in
many situations is to employ a carrier's carrier. Unlike the monopolist, the
carrier's carrier can fill its network with calls originating in many countries
without being bound by accounting rates.
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Teledensity
A major trend in the worldwide telecommunications industry in recent years
has been increased teledensity, or the measure of telephone lines per units of
population. Teledensity rates vary widely across different regions and
countries, with a relatively strong relationship between a country's per capita
income and its teledensity, as richer countries tend to have higher teledensity
rates than do their poorer counterparts.
However, it appears as though the "teledensity gap" may be narrowing. Many
governments of developing nations have begun to view increased teledensity as a
potential driver for economic growth, and have been focusing on improving
telephone line penetration in their countries. As a result, teledensity rates
around the world have been rising, and are expected to continue to increase over
the foreseeable future. As more people around the world gain access to
telephones, international long distance minutes will increase.
Focus on Latin America and the former Soviet Union.
IDT believes that it is well positioned to benefit from the anticipated
improvements in teledensity rates in areas such as Africa and Asia as a whole,
but particularly in the former Soviet Union and in Latin America. Our prepaid
calling cards are marketed primarily to the ethnic, immigrant communities in the
U.S., Europe and Latin America; and a large portion of our customers hail from
the Hispanic community. Therefore, a significant proportion of our international
debit card minutes go to Latin America, as U.S. Latinos call their friends and
families in their native countries. Yet IDT believes that there is significant
untapped market for prepaid calling cards in Latin America itself, where certain
countries serve as a regional nexus, attracting immigrants due to stronger job
markets and opportunities, just as the United States does. Immigrants from
satellite countries share the needs of their U.S. counterparts for low-cost,
prepaid calling solutions to maintain contact with close-knit family units in
their countries of origin. In Fiscal 2002, IDT intends to establish beachheads
in prepaid calling card distribution in South America and certain areas of
Central America.
In the former Soviet Union, IDT expects to see considerable leaps in
teledensity with increased privatization and development of the
telecommunications and personal electronics industries. In Fiscal 2002, IDT will
focus on the development of its Russian operations through ventures with or
acquisitions of Russian companies, hoping to profit from the growth of Russian
telecommunications.
New Technologies
New technologies, including the development of next-generation fiber-optic
cable and improvements in digital compression, have improved quality and
increased transmission capacities and speed, with transmission costs decreasing
as a result. "Softswitches," first widely used in 2000, enable carriers to run
voice and data services over the same network at significantly reduced cost;
they increasingly facilitate new service offerings in the industry. In addition,
the growth of the Internet as a communications medium, and advances in packet
switching technology and Internet telephony, are expected to have an increasing
impact on the international telecommunications market.
Advances in technology have created a variety of ways for
telecommunications carriers to provide customer access to their networks and
services. These include customer-paid local access, international and domestic
toll-free access, direct digital access through dedicated lines, equal access
through automated routing from the public switched telephone network and
Internet telephony. The type of access offered depends on the proximity of
switching facilities to the customer, the needs of the customer and the
regulatory environment in which the carrier competes. Overall, these advances
have resulted in a trend towards bypassing traditional international long
distance agreements between national monopolies and the proliferation of voice
and data service providers.
Furthermore, technological advancements have allowed the use of "packet
switching" technology for the transmission of voice telecommunications traffic,
enabling a substantial increase in network efficiency, as well as the use of the
Internet for voice communications. Traditional international long distance calls
use a technology called "circuit switching," which carries the calls over
international voice telephone networks. Circuit switching requires a dedicated
connection between the caller and the recipient that must stay open for the
duration of the call. On the other hand, packet switching technology breaks
voice and fax calls into separate data packets, sends them over the Internet,
then reassembles them in their original form for delivery to the recipient. This
technology allows data packets representing multiple conversations to be carried
over the same line, and is therefore inherently more efficient than is circuit
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switching technology. In addition, the use of the Internet as a voice
communications medium provides significant reductions in the cost of
transmitting traffic, while bypassing the cumbersome and expensive settlement
process traditional in international voice communications. The development of
voice applications for the Internet is part of a larger trend of convergence of
standard voice and data networks. Internet telephony services are expected to be
one of the fastest growth segments in the telecommunications industry.
Increasing Importance of Data Services
As the world continues to transition to information-based economies, and
the telecommunications and Internet industries continue to converge, the
transmission of data will take on a more important role in the business of
telecommunications carriers such as IDT. Although we believe that transmission
of "voice minutes" will continue to increase, we anticipate that more of our
business in the future will involve the transmission of "data minutes."
Currently, data is the major driver behind the industry's projections of future
demand, and the basis for the enormous amount of bandwidth that is being
installed around the globe. This increased demand for data services is being
fueled by several factors, including:
o Increasing use of the Internet and corporate Intranets
o Continued personal computer penetration
o The emergence, and rapid acceptance, of e-commerce as a substitute for
more traditional transactions
o Growing demand for other Internet-related services, such as web
hosting
As with the voice minutes market, we believe that the growth in the data
services market will be greater overseas than in the U.S., owing to the
significantly lower relative levels of Internet use, PC penetration and
corporate Intranet and web hosting activities outside the U.S. This indicates
greater potential upside in these international markets.
The growth in data transmission presents us with opportunities to both
expand our business with our existing customers, and to reach a new customer
base. We will be able to add a data element to the services we currently provide
our existing telecommunications customers, offering services such as Internet
telephony, remote Internet access, web-hosting, and co-location and data center
services. We will also be able to offer services to a broad, new customer base
for IDT, including Internet Service Providers (ISPs) and Application Service
Providers, as we carry their data minutes over our network.
A Word about Bandwidth
Currently, the telecommunications industry in its broadest sense -
professionals, analysts and journalists - is embroiled in a debate about future
demand for bandwidth capacity. One side of the debate sounds the cautionary note
that the industry has already been flooded with more bandwidth than it will ever
be able to use. The other side asserts that increasingly sophisticated
applications will generate ever-growing bandwidth demand among end users, and
that as the global community gets plugged in and wired up, the copious bandwidth
currently available will fall far short of satisfying demand.
We believe that there are elements of truth to both arguments. Innovative
new technologies provide multiples of existing bandwidth at reduced rates.
Optical wavelength services amplify existing transmission capacity by creating
multiple wavelengths on a single strand of fiber. By making use of different
light frequencies within a cable, Dense Wavelength Division Multiplexing, or
DWDM, can increase the capacity of a single strand of fiber by a multiple of
160. DWDM also alters the economics of increasing capacity along existing
routes. Rather than requiring the deployment of additional cables to augment
saturated routes, suppliers can increase system capacity using DWDM simply by
adding equipment to transmit on additional wavelengths at a fraction of the cost
of laying new cable.
Yet traffic demands continue to grow as well. While international voice
traffic has grown an average of less than 20% a year over the last five years,
data growth has been far more dramatic. The wildcard, however, remains public
Internet traffic, which probably constitutes the largest component of growth in
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bandwidth demand but may be the most difficult to accurately track. We believe,
however, that transoceanic submarine cable capacity, which grew 100% in 1998 and
a little over 175% in 1999, is well-poised to keep up with traffic demand -
growth projections for 2000 have it increasing 750%, followed by 140% growth in
2001.
Chalkboard mathematics can be misleading when divorced from the real world,
and in the real world, bandwidth growth has not blanketed the globe in an even
fashion. Communications conduits employed in a geographic locale may limit the
bandwidth available: satellite technologies lag behind fiber-optic advances, and
submarine cable is subject to certain logistical constraints that terrestrial
fiber is not bound by. Additionally, the degree of market freedom in any given
nation or region will determine the number of competitors vying to own fiber
capacity, and will thus by extension determine overall fiber volume. At present,
therefore, bandwidth capacity in the open markets of Europe and North America
continues to grow far more rapidly than in the more restrictive markets of Asia
and Latin America, where government monopolies still hold sway.
In the real world, then, some regions will experience bandwidth glut; in
others, bandwidth will continue to be in relatively short supply. We therefore
expect to see steady price reduction in some parts of the world, while bandwidth
prices in other regions will remain near their current levels. We have tailored
our own strategies to our analysis of the world bandwidth market. We are wary of
long-term, high-price leases on routes where we believe capacity overabundance
will cause prices to continue falling; and we have avoided the trap of premature
and inflated purchases of excess capacity. Finally, we have eschewed marking
bandwidth prices to bandwidth exchange quotes. While sellers have flocked to
these exchanges, appearances by buyers are rare. The prices generated by these
exchanges therefore tend to represent sellers' offers rather than actual prices
paid by buyers, and may be over-inflated.
We feel fortunate to have addressed the bulk of our own intercontinental
bandwidth needs for the foreseeable future with little capital outlay. Our IRUs
on Tycom's trans-Atlantic and trans-Pacific bandwidth promise to satisfy a
significant portion of our international capacity requirements well into the
future. We believe that as Asia and Latin America open themselves to further
free market competition, we will see build-outs of bandwidth capacity in those
regions, and we plan to avail ourselves of the attendant opportunities.
The IDT Approach
IDT's background as a leading alternative provider of retail and wholesale
international telecommunications services, combined with its experience as a
domestic Internet service provider and its leadership role in the field of
Internet telephony, position it to capitalize on the various opportunities
presented by today's telecommunications industry. Our objective is to enhance
our current position as a leading facilities-based provider of high-quality,
low-cost telecommunications services to retail and wholesale customers in both
the U.S. and abroad. The following goals represent key elements of our strategy:
Focus on International Telecommunications. We believe that the
international long distance market provides attractive opportunities due to its
higher revenue and gross profit per minute, and higher projected growth rate
compared to the domestic long distance market. We target international markets
with high volumes of traffic, relatively high per-minute rates and favorable
prospects for deregulation and privatization. We believe that the ongoing trend
toward deregulation and privatization, coupled with the increasing capture of
the long distance market by RBOCs more heavily reliant on carrier's carriers
such as IDT, will create new opportunities for us to increase our revenues and
to reduce our termination costs, while maintaining balanced growth in retail and
wholesale traffic.
Expand Switching and Transmission Facilities. We are continuing to expand
and enhance our network facilities by investing in switching and transmission
facilities where traffic volumes justify such investments. During Fiscal 2002 we
intend to invest in:
o Expansion of our debit card platform
o Long haul and local loop fiber capacity within the U.S. and Europe
o Gateway switches and facilities in the U.S., the U.K., and other
European countries
o Additional network compression equipment.
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We believe that these investments will allow us to broaden the scope of our
telecommunications activities and to reduce the cost of our services, while
maintaining our high service quality.
Expand Service Offerings and Marketing Activities. We intend to continue to
develop value-added services and to market them on a retail and wholesale basis
in order to increase margins, optimize network utilization and improve customer
loyalty. Within our retail division, we intend to significantly expand our
marketing of our consumer long distance and prepaid calling products;
additionally, we will identify and target new markets for our prepaid calling
cards. We will continue to seek profitable niches within the telecommunications
markets, adding higher-margin retail businesses, such as residential long
distance, to our existing sales mix. Additionally, our wholesale business will
attempt to offer a more complete suite of value-added carrier services to both
its existing customer base and to new customers. We intend to build out our
product offerings to our traditional customer base through vehicles which may
include joint ventures with other service providers.
Pursue Strategic Alliances and International Agreements. We intend to
capitalize on our strategic alliances and other relationships with U.S. and
foreign companies in order to expand our customer base. We have traditionally
been able to capitalize on our significant traffic volume and technological
expertise to negotiate favorable termination agreements with international
carriers. We intend to continue to seek new termination relationships with
established and emerging carriers to reduce our termination costs for
traditional international voice telephony, and we continue to use our
relationship with Net2Phone for additional low cost termination. To date, we
have entered into approximately 65 agreements with carriers that provide for the
favorably priced termination of its calls worldwide.
Telecommunications Services
IDT provides its retail and wholesale customers with integrated and
competitively priced international and domestic telecommunications services. Our
four primary telecommunications services are: prepaid calling cards, domestic
long distance services in the U.S., and wholesale carrier services. We generated
revenues from our telecommunications business of approximately $1.2 billion
during Fiscal 2001, an increase over our $1.0 billion of revenue during Fiscal
2000. Telecommunications revenues represented 97.9% of IDT's total consolidated
revenues in Fiscal 2001, as compared to 93.5% in Fiscal 2000.
Retail Telecommunications
Prepaid Calling Cards
We sell prepaid debit and rechargeable calling cards providing access to
more than 230 countries and territories. Our rates are significantly lower than
the rates for international calls that are charged by the major facilities-based
carriers. We market debit cards primarily to ethnic communities in the U.S. that
generate high levels of international traffic to specific countries where we
have favorable termination agreements, with a particular emphasis on the U.S.
Hispanic community. Recent immigrants and members of the ethnic communities tend
to be heavy users of international long distance, given their desire to keep in
touch with family members and friends back home. Our business is particularly
strong in the Northeastern U.S., aided by our extensive distribution network and
attractive rates to areas such as Colombia, Mexico and the Dominican Republic.
Approximately 50% of our U.S. debit card sales are from the New York-New
Jersey-Connecticut (Tri-State) area. We have also been rapidly expanding our
operations in California, Florida, Georgia, Texas and other parts of the U.S.
Outside the U.S., we market our calling cards in the U.K., the Netherlands,
Spain, Germany, Belgium and parts of Scandinavia, seeking to capitalize on the
opportunity presented by the recent surge in immigration from under-developed
countries around the globe to Europe's developed nations. We have also recently
begun to sell cards in Latin America, with plans to ramp-up sales of calling
cards in Argentina, Chile and Peru during Fiscal 2002. We sold over 100,000,000
prepaid calling cards during Fiscal 2001. During Fiscal 2001, sales of prepaid
calling cards accounted for 61.3% of IDT's total consolidated revenues.
Focus Point: Rise of the Hispanic Consumer. Given IDT's strong customer
base in the Hispanic community, we believe that the trends depicted in the 2000
census portend a steadily increasing revenue stream for our prepaid debit cards.
According the 2000 United States Census, the population of U.S. Hispanics rose
to 35.3 million, a 61 percent increase during the past ten years. As we value
America's Latinos as loyal customers, and since so many of our debit card
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products cater to their needs, we believe the continued growth of the Hispanic
community will further buoy sales of our prepaid calling cards.
We offer both IDT-branded and non-IDT-branded prepaid calling cards, with
favorable rates to specific areas of the world. The cards are sold in several
different dollar denominations, most commonly $5, $10 and $20. The table below
lists some of the major IDT phone cards that we sell:
Asimon Florida Exclusive New York Alliance
Blackstone America Florida Friends New York Exclusive
California Exclusive Georgia Exclusive Pennsylvania Exclusive
Carribean Friend Illinois Exclusive Pepe Colombianita
Carolina Exclusive Kababayan Pepe Megatel
Centro Americard Long Island Exclusive Puerto Rico Exclusive
China Card Mass Exclusive Rhode Island Exclusive
Colombianita Card Massachusetts Talk South Seas
Connecticut Exclusive Mega Mexico Tele Talk
Cumbia Megatel Texas Exclusive
Dominicall Megatel Vending Union Phone Card
Eastern European Metropolis Union Phone Vending
Easy Pass IDT Merengue Vending Exclusive
Easytalk LA Michigan Exclusive Virtual Internet Card
Easy Talk NJ New Jersey Alliance Washington Alliance
New Jersey Exclusive Washington Exclusive
Our rechargeable cards, distributed primarily through in-flight magazines,
permit users to place calls from over 40 countries through international
toll-free services.
Our retail customers can use our calling cards at a touch tone telephone by
dialing an access number, followed by a personal identification number (a "PIN")
assigned to each prepaid calling card and the telephone number the customer
seeks to reach. Our switch completes the call, and our debit card platform
reduces the outstanding balance of the card during the call. We offer prepaid
calling cards that can be used to access our network by dialing a toll-free
number or, in specific metropolitan markets, local area calling cards that only
require a local call. We believe that many of our customers typically use our
calling cards as their primary means of making long distance calls due to
attractive rates, reliable service, the ease of monitoring and budgeting their
long distance spending and the appealing variety of calling cards we offer to
different market segments.
In Fiscal 2001, IDT purchased PT-1 Communications, Inc. debit card
business, including all trade names and intellectual property. This key purchase
served to greatly increase IDT's revenue from its debit card business,
establishing IDT as the largest seller of prepaid calling cards in the United
States. IDT hopes to continue to expand its prepaid calling card sales and
distribution networks, identifying markets which it has yet to penetrate.
IDT also markets private label calling cards, often used as lucrative
promotional items or utilized by corporate customers to help generate brand name
awareness. In Fiscal 2002, we will increase our efforts to market private label
cards, with an intense focus on department store chains and franchises.
Competitive Advantages
We believe that we possess the following advantages over our competition in
the prepaid calling card industry:
o Our status as a carrier's carrier allows us to offer calling time over
more routes to the countries that are in demand in the retail
marketplace, at attractive prices.
o Our debit platform, which we believe to be among the most advanced in
the industry, enables us to process a large number of cards
simultaneously and to provide multi-lingual and multi-currency cards.
o Our expertise, market savvy and distribution channel, which covers
over 300,000 retail outlets worldwide.
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o Our understanding of, and commitment to, the ethnic prepaid calling
card market.
o We are able to provide low rates and at the same time maintain our
margins by taking a disciplined approach to advertising and because we
enjoy low overhead and low headcount. We believe that as our carrier
business builds out its network, our prepaid business' cost per minute
will decline, helping margins.
Domestic Long Distance Services
IDT markets certain long distance services directly to retail customers in
the U.S. Introduced in February 2000, our calling plan features a flat rate of
five cents per minute for all state-to-state calls within the continental United
States, 24 hours a day, seven days a week. We also offer a free IDT Calling
Card, with no monthly fees or per-call surcharges, featuring a domestic rate of
ten cents per minute. Our rates for international calls are also extremely
competitive, well below those charged by the major facilities-based carriers.
During Fiscal 2001, we continued aggressively marketing our domestic long
distance services by expanding the existing TV ad campaign to additional markets
and introducing new marketing channels, including print advertisements, direct
mail, online advertising and partnerships.
As of October 1, 2001, we had over 300,000 active domestic long distance
customers. Domestic long distance services accounted for 4.6% of our total
consolidated revenues in Fiscal 2001. As we continue to make significant
expenditures to market this service, resulting in customer growth, we anticipate
that domestic long distance services will begin to account for an increasing
proportion of our total revenues in future periods.
Wholesale Carrier Services
We sell our wholesale carrier services to other U.S. and international
carriers, utilizing flexible and least-cost traffic routing and based on our
expertise in navigating the complex accounting rate system. In this way, we act
as a "carrier's carrier," providing major carriers and niche players alike with
rates that are much lower than those traditionally available through the more
established carriers. We are able to offer competitive rates to our carrier
customers as a result of our extensive relationships in the long distance
telecommunications industry, our ability to generate a high volume of long
distance call traffic and the advantageous rates negotiated with foreign PTTs
and competitive carriers. As of October 1, 2001, we had approximately 185
wholesale customers located in the U.S. and Europe, with wholesale carrier sales
representing 31.5% of IDT's total consolidated revenues in Fiscal 2001.
As anticipated, although perhaps at a faster rate than foreseen, price
declines in the industry combined with the overall reduction of investment
capital in the market have combined to push less efficient operators out of the
market. This has in turn led to some measure of price stabilization, resulting
in increased revenue per minute on certain routes and reduced margin pressure.
We anticipate that IDT, among other financially sound market players, will gain
some market share as weaker companies continue to dissolve. Additionally, as the
RBOCs increase their market share in the long distance market at the expense of
traditional long distance service providers, we expect to gain revenue due to
the RBOCs' current dependence on the global infrastructure of carrier's carriers
such as IDT for the termination of their international voice traffic.
Capitalizing on Strengths
In the coming fiscal year, we intend to capitalize on some of our inherent
strengths in order to tailor an increasingly strong, global company:
o Our strong existing relationships with national monopolies and other
leading carriers will, we believe, continue to allow us to negotiate
advantageous rates.
o Our prepaid card business, which generates a high volume of original
long distance call traffic, will continue to prove attractive to PTTs,
as we "create" new streams of traffic and direct it to the PTT, as
opposed to simply transferring minutes from another carrier with whom
the PTT is already allied.
o The superior switching, routing and customer service technology
supporting our backbone network will continue to provide us with
better cost analysis, customer service, and strict quality controls.
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o We will continue to distinguish ourselves from purely wholesale
competitors through our ability to offer "value-added carrier
services," such as giving carriers remote access to our debit card
platform. This enables us to offer additional "turnkey" capabilities
to carrier customers and positions us as a "total outsourcing
provider" of carrier services.
o We hope to maintain our "mobility advantage" in rapidly reacting to
changing price environments, identifying and capitalizing on
attractive rates more quickly than have our competitors.
o Our highly specialized analysis team composed of well-trained
telecommunications professionals continually monitoring volume data
will allow us to maintain maximum system efficiency, enabling us to
run our switches and lines at a higher volume than that maintained by
other telecommunications companies.
o Our constant attention to cost control, efficiency and the maintenance
of lower general overhead expenses will continue to ensure that we
waste few corporate resources, delivering value to partners,
customers, and shareholder alike.
These factors will advance our long-term goal: emergence as a multi-faceted
service provider offering a portfolio of services to the most financially stable
market participants through long-term contractual relationships. In order to
reach this goal, we intend to employ these tactics in Fiscal 2002:
o Broadening our portfolio of products and services offered to our
carrier partners.
o Cultivating relationships with the top global carriers.
o Continual evaluation of financial stability of weaker wholesale
customers, and cautious management of our financial exposure to such
customers, in order to safeguard against nonpayment of outstanding
receivables.
o Generating significant incentives, such as volume commitments and
price incentives, for global carriers to enter into long-term
contracts with mutual commitments.
Wholesale Carrier Strategies
We have strategies tailored to different markets: regulated markets,
deregulated markets and markets that are currently deregulating.
In deregulated countries, we offer new market entrants, who are generally
not in the position to build their own infrastructure, carrier services at rates
that are typically lower than the incumbent carrier is offering. In such
countries, we also establish and expand our arbitrage operations by taking
advantage of the competitive environment to buy minutes at a lower rate and then
sell them at a higher rate. In markets that are fully regulated, our strategy is
to establish a relationship with the national monopoly and enter into agreements
to carry and terminate its minutes. We can typically offer the national
monopolies lower prices than those offered in their existing bilateral
agreements. In markets that are undergoing the deregulation process, there are
typically two or three competing carriers, including the national monopoly. In
these markets, our strategy involves selling minutes to, and buying minutes
from, the competitive carriers, who seek minutes volume as well as lower costs
in order to compete. We also continue to offer similar services to the national
monopoly.
These different strategies, for the three types of markets, are part of our
overall strategy for the deregulating world. As a country moves from regulated
to fully deregulated status, our strategy for that country shifts to take
advantage of the opportunities presented at any given time. By first entering a
market when it is regulated and establishing relationships with the national
monopoly, we obtain early entrant status, which prepares us to compete more
effectively as the market deregulates. By the time the market opens for
competition, we have acquired a thorough knowledge of the market (in terms of
potential minutes generated, most frequently called routes, culture, etc.),
which we believe is a competitive advantage for both our retail and wholesale
carrier operations.
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Sales, Marketing and Distribution
We primarily market our international telecommunications services through
our direct wholesale carrier services sales staff. The staff benefits from (i)
IDT's extensive relationships and premier international name and recognition
throughout the long distance industry for marketing its carrier services; (ii)
our substantial traffic volumes, which enable us to negotiate for lower rates;
and (iii) favorable terminating rates negotiated with PTTs and foreign carriers.
We currently market our prepaid debit cards to retail outlets throughout
the U.S. through Union Telecard Alliance, LLC ("Union"), a joint venture company
of which we own 51% of the outstanding equity interests. Union is one of the
largest distributors of prepaid calling cards in the nation, utilizing a network
of over 600 sub-distributors who sell through over 250,000 retail outlets
throughout the United States. As part of our plan to expand our territory beyond
the U.S., we have begun to establish a distribution network in the Dominican
Republic to replicate our calling card distribution network in the United States
in conjunction with Union and other distributors. In May 2000, Union began
distributing prepaid cards in Puerto Rico, and plans to begin distributing cards
in parts of Central and South America during Fiscal 2002, targeting Argentina as
a nexus for immigrant populations from Peru and Chile.
Union has entered into agreements with sub-distributors, located in
Illinois, Florida, New York, Ohio and Texas, whereby the sub-distributors have
agreed to market our prepaid calling cards in exchange for preferential pricing,
exclusive cards, extensions of credit, incentive bonuses and technical support
from us, which is intended to assist each respective sub-distributor in the
growth and development of its business. Our exclusive calling cards will be
marketed by the corresponding partnership in a given state.
In addition to selling IDT's prepaid calling cards, Union sells prepaid
calling cards of other companies. This allows Union to operate as a "one-stop
shop" for the widest possible range of prepaid phone cards, enabling Union to
enhance its sales to the retail outlets it currently serves.
IDT also sells rechargeable calling cards, which are marketed primarily
through in-flight magazines.
We increased our marketing expenditures for our domestic long distance
services in order to continue to position ourselves as the market's lowest-price
provider. The advertising campaign for these services is mostly driven by direct
television advertising in targeted markets. Our goal is to continue spending on
marketing and advertising to build our domestic long distance customer base,
with a primary focus on keeping cost-per-customer acquired at or below our
targeted levels.
Billing and Customer Support
IDT believes that reliable, sophisticated and flexible billing and
information systems are essential to its ability to remain competitive in the
global telecommunications market. Accordingly, we have invested substantial
resources to develop and implement our proprietary management information
systems.
Our billing system enables us to:
o Accurately analyze our network traffic, revenues and margins by
customer and by route on an intra-day basis;
o Validate carrier settlements; and
o Monitor least cost routing of customer traffic.
The entire process is fully automated and increases efficiencies by
reducing the need for monitoring by our employees. We believe that the accuracy
and efficiency of our management information systems provide us with a
significant strategic advantage over other emerging carriers.
We believe that our ability to provide adequate customer support services
is a crucial component of our ability to retain customers. We have successfully
focused on improving such service through a number of measures, including the
15
addition of support personnel and the monitoring of customer waiting time. The
customer support staff provides 24-hour technical assistance in addition to
general service assistance. Customer support personnel communicate with
subscribers via telephone, e-mail and fax. We answer over 30,000 calls per day,
of which roughly half are handled by our automatic Integrated Voice Response
System. The other roughly 15,000 answered calls are handled by our customer
support staff, whose approximately 150 members are required to field a minimum
number of calls and e-mails each day. We set high performance standards and
respect the value of our customers' time: 90% of our calls are answered within
the first 90 seconds, well above industry standards. We utilize sophisticated
"real time" monitoring by a quality control department, which monitors over 600
calls per day. We also employ liaisons between the customer support and
technical staffs to ensure maximum responsiveness to changing customer demands.
Network Infrastructure
We maintain an international telecommunications switching infrastructure
and U.S. domestic network, consisting of owned and leased lines that enable us
to provide an array of telecommunications, Internet access and Internet
telephony services to our customers worldwide. IDT's network is monitored 24
hours a day, seven days a week, 365 days a year by its network operations
center. The entire network is centrally managed from IDT's control center
through the use of a standardized communications protocol. In addition, we use
two proprietary monitoring systems to manage modem pools.
Telecommunications Network
Private Line Network
We operate a growing telephone network consisting of U.S. domestic
dedicated leased fiber-optic and copper lines, and IDT-owned switch equipment in
the U.S. which are interconnected to major PTTs, emerging carriers and domestic
interexchange carriers, local exchange carriers and competitive local exchange
carriers. Our major switching facilities are located in Piscataway, N.J.;
Newark, N.J.; New York, N.Y.; and London, England. These varied locations serve
to provide the network with redundancy and diversity. All of these locations are
linked with the dominant local exchange carrier as well as at least one of the
competitive local exchange carriers, allowing us to interconnect with all major
interexchange carriers to switch traffic via our leased private-line DS3
network. Furthermore, all of our locations are interconnected via leased lines
to enhance network reliability and redundancy as each location interconnects
with the various carriers.
In September 1998, we obtained from Frontier Communications (now a unit of
Global Crossing Ltd.) dedicated DS-1, DS-3, OC-3 and OC-12 circuit capacity in
the U.S. over Frontier's network, connecting more than 120 metropolitan areas
around the nation. These network facilities have enabled us to expand the range
and reliability of our data and voice transmission service, while reducing
network costs. IDT is able to offer nationwide dial-up long distance and
dial-around ("10xxx") services, reduce 800-origination costs and provide for
origination and termination of carrier traffic in all major U.S. cities.
In October 1999, we entered into an agreement with Frontier whereby we
enhanced our ability to provide presubscribed long distance (1+) and dedicated
and toll-free services throughout the United States as well as casual calling
("10xxx") in selected areas of the country.
In October 2000, in settlement of a suit filed by IDT against Tyco Group
S.A.R.L. and Tyco Submarine Systems, Ltd., IDT received certain indefeasible
rights of use ("IRUs") relating to capacity in Tycom Ltd.'s trans-Atlantic and
trans-Pacific undersea fiber-optic networks. Under the terms of the settlement,
IDT received IRUs for two 10 Gb/s wavelengths on both the trans-Atlantic and the
trans-Pacific network for fifteen years, free of charge. IDT is scheduled to
commence the use of the fiber in increments through Spring 2003.
In addition, we own and lease switched services to connect our U.S. and
U.K. facilities. These services are used to originate traffic from IDT's
customer base in the U.K. and to terminate existing carrier and call
reorigination traffic to the U.K. We have about 65 operating and terminating
agreements that provide for the termination of traffic worldwide, and we plan to
obtain leased lines to certain destinations, where it will result in reduced
termination costs.
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Switching Platforms
We utilize two major switching platforms. We use Lucent switches for all
application-based products such as direct dial, call through, prepaid calling
cards, and value-added services such as voice prompts, speed dialing, voice mail
and conferencing. The Lucent switches (such as the LNX) are flexible and
programmable, and are designed to implement network-based intelligence quickly
and efficiently. We currently own and/or lease 151 Lucent switches. The other
platform is the Nortel DMS250-300 and Nortel GSP, which serves as an
international gateway and generic carrier switch. We currently own four Nortel
switches. We plan to upgrade our switching platforms in New Jersey and London
during Fiscal 2002. All of our switches are modular, scaleable and equipped to
signal in such protocols as ISDN or C7/SS7 so as to be compatible with either
domestic or foreign networks.
Software
Our switches work in conjunction with Company-developed proprietary
software platforms to run all of the applications we require to provide
value-added services, as well as billing and traffic analysis. The software
enables the switches to route all calls via our least-cost routing matrix.
Least-cost routing is a process by which we optimize the routing of calls over
the least-cost route on our switches for over 230 countries. In the event that
traffic cannot be handled over the least-cost route due to capacity or network
limitations, the least-cost routing system is designed to transmit the traffic
over the next least-cost route. The least-cost routing system analyzes several
variables that may affect the cost of a long distance call, including different
suppliers, different time zones and multiple choices of terminating carrier in
each country. In some instances, instead of routing a call directly between two
overseas points, the least-cost routing system may backhaul a carrier's minutes
using resold switched services to another of our U.S.-based switches in order to
terminate the traffic in a third country while taking advantage of our
competitive international long distance rates. The least-cost routing system is
continually reviewed in light of rates available from different suppliers to
different countries to determine whether we should add new suppliers to its
switch to further reduce the cost of routing traffic to a specific country and
to maintain redundancy, diversity and quality within the switching network. By
utilizing a least-cost routing system, we are able to minimize our costs, and
offer lower rates to our customers. This is of significant importance when
serving a market that has become increasingly price-sensitive.
Research and Development
We employ a technical staff that is devoted to the improvement and
enhancement of our existing telecommunications and Internet products and
services, including switching technologies and the development of new
technologies and products. We believe that the ability to adjust and improve
existing technology and to develop new technologies in response to, and in
anticipation of, customers' changing demands is necessary to compete in the
rapidly changing telecommunications and Internet industries. There can be no
assurance that we will be able to successfully develop new technologies or
effectively respond to technological changes or new industry standards or
developments on a timely basis, if at all.
Competition
The markets in which we operate are extremely competitive and can be
significantly influenced by the marketing and pricing decisions of the larger
industry participants. The barriers to entry are not insurmountable in any of
the markets in which we compete. We expect competition in these markets to
intensify in the future.
In the prepaid calling card market, we compete with other providers of
prepaid calling cards and with providers of telecommunications services in
general. Many of the largest telecommunications providers, including AT&T,
WorldCom and Sprint, currently market prepaid calling cards, which in certain
cases, compete with the prepaid calling cards we sell. These companies are
substantially larger and have greater financial, technical, engineering,
personnel and marketing resources, longer operating histories, greater name
17
recognition and larger customer bases than does the Company. In marketing
prepaid calling cards to customers outside the U.S. market, we compete with the
large PTTs, such as British Telecommunications ("BT") in the U.K.
With respect to its other telecommunication services, we compete with:
o Interexchange carriers and other long distance resellers and
providers, including large carriers such as AT&T, WorldCom, Inc. and
Sprint
o Foreign PTTs
o Other providers of international long distance services
o Alliances between large multinational carriers that provide wholesale
carrier services
o New entrants to the domestic long distance market such as the regional
bell operating companies in the U.S., who have announced plans to
enter the U.S. interstate long distance market pursuant to recent
legislation conditionally authorizing such entry
o Small long distance resellers.
Moreover, some of our competitors have announced business plans similar to
ours regarding the expansion of telecommunications networks into Europe and
Latin America. Many of our competitors are significantly larger and have
substantially greater market presence, as well as greater financial, technical,
operational, marketing and other resources and experience than the Company.
We compete for customers in the telecommunications markets primarily based
on price and, to a lesser extent, the type and quality of service offered.
Increased competition could force us to reduce our prices and profit margins if
our competitors are able to procure rates or enter into service agreements that
are comparable to or better than those we obtain, or are able to offer other
incentives to existing and potential customers. Similarly, we have no control
over the prices set by our competitors in the long distance resale
carrier-to-carrier market.
IDT Ventures
IDT's Ventures division has been tasked with a treble mission. First,
Ventures is meant to guide investment strategy, selecting investments that
appropriately complement IDT internal endeavors. Second, Ventures must incubate
a small portfolio of in-house, non-telecom businesses to financial viability,
often working hand in hand with the Company's management team. Finally, Ventures
is responsible for surveying the broader marketplace to enter and build
businesses in those fields in which Ventures identifies opportunities for
significant profitable growth and which, at the same time, add qualitatively to
the range of businesses in the IDT portfolio.
The IDT Approach
By its very nature, the Ventures division represents a fusion of the
analytical and the visionary. Its approach combines the far-sightedness
necessary to evaluate and forecast the prospects of broad industries with an
exacting attention to the levels of detail that fledgling businesses require.
Our high-level executive development team draws on its substantial experience to
identify existing yet overlooked opportunities, while at the same time
anticipating and evaluating future demand for certain new technologies, products
and services. In order to ensure proper management focus on each potential new
business, we provide each venture with a dedicated management team, seeking
individuals whose skill-sets and experience most closely match those needed for
each particular venture.
Ventures has adopted a very selective stance in seeking out companies to
acquire and manage. Target companies must show potential of generating moderate
annual returns within a short to medium period of time after being acquired.
Ongoing cash requirements of these target companies must fall below a pre-set
ceiling, and the business itself must fit comfortably into IDT's overall growth
strategy. Currently, IDT Ventures (either through ownership or a management
relationship on behalf of another IDT entity) comprises three existing IDT
business areas, together with three business lines that IDT has newly acquired
or entered. These include newly acquired Talk America Radio Network and a
controlling interest in Net2Phone recently acquired in conjunction with AT&T
18
Corp. and Liberty Media Corp., an ambitious and burgeoning distribution venture
with Union, CTM Brochure Display, IDT dedicated Internet & Web hosting, and
1-800-TOWTRUCK.
Talk America Radio Network
On October 17, 2001, IDT completed its acquisition of Sports Final Radio
Network, Inc., a radio programming and syndication network doing business as
Talk America Radio Network. This acquisition marks IDT's point of entry into the
world of broadcast media, which Ventures has identified as a prime focus for its
endeavors. Through Talk America Radio Network, Ventures intends to develop and
market original radio programming content, as well as hire existing radio
talent. IDT believes that the economic downturn will increasingly reflect itself
in a reduction of advertising revenue, resulting in contraction in the radio
industry. As owners of station clusters selectively weed stations from their
portfolios or require additional capital, IDT believes that we will have the
opportunity to acquire radio stations at highly economic prices.
Net2Phone, Inc.
On October 23, 2001, IDT entered into an agreement to lead a consortium in
purchasing a controlling interest in Net2Phone, Inc., a Newark-based publicly
traded company that routes voice calls over the Internet. The consortium
includes AT&T Corp. and Liberty Media Corp., controls approximately 64% of the
voting power of Net2Phone, and will be managed by IDT. As part of the agreement,
IDT and AT&T contributed their shares of Net2Phone (approximately 10.0 million
and 18.9 million shares, respectively) to a newly formed limited liability
company (an "LLC"). Liberty Media then acquired a substantial portion of the
LLC's units from AT&T.
Net2Phone was originally formed by IDT in 1996, and functioned as a
wholly-owned subsidiary of IDT until August 1999, when it completed an initial
public offering. In December 1999, Net2Phone completed a secondary offering,
subsequent to which IDT maintained a 56% voting interest in the company. In
August 2000, we sold approximately 14.9 million shares of Net2Phone to AT&T
Corp. for aggregate consideration of approximately $1.1 billion. As a result of
the October 2001 transaction, IDT has, through the LLC, increased its stake in
Net2Phone, Liberty Media has acquired an interest in Net2Phone, and AT&T still
retains a significant interest.
While Net2Phone has become the world's leading provider of Internet
telephony products and services, its share price has fallen sharply since April
2000, mirroring the performance of the NASDAQ stock market over that time. IDT
Ventures will contribute to redirecting the energies of Net2Phone and
identifying avenues of business to raise profits.
Product Marketing and Distribution Network
IDT Ventures will attempt to build on the distribution network built by
Union and the expertise amassed by IDT in marketing to the urban ethnic market
in two ways. First, in partnership with Union, IDT will seek to join with other
companies in distributing new products through Union's distribution network of
an estimated 250,000 retailers. Second, IDT has assembled a select team of
individuals with expertise in marketing products to the Hispanic community, and
has begun working to directly market products and services to the Hispanic
community.
CTM Brochure Display
With over 2,000 clients in over 25 states and provinces, CTM Brochure
Display is the premier distributor of travel and entertainment brochures in the
eastern United States. Brochures are distributed through over 8,000 display
stands owned by CTM and located in hotels and public venues such as malls, bus
stations, and airports. Ventures intends to continue to grow this IDT company
and to foster its geographic expansion and the expansion of the services it
provides through internal growth and selective acquisitions.
IDT Dedicated Internet/Web Hosting
IDT has long offered broadband internet connectivity and web hosting
services to corporate customers. We believe that the current economic climate
has severely depressed the values for web hosting concerns, and Ventures will
seek to assist IDT Nevada Holdings, Inc. in acquiring several small web hosting
operations with the goal of integrating them into our own infrastructure and
operations.
19
1-800-TOWTRUCK
1-800-TOWTRUCK ("TowTruck") is both a motorist service that provides
roadside assistance to stranded motorists, and a towing referral service to
towing operators. We derive revenue from the towing operators, who pay to become
the exclusive 1-800-TOW-TRUCK operator in their area, as well as from a revenue
share of the towing fee.
TowTruck generated motorist calls come from two streams. Advertising
literature prompts individual motorists to dial 1-800-TOW-TRUCK directly; at the
same time, TowTruck has agreements with several emergency assistance services,
who are compensated for directing calls from stranded motorists to TowTruck.
Ventures will continue to work with TowTruck in developing unique technical
services and various proprietary technologies.
IDT Nevada Holdings, Inc. ("Nevada Holdings")
IDT Nevada Holdings, Inc. guides and manages IDT's equity investments in
other information technology ("IT") companies, and owns certain of the
businesses which are managed by Ventures. Nevada Holdings goal is to identify
opportunities in the telecommunications and Internet fields that can be
exploited through the use of superior technology, and taking advantage of such
opportunities through minority investments in other entities. In Fiscal 2001,
Nevada Holdings pursued a strategy of buying distressed companies in the
telecommunications sector in the hopes of capitalizing on the sale of their
assets or with the intent of acting in an advisory capacity to redirect and
strengthen the company's operations and fiscal outlook. In Fiscal 2001 Nevada
Holdings purchased, among several minor investments, a significant minority
stake in Teligent, Inc., a provider of broadband communications services. In May
2001, Teligent filed a voluntary bankruptcy petition under Chapter 11 of the
U.S. Bankruptcy Code.
Regulatory Environment
Deregulation in the U.S. and International Telecommunications Markets
Deregulation accelerated in the U.S. in 1984 with the divestiture by
American Telephone & Telegraph, Inc. ("AT&T") of the regional bell operating
companies. This gave rise to an influx of competitive telecommunications
companies. Today, there are over 500 U.S. long distance companies. Deregulation
in the U.K. began in 1981, when Mercury, a subsidiary of Cable & Wireless plc,
was granted a license to operate a facilities-based network and compete with
British Telecommunications plc ("BT"). Deregulation spread to other European
countries with the adoption of the "Directive on Competition in the Markets for
Telecommunication Services" in 1990. A series of subsequent European Union
directives, reports and actions have resulted in significant but not complete
deregulation of the telecommunications industries in most European Union member
states. Further deregulation of the European Union telecommunications market is
scheduled to occur in 2000 upon the implementation of the European Union's
"Amending Directive to the Interconnection Directive," which mandates the
introduction of equal access and carrier pre-selection by 2000. See
"Regulation--European Regulation of Telecommunications Services." A similar
movement toward deregulation has already taken place in Australia and New
Zealand, and is also taking place in Japan, Mexico, Hong Kong and other markets.
Other governments have begun to allow competition for value-added and other
selected telecommunications services and features, including data and facsimile
services and certain restricted voice services. Deregulation and privatization
have also allowed new long distance providers to emerge in other foreign
markets. In many countries, however, the rate of change and emergence of
competition remain slow, and the timing and extent of future deregulation is
uncertain.
Deregulation has encouraged competition, which in turn has prompted
carriers to offer a wider selection of products and services at lower prices. We
believe that the lower prices for telecommunications services that have resulted
from increased competition have been more than offset by decreases in the costs
of providing such services and increases in telecommunications usage. For
example, based on FCC data for the period 1989 through 1995, per-minute
settlement payments by U.S.-based carriers to foreign PTTs fell 31.4%, from
$0.70 per minute to $0.48 per minute. Over this same period, however, per-minute
international billed revenues fell only 13.7%, from $1.02 in 1989 to $0.88 in
1995. We believe that as settlement rates and capacity costs continue to
decline, international long distance will continue to provide opportunities to
generate relatively high revenues and per-minute gross profits.
20
Government Regulation of the Telecommunications Industry
Telecommunications
As a multinational telecommunications company, the Company is subject to
varying degrees of regulation in each of the jurisdictions in which it operates.
As a non-dominant carrier lacking substantial power to influence market prices
in the U.S., the Company's provision of international and domestic long distance
telecommunications services in the U.S. is generally subject to less regulation
than a carrier that has such power. Despite recent trends toward deregulation,
some of the countries in which the Company intends to provide telecommunications
services do not currently permit the Company to provide public switched voice
telecommunications services. In those countries in which the Company operates
that are not yet open to public switched voice service competition, the Company
provides services to closed user groups and a variety of value-added services,
as permitted by each country's laws.
In February 1997, the United States and 68 other countries signed the World
Trade Organization Agreement on Basic Telecommunications Services ("WTO
Agreement") to facilitate competition in basic telecommunications services.
Pursuant to the WTO Agreement, signatories committed to varying degrees and
within varying time frames to provide competitive telecommunications providers
access to their domestic and international markets, reduce or eliminate foreign
ownership restrictions, and establish regulatory regimes that foster
telecommunications competition. The WTO Agreement became effective on February
5, 1998. Although the Company believes that the WTO Agreement could provide us
with significant opportunities to compete in markets that were not previously
accessible, it could also provide opportunities for our competitors. There can
be no assurance that the pro-competitive effects of the WTO Agreement will not
have a material adverse effect on the Company's business, financial condition,
and results of operation or that members of the WTO will implement the terms of
the WTO Agreement.
Regulation of U.S. Domestic Telecommunications Services. In the U.S.,
provision of the Company's services is subject to the provisions of the
Communications Act of 1934, as amended by the Telecommunications Act of 1996
(the "Act"), regulations promulgated thereunder, as well as the applicable laws
and regulations of the various states administered by the relevant state
authorities. The recent trend in the U.S., for both federal and state regulation
of telecommunications service providers, has been in the direction of reducing
regulation. Nonetheless, the FCC and relevant state authorities continue to
regulate ownership of transmission facilities, provision of services and the
terms and conditions under which the Company's services are provided.
Non-dominant carriers, such as the Company, have generally been required by
federal and state law and regulations to file tariffs listing the rates, terms
and conditions for the services they provide.
In October 1996, the FCC adopted an order (the "Detariffing Order") which
eliminated the requirement that non-dominant interstate carriers such as the
Company maintain tariffs on file with the FCC for domestic interstate services.
After years of legal challenges, the Detariffing Order was upheld by the U.S.
Court of Appeals for the D.C. Circuit and subsequently implemented by the FCC on
July 31, 2001. In accordance with the Detariffing Order and the rules
promulgated thereunder, the Company withdrew its FCC interstate interexchange
service tariff on July 31, 2001 and placed its rates, terms and conditions for
domestic interstate services on its website. The Company concurrently notified
its subscribers of its compliance with the Detariffing Order. The detariffing of
domestic interstate services poses additional risks for the Company because it
will no longer have the benefit of the "filed rate doctrine." This doctrine
enabled the Company to bind its customers to the terms and conditions of the
tariff without having each customer sign a written contract and enabled the
Company to change rates and services on one day's notice. Since the rates and
terms of service are no longer tariffed, the Company may be subjected to
increased risk of claims from customers involving terms of service and rates
that could impact the Company's financial operations.
In 1997, the FCC issued an order to implement the provisions of the Act
relating to the preservation and advancement of universal telephone service (the
"Universal Service Order"). The Universal Service Order requires all
telecommunications carriers providing interstate telecommunications services to
contribute to universal support by contributing to (i) a fund for schools and
libraries, (ii) a fund for rural health care and (iii) a fund for the
development of regions characterized by high telecommunications costs and low
income levels (collectively, the "Universal Service Funds"). These contributions
became due beginning in 1998 for all providers of interstate telecommunications
services. Such contributions are assessed based on certain interstate and
international end user telecommunications revenues, which are calculated by the
21
Company in accordance with the legislative rules adopted by the FCC.
Contribution factors vary quarterly, and carriers, including the Company, are
billed each month. In addition, many state regulatory agencies have instituted
proceedings to revise state universal support mechanisms to make them consistent
with the requirements of the Act. As a result, the Company will be subject to
state, as well as federal, universal service fund contribution requirements,
which will vary from state to state. The amounts remitted to the Universal
Service Fund may be billed to the Company's customers. If the Company does not
bill these amounts to its customers, its profit margins may be less than if it
had elected to do so. However, if the Company elects to bill these amounts to
its customers, customers may reduce their use of the Company's services, or
elect to use the services provided by the Company's competitors, which may have
a material adverse effect upon the Company's business, financial condition, or
results of operations.
Over the past year, the FCC has increased the Universal Service Fund
contribution percentage from 5.6688% in the fourth quarter of 2000 to 6.9187%
for the fourth quarter of 2001. In addition, over the past year, the FCC has
made several rule changes that affect the Company's contribution to the
Universal Service Fund. As a result of these changes, the increases to the
contribution percentage, and an increase in the Company's revenue the Company's
Universal Service Fund payments have increased.
In May 2001, the FCC proposed several changes to its Universal Service
Fund regulations that, if adopted, would alter the basis on which the Company's
Universal Service Fund contributions are determined and the ability and means by
which such contributions may be recovered from the Company's customers. Also in
May 2001, the United States Court of Appeals for the Fifth Circuit, ruling on a
petition for review of a November 1999 FCC decision, held that the FCC cannot
allow any incumbent local telephone company to recover universal service costs
implicitly in access charges. Reconsideration petitions pending at the FCC seek
retroactive treatment for implementation of this decision. In July 2001, the
United States Court of Appeals for the Tenth Circuit remanded to the FCC an
order that provided high cost support for rural high cost areas. Depending on
the resolution of these rural issues, the Federal Universal Service Program
could grow substantially. The Commission has not yet acted on these proposals
and it is not clear whether the FCC will adopt any of these proposals. However,
if the FCC were to do so, the changes could limit the Company's ability to
recover its Universal Service Fund expenses from its customers, thereby having a
material adverse effect upon the Company.
Based on the foregoing, the application and effect of the Universal Service
Fund requirements (and comparable state contribution requirements) on the
telecommunications industry generally and on certain of the Company's business
activities cannot be definitively ascertained at this time.
The FCC has approved Verizon's Section 271 applications for authority to
provide interLATA interexchange service to customers in New York, Massachusetts,
Pennsylvania and Connecticut and SBC's Section 271 applications to provide
interLATA interexchange service to customers in Texas, Kansas and Oklahoma.
Because the FCC has approved these Section 271 applications, interexchange
carriers, such as the Company, will be subjected to increased competition from
these companies in the New York, Massachusetts, Pennsylvania, Connecticut,
Texas, Kansas and Oklahoma markets for interexchange services. As a result, the
Company may face increased pressure to reduce its rates for interexchange
services that may have an adverse impact on the Company's revenues.
SBC recently filed Section 271 applications to provide interLATA
interexchange services in Missouri and Arkansas and Bell South recently filed a
Section 271 application to provide interLATA interexchange service in Georgia
and Louisiana. Verizon, SBC, Qwest, and Bell South have announced that they
intend to file Section 271 applications in additional states, which if granted,
would further increase competition in the provision of interexchange services
and result in downward price pressures for such services in these states. In
addition, legislation has been introduced in Congress that would have the effect
of allowing Verizon, SBC, BellSouth and Qwest to offer in-region long distance
services without satisfying Section 271 of the Act. If signed into law, this
would further increase competition in the provision of data services, placing
increased pressure on the Company to reduce its rates for data services and
could potentially have an adverse impact on the Company's revenues.
The Company's costs of providing long distance services will be affected by
changes in access charge rates imposed by regional bell operating companies on
long distance carriers for origination and termination of calls over the local
facilities. The FCC has made major changes in the interstate access charge
structure. On May 31, 2000, the FCC issued an Order adopting the access charge
reform measures based on a proposal from an industry coalition referred to as
CALLS that included some major interexchange carriers, most regional bell
operating companies, and GTE. This proposal lowers collective interstate access
charges by local exchange carriers subject to price cap regulation by $3.2
billion and ends certain charges paid by interexchange carriers. As part of the
proposal, AT&T and Sprint agreed to pass through access charge savings to
customers. The Order, which was largely upheld by the U.S. Court of Appeals for
the Fifth Circuit, will reduce access charges for interexchange carriers and the
Company may face increased competition to lower its prices for long distance
services.
The Company's costs of providing long distance services are also affected
by changes in access charge rates imposed by competitive local exchange
carriers. On April 27, 2001, the FCC released an order lowering the rates CLECs
can charge long distance carriers for origination and termination of calls over
the local facilities. Under the Order, these rates will be further reduced in
the future. As a result of the Order, access charges will decrease for
interexchange carriers and the Company may face increased competition to lower
22
its prices for long distance services. Since the rates and terms of service are
no longer tariffed, the Company may be subjected to increased risk of claims
from customers involving terms of service and rates that could impact the
Company's financial operations.
In addition to regulation by the FCC, the majority of the states require
the Company to register or apply for certification prior to initiating
intrastate interexchange telecommunications services. To date, the Company,
together with its subsidiaries, is authorized through certification,
registration or on a deregulated basis to provide intrastate interexchange
telecommunications services in 50 states. The Company is subject to the
obligations that applicable state law places on all similarly certificated
carriers including the filing of tariffs, regulations of service offerings,
pricing, payment of regulatory fees and reporting requirements. State issued
certificates of authority to provide intrastate interexchange telecommunications
services can generally be conditioned, modified, canceled, terminated or revoked
by state regulatory authorities for failure to comply with state law and/or the
rules, regulations and policies of the state regulatory authorities. Fines and
other penalties also may be imposed for such violations. As a provider of
presubscribed intra- and interstate toll services, the Company is subject to
federal and state laws prohibiting "slamming," which occurs when a
telecommunications service provider switches a subscriber's presubscribed
carrier without authorization or not in conformance with applicable law.
Although the Company attempts to diligently comply with all such laws and
regulations and has procedures in place to prevent "slamming," if violations of
such laws and regulations occur, the Company could become subject to significant
fines and penalties, legal fees and costs, and its business reputation could be
harmed.
U.S. Regulation of International Telecommunications Services. In the United
States, to the extent that the Company offers services as a carrier, the Company
is required to obtain authority under Section 214 of the Act, in order to
provide telecommunications service that originates within the U.S. and
terminates outside the United States. The Company has obtained the required
Section 214 authorization from the FCC to provide U.S. international service. In
addition, as a condition of the Company's Section 214 authorization, the Company
is subject to various reporting and filing requirements. Failure to comply with
the FCC's rules could result in fines, penalties, forfeitures or revocation of
the Company's FCC authorization, each of which could have a material adverse
effect on our business, financial condition, and results of operation.
In the past, the provision of international telecommunications service
required the filing of an International Interexchange Service Tariff with the
FCC. In March 2001, the FCC adopted its International Detariffing Order,
mandating that non-dominant carriers, such as the Company, remove their
International Interexchange Service Tariffs from the FCC by no later than
January 28, 2002. Concurrent with its July 31, 2001 removal of its Domestic
Interexchange Service Tariff, the Company removed its International Exchange
Service Tariff. Since that time, the Company has made its international
interexchange rates and terms of service available to the public, as required by
the FCC's regulations. Since the rates and terms of international interexchange
service are no longer tariffed, the Company may be subjected to increased risk
of claims from customers involving terms of service and rates that could impact
the Company's financial operations.
The Company must conduct its U.S. international business in compliance with
the FCC's International Settlements Policy, the rules that establish the
parameters by which U.S.-based carriers and their foreign correspondents settle
the cost of terminating each other's traffic over their respective networks.
Under the FCC's International Settlements Policy, absent approval from the FCC,
international telecommunications service agreements with dominant foreign
carriers must be non-discriminatory, provide for settlement rates usually equal
to one-half of the accounting rate, and require proportionate share of return
traffic.
In recent rule reforms, the FCC expressly exempted from the International
Settlements Policy rules, U.S. carrier arrangements with non-dominant foreign
carriers as well as arrangements with any foreign carrier (dominant or
non-dominant) on certain competitive routes where at least 50% of U.S.-billed
traffic is terminated at settlement rates at least 25% below the FCC's
applicable benchmark settlement rates. These routes currently include: Canada,
Denmark, France, Germany, Hong Kong, Ireland, Italy, Monaco, the Netherlands,
Norway, Saudi Arabia, Sweden and the United Kingdom. For arrangements that will
continue to be subject to the International Settlements Policy, the FCC imposes
mandatory settlement rate benchmarks. These benchmarks are intended to reduce
the rates that U.S. carriers pay foreign carriers to terminate traffic in their
home countries. The FCC also prohibits a U.S. carrier affiliated with a foreign
carrier from providing facilities-based switched or private line services to the
foreign carrier's home market unless and until the foreign carrier has
implemented a settlement rate at or below the relevant benchmark. Certain
confidential filing requirements still apply to dominant carrier arrangements.
The FCC's new rules declined to expand the scope of the International
Simple Resale ("ISR") policy, which permits U.S. carriers to provide
international switched services over private lines interconnected to the public
switched telecommunications network on the current FCC-authorized routes. The
FCC will continue to maintain the distinction between routes it approves for ISR
and routes on which it removes the International Settlements Policy. Even though
the FCC dramatically scaled back the application of the International
Settlements Policy, the FCC's ISR policy still requires FCC approval to provide
ISR services in an arrangement with a foreign dominant carrier on
non-competitive routes.
23
The FCC has removed the International Settlements Policy for
telecommunications traffic sent to 56 countries, representing 46% of all U.S.
international traffic. To the extent that the International Settlements Policy
still applies, however, the FCC could find that the Company does not meet
certain International Settlements Policy requirements with respect to certain of
our foreign carrier agreements. Although the FCC generally has not issued
penalties in this area, it has issued a Notice of Apparent Liability to a U.S.
company for violations of the International Settlements Policy and it could,
among other things, issue a cease and desist order, impose fines or allow the
collection of damages if it finds that we are not in compliance with the
International Settlements Policy. Any of these events could have a material
adverse effect on the Company's business, financial condition, or results of
operation.
The Company offers its callback services pursuant to its Section 214
Authorization. The FCC has determined that callback services that use
uncompleted call signaling do not violate U.S. or international law, but that
U.S. companies providing such services must comply with the laws of the
countries in which they operate as a condition of such companies' Section 214
Authorizations. The FCC reserves the right to condition, modify or revoke any
Section 214 Authorizations and impose fines for violations of the Act or the
FCC's regulations, rules or policies promulgated thereunder, or for violations
of the clear and explicit telecommunications laws of other countries that are
unable to enforce their laws against callback services using uncompleted call
signaling. FCC policy provides that foreign governments that satisfy certain
conditions may request FCC assistance in enforcing their laws against callback
providers based in the U.S. that are violating the laws of these jurisdictions.
Thirty-six countries have formally notified the FCC that callback services
violate their laws. The FCC has held that it would consider enforcement action
against companies based in the U.S. engaged in callback services by means of
uncompleted call signaling in countries where this activity is expressly
prohibited. In fact, the FCC granted a complaint by the Philippines Long
Distance Telephone Company and required U.S. carriers to stop providing callback
services to customers in the Philippines. A petition filed by the
Telecommunications Resellers Association in 1998 requesting that the FCC cease
enforcing foreign laws against callback services is still pending. There can be
no assurance that the FCC will not take further action in the future.
Enforcement action could include an order to cease providing callback services
in such country, the imposition of one or more restrictions on the Company,
monetary fines or, in extreme circumstances, the revocation of the Company's
Section 214 Authorization, and could have a material adverse effect on the
Company's business, financial condition and results of operations.
To date, the FCC has made no pronouncement as to whether refiling
arrangements are inconsistent with the regulations of the U.S. or the
International Telecommunication Union (the "ITU"), and a 1995 petition to the
FCC for declaratory ruling regarding Sprint's Fonaccess service was withdrawn.
Although it is possible that the FCC will determine that refiling violates U.S.
and/or international law and that such a finding could have a material adverse
effect on the Company's business, operating results and financial condition, the
FCC is not currently considering such issues in any active proceeding.
Regulatory requirements pertinent to the Company's operations will continue
to evolve as a result of the WTO Agreement, federal legislation, court
decisions, and new and revised policies of the FCC. In particular, the FCC
continues to refine its international service rules to promote competition,
reflect and encourage liberalization in foreign countries and reduce
international accounting rates toward cost.
European Regulation of Telecommunications Services. In Europe, the
regulation of the telecommunications industry is governed at a supranational
level by the European Union and to a large extent by the national law of the
individual European Union Member States. The European Union's institutions, such
as the European Commission, are responsible for creating pan-European policies.
Through its legislation, the European Union has developed a regulatory framework
aimed at creating an open, competitive telecommunications market. The European
Union was established by the Treaty of Rome and subsequent conventions and the
European Commission and the Council of Ministers of the European Union are
authorized by such treaties to issue European Union "directives." European Union
Member States are required to implement these directives through national
legislation. If a Member State fails to adopt such directives, the European
Commission may take action, including referral to the European Court of Justice,
to enforce the directives. In practice, Member States have significant
discretion regarding how to implement Directives into their national law system.
For example, while the Licensing Directive provides Member States the required
overall framework, the licensing regimes adopted by Member States vary
accordingly. Only in specific cases, the European Commission, in concert with
the European Parliament and other relevant European Union institutions will
render regulations or individual decisions on specific issues that become
effective immediately without requiring Member States to adopt them on a
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