PART I

Item 1. Business

Company Overview

We are a leading provider of international communications services and a provider of retail prepaid calling services. Our operations consist of our Voice-Over-Internet-Protocol (“VoIP”) trading business (“Trading”), in which we connect buyers and sellers of international telecommunications services, and our retail services business (“Retail”). In the Trading business we receive voice traffic from buyers—originating carriers who are interconnected to our network via VoIP or traditional time division multiplexing (“TDM”) connections, and we route that traffic over the Internet to sellers—local service providers and carriers in the destination countries with whom we have established agreements to manage the completion or termination of the call. We use proprietary, patent-pending technology to automate the selection 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, consumer VoIP companies, telephony resellers and other service providers worldwide. We have call termination agreements with local service providers in North America, Europe, Asia, the Middle East, Latin America, Africa and Australia.

We continue to expand our market share in our Trading business by expanding our customer base and by introducing cost-effective solutions for our customers to interconnect with our network. We have expanded our DirectVoIP offering with DirectVoIPTM Broadband, which addresses interconnection requirements that are specific to the growing consumer VoIP market. We have more than 30 customers in the consumer VoIP market, including two of the industry leaders, and we believe this market offers significant growth potential for us. In addition, we continue to increase the traffic we terminate to mobile phones, which generally delivers higher average revenue per minute and higher margins than fixed-line traffic. We also offer our PremiumCertified® international routing product which is designed to enhance our ability to compete for retail international traffic from existing customers as well as from mobile operators and consumer VoIP providers. PremiumCertified® features routes to more than 700 destinations that are actively monitored and managed to deliver a level of quality that is equal to or exceeds the highest industry benchmarks for retail quality.

Our Retail business was launched in late 2003, with the introduction of our retail prepaid calling cards that are marketed through distributors primarily to ethnic communities within major metropolitan markets in the U.S. Our retail prepaid calling card business leverages our existing international VoIP network and has the potential to deliver higher margins than are typically achieved in the Trading business. In addition, the retail prepaid calling card business typically has a faster cash collection cycle than the Trading business. In September 2004, we launched Pingo®, a prepaid calling service offered directly to consumers through an eCommerce web interface, which we have included in our Retail business segment. Revenues from our Pingo services were not material in 2005 and 2004.

We were incorporated as a Delaware corporation in 1996. Our principal executive offices are located at 20 Second Avenue, Burlington, Massachusetts and our telephone number is (781) 505-7500. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K are available through the Securities and Exchange Commission’s (“SEC”) website at www.sec.gov or free of charge on our investor relations website at http://investor.ibasis.com.

Industry Overview

Market Overview. The international voice and fax traffic market is estimated by industry analyst TeleGeography to be worth more than $65 billion. We believe that this market will grow as countries around the world continue to deregulate their telecommunication markets, prices fall and underlying trends in migration and economic integration drive fundamental demand. We believe there are three

major industry trends that will drive continued growth in the wholesale trading of international voice traffic. These trends involve the migration of voice traffic:

· from traditional vertically-integrated international carriers to more specialized local service providers;

· from fixed-line networks to mobile networks; and

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

In most cases, international traffic is moving to carriers that do not have extensive international networks and are dependent on wholesale providers like iBasis to provide effective international service for retail customers.

Global deregulation combined with rapid technological advances has enabled the emergence of many new communications service providers in dozens of local markets. In their efforts to remain competitive, national carriers are focusing their 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 expand their ability to serve all of their customers’ telecom needs, while simultaneously reducing the cost of providing international services. Increasingly, the world’s carriers are seeking to outsource international voice traffic to efficient VoIP networks, such as The iBasis NetworkÔ, whose inherently lower infrastructure and transport costs can help improve a carrier’s competitiveness and bottom line, without compromising service quality.

The Mainstreaming of VoIP. Although the consumer adoption of VoIP services is a recent development, iBasis has been transmitting VoIP calls for many of the world’s largest carriers for several years. Managing quality of service at the core of the network, which iBasis pioneered and mastered, has allowed phone-to-phone calls to be transmitted over the Internet with quality nearly indistinguishable from that of traditional voice networks. Enabled by the quality of VoIP service from providers like iBasis, international VoIP traffic has grown rapidly. According to industry analyst, TeleGeography, international VoIP traffic grew from 23 billion minutes in 2003, to 31 billion minutes in 2004, and was forecasted to reach 43 billion minutes in 2005.

Unlike fixed-line telecommunication networks and managed IP networks, the Internet has many potential points of congestion where information, in the form of data packets, can be delayed or dropped. For non real-time communications, such as email, a slight delay in the receipt of a message is not significant. However, for real-time communications, such as telephone calls, the result of a delay in transmitting the call, or losing the call altogether, is significant. To minimize the risk of delays or losing calls over the Internet, we utilize complex and proprietary performance monitoring and call routing technology to ensure consistently high call completion and voice quality. We have developed patent-pending quality management technology that enables us to deliver call completion rates and average call durations (the standard metrics carriers use for measuring quality) that we believe are consistently equal to or better than those achieved by traditional fixed-line carriers.

VoIP’s principal benefits are:

· Cost Advantage from Internet Transport. Traditional voice networks use circuit-switching technology, which establishes dedicated channels between an originating and terminating point for the duration of a call. Physical facilities (typically fiber and associated equipment) are dedicated to voice traffic between switching nodes, regardless of changes in demand. In contrast, VoIP is based on packet-switching technology. This technology completes a call by digitizing and dividing a speaker’s voice into small packets that travel to their destination along lines carrying packets of other Internet traffic, in much the same way as email travels. Using a network of service facilities connected to the

public Internet for transport is less costly than building a dedicated network as our calls share the Internet with other traffic.

· Cost Advantage from IP Technology. VoIP gateway equipment which is used to convert and route phone calls over the Internet is less expensive and requires less physical space in telecom facilities than traditional telecommunications equipment.

· Cost Advantage from Bypass of International Settlement Rates. Traditional international long distance calls are completed through international toll switches that provide access to the terminating network. These networks are often owned by government bodies or telecommunications carriers who charge settlement rates well in excess of costs. Although these fees are being reduced in many countries as industry deregulation continues, these charges remain significant. Calls routed over the Internet bypass the toll switches, avoiding a significant portion of these fees, which further lowers the cost of completing such calls.

· Positioning for New Services. In contrast to the closed, proprietary structure inherent in a traditional circuit-switched voice network, VoIP embraces an open architecture and open standards, which facilitates innovation at lower cost. Traditional voice networks have been designed specifically to provide one basic service, making it difficult and costly to introduce new services over those networks and their proprietary platforms. As data networks convert all services into standard data packets, new services are delivered from industry standard servers, integrating the Internet with the revolution in commodity computing. As a result, new services can be developed and brought to market much faster and more cost-efficiently.

Outsourcing VoIP services. Given the advantages of VoIP, many carriers have begun to carry some portion of their voice traffic over IP networks. Despite the move by some large carriers to develop their own international VoIP infrastructures, most carriers have demonstrated more interested in outsourcing international traffic to providers such as iBasis. The reasons these carriers prefer to outsource international traffic include:

· the relatively low percentage of revenue that international service represents for many large carriers;

· the disproportionate cost and complexity of deploying and supporting international service infrastructure in contrast with domestic investment opportunities;

· a hesitation to build new networks and cannibalize traffic from their traditional voice networks;

· concerns over sufficient in-house VoIP expertise to ensure that voice quality and network reliability are comparable to that of the public-switched telephone network, especially when routing traffic over the Internet versus private networks; and

· generally reduced capital budgets for network investment of any kind.

Trading Business

Our VoIP Trading business enables carriers and other communications service providers to outsource international voice and fax traffic, substantially lowering their transport and service support costs, without compromising quality. Our carrier customers access The iBasis Network, our international VoIP network, by establishing an interconnection through one of our “Internet Central Offices” or “ICOs”. ICOs are strategically located in major telecommunications hubs in the U.S., Asia, and Europe. Calls are transported over the Internet and terminated at “Internet Branch Offices” or “IBOs” generally managed by our terminating partners. In this way, our originating customers receive a single point of interconnection to a global network of termination points without the burden of managing the international network logistics and interconnection agreements on the far end. Likewise, our partners, who sell us termination

capacity in their countries, receive a substantial source of traffic revenue without having to negotiate individual agreements and interconnections with originating carriers. Our services provide the following key benefits to our customers:

High Quality Call Completion. Our network, monitoring and management technologies enable us to complete international voice and fax calls with quality comparable to that of traditional circuit-switched voice networks. This high quality is reflected in the fact that carriers choose to provide our VoIP services to their retail customers undifferentiated from their traditional services. We achieve high quality over the Internet through a variety of controls and technologies. At our 24x7, expert-staffed global Network Operations Centers (NOCs) in Burlington, Massachusetts, USA and Hong Kong, we are able to monitor our carrier customers’ voice traffic and automatically select optimal routing choices according to real time performance data. Using our patent-pending Assured Quality Routing® and PathEngineÔ technology, we dynamically route customers’ traffic over multiple Internet routes, completing calls on our partners’ phone networks in destination countries.

Cost Effective Services. Our call transport costs are lower because packet switching is more efficient than traditional circuit-switching. Because we use the Internet, rather than a private IP network, to deliver international voice traffic, we have greater infrastructure flexibility and lower capital costs than service providers that employ dedicated point-to-point connections. VoIP equipment is less costly and has lower facilities costs (due to its smaller physical footprint) than equivalent capacity circuit-switched equipment. We offer an open, scalable architecture that enables carriers and communications service providers to connect quickly and without investment or technical expertise. An additional advantage derives from our ability to bypass many of the international settlement rates associated with some international traffic carried over circuit-switched voice networks, which produces additional cost savings.

For financial information regarding our Trading business segment, see Note 3, Business Segment and Geographic Information, to our Consolidated Financial Statements.

Retail Business

Our Retail business consists primarily of our prepaid calling card services and Pingo, our prepaid calling service sold directly to consumer via an eCommerce interface. Our prepaid calling card business, which we launched in late 2003, leverages our global VoIP network and back-office systems, including a sophisticated prepaid rating and billing platform. We sell our retail prepaid calling cards through established distributors to retail outlets in major metropolitan markets across the U.S. We have established a dedicated operation to sell and service our prepaid retail calling card services. Typically, our Retail business delivers higher gross margins and has a faster cash collection cycle than our Trading business.

In September 2004, we launched Pingo, our retail calling services offered directly to consumers through our eCommerce web interface. Pingo customers in the United States use credit cards to purchase calling time over The iBasis Network by selecting a pre-set amount. Customers are provided with a toll-free access number, account number and personal identification number to access the service. International access numbers enable customers to use their Pingo accounts to save on international calls from approximately 35 other countries. Pingo’s enhanced features include access to on-line call and billing history, automatic recharging to maintain a balance in the customer’s Pingo account, and PINpassÔ PIN-less dialing, which enables a customer to avoid keying in their account number and PIN when calling from any fixed or mobile phone they have registered on the Pingo site. These features are designed to increase the customer’s convenience and loyalty to the service. For financial information regarding our Retail business segment, see Note 3, Business Segment and Geographic Information, to our Consolidated Financial Statements.

Our Retail services build upon the underlying iBasis network and systems and gives us opportunities to capture retail traffic directly from consumers, which may provide us higher margins than traffic we receive

through other carriers. In offering these services, we can, as described in the next section, take advantage of our high quality call completion and cost effective services.

The iBasis Network

iBasis transported approximately 7.8 billion minutes of traffic over the iBasis Network in 2005, a volume of traffic that positions the Compnay among the ten largest carriers of international traffic in the world, based on global traffic statistics contained in the industry analyst publication TeleGeography 2006. As of December 31, 2005, we had Points of Presence—generally referred to as POPs—in 108 countries. POPs designate points where The iBasis Network is directly connected to local telephone networks for call origination or termination. In fact, we are capable of connecting to local networks in many more countries through our relationships with other carriers. These routes are commonly referred to as “off-net” routes and are utilized opportunistically when pricing is favorable.

The iBasis Network is based on a technologically advanced switchless architecture, leveraging proven hardware from industry leaders such as Cisco Systems and NexTone, as well as patent-pending iBasis software for quality management and advanced routing. Our Assured Quality Routing® and PathEngineÔ technology enable ongoing monitoring of network performance and automatic selection of best quality routes based on near real-time performance data. The switchless architecture provides us with significant savings in operational costs and capital expense by eliminating the need for costly telecommunications switches and other equipment and connectivity in central offices. It also has enabled us to simplify provisioning, real-time route monitoring, and network management by decreasing the number of network components involved in carrying a call. The result for our customers is higher voice quality, call completion and call duration.

The iBasis Network consists of four principal elements:

· Internet Central Offices (ICOs) and Internet Branch Offices (IBOs) that convert circuit-switched voice traffic into data for transmission and reception over the Internet or vice versa;

· the transmission medium, which is principally the Internet;

· Assured Quality Routing® (AQR), our proprietary traffic monitoring and routing management software; and

· our network operations centers (NOCs), from which we oversee and coordinate the operation of the ICOs and IBOs.

Internet Central Offices and Internet Branch Offices. Our customers interconnect with our network, at their cost, by connecting dedicated voice circuits from their facilities to one of our ICOs, which are strategically located in Frankfurt, Hong Kong, London, Los Angeles, New York, Paris, and Tokyo. Alternatively, our customers may elect to install an iBasis IBO at their facilities. ICOs and IBOs receive calls directly from a local carrier’s switched network. VoIP gateways in each ICO or IBO digitize, compress and packetize voice and fax calls and then transmit them over the Internet. At the destination, another ICO or IBO reverses the process and the call is switched back from the Internet to a local carrier’s circuit-switched network in the destination country. Increasingly, customers are investing in VoIP equipment and connecting to us using an IP signal. As this trend progresses, our already asset-effective business model gains further strength, as iBasis no longer bears all the cost of converting calls between traditional voice network and the Internet and dedicated physical circuit-switched interconnects are eliminated altogether.

The Internet. We use the Internet to transmit the substantial majority of our voice and fax traffic because of its global coverage, low cost and flexible connectivity. As a result, we have avoided the expense and delay of deploying and maintaining a private, dedicated network of fiber and cable connections. In addition, because we do not have fixed, point-to-point connections, we can adapt to changes in international traffic flows rapidly and at minimal cost. We effectively address the challenges of using the Internet for high quality, real-time voice communications by:

· selecting only high quality, service-oriented Internet service providers as our vendors;

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

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

Assured Quality Routing. We have deployed a proprietary patent-pending system of tools—collectively known as Assured Quality Routing (“AQR”) to maintain high quality service over the Internet. AQR optimizes the quality of calls placed over The iBasis Network by integrating quality parameters into routing decisions. These parameters include measures of quality that are of direct importance to carriers including call duration, call completion and post-dial delay as well as underlying determinants of successful data transmission, namely packet loss, jitter and latency. Utilizing data collected in near real-time by our PathEngine performance reporting technology, AQR automatically reroutes traffic in anticipation of quality dropping below specific thresholds, sending subsequent calls through another Internet path, to an alternative terminating IP partner or to a circuit-switched backup vendor if necessary.

Global Network Operations Centers. We manage our network and implement AQR through our network operations centers (“NOCs”). iBasis NOCs use leading network management tools from Hewlett-Packard and a number of other vendors, which are integrated with our AQR systems to enable us to monitor, test and diagnose all components of The iBasis Network. NOCs in Burlington, Massachusetts and Hong Kong are staffed by network and traffic engineers to provide expert coverage 7 days a week, 24 hours a day, 365 days a year, and are equipped with:

· tools that support the monitoring and analysis of various components of The iBasis Network to identify and address potential network problems before they affect our customers’

· system redundancy, including power back-up; and

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

Research and Development

Our research and development activities are primarily focused on developing, improving and expanding The iBasis Network and increasing the efficiency of our interconnections with buyers and sellers of telecommunications services. These activities include the development of specific tools for our networks, such as our patent-pending Assured Quality Routing and PathEngine technologies, as well as specialized interconnection technologies like our DirectVoIPÔ Broadband service, which is designed to meet the needs of emerging providers of consumer VoIP services. In addition, our engineering personnel contribute to the support and operation of our global network operations centers, which oversee and coordinate the operation of our ICO’s and IBO’s. Research and development expenses were $12.4 million, $13.8 million and $13.4 million for 2005, 2004 and 2003, respectively.

Markets and Customers

Our VoIP Trading customer base can be segregated by size into Tier 1, Tier 2 and Tier 3 carriers. Generally, Tier 1 carriers are large domestic and international carriers, such as AT&T, MCI, Sprint, Cable & Wireless, and certain government-affiliated or privatized dominant carriers, such as the Chinese telecommunications carrier China United Telecom (Unicom). Tier 1 carriers generally have annual

revenues in excess of $2 billion. Tier 2 carriers generally have annual revenues in the range of $750 million to $2 billion, but have fewer direct operating agreements with other carriers and fewer international facilities. Tier 3 carriers are typically switch-based resellers with annual revenues of less than $750 million. Recently, fast-growing providers of consumer VoIP services have emerged as a new type of carrier with distinct requirements including support for Session Initiation Protocol (SIP) signaling and security and support for multiple types of end user devices such as computer softphones and IP phones. Our DirectVoIP Broadband service provides the necessary signaling and security support, and PremiumCertified delivers the retail-quality international routing. As a result, we have begun to capture a significant share of this rapidly growing market.

A significant portion of traffic carried over The iBasis Network is from Tier 1 carriers. In 2005, Tier 1 carriers, the world’s largest and most demanding carriers, accounted for 35% of our total revenue. The ability to provide quality call completion consistently acceptable to Tier 1 carriers is of vital importance because these carriers control the vast majority of the world’s retail traffic. Tier 1 carriers will continue to be a main area of focus for our sales force. The proportion of our traffic that originates from Tier 1 carriers in the future will be impacted by the growth of our Retail services business. Traffic that comes to iBasis directly from consumers through our Retail services business has grown dramatically since the launch of our retail prepaid calling cards in late 2003.

As of December 31, 2005, iBasis provided services to approximately 391 carriers worldwide. No one carrier accounted for 10% or more of revenue in 2005. One carrier accounted for more than 10% of revenue in 2004 and 2003. For further discussion of our revenues related to significant customers and customers in other countries and other geographic information, refer to Notes 2 and 3 to our consolidated financial statements.

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

Increasingly, traffic flows are becoming reciprocal—formerly distinct customers and suppliers are becoming “trading-partners”—as deregulation and competition erode the distinction between the business models of our customers and suppliers. We expect continued growth in both size and profitability as this trend progresses and we further consolidate our position as a leading carrier that interconnects the world’s local service providers.

Margins on calls originating from outside the U.S. are generally higher than margins on calls originated from within the U.S. Deregulation and increased competition in the telecommunications industry has caused prices for long distance telephone service to steadily decline, particularly in the U.S. As a wholesale provider of long distance telephone services, our margins in this business reflect the effect of these lower prices. We attempt to offset the effect of these lower prices by negotiating lower costs from our call termination partners and by increasing the cost efficiency and utilization of our network. We have implemented a strategy to leverage retail traffic originating from both our VoIP Trading customers and our own Retail services to drive higher margins than we might typically realize from our Trading services. With our prepaid calling cards and Pingo, we are able to charge per-minute rates that can exceed our wholesale long distance rates, as well as generate revenue from fees typically associated with the use of prepaid calling cards. In addition, our premium product, PremiumCertifiedR, is designed to deliver the highest level of quality, comparable to that of any retail carrier. We have more than 700 certified routes in the PremiumCertified product and these are generally priced higher and offer higher margin potential. PremiumCertified is marketed to all iBasis trading customers and used in the delivery of the prepaid calling card and Pingo services.

Sales and Marketing

Sales Strategy. Our sales efforts for the VoIP Trading business target both buyers of international minutes and sellers of termination capacity-leading fixed line and wireless telecommunications carriers globally, as well as emerging providers of consumer VoIP services over broadband connections. Our sales force is composed of experienced personnel with well-established relationships in the telecommunications industry, based in key markets worldwide and typically responsible for business development in a small number of countries regionally. Our sales process often involves a test of our services by potential originating customers in which they route traffic over our network to a particular country. Our experience to date has been that once a carrier has begun to use our network for a single country and finds our quality to be acceptable, the sales process for increasing the volume of traffic they send to us and increasing the number of destinations for which they use our network becomes incrementally easier. We also seek to cultivate relationships with service providers that can terminate the local leg of international calls. iBasis country managers actively pursue connections with capable, licensed termination partners in their regions. Our ability to deliver a high volume of traffic, due to our interconnections with more than 280 carriers with international minutes, makes us an attractive potential partner for local service providers.

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

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

Marketing Strategy. In our VoIP Trading business, we seek to attract termination partners as well as customers and consequently address our marketing efforts to both. A very large portion of retail origination continues to be controlled by the largest (Tier 1) retail carriers. We believe that we have largely achieved our primary marketing objectives of awareness and acceptance among much of this customer segment, as evidenced by our penetration of these carriers in the major developed regions of the world. We continue to reinforce our brand presence with this segment to help increase our share of its international traffic. We also concentrate on state-owned carriers, known as PTTs—in Asia and in developing economies generally—who we view as natural customers. In addition to the Tier 1 carriers, we have over the past year begun to focus marketing effort on raising awareness of iBasis among consumer VoIP companies and mobile operators, which represent signficant growth opportunities for iBasis.

While we increasingly expect our customers to also be our termination partners, local circumstances in many countries still are such that we look to partner with ISPs, new Competitive Local Exchange Carriers (CLECs) and specialist termination providers. Unlike marketing to the well-known Tier 1 carriers, we actively identify and attract smaller termination partners in many countries, many of which are start-ups formed specifically to terminate international traffic. Our marketing plan includes public relations activity, outreach with industry analysts and the trade press, participation in industry trade shows and conferences, targeted mailings and a comprehensive website, and regular communications with our existing customer base.

Our sales and marketing strategy for our Retail services business differs for the disposable prepaid calling card business and the Pingo eCommerce business. For the calling card business, we are focused on four areas:

· developing calling card brands;

· broadening calling card distribution;

· expanding gross margins; and

· enhancing quality.

In developing our own calling card brands, in addition to supporting established brands of our distributors, we are building presence of select brands in multiple markets across multiple distributors. These brands leverage a common rate and fee structure and are able to leverage common design and advertising, which enhances both administrative and marketing efficiency while building distributor and customer loyalty. To broaden our calling distribution we identify the leading established distributors in major urban markets in the U.S. and work to establish mutually beneficial relationships. These distributors possess the local market knowledge and relationships with retail outlets required to effectively build market presence for our calling cards. Some of our distributors operate as master distributors supporting smaller sub-distributors that help to broaden and reinforce their market share within various territories or types of outlets. We expand distribution into new ethnic and geographic markets by leveraging existing relationships and by pursuing new distributors as necessary. Expanding gross margins in the prepaid calling card business is a function of managing card lifecycles. Typically, new cards are introduced with very aggressive promotional pricing to build distributor and retailer enthusiasm and consumer interest. Once the card has proven its quality and reliability we move beyond the promotional stage into production, enabling us to realize higher margins. As we establish our presence in the calling card market the overall age of our product portfolio will increase, essentially resulting in more product having graduated from the promotional phase into producing higher margins.

The sales and marketing strategy for our Pingo service leverages the cost-efficiency and tracking capabilities of on-line paid placement advertising on major search engines, such as Google and Yahoo, as well as targeted email campaigns utilizing opt-in email lists to create exposure of the Pingo website and encourage sales. We have retained a search engine marketing firm with specific expertise and proprietary technology designed to optimize our advertising investment. We also use search engine optimization techniques on the Pingo.com website. When prospects visit the Pingo website, we utilize special bonus awards and promotions to encourage initial purchase. We also market to our existing Pingo customers to encourage use of the service, recharges, and referrals.

Strategic Technology Relationships

Strategic technology relationships are important because they give us early access to new technologies, a voice in vendors’ development direction and because strategic partners engage with us in support of our sales and marketing programs. Since our founding in 1996, we have maintained a strong technology and business relationship with Cisco Systems. The iBasis Network is a Cisco PoweredÔ network. This designation means that The iBasis Network is built predominantly with Cisco products and technologies, and meets a high standard of reliability and performance. As a Cisco PoweredÔ network, we have enhanced access to Cisco technical resources and are able to more quickly deliver new capabilities and service features.

Competition

We compete in two markets: international VoIP services, which we sell on a wholesale basis to other carriers, and retail prepaid calling services which we sell to consumers directly and through distributors. As described more completely in Item 1A “Risk Factors,” the market for VoIP services is highly competitive. We compete with other wholesale trading carriers worldwide. Many of these carriers have more resources, longer operating histories and more established positions in the communications marketplace, and, in some cases, have begun to develop VoIP capabilities. We also compete with smaller companies, including those that may be specialists in just one or two routes. We compete with our own customers who have or may develop the ability to carry traffic themselves, including retail carriers who develop their own international networks or interconnect with one another 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 U.S. “Baby Bells”. Also, at present, we do not compete with emerging retail VoIP carriers as most have not developed international networks. We compete principally on quality of service and price. In the

overall international long distance market, which was approximately 260 billion minutes of phone calls in 2005 based on current information, we were among the ten largest carriers with about 3% market share. We carried more than 18% of the projected 43 billion minutes of international VoIP traffic in 2005.

In the retail prepaid calling card business, we compete with major telecommunications carriers, and many smaller telecommunications providers. Many of our competitors have a longer operating history and a more established market presence in the retail prepaid calling card business than we do. Also, many of these competitors have greater resources.

Our Pingo business competes with other on-line sellers of prepaid calling cards and services. Many of these operate on-line catalogs, selling the same cards that are available in physical form in retail stores.

Although the market for wholesale international traffic and retail prepaid calling services is highly competitive and will almost certainly remain so, we believe that our brand-strength, customer base, established global distribution and patented ability to manage traffic across the low-cost Internet while maintaining required quality, collectively represent a competitive advantage that will allow us to continue expanding both volume and margins.

Government Regulation

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

We are not licensed to offer traditional telecommunications services in any U.S. state and we have not filed tariffs for any service at the Federal Communications Commission (“FCC”) or at any state regulatory commission. Nonetheless, aspects of our operations may currently be, or become, subject to state or federal regulations governing licensing, universal service funding, advertising, disclosure of confidential communications or other information, excise taxes, U.S. embargos and other reporting or compliance requirements.

While the FCC to date has maintained an informal policy that information service providers, including VoIP providers, are not telecommunications carriers for regulatory purposes, various entities have challenged this premise, both before the FCC and at various state government agencies. However, the FCC has ruled that certain traffic carried in part utilizing the Internet protocol format was nonetheless regulated telecommunications for which certain regulatory obligations applied. The FCC is presiding over several proceedings related to VoIP services, including regulation of prepaid calling cards and the extent that Internet protocol capabilities insulate such offerings from traditional regulation, and other proceedings covering access charges, universal service, and interconnection rights for VoIP. Adverse rulings or rulemakings could subject us to licensing requirements and additional fees and subsidies.

The regulatory treatment of VoIP and other iBasis services varies widely among other countries and is subject to constant change. Until recently, most countries did not have regulations addressing VoIP or other VoIP services such as calling cards, in some cases classifying these services as unregulated services. As the VoIP market has grown and matured, increasing numbers of regulators have begun to reconsider whether to regulate VoIP and other VoIP services. Some countries currently impose little or no regulation on VoIP or VoIP services. Conversely, other countries that prohibit or limit competition for traditional voice telephony services generally do not permit Internet telephony or VoIP services or strictly limit the terms under which such services may be provided, even imposing criminal penalties for individuals associated with such offerings. Still other countries regulate VoIP and VoIP services like traditional voice telephony services, requiring VoIP companies to obtain licenses, incorporate local subsidiaries, make universal service contributions and pay other taxes.

We have advocated and supported deregulation for free and open market competition in a variety of countries.

Intellectual Property

We regard our copyrights, service marks, trademarks, trade dress, trade secrets, patents, patent applications and similar intellectual property as critical to our success and we rely on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners, and others to protect our proprietary rights. Our policy is to seek patent protection of the technology, inventions and improvements that we consider important to the development of our business. As of December 31, 2005, we had several pending United States patent applications for The iBasis Network and other inventions related to our business. We pursue the registration of our trademarks and service marks in the United States and overseas. As of March 15, 2006, we have been granted trademark registration for the marks iBasis, Pingo, Assured Quality Routing, PremiumCertified, The last calling card you’ll ever need!, ConnectPoint, and Mero Mejicano in the United States, and iBasis in the European community, and have pending registration applications for other service marks. We also rely on trade secrets, technical know-how and continuing innovation to develop and maintain our competitive position. We have granted licenses in the ordinary course of business for occasional use of the company’s name, logo, trademarks and /or servicemarks to certain marketing partners pursuant to joint marketing and/or other agreements. Likewise, we have been granted certain licenses for use in the ordinary course of business.

Employees

As of December 31, 2005, we employed 230 people. Our employees are not represented by a labor union.

Geographic Areas

For financial information about geographic areas, including information about revenues and long-lived assets, see Note 3, “Business Segment and Geographic Information” to our Consolidated Financial Statements.

Item 1A. Risk Factors

RISK FACTORS

Any investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, which we believe include all the material risks to our business, together with the information contained elsewhere in this report, before you make a decision to invest in our company.

Factors That May Affect Future Results and Financial Condition

Risks Related to Our Operations

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

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

· the amount of traffic we are able to sell to our customers, and their decisions on whether to route traffic over our network;

· increased competitive pricing pressure in the international long distance market;

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

· loss of arbitrage opportunities resulting from declines in international settlement rates or tariffs;

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

· our continuing ability to negotiate competitive costs to connect our network with those of other carriers and Internet backbone providers;

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

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

· capital expenditures required to expand or upgrade our network;

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

· the portion of our total traffic that we carry over more lucrative routes could decline, independent of route-specific price, cost or volume changes;

· technical difficulties or failures of our network systems or third party delays in expansion or provisioning system components;

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

· our ability to manage our traffic on a constant basis so that routes are profitable;

· our ability to collect from our customers; and

· currency fluctuations and restrictions in countries where we operate.

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

We may never generate sufficient revenue and gross margin to become profitable if telecommunications carriers and other communications service providers or others are reluctant to use our services or do not use our services, including any new services, in sufficient volume.

If the market for VoIP telephony and new services does not develop as we expect, or develops more slowly than expected, our business, financial condition and results of operations will be materially and adversely affected.

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

· perceptions that the quality of voice transmitted over the Internet is low;

· perceptions that VoIP is unreliable;

· our inability to deliver traffic over the Internet with significant cost advantages;

· development of their own capacity on routes served by us; and

· an increase in termination costs of international calls.

The growth of our core Trading business depends on carriers and other communications service providers generating an increased volume of international voice and fax traffic and selecting our network to carry at least some of this traffic. Similarly, the growth of Retail services we offer depends on these factors as well as acceptance in the market of the brands that we service, including their respective rates, terms and

conditions. If the volume of international voice and fax traffic and associated or other retail services fail to increase or decrease and these parties or other customers do not employ our network or otherwise use our services, our profitability will be materially and adversely affected.

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

Some of our customers have closed their businesses or filed for bankruptcy owing us significant amounts for services we have provided to them in the past. Despite our efforts to collect these overdue funds, we may never be paid. The bankruptcy court may require us to continue to provide services to these companies during their reorganizations. Other customers may discontinue their use of our services at any time and without notice, or delay payments that are owed to us. Additionally, we may have difficulty in collecting amounts from them. Although we have internal credit risk policies to identify companies with poor credit histories, we may not effectively manage these policies and may provide services to companies that refuse to pay. The risk is even greater in foreign countries, where the legal and collection systems available may not be adequate or impartial for us to enforce the payment provisions of our contracts. Our cash reserves will be reduced and our results of operations will be materially adversely affected if we are unable to collect amounts from our customers.

We have received claims including lawsuits from estates of bankrupt companies alleging that we received preferential payments prior to such companies’ bankruptcy filing. We may be required to return amounts received from subsequent bankrupt entities. We intend to employ all available defenses in contesting such claims or, in the alternative settle such claims. The results of any suit or settlement may have a material adverse affect on our business.

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

Vendors. We rely upon third-party vendors to provide us with the equipment, software, circuits, and other facilities that we use to provide our services. For example, we purchase a substantial portion of our VoIP equipment from Cisco Systems. We may be forced to try to renegotiate terms with vendors for products or services that have become obsolete. Some vendors may be unwilling to renegotiate such contracts, which could affect our ability to continue to provide services and consequently render us unable to generate sufficient revenues for our business.

Parties that Maintain Phone and Data Lines and Other Telecommunications Services. Our business model depends on the availability of the Internet and traditional telephone networks to transmit voice and fax calls. Third parties maintain and own these networks, other components that comprise the Internet, and business relationships that allow telephone calls to be terminated over the public switched telephone network. Some of these third parties are telephone companies. They may increase their charges for using these lines at any time and thereby increase our expenses. They may also fail to maintain their lines properly, fail to maintain the ability to terminate calls, or otherwise disrupt our ability to provide service to our customers. Any such failure that leads to a material disruption of our ability to complete calls or provide other services could discourage our customers from using our network, which could adversely effect our revenues.

Local Communications Service Providers. We maintain relationships with local communications service providers in many countries, some of whom own the equipment that translates calls from traditional voice networks to the Internet, and vice versa. We rely upon these third parties both to provide lines over which we complete calls and to increase their capacity when necessary as the volume of our traffic increases. There is a risk that these third parties may be slow, or may fail, to provide lines, which would affect our ability to complete calls to certain destinations. We may not be able to continue our relationships with these local service providers on acceptable terms, if at all. Because we rely upon entering into relationships

with local service providers to expand into additional countries, we may not be able to increase the number of countries to which we provide service. Finally, any technical difficulties that these providers suffer, or difficulties in their relationships with companies that manage the public switched telephone network, could affect our ability to transmit calls to the countries that those providers help serve.

Strategic Relationships. We depend in part on our strategic relationships to expand our distribution channels and develop and market our services. Strategic relationship partners may choose not to renew existing arrangements on commercially acceptable terms, if at all. In general, if we lose these key strategic relationships, or if we fail to maintain or develop new relationships in the future, our ability to expand the scope and capacity of our network and services provided, and to maintain state-of-the-art technology, would be materially adversely affected.

Distributors of prepaid calling cards to retail outlets. We make arrangements with distributors to market and sell prepaid calling cards to retail outlets. In some cases, we rely on these distributors to print cards, prepare marketing material, activate accounts, track usage and other data, and remit payments collected from retailers. There is a risk that distributors will not properly perform these responsibilities, comply with legal requirements, or pay us monies when due. We may not have adequate contractual or credit protections against these risks. There is also a risk that we will be ineffective in our efforts to implement new systems, policies covering customer care, disclosure, and privacy, and certain technical and business processes. The result of any attendant difficulties may have a material impact on our business.

We may not be able to succeed in the intensely competitive market for our Trading services.

We compete in our Trading business principally on quality of service and price. In recent years, prices for long distance telephone services have been declining as a result of deregulation and increased competition. We face competition from major telecommunications carriers, including AT&T, British Telecom, Deutsche Telekom, Verizon/MCI and Qwest, as well as new emerging carriers. We also compete with Internet protocol and other VoIP service providers who route traffic to destinations worldwide. VoIP service providers that presently focus on retail customers may in the future enter the wholesale market and compete with us. If we can not offer competitive prices and quality of service our business could be materially adversely affected.

We may not be able to succeed in the intensely competitive market for prepaid calling services.

The market for prepaid calling services is extremely competitive. Hundreds of providers offer calling card products and services. We have relatively recently begun offering prepaid calling card and related web-based services and have little prior experience in these businesses. If we do not successfully maintain and expand our distribution channel and enter geographic markets in which our rates, fees, surcharges, country services, and our other products and service characteristics can successfully compete, our business could be materially adversely affected.

We are subject to downward pricing pressures and a continuing need to renegotiate overseas rates.

As a result of numerous factors, including increased competition and global deregulation of telecommunications services, prices for international long distance calls have been decreasing. This downward trend of prices to end-users has caused us to lower the prices we charge communications service providers and calling card distributors for call completion on our network. If this downward pricing pressure continues, we may not be able to offer VoIP services at costs lower than, or competitive with, the traditional voice network services with which we compete. Moreover, in order for us to lower our prices, we have to renegotiate rates with our overseas local service providers who complete calls for us. We may not be able to renegotiate these terms favorably enough, or fast enough, to allow us to continue to offer services in a particular country on a cost-effective basis. The continued downward pressure on prices and

our failure to renegotiate favorable terms in a particular country could have a material adverse effect on our ability to operate our network and VoIP business profitably.

A variety of risks associated with our international operations could materially adversely affect our business.

Because we provide many of our services internationally, we are subject to additional risks related to operating in foreign countries. In particular, in order to provide services and operate facilities in some countries, we have established subsidiaries or other legal entities or may have forged relationships with service partners or entities set up by our employees. We also rely on our own employees to maintain certain functions of our Internet Central Offices and, in some cases, to deploy and operate our smaller Points of Presence installations. Associated risks include:

· unexpected changes in tariffs, trade barriers and regulatory requirements relating to Internet access or VoIP;

· economic weakness, including inflation, or political instability in particular foreign economies and markets;

· difficulty in collecting accounts receivable;

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

· compliance with tax, employment, securities, immigration, labor and other laws for employees living and traveling, or conducting business, abroad, which may subject them or us to criminal or civil penalties;

· foreign taxes including withholding of payroll taxes;

· foreign currency fluctuations, which could result in increased operating expenses and reduced revenues;

· unreliable government power to protect our rights and those of our employees;

· exposure to liability under the Foreign Corrupt Practices Act or similar laws in foreign countries;

· other obligations or restrictions, including, but not limited to, criminal penalties against us or our employees incident to doing business or operating a subsidiary or other entity in another country;

· individual criminal exposure of our employees, some of whom have been sought by law enforcement agencies abroad to answer for the activities of the Company;

· the personal safety of our employees and their families who at times have received threats of, or who may in any case be subject to, violence, and who may not be adequately protected by legal authorities or other means; and

· inadequate insurance coverage to address these risks.

These and other risks associated with our international operations may materially adversely affect our ability to attain or maintain profitable operations.

International governmental regulation and legal uncertainties and other laws could limit our ability to provide our services, make them more expensive, or subject us or our employees to legal or criminal liability.

Many countries currently prohibit or limit competition in the provision of traditional voice telephony services. In some of those countries, licensed telephony carriers as well as government regulators and law enforcement authorities have questioned our legal authority and/or the legal authority of our service

partners or affiliated entities and employees to offer our services. We may face similar questions in additional countries. Our failure to qualify as a properly licensed service provider, or to comply with other foreign laws and regulations, could materially adversely affect our business, financial condition and results of operations, including subjecting us or our employees to taxes and criminal or other penalties and/or by precluding us from, or limiting us in, enforcing contracts in such jurisdictions.

It is also possible that countries may apply to our activities laws relating to services provided over the Internet, including laws governing:

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

· user privacy;

· pricing controls and termination costs;

· characteristics and quality of products and services;

· qualification to do business;

· consumer protection;

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

· copyright, trademark and patent infringement; and

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

If foreign governments or other bodies begin to impose related restrictions on VoIP or our other services or otherwise enforce criminal or other laws against us, our affiliates or our employees, such actions could have a material adverse effect on our operations.

The telecommunications industry is subject to domestic governmental regulation and legal uncertainties and other laws that could materially increase our costs and prevent us from executing our business plan.

We are not licensed to offer traditional telecommunications services in any U.S. state and we have not filed tariffs for any service at the FCC or at any state regulatory commission.

Aspects of our operations may currently be, or may become, subject to state or federal regulations governing licensing, universal service funding, access charges, advertising, disclosure of confidential communications or other information, excise taxes, U.S. embargos and other reporting or compliance requirements.

While the FCC to date has maintained an informal policy that information service providers, including VoIP providers, are not telecommunications carriers for regulatory purposes, various entities have challenged this idea before the FCC and at various state government agencies. In 2004, the FCC ruled that certain traffic AT&T carried in part utilizing an Internet protocol format was nonetheless regulated telecommunications for which terminating access charges were due. The FCC subsequently found that AT&T’s prepaid calling cards, which AT&T had claimed as an enhanced, non-regulated offering, constituted traditional telecommunications for which universal service subsidies are due. In so doing, the FCC imposed such liability retroactively, and ruled that similarly situated carriers must also fulfill reporting and contribution requirements for universal service funding. The FCC is proceeding over several related topics, including regulation of prepaid calling cards and the extent that Internet protocol capabilities insulate such offerings from traditional regulation, the extent to which wholesale and other VoIP offerings may be subject to access charges or eligible for interconnection with incumbent networks,

and proceedings covering IP-enabled services and Universal Service subsidies more generally. Adverse rulings or rulemakings could subject us to licensing requirements and additional fees and subsidies.

We believe that iBasis qualifies for the enhanced service provider (“ESP”) exemption for federal universal service fund contributions because it provides a VoIP information service. Nevertheless, while reserving rights to claim the ESP exemption, we have decided to contribute to the federal universal service fund as of January 1, 2005 on our interstate VoIP transport revenues.

The IRS and the U.S. Department of Treasury have issued a notice of proposed rulemaking suggesting that VoIP calls may be subject to a 3% federal excise tax which could affect our competitiveness.

We have offered our prepaid international calling card services on a wholesale basis to international carrier customers, and others, some of which provide these services to end-user customers, enabling them to call internationally over The iBasis Network from the U.S. We participate in selling and marketing such cards through a network of distributors on a retail basis. Further, we also offer a web-based prepaid card offering. Although the calling cards are not primarily used for domestic interstate or intrastate use, we have not blocked the ability to place such calls or required our wholesale customers or distributors to show evidence of their compliance with U.S. and state regulations. As a result, there may be domestic use of the cards. Because we provide services that are primarily wholesale and/or international and utilize an enhanced technology, we do not believe that we are subject to federal or state telecommunications regulation for the possible uses of these services described here and, accordingly, we have not obtained state licenses, filed state or federal tariffs, posted bonds, or undertaken other possible compliance steps. We have also been questioned by regulators about our offerings. Under current standards or as-yet undetermined rules, the FCC and state regulatory authorities may not agree with our position. If they do not, we could become subject to regulation at the federal and state level for these services, and could become subject to licensing and bonding requirements, and federal and state fees and taxes, and other laws, all of which could materially affect our business.

We are also subject to federal and state laws and regulations regarding consumer protection, advertising, and disclosure regulations. These rules could substantially increase the cost of doing business domestically and in any particular state. Law enforcement authorities may utilize their powers under consumer protection laws against us in the event we do not meet legal requirements in a given jurisdiction which could either increase costs or prevent us from doing business there.

The Telecommunications Act of 1996 requires that payphone service providers be compensated for all completed calls originating from payphones in the United States. When calling cards are used, the FCC’s prior rules required the first switch-based carrier to compensate the payphone service provider, but subsequently adopted rules require the last switched-based carrier to do so, and further require that all carriers in the call chain implement a call-tracking system, utilize it to identify such calls, provide an independent audit of the adequacy of such system, and provide a report on these matters to the FCC and others in the call chain. We maintain that as an international VoIP provider, we sell an information service. We therefore claim that we are not a “carrier” for regulatory purposes and, in any case, our Internet-based systems do not rely on traditional long distance switches. Nonetheless, we have indirectly paid, and intend to continue paying, payphone service providers as part of our prepaid calling card business. We have contracted with a clearinghouse to remit funds directly to payphone service providers for calls originating from payphones utilizing our prepaid calling cards. For all other types of traffic related to our wholesale business, we believe that we are not responsible for payphone compensation, but rather that the carrier that precedes us is. In accordance therewith, for wholesale traffic, we have in most cases sought to apportion such responsibility by contract.

We are subject to other laws related to our business dealings that are not specifically related to telecommunications regulation. As an example, the Office of Foreign Asset Control of the U.S. Department of the Treasury, or OFAC, administers the United States’ sanctions against certain countries. OFAC rules restrict many business transactions with such countries and, in some cases, require that licenses be obtained for such transactions. We may currently, or in the future, transmit telephone calls between the U.S. and countries subject to U.S. sanctions regulations and undertake other transactions related to those services. We have undertaken such activities via our network or through various reciprocal traffic exchange agreements to which we are a party. We have received licenses from OFAC to send traffic to some countries and, if necessary, will remain in contact with OFAC with regard to other transactions. Failure to obtain proper authority could expose us to legal and criminal liability.

If we are not able to keep up with rapid technological change in a cost-effective way, the relative quality of our services could suffer.

The technology upon which our services depend is changing rapidly. Significant technological changes could render the hardware and software that we use obsolete, and competitors may begin to offer new services that we are unable to offer. If we are unable to respond successfully to these developments or do not respond in a cost-effective way, we may not be able to offer competitive services and our business results may suffer.

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

Our VoIP business requires that we handle a large number of international calls simultaneously. As we expand our operations, we expect to handle significantly more calls. If we do not expand and upgrade our hardware and software quickly enough, we will not have sufficient capacity to handle the increased traffic and growth in our operating performance would suffer as a result. Even with such expansion, we may be unable to manage new deployments or utilize them in a cost-effective manner. In addition to lost growth opportunities, any such failure could adversely affect customer confidence in The iBasis Network and could result in us losing business outright.

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

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

Single points of failure on our network may make our business vulnerable.

We operate two NOCs as well as numerous ICOs throughout the world. In some cases we have designed redundant systems, provided for excess capacity, and taken other precautions against platform and network failures as well as facility failures relating to power, air conditioning, destruction, or theft. Nonetheless, some of our infrastructure and functionality, including that associated with certain components of our retail business, operate as a single point of failure, meaning, failures of the type described may prohibit us from offering services.

We depend on our current personnel and may have difficulty attracting and retaining the skilled employees we need to execute our business plan.

Our future success will depend, in large part, on the continued service of our key management and technical personnel. If any of these individuals or others we employ are unable or unwilling to continue in their present positions, our business, financial condition and results of operations could suffer. We do not carry key person life insurance on our personnel.

We will need to retain skilled personnel to execute our plans.

Our future success will also depend on our ability to attract, retain and motivate highly skilled employees, particularly engineering and technical personnel. Past workforce reductions have resulted in reallocations of employee duties that could result in employee and contractor uncertainty and dissatisfaction. Reductions in our workforce or restrictions on salary increases or payment of bonuses may make it difficult to motivate and retain employees and contractors, which could affect our ability to deliver our services in a timely fashion and otherwise negatively affect our business.

If we are unable to protect our intellectual property, our competitive position would be adversely affected.

We rely on patent, trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our intellectual property. Unauthorized third parties may copy our services or reverse 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 the laws of certain jurisdictions and foreign countries. We may seek to patent certain processes or equipment in the future. We do not know if any of our pending patent applications will be issued with the scope of the claims we seek, if at all. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. Our means of protecting our proprietary rights in the United States or abroad may not be adequate and third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. If we fail to protect our intellectual property and proprietary rights, our business, financial condition and results of operations would suffer.

We believe that we do not infringe upon the proprietary rights of any third party. Nonetheless, we have received claims that our products or brands, or those of our retail prepaid calling card distributors, infringe valid patents or trademarks. Such claims, even if resolved in our favor, could be substantial, and the litigation could divert management efforts. It is also possible that such claims might be asserted successfully against us in the future. Our ability to provide services depends on our freedom to operate. That is, we must ensure that we do not infringe upon the proprietary rights of others or have licensed all such rights. A party making an infringement claim could secure a substantial monetary award or obtain injunctive relief that could effectively block our ability to provide services in the United States or abroad.

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

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

We may undertake strategic acquisitions or dispositions, or may be the target of similar strategic initiatives, that could be difficult to integrate or could damage our business.

We may acquire additional businesses and technologies that complement or augment our existing businesses, services and technologies. We may also be subject to or participate in strategic activities by others that result in a transfer of control of our assets or control of our outstanding shares of stock. We may need to raise additional funds through public or private debt or equity financing or issue more shares to effect such activities, which may result in dilution for shareholders and the incurrence of indebtedness. We may have difficulty integrating any additional businesses into our existing business and the process of any acquisitions or subsequent integration could divert management’s attention and expend our resources.

We may not be able to operate acquired businesses profitably or otherwise implement our growth strategy successfully.

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

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

Risks Related to the Internet and Internet Telephony Industry

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

Our future success will depend upon the maintenance of the Internet infrastructure, including a reliable network backbone with the necessary speed, data capacity and security for providing reliability and timely Internet access and services. To the extent that the Internet continues to experience increased numbers of users, frequency of use or bandwidth requirements, the Internet may become congested and be unable to support the demands placed on it and its performance or reliability may decline thereby impairing our ability to complete calls and provide other services using the Internet at consistently high quality. The Internet has experienced a variety of outages and other delays as a result of failures of portions of its infrastructure or otherwise. Future outages or delays could adversely affect our ability to complete calls and provide other services. Moreover, critical issues concerning the commercial use of the Internet, including security, cost, ease of use and access, intellectual property ownership and other legal liability issues, remain unresolved and could materially and adversely affect both the growth of Internet usage generally and our business in particular. Finally, important opportunities to increase traffic on The iBasis Network will not be realized if the underlying infrastructure of the Internet does not continue to be expanded to more locations worldwide.

Network security breaches could adversely affect our operations.

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

Undetected defects in our technology could adversely affect our operations.

Our technology is complex and is susceptible to errors, defects or performance problems, commonly called “bugs”. Although we regularly test our software and systems extensively, we can not ensure that our testing will detect every potential bug. Any such bug could materially adversely affect our business.

Our ability to provide our services using the Internet may be adversely affected by computer vandalism.

If the overall performance of the Internet is seriously downgraded by website attacks, failure of service attacks, or other acts of computer vandalism or virus infection, our ability to deliver our communication services over the Internet could be adversely impacted, which could cause us to have to increase the amount of traffic we have to carry over alternative networks, including the more costly public switched telephone network. In addition, traditional business interruption insurance may not cover losses we could

incur because of any such disruption of the Internet. While some insurers are beginning to offer products purporting to cover these losses, we do not have any of this insurance at this time.

Risks Related to Our Company

A failure to obtain necessary additional capital in the future could jeopardize our operations.

We may need additional capital in the future to fund our operations, finance investments in equipment and corporate infrastructure, expand our network, increase the range of services we offer and respond to competitive pressures and perceived opportunities. We may not be able to obtain additional financing on terms acceptable to us, if at all. If we raise additional funds by selling equity securities, the relative equity ownership of our existing investors could be diluted or the new investors could obtain terms more favorable than previous investors. A failure to obtain additional funding could prevent us from making expenditures that are needed to allow us to grow or maintain our operations.

Investor interest in our common stock may be negatively affected by our continued trading on the Over-the-Counter Bulletin Board.

Since receiving a determination from the Nasdaq National Market on November 13, 2002 that shares of our common stock would no longer trade on the Nasdaq National Market because we failed to meet certain minimum listing requirements, our common stock began trading on the NASD-operated Over-the-Counter Bulletin Board. The Over-the-Counter Bulletin Board market is generally considered to be less efficient and not as liquid as the Nasdaq National Market (now known as the Nasdaq Stock Market). Trading in this market may decrease the market value and liquidity of our common stock, which could materially and adversely affect our ability to attract additional investment to finance our operations.

We have also learned that our common stock may be trading on the Berlin, Germany stock exchange, which we have not authorized. Such exchange has been rumored to allow “naked” short selling of stock, or otherwise not comply with exchange requirements that are customary in the U.S., and could thereby be detrimental to the value of our stock and our ability to attract investors.

Provisions of our governing documents and Delaware law could also discourage acquisition proposals or delay a change in control.

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

· our board of directors has the authority to issue common stock and preferred stock, and to determine the price, rights and preferences of any new series of preferred stock, without stockholder approval;

· our board of directors is divided into three classes, each serving three-year terms;

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

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

· our stockholders may not take action by written consent; and

· our stockholders must provide specified advance notice to nominate directors or submit stockholder proposals.

In addition, provisions of Delaware law and our stock option plan may discourage, delay or prevent a change of control of our company or an unsolicited acquisition proposal.

Item 6. Selected Financial Data

The following historical selected financial information of iBasis has been derived from, and should be read in conjunction with, the consolidated financial statements and related notes included elsewhere in this document.

During July 2002, we sold our Speech Solutions Business. Accordingly, the Consolidated Statements of Operations have been reclassified to present the results of the Speech Solutions Business separately from continuing operations as discontinued operations for all periods presented.

	Year Ended December 31,
	2005			2004			2003			2002			2001
	(In thousands, except per share data)
Consolidated Statements of Operations Data:
Net revenue	$	385,485		$	263,678		$	178,159		$	164,942		$	110,180
Cost and operating expenses:
Data communications and telecommunications (excluding depreciation and amortization)	336,152			225,169			152,853			142,847			102,320
Research and development	12,435			13,803			13,387			17,781			23,939
Selling and marketing	11,618			9,205			7,513			11,279			20,323
General and administrative	15,203			12,822			8,174			24,387			25,601
Depreciation and amortization	6,712			10,345			20,065			31,871			32,364
Non-cash stock-based compensation	—			—			86			967			1,368
Loss on sale of messaging business	—			—			—			2,066			—
Restructuring costs	218			165			—			5,536			51,834
Total cost and operating expenses	382,338			271,509			202,078			236,734			257,749
Income (loss) from operations	3,147			(7,831		)	(23,919		)	(71,792		)	(147,569		)
Interest income	1,109			218			161			1,290			9,169
Interest expense	(2,601		)	(4,249		)	(3,967		)	(11,608		)	(16,518		)
Gain on bond repurchases and exchanges	—			—			16,615			25,790			14.549
Other expense, net	(324		)	(184		)	(180		)	(330		)	(565		)
Loss on long-term non-marketable security	—			(5,000		)	—			—			—
Foreign exchange (loss) gain	(939		)	339			509			201			38
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	(1,583		)	(19,347		)	(10,781		)	(56,449		)	(140,896		)
Foreign income tax expense	(93		)	(50		)	(157		)	(52		)	(22		)
Loss from continuing operations	(1,676		)	(19,397		)	(10,938		)	(56,501		)	(140,918		)
Income (loss) from discontinued operations	—			1,861			1,251			(65,222		)	(49,771		)
Net loss	$	(1,676	)	$	(17,536	)	$	(9,687	)	$	(121,723	)	$	(190,689	)
Basic and diluted net loss per share:
Loss from continuing operations	$	(0.02	)	$	(0.38	)	$	(0.24	)	$	(1.25	)	$	(3.30	)
Income (loss) from discontinued operations	—			0.03			0.03			(1.45		)	(1.17		)
Basic and diluted net loss per share	$	(0.02	)	$	(0.35	)	$	(0.21	)	$	(2.70	)	$	(4.47	)
Basic and diluted weighted average common shares outstanding	80,236			50,514			44,696			45,164			42,645

	December 31,
	2005		2004			2003			2002			2001
	(In thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	44,414	$	38,825		$	17,270		$	32,317		$	118,690
Working capital	31,341		30,774			3,264			21,906			155,509
Total assets	106,808		87,776			67,538			98,524			328,825
Long term debt, net of current portion	2,216		65,933			65,829			93,590			171,343
Total stockholders’ equity (deficit)	40,286		(23,893		)	(42,108		)	(33,972		)	86,717

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

Overview

Our Retail business was launched in late 2003, with the introduction of our retail prepaid calling cards that are marketed through distributors primarily to ethnic communities within major metropolitan markets in the U.S.. Our retail prepaid calling card business leverages our existing international VoIP network and has the potential to deliver higher margins than are typically achieved in the Trading business. In addition, the retail prepaid calling card business typically has a faster cash collection cycle than the Trading business. In September 2004, we launched Pingo®, a prepaid calling service offered directly to consumers through an eCommerce web interface, which we have included in our Retail business segment. Revenues from our Pingo services were not material in 2005 and 2004.

Critical Accounting Policies

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

Revenue Recognition. For our Trading business, our revenue transactions are derived from the resale of international minutes of calling time. We recognize revenue in the period the service is provided, net of

revenue reserves for potential billing disputes. Such disputes can result from disagreements with customers regarding the duration, destination or rates charged for each call. For our Retail business, revenue is deferred upon activation of the cards, or purchase of our web-based calling services, and is only recognized as the prepaid balances are reduced based upon minute usage and service charges.

Short-term marketable investments. Our investments are classified as available-for-sale, carried at fair value and consist of securities that are readily convertible into cash, including government securities and commercial paper, with original maturities at the date of acquisition ranging from 90 days to one year. As our investments are classified as available-for-sale, we are only exposed to charges to our results of operations in the event of a sale or an impairment of a security.

Allowance for Doubtful Accounts. We perform ongoing credit evaluations of our customers and adjust credit limits based upon their payment history and current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and take a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. We have been able to mitigate our credit risk, in part, by using reciprocal arrangements with customers, who are also iBasis suppliers, to offset our outstanding receivables, as well as requiring letters of credit and prepayments for certain customers. A majority of our accounts receivable are from international carriers. For financial information about geographic areas and significant customers, see Note 3, “Business Segment and Geographic Information” to our Consolidated Financial Statements.

Impairment of Long Lived Assets. Our long-lived assets consist primarily of property and equipment, which are carried at historical cost. Only in situations where there are specific impairment indicators are the value of these assets subject to impairment. Any future impairment would not impact cash flow but would result in a charge to our statement of operations.

Restructuring Charges. In prior years, we recorded significant charges to operations in connection with our restructuring programs. The related reserves reflect estimates, including those pertaining to severance costs and facility exit costs. We reassess the reserve requirements to complete each restructuring program at the end of each reporting period. Actual experience may be different from these estimates. We had no changes to our restructuring accrual in 2003. In 2005 and 2004, we took an additional charge of $0.2 million each year as a result of a change in estimates relating to our future sublease assumptions on vacant facilities.

Income Taxes. We have net deferred tax assets related to net operating loss carryforwards, that expire at various dates through 2025 and other tax temporary differences. Significant judgment is required in determining our provision for income taxes, the amount of deferred tax assets and liabilities and the valuation allowance required to offset against our net deferred tax assets. Factors such as future reversals of deferred tax assets and liabilities, projected future taxable income, changes in enacted tax rates and the period over which our deferred tax assets will be recoverable are considered in making these determinations. We evaluate the realizability of our deferred tax assets quarterly and we may reverse a portion, or all of our net deferred tax asset in future periods. If this occurs, a tax benefit would be recorded for financial reporting purposes. Our deferred tax asset is subject to a 100% valuation allowance.

Results of Operations

The following table sets forth for the periods indicated the principal items included in the Consolidated Statements of Operations as percentages of net revenue.

	Year Ended December 31,
	2005		2004		2003
Net revenue	100.0	%	100.0	%	100.0	%
Costs and operating expenses:
Data communications and telecommunications	87.2		85.4		85.8
Research and development	3.2		5.2		7.5
Selling and marketing	3.0		3.5		4.2
General and administrative	4.0		4.8		4.6
Depreciation and amortization	1.7		3.9		11.3
Non-cash stock-based compensation	—		—		—
Restructuring costs	0.1		0.1		—
Total costs and operating expenses	99.2		102.9		113.4
Income (loss) from operations	0.8		(2.9	)	(13.4	)
Interest income	0.3		0.1		0.1
Interest expense	(0.7	)	(1.6	)	(2.2	)
Gains on bond repurchases and exchanges	—		—		9.3
Other expenses, net	(0.1	)	(0.1	)	(0.1	)
Loss on long-term non-marketable security	—		(1.9	)	—
Foreign exchange (loss) gain	(0.2	)	0.1		0.3
Debt conversion premium and transaction costs	(0.5	)	—		—
Debt refinancing charges	—		(1.0	)	—
Loss before income taxes from continuing operations	(0.4	)	(7.3	)	(6.0	)
Foreign income tax expense	—		—		(0.1	)
Loss from continuing operations	(0.4	)	(7.3	)	(6.1	)
Income from discontinued operations	—		0.7		0.7
Net loss	(0.4	)%	(6.6	)%	(5.4	)%

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

Net revenue. Our primary source of revenue is the fees that we charge customers for completing voice and fax calls over our network and revenues from the sale of our prepaid calling services. Our VoIP Trading revenue is dependent on the volume of voice and fax traffic carried over the network, which is measured in minutes. We charge our customers fees, per minute of traffic, that are dependent on the length and destination of the call and recognize this revenue in the period in which the call is completed. Our average revenue per minute is based upon our total net revenue divided by the number of minutes of traffic over our network for the applicable period. Average revenue per minute is a key telecommunications industry financial measurement. We believe this measurement is useful in understanding our financial performance, as well as industry trends. Although the long distance telecommunications industry has been experiencing declining prices in recent years, due to the effects of deregulation and increased competition, our average revenue per minute can fluctuate from period to period as a result of shifts in traffic over our network to higher priced, or lower priced, destinations.

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 to 7.8 billion minutes for 2005 from 4.9 billion minutes for 2004. Our average revenue per minute was 5.0 cents per minute in 2005 compared to 5.4 cents per minute in 2004. The lower average revenue per minute in 2005 primarily reflected a proportionately higher mix of lower priced traffic. Trading revenue increased $87.3 million, or 39%, to $312.6 million in 2005 compared to $225.3 million in 2004. The increase in Trading revenue in 2005 was, in part, a result of adding approximately 100 new Trading customers during the year. We ended 2005 with approximately 30

consumer VoIP customers, including two industry leaders, and achieved significant year-to-year revenue growth in this fast growing market. Retail revenue increased $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 our retail prepaid calling card services, which we introduced in late 2003. During 2005, we introduced a significant number of new calling card brands and expanded our distribution network, particularly in southern California. Revenue from our Pingo calling services, part of our Retail services, which we launched in September 2004, was not material in 2005 or 2004. We believe that total revenue in 2006 will be in the range of $480 million to $500 million.

Data communications and telecommunications expenses. Data communications and telecommunications expenses are composed primarily of termination and circuit costs. Termination costs are paid to local service providers to terminate voice and fax calls received from our network. Terminating costs are negotiated with the local service provider. Should competition cause a decrease in the prices we charge our customers and, as a result, a decrease in our profit margins, our contracts, in some cases, provide us with the flexibility to renegotiate the per-minute termination fees. Circuit costs include charges for Internet access at our Internet Central Offices, fees for connections between our Internet Central Offices and our customers and/or service provider partners, facilities charges for overseas Internet access and phone lines to the primary telecommunications carriers in particular countries, and charges for the limited number of dedicated international 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 and telecommunications expenses increased by $111.0 million, or 49%, to $336.2 million for 2005 from $225.2 million for 2004. Data communications and telecommunications expenses were $276.4 million and $60.8 million for our Trading and Retail business segments in 2005, respectively, compared to $192.6 million and $32.6 million in 2004, respectively. The increase in data communications and telecommunications expense primarily reflects the increase in revenue and traffic, as discussed above. The largest component of this expense, termination costs, increased to $329.4 million for 2005 from $219.1 million for 2004 while circuit costs increased slightly to $6.8 million for 2005 from $6.1 million in 2004. As a percentage of net revenues, data communications and telecommunications costs increased to 87.4% for 2005 from 85.4% in 2004.

Gross margin Total gross margin (net revenue less data communications and telecommunications costs) declined to 12.8% of total net revenue in 2005, compared to 14.6% of total net revenue in 2004. Trading gross margin was 11.9% of Trading revenue in 2005, compared to 14.5% in 2004. The lower Trading gross margin was primarily due to lower rates on certain U.S.-originated and China-originated traffic in 2005. Retail gross margin was 16.6% of Retail revenue in 2005, compared to 14.9% in 2004.

Research and development expenses Research and development expenses include the expenses associated with developing, operating, supporting and expanding our international and domestic network, expenses for improving and operating our global network operations centers, salaries, and payroll taxes and benefits paid for employees directly involved in the development and operation of our global network operations centers and the rest of our network. Also included in this category are research and development expenses that consist primarily of expenses incurred in enhancing, developing, updating and supporting our network and our proprietary software applications.

Research and development expenses decreased $1.4 million to $12.4 million for 2005 from $13.8 million for 2004. The decrease in research and development expenses is due to lower expenditures related to the support of The iBasis Network. As a percentage of net revenue, research and development expenses decreased to 3.2% for 2005 from 5.2% for 2004.

Selling and marketing expenses. Selling and marketing expenses increased by $2.4 million, to $11.6 million in 2005, from $9.2 million in 2004. The increase in expenses primarily relates to additional investments we have made in sales and marketing, primarily to support our expanding Retail business, including increasing

advertising and marketing expenditures by $0.6 million. As a percentage of net revenue, selling and marketing expenses decreased to 3.0% for 2005 from 3.5% for 2004.

General and administrative expenses. General and administrative expenses include salary, payroll tax and benefit expenses and related costs for general corporate functions, including executive management, finance and administration, legal and regulatory, facilities, information technology and human resources.

General and administrative expenses increased by $2.4 million to $15.2 million for 2005 from $12.8 million for 2004. Increases to the allowance for doubtful accounts were $0.9 million in 2005 compared to $0.3 million in 2004. In addition, incentive compensation was $0.3 million and professional fees increased by $0.8 million, which related largely to compliance with the internal control provisions under section 404 of the Sarbanes-Oxley Act. As a percentage of net revenue, general and administrative expenses were 4.0% for 2005 and 4.8% for 2004.

Restructuring costs. In 2005 and 2004, we took charges of $0.2 million for a change in estimate relating to our sublease assumptions associated with our prior restructuring charges.

Depreciation and amortization expenses. Depreciation and amortization expenses decreased by $3.6 million to $6.7 million for 2005 from $10.3 million for 2004. This decrease was primarily due to the end of the depreciable life of certain networking equipment and computer software. As a percentage of net revenue, depreciation and amortization expenses decreased to 1.7% for 2005 from 3.9% for 2004.

Interest income. Interest income was $1.1 million for 2005, compared to $0.2 million in 2004. This increase primarily reflects the income earned on higher average cash and short-term investment balances in 2005 compared to 2004.

Interest expense. Interest expense decreased $1.6 million in 2005 to $2.6 million, from $4.2 million in 2004, as a result of the conversion of our 6 ¾% Convertible Subordinated Notes and 8% Secured Convertible Notes to common stock between June and September 2005. In addition, interest expense also includes interest on capital leases of $0.3 million and $0.5 million in 2005 and 2004, respectively.

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

Foreign exchange loss (gain), net. Foreign exchange loss was $0.9 million in 2005, compared to a gain of $0.3 million in 2004. The increase in foreign exchange loss primarily reflects the effect of the weakening Euro on our Euro-denominated accounts receivable. We began separately reporting foreign exchange gain and losses in 2005 as they have become material. We have reclassified prior year amounts to conform to the current year presentation.

Loss on long-term non-marketable security. In the first quarter of 2004, we determined that our equity investment in a privately-held company had been other 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-held company’s current cash position and recent operating results, as well as the perceived inability of that company to obtain additional financing at a level, and in a timely manner, to support its continued operations.

Debt conversion premium and transaction costs. Debt conversion premium and transaction costs of $2.0 million reflects debt conversion premium payments made of $1,855,000 to certain noteholders in June and July 2005 in negotiated agreements to encourage early conversion of $29.0 of our 8% Secured Convertible Notes due June 2007 and $2.0 million of our 6¾% Convertible Subordinated Notes due June 2009. Of the total payment, $1,740,000 was paid in cash and the balance was paid in the form of 43,736 shares of iBasis common stock with a fair value of $115,000. In addition, transactions costs were approximately $120,000 and consisted of investment banking and legal fees.

Refinancing transaction costs. Transaction costs relating to the refinancing of our debt in June 2004 were $2.2 million. These costs consisted primarily of investment banking services, legal and audit fees.

Refinancing related interest expense. We issued warrants to purchase a total of 5.2 million shares of our common stock, at $1.85 per share, to the holders of the 111¤2% Senior Secured Notes due January 2005 as partial consideration for the prepayment of these notes in June 2004. The fair value of $2.1 million for these warrants has been charged to operations as additional interest expense. Future interest on the 111¤2% Senior Secured Notes due January 2005 of $1.6 million, that had originally been charged to the gain on bond exchanges in 2003 and was not paid as a result of the prepayment of these notes, was recorded as a reduction to the additional interest expense associated with the refinancing. As a result, refinancing related interest expense, net was $0.5 million in 2004.

Income taxes. We have not recorded an income tax benefit for the losses associated with our operations in 2005 and 2004, as we believe that it is more likely than not that these benefits will not be realized. Foreign income tax expense on the earnings of our foreign subsidiaries was $93,000 and $50,000 in 2005 and 2004, respectively.

Income from discontinued operations. We had no income or loss from discontinued operations in 2005. Income from discontinued operations of $1.9 million in 2004 relates to the expiration of certain contingent obligations associated with the sale of our former Speech Solutions Business in 2002.

Net loss. Loss from continuing operations was $1.7 million in 2005 compared to a loss of $19.4 million in 2004. Excluding debt conversion premium and transaction costs of $2.0 million, profit from continuing operations was $0.3 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 $11.8 million. The improved profitability of $12.1 million in 2005 compared to 2004, excluding debt conversion premium and transactions costs, refinancing charges and loss on a long-term non-marketable security, relates to the proportionately lower level of costs and operating expenses on the higher level of revenues year-to-year. In 2006, we expect to achieve net income per share of $0.05 per share to $0.08 per share.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Net revenue. Our total net revenue increased by $85.5 million, or 48%, to $263.7 million for 2004 from $178.2 million for 2003. Traffic carried over our network increased to 4.9 billion minutes for 2004 from 3.5 billion minutes for 2003 and our average revenue per minute increased to 5.4 cents per minute in 2004 compared to 5.1 cents per minute in 2003, as our traffic, as indicated above, moved to higher priced destinations. Trading revenue increased $52.7 million, or 31%, to $225.3 million in 2004 compared to $172.6 million in 2003. Retail revenue increased $32.8 million, or nearly 7 times, to $38.4 million in 2004 compared to $5.6 million in 2003. This increase reflects the rapid growth we have achieved with our retail prepaid calling card services, which we introduced in the third quarter of 2003. Revenue from our Pingo calling services, part of our Retail services, which we launched in September 2004, was not material in 2004.

Data communications and telecommunications expenses. Data communications and telecommunications expenses increased by $72.3 million, or 47%, to $225.2 million for 2004 from $152.9 million for 2003. Data communications and telecommunications expenses were $192.6 million and $32.6 million for our Trading and Retail business segments, respectively. The increase in data communications and telecommunications expense primarily reflects the increase in revenue and traffic, as discussed above. The largest component of this expense, termination costs, increased to $219.1 million for 2004 from $147.2 million for 2003 while circuit costs increased slightly to $6.1 million for 2004 from $5.7 million in 2003. As a percentage of net revenues, data communications and telecommunications expenses decreased to 85.4% for 2004 from 85.8% in 2003.

Gross margin Total gross margin (net revenue less data communications and telecommunications costs) increased to 14.6% of total net revenue in 2004, compared to 14.2% of total net revenue in 2003. Trading gross margin increased to 14.5% of Trading revenue in 2004, compared to 13.7% in 2003. Retail gross margin was 14.9% of Retail revenue in 2004, compared to 29.4% in 2003.

Research and development expenses Research and development expenses increased by $0.4 million to $13.8 million for 2004 from $13.4 million for 2003. The increase in research and development expenses is due to expenditures related to the support of The iBasis Network, including network hardware and software maintenance. As a percentage of net revenue, research and development expenses decreased to 5.2% for 2004 from 7.5% for 2003.

Selling and marketing expenses. Selling and marketing expenses increased by $1.7 million, to $9.2 million in 2004, from $7.5 million in 2003. The increase in expenses primarily relates to additional investments we have made in sales and marketing to support our rapidly expanding Retail business. As a percentage of net revenue, selling and marketing expenses decreased to 3.5% for 2004 from 4.2% for 2003.

General and administrative expenses. General and administrative expenses increased by $4.6 million to $12.8 million for 2004 from $8.2 million for 2003. In 2003, general and administrative expenses were reduced by $4.3 million for the recovery of a previously reserved customer accounts receivable balance. Bad debt expense in 2004 was $0.3 million compared to $0.8 million in 2003. Professional fees increased by $0.4 million, related in part to compliance with the Sarbanes-Oxley Act. As a percentage of net revenue, general and administrative expenses were 4.7% for 2004 and 4.3% for 2003.

Restructuring costs. In the fourth quarter of 2004, we took a charge of $0.2 million for a change in estimate relating to our sublease assumptions associated with our restructuring charge initiated in 2002.

Depreciation and amortization expenses. Depreciation and amortization expenses decreased by $9.8 million to $10.3 million for 2004 from $20.1 million for 2003. This decrease was primarily due to the end of the depreciable life of certain networking equipment and computer software. As a percentage of net revenue, depreciation and amortization expenses decreased to 3.9% for 2004 from 11.3% for 2003.

Non-cash stock-based compensation. Non-cash stock-based compensation represents compensation expense incurred in connection with the grant of stock options to our employees with exercise prices less than the fair value of our common stock at the respective dates of grant. Such grants were made prior to our initial public stock offering and are being expensed over the vesting periods of the options granted. Non-cash stock-based compensation was $86,000 in 2003. There was no non-cash stock-based compensation expense in 2004 as these options became fully vested in 2003.

Interest income. Interest income was $218,000 and $161,000 for 2004 and 2003, respectively. This increase primarily reflects the income earned on the proceeds from our private equity placement in September 2004.

Interest expense. Interest expense in 2004 is primarily composed of interest expense on the 6¾% Convertible Subordinated Notes and the 8% Secured Convertible Notes, as well as capital leases. Interest expense increased by $0.2 million to $4.2 million in 2004 from $4.0 million in 2003. As a result of the completion of the refinancing of our debt in June 2004, interest expense includes interest on the new 8% Secured Convertible Notes due June 2007. Previously, all of the interest on our 11½% Senior Secured Notes due January 2005 had been charged to the gain on bond exchanges in 2003, in accordance with SFAS No. 15, “Accounting by Debtors and Creditors Regarding Troubled Debt Restructuring”. As a result, prior to the third quarter of 2004, interest expense did not include interest on the 11½% Senior Secured Notes due January 2005.

Gain on bond exchanges. During 2003, we entered into agreements with principal holders of our 5¾% Convertible Subordinated Notes which resulted in the retirement of $50.4 million of such notes in

exchange for new debt instruments at 50% of the face value of the retired notes. Under the terms of the agreement, the holders of the retired notes received $25.2 million of new 11½% Senior Secured Notes and warrants for 4,915,416 shares of our common stock. Each warrant had an initial exercise price of $0.65 per share and is exercisable over a five-year term. The 11½% Senior Secured Notes, shared in a second priority lien on our assets and were subordinated to our bank revolving line of credit.

The gain we recognized in 2003 was calculated as follows:

	2003
	(in thousands)
Face value of surrendered 5¾% Convertible Subordinated Notes due March 2005		$	50,350
Less: Face value of issued 11½% Senior Secured Notes due January 2005		(25,175		)
Future interest payments on 11½% Senior Secured Notes due January 2005		(5,527		)
Fair value of warrants issued		(1,375		)
Reduction of deferred debt financing costs		(723		)
Professional fees		(935		)
Gain		$	16,615

Other expenses, net. Other expenses, net were $0.2 million and $0.3 million in 2004 and 2003, respectively, and relate mostly to state excise, use and franchise taxes.

Foreign exchange gain, net. Foreign exchange gain was $0.3 million in 2004, compared to a gain of $0.5 million in 2003. The foreign exchange gains in both years primarily reflected the effect of the strengthening Euro on our Euro-denominated accounts receivable.

Refinancing related interest expense. We issued warrants to purchase a total of 5.2 million shares of our common stock, at $1.85 per share, to the holders of the 11½% Senior Secured Notes as partial consideration for the prepayment of these notes in June 2004. The fair value of $2.1 million for these warrants has been charged to operations as additional interest expense. Future interest on the 11½% Senior Secured Notes of $1.6 million, that had originally been charged to the gain on bond exchanges in 2003 and was not paid as a result of the prepayment of these notes, was recorded as a reduction to the additional interest expense associated with the refinancing. As a result, refinancing related interest expense, net was $0.5 million in 2004.

Income taxes. We have not recorded an income tax benefit for the losses associated with our operating losses in 2004 and 2003, as we believe that it is more likely than not that these benefits will not be realized. Foreign income tax expense on the earnings of our foreign subsidiaries was $50,000 and $157,000 in 2004 and 2003, respectively.

Income from discontinued operations. Income from discontinued operations of $1.9 million in 2004 relates to the expiration of certain contingent obligations associated with the sale of our former Speech Solutions

Business in 2002. Income from discontinued operations of $1.3 million in 2003 represents additional consideration of $1.3 million for an earn-out payment based on the achievement of certain 2003 revenue-based milestones associated with our former Speech Solutions Business.

Net loss. Loss from continuing operations was $19.4 million in 2004 compared to a loss of $10.9 million in 2003. Excluding 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 $11.7 million. Excluding the gain on bond exchanges of $16.6 million, the loss in 2003 was $27.5 million. The reduction in the net loss in 2004 compared to 2003 of $15.8 million, excluding debt refinancing charges, loss on a long-term non-marketable security and gain on bond exchanges, relates to the proportionately lower level of costs and operating expenses on the higher level of revenues year-to-year.

Liquidity and Capital Resources

Our principal capital and liquidity needs historically have related to the development of our network infrastructure, our sales and marketing activities, research and development expenses, and general capital needs. Our working capital needs have been met, in large part, from the net proceeds from public and private offerings of common stock and issuances of convertible debt. In addition, we have also met our capital needs through vendor capital leases and other equipment financings.

Net cash provided by operating activities was $12.2 million in 2005, compared to net cash used in operating activities of $7.2 million and $3.2 million in 2004 and 2003, respectively. Cash provided by operating activities in 2005 was result of the loss of $1.6 million offset by non-cash charges of $8.0 million, and an increase in accounts payable, accrued expenses and deferred revenue of $20.6 million, partially offset by an increase in accounts receivable of $14.4 million. The increases in accounts receivable and accounts payable relate primarily to the growth in revenue and traffic in 2005 compared to 2004. Accounts receivable days sales outstanding declined to 41 days at December 31, 2005 compared to 43 days at December 31, 2004. Cash used in operating activities in 2004 related to the loss from continuing operations of $19.4 million, partially offset by non-cash charges of $17.9 million. In addition, the increase in accounts receivable of $12.6 million was partially offset by an increase in accounts payable, accrued expenses and deferred revenue of $8.1 million. Cash used in continuing operating activities in 2003 related to our loss from continuing operations of $10.9 million and the non-cash gain on our debt exchange of $16.6 million, partially offset by non-cash charges of $17.0 million and changes in other assets and liabilities of $7.4 million.

Net cash used in investing activities in 2005 of $2.4 million included $3.4 million used for capital expenditures, partially offset by net maturities of $1.0 million of short-term investments. Our short-term investments are classified as available-for-sale and consist of securities that are readily convertible into cash, including government securities and commercial paper, with original maturities at the date of acquisition ranging from 90 days to one year. At December 31, 2005, $16.9 million of securities with maturities of less than one year were classified as short-term investments. Net cash used in investing activities in 2004 of $18.7 million consisted of $3.3 million used for capital expenditures and $17.9 million in net purchases of short-term investments. In 2004, we also received proceeds from an earn-out receivable and escrow payment of $1.0 million and $1.5 million, respectively, relating to the sale of our former Speech Solutions Business. Net cash used in investing activities was $5.2 million in 2003, of which $4.5 million was used for capital expenditures and $0.7 million was a payment relating to an adjustment associated with the sale of our Speech Solutions Business.

Net cash used in financing activities was $3.2 million in 2005 and consisted of debt conversion premium payments and transaction costs of $1.9 million, the redemption of the remaining $0.9 million of 5¾% Convertible Subordinated Notes on their maturity date in March 2005 and capital lease payments of $1.2 million. During 2005, we received proceeds of $2.6 million from warrant and stock option exercises. In

addition, in October 2005, we announced a program to repurchase up to $5.0 million of our common stock. In the fourth quarter of 2005, we repurchased 983,050 shares of our common stock at a cost of $1.9 million. In February 2006, we expanded our stock repurchase program to allow for the repurchase of up to a total of $15.0 million. Through March 10, 2006, we repurchased an additional 1,131,300 shares in 2006 at a cost of $2.3 million, leaving $10.9 million remaining for repurchases under this program.

During 2005, we completed the process of eliminating our long-term bond debt through a series of debt conversion transactions. These transactions have resulted in interest savings on an annualized basis of approximately $4.7 million. In June 2005, we negotiated (i) the early conversion of $9,100,000 of our 8% Secured Convertible Notes due June 2007 into 4.9 million shares of common stock at the conversion price of $1.85 per common share and (ii) the early conversion of $2,000,000 of our 6¾% Convertible Subordinated Notes due June 2009 into 1.1 million shares of common stock at the conversion price of $1.85 per common share. We paid a total of $661,000 in premiums to the noteholders to encourage the early conversion of these notes, of which $546,000 was paid in cash and the remaining $115,000 was paid in the form of 43,736 shares of our common stock with a fair value of $115,000. In addition, $1,150,000 of our 6¾% Convertible Subordinated Notes due June 2009 voluntarily converted into 0.6 million shares of common stock at the conversion price of $1.85 per share. In total, $12,250,000 of notes were converted into 6.6 million shares of common stock.

In July 2005, we negotiated the early conversion of the remaining $19,900,000 of our 8% Secured Convertible Notes due June 2007 into 10.8 million shares of common stock at the stated conversion price of $1.85 per share. We paid a total premium of $1,194,000 in cash to the noteholders to encourage the early conversion of these notes. In addition, transaction costs associated with this early conversion were $0.1 million and consisted primarily of investment banking fees.

From mid-August 2005 through early September 2005, the remaining $32,599,000 of our 6¾% Convertible Subordinated Notes due June 2009 were converted to shares of our common stock at the stated conversion price of $1.85 per share. In mid-August 2005, we announced our intention to redeem all of these outstanding notes for cash at the face value of the notes, plus accrued interest, with a planned redemption date of September 6, 2005. Prior to the redemption date, all of the holders elected to convert their notes to common stock at the stated conversion price of $1.85 per share.

Net cash provided by financing activities was $29.5 million in 2004. In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer, pursuant to which $37.3 million of our outstanding 5¾% Convertible Subordinated Notes due March 2005, representing approximately 98% of the total amount of these notes then outstanding, were tendered for the same principal amount of new 6¾% Convertible Subordinated Notes due June 2009. Approximately $0.9 million of the 5¾% Convertible Subordinated Notes due March 2005 remained outstanding after the exchange offer. Simultaneously with the exchange offer, we prepaid all $25.2 million of our existing 11½% Senior Secured Notes due January 2005 for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock at $1.85 per share. We issued $29.0 million of new 8% Secured Convertible Notes due June 2007 of which $25.2 million was used to prepay the 11½% 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 million of 6¾% Convertible Subordinated Notes due June 2009 voluntarily converted their notes into 0.7 million shares of common stock at the conversion price of $1.85 per share. In 2005, the remaining 6¾% Convertible Subordinated Notes due June 2009 and the 8% Secured Convertible Notes due June 2007 were converted into shares of our common stock at $1.85 per share, as described above.

In September 2004, we completed a private equity placement of 15,000,000 shares of our common stock at $2.10 per share, for total gross proceeds of $31.5 million, to a group of institutional and accredited

investors. Investment banking fees and other costs of the transaction were $1.3 million, resulting in net proceeds to us from the private equity placement of $30.2 million. The net proceeds from the private equity placement were used for working capital requirements, capital asset purchases and general corporate purposes. In addition in 2004, we received proceeds of $2.0 million from the exercise of warrants and stock options, made payments on capital leases of $2.2 million and paid down our bank borrowings of $2.3 million.

Net cash used in financing activities was $6.7 million in 2003, of which $5.8 million was used to repay our capital lease obligations and $0.9 million was paid for fees in connection the exchange of a portion of our outstanding 5¾% Convertible Subordinated Notes for 11½% Senior Secured Notes.

During 2003, we entered into agreements with principal holders of our 5¾% Convertible Subordinated Notes due March 2005 which resulted in the retirement of $50.4 million of such notes in exchange for new debt instruments at 50% of the face value of the retired notes. Under the terms of the agreement, the holders of the retired notes received $25.2 million of new 8% Senior Secured Notes due January 2005 and warrants to purchase 4,915,416 shares of common stock. Each warrant has an exercise price of $0.65 per share and is exercisable over a five-year term. The 8% Senior Secured Notes due January 2005 were prepaid in June 2004 as part of our debt refinancing. During 2003, our bank exercised a warrant we issued in connection with our bank lines for 0.3 million shares of common stock on a cashless basis.

In January 2005, we amended and extended our revolving line of credit with our bank. The new $15.0 million revolving line of credit has a two-year term, bears interest at the bank’s prime rate plus ½% and is collateralized by substantially all of our assets. Borrowings under the line may also be used for letters of credit and foreign exchange contracts and are no longer on a borrowing formula. The new revolving line of credit requires us to comply with various non-financial and financial covenants, including minimum profitability and liquidity and requires us to maintain a minimum cash balance of $15.0 million with the bank, or be subject to certain additional fees. We were in compliance with all of the covenants under our new revolving lines of credit during 2005. At December 31, 2005 and 2004, we had no borrowings under our bank line of credit. We had borrowings outstanding under previous revolving lines of credit of $2.3 million at December 31, 2003. At December 31, 2005, we had $2.4 million in letters of credit outstanding under our bank line of credit.

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

In February 2006, we announced our intention to seek shareholder approval for a reverse stock split at our next Annual Meeting for the purpose of increasing the share price of our common stock to help achieve compliance with the listing requirements of the NASDAQ National Market.

At a Special Meeting of Shareholders held on June 18, 2004, shareholders voted to increase the number of authorized shares of common stock, par value $0.001 per share, from 85,000,000 shares to 170,000,000 shares. As a result, on June 18, 2004, we filed an Amendment to our First Amended and Restated Certificate of Incorporation to increase the number of authorized shares of common stock, par value $0.001 per share, from 85,000,000 shares to 170,000,000 shares.

We anticipate that the December 31, 2005 balance of $44.4 million in cash, cash equivalents and short-term investments, together with expected cash flow generated from operations, will be sufficient to fund our operations, capital expenditures and stock repurchase program for at least the next twelve months. We expect capital expenditures to be between $10 million and $12 million in 2006. In addition, we have expanded our stock repurchase program in February 2006 to repurchase up to $15 million of our common stock, of which $1.9 million was used in 2005, leaving $13.1 million remaining for 2006.

Off-Balance Sheet Arrangements

Under accounting principles generally accepted in the U.S., certain obligations and commitments are not required to be included in the consolidated balance sheets and statements of operations. These obligations and commitments, while entered into in the normal course of business, may have a material impact on liquidity. We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited 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

The following table summarizes our future contractual obligations as of December 31, 2005:

	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, including interest	$	4,265		$1,866		$1,604		$	795	$	—		$	—
Operating leases	8,782			2,669		2,136		1,834		2,143			—
Total	$	13,047		$	4,535	$	3,740	$	2,629	$	2,143		$	—

New Accounting Pronouncements

In April 2005, the Securities and Exchange Commission announced a new rule that amends the compliance date for adoption of Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”). The new rule extends the required adoption of SFAS No. 123R for companies with calendar fiscal years to the first quarter of 2006. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions).

We expect to adopt SFAS No. 123R using the Statement’s modified prospective application method. Adoption of SFAS No. 123R is expected to increase our stock compensation expense. We are currently in the process of evaluating the financial statement impact of the implementation of SFAS No. 123R. We expect stock compensation expense in 2006, relating to unvested, outstanding stock options as of December 31, 2005, will be in the range of $0.7 million to $1.0 million. Additional grants of stock options in 2006 will further increase our stock compensation expense.

In March 2005 the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (“FIN 47”). FIN 47 requires us to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably recognized. A conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity, such as restoring a leased facility to its original condition, and where the timing and method of settlement are contingent upon a future event, that may or may not be beyond our control. This liability should be recognized when incurred; typically upon acquisition or entering into a lease. The adoption of FIN 47 did not have a material impact on our consolidated results of operations and financial condition in 2005.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk exposure is related to interest rates and foreign currency exchange rates. To date, we have not engaged in trading market risk sensitive instruments or purchasing hedging instruments,

whether interest rate, foreign currency exchange, commodity price or equity price risk. We have not purchased options or entered into swaps or forward or futures contracts.

Our investments in commercial paper and debt instruments are subject to interest rate risk, but due to the short-term nature of these investments, interest rates would not have a material impact on their value at December 31, 2005. Our primary interest rate risk is the risk on borrowings under our line of credit agreements, which are subject to interest rates based on the bank’s prime rate. A change in the applicable interest rates would also affect the rate at which we could borrow funds or finance equipment purchases. Our capital lease obligations are fixed rate debt. A 10% change in interest rates would not have a material impact on interest expense associated with our line of credit agreement.

Although we conduct our business in various regions of the world, most of our revenues and costs are denominated in U.S. dollars with the remaining being primarily denominated in Euros or British pounds. Thus, we are exposed to foreign currency exchange rate fluctuations as the financial results and balances of our foreign subsidiaries are translated into U.S. dollars. As exchange rates vary, these results, when translated, may vary from expectations and may adversely impact our results of operations and financial condition. Accordingly, if the dollar weakens relative to foreign currencies, particularly the Euro or British Pound, our foreign currency-based denominated revenues and expenses would increase when stated in U.S. Dollars. Conversely, if the dollar strengthens, our foreign currency denominated revenues and expenses would decrease.

iBasis, Inc.
Consolidated Balance Sheets

	December 31,
	2005			2004
	(In thousands, except per share data)
Assets
Current assets:
Cash and cash equivalents	$	27,478		$	20,928
Short-term marketable investments	16,936			17,897
Accounts receivable, net of allowance for doubtful accounts of $2,507 and $3,391, respectively	47,641			34,133
Prepaid expenses and other current assets	2,676			2,420
Total current assets	94,731			75,378
Property and equipment, at cost:
Network equipment	53,434			74,768
Equipment under capital lease	4,917			5,632
Computer software	10,353			10,006
Leasehold improvements	6,697			6,437
Furniture and fixtures	1,049			1,075
	76,450			97,918
Less—Accumulated depreciation and amortization	(64,696		)	(86,057		)
	11,754			11,861
Deferred debt financing costs, net	—			177
Other assets	323			360
	$	106,808		$	87,776
Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	27,796		$	24,340
Accrued expenses	24,479			12,186
Deferred revenue	9,517			6,303
Current portion of long-term debt	1,598			1,775
Total current liabilities	63,390			44,604
Long-term debt, net of current portion	2,216			65,933
Other long-term liabilities	916			1,132
Commitments and contingencies
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—102,336 and 64,778 shares, respectively;	102			65
Treasury stock, 2,074 and 1,135 shares, respectively, at cost	(2,091		)	(341		)
Additional paid-in capital	473,710			406,137
Accumulated other comprehensive loss	(17		)	(12		)
Accumulated deficit	(431,418		)	(429,742		)
Total stockholders’ equity (deficit)	40,286			(23,893		)
	$	106,808		$	87,776

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

iBasis, Inc.
Consolidated Statements of Operations

	Years Ended December 31,
	2005			2004			2003
	(In thousands, except per share data)
Net revenue	$	385,485		$	263,678		$	178,159
Cost and operating expenses:
Data communications and telecommunications (excluding depreciation and amortization)	336,152			225,169			152,853
Research and development	12,435			13,803			13,387
Selling and marketing	11,618			9,205			7,513
General and administrative	15,203			12,822			8,174
Depreciation and amortization	6,712			10,345			20,065
Non-cash stock-based compensation	—			—			86
Restructuring costs	218			165			—
Total cost and operating expenses	382,338			271,509			202,078
Income (loss) from operations	3,147			(7,831		)	(23,919		)
Interest income	1,109			218			161
Interest expense	(2,601		)	(4,249		)	(3,967		)
Gain on bond repurchases and exchanges	—			—			16,615
Other expenses, net	(324		)	(184		)	(180		)
Loss on long-term non-marketable security	—			(5,000		)	—
Foreign exchange (loss) gain	(939		)	339			509
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	(1,583		)	(19,347		)	(10,781		)
Foreign income tax expense	(93		)	(50		)	(157		)
Loss from continuing operations	(1,676		)	(19,397		)	(10,938		)
Income from discontinued operations	—			1,861			1,251
Net loss	$	(1,676	)	$	(17,536	)	$	(9,687	)
Basic and diluted net loss per share:
Loss from continuing operations	$	(0.02	)	$	(0.38	)	$	(0.24	)
Income from discontinued operations	—			0.03			0.03
Net loss	$	(0.02	)	$	(0.35	)	$	(0.21	)
Basic and diluted weighted average common shares outstanding	80,236			50,514			44,696

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

iBasis, Inc.
Consolidated Statements of Stockholders’ Equity (Deficit)

	Common Stock					Treasury Stock							Additional												Accumulated Other				Total Stockholders'
	Number of Shares		$0.001 Par Value			Number of Shares			Amount				Paid-In Capital				Deferred Compensation				Accumulated Deficit				Comprehensive Loss				Equity (Deficit)
	(In thousands)
Balance, January 1, 2003		45,785		$	46		(1,135	)		$	(341	)		$	368,927			$	(86	)		$	(402,519	)		$	—			$	(33,973	)
Net loss		—		—			—			—				—				—				(9,687		)		—				(9,687		)
Translation adjustment		—		—			—			—				—				—				—				—				—
Total comprehensive loss																														(9,687		)
Exercise of common stock options.		128		—			—			—				91				—				—				—				91
Fair value of warrants issued on bond exchange		—		—			—			—				1,375				—				—				—				1,375
Amortization of deferred compensation		—		—			—			—				—				86				—				—				86
Balance, December 31, 2003		45,913		46			(1,135	)		(341		)		370,393				—				(412,206		)		—				(42,108		)
Net loss		—		—			—			—				—				—				(17,536		)		—				(17,536		)
Unrealized loss on available-for-sale short-term investments		—		—			—			—				—				—				—				(12		)		(12		)
Translation adjustment		—		—			—			—				—				—				—				—				—
Total comprehensive loss																														(17,548		)
Gross proceeds from sale of common stock in private placement		15,000		15			—			—				31,485				—				—				—				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		110		0			—			—				175				—				—				—				175
Exercise of common stock options		508		0			—			—				455				—				—				—				455
Exercise of warrants		2,522		3			—			—				1,459				—				—				—				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		725		1			—			—				1,340				—				—				—				1,341
Balance, December 31, 2004		64,778		65			(1,135	)		(341		)		406,137				—				(429,742		)		(12		)		(23,893		)
Net loss		—		—			—			—				—				—				(1,676		)		—				(1,676		)
Unrealized loss on available-for-sale short-term investments		—		—			—			—				—				—				—				(5		)		(5		)
Translation adjustment		—		—			—			—				—				—				—				—				—		)
Total comprehensive loss																														(1,681		)
Exercise of common stock options.		238		0			—			—				244				—				—				—				244
Exercise of warrants		2,215		2			—			—				2,420				—				—				—				2,422
Convertible Subordinated Notes due June 2009 converted to common stock		19,429		19			—			—				35,925				—				—				—				35,944
Secured Convertible Notes due June 2007 converted to common stock		15,676		16			—			—				28,984				—				—				—				29,000
Common shares issued as payment of debt conversion premium.		—		—			44			115				—				—				—				—				115
Repurchases of common stock		—		—			(983	)		(1,865		)		—				—				—				—				(1,865		)
Balance, December 31, 2005		102,336		$	102		(2,074	)		$	(2,091	)		$	473,710			$	—			$	(431,418	)		$	(17	)		$	40,286

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

iBasis, Inc.
Consolidated Statements of Cash Flows

	Years ended December 31,
	2005			2004			2003
	(In thousands)
Cash flows from operating activities:
Net loss	$	(1,676	)	$	(17,536	)	$	(9,687	)
Income from discontinued operations	—			(1,861		)	(1,251		)
Loss from continuing operations	(1,676		)	(19,397		)	(10,938		)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
Gain on bond repurchases and exchanges	—			—			(16,615		)
Restructuring costs	218			165			—
Depreciation and amortization	6,712			10,345			20,065
Amortization of deferred debt financing costs	177			149			333
Amortization of discount on short-term marketable securities	(45		)	—			—
Non-cash debt conversion premium	115			—			—
Amortization of deferred compensation	—			—			86
Loss on long-term non-marketable security	—			5,000			—
Fair value of warrant issued in debt refinancing	—			2,140			—
Allowance for doubtful accounts	850			250			800
Recovery of previously reserved receivable balance	—			—			(4,269		)
Changes in current assets and liabilities:
Accounts receivable, net	(14,358		)	(12,616		)	2,556
Prepaid expenses and other current assets	(256		)	124			1,330
Other assets	37			345			535
Accounts payable	3,443			4,438			6,760
Deferred revenue	3,214			5,886			417
Accrued expenses	13,935			(2,369		)	(4,718		)
Other long-term liabilities	(216		)	(1,617		)	481
Net cash provided by (used in) continuing operating activities	12,150			(7,157		)	(3,177		)
Cash flows from investing activities:
Purchases of property and equipment	(3,441		)	(3,266		)	(4,452		)
Purchases of available-for-sale short-term marketable investments	(28,234		)	(18,534		)	—
Maturities of available-for-sale short-term marketable investments	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			—
Payment associated with the sale of Speech Solutions businesses	—			—			(736		)
Net cash used in investing activities	(2,440		)	(18,666		)	(5,188		)
Cash flows from financing activities:
Redemption of 5¾% 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			9,200
Repayments of bank borrowings	—			(6,900		)	(9,200		)
Payments of principal on capital lease obligations	(1,206		)	(2,167		)	(5,838		)
Debt conversion premium and transaction costs	(1,860		)	—			—
Transaction costs of debt refinancing and exchange of debt	—			(1,984		)	(935		)
Repurchases of common stock	(1,865		)	—			—
Proceeds from exercise of warrants	2,422			1,462			—
Proceeds from exercise of common stock options	244			455			91
Net cash (used in) provided by financing activities	(3,160		)	29,481			(6,682		)
Net increase (decrease) in cash and cash equivalents	6,550			3,658			(15,047		)
Cash and cash equivalents, beginning of year	20,928			17,270			32,317
Cash and cash equivalents, end of year	$	27,478		$	20,928		$	17,270

iBasis, Inc.
Consolidated Statements of Cash Flows (Continued)

Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	2,651	$	7,198	$	5,996
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% 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	$	—
Exchange of 53¤4% Convertible Subordinated Notes for 111¤2% Senior Secured Notes:
Face value of 53¤4% Convertible Subordinated Notes surrendered	$	—	$	—	$	50,350
Face value of 111¤2% Senior Secured Notes issued	$	—	$	—	$	25,175
Future interest payments on 111¤2% Senior Secured Notes	$	—	$	—	$	5,527
Fair value of warrants issued	$	—	$	—	$	1,375
Reduction in deferred financing costs	$	—	$	—	$	723
Equipment acquired under capital lease obligations	$	3,151	$	1,765	$	—
Equipment acquired under operating lease obligations	$	—	$	577	$	—
Escrow and earn-out receivable related to sale of Speech Solutions Business	$	—	$	—	$	1,251

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

iBasis, Inc.
Notes to Consolidated Financial Statements

(1) Business

Business—We are a leading provider of international communications services and a provider of retail prepaid calling services. Our operations consist of our Voice-Over-Internet-Protocol (“VoIP”) trading business (“Trading”), in which we connect buyers and sellers of international telecommunications services, and our retail services business (“Retail”). In the Trading business we receive voice traffic from buyers—originating carriers who are interconnected to our network via VoIP or traditional time division multiplexing (“TDM”) connections, and we route that traffic over the Internet to sellers—local carriers in the destination countries with whom we have established agreements to manage the completion or termination of the call. We use proprietary, patent-pending technology to automate the selection 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 call termination agreements with local service providers in North America, Europe, Asia, the Middle East, Latin America, Africa and Australia. Our Retail business was launched in late 2003, with the introduction of our retail prepaid calling cards which are marketed through distributors primarily to ethnic communities within major metropolitan markets in the U.S. In September 2004, we launched a prepaid calling service, Pingo®, offered directly to consumers through an eCommerce web interface, which we have included in our Retail business segment. Revenues from our Pingo services were not material in the years ended December 31, 2005 or 2004.

(2) Summary of Significant Accounting Policies

Principles of Consolidation—The accompanying consolidated financial statements include the accounts of iBasis, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated on consolidation.

Use of Estimates—The preparation of these financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires us to (i) make judgments, assumptions and estimates that affect the reported amounts of assets, liabilities, revenue and expenses; and (ii) disclose contingent assets and liabilities. We base our accounting estimates on historical experience and other factors that we consider reasonable under the circumstances. Actual results and outcomes may differ from our estimates and assumptions.

Foreign Currency Translation and Transactions—The functional currency of our foreign subsidiaries is the local currency. For the purposes of presenting the consolidated financial statements, the functional currencies of our foreign subsidiaries have been converted into U.S. dollars for balance sheet accounts using the exchange rate in effect at the balance sheet date, and for revenue and expense accounts using an average exchange rate for the respective periods. The gains or losses resulting from such translations were not material since the majority of our business is carried out by our U.S. operations. Transactions in foreign currency are recorded at the original rates of exchange in force at the time the transactions are effected. Exchange differences arising on (i) settlement of transactions and (ii) translation of such transactions, given that no settlement has occurred, are recognized in operations. Translation adjustments, while normally a component of other comprehensive income or loss, were not material in 2005, 2004 and 2003 and were charged or credited to results of operations.

Revenue Recognition—For our Trading services, our revenue transactions are derived from the resale of international minutes of calling time. We recognize revenue in the period the service is provided, net of revenue reserves for potential billing credits. Such disputes can result from disagreements with customers regarding the duration, destination or rates charged for each call. For our Retail services, revenue is

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

deferred upon activation of the cards, or purchase of the calling service, and is recognized as the prepaid calling card balances, or purchased calling services, are reduced based upon minute usage and service charges. Revenue for both our Trading and Retail services is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable and collectibility is reasonably assured.

Net Loss Per Share—Basic and diluted net loss per common share are determined by dividing net loss by the weighted average common shares outstanding during the period. Basic net loss per share and diluted net loss per share are the same for all periods presented, as outstanding common stock options, common shares to be issued upon conversion of the Company’s convertible notes and warrants to purchase common shares are anti-dilutive.

The following have been excluded from the computation of diluted weighted average common shares for the periods presented:

	Years Ended December 31,
	2005	2004	2003
	(In thousands)
Options to purchase common shares	6,305	6,569	6,332
Warrants to purchase common shares, issued in connection with the prepayment of the 111¤2% Senior Secured Notes	4,376	5,176	—
Warrants to purchase common shares, issued in connection with the issuance of the 111¤2% Senior Secured Notes	1,266	2,666	4,915
Warrants to purchase common shares issued for investment banking services in connection with the private equity placement	1,718	1,733	—
Common shares to be issued upon conversion of the 63¤4% Convertible Subordinated Notes	—	19,429	—
Common shares to be issued upon conversion of the 8% Secured Convertible Notes	—	15,676	—
Common shares to be issued upon conversion of the 53¤4% Convertible Subordinated Notes	—	10	443
Warrants to purchase common shares issued in connection with bank credit lines	—	—	338
Total common shares excluded	13,665	51,259	12,028

Other Comprehensive Income (Loss)—We report comprehensive income (loss) in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS 130”). For 2005 and 2004, the unrealized loss on our short-term marketable investments, which is recorded as a component of stockholders’ equity, was the only difference between reported net loss and total comprehensive loss. Translation adjustments, while normally a component of other comprehensive income or loss, were not material in 2005, 2004 and 2003 and were charged or credited to results of operations.

Cash and Cash Equivalents—We consider highly liquid investments purchased with an original maturity of 90 days or less at the time of purchase to be cash equivalents. Cash equivalents include money market accounts and commercial paper that are readily convertible into cash.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

Short-term marketable investments—Our investments at December 31, 2005, are classified as available-for-sale and carried at fair value. These investments consist of securities that are readily convertible into cash, including government securities and commercial paper, with original maturities at the date of acquisition ranging from 90 days to one year.

Short-term marketable investments consist of:

	December 31,
	2005							2004
Description of Security	Fair Value			Unrealized Loss				Fair Value			Unrealized Loss
	(In thousands)
Government securities		$	5,402		$	(7	)		$	7,728		$	(7	)
Commercial paper and corporate bonds		11,534			(10		)		10,169			(5		)
Total		$	16,936		$	(17	)		$	17,897		$	(12	)

The net unrealized loss of $17,000 as of December 31, 2005 on our short-term marketable investments in government securities, commercial paper and corporate bonds was caused by interest rate increases. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2005 due to the short-term duration and insignificant severity of the impairment. As of December 31, 2005 and 2004, the unrealized loss on our short-term marketable securities is a component of other comprehensive loss.

Property and Equipment—Property and equipment are stated at cost. Assets under capital leases are recorded at the present value of minimum lease payments. These assets are depreciated over the lesser of the lease term or the estimated useful lives of the assets using the straight-line method. Significant improvements and betterments are capitalized if they extend the useful life of the asset. Routine repairs and maintenance are expensed when incurred.

For assets that have been placed in service, we provide for depreciation and amortization using the straight-line method over the useful life of the asset, as follows:

Asset Classification				Estimated Useful Life
Network equipment				3 years
Equipment under capital lease				Life of lease
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 whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. During the year ended December 31, 2005, we retired approximately $28.1 million of fully depreciated property and equipment. Total depreciation and amortization expense included in the

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

consolidated statements of operations was approximately $6.7 million, $10.3 million, and $20.1 million for the years ended December 31, 2005, 2004 and 2003, respectively.

Deferred Debt Financing Costs—Underwriter discounts and other costs incurred in connection with the issuance of convertible debt were amortized to interest expense using the straight-line method over the term of the debt, which approximated the effective interest method. As a result of our debt conversions to common stock in 2005, remaining unamortized deferred debt financing costs were charged to interest expense.

Investment in Long-Term Non-marketable Security—Our long-term investment in a non-marketable security represents a small equity investment in a privately-held company that was made in 2000 in connection with a round of financing with other third-party investors. As our investment does not permit us to exert significant influence or control over the entity in which we have invested, the recorded amount represents our cost of the investment less any adjustments we make when we determine that an investment’s carrying value is other than temporarily impaired.

The process of assessing whether the equity investment’s net realizable value is less than its carrying cost requires a significant amount of judgment due to the lack of a mature and stable public market for investments of this type. In making this judgment, we carefully consider the investee’s most recent financial results, cash position, recent cash flow data, projected cash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data, the current investing environment, management or ownership changes, and competition. This valuation process is based primarily on information that we request, receive and discuss with the investees’ management on a quarterly basis. Such evaluation is performed 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 has been other than temporarily impaired and, as a result, we recorded a $5.0 million non-cash charge to continuing operations for the quarter ended March 31,2004. This charge represented the full carrying value of this investment. Our decision was based on our evaluation of the company’s current cash position and recent operating results, as well as the perceived inability of the company to obtain additional financing at a level, and in a timely manner, to support its continued operations.

Other Assets—Other assets at December 31, 2005 and 2004 consist primarily of deposits for call termination services and leased facilities.

Research and Development Expenses—We charge research and development expenses to operations as incurred.

Concentration of Credit Risk/Significant Customers—Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash investments, short-term marketable investments and accounts receivable. We place our cash investments with a high quality financial institution and limits the amount of credit exposure. We have established certain credit requirements that our customers must meet before sales credit is extended. We monitor the financial condition of our customers to help ensure collections and to minimize losses.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

We did not have a customer that accounted for 10% or more of net revenue for the year ended December 31, 2005. We had one customer which accounted for 11% of net revenue, each year, for the years ended December 31, 2004 and 2003. We did not have a customer that accounted for 10% or more of accounts receivable at either December 31, 2005 and 2004.

Fair Value of Financial Instruments—Financial instruments consist principally of cash and cash equivalents, short-term marketable investments, accounts receivable, long-term investments in marketable securities, long-term debt and accounts payable. The estimated fair value of these instruments approximates their carrying value.

Stock-Based Compensation—We account for stock-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” using the intrinsic-value method as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 encourages, but does not require, the recognition of compensation expense for the fair value of stock options and other equity instruments issued to employees and non-employee directors.

At December 31, 2005, we had one stock-based employee compensation plan, which is described more fully in Note 11. The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123.

	December 31,
	2005			2004			2003
	(In thousands)
Net loss:
As reported	$	(1,676	)	$	(17,536	)	$	(9,687	)
Deduct: Stock-based employee compensation expense included in reported net loss	—			—			86
Add: Total stock-based employee compensation expense determined under fair value based method for all awards	(1,731		)	(2,737		)	(2,200		)
Pro forma	$	(3,407	)	$	(20,273	)	$	(11,801	)
Basic and diluted net loss per share:
As reported	$	(0.02	)	$	(0.35	)	$	(0.21	)
Pro forma	$	(0.04	)	$	(0.40	)	$	(0.26	)

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

We estimate the fair value of stock-based awards to employees and non-employee directors using the Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because stock-based awards to employees and non-employee directors have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of stock-based awards to employees and non-employee directors. The fair value of stock-based awards to employees and non-employee directors was estimated assuming no expected dividends and the following weighted-average assumptions:

	December 31,
	2005		2004		2003
Risk-free interest rate	4.00	%	3.35	%	3.25	%
Dividend yield	0.0	%	0.0	%	0.0	%
Expected life	5 years		5 years		5 years
Expected volatility	121	%	136	%	143	%

The weighted average fair value of options granted was $2.14, $1.77 and $0.88 per share for the years ended December 31, 2005, 2004 and 2003, respectively. The weighted average remaining contractual life was 7.26 years, 8.17 years and 8.84 years as of December 31, 2005, 2004 and 2003, respectively.

Income Taxes—We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” This statement requires an asset and liability approach to accounting for income taxes based upon the future expected values of the related assets and liabilities. Deferred income taxes are provided for tax and financial reporting basis differences between assets and liabilities at tax rates expected to be in effect when the basis differences reverse. Valuation allowances are provided in situations where recoverability of deferred tax assets is not considered more likely than not.

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and superceded Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). In April 2005, the Securities and Exchange Commission amended the compliance date for adoption of SFAS No. 123R. The new rule extends the required adoption of SFAS No. 123R for companies with calendar fiscal years to the first quarter of 2006. SFAS No. 123R is effective for us beginning in the first quarter of 2006.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(2) Summary of Significant Accounting Policies (Continued)

We expect to adopt SFAS No. 123R using the Statement’s modified prospective application method. Adoption of SFAS No. 123R is expected to increase our stock compensation expense significantly. We are currently in the process of evaluating the impact and implementation of SFAS No. 123R. In addition, SFAS No. 123R requires that the excess of tax benefits related to stock compensation be reported as a financing cash inflow rather than as a reduction of taxes paid in cash from operations.

(3) Business Segment and Geographic Information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-making group is composed of the chief executive officer, members of senior management and the Board of Directors. We have viewed our operations and we manage our business principally as two business segments, Trading and Retail.

Business Segment Information—Beginning in the second quarter of 2004, our retail prepaid calling card services and other enhanced services (“Retail”) became a reportable business segment, in addition to our international wholesale VoIP services (“Trading”). Since we introduced our retail prepaid calling card services, revenue from our Retail services has grown substantially.

Our Trading business consists of international long distance services we provide using VoIP. We offer these services on a wholesale basis through our worldwide network to carriers, telephony resellers and others around the world by operating through various service agreements with local service providers in United States, Europe, Asia, the Middle East, Latin America, Africa and Australia.

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

Our executive management team uses net revenue and gross margin, which is net revenue less data communications and telecommunications costs, as the basis for measuring profit or loss by segment and making decisions on our Trading and Retail businesses. We do not allocate our research and development expenses, selling and marketing expenses, general and administrative expenses, restructuring costs and depreciation and amortization between Trading and Retail.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(3) Business Segment and Geographic Information (Continued)

Operating results, excluding interest income and expense, other income and expense, and refinancing related charges, for our two business segments are as follows:

	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 margin	$	37,216	$	12,117	49,333
Research and development expenses					12,435
Selling and marketing expenses					11,618
General and administrative expenses and restructuring costs					15,421
Depreciation and amortization					6,712
Income from operations					$	3,147

	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 margin	$	32,783	$	5,726	38,509
Research and development expenses					13,803
Selling and marketing expenses					9,205
General and administrative expenses and restructuring costs					12,987
Depreciation and amortization					10,345
Loss from operations					$	(7,831	)

	Year ended December 31, 2003
	Trading		Retail		Total
	(In thousands)
Net revenue	$	172,552	$	5,607	$	178,159
Data communications and telecommunication costs (excluding depreciation and amortization)	148,895		3,958		152,853
Gross margin	$	23,657	$	1,649	25,306
Research and development expenses					13,387
Selling and marketing expenses					7,513
General and administrative expenses					8,174
Depreciation and amortization					20,065
Non-cash stock based compensation					86
Loss from operations					$(23,919		)

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(3) Business Segment and Geographic Information (Continued)

Our executive management team uses accounts receivable as a basis for measuring liquidity and making decisions on our Trading and Retail businesses. We do not allocate any other assets or liabilities between Trading and Retail.

	As of December 31, 2005
	Trading		Retail		Total
	(In thousands)
Segment assets	$	38,574	$	9,067	$	47,641
Non-segment assets					59,167
Total assets					$	106,808

	As of December 31, 2004
	Trading		Retail		Total
	(In thousands)
Segment assets	$	28,541	$	5,592	$	34,133
Non-segment assets					53,643
Total assets					$	87,776

Geographic Information—The following table represents percentage of total revenue derived from each geographic region:

	Year Ended December 31,
	2005			2004			2003
North America		54	%		58	%		57	%
Europe, Middle East and Africa		33			29			16
Asia Pacific		11			11			3
Other		2			2			24
		100	%		100	%		100	%

We did not have any single customer account for 10% of net revenue for the year ended December 31, 2005. We had one customer account for 11% of net revenue, each year, for the years ended December 31, 2004 and 2003. We did not have a customer that accounted for 10% of accounts receivable at December 31, 2005 and 2004.

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

	As of December 31,
Geographic Location	2005		2004
	(In thousands)
North America	$	11,715	$	11,753
Europe	26		67
Asia	13		41
	$	11,754	$	11,861

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(4) Discontinued Operations

Income from discontinued operations. In 2002 we completed the sale of substantially all the assets of our Speech Solutions Business for $18.5 million in cash ($1.5 million of this amount was held in escrow until March 2004). Losses from discontinued operations in 2002 and prior years had been recorded under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets.” In the fourth quarter of 2003, we recognized additional consideration of approximately $1.3 million for an earn-out payment based on the achievement of certain 2003 revenue-based milestones associated with this business. The cash payment associated with the earn-out was $1.1 million and was received in February 2004. In addition, in March 2004, we received the balance of $1.5 million that had been held in escrow from the sale of this business since July 2002. In the third quarter of 2004, we recognized income from discontinued operations of $1.9 million resulting from the expiration of certain contingent obligations.

(5) Accrued Expenses

Accrued expenses at December 31, consist of the following:

	2005		2004
	(In thousands)
Termination fees and circuit costs	$	20,824	$	8,926
Payroll and related costs	665		462
Professional services	513		372
Restructuring costs (current portion)	475		559
Customer deposits	235		250
Interest	—		226
Accrued other	1,767		1,391
Total accrued expenses	$	24,479	$	12,186

(6) Restructuring Costs

During 2002, we announced restructuring plans to better align our organization with our corporate strategy and recorded a charge of to our Statements of Operations in that year in accordance with the criteria set forth in EITF 94-3 and SEC Staff Accounting Bulletin 100. The restructuring included the write-off of property and equipment, contractual obligations relating to vacant certain leased facilities and a reduction in our workforce resulting in employee severance costs.

At December 31, 2005, accrued restructuring costs of $1.4 million consisted of costs accrued for leased facility obligations, net of certain future sublease assumptions. In the years ended December 31, 2005 and 2004, we took an additional charge of $218,000 and $165,000, respectively, as a result of a change in estimates relating to our future sublease assumptions.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(6) Restructuring Costs (Continued)

A summary of accrued restructuring costs is as follows:

	Property and Equipment			Contractual Obligations Relating to Vacant Facilities			Employee Severance Costs			Total
	(In thousands)
Original charge		$	2,427		$	2,794		$	750	$	5,971
Less: write-off of property and equipment		2,427			—			—		2,427
Less: cash payments		—			743			725		1,468
Balance, December 31, 2003		—			2,051			25		2,076
Change in estimates		—			165			—		165
Less: cash payments, net of sublease income		—			525			25		550
Balance, December 31, 2004		—			1,691			—		1,691
Change in estimates		—			218			—		218
Less: cash payments		—			518			—		518
Balance, December 31, 2005		$	—		$	1,391		$	—	$	1,391

At December 31, 2005 and 2004, the current portion of accrued restructuring costs were $475,000 and $559,000 and the long-term portion of accrued restructuring costs were $916,000 and $1,132,000, respectively

(7) Deferred Revenue

A summary of our deferred revenue activity is as follows:

	(In thousands)
Balance at January 1, 2004		$417
Revenue deferred		44,240
Revenue recognized		(38,354		)
Balance at December 31, 2004		6,303
Revenue deferred		76,105
Revenue recognized		(72,891		)
Balance at December 31, 2005		$	9,517

Deferred revenue consists of billings to our distributors for prepaid calling cards and purchases of our Pingo prepaid calling services, for which revenue is recognized when minute usage and service charges occur.

(8) Income Taxes

No provision or benefit for federal or state income taxes has been recorded, as we have incurred net operating losses for all periods presented and it is more likely than not that the tax benefit of such losses will not be realized. As of December 31, 2005, we had net operating loss carryforwards of approximately $313 million, and tax credit carryforwards of approximately $1 million, available to reduce future federal and state income taxes, if any. If not utilized, these carryforwards expire between 2020 and 2025. If substantial changes in our ownership should occur, as defined by Section 382 of the Internal Revenue Code (the “Code”), there could be annual limitations on the amount of carryforwards which can be

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(8) Income Taxes (Continued)

realized in future periods. The Company has completed multiple convertible debt and equity financings and an acquisition since its inception and an ownership change, as defined under the Code, may have occurred.

The approximate income tax effects of temporary differences and carryforwards are as follows:

	December 31,
	2005			2004
	(in thousands)
Net operating loss and tax credit carryforwards	$	123,898		$	97,616
Accruals	1,015			956
Depreciation	—			8,280
Accounts receivable	1,003			1,120
Capital loss carry-forward	2,000			1,700
Total deferred tax assets	127,916			109,672
Valuation allowance	(127,916		)	(109,672		)
	$	—		$	—

The major components of the changes in our temporary differences and carryforwards are as follows:

	2005			2004			2003
	(in thousands)
Net operating loss carryforwards	$	(26,282	)	$	(14,028	)	$	(11,667	)
Deferred tax items	8,038			(189		)	(20,888		)
Valuation allowance	18,244			14,217			32,555
	$	—		$	—		$	—

We have recorded a 100% valuation allowance against the net deferred tax asset as of December 31, 2005 and 2004, as we have determined that it is more likely than not that such assets will not be realized. We had income tax expense of $93,000, $50,000, and $157,000 related to taxes on earnings of our foreign subsidiaries in 2005, 2004 and 2003, respectively.

A reconciliation between the statutory federal income tax rate and our effective tax rate for the years ended December 31, is as follows:

	2005			2004			2003
	(in thousands)
Statutory federal income tax (benefit)	$	(554	)	$	(6,771	)	$	(3,773	)
State taxes, net of federal benefit	(79		)	(967		)	(755		)
Valuation allowance	633			7,738			4,528
Foreign income taxes	93			50			157
Tax expense	$	93		$	50		$	157

On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law. The Act contains a one-time foreign dividend repatriation provision, which provides for a special deduction with respect to certain qualifying dividends from foreign subsidiaries for a limited period. The deduction is subject to a number of limitations and uncertainty remains as to the interpretation of numerous provisions in the Act. We have no plans to repatriate any earnings of our foreign subsidiaries under the foreign dividend repatriation provisions of the Act.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(9) Long-Term Debt

Long-term debt consists of the following as of December 31:

	2005		2004
	(In thousands)
Capital lease obligations	$	3,814	$	1,869
6¾% Convertible Subordinated Notes due June 2009	—		35,944
8% Secured Convertible Notes due June 2007	—		29,000
5¾% Convertible Subordinated Notes due March 2005	—		895
Total	3,814		67,708
Less: Current portion	1,598		1,775
	$	2,216	$	65,933

(a) Convertible Notes

From mid-August 2005 through early September 2005, all of our remaining $32,599,000 of 6¾% Convertible Subordinated Notes due June 2009 were converted to 17.6 million shares of our common stock at the stated conversion price of $1.85 per share. In mid-August 2005, we announced our intention to redeem all of these outstanding notes for cash at the face value of the notes, plus accrued interest, with a planned redemption date of September 6, 2005. Prior to the redemption date, all of the holders elected to convert their notes to common stock at the stated conversion price of $1.85 per share. We were not required to pay any accrued interest upon conversion of these notes.

In July 2005, we negotiated the early conversion of the remaining $19,900,000 of our 8% Secured Convertible Notes due June 2007 into 10.8 million shares of common stock at the stated conversion price of $1.85 per share. We paid a total premium of $1,194,000 in cash to the noteholders to encourage the early conversion of these notes. In addition, transactions costs associated with this early conversion were $0.1 million and consisted primarily of investment banking fees.

In June 2005, we negotiated (i) the early conversion of $9,100,000 of our 8% Secured Convertible Notes due June 2007 into 4.9 million shares of common stock at the stated conversion price of $1.85 per common share and (ii) the early conversion of $2,000,000 of our 6¾% Convertible Subordinated Notes due June 2009 into 1.1 million shares of common stock at the stated conversion price of $1.85 per common share. We paid a total of $661,000 in premiums to the noteholders to encourage the early conversion of these notes, of which $546,000 was paid in cash and the remaining amount was paid in the form of 43,736 shares of the Company’s common stock that had a fair value of $115,000. In addition, $1,150,000 of our 6¾% Convertible Subordinated Notes due June 2009 voluntarily converted into 0.6 million shares of common stock at the conversion price of $1.85 per share. In total, $12,250,000 of notes were converted into 6.6 million shares of common stock.

In the first quarter of 2005, holders of $0.2 million of 6¾% Convertible Subordinated Notes due June 2009 voluntarily converted their notes into 0.1 million shares of common stock at the conversion price of $1.85 per share. In March 2005, we redeemed the remaining $895,000 of our outstanding 5¾% Convertible Subordinated Notes for cash on the maturity date of these notes.

(b) Bank Line of Credit

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(9) Long-Term Debt (Continued)

and is collateralized by substantially all of our assets. Borrowings under the line may also be used for letters of credit and foreign exchange contracts and are no longer on a borrowing formula. The new revolving line of credit requires us to comply with various non-financial and financial covenants, including minimum profitability and liquidity and requires us to maintain a minimum cash balance of $15.0 million with the bank, or be subject to certain additional fees. At December 31, 2005, we had no borrowings under this agreement. Our previous $15.0 million revolving line of credit, which commenced in December 2003, bore interest at the bank’s prime rate plus 1%, matured on January 5, 2005 and was also collateralized by substantially all of our assets. Borrowings under this previous revolving line of credit were on a formula basis and were limited to eligible accounts receivable. At December 31, 2004, we had no borrowings under our previous revolving line of credit. At December 31, 2005 and 2004, we had $2.4 million and $3.0 million in letters of credit outstanding, respectively.

In June 2004, we completed a refinancing of our outstanding debt obligations. As part of the refinancing, we completed an exchange offer, pursuant to which $37.3 million of our 5¾% Convertible Subordinated Notes due March 2005, representing approximately 98% of the total amount outstanding, were tendered for the same principal amount of new 6¾% Convertible Subordinated Notes due June 2009. Approximately $0.9 million of the 5¾% Convertible Subordinated Notes due March 2005 remained outstanding after the exchange offer. Simultaneously with the exchange offer, we prepaid all $25.2 million of our 11½% Senior Secured Notes due January 2005 for cash equal to the principal amount plus accrued but unpaid interest and the issuance of warrants exercisable for an aggregate of 5,176,065 shares of our common stock at $1.85 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 11½% Senior Secured Notes due January 2005. The 6¾% Convertible Subordinated Notes due June 2009 and the 8% Secured Convertible Notes due June 2007 were convertible into shares of common stock at $1.85 per share. During the second half of 2004, holders of $1.3 million of 6¾% Convertible Subordinated Notes due June 2009 voluntarily converted their notes into 0.7 million shares of common stock at the conversion price of $1.85 per share.

(c) Capital Lease Obligations

During 2005 and 2004, we entered into capital lease agreements to finance $3.2 million and $1.8 million in equipment purchases for The iBasis Network, respectively. The capital lease agreements primarily have a term of three years.

Gains on Exchanges and Repurchases of 5¾% Convertible Subordinated Notes—During 2003, we entered into agreements with principal holders of our 5 ¾% Convertible Subordinated Notes which resulted in the retirement of $50.4 million of such notes in exchange for new debt instruments at 50% of the face value of the retired Notes. Under the terms of the agreement, the holders of the retired Notes received $25.2 million of new, 11½% Senior Secured Notes and warrants to purchase 4..9 million shares of our common stock. Each warrant has an initial exercise price of $0.65 per share and is exercisable over a five-year term. The 11½% Senior Secured Notes were scheduled to mature on January 15, 2005 and shared in a second priority lien on our assets and were subordinated to our revolving line of credit with our bank.

In accordance with SFAS No. 15, “Accounting by Debtors and Creditors Regarding Troubled Debt Restructuring,” we recorded a gain on the exchange of debt of approximately $16.6 million during the year ended December 31, 2003. SFAS No. 15 requires that the gain on the exchange be recorded net of the accrual for future interest payments on the 11½% Senior Secured Notes, the fair value of the warrants issued, the reduction of the net book value of the deferred financing costs originally capitalized with the

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(9) Long-Term Debt (Continued)

issuance of our 5¾% Convertible Subordinated Notes and any other fees or costs. The fair value of $1,375,000 of the detachable warrants was estimated utilizing a valuation method similar to the Black-Scholes model. Assumptions utilized within the pricing model included a) a useful life of 5 years; b) volatility of 46%; c) no dividends; and d) a discount rate of 3%. While our future cash flows relating to interest payments will not be affected by the exchange, our future Statement of Operations will show, as required, a reduction of interest expense due to the accrual of the future interest payments on the 11½% Senior Secured Notes within the gain.

The gain recognized in 2003 was calculated as follows:

	(In thousands)
Face value of surrendered 5 ¾% Convertible Subordinated Notes		$	50,350
Less: Face value of issued 11½% Senior Secured Notes		(25,175		)
Future interest payments on 11½% Senior Secured Notes		(5,527		)
Fair value of warrants issued		(1,375		)
Reduction of deferred debt financing costs		(723		)
Professional fees		(935		)
Gain		$	16,615

Scheduled maturities of capital lease obligations as of December 31, 2005 are as follows:

Year	(in thousands)
2006		$	1,866
2007		1,604
2008		795
2009		—
2010		—
Thereafter		—
Total future minimum payments		4,265
Less: Amounts representing interest		451
Present value of minimum repayments		3,814
Less: Current portion		1,598
Long-term portion		$	2,216

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(10) Commitments and Contingencies

Operating Leases We lease our administrative and operating facilities and certain equipment under non-cancelable operating leases, which expire at various dates through 2011. The future approximate minimum lease payments under such operating leases consist of the following:

Year	(in thousands)
2006		$	2,669
2007		2,136
2008		1,834
2009		1,514
2010		629
Thereafter		—
Total future minimum lease payments		$	8,782

Total rent expense included in the consolidated statements of operations was $2,954,000, $3,818,000, and $3,669,000 for the years ended December 31, 2005, 2004, and 2003, respectively.

Litigation—In addition to litigation that we have initiated or responded to in the ordinary course of business, we are currently party to the following potentially material legal proceedings:

Beginning July 11, 2001, we were served with several class action complaints that were filed in the United States District Court for the Southern District of New York against us and several of our officers, directors, and former officers and directors, as well as against the investment banking firms that underwrote our November 10, 1999 initial public offering of common stock and our March 9, 2000 secondary offering of common stock. The complaints were filed on behalf of persons who purchased our common stock during different time periods, all beginning on or after November 10, 1999 and ending on or before December 6, 2000.

The complaints are similar to each other and to hundreds of other complaints filed against other issuers and their underwriters, and allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 primarily based on the assertion that there was undisclosed compensation received by our underwriters in connection with our public offerings and that there were understandings with customers to make purchases in the aftermarket. The plaintiffs have sought an undetermined amount of monetary damages in relation to these claims. On September 4, 2001, the cases against us were consolidated. On October 9, 2002, the individual defendants were dismissed from the litigation by stipulation and without prejudice.

On June 11, 2004, we and the individual defendants, as well as many other issuers named as defendants in the class action proceeding, entered into an agreement-in-principle to settle this matter, and on June 14, 2004, this settlement was presented to the court. The district court granted a preliminary approval of the issuers’ settlement on February 15, 2005, subject to certain modifications to the proposed bar order, to which plaintiffs and issuers agreed. On August 31, 2005, the court issued a preliminary order further approving the modifications to the settlement and certifying the settlement classes. The court appointed Garden City Group as the notice administrator for the settlement and ordered that notice of the settlement be distributed to all settlement class members beginning on November 15, 2005 and completed by January 15, 2006. The deadline for filing objections to the settlement is March 24, 2006, and the fairness hearing has been set for April 26, 2006. Although we believe that we and the individual defendants have meritorious defenses to the claims made in the complaints, in deciding to pursue settlement, we

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(10) Commitments and Contingencies (Continued)

considered, among other factors, the substantial costs and the diversion of our management’s attention and resources that would be required by litigation.

Pursuant to the terms of the proposed settlement, in exchange for a termination and release of all claims against us and the individual defendants and certain protections against third-party claims, we will assign to the plaintiffs certain claims we may have as an issuer against the underwriters, and our insurance carriers, along with the insurance carriers of the other issuers, will ensure a floor of $1 billion for any underwriter-plaintiff settlement. Although the financial effect of the settlement on us will not be material, our insurance carriers’ exposure in this connection will range from zero to a few hundred thousand dollars, and will be reduced proportionately by any amounts recovered by plaintiffs directly from the underwriters.

We cannot assure you that the settlement which has been finalized will be accepted by the court, or that we will be fully covered by collateral or related claims from underwriters, and that we would be successful in resulting litigation. In addition, even though we have insurance and contractual protections that could cover some or all of the potential damages in these cases, or amounts that we might have to pay in settlement of these cases, an adverse resolution of one or more of these lawsuits could have a material adverse affect on our financial position and results of operations in the period in which the lawsuits are resolved. We are not presently able to estimate potential losses, if any, related to the lawsuits.

We are also party to suits for collection, related commercial disputes, claims by former employees, claims related to certain taxes, claims from carriers and foreign service partners over reconciliation of payments for circuits, Internet bandwidth and/or access to the public switched telephone network, and claims from estates of bankrupt companies alleging that we received preferential payments from such companies prior to their bankruptcy filings. Our employees have also been named in proceedings arising out of business activities in foreign countries. We intend to prosecute vigorously claims that we have brought and employ all available defenses in contesting claims against us, or our employees. Nevertheless, in deciding whether to pursue settlement, we will consider, among other factors, the substantial costs and the diversion of management’s attention and resources that would be required in litigation. In light of such costs, we have settled various and in some cases similar matters on what we believe have been favorable terms which did 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 adverse affect on our business.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(11) Stockholders’ Equity (Deficit)

(a) Authorized Capital Stock We have authorized for issuance 170,000,000 shares of common stock, $0.001 par value per share (“Common Stock”) and 15,000,000 shares of preferred stock, $0.001 par value per share (“Preferred Stock”).

(b) Reverse Stock Split In February 2006, we announced our intention to seek shareholder approval to authorize our Board of Directors to implement a reverse stock split based on a range of possible exchange ratios.

(c) Treasury Stock In October 2005, we announced a program to repurchase up to $5.0 million of our common stock. The stock repurchases under this program may be made over the next year through open market and privately negotiated transactions at times and in such amounts as we deem appropriate. The stock repurchase program may be limited or terminated at any point in time. During the fourth quarter of 2005, we repurchased 983,050 shares of Common Stock at a total cost of $1,865,000. In February 2006, we expanded our stock repurchase program to allow for the repurchase of up to a total of $15.0 million. Through March 10, 2006, we had repurchased an additional 1,131,300 shares of Common Stock in 2006 at a total cost of $2,268,000, leaving $10,867,000 remaining for repurchases under this program.

In addition, during 2005, we reissued 43,736 shares from our treasury stock as partial payment of our debt conversion premium.

(d) Stock Incentive Plan Our 1997 Stock Incentive Plan (the “Plan”) provides for the granting of restricted stock awards and incentive stock options (“ISOs”) and nonqualified options to purchase shares of Common Stock to key employees, directors and consultants. Under the terms of the Plan, the exercise price of options granted shall be determined by the Board of Directors and for ISOs shall not be less than fair market value of our Common Stock on the date of grant. Options vest quarterly in equal installments over two to four years, provided that no options shall vest during the employees’ first year of employment. The expiration date of each stock option shall be determined by the Board of Directors, but shall not exceed 10 years from the date of grant. At our May 2005 annual meeting, our stockholders approved an additional 5.0 million shares of Common Stock to be granted under the Plan.

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(11) Stockholders’ Equity (Deficit) (Continued)

The following table summarizes the option activity for the years ended December 31, 2005, 2004 and 2003:

	Number of Shares			Exercise Price Per Share		Weighted Average Exercise Price
	(In thousands)
Outstanding, January 1, 2003		2,257		$	0.25-$28.75		$	2.02
Granted		4,710		0.38-1.54			1.02
Exercised		(128	)	0.86-1.57			1.39
Forfeited		(507	)	0.25-14.81			1.86
Outstanding, December 31, 2003		6,332		0.25-28.75			1.35
Granted		1,327		1.17-2.42			1.87
Exercised		(508	)	0.25-2.16			0.90
Forfeited		(582	)	0.25-14.81			1.23
Outstanding, December 31, 2004		6,569		0.25-28.75			1.51
Granted		298		1.91-2.57			2.27
Exercised		(238	)	0.37-2.16			1.03
Forfeited		(324	)	0.38-14.82			2.02
Outstanding, December 31, 2005		6,305		$	0.25-$28.75		$	1.54
Exercisable, December 31, 2005		4,279		$	0.25-$28.75		$	1.59
Exercisable, December 31, 2004		3,269		$	0.25-$28.75		$	1.73
Exercisable, December 31, 2003		2,216		$	0.25-$28.75		$	1.90

The following table summarizes information relating to currently outstanding and exercisable stock options as of December 31, 2005:

			Outstanding					Exercisable
Range of Exercise Prices	Outstanding Options		Weighted Average Remaining Contractual Life (in Years)		Weighted Average Exercise Price			Options Outstanding		Weighted Average Exercise Price
	(In thousands)							(in thousands)
$0.25-$0.69		211		6.02		$	0.56		193		$	0.57
0.72		730		5.87		$	0.72		730		$	0.72
0.88-1.10		2,272		7.26		$	0.92		1,288		$	0.93
1.17-1.88		2,271		8.01		$	1.50		1,555		$	1.36
2.12-3.10		508		8.33		$	2.42		200		$	2.58
3.71-5.00		220		4.13		$	4.55		220		$	4.55
11.00-13.50		47		4.37		$	13.39		47		$	13.39
$14.81-$28.75		46		4.42		$	15.29		46		$	15.29
		6,305		7.26		$	1.54		4,279		$	1.59

At December 31, 2005, options to purchase 5.4 million shares of Common Stock were available for future grants under the Plan.

(e) Stock Option Exchange Program In December 2002 we announced an offer to exchange outstanding employee stock options in return for new stock options to be granted by us. In exchange for existing options, each option holder received a commitment to receive new options to be issued exercisable for the

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(11) Stockholders’ Equity (Deficit) (Continued)

same number of shares of common stock tendered by the option holder and accepted for exchange. A total of 1,786,950 options were accepted for exchange under the exchange offers and, accordingly, were canceled in 2002. The new option grants were granted in the second quarter of 2003 at $1.24 per share, more than six months and one day from the date on which each exchange offer terminated and vest quarterly over a two-year period.

(f) Warrants As described in Note 9, we issued 5,176,065 warrant shares in connection with our debt refinancing in June 2004 (“2004 Warrant”). The 2004 Warrant shares were issued to the holders of our 11½% Senior Secured Notes for the right to prepay the notes. Each 2004 Warrant share is exercisable into our common stock on a one-to-one basis at an exercise price of $1.85 per share and is exercisable over a five-year term. The fair value of $2.1 million of the 2004 Warrant was charged to results of operations as additional interest associated with our debt refinancing.

In 2003, we issued 4,915,416 warrant shares in connection with the exchange of our 5¾% Convertible Subordinated Notes for the 11½% Senior Secured Notes (“2003 Warrant”). Each 2003 Warrant share is exercisable into our common stock on a one-to-one basis at an exercise price of $0.65 per warrant share and are exercisable over a five-year term. The warrant had a fair value of $1.4 million and was charged to the gain on the debt exchanges in 2003. In connection with our private equity placement in September 2004, we issued a warrant for 1,732,500 shares in partial payment of investment banking services. This warrant has an exercise price of $2.10 per share, is exercisable 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 a non-cash transaction cost of the private equity placement. During the year ended December 31, 2005, 2004 Warrants totaling 800,000 shares were exercised for $1.5 million in cash; 2003 Warrants totaling 1,400,000 shares were exercised for $0.9 million in cash and warrants totaling 15,000 shares issued for investment banking services were exercised for $32,000 in cash. During the year ended December 31, 2004, 2003 Warrants totaling 2,249,316 shares were exercised for $1.5 million in cash.

In December 2002, in conjunction with the initiation of our bank credit lines, we issued a warrant to the bank for the purchase of 337,500 shares of our common stock at an exercise price of $0.337 per share. In 2004, the bank exercised its warrant in full on a net issue basis, and received 272,876 shares of our common stock. As a result of the bank exercising its warrant on a net issue basis, no cash was received by us.

At December 31, 2005 and 2004, outstanding warrants were:

	2005	2004
	(In thousands)
2004 Warrant	4,376	5,176
2003 Warrant	1,266	2,666
Warrant issued for investment banking services	1,718	1,733
Total warrants outstanding	7,360	9,575

iBasis, Inc.
Notes to Consolidated Financial Statements (Continued)

(12) Valuation and Qualifying Accounts

The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the account receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. 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)
2003		$	7,833		800		(1,236	)		(4,269	)		$	3,128
2004		$	3,128		250		13			—			$	3,391
2005		$	3,391		850		(1,734	)		—			$	2,507

(13) Summary of Quarterly Information (Unaudited)

Quarterly financial information for 2005 and 2004 is as follows:

2005	First Quarter		Second Quarter(1)				Third Quarter(2)				Fourth Quarter		Total Year
	(In thousands, except per share amounts)
Net revenue	$	88,672		$	94,581			$	94,644		$	107,588	$	385,485
Total costs and operating expenses	87,193			93,338				95,002			106,805		382,338
Income (loss) from operations	1,479			1,243				(358		)	783		3,147
Net (loss) income	$	190		$	(767	)		$	(1,720	)	$	621	$	(1,676	)
Net income (loss) per share:
Basic	$	0.00		$	(0.01	)		$	(0.02	)	$	0.01	$	(0.02	)
Diluted	$	0.00		$	(0.01	)		$	(0.02	)	$	0.01	$	(0.02	)

2004	First Quarter(3)				Second Quarter(4)				Third Quarter(5)				Fourth Quarter			Total Year
	(In thousands, except per share amounts)
Net revenue		$	57,008			$	61,175			$	70,359		$	75,136		$	263,678
Total costs and operating expenses		60,791				63,687				71,773			75,258			271,509
Loss from operations		(3,783		)		(2,512		)		(1,414		)	(122		)	(7,831		)
Loss from continuing operations		(9,342		)		(5,913		)		(2,896		)	(1,246		)	(19,397		)
Income from discontinued operations		—				—				1,861			—			1,861
Net loss		$	(9,342	)		$	(5,913	)		$	(1,035	)	$	(1,246	)	$	(17,536	)
Basic and diluted net loss per share:
Loss from continuing operations		$	(0.21	)		$	(0.13	)		$	(0.06	)	$	(0.02	)	$	(0.38	)
Income from discontinued operations		—				—				0.04			—			0.03
Net loss		$	(0.21	)		$	(0.13	)		$	(0.02	)	$	(0.02	)	$	(0.35	)

(1) Net loss includes $0.7 million in debt conversion premiums and transaction costs

(2) Net loss includes $1.3 million in debt conversion premiums and transactions costs

(3) Loss from continuing operations includes $5.0 million charge for loss on long-term non-marketable security.

(4) Loss from continuing operations includes $2.4 million in debt refinancing related charges

(5) Loss from continuing operations includes $0.2 million in debt refinancing related charges

PART IV

Item 15. Exhibits, Financial Statements and Schedules

(A) List of Documents Filed as a Part of This Annual Report:

(1) Financial Statements:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Stockholders’ Equity (Deficit)

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

(2) Index to Financial Statements Schedules: All financial statement schedules have been omitted because the required information is included in our consolidated financial statements, or the related notes, or is not applicable.

(3) Index to Exhibits:

Exhibit Number		Description
	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)).
	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)).
	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 30, 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 Amendment No. 1 on Form S-1 (file no. 33-119796), filed November 22, 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	Offer Letter between the Registrant and Timothy P. Enright, dated as of December 13, 2005, and Employment Agreement dated December 19, 2005.
	10.76	2006 Executive Officer Bonus Plan.
	16.1	Amended letter of Arthur Andersen LLP regarding change in certifying accountant (incorporated by reference from Exhibit 16.1 to the Registrant’s Current Report on Form 8-K dated May 20, 2002 (file no .000-27127)).
	21.1	Significant Subsidiaries of the Registrant.
	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	Offer Letter between the Registrant and Timothy P. Enright, dated as of December 13, 2005, and Employment Agreement dated December 19, 2005.
	10.76	2006 Executive Officer Compensation Plan.
	23.1	Consent of Independent Registered Public Accounting Firm.

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

Location	Square Footage	Expiration of Lease	Facility Use
Burlington, MA	44,265	April 2010	Headquarters and global network operations center
New York, NY	11,654	Various, 2008-2010	Internet Central Office
Miami, FL	10,500	February 2010	Vacant
Los Angeles, CA	3,156	April 2008	Internet Central Office

	High		Low
Fiscal 2005:
Fourth Quarter	$	2.75	$	1.76
Third Quarter	3.42		2.40
Second Quarter	2.72		2.08
First Quarter	2.48		1.95
Fiscal 2004:
Fourth Quarter	$	2.78	$	2.27
Third Quarter	2.39		1.68
Second Quarter	1.95		1.17
First Quarter	1.80		1.44

Period	Total Shares Purchased		Average Price Paid per Share
October 1, 2005—October 31, 2005		—		—
November 1, 2005—November 30, 2005		86,900		$	1.89
December 1, 2005—December 31, 2005		896,150		1.86
Total		983,050		$	1.87

	iBASIS, INC.
	By:	/s/ OFER GNEEZY
		Ofer Gneezy
		President and Chief Executive Officer
March 15, 2006

	Table of Contents	Page
	PART I
Item 1.	Business	3
Item 1A	Risk Factors	13
Item 2.	Properties	24
Item 3.	Legal Proceedings	24
	PART II
Item 5.	Market for the Registrant’s Common Equity and Related Stockholder Matters, and Issuer Purchases of Securities	26
Item 6.	Selected Financial Data	27
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 8.	Financial Statements and Supplementary Data	41
Item 9A.	Controls and Procedures	69
Item 9B.	Other Information	71
	PART III
Item 10.	Directors and Executive Officers of the Registrant	71
Item 11.	Executive Compensation	71
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	71
Item 13.	Certain Relationships and Related Transactions	71
Item 14.	Principal Accountant Fees and Services	71
	PART IV
Item 15.	Exhibits and Financial Statement Schedules	72
Signatures		75

	Page
Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm		42
Consolidated Balance Sheets as of December 31, 2005 and 2004		43
Consolidated Statements of Operations for the Three Years Ended December 31, 2005		44
Consolidated Statements of Stockholders’ Equity (Deficit) for the Three Years Ended December 31, 2005		45
Consolidated Statements of Cash Flows for the Three Years Ended December 31, 2005		46
Notes to Consolidated Financial Statements		48

	Name		Title		Date
/s/ OFER GNEEZY		President and Chief Executive Officer and Director		March 15, 2006
Ofer Gneezy		(Principal Executive Officer)
/s/ GORDON J. VANDERBRUG		Executive Vice President and Director		March 15, 2006
Gordon J. VanderBrug
/s/ RICHARD G. TENNANT		Senior Vice President, Finance and Chief Financial		March 15, 2006
Richard G. Tennant		Officer (Principal Financial and Accounting Officer)
/s/ ROBERT H. BRUMLEY		Director		March 15, 2006
Robert H. Brumley
/s/ CHARLES N. CORFIELD		Director		March 15, 2006
Charles N. Corfield
/s/ W. FRANK KING		Director		March 15, 2006
W. Frank King
/s/ DAVID LEE		Director		March 15, 2006
David Lee
/s/ CHARLES M. SKIBO		Director		March 15, 2006
Charles M. Skibo