**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THE

**                                                SECURITIESEXCHANGE ACT OF 1934**

**For the fiscal year ended December 31,2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

**                                                SECURITIESEXCHANGE ACT OF 1934**

**Forthe transition period from ***            * to

**Commission file number: 000-27127**

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**iBasis, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                     |   | **04-3332534**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer     |
| incorporation or  organization)  |   | Identification  No.) |

 

**20Second Avenue, Burlington, MA 01803**(Addressof principal executive offices, including zip code)

**(781) 505-7500**(Registrant’stelephone number, including area code)

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Securities registeredpursuant to Section 12(b) of the Act:

| **Title of Each Class**                   |   | **Name of  Each Exchange on Which Registered** |
|-------------------------------------------|--------|------------------------------------------------|
| Common Stock, par  value $0.001 per share |   | The Nasdaq Stock  Market LLC                   |

 

Securities registered pursuant to Section 12(g) ofthe Act:

**None**

(Title of Class)

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes o No x

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes o No x

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated  filer o |
|---------------------------|--------|---------------------|--------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o No x

The aggregate market value of the registrant’s commonstock, $0.001 par value per share, held by non-affiliates of the registrant asof June 30, 2006 was approximately $270,818,000  based on 30,774,778 shares held by suchnon-affiliates at the closing price of a share of common stock of $8.80 asreported on The Nasdaq Global Market on such date. Affiliates of the Company(defined as officers, directors and owners of 10 percent or more of theoutstanding share of common stock) owned 2,372,335 shares of common stockoutstanding on such date. The number of outstanding shares of common stock ofthe Company on May 31, 2007 was 33,467,841 shares.

 

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**Explanatory Note**

In this Annual Report on Form 10-K (“Form 10-K”),we are restating our consolidated financial statements as of December 31,2005 and for each of the years ended December 31, 2005 and 2004, andquarterly data for 2005 and the first two quarters of 2006, which are includedin “Financial Statements and Supplementary Data” in Item 8. This Form 10-Kalso reflects the restatement of selected financial data as of and for each ofthe years ended December 31, 2002 through 2005, which is included in “SelectedFinancial Data” in Item 6, and the fiscal years ended December 31, 2005and 2004, which is included in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in Item 7.

Previously filed annual reports on Form 10-Kand quarterly reports on Form 10-Q affected by the restatement havenot been amended and should not be relied on.

The restatement ofour consolidated financial statements reflects:

i)                 stock-basedcompensation expense not previously recorded for certain stock option grantsfor which we used an incorrect measurement date for accounting purposes;

ii)             tax-relatedadjustments resulting from the above errors in stock option accounting; and

iii)         the recording ofpreviously unrecorded adjustments not related to accounting for stock optionsthat were previously deemed to be immaterial to our historical consolidatedfinancial statements.

During the quarter ended September 30, 2006 ourBoard of Directors formed a Special Committee of independent directors tocommence a voluntary investigation of our historical stock option grants andpractices. The Special Committee concluded that the appropriate measurementdates for determining the accounting treatment of certain historical stockoption grants differed from the measurement dates we used in preparing ourconsolidated financial statements. Because the exercise prices at theoriginally stated grant dates, in certain cases, were lower than the prices onthe revised measurement dates, we determined we should have recognized materialamounts of stock-based compensation expense which were not accounted for in ourpreviously issued consolidated financial statements. The Special Committee alsofound that in a number of instances the date and exercise price of optiongrants had been determined with hindsight to provide a more favorable price forsuch grants.

As aresult, we have determined revised measurement dates for certain stock optiongrants and have recorded total additional stock-based compensation expense of$10.0 million for the years ended December 31, 2000 through 2005, and $0.1 millionfor the first two quarters of 2006. A summary of additional stock-basedcompensation expense, by period, with the most significant stock option grantsshown separately, is as follows:

 

| **(000’s)**    | ** ** | **Year Ended December 31,** | ** ** | **Total** | ** ** | **Three  Months  Ended  March 31,** | ** ** | **Six  Months  Ended  June 30,** | ** ** |
|---------------------|------------|--------------------------------------------|------------|-----------|------------|------------------------------------------|------------|---------------------------------------|------------|
| **Grant Date** | ** ** | ** **                                 | ** ** | **2000**  | ** ** | **2001**                                 | ** ** | **2002**                              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | ** ** | ** ** | **2006** | ** ** | **2006** | ** ** |
| May 25, 2000   |       | $                                          | 1,540      |      | $          | 2,699                                    |       | $                                     | 3,028      |   | $ | 281 |   | $ | 135 |   | $ | — |   | $ | 7,683 |   |   | $ | — |   |   |   | $ | — |   |   |
| Nov. 15,  2001 |       |                                       |       |      |       | 554                                      |       | 391                                   |       | 39 |   | 39 |   | 1,023 |   |   |   |   |   |   |   |   |   |
| Aug. 11,  2003 |       |                                       |       |      |       |                                     |       | 47                                    |       | 185 |   | 162 |   | 394 |   |   | 20 |   |   |   | 40 |   |   |
| All other grants    |       | 118                                        |       | 186       |       | 196                                      |       | 92                                    |       | 144 |   | 136 |   | 872 |   |   | 15 |   |   |   | 52 |   |   |
| Total               |       | $                                          | 1,658      |      | $          | 2,885                                    |       | $                                     | 3,778      |   | $ | 811 |   | $ | 503 |   | $ | 337 |   | $ | 9,972 |   |   | $ | 35 |   |   |   | $ | 92 |   |   |
|                     |            |                                            |            |           |            |                                          |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As a result of determining revised measurement dates,we have also recorded payroll withholding tax related adjustments for certainoptions previously classified as Incentive Stock Option (“ISO”) grants underthe Internal Revenue Service Code of 1986, as amended (“the Code”). Suchoptions were determined to have been granted with an exercise price below thefair market value of our common stock on the revised measurement date. As aresult, such options do not qualify for ISO tax treatment. The disqualificationof ISO classification and the resulting conversion to Non-qualified StockOption status results in additional withholding taxes on exercise of suchoptions. We have accordingly recorded a tax 

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liability of $0.5 million****as of December 31, 2006 in connection with thedisqualification of such ISO tax treatment.

In addition, as a result of the change in themeasurement dates of certain stock option grants, certain options vestingsubsequent to December 2004 result in non-qualified deferred compensationfor purposes of Section 409A of the Code, and holders are subject to anexcise tax on the value of the options in the year in which they vest. We haveconcluded that it is probable that we will implement a plan to assist theaffected employees for the amount of this tax, or adjust the terms of theoriginal option grant, which would also have financial statement ramifications.

In those instanceswhere the approval date of the stock option grant could not be determined withcertainty, or the terms of the option grant, including exercise price andnumber of shares were not final on the determined date of approval, we used aconsistent methodology to determine the most likely measurement date of theoption grant. In determining a measurement date, we considered the date bywhich both approval of the stock option grant had been obtained and the termsof the option grant, including exercise price and number of shares, were final.For each of our past stock option grants, we determined a measurement dateusing the following criteria:

1)              For stock optiongrants approved at a meeting of either our Board of Directors or ourCompensation Committee and evidenced by meeting minutes, the date of themeeting was determined to be the measurement date, provided the terms of theoption grant, including exercise price and number of shares, were final on thedate of the meeting.

2)              For stock optiongrants approved by the members of our Compensation Committee through theprocess of signing unanimous written consents (“UWCs”), the following criteriawere used to determine the measurement date of the grant:

a)                If there wasevidence of the date of signature for all of our Compensation Committeemembers, the date that the last Compensation Committee member signed the UWCwas determined to be the measurement date, provided the terms of the optiongrant, including exercise price and number of shares, were final on that date;

b)               If there wasevidence of the date of signature for all of our Compensation Committeemembers, other than our Chief Executive Officer when he was a member of theCompensation Committee, the date that the last Compensation Committee membersigned the UWC was determined to be the measurement date, provided the terms ofthe option grant, including exercise price and number of shares, were final onthat date.

3)              If there was noevidence that grants were approved through the process of signing UWCs, orthere was no evidence as to the date of the signatures on the UWCs by ourCompensation Committee members we considered email evidence to support theapproval date.

We determined the measurement date based on the dateof statements made in email correspondence that indicated that the stock optiongrant had been approved by all of the members of our Compensation Committee, providedthe terms of the option grant, including exercise price and number of shares,were final on that date. We considered emails from our Compensation Committeemembers indicating the date of approval of the option grant and/or emails fromour legal or human resources personnel indicating the date of approval of theoption grant.

4)              If there was a Form 3or Form 4 filing associated with the option grant, we used the followingcriteria to determine the measurement date of the grant:

a)                If an officer ordirector required to file reports under Section 16 of the SecuritiesExchange Act of 1934, as amended, filed a Form 3 or Form 4, wedetermined the measurement date to be the date that the Form 3 or Form 4was filed;

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b)               If employees whowere not Section 16 officers were included in the grant with Section 16officers who filed a Form 3 or Form 4 and the number of sharesattributable to employees who were not Section 16 officers were determinedwith finality at the time of the filing, we determined the measurement date tobe the filing date of the Form 3 or Form 4 as it provided finality asto the exercise price.

5)               If we did not haveany corroborating evidence to indicate the date the stock option grant had beenapproved by all of the members of the Compensation Committee, and the filing ofa Form 3 or Form 4 was not applicable, we looked for evidence thatindicated the date on which the UWC was sent for signature, via email or fax,from us to our Compensation Committee members. If this evidence existed, weanalyzed the number of days it took for our Compensation Committee members toreturn the signed UWCs. A range of response time was determined by individualCompensation Committee member and used to develop a response time range for ourCompensation Committee, as a group, during specific periods, as the compositionof our Compensation Committee members changed over time. Based on thisanalysis, four different ranges were determined. The range of response timesfrom Compensation Committee members varied from a minimum of 1 to 2 days, forwhich there was one instance, to a maximum of 0 to 91 days, for which therewere two instances. Based on the range of response time, we determined themeasurement date to be the last day of the response time period, provided the optionterms were final on this date, as this is the date we have determined is thedate by which approval is most likely to have been obtained.

6)               In instances wherethere was no evidence of the approval of the grant and/or finality of theoption  recipients and grant terms, wedetermined the measurement date based on the last date of entry for these stockoptions into our stock option tracking system. This date was deemed to be themost likely approval date as our policy and historical practice was to enter stockoption grants into its stock option tracking system only after we believed thatthe option grants had been approved.

The restatement of prior year financial statementsalso includes adjustments for other errors that were not previously recordedbecause we believed the amount of any such errors, both individually and in theaggregate, were not material to our historical consolidated financialstatements. Such errors primarily related to the recording of deferred income,classification of reserves for customer disputes, adjustments to accruals, andfixed asset depreciation.

Thefollowing is a summary of the effects on net income of the adjustments relatedto the above errors (in thousands):
| Year Ended December 31,  | ** ** | ** **                                              | ** ** | **Stock based  compensation and  related payroll tax  withholding adjustments** | ** ** | **Other  adjustments** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                              | ** ** | **Increase (decrease) to net loss** | ** ** | ** **                                                                                               | ** ** |
| 2000                                    |       |                                                    | $          | 1,661                                                                                                    |       |                   |       | $         | 78         |   |   | $ | 1,739 |   |
| 2001                                    |       |                                                    | 2,885      |                                                                                                     |       |                   | 98         |      |       | 2,983 |   |
| 2002                                    |       |                                                    | 3,778      |                                                                                                     |       |                   | (420       | )         |       | 3,358 |   |
| 2003                                    |       |                                                    | 822        |                                                                                                     |       |                   | 574        |      |       | 1,396 |   |
| 2004                                    |       |                                                    | 613        |                                                                                                     |       |                   | 175        |      |       | 788 |   |
| 2005                                    |       |                                                    | 459        |                                                                                                     |       |                   | (97        | )         |       | 362 |   |
| Total                                   |       |                                                    | $          | 10,218                                                                                                   |       |                   |       | 408       |       |   | $ | 10,626 |   |
| ** **                              | ** ** | **Decrease (increase) to net income**                   | ** ** | ** **                                                                                               | ** ** |
| Three months  ended March 31, 2006 |       |                                                    | 63         |                                                                                                     |       |                   | (45)       |      |       | 18 |   |
| Three months ended June  30, 2006       |       |                                                    | 100        |                                                                                                     |       |                   | (74)       |      |       | 26 |   |

 

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**iBASIS, INC.**

**FORM 10-KFor the Year Ended December 31, 2006**

**Table of Contents**
|            | ** ** | ** **                                                                                                                      | ** ** | **Page** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
|       | ** ** | **PART I**                                                                                                                 |       |     |       |
| Item 1.    |       | Business                                                                                                                        |       | 1        |       |
| Item 1A    |       | Risk Factors                                                                                                                    |       | 12       |       |
| Item 1B.   |       | Unresolved Staff  Comments                                                                                                      |       | 30       |       |
| Item 2.    |       | Properties                                                                                                                      |       | 31       |       |
| Item 3.    |       | Legal Proceedings                                                                                                               |       | 31       |       |
| Item 4.    |       | Submission of  Matters to a Vote of Security Holders                                                                            |       | 33       |       |
|       | ** ** | **PART II**                                                                                                                |       |     |       |
| Item 5.    |       | Market for the  Registrant’s Common Equity and Related Stockholder Matters, and Issuer  Purchases of Equity Securities     |       | 34       |       |
| Item 6.    |       | Selected Financial  Data                                                                                                        |       | 37       |       |
| Item 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       |       | 39       |       |
| Item 7A.   |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                     |       | 59       |       |
| Item 8.    |       | Financial  Statements and Supplementary Data                                                                                    |       | 60       |       |
| Item 9.    |       | Change in and  Disagreement with Accountants on Accounting and Financial Disclosure                                             |       | 105      |       |
| Item 9A.   |       | Controls and  Procedures                                                                                                        |       | 105      |       |
| Item 9B.   |       | Other Information                                                                                                               |       | 108      |       |
|       | ** ** | **PART III**                                                                                                               |       |     |       |
| Item 10.   |       | Directors and  Executive Officers of the Registrant                                                                             |       | 110      |       |
| Item 11.   |       | Executive  Compensation                                                                                                         |       | 113      |       |
| Item 12.   |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                 |       | 129      |       |
| Item 13.   |       | Certain  Relationships and Related Transactions and Director Independence                                                       |       | 132      |       |
| Item 14.   |       | Principal  Accountant Fees and Services                                                                                         |       | 133      |       |
|       | ** ** | **PART IV**                                                                                                                |       |     |       |
| Item 15.   |       | Exhibits and  Financial Statement Schedules                                                                                     |       | 134      |       |
| Signatures |       | 137                                                                                                                             |       |

 

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**PART I**

**Item 1.**                        *Business*

**Company Overview**

We are a leading provider of internationalcommunications services and a provider of retail prepaid calling services. Ouroperations consist of our Voice-Over-Internet-Protocol (“VoIP”) tradingbusiness (“Trading”), in which we connect buyers and sellers of internationaltelecommunications services, and our retail services business (“Retail”). Inthe Trading business we receive voice traffic from buyers—originating carrierswho are interconnected to our network via VoIP or traditional time divisionmultiplexing (‘TDM”) connections, and we route that traffic over the Internetto sellers—local service providers and carriers in the destination countrieswith whom we have established agreements to manage the completion ortermination of the call. We use proprietary, patent-pending technology toautomate the selection of routes and termination partners based on a variety ofperformance, quality, and business metrics. We offer this Trading service on awholesale basis to carriers, consumer VoIP companies, telephony resellers andother service providers worldwide. We have call termination agreements withlocal service providers in North America, Europe, Asia, the Middle East, LatinAmerica, Africa and Australia.

We continue to expand our market share in our Tradingbusiness by expanding our customer base and by introducing cost-effectivesolutions for our customers to interconnect with our network. Our Tradingproducts include iBasis DirectsTM, which features our direct routes to more than100 countries, which are our most cost-efficient routes. Designed for carriercustomers with sophisticated Least Cost Routing capabilities, Directs offersour most competitive rates. We also offer our PremiumCertified® international routing product which featuresroutes to more than 700 destinations that are actively monitored and managed todeliver a level of quality that is equal to or exceeds the highest industrybenchmarks for retail quality. PremiumCertified is designed to take advantageof third-party or off-net routes to provide thorough worldwide coverage forcustomers, and enhances our ability to compete for retail international trafficfrom existing customers as well as from mobile operators and consumer VoIPproviders.

In targeting the emerging consumer VoIP providers, wehave expanded our DirectVoIPTM IPinterconnection offering with DirectVoIP Broadband, which addressesrequirements that are specific to the growing consumer VoIP market. DirectVoIPBroadband includes our transcoding solution, which enables us to providegreater interoperability among devices and voice applications, as well asdeliver high quality service even over sub-optimal network connections. We haveapproximately 60 customers in the consumer VoIP market, including leaders amongthe emerging independent providers and cable operators, and we believe thismarket offers significant growth potential for us.

We launchedour Retail business in late 2003, with the introduction of our retail prepaidcalling cards, which are marketed through distributors primarily to ethniccommunities within major metropolitan markets in the United States. In September 2004,we expanded our Retail business segment with Pingo®, a prepaid calling servicethat we offer and sell directly to consumers and business customers through anInternet website on a prepaid basis . Both the prepaid calling card businessand Pingo leverage our existing international VoIP network and have thepotential to deliver higher margins than are typically achieved in the Tradingbusiness. In addition, the retail prepaid calling card business typically has afaster cash collection cycle than the Trading business. Pingo is sold directlyto consumers and business customers.  Todate, revenues from our Pingo services have not been material.

We were incorporated as a Delaware corporation in 1996. Ourprincipal executive offices are located at 20 Second Avenue, Burlington,Massachusetts and our telephone number is (781) 505-7500. Our annualreports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and all amendments to those reports,are available to you free of charge through the Securities and ExchangeCommission’s 

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(“SEC”) website at *www.sec.gov* or on our investor relations website at *http://investor.ibasis.com*as soon as reasonably practicable after such materials have been electronicallyfiled with, or furnished to, the SEC.

**ProposedTransaction with KPN Telecom B.V., a subsidiary of Royal KPN N.V.**

On June 21,2006, we entered into a Share Purchase and Sale Agreement (Share PurchaseAgreement, with KPN Telecom B.V., (“KPN”), a subsidiary of Royal KPN N.V. and aprivate limited liability company organized under the laws of The Netherlands.Pursuant to the Share Purchase Agreement, we will acquire the shares of twosubsidiaries of KPN and receive $55 million in cash from KPN in return forissuing to KPN that number of shares, of our common stock which, on a postissuance basis, represents 51% of the issued and outstanding shares of ourcommon stock and outstanding in-the-money stock options and warrants. The twoentities which we are acquiring from KPN encompass KPN’s internationalwholesale voice business.

Upon the completion of the foregoing transactions, wewill pay a dividend in the aggregate amount of $113 million, on a pro ratabasis to those persons who are our shareholders of record on the dateimmediately prior to the date of the closing of the transactions contemplatedby the Share Purchase Agreement. In connection with our payment of thedividend, we will adjust the exercise price and number of shares to be issuedupon exercise of our outstanding common stock options to preserve their value.The proposed transaction, which is subject to customary closing conditions, including regulatory approvalsand the approval of our shareholders, is expected to be completed before theend of  October 2007. On April 27,2007, we announced that we and KPN had amended the Share Purchase Agreement toextend the outside date for completion of the transactions to October 31,2007.

Although we will be issuing shares of ourcommon stock in acquiring the two subsidiaries of KPN, after the merger iscompleted, KPN will hold a majority of our outstanding common stock.Accordingly, for accounting and financial reporting purposes, we will betreated as the accounting acquiree. Under the purchase method of accounting,our assets and liabilities will be, as of the date of the transaction, recordedat their fair value and added to the historical assets and liabilities of thetwo subsidiaries of KPN, including any amount for goodwill representing thedifference between the deemed purchase price of iBasis and the fair value ofour identifiable net assets.

**Industry Overview**

*Market Overview.**  *The international voice and faxtraffic market is estimated by industry analyst TeleGeography to beapproximately $70 billion. We believe that this market will continue togrow as countries around the world continue to deregulate theirtelecommunication markets, prices fall and underlying trends in migration andeconomic integration drive fundamental demand. We believe there are three majorindustry trends that will drive continued growth in the wholesale trading ofinternational voice traffic. These trends involve the migration of voicetraffic:

·       fromtraditional vertically-integrated international carriers to morespecialized local service providers;

·       fromtraditional fixed line offerings to consumer VoIP; and

·       fromthe traditional time-division multiplexing (TDM) network to VoIP.

In many cases, international traffic is moving tocarriers that do not have extensive international networks and are dependent onwholesale providers like iBasis to provide effective international service forretail customers.

Global deregulation combined with rapid technologicaladvances has enabled the emergence of many new communications service providersin dozens of local markets. In their efforts to remain competitive, 

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national carriers are focusingtheir capital spending on “last-mile” services such as fixed-line, wireless,and cable, which account for a very large percentage of their revenues.Consequently, communications service providers are looking for ways to expandtheir ability to serve all of their customers’ telecommunication needs, whilesimultaneously reducing the cost of providing international services. As theinternational voice business becomes increasingly commoditized, the criticalsuccess factor is scale. For the vast majority of carriers, internationaltraffic represents a very small portion of their overall business. Therefore,many of the world’s carriers are seeking to leverage efficient VoIP networks,such as The iBasis NetworkÔ,whose lower infrastructure and transport costs can help improve a carrier’scompetitiveness and bottom line, without compromising service quality. Somecarrier customers turn to us for their biggest routes, some for their smallestroutes, and others for all routes, effectively outsourcing their internationalvoice traffic to iBasis.

*TheMainstreaming of VoIP.**  *Althoughthe consumer adoption of VoIP services is a recent development, we have beentransmitting VoIP calls for many of the world’s largest carriers for severalyears. Managing quality of service at the core of the network, which wepioneered and mastered, has allowed phone-to-phone calls to betransmitted over the Internet with quality nearly indistinguishable from thatof traditional voice networks. Enabled by the quality of VoIP service fromproviders like us, international VoIP traffic has grown rapidly. According toindustry analyst, TeleGeography, international VoIP traffic grew 36% to32 billion minutes in 2004, and 42% to 45 billion minutes in 2005 and wasexpected to reach 62 billion minutes in 2006, which is more than 20% ofprojected international traffic worldwide.

Unlike fixed-line telecommunication networks andmanaged internet protocol (“IP”) networks, the Internet has many potentialpoints of congestion where information, in the form of data packets, can bedelayed or dropped. For non real-time communications, such as email, a slightdelay in the receipt of a message is not significant. However, for real-timecommunications, such as telephone calls, the result of a delay in transmittingthe call, or losing the call altogether, is significant. To minimize the riskof delays or losing calls over the Internet, we utilize complex and proprietaryperformance monitoring and call routing technology to ensure consistently highcall completion and voice quality. We have developed patent-pendingquality management technology that enables us to deliver call completion ratesand average call durations (the standard metrics carriers use for measuringquality) that we believe are consistently equal to or better than thoseachieved by traditional fixed-line carriers.

VoIP’s principalbenefits are:

·       *Cost Advantage from Internet Transport*.Traditional voice networks use circuit-switching technology, whichestablishes dedicated channels between an originating and terminating point forthe duration of a call. Physical facilities (typically fiber and associatedequipment) are dedicated to voice traffic between switching nodes, regardlessof changes in demand. In contrast, VoIP is based on packet-switchingtechnology. This technology completes a call by digitizing and dividing aspeaker’s voice into small packets that travel to their destination along linescarrying packets of other Internet traffic, in much the same way as emailtravels. Using a network of service facilities connected to the public Internetfor transport is less costly than building a dedicated network as our callsshare the Internet with other traffic.

·       *Cost Advantage from IP Technology*. VoIPgateway equipment and session border controllers which are used to convert androute phone calls over the Internet is less expensive and requires lessphysical space in telecommunication facilities than traditionaltelecommunications equipment.

·       *Cost Advantage from Bypass of International SettlementRates*. Traditional international long distance calls are completedthrough international toll switches that provide access to the terminatingnetwork. These networks are often owned by government bodies ortelecommunications carriers who charge settlement rates well in excess ofcosts. Although these fees are being reduced in many 

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countries as industryderegulation continues, these charges remain significant. Calls routed over theInternet bypass the toll switches, avoiding a significant portion of thesefees, which further lowers the cost of completing such calls.

·       *Positioning for New Services.* In contrastto the closed, proprietary structure inherent in a traditional circuit-switchedvoice network, VoIP embraces an open architecture and open standards, whichfacilitates innovation at a lower cost. Traditional voice networks have beendesigned specifically to provide one basic service, making it difficult andcostly to introduce new services over those networks and their proprietaryplatforms. As data networks convert all services into standard data packets,new services are delivered from industry standard servers, integrating theInternet with the revolution in commodity computing. As a result, new servicescan be developed and brought to market much faster and more cost-efficiently.

*Outsourcing VoIP services.**  *Given the advantages of VoIP, manycarriers have announced plans to migrate to IP and have begun to carry someportion of their voice traffic over IP networks. Despite the move by some largecarriers to develop their own international VoIP infrastructures, most carriershave demonstrated more interest in outsourcing international traffic toproviders such as iBasis. The reasons these carriers prefer to outsourceinternational traffic include:

·       therelatively low percentage of revenue and gross profit that internationalservice represents for many large carriers;

·       thedisproportionate cost and complexity of deploying and supporting internationalservice infrastructure in contrast with domestic investment opportunities;

·       ahesitation to build new networks and cannibalize traffic from their traditionalvoice networks;

·       concernsover sufficient in-house VoIP expertise to ensure that voice quality andnetwork reliability are comparable to that of the public-switchedtelephone network, especially when routing traffic over the Internet versusprivate networks; and

·       generally reduced capitalbudgets for network investments of any kind.

**Trading Business**

Our VoIP Trading business enables carriers and othercommunications service providers to outsource international voice and faxtraffic, substantially lowering their transport and service support costs,without compromising quality. Our carrier customers access The iBasis Network,our international VoIP network, directly from their own VoIP equipment anywhereor by establishing an interconnection through one of our “Internet centraloffices” or “ICOs” strategically located in major telecommunications hubs inthe U.S., Asia, and Europe. Calls are transported over the Internet andterminated at “Internet branch offices” or “IBOs” generally managed by ourterminating partners. In this way, our originating customers receive a singlepoint of interconnection to a global network of termination points without theburden of managing the international network logistics and interconnectionagreements on the far end. Likewise, our partners, who sell us terminationcapacity in their countries, receive a substantial source of traffic revenuewithout having to negotiate individual agreements and interconnections withoriginating carriers. Our services provide the following key benefits to ourcustomers:

*HighQuality Call Completion.**  *Our network, monitoring and management technologiesenable us to complete international voice and fax calls with quality comparableto that of traditional circuit-switched voice networks. This high qualityis reflected in the fact that carriers choose to provide our VoIP services totheir retail customers undifferentiated from their traditional services. Weachieve high quality over the Internet through a variety of controls andtechnologies. At our 24x7, expert-staffed global Network OperationsCenters (NOCs) in Burlington, Massachusetts, USA and Hong Kong, we are able tomonitor 

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our carrier customers’voice traffic and automatically select optimal routing choices according toreal time performance data. Using our patent-pending Assured QualityRouting® and PathEngineTM technologies, we dynamicallyroute customers’ traffic over multiple Internet routes, completing calls on ourpartners’ phone networks in destination countries.

*CostEffective Services.**  *Ourcall transport costs are lower because packet switching is more efficient thantraditional circuit-switching. Because we use the Internet, rather than aprivate IP network, to deliver international voice traffic, we have greaterinfrastructure flexibility and lower capital costs than service providers thatemploy dedicated point-to-point connections. VoIP equipment is less costly andhas lower facilities costs (due to its smaller physical footprint) thanequivalent capacity circuit-switched equipment. We offer an open,scalable architecture that enables carriers and communications serviceproviders to connect quickly and without investment or technical expertise. Anadditional advantage derives from our ability to bypass many of theinternational settlement rates associated with some international trafficcarried over circuit-switched voice networks, which produces additionalcost savings.

For financial informationregarding our Trading business segment, see Note 5, Business Segment andGeographic Information, to our Consolidated Financial Statements.

**Retail Business**

Our Retail business consists primarily of our prepaidcalling card services and Pingo, our prepaid calling service sold directly toconsumers through an Internet website. Our prepaid calling card business, whichwe launched in late 2003, leverages our global VoIP network and back-officesystems, including a sophisticated prepaid rating and billing platform**.**We sell more than 300 brands of retailprepaid calling cards through established distributors to retail outlets inmajor metropolitan markets across the U.S. Many of the calling card brands areowned (trademarked) by iBasis and feature our component branding, “QualityCalls from iBasis”, on the cards. We also enable established carriers toleverage the strength of their brands by taking advantage of our prepaidcalling card platform, production and distribution. The Oi brand calling card fromBrazilian carrier Oi is one example. We have established a dedicated operationto sell and service our prepaid retail calling card services. Typically, ourRetail business delivers higher gross margins and has a faster cash collectioncycle than our Trading business.

In September 2004, we launched Pingo®, our retail calling serviceoffered directly to consumers  andbusiness through our eCommerce web interface. Pingo customers in the UnitedStates and 35 additional countries use credit cards or alternative web-basedpayment methods, such as PayPal® to purchase calling time over The iBasisNetwork by selecting a pre-set amount. Customers are provided with toll-free orlocal access numbers, account number and personal identification number toaccess the service. Pingo’s enhanced convenience features include access toon-line call and billing history, automatic recharging to maintain a balance inthe customer’s Pingo account, and PIN*pass*TM PIN-lessdialing, which enables a customer to avoid keying in their account number andPIN when calling from any fixed or mobile phone they have registered on thePingo site. These features are designed to increase the customer’s convenienceand loyalty to the service. For financial information regarding our Retail businesssegment, see Note 5, Business Segment and Geographic Information, to ourConsolidated Financial Statements.

Our Retail services buildupon the underlying iBasis network and systems and gives us opportunities tocapture retail traffic directly from consumers, which may provide us highermargins than traffic we receive through other carriers. In offering theseservices, we can, as described in the next section, take advantage of our highquality call completion and cost effective services.

**The iBasis Network**

We transported approximately 11.1 billion minutesof traffic over the iBasis Network in 2006, a volume of traffic that positionsus among the ten largest carriers of international traffic in the world, based 

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on global trafficstatistics contained in the industry analyst publication TeleGeography 2007.  As of December 31, 2006, we had Points ofPresence—generally referred to as POPs—in 100 countries. POPs designate pointswhere The iBasis Network is directly connected to local telephone networks forcall origination or termination. In fact, we are capable of connecting to localnetworks in many more countries through our relationships with other carriers.These routes are commonly referred to as “off-net” routes and areutilized opportunistically when pricing is favorable.

The iBasis Network is based on a technologicallyadvanced switchless architecture, leveraging proven hardware from industryleaders such as Cisco Systems and NexTone, as well as patent-pendingiBasis software for quality management and advanced routing. Our AssuredQuality Routing and PathEngine technology enable ongoing monitoring of networkperformance and automatic selection of best quality routes based on nearreal-time performance data. The switchless architecture provides us withsignificant savings in operational costs and capital expense by eliminating theneed for costly telecommunications switches and other equipment andconnectivity in central offices. It also has enabled us to simplifyprovisioning, real-time route monitoring, and network management by decreasingthe number of network components involved in carrying a call. The result forour customers is higher voice quality, call completion and call duration.

In 2006 we began deploying specialized transcodingequipment that enables our network to accept traffic in a wider variety offormats associated with codecs—compression/decompression algorithms used byconsumer VoIP providers to support different devices, applications and networks.As part of our DirectVoIPTM Broadband offering, the transcoding solution giveiBasis an advantage in meeting the interoperability requirements of emergingservice providers.

The iBasis Networkconsists of four principal elements:

·       InternetCentral Offices (ICOs) and Internet Branch Offices (IBOs) that convert circuit-switchedvoice traffic into data for transmission and reception over the Internet orvice versa;

·       thetransmission medium, which is principally the public Internet;

·       AssuredQuality Routing (AQR), our proprietary traffic monitoring and routingmanagement software; and

·       ournetwork operations centers (NOCs), from which we oversee and coordinate theoperation of the ICOs and IBOs.

*InternetCentral Offices and Internet Branch Offices.**  *Our customers interconnect with ournetwork, at their cost, by connecting dedicated voice circuits from theirfacilities to one of our ICOs, which are strategically located in Frankfurt,Hong Kong, London, Los Angeles, New York, Paris, Sydney and Tokyo.Alternatively, our customers may elect to install an iBasis IBO at theirfacilities. ICOs and IBOs receive calls directly from a local carrier’sswitched network. VoIP gateways in each ICO or IBO digitize, compress andpacketize voice and fax calls and then transmit them over the Internet. At thedestination, another ICO or IBO reverses the process and the call is switchedback from the Internet to a local carrier’s circuit-switched network inthe destination country. Increasingly, customers are investing in VoIPequipment and connecting to us using an IP signal. As this trend progresses,our already asset-effective business model gains further strength, as weno longer bear all the cost of converting calls between traditional voicenetwork and the Internet and dedicated physical circuit-switchedinterconnects are eliminated altogether.

*The Internet.**  *We use the Internet to transmit thesubstantial majority of our voice and fax traffic because of its globalcoverage, low cost and flexible connectivity. As a result, we have avoided theexpense and delay of deploying and maintaining a private, dedicated network offiber and cable connections. In addition, because we do not have fixed,point-to-point connections, we can adapt to changes in 

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internationaltraffic flows rapidly and at minimal cost. We effectively address thechallenges of using the Internet for high quality, real-time voicecommunications by:

·       selectingonly high quality, service-oriented Internet service providers as ourvendors;

·       purchasingmultiple, high-speed connections into the Internet backbone; and

·       continuouslymonitoring performance across our entire network of POPs and the Internet.

*AssuredQuality Routing.**  *Wehave deployed a proprietary patent-pending system of tools—collectivelyknown as Assured Quality Routing (“AQR”) to maintain high quality service overthe Internet. AQR optimizes the quality of calls placed over The iBasis Networkby integrating quality parameters into routing decisions. These parametersinclude measures of quality that are of direct importance to carriers includingcall duration, call completion and post-dial delay as well as underlyingdeterminants of successful data transmission, namely packet loss, jitter andlatency. Utilizing data collected in near real-time by our PathEngineperformance reporting technology, AQR automatically reroutes traffic inanticipation of quality dropping below specific thresholds, sending subsequentcalls through another Internet path, to an alternative terminating IP partneror to a circuit-switched backup vendor if necessary.

*Global Network OperationsCenters.**  *Wemanage our network and implement AQR through our network operations centers (“NOCs”).iBasis NOCs use leading network management tools from Hewlett-Packard anda number of other vendors, which are integrated with our AQR systems to enableus to monitor, test and diagnose all components of The iBasis Network. NOCs inBurlington, Massachusetts and Hong Kong are staffed by network and trafficengineers to provide expert coverage 7 days a week, 24 hours a day,365 days a year, and are equipped with:

·       toolsthat support the monitoring and analysis of various components of The iBasisNetwork to identify and address potential network problems before they affectour customers’

·       systemredundancy, including power back-up; and

·       a help desk that allows usto respond quickly to our customer’s needs and concerns.

**Research andDevelopment**

Our research anddevelopment activities are primarily focused on developing, improving andexpanding The iBasis Network and increasing the efficiency of ourinterconnections with buyers and sellers of telecommunications services. Theseactivities include the development of specific tools for our networks, such asour patent-pending Assured Quality Routing and PathEngine technologies,as well as specialized interconnection technologies like our DirectVoIPBroadband service, which is designed to meet the needs of emerging providers ofconsumer VoIP services. In addition, our engineering personnel contribute tothe support and operation of our global network operations centers, which overseeand coordinate the operation of our ICO’s and IBO’s. Research and developmentexpenses were $13.5 million, $12.6 million and $14.0 million for2006, 2005 and 2004, respectively.

**Markets andCustomers**

According to Telegeography 2007 (PriMetrica, Inc.),the global market for international phone service is estimated to beapproximately a $70 billion market in which international voice minutes grew14% from 2004 to 2005. As a subset, international VoIP traffic grew 42% in thatsame period to approximately 45 billion minutes. In all but two of the 15 yearsfrom 1991 to 2005 the rate of increase in traffic volume has outstripped therate of decline in pricing, providing the opportunity for continued revenuegrowth. With the increasing migration of international traffic to VoIP and thegrowth in calls that are originating as IP through incumbent and emergingproviders, including cable operators, growth of international VoIP traffic islikely to continue and even to accelerate. This reinforces the growth opportunitiesfor us, as it is natural 

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for providers who areoriginating their traffic on IP will turn to VoIP carriers, like iBasis, toavoid unnecessary conversions to TDM to complete their international calls.

As of December 31, 2006, iBasis provided servicesto approximately 550 carriers worldwide. No one carrier accounted for 10% ormore of revenue in 2006 or 2005. One carrier accounted for more than 10% ofrevenue in 2004. For further discussion of our revenues related to significantcustomers and customers in other countries and other geographic information,refer to Notes 2 and 5 in our Notes to Consolidated Financial Statements.

In countries where we terminate our traffic, we haveestablished relationships with local service providers that have strong localmarket expertise and relationships. Some of our overseas partners are verylarge, well-established national carriers. Others are emerging competitivecarriers or Internet Service Providers (ISPs) who are able to provide theinterconnection necessary to terminate minutes for us in their country.

*Increasingly, traffic flows arebecoming reciprocal—formerly distinct customers and suppliers are becoming“trading-partners”—as deregulation and competition erode the distinctionbetween the business models of our customers and suppliers. We expect continuedgrowth in both size and profitability as this trend progresses and we furtherconsolidate our position as a leading carrier that interconnects the world’slocal service providers.*

*Deregulationand increased competition in the telecommunications industry has caused pricesfor long distance telephone service to steadily decline, particularly in theU.S. and Western Europe. As a wholesale provider of long distance telephoneservices, our margins in this business reflect the effect of these lowerprices. We attempt to offset the effect of these lower prices by negotiatinglower costs from our call termination partners and by increasing the costefficiency and utilization of our network. We have implemented a strategy toleverage retail traffic originating from both our Trading customers and our ownRetail services to drive higher margins than we might typically realize fromour Trading services. With our prepaid calling cards and Pingo, we are able tocharge per-minute rates that can exceed our wholesale long distance rates, aswell as generate revenue from fees typically associated with the use of prepaidservices. In addition, our premium product, PremiumCertified*Ô, is designed todeliver the highest level of quality, comparable to that of any retail carrier.We have more than 700 certified routes in the PremiumCertified product, andthese are generally priced higher and offer higher margin potential.PremiumCertified is marketed to all iBasis trading customers and used in thedelivery of our prepaid calling card and Pingo services.

**Sales and Marketing**

*SalesStrategy.**  *Oursales efforts for the Trading business target leading fixed line and wirelesstelecommunications carriers globally as both buyers of international minutesand sellers of termination capacity, as well as emerging providers of consumerVoIP services over broadband connections. Our sales force is composed ofexperienced personnel with well-established relationships in thetelecommunications industry, based in key markets worldwide and typicallyresponsible for business development in a small number of countries regionally.Our sales process often involves a test of our services by potentialoriginating customers in which they route traffic over our network to aparticular country. Our experience to date has been that once a carrier hasbegun to use our network for a single country and finds our quality to beacceptable, the sales process for increasing the volume of traffic they send tous and increasing the number of destinations for which they use our networkbecomes incrementally easier. We also seek to cultivate relationships withservice providers that can terminate the local leg of international calls. Ourcountry managers actively pursue connections with capable, licensed terminationpartners in their regions. Our ability to deliver a high volume of traffic, dueto our interconnections with more than 550 carriers with internationalminutes, makes us an attractive potential partner for local service providers.

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As deregulation and competition push all local serviceproviders to both originate and terminate as much traffic as possible on theirlocal networks, we believe we will increasingly enjoy “reciprocal”relationships with the providers with which we do business, further improvingsales productivity.

We have offices providing sales coverage in Europe,Africa, the Middle East, Latin America, the Asia-Pacific region, and NorthAmerica.

*MarketingStrategy.**  *Inour Trading business, we seek to attract termination partners as well ascustomers and therefore address our marketing efforts to both. A very largeportion of retail origination continues to be controlled by large incumbentretail carriers. We believe that we have largely achieved our primary marketingobjectives of awareness and acceptance among much of this customer segment, asevidenced by our penetration of these carriers in the major developed regionsof the world. We continue to reinforce our brand presence with this segment tohelp increase our share of its international traffic. We also concentrate onstate-owned carriers, known as PTTs, in Asia and in developing economiesgenerally, who we view as natural customers. In addition, we have focusedmarketing effort on raising awareness of iBasis among emerging consumer VoIPcompanies, cable operators, prepaid calling card providers, and mobileoperators, which represent signficant growth opportunities for us.

While we increasingly expect our customers to also beour termination partners, local circumstances in many countries still are suchthat we also look to partner with ISPs, new Competitive Local Exchange Carriers(CLECs) and specialist termination providers, many of which are start-upsformed specifically to terminate international traffic. Connecting withmultiple terminating providers in a given destination provides us with greatercapacity and leverage in negotiations to reduce our costs.

Our marketing activities include sponsoring,exhibiting and presenting at industry trade shows and conferences, media andindustry analyst relations,  acomprehensive website, and regular communications with our existing customerbase.

Our sales andmarketing strategy for our Retail services business differs for the disposableprepaid calling card business and the Pingo eCommerce business. For the callingcard business, we are focused on the following areas:

·       expandingthe iBasis-branded calling cards;

·       increasingour share of existing distributors’ business and cultivating new distributors;

·       expandinggross margins; and

·       enhancingquality.

In developing our own calling card brands, in additionto supporting established brands of our distributors, we are building presenceof select brands in multiple markets across multiple distributors. These brandsleverage a common rate and fee structure and are able to leverage common designand advertising, which enhances both administrative and marketing efficiencywhile building distributor and customer loyalty. To broaden our calling carddistribution we identify the leading established distributors in major urbanmarkets in the U.S. and work to establish mutually beneficial relationships.These distributors possess the local market knowledge and relationships with retailoutlets required to effectively build market presence for our calling cards.Some of our distributors operate as master distributors supporting smaller sub-distributorsthat help to broaden and reinforce their market share within variousterritories or types of outlets. We expand distribution into new ethnic andgeographic markets by leveraging existing relationships and by pursuing newdistributors as necessary. Expanding gross margins in the prepaid calling cardbusiness is a function of managing card lifecycles. Typically, new cards areintroduced with very aggressive promotional pricing to build distributor andretailer enthusiasm and consumer interest. Once the card has proven its qualityand reliability we move beyond the promotional stage into production, enablingus to realize higher margins. As we establish our presence in the calling 

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card market the overallage of our product portfolio will increase, essentially resulting in moreproduct having graduated from the promotional phase into producing highermargins.

The sales and marketingstrategy for our Pingo service leverages the cost-efficiency and trackingcapabilities of on-line paid placement advertising on major search engines,such as Google and Yahoo, as well as opportunistic online banner advertisingand editorial placement, particularly on ethnic and travel-oriented web sites,and occasional print advertising in well-targeted publications. We also drivebusiness though a web-based affiliate sales program, and promotion of freetrial cards at events and through distribution partners. In addition, weleverage search engine optimization techniques on the Pingo.com website tomaximize natural search results. We have retained a search engine marketingfirm and an online creative firm with specific expertise and proprietarytechnology designed to optimize our online advertising investments. Whenprospects visit the Pingo website, we utilize special bonus awards andpromotions to encourage initial purchase. We also maintain communicaton withour existing Pingo customers through frequent email announcements to encourageuse of the service, recharges, and referrals, as well as provide rewards fortheir loyalty.

**StrategicTechnology Relationships**

Strategic technology relationships are importantbecause they give us early access to new technologies, a voice in vendors’development direction and because strategic partners engage with us in supportof our sales and marketing programs.

Since our founding in1996, we have maintained a strong technology and business relationship withCisco Systems. The iBasis Network is a Cisco PoweredÔnetwork. This designation means that The iBasis Network is built predominantlywith Cisco products and technologies, and meets a high standard of reliabilityand performance. As a Cisco PoweredÔ network, we haveenhanced access to Cisco technical resources and are able to more quicklydeliver new capabilities and service features. We also have formedrelationships with NexTone, a leading provider of session border controllers, whichare deployed in our ICOs and provide interoperability and protocol conversioncapabilities, and with Digium, the supplier of our transcoding platform, whichis deployed as part of our DirectVoIP Broadband offering.

**Competition**

We compete in two markets: international voicetermination services, which we sell on a wholesale basis to other carriers, andretail prepaid calling services which we sell to consumers directly and throughdistributors. As described more completely in Item 1A “Risk Factors,” themarket for voice services is highly competitive. We compete with otherwholesale trading carriers worldwide. Many of these carriers have moreresources, longer operating histories and more established positions in thecommunications marketplace, and, in some cases, have begun to develop VoIPcapabilities. We also compete with smaller companies, including those that maybe specialists in just one or two routes. We compete with our own customers whohave or may develop the ability to carry traffic themselves, including retailcarriers who develop their own international networks or interconnect with oneanother and exchange international traffic by “meeting” in a major telecom hub.At present, we do not compete with cable operators, or local exchange carriers,such as the former U.S. Regional Bell Operating Companies (“RBOCs”). Also, atpresent, we do not compete with emerging retail VoIP carriers as most have notdeveloped international networks. We compete principally on quality of serviceand price. In the overall international long distance market, which wasapproximately 260 billion minutes of phone calls in 2005 based on  current information, we were among the tenlargest carriers with about 3% market share. We carried more than 17% of theprojected 45 billion minutes of international VoIP traffic in 2005.

In the retail prepaid calling card business, wecompete with major telecommunications carriers, and many smallertelecommunications providers. Many of our competitors have a longer operatinghistory and 

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a more established marketpresence in the retail prepaid calling card business than we do. Also, many ofthese competitors have greater resources. Our Pingo business competes withother on-line sellers of prepaid calling cards and services. Many ofthese operate on-line catalogs, selling the same cards that are availablein physical form in retail stores. Because we terminate our retail traffic onour own VoIP network  we believe we enjoya competitive advantage over the majority of competing calling card companiesand online retailers.

Although the market forwholesale international traffic and retail prepaid calling services is highlycompetitive and will almost certainly remain so, we believe that our brand-strength,customer base, established global distribution, sophisticated and automatedback-office systems, and our patent-pending ability to manage traffic acrossthe low-cost Internet while maintaining required quality, collectivelyrepresent a competitive advantage that will allow us to continue expanding bothvolume and margins.

**GovernmentRegulation**

As more fully described in Item 1A “Risk Factors” ourbusiness is subject to U.S. and foreign laws, which may include those relatingto telecommunications.

We are not licensed to offer traditional telecommunicationsservices in any U.S. state and we have not filed tariffs for any service at theFederal Communications Commission (“FCC”) or at any state regulatorycommission. Nonetheless, aspects of our operations may currently be, or become,subject to state or federal regulations governing licensing, universal servicefunding, advertising, disclosure of confidential communications or otherinformation, excise taxes,  U.S. embargosand other reporting or compliance requirements.

While the FCC hasmaintained that information service providers, including VoIP providers, arenot telecommunications carriers for regulatory purposes, various entities havechallenged this premise, both before the FCC and at various state governmentagencies. The FCC has ruled that certain communications carried in partutilizing the IP format, including prepaid calling card services such as thosewe provide, are regulated telecommunications services or which certainregulatory obligations, such as federal USF payments and access chargepayments, apply. The FCC is presiding over several generic proceedings relatedto VoIP services and the extent that IP capabilities insulate such offeringsfrom traditional regulation such as access charges, universal service, andinterconnection rights for VoIP providers. Adverse rulings or rulemakings couldsubject us to licensing and reporting requirements and additional fees andcharges.

The regulatory treatment of VoIP and other iBasisservices varies widely among other countries and is subject to constant change.Until recently, most countries did not have regulations addressing VoIP orother VoIP services such as calling cards, in some cases classifying theseservices as unregulated services. As the VoIP market has grown and matured,increasing numbers of regulators have begun to reconsider whether to regulateVoIP and other VoIP services. Some countries currently impose little or noregulation on VoIP or VoIP services. Conversely, other countries that prohibitor limit competition for traditional voice telephony services generally do notpermit Internet telephony or VoIP services or strictly limit the terms underwhich such services may be provided, even imposing criminal penalties forindividuals associated with such offerings. Still other countries regulate VoIPand VoIP services like traditional voice telephony services, requiring VoIPcompanies to obtain licenses, incorporate local subsidiaries, make universalservice contributions and pay other taxes.

We have advocated andsupported deregulation for free and open market competition in a variety ofcountries.

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**IntellectualProperty**

We regard our copyrights,service marks, trademarks, trade dress, trade secrets, patents, patentapplications and similar intellectual property as critical to our success andwe rely on trademark and copyright law, trade secret protection andconfidentiality and/or license agreements with our employees, customers,partners, and others to protect our proprietary rights. Our policy is to seekpatent protection of the technology, inventions and improvements that weconsider important to the development of our business. As of December 31,2006, we had several pending U.S. patent applications for The iBasis Networkand other inventions related to our business. We pursue the registration of ourtrademarks and service marks in the United States and overseas. We have beengranted trademark registration for various marks related to our business,including iBasis, Pingo, Assured Quality Routing, PremiumCertified, The lastcalling card you’ll ever need!, and several marks related to our prepaid callingcard products in the United States, and iBasis in the European community, andhave pending registration applications for other service marks. We also rely ontrade secrets, technical know-how and continuing innovation to develop andmaintain our competitive position. We have granted licenses in the ordinarycourse of business for occasional use of the company’s name, logo, trademarksand /or servicemarks to certain marketing partners pursuant to joint marketingand/or other agreements. Likewise, we have been granted certain licenses foruse in the ordinary course of business.

**Employees**

As of December 31,2006, we employed 251 people. Our employees are not represented by a laborunion.

**Geographic Areas**

For financial informationabout geographic areas, including information about revenues and long-livedassets, see Note 5, “Business Segment and Geographic Information” to ourConsolidated Financial Statements.

**Item 1A.**                RiskFactors

**RISK FACTORS**

*Any investment in our common stock involves a highdegree of risk. You should carefully consider the risks described below, whichwe believe are all the material risks related to our business, together with the information contained elsewhere inthis report, before you make a decision to invest in our company.*

**Factors That May AffectFuture Results and Financial Condition**

***Risk Related to the Restatement of Our Prior FinancialResults***

**Our Special Committee investigation, our internalreview of our historical financial statements, the restatement of ourconsolidated financial statements, investigation by the SEC, review by TheNasdaq Stock Market and related events have had, and will continue to have, amaterial adverse effect on us.**

In conjunction with the preparation and filing of our Form 10-Qfor the three months ended June 30, 2006, we performed an internal reviewof our historical option grants from January 1, 2004 through May 2006to discern any patterns relating to the timing and pricing of option grants. Thisinternal review indicated that certain stock options grants were made at arelatively low price, compared to the price of our common stock in the daysaround the date of the stock option grant. In reviewing this information, ourmanagement did not believe that there would be a potential change in themeasurement dates for these grants. On August 9, 2006, we filed our Form 10-Qfor the quarter ended June 30, 2006.

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At a meeting of our Board of Directors held on August 10,2006, the status of the internal review was discussed. Subsequent to thismeeting, our Executive Management and Board of Directors became aware, based oninformation provided to them by our former Vice President of Business Affairsand General Counsel, of email messages that he had written or receivedindicating that the date and exercise price of certain option grants may havebeen determined with hindsight.

On August 20, 2006, following review of the emailmessages and internal review, our Board of Directors formed a Special Committeeof independent directors to commence a voluntary investigation of ourhistorical stock option grants and practices. The Special Committee’sinvestigation considered evidence of all stock options grants for the period December 1999through May 2006.

On October 17, 2006, the Special Committeeconcluded that the measurement dates for determining the accounting treatmentof certain historical stock option grants differed from the measurement datesused by us in preparing our financial statements. Because the prices at theoriginally stated grant dates were, in certain cases, lower than the prices onthe actual dates of the determination, we determined we should have recognizedmaterial amounts of stock-based compensation expense which were not accountedfor in our previously issued financial statements. The Special Committee alsofound that in a number of instances the date and exercise price of optiongrants had been determined with hindsight to provide a more favorable price forsuch grants. Consequently, on October 18, 2006, our Audit Committee, inconsultation with our management concluded that our financial statements,including the reports of our independent registered public accounting firmthereon, and our earnings releases and similar communications for the 1999fiscal year and subsequent periods should no longer be relied upon.

On October 20,2006, we announced that we had received notice that the SEC was conducting aninformal inquiry concerning historical stock option grant practices todetermine whether violations of the securities laws had occurred. The SEC hasmade informal requests for the production of documents related to ourhistorical stock option grant practices. On March 29, 2007, we wereinformed that the SEC had obtained a Formal Order of Private Investigationrelating to our historical stock option grant practices. We are cooperatingfully with the investigation being conducted by the SEC. At this point we areunable to predict what, if any, consequences the SEC investigation may have onus. However, the investigation could result in considerable legal expenses,divert management’s attention from other business concerns and harm ourbusiness. If the SEC were to commence legal action, we could be required to paysignificant penalties and/or fines and could become subject to anadministrative order and/or a cease and desist order. The filing of ourrestated financial statements to correct the discovered accounting errors hasnot resolved the pending SEC investigation into our past practices with respectto equity incentives. The resolution of the SEC investigation could requirethat we take other actions not presently contemplated.

As a result of theevents described above, we have become subject to the following significantrisks, each of which is described in more detail below. Each of these riskscould have a material adverse effect on our business, financial condition andresults of operations:

·       weare subject to an ongoing investigation by the SEC, and we may become subjectto additional investigation by other governmental agencies, which has required,any may continue to require, significant management time and attention andcaused us to incur significant accounting and legal expense and which couldrequire us to pay substantial fines or other penalties;

·       weare subject to derivative civil claims made on our behalf against certain ofour current and former officers and directors, the defense of whom will requireour management to devote significant attention and to incur significant legalexpense and which litigation, if decided against them, could require us to paysubstantial judgments, settlements or other penalties pursuant to anyindemnification obligations that we may have with them;

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·       wehave incurred and our option holders have incurred tax liability which hascaused us to, and may continue to cause us to, pay penalties and interest forthe late payment of our withholding tax obligations and payments to ouraffected option holders to offset against their additional tax liabilities;

·       wehave been unable to remain current with the filing of our periodic reports withthe SEC and our efforts to become current will require substantial managementtime and attention as well as additional accounting and legal expense; and

·       as a result of therestatement and the delayed filing of our periodic reports, we may becomedelisted from The Nasdaq Stock Market and there can be no assurance that wewill be able to obtain listing of our common stock on another nationalsecurities exchange.

**We cannot predict the outcome of the SEC’s formalinvestigation of our past stock option practices. The investigation hasrequired, and may continue to require, significant management time andattention, as well as additional accounting and legal expense, and could resultin civil and/or criminal actions seeking, among other things, injunctive andmonetary relief from us.**

The SEC’s formal investigation of our past stockoption practices is ongoing. We continue to fully cooperate with the SEC andhave provided the staff with extensive documentation relating to the SpecialCommittee’s investigation and our internal review of our historical financialstatements. The SEC investigation and requests for information have requiredsignificant management attention and resources. The period of time necessary toresolve the SEC investigation is uncertain, and these matters could requiresignificant additional attention and resources which could otherwise be devotedto the operation of our business. We have incurred substantial expenses withthird parties for legal, accounting, tax and other professional services inconnection with these matters and expect to continue to incur significantexpenses in the future, which may adversely affect our results of operationsand cash flows. We will continue to cooperate with the SEC regarding thismatter, there can be no assurance that our efforts to resolve the SEC’sinvestigation will be successful and we cannot predict whether we will be ableto reach any type of resolution with the SEC.

Further, there is noassurance that other regulatory inquiries will not be commenced by other U.S.federal, state or foreign regulatory agencies and as a result, we are subject to the risk of additionallitigation and regulatory proceedings or actions in connection with the SpecialCommittee investigation and the related restatement, which would also lead tosubstantial expenses that may adversely affect our financial condition, resultsof operations or cash flows.

**Following the Special Committee investigation, twoderivative civil action lawsuits have been brought, purportedly on our behalf,which could require significant management time and attention and result insignificant legal expenses and may result in an unfavorable outcome against ourmanagement, which could require us to pay substantial judgments or settlements pursuantto any indemnification obligations that we may have with them, which could havea material adverse effect on our business, financial condition and results ofoperations.**

Following the Special Committee investigation, twoderivative civil claims were filed, purportedly on our behalf, against certainof our current and former officers and directors. See Note 12, “Commitments andContingencies” to the Notes to Consolidated Financial Statements.

The amount of time to resolve these lawsuits isunpredictable, and in defending themselves, our management’s attention may bediverted from the day-to-day operations of our business, which could adverselyaffect our business, financial condition and results of operations. Inaddition, an unfavorable outcome in such litigation could require us to incursignificant legal expenses and substantial judgments or settlements pursuant toany indemnification obligations that we may have with our officers anddirectors, 

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which could also have amaterial adverse effect on our business, financial position, results ofoperations or cash flows.

Our insurance coverage maynot be sufficient to cover our total liabilities in either of these actions ifwe are obligated to indemnify (and advance legal expenses to) former or currentdirectors or officers in accordance with the terms of our certificate ofincorporation, bylaws, other applicable agreements, and Delaware law. Wecurrently hold insurance policies for the benefit of our directors andofficers, although our insurance coverage may not be sufficient in either ofthese matters. Furthermore, the underwriters of our directors and officersinsurance policy may seek to rescind or otherwise deny coverage in some or allof these matters, in which case we may have to self-fund the indemnificationamounts owed to such directors and officers.

**We have incurred and our option holders have incurredtax liability which has caused us to, and may continue to cause us to, paypenalties and interest for the late payment of our withholding tax obligationsand payments to our affected option holders to offset against their additionaltax liabilities. In addition, we may incur significant accounting and legalexpense in connection with the implementation of a program to assist ouraffected employees.**

As a result of determining revised measurement datesfor certain of our stock options, we have recorded payroll withholding taxrelated adjustments for certain options previously classified as ISO grantsunder the Code. Such stock options were determined to have been granted with anexercise price below the fair market value of our common stock on the revisedmeasurement date. As a result, such stock options do not qualify for ISO taxtreatment. The disqualification of ISO classification and the resulting conversionto non-qualified stock option status results in withholding taxes on theexercise of such stock options. In addition, as a result of the change in themeasurement dates of certain stock option grants, certain stock options vestingsubsequent to December 2004 result in non-qualified deferred compensationfor purposes of Section 409A of the Code, and option holders are subjectto an excise tax on the value of the options in the year in which they vest.

To assist any affectedemployees who may be subject to these tax liabilities, we may decide to makepayments to them. We will also likely implement a plan to amend the terms ofcertain of our outstanding stock option grants held by our non-executiveemployees to adjust the exercise price as the fair market value of our commonstock on the legal grant date, for which we may incur significant accountingand legal expense and we may become obligated to pay a significant amount ofmoney to our non-executive employees whose stock options will have an increasedexercise price. Both our assistance with our option holders’ tax liabilitiesand our implementation of a plan to amend existing stock options could have anadverse impact on our financial position, results of operations or cash flows.

**We have been unable to remain current with the filingof our periodic reports with the SEC, and our efforts to become current mayrequire substantial management time and attention as well as additionalaccounting and legal expense.**

As a result of ourrestatement, we experienced significant delays in the filing of our periodicreports, and following the filing of this Annual Report on Form 10-Kand our quarterly report on Form 10-Q for the third quarter of 2006,we will need to file our now delinquent quarterly report on Form 10-Qfor the first quarter of 2007. The completion of these outstanding reports willrequire substantial management time and attention as well as additionalaccounting and legal expense. In addition, if we are unable to become currentwith our filings with the SEC, we may face several adverse consequences. If weare unable to become current with our filings with the SEC, investors in oursecurities will not have information regarding our business and financialcondition with which to make decisions regarding investment in our securities.In addition, we will not be able to have a registration statement under theSecurities Act of 1933, as amended, covering a public offering of securities,declared effective by the SEC, and we will not be able 

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to makeofferings pursuant to existing registration statements and pursuant to certain “privateplacement” rules of the SEC under Regulation D to any purchasers notqualifying as “accredited investors.”  Wealso will not be eligible to use a “short form” registration statement on Form S-3for a period of 12 months after the time we become current in our filings.These restrictions could adversely affect our business, financial position,results of operations and cash flows.

**Our common stock may become delisted from The NasdaqStock Market as a result of the restatement and delayed filing of our periodicreports, and if delisted, we may be unable to obtain listing of our commonstock on another national securities exchange.**

As a result of therestatement and the delayed filing of our periodic reports with the SEC, wewere unable to comply with the listing standards of The Nasdaq Stock Market. InNovember 2006, we were notified by The Nasdaq Stock Market that our commonstock was subject to delisting due to our failure to file our Quarterly Reporton Form 10-Q for the third quarter in the year ended Decmeber 31,2006 in a timely manner. We have subsequently received additional notices fromThe Nasdaq Stock Market stating that our failure to file our Annual Report on Form 10-Kfor the year ended December 31, 2006 and our Quarterly Report on Form 10-Qfor the first quarter in the year ending December 31, 2007 in a timelymanner could serve as an additional basis for the delisting of our common stockfrom The Nasdaq Stock Market. The Nasdaq Stock Market has stayed the delistingof our common stock pending further action of the Nasdaq Listing and HearingReview Council, or the Listing Council. On June 1, 2007 we submitedadditional information for the consideration of the Listing Council, includingour plans to update our SEC filings to meet the Nasdaq National Stock Marketlisting requirements and we requested the Listing Council for an extension to June 30,2007 to file our periodic reports. There can be no assurance that we will beable to maintain the listing of our common stock with The Nasdaq Stock Market,or that if delisted, that we will be able to obtain listing of our common stockon another national securities exchange. If we are not successful inmaintaining our listing or if our common stock is delisted, the price of ourcommon stock may be adversely affected.

***Risks Related to Our Business***

**Our results ofoperations may fluctuate and the market price of our common stock may fall.**

Our revenue andresults of operations have fluctuated and will continue to fluctuatesignificantly from quarter to quarter in the future due to a number of factors,some of which are not in our control, including, among others:

·       theamount of traffic we are able to sell to our customers, and their decisions onwhether to route traffic over our network;

·       increasedcompetitive pricing pressure in the international long distance market;

·       thepercentage of traffic that we are able to carry over the Internet rather thanover the more costly traditional public-switched telephone network;

·       theloss of arbitrage opportunities resulting from declines in internationalsettlement rates or tariffs;

·       ourability to negotiate lower termination fees charged by our local providers;

·       ourcontinuing ability to negotiate competitive costs to connect our network withthose of other carriers and Internet backbone providers;

·       fraudulentlysent or received traffic which is unbillable, for which we may be liable;

·       creditcard fraud in connection with our web-based prepaid offering;

·       capitalexpenditures required to expand or upgrade our network;

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·       changesin call volume among the countries to which we complete calls;

·       theportion of our total traffic that we carry over more lucrative routes coulddecline, independent of route-specific price, cost or volume changes;

·       technicaldifficulties or failures of our network systems or third party delays inexpansion or provisioning system components;

·       ourability to manage distribution arrangements and provision of retail offerings,including card printing, marketing, usage tracking, web-based offerings andcustomer service requirements, and resolution of associated disputes;

·       ourability to manage our traffic on a constant basis so that routes areprofitable;

·       ourability to collect from our customers; and

·       currencyfluctuations and restrictions in countries where we operate.

Because of these factorsand others, you should not rely on quarter-to-quarter comparisons of ourresults of operations as an indication of our future performance. It ispossible that, in future periods, our results of operations will besignificantly lower than the estimates of public market analysts, investors orour own estimates. Such a discrepancy could cause the price of our common stockto decline significantly and adversely affect our profitability.

**We may not be ableto generate sufficient revenue and gross profit that will enable us to beprofitable in the long term if telecommunications carriers and othercommunications service providers are reluctant to use our services insufficient volume.**

If the market for VoIP telephony and new services doesnot develop as we expect, or develops more slowly than expected, our business,financial condition and results of operations will be materially and adverselyaffected.

Our customers maybe reluctant to use our VoIP services for a number of reasons, including:

·       perceptionsthat the quality of voice transmitted over the Internet is low;

·       perceptionsthat VoIP is unreliable;

·       ourinability to deliver traffic over the Internet with significant costadvantages;

·       developmentof their own capacity on routes served by us;

·       anincrease in termination costs of international calls;

·       uncertaintyregarding the regulatory status of VoIP services; and

·       uncertaintyregarding potential patent infringement related to certain VoIP services.

The growth of our coreTrading business depends on carriers and other communications service providersgenerating an increased volume of international voice and fax traffic andselecting our network to carry at least some of this traffic. Similarly, thegrowth of Retail services we offer depends on these factors as well asacceptance in the market of the brands that we service, including theirrespective rates, terms and conditions. If the volume of international voiceand fax traffic and associated or other retail services do not increase or ifthey decrease and these parties or other customers do not employ our network orotherwise use our services, we may not be able to achieve profitability.

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**We may not be able to collect amounts due to us fromour customers and we may have to disgorge amounts already paid.**

Some of our customers have closed their businesses orfiled for bankruptcy while owing us significant amounts for services we haveprovided to them in the past. Despite our efforts to collect these overduefunds, we may never be paid. The bankruptcy court may require us to continue toprovide services to these companies during their reorganizations. Othercustomers may discontinue their use of our services at any time and withoutnotice, or delay payments that are owed to us. Additionally, we may havedifficulty in collecting amounts from them. Although we have internal creditrisk policies to identify companies with poor credit histories, we may noteffectively manage these policies and may provide services to companies thatrefuse to pay. The risk is even greater in foreign countries, where the legaland collection systems available may not be adequate or impartial for us toenforce the payment provisions of our contracts. Our cash reserves will bereduced and our results of operations will be materially adversely affected ifwe are unable to collect amounts from our customers.

We have received claimsincluding lawsuits from estates of bankrupt companies alleging that we receivedpreferential payments prior to such companies’ bankruptcy filing. We may berequired to return amounts received from entities that subsequently becomebankrupt. We intend to employ all available defenses in contesting such claimsor, in the alternative settle such claims. The results of any suit orsettlement may have a material adverse affect on results of operations.

**We may increasecosts and risks in our business to the extent we rely on third parties.**

*Vendors.*   Werely upon third-party vendors to provide us with the equipment, software,circuits, and other facilities that we use to provide our services. Forexample, we purchase a substantial portion of our VoIP equipment from CiscoSystems. We may be forced to try to renegotiate terms with vendors for productsor services that have become obsolete. Some vendors may be unwilling torenegotiate such contracts, which could affect our ability to continue toprovide services and consequently render us unable to generate sufficientrevenues for our business.

*Partiesthat Maintain Phone and Data Lines and Other Telecommunications Services.*   Ourbusiness model depends on the availability of the Internet and traditionaltelephone networks to transmit voice and fax calls. Third parties maintain andown these networks, other components that comprise the Internet, and businessrelationships that allow telephone calls to be terminated over the publicswitched telephone network. Some of these third parties are telephonecompanies. They may increase their charges for using these lines at any timeand thereby increase our expenses. They may also fail to maintain their linesproperly, fail to maintain the ability to terminate calls, or otherwise disruptour ability to provide service to our customers. Any such failure that leads toa material disruption of our ability to complete calls or provide otherservices could discourage our customers from using our network, which couldadversely effect our results of operations.

*LocalCommunications Service Providers.*   We maintainrelationships with local communications service providers in many countries,some of whom own the equipment that translates calls from traditional voicenetworks to the Internet, and vice versa. We rely upon these third parties bothto provide lines over which we complete calls and to increase their capacitywhen necessary as the volume of our traffic increases. There is a risk thatthese third parties may be slow, or may fail, to provide lines, which wouldaffect our ability to complete calls to certain destinations. We may not beable to continue our relationships with these local service providers onacceptable terms, if at all. Because we rely upon entering into relationshipswith local service providers to expand into additional countries, we may not beable to increase the number of countries to which we provide service. Finally,any technical difficulties that these providers suffer, or difficulties intheir relationships with companies that manage the public switched 

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telephone network, couldaffect our ability to transmit calls to the countries that those providers helpserve.

*StrategicRelationships.*   We depend in part on ourstrategic relationships to expand our distribution channels and develop andmarket our services. Strategic relationship partners may choose not to renewexisting arrangements on commercially acceptable terms, if at all. In general,if we lose these key strategic relationships, or if we fail to maintain ordevelop new relationships in the future, our ability to expand the scope andcapacity of our network and services provided, and to maintain state-of-the-arttechnology, would be materially adversely affected.

*Distributors of prepaidcalling cards to retail outlets.*   We makearrangements with distributors to market and sell prepaid calling cards toretail outlets. In some cases, we rely on these distributors to print cards,prepare marketing material, activate accounts, track usage and other data, andremit payments collected from retailers. There is a risk that distributors willnot properly perform these responsibilities, comply with legal requirements, orpay us monies when due. We may not have adequate contractual or creditprotections against these risks. There is also a risk that we will beineffective in our efforts to implement new systems, policies covering customercare, disclosure, and privacy, and certain technical and business processes.The result of any attendant difficulties may have a material impact on ourbusiness.

**We may not be able to succeed in the intenselycompetitive market for our Trading services or for Prepaid Calling Services.**

We compete in our Trading business principally onquality of service and price. In recent years, prices for long distancetelephone services have been declining as a result of deregulation andincreased competition. We face competition from major telecommunicationscarriers, including AT&T, British Telecom, Deutsche Telekom, Verizon/MCIand Qwest, as well as new emerging carriers. We also compete with Internetprotocol and other VoIP service providers who route traffic to destinationsworldwide. VoIP service providers that presently focus on retail customers mayin the future enter the wholesale market and compete with us. If we cannotoffer competitive prices and quality of service our business could bematerially adversely affected.

The market for prepaidcalling services is extremely competitive. Hundreds of providers offer callingcard products and services. We have relatively recently begun offering prepaidcalling card and related web-based services and have little prior experience inthese businesses. If we do not successfully maintain and expand ourdistribution channel and enter geographic markets in which our rates, fees,surcharges, country services, and our other products and servicecharacteristics can successfully compete, our business could be materiallyadversely affected.

**We are subject to downward pricing pressures and acontinuing need to renegotiate overseas rates.**

As a result of numerousfactors, including increased competition and global deregulation oftelecommunications services, prices for international long distance calls havebeen decreasing. This downward trend of prices to end-users has caused us tolower the prices we charge communications service providers and calling carddistributors for call completion on our network. If this downward pricingpressure continues, we may not be able to offer VoIP services at costs lowerthan, or competitive with, the traditional voice network services with which wecompete. Moreover, in order for us to lower our prices, we have to renegotiaterates with our overseas local service providers who complete calls for us. Wemay not be able to renegotiate these terms favorably enough, or fast enough, toallow us to continue to offer services in a particular country on acost-effective basis. The continued downward pressure on prices and our failureto renegotiate favorable terms in a particular country could have a materialadverse effect on our ability to operate our network and VoIP businessprofitably.

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**A variety of risks associated with our internationaloperations could materially adversely affect our business.**

Because we providemany of our services internationally, we are subject to additional risksrelated to operating in foreign countries. In particular, in order to provideservices and operate facilities in some countries, we have establishedsubsidiaries or other legal entities or may have forged relationships withservice partners or entities set up by our employees. We also rely on our ownemployees to maintain certain functions of our Internet central offices and, insome cases, to deploy and operate our smaller Points of Presence installations.Associated risks include:

·       unexpectedchanges in tariffs, trade barriers and regulatory requirements relating toInternet access or VoIP;

·       economicweakness, including inflation, or political instability in particular foreigneconomies and markets;

·       difficultyin collecting accounts receivable;

·       tax,consumer protection, telecommunications, and other laws;

·       compliancewith tax, employment, securities, immigration, labor and other laws foremployees living and traveling, or conducting business, abroad, which may subjectthem or us to criminal or civil penalties;

·       foreigntaxes including withholding of payroll taxes;

·       foreigncurrency fluctuations, which could result in increased operating expenses andreduced revenues;

·       unreliablegovernment power to protect our rights and those of our employees;

·       exposureto liability under the Foreign Corrupt Practices Act or similar laws in foreigncountries;

·       otherobligations or restrictions, including, but not limited to, criminal penaltiesagainst us or our employees incident to doing business or operating asubsidiary or other entity in another country;

·       individualcriminal exposure of our employees, some of whom have been sought by lawenforcement agencies abroad to answer for the activities of the Company;

·       thepersonal safety of our employees and their families who at times have receivedthreats of, or who may in any case be subject to, violence, and who may not beadequately protected by legal authorities or other means; and

·       inadequateinsurance coverage to address these risks.

These and other risksassociated with our international operations may materially adversely affectour ability to attain or maintain profitable operations.

**In addition to the proposed transaction with KPN, wemay undertake strategic acquisitions or dispositions, or may be the target ofsimilar strategic initiatives, that could be difficult to integrate or coulddamage our business.**

In addition to the proposed transaction with KPN, wemay acquire additional businesses and technologies that complement or augmentour existing businesses, services and technologies. We may also be subject toor participate in strategic activities by others that result in a transfer ofcontrol of our assets or control of our outstanding shares of stock. We mayneed to raise additional funds through public or private debt or equityfinancing or issue more shares to affect such activities, which may result indilution for shareholders and the incurrence of indebtedness. We may havedifficulty integrating any additional 

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businesses into ourexisting business and the process of any acquisitions or subsequent integrationcould divert management’s attention and expend our resources. We may not beable to operate acquired businesses profitably or otherwise implement ourgrowth strategy successfully.

If we are unable to effectively integrate any newbusiness into our overall business operations, our costs may increase and ourbusiness results may suffer significantly.

We may need to sellexisting assets or businesses in the future to generate cash or focus ourefforts on making our core Trading business profitable. As with many companiesin our sector that have experienced rapid growth in recent years, we may needto reach profitability in one market before entering another. In the future, wemay need to sell assets to cut costs or generate liquidity.

**If we are not able to keep up with rapid technologicalchange in a cost-effective way, the relative quality of our services couldsuffer.**

The technology upon whichour services depend is changing rapidly. Significant technological changescould render the hardware and software that we use obsolete, and competitorsmay begin to offer new services that we are unable to offer. If we are unableto respond successfully to these developments or do not respond in acost-effective way, we may not be able to offer competitive services and ourbusiness results may suffer.

**We may not be able to expand and upgrade our networkadequately and cost-effectively to accommodate any future growth.**

Our VoIP business requiresthat we handle a large number of international calls simultaneously. As weexpand our operations, we expect to handle significantly more calls. If we donot expand and upgrade our hardware and software quickly enough, we will nothave sufficient capacity to handle the increased traffic and growth in ouroperating performance would suffer as a result. Even with such expansion, wemay be unable to manage new deployments or utilize them in a cost-effectivemanner. In addition to lost growth opportunities, any such failure couldadversely affect customer confidence in The iBasis Network and could result inus losing business.

**We may not be able to maintain our routing, reporting,and billing systems and related databases adequately and cost-effectively toaccommodate our continuing needs.**

Our business requires thatwe track enormous volumes of data so that we can manage traffic, margin,revenue, and customer accounts. We constantly measure and upgrade our technicalcapabilities, and develop new tools to address our needs. If we do not maintainthese systems or modify them in an appropriate manner, or bill our customersproperly, our business will be negatively affected.

**Single points offailure on our network may make our business vulnerable.**

We operate two network operations centers as well asnumerous Internet central offices throughout the world. In some cases, we havedesigned redundant systems, provided for excess capacity, and taken otherprecautions against platform and network failures as well as facility failuresrelating to power, air conditioning, destruction, or theft. Nonetheless, someof our infrastructure and functionality, including those associated withcertain components of our Retail business, operate as a single point of failure,meaning, failures of the type described may prohibit us from offering servicesat all at any given time. The potential of such a failure may discourage othersfrom using our network, which may adversely impact our business.

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**We depend on our current personnel and may havedifficulty attracting and retaining the skilled employees we need to executeour business plan.**

Our future success willdepend, in large part, on the continued service of our key management andtechnical personnel. If any of these individuals or others we employ are unableor unwilling to continue in their present positions, our business, financialpositon,, results of operations or cash flows could suffer. We do not carry keyperson life insurance on our personnel.

**We will need toretain skilled personnel to execute our plans.**

Our future success willalso depend on our ability to attract, retain and motivate highly skilledemployees, particularly engineering and technical personnel. Past workforcereductions have resulted in reallocations of employee duties that may haveresulted in employee and contractor uncertainty and dissatisfaction. Reductionsin our workforce or restrictions on salary increases or payment of bonuses maymake it difficult to motivate and retain employees and contractors, which couldaffect our ability to deliver our services in a timely fashion and otherwisenegatively affect our business.

**We cannot ensure that our existing capital will besufficient to meet our requirements for the future and a failure to obtain necessaryadditional capital in the future could jeopardize our operations.**

We believe that we have sufficient capital to satisfy ouroperations and capital asset expenditures for at least the next twelve months,however, we may need additional capital in the future to fund our operations,finance investments in equipment and corporate infrastructure, expand ournetwork, increase the range of services we offer and respond to competitivepressures and perceived opportunities. We may not be able to obtain additionalfinancing on terms acceptable to us, if at all. If we raise additional funds byselling equity securities, the relative equity ownership of our existinginvestors could be diluted or the new investors could obtain terms morefavorable than previous investors. A failure to obtain additional funding couldprevent us from making expenditures that are needed to allow us to grow ormaintain our operations.

***RisksRelated to Regulatory Matters***

**Thetelecommunications industry is subject to domestic governmental regulation andlegal uncertainties and other laws that could materially increase our costs andprevent us from executing our business plan.**

Under FCCrules, services classified as telecommunications services are subject toregulation, whereas services classified as information or enhanced services arelargely exempt from regulation, including the requirement to pay access charges.We have taken the position that our Trading services are enhanced services thatare exempt from traditional regulation that applies to telecommunicationsservices. While the FCC has traditionally maintained that information serviceproviders, including VoIP providers, do not provide telecommunications servicesfor regulatory purposes, various entities have challenged this policy at thestate and federal levels and the FCC has begun to regulate certain aspects ofvarious types of VoIP services. For example, in 2004, the FCC concluded thatlong distance calls that begin and end as regular calls but use IP to transportsome portion of the call are telecommunications services. As indicated above,the FCC also concluded that prepaid calling cards that utilize IP-transport area telecommunications services, not an information service. Additionally, theFCC recently found that certain VoIP services that interconnect with thetraditional public telephone network must begin making Universal Service Fund,or USF, contributions, but the agency declined to determine whether thatservice is a telecommunications service or an information service.

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As a resultof these and other rulings, aspects of our operations may currently be, or maybecome, subject to state or federal regulations governing licensing, USFfunding, interstate or intrastate access charges, advertising, disclosure ofconfidential communications or other information, excise and other fees, taxesand surcharges, U.S. embargos and other reporting or compliance requirements.

In theevent of an audit from the federal Universal Service Administrator or complaintfrom a local access provider, we could be subject to arrearages for USFcontributions or access charges. Further, as regulated telecommunications, ourprepaid calling cards would be subject to additional obligations includingvarious traffic reporting obligations.

Inaddition, to the extent that our services are classified as telecommunicationsservices, state regulatory authorities may also assert jurisdiction over  any intrastate  aspect of our service potentially  subjecting us to licensing requirements andadditional fees and subsidies from the state regulatory authorities. We are notlicensed to offer traditional telecommunications services in any U.S. state andwe have not filed tariffs for any service at the FCC or at any state regulatorycommission.

Although we believe that our interstate Tradingproducts qualify as information services that are exempt from federal USFcontributions, we have, as of January 1, 2005, made such contributions onour qualifying interstate wholesale VoIP transport revenues, while reservingour rights.

We haveoffered our prepaid international calling card services on a wholesale basis tointernational carrier customers, and others, some of which provide theseservices to end-user customers, enabling them to call internationally over TheiBasis Network. We participate in selling and marketing of calling cardsthrough a network of distributors on a retail basis. We also offer a web-basedretail prepaid calling card offering. Although the calling cards are primarilyused for international calling, we have not blocked the ability of users toplace interstate and intrastate calls and we have not required our wholesalecustomers or distributors to provide evidence of their compliance with U.S. andstate regulations.

The FederalTelecommunications Act of 1996 requires that payphone service providers becompensated for all completed calls originating from payphones in the UnitedStates. When calling cards are used, the FCC’s rules require the lastswitched-based carrier to compensate payphone providers, and further requirethat all carriers in the call chain implement a call-tracking system, utilizeit to identify such calls, provide an independent audit of the adequacy of suchsystem, and provide a report on these matters to the FCC and others in the callchain, unless alternative contractual arrangements have been made. We haveindirectly paid, and intend to continue paying, payphone service providers aspart of our prepaid calling card business. We have contracted with aclearinghouse to remit funds directly to payphone service providers for callsoriginating from payphones utilizing our prepaid calling cards. For all othertypes of traffic related to our Trading business, we believe that we are notresponsible for payphone compensation, but rather that the carrier thatprecedes us bears that responsibility. In accordance therewith, for trafficrelated to our Trading business, we have in most cases sought to apportion suchresponsibility by contract.

We havealso been questioned by regulators about our offerings. Under current standardsand recent FCC decisions, the FCC and state regulatory authorities may notagree with our positions. If they do not, we could be penalized, become subjectto regulation at the federal and state level for both our Retail and Tradingservices, and could become subject to licensing and bonding requirements,federal and state fees and taxes, and other laws, all of which could materiallyaffect our business.

We are alsosubject to federal and state laws and regulations regarding consumerprotection, advertising, and disclosure regulations. These rules couldsubstantially increase the cost of doing business domestically and in anyparticular state. Law enforcement authorities may utilize their powers underconsumer protection laws against us in the event we do not meet legalrequirements in a given jurisdiction which could either increase costs orprevent us from doing business there.

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We are subject to other laws related to our businessdealings that are not specifically related to telecommunications regulation. Asan example, the Office of Foreign Asset Control of the U.S. Department of theTreasury, or OFAC, administers the United States’ sanctions against certaincountries. OFAC rules restrict many business transactions with such countriesand, in some cases, require that licenses be obtained for such transactions. Wemay currently, or in the future, transmit telephone calls between the U.S. andcountries subject to U.S. sanctions regulations and undertake othertransactions related to those services. We have undertaken such activities viaour network or through various reciprocal traffic exchange agreements to whichwe are a party. We have received licenses from OFAC to send traffic to somecountries and, if necessary, will remain in contact with OFAC with regard toother transactions. Failure to obtain proper authority could expose us to legaland criminal liability.

**Foreign government telecommunications regulation could alsoaffect our costs.**

Our Retail and Trading services are offered in foreignjurisdictions. The regulation of VoIP differs from jurisdiction tojurisdiction. We cannot be certain that we or our partners and distributors arein compliance with all of the relevant regulations and laws in each of theforeign jurisdictions in which we operate at any given point in time. As aresult, changes in regulation in foreign jurisdictions or failure to complywith applicable foreign laws and regulations can subject us to enforcementaction and penalties that could negatively affect our business and ability tocontinue to provide services in these foreign jurisdictions. In addition, innumerous countries where we operate or plan to operate, we may be subject tomany local laws and regulations that, among other things, may restrict or limitthe ability of telecommunications companies to provide telecommunicationsservices in competition with state-owned or state-sanctioned dominant carriers.

**Otherinternational governmental regulation and legal uncertainties and other lawscould limit our ability to provide our services, make them more expensive, orsubject us or our employees to legal or criminal liability.**

Manycountries currently prohibit or limit competition in the provision oftraditional voice telephony services. In some of those countries, licensedtelephony carriers as well as government regulators and law enforcementauthorities have questioned our legal authority and/or the legal authority ofour service partners or affiliated entities and employees to offer ourservices. We may face similar questions in additional countries. Our failure toqualify as a properly licensed service provider, or to comply with otherforeign laws and regulations, could materially adversely affect our business,financial condition and results of operations, including subjecting us or ouremployees to taxes and criminal or other penalties and/or by precluding usfrom, or limiting us in, enforcing contracts in such jurisdictions.

It is alsopossible that countries may apply to our activities laws relating to servicesprovided over the Internet, including laws governing:

·       sales and other taxes,including payroll-withholding applications;

·       user privacy;

·       pricing controls andtermination costs;

·       characteristics and qualityof products and services;

·       qualification to dobusiness;

·       consumer protection;

·       cross-border commerce,including laws that would impose tariffs, duties and other import restrictions;

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·       copyright, trademark andpatent infringement; and

·       claims based on the natureand content of Internet materials, including defamation, negligence and thefailure to meet necessary obligations.

If foreign governments or other bodies begin to imposerelated restrictions on our services or otherwise enforce criminal or otherlaws against us, our affiliates or our employees, such actions could have amaterial adverse effect on our operations.

***RisksRelated to Our Intellectual Property***

**If we are unable toprotect our intellectual property, our competitive position would be adverselyaffected.**

We rely on patent, trademarkand copyright law, trade secret protection and confidentiality and/or licenseagreements with our employees, customers, partners and others to protect ourintellectual property. Unauthorized third parties may copy our services orreverse engineer or obtain and use information that we regard as proprietary.End-user license provisions protecting against unauthorized use, copying,transfer and disclosure of any licensed program may be unenforceable under thelaws of certain jurisdictions and foreign countries. We may seek to patentcertain processes or equipment in the future. We do not know if any of ourpending patent applications will be issued with the scope of the claims weseek, if at all. In addition, the laws of some foreign countries do not protectproprietary rights to the same extent as do the laws of the United States. Ourmeans of protecting our proprietary rights in the United States or abroad maynot be adequate and third parties may infringe or misappropriate ourcopyrights, trademarks and similar proprietary rights. If we fail to protectour intellectual property and proprietary rights, our business, financialcondition and results of operations would suffer.

**Our services might be found to infringe the intellectualproperty rights of others.**

We believe that we do notinfringe upon the proprietary rights of any third party. Nonetheless, we havereceived claims that our products or brands, or those of our retail prepaidcalling card distributors, infringe valid patents or trademarks. Such claims,even if resolved in our favor, could be substantial, and the litigation coulddivert management efforts. It is also possible that such claims might beasserted successfully against us in the future. Our ability to provide servicesdepends on our freedom to operate. That is, we must ensure that we do notinfringe upon the proprietary rights of others or have licensed all suchrights. A party making an infringement claim could secure a substantialmonetary award or obtain injunctive relief that could effectively block ourability to provide services in the United States or abroad. In addition, the assertionof infringement claims by others against our customers, including thoseproviding consumer VoIP services, could adversely affect our business.

**We rely on a variety of technologies, primarilysoftware, which is licensed from third parties or is freely available.**

Continued use of certaintechnology by us requires that we purchase new or additional licenses fromthird parties or, in some cases, avail ourselves of “shareware” or otherwiseavailable open source code. We may not be able to obtain those third-partylicenses needed for our business or the technology and software that we do havemay not continue to be available to us on commercially reasonable terms or atall. The loss or inability to maintain or obtain upgrades to any suchtechnology or software could result in delays or breakdowns in our ability tocontinue developing and providing our services or to enhance and upgrade ourservices.

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***Risks Related to the Internet and Internet TelephonyIndustry***

**If the Internet infrastructure is not adequatelymaintained, we may be unable to maintain the quality of our services andprovide them in a timely and consistent manner.**

Our future success willdepend upon the maintenance of the Internet infrastructure, including areliable network backbone with the necessary speed, data capacity and securityfor providing reliability and timely Internet access and services. To theextent that the Internet continues to experience increased numbers of users,frequency of use or bandwidth requirements, the Internet may become congestedand be unable to support the demands placed on it and its performance orreliability may decline thereby impairing our ability to complete calls andprovide other services using the Internet at consistently high quality. TheInternet has experienced a variety of outages and other delays as a result offailures of portions of its infrastructure or otherwise. Future outages ordelays could adversely affect our ability to complete calls and provide otherservices. Moreover, critical issues concerning the commercial use of theInternet, including security, cost, ease of use and access, intellectualproperty ownership and other legal liability issues, remain unresolved andcould materially and adversely affect both the growth of Internet usagegenerally and our business in particular. Finally, important opportunities toincrease traffic on The iBasis Network will not be realized if the underlyinginfrastructure of the Internet does not continue to be expanded to morelocations worldwide.

**Network securitybreaches could adversely affect our operations.**

We currently havepractices, policies and procedures in place to ensure the integrity andsecurity of our network. Nevertheless, from time to time we have experiencedfraudulent activities whereby perpetrators have disguised themselves as ourcustomers and transmitted traffic to us, or have disguised themselves as us andtransmitted traffic to our communications service providers and other serviceproviders for termination. While we have undertaken steps to thwart such fraud,including revamping our securities procedures and capabilities and alertingother members of the industry as well as law enforcement personnel, suchactions may not be sufficient and financial exposure and reputational damagefrom fraudulent activities could materially adversely affect us.

**Undetected defectsin our technology could adversely affect our operations.**

Our technology is complexand is susceptible to errors, defects or performance problems, commonly called “bugs”.Although we regularly test our software and systems extensively, we can notensure that our testing will detect every potential bug. Any such bug couldmaterially adversely affect our business.

**Our ability to provide our services using the Internetmay be adversely affected by computer vandalism.**

If the overall performanceof the Internet is seriously downgraded by website attacks, failure of serviceattacks, or other acts of computer vandalism or virus infection, our ability todeliver our communication services over the Internet could be adverselyimpacted, which could cause us to have to increase the amount of traffic wehave to carry over alternative networks, including the more costly publicswitched telephone network. In addition, traditional business interruptioninsurance may not cover losses we could incur because of any such disruption ofthe Internet. While some insurers are beginning to offer products purporting tocover these losses, we do not have any of this insurance at this time.

***Risks Related to the Proposed Transaction with KPN***

**We may not be able to timely and successfullyintegrate KPN’s international wholesale voice business with our operations, andthus we may fail to realize all of the anticipated benefits of the proposedtransaction.**

Integration of KPN’sinternational wholesale voice business into our business will be a complex,time consuming and costly process. Failure to timely and successfully integratethese operations may have a 

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materialadverse effect on the combined company’s business, financial condition andresults of operations. The difficulties of combining these businesses willpresent challenges to the combined company’s management, including:

·       experiencingoperational interruptions or the loss of key employees, customers or suppliers;

·       operatinga significantly larger combined company with operations in geographic areas inwhich we have not previously  operated ona stand-alone basis; and

·       consolidatingcorporate and administrative functions.

The combined company willalso be exposed to other risks that are commonly associated with transactionssimilar to this proposed transaction, such as unanticipated liabilities andcosts, some of which may be material, and diversion of management’s attention. Asa result, the anticipated benefits of the merger of KPN’s internationalwholesale voice business into our Company, including anticipated synergies, maynot be fully realized, if at all.

**We may not be able to obtain approval from ourshareholders to issue shares constituting 51% of our common stock to KPN, whichis required by the Markeplace Rules of The Nasdaq Stock Market.**

Because our common stockis listed on The Nasdaq Stock Market, we are subject to the Marketplace Rules ofNasdaq. Under Rule 4350(i), the issuance of shares constituting 51% of ourcommon stock to KPN requires the approval of the holders of a majority of theshares of common stock voted on such proposal prior to their issuance to KPN. Inaddition, such approval by our shareholders of the issuance of the TransactionShares is a condition to the obligations of the parties to close the proposedtransaction. We may not be able to obtain such approval from our shareholders,and therefore, we may not be able to close the proposed transaction.

**The transactions contemplated by the Share Purchaseand Sale Agreement may not be consummated even if shareholder approval for theproposed transaction is obtained.**

The Share Ppurchase and SaleAgreement contains conditions that, if not satisfied or waived, would result inthe proposed transaction not occurring, even though our shareholders may havevoted in favor of the issuance of shares to KPN. In addition, KPN and ourCompany can agree not to consummate the transactions even if shareholderapproval has been received. The closing conditions to the proposed transactionmay not be satisfied, and any unsatisfied conditions may not be waived, whichmay cause the proposed transaction not to occur.

**While the Share Purchase and Sale Agreement is ineffect, we may be limited in our ability to pursue other attractive businessopportunities.**

Under certain circumstances, in connection with thetermination of the Share Purchase and Sale Agreement, we will be required topay KPN a termination fee of $10 million plus additional amounts forreimbursement of expenses. Such fees are intended to provide a financialincentive for us to seek to complete the proposed transaction.

We have also agreed to refrain from taking certainactions with respect to our business and financial affairs pending completionof the proposed transaction or termination of the Share Purchase and SaleAgreement. These restrictions and no-solicitation provisions contained in theShare Purchase and Sale Agreement could be in effect for an extended period oftime if completion of the proposed transaction is delayed.

In addition to theeconomic costs associated with pursuing the proposed transaction, ourmanagement is devoting substantial time and other human resources to theproposed transaction and related matters, 

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whichcould limit our ability to pursue other attractive business opportunities,including potential joint ventures, stand-alone projects and other transactions.If we are unable to pursue such other attractive business opportunities, thenour growth prospects and the long-term strategic position of our business andthe combined business could be adversely affected.

**Regulatory agencies may delay approval of the proposedtransaction, which may diminish the anticipated benefits of the proposedtransaction.**

Completion of the proposedtransaction with KPN is conditioned upon the receipt of required governmentalconsents, approvals, orders and authorizations. Although KPN and our companyintend to pursue vigorously all required governmental approvals, therequirement to receive these approvals before the consummation of the proposedtransaction could delay the completion of the proposed transaction, possiblyfor a significant period of time after our shareholders have approved theissuance of shares to KPN. Any delay in the completion of the proposedtransaction could diminish anticipated benefits of it or result in additionaltransaction costs, loss of revenue or other effects associated with uncertaintyabout the transaction. In addition, until the proposed transaction iscompleted, the attention of management may be diverted from ongoing businessconcerns and regular business responsibilities to the extent management isfocused on matters relating to the transaction, such as obtaining regulatoryapprovals.

**Following the closing of the proposed transaction withKPN, KPN will own a majority of the shares of our common stock, and we will bea controlled company within the meaning of Nasdaq Marketplace Rules.**

Following the closing of the proposed transaction withKPN, KPN will own in excess of 51% of the outstanding shares of our commonstock, which will make it difficult to complete some corporate transactionswithout KPN’s support.

In addition, because KPN will be deemed tobeneficially own, in the aggregate, more than 50.0% of our common stock, afterthe closing of the transaction, we will be a “controlled company” within themeaning of Nasdaq Marketplace Rule 4350(c)(5). As a result, the Company isexempt from Nasdaq rules that require listed companies to have (i) amajority of independent directors on the Board of Directors, (ii) acompensation committee and nominating committee composed solely of independentdirectors, (iii) the compensation of executive officers determined by amajority of independent directors or a compensation committee composed solelyof independent directors, and (iv) a majority of the independent directorsor a nominating committee composed solely of independent directors elect orrecommend director nominees for selection by the Board of Directors. Furthermore,as part of the proposed transaction, our by-laws will be amended to provide KPNcertain board representation rights and certain veto rights. As a result of thesechanges, and KPN’s majority holdings, after the Closing KPN will have theability to control the outcome of all matters submitted to our stockholders forapproval. We cannot assure you that the interests of KPN will be consistentwith the interests of other holders of our common stock, or that KPN will voteits shares of common stock, or exercise its veto rights, in a manner thatbenefits other holders of our common stock.

Finally, KPN’s ownershipof 51% of the shares of our common stock could discourage the acquisition ofour common stock by potential investors and could have an anti-takeover effect,possibly depressing the trading price of our common stock.

**KPN may sell all or a substantial portion of theshares it acquires in this potential transaction at any time in the future,which could cause the market price of our common stock to decline.**

We have not entered intoany lock-up agreement with KPN as part of the proposed transaction. As aresult, following the closing of the transaction with KPN, the sale, or thepossibility of a sale, by KPN of all or a substantial number of its shares inthe public market could cause the market price of our common 

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stock todecline. The sale of a substantial number of shares or the possibility of sucha sale also could make it more difficult for us to sell our common stock orother equity securities in the future at a time and at a price that we deemappropriate.

**Following the closing of the transaction, we will haveless available cash and our liquidity may be adversely affected.**

We will pay to our shareholders a dividend in anaggregate amount of $113,000,000 promptly following the closing of the proposedtransaction. The funds used to pay the dividend will come from cash on hand andthe proceeds of the proposed transaction. Also, under the terms of outstandingwarrants for our common stock, upon exercise of such warrants after the closingof the proposed transaction, the holders of the warrants shall be entitled toreceive payment of an amount in cash equal to the amount such holder would havereceived in connection with the dividend payment if such warrants had beenexercised immediately prior to the closing of the proposed transaction, inaddition to the number of shares of common stock issuable upon such exercise. Theseexercises could result in the Company being required to pay up to an additional$8.6 million in connection with such exercises.

Furthermore, in connection with the merger of KPN’sinternational wholesale voice business into our Company, we expect that we willassume certain short-term liabilities associated therewith which may exceed thecash and short-term assets that such business will bring.

Each of the foregoingevents will have an adverse effect on our cash reserves and could significantlycompromise our liquidity after the Closing, which could result in us having toincrease borrowings (which may not be available, or may be available only atsignificant cost), dispose of assets out of the ordinary course of business, orforego business opportunities that would otherwise be attractive.

**Provisionsof our governing documents and Delaware law could also discourage acquisitionproposals or delay a change in control.**

Our certificate of incorporation and by-laws containanti-takeover provisions, including those listed below, that could make itdifficult for a third party to acquire control of our company, even if thatchange in control would be beneficial to stockholders:

·       our Board of Directors hasthe authority to issue common stock and preferred stock, and to determine theprice, rights and preferences of any new series of preferred stock, withoutstockholder approval;

·       our Board of Directors isdivided into three classes, each serving three-year terms;

·       a supermajority of votes ofour stockholders is required to amend key provisions of our certificate ofincorporation and by-laws;

·       our bylaws containprovisions limiting who can call special meetings of stockholders;

·       our stockholders may nottake action by written consent; and

·       our stockholders mustprovide specified advance notice to nominate Directors or submit stockholderproposals.

Inaddition, provisions of Delaware law and our Amended and Restated 1997 StockIncentive Plan may discourage, delay or prevent a change of control of ourcompany or an unsolicited acquisition proposal.

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***SPECIAL NOTE REGARDING FORWARD-LOOKINGSTATEMENTS***

This Form 10-K and, in particular, thedescription of our Business set forth in Item 1, the Risk Factors set forth inthis Item 1A and our Management’s Discussion and Analysis of FinancialCondition and Results of Operations set forth in Item 7 contain or incorporatea number of forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, including statements regarding:

·       expectations regarding ourability to expand our market share in our Trading business;

·       our expectations regardingthe number of customers that will use our Trading and Retail services;

·       our expectations regardingthe future market demand for our Trading and Retail services;

·       the size of our market;

·       our business strategy;

·       the focus of our marketingefforts;

·       the establishment,development and maintenance of relationships with strategic partners;

·       our estimates regarding obligationsassociated with our leased facilities; and

·       our liquidity.

Any or allof our forward-looking statements in this Form 10-K may turn out tobe wrong. They can be affected by inaccurate assumptions we might make or byknown or unknown risks and uncertainties. Many factors mentioned in ourdiscussion in this Form 10-K will be important in determining futureresults. Consequently, no forward-looking statement can be guaranteed. Actualfuture results may vary materially.

We alsoprovide a cautionary discussion of risks and uncertainties under “Risk Factors”in Item 1A. These are factors that we think could cause our actual results todiffer materially from expected results. Other factors besides those listedthere could also adversely affect us.

Without limiting the foregoing, the words “believes,” “anticipates,”“plans,” “expects” and similar expressions are intended to identifyforward-looking statements. There are a number of factors that could causeactual events or results to differ materially from those indicated by suchforward-looking statements, many of which are beyond our control, including theRisk Factors set forth under Item 1A. In addition, the forward-lookingstatements contained herein represent our estimate only as of the date of thisfiling and should not be relied upon as representing our estimate as of anysubsequent date. While we may elect to update these forward-looking statementsat some point in the future, we specifically disclaim any obligation to do soto reflect actual results, changes in assumptions or changes in other factorsaffecting such forward-looking statements.

**Item 1B.**               Unresolved Staff Comments.

Not applicable.

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**Item 2.**                        Properties

We lease the followingfacilities:

| Location        | ** ** | ** ** | ** ** | **Square Footage** | ** ** | **Expiration of Lease**                           | ** ** | **Facility Use** |
|-----------------|------------|------------|------------|--------------------|------------|---------------------------------------------------|------------|------------------|
| Burlington, MA  |       | 44,265     |       | April 2010    |       | Headquarters and global network operations center |
| New York, NY    |       | 4,372      |       | Various, 2009-2018 |       | Internet central office                           |
| Miami, FL       |       | 10,500     |       | February 2010 |       | Partially sub-leased, partially vacant            |
| Los Angeles, CA |       | 3,156      |       | April 2008    |       | Internet central office                           |

 

In addition to thefacilities listed above, we have obtained collocation space in specialfacilities around the world that are dedicated to housing equipment of multiplecompetitive telephony carriers. We lease these smaller spaces to house Internetrouting and related equipment. We lease collocation space in Frankfurt, HongKong, London, Paris, Sydney and Tokyo. We also rent smaller office space inLondon, Beijing, Buenos Aires, Dubai and Hong Kong. We believe that ourexisting facilities are adequate for our current needs and that suitableadditional or alternative space will be available in the future on commerciallyreasonable terms.

**Item3.**                        LegalProceedings

In addition to litigation thatwe have initiated or responded to in the ordinary course of business, we arecurrently party to the following potentially material legal proceedings:

*Class Action Pursuant to 1999 Initial PublicOffering*

In 2001, we were servedwith several class action complaints that were filed in the United StatesDistrict Court for the Southern District of New York against us and several ofour officers, directors, and former officers and directors, as well as againstthe investment banking firms that underwrote our November 10, 1999 initialpublic offering of common stock and our March 9, 2000 secondary offeringof common stock. The complaints were filed on behalf of a class of persons whopurchased our common stock between November 10, 1999 and December 6,2000.

The complaints are similarto each other and to hundreds of other complaints filed against other issuersand their underwriters, and allege violations of the Securities Act of 1933 andthe Securities Exchange Act of 1934 primarily based on the assertion that therewas undisclosed compensation received by our underwriters in connection withour public offerings and that there were understandings with customers to makepurchases in the aftermarket. In September, 2001, the complaints wereconsolidated and allege that our prospectuses failed to disclose thesearrangements. The consolidated complaint seeks an unspecified amount ofmonetary damages and other relief.  In October 2002,the individual defendants were dismissed from the litigation by stipulation andwithout prejudice and subject to an agreement to toll the running of time-baseddefenses. In February 2003, the district court denied our motion todismiss.

In June, 2004, we and theindividual defendants, as well as many other issuers named as defendants in theclass action proceeding, entered into an agreement-in-principle to settle thismatter, and this settlement was presented to the court. The district courtgranted a preliminary approval of the settlement in February 2005, subjectto certain modifications to the proposed bar order, to which plaintiffs andissuers agreed. In August 2005, the district court issued a preliminaryorder further approving the modifications to the settlement, certifying thesettlement classes and scheduled a fairness hearing, after notice to the class. The fairness hearing was held on April 24,2006 and the motion for approval of the settlement is pending. Plaintiffs havecontinued to pursue their claims against the underwriters. The district courthas established a procedure whereby six “focus” cases are being pursuedinitially and has certified a class of purchasers in those cases. Theunderwriters appealed the certification order and in December 2006, theUnited States 

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Court ofAppeals for the Second Circuit reversed the certification order. Since thepending settlement with the issuers involves parallel classes to those in thesix focus cases, it is not expected that the district court will act favorablyon the issuer settlement in its current form.

We anticipate additional settlementnegotiations will occur, but there can be no assurance that those negotiationswill result in a revised settlement. We believe that if this matter is notsettled, we have meritorious defenses and intend to defend vigorously. 

We cannot estimate potentiallosses, if any, from these matters or whether, in light of the Company’sinsurance coverage, any loss would be material to the Company’s financialcondition, results of operations or cash flows. As such, no amounts have beenaccrued as of December 31, 2006.

***Actions Pursuant to OptionInvestigation***

On December 21, 2006, two derivative actions naming usas a nominal defendant were filed in the United States District Court for theDistrict of Massachusetts: *David Shutvet,Derivatively on Behalf of iBasis, Inc., v. Ofer Gneezy et al.,*U.S.D.C. Civil Action No. 06-12276-DPW; and *Victor Malozi, Derivatively on Behalf of iBasis, Inc., v. OferGneezy et al.,* U.S.D.C. Civil Action No. 06-12277-DPW.The complaints in these two actions each name the same defendants:   Ofer Gneezy, our President, Chief ExecutiveOfficer and Director; Gordon J. VanderBrug, our Executive Vice President,Assistant Secretary and Director; Richard G. Tennant, our Senior Vice Presidentof Finance and Administration and Chief Financial Officer; Paul H. Floyd, ourSenior Vice President of R&D, Engineering and Operations; Charles Corfield,Charles M. Skibo, W. Frank King, David Lee, and Robert H. Brumley, ourDirectors; Daniel Price, our former Senior Vice President of Speech Solutionsand our former Director; John G. Henson, Jr., our former Vice President,Engineering and Operations; Michael J. Hughes, our former Chief FinancialOfficer and former Vice President of Finance and Administration;  Charles Giambalvo, our former Senior VicePresident of Worldwide Sales; Jonathan D. Draluck, our former Vice President,Business Affairs, and former General Counsel and former Secretary; and JohnJarve, Charles Houser, and Carl Redfield, our former Directors.  The complaints allege that the defendantscaused or allowed our “insiders” to backdate their stock option grants, andcaused or allowed us (i) to file materially false and misleading financialstatements that materially understated our compensation expenses and materiallyoverstated our quarterly and annual net income and earnings per share, and (ii) tomake disclosures in its periodic filings and proxy statements that falselyportrayed our options as having been granted at exercise prices equal to thefair market value of our common stock on the date of the grant. The complaintsalso allege that certain defendants engaged in illegal insider selling of ourcommon stock while in possession of undisclosed material adverse information. Basedon these and other allegations, the complaints assert claims for:  violation of Section 14(a) of theExchange Act; disgorgement under the Sarbanes-Oxley Act of 2002; unjustenrichment; breach of fiduciary duty for approving improperly dated stockoption grants to our executive officers; breach of fiduciary duties for insiderselling and misappropriation of information; abuse of control; grossmismanagement; waste of corporate assets; an accounting; rescission of certainstock option contracts; and constructive trust. The complaints seek thefollowing relief:  damages in favor of usfor the individual defendants’ alleged wrongdoing; disgorgement of all bonusesor other incentive-based or equity-based compensation received by Mr. Gneezyand Mr. Tennant  during any periodfor which we restate our financial results; a declaration that the directordefendants caused us to violate Section 14(a) of the Exchange Act;certain corporate governance reforms; an accounting of all undisclosedbackdated stock option grants, cancellation of all unexercised grants, and revisionof our financial statements; disgorgement of all profits obtained by thedefendants from the allegedly backdated stock option grants and relatedequitable relief; and an award to the plaintiffs of their costs anddisbursements for the action, including reasonable attorney’s fees andaccountants’ and experts’ fees, costs and expenses.

On May 10, 2007, the United States District Court forthe District of Massachusetts entered orders consolidating the above derivativeactions under Civil Action No. 06-12276-DPW and requiring theplaintiffs to file a consolidated complaint by June 15, 2007. Our responseto the consolidated complaint is 

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due on August 3, 2007. Basedon the allegations in the complaints presently on file, we anticipate that wewill file a motion to dismiss the consolidated complaint at that time.

We announced on October 20, 2006that we were contacted by the SEC as part of an informal inquiry and we furtherdisclosed on March 29, 2007, on Form 8-K, that the SEC hadnotified us that we would be receiving a formal order of investigation relatingto our stock option practices*.* On April 13,2007, we received the formal order of investigation. The SEC investigationseeks documents and information from us relating to the grant of our optionsfrom 1999 to the present. We expect that the SEC will seek the testimony ofindividuals including certain of our executive officers.  We are cooperating fully with the SECinvestigation that is ongoing. There is no assurance that other regulatoryinquiries will not be commenced by other U.S. federal, state or otherregulatory agencies.

We cannot estimate the amount of losses, if any from thesematters or whether any loss would be material to our financial condition,results of operations or cash flows. As such, no amounts have been accrued asof December 31, 2006.

*RegulatoryProceedings*

On June 30, 2006, the Federal CommunicationsCommission (“FCC”) issued an order requiring providers of prepaid calling cardsthat utilize IP to contribute to the Universal Service Fund (“USF”) and payaccess charges and other regulatory fees both in the future and for some priorperiod of time. In connection with our Retail business, we plan to absorb orpass along such future fees, to the extent permitted by law, which, based oncurrent traffic mix, equal approximately 1.8% of revenue. We have filed anappeal of the retroactive aspect of the FCC Order with the United States Courtof Appeals in Washington, D.C. In October 2006, we filed a motion to staythat aspect of the FCC Order pending the outcome of the appeal. On November 1,2006, the Court deferred ruling on the stay request pending the FCC’s ruling ona similar stay motion pending before the agency. The agency denied the stayrequest on March 29, 2007.  As of December 31,2006, we estimate that the maximum potential retroactive USF charge relating toour Retail business prior to the third quarter of the year ended December 31,2006 would be approximately $2.6 million. As the amount of retroactive fees arenot probable of being incurred, no amounts have been accrued as ofDecember 31, 2006.

We are also party to suitsfor collection, related commercial disputes, claims by former employees, claimsrelated to certain taxes, claims from carriers and foreign service partnersover reconciliation of payments for circuits, Internet bandwidth and/or accessto the public switched telephone network, and claims from estates of bankruptcompanies alleging that we received preferential payments from such companiesprior to their bankruptcy filings. Our employees have also been named inproceedings arising out of business activities in foreign countries. We intendto prosecute vigorously claims that we have brought and employ all availabledefenses in contesting claims against us, or our employees. Nevertheless, indeciding whether to pursue settlement, we will consider, among other factors,the substantial costs and the diversion of management’s attention and resourcesthat would be required in litigation. In light of such costs, we have settledvarious and in some cases similar matters on what we believe have beenfavorable terms which did not have a material impact our financial position,results of operations, or cash flows. The results or failure of any suit mayhave a material adverse affect on our business.

We cannot estimate the amountof losses, if any, from these matters, or whether any loss would be material toour financial condition, results or operations or cash flows. As such, noamounts have been accrued as of December 31, 2006.

**Item 4.**                        Submission of Matters to aVote of Security Holders

No matters were submitted to a vote of security holdersduring the fourth quarter of the year ended December 31, 2006.

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**PART II**

**Item5.****                        *Market for the Registrant’s Common Equity, Related Stockholder Mattersand Issuer Purchases of Securities***

*Market Information*

Our commonstock began trading publicly on The Nasdaq Global Market on November 10,1999 and was traded under the symbol “IBAS.” After we had failed to meetcertain minimum listng requirements for The Nasdaq Stock Market, our commonstock traded on the Nasdaq operated Over-the-Counter Bulletin Board from November 14,2002 until June 20, 2006, under the stock symbol “IBAS”. On June 21,2006, our common stock resumed trading on The Nasdaq Global Market under thestock symbol “IBAS”, after we met the requirements for relisting. In November 2006,we were notified by The Nasdaq Stock Market that our common stock was subject todelisting from The Nasdaq Global Market due to our failure to file ourQuarterly Report on Form 10-Q for the third quarter in the yearended Decmeber 31, 2006 in a timely manner. We have subsequently receivedadditional notices from The Nasdaq Stock Market stating that our failure tofile our Annual Report on Form 10-K for the year ended December 31,2006 and our Quarterly Report on Form 10-Q for the first quarter forthe year ending December 31, 2007 in a timely manner could serve as anadditional basis for the delisting of our common stock from The Nasdaq GlobalMarket. The Nasdaq Stock Market has stayed the delisting of our common stockpending further action of the Nasdaq Listing and Hearing Review Council (“ListingCouncil”). On June 1, 2007 we submited additional information for theconsideration of the Listing Council, including our plans to upate our SECfilings to meet The Nasdaq National Stock Market listing requirements and werequesed the Listing Council for an extension until June 30, 2007 to fileour periodic reports. There can be no assurance that the listing of our commonstock on The Nasdaq Global Market will be maintained.

Thefollowing table shows the range of the high and low closing per share prices ofour common stock, as reported by Nasdaq Global Market, since June 21,2006, and by the Over-the-Counter Bulletin Board for the periods prior to June 21,2006. Over-the-Counter market quotations reflect interdealer prices, withoutretail mark-up, mark-down or commission and may not necessarily reflect actualtransactions.

| ** **        | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------|------------|----------|------------|---------|------------|
| **Fiscal 2006:**  |       |     |       |    |       |
| Fourth Quarter    |       | $        | 8.62       |    | $          | 7.78 |   |
| Third Quarter     |       | 8.90     |       | 7.74    |       |
| Second Quarter    |       | 8.80     |       | 6.66    |       |
| First Quarter     |       | 6.84     |       | 5.34    |       |
| **Fiscal  2005:** |       |     |       |    |       |
| Fourth Quarter    |       | $        | 8.25       |    | $          | 5.27 |   |
| Third Quarter     |       | 10.26    |       | 7.20    |       |
| Second Quarter    |       | 8.16     |       | 6.24    |       |
| First Quarter     |       | 7.44     |       | 5.85    |       |

 

*Stockholders*

As of May 31, 2007,we had 203 stockholders of record. This does not reflect persons or entitieswho hold their stock in nominee or “street” name through various brokeragefirms.

*Reverse Stock Split*

On May 2, 2006, aftershareholder approval, we effected a one-for-three reverse stock split of ourissued and outstanding shares of common stock. All share and per share amountsfor all periods presented have been adjusted to reflect the reverse stocksplit.

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*Dividends*

We have never declared or paid cash dividends on ourcommon stock.

As soon as practicablefollowing the closing of the proposed transaction with KPN, we will pay to ourshareholders of record as of the close of business on the day immediatelypreceding the closing, a dividend in an aggregate amount of $113 million. Thefunds used to pay the dividend will come from cash on hand and the proceeds ofthe proposed transaction. Also, under the terms of outstanding warrants for ourcommon stock, upon exercise of such warrants after the closing of the proposedtransaction, the holders of the warrants shall be entitled to receive paymentof an amount in cash equal to the amount such holder would have received inconnection with the dividend payment if such warrants had been exercisedimmediately prior to the closing of the proposed transaction, in addition tothe number of shares of common stock issuable upon such exercise.

*Issuer Purchases ofEquity Securities*

During the year ended December 31, 2006, wepurchased anaggregate of 377,101 of our common stock under a $5 million stockrepurchase program publicly announced in October 2005.

In February 2006, weannounced a $10 million increase in our stock repurchase program. We have madeno further repurchases of our common stock under our stock repurchase programsince March 2006 and we have no plans to make any further repurchasesunder this program.

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**Performance Graph**

The following graph compares theannual percentage change in our cumulative total stockholder return on ourcommon stock during a period commencing on December 31, 2001 and ending onDecember 31, 2006 (as measured by dividing (i) the sum of (A) thecumulative amount of dividends for the measurement period, assuming dividendreinvestment, and (B) the difference between our share price at the endand the beginning of the measurement period; by (ii) our share price atthe beginning of the measurement period) with the cumulative total return ofthe Nasdaq Composite Index and the Nasdaq Telecommunications Index during suchperiod. We have not paid any dividends on our common stock, and we do notinclude dividends in the representation of our performance. The stock priceperformance on the graph below does not necessarily indicate future priceperformance. The following graph shall not be deemed to be filed with the SECunder the Securities Act of 1933, as amended, or the Securities and ExchangeAct of 1934, as amended, or incorporated by reference in any document so filed.

**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN***Among iBasis Inc., The NASDAQ Composite IndexAnd The NASDAQ Telecommuncations Index

*$100 invested on 12/31/01 in stockor index-including reinvestment of dividends.

Fiscalyear ending December 31.

| ** **                    | ** ** | **12/01**  | ** ** | **12/02** | ** ** | **12/03**  | ** ** | **12/04**  | ** ** | **12/05**  | ** ** | **12/06**  | ** ** |
|-------------------------------|------------|------------|------------|-----------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **iBasis, Inc.**         | ** ** | **100.00** | ** ** | **25.19** | ** ** | **121.37** | ** ** | **187.79** | ** ** | **139.69** | ** ** | **216.28** | ** ** |
| **NASDAQ  Composite**         | ** ** | **100.00** | ** ** | **69.53** | ** ** | **104.28** | ** ** | **114.68** | ** ** | **118.32** | ** ** | **131.85** | ** ** |
| **NASDAQ Telecommunications** | ** ** | **100.00** | ** ** | **56.94** | ** ** | **107.05** | ** ** | **114.25** | ** ** | **110.17** | ** ** | **142.20** | ** ** |

 

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**Item 6.**                        *Selected Financial Data*

Thefollowing selected consolidated financial data with respect to our company foreach of the five years in the period ended December 31, 2006 has beenrestated and is derived from our consolidated financial statements, whichfinancial statements as of December 31, 2006 and 2005 and for the yearsended December 31, 2006, 2005 and 2004 have been audited by Deloitte &Touche LLP, independent registered public accountants. Such consolidatedfinancial statements and the report thereon are included elsewhere in thisreport. The information below should be read in conjunction with theconsolidated financial statements and notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andother financial data included elsewhere in this report. Our historical resultsof operations are not necessarily indicative of results of operations to beexpected for any future period.

See Note 3, “Restatement of Consolidated FinancialStatements,” of the Notes to Consolidated Financial Statements for moredetailed information regarding the restatement of our consolidated financialstatements.

DuringJuly 2002, we sold our Speech Solutions Business. Accordingly, theConsolidated Statements of Operations have been reclassified to present theresults of the Speech Solutions Business separately from continuing operationsas discontinued operations.
|                                                                                       | ** ** | **Year Ended December 31,**   | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                            | ** ** | ** **                                   | ** ** | **(as  restated)  (1)** | ** ** | **(as  restated)  (1)** | ** ** | **(as  previously  reported)** | ** ** | **(adjustments)** | ** ** | **(as  restated)  (2)** | ** ** | **(as  previously  reported)** | ** ** | **(adjustments)** | ** ** | **(as  restated)  (2)** | ** ** |
| ** **                                                                            | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **(unaudited)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(unaudited)** | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of Operations  Data:**                                      |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenue                                                                           |       | $ 511,083                               |       |   | $ 385,485 |   |   |   | $ 263,678 |   |   |   | $ 178,159 |   |   |   | $       — |   |   |   | $ 178,159 |   |   |   | $ 164,942 |   |   |   | $       — |   |   | $ 164,942 |   |
| Costs and operating  expenses:                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Data communications and telecommunications (excluding  depreciation and amortization) |       | 447,697                                      |       |   | 336,152 |   |   |   | 225,169 |   |   |   | 152,853 |   |   |   | 187 |   |   |   | 153,040 |   |   |   | 142,847 |   |   |   | (219 | ) |   | 142,628 |   |
| Research and development                                                              |       | 13,498                                       |       |   | 12,568 |   |   |   | 14,013 |   |   |   | 13,387 |   |   |   | 395 |   |   |   | 13,782 |   |   |   | 17,781 |   |   |   | 1,777 |   |   | 19,558 |   |
| Selling and marketing                                                                 |       | 16,347                                       |       |   | 11,712 |   |   |   | 9,351 |   |   |   | 7,513 |   |   |   | 494 |   |   |   | 8,007 |   |   |   | 11,279 |   |   |   | 1,220 |   |   | 12,499 |   |
| General and administrative                                                            |       | 25,062                                       |       |   | 15,543 |   |   |   | 13,162 |   |   |   | 8,174 |   |   |   | 50 |   |   |   | 8,224 |   |   |   | 24,387 |   |   |   | 1,514 |   |   | 25,901 |   |
| Depreciation and amortization                                                         |       | 7,055                                        |       |   | 6,507 |   |   |   | 10,437 |   |   |   | 20,065 |   |   |   | 356 |   |   |   | 20,421 |   |   |   | 31,871 |   |   |   | 33 |   |   | 31,904 |   |
| Write-off of leasehold improvements                                                   |       | 1,047                                        |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Restructuring costs                                                                   |       | 1,272                                        |       |   | 218 |   |   |   | 165 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,536 |   |   |   | — |   |   | 5,536 |   |
| Merger related expenses                                                               |       | 2,996                                        |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Non-cash stock-based compensation(3)                                                  |       | —                                       |       |   | — |   |   |   | — |   |   |   | 86 |   |   |   | (86 | ) |   |   | — |   |   |   | 967 |   |   |   | (967 | ) |   | — |   |
| Loss on sale of messaging business                                                    |       | —                                       |       |   | — |   |   |   | — |   |   |   | — |   |   |   |   |   |   |   |   |   |   |   | 2,066 |   |   |   |   |   |   | 2,066 |   |
| Total costs and operating expenses                                                    |       | 514,974                                      |       |   | 382,700 |   |   |   | 272,297 |   |   |   | 202,078 |   |   |   | 1,396 |   |   |   | 203,474 |   |   |   | 236,734 |   |   |   | 3,358 |   |   | 240,092 |   |
| Income (loss) from operations                                                         |       | (3,891                                       | )          |   | 2,785 |   |   |   | (8,619 | ) |   |   | (23,919 | ) |   |   | (1,396 | ) |   |   | (25,315 | ) |   |   | (71,792 | ) |   |   | (3,358 | ) |   | (75,150 | ) |
| Interest income                                                                       |       | 1,887                                        |       |   | 1,109 |   |   |   | 218 |   |   |   | 161 |   |   |   |   |   |   |   | 161 |   |   |   | 1,290 |   |   |   |   |   |   | 1,290 |   |
| Interest expense                                                                      |       | (337                                         | )          |   | (2,601 | ) |   |   | (4,249 | ) |   |   | (3,967 | ) |   |   |   |   |   |   | (3,967 | ) |   |   | (11,608 | ) |   |   |   |   |   | (11,608 | ) |
| Gain on bond repurchases and exchanges                                                |       | —                                       |       |   | — |   |   |   | — |   |   |   | 16,615 |   |   |   |   |   |   |   | 16,615 |   |   |   | 25,790 |   |   |   |   |   |   | 25,790 |   |
| Other expense, net                                                                    |       | (188                                         | )          |   | (324 | ) |   |   | (184 | ) |   |   | (180 | ) |   |   |   |   |   |   | (180 | ) |   |   | (330 | ) |   |   |   |   |   | (330 | ) |
| Loss on long-term non-marketable security                                             |       | —                                       |       |   | — |   |   |   | (5,000 | ) |   |   | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   | — |   |
| Foreign exchange (loss) gain                                                          |       | 372                                          |       |   | (939 | ) |   |   | 339 |   |   |   | 509 |   |   |   |   |   |   |   | 509 |   |   |   | 201 |   |   |   |   |   |   | 201 |   |
| Debt conversion premium and transaction costs                                         |       | —                                       |       |   | (1,975 | ) |   |   | — |   |   |   | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   | — |   |
| Debt  refinancing charges:                                                            |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Transaction costs                                                                     |       | —                                       |       |   | — |   |   |   | (2,159 | ) |   |   | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   | — |   |
| Additional interest expense, net                                                      |       | —                                       |       |   | — |   |   |   | (481 | ) |   |   | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   | — |   |
| Loss before taxes from continuing operations                                          |       | (2,157                                       | )          |   | (1,945 | ) |   |   | (20,135 | ) |   |   | (10,781 | ) |   |   | (1,396 | ) |   |   | (12,177 | ) |   |   | (56,449 | ) |   |   | (3,358 | ) |   | (59,807 | ) |
| Income tax expense                                                                    |       | (37                                          | )          |   | (93 | ) |   |   | (50 | ) |   |   | (157 | ) |   |   |   |   |   |   | (157 | ) |   |   | (52 | ) |   |   |   |   |   | (52 | ) |
| Loss from continuing operations                                                       |       | (2,194                                       | )          |   | (2,038 | ) |   |   | (20,185 | ) |   |   | (10,938 | ) |   |   | (1,396 | ) |   |   | (12,334 | ) |   |   | (56,501 | ) |   |   | (3,358 | ) |   | (59,859 | ) |
| Income (loss) from discontinued operations                                            |       | —                                       |       |   | — |   |   |   | 1,861 |   |   |   | 1,251 |   |   |   |   |   |   |   | 1,251 |   |   |   | (65,222 | ) |   |   |   |   |   | (65,222 | ) |
| Net loss                                                                              |       | $  (2,194                          | )          |   | $  (2,038 | ) |   |   | $ (18,324 | ) |   |   | $  (9,687 | ) |   |   | $ (1,396 | ) |   |   | $ (11,083 | ) |   |   | $ (121,723 | ) |   |   | $ (3,358 | ) |   | $ (125,081 | ) |
| Basic and diluted net  loss per share:                                                |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from continuing operations                                                       |       | $     (0.07         | )          |   | $     (0.08 | ) |   |   | $     (1.20 | ) |   |   | $     (0.73 | ) |   |   | $  (0.10 | ) |   |   | $     (0.83 | ) |   |   | $       (3.75 | ) |   |   | $  (0.23 | ) |   | $       (3.98 | ) |
| Income (loss) from discontinued operations                                            |       | —                                       |       |   | — |   |   |   | 0.11 |   |   |   | 0.08 |   |   |   |   |   |   |   | 0.08 |   |   |   | (4.33 | ) |   |   | — |   |   | (4.33 | ) |
| Basic and diluted net loss per share                                                  |       | $     (0.07         | )          |   | $     (0.08 | ) |   |   | $     (1.09 | ) |   |   | $     (0.65 | ) |   |   | $  (0.10 | ) |   |   | $     (0.75 | ) |   |   | $       (8.08 | ) |   |   | $  (0.23 | ) |   | $       (8.31 | ) |
| Basic and diluted  weighted average common shares outstanding                         |       | 33,198                                       |       |   | 26,745 |   |   |   | 16,838 |   |   |   | 14,899 |   |   |   |   |   |   |   | 14,899 |   |   |   | 15,055 |   |   |   |   |   |   | 15,055 |   |

 

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|                                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                       | ** ** | **(In thousands)**                    | ** ** |
| ** **                                                                       | ** ** | ** **                                 | ** ** | **(as  restated)  (1)** | ** ** | **(as  previously  reported)** | ** ** | **(adjustment)** | ** ** | **(as  restated)  (2)** | ** ** | **(as  previously  reported)** | ** ** | **(adjustment)** | ** ** | **(as  restated)  (2)** | ** ** | **(as  previously  reported)** | ** ** | **(adjustment)** | ** ** | **(as  restated)  (2)** | ** ** |
| **Consolidated Balance Sheet  Data:**                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents, restricted cash and  short-term marketable securities |       | $ 54,071                              |       |   | $ 44,414 |   |   |   | $ 38,825 |   |   |   | $    — |   |   |   | $ 38,825 |   |   |   | $ 17,270 |   |   |   | $        — |   |   |   | $ 17,270 |   |   |   | $ 32,317 |   |   |   | $        — |   |   |   | $ 32,317 |   |   |
| Working capital                                                                  |       | 25,285                                     |       |   | 30,795 |   |   |   | 30,774 |   |   |   | (544 | ) |   |   | 30,230 |   |   |   | 3,264 |   |   |   | (350 | ) |   |   | 2,914 |   |   |   | 21,906 |   |   |   | (122 | ) |   |   | 21,784 |   |   |
| Total assets                                                                     |       | 137,664                                    |       |   | 106,151 |   |   |   | 87,776 |   |   |   | (466 | ) |   |   | 87,310 |   |   |   | 67,538 |   |   |   | (223 | ) |   |   | 67,315 |   |   |   | 98,524 |   |   |   | 134 |   |   |   | 98,658 |   |   |
| Long-term debt, net of current portion                                           |       | 755                                        |       |   | 2,216 |   |   |   | 65,933 |   |   |   |   |   |   |   | 65,933 |   |   |   | 65,829 |   |   |   |   |   |   |   | 65,829 |   |   |   | 93,590 |   |   |   |   |   |   |   | 93,590 |   |   |
| Stockholders’  equity (deficit)                                             |       | 37,381                                     |       |   | 39,403 |   |   |   | (23,893 | ) |   |   | (858 | ) |   |   | (24,751 | ) |   |   | (42,108 | ) |   |   | (573 | ) |   |   | (42,681 | ) |   |   | (33,972 | ) |   |   | 12 |   |   |   | (33,960 | ) |   |

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(1)                See Note 3, “Restatement of Consolidated FinancialStatements,” of the Notes to Consolidated Financial Statements.

(2)                See Explanatory Note above. The restated amounts forthese periods are unaudited.

(3)                Previously reported stock-based compensation amounts in2003 and 2002 have been reclassified to conform to the current presentation.

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**Item7.****                        *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations***

**Overview**

We are a leading provider of internationalcommunications services and a provider of retail prepaid calling services. Ouroperations consist of our Voice-Over-Internet-Protocol (“VoIP”) tradingbusiness (“Trading”), in which we connect buyers and sellers of internationaltelecommunications services, and our retail services business (“Retail”). Inthe Trading business we receive voice traffic from buyers—originating carrierswho are interconnected to our network via VoIP or traditional time divisionmultiplexing (‘TDM”) connections, and we route that traffic over the Internetto sellers—local service providers and carriers in the destination countrieswith whom we have established agreements to manage the completion ortermination of the call. We use proprietary, patent-pending technology toautomate the selection of routes and termination partners based on a variety ofperformance, quality, and business metrics. We offer this Trading service on awholesale basis to carriers, consumer VoIP companies, telephony resellers andother service providers worldwide. We have call termination agreements withlocal service providers in North America, Europe, Asia, the Middle East, LatinAmerica, Africa and Australia.

We continue to expand our market share in our Tradingbusiness by expanding our customer base and by introducing cost-effectivesolutions for our customers to interconnect with our network. Our Tradingproducts include iBasis DirectsTM, which features our direct routes to more than100 countries, which are our most cost-efficient routes. Designed for carriercustomers with sophisticated Least Cost Routing capabilities, Directs offersour most competitive rates. We also offer our PremiumCertified® international routing product which featuresroutes to more than 700 destinations that are actively monitored and managed todeliver a level of quality that is equal to or exceeds the highest industrybenchmarks for retail quality. PremiumCertified is designed to take advantageof third-party or off-net routes to provide thorough worldwide coverage forcustomers, and enhances our ability to compete for retail international trafficfrom existing customers as well as from mobile operators and consumer VoIPproviders.

In targeting the emerging consumer VoIP providers, wehave expanded our DirectVoIPTM IPinterconnection offering with DirectVoIP Broadband, which addressesrequirements that are specific to the growing consumer VoIP market. DirectVoIPBroadband includes our transcoding solution, which enables us to providegreater interoperability among devices and voice applications, as well asdeliver high quality service even over sub-optimal network connections. We haveapproximately 60 customers in the consumer VoIP market, including leaders amongthe emerging independent providers and cable operators, and we believe thismarket offers significant growth potential for us.

Our Retail business waslaunched in late 2003, with the introduction of our retail prepaid callingcards, which are marketed through distributors primarily to ethnic communitieswithin major metropolitan markets in the U.S.. In September 2004, weexpanded our Retail business segment with Pingo®, a prepaid calling service offereddirectly to consumers through an eCommerce web interface. Both the prepaidcalling card business and Pingo leverage our existing international VoIPnetwork and have the potential to deliver higher margins than are typicallyachieved in the Trading business. In addition, the retail prepaid calling cardbusiness typically has a faster cash collection cycle than the Trading business.Pingo is sold directly to consumers and business customers on a prepaid basis. Revenuesfrom our Pingo services were not material in 2006, 2005 and 2004.

**Restatement ofConsolidated Financial Statements, Summary of Historical Granting Process andDetermination of Measurement Date and Related Proceedings**

***Restatement of Consolidated Financial Statements***

In conjunction with the preparation and filing of our Form 10-Qfor the three months ended June 30, 2006, we performed an internal reviewof our historical option grants from January 1, 2004 through 

39

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May 2006 to discernany patterns relating to the timing and pricing of option grants. This internalreview indicated that certain stock options grants were made at a relativelylow price, compared to the price of our common stock in the days around thedate of the stock option grant. In reviewing this information, our managementdid not believe that there would be a potential change in the measurement datesfor these grants. On August 9, 2006, we filed our Form 10-Q forthe quarter ended June 30, 2006.

At a meeting of our Board of Directors held on August 10,2006, the status of the internal review was discussed. Subsequent to thismeeting, our Executive Management and Board of Directors became aware, based oninformation provided to them by our former Vice President of Business Affairsand General Counsel, of email messages that he had written or receivedindicating that the date and exercise price of certain option grants may havebeen determined with hindsight.

On August 20, 2006, following review of the emailmessages and internal review, our Board of Directors formed a Special Committeeof independent directors to commence a voluntary investigation of ourhistorical stock option grants and practices. The Special Committee’sinvestigation considered evidence of all stock options grants for the period December 1999through May 2006. The Special Committee was given broad authority toinvestigate and address our historical stock option grants and practices. TheSpecial Committee was composed of two independent members of our Board ofDirectors, W. Frank King and Robert H. Brumley. The Special Committee retainedthe law firm of Goodwin Procter LLP as its independent outside counsel andGoodwin Procter LLP hired Law and Economics Consulting Group as independentaccounting experts to aid in its investigation.

On October 17, 2006, the Special Committeeconcluded that the measurement dates for determining the accounting treatmentof certain historical stock option grants differed from the measurement datesused by us in preparing our financial statements. Because the prices at theoriginally stated grant dates were, in certain cases, lower than the prices onthe actual dates of the determination, we determined we should have recognizedmaterial amounts of stock-based compensation expense which were not accountedfor in our previously issued financial statements. In certain instances, theapproval date of an option grant could not be determined with certainty. Inaddition, the terms of an option grant, including exercise price and number ofshares, may not have been final on the date of approval. In those instances, weused other relevant available evidence to determine the most likely measurementdate for the option grant. The Special Committee also found that in a number ofinstances the date and exercise price of option grants had been determined withhindsight to provide a more favorable price for such grants.

In those instances wherethe approval date of the stock option grant could not be determined withcertainty, or the terms of the option grant, including exercise price and numberof shares were not final on the determined date of approval, we used aconsistent methodology to determine the most likely measurement date of theoption grant. In determining a measurement date, we considered the date bywhich both approval of the stock option grant had been obtained and the termsof the option grant, including exercise price and number of shares, were final.

***Summary of Historical Granting Process andDetermination of Measurement Dates***

*Pre IPO ApprovalProcess*

Since the Company’s inceptionin 1997 through November 1999, the month in which we went public, themajority of the stock option grants were approved in meetings of ourCompensation Committee or Board of Directors.

*Post IPO ApprovalProcess*

From December 1999,the month in which the first post IPO stock option grant was made, to February 2002,we obtained approval for the majority of option grants through the practice ofsending a 

40

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unanimouswritten consent (“UWC”) to our Compensation Committee that contained an *“as of”* grant date and exercise price, and a list of optionrecipients and shares awarded by recipient attached to the UWC. Beginning in May 2002,our General Counsel’s practice changed to sending a UWC, with a blank grantdate and blank exercise price, to our Compensation Committee members forapproval, with a list of option recipients and shares to be awarded byrecipient attached.

*December 1999to February 2002*

Between December 1999 and February 2002, wehad a total of twenty-three stock option grants. Of the twenty-three, we haveevidence of seven option grants that were approved by UWCs that contained grantdates and exercise prices when the UWCs were sent to the Compensation Committeefor approval. For eight other option grants approved by a UWC during thisperiod, we do not have evidence of what the UWC contained when it was sent tothe Compensation Committee for approval. Compensation Committee membersgenerally returned their signed UWC signature pages to our General Counsel.The final UWC was then completed by our General Counsel, including attachingthe previously obtained signature pages of the Compensation Committeemembers.

Of the remaining eight grants which occurred duringthe period from December 1999 to February 2002, one employee optiongrant was approved in a meeting of our Compensation Committee and one Directorgrant was approved in a meeting of our Board of Directors. The documentation ofthese meetings included the grant date, exercise price, option recipients,shares awarded and vesting terms. The remaining six option grants had noevidence or documentation supporting approval of the option grant, other thancertain employee stock option agreements and the date of entry into our stockoption tracking system.

During this period, theapproved list of stock option grants, including the stock option grant date andexercise price, was then communicated by our General Counsel to our HumanResources personnel for entry into our stock option tracking system*.*With respect to the grants in which the exercise price ofthe option was initially set forth in the UWC circulated to the CompensationCommittee (provided the list of option recipients and shares awarded werefinal), we believe that on the date the Compensation Committee approved theoption grant all of the terms of the option grant, including exercise price,were known with finality, as such terms were included in the UWC approved bythe Compensation Committee and such terms were also consistent with theinformation that was ultimately entered into our stock option tracking systemand communicated to employees.

*May 2002 to May 2006*

Between May 2002 and May 2006, we had atotal of thirty-one stock option grants. Of the thirty one grants, we haveevidence of seventeen option grants for which the UWC, when sent to ourCompensation Committee, or Board of Directors for approval, did not contain agrant date and exercise price. Sometime after sending the UWCs out toCompensation Committee members for signatures, the date of the stock optiongrant and the stock option exercise price (equal to the closing price of ourcommon stock on the stated grant date) were inserted into the final UWC by ourGeneral Counsel. We have evidence for one grant in which the UWC, when sent tothe Compensation Committee, contains a grant date and an exercise price. CompensationCommittee members generally returned their signed UWC signature pages toour General Counsel. For eight other option grants during this period, we didnot have evidence of what the UWC contained when it was sent to the CompensationCommittee for approval. Once signed UWCs were obtained the approved list ofstock option grants, including the stock option grant date and exercise price,was then communicated by our General Counsel to our Human Resources personnelfor entry into our stock option tracking system.

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Three other employee option grants were approved inmeetings of our Compensation Committee and one non-employee Director grant wasapproved in a meeting of our Board of Directors. The documentation of thesemeetings included the grant date, exercise price, option recipients, sharesawarded and vesting terms. In addition, there was one option grant during thisperiod for which no evidence or documentation supporting approval of the optiongrant could be found, other than certain employee stock option agreements andthe date of entry into our stock option tracking system.

For each of ourpast stock option grants, we determined a measurement date using the followingcriteria:

1)              For stock optiongrants approved at a meeting of either our Board of Directors or ourCompensation Committee and evidenced by meeting minutes, the date of themeeting was determined to be the measurement date, provided the terms of theoption grant, including exercise price and number of shares, were final on thedate of the meeting.

2)              For stock optiongrants approved by the members of our Compensation Committee through theprocess of signing UWCs, the following criteria were used to determine themeasurement date of the grant:

a)                If there wasevidence of the date of signature for all of our Compensation Committeemembers, the date that the last Compensation Committee member signed the UWCwas determined to be the measurement date, provided the terms of the optiongrant, including exercise price and number of shares, were final on that date;

b)               If there wasevidence of the date of signature for all of our Compensation Committeemembers, other than our Chief Executive Officer when he was a member of theCompensation Committee, the date that the last Compensation Committee membersigned the UWC was determined to be the measurement date, provided the terms ofthe option grant, including exercise price and number of shares, were final onthat date.

3)              If there was noevidence that grants were approved through the process of signing UWCs, orthere was no evidence as to the date of the signatures on the UWCs byCompensation Committee members we considered email evidence to support theapproval date.

We determined the measurement date based on the dateof statements made in email correspondence that indicated that the stock optiongrant had been approved by all of the members of our Compensation Committee,provided the terms of the option grant, including exercise price and number ofshares, were final on that date. We considered emails from CompensationCommittee members indicating the date of approval of the option grant and/oremails from our legal or human resources personnel indicating the date ofapproval of the option grant.

4)              If there was a Form 3or Form 4 filing associated with the option grant, we used the followingcriteria to determine the measurement date of the grant:

a)                If an officer ordirector required to file reports under Section 16 of the SecuritiesExchange Act of 1934, as amended, filed a Form 3 or Form 4, wedetermined the measurement date to be the date that the Form 3 or Form 4was filed;

b)               If employees whowere not Section 16 officers were included in the grant with Section 16officers who filed a Form 3 or Form 4 and the number of sharesattributable to employees who were not Section 16 officers were determinedwith finality at the time of the filing, we determined the measurement date tobe the filing date of the Form 3 or Form 4 as it provided finality asto the exercise price.

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5)              If we did not haveany corroborating evidence to indicate the date the stock option grant had beenapproved by all of the members of our Compensation Committee, and the filing ofa Form 3 or Form 4 was not applicable, we looked for evidence thatindicated the date on which the UWC was sent for signature, via email or fax,from us to the Compensation Committee members. If this evidence existed, weanalyzed the number of days it took for Compensation Committee members toreturn the signed UWCs. A range of response time was determined by individual CompensationCommittee member and used to develop a response time range for the CompensationCommittee, as a group, during specific periods, as the composition of theCompensation Committee members changed over time. Based on this analysis, fourdifferent ranges were determined. The range of response times from CompensationCommittee members varied from a minimum of 1 to 2 days, for which there was oneinstance, to a maximum of 0 to 91 days, for which there were two instances.Based on the range of response time, we determined the measurement date to bethe last day of the response time period, provided the option terms were finalon this date, as we have determined that this is the date by which approval ismost likely to have been obtained.

6)              In instances wherethere was no evidence of the approval of the grant and/or finality of theoption recipients and grant terms, we determined the measurement date based onthe last date of entry for these stock options into our stock option trackingsystem. This date was deemed to be the most likely approval date as our policyand historical practice was to enter stock option grants into its stock optiontracking system only after we believed that the option        grants had been approved.

The measurement dates we determined for past stockoption grants, using the criteria as described above, resulted in additionalstock-based compensation of approximately $10.0 million for the years ended December 31,2000 through December 31, 2005 and $37,000 and $57,000 for the threemonths ended March 31, 2006 and June 30, 2006, respectively. Themeasurement date that we determined for one stock option grant dated May 25,2000 resulted in approximately $7.7 million of the $10.0 million of additionalstock-based compensation for years ended December 31, 2000 through December 31,2005. For this particular grant, we could not determine with certainty the dateof approval of such option grant. As a result, we determined the measurementdate for the May 25, 2000 stock option grant to be the last day of theresponse period for Compensation Committee members to return their signed UWCsunder criteria #5 as described above.

Asummary of the additional stock-based compensation, by year, with the mostsignificant stock option grants shown separately, is as follows:

| **(In thousands)** | ** ** | ** ** | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------|------------|------------|------------|--------------------------------------------|------------|
| **Grant Date**     | ** ** | ** ** | ** ** | **2000**                                   | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **Total** | ** ** |
| May 25, 2000       |       | $          | 1,540      |                                       | $          | 2,699 |   | $ | 3,028 |   | $ | 281 |   | $ | 135 |   | $ | — |   | $ | 7,683 |   |
| Nov. 15,  2001     |       |       |       |                                       |       | 554 |   | 391 |   | 39 |   | 39 |   | 1,023 |   |
| Aug. 11,  2003     |       |       |       |                                       |       |   |   | 47 |   | 185 |   | 162 |   | 394 |   |
| All other grants        |       | 118        |       | 186                                        |       | 196 |   | 92 |   | 144 |   | 136 |   | 872 |   |
| Total                   |       | $          | 1,658      |                                       | $          | 2,885 |   | $ | 3,778 |   | $ | 811 |   | $ | 503 |   | $ | 337 |   | $ | 9,972 |   |
|                         |            |            |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Many of our measurement date conclusions are dependenton the facts and circumstances of each stock option grant and involved theapplication of significant management judgment. We believe the revisedmeasurement dates we determined for option grants under criteria #4, #5 and #6of our methodology, as described above, required the most judgment. As therevised measurement date may not be the actual measurement date, we performedseveral analyses to compare the impact on compensation of selecting measurementdates based upon the above described methodology to what would have resulted 

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under different criteriafor option grants where we determined the revised measurement date usingcriteria #4, #5 and #6 of our methodology.

In the first analysis, we considered that themeasurement dates for eight stock option grants, where we had used the last dayof a Compensation Committee member response period as the approval date(criteria #5), to be the date using both the lowest and highest stock priceassociated with a Compensation Committee approval period. Had we applied thesealternate approaches, the first alternate measurement dates would have resultedin $4,533,000 in additional cumulative stock-based compensation charges beingrecorded from 2000 through June 30, 2006 for the alternative approach ofusing the highest stock price within the response period. The May 25, 2000stock option grant accounts for approximately $4,470,000 of the additional$4,533,000 of stock-based compensation charges that would be recorded using thealternate approach of the highest stock price within the response period. Thesecond alternate measurement dates would have resulted in $24,000 less inadditional cumulative stock-based compensation charges being recorded from 2000through June 30, 2006 for the alternative approach of using the loweststock price within the response period. In addition, we also considered theimpact on four grants where the approval response time as determined was laterthan the date such grants were entered into our option tracking system. In suchcases, if the last date of entry into our option tracking system was usedinstead, the compensation charge would have been $28,000 less for the period.

In the second analysis, we considered the measurementdates for the twenty-five stock option grants, where we had used the last dateof entry into our stock option tracking system as the measurement date(criteria #6), to be the date using both the lowest and highest stock pricebetween the earliest possible approval date of the grant and the last date ofentry into our stock option tracking system. Had we used these alternativemeasurement dates, this would have resulted in approximately $0.9 million inadditional cumulative stock-based compensation using the highest stock price,and approximately $0.9 million less in additional cumulative stock-basedcompensation using the lowest stock price, being recorded from 2000 through June 30,2006.

In the third analysis we considered the measurementdates for the nine stock option grants, where we used the dates of Form 3or Form 4 filings as the measurement date (criteria #4), to be the dateusing both the lowest and highest stock price between the earliest possibledate of approval of the grant and the date of the Form 3 or Form 4filings. Had we used these alternative measurement dates, this would haveresulted in $33,000 of additional cumulative stock-based compensation using thehighest stock price, and approximately $0.3 million less in additionalcumulative stock-based compensation using the lowest stock price, beingrecorded from 2000 through June 30, 2006.

We believe our methodology results in the most likelymeasurement dates for our stock option grants.

As a result of the Special Committee’s investigation,we have restated our consolidated financial statements for the years ended December 31, 2005and 2004 in this Form 10-K. The impact of these errors also extendedto the periods prior to the year ended December 31, 2004. In the restatedconsolidated financial statements included in this Form 10-K thecumulative impact of the errors as of December 31, 2003 is represented asan increase to beginning accumulated deficit as of January 1, 2004. Forfurther information, see Explanatory Note above and Note 3, “Restatement ofConsolidated Financial Statements,” to the Notes to Consolidated Financial Statements.

As a result of determining revised measurement dates,we have also recorded payroll withholding tax related adjustments for certainoptions previously classified as Incentive Stock Option (“ISO”) grants underthe Internal Revenue Service Code of 1986, as amended (“the Code”). Suchoptions were determined to have been granted with an exercise price below thefair market value of the Company’s stock on the revised measurement date. As aresult such options do not qualify for ISO tax treatment. The disqualificationof ISO classification and the resulting conversion to non-qualified stockoption status results in additional withholding taxes on exercise of suchoptions. We have accordingly recorded a tax 

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liability of$0.5 million, as of December 31, 2006 in connection with thedisqualification of such ISO tax treatment.

In addition, as a result of the change in themeasurement dates of certain stock option grants, certain options vestingsubsequent to December 2004 result in non-qualified deferred compensationfor purposes of Section 409A of the Code, and holders are subject to anexcise tax on the value of the options in the year in which they vest. We haveconcluded that it is probable that we will implement a plan to assist theaffected employees for the amount of this tax, or adjust the terms of theoriginal option grant, which would also have financial statement ramifications.We and our executive officers and directors agreed to amendcertain outstanding stock options vesting after December 2004 that weredetermined to have been granted with exercise prices below the fair marketvalue of our common stock on the legal grant date. In December, 2006, we andour executive officers and directors agreed to amend each of these options toincrease the option exercise price to the fair market value on the revisedmeasurement date. As these amendments involved no consideration to ourexecutive officers and directors, we will not recognize any expense associatedwith these modifications in accordance with SFAS 123R.

The restatement of prior year financial statementsalso includes adjustments for other errors that were not previously recordedbecause we believed the amount of any such errors, both individually and in theaggregate, were not material to our historical consolidated financialstatements. Such errors primarily related to the recording of deferred income,classification of reserves for customer disputes, adjustments to accruals, and fixedasset depreciation.

Our restated consolidated financial statements reflectan increase in net loss of approximately $10.6 million for the periods2000 through December 31, 2005 consisting principally of non-cashadjustments to stock-based compensation expense resulting from the stock optiongrant and exercise practices discussed above. The expenses for the periods 2000to 2003 are reflected as an increase to accumulated deficit in the openingbalance sheet for 2004 of approximately $9.5 million.

In accordance with the determinations of the SpecialCommittee’s investigation, our Board of Directors terminated the employment ofour former Vice President, Business Affairs and General Counsel and directedour Compensation Committee to adjust downward the compensation for fiscal year2006 for both our Chief Executive Officer, Ofer Gneezy, and our Executive VicePresident, Gordon VanderBrug, because their oversight of our stock optiongranting practices was inadequate. Additionally, the Special Committee recommended,and we have implemented, changes to our stock-based compensation transactionprocedures and approval policies that require additional and more systematicauthorization to ensure that all stock option transactions adhere to ourapproval process and stated policies, and that all such transactions areproperly recorded in our stock administration systems and have appropriatesupporting documentation.

The discussion and analysis set forth below in thisItem 7 has been amended to reflect the restatement as described above in theExplanatory Note to this Annual Report on Form 10-K and in Note 3, “Restatementof Consolidated Financial Statements,” to the Notes to Consolidated FinancialStatements. For this reason, the data set forth in this section may not becomparable to discussions and data in our previously filed Annual Reports on Form 10-K.

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***Related Proceedings***

We announced on October 20, 2006 that we were contacted by the SEC aspart of an informal inquiry and we further disclosed on March 29, 2007, onForm 8-K, that the SEC had notified us that we would be receiving aformal order of investigation relating to our stock option practices*.* On April 13, 2007, we received the formal order ofinvestigation. The SEC investigation seeks documents and information from usrelating to the grant of our options from 1999 to the present. We expect thatthe SEC will seek the testimony of individuals including certain of ourexecutive officers. We are cooperating fully with the SEC investigation that isongoing. There is no assurance that other regulatory inquiries will not becommenced by other U.S. federal, state or other regulatory agencies.

We have incurredsubstantial expenses for legal, accounting, tax and other professional servicesin connection with the Special Committee investigation, our internal review ofour historical financial statements, the preparation and audit of the restatedfinancial statements, the SEC investigation and related civil derivativelitigation. These expenses were approximately $2.3 million for the year ended December 31,2006. We have continued to incur significant expense in connection with thesematters since December 31, 2006.

***NASDAQ Listing***

On June 21, 2006, our common stock began tradingagain on the NASDAQ National Market under the stock symbol “IBAS”. On May 3,2006, we affected a one-for-three reverse stock split and subsequentlysubmitted an application to NASDAQ to achieve this relisting.

On November 12, 2006,the Nasdaq Listings Qualification Panel (“Nasdaq Panel”) notified us that ourcommon stock was subject to delisting from the NASDAQ National Market as aresult of our failure to timely file our Form 10-Q for the thirdquarter of 2006. In January 2007, the Nasdaq Panel granted our request forcontinued listing on the NASDAQ National Market through April 26, 2007. InMarch 2007, the Nasdaq Listing and Hearing Review Council (the “ListingCouncil”) informed us they had stayed the April 26, 2007 deadline for thedelisting of our common stock, pending their further review. On March 20,2007 and May 16, 2007, we received additional Nasdaq staff determinationletters notifying us that our failure to timely file our Form 10-Kfor the period ended December 31, 2006 and our Form 10-Q forthe quarter ended March 31, 2007, respectively, could serve as anadditional bases for the delisting of the Company’s securities from The NasdaqStock Market. On June 1, 2007 we submited additional information for theconsideration of the Listing Council, including our plans to update our SECfilings to meet the Nasdaq National Stock Market listing requirements and werequested the Listing Council for an extension to June 30, 2007 to fileour periodic reports.

***Proposed Transaction with KPN Telecom B.V., asubsidiary of Royal KPN N.V.***

On June 21, 2006, we announced the signing of adefinitive agreement to merge the international wholesale voice business ofRoyal KPN N.V. (“KPN”) into iBasis. Pursuant to the Share Purchase and SaleAgreement, we will acquire KPN’s subsidiary KPN Global Carrier Services andreceive $55 million in cash in exchange for newly-issued shares of our commonstock representing, on a post issuance basis, 51% of our issued and outstandingshares of common stock and outstanding in-the-money stock options and warrants,or approximately 40 million shares. As of December 31, 2006, thenewly-issued shares to KPN would represent approximately 55% of our issued andoutstanding common shares. Our shareholders of record immediately prior toclosing will receive a cash dividend of $113 million as soon as practicablefollowing the closing. In connection with payment of the dividend, we willadjust the exercise price and number of shares to be issued upon exercise ofour outstanding common stock options to preserve their value.

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On April 27, 2007, we announced that the Companyand KPN had amended the Share Purchase and Sale Agreement to extend the outsidedate for completion of the transaction to October 31, 2007. Previously, inDecember 2006, we announced that the Company and KPN had extended theoutside date for completion of the transaction from December 31, 2006 to April 30,2007. The proposed transaction is subject to customary closing conditions andthe approval of iBasis shareholders.

Although we will belegally acquiring KPN Global Carrier Services, after the transaction iscompleted, the former sole stockholder of KPN Global Carrier Services (asubsidiary of KPN), will hold a majority of our outstanding common stock. Accordingly,for accounting and financial statement purposes, the transaction will betreated as an acquisition of iBasis by KPN Global Carrier Services under thepurchase method of accounting. Under the purchase method of accounting, ourassets and liabilities will be, as of the closing date of the transaction,recorded at their fair value and added to the assets and liabilities of KPNGlobal Carrier Services, including an amount for goodwill representing thedifference between the deemed purchase price of iBasis and the fair value ofour identifiable net assets. We haveincurred merger related expenses of $3.0 million through December 31,2006, consisting primarily of investment banking advisory services, legal andaccounting fees. Such amounts have been expensed because we are the accountingacquiree.

***Critical Accounting Policies***

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements.The preparation of these financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesof America requires us to (i) make judgments, assumptions and estimatesthat affect the reported amounts of assets, liabilities, revenue and expenses;and (ii) disclose contingent assets and liabilities. We base ouraccounting estimates on historical experience and other factors that weconsider reasonable under the circumstances. However, actual results may differfrom these estimates. To the extent there are material differences between ourestimates and the actual results, our future financial condition and results ofoperations will be affected. The following is a summary of our criticalaccounting policies and estimates.

*RevenueRecognition.**  *Forour Trading business, our revenue transactions are derived from the resale ofinternational minutes of calling time. We recognize revenue in the period theservice is provided, net of revenue reserves for potential billing disputes,provided the collection of amounts billed is reasonably assured. Disputes canresult from disagreements with customers regarding the duration, destination orrates charged for each call. For our Retail business, revenue is deferred uponactivation of the cards, or purchase of our web-based calling services, and isonly recognized as the prepaid balances are reduced based upon minute usage andservice charges.

*Short-termmarketable investments.**  *Our investments are classified as available-for-sale,carried at fair value and consist of securities that are readily convertibleinto cash, including government securities and commercial paper, with originalmaturities at the date of acquisition ranging from 90 days to one year. Asour investments are classified as available-for-sale, we are only exposed tocharges to our results of operations in the event of a sale or an impairment ofa security.

*Allowancefor Doubtful Accounts.**  *Weperform ongoing credit evaluations of our customers and adjust credit limitsbased upon their payment history and current credit worthiness, as determinedby our review of their current credit information. We continuously monitorcollections and payments from our customers and take a provision for estimatedcredit losses based upon our historical experience and any specific customercollection issues that we have identified. We have been able to mitigate ourcredit risk, in part, by using reciprocal arrangements with customers, who arealso iBasis suppliers, to offset our outstanding receivables, as well asrequiring letters of credit and prepayments for certain customers. A majorityof our accounts receivable are from international carriers. For financialinformation about 

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geographic areas andsignificant customers, see Note 5, “Business Segment and GeographicInformation” to our Consolidated Financial Statements.

*Stock-basedCompensation—*Effective January 1, 2006, weadopted the provisions of Statement of Financial Accounting Standards 123R, *“Share-Based Payment”* (“SFAS 123R”), which require us torecord compensation expense related to the fair value of our stock-basedcompensation awards. Prior to January 1, 2006, we accounted for ourstock-based compensation in accordance with Accounting Principles Board (“APB”)Opinion 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.

We elected to use the modified prospective transitionmethod as permitted under SFAS 123R and, therefore, have not restated ourfinancial results for the prior periods to reflect the fair value ofstock-based compensation awards. Under this transition method, stock-basedcompensation expense for the year ended December 31, 2006 includescompensation expense for all stock option awards granted prior to, but not yetvested as of December 31, 2005, based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123. Stock-basedcompensation expense for all stock option awards granted subsequent to December 31,2005 was based on the grant date fair value estimated in accordance with SFAS123R. We recognize compensation expense for stock option awards granted on astraight-line basis over the requisite service period of the award. SeeExplanatory Note and Note 3, “Restatement of Consolidated FinancialStatements,” of the Notes to Consolidated Financial Statements regarding ourdetermination of measurement dates for certain stock option grants.

*Impairmentof Long Lived Assets.**  *Ourlong-lived assets consist primarily of property and equipment, which arecarried at historical cost. Only in situations where there are specific events thatmay change the estimated remaining useful life of such assets are the value ofthese assets subject to impairment. Any future impairment would not impact cashflow but would result in a charge to our statement of operations.

*RestructuringCharges.**  *Inthe fourth quarter of 2006, we recorded a charge of approximately $0.9 millionfor the early termination of a facility lease, primarily representing futurepayments required by us under the lease termination agreement. In prior years,we recorded significant charges to operations in connection with ourrestructuring programs. The related reserves reflect estimates, primarilyrelating to facility exit costs. We reassess the reserve requirements tocomplete each restructuring program at the end of each reporting period. Actualexperience may be different from these estimates. In 2006, 2005 and 2004, wetook an additional charge of $0.4 million, $0.2 million and $0.2 million,respectively, relating to our prior restructuring charges as a result of achange in estimates relating to our future sublease assumptions.

*IncomeTaxes.**  *Wehave net deferred tax assets related to net operating loss carryforwards, thatexpire at various dates through 2025 and other tax temporary differences. Significantjudgment is required in determining our provision for income taxes, the amountof deferred tax assets and liabilities and the valuation allowance required tooffset against our net deferred tax assets. Factors such as future reversals ofdeferred tax assets and liabilities, projected future taxable income, changesin enacted tax rates and the period over which our deferred tax assets will berecoverable are considered in making these determinations. We evaluate therealizability of our deferred tax assets quarterly and we may reverse aportion, or all of our valuation allowance against our net deferred tax assetin future periods. If this occurs, a tax benefit would be recorded forfinancial reporting purposes. Our deferred tax asset is subject to a 100%valuation allowance as of December 31, 2006 and 2005.

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**Results ofOperations**

Thefollowing table sets forth for the periods indicated the principal itemsincluded in the Consolidated Statements of Operations as percentages of netrevenue.

| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue                                          |       | 100.0                                      | %          |   | 100.0 | % |   |   | 100.0 | % |   |
| Costs and operating  expenses:                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Data  communications and telecommunications          |       | 87.6                                       |       |   | 87.2 |   |   |   | 85.4 |   |   |
| Research and  development                            |       | 2.6                                        |       |   | 3.3 |   |   |   | 5.3 |   |   |
| Selling and  marketing                               |       | 3.2                                        |       |   | 3.0 |   |   |   | 3.5 |   |   |
| General and  administrative                          |       | 4.9                                        |       |   | 4.0 |   |   |   | 5.0 |   |   |
| Depreciation and  amortization                       |       | 1.4                                        |       |   | 1.7 |   |   |   | 4.0 |   |   |
| Write-off of  leasehold improvements                 |       | 0.2                                        |       |   | — |   |   |   | — |   |   |
| Restructuring  costs                                 |       | 0.2                                        |       |   | 0.1 |   |   |   | 0.1 |   |   |
| Merger related  expenses                             |       | 0.6                                        |       |   | — |   |   |   | — |   |   |
| Total costs and  operating expenses                  |       | 100.8                                      |       |   | 99.3 |   |   |   | 103.3 |   |   |
| Income (loss)  from operations                       |       | (0.8                                       | )          |   | 0.7 |   |   |   | (3.3 | ) |   |
| Interest income                                      |       | 0.4                                        |       |   | 0.3 |   |   |   | 0.1 |   |   |
| Interest expense                                     |       | (0.1                                       | )          |   | (0.7 | ) |   |   | (1.6 | ) |   |
| Other expenses,  net                                 |       | (0.0                                       | )          |   | (0.1 | ) |   |   | (0.0 | ) |   |
| Loss on long-term  non-marketable security           |       | —                                     |       |   | — |   |   |   | (1.9 | ) |   |
| Foreign exchange  (loss) gain                        |       | 0.1                                        |       |   | (0.2 | ) |   |   | 0.1 |   |   |
| Debt conversion  premium and transaction costs       |       | —                                     |       |   | (0.5 | ) |   |   | — |   |   |
| Debt refinancing  charges                            |       | —                                     |       |   | — |   |   |   | (1.0 | ) |   |
| Loss before  income taxes from continuing operations |       | (0.4                                       | )          |   | (0.5 | ) |   |   | (7.6 | ) |   |
| Foreign income  tax expense                          |       | (0.0                                       | )          |   | (0.0 | ) |   |   | (0.0 | ) |   |
| Loss from  continuing operations                     |       | (0.4                                       | )          |   | (0.5 | ) |   |   | (7.6 | ) |   |
| Income from  discontinued operations                 |       | —                                     |       |   | — |   |   |   | 0.7 |   |   |
| Net loss                                             |       | (0.4                                       | )%         |   | (0.5 | )% |   |   | (6.9 | )% |   |

 

**Year Ended December 31,2006 Compared to Year Ended December 31, 2005**

*Netrevenue.**  *Ourprimary source of revenue is the fees that we charge customers for completingvoice and fax calls over our network and revenues from the sale of our prepaidcalling services. Our VoIP Trading revenue is dependent on the volume of voiceand fax traffic carried over the network, which is measured in minutes. Wecharge our customers fees, per minute of traffic, that are dependent on thelength and destination of the call and recognize this revenue in the period inwhich the call is completed. Our average revenue per minute (“ARPM”) is basedupon our total net revenue divided by the number of minutes of traffic over ournetwork for the applicable period. ARPM is a key telecommunications industryfinancial measurement. We believe this measurement is useful in understandingour financial performance, as well as industry trends. Although the longdistance telecommunications industry has been experiencing declining prices inrecent years due to the effects of deregulation and increased competition, ouraverage revenue per minute can fluctuate from period to period as a result ofshifts in traffic over our network to higher priced, or lower priced,destinations.

Our total revenueincreased by $125.6 million, or 33%, to $511.1 million for 2006 from$385.5 million for 2005. Traffic carried over our network increased to11.1 billion minutes for 2006 from 7.8 billion minutes for 2005. Ouraverage revenue per minute was 4.6 cents per minute in 2006 compared to 5.0cents per minute in 2005. The lower average revenue per minute in 2006primarily reflected the growth in our 

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Retailbusiness, which typically has lower average revenue per minute than our Tradingbusiness. Trading revenue increased $104.0 million, or 33%, to$416.6 million in 2006 compared to $312.6 million in 2005. Theincrease in Trading revenue in 2006 was, in part, a result of addingapproximately 150 new Trading customers during the year. We ended 2006 withapproximately 50 consumer VoIP customers, including two industry leaders, andachieved significant year-to-year revenue growth in this fast growing market. Retailrevenue increased $21.6 million, or 30%, to $94.5 million compared to$72.9 million in 2005. This increase reflects the growth we have achievedwith our retail prepaid calling card services, which we introduced in late2003. During 2006, we continued to introduce a significant number of newcalling card brands and expand our distribution network. Revenue from our Pingocalling services, part of our Retail services, which we launched in September 2004,was not material in 2006 or 2005.

*Data communications andtelecommunications costs.**  *Data communications and telecommunications costs arecomposed primarily of termination and circuit costs. Termination costs are paidto local service providers to terminate voice and fax calls received from ournetwork. Terminating costs are negotiated with the local service provider.Should competition cause a decrease in the prices we charge our customers, ourcontracts, in some cases, provide us with the flexibility to renegotiate theper-minute termination fees to mitigate the impact on our profit margins.Circuit costs include charges for Internet access at our Internet centraloffices, fees for connections between our Internet central offices and ourcustomers and/or service provider partners, facilities charges for overseasInternet access and phone lines to the primary telecommunications carriers inparticular countries, and charges for the limited number of dedicatedinternational private line circuits we use. For our Retail calling services,these costs also include the cost of local and toll free access charges.

Data communications andtelecommunications costs increased by $111.5 million, or 33%, to$447.7 million for 2006 from $336.2 million for 2005. Datacommunications and telecommunications costs were $367.0 million and $80.7million for our Trading and Retail business segments in 2006, respectively,compared to $275.4 million and $60.8 million in 2005, respectively. Theincrease in data communications and telecommunications costs reflects theincrease in revenue and traffic, as discussed above. The largest component ofthese costs, termination costs, increased to $439.7 million for 2006 from$329.4 million for 2005 while circuit costs increased to $8.0 millionfor 2006 from $6.8 million in 2005. Our average cost per minute was 4.0cents per minute in 2006 compared to 4.3 cents per minute in 2005. As apercentage of net revenues, data communications and telecommunications costsincreased to 87.6% for 2006 from 87.2% in 2005.

*Gross profit.**  *Total gross profit (net revenue less datacommunications and telecommunications costs) was $63.4 million, or 12.4% oftotal net revenue in 2006, compared to $49.3 million, or 12.8% of total netrevenue in 2005. Trading gross profit was $49.6 million, or 11.9% of Tradingrevenue in 2006, compared to $37.2 million, or 11.9% of Trading revenue in 2005.Retail gross profit was $13.8 million, or 14.6% of Retail revenue in 2006,compared to $12.1 million, or 16.6% of Retail revenue in 2005.  In Q3 of 2006, we disengaged with one of ourlargest prepaid calling card distributors due to delinquent payments. Theprepaid cards we had sold through this distributor were primarily establishedbrands and carried higher than average margins. As a result, the disengagementfrom this distributor had an adverse effect on our Retail revenue and marginsin the second half of 2006.

On June 30, 2006, theFederal Communications Commission (“FCC”) issued an order requiring providersof prepaid calling cards that utilize IP to contribute to the Universal ServiceFund (“USF”) and pay access charges and other regulatory fees both in thefuture and for some prior period of time. We have filed an appeal of theretroactive aspect of the FCC Order with the United States Court of Appeals inWashington, D.C. As of December 31, 2006, we estimate that the maximumpotential retroactive USF charge relating to our Retail business prior to thethird quarter of the year ended December 31, 2006 would be approximately$2.6 million. As the amount of retroactive fees are not probable of beingincurred, no amounts have been accrued as of December 31, 2006. Retailgross profit was reduced by $0.8 million in 

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thesecond half of 2006 for USF and other regulatory fees associated with ourRetail business as a result of the FCC Order.

*Research and developmentexpenses.*   Research and development expensesinclude the expenses associated with developing, operating, supporting andexpanding our international and domestic network, expenses for improving andoperating our global network operations centers, salaries, and payroll taxesand benefits paid for employees directly involved in the development andoperation of our global network operations centers and the rest of our network.Also included in this category are research and development expenses thatconsist primarily of expenses incurred in enhancing, developing, updating andsupporting our network and our proprietary software applications.

Research and developmentexpenses increased $0.9 million to $13.5 million for 2006 from$12.6 million for 2005. The increase in research and development expensesis primarily due to higher expenditures related to the support of The iBasisNetwork. Stock-based compensation included in research and development expenseswas $0.5 million in 2006 and was primarily the result of the adoption of SFAS123R, compared to $0.01 million in 2005. As a percentage of net revenue,research and development expenses decreased to 2.6% for 2006 from 3.3% for2005.

*Selling and marketingexpenses.**  *Sellingand marketing expenses increased by $4.6 million, to $16.3 million in2006, from $11.7 million in 2005. The increase in expenses primarilyrelates to additional investments we have made in sales and marketing,primarily to support our expanding Retail business, including an increase inadvertising and marketing expenditures of $1.4 million in 2006 over 2005.Stock-based compensation included in selling and marketing expenses was $0.4million in 2006 and was primarily the result of the adoption of SFAS 123R,compared to $0.1 million in 2005. As a percentage of net revenue, selling andmarketing expenses increased to 3.2% for 2006 from 3.0% for 2005.

*General and administrativeexpenses.**  *Generaland administrative expenses include salary, payroll tax and benefit expensesand related costs for general corporate functions, including executivemanagement, finance and administration, legal and regulatory, facilities,information technology and human resources.

General and administrativeexpenses increased by $9.6 million to $25.1 million for 2006 from$15.5 million for 2005. We increased our allowance for doubtful accountsby $3.8 million in 2006, including $1.3 million to cover amounts due from aprepaid calling card distributor we disengaged from doing business with in Q3of 2006 due to delinquent payments. In 2005, we increased our allowance fordoubtful accounts by $0.8 million.  Theincrease to our allowance for doubtful accounts in 2006 relates primarily tospecific customer accounts which we believe may not be collectible. We incurred$2.3 million in costs in 2006 relating to the investigation of our stock optiongranting practices, which primarily consisted of legal and accounting fees. Stock-basedcompensation included in general and administrative expenses was $0.8 millionin 2006 and was primarily the result of the adoption of SFAS 123R, compared to$0.1 million in 2005. In addition, general and administrative expenses in 2006include $0.2 million for the fair value of a warrant issued as partial paymentfor investment banking advisory services. As a percentage of net revenue,general and administrative expenses were 4.9% for 2006 and 4.0% for 2005.

*Depreciation andamortization expenses.**  *Depreciationand amortization expenses increased by $0.6 million to $7.1 millionfor 2006 from $6.5 million for 2005. As a percentage of net revenue,depreciation and amortization expenses decreased to 1.4% for 2006 from 1.7% for2005.

*Write-off of leaseholdimprovements and lease termination costs.**  *In October 2006,we negotiated the early termination of leased space for one of our locations inNew York City which we no longer needed.  We had begun the process of negotiation withour landlord during Q3 and finalized an agreement to terminate the lease onthis space in Q4 of 2006.  As a result ofour plan to terminate this lease, we took a non-cash charge of $1.0 million forthe write-off of the carrying value of leasehold improvements in 2006.

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*Restructuring costs.**  *In the fourth quarter of 2006, wetook a charge of $0.9 million relating to our early termination of leased spacefor one of our locations in New York City.  Under the lease termination agreement, we willhave future monthly payment obligations totaling approximately $1.1 millionthrough February 2011, the original lease termination date. The charge of$0.9 million consisted of  our futurepayment obligations of $1.1 million, net of a $0.2 million reversal in adeferred rent liability arising from the difference between cumulative rentalpayments made under the lease agreement and rental expense recorded in ourfinancial statements on a straight-line basis.  As a result of this early lease termination,we will achieve approximately $1.2 million in future cash savings through February 2011,which represents the amount we would have paid under our original leaseobligation less our future payment obligation as a result of our leasetermination.

In addition, we tookcharges of $0.4 million and $0.2 million in 2006 and 2005, respectively, for achange in estimate relating to our sublease assumptions associated with ourprior restructuring charges.

*Merger related expenses.**  *Merger relatedexpenses of $3.0 million relate to transaction costs incurred in 2006 for thepending proposed transaction with KPN. These transaction costs consistprimarily of investment banking advisory services, legal and accounting fees. Thesecosts have been expensed as iBasis is not considered the accounting acquirerand the transaction will be accounted for as a reverse acquisition.

*Interest income.**  *Interest income was $1.9 millionfor 2006, compared to $1.1 million in 2005. This increase reflects acombination of higher short-term interest rates and the income earned on higheraverage cash and short-term investment balances in 2006 compared to 2005.

*Interest expense.**  *Interest expense decreased $2.3million in 2006 to $0.3 million, from $2.6 million in 2005, as a result of theconversion of our  63⁄4% ConvertibleSubordinated Notes due June 2009 and 8% Secured Convertible Notes due June 2007to common stock between June and September 2005. Interest expense in2006 primarily consists of  interest oncapital equipment leases.

*Other expenses, net.**  *Other expenses, net were$0.2 million and $0.3 million in 2006 and 2005, respectively, andrelate mostly to state excise, use and franchise taxes.

*Foreign exchange loss(gain), net.**  *Foreignexchange gain was $0.4 million in 2006, compared to a loss of $0.9 million in2005. The foreign exchange gain in 2006 primarily reflects the effect of astronger Euro relative to the U.S. dollar on our Euro-denominated accountsreceivable and the foreign exchange loss in 2005 primarily reflects the effectof a weaker Euro relative to the U.S. dollar in 2005 on our Euro-denominatedaccounts receivable.

*Debt conversion premiumand transaction costs.**  *Debtconversion premium and transaction costs of $2.0 million in 2005 reflects debtconversion premium payments made of $1.9 million to certain noteholders in June andJuly 2005 in negotiated agreements to encourage early conversion of $29.0of our 8% Secured Convertible Notes due June 2007 and $2.0 million of our63⁄4% Convertible Subordinated Notes due June 2009.  Of the total payment, $1.7 million was paid incash and the balance was paid in the form of 14,579 shares of our common stockwith a fair value of $115,000. In addition, transactions costs wereapproximately $120,000 and consisted of investment banking and legal fees.

*Income taxes.**  *In 2006 we utilized approximately$3.2 million in net operating loss carry-forwards to offset taxable income. Weprovided a full valuation allowance against our remaining net deferred taxassets at December 31, 2006. We did not record an income tax benefit forthe tax losses associated with our operations in 2005, as we believe that it ismore likely than not that these benefits will not be realized. Foreign incometax expense on the earnings of our foreign subsidiaries was $37,000 and $93,000in 2006 and 2005, respectively.

*Net loss.**  *Net loss was $2.2 million, or$(0.07) per share, in 2006 compared to a net loss of $2.0 million, or$(0.08) per share, in 2005.  Net loss of$2.2 million in 2006 includes $3.0 million in merger related expenses, $2.3million in expenses related to the investigation of our past option grantingpractices, 

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and $1.9 million incharges related to the early termination of a leased facility.  The net loss of $2.0 million in 2005 included$2.0 million in debt conversion premiums and transaction costs.

**Year Ended December 31, 2005 Compared to YearEnded December 31, 2004**

*Net revenue.**  *Our total net revenue increased by$121.8 million, or 46%, to $385.5 million for 2005 from$263.7 million for 2004. Traffic carried over our network increased to7.8 billion minutes for 2005 from 4.9 billion minutes for 2004. Ouraverage revenue per minute was 5.0 cents per minute in 2005 compared to 5.4cents per minute in 2004. The lower average revenue per minute in 2005primarily reflected a proportionately higher mix of lower priced traffic. Tradingrevenue increased $87.3 million, or 39%, to $312.6 million in 2005compared to $225.3 million in 2004. The increase in Trading revenue in2005 was, in part, a result of adding approximately 100 new Trading customersduring the year. We ended 2005 with approximately 30 consumer VoIP customers,including two industry leaders, and achieved significant year-to-year revenuegrowth in this  market. Retail revenueincreased $34.5 million to $72.9 million, or nearly double 2004 revenue of$38.4 million. This increase reflects the growth we have achieved with ourretail prepaid calling card services, which we introduced in late 2003. During2005, we introduced a significant number of new calling card brands andexpanded our distribution network, particularly in southern California. Revenuefrom our Pingo calling services, part of our Retail services, which we launchedin September 2004, was not material in 2005 or 2004.

*Data communications andtelecommunications costs.**  *Data communications and telecommunications costsincreased by $111.0 million, or 49%, to $336.2 million for 2005 from$225.2 million for 2004. Data communications and telecommunications costswere $276.4 million and $60.8 million for our Trading and Retail businesssegments in 2005, respectively, compared to $192.6 million and $32.6 million in2004, respectively. The increase in data communications and telecommunicationscosts primarily reflects the increase in revenue and traffic, as discussedabove. The largest component of these costs, termination costs, increased to$329.4 million for 2005 from $219.1 million for 2004 while circuitcosts increased slightly to $6.8 million for 2005 from $6.1 millionin 2004. As a percentage of net revenues, data communications andtelecommunications costs increased to 87.2% for 2005 from 85.4% in 2004.

*Gross profit.**  *Total gross profit (net revenue less datacommunications and telecommunications costs) declined to 12.8% of total netrevenue in 2005, compared to 14.6% of total net revenue in 2004. Trading grossmargin was 11.9% of Trading revenue in 2005, compared to 14.5% in 2004. Thelower Trading gross margin was primarily due to lower rates on certainU.S.-originated and China-originated traffic in 2005. Retail gross margin was16.6% of Retail revenue in 2005, compared to 14.9% in 2004.

*Research and developmentexpenses.*   Research and development expensesdecreased $1.4 million to $12.6 million for 2005 from$14.0 million for 2004. The decrease in research and development expensesis due to lower expenditures related to the support of The iBasis Network. As apercentage of net revenue, research and development expenses decreased to 3.3%for 2005 from 5.3% for 2004.

*Selling and marketingexpenses.**  *Sellingand marketing expenses increased by $2.3 million, to $11.7 million in2005, from $9.4 million in 2004. The increase in expenses primarily relates toadditional investments we have made in sales and marketing, primarily tosupport our expanding Retail business, including increasing advertising andmarketing expenditures by $0.6 million. As a percentage of net revenue, sellingand marketing expenses decreased to 3.0% for 2005 from 3.5% for 2004.

*General and administrativeexpenses.**  *Generaland administrative expenses increased by $2.3 million to$15.5 million for 2005 from $13.2 million for 2004. Increases to theallowance for doubtful accounts were $0.9 million in 2005 compared to$0.3 million in 2004. In addition, incentive compensation was $0.3 millionand professional fees increased by $0.8 million, which related largely tocompliance with the internal control provisions under Section 404 of theSarbanes-Oxley Act. As a percentage of net revenue, general andadministrative expenses were 4.0% for 2005 and 4.8% for 2004.

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*Restructuringcosts.**  *In2005 and 2004, we took charges of $0.2 million for a change in estimaterelating to our sublease assumptions associated with our prior restructuringcharges.

*Depreciationand amortization expenses.**  *Depreciation and amortization expenses decreased by$3.9 million to $6.5 million for 2005 from $10.4 million for 2004.This decrease was primarily due to the end of the depreciable life of certainnetworking equipment and computer software. As a percentage of net revenue,depreciation and amortization expenses decreased to 1.7% for 2005 from 4.0% for2004.

*Interestincome.**  *Interestincome was $1.1 million for 2005, compared to $0.2 million in 2004. Thisincrease primarily reflects the income earned on higher average cash andshort-term investment balances in 2005 compared to 2004.

*Interestexpense.**  *Interestexpense decreased $1.6 million in 2005 to $2.6 million, from $4.2 million in2004, as a result of the conversion of our 63⁄4% Convertible Subordinated Notes due June 2009 and 8% SecuredConvertible Notes due June 2007 to common stock between June and September 2005.In addition, interest expense also includes interest on capital leases of $0.3million and $0.5 million in 2005 and 2004, respectively.

*Otherexpenses, net.**  *Otherexpenses, net were $0.4 million and $0.2 million in 2005 and 2004,respectively, and relate mostly to state excise, use and franchise taxes.

*Foreignexchange loss(gain), net.**  *Foreignexchange loss was $0.9 million in 2005, compared to a gain of $0.3 million in2004. The increase in foreign exchange loss primarily reflects the effect ofthe weakening Euro relative to the U.S. dollar on our Euro-denominated accountsreceivable. We began separately reporting foreign exchange gain and losses in2005 as they have become material. We have reclassified prior year amounts toconform to the current year presentation.

*Losson long-term non-marketable security.**  *In the first quarter of 2004, wedetermined that our equity investment in a privately-held company had beenother than temporarily impaired, and, as a result, recorded a non-cash$5.0 million charge. Our decision was based on our evaluation of the privately-heldcompany’s current cash position and recent operating results, as well as theperceived inability of that company to obtain additional financing at a level,and in a timely manner, to support its continued operations.

*Debtconversion premium and transaction costs.**  *Debt conversion premium and transactioncosts of $2.0 million reflects debt conversion premium payments made of $1.9million to certain noteholders in June and July 2005 in negotiatedagreements to encourage early conversion of $29.0 of our 8% Secured ConvertibleNotes due June 2007 and $2.0 million of our 63⁄4% Convertible SubordinatedNotes due June 2009.  Of the totalpayment, $1.7 million was paid in cash and the balance was paid in the form of14,579 shares of our common stock with a fair value of $115,000. In addition,transactions costs were approximately $120,000 and consisted of investmentbanking and legal fees.

*Refinancingtransaction costs.**  *Transactioncosts relating to the refinancing of our debt in June 2004 were$2.2 million. These costs consisted primarily of investment bankingservices, legal and audit fees.

*Refinancingrelated interest expense.**  *We issued warrants to purchase a total of1.7 million shares of our common stock, at $5.55 per share, to the holdersof the 111¤2%  Senior Secured Notes due January 2005 aspartial consideration for the prepayment of these notes in June 2004. Thefair value of $2.1 million for these warrants has been charged tooperations as additional interest expense. Future interest on the 111¤2%Senior Secured Notes due January 2005 of $1.6 million, that hadoriginally been charged to the gain on bond exchanges in 2003 and was not paidas a result of the prepayment of these notes, was recorded as a reduction tothe additional interest expense associated with the refinancing. As a result,refinancing related interest expense, net was $0.5 million in 2004.

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*Income taxes.**  *We have not recorded an income taxbenefit for the tax losses associated with our operations in 2005 and 2004, aswe believe that it is more likely than not that these benefits will not berealized. Foreign income tax expense on the earnings of our foreignsubsidiaries was $93,000 and $50,000 in 2005 and 2004, respectively.

*Income from discontinuedoperations.**  *Wehad no income or loss from discontinued operations in 2005. Income fromdiscontinued operations of $1.9 million in 2004 relates to the expirationof certain contingent obligations associated with the sale of our former SpeechSolutions Business in 2002.

*Net loss.**  *Loss from continuing operations was$2.0 million in 2005 compared to a loss of $20.2 million in 2004.

Excluding debt conversionpremium and transaction costs of $2.0 million, loss from continuing operationswas $0.1 million in 2005. Excluding debt refinancing charges of$2.6 million and the loss on a long-term non-marketable security of$5.0 million, the loss from continuing operations in 2004 was$12.5 million. The improved profitability of $12.1 million in 2005compared to 2004, excluding debt conversion premium and transactions costs,refinancing charges and loss on a long-term non-marketable security, relates tothe proportionately lower level of costs and operating expenses on the higherlevel of revenues year-to-year.

**Liquidity and Capital Resources**

Our principal capital andliquidity needs historically have related to the development of our networkinfrastructure, our sales and marketing activities, research and developmentexpenses, and general capital needs. Our working capital needs have been met,in large part, from the net proceeds of public and private offerings of commonstock and issuances of convertible debt. In addition, we have also met ourcapital needs through capital equipment leases and other equipment financings.

Net cash provided byoperating activities was $23.4 million in 2006, compared to net cashprovided by operating activities of $12.2 million in 2005 and net cashused in operating activities of $7.2 million in 2004. Cash provided by operating activities in 2006was the result of the  loss of $2.2million offset by non-cash charges of $14.1million, and an increase in accountspayable, accrued expenses and deferred revenue of $35.6 million, partiallyoffset by an increase in accounts receivable of $21.7 million. The increases inaccounts receivable and accounts payable relate primarily to the growth inrevenue and traffic in 2006 over 2005. Accounts receivable days salesoutstanding were 43 days at December 31, 2006 compared to 41 days at December 31,2005. Cash provided by operating activities in 2005 of $12.2 million was aresult of the loss of $2.0 million, offset by non-cash charges of $8.2 million,and an increase in accounts payable, accrued expenses and deferred revenue of$20.7 million, partially offset by an increase in accounts receivable of $14.2million. Cash used in operating activities in 2004 of $7.2 million is a resultof the loss from continuing operations of $20.2 million, partially offset bynon-cash charges of $18.6 million. In addition, the increase in accountsreceivable of $12.5 million was partially offset by an increase in accountspayable, accrued expenses and deferred revenue of $8.0 million.

Net cash used in investingactivities in 2006 of $12.1 million included $10.5 million used forcapital expenditures and net purchases of $1.6 million of short-terminvestments. Our short-term investments are classified as available-for-saleand consist of securities that are readily convertible into cash, includinggovernment securities and commercial paper, with original maturities at thedate of acquisition ranging from 90 days to one year. At December 31,2006, $18.5 million of securities with maturities of less than one year wereclassified as short-term investments. Net cash used in investing activities in2005 of $2.4 million included $3.4 million used for capital expenditures, partiallyoffset by net maturities of short-term investments of $1.0 million.  Net cash used in investing activities in 2004of $18.7 million consisted of $3.3 million used for capital expendituresand $17.9 million in net purchases of short-term  investments.  In 

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2004, wealso received proceeds from an earn-out receivable and escrow payment of$1.0 million and $1.5 million, respectively, relating to the sale ofour former Speech Solutions Business.

Net cash used in financingactivities was $3.3 million in 2006 and included $2.3 million used to purchaseshares of our common stock under our stock repurchase program and $1.6 millionin capital equipment lease payments, partially offset by $0.6 million inproceeds from stock option exercises. In February of 2006, we expanded our previously announced program toallow for the purchase of up to a total of $15.0 million of our common stock. Inthe first quarter of 2006, we purchased 0.4 million shares of our common stockat a cost of $2.3 million, leaving $10.8 million available for future purchases.Since March 2006, we have not made any purchases of our common stock andwe have no current plans for any further purchases under this program. Net cashused in financing activities was $3.2 million in 2005 and consisted of debtconversion premium payments and transaction costs of $1.9 million, theredemption of the remaining $0.9 million of 53⁄4% Convertible Subordinated Noteson their maturity date in March 2005 and capital lease payments of $1.2million. During 2005, we received proceeds of $2.6 million from warrant andstock option exercises. In the fourth quarter of 2005, we repurchased 0.3million shares of our common stock at a cost of $1.9 million under our stockrepurchase program announced in October 2005 to purchase up to $5.0million of our common stock.

During 2005, we completedthe process of eliminating our long-term bond debt through a series of debtconversion transactions.  Thesetransactions have resulted in interest savings on an annualized basis ofapproximately $4.7 million. In June 2005, we negotiated (i) the earlyconversion of $9.1 million of our 8% Secured Convertible Notes due June 2007into 1.6 million shares of common stock at the conversion price of $5.55 percommon share and (ii) the early conversion of $2.0 million of our 63⁄4%Convertible Subordinated Notes due June 2009 into 0.4 million shares ofcommon stock at the conversion price of $5.55 per common share.  We paid a total of $0.7 million in premiums tothe noteholders to encourage the early conversion of these notes, of which $0.6million was paid in cash and the remaining $115,000 was paid in the form of14,579 shares of our common stock with a fair value of $0.1 million.  In addition, $1.2 million of our 63⁄4%Convertible Subordinated Notes due June 2009 voluntarily converted into0.2 million shares of common stock at the conversion price of $5.55 per share. Intotal, $12.3 million of notes were converted into 2.2 million shares of commonstock.

In July 2005, wenegotiated the early conversion of the remaining $19.9 million of our 8%Secured Convertible Notes due June 2007 into 3.6 million shares of commonstock at the stated conversion price of $5.55 per share. We paid a totalpremium of $1.2 million in cash to the noteholders to encourage the earlyconversion of these notes. In addition, transaction costs associated with thisearly conversion were $0.1 million and consisted primarily of investmentbanking fees.

From mid-August 2005through early September 2005, the remaining $32.6 million of our 63⁄4%Convertible Subordinated Notes due June 2009 were converted to shares ofour common stock at the stated conversion price of $5.55 per share. In mid-August 2005,we announced our intention to redeem all of these outstanding notes for cash atthe face value of the notes, plus accrued interest, with a planned redemptiondate of September 6, 2005. Prior to the redemption date, all of theholders elected to convert their notes to common stock at the stated conversionprice of $5.55 per share.

Net cash provided byfinancing activities was $29.5 million in 2004. In June 2004, wecompleted a refinancing of our outstanding debt obligations. As part of therefinancing, we completed an exchange offer, pursuant to which$37.3 million of our outstanding 53⁄4% Convertible Subordinated Notes due March 2005,representing approximately 98% of the total amount of these notes thenoutstanding, were tendered for the same principal amount of new 63⁄4% ConvertibleSubordinated Notes due June 2009. Approximately $0.9 million of the53⁄4% Convertible Subordinated Notes due March 2005 remained outstandingafter the exchange offer. Simultaneously with the exchange offer, we prepaidall $25.2 million of our existing 111⁄2% Senior Secured Notes due January 2005for cash equal to the principal amount plus 

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accruedbut unpaid interest and the issuance of warrants exercisable for an aggregateof 1.7 million shares of our common stock at $5.55 per share. We issued$29.0 million of new 8% Secured Convertible Notes due June 2007 ofwhich $25.2 million was used to prepay the 111⁄2% Senior Secured Notes due January 2005.Cash paid for transactions costs associated with the debt refinancing were$2.0 million. During the second half of 2004, holders of $1.3 millionof 63⁄4% Convertible Subordinated Notes due June 2009 voluntarily convertedtheir notes into 0.2 million shares of common stock at the conversionprice of $5.55 per share. In 2005, the remaining 63⁄4% Convertible SubordinatedNotes due June 2009 and the 8% Secured Convertible Notes due June 2007were converted into shares of our common stock at $5.55 per share, as describedabove.

In September 2004, wecompleted a private equity placement of 5.0 million shares of our common stockat $6.30 per share, for total gross proceeds of $31.5 million, to a groupof institutional and accredited investors. Investment banking fees and othercosts of the transaction were $1.3 million, resulting in net proceeds tous from the private equity placement of $30.2 million. The net proceedsfrom the private equity placement were used for working capital requirements,capital asset purchases and general corporate purposes. In addition in 2004, wereceived proceeds of $2.0 million from the exercise of warrants and stockoptions, made payments on capital leases of $2.2 million and paid down ourbank borrowings of $2.3 million.

In May 2007, we amendedcertain financial covenants and extended the maturity date of our revolvingline of credit with our bank from May 31, 2007 until July 30, 2007. The$15.0 million revolving line of credit bears interest at the bank’s primerate plus  1¤2% and iscollateralized by substantially all of our assets. Borrowings under the linemay also be used for letters of credit and foreign exchange contracts. Therevolving line of credit requires us to comply with various non-financial andfinancial covenants, including minimum profitability and liquidity and requiresus to maintain a minimum cash balance of $15.0 million with the bank, orbe subject to certain additional fees. We have received waivers ofnon-compliance of certain financial covenants from our bank for Q3 and Q4 of2006. At December 31, 2006 and 2005, we had no borrowings under our bankline of credit. At December 31, 2006, we had $2.7 million in letters ofcredit outstanding under our bank line of credit.

During 2005 and 2004, wefinanced $3.2 million and $1.8 million of capital expenditures, respectively,with lease financing. The majority of the capital lease obligations have athree year term.

On May 2, 2006, afterreceiving shareholder approval, we affected a one-for-three reverse stock splitof our issued and outstanding shares of common stock. On June 21, 2006,our common stock resumed trading on The Nasdaq Global Market under the stocksymbol “IBAS”, after we met the requirements for relisting on The Nasdaq GlobalMarket.

On June 30, 2006, the Federal CommunicationsCommission (“FCC”) issued an order requiring providers of prepaid calling cardsthat utilize IP to contribute to the Universal Service Fund (“USF”) and payaccess charges and other regulatory fees both in the future and for some priorperiod of time. In connection with our Retail business, we plan to absorb orpass along such future fees, to the extent permitted by law, which, based oncurrent traffic mix, equal approximately 1.8% of revenue. We have filed anappeal of the retroactive aspect of the FCC Order with the United States Courtof Appeals in Washington, D.C. In October 2006, we filed a motion to staythat aspect of the FCC Order pending the outcome of the appeal. On November 1,2006, the Court deferred ruling on the stay request pending the FCC’s ruling ona similar stay motion pending before the agency. The agency denied the stayrequest on March 29, 2007.  As of December 31,2006, we estimate that the maximum potential retroactive USF charge relating toour Retail business prior to the third quarter of the year ended December 31,2006 would be approximately $2.6 million.  If we are not successful with our appeal ofthe retroactive aspect of the FCC Order and are required to pay USF and otherfees on a retroactive basis, we do not believe we would be able to  recover these fees from our customers. Assuch, we would have to fund these fees up to 

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the estimated maximum retroactiveamount of $2.6 million. As the amount of retroactive fees are not probable ofbeing incurred, no amounts have been accrued as of December 31, 2006.

In 2006 we utilizedapproximately $3.2 million in net operating loss carry-forwards to offsettaxable income.  At December 31,2006, we had a deferred tax asset of approximately $125.1 million representingnet operating loss and tax credit carry-forwards available to us to offsetfuture potential taxable income. We have provided a full valuation allowanceagainst all of our deferred tax assets as of December 31, 2006.

We have incurredsubstantial expenses for legal, accounting, tax and other professional servicesin connection with the Special Committee investigation, our internal review ofour historical financial statements, the preparation of the restated financialstatements and the SEC investigation. These expenses were approximately $2.3million in 2006 and we have continued to incur significant expenses inconnection with these matters since December 31, 2006.

We anticipate that the December 31,2006 balance of $54.1 million in cash, cash equivalents and short-terminvestments, together with expected net cash flow generated from operations,will be sufficient to fund our operations and capital asset expenditures for atleast the next twelve months. We expect capital asset expenditures to bebetween $15 million and $20 million in 2007.

**Off-Balance Sheet Arrangements**

Under accountingprinciples generally accepted in the U.S., certain obligations and commitmentsare not required to be included in the consolidated balance sheets andstatements of operations. These obligations and commitments, while entered intoin the normal course of business, may have a material impact on liquidity. Wedo not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. As such, we are not exposed to any financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.

**Contractual Obligations**

Thefollowing table summarizes our future contractual obligations as of December 31,2006:

| ** **                 | ** ** | ** **              | ** ** | **Payment Due Dates** | ** ** |
|----------------------------|------------|-------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Total**               | ** ** | **Less than  1 Year** | ** ** | **1 to 2  Years** | ** ** | **2 to 3  Years** | ** ** | **3 to 5  Years** | ** ** | **After  5 Years** | ** ** |
| ** **                 | ** ** | **(In thousands)** | ** ** |
| Capital lease  obligations |       | $                       | 2,363      |                            |       | $ | 1,568 |   |   | $ | 795 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases           |       | 9,293                   |       |                            | 2,442      |   |   | 1,894 |   | 1,688 |   | 1,178 |   | 2,091 |   |
| Total                      |       | $                       | 11,656     |                            |       | $ | 4,010 |   |   | $ | 2,689 |   | $ | 1,688 |   | $ | 1,178 |   | $ | 2,091 |   |

 

**New Accounting Pronouncements**

In June 2006, theFASB issued Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes—an Interpretation of FASB Statement No. 109” (FIN 48). FIN 48prescribes a comprehensive model for the financial statement recognition,measurement, presentation and disclosure of uncertain tax positions taken orexpected to be taken in income tax returns. In particular, the Interpretationrequires that a tax benefit related to a given tax position be reflected in thefinancial statements only if it is more likely than not that it would besustained on its technical merits in the event of a tax audit. FIN 48 willbecome effective for us on January 1, 2007. The adoption of FIN 48 willnot have a material effect on our financial position, results of operations orcash flows.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted 

58

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accountingprinciples, and expands disclosures about fair value measurements.SFAS 157 does not require any new fair value measurements but may changecurrent practice for some entities. SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007 andinterim periods within those years. We do not believe that the adoption ofSAB 157 will have a material effect on our financial position, results ofoperations or cash flows.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities” (SFAS 159), which provides entities with the option tomeasure certain financial instruments and other items at fair value, whereas thoseitems are not currently required to be measured at fair value. SFAS 159 will beeffective for us on January 1, 2008. We are currently evaluating theimpact the adoption of  SFAS 159 will have on our financial position,results of operations or cash flows.

In September 2006,the Staff of the SEC issued Staff Accounting Bulletin No. 108, “*Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*”(“SAB 108”). SAB 108 provides guidance on the consideration of the effects ofprior year misstatements in quantifying current year misstatements for thepurpose of determining whether the current year’s financial statements arematerially misstated. SAB 108 was effective for fiscal years ended December 31,2006. The adoption of SAB 108 did not have any material effect on our financialposition, results of operations or cash flows.

**Item7A.**                *Quantitative and Qualitative Disclosures About Market Risk*

Our primary market riskexposure is related to interest rates and foreign currency exchange rates. Todate, we have not engaged in trading market risk sensitive instruments orpurchasing hedging instruments, whether interest rate, foreign currencyexchange, commodity price or equity price risk. We have not purchased optionsor entered into swaps or forward or futures contracts.

Our investments incommercial paper and debt instruments are subject to interest rate risk, butdue to the short-term nature of these investments, interest rates would nothave a material impact on their value at December 31, 2006. Our primaryinterest rate risk is the risk on borrowings under our bank line of credit,which is subject to interest rates based on the bank’s prime rate. We had noborrowings under our bank line of credit at December 31, 2006. A change inthe applicable interest rates would also affect the rate at which we couldborrow funds or finance equipment purchases. Our capital lease obligations arefixed rate debt. A 10% change in interest rates would not have a materialimpact on interest expense associated with our bank line of credit.

Although we conduct ourbusiness in various regions of the world, most of our revenues and costs aredenominated in U.S. dollars with the remaining being primarily denominated inEuros or British pounds. Thus, we are exposed to foreign currency exchange ratefluctuations as the financial results and balances of our foreign subsidiariesare translated into U.S. dollars. As exchange rates vary, these results, whentranslated, may vary from expectations and may adversely impact our results ofoperations and financial condition. Accordingly, if the dollar weakens relativeto foreign currencies, particularly the Euro or British Pound, our foreigncurrency-based denominated revenues and expenses would increase whenstated in U.S. Dollars. Conversely, if the dollar strengthens, our foreigncurrency denominated revenues and expenses would decrease. Based on our netrevenue for the year ended December 31, 2006, if the U.S. dollar hadweakened against the Euro and British Pound by 10%, our net revenue would haveincreased approximately 3%. Conversely, based on our net revenue for the yearended December 31, 2006, if the U.S. dollar had strengthened against theEuro and British Pound by 10%, our net revenue would have decreased byapproximately 3%. The impact of a 10% change in the exchange rate between theU.S. dollar and the Euro or British Pound would not have a material effect onour foreign currency denominated operating expenses.

59

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**Item 8.**                        *Financial Statements and Supplementary Data*

**Index to ConsolidatedFinancial Statements**

|                                                                                                                                                                                | ** ** | **Page** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **Consolidated Financial  Statements:**                                                                                                                                        |       |     |       |   |   |
| Report of Independent Registered Public Accounting  Firm                                                                                                                       |       |     | 61         |   |   |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005 (as restated)                                                                                          |       |     | 62         |   |   |
| Consolidated Statements of Operations for the Year  Ended December 31, 2006 (and years ended December 31, 2005 and  2004, as restated)                          |       |     | 63         |   |   |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the Year Ended December 31, 2006 (and years ended  December 31, 2005 and 2004, as restated) |       |     | 64         |   |   |
| Consolidated Statements of Cash Flows for the Year  Ended December 31, 2006 (and years ended December 31, 2005 and  2004, as restated)                          |       |     | 65         |   |   |
| Notes to Consolidated Financial Statements                                                                                                                                     |       |     | 66         |   |   |

 

60

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders of iBasis, Inc.:

We have audited theaccompanying consolidated balance sheets of iBasis, Inc. andsubsidiaries (the “Company”) as of December 31, 2006 and December 31,2005, and the related consolidated statements of operations, shareholders’equity (deficit), and cash flows for each of the three years in the periodended December 31, 2006. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of December 31, 2006 and December 31, 2005, and the results of itsoperations and its cash flows for each of the three years in the period ended December 31,2006, in conformity with accounting principles generally accepted in the UnitedStates of America.

As discussed in Note 2 to the consolidated financialstatements, the Company adopted Statement of Financial Accounting Standards No. 123(R), *“Share-Based Payment,”*on January 1,2006.

As discussed in Note 3 to the consolidated financialstatements, the accompanying 2005 and 2004 consolidated financial statementshave been restated.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006, based on* *the criteria established in*Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated June 11, 2007, expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Boston, MassachusettsJune 11, 2007

61

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**iBasis, Inc.**

**ConsolidatedBalance Sheets**

| ** **                                                                                                                      | ** ** | **December 31,**                                          | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2006**                                                       | ** ** | **2005** | ** ** |
| ** **                                                                                                                      | ** ** | ** **                                                     | ** ** | **(as restated)(1)** | ** ** |
| ** **                                                                                                                      | ** ** | **(In thousands, except  per share data)** | ** ** |
| **Assets**                                                                                                                      |       |                                                           |       |   |   |   |   |
| Current assets:                                                                                                                 |       |                                                           |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                      |       | $                                                              | 35,525     |   |   | $ | 27,478 |   |   |
| Short-term  marketable investments                                                                                              |       | 18,546                                                         |       |   | 16,936 |   |   |
| Accounts receivable, net  of allowance for doubtful accounts of $3,803 and $2,507, respectively                            |       | 65,135                                                         |       |   | 47,321 |   |   |
| Prepaid expenses and  other current assets                                                                                      |       | 4,190                                                          |       |   | 2,676 |   |   |
| Total current assets                                                                                                            |       | 123,396                                                        |       |   | 94,411 |   |   |
| Property and equipment, at cost:                                                                                                |       |                                                           |       |   |   |   |   |
| Network equipment                                                                                                               |       | 38,696                                                         |       |   | 53,434 |   |   |
| Equipment under capital  lease                                                                                                  |       | 4,917                                                          |       |   | 4,917 |   |   |
| Computer software                                                                                                               |       | 9,837                                                          |       |   | 10,353 |   |   |
| Leasehold improvements                                                                                                          |       | 4,867                                                          |       |   | 6,697 |   |   |
| Furniture and fixtures                                                                                                          |       | 848                                                            |       |   | 1,049 |   |   |
|                                                                                                                            |       | 59,165                                                         |       |   | 76,450 |   |   |
| Less—Accumulated  depreciation and amortization                                                                            |       | (45,307                                                        | )          |   | (65,033 | ) |   |
|                                                                                                                            |       | 13,858                                                         |       |   | 11,417 |   |   |
| Other assets                                                                                                                    |       | 410                                                            |       |   | 323 |   |   |
|                                                                                                                            |       | $                                                              | 137,664    |   |   | $ | 106,151 |   |   |
| **Liabilities and Stockholders’  Equity**                                                                                  | ** ** | ** **                                                     | ** ** |   |   |   |   |
| Current liabilities:                                                                                                            |       |                                                           |       |   |   |   |   |
| Accounts payable                                                                                                                |       | $                                                              | 48,638     |   |   | $ | 27,796 |   |   |
| Accrued expenses                                                                                                                |       | 37,302                                                         |       |   | 24,705 |   |   |
| Deferred revenue                                                                                                                |       | 10,709                                                         |       |   | 9,517 |   |   |
| Current portion of long-term  debt                                                                                              |       | 1,462                                                          |       |   | 1,598 |   |   |
| Total current  liabilities                                                                                                      |       | 98,111                                                         |       |   | 63,616 |   |   |
| Long-term debt,  net of current portion                                                                                         |       | 755                                                            |       |   | 2,216 |   |   |
| Other long-term  liabilities                                                                                                    |       | 1,417                                                          |       |   | 916 |   |   |
| Commitments and contingencies (Note 12)                                                                                         |       |                                                           |       |   |   |   |   |
| Stockholders’ equity (deficit):                                                                                            |       | —                                                         |       |   | — |   |   |
| Preferred stock, $0.001  par value, authorized 15,000 shares; issued and outstanding; none                                 |       | —                                                         |       |   | — |   |   |
| Common stock, $0.001 par  value, authorized—170,000 shares; issued—34,286 and 34,112 shares,  respectively; |       | 34                                                             |       |   | 34 |   |   |
| Treasury stock, 1,069  and 691 shares, respectively, at cost                                                                    |       | (4,358                                                         | )          |   | (2,091 | ) |   |
| Additional paid-in  capital                                                                                                     |       | 485,940                                                        |       |   | 483,771 |   |   |
| Deferred compensation                                                                                                           |       | —                                                         |       |   | (250 | ) |   |
| Accumulated other  comprehensive income (loss)                                                                                  |       | 3                                                              |       |   | (17 | ) |   |
| Accumulated deficit                                                                                                             |       | (444,238                                                       | )          |   | (442,044 | ) |   |
| Total stockholders’  equity                                                                                                |       | 37,381                                                         |       |   | 39,403 |   |   |
|                                                                                                                            |       | $                                                              | 137,664    |   |   | $ | 106,151 |   |   |

----

(1)          See Note 3, “Restatementof Consolidated Financial Statements,” of the Notes to Consolidated FinancialStatements.

*The accompanying notes are an integral part of these consolidated financial statements.*

62

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**iBasis, Inc.**

**ConsolidatedStatements of Operations**

| ** **                                                                             | ** ** | **Years Ended December 31,**                        | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                             | ** ** | ** **                                                         | ** ** | **(as restated)(1)** | ** ** | **(as restated)(1)** | ** ** |
| ** **                                                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| Net revenue                                                                            |       | $                                                                  | 511,083    |   |   | $ | 385,485 |   |   |   | $ | 263,678 |   |   |
| Costs and operating expenses:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |
| Data  communications and telecommunications (excluding depreciation and  amortization) |       | 447,697                                                            |       |   | 336,152 |   |   |   | 225,169 |   |   |
| Research and  development                                                              |       | 13,498                                                             |       |   | 12,568 |   |   |   | 14,013 |   |   |
| Selling and  marketing                                                                 |       | 16,347                                                             |       |   | 11,712 |   |   |   | 9,351 |   |   |
| General and  administrative                                                            |       | 25,062                                                             |       |   | 15,543 |   |   |   | 13,162 |   |   |
| Depreciation and  amortization                                                         |       | 7,055                                                              |       |   | 6,507 |   |   |   | 10,437 |   |   |
| Write-off of  leasehold improvements                                                   |       | 1,047                                                              |       |   | — |   |   |   | — |   |   |
| Restructuring  costs                                                                   |       | 1,272                                                              |       |   | 218 |   |   |   | 165 |   |   |
| Merger related  expenses                                                               |       | 2,996                                                              |       |   | — |   |   |   | — |   |   |
| Total costs and operating expenses                                                     |       | 514,974                                                            |       |   | 382,700 |   |   |   | 272,297 |   |   |
| (Loss) income  from operations                                                         |       | (3,891                                                             | )          |   | 2,785 |   |   |   | (8,619 | ) |   |
| Interest income                                                                        |       | 1,887                                                              |       |   | 1,109 |   |   |   | 218 |   |   |
| Interest expense                                                                       |       | (337                                                               | )          |   | (2,601 | ) |   |   | (4,249 | ) |   |
| Other expenses,  net                                                                   |       | (188                                                               | )          |   | (324 | ) |   |   | (184 | ) |   |
| Loss on long-term  non-marketable security                                             |       | —                                                             |       |   | — |   |   |   | (5,000 | ) |   |
| Foreign exchange  gain (loss)                                                          |       | 372                                                                |       |   | (939 | ) |   |   | 339 |   |   |
| Debt conversion  premium and transaction costs                                         |       | —                                                             |       |   | (1,975 | ) |   |   | — |   |   |
| Debt refinancing  charges:                                                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Transaction costs                                                                      |       | —                                                             |       |   | — |   |   |   | (2,159 | ) |   |
| Additional interest expense, net                                                       |       | —                                                             |       |   | — |   |   |   | (481 | ) |   |
| Loss before taxes  from continuing operations                                          |       | (2,157                                                             | )          |   | (1,945 | ) |   |   | (20,135 | ) |   |
| Income tax  expense                                                                    |       | (37                                                                | )          |   | (93 | ) |   |   | (50 | ) |   |
| Loss from  continuing operations                                                       |       | (2,194                                                             | )          |   | (2,038 | ) |   |   | (20,185 | ) |   |
| Income from  discontinued operations                                                   |       | —                                                             |       |   | — |   |   |   | 1,861 |   |   |
| Net loss                                                                               |       | $                                                                  | (2,194     | ) |   | $ | (2,038 | ) |   |   | $ | (18,324 | ) |   |
| Basic and diluted net  loss per share:                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                                                       |       | $                                                                  | (0.07      | ) |   | $ | (0.08 | ) |   |   | $ | (1.20 | ) |   |
| Income from  discontinued operations                                                   |       | —                                                             |       |   | — |   |   |   | 0.11 |   |   |
| Net loss per  share                                                                    |       | $                                                                  | (0.07      | ) |   | $ | (0.08 | ) |   |   | $ | (1.09 | ) |   |
| Basic and diluted  weighted average common shares outstanding                          |       | 33,198                                                             |       |   | 26,745 |   |   |   | 16,838 |   |   |

----

(1)          See Note 3, “Restatementof Consolidated Financial Statements,” of the Notes to Consolidated FinancialStatements.

*The accompanying notes are an integral part of these consolidated financial statements.*

63

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**iBasis, Inc.**

**Consolidated Statements of Stockholders’ Equity(Deficit)**

**(as restated)(1)**

| ** **                                                                          | ** ** | **Common Stock**   | ** ** | **Treasury Stock** | ** ** | ** **             | ** ** | ** ** | ** ** | ** **                       | ** ** | **Accumulated**            | ** ** | **Total**                | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                                                          | ** ** | **Number  of  Shares**  | ** ** | **$0.001  Par  Value**  | ** ** | **Number  of  Shares** | ** ** | **Amount** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Loss** | ** ** | **Stockholders’  Equity  (Deficit)** | ** ** |
| ** **                                                                          | ** ** | **(In thousands)** | ** ** |
| Balance,  December 31, 2003 (as previously reported)                           |       | 15,305                  |       |                    | $          | 15                     |       |       |       | (378                             | )          |                       | $          | (341                     | )          |   | $ | 370,424 |   |   |   | $ | — |   |   |   | $ | (412,206 | ) |   |   | $ | — |   |   |   | $ | (42,108 | ) |   |
| Adjustments to  beginning stockholders’ deficit in connection with restatement |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 9,426      |   |   |   | (523 | ) |   |   | (9,476 | ) |   |   | — |   |   |   | (573 | ) |   |
| Balance,  December 31, 2003 (as restated)                                      |       | 15,305                  |       |                    | 15         |                   |       |       | (378       | )                                |       | (341                       | )          |                     | 379,850    |   |   |   | (523 | ) |   |   | (421,682 | ) |   |   | — |   |   |   | (42,681 | ) |   |
| Net loss                                                                            |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | (18,324 | ) |   |   | — |   |   |   | (18,324 | ) |   |
| Unrealized loss on  available-for-sale short-term investments                       |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | — |   |   |   | (12 | ) |   |   | (12 | ) |   |
| Total  comprehensive loss                                                           |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (18,336 | ) |   |
| Gross proceeds  from sale of common stock in private placement                      |       | 5,000                   |       |                    | 5          |                   |       |       | —     |                             |       | —                     |       |                     | 31,495     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 31,500 |   |   |
| Cash transaction  costs of private placement                                        |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | (1,310     | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,310 | ) |   |
| Fair value of  warrant issued for investment banking services                       |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | (2,808     | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,808 | ) |   |
| Issuance of  warrant for investment banking services                                |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 2,808      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 2,808 |   |   |
| Common stock  issued as partial payment of investment banking fees                  |       | 37                      |       |                    |       |                   |       |       | —     |                             |       | —                     |       |                     | 175        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 175 |   |   |
| Exercise of common  stock options                                                   |       | 169                     |       |                    |       |                   |       |       | —     |                             |       | —                     |       |                     | 455        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 455 |   |   |
| Exercise of  warrants                                                               |       | 840                     |       |                    | 1          |                   |       |       | —     |                             |       | —                     |       |                     | 1,461      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,462 |   |   |
| Fair value of  warrants issued in debt refinancing                                  |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 2,140      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 2,140 |   |   |
| Conversion of 63¤4%                                                            |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Convertible  Subordinated Notes due June 2009 converted to common stock        |       | 242                     |       |                    | 1          |                   |       |       | —     |                             |       | —                     |       |                     | 1,340      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,341 |   |   |
| Increase in  deferred compensation                                                  |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 456        |   |   |   | (456 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of  deferred compensation                                              |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | 503 |   |   |   | — |   |   |   | — |   |   |   | 503 |   |   |
| Reduction in  deferred compensation for terminations                                |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | (44        | ) |   |   | 44 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Balance,  December 31, 2004                                                    |       | 21,593                  |       |                    | 22         |                   |       |       | (378       | )                                |       | (341                       | )          |                     | 416,018    |   |   |   | (432 | ) |   |   | (440,006 | ) |   |   | (12 | ) |   |   | (24,751 | ) |   |
| Net loss                                                                            |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | (2,038 | ) |   |   | — |   |   |   | (2,038 | ) |   |
| Unrealized loss on  available-for-sale short-term investments                       |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | — |   |   |   | (5 | ) |   |   | (5 | ) |   |
| Total  comprehensive loss                                                           |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (2,043 | ) |   |
| Exercise of common  stock options.                                                  |       | 79                      |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 244        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 244 |   |   |
| Exercise of  warrants                                                               |       | 739                     |       |                    | 1          |                   |       |       | —     |                             |       | —                     |       |                     | 2,421      |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 2,422 |   |   |
| Convertible  Subordinated Notes due June 2009 converted to common stock        |       | 6,476                   |       |                    | 6          |                   |       |       | —     |                             |       | —                     |       |                     | 35,938     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 35,944 |   |   |
| Secured  Convertible Notes due June 2007 converted to common stock             |       | 5,225                   |       |                    | 5          |                   |       |       | —     |                             |       | —                     |       |                     | 28,995     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 29,000 |   |   |
| Common shares  issued as payment of debt conversion premium.                        |       | —                  |       |                    | —     |                   |       |       | 15         |                             |       | 115                        |       |                     | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 115 |   |   |
| Repurchases of  common stock                                                        |       | —                  |       |                    | —     |                   |       |       | (328       | )                                |       | (1,865                     | )          |                     | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,865 | ) |   |
| Increase in  deferred compensation                                                  |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 176        |   |   |   | (176 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Amortization of  deferred compensation                                              |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     |       |   |   |   | 337 |   |   |   | — |   |   |   | — |   |   |   | 337 |   |   |
| Reduction in  deferred compensation for terminations                                |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | (21        | ) |   |   | 21 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Balance,  December 31, 2005                                                    |       | 34,112                  |       |                    | 34         |                   |       |       | (691       | )                                |       | (2,091                     | )          |                     | 483,771    |   |   |   | (250 | ) |   |   | (442,044 | ) |   |   | (17 | ) |   |   | 39,403 |   |   |
| Net loss                                                                            |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | (2,194 | ) |   |   | — |   |   |   | (2,194 | ) |   |
| Unrealized gain on  available-for-sale short-term investments                       |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | — |   |   |   | 19 |   |   |   | 19 |   |   |
| Translation  adjustment                                                             |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | —     |   |   |   | — |   |   |   | — |   |   |   | 1 |   |   |   | 1 |   |   |
| Total  comprehensive loss                                                           |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (2,174 | ) |   |
| Exercise of common  stock options                                                   |       | 174                     |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 590        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 590 |   |   |
| Fair value of  warrant issued for investment advisory services                      |       | —                  |       |                    | —     |                   |       |       | —     |                             |       | —                     |       |                     | 162        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 162 |   |   |
| Repurchases of  common stock                                                        |       | —                  |       |                    | —     |                   |       |       | (378       | )                                |       | (2,267                     | )          |                     | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,267 | ) |   |
| Elimination of  deferred compensation                                               |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     | (250       | ) |   |   | 250 |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Stock-based  compensation                                                           |       |                    |       |                    |       |                   |       |       |       |                             |       |                       |       |                     | 1,667      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 1,667 |   |   |
| Balance,  December 31, 2006                                                    |       | 34,286                  |       |                    | $          | 34                     |       |       |       | (1,069                           | )          |                       | $          | (4,358                   | )          |   | $ | 485,940 |   |   |   | $ | — |   |   |   | $ | (444,238 | ) |   |   | $ | 3 |   |   |   | $ | 37,381 |   |   |

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(1)               See Note 3, “Restatement of Consolidated FinancialStatements,” of the Notes to Consolidated Financial Statements.

*The accompanying notes are an integral part of these consolidated financial statements.*

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**iBasis, Inc.**

**ConsolidatedStatements of Cash Flows**

| ** **                                                                                          | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | ** **                                  | ** ** | **(as restated)(1)** | ** ** | **(as restated)(1)** | ** ** |
| ** **                                                                                          | ** ** | **(In thousands)**                     | ** ** |
| Cash flows from operating activities:                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                            |       | $                                           | (2,194     | ) |   | $ | (2,038 | ) |   |   | $ | (18,324 | ) |   |
| Income from  discontinued operations                                                                |       | —                                      |       |   | — |   |   |   | (1,861 | ) |   |
| Loss from  continuing operations                                                                    |       | (2,194                                      | )          |   | $ | (2,038 | ) |   |   | (20,185 | ) |   |
| Adjustments to reconcile  loss from continuing operations to net cash used in operating activities: |       |                                        |       |   |   |   |   |   |   |   |   |
| Restructuring  costs                                                                                |       | 1,414                                       |       |   | 218 |   |   |   | 165 |   |   |
| Depreciation and  amortization                                                                      |       | 7,055                                       |       |   | 6,507 |   |   |   | 10,437 |   |   |
| Amortization of  deferred debt financing costs                                                      |       | —                                      |       |   | 177 |   |   |   | 149 |   |   |
| Amortization of  discount on short-term marketable securities                                       |       | (2                                          | )          |   | (45 | ) |   |   | — |   |   |
| Non-cash debt conversion  premium                                                                   |       | —                                      |       |   | 115 |   |   |   | — |   |   |
| Stock-based  compensation and services                                                              |       | 1,829                                       |       |   | 337 |   |   |   | 503 |   |   |
| Write-off of  leasehold improvements                                                                |       | 1,047                                       |       |   | — |   |   |   | — |   |   |
| Loss on long-term  non-marketable security                                                          |       | —                                      |       |   | — |   |   |   | 5,000 |   |   |
| Fair value of  warrant issued in debt refinancing                                                   |       | —                                      |       |   | — |   |   |   | 2,140 |   |   |
| Allowance for  doubtful accounts                                                                    |       | 3,847                                       |       |   | 850 |   |   |   | 250 |   |   |
| Changes in current assets  and liabilities:                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Accounts  receivable, net                                                                           |       | (21,661                                     | )          |   | (14,190 | ) |   |   | (12,464 | ) |   |
| Prepaid expenses  and other current assets                                                          |       | (1,514                                      | )          |   | (256 | ) |   |   | 124 |   |   |
| Other assets                                                                                        |       | (87                                         | )          |   | 37 |   |   |   | 345 |   |   |
| Accounts payable                                                                                    |       | 20,835                                      |       |   | 3,443 |   |   |   | 4,438 |   |   |
| Deferred revenue                                                                                    |       | 1,192                                       |       |   | 3,214 |   |   |   | 5,886 |   |   |
| Accrued expenses                                                                                    |       | 11,183                                      |       |   | 13,997 |   |   |   | (2,328 | ) |   |
| Other long-term  liabilities                                                                        |       | 501                                         |       |   | (216 | ) |   |   | (1,617 | ) |   |
| Net cash provided  by (used in) continuing operating activities                                     |       | 23,445                                      |       |   | 12,150 |   |   |   | (7,157 | ) |   |
| Cash flows from investing activities:                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Purchases of  property and equipment                                                                |       | (10,536                                     | )          |   | (3,441 | ) |   |   | (3,266 | ) |   |
| Purchases of  available-for-sale short-term marketable investments                                  |       | (39,914                                     | )          |   | (28,234 | ) |   |   | (18,534 | ) |   |
| Maturities of  available-for-sale short-term marketable investments                                 |       | 38,325                                      |       |   | 29,235 |   |   |   | 625 |   |   |
| Proceeds from sale  of Speech Solutions business                                                    |       |                                        |       |   | — |   |   |   | 1,500 |   |   |
| Proceeds from earn-out  relating to sale of Speech Solutions business                               |       |                                        |       |   | — |   |   |   | 1,009 |   |   |
| Net cash used in  investing activities                                                              |       | (12,125                                     | )          |   | (2,440 | ) |   |   | (18,666 | ) |   |
| Cash flows from financing activities:                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Redemption of 53¤4% Convertible Subordinated Notes                                             |       | —                                      |       |   | (895 | ) |   |   | — |   |   |
| Proceeds from sale  of common stock in private placement                                            |       | —                                      |       |   | — |   |   |   | 31,500 |   |   |
| Transaction costs  of private placement                                                             |       | —                                      |       |   | — |   |   |   | (1,310 | ) |   |
| Proceeds from  issuance of 8% Secured Convertible Notes due June 2007                          |       | —                                      |       |   | — |   |   |   | 29,000 |   |   |
| Prepayment of 111¤2% 8% Senior Secured Notes due January 2005                             |       | —                                      |       |   | — |   |   |   | (25,175 | ) |   |
| Bank borrowings                                                                                     |       | —                                      |       |   | — |   |   |   | 4,600 |   |   |
| Repayments of bank  borrowings                                                                      |       | —                                      |       |   | — |   |   |   | (6,900 | ) |   |
| Payments of  principal on capital lease obligations                                                 |       | (1,597                                      | )          |   | (1,206 | ) |   |   | (2,167 | ) |   |
| Debt conversion  premium and transaction costs                                                      |       | —                                      |       |   | (1,860 | ) |   |   | — |   |   |
| Transaction costs  of debt refinancing and exchange of debt                                         |       | —                                      |       |   | — |   |   |   | (1,984 | ) |   |
| Repurchases of  common stock                                                                        |       | (2,267                                      | )          |   | (1,865 | ) |   |   | — |   |   |
| Proceeds from  exercise of warrants                                                                 |       | —                                      |       |   | 2,422 |   |   |   | 1,462 |   |   |
| Proceeds from exercise  of common stock options                                                     |       | 590                                         |       |   | 244 |   |   |   | 455 |   |   |
| Net cash (used in)  provided by financing activities                                                |       | (3,274                                      | )          |   | (3,160 | ) |   |   | 29,481 |   |   |
| Effect of changes  in exchange rates on cash                                                        |       | 1                                           |       |   | — |   |   |   | — |   |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | 8,047                                       |       |   | 6,550 |   |   |   | 3,658 |   |   |
| Cash and cash  equivalents, beginning of year                                                       |       | 27,478                                      |       |   | 20,928 |   |   |   | 17,270 |   |   |
| Cash and cash  equivalents, end of year                                                             |       | $                                           | 35,525     |   |   | $ | 27,478 |   |   |   | $ | 20,928 |   |   |
| Supplemental disclosure of cash flow information:                                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| Cash paid during  the year for interest                                                             |       | $                                           | 337        |   |   | $ | 2,651 |   |   |   | $ | 7,198 |   |   |
| Supplemental disclosure of non-cash investing  and financing activities:                            |       |                                        |       |   |   |   |   |   |   |   |   |
| Conversion of 63¤4% Convertible Subordinated Notes to common stock                             |       | $                                           | —     |   |   | $ | 35,944 |   |   |   | $ | 1,341 |   |   |
| Conversion of 8¤4% Secured Convertible Notes to common  stock                                  |       | $                                           | —     |   |   | $ | 29,000 |   |   |   | $ | — |   |   |
| Face value of 53¤4% Convertible Subordinated Notes due March 2005  surrendered            |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 37,285 |   |   |
| Face value of 6 3¤4% Convertible Subordinated Notes due  June 2009 issued            |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 37,285 |   |   |
| Common stock  issued as partial payment of investment banking fees                                  |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 175 |   |   |
| Exercise of  warrant issued to bank on net basis                                                    |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 114 |   |   |
| Fair value of  warrant issued for investment banking services                                       |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 2,808 |   |   |
| Equipment acquired  under capital lease obligations                                                 |       | $                                           | —     |   |   | $ | 3,151 |   |   |   | $ | 1,765 |   |   |
| Equipment acquired  under operating lease obligations                                               |       | $                                           | —     |   |   | $ | — |   |   |   | $ | 577 |   |   |

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(1)              See Note 3, “Restatement ofConsolidated Financial Statements,” of the Notes to Consolidated FinancialStatements.

*The accompanying notes are an integral part of these consolidated financial statements.*

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**iBasis, Inc.Notes to Consolidated Financial Statements**

**(1)**          Business

***Business******—******We***are aleading provider of international communications services and a provider ofretail prepaid calling services. Our operations consist of our Voice-Over-Internet-Protocol(“VoIP”) trading business (“Trading”), in which we connect buyers and sellersof international telecommunications services, and our retail services business(“Retail”). In the Trading business we receive voice traffic from buyers—originatingcarriers who are interconnected to our network via VoIP or traditional timedivision multiplexing (“TDM”) connections, and we route that traffic over theInternet to sellers—local carriers in the destination countries with whom wehave established agreements to manage the completion or termination of thecall. We use proprietary, patent-pending technology to automate theselection of routes and termination partners based on a variety of performance,quality, and business metrics. We offer this Trading  service on a wholesale basis to carriers,telephony resellers and other service providers worldwide. We have calltermination agreements with local service providers in North America, Europe,Asia, the Middle East, Latin America, Africa and Australia. Our Retail businesswas launched in late 2003, with the introduction of our retail prepaid callingcards which are marketed through distributors primarily to ethnic communitieswithin major metropolitan markets in the U.S. In September 2004, welaunched a prepaid calling service, Pingo® , offered directly to consumersthrough an Internet website on a prepaid basis, which we have included in ourRetail business segment. To date, revenues from our Pingo services have notbeen material.

***ProposedTransaction with KPN Telecom B.V., a subsidiary of Royal KPN N.V.******—******On***June 21,2006, we announced the signing of a definitive agreement to merge theinternational wholesale voice business of Royal KPN N.V. (“KPN”) into iBasis. Pursuantto the Share Purchase and Sale Agreement, we will acquire KPN’s subsidiary KPNGlobal Carrier Services and receive $55 million in cash in exchange fornewly-issued shares of our common stock representing, on a post-issuance basis,51% of our issued and outstanding shares of common stock and outstandingin-the-money stock options and warrants, or approximately 40 million shares. Asof December 31, 2006, the newly-issued shares to KPN would representapproximately 55% of our issued and outstanding common shares. Our shareholdersof record immediately prior to closing will receive a cash dividend of $113million as soon as practicable following closing. In connection with payment ofthe dividend, we will adjust the exercise price and number of shares to beissued upon exercise of our outstanding common stock options to preserve theirvalue.

On April 27, 2007, we announced that the Companyand KPN had amended the Share Purchase and Sale Agreement to extend the outsidedate for completion of the transaction to October 31, 2007. Previously, inDecember 2006, we announced that the Company and KPN had extended theoutside date for completion of the transaction from December 31, 2006 to April 30,2007. The proposed transaction is subject to customary closing conditions andthe approval of iBasis shareholders.

Although we will belegally acquiring KPN Global Carrier Services, after the transaction iscompleted the former sole stockholder of KPN Global Carrier Services (asubsidiary of KPN), will hold a majority of our outstanding common stock. Accordingly,for accounting and financial statement purposes, the transaction will betreated as an acquisition of iBasis by KPN Global Carrier Services under thepurchase method of accounting. Under the purchase method of accounting, ourassets and liabilities will be, as of the closing date of the transaction,recorded at their fair value and added to the assets and liabilities of KPNGlobal Carrier Services, including an amount for goodwill representing thedifference between the deemed purchase price of iBasis and the fair value of ouridentifiable net assets.  We have incurred merger related expenses of$3.0 million through December 31, 2006, consisting primarily of investmentbanking 

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advisory services, legal and accounting fees. Suchamounts have been expensed because we are the accounting acquiree.

**(2)**          Summaryof Significant Accounting Policies

***Principles ofConsolidation******—******The***accompanyingconsolidated financial statements include the accounts of iBasis, Inc. andits subsidiaries. All intercompany balances and transactions have been eliminatedon consolidation.

***Use of Estimates******—******The***preparationof these financial statements and related disclosures in conformity withaccounting principles generally accepted in the United States of Americarequires us to (i) make judgments, assumptions and estimates that affectthe reported amounts of assets, liabilities, revenue and expenses; and (ii) disclosecontingent assets and liabilities. We base our accounting estimates onhistorical experience and other factors that we consider reasonable under the circumstances.Actual results and outcomes may differ from our estimates and assumptions.

***Foreign CurrencyTranslation and Transactions******—******The***functionalcurrency of our foreign subsidiaries is the local currency. For the purposes ofpresenting the consolidated financial statements, the functional currencies ofour foreign subsidiaries have been converted into U.S. dollars for balancesheet accounts using the exchange rate in effect at the balance sheet date, andfor revenue and expense accounts using an average exchange rate for therespective periods. The gains or losses resulting from such translations werenot material since the majority of our business is carried out by our U.S.operations.   Transactions in foreigncurrency are recorded at the original rates of exchange in force at the timethe transactions are effected. Exchange differences arising on settlement oftransactions are recognized in results of operations.

***Revenue Recognition******—******For***ourTrading services our revenue transactions are derived from the resale ofinternational minutes of calling time. We recognize revenue in the period theservice is provided, net of revenue reserves for potential billing disputes,provided the collection of amounts billed is reasonably assured. Disputes canresult from disagreements with customers regarding the duration, destination orrates charged for each call. For our Retail services, revenue is deferred uponactivation of the cards, or purchase of the calling service, and is recognizedas the prepaid calling card balances, or purchased calling services, arereduced based upon minute usage and service charges. Revenue for both ourTrading and Retail services is recognized when all of the following criteriaare met: persuasive evidence of an arrangement exists, delivery has occurred orservices have been rendered, the seller’s price to the buyer is fixed ordeterminable and collectibility is reasonably assured.

***Net Loss Per Share******—******Basic*** anddiluted net loss per common share are determined by dividing net loss by theweighted average common shares outstanding during the period. Basic net lossper share and diluted net loss per share are the same for all periodspresented, as outstanding common stock options, common shares to be issued uponconversion of the Company’s convertible notes and warrants to purchase commonshares are anti-dilutive.

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Thefollowing have been excluded from the computation of basic and diluted weightedaverage common shares for the periods presented:

| ** **                                                                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                  | ** ** | **(In thousands)**                     | ** ** |
| Stock options to  purchase common shares                                                                                    |       | 2,404                                       |       | 2,102 |   | 2,190 |   |
| Warrants to  purchase common shares, issued in connection with the prepayment of the 111¤2%  Senior Secured Notes      |       | 1,459                                       |       | 1,459 |   | 1,725 |   |
| Warrants to  purchase common shares, issued in connection with the issuance of the 111¤2%  Senior Secured Notes        |       | 422                                         |       | 422 |   | 889 |   |
| Warrants to  purchase common shares issued for investment banking services in connection  with the private equity placement |       | 573                                         |       | 573 |   | 578 |   |
| Warrants to  purchase common shares issued for investment banking advisory services                                         |       | 67                                          |       | — |   | — |   |
| Common shares to  be issued upon conversion of the 63¤4%  Convertible Subordinated Notes                               |       | —                                      |       | — |   | 6,476 |   |
| Common shares to  be issued upon conversion of the 8% Secured Convertible Notes                                             |       | —                                      |       | — |   | 5,225 |   |
| Common shares to  be issued upon conversion of the 53¤4%  Convertible Subordinated Notes                               |       | —                                      |       | — |   | 3 |   |
| Total common shares  excluded                                                                                               |       | 4,925                                       |       | 4,556 |   | 17,086 |   |

 

***Other ComprehensiveIncome (Loss)******—******We***reportcomprehensive income (loss) in accordance with Statement of FinancialAccounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS 130”).Unrealized gains and losses on our short-term marketable investments andtranslation adjustments were the only differences between reported net loss andtotal comprehensive loss. Translation adjustments were not material in 2006, 2005and 2004.

***Cash and CashEquivalents******—******We***considerhighly liquid investments purchased with an original maturity of 90 daysor less at the time of purchase to be cash equivalents. Cash equivalentsinclude money market accounts and commercial paper that are readily convertibleinto cash.

***Short-termmarketable investments******—******Our***investmentsat December 31, 2006, are classified as available-for-sale and carried atfair value. These investments consist of securities that are readilyconvertible into cash, including government securities and commercial paper,with original maturities at the date of acquisition ranging from 90 daysto one year.

Short-termmarketable investments consist of:

| ** **                            | ** ** | **December 31,**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2006**                | ** ** | **2005** | ** ** |
| **Description of Security** | ** ** | ** **              | ** ** | **Fair  Value** | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Government  securities                |       | $                       | 1,986      |   |   | $ | — |   |   | $ | 5,402 |   |   | $ | (7 | ) |   |
| Commercial paper  and corporate bonds |       | 16,560                  |       |   | 2 |   |   | 11,534 |   |   | (10 | ) |   |
| Total                                 |       | $                       | 18,546     |   |   | $ | 2 |   |   | $ | 16,936 |   |   | $ | (17 | ) |   |
|                                       |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2006 and 2005, the unrealizedgain (loss) on our short-term marketable securities is a component of other comprehensiveincome (loss).

***Property andEquipment******—******Property***andequipment are stated at cost. Assets under capital leases are recorded at thepresent value of minimum lease payments. These assets are depreciated over thelesser of 

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the lease term or theestimated useful lives of the assets using the straight-line method.Significant improvements and betterments are capitalized if they extend theuseful life of the asset. Routine repairs and maintenance are expensed whenincurred.

Forassets that have been placed in service, we provide for depreciation andamortization using the straight-line method over the estimated useful life ofthe asset, as follows:

| **Asset  Classification**      | ** ** | ** **                              | ** ** | **Estimated Useful Life** |
|--------------------------------|------------|-----------------------------------------|------------|---------------------------|
| Network equipment              |       | 3  years                                |
| Equipment under capital  lease |       | Lesser  of Life of lease or Useful Life |
| Computer software              |       | 3  years                                |
| Leasehold improvements         |       | Lesser  of Useful Life or Lease Term    |
| Furniture and fixtures         |       | 5 years                                 |

 

We review long-lived assets for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets to be held and used ismeasured by a comparison of the carrying amount of an asset to futureundiscounted net cash flows expected to be generated by the asset. If suchassets are considered to be impaired, the impairment recognized is measured bythe amount by which the carrying amount of the assets exceeds the fair value ofthe assets. Assets to be disposed of are reported at the lower of the carryingamount or fair value less costs to sell. Total depreciation and amortizationexpense included in the consolidated statements of operations was approximately$7.1 million, $6.5 million, and $10.4 million for the years ended December 31,2006, 2005 and 2004, respectively.

***Deferred DebtFinancing Costs******—******Underwriter***discountsand other costs incurred in connection with the issuance of  convertible debt were amortized to interestexpense using the straight-line method over the term of the debt, whichapproximated the effective interest method. As a result of our debt conversionsto common stock in 2005, remaining unamortized deferred debt financing costswere charged to interest expense.

***Investment inLong-Term Non-marketable Security******—******Our***long-terminvestment in a non-marketable security represents an equity investment in aprivately-held company that was made in 2000 in connection with a round offinancing with other third-party investors. As our investment does notpermit us to exert significant influence or control over the entity in which wehave invested, the recorded amount represents our cost of the investment lessany adjustments we make when we determine that an investment’s carrying valueis other than temporarily impaired.

The process of assessing whether the equity investment’snet realizable value is less than its carrying cost requires a significantamount of judgment due to the lack of a mature and stable public market forinvestments of this type. In making this judgment, we carefully consider theinvestee’s most recent financial results, cash position, recent cash flow data,projected cash flows (both short and long-term), financing needs, recentfinancing rounds, most recent valuation data, the current investingenvironment, management or ownership changes, and competition. This valuationprocess is based primarily on information that we request, receive and discusswith the investees’ management on a quarterly basis. Such evaluation isperformed on a quarterly basis.

Based on our evaluation during the quarter ended March 31,2004, we had determined that our investment in this privately-held company hasbeen other than temporarily impaired and, as a result, we recorded a$5.0 million non-cash charge to continuing operations for the year ended December 31,2004. This charge represented the full carrying value of this investment. Ourdecision was based on our evaluation of the company’s current cash position andrecent operating results, as well as the perceived 

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inability of the companyto obtain additional financing at a level, and in a timely manner, to supportits continued operations.

***Other Assets******—******Other***assetsat December 31, 2006 and 2005 consist primarily of deposits for calltermination services and leased facilities.

***Research andDevelopment Expenses******—******We***chargeresearch and development expenses to operations as incurred.

***Concentration ofCredit Risk/Significant Customers******—******Financial***instrumentsthat potentially subject us to significant concentrations of credit riskconsist principally of cash investments, short-term marketable investments andaccounts receivable. We place our cash investments with a high qualityfinancial institution and limit the amount of credit exposure. We haveestablished certain credit requirements that our customers must meet beforesales credit is extended. We monitor the financial condition of our customersto help ensure collections and to minimize losses.

We did not have a customer that accounted for 10% ormore of net revenue for the years ended December 31, 2006 and 2005. We hadone customer which accounted for 11% of net revenue for the year ended December 31,2004. We did not have a customer that accounted for 10% or more of accountsreceivable at either December 31, 2006 and 2005.

***Fair Value ofFinancial Instruments******—******Financial***instrumentsconsist principally of cash and cash equivalents, short-term marketableinvestments, accounts receivable, long-term investments in marketablesecurities, long-term debt and accounts payable. The estimated fair value ofthese instruments approximates their carrying value.

***Stock-basedCompensation****—*EffectiveJanuary 1, 2006, we adopted the provisions of Statement of FinancialAccounting Standards 123R, *“Share-Based Payment”*(“SFAS 123R”), which require us to record compensation expense related to thefair value of our stock-based compensation awards. Prior to January 1,2006, we accounted for our stock-based compensation in accordance withAccounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued toEmployees,” and related interpretations.

We elected to use the modified prospective transitionmethod as permitted under SFAS 123R and, therefore, have not restated ourfinancial results for the prior periods to reflect the fair value ofstock-based compensation awards.. Under this transition method, stock-basedcompensation expense for the year ended December 31, 2006 includescompensation expense for all stock option awards granted prior to, but not yetvested as of December 31, 2005, based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123. Stock-basedcompensation expense for all stock option awards granted subsequent to December 31,2005 was based on the grant date fair value estimated in accordance with SFAS123R. We recognize compensation expense for stock option awards granted on astraight-line basis over the requisite service period of the award.

***Income Taxes******—******We***accountfor income taxes in accordance with SFAS No. 109, “Accounting for IncomeTaxes.” This statement requires an asset and liability approach to accountingfor income taxes based upon the future expected values of the related assetsand liabilities. Deferred income taxes are provided for tax and financialreporting basis differences between assets and liabilities at tax ratesexpected to be in effect when the basis differences reverse. Valuationallowances are provided in situations where recoverability of deferred taxassets is not considered more likely than not.

***New Accounting Pronouncements***

In June 2006, the FASB issued Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an Interpretation of FASB StatementNo. 109” (FIN 48). FIN 48 prescribes a comprehensive model for thefinancial statement recognition, measurement, presentation and disclosure ofuncertain tax positions taken 

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or expected to be taken inincome tax returns. In particular, the Interpretation requires that a taxbenefit related to a given tax position be reflected in the financialstatements only if it is more likely than not that it would be sustained on itstechnical merits in the event of a tax audit. FIN 48 will become effectivefor us on January 1, 2007. The adoption of FIN 48 will not have a materialeffect on our financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements,” (“ SFAS 157”). SFAS 157 defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS 157 does not require any new fair value measurements but may changecurrent practice for some entities. SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007 andinterim periods within those years. We do not believe that the adoption ofSAB 157 will have a material effect on our financial position, results ofoperations or cash flows.

In February 2007, the FASB issued SFASNo. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities” (SFAS 159), which provides entities with the option to measurecertain financial instruments and other items at fair value, whereas thoseitems are not currently required to be measured at fair value. SFAS 159 will beeffective for us on January 1, 2008. We are currently evaluating theimpact the adoption of  SFAS 159 will have on our financial position,results of operations or cash flows.

In September 2006,the Staff of the SEC issued Staff Accounting Bulletin No. 108, “*Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*”(“SAB 108”). SAB 108 provides guidance on the consideration of the effects ofprior year misstatements in quantifying current year misstatements for thepurpose of determining whether the current year’s financial statements arematerially misstated. SAB 108 was effective for fiscal years endedDecember 31, 2006. The adoption of SAB 108 did not have any materialeffect on our financial position, results of operations or cash flows.

**(3)**          Restatementof Consolidated Financial Statements

During the quarter ended September 30, 2006,subsequent to the issuance of the unaudited condensed consolidated financialstatements for the three months ended June 30, 2006, our Board ofDirectors formed a Special Committee of independent directors to commence avoluntary investigation of our historical stock option grants and practices.Based upon the Special Committee’s review, the Audit Committee and ourmanagement determined that certain option grants during the periods from 1999through 2006 were accounted for improperly, and, as such, stock-basedcompensation associated with certain grants was misstated for the years ended2000 through 2005 and for each of the quarters in the six months ended June 30,2006. The Special Committee identified errors and concluded that themeasurement dates for determining the accounting treatment of certainhistorical stock option grants differed from the measurement dates used by usin preparing our financial statements. In certain instances, the approval dateof an option grant could not be determined with certainty. In addition, theterms of an option grant, including exercise price and number of shares, maynot have been final on the date of approval. In those instances, we used otherrelevant available evidence to determine the measurement date of an optiongrant, based on the date by which option terms were final and approval of theoption grant had most likely been obtained. The Special Committee also found thatin a number of instances the date and exercise price of option grants had beendetermined with hindsight to provide a more favorable price for such grants.

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For each of ourpast stock option grants, we determined a measurement date using the followingcriteria:

1)              For stock optiongrants approved at a meeting of either our Board of Directors or ourCompensation Committee and evidenced by meeting minutes, the date of themeeting was determined to be the measurement date, provided the terms of theoption grant, including exercise price and number of shares, were final on thedate of the meeting.

2)              For stock optiongrants approved by the members of our Compensation Committee through theprocess of signing Unanimous Written Consents (“UWCs”), the following criteriawere used to determine the measurement date of the grant:

a)                If there wasevidence of the date of signature for all of our Compensation Committeemembers, the date that the last Compensation Committee member signed the UWCwas determined to be the measurement date, provided the terms of the optiongrant, including exercise price and number of shares, were final on that date;

b)               If there was evidenceof the date of signature for all of the Compensation Committee members, otherthan our Chief Executive Officer when he was a member of the CompensationCommittee, the date that the last Compensation Committee member signed the UWCwas determined to be the measurement date, provided the terms of the optiongrant, including exercise price and number of shares, were final on that date.

3)              If there was noevidence that grants were approved through the process of signing UWCs, orthere was no evidence as to the date of the signatures on the UWCs byCompensation Committee members, we considered email evidence to support theapproval date.

We determined the measurement date based on the dateof statements made in email correspondence that indicated that the stock optiongrant had been approved by all of the members of our Compensation Committee,provided the terms of the option grant, including exercise price and number ofshares, were final on that date. We considered emails from CompensationCommittee members indicating the date of approval of the option grant and/oremails from our legal or human resources personnel indicating the date ofapproval of the option grant.

4)              If there was a Form 3or Form 4 filing associated with the option grant, we used the followingcriteria to determine the measurement date of the grant:

a)                If an officer ordirector required to file reports under Section 16 of the SecuritiesExchange Act of 1934, as amended, filed a Form 3 or Form 4, wedetermined the measurement date to be the date that the Form 3 or Form 4was filed;

b)               If employees whowere not Section 16 officers were included in the grant with Section 16officers who filed a Form 3 or Form 4 and the number of sharesattributable to employees who were not Section 16 officers were determinedwith finality at the time of the filing, we determined the measurement date tobe the filing date of the Form 3 or Form 4 as it provided finality asto the exercise price.

5)              If we did not haveany corroborating evidence to indicate the date the stock option grant had beenapproved by all of the members of our Compensation Committee, and the filing ofa Form 3 or Form 4 was not applicable, we looked for evidence thatindicated the date on which the UWC was sent for signature, via email or fax,from us to the Compensation Committee members. If this evidence existed, weanalyzed the number of days it took for Compensation Committee members toreturn the signed UWCs. A range of response time was determined by individualCompensation Committee member and used to develop a response time range for the

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Compensation Committee, asa group, during specific periods, as the composition of theCompensationCommittee members changed over time. Based on this analysis, four differentranges were determined. The range of response times from Compensation Committeemembers varied from a minimum of 1 to 2 days, for which there was one instance,to a maximum of 0 to 91 days, for which there were two instances. Based on therange of response time, we determined the measurement date to be the last dayof the response time period, provided the option terms were final on this date,as this is the date we have determined is the date by which approval is mostlikely to have been obtained.

6)              In instances wherethere was no evidence of the approval of the grant and/or finality of theoption recipients and grant terms, we determined the measurement date based onthe last date of entry for these stock options into our stock option trackingsystem,. This date was deemed to be the most likely approval date as our policyand historical practice was to enter stock option grants into our stock optiontracking system only after we believed that the option grants had beenapproved.

As a result of the errors in determining measurementdates, we have also recorded payroll withholding tax related adjustments forcertain options previously classified as Incentive Stock Option (ISO) grantsunder Internal Revenue Service Code. Such options were determined to have beengranted with an exercise price below the fair market value of our common stockon the grant date determined. As a result, such options do not qualify for ISOtax treatment. The disqualification of ISO classification and the resultingconversion to a non-qualified option results in additional withholding taxes onexercise of such options. Accordingly, we have recorded estimated payrollwithholding tax charges of $122,000 and $110,000 for the years ended December 31,2005 and 2004, respectively, in connection with the disqualification of suchISO tax treatment.

In addition, as a result of the change in themeasurement dates of certain stock option grants, certain options vestingsubsequent to December 2004 result in non-qualified deferred compensationfor purposes of Section 409A of the Code, and holders are subject to anexcise tax on the value of the options in the year in which they vest. We and ourexecutive officers and directors agreed to amend certain outstanding stockoptions vesting after December 2004 that were determined to have beengranted with exercise prices below the fair market value of our common stock onthe legal grant date. In December, 2006, we and our executive officers anddirectors agreed to amend each of these options to increase the option exerciseprice to the fair market value on the revised measurement date. As theseamendments involved no consideration to our executive officers and directors,we will  not recognize any expenseassociated with these modifications in accordance with SFAS 123R.

The stock-based compensation charges, including theaforementioned payroll withholding tax related adjustments, increase our netloss by $459,000 and $613,000 for the years ended December 31, 2005 and2004 and resulted in additional charges totaling $9,146,000 for the periodsprior to 2004, which is reflected in the January 1, 2004 beginningaccumulated deficit.

The restatement of prior year financial statementsalso includes adjustments for other errors that were not previously recordedbecause we believed the amount of any such errors, both individually and in theaggregate, were not material to our historical consolidated financialstatements. Such errors related to the recording of deferred income,classification of reserves for customer disputes, adjustments to accruals, andfixed asset depreciation.

As a result of the above, we have restated ourfinancial statements as of December 31, 2005 and for the years ended December 31,2005 and 2004.  The restatement alsoaffected years prior to 2004.

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Thefollowing table reconciles previously reported to as restated net loss for theyears ended December 31, 2005 and 2004 and accumulated deficit as of January 1,2004:

| ** **                                                | ** ** | **Net loss for Years  Ended December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| ** **                                                | ** ** | **2005**                                                            | ** ** | **2004**   | ** ** | **Accumulated Deficit  as of January 1, 2004** | ** ** |
| ** **                                                | ** ** | **(In thousands)**                                             | ** ** |
| As previously  reported                                   |       | $                                                                   | (1,676     | )          | $          | (17,536 | ) |   | $ | (412,206 | ) |   |
| (Increase) decrease to  net loss and accumulated deficit: |       |                                                                |       |       |       |   |   |   |   |
| Stock-based compensation expense                          |       | (337                                                                | )          | (503       | )          |   | (9,132 | ) |   |
| Payroll withholding taxes                                 |       | (122                                                                | )          | (110       | )          |   | (14 | ) |   |
| Other adjustments                                         |       | 97                                                                  |       | (175       | )          |   | (330 | ) |   |
| Total                                                     |       | (362                                                                | )          | (788       | )          |   | (9,476 | ) |   |
| As restated                                               |       | $                                                                   | (2,038     | )          | $          | (18,324 | ) |   | $ | (421,682 | ) |   |

 

The following table summarizes the above adjustmentsto accumulated deficit as of January 1, 2004 by fiscal year:

| **Year Ended December 31,** | ** ** | ** **              | ** ** | **Stock-based  Compensation Expense** | ** ** | **Payroll  Withholding Taxes** | ** ** | **Other  Adjustments** | ** ** | **Total  Adjustments** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| 2000                                       |       |                    | $          | 1,658                                      |       |                                |       | $                      | 3          |                   |       |   | $ | 78 |   |   |   | $ | 1,739 |   |   |
| 2001                                       |       |                    | 2,885      |                                       |       |                                | —     |                   |       |                   | 98         |   |   |   | 2,983 |   |   |
| 2002                                       |       |                    | 3,778      |                                       |       |                                | —     |                   |       |                   | (420       | ) |   |   | 3,358 |   |   |
| 2003                                       |       |                    | 811        |                                       |       |                                | 11         |                   |       |                   | 574        |   |   |   | 1,396 |   |   |
| Totals per above                           |       |                    | $          | 9,132                                      |       |                                |       | $                      | 14         |                   |       |   | $ | 330 |   |   |   | $ | 9,476 |   |   |

 

Thefollowing table sets forth the effect of the restatement on our previouslyreported stock-based compensation expense for the years ended December 31,2000, 2001, 2002 and 2003:

| ** **                                 | ** ** | **Stock-based Compensation(1)**   | ** ** |
|--------------------------------------------|------------|----------------------------------------|------------|
| **Year Ended December 31,** | ** ** | **(as previously reported)** | ** ** | **Adjustment** | ** ** | **(as restated)** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                | ** ** |
| 2000                                       |       |                                   | $          | 1,061 |   |   |   | $ | 1,658 |   |   |   | $ | 2,719 |   |   |
| 2001                                       |       |                                   | 1,368      |   |   |   | 2,885 |   |   |   | 4,253 |   |   |
| 2002                                       |       |                                   | 967        |   |   |   | 3,778 |   |   |   | 4,745 |   |   |
| 2003                                       |       |                                   | 86         |   |   |   | 811 |   |   |   | 897 |   |   |
| Totals per above                           |       |                                   | $          | 3,482 |   |   |   | $ | 9,132 |   |   |   | $ | 12,614 |   |   |

----

(1)          Represents employeestock-based compensation as determined under APB 25 and used in disclosurespursuant to SFAS No. 123.

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Thefollowing tables set forth the effects of the restatement of our consolidatedstatements of operations and cash flows for each of the years ended December 31,2005 and 2004 and consolidated balance sheet as of December 31, 2005.

| ** **                                                                             | ** ** | **Year Ended December 31, 2005**                  | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **(as previously  reported)**                                    | ** ** | **Stock-based  compensation   and related  payroll tax  adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of  Operations Data:**                                       |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenue                                                                            |       |                                                                  | $          | 385,485 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 385,485 |   |   |
| Costs and operating  expenses:                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Data  communications and telecommunications (excluding depreciation and  amortization) |       |                                                                  | 336,152    |   |   |   |   |   |   |   |   |   |   |   | 336,152 |   |   |
| Research and development                                                               |       |                                                                  | 12,435     |   |   |   | 105 |   |   |   | 28 |   |   |   | 12,568 |   |   |
| Selling and  marketing                                                                 |       |                                                                  | 11,618     |   |   |   | 94 |   |   |   |   |   |   |   | 11,712 |   |   |
| General and  administrative                                                            |       |                                                                  | 15,203     |   |   |   | 260 |   |   |   | 80 |   |   |   | 15,543 |   |   |
| Depreciation and  amortization                                                         |       |                                                                  | 6,712      |   |   |   |   |   |   |   | (205 | ) |   |   | 6,507 |   |   |
| Restructuring  costs                                                                   |       |                                                                  | 218        |   |   |   |   |   |   |   |   |   |   |   | 218 |   |   |
| Total costs and  operating expenses                                                    |       |                                                                  | 382,338    |   |   |   | 459 |   |   |   | (97 | ) |   |   | 382,700 |   |   |
| Income (loss)  from operations                                                         |       |                                                                  | 3,147      |   |   |   | (459 | ) |   |   | 97 |   |   |   | 2,785 |   |   |
| Interest income                                                                        |       |                                                                  | 1,109      |   |   |   |   |   |   |   |   |   |   |   | 1,109 |   |   |
| Interest expense                                                                       |       |                                                                  | (2,601     | ) |   |   |   |   |   |   |   |   |   |   | (2,601 | ) |   |
| Other expense,  net                                                                    |       |                                                                  | (324       | ) |   |   |   |   |   |   |   |   |   |   | (324 | ) |   |
| Foreign exchange  (loss) gain                                                          |       |                                                                  | (939       | ) |   |   |   |   |   |   |   |   |   |   | (939 | ) |   |
| Debt conversion  premium and transaction costs                                         |       |                                                                  | (1,975     | ) |   |   |   |   |   |   |   |   |   |   | (1,975 | ) |   |
| Loss before taxes                                                                      |       |                                                                  | (1,583     | ) |   |   | (459 | ) |   |   | 97 |   |   |   | (1,945 | ) |   |
| Foreign income tax  expense                                                            |       |                                                                  | (93        | ) |   |   |   |   |   |   |   |   |   |   | (93 | ) |   |
| Net loss                                                                               |       |                                                                  | $          | (1,676 | ) |   |   | $ | (459 | ) |   |   | $ | 97 |   |   |   | $ | (2,038 | ) |   |
| Basic and diluted net  loss per share:                                                 |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                  |       |                                                                  | $          | (0.06 | ) |   |   | $ | (0.02 | ) |   |   | $ | 0.00 |   |   |   | $ | (0.08 | ) |   |
| Diluted                                                                                |       |                                                                  | $          | (0.06 | ) |   |   | $ | (0.02 | ) |   |   | $ | 0.00 |   |   |   | $ | (0.08 | ) |   |
| Basic and diluted  weighted average common shares outstanding                          |       |                                                                  | 26,745     |   |   |   |   |   |   |   |   |   |   |   | 26,745 |   |   |

 

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| ** **                                                                             | ** ** | **Year Ended December 31, 2004**                  | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **(as previously  reported)**                                    | ** ** | **Stock-based  compensation   and related  payroll tax  adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of  Operations Data:**                                       |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenue                                                                            |       |                                                                  | $          | 263,678 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 263,678 |   |   |
| Costs and operating  expenses:                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Data  communications and telecommunications (excluding depreciation and  amortization) |       |                                                                  | 225,169    |   |   |   |   |   |   |   |   |   |   |   | 225,169 |   |   |
| Research and  development                                                              |       |                                                                  | 13,803     |   |   |   | 176 |   |   |   | 34 |   |   |   | 14,013 |   |   |
| Selling and  marketing                                                                 |       |                                                                  | 9,205      |   |   |   | 146 |   |   |   |   |   |   |   | 9,351 |   |   |
| General and  administrative                                                            |       |                                                                  | 12,822     |   |   |   | 291 |   |   |   | 49 |   |   |   | 13,162 |   |   |
| Depreciation and  amortization                                                         |       |                                                                  | 10,345     |   |   |   |   |   |   |   | 92 |   |   |   | 10,437 |   |   |
| Restructuring  costs                                                                   |       |                                                                  | 165        |   |   |   |   |   |   |   |   |   |   |   | 165 |   |   |
| Total costs and  operating expenses                                                    |       |                                                                  | 271,509    |   |   |   | 613 |   |   |   | 175 |   |   |   | 272,297 |   |   |
| Loss from  operations                                                                  |       |                                                                  | (7,831     | ) |   |   | (613 | ) |   |   | (175 | ) |   |   | (8,619 | ) |   |
| Interest income                                                                        |       |                                                                  | 218        |   |   |   |   |   |   |   |   |   |   |   | 218 |   |   |
| Interest expense                                                                       |       |                                                                  | (4,249     | ) |   |   |   |   |   |   |   |   |   |   | (4,249 | ) |   |
| Other expense,  net                                                                    |       |                                                                  | (184       | ) |   |   |   |   |   |   |   |   |   |   | (184 | ) |   |
| Loss on long-term  non-marketable security                                             |       |                                                                  | (5,000     | ) |   |   |   |   |   |   |   |   |   |   | (5,000 | ) |   |
| Foreign exchange  (loss) gain                                                          |       |                                                                  | 339        |   |   |   |   |   |   |   |   |   |   |   | 339 |   |   |
| Debt refinancing  charges:                                                             |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Transaction costs                                                                      |       |                                                                  | (2,159     | ) |   |   |   |   |   |   |   |   |   |   | (2,159 | ) |   |
| Additional  interest expense, net                                                      |       |                                                                  | (481       | ) |   |   |   |   |   |   |   |   |   |   | (481 | ) |   |
| Loss before taxes  from continuing operations                                          |       |                                                                  | (19,347    | ) |   |   | (613 | ) |   |   | (175 | ) |   |   | (20,135 | ) |   |
| Foreign income tax expense                                                             |       |                                                                  | (50        | ) |   |   |   |   |   |   |   |   |   |   | (50 | ) |   |
| Loss from continuing operations                                                        |       |                                                                  | (19,397    | ) |   |   | (613 | ) |   |   | (175 | ) |   |   | (20,185 | ) |   |
| Income from  discontinued operations                                                   |       |                                                                  | 1,861      |   |   |   |   |   |   |   |   |   |   |   | 1,861 |   |   |
| Net loss                                                                               |       |                                                                  | $          | (17,536 | ) |   |   | $ | (613 | ) |   |   | $ | (175 | ) |   |   | $ | (18,324 | ) |   |
| Basic and diluted net  loss per share:                                                 |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  continuing operations                                                       |       |                                                                  | $          | (1.15 | ) |   |   | $ | (0.04 | ) |   |   | $ | (0.01 | ) |   |   | $ | (1.20 | ) |   |
| Income from  discontinued operations                                                   |       |                                                                  | 0.11       |   |   |   |   |   |   |   |   |   |   |   | 0.11 |   |   |
| Basic and diluted  net loss per share                                                  |       |                                                                  | $          | (1.04 | ) |   |   | $ | (0.04 | ) |   |   | $ | (0.01 | ) |   |   | $ | (1.09 | ) |   |
| Basic and diluted  weighted average common shares outstanding                          |       |                                                                  | 16,838     |   |   |   |   |   |   |   |   |   |   |   | 16,838 |   |   |

 

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| ** **                                                                                 | ** ** | **As of December 31, 2005**                       | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **(as previously  reported)**                                    | ** ** | **Stock-based  compensation   and related  payroll tax  adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Balance Sheet**                                                             |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Assets**                                                                                 |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                                  | $          | 27,478 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 27,478 |   |   |
| Short-term  marketable investments                                                         |       |                                                                  | 16,936     |   |   |   |   |   |   |   |   |   |   |   | 16,936 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $2,507                     |       |                                                                  | 47,641     |   |   |   |   |   |   |   | (320 | ) |   |   | 47,321 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                                  | 2,676      |   |   |   |   |   |   |   |   |   |   |   | 2,676 |   |   |
| Total current assets                                                                       |       |                                                                  | 94,731     |   |   |   |   |   |   |   | (320 | ) |   |   | 94,411 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                                  | 53,434     |   |   |   |   |   |   |   |   |   |   |   | 53,434 |   |   |
| Equipment under capital lease                                                              |       |                                                                  | 4,917      |   |   |   |   |   |   |   |   |   |   |   | 4,917 |   |   |
| Computer software                                                                          |       |                                                                  | 10,353     |   |   |   |   |   |   |   |   |   |   |   | 10,353 |   |   |
| Leasehold improvements                                                                     |       |                                                                  | 6,697      |   |   |   |   |   |   |   |   |   |   |   | 6,697 |   |   |
| Furniture and fixtures                                                                     |       |                                                                  | 1,049      |   |   |   |   |   |   |   |   |   |   |   | 1,049 |   |   |
|                                                                                       |       |                                                                  | 76,450     |   |   |   |   |   |   |   |   |   |   |   | 76,450 |   |   |
| Less: Accumulated depreciation and amortization                                            |       |                                                                  | (64,696    | ) |   |   |   |   |   |   | (337 | ) |   |   | (65,033 | ) |   |
| Property and  equipment, net                                                               |       |                                                                  | 11,754     |   |   |   |   |   |   |   | (337 | ) |   |   | 11,417 |   |   |
| Other assets                                                                               |       |                                                                  | 323        |   |   |   |   |   |   |   |   |   |   |   | 323 |   |   |
| Total assets                                                                               |       |                                                                  | $          | 106,808 |   |   |   | $ | — |   |   |   | $ | (657 | ) |   |   | $ | 106,151 |   |   |
| **Liabilities and Stockholders’ Equity**                                              |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                                  | $          | 27,796 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 27,796 |   |   |
| Accrued expenses                                                                           |       |                                                                  | 24,479     |   |   |   | 246 |   |   |   | (20 | ) |   |   | 24,705 |   |   |
| Deferred revenue                                                                           |       |                                                                  | 9,517      |   |   |   |   |   |   |   |   |   |   |   | 9,517 |   |   |
| Current portion  of long-term debt                                                         |       |                                                                  | 1,598      |   |   |   |   |   |   |   |   |   |   |   | 1,598 |   |   |
| Total current liabilities                                                                  |       |                                                                  | 63,390     |   |   |   | 246 |   |   |   | (20 | ) |   |   | 63,616 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                                  | 2,216      |   |   |   |   |   |   |   |   |   |   |   | 2,216 |   |   |
| Other long term liabilities                                                                |       |                                                                  | 916        |   |   |   |   |   |   |   |   |   |   |   | 916 |   |   |
| Commitments and contingencies (Note 12)                                                    |       |                                                                  | —     |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Stockholders’  equity:                                                                |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock, $0.001 par value, authorized—170,000  shares; issued—34,112 shares |       |                                                                  | 34         |   |   |   |   |   |   |   |   |   |   |   | 34 |   |   |
| Treasury stock; 691 shares, at cost                                                        |       |                                                                  | (2,091     | ) |   |   |   |   |   |   |   |   |   |   | (2,091 | ) |   |
| Additional paid-in capital                                                                 |       |                                                                  | 473,778    |   |   |   | 10,222 |   |   |   | (229 | ) |   |   | 483,771 |   |   |
| Deferred compensation                                                                      |       |                                                                  | —     |   |   |   | (250 | ) |   |   |   |   |   |   | (250 | ) |   |
| Accumulated other comprehensive (loss)                                                     |       |                                                                  | (17        | ) |   |   |   |   |   |   |   |   |   |   | (17 | ) |   |
| Accumulated deficit                                                                        |       |                                                                  | (431,418   | ) |   |   | (10,218 | ) |   |   | (408 | ) |   |   | (442,044 | ) |   |
| Total stockholders’ equity                                                            |       |                                                                  | 40,286     |   |   |   | (246 | ) |   |   | (637 | ) |   |   | 39,403 |   |   |
| Total liabilities  and stockholders’ equity                                           |       |                                                                  | $          | 106,808 |   |   |   | $ | — |   |   |   | $ | (657 | ) |   |   | $ | 106,151 |   |   |

 

77

----

 

| ** **                                                                                          | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **(as previously  reported)**                   | ** ** | **Stock-based  compensation and  related payroll  withholding tax  adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                          | ** ** | **(In thousands)**                              | ** ** |
| **Statement  of Cash Flows**                                                                        |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash flows from  operating activities:                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                            |       |                                                 | $          | (1,676 | ) |   |   | $ | (459 | ) |   |   | $ | 97 |   |   |   | $ | (2,038 | ) |   |
| Adjustments to reconcile loss from continuing  operations to net cash used in operating activities: |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Restructuring costs                                                                                 |       |                                                 | 218        |   |   |   |   |   |   |   |   |   |   |   | 218 |   |   |
| Depreciation and amortization                                                                       |       |                                                 | 6,712      |   |   |   |   |   |   |   | (205 | ) |   |   | 6,507 |   |   |
| Amortization of deferred debt financing costs                                                       |       |                                                 | 177        |   |   |   |   |   |   |   |   |   |   |   | 177 |   |   |
| Amortization of discount on short-term marketable  securities                                       |       |                                                 | (45        | ) |   |   |   |   |   |   |   |   |   |   | (45 | ) |   |
| Non-cash debt conversion premium                                                                    |       |                                                 | 115        |   |   |   |   |   |   |   |   |   |   |   | 115 |   |   |
| Stock-based compensation                                                                            |       |                                                 | —     |   |   |   | 337 |   |   |   |   |   |   |   | 337 |   |   |
| Allowance for doubtful accounts                                                                     |       |                                                 | 850        |   |   |   |   |   |   |   |   |   |   |   | 850 |   |   |
| Changes in current  assets and liabilities:                                                         |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts receivable, net                                                                            |       |                                                 | (14,358    | ) |   |   |   |   |   |   | 168 |   |   |   | (14,190 | ) |   |
| Prepaid expenses and other current assets                                                           |       |                                                 | (256       | ) |   |   |   |   |   |   |   |   |   |   | (256 | ) |   |
| Other assets                                                                                        |       |                                                 | 37         |   |   |   |   |   |   |   |   |   |   |   | 37 |   |   |
| Accounts payable                                                                                    |       |                                                 | 3,443      |   |   |   |   |   |   |   |   |   |   |   | 3,443 |   |   |
| Deferred revenue                                                                                    |       |                                                 | 3,214      |   |   |   |   |   |   |   |   |   |   |   | 3,214 |   |   |
| Accrued expenses                                                                                    |       |                                                 | 13,935     |   |   |   | 122 |   |   |   | (60 | ) |   |   | 13,997 |   |   |
| Other long-term liabilities                                                                         |       |                                                 | (216       | ) |   |   |   |   |   |   |   |   |   |   | (216 | ) |   |
| Net cash provided by (used in) continuing operating  activities                                     |       |                                                 | 12,150     |   |   |   | — |   |   |   | — |   |   |   | 12,150 |   |   |
| Cash flows from  investing activities:                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchases of property and equipment                                                                 |       |                                                 | (3,441     | ) |   |   |   |   |   |   |   |   |   |   | (3,441 | ) |   |
| Purchases of available-for-sale short-term  marketable investments                                  |       |                                                 | (28,234    | ) |   |   |   |   |   |   |   |   |   |   | (28,234 | ) |   |
| Maturities of available-for-sale short-term  marketable investments                                 |       |                                                 | 29,235     |   |   |   |   |   |   |   |   |   |   |   | 29,235 |   |   |
| Net cash used in investing activities                                                               |       |                                                 | (2,440     | ) |   |   |   |   |   |   |   |   |   |   | (2,440 | ) |   |
| Cash flows from  financing activities:                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Redemption of 53⁄4% Convertible Subordinated Notes                                               |       |                                                 | (895       | ) |   |   |   |   |   |   |   |   |   |   | (895 | ) |   |
| Payments of principal on capital lease obligations                                                  |       |                                                 | (1,206     | ) |   |   |   |   |   |   |   |   |   |   | (1,206 | ) |   |
| Debt conversion premium and transaction costs                                                       |       |                                                 | (1,860     | ) |   |   |   |   |   |   |   |   |   |   | (1,860 | ) |   |
| Repurchases of common stock                                                                         |       |                                                 | (1,865     | ) |   |   |   |   |   |   |   |   |   |   | (1,865 | ) |   |
| Proceeds from exercise of warrants                                                                  |       |                                                 | 2,422      |   |   |   |   |   |   |   |   |   |   |   | 2,422 |   |   |
| Proceeds from exercise of common stock options                                                      |       |                                                 | 244        |   |   |   |   |   |   |   |   |   |   |   | 244 |   |   |
| Net cash (used in) provided by financing activities                                                 |       |                                                 | (3,160     | ) |   |   |   |   |   |   |   |   |   |   | (3,160 | ) |   |
| Net increase (decrease) in cash and cash equivalents                                                |       |                                                 | 6,550      |   |   |   | — |   |   |   | — |   |   |   | 6,550 |   |   |
| Cash and cash  equivalents, beginning of year                                                       |       |                                                 | 20,928     |   |   |   |   |   |   |   |   |   |   |   | 20,928 |   |   |
| Cash and cash  equivalents, end of year                                                             |       |                                                 | $          | 27,478 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 27,478 |   |   |

 

78

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| ** **                                                                                          | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **(as previously  reported)**                   | ** ** | **Stock-based  compensation and  related payroll  withholding tax  adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                          | ** ** | **(In thousands)**                              | ** ** |
| **Statement of Cash Flows**                                                                         |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash flows from operating activities:                                                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                            |       |                                                 | $          | (17,536 | ) |   |   | $ | (613 | ) |   |   | $ | (175 | ) |   |   | $ | (18,324 | ) |   |
| Income from discontinued  operations                                                                |       |                                                 | (1,861     | ) |   |   |   |   |   |   |   |   |   |   | (1,861 | ) |   |
| Loss from continuing  operations                                                                    |       |                                                 | (19,397    | ) |   |   | (613 | ) |   |   | (175 | ) |   |   | (20,185 | ) |   |
| Adjustments to reconcile loss from continuing  operations to net cash used in operating activities: |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Restructuring costs                                                                                 |       |                                                 | 165        |   |   |   |   |   |   |   |   |   |   |   | 165 |   |   |
| Depreciation and  amortization                                                                      |       |                                                 | 10,345     |   |   |   |   |   |   |   | 92 |   |   |   | 10,437 |   |   |
| Amortization of deferred  debt financing costs                                                      |       |                                                 | 149        |   |   |   |   |   |   |   |   |   |   |   | 149 |   |   |
| Stock-based compensation                                                                            |       |                                                 | —     |   |   |   | 503 |   |   |   |   |   |   |   | 503 |   |   |
| Loss on long-term  non-marketable security                                                          |       |                                                 | 5,000      |   |   |   |   |   |   |   |   |   |   |   | 5,000 |   |   |
| Fair value of warrant  issued in debt refinancing                                                   |       |                                                 | 2,140      |   |   |   |   |   |   |   |   |   |   |   | 2,140 |   |   |
| Allowance for doubtful  accounts                                                                    |       |                                                 | 250        |   |   |   |   |   |   |   |   |   |   |   | 250 |   |   |
| Changes in current assets and liabilities:                                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts receivable, net                                                                            |       |                                                 | (12,616    | ) |   |   |   |   |   |   | 152 |   |   |   | (12,464 | ) |   |
| Prepaid expenses and  other current assets                                                          |       |                                                 | 124        |   |   |   |   |   |   |   |   |   |   |   | 124 |   |   |
| Other assets                                                                                        |       |                                                 | 345        |   |   |   |   |   |   |   |   |   |   |   | 345 |   |   |
| Accounts payable                                                                                    |       |                                                 | 4,438      |   |   |   |   |   |   |   |   |   |   |   | 4,438 |   |   |
| Deferred revenue                                                                                    |       |                                                 | 5,886      |   |   |   |   |   |   |   |   |   |   |   | 5,886 |   |   |
| Accrued expenses                                                                                    |       |                                                 | (2,369     | ) |   |   | 110 |   |   |   | (69 | ) |   |   | (2,328 | ) |   |
| Other long-term  liabilities                                                                        |       |                                                 | (1,617     | ) |   |   |   |   |   |   |   |   |   |   | (1,617 | ) |   |
| Net cash provided by  (used in) continuing operating activities                                     |       |                                                 | (7,157     | ) |   |   | — |   |   |   | — |   |   |   | (7,157 | ) |   |
| Cash flows from investing activities:                                                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchases of property and  equipment                                                                |       |                                                 | (3,266     | ) |   |   |   |   |   |   |   |   |   |   | (3,266 | ) |   |
| Purchases of available-for-sale  short-term marketable investments                                  |       |                                                 | (18,534    | ) |   |   |   |   |   |   |   |   |   |   | (18,534 | ) |   |
| Maturities of available-for-sale  short-term marketable investments                                 |       |                                                 | 625        |   |   |   |   |   |   |   |   |   |   |   | 625 |   |   |
| Proceeds from sale of  Speech Solutions business                                                    |       |                                                 | 1,500      |   |   |   |   |   |   |   |   |   |   |   | 1,500 |   |   |
| Proceeds from earn-out  relating to sale of Speech Solutions business                               |       |                                                 | 1,009      |   |   |   |   |   |   |   |   |   |   |   | 1,009 |   |   |
| Net cash used in  investing activities                                                              |       |                                                 | (18,666    | ) |   |   |   |   |   |   |   |   |   |   | (18,666 | ) |   |
| Cash flows from financing activities:                                                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from sale of  common stock in private placement                                            |       |                                                 | 31,500     |   |   |   |   |   |   |   |   |   |   |   | 31,500 |   |   |
| Transaction costs of  private placement                                                             |       |                                                 | (1,310     | ) |   |   |   |   |   |   |   |   |   |   | (1,310 | ) |   |
| Proceeds from issuance of  8% Secured Convertible Notes due June 2007                          |       |                                                 | 29,000     |   |   |   |   |   |   |   |   |   |   |   | 29,000 |   |   |
| Prepayment of 111¤2% 8% Senior Secured Notes due  January 2005                            |       |                                                 | (25,175    | ) |   |   |   |   |   |   |   |   |   |   | (25,175 | ) |   |
| Bank borrowings                                                                                     |       |                                                 | 4,600      |   |   |   |   |   |   |   |   |   |   |   | 4,600 |   |   |
| Repayments of bank  borrowings                                                                      |       |                                                 | (6,900     | ) |   |   |   |   |   |   |   |   |   |   | (6,900 | ) |   |
| Payments of principal on  capital lease obligations                                                 |       |                                                 | (2,167     | ) |   |   |   |   |   |   |   |   |   |   | (2,167 | ) |   |
| Transaction costs of debt  refinancing and exchange of debt                                         |       |                                                 | (1,984     | ) |   |   |   |   |   |   |   |   |   |   | (1,984 | ) |   |
| Proceeds from exercise of  warrants                                                                 |       |                                                 | 1,462      |   |   |   |   |   |   |   |   |   |   |   | 1,462 |   |   |
| Proceeds from exercise of  common stock options                                                     |       |                                                 | 455        |   |   |   |   |   |   |   |   |   |   |   | 455 |   |   |
| Net cash (used in)  provided by financing activities                                                |       |                                                 | 29,481     |   |   |   |   |   |   |   |   |   |   |   | 29,481 |   |   |
| Net increase (decrease)  in cash and cash equivalents                                               |       |                                                 | 3,658      |   |   |   | — |   |   |   | — |   |   |   | 3,658 |   |   |
| Cash and cash  equivalents, beginning of year                                                       |       |                                                 | 17,270     |   |   |   |   |   |   |   |   |   |   |   | 17,270 |   |   |
| Cash and cash  equivalents, end of year                                                             |       |                                                 | $          | 20,928 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 20,928 |   |   |

 

Certain other Notes tothese Consolidated Financial Statements were impacted by these corrections.Refer to Notes 2, 4, 5, 7,  10 and 15.

79

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**(4)**          StockBased Compensation

We issue stock options as an equity incentive toemployees, outside directors and non-employee contractors under our 1997 StockIncentive Plan (the “1997 Plan”).  Thestock options we issue are for a fixed number of shares with an exercise priceequal to the fair market value of our stock on the date of grant. The employeestock option grants typically vest quarterly in equal installments over fouryears, provided that no options shall vest during the employees’ first year ofemployment, and have a term of ten years.

Effective January 1, 2006, we adopted theprovisions of SFAS 123R, which require us to record compensation expenserelated to the fair value of our stock-based compensation awards. For periodsprior to January 1, 2006, we accounted for our stock-based compensation inaccordance with Accounting Principles Board (“APB”) Opinion 25, “Accounting forStock Issued to Employees,” and related interpretations.

We elected to use the modified prospective transitionmethod as permitted under SFAS 123R and, therefore, have not restated ourfinancial results for the prior periods to reflect the fair value ofstock-based compensation awards in such periods.   Under this transition method, stock-basedcompensation expense for the year ended December 31, 2006 includescompensation expense for all stock option awards granted prior to, but not yetvested as of December 31, 2005, based on the grant date fair valueestimated in accordance with the original provisions of SFAS 123. Stock-basedcompensation expense for all stock option awards granted subsequent to December 31,2005 was based on the grant date fair value estimated in accordance with SFAS123R. We recognize compensation expense for stock option awards granted on astraight-line basis over the requisite service period of the award.

Thefollowing table presents the stock-based compensation expense included in ourconsolidated statement of operations.

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In thousands)**                    | ** ** |
| Stock-based compensation:            |       |                                       |       |   |   |   |   |   |   |   |   |
| Research and development expenses    |       | $                                          | 456        |   |   | $ | 105 |   |   |   | $ | 176 |   |   |
| Selling and marketing expenses       |       | 383                                        |       |   | 94 |   |   |   | 146 |   |   |
| General and administrative expenses  |       | 828                                        |       |   | 138 |   |   |   | 181 |   |   |
| Total stock-based compensation       |       | 1,667                                      |       |   | 337 |   |   |   | 503 |   |   |
| Provision for income taxes           |       | —                                     |       |   | — |   |   |   | — |   |   |
| Net stock-based compensation expense |       | $                                          | 1,667      |   |   | $ | 337 |   |   |   | $ | 503 |   |   |

 

The adoption of SFAS 123R increased our basic anddiluted net loss per share for year ended December 31, 2006 by $0.05.

No income tax benefit was realized from stock optionexercises during the years ended December 31, 2006, 2005, and 2004.

80

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**Thefair value of our stock option awards was estimated using the Black-Scholesmodel with the following weighted-average assumptions:**

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Risk-free  interest rate                        |       | 4.66                                       | %          | 4.00 | % | 3.35 | % |
| Dividend yield                                  |       | 0.0                                        | %          | 0.0 | % | 0.0 | % |
| Expected life                                   |       | 6.25 years                                 |       | 5 years |   | 5 years |   |
| Expected  volatility                            |       | 114                                        | %          | 121 | % | 136 | % |
| Weighted average  remaining contractual life    |       | 6.95 years                                 |       | 7.26 years |   | 8.17 years |   |
| Weighted average fair  value of options granted |       | $5.62                                      |       | $5.47 |   | $5.55 |   |

 

The risk-free interest rate was based on the U.S.Treasury yield curve in effect at the time of grant. The expected dividendyield of zero is based on the fact that we have never paid cash dividends andwe have no current intention to pay cash dividends, other than the specialdividend that would be paid in connection with the consummation of the KPNtransaction. Our estimate of the expected life was determined using thesimplified method allowed under Staff Accounting Bulletin No. 107 as ourstock options qualify as “plain vanilla” options. Our estimate of expectedvolatility is based on the historical volatility of our common stock over theperiod which approximates the expected life of the options.

Priorto January 1, 2006, we accounted for stock-based compensation plans inaccordance with the provisions of APB 25, as permitted by SFAS 123, and,accordingly, did not recognize compensation expense for the issuance of stockoptions with an exercise price equal to the market price at the date of grant. Thefollowing table illustrates the effect on net income and net income per shareif we had applied the fair value recognition provisions of SFAS 123.

| ** **                                                                                                       | ** ** | **Year Ended December 31,**                        | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2005**                                                          | ** ** | **2004** | ** ** |
| ** **                                                                                                       | ** ** | **(In thousands, except  per share amounts)** | ** ** |
| Net loss:                                                                                                        |       |                                                              |       |   |   |   |   |   |   |
| As reported                                                                                                      |       |                                                              | $          | (2,038 | ) |   |   | $ | (18,324 | ) |   |
| Add: Stock-based employee compensation expense  included in reported net loss                                    |       |                                                              | 337        |   |   |   | 503 |   |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards |       |                                                              | (1,859     | ) |   |   | (3,041 | ) |   |
| Pro forma                                                                                                        |       |                                                              | $          | (3,560 | ) |   |   | $ | (20,862 | ) |   |
| Basic and diluted  net loss per share:                                                                           |       |                                                              |       |   |   |   |   |   |   |
| As reported                                                                                                      |       |                                                              | $          | (0.08 | ) |   |   | $ | (1.09 | ) |   |
| Pro forma                                                                                                        |       |                                                              | $          | (0.13 | ) |   |   | $ | (1.24 | ) |   |

 

81

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***Stock OptionActivity***

Thefollowing table presents the activity for the 1997 Plan for the years ended December 31,2006, 2005 and 2004:

| ** **                                             | ** ** | **Shares**              | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **(In thousands)** | ** ** | ** **                             | ** ** |
| Outstanding at  January 1, 2004                   |       |                    | 2,111      |                                   |       |   | $ | 4.05 |   |   |
| Granted                                                |       |                    | 442        |                                   |       |   | 5.61 |   |   |
| Exercised                                              |       |                    | (169       | )                                      |       |   | 2.70 |   |   |
| Cancelled                                              |       |                    | (194       | )                                      |       |   | 3.69 |   |   |
| Outstanding at  December 31, 2004                 |       |                    | 2,190      |                                   |       |   | 4.53 |   |   |
| Granted                                                |       |                    | 99         |                                   |       |   | 6.81 |   |   |
| Exercised                                              |       |                    | (79        | )                                      |       |   | 3.09 |   |   |
| Cancelled                                              |       |                    | (108       | )                                      |       |   | 6.06 |   |   |
| Outstanding at  December 31, 2005                 |       |                    | 2,102      |                                   |       |   | 4.62 |   |   |
| Granted                                                |       |                    | 641        |                                   |       |   | 6.60 |   |   |
| Exercised                                              |       |                    | (173       | )                                      |       |   | 3.41 |   |   |
| Cancelled                                              |       |                    | (166       | )                                      |       |   | 5.29 |   |   |
| Outstanding at  December 31, 2006                 |       |                    | 2,404      |                                   |       |   | $ | 5.18 |   |   |
| Exercisable at  December 31, 2006                 |       |                    | 1,648      |                                   |       |   | $ | 4.87 |   |   |
| Expected to vest  at December 31, 2006            |       |                    | 756        |                                   |       |   | $ | 5.86 |   |   |
| Available for future  grants at December 31, 2006 |       |                    | 1,312      |                                   |       |   |   |   |   |

 

Thefollowing table presents weighted average price and contract life informationabout significant option groups outstanding and exercisable as of December 31,2006:

| ** **                                  | ** ** | ** **              | ** ** | **Outstanding**          | ** ** | ** **                                        | ** ** | ** **                             | ** ** | ** **               | ** ** |
|---------------------------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | ** **              | ** ** | **Weighted**             | ** ** | ** **                                        | ** ** | ** **                             | ** ** | ** **               | ** ** |
| ** **                                  | ** ** | ** **              | ** ** | **Average**              | ** ** | ** **                                        | ** ** | **Exercisable**                        | ** ** |
| **Range of Exercise Prices** | ** ** | ** **              | ** ** | **Outstanding  Options** | ** ** | **Remaining  Contractual  Life  (in Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                                  | ** ** | **(In thousands)** | ** ** | ** **               | ** ** | ** **                                        | ** ** | **(in thousands)**                | ** ** | ** **               | ** ** |
| $0.75–$2.07                            |       |                    | 64         |                     |       |                                              | 5.15       |                                   |       |                     | $          | 1.69 |   |   |   | 64 |   |   |   | $ | 1.69 |   |   |
| 2.16                                        |       |                    | 226        |                     |       |                                              | 4.87       |                                   |       |                     | 2.16       |   |   |   | 226 |   |   |   | 2.16 |   |   |
| 2.64–3.30                              |       |                    | 611        |                     |       |                                              | 6.20       |                                   |       |                     | 2.70       |   |   |   | 495 |   |   |   | 2.72 |   |   |
| 3.51–5.64                              |       |                    | 659        |                     |       |                                              | 6.99       |                                   |       |                     | 4.43       |   |   |   | 526 |   |   |   | 4.18 |   |   |
| 5.73–6.54                              |       |                    | 512        |                     |       |                                              | 8.94       |                                   |       |                     | 6.47       |   |   |   | 132 |   |   |   | 6.43 |   |   |
| 6.72–9.30                              |       |                    | 233        |                     |       |                                              | 8.58       |                                   |       |                     | 7.48       |   |   |   | 106 |   |   |   | 7.57 |   |   |
| 11.13–15.00                            |       |                    | 68         |                     |       |                                              | 3.04       |                                   |       |                     | 13.82      |   |   |   | 68 |   |   |   | 13.82 |   |   |
| 33.00–40.50                            |       |                    | 15         |                     |       |                                              | 3.38       |                                   |       |                     | 40.33      |   |   |   | 15 |   |   |   | 40.33 |   |   |
| $44.43–86.25                           |       |                    | 16         |                     |       |                                              | 3.42       |                                   |       |                     | 45.88      |   |   |   | 16 |   |   |   | 45.88 |   |   |
|                                        |       |                    | 2,404      |                     |       |                                              | 6.95       |                                   |       |                     | $          | 5.18 |   |   |   | 1,648 |   |   |   | $ | 4.87 |   |   |
|                                             |            |                         |            |                          |            |                                                   |            |                                        |            |                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The aggregate intrinsic value of exercisable optionsoutstanding as of December 31, 2006 was $7.4 million, whichrepresents the amount option holders would have received had they exercisedtheir options as of that date. The aggregate intrinsic value of optionsexpected to vest as of December 31, 2006 was $2.0 million, whichrepresents the amount option holders would have received had they exercisedtheir 

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options as of that date. Theintrinsic value is the difference between our closing stock price on the lasttrading day of the year ended December 31, 2006 and the stock optionexercise price, times the number of stock option shares. The intrinsic value ofoptions exercised during the year ended December 31, 2006 was $0.7 million.The fair value of options vested during the year ended December 31, 2006was $1.8 million.

Thefollowing table presents the non-vested shares for the 1997 Plan for the yearended December 31, 2006:

| **Non-vested Stock Options** | ** ** | ** **              | ** ** | **Shares** | ** ** | **Weighted-Average  Grant-Date Fair  Value** | ** ** |
|----------------------------------------|------------|-------------------------|------------|------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Non-vested at  December 31, 2005  |       |                    | 674        |       |       |                                              | $     | 4.49 |   |   |
| Granted                                |       |                    | 641        |       |       |                                              | 5.62       |   |   |
| Vested                                 |       |                    | (402       | )          |       |                                              | 4.59       |   |   |
| Forfeited                              |       |                    | (157       | )          |       |                                              | 4.76       |   |   |
| Non-vested at  December 31, 2006  |       |                    | 756        |       |       |                                              | 5.34       |   |   |

 

As of December 31,2006, unrecognized compensation expense related to the unvested portion of ourstock options was $2.7 million and is expected to be recognized over aweighted-average period of approximately 2.2 years.

**(5)**          BusinessSegment and Geographic Information

SFAS No. 131, “Disclosures about Segments of anEnterprise and Related Information,” establishes standards for reportinginformation about operating segments in annual financial statements andrequires selected information about operating segments in interim financialreports issued to stockholders. It also establishes standards for relateddisclosures about products and services, and geographic areas. Operatingsegments are defined as components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker, or decision-making group, in deciding how toallocate resources and in assessing performance. Our chief operating decision-makinggroup is composed of the chief executive officer, members of senior managementand the Board of Directors. We have viewed our operations and we manage ourbusiness principally as two business segments, Trading and Retail.

***Business SegmentInformation******—******Beginning***inthe second quarter of 2004, our retail prepaid calling card services and otherenhanced services (“Retail”) became a reportable business segment, in additionto our international wholesale VoIP services (“Trading”). Since we introducedour retail prepaid calling card services, revenue from our Retail services hasgrown substantially.

Our Trading business consists of international longdistance services we provide using VoIP. We offer these services on a wholesalebasis through our worldwide network to carriers, telephony resellers and othersaround the world by operating through various service agreements with localservice providers in United States, Europe, Asia, the Middle East, LatinAmerica, Africa and Australia.

Our Retail business consists of our retail prepaidcalling cards, and Pingo, a prepaid calling service sold to consumers throughan eCommerce interface. To date, we have marketed our retail prepaid callingcard services primarily to ethnic communities within major domestic marketsthrough distributors.  Launched in thethird quarter of 2004, Pingo revenues were not material in the years ended December 31,2006, 2005 or 2004.

Our executive management team uses net revenue andgross profit, which is net revenue less data communications and telecommunicationscosts, as the basis for measuring profit or loss by segment and makingdecisions on our Trading and Retail businesses. We do not allocate our researchand development 

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expenses, selling andmarketing expenses, general and administrative expenses and depreciation andamortization between Trading and Retail.

Operatingresults for our two business segments are as follows:

| ** **                                                                                  | ** ** | **Year ended December 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **Trading**                                          | ** ** | **Retail** | ** ** | **Total** | ** ** |
| ** **                                                                                  | ** ** | **(In thousands)**                              | ** ** |
| Net revenue                                                                                 |       | $                                                    | 416,627    |   | $ | 94,456 |   | $ | 511,083 |   |
| Data  communications and telecommunication costs (excluding depreciation and  amortization) |       | 366,985                                              |       | 80,712 |   | 447,697 |   |
| Gross profit                                                                                |       | 49,642                                               |       | 13,744 |   | 63,386 |   |
| Research and  development expenses                                                          |       |                                                 |       |   |   | 13,498 |   |
| Selling and  marketing expenses                                                             |       |                                                 |       |   |   | 16,347 |   |
| General and  administrative expenses                                                        |       |                                                 |       |   |   | 25,062 |   |
| Depreciation and  amortization                                                              |       |                                                 |       |   |   | 7,055 |   |
| Write-off of  leasehold improvements                                                        |       |                                                 |       |   |   | 1,047 |   |
| Restructuring  costs                                                                        |       |                                                 |       |   |   | 1,272 |   |
| Merger related  expenses                                                                    |       |                                                 |       |   |   | 2,996 |   |
| Loss from operations                                                                        |       |                                                 |       |   |   | (3,891 | ) |
|                                                                                             |            |                                                      |            |  |  |  |  |  |  |  |

 

| ** **                                                                                  | ** ** | **Year ended December 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **Trading**                                          | ** ** | **Retail** | ** ** | **Total** | ** ** |
| ** **                                                                                  | ** ** | **(In thousands)**                              | ** ** |
| Net revenue                                                                                 |       | $                                                    | 312,594    |   | $ | 72,891 |   | $ | 385,485 |   |
| Data  communications and telecommunication costs (excluding depreciation and  amortization) |       | 275,378                                              |       | 60,774 |   | 336,152 |   |
| Gross profit                                                                                |       | $                                                    | 37,216     |   | $ | 12,117 |   | 49,333 |   |
| Research and  development expenses                                                          |       |                                                 |       |   |   | 12,568 |   |
| Selling and  marketing expenses                                                             |       |                                                 |       |   |   | 11,712 |   |
| General and  administrative expenses and restructuring costs                                |       |                                                 |       |   |   | 15,761 |   |
| Depreciation and  amortization                                                              |       |                                                 |       |   |   | 6,507 |   |
| Income from operations                                                                      |       |                                                 |       |   |   | $ | 2,785 |   |

 

| ** **                                                                                  | ** ** | **Year ended December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **Trading**                                          | ** ** | **Retail** | ** ** | **Total** | ** ** |
| ** **                                                                                  | ** ** | **(In thousands)**                              | ** ** |
| Net revenue                                                                                 |       | $                                                    | 225,324    |   | $ | 38,354 |   | $ | 263,678 |   |
| Data  communications and telecommunication costs (excluding depreciation and  amortization) |       | 192,541                                              |       | 32,628 |   | 225,169 |   |
| Gross profit                                                                                |       | $                                                    | 32,783     |   | $ | 5,726 |   | 38,509 |   |
| Research and  development expenses                                                          |       |                                                 |       |   |   | 14,013 |   |
| Selling and  marketing expenses                                                             |       |                                                 |       |   |   | 9,351 |   |
| General and  administrative expenses and restructuring costs                                |       |                                                 |       |   |   | 13,327 |   |
| Depreciation and  amortization                                                              |       |                                                 |       |   |   | 10,437 |   |
| Loss from operations                                                                        |       |                                                 |       |   |   | $ | (8,619 | ) |

 

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Assetsrelating to our Trading and Retail business consist of accounts receivable, netof allowance for doubtful accounts. We do not allocate cash and cashequivalents, short-term marketable investments, prepaid expenses and othercurrent assets, property and equipment, net or other assets between Trading andRetail.

| ** **          | ** ** | **Year ended December 31, 2006** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|
| ** **          | ** ** | **Trading**                                          | ** ** | **Retail** | ** ** | **Total** | ** ** |
| ** **          | ** ** | **(In thousands)**                              | ** ** |
| Segment assets      |       | $                                                    | 57,832     |   | $ | 7,303 |   | $ | 65,135 |   |
| Non-segment  assets |       |                                                 |       |   |   | 72,529 |   |
| Total assets        |       |                                                 |       |   |   | $ | 137,664 |   |
|                     |            |                                                      |            |  |  |  |  |  |  |  |

 

| ** **          | ** ** | **Year ended December 31, 2005** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|
| ** **          | ** ** | **Trading**                                          | ** ** | **Retail** | ** ** | **Total** | ** ** |
| ** **          | ** ** | **(In thousands)**                              | ** ** |
| Segment assets      |       | $                                                    | 38,254     |   | $ | 9,067 |   | $ | 47,321 |   |
| Non-segment  assets |       |                                                 |       |   |   | 58,830 |   |
| Total assets        |       |                                                 |       |   |   | $ | 106,151 |   |
|                     |            |                                                      |            |  |  |  |  |  |  |  |

 

***Geographic Information******—The***followingtable represents percentage of total revenue derived from each geographicregion:

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| North America                   |       |                                       | 56         | % |   |   | 54 | % |   |   | 58 | % |   |
| Europe, Middle  East and Africa |       |                                       | 33         |   |   |   | 33 |   |   |   | 29 |   |   |
| Asia Pacific                    |       |                                       | 7          |   |   |   | 11 |   |   |   | 11 |   |   |
| Other                           |       |                                       | 4          |   |   |   | 2 |   |   |   | 2 |   |   |
|                            |       |                                       | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

We did not have any single customer account for 10% ofnet revenue for the years ended December 31, 2006 and 2005. We had onecustomer account for 11% of net revenue for the year ended December 31,2004. We did not have a customer that accounted for 10% of accounts receivableat December 31, 2006 and 2005.

Thenet book value of long-lived tangible assets by geographic area was as follows:

| **Geographic Location** | ** ** | ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                   | ** ** | **(In thousands)** | ** ** |
| North America                |       | $                       | 13,803     |     |       | $        | 11,378     |   |   |
| Europe                       |       | —                  |       |     | 26         |     |       |
| Asia                         |       | 55                      |       |     | 13         |     |       |
|                         |       | $                       | 13,858     |     |       | $        | 11,417     |   |   |

 

85

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**(6)**          DiscontinuedOperations

*Income  from discontinued operations.**  *In 2002 we completed the sale ofsubstantially all the assets of our Speech Solutions Business for$18.5 million in cash ($1.5 million of this amount was held in escrowuntil March 2004). Losses from discontinued operations in 2002 and prioryears had been recorded under the provisions of SFAS No. 144, “Accountingfor the Impairment or Disposal of Long Lived Assets.” In the third quarter of2004, we recognized income from discontinued operations of $1.9 millionresulting from the expiration of certain contingent obligations.

**(7)**          AccruedExpenses

Accruedexpenses at December 31, consist of the following:

| ** **                             | ** ** | **2006**                | ** ** | **2005** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Termination fees  and circuit costs    |       | $                       | 29,946     |     |       | $ | 20,824 |   |   |
| Payroll and  related costs             |       | 1,019                   |       |     | 665        |   |   |
| Professional  services                 |       | 1,272                   |       |     | 513        |   |   |
| Restructuring  costs (current portion) |       | 777                     |       |     | 475        |   |   |
| Customer deposits                      |       | 329                     |       |     | 235        |   |   |
| Accrued other                          |       | 3,959                   |       |     | 1,993      |   |   |
| Total accrued expenses                 |       | $                       | 37,302     |     |       | $ | 24,705 |   |   |

 

**(8)**          RestructuringCosts

In October 2006, we negotiated the early terminationof leased space for one of our locations in New York City which we no longerneeded. We had begun the process of negotiation with our landlord during Q3 of2006 and finalized an agreement to terminate the lease on this space subsequentto the end of Q3 of 2006.  As a result ofour plan in Q3 of 2006 to terminate this lease, we took a non-cash charge of$1.0 million for the write-off of the carrying value of leaseholdimprovements relating to this location in 2006. Under the lease terminationagreement, we will have future monthly payment obligations totaling $1.1 millionthrough February 2011, the original lease termination date. In Q4 of 2006,we recorded a charge of $0.9 million relating to our future payment obligationof $1.1 million, net of a $0.2 million reversal in a deferred rentliability arising from the difference between cumulative rental payments madeunder the lease agreement and rental expense recorded in our financialstatements on a straight-line basis.

During 2002, we announced restructuring plans tobetter align our organization with our corporate strategy and recorded a chargeto our Statements of Operations in that year in accordance with the criteriaset forth in EITF 94-3 and SEC Staff Accounting Bulletin 100. The restructuringincluded the write-off of property and equipment, contractual obligationsrelating to certain vacant leased facilities and a reduction in our workforceresulting in employee severance costs. In the years ended December 31,2006, 2005 and 2004, we took an additional charge of $387,000, $218,000 and$165,000, respectively, as a result of a change in estimates relating to ourfuture sublease assumptions relating to this restructuring program.

At December 31, 2006, accrued restructuring costsof $2.2 million consisted of costs accrued for leased facilityobligations, net of certain future sublease assumptions, and future paymentobligations for the early terminatin of the facility.

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Asummary of accrued restructuring costs is as follows:

| ** **                             | ** ** | **Future  Payment  Obligation  on Lease  Termination** | ** ** | **Contractual  Obligations  Relating to  Vacant  Facilities** | ** ** | **Employee  Severance  Costs** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------|------------|-----------|------------|
| Original charge                        |       |                                                        |       |                                                               |       |                           | $          | 2,794     |       |   |   | $ | 750 |   |   | $ | 3,544 |   |
| Change in  estimates                   |       |                                                        | —     |                                                               |       |                           | 165        |      |       |   |   |   |   | 165 |   |
| Cash payments                          |       |                                                        | —     |                                                               |       |                           | (1,268     | )         |       |   | (750 | ) |   | (2,018 | ) |
| Balance,  December 31, 2004       |       |                                                        | —     |                                                               |       |                           | 1,691      |      |       |   | — |   |   | 1,691 |   |
| Change in  estimates                   |       |                                                        | —     |                                                               |       |                           | 218        |      |       |   | — |   |   | 218 |   |
| Cash payments,  net of sublease income |       |                                                        | —     |                                                               |       |                           | (518       | )         |       |   | — |   |   | (518 | ) |
| Balance,  December 31, 2005       |       |                                                        | —     |                                                               |       |                           | 1,391      |      |       |   | — |   |   | 1,391 |   |
| Original charge                        |       |                                                        | 1,102      |                                                               |       |                           |       |      |       |   |   |   |   | 1,102 |   |
| Change in  estimates                   |       |                                                        | —     |                                                               |       |                           | 387        |      |       |   | — |   |   | 387 |   |
| Cash payments                          |       |                                                        | (75        | )                                                                  |       |                           | (611       | )         |       |   |   |   |   | (686 | ) |
| Balance,  December 31, 2006       |       |                                                        | $          | 1,027                                                              |       |                           |       | $         | 1,167      |   |   |   | $ | — |   |   | $ | 2,194 |   |
|                                        |            |                                                             |            |                                                                    |            |                                |            |           |            |  |  |  |  |  |  |  |  |  |  |

 

At December 31, 2006and 2005, the current portion of accrued restructuring costs were $777,000 and$475,000 and the long-term portion of accrued restructuring costs were$1,417,000 and $916,000, respectively.

**(9) DeferredRevenue**

Asummary of our deferred revenue activity is as follows:

| ** **                         | ** ** | **(In thousands)** | ** ** |
|------------------------------------|------------|-------------------------|------------|
| Balance at  January 1, 2005   |       |                    | $          | 6,303 |   |   |
| Revenue deferred                   |       |                    | 76,105     |   |   |
| Revenue  recognized                |       |                    | (72,891    | ) |   |
| Balance at  December 31, 2005 |       |                    | $          | 9,517 |   |   |
| Revenue deferred                   |       |                    | 95,648     |   |   |
| Revenue  recognized                |       |                    | (94,456    | ) |   |
| Balance at  December 31, 2006 |       |                    | $          | 10,709 |   |   |

 

Deferred revenue consistsof billings to our distributors for prepaid calling cards and purchases of ourPingo prepaid calling services, for which revenue is recognized when minuteusage and service charges occur.

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**(10)**   IncomeTaxes

Theprovision for income taxes consisted of the following:

| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | **(In thousands)**                    | ** ** |
| Current (before  application of net operating loss carry-forwards): |       |                                       |       |   |   |   |   |   |   |   |   |
| Federal                                                             |       | $                                          | 1,107      |   |   | $ | — |   |   |   | $ | — |   |   |
| State                                                               |       | 137                                        |       |   | — |   |   |   | — |   |   |
| Foreign                                                             |       | 37                                         |       |   | 93 |   |   |   | 50 |   |   |
| Benefit from net  operating loss carry-forwards:                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Federal                                                             |       | (1,107                                     | )          |   | — |   |   |   | — |   |   |
| State                                                               |       | (137                                       | )          |   | — |   |   |   | — |   |   |
|                                                                |       | 37                                         |       |   | 93 |   |   |   | 50 |   |   |
| Deferred:                                                           |       |                                       |       |   |   |   |   |   |   |   |   |
| Federal                                                             |       | (1,551                                     | )          |   | (681 | ) |   |   | (7,047 | ) |   |
| State                                                               |       | (222                                       | )          |   | (97 | ) |   |   | (1,007 | ) |   |
| Foreign                                                             |       | —                                     |       |   | — |   |   |   | — |   |   |
| Valuation allowance increase                                        |       | 1,773                                      |       |   | 778 |   |   |   | 8,054 |   |   |
|                                                                |       | —                                     |       |   | — |   |   |   | — |   |   |
| Provision for  income taxes                                         |       | $                                          | 37         |   |   | $ | 93 |   |   |   | $ | 50 |   |   |

 

Asummary of the income tax effects of temporary differences and carryforwardsare as follows:

| ** **                                         | ** ** | **December 31,**   | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| Net operating  losses and tax credit carryforwards |       | $                       | 125,066    |   |   | $ | 126,297 |   |   |
| Accruals                                           |       | 1,433                   |       |   | 595 |   |   |
| Stock  compensation                                |       | 1,520                   |       |   | 1,103 |   |   |
| Accounts  receivable                               |       | 1,521                   |       |   | 1,003 |   |   |
| Capital loss  carry-forward                        |       | 2,000                   |       |   | 2,000 |   |   |
| Total deferred  tax assets                         |       | 131,540                 |       |   | 130,998 |   |   |
| Valuation  allowance                               |       | (131,540                | )          |   | (130,998 | ) |   |
| Net deferred tax assets                            |       | $                       | —     |   |   | $ | — |   |   |

 

Areconciliation between statutory federal income tax rate and our effective taxrate for the years ended December 31, is as follow:

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(In thousands)**                    | ** ** |
| Statutory federal  income tax (benefit) |       | $                                          | (755       | ) |   | $ | (681 | ) |   |   | $ | (7,047 | ) |   |
| State taxes, net  of federal benefit    |       | (133                                       | )          |   | (97 | ) |   |   | (1,007 | ) |   |
| Permanent  differences and other        |       | 346                                        |       |   | — |   |   |   | — |   |   |
| Net change in  valuation allowance      |       | 542                                        |       |   | 778 |   |   |   | 8,054 |   |   |
| Foreign income  taxes                   |       | 37                                         |       |   | 93 |   |   |   | 50 |   |   |
|                                    |       | $                                          | 37         |   |   | $ | 93 |   |   |   | $ | 50 |   |   |

 

As of December 31, 2006, we had net operatingloss carryforwards of approximately $315 million, and tax creditcarryforwards of approximately $0.9 million, available to reduce future federaland state income 

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taxes, if any. If notutilized, these carryforwards expire between 2020 and 2025. If substantialchanges in our ownership should occur, as defined by Section 382 of theInternal Revenue Code (the “Code”), there could be annual limitations on theamount of carryforwards which can be realized in future periods. The Companyhas completed multiple convertible debt and equity financings and anacquisition since its inception and an ownership change, as defined under theCode, may have occurred. In addition, upon completion of the proposedtransaction with KPN, there will be an ownership change which will result inannual limitations on the amount of our operating loss carry-forwards availableto us to offset potential taxable income in future periods.

Certain tax benefits related to the exercise of stockoptions, which were not material, were included, in our net operating losscarry-forwards as of December 31, 2006. We recognize the tax benefit fromsuch exercises after utilization of net operating losses from operations toreduce income taxes payable. To date, no such amounts have been recognized.

We haverecorded a 100% valuation allowance against the net deferred tax asset as of December 31,2006 and 2005, as we have determined that it is more likely than not that suchassets will not be realized.

**(11)**   Long-TermDebt

Long-termdebt consists of the following as of December 31:

| ** **                 | ** ** | **2006**                | ** ** | **2005** | ** ** |
|----------------------------|------------|-------------------------|------------|----------|------------|
| ** **                 | ** ** | **(In thousands)** | ** ** |
| Capital lease  obligations |       | $                       | 2,217      |     | $          | 3,814 |   |
| Less: Current  portion     |       | 1,462                   |       | 1,598    |       |
| Long-term portion          |       | $                       | 755        |     | $          | 2,216 |   |

 

***(a) Capital LeaseObligations***

Scheduledmaturities of capital lease obligations as of December 31, 2006 are asfollows:

| **Year**                             | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------|------------|
| 2007                                 |       |       | $          | 1,583                   |       |   |
| 2008                                 |       |       | 780        |                    |       |
| Total future  minimum payments       |       |       | 2,363      |                    |       |
| Less: Amounts  representing interest |       |       | 146        |                    |       |
| Present value of  minimum repayments |       |       | 2,217      |                    |       |
| Less: Current portion                |       |       | 1,462      |                    |       |
| Long-term portion                    |       |       | $          | 755                     |       |   |

 

During2005 and 2004, we entered into capital lease agreements to finance $3.2 millionand $1.8 million in equipment purchases for The iBasis Network,respectively. The capital lease agreements primarily have a term of threeyears.

***(b) Bank Line ofCredit***

In May 2007,we amended certain financial covenants and extended the maturity date of ourrevolving line of credit with our bank from May 31, 2007 until July 30,2007. Our $15.0 million revolving line of credit bears interest at thebank’s prime rate plus 1¤2% and is collateralized bysubstantially all of our assets. Borrowings under the line may also be used forletters of credit and foreign exchange contracts. The revolving line of creditrequires us to comply with various non-financial and financial covenants,including minimum profitability and liquidity and requires us to maintain aminimum cash balance of $15.0 million with the bank, or be subject tocertain additional fees. As of December 31, 2006, we were not in 

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compliancewith certain financial covenants and we have received waivers of non-complianceof these covenants from our bank for Q3 and Q4 of 2006. We were also not incompliance with certain financial covenants as of March 31, 2007 and wehave received a waiver of non-compliance from our bank for Q1 of 2007. At December 31,2006 and 2005, we had no borrowings under this agreement At December 31,2006 and 2005, we had $2.7 million and $2.4 million in letters of creditoutstanding, respectively.

***(c) ConvertibleNotes***

From mid-August 2005 through early September 2005,all of our remaining $32.6 million of 63⁄4% Convertible Subordinated Notes due June 2009were converted to shares of our common stock at the stated conversion price of$5.55 per share. In mid-August 2005, we announced our intention to redeemall of these outstanding notes for cash at the face value of the notes, plusaccrued interest, with a planned redemption date of September 6, 2005. Priorto the redemption date, all of the holders elected to convert their notes tocommon stock at the stated conversion price of $5.55 per share. We were notrequired to pay any accrued interest upon conversion of these notes.

In July 2005, we negotiated the early conversionof the remaining $19.9 million of our 8% Secured Convertible Notes due June 2007into 3.6 million shares of common stock at the stated conversion price of $5.55per share. We paid a total premium of $1.2 million in cash to the noteholdersto encourage the early conversion of these notes. In addition, transactionscosts associated with this early conversion were $0.1 million and consistedprimarily of investment banking fees.

In June 2005, we negotiated (i) the earlyconversion of $9.1 million of our 8% Secured Convertible Notes due June 2007into 1.6 million shares of common stock at the stated conversion price of $5.55per common share and (ii) the early conversion of $2.0 million of our 63⁄4%Convertible Subordinated Notes due June 2009 into 0.4 million shares ofcommon stock at the stated conversion price of $5.55 per common share. We paida total of $0.7 million in premiums to the noteholders to encourage the earlyconversion of these notes, of which $0.6 million was paid in cash and theremaining amount was paid in the form of 14,579 shares of the Company’s commonstock that had a fair value of $0.1 million. In addition, $1.2 million of our63⁄4% Convertible Subordinated Notes due June 2009 voluntarily convertedinto 0.2 million shares of common stock at the conversion price of $5.55 per share.In total, $12.3 million of notes were converted into 2.2 million shares ofcommon stock.

In the first quarter of 2005, holders of $0.2 millionof 63⁄4% Convertible Subordinated Notes due June 2009 voluntarily convertedtheir notes into 0.1 million shares of common stock at the conversion price of$5.55 per share. In March 2005, we redeemed the remaining $0.9 million ofour outstanding 53⁄4% Convertible Subordinated Notes for cash on the maturitydate of these notes.

In June 2004, wecompleted a refinancing of our outstanding debt obligations. As part of therefinancing, we completed an exchange offer, pursuant to which$37.3 million of our 53⁄4% Convertible Subordinated Notes due March 2005,representing approximately 98% of the total amount outstanding, were tenderedfor the same principal amount of new 63⁄4% Convertible Subordinated Notes due June 2009.Approximately $0.9 million of the 53⁄4% Convertible Subordinated Notes due March 2005remained outstanding after the exchange offer. Simultaneously with the exchangeoffer, we prepaid all $25.2 million of our 111⁄2%Senior Secured Notes due January 2005for cash equal to the principal amount plus accrued but unpaid interest and theissuance of warrants exercisable for an aggregate of 1.7 million shares of ourcommon stock at $5.55 per share, which had a fair value of $2.1 million.We issued $29.0 million of new 8% Secured Convertible Notes due June 2007,of which $25.2 million was used to prepay the 111⁄2% Senior Secured Notesdue January 2005. The 63⁄4%Convertible Subordinated Notes due June 2009and the 8% Secured Convertible Notes due June 2007 were convertible intoshares of common stock at $5.55 per share. During the second half of 2004,holders of $1.3 million of 63⁄4% Convertible Subordinated Notes due June 2009voluntarily converted their notes into 0.2 million shares of common stockat the conversion price of $5.55 per share.

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**(12)**   Commitmentsand Contingencies

**Operating Leases  **We lease ouradministrative and operating facilities and certain equipment under non-cancelableoperating leases, which expire at various dates through 2011. The futureapproximate minimum lease payments under such operating leases consist of thefollowing:

| **Year**                             | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------|------------|
| 2007                                 |       |       | $          | 2,442                   |       |   |
| 2008                                 |       |       | 1,894      |                    |       |
| 2009                                 |       |       | 1,688      |                    |       |
| 2010                                 |       |       | 782        |                    |       |
| 2011                                 |       |       | 396        |                    |       |
| Thereafter                           |       |       | 2,091      |                    |       |
| Total future minimum  lease payments |       |       | $          | 9,293                   |       |   |

 

Total rent expense included in the consolidatedstatements of operations was $3,048,000, $2,954,000, and $2,818,000 for theyears ended December 31, 2006, 2005, and 2004, respectively.

**Litigation  **In addition to litigationthat we have initiated or responded to in the ordinary course of business, weare currently party to the following potentially material legal proceedings:

*Class ActionPursuant to 1999 Initial Public Offering*

In 2001, we were served with several class actioncomplaints that were filed in the United States District Court for the SouthernDistrict of New York against us and several of our officers, directors, andformer officers and directors, as well as against the investment banking firmsthat underwrote our November 10, 1999 initial public offering of commonstock and our March 9, 2000 secondary offering of common stock. Thecomplaints were filed on behalf of a class of persons who purchased our commonstock between November 10, 1999 and December 6, 2000.

The complaints are similar to each other and tohundreds of other complaints filed against other issuers and theirunderwriters, and allege violations of the Securities Act of 1933 and theSecurities Exchange Act of 1934 primarily based on the assertion that there wasundisclosed compensation received by our underwriters in connection with ourpublic offerings and that there were understandings with customers to makepurchases in the aftermarket. In September, 2001, the complaints wereconsolidated and allege that our prospectuses failed to disclose thesearrangements. The consolidated complaint seeks an unspecified amount ofmonetary damages and other relief. In October 2002, the individual defendantswere dismissed from the litigation by stipulation and without prejudice andsubject to an agreement to toll the running of time-based defenses. In February 2003,the district court denied our motion to dismiss.

In June, 2004, we and the individual defendants, aswell as many other issuers named as defendants in the class action proceeding,entered into an agreement-in-principle to settle this matter, and thissettlement was presented to the court. The district court granted a preliminaryapproval of the settlement in February 2005, subject to certainmodifications to the proposed bar order, to which plaintiffs and issuers agreed.In August 2005, the district court issued a preliminary order furtherapproving the modifications to the settlement, certifying the settlementclasses and scheduled a fairness hearing, after notice to the class. Thefairness hearing was held on April 24, 2006 and the motion for approval ofthe settlement is pending. Plaintiffs have continued to pursue their claimsagainst the underwriters. The district court has established a procedurewhereby six “focus” cases are being pursued initially and has certified a classof purchasers in those cases. The underwriters appealed the certification orderand in December 2006, the United States Court of Appeals for the SecondCircuit reversed the certification order. Since the pending settlement with 

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the issuers involvesparallel classes to those in the six focus cases, it is not expected that thedistrict court will act favorably on the issuer settlement in its current form.

We anticipate additional settlement negotiations willoccur, but there can be no assurance that those negotiations will result in arevised settlement. We believe that if this matter is not settled, we havemeritorious defenses and intend to defend vigorously. 

We cannot estimatepotential losses, if any, from these matters or whether, in light of theCompany’s insurance coverage, any loss would be material to the Company’sfinancial condition, results of operations or cash flows. As such, no amountshave been accrued as of December 31, 2006.

*Actions Pursuant toOption Investigation*

On December 21,2006, two derivative actions naming us as a nominal defendant were filed in theUnited States District Court for the District of Massachusetts: *David Shutvet, Derivatively on Behalf of iBasis, Inc., v. OferGneezy et al.,* U.S.D.C. Civil Action No. 06-12276-DPW;and *Victor Malozi, Derivatively on Behalf of iBasis, Inc.,v. Ofer Gneezy et al.,* U.S.D.C. Civil Action No. 06-12277-DPW.The complaints in these two actions each name the same defendants: Ofer Gneezy,our President, Chief Executive Officer, Treasurer and Director; Gordon J.VanderBrug, our Executive Vice President, Assistant Secretary and Director;Richard G. Tennant, our Senior Vice President of Finance and Administration andChief Financial Officer; Paul H. Floyd, our Senior Vice President of R&D,Engineering and Operations; Charles Corfield, Charles M. Skibo, W. Frank King,David Lee, and Robert H. Brumley, our Directors; Daniel Price, former SeniorVice President of Speech Solutions and our former Director; John G. Henson, Jr.,our former Vice President, Engineering and Operations; Michael J. Hughes, ourformer Chief Financial Officer and former Vice President of Finance andAdministration; Charles Giambalvo, our former Senior Vice President ofWorldwide Sales; Jonathan D. Draluck, our former Vice President, BusinessAffairs, and former General Counsel and former Secretary; and John Jarve,Charles Houser, and Carl Redfield, our former Directors. The complaints allegethat the defendants caused or allowed our “insiders” to backdate theirstock-option grants, and caused or allowed us (i) to file materially falseand misleading financial statements that materially understated itscompensation expenses and materially overstated its quarterly and annual netincome and earnings per share, and (ii) to make disclosures in itsperiodic filings and proxy statements that falsely portrayed our options ashaving been granted at exercise prices equal to the fair market value of ourcommon stock on the date of the grant. The complaints also allege that certaindefendants engaged in illegal insider selling of our common stock while inpossession of undisclosed material adverse information. Based on these andother allegations, the complaints assert claims for: violation of Section 14(a) ofthe Exchange Act; disgorgement under the Sarbanes-Oxley Act of 2002; unjustenrichment; breach of fiduciary duty for approving improperly dated stockoption grants to our executive officers; breach of fiduciary duties for insiderselling and misappropriation of information; abuse of control; grossmismanagement; waste of corporate assets; an accounting; rescission of certainstock option contracts; and constructive trust. The complaints seek thefollowing relief: damages in favor of us for the individual defendants’ allegedwrongdoing; disgorgement of all bonuses or other incentive-based orequity-based compensation received by Mr. Gneezy and Mr. Tennant duringany period for which we restate our financial results; a declaration that thedirector defendants caused us to violate Section 14(a) of theExchange Act; certain corporate governance reforms; an accounting of allundisclosed backdated stock option grants, cancellation of all unexercisedgrants, and revision of our financial statements; disgorgement of all profitsobtained by the defendants from the allegedly backdated stock option grants andrelated equitable relief; and an award to the plaintiffs of their costs anddisbursements for the action, including reasonable attorney’s fees andaccountants’ and experts’ fees, costs and expenses.

On May 10,2007, the United States District Court for the District of Massachusettsentered orders consolidating the above derivative actions under Civil Action No. 06-12276-DPWand requiring the plaintiffs to file a consolidated complaint by June 15,2007. Our response to the consolidated complaint is 

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due on August 3, 2007. Based on the allegations in thecomplaints presently on file, we anticipate that we will file a motion todismiss the consolidated complaint at that time.

We announced on October 20, 2006 that we were contacted by the SEC aspart of an informal inquiry and we further disclosed on March 29, 2007, onForm 8-K, that the SEC had notified us that we would be receiving aformal order of investigation relating to our stock option practices*.* On April 13, 2007, we received the formal order ofinvestigation. The SEC investigation seeks documents and information from usrelating to the grant of our options from 1999 to the present. We expect thatthe SEC will seek the testimony of individuals including certain of ourexecutive officers. We are cooperating fully with the SEC investigation that isongoing. There is no assurance that other regulatory inquiries will not becommenced by other U.S. federal, state or other regulatory agencies.

We cannot estimate the amount of losses,if any, from these matters, or whether any loss would be material to ourfinancial condition, results of operations or cash flows. As such, no amountshave been accrued as of December 31, 2006.

*Regulatory Proceedings*

On June 30,2006, the Federal Communications Commission (“FCC”) issued an order requiringproviders of prepaid calling cards that utilize IP to contribute to theUniversal Service Fund (“USF”) and pay access charges and other regulatory feesboth in the future and for some prior period of time. In connection with ourRetail business, we plan to absorb or pass along such future fees, to theextent permitted by law, which, based on current traffic mix, equalapproximately 1.8% of revenue. We have filed an appeal of the retroactiveaspect of the FCC Order with the United States Court of Appeals in Washington,D.C. In October 2006, we filed a motion to stay that aspect of the FCCOrder pending the outcome of the appeal. On November 1, 2006, the Courtdeferred ruling on the stay request pending the FCC’s ruling on a similar staymotion pending before the agency. The agency denied the stay request on March 29,2007. As of December 31, 2006, we estimate that the maximum potentialretroactive USF charge relating to our Retail business prior to the thirdquarter of the year ended December 31, 2006 would be approximately $2.6million. As the amount of retroactive fees are not probable of being incurred,no amounts are accrued as of December 31, 2006.

We are also party to suits for collection, relatedcommercial disputes, claims by former employees, claims related to certaintaxes, claims from carriers and foreign service partners over reconciliation ofpayments for circuits, Internet bandwidth and/or access to the public switchedtelephone network, and claims from estates of bankrupt companies alleging thatwe received preferential payments from such companies prior to their bankruptcyfilings. Our employees have also been named in proceedings arising out ofbusiness activities in foreign countries. We intend to prosecute vigorouslyclaims that we have brought and employ all available defenses in contestingclaims against us, or our employees. Nevertheless, in deciding whether topursue settlement, we will consider, among other factors, the substantial costsand the diversion of management’s attention and resources that would berequired in litigation. In light of such costs, we have settled various and insome cases similar matters on what we believe have been favorable terms whichdid not have a material impact our financial position, results of operations,or cash flows. The results or failure of any suit may have a material adverseaffect on our business.

We cannot estimate the amount of losses, if any, from thesematters, or whether any loss would be material to our financial condition,results of operations or cash flows. As such, no amounts have been accrued asof December 31, 2006.

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**(13)**   Stockholders’Equity

***(a)   Authorized Capital Stock  ***Wehave authorized for issuance 170 million shares of common stock, $0.001 parvalue per share and 15 million shares of preferred stock, $0.001 par value pershare.

At a SpecialMeeting of Shareholders held on June 18, 2004, shareholders voted toincrease the number of authorized shares of common stock, par value $0.001 pershare, from 85 million shares to 170 million shares. As a result, on June 18,2004, we filed an Amendment to our First Amended and Restated Certificate ofIncorporation to increase the number of authorized shares of common stock, parvalue $0.001 per share, from 85 million shares to 170 million shares.

***(b)   Reverse Stock Split  ***OnMay 2, 2006, we affected a one-for-three reverse stock split of our issuedand outstanding shares of common stock. All share and per share amounts for allperiods presented in these consolidated financial statements and notes includedherein have been adjusted to reflect the reverse stock split.

***(c)    Treasury Stock***   In October 2005, we announced aprogram to repurchase up to $5.0 million of our common stock and in February 2006we expanded the program to purchase up to $15.0 million of our common stock. Duringthe fourth quarter of 2005, we repurchased 0.3 million shares of our commonstock at a total cost of $1.9 million. In Q1 of 2006, we repurchased anadditional 0.4 million shares of our common stock at a total cost of $2.3million. Since March 2006, we have notmade any purchases of our common stock and we have no current plans for anyfurther purchases under this program.

In addition, during2005, we reissued 14,579 shares from our treasury stock as partial payment ofour debt conversion premium.

***(d)   Stock Incentive Plan***   Our1997 Stock Incentive Plan (the “Plan”) provides for the granting of restrictedstock awards and incentive stock options (“ISOs”) and nonqualified options topurchase shares of Common Stock to key employees, directors and consultants.Under the terms of the Plan, the exercise price of options granted shall bedetermined by the Board of Directors and for ISOs shall not be less than fairmarket value of our Common Stock on the date of grant. Options vest quarterlyin equal installments over four years, provided that no options shall vestduring the employees’ first year of employment. The expiration date of eachstock option shall be determined by the Board of Directors, but shall notexceed 10 years from the date of grant. At our May 2005 annualmeeting, our stockholders approved an additional 1.7 million shares of CommonStock to be granted under the Plan.

***(e)    Warrants***   In thesecond quarter of 2006, we issued a warrant exercisable into 66,667 shares ofour common stock to an investment banking firm as partial payment of advisoryservices. The warrant is exercisable into our common stock at an exercise priceof $9.00 per share and has a five year term. The fair value of $0.2 million forthis warrant was charged to results of operations in Q2 of 2006.

As described in Note 11, we issued warrantsexercisable into 1.7 million shares of our common stock in connection with ourdebt refinancing in June 2004 (“2004 Warrant”). The 2004 Warrant wasissued to the holders of our 111⁄2% Senior Secured Notes for the right to prepaythe notes. Each 2004 Warrant share is exercisable into our common stock at anexercise price of $5.55 per share and expire in June 2007. The fair valueof $2.1 million of the 2004 Warrant was charged to results of operationsas additional interest associated with our debt refinancing**.**

In 2003, we issued warrants exercisable into 1.6million shares of our common stock in connection with the exchange of our 53⁄4%Convertible Subordinated Notes for the 111⁄2% Senior Secured Notes (“2003 Warrant”).Each 2003 Warrant share is exercisable into our common stock at an exerciseprice of $1.95 per warrant share and expire in 2008. The warrant had a fairvalue of $1.4 million and was charged to the gain on the debt exchanges in2003. In connection with our private equity placement in September 2004,we issued a warrant exercisable into 0.6 million shares of our common stock inpartial 

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payment of investmentbanking services. This warrant has an exercise price of $6.30 per share, isexercisable over a five-year term and had a fair value of $2.8 million.The fair value of this warrant was charged to stockholders’ deficit as anon-cash transaction cost of the private equity placement. There were noexercises of warrants during the year ended December 31, 2006. During theyear ended December 31, 2005, 2004 Warrants for 0.3 million shares ofcommon stock were exercised for $1.5 million in cash; 2003 Warrants for 0.5million shares of common stock were exercised for $0.9 million in cash andwarrants for 5,000 shares issued for investment banking services were exercisedfor $32,000 in cash. During the year ended December 31, 2004, 2003Warrants for 0.7 million shares of common stock were exercised for$1.5 million in cash.

At December 31,2006 and 2005, outstanding warrants were:

| ** **                                                                                  | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                  | ** ** | **(In thousands)** | ** ** |
| 2004 Warrant                                                                                |       | 1,459                   |       | 1,459    |       |
| 2003 Warrant                                                                                |       | 422                     |       | 422      |       |
| Warrant issued  for investment banking services in connection with private equity placement |       | 573                     |       | 573      |       |
| Warrant issued  for investment banking advisory services                                    |       | 67                      |       | —   |       |
| Total warrants  outstanding                                                                 |       | 2,521                   |       | 2,454    |       |

 

**(14)**   Valuationand Qualifying Accounts

Theallowance for doubtful accounts reflects our best estimate of probable lossesinherent in the account receivable balance. We determine the allowance based onknown troubled accounts, historical experience, and other currently availableevidence. Activity in the allowance for doubtful accounts is as follows:

| **Year Ended  December 31,** | ** ** | ** **              | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged to  costs and  expenses** | ** ** | **Write-offs  and other** | ** ** | **Recovery  of previously  reserved  balance** | ** ** | **Balance at  End of Year** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **(In thousands)** | ** ** |
| 2004                                   |       |                    | $          | 3,128                                        |       |                                          |       | $                              | 250        |                                                |       |                                       | $          | 13 |   |   |   | — |   |   |   | $ | 3,391 |   |   |
| 2005                                   |       |                    | $          | 3,391                                        |       |                                          |       | $                              | 850        |                                                |       |                                       | $          | (1,734 | ) |   |   | — |   |   |   | $ | 2,507 |   |   |
| 2006                                   |       |                    | $          | 2,507                                        |       |                                          |       | $                              | 3,847      |                                                |       |                                       | (2,551     | ) |   |   | — |   |   |   | $ | 3,803 |   |   |

 

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**(15)**   Summaryof Quarterly Information (Unaudited)

Thefollowing tables reflect the restatement of our previously issued quarterlycondensed consolidated financial statements as discussed in Note 3.

| ** **                                       | ** ** | **Three Months Ended March 31, 2006**        | ** ** | **Three Months Ended June 30, 2006**                               | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **(as  previously  reported)**                                        | ** ** | **Stock-based  compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** | **(as  previously  reported)** | ** ** | **Stock-based  compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated  Statements of Operations Data:** |       |                                                                  |       |                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                  |            |                                                                       |            |                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| Net revenue                                                                           |   |   | $       | 110,779 |   |   |   | $      | — |   |   |   | $      | —  |   |   | $       | 110,779 |   |   | $      | 127,324 |   |   |   | $      | — |    |   |   | $ | — |   |   | $ | 127,324 |   |
|---------------------------------------------------------------------------------------|--------|--------|---------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|---------|---------|--------|--------|--------|---------|--------|--------|--------|--------|--------|---------|--------|--------|---|--------|--------|--------|---|---------|--------|
| Total costs and  operating expenses:                                                  |   |   |    |    |   |   |   |   |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |   |   |   |   |    |   |
| Data communications and telecommunications (excluding  depreciation and amortization) |   |   | 96,462  |    |   |   |   |   |   |   |   |   |   | 96,462  |   |   | 110,981 |    |   |   |   |    |   |   |   |   |   | 110,981 |   |
| Research and development                                                              |   |   | 3,240   |    |   |   | 17     |   |   |   | (9     | )      |   | 3,248   |   |   | 3,539   |    |   |   | 14     |    |   |   | (6     | )      |   | 3,547   |   |
| Selling and marketing                                                                 |   |   | 3,590   |    |   |   | 13     |   |   |   | (8     | )      |   | 3,595   |   |   | 4,260   |    |   |   | 11     |    |   |   | (5     | )      |   | 4,266   |   |
| General and administrative                                                            |   |   | 4,521   |    |   |   | 33     |   |   |   | (82    | )      |   | 4,472   |   |   | 5,288   |    |   |   | 75     |    |   |   | (150   | )      |   | 5,213   |   |
| Depreciation and amortization                                                         |   |   | 1,566   |    |   |   |   |   |   |   | (18    | )      |   | 1,548   |   |   | 1,822   |    |   |   |   |    |   |   | (18    | )      |   | 1,804   |   |
| Restructuring costs                                                                   |   |   | —  |    |   |   |   |   |   |   | 72     |   |   | 72      |   |   | —  |    |   |   |   |    |   |   | 105    |   |   | 105     |   |
| Merger related expenses                                                               |   |   | —  |    |   |   |   |   |   |   |   |   |   | —  |   |   | 1,542   |    |   |   |   |    |   |   |   |   |   | 1,542   |   |
| Total costs and operating expenses                                                    |   |   | 109,379 |    |   |   | 63     |   |   |   | (45    | )      |   | 109,397 |   |   | 127,432 |    |   |   | 100    |    |   |   | (74    | )      |   | 127,458 |   |
| Income (loss) from operations                                                         |   |   | 1,400   |    |   |   | (63    | )      |   |   | 45     |   |   | 1,382   |   |   | (108    | )       |   |   | (100   | )       |   |   | 74     |   |   | (134    | )      |
| Interest income                                                                       |   |   | 412     |    |   |   |   |   |   |   |   |   |   | 412     |   |   | 450     |    |   |   |   |    |   |   |   |   |   | 450     |   |
| Interest expense                                                                      |   |   | (94     | )       |   |   |   |   |   |   |   |   |   | (94     | )      |   | (95     | )       |   |   |   |    |   |   |   |   |   | (95     |   |
| Other expense, net                                                                    |   |   | (47     | )       |   |   |   |   |   |   |   |   |   | (47     | )      |   | (43     | )       |   |   |   |    |   |   |   |   |   | (43     | )      |
| Foreign exchange (loss) gain                                                          |   |   | (17     | )       |   |   |   |   |   |   |   |   |   | (17     | )      |   | 148     |    |   |   |   |    |   |   |   |   |   | 148     |   |
| Income (loss) before taxes                                                            |   |   | 1,654   |    |   |   | (63    | )      |   |   | 45     |   |   | 1,636   |   |   | 352     |    |   |   | (100   | )       |   |   | 74     |   |   | 326     |   |
| Foreign income tax expense                                                            |   |   | (11     | )       |   |   |   |   |   |   |   |   |   | (11     | )      |   | (11     | )       |   |   |   |    |   |   |   |   |   | (11     | )      |
| Net income (loss)                                                                     |   |   | $       | 1,643   |   |   |   | $      | (63    | )      |   |   | $      | 45      |   |   | $       | 1,625   |   |   | $      | 341     |   |   |   | $      | (100   | )       |   |   | $ | 74     |   |   | $ | 315     |   |
| Net income (loss)  per share:                                                         |   |   |    |    |   |   |   |   |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |   |   |   |   |    |   |
| Basic                                                                                 |   |   | $       | 0.05    |   |   |   | $      | (0.00  | )      |   |   | $      | 0.00    |   |   | $       | 0.05    |   |   | $      | 0.01    |   |   |   | $      | (0.00  | )       |   |   | $ | 0.00   |   |   | $ | 0.01    |   |
| Diluted                                                                               |   |   | $       | 0.05    |   |   |   | $      | (0.00  | )      |   |   | $      | 0.00    |   |   | $       | 0.05    |   |   | $      | 0.01    |   |   |   | $      | (0.00  | )       |   |   | $ | 0.00   |   |   | $ | 0.01    |   |
| Weighted average  common shares outstanding                                           |   |   |    |    |   |   |   |   |   |   |   |   |   |    |   |   |    |    |   |   |   |    |   |   |   |   |   |    |   |
| Basic                                                                                 |   |   | 33,257  |    |   |   |   |   |   |   |   |   |   | 33,257  |   |   | 33,133  |    |   |   |   |    |   |   |   |   |   | 33,133  |   |
| Diluted                                                                               |   |   | 34,335  |    |   |   |   |   |   |   |   |   |   | 34,335  |   |   | 34,948  |    |   |   |   |    |   |   |   |   |   | 34,948  |   |

 

96

----

 

| ** **                                                                             | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Three Months Ended  December 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **Consolidated  Statements of Operations Data:**                                       |       |                                                           |       |                                                          |       |   |   |   |   |
| Net revenue                                                                            |       |                                                           | $          | 133,470                                                       |       |   |   | $ | 139,510 |   |   |
| Total costs and  operating expenses:                                                   |       |                                                           |       |                                                          |       |   |   |   |   |
| Data  communications and telecommunications (excluding depreciation and  amortization) |       |                                                           | 117,858    |                                                          |       |   | 122,396 |   |   |
| Research and  development                                                              |       |                                                           | 3,277      |                                                          |       |   | 3,426 |   |   |
| Selling and  marketing                                                                 |       |                                                           | 4,281      |                                                          |       |   | 4,205 |   |   |
| General and  administrative                                                            |       |                                                           | 7,300      |                                                          |       |   | 8,077 |   |   |
| Depreciation and  amortization                                                         |       |                                                           | 1,810      |                                                          |       |   | 1,893 |   |   |
| Write-off of  leasehold improvements                                                   |       |                                                           | 1,047      |                                                          |       |   | —- |   |   |
| Restructuring  costs                                                                   |       |                                                           | 105        |                                                          |       |   | 990 |   |   |
| Merger related  expenses                                                               |       |                                                           | 1,244      |                                                          |       |   | 210 |   |   |
| Total operating  expenses                                                              |       |                                                           | 136,922    |                                                          |       |   | 141,197 |   |   |
| Loss from  operations                                                                  |       |                                                           | (3,452     | )                                                             |       |   | (1,687 | ) |   |
| Interest income                                                                        |       |                                                           | 508        |                                                          |       |   | 517 |   |   |
| Interest expense                                                                       |       |                                                           | (71        | )                                                             |       |   | (77 | ) |   |
| Other expense,  net                                                                    |       |                                                           | (49        | )                                                             |       |   | (49 | ) |   |
| Foreign exchange  (loss) gain                                                          |       |                                                           | 58         |                                                          |       |   | 183 |   |   |
| Loss before taxes                                                                      |       |                                                           | (3,006     | )                                                             |       |   | (1,113 | ) |   |
| Foreign income  tax expense                                                            |       |                                                           | (11        | )                                                             |       |   | (4 | ) |   |
| Net loss                                                                               |       |                                                           | $          | (3,017                                                        | )          |   |   | $ | (1,117 | ) |   |
| Basic and diluted  net loss per share                                                  |       |                                                           | $          | (0.09                                                         | )          |   |   | $ | (0.03 | ) |   |
| Basic and diluted  weighted average common shares  outstanding                         |       |                                                           | 33,187     |                                                          |       |   | 33,217 |   |   |

 

97

----

|                                                  | ** ** | **Three Months Ended March 31, 2005**        | ** ** | **Three Months Ended June 30, 2005**                               | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **(as  previously  reported)**                                        | ** ** | **Stock-based  compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** | **(as  previously   reported)** | ** ** | **Stock-based   compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of  Operations Data:** |       |                                                                  |       |                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                  |            |                                                                       |            |                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Net revenue                                                                           |   |   | $      | 88,672 |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | 88,672 |   |   |   | $      | 94,581 |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $ | 94,581 |   |   |
|---------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|--------|
| Total costs and operating  expenses:                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Data communications and telecommunications (excluding  depreciation and amortization) |   |   | 76,301 |   |   |   |   |   |   |   |   |   |   |   | 76,301 |   |   |   | 81,874 |   |   |   |   |   |   |   |   |   |   |   | 81,874 |   |   |
| Research and development                                                              |   |   | 3,132  |   |   |   | 29     |   |   |   | 8      |   |   |   | 3,169  |   |   |   | 3,126  |   |   |   | 33     |   |   |   | 13     |   |   |   | 3,172  |   |   |
| Selling and marketing                                                                 |   |   | 2,727  |   |   |   | 27     |   |   |   |   |   |   |   | 2,754  |   |   |   | 2,866  |   |   |   | 29     |   |   |   |   |   |   |   | 2,895  |   |   |
| General and administrative                                                            |   |   | 3,313  |   |   |   | 54     |   |   |   | 30     |   |   |   | 3,397  |   |   |   | 3,746  |   |   |   | 94     |   |   |   | 30     |   |   |   | 3,870  |   |   |
| Depreciation and amortization                                                         |   |   | 1,720  |   |   |   |   |   |   |   | 23     |   |   |   | 1,743  |   |   |   | 1,726  |   |   |   |   |   |   |   | (114   | )      |   |   | 1,612  |   |   |
| Restructuring costs                                                                   |   |   | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |
| Total costs and operating expenses                                                    |   |   | 87,193 |   |   |   | 110    |   |   |   | 61     |   |   |   | 87,364 |   |   |   | 93,338 |   |   |   | 156    |   |   |   | (71    | )      |   |   | 93,423 |   |   |
| Income (loss) from operations                                                         |   |   | 1,479  |   |   |   | (110   | )      |   |   | (61    | )      |   |   | 1,308  |   |   |   | 1,243  |   |   |   | (156   | )      |   |   | 71     |   |   |   | 1,158  |   |   |
| Interest income                                                                       |   |   | 210    |   |   |   |   |   |   |   |   |   |   |   | 210    |   |   |   | 254    |   |   |   |   |   |   |   |   |   |   |   | 254    |   |   |
| Interest expense                                                                      |   |   | (1,246 | )      |   |   |   |   |   |   |   |   |   |   | (1,246 | )      |   |   | (1,116 | )      |   |   |   |   |   |   |   |   |   |   | (1,116 | )      |   |
| Other expense, net                                                                    |   |   | (20    | )      |   |   |   |   |   |   |   |   |   |   | (20    | )      |   |   | (140   | )      |   |   |   |   |   |   |   |   |   |   | (140   | )      |   |
| Foreign exchange (loss) gain                                                          |   |   | (233   | )      |   |   |   |   |   |   |   |   |   |   | (233   | )      |   |   | (347   | )      |   |   |   |   |   |   |   |   |   |   | (347   | )      |   |
| Debt conversion premium and transaction costs                                         |   |   | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | (661   | )      |   |   |   |   |   |   |   |   |   |   | (661   | )      |   |
| Income (loss) before taxes                                                            |   |   | 190    |   |   |   | (110   | )      |   |   | (61    | )      |   |   | 19     |   |   |   | (767   | )      |   |   | (156   | )      |   |   | 71     |   |   |   | (852   | )      |   |
| Foreign income tax expense                                                            |   |   | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                     |   |   | $      | 190    |   |   |   | $      | (110   | )      |   |   | $      | (61    | )      |   |   | $      | 19     |   |   |   | $      | (767   | )      |   |   | $      | (156   | )      |   |   | $      | 71     |   |   |   | $ | (852   | )      |   |
| Net income (loss)  per share:                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                 |   |   | $      | 0.01   |   |   |   | $      | (0.01  | )      |   |   | $      | (0.00  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.03  | )      |   |   | $      | (0.01  | )      |   |   | $      | 0.00   |   |   |   | $ | (0.04  | )      |   |
| Diluted                                                                               |   |   | $      | 0.01   |   |   |   | $      | (0.01  | )      |   |   | $      | (0.00  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.03  | )      |   |   | $      | (0.01  | )      |   |   | $      | 0.00   |   |   |   | $ | (0.04  | )      |   |
| Weighted average common  shares outstanding                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                 |   |   | 21,661 |   |   |   |   |   |   |   |   |   |   |   | 21,661 |   |   |   | 21,998 |   |   |   |   |   |   |   |   |   |   |   | 21,998 |   |   |
| Diluted                                                                               |   |   | 23,149 |   |   |   |   |   |   |   |   |   |   |   | 23,149 |   |   |   | 21,998 |   |   |   |   |   |   |   |   |   |   |   | 21,998 |   |   |

 

98

----

 
|                                                  | ** ** | **Three Months Ended September 30, 2005**    | ** ** | **Three Months Ended December 31, 2005**                           | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **(as  previously   reported)**                                  | ** ** | **Stock-based  compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** | **(as  previously   reported)** | ** ** | **Stock-based   compensation  and related  payroll tax  withholding  adjustments** | ** ** | **Other  adjustments** | ** ** | **(as  restated)** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated Statements of  Operations Data:** |       |                                                                  |       |                                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                  |            |                                                                       |            |                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Net revenue                                                                           |   |   | $      | 94,644 |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | 94,644  |   |   |   | $      | 107,588 |   |   |   | $      | — |    |   |   | $ | — |   |   | $ | 107,588 |   |
|---------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|--------|---------|--------|--------|--------|--------|--------|---------|--------|--------|---|--------|--------|--------|---|---------|--------|
| Total costs and operating  expenses:                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |
| Data communications and telecommunications (excluding  depreciation and amortization) |   |   | 83,143 |   |   |   |   |   |   |   |   |   |   |   | 83,143 |   |   |   | 94,834  |   |   |   |   |    |   |   |   |   |   | 94,834  |   |
| Research and development                                                              |   |   | 3,076  |   |   |   | 22     |   |   |   | 5      |   |   |   | 3,103  |   |   |   | 3,101   |   |   |   | 21     |    |   |   | 2      |   |   | 3,124   |   |
| Selling and marketing                                                                 |   |   | 2,999  |   |   |   | 19     |   |   |   |   |   |   |   | 3,018  |   |   |   | 3,026   |   |   |   | 19     |    |   |   |   |   |   | 3,045   |   |
| General and administrative                                                            |   |   | 4,102  |   |   |   | 77     |   |   |   | (105   | )      |   |   | 4,074  |   |   |   | 4,177   |   |   |   | 35     |    |   |   | (10    | )      |   | 4,202   |   |
| Depreciation and amortization                                                         |   |   | 1,682  |   |   |   |   |   |   |   | (114   | )      |   |   | 1,568  |   |   |   | 1,584   |   |   |   |   |    |   |   |   |   |   | 1,584   |   |
| Restructuring costs                                                                   |   |   | — |   |   |   |   |   |   |   | 135    |   |   |   | 135    |   |   |   | 83      |   |   |   |   |    |   |   |   |   |   | 83      |   |
| Total costs and operating expenses                                                    |   |   | 95,002 |   |   |   | 118    |   |   |   | (79    | )      |   |   | 95,041 |   |   |   | 106,805 |   |   |   | 75     |    |   |   | (8     | )      |   | 106,872 |   |
| Income (loss) from operations                                                         |   |   | (358   | )      |   |   | (118   | )      |   |   | 79     |   |   |   | (397   | )      |   |   | 783     |   |   |   | (75    | )       |   |   | 8      |   |   | 716     |   |
| Interest income                                                                       |   |   | 294    |   |   |   |   |   |   |   |   |   |   |   | 294    |   |   |   | 351     |   |   |   |   |    |   |   |   |   |   | 351     |   |
| Interest expense                                                                      |   |   | (128   | )      |   |   |   |   |   |   |   |   |   |   | (128   | )      |   |   | (111    | )      |   |   |   |    |   |   |   |   |   | (111    | )      |
| Other expense, net                                                                    |   |   | (40    | )      |   |   |   |   |   |   |   |   |   |   | (40    | )      |   |   | (124    | )      |   |   |   |    |   |   |   |   |   | (124    | )      |
| Foreign exchange (loss) gain                                                          |   |   | (174   | )      |   |   |   |   |   |   |   |   |   |   | (174   | )      |   |   | (185    | )      |   |   |   |    |   |   |   |   |   | (185    | )      |
| Debt conversion premium and transaction costs                                         |   |   | (1,314 | )      |   |   |   |   |   |   |   |   |   |   | (1,314 | )      |   |   | —  |   |   |   |   |    |   |   |   |   |   | —  |   |
| Income (loss) before taxes                                                            |   |   | (1,720 | )      |   |   | (118   | )      |   |   | 79     |   |   |   | (1,759 | )      |   |   | 714     |   |   |   | (75    | )       |   |   | 8      |   |   | 647     |   |
| Foreign income tax expense                                                            |   |   | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | 93      |   |   |   |   |    |   |   |   |   |   | 93      |   |
| Net income (loss)                                                                     |   |   | $      | (1,720 | )      |   |   | $      | (118   | )      |   |   | $      | 79     |   |   |   | $      | (1,759  | )      |   |   | $      | 621     |   |   |   | $      | (75    | )       |   |   | $ | 8      |   |   | $ | 554     |   |
| Net income (loss)  per share:                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |
| Basic                                                                                 |   |   | $      | (0.06  | )      |   |   | $      | (0.00  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.06   | )      |   |   | $      | 0.02    |   |   |   | $      | (0.00  | )       |   |   | $ | 0.00   |   |   | $ | 0.02    |   |
| Diluted                                                                               |   |   | $      | (0.06  | )      |   |   | $      | (0.00  | )      |   |   | $      | 0.00   |   |   |   | $      | (0.06   | )      |   |   | $      | 0.02    |   |   |   | $      | (0.00  | )       |   |   | $ | 0.00   |   |   | $ | 0.02    |   |
| Weighted average common  shares outstanding                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |   |    |   |   |   |   |   |    |   |
| Basic                                                                                 |   |   | 29,641 |   |   |   |   |   |   |   |   |   |   |   | 29,641 |   |   |   | 33,682  |   |   |   |   |    |   |   |   |   |   | 33,682  |   |
| Diluted                                                                               |   |   | 29,641 |   |   |   |   |   |   |   |   |   |   |   | 29,641 |   |   |   | 35,034  |   |   |   |   |    |   |   |   |   |   | 35,034  |   |

 

99

----

| ** **                                                                                 | ** ** | **As of March 31, 2006**                       | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Condensed Consolidated Balance Sheet**                                    | ** ** | **(as previously   reported)**                           | ** ** | **Stock-Based  Compensation and  Related Payroll  Withholding  Adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| **Assets**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                               | $          | 27,856 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 27,856 |   |   |
| Short-term  marketable investments                                                         |       |                                                               | 18,191     |   |   |   |   |   |   |   |   |   |   |   | 18,191 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $2,807                     |       |                                                               | 52,067     |   |   |   |   |   |   |   | (551 | ) |   |   | 51,516 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                               | 3,489      |   |   |   |   |   |   |   |   |   |   |   | 3,489 |   |   |
| Total current assets                                                                       |       |                                                               | 101,603    |   |   |   |   |   |   |   | (551 | ) |   |   | 101,052 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                               | 50,550     |   |   |   |   |   |   |   |   |   |   |   | 50,550 |   |   |
| Equipment under  capital lease                                                             |       |                                                               | 4,917      |   |   |   |   |   |   |   |   |   |   |   | 4,917 |   |   |
| Computer software                                                                          |       |                                                               | 10,535     |   |   |   |   |   |   |   |   |   |   |   | 10,535 |   |   |
| Leasehold  improvements                                                                    |       |                                                               | 6,984      |   |   |   |   |   |   |   |   |   |   |   | 6,984 |   |   |
| Furniture and  fixtures                                                                    |       |                                                               | 1,050      |   |   |   |   |   |   |   |   |   |   |   | 1,050 |   |   |
|                                                                                       |       |                                                               | 74,036     |   |   |   |   |   |   |   |   |   |   |   | 74,036 |   |   |
| Less: Accumulated  depreciation and amortization                                           |       |                                                               | (60,301    | ) |   |   |   |   |   |   | (319 | ) |   |   | (60,620 | ) |   |
| Property and  equipment, net                                                               |       |                                                               | 13,735     |   |   |   |   |   |   |   | (319 | ) |   |   | 13,416 |   |   |
| Other assets                                                                               |       |                                                               | 330        |   |   |   |   |   |   |   |   |   |   |   | 330 |   |   |
| Total assets                                                                               |       |                                                               | $          | 115,668 |   |   |   | $ | — |   |   |   | $ | (870 | ) |   |   | $ | 114,798 |   |   |
| **Liabilities and Stockholders’ Equity**                                              |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                               | $          | 33,213 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 33,213 |   |   |
| Accrued expenses                                                                           |       |                                                               | 27,569     |   |   |   | 274 |   |   |   | (251 | ) |   |   | 27,592 |   |   |
| Deferred revenue                                                                           |       |                                                               | 10,517     |   |   |   |   |   |   |   |   |   |   |   | 10,517 |   |   |
| Current portion  of long-term debt                                                         |       |                                                               | 1,629      |   |   |   |   |   |   |   |   |   |   |   | 1,629 |   |   |
| Total current liabilities                                                                  |       |                                                               | 72,928     |   |   |   | 274 |   |   |   | (251 | ) |   |   | 72,951 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                               | 1,798      |   |   |   |   |   |   |   |   |   |   |   | 1,798 |   |   |
| Other long term  liabilities                                                               |       |                                                               | 796        |   |   |   |   |   |   |   |   |   |   |   | 796 |   |   |
| Stockholders’ equity:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock,  $0.001 par value, authorized—170,000 shares; issued—34,179 shares |       |                                                               | 34         |   |   |   |   |   |   |   |   |   |   |   | 34 |   |   |
| Treasury stock;  1,069 shares at cost                                                      |       |                                                               | (4,358     | ) |   |   |   |   |   |   |   |   |   |   | (4,358 | ) |   |
| Additional paid-in  capital                                                                |       |                                                               | 474,261    |   |   |   | 10,007 |   |   |   | (256 | ) |   |   | 484,012 |   |   |
| Accumulated other  comprehensive loss                                                      |       |                                                               | (16        | ) |   |   |   |   |   |   |   |   |   |   | (16 | ) |   |
| Accumulated  deficit                                                                       |       |                                                               | (429,775   | ) |   |   | (10,281 | ) |   |   | (363 | ) |   |   | (440,419 | ) |   |
| Total stockholders’ equity                                                            |       |                                                               | 40,146     |   |   |   | (274 | ) |   |   | (619 | ) |   |   | 39,253 |   |   |
| Total liabilities  and stockholders’ equity                                           |       |                                                               | $          | 115,668 |   |   |   | $ | — |   |   |   | $ | (870 | ) |   |   | $ | 114,798 |   |   |

 

100

----

 
|                                                                                            | ** ** | **As of June 30, 2006**                        | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Condensed Consolidated Balance Sheet**                                    | ** ** | **(as previously   reported)**                           | ** ** | **Stock-Based  Compensation and  Related Payroll  Withholding  Adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| **Assets**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                               | $          | 30,020 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 30,020 |   |   |
| Short-term  marketable investments                                                         |       |                                                               | 19,400     |   |   |   |   |   |   |   |   |   |   |   | 19,400 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $3,182                     |       |                                                               | 56,193     |   |   |   |   |   |   |   | (582 | ) |   |   | 55,611 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                               | 3,173      |   |   |   |   |   |   |   |   |   |   |   | 3,173 |   |   |
| Total current assets                                                                       |       |                                                               | 108,786    |   |   |   |   |   |   |   | (582 | ) |   |   | 108,204 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                               | 48,612     |   |   |   |   |   |   |   |   |   |   |   | 48,612 |   |   |
| Equipment under  capital lease                                                             |       |                                                               | 4,917      |   |   |   |   |   |   |   |   |   |   |   | 4,917 |   |   |
| Computer software                                                                          |       |                                                               | 10,271     |   |   |   |   |   |   |   | 23 |   |   |   | 10,294 |   |   |
| Leasehold  improvements                                                                    |       |                                                               | 7,037      |   |   |   |   |   |   |   |   |   |   |   | 7,037 |   |   |
| Furniture and  fixtures                                                                    |       |                                                               | 998        |   |   |   |   |   |   |   |   |   |   |   | 998 |   |   |
|                                                                                       |       |                                                               | 71,835     |   |   |   |   |   |   |   | 23 |   |   |   | 71,858 |   |   |
| Less: Accumulated  depreciation and amortization                                      |       |                                                               | (58,211    | ) |   |   |   |   |   |   | (301 | ) |   |   | (58,512 | ) |   |
| Property and  equipment, net                                                               |       |                                                               | 13,624     |   |   |   |   |   |   |   | (301 | ) |   |   | 13,346 |   |   |
| Other assets                                                                               |       |                                                               | 325        |   |   |   |   |   |   |   |   |   |   |   | 325 |   |   |
| Total assets                                                                               |       |                                                               | $          | 122,735 |   |   |   | $ | — |   |   |   | $ | (860 | ) |   |   | $ | 121,875 |   |   |
| **Liabilities and Stockholders’  Equity**                                             |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                               | $          | 38,621 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 38,621 |   |   |
| Accrued expenses                                                                           |       |                                                               | 26,971     |   |   |   | 317 |   |   |   | (288 | ) |   |   | 27,000 |   |   |
| Deferred revenue                                                                           |       |                                                               | 11,738     |   |   |   |   |   |   |   |   |   |   |   | 11,738 |   |   |
| Current portion  of long-term debt                                                         |       |                                                               | 1,661      |   |   |   |   |   |   |   |   |   |   |   | 1,661 |   |   |
| Total current liabilities                                                                  |       |                                                               | 78,991     |   |   |   | 317 |   |   |   | (288 | ) |   |   | 79,020 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                               | 1,370      |   |   |   |   |   |   |   |   |   |   |   | 1,370 |   |   |
| Other long term  liabilities                                                               |       |                                                               | 922        |   |   |   |   |   |   |   |   |   |   |   | 922 |   |   |
| Stockholders’ equity:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock,  $0.001 par value, authorized—170,000 shares; issued—34,216 shares |       |                                                               | 34         |   |   |   |   |   |   |   |   |   |   |   | 34 |   |   |
| Treasury stock;  1,069 shares at cost                                                      |       |                                                               | (4,358     | ) |   |   |   |   |   |   |   |   |   |   | (4,358 | ) |   |
| Additional paid-in  capital                                                                |       |                                                               | 475,223    |   |   |   | 10,064 |   |   |   | (283 | ) |   |   | 485,004 |   |   |
| Accumulated other  comprehensive loss                                                      |       |                                                               | (13        | ) |   |   |   |   |   |   |   |   |   |   | (13 | ) |   |
| Accumulated  deficit                                                                       |       |                                                               | (429,434   | ) |   |   | (10,381 | ) |   |   | (289 | ) |   |   | (440,104 | ) |   |
| Total stockholders’ equity                                                            |       |                                                               | 41,452     |   |   |   | (317 | ) |   |   | (572 | ) |   |   | 40,563 |   |   |
| Total liabilities  and stockholders’ equity                                           |       |                                                               | $          | 122,735 |   |   |   | $ | — |   |   |   | $ | (860 | ) |   |   | $ | 121,875 |   |   |

 

101

----

 

| ** **                                                                                 | ** ** | **As of March 31, 2005**                       | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Condensed Consolidated Balance Sheet**                                    | ** ** | **(as previously   reported)**                           | ** ** | **Stock-Based  Compensation and  Related Payroll  Withholding  Adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| **Assets**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                               | $          | 22,719 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 22,719 |   |   |
| Short-term  marketable investments                                                         |       |                                                               | 18,876     |   |   |   |   |   |   |   |   |   |   |   | 18,876 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $3,507                     |       |                                                               | 41,761     |   |   |   |   |   |   |   | (179 | ) |   |   | 41,582 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                               | 2,937      |   |   |   |   |   |   |   |   |   |   |   | 2,937 |   |   |
| Total current assets                                                                       |       |                                                               | 86,293     |   |   |   |   |   |   |   | (179 | ) |   |   | 86,114 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                               | 58,605     |   |   |   |   |   |   |   |   |   |   |   | 58,605 |   |   |
| Equipment under  capital lease                                                             |       |                                                               | 1,867      |   |   |   |   |   |   |   |   |   |   |   | 1,867 |   |   |
| Computer software                                                                          |       |                                                               | 10,213     |   |   |   |   |   |   |   |   |   |   |   | 10,213 |   |   |
| Leasehold  improvements                                                                    |       |                                                               | 6,457      |   |   |   |   |   |   |   |   |   |   |   | 6,457 |   |   |
| Furniture and  fixtures                                                                    |       |                                                               | 1,071      |   |   |   |   |   |   |   |   |   |   |   | 1,071 |   |   |
|                                                                                       |       |                                                               | 78,213     |   |   |   |   |   |   |   |   |   |   |   | 78,213 |   |   |
| Less: Accumulated  depreciation and amortization                                           |       |                                                               | (66,951    | ) |   |   |   |   |   |   | (565 | ) |   |   | (67,516 | ) |   |
| Property and  equipment, net                                                               |       |                                                               | 11,262     |   |   |   |   |   |   |   | (565 | ) |   |   | 10,697 |   |   |
| Deferred debt  financing costs                                                             |       |                                                               | 165        |   |   |   |   |   |   |   |   |   |   |   | 165 |   |   |
| Other assets                                                                               |       |                                                               | 284        |   |   |   |   |   |   |   |   |   |   |   | 284 |   |   |
| Total assets                                                                               |       |                                                               | $          | 98,004 |   |   |   | $ | — |   |   |   | (744 | ) |   |   | $ | 97,260 |   |   |
| **Liabilities and Stockholders’  Deficit**                                            |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                               | $          | 25,824 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 25,824 |   |   |
| Accrued expenses                                                                           |       |                                                               | 20,084     |   |   |   | 139 |   |   |   | 51 |   |   |   | 20,274 |   |   |
| Deferred revenue                                                                           |       |                                                               | 7,372      |   |   |   |   |   |   |   |   |   |   |   | 7,372 |   |   |
| Current portion  of long-term debt                                                         |       |                                                               | 655        |   |   |   |   |   |   |   |   |   |   |   | 655 |   |   |
| Total current liabilities                                                                  |       |                                                               | 53,935     |   |   |   | 139 |   |   |   | 51 |   |   |   | 54,125 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                               | 65,594     |   |   |   |   |   |   |   |   |   |   |   | 65,594 |   |   |
| Other long term  liabilities                                                               |       |                                                               | 1,061      |   |   |   |   |   |   |   |   |   |   |   | 1,061 |   |   |
| Stockholders’ equity:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock,  $0.001 par value, authorized—170,000 shares; issued—22,106 shares |       |                                                               | 22         |   |   |   |   |   |   |   |   |   |   |   | 22 |   |   |
| Treasury stock;  356 shares at cost                                                        |       |                                                               | (341       | ) |   |   |   |   |   |   |   |   |   |   | (341 | ) |   |
| Additional paid-in  capital                                                                |       |                                                               | 407,321    |   |   |   | 10,067 |   |   |   | (229 | ) |   |   | 417,159 |   |   |
| Deferred  compensation                                                                     |       |                                                               | —-    |   |   |   | (337 | ) |   |   |   |   |   |   | (337 | ) |   |
| Accumulated other  comprehensive loss                                                      |       |                                                               | (36        | ) |   |   |   |   |   |   |   |   |   |   | (36 | ) |   |
| Accumulated  deficit                                                                       |       |                                                               | (429,552   | ) |   |   | (9,869 | ) |   |   | (566 | ) |   |   | (439,987 | ) |   |
| Total stockholders’ deficit                                                           |       |                                                               | (22,586    | ) |   |   | (139 | ) |   |   | (795 | ) |   |   | (23,520 | ) |   |
| Total liabilities  and stockholders’ deficit                                          |       |                                                               | $          | 98,004 |   |   |   | $ | — |   |   |   | $ | (744 | ) |   |   | $ | 97,260 |   |   |

 

102

----

 

| ** **                                                                                 | ** ** | **As of June 30, 2005**                        | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Condensed Consolidated Balance Sheet**                                    | ** ** | **(as previously   reported)**                           | ** ** | **Stock-Based  Compensation and  Related Payroll  Withholding  Adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| **Assets**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                               | $          | 24,111 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 24,111 |   |   |
| Short-term  marketable investments                                                         |       |                                                               | 18,506     |   |   |   |   |   |   |   |   |   |   |   | 18,506 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $3,391                     |       |                                                               | 39,673     |   |   |   |   |   |   |   | (256 | ) |   |   | 39,417 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                               | 2,825      |   |   |   |   |   |   |   |   |   |   |   | 2,825 |   |   |
| Total current assets                                                                       |       |                                                               | 85,115     |   |   |   |   |   |   |   | (256 | ) |   |   | 84,859 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                               | 59,582     |   |   |   |   |   |   |   |   |   |   |   | 59,582 |   |   |
| Equipment under  capital lease                                                             |       |                                                               | 3,065      |   |   |   |   |   |   |   |   |   |   |   | 3,065 |   |   |
| Computer software                                                                          |       |                                                               | 10,337     |   |   |   |   |   |   |   |   |   |   |   | 10,337 |   |   |
| Leasehold  improvements                                                                    |       |                                                               | 6,463      |   |   |   |   |   |   |   |   |   |   |   | 6,463 |   |   |
| Furniture and  fixtures                                                                    |       |                                                               | 1,064      |   |   |   |   |   |   |   |   |   |   |   | 1,064 |   |   |
|                                                                                       |       |                                                               | 80,511     |   |   |   |   |   |   |   |   |   |   |   | 80,511 |   |   |
| Less: Accumulated  depreciation and amortization                                           |       |                                                               | (68,659    | ) |   |   |   |   |   |   | (451 | ) |   |   | (69,110 | ) |   |
| Property and  equipment, net                                                               |       |                                                               | 11,852     |   |   |   |   |   |   |   | (451 | ) |   |   | 11,401 |   |   |
| Deferred debt  financing costs                                                             |       |                                                               | 155        |   |   |   |   |   |   |   |   |   |   |   | 155 |   |   |
| Other assets                                                                               |       |                                                               | 374        |   |   |   |   |   |   |   |   |   |   |   | 374 |   |   |
| Total assets                                                                               |       |                                                               | $          | 97,496 |   |   |   | $ | — |   |   |   | $ | (707 | ) |   |   | $ | 96,789 |   |   |
| **Liabilities  and Stockholders’ Deficit**                                            |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                               | $          | 26,399 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 26,399 |   |   |
| Accrued expenses                                                                           |       |                                                               | 18,419     |   |   |   | 190 |   |   |   | 17 |   |   |   | 18,626 |   |   |
| Deferred revenue                                                                           |       |                                                               | 7,441      |   |   |   |   |   |   |   |   |   |   |   | 7,441 |   |   |
| Current portion  of long-term debt                                                         |       |                                                               | 1,017      |   |   |   |   |   |   |   |   |   |   |   | 1,017 |   |   |
| Total current liabilities                                                                  |       |                                                               | 53,276     |   |   |   | 190 |   |   |   | 17 |   |   |   | 53,483 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                               | 54,019     |   |   |   |   |   |   |   |   |   |   |   | 54,019 |   |   |
| Other long term  liabilities                                                               |       |                                                               | 1,079      |   |   |   |   |   |   |   |   |   |   |   | 1,079 |   |   |
| Stockholders’ equity:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock,  $0.001 par value, authorized—170,000 shares; issued—24,362 shares |       |                                                               | 24         |   |   |   |   |   |   |   |   |   |   |   | 24 |   |   |
| Treasury stock;  356 shares at cost                                                        |       |                                                               | (341       | ) |   |   |   |   |   |   |   |   |   |   | (341 | ) |   |
| Additional paid-in  capital                                                                |       |                                                               | 419,786    |   |   |   | 10,075 |   |   |   | (229 | ) |   |   | 419,786 |   |   |
| Deferred  compensation                                                                     |       |                                                               | —     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accumulated other  comprehensive loss                                                      |       |                                                               | (28        | ) |   |   | (240 | ) |   |   |   |   |   |   | (28 | ) |   |
| Accumulated  deficit                                                                       |       |                                                               | (430,319   | ) |   |   | (10,025 | ) |   |   | (495 | ) |   |   | (430,319 | ) |   |
| Total stockholders’ deficit                                                           |       |                                                               | (10,878    | ) |   |   | (190 | ) |   |   | (724 | ) |   |   | (10,878 | ) |   |
| Total liabilities  and stockholders’ deficit                                          |       |                                                               | $          | 97,496 |   |   |   | $ | — |   |   |   | $ | (707 | ) |   |   | $ | 97,496 |   |   |

 

103

----

 

| ** **                                                                                 | ** ** | **As of September 30, 2005**                   | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| **Condensed Consolidated Balance Sheet**                                    | ** ** | **(as previously   reported)**                           | ** ** | **Stock-Based  Compensatio and  Related Payroll  Withholding  Adjustments** | ** ** | **Other  Adjustments** | ** ** | **(as restated)** | ** ** |
| ** **                                                                                 | ** ** | **(In thousands, except per share data)** | ** ** |
| **Assets**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                 |       |                                                               | $          | 19,935 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 19,935 |   |   |
| Short-term  marketable investments                                                         |       |                                                               | 23,375     |   |   |   |   |   |   |   |   |   |   |   | 23,375 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $2,257                     |       |                                                               | 43,723     |   |   |   |   |   |   |   | (249 | ) |   |   | 43,474 |   |   |
| Prepaid expenses  and other current assets                                                 |       |                                                               | 3,179      |   |   |   |   |   |   |   |   |   |   |   | 3,179 |   |   |
| Total current assets                                                                       |       |                                                               | 90,212     |   |   |   |   |   |   |   | (249 | ) |   |   | 89,963 |   |   |
| Property and equipment,  at cost:                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Network equipment                                                                          |       |                                                               | 59,938     |   |   |   |   |   |   |   |   |   |   |   | 59,938 |   |   |
| Equipment under  capital lease                                                             |       |                                                               | 4,152      |   |   |   |   |   |   |   |   |   |   |   | 4,152 |   |   |
| Computer software                                                                          |       |                                                               | 10,516     |   |   |   |   |   |   |   |   |   |   |   | 10,516 |   |   |
| Leasehold  improvements                                                                    |       |                                                               | 6,692      |   |   |   |   |   |   |   |   |   |   |   | 6,692 |   |   |
| Furniture and  fixtures                                                                    |       |                                                               | 1,061      |   |   |   |   |   |   |   |   |   |   |   | 1,061 |   |   |
|                                                                                       |       |                                                               | 82,359     |   |   |   |   |   |   |   |   |   |   |   | 82,359 |   |   |
| Less: Accumulated  depreciation and amortization                                           |       |                                                               | (70,338    | ) |   |   |   |   |   |   | (337 | ) |   |   | (70,675 | ) |   |
| Property and  equipment, net                                                               |       |                                                               | 12,021     |   |   |   |   |   |   |   | (337 | ) |   |   | 11,684 |   |   |
| Other assets                                                                               |       |                                                               | 365        |   |   |   |   |   |   |   |   |   |   |   | 365 |   |   |
| Total assets                                                                               |       |                                                               | $          | 102,598 |   |   |   | $ | — |   |   |   | $ | (586 | ) |   |   | $ | 102,012 |   |   |
| **Liabilities and Stockholders’  Equity**                                             |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts payable                                                                           |       |                                                               | $          | 27,545 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 27,545 |   |   |
| Accrued expenses                                                                           |       |                                                               | 20,731     |   |   |   | 239 |   |   |   | 59 |   |   |   | 21,029 |   |   |
| Deferred revenue                                                                           |       |                                                               | 8,442      |   |   |   |   |   |   |   |   |   |   |   | 8,442 |   |   |
| Current portion  of long-term debt                                                         |       |                                                               | 1,370      |   |   |   |   |   |   |   |   |   |   |   | 1,370 |   |   |
| Total current liabilities                                                                  |       |                                                               | 58,088     |   |   |   | 239 |   |   |   | 59 |   |   |   | 58,386 |   |   |
| Long term debt,  net of current portion                                                    |       |                                                               | 1,997      |   |   |   |   |   |   |   |   |   |   |   | 1,997 |   |   |
| Other long term  liabilities                                                               |       |                                                               | 1,016      |   |   |   |   |   |   |   |   |   |   |   | 1,016 |   |   |
| Stockholders’ equity:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock,  $0.001 par value, authorized—170,000 shares; issued—34,120 shares |       |                                                               | 34         |   |   |   |   |   |   |   |   |   |   |   | 34 |   |   |
| Treasury stock;  356 shares at cost                                                        |       |                                                               | (341       | ) |   |   |   |   |   |   |   |   |   |   | (341 | ) |   |
| Additional paid-in  capital                                                                |       |                                                               | 473,871    |   |   |   | 10,079 |   |   |   | (229 | ) |   |   | 483,721 |   |   |
| Deferred  compensation                                                                     |       |                                                               | —     |   |   |   | (175 | ) |   |   |   |   |   |   | (175 | ) |   |
| Accumulated other  comprehensive loss                                                      |       |                                                               | (28        | ) |   |   |   |   |   |   |   |   |   |   | (28 | ) |   |
| Accumulated  deficit                                                                       |       |                                                               | (432,039   | ) |   |   | (10,143 | ) |   |   | (416 | ) |   |   | (442,598 | ) |   |
| Total stockholders’ equity                                                            |       |                                                               | 41,497     |   |   |   | (239 | ) |   |   | (645 | ) |   |   | 40,613 |   |   |
| Total liabilities  and stockholders’ equity                                           |       |                                                               | $          | 102,598 |   |   |   | $ | — |   |   |   | $ | (586 | ) |   |   | $ | 102,012 |   |   |

 

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**Item 9.**                        *Change in and Disagreements withAccountants on Accounting and Financial Disclosure*

Not applicable.

**Item 9A.**                *Controls and Procedures*

**Special CommitteeReview of Historical Stock Option Granting Practices and Restatement ofConsolidated Financial Statements**

*Background Findingsand Restatement*

As discussed in the Explanatory Note preceding Part Iand in Note 3 in the Notes to the Consolidated Financial Statements of this Form 10-K,on August 20, 2006 our board of directors formed a Special Committee ofindependent directors to commence a voluntary internal investigation of ourhistorical stock option grants and practices. The Special Committee was givenbroad authority to investigate and address our historical stock option grantsand practices. The Special Committee was composed of two independent members ofour Board of Directors, W. Frank King and Robert H. Brumley. The SpecialCommittee retained the law firm of Goodwin Procter LLP as its independentoutside counsel. Goodwin Procter LLP hired Law and Economics Consulting Groupas independent accounting experts to aid in its investigation.

On October 17, 2006, the Special Committeeconcluded that the measurement dates for determining the accounting treatmentof certain historical stock option grants differed from the measurement datesused by us in preparing our financial statements. Because the prices at theoriginally stated grant dates were, in certain cases, lower than the prices onthe actual dates of the determination, we determined that it should haverecognized material amounts of stock-based compensation expense which were notaccounted for in our previously issued financial statements. The SpecialCommittee also found in a number of instances that the date and exercise priceof option grants had been determined, with hindsight, to provide a morefavorable price for such grants.

On October 18, 2006, the Audit Committee, inconsultation with management, concluded that our previously issued unauditedinterim and audited annual consolidated financial statements for fiscal 1999and subsequent periods through June 30, 2006, should no longer be reliedupon because these financial statements contained material misstatements andwould need to be restated. We subsequently determined that fiscal 1999 did notrequire restatement.

In accordance with the determinations of the SpecialCommittee’s investigation, our Board of Directors terminated the employment ofour Vice President, Business Affairs and General Counsel and directed ourcompensation committee to adjust downward the compensation for the upcomingfiscal year for both our Chief Executive Officer, Ofer Gneezy, and ourExecutive Vice President, Gordon VanderBrug, because their oversight of ourstock option granting practices was inadequate. Additionally, the SpecialCommittee recommended, and we have implemented, changes to our stock-basedcompensation transaction procedures and approval policies that requireadditional and more systematic authorization to ensure that all stock optiontransactions adhere to our approval process and stated policies, and that allsuch transactions are properly recorded in our stock administration systems andhave appropriate supporting documentation.

Our management determinedthat we did not maintain effective entity level controls over the granting,approval and documentation of stock options based on criteria established inthe COSO framework as of September 30, 2006. Specifically, we did notmaintain controls adequate to prevent or detect instances of either (i) intentionaloverride or intervention of our controls, or (ii) misconduct by a formermember of senior management and we did not maintain controls to providereasonable assurance that historical measurement dates for stock option grantsto employees were appropriately determined and the Company’s accounting forthose grants was in accordance with Accounting Principles Board Opinion 25,Accounting for Stock Issued to Employees and, beginning January 1,2006  Financial Accounting 

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StandardNo. 123(R), Share-based Payments. This material weakness resulted in therestatement described in Note 3 to the restated consolidated financialstatements included in this Form 10-K. Our management determinedthat this control deficiency was a design deficiency in our entity levelcontrols and was a material weakness as of September 30, 2006, based uponthe actual misstatements identified, the potential for additional materialmisstatements to have occurred as a result of the deficiency, and the lack ofother mitigating controls.

**Changes in internalcontrols**

Management hastaken steps to remediate the material weakness identified above by implementingchanges to our internal control over financial reporting as of December 31,2006. Specifically, management, along with our Board of Directors, hasimplemented changes during the fourth quarter of 2006 to our option grantingprocess for the timing, approval and pricing of stock option grants as detailedbelow:

·                    Alloption grants to our employees must be approved in minuted meetings of ourCompensation Committee;

·                    Theexercise price of each stock option will be the closing price on the date ofthe Compensation Committee meeting;

·                    Inadvance of each meeting, our Compensation Committee will receive informationfrom management, including, but not limited to, information related to thenumber of options in the pool and a recommendation of option recipients,including the number of options for each recommended recipient;

·                    Alloption grants other than new hire grants will be granted at the same time eachyear;

·                    Ifthe Compensation Committee agrees to a grant date other than the ordinarilyprescribed time, the grants must be approved in a minuted meeting of theCompensation Committee;

·                    Everyoffer letter must state that each option is subject to approval by ourCompensation Committee and that the exercise price of option grants will be theclosing price on the date of approval by our Compensation Committee;

Our management andBoard of Directors will also be implementing the following changes to ouroption granting process in 2007 as detailed below:

·       OurCompensation Committee has adopted a written charter in January 2007,taking into account similarly situated corporations and industry-wide bestpractices.

·       OurCompensation Committee will arrange for counsel, in conjunction with outsidethird parties as deemed necessary, to provide training to management on stockoption granting practices and accounting on at least a biannual basis;

·       OurCompensation Committee shall be required to do a self-assessment process andcommunicate the results to the full Board.

Additionally, management is investing in ongoingefforts to continuously improve the control environment and has committedconsiderable resources to the continuous improvement of the design,implementation, documentation, testing and monitoring of our internal controls.

During the quarter ended December 31,2006, there have not been any other changes in our internal controls overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

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**Evaluation ofdisclosure controls and procedures**

As of December 31,2006, we carried out an evaluation, under the supervision and with theparticipation of our management, including the our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the securities and Exchange Act of 1934, as amended.. Based upon that evaluation, our management, including our Chief ExecutiveOfficer and the Chief Financial Officer, concluded that our disclosure controlsand procedures are effective.

**Management’s AnnualReport on Internal Control Over Financial Reporting**

We are responsible for establishing and maintainingadequate internal control over financial reporting, as defined in Rule 13a-15(f) underthe Exchange Act. Our internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of ourfinancial reporting and preparation of our financial statements for externalpurposes in accordance with generally accepted accounting principles in theUnited States. Under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and Chief Financial Officer,we conducted an evaluation of the effectiveness of our internal control overfinancial reporting based on the framework in Internal Control IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”). Based upon that evaluation, management has concluded thatour internal control over financial reporting was effective on December 31,2006.

Our assessment of the effectiveness of our internalcontrol over financial reporting as of December 31, 2006 has been auditedby Deloitte & Touche LLP, an independent registered public accountingfirm, and such firm has issued an attestation report on management’s assessmentof our internal control over financial reporting, which appears on page 108.

Due to inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions or thatcompliance with the policies or procedures may deteriorate.

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**Item9B.**               *Other Information*

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders of iBasis, Inc.:

We have audited management’s assessment, included inthe accompanying *Management’s Report on Internal Control OverFinancial Reporting*, that iBasis, Inc. and its subsidiaries(the “Company”) maintained effective internal control over financial reportingas of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission. TheCompany’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—IntegratedFramework*issued by the Committee of Sponsoring Organizations of theTreadway Commission. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2006, based on the criteria established in *InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission.

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We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated financial statements as ofand for the year ended December 31, 2006, of the Company and our reportdated June 11, 2007 expressed an unqualified opinion on those financialstatements and included an explanatory paragraph related to the adoption of anew accounting standard.

/s/ DELOITTE & TOUCHE LLP

Boston, MassachusettsJune 11, 2007

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**PART III**

**Item 10.**                 *Directors and Executive Officers of the Registrant*

Thefollowing table sets forth information on each of our directors.
| Director’s Name    | ** ** | ** ** | ** ** | **Age** | ** ** | **Position(s) Held**            | ** ** | **Director  Since** | ** ** | **Year Term  Will Expire** | ** ** | **Class of  Director** | ** ** |
|------------------------------|------------|------------|------------|---------|------------|--------------------------------------|------------|---------------------|------------|--------------------------------------|------------|-----------------------------|------------|
| Ofer Gneezy                  |       |       | 55         |    |       | President,  Chief Executive Officer, |       |                | 1996       |                                 |       |                        | 2008       |   |   |   | 3 |   |   |
|                         |       |       |       |    |       | Treasurer  and Director              |       |                |       |                                 |       |                        |       |   |   |   |   |   |   |
| Gordon J. VanderBrug         |       |       | 64         |    |       | Executive  Vice President, Assistant |       |                | 1996       |                                 |       |                        | 2009       |   |   |   | 1 |   |   |
|                         |       |       |       |    |       | Secretary  and Director              |       |                |       |                                 |       |                        |       |   |   |   |   |   |   |
| Charles N. Corfield(1)(2)(5) |       |       | 48         |    |       | Director                             |       |                | 1997       |                                 |       |                        | 2008       |   |   |   | 3 |   |   |
| Charles M. Skibo(1)(3)(5)    |       |       | 68         |    |       | Director                             |       |                | 1999       |                                 |       |                        | 2007       |   |   |   | 2 |   |   |
| W. Frank King(2)(3)(4)(5)    |       |       | 67         |    |       | Director                             |       |                | 2001       |                                 |       |                        | 2007       |   |   |   | 2 |   |   |
| David Lee(2)(3)(5)           |       |       | 69         |    |       | Director                             |       |                | 2002       |                                 |       |                        | 2009       |   |   |   | 1 |   |   |
| Robert H. Brumley  (4)(5)    |       |       | 58         |    |       | Director                             |       |                | 2005       |                                 |       |                        | 2008       |   |   |   | 3 |   |   |

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(1)          Member of theCompensation Committee.

(2)          Member of the AuditCommittee.

(3)          Member of theShareholder Litigation Committee.

(4)          Member of the SpecialCommittee.

(5)          Our Board of Directors has determined thesedirectors to be independent in accordance with The Nasdaq Stock Market listingrules.

*Mr. Gneezy***co-founder ofiBasis, has served as President, Chief Executive Officer, Treasurer anddirector since our formation in August 1996. From 1994 to 1996, Mr. Gneezyserved as President of Acuity Imaging, Inc., a multinational companyfocused on the industrial automation industry. From 1980 to 1994, Mr. Gneezywas an executive of Automix, Inc. (a predecessor to Acuity Imaging), anindustrial automation company, most recently having served as its President andChief Executive Officer. Since July 2000, Mr. Gneezy has served as adirector and a member of the Audit Committee of NMS Communications Corporation,which provides communication solutions for wireless and wireline networks. Mr. Gneezygraduated form Tel-Aviv University, has a Masters of Science in engineeringfrom M.I.T and is a graduate of the Advanced Management Program at Harvard’sUniversity’s Graduate School of Business Administration.

*Dr. VanderBrug***co-founder ofiBasis, has served as Executive Vice President, Assistant Secretary anddirector of iBasis since October 1996. From 1991 to 1996, Dr. VanderBrugwas the Director of Marketing, Electronic Imaging Systems of Polaroid Corporation.In 1980, Dr. VanderBrug co-founded Automatix, Inc. Dr. VanderBrugreceived his B.A. in mathematics from Calvin College, an M.A. in mathematicsfrom Wayne State University, and his Ph.D. in computer science from theUniversity of Maryland.

*Mr. Corfield*hasbeen a director of iBasis since September 1997. Since 2000, Mr. Corfieldhas been the Chief Executive Officer of SandCherry Networks. Mr. Corfieldco-founded Frame Technology, a software company, in 1986 and was a member ofits board of directors and its Chief Technology Officer until Adobe Systemsacquired it in 1995. Mr. Corfield serves on the board of directors ofSandCherry Networks, BeVocal, and Intuicom.

*Mr. Skibo*hasbeen a director of iBasis since September 1999. Mr. Skibo was theChief Executive Officer of Salvage Services of America, Inc., (“SSA”) fromMarch 2006 until April 2007. Prior to his position with SSA, from September 2004until June 2005, Mr. Skibo served as the Chief Executive Officer 

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and as a director ofHouseRaising, Inc., a public company focused on software and custom homebuilding services. He served as President of iBasis Speech Solutions, Inc.from November 2001 to July 2002. From January 1999 to September 2001,Mr. Skibo served as the Chief Executive Officer and Chairman of Colo.com,a company that provided facilities and co-location services to communicationand information technology industries. Since 1994, Mr. Skibo has alsoserved as Chairman and Chief Executive Officer of Strategic Enterprises andCommunications, Inc., a venture capital firm. From 1985 to 1987, Mr. Skibowas President and Chief Executive Officer of US Sprint and its predecessorcompany, US Telecom. Mr. Skibo is a director of CyraCom International, Inc.,a private company providing interpretation services to the hospital industryand Pay Ease, a private company focused on providing payment systems over theInternet.

*Dr. King***has been a private investor since November 1998and a director of iBasis since June 2001. From 1992 to 1998, he was ChiefExecutive Officer and director of PSW Technologies, Inc. (formerly adivision of Pencom, Inc.), a provider of software services. From 1988 to1992, Dr. King was Senior Vice President of Development of LotusDevelopment Corporation, and for the previous 19 years he served in variouspositions with IBM Corporation, including his last position as Vice Presidentof Development for the entry system division. Dr. King is a director ofNMS Communications, Inc. and eOn Communications Corporation.

*Mr. Lee*hasbeen a director of iBasis since May 2002. Mr. Lee has founded, servedas chairman, and held senior executive positions at several communicationstechnology companies, including ITT Corporation. Mr. Lee joined ITT afterthat company acquired Qume Corporation, a company he had co-founded in 1973. AtITT Qume, Mr. Lee held the positions of Executive Vice President from 1978to 1981, and President from 1981 through 1983. Mr. Lee later becamePresident and Chairman of Data Technology Corporation. Through his service onthe Advisory Committee on Trade Policy and Negotiation for Presidents Bush(senior) and Clinton, and his role on President George W. Bush’s Council on the21st Century Workforce, Mr. Lee is one of the world’s foremost experts onUS-China commerce and the Chinese telecommunications industry. Mr. Lee isChairman of the Board of eOn Communications Corporation, and is a director ofLinear Technology Corporation. Mr. Lee also served as a Regent for theUniversity of California.

*Mr. Brumley*hasbeen a director of iBasis since September 2005. Mr. Brumley has beenPresident and CEO of TerreStar Networks, an emerging provider of advancedmobile satellite services, since August 2005. Prior to joining TerreStar, Mr. Brumleywas founder and managing member of Pegasus Global LLC, an internationaldevelopment and advisory services firm specializing in technology, capitalformation, and market strategies and solutions for domestic and internationalcompanies from January 2002 until August 2005. From January 2000until January 2002, Mr. Brumley was the Executive Vice President forStrategy and Corporate Development for Cambrian Communications, LLC, awholesale metropolitan area network provider. Cambrian Communications filed forbankruptcy in September 2002. Mr. Brumley is a director of MotientCorporation.

**Executive Officers**

The following table sets forth information on each ofour executive officers who are not also our directors:

| **Name**           | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                                     | ** ** | ** ** |
|--------------------|------------|------------|------------|---------|------------|----------------------------------------------------------------------------------|------------|------------|
| Dan Powdermaker    |       |       | 43         |    |       | Senior Vice President of  Worldwide Sales                                        |       |
| Paul H. Floyd      |       |       | 49         |    |       | Senior Vice President of  R&D, Engineering and Operations                    |       |
| Richard G. Tennant |       |       | 62         |    |       | Senior Vice President of  Finance and Administration and Chief Financial Officer |       |
| Mark S. Flynn      |       |       | 53         |    |       | Chief Legal Officer and Corporate Secretary                                      |       |
|                    |            |            |            |         |            |                                                                                  |            |            |  |  |  |

 

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*Mr. Powdermaker*has served as our Senior Vice President of WorldwideSales since June 2002. An early member of the iBasis management team, Mr. Powdermakerhas spent the past seven years at iBasis developing relationships with carriersand service providers around the world and establishing the sales force tosupport these customers and partners. During that time, he has worked to bringiBasis’ initial U.S. customers onto The iBasis NetworkÔ,has served as Vice President of Sales for Asia and more recently as Vice President,Europe, the Middle East and Africa. Prior to joining iBasis, Mr. Powdermakerworked in sales management for AT&T Global Markets, a networking servicesdivision of AT&T focused on the world’s 2,000 largest telecommunicationsusers.

*Mr. Floyd*has served as our Senior Vice President of R&D,Engineering and Operations since September 2001. From April 2001until September 2001, Mr. Floyd was our Vice President of Researchand Development. Prior to joining iBasis, from 2000 until January 2001, Mr. Floydwas a Senior Vice President of DSL Business at Paradyne Networks, Inc., amanufacturer of high-speed broadband access products and technology thatsupport and manage high-bandwidth applications and network traffic. From 1996to 2000, Mr. Floyd served as Vice President of Research and Developmentand Engineering at Paradyne.

*Mr. Tennant*has served as our Chief Financial Officer since October 2001and was promoted on February 16, 2006 from Vice President of Finance andAdministration to Senior Vice President of Finance and Administration. From June 2000to September 2001, Mr. Tennant was the Vice President, ChiefFinancial Officer and Treasurer of ScoreBoard, Inc., a software companyproviding optimization solutions for wireless carriers. From 1999 to 2000, Mr. Tennantserved as Senior Vice President and Chief Financial Officer of Orbcomm Global,L.P., the world’s first commercial provider of global low-earth satellite dataand messaging services. From 1997 to 1999, Mr. Tennant served as SeniorVice President and Chief Financial Officer of Information Resource Engineering,now known as SafeNet, Inc., a developer and manufacturer of security andencryption products for computer data networks.

*Mr. Flynn*has served as our Chief Legal Officer and Corporate Secretary since February 2007.Previously, from 2001 to 2006, Mr. Flynn was Vice President, GeneralCounsel and Secretary of Imagistics International Inc., a NYSE traded providerof office imaging products and services. Prior to joining Imagistics, Mr. Flynnwas a partner in the corporate department of the law firm of Wiggin and DanaLLP in Stamford, CT. from 1999 to 2001. Previously Mr. Flynn was SeniorDeputy General Counsel with Olin Corporation, a diversified manufacturer, from1997 to 1999; Executive Vice President, General Counsel and Secretary ofServiceMaster Diversified Health Services, L.P., a nursing home management anddevelopment company, from 1992 to 1997; and Vice President, General Counsel andSecretary of Arcadian Corporation, a fertilizer manufacturer, from 1989 to1992.

**Section 16(a) BeneficialOwnership Reporting Compliance**

Section 16(a) of the Exchange Actrequires our officers and directors, as well as persons who own more than tenpercent of a registered class of our equity securities to file reports ofownership on Forms 3, 4, and 5 with the SEC and with us. Based on our review ofcopies of such forms, all officers, directors and 10% holders complied with theSection 16(a) filing requirements.

**Code of Ethics**

We have adopted a code ofethics that applies to each officer, employee and member of our Board ofDirectors. This code of ethics is available on our website at *www.ibasis.com.*We post any amendments or waivers of the Code of Ethics on our website.A free copy of this code may be obtained by visiting this site, writing to ourInvestor Relations Department at iBasis, Inc., 20 Second Avenue,Burlington, MA 01803, or by sending an email to *ir@ibasis.net.*

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**ShareholderProposals and Communications**

There have not been anychanges to the procedures by which shareholders may recommend nominees to ourBoard of Directors since the procedures were described in our 2006 AnnualMeeting Proxy filed on March 23, 2006.

**Audit Committee**

The Audit Committee of the board of directors iscomposed of three directors, Charles Corfield, David Lee and W. Frank King,each of whom is independent as defined by The Nasdaq Stock Market listingrules. Our Board of Directors made an affirmative determination as to theindependence of each member of the Audit Committee, including a determinationthat no member of the Audit Committee has a relationship with iBasis that mayinterfere with his independence from iBasis and its management. No member ofthe Audit Committee has participated in the preparation of  our financial statements, and each committeemember is able to read and understand fundamental financial statements,including our balance sheet, income statement, and cash flow statement. OurBoard of Directors has determined that Dr. King is an audit committeefinancial expert as defined by applicable rules and regulations under theExchange Act.

**Item 11.**                 *Executive Compensation*

**COMPENSATION DISCUSSION AND ANALYSIS**

**CompensationPhilosophy**

*CompensationObjectives*

Ourcompensation programs are designed to meet the following objectives:

·       Offer compensation opportunities that attract highlyqualified executives, reward outstanding initiative and achievement, and retainthe leadership and skills necessary to build long-term shareholder value;

·       Emphasize pay-for-performance by maintaining asignificant portion of executives’ total compensation at risk, tied to both ourannual and long-term financial performance and the creation of shareholdervalue; and

·       Further ourshort and long-term strategic goals and values by aligning executive officercompensation with business objectives and individual performance.

OurCompensation Committee believes that an executive’s compensation should be tiednot just to how the individual executive performs, but also to how well we andour management team perform against both financial and non-financial goals.

*CompensationElements*

Ourexecutive compensation program is intended to be simple and clear, and consistsof the following elements (depending on individual performance as well as ourperformance):

·       Base salary;

·       Annual performance-based cash bonus;

·       Commissions (only for Mr. Powdermaker);

·       Long-term incentives in the form of stock options;

·       Severance and change incontrol arrangements; and

·       Benefits thatare offered to executives on the same basis as our non-executive employees; and

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*TargetedCompensation and Compensation Mix*

In determining all of ourcompensation elements, we have historically targeted the median of the market. However,in the third quarter of 2002, in order tofacilitate our efforts to reduce our debt obligations, we instituted a salaryfreeze that resulted in compensation well below the median of themarket, which also helped us to perform in a very challenging business climate with limited internally generated capital resources.In the first quarter of 2006, due to our improved financial position and due toour desire to continue to retain our executive officers and hire new employees,we lifted this salary freeze and modestly increased salaries. Although our business environment remainschallenging, the growth in our business and other actions taken by ourmanagement to strengthen our capital structure have improved our overallfinancial performance and we are now in a position to targetcompensation at the median of the market again. Our 2007 Base Salary increasesdiscussed below reflect this change in policy. Actual compensation paid to eachexecutive officer will be above or below the targeted percentile based onindividual employee performance and our performance, attraction and retentionconsiderations, internal equity considerations, executive seniority, and otherkey business factors.

**Role of Managementin Determining Compensation Decisions**

At the request of our Compensation Committee, ourmanagement makes recommendations to our Compensation Committee relating toexecutive compensation program design, specific compensation amounts, bonustargets, incentive plan structure and other executive compensation relatedmatters, including with respect to such matters pertaining to our ChiefExecutive Officer. Our Compensation Committee maintains decision makingauthority with respect to these executive compensation matters.

Our Compensation Committeereviews the recommendations of our management with respect to total executivecompensation and each element of compensation when making pay decisions. Inallocating compensation among compensation elements, we emphasize incentive,not fixed compensation to ensure that executives only receive superior pay forsuperior results. We equally value short- and long-term compensation becauseboth short- and long-term results are critical to our success.

**CompensationElements**

Our executive compensationprogram has three primary integrated components: base salary, annual incentiveawards, and long term-incentive awards in theform of stock options. We also provide severance and acceleration ofvesting of options to our executives under certain arrangements we have withthem under their employment agreements or offer letters. In addition, ourcompensation program is comprised of various benefits provided to allemployees, including life insurance, health insurance, dental insurance andother customary benefits. The objectives and details of why each element ofcompensation is paid are described below.

*BaseSalary*

Our objective for paying base salaries to executivesis to reward them for performing the core responsibilities of their positionsand to provide a level of security with respect to a portion of theircompensation. Our Compensation Committee considers a number of factors whensetting base salaries for executives, including the following:

·       Existing salary levels;

·       Competitive pay practices;

·       Individual and corporateperformance; and

·       Internal equity among ourexecutives, taking into consideration their relative contributions to oursuccess.

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In the first quarter of2006, we lifted the base salary freeze and increased base salaries for our executive officers by approximately 3%to 4% which we determined to be an appropriate amount based on our cashconstraints. Although we recognized that these modest increases would notcompensate for the extended freeze, we believed that even a small increasewould be symbolically significant, signaling renewed confidence in our business.Given the length of the duration of the salary freeze, and despite this salaryincrease, our Compensation Committee believed that our named executive officers’2006 base salaries remained significantly behind the competitive market. Distinctionsamong individual performance of our named executives and internal equityconsiderations were not significant factors in determining 2006 base salarylevels. The actual salary earned by our each of our named executive officers in2006 can be found in the Summary Compensation Table.

*AnnualIncentive Awards*

Our objective for offering annual cash bonus awards toour named executive officers is to motivate them to achieve our financialgoals, while taking into account their individual goals and responsibilities. OurCompensation Committee implemented our 2006 executive officer bonus plan,effective as of the first quarter of 2006 pursuant to which our named executiveofficers became eligible to receive cash bonus awards payable in early 2007,except that Mr. Powdermaker’s bonus is calculated and paid on a quarterlybasis, and the commission portion of his incentive compensation is calculatedand paid on a monthly basis in accordance with our 2006 commission plan that wehave established for him as the head of our sales organization. The amountspayable under our 2006 executive officer bonus plan were to be calculated basedon our net income for fiscal 2006 against the2006 financial plan approved by our Board of Directors.

Under our 2006 executive officer bonus plan, weassigned a specific bonus target to each executive for performance in 2006. OurCompensation Committee intentionally designed these bonus targets to allow forsuperior pay in the event we have superior financial results and also to offsetthe low base salaries that had resulted from the previous salary freeze. Cashbonus targets were determined based on individual responsibility levels andperformance expectations and would be payable in a proportionate amountrepresenting the percentage of our targeted corporate net income goal pursuantto our 2006 financial plan. In addition, Mr. Powdermaker received a bonustarget substantially less than the target of our other executive officers as healso receives a bonus payment based on a sales commission plan. Our managementmade recommendations to our Compensation Committee regarding suggested 2006target bonuses based on competitive total cash survey data. In reviewing ourmanagement’s proposal, our Compensation Committee considered the below-marketbase salaries, the difficulty level of reaching the incentivized targets,executive officer performance and the survey data provided by management. Afterdiscussion and deliberation, our Compensation Committee approved our management’srecommendations. Our 2006 executive officer bonus plan is described in detailbelow the Grant of Plan Based Awards table.

Payouts under our 2006 executive officer bonus planare dependent on our achievement towards the net income goal such that 100% ofthe bonus target amounts would be paid upon achievement of 100% of the netincome goal. Above and below target performance methodologies were alsoestablished.

We and our Compensation Committee consider thespecific net income goals in our 2006 financial plan to be our confidentialinformation, the disclosure of which would cause us to experience financialharm. The target in our 2006 executive officer bonus plan was aggressively setwith a high level of difficulty for achievement as demonstrated by the maximumactual 2006 bonus payout for any named executive officer at substantially below100% of the target payout. We believe that tying annual bonus payments for eachof our named executive officers to the achievement of challenging net incomegoals best aligns the interest of our executives with the interests of our shareholdersand promotes a unity of purpose among our key business leaders.

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Regardless of our actual financial performance underour 2006 financial plan, our Compensation Committee retained the discretion toadjust bonuses payable under our 2006 executive officer bonus plan up or downas it deemed appropriate. Our Compensation Committee reviewed our performanceas it related to our 2006 financial plan and determined to revise thedefinition of net income before determining the formulaic payout under our 2006executive officer bonus plan. Our Compensation Committee determined that for Messrs. Tennant,Floyd and Powdermaker, the definition of net income should be revised toeliminate the impact of non-recurring expenses related to our stock optiongrant investigation, the KPN transaction and a lease termination charge. Afterthese adjustments, the bonus payouts were at 56.19% of the target bonus for Messrs. Tennantand Floyd and 50% for Mr. Powdermaker. Mr. Powdermaker’s bonus payoutwas less due to the quarterly calculation and quarterly payment of his bonus.

For Mr. Gneezyand Mr. VanderBrug, the Compensation Committee did not, in calculatingtheir bonus payments, revise net income by eliminating the impact of the stockoption investigation related expenses due to the fact that they were our mostsenior officers with the ultimate oversight responsibility for our stock optiongrant practices and our Compensation Committee did not consider it appropriateto eliminate this financial impact. Their bonus payouts were at 33% of theirtarget bonus. Actual bonus payouts for 2006 that were paid in 2007 can be foundin the Summary Compensation Table.

Mr.  Powdermaker is also compensated by commissions tied directly to hismeeting wholesale gross profit quotas on a monthly basis to recognize thecontributions he makes throughout the year toward our 2006 quotas, which isconsistent with the compensation structure of the sales organization that heleads.

*Long-TermIncentives*

Our named executive officers are eligible to receive long-termincentive awards under our Stock Plan. Our objectives of providing ournamed executive officers with long-term incentive awards are:

·       Toalign executive and shareholder interests;

·       Toprovide a competitive compensation package; and

·       Toprovide for retention of executives through the use of vesting over time.

In 2006, all long-term incentive awards were issued inthe form of stock options. Our stock options for all our employees, includingour named executive officers, vest in quarterly installments, generally overfour years.

When determiningthe potential grant of option awards for a named executive officer, ourCompensation Committee considers the following factors:

·       Theexecutive officer’s current contribution to our performance;

·       Ourexecutive retention objectives;

·       Theexecutive officer’s anticipated contribution to meeting our long-term strategicperformance goals;

·       Industrypractices and norms; and

·       Theexecutive officer’s existing level of stock ownership, and whether pastincentives are still effective.

Our management made recommendations to our CompensationCommittee regarding the 2006 stock option grants. In reviewing management’sproposal, our Compensation Committee considered each executive officer’scurrent contribution to our overall performance, our executive officerretention objectives, the executive officer’s anticipated contribution tomeeting our long-term strategic performance 

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goals, and industrypractices and norms. After discussion and deliberation, our CompensationCommittee approved our management’s recommendations. Details of the options grantedin 2006 can be found in the Grants of Plan-Based Awards table.

In addition, as disclosed elsewhere in this Form 10-K,the measurement dates for determining the accounting treatment of certainhistorical stock option grants differed from the measurement dates we used inpreparing our consolidated financial statements. As a result, we needed todetermine a new measurement date of certain option grants. Also, as a result ofthe change in the measurement dates of certain stock option grants, certainoptions vesting subsequent to December 2004 result in non-qualifieddeferred compensation for purposes of Section 409A of the Code, andholders are subject to an excise tax on the value of the options in the yearsin which they vest. To avoid these adverse tax consequences, prior to December 31,2006, we and our named executive officers agreed to amend their affected stockoptions to increase the applicable exercise price to the fair market value ofour common stock on the revised measurement date. In connection with the filingof our restated financial statements in this Form 10-K, we havefinalized these new exercise prices. We will not compensate our named executiveofficers for any increase in the exercise price that may arise as a result ofthis amendment. We have also concluded that it is probable that we willimplement a plan to assist  affectedemployees, other than our named executive officers, for the amount of this tax,or adjust the terms of the original option grant, which would also havefinancial statement ramifications.

In addition, our management, along withour Board of Directors, has implemented changes during the fourth quarter of2006  to our option granting process forthe timing, approval and pricing of stock option grants as detailed below:

·       All optiongrants to our employees must be approved in minuted meetings of ourCompensation Committee;

·       The exerciseprice of each stock option will be the closing price on the date of ourCompensation Committee meeting;

·       In advanceof each meeting, our Compensation Committee will receive information from ourmanagement, including, but not limited to, information related to the number ofoptions in the pool and a recommendation of option recipients, including thenumber of options for each recommended recipient;

·       All optiongrants other than new hire grants will be granted at the same time each year;

·       If ourCompensation Committee agrees to a grant date other than the ordinarilyprescribed time, the grants must be approved in a minuted meeting of our CompensationCommittee; and

·       Every offerletter for new hires must state that each option is subject to approval by ourCompensation Committee and that the exercise price of option grants will be theclosing price on the date of approval by our Compensation Committee;

*Severance andChange in Control Arrangements*

We entered into arrangements to provide a competitivetotal compensation package for all of our named executive officers and toprovide them with a level of security in the event of a change-in-control tominimize creating conflicting interests between the executive and our company.

Each arrangement provides compensation elements andpayments that would be made, and vesting acceleration that would occur, in theevent of certain types of executive terminations.

Each officer’s employmentmay be terminated at any time with or without cause and each officer mayvoluntarily resign at any time with or without good reason. A detaileddescription of the arrangements and 

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payoutsassociated with these agreements is provided in this Item 11 under the caption “Potential Payments Upon Termination or Changein Control.”

*Perquisitesand Benefits*

We donot offer our executives any perquisites and all benefits received byexecutives are provided under the same terms and conditions as to our otheremployees, including health and dental coverage, group term life insurance,disability programs and matching contributions to our 401(k) plan.

**2007Compensation**

·       2007 BaseSalaries.

Our management made recommendations to our Compensation Committee of largersalary increases for our executive officers and smaller bonus opportunities asa percentage of base salary for 2007 to bring our compensation program more inline with the competitive marketplace. In reviewing our management’s proposal,our Compensation Committee considered a variety of factors including existingsalary levels, competitor pay practices from both survey data and informationpublicly available, the four-year salary freeze on executives, internal equity,and 2006 corporate and individual performance. After discussion anddeliberation, our Compensation Committee ultimately approved our management’srecommendations as detailed below:
| Name              | ** ** | ** **                                     | ** ** | **Title** | ** ** | **2006 Base  Salary** | ** ** | **2007 Base  Salary** | ** ** |
|-------------------|------------|------------------------------------------------|------------|-----------|------------|----------------------------|------------|----------------------------|------------|
| Ofer Gneezy       |       | Pesident & Chief Executive Officer    |       | $         | 208,000    |                       | $          | 350,000                    |       |
| Gordon VanderBrug |       | Executive Vice President                       |       | $         | 187,000    |                       | $          | 300,000                    |       |
| Paul Floyd        |       | VP Engineering & Operations           |       | $         | 185,000    |                       | $          | 225,000                    |       |
| Dan Powdermaker   |       | SVP, Worldwide Sales                           |       | $         | 154,500    |                       | $          | 180,000                    |       |
| Richard  Tennant  |       | SVP  Finance & Chief Financial Office |       | $         | 185,000    |                       | $          | 250,000                    |       |

 

·       2007 BonusTargets.

As discussed above, management made recommendations to ourCompensation Committee relating to generally providing smaller bonusopportunities as a percentage of base salary for 2007 to bring our compensationprogram more in line with the competitive marketplace. As was the case for 2006bonuses, the actual payouts for 2007 will depend on the level of achievement ofthe net income goals in the 2007 financial plan approved by our Board ofDirectors. After discussion and deliberation, our Compensation Committeeultimately approved our management’s recommendations as detailed below:
| Name              | ** ** | ** **                                     | ** ** | **Title** | ** ** | **2006 Target  Bonus** | ** ** | **2007 Target  Bonus** | ** ** |
|-------------------|------------|------------------------------------------------|------------|-----------|------------|-----------------------------|------------|-----------------------------|------------|
| Ofer Gneezy       |       | Pesident & Chief Executive Officer    |       |      | $          | 400,000                     |       |                        |       | $ | 350,000 |   |   |
| Gordon VanderBrug |       | Executive Vice President                       |       |      | $          | 360,000                     |       |                        |       | $ | 300,000 |   |   |
| Paul Floyd        |       | VP Engineering & Operations           |       |      | $          | 200,000                     |       |                        |       | $ | 190,000 |   |   |
| Dan Powdermaker   |       | SVP, Worldwide Sales                           |       |      | $          | 81,000                      |       |                        |       | $ | 90,000 |   |   |
| Richard  Tennant  |       | SVP  Finance & Chief Financial Office |       |      | $          | 200,000                     |       |                        |       | $ | 190,000 |   |   |

 

On January 15,2007, our Board of Directors approved our Compensation Committees’recommendations relating to the 2006 annual bonus payouts and 2007 basesalaries and bonus targets.

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**Impactof Tax and Accounting on Executive Compensation**

Section 162(m) of theInternal Revenue Code (“the Code”), limits the tax deduction to $1 million forcompensation paid to certain executives of public companies. This deductionlimitation does not apply to compensation that constitutes “qualifiedperformance-based compensation” within the meaning of Section 162(m) ofthe Code and the regulations promulgated thereunder. In any case, the combinedsalary and bonus of each executive officer has been below the $1 million limit.Our Compensation Committee’s present intention is to structure executivecompensation to minimize the application of the deduction limitation of Section 162(m) ofthe Code unless it feels that the necessary changes in our accounting methodsin order to do so would not be in our best interest or in the best interest ofour  shareholders.

OurCompensation Committee has considered the impact of FAS 123R on ourcompensation program, but determined that stock options are still the bestlong-term incentive instrument for us because we believe that stock options aremore appreciated and understood by our management team than other types ofequity-based compensation and we were concerned about the tax implications ofother forms of equity. We will continue to review compensation strategies andmay implement additional approaches at some point in the future.

**Compensation Committee Interlocks andInsider Participation**

No member of ourCompensation Committee is currently an officer or employee of ours. Mr. Gneezywas formerly a member of our Compensation Committee until August, 2005. None ofour executive officers served as a member of the Board of Directors orcompensation committee of any other entity that has one or more executiveofficers serving as a member of our Board of Directors or our CompensationCommittee.

**COMPENSATION COMMITTEE REPORT**

The Compensation Committee of our Board of Directors has reviewed anddiscussed the Compensation Discussion and Analysis required by Item 402(b) ofRegulation S-K, which appears elsewhere in this Annual Report on Form 10-K,with our management. Based on this review and discussion, the CompensationCommittee has recommended to our Board of Directors that the CompensationDiscussion and Analysis be included in our Annual Report on Form 10-K.

Members of iBasis, Inc.Compensation Committee:

Charles N. CorfieldCharles M. Skibo

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**EXECUTIVE COMPENSATION**

Thefollowing table summarizes aggregate amounts paid by or accrued by our companyfor the fiscal year ended December 31, 2006 for services rendered by ournamed executive officers.

**SummaryCompensation Table**

| Name and Principal Position                            | ** ** | ** ** | ** ** | **Year**   | ** ** | **Salary  ($)** | ** ** | **Option  Awards  ($)(1)** | ** ** | **Non-Equity  Incentive Plan  Compensation  ($)(2)** | ** ** | **All Other  Compensation**($)(3) | ** ** | **Total  ($)** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|------------|------------|-----------------|------------|----------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------|------------|----------------|------------|
| **Ofer Gneezy**                                                       |       | 2006       |       | $          | 208,000    |            | $          | 60,485                     |       |                                                      | $          | 132,000                                |       |           |       | $ | 4,400 |   |   | $ | 404,885 |   |
| **President & Chief Executive Officer**                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** |                       |       |                                                      |       |                                   |       |           | ** ** | ** ** | ** ** |
| **Gordon VanderBrug**                                                 |       | 2006       |       | $          | 187,000    |            | $          | 60,485                     |       |                                                      | $          | 118,800                                |       |           |       | $ | 4,400 |   |   | $ | 370,685 |   |
| **Executive Vice President**                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** |                       |       |                                                      |       |                                   |       |           | ** ** | ** ** | ** ** |
| **Paul Floyd**                                                        |       | 2006       |       | $          | 185,000    |            | $          | 48,341                     |       |                                                      | $          | 112,387                                |       |           |       | $ | 4,400 |   |   | $ | 350,128 |   |
| **Senior Vice President, Engineering & Operations**          | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** |                       |       |                                                      |       |                                   |       |           | ** ** | ** ** | ** ** |
| **Dan Powdermaker**                                                   |       | 2006       |       | $          | 154,500    |            | $          | 48,341                     |       |                                                      | $          | 133,326                                | (4)        |           |       | $ | 4,400 |   |   | $ | 340,567 |   |
| **Senior Vice President,  Worldwide Sales**                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** |                       |       |                                                      |       |                                   |       |           | ** ** | ** ** | ** ** |
| **Richard Tennant**                                                   |       | 2006       |       | $          | 185,000    |            | $          | 48,341                     |       |                                                      | $          | 112,387                                |       |           |       | $ | 4,400 |   |   | $ | 350,128 |   |
| **Senior Vice President, Finance & Chief Financial Officer** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **      | ** ** |                       |       |                                                      |       |                                   |       |           | ** ** | ** ** | ** ** |

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(1)          Represents theproportionate amount of the total fair value of option awards recognized by usas an expense in 2006 for financial accounting purposes. The fair values ofthese awards and the amounts expensed in 2006 were determined in accordancewith Financial Accounting Standards Board Statement of Financial AccountingStandards No. 123 (revised 2004) Share-Based Payment (FAS 123R). Theawards for which expense is shown in this table include the awards described inthe Grants of Plan-Based Awards Table, as well as awards granted in previousyears for which we continued to recognize expense in 2006. See Note 4 to ourConsolidated Financial Statements for details as to the assumptions used todetermine the fair value of the option awards.

(2)          Reflects the actualamounts earned during fiscal year 2006 under our 2006 executive officer bonusplan, although paid in 2007.

(3)          Reflects the 401(k) matchthat is available to all of our employees.

(4)          Reflectsthe sum of Mr. Powdermaker’s quarterly payouts under the 2006 bonus plan($40,500) and his monthly sales commissions paid pursuant to his 2006 salescommission plan ($92,826).

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**Grants of Plan-Based Awards**

The following table shows information regarding grants ofequity awards during the fiscal year ended December 31, 2006 to ourexecutive officers named in the Summary Compensation Table above.

|                       | ** ** | ** ** | ** ** | **Estimated Future Payouts Under  Non-Equity Incentive Plan Awards** | ** ** | **All Other  Stock Awards:  Number of  Securities** | ** ** | **Exercise  or Base  Price of ** | ** ** | **Grant Date  Fair Value  of Stock ** | ** ** |
|-----------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **            | ** ** | ** ** | ** ** | **Threshold**                                                                                      | ** ** | **Target**                                                         | ** ** | **Maximum**                                     | ** ** | **Underlying **                                      | ** ** | **Option Awards ** | ** ** | **and Option** | ** ** |
| **Name**              | ** ** | ** ** | ** ** | **Grant Date(1)**                                                                             | ** ** | **($)**                                                            | ** ** | **($)**                                         | ** ** | **($)**                                                   | ** ** | **Options (#)** | ** ** | **($/Sh)(2)** | ** ** | **Awards** | ** ** |
| **Ofer Gneezy**       | ** ** |       | ** ** |                                                                                               |       |                                                               | $          | 0                                               |       |                                                      | $          | 400,000 |   | $ | 800,000 | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
|                       |       |       | 3/29/2006  |                                                                                               |       |                                                               |       |                                            | ** ** | ** **                                                | ** ** | ** ** |   |   | 26,667 | ** ** |   |   | $ | 6.54 | ** ** |   |   | $ | 151,735 | ** ** |   |
| **Gordon VanderBrug** |       |       |       |                                                                                               |       |                                                               | $          | 0                                               |       |                                                      | $          | 360,000 |   | $ | 720,000 |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |
| ** **            |       |       | 3/29/2006  |                                                                                               |       |                                                               |       |                                            |       |                                                      |       |   |   |   | 26,667 | ** ** |   |   | $ | 6.54 | ** ** |   |   | $ | 151,735 | ** ** |   |
| **Paul Floyd**        |       |       |       |                                                                                               |       |                                                               | $          | 0                                               |       |                                                      | $          | 200,000 |   | $ | 400,000 |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |
|                       |       |       | 3/29/2006  |                                                                                               |       |                                                               |       |                                            |       |                                                      |       |   |   |   | 16,667 | ** ** |   |   | $ | 6.54 | ** ** |   |   | $ | 94,835 | ** ** |   |
| **Dan Powdermaker**   |       |       |       |                                                                                               |       |                                                               | $          | 0                                               |       |                                                      | $          | 81,000 |   | $ | 162,000 |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |
| ** **            |       |       |       |                                                                                               |       |                                                               |       |                                            |       | $                                                         | 81,000     |   |   |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |
| ** **            |       |       | 3/29/2006  |                                                                                               |       |                                                               |       |                                            |       |                                                      |       |   |   |   | 16,667 | ** ** |   |   | $ | 6.54 | ** ** |   |   | $ | 94,835 | ** ** |   |
| **Richard Tennant**   |       |       |       |                                                                                               |       |                                                               | $          | 0                                               |       |                                                      | $          | 200,000 |   | $ | 400,000 |   |   |   | ** ** |   |   |   | ** ** |   |   |   | ** ** |   |
|                       |       |       | 3/29/2006  |                                                                                               |       |                                                               |       |                                            |       |                                                      |       |   |   |   | 16,667 | ** ** |   |   | $ | 6.54 | ** ** |   |   | $ | 94,835 | ** ** |   |
|                       |            |            |            |                                                                                                    |            |                                                                    |            |                                                 |            |                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Reflects the SFAS 123Rdate of the grant.

(2)          Asrequired under our Stock Plan, these stock options were granted with anexercise price equal to the closing price of our common stock on the date ofgrant. The March 29, 2006 option grants were not included in therestatement of our stock based compensation.

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**Narrative Disclosure to Summary Compensation Table and Grants of Plan-BasedAwards Table**

The compensation paid to our named executive officers in 2006 summarized inour Summary Compensation Table above is determined in accordance withemployment agreements and letter agreements that we have entered into with eachof our named executive officers. These agreements provided a compensationpackage, including severance benefits, to our named executive officers. Thematerial terms of these agreements are discussed under the caption “CompensationDiscussion and Analysis—Employment and Change in Control Agreements” and “PotentialPayments Upon Termination or Change in Control.”

On March 15, 2006, we adopted our 2006 executiveofficer bonus plan.

Payoutsunder the 2006 bonus plan are dependent on achievement towards the net incomegoal in our 2006 financial plan, although our Compensation Committee had thediscretion to amend the goal. The payouts from the plan are linear up to 100%of the net income goal in our 2006 financial plan, so that 100% of the bonustarget would be paid at 100% achievement of the net income goal in our 2006financial plan. For performance from 100% of the net income goal in the 2006financial plan up to 150% of the net income goal in the 2006 financial plan,the bonus payout would increase linearly from 100% of the bonus target to 200% ofthe bonus target. The maximum bonus that can be paid is 200%. The table belowdemonstrates various payouts for various performance levels in the plan:

| ** ** | **Achievement  Towards 2006  Financial Plan Net Income Goal** | ** ** | ** ** | ** ** | **Percentage of  Bonus Target Paid Out** | ** ** |
|------------|---------------------------------------------------------------|------------|------------|------------|------------------------------------------|------------|
| 0%         |                                                          | 0%         |
| 50%        |                                                          | 50%        |
| 100%       |                                                          | 100%       |
| 125%       |                                                          | 150%       |
| 150%       |                                                          | 200%       |

 

Mr.  Powdermaker’sincentive compensation also includes a commission opportunity with a targetpayment of $81,000 at 100% achievement of 2006 wholesale gross profit quotawhere the actual amount paid is dependent on the percentage achievement ofmonthly quota amounts.

The options granted to our named executive officers in2006 summarized in our Grants of Plan-Based Awards Table were granted pursuantto our Stock Plan. These options were granted with an exercise price equal tothe fair market value of our common stock on the stated date of grant. All ofthe options granted in 2006 vest quarterly over a period of four years insixteen installments of 6.25% of the options granted and have a ten year term.

As a result of the review of our historic stock optiongranting practices and related accounting determinations, we agreed in December 2006to amend certain options granted to our named executive officers after October 3,2004 or that vest after December 31, 2004, and that have an exercise pricethat is less than the fair market value of our common stock on the redetermineddate of grant. These amendments increase the option exercise price to the fairmarke value on the redetermined date of grant and there was no considerationfrom us to our named executive officers for these amendments. In connectionwith the filing of our restated financial statements in this Form 10-K,we have finalized these new exercise prices.

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**Outstanding Equity Awards**

The following table shows grants of stock optionsoutstanding on December 31, 2006, the last day of the fiscal year, held byeach of the executive officers named in the Summary Compensation Table above.

|                       | ** ** | **Option Awards(1)**                                    | ** ** |
|-----------------------|------------|--------------------------------------------------------------|------------|
| ** **            | ** ** | **Number of **                                     | ** ** | **Number of** | ** ** | **Equity   Incentive   Plan Awards** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | **Securities   Underlying   Unexercised   Options(#) ** | ** ** | **Securities   Underlying**

**Unexercised   Options(#)** | ** ** | **Number of    Securities   Underlying   Unearned** | ** ** | **Option Exercise ** | ** ** | **Option ** | ** ** |
| **Name**              | ** ** | ** **                                                   | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** | **Options(#)** | ** ** | **Price($)** | ** ** | **Expiration Date** | ** ** |
| **Ofer Gneezy**       |       |                                                         | 26,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 3.30 |   |   |   | 12/03/2008 |   |   |
|                       |       |                                                         | 9,752      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 44.55 |   |   |   | 05/25/2010 |   |   |
|                       |       |                                                         | 3,582      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 44.55 |   |   |   | 05/25/2010 |   |   |
|                       |       |                                                         | 6          |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                       |       |                                                         | 16,661     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                       |       |                                                         | 20,000     |   |   |   | 7,501 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 10,004     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 1,248      |   |   |   | 468 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 780        |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 833        |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 6.36 |   |   |   | 09/14/2014 |   |   |
|                       |       |                                                         | 6,667      |   |   |   | 5,834 |   |   |   | 0 |   |   |   | $ | 7.05 | (2) |   |   | 09/14/2014 |   |   |
|                       |       |                                                         | 5,000      |   |   |   | 21,667 |   |   |   | 0 |   |   |   | $ | 6.54 |   |   |   | 03/29/2016 |   |   |
| **Gordon VanderBrug** |       |                                                         | 20,000     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 3.30 |   |   |   | 12/03/2008 |   |   |
| ** **            |       |                                                         | 9,166      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 40.50 |   |   |   | 05/25/2010 |   |   |
| ** **            |       |                                                         | 834        |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 40.50 |   |   |   | 05/25/2010 |   |   |
| ** **            |       |                                                         | 2          |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
| ** **            |       |                                                         | 16,665     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
| ** **            |       |                                                         | 20,000     |   |   |   | 7,500 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 11/15/2011 |   |   |
| ** **            |       |                                                         | 10,001     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
| ** **            |       |                                                         | 2,499      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
| ** **            |       |                                                         | 6,667      |   |   |   | 5,834 |   |   |   | 0 |   |   |   | $ | 7.05 | (2) |   |   | 09/14/2014 |   |   |
| ** **            |       |                                                         | 833        |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 6.36 |   |   |   | 09/14/2014 |   |   |
| ** **            |       |                                                         | 5,000      |   |   |   | 21,667 |   |   |   | 0 |   |   |   | $ | 6.54 |   |   |   | 03/29/2016 |   |   |
| **Paul Floyd**        |       |                                                         | 20,000     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                       |       |                                                         | 22,395     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                       |       |                                                         | 35,939     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                       |       |                                                         | 16,667     |   |   |   | 6,251 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 10,416     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                       |       |                                                         | 833        |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 6.36 |   |   |   | 09/14/2014 |   |   |
|                       |       |                                                         | 6,667      |   |   |   | 5,834 |   |   |   | 0 |   |   |   | $ | 7.05 | (2) |   |   | 09/14/2014 |   |   |
|                       |       |                                                         | 3,125      |   |   |   | 13,542 |   |   |   | 0 |   |   |   | $ | 6.54 |   |   |   | 03/29/2016 |   |   |
|                       |            |                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

123

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| **Dan Powdermaker** |   |   | 10,000 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|---------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|--------|---|------|--------|--------|--------|------------|--------|--------|
|                |   |   | 12,500 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                |   |   | 4,167  |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                |   |   | 2,187  |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                |   |   | 21,147 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 3.72 |   |   |   | 06/24/2013 |   |   |
|                |   |   | 16,667 |   |   |   | 6,251  |   |   |   | 0 |   |   |   | $ | 3.18 | (2)    |   |   | 08/11/2013 |   |   |
|                |   |   | 10,416 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                |   |   | 833    |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 6.36 |   |   |   | 09/14/2014 |   |   |
|                |   |   | 6,667  |   |   |   | 5,834  |   |   |   | 0 |   |   |   | $ | 7.05 | (2)    |   |   | 09/14/2014 |   |   |
|                |   |   | 3,125  |   |   |   | 13,542 |   |   |   | 0 |   |   |   | $ | 6.54 |   |   |   | 03/29/2016 |   |   |
| **Richard Tennant** |   |   | 37,500 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                     |   |   | 12,500 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 5.10 | (2)    |   |   | 11/15/2011 |   |   |
|                     |   |   | 16,667 |   |   |   | 6,251  |   |   |   | 0 |   |   |   | $ | 3.18 | (2)    |   |   | 08/11/2013 |   |   |
|                     |   |   | 10,416 |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                     |   |   | 833    |   |   |   | 0      |   |   |   | 0 |   |   |   | $ | 6.36 |   |   |   | 09/14/2014 |   |   |
|                     |   |   | 6,667  |   |   |   | 5,834  |   |   |   | 0 |   |   |   | $ | 7.05 | (2)    |   |   | 09/14/2014 |   |   |
|                     |   |   | 3,125  |   |   |   | 13,542 |   |   |   | 0 |   |   |   | $ | 6.54 |   |   |   | 03/29/2016 |   |   |

----

(1)          All outstanding stockoption grants vest in quarterly increments over a four-year period.

(2)          Reflectsrevised exercise price of stock options amended as of December 2006.

**Option Exercises**

Nooptions to purchase our common stock were exercised by our executive officersnamed in the Summary Compensation Table above during the fiscal year ended December 31,2006

**Pension Benefits**

We do not have any qualified ornon-qualified defined benefit plans.

**Nonqualified Deferred Compensation**

We do not have any non-qualified definedcontribution plans or other deferred compensation plans.

**Potential Payments Upon Termination orChange in Control**

*Mr. Gneezy andDr. VanderBrug*

The terms of our employment agreements with OferGneezy, our President and Chief Executive Officer, and Gordon VanderBrug, ourExecutive Vice President, in addition to providing for a base salary in amountsto be determined by our Compensation Committee and for the potential to receivean annual bonus at the discretion of our Compensation Committee, also providethat in the event that we terminate each executive officer’s employment withoutcause, or if each executive officer resigns for good reason, then theterminated or terminating executive officer is entitled to continuation of hisbase salary and his health benefits for one year. Further, in the event of anacquisition or change in control, the executives’ 

124

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options and restrictedshares, if any, automatically become fully vested immediately prior to theevent, and each option remains exercisable until the expiration of the optionor until it sooner terminates in accordance with its terms.

For purposes of these employmentagreements, an acquisition is defined as (i) a meger, consolidation orsimilar transaction in which securities possessing more than 50% of the totalcombined voting power of our outstanding securities are transferred to a personor persons different from the person who held those securities immediately prioto such transaction, or (ii) the sale, transfer, or other disposition ofall or substantially all of our assets to one or more persons (other than ourwholly-owned subsidiary) in a single transaction or series of relatedtransactions.

Forpurposes of these employment agreements, a change in control is defined as achange in ownership or control of our company effected because either (i) aperson or related group of persons (other than us or a person that directly orindirectly controls, is controlled by, or is under common control with us)directly or indirectly acquires beneficial ownership (determined pursuant to Rule 13d-3promulgated under the Exchange Act) of securities possessing more than 50% ofthe total combined voting power of our outstanding seucirites pursuant to atender or exchange offer made directly to our stockholders or (ii) over aperiod of 36 consecutive months or less, a change in the composition of ourBoard of Directors occurs such that a majority of our Board of Directorsceases, by reason of one or more proxy contests for the elction of directors tobe composed of indviduals who either (A) have been members of our Board ofDirectors continuously since the beginning of such period, or (B) havebeen elected or nominated for election as members of our Board of Directorsduring such period by at least a majority of our Board of Directors who werestill in office at the time such electon or nomination was approved by ourBoard of Directors.

*Messrs.Floyd, Powdermaker and Tennant*

The terms of our letter agreements with Messrs. Floyd,Powdermaker, and Tennant for serving in their respective capacities providethat if, within six months following an acquisition or change of control, weterminate any of these executive officers, without cause, or if any of theseexecutive officers resigns for good reason, then we are obligated to pay theterminated or terminating executive officer his base salary for nine months andhis stock options immediately vest and become exercisable. Mr. Powdermakerwould also be entitled to continuation of his health benefits for the ninemonth period.

The following tables summarize payments to our namedexecutive officers assuming a termination as of the last day of our fiscal year2006.

| ** **             | ** ** | **Severance Payable Upon a  Termination Without  Cause or For Good Reason(1)** | ** ** | **Accelerated Vesting of Equity  Upon a Change in Control(2)** | ** ** | ** **                      | ** ** |
|------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| **Officer**            | ** ** | ** **                                                                                                             | ** ** | **Cash Severance**                                                                           | ** ** | **Health  Insurance  Benefits** | ** ** | **Value   of Vested  Equity** | ** ** | **Value of  Accelerated  Unvested Equity** | ** ** | **Total** | ** ** |
| **Ofer Gneezy**        |       |                                                                                                                   | $          | 208,000                                                                                           |       |                            |       | $ | 8,892 |   |   | $ | 457,895 |   |   | $ | 101,650 |   |   | $ | 776,437 |   |
| **Gordon  VanderBrug** |       |                                                                                                                   | $          | 187,000                                                                                           |       |                            |       | $ | 11,441 |   |   | $ | 425,969 |   |   | $ | 98,902 |   |   | $ | 723,312 |   |
|                        |            |                                                                                                                        |            |                                                                                                   |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          In the event of termination without causeor by the executive for good reason, the executive is entitled to 12 monthsbase salary continuation (which is mitigated dollar for dollar in the event theexecutive begins new employment) and 12 months of health insurancecontinuation.

(2)          Reflects the excess of the fair marketvalue over the exercise price of all vested and unvested outstanding stockoptions based on a stock price of $8.50 as of 12/29/2006. Any unvested andoutstanding equity awards held by the executive will become 100% vested upon achange-in-control.

125

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| ** **           | ** ** | **Severance Payable Upon  a Termination Without  Cause or For Good** | ** ** | **Accelerated Vesting of  Equity Upon a Termination  Following a Change in Control(1)** | ** ** | ** **                               | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| **Officer**          | ** ** | ** **                                                                                              | ** ** | **Reason Following a  Change in Control  $**                                                                     | ** ** | **Value of  Vested Equity(2)** | ** ** | **Value of  Accelerated  Unvested Equity** | ** ** | **Total** | ** ** |
| **Paul Floyd**       |       |                                                                                                    | $          | 138,750                                                                                                                              |       |                                     |       | $ | 586,518 |   |   |   | $ | 75,658 |   |   | $ | 800,926 |   |
| **Dan Powdermaker**  |       |                                                                                                    | $          | 115,875                                                                                                                              |       |                                     |       | $ | 435,486 |   |   |   | $ | 75,658 |   |   | $ | 627,019 |   |
| **Richard  Tennant** |       |                                                                                                    | $          | 138,750                                                                                                                              |       |                                     |       | $ | 497,881 |   |   |   | $ | 75,658 |   |   | $ | 712,289 |   |
|                      |            |                                                                                                         |            |                                                                                                                                      |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          If the executive is terminated withoutcause or resigns for good reason within 6 months of a change in control, anyunvested and outstanding equity awards held by the executive will become 100%vested. 

(2)          Reflects the excess of the fair marketvalue over the exercise price of all vested and unvested outstanding stockoptions based on a stock price of $8.50 as of 12/29/2006.

(3)          The costof providing continuation of Mr. Powdermakers health benefits for 9 monthswould be $12,151.

**Compensationof Directors**

In 2006, each of our non-employee independentdirectors earned $15,000 in cash compensation and 20,000 stock options vestingin a series of four installments of 25%, with the first installment exercisableimmediately and with each additional installment to become exercisable at eachof the next three annual shareholder meetings for their services as directors. NeitherMr. Gneezy nor Dr. VanderBrug received additional compensation forserving as our directors. The directors who do not live in the BostonMetropolitan area were also reimbursed for travel expenses. We maintaindirectors’ and officers’ liability insurance and our by-laws provide formandatory indemnification of directors and officers to the fullest extentpermitted by Delaware law. In addition, our certificate of incorporation limitsthe liability of directors to either our company or our shareholders forbreaches of the directors’ fiduciary duties to the fullest extent permitted byDelaware law.

For2007, our Board of Directors approved a modified director compensation packagethat will pay the following cash to our directors:

·       $20,000 annualretainer for service on our Board of Directors.

·       $10,000 annualretainer for service on our Audit Committee.

·       $5,000 annualretainer for service on our Compensation Committee.

·       Aspecial one-time payment for each Special Committee member in connection withthe review of our prior stock option grant practices in the amounts of $50,000for Mr. King and $25,000 for Mr. Brumley.

On May 10, 2007 eachof our non-employee directors received a grant of 15,000 stock options thatvest in full on May 10, 2008; provided that accelerated vesting shalloccur with respect to the options granted to a director who ceases to be adirector upon the closing of the Share Purchase and Sale Agreement with KPN.

126

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**DirectorCompensation Paid for Fiscal Year 2006**

The table below summarizes all compensation paid todirectors during fiscal year 2006.

| **Name**            | ** ** | ** ** | ** ** | **Fees Earned  or Paid  in Cash ($)** | ** ** | **Option  Awards($)(1)(2)** | ** ** | **Total ($)** | ** ** |
|---------------------|------------|------------|------------|-----------------------------------------------------------|------------|-----------------------------|------------|--------------------|------------|
| Charles Corfield(4) |       |       | $          | 15,000                                                    |       |                        |       | $                  | 78,644     |   |   | $ | 93,644 |   |
| Charles Skibo       |       |       | $          | 15,000                                                    |       |                        |       | $                  | 78,644     |   |   | $ | 93,644 |   |
| Frank King          |       |       | $          | 15,000                                                    |       |                        |       | $                  | 78,644     |   |   | $ | 93,644 |   |
| David Lee           |       |       | $          | 15,000                                                    |       |                        |       | $                  | 76,615     |   |   | $ | 91,615 |   |
| Robert Brumley      |       |       | $          | 15,000                                                    |       |                        |       | $                  | 126,780    |   |   | $ | 141,780 |   |

----

(1)          Represents theproportionate amount of the total fair value of stock option awards recognizedby us as an expense in 2006 for financial accounting purposes. The fair valuesof these awards and the amounts expensed in 2006 were determined in accordancewith Financial Accounting Standards Board Statement of Financial AccountingStandards No.123 (revised 2004) Share-Based Payment (FAS 123R). The awards forwhich expense is shown in this table include the awards granted in 2006, aswell as awards granted in previous years for which we continued to recognizeexpense in 2006. See Note 4  to ourConsolidated Financial Statements for details as to the assumptions used todetermine the fair value of the option awards.

(2)          All Directors received agrant of 20,000 stock options on April 3, 2006. The fair value of each ofthese awards determined under FAS 123R was $103,400.

As a result of the review of our historic stock optiongranting practices and related accounting determinations, we agreed in December 2006to amend certain options granted to our directors after October 3, 2004 orthat vest after December 31, 2004, and that have an exercise price that isless than the fair market value of our common stock on the redetermined date ofgrant. These amendments increase the option exercise price to the fair markevalue on the redetermined date of grant and there was no consideration from usto our directors for these amendments. In connection with the filing of ourrestated financial statements in this Form 10-K, we have finalizedthese new exercise prices.

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The following table shows grants of stock optionsoutstanding on December 31, 2006, the last day of the fiscal year, held byeach of our directors named in the director compensation table above.

|                      | ** ** | **Option Awards**1                                             | ** ** |
|----------------------|------------|---------------------------------------------------------------------|------------|
| ** **           | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Equity  Incentive  Plan Awards** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **           | ** ** | **Number of  Securities  Underlying  Unexercised  Options(#)** | ** ** | **Number of  Securities  Underlying  Unexercised  Options(#)** | ** ** | **Number of   Securities  Underlying  Unearned  Options** | ** ** | **Option Exercise ** | ** ** | **Option Expiration ** | ** ** |
| **Name**             | ** ** | ** **                                                          | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** | **(#)** | ** ** | **Price($)** | ** ** | **Date** | ** ** |
| **Charles Corfield** |       |                                                                | 13,334     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 15.00 |   |   |   | 09/09/2009 |   |   |
|                      |       |                                                                | 13,334     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                      |       |                                                                | 13,333     |   |   |   | 6,667 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                      |       |                                                                | 6,667      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                      |       |                                                                | 10,000     |   |   |   | 10,000 |   |   |   | 0 |   |   |   | $ | 7.14 | (2) |   |   | 04/03/2016 |   |   |
| **Charles Skibo**    |       |                                                                | 26,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 15.00 |   |   |   | 09/09/2009 |   |   |
| ** **           |       |                                                                | 13,334     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
| ** **           |       |                                                                | 16,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 3.06 |   |   |   | 11/19/2011 |   |   |
| ** **           |       |                                                                | 13,333     |   |   |   | 6,667 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
| ** **           |       |                                                                | 6,667      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
| ** **           |       |                                                                | 10,000     |   |   |   | 10,000 |   |   |   | 0 |   |   |   | $ | 7.14 | (2) |   |   | 04/03/2016 |   |   |
| **Frank King**       |       |                                                                | 26,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 9.30 |   |   |   | 06/20/2011 |   |   |
|                      |       |                                                                | 16,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.16 |   |   |   | 11/15/2011 |   |   |
|                      |       |                                                                | 13,333     |   |   |   | 6,667 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                      |       |                                                                | 6,667      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                      |       |                                                                | 10,000     |   |   |   | 10,000 |   |   |   | 0 |   |   |   | $ | 7.14 | (2) |   |   | 04/03/2016 |   |   |
| **David Lee**        |       |                                                                | 26,667     |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.07 |   |   |   | 05/09/2012 |   |   |
|                 |       |                                                                | 6,666      |   |   |   | 3,334 |   |   |   | 0 |   |   |   | $ | 3.18 | (2) |   |   | 08/11/2013 |   |   |
|                 |       |                                                                | 3,334      |   |   |   | 0 |   |   |   | 0 |   |   |   | $ | 2.64 |   |   |   | 08/11/2013 |   |   |
|                 |       |                                                                | 10,000     |   |   |   | 10,000 |   |   |   | 0 |   |   |   | $ | 7.14 | (2) |   |   | 04/03/2016 |   |   |
| **Robert Brumley**   |       |                                                                | 13,334     |   |   |   | 13,333 |   |   |   | 0 |   |   |   | $ | 7.71 |   |   |   | 09/20/2015 |   |   |
|                      |       |                                                                | 10,000     |   |   |   | 10,000 |   |   |   | 0 |   |   |   | $ | 7.14 | (2) |   |   | 04/03/2016 |   |   |
|                      |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          All outstanding stockoption grants vest in quarterly increments over a four-year period. 

(2)          Reflects revisedexercise price of  stock options amendedas of December 2006.

128

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**Item12.****                 *Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters***

**Equity CompensationPlan Information**

Thefollowing table provides information as of December 31, 2006 with respectto the shares of our Common Stock that may be issued under our existing equitycompensation plan.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of securities to be  issued upon exercise of  outstanding options (a)** | ** ** | **Weighted-average exercise  price of outstanding  options (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)  |       |       | 2,404,096  |                                                                                                                          |       |                                                                                 | $          | 5.18                                                                                                                                                                                                             |       |   |   | 1,312,272 |   |   |
| Equity  compensation plans not approved by security holders |       |       | 0          |                                                                                                                          |       |                                                                                 | N/A        |                                                                                                                                                                                                             |       |   | 0 |   |   |
| Total                                                       |       |       | 2,404,096  |                                                                                                                          |       |                                                                                 | $          | 5.18                                                                                                                                                                                                             |       |   |   | 1,312,272 |   |   |

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(1)          Consistsof the Company’s Amended and Restated 1997 Stock Incentive Plan.

**Security Ownershipof Certain Beneficial Owners and Management**

The following tablesets forth certain information regarding beneficial ownership of our commonstock by:

·       eachperson we know owns beneficially more than five percent (5%) of our commonstock;

·       eachof our directors;

·       eachof our named executive officers; and

·       alldirectors and named executive officers as a group.

Beneficial ownership is determined inaccordance with the rules and regulations of the SEC and includes votingor investment power with respect to the securities. In computing the number ofshares beneficially owned by a person and the percentage of ownership of thatperson, shares of common stock subject to options and warrants held by thatperson that are currently exercisable or exercisable within 60 days of June 1,2007 are deemed to be outstanding for the purpose of computing the percentageownership of such individual or group. These shares, however, are not deemedoutstanding for the purpose of computing the percentage ownership of any otherperson. Percentage of ownership is based on 33,467,841 shares of common stockoutstanding on June 1, 2006. Except as indicated in the footnotes to thistable and pursuant to applicable community property laws, each shareholdernamed in the table has sole voting and investment power with respect to theshares set forth opposite the shareholder’s name. Unless otherwise indicated,the address for each shareholder is c/o iBasis, Inc., 20 Second Avenue,Burlington, Massachusetts 01803.

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| Name and Address of Beneficial Owner                                                                            | ** ** | ** ** | ** ** | **Amount and  Nature of  Beneficial  Ownership  Number** | ** ** | **Percent  of Class** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|----------------------------|------------|
| LC Capital Master  Fund, Ltd.(1)                                                                                                         |       |       | 3,322,959  |                                                               |       |                       | 9.93       | % |   |
| c/o Trident Fund Services (B.V.I.) Limited  P.O. Box 146  Waterfront Drive  Wickhams Cay Road Town, Tortola  British Virgin Islands |       |       |       |                                                               |       |                       |       |   |   |
| Lampe, Conway & Co., LLC  Steven G. Lampe  Richard F. Conway  680 Fifty Avenue  Suite 1202  New York, NY 10019             |       |       |       |                                                               |       |                       |       |   |   |
| Singer Children’s Management Trust(2)                                                                                               |       |       | 2,415,178  |                                                               |       |                       | 7.05       | % |   |
| c/o Romulus Holdings, Inc.  560 Sylvan Ave  Englewood Cliffs, NJ 07632                                                              |       |       |       |                                                               |       |                       |       |   |   |
| Loeb Partners Corporation(3)                                                                                                             |       |       | 1,692,291  |                                                               |       |                       | 5.06       | % |   |
| 61 Broadway  New York, NY 10006                                                                                                          |       |       |       |                                                               |       |                       |       |   |   |
| Koninklijke KPN N.V.(4)                                                                                                                  |       |       | 8,123,484  |                                                               |       |                       | 19.53      | % |   |
| KPN Telecom B.V.  Maanplein 55  2516 CK  The Hague  The Netherlands                                                                      |       |       |       |                                                               |       |                       |       |   |   |
| Ofer Gneezy(5)                                                                                                                           |       |       | 1,480,323  |                                                               |       |                       | 4.41       | % |   |
| Gordon J. VanderBrug(6)                                                                                                                  |       |       | 627,341    |                                                               |       |                       | 1.87       | % |   |
| Charles N. Corfield(7)                                                                                                                   |       |       | 536,474    |                                                               |       |                       | 1.60       | % |   |
| Charles Skibo(8)                                                                                                                         |       |       | 118,335    |                                                               |       |                       | *          |   |   |
| David Lee(9)                                                                                                                             |       |       | 80,001     |                                                               |       |                       | *          |   |   |
| W. Frank King(10)                                                                                                                        |       |       | 100,251    |                                                               |       |                       | *          |   |   |
| Robert H. Brumley(11)                                                                                                                    |       |       | 61,667     |                                                               |       |                       | *          |   |   |
| Richard G. Tennant(12)                                                                                                                   |       |       | 101,625    |                                                               |       |                       | *          |   |   |
| Paul H. Floyd(13)                                                                                                                        |       |       | 133,959    |                                                               |       |                       | *          |   |   |
| Dan Powdermaker(14)                                                                                                                      |       |       | 104,087    |                                                               |       |                       | *          |   |   |
| Mark S. Flynn(15)                                                                                                                        | ** ** | ** ** | **—** |                                                               |       |                       | *          |   |   |
| All executive  officers and directors as a group (11 persons)(16)                                                                        |       |       | 3,344,063  |                                                               |       |                       | 9.71       | % |   |

 

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                 * Represents less than 1% of the outstandingshares of common stock.

*       (1)*According to a Schedule 13G Amendment filedwith the SEC on February 7, 2007.

*       (2)*According to a Schedule 13G Amendment filedwith the SEC on February 14, 2007, shares consist of (i) 1,633,283shares of common stock, (ii) warrants to purchase 222,033 shares of commonstock at an exercise price of $1.95 per share, (iii) warrants to purchase481,529 shares of common stock at an exercise price of $5.55 per share, and (iv) warrantsto purchase 78,333 shares of common stock at an exercise price of $6.30 per share.

*       (3)*According to information contained in aSchedule 13D filed with the SEC on June 29, 2006, and excludes the numberof shares issuable upon exercise of warrants within 60 days of June 20,2006.

*       (4)*According to a Schedule 13D filed with theSEC on June 29, 2006, pursuant to the Voting Agreements (described in thesection titled, “Changes in Control” below), KPN Telecom may be deemed to haveshared voting or dispositive power with respect to: (i) 1,399,992 shareswith Mr. Ofer Gneezy (includes 16,667 shares held by The Ofer Gneezy 1999Family Trust for the benefit of Mr. Gneezy’s children for which Mr. Gneezydisclaims beneficial ownership of the shares of common stock held by The OferGneezy 1999 Family Trust, and 93,543 shares subject to stock optionsexercisable within 60 days of June 20, 2006); (ii) 553,729 shareswith Dr. Gordon VanderBrug (includes 392,448 shares held by the G.J. &C.E. VanderBrug Family Limited Partnership for which Dr. VanderBrugdisclaims beneficial ownership of the shares held by the G.J. & C.E.VanderBrug Family Limited Partnership, and 84,166 shares subject to stockoptions exercisable within 60 days of June 20, 2006); (iii) 2,270,161shares with LC Capital Master Fund, Ltd. (excludes the number of sharesissuable upon exercise of warrants within 60 days of June 20, 2006); (iv) 1,692,291shares with Loeb Partners Corporation (excludes the number of shares issuableupon exercise of warrants within 60 days of June 20, 2006); and (v) 2,207,311shares with Singer Chidren’s Management Trust (excludes the number of sharesissuable upon exercise of warrants within 60 days of June 20, 2006). KPNand KPN Telecom (i) are not entitled to any rights as a stockholder of theCompany as to the shares of common stock listed above, except pursuant to theproxies granted under the Voting Agreements, and (ii) disclaim anybeneficial ownership of the shares of common stock listed above.

*       (5)*Includes 111,512 shares of common stockissuable upon exercise of options within 60 days of June 1, 2007. Alsoincludes 16,667 shares held by The Ofer Gneezy 1999 Family Trust for thebenefit of Mr. Gneezy’s children. Mr. Gneezy disclaims beneficialownership of the shares held by the Ofer Gneezy 1999 Family Trust.

*       (6)*Includes 101,667 shares of common stock issuableupon exercise of options within 60 days of June 1, 2007. Alsoincludes 392,449 shares held by the G.J. & C.E. VanderBrug FamilyLimited Partnership. Dr. VanderBrug disclaims beneficial ownership of theshares held by the G.J. & C.E. VanderBrug Family Limited Partnership,except to the extent of his pecuniary interest therein. Does not include 9,744shares of Common Stock held by Dr. VanderBrug’s spouse of which shares Dr. VanderBrugdisclaims beneficial ownership.

*       (7)*Accordingto a Form 4 filed with the SEC on May 14, 2007, includes88,335 shares of Common Stock issuable upon exercise of options within60 days of May 14, 2007. Also includes 448,139 shares held by theCharles N. Corfield Trust u/a/d 12/19/91, revised and amended 10/19/04, arevocable trust of which Mr. Corfield is the sole trustee.

*       (8)*Accordingto a Form 4 filed with the SEC on May 14, 2007, includes118,335 shares of common stock issuable upon exercise of options within60 days of May 14, 2007.

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*       (9)*Accordingto a Form 4 filed with the SEC on May 14, 2007, includes75,001 shares of common stock issuable upon exercise of options within60 days of May 14, 2007.

*(10)*Accordingto a Form 4 filed with the SEC on May 14, 2007, includes100,001 shares of common stock issuable upon exercise of options within60 days of May 14, 2007.

*(11)*Accordingto a Form 4 filed with the SEC on May 14, 2007, includes61,667 shares of common stock issuable upon exercise of options within60 days of May 14, 2007.

*(12)*Includes 95,625 shares of common stockissuable upon exercise of options within 60 days of June 1, 2007.

*(13)*Includes 123,959 shares of common stockissuable upon exercise of options within 60 days of June 1, 2007.

*(14)*Includes 95,626 shares of common stockissuable upon exercise of options within 60 days of June 1, 2007.

*(15)*See notes (5)–(14). Our remaining executiveofficer does not benefically own any shares of our common stock.

*(16*) Includes971,728 shares of common stock issuable upon exercise of options within60 days of June 1, 2007.

**Item 13.****                *****Certain Relationships and RelatedTransactions, and Director Independence***

Each of Mr. Gneezy and Mr. VanderBrug and collectively LC CapitalMaster Fund, Ltd., Loeb Partners Corporation and Singer Children’s ManagementTrust, together, the Stockholders, on the one hand and solely in their capacityas a stockholder of our company, and KPN, on the other hand, have entered intoa Shareholder Voting Agreement, collectively, the Voting Agreements, withrespect to certain shares of common stock beneficially owned by theStockholders. The purpose of the Voting Agreements is to facilitate thetransactions contemplated by the Share Purchase between us and KPN.

Pursuant to the Share Purchase Agreement, KPN has agreed to acquire anumber of newly issued shares of common stock such that after such issuance KPNwill own 51% of the shares of our common stock on a fully-diluted basis, inexchange for: (i) all of the issued and outstanding shares of a newlycreated subsidiary of KPN, which will be a private limited liability companyorganized under the laws of the Netherlands, or the New Subsidiary, (ii) allof the issued and outstanding shares of a U.S. subsidiary of an affiliate ofthe New Subsidiary and (iii) U.S. $55,000,000 in cash. Our stockholders ofrecord immediately following to the closing of the transactions will receive adividend of $113,000,000 following the closing of the transactions.

Pursuant to the Voting Agreements, each of the Stockholders agreed, amongother things and subject to certain restrictions, to vote (or cause to bevoted) all of the shares of common stock owned by each Stockholder (a) infavor of the approval of the issuance of the Transaction Shares and (b) againstany proposal, action or transaction involving us or any of our subsidiaries orany of our stockholders, which proposal, action or transaction would in anymanner impede, frustrate, prevent or delay the consummation of the transactionscontemplated by the Share Purchase Agreement or change in any manner the votingrights of the holders of the shares of our capital stock.

Each of Mr. Gneezy and Mr. VanderBrug has also granted KPN anirrevocable proxy to vote their shares of common stock as provided for in the applicable Voting Agreement. Eachproxy will automatically expire upon the termination of each Voting Agreement.Each Voting Agreement will terminate upon the earlier (subject to extension incertain circumstances) to occur of (i) the closing of the 

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transactions contemplated by the SharePurchase Agreement and (ii) the termination of the Share PurchaseAgreement in accordance with its terms.

Our board of directors has adopted aresolution to amend our by-laws effective at the closing of the transactionscontemplated by the Share Purchase Agreement. Such by-laws, once effective,will include certain agreed upon governance mechanics.

**Item14.****                 *Principal Accounting Fees and Services***

**Audit and Non-AuditFees**

Thefollowing table presents fees for audit services rendered by Deloitte &Touche for the audit of our annual financial statements for the years ended December 31,2006 and 2005 and fees billed for other services rendered by Deloitte &Touche during those periods.

| **In thousands**               | ** ** | **Fiscal 2006** | ** ** | **Fiscal 2005** | ** ** |
|-------------------------------------|------------|----------------------|------------|----------------------|------------|
| **Deloitte & Touche, LLP** |       |                 |       |                 |       |   |   |   |   |
| Audit Fees(1)                       |       |                 | $          | 1,407                |       |   |   | $ | 835 |   |   |
| Audit-Related  Fees(2)              |       |                 | 417        |                 |       |   | 10 |   |   |
| Tax Fees(3)                         |       |                 | 95         |                 |       |   | 97 |   |   |
| Other fees                          |       |                 | —     |                 |       |   | — |   |   |
| Total                               |       |                 | $          | 1,919                |       |   |   | $ | 942 |   |   |

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(1)          Audit Fees—Audit feesbilled to us by Deloitte & Touche for auditing our annual financialstatements and internal controls, reviewing the financial statements includedin iBasis’ Quarterly Reports on Form 10-Q, and auditing therestatement of our prior period financial statements.

(2)          Audit-Related Fees—Audit-relatedfees billed to us by Deloitte & Touche include fees related to financialdue diligence performed on our behalf and review of the accounting related tothe proposed transaction with KPN.

(3)          Tax Fees—Tax fees billedto us by Deloitte & Touche include fees related to the preparation ofour tax returns and tax advice.

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**PART IV**

**Item15.****                 *Exhibits,  Financial Statementsand Schedules***

**(A)   List ofDocuments Filed as a Part of This Annual Report:**

**(1)   FinancialStatements:**

Report of Independent Registered Public AccountingFirm

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Stockholders’ Equity(Deficit)

Consolidated Statements of Cash Flows

**Notes to Consolidated FinancialStatements**

**(2)   Index to FinancialStatements Schedules:  **All financial statement scheduleshave been omitted because the required information is included in ourconsolidated financial statements, or the related notes, or is not applicable.

**(3)   Indexto Exhibits:**
| Exhibit   Number | ** ** | **Description** | ** ** |
|------------------|------------|-----------------|------------|
|             | 2.1        |            |       | Share Purchase  and Sale Agreement between the Registrant and KPN Telecom B.V. dated as of  June 21, 2006 (incorporated by reference from Exhibit 10.1 to the  Registrant’s Quarterly Report on Form 10-Q filed August 9,  2006 (file no. 000-27127)). |   |
|             | 2.2        |            |       | Amendment No. 1 to Share Purchase  and Sale Agreement between the Registrant and KPN Telecom B.V.dated as of  December 18, 2006 (incorporated by reference from Exhibit 10.1 to  the Registration’s Current Report on Form 8-K filed  December 18, 2006 (file no. 000-27127)). |   |
|             | 2.3        |            |       | Amendment No. 2 to Share Purchase  and Sale Agreement between the Registrant and KPN Telecom B.V. dated as of  April 27, 2007 (incorporated by reference from Exhibit 10.1 to the  Registration’s Current Report on Form 8-K filed April 27,  2007 (file no. 000-27127)). |   |
|             | 3.1        |            |       | Amended and  Restated Certificate of Incorporation of the Registrant (incorporated by  reference from Exhibit 3.1 to the Registrant’s Registration Statement on  Form S-1 (file no. 333-96535)). |   |
|             | 3.2        |            |       | Amended and  Restated By-Laws of the Registrant (incorporated by reference from  Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1  (file no. 333-96535)). |   |
|             | 10.1       |            |       | Lease, dated  January 8, 1999, as amended, between the Registrant and Rodger P.  Nordblum and Peter C. Nordblum as Trustees of Northwest Associates under  Declaration of Trust dated December 9, 1971 with respect to property  located at 20 Second Avenue, Burlington, Massachusetts (incorporated by  reference from Exhibit 10.1 to the Registrant’s Registration Statement  on Form S-1 (file no. 333-85545)). |   |
|             | 10.2       |            |       | Lease, dated as  of August 7, 1998, between the Registrant and 111 Eighth Avenue LLC,  relating to property located at 111 Eighth Avenue, New York, New York  (incorporated by reference from Exhibit 10.3 to the Registrant’s Registration  Statement on Form S-1 (file no. 333-85545)). |   |

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|        | 10.3  |   |   | Lease, dated  December 11, 1998 between the Registrant and Downtown Properties L.L.C.,  with respect to property located at 611 Wilshire Boulevard, Los Angeles,  California (incorporated by reference from Exhibit 10.4 to the  Registrant’s Registration Statement on Form S-1 (file no. 333-85545)).                                                                                                                                                                                                                 |   |
|--------|-------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | 10.7  |   |   | 1997 Stock  Incentive Plan of the Registrant (incorporated by reference from  Exhibit 10.8 to the Registrant’s Registration Statement on Form S-1  (file no. 333-85545).                                                                                                                                                                                                                                                                                                                                                      |   |
|   | 10.8  |   |   | Employment  Agreement between the Registrant and Ofer Gneezy, dated as of August 11,  1997 (incorporated by reference from Exhibit 10.9 to the Registrant’s  Registration Statement on Form S-1 (file no. 333-85545)).                                                                                                                                                                                                                                                                                                   |   |
|   | 10.9  |   |   | Employment  Agreement between the Registrant and Gordon J. VanderBrug, dated as of  August 11, 1997. (incorporated by reference from Exhibit 10.10 to  the Registrant’s Registration Statement on Form S-1 (file no. 333-85545)).                                                                                                                                                                                                                                                                                        |   |
|   | 10.13 |   |   | First Amended and  Restated Registration Rights Agreement, dated as of July 12, 1999, among  the Registrant and the holders of the capital stock of the Registrant who  become parties thereto (incorporated by reference from Exhibit 10.17 to  the Registrant’s Registration Statement on Form S-1 (file no. 333-  85545)).                                                                                                                                                                                            |   |
|   | 10.20 |   |   | Lease, dated  October 22, 1999, between the Registrant and Roger P. Nordblom and Peter  C. Nordblom, as Trustees of N.W. Building 1 Associates under Declaration of  Trust dated November 11, 1984 and filed with the Middlesex South  Registry District of the Land Court as Document Number 674807 with respect to  property located at 10 Second Avenue, Burlington, Massachusetts (incorporated  by reference from Exhibit 10.28 to the Registrant’s Registration  Statement on Form S-1 (file no. 333-96535)). |   |
|   | 10.22 |   |   | Offer Letter  between the Registrant and Richard Tennant, dated as of September 17,  2001 and Employment Agreement, dated as of September 20, 2001  (incorporated by reference from Exhibit 10.30 to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 2001  (file no. 000-27127)).                                                                                                                                                                                       |   |
|   | 10.23 |   |   | Offer Letter  between the Registrant and Paul Floyd, dated as of April 2, 2001 and  Proprietary Information and Inventions Agreement dated April 12, 2001  (incorporated by reference from Exhibit 10.31 to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 2001  (file no. 000-27127)).                                                                                                                                                                                |   |
|   | 10.27 |   |   | Warrant and  Registration Rights Agreement, dated January 29, 2003, by and among  iBasis, Inc. and U.S. Bank National Association, as Collateral Agent  (incorporated by reference from Exhibit 4.3 to the Registrant’s Current  Report on Form 8-K dated January 30, 2003  (file no. 000-27127)).                                                                                                                                                                                                   |   |
|   | 10.55 |   |   | Amended and  Restated Loan and Security Agreement dated December 29, 2003, evidenced  by, among other documents, a certain Amended and Restated Loan and Security  Agreement dated as of December 29, 2003 between iBasis, Inc. and  Silicon Valley Bank (incorporated by reference from Exhibit 10.61 of the  Registrant’s Annual Report on Form 10-K for the year ended  December 31, 2003 (file no. 000-27127)).                                                                                       |   |
|   | 10.58 |   |   | Global Warrant  Certificate, issued June 18, 2004, representing 5,176,065 shares of  common stock (incorporated by reference from Exhibit 99.5 to the  Registrant’s Current Report on Form 8-K dated June 29, 2004  (file no. 000-27127)).                                                                                                                                                                                                                                                                          |   |

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|            | 10.70                                                                                              |       |   | Form of  Common Stock Purchase Warrant issued by the Registrant pursuant to the terms  of the Securities Purchase Agreement, dated as of September 24, 2004, by  and among the Registrant and the Purchasers (as defined therein) to each of  the Purchasers (incorporated by reference from Exhibit 10.3 to the  Registrant’s Current Report on Form 8-K dated September 24,  2004 (file no. 000-27127)).                                                            |   |
|------------|----------------------------------------------------------------------------------------------------|------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|       | 10.71                                                                                              |       |   | Common Stock  Purchase Warrant issued by the Registrant to Tejas Securities  Group, Inc. on September 24, 2004. (incorporated by reference from  Exhibit 10.70 to the Registrant’s Form S-1 (file no. 333-119796),  filed October 18, 2004.                                                                                                                                                                                                                           |   |
|       | 10.72                                                                                              |       |   | Third  Loan Modification Agreement, dated January 5, 2005, to the Amended and  Restated Loan and Security Agreement dated December 29, 2003, evidenced  by, among other documents, a certain Third Loan Modification Agreement, dated  January 5, 2005 between iBasis, Inc. and Silicon Valley Bank, (incorporated  by reference from Exhibit 10.72 to the Registrant’s Annual Report on  Form 10-K for year ended December 31, 2004 (file no. 000-27127)). |   |
|       | 10.73                                                                                              |       |   | Amended and  Restated 1997 Stock Incentive Plan, amended March 2005 (incorporated by  reference from Appendix A to the Registrant’s Proxy Statement dated  April 13, 2005).                                                                                                                                                                                                                                                                                                          |   |
|       | 10.74                                                                                              |       |   | Letter Agreement,  dated June 21, 2005, by and among the Registrant, JMG Triton Offshore  Fund, Ltd. and JMG Capital Partners (incorporated by reference from  Exhibit 10.1 to the Registrant’s Current Report on Form 8-K  dated June 21, 2005 (file no. 000-27127)).                                                                                                                                                                                                     |   |
|       | 10.75                                                                                              |       |   | Letter between  the Registrant and Dan Powdermaker, dated July 10, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                       |   |
|       | 23.1                                                                                               |       |   | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
|       | 31.1                                                                                               |       |   | Certificate of  iBasis, Inc. Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                          |   |
|       | 31.2                                                                                               |       |   | Certificate of  iBasis, Inc. Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                          |   |
|       | 32.1                                                                                               |       |   | Certificate of  iBasis, Inc Chief Executive Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                |   |
|       | 32.2                                                                                               |       |   | Certificate of iBasis,  Inc Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                |   |
| ** ** | **(b)          Material Contracts filed as Exhibits** | ** ** |
|       | 10.75                                                                                              |       |   | Letter  between the Registrant and Dan Powdermaker, dated July 10, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                       |   |

 

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15 (d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this Report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                   | iBASIS, INC. |
|-------------------|--------------|
| June 8, 2007 | By:          | /s/ OFER GNEEZY |
|              |         | Ofer Gneezy*President and Chief Executive Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this Report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities indicated.
|                           | **Name** | ** **                                                            | ** ** | ** **        | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|---------------------------|----------|-----------------------------------------------------------------------|------------|-------------------|-----------|------------|------------|------------|----------|------------|
| /s/ OFER GNEEZY           |     | President and Chief  Executive Officer and                            |       | June 8, 2007 |
| Ofer  Gneezy              |     | Director  (Principal Executive Officer)                               |       |              |
| /s/ GORDON J.  VANDERBRUG |     | Executive Vice  President and Director                                |       | June 8, 2007 |
| Gordon  J. VanderBrug     |     |                                                                  |       |              |
| /s/ RICHARD G.  TENNANT   |     | Senior Vice  President, Finance and                                   |       | June 8, 2007 |
| Richard  G. Tennant       |     | Chief Financial Officer  (Principal Financial and Accounting Officer) |       |              |
| /s/ ROBERT H.  BRUMLEY    |     | Director                                                              |       | June 8, 2007 |
| Robert  H. Brumley        |     |                                                                  |       |              |
| /s/ CHARLES N.  CORFIELD  |     | Director                                                              |       | June 8, 2007 |
| Charles  N. Corfield      |     |                                                                  |       |              |
| /s/ W. FRANK  KING        |     | Director                                                              |       | June 8, 2007 |
| W.  Frank King            |     |                                                                  |       |              |
| /s/ DAVID LEE             |     | Director                                                              |       | June 8, 2007 |
| David  Lee                |     |                                                                  |       |              |
| /s/ CHARLES M.  SKIBO     |     | Director                                                              |       | June 8, 2007 |
| Charles M. Skibo          |     |                                                                  |       |              |

 

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