NET2PHONE INC
424B1, 1999-07-30
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)
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<PAGE>

                                               Filed Pursuant To Rule 424(b)(1)
                                               Registration No. 333-78713

PROSPECTUS


                                5,400,000 Shares
                               NET2PHONE [LOGO]

                                  Common Stock

   This is an initial public offering of common stock by Net2Phone, Inc.
Net2Phone is selling 5,400,000 shares of common stock.

                                 ------------

   At the request of Net2Phone, the underwriters intend to reserve up to an
aggregate of $12.5 million worth of common stock to be sold in this offering to
three of our current stockholders at the initial offering price. Any reserved
shares not sold to these stockholders will be offered to the general public on
the same basis as the other shares offered hereby.

   Net2Phone's common stock has been approved for listing on the Nasdaq
National Market under the symbol NTOP.

                                 ------------

<TABLE>
<CAPTION>
                                                          Per Share    Total
<S>                                                       <C>       <C>
Initial public offering price............................  $15.00   $81,000,000
Underwriting discounts and commissions...................  $ 1.05   $ 5,040,000
Proceeds to Net2Phone, before expenses...................  $13.95   $75,960,000
</TABLE>

   Net2Phone has granted the underwriters an option for a period of 30 days to
purchase up to 810,000 additional shares of common stock.

                                 ------------

         Investing in the common stock involves a high degree of risk.
                    See "Risk Factors" beginning on page 5.

                                 ------------

   Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.



Hambrecht & Quist                                                 BT Alex. Brown

                                 ------------

                            Bear, Stearns & Co. Inc.

July 29, 1999
<PAGE>

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
     <S>                                                                   <C>
     Prospectus Summary...................................................   1
     Risk Factors.........................................................   5
     Forward-Looking Statements...........................................  13
     Use of Proceeds......................................................  14
     Dividend Policy......................................................  14
     Capitalization.......................................................  15
     Dilution.............................................................  16
     Selected Financial Data..............................................  17
     Management's Discussion and Analysis of
      Financial Condition and Results of Operations.......................  18
     Business.............................................................  28
     Management...........................................................  46
     Principal Stockholders...............................................  56
     Certain Transactions.................................................  58
     Description of Capital Stock.........................................  66
     Shares Eligible for Future Sale......................................  69
     Underwriting.........................................................  71
     Legal Matters........................................................  74
     Experts..............................................................  74
     Where You Can Find More Information..................................  74
     Index to Financial Statements ....................................... F-1
</TABLE>


   We maintain Web sites at www.Net2Phone.com and www.EZSurf.com. Information
contained on our Web sites does not constitute part of this prospectus.

   "Net2Phone," "Net2Fax" and "N2P" are our registered marks. Applications to
register the service marks "Phone2Phone," "Click2Talk," "Net2Phone Pro" and
"Fax2Fax" have been filed with the United States Patent and Trademark Office.
This prospectus also includes references to registered service marks and
trademarks of other entities.
<PAGE>


                               PROSPECTUS SUMMARY

   This summary highlights selected information contained elsewhere in this
prospectus. This summary may not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including "Risk Factors" and the financial statements,
before making an investment decision.

                                   Net2Phone

   Net2Phone is a leading provider of services enabling users to make high
quality, low-cost telephone calls over the Internet. These services are
commonly referred to as Internet telephony. Our Internet telephony services
enable our customers to call individuals and businesses worldwide using their
personal computers or traditional telephones. According to Frost & Sullivan, a
leading market research firm, we were the largest provider of Internet calls in
the world in 1997 with a 30% market share.

   In August 1996, we introduced our first service, "PC2Phone." We believe that
PC2Phone was the first commercial telephone service to connect calls between
personal computers and telephones over the Internet. In September 1997, we
introduced "Phone2Phone," a service that enables international and domestic
calls to be made over the Internet using traditional telephones. Our customers
often pay substantially less for long-distance calls they make using our
services than they would for calls made over traditional long distance
networks, such as those owned by AT&T, Sprint and MCI.

   We are using our expertise in Internet telephony to integrate live voice
capabilities into the Web. We have developed simple, easy to use PC2Phone
software that operates on a personal computer and allows individuals and
businesses to:

  .  speak with sales or customer service representatives of online retailers
     and other Web-based businesses while visiting their Web sites;

  .  speak with individuals or businesses listed on various online
     directories, such as Yahoo! People Search; and

  .  call almost any telephone number in the world.

  We promote our services through relationships with international resellers
and leading Internet companies. For example, our PC2Phone software will be
embedded on an exclusive basis into future versions of Netscape's Internet
browser, including Netscape Navigator and Netscape Communicator, for the term
of our agreement. Netscape will also include a Net2Phone icon on the Netscape
Navigator Personal Toolbar and integrate our services into Netscape Netcenter,
allowing Netscape users to access our services from anywhere on the Web. In
addition, we have entered into an agreement with ICQ, a subsidiary of America
Online, to provide Internet telephony services to users of ICQ's instant
messenging service. ICQ will embed our Internet telephony software into ICQ's
Instant Messenger software on an exclusive basis, allowing ICQ users to make
PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls. We will also
co-brand a pre-paid Phone2Phone calling card with ICQ, allowing users to place
calls from the United States and 19 other countries to virtually anywhere in
the world.

  Our strategy for building on our leadership position in our market and making
live voice communication a common feature on the Internet includes the
following key elements:

  .  marketing our services widely;

  .  pursuing multiple sources of revenue;

  .  enhancing brand recognition;

  .  making our software readily available worldwide; and

  .  expanding and enhancing our products and services.

  Upon closing of this offering, IDT will own approximately 57.1% of our
outstanding capital stock. IDT owns Class A stock that has twice the voting
power of our common stock. As a result, IDT will control 64.6% of our vote.

  Our principal executive offices are located at 171 Main Street, Hackensack,
New Jersey 07601, and our telephone number at that address is (201) 907-5304.

                                       1
<PAGE>

                                  The Offering

<TABLE>
 <C>                                            <S>
 Common stock offered by Net2Phone............   5,400,000 shares
 Capital stock to be outstanding after this
  offering....................................  47,522,619 shares
  Common stock................................  10,944,429 shares
  Class A stock...............................  36,578,190 shares
 Use of proceeds..............................  $7.0 million of the net
                                                proceeds from this offering
                                                will be used to repay a portion
                                                of a note outstanding to IDT
                                                Corporation, $3.5 million will
                                                be used to pay ICQ, Inc., a
                                                subsidiary of America Online,
                                                Inc., in connection with our
                                                distribution and marketing
                                                agreement and $1.5 million will
                                                be used to pay to NBC for the
                                                purchase of television
                                                advertising. We have not made
                                                any other specific allocations
                                                with respect to the proceeds.
                                                We expect to use the balance of
                                                the proceeds: for developing
                                                and maintaining strategic
                                                Internet relationships; for
                                                advertising and promotion; for
                                                research and development; for
                                                upgrading and expanding our
                                                network; and for general
                                                corporate purposes, including
                                                working capital.
 Nasdaq National Market symbol................  NTOP
</TABLE>

                             --------------------

   This information excludes:

  .  920,000 shares subject to outstanding options granted to Jonathan Fram,
     our President, as ofJuly 27, 1999, of which 460,000 shares were granted
     at an exercise price of $3.33 per share and the remaining 460,000 shares
     were granted at an exercise price of $11.00 per share;

  .  an additional 3,666,366 shares subject to outstanding options as of July
     27, 1999 at a weighted average exercise price of $3.33 per share; and

  .  2,438,878 shares reserved for issuance under our 1999 Stock Incentive
     Plan as of July 28, 1999.

Unless otherwise noted, the information in this prospectus:

  .  reflects a 10,320-for-one stock split on our common stock, which took
     place in April 1999;

  .  reflects a three-for-one stock split on our common stock and Class A
     stock, which took place in June 1999;

  .  assumes 4,683,237 shares of common stock outstanding in July 1999;

  .  assumes 27,621,982 shares of Class A stock outstanding in July 1999;

  .  assumes the exercise of warrants to purchase 272,400 shares of our
     common stock at a price of $3.33 per share prior to the closing of this
     offering for proceeds of $907,092;

                                       2
<PAGE>


  .  assumes the exercise of options to purchase 75,000 shares of our common
     stock at a price of $3.33 per share and options to purchase 50,000
     shares of our common stock at an exercise price of $15.00 prior to the
     closing of this offering for aggregate proceeds of $999,750;

  .  assumes the conversion of 463,792 shares of Class A stock to common
     stock upon the transfer of these shares from IDT to Clifford M. Sobel,
     our Chairman, at the closing of this offering; and

  .  gives effect to the conversion of all 3,140,000 outstanding shares of
     our Series A convertible preferred stock into 9,420,000 shares of Class
     A stock at the closing of this offering.

   Each share of Class A stock entitles the holder to two votes, while holders
of our common stock are entitled to only one vote. Each share of Class A stock
is convertible into one share of common stock, and automatically converts into
common stock upon transfer.

                             --------------------

   Our fiscal year ends on July 31 of each calendar year. All references to
fiscal years in this prospectus refer to the fiscal years ending in the
indicated calendar years. For example, "fiscal 1998" refers to the fiscal year
ended July 31, 1998.


                                       3
<PAGE>


   The table below sets forth summary financial information for the periods
indicated. This information is not necessarily indicative of the results of
operations or financial position which would have resulted had we operated as
an independent entity during the periods indicated. It is important that you
read this information together with the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our financial statements and the notes thereto included elsewhere in this
prospectus.
                         Summary Financial Information

<TABLE>
<CAPTION>
                            Period from         Year Ended            Nine Months Ended
                          January 2, 1996        July 31,                 April 30,
                          (inception) to  ------------------------  -----------------------
                           July 31, 1996     1997         1998         1998        1999
                          --------------- -----------  -----------  ----------  -----------
<S>                       <C>             <C>          <C>          <C>         <C>
Statement of Operations:
  Revenue...............     $      --    $ 2,652,303  $12,005,972  $7,954,374  $22,203,257
  Loss from operations..      (507,758)    (1,697,647)  (3,544,689)   (673,922)  (2,905,966)
  Net loss..............     $(507,758)   $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966)
  Net loss per share--
   basic and diluted....     $   (0.02)   $     (0.06) $     (0.12) $    (0.02) $     (0.09)
  Shares used in
   calculation of basic
   and diluted loss per
   share................    27,864,000     27,864,000   30,186,000  29,928,000   30,960,000
</TABLE>

   The pro forma balance sheet data summarized below gives effect to:

  .  the sale of 3,140,000 shares of Series A convertible preferred stock,
     which are convertible into 9,420,000 shares of our Class A common stock,
     and warrants to purchase 180,000 shares of our common stock in May 1999
     for net proceeds of $29.9 million;
  .  the conversion of all outstanding shares of our Series A convertible
     preferred stock into shares of our Class A stock at the closing of this
     offering;
  .  the issuance of warrants to purchase 92,400 shares of our common stock
     granted to the placement agent in May 1999 in connection with the sale
     of our Series A convertible preferred stock;
  .  the repayment of $8.0 million of the amounts owed to IDT in May 1999;
     and
  .  the exercise of options to purchase 1,345,219 shares of common stock in
     May 1999 in exchange for $3.1 million in promissory notes and $1.3
     million in cash.

   The pro forma as adjusted balance sheet summarized below reflects:

  .  the sale of 5,400,000 shares of common stock in this offering;
  .  the application of $7.0 million of the estimated net proceeds from this
     offering to pay a portion of the amounts due to IDT;
  .  the application of $3.5 million of the estimated net proceeds from this
     offering to pay ICQ in connection with our distribution and marketing
     agreement;
  .  the application of $1.5 million of the estimated net proceeds from this
     offering to pay NBC for television advertising;
  .  the exercise of warrants to purchase 272,400 shares of common stock
     prior to the closing of this offering for proceeds of $907,092; and
  .  the exercise of options to purchase 75,000 shares of our common stock at
     a price of $3.33 per share and options to purchase 50,000 shares of our
     common stock at an exercise price of $15.00 prior to the closing of this
     offering for proceeds of $999,750.
<TABLE>
<CAPTION>
                                                     April 30, 1999
                                          --------------------------------------
                                                                     Pro Forma
                                             Actual      Pro Forma   As Adjusted
                                          ------------  ----------- ------------
<S>                                       <C>           <C>         <C>
Balance Sheet Data:
  Cash and cash equivalents.............. $  1,782,194  $25,016,264 $ 88,883,106
  Working capital........................  (17,255,452)  13,978,618   86,345,460
  Total assets...........................   19,818,328   43,052,398  111,919,240
  Due to IDT.............................   22,000,000   14,000,000    7,000,000
  Total stockholders' (deficit) equity...   (3,926,122)  27,307,948  103,174,790
</TABLE>

                                       4
<PAGE>

                                  RISK FACTORS

   You should carefully consider the risks described below before making an
investment decision. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected. In that event, the trading price of our shares could
decline, and you may lose part or all of your investment.

           Risks Related to Our Financial Condition and Our Business

Our limited operating history makes evaluating our business difficult.

   IDT formed us as a subsidiary in October 1997. Prior to that, we conducted
business as a division of IDT. Therefore, we have only a limited operating
history with which you may evaluate our business. You must consider the
numerous risks and uncertainties an early stage company like ours faces in the
new and rapidly evolving market for Internet-related services. These risks
include our ability to:

  .  increase awareness of our brand and continue to build user loyalty;

  .  maintain our current, and develop new, strategic relationships;

  .  respond effectively to competitive pressures; and

  .  continue to develop and upgrade our network and technology.

   If we are unsuccessful in addressing these risks, sales of our products and
services, as well as our ability to maintain or increase our customer base,
will be substantially diminished.

We have never been profitable and expect our losses to continue for the
   foreseeable future.

   We have never been profitable on an annual basis. We had an accumulated
deficit of approximately $8.7 million as of April 30, 1999. We expect to
continue to incur operating losses for the forseeable future. Our operating and
marketing expenses have continuously increased since inception and we expect
them to continue to increase significantly during the next several years.
Accordingly, we will need to generate significant revenue to achieve
profitability. We may not be able to do so. Even if we do achieve
profitability, we cannot assure you that we will be able to sustain or increase
profitability on a quarterly or annual basis in the future.

   Further, it is probable that we will have to recognize significant
additional charges relating to non-cash compensation in connection with options
that we granted in May 1999 and that we expect to grant prior to the closing of
this offering. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

We intend to pursue new streams of revenue, which we have not attempted to
   generate before and which may not be profitable.

   In the future, we intend to pursue revenue from new Web-based opportunities,
such as banner and audio advertising, as well as from sponsorship opportunities
on our user interface and our EZSurf.com Internet shopping directory. We also
intend to explore the availability of revenue-sharing opportunities. We have
not attempted to generate this type of revenue before. We intend to devote
significant capital and resources to create these new revenue streams and we
cannot ensure that these investments will be profitable.

We may have difficulties managing our expanding operations, which may reduce
   our chances of achieving profitability.

   Our future performance will depend, in part, on our ability to manage our
growth effectively. To that end, we will have to undertake the following tasks,
among others:

  .  develop our operating, administrative, and financial and accounting
     systems and controls;

                                       5
<PAGE>

  .  improve coordination among our engineering, accounting, finance,
     marketing and operations personnel;

  .  enhance our management information systems capabilities; and

  .  hire and train additional qualified personnel.

If we cannot accomplish these tasks, we will diminish our chances of achieving
profitability.

If we fail to establish and maintain strategic relationships our ability to
   increase our sales would suffer.

   We currently have strategic relationships with ICQ, Netscape, Compaq,
Yahoo!, Excite and others. We depend on these relationships to:

  .  distribute our products to potential customers;

  .  increase usage of our services;

  .  build brand awareness; and

  .  cooperatively market our products and services.

   We believe that our success depends, in part, on our ability to develop and
maintain strategic relationships with leading Internet companies and computer
hardware and software companies, as well as key marketing distribution
partners. If any of our strategic relationships are discontinued, sales of our
products and services and our ability to maintain or increase our customer base
may be substantially diminished.

If we hire a reseller who fails to market our products and services effectively
   or who provides poor customer service, our reputation will suffer and we
   could lose customers.

   If we hire a reseller who fails to market our products and services
effectively, we could lose market share. Additionally, if a reseller provides
poor customer service, we could lose brand equity. Therefore, we must maintain
and hire additional resellers throughout the world that are capable of
providing high-quality sales and service efforts. If we lose a reseller in a
key market, or if a current or future reseller fails to adequately provide
customer support, our reputation will suffer and sales of our products and
services and our customer base will be substantially diminished.

Competition could reduce our market share and decrease our revenue.

   The market for our services has been extremely competitive. Many companies
offer products and services like ours, and many of these companies have a
substantial presence in this market. Current product offerings include VocalTec
Communications' Internet Phone, QuarterDeck's WebPhone and Microsoft's
NetMeeting.

   In addition, a number of large telecommunications providers and equipment
manufacturers, such as Alcatel, Cisco, Lucent, Northern Telecom and Dialogic
(which has entered into an agreement to be acquired by Intel), have announced
that they intend to offer similar products. We expect these products to allow
live voice communications over the Internet between parties using a personal
computer and a telephone and between two parties using telephones. Cisco
Systems has also taken further steps by recently acquiring companies that
produce devices that help Internet service providers carry voice over the
Internet while maintaining traditional phone usage and infrastructure. Other
competitors of ours, such as ICG Communications, IPVoice.com, ITXC, RSL
Communications (through its Delta Three subsidiary) and VIP Calling, route
voice traffic worldwide over the Internet. In addition, major long distance
providers, such as AT&T, Deutsche Telekom, MCI WorldCom and Qwest
Communications, as well as other major companies such as Motorola and Intel,
have all entered or plan to enter the market for carrying voice over the
Internet. These companies are larger than we are and have substantially greater
financial, distribution and marketing resources than we do. We may not be able
to compete successfully in this market.

                                       6
<PAGE>

Pricing pressures may lessen our competitive pricing advantage.

   Our success is based on our ability to provide discounted domestic and
international long distance services by taking advantage of cost savings
achieved by carrying voice traffic over the Internet, as compared to carrying
calls over long distance networks, such as those owned by AT&T, Sprint and MCI.
In recent years, the price of long distance calls has fallen. In response, we
have lowered the price of our service offerings. The price of long distance
calls may decline to a point where we no longer have a price advantage over
these traditional long distance services. We would then have to rely on factors
other than price to differentiate our product and service offerings, which we
may not be able to do.

We may not be able to hire and retain the personnel we need to sustain our
   business.

   We depend on the continued services of our executive officers and other key
personnel. We have an employment agreement with only one of our executive
officers, Clifford M. Sobel, our Chairman and President. We need to attract and
retain other highly-skilled technical and managerial personnel for whom there
is intense competition. If we are unable to attract and retain qualified
technical and managerial personnel, we may never achieve profitability.

If our customers do not perceive our service to be effective or of high
   quality, our brand and name recognition would suffer.

   We believe that establishing and maintaining a brand and name recognition is
critical for attracting and expanding our targeted client base. We also believe
that the importance of reputation and name recognition will increase as
competition in our market increases. Promotion and enhancement of our name will
depend on the effectiveness of our marketing and advertising efforts and on our
success in continuing to provide high-quality products and services, neither of
which can be assured. If our customers do not perceive our service to be
effective or of high quality, our brand and name recognition would suffer.

We depend on our international operations, which subject us to unpredictable
   regulatory and political situations.

   As of April 30, 1999, approximately 65% of our customers were based outside
of the United States, generating approximately 58% of our revenues during the
nine months ended on that date. A significant component of our strategy is to
continue to expand internationally. We cannot assure you that we will be
successful in expanding into additional international markets. In addition to
the uncertainty regarding our ability to generate revenue from foreign
operations and expand our international presence, there are certain risks
inherent in doing business on an international basis, including:

  .  changing regulatory requirements;

  .  increased bad debt and subscription fraud;

  .  legal uncertainty regarding liability, tariffs and other trade barriers;

  .  political instability; and

  .  potentially adverse tax consequences.

We cannot assure you that one or more of these factors will not materially
adversely affect the growth of our business or our customer base.

All of the telephone calls made by our customers are connected through local
   telephone companies and, at least in part, through leased networks that may
   become unavailable.

   We are not a local telephone company or a registered local exchange carrier.
Our network covers only portions of the United States. Accordingly, we must
route parts of some domestic and all international calls made by our customers
over leased transmission facilities. Further, because our network does not
extend

                                       7
<PAGE>

to homes or businesses, we must route calls through a local telephone company
to reach our network and, ultimately, to reach their final destinations.

   In many of the foreign jurisdictions in which we conduct or plan to conduct
business, the primary provider of significant intra-national transmission
facilities is the national telephone company. Accordingly, we may have to lease
transmission capacity at artificially high rates from a monopolistic provider
and, consequently, we may not be able to generate a profit on those calls. In
addition, national telephone companies may not be required by law to lease
necessary transmission lines to us or, if applicable law requires national
telephone companies to lease transmission facilities to us, we may encounter
delays in negotiating leases and interconnection agreements and commencing
operations. Additionally, disputes may result with respect to pricing terms and
billing.

   In the United States, the providers of local telephone service are generally
the incumbent local telephone companies, including the regional Bell operating
companies. The permitted pricing of local transmission facilities that we lease
in the United States is subject to uncertainties. The Federal Communications
Commission has issued an order requiring incumbent local telephone companies to
price those facilities at total element long-run incremental cost, and the
United States Supreme Court recently upheld the FCC's jurisdiction to set a
pricing standard for local transmission facilities provided to competitors.
However, the incumbent local telephone companies can be expected to bring
further legal challenges to the FCC's total element long-run incremental cost
standard and, if they succeed, the result may be to increase the cost of
incumbent local transmission facilities obtained by us.

Our success depends on our ability to handle a large number of simultaneous
   calls, which our systems may not be able to accommodate.

   We expect the volume of simultaneous calls to increase significantly as we
expand our operations. Our network hardware and software may not be able to
accommodate this additional volume. If we fail to maintain an appropriate level
of operating performance, or if our service is disrupted, our reputation could
be hurt and we could lose customers.

Because we are unable to predict the volume of usage and our capacity needs, we
   may be forced to enter into disadvantageous contracts that would reduce our
   operating margins.

   In order to ensure that we are able to handle additional usage, we have
agreed to pay IDT a one-time fee of approximately $6.0 million for a 20-year
right to use part of a new high capacity network that is under construction.
This network has been pledged by IDT to its lenders under a credit facility. We
may have to enter into additional long-term agreements for leased capacity. To
the extent that we overestimate our call volume, we may be obligated to pay for
more transmission capacity than we actually use, resulting in costs without
corresponding revenue. Conversely, if we underestimate our capacity needs, we
may be required to obtain additional transmission capacity through more
expensive means that may not be available.

We may not be able to obtain sufficient funds to grow our business.

   We intend to continue to grow our business. Due to our limited operating
history and the nature of our industry, our future capital needs are difficult
to predict. Therefore, we may require additional capital after this offering to
fund any of the following:

  .  unanticipated opportunities;

  .  strategic alliances;

  .  potential acquisitions;

  .  changing business conditions; and

  .  unanticipated competitive pressures.

                                       8
<PAGE>

Obtaining additional financing will be subject to a number of factors,
including market conditions, our operating performance and investor sentiment.
These factors may make the timing, amount, terms and conditions of additional
financings unattractive to us. If we are unable to raise additional capital,
our growth could be impeded.

Any damage to or failure of our systems or operations could result in
   reductions in, or terminations of, our services.

   Our success depends on our ability to provide efficient and uninterrupted,
high-quality services. Our systems and operations are vulnerable to damage or
interruption from natural disasters, power loss, telecommunication failures,
physical or electronic break-ins, sabotage, intentional acts of vandalism and
similar events that may be or may not be beyond our control. The occurrence of
any or all of these events could hurt our reputation and cause us to lose
customers.

Unauthorized use of our intellectual property by third parties may damage our
   brand.

   We regard our copyrights, service marks, trademarks, trade secrets and other
intellectual property as critical to our success. We rely on trademark and
copyright law, trade secret protection and confidentiality agreements with our
employees, customers, partners and others to protect our intellectual property
rights. Despite our precautions, it may be possible for third parties to obtain
and use our intellectual property without authorization. Furthermore, the
validity, enforceability and scope of protection of intellectual property in
Internet-related industries is uncertain and still evolving. The laws of some
foreign countries are uncertain or do not protect intellectual property rights
to the same extent as do the laws of the United States. The unauthorized use of
our intellectual property by third parties may damage our brand.

Defending against intellectual property infringement claims could be expensive
   and could disrupt our business.

   We cannot be certain that our products do not or will not infringe upon
valid patents, trademarks, copyrights or other intellectual property rights
held by third parties. We may be subject to legal proceedings and claims from
time to time relating to the intellectual property of others in the ordinary
course of our business. We may incur substantial expenses in defending against
these third-party infringement claims, regardless of their merit. Successful
infringement claims against us may result in substantial monetary liability or
may materially disrupt the conduct of our business. See "Business--Intellectual
Property."

Year 2000 problems may disrupt our operations.

   Many computer systems and software products are coded to understand only
dates that have two digits for the relevant year. These systems and products
need upgrading to accept four digit entries in order to distinguish 21st
century dates from 20th century dates. Without upgrading, many computer
applications could fail or create erroneous results beginning in the year 2000.
The "Year 2000" problems of companies on the Internet generally could affect
our systems or operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Systems Costs" for a
more complete description of the Year 2000 risks that we face and the steps we
have taken to reduce those risks.

                   Risks Related to Our Relationship with IDT

We have contracted with IDT for various services and for the use of its
   telecommunications network, which contracts we may not be able to renew when
   they expire.

   In May 1999, we entered into agreements with IDT under which IDT will
continue to provide administrative and telecommunication services to us. When
these agreements expire, we will need to extend them, engage other entities to
perform these services or perform these services ourselves. In addition, after
the initial term, these agreements are terminable by either party upon prior
written notice. We cannot

                                       9
<PAGE>

assure you that IDT will not terminate these agreements or continue to provide
these services after the initial term of the agreements. As a result, we may
have to purchase these services from third parties or devote resources to
handle these functions internally, which may cost us more than we paid IDT for
the same services. In addition, IDT has provided us in the past with working
capital to fund our operations, and IDT is not under any obligation, under
these agreements or otherwise, to do so in the future.

We may experience conflicts of interest with IDT, which may not be resolved in
   our favor.

   Two members of our board of directors are officers and directors of IDT. One
of these directors, Howard S. Jonas, is the Chairman and Chief Executive
Officer of IDT and IDT's controlling shareholder. Additionally, one of our
directors, James R. Mellor, was a director of IDT until June 1999. Clifford M.
Sobel, our Chairman, has an option to transfer his interest in us to IDT in
exchange for an option to purchase 875,000 shares of IDT common stock at a
purchase price of $6.50 per share. See "Management--Employment Contracts." In
addition, certain of our executive officers, directors and employees hold
shares of IDT common stock and options to acquire shares of IDT common stock.
These individuals may have conflicts of interest with respect to certain
decisions involving business opportunities and similar matters that may arise
in the ordinary course of our business or the business of IDT. If conflicts
arise with IDT, we expect to resolve those conflicts on a case-by-case basis,
and in the manner required by applicable law and customary business practices,
subject to our agreement with IDT to resolve disputes involving $5.0 million or
less through mandatory, binding arbitration. Conflicts, if any, could be
resolved in a manner adverse to us and our stockholders, which could harm our
business.

Through its ownership of our stock, IDT effectively controls our company and
   may exert influence contrary to the interests of other stockholders.

   Immediately following this offering, IDT will own approximately 57.1% of our
outstanding capital stock. Because IDT owns Class A stock, which entitles the
holder to two votes per share, IDT will control 64.6% of our voting power.
Therefore, IDT will have the power to determine the election of our directors,
the appointment of new management and the approval of any other action
requiring the approval of our stockholders, including any amendments to our
certificate of incorporation and mergers or sales of our company or of all of
our assets. In addition, without the consent of IDT, we could be prevented from
entering into certain transactions that could be beneficial to us. Third
parties could be discouraged from making a tender offer or bid to acquire us
because of IDT's stockholdings and voting rights. IDT's ownership will increase
further if Clifford M. Sobel exercises his option to transfer his shares of our
stock to IDT in exchange for an option to purchase shares of IDT. See
"Principal Stockholders."

IDT has pledged its shares of our stock to secure a credit facility, which
   shares may be transferred to a third party that would effectively control us
   if IDT defaults on its obligations.

   The shares owned by IDT are pledged as collateral to secure an IDT credit
facility. The lenders under the credit facility have agreed to permit IDT to
transfer our shares free and clear of any liens as and when IDT seeks to
transfer shares of our stock. Such transferability will cease if IDT's
ownership of our capital stock drops below 50% of the number of shares which it
owns 72 hours after the consummation of this offering. If IDT defaults in its
obligations under the credit facility, then a third party could acquire the
voting rights with respect to the pledged stock and become party to our
intercompany agreements. We cannot assume that a third party would maintain
good relations with us or maintain or renew our agreements with IDT.

                         Risks Related to Our Industry

If the Internet does not continue to grow as a medium for voice communications,
   our business will suffer.

   The technology that allows voice communications over the Internet is still
in its early stages of development. Historically, the sound quality of Internet
calls was poor. As the industry has grown, sound

                                       10
<PAGE>

quality has improved, but the technology requires further refinement.
Additionally, the Internet's capacity constraints may impede the acceptance of
Internet telephony. Callers could experience delays, errors in transmissions or
other interruptions in service. Making telephone calls over the Internet must
also be accepted as an alternative to traditional telephone service. Because
the Internet telephony market is new and evolving, predicting the size of this
market and its growth rate is difficult. If our market fails to develop, then
we will be unable to grow our customer base and our opportunity for
profitability will be harmed.

Our business will not grow without increased use of the Internet.

   The use of the Internet as a commercial marketplace is at an early stage of
development. Demand and market acceptance for recently introduced products and
services over the Internet are still uncertain. We cannot predict whether
customers will be willing to shift their traditional activities online. The
Internet may not prove to be a viable commercial marketplace for a number of
reasons, including:

  .  concerns about security;

  .  Internet congestion;

  .  inconsistent service; and

  .  lack of cost-effective, high-speed access.

If the use of the Internet as a commercial marketplace does not continue to
grow, we may not be able to grow our customer base, which may prevent us from
achieving profitability.

Governmental regulations regarding the Internet may be passed, which could
   impede our business.

   To date, governmental regulations have not materially restricted use of the
Internet in our market. However, the legal and regulatory environment that
pertains to the Internet is uncertain and may change. New regulations could
increase our costs of doing business and prevent us from delivering our
products and services over the Internet. The growth of the Internet may also be
significantly slowed. This could delay growth in demand for our products and
services and limit the growth of our revenue.

   In addition to new regulations being adopted, existing laws may be applied
to the Internet. See "Business--Regulation." New and existing laws may cover
issues that include:

  .  sales and other taxes;

  .  access charges;

  .  user privacy;

  .  pricing controls;

  .  characteristics and quality of products and services;

  .  consumer protection;

  .  contributions to the universal service fund, an FCC-administered fund
     for the support of local telephone service in rural and high cost areas;

  .  cross-border commerce;

  .  copyright, trademark and patent infringement; and

  .  other claims based on the nature and content of Internet materials.

   In September 1998, two regional Bell operating companies advised Internet
telephony providers that these companies would impose access charges on
Internet telephony traffic. One of these operating companies also petitioned
the FCC for a declaratory ruling that providers of interstate Internet
telephony

                                       11
<PAGE>

must pay federal access charges, and has petitioned the public utilities
commissions of Nebraska and Colorado for similar rulings concerning payment of
access charges for intrastate Internet telephone calls. The outcome of these
proceedings is uncertain. If these states decide that access charges may be
levied against Internet telephony providers, we would have to pay money for
access in those states. If additional state utility commissions make similar
rulings, we may not be able to operate profitably in any state that assesses
access charges against us.

Our risk management practices may not be sufficient to protect us from
   unauthorized transactions or thefts of services.

   We may be the victim of fraud or theft of service. From time to time,
callers have obtained our services without rendering payment by unlawfully
using our access numbers and personal identification numbers. We attempt to
manage these theft and fraud risks through our internal controls and our
monitoring and blocking systems. If these efforts are not successful, the theft
of our services may cause our revenue to decline significantly.

                         Risks Related to this Offering

Our stock price is likely to be highly volatile and could drop unexpectedly.

   Following this offering, the price for our common stock could be highly
volatile and subject to wide fluctuations in response to the following factors:

  .  quarterly variations in our operating results;

  .  announcements of technical innovations, new products or services by us
     or our competitors;

  .  investor perception of us, the Internet telephony market or the Internet
     in general;

  .  changes in financial estimates by securities analysts; and

  .  general economic and market conditions.

   The stocks of many Internet-related companies have experienced significant
fluctuations in trading price and volume. Often these fluctuations have been
unrelated to operating performance. Declines in the market price of our common
stock could also materially adversely affect employee morale and retention, our
access to capital and other aspects of our business.

If our stock price is volatile, we may become subject to securities litigation,
   which is expensive and could divert our resources.

   In the past, following periods of market volatility in the price of a
company's securities, security holders have instituted class action litigation.
Many companies in our industry have been subject to this type of litigation. If
the market value of our stock experiences adverse fluctuations, and we become
involved in this type of litigation, regardless of the outcome, we could incur
substantial legal costs and our management's attention could be diverted,
causing our business to suffer.

The sale of a substantial number of shares of our common stock after this
   offering may affect our stock price.

   The market price of our common stock could decline as a result of sales of
substantial amounts of common stock in the public market after the closing of
this offering or the perception that substantial sales could occur. These sales
also might make it difficult for us to sell equity securities in the future at
a time and at a price that we deem appropriate.


                                       12
<PAGE>

We may use the proceeds from this offering in ways with which you may not
   agree.

   We have significant flexibility in applying the proceeds we receive in this
offering. Other than the repayment of $7.0 million on an outstanding note to
IDT, the payment of $3.5 million to ICQ in connection with our distribution and
marketing agreement and the payment of $1.5 million to NBC for television
advertising, the proceeds are not required to be allocated to any specific
investment or transaction. Therefore, you cannot determine the value or
propriety of our use of proceeds. If we do not apply the funds we receive
effectively, our accumulated deficit will increase and we may lose significant
business opportunities. See "Use of Proceeds" for a more detailed description
of how we intend to apply the proceeds from this offering.

Our certificate of incorporation, our bylaws and Delaware law make it difficult
   for a third party to acquire us, despite the possible benefit to our
   stockholders.

   Provisions of our certificate of incorporation, our bylaws and Delaware law
could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders. For example, our certificate of
incorporation provides for a classified board of directors, meaning that only
approximately one-third of our directors will be subject to re-election at each
annual stockholder meeting. Moreover, our certificate of incorporation creates
a class of stock with super-voting rights. The holders of Class A stock are
entitled to two votes per share while the holders of common stock are entitled
to one vote per share. Except as otherwise required by law or as described
below, the holders of Class A stock and common stock will vote together as a
single class on all matters presented to the stockholders for their vote or
approval, including the election of directors. The holders of Class A stock may
have the ability to elect all of our directors and to effect or prevent certain
corporate transactions. These provisions could discourage takeover attempts and
could materially adversely affect the price of our stock.

                           FORWARD-LOOKING STATEMENTS

   This prospectus contains "forward-looking statements." These forward-looking
statements include, without limitation, statements about our market
opportunity, strategies, competition, expected activities and expenditures as
we pursue our business plan, and the adequacy of our available cash resources.
Our actual results could differ materially from those expressed or implied by
these forward-looking statements as a result of various factors, including the
risk factors described above and elsewhere in this prospectus.

                                       13
<PAGE>

                                USE OF PROCEEDS

   Net2Phone will receive net proceeds of approximately $74.0 million from the
sale of 5,400,000 shares of common stock (and an additional $11.3 million from
the sale of 810,000 shares if the underwriters over-allotment option is
exercised in full) at the initial public offering price of $15.00 per share
after deducting underwriting commissions and discounts of $5.0 million (and an
additional $851,000 if the underwriters' over-allotment option is exercised in
full) and estimated expenses of $2.0 million.

   $7.0 million of the net proceeds from this offering will be used to repay a
portion of the $14.0 million note outstanding to IDT. $3.5 million will be used
to pay ICQ, a subsidiary of America Online, in connection with our distribution
and marketing agreement and $1.5 million will be used to prepay NBC for
television advertising. As of the date of this prospectus, we have not made any
other specific allocations with respect to the proceeds. Therefore, we cannot
specify with certainty the particular uses for the net proceeds to be received
upon consummation of this offering. Accordingly, our management will have
significant flexibility in applying the net proceeds from this offering.

   We expect to use the balance of the net proceeds of this offering for:

  .  developing and maintaining strategic Internet relationships;

  .  advertising and promotion;

  .  research and development;

  .  upgrading and expanding our network; and

  .  general corporate purposes, including working capital.

   Pending any use, the net proceeds of this offering will be invested in
short-term, interest-bearing securities.

                                DIVIDEND POLICY

   We have not paid any dividends in the past and do not intend to pay cash
dividends on our capital stock for the foreseeable future. Instead, we intend
to retain all earnings for use in the operation and expansion of our business.

                                       14
<PAGE>

                                 CAPITALIZATION
   The following table sets forth:
  .  our actual capitalization as of April 30, 1999;
  .  our pro forma capitalization to give effect to:
    .  the conversion of IDT's 27,864,000 shares of our common stock into
       27,864,000 shares of Class A stock in May 1999,
    .  the sale of 3,140,000 shares of Series A convertible preferred
       stock, which are convertible into 9,420,000 shares of our Class A
       common stock, and warrants to purchase 180,000 shares of our common
       stock in May 1999 for net proceeds of $29.9 million,
    .  the conversion of all outstanding shares of our Series A convertible
       preferred stock into shares of our Class A stock at the closing of
       this offering,
    .  the issuance of warrants to purchase 92,400 shares of our common
       stock granted to the placement agent in May 1999 in connection with
       the sale of our Series A convertible preferred stock,
    .  the repayment of $8.0 million of the amounts owed to IDT in May
       1999,
    .  the conversion of 242,018 shares of Class A stock to common stock
       upon the transfer of these shares from IDT to Clifford M. Sobel in
       May 1999, and
    .  the exercise of stock options to purchase 1,345,219 shares of common
       stock in May 1999 in exchange for $3.1 million in promissory notes
       and $1.3 million in cash; and
  .  the pro forma as adjusted balance sheet summarized below reflects:
    .  the sale of 5,400,000 shares of common stock in this offering,
    .  the application of $7.0 million of the net proceeds from this
       offering to pay a portion of the amounts due to IDT,
    .  the conversion of 463,792 shares of Class A stock to common stock
       upon the transfer of those shares from IDT to Clifford M. Sobel at
       the closing of this offering, and
    .  the exercise of warrants prior to the closing of this offering to
       purchase 272,400 shares of common stock for proceeds of $907,000,
       and
    .  the exercise of options to purchase 75,000 shares of our common
       stock at a price of $3.33 per share and options to purchase 50,000
       shares of our common stock at $15.00 prior to the closing of this
       offering for proceeds of $999,750.

   The information set forth in the table below excludes 920,000 shares of
common stock issuable upon exercise of options granted to Jonathan Fram, our
President, of which 460,000 shares were granted at an exercise price of $3.33
per share and the remaining 460,000 shares were granted at an exercise price of
$11.00 per share. This information also excludes an additional 3,666,366 shares
of common stock issuable upon exercise of options to purchase our common stock
at a weighted average exercise price of $3.33 per share. This information also
excludes the effect of non-cash compensation in connection with options to
purchase approximately 5,040,000 shares of our common stock that were granted
in May 1999, options to purchase 920,000 shares of common stock granted to Mr.
Fram and options to purchase 2,671,500 additional shares of our common stock
that were granted on July 28, 1999. See "Management--1999 Stock Incentive Plan"
and "Certain Transactions--Relationship with Other Investors."
<TABLE>
<CAPTION>
                                                    April 30, 1999
                                         --------------------------------------
                                                                    Pro Forma
                                           Actual      Pro Forma   As Adjusted
                                         -----------  -----------  ------------
<S>                                      <C>          <C>          <C>
Due to IDT.............................  $22,000,000  $14,000,000  $  7,000,000
Redeemable convertible preferred stock,
 Series A, $.01 par value; 3,150,000
 shares authorized, no shares issued
 and outstanding.......................           --           --            --
Stockholders' (deficit) equity:
Preferred stock, $.01 par value;
 6,850,000 shares authorized, no shares
 issued and outstanding................           --           --            --
Common stock, $.01 par value;
 200,000,000 shares authorized;
 30,960,000 (actual) 4,683,237 (pro
 forma) and 10,944,429 (pro forma as
 adjusted) shares issued and
 outstanding...........................      309,600       46,832       109,444
Class A stock, $.01 par value;
 37,042,089 shares authorized; none
 (actual) 37,041,982 (pro forma) and
 36,578,190 (pro forma as adjusted)
 shares issued and outstanding.........           --      370,420       365,782
Additional paid-in capital.............    4,420,338   38,696,746   114,505,614
Loans to stockholders..................           --   (3,149,990)   (3,149,990)
Accumulated deficit....................   (8,656,060)  (8,656,060)   (8,656,060)
                                         -----------  -----------  ------------
Total stockholders' (deficit) equity...   (3,926,122)  27,307,948   103,174,790
                                         -----------  -----------  ------------
Total capitalization...................  $18,073,878  $41,307,948  $110,174,790
                                         ===========  ===========  ============
</TABLE>

                                       15
<PAGE>

                                    DILUTION

   The net tangible book value of Net2Phone common stock and Class A stock as
of April 30, 1999, as adjusted to give effect to a private placement of
3,140,000 shares of Series A convertible preferred stock in May 1999, the
conversion of those shares into Class A stock and the exercise of stock options
to purchase 1,345,219 shares of common stock, was $22.3 million, or $0.53 per
share of common stock and Class A stock. Net tangible book value per share
represents the amount of our total tangible assets less our total liabilities,
divided by the total number of shares of common stock and Class A stock
outstanding.

   After giving effect to this offering and the receipt of $74.0 million of net
proceeds from this offering, the issuance of 3,140,000 shares of Series A
convertible preferred stock in May 1999, the conversion of the Series A
convertible preferred stock into 9,420,000 shares of Class A stock, the
exercise of warrants to purchase 272,400 shares of common stock and the
exercise of options to purchase 125,000 shares of common stock, the pro forma
net tangible book value of the common stock and Class A stock as of April 30,
1999 would have been $98.2 million, or $2.07 per share. This amount represents
an immediate increase in net tangible book value of $1.54 per share to the
existing stockholders and an immediate dilution in net tangible book value of
$12.93 per share to purchasers of common stock in this offering. Dilution is
determined by subtracting pro forma net tangible book value per share after
this offering from the amount of cash paid by a new investor for a share of
common stock. The following table illustrates such dilution:

<TABLE>
<S>                                                                <C>   <C>
  Initial public offering price per share.........................       $15.00
    Net tangible book value per share at April 30, 1999 .......... $0.53
    Increase per share attributable to new investors..............  1.54
                                                                   -----
  Pro forma net tangible book value per share after this
  offering........................................................         2.07
                                                                         ------
  Dilution per share to new investors.............................       $12.93
                                                                         ======
</TABLE>

   The following table sets forth, as of April 30, 1999, on the pro forma basis
described above, the number of shares of capital stock purchased from us, the
total consideration paid to us and the average price per share paid by existing
stockholders and by new investors who purchase shares of common stock in this
offering, before deducting the underwriting discounts and commissions and
estimated offering expenses.

<TABLE>
<CAPTION>
                           Shares Purchased  Total Consideration
                          ------------------ -------------------  Average Price
                            Number   Percent    Amount    Percent   Per Share
                          ---------- ------- ------------ ------- -------------
<S>                       <C>        <C>     <C>          <C>     <C>
  Existing stockholders.. 42,122,619   88.6% $ 41,020,840   33.6%    $ 0.97
  New investors..........  5,400,000   11.4%   81,000,000   66.4%     15.00
                          ----------  -----  ------------  -----
      Total.............. 47,522,619  100.0% $122,020,840  100.0%
                          ==========  =====  ============  =====
</TABLE>

                                       16
<PAGE>

                            SELECTED FINANCIAL DATA

   The following selected financial data should be read in conjunction with our
financial statements and related notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this prospectus. The statement of operations data for the period from
January 2, 1996 (inception) to July 31, 1996, fiscal 1997 and fiscal 1998 and
the balance sheet data as of July 31, 1997 and 1998 are derived from our
financial statements that have been audited by Ernst & Young LLP, independent
auditors, which are included elsewhere in this prospectus. The statement of
operations data for the nine months ended April 30, 1998 and 1999 and the
balance sheet data as of April 30, 1999 have been derived from our unaudited
financial statements that have been prepared on the same basis as the audited
financial statements and, in the opinion of management, include all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the financial data for the periods presented. The financial
data for the interim periods is not necessarily indicative of results that may
be expected for any other interim period or for the year as a whole.

<TABLE>
<CAPTION>
                           Period from          Year Ended             Nine Months Ended
                         January 2, 1996         July 31,                  April 30,
                           (inception)    ------------------------  -------------------------
                         to July 31, 1996    1997         1998          1998         1999
                         ---------------- -----------  -----------  ------------  -----------
<S>                      <C>              <C>          <C>          <C>           <C>
Statement of Operations
 Data:
 Revenue:
  PC2Phone..............     $      --    $ 2,170,442  $ 7,962,821  $  5,085,176  $13,774,837
  Phone2Phone...........            --            272    2,030,516     1,018,835    6,503,697
  Other.................            --        481,589    2,012,635     1,850,363    1,924,723
                            ----------    -----------  -----------  ------------  -----------
    Total revenue.......            --      2,652,303   12,005,972     7,954,374   22,203,257
                            ----------    -----------  -----------  ------------  -----------
 Cost and expenses:
  Direct cost of
   revenue, excluding
   depreciation.........            --      1,553,443    6,848,759     3,589,301   11,848,089
  Sales and marketing...        34,468         76,724    2,887,766     1,363,060    4,746,316
  General and
   administrative.......       465,015      2,599,283    5,087,628     3,254,287    7,298,106
  Depreciation..........         8,275        120,500      726,508       421,648    1,216,712
                            ----------    -----------  -----------  ------------  -----------
    Total costs and
     expenses...........       507,758      4,349,950   15,550,661     8,628,296   25,109,223
                            ----------    -----------  -----------  ------------  -----------
 Loss from operations
  and net loss..........     $(507,758)   $(1,697,647) $(3,544,689) $   (673,922) $(2,905,966)
                            ==========    ===========  ===========  ============  ===========
 Net loss per share--
  basic and diluted.....     $   (0.02)   $     (0.06) $     (0.12) $      (0.02) $     (0.09)
                            ==========    ===========  ===========  ============  ===========
 Shares used in
  calculation of basic
  and diluted net loss
  per share.............    27,864,000     27,864,000   30,186,000    29,928,000   30,960,000


<CAPTION>
                                                        July 31,                   April 30,
                                          --------------------------------------  -----------
                                             1996         1997          1998         1999
                                          -----------  -----------  ------------  -----------
<S>                      <C>              <C>          <C>          <C>           <C>
Balance Sheet Data:
 Cash and cash equivalents...............  $       --  $        --  $     10,074  $ 1,782,194
 Working capital.........................    (681,532)  (3,104,830)  (11,149,553) (17,255,452)
 Total assets............................     174,674      916,025     6,975,108   19,818,328
 Due to IDT..............................     681,532    2,960,429    11,814,988   22,000,000
 Total stockholders' (deficit)...........    (507,758)  (2,205,305)   (5,649,994)  (3,926,122)
</TABLE>

                                       17
<PAGE>

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   The following discussion should be read in conjunction with our financial
statements and notes thereto. The historical financial information included in
this prospectus does not necessarily reflect what our financial condition and
results of operations would have been had we been operated as an independent
entity during the periods presented.

Overview

   We began our operations in January 1996, launched our first Net2Phone
product in August 1996, and were established as a separate subsidiary of IDT in
October 1997. During the period ended July 31, 1996, we incurred approximately
$500,000 in start-up costs, primarily for research and development. We have
incurred net operating losses since inception and expect to incur additional
losses for the foreseeable future, primarily as a result of increased sales and
marketing efforts. As of April 30, 1999, we had accumulated net losses of
approximately $8.7 million.

   We will recognize significant charges relating to non-cash executive
compensation expense in the current fiscal quarter ending July 31, 1999 and on
an ongoing basis. In connection with 5,040,000 options granted with an exercise
price of $3.33 per share on May 17, 1999, including options granted to IDT
employees, we will recognize approximately $41 million of non-cash charges over
the vesting period of these options. We will recognize a charge of $13 million
in the current quarter, $10 million during fiscal 2000, $10 million during
fiscal 2001 and $8 million during fiscal 2002. We also granted options to
purchase approximately 2,503,500 shares of our common stock on July 28, 1999 to
our employees, consultants and others which have an exercise price of $15.00
per share, and additional options to purchase 168,000 shares of our common
stock at an exercise price of $3.33 per share, which will result in additional
non-cash compensation charges.

   In addition, in connection with the 460,000 options granted to our President
with an exercise price of $3.33 per share, we will recognize approximately $3.6
million of non-cash charges over the vesting period of these options. We will
recognize a charge of $1.2 million during the current quarter, $800,000 during
fiscal 2000, $800,000 during fiscal 2001 and $800,000 during fiscal 2002. In
connection with the remaining 460,000 options granted to our President, which
have an exercise price equal to $11.00 per share, we will also recognize a
compensation charge. The non-cash compensation charge will be $1,840,000 and
will be amortized over the three-year vesting period of the options.

   In May 1999, we issued 3,140,000 shares of Series A convertible preferred
stock which are convertible into 9,420,000 shares of Class A stock at $3.33 per
share. The Series A convertible preferred stock contains beneficial conversion
features. The total value of the beneficial conversion features is
approximately $75 million. For accounting purposes the value of the beneficial
conversion features was limited to the amount of proceeds allocated to the
Series A convertible preferred stock. We will record a reduction in net income
available to common stockholders in the quarter ending July 31, 1999 of
approximately $29.3 million. In connection with the issuance of the Series A
convertible preferred stock, we issued warrants to purchase 272,400 shares of
common stock at an exercise price of $3.33 per share. The fair value of
warrants on the date of issuance was $2.1 million. The fair value of the
warrants will be recorded as an increase to additional paid in capital and a
decrease to the carrying value of the Series A convertible preferred stock. The
decrease in the carrying value of the Series A convertible preferred stock will
be accreted, with a corresponding reduction of additional paid-in capital, over
the period to the initial redemption date in May 2006. In connection with this
offering, the Series A convertible preferred stock will be converted in Class A
stock. At that time, the balance of the unamortized discount will be recorded
as a reduction of the amount of income available for common shareholders.

                                       18
<PAGE>

   In connection with our distribution and marketing agreement with ICQ, we
issued a warrant to America Online to purchase up to 3% of our outstanding
capital stock on a fully-diluted basis. This warrant will vest in 1% increments
upon the achievement of each of three incremental thresholds of revenue
generated under the agreement during the first four years that the warrant is
outstanding. The per share exercise price under the warrant will be equal to
the lesser of $12.00 per share or $450 million divided by the number of our
fully-diluted shares on the initial exercise date. If one or more of the
revenue thresholds set forth in the warrant are achieved, we will recognize
additional non-cash charges in an amount equal to the value of the warrant, as
determined at the time that these thresholds are met.

 Sources of Revenue

   For the first nine months of fiscal 1999, approximately 62% of our revenue
has been derived from per-minute charges we billed to our customers on a
prepaid basis to use our PC2Phone service, and approximately 29% of our revenue
has been derived from per-minute charges we billed to our customers and our
international resellers on a prepaid basis to use our Phone2Phone service. The
remainder of our revenue has been derived from the sale of Internet telephony
equipment for Net2Phone Pro, a product that integrates our software into
hardware for the personal computer, and for services we provide to IDT and
other carriers. In the future, in order to diversify and further enhance our
revenue sources, we plan to introduce a variety of value-added services and
Internet commerce solutions. In addition, we plan to sell Web-based advertising
to further leverage our customer reach. To date, these additional products and
services have provided no revenue and we do not anticipate material revenue
from these additional products and services through at least December 1999.

   Approximately 91% of our revenue is generated from per-minute charges we
charge our customers on a prepaid basis to use our PC2Phone and Phone2Phone
services. As of April 30, 1999, we served over 250,000 active customers who
spent an average of approximately 60 minutes per month placing calls over the
Internet. We recognize revenue as our customers utilize the balances in their
prepaid accounts by placing calls. As such, we have deferred revenue for all
unutilized balances in our customers' accounts. The remaining 9% of our
revenue, which is derived from equipment sales and from services provided to
IDT and other carriers, is recognized upon installation of the equipment and
performance of the services.

 Cost Structure

   Our costs and expenses include:

  .  direct cost of revenue, excluding depreciation;
  .  sales and marketing;
  .  general and administrative; and
  .  depreciation.

 Direct Cost of Revenue

   Direct cost of revenue consists primarily of network costs associated with
carrying our customers' traffic on our network and leased networks, and routing
their calls through a local telephone company to reach their final destination.
These costs exclude depreciation and include:

  .  amounts paid to other carriers to terminate traffic on a per-minute
     basis;
  .  the cost of leased routers and access servers;
  .  telecommunications costs, including the cost of local telephone lines to
     carry subscriber calls to our network;
  .  the costs associated with leased lines connecting our network directly
     to the Internet or to our operations centers and connecting our
     operations centers to the Internet; and
  .  Internet backbone costs, which are the amounts we pay to Internet
     service providers for capacity.

                                       19
<PAGE>

   We expect our direct cost of revenue to increase in absolute terms over time
to support our growing customer base. While some of these costs are fixed,
other costs vary on a per minute basis. Therefore, there may be some volatility
in our direct cost of revenue as a percentage of revenue, particularly as we
expand our network. We try to terminate calls on our own network whenever
possible. When we cannot terminate calls on our network, we terminate calls on
the network of other suppliers, primarily IDT. We expect to continue to utilize
this process. We also expect the percentage of our traffic that we terminate
with IDT will decline in the future as we expand our own network.

   Sales and Marketing. Sales and marketing includes the expenses associated
with acquiring customers, including commissions paid to our sales personnel,
advertising costs, referral fees and amounts paid to our strategic partners in
connection with revenue-sharing arrangements. We expect sales and marketing
expenses to increase over time as we aggressively market our products and
services. Historically, sales and marketing expenses have been a relatively
variable cost and are expected to increase both in terms of absolute dollars
and as a percentage of revenue as our revenue grows. We expect to spend
significant capital to build brand recognition. Most of our sales and marketing
expenses will go toward securing significant and strategic relationships with a
variety of Internet companies. We have strategic alliances with ICQ, Netscape,
Snap.com, Yahoo!, ZDNet, and InfoSpace.com, and intend to continue to pursue
relationships with other companies.

   General and Administrative. General and administrative expenses consist of
the salaries of our employees and associated benefits, and the cost of
insurance, travel, entertainment, rent and utilities. A large portion of our
general and administrative expenses include operations and customer support.
These include the expenses associated with customer service and technical
support, and consist primarily of the salaries and employment costs of the
employees responsible for those efforts. We expect operations and customer
support expenses to increase over time to support new and existing customers.
We expect general and administrative costs to increase to support our growth,
particularly as we establish a larger organization to implement our business
plan. We include our research and development costs, comprised primarily of
payroll expenses for our technical team of engineers and developers, in general
and administrative expenses. We plan to incur additional costs for research and
development, though they are not expected to increase as a percentage of
revenue. Over time, we expect these relatively fixed general and administrative
expenses to decrease as a percentage of revenue.

   Depreciation. Depreciation primarily relates to our hardware infrastructure.
We depreciate our network equipment over its estimated five-year useful life
using the straight-line method. We plan to acquire a domestic high capacity
network to provide additional capacity to handle the expected increase in
customer traffic as our business grows. In addition, we will be adding more
network hardware as traffic volumes justify. We expect depreciation to increase
in absolute terms as we expand our network to support new and acquired
customers, but to decrease as a percentage of total revenue. We have also
entered into a strategic agreement with Netscape, part of which includes the
purchase of software and trademark licenses. We expect to amortize the costs
relating to the software and trademark licenses acquired from Netscape over the
two-year term of the agreement.

   Dependence on IDT. Historically, we have been dependent on IDT for working
capital, its telecommunications network and for various services. In connection
with establishing ourselves as an independent operating entity, we recently
contracted with IDT for telecommunications services and administrative support.
We believe that the terms of our agreements with IDT are no less favorable than
those we would have obtained from unaffiliated third parties.

                                       20
<PAGE>

Results of Operations

  The following table sets forth certain items in our statement of operations
as a percentage of total revenue for the periods indicated:

<TABLE>
<CAPTION>
                                        Percentage of Revenue
                              -----------------------------------------------
                              Period from
                              January 2,
                                 1996     Year Ended      Nine Months Ended
                              (inception)  July 31,           April 30,
                              to July 31, -------------   -------------------
                                 1996     1997    1998      1998       1999
                              ----------- -----   -----   --------   --------
<S>                           <C>         <C>     <C>     <C>        <C>
Revenue:
    PC2Phone.................       --     81.8%   66.3%      63.9%      62.0%
    Phone2Phone..............       --       --    16.9       12.8       29.3
    Other....................       --     18.2    16.8       23.3        8.7
                                 -----    -----   -----   --------   --------
        Total revenue........       --    100.0   100.0      100.0      100.0
                                 -----    -----   -----   --------   --------
Cost and expenses:
    Direct cost of revenue,
     excluding depreciation..       --     58.6    57.0       45.1       53.4
    Sales and marketing......       --      2.9    24.1       17.1       21.4
    General and
    administrative...........       --     98.0    42.4       40.9       32.8
    Depreciation.............       --      4.5     6.1        5.3        5.5
                                 -----    -----   -----   --------   --------
        Total costs and
         expenses............       --    164.0   129.6      108.4      113.1
                                 -----    -----   -----   --------   --------
Loss from operations and net
   loss......................       --    (64.0)% (29.6)%     (8.4)%    (13.1)%
                                 =====    =====   =====   ========   ========
</TABLE>

Comparison of Nine Months Ended April 30, 1998 and 1999

   Revenue. Revenue increased approximately 178% from approximately $8.0
million for the nine months ended April 30, 1998 to approximately $22.2 million
for the nine months ended April 30, 1999. Of total revenue for the nine months
ended April 30, 1999, PC2Phone generated approximately $13.8 million and
Phone2Phone generated approximately $6.5 million. The increase in revenue was
primarily due to an increase in minutes of use resulting from additional
marketing of our products and services. Specifically, revenue from PC2Phone
services increased approximately 171% from approximately $5.1 million for the
nine months ended April 30, 1998 to approximately $13.8 million in revenue for
the corresponding nine-month period in fiscal 1999. Revenue from Phone2Phone
increased approximately 550% from approximately $1.0 million for the nine
months ended April 30, 1998 to approximately $6.5 million for the nine months
ended April 30, 1999. We anticipate that revenue from PC2Phone and Phone2Phone
will increase in absolute terms as our products become more widely distributed.
However, as a percentage of revenue, we expect revenue from these products to
decline over the next several years as we begin to market additional products
and services and pursue additional sources of revenue.

   In addition, we recognized revenue from certain amounts charged to IDT and
other carriers and from equipment sales, as shown above in the category
"Other." From these transactions, including monitoring IDT's network operations
center for Internet customers, we recognized revenue of approximately $329,000
and $680,000 for the nine months ended April 30, 1998 and 1999, respectively.
We also realized revenue from the sale of equipment, totaling approximately
$1.5 million for the nine months ended April 30, 1998 as compared to equipment
sales of approximately $446,000 for the nine months ended April 30, 1999.
Equipment sales for the nine months ended April 30, 1999 were derived from our
Net2Phone Pro product, while equipment sales for the nine months ended April
30, 1998 represented Internet telephony servers sold, on a one-time
non-recurring basis, to an international Phone2Phone reseller for deployment
abroad. Revenue from equipment sales, particularly revenue from sales of
Internet telephony servers, reflect sales that we believe to be non-recurring
and do not represent any trend.

                                       21
<PAGE>

   Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue,
excluding depreciation increased by 228% from $3.6 million for the nine months
ended April 30, 1998 to approximately $11.8 million for the nine months ended
April 30, 1999. As a percentage of total revenue, these costs increased from
approximately 45.1% for the nine months ended April 30, 1998 to approximately
53.4% for the nine months ended April 30, 1999. This increase is primarily
attributable to the fact that we sold approximately $1.5 million of equipment
in the nine months ended April 30, 1998 as compared to approximately $446,000
in the nine months ended April 30, 1999. Such equipment sales have a low cost
of sales associated with them. Over time, we expect direct cost of revenue to
decline on a per-minute basis as international competition among carriers
intensifies, resulting in lower prices from our suppliers, and as we leverage
our position as a large provider of services and expand our own network. As a
percentage of revenue, we expect direct cost of revenue to increase as a result
of a decline in per-minute charges to customers. We expect to continue to
utilize IDT's international and domestic networks at the current fair market
value rates for termination. We also expect to incur additional costs in
connection with the growth of our business, especially in connection with
increasing our own network capacity to handle increased traffic volumes.

   Sales and Marketing. Sales and marketing expenses increased approximately
236% from approximately $1.4 million for the nine months ended April 30, 1998
to approximately $4.7 million for the nine months ended April 30, 1999. As a
percentage of total revenue, these costs increased from approximately 17.1% for
the nine months ended April 30, 1998 to approximately 21.4% for the nine months
ended April 30, 1999. This increase primarily reflects the increased marketing
and advertising expenses associated with the agreements established with
Yahoo!, Excite and other strategic partners. We expect to continue to increase
significantly our advertising and marketing expenditures to further build brand
recognition, and to enhance the distribution of our products and services.

   General and Administrative. General and administrative expenses increased
approximately 121% from approximately $3.3 million for the nine months ended
April 30, 1998 to approximately $7.3 million for the nine months ended April
30, 1999. As a percentage of total revenue, these costs decreased from
approximately 40.9% for the nine months ended April 30, 1998 to approximately
32.8% for the nine months ended April 30, 1999. This decrease primarily
reflects the efficiencies we have begun to realize from leveraging our sales
and support infrastructure. We believe that general and administrative expenses
will continue to decline as a percentage of total revenue as a result of
greater economies of scale and further efficiencies. In absolute terms, we
expect these expenses to continue to increase as we incur additional costs in
product development and costs associated with hiring additional personnel and
adding new office space. Moreover, in absolute terms, our research and
development expenses will increase as we hire the additional engineers
necessary to continue the development of new products and services. However,
these research and development expenses are not expected to significantly
increase as a percentage of our total revenue.

   Depreciation. Depreciation increased from approximately $422,000 for the
nine months ended April 30, 1998 to approximately $1.2 million for the nine
months ended April 30, 1999. This increase is primarily attributable to the
increase in capital expenditures for the deployment of network equipment both
domestically and internationally to manage increased call volumes. Depreciation
will continue to increase as we build out our network and amortize intangibles
such as our licenses and trademark rights acquired under agreements with
strategic partners, including Netscape.

   Loss from Operations. Loss from operations was approximately $674,000 for
the nine months ended April 30, 1998 as compared to loss from operations of
approximately $2.9 million for the nine months ended April 30, 1999. This
change is due to the substantial increase in both sales and marketing expenses
as well as general and administrative expenses we incurred as we expanded our
corporate infrastructure and human resources. We anticipate continued and
increasing losses as we pursue our growth strategy.

Comparison of Fiscal Years Ended July 31, 1997 and 1998

   Revenue. Revenue increased approximately 344% from approximately $2.7
million for fiscal 1997 to approximately $12.0 million for fiscal 1998. The
increase in revenue was primarily due to an increase in minutes of use
resulting from increased marketing of our Internet telephony products and
services.

                                       22
<PAGE>

   Of total revenue for the year ended July 31, 1998, PC2Phone generated
approximately $8.0 million in revenue and Phone2Phone generated approximately
$2.0 million. The increase in revenue was primarily due to an increase in
minutes of use due to the marketing of our Internet telephony products and
services. Specifically, revenue from PC2Phone services increased approximately
264% from approximately $2.2 million in revenue for fiscal 1997 to
approximately $8.0 million in revenue for fiscal 1998. We realized significant
revenue for the first time from our Phone2Phone services for fiscal 1998, as
well as recorded revenue of approximately $1.5 million from the sale of
equipment. In addition, we recognized revenue from amounts charged to IDT
including monitoring the network operations center for IDT's Internet
customers, of approximately $297,000 and $453,000, respectively, for fiscal
1997 and 1998. We do not expect to realize significant revenue from the sale of
equipment in the future.

   Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue,
excluding depreciation increased by approximately 325% from approximately $1.6
million for fiscal 1997 to approximately $6.8 million for fiscal 1998. As a
percentage of total revenue, these costs decreased from approximately 58.6% for
fiscal 1997 to approximately 57.0% for fiscal 1998. This decrease is primarily
attributable to the impact of the higher margin equipment sold in the first
half of fiscal 1998. Since we do not expect to realize significant revenue from
the sale of equipment in the future, our direct costs will reflect our ability
to terminate our traffic worldwide cost-effectively through our own network
relationships or via those of IDT, our primary supplier. As a percentage of
revenue we anticipate direct costs to remain approximately the same as our
network expansion efforts mitigate potential pricing pressures.

   Sales and Marketing. Sales and marketing expenses increased by a factor of
37 from approximately $77,000 for fiscal 1997 to approximately $2.9 million for
fiscal 1998. As a percentage of total revenue, these costs increased from
approximately 2.9% for fiscal 1997 to approximately 24.1% for fiscal 1998. This
increase primarily reflects the increased marketing and advertising expenses
associated with the agreements established with Yahoo!, Excite and other
strategic partners. We expect to continue to increase significantly our
advertising and marketing expenditures to further build brand recognition, and
to enhance the distribution of our products and services.

   General and Administrative. General and administrative expenses increased
approximately 96% from approximately $2.6 million for fiscal 1997 to
approximately $5.1 million for fiscal 1998. As a percentage of total revenue,
these costs decreased from approximately 98.0% for fiscal 1997 to approximately
42.4% for fiscal 1998. This decrease primarily reflects the efficiencies we
have begun to realize from leveraging our sales and support infrastructure. We
expect to continue to see further efficiencies and greater economies of scale,
so that general and administrative expenses will continue to decline as a
percentage of total revenue. In absolute terms, we expect these expenses to
continue to increase as we incur additional costs associated with developing
new products, hiring of additional personnel and adding new office space.

   Depreciation. Depreciation increased from approximately $121,000 for fiscal
1997 to approximately $727,000 for fiscal 1998. This increase is primarily
attributable to the increase in capital expenditures for the deployment of
communications equipment both domestically and internationally to manage
increased customer volume.

   Loss from Operations. Loss from operations was approximately $1.7 million
for fiscal 1997 as compared to approximately $3.5 million for fiscal 1998. The
increased losses reflect the substantial increase in marketing and general and
administrative costs we incurred as we expanded our corporate infrastructure
and resources to gain additional market share for our products and services.

Period from January 2, 1996 (inception) to July 31, 1996

   During the period from January 2, 1996 (inception) to July 31, 1996, we did
not generate any revenue. During this period, we incurred approximately
$500,000 in start-up costs, primarily for research and development, as we
prepared to introduce our products and services.

                                       23
<PAGE>

Quarterly Results of Operations

   The following table sets forth certain quarterly financial data for the
seven quarters ended April 30, 1999. This quarterly information is unaudited,
has been prepared on the same basis as the annual financial statements, and, in
our opinion, reflects all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of the information for periods
presented. Operating results for any quarter are not necessarily indicative of
results for any future period.

<TABLE>
<CAPTION>
                                                          Quarter Ended
                         -----------------------------------------------------------------------------------------
                          Oct. 31,    Jan. 31,    April 30,     July 31,      Oct. 31,      Jan. 31,    April 30,
                            1997        1998        1998          1998          1998          1999         1999
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
<S>                      <C>         <C>         <C>           <C>           <C>           <C>          <C>
Revenue:
 PC2Phone............... $1,371,598  $1,693,812  $ 2,019,766   $ 2,877,645   $ 3,776,777   $4,809,644   $5,188,416
 Phone2Phone............     70,939     148,572      799,324     1,011,681     1,287,415    2,280,366    2,935,916
 Other..................    825,000     905,000      120,363       162,272       599,227      412,456      913,040
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
   Total revenue........  2,267,537   2,747,384    2,939,453     4,051,598     5,663,419    7,502,466    9,037,372
Cost and expenses:
 Direct cost of
  revenue, excluding
  depreciation..........    602,389   1,070,051    1,916,861     3,259,458     3,353,247    3,970,504    4,524,338
 Sales and marketing....    133,963     316,141      912,956     1,524,706     1,299,903    1,691,810    1,754,603
 General and
  administrative........    730,893   1,073,165    1,450,229     1,833,341     1,900,234    2,286,770    3,111,102
 Depreciation...........     68,169     123,844      229,635       304,860       338,469      400,584      477,659
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
   Total costs and
    expenses............  1,535,414   2,583,201    4,509,681     6,922,365     6,891,853    8,349,668    9,867,702
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
Income (loss) from
 operations and net
 income (loss).......... $  732,123  $  164,183  $(1,570,228)  $(2,870,767)  $(1,228,434)  $ (847,202)  $ (830,330)
                         ==========  ==========  ===========   ===========   ===========   ==========   ==========
<CAPTION>
                                                   As a Percentage of Revenue
                         -----------------------------------------------------------------------------------------
<S>                      <C>         <C>         <C>           <C>           <C>           <C>          <C>
Revenue:
 PC2Phone...............       60.5%       61.7%        68.7%         71.0%         66.7%        64.1%        57.4%
 Phone2Phone............        3.1         5.4         27.2          25.0          22.7         30.4         32.5
 Other..................       36.4        32.9          4.1           4.0          10.6          5.5         10.1
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
   Total revenue........      100.0       100.0        100.0         100.0         100.0        100.0        100.0
Cost and expenses:
 Direct cost of
  revenue, excluding
  depreciation..........       26.6        38.9         65.2          80.4          59.2         52.9         50.1
 Sales and marketing....        5.9        11.5         31.1          37.6          23.0         22.6         19.4
 General and
  administrative........       32.2        39.1         49.3          45.2          33.6         30.5         34.4
 Depreciation...........        3.0         4.5          7.8           7.5           6.0          5.3          5.3
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
   Total costs and
    expenses............       67.7        94.0        153.4         170.7         121.8        111.3        109.2
                         ----------  ----------  -----------   -----------   -----------   ----------   ----------
Income (loss) from
 operations and net
 income (loss)..........       32.3%        6.0%       (53.4)%       (70.7)%       (21.8)%      (11.3)%       (9.2)%
                         ==========  ==========  ===========   ===========   ===========   ==========   ==========
</TABLE>

   We have experienced growth in revenue in each quarter since inception,
reflecting greater acceptance and usage of our products and services by our
expanded customer base. We expect our revenue to grow over time as minutes of
use increase. However, we may experience declines in average revenue per minute
due to competitive pressures, promotions and marketing initiatives, increased
commissions paid to our international resellers and increased amounts paid to
our strategic partners under existing and future revenue-sharing arrangements.

   Since we derive revenue from more than one source, we have experienced
volatility in our direct costs of revenue. Specifically, our direct cost of
revenue in the first two quarters of fiscal 1998 were low as a percentage of
total revenue due to sales of equipment in these quarters. Since these sales
were on a non-recurring basis, we realized a significant, albeit temporary,
reduced direct cost of revenue for these two quarters.

   In the second half of fiscal 1998, we increased our advertising expenditures
as we began marketing our Phone2Phone service. Revenue from our Phone2Phone
service grew from approximately 5% of total revenue in the first half of the
year to approximately 26% of total revenue in the latter half. We experienced
start-up costs for Phone2Phone that increased our direct cost of revenue for
those two quarters. However, we have been able to reduce direct cost of revenue
for our Phone2Phone product as we expanded our network in the first three
quarters of fiscal 1999, which resulted in lower direct cost of revenue. In the
most recent quarter, direct cost of revenue as a percentage of revenue
accounted for approximately 50% as

                                       24
<PAGE>

compared to approximately 80% in the quarter ended July 31, 1998. Our increased
sales and marketing expenses reflect the relationships we have with various
online strategic partners with whom we advertise our PC2Phone and Phone2Phone
services. We expect to continue to increase significantly our advertising and
marketing expenditures to further build brand recognition of our products and
services.

   As a result of our limited operating history and the emerging nature of the
markets in which we compete, we are unable to accurately forecast our revenue
and direct cost of revenue as they may be impacted by a variety of factors.
These factors include the level of use of the Internet as a communications
medium, seasonal trends, capacity constraints, the amount and timing of our
capital expenditures, introduction of new services by us or our competitors,
price competition, technical difficulties or system downtime, and the
development of regulatory restrictions.

Liquidity and Capital Resources

   Since inception in January 1996, we have financed our operations through
advances from IDT. During the nine months ended April 30, 1999 we also received
capital contributions from IDT of approximately $4.6 million. As of April 30,
1999, we had approximately $1.8 million in cash and cash equivalents. In May
1999 we raised net proceeds of approximately $29.9 million from the sale of
Series A convertible preferred stock and warrants. Our operating activities
generated negative cash flow of approximately $409,000 in the nine months ended
April 30, 1998 compared to negative cash flow of approximately $4.0 million in
the nine months ended April 30, 1999.

   Cash used in investing activities was approximately $4.2 million and
approximately $9.0 million for the nine months ended April 30, 1998 and 1999,
respectively. Our use of cash in investing activities was principally for the
purchase of telecommunications and Internet equipment and for the purchase of a
trademark in the 1999 period.

   In May 1999, we received $29.9 million in net proceeds from the sale of our
Series A convertible preferred stock and warrants. We applied a portion of the
net proceeds from this sale to repay $8.0 million of the $22.0 million of
advances from IDT that were outstanding as of April 30, 1999. The remaining
$14.0 million due to IDT was converted into a promissory note in May 1999. We
utilized a portion of the net proceeds from this sale to pay ICQ a $4.0 million
fee payable upon the signing of our distribution and marketing agreement with
ICQ.

   Our principal commitments following the closing of this offering are
   expected to consist of:

  .  the repayment of $7.0 million with respect to the $14.0 million note due
     to IDT;

  .  the payment of $3.5 million to ICQ in connection with our distribution
     and marketing agreement;

  .  the payment of $1.5 million to NBC for television advertising;

  .  repayment of the remaining balance on the $14.0 million note to IDT
     described above, which is payable in 60 monthly installments of
     principal and interest at a rate of 9% per annum, commencing in June
     1999;

  .  the acquisition of a new network with expanded capacity from IDT in
     exchange for a $6.0 million note, payable in 60 monthly installments of
     principal and interest at a rate of 9% per annum;

  .  other costs relating to network equipment and expansion; and

  .  payments to Internet companies in connection with marketing our products
     and services, which as of April 30, 1999, were approximately $15
     million.

   Our future capital requirements will depend on numerous factors, including
market acceptance of our services, brand promotions, the amount of resources we
devote to the development of our current and future products, and the expansion
of our sales force and marketing our services. We may experience a substantial
increase in our capital expenditures and lease arrangements consistent with the
growth in our operations and staffing. Additionally, we will evaluate possible
investments in businesses, products and technologies. We believe that our
current cash balances, expected cash flow from our operations and the proceeds
of this offering will be sufficient to meet our working capital and capital
expenditure needs for at

                                       25
<PAGE>

least the next 12 months. However, there can be no assurance that we will have
sufficient capital to finance potential acquisitions or other growth oriented
activities, and may issue additional equity securities, incur debt or obtain
other financing.

Warrant Issued to America Online

   In connection with our distribution and marketing agreement with ICQ, we
issued a warrant to America Online to purchase up to 3% of our outstanding
capital stock on a fully-diluted basis. This warrant will vest in 1% increments
upon the achievement of each of three incremental thresholds of revenue
generated under the agreement during the first four years that the warrant is
outstanding. The per share exercise price under the warrant will be equal to
the lesser of $12.00 per share or $450 million divided by the number of our
fully-diluted shares on the initial exercise date.

   For example, if the first revenue threshhold was reached immediately after
the closing of this offering, AOL would be permitted to purchase 1% of the sum
of:

  .  10,944,429 shares of our outstanding common stock; plus

  .  36,578,190 shares of our common stock issuable upon conversion of our
     Class A stock; plus

  .  8,776,744 shares of our common stock reserved for issuance upon exercise
     of stock options that are outstanding or reserved for issuance under our
     1999 Stock Option and Incentive Plan;

a total of 56,299,363 shares.

   Thus, AOL would be permitted to purchase a total of 562,993 shares of common
stock. At our initial public offering price of our common stock of $15.00, the
per share exercise price of the AOL warrant would be $7.99 per share, which is
$450 million divided by the 56,299,363 fully-diluted shares expected to be
outstanding.

Year 2000 Systems Costs

   Computer systems, software packages, and microprocessor-dependent equipment
may cease to function or generate erroneous data on or after January 1, 2000.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. For example, computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities. To correctly identify the Year 2000, and therefore be
"Year 2000 compliant," a four-digit date code field is required.

   We have conducted a comprehensive review of the computer hardware and
software that we use in order to ensure that our computer-related applications
are Year 2000 compliant. This review commenced when we were operated as a
division of IDT, at which time IDT provided services in connection with this
review. Our cost of addressing the Year 2000 issue is not expected to be
material to our operations or financial position. However, the consequences of
an incomplete or untimely resolution of the Year 2000 issue could be expected
to have a material adverse effect upon our financial results. In the absence of
such a resolution, our ability to route traffic in a cost effective manner, to
deliver our services, to properly obtain payment for these services, and/or to
maintain accurate records of our business and operations, could be
substantially impaired until this issue is remedied. We may become liable for
substantial damages in the event that, as a result of the Year 2000 issue, we
fail to deliver any services that we have contracted to provide. Also, our name
and reputation may be harmed if our services are disrupted due to Year 2000
problems.

                                       26
<PAGE>

   Our plan to ensure Year 2000 compliance consisted of the following phases:

   .  conducting a comprehensive inventory of internal systems;

   .  assessing and prioritizing any required remediation;

   .  repairing or, if appropriate, replacing any non-compliant systems;

   .  testing all remediated systems for Year 2000 compliance; and

   .  developing contingency plans that may be employed in the event that any
      systems used by us is unexpectedly affected by a previously
      unanticipated Year 2000 problem.

We have substantially completed each of these phases, and believe that our
internal systems are Year 2000 compliant.

   We are conducting an external review of our customers and suppliers, and any
other third parties with whom we do business, to determine their vulnerability
to Year 2000 problems and any potential impact on us. These parties include our
equipment and systems providers. In particular, we may experience problems to
the extent that telecommunications carriers whose networks connect with ours
are not Year 2000 compliant. Our ability to determine the ability of these
third parties to address issues relating to the Year 2000 problem is limited.
To the extent that a limited number of carriers experience disruptions in
service due to the Year 2000 issue, we believe that we will be able to obtain
service from alternate carriers. However, our ability to provide certain
services to customers in selected geographic locations may be limited. There
can be no assurance that such problems will not have a material adverse effect
on our business, reputation or operating results.

   We are also in the process of developing contingency plans with regard to
potential or unforeseen Year 2000 problems. We believe that, in the event that
one or more of our systems, or the systems of third parties with which we do
business, is impaired due to unanticipated Year 2000 issues, our contingency
plans will enable us to temporarily conduct operations on a temporarily
modified basis until the impaired system or systems is remediated.

   There can be no assurances that our suppliers and customers will achieve
full year 2000 compliance before the end of 1999 or that we will develop or
implement effective contingency plans on a timely basis. A failure of our
computer systems or the failure of our suppliers or customers to effectively
upgrade their software and systems for transition to the Year 2000 could have a
material adverse effect on our business, financial conditions and results of
operations.

   Most of our internal systems were developed after developers became aware of
Year 2000 problems. To date, we have not incurred material expenses in
connection with the remediation of Year 2000 related issues. We do not expect
to incur significant costs in connection with Year 2000 related issues.
However, our actual costs may be significant if we discover that any major
portion of our internal systems requires unforeseen remediation. We expense
costs associated with Year 2000 remediation when they are incurred.

Effects of Inflation

   Due to relatively low levels of inflation over the last several years,
inflation has not had a material effect on our results of operations.

Impact of Recently Issued Accounting Standards

   SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, was issued in June 1997. We will be required to adopt this new
statement for fiscal 1999. This statement requires use of the "management
approach" model for segment reporting. The management approach model is based
on the way a company's management organizes segments within the company for
making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management
structure or any other manner in which management disaggregates a company. We
do not anticipate that the adoption of this statement will have significant
impact on our financial statements.

                                       27
<PAGE>

                                    BUSINESS

Overview

   Net2Phone is a leading provider of services enabling users to make high-
quality, low-cost telephone calls over the Internet. This service is commonly
referred to as Internet telephony. Our Internet telephony services enable our
customers to call individuals and businesses worldwide using their personal
computers or traditional telephones. We are leveraging our Internet telephony
expertise to integrate real-time voice communication capabilities into the Web.
We currently offer Web-based Internet telephony services, which enable
customers to make calls and send faxes over the Internet using their personal
computers, and basic Internet telephony services, which enable customers to
make calls using traditional telephones and fax machines.

   We have developed a sophisticated PC2Phone software application that enables
the use of our Web-based Internet telephony services. We distribute this
software free of charge through the Internet and through agreements to include
our software with products sold by our strategic partners. In January 1999,
Netscape agreed to embed our PC2Phone software on an exclusive basis into all
versions of Netscape's Internet browser released during the term of our
agreement, including Netscape Navigator and Netscape Communicator. Netscape
also agreed to include a Net2Phone icon on the Netscape Navigator Personal
Toolbar. In addition, we have entered into an agreement with ICQ, a subsidiary
of America Online, to provide Internet telephony services to users of ICQ's
instant messenging service. ICQ will embed our Internet telephony software into
ICQ's Instant Messenger software on an exclusive basis, allowing ICQ users to
make PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls. We will
also co-brand a pre-paid Phone2Phone calling card with ICQ, allowing users to
place calls from the United States and 19 other countries to virtually anywhere
in the world.

   We also have entered into strategic marketing and distribution relationships
with leading Internet companies, including Excite, InfoSpace.com, Snap.com,
Yahoo! and ZDNet. We have also entered into arrangements with leading computer
equipment and software companies, such as IBM, Compaq, Packard Bell-NEC Europe
and Creative Labs to include our software with their products. We promote our
services through direct sales and marketing and through international resellers
who buy minutes of use from us in bulk, and resell them to customers in their
respective countries. Our software is currently available in eight languages
(English, Spanish, Japanese, French, Dutch, Portuguese, Italian and German). We
intend to make our software available in additional languages as we expand our
international customer base and distribution channels.

   As of April 30, 1999, we served over 250,000 active customers who made an
average of approximately 60 minutes of calls per month and handled over 20
million minutes of use per month. Our net loss increased from approximately
$500,000 in fiscal 1996 and $1.7 million in fiscal 1997 to $3.5 million in
fiscal 1998. Our total assets increased from $916,000 at July 31, 1997 to $7.0
million at July 31, 1998. Our revenue has grown substantially, increasing from
approximately $2.7 million in fiscal 1997 to approximately $12.0 million in
fiscal 1998. Our revenue for the nine months ended April 30, 1999 was
approximately $22.2 million.

Industry Background

   The Internet is experiencing unprecedented growth as a global medium for
communications and commerce. International Data Corporation estimates that the
number of Internet users worldwide will grow from approximately 142 million at
the end of 1998 to 399 million by the end of 2002. These users are increasingly
using the Internet as a communications medium. A recent study by E-Marketer, a
market research firm, estimated that 9.4 billion e-mail messages are delivered
daily. Instant text communication through online "chat" rooms is also gaining
widespread acceptance.

   Online commerce is also becoming widely accepted as a means of doing
business. According to International Data Corporation, Internet users worldwide
purchased more than $50 billion of goods and services in 1998. International
Data Corporation projects that commerce over the Internet will to grow to
approximately $1.3 trillion in 2003.

                                       28
<PAGE>

   Emergence of Internet Telephony

   TeleGeography, a market research firm, estimates that the international long
distance market will grow to $79 billion in 2001, with consumers and businesses
making an estimated 143 billion minutes of international long distance calls.
Despite the large size of this market and the number of minutes of calls made,
traditional international long distance calls are still relatively expensive
for the consumer. The primary reason for this expense is tariffs set by foreign
governments and carriers that are passed on to consumers in the form of higher
long distance rates.

   Internet telephony has emerged as a low cost alternative to traditional long
distance calls. International Data Corporation projects that the Internet
telephony market will grow rapidly to over $23.4 billion in 2003, from
approximately $1.1 billion in 1998.

   Internet telephone calls are less expensive than traditional international
long distance calls primarily because these calls are carried over the Internet
or our network and therefore bypass a significant portion of international long
distance tariffs. The technology by which Internet phone calls are made is also
more cost-effective than the technology by which traditional long distance
calls are made.

   We use a technology called "packet-switching" to break voice and fax calls
into discrete data packets, route them over the Internet or our network and
reassemble them into their original form for delivery to the recipient.
Traditional international long distance calls, in contrast, are made using a
technology called "circuit switching" which carries these calls over
international voice telephone networks. These networks are typically owned by
governments or carriers who charge a tariff for their use. Circuit switching
requires a dedicated connection between the caller and the recipient that must
remain open for the duration of the call. As a result, circuit-switching
technology is inherently less efficient than packet-switching technology which
allows data packets representing multiple conversations to be carried over the
same line. This greater efficiency creates network cost savings that can be
passed on to the consumer in the form of lower long distance rates.

  Integration of Voice into the Web

   We believe that Internet telephony offers significant benefits to consumers
and businesses over and above international long distance cost savings. The
technologies that enable Internet telephony can be applied to integrate live
voice capabilities into the Web. We believe that this integration can further
enhance the potential for the Internet to become the preferred medium for both
communications and commerce. For example, the integration of voice into the Web
would supplement existing text-based modes of Internet communication such as e-
mail and online chat by adding a live, secure, low-cost or free voice
alternative. We believe that this will be attractive both to consumers and
businesses.

   In addition, voice-enabling the Web would give Internet shoppers the ability
to speak directly with customer service representatives of online retailers in
order to ask questions and alleviate concerns about online security. This may
increase the probability that a sale is made and may give online retailers a
key competitive advantage by providing them with opportunities to sell higher
margin and additional products to these customers. Voice-enabling a commercial
Web site may also give online retailers the ability to provide more responsive
customer support and service.

   Integrating live voice capabilities into the Web would also enable Internet
companies to offer enhanced communications services, such as providing Internet
users with a central source for retrieving voicemail, e-mail, faxes and pages.
We believe this would allow these companies to attract more users to their
sites and to increase the amount of time these users spend on their sites. This
increased usage will allow these Internet companies to attract advertisers and
secure higher advertising rates, thereby increasing revenue.

                                       29
<PAGE>

  Limitations of Existing Internet Telephony Solutions

   The growth of Internet telephony has been limited to date due to poor sound
quality attributable to technological issues such as delays in packet
transmission and network capacity limitations. However, recent improvements in
packet-switching technology, new software algorithms and improved hardware have
substantially reduced delays in packet transmissions. In addition, the use of
private networks to transmit calls as an alternative to the public Internet is
helping to alleviate network capacity constraints. Finally, the emergence of
new, lower cost Internet access technologies, such as high-speed modems, are
addressing local Internet access issues.

   Several large long distance carriers, including AT&T and Sprint, have
announced Internet telephony service offerings. However, many of these service
offerings have not been deployed on a large scale. Many also require users to
purchase other telecommunications services or allow only domestic calling.
Smaller Internet telephony service providers also offer low-cost Internet
telephony services from personal computers to telephones and from telephones to
telephones. These services, however, are available only in limited geographic
areas and require payment by credit card which may preclude many international
customers from signing up for these services. We also believe that existing
Internet telephony service providers rely upon technologies and systems that
lack large-scale billing, network management and monitoring systems, and
customer service capabilities required for the integration of voice
communication into the Web.

   In addition, many companies currently provide Internet telephony software
and services that allow Internet telephone calls to be made between personal
computers. However, most of these companies require both the initiator and the
recipient of the call to have the same software installed on their personal
computers and to be online at the same time.

The Net2Phone Solution

   We deliver high-quality Internet telephony services and voice-enabling Web
applications to consumers and businesses. Our solution provides the following
benefits to our customers:

  .  Low Cost. Our PC2Phone software is distributed free of charge, and our
     services allow our customers to make telephone calls often at a fraction
     of the cost of traditional long distance service. Because international
     long distance calls routed over the Internet bypass the international
     settlement process, we are able to charge lower rates than traditional
     long distance carriers.

  .  High Voice Quality. We offer high voice quality through our proprietary
     packet-switching technologies, which reduce packet loss and delay, route
     packets efficiently and perform quality enhancing functions, such as
     echo cancellation. We intend to continue to enhance the voice quality of
     our services as our customer base and business grow.

  .  Ease of Use and Access. Our services are designed to be convenient and
     easy to access from anywhere in the world. To make a call using our Web-
     based services, a customer need only install our free software on a
     sound-enabled personal computer, register and be connected to the
     Internet. No additional telephone lines or special equipment are
     required. Our Phone2Phone service is also easy to use and requires a
     customer only to register and dial a toll-free or local access number
     from any telephone or fax machine.

  .  Voice-Enabled Online Retailing. Our services enable users anywhere in
     the world to speak with sales or customer service representatives of
     online retailers and other Web-based businesses while visiting their Web
     sites. This provides customers an opportunity to ask questions of and to
     provide credit card information directly to a customer service
     representative if they are concerned about Internet security, thereby
     increasing the likelihood of consummating an online sale. In addition,
     our services allow our customers outside of the United States and Canada
     to access telephone numbers that might otherwise be inaccessible to them
     through their local carriers. For example, users of our services in
     other countries may call United States or Canadian toll-free numbers
     (i.e.,

                                       30
<PAGE>

     telephone numbers with 800, 877 or 888 prefixes), which are not
     otherwise available to them, at no charge. The ability to communicate
     with international customers in this manner provides United States and
     Canadian-based online retailers and other Web-based businesses with cost
     effective access to an expansive international customer base.

  .  Reliable Service. Our network is reliable because of its technologically
     advanced design. This design allows us to expand our network and add
     capacity by adding switches to the existing network. Our system also
     provides seamless service and high-quality voice transmission through
     our ability to reroute packets if problems arise. We believe that our
     ability to provide reliable service is essential to voice-enable the
     Web.

  .  Ease of Payment and Online Account Access. Once registered, our
     customers are able to make unlimited toll-free calls. In addition, they
     can make toll calls by opening a prepaid account using credit cards,
     wire transfers or checks payable in United States dollars. Acceptance of
     payment in multiple forms enables international customers who may not
     necessarily have credit cards to use our services. Our customers can
     access their accounts via the Internet in order to view their call
     history and account balances, and to increase their prepaid amounts.

  .  Customer Support. We offer live customer support 24 hours a day, seven
     days a week in multiple languages. Our customer support center can be
     accessed from anywhere in the world at no charge either by calling our
     toll-free number, where available, or by using our Web-based Internet
     telephony service. Our integrated customer billing software and call
     management system provide our customer support staff with immediate
     access to user accounts, calling patterns and billing history to help us
     provide better, more responsive customer support.

Strategy

   Our mission is to become the premier Web-based communications enabler. We
intend to leverage our leadership position in the Internet telephony market to
make our communications services readily available worldwide on the Internet
and to develop and market online commerce and related products. Our strategy
includes the following key elements:

  .  Drive Usage through Resellers and Strategic Partners. We promote our
     services through direct sales and marketing and through relationships
     with international resellers and leading Internet hardware, software and
     content companies. We intend to build on these relationships and to add
     more partners and resellers to drive usage of our Internet telephony
     services. We also intend to partner with large telecommunications
     companies to enable them to offer our Internet telephony services under
     their brand.

  .  Pursue Multiple Sources of Revenue. In addition to our minutes-based
     revenue, we intend to pursue new Web-based revenue opportunities from
     banner and audio advertising, as well as sponsorship opportunities on
     our PC2Phone software user interface and our EZSurf.com Web site. We
     also intend to explore the availability of revenue-sharing opportunities
     with online retailers.

  .  Enhance Brand Recognition. We have established strong brand identity in
     the Internet telephony market in large part due to the high-quality of
     our services and our marketing efforts. We have entered into advertising
     relationships with leading Web companies such as Netscape, Yahoo! and
     Excite in order to promote our services. We intend to continue to
     implement aggressive advertising and sales campaigns to increase brand
     awareness. In addition, we intend to enhance our brand recognition by
     cooperatively marketing our Internet telephony services with leading
     computer hardware and software companies and Internet services
     providers.

  .  Make Our Software Readily Available Worldwide. We have entered into
     strategic distribution relationships with leading computer equipment and
     software companies to expand the availability of our software. For
     example, our software will be embedded into future versions of
     Netscape's Internet browser and a Net2Phone icon will be prominently
     positioned next to AOL's Instant Messenger icon on the Netscape
     Navigator Personal Tool Bar. In addition, customized versions of

                                      31
<PAGE>

     our software will be embedded in ICQ's Instant Messenger software and
     distributed by ICQ. Our software is included with IBM's Internet
     services and may be pre-loaded on computers sold by Compaq
     internationally. We intend to build upon these relationships and enter
     into new distribution relationships with other leading companies in
     order to enhance the distribution of our software worldwide.

  .  Expand and Enhance Products and Services. We have committed significant
     resources to expand our network, enhance our existing product and
     service offerings and to develop and market additional products and
     services in order to continue to provide customers with high-quality
     Internet telephony services. For example, we plan to introduce new
     products and services, including:

    .  PC2PC, which will allow high-quality Internet telephony from one
       personal computer to another,

    .  Phone2PC, which will allow calls from a traditional telephone to a
       personal computer,

    .  voice-enabled chat, which will allow two participants in an online
       chat room discussion to establish direct voice communication with
       each other while maintaining anonymity,

    .  unified messaging services, which we anticipate will include voice,
       fax and electronic messaging with multiple points of access,
       including the Web and conventional telephones,

    .  online commerce applications, which will provide customer service
       representatives of online retailers with real-time access to a
       caller's profile and enable them to "push" specific content onto a
       caller's personal computer screen in order to better assist the
       caller in answering their inquiries,

    .  customer payment applications, which will allow customers to pay for
       online commerce transactions by debiting their Net2Phone account, and

    .  video conferencing between two or more personal computer users over
       the Internet.

Strategic Relationships

   We have entered into strategic distribution, integration and advertising
relationships with leading Internet and computer hardware and software
companies. These relationships typically include arrangements under which we
share with our strategic partners a portion of the revenue they bring to us.
We believe that these relationships are important because they provide
incentive to our partners and allow us to leverage the strong brand names and
distribution channels of these companies to market our products and services.
Our strategic partners include:

   Netscape

   Netscape has agreed to embed our PC2Phone software on an exclusive basis in
future versions of Netscape's Internet browser released during the term of our
agreement, including Netscape Navigator and Netscape Communicator. Netscape
also has agreed to:

  .  place a Net2Phone icon on the Netscape Navigator Personal Toolbar
     immediately to the right of the AOL Instant Messenger icon, which will
     allow Netscape users to use our Web-based Internet telephony services
     from anywhere on the Web simply by clicking on our icon;

  .  integrate our services into, and prominently display our services on,
     Netscape Netcenter, including Netscape's Address Book Contacts section
     and Voice Communications section, which will allow Netscape users to
     make calls using our services simply by clicking on a displayed
     telephone number; and


                                      32
<PAGE>

  .  include the software for our Web-based Internet telephony services in
     Netscape's suite of online plug-in software and Netscape Smart Update
     programs (both domestically and when available internationally) for
     downloading by Netscape users from centralized locations on Netscape's
     Web site.

   We also have the right to place a specified amount of banner and other
advertisements on Web pages of our choice on Netscape's domestic and
international Web site. The two-year term of our exclusive agreement with
Netscape commences with the beta release of the next version of Netscape's
Internet browser, which we believe will occur later this year.

  ICQ

   In July 1999, we entered into an exclusive, four-year distribution and
marketing agreement with ICQ, a subsidiary of America Online. Under this
agreement, ICQ has agreed to:

  .  co-brand and promote our phone-to-phone Internet telephony services in
     the United States and in 19 other countries;

  .  embed customized versions of our software on an exclusive basis into
     ICQ's Instant Messenger software to allow ICQ customers to make PC-to-
     phone and PC-to-PC calls and to receive phone-to-PC calls;

  .  share revenue from advertisements and sponsorships sold by ICQ on our
     software that is embedded in ICQ's Instant Messenger software; and

  .  promote our services on some of ICQ's Web sites.

   All of the Internet telephony services that ICQ promotes under our agreement
will be co-branded under both of our labels. We believe the phone-to-phone
services will be launched in the United States later this year and
internationally by early 2000. We believe that the PC-based Internet telephony
services will be launched in mid-2000.

   Yahoo!, Excite and InfoSpace.com

   In 1998 we signed an agreement with Yahoo!, which was recently renewed
through 2000. Our Web-based Internet telephony service is integrated into
Yahoo!'s People Search online telephone directory. As a result of this
integration, an Internet user who performs a search on Yahoo! People Search can
simply click on a displayed telephone number to initiate a call to that number.
Under this agreement, we also have the right to have our banner advertising
appear when an Internet user performs a word- or category-search for "Internet
Telephony" or related phrases on Yahoo! Additionally, we have contracted with
Yahoo! to integrate our PC2Phone service into Yahoo!'s Yellow Pages and White
Pages online directories.

   Our Web-based Internet telephony software is also integrated into Excite's
Web sites in its International Network, which includes the United Kingdom,
Germany, France, Japan, Italy, Australia, Sweden and the Netherlands. As a
result, an Internet user in any of these countries will be able to click on any
telephone number that appears on any page on these sites to initiate a call to
that number using our PC2Phone service. In addition, our services will be
prominently featured within the Excite International Network via advertising
and promotion on various channels, including each member's homepage, business,
technology/computer and travel channels, as well as the localized versions of
My Excite, What's New/What's Cool and Mail Excite. We are negotiating with
Excite to have our services integrated into Excite's United States Web sites as
well.

   In addition, our Web-based Internet telephony software is integrated into
InfoSpace.com's network of white and yellow page directory services. This
network of sites includes all the white and yellow page listings in Netscape's
Netcenter Web site, the Microsoft Network, the GO Network and Xoom.com.


                                       33
<PAGE>

   Other Strategic Relationships

   We also have entered into other important strategic relationships with other
leading Internet and computer hardware and software companies, including:

  .  Compaq. Our software is featured as a download from a special Compaq Web
     site accessible directly from the Compaq-branded keyboard, may be pre-
     installed on Compaq-branded computers distributed internationally and
     may be included with their other products.

  .  Snap.com. Promotions for our services and a link to our Web site will be
     prominently displayed on the Snap.com Web site, and we are their
     preferred provider of PC-to-phone services.

  .  ZDNet. We are the preferred provider of Internet telephony services for
     ZDNet and our Web-based Internet telephony service will be integrated
     throughout the ZDNet Web site.

  .  Quicknet Technologies. Our PC2Phone software is integrated into
     Quicknet's telephone handset product called Internet PhoneJACK.

  .  Bigfoot International, WorldPages/Web YP and Internet 800 Directory. Our
     PC2Phone service is integrated into these three popular online
     directories, which allow Internet users to call any listed telephone
     number simply by clicking on the displayed number.

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<PAGE>

Products and Services

   Current Products and Services

   Our services enable our customers to make low-cost, high-quality phone calls
over the Internet using their personal computers or traditional telephones. Our
principal current product and service offerings are described in the table
below.


 Product/Service       Description                    Benefits
- --------------------------------------------------------------------------------
 Basic Internet
 Telephony Services:

  . Phone2Phone        .  Enables customers to         .  International long
                          make calls over                 distance rates are
  . Fax2Fax               traditional telephones          typically 50% to
                          and fax machines routed         70% lower than the
  . Net2Phone Pro         over the Internet.              rate charged by
                          Customers must dial a           traditional long
                          local or domestic toll-         distance carriers
                          free access number to           for calls
                          access the Net2Phone            originating in the
                          network.                        United States, and
                                                          up to 95% lower for
                       .  Customers are charged           calls originating
                          for toll and long               outside the United
                          distance calls on a             States.
                          per-minute basis. There      .  Users do not need
                          is no charge for                to purchase
                          calling United States           expensive hardware
                          and Canadian toll-free          or software.
                          numbers.
                                                       .  High voice quality.
                       .  Available in the United      .  Faxes are
                          States and in many              transmitted without
                          international                   delay and users
                          locations.                      receive immediate
                                                          delivery
                       .  We market Phone2Phone           confirmations.
                          under the brand
                          "Net2Phone Direct."

- --------------------------------------------------------------------------------
 Web-based Internet
 Telephony Services:

  . PC2Phone           .  Enables customers to         .  Services are
                          make calls and send             available to any
  . Click2Talk            faxes over the Internet         Internet user with
                          using their personal            a sound-equipped
  . PC2Fax                computers. Customers            personal computer.
                          must install our             .  International long
                          software on their               distance rates are
                          personal computers,             typically 50% to
                          register with us and be         70% lower than the
                          online in order to make         rates charged by
                          calls. When browsing            traditional long
                          Web sites that have a           distance carriers
                          Click2Talk icon,                for calls
                          customers may initiate          originating in the
                          calls to a company              United States, and
                          whose site they are             up to 95% lower for
                          browsing simply by              calls originating
                          clicking on the                 outside the United
                          Click2Talk icon.                States.
                       .  Customers are charged        .  United States and
                          for toll and long               Canadian toll-free
                          distance calls on a             numbers can be
                          per-minute basis. There         accessed from
                          is no charge for                outside the United
                          calling United States           States and Canada.
                          and Canadian toll-free
                          numbers.                     .  Facilitates online
                                                          commerce by
                                                          providing live
                                                          voice contact
                                                          between online
                                                          retailers and
                                                          Internet shoppers.
                                                       .  Customers do not
                                                          require multiple
                                                          telephone lines and
                                                          need not log off
                                                          the Internet to
                                                          initiate a call.

- --------------------------------------------------------------------------------

 EZSurf.com            .  A Web-based shopping         .  Enables voice
                          directory powered by            communications with
                          our Web-based Internet          over 300 Web sites.
                          telephony services from      .  Educates users by
                          which Internet users            providing them with
                          can initiate calls to           essential
                          listed online retailers         information
                          by clicking on an icon          required to buy
                          on the Web site.                products online.
                       .  Lists useful
                          information for key
                          online retailers,
                          including payment and
                          shipping options and
                          return policies.



                                       35
<PAGE>

Sales, Marketing and Distribution

   We distribute our software through the Internet, strategic partnerships and
international resellers. In addition, our software will be embedded into future
versions of Netscape's browser, which, according to International Data
Corporation, was used by 41.5% of all consumer Internet users in mid-1998.
Additionally, our software will be distributed into future versions of ICQ's
Instant Messenger software. Customers can also download our software at no
charge from our Web site and other Web sites, including Yahoo!'s People Search
and Lands' End's home page.

   We also distribute our software through strategic relationships with leading
Internet and computer hardware and software companies, including IBM, Compaq,
Packard Bell-NEC Europe and Creative Labs. Our software is included with our
partners' products and services and distributed domestically and
internationally. We expect to distribute over 25 million units of our software
in 1999 as a result of these and other distribution arrangements.

   We promote our services through online and Internet-based advertising venues
and traditional print advertising in domestic and international publications.
We will also be advertising our services on the NBC television network. Another
way we sell our services internationally is by entering into exclusive
agreements with resellers in other countries. We sell these resellers bulk
amounts of minutes of use of our products and services to be resold in the
resellers' respective countries. For example, in Asia, we have agreements with
Daewoo and Naray Mobile Telecom in South Korea and Marubeni in Japan. In Europe
and the Middle East, we have agreements with CAPCOM in Spain and Dot.LB in
Lebanon, among others. To facilitate distribution and attract users in foreign
countries, we have developed our software in eight languages (English, Spanish,
Japanese, French, Dutch, Portuguese, Italian and German) and intend to increase
the number of languages as our distribution broadens.

Customer Service

   As part of our goal to attract and retain customers, we offer free live
customer support in multiple languages. We employ approximately 67 customer
service representatives, who offer customer support to our users 24 hours a
day, seven days a week. These services can be reached from anywhere in the
world at no cost using either our toll-free number, where available, or our
Web-based Internet telephony services. The customer support staff provides
technical assistance, as well as general service assistance, for all of our
products and services. We also offer customer support via e-mail and fax. Our
integrated customer billing software and call management system provide our
customer support staff with immediate access to user accounts, calling patterns
and billing history, thereby enhancing the quality of service provided to our
customers. In addition, our international resellers typically provide their own
front-line customer support.

Technology

   PC2Phone Software

   Our PC2Phone software is simple to install and to use and has won various
industry awards. The installation process is wrapped in the industry-standard
"Install Shield" product. During installation, the Net2Phone "wizard" verifies
that the user's microphone and speakers are properly set for Internet
telephony. The installation also has a service registration process that allows
the customer to quickly register for paid time with the product. Our software
has several buttons and drop down headings to enable customization. These
buttons allow the user to change specific properties, access and modify
customer account information, program and use speed dialing and verify rates.

   Our PC2Phone software has gone through fourteen releases, each improving
upon our Internet telephony capabilities. The software is a Windows-compliant,
32-bit application written in a high-level PC language. The code is extendible
allowing us to easily add new functionality, yet is relatively compact. The
newest release of our software can record and play sound files allowing us to
deliver voice-mail services and can interface with third party PC mail software
applications such as Eudora and Microsoft Outlook.

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   We also have developed a software development kit allowing other companies
to quickly and easily integrate their products with our PC2Phone software. For
example, our services have been successfully integrated with Quicknet's line of
sound cards and telephone interface cards. This integration enables Internet
telephony service to be deployed through inexpensive equipment currently used
throughout the world.

   Call Management System

   To maintain our leadership position in the Internet telephony market, we
believe that reliable and flexible billing, information management, monitoring
and control systems are critical. Accordingly, we have invested substantial
resources to develop and implement our sophisticated real-time call management
information system. Key elements of this system include:

  .  Customer Provisioning. The system provides automated online customer
     registration and customer registration through call centers and
     resellers. It also provides online credit card authorization and batch
     billing capabilities that streamline customer registration. A special
     remote access application program allows other people access to our
     database, enabling sophisticated partners to remotely service customers
     through our system, and to tie our system directly to their own business
     systems. This remote capability includes remote account management and
     continuous real-time call detail and billing information. Additionally,
     the system makes customer account records readily available to call
     center representatives in the event of customer billing problems.

  .  Customer Access. Our system allows customers to independently access
     their billing records online without the need to contact customer
     service representatives.

  .  Fraud Control. Fraud detection and prevention features include caller
     authentication, prevention of multiple simultaneous calls using the same
     account, pin code verification and call duration timers. We also
     generate reports on suspicious calling patterns to detect caller
     registration fraud. We routinely scan for fraudulent content before
     credit card purchases are allowed.

  .  Network Security. Firewalls are employed to prevent attacks on our
     network. We use sophisticated techniques to safeguard sensitive database
     information. In addition, we encrypt call requests and portions of the
     call to prevent "network sniffers" from unauthorized access to data.

  .  Call Routing. The network management system identifies and routes calls
     to the most efficiently priced carrier. The system also automatically
     routes calls around links or servers that are experiencing problems,
     have failed or have been manually taken out of service for maintenance
     or upgrades. This system provides remote administration facilities for
     maintaining routing tables and system monitoring.

  .  Monitoring. The management system provides for real-time monitoring of
     all call information. We are able to track potential problems such as
     too many short calls on a server or a low percentage of call
     completions. The system also provides remote management that allows
     partners to monitor and manage their own accounts.

  .  Reliability. We maintain two separate network operations centers in
     Hackensack and Lakewood, New Jersey. These facilities house redundant
     equipment and have the ability to track calls simultaneously. This
     redundant system gives our network a high degree of reliability,
     enabling each network operations center to serve as a back-up to the
     other.

  .  Detailed Call Records. The management software maintains detailed
     records for each call, including the account number of the caller, the
     caller's phone number, access number used, the point at which the call
     enters and exits our network, the account owner, the calling party, the
     server/service phone number, the number of the called party, a running
     account balance, and rate and billing information, including surcharges.

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   The Net2Phone Network

   Through an agreement with IDT, we lease capacity on an Internet network
comprised of leased high-speed fiber optic lines connecting eight major cities
across the United States, and lease high-speed fiber optic lines connecting
smaller cities to the network. We have a right to use network capacity leased
by IDT. The network backbone uses state-of-the-art hardware including Cisco
Series 7000 routers and Nortel Passport switches. Our high-speed backbone
connects traffic at four major public Internet exchange points and is also
facilitated by a growing number of private peering or exchange points with
other networks. Through peering arrangements, we exchange Internet traffic with
25 other Internet backbone providers at these points. We operate IDT's network,
one of the largest Internet access networks, providing local dial-up access
through 36 locations. Our Internet network also includes more than 700
additional network access locations owned by local and regional Internet
service providers.

   We are able to provide service in areas where we do not have dial-up
equipment by utilizing call-forwarding technology to expand our coverage areas
by increasing the total number of local access numbers. We have been closing
down multiple network access points in a number of states in order to
consolidate our equipment into central "Super Point of Presence" locations. For
example, one Super Point of Presence in New Jersey can supply local access for
the entire state of New Jersey.

   The diagram below illustrates the routing of an Internet telephony call
initiated by a customer using a telephone, fax or a personal computer to a
terminating telephone or fax machine over our network.

                             [Call routing diagram]

   We seek to retain flexibility by utilizing dynamic call routing
alternatives. This approach is intended to enable us to take advantage of the
rapidly evolving Internet market in order to provide low-cost service to our
customers. Accordingly, our network employs an "Open Shortest Path First"
protocol that promotes efficient routing of traffic. Additionally, we have
placed redundant hardware for reliability in high traffic areas to minimize
loss of data packets. Each network data exchange point employs hardware to
direct network traffic and a minimum of two dedicated leased data lines to
further increase reliability.

   We manage our network hardware remotely. It is compatible with a variety of
local network systems around the world. We believe our Internet telephony
network can currently support approximately 5,000 simultaneous calls. We
believe our systems are scalable to 10 times their current capacity through the
purchase and installation of certain additional hardware. To date, the highest
number of simultaneous calls serviced by our network was approximately 1,660
simultaneous calls made on Father's Day in June 1999.

   The Network Operations Center

   Our Network Operations Center, located in Hackensack, New Jersey, currently
employs a staff of 25 people. There are two groups that work within the network
operations center, the network analysis group and the Internet telephony
monitoring group. Both groups have 24 hours a day, seven days a week coverage
to quickly respond to any issues.

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   The network analysis group works around-the-clock monitoring network issues,
handling customer requests, repairing outages and solving security problems.
Their key objective is to provide quality service upon which customers can
rely. Our monitoring group oversees a nationwide real-time network analysis
map, which notifies our staff of network errors. They also use software we
developed to monitor our hardware around the world. This group can dynamically
turn on or turn off equipment and re-route Internet telephony traffic, as
necessary.

Customers

   We have a diverse, global customer base. As of April 30, 1999, approximately
65% of our customers were based outside of the United States. As of April 30,
1999, we served over 250,000 active customers who had used our services during
the preceding three months. In addition, as of June 25, 1999, we had installed
the Click2Talk service on approximately 150 commercial Web sites.

Competition

  Long Distance Market

   The long distance telephony market and, in particular, the Internet
telephony market, is highly competitive. There are several large and numerous
small competitors, and we expect to face continuing competition based on price
and service offerings from existing competitors and new market entrants in the
future. The principal competitive factors in the market include price, quality
of service, breadth of geographic presence, customer service, reliability,
network capacity and the availability of enhanced communications services. Our
competitors include AT&T, MCI WorldCom and Sprint in the United States and
foreign telecommunications carriers.

   Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we
have. As a result, certain of these competitors may be able to adopt more
aggressive pricing policies, which could hinder our ability to market our
Internet telephony services. One of our key competitive advantages is the
ability to route calls through Internet service providers, which allows us to
bypass the international settlement process and realize substantial savings
compared to traditional telephone service. Any change in the regulation of an
Internet service provider could force us to increase prices and offer rates
that are comparable to traditional telephone call providers.

  Web-Based Internet Telephony Services

   As consumers and telecommunications companies have grown to understand the
benefits that may be obtained from transmitting voice over the Internet, a
substantial number of companies have emerged to provide voice over the
Internet. In addition, companies currently in related markets have begun to
provide voice over the Internet services or adapt their products to enable
voice over the Internet services. These related companies may potentially
migrate into the Internet telephony market as direct competitors.

  .  Internet Telephony Service Providers. During the past several years, a
     number of companies have introduced services that make Internet
     telephony services available to businesses and consumers. In addition to
     us, AT&T Jens (a Japanese affiliate of AT&T), ICG Communications,
     IPVoice.com, ITXC, OzEmail (which was recently acquired by MCI
     WorldCom), RSL Communications (through its Delta Three subsidiary) and
     VIP Calling provide a range of voice-over-the-Internet services. These
     companies offer PC-to-phone or phone-to-phone services that are similar
     to the services we offer. Some, such as AT&T Jens and OzEmail, offer
     these services within limited geographic areas. Additionally, a number
     of companies have recently introduced Web-based voice-mail services and
     voice-chat services to Internet users.

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<PAGE>

  .  Software/Hardware Providers. Many companies produce software and other
     computer equipment that may be installed on a user's computer to permit
     voice communications over the Internet. These products generally require
     each user to have compatible software and hardware equipment and rely on
     the public Internet for the transmission of traffic, which often results
     in reduced quality of communications. Representative companies include
     VocalTec and Netspeak. We believe VocalTec's software and hardware are
     unable to handle large numbers of simultaneous calls. Netspeak focuses
     on delivering solutions targeted at traditional call centers that
     require significant customization.

  .  Telecommunications Companies. A number of telecommunications companies,
     including AT&T, Deutsche Telekom, MCI WorldCom and Qwest, currently
     maintain, or plan to maintain, packet-switched networks to route the
     voice traffic of other telecommunications companies. These companies,
     which tend to be large entities with substantial resources, generally
     have large budgets available for research and development and therefore
     may further enhance the quality and acceptance of the transmission of
     voice over the Internet. However, many of these companies are new to the
     Internet telephony market, and therefore may not build brand recognition
     among consumers for these services. These companies also may not have
     the range of product and service offerings that are necessary to
     independently provide a broad set of voice-enabled Web services. AT&T,
     for example, has attempted to enter the market but has focused its
     effort on the cable market and it is unclear if it will continue to
     pursue voice over the Web. Qwest has taken steps to enter the market by
     building a high capacity network in the United States. In addition,
     Qwest has also entered into a three-year strategic alliance with
     Netscape to provide one-stop access to Internet services including long
     distance calling, e-mail, voice mail, faxes, Internet access and
     conference calls.

  .  Network Hardware Manufacturers. Several of the world's major providers
     of telecommunications equipment, such as Alcatel, Cisco, Lucent,
     Northern Telecom and Dialogic (which has entered into an agreement to be
     acquired by Intel) have developed or plan to develop network equipment
     that may be used in connection with the provision of voice over the Web
     services, including routers, servers and related hardware and software.
     By developing this equipment, these manufacturers may exert substantial
     influence over the technology that is used in connection with
     transmission of voice over the Web and may develop products that
     facilitate the quality and timely roll-out of these networks. However,
     these companies are dependent upon the operators of Internet telephony
     networks to purchase and install their equipment into their networks.
     They are also dependent upon the developers of hardware and software to
     market their systems to end users. Cisco currently manufactures Internet
     telephony equipment for low to medium scale networking, but does not
     manufacture high-end Internet telephony equipment for large networks.
     However, Cisco recently acquired two companies that produce devices to
     help Internet service providers transition voice and data traffic to
     packet networks while maintaining traditional phone usage and network
     equipment. Lucent has recently co-developed with VocalTec a set of
     industry standards that have been adopted by major competitors and is
     currently marketing Internet telephony hardware, including servers that
     allow the transmission of calls and faxes over the Internet. Lucent also
     offers related support products, such as billing centers and "Internet
     call centers," which allow Internet access and conversation with a
     customer support agent on a single line.

Research and Development

  Strategic Research and Development

   At our primary research and development center in Lakewood, New Jersey, we
currently employ 12 engineers, whose specialties include software, hardware,
switching, Internet security, voice compression, engineering real-time online
transactions, billing, and network and call management. This staff is devoted
to the improvement and enhancement of our existing product and service
offerings, as well as to the

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<PAGE>

development of new products and services. Current research and development
activities include enhancements to our customer billing software and call
management system to increase the capacity of these systems, improvements to
our Internet telephony hardware to increase capacity and modifications to our
PC2Phone software to increase functionality. Our future success will depend, in
part, on our ability to improve existing technology and develop new products
services that incorporate leading technology.

   We incurred $473,000 and $481,000 in product development expenses during
fiscal 1997 and fiscal 1998, respectively. For the nine months ended April 30,
1999, we incurred product development expenses of $466,000.

  Management Information Systems Research and Development

   Our management information systems development team, located in Hackensack,
New Jersey, has eleven programmers and a development manager dedicated to
traditional management information systems development and upgrades. The group
supports back-office accounting and reporting software, customer service
support software and database support. The development schedule is primarily
focused on a detailed list of upgrades that have been identified and
prioritized by a team manager. The database architecture is managed by a senior
developer in our Lakewood laboratory who was responsible for similar database
functions at AT&T's WorldNet division.

  Web Research and Development

   The majority of our Web research and development is done by a separate Web
development group located in our headquarters in Hackensack. The group of nine
consists of five developers, two programmers, one graphics designer and one
development manager. The team is responsible for our multiple language Web
site, the EZSurf.com Web site and specialized Web interfaces, including the
integration of our PC2Phone client software into Netscape's Internet browser.

Regulation

  Regulation of Internet Telephony

   The use of the Internet to provide telephone service is a recent market
development. Currently, the Federal Communications Commission is considering
whether to impose surcharges or additional regulations upon certain providers
of Internet telephony. On April 10, 1998, the FCC issued its report to Congress
concerning the implementation of the universal service provisions of the
Telecommunications Act. In the report, the FCC indicated that it would examine
the question of whether certain forms of phone-to-phone Internet telephony are
information services or telecommunications services. The FCC noted that it did
not have, as of the date of the report, an adequate record on which to make a
definitive pronouncement, but that the record suggested that certain forms of
phone-to-phone Internet telephony appear to have the same functionality as non-
Internet telecommunications services and lack the characteristics that would
render them information services. If the FCC were to determine that certain
services are subject to FCC regulation as telecommunications services, the FCC
may require providers of Internet telephony services to make universal service
contributions, pay access charges or be subject to traditional common carrier
regulation. It is also possible that PC2Phone and Phone2Phone services may be
regulated by the FCC differently. In addition, the FCC sets the access charges
on traditional telephony traffic and if it reduces these access charges, the
cost of traditional long distance telephone calls will probably be lowered,
thereby decreasing our competitive pricing advantage.

   In September 1998, two regional Bell operating companies, U S WEST and
BellSouth, advised Internet telephony providers that the regional companies
would impose access charges on Internet telephony traffic. In addition, U S
WEST has petitioned the FCC for a declaratory ruling that providers of
interstate Internet telephony must pay federal access charges, and has
petitioned the public utilities commissions of Nebraska and Colorado for
similar rulings concerning payment of access charges for intrastate Internet
telephone calls.

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<PAGE>

At this time, it is not known whether these companies, U S WEST and BellSouth,
will actually impose access charges or when such charges will become effective.
If these companies succeed in imposing access charges that may reduce the cost
savings of using Internet telephony as compared to traditional telephone
service. The existence of these access charges would materially adversely
affect the development of our Internet telephony business. In February 1999,
the FCC adopted an order concerning payment of reciprocal compensation that
provides support for a possible finding by the FCC that providers of Internet
telephony must pay access charges for at least some subset of Internet
telephony services. If the FCC were to make such a finding, the payment of
access charges could materially adversely effect our business, results of
operations and financial condition. Many of our competitors are lobbying the
FCC for the imposition of access charges on Internet telephony traffic.

   To our knowledge, there are currently no domestic and few foreign laws or
regulations that prohibit voice communications over the Internet. State public
utility commissions may retain jurisdiction to regulate the provision of
intrastate Internet telephony services. A number of countries that currently
prohibit competition in the provision of voice telephony have also prohibited
Internet telephony. Other countries permit but regulate Internet telephony. If
Congress, the FCC, state regulatory agencies or foreign governments begin to
regulate Internet telephony, such regulation may materially adversely affect
our business, financial condition or results of operations.

  Regulation of the Internet

   Congress has recently adopted legislation that regulates certain aspects of
the Internet, including online content, user privacy, taxation, access charges,
liability for third-party activities and jurisdiction. The European Union has
also enacted several directives relating to the Internet, one of which
addresses online commerce. In addition, federal, state, local and foreign
governmental organizations are considering other legislative and regulatory
proposals that would regulate the Internet. Increased regulation of the
Internet may decrease its growth, which may negatively impact the cost of doing
business via the Internet or otherwise materially adversely affect our
business, results of operations and financial condition.

   The Federal Trade Commission has proposed regulations regarding the
collection and use of personal identifying information obtained from
individuals when accessing Web sites, with particular emphasis on access by
minors. These regulations may include requirements that companies establish
certain procedures to disclose and notify users of privacy and security
policies, obtain consent from users for certain collection and use of
information and to provide users with the ability to access, correct and delete
personal information stored by the company. These regulations may also include
enforcement and redress provisions. There can be no assurance that we will
adopt policies that conform with any regulations adopted by the FTC. Moreover,
even in the absence of those regulations, the FTC has begun investigations into
the privacy practices of companies that collect information on the Internet.
One investigation resulted in a consent decree pursuant to which an Internet
company agreed to establish programs to implement the principles noted above.
We may become subject to a similar investigation, or the FTC's regulatory and
enforcement efforts may adversely affect the ability to collect demographic and
personal information from users, which could have an adverse effect on our
ability to provide highly targeted opportunities for advertisers and electronic
commerce marketers. Any of these developments would materially adversely affect
our business, results of operations and financial condition.

   The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. Under the directive, citizens of the
European Union are guaranteed rights to access their data, rights to know where
the data originated, rights to have inaccurate data rectified, rights to
recourse in the event of unlawful processing and rights to withhold permission
to use their data for direct marketing. The directive could, among other
things, affect United States companies that collect information over the
Internet from individuals in European Union member countries, and may impose
restrictions that are more stringent than current Internet privacy standards in
the United States. In particular, companies with offices located in European
Union countries will not be allowed to send personal information to countries
that do

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<PAGE>

not maintain adequate standards of privacy. The directive does not, however,
define what standards of privacy are adequate. As a result, the directive may
adversely affect the activities of entities such as us that engage in data
collection from users in European Union member countries.

Intellectual Property

   Our performance and ability to compete are dependent to a significant degree
on our proprietary and licensed technology. We rely on a combination of patent,
copyright, trademark and trade secret laws and contractual restrictions to
establish and protect our technology. We do not currently have any issued
patents or registered copyrights. All key employees have signed confidentiality
agreements and we intend to require each newly hired employee to execute a
confidentiality agreement. These agreements provide that confidential
information developed by or with an employee or consultant, or disclosed to
such person during his or her relationship with us, may not be disclosed to any
third party except in certain specified circumstances. These agreements also
require our employees to assign their rights to any inventions to us. The steps
taken by us may not, however, be adequate to prevent the misappropriation of
our proprietary rights or technology. In addition, our competitors may
independently develop technologies that are substantially equivalent or
superior to our technology.

   We own the registered service mark for three of the marks used in our
business and have applications pending to register several other service marks
used in our business. There can be no assurance that we will be able to secure
significant protection for all our service marks. Competitors of ours or others
could adopt product or service marks similar to our marks, or try to prevent us
from using our marks, thereby impeding our ability to build brand identity and
possibly leading to customer confusion.

   We have received correspondence from a company, NetPhone Inc., claiming that
our use of the mark "Net2Phone" in connection with Internet telephony services
infringes one of that company's United States registered trademarks and
requesting that we cease and desist from using the Net2Phone mark. We have
responded by denying any infringement and no legal proceedings have been
commenced against us with respect to this matter. NetPhone currently operates a
Web site at www.netphone.com. There can be no assurance that the existence of
NetPhone's business and Web site will not materially adversely affect our
business.

   AT&T, who may have rights in the terms "Click2Dial," "Click2Whisper" and
"Click2Interact," has filed with the United States Patent and Trademark Office
for an extension of the time limit for opposing our service mark application
filed for the "Click2Talk" mark. AT&T could oppose registration of our
Click2Talk mark or take other action aimed at restricting us from using this
mark.

   We are also aware of several other parties that use marks that are the same
or similar to marks that we use, though in some instances, to the best of our
knowledge, these parties are not in the same business as we are.

   There can be no assurance that the companies that notified us or other
companies with marks similar to our marks will not bring suit to prevent us
from using the Net2Phone mark or other marks. Defending or losing any
litigation relating to intellectual property rights could materially adversely
affect our business, results of operations and financial condition.

   In addition, one of our international resellers, a company known as ITM,
operates a Web site at www.net2phone.net without our permission or
authorization, and in violation of the agency agreement ITM entered into with
us for the distribution of the Net2Phone software with certain ITM software.
Furthermore, ITM has also taken steps to secure registration and ownership of
the Net2Phone mark in France. We have notified ITM of these violations, have
taken actions to oppose ITM's registration of the Net2Phone mark, as well as
filed a dispute policy complaint with Network Solutions, Inc., and will
continue

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<PAGE>

to pursue our claim against them, but there can be no assurances that we can
prevent, through litigation or otherwise, ITM from continuing its operation of
the www.net2phone.net Web site or from obtaining registration and ownership of
the Net2Phone mark in France. We have also commenced trademark opposition
proceedings in Ecuador and in Venezuela against two parties that are attempting
to register the Net2Phone mark or a confusingly similar mark in these
countries.


   We have not taken steps to assure foreign protection of our trademarks,
except for our recent filing of a Community Trademark application for
registration of the Net2Phone mark, which covers certain European countries. To
the extent trademark rights are acquired through registration in countries
outside the United States, we may not be able to protect our marks or assure
that we are not infringing other parties' marks in those countries. Moreover,
we have not taken steps to register the Net2Phone domain names with the various
international registries.

   We have been assigned the rights to patent applications claiming a number of
the technologies underlying our products and services. Our two United States
patent applications have been rejected, but we are continuing to pursue patent
protection for the claimed subject material. There can be no assurance that the
applications will result in the issuance of patents or that, if issued, such
patents would adequately protect us against competitive technology or that they
would be held valid and enforceable against a challenge. In addition, it is
possible that our competitors may be able to design around any such patents.
Also, our competitors may obtain patents that we would need to license or
circumvent in order to make, use, sell or offer for sale the technology.

   We believe that we do not infringe upon the proprietary rights of any third
party, and no third party has asserted a patent infringement claim against us.
It is possible, however, that such a claim might be asserted successfully
against us in the future. Our ability to make, use, sell or offer for sale our
products and services depends on our freedom to operate. That is, we must
ensure that we do not infringe upon the proprietary rights of others or have
licensed all such rights. We have not requested or obtained an opinion from our
outside counsel as to whether our products and services infringe upon the
intellectual property rights of any third parties. We are aware that patents
have recently been granted to others based on fundamental technologies in the
Internet telephony area. In addition, we are aware of at least one other patent
application involving potentially similar technologies to our own which if
issued could materially adversely affect our business. Because patent
applications in the Unites States are not publicly disclosed until issued,
other applications may have been filed which, if issued as patents, could
relate to our services and products. However, foreign patent applications do
publish before issuance. We are aware of several such publications that relate
to Internet telephony. One such published application claims as an inventor a
previous consultant to IDT and has been assigned to another company. Issuance
of a patent or patents from this application could materially adversely affect
our ability to operate. A party making an infringement claim could secure a
substantial monetary award or obtain injunctive relief which could effectively
block our ability to provide services or products in the United States or
abroad.

   If any of these risks materialize, we could be forced to suspend operations,
to pay significant amounts to defend our rights, and a substantial amount of
the attention of our management may be diverted from our ongoing business, each
of which could materially adversely affect our ability to operate.

   We rely on a variety of technology, primarily software, that we license from
third parties. Most of this technology was purchased or licensed on our behalf
by IDT. Continued use of this technology by us may require that we purchase new
or additional licenses from third parties or obtain consents from third parties
to assign the applicable licenses from IDT. There can be no assurances that we
can obtain those third party licenses needed for our business or that the third
party technology licenses that we do have will continue to be available to us
on commercially reasonable terms or at all. The loss or inability to maintain
or obtain upgrades to any of these technology licenses could result in delays
or breakdowns in our ability to continue developing and providing our products
and services or to enhance and upgrade our products and services.

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Employees

   As of May 31, 1999, we had approximately 171 full-time employees, including
approximately 66 in technical support and customer service, 26 in sales and
marketing, 20 in management and finance, 47 in operations, and 12 in research
and development. Our employees are not represented by any union, and we
consider our employee relations to be good. We have never experienced a work
stoppage.

Properties

   Our primary facilities consist of approximately 15,445 square feet, which
comprise our headquarters, executive offices and customer service and technical
support centers, and are located in two buildings in Hackensack, New Jersey
leased from corporations that are owned and controlled by Howard S. Jonas. Mr.
Jonas is one of our directors, a director of IDT and the controlling
stockholder of IDT. These leases expire at the end of February 2002 and require
us to make annual rental payments of $186,144. We also sublease space for some
of our computer equipment in Piscataway, New Jersey from IDT, which leases this
space from a company also owned and controlled by Mr. Jonas. This lease runs
for a three-year term, beginning in May 1999, with monthly rent of $8,400. In
addition, we lease office space in Lakewood, New Jersey for our research and
development center. Pursuant to this lease, which expires at the end of August
2001, we are required to make annual rental payments of $48,125. See "Certain
Transactions--Facility Leases."

Legal Proceedings

   We are not currently a party to any material legal proceedings.

                                       45
<PAGE>

                                   MANAGEMENT

Executive Officers, Directors and Key Employees

   The following persons are our executive officers and directors:

<TABLE>
<CAPTION>
 Name                       Age Position
 ----                       --- --------
 <C>                        <C> <S>
 Clifford M. Sobel.........  50 Chairman of the Board
 Howard S. Balter..........  37 Chief Executive
                                Officer and Vice
                                Chairman of the
                                Board
 Jonathan Fram.............  42 President
 David Greenblatt..........  47 Chief Operating
                                Officer
 Ilan M. Slasky............  29 Chief Financial
                                Officer
 H. Jeff Goldberg..........  46 Chief Technology
                                Officer
 Jonathan Reich............  33 Executive Vice
                                President-
                                Marketing and
                                Corporate
                                Development
 Martin Rothberg...........  30 Executive Vice
                                President-
                                Strategic Sales
 Jonathan Rand.............  36 Executive Vice
                                President-
                                International
                                Sales and
                                Treasurer
 Howard S. Jonas...........  43 Director
 James A. Courter..........  57 Director
 Gary E. Rieschel..........  43 Director
 James R. Mellor...........  69 Director
 Stephen A. Oxman..........  54 Director
 Jesse King................  44 Director
</TABLE>

   Clifford M. Sobel has been Chairman of the board of directors since May
1999, served as our President from October 1997 to July 1999 and served as our
Chief Executive Officer from October 1997 to January 1999. Since 1994, Mr.
Sobel has been Chairman and Chief Executive Officer of SJJ Investment Corp.,
which has invested in Internet, cable, real estate and cosmetics companies.
Prior to this, Mr. Sobel founded several companies in the design and
manufacturing of retail interiors and themed environments, including DVMI and
its subsidiary, Bon-Art International, and Bauchet International. These
companies were sold in 1994 by Bear, Stearns & Co. Inc. Mr. Sobel has testified
before Congress on foreign trade issues and, by Presidential appointment,
served on the Holocaust Memorial Council in Washington, D.C.

   Howard S. Balter has been a director since October 1997, our Chief Executive
Officer since January 1999, and our Vice Chairman of the board of directors
since May 1999. Mr. Balter also served as our Treasurer from October 1997 to
July 1999. Prior to his employment with us, Mr. Balter was IDT's Chief
Operating Officer from 1993 to 1998 and Chief Financial Officer from 1993 to
1995. Mr. Balter was a director of IDT from December 1995 to January 1999 and
Vice Chairman of IDT's board from 1996 to 1999. From 1985 to 1993, Mr. Balter
operated his own real estate development firm.

   Jonathan Fram became our President in July 1999. Prior to his employment
with us, Mr. Fram was General Manager of Bloomberg L.P.'s New Media Group from
1996 to 1999, where he was responsible for Bloomberg's Internet strategy. Mr.
Fram was employed as General Manager of Bloomberg's Television and Radio Group
from 1991 to 1996. From 1989 to 1991, Mr. Fram served as the Chief Executive
Officer of FNN:PRO - Institutional Research Network, Inc. Mr. Fram was also
employed by both Bear Stearns & Co. and Paine Webber, Inc. as a securities
analyst, and worked for IBM as a computer design engineer.

   David Greenblatt has been our Chief Operating Officer since January 1999.
Between January 1998 and January 1999, Mr. Greenblatt served as IDT's Vice
President of Networks, during which time he was primarily responsible for the
operations of Net2Phone. Prior to his employment with IDT in January 1998,
Mr. Greenblatt was Senior Vice President of Research and Development for
Nextwave Communications from 1996 to 1997. From January 1984 to August 1996,
Mr. Greenblatt was a principal of Financial Technologies, Inc., where he
managed the process of software conversion for large and medium-sized
businesses. From January 1980 to December 1984, Mr. Greenblatt was an
information technologies

                                       46
<PAGE>

consultant for various money center banks. From 1970 to 1980, Mr. Greenblatt
has lectured in the areas of Computer Science and Mathematics at Queens
College, New York University, Hunter College and Pace University.

   Ilan M. Slasky has been our Chief Financial Officer since January 1999.
Prior to his employment with us, Mr. Slasky was IDT's Executive Vice President
of Finance from December 1997 to January 1999, IDT's director of carrier
services from November 1996 to July 1997 and IDT's Director of Finance from May
1996 to November 1996. From 1991 to 1996, Mr. Slasky worked for Merrill Lynch
in various areas of finance, including risk management, fixed income trading
and equity derivatives.

   H. Jeff Goldberg has been our Chief Technology Officer since January 1999.
From January 1996 to January 1999, Mr. Goldberg was our Director of Technology
and a consultant to IDT. Mr. Goldberg was an independent software consultant
from 1985 to 1995, Vice President of Software and a member of the board of
directors at Charles River Data Systems in Massachusetts from 1979 to 1985 and
a developer of multimedia communications software at AT&T Bell Laboratories
from 1977 to 1979. Mr. Goldberg is a founding member of the UNIX standards
committee.

   Jonathan Reich has been our Executive Vice President--Marketing and
Corporate Development since January 1999. Prior to his employment with us, Mr.
Reich was IDT's Senior Vice President of Advertising, Marketing and Business
Development in charge of strategic relationships for both us and IDT from June
1997 to December 1998 and IDT's director of advertising from January 1995 to
November 1997. From 1992 to 1993, Mr. Reich worked for Sanford Bernstein & Co.
as an associate analyst. Prior to this, Mr. Reich was an internal consultant
for Morgan Stanley & Co.

   Martin Rothberg has been our Executive Vice President--Strategic Sales since
January 1999 and a key employee since June 1997. Prior to his employment with
us, Mr. Rothberg was IDT's Director of International Sales from September 1996
to June 1997 and IDT's Director of Domestic Sales from June 1995 to September
1996.

   Jonathan Rand has been our Executive Vice President--International Sales
since January 1999, Treasurer since July 1999 and a key employee since January
1998. Prior to joining us, Mr. Rand was a member of IDT's senior management
from 1992 to January 1999, including service as Senior Vice President--
International Sales and Senior Vice President--Finance. Additionally, Mr. Rand
is a co-founder and director of the International Internet Association. Prior
to joining IDT, Mr. Rand operated his own magazine publishing business from
1986 to 1992 and was employed by Procter & Gamble from 1985 to 1986 in Brand
Management.

   Howard S. Jonas was appointed a director in October 1997. Mr. Jonas founded
IDT in August 1990 and has served as Chairman of the Board and Treasurer since
its inception and as Chief Executive Officer since December 1991. Additionally,
he served as President of IDT from December 1991 through September 1996. Mr.
Jonas is also the founder and has been President of Jonas Publishing Corp., a
publisher of trade directories, since its inception in 1979.

   James A. Courter was appointed a director in May 1999. Mr. Courter has been
President of IDT since October 1996 and a director of IDT since March 1996. Mr.
Courter has been a senior partner in the New Jersey law firm of Courter,
Kobert, Laufer & Cohen, P.C. since 1972. He was also a partner in the
Washington, D.C. law firm of Verner, Liipfert, Bernhard, McPherson & Hand from
January 1994 to September 1996. From 1991 to 1994, Mr. Courter was chairman of
the President's Defense Base Closure and Realignment Commission. Mr. Courter
was a member of the United States House of Representatives for 12 years,
retiring in January 1991. Mr. Courter also serves on the board of directors of
Envirogen and The Berkeley School.

   Gary E. Rieschel was appointed a director in June 1999. Mr. Rieschel is the
Executive Managing Director of SOFTBANK Technology Ventures, which he joined in
January 1996. Mr. Rieschel has extensive

                                       47
<PAGE>

overseas experience, having spent over four years in Tokyo as General Manager
of Sequent Computer Systems' Asian operations. He serves as a Director for
several SOFTBANK Technology Ventures' portfolio companies and is a member of
SOFTBANK Corporation's Global Executive Board.

   James R. Mellor was appointed a director in June 1999. Mr. Mellor served as
a director of IDT between August 1997 and June 1999. Since 1981, Mr. Mellor
worked for General Dynamics Corporation, a developer of nuclear submarines,
surface combatant ships and combat systems. From 1994 until 1997, Mr. Mellor
served as Chairman and Chief Executive Officer of General Dynamics, and from
1993 to 1994, he served as President and Chief Operating Officer of General
Dynamics. Before joining General Dynamics, Mr. Mellor served as President and
Chief Operating Officer of AM International, Inc. now Multigraphics, Inc.
Before that time, Mr. Mellor spent 18 years with Litton Industries in a variety
of engineering and management positions, including Executive Vice President in
charge of Litton's Defense Group from 1973 to 1997.

   Stephen A. Oxman was appointed a director in July 1999. Mr. Oxman currently
serves as a managing director in the mergers, acquisitions and corporate
advisory group of Deutsche Bank Securities Inc., an affiliate of BT Alex. Brown
Incorporated. He heads the group's telecommunications practice and also focuses
on the firm's work in Europe. In 1995, Mr. Oxman became a partner in the
investment banking firm of James D. Wolfensohn Incorporated, which merged in
1996 with Bankers Trust, which in turn merged with Deutsche Bank in 1999. From
1993 to 1994, Mr. Oxman served as Assistant Secretary of State for European and
Canadian Affairs. From 1988 to 1993, Mr. Oxman was a managing director of
Wasserstein Perella & Co. and Deputy Chairman of Wasserstein Perella
International. From 1980 to 1988, he was a partner in the law firm of Shearman
& Sterling. During the Carter administration, Mr. Oxman was Executive Assistant
to the Deputy Secretary of State, and subsequently a consultant to the
Secretary of State concerning the Iran hostage crisis.

   Jesse King was appointed a director in July 1999. Mr. King has served as the
Operation Manager for the Rockefeller Foundation's Next Generation Leadership
Program and the Philanthropy Workshop since January of 1996. Before joining The
Rockefeller Foundation, Mr. King worked as the Senior Program Director and
Human Resource Director for the Colorado Outward Bound School from 1990 to
1996. Additionally, Mr. King worked as a Project Director and Consultant for
the Children's Defense Fund and the Black Community Crusade for Children from
February 1994 to 1995.

   In addition, we employ the following additional key employees:

   Ira A. Greenstein has been our General Counsel and Secretary since May 1999.
Mr. Greenstein has been a partner in the law firm of Morrison & Foerster LLP
since 1997 where he serves as the chair of that firm's New York office's
Corporate Department. Prior to 1997, Mr. Greenstein was an associate in the
New York and Toronto offices of Skadden, Arps, Slate, Meagher & Flom LLP. From
1991 to 1992, Mr. Greenstein served as counsel to the Ontario Securities
Commission advising on the implementation of the Multijurisdictional Disclosure
System with the Securities and Exchange Commission. Mr. Greenstein also served
on the Securities Advisory Committee to the Ontario Securities Commission from
1992 to 1996. Mr. Greenstein has testified as an expert in the U.S. securities
laws in U.S. District Court.

   Chaim Ackerman has been a senior software engineer of ours since February
1996. Prior to his employment with us, Mr. Ackerman was a member of the
technical staff at AT&T Bell Laboratories from 1986 to 1996. From 1984 to 1986,
Mr. Ackerman was a member of the technical staff at AT&T Consumer Products.
From 1980 to 1984, Mr. Ackerman worked for Computer Horizons Corporation as a
consultant to Bell Laboratories.

   Sarah Hofstetter has been our Vice President-Corporate Communications since
May 1999. Prior to her employment with us, Ms. Hofstetter was IDT's Vice
President of Corporate Communications, in charge of public relations and brand
imaging from April 1996 to January 1999. From 1995 to 1996, Ms. Hofstetter

                                       48
<PAGE>

worked at The New York Times Syndicate as an editor of the New America News
Service, a wire service specializing in issues related to diversity in the
marketplace. Ms. Hofstetter sits on the editorial boards of Telecom Business
and TeleCard World magazines, and on the Editorial Roundtable of Intel-Card
News magazine.

Board of Directors and Committees of the Board

   Our certificate of incorporation, as amended and restated, provides that the
number of members of our board of directors shall be not less than five and not
more than 11. The number of directors is currently eight. We anticipate that
one additional director will be elected after the closing of this offering. Our
board of directors has been divided into three classes, and each class will be
kept as nearly equal in number as possible. At each annual meeting of
stockholders, the successors to the class of directors whose term expires at
that time will be elected to hold office for a term of three years and until
their respective successors are elected and qualified. All of the officers
identified above serve at the discretion of our board of directors.

   IDT and Clifford M. Sobel, our Chairman, have agreed to vote all of their
shares in favor of the election of a director nominated by SOFTBANK Technology
Ventures IV and a director nominated by either GE Capital Equity Investments or
NBC, in each case for as long as either entity holds a majority of the shares
of Series A convertible preferred stock originally purchased by them or the
shares into which they are convertible. Gary E. Rieschel was nominated to our
board by SOFTBANK. Neither GE nor NBC has nominated a director.

   We have established an audit committee and a compensation committee. The
initial members of the Compensation Committee are James R. Mellor and Jesse
King. We expect to appoint one or more additional directors to this committee
after the closing of this offering. Mr. Mellor and Mr. Oxman sit on the Audit
Committee.

   The audit committee oversees the retention, performance and compensation of
the independent public accountants, and the establishment and oversight of such
systems of internal accounting and auditing control as it deems appropriate.

   The compensation committee reviews and approves the compensation of our
executive officers, including payment of salaries, bonuses and incentive
compensation, determines our compensation policies and programs, and
administers our stock option plans.

   The board of directors does not have a nominating committee. However, the
board of directors will consider nomination recommendations from stockholders,
which should be addressed to our corporate secretary at our principal executive
offices.

                                       49
<PAGE>

Executive Compensation

   The following table identifies our most highly compensated executive
officers whose salaries and bonuses exceeded $100,000 during fiscal 1998 and
who served as executive officers of Net2Phone during fiscal 1998. Our Chief
Executive Officer, Howard S. Balter was employed as the Chief Operating Officer
and Vice Chairman of IDT during fiscal 1998 and did not serve as an executive
officer of Net2Phone during fiscal 1998. All of the named executive officers
listed below were compensated by IDT during fiscal 1998.

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                     Long-Term
                                      Annual        Compensation
                                   Compensation        Awards
                                ------------------ --------------
                                                     Securities
Name and Principal       Fiscal                      Underlying      All Other
Position                  Year  Salary($) Bonus($) IDT Options(#) Compensation($)
- ------------------       ------ --------- -------- -------------- ---------------
<S>                      <C>    <C>       <C>      <C>            <C>
Clifford M. Sobel(1)....  1998   100,000        --         --                  --
 Chairman and President
David Greenblatt........  1998   104,238        --     20,000                  --
 Chief Operating Officer
H. Jeff Goldberg........  1998   209,447        --     50,000                  --
 Chief Technology
  Officer
</TABLE>
- ---------------------
(1) Mr. Sobel served as our Chief Executive Officer from October 1997 to
   January 1999 and our President from October 1997 to July 1999.

                        Option Grants During Fiscal 1998

   No options to purchase shares of Net2Phone were granted to the executive
officers named above during fiscal 1998.

   The following table describes the options to acquire shares of common stock
of IDT granted to the individuals named above during fiscal 1998:

<TABLE>
<CAPTION>
                                                                  Potential
                                                              Realizable Value
                                % of                                 at
                                Total                          Assumed Annual
                   Number of   Options                         Rates of Stock
                  Securities   Granted                              Price
                    Under-       to      Exercise               Appreciation
                   lying IDT  Employees     or                 for Option Term
                    Options   in Fiscal Base Price Expiration -----------------
Name              Granted (#) Year (%)    ($/Sh)      Date    5% ($)   10% ($)
- ----              ----------- --------- ---------- ---------- ------- ---------
<S>               <C>         <C>       <C>        <C>        <C>     <C>
David
 Greenblatt......   20,000       1.6      $18.00   Nov. 2007  226,402   573,747
H. Jeff
 Goldberg........   50,000       4.0      $24.25   June 2008  762,534 1,932,413
</TABLE>

                                       50
<PAGE>

                        Option Grants During Fiscal 1999

   The following table describes the options to acquire shares of our common
stock that have been granted to our executive officers in fiscal 1999:

<TABLE>
<CAPTION>
                                       % of                               Potential
                                      Total                           Realizable Value
                                     Options                                 at
                          Number of  Granted                           Assumed Annual
                         Securities     to                             Rates of Stock
                         Underlying  Grantees  Exercise              Price Appreciation
                          Net2Phone     in        or                 for Option Term (1)
                           Options    Fiscal  Base Price Expiration ---------------------
Name                     Granted (#) Year (%)   ($/Sh)      Date      5% ($)    10% ($)
- ----                     ----------- -------- ---------- ---------- ---------- ----------
<S>                      <C>         <C>      <C>        <C>        <C>        <C>
Howard S. Balter........  1,650,999    19.2      3.33     May 2009  34,836,078 58,742,544
Howard S. Balter........    223,500     2.6     15.00    July 2009   2,107,605  5,343,885
Jonathan Fram...........    460,000     5.3      3.33    July 2009   9,706,000 16,366,800
Jonathan Fram...........    460,000     5.3     11.00    July 2009   1,343,000  2,791,000
Jonathan Fram...........    100,000     1.2     15.00    July 2009     943,000  2,391,000
David Greenblatt........    360,000     4.2      3.33     May 2009   7,596,000 12,808,800
David Greenblatt........    100,000     1.2      3.33    July 2009   2,110,000  3,558,000
H. Jeff Goldberg........    360,000     4.2      3.33     May 2009   7,596,000 12,808,800
H. Jeff Goldberg........    100,000     1.2     15.00    July 2009     943,000  2,391,000
Ilan M. Slasky..........    360,000     4.2      3.33     May 2009   7,596,000 12,808,800
Jonathan Reich..........     75,000     0.9      3.33     May 2009   1,582,500  2,668,500
Jonathan Reich..........    200,000     2.3     15.00    July 2009   1,886,000  4,782,000
Martin Rothberg.........    360,000     4.2      3.33     May 2009   7,596,000 12,808,800
Jonathan Rand...........     45,000     0.5      3.33     May 2009     949,500  1,601,100
Jonathan Rand...........     75,000     0.9     15.00    July 2009     707,250  1,793,250
</TABLE>
- ---------------------
(1) Assumes that the fair market value of each grant on the date of each grant
    was equal to the initial public offering price of $15.00 per share.

                        Value of IDT Options at Year End

   The following table describes the value of IDT options exercised in fiscal
1998 and the value of unexercised options held by the individuals named above
at July 31, 1998:

<TABLE>
<CAPTION>
                                                       Number of Securities         Value of Unexercised
                          Number of                   Underlying Unexercised            in-the-Money
                           Shares                   Options at Fiscal Year-End   Options at Fiscal Year-End
                         Acquired on                --------------------------- -----------------------------
Names                     Exercise   Value Realized  Exercisable/Unexercisable  Exercisable/Unexercisable (1)
- -----                    ----------- -------------- --------------------------- -----------------------------
<S>                      <C>         <C>            <C>                         <C>
Clifford M. Sobel(2)....   100,000     $1,701,500         100,000/875,000               $1,775,000/--
David Greenblatt........        --             --                20,000/0                  125,000/--
H. Jeff Goldberg........     5,000        111,250          210,000/50,000                3,556,500/0
</TABLE>
- ---------------------
(1) The closing price of IDT's common stock on July 31, 1998, as reported on
    the Nasdaq National Market, was $24.25 per share.
(2) Mr. Sobel has an option that may be exercised beginning in September 1999,
    to transfer his shares of Net2Phone to IDT in exchange for an option to
    acquire 875,000 shares of IDT common stock at a purchase price of $6.50 per
    share. Mr. Sobel will be prohibited by an agreement with the underwriters
    from exercising this option during the 180-day period following the date of
    this prospectus.


                                       51
<PAGE>

                     Value of Net2Phone Options at Year End

   The following table describes the value of Net2Phone options exercised in
fiscal 1998 and the value of unexercised options held by Clifford M. Sobel, our
Chairman and President, at July 31, 1998. None of the other individuals named
in the Summary Compensation Table were granted options to purchase shares of
Net2Phone prior to fiscal 1999.

<TABLE>
<CAPTION>
                                                   Number of Securities         Value of Unexercised
                         Number of                Underlying Unexercised            in-the-Money
                          Shares                Options at Fiscal Year-End   Options at Fiscal Year-End
                         Acquired     Value    ---------------------------- ----------------------------
Names                    Exercise  Realized(1) Exercisable/Unexercisable(2) Exercisable/Unexercisable(2)
- -----                    --------- ----------- ---------------------------- ----------------------------
<S>                      <C>       <C>         <C>                          <C>
Clifford M. Sobel....... 3,096,000     $ 0              0/347,865                       0/--
</TABLE>
- ---------------------
(1) For purposes of this table, the per share value of each share of Net2Phone
    common stock in January 1998 is assumed to be $.03 per share, based upon a
    valuation report prepared by an independent appraiser.
(2) Mr. Sobel received options to purchase an aggregate of 11% of Net2Phone's
    capital stock in connection with his May 1997 employment agreement. Mr.
    Sobel exercised his option to purchase 10% of Net2Phone's capital stock in
    January 1998, and his option to purchase the additional 1% of Net2Phone's
    capital stock terminated under an amendment to his employment agreement
    entered into in May 1999. Mr. Sobel does not currently own any options to
    purchase shares of Net2Phone.

Compensation of Directors

   We intend to grant options to purchase shares of common stock to all of our
non-employee directors under the 1999 Stock Incentive Plan, other than non-
employee directors who serve as officers of IDT. See "1999 Stock Incentive
Plan." Other than as will be provided in that plan and the reimbursement of
reasonable expenses incurred with attending board and committee meetings, we
have not yet adopted specific policies on directors' compensation and benefits
following the closing of this offering.

Employment Agreements

   Clifford M. Sobel, our Chairman, is employed pursuant to an employment
agreement that was entered into in May 1997 and amended in May 1999. The
agreement commenced in September 1997 and will expire in September 2000, and
will automatically be extended though September 2001 unless either we or Mr.
Sobel notifies the other that the extension will not take effect. Mr. Sobel
receives an annual base salary of $100,000. In January 1998, in connection with
an option set forth in his employment agreement, Mr. Sobel purchased 10% of our
common stock for $100,000. On the closing date of this offering, Mr. Sobel will
receive from IDT that number of shares of our common stock which will maintain
his holdings, when combined with shares owned by a trust for the benefit of his
offspring, at 8% of our total outstanding capital stock as of that date. Mr.
Sobel's employment agreement also provides him with an option to transfer his
interest in us to IDT in exchange for an option from IDT to purchase 875,000
registered shares of IDT common stock at a purchase price of $6.50 per share.
This option is exercisable at any time from September 15, 1999 through
September 15, 2000, so long as he is employed by us as of September 15, 1999
and owns and holds all of the stock he received, other than shares that he
transferred to a trust for the benefit of his offspring. Mr. Sobel will be
prohibited by an agreement with the underwriters from exercising this option
during the 180-day period following the date of this prospectus.

   On July 2, 1999, we signed a three-year employment agreement with Jonathan
Fram, our President. After its initial term, which ends on June 30, 2002, our
agreement with Mr. Fram may be renewed annually. We will pay Mr. Fram an annual
base salary of $350,000 and he is entitled to receive an annual bonus
calculated on the basis of our gross revenue, which bonus could be up to
$100,000. Additionally, we granted Mr. Fram options to purchase 920,000 shares
of our common stock under our 1999 Stock Option and Incentive Plan. Of these
options, 460,000 were granted at an exercise price of $3.33, 153,333 of which
are

                                       52
<PAGE>

vested and exercisable. The options to purchase the remaining 460,000 shares
have an exercise price of $11.00. Other than those options already vested, the
remaining 766,667 options will vest in three equal annual installments,
commencing on July 20, 2000. An option to purchase an additional 100,000 shares
of our common stock was granted to Mr. Fram on July 28, 1999. This option is
immediately exercisable and has an exercise price equal to the initial public
offering price of our common stock of $15.00 per share. These options will vest
immediately if we terminate Mr. Fram's employment without cause, if Mr. Fram
terminates his employment for good reason, or if the options of any other
employee are accelerated upon a change of control of our company.

   At present, none of the other named executive officers or key employees is
party to an employment agreement with us.

1999 Stock Incentive Plan

   Our 1999 Stock Option and Incentive Plan was adopted in April 1999. Under
the plan, our officers, directors, key employees and consultants, together with
those of IDT and its subsidiaries, are eligible to receive awards of stock
options, stock appreciation rights, limited stock appreciation rights and
restricted stock. Options granted under the plan may be incentive stock options
or nonqualified stock options. Stock appreciation rights and limited stock
appreciation rights may be granted simultaneously with the grant of an option
or, in the case of nonqualified stock options, at any time during its term.
Restricted stock may be granted in addition to or in lieu of any other award
made under the plan. A total of 11,040,000 shares of common stock have been
authorized to date for issuance under the plan, 5,040,000 of which were granted
in May 1999, and 1,345,219 of which have been exercised. These options have a
weighted average exercise price of $3.33 per share. In connection with loans
granted to several grantees under the plan to exercise a portion of these
options, 23,382 outstanding options were cancelled. Additional options to
purchase 6,996 shares were cancelled in connection with the termination of the
employment of four grantees. In July 1999, we granted options to purchase an
additional 920,000 shares of our common stock to Jonathan Fram, our President.
See "--Employment Agreements." We granted options to purchase approximately
2,503,500 additional shares of our common stock on July 28, 1999 that have an
exercise price equal to the initial public offering price of $15.00, together
with additional options to purchase 168,000 shares of our common stock that
have an exercise price of $3.33 per share.

   The 1999 Stock Option and Incentive Plan is administered by the compensation
committee of our board. Subject to the provisions of the plan, the board of
directors or the compensation committee will determine the type of award, when
and to whom awards will be granted, the number of shares covered by each award
and the terms and kind of consideration payable with respect to awards. The
board of directors or the compensation committee may interpret the plan and may
at any time adopt the rules and regulations for the plan as it deems advisable.
In determining the persons to whom awards shall be granted and the number of
shares covered by each award, the board of directors or the compensation
committee may take into account the duties of the respective persons, their
present and potential contribution to our success and other relevant factors.

   Stock Options. An option may be granted on the terms and conditions as the
board of directors or the compensation committee may approve, and generally may
be exercised for a period of up to ten years from the date of grant. Generally,
incentive stock options will be granted with an exercise price equal to the
fair market value on the date of grant. Additional limitations will apply to
incentive stock options granted to a grantee that beneficially holds 10% or
more of our voting stock. The board of directors or compensation committee may
authorize loans to individuals to finance their exercise of vested options. See
"Certain Transactions--Officer Loans." Options granted under the 1999 Stock
Option and Incentive Plan will become exercisable at those times and under the
conditions determined by the board of directors or the compensation committee.
To date, the options that have been granted to our executive officers will
generally vest automatically in the event that there is a change of control of
our company, if we are merged into another company or if any of these
individuals are employed by a subsidiary of our company that is sold to another
company.

                                       53
<PAGE>

   The 1999 Stock Option and Incentive Plan provides for automatic option
grants to eligible non-employee directors. Options to purchase 10,000 shares of
common stock have been granted to each eligible non-employee director and
options to purchase 10,000 shares of common stock will be granted to each new
eligible non-employee director upon the director's initial election to the
board. In addition, options to purchase 10,000 shares of common stock are
granted annually to each eligible non-employee director on the anniversary date
of his or her election to the board. Each of these options will have an
exercise price equal to the fair market value of a share of common stock on the
date of grant. All options granted to non-employee directors will be
immediately exercisable. All options held by non-employee directors, to the
extent not exercised, expire on the earliest of:

  .  the tenth anniversary of the date of grant;

  .  one year following the optionee's termination of directorship other than
     for cause; and

  .  three months following the optionee's termination of directorship for
     cause.

   Stock Appreciation Rights and Limited Stock Appreciation Rights. The 1999
Stock Option and Incentive Plan also permits the board of directors or the
compensation committee to grant stock appreciation rights and/or limited stock
appreciation rights with respect to all or any portion of the shares of common
stock covered by options. Generally, stock appreciation rights and limited
stock appreciation rights may be exercised only at that time as the related
option is exercisable. Upon exercise of a stock appreciation right, a grantee
will receive for each share for which an stock appreciation right is exercised,
an amount in cash or common stock, as determined by the board of directors or
the compensation committee, equal to the excess of the fair market value of a
share of common stock on the date the stock appreciation right is exercised
over the exercise price per share of the option to which the stock appreciation
right relates.

   Limited stock appreciation rights may be exercised only during the 90 days
following a change in control, or a merger or similar transaction, involving
Net2Phone. Upon exercise of a limited stock appreciation right, a grantee will
receive, for each share for which a limited stock appreciation rights is
exercised, an amount in cash equal to the excess of the highest fair market
value of a share of our common stock during the 90-day period ending on the
date of the limited stock appreciation rights is exercised, or an amount equal
to the highest price per share paid for shares of our common stock in
connection with a merger or a change of control of Net2Phone, whichever is
greater, over the exercise price per share of the option to which the limited
stock appreciation rights relates. In no event, however, may the holder of a
limited stock appreciation right granted in connection with an incentive stock
option receive an amount in excess of the maximum amount that will enable the
option to continue to qualify as an incentive stock option.

   Restricted Stock. The 1999 Stock Option and Incentive Plan further provides
for the granting of restricted stock awards, which are awards of common stock
that may not be disposed of, except by will or the laws of descent and
distribution, for a period of time determined by the compensation committee or
the board of directors. The board or the compensation committee may also impose
other conditions and restrictions on the shares as it deems appropriate,
including the satisfaction of performance criteria. All restrictions affecting
the awarded shares will lapse in the event of a merger or similar transaction
involving Net2Phone.

   The board may amend or terminate the 1999 Stock Option and Incentive Plan.
However, as required by any law, regulation or stock exchange rule, no change
shall be effective without the approval of our stockholders. In addition, no
change may adversely affect an award previously granted, except with the
written consent of the grantee.

   No awards may be granted under the 1999 Stock Option and Incentive Plan
after the tenth anniversary of its initial adoption.

                                       54
<PAGE>

   Options and Awards Under the 1999 Stock Option and Incentive Plan. We cannot
now determine the number of options or awards to be granted in the future under
the 1999 Stock Option and Incentive Plan to officers, directors and employees.

Compensation Committee Interlocks and Insider Participation.

   We did not have a compensation committee during fiscal 1998. Compensation
decisions relating to our executive officers, key employees and other senior
personnel were made primarily by IDT, which owned all of our outstanding
capital stock at the beginning of fiscal 1998. During fiscal 1998, Howard S.
Jonas, who was serving as our chairman, and Howard S. Balter, who was serving
as our treasurer, also served as directors of IDT.

401(k) Plan

   Prior to May 1999, our employees participated in IDT's 401(k) Savings and
Retirement Plan. We are in the process of establishing our own 401(k) plan that
is intended to qualify for preferential tax treatment under section 401(k) of
the Internal Revenue Code. We intend that most of our employees will be
eligible to participate in our 401(k) Savings and Retirement Plan upon
adoption.

                                       55
<PAGE>

                             PRINCIPAL STOCKHOLDERS

   The following table sets forth information with respect to the beneficial
ownership of our outstanding common stock as of July 28, 1999 and as adjusted
to reflect the sale of the common stock offered hereby by:

  .  each person who is the beneficial owner of more than 5% of our capital
     stock;

  .  each of our directors;

  .  each of our named executive officers; and

  .  all of our named executive officers and directors as a group.

   Except as otherwise indicated, all of the shares indicated in the table are
shares of common stock.

<TABLE>
<CAPTION>
                                                                 Percentage
                                          Number of Shares      Beneficially
                                         Beneficially Owned       Owned(1)
                                        --------------------- -----------------
                                         Prior to    After    Prior to  After
Holders                                  Offering   Offering  Offering Offering
- --------------------------------------  ---------- ---------- -------- --------
<S>                                     <C>        <C>        <C>      <C>
IDT Corporation(2)....................  27,621,982 27,158,190   65.8%    57.1%
190 Main Street
Hackensack, New Jersey 07601
Howard S. Jonas(3)....................  27,621,982 27,158,190   65.8%    57.1%
c/o IDT Corporation
190 Main Street
Hackensack, New Jersey 07601
James A. Courter(4)...................  27,657,982 27,194,190   65.9%    57.2%
c/o IDT Corporation
190 Main Street
Hackensack, New Jersey 07601
SOFTBANK Technology Ventures IV,
 L.P.(5)..............................   4,590,000  4,590,000   10.9%     9.6%
333 West San Carlos Street, Suite 1225
San Jose, California 95110
Gary E. Rieschel(6)...................   4,600,000  4,600,000   11.0%     9.7%
c/o SOFTBANK Technology Ventures IV,
 L.P.
333 West San Carlos Street, Suite 1225
San Jose, California 95110
Clifford M. Sobel(7)..................   3,338,018  3,801,810    8.0%     8.0%
c/o Net2Phone, Inc.
171 Main Street
Hackensack, New Jersey 07601
America Online, Inc.(8)...............   2,295,000  2,795,000    5.5%     5.9%
22000 AOL Way
Dulles, Virginia 20166
General Electric Company Group(9).....   2,295,000  2,628,333    5.5%     5.5%
120 Long Ridge Road
Stamford, Connecticut 06927
Howard S. Balter(10)..................     736,188    736,188    1.8%     1.5%
Jonathan Fram(11).....................     253,333    253,333      *        *
David Greenblatt(12)..................     135,840    135,840      *        *
H. Jeff Goldberg(13)..................     135,840    135,840      *        *
James R. Mellor(14)...................      10,000     10,000      *        *
Stephen A. Oxman(14)..................      17,500     17,500      *        *
Jesse King(14)........................      10,000     10,000      *        *
Officers and Directors as a Group
 (15 Persons)(15).....................  37,093,501 37,093,511   87.3%    77.2%
</TABLE>

                                       56
<PAGE>

- ---------------------
  * Less than one percent.
 (1) Percentage of beneficial ownership prior to this offering is based on
     4,683,237 shares of common stock and 27,621,982 shares of Class A stock
     outstanding at July 28, 1999 plus 9,420,000 shares of Class A stock
     issuable upon conversion of the Series A convertible preferred stock at
     the same date and the assumed exercise of 272,400 warrants to purchase our
     common stock. Percentage of beneficial ownership after this offering is
     based on 47,522,619 total shares outstanding, which includes all of the
     foregoing shares, plus 5,400,000 shares of common stock to be sold in this
     offering. All percentage calculations assume that all shares of
     Net2Phone's Class A stock have been converted into shares of Net2Phone's
     common stock.
 (2) All of the shares held by IDT are Class A stock. IDT has pledged its
     shares as collateral to secure a credit facility. The lenders under the
     credit facility have agreed to release IDT's shares from collateral to
     permit IDT to transfer our shares free and clear of any liens as and when
     IDT seeks to transfer our shares. Such transferability will cease if IDT's
     ownership of our capital stock drops below 50% of the capital stock owned
     by IDT 72 hours after the consummation of this offering. Unless IDT
     defaults in its obligations under the pledge agreement, it has the voting
     rights with respect to the pledged stock. In addition, in connection with
     the employment agreement between IDT, Mr. Sobel and Net2Phone, IDT will
     transfer to Mr. Sobel the number of shares of stock upon consummation of
     this offering that is necessary to maintain Mr. Sobel's percentage
     ownership of our outstanding stock, together with a trust for the benefit
     of his offspring, at 8%.
 (3) Howard S. Jonas, together with a number of entities formed for the benefit
     of charities and members of his family, owns shares of IDT's capital stock
     that enable him to vote more than 50% of IDT's capital stock. As a result,
     he may be deemed to be the beneficial owner of the shares of Net2Phone
     capital stock owned by IDT. Mr. Jonas disclaims beneficial ownership of
     these shares.
 (4) James A. Courter, one of our directors, is the President, Vice Chairman
     and a director of IDT. As a result, in addition to the 36,000 shares of
     our common stock that he holds directly, he may be deemed to be the
     beneficial owner of the shares of Net2Phone capital stock owned by IDT.
     Mr. Courter disclaims beneficial ownership of these additional shares.
 (5) Includes 4,415,400 shares of Class A stock and 88,308 shares of common
     stock issuable upon conversion of shares of Series A convertible preferred
     stock and presently exercisable warrants, respectively, that have been
     issued to SOFTBANK Technology Ventures IV, L.P. Also includes 84,600
     shares of Class A stock and 1,692 shares of common stock issuable upon
     conversion of shares of Series A preferred stock and presently exercisable
     warrants, respectively, that have been issued to SOFTBANK Technology
     Advisors Fund L.P.
 (6) Gary E. Rieschel is the Executive Managing Director of SOFTBANK Technology
     Ventures, and as a result, he may exercise the power to vote and to
     dispose of the shares held by SOFTBANK. Includes 10,000 shares issuable
     upon exercise of presently exersiable stock options.
 (7) Includes shares transferred to a trust for the benefit of Mr. Sobel's
     offspring. All of these shares are deemed to be beneficially owned by Mr.
     Sobel. In addition, in connection with the employment agreement between
     IDT, Mr. Sobel and Net2Phone, IDT will transfer to Mr. Sobel the number of
     shares of stock upon consummation of this offering that is necessary to
     maintain Mr. Sobel's percentage ownership of our outstanding stock,
     together with a trust for the benefit of his offspring, at 8%.
 (8) Includes 2,250,000 shares of Class A stock and 45,000 shares of common
     stock issuable upon conversion of shares of Series A convertible preferred
     stock and issuable upon exercise of presently exercisable warrants,
     respectively. Shares owned after the offering assumes the purchase by
     America Online of 500,000 shares in this offering.
 (9) Includes 1,125,000 of Class A stock issuable upon conversion of shares of
     Series A convertible preferred stock that are held of record by GE Capital
     Equity Investments, Inc., which shares beneficial ownership with its
     parent General Electric Capital Corporation, a wholly-owned subsidiary of
     the General Electric Company. Also includes 1,125,000 shares of Class A
     stock issuable upon exercise of shares of Series A convertible preferred
     stock that are beneficially owned by NBC, a wholly-owned indirect
     subsidiary of the General Electric Company, of which 300,000 shares are
     issuable upon conversion of shares of Series A convertible preferred stock
     that are held of record by Snap! LLC, an Internet portal service of NBC
     and CNET, Inc. Includes 22,500, 16,500 and 6,000 shares of common stock
     issuable upon exercise of warrants held by GE Capital Equity Investments,
     NBC and Snap! LLC, respectively. Shares owned after the offering assumes
     the purchase by NBC of 200,000 shares in this offering and the purchase by
     GE Capital of 133,333 shares in this offering.
(10) Includes 360,000 shares held of record by a trust for the benefit of
     Mr. Balter's family members, of which Mr. Balter and his spouse are the
     trustees. Also includes an aggregate of 138,000 shares held of record by
     trusts for the benefit of the family members of Messrs. Greenblatt, Slasky
     and Rothberg, for which Mr. Balter acts as trustee. Also includes 67,050
     shares issuable upon exercise of presently exercisable stock options.
(11) Includes 253,333 shares of common stock issuable upon exercise of
     presently exercisable stock options.
(12) Includes 54,000 shares held of record by a trust for the benefit of Mr.
     Greenblatt's family members, of which Mr. Balter is the trustee. Also
     includes 30,000 shares issuable upon exercise of presently exercisable
     stock options.
(13) Includes 72,000 shares held of record by a trust for the benefit of Mr.
     Goldberg's family members, of which Mr. Goldberg's spouse is the trustee.
     Also includes 30,000 shares issuable upon exercise of presently
     exercisable stock options.
(14) Includes 10,000 shares issuable upon exercise of presently exercisable
     stock options.
(15) Includes the shares of Class A stock held by IDT and the shares of Class A
     stock and the shares of common stock issuable upon exercise of presently
     exercisable warrants held by SOFTBANK. Also includes an aggregate of
     502,883 shares issuable upon exercise of presently exercisable stock
     options.

                                       57
<PAGE>

                              CERTAIN TRANSACTIONS

   We believe that all of the transactions set forth below were made on an
arms-length basis. All future transactions between us and our officers,
directors, principal stockholders and affiliates will be approved by a majority
of the board of directors, including a majority of the outside directors, and
will continue to be on terms no less favorable to us than could be obtained
from unaffiliated third parties.

Relationship with IDT

   Upon the closing of this offering, IDT will own approximately 57.1% of our
capital stock. IDT owns Class A stock that has twice the voting power of our
common stock. Therefore, upon the closing of this offering, IDT will control
64.6% of our vote. Since inception, we have received various services from IDT,
including administration (accounting, human resources, legal), customer
support, telecommunications and joint marketing. IDT has also provided us with
the services of a number of its executives and employees. In consideration for
these services, IDT has historically allocated a portion of its overhead costs
related to those services to us. We believe that the amounts allocated to us
have been no greater than the expenses we would have incurred if we obtained
those services on our own or from unaffiliated third parties. Prior to the
execution of the agreements with IDT described below, none of these services
had been provided to us pursuant to any written agreement.

   We entered into a suite of agreements with IDT in May 1999, including an
assignment agreement, a separation agreement, an IDT services agreement, a
Net2Phone services agreement, a tax sharing and indemnification agreement, a
joint marketing agreement and an Internet/telecommunications agreement.

  Assignment Agreement

   In connection with this agreement, IDT assigned to us certain proprietary
products, information, patent applications, trademarks and related intellectual
property rights used in connection with our business. IDT also licensed to us
certain proprietary business information that relates to our business. We
licensed back to IDT certain software that IDT will use in connection with its
business.

  IDT Services Agreement

   In connection with this agreement, IDT will continue to provide us with
various administrative services, including general accounting services, payroll
and benefits administration and customer support.

  .  General Accounting Services. IDT will provide us with accounts payable
     services and general ledger services. IDT will charge us cost plus 20%
     for these services. This portion of the IDT services agreement may be
     cancelled by either party on 30-days prior written notice and may be
     renewed by mutual agreement of the parties.

  .  Payroll and Benefits Administration. IDT will administer our payroll.
     Until we terminate this agreement or establish our own benefit plan for
     our employees, our employees will continue to be covered under IDT's
     health insurance policies. We will pay IDT for administering our payroll
     and benefits plans at IDT's cost plus 20%. Additionally, we will
     reimburse IDT for the employer's cost of health insurance attributable
     to each of our employees participating in IDT's group health insurance
     plan and for any other direct costs attributable to our employees'
     participation in IDT's benefit plans.

  .  Customer Support. IDT has agreed to provide customer support services to
     our customers on a cost-plus 20% basis.

   In the event we request additional services from IDT and IDT agrees to
provide those services, we will enter into an addendum to the IDT Services
Agreement covering those services. We will negotiate in good faith any fees
payable to IDT for those additional services.

                                       58
<PAGE>

  Net2Phone Services Agreement

   In connection with this agreement, we will support IDT's debit card
platform, provide technical support for the debit card platform, order lines to
handle calls, manage the debit card database and monitor the network, 24 hours
per day, seven days per week. We will provide these services at the greater of
cost-plus 20% and $.0025 per minute of IDT usage of the debit card platform. In
addition, IDT will reimburse us for all of our direct costs in connection with
the acquisition, maintenance or support of any and all additional or
replacement equipment needed for the debit card platform.

   The Net2Phone services agreement has an initial term of one year, which
automatically renews for subsequent one-year periods unless one party gives the
other 30-days prior written notice. In addition, following the initial term,
the Net2Phone services agreement may be terminated at any time at either
party's option upon 30-days prior written notice.

   In the event IDT requests services in addition to those described in the
Net2Phone services agreement and we agree to provide those services, we will
enter into an addendum to the Net2Phone services agreement covering those
services. We will negotiate in good faith any fees payable to us for those
additional services.

  Tax Sharing and Indemnification Agreement

   In connection with this agreement, IDT and Net2Phone will share certain past
tax liabilities and benefits, including:

  .  the allocation and payment of taxes for periods during which we and our
     subsidiaries, if any, were included in the same consolidated group with
     IDT for federal income tax purposes, and are, or were, included in the
     same consolidated, combined or unitary returns for state, local or
     foreign tax purposes;

  .  the allocation of responsibility for the filing of tax returns;

  .  the conduct of tax audits and the handling of tax controversies; and

  .  various related matters.

   For periods during which we and our subsidiaries, if any, were or are
included in IDT's consolidated federal income tax returns or state, local or
foreign consolidated, combined, or unitary tax returns, we are required to pay
an amount of tax equal to the amount we would have paid had we and our
subsidiaries, if any, had filed a tax return as a separate affiliated group of
corporations filing a consolidated federal income tax return or state, local or
foreign consolidated, combined, or unitary tax returns. We are responsible for
our own separate tax liabilities that are not determined on a consolidated or
combined basis with IDT.

   As a result of leaving the IDT consolidated group, certain tax attributes of
the IDT group attributable to our operations, such as net operating loss
carryforwards, may be allocated to us. The tax sharing and indemnification
agreement obligates us, where permitted by law, to elect to carry any post-
deconsolidation losses forward, rather than to carry back such losses to tax
years when we were included in the IDT consolidated or combined returns.

   We were included in IDT's consolidated group for federal income tax purposes
from our incorporation in October 1997 until May 1999 when we concluded the
sale of our Series A convertible preferred stock. Each corporation that is a
member of a consolidated group during any portion of the group's tax year is
jointly and severally liable for the federal income tax liability of the group
for that year. While the tax sharing and indemnification agreement allocates
tax liabilities between us and IDT during the period on or prior to the closing
date of this offering, in which we are included in IDT's consolidated group, we
could be liable in the event federal tax liability allocated to IDT is
incurred, but not paid, by IDT or any other member of

                                       59
<PAGE>

IDT's consolidated group for IDT's tax years that include such periods. In such
event, we would be entitled to seek indemnification from IDT pursuant to the
tax sharing and indemnification agreement.

  Joint Marketing Agreement

   In connection with this agreement, we agreed to:

  .  continue to offer links to the other's Web site;

  .  cross-sell one another's products, including through their promotional
     materials and customer services representatives; and

  .  undertake additional promotions as to which the parties shall agree from
     time to time.

   IDT will pay to us a fee of $8.00 for each of our customers who becomes a
new customer of IDT as a result of our referral. We will pay IDT a fee of $8.00
for each customer of IDT who becomes a new customer of ours as a result of an
IDT referral. However, in either case, these fees will be payable only with
respect to any new customer who incurs and pays $50.00 or more in charges.

   The joint marketing agreement has an initial term of one year, which
automatically renews for subsequent one-year periods unless one party gives the
other party 60-days prior written notice. In addition, following the initial
term, the joint marketing agreement may be terminated at any time at either
party's option upon 60-days prior written notice.

  Internet/Telecommunications Agreement

   IDT has granted us an indefeasible right to use portions of its current
high-speed network. We have the right to terminate portions of the existing
network to the extent that the existing network is replaced, the underlying
leases expire or at anytime with IDT's consent. We are obligated to reimburse
IDT for all termination or cancellation charges which it incurs. We have agreed
to pay IDT $60,000 per month for the right to use those portions of its
existing network. This amount will be reduced as IDT terminates portions of the
existing network at our request. IDT also granted us an indefeasible right to
use portions of a new DS3 Network, which it will have the right to use for 20
years. This grant will be effective as construction of this new network is
completed and delivered to IDT. This network has been pledged by IDT to the
lenders under a credit facility. We have agreed to pay IDT an installation fee
of $600,000 for this network, which we will pay as each portion of the new
network is delivered. We also will reimburse IDT for the one-time fee of
approximately $6.0 million payable in monthly installments over a five-year
period, with interest of 9% per annum. We will reimburse IDT for all of
maintenance and upgrade costs incurred by IDT with respect to those portions of
the network that we use.

   Further, IDT has granted us a right to use IDT's equipment and other assets
at its backbone points of presence and its network operations center for a two-
year period. We will pay IDT an aggregate of $1.2 million for this right over
the two-year period. At the end of the two-year period, we have the right to
purchase any of this equipment then owned by IDT at fair market value. We must
pay for all repairs, maintenance and upgrades of equipment and other facilities
we use pursuant to this agreement.

   IDT also has agreed to enter into transit relationship agreements with us
giving us access substantially identical to IDT's at five different core
locations for a period of one year commencing May 1999. Following the initial
term, the transit relationship agreements may be terminated at any time at
either party's option upon 60-days prior written notice.

   IDT retains primary control over the equipment covered by this agreement but
may require assistance from us in gaining Internet access. We have agreed to
assist in facilitating access for a one-year period commencing May 1999. For
each month during the effectiveness of the agreement, IDT will pay us:

  .  $1.00 for each of IDT's dial-up Internet customers;

                                       60
<PAGE>

  .  for each dedicated-line Internet customer, the lesser of $100.00 or 20%
     of the fee IDT charges; and

  .  25% of all fees charged by IDT for installation of dedicated lines.

Following the initial one year term, this agreement automatically renews for
one-year periods unless one party gives the other 60-days prior written notice
of termination.

  Separation Agreement

   The separation agreement with IDT provides for the following:

  .  Releases. This agreement provides for mutual general releases between us
     and IDT for alleged liability to the date of the agreement, with certain
     limited exceptions, including:

    .  liability specifically excluded by any of the other agreements
       between us and IDT, and

    .  liability for unpaid amounts for products or services or refunds
       owing on products or services due on a value-received basis for work
       done by one party at the request or on behalf of the other.

  .  Indemnification by Net2Phone. We have agreed to indemnify IDT and each
     of IDT's directors, officers and employees from all liabilities relating
     to, arising out of or resulting from:

    .  our failure or the failure of any other person to pay, perform or
       otherwise promptly discharge any of our liabilities in accordance
       with their respective terms, and

    .  any breach by us of the agreements between us and IDT.

  .  Indemnification by IDT. IDT has agreed to indemnify us and each of our
     directors, officers and employees from all liabilities relating to,
     arising out of or resulting from:

    .  the failure of IDT or any other person to pay, perform or otherwise
       promptly discharge any liabilities of IDT other than our
       liabilities, and

    .  any breach by IDT of the agreements between us and IDT.

  .  Dispute Resolution. We will attempt to resolve disputes by referring
     controversial matters to senior management (or other mutually agreed
     upon) representatives of the parties. If these efforts are not
     successful, either party may submit the dispute to mandatory, binding
     arbitration. This agreement contains procedures that are intended to
     expedite dispute resolution, including the selection of an arbitrator
     and certain limitations on discovery. In the event that any dispute may
     be in excess of $5.0 million, or in the event that an arbitration award
     in excess of $5.0 million is issued, either party may submit the dispute
     to a court of competent jurisdiction. If the parties disagree that the
     amount in controversy is in excess of $5.0 million, the parties are
     required to submit the disagreement to arbitration.

  .  Noncompetition; Certain Business Transactions. For a period of 36 months
     commencing May 1999, IDT may not directly or indirectly, engage in the
     provision of or developmental efforts related to Internet telephony
     services and voice enabling Web applications anywhere in the world or
     become a stockholder, partner or owner of any entity that is engaged in
     such business anywhere in the world. However, subject to our approval,
     which may not be unreasonably withheld, IDT may acquire a passive
     interest of up to 20% in such entity so long as IDT does not assist that
     entity in developing an Internet telephony business or otherwise
     engaging in our business. Neither we nor IDT will have any duty to
     communicate or offer any corporate opportunity to the other party and
     may pursue or acquire any such opportunity for itself or direct such
     opportunity to any other person.

  Payable to IDT

   Since inception, IDT has provided the funds to finance our operations in the
form of advances (approximately $22.0 million as of April 30, 1999, of which we
repaid $8.0 million in May 1999). These

                                       61
<PAGE>

advances have been converted into a note that is payable in 60 monthly
installments of principal and interest. $7.0 million of the proceeds of this
offering will be used to prepay a portion of the note. The balance of the note
is payable in 60 monthly installments of principal and interest at a rate of 9%
per annum.

  Expenses

   We have agreed to pay all third-party costs, fees and expenses relating to
this offering, all of the reimbursable expenses of the underwriters pursuant to
the underwriting agreement, all of the costs of producing, printing, mailing
and otherwise distributing this prospectus, as well as the underwriters'
discount as provided in the underwriting agreement. See "Underwriting." Except
as expressly set forth in the agreements between us and IDT, whether or not
this offering is consummated, each party shall bear its own respective third-
party fees, costs and expenses paid or incurred in connection with this
offering.

Relationship with Other Investors

  Series A Subscription Agreements

   Pursuant to Series A Subscription Agreements, dated as of May 13, 1999,
SOFTBANK Technology Ventures IV, GE Capital Equity Investments, America Online,
Access Technology Partners, Hambrecht & Quist and its affiliates and BT Alex.
Brown and its affiliates, purchased from us, in the aggregate, 3,140,000 shares
of Series A convertible preferred stock and warrants to purchase 180,000 shares
of our common stock, which expire upon the closing of this offering, for a net
aggregate purchase price of $29.9 million. Additionally, a warrant to purchase
92,400 shares of our common stock was issued to Hambrecht & Quist as part of
its fee as placement agent with respect to the sale of our Series A convertible
preferred stock. This warrant expires upon the closing of this offering. In
connection with the subscription agreements, we also entered into a
registration rights agreement and a stockholders agreement, each of which is
described below.

  Registration Rights Agreement

   The Series A investors acquired the following registration rights:

  .  one demand for registration at any time on or after the earlier to occur
     of the second anniversary of the Series A offering or 180 days following
     the consummation of this offering. This demand registration right may be
     made by one or more holders of the Series A convertible preferred stock
     that own at least 50% of the shares of Class A stock into which the
     Series A convertible preferred stock converts. If our board of directors
     determines in good faith that the demand registration would be
     materially detrimental to us, we are entitled to postpone the filing of
     the registration statement otherwise required to be prepared and filed
     by us for a reasonable period of time, not to exceed 90 days;

  .  piggyback registration rights if we propose to register any securities
     under the Securities Act in connection with any offering of our
     securities other than a registration statement on Form S-8 or Form S-4,
     subject to quantity limitations determined by underwriters if the
     offering involves an underwriting; and

  .  two demand registrations at any time after we become eligible to
     register our securities on Form S-3 (or any successor form). Holders
     that beneficially own at least 20% of the shares of Class A stock into
     which the Series A convertible preferred stock converts may make these
     demands.

   We agreed to pay all reasonable expenses incurred in connection with any
registration, filing or qualification pursuant to the Registration Rights
Agreement. We also agreed, to the extent permitted by law, to indemnify the
Series A investors against some liabilities in connection with the offering of
the shares, including liabilities arising under the Securities Act.

                                       62
<PAGE>

   Stockholders Agreement

   IDT and Clifford M. Sobel, our Chairman, agreed to vote all of their shares
in favor of the election of a director nominated by SOFTBANK Technology
Ventures IV and a director nominated by GE Capital Equity Investments or NBC,
in each case for as long as either entity holds a majority of the shares of
Series A convertible preferred stock originally purchased by them or the shares
into which they are convertible.

   In addition, each Series A convertible investor agreed to a lock up with
respect to their shares for a period of 180 days following this offering. The
Series A investors, IDT and Mr. Sobel also agreed not to transfer any of their
shares to any of our competitors for a period of 36 months, and thereafter only
subject to our right of first refusal. However, the stockholders agreement does
permit transfers between Series A investors.

Agreements with America Online and Subsidiaries

   Netscape

   We signed a series of related agreements with Netscape, a subsidiary of
America Online, on January 31, 1999, allowing us to embed our software and
services in future versions of Netscape's Internet browsers. The two-year term
of our exclusive arrangement with Netscape commences with the beta release of
the next version of Netscape's Internet browser, which we believe will occur
later this year. In addition, our services will be displayed on Netscape
Netcenter and bundled with Netscape's suite of software and software updates.
We also have a right to place advertisements on Netscape's Web site. In
exchange, we will pay Netscape one-time licensing fees, a percentage of revenue
generated by calls provided through our co-branded service and a percentage of
advertising revenue generated by a co-branded Web page. Netscape's parent
company, America Online, will beneficially own over 5% of our common stock upon
the closing of this offering.

   ICQ

   In July 1999, we entered into an exclusive, four-year distribution and
marketing agreement with ICQ, a subsidiary of America Online. ICQ provides
software that enables Internet users to contact other users on a real-time
basis, and to determine whether other individuals are on-line. ICQ's software
also enables Internet users to chat, send messages and files and to play
Internet-based games with one another. We believe that this agreement will
enable us to attract a substantial number of ICQ's users to utilize our
services, which will enhance our revenue, customer base and market share. Under
this agreement, ICQ has agreed to:

  .  co-brand and promote our phone-to-phone Internet telephony services in
     the United States and in 19 other countries.

  .  embed customized versions of our software on an exclusive basis to allow
     ICQ customers to make PC-to-phone and PC-to-PC calls and to receive
     phone-to-PC calls;

  .  share revenue from advertisements and sponsorships sold by ICQ on our
     software that is embedded in ICQ's Instant Messenger software; and

  .  promote our services on some of ICQ's Web sites.

   We have agreed to:

  .  pay ICQ a fee of $7.5 million, $4.0 million of which was paid at
     signing, with the remaining $3.5 million to be paid upon the closing of
     this offering;

  .  pay ICQ a share of minutes-based revenue generated through ICQ and award
     ICQ a performance bonus on the basis of the total revenue derived under
     the agreement; and

  .  promote ICQ on our Web sites.


                                       63
<PAGE>

   ICQ has the right to terminate the exclusivity granted to Net2Phone as to a
particular service under the agreement under certain circumstances, including
if:

  .  the price for the service or the scope of the service offered by
     Net2Phone to retail customers through any other distribution channel is
     more favorable than the corresponding service offered by Net2Phone
     through ICQ;

  .  mutually agreed upon third party reviewers determine that the service
     offered by Net2Phone is not competitive as to per minute rates and
     quality with similar services offered by a competitor of Net2Phone; or

  .  the Net2Phone service is not prepared for launch in a particular country
     by the applicable cut-off date specified in the agreement.

   In addition, ICQ has the right to terminate the entire agreement under
certain circumstances, including if:

  .  two or more of Net2Phone's services are not competitive with those of
     Net2Phone's competitors in terms of price, and the scope and quality of
     service; or

  .  if more than one of Net2Phone's services is not fully prepared for
     launch by the specified cut-off dates.

   If at any time after July 14, 2001, ICQ or America Online enters into a
strategic relationship with any major national or international
telecommunications provider for the distribution of telecommunications services
using America Online and its affiliates, and if ICQ terminates the agreement
and the telecommunications provider does not agree to offer all of Net2Phone's
services that are offered under the agreement on terms comparable to those in
the agreement, then ICQ will be required to pay Net2Phone a termination fee of
up to $60.0 million. The amount of the termination fee, if any, will depend on
whether the telecommunications provider offers any of Net2Phone's services and
the aggregate transaction revenues represented by Net2Phone's services that
will not be offered.

   In connection with our distribution and marketing agreement with ICQ, we
issued a warrant to America Online to purchase up to 3% of our outstanding
capital stock on a fully-diluted basis. This warrant will vest in 1% increments
upon the achievement of each of three incremental thresholds of revenue
generated under the agreement during the first four years that the warrant is
outstanding. The per share exercise price under the warrant will be equal to
the lesser of $12.00 per share or $450 million divided by the number of our
fully-diluted shares on the initial exercise date. The warrant may be exercised
for a period of five years from the date of issuance.

   The warrant grants to America Online demand registration rights enabling
America Online to cause us to effect two registrations and piggy-back
registration rights that can be used in connection with future registrations.
In addition, America Online will have the right to require us to file up to two
additional registration statements relating to the shares issuable upon
exercise of the warrant at such time as we shall become eligible to register
these shares on Form S-3 under the Securities Act of 1933.

Agreements with NBC and Snap

   We signed an agreement with NBC on June 25, 1999 to purchase $1.5 million in
television advertising time on the NBC television network. We also have the
right to purchase additional spots to be telecast prior to June 30, 2000.
Additionally, on May 18, 1999, we signed a non-binding letter of intent with
NBC Multimedia, an affiliate of NBC. This letter of intent contemplates a one-
year agreement whereby we will pay NBC Multimedia $280,000 in exchange for the
integration of our services into the NBC.com and NBC Interactive Neighborhood
Web sites. Upon the closing of this offering, assuming that NBC purchases
200,000 shares in this offering and exercises warrants to purchase 46,500
shares, NBC will beneficially own 1,125,000 shares of our Series A stock and
266,500 shares of our common stock. NBC is a wholly-owned

                                       64
<PAGE>

indirect subsidiary of the General Electric Company Group, which will
beneficially own more than 5.0% of our outstanding common stock after the
closing of this offering.

   On May 17, 1999, we entered into an agreement with Snap. Snap, an Internet
portal service of NBC and CNET, will strategically display links to our Web
site and services on its Snap.com Web site. In addition, we are their preferred
provider of PC-to-phone services during the two-year term of this agreement.
Snap also will deliver a preset minimum number of impressions on its site and
has agreed to give us the right to a certain amount of online advertising,
subject to certain conditions. In exchange, we agreed to pay Snap a one-time
fee, a percentage of revenue generated through their site and bonus payments
for customers delivered by Snap after meeting certain quotas. NBC, a wholly-
owned indirect subsidiary of General Electric Company, owns a majority interest
in Snap.

Facility Leases

   We have entered into leases for the use of our Hackensack facilities with
corporations that are owned and controlled by Howard S. Jonas, a member of our
board of directors and a director of IDT. Additionally, Mr. Jonas, together
with a number of entities formed for the benefit of charities and members of
his family, owns shares of IDT's capital stock that enable him to vote more
than 50% of IDT'S capital stock. As a result, he may be deemed to be the
beneficial owner of the shares of Net2Phone capital stock owned by IDT. The two
Hackensack leases run for three-year terms, beginning on March 1, 1999 with
monthly rent of $5,600 for 294-298 State Street and $9,912 for 171-173 Main
Street. We have also entered into a sublease with IDT for our Piscataway
facility, which is leased by IDT from a corporation owned and controlled by Mr.
Jonas. The Piscataway sublease runs for a three-year term, beginning in May
1999, with monthly rent of $8,400.

Officer Loans

   In May 1999, Howard S. Balter, Ilan M. Slasky, David Greenblatt, Martin
Rothberg, H. Jeff Goldberg, Jonathan Reich, and Jonathan Rand, each of whom is
an executive officer, borrowed $1,447,240, $352,800, $352,800, $352,800,
$352,800, $98,000 and $44,100, respectively, from us. All of the proceeds of
these loans were used to purchase shares of Net2Phone common stock upon the
exercise of stock options. The loans bear interest at the rate of 7.0% per
annum, and will mature in May 2001. As a condition to receiving these loans,
these officers agreed to surrender their respective right to exercise 8,862,
2,160, 2,160, 2,160, 2,160, 600 and 270 immediately exercisable options,
respectively.

Relationship with Law Firm

   Ira A. Greenstein, our General Counsel and Secretary, is a partner of the
law firm Morrison & Foerster LLP, which has provided legal services to us and
to IDT and its subsidiaries since December 1996, and in connection with this
offering.


                                       65
<PAGE>

                          DESCRIPTION OF CAPITAL STOCK

Authorized Capital Stock

   Our certificate of incorporation, as amended and restated, authorizes
247,042,089 shares of capital stock consisting of:

   .  6,850,000 shares of preferred stock, $0.01 par value;

   .  3,150,000 shares of Series A convertible preferred stock, $0.01 par value;

   .  37,042,089 shares of Class A stock, $0.01 par value; and

   .  200,000,000 shares of common stock, $0.01 par value.

   Of the shares of common stock, 5,400,000 shares of our common stock are
being offered through this prospectus. Immediately following the closing of the
offering, 10,944,429 shares of common stock and 36,578,190 shares of Class A
stock will be outstanding.

   As of July 28, 1999, there were 26 holders of our Series A convertible
preferred stock, one holder of our Class A stock and 33 holders of our common
stock.

Common Stock and Class A Stock

   General. The rights of holders of common stock and holders of Class A stock
are identical, except for voting rights, conversion rights and restrictions on
transferability. As of July 28, 1999, there were 4,683,237 shares of common
stock outstanding and 27,621,982 shares of Class A stock outstanding. An
additional 9,420,000 shares of Class A stock are issuable upon conversion of
our outstanding Series A convertible preferred stock.

   Voting Rights. The holders of Class A stock are entitled to two votes per
share and the holders of common stock are entitled to one vote per share.
Except as otherwise required by law or as described below, holders of Class A
stock and common stock will vote together as a single class on all matters
presented to the stockholders for their vote or approval, including the
election of directors. Stockholders are not entitled to vote cumulatively for
the election of directors, and no class of outstanding capital stock acting
alone is entitled to elect any directors. IDT will hold 57.1% of our Class A
stock upon consummation of this offering. Accordingly, IDT will retain
effective control of us through holding approximately 64.6% of the combined
voting power of our outstanding capital stock. Therefore, IDT has the ability
to elect all of our directors and to effect or prevent certain corporate
transactions which require majority approval of the combined classes, including
mergers and other business combinations.

   Transfer Restrictions. Class A stock is subject to certain limitations on
transferability that do not apply to the common stock. Our certificate of
incorporation provides that shares of Class A stock automatically convert into
an equal number of shares of common stock if there is a transfer of shares of
Class A stock to a person other than a permitted transferee. Thereafter, such
shares of common stock may be freely transferred, subject to restrictions
imposed under applicable securities laws. Shares of Class A stock acquired by
us will be canceled and may not be reissued.

   Dividends and Liquidation. Holders of Class A stock and holders of common
stock have an equal right to receive dividends when and if declared by the
board of directors out of legally available funds. In the event of a
liquidation, dissolution or winding up, holders of the shares of Class A stock
and common stock are entitled to share equally, share-for-share, in the assets
available for distribution after payment of all creditors and the liquidation
preferences of our preferred stock.

   Optional Conversion Rights. Each share of Class A stock may, at any time and
at the option of the holder, be converted into one fully paid and non-
assessable share of common stock. Upon conversion, such shares of common stock
would not be subject to restrictions on transfer that applied to the shares of
Class A

                                       66
<PAGE>

stock prior to conversion except to the extent such restrictions are imposed
under applicable securities laws. The shares of common stock are not
convertible into or exchangeable for shares of Class A stock or any other
shares or securities.

   Other Provisions. Holders of Class A stock and common stock have no
preemptive rights to subscribe to any additional securities of any class which
we may issue and there are no redemption provisions or sinking fund provisions
applicable to either such class, nor is the Class A stock or the common stock
subject to calls or assessments by us. The rights, preferences, and privileges
of the holders of common stock and Class A stock are subject to and may be
adversely affected by, the rights of the holders of any series of preferred
stock.

Preferred Stock

   Our certificate of incorporation provides that we may issue up to 10,000,000
shares of preferred stock in one or more series as may be determined by our
board of directors who may establish the number of shares to be included in
each such series, fix the designation, powers, preferences and relative rights
of the shares of each such series and any qualifications, limitations, or
restrictions thereof, and increase or decrease the number of shares of any such
series without any further vote or action by the stockholders. 3,150,000 shares
of the preferred stock have been designated as Series A. The board of directors
may authorize, without stockholder approval, the issuance of preferred stock
with voting and conversion rights that could adversely affect the voting power
and other rights of holders of common stock or Class A stock. Preferred stock
could be issued quickly with terms designated to delay or prevent a change in
our control or to make the removal of management more difficult. This could
have the effect of decreasing the market price of the common stock. In May
1999, we sold 3,140,000 shares of Series A convertible preferred stock pursuant
to Series A Subscription Agreements. All shares of the Series A convertible
preferred stock will automatically convert into 9,420,000 shares of our Class A
stock at the closing of this offering.

   We believe that the ability of the board to issue one or more series of
preferred stock will provide us with flexibility in structuring possible future
financings and acquisitions, and in meeting other corporate needs that might
arise. The authorized shares of preferred stock, as well as shares of common
stock, will be available for issuance without further action by our
stockholders, unless such action is required by applicable law or the rules of
any stock exchange or automated quotation system on which our securities may be
listed or traded.

   Although the board has no intention at the present time of doing so, it
could issue a series of preferred stock that could, depending on the terms of
such series, impede the completion of a merger, tender offer or other takeover
attempt. The board will make any determination to issue such shares based on
its judgment as to our best interests and the best interests of our
stockholders. The board could issue preferred stock having terms that could
discourage an acquisition attempt through which an acquirer may be able to
change the composition of the board, including a tender offer or other
transaction that some, or a majority, of our stockholders might believe to be
in their best interests or in which stockholders might receive a premium for
their stock over the then current market price.

   Certain Anti-Takeover Effects. Certain provisions of the certificate of
incorporation and bylaws, summarized in the following paragraphs, may be
considered to have an anti-takeover effect and may delay, deter or prevent a
tender offer, proxy contest or other takeover attempt that a stockholder might
consider to be in such stockholder's best interest, including such an attempt
that might result in payment of a premium over the market price for shares held
by stockholders.

   The certificate of incorporation and bylaws provide for the board of
directors to be divided into three classes of directors serving staggered
three-year terms upon the consummation of this offering. As a result,
approximately one-third of the board of directors will be elected each year.
Classification of the board of directors expands the time required to change
the composition of a majority of directors and may tend to

                                       67
<PAGE>

discourage a proxy contest or other takeover bid for us. Moreover, under the
Delaware General Corporation Law, in the case of a corporation having a
classified board of directors, the stockholders may remove a director only for
cause.

   The certificate of incorporation provides that a special meeting of
stockholders may be called by any of the following:

    .  the chairman of our board;

    .  our president;

    .  any of our vice presidents; or

    .  our secretary.

   In addition, a special meeting of stockholders may be called by any such
officer at the written request of a majority of the board of directors or at
the written request of stockholders owning a majority of our capital stock
issued and outstanding and entitled to vote.

   Section 203 of the Delaware General Corporation Law provides that, subject
to certain exceptions specified therein, an "interested stockholder" of a
Delaware corporation shall not engage in any business combinations, including
mergers or consolidations or acquisitions of additional shares of the
corporation, with the corporation for a three-year period following the date
that such stockholder becomes an interested stockholder unless:

    .  prior to such date, the board of directors of the corporation
       approved either the business combination or the transaction that
       resulted in the stockholder becoming an interested stockholder;

    .  upon consummation of the transaction that resulted in the
       stockholder becoming an "interested stockholder," the interested
       stockholder owned at least 85% of the voting stock of the
       corporation outstanding at the time the transaction commenced
       (excluding certain shares); or

    .  on or subsequent to such date, the business combination is approved
       by the board of directors of the corporation and authorized at an
       annual or special meeting of stockholders by the affirmative vote of
       at least 66.67% of the outstanding voting stock that is not owned by
       the interested stockholder.

Except as otherwise specified in Section 203 of the Delaware General
Corporation Law, an interested stockholder is defined to include (x) any person
that owns (or, within the prior three years, did own) 15% or more of the
outstanding voting stock of the corporation, or is an affiliate or associate of
the corporation and was the owner of 15% or more of the outstanding voting
stock of the corporation at any time within three years immediately prior to
the date of determination and (y) the affiliates and associates of any such
person.

   Under certain circumstances, Section 203 of the Delaware General Corporation
Law makes it more difficult for a person who would be an interested stockholder
to effect various business combinations with a corporation for a three-year
period. We have not elected to be exempt from the restrictions imposed under
Section 203 of the Delaware General Corporation Law. However, IDT and its
affiliates are excluded from the definition of "interested stockholder"
pursuant to the terms of Section 203 of the Delaware General Corporation Law.
The provisions of Section 203 of the Delaware General Corporation Law may
encourage persons interested in acquiring us to negotiate in advance with the
board, since the stockholder approval requirement would be avoided if a
majority of the directors then in office approves either the business
combination or the transaction which results in any such person becoming an
interested stockholder. Such provisions also may have the effect of preventing
changes in our management. It is possible that such provisions could make it
more difficult to accomplish transactions that our stockholders may otherwise
deem to be in their best interests.

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<PAGE>

Liability of Directors; Indemnification

   The certificate of incorporation contains a provision that is designed to
limit directors' liability to the extent permitted by the Delaware General
Corporation Law. Specifically, directors will not be held liable
to us or our stockholders for monetary damages for any breach of fiduciary duty
as a director, except for liability as a result of:

    .  any breach of the duty of loyalty to us or our stockholders;

    .  actions or omissions not in good faith or which involve intentional
       misconduct or a knowing violation of law;

    .  payment of an improper dividend or improper repurchase of our stock
       under Section 174 of the Delaware General Corporation Law; or

    .  actions or omissions pursuant to which the director received an
       improper personal benefit.

   The principal effect of the limitation of liability provision is that a
stockholder is unable to prosecute an action for monetary damages against a
director of ours unless the stockholder can demonstrate one of the specified
bases for liability. The provision, however, does not eliminate or limit
director liability arising in connection with causes of action brought under
the federal securities laws. The certificate of incorporation does not
eliminate a director's duty of care. The inclusion of this provision in the
certificate of incorporation may discourage or deter stockholders or management
from bringing a lawsuit against directors for a breach of their fiduciary
duties, even though such an action, if successful, might otherwise have
benefited us and our stockholders. This provision should not affect the
availability of equitable remedies such as injunction or rescission based upon
a director's breach of the duty of care.

   The bylaws also provide that we will indemnify our directors and officers,
and may indemnify any of our employees and agents, to the fullest extent
permitted by Delaware law. We are generally required to indemnify our directors
and officers for all judgments, fines, penalties, settlements, legal fees and
other expenses incurred in connection with pending, threatened or completed
legal proceedings because of the director's or officer's position with us or
another entity that the director or officer serves at our request, subject to
certain conditions, and to advance funds to its directors and officers to
enable them to defend against such proceedings.

   At present, there is no pending or threatened litigation or proceeding
involving any director or officer, employee or agent of ours where such
indemnification will be required or permitted.

Transfer Agent and Registrar

   American Stock Transfer & Trust Company will be the transfer agent and
registrar for the common stock.

                        SHARES ELIGIBLE FOR FUTURE SALE

   Of the 10,944,429 shares of common stock and 36,578,190 shares of Class A
stock to be outstanding on the closing of the offering (11,819,229 shares of
common stock if the underwriters exercise their over-allotment option in full),
the 5,400,000 shares of common stock sold in the offering (6,210,000 shares if
the underwriters exercise their over-allotment option in full) will be freely
tradable without restriction under the Securities Act of 1933, except for any
such shares which may be acquired by an affiliate of ours, as that term is
defined in Rule 144 promulgated under the Securities Act of 1933. On the
closing of the offering, IDT will own 27,158,190 shares of Class A stock, which
will constitute approximately 57.1% of our outstanding capital stock
(approximately 56.1% if the underwriters exercise their over-allotment option
in full).

                                       69
<PAGE>

   Persons who are affiliates of ours will be permitted to sell the shares of
common stock that are issued in the offering only pursuant to an effective
registration statement under the Securities Act of 1933 or an exemption from
the registration requirements of the Securities Act of 1933, including
exemptions provided by Rule 144 of the Securities Act of 1933.

   Upon closing of this offering, we intend to file a registration statement
for the resale of the shares of common stock that are authorized for issuance
under our stock option plan. We expect this registration statement to become
effective immediately upon filing. Shares issued pursuant to our stock option
plan after the effective date of this registration statement (other than shares
issued to our affiliates) generally will be freely tradable without restriction
or further registration under the Securities Act of 1933. As of June 27, 1999,
options to purchase 5,960,000 shares of common stock under our stock option
plan have been granted, of which 1,375,218 have been exercised. We granted
additional options to purchase 2,671,500 shares on July 28, 1999, including
options to purchase 10,000 shares of our common stock to each of our eligible
non-employee directors. See "Management--1999 Stock Incentive Plan."

   The shares of capital stock held by IDT are deemed "restricted securities"
as defined in Rule 144 of the Securities Act of 1933, and may not be sold other
than through registration under the Securities Act of 1933 or pursuant to an
exemption from the regulations thereunder, including exceptions provided by
Rule 144 of the Securities Act of 1933. Subject to applicable law and to the
contractual restriction with the underwriters described below, IDT may sell any
and all of the shares of capital stock it owns after completion of the
offering. We, along with our directors and executive officers, IDT, the Series
A investors and substantially all of our remaining securityholders have agreed,
for a period of 180 days after the date of this prospectus, not to offer or
sell any shares of Class A stock or common stock, subject to limited
exceptions, without the prior written consent of Hambrecht & Quist LLC. IDT's
shares of our capital stock are pledged as collateral to secure a credit
facility. If IDT defaults in its obligations under the pledge agreement, then a
third party could acquire the pledged stock and would not be subject to these
agreements. See "Underwriting."

   Upon closing of this offering, the holders of 9,420,000 shares of our Class
A stock, or their transferees, will be entitled to request that we register
their shares under the Securities Act. See "Certain Transactions--Relationship
with Other Investors--Registration Rights Agreement."

                                       70
<PAGE>

                                  UNDERWRITING

   Hambrecht & Quist LLC, BT Alex. Brown Incorporated and Bear, Stearns & Co.
Inc. are the representatives of the underwriters. Hambrecht & Quist LLC and BT
Alex. Brown Incorporated are acting as joint book-running managers and Bear,
Stearns & Co. Inc. is acting as co-manager. Subject to the terms and conditions
of the Underwriting Agreement, the underwriters named below, through their
representatives, have severally agreed to purchase from Net2Phone the following
respective number of shares of common stock:

<TABLE>
<CAPTION>
                                                     Number of
           Name                                       Shares
           ----                                      ---------
           <S>                                       <C>
           Hambrecht & Quist LLC...................  1,666,000
           BT Alex. Brown Incorporated.............  1,666,000
           Bear, Stearns & Co. Inc.................    833,000
           BancBoston Robertson Stephens Inc.......    130,000
           CIBC World Markets Corp.................    130,000
           Donaldson, Lufkin & Jenrette Securities
            Corporation............................    130,000
           Goldman, Sachs & Co.....................    130,000
           Morgan Stanley & Co. Incorporated.......    130,000
           Charles Schwab & Co., Inc...............    130,000
           Thomas Weisel Partners LLC..............    130,000
           E* OFFERING Corp........................     65,000
           First Albany Corporation................     65,000
           Friedman, Billings, Ramsey & Co., Inc...     65,000
           U.S. Bancorp Piper Jaffray, Inc.........     65,000
           Wit Capital Corporation.................     65,000
                                                     ---------
           Total...................................  5,400,000
                                                     =========
</TABLE>

   The underwriting agreement provides that the obligations of the underwriters
are subject to certain conditions precedent, including the absence of any
material adverse change in our business and the receipt of certain
certificates, opinions and letters from us, our counsel and the independent
auditors. The underwriters are committed to purchase all of the shares of
common stock offered by us if they purchase any shares.

   The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters. Such amounts are shown assuming
both no exercise and full exercise of the underwriters' over-allotment option
to purchase additional shares. The underwriters will not be paid a discount or
commission with respect to 600,000 shares sold to three of our current
stockholders in this offering, which are excluded from the calculation of per
share amounts in the following table.

                     Underwriting Discounts and Commissions

<TABLE>
<CAPTION>
                                                      Without          With
                                                   Over-Allotment Over-Allotment
                                                      Exercise       Exercise
                                                   -------------- --------------
      <S>                                          <C>            <C>
      Per Share...................................   $     1.05     $     1.05
      Total.......................................   $5,040,000     $5,890,500
</TABLE>

   We estimate that the total expenses of this offering, excluding underwriting
discounts and commissions, will be approximately $2.0 million.

                                       71
<PAGE>

   The underwriters propose to offer the shares of common stock directly to the
public at the initial public offering price set forth on the cover page of this
prospectus and to certain dealers at that price less a concession not in excess
of $.60 per share. The underwriters may allow and such dealers may reallow a
concession not in excess of $.10 per share to certain other dealers. After the
initial public offering of the shares, the offering price and other selling
terms may be changed by the underwriters.

   We have granted to the underwriters an option, exercisable no later than 30
days after the date of this prospectus, to purchase up to 810,000 additional
shares of common stock at the initial public offering price, less the
underwriting discount set forth on the cover page of this prospectus. To the
extent that the underwriters exercise this option, each of the underwriters
will have a firm commitment to purchase approximately the same percentage
thereof which the number of shares of common stock to be purchased by it shown
in the above table bears to the total number of shares of common stock offered
hereby. We will be obligated, pursuant to the option, to sell shares to the
underwriters to the extent the option is exercised. The underwriters may
exercise this option only to cover over-allotments made in connection with the
sale of shares of common stock offered by us.

   The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.

   We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, and to contribute to payments
the underwriters may be required to make in respect of these liabilities.

   Substantially all of our securityholders, including the Series A investors,
IDT, and our executive officers and directors have agreed that they will not,
without the prior written consent of Hambrecht & Quist LLC, offer, sell or
otherwise dispose of any shares of capital stock, options or warrants to
acquire shares of capital stock or securities exchangeable for or convertible
into shares of capital stock owned by them for a period of 180 days following
the date of this prospectus. We have agreed that we will not, without the prior
written consent of Hambrecht & Quist LLC, offer, sell or otherwise dispose of
any shares of capital stock, options or warrants to acquire shares of capital
stock or securities exchangeable for or convertible into shares of capital
stock for a period of 180 days following the date of this prospectus, except
that we may issue shares upon the exercise of options and warrants granted
prior to the date hereof, and may grant additional options under our stock
option plans. Without the prior written consent of Hambrecht & Quist LLC, any
additional options granted shall not be exercisable during this 180-day period.

   Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the common stock at levels above those which might otherwise prevail in the
open market, including by entering stabilizing bids, effecting syndicate
covering transactions or imposing penalty bids. A stabilizing bid means the
placing of any bid or effecting of any purchase, for the purpose of pegging,
fixing or maintaining the price of the common stock. A syndicate covering
transaction means the placing of any bid on behalf of the underwriting
syndicate or the effecting of any purchase to reduce a short position created
in connection with the offering. A penalty bid means an arrangement that
permits the underwriters to reclaim a selling concession from a syndicate
member in connection with the offering when shares of common stock sold by the
syndicate member are purchased in syndicate covering transactions. Such
transactions may be effected on the Nasdaq National Market, in the over-the-
counter market, or otherwise. Such stabilizing, if commenced, may be
discontinued at any time.

   Prior to this offering, there has been no public market for our common
stock. The initial public offering price for the common stock will be
determined by negotiations among us and the representatives. Among the factors
to be considered in determining the initial public offering price will be
prevailing market and economic conditions, our revenue and earnings, market
valuations of other companies engaged in activities similar to our business
operations and our management. The estimated initial public offering price
range set forth on the cover of this preliminary prospectus is subject to
change as a result of market conditions or other factors.

                                       72
<PAGE>

   At our request, the underwriters have reserved at the initial public
offering price the number of shares of common stock that may be purchased for
$7.5 million for sale to America Online, the number of shares of common stock
that may be purchased for $3.0 million for sale to NBC and the number of shares
of common stock that may be purchased for $2.0 million to GE Capital. Based
upon the initial offering price of $15, America Online may therefore purchase
in the offering up to 500,000 shares of our common stock, NBC may purchase up
to 200,000 shares of our common stock and GE Capital may purchase up to 133,333
shares of our common stock. America Online, NBC and GE Capital have each
expressed an interest in purchasing these shares, which will be subject to a
lock-up agreement that each company has entered into with the underwriters,
under which it has agreed not to sell shares for 180 days after the date of
this prospectus. There can be no assurance that any of the reserved shares will
be purchased. The number of shares available for sale to the general public in
this offering will be reduced by the number of reserved shares sold. Any
reserved shares not so purchased will be offered to the general public on the
same basis as the other shares offered hereby.

   In addition, at our request, the underwriters have reserved up to 270,000
shares of common stock for sale at the initial public offering price to our
directors, officers, employees, business associates and related persons. The
number of shares of common stock available for sale to the general public will
be reduced if such persons purchase the reserved shares. Any reserved shares
which are not so purchased will be offered by the underwriters to the general
public on the same basis as the other shares offered hereby.

   In connection with this offering, certain underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in our common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid of
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase
limits are exceeded.

   Hambrecht & Quist LLC and persons associated with Hambrecht & Quist LLC
beneficially own 20,000 shares of Series A convertible preferred stock and
warrants to purchase 92,400 shares of common stock at an exercise price of
$3.33 per share, which warrants expire upon the closing of this offering.
Additionally, Access Technology Partners, L.P., a fund of outside investors
that is managed by a subsidiary of Hambrecht & Quist California, owns 80,000
shares of Series A convertible preferred stock.

   BT Alex. Brown Incorporated and persons associated with BT Alex. Brown
Incorporated own 37,500 shares of Series A convertible preferred stock.
Additionally, Stephen A. Oxman, one of our directors and a managing director at
Deutsche Bank Securities Inc., an affiliate of BT Alex. Brown Incorporated,
owns 2,500 shares of Series A convertible preferred stock, and will be granted
options to purchase 10,000 shares of common stock upon the closing of this
offering, which will have an exercise price equal to the initial public
offering price.

   Denis Bovin, Vice Chairman-Investment Banking of Bear, Stearns & Co. Inc.,
owns options to purchase 75,000 shares of common stock at an exercise price of
$3.33 per share, and options to purchase 50,000 shares of common stock at the
offering price. We expect that all of these options will be exercised prior to
the closing of this offering.

   Prior to the closing of this offering, each of Hambrecht & Quist LLC and
persons associated with it, SOFTBANK Technology Advisors Fund, L.P., The
Charles Schwab Corporation, BT Alex. Brown Incorporated and persons associated
with it, Denis Bovin and Stephen A. Oxman will enter into written agreements
with Net2Phone, whereby each of them will agree, for a period of one year from
the date of this prospectus with respect to 106,581 shares of capital stock,
and three years from the date of this prospectus with respect to 226,324 shares
of capital stock, not to sell, transfer, assign, pledge or hypothecate any
shares of capital stock owned by them that are deemed to be underwriting
compensation.

   Hambrecht & Quist LLC and BT Alex. Brown Incorporated have provided
financial advisory services to Net2Phone and IDT in the past and have received
compensation at market rates for these services.


                                       73
<PAGE>

                                 LEGAL MATTERS

   Certain legal matters with respect to the validity of the common stock
offered hereby will be passed upon for us by Morrison & Foerster LLP, New York,
New York. Ira A. Greenstein, our General Counsel and Secretary, is a partner of
Morrison & Foerster LLP. Certain legal matters relating to this offering will
be passed upon for the underwriters by Brobeck, Phleger & Harrison LLP, New
York, New York.

                                    EXPERTS

   The financial statements of Net2Phone, Inc. and, for the periods prior to
its incorporation, the Net2Phone division of IDT Corporation, July 31, 1997 and
July 31, 1998 and for the period from January 2, 1996 (date of inception) to
July 31, 1996 and the years ended July 31, 1997 and 1998, appearing in this
prospectus and registration statement have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and are included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.

                      WHERE YOU CAN FIND MORE INFORMATION

   We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act of 1933 with respect to the
common stock offered hereby. This prospectus does not contain all of the
information set forth in the registration statement, certain portions of which
are omitted as permitted by the rules and regulations of the Securities and
Exchange Commission. For further information pertaining to us and the common
stock to be sold in this offering, reference is made to the registration
statement, including the exhibits thereto and the financial statements, notes
and schedules filed as a part thereof. Statements contained in this prospectus
regarding the contents of any contract or other document referred to herein or
therein are not necessarily complete, and in each instance reference is made to
the copy of such contract or other document filed as an exhibit to the
registration statement or such other document, each such statement being
qualified in all respects by such reference.

   On the closing of the offering, we will be subject to the informational
requirements of the Securities Exchange Act of 1934 and will file reports,
proxy statements and other information with the Securities and Exchange
Commission. Such reports, proxy statements and other information, as well as
the registration statement and the exhibits and schedules thereto, may be
inspected, without charge, at the public reference facility maintained by the
Securities and Exchange Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, NW, Washington, D.C. 20549, and at the Securities and Exchange
Commission's regional offices located at Seven World Trade Center, New York,
New York 10048 and Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such material may also be obtained
from the Public Reference Section of the Securities and Exchange Commission at
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Such
materials can also be inspected on the Securities and Exchange Commission's Web
site at www.sec.gov.

                                       74
<PAGE>

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Report of Independent Auditors............................................ F-2
Balance Sheets as of July 31, 1997 and 1998 and April 30, 1999
 (Unaudited).............................................................. F-3
Statements of Operations for the period from January 2, 1996 (date of
 inception) to July 31, 1996 and the years ended July 31, 1997 and 1998
 and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-4
Statements of Stockholders' Deficit for the period from January 2, 1996
 (date of inception) to July 31, 1996 and the years ended July 31, 1997
 and 1998 and the nine months ended April 30, 1999 (Unaudited)............ F-5
Statements of Cash Flows for the period from January 2, 1996 (date of
 inception) to July 31, 1996 and the years ended July 31, 1997 and 1998
 and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-6
Notes to Financial Statements............................................. F-7
</TABLE>

                                      F-1
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
 Net2Phone, Inc.

   We have audited the accompanying balance sheets of Net2Phone, Inc. and, for
the periods prior to its incorporation, the Net2Phone division of IDT
Corporation (the "Company") as of July 31, 1997 and 1998, and the related
statements of operations, stockholders' deficit and cash flows for the period
from January 2, 1996 (date of inception) to July 31, 1996 and the years ended
July 31, 1997 and 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

   In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company at July 31,
1997 and 1998 and the results of its operations and its cash flows for the
period from January 2, 1996 (date of inception) to July 31, 1996 and the years
ended July 31, 1997 and 1998, in conformity with generally accepted accounting
principles.

                                           Ernst & Young LLP

New York, New York
May 11, 1999, except for Note 9,
the date of which is June 25, 1999

                                      F-2
<PAGE>

                                Net2Phone, Inc.

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                 July 31            April 30
                                         ------------------------  -----------
                                            1997         1998         1999
                                         -----------  -----------  -----------
                                                                   (Unaudited)
<S>                                      <C>          <C>          <C>
Assets
Current assets:
  Cash and cash equivalents............. $       --   $    10,074  $ 1,782,194
  Trade accounts receivable, net........      16,500    1,465,475      329,577
  Due from IDT Corporation..............         --           --       346,176
  Prepaid contract deposits.............         --           --     4,000,000
  Other current assets..................         --           --        31,051
                                         -----------  -----------  -----------
    Total current assets................      16,500    1,475,549    6,488,998
Property and equipment, net.............     899,525    5,409,061    8,228,218
Trademark, net..........................         --           --     5,000,000
Other assets............................         --        90,498      101,112
                                         -----------  -----------  -----------
    Total assets........................ $   916,025  $ 6,975,108  $19,818,328
                                         ===========  ===========  ===========
Liabilities and stockholders' deficit
Current liabilities:
  Accounts payable...................... $       --   $       --   $   248,675
  Deferred revenue......................     161,001      810,114    1,495,775
  Due to IDT Corporation................   2,960,429   11,814,988   22,000,000
                                         -----------  -----------  -----------
    Total current liabilities...........   3,121,430   12,625,102   23,744,450
Commitments and contingencies
  Redeemable convertible preferred
   stock,
   Series A, $.01 par value; authorized
   shares--
   3,150,000; no shares issued and
   outstanding..........................         --           --           --
Stockholders' deficit:
  Preferred stock, $.01 par value;
   authorized shares--6,850,000; no
   shares issued and outstanding........         --           --           --
  Common stock, $.01 par value;
   authorized shares-- 200,000,000;
   30,960,000 shares issued and
   outstanding at July 31, 1998 and
   April 30, 1999 (None at July 31,
   1997)................................         --       100,100      309,600
  Class A stock, $.01 par value;
   authorized shares    37,042,089; no
   shares issued and outstanding........         --           --           --
  Additional paid-in capital............         --           --     4,420,338
  Accumulated deficit...................  (2,205,405)  (5,750,094)  (8,656,060)
                                         -----------  -----------  -----------
    Total stockholders' deficit.........  (2,205,405)  (5,649,994)  (3,926,122)
                                         -----------  -----------  -----------
    Total liabilities and stockholders'
     deficit............................ $   916,025  $ 6,975,108  $19,818,328
                                         ===========  ===========  ===========
</TABLE>

                            See accompanying notes.

                                      F-3
<PAGE>

                                Net2Phone, Inc.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                             Period from
                           January 2, 1996
                         (date of inception)                            Nine months ended April
                             to July 31         Year ended July 31                 30
                         ------------------- -------------------------  -------------------------
                                1996            1997          1998         1998          1999
                         ------------------- -----------  ------------  -----------  ------------
<S>                      <C>                 <C>          <C>           <C>          <C>
                                                                              (Unaudited)
Revenues:
  Service revenue.......     $      --       $ 2,652,303  $ 10,490,972  $ 6,439,374  $ 21,757,721
  Product revenue.......            --               --      1,515,000    1,515,000       445,536
                             ----------      -----------  ------------  -----------  ------------
    Total revenue.......            --         2,652,303    12,005,972    7,954,374    22,203,257
Costs and expenses:
 Direct cost of
  revenue:
  Service cost of
   revenue*.............            --         1,547,443     6,576,523    3,317,065    11,787,689
  Product cost of
   revenue*.............            --             6,000       272,236      272,236        60,400
                             ----------      -----------  ------------  -----------  ------------
    Total direct cost of
     revenue*...........            --         1,553,443     6,848,759    3,589,301    11,848,089
  Selling and
   marketing............         34,468           76,724     2,887,766    1,363,060     4,746,316
  General and
   administrative.......        465,015        2,599,283     5,087,628    3,254,287     7,298,106
  Depreciation..........          8,275          120,500       726,508      421,648     1,216,712
                             ----------      -----------  ------------  -----------  ------------
    Total costs and
     expenses...........        507,758        4,349,950    15,550,661    8,628,296    25,109,223
                             ----------      -----------  ------------  -----------  ------------
Loss from operations
 before provision for
 income taxes...........       (507,758)      (1,697,647)   (3,544,689)    (673,922)   (2,905,966)
Provision for income
 taxes..................            --               --            --           --            --
                             ----------      -----------  ------------  -----------  ------------
Net loss................     $ (507,758)     $(1,697,647) $ (3,544,689) $  (673,922) $ (2,905,966)
                             ==========      ===========  ============  ===========  ============
Net loss per share--
 basic and diluted......     $    (0.02)     $     (0.06) $      (0.12) $     (0.02) $      (0.09)
                             ==========      ===========  ============  ===========  ============
Weighted average number
 of shares used in
 calculation of basic
 and diluted net loss
 per share..............     27,864,000       27,864,000    30,186,000   29,928,000    30,960,000
                             ==========      ===========  ============  ===========  ============
</TABLE>

- --------
* Excludes depreciation and amortization

                              See accompanying notes.

                                      F-4
<PAGE>

                                Net2Phone, Inc.

                      STATEMENTS OF STOCKHOLDERS' DEFICIT

 Period from January 2, 1996 (date of inception) to July 31, 1996 and the years
     ended July 31, 1997 and 1998 and the nine months ended April 30, 1999
        (unaudited with respect to the nine months ended April 30, 1999)

<TABLE>
<CAPTION>
                             Common Stock     Additional                  Total
                          -------------------  Paid-In   Accumulated  Stockholders'
                            Shares    Amount   Capital     Deficit       Deficit
                          ---------- -------- ---------- -----------  -------------
<S>                       <C>        <C>      <C>        <C>          <C>
  Net loss for the
   period January 2,
   1996 (date of
   inception) to July
   31, 1996.............         --  $    --  $      --  $  (507,758)  $  (507,758)
                          ---------- -------- ---------- -----------   -----------
Balance at July 31, 1996
 .......................         --       --         --     (507,758)     (507,758)
  Net loss for the year
   ended July 31, 1997..         --       --         --   (1,697,647)   (1,697,647)
                          ---------- -------- ---------- -----------   -----------
Balance at July 31,
 1997...................         --       --         --   (2,205,405)   (2,205,405)
  Issuance of Stock to
   IDT Corporation......  27,864,000      100        --          --            100
  Sale of Common Stock
   to officer...........   3,096,000  100,000        --          --        100,000
  Net loss for the year
   ended
   July 31, 1998........         --       --         --   (3,544,689)   (3,544,689)
                          ---------- -------- ---------- -----------   -----------
Balance at July 31,
 1998...................  30,960,000  100,100        --   (5,750,094)   (5,649,994)
  Capital contributions
   from IDT
   Corporation..........         --   209,500  4,420,338         --      4,629,838
  Net loss for the nine
   months ended April
   30, 1999.............         --       --         --   (2,905,966)   (2,905,966)
                          ---------- -------- ---------- -----------   -----------
Balance at April 30,
 1999...................  30,960,000 $309,600 $4,420,338 $(8,656,060)  $(3,926,122)
                          ========== ======== ========== ===========   ===========
</TABLE>





                            See accompanying notes.

                                      F-5
<PAGE>

                                Net2Phone, Inc.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                            Period from
                          January 2, 1996
                             (date of                                 Nine months ended
                            inception)      Year ended July 31             April 30
                            to July 31    ------------------------  -----------------------
                               1996          1997         1998         1998        1999
                          --------------- -----------  -----------  ----------  -----------
                                                                         (Unaudited)
<S>                       <C>             <C>          <C>          <C>         <C>
Operating activities
Net loss................     $(507,758)   $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966)
Adjustments to reconcile
 net loss to net cash
 used in operating
 activities:
 Depreciation...........         8,275        120,500      726,508     421,648    1,216,712
 Changes in assets and
  liabilities:
   Accounts receivable..           --         (16,500)  (1,448,975)   (555,000)   1,135,898
   Due from IDT
    Corporation.........           --             --           --          --      (346,176)
   Prepaid contract
    deposits............           --             --           --          --    (4,000,000)
   Other current
    assets..............           --             --           --          --       (31,051)
   Other assets.........           --             --       (90,498)    (73,323)     (10,614)
   Accounts Payable.....           --             --           --          --       248,675
   Deferred revenue.....           --         161,001      649,113     471,524      685,661
                             ---------    -----------  -----------  ----------  -----------
Net cash used in
 operating activities...      (499,483)    (1,432,646)  (3,708,541)   (409,073)  (4,006,861)
Investing activities
Purchase of trademark...           --             --           --          --    (5,000,000)
Purchases of property
 and equipment..........      (182,949)      (845,351)  (5,236,044) (4,230,909)  (4,035,869)
                             ---------    -----------  -----------  ----------  -----------
Net cash used in
 investing activities...      (182,949)      (845,351)  (5,236,044) (4,230,909)  (9,035,869)
Financing activities
Proceeds from issuance
 of Common Stock to IDT
 Corporation                       --             --           100         100          --
Proceeds from issuance
 Common Stock to
 officer................           --             --       100,000         --           --
Capital contributions
 from IDT Corporation...           --             --           --          --     4,629,838
Net advances from IDT
 Corporation............       682,432      2,277,997    8,854,559   4,639,882   10,185,012
                             ---------    -----------  -----------  ----------  -----------
Net cash provided by
 financing activities...       682,432      2,277,997    8,954,659   4,639,982   14,814,850
                             ---------    -----------  -----------  ----------  -----------
Net increase in cash and
 cash equivalents.......           --             --        10,074         --     1,772,120
Cash and cash
 equivalents at
 beginning of period....           --             --           --          --        10,074
                             ---------    -----------  -----------  ----------  -----------
Cash and cash
 equivalents at end of
 period.................     $     --     $       --   $    10,074  $      --   $ 1,782,194
                             =========    ===========  ===========  ==========  ===========
Supplemental disclosure
 of cash flow
 information:
Cash payments made for
 interest...............     $     --     $       --   $       --   $      --   $       --
                             =========    ===========  ===========  ==========  ===========
Cash payments made for
 income taxes...........     $     --     $       --   $       --   $      --   $       --
                             =========    ===========  ===========  ==========  ===========
</TABLE>


                              See accompanying notes.

                                      F-6
<PAGE>

                                Net2Phone, Inc.

                         NOTES TO FINANCIAL STATEMENTS

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)

1. Description of Business and Basis of Presentation

   The accompanying financial statements reflect the historical financial
information of Net2Phone, Inc. and, for the periods prior to its incorporation,
the Net2Phone division of IDT Corporation (the "Company"), a majority owned
subsidiary of IDT Corporation ("IDT"), incorporated in October 1997, to operate
and develop its Internet telephony business. Prior to such time, the Company's
business was conducted as a division of IDT. The incorporation of Net2Phone
Inc. as a subsidiary of IDT was accounted for similar to a recapitalization.
All earnings per share calculations assume that such shares were outstanding
for all prior periods.

   The Company's statements of operations include allocations of certain costs
and expenses from IDT (Note 4). Although such allocations are not necessarily
indicative of the costs that would have been incurred if the Company operated
as an unaffiliated entity, management believes that the allocation methods are
reasonable.

2. Summary of Significant Accounting Policies

Use of Estimates

   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.

Interim Financial Information

   The unaudited interim information as of April 30, 1999 and for the nine
months ended April 30, 1998 and 1999 has been prepared on the same basis as the
annual financial statements and, in the opinion of the Company's management,
contains all adjustments (consisting of normal recurring accruals) necessary
for a fair presentation. Operating results for any interim period are not
necessarily indicative of results to be expected for the entire year.

Revenue Recognition

   Internet telephony service revenue is recognized as service is provided.
Revenue derived from equipment sales and from services provided to IDT is
recognized upon installation of the equipment and performance of the services,
respectively. (See Note 4)

   Pre-payments for communications services are deferred and recognized as
revenue as the communications services are provided.

   The sale of equipment with software necessary to provide the Company's
services is within the scope of SOP 97-2 "Software Revenue Recognition."
Revenue on such sales is recognized when such products are delivered, the
payments received are non refundable and there are no significant future
obligations.

Direct Cost of Revenue

   Direct cost of revenue consists primarily of telecommunication costs,
connectivity costs, and the cost of equipment sold to customers. Direct cost of
revenue excludes depreciation and amortization.

                                      F-7
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


2. Summary of Significant Accounting Policies (continued)

Property and Equipment

   Equipment and furniture and fixtures are recorded at cost and depreciated
using the straight-line method over the estimated useful lives of the assets of
five years.

   Computer software is amortized using the straight-line method over the
shorter of five years or the term of the related agreement.

Advertising Costs

   The Company expenses the costs of advertising as incurred. Typically the
Company purchases banner advertising on other companies' web sites pursuant to
contracts which have one to three year terms and may include the guarantee of
(i) a minimum number of impressions, (ii) the number of times that an
advertisement appears in pages displayed to users of the web site, or (iii) a
minimum amount of revenue that will be recognized by the Company from customers
directed to the Company's web site as a direct result of the advertisement. The
Company recognizes expense with respect to such advertising ratably over the
period in which the advertisement is displayed. In addition, some agreements
require additional payments as additional impressions are delivered. Such
payments are expensed when the impressions are delivered.

   In one case, the Company entered into an agreement with no specified term of
years. In this case, the Company amortizes as expense the lesser of (i) the
number of impressions to date/minimum guaranteed impressions or (ii) revenue to
date/minimum guaranteed revenue as a percentage of the total payments. (See
Note 7.)

   For the years ended July 31, 1997 and 1998 and the nine months ended April
30, 1998 and 1999, advertising expense totaled approximately $6,000,
$1,962,000, $888,000, and $3,165,000, respectively. There was no advertising
expense for the period from January 2, 1996 (date of inception) to July 31,
1996.

Software Development Costs

   Costs for the internal development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established, at which time any additional
costs would be capitalized. To date, the Company has essentially completed its
software development concurrently with the establishment of technological
feasibility and, accordingly, no such costs have been capitalized to date.
Software development costs are the Company's only research and development
expenditures. For the period from January 2, 1996 (date of inception) to July
31, 1996, software development costs of $340,000 were expensed. No software
development costs were expensed for the years ended July 31, 1997 and 1998 and
the nine months ended April 30, 1998 and 1999.

Capitalized Internal Use Software Costs

   In March 1998, the Accounting Standards Executive Committee of the AICPA
issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. The SOP, which has been
adopted by the Company requires the capitalization of certain costs incurred in
connection with developing or obtaining internal use software. The Company's
policy prior to the adoption of the SOP was to capitalize substantially all
internal use software costs. These costs consisted of payments made to third
parties and the salaries of employees working on such software development.
Therefore, the adoption of the SOP did not have a material effect on the
Company's financial position or results of operations. At July 31, 1997 and
1998 and April 30, 1999, the Company has capitalized $493,000, $2,198,000 and
$3,598,000, respectively, of internal use software costs as computer software.

                                      F-8
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


2. Summary of Significant Accounting Policies (continued)

Cash and Cash Equivalents

   The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Cash and cash equivalents
are carried at cost which approximates market value.

Trademark

   Costs associated with obtaining the right to use trademarks owned by third
parties are capitalized and amortized on a straight-line basis over the two
year term of the agreement.

Income Taxes

   The Company accounts for income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities.

Stock Based Compensation

   The Company applies the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. The Company accounts for stock options
using APB Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. Options issued to non-employees are accounted for in
accordance with SFAS No. 123.

Earnings (Loss) Per Share

   Earnings (loss) per share is calculated in accordance with FASB Statement
No. 128, Earnings per Share. Basic earnings (loss) per share is computed by
dividing the net income (loss) applicable to common shares by the weighted
average of common shares outstanding during the period. Diluted earnings (loss)
per share adjusts basic earnings (loss) per share for the effects of
convertible securities, stock options and other potentially dilutive financial
instruments, only in the periods in which such effect is dilutive. There were
no dilutive securities in any of the periods presented herein.

Current Vulnerability Due to Certain Concentrations

   Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of cash, cash equivalents, and trade
receivables. Concentrations of credit risk with respect to trade receivables
are limited due to the large number of customers comprising the Company's
customer base.

   Management regularly monitors the creditworthiness of its domestic and
international customers and believes that it has adequately provided for any
exposure to potential credit losses.

Long-Lived Assets

   In accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, the Company reviews the
impairment of long-lived assets and certain identifiable intangibles whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. The analysis of the recoverability utilizes
undiscounted cash flows. The

                                      F-9
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


2. Summary of Significant Accounting Policies (continued)

measurement of the loss, if any, will be calculated as the amount by which the
carrying amount of the asset exceeds the fair value of the asset.

Recently Issued Financial Accounting Standards

   SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, was issued in June 1997. The Company will be required to adopt the
new statement for the year ending July 31, 1999. This statement requires use of
the "management approach" model for segment reporting. The management approach
model is based on the way a company's management organizes segments within the
company for making operating decisions and assessing performance. Reportable
segments are based on products and services, geography, legal structure,
management structure, or any other manner in which management disaggregates a
company. The Company intends to adopt this statement in fiscal 1999 and does
not anticipate that the adoption of the statement will have significant impact
on its financial statements.

3. Property and Equipment

   Property and equipment consists of the following:

<TABLE>
<CAPTION>
                                                    July 31           April 30
                                              ---------------------  ----------
                                                1997        1998        1999
                                              ---------  ----------  ----------
     <S>                                      <C>        <C>         <C>
     Equipment............................... $ 348,625  $3,631,140  $6,094,189
     Computer software.......................   679,484   2,595,572   4,118,590
     Furniture and fixtures..................       191      37,632      87,415
                                              ---------  ----------  ----------
                                              1,028,300   6,264,344  10,300,194
     Accumulated depreciation................  (128,775)   (855,283) (2,071,976)
                                              ---------  ----------  ----------
     Property and equipment, net............. $ 899,525  $5,409,061  $8,228,218
                                              =========  ==========  ==========
</TABLE>

4. Related Party Transactions

   In May 1999, the Company and IDT entered into a separation agreement whereby
the transactions and agreements necessary to govern the relationship between
the two companies necessary to effect their separation were determined. In
accordance with such agreement, it was determined that amounts paid by IDT in
excess of $22 million would be deemed to be capital contributions.

   In May 1999, the Company and IDT entered into an Internet/telecommunications
agreement whereby the Company has agreed to pay IDT up to $110,000 per month
for connectivity, the use of certain computer software and equipment owned or
leased by IDT and to provide a platform for IDT's Internet services for a
monthly per customer charge. In connection with such agreement, IDT has also
granted the Company an indefeasible right, for a period of 20 years, to use a
certain telecommunications network as it is completed and delivered for up to
approximately $6.0 million.

   In May 1999, the Company and IDT entered into two one-year services
agreements whereby the Company agreed to pay IDT for certain administrative,
customer support and other services that IDT provides to it at the cost of such
services plus 20%. Also, in conjunction with such agreements, the Company has
agreed to provide IDT with certain support services for the cost of such
services plus 20%. The agreement is effective for a period of two years.

                                      F-10
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


4. Related Party Transactions (continued)

   In May 1999, the Company and IDT entered into a joint marketing agreement
whereby the companies have agreed to jointly advertise and market their
products. The agreement continues for a term of one year and is automatically
renewable for an additional one year unless terminated by either party. In
conjunction with such agreement, a commission will be earned by each company
for new customers generated by the other company as a result of such programs.

   In May 1999, the Company and IDT entered into an assignment agreement
whereby IDT assigned all of its rights in certain trademarks, patents and
proprietary products and information to the Company. These assets were
contributed at IDT's historical cost which was $0.

   The accompanying financial statements for periods prior to the signing of
the aforementioned agreements include charges by IDT to the Company for the
aforementioned services. Such charges were based principally upon the Company's
allocable portion of IDT's costs for such services. The ratios used to allocate
these costs were the Company's total payroll to IDT's total payroll and the
Company's total revenue to IDT's total revenue, depending on the type of
services provided. The allocated costs approximate the amounts that would have
been charged under the inter-company agreements if they had been in effect
during such periods.

   For the period from January 2, 1996 (date of inception) to July 31, 1996 and
the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998
and 1999, all of the Company's operations were financed by IDT.

   For the years ended July 31, 1997 and 1998 and the nine months ended April
30, 1998 and 1999, the Company recognized revenue for services provided to IDT
of $297,000, $453,000, $323,000, and $680,000, respectively.

   At July 31, 1997 and 1998 and April 30, 1999, the due to IDT balance
represents the net amounts owed to IDT as a result of the aforementioned
agreements and financing. No interest was charged on the Company's advances
from IDT. The average balance owed to IDT during the period from January 2,
1996 (date of inception) to July 31, 1996, the years ended July 31, 1997 and
1998, and the nine months ended April 30, 1999 and 1998 were $341,000,
$1,821,000, $7,388,000, $16,907,000 and $5,280,000, respectively.

   The activity in the intercompany account with IDT was as follows:

<TABLE>
<CAPTION>
                             Period from                              Nine months
                           January 2, 1996     Year Ended July 31        ended
                         (date of inception) -----------------------   April 30,
                          to July 31, 1996      1997        1998         1999
                         ------------------- ----------  -----------  -----------
<S>                      <C>                 <C>         <C>          <C>
Opening balance.........      $    --        $  682,432  $ 2,960,429  $11,814,988
Expenses paid by IDT on
 behalf of the Company,
 net of cash received...       315,565        1,225,771    6,955,525    7,234,992
Net charges to the
 Company for services
 provided by IDT........       366,867        1,349,226    2,351,934    3,420,520
Revenue recognized by
 the Company for
 services provided to
 IDT....................           --          (297,000)    (453,000)    (680,000)
Capital contribution
 from IDT...............           --               --           100      209,500
                              --------       ----------  -----------  -----------
Ending balance..........      $682,432       $2,960,429  $11,814,988  $22,000,000
                              ========       ==========  ===========  ===========
</TABLE>

                                      F-11
<PAGE>

                                Net2Phone, Inc.

                  NOTES TO FINANCIAL STATEMENTS--(Continued)

                 July 31, 1998 (unaudited with respect to the
                  nine months ended April 30, 1998 and 1999)


5. Income Taxes

   The Company files a consolidated Federal income tax return with IDT and has
entered into a tax sharing agreement with IDT. Pursuant to such tax sharing
agreement, the Company would, while included in the IDT consolidated tax
return, be reimbursed for the use of its tax losses to the extent IDT realizes
a tax reduction from the use of such tax losses. When IDT's ownership interest
in the Company falls below 80%, the Company will no longer be a part of the
IDT consolidated Federal tax group.

   Significant components of the Company's deferred tax assets and liabilities
consists of the following:

<TABLE>
<CAPTION>
                                                       July 31        April 30
                                                  ------------------  ---------
                                                    1997     1998       1999
                                                  -------- ---------  ---------
     <S>                                          <C>      <C>        <C>
     Deferred tax assets:
       Net operating loss carryforwards.......... $    --  $ 314,000  $ 670,000
     Deferred tax liabilities:
       Depreciation..............................      --   (300,000)  (609,000)
                                                  -------- ---------  ---------
       Net deferred tax assets...................      --     14,000     61,000
       Valuation allowance.......................      --    (14,000)   (61,000)
                                                  -------- ---------  ---------
       Total deferred tax assets................. $    --  $     --   $     --
                                                  ======== =========  =========
</TABLE>

   The net deferred tax assets have been fully offset by a valuation allowance
due to the uncertainty of the realization of the assets.

   At April 30, 1999, the Company had net operating loss carryforwards for
state income tax purposes of approximately $7.5 million expiring in years
through 2006. These net operating loss carryforwards may be limited to future
taxable earnings of the Company.

<TABLE>
<CAPTION>
                                Period from         Year Ended           Nine Months
                              January 2, 1996         July 31          Ended April 30
                            (date of inception) --------------------  ------------------
                             to July 31, 1996     1997       1998       1998      1999
                            ------------------- --------  ----------  --------  --------
   <S>                      <C>                 <C>       <C>         <C>       <C>
   Tax at effective rate...      (173,000)      (577,000) (1,205,000) (229,000) (988,000)
   Benefit used by IDT for
    which the Company
    received no
    compensation...........       173,000        577,000   1,205,000   229,000   988,000
                                 --------       --------  ----------  --------  --------
   Tax provision...........           --             --          --        --        --
                                 ========       ========  ==========  ========  ========
</TABLE>

6. Stockholders' Deficit

   In April 1999, the Company amended and restated its Certificate of
Incorporation (the "Amendment"). As a result of the Amendment, the Company
increased its authorized shares of capital stock from 1,500 to 110,000,000, of
which 100,000,000 shares are designated as common stock and 10,000,000 shares
are designated as preferred stock.

   Subject to any voting rights which may be provided to future holders of
preferred stock, the holders of common stock have exclusive voting rights on
all matters requiring a vote of the Company and are entitled to one vote per
share of common stock held.

   In conjunction with the Amendment, the Company effectuated a 10,320 for one
stock split. The accompanying financial statements give retroactive effect to
the stock split.

                                     F-12
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


7. Commitments

   On February 8, 1998, the Company entered into an agreement with an Internet
company to develop a link between its Internet site and that of the Company and
advertise Company products on such site. The agreement is effective for fifteen
months upon the completion of the link and automatically extends for an
additional one year unless terminated by either party. Pursuant to such
agreement, the Company has made payments of $2.85 million through April 30,
1999 for the design, development, installation and implementation of the link
as well as the placement of Company advertisements on the Internet company's
site, of which $750,000 attributable to the establishment of such link was
deferred and is being amortized over the term of the agreement and $2.1 million
attributable to monthly payments for advertising and the maintenance of the
link was expensed monthly as incurred. As of April 30, 1999, the Company was
required to make an additional payment of $150,000 in fiscal 1999 and pay
certain future commissions, as defined, based upon revenue earned and usage of
the link.

   On August 4, 1998, the Company entered into an agreement with an Internet
company to advertise Company products on its Internet site. The agreement is
effective as of October 1, 1998, the launch date of the link, and extends
indefinitely until the Internet company fully provides all advertising
impressions guaranteed under the agreement. Pursuant to such agreement, the
Company has made payments of $495,000 through April 30, 1999 for the Company
advertisements on such site. As of April 30, 1999, the Company is required to
make additional payments of $213,000 in fiscal 1999, $975,000 in fiscal 2000,
and $167,000 in fiscal 2001 and pay certain future commissions, as defined,
based upon revenue earned and usage of the link. Under this agreement the
Company records expenses equal to the lesser of (i) the number of impressions
to date/minimum guaranteed impressions or (ii) revenue to date/minimum
guaranteed revenue as a percentage of the total payments.

   On February 19, 1999, the Company entered into an agreement under which an
international computer company is to provide connections to its global network.
These connections will allow worldwide transport of the Company's IP traffic.
The agreement is effective for 63 months upon availability of the connections.
Pursuant to such agreement, the Company has made payments of $1 million through
April 30, 1999 which have been reflected on the consolidated balance sheets as
prepaid contract deposits. As of April 30, 1999, the Company is required to
make an additional payment of $1 million when the connections are available and
pay fees for additional connections and usage. The $2 million of prepayments
will be amortized over the term of the agreement beginning at the time the
connections are available for use.

   On January 31, 1999, the Company entered into a series of agreements with a
third party. The agreements call for the bundling of the Company's Internet
telephony products with the third party's Internet browser, the purchase of
software from the third party and the use of the third party's trademark. The
agreements require the Company to pay the third party (i) $5,000,000 for the
use of the trademark (ii) $8,000,000 for the purchase of software and (iii)
commissions on revenues generated from customers that the Company obtains from
the bundling of products. Through April 30, 1999, the Company had paid $5
million for the right to use the trademark and $3 million for certain software.
The Company has capitalized the costs of the right to use the trademark and the
software costs and will amortize them over the term of the bundling agreement,
which expires two years after the release of the bundled product.

   The Company has distribution agreements under which it has agreed to pay its
agents commissions for obtaining new Internet telephony customers. The
agreements require commissions upon activation of the customers.

   In May 1997, the Company entered into a three year employment agreement with
one of its officers. Under the terms of such agreement, which was amended in
May 1999, the Company agreed to, among other things, provide such officer with
an annual salary of $100,000 and the right to purchase a 10% interest

                                      F-13
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


7. Commitments (continued)

in the Company for $100,000, which was the fair market value of the Company at
that time. Such right, which includes an anti-dilutive provision mandating that
the officer's ownership interest cannot be diluted
below 8% of the total outstanding shares upon consummation of an initial public
offering of the Company's common stock, was exercised during fiscal 1998. The
agreement is automatically renewable on an annual basis after its initial three
year term unless terminated by either party.

8. Customer and Geographical Area

   Revenue from customers outside the United States represented approximately
44%, 72%, 63%, and 58% of total revenue during the years ended July 31, 1997
and 1998 and the nine months ended April 30, 1998 and 1999, respectively.
During the year ended July 31, 1998 and the nine months ended April 30, 1998,
revenues derived from equipment sales to a customer in Korea represented
approximately 14% and 19%, respectively, of total revenue. No single geographic
area accounted for more than 10% of total revenue during the year ended July
31, 1997 and the nine months ended April 30, 1999. No customer accounted for
more than 10% of revenue during the year ended July 31, 1997 and the nine
months ended April 30, 1999.

9. Subsequent Events

   On June 25, 1999, the Company effectuated a three-for-one stock split. The
financial statements give retroactive effect to the stock split. In addition,
the Company designated 15,000,000 shares of its capital stock as Class A stock.
The holders of Class A stock are identical to those of common stock except for
voting and conversion rights and restrictions on transferability. The Class A
stock is entitled to two votes per share.

   In March 1999, the Company entered into two lease agreements with companies
which are owned by the Chairman, Chief Executive Officer and Treasurer of IDT.
Pursuant to such lease agreements, the Company is required to make equal
monthly rental payments aggregating $558,000 to such companies through February
2002.

   On May 12, 1999, the Company converted a portion of its liability to IDT
into a $14,000,000 promissory note. Such promissory note accrues interest at a
rate of 9% per annum and is payable in 60 equal monthly installments of
principal and interest. Notwithstanding the foregoing, $7,000,000 in principal
will be repaid within 10 days of the consummation of a proposed initial public
offering of the Company's common stock.

   On May 13, 1999, the Company designated 3,150,000 shares of its preferred
stock as Series A ("Series A Stock") and sold 3,140,000 of such shares to
unrelated third parties in a private placement transaction for aggregate gross
proceeds of $31,400,000.

   The Series A Stock entitles its holders to a non-cumulative dividend of 8%
per annum on the original issue price. Each share of Series A Stock is
convertible into three shares of Class A stock at the option of the holder,
subject to certain adjustments as, defined. Each share of Series A stock also
entitles its holders to vote on corporate matters on an as if converted basis.
Holders of Series A Stock have priority over common stock and Class A stock
with respect to the payment of dividends and in the event of the liquidation or
dissolution of the Company. The liquidation preference of the Series A Stock is
equivalent to the original issue price plus an amount equal to 8% of the
original issue price compounded on an annual basis from the date of issuance
plus any declared, but unpaid dividends. The Series A Stock is redeemable at
the option of the holder, beginning May 2006, over a period of 3 years.

                                      F-14
<PAGE>

                                Net2Phone, Inc.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

                  July 31, 1998 (unaudited with respect to the
                   nine months ended April 30, 1998 and 1999)


9. Subsequent Events (continued)

   The Series A Stock contains beneficial conversion features. The total value
of the beneficial conversion feature approximated $75 million. For accounting
purposes the value of the beneficial conversion features was limited to the
amount of proceeds allocated to the Series A Stock. The Company will record a
reduction in net income available to common stockholders on the date of the
issuance of the Series A Stock in the amount of approximately $29.3 million.

   In connection with the sale of Series A Stock, the Company granted warrants
to purchase 272,400 shares of common stock at an exercise price of $3.33 per
share, subject to certain adjustments as defined, from the date of issuance
through May 13, 2004 to the Series A Stock investors and placement agent. The
warrants contain a provision whereby they are automatically terminated upon a
merger or sale of the Company or an initial public offering of the Company's
stock. As a result, the warrants are expected to be exercised prior to the
proposed initial public offering of the Company's common stock. The fair value
of warrants on the date of issuance was $2.1 million. This was computed using
the Black Scholes model with the following assumptions: the fair value of the
common stock equal to $11.00 per share, the risk free interest rate of 4.79%,
volatility factor of 84%, an expected life of 6 months, and a dividend yield of
0%

   The fair value of the warrants will be recorded as an increase to additional
paid in capital and a decrease to the carrying value of the preferred stock.
The decrease in the carrying value of Series A Stock will be accreted with a
reduction of additional paid-in capital over the period to the initial
redemption date in May 2006. In connection with this offering, the Series A
convertible preferred stock will be converted into Class A stock. At that time,
the balance of the unamortized discount will be recorded as a reduction of the
amount of income available for common shareholders.

   In April 1999, the Company adopted a stock option and incentive plan (the
"Plan"). Pursuant to the Plan, the Company's officers, employees and non-
employee directors, as well as those of IDT, are eligible to receive awards of
incentive and non-qualified stock options, stock appreciation rights, limited
stock appreciation rights and restricted stock.

   In May 1999, a total of 5,040,000 shares of common stock were authorized for
issuance under the plan to employees of the Company and to employees and
consultants of IDT, all of which were granted with an exercise price of $3.33
per share and 1,345,219 of which were exercised through June 25, 1999. The
options generally vest over periods up to four years and expire ten years from
the date of grant. In connection with the exercise of such options, the Company
extended $3,150,000 in loans to employees. In order to obtain such loans, the
optionees agreed to the cancellation of 23,382 outstanding options.
Compensation expense in connection with the options to purchase 3,718,503
shares of common stock issued to employees of the Company will be computed in
accordance with APB 25. The expense will be computed as the difference between
the exercise price of $3.33 per share and the fair market value of the stock on
the date of grant ($11 per share). The deferred compensation expense of
approximately $28.5 million will be amortized over the vesting period of the
options. Compensation expense in connection with the options to purchase
1,321,497 shares of common stock issued to employees and consultants of IDT
will be computed in accordance with FAS 123. The expense will be computed using
the Black Scholes model with the following assumptions: the fair market value
of the common stock on date of grant equal to $11.00 per share, the risk free
interest rate of 5.92%, volatility factor of 84%, an expected life of 5 years,
and a dividend yield of 0%. The deferred compensation expense of approximately
$12.4 million will be amortized over the vesting period of the options.
Compensation expense from both the options issued to the Company's employees
and employees and consultants to IDT will be charged to expense over the
vesting period: fiscal 1999, $14.8 million; fiscal 2000, $9.8 million; fiscal
2001, $9.8 million; and fiscal 2002, $6.5 million. On June 25, 1999, the shares
authorized for issuance under the plan was increased by 6,000,000 shares.

                                      F-15
<PAGE>

9. Subsequent Events (continued)

   The Company entered into an agreement with Snap, an Internet postal service
of NBC and CNET, on May 17, 1999. Snap will display links to the Company's Web
site and services on its Snap.com Web site. In addition, the Company is Snap's
preferred provider of PC-to-phone services during the two-year term of this
agreement. Snap also will deliver a preset minimum number of impressions on its
site and agreed to give the Company the right to advertise on its Snap.com Web
site, subject to certain conditions. In exchange, the Company agreed to pay
Snap a one-time fee, a percentage of revenue generated through their site and
bonus payments for customers delivered by Snap after meeting certain quotas.
The Company will amortize the up front payment over the term of the agreement.

   The Company signed an agreement with NBC on June 25, 1999 to purchase $1.5
million in television advertising on the NBC television network. The Company
also has the right to purchase additional spots to be telecast prior to June
30, 2000. The cost of the advertising will be expensed as the spots are shown.

   On July 2, 1999, the Company signed a three-year employment agreement with
its new President. After the initial term, the agreement may be renewed
annually. The Company will pay its President an annual base salary of $350,000
and he is entitled to receive an annual bonus calculated on the basis of the
Company's gross revenue, which bonus could be up to $100,000. The Company
granted its President options to purchase 920,000 shares of its common stock
under its 1999 Stock Option and Incentive Plan. Of these options, 460,000 were
granted at an exercise price of $3.33 per share, 153,333 of which are vested
and exercisable. The options to purchase the remaining 460,000 shares were
granted at the lower of the initial public offering price or $11.00 per share.
Other than those options which are vested, the remaining 766,667 options will
vest in three equal annual installments, commencing on July 20, 2000. The
Company will record compensation in connection with the issuance of options
with an exercise price less than the fair market value of the stock.

   On July 15, 1999, the Company entered into a four-year distribution and
marketing agreement with ICQ, a subsidiary of America Online. Under this
agreement, ICQ has agreed to co-brand and promote the Company's Internet
telephony services in the U.S. and in 19 other countries, embed customized
versions of the Company's software to allow ICQ customers to make PC-to-phone
and PC-to-PC calls and to receive phone-to-PC calls, share revenue from
advertisements and sponsorships sold by ICQ on the Company's software that is
embedded in ICQ's Instant Messenger software, and promote the Company's
services on some of ICQ's Web sites. The Company agreed to pay ICQ a fee of
$7.5 million, $4.0 million of which was paid at signing, and the remainder of
which will be paid at the closing of the Company's initial public offering. The
Company also agreed to pay ICQ a share of minutes-based revenue generated
through ICQ and to award ICQ a performance bonus on the basis of the total
revenue derived under the agreement, and to promote ICQ on the Company's Web
sites.

   In connection with the Company's distribution and marketing agreement with
ICQ, the Company issued a warrant to America Online to purchase up to 3% of the
Company's outstanding capital stock on a fully-diluted basis. This warrant will
vest in 1% increments upon the achievement of each of three incremental
thresholds of revenue generated under the agreement during the first four years
that the warrant is outstanding. The per share exercise price under the warrant
will be equal to the lesser of 80% of the price per share in the Company's
initial public offering, or $450 million divided by the number of the Company's
fully-diluted shares on the initial exercise date. The warrant may be exercised
for a period of five years from the date of issuance.


                                      F-16
<PAGE>

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                               5,400,000 Shares

                               NET2PHONE [LOGO]

                                 Common Stock

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                                  PROSPECTUS

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                               HAMBRECHT & QUIST

                                BT ALEX. BROWN

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                           BEAR, STEARNS & CO. INC.


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                                 July 29, 1999

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   You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.

   No action is being taken in any jurisdiction outside the United States to
permit a public offering of the common stock or possession or distribution of
this prospectus in that jurisdiction. Persons who come into possession of this
prospectus in jurisdictions outside the United States are required to inform
themselves about and to observe any restrictions as to this offering and the
distribution of this prospectus applicable to that jurisdiction.

   Until August 23, 1999, all dealers that buy, sell or trade in our common
stock, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.

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