SecProbe.io

CORRESP
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Prepared and filed by St Ives Burrups

[Net2Phone Letterhead]

March 30, 2005

VIA TELECOPIER AND ELECTRONIC TRANSMISSION

Larry M. Spirgel

Assistant Director

United States Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549-0303

Mail Stop 0407

  Re:

  Net2Phone, Inc.

  Form 10-K for the fiscal year ended July 31, 2004

  Filed October 14, 2004

Form 10-Q for the quarter ended October 31, 2004

File No. 0-26763

Dear Mr. Spirgel:

We
    are responding to what we believe is the one remaining open issue from your
    letter dated December 15, 2004 (the “Comment Letter”) and our
    letters to you in response dated January 14, 2005 (the “January Response
    Letter”) and March 16, 2005 and several follow-up telephone calls,
    relating to the filings referenced above (the “Filings”).  For
    your convenience, we have repeated the Staff’s comments below prior
    to our responses.

Form 10-K for the fiscal year ended July 31, 2004

Note 2 – Summary of Significant Accounting Policies

     Revenue Recognition

6.

We note that you recognize revenue from pre-payments for services after you conduct evaluations of outstanding, remaining pre-payment balances and determine, based on historical data, that such balances are not likely to be utilized.  Please clarify the nature of these services and tell us the terms of the agreement.  Tell us how you determine that it is appropriate to recognize revenue before you have no further obligations with respect to the pre-paid services.  Also, describe for us the amount and nature of the historical transactions which you use to support your accounting policy.

Over
    the ten-year history of Net2Phone, we have offered a wide variety of products
    and services to our consumer and enterprise customers. These products and
    services are designed around our Voice over Internet Protocol, or VoIP, technology,
    which transmits digital voice communications over managed data networks and
    the Internet. Our prepaid products and services are primarily based on a
    relatively simple business model. Consumers and resellers buy accounts that
    contain a certain number of telephony minutes, or are established at a dollar
    (or other currency) value. We then charge those accounts for telephone call
    activity. In addition, many of our products and services have monthly or
    bi-weekly service fees associated with them, and, over a period of time,
    these fees result in the depletion of the prepaid balances remaining in accounts
    established with our consumers or resellers. In addition, many accounts are
    subject to expiration provisions that deplete remaining balances after an
    established period of non-use or other period of time. We reduce deferred
    revenue and record revenue to reflect call usage, service charges and the
    expiration of account balances, if any.

Net2Phone’s operating corporate
    structure consists primarily of two wholly owned operating subsidiaries,
    Net2Phone Global Services and Net2Phone Cable Telephony. This response will
    focus on products and services offered by our Net2Phone Global Services subsidiary,
    as the deferred revenue liability associated with our Net2Phone Cable Telephony
    subsidiary represents less than 10% of our overall deferred revenue liability
    and is currently calculated based upon advance payments of subscriber activation
    fees, which are in turn based on customer contracted commitment levels. These
    fees are collected and revenue deferred and recognized over the remaining
    life of the agreement with the cable operator.

Net2Phone Global Services’ has
    three divisions: International Communications Services (“ICS”),
    U.S. Consumer and Global Carrier. Our ICS and U.S. Consumer divisions offer
    prepaid products and services, and customers establish accounts and fund
    these accounts with prepayments, which we initially record as deferred revenue.
    Our Global Carrier division sells wholesale minutes through our VoIP network
    to other telecommunications providers on a postpaid basis; thus, its activities
    do not impact our deferred revenue liability. Therefore, this response will
    focus on the prepaid products and services offered by our ICS and U.S. Consumer
    division.

International Communication Services

ICS’s major line of business
    is selling retail and wholesale minutes to overseas resellers, who then sell
    the minutes directly to end-users. Since approximately two years ago, all
    new reseller accounts are established with expiration settings. The terms
    and conditions of expiration settings vary among resellers, but generally
    expiration is based on a certain number of days from the first billable call.
    If an account has not had a first billable call, the balance will remain
    in the account as governed by the terms of the commercial relationship between
    the parties. To date, ICS has very few, if any, service fees associated with
    reseller accounts.

It
    is important to note that there are some legacy accounts in our system which
    do not have expiration dates or service fees associated with them based on
    the original reseller agreement. In some cases, we have established and applied
    expiration periods to these legacy accounts. For example, we have set a 180-day
    expiration period on legacy reseller accounts, where we did not have a formal
    expiration period initially established with the reseller, and informed the
    reseller accordingly.

2

Our
    ICS division also offers our VoiceLineSM service to international
    resellers. VoiceLine allows high-speed data providers to offer their subscribers
    residential broadband telephony solutions. VoiceLine includes the sale of
    hardware and a variety of prepaid minute plans, but the primarily business
    model is based on a flat monthly fee for unlimited calling. VoiceLine is not
    yet a material contributor to revenue or deferred revenue.

U.S. Consumer Division

Our
    U.S. Consumer Division offers what we call our “PC-to-Phone” service,
    our VoiceLine service, and our rechargeable calling card accounts direct to
    consumers around the world but primarily in the United States. Each of these
    services is described below:

•

PC-to-Phone – This was our flagship product, which we now provide to consumers globally through our web site.  Our PC-to-Phone service facilitates phone calls from personal computers.  Most PC-to-Phone accounts expire after 90 days of inactivity according to the terms and conditions agreed to by the consumer when they open their account. However, there are some exceptions that don’t follow the standard expiration and monthly service charge policy due to cross product bundling and various promotional efforts

•

VoiceLine – We began to market a new version of our residential broadband telephony service, under the brand name VoiceLine, directly to consumers from the Net2Phone website in April 2004.  VoiceLine is not yet a material contributor to revenue or deferred revenue.

•

Calling Cards/Rechargeable Accounts – We provide
domestic VoIP minutes for consumers through the sale of rechargeable prepaid
calling cards and virtual accounts. We discontinued our domestic disposable calling
card business during the second quarter of fiscal 2004, when we reached a settlement
with Union Telecard Alliance (“UTA”), an affiliate of IDT Corporation,
our controlling shareholder. We sell rechargeable accounts direct to U.S. consumers
primarily through products such as Penny Talk and Net2Phone Direct through our
web site. We categorize these products in our management reporting as “Phone-to-Phone” as
distinguished from PC-to-Phone. The majority of rechargeable calling card accounts
include a monthly service charge that removes a certain dollar amount from their
prepaid balance each month, which is recorded as revenue.

As background to our response, we
    have supplementally provided the SEC with a table indicating the percentage
    of revenue derived from the above referenced products during the past three
    fiscal years.

3

At the inception of our company,
    we created an operating platform to enable our customers to establish accounts
    and place telephone calls. This database includes millions of accounts and
    balances. Until the most recent 18-24 months, very few, if any, of Net2Phone’s
    products stipulated expiration terms. Therefore, many of these millions of
    accounts and balances have been inactive for many years and have never been
    removed from the database. However, since this database is not a financial
    sub-ledger to the deferred revenue liability account, but rather an operating
    platform, the balances left on it are not indicative of our true liability
    to provide services to prepaid customers. Balances remaining in inactive
    accounts cannot be relied upon as indicative of a liability because of various
    transactions with those customers that have been recorded through the general
    ledger but have not been reflected in the database. In addition, other characteristics
    of the database are not indicative of a liability to provide services. For
    instance, the database is populated with balances relating to postpaid customers
    so that those customers can place telephone calls through the platform even
    though Net2Phone has no deferred liability associated with those accounts.
    At the end of a monthly billing cycle those accounts are sent a bill for
    their telephone calling activity but that bill and the payment of that bill
    are not reflected in the database.

Therefore, a process is in place
    to evaluate the adequacy of our deferred revenue liability based on a monthly
    analysis of the operating database through which we identify balances that
    are true liabilities and compare this relevant information to the balance
    reflected in our deferred revenue account on the general ledger. If the balance
    on the general ledger is different from the liability identified through analysis
    of the operating database, an adjustment is recorded in the deferred revenue
    liability account.

The first step in the monthly analysis
    is to classify account balances as active or inactive. If there was usage
    in or payments made to an account within the last 90 or 120 days (depending
    on the product) it is classified as active. The 90 day and 120 day periods
    were determined by calculating the likelihood that accounts that were inactive
    for various periods would generate any revenue from call activity. These
    two periods were selected based upon analyses of subsequent quarters to determine
    whether significant call activity was generated by accounts that had been
    classified in the prior period as inactive. Overall, we determined that only
    2% of monthly prepaid call activity revenue is generated by accounts that
    had previously been categorized as inactive.

Prior to the current reassessment
    of this process, which was concluded as of January 31, 2005, the active accounts
    in one period were then analyzed in subsequent periods to determine whether
    subsequent activity was nil (no calls) or minimal (1-4 calls). The percentage
    of balances related to subsequent inactivity would then be deducted from
    gross active balances to arrive at a net active balance that would be compared
    to the deferred revenue liability to determine whether an adjustment of the
    general ledger balance was required.

Beginning as of January 31, 2005,
    pursuant to an initiative to further refine the control procedures in place
    to evaluate the adequacy of our deferred revenue liability, we began sorting
    all accounts for both our ICS and U.S. Consumer Divisions into three categories; “Will
    Deplete”, “May Deplete”, and “Won’t Deplete”.
    Accounts directed to the Will Deplete category are accounts that either (i)
    have an expiration setting that is active, if the expiration setting is based
    strictly on a set period of inactivity or, (ii) if expiration is dependent
    on the account having placed a first billable call, a first billable call
    has been placed, or (iii) have a service charge that will continue to deplete
    the account until there is a zero balance. Accounts directed to the May Deplete
    category are those accounts which are not charged a service fee and have
    an expiration setting that is not yet active, for instance if the expiration
    setting is dependent on the account placing a first billable call and a first
    billable call has not yet been placed. If these accounts never place a first
    call, the funds will remain in the account until such time as we terminate
    or modify the commercial relationship governing the accounts. Lastly, all
    accounts directed to the Won’t Deplete category are inactive accounts
    that do not have an expiration setting nor do they have any service charges
    applied against them. These are generally legacy accounts that pre-date our
    procedures that require establishment of service fees or expiration dates
    on our products and services.

4

Effective January 31, 2005, all account
    balances categorized as Will Deplete are included in our deferred revenue
    account. Minimal (1-4 calls) subsequent call activity is no longer considered
    as part of the analysis, so we no longer deduct a percentage from gross active
    balances relating to active accounts from prior periods that we note only
    conduct minimal calls in future periods. In addition, we now only deduct
    a percentage from Won’t Deplete gross active balances relating to active
    accounts from prior periods that we note conduct no calls in the subsequent
    period. However, in a related sense, for the period ended January 31, 2005,
    Net2Phone determined that since previously inactive accounts, which would
have otherwise been excluded from our deferred revenue balance, have historically
    generated about 2% of call activity, such amount should be added to the deferred
    revenue balance.

Also effective January 31, 2005,
    we include reseller balances in our deferred revenue account that have not
    been active in the prior 120-day period because, as commercial counterparties,
    we assume that most resellers would seek to realize value from their prepaid
    investments by selling their paid balances to end-users. We do, however,
    exclude certain inactive reseller balances if Net2Phone’s relationship
    with a reseller has been terminated and no funds are deemed owed to the reseller
    based on discussions, settlements, and/or restrictions in place preventing
    access to those balances.

Based on the guidelines set forth
    in Concepts Statement 5, paragraph 83(b) revenue should only be recognized
    when it is realized or realizable and earned. In making this determination,
    Net2Phone recognizes revenue in accordance with SAB 104, in which the SEC
    staff believes that revenue generally is realized or realizable and earned
    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. Net2Phone currently recognizes revenue on its rechargeable calling
    cards based on actual usage, as service charges are levied and upon card
    expiration. Accordingly, the Company recognizes revenue when each of the
    criteria in SAB 104 is met. Furthermore, we expanded our revenue recognition
    policy to refer to our evaluation of outstanding, remaining prepaid balances and
    to more precisely reflect the revenue related characteristics of our current
    products.

6

During
    our refinement