ITXC CORP - 10-Q Quarterly Report

Indicate by checkmark 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At April 30, 2004, there were 43,442,098 shares of Common Stock, par value $.001 per share, outstanding.

The March 31, 2004 and 2003 financial statements have been prepared by ITXC Corp. (the “Company” or “ITXC”) and are unaudited. In the opinion of the Company’s management, all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows for the interim periods have been made. Certain information and footnote disclosures required under accounting principles generally accepted in the United States have been condensed or omitted from the consolidated financial statements and notes thereto presented herein pursuant to the rules and regulations of the Securities and Exchange Commission. The condensed consolidated financial statements and notes thereto presented herein should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2003 and notes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for any other interim period or the entire fiscal year.

The consolidated financial statements include the accounts of ITXC Corp. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

On November 4, 2003, the Company and Teleglobe International Holdings Ltd (“Teleglobe”) announced that they had signed a definitive merger agreement for the acquisition of the Company by Teleglobe. Upon consummation of the merger, the outstanding shares of the Company’s common stock will be converted into approximately 28% of the capital stock of a newly formed parent company of Teleglobe, Teleglobe International Holdings Ltd. (formerly Teleglobe Bermuda Holdings, Ltd) (“New Teleglobe”). All outstanding options and warrants of ITXC will be converted into options and warrants of New Teleglobe. The merger is subject to several conditions, including receipt of governmental approvals, and the approval of the Company’s stockholders. Teleglobe is a privately held Bermuda company and is one of the worlds leading wholesale providers of voice, data, IP and mobile roaming services. Early termination of the Hart-Scott-Rodino review period has been received. On April 30, 2004, New Teleglobe received notification that its amended registration statement filed on Form S-4 with the SEC had been declared effective. The Company has mailed proxy statements to its stockholders and has scheduled a stockholders’ meeting seeking approval of the transaction for May 28, 2004.

Pursuant to the announcement of the Teleglobe merger, certain employees of the Company received severance and/or retention agreements. The potential future obligations under these agreements are not expected to exceed $3.9 million.

The components of comprehensive loss for the three-month periods ended March 31, 2004 and 2003 were as follows:

The Company accounts for employee stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” using an intrinsic value approach to measure compensation expense, if any. Appropriate disclosures using a fair value based method, as provided by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”, are also reflected in these notes to the financial statements. The Company has not issued any options other than to employees and directors and certain consultants who are occupied full time in the Company’s activities.

The following table summarizes relevant information as to reported results under the Company’s intrinsic value method of accounting for stock options, with supplemental information as if the fair value recognition provisions of SFAS No. 123 had been applied for the three-month periods ended March 31, 2004 and 2003:

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51. The Interpretation introduces a new consolidation model, the variable interests model, based on potential variability in gains and losses of the entity being evaluated for consolidation. It provides guidance for determining whether an entity lacks sufficient equity or the entity’s equity holders lack adequate decision-making ability. These entities, variable interest entities (VIE), are evaluated for consolidation based on their variable interests. Variable interests are contractual, ownership or other interests in an entity that expose their holders to the risks and rewards of the VIE. The Interpretation’s provisions are effective currently for variable interests in VIE’s created after January 31, 2003, and for variable interests in VIE’s created before February 1, 2003, no later than the end of the first interim or annual reporting period ending after March 15, 2004. Management does not believe that the adoption of this standard will have any impact on the Company’s financial statements.

In conjunction with its letter of credit facility for its Princeton, New Jersey lease, the Company has $2.3 million in restricted cash as of March 31, 2004 that represents the collateral supporting the letter of credit. The Company is obligated to maintain the letter of credit for the term of the lease, which expires on July 31, 2011. As a result, the Company will be required to either maintain the restricted cash or provide an alternative means of collateral. In addition, in November 2003, the Company issued a letter of credit to a vendor in the amount of $4.0 million. This instrument was issued as a means of obtaining more beneficial payment terms from the vendor. In order to secure the facility, the Company was required to deposit $4.0 million in a restricted bank account and maintain such balance as long as the facility remains in place.

The Company is involved in certain claims and legal actions arising in the normal course of business. Management does not expect that the outcome of these cases will have a material effect on the Company’s financial position or results of operations.

The Company has received a copy of a complaint filed on February 24, 2004 as a class action suit in New Jersey Superior Court naming the Company and directors Tom Evslin, Edward Jordan, Frank Gill and Fred Wilson as defendants. Two claims are asserted against the individual defendants, one for breach of fiduciary duty and the other for breach of the duty of candor. Although the Company was identified as a defendant, no cause of action is asserted against the Company for damages. The action seeks to enjoin the stockholders’ meeting to approve ITXC’s proposed merger with Teleglobe until certain alleged deficiencies in the proxy statement have been cured and seeks to permanently enjoin the consummation of the merger. ITXC had previously announced that New Teleglobe filed a registration statement on Form S-4 with the Securities and Exchange Commission in connection with the proposed merger. ITXC believes the complaint contains factual inaccuracies, is premature and is wholly without merit and intends to vigorously defend the lawsuit.

On May 23, 2000, Connectel, LLC, filed suit against the Company in the United States District Court for the Eastern District of Pennsylvania. Connectel alleges in its complaint that the Company is infringing on the claims of a patent owned by Connectel by, acting alone or with others, assembling, offering to sell, selling or using communications networks or switching systems within the United States and for export worldwide without license from Connectel. Connectel also seeks unspecified damages. Discovery has closed and ITXC moved for summary judgment in October 2002. Thereafter, in December 2002, the case was reassigned to a newly appointed United States District Judge, Hon. James Knoll Gardner. Oral argument on the motion for summary judgment and on certain other pretrial issues was held in February 2004. On March 17, 2004, Judge Gardner issued an opinion finding for the Company on all issues related to the meaning of the patent claims, but denying summary judgment without prejudice to renew the motion at or after a scheduled June 9, 2004 hearing to determine whether portions of Connectel’s expert testimony will be inadmissible in connection with the motion. The Company believes that the Connectel claims are without merit.

the individual defendants nor the Company nor its insurers paid any consideration for these dismissals. The parties have negotiated a settlement entirely funded by the directors and officers’ insurance carriers, and it is anticipated that this proposed settlement will be submitted to the Court for approval in the near future. Under the terms of the proposed settlement, neither the Company nor individual defendants will have either future liability or expenses in connection with the litigation, except for a limited obligation to cooperate in discovery in the plaintiffs’ continuing cases against the underwriters.

Interactive Marketing Technologies, Inc., (“IMT”) is a telecommunications service bureau headquartered in Erlanger, Kentucky, to which ITXC had discontinued service on February 20, 2003, and from which ITXC had demanded payment of a multimillion dollar past due balance, after the parties were unsuccessful in efforts to restructure IMT’s obligations to ITXC. IMT then sued ITXC seeking unspecified compensatory and punitive damages in the United States District Court for the Eastern District of Kentucky alleging breach of contract, bad faith, tortuous[sic] interference with contract and negligent misrepresentation, among other claims. The Company thereafter commenced an arbitration action against IMT seeking to recover the amounts owed by IMT, and on July 8, 2003, the United States District Court dismissed IMT’s case in favor of the arbitration proceeding. IMT asserted its claims in the arbitration, and has now filed for bankruptcy protection. The Company believes IMT’s claims are without merit. The Company’s claims against IMT will be pursued, if at all, in the bankruptcy proceeding, which has been converted into a Chapter 7 proceeding.

We are not a party to any other legal proceeding, the adverse outcome of which is expected to have a material adverse effect on our business, financial condition, operating results or future prospects.

For the quarters ended March 31, 2004 and 2003, the Company has recorded $69,000 and $174,000, respectively, of tax expense relating to certain foreign tax accruals for its overseas offices.

Acceris Communications Technologies Inc., a subsidiary of Acceris Communications Inc. has filed a patent infringement lawsuit against the Company, which was served on April 28, 2004. The case is pending in the United States District Court of the District of New Jersey and alleges that ITXC’s Voice over Internet Protocol (VoIP) services and systems infringe Acceris’ U.S. Patent No. 6,243,373, entitled “Method and Apparatus for Implementing a Computer Network/Internet Telephone System.” The Company intends to vigorously defend against the allegations of infringement and believes that it has substantial defenses to them. However, an adverse result in this litigation could either result in injunctive relief precluding all or a portion of the Company’s VoIP activity or materially impact the Company’s revenues and profitability.

The Company has filed a separate lawsuit against Acceris Communications Technologies, Inc. and Acceris Communications, Inc. for infringement of a number of ITXC’s patents directed generally to the transmission of telephone calls over the Internet and the completion of telephone calls by switching them off the Internet and onto a public switched telephone network (PSTN).

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

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements, the related Notes to Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 (the “10-K”) and the Unaudited Condensed Consolidated Financial Statements and related Notes to Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q.

ITXC has included in this Quarterly Report certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 concerning ITXC’s business, operations and financial

condition. “Forward-looking statements” consist of all non-historical information, and the analysis of historical information, including any references in this Annual Report to future revenue growth, future expense growth, future credit exposure, future profitability, anticipated cash resources, anticipated capital expenditures, capital requirements, and the Company’s plans for future periods. In addition, the words “could”, “expects”, “anticipates”, “objective”, “plan”, “may affect”, “may depend”, “believes”, “estimates”, “projects” and similar words and phrases are also intended to identify such forward-looking statements.

Actual results could differ materially from those projected in the Company’s forward-looking statements due to numerous known and unknown risks and uncertainties, including, among other things, (i) uncertainties relating to executing the pending merger with Teleglobe, including, but not limited to the risks of delay in consummation of the merger; the risk that either material adverse changes to either entity, or governmental action or litigation may prevent the merger from closing or render it less desirable than anticipated; and risks relating to delays in closing the merger; uncertainties relating to the combined company after the proposed merger with Teleglobe, including but not limited to, unexpectedly high transaction costs; problems in the integration effort; Teleglobe’s anticipated debt level and the inherent lack of flexibility resulting therefrom; inability to retain key employees, customers and suppliers through and after the merger process; inability to capture anticipated synergies; the ability of Cerberus Capital Management, L.P., Teleglobe’s current controlling shareholder and majority owner of New Teleglobe after the merger, to exert control over the combined company; the existence of undisclosed or unanticipated contingent liabilities; the risk stemming from the fact that New Teleglobe is not currently a publicly traded company; and the risk that Teleglobe may not be able to effectively execute its business plan and (ii) other risks relating to the Company independent of the proposed merger, including the volatile and competitive environment for Internet telephony and telecommunications; changes in domestic and foreign economic, market and regulatory conditions; the inherent uncertainty of financial estimates and projections; uncertainty inherent in litigation; unanticipated technological difficulties; the risk that the Company may not be able to access sufficient capital; the creditworthiness of and relationship with our customers; future transactions; risks inherent in being subject to significant regulation; and other considerations described as “Risk Factors” in Exhibit 99.1 to Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and in other filings made by us with the SEC. Such factors may also cause substantial volatility in the market price of our Common Stock. All such forward-looking statements are current only as of the date on which such statements were made. ITXC does not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events.

ITXC’s discussion and analysis of its financial condition and results of operations are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, investments, intangible assets, restructuring and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies apply to and affect significant judgments and estimates used in the preparation of its Consolidated Financial Statements:

Allowance for Doubtful Accounts. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make

payments, additional allowances may be required. The Company estimates the amount of the allowance for doubtful accounts required to reduce accounts receivable to expected net realized value by reviewing the status of significant past-due receivables and analyzing historical bad debt trends and industry and customer specific conditions.

Revenue Recognition. The Company recognizes telecommunications revenue and the related costs at the time the services are rendered. Telecommunications revenue is derived from fees charged to terminate voice and fax services over the Company’s network. Increased competition from other providers of Internet telephony services and traditional telephony services could materially adversely affect revenue in future periods. To date, the Company has derived a significant portion of its revenue from a small number of customers. The loss of a major customer could have a material adverse effect on the Company’s business, financial condition, operating results and future prospects.

Goodwill and Other Intangible Assets. On January 1, 2002, the Company adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”. In assessing the recoverability of its goodwill and other intangibles, the Company must make assumptions regarding estimated future cash flows. If such assumptions change in the future, the Company may be required to record impairment charges for these assets.

Property and Equipment. On January 1, 2002, the Company adopted Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. If indicators of impairment are present, the Company must determine whether the sum of the estimated undiscounted cash flows attributable to the assets in question is less than its carrying amount. If less, the Company will be required to recognize an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. The Company has simplified its network to eliminate the need for circuit switches, to lower costs and improve quality and reliability for its customers, and to reduce further capital costs and operating complexity.

From time to time, the Company is required to make other significant estimates such as the carrying value of its investments, restructuring charges, litigation accruals and employee termination benefits. Actual results could differ from these estimates.

We are a leading global provider of voice and fax services. We primarily use the Internet for transport of these calls. From our inception in July 1997 through April 1998, our operating activities were focused primarily on:

In April 1998, we launched our first service delivered over ITXC.net—our WWeXchange Service. Our operations since that time have included:

To date, we have derived a significant portion of our revenue from a small number of customers. The loss of a major customer could have a material adverse effect on our business, financial condition, operating results and future prospects.

that we operated an e-commerce business, network operations expenses also include related expenses incurred to operate our e-commerce services.

The FCC has not determined that the Services that we provide using Internet telephony are subject to direct regulation and the FCC has generally maintained a long-standing policy to keep consumer Internet services free from burdensome economic regulation at both the federal and state levels. However, the FCC has been collecting information regarding Internet telephony services in various proceedings. For instance, the FCC has been asked by certain ILECs to declare that Internet telephony services are subject to regulation as telecommunications services and therefore subject to interstate switched access charges and universal service fund assessments. Alternatively, other carriers and companies such as AT&T, Level 3 and pulver.com have filed their own petitions for declaratory ruling asking the FCC to find that certain Internet telephony services are exempt from certain regulations for a variety of reasons. As a result, on February 12, 2004, the FCC ruled that pulver.com’s Free World Dialup (FWD) offering, which allows users of broadband Internet access services to make voice over Internet Protocol or other types of peer-to-peer communications directly to other FWD members, without charge, is an unregulated information service that is subject to federal jurisdiction. On April 21, 2004, the FCC issued an order finding that specific end user retail phone-to-phone VoIP services offered by AT&T are basic services and therefore subject to access charges and certain other regulation. The FCC’s decision in the AT&T matter was, however, limited to services that use only ordinary customer premise equipment with no enhanced functionality, originate and terminate on the public switched network and undergo no net protocol conversion and provide no enhanced functionality to end users due to the provider’s use of IP technology. We believe that the great bulk of wholesale international services that we provide are distinguishable from the phone-to-phone VoIP telephony services provided by AT&T. Moreover, the FCC explicitly stated that its decision is an interpretation of existing rules and does not preclude the FCC from taking a different direction in its general proceeding on IP-enabled services or in another pending proceeding dealing with intercarrier compensation which may materially change the existing access charge regime which the AT&T decision interpreted. It is possible that the AT&T decision has increased the likelihood that the Internet

telephony services we offer may be regulated or may be subject to regulation in the future, although the FCC expressly left open the possibility of revisiting the AT&T decision at a later date.

On March 10, 2004, the FCC initiated a comprehensive rulemaking proceeding to seek public comment on the appropriate regulatory treatment of IP-enabled services, including Internet telephony. In that proceeding, the FCC sought comment on fundamental questions that will affect every aspect of IP-enabled services. The FCC posed questions that may signal an openness to consider significant changes in the way the FCC regulates today’s evolving telecommunications networks and services. The proceeding promises to analyze statutory definitions, jurisdictional matters and revisit prior FCC decisions in a manner that will likely restructure the existing regulatory framework for Internet telephony and other IP-enables services. The FCC made clear that it is starting from the premise that IP-enables services should only be minimally regulated, in light of the public interest in encouraging broadband infrastructure and greater customer choice. However, if the FCC were to determine that certain Internet-related services including the Internet telephony services we provide are subject to FCC regulation as telecommunications services, the FCC could subject providers of such services, including us, to traditional common carrier regulation, including requirements to comply with the international settlement regime for international services, make universal service contributions, and pay access charges to local telephone companies. This regulation could significantly increase our costs of providing service, impose new technically challenging requirements or otherwise adversely affect us. Finally, the FCC has initiated a CALEA proceeding to consider the technical and policy issues associated with law-enforcement access to IP-enabled services under CALEA. This proceeding addresses the scope of covered services, the assignment of responsibility for compliance, and the wiretap capabilities required.

We anticipate that from time to time our operating expenses may increase on a per minute basis as a result of decisions to route additional traffic over the traditional telephone network or private data networks in order to maintain quality transmissions during relatively short periods of time as we transition our network to increased levels of capacity, or to meet peak demands. During these periods, we occasionally experience reductions in volume from certain customers. Historically, we have satisfactorily resolved these transition issues. However, in the future other anticipated or unanticipated operating problems associated with the growth of ITXC.net may develop.

Since our inception in July 1997, we have experienced operating losses in each quarterly and annual period and negative cash flows from operations in each quarter since we commenced offering services over ITXC.net in April 1998. As of March 31, 2004, we had an accumulated deficit of $373.6 million. The profit potential of our business is unproven, and our limited operating history makes an evaluation of us and our prospects difficult. We may not achieve profitability or, if we achieve profitability, we might not sustain profitability.

Our profitability for terminating calls over ITXC.net is a function of our ability to maximize our “buy-sell” margin, i.e. the difference between what we pay on a per minute basis to receive termination service from our suppliers and what we are able to charge our customers. For the quarters ended March 31, 2004 and 2003, our “buy-sell margin” was $10.5 million and $11.9 million, respectively. Our average “buy-sell margin” per minute in the quarters ended March 31, 2004 and March 31, 2003 was $0.0084 (0.84 cents) and $0.0135 (1.35 cents), respectively. Total minutes for the quarters ended March 31, 2004 and 2003 were 1.3 billion and 884 million, respectively. The sum of the cost component of the buy-sell margin, IP connectivity costs, PSTN connectivity costs and collocation costs comprise the line item reported as Data Communications and Telecommunications Expense in our consolidated statements of operations.

Results of Operations – Comparison of the Three Months Ended March 31, 2004 and 2003

The following table sets forth, for the three months ended March 31, the percentage of telecommunications revenues represented by various line items in our consolidated statements of operations.

The following table shows the percentage increase or decrease in the above-mentioned line items for the quarterly periods from March 31, 2003 to March 31, 2004.

Telecommunications revenues amounted to $96.3 million during the quarter ended March 31 2004 and $81.7 million during the three months ended March 31, 2003, an increase of 17.9%. This increase was primarily due to the increased revenue generated from our call completion service, which provides international call completion to our customers and enables them to offer their own customers phone-to-phone global voice service. Almost all of our total revenue during the first quarter of 2004 was derived from our call completion service.

We have increased the volume of call completion service traffic over ITXC.net. In terms of minutes of traffic, we increased our minutes to 1.3 billion in the first

quarter of 2004 from 884 million minutes in the first quarter of 2003. Our average revenues per minute (ARPM) for call completion service declined to 7.7 cents per minute during the first quarter of 2004 from 9.2 cents per minute during the first quarter of 2003. The decline in average revenues per minute is primarily attributable to increased competition and changes in route mix.

Approximately $8.7 million of revenues reported for the first quarter of 2003 related to amounts from Interactive Marketing Technologies, Inc. (“IMT”). IMT filed for bankruptcy protection and the Company therefore wrote-off $8.7 million. Excluding IMT, our ARPM for the first quarter of 2003 would have been $.087 (8.7 cents).

We focus on margin rather than revenue. Since 2001,we have used buy-sell margin as the major basis for sales compensation.

Data Communications and Telecommunications Expenses. During the three months ended March 31, 2004 and 2003, data communication and telecommunications expenses amounted to $87.8 million and $72.6 million, respectively. The increase in the dollar amount of such costs primarily reflected the increased traffic during 2004, as well as costs associated with establishing an increasing capacity at our hubs in anticipation of future growth in traffic.

Network Operations Expenses. Network operations expenses decreased to $2.4 million during the three months ended March 31, 2004 from $2.5 million during the three months ended March 31, 2003. Such expenses primarily reflected the cost of operating our 24-hours-a-day, 7 days-a-week network operations center, as well as start-up costs associated with the Germany and Hong Kong hubs. In the first quarter of 2003 we announced a new network hub in Germany and in the fourth quarter of 2003 we announced a new network hub in Hong Kong. In general, network operations expenses are not proportional to the volume of our traffic; regardless of our volume, we are required to pay the salaries and related costs associated with operating our network operations center in Princeton. We anticipate that we will be able to continue to leverage network operations expenses over a larger revenue base in future periods. Such expectation represents a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ from such expectation as a result of a number of factors, including the extent to which we incur unanticipated expenses associated with the expansion of our hubs and the growth of our network.

Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses decreased to $9.8 million during the three months ended March 31, 2004 from $18.7 million during the three months ended March 31, 2003. The decrease in SG&A expenses from 2003 is primarily attributable to a specific bad debt provision of $8.7 million that we made to our accounts receivable reserve in the first quarter of 2003 and higher headcount levels during the first quarter of 2003 offset by $1.3 million in transaction, integration and employee retention/severance expenses in the first quarter of 2004 relating to the planned Teleglobe merger. We had 224 employees at March 31, 2004, as compared with 287 employees at the end of the first quarter of 2003.

As our revenues continue to grow, we expect SG&A expenses to decrease as a percentage of revenues. Such expectation represents a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ from such expectation as a result of a number of factors, including the extent to which we incur unanticipated expenses associated with revenue growth and the extent to which our customers present unanticipated credit problems.

Depreciation expense decreased to $4.3 million during the three months ended March 31, 2004 from

$5.6 million during the three months ended March 31, 2003. The decrease in depreciation expense from 2003 to 2004 was a result of greater efficiencies from our installed asset base. We added $2.0 million of capital expenditures during the first quarter of 2004.

In connection with our May 2, 2002 acquisition of the assets of Nexcom, we recorded $7.9 million of goodwill and $2.9 million of other intangibles. During the fourth quarter of 2003, upon reviewing the current and future value of an exclusive relationship in Lithuania, we wrote off the full value of the intangible asset. This resulted in a $2.0 million charge in 2003. We amortized $20,000 and $121,000 of other intangibles during the three months ended March 31, 2004 and March 31, 2003, respectively.

Our interest income, net principally represents income from cash and investments, which, in turn, were derived from capital contributions made by our investors. During the quarters ended March 31, 2004 and 2003, the interest on our marketable securities, including the interest earned on the proceeds from our initial and follow-on public offerings, exceeded the interest that we paid on our capital leases by $0.1 million and $0.4 million, respectively. The reduction in our interest income reflects our usage of cash and yield reductions resulting from a decline in short-term interest rates.

Prior to our initial public offering, we financed our operations primarily through the private placement of our capital stock and, to a lesser extent, through equipment financing. Net proceeds from our initial public offering, including proceeds resulting from the exercise by the underwriters of their over-allotment option, were $78.4 million. This capital was supplemented by net proceeds of $161.4 million raised upon consummation of our March 2000 follow-on offering of Common Stock.

Net cash provided by financing activities was $0.07 million for the three months ended March 31, 2004, principally reflecting the proceeds from the exercise of stock options and the issuance of stock related to employee stock purchase plans, offset by repayment of certain capital lease obligations.

Net cash used in operating activities amounted to $0.5 million for the three months ended March 31, 2004, primarily the result of net operating losses offset by depreciation, lower accounts receivable and an increase in accounts payable and accrued expenses.

Net cash used in investing activities was $2.4 million for the three months ended March 31, 2004 and was primarily related to the purchases of property and equipment of $2.0 million.

As of March 31, 2004, our principal commitments consisted of obligations outstanding under operating and capital leases. At that date, future minimum payments for all non-cancelable leases included required payments of $3.2 million during 2005 and $13.6 million for years 2006-2009 and thereafter under all leases. The remaining future minimum payments for 2004 are estimated to be $2.8 million. The minimum lease payments have not been reduced by minimum operating sublease rentals of $1.1 million due in the future under noncancelable subleases.

On October 23, 2002 the Company announced that its Board of Directors had authorized a stock repurchase program for up to $10 million. As of December 31, 2002, the Company had used $9.8 million of this authorization to repurchase a total of 3,883,700 shares. Included in this total was the negotiated direct purchase of 3,783,000 shares from VocalTec Communications Inc. at $2.53 per share, pursuant to a purchase agreement. On March 31, 2003 the Board authorized an additional $5.0 million repurchase. Pursuant to the merger agreement with Teleglobe, the Company no longer has any outstanding buyback authorization. The Company did not purchase any shares in 2003 under its prior buyback authorizations.

In conjunction with the Company’s letter of credit facility for its Princeton, New Jersey lease, the Company has $2.3 million of restricted cash. In addition, in November 2003, the Company issued a letter of credit to a vendor in the amount of $4.0 million. This instrument was issued as a means of obtaining more beneficial payment terms from the vendor. In order to secure the facility, the Company was required to deposit $4.0 million in a restricted bank account and maintain such balance as long as the facility remains in place.

The primary sources of our short-term funding continue to be the capital that we have raised. Our capital requirements depend on numerous factors, including market acceptance of our services, the responses of our competitors, the resources allocated to ITXC.net and the development of future applications of our technology, our success in marketing and selling our services, and other factors. We have experienced substantial increases in our capital expenditures since our inception, consistent with growth in our operations and staffing. If the Teleglobe merger is not consummated, we currently believe that our available cash and cash equivalents would be sufficient to meet our anticipated needs for working capital and capital expenditures for at least the next 12 months. This statement represents a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from our expectations as a result of certain of the risk factors described in Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. If the Teleglobe merger is not consummated, we may need to raise additional funds in order to fund operations and/or more rapid expansion, to develop new or enhance existing services, to respond to competitive pressures or to acquire or invest in complementary business, technologies or services. Additional funding may not be available on favorable terms or at all. Any such funding may be dilutive to existing stockholders (if in the form of equity) and may result in the imposition of restraints on management’s ability to operate the Company’s business.

The following summarizes ITXC’s contractual obligations at March 31, 2004, and the effect such obligations are expected to have on the Company’s liquidity and cash flow in future periods.

Certain executive officers of the Company have employment agreements for a limited term that provides to each such executive officer certain benefits in the event that his employment is terminated without cause. In such event, such individuals would be entitled to receive their salary through the end of the term and certain

bonus payments, as well as related benefits described in the agreement. The potential future obligations under these agreements do not exceed $1.4 million. In addition, Anthony Servidio, who recently became Chief Financial Officer, has an employment agreement providing for a special retention bonus if he remains in the employ of the Company through a specified transition period.

Tax expense for the three months ended March 31, 2004 and March 31, 2003 was $69,000 and $174,000, respectively, related to certain foreign tax accruals. In addition, the 2003 expense included a state provision that was subsequently reversed. Since we are in a net loss position, we have no provision for federal taxes.

The Company has a federal and state NOL carryforward for which a full valuation allowance has been provided. An ownership change (such as the Teleglobe merger) would cause an imposition of an annual limitation on the use of NOL carryforwards attributable to periods before the change. The Company has not determined the amount of the potential limitation.

On April 30, 2004, New Teleglobe received notification that its amended registration statement filed on Form S-4 with the SEC had been declared effective. The Company has mailed proxy statements to its stockholders and has scheduled a stockholders’ meeting seeking approval of the transaction for May 28, 2004.

Acceris Communications Technologies Inc., a subsidiary of Acceris Communications Inc. has filed a patent infringement lawsuit against the Company, which was served on April 28, 2004. The case is pending in the United States District Court of the District of New Jersey and alleges that ITXC’s Voice over Internet Protocol (VoIP) services and systems infringe Acceris’ U.S. Patent No. 6,243,373, entitled “Method and Apparatus for Implementing a Computer Network/Internet Telephone System.” The Company intends to vigorously defend against the allegations of infringement and believes that it has substantial defenses to them. However, an adverse result in this litigation could either result in injunctive relief precluding all or a portion of ITXC’s VoIP activity or materially impact ITXC’s revenues and profitability.

We had investments of $30.8 million as of March 31, 2004 in certain marketable securities, which primarily consist of short-term fixed income investments. Due to the short-term nature of our investments, we believe that the effects of changes in interest rates are limited and would not have a material impact on our financial condition or operating results.

a) Disclosure Controls and Procedures. The Company has established and maintains disclosure controls and procedures which are designed to provide reasonable assurance that material information relating to us, including our consolidated subsidiaries, is made known to senior managers responsible for disclosure by others within those entities, particularly during the period in which this quarterly report is being prepared. We have established a Disclosure Committee which is made up of several key management employees and reports directly to the Chief Executive Officer and Chief Financial Officer, to monitor and evaluate these disclosure controls and procedures. The Audit Committee of the Board also has reviewed reports of the Disclosure Committee. As of the end of the Company’s most recently completed fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) covered by this report, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

b) Changes in internal controls over financial reporting. There have been no changes in the Company’s internal controls over financial reporting that occurred during the Company’s last fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

From time to time, we are involved in various legal proceedings relating to claims arising in the ordinary course of business.

The Company has received a copy of a complaint filed on February 24, 2004 as a class action suit in New Jersey Superior Court naming the Company and directors Tom Evslin, Edward Jordan, Frank Gill and Fred Wilson as defendants. Two claims are asserted against the individual defendants, one for breach of fiduciary duty and the other for breach of the duty of candor. Although the Company was identified as a defendant, no cause of action is asserted against the Company for damages. The action seeks to enjoin a stockholder meeting to approve ITXC’s proposed merger with Teleglobe until certain alleged deficiencies in the proxy statement have been cured and seeks to permanently enjoin the consummation of the merger. ITXC had previously announced that New Teleglobe filed a registration statement on Form S-4 with the Securities and Exchange Commission in connection with the proposed merger. ITXC believes the complaint contains factual inaccuracies, is premature and is wholly without merit and intends to vigorously defend the lawsuit.

Acceris Communications Technologies Inc., a subsidiary of Acceris Communications Inc. has filed a patent infringement lawsuit against the Company, which was served on April 28, 2004. The case is pending in the United States District Court of the District of New Jersey. The Company intends to vigorously defend against the allegations of infringement and believes that it has substantial defenses to them. However, an adverse result in this litigation could either result in injunctive relief precluding all or a portion of ITXC’s VoIP activity or materially impact ITXC’s revenues and profitability.

On May 23, 2000, Connectel, LLC, filed suit against the Company in the United States District Court for the Eastern District of Pennsylvania. Connectel alleges in its complaint that the Company is infringing on the claims of a patent owned by Connectel by, acting alone or with others, assembling, offering to sell, selling or using communications networks or switching systems within the United States and for export worldwide without license from Connectel. Connectel also seeks unspecified damages. Discovery has closed and ITXC moved for summary judgment in October 2002. Thereafter, in December 2002, the case was reassigned to a newly appointed United States District judge, Hon. James Knoll Gardner. Oral argument on the motion for summary judgment and on certain other pretrial issues was held in February 2004. On March 17^th, 2004, Judge Gardner issued an opinion finding for the Company on all issues related to the meaning of the patent claims, but denying summary judgment without prejudice to renew the motion pending a scheduled June 9^th, 2004 hearing to determine whether portions of Connectel’s expert testimony will be inadmissible in connection with the motion. The Company believes that the Connectel claims are without merit.

The Company and certain of its officers/directors were named as defendants in several purported shareholder class action lawsuits commenced in 2001. The lawsuits allege, among other things, that, in connection with the Company’s public offerings of securities, its Prospectus did not disclose certain alleged practices involving its underwriters and their customers. These actions seek compensatory and other damages, and costs and expenses associated with the litigation. No discovery has taken place. ITXC is one of hundreds of companies named in substantially identical lawsuits. Management believes that ITXC and its officers/directors did not engage in any improper or illegal conduct. All of these cases have been consolidated for pretrial purposes before Judge Scheindlin in the Southern District of New York, who refused to dismiss the cases in an opinion issued in February 2003. All of the individual defendants who had been named as defendants in the Company’s case have now been dismissed from the proceeding without prejudice, pursuant to a stipulation with the plaintiffs. Neither the individual defendants nor the Company nor its insurers paid any consideration for these dismissals. The parties have negotiated a settlement entirely funded by the directors and officers’ insurance carriers, and it is anticipated that this proposed settlement will be submitted to the Court for approval in the near future. Under the terms of the proposed settlement, neither the Company nor individual defendants will have either future liability or expenses in connection with the litigation, except for a limited obligation to cooperate in discovery in the plaintiffs’ continuing cases against the underwriters.

(b) The registrant submitted four Current Reports on Form 8-K during the quarter ended March 31, 2004. Information regarding the items reported on is as follows:

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


ITXC CORP.

By:		/s/ Anthony Servidio

		Anthony Servidio Chief Financial Officer


		Page

Part I. Financial Information

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of March 31, 2004 (Unaudited) and December 31, 2003		1

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (Unaudited)		2

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (Unaudited)		3

Notes to Condensed Consolidated Financial Statements (Unaudited)		4

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		7

Item 3. Quantitative and Qualitative Disclosure About Market Risk		18

Item 4. Controls and Procedures		18

Part II. Other Information

Item 1. Legal Proceedings		18

Item 6. Exhibits and Reports on Form 8-K		20

Signatures		21


	March 31, 2004 (Unaudited)			December 31, 2003
Assets
Current assets:
Cash and cash equivalents	$	13,226,803		$	16,069,798
Marketable securities		30,792,423			30,402,118
Accounts receivable, net		38,580,502			41,265,689
Prepaid expenses and other current assets		5,640,852			5,403,759
Restricted cash		6,306,709			6,294,344

Total current assets		94,547,289			99,435,708

Property and equipment, net		25,435,680			27,750,964
Goodwill		7,913,319			7,913,319
Other Intangibles, net		159,054			179,157
Other assets		259,788			259,453

Total assets	$	128,315,130		$	135,538,601


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable and accrued liabilities	$	48,635,160		$	48,138,025
Other liabilities		885,414			768,426
Current portion of capital lease obligations		847,226			1,038,323

Total current liabilities		50,367,800			49,944,774

Capital lease obligation, less current portion		543,799			761,129

Stockholders’ equity:
Common stock		47,336			47,205
Additional paid in capital		460,941,216			460,462,616
Accumulated other comprehensive loss		(142,364	)		(119,811	)
Accumulated deficit		(373,628,846	)		(365,743,501	)
Treasury stock		(9,813,811	)		(9,813,811	)

Total stockholders’ equity		77,403,531			84,832,698


Total liabilities and stockholders’ equity	$	128,315,130		$	135,538,601


	Three Months ended March 31,
	2004			2003
Total revenues	$	96,347,887		$	81,707,917
Costs and expenses:
Data communications and telecommunications (exclusive of depreciation shown separately below)		87,842,690			72,619,514
Network operations (exclusive of depreciation shown separately below)		2,377,131			2,498,219
Selling, general and administrative (exclusive of depreciation shown separately below)		9,778,488			18,704,116
Depreciation		4,258,600			5,635,925
Amortization		20,103			121,352

Total costs and expenses		104,277,012			99,579,126

Loss from operations		(7,929,125	)		(17,871,209	)
Interest income, net		113,252			353,843

Loss before income taxes		(7,815,873	)		(17,517,366	)
Income tax expense		69,472			173,534

Net loss	$	(7,885,345	)	$	(17,690,900	)


Basic and diluted net loss per share	$	(0.18	)	$	(0.41	)


Weighted average shares used in computation of basic and diluted net loss per share		43,410,518			42,641,594


	Three months ended March 31,
	2004			2003
Operating activities
Net loss	$	(7,885,345	)	$	(17,690,900	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		4,258,600			5,635,925
Amortization of intangibles		20,103			121,352
Provision for doubtful accounts		191,000			8,847,268
Realized loss on sale of investments		15,688			42,807
Amortization of original issue discounts		13,159			38,837
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable		2,494,187			(8,834,792	)
Increase in prepaid expenses and other assets		(237,428	)		(320,022	)
Increase (decrease) in accounts payable and accrued expenses		497,135			(3,038,064	)
Increase in other liabilities		116,988			5,000

Net cash used in operating activities		(515,913	)		(15,192,589	)


Investing activities
Purchase of property and equipment		(2,000,808	)		(6,402,099	)
Proceeds from sale of equipment		57,493			—
Increase in restricted cash		(12,365	)		(15,992	)
Purchase of available for sale securities		(6,742,102	)		(29,289,054	)
Sale of available for sale securities		6,231,974			18,312,126
Maturities of available for sale securities		91,000			9,600,000

Net cash used in investing activities		(2,374,808	)		(7,795,019	)


Financing activities
Repayment of capital lease obligations		(408,427	)		(722,359	)
Proceeds from exercise of stock options		327,775			68,564
Proceeds from issuance of common stock related to employee stock purchase plan		150,956			260,928

Net cash provided by (used in) financing activities		70,304			(392,867	)


Effect of exchange rate fluctuations on cash		(22,578	)		555


Decrease in cash		(2,842,995	)		(23,379,920	)
Cash and cash equivalents at beginning of period		16,069,798			33,027,369

Cash and cash equivalents at end of period	$	13,226,803		$	9,647,449


	Three Months ended March 31,
	2004			2003
Net loss	$	(7,885,345	)	$	(17,690,900	)
Other comprehensive income:
Unrealized holding gains (losses) arising during period		24			(27,058	)
Foreign currency translation adjustments		(22,578	)		555

Comprehensive loss	$	(7,907,899	)	$	(17,717,403	)


	2004		2003
Revenues:
Telecommunications revenue	100.0	%	100.0	%
Costs and expenses:
Data communications and telecommunications (exclusive of depreciation shown separately below)	91.2		88.9
Network operations (exclusive of depreciation shown separately below)	2.5		3.1
Selling, general and administrative (exclusive of depreciation shown separately below)	10.1		22.9
Depreciation	4.4		6.9
Amortization	0.0		0.1
Total cost and expenses	108.2		121.9
Interest income, net	0.1		0.4
Income tax expense	0.0		0.2
Net loss	(8.2	)	(21.7	)


	March 31, 2003 vs. March 31, 2004
Revenues:
Telecommunications revenue	17.9	%
Costs and expenses:
Data communications and telecommunications (exclusive of depreciation shown separately below)	21.0
Network operations (exclusive of depreciation shown separately below)	(4.8	)
Selling, general and administrative (exclusive of depreciation shown separately below)	(47.7	)
Depreciation	(24.4	)
Amortization	(83.4	)
Total cost and expenses	4.7
Interest income, net	(68.0	)
Income tax expense	(60.0	)
Net loss	(55.4	)


Contractual Obligations	Payments Due by Period
Contractual Obligations	Total		Less than 1 Year		1 – 3 years		4 – 5 years		After 5 years
Capital lease obligations	$	1,526,199	$	739,991	$	786,208	$	—	$	—
Operating leases	$	18,046,159	$	2,018,210	$	7,795,541	$	4,641,636	$	3,590,772

Total contractual cash obligations	$	19,572,358	$	2,758,201	$	8,581,749	$	4,641,636	$	3,590,772

Other Commercial Commitments	Total Amounts Committed		Less than 1 Year		1 – 3 years		4 – 5 years		Over 5 years
Lines of credit	$	—	$	—	$	—	$	—	$	—
Standby letters of credit	$	6,133,923	$	4,050,000	$	—	$	—	$	2,083,923

Total commercial commitments	$	6,133,923	$	4,050,000	$	—	$	—	$	2,083,923



31.1		Certification of the Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

99.1		Risk Factors (incorporated by reference to Exhibit 99.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003).


Date		Matter Reported On
February 18, 2004		Disseminated a press release dated February 18, 2004 (disclosure under Item 5).
February 27, 2004		Disseminated a press release dated February 27, 2004 (disclosure under Item 5).
March 15, 2004		Disseminated a press release dated March 15, 2004 (disclosure under Item 5).
March 29, 2004		Filing of an Amendment Number 1 on Form S-4 by Teleglobe Bermuda Holdings Ltd (disclosure under Item 9).