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Management Discussion for IDT CORP (IDTC) 07/1998
OVERVIEW
IDT is a leading multinational carrier that provides its wholesale and
retail customers with integrated and competitively priced international and
domestic long distance telecommunications service, Internet access and,
through its Net2Phone products and services, Internet telephony services. IDT
delivers these services over a high-quality network consisting of 60 switches
in the U.S. and Europe and owned and leased capacity on 16 undersea fiber
optic cables. In addition, the Company obtains additional transmission
capacity from other carriers.
The Company delivers its international traffic worldwide pursuant to its
agreements with U.S.-based carriers, foreign carriers, and 17 of the companies
that are primarily responsible for providing telecommunications services in
particular countries (many of which are commonly referred to as "PTTs"). In
addition,
IDT maintains a high-speed network that carries Internet traffic in order to
support both its Internet access services and its Internet telephony services.
The Company has grown considerably in recent years, generating revenues of
$57.7 million, $135.2 million and $335.4 million in Fiscal 1996, Fiscal 1997
and Fiscal 1998, respectively.
The Company entered the international call reorigination business in 1990 to
capitalize on the opportunity created by the spread between U.S. and foreign-
originated international long distance telephone rates. IDT leveraged the
expertise derived from, and calling volume generated by, its call
reorigination business to enter the domestic long distance business in late
1993, by reselling long distance services of other carriers to IDT's domestic
customers. As a value-added service for its domestic long distance customers,
the Company began offering Internet access in early 1994, eventually offering
dial-up and dedicated Internet access to individuals and to businesses as
stand-alone services. In 1995, IDT began reselling to other long distance
carriers access to the favorable telephone rates and special tariffs the
Company receives as a result of the calling volume generated by its call
reorigination customers. IDT entered the Internet telephony market in August
1996 with its introduction of Net2Phone, and expanded its Internet telephony
offerings in October 1997 with the introduction of its Net2Phone Direct
service. The Company began marketing its prepaid calling cards in January
1997.
In May 1998, the Company acquired a 51% interest in Union, which distributes
the Company's prepaid calling cards in key markets nationwide. In May 1998,
the Company also acquired InterExchange, an operator of one of the largest
international prepaid calling card platforms in the United States. In
September 1998, the Company entered into a long-term agreement with Frontier
Communications of the West, Inc. ("Frontier") whereby Frontier will provide to
the Company nationwide network bandwidth capacity and maintenance services in
exchange for payments estimated at approximately $52.0 million during the term
of the agreement.
Beginning in Fiscal 1997, the Company began to place increased emphasis on
its international telecommunications operations and less emphasis on its
Internet access services. In Fiscal 1998, the Company focused its marketing
efforts on expanding the wholesale services offered to other carriers,
developing and increasing its retail prepaid calling card business and
broadening its range of Internet telephony services and products. As a result
of these developments, the Company's telecommunications revenues as a
percentage of total revenues increased from 73.9% for Fiscal 1997 to 90.6% for
Fiscal 1998. In addition, the Company's revenues from telecommunications
operations increased from $99.9 million during Fiscal 1997 to $303.9 million
during Fiscal 1998. Revenues from the Company's telecommunications operations
are derived primarily from the following activities: (i) prepaid calling
cards; (ii) wholesale carrier services to other long distance carriers; (iii)
international retail long distance services to individuals and businesses
worldwide (primarily provided through call reorigination services); and (iv)
domestic long distance services to individuals and businesses. The Company
generates revenues from the sale of its prepaid calling cards to distributors,
selling them to distributors at a discount to their face values of different
denominations, and recording the sales as deferred revenue until the card user
utilizes the calling time. Revenues from the Company's Internet operations are
derived primarily from providing Internet access services to individuals and
businesses. The Company's Net2Phone revenues are derived from the marketing of
Net2Phone and Net2Phone Direct services and equipment to individuals,
businesses and the Company's foreign partners.
While the Company's most significant customers vary from quarter to quarter,
the Company's five largest customers accounted for 20.8% of revenues in Fiscal
1997, and 26.2% of revenues in Fiscal 1998. Of this group, the customer
accounting for the most revenues during Fiscal 1997 (17.0% of revenues) and
Fiscal 1998 (40.7% of revenues), was an entity controlled by Carlos Gomez,
which ceased to be a customer of the Company when the Company acquired its
interest in Union in May 1998. This concentration of revenues increases the
risk of nonpayment by customers, and other carriers have experienced
significant write-offs related to the provision of wholesale carrier services
in situations in which large customers failed to pay their outstanding
balances. The Company performs ongoing credit evaluations of its customers,
but it generally does not require collateral to support accounts receivable
from its customers.
Direct cost of revenues for the Company's telecommunications services
include costs associated with the transmission and termination of
international and domestic long distance services. Historically, this expense
has
primarily been variable, based upon minutes of use, and consists mainly of
payments to other long distance carriers and, to a lesser extent,
customer/carrier interconnect charges, leased fiber circuit charges and switch
facility costs. The direct cost of revenues for Internet access and Net2Phone
services consists primarily of leased circuit and network costs and local
access costs. Direct cost of revenues for Internet services also includes fees
paid to the Company's Alliance Partners.
The Company operates a growing facilities-based telecommunications network
consisting of (i) 60 switches in the U.S. and Europe; (ii) owned and leased
transmission capacity on 16 undersea fiber optic cables connecting the
Company's U.S. facilities with its international facilities, and with the
facilities of its foreign partners in Europe, Latin America and Asia; and
(iii) resale capacity obtained on a per-minute basis from other carriers. The
Company seeks to follow a disciplined strategy of establishing significant
traffic volumes prior to investing in fixed-cost facilities. As the Company
expands its network and the volume of its traffic, the cost of revenues will
increasingly consist of fixed costs associated with leased and owned lines, as
well as costs arising from the ownership and maintenance of its switches. The
Company expects that these factors will cause the direct cost of revenues to
decline as a percentage of revenues over time. The fixed nature of these costs
may also lead to larger fluctuations in gross margins, depending on the
minutes of traffic and associated revenues generated by the Company.
Selling expenses consist primarily of sales commissions paid to independent
agents and internal salespersons, which are the primary cost associated with
the acquisition of customers. General and administrative expenses include
salaries, benefits, and other corporate overhead costs. These costs have
increased in recent fiscal years due to the development and expansion of the
Company's operations and corporate infrastructure.
The Company's telecommunications revenues are generally associated with
lower selling, general and administrative expenses than the Company's Internet
revenues, and the Company's revenues from its wholesale sales of
telecommunications services have generally had lower selling, general and
administrative expenses than other types of telecommunications revenues. As a
result of these factors, and as a result of the increasing percentage of the
Company's revenues that are derived from telecommunications services and the
decreased emphasis placed on Internet access services, the Company's selling,
general and administrative expenses generally have declined as a percentage of
total revenues. However, as the Company expects its prepaid calling card and
Internet telephony businesses to grow, it is likely that selling, general and
administrative expenses will also grow as a percentage of revenues.
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