-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RTo4WF5NOz8BTdJvQGjOlpRodtLXos0PSJ4QBfSo3/nsUtxq/DRUpWVUtgUqu7Io vzh6ej9bSsN4Jkx3L5x1rQ== 0000950130-99-004314.txt : 19990729 0000950130-99-004314.hdr.sgml : 19990729 ACCESSION NUMBER: 0000950130-99-004314 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 19990728 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NET2PHONE INC CENTRAL INDEX KEY: 0001086472 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 223559037 STATE OF INCORPORATION: DE FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-78713 FILM NUMBER: 99672041 BUSINESS ADDRESS: STREET 1: 17 MAIN STREET CITY: HACKENSACK STATE: NJ ZIP: 07601 BUSINESS PHONE: 2019282990 MAIL ADDRESS: STREET 1: 17 MAIN STREET CITY: HACKENSACK STATE: NJ ZIP: 07601 S-1/A 1 AMENDMENT NO. 5 TO FORM S-1 As filed with the Securities and Exchange Commission on July 28, 1999 Registration No. 333-78713 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- AMENDMENT NO. 5 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------- Net2Phone, Inc. (Exact name of registrant as specified in its charter)
Delaware 4813 22-3559037 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification No.)
171 Main Street Hackensack, New Jersey 07601 (201) 907-5304 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Howard S. Balter Chief Executive Officer Net2Phone, Inc. 171 Main Street Hackensack, New Jersey 07601 (201) 907-5304 (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------- Copies to: Ira A. Greenstein, Esq. Alexander D. Lynch, Esq. Morrison & Foerster LLP Kenneth R. McVay, Esq. 1290 Avenue of the Americas Brobeck, Phleger & Harrison LLP New York, New York 10104 1633 Broadway, 47th Floor (212) 468-8000 New York, New York 10019 (212) 581-1600
-------------- Approximate date of commencement of the proposed sale to the public: As soon as practicable after this registration statement becomes effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [_] -------------- We hereby amend the registration statement on such date or dates as may be necessary to delay its effective date until we shall file a further amendment which specifically states that the registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and it is not soliciting an offer to buy these + +securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED JULY 28, 1999 PROSPECTUS 5,400,000 Shares [LOGO OF NET2PHONE] Common Stock This is an initial public offering of common stock by Net2Phone, Inc. Net2Phone is selling 5,400,000 shares of common stock. The estimated initial public offering price is between $12.00 and $14.00 per share. -------- At the request of Net2Phone, the underwriters intend to reserve up to an aggregate of $12.5 million worth of common stock to be sold in this offering to three of our current stockholders at the initial offering price. Any reserved shares not sold to these stockholders will be offered to the general public on the same basis as the other shares offered hereby. We have applied for listing of Net2Phone's common stock on the Nasdaq National Market under the symbol NTOP. --------
Per Share Total Initial public offering price................................... $ $ Underwriting discounts and commissions.......................... $ $ Proceeds to Net2Phone, before expenses.......................... $ $
Net2Phone has granted the underwriters an option for a period of 30 days to purchase up to 810,000 additional shares of our common stock. -------- Investing in the common stock involves a high degree of risk. See "Risk Factors" beginning on page 5. -------- Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. Hambrecht & Quist BT Alex. Brown -------- Bear, Stearns & Co. Inc. , 1999 TABLE OF CONTENTS
Page ---- Prospectus Summary................................................... 1 Risk Factors......................................................... 5 Forward-Looking Statements........................................... 13 Use of Proceeds...................................................... 14 Dividend Policy...................................................... 14 Capitalization....................................................... 15 Dilution............................................................. 16 Selected Financial Data.............................................. 17 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 18 Business............................................................. 28 Management........................................................... 46 Principal Stockholders............................................... 56 Certain Transactions................................................. 58 Description of Capital Stock......................................... 66 Shares Eligible for Future Sale...................................... 69 Underwriting......................................................... 71 Legal Matters........................................................ 74 Experts.............................................................. 74 Where You Can Find More Information.................................. 74 Index to Financial Statements ....................................... F-1
We maintain Web sites at www.Net2Phone.com and www.EZSurf.com. Information contained on our Web sites does not constitute part of this prospectus. "Net2Phone," "Net2Fax" and "N2P" are our registered marks. Applications to register the service marks "Phone2Phone," "Click2Talk," "Net2Phone Pro" and "Fax2Fax" have been filed with the United States Patent and Trademark Office. This prospectus also includes references to registered service marks and trademarks of other entities. PROSPECTUS SUMMARY This summary highlights selected information contained elsewhere in this prospectus. This summary may not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus carefully, including "Risk Factors" and the financial statements, before making an investment decision. Net2Phone Net2Phone is a leading provider of services enabling users to make high quality, low-cost telephone calls over the Internet. These services are commonly referred to as Internet telephony. Our Internet telephony services enable our customers to call individuals and businesses worldwide using their personal computers or traditional telephones. According to Frost & Sullivan, a leading market research firm, we were the largest provider of Internet calls in the world in 1997 with a 30% market share. In August 1996, we introduced our first service, "PC2Phone." We believe that PC2Phone was the first commercial telephone service to connect calls between personal computers and telephones over the Internet. In September 1997, we introduced "Phone2Phone," a service that enables international and domestic calls to be made over the Internet using traditional telephones. Our customers often pay substantially less for long-distance calls they make using our services than they would for calls made over traditional long distance networks, such as those owned by AT&T, Sprint and MCI. We are using our expertise in Internet telephony to integrate live voice capabilities into the Web. We have developed simple, easy to use PC2Phone software that operates on a personal computer and allows individuals and businesses to: . speak with sales or customer service representatives of online retailers and other Web-based businesses while visiting their Web sites; . speak with individuals or businesses listed on various online directories, such as Yahoo! People Search; and . call almost any telephone number in the world. We promote our services through relationships with international resellers and leading Internet companies. For example, our PC2Phone software will be embedded on an exclusive basis into future versions of Netscape's Internet browser, including Netscape Navigator and Netscape Communicator, for the term of our agreement. Netscape will also include a Net2Phone icon on the Netscape Navigator Personal Toolbar and integrate our services into Netscape Netcenter, allowing Netscape users to access our services from anywhere on the Web. In addition, we have entered into an agreement with ICQ, a subsidiary of America Online, to provide Internet telephony services to users of ICQ's instant messenging service. ICQ will embed our Internet telephony software into ICQ's Instant Messenger software on an exclusive basis, allowing ICQ users to make PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls. We will also co-brand a pre-paid Phone2Phone calling card with ICQ, allowing users to place calls from the United States and 19 other countries to virtually anywhere in the world. Our strategy for building on our leadership position in our market and making live voice communication a common feature on the Internet includes the following key elements: . marketing our services widely; . pursuing multiple sources of revenue; . enhancing brand recognition; . making our software readily available worldwide; and . expanding and enhancing our products and services. Upon completion of this offering, IDT will own approximately 57.1% of our outstanding capital stock. IDT owns Class A stock that has twice the voting power of our common stock. As a result, IDT will control 64.6% of our vote. Our principal executive offices are located at 171 Main Street, Hackensack, New Jersey 07601, and our telephone number at that address is (201) 907-5304. 1 The Offering Common stock offered by Net2Phone............ 5,400,000 shares Capital stock to be outstanding after this offering.................................... 47,522,619 shares Common stock................................ 10,944,429 shares Class A stock............................... 36,578,190 shares Use of proceeds.............................. $7.0 million of the net proceeds from this offering will be used to repay a portion of a note outstanding to IDT Corporation. $3.5 million will be used to pay ICQ, Inc., a subsidiary of America Online, Inc., in connection with our distribution and marketing agreement and $1.5 million will be used to pay to NBC for the purchase of television advertising. We have not made any other specific allocations with respect to the proceeds. We expect to use the balance of the proceeds: for developing and maintaining strategic Internet relationships; for advertising and promotion; for research and development; for upgrading and expanding our network; and for general corporate purposes, including working capital. Nasdaq National Market symbol................ NTOP
-------------------- This information excludes: . 920,000 shares subject to outstanding options granted to Jonathan Fram, our President, as ofJuly 27, 1999, of which 460,000 shares were granted at an exercise price of $3.33 per share and the remaining 460,000 shares were granted at the lower of our initial public offering price or $11.00 per share; . an additional 3,666,366 shares subject to outstanding options as of July 27, 1999 at a weighted average exercise price of $3.33 per share; and . 5,110,378 shares reserved for issuance under our 1999 Stock Incentive Plan, as of July 27, 1999, approximately 2,671,500 of which we expect to grant prior to the closing of this offering. Unless otherwise noted, the information in this prospectus: . reflects a 10,320-for-one stock split on our common stock, which took place in April 1999; . reflects a three-for-one stock split on our common stock and Class A stock, which took place in June 1999; . assumes 4,683,237 shares of common stock outstanding in July 1999; . assumes 27,621,982 shares of Class A stock outstanding in July 1999; . assumes the exercise of warrants to purchase 272,400 shares of our common stock at a price of $3.33 per share prior to the closing of this offering for proceeds of $907,092; 2 . assumes the exercise of options to purchase 75,000 shares of our common stock at a price of $3.33 per share and options to purchase 50,000 shares of our common stock at an assumed price of $13.00 prior to the closing of this offering for aggregate proceeds of $899,750; . gives effect to the conversion of 463,792 shares of Class A stock to common stock upon the transfer of these shares from IDT to Clifford M. Sobel, our Chairman, at the closing of this offering; and . gives effect to the conversion of all 3,140,000 outstanding shares of our Series A convertible preferred stock into 9,420,000 shares of Class A stock at the closing of this offering. Each share of Class A stock entitles the holder to two votes, while holders of our common stock are entitled to only one vote. Each share of Class A stock is convertible into one share of common stock, and automatically converts into common stock upon transfer. -------------------- Our fiscal year ends on July 31 of each calendar year. All references to fiscal years in this prospectus refer to the fiscal years ending in the indicated calendar years. For example, "fiscal 1998" refers to the fiscal year ended July 31, 1998. 3 The table below sets forth summary financial information for the periods indicated. This information is not necessarily indicative of the results of operations or financial position which would have resulted had we operated as an independent entity during the periods indicated. It is important that you read this information together with the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and the notes thereto included elsewhere in this prospectus. Summary Financial Information
Period from Year Ended Nine Months Ended January 2, 1996 July 31, April 30, (inception) to ------------------------ ----------------------- July 31, 1996 1997 1998 1998 1999 --------------- ----------- ----------- ---------- ----------- Statement of Operations: Revenue............... $ -- $ 2,652,303 $12,005,972 $7,954,374 $22,203,257 Loss from operations.. (507,758) (1,697,647) (3,544,689) (673,922) (2,905,966) Net loss.............. $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966) Net loss per share-- basic and diluted.... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09) Shares used in calculation of basic and diluted loss per share................ 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000
The pro forma balance sheet data summarized below gives effect to: . the sale of 3,140,000 shares of Series A convertible preferred stock, which are convertible into 9,420,000 shares of our Class A common stock, and warrants to purchase 180,000 shares of our common stock in May 1999 for net proceeds of $29.9 million; . the conversion of all outstanding shares of our Series A convertible preferred stock into shares of our Class A stock at the closing of this offering; . the issuance of warrants to purchase 92,400 shares of our common stock granted to the placement agent in May 1999 in connection with the sale of our Series A convertible preferred stock; . the repayment of $8.0 million of the amounts owed to IDT in May 1999; and . the exercise of options to purchase 1,345,219 shares of common stock in May 1999 in exchange for $3.1 million in promissory notes and $1.3 million in cash. The pro forma as adjusted balance sheet summarized below reflects: . the sale of 5,400,000 shares of common stock in this offering; . the application of $7.0 million of the estimated net proceeds from this offering to pay a portion of the amounts due to IDT; . the application of $3.5 million of the estimated net proceeds from this offering to pay ICQ in connection with our distribution and marketing agreement; . the application of $1.5 million of the estimated net proceeds from this offering to pay NBC for television advertising; . the exercise of warrants to purchase 272,400 shares of common stock prior to the closing of this offering for proceeds of $907,092; and . the exercise of options to purchase 75,000 shares of our common stock at a price of $3.33 per share and options to purchase 50,000 shares of our common stock at an assumed price of $13.00 prior to the closing of this offering for proceeds of $899,750.
April 30, 1999 -------------------------------------- Pro Forma Actual Pro Forma As Adjusted ------------ ----------- ------------ Balance Sheet Data: Cash and cash equivalents.............. $ 1,782,194 $25,016,264 $ 78,739,106 Working capital........................ (17,255,452) 13,978,618 76,201,460 Total assets........................... 19,818,328 43,052,398 101,775,240 Due to IDT............................. 22,000,000 14,000,000 7,000,000 Total stockholders' (deficit) equity... (3,926,122) 27,307,948 93,030,790
4 RISK FACTORS You should carefully consider the risks described below before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that event, the trading price of our shares could decline, and you may lose part or all of your investment. Risks Related to Our Financial Condition and Our Business Our limited operating history makes evaluating our business difficult. IDT formed us as a subsidiary in October 1997. Prior to that, we conducted business as a division of IDT. Therefore, we have only a limited operating history with which you may evaluate our business. You must consider the numerous risks and uncertainties an early stage company like ours faces in the new and rapidly evolving market for Internet-related services. These risks include our ability to: . increase awareness of our brand and continue to build user loyalty; . maintain our current, and develop new, strategic relationships; . respond effectively to competitive pressures; and . continue to develop and upgrade our network and technology. If we are unsuccessful in addressing these risks, sales of our products and services, as well as our ability to maintain or increase our customer base, will be substantially diminished. We have never been profitable and expect our losses to continue for the foreseeable future. We have never been profitable on an annual basis. We had an accumulated deficit of approximately $8.7 million as of April 30, 1999. We expect to continue to incur operating losses for the forseeable future. Our operating and marketing expenses have continuously increased since inception and we expect them to continue to increase significantly during the next several years. Accordingly, we will need to generate significant revenue to achieve profitability. We may not be able to do so. Even if we do achieve profitability, we cannot assure you that we will be able to sustain or increase profitability on a quarterly or annual basis in the future. Further, it is probable that we will have to recognize significant additional charges relating to non-cash compensation in connection with options that we granted in May 1999 and that we expect to grant prior to the closing of this offering. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." We intend to pursue new streams of revenue, which we have not attempted to generate before and which may not be profitable. In the future, we intend to pursue revenue from new Web-based opportunities, such as banner and audio advertising, as well as from sponsorship opportunities on our user interface and our EZSurf.com Internet shopping directory. We also intend to explore the availability of revenue-sharing opportunities. We have not attempted to generate this type of revenue before. We intend to devote significant capital and resources to create these new revenue streams and we cannot ensure that these investments will be profitable. We may have difficulties managing our expanding operations, which may reduce our chances of achieving profitability. Our future performance will depend, in part, on our ability to manage our growth effectively. To that end, we will have to undertake the following tasks, among others: . develop our operating, administrative, and financial and accounting systems and controls; 5 . improve coordination among our engineering, accounting, finance, marketing and operations personnel; . enhance our management information systems capabilities; and . hire and train additional qualified personnel. If we cannot accomplish these tasks, we will diminish our chances of achieving profitability. If we fail to establish and maintain strategic relationships our ability to increase our sales would suffer. We currently have strategic relationships with ICQ, Netscape, Compaq, Yahoo!, Excite and others. We depend on these relationships to: . distribute our products to potential customers; . increase usage of our services; . build brand awareness; and . cooperatively market our products and services. We believe that our success depends, in part, on our ability to develop and maintain strategic relationships with leading Internet companies and computer hardware and software companies, as well as key marketing distribution partners. If any of our strategic relationships are discontinued, sales of our products and services and our ability to maintain or increase our customer base may be substantially diminished. If we hire a reseller who fails to market our products and services effectively or who provides poor customer service, our reputation will suffer and we could lose customers. If we hire a reseller who fails to market our products and services effectively, we could lose market share. Additionally, if a reseller provides poor customer service, we could lose brand equity. Therefore, we must maintain and hire additional resellers throughout the world that are capable of providing high-quality sales and service efforts. If we lose a reseller in a key market, or if a current or future reseller fails to adequately provide customer support, our reputation will suffer and sales of our products and services and our customer base will be substantially diminished. Competition could reduce our market share and decrease our revenue. The market for our services has been extremely competitive. Many companies offer products and services like ours, and many of these companies have a substantial presence in this market. Current product offerings include VocalTec Communications' Internet Phone, QuarterDeck's WebPhone and Microsoft's NetMeeting. In addition, a number of large telecommunications providers and equipment manufacturers, such as Alcatel, Cisco, Lucent, Northern Telecom and Dialogic (which has entered into an agreement to be acquired by Intel), have announced that they intend to offer similar products. We expect these products to allow live voice communications over the Internet between parties using a personal computer and a telephone and between two parties using telephones. Cisco Systems has also taken further steps by recently acquiring companies that produce devices that help Internet service providers carry voice over the Internet while maintaining traditional phone usage and infrastructure. Other competitors of ours, such as ICG Communications, IPVoice.com, ITXC, RSL Communications (through its Delta Three subsidiary) and VIP Calling, route voice traffic worldwide over the Internet. In addition, major long distance providers, such as AT&T, Deutsche Telekom, MCI WorldCom and Qwest Communications, as well as other major companies such as Motorola and Intel, have all entered or plan to enter the market for carrying voice over the Internet. These companies are larger than we are and have substantially greater financial, distribution and marketing resources than we do. We may not be able to compete successfully in this market. 6 Pricing pressures may lessen our competitive pricing advantage. Our success is based on our ability to provide discounted domestic and international long distance services by taking advantage of cost savings achieved by carrying voice traffic over the Internet, as compared to carrying calls over long distance networks, such as those owned by AT&T, Sprint and MCI. In recent years, the price of long distance calls has fallen. In response, we have lowered the price of our service offerings. The price of long distance calls may decline to a point where we no longer have a price advantage over these traditional long distance services. We would then have to rely on factors other than price to differentiate our product and service offerings, which we may not be able to do. We may not be able to hire and retain the personnel we need to sustain our business. We depend on the continued services of our executive officers and other key personnel. We have an employment agreement with only one of our executive officers, Clifford M. Sobel, our Chairman and President. We need to attract and retain other highly-skilled technical and managerial personnel for whom there is intense competition. If we are unable to attract and retain qualified technical and managerial personnel, we may never achieve profitability. If our customers do not perceive our service to be effective or of high quality, our brand and name recognition would suffer. We believe that establishing and maintaining a brand and name recognition is critical for attracting and expanding our targeted client base. We also believe that the importance of reputation and name recognition will increase as competition in our market increases. Promotion and enhancement of our name will depend on the effectiveness of our marketing and advertising efforts and on our success in continuing to provide high-quality products and services, neither of which can be assured. If our customers do not perceive our service to be effective or of high quality, our brand and name recognition would suffer. We depend on our international operations, which subject us to unpredictable regulatory and political situations. As of April 30, 1999, approximately 65% of our customers were based outside of the United States, generating approximately 58% of our revenues during the nine months ended on that date. A significant component of our strategy is to continue to expand internationally. We cannot assure you that we will be successful in expanding into additional international markets. In addition to the uncertainty regarding our ability to generate revenue from foreign operations and expand our international presence, there are certain risks inherent in doing business on an international basis, including: . changing regulatory requirements; . increased bad debt and subscription fraud; . legal uncertainty regarding liability, tariffs and other trade barriers; . political instability; and . potentially adverse tax consequences. We cannot assure you that one or more of these factors will not materially adversely affect the growth of our business or our customer base. All of the telephone calls made by our customers are connected through local telephone companies and, at least in part, through leased networks that may become unavailable. We are not a local telephone company or a registered local exchange carrier. Our network covers only portions of the United States. Accordingly, we must route parts of some domestic and all international calls made by our customers over leased transmission facilities. Further, because our network does not extend 7 to homes or businesses, we must route calls through a local telephone company to reach our network and, ultimately, to reach their final destinations. In many of the foreign jurisdictions in which we conduct or plan to conduct business, the primary provider of significant intra-national transmission facilities is the national telephone company. Accordingly, we may have to lease transmission capacity at artificially high rates from a monopolistic provider and, consequently, we may not be able to generate a profit on those calls. In addition, national telephone companies may not be required by law to lease necessary transmission lines to us or, if applicable law requires national telephone companies to lease transmission facilities to us, we may encounter delays in negotiating leases and interconnection agreements and commencing operations. Additionally, disputes may result with respect to pricing terms and billing. In the United States, the providers of local telephone service are generally the incumbent local telephone companies, including the regional Bell operating companies. The permitted pricing of local transmission facilities that we lease in the United States is subject to uncertainties. The Federal Communications Commission has issued an order requiring incumbent local telephone companies to price those facilities at total element long-run incremental cost, and the United States Supreme Court recently upheld the FCC's jurisdiction to set a pricing standard for local transmission facilities provided to competitors. However, the incumbent local telephone companies can be expected to bring further legal challenges to the FCC's total element long-run incremental cost standard and, if they succeed, the result may be to increase the cost of incumbent local transmission facilities obtained by us. Our success depends on our ability to handle a large number of simultaneous calls, which our systems may not be able to accommodate. We expect the volume of simultaneous calls to increase significantly as we expand our operations. Our network hardware and software may not be able to accommodate this additional volume. If we fail to maintain an appropriate level of operating performance, or if our service is disrupted, our reputation could be hurt and we could lose customers. Because we are unable to predict the volume of usage and our capacity needs, we may be forced to enter into disadvantageous contracts that would reduce our operating margins. In order to ensure that we are able to handle additional usage, we have agreed to pay IDT a one-time fee of approximately $6.0 million for a 20-year right to use part of a new high capacity network that is under construction. This network has been pledged by IDT to its lenders under a credit facility. We may have to enter into additional long-term agreements for leased capacity. To the extent that we overestimate our call volume, we may be obligated to pay for more transmission capacity than we actually use, resulting in costs without corresponding revenue. Conversely, if we underestimate our capacity needs, we may be required to obtain additional transmission capacity through more expensive means that may not be available. We may not be able to obtain sufficient funds to grow our business. We intend to continue to grow our business. Due to our limited operating history and the nature of our industry, our future capital needs are difficult to predict. Therefore, we may require additional capital after this offering to fund any of the following: . unanticipated opportunities; . strategic alliances; . potential acquisitions; . changing business conditions; and . unanticipated competitive pressures. 8 Obtaining additional financing will be subject to a number of factors, including market conditions, our operating performance and investor sentiment. These factors may make the timing, amount, terms and conditions of additional financings unattractive to us. If we are unable to raise additional capital, our growth could be impeded. Any damage to or failure of our systems or operations could result in reductions in, or terminations of, our services. Our success depends on our ability to provide efficient and uninterrupted, high-quality services. Our systems and operations are vulnerable to damage or interruption from natural disasters, power loss, telecommunication failures, physical or electronic break-ins, sabotage, intentional acts of vandalism and similar events that may be or may not be beyond our control. The occurrence of any or all of these events could hurt our reputation and cause us to lose customers. Unauthorized use of our intellectual property by third parties may damage our brand. We regard our copyrights, service marks, trademarks, trade secrets and other intellectual property as critical to our success. We rely on trademark and copyright law, trade secret protection and confidentiality agreements with our employees, customers, partners and others to protect our intellectual property rights. Despite our precautions, it may be possible for third parties to obtain and use our intellectual property without authorization. Furthermore, the validity, enforceability and scope of protection of intellectual property in Internet-related industries is uncertain and still evolving. The laws of some foreign countries are uncertain or do not protect intellectual property rights to the same extent as do the laws of the United States. The unauthorized use of our intellectual property by third parties may damage our brand. Defending against intellectual property infringement claims could be expensive and could disrupt our business. We cannot be certain that our products do not or will not infringe upon valid patents, trademarks, copyrights or other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business. We may incur substantial expenses in defending against these third-party infringement claims, regardless of their merit. Successful infringement claims against us may result in substantial monetary liability or may materially disrupt the conduct of our business. See "Business--Intellectual Property." Year 2000 problems may disrupt our operations. Many computer systems and software products are coded to understand only dates that have two digits for the relevant year. These systems and products need upgrading to accept four digit entries in order to distinguish 21st century dates from 20th century dates. Without upgrading, many computer applications could fail or create erroneous results beginning in the year 2000. The "Year 2000" problems of companies on the Internet generally could affect our systems or operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Systems Costs" for a more complete description of the Year 2000 risks that we face and the steps we have taken to reduce those risks. Risks Related to Our Relationship with IDT We have contracted with IDT for various services and for the use of its telecommunications network, which contracts we may not be able to renew when they expire. In May 1999, we entered into agreements with IDT under which IDT will continue to provide administrative and telecommunication services to us. When these agreements expire, we will need to extend them, engage other entities to perform these services or perform these services ourselves. In addition, after the initial term, these agreements are terminable by either party upon prior written notice. We cannot 9 assure you that IDT will not terminate these agreements or continue to provide these services after the initial term of the agreements. As a result, we may have to purchase these services from third parties or devote resources to handle these functions internally, which may cost us more than we paid IDT for the same services. In addition, IDT has provided us in the past with working capital to fund our operations, and IDT is not under any obligation, under these agreements or otherwise, to do so in the future. We may experience conflicts of interest with IDT, which may not be resolved in our favor. Two members of our board of directors are officers and directors of IDT. One of these directors, Howard S. Jonas, is the Chairman and Chief Executive Officer of IDT and IDT's controlling shareholder. Additionally, one of our directors, James R. Mellor, was a director of IDT until June 1999. Clifford M. Sobel, our Chairman, has an option to transfer his interest in us to IDT in exchange for an option to purchase 875,000 shares of IDT common stock at a purchase price of $6.50 per share. See "Certain Transactions." In addition, certain of our executive officers, directors and employees hold shares of IDT common stock and options to acquire shares of IDT common stock. These individuals may have conflicts of interest with respect to certain decisions involving business opportunities and similar matters that may arise in the ordinary course of our business or the business of IDT. If conflicts arise with IDT, we expect to resolve those conflicts on a case-by-case basis, and in the manner required by applicable law and customary business practices, subject to our agreement with IDT to resolve disputes involving $5.0 million or less through mandatory, binding arbitration. Conflicts, if any, could be resolved in a manner adverse to us and our stockholders, which could harm our business. Through its ownership of our stock, IDT effectively controls our company and may exert influence contrary to the interests of other stockholders. Immediately following this offering, IDT will own approximately 57.1% of our outstanding capital stock. Because IDT owns Class A stock, which entitles the holder to two votes per share, IDT will control 64.6% of our voting power. Therefore, IDT will have the power to determine the election of our directors, the appointment of new management and the approval of any other action requiring the approval of our stockholders, including any amendments to our certificate of incorporation and mergers or sales of our company or of all of our assets. In addition, without the consent of IDT, we could be prevented from entering into certain transactions that could be beneficial to us. Third parties could be discouraged from making a tender offer or bid to acquire us because of IDT's stockholdings and voting rights. IDT's ownership will increase further if Clifford M. Sobel exercises his option to transfer his shares of our stock to IDT in exchange for an option to purchase shares of IDT. See "Principal Stockholders." IDT has pledged its shares of our stock to secure a credit facility, which shares may be transferred to a third party that would effectively control us if IDT defaults on its obligations. The shares owned by IDT are pledged as collateral to secure an IDT credit facility. The lenders under the credit facility have agreed to permit IDT to transfer our shares free and clear of any liens as and when IDT seeks to transfer shares of our stock. Such transferability will cease if IDT's ownership of our capital stock drops below 50% of the number of shares which it owns 72 hours after the consummation of this offering. If IDT defaults in its obligations under the credit facility, then a third party could acquire the voting rights with respect to the pledged stock and become party to our intercompany agreements. We cannot assume that a third party would maintain good relations with us or maintain or renew our agreements with IDT. Risks Related to Our Industry If the Internet does not continue to grow as a medium for voice communications, our business will suffer. The technology that allows voice communications over the Internet is still in its early stages of development. Historically, the sound quality of Internet calls was poor. As the industry has grown, sound 10 quality has improved, but the technology requires further refinement. Additionally, the Internet's capacity constraints may impede the acceptance of Internet telephony. Callers could experience delays, errors in transmissions or other interruptions in service. Making telephone calls over the Internet must also be accepted as an alternative to traditional telephone service. Because the Internet telephony market is new and evolving, predicting the size of this market and its growth rate is difficult. If our market fails to develop, then we will be unable to grow our customer base and our opportunity for profitability will be harmed. Our business will not grow without increased use of the Internet. The use of the Internet as a commercial marketplace is at an early stage of development. Demand and market acceptance for recently introduced products and services over the Internet are still uncertain. We cannot predict whether customers will be willing to shift their traditional activities online. The Internet may not prove to be a viable commercial marketplace for a number of reasons, including: . concerns about security; . Internet congestion; . inconsistent service; and . lack of cost-effective, high-speed access. If the use of the Internet as a commercial marketplace does not continue to grow, we may not be able to grow our customer base, which may prevent us from achieving profitability. Governmental regulations regarding the Internet may be passed, which could impede our business. To date, governmental regulations have not materially restricted use of the Internet in our market. However, the legal and regulatory environment that pertains to the Internet is uncertain and may change. New regulations could increase our costs of doing business and prevent us from delivering our products and services over the Internet. The growth of the Internet may also be significantly slowed. This could delay growth in demand for our products and services and limit the growth of our revenue. In addition to new regulations being adopted, existing laws may be applied to the Internet. See "Business--Regulation." New and existing laws may cover issues that include: . sales and other taxes; . access charges; . user privacy; . pricing controls; . characteristics and quality of products and services; . consumer protection; . contributions to the universal service fund, an FCC-administered fund for the support of local telephone service in rural and high cost areas; . cross-border commerce; . copyright, trademark and patent infringement; and . other claims based on the nature and content of Internet materials. In September 1998, two regional Bell operating companies advised Internet telephony providers that these companies would impose access charges on Internet telephony traffic. One of these operating companies also petitioned the FCC for a declaratory ruling that providers of interstate Internet telephony 11 must pay federal access charges, and has petitioned the public utilities commissions of Nebraska and Colorado for similar rulings concerning payment of access charges for intrastate Internet telephone calls. The outcome of these proceedings is uncertain. If these states decide that access charges may be levied against Internet telephony providers, we would have to pay money for access in those states. If additional state utility commissions make similar rulings, we may not be able to operate profitably in any state that assesses access charges against us. Our risk management practices may not be sufficient to protect us from unauthorized transactions or thefts of services. We may be the victim of fraud or theft of service. From time to time, callers have obtained our services without rendering payment by unlawfully using our access numbers and personal identification numbers. We attempt to manage these theft and fraud risks through our internal controls and our monitoring and blocking systems. If these efforts are not successful, the theft of our services may cause our revenue to decline significantly. Risks Related to this Offering Our stock price is likely to be highly volatile and could drop unexpectedly. Following this offering, the price for our common stock could be highly volatile and subject to wide fluctuations in response to the following factors: . quarterly variations in our operating results; . announcements of technical innovations, new products or services by us or our competitors; . investor perception of us, the Internet telephony market or the Internet in general; . changes in financial estimates by securities analysts; and . general economic and market conditions. The stocks of many Internet-related companies have experienced significant fluctuations in trading price and volume. Often these fluctuations have been unrelated to operating performance. Declines in the market price of our common stock could also materially adversely affect employee morale and retention, our access to capital and other aspects of our business. If our stock price is volatile, we may become subject to securities litigation, which is expensive and could divert our resources. In the past, following periods of market volatility in the price of a company's securities, security holders have instituted class action litigation. Many companies in our industry have been subject to this type of litigation. If the market value of our stock experiences adverse fluctuations, and we become involved in this type of litigation, regardless of the outcome, we could incur substantial legal costs and our management's attention could be diverted, causing our business to suffer. The sale of a substantial number of shares of our common stock after this offering may affect our stock price. The market price of our common stock could decline as a result of sales of substantial amounts of common stock in the public market after the closing of this offering or the perception that substantial sales could occur. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. 12 We may use the proceeds from this offering in ways with which you may not agree. We have significant flexibility in applying the proceeds we receive in this offering. Other than the repayment of $7.0 million on an outstanding note to IDT, the payment of $3.5 million to ICQ in connection with our distribution and marketing agreement and the payment of $1.5 million to NBC for television advertising, the proceeds are not required to be allocated to any specific investment or transaction. Therefore, you cannot determine the value or propriety of our use of proceeds. If we do not apply the funds we receive effectively, our accumulated deficit will increase and we may lose significant business opportunities. See "Use of Proceeds" for a more detailed description of how we intend to apply the proceeds from this offering. Our certificate of incorporation, our bylaws and Delaware law make it difficult for a third party to acquire us, despite the possible benefit to our stockholders. Provisions of our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. For example, our certificate of incorporation provides for a classified board of directors, meaning that only approximately one-third of our directors will be subject to re-election at each annual stockholder meeting. Moreover, our certificate of incorporation creates a class of stock with super-voting rights. The holders of Class A stock are entitled to two votes per share while the holders of common stock are entitled to one vote per share. Except as otherwise required by law or as described below, the holders of Class A stock and common stock will vote together as a single class on all matters presented to the stockholders for their vote or approval, including the election of directors. The holders of Class A stock may have the ability to elect all of our directors and to effect or prevent certain corporate transactions. These provisions could discourage takeover attempts and could materially adversely affect the price of our stock. FORWARD-LOOKING STATEMENTS This prospectus contains "forward-looking statements." These forward-looking statements include, without limitation, statements about our market opportunity, strategies, competition, expected activities and expenditures as we pursue our business plan, and the adequacy of our available cash resources. Our actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described above and elsewhere in this prospectus. 13 USE OF PROCEEDS Net2Phone will receive net proceeds of approximately $63.9 million from the sale of 5,400,000 shares of common stock (and an additional approximately $9.8 million from the sale of 810,000 shares if the underwriters over-allotment option is exercised in full) at an assumed initial public offering price of $13.00 per share after deducting underwriting commissions and discounts of $4.3 million (and an additional approximately $737,000 if the underwriters' over- allotment option is exercised in full) and estimated expenses of $2.0 million. $7.0 million of the net proceeds from this offering will be used to repay a portion of the $14.0 million note outstanding to IDT. $3.5 million will be used to pay ICQ, a subsidiary of America Online, in connection with our distribution and marketing agreement and $1.5 million will be used to prepay NBC for television advertising. As of the date of this prospectus, we have not made any other specific allocations with respect to the proceeds. Therefore, we cannot specify with certainty the particular uses for the net proceeds to be received upon consummation of this offering. Accordingly, our management will have significant flexibility in applying the net proceeds from this offering. We expect to use the balance of the net proceeds of this offering for: . developing and maintaining strategic Internet relationships; . advertising and promotion; . research and development; . upgrading and expanding our network; and . general corporate purposes, including working capital. Pending any use, the net proceeds of this offering will be invested in short-term, interest-bearing securities. DIVIDEND POLICY We have not paid any dividends in the past and do not intend to pay cash dividends on our capital stock for the foreseeable future. Instead, we intend to retain all earnings for use in the operation and expansion of our business. 14 CAPITALIZATION The following table sets forth: . our actual capitalization as of April 30, 1999; . our pro forma capitalization to give effect to: . the conversion of IDT's 27,864,000 shares of our common stock into 27,864,000 shares of Class A stock in May 1999, . the sale of 3,140,000 shares of Series A convertible preferred stock, which are convertible into 9,420,000 shares of our Class A common stock, and warrants to purchase 180,000 shares of our common stock in May 1999 for net proceeds of $29.9 million, . the conversion of all outstanding shares of our Series A convertible preferred stock into shares of our Class A stock at the closing of this offering, . the issuance of warrants to purchase 92,400 shares of our common stock granted to the placement agent in May 1999 in connection with the sale of our Series A convertible preferred stock, . the repayment of $8.0 million of the amounts owed to IDT in May 1999, . the conversion of 242,018 shares of Class A stock to common stock upon the transfer of these shares from IDT to Clifford M. Sobel in May 1999, and . the exercise of stock options to purchase 1,375,219 shares of common stock in May 1999 in exchange for $3.1 million in promissory notes and $1.3 million in cash; and . the pro forma as adjusted balance sheet summarized below reflects: . the sale of 5,400,000 shares of common stock in this offering, . the application of $7.0 million of the estimated net proceeds from this offering to pay a portion of the amounts due to IDT, . the conversion of 463,792 shares of Class A stock to common stock upon the transfer of those shares from IDT to Clifford M. Sobel at the closing of this offering, and . the exercise of warrants prior to the closing of this offering to purchase 272,400 shares of common stock for proceeds of $907,000, and . the exercise of options to purchase 75,000 shares of our common stock at a price of $3.33 per share and options to purchase 50,000 shares of our common stock at an assumed price of $13.00 prior to the closing of this offering for proceeds of $899,750. The information set forth in the table below excludes 920,000 shares of common stock issuable upon exercise of options granted to Jonathan Fram, our President, of which 460,000 shares were granted at an exercise price of $3.33 per share and the remaining 460,000 shares were granted at the lower of our initial public offering price or $11.00 per share. This information also excludes an additional 3,666,366 shares of common stock issuable upon exercise of options to purchase our common stock at a weighted average exercise price of $3.33 per share. This information also excludes the effect of non-cash compensation in connection with options to purchase approximately 5,040,000 shares of our common stock that were granted in May 1999, options to purchase 920,000 shares of common stock granted to Mr. Fram and options to purchase 2,111,000 additional shares of our common stock that are expected to be granted prior to the closing of this offering. See "Management--1999 Stock Incentive Plan" and "Certain Transactions--Relationship with Other Investors."
April 30, 1999 -------------------------------------- Pro Forma Actual Pro Forma As Adjusted ----------- ----------- ------------ Due to IDT............................. $22,000,000 $14,000,000 $ 7,000,000 Redeemable convertible preferred stock, Series A, $.01 par value; 3,150,000 shares authorized, no shares issued and outstanding....................... -- -- -- Stockholders' (deficit) equity: Preferred stock, $.01 par value; 6,850,000 shares authorized, no shares issued and outstanding................ -- -- -- Common stock, $.01 par value; 200,000,000 shares authorized; 30,960,000 (actual) 4,683,237 (pro forma) and 10,944,429 (pro forma as adjusted) shares issued and outstanding........................... 309,600 46,832 109,444 Class A stock, $.01 par value; 37,042,089 shares authorized; none (actual) 37,041,982 (pro forma) and 36,578,190 (pro forma as adjusted) shares issued and outstanding......... -- 370,420 365,782 Additional paid-in capital............. 4,420,338 38,696,746 104,361,614 Loans to stockholders.................. -- (3,149,990) (3,149,990) Accumulated deficit.................... (8,656,060) (8,656,060) (8,656,060) ----------- ----------- ------------ Total stockholders' (deficit) equity... (3,926,122) 27,307,948 93,030,790 ----------- ----------- ------------ Total capitalization................... $18,073,878 $41,307,948 $100,030,790 =========== =========== ============
15 DILUTION The net tangible book value of Net2Phone common stock and Class A stock as of April 30, 1999, as adjusted to give effect to a private placement of 3,140,000 shares of Series A convertible preferred stock in May 1999, the conversion of those shares into Class A stock and the exercise of stock options to purchase 1,345,219 shares of common stock, was $22.3 million, or $0.53 per share of common stock and Class A stock. Net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the total number of shares of common stock and Class A stock outstanding. After giving effect to this offering and the receipt of an assumed $63.9 million of net proceeds from this offering (based on an assumed initial public offering price of $13.00 per share), the issuance of 3,140,000 shares of Series A convertible preferred stock in May 1999, the conversion of the Series A convertible preferred stock into 9,420,000 shares of Class A stock, the exercise of warrants to purchase 272,400 shares of common stock and the exercise of options to purchase 125,000 shares of common stock, the pro forma net tangible book value of the common stock and Class A stock as of April 30, 1999 would have been $88.0 million, or $1.82 per share. This amount represents an immediate increase in net tangible book value of $1.29 per share to the existing stockholders and an immediate dilution in net tangible book value of $11.18 per share to purchasers of common stock in this offering. Dilution is determined by subtracting pro forma net tangible book value per share after this offering from the amount of cash paid by a new investor for a share of common stock. The following table illustrates such dilution: Assumed initial public offering price per share................. $13.00 Net tangible book value per share at April 30, 1999 .......... $0.53 Increase per share attributable to new investors.............. 1.29 ----- Pro forma net tangible book value per share after this offering........................................................ 1.82 ------ Dilution per share to new investors............................. $11.18 ======
The following table sets forth, as of April 30, 1999, on the pro forma basis described above, the number of shares of capital stock purchased from us, the total consideration paid to us and the average price per share paid by existing stockholders and by new investors who purchase shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and offering expenses.
Shares Purchased Total Consideration ------------------ ------------------- Average Price Number Percent Amount Percent Per Share ---------- ------- ------------ ------- ------------- Existing stockholders.. 42,122,619 88.6% $ 40,920,820 36.8% $ 0.96 New investors.......... 5,400,000 11.4% 70,200,000 63.2% 13.00 ---------- ----- ------------ ----- Total.............. 47,522,619 100.0% $111,120,820 100.0% ========== ===== ============ =====
16 SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with our financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus. The statement of operations data for the period from January 2, 1996 (inception) to July 31, 1996, fiscal 1997 and fiscal 1998 and the balance sheet data as of July 31, 1997 and 1998 are derived from our financial statements that have been audited by Ernst & Young LLP, independent auditors, which are included elsewhere in this prospectus. The statement of operations data for the nine months ended April 30, 1998 and 1999 and the balance sheet data as of April 30, 1999 have been derived from our unaudited financial statements that have been prepared on the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the financial data for the periods presented. The financial data for the interim periods is not necessarily indicative of results that may be expected for any other interim period or for the year as a whole.
Period from Year Ended Nine Months Ended January 2, 1996 July 31, April 30, (inception) ------------------------ ------------------------- to July 31, 1996 1997 1998 1998 1999 ---------------- ----------- ----------- ------------ ----------- Statement of Operations Data: Revenue: PC2Phone.............. $ -- $ 2,170,442 $ 7,962,821 $ 5,085,176 $13,774,837 Phone2Phone........... -- 272 2,030,516 1,018,835 6,503,697 Other................. -- 481,589 2,012,635 1,850,363 1,924,723 ---------- ----------- ----------- ------------ ----------- Total revenue....... -- 2,652,303 12,005,972 7,954,374 22,203,257 ---------- ----------- ----------- ------------ ----------- Cost and expenses: Direct cost of revenue, excluding depreciation......... -- 1,553,443 6,848,759 3,589,301 11,848,089 Sales and marketing... 34,468 76,724 2,887,766 1,363,060 4,746,316 General and administrative....... 465,015 2,599,283 5,087,628 3,254,287 7,298,106 Depreciation.......... 8,275 120,500 726,508 421,648 1,216,712 ---------- ----------- ----------- ------------ ----------- Total costs and expenses........... 507,758 4,349,950 15,550,661 8,628,296 25,109,223 ---------- ----------- ----------- ------------ ----------- Loss from operations and net loss.......... $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966) ========== =========== =========== ============ =========== Net loss per share-- basic and diluted..... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09) ========== =========== =========== ============ =========== Shares used in calculation of basic and diluted net loss per share............. 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000 July 31, April 30, -------------------------------------- ----------- 1996 1997 1998 1999 ----------- ----------- ------------ ----------- Balance Sheet Data: Cash and cash equivalents............... $ -- $ -- $ 10,074 $ 1,782,194 Working capital......................... (681,532) (3,104,830) (11,149,553) (17,255,452) Total assets............................ 174,674 916,025 6,975,108 19,818,328 Due to IDT.............................. 681,532 2,960,429 11,814,988 22,000,000 Total stockholders' (deficit)........... (507,758) (2,205,305) (5,649,994) (3,926,122)
17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our financial statements and notes thereto. The historical financial information included in this prospectus does not necessarily reflect what our financial condition and results of operations would have been had we been operated as an independent entity during the periods presented. Overview We began our operations in January 1996, launched our first Net2Phone product in August 1996, and were established as a separate subsidiary of IDT in October 1997. During the period ended July 31, 1996, we incurred approximately $500,000 in start-up costs, primarily for research and development. We have incurred net operating losses since inception and expect to incur additional losses for the foreseeable future, primarily as a result of increased sales and marketing efforts. As of April 30, 1999, we had accumulated net losses of approximately $8.7 million. We will recognize significant charges relating to non-cash executive compensation expense in the current fiscal quarter ending July 31, 1999 and on an ongoing basis. In connection with 5,040,000 options granted with an exercise price of $3.33 per share on May 17, 1999, including options granted to IDT employees, we will recognize approximately $41 million of non-cash charges over the vesting period of these options. We will recognize a charge of $13 million in the current quarter, $10 million during fiscal 2000, $10 million during fiscal 2001 and $8 million during fiscal 2002. We also plan to grant options to purchase approximately 2,503,500 shares of our common stock to our employees, consultants and others prior to the closing of this offering, which will have an exercise price equal to the initial offering price, together with additional options to purchase 168,000 shares of our common stock at an exercise price of $3.33 per share, and which will result in additional non-cash compensation charges. In addition, in connection with the 460,000 options granted to our President with an exercise price of $3.33 per share, we will recognize approximately $3.6 million of non-cash charges over the vesting period of these options. We will recognize a charge of $1.2 million during the current quarter, $800,000 during fiscal 2000, $800,000 during fiscal 2001 and $800,000 during fiscal 2002. In connection with the remaining 460,000 options granted to our President with an exercise price equal to the lower of our initial offering price or $11.00 per share, we will recognize a compensation charge if our initial offering price is more than $11.00 per share. The non-cash compensation charge will be equal to the excess of our initial offering price over $11.00 multiplied by the 460,000 shares and will be amortized over the three-year vesting period of the options. In May 1999 the Company issued 3,140,000 shares of Series A convertible preferred stock which is convertible into 9,420,000 shares of Class Common Stock at $3.33 per share. The Series A convertible preferred stock contains beneficial conversion features. The total value of the beneficial conversion feature approximates $75 million. For accounting purposes the value of the beneficial conversion features was limited to the amount of proceeds allocated to the Series A convertible preferred stock. The Company will record a reduction in net income available to common stockholders in the quarter ending July 31, 1999 of approximately $29.3 million. In connection with the issuance of the Series A convertible preferred stock, we issued warrants to purchase 272,400 shares of common stock at an exercise price of $3.33 per share. The fair value of warrants on the date of issuance was $2.1 million. The fair value of the warrants will be recorded as an increase to additional paid in capital and a decrease to the carrying value of the Series A convertible preferred stock. The decrease in the carrying value of the Series A convertible preferred stock will be accreted, with a corresponding reduction of additional paid-in capital, over the period to the initial redemption date in May 2006. In connection with this offering, the Series A convertible preferred stock will be converted in Class A stock. At that time, the balance of the unamortized discount will be recorded as a reduction of the amount of income available for common shareholders. 18 In connection with our distribution and marketing agreement with ICQ, we issued a warrant to America Online to purchase up to 3% of our outstanding capital stock on a fully-diluted basis. This warrant will vest in 1% increments upon the achievement of each of three incremental thresholds of revenue generated under the agreement during the first four years that the warrant is outstanding. The per share exercise price under the warrant will be equal to the lesser of 80% of the price per share in this offering, or $450 million divided by the number of our fully-diluted shares on the initial exercise date. If one or more of the revenue thresholds set forth in the warrant are achieved, we will recognize additional non-cash charges in an amount equal to the value of the warrant, as determined at the time that these thresholds are met. Sources of Revenue For the first nine months of fiscal 1999, approximately 62% of our revenue has been derived from per-minute charges we billed to our customers on a prepaid basis to use our PC2Phone service, and approximately 29% of our revenue has been derived from per-minute charges we billed to our customers and our international resellers on a prepaid basis to use our Phone2Phone service. The remainder of our revenue has been derived from the sale of Internet telephony equipment for Net2Phone Pro, a product that integrates our software into hardware for the personal computer, and for services we provide to IDT and other carriers. In the future, in order to diversify and further enhance our revenue sources, we plan to introduce a variety of value-added services and Internet commerce solutions. In addition, we plan to sell Web-based advertising to further leverage our customer reach. To date, these additional products and services have provided no revenue and we do not anticipate material revenue from these additional products and services through at least December 1999. Approximately 91% of our revenue is generated from per-minute charges we charge our customers on a prepaid basis to use our PC2Phone and Phone2Phone services. As of April 30, 1999, we served over 250,000 active customers who spent an average of approximately 60 minutes per month placing calls over the Internet. We recognize revenue as our customers utilize the balances in their prepaid accounts by placing calls. As such, we have deferred revenue for all unutilized balances in our customers' accounts. The remaining 9% of our revenue, which is derived from equipment sales and from services provided to IDT and other carriers, is recognized upon installation of the equipment and performance of the services. Cost Structure Our costs and expenses include: . direct cost of revenue, excluding depreciation; . sales and marketing; . general and administrative; and . depreciation. Direct Cost of Revenue Direct cost of revenue consists primarily of network costs associated with carrying our customers' traffic on our network and leased networks, and routing their calls through a local telephone company to reach their final destination. These costs exclude depreciation and include: . amounts paid to other carriers to terminate traffic on a per-minute basis; . the cost of leased routers and access servers; . telecommunications costs, including the cost of local telephone lines to carry subscriber calls to our network; . the costs associated with leased lines connecting our network directly to the Internet or to our operations centers and connecting our operations centers to the Internet; and . Internet backbone costs, which are the amounts we pay to Internet service providers for capacity. 19 We expect our direct cost of revenue to increase in absolute terms over time to support our growing customer base. While some of these costs are fixed, other costs vary on a per minute basis. Therefore, there may be some volatility in our direct cost of revenue as a percentage of revenue, particularly as we expand our network. We try to terminate calls on our own network whenever possible. When we cannot terminate calls on our network, we terminate calls on the network of other suppliers, primarily IDT. We expect to continue to utilize this process. We also expect the percentage of our traffic that we terminate with IDT will decline in the future as we expand our own network. Sales and Marketing. Sales and marketing includes the expenses associated with acquiring customers, including commissions paid to our sales personnel, advertising costs, referral fees and amounts paid to our strategic partners in connection with revenue-sharing arrangements. We expect sales and marketing expenses to increase over time as we aggressively market our products and services. Historically, sales and marketing expenses have been a relatively variable cost and are expected to increase both in terms of absolute dollars and as a percentage of revenue as our revenue grows. We expect to spend significant capital to build brand recognition. Most of our sales and marketing expenses will go toward securing significant and strategic relationships with a variety of Internet companies. We have strategic alliances with ICQ, Netscape, Snap.com, Yahoo!, ZDNet, and InfoSpace.com, and intend to continue to pursue relationships with other companies. General and Administrative. General and administrative expenses consist of the salaries of our employees and associated benefits, and the cost of insurance, travel, entertainment, rent and utilities. A large portion of our general and administrative expenses include operations and customer support. These include the expenses associated with customer service and technical support, and consist primarily of the salaries and employment costs of the employees responsible for those efforts. We expect operations and customer support expenses to increase over time to support new and existing customers. We expect general and administrative costs to increase to support our growth, particularly as we establish a larger organization to implement our business plan. We include our research and development costs, comprised primarily of payroll expenses for our technical team of engineers and developers, in general and administrative expenses. We plan to incur additional costs for research and development, though they are not expected to increase as a percentage of revenue. Over time, we expect these relatively fixed general and administrative expenses to decrease as a percentage of revenue. Depreciation. Depreciation primarily relates to our hardware infrastructure. We depreciate our network equipment over its estimated five-year useful life using the straight-line method. We plan to acquire a domestic high capacity network to provide additional capacity to handle the expected increase in customer traffic as our business grows. In addition, we will be adding more network hardware as traffic volumes justify. We expect depreciation to increase in absolute terms as we expand our network to support new and acquired customers, but to decrease as a percentage of total revenue. We have also entered into a strategic agreement with Netscape, part of which includes the purchase of software and trademark licenses. We expect to amortize the costs relating to the software and trademark licenses acquired from Netscape over the two-year term of the agreement. Dependence on IDT. Historically, we have been dependent on IDT for working capital, its telecommunications network and for various services. In connection with establishing ourselves as an independent operating entity, we recently contracted with IDT for telecommunications services and administrative support. We believe that the terms of our agreements with IDT are no less favorable than those we would have obtained from unaffiliated third parties. 20 Results of Operations The following table sets forth certain items in our statement of operations as a percentage of total revenue for the periods indicated:
Percentage of Revenue ----------------------------------------------- Period from January 2, 1996 Year Ended Nine Months Ended (inception) July 31, April 30, to July 31, ------------- ------------------- 1996 1997 1998 1998 1999 ----------- ----- ----- -------- -------- Revenue: PC2Phone................. -- 81.8% 66.3% 63.9% 62.0% Phone2Phone.............. -- -- 16.9 12.8 29.3 Other.................... -- 18.2 16.8 23.3 8.7 ----- ----- ----- -------- -------- Total revenue........ -- 100.0 100.0 100.0 100.0 ----- ----- ----- -------- -------- Cost and expenses: Direct cost of revenue, excluding depreciation.. -- 58.6 57.0 45.1 53.4 Sales and marketing...... -- 2.9 24.1 17.1 21.4 General and administrative........... -- 98.0 42.4 40.9 32.8 Depreciation............. -- 4.5 6.1 5.3 5.5 ----- ----- ----- -------- -------- Total costs and expenses............ -- 164.0 129.6 108.4 113.1 ----- ----- ----- -------- -------- Loss from operations and net loss...................... -- (64.0)% (29.6)% (8.4)% (13.1)% ===== ===== ===== ======== ========
Comparison of Nine Months Ended April 30, 1998 and 1999 Revenue. Revenue increased approximately 178% from approximately $8.0 million for the nine months ended April 30, 1998 to approximately $22.2 million for the nine months ended April 30, 1999. Of total revenue for the nine months ended April 30, 1999, PC2Phone generated approximately $13.8 million and Phone2Phone generated approximately $6.5 million. The increase in revenue was primarily due to an increase in minutes of use resulting from additional marketing of our products and services. Specifically, revenue from PC2Phone services increased approximately 171% from approximately $5.1 million for the nine months ended April 30, 1998 to approximately $13.8 million in revenue for the corresponding nine-month period in fiscal 1999. Revenue from Phone2Phone increased approximately 550% from approximately $1.0 million for the nine months ended April 30, 1998 to approximately $6.5 million for the nine months ended April 30, 1999. We anticipate that revenue from PC2Phone and Phone2Phone will increase in absolute terms as our products become more widely distributed. However, as a percentage of revenue, we expect revenue from these products to decline over the next several years as we begin to market additional products and services and pursue additional sources of revenue. In addition, we recognized revenue from certain amounts charged to IDT and other carriers and from equipment sales, as shown above in the category "Other." From these transactions, including monitoring IDT's network operations center for Internet customers, we recognized revenue of approximately $329,000 and $680,000 for the nine months ended April 30, 1998 and 1999, respectively. We also realized revenue from the sale of equipment, totaling approximately $1.5 million for the nine months ended April 30, 1998 as compared to equipment sales of approximately $446,000 for the nine months ended April 30, 1999. Equipment sales for the nine months ended April 30, 1999 were derived from our Net2Phone Pro product, while equipment sales for the nine months ended April 30, 1998 represented Internet telephony servers sold, on a one-time non-recurring basis, to an international Phone2Phone reseller for deployment abroad. Revenue from equipment sales, particularly revenue from sales of Internet telephony servers, reflect sales that we believe to be non-recurring and do not represent any trend. 21 Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue, excluding depreciation increased by 228% from $3.6 million for the nine months ended April 30, 1998 to approximately $11.8 million for the nine months ended April 30, 1999. As a percentage of total revenue, these costs increased from approximately 45.1% for the nine months ended April 30, 1998 to approximately 53.4% for the nine months ended April 30, 1999. This increase is primarily attributable to the fact that we sold approximately $1.5 million of equipment in the nine months ended April 30, 1998 as compared to approximately $446,000 in the nine months ended April 30, 1999. Such equipment sales have a low cost of sales associated with them. Over time, we expect direct cost of revenue to decline on a per-minute basis as international competition among carriers intensifies, resulting in lower prices from our suppliers, and as we leverage our position as a large provider of services and expand our own network. As a percentage of revenue, we expect direct cost of revenue to increase as a result of a decline in per-minute charges to customers. We expect to continue to utilize IDT's international and domestic networks at the current fair market value rates for termination. We also expect to incur additional costs in connection with the growth of our business, especially in connection with increasing our own network capacity to handle increased traffic volumes. Sales and Marketing. Sales and marketing expenses increased approximately 236% from approximately $1.4 million for the nine months ended April 30, 1998 to approximately $4.7 million for the nine months ended April 30, 1999. As a percentage of total revenue, these costs increased from approximately 17.1% for the nine months ended April 30, 1998 to approximately 21.4% for the nine months ended April 30, 1999. This increase primarily reflects the increased marketing and advertising expenses associated with the agreements established with Yahoo!, Excite and other strategic partners. We expect to continue to increase significantly our advertising and marketing expenditures to further build brand recognition, and to enhance the distribution of our products and services. General and Administrative. General and administrative expenses increased approximately 121% from approximately $3.3 million for the nine months ended April 30, 1998 to approximately $7.3 million for the nine months ended April 30, 1999. As a percentage of total revenue, these costs decreased from approximately 40.9% for the nine months ended April 30, 1998 to approximately 32.8% for the nine months ended April 30, 1999. This decrease primarily reflects the efficiencies we have begun to realize from leveraging our sales and support infrastructure. We believe that general and administrative expenses will continue to decline as a percentage of total revenue as a result of greater economies of scale and further efficiencies. In absolute terms, we expect these expenses to continue to increase as we incur additional costs in product development and costs associated with hiring additional personnel and adding new office space. Moreover, in absolute terms, our research and development expenses will increase as we hire the additional engineers necessary to continue the development of new products and services. However, these research and development expenses are not expected to significantly increase as a percentage of our total revenue. Depreciation. Depreciation increased from approximately $422,000 for the nine months ended April 30, 1998 to approximately $1.2 million for the nine months ended April 30, 1999. This increase is primarily attributable to the increase in capital expenditures for the deployment of network equipment both domestically and internationally to manage increased call volumes. Depreciation will continue to increase as we build out our network and amortize intangibles such as our licenses and trademark rights acquired under agreements with strategic partners, including Netscape. Loss from Operations. Loss from operations was approximately $674,000 for the nine months ended April 30, 1998 as compared to loss from operations of approximately $2.9 million for the nine months ended April 30, 1999. This change is due to the substantial increase in both sales and marketing expenses as well as general and administrative expenses we incurred as we expanded our corporate infrastructure and human resources. We anticipate continued and increasing losses as we pursue our growth strategy. Comparison of Fiscal Years Ended July 31, 1997 and 1998 Revenue. Revenue increased approximately 344% from approximately $2.7 million for fiscal 1997 to approximately $12.0 million for fiscal 1998. The increase in revenue was primarily due to an increase in minutes of use resulting from increased marketing of our Internet telephony products and services. 22 Of total revenue for the year ended July 31, 1998, PC2Phone generated approximately $8.0 million in revenue and Phone2Phone generated approximately $2.0 million. The increase in revenue was primarily due to an increase in minutes of use due to the marketing of our Internet telephony products and services. Specifically, revenue from PC2Phone services increased approximately 264% from approximately $2.2 million in revenue for fiscal 1997 to approximately $8.0 million in revenue for fiscal 1998. We realized significant revenue for the first time from our Phone2Phone services for fiscal 1998, as well as recorded revenue of approximately $1.5 million from the sale of equipment. In addition, we recognized revenue from amounts charged to IDT including monitoring the network operations center for IDT's Internet customers, of approximately $297,000 and $453,000, respectively, for fiscal 1997 and 1998. We do not expect to realize significant revenue from the sale of equipment in the future. Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue, excluding depreciation increased by approximately 325% from approximately $1.6 million for fiscal 1997 to approximately $6.8 million for fiscal 1998. As a percentage of total revenue, these costs decreased from approximately 58.6% for fiscal 1997 to approximately 57.0% for fiscal 1998. This decrease is primarily attributable to the impact of the higher margin equipment sold in the first half of fiscal 1998. Since we do not expect to realize significant revenue from the sale of equipment in the future, our direct costs will reflect our ability to terminate our traffic worldwide cost-effectively through our own network relationships or via those of IDT, our primary supplier. As a percentage of revenue we anticipate direct costs to remain approximately the same as our network expansion efforts mitigate potential pricing pressures. Sales and Marketing. Sales and marketing expenses increased by a factor of 37 from approximately $77,000 for fiscal 1997 to approximately $2.9 million for fiscal 1998. As a percentage of total revenue, these costs increased from approximately 2.9% for fiscal 1997 to approximately 24.1% for fiscal 1998. This increase primarily reflects the increased marketing and advertising expenses associated with the agreements established with Yahoo!, Excite and other strategic partners. We expect to continue to increase significantly our advertising and marketing expenditures to further build brand recognition, and to enhance the distribution of our products and services. General and Administrative. General and administrative expenses increased approximately 96% from approximately $2.6 million for fiscal 1997 to approximately $5.1 million for fiscal 1998. As a percentage of total revenue, these costs decreased from approximately 98.0% for fiscal 1997 to approximately 42.4% for fiscal 1998. This decrease primarily reflects the efficiencies we have begun to realize from leveraging our sales and support infrastructure. We expect to continue to see further efficiencies and greater economies of scale, so that general and administrative expenses will continue to decline as a percentage of total revenue. In absolute terms, we expect these expenses to continue to increase as we incur additional costs associated with developing new products, hiring of additional personnel and adding new office space. Depreciation. Depreciation increased from approximately $121,000 for fiscal 1997 to approximately $727,000 for fiscal 1998. This increase is primarily attributable to the increase in capital expenditures for the deployment of communications equipment both domestically and internationally to manage increased customer volume. Loss from Operations. Loss from operations was approximately $1.7 million for fiscal 1997 as compared to approximately $3.5 million for fiscal 1998. The increased losses reflect the substantial increase in marketing and general and administrative costs we incurred as we expanded our corporate infrastructure and resources to gain additional market share for our products and services. Period from January 2, 1996 (inception) to July 31, 1996 During the period from January 2, 1996 (inception) to July 31, 1996, we did not generate any revenue. During this period, we incurred approximately $500,000 in start-up costs, primarily for research and development, as we prepared to introduce our products and services. 23 Quarterly Results of Operations The following table sets forth certain quarterly financial data for the seven quarters ended April 30, 1999. This quarterly information is unaudited, has been prepared on the same basis as the annual financial statements, and, in our opinion, reflects all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the information for periods presented. Operating results for any quarter are not necessarily indicative of results for any future period.
Quarter Ended ----------------------------------------------------------------------------------------- Oct. 31, Jan. 31, April 30, July 31, Oct. 31, Jan. 31, April 30, 1997 1998 1998 1998 1998 1999 1999 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Revenue: PC2Phone............... $1,371,598 $1,693,812 $ 2,019,766 $ 2,877,645 $ 3,776,777 $4,809,644 $5,188,416 Phone2Phone............ 70,939 148,572 799,324 1,011,681 1,287,415 2,280,366 2,935,916 Other.................. 825,000 905,000 120,363 162,272 599,227 412,456 913,040 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Total revenue........ 2,267,537 2,747,384 2,939,453 4,051,598 5,663,419 7,502,466 9,037,372 Cost and expenses: Direct cost of revenue, excluding depreciation.......... 602,389 1,070,051 1,916,861 3,259,458 3,353,247 3,970,504 4,524,338 Sales and marketing.... 133,963 316,141 912,956 1,524,706 1,299,903 1,691,810 1,754,603 General and administrative........ 730,893 1,073,165 1,450,229 1,833,341 1,900,234 2,286,770 3,111,102 Depreciation........... 68,169 123,844 229,635 304,860 338,469 400,584 477,659 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Total costs and expenses............ 1,535,414 2,583,201 4,509,681 6,922,365 6,891,853 8,349,668 9,867,702 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Income (loss) from operations and net income (loss).......... $ 732,123 $ 164,183 $(1,570,228) $(2,870,767) $(1,228,434) $ (847,202) $ (830,330) ========== ========== =========== =========== =========== ========== ========== As a Percentage of Revenue ----------------------------------------------------------------------------------------- Revenue: PC2Phone............... 60.5% 61.7% 68.7% 71.0% 66.7% 64.1% 57.4% Phone2Phone............ 3.1 5.4 27.2 25.0 22.7 30.4 32.5 Other.................. 36.4 32.9 4.1 4.0 10.6 5.5 10.1 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Total revenue........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Cost and expenses: Direct cost of revenue, excluding depreciation.......... 26.6 38.9 65.2 80.4 59.2 52.9 50.1 Sales and marketing.... 5.9 11.5 31.1 37.6 23.0 22.6 19.4 General and administrative........ 32.2 39.1 49.3 45.2 33.6 30.5 34.4 Depreciation........... 3.0 4.5 7.8 7.5 6.0 5.3 5.3 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Total costs and expenses............ 67.7 94.0 153.4 170.7 121.8 111.3 109.2 ---------- ---------- ----------- ----------- ----------- ---------- ---------- Income (loss) from operations and net income (loss).......... 32.3% 6.0% (53.4)% (70.7)% (21.8)% (11.3)% (9.2)% ========== ========== =========== =========== =========== ========== ==========
We have experienced growth in revenue in each quarter since inception, reflecting greater acceptance and usage of our products and services by our expanded customer base. We expect our revenue to grow over time as minutes of use increase. However, we may experience declines in average revenue per minute due to competitive pressures, promotions and marketing initiatives, increased commissions paid to our international resellers and increased amounts paid to our strategic partners under existing and future revenue-sharing arrangements. Since we derive revenue from more than one source, we have experienced volatility in our direct costs of revenue. Specifically, our direct cost of revenue in the first two quarters of fiscal 1998 were low as a percentage of total revenue due to sales of equipment in these quarters. Since these sales were on a non-recurring basis, we realized a significant, albeit temporary, reduced direct cost of revenue for these two quarters. In the second half of fiscal 1998, we increased our advertising expenditures as we began marketing our Phone2Phone service. Revenue from our Phone2Phone service grew from approximately 5% of total revenue in the first half of the year to approximately 26% of total revenue in the latter half. We experienced start-up costs for Phone2Phone that increased our direct cost of revenue for those two quarters. However, we have been able to reduce direct cost of revenue for our Phone2Phone product as we expanded our network in the first three quarters of fiscal 1999, which resulted in lower direct cost of revenue. In the most recent quarter, direct cost of revenue as a percentage of revenue accounted for approximately 50% as 24 compared to approximately 80% in the quarter ended July 31, 1998. Our increased sales and marketing expenses reflect the relationships we have with various online strategic partners with whom we advertise our PC2Phone and Phone2Phone services. We expect to continue to increase significantly our advertising and marketing expenditures to further build brand recognition of our products and services. As a result of our limited operating history and the emerging nature of the markets in which we compete, we are unable to accurately forecast our revenue and direct cost of revenue as they may be impacted by a variety of factors. These factors include the level of use of the Internet as a communications medium, seasonal trends, capacity constraints, the amount and timing of our capital expenditures, introduction of new services by us or our competitors, price competition, technical difficulties or system downtime, and the development of regulatory restrictions. Liquidity and Capital Resources Since inception in January 1996, we have financed our operations through advances from IDT. During the nine months ended April 30, 1999 we also received capital contributions from IDT of approximately $4.6 million. As of April 30, 1999, we had approximately $1.8 million in cash and cash equivalents. In May 1999 we raised net proceeds of approximately $29.9 million from the sale of Series A convertible preferred stock and warrants. Our operating activities generated negative cash flow of approximately $409,000 in the nine months ended April 30, 1998 compared to negative cash flow of approximately $4.0 million in the nine months ended April 30, 1999. Cash used in investing activities was approximately $4.2 million and approximately $9.0 million for the nine months ended April 30, 1998 and 1999, respectively. Our use of cash in investing activities was principally for the purchase of telecommunications and Internet equipment and for the purchase of a trademark in the 1999 period. In May 1999, we received $29.9 million in net proceeds from the sale of our Series A convertible preferred stock and warrants. We applied a portion of the net proceeds from this sale to repay $8.0 million of the $22.0 million of advances from IDT that were outstanding as of April 30, 1999. The remaining $14.0 million due to IDT was converted into a promissory note in May 1999. We utilized a portion of the net proceeds from this sale to pay ICQ a $4.0 million fee payable upon the signing of our distribution and marketing agreement with ICQ. Our principal commitments following the closing of this offering are expected to consist of: . the repayment of $7.0 million with respect to the $14.0 million note due to IDT; . the payment of $3.5 million to ICQ in connection with our distribution and marketing agreement; . the payment of $1.5 million to NBC for television advertising; . repayment of the remaining balance on the $14.0 million note to IDT described above, which is payable in 60 monthly installments of principal and interest at a rate of 9% per annum, commencing in June 1999; . the acquisition of a new network with expanded capacity from IDT in exchange for a $6.0 million note, payable in 60 monthly installments of principal and interest at a rate of 9% per annum; . other costs relating to network equipment and expansion; and . payments to Internet companies in connection with marketing our products and services, which as of April 30, 1999, were approximately $15 million. Our future capital requirements will depend on numerous factors, including market acceptance of our services, brand promotions, the amount of resources we devote to the development of our current and future products, and the expansion of our sales force and marketing our services. We may experience a substantial increase in our capital expenditures and lease arrangements consistent with the growth in our operations and staffing. Additionally, we will evaluate possible investments in businesses, products and technologies. We believe that our current cash balances, expected cash flow from our operations and the proceeds of this offering will be sufficient to meet our working capital and capital expenditure needs for at 25 least the next 12 months. However, there can be no assurance that we will have sufficient capital to finance potential acquisitions or other growth oriented activities, and may issue additional equity securities, incur debt or obtain other financing. Warrant Issued to America Online In connection with our distribution and marketing agreement with ICQ, we issued a warrant to America Online to purchase up to 3% of our outstanding capital stock on a fully-diluted basis. This warrant will vest in 1% increments upon the achievement of each of three incremental thresholds of revenue generated under the agreement during the first four years that the warrant is outstanding. The per share exercise price under the warrant will be equal to the lesser of 80% of the price per share in this offering, or $450 million divided by the number of our fully-diluted shares on the initial exercise date. For example, if the first revenue threshhold was reached immediately after the closing of this offering, AOL would be permitted to purchase 1% of the sum of: . 10,944,429 shares of our outstanding common stock; plus . 36,578,190 shares of our common stock issuable upon conversion of our Class A stock; plus . 8,776,744 shares of our common stock reserved for issuance upon exercise of stock options that are outstanding or reserved for issuance under our 1999 Stock Option and Incentive Plan; a total of 56,299,363 shares. Thus, AOL would be permitted to purchase a total of 562,993 shares of common stock. If the initial public offering price of our common stock is $13.00, the per share exercise price of the AOL warrant would be $7.99 per share, which is $450 million divided by the 56,299,363 fully-diluted shares expected to be outstanding. Year 2000 Systems Costs Computer systems, software packages, and microprocessor-dependent equipment may cease to function or generate erroneous data on or after January 1, 2000. The problem affects those systems or products that are programmed to accept a two-digit code in date code fields. For example, computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. To correctly identify the Year 2000, and therefore be "Year 2000 compliant," a four-digit date code field is required. We have conducted a comprehensive review of the computer hardware and software that we use in order to ensure that our computer-related applications are Year 2000 compliant. This review commenced when we were operated as a division of IDT, at which time IDT provided services in connection with this review. Our cost of addressing the Year 2000 issue is not expected to be material to our operations or financial position. However, the consequences of an incomplete or untimely resolution of the Year 2000 issue could be expected to have a material adverse effect upon our financial results. In the absence of such a resolution, our ability to route traffic in a cost effective manner, to deliver our services, to properly obtain payment for these services, and/or to maintain accurate records of our business and operations, could be substantially impaired until this issue is remedied. We may become liable for substantial damages in the event that, as a result of the Year 2000 issue, we fail to deliver any services that we have contracted to provide. Also, our name and reputation may be harmed if our services are disrupted due to Year 2000 problems. 26 Our plan to ensure Year 2000 compliance consisted of the following phases: . conducting a comprehensive inventory of internal systems; . assessing and prioritizing any required remediation; . repairing or, if appropriate, replacing any non-compliant systems; . testing all remediated systems for Year 2000 compliance; and . developing contingency plans that may be employed in the event that any systems used by us is unexpectedly affected by a previously unanticipated Year 2000 problem. We have substantially completed each of these phases, and believe that our internal systems are Year 2000 compliant. We are conducting an external review of our customers and suppliers, and any other third parties with whom we do business, to determine their vulnerability to Year 2000 problems and any potential impact on us. These parties include our equipment and systems providers. In particular, we may experience problems to the extent that telecommunications carriers whose networks connect with ours are not Year 2000 compliant. Our ability to determine the ability of these third parties to address issues relating to the Year 2000 problem is limited. To the extent that a limited number of carriers experience disruptions in service due to the Year 2000 issue, we believe that we will be able to obtain service from alternate carriers. However, our ability to provide certain services to customers in selected geographic locations may be limited. There can be no assurance that such problems will not have a material adverse effect on our business, reputation or operating results. We are also in the process of developing contingency plans with regard to potential or unforeseen Year 2000 problems. We believe that, in the event that one or more of our systems, or the systems of third parties with which we do business, is impaired due to unanticipated Year 2000 issues, our contingency plans will enable us to temporarily conduct operations on a temporarily modified basis until the impaired system or systems is remediated. There can be no assurances that our suppliers and customers will achieve full year 2000 compliance before the end of 1999 or that we will develop or implement effective contingency plans on a timely basis. A failure of our computer systems or the failure of our suppliers or customers to effectively upgrade their software and systems for transition to the Year 2000 could have a material adverse effect on our business, financial conditions and results of operations. Most of our internal systems were developed after developers became aware of Year 2000 problems. To date, we have not incurred material expenses in connection with the remediation of Year 2000 related issues. We do not expect to incur significant costs in connection with Year 2000 related issues. However, our actual costs may be significant if we discover that any major portion of our internal systems requires unforeseen remediation. We expense costs associated with Year 2000 remediation when they are incurred. Effects of Inflation Due to relatively low levels of inflation over the last several years, inflation has not had a material effect on our results of operations. Impact of Recently Issued Accounting Standards SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, was issued in June 1997. We will be required to adopt this new statement for fiscal 1999. This statement requires use of the "management approach" model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure or any other manner in which management disaggregates a company. We do not anticipate that the adoption of this statement will have significant impact on our financial statements. 27 BUSINESS Overview Net2Phone is a leading provider of services enabling users to make high- quality, low-cost telephone calls over the Internet. This service is commonly referred to as Internet telephony. Our Internet telephony services enable our customers to call individuals and businesses worldwide using their personal computers or traditional telephones. We are leveraging our Internet telephony expertise to integrate real-time voice communication capabilities into the Web. We currently offer Web-based Internet telephony services, which enable customers to make calls and send faxes over the Internet using their personal computers, and basic Internet telephony services, which enable customers to make calls using traditional telephones and fax machines. We have developed a sophisticated PC2Phone software application that enables the use of our Web-based Internet telephony services. We distribute this software free of charge through the Internet and through agreements to include our software with products sold by our strategic partners. In January 1999, Netscape agreed to embed our PC2Phone software on an exclusive basis into all versions of Netscape's Internet browser released during the term of our agreement, including Netscape Navigator and Netscape Communicator. Netscape also agreed to include a Net2Phone icon on the Netscape Navigator Personal Toolbar. In addition, we have entered into an agreement with ICQ, a subsidiary of America Online, to provide Internet telephony services to users of ICQ's instant messenging service. ICQ will embed our Internet telephony software into ICQ's Instant Messenger software on an exclusive basis, allowing ICQ users to make PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls. We will also co-brand a pre-paid Phone2Phone calling card with ICQ, allowing users to place calls from the United States and 19 other countries to virtually anywhere in the world. We also have entered into strategic marketing and distribution relationships with leading Internet companies, including Excite, InfoSpace.com, Snap.com, Yahoo! and ZDNet. We have also entered into arrangements with leading computer equipment and software companies, such as IBM, Compaq, Packard Bell-NEC Europe and Creative Labs to include our software with their products. We promote our services through direct sales and marketing and through international resellers who buy minutes of use from us in bulk, and resell them to customers in their respective countries. Our software is currently available in eight languages (English, Spanish, Japanese, French, Dutch, Portuguese, Italian and German). We intend to make our software available in additional languages as we expand our international customer base and distribution channels. As of April 30, 1999, we served over 250,000 active customers who made an average of approximately 60 minutes of calls per month and handled over 20 million minutes of use per month. Our net loss increased from approximately $500,000 in fiscal 1996 and $1.7 million in fiscal 1997 to $3.5 million in fiscal 1998. Our total assets increased from $916,000 at July 31, 1997 to $7.0 million at July 31, 1998. Our revenue has grown substantially, increasing from approximately $2.7 million in fiscal 1997 to approximately $12.0 million in fiscal 1998. Our revenue for the nine months ended April 30, 1999 was approximately $22.2 million. Industry Background The Internet is experiencing unprecedented growth as a global medium for communications and commerce. International Data Corporation estimates that the number of Internet users worldwide will grow from approximately 142 million at the end of 1998 to 399 million by the end of 2002. These users are increasingly using the Internet as a communications medium. A recent study by E-Marketer, a market research firm, estimated that 9.4 billion e-mail messages are delivered daily. Instant text communication through online "chat" rooms is also gaining widespread acceptance. Online commerce is also becoming widely accepted as a means of doing business. According to International Data Corporation, Internet users worldwide purchased more than $50 billion of goods and services in 1998. International Data Corporation projects that commerce over the Internet will to grow to approximately $1.3 trillion in 2003. 28 Emergence of Internet Telephony TeleGeography, a market research firm, estimates that the international long distance market will grow to $79 billion in 2001, with consumers and businesses making an estimated 143 billion minutes of international long distance calls. Despite the large size of this market and the number of minutes of calls made, traditional international long distance calls are still relatively expensive for the consumer. The primary reason for this expense is tariffs set by foreign governments and carriers that are passed on to consumers in the form of higher long distance rates. Internet telephony has emerged as a low cost alternative to traditional long distance calls. International Data Corporation projects that the Internet telephony market will grow rapidly to over $23.4 billion in 2003, from approximately $1.1 billion in 1998. Internet telephone calls are less expensive than traditional international long distance calls primarily because these calls are carried over the Internet or our network and therefore bypass a significant portion of international long distance tariffs. The technology by which Internet phone calls are made is also more cost-effective than the technology by which traditional long distance calls are made. We use a technology called "packet-switching" to break voice and fax calls into discrete data packets, route them over the Internet or our network and reassemble them into their original form for delivery to the recipient. Traditional international long distance calls, in contrast, are made using a technology called "circuit switching" which carries these calls over international voice telephone networks. These networks are typically owned by governments or carriers who charge a tariff for their use. Circuit switching requires a dedicated connection between the caller and the recipient that must remain open for the duration of the call. As a result, circuit-switching technology is inherently less efficient than packet-switching technology which allows data packets representing multiple conversations to be carried over the same line. This greater efficiency creates network cost savings that can be passed on to the consumer in the form of lower long distance rates. Integration of Voice into the Web We believe that Internet telephony offers significant benefits to consumers and businesses over and above international long distance cost savings. The technologies that enable Internet telephony can be applied to integrate live voice capabilities into the Web. We believe that this integration can further enhance the potential for the Internet to become the preferred medium for both communications and commerce. For example, the integration of voice into the Web would supplement existing text-based modes of Internet communication such as e- mail and online chat by adding a live, secure, low-cost or free voice alternative. We believe that this will be attractive both to consumers and businesses. In addition, voice-enabling the Web would give Internet shoppers the ability to speak directly with customer service representatives of online retailers in order to ask questions and alleviate concerns about online security. This may increase the probability that a sale is made and may give online retailers a key competitive advantage by providing them with opportunities to sell higher margin and additional products to these customers. Voice-enabling a commercial Web site may also give online retailers the ability to provide more responsive customer support and service. Integrating live voice capabilities into the Web would also enable Internet companies to offer enhanced communications services, such as providing Internet users with a central source for retrieving voicemail, e-mail, faxes and pages. We believe this would allow these companies to attract more users to their sites and to increase the amount of time these users spend on their sites. This increased usage will allow these Internet companies to attract advertisers and secure higher advertising rates, thereby increasing revenue. 29 Limitations of Existing Internet Telephony Solutions The growth of Internet telephony has been limited to date due to poor sound quality attributable to technological issues such as delays in packet transmission and network capacity limitations. However, recent improvements in packet-switching technology, new software algorithms and improved hardware have substantially reduced delays in packet transmissions. In addition, the use of private networks to transmit calls as an alternative to the public Internet is helping to alleviate network capacity constraints. Finally, the emergence of new, lower cost Internet access technologies, such as high-speed modems, are addressing local Internet access issues. Several large long distance carriers, including AT&T and Sprint, have announced Internet telephony service offerings. However, many of these service offerings have not been deployed on a large scale. Many also require users to purchase other telecommunications services or allow only domestic calling. Smaller Internet telephony service providers also offer low-cost Internet telephony services from personal computers to telephones and from telephones to telephones. These services, however, are available only in limited geographic areas and require payment by credit card which may preclude many international customers from signing up for these services. We also believe that existing Internet telephony service providers rely upon technologies and systems that lack large-scale billing, network management and monitoring systems, and customer service capabilities required for the integration of voice communication into the Web. In addition, many companies currently provide Internet telephony software and services that allow Internet telephone calls to be made between personal computers. However, most of these companies require both the initiator and the recipient of the call to have the same software installed on their personal computers and to be online at the same time. The Net2Phone Solution We deliver high-quality Internet telephony services and voice-enabling Web applications to consumers and businesses. Our solution provides the following benefits to our customers: . Low Cost. Our PC2Phone software is distributed free of charge, and our services allow our customers to make telephone calls often at a fraction of the cost of traditional long distance service. Because international long distance calls routed over the Internet bypass the international settlement process, we are able to charge lower rates than traditional long distance carriers. . High Voice Quality. We offer high voice quality through our proprietary packet-switching technologies, which reduce packet loss and delay, route packets efficiently and perform quality enhancing functions, such as echo cancellation. We intend to continue to enhance the voice quality of our services as our customer base and business grow. . Ease of Use and Access. Our services are designed to be convenient and easy to access from anywhere in the world. To make a call using our Web- based services, a customer need only install our free software on a sound-enabled personal computer, register and be connected to the Internet. No additional telephone lines or special equipment are required. Our Phone2Phone service is also easy to use and requires a customer only to register and dial a toll-free or local access number from any telephone or fax machine. . Voice-Enabled Online Retailing. Our services enable users anywhere in the world to speak with sales or customer service representatives of online retailers and other Web-based businesses while visiting their Web sites. This provides customers an opportunity to ask questions of and to provide credit card information directly to a customer service representative if they are concerned about Internet security, thereby increasing the likelihood of consummating an online sale. In addition, our services allow our customers outside of the United States and Canada to access telephone numbers that might otherwise be inaccessible to them through their local carriers. For example, users of our services in other countries may call United States or Canadian toll-free numbers (i.e., 30 telephone numbers with 800, 877 or 888 prefixes), which are not otherwise available to them, at no charge. The ability to communicate with international customers in this manner provides United States and Canadian-based online retailers and other Web-based businesses with cost effective access to an expansive international customer base. . Reliable Service. Our network is reliable because of its technologically advanced design. This design allows us to expand our network and add capacity by adding switches to the existing network. Our system also provides seamless service and high-quality voice transmission through our ability to reroute packets if problems arise. We believe that our ability to provide reliable service is essential to voice-enable the Web. . Ease of Payment and Online Account Access. Once registered, our customers are able to make unlimited toll-free calls. In addition, they can make toll calls by opening a prepaid account using credit cards, wire transfers or checks payable in United States dollars. Acceptance of payment in multiple forms enables international customers who may not necessarily have credit cards to use our services. Our customers can access their accounts via the Internet in order to view their call history and account balances, and to increase their prepaid amounts. . Customer Support. We offer live customer support 24 hours a day, seven days a week in multiple languages. Our customer support center can be accessed from anywhere in the world at no charge either by calling our toll-free number, where available, or by using our Web-based Internet telephony service. Our integrated customer billing software and call management system provide our customer support staff with immediate access to user accounts, calling patterns and billing history to help us provide better, more responsive customer support. Strategy Our mission is to become the premier Web-based communications enabler. We intend to leverage our leadership position in the Internet telephony market to make our communications services readily available worldwide on the Internet and to develop and market online commerce and related products. Our strategy includes the following key elements: . Drive Usage through Resellers and Strategic Partners. We promote our services through direct sales and marketing and through relationships with international resellers and leading Internet hardware, software and content companies. We intend to build on these relationships and to add more partners and resellers to drive usage of our Internet telephony services. We also intend to partner with large telecommunications companies to enable them to offer our Internet telephony services under their brand. . Pursue Multiple Sources of Revenue. In addition to our minutes-based revenue, we intend to pursue new Web-based revenue opportunities from banner and audio advertising, as well as sponsorship opportunities on our PC2Phone software user interface and our EZSurf.com Web site. We also intend to explore the availability of revenue-sharing opportunities with online retailers. . Enhance Brand Recognition. We have established strong brand identity in the Internet telephony market in large part due to the high-quality of our services and our marketing efforts. We have entered into advertising relationships with leading Web companies such as Netscape, Yahoo! and Excite in order to promote our services. We intend to continue to implement aggressive advertising and sales campaigns to increase brand awareness. In addition, we intend to enhance our brand recognition by cooperatively marketing our Internet telephony services with leading computer hardware and software companies and Internet services providers. . Make Our Software Readily Available Worldwide. We have entered into strategic distribution relationships with leading computer equipment and software companies to expand the availability of our software. For example, our software will be embedded into future versions of Netscape's Internet browser and a Net2Phone icon will be prominently positioned next to AOL's Instant Messenger icon on the Netscape Navigator Personal Tool Bar. In addition, customized versions of 31 our software will be embedded in ICQ's Instant Messenger software and distributed by ICQ. Our software is included with IBM's Internet services and may be pre-loaded on computers sold by Compaq internationally. We intend to build upon these relationships and enter into new distribution relationships with other leading companies in order to enhance the distribution of our software worldwide. . Expand and Enhance Products and Services. We have committed significant resources to expand our network, enhance our existing product and service offerings and to develop and market additional products and services in order to continue to provide customers with high-quality Internet telephony services. For example, we plan to introduce new products and services, including: . PC2PC, which will allow high-quality Internet telephony from one personal computer to another, . Phone2PC, which will allow calls from a traditional telephone to a personal computer, . voice-enabled chat, which will allow two participants in an online chat room discussion to establish direct voice communication with each other while maintaining anonymity, . unified messaging services, which we anticipate will include voice, fax and electronic messaging with multiple points of access, including the Web and conventional telephones, . online commerce applications, which will provide customer service representatives of online retailers with real-time access to a caller's profile and enable them to "push" specific content onto a caller's personal computer screen in order to better assist the caller in answering their inquiries, . customer payment applications, which will allow customers to pay for online commerce transactions by debiting their Net2Phone account, and . video conferencing between two or more personal computer users over the Internet. Strategic Relationships We have entered into strategic distribution, integration and advertising relationships with leading Internet and computer hardware and software companies. These relationships typically include arrangements under which we share with our strategic partners a portion of the revenue they bring to us. We believe that these relationships are important because they provide incentive to our partners and allow us to leverage the strong brand names and distribution channels of these companies to market our products and services. Our strategic partners include: Netscape Netscape has agreed to embed our PC2Phone software on an exclusive basis in future versions of Netscape's Internet browser released during the term of our agreement, including Netscape Navigator and Netscape Communicator. Netscape also has agreed to: . place a Net2Phone icon on the Netscape Navigator Personal Toolbar immediately to the right of the AOL Instant Messenger icon, which will allow Netscape users to use our Web-based Internet telephony services from anywhere on the Web simply by clicking on our icon; . integrate our services into, and prominently display our services on, Netscape Netcenter, including Netscape's Address Book Contacts section and Voice Communications section, which will allow Netscape users to make calls using our services simply by clicking on a displayed telephone number; and 32 . include the software for our Web-based Internet telephony services in Netscape's suite of online plug-in software and Netscape Smart Update programs (both domestically and when available internationally) for downloading by Netscape users from centralized locations on Netscape's Web site. We also have the right to place a specified amount of banner and other advertisements on Web pages of our choice on Netscape's domestic and international Web site. The two-year term of our exclusive agreement with Netscape commences with the beta release of the next version of Netscape's Internet browser, which we believe will occur later this year. ICQ In July 1999, we entered into an exclusive, four-year distribution and marketing agreement with ICQ, a subsidiary of America Online. Under this agreement, ICQ has agreed to: . co-brand and promote our phone-to-phone Internet telephony services in the United States and in 19 other countries; . embed customized versions of our software on an exclusive basis into ICQ's Instant Messenger software to allow ICQ customers to make PC-to- phone and PC-to-PC calls and to receive phone-to-PC calls; . share revenue from advertisements and sponsorships sold by ICQ on our software that is embedded in ICQ's Instant Messenger software; and . promote our services on some of ICQ's Web sites. All of the Internet telephony services that ICQ promotes under our agreement will be co-branded under both of our labels. We believe the phone-to-phone services will be launched in the United States later this year and internationally by early 2000. We believe that the PC-based Internet telephony services will be launched in mid-2000. Yahoo!, Excite and InfoSpace.com In 1998 we signed an agreement with Yahoo!, which was recently renewed through 2000. Our Web-based Internet telephony service is integrated into Yahoo!'s People Search online telephone directory. As a result of this integration, an Internet user who performs a search on Yahoo! People Search can simply click on a displayed telephone number to initiate a call to that number. Under this agreement, we also have the right to have our banner advertising appear when an Internet user performs a word- or category-search for "Internet Telephony" or related phrases on Yahoo! Additionally, we have contracted with Yahoo! to integrate our PC2Phone service into Yahoo!'s Yellow Pages and White Pages online directories. Our Web-based Internet telephony software is also integrated into Excite's Web sites in its International Network, which includes the United Kingdom, Germany, France, Japan, Italy, Australia, Sweden and the Netherlands. As a result, an Internet user in any of these countries will be able to click on any telephone number that appears on any page on these sites to initiate a call to that number using our PC2Phone service. In addition, our services will be prominently featured within the Excite International Network via advertising and promotion on various channels, including each member's homepage, business, technology/computer and travel channels, as well as the localized versions of My Excite, What's New/What's Cool and Mail Excite. We are negotiating with Excite to have our services integrated into Excite's United States Web sites as well. In addition, our Web-based Internet telephony software is integrated into InfoSpace.com's network of white and yellow page directory services. This network of sites includes all the white and yellow page listings in Netscape's Netcenter Web site, the Microsoft Network, the GO Network and Xoom.com. 33 Other Strategic Relationships We also have entered into other important strategic relationships with other leading Internet and computer hardware and software companies, including: . Compaq. Our software is featured as a download from a special Compaq Web site accessible directly from the Compaq-branded keyboard, may be pre- installed on Compaq-branded computers distributed internationally and may be included with their other products. . Snap.com. Promotions for our services and a link to our Web site will be prominently displayed on the Snap.com Web site, and we are their preferred provider of PC-to-phone services. . ZDNet. We are the preferred provider of Internet telephony services for ZDNet and our Web-based Internet telephony service will be integrated throughout the ZDNet Web site. . Quicknet Technologies. Our PC2Phone software is integrated into Quicknet's telephone handset product called Internet PhoneJACK. . Bigfoot International, WorldPages/Web YP and Internet 800 Directory. Our PC2Phone service is integrated into these three popular online directories, which allow Internet users to call any listed telephone number simply by clicking on the displayed number. 34 Products and Services Current Products and Services Our services enable our customers to make low-cost, high-quality phone calls over the Internet using their personal computers or traditional telephones. Our principal current product and service offerings are described in the table below. Product/Service Description Benefits - -------------------------------------------------------------------------------- Basic Internet Telephony Services: . Phone2Phone . Enables customers to . International long make calls over distance rates are . Fax2Fax traditional telephones typically 50% to and fax machines routed 70% lower than the . Net2Phone Pro over the Internet. rate charged by Customers must dial a traditional long local or domestic toll- distance carriers free access number to for calls access the Net2Phone originating in the network. United States, and up to 95% lower for . Customers are charged calls originating for toll and long outside the United distance calls on a States. per-minute basis. There . Users do not need is no charge for to purchase calling United States expensive hardware and Canadian toll-free or software. numbers. . High voice quality. . Available in the United . Faxes are States and in many transmitted without international delay and users locations. receive immediate delivery . We market Phone2Phone confirmations. under the brand "Net2Phone Direct." - -------------------------------------------------------------------------------- Web-based Internet Telephony Services: . PC2Phone . Enables customers to . Services are make calls and send available to any . Click2Talk faxes over the Internet Internet user with using their personal a sound-equipped . PC2Fax computers. Customers personal computer. must install our . International long software on their distance rates are personal computers, typically 50% to register with us and be 70% lower than the online in order to make rates charged by calls. When browsing traditional long Web sites that have a distance carriers Click2Talk icon, for calls customers may initiate originating in the calls to a company United States, and whose site they are up to 95% lower for browsing simply by calls originating clicking on the outside the United Click2Talk icon. States. . Customers are charged . United States and for toll and long Canadian toll-free distance calls on a numbers can be per-minute basis. There accessed from is no charge for outside the United calling United States States and Canada. and Canadian toll-free numbers. . Facilitates online commerce by providing live voice contact between online retailers and Internet shoppers. . Customers do not require multiple telephone lines and need not log off the Internet to initiate a call. - -------------------------------------------------------------------------------- EZSurf.com . A Web-based shopping . Enables voice directory powered by communications with our Web-based Internet over 300 Web sites. telephony services from . Educates users by which Internet users providing them with can initiate calls to essential listed online retailers information by clicking on an icon required to buy on the Web site. products online. . Lists useful information for key online retailers, including payment and shipping options and return policies. 35 Sales, Marketing and Distribution We distribute our software through the Internet, strategic partnerships and international resellers. In addition, our software will be embedded into future versions of Netscape's browser, which, according to International Data Corporation, was used by 41.5% of all consumer Internet users in mid-1998. Additionally, our software will be distributed into future versions of ICQ's Instant Messenger software. Customers can also download our software at no charge from our Web site and other Web sites, including Yahoo!'s People Search and Lands' End's home page. We also distribute our software through strategic relationships with leading Internet and computer hardware and software companies, including IBM, Compaq, Packard Bell-NEC Europe and Creative Labs. Our software is included with our partners' products and services and distributed domestically and internationally. We expect to distribute over 25 million units of our software in 1999 as a result of these and other distribution arrangements. We promote our services through online and Internet-based advertising venues and traditional print advertising in domestic and international publications. We will also be advertising our services on the NBC television network. Another way we sell our services internationally is by entering into exclusive agreements with resellers in other countries. We sell these resellers bulk amounts of minutes of use of our products and services to be resold in the resellers' respective countries. For example, in Asia, we have agreements with Daewoo and Naray Mobile Telecom in South Korea and Marubeni in Japan. In Europe and the Middle East, we have agreements with CAPCOM in Spain and Dot.LB in Lebanon, among others. To facilitate distribution and attract users in foreign countries, we have developed our software in eight languages (English, Spanish, Japanese, French, Dutch, Portuguese, Italian and German) and intend to increase the number of languages as our distribution broadens. Customer Service As part of our goal to attract and retain customers, we offer free live customer support in multiple languages. We employ approximately 67 customer service representatives, who offer customer support to our users 24 hours a day, seven days a week. These services can be reached from anywhere in the world at no cost using either our toll-free number, where available, or our Web-based Internet telephony services. The customer support staff provides technical assistance, as well as general service assistance, for all of our products and services. We also offer customer support via e-mail and fax. Our integrated customer billing software and call management system provide our customer support staff with immediate access to user accounts, calling patterns and billing history, thereby enhancing the quality of service provided to our customers. In addition, our international resellers typically provide their own front-line customer support. Technology PC2Phone Software Our PC2Phone software is simple to install and to use and has won various industry awards. The installation process is wrapped in the industry-standard "Install Shield" product. During installation, the Net2Phone "wizard" verifies that the user's microphone and speakers are properly set for Internet telephony. The installation also has a service registration process that allows the customer to quickly register for paid time with the product. Our software has several buttons and drop down headings to enable customization. These buttons allow the user to change specific properties, access and modify customer account information, program and use speed dialing and verify rates. Our PC2Phone software has gone through fourteen releases, each improving upon our Internet telephony capabilities. The software is a Windows-compliant, 32-bit application written in a high-level PC language. The code is extendible allowing us to easily add new functionality, yet is relatively compact. The newest release of our software can record and play sound files allowing us to deliver voice-mail services and can interface with third party PC mail software applications such as Eudora and Microsoft Outlook. 36 We also have developed a software development kit allowing other companies to quickly and easily integrate their products with our PC2Phone software. For example, our services have been successfully integrated with Quicknet's line of sound cards and telephone interface cards. This integration enables Internet telephony service to be deployed through inexpensive equipment currently used throughout the world. Call Management System To maintain our leadership position in the Internet telephony market, we believe that reliable and flexible billing, information management, monitoring and control systems are critical. Accordingly, we have invested substantial resources to develop and implement our sophisticated real-time call management information system. Key elements of this system include: . Customer Provisioning. The system provides automated online customer registration and customer registration through call centers and resellers. It also provides online credit card authorization and batch billing capabilities that streamline customer registration. A special remote access application program allows other people access to our database, enabling sophisticated partners to remotely service customers through our system, and to tie our system directly to their own business systems. This remote capability includes remote account management and continuous real-time call detail and billing information. Additionally, the system makes customer account records readily available to call center representatives in the event of customer billing problems. . Customer Access. Our system allows customers to independently access their billing records online without the need to contact customer service representatives. . Fraud Control. Fraud detection and prevention features include caller authentication, prevention of multiple simultaneous calls using the same account, pin code verification and call duration timers. We also generate reports on suspicious calling patterns to detect caller registration fraud. We routinely scan for fraudulent content before credit card purchases are allowed. . Network Security. Firewalls are employed to prevent attacks on our network. We use sophisticated techniques to safeguard sensitive database information. In addition, we encrypt call requests and portions of the call to prevent "network sniffers" from unauthorized access to data. . Call Routing. The network management system identifies and routes calls to the most efficiently priced carrier. The system also automatically routes calls around links or servers that are experiencing problems, have failed or have been manually taken out of service for maintenance or upgrades. This system provides remote administration facilities for maintaining routing tables and system monitoring. . Monitoring. The management system provides for real-time monitoring of all call information. We are able to track potential problems such as too many short calls on a server or a low percentage of call completions. The system also provides remote management that allows partners to monitor and manage their own accounts. . Reliability. We maintain two separate network operations centers in Hackensack and Lakewood, New Jersey. These facilities house redundant equipment and have the ability to track calls simultaneously. This redundant system gives our network a high degree of reliability, enabling each network operations center to serve as a back-up to the other. . Detailed Call Records. The management software maintains detailed records for each call, including the account number of the caller, the caller's phone number, access number used, the point at which the call enters and exits our network, the account owner, the calling party, the server/service phone number, the number of the called party, a running account balance, and rate and billing information, including surcharges. 37 The Net2Phone Network Through an agreement with IDT, we lease capacity on an Internet network comprised of leased high-speed fiber optic lines connecting eight major cities across the United States, and lease high-speed fiber optic lines connecting smaller cities to the network. We have a right to use network capacity leased by IDT. The network backbone uses state-of-the-art hardware including Cisco Series 7000 routers and Nortel Passport switches. Our high-speed backbone connects traffic at four major public Internet exchange points and is also facilitated by a growing number of private peering or exchange points with other networks. Through peering arrangements, we exchange Internet traffic with 25 other Internet backbone providers at these points. We operate IDT's network, one of the largest Internet access networks, providing local dial-up access through 36 locations. Our Internet network also includes more than 700 additional network access locations owned by local and regional Internet service providers. We are able to provide service in areas where we do not have dial-up equipment by utilizing call-forwarding technology to expand our coverage areas by increasing the total number of local access numbers. We have been closing down multiple network access points in a number of states in order to consolidate our equipment into central "Super Point of Presence" locations. For example, one Super Point of Presence in New Jersey can supply local access for the entire state of New Jersey. The diagram below illustrates the routing of an Internet telephony call initiated by a customer using a telephone, fax or a personal computer to a terminating telephone or fax machine over our network. [Chart showing work flow within Company] We seek to retain flexibility by utilizing dynamic call routing alternatives. This approach is intended to enable us to take advantage of the rapidly evolving Internet market in order to provide low-cost service to our customers. Accordingly, our network employs an "Open Shortest Path First" protocol that promotes efficient routing of traffic. Additionally, we have placed redundant hardware for reliability in high traffic areas to minimize loss of data packets. Each network data exchange point employs hardware to direct network traffic and a minimum of two dedicated leased data lines to further increase reliability. We manage our network hardware remotely. It is compatible with a variety of local network systems around the world. We believe our Internet telephony network can currently support approximately 5,000 simultaneous calls. We believe our systems are scalable to 10 times their current capacity through the purchase and installation of certain additional hardware. To date, the highest number of simultaneous calls serviced by our network was approximately 1,660 simultaneous calls made on Father's Day in June 1999. The Network Operations Center Our Network Operations Center, located in Hackensack, New Jersey, currently employs a staff of 25 people. There are two groups that work within the network operations center, the network analysis group and the Internet telephony monitoring group. Both groups have 24 hours a day, seven days a week coverage to quickly respond to any issues. 38 The network analysis group works around-the-clock monitoring network issues, handling customer requests, repairing outages and solving security problems. Their key objective is to provide quality service upon which customers can rely. Our monitoring group oversees a nationwide real-time network analysis map, which notifies our staff of network errors. They also use software we developed to monitor our hardware around the world. This group can dynamically turn on or turn off equipment and re-route Internet telephony traffic, as necessary. Customers We have a diverse, global customer base. As of April 30, 1999, approximately 65% of our customers were based outside of the United States. As of April 30, 1999, we served over 250,000 active customers who had used our services during the preceding three months. In addition, as of June 25, 1999, we had installed the Click2Talk service on approximately 150 commercial Web sites. Competition Long Distance Market The long distance telephony market and, in particular, the Internet telephony market, is highly competitive. There are several large and numerous small competitors, and we expect to face continuing competition based on price and service offerings from existing competitors and new market entrants in the future. The principal competitive factors in the market include price, quality of service, breadth of geographic presence, customer service, reliability, network capacity and the availability of enhanced communications services. Our competitors include AT&T, MCI WorldCom and Sprint in the United States and foreign telecommunications carriers. Many of our competitors have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the industry than we have. As a result, certain of these competitors may be able to adopt more aggressive pricing policies, which could hinder our ability to market our Internet telephony services. One of our key competitive advantages is the ability to route calls through Internet service providers, which allows us to bypass the international settlement process and realize substantial savings compared to traditional telephone service. Any change in the regulation of an Internet service provider could force us to increase prices and offer rates that are comparable to traditional telephone call providers. Web-Based Internet Telephony Services As consumers and telecommunications companies have grown to understand the benefits that may be obtained from transmitting voice over the Internet, a substantial number of companies have emerged to provide voice over the Internet. In addition, companies currently in related markets have begun to provide voice over the Internet services or adapt their products to enable voice over the Internet services. These related companies may potentially migrate into the Internet telephony market as direct competitors. . Internet Telephony Service Providers. During the past several years, a number of companies have introduced services that make Internet telephony services available to businesses and consumers. In addition to us, AT&T Jens (a Japanese affiliate of AT&T), ICG Communications, IPVoice.com, ITXC, OzEmail (which was recently acquired by MCI WorldCom), RSL Communications (through its Delta Three subsidiary) and VIP Calling provide a range of voice-over-the-Internet services. These companies offer PC-to-phone or phone-to-phone services that are similar to the services we offer. Some, such as AT&T Jens and OzEmail, offer these services within limited geographic areas. Additionally, a number of companies have recently introduced Web-based voice-mail services and voice-chat services to Internet users. 39 . Software/Hardware Providers. Many companies produce software and other computer equipment that may be installed on a user's computer to permit voice communications over the Internet. These products generally require each user to have compatible software and hardware equipment and rely on the public Internet for the transmission of traffic, which often results in reduced quality of communications. Representative companies include VocalTec and Netspeak. We believe VocalTec's software and hardware are unable to handle large numbers of simultaneous calls. Netspeak focuses on delivering solutions targeted at traditional call centers that require significant customization. . Telecommunications Companies. A number of telecommunications companies, including AT&T, Deutsche Telekom, MCI WorldCom and Qwest, currently maintain, or plan to maintain, packet-switched networks to route the voice traffic of other telecommunications companies. These companies, which tend to be large entities with substantial resources, generally have large budgets available for research and development and therefore may further enhance the quality and acceptance of the transmission of voice over the Internet. However, many of these companies are new to the Internet telephony market, and therefore may not build brand recognition among consumers for these services. These companies also may not have the range of product and service offerings that are necessary to independently provide a broad set of voice-enabled Web services. AT&T, for example, has attempted to enter the market but has focused its effort on the cable market and it is unclear if it will continue to pursue voice over the Web. Qwest has taken steps to enter the market by building a high capacity network in the United States. In addition, Qwest has also entered into a three-year strategic alliance with Netscape to provide one-stop access to Internet services including long distance calling, e-mail, voice mail, faxes, Internet access and conference calls. . Network Hardware Manufacturers. Several of the world's major providers of telecommunications equipment, such as Alcatel, Cisco, Lucent, Northern Telecom and Dialogic (which has entered into an agreement to be acquired by Intel) have developed or plan to develop network equipment that may be used in connection with the provision of voice over the Web services, including routers, servers and related hardware and software. By developing this equipment, these manufacturers may exert substantial influence over the technology that is used in connection with transmission of voice over the Web and may develop products that facilitate the quality and timely roll-out of these networks. However, these companies are dependent upon the operators of Internet telephony networks to purchase and install their equipment into their networks. They are also dependent upon the developers of hardware and software to market their systems to end users. Cisco currently manufactures Internet telephony equipment for low to medium scale networking, but does not manufacture high-end Internet telephony equipment for large networks. However, Cisco recently acquired two companies that produce devices to help Internet service providers transition voice and data traffic to packet networks while maintaining traditional phone usage and network equipment. Lucent has recently co-developed with VocalTec a set of industry standards that have been adopted by major competitors and is currently marketing Internet telephony hardware, including servers that allow the transmission of calls and faxes over the Internet. Lucent also offers related support products, such as billing centers and "Internet call centers," which allow Internet access and conversation with a customer support agent on a single line. Research and Development Strategic Research and Development At our primary research and development center in Lakewood, New Jersey, we currently employ 12 engineers, whose specialties include software, hardware, switching, Internet security, voice compression, engineering real-time online transactions, billing, and network and call management. This staff is devoted to the improvement and enhancement of our existing product and service offerings, as well as to the 40 development of new products and services. Current research and development activities include enhancements to our customer billing software and call management system to increase the capacity of these systems, improvements to our Internet telephony hardware to increase capacity and modifications to our PC2Phone software to increase functionality. Our future success will depend, in part, on our ability to improve existing technology and develop new products services that incorporate leading technology. We incurred $473,000 and $481,000 in product development expenses during fiscal 1997 and fiscal 1998, respectively. For the nine months ended April 30, 1999, we incurred product development expenses of $466,000. Management Information Systems Research and Development Our management information systems development team, located in Hackensack, New Jersey, has eleven programmers and a development manager dedicated to traditional management information systems development and upgrades. The group supports back-office accounting and reporting software, customer service support software and database support. The development schedule is primarily focused on a detailed list of upgrades that have been identified and prioritized by a team manager. The database architecture is managed by a senior developer in our Lakewood laboratory who was responsible for similar database functions at AT&T's WorldNet division. Web Research and Development The majority of our Web research and development is done by a separate Web development group located in our headquarters in Hackensack. The group of nine consists of five developers, two programmers, one graphics designer and one development manager. The team is responsible for our multiple language Web site, the EZSurf.com Web site and specialized Web interfaces, including the integration of our PC2Phone client software into Netscape's Internet browser. Regulation Regulation of Internet Telephony The use of the Internet to provide telephone service is a recent market development. Currently, the Federal Communications Commission is considering whether to impose surcharges or additional regulations upon certain providers of Internet telephony. On April 10, 1998, the FCC issued its report to Congress concerning the implementation of the universal service provisions of the Telecommunications Act. In the report, the FCC indicated that it would examine the question of whether certain forms of phone-to-phone Internet telephony are information services or telecommunications services. The FCC noted that it did not have, as of the date of the report, an adequate record on which to make a definitive pronouncement, but that the record suggested that certain forms of phone-to-phone Internet telephony appear to have the same functionality as non- Internet telecommunications services and lack the characteristics that would render them information services. If the FCC were to determine that certain services are subject to FCC regulation as telecommunications services, the FCC may require providers of Internet telephony services to make universal service contributions, pay access charges or be subject to traditional common carrier regulation. It is also possible that PC2Phone and Phone2Phone services may be regulated by the FCC differently. In addition, the FCC sets the access charges on traditional telephony traffic and if it reduces these access charges, the cost of traditional long distance telephone calls will probably be lowered, thereby decreasing our competitive pricing advantage. In September 1998, two regional Bell operating companies, U S WEST and BellSouth, advised Internet telephony providers that the regional companies would impose access charges on Internet telephony traffic. In addition, U S WEST has petitioned the FCC for a declaratory ruling that providers of interstate Internet telephony must pay federal access charges, and has petitioned the public utilities commissions of Nebraska and Colorado for similar rulings concerning payment of access charges for intrastate Internet telephone calls. 41 At this time, it is not known whether these companies, U S WEST and BellSouth, will actually impose access charges or when such charges will become effective. If these companies succeed in imposing access charges that may reduce the cost savings of using Internet telephony as compared to traditional telephone service. The existence of these access charges would materially adversely affect the development of our Internet telephony business. In February 1999, the FCC adopted an order concerning payment of reciprocal compensation that provides support for a possible finding by the FCC that providers of Internet telephony must pay access charges for at least some subset of Internet telephony services. If the FCC were to make such a finding, the payment of access charges could materially adversely effect our business, results of operations and financial condition. Many of our competitors are lobbying the FCC for the imposition of access charges on Internet telephony traffic. To our knowledge, there are currently no domestic and few foreign laws or regulations that prohibit voice communications over the Internet. State public utility commissions may retain jurisdiction to regulate the provision of intrastate Internet telephony services. A number of countries that currently prohibit competition in the provision of voice telephony have also prohibited Internet telephony. Other countries permit but regulate Internet telephony. If Congress, the FCC, state regulatory agencies or foreign governments begin to regulate Internet telephony, such regulation may materially adversely affect our business, financial condition or results of operations. Regulation of the Internet Congress has recently adopted legislation that regulates certain aspects of the Internet, including online content, user privacy, taxation, access charges, liability for third-party activities and jurisdiction. The European Union has also enacted several directives relating to the Internet, one of which addresses online commerce. In addition, federal, state, local and foreign governmental organizations are considering other legislative and regulatory proposals that would regulate the Internet. Increased regulation of the Internet may decrease its growth, which may negatively impact the cost of doing business via the Internet or otherwise materially adversely affect our business, results of operations and financial condition. The Federal Trade Commission has proposed regulations regarding the collection and use of personal identifying information obtained from individuals when accessing Web sites, with particular emphasis on access by minors. These regulations may include requirements that companies establish certain procedures to disclose and notify users of privacy and security policies, obtain consent from users for certain collection and use of information and to provide users with the ability to access, correct and delete personal information stored by the company. These regulations may also include enforcement and redress provisions. There can be no assurance that we will adopt policies that conform with any regulations adopted by the FTC. Moreover, even in the absence of those regulations, the FTC has begun investigations into the privacy practices of companies that collect information on the Internet. One investigation resulted in a consent decree pursuant to which an Internet company agreed to establish programs to implement the principles noted above. We may become subject to a similar investigation, or the FTC's regulatory and enforcement efforts may adversely affect the ability to collect demographic and personal information from users, which could have an adverse effect on our ability to provide highly targeted opportunities for advertisers and electronic commerce marketers. Any of these developments would materially adversely affect our business, results of operations and financial condition. The European Union has adopted a directive that imposes restrictions on the collection and use of personal data. Under the directive, citizens of the European Union are guaranteed rights to access their data, rights to know where the data originated, rights to have inaccurate data rectified, rights to recourse in the event of unlawful processing and rights to withhold permission to use their data for direct marketing. The directive could, among other things, affect United States companies that collect information over the Internet from individuals in European Union member countries, and may impose restrictions that are more stringent than current Internet privacy standards in the United States. In particular, companies with offices located in European Union countries will not be allowed to send personal information to countries that do 42 not maintain adequate standards of privacy. The directive does not, however, define what standards of privacy are adequate. As a result, the directive may adversely affect the activities of entities such as us that engage in data collection from users in European Union member countries. Intellectual Property Our performance and ability to compete are dependent to a significant degree on our proprietary and licensed technology. We rely on a combination of patent, copyright, trademark and trade secret laws and contractual restrictions to establish and protect our technology. We do not currently have any issued patents or registered copyrights. All key employees have signed confidentiality agreements and we intend to require each newly hired employee to execute a confidentiality agreement. These agreements provide that confidential information developed by or with an employee or consultant, or disclosed to such person during his or her relationship with us, may not be disclosed to any third party except in certain specified circumstances. These agreements also require our employees to assign their rights to any inventions to us. The steps taken by us may not, however, be adequate to prevent the misappropriation of our proprietary rights or technology. In addition, our competitors may independently develop technologies that are substantially equivalent or superior to our technology. We own the registered service mark for three of the marks used in our business and have applications pending to register several other service marks used in our business. There can be no assurance that we will be able to secure significant protection for all our service marks. Competitors of ours or others could adopt product or service marks similar to our marks, or try to prevent us from using our marks, thereby impeding our ability to build brand identity and possibly leading to customer confusion. We have received correspondence from a company, NetPhone Inc., claiming that our use of the mark "Net2Phone" in connection with Internet telephony services infringes one of that company's United States registered trademarks and requesting that we cease and desist from using the Net2Phone mark. We have responded by denying any infringement and no legal proceedings have been commenced against us with respect to this matter. NetPhone currently operates a Web site at www.netphone.com. There can be no assurance that the existence of NetPhone's business and Web site will not materially adversely affect our business. AT&T, who may have rights in the terms "Click2Dial," "Click2Whisper" and "Click2Interact", has filed with the United States Patent and Trademark Office for an extension of the time limit for opposing our service mark application filed for the "Click2Talk" mark. AT&T could oppose registration of our Click2Talk mark or take other action aimed at restricting us from using this mark. We are also aware of several other parties that use marks that are the same or similar to marks that we use, though in some instances, to the best of our knowledge, these parties are not in the same business as we are. There can be no assurance that the companies that notified us or other companies with marks similar to our marks will not bring suit to prevent us from using the Net2Phone mark or other marks. Defending or losing any litigation relating to intellectual property rights could materially adversely affect our business, results of operations and financial condition. In addition, one of our international resellers, a company known as ITM, operates a Web site at www.net2phone.net without our permission or authorization, and in violation of the agency agreement ITM entered into with us for the distribution of the Net2Phone software with certain ITM software. Furthermore, ITM has also taken steps to secure registration and ownership of the Net2Phone mark in France. We have notified ITM of these violations, have taken actions to oppose ITM's registration of the Net2Phone mark, as well as filed a dispute policy complaint with Network Solutions, Inc., and will continue 43 to pursue our claim against them, but there can be no assurances that we can prevent, through litigation or otherwise, ITM from continuing its operation of the www.net2phone.net Web site or from obtaining registration and ownership of the Net2Phone mark in France. We have also commenced trademark opposition proceedings in Ecuador and in Venezuela against two parties that are attempting to register the Net2Phone mark or a confusingly similar mark in these countries. We have not taken steps to assure foreign protection of our trademarks, except for our recent filing of a Community Trademark application for registration of the Net2Phone mark, which covers certain European countries. To the extent trademark rights are acquired through registration in countries outside the United States, we may not be able to protect our marks or assure that we are not infringing other parties' marks in those countries. Moreover, we have not taken steps to register the Net2Phone domain names with the various international registries. We have been assigned the rights to patent applications claiming a number of the technologies underlying our products and services. Our two United States patent applications have been rejected, but we are continuing to pursue patent protection for the claimed subject material. There can be no assurance that the applications will result in the issuance of patents or that, if issued, such patents would adequately protect us against competitive technology or that they would be held valid and enforceable against a challenge. In addition, it is possible that our competitors may be able to design around any such patents. Also, our competitors may obtain patents that we would need to license or circumvent in order to make, use, sell or offer for sale the technology. We believe that we do not infringe upon the proprietary rights of any third party, and no third party has asserted a patent infringement claim against us. It is possible, however, that such a claim might be asserted successfully against us in the future. Our ability to make, use, sell or offer for sale our products and services depends on our freedom to operate. That is, we must ensure that we do not infringe upon the proprietary rights of others or have licensed all such rights. We have not requested or obtained an opinion from our outside counsel as to whether our products and services infringe upon the intellectual property rights of any third parties. We are aware that patents have recently been granted to others based on fundamental technologies in the Internet telephony area. In addition, we are aware of at least one other patent application involving potentially similar technologies to our own which if issued could materially adversely affect our business. Because patent applications in the Unites States are not publicly disclosed until issued, other applications may have been filed which, if issued as patents, could relate to our services and products. However, foreign patent applications do publish before issuance. We are aware of several such publications that relate to Internet telephony. One such published application claims as an inventor a previous consultant to IDT and has been assigned to another company. Issuance of a patent or patents from this application could materially adversely affect our ability to operate. A party making an infringement claim could secure a substantial monetary award or obtain injunctive relief which could effectively block our ability to provide services or products in the United States or abroad. If any of these risks materialize, we could be forced to suspend operations, to pay significant amounts to defend our rights, and a substantial amount of the attention of our management may be diverted from our ongoing business, each of which could materially adversely affect our ability to operate. We rely on a variety of technology, primarily software, that we license from third parties. Most of this technology was purchased or licensed on our behalf by IDT. Continued use of this technology by us may require that we purchase new or additional licenses from third parties or obtain consents from third parties to assign the applicable licenses from IDT. There can be no assurances that we can obtain those third party licenses needed for our business or that the third party technology licenses that we do have will continue to be available to us on commercially reasonable terms or at all. The loss or inability to maintain or obtain upgrades to any of these technology licenses could result in delays or breakdowns in our ability to continue developing and providing our products and services or to enhance and upgrade our products and services. 44 Employees As of May 31, 1999, we had approximately 171 full-time employees, including approximately 66 in technical support and customer service, 26 in sales and marketing, 20 in management and finance, 47 in operations, and 12 in research and development. Our employees are not represented by any union, and we consider our employee relations to be good. We have never experienced a work stoppage. Properties Our primary facilities consist of approximately 15,445 square feet, which comprise our headquarters, executive offices and customer service and technical support centers, and are located in two buildings in Hackensack, New Jersey leased from corporations that are owned and controlled by Howard S. Jonas. Mr. Jonas is one of our directors, a director of IDT and the controlling stockholder of IDT. These leases expire at the end of February 2002 and require us to make annual rental payments of $186,144. We also sublease space for some of our computer equipment in Piscataway, New Jersey from IDT, which leases this space from a company also owned and controlled by Mr. Jonas. This lease runs for a three-year term, beginning in May 1999, with monthly rent of $8,400. In addition, we lease office space in Lakewood, New Jersey for our research and development center. Pursuant to this lease, which expires at the end of August 2001, we are required to make annual rental payments of $48,125. See "Certain Transactions--Facility Leases." Legal Proceedings We are not currently a party to any material legal proceedings. 45 MANAGEMENT Executive Officers, Directors and Key Employees The following persons are our executive officers and directors:
Name Age Position ---- --- -------- Clifford M. Sobel......... 50 Chairman of the Board Howard S. Balter.......... 37 Chief Executive Officer and Vice Chairman of the Board Jonathan Fram............. 42 President David Greenblatt.......... 47 Chief Operating Officer Ilan M. Slasky............ 29 Chief Financial Officer H. Jeff Goldberg.......... 46 Chief Technology Officer Jonathan Reich............ 33 Executive Vice President- Marketing and Corporate Development Martin Rothberg........... 30 Executive Vice President- Strategic Sales Jonathan Rand............. 36 Executive Vice President- International Sales and Treasurer Howard S. Jonas........... 43 Director James A. Courter.......... 57 Director Gary E. Rieschel.......... 43 Director James R. Mellor........... 69 Director Stephen A. Oxman.......... 54 Director Jesse King................ 44 Director
Clifford M. Sobel has been Chairman of the board of directors since May 1999, served as our President from October 1997 to July 1999 and served as our Chief Executive Officer from October 1997 to January 1999. Since 1994, Mr. Sobel has been Chairman and Chief Executive Officer of SJJ Investment Corp., which has invested in Internet, cable, real estate and cosmetics companies. Prior to this, Mr. Sobel founded several companies in the design and manufacturing of retail interiors and themed environments, including DVMI and its subsidiary, Bon-Art International, and Bauchet International. These companies were sold in 1994 by Bear, Stearns & Co. Inc. Mr. Sobel has testified before Congress on foreign trade issues and, by Presidential appointment, served on the Holocaust Memorial Council in Washington, D.C. Howard S. Balter has been a director since October 1997, our Chief Executive Officer since January 1999, and our Vice Chairman of the board of directors since May 1999. Mr. Balter also served as our Treasurer from October 1997 to July 1999. Prior to his employment with us, Mr. Balter was IDT's Chief Operating Officer from 1993 to 1998 and Chief Financial Officer from 1993 to 1995. Mr. Balter was a director of IDT from December 1995 to January 1999 and Vice Chairman of IDT's board from 1996 to 1999. From 1985 to 1993, Mr. Balter operated his own real estate development firm. Jonathan Fram became our President in July 1999. Prior to his employment with us, Mr. Fram was General Manager of Bloomberg L.P.'s New Media Group from 1996 to 1999, where he was responsible for Bloomberg's Internet strategy. Mr. Fram was employed as General Manager of Bloomberg's Television and Radio Group from 1991 to 1996. From 1989 to 1991, Mr. Fram served as the Chief Executive Officer of FNN:PRO - Institutional Research Network, Inc. Mr. Fram was also employed by both Bear Stearns & Co. and Paine Webber, Inc. as a securities analyst, and worked for IBM as a computer design engineer. David Greenblatt has been our Chief Operating Officer since January 1999. Between January 1998 and January 1999, Mr. Greenblatt served as IDT's Vice President of Networks, during which time he was primarily responsible for the operations of Net2Phone. Prior to his employment with IDT in January 1998, Mr. Greenblatt was Senior Vice President of Research and Development for Nextwave Communications from 1996 to 1997. From January 1984 to August 1996, Mr. Greenblatt was a principal of Financial Technologies, Inc., where he managed the process of software conversion for large and medium-sized businesses. From January 1980 to December 1984, Mr. Greenblatt was an information technologies 46 consultant for various money center banks. From 1970 to 1980, Mr. Greenblatt has lectured in the areas of Computer Science and Mathematics at Queens College, New York University, Hunter College and Pace University. Ilan M. Slasky has been our Chief Financial Officer since January 1999. Prior to his employment with us, Mr. Slasky was IDT's Executive Vice President of Finance from December 1997 to January 1999, IDT's director of carrier services from November 1996 to July 1997 and IDT's Director of Finance from May 1996 to November 1996. From 1991 to 1996, Mr. Slasky worked for Merrill Lynch in various areas of finance, including risk management, fixed income trading and equity derivatives. H. Jeff Goldberg has been our Chief Technology Officer since January 1999. From January 1996 to January 1999, Mr. Goldberg was our Director of Technology and a consultant to IDT. Mr. Goldberg was an independent software consultant from 1985 to 1995, Vice President of Software and a member of the board of directors at Charles River Data Systems in Massachusetts from 1979 to 1985 and a developer of multimedia communications software at AT&T Bell Laboratories from 1977 to 1979. Mr. Goldberg is a founding member of the UNIX standards committee. Jonathan Reich has been our Executive Vice President--Marketing and Corporate Development since January 1999. Prior to his employment with us, Mr. Reich was IDT's Senior Vice President of Advertising, Marketing and Business Development in charge of strategic relationships for both us and IDT from June 1997 to December 1998 and IDT's director of advertising from January 1995 to November 1997. From 1992 to 1993, Mr. Reich worked for Sanford Bernstein & Co. as an associate analyst. Prior to this, Mr. Reich was an internal consultant for Morgan Stanley & Co. Martin Rothberg has been our Executive Vice President--Strategic Sales since January 1999 and a key employee since June 1997. Prior to his employment with us, Mr. Rothberg was IDT's Director of International Sales from September 1996 to June 1997 and IDT's Director of Domestic Sales from June 1995 to September 1996. Jonathan Rand has been our Executive Vice President--International Sales since January 1999, Treasurer since July 1999 and a key employee since January 1998. Prior to joining us, Mr. Rand was a member of IDT's senior management from 1992 to January 1999, including service as Senior Vice President-- International Sales and Senior Vice President--Finance. Additionally, Mr. Rand is a co-founder and director of the International Internet Association. Prior to joining IDT, Mr. Rand operated his own magazine publishing business from 1986 to 1992 and was employed by Procter & Gamble from 1985 to 1986 in Brand Management. Howard S. Jonas was appointed a director in October 1997. Mr. Jonas founded IDT in August 1990 and has served as Chairman of the Board and Treasurer since its inception and as Chief Executive Officer since December 1991. Additionally, he served as President of IDT from December 1991 through September 1996. Mr. Jonas is also the founder and has been President of Jonas Publishing Corp., a publisher of trade directories, since its inception in 1979. James A. Courter was appointed a director in May 1999. Mr. Courter has been President of IDT since October 1996 and a director of IDT since March 1996. Mr. Courter has been a senior partner in the New Jersey law firm of Courter, Kobert, Laufer & Cohen, P.C. since 1972. He was also a partner in the Washington, D.C. law firm of Verner, Liipfert, Bernhard, McPherson & Hand from January 1994 to September 1996. From 1991 to 1994, Mr. Courter was chairman of the President's Defense Base Closure and Realignment Commission. Mr. Courter was a member of the United States House of Representatives for 12 years, retiring in January 1991. Mr. Courter also serves on the board of directors of Envirogen and The Berkeley School. Gary E. Rieschel was appointed a director in June 1999. Mr. Rieschel is the Executive Managing Director of SOFTBANK Technology Ventures, which he joined in January 1996. Mr. Rieschel has extensive 47 overseas experience, having spent over four years in Tokyo as General Manager of Sequent Computer Systems' Asian operations. He serves as a Director for several SOFTBANK Technology Ventures' portfolio companies and is a member of SOFTBANK Corporation's Global Executive Board. James R. Mellor was appointed a director in June 1999. Mr. Mellor served as a director of IDT between August 1997 and June 1999. Since 1981, Mr. Mellor worked for General Dynamics Corporation, a developer of nuclear submarines, surface combatant ships and combat systems. From 1994 until 1997, Mr. Mellor served as Chairman and Chief Executive Officer of General Dynamics, and from 1993 to 1994, he served as President and Chief Operating Officer of General Dynamics. Before joining General Dynamics, Mr. Mellor served as President and Chief Operating Officer of AM International, Inc. now Multigraphics, Inc. Before that time, Mr. Mellor spent 18 years with Litton Industries in a variety of engineering and management positions, including Executive Vice President in charge of Litton's Defense Group from 1973 to 1997. Stephen A. Oxman was appointed a director in July 1999. Mr. Oxman currently serves as a managing director in the mergers, acquisitions and corporate advisory group of Deutsche Bank Securities Inc., an affiliate of BT Alex. Brown Incorporated. He heads the group's telecommunications practice and also focuses on the firm's work in Europe. In 1995, Mr. Oxman became a partner in the investment banking firm of James D. Wolfensohn Incorporated, which merged in 1996 with Bankers Trust, which in turn merged with Deutsche Bank in 1999. From 1993 to 1994, Mr. Oxman served as Assistant Secretary of State for European and Canadian Affairs. From 1988 to 1993, Mr. Oxman was a managing director of Wasserstein Perella & Co. and Deputy Chairman of Wasserstein Perella International. From 1980 to 1988, he was a partner in the law firm of Shearman & Sterling. During the Carter administration, Mr. Oxman was Executive Assistant to the Deputy Secretary of State, and subsequently a consultant to the Secretary of State concerning the Iran hostage crisis. Jesse King was appointed a director in July 1999. Mr. King has served as the Operation Manager for the Rockefeller Foundation's Next Generation Leadership Program and the Philanthropy Workshop since January of 1996. Before joining The Rockefeller Foundation, Mr. King worked as the Senior Program Director and Human Resource Director for the Colorado Outward Bound School from 1990 to 1996. Additionally, Mr. King worked as a Project Director and Consultant for the Children's Defense Fund and the Black Community Crusade for Children from February 1994 to 1995. In addition, we employ the following additional key employees: Ira A. Greenstein has been our General Counsel and Secretary since May 1999. Mr. Greenstein has been a partner in the law firm of Morrison & Foerster LLP since 1997 where he serves as the chair of that firm's New York office's Corporate Department. Prior to 1997, Mr. Greenstein was an associate in the New York and Toronto offices of Skadden, Arps, Slate, Meagher & Flom LLP. From 1991 to 1992, Mr. Greenstein served as counsel to the Ontario Securities Commission advising on the implementation of the Multijurisdictional Disclosure System with the Securities and Exchange Commission. Mr. Greenstein also served on the Securities Advisory Committee to the Ontario Securities Commission from 1992 to 1996. Mr. Greenstein has testified as an expert in the U.S. securities laws in U.S. District Court. Chaim Ackerman has been a senior software engineer of ours since February 1996. Prior to his employment with us, Mr. Ackerman was a member of the technical staff at AT&T Bell Laboratories from 1986 to 1996. From 1984 to 1986, Mr. Ackerman was a member of the technical staff at AT&T Consumer Products. From 1980 to 1984, Mr. Ackerman worked for Computer Horizons Corporation as a consultant to Bell Laboratories. Sarah Hofstetter has been our Vice President-Corporate Communications since May 1999. Prior to her employment with us, Ms. Hofstetter was IDT's Vice President of Corporate Communications, in charge of public relations and brand imaging from April 1996 to January 1999. From 1995 to 1996, Ms. Hofstetter 48 worked at The New York Times Syndicate as an editor of the New America News Service, a wire service specializing in issues related to diversity in the marketplace. Ms. Hofstetter sits on the editorial boards of Telecom Business and TeleCard World magazines, and on the Editorial Roundtable of Intel-Card News magazine. Board of Directors and Committees of the Board Our certificate of incorporation, as amended and restated, provides that the number of members of our board of directors shall be not less than five and not more than 11. The number of directors is currently eight. We anticipate that one additional director will be elected after the closing of this offering. Upon consummation of this offering, the board of directors will be divided into three classes, with each class to be as nearly equal in number as possible. At each annual meeting of stockholders, the successors to the class of directors whose term expires at that time will be elected to hold office for a term of three years and until their respective successors are elected and qualified. All of the officers identified above serve at the discretion of our board of directors. IDT and Clifford M. Sobel, our Chairman, have agreed to vote all of their shares in favor of the election of a director nominated by SOFTBANK Technology Ventures IV and a director nominated by either GE Capital Equity Investments or NBC, in each case for as long as either entity holds a majority of the shares of Series A convertible preferred stock originally purchased by them or the shares into which they are convertible. Gary E. Rieschel was nominated to our board by SOFTBANK. Neither GE nor NBC has nominated a director. We have established an audit committee and a compensation committee. The initial members of the Compensation Committee are James R. Mellor and Jesse King. We expect to appoint one or more additional directors to this committee after the closing of this offering. Mr. Mellor and Mr. Oxman sit on the Audit Committee. The audit committee oversees the retention, performance and compensation of the independent public accountants, and the establishment and oversight of such systems of internal accounting and auditing control as it deems appropriate. The compensation committee reviews and approves the compensation of our executive officers, including payment of salaries, bonuses and incentive compensation, determines our compensation policies and programs, and administers our stock option plans. The board of directors does not have a nominating committee. However, the board of directors will consider nomination recommendations from stockholders, which should be addressed to our corporate secretary at our principal executive offices. Executive Compensation The following table identifies our most highly compensated executive officers whose salaries and bonuses exceeded $100,000 during fiscal 1998 and who served as executive officers of Net2Phone during fiscal 1998. Our Chief Executive Officer, Howard S. Balter was employed as the Chief Operating Officer and Vice Chairman of IDT during fiscal 1998 and did not serve as an executive officer of Net2Phone during fiscal 1998. All of the named executive officers listed below were compensated by IDT during fiscal 1998. 49 Summary Compensation Table
Long-Term Annual Compensation Compensation Awards ------------------ -------------- Securities Name and Principal Fiscal Underlying All Other Position Year Salary($) Bonus($) IDT Options(#) Compensation($) - ------------------ ------ --------- -------- -------------- --------------- Clifford M. Sobel(1).... 1998 100,000 -- -- -- Chairman and President David Greenblatt........ 1998 104,238 -- 20,000 -- Chief Operating Officer H. Jeff Goldberg........ 1998 209,447 -- 50,000 -- Chief Technology Officer
- --------------------- (1) Mr. Sobel served as our Chief Executive Officer from October 1997 to January 1999 and our President from October 1997 to July 1999. Option Grants During Fiscal 1998 No options to purchase shares of Net2Phone were granted to the executive officers named above during fiscal 1998. The following table describes the options to acquire shares of common stock of IDT granted to the individuals named above during fiscal 1998:
Potential Realizable Value % of at Number of Total Assumed Annual Securities Options Rates of Stock Under- Granted Price lying IDT to Exercise Appreciation Options Employees or for Option Term Granted in Fiscal Base Price Expiration ----------------- Name (#) Year (%) ($/Sh) Date 5% ($) 10% ($) - ---- ---------- --------- ---------- ---------- ------- --------- David Greenblatt.. 20,000 1.6 $18.00 Nov. 2007 226,402 573,747 H. Jeff Goldberg.. 50,000 4.0 $24.25 June 2008 762,534 1,932,413
50 Option Grants During Fiscal 1999 The following table describes the options to acquire shares of our common stock that have been granted to our executive officers in fiscal 1999, and the options that we expect to grant to these individuals upon consummation of this offering.
% of Potential Total Realizable Value Number of Options at Securities Granted Assumed Annual Underlying to Rates of Stock Net2Phone Grantees Exercise Price Appreciation Options in or for Option Term (1) Granted Fiscal Base Price Expiration --------------------- Name (#) Year (%) ($/Sh) Date 5% ($) 10% ($) - ---- ---------- -------- ---------- ---------- ---------- ---------- Howard S. Balter........ 1,650,999 19.2 3.33 May 2009 29,470,332 50,173,859 Howard S. Balter........ 223,500 2.6 13.00(1) July 2009 1,828,230 4,630,920 Jonathan Fram........... 460,000 5.3 3.33 July 2009 8,211,000 13,979,400 Jonathan Fram........... 460,000 5.3 11.00(2) July 2009 4,682,800 10,451,200 Jonathan Fram........... 100,000 1.2 13.00(1) July 2009 818,000 2,072,000 David Greenblatt........ 360,000 4.2 3.33 May 2009 6,426,000 10,940,400 David Greenblatt........ 100,000 1.2 3.33 July 2009 1,785,000 3,039,000 H. Jeff Goldberg........ 360,000 4.2 3.33 May 2009 6,426,000 10,940,400 H. Jeff Goldberg........ 100,000 1.2 13.00(1) July 2009 818,000 2,072,000 Ilan M. Slasky.......... 360,000 4.2 3.33 May 2009 6,426,000 10,940,400 Jonathan Reich.......... 75,000 0.9 3.33 May 2009 1,338,750 2,279,250 Jonathan Reich.......... 200,000 2.3 13.00(1) July 2009 1,636,000 4,144,000 Martin Rothberg......... 360,000 4.2 3.33 May 2009 6,426,000 10,940,400 Jonathan Rand........... 45,000 0.5 3.33 May 2009 803,250 1,367,550 Jonathan Rand........... 75,000 0.9 13.00(1) July 2009 613,500 1,554,000
- --------------------- (1) Assumes that the fair market value of each grant on the date of each grant was the estimated initial public offering price of $13.00 per share. (2) The exercise price of these options is equal to the lesser of $11.00 or the initial offering price of our common stock. Value of IDT Options at Year End The following table describes the value of IDT options exercised in fiscal 1998 and the value of unexercised options held by the individuals named above at July 31, 1998:
Number of Securities Value of Unexercised Number of Underlying Unexercised in-the-Money Shares Options at Fiscal Year-End Options at Fiscal Year-End Acquired on --------------------------- ----------------------------- Names Exercise Value Realized Exercisable/Unexercisable Exercisable/Unexercisable (1) - ----- ----------- -------------- --------------------------- ----------------------------- Clifford M. Sobel(2).... 100,000 $1,701,500 100,000/875,000 $1,775,000/-- David Greenblatt........ -- -- 20,000/0 125,000/-- H. Jeff Goldberg........ 5,000 111,250 210,000/50,000 3,556,500/0
- --------------------- (1) The closing price of IDT's common stock on July 31, 1998, as reported on the Nasdaq National Market, was $24.25 per share. (2) Mr. Sobel has an option that may be exercised beginning in September 1999, to transfer his shares of Net2Phone to IDT in exchange for an option to acquire 875,000 shares of IDT common stock at a purchase price of $6.50 per share. Mr. Sobel will be prohibited by an agreement with the underwriters from exercising this option during the 180-day period following the date of this prospectus. 51 Value of Net2Phone Options at Year End The following table describes the value of Net2Phone options exercised in fiscal 1998 and the value of unexercised options held by Clifford M. Sobel, our Chairman and President, at July 31, 1998. None of the other individuals named in the Summary Compensation Table were granted options to purchase shares of Net2Phone prior to fiscal 1999.
Number of Securities Value of Unexercised Number of Underlying Unexercised in-the-Money Shares Options at Fiscal Year-End Options at Fiscal Year-End Acquired Value ---------------------------- ---------------------------- Names Exercise Realized(1) Exercisable/Unexercisable(2) Exercisable/Unexercisable(2) - ----- --------- ----------- ---------------------------- ---------------------------- Clifford M. Sobel....... 3,096,000 $ 0 0/347,865 0/--
- --------------------- (1) For purposes of this table, the per share value of each share of Net2Phone common stock in January 1998 is assumed to be $.03 per share, based upon a valuation report prepared by an independent appraiser. (2) Mr. Sobel received options to purchase an aggregate of 11% of Net2Phone's capital stock in connection with his May 1997 employment agreement. Mr. Sobel exercised his option to purchase 10% of Net2Phone's capital stock in January 1998, and his option to purchase the additional 1% of Net2Phone's capital stock terminated under an amendment to his employment agreement entered into in May 1999. Mr. Sobel does not currently own any options to purchase shares of Net2Phone. Compensation of Directors We intend to grant options to purchase shares of common stock to all of our non-employee directors under the 1999 Stock Incentive Plan, other than non- employee directors who serve as officers of IDT. See "1999 Stock Incentive Plan." Other than as will be provided in that plan and the reimbursement of reasonable expenses incurred with attending board and committee meetings, we have not yet adopted specific policies on directors' compensation and benefits following the closing of this offering. Employment Agreements Clifford M. Sobel, our Chairman, is employed pursuant to an employment agreement that was entered into in May 1997 and amended in May 1999. The agreement commenced in September 1997 and will expire in September 2000, and will automatically be extended though September 2001 unless either we or Mr. Sobel notifies the other that the extension will not take effect. Mr. Sobel receives an annual base salary of $100,000. In January 1998, in connection with an option set forth in his employment agreement, Mr. Sobel purchased 10% of our common stock for $100,000. On the closing date of this offering, Mr. Sobel will receive from IDT that number of shares of our common stock which will maintain his holdings, when combined with shares owned by a trust for the benefit of his offspring, at 8% of our total outstanding capital stock as of that date. Mr. Sobel's employment agreement also provides him with an option to transfer his interest in us to IDT in exchange for an option from IDT to purchase 875,000 registered shares of IDT common stock at a purchase price of $6.50 per share. This option is exercisable at any time from September 15, 1999 through September 15, 2000, so long as he is employed by us as of September 15, 1999 and owns and holds all of the stock he received, other than shares that he transferred to a trust for the benefit of his offspring. Mr. Sobel will be prohibited by an agreement with the underwriters from exercising this option during the 180-day period following the date of this prospectus. On July 2, 1999, we signed a three-year employment agreement with Jonathan Fram, our President. After its initial term, which ends on June 30, 2002, our agreement with Mr. Fram may be renewed annually. We will pay Mr. Fram an annual base salary of $350,000 and he is entitled to receive an annual bonus calculated on the basis of our gross revenue, which bonus could be up to $100,000. Additionally, we granted Mr. Fram options to purchase 920,000 shares of our common stock under our 1999 Stock Option and Incentive Plan. Of these options, 460,000 were granted at an exercise price of $3.33, 153,333 of which are 52 vested and exercisable. The options to purchase the remaining 460,000 shares were granted at the lower of our initial public offering price or $11.00. Other than those options already vested, the remaining 766,667 options will vest in three equal annual installments, commencing on July 20, 2000. An option to purchase an additional 100,000 shares of our common stock will be granted to Mr. Fram prior to the closing of this offering. This option will be immediately exercisable and will have an exercise price equal to the initial public offering price of our common stock. These options will vest immediately if we terminate Mr. Fram's employment without cause, if Mr. Fram terminates his employment for good reason, or if the options of any other employee are accelerated upon a change of control of our company. At present, none of the other named executive officers or key employees is party to an employment agreement with us. 1999 Stock Incentive Plan Our 1999 Stock Option and Incentive Plan was adopted in April 1999. Under the plan, our officers, directors, key employees and consultants, together with those of IDT and its subsidiaries, are eligible to receive awards of stock options, stock appreciation rights, limited stock appreciation rights and restricted stock. Options granted under the plan may be incentive stock options or nonqualified stock options. Stock appreciation rights and limited stock appreciation rights may be granted simultaneously with the grant of an option or, in the case of nonqualified stock options, at any time during its term. Restricted stock may be granted in addition to or in lieu of any other award made under the plan. A total of 11,040,000 shares of common stock have been authorized to date for issuance under the plan, 5,040,000 of which were granted in May 1999, and 1,345,219 of which have been exercised. These options have a weighted average exercise price of $3.33 per share. In connection with loans granted to several grantees under the plan to exercise a portion of these options, 23,382 outstanding options were cancelled. Additional options to purchase 6,996 shares were cancelled in connection with the termination of the employment of four grantees. In July 1999, we granted options to purchase an additional 920,000 shares of our common stock to Jonathan Fram, our President. See "--Employment Agreements." We expect to grant options to purchase approximately 2,503,500 additional shares of our common stock at the initial public offering price prior to the closing of this offering, together with additional options to purchase 168,000 shares of our common stock at an exercise price of $3.33 per share. The 1999 Stock Option and Incentive Plan is administered by the compensation committee of our board. Subject to the provisions of the plan, the board of directors or the compensation committee will determine the type of award, when and to whom awards will be granted, the number of shares covered by each award and the terms and kind of consideration payable with respect to awards. The board of directors or the compensation committee may interpret the plan and may at any time adopt the rules and regulations for the plan as it deems advisable. In determining the persons to whom awards shall be granted and the number of shares covered by each award, the board of directors or the compensation committee may take into account the duties of the respective persons, their present and potential contribution to our success and other relevant factors. Stock Options. An option may be granted on the terms and conditions as the board of directors or the compensation committee may approve, and generally may be exercised for a period of up to ten years from the date of grant. Generally, incentive stock options will be granted with an exercise price equal to the fair market value on the date of grant. Additional limitations will apply to incentive stock options granted to a grantee that beneficially holds 10% or more of our voting stock. The board of directors or compensation committee may authorize loans to individuals to finance their exercise of vested options. See "Certain Transactions--Officer Loans." Options granted under the 1999 Stock Option and Incentive Plan will become exercisable at those times and under the conditions determined by the board of directors or the compensation committee. To date, the options that have been granted to our executive officers will generally vest automatically in the event that there is a change of control of our company, if we are merged into another company or if any of these individuals are employed by a subsidiary of our company that is sold to another company. 53 The 1999 Stock Option and Incentive Plan provides for automatic option grants to eligible non-employee directors. Options to purchase 10,000 shares of common stock will be granted to each eligible non-employee director upon consummation of this offering and options to purchase 10,000 shares of common stock will be granted to each new eligible non-employee director upon the director's initial election to the board. In addition, options to purchase 10,000 shares of common stock are granted annually to each eligible non- employee director on the anniversary date of his or her election to the board. Each of these options will have an exercise price equal to the fair market value of a share of common stock on the date of grant. All options granted to non-employee directors will be immediately exercisable. All options held by non-employee directors, to the extent not exercised, expire on the earliest of: . the tenth anniversary of the date of grant; . one year following the optionee's termination of directorship other than for cause; and . three months following the optionee's termination of directorship for cause. Stock Appreciation Rights and Limited Stock Appreciation Rights. The 1999 Stock Option and Incentive Plan also permits the board of directors or the compensation committee to grant stock appreciation rights and/or limited stock appreciation rights with respect to all or any portion of the shares of common stock covered by options. Generally, stock appreciation rights and limited stock appreciation rights may be exercised only at that time as the related option is exercisable. Upon exercise of a stock appreciation right, a grantee will receive for each share for which an stock appreciation right is exercised, an amount in cash or common stock, as determined by the board of directors or the compensation committee, equal to the excess of the fair market value of a share of common stock on the date the stock appreciation right is exercised over the exercise price per share of the option to which the stock appreciation right relates. Limited stock appreciation rights may be exercised only during the 90 days following a change in control, or a merger or similar transaction, involving Net2Phone. Upon exercise of a limited stock appreciation right, a grantee will receive, for each share for which a limited stock appreciation rights is exercised, an amount in cash equal to the excess of the highest fair market value of a share of our common stock during the 90-day period ending on the date of the limited stock appreciation rights is exercised, or an amount equal to the highest price per share paid for shares of our common stock in connection with a merger or a change of control of Net2Phone, whichever is greater, over the exercise price per share of the option to which the limited stock appreciation rights relates. In no event, however, may the holder of a limited stock appreciation right granted in connection with an incentive stock option receive an amount in excess of the maximum amount that will enable the option to continue to qualify as an incentive stock option. Restricted Stock. The 1999 Stock Option and Incentive Plan further provides for the granting of restricted stock awards, which are awards of common stock that may not be disposed of, except by will or the laws of descent and distribution, for a period of time determined by the compensation committee or the board of directors. The board or the compensation committee may also impose other conditions and restrictions on the shares as it deems appropriate, including the satisfaction of performance criteria. All restrictions affecting the awarded shares will lapse in the event of a merger or similar transaction involving Net2Phone. The board may amend or terminate the 1999 Stock Option and Incentive Plan. However, as required by any law, regulation or stock exchange rule, no change shall be effective without the approval of our stockholders. In addition, no change may adversely affect an award previously granted, except with the written consent of the grantee. No awards may be granted under the 1999 Stock Option and Incentive Plan after the tenth anniversary of its initial adoption. 54 Options and Awards Under the 1999 Stock Option and Incentive Plan. We cannot now determine the number of options or awards to be granted in the future under the 1999 Stock Option and Incentive Plan to officers, directors and employees. Compensation Committee Interlocks and Insider Participation. We did not have a compensation committee during fiscal 1998. Compensation decisions relating to our executive officers, key employees and other senior personnel were made primarily by IDT, which owned all of our outstanding capital stock at the beginning of fiscal 1998. During fiscal 1998, Howard S. Jonas, who was serving as our chairman, and Howard S. Balter, who was serving as our treasurer, also served as directors of IDT. 401(k) Plan Prior to May 1999, our employees participated in IDT's 401(k) Savings and Retirement Plan. We are in the process of establishing our own 401(k) plan that is intended to qualify for preferential tax treatment under section 401(k) of the Internal Revenue Code. We intend that most of our employees will be eligible to participate in our 401(k) Savings and Retirement Plan upon adoption. 55 PRINCIPAL STOCKHOLDERS The following table sets forth information with respect to the beneficial ownership of our outstanding common stock as of July 27, 1999 and as adjusted to reflect the sale of the common stock offered hereby by: . each person who is the beneficial owner of more than 5% of our capital stock; . each of our directors; . each of our named executive officers; and . all of our named executive officers and directors as a group. Except as otherwise indicated, all of the shares indicated in the table are shares of common stock.
Percentage Number of Shares Beneficially Beneficially Owned Owned(1) --------------------- ----------------- Prior to After Prior to After Holders Offering Offering Offering Offering - -------------------------------------- ---------- ---------- -------- -------- IDT Corporation(2).................... 27,621,982 27,158,190 65.8% 57.1% 190 Main Street Hackensack, New Jersey 07601 Howard S. Jonas(3).................... 27,621,982 27,158,190 65.8% 57.1% c/o IDT Corporation 190 Main Street Hackensack, New Jersey 07601 James A. Courter(4)................... 27,657,982 27,194,190 65.9% 57.2% c/o IDT Corporation 190 Main Street Hackensack, New Jersey 07601 SOFTBANK Technology Ventures IV, L.P.(5).............................. 4,590,000 4,590,000 10.9% 9.6% 333 West San Carlos Street, Suite 1225 San Jose, California 95110 Gary E. Rieschel(6)(7)................ 4,590,000 4,600,000 10.9% 9.7% c/o SOFTBANK Technology Ventures IV, L.P. 333 West San Carlos Street, Suite 1225 San Jose, California 95110 Clifford M. Sobel(8).................. 3,338,018 3,801,810 8.0% 8.0% c/o Net2Phone, Inc. 171 Main Street Hackensack, New Jersey 07601 America Online, Inc.(9)............... 2,295,000 2,920,000 5.5% 6.1% 22000 AOL Way Dulles, Virginia 20166 General Electric Company Group(10).... 2,295,000 2,711,666 5.5% 5.7% 120 Long Ridge Road Stamford, Connecticut 06927 Howard S. Balter(7)(11)............... 669,138 736,188 1.6% 1.5% Jonathan Fram(7)(12).................. 153,333 253,333 * * David Greenblatt(7)(13)............... 105,840 135,840 * * H. Jeff Goldberg(7)(14)............... 105,840 135,840 * * James R. Mellor(7).................... -- 10,000 * * Stephen A. Oxman(7)................... 7,500 12,500 * * Jesse King(7)......................... -- 10,000 * * Officers and Directors as a Group (15 Persons)(15)..................... 36,743,961 37,093,511 87.2% 77.4%
56 - --------------------- * Less than one percent. (1) Percentage of beneficial ownership prior to this offering is based on 4,683,237 shares of common stock and 27,621,982 shares of Class A stock outstanding at July 26, 1999 plus 9,420,000 shares of Class A stock issuable upon conversion of the Series A convertible preferred stock at the same date and the exercise of 272,400 warrants to purchase our common stock. Percentage of beneficial ownership after this offering is based on 47,522,619 total shares outstanding, which includes all shares outstanding prior to this offering, plus 5,400,000 shares of common stock to be sold in this offering at an assumed price of $12 per share. All percentage calculations assume that all shares of Net2Phone's Class A stock have been converted into shares of Net2Phone's common stock. (2) All of the shares held by IDT are Class A stock. IDT has pledged its shares as collateral to secure a credit facility. The lenders under the credit facility have agreed to release IDT's shares from collateral to permit IDT to transfer our shares free and clear of any liens as and when IDT seeks to transfer our shares. Such transferability will cease if IDT's ownership of our capital stock drops below 50% of the capital stock owned by IDT 72 hours after the consummation of this offering. Unless IDT defaults in its obligations under the pledge agreement, it has the voting rights with respect to the pledged stock. In addition, in connection with the employment agreement between IDT, Mr. Sobel and Net2Phone, IDT will transfer to Mr. Sobel the number of shares of stock upon consummation of this offering that is necessary to maintain Mr. Sobel's percentage ownership of our outstanding stock, together with a trust for the benefit of his offspring, at 8%. (3) Howard S. Jonas, together with a number of entities formed for the benefit of charities and members of his family, owns shares of IDT's capital stock that enable him to vote more than 50% of IDT's capital stock. As a result, he may be deemed to be the beneficial owner of the shares of Net2Phone capital stock owned by IDT. Mr. Jonas disclaims beneficial ownership of these shares. (4) James A. Courter, one of our directors, is the President, Vice Chairman and a director of IDT. As a result, in addition to the 36,000 shares of our common stock that he holds directly, he may be deemed to be the beneficial owner of the shares of Net2Phone capital stock owned by IDT. Mr. Courter disclaims beneficial ownership of these additional shares. (5) Includes 4,415,400 shares of Class A stock and 88,308 shares of common stock issuable upon conversion of shares of Series A convertible preferred stock and presently exercisable warrants, respectively, that have been issued to SOFTBANK Technology Ventures IV, L.P. Also includes 84,600 shares of Class A stock and 1,692 shares of common stock issuable upon conversion of shares of Series A preferred stock and presently exercisable warrants, respectively, that have been issued to SOFTBANK Technology Advisors Fund L.P. (6) Gary E. Rieschel is the Executive Managing Director of SOFTBANK Technology Ventures, and as a result, he may exercise the power to vote and to dispose of the shares held by SOFTBANK. (7) Shares owned after the offering include 10,000, 67,050, 100,000, 30,000, 15,000, 10,000, 10,000 and 10,000 shares of common stock that will be issuable upon the exercise of stock options that we expect to issue to Messrs. Rieschel, Balter, Fram, Greenblatt, Goldberg, Mellor, Oxman and King respectively, upon the closing of this offering. Each of these options will be immediately exercisable. (8) Clifford M. Sobel transferred 1% of our common stock to a trust for the benefit of his offspring. All of these shares are deemed to be beneficially owned by Mr. Sobel. In addition, in connection with the employment agreement between IDT, Mr. Sobel and Net2Phone, IDT will transfer to Mr. Sobel the number of shares of stock upon consummation of this offering that is necessary to maintain Mr. Sobel's percentage ownership of our outstanding stock, together with a trust for the benefit of his offspring, at 8%. (9) Includes 2,250,000 shares of Class A stock and 45,000 shares of common stock issuable upon conversion of shares of Series A convertible preferred stock and issuable upon exercise of presently exercisable warrants, respectively. Shares owned after the offering assumes the purchase by America Online of 625,000 shares in this offering. (10) Includes 1,125,000 of Class A stock issuable upon conversion of shares of Series A convertible preferred stock that are held of record by GE Capital Equity Investments, Inc., which shares beneficial ownership with its parent General Electric Capital Corporation, which is a wholly-owned subsidiary of the General Electric Company. Also includes 1,125,000 shares of Class A stock issuable upon exercise of shares of Series A convertible preferred stock that are beneficially owned by NBC, a wholly-owned indirect subsidiary of the General Electric Company, of which 300,000 shares are issuable upon conversion of shares of Series A convertible preferred stock that are held of record by Snap! LLC, an Internet portal service of NBC and CNET, Inc. Includes 22,500, 16,500 and 6,000 shares of common stock issuable upon exercise of warrants held by GE Capital Equity Investments, NBC and Snap! LLC, respectively. Shares owned after the offering assumes the purchase by NBC of 250,000 shares in this offering and the purchase by GE Capital of 166,666 shares in this offering. (11) Includes 360,000 shares held of record by a trust for the benefit of Mr. Balter's family members, of which Mr. Balter and his spouse are the trustees. Also includes an aggregate of 138,000 shares held of record by trusts for the benefit of the family members of Messrs. Greenblatt, Slasky and Rothberg, for which Mr. Balter acts as trustee. (12) Includes 153,333 shares of common stock issuable upon exercise of presently exercised stock options. (13) Includes 54,000 shares held of record by a trust for the benefit of Mr. Greenblatt's family members, of which Mr. Balter is the trustee. (14) Includes 72,000 shares held of record by a trust for the benefit of Mr. Goldberg's family members, of which Mr. Goldberg's spouse is the trustee. (15) Includes the shares of Class A stock held by IDT and the shares of Class A stock and the shares of common stock issuable upon exercise of presently exercisable warrants held by SOFTBANK. Shares owned after the offering also includes options to purchase 339,550 shares of common stock that will be granted to our directors and executive officers upon the closing of this offering. Each of these options will be immediately exercisable. 57 CERTAIN TRANSACTIONS We believe that all of the transactions set forth below were made on an arms-length basis. All future transactions between us and our officers, directors, principal stockholders and affiliates will be approved by a majority of the board of directors, including a majority of the outside directors, and will continue to be on terms no less favorable to us than could be obtained from unaffiliated third parties. Relationship with IDT Upon the closing of this offering, IDT will own approximately 57.1% of our capital stock. IDT owns Class A stock that has twice the voting power of our common stock. Therefore, upon the closing of this offering, IDT will control 64.6% of our vote. Since inception, we have received various services from IDT, including administration (accounting, human resources, legal), customer support, telecommunications and joint marketing. IDT has also provided us with the services of a number of its executives and employees. In consideration for these services, IDT has historically allocated a portion of its overhead costs related to those services to us. We believe that the amounts allocated to us have been no greater than the expenses we would have incurred if we obtained those services on our own or from unaffiliated third parties. Prior to the execution of the agreements with IDT described below, none of these services had been provided to us pursuant to any written agreement. We entered into a suite of agreements with IDT in May 1999, including an assignment agreement, a separation agreement, an IDT services agreement, a Net2Phone services agreement, a tax sharing and indemnification agreement, a joint marketing agreement and an Internet/telecommunications agreement. Assignment Agreement In connection with this agreement, IDT assigned to us certain proprietary products, information, patent applications, trademarks and related intellectual property rights used in connection with our business. IDT also licensed to us certain proprietary business information that relates to our business. We licensed back to IDT certain software that IDT will use in connection with its business. IDT Services Agreement In connection with this agreement, IDT will continue to provide us with various administrative services, including general accounting services, payroll and benefits administration and customer support. . General Accounting Services. IDT will provide us with accounts payable services and general ledger services. IDT will charge us cost plus 20% for these services. This portion of the IDT services agreement may be cancelled by either party on 30-days prior written notice and may be renewed by mutual agreement of the parties. . Payroll and Benefits Administration. IDT will administer our payroll. Until we terminate this agreement or establish our own benefit plan for our employees, our employees will continue to be covered under IDT's health insurance policies. We will pay IDT for administering our payroll and benefits plans at IDT's cost plus 20%. Additionally, we will reimburse IDT for the employer's cost of health insurance attributable to each of our employees participating in IDT's group health insurance plan and for any other direct costs attributable to our employees' participation in IDT's benefit plans. . Customer Support. IDT has agreed to provide customer support services to our customers on a cost-plus 20% basis. In the event we request additional services from IDT and IDT agrees to provide those services, we will enter into an addendum to the IDT Services Agreement covering those services. We will negotiate in good faith any fees payable to IDT for those additional services. 58 Net2Phone Services Agreement In connection with this agreement, we will support IDT's debit card platform, provide technical support for the debit card platform, order lines to handle calls, manage the debit card database and monitor the network, 24 hours per day, seven days per week. We will provide these services at the greater of cost-plus 20% and $.0025 per minute of IDT usage of the debit card platform. In addition, IDT will reimburse us for all of our direct costs in connection with the acquisition, maintenance or support of any and all additional or replacement equipment needed for the debit card platform. The Net2Phone services agreement has an initial term of one year, which automatically renews for subsequent one-year periods unless one party gives the other 30-days prior written notice. In addition, following the initial term, the Net2Phone services agreement may be terminated at any time at either party's option upon 30-days prior written notice. In the event IDT requests services in addition to those described in the Net2Phone services agreement and we agree to provide those services, we will enter into an addendum to the Net2Phone services agreement covering those services. We will negotiate in good faith any fees payable to us for those additional services. Tax Sharing and Indemnification Agreement. In connection with this agreement, IDT and Net2Phone will share certain past tax liabilities and benefits, including: . the allocation and payment of taxes for periods during which we and our subsidiaries, if any, were included in the same consolidated group with IDT for federal income tax purposes, and are, or were, included in the same consolidated, combined or unitary returns for state, local or foreign tax purposes; . the allocation of responsibility for the filing of tax returns; . the conduct of tax audits and the handling of tax controversies; and . various related matters. For periods during which we and our subsidiaries, if any, were or are included in IDT's consolidated federal income tax returns or state, local or foreign consolidated, combined, or unitary tax returns, we are required to pay an amount of tax equal to the amount we would have paid had we and our subsidiaries, if any, had filed a tax return as a separate affiliated group of corporations filing a consolidated federal income tax return or state, local or foreign consolidated, combined, or unitary tax returns. We are responsible for our own separate tax liabilities that are not determined on a consolidated or combined basis with IDT. As a result of leaving the IDT consolidated group, certain tax attributes of the IDT group attributable to our operations, such as net operating loss carryforwards, may be allocated to us. The tax sharing and indemnification agreement obligates us, where permitted by law, to elect to carry any post- deconsolidation losses forward, rather than to carry back such losses to tax years when we were included in the IDT consolidated or combined returns. We were included in IDT's consolidated group for federal income tax purposes from our incorporation in October 1997 until May 1999 when we concluded the sale of our Series A convertible preferred stock. Each corporation that is a member of a consolidated group during any portion of the group's tax year is jointly and severally liable for the federal income tax liability of the group for that year. While the tax sharing and indemnification agreement allocates tax liabilities between us and IDT during the period on or prior to the closing date of this offering, in which we are included in IDT's consolidated group, we could be liable in the event federal tax liability allocated to IDT is incurred, but not paid, by IDT or any other member of 59 IDT's consolidated group for IDT's tax years that include such periods. In such event, we would be entitled to seek indemnification from IDT pursuant to the tax sharing and indemnification agreement. Joint Marketing Agreement. In connection with this agreement, we agreed to: . continue to offer links to the other's Web site; . cross-sell one another's products, including through their promotional materials and customer services representatives; and . undertake additional promotions as to which the parties shall agree from time to time. IDT will pay to us a fee of $8.00 for each of our customers who becomes a new customer of IDT as a result of our referral. We will pay IDT a fee of $8.00 for each customer of IDT who becomes a new customer of ours as a result of an IDT referral. However, in either case, these fees will be payable only with respect to any new customer who incurs and pays $50.00 or more in charges. The joint marketing agreement has an initial term of one year, which automatically renews for subsequent one-year periods unless one party gives the other party 60-days prior written notice. In addition, following the initial term, the joint marketing agreement may be terminated at any time at either party's option upon 60-days prior written notice. Internet/Telecommunications Agreement. IDT has granted us an indefeasible right to use portions of its current high-speed network. We have the right to terminate portions of the existing network to the extent that the existing network is replaced, the underlying leases expire or at anytime with IDT's consent. We are obligated to reimburse IDT for all termination or cancellation charges which it incurs. We have agreed to pay IDT $60,000 per month for the right to use those portions of its existing network. This amount will be reduced as IDT terminates portions of the existing network at our request. IDT also granted us an indefeasible right to use portions of a new DS3 Network, which it will have the right to use for 20 years. This grant will be effective as construction of this new network is completed and delivered to IDT. This network has been pledged by IDT to the lenders under a credit facility. We have agreed to pay IDT an installation fee of $600,000 for this network, which we will pay as each portion of the new network is delivered. We also will reimburse IDT for the one-time fee of approximately $6.0 million payable in monthly installments over a five-year period, with interest of 9% per annum. We will reimburse IDT for all of maintenance and upgrade costs incurred by IDT with respect to those portions of the network that we use. Further, IDT has granted us a right to use IDT's equipment and other assets at its backbone points of presence and its network operations center for a two- year period. We will pay IDT an aggregate of $1.2 million for this right over the two-year period. At the end of the two-year period, we have the right to purchase any of this equipment then owned by IDT at fair market value. We must pay for all repairs, maintenance and upgrades of equipment and other facilities we use pursuant to this agreement. IDT also has agreed to enter into transit relationship agreements with us giving us access substantially identical to IDT's at five different core locations for a period of one year commencing May 1999. Following the initial term, the transit relationship agreements may be terminated at any time at either party's option upon 60-days prior written notice. IDT retains primary control over the equipment covered by this agreement but may require assistance from us in gaining Internet access. We have agreed to assist in facilitating access for a one-year period commencing May 1999. For each month during the effectiveness of the agreement, IDT will pay us: . $1.00 for each of IDT's dial-up Internet customers; 60 . for each dedicated-line Internet customer, the lesser of $100.00 or 20% of the fee IDT charges; and . 25% of all fees charged by IDT for installation of dedicated lines. Following the initial one year term, this agreement automatically renews for one-year periods unless one party gives the other 60-days prior written notice of termination. Separation Agreement The separation agreement with IDT provides for the following: . Releases. This agreement provides for mutual general releases between us and IDT for alleged liability to the date of the agreement, with certain limited exceptions, including: . liability specifically excluded by any of the other agreements between us and IDT, and . liability for unpaid amounts for products or services or refunds owing on products or services due on a value-received basis for work done by one party at the request or on behalf of the other. . Indemnification by Net2Phone. We have agreed to indemnify IDT and each of IDT's directors, officers and employees from all liabilities relating to, arising out of or resulting from: . our failure or the failure of any other person to pay, perform or otherwise promptly discharge any of our liabilities in accordance with their respective terms, and . any breach by us of the agreements between us and IDT. . Indemnification by IDT. IDT has agreed to indemnify us and each of our directors, officers and employees from all liabilities relating to, arising out of or resulting from: . the failure of IDT or any other person to pay, perform or otherwise promptly discharge any liabilities of IDT other than our liabilities, and . any breach by IDT of the agreements between us and IDT. . Dispute Resolution. We will attempt to resolve disputes by referring controversial matters to senior management (or other mutually agreed upon) representatives of the parties. If these efforts are not successful, either party may submit the dispute to mandatory, binding arbitration. This agreement contains procedures that are intended to expedite dispute resolution, including the selection of an arbitrator and certain limitations on discovery. In the event that any dispute may be in excess of $5.0 million, or in the event that an arbitration award in excess of $5.0 million is issued, either party may submit the dispute to a court of competent jurisdiction. If the parties disagree that the amount in controversy is in excess of $5.0 million, the parties are required to submit the disagreement to arbitration. . Noncompetition; Certain Business Transactions. For a period of 36 months commencing May 1999, IDT may not directly or indirectly, engage in the provision of or developmental efforts related to Internet telephony services and voice enabling Web applications anywhere in the world or become a stockholder, partner or owner of any entity that is engaged in such business anywhere in the world. However, subject to our approval, which may not be unreasonably withheld, IDT may acquire a passive interest of up to 20% in such entity so long as IDT does not assist that entity in developing an Internet telephony business or otherwise engaging in our business. Neither we nor IDT will have any duty to communicate or offer any corporate opportunity to the other party and may pursue or acquire any such opportunity for itself or direct such opportunity to any other person. Payable to IDT. Since inception, IDT has provided the funds to finance our operations in the form of advances (approximately $22.0 million as of April 30, 1999, of which we repaid $8.0 million in May 1999). These 61 advances have been converted into a note that is payable in 60 monthly installments of principal and interest. $7.0 million of the proceeds of this offering will be used to prepay a portion of the note. The balance of the note is payable in 60 monthly installments of principal and interest at a rate of 9% per annum. Expenses We have agreed to pay all third-party costs, fees and expenses relating to this offering, all of the reimbursable expenses of the underwriters pursuant to the underwriting agreement, all of the costs of producing, printing, mailing and otherwise distributing this prospectus, as well as the underwriters' discount as provided in the underwriting agreement. See "Underwriting." Except as expressly set forth in the agreements between us and IDT, whether or not this offering is consummated, each party shall bear its own respective third- party fees, costs and expenses paid or incurred in connection with this offering. Relationship with Other Investors Series A Subscription Agreements Pursuant to Series A Subscription Agreements, dated as of May 13, 1999, SOFTBANK Technology Ventures IV, GE Capital Equity Investments, America Online, Access Technology Partners, Hambrecht & Quist and its affiliates and BT Alex. Brown and its affiliates, purchased from us, in the aggregate, 3,140,000 shares of Series A convertible preferred stock and warrants to purchase 180,000 shares of our common stock, which expire upon the closing of this offering, for a net aggregate purchase price of $29.9 million. Additionally, a warrant to purchase 92,400 shares of our common stock was issued to Hambrecht & Quist as part of its fee as placement agent with respect to the sale of our Series A convertible preferred stock. This warrant expires upon the closing of this offering. In connection with the subscription agreements, we also entered into a registration rights agreement and a stockholders agreement, each of which is described below. Registration Rights Agreement The Series A investors acquired the following registration rights: . one demand for registration at any time on or after the earlier to occur of the second anniversary of the Series A offering or 180 days following the consummation of this offering. This demand registration right may be made by one or more holders of the Series A convertible preferred stock that own at least 50% of the shares of Class A stock into which the Series A convertible preferred stock converts. If our board of directors determines in good faith that the demand registration would be materially detrimental to us, we are entitled to postpone the filing of the registration statement otherwise required to be prepared and filed by us for a reasonable period of time, not to exceed 90 days; . piggyback registration rights if we propose to register any securities under the Securities Act in connection with any offering of our securities other than a registration statement on Form S-8 or Form S-4, subject to quantity limitations determined by underwriters if the offering involves an underwriting; and . two demand registrations at any time after we become eligible to register our securities on Form S-3 (or any successor form). Holders that beneficially own at least 20% of the shares of Class A stock into which the Series A convertible preferred stock converts may make these demands. We agreed to pay all reasonable expenses incurred in connection with any registration, filing or qualification pursuant to the Registration Rights Agreement. We also agreed, to the extent permitted by law, to indemnify the Series A investors against some liabilities in connection with the offering of the shares, including liabilities arising under the Securities Act. 62 Stockholders Agreement IDT and Clifford M. Sobel, our Chairman, agreed to vote all of their shares in favor of the election of a director nominated by SOFTBANK Technology Ventures IV and a director nominated by GE Capital Equity Investments or NBC, in each case for as long as either entity holds a majority of the shares of Series A convertible preferred stock originally purchased by them or the shares into which they are convertible. In addition, each Series A convertible investor agreed to a lock up with respect to their shares for a period of 180 days following this offering. The Series A investors, IDT and Mr. Sobel also agreed not to transfer any of their shares to any of our competitors for a period of 36 months, and thereafter only subject to our right of first refusal. However, the stockholders agreement does permit transfers between Series A investors. Agreements with America Online and Subsidiaries Netscape We signed a series of related agreements with Netscape, a subsidiary of America Online, on January 31, 1999, allowing us to embed our software and services in future versions of Netscape's Internet browsers. The two-year term of our exclusive arrangement with Netscape commences with the beta release of the next version of Netscape's Internet browser, which we believe will occur later this year. In addition, our services will be displayed on Netscape Netcenter and bundled with Netscape's suite of software and software updates. We also have a right to place advertisements on Netscape's Web site. In exchange, we will pay Netscape one-time licensing fees, a percentage of revenue generated by calls provided through our co-branded service and a percentage of advertising revenue generated by a co-branded Web page. Netscape's parent company, America Online, will beneficially own over 5% of our common stock upon the closing of this offering. ICQ In July 1999, we entered into an exclusive, four-year distribution and marketing agreement with ICQ, a subsidiary of America Online. ICQ provides software that enables Internet users to contact other users on a real-time basis, and to determine whether other individuals are on-line. ICQ's software also enables Internet users to chat, send messages and files and to play Internet-based games with one another. We believe that this agreement will enable us to attract a substantial number of ICQ's users to utilize our services, which will enhance our revenue, customer base and market share. Under this agreement, ICQ has agreed to: . co-brand and promote our phone-to-phone Internet telephony services in the United States and in 19 other countries. . embed customized versions of our software on an exclusive basis to allow ICQ customers to make PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls; . share revenue from advertisements and sponsorships sold by ICQ on our software that is embedded in ICQ's Instant Messenger software; and . promote our services on some of ICQ's Web sites. We have agreed to: . pay ICQ a fee of $7.5 million, $4.0 million of which was paid at signing, with the remaining $3.5 million to be paid upon the closing of this offering; . pay ICQ a share of minutes-based revenue generated through ICQ and award ICQ a performance bonus on the basis of the total revenue derived under the agreement; and . promote ICQ on our Web sites. 63 ICQ has the right to terminate the exclusivity granted to Net2Phone as to a particular service under the agreement under certain circumstances, including if: . the price for the service or the scope of the service offered by Net2Phone to retail customers through any other distribution channel is more favorable than the corresponding service offered by Net2Phone through ICQ; . mutually agreed upon third party reviewers determine that the service offered by Net2Phone is not competitive as to per minute rates and quality with similar services offered by a competitor of Net2Phone; or . the Net2Phone service is not prepared for launch in a particular country by the applicable cut-off date specified in the agreement. In addition, ICQ has the right to terminate the entire agreement under certain circumstances, including if: . two or more of Net2Phone's services are not competitive with those of Net2Phone's competitors in terms of price, and the scope and quality of service; or . if more than one of Net2Phone's services is not fully prepared for launch by the specified cut-off dates. If at any time after July 14, 2001, ICQ or America Online enters into a strategic relationship with any major national or international telecommunications provider for the distribution of telecommunications services using America Online and its affiliates, and if ICQ terminates the agreement and the telecommunications provider does not agree to offer all of Net2Phone's services that are offered under the agreement on terms comparable to those in the agreement, then ICQ will be required to pay Net2Phone a termination fee of up to $60.0 million. The amount of the termination fee, if any, will depend on whether the telecommunications provider offers any of Net2Phone's services and the aggregate transaction revenues represented by Net2Phone's services that will not be offered. In connection with our distribution and marketing agreement with ICQ, we issued a warrant to America Online to purchase up to 3% of our outstanding capital stock on a fully-diluted basis. This warrant will vest in 1% increments upon the achievement of each of three incremental thresholds of revenue generated under the agreement during the first four years that the warrant is outstanding. The per share exercise price under the warrant will be equal to the lesser of 80% of the price per share in this offering, or $450 million divided by the number of our fully-diluted shares on the initial exercise date. The warrant may be exercised for a period of five years from the date of issuance. The warrant grants to America Online demand registration rights enabling America Online to cause us to effect two registrations and piggy-back registration rights that can be used in connection with future registrations. In addition, America Online will have the right to require us to file up to two additional registration statements relating to the shares issuable upon exercise of the warrant at such time as we shall become eligible to register these shares on Form S-3 under the Securities Act of 1933. Agreements with NBC and Snap We signed an agreement with NBC on June 25, 1999 to purchase $1.5 million in television advertising time on the NBC television network. We also have the right to purchase additional spots to be telecast prior to June 30, 2000. Additionally, on May 18, 1999, we signed a non-binding letter of intent with NBC Multimedia, an affiliate of NBC. This letter of intent contemplates a one- year agreement whereby we will pay NBC Multimedia $280,000 in exchange for the integration of our services into the NBC.com and NBC Interactive Neighborhood Web sites. Upon the closing of this offering, assuming that NBC purchases 250,000 shares in this offering, NBC will beneficially own 1,125,000 shares of our Series A stock and 266,500 64 shares of our common stock; NBC is a wholly-owned indirect subsidiary of the General Electric Company Group, which will beneficially own more than 5.0% of our outstanding common stock after the closing of this offering. On May 17, 1999, we entered into an agreement with Snap. Snap, an Internet portal service of NBC and CNET, will strategically display links to our Web site and services on its Snap.com Web site. In addition, we are their preferred provider of PC-to-phone services during the two-year term of this agreement. Snap also will deliver a preset minimum number of impressions on its site and has agreed to give us the right to a certain amount of online advertising, subject to certain conditions. In exchange, we agreed to pay Snap a one-time fee, a percentage of revenue generated through their site and bonus payments for customers delivered by Snap after meeting certain quotas. NBC, a wholly- owned indirect subsidiary of General Electric Company, owns a majority interest in Snap. Facility Leases We have entered into leases for the use of our Hackensack facilities with corporations that are owned and controlled by Howard S. Jonas, a member of our board of directors and a director of IDT. Additionally, Mr. Jonas, together with a number of entities formed for the benefit of charities and members of his family, owns shares of IDT's capital stock that enable him to vote more than 50% of IDT'S capital stock. As a result, he may be deemed to be the beneficial owner of the shares of Net2Phone capital stock owned by IDT. The two Hackensack leases run for three-year terms, beginning on March 1, 1999 with monthly rent of $5,600 for 294-298 State Street and $9,912 for 171-173 Main Street. We have also entered into a sublease with IDT for our Piscataway facility, which is leased by IDT from a corporation owned and controlled by Mr. Jonas. The Piscataway sublease runs for a three-year term, beginning in May 1999, with monthly rent of $8,400. Officer Loans In May 1999, Howard S. Balter, Ilan M. Slasky, David Greenblatt, Martin Rothberg, H. Jeff Goldberg, Jonathan Reich, and Jonathan Rand, each of whom is an executive officer, borrowed $1,447,240, $352,800, $352,800, $352,800, $352,800, $98,000 and $44,100, respectively, from us. All of the proceeds of these loans were used to purchase shares of Net2Phone common stock upon the exercise of stock options. The loans bear interest at the rate of 7.0% per annum, and will mature in May 2001. As a condition to receiving these loans, these officers agreed to surrender their respective right to exercise 8,862, 2,160, 2,160, 2,160, 2,160, 600 and 270 immediately exercisable options, respectively. Relationship with Law Firm Ira A. Greenstein, our General Counsel and Secretary, is a partner of the law firm Morrison & Foerster LLP, which has provided legal services to us and to IDT and its subsidiaries since December 1996, and in connection with this offering. 65 DESCRIPTION OF CAPITAL STOCK Authorized Capital Stock Our certificate of incorporation, as amended and restated, authorizes 247,042,089 shares of capital stock consisting of: . 6,850,000 shares of preferred stock, $0.01 par value; . 3,150,000 shares of Series A convertible preferred stock, $0.01 par value; . 37,042,089 shares of Class A stock, $0.01 par value; and . 200,000,000 shares of common stock, $0.01 par value. Of the shares of common stock, 5,400,000 shares of our common stock are being offered through this prospectus. Immediately following the closing of the offering, 10,924,429 shares of common stock and 36,578,190 shares of Class A stock will be outstanding. As of July 27, 1999, there were 26 holders of our Series A convertible preferred stock, one holder of our Class A stock and 33 holders of our common stock. Common Stock and Class A Stock General. The rights of holders of common stock and holders of Class A stock are identical, except for voting rights, conversion rights and restrictions on transferability. As of July 26, 1999, there were 4,683,237 shares of common stock outstanding and 27,621,982 shares of Class A stock outstanding. An additional 9,420,000 shares of Class A stock are issuable upon conversion of our outstanding Series A convertible preferred stock. Voting Rights. The holders of Class A stock are entitled to two votes per share and the holders of common stock are entitled to one vote per share. Except as otherwise required by law or as described below, holders of Class A stock and common stock will vote together as a single class on all matters presented to the stockholders for their vote or approval, including the election of directors. Stockholders are not entitled to vote cumulatively for the election of directors, and no class of outstanding capital stock acting alone is entitled to elect any directors. IDT will hold 57.1% of our Class A stock upon consummation of this offering. Accordingly, IDT will retain effective control of us through holding approximately 64.6% of the combined voting power of our outstanding capital stock. Therefore, IDT has the ability to elect all of our directors and to effect or prevent certain corporate transactions which require majority approval of the combined classes, including mergers and other business combinations. Transfer Restrictions. Class A stock is subject to certain limitations on transferability that do not apply to the common stock. Our certificate of incorporation provides that shares of Class A stock automatically convert into an equal number of shares of common stock if there is a transfer of shares of Class A stock to a person other than a permitted transferee. Thereafter, such shares of common stock may be freely transferred, subject to restrictions imposed under applicable securities laws. Shares of Class A stock acquired by us will be canceled and may not be reissued. Dividends and Liquidation. Holders of Class A stock and holders of common stock have an equal right to receive dividends when and if declared by the board of directors out of legally available funds. In the event of a liquidation, dissolution or winding up, holders of the shares of Class A stock and common stock are entitled to share equally, share-for-share, in the assets available for distribution after payment of all creditors and the liquidation preferences of our preferred stock. Optional Conversion Rights. Each share of Class A stock may, at any time and at the option of the holder, be converted into one fully paid and non- assessable share of common stock. Upon conversion, such shares of common stock would not be subject to restrictions on transfer that applied to the shares of Class A 66 stock prior to conversion except to the extent such restrictions are imposed under applicable securities laws. The shares of common stock are not convertible into or exchangeable for shares of Class A stock or any other shares or securities. Other Provisions. Holders of Class A stock and common stock have no preemptive rights to subscribe to any additional securities of any class which we may issue and there are no redemption provisions or sinking fund provisions applicable to either such class, nor is the Class A stock or the common stock subject to calls or assessments by us. The rights, preferences, and privileges of the holders of common stock and Class A stock are subject to and may be adversely affected by, the rights of the holders of any series of preferred stock. Preferred Stock Our certificate of incorporation provides that we may issue up to 10,000,000 shares of preferred stock in one or more series as may be determined by our board of directors who may establish the number of shares to be included in each such series, fix the designation, powers, preferences and relative rights of the shares of each such series and any qualifications, limitations, or restrictions thereof, and increase or decrease the number of shares of any such series without any further vote or action by the stockholders. 3,150,000 shares of the preferred stock have been designated as Series A. The board of directors may authorize, without stockholder approval, the issuance of preferred stock with voting and conversion rights that could adversely affect the voting power and other rights of holders of common stock or Class A stock. Preferred stock could be issued quickly with terms designated to delay or prevent a change in our control or to make the removal of management more difficult. This could have the effect of decreasing the market price of the common stock. In May 1999, we sold 3,140,000 shares of Series A convertible preferred stock pursuant to Series A Subscription Agreements. All shares of the Series A convertible preferred stock will automatically convert into 9,420,000 shares of our Class A stock at the closing of this offering. We believe that the ability of the board to issue one or more series of preferred stock will provide us with flexibility in structuring possible future financings and acquisitions, and in meeting other corporate needs that might arise. The authorized shares of preferred stock, as well as shares of common stock, will be available for issuance without further action by our stockholders, unless such action is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Although the board has no intention at the present time of doing so, it could issue a series of preferred stock that could, depending on the terms of such series, impede the completion of a merger, tender offer or other takeover attempt. The board will make any determination to issue such shares based on its judgment as to our best interests and the best interests of our stockholders. The board could issue preferred stock having terms that could discourage an acquisition attempt through which an acquirer may be able to change the composition of the board, including a tender offer or other transaction that some, or a majority, of our stockholders might believe to be in their best interests or in which stockholders might receive a premium for their stock over the then current market price. Certain Anti-Takeover Effects. Certain provisions of the certificate of incorporation and bylaws, summarized in the following paragraphs, may be considered to have an anti-takeover effect and may delay, deter or prevent a tender offer, proxy contest or other takeover attempt that a stockholder might consider to be in such stockholder's best interest, including such an attempt that might result in payment of a premium over the market price for shares held by stockholders. The certificate of incorporation and bylaws provide for the board of directors to be divided into three classes of directors serving staggered three-year terms upon the consummation of this offering. As a result, approximately one-third of the board of directors will be elected each year. Classification of the board of directors expands the time required to change the composition of a majority of directors and may tend to 67 discourage a proxy contest or other takeover bid for us. Moreover, under the Delaware General Corporation Law, in the case of a corporation having a classified board of directors, the stockholders may remove a director only for cause. The certificate of incorporation provides that a special meeting of stockholders may be called by any of the following: . the chairman of our board; . our president; . any of our vice presidents; or . our secretary. In addition, a special meeting of stockholders may be called by any such officer at the written request of a majority of the board of directors or at the written request of stockholders owning a majority of our capital stock issued and outstanding and entitled to vote. Section 203 of the Delaware General Corporation Law provides that, subject to certain exceptions specified therein, an "interested stockholder" of a Delaware corporation shall not engage in any business combinations, including mergers or consolidations or acquisitions of additional shares of the corporation, with the corporation for a three-year period following the date that such stockholder becomes an interested stockholder unless: . prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; . upon consummation of the transaction that resulted in the stockholder becoming an "interested stockholder," the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding certain shares); or . on or subsequent to such date, the business combination is approved by the board of directors of the corporation and authorized at an annual or special meeting of stockholders by the affirmative vote of at least 66.67% of the outstanding voting stock that is not owned by the interested stockholder. Except as otherwise specified in Section 203 of the Delaware General Corporation Law, an interested stockholder is defined to include (x) any person that owns (or, within the prior three years, did own) 15% or more of the outstanding voting stock of the corporation, or is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within three years immediately prior to the date of determination and (y) the affiliates and associates of any such person. Under certain circumstances, Section 203 of the Delaware General Corporation Law makes it more difficult for a person who would be an interested stockholder to effect various business combinations with a corporation for a three-year period. We have not elected to be exempt from the restrictions imposed under Section 203 of the Delaware General Corporation Law. However, IDT and its affiliates are excluded from the definition of "interested stockholder" pursuant to the terms of Section 203 of the Delaware General Corporation Law. The provisions of Section 203 of the Delaware General Corporation Law may encourage persons interested in acquiring us to negotiate in advance with the board, since the stockholder approval requirement would be avoided if a majority of the directors then in office approves either the business combination or the transaction which results in any such person becoming an interested stockholder. Such provisions also may have the effect of preventing changes in our management. It is possible that such provisions could make it more difficult to accomplish transactions that our stockholders may otherwise deem to be in their best interests. 68 Liability of Directors; Indemnification The certificate of incorporation contains a provision that is designed to limit directors' liability to the extent permitted by the Delaware General Corporation Law. Specifically, directors will not be held liable to us or our stockholders for monetary damages for any breach of fiduciary duty as a director, except for liability as a result of: . any breach of the duty of loyalty to us or our stockholders; . actions or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . payment of an improper dividend or improper repurchase of our stock under Section 174 of the Delaware General Corporation Law; or . actions or omissions pursuant to which the director received an improper personal benefit. The principal effect of the limitation of liability provision is that a stockholder is unable to prosecute an action for monetary damages against a director of ours unless the stockholder can demonstrate one of the specified bases for liability. The provision, however, does not eliminate or limit director liability arising in connection with causes of action brought under the federal securities laws. The certificate of incorporation does not eliminate a director's duty of care. The inclusion of this provision in the certificate of incorporation may discourage or deter stockholders or management from bringing a lawsuit against directors for a breach of their fiduciary duties, even though such an action, if successful, might otherwise have benefited us and our stockholders. This provision should not affect the availability of equitable remedies such as injunction or rescission based upon a director's breach of the duty of care. The bylaws also provide that we will indemnify our directors and officers, and may indemnify any of our employees and agents, to the fullest extent permitted by Delaware law. We are generally required to indemnify our directors and officers for all judgments, fines, penalties, settlements, legal fees and other expenses incurred in connection with pending, threatened or completed legal proceedings because of the director's or officer's position with us or another entity that the director or officer serves at our request, subject to certain conditions, and to advance funds to its directors and officers to enable them to defend against such proceedings. At present, there is no pending or threatened litigation or proceeding involving any director or officer, employee or agent of ours where such indemnification will be required or permitted. Transfer Agent and Registrar American Stock Transfer & Trust Company will be the transfer agent and registrar for the common stock. SHARES ELIGIBLE FOR FUTURE SALE Of the 10,944,429 shares of common stock and 36,578,190 shares of Class A stock to be outstanding on the closing of the offering (11,819,229 shares of common stock if the underwriters exercise their over-allotment option in full), the 5,400,000 shares of common stock sold in the offering (6,210,000 shares if the underwriters exercise their over-allotment option in full) will be freely tradable without restriction under the Securities Act of 1933, except for any such shares which may be acquired by an affiliate of ours, as that term is defined in Rule 144 promulgated under the Securities Act of 1933. On the closing of the offering, IDT will own 27,158,190 shares of Class A stock, which will constitute approximately 57.1% of our outstanding capital stock (approximately 56.1% if the underwriters exercise their over-allotment option in full). 69 Persons who are affiliates of ours will be permitted to sell the shares of common stock that are issued in the offering only pursuant to an effective registration statement under the Securities Act of 1933 or an exemption from the registration requirements of the Securities Act of 1933, including exemptions provided by Rule 144 of the Securities Act of 1933. Upon closing of this offering, we intend to file a registration statement for the resale of the shares of common stock that are authorized for issuance under our stock option plan. We expect this registration statement to become effective immediately upon filing. Shares issued pursuant to our stock option plan after the effective date of this registration statement (other than shares issued to our affiliates) generally will be freely tradable without restriction or further registration under the Securities Act of 1933. As of the date of this prospectus, options to purchase 5,960,000 shares of common stock under our stock option plan have been granted, of which 1,375,218 have been exercised. We expect to grant options to purchase approximately 2,671,500 additional shares prior to the closing of this offering, including options to purchase 10,000 shares of our common stock that we will grant to each of our eligible non- employee directors. See "Management--1999 Stock Incentive Plan." The shares of capital stock held by IDT are deemed "restricted securities" as defined in Rule 144 of the Securities Act of 1933, and may not be sold other than through registration under the Securities Act of 1933 or pursuant to an exemption from the regulations thereunder, including exceptions provided by Rule 144 of the Securities Act of 1933. Subject to applicable law and to the contractual restriction with the underwriters described below, IDT may sell any and all of the shares of capital stock it owns after completion of the offering. We, along with each of our security-holders, our directors and executive officers, IDT and the Series A investors have agreed, for a period of 180 days after the date of this prospectus, not to offer or sell any shares of Class A stock or common stock, subject to limited exceptions, without the prior written consent of Hambrecht & Quist LLC. IDT's shares of our capital stock are pledged as collateral to secure a credit facility. If IDT defaults in its obligations under the pledge agreement, then a third party could acquire the pledged stock and would not be subject to these agreements. See "Underwriting." Upon closing of this offering, the holders of 9,420,000 shares of our Class A stock, or their transferees, will be entitled to request that we register their shares under the Securities Act. See "Certain Transactions--Relationship with Other Investors--Registration Rights Agreement." 70 UNDERWRITING Hambrecht & Quist LLC, BT Alex. Brown Incorporated and Bear, Stearns & Co. Inc. are the representatives of the underwriters. Hambrecht & Quist LLC and BT Alex. Brown Incorporated are acting as joint book-running managers and Bear, Stearns & Co. Inc. is acting as co-manager. Subject to the terms and conditions of the Underwriting Agreement, the underwriters named below, through their representatives, have severally agreed to purchase from Net2Phone the following respective number of shares of common stock:
Number of Name Shares ---- --------- Hambrecht & Quist LLC................... BT Alex. Brown Incorporated............. Bear, Stearns & Co. Inc................. --------- Total................................... 5,400,000 =========
The underwriting agreement provides that the obligations of the underwriters are subject to certain conditions precedent, including the absence of any material adverse change in our business and the receipt of certain certificates, opinions and letters from us, our counsel and the independent auditors. The underwriters are committed to purchase all of the shares of common stock offered by us if they purchase any shares. The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters. Such amounts are shown assuming both no exercise and full exercise of the underwriters' over-allotment option to purchase additional shares. The underwriters will not be paid a discount or commission with respect to shares sold to three of our current stockholders in this offering, which are excluded from the calculation of per share amounts in the following table. Underwriting Discounts and Commissions
With Without Over-Allotment Over-Allotment Exercise Exercise -------------- -------------- Per Share................................... $ $ Total....................................... $ $
We estimate that the total expenses of this offering, excluding underwriting discounts and commissions, will be approximately $2.0 million. The underwriters propose to offer the shares of common stock directly to the public at the initial public offering price set forth on the cover page of this prospectus and to certain dealers at that price less a concession not in excess of $ per share. The underwriters may allow and such dealers may reallow a concession not in excess of $ per share to certain other dealers. After the initial public offering of the shares, the offering price and other selling terms may be changed by the underwriters. We have granted to the underwriters an option, exercisable no later than 30 days after the date of this prospectus, to purchase up to 810,000 additional shares of common stock at the initial public offering price, less the underwriting discount set forth on the cover page of this prospectus. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase 71 approximately the same percentage thereof which the number of shares of common stock to be purchased by it shown in the above table bears to the total number of shares of common stock offered hereby. We will be obligated, pursuant to the option, to sell shares to the underwriters to the extent the option is exercised. The underwriters may exercise this option only to cover over- allotments made in connection with the sale of shares of common stock offered by us. The offering of the shares is made for delivery when, as and if accepted by the underwriters and subject to prior sale and to withdrawal, cancellation or modification of the offering without notice. The underwriters reserve the right to reject an order for the purchase of shares in whole or in part. We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of these liabilities. All of our security-holders, including the Series A investors, IDT, and our executive officers and directors have agreed that they will not, without the prior written consent of Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of capital stock, options or warrants to acquire shares of capital stock or securities exchangeable for or convertible into shares of capital stock owned by them for a period of 180 days following the date of this prospectus. We have agreed that we will not, without the prior written consent of Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of capital stock, options or warrants to acquire shares of capital stock or securities exchangeable for or convertible into shares of capital stock for a period of 180 days following the date of this prospectus, except that we may issue shares upon the exercise of options and warrants granted prior to the date hereof, and may grant additional options under our stock option plans. Without the prior written consent of Hambrecht & Quist LLC, any additional options granted shall not be exercisable during this 180-day period. Certain persons participating in this offering may over-allot or effect transactions which stabilize, maintain or otherwise affect the market price of the common stock at levels above those which might otherwise prevail in the open market, including by entering stabilizing bids, effecting syndicate covering transactions or imposing penalty bids. A stabilizing bid means the placing of any bid or effecting of any purchase, for the purpose of pegging, fixing or maintaining the price of the common stock. A syndicate covering transaction means the placing of any bid on behalf of the underwriting syndicate or the effecting of any purchase to reduce a short position created in connection with the offering. A penalty bid means an arrangement that permits the underwriters to reclaim a selling concession from a syndicate member in connection with the offering when shares of common stock sold by the syndicate member are purchased in syndicate covering transactions. Such transactions may be effected on the Nasdaq National Market, in the over-the- counter market, or otherwise. Such stabilizing, if commenced, may be discontinued at any time. Prior to this offering, there has been no public market for our common stock. The initial public offering price for the common stock will be determined by negotiations among us and the representatives. Among the factors to be considered in determining the initial public offering price will be prevailing market and economic conditions, our revenue and earnings, market valuations of other companies engaged in activities similar to our business operations and our management. The estimated initial public offering price range set forth on the cover of this preliminary prospectus is subject to change as a result of market conditions or other factors. At our request, the underwriters have reserved at the initial public offering price the number of shares of common stock that may be purchased for $7.5 million for sale to America Online, the number of shares of common stock that may be purchased for $3.0 million for sale to NBC and the number of shares of common stock that may be purchased for $2.0 million to GE Capital. Based upon the low end of the estimated range on the front cover of this prospectus, America Online may therefore purchase in the offering up to 625,000 shares of our common stock, NBC may purchase up to 250,000 shares of our common stock and GE Capital may purchase up to 166,666 shares of our common stock. America Online, NBC and GE Capital have each 72 expressed an interest in purchasing these shares, which will be subject to a lock-up agreement that each company has entered into with the underwriters, under which it has agreed not to sell shares for 180 days after the date of this prospectus. There can be no assurance that any of the reserved shares will be purchased. The number of shares available for sale to the general public in this offering will be reduced by the number of reserved shares sold. Any reserved shares not so purchased will be offered to the general public on the same basis as the other shares offered hereby. In addition, at our request, the underwriters have reserved up to 270,000 shares of common stock for sale at the initial public offering price to our directors, officers, employees, business associates and related persons. The number of shares of common stock available for sale to the general public will be reduced if such persons purchase the reserved shares. Any reserved shares which are not so purchased will be offered by the underwriters to the general public on the same basis as the other shares offered hereby. In connection with this offering, certain underwriters and selling group members (if any) who are qualified market makers on the Nasdaq National Market may engage in passive market making transactions in our common stock on the Nasdaq National Market in accordance with Rule 103 of Regulation M under the Securities Exchange Act of 1934, as amended. In general, a passive market maker must display its bid at a price not in excess of the highest independent bid of such security; if all independent bids are lowered below the passive market maker's bid, however, such bid must then be lowered when certain purchase limits are exceeded. Hambrecht & Quist LLC and persons associated with Hambrecht & Quist LLC beneficially own 20,000 shares of Series A convertible preferred stock and warrants to purchase 92,400 shares of common stock at an exercise price of $3.33 per share, which warrants expire upon the closing of this offering. Additionally, Access Technology Partners, L.P., a fund of outside investors that is managed by a subsidiary of Hambrecht & Quist California, owns 80,000 shares of Series A convertible preferred stock. BT Alex. Brown Incorporated and persons associated with BT Alex. Brown Incorporated own 37,500 shares of Series A convertible preferred stock. Additionally, Stephen A. Oxman, one of our directors and a managing director at Deutsche Bank Securities Inc., an affiliate of BT Alex. Brown Incorporated, owns 2,500 shares of Series A convertible preferred stock, and will be granted options to purchase 10,000 shares of common stock upon the closing of this offering, which will have an exercise price equal to the initial public offering price. Denis Bovin, Vice Chairman-Investment Banking of Bear, Stearns & Co. Inc., owns options to purchase 75,000 shares of common stock at an exercise price of $3.33 per share. Additionally, Mr. Bovin will receive options to purchase 50,000 shares of common stock at the offering price upon the consummation of this offering. We expect that all of these options will be exercised prior to the closing of this offering. Prior to the closing of this offering, each of Hambrecht & Quist LLC and persons associated with it, BT Alex. Brown Incorporated and persons associated with it, Denis Bovin and Stephen A. Oxman will enter into written agreements with Net2Phone, whereby each of them will agree, for a period of one year from the date of this prospectus with respect to 136,031 shares of capital stock, and three years from the date of this prospectus with respect to 188,769 shares of capital stock, not to sell, transfer, assign, pledge or hypothecate any shares of capital stock owned by them that are deemed to be underwriting compensation. Hambrecht & Quist LLC and BT Alex. Brown Incorporated have provided financial advisory services to Net2Phone and IDT in the past and have received compensation at market rates for these services. 73 LEGAL MATTERS Certain legal matters with respect to the validity of the common stock offered hereby will be passed upon for us by Morrison & Foerster LLP, New York, New York. Ira A. Greenstein, our General Counsel and Secretary, is a partner of Morrison & Foerster LLP. Certain legal matters relating to this offering will be passed upon for the underwriters by Brobeck, Phleger & Harrison LLP, New York, New York. EXPERTS The financial statements of Net2Phone, Inc. and, for the periods prior to its incorporation, the Net2Phone division of IDT Corporation, July 31, 1997 and July 31, 1998 and for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998, appearing in this prospectus and registration statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION We have filed with the Securities and Exchange Commission a registration statement on Form S-1 under the Securities Act of 1933 with respect to the common stock offered hereby. This prospectus does not contain all of the information set forth in the registration statement, certain portions of which are omitted as permitted by the rules and regulations of the Securities and Exchange Commission. For further information pertaining to us and the common stock to be sold in this offering, reference is made to the registration statement, including the exhibits thereto and the financial statements, notes and schedules filed as a part thereof. Statements contained in this prospectus regarding the contents of any contract or other document referred to herein or therein are not necessarily complete, and in each instance reference is made to the copy of such contract or other document filed as an exhibit to the registration statement or such other document, each such statement being qualified in all respects by such reference. On the closing of the offering, we will be subject to the informational requirements of the Securities Exchange Act of 1934 and will file reports, proxy statements and other information with the Securities and Exchange Commission. Such reports, proxy statements and other information, as well as the registration statement and the exhibits and schedules thereto, may be inspected, without charge, at the public reference facility maintained by the Securities and Exchange Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C. 20549, and at the Securities and Exchange Commission's regional offices located at Seven World Trade Center, New York, New York 10048 and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material may also be obtained from the Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Such materials can also be inspected on the Securities and Exchange Commission's Web site at www.sec.gov. 74 INDEX TO FINANCIAL STATEMENTS
Page ---- Report of Independent Auditors............................................ F-2 Balance Sheets as of July 31, 1997 and 1998 and April 30, 1999 (Unaudited).............................................................. F-3 Statements of Operations for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-4 Statements of Stockholders' Deficit for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1999 (Unaudited)............ F-5 Statements of Cash Flows for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-6 Notes to Financial Statements............................................. F-7
F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Net2Phone, Inc. We have audited the accompanying balance sheets of Net2Phone, Inc. and, for the periods prior to its incorporation, the Net2Phone division of IDT Corporation (the "Company") as of July 31, 1997 and 1998, and the related statements of operations, stockholders' deficit and cash flows for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at July 31, 1997 and 1998 and the results of its operations and its cash flows for the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP New York, New York May 11, 1999, except for Note 9, the date of which is June 25, 1999 F-2 Net2Phone, Inc. BALANCE SHEETS
July 31 April 30 ------------------------ ----------- 1997 1998 1999 ----------- ----------- ----------- (Unaudited) Assets Current assets: Cash and cash equivalents............. $ -- $ 10,074 $ 1,782,194 Trade accounts receivable, net........ 16,500 1,465,475 329,577 Due from IDT Corporation.............. -- -- 346,176 Prepaid contract deposits............. -- -- 4,000,000 Other current assets.................. -- -- 31,051 ----------- ----------- ----------- Total current assets................ 16,500 1,475,549 6,488,998 Property and equipment, net............. 899,525 5,409,061 8,228,218 Trademark, net.......................... -- -- 5,000,000 Other assets............................ -- 90,498 101,112 ----------- ----------- ----------- Total assets........................ $ 916,025 $ 6,975,108 $19,818,328 =========== =========== =========== Liabilities and stockholders' deficit Current liabilities: Accounts payable...................... $ -- $ -- $ 248,675 Deferred revenue...................... 161,001 810,114 1,495,775 Due to IDT Corporation................ 2,960,429 11,814,988 22,000,000 ----------- ----------- ----------- Total current liabilities........... 3,121,430 12,625,102 23,744,450 Commitments and contingencies Redeemable convertible preferred stock, Series A, $.01 par value; authorized shares-- 3,150,000; no shares issued and outstanding.......................... -- -- -- Stockholders' deficit: Preferred stock, $.01 par value; authorized shares--6,850,000; no shares issued and outstanding........ -- -- -- Common stock, $.01 par value; authorized shares-- 200,000,000; 30,960,000 shares issued and outstanding at July 31, 1998 and April 30, 1999 (None at July 31, 1997)................................ -- 100,100 309,600 Class A stock, $.01 par value; authorized shares 37,042,089; no shares issued and outstanding........ -- -- -- Additional paid-in capital............ -- -- 4,420,338 Accumulated deficit................... (2,205,405) (5,750,094) (8,656,060) ----------- ----------- ----------- Total stockholders' deficit......... (2,205,405) (5,649,994) (3,926,122) ----------- ----------- ----------- Total liabilities and stockholders' deficit............................ $ 916,025 $ 6,975,108 $19,818,328 =========== =========== ===========
See accompanying notes. F-3 Net2Phone, Inc. STATEMENTS OF OPERATIONS
Period from January 2, 1996 (date of inception) Nine months ended April to July 31 Year ended July 31 30 ------------------- ------------------------- ------------------------- 1996 1997 1998 1998 1999 ------------------- ----------- ------------ ----------- ------------ (Unaudited) Revenues: Service revenue....... $ -- $ 2,652,303 $ 10,490,972 $ 6,439,374 $ 21,757,721 Product revenue....... -- -- 1,515,000 1,515,000 445,536 ---------- ----------- ------------ ----------- ------------ Total revenue....... -- 2,652,303 12,005,972 7,954,374 22,203,257 Costs and expenses: Direct cost of revenue: Service cost of revenue*............. -- 1,547,443 6,576,523 3,317,065 11,787,689 Product cost of revenue*............. -- 6,000 272,236 272,236 60,400 ---------- ----------- ------------ ----------- ------------ Total direct cost of revenue*........... -- 1,553,443 6,848,759 3,589,301 11,848,089 Selling and marketing............ 34,468 76,724 2,887,766 1,363,060 4,746,316 General and administrative....... 465,015 2,599,283 5,087,628 3,254,287 7,298,106 Depreciation.......... 8,275 120,500 726,508 421,648 1,216,712 ---------- ----------- ------------ ----------- ------------ Total costs and expenses........... 507,758 4,349,950 15,550,661 8,628,296 25,109,223 ---------- ----------- ------------ ----------- ------------ Loss from operations before provision for income taxes........... (507,758) (1,697,647) (3,544,689) (673,922) (2,905,966) Provision for income taxes.................. -- -- -- -- -- ---------- ----------- ------------ ----------- ------------ Net loss................ $ (507,758) $(1,697,647) $ (3,544,689) $ (673,922) $ (2,905,966) ========== =========== ============ =========== ============ Net loss per share-- basic and diluted...... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09) ========== =========== ============ =========== ============ Weighted average number of shares used in calculation of basic and diluted net loss per share.............. 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000 ========== =========== ============ =========== ============
- -------- * Excludes depreciation and amortization See accompanying notes. F-4 Net2Phone, Inc. STATEMENTS OF STOCKHOLDERS' DEFICIT Period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1999 (unaudited with respect to the nine months ended April 30, 1999)
Common Stock Additional Total ------------------- Paid-In Accumulated Stockholders' Shares Amount Capital Deficit Deficit ---------- -------- ---------- ----------- ------------- Net loss for the period January 2, 1996 (date of inception) to July 31, 1996............. -- $ -- $ -- $ (507,758) $ (507,758) ---------- -------- ---------- ----------- ----------- Balance at July 31, 1996 ....................... -- -- -- (507,758) (507,758) Net loss for the year ended July 31, 1997.. -- -- -- (1,697,647) (1,697,647) ---------- -------- ---------- ----------- ----------- Balance at July 31, 1997................... -- -- -- (2,205,405) (2,205,405) Issuance of Stock to IDT Corporation...... 27,864,000 100 -- -- 100 Sale of Common Stock to officer........... 3,096,000 100,000 -- -- 100,000 Net loss for the year ended July 31, 1998........ -- -- -- (3,544,689) (3,544,689) ---------- -------- ---------- ----------- ----------- Balance at July 31, 1998................... 30,960,000 100,100 -- (5,750,094) (5,649,994) Capital contributions from IDT Corporation.......... -- 209,500 4,420,338 -- 4,629,838 Net loss for the nine months ended April 30, 1999............. -- -- -- (2,905,966) (2,905,966) ---------- -------- ---------- ----------- ----------- Balance at April 30, 1999................... 30,960,000 $309,600 $4,420,338 $(8,656,060) $(3,926,122) ========== ======== ========== =========== ===========
See accompanying notes. F-5 Net2Phone, Inc. STATEMENTS OF CASH FLOWS
Period from January 2, 1996 (date of Nine months ended inception) Year ended July 31 April 30 to July 31 ------------------------ ----------------------- 1996 1997 1998 1998 1999 --------------- ----------- ----------- ---------- ----------- (Unaudited) Operating activities Net loss................ $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation........... 8,275 120,500 726,508 421,648 1,216,712 Changes in assets and liabilities: Accounts receivable.. -- (16,500) (1,448,975) (555,000) 1,135,898 Due from IDT Corporation......... -- -- -- -- (346,176) Prepaid contract deposits............ -- -- -- -- (4,000,000) Other current assets.............. -- -- -- -- (31,051) Other assets......... -- -- (90,498) (73,323) (10,614) Accounts Payable..... -- -- -- -- 248,675 Deferred revenue..... -- 161,001 649,113 471,524 685,661 --------- ----------- ----------- ---------- ----------- Net cash used in operating activities... (499,483) (1,432,646) (3,708,541) (409,073) (4,006,861) Investing activities Purchase of trademark... -- -- -- -- (5,000,000) Purchases of property and equipment.......... (182,949) (845,351) (5,236,044) (4,230,909) (4,035,869) --------- ----------- ----------- ---------- ----------- Net cash used in investing activities... (182,949) (845,351) (5,236,044) (4,230,909) (9,035,869) Financing activities Proceeds from issuance of Common Stock to IDT Corporation -- -- 100 100 -- Proceeds from issuance Common Stock to officer................ -- -- 100,000 -- -- Capital contributions from IDT Corporation... -- -- -- -- 4,629,838 Net advances from IDT Corporation............ 682,432 2,277,997 8,854,559 4,639,882 10,185,012 --------- ----------- ----------- ---------- ----------- Net cash provided by financing activities... 682,432 2,277,997 8,954,659 4,639,982 14,814,850 --------- ----------- ----------- ---------- ----------- Net increase in cash and cash equivalents....... -- -- 10,074 -- 1,772,120 Cash and cash equivalents at beginning of period.... -- -- -- -- 10,074 --------- ----------- ----------- ---------- ----------- Cash and cash equivalents at end of period................. $ -- $ -- $ 10,074 $ -- $ 1,782,194 ========= =========== =========== ========== =========== Supplemental disclosure of cash flow information: Cash payments made for interest............... $ -- $ -- $ -- $ -- $ -- ========= =========== =========== ========== =========== Cash payments made for income taxes........... $ -- $ -- $ -- $ -- $ -- ========= =========== =========== ========== ===========
See accompanying notes. F-6 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 1. Description of Business and Basis of Presentation The accompanying financial statements reflect the historical financial information of Net2Phone, Inc. and, for the periods prior to its incorporation, the Net2Phone division of IDT Corporation (the "Company"), a majority owned subsidiary of IDT Corporation ("IDT"), incorporated in October 1997, to operate and develop its Internet telephony business. Prior to such time, the Company's business was conducted as a division of IDT. The incorporation of Net2Phone Inc. as a subsidiary of IDT was accounted for similar to a recapitalization. All earnings per share calculations assume that such shares were outstanding for all prior periods. The Company's statements of operations include allocations of certain costs and expenses from IDT (Note 4). Although such allocations are not necessarily indicative of the costs that would have been incurred if the Company operated as an unaffiliated entity, management believes that the allocation methods are reasonable. 2. Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates. Interim Financial Information The unaudited interim information as of April 30, 1999 and for the nine months ended April 30, 1998 and 1999 has been prepared on the same basis as the annual financial statements and, in the opinion of the Company's management, contains all adjustments (consisting of normal recurring accruals) necessary for a fair presentation. Operating results for any interim period are not necessarily indicative of results to be expected for the entire year. Revenue Recognition Internet telephony service revenue is recognized as service is provided. Revenue derived from equipment sales and from services provided to IDT is recognized upon installation of the equipment and performance of the services, respectively. (See Note 4) Pre-payments for communications services are deferred and recognized as revenue as the communications services are provided. The sale of equipment with software necessary to provide the Company's services is within the scope of SOP 97-2 "Software Revenue Recognition." Revenue on such sales is recognized when such products are delivered, the payments received are non refundable and there are no significant future obligations. Direct Cost of Revenue Direct cost of revenue consists primarily of telecommunication costs, connectivity costs, and the cost of equipment sold to customers. Direct cost of revenue excludes depreciation and amortization. F-7 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 2. Summary of Significant Accounting Policies (continued) Property and Equipment Equipment and furniture and fixtures are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets of five years. Computer software is amortized using the straight-line method over the shorter of five years or the term of the related agreement. Advertising Costs The Company expenses the costs of advertising as incurred. Typically the Company purchases banner advertising on other companies' web sites pursuant to contracts which have one to three year terms and may include the guarantee of (i) a minimum number of impressions, (ii) the number of times that an advertisement appears in pages displayed to users of the web site, or (iii) a minimum amount of revenue that will be recognized by the Company from customers directed to the Company's web site as a direct result of the advertisement. The Company recognizes expense with respect to such advertising ratably over the period in which the advertisement is displayed. In addition, some agreements require additional payments as additional impressions are delivered. Such payments are expensed when the impressions are delivered. In one case, the Company entered into an agreement with no specified term of years. In this case, the Company amortizes as expense the lesser of (i) the number of impressions to date/minimum guaranteed impressions or (ii) revenue to date/minimum guaranteed revenue as a percentage of the total payments. (See Note 7.) For the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999, advertising expense totaled approximately $6,000, $1,962,000, $888,000, and $3,165,000, respectively. There was no advertising expense for the period from January 2, 1996 (date of inception) to July 31, 1996. Software Development Costs Costs for the internal development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. To date, the Company has essentially completed its software development concurrently with the establishment of technological feasibility and, accordingly, no such costs have been capitalized to date. Software development costs are the Company's only research and development expenditures. For the period from January 2, 1996 (date of inception) to July 31, 1996, software development costs of $340,000 were expensed. No software development costs were expensed for the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999. Capitalized Internal Use Software Costs In March 1998, the Accounting Standards Executive Committee of the AICPA issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The SOP, which has been adopted by the Company requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software. The Company's policy prior to the adoption of the SOP was to capitalize substantially all internal use software costs. These costs consisted of payments made to third parties and the salaries of employees working on such software development. Therefore, the adoption of the SOP did not have a material effect on the Company's financial position or results of operations. At July 31, 1997 and 1998 and April 30, 1999, the Company has capitalized $493,000, $2,198,000 and $3,598,000, respectively, of internal use software costs as computer software. F-8 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 2. Summary of Significant Accounting Policies (continued) Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents are carried at cost which approximates market value. Trademark Costs associated with obtaining the right to use trademarks owned by third parties are capitalized and amortized on a straight-line basis over the two year term of the agreement. Income Taxes The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities. Stock Based Compensation The Company applies the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The Company accounts for stock options using APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Options issued to non-employees are accounted for in accordance with SFAS No. 123. Earnings (Loss) Per Share Earnings (loss) per share is calculated in accordance with FASB Statement No. 128, Earnings per Share. Basic earnings (loss) per share is computed by dividing the net income (loss) applicable to common shares by the weighted average of common shares outstanding during the period. Diluted earnings (loss) per share adjusts basic earnings (loss) per share for the effects of convertible securities, stock options and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive. There were no dilutive securities in any of the periods presented herein. Current Vulnerability Due to Certain Concentrations Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, and trade receivables. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base. Management regularly monitors the creditworthiness of its domestic and international customers and believes that it has adequately provided for any exposure to potential credit losses. Long-Lived Assets In accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, the Company reviews the impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The analysis of the recoverability utilizes undiscounted cash flows. The F-9 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 2. Summary of Significant Accounting Policies (continued) measurement of the loss, if any, will be calculated as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Recently Issued Financial Accounting Standards SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, was issued in June 1997. The Company will be required to adopt the new statement for the year ending July 31, 1999. This statement requires use of the "management approach" model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company intends to adopt this statement in fiscal 1999 and does not anticipate that the adoption of the statement will have significant impact on its financial statements. 3. Property and Equipment Property and equipment consists of the following:
July 31 April 30 --------------------- ---------- 1997 1998 1999 --------- ---------- ---------- Equipment............................... $ 348,625 $3,631,140 $6,094,189 Computer software....................... 679,484 2,595,572 4,118,590 Furniture and fixtures.................. 191 37,632 87,415 --------- ---------- ---------- 1,028,300 6,264,344 10,300,194 Accumulated depreciation................ (128,775) (855,283) (2,071,976) --------- ---------- ---------- Property and equipment, net............. $ 899,525 $5,409,061 $8,228,218 ========= ========== ==========
4. Related Party Transactions In May 1999, the Company and IDT entered into a separation agreement whereby the transactions and agreements necessary to govern the relationship between the two companies necessary to effect their separation were determined. In accordance with such agreement, it was determined that amounts paid by IDT in excess of $22 million would be deemed to be capital contributions. In May 1999, the Company and IDT entered into an Internet/telecommunications agreement whereby the Company has agreed to pay IDT up to $110,000 per month for connectivity, the use of certain computer software and equipment owned or leased by IDT and to provide a platform for IDT's Internet services for a monthly per customer charge. In connection with such agreement, IDT has also granted the Company an indefeasible right, for a period of 20 years, to use a certain telecommunications network as it is completed and delivered for up to approximately $6.0 million. In May 1999, the Company and IDT entered into two one-year services agreements whereby the Company agreed to pay IDT for certain administrative, customer support and other services that IDT provides to it at the cost of such services plus 20%. Also, in conjunction with such agreements, the Company has agreed to provide IDT with certain support services for the cost of such services plus 20%. The agreement is effective for a period of two years. F-10 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 4. Related Party Transactions (continued) In May 1999, the Company and IDT entered into a joint marketing agreement whereby the companies have agreed to jointly advertise and market their products. The agreement continues for a term of one year and is automatically renewable for an additional one year unless terminated by either party. In conjunction with such agreement, a commission will be earned by each company for new customers generated by the other company as a result of such programs. In May 1999, the Company and IDT entered into an assignment agreement whereby IDT assigned all of its rights in certain trademarks, patents and proprietary products and information to the Company. These assets were contributed at IDT's historical cost which was $0. The accompanying financial statements for periods prior to the signing of the aforementioned agreements include charges by IDT to the Company for the aforementioned services. Such charges were based principally upon the Company's allocable portion of IDT's costs for such services. The ratios used to allocate these costs were the Company's total payroll to IDT's total payroll and the Company's total revenue to IDT's total revenue, depending on the type of services provided. The allocated costs approximate the amounts that would have been charged under the inter-company agreements if they had been in effect during such periods. For the period from January 2, 1996 (date of inception) to July 31, 1996 and the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999, all of the Company's operations were financed by IDT. For the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999, the Company recognized revenue for services provided to IDT of $297,000, $453,000, $323,000, and $680,000, respectively. At July 31, 1997 and 1998 and April 30, 1999, the due to IDT balance represents the net amounts owed to IDT as a result of the aforementioned agreements and financing. No interest was charged on the Company's advances from IDT. The average balance owed to IDT during the period from January 2, 1996 (date of inception) to July 31, 1996, the years ended July 31, 1997 and 1998, and the nine months ended April 30, 1999 and 1998 were $341,000, $1,821,000, $7,388,000, $16,907,000 and $5,280,000, respectively. The activity in the intercompany account with IDT was as follows:
Period from Nine months January 2, 1996 Year Ended July 31 ended (date of inception) ----------------------- April 30, to July 31, 1996 1997 1998 1999 ------------------- ---------- ----------- ----------- Opening balance......... $ -- $ 682,432 $ 2,960,429 $11,814,988 Expenses paid by IDT on behalf of the Company, net of cash received... 315,565 1,225,771 6,955,525 7,234,992 Net charges to the Company for services provided by IDT........ 366,867 1,349,226 2,351,934 3,420,520 Revenue recognized by the Company for services provided to IDT.................... -- (297,000) (453,000) (680,000) Capital contribution from IDT............... -- -- 100 209,500 -------- ---------- ----------- ----------- Ending balance.......... $682,432 $2,960,429 $11,814,988 $22,000,000 ======== ========== =========== ===========
F-11 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 5. Income Taxes The Company files a consolidated Federal income tax return with IDT and has entered into a tax sharing agreement with IDT. Pursuant to such tax sharing agreement, the Company would, while included in the IDT consolidated tax return, be reimbursed for the use of its tax losses to the extent IDT realizes a tax reduction from the use of such tax losses. When IDT's ownership interest in the Company falls below 80%, the Company will no longer be a part of the IDT consolidated Federal tax group. Significant components of the Company's deferred tax assets and liabilities consists of the following:
July 31 April 30 ------------------ --------- 1997 1998 1999 -------- --------- --------- Deferred tax assets: Net operating loss carryforwards.......... $ -- $ 314,000 $ 670,000 Deferred tax liabilities: Depreciation.............................. -- (300,000) (609,000) -------- --------- --------- Net deferred tax assets................... -- 14,000 61,000 Valuation allowance....................... -- (14,000) (61,000) -------- --------- --------- Total deferred tax assets................. $ -- $ -- $ -- ======== ========= =========
The net deferred tax assets have been fully offset by a valuation allowance due to the uncertainty of the realization of the assets. At April 30, 1999, the Company had net operating loss carryforwards for state income tax purposes of approximately $7.5 million expiring in years through 2006. These net operating loss carryforwards may be limited to future taxable earnings of the Company.
Period from Year Ended Nine Months January 2, 1996 July 31 Ended April 30 (date of inception) -------------------- ------------------ to July 31, 1996 1997 1998 1998 1999 ------------------- -------- ---------- -------- -------- Tax at effective rate... (173,000) (577,000) (1,205,000) (229,000) (988,000) Benefit used by IDT for which the Company received no compensation........... 173,000 577,000 1,205,000 229,000 988,000 -------- -------- ---------- -------- -------- Tax provision........... -- -- -- -- -- ======== ======== ========== ======== ========
6. Stockholders' Deficit In April 1999, the Company amended and restated its Certificate of Incorporation (the "Amendment"). As a result of the Amendment, the Company increased its authorized shares of capital stock from 1,500 to 110,000,000, of which 100,000,000 shares are designated as common stock and 10,000,000 shares are designated as preferred stock. Subject to any voting rights which may be provided to future holders of preferred stock, the holders of common stock have exclusive voting rights on all matters requiring a vote of the Company and are entitled to one vote per share of common stock held. In conjunction with the Amendment, the Company effectuated a 10,320 for one stock split. The accompanying financial statements give retroactive effect to the stock split. F-12 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 7. Commitments On February 8, 1998, the Company entered into an agreement with an Internet company to develop a link between its Internet site and that of the Company and advertise Company products on such site. The agreement is effective for fifteen months upon the completion of the link and automatically extends for an additional one year unless terminated by either party. Pursuant to such agreement, the Company has made payments of $2.85 million through April 30, 1999 for the design, development, installation and implementation of the link as well as the placement of Company advertisements on the Internet company's site, of which $750,000 attributable to the establishment of such link was deferred and is being amortized over the term of the agreement and $2.1 million attributable to monthly payments for advertising and the maintenance of the link was expensed monthly as incurred. As of April 30, 1999, the Company was required to make an additional payment of $150,000 in fiscal 1999 and pay certain future commissions, as defined, based upon revenue earned and usage of the link. On August 4, 1998, the Company entered into an agreement with an Internet company to advertise Company products on its Internet site. The agreement is effective as of October 1, 1998, the launch date of the link, and extends indefinitely until the Internet company fully provides all advertising impressions guaranteed under the agreement. Pursuant to such agreement, the Company has made payments of $495,000 through April 30, 1999 for the Company advertisements on such site. As of April 30, 1999, the Company is required to make additional payments of $213,000 in fiscal 1999, $975,000 in fiscal 2000, and $167,000 in fiscal 2001 and pay certain future commissions, as defined, based upon revenue earned and usage of the link. Under this agreement the Company records expenses equal to the lesser of (i) the number of impressions to date/minimum guaranteed impressions or (ii) revenue to date/minimum guaranteed revenue as a percentage of the total payments. On February 19, 1999, the Company entered into an agreement under which an international computer company is to provide connections to its global network. These connections will allow worldwide transport of the Company's IP traffic. The agreement is effective for 63 months upon availability of the connections. Pursuant to such agreement, the Company has made payments of $1 million through April 30, 1999 which have been reflected on the consolidated balance sheets as prepaid contract deposits. As of April 30, 1999, the Company is required to make an additional payment of $1 million when the connections are available and pay fees for additional connections and usage. The $2 million of prepayments will be amortized over the term of the agreement beginning at the time the connections are available for use. On January 31, 1999, the Company entered into a series of agreements with a third party. The agreements call for the bundling of the Company's Internet telephony products with the third party's Internet browser, the purchase of software from the third party and the use of the third party's trademark. The agreements require the Company to pay the third party (i) $5,000,000 for the use of the trademark (ii) $8,000,000 for the purchase of software and (iii) commissions on revenues generated from customers that the Company obtains from the bundling of products. Through April 30, 1999, the Company had paid $5 million for the right to use the trademark and $3 million for certain software. The Company has capitalized the costs of the right to use the trademark and the software costs and will amortize them over the term of the bundling agreement, which expires two years after the release of the bundled product. The Company has distribution agreements under which it has agreed to pay its agents commissions for obtaining new Internet telephony customers. The agreements require commissions upon activation of the customers. In May 1997, the Company entered into a three year employment agreement with one of its officers. Under the terms of such agreement, which was amended in May 1999, the Company agreed to, among other things, provide such officer with an annual salary of $100,000 and the right to purchase a 10% interest F-13 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 7. Commitments (continued) in the Company for $100,000, which was the fair market value of the Company at that time. Such right, which includes an anti-dilutive provision mandating that the officer's ownership interest cannot be diluted below 8% of the total outstanding shares upon consummation of an initial public offering of the Company's common stock, was exercised during fiscal 1998. The agreement is automatically renewable on an annual basis after its initial three year term unless terminated by either party. 8. Customer and Geographical Area Revenue from customers outside the United States represented approximately 44%, 72%, 63%, and 58% of total revenue during the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999, respectively. During the year ended July 31, 1998 and the nine months ended April 30, 1998, revenues derived from equipment sales to a customer in Korea represented approximately 14% and 19%, respectively, of total revenue. No single geographic area accounted for more than 10% of total revenue during the year ended July 31, 1997 and the nine months ended April 30, 1999. No customer accounted for more than 10% of revenue during the year ended July 31, 1997 and the nine months ended April 30, 1999. 9. Subsequent Events On June 25, 1999, the Company effectuated a three-for-one stock split. The financial statements give retroactive effect to the stock split. In addition, the Company designated 15,000,000 shares of its capital stock as Class A stock. The holders of Class A stock are identical to those of common stock except for voting and conversion rights and restrictions on transferability. The Class A stock is entitled to two votes per share. In March 1999, the Company entered into two lease agreements with companies which are owned by the Chairman, Chief Executive Officer and Treasurer of IDT. Pursuant to such lease agreements, the Company is required to make equal monthly rental payments aggregating $558,000 to such companies through February 2002. On May 12, 1999, the Company converted a portion of its liability to IDT into a $14,000,000 promissory note. Such promissory note accrues interest at a rate of 9% per annum and is payable in 60 equal monthly installments of principal and interest. Notwithstanding the foregoing, $7,000,000 in principal will be repaid within 10 days of the consummation of a proposed initial public offering of the Company's common stock. On May 13, 1999, the Company designated 3,150,000 shares of its preferred stock as Series A ("Series A Stock") and sold 3,140,000 of such shares to unrelated third parties in a private placement transaction for aggregate gross proceeds of $31,400,000. The Series A Stock entitles its holders to a non-cumulative dividend of 8% per annum on the original issue price. Each share of Series A Stock is convertible into three shares of Class A stock at the option of the holder, subject to certain adjustments as, defined. Each share of Series A stock also entitles its holders to vote on corporate matters on an as if converted basis. Holders of Series A Stock have priority over common stock and Class A stock with respect to the payment of dividends and in the event of the liquidation or dissolution of the Company. The liquidation preference of the Series A Stock is equivalent to the original issue price plus an amount equal to 8% of the original issue price compounded on an annual basis from the date of issuance plus any declared, but unpaid dividends. The Series A Stock is redeemable at the option of the holder, beginning May 2006, over a period of 3 years. F-14 Net2Phone, Inc. NOTES TO FINANCIAL STATEMENTS--(Continued) July 31, 1998 (unaudited with respect to the nine months ended April 30, 1998 and 1999) 9. Subsequent Events (continued) The Series A Stock contains beneficial conversion features. The total value of the beneficial conversion feature approximated $75 million. For accounting purposes the value of the beneficial conversion features was limited to the amount of proceeds allocated to the Series A Stock. The Company will record a reduction in net income available to common stockholders on the date of the issuance of the Series A Stock in the amount of approximately $29.3 million. In connection with the sale of Series A Stock, the Company granted warrants to purchase 272,400 shares of common stock at an exercise price of $3.33 per share, subject to certain adjustments as defined, from the date of issuance through May 13, 2004 to the Series A Stock investors and placement agent. The warrants contain a provision whereby they are automatically terminated upon a merger or sale of the Company or an initial public offering of the Company's stock. As a result, the warrants are expected to be exercised prior to the proposed initial public offering of the Company's common stock. The fair value of warrants on the date of issuance was $2.1 million. This was computed using the Black Scholes model with the following assumptions: the fair value of the common stock equal to $11.00 per share, the risk free interest rate of 4.79%, volatility factor of 84%, an expected life of 6 months, and a dividend yield of 0% The fair value of the warrants will be recorded as an increase to additional paid in capital and a decrease to the carrying value of the preferred stock. The decrease in the carrying value of Series A Stock will be accreted with a reduction of additional paid-in capital over the period to the initial redemption date in May 2006. In connection with this offering, the Series A convertible preferred stock will be converted into Class A stock. At that time, the balance of the unamortized discount will be recorded as a reduction of the amount of income available for common shareholders. In April 1999, the Company adopted a stock option and incentive plan (the "Plan"). Pursuant to the Plan, the Company's officers, employees and non- employee directors, as well as those of IDT, are eligible to receive awards of incentive and non-qualified stock options, stock appreciation rights, limited stock appreciation rights and restricted stock. In May 1999, a total of 5,040,000 shares of common stock were authorized for issuance under the plan to employees of the Company and to employees and consultants of IDT, all of which were granted with an exercise price of $3.33 per share and 1,345,219 of which were exercised through June 25, 1999. The options generally vest over periods up to four years and expire ten years from the date of grant. In connection with the exercise of such options, the Company extended $3,150,000 in loans to employees. In order to obtain such loans, the optionees agreed to the cancellation of 23,382 outstanding options. Compensation expense in connection with the options to purchase 3,718,503 shares of common stock issued to employees of the Company will be computed in accordance with APB 25. The expense will be computed as the difference between the exercise price of $3.33 per share and the fair market value of the stock on the date of grant ($11 per share). The deferred compensation expense of approximately $28.5 million will be amortized over the vesting period of the options. Compensation expense in connection with the options to purchase 1,321,497 shares of common stock issued to employees and consultants of IDT will be computed in accordance with FAS 123. The expense will be computed using the Black Scholes model with the following assumptions: the fair market value of the common stock on date of grant equal to $11.00 per share, the risk free interest rate of 5.92%, volatility factor of 84%, an expected life of 5 years, and a dividend yield of 0%. The deferred compensation expense of approximately $12.4 million will be amortized over the vesting period of the options. Compensation expense from both the options issued to the Company's employees and employees and consultants to IDT will be charged to expense over the vesting period: fiscal 1999, $14.8 million; fiscal 2000, $9.8 million; fiscal 2001, $9.8 million; and fiscal 2002, $6.5 million. On June 25, 1999, the shares authorized for issuance under the plan was increased by 6,000,000 shares. F-15 9. Subsequent Events (continued) The Company entered into an agreement with Snap, an Internet postal service of NBC and CNET, on May 17, 1999. Snap will display links to the Company's Web site and services on its Snap.com Web site. In addition, the Company is Snap's preferred provider of PC-to-phone services during the two-year term of this agreement. Snap also will deliver a preset minimum number of impressions on its site and agreed to give the Company the right to advertise on its Snap.com Web site, subject to certain conditions. In exchange, the Company agreed to pay Snap a one-time fee, a percentage of revenue generated through their site and bonus payments for customers delivered by Snap after meeting certain quotas. The Company will amortize the up front payment over the term of the agreement. The Company signed an agreement with NBC on June 25, 1999 to purchase $1.5 million in television advertising on the NBC television network. The Company also has the right to purchase additional spots to be telecast prior to June 30, 2000. The cost of the advertising will be expensed as the spots are shown. On July 2, 1999, the Company signed a three-year employment agreement with its new President. After the initial term, the agreement may be renewed annually. The Company will pay its President an annual base salary of $350,000 and he is entitled to receive an annual bonus calculated on the basis of the Company's gross revenue, which bonus could be up to $100,000. The Company granted its President options to purchase 920,000 shares of its common stock under its 1999 Stock Option and Incentive Plan. Of these options, 460,000 were granted at an exercise price of $3.33 per share, 153,333 of which are vested and exercisable. The options to purchase the remaining 460,000 shares were granted at the lower of the initial public offering price or $11.00 per share. Other than those options which are vested, the remaining 766,667 options will vest in three equal annual installments, commencing on July 20, 2000. The Company will record compensation in connection with the issuance of options with an exercise price less than the fair market value of the stock. On July 15, 1999, the Company entered into a four-year distribution and marketing agreement with ICQ, a subsidiary of America Online. Under this agreement, ICQ has agreed to co-brand and promote the Company's Internet telephony services in the U.S. and in 19 other countries, embed customized versions of the Company's software to allow ICQ customers to make PC-to-phone and PC-to-PC calls and to receive phone-to-PC calls, share revenue from advertisements and sponsorships sold by ICQ on the Company's software that is embedded in ICQ's Instant Messenger software, and promote the Company's services on some of ICQ's Web sites. The Company agreed to pay ICQ a fee of $7.5 million, $4.0 million of which was paid at signing, and the remainder of which will be paid at the closing of the Company's initial public offering. The Company also agreed to pay ICQ a share of minutes-based revenue generated through ICQ and to award ICQ a performance bonus on the basis of the total revenue derived under the agreement, and to promote ICQ on the Company's Web sites. In connection with the Company's distribution and marketing agreement with ICQ, the Company issued a warrant to America Online to purchase up to 3% of the Company's outstanding capital stock on a fully-diluted basis. This warrant will vest in 1% increments upon the achievement of each of three incremental thresholds of revenue generated under the agreement during the first four years that the warrant is outstanding. The per share exercise price under the warrant will be equal to the lesser of 80% of the price per share in the Company's initial public offering, or $450 million divided by the number of the Company's fully-diluted shares on the initial exercise date. The warrant may be exercised for a period of five years from the date of issuance. F-16 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 5,400,000 Shares [NET2PHONE LOGO] Common Stock ---------------- PROSPECTUS ---------------- HAMBRECHT & QUIST BT ALEX. BROWN ---------------- BEAR, STEARNS & CO. INC. ---------------- , 1999 ---------------- You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. No action is being taken in any jurisdiction outside the United States to permit a public offering of the common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction. Until , 1999, all dealers that buy, sell or trade in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Other expenses in connection with the issuance and distribution of the securities to be registered hereunder, all of which will be paid by us, will be substantially as follows (all amounts are estimated except the Securities and Exchange Commission registration fee, the National Association of Securities Dealers filing fee and the Nasdaq National Market listing fee):
Item Amount ---- ---------- Securities and Exchange Commission registration fee........... $ 24,170 NASD filing fee............................................... 8,694 Nasdaq National Market listing fee............................ 78,875 Blue Sky filing fees and expenses............................. 20,000 Accounting fees and expenses.................................. 300,000 Legal fees and expenses....................................... 900,000 Transfer agent fees and expenses.............................. 3,500 Printing and engraving expenses............................... 400,000 Miscellaneous expenses........................................ 264,761 ---------- Total....................................................... $2,000,000 ==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Reference is made to Section 145 of the Delaware General Corporation Law, which provides for indemnification of directors, officers and other employees in certain circumstances, and to Section 102(b)(7)of the Delaware General Corporation Law, which provides for the elimination or limitation of the personal liability for monetary damages of directors under certain circumstances. Article Sixth of our certificate of incorporation, as amended and restated, eliminates the personal liability for monetary damages of directors under certain circumstances. Our bylaws provide indemnification to our directors and officers to the fullest extent permitted by the Delaware General Corporation Law for, among other things, liabilities for judgments in and settlements of lawsuits and other proceedings and for the advance and payment of fees and expenses reasonably incurred by the director or officer in defense of any such lawsuit or proceeding. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES In October 1997, in connection with our initial organization, IDT Corporation purchased 27,864,000 shares of our common stock for nominal consideration. In January 1998, pursuant to the terms of his employment agreement with IDT Corporation, Mr. Clifford M. Sobel purchased 3,096,000 shares of our common stock for the purchase price of $100,000. This transaction was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. In May 1999, we issued and sold an aggregate of 3,140,000 shares of Series A convertible preferred stock at $10.00 per share, which are convertible into 9,420,000 shares of our common stock, together with warrants to purchase 180,000 shares of our class A stock to several investors for an aggregate of $31,400,000, pursuant to Series A Subscription Agreements, dated as of May 13, 1999. This transaction was exempt from registration under Section 4(2) of the Securities Act of 1933. We also issued a warrant to purchase 92,400 shares of our common stock to the placement agent as partial consideration for its services. This transaction was exempt from registration under Section 4(2) of the Securities Act of 1933. II-1 In May 1999, we issued options to purchase 5,040,000 shares pursuant to our 1999 Stock Option and Incentive Plan, and issued approximately 1,345,219 shares of common stock upon exercise of these options. In July 1999, we issued options to purchase an additional 920,000 shares under the Plan to our President. These transactions were exempt from registration under Section 4(2) of the Securities Act of 1933. In July 1999, in connection with our distribution and marketing agreement with ICQ we issued a warrant to America Online, enabling it to acquire shares of common stock representing up to 3% of our outstanding capital on a fully- diluted basis. This transaction was exempt from registration under Section 4(2) of the Securities Act of 1933. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES Exhibits:
Exhibit Number Description of Exhibit ------- ---------------------- 1.1+ Form of Underwriting Agreement. 3.1+ Certificate of Incorporation, as amended. 3.2+ Bylaws. 3.3+ Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant. 3.4+ Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant. 4.1+ Specimen Common Stock Certificate of the Registrant. 5.1+ Form of Opinion of Morrison & Foerster LLP. 10.1+ Employment Agreement, dated May 1, 1997, by and between Clifford M. Sobel and IDT Corporation. 10.2+ Amendment to Employment Agreement between IDT Corporation and Clifford M. Sobel, dated as of May 11, 1999, by and between Clifford M. Sobel, IDT Corporation and the Registrant. 10.3#+ Bundling and Distribution Services Agreement, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant. 10.4+ General License Terms & Conditions, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant. 10.5 Trademark License Agreement, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant Assignment. 10.6+ Internet/Telecommunications Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.7+ Joint Marketing Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.8+ IDT Services Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.9+ Net2Phone Services Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.10+ Assignment Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.11+ Tax Sharing and Indemnification Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.12+ Separation Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.13+ Lease Agreement, dated as of March 1, 1999, by and between 171-173 Main Street Corporation and the Registrant. 10.14+ Lease Agreement, dated as of March 1, 1999, by and between 294-298 State Street Corporation and the Registrant. 10.15+ The Registrant's Amended and Restated 1999 Stock Option and Incentive Plan.
II-2
Exhibit Number Description of Exhibit ------- ---------------------- 10.16+ Series A Subscription Agreement, dated as of May 13, 1999, by and between the Investors listed therein and the Registrant. 10.17+ Series A Preferred Shareholder Registration Rights Agreement, dated as of May 13, 1999, by and between the Investors listed therein and the Registrant. 10.18+ Form of Warrant to Purchase Common Stock. 10.19+ Promissory Note of Registrant to IDT Corporation, dated as of May 12, 1999. 10.20+ Stockholders Agreement, dated as of May 13, 1999, by and among the Investors listed therein, IDT Corporation, Clifford M. Sobel, the trustee of the Scott Sobel Annual Gift Trust and the Registrant. 10.21+ Letter agreement, dated as of May 12, 1999, by and among IDT Corporation, Clifford M. Sobel and the Registrant. 10.22+ Letter agreement, dated as of May 17, 1999, by and among IDT Corporation, Clifford M. Sobel and the Registrant. 10.23+ Co-Location and Facilities Management Services Agreement, dated as of May 20, 1999, by and between IDT Corporation and the Registrant. 10.24+ Form of Loan Agreement between the Registrant and each of its executive officers. 10.25+ Form of Stock Option Agreement for Executive Officers. 10.26#+ Letter agreement, dated as of June 25, 1999, by and between National Broadcasting Company, Inc. and the Registrant. 10.27+ Employment Agreement, dated July 2, 1999, by and between Jonathan Fram and the Registrant. 10.28# IP Telephony Services Distribution and Interactive Marketing Agreement, dated as of July 15, 1999, by and between ICQ, Inc. and the Registrant. 10.29#+ Stock Subscription Warrant, dated July 15, 1999, by and between America Online, Inc. and the Registrant. 10.30 Amendment No. 1 to Employment Agreement, dated July 16, 1999, by and between Jonathan Fram and the Registrant. 23.1 Consent of Ernst & Young LLP. 23.2+ Consent of Morrison & Foerster LLP (incorporated by reference into Exhibit 5.1). 24.1+ Power of Attorney (set forth on the signature page to this registration statement). 27.1+ Financial Data Schedule.
- -------- # Confidential treatment has been requested with respect to certain portions of the Exhibit. Omitted portions will be filed separately with the Securities and Exchange Commission. + Previously filed. Financial Statements and Schedule: Financial Statements: Financial Statements filed as a part of this registration statement are listed in the Index to Financial Statements of page F-1. Financial Statement Schedules: None. ITEM 17. UNDERTAKINGS The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing of the offering specified in the Underwriting Purchase Agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. II-3 Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act of 1933 shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II- 4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this Amendment No. 5 to the registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Hackensack, State of New Jersey, on July 28, 1999. Net2Phone, Inc. /s/ Howard S. Balter By: _________________________________ Howard S. Balter Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Amendment to the registration statement has been signed by the following persons in the capacities and on the dates indicated.
Name and Signatures Title Date ------------------- ----- ---- /s/ Clifford M. Sobel Chairman of the Board July 28, 1999 ___________________________________________ Clifford M. Sobel* /s/ Howard S. Balter Chief Executive Officer July 28, 1999 ___________________________________________ and Director (Principal Howard S. Balter Executive Officer) /s/ Ilan M. Slasky Chief Financial Officer July 28, 1999 ___________________________________________ (Chief Accounting Ilan M. Slasky* Officer) /s/ James R. Mellor Director July 28, 1999 ___________________________________________ James R. Mellor* /s/ Howard S. Jonas Director July 28, 1999 ___________________________________________ Howard S. Jonas* Director July 28, 1999 ___________________________________________ Gary E. Rieschel /s/ James A. Courter Director July 28, 1999 ___________________________________________ James A. Courter* Director July 28, 1999 ___________________________________________ Stephen A. Oxman Director July 28, 1999 ___________________________________________ Jesse King
*Executed by attorney-in-fact: Howard S. Balter II-5 INDEX OF EXHIBITS
Exhibit Number Description of Exhibit ------- ---------------------- 1.1+ Form of Underwriting Agreement. 3.1+ Certificate of Incorporation, as amended. 3.2+ Bylaws. 3.3+ Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant. 3.4+ Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant. 4.1+ Specimen Common Stock Certificate of the Registrant. 5.1+ Form of Opinion of Morrison & Foerster LLP. 10.1+ Employment Agreement, dated May 1, 1997, by and between Clifford M. Sobel and IDT Corporation. 10.2+ Amendment to Employment Agreement between IDT Corporation and Clifford M. Sobel, dated as of May 11, 1999, by and between Clifford M. Sobel, IDT Corporation and the Registrant. 10.3#+ Bundling and Distribution Services Agreement, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant. 10.4+ General License Terms & Conditions, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant. 10.5 Trademark License Agreement, dated as of January 31, 1999, by and between Netscape Communications Corporation and the Registrant Assignment . 10.6+ Internet/Telecommunications Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.7+ Joint Marketing Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.8+ IDT Services Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.9+ Net2Phone Services Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.10+ Assignment Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.11+ Tax Sharing and Indemnification Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.12+ Separation Agreement, dated as of May 7, 1999, by and between IDT Corporation and the Registrant. 10.13+ Lease Agreement, dated as of March 1, 1999, by and between 171-173 Main Street Corporation and the Registrant. 10.14+ Lease Agreement, dated as of March 1, 1999, by and between 294-298 State Street Corporation and the Registrant. 10.15+ The Registrant's Amended and Restated 1999 Stock Option and Incentive Plan. 10.16+ Series A Subscription Agreement, dated as of May 13, 1999, by and between the Investors listed therein and the Registrant. 10.17+ Series A Preferred Shareholder Registration Rights Agreement, dated as of May 13, 1999, by and between the Investors listed therein and the Registrant. 10.18+ Form of Warrant to Purchase Common Stock. 10.19+ Promissory Note of Registrant to IDT Corporation, dated as of May 12, 1999. 10.20+ Stockholders Agreement, dated as of May 13, 1999, by and among the Investors listed therein, IDT Corporation, Clifford M. Sobel, the trustee of the Scott Sobel Annual Gift Trust and the Registrant.
Exhibit Number Description of Exhibit ------- ---------------------- 10.21+ Letter agreement, dated as of May 12, 1999, by and among IDT Corporation, Clifford M. Sobel and the Registrant. 10.22+ Letter agreement, dated as of May 17, 1999, by and among IDT Corporation, Clifford M. Sobel and the Registrant. 10.23+ Co-Location and Facilities Management Services Agreement, dated as of May 20, 1999, by and between IDT Corporation and the Registrant. 10.24+ Form of Loan Agreement between the Registrant and each of its executive officers. 10.25+ Form of Stock Option Agreement for Executive Officers. 10.26#+ Letter agreement, dated as of June 25, 1999, by and between National Broadcasting Company, Inc. and the Registrant. 10.27+ Employment Agreement, dated July 2, 1999, by and between Jonathan Fram and the Registrant. 10.28# IP Telephony Services Distribution and Interactive Marketing Agreement, dated as of July 15, 1999, by and between ICQ, Inc. and the Registrant. 10.29#+ Stock Subscription Warrant, dated July 15, 1999, by and between America Online, Inc. and the Registrant. 10.30 Amendment No. 1 to Employment Agreement, dated July 16, 1999, by and between Jonathan Fram and the Registrant 23.1 Consent of Ernst & Young LLP. 23.2+ Consent of Morrison & Foerster LLP (incorporated by reference into Exhibit 5.1). 24.1+ Power of Attorney (set forth on the signature page to this registration statement). 27.1+ Financial Data Schedule.
- -------- # Confidential treatment has been requested with respect to certain portions of the Exhibit. Omitted portions will be filed separately with the Securities and Exchange Commission. + Previously filed. 2 EX-10.5 2 NETSCAPE AGREEMENT EXHIBIT 10.5 Netscape Agreement # 005439 TRADEMARK LICENSE AGREEMENT This Trademark License Agreement ("Agreement") is effective as of the 31st day of January, 1999 ("the Effective Date") and is entered into by and between Netscape Communications Corporation ("Netscape"), a Delaware corporation located at 501 East Middlefield Road, Mountain View California 94043, and Net2Phone, Inc., ("Licensee"), a New Jersey corporation located at 171 Main Street, Hackensack, NJ 07601. RECITALS A. Netscape owns and uses the trademark NETSCAPE (the "Mark"), in connection with its Internet-related software products, services and technology; B. Licensee, among other things, produces certain client software products that operate in conjunction with Netscape client software products or are accessible from and promoted on Netscape's Internet web sites ("Co-branded Products"). C. Licensee desires to use the Mark in connection with the promotion, marketing and delivery of Licensee's Co-branded Products over the Internet, enterprise networks or similar networks through web pages in the languages and geographic territories set forth in Exhibit A; and --------- D. Netscape is willing to permit such use of the Mark under the terms and conditions set forth in this Agreement. NOW THEREFORE, the parties agree as follows: 1. Grant of License. 1.1. Grant of License. Netscape hereby grants to Licensee a non-exclusive, nontransferable, license to use the Mark in connection with the Co-branded Products solely to promote, market, sell and deliver Co-branded Products to end users in the languages and geographic territories mutually agreed upon in writing by the parties, including those set forth in Exhibit A. Licensee may ------------ only use the Mark as a collective whole and shall not separately use any element or elements of the Mark. 1.2. Reservation of Rights. Netscape hereby reserves any and all rights not expressly and explicitly granted in this Agreement, including Netscape's right to authorize or license use of the Mark or any other trademarks or names containing NETSCAPE, to any third party for use in connection with any goods and services, including, but not limited to, Co-branded Products. Without limiting the rights reserved in the first sentence, Netscape hereby reserves any and all rights to use, authorize use or license use of the Mark or any other trademarks or names containing the Marks in any geographic territory and in any language, except as otherwise agreed to in writing. Licensee shall have no obligation to use the Mark as contemplated under this Agreement. 2. License Fee. For the rights granted to Licensee herein, Licensee shall pay Netscape, by wire transfer, a one-time non-refundable license fee of Five Million Dollars ($500,000,000) at the time of the execution of this Agreement. The license fee due hereunder is exclusive of any applicable taxes. Netscape shall be responsible for and shall reimburse Licensee for, and promptly pay, all applicable national, state and local taxes, value added or sales taxes, and other taxes pertaining to payments except taxes based on Licensee's income. If Netscape in good faith contests any tax that is so payable or reimbursable by Netscape, Licensee shall cooperate in good faith in the contest at Netscape's expense. Licensee shall pass on to Netscape any tax refund and interest related thereto, received by Licensee with respect to Licensee's previous payment or reimbursement of applicable taxes and interest related thereto hereunder, if any 3. Ownership of Mark. Licensee hereby acknowledges that Netscape is the owner of the Mark, and any trademark applications and/or registrations thereto, agrees that it will do nothing inconsistent with Netscape's intellectual property rights in the Mark and agrees that all use of the Mark by Licensee shall inure to the benefit of Netscape. Licensee agrees that nothing in this Agreement shall give Licensee any right, title or interest in the Mark other than the right to use the Mark in accordance with this Agreement. Licensee agrees not to register or attempt to register the Marks as a trademark, service mark, Internet domain name, trade name, with any domestic or foreign governmental or quasi- governmental authority and agrees it will not violate any of Netscape's intellectual property rights in the Mark. Licensee may not register or use either the Mark, or an abbreviation of the Mark, as part of an Internet domain name. The provisions of this paragraph shall survive the expiration or termination of this Agreement. 4. Use of the Mark; Protection of the Mark. 4.1. Proper Use. Licensee agrees that all use of the Mark under this Agreement shall only occur in connection with The Co-branded Products and shall be in compliance with the terms of this Agreement. Licensee may use the Mark as set forth in Section 1.1 as well as in connection with the promotion of The Co- branded Products. Licensee shall use the Mark in conformance with Netscape's trademark guidelines ("Trademark Guidelines"), set forth in Exhibit B, which may --------- reasonably be revised by Netscape from time to time. Licensee agrees not to use any other trademark or service mark in combination with the Mark other than as described in Section 1.1. Except as provided in Section 8.3, Licensee has no right to sublicense, transfer or assign the use of the Mark or use the Mark for any other purpose other than the purpose described herein. Licensee may not use the Mark in connection with or for the benefit of, any third party's products or services. Licensee further agrees not to use the Mark on or in connection with any products or services that are or could reasonably be deemed to be obscene, pornographic, disparaging of Netscape or its products or services, or that are themselves unlawful or whose purpose is to encourage unlawful activities by others (provided however that this clause shall not be applicable to the content sent through the use of the Co-branded Products except if such content is originated by Licensee). The parties acknowledge that nothing in the Agreement prevents the other from using the Mark in a non-denominative, non-trademark fashion that is otherwise allowed by law. 4.2. Quality Standards. If Licensee uses the Mark in connection with the Co- branded Products, Licensee agrees to maintain a consistent level of quality of the Co-branded Products made available thereunder, substantially equal to that found in Licensee's existing products and Web site services. Licensee further agrees to maintain a level of quality of the Co-branded Products in connection with its use of the Mark that is consistent with general industry standards. 4.3. Monitoring by Netscape. Licensee acknowledges that Netscape has no further obligations under this Agreement but that Netscape does have the right to periodically monitor, no more than quarterly, Licensee's use of the Mark in conjunction with the Co-branded Products. Upon reasonable request by Netscape, no more often than quarterly, Licensee shall provide Netscape with representative samples of each such use prior to the time the Mark is published on the Internet or in press materials or marketing or advertising materials. If Netscape determines in good faith that Licensee is using the Mark improperly, and/or in connection with Products, or products, which do not meet the standards set forth in Section 4.1 or Section 4.2, Netscape shall notify Licensee, and Licensee shall use reasonable efforts to remedy the improper use within ten (10) business days following receipt of such notice from Netscape. Use of the Mark on goods or services other than in connection with the Co-branded Products, in a manner inconsistent with the Trademark Guidelines, or in connection with an infringement of Netscape's or a third party's rights, including but not limited to rights under trademark, patent, trade secret or copyright, laws may constitute material breach of this Agreement which shall be treated in accordance with Section 7.1.. 4.4. Legend; Disclaimer. Licensee shall include with any online publication or publication in print of the Mark a trademark legend indicating that the Mark is that of Netscape, used under license, and a disclaimer that Licensee and not Netscape has produced The Co-branded Products. 4.5. Licensee's Co-branded Products. If the Co-branded Products contain or present any material that constitutes an infringement of Netscape's trademark, patents, copyrights or trade secrets (except with respect to any such material provided or included by Netscape or at the request of Netscape), Licensee's right to use the Mark pursuant to the grant described in Section 1.1 shall, upon written notice from Netscape and following an opportunity to cure in at least ten (10) business days from receipt of such notice, be suspended until Licensee has revised, removed or removed links to such material to Netscape's reasonable satisfaction. If such revision or removal of, or removal of links to, such material to Netscape's reasonable satisfaction has not occurred within thirty (30) days of the notice from Netscape described in the preceding sentence, Netscape may terminate this Agreement in accordance with Section 7.1. If the Co-branded Products contain or present any material that constitute an infringement of a third party's copyright, trademark, patents or trade secrets, (except for any such material provided or included by Netscape or at the request of Netscape), Netscape may terminate this Agreement in accordance with Section 7.1. 5. Confidential Information and Disclosure. Unless required by law, and except to assert its rights hereunder or for disclosures to its own employees, consultants, accountants, agents, representatives and attorneys on a "need to know" basis, each party agrees not to disclose the terms of this Agreement or matters relating thereto without the prior written consent of the other. 6. Indemnification 6.1. By Netscape. Netscape agrees to indemnify Licensee and to hold Licensee harmless from any and all liability, loss, damages, claims or causes of action, including reasonable legal fees and expenses that may be incurred by Licensee, arising out of claims by a third party that Licensee's use of the Marks in accordance with this Agreement infringes such third party's rights in the Marks. Licensee shall provide Netscape with prompt written notice of any claim for which indemnification is sought, and shall cooperate fully with and allow Netscape to control the defense and settlement of such claim. Netscape may not settle any such claim without Licensee's prior written consent, which consent shall not be unreasonably withheld. Licensee shall have the right, at its own expense, to participate in the defense of any such claim. 7. Termination Term and Termination. This Agreement and the term of the license granted herein shall be perpetual unless terminated as provided in Section 4.3, Section 4.5 or this Section 7.1. Netscape shall have the right to terminate this Agreement upon the occurrence of one or more of the following: (a) any material breach by Licensee of its obligations under this Agreement, including without limitation, those indicated in Section 4.3 and 4.5 of this Agreement, which remains uncured for (i) thirty (30) days or more following written notice of such breach from Netscape, or (ii) in the event Licensee provides Netscape, within such thirty (30) day period, a written plan to remedy such breach, sixty (60) days of more from the date such plan is provided to Netscape (b) Licensee decides not to develop and launch a Co-branded Products that uses the Mark, or (c) The Co- branded Products are discontinued for a continuous period of four (4) months and not restarted within thirty (30) days of written notice from Netscape of such fact; provided, however, that Netscape shall not be entitled to terminate the Agreement under subsections (b) or (c)of the foregoing provision prior to the date two (2) years following the Effective Date. Licensee may terminate this Agreement at any time for any reason, or for no reason, by written notice thereof. Notwithstanding the above, if in its reasonable discretion Netscape determines that as a result of a breach of this Agreement it will be materially and adversely affected in a substantial manner by failing to immediately suspend the licenses granted herein, Netscape may suspend the licenses granted in Section 1 until such breach is cured. 7.2. Effect of Termination. Upon termination of the Agreement, Licensee agrees it shall immediately cease any and all use of the Mark. 8. General 8.1. Governing Law. This Agreement shall be subject to and governed in all respects by the statutes and laws of the State of Delaware without regard to the conflicts of laws or principles thereof. 8.2. Entire Agreement. This Agreement, including Exhibit A and Exhibit B --------- --------- attached hereto, constitute the entire Agreement and understanding between the parties and integrates all prior discussions between them related to its subject matter. No amendment or modification of any of the terms of this Agreement shall be valid unless in writing and signed by an authorized representative of each party. 8.3. Assignment. Except as set forth below, neither party may assign any of its rights or (except in the normal course of its business) delegate any of its duties under this Agreement, or otherwise assign or transfer this Agreement without the prior written consent of the other party. Either party may assign this Agreement in connection with any merger, acquisition, reorganization, sale of substantially all the assets or stock of that party or any similar event ("Change of Control Event") without the prior written consent of the other party. In the event of a Change of Control Event in which Netscape is not to be a surviving entity, Netscape will use commercially reasonable efforts to ensure this Agreement is assigned to the successor entity. Netscape shall have the right to terminate this Agreement upon thirty (30) days prior written notice if Participant assigns or transfers this Agreement as permitted to a direct competitor of Netscape in the web client or web portal business without Netscape's consent. Any attempted assignment, delegation or transfer in derogation of the foregoing shall be null and void. This Agreement shall apply to and bind any permitted successors or assigns of the parties hereto and any reference to the applicable parties herein shall refer to the applicable successors or assigns. 8.4. Notices. All notices required or permitted hereunder shall be given in writing addressed to the respective parties as set forth below and shall either be (a) personally delivered or (b)transmitted by nationally-recognized private express courier, and shall be deemed to have been given on the date of receipt if delivered personally, or 2 days after deposit with such express courier. Either party may change its address for purposes hereof by written notice to the other in accordance with the provisions of this Subsection. The addresses for the parties are as follows: Licensee: Netscape: Net2Phone, Inc. Netscape Communications Corporation 171 Main Street 501 East Middlefield Road, MV-002 Hackensack, NJ 07601 Mountain View, CA 94043 Fax: _____________ Fax: (650) 528-4123 Attn: General Counsel Attn: General Counsel 8.5. Force Majeure. Neither party will be responsible for any failure to perform its obligations under this Agreement due to causes beyond its reasonable control, including but not limited to acts of God, war, riot, embargoes, acts of civil or military authorities, fire, floods or accidents. 8.6. Waiver. Any waiver, either expressed or implied, by either party of any default by the other in the observance and performance of any of the conditions, covenants of duties set forth herein shall not constitute or be construed as a waiver of any subsequent or other default. 8.7. Headings. The headings to the Sections and Subsections of this Agreement are included merely for convenience of reference and shall not affect the meaning of the language included therein. 8.8. Independent Contractors. The parties acknowledge and agree that they are dealing with each other hereunder as independent contractors. Nothing contained in the Agreement shall be interpreted as constituting either party the joint venture or partner of the other party or as conferring upon either party the power of authority to bind the other party in any transaction with third parties. 8.9. Survival. The provisions of Section 1.2 (Reservation of Rights), 3 (Ownership of Mark), 4.4 (Legend; Disclaimer), 5 (Confidential Information and Disclosure), 6 (Indemnification by Netscape), 7.2 (Effect of Termination) and 8 (General) will survive any termination of this Agreement. 8.10. Equitable Relief. Licensee recognizes and acknowledges that a breach by Licensee of this Agreement may cause Netscape irreparable damage which cannot be readily remedied in monetary damages in an action at law, and may, in addition thereto, constitute an infringement of the Mark. In the event of any default or breach by Licensee that could result in irreparable harm to Netscape or cause some loss or dilution of Netscape's goodwill, reputation, or rights in the Mark, Netscape shall be entitled to seek immediate injunctive relief to prevent such irreparable harm, loss, or dilution in addition to any other remedies available. 8.11. Severability. Except as otherwise set forth in this Agreement, the provisions of this Agreement are severable, and if any one or more such provisions shall be determined to be invalid, illegal or unenforceable, in whole or in part, the validity, legality and enforceability of any of the remaining provisions or portions thereof shall not in any way be affected thereby and shall nevertheless be binding between the parties hereto. IN WITNESS WHEREOF, the parties have executed this Agreement as of the Effective Date. NET2PHONE, INC. NETSCAPE COMMUNICATIONS CORPORATION By: /s/ Jonathan Reich By: /s/ Noreen G. Bergin Name: JONATHAN REICH Name: Noreen G. Bergin Title: SENIOR VICE PRESIDENT MARKET Title: Senior Vice President Finance & BUS. DEV. & Corporate Controller Date: JANUARY 31, 1999 Date: 01-31-99 Exhibit A: Marks; Target Language and Geographic Combinations - --------- Exhibit B: Trademark Guidelines - --------- APPROVED REVENUE ACCTG. REVIEWED BY NETSCAPE LEGAL Initial /s/ AM 1/31/99/ EX-10.28 3 IP TELEPHONY SERVICES MARKETING AGREEMENT CONFIDENTIAL **** CERTAIN PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT UNDER RULE 406 OF THE SECURITIES ACT OF 1933, AS AMENDED. EXHIBIT 10.28 IP TELEPHONY SERVICES DISTRIBUTION AND INTERACTIVE MARKETING AGREEMENT ---------------------------------------------------------------------- This IP Telephony Services Distribution and Interactive Marketing Agreement (this "Agreement"), dated as of July 14, 1999 (the "Effective Date"), is between ICQ, Inc., a Delaware corporation, with offices at 22000 AOL Way, Dulles, Virginia 20166 ("ICQ"), and Net2Phone, Inc. ("N2P"), a Delaware corporation, with offices at 171 Main Street, Hackensack, NJ 07601. ICQ and N2P may be referred to individually as a "Party" and collectively as the "Parties." INTRODUCTION ------------ ICQ is a provider of online communication services, including the ICQ Service, and is a subsidiary of America Online, Inc., a Delaware corporation ("AOL"). N2P is a provider of various IP Telephony services. The Parties wish for N2P to develop and provide to ICQ a customized version of certain N2P Services that can be distributed through the ICQ Service so as to enable ICQ Users to send and receive free, or low cost, Internet-enabled telephony communications. This relationship is further described below and is subject to the terms and conditions set forth in this Agreement. Defined terms used but not defined in the body of the Agreement shall have the meanings ascribed to such terms in Exhibit A hereto. TERMS ----- 1. ICQ IP TELEPHONY SERVICES GENERALLY ----------------------------------- 1.1 Description of ICQ IP Telephony Services. The N2P Services to be ---------------------------------------- offered collectively as the customized ICQ IP Telephony Services shall be comprised of the following: 1.1.1. PC-to-PC Service. A PC-to-PC calling service (the ---------------- "PC-to-PC Service"), which shall allow any ICQ User (through use of the ICQ IP Telephony Software as distributed through the ICQ Service in accordance with the terms of this Agreement) to originate a voice conversation on an Internet enabled PC and to terminate such conversation on another Internet-enabled PC. The PC-to-PC Service initially shall be provided to ICQ Users without a per-minute or other similar charge. The provision of such PC-to-PC Service by N2P shall not be designed to compromise the ability of any ICQ User to make PC- to-PC calls through ICQ with other clients (e.g., **** or other AOL PC to PC communications products, Vocaltec, Voxware, HoneyQ, Qtalk, etc). 1.1.2. PC-to-Phone Service. A PC-to-telephone calling ------------------- service (the "PC- to-Phone Service"), which shall allow any ICQ User to originate a voice conversation on an Internet-enabled PC (through use of the ICQ IP Telephony Software as distributed through the ICQ Service in accordance with the terms of this Agreement) and terminate such conversation on a telephone located virtually anywhere in the world. 1.1.3. Phone-to-PC Service. A telephone-to-PC calling service ------------------- (the "Phone-to-PC Service"), which shall allow any ICQ User to originate a voice conversation from a telephone and terminate such voice conversation on an Internet-enabled PC (through use of the ICQ IP Telephony Software as distributed through the ICQ Service in accordance with the terms of this Agreement). Such calls shall be initiated by any such ICQ User by dialing a local and/or toll-free N2P access number (i.e., a local POP) and entering any such ICQ User's account number and PIN, and then the number of the receiving party. The Phone-to-PC Service generally shall enable telephone conversations with any ICQ User online even if such ICQ User is also using his or her only telephone line for online access. [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. CONFIDENTIAL EXECUTION VERSION 1.1.4. Phone-to-Phone Calling Card Service. A ----------------------------------- telephone-to-telephone calling card service using IP Telephony (the "PTP Calling Card Service"), which shall allow any ICQ User to call a third party by dialing a local and/or toll-free N2P access number (i.e., local POP) and entering the ICQ User's account number and PIN, and then dialing the phone number of the person whom such ICQ User is calling. For the avoidance of doubt, the Parties acknowledge that the PTP Calling Card Service shall include fax-to-fax service. 1.1.5. Conference Calling Service. A conference calling -------------------------- service (the "Conference Calling Service"), which shall allow conference calls initiated from a combination of phones and/or Internet-enabled PCs. 1.1.6. Optional Services. ICQ shall provide N2P with a right ----------------- of first negotiation (for a period not to exceed thirty (30) days with respect to the provision of the following additional services as additional ICQ IP Telephony Services: (i) an integrated voice- messaging service, whereby ICQ Users shall be able to send and receive voice messages online and via telephone; (ii) a video conference calling service; (iii) a universal messaging service, whereby ICQ Users shall be able to access voice mails, e-mails, faxes, etc., in one area of the ICQ Service, with such messaging capable of being accessed via telephone, the ICQ Client or the Worldwide Web; and (iv) **** (the **** aforementioned services, collectively, the "Optional Services" and each, an "Optional Service"). In the event that the Parties cannot agree, within any such thirty (30) day period, to the terms and conditions pursuant to which N2P would offer any such Optional Service(s) to ICQ Users, then ICQ shall have the right to enter into an arrangement with any third party (including, without limitation, any N2P Competitor) regarding the provision of any such Optional Service(s) to ICQ Users through the ICQ Service. In addition, the Parties shall, within sixty (60) days after the Effective Date, mutually determine whether (i) a PC-to-fax service, whereby ICQ Users may send faxes from their PCs to a facsimile machine of a third party, (ii) a fax-to-PC service, whereby ICQ Users may receive faxes through their PCs from a facsimile machine of a third party, and/or (iii) a virtual private network (VPN) service shall be added to this Agreement as additional ICQ IP Telephony Services. Moreover, ICQ shall provide N2P with a right of first negotiation (for a period not to exceed thirty (30) days) with respect to the offering of any Core Premium Services in any country other than a Collective International Gateway. N2P acknowledges, for the avoidance of doubt, that the right to access the ICQ IP Telephony Services initially shall be free of any member fee or similar access charge (but excluding per-minute, flat-rate or other usage charges and Internet service provider access charges) to ICQ Users, provided that N2P reserves the right to charge any fee or charge for such -------- services consistent with its obligations under Sections 3.1 and 3.3. In addition to the foregoing services, N2P shall (i) provide APIs and (ii) to the extent commercially reasonable (a) provide connection for ICQ to N2P's local equipment and (b) assist finding space for ICQ and its Affiliates to locate equipment along with or near N2P's local equipment to enable ICQ and its partners to link into aspects or features of the ICQ IP Telephony System to provide related services (e.g., voice messaging); provided, -------- however, that any such arrangement shall be subject to the mutual agreement ------- of the Parties as to the reasonable terms and conditions for such arrangement. 1.2 Performance Each Party shall cause all aspects of the ICQ IP Telephony ----------- Services within its control, including customer service and billing, network coverage and performance and fraud detection, to comply in all material respects with the applicable standards set forth on Exhibits B, C and D. [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 2 CONFIDENTIAL EXECUTION VERSION 1.3 Launch Cutoff ------------- 1.3.1 Cutoff Dates. N2P shall cause (i) the PTP Calling Card ------------ Service to be fully prepared for launch on the ICQ Service (A) for calls originating in the United States, within **** (****) **** following the Effective Date, (B) for calls originating in the Primary International Gateways, within **** (****) **** following the Effective Date, and (C) for calls originating in the Secondary International Gateways, within **** (****) **** following the Effective Date; and (ii) each of the Secondary ICQ IP Telephony Services (including, without limitation, with respect to the Collective International Gateways) to be fully prepared for launch on the ICQ Service by the respective cutoff dates therefor set forth on Exhibit I to this Agreement (each such date in clauses (i) and (ii) above, a "Cutoff Date," and collectively, the "Cutoff Dates"). If any Core Premium Service is not fully prepared for launch in a particular country (whether the United States or a Collective International Gateway) by the applicable Cutoff Date, ICQ shall have the right to terminate the exclusivity (as set forth in Section 9 of this Agreement) with respect to such Core Premium Service in such country (each such country, a "Non-Exclusive Gateway"), and thereby enter into an agreement with any third party (including a N2P Competitor) with respect to such Core Premium Service in such Non-Exclusive Gateway. In the event that within sixty (60) days following any Cutoff Date (as to a Core Premium Service), N2P shall not have caused any such Core Premium Service to be fully prepared for launch in any such Non- Exclusive Gateway and fails to cause such Core Premium Service to be fully ready for launch in substitute gateways approved by ICQ (such approval not to be unreasonably withheld) that would provide a substantially similar percentage of the ICQ User base access to such Core Premium Service, then ICQ shall have the right to terminate the exclusivity (as set forth in Section 9 of this Agreement) with respect to such Core Premium Service, and thereby to enter into an agreement with any third party (including, without limitation, any N2P Competitor) with respect to such Core Premium Service. 1.3.2 ICQ Assistance. To the extent that it shall be reasonably -------------- necessary for ICQ to undertake any activities within ICQ's reasonable control (including providing information or materials) reasonably requested by N2P in order to enable N2P to fulfill its development and deployment obligations and meet any Cutoff Date, ICQ shall undertake any such activities in a timely manner. 1.3.3 Excusable Delays. Each applicable Cutoff Date (together ---------------- with any rights of ICQ related thereto, including, without limitation, any right to terminate this Agreement or any exclusivity hereunder) shall be deemed extended, subject to the remainder of this Section 1.3.3, to the extent (and only for the duration in which): (i) ICQ fails to undertake the reasonably requested and reasonably necessary activities described in Section 1.3.2 with respect to any Core Premium Service, and N2P has provided ICQ with reasonable informal notice (e.g., by e-mail message to the ICQ Technical Liaison or through discussion at the quarterly meetings described in Section 2.8) of such failure and of its causal effect on N2P's ability to meet any such Cutoff Date (an "ICQ Delay"); (ii) there is (or is reasonably expected to be) a U.S. or other regulation which would prevent N2P from offering a Core Premium Service in the United States or in any Collective International Gateway (or which such regulation would make it commercially unreasonable for N2P to offer any such Core Premium Service (in such country)) (collectively, a "Regulatory Event"); or (iii) any other Force Majeure Event occurs. The Parties, through the Management Committee, shall determine in good faith the period by which the Cutoff Date is to be extended (or any other obligations or criteria that are to be affected), if at all, by any of the events described in this Section 1.3.3; provided, however, that, unless -------- ------- otherwise agreed by the Parties, the extension of any Cutoff Date resulting from any Regulatory Event or Force Majeure Event shall not exceed **** (****) **** in the aggregate. In the event that a Regulatory Event or Force Majeure Event affects N2P Competitors generally with respect to the provision of the PTP Calling Card Service, then **** CERTAIN PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT UNDER RULE 406 OF THE SECURITIES ACT OF 1933, AS AMENDED. 3 CONFIDENTIAL EXECUTION VERSION ICQ shall discuss with N2P in good faith extending the Cutoff Date beyond such ninety (90) day period. Notwithstanding the foregoing, so long as any such Regulatory Event or Force Majeure Event prevents N2P from offering the PTP Calling Card Service to ICQ Users in any particular Collective International Gateway(s), then N2P's exclusivity with respect to the PTP Calling Card Service in such Collective International Gateway(s) shall extend beyond such ninety (90) day period unless and until a third party is in a position to provide a comparable phone-to-phone calling card service in such Collective International Gateway(s) and ICQ enters into an agreement with such third party for the provision of such phone-to-phone calling card service to ICQ Users in such Collective International Gateway(s). For the avoidance of doubt, any extension of a Cutoff Date due to an ICQ Delay shall be as mutually agreed upon in writing by the Parties. 1.4 Launch Dates. The Parties shall record the date on which each ICQ IP ------------ Telephony Service is launched (each such date, a "Launch Date") in a written instrument signed by both Parties promptly following any such Launch Date; provided, however, that in the event that the Parties -------- ------- cannot agree as to the definitive Launch Date with respect to a particular ICQ IP Telephony Service, the Parties shall submit such Dispute to the dispute resolution provisions set forth in Section 17 of this Agreement. 2. DEVELOPMENT OBLIGATIONS ----------------------- 2.1 Initial Version. The initial version of each of the ICQ IP --------------- Telephony Services shall be developed by N2P, by customizing each of the existing N2P Services as set forth in Sections 1.1.1 through 1.1.5 to conform to the product specifications set forth in Exhibit B to this Agreement (collectively, together with such modifications thereto or any such additional specifications as may be agreed to in writing by the Parties after the Effective Date, the "Specifications"). As part of such customization, the N2P Services shall be developed to function in an integrated manner with the operation of the ICQ Client to the extent set forth in the Specifications or elsewhere in this Agreement. To the extent that any material conflict exists between (i) Exhibit B to this Agreement and (ii) the provisions of the principal body of this Agreement, the principal body of this Agreement (i.e., Sections 1 through 18 hereof) shall govern. 2.2 Updates. ------- 2.2.1 Notification of Updates. If, during the Term, N2P --------------------- develops any Update of any N2P Service that is generally commercially available to users of the N2P Services, N2P shall, in each such case, (i) promptly notify ICQ of such Update and (ii) promptly (i.e., in the shortest commercially reasonable time period) include such Update (provided that such Update complies with the Specifications or the --------- terms of this Agreement) in the applicable ICQ IP Telephony Service. 2.2.2 No Notification Required. N2P shall not be ------------------------ obligated to notify ICQ of or to provide to ICQ any modification, improvement, addition, deletion, feature or functionality of the N2P Services provided by N2P to another customer if such modification, improvement, addition, deletion, feature or functionality is subject to contractual restrictions that would prohibit N2P from providing it to ICQ hereunder. For the avoidance of doubt, the Parties acknowledge that N2P shall not be required to notify ICQ of or provide to ICQ any modification, improvement, addition, deletion, feature or functionality of any Optional Service, Expanded Service or other IP Telephony Service (apart from any Core Premium Service) unless the Parties have agreed to the provision by N2P to ICQ Users of any such service pursuant to the terms of this Agreement. 4 CONFIDENTIAL EXECUTION VERSION 2.2.3 Disagreement. In the event of any disagreement between ------------ the Parties regarding the provision by N2P of any such Updates to ICQ (e.g., as to whether any such Update is generally commercially available, the length of the time period in which any such Update is to be implemented, etc.), such disagreement shall be submitted to the Management Committee pursuant to Section 17 of this Agreement. 2.3 Additional ICQ Modifications. ---------------------------- 2.3.1 Definition. ICQ may in its discretion, from time ---------- to time during the Initial Term, request that N2P, to the extent commercially reasonable, (i) add new functionality or features to any ICQ IP Telephony Service(s), (ii) modify elements related to the ICQ GUI (but not elements of the ICQ GUI itself), and/or (iii) modify the ICQ IP Telephony Services in connection with modifications of the ICQ Client and ICQ Service (which modifications shall be subject to Section 2.7 and which modifications ICQ estimates will occur at least twice a year), (each of (i), (ii) and (iii) above, an "Additional ICQ Modification"). The Parties agree that any features, functionality, additions, deletions or other modifications necessary to be carried out by N2P in order for N2P to comply with its obligations under Section 3 of this Agreement (collectively, the "Necessary Modifications") shall not constitute Additional ICQ Modifications and that ICQ shall not be required to pay for any such Necessary Modifications. 2.3.2 Request for Non-Substantial Modification. In the ---------------------------------------- event that ICQ requests Additional ICQ Modifications that N2P reasonably believes would not involve (i) a substantial cost or expense to N2P (i.e., less than Two Hundred Thousand Dollars ($200,000) in the aggregate during any Year of this Agreement) or (ii) a substantial commitment of N2P personnel, N2P shall develop the Additional ICQ Modifications in cooperation with ICQ on a schedule to be mutually agreed upon by the Parties. Each Party shall allocate development resources on a high priority basis to complete such Additional ICQ Modifications in accordance with such schedule. ICQ shall pay for the actual, reasonable, fully-allocated cost of developing any such Additional ICQ Modifications. 2.3.3 Request for Substantial Modification. In the event ------------------------------------ that ICQ requests an Additional ICQ Modification that N2P reasonably believes would involve a substantial cost or expense to N2P, or a substantial commitment of N2P personnel, the Parties shall negotiate in good faith regarding the request for such Additional ICQ Modification, including, without limitation, the appropriate schedule for development and deployment, rights to the results of the development, interoperability requirements, and the relevant business terms (e.g., amount of any payments for the development, the revenue model for the features or functions, etc.). If and when the Parties reach agreement on the terms and conditions for such Additional ICQ Modification, N2P shall develop the Additional ICQ Modification in cooperation with ICQ, and each Party shall allocate development resources on a high priority basis to complete such Additional ICQ Modification in accordance with such schedule. 2.3.4 Commissioned Works. Notwithstanding the foregoing, ------------------ in the event that the Parties are unable to agree as to the development or deployment of any Additional ICQ Modification in accordance with Section 2.3.3, ICQ shall have the right during the Initial Term to require N2P to assist ICQ in securing a mutually agreed-upon third party to develop any such Additional ICQ Modifications for ICQ; provided, however, that either N2P or (at ICQ's -------- ------- option) ICQ may perform such development. In the event that a third party is secured to perform such development, N2P will use commercially reasonable efforts to assist such third party in performing such development. Any development by any such third parties shall not be considered the responsibility of N2P, and such third parties shall not be considered contractors of N2P. To the extent that portions of such Additional ICQ Modifications (including intellectual property rights therein) are developed 5 CONFIDENTIAL EXECUTION VERSION by N2P specifically for ICQ pursuant to this Section 2.3.4, such portions shall be considered "Commissioned Works," but "Commissioned Works" shall exclude, any software, modules, routines or subroutines, documentation or other materials, and any methods, processes, techniques or inventions, that were (i) developed by or for N2P prior to such development for ICQ or (ii) developed independently by or for N2P (i.e., independent of the development carried out for ICQ under this Section 2.3.4 by N2P). To the extent that (a) N2P develops any Commissioned Works pursuant to this Section 2.3.4 without requiring that ICQ pay for such Commissioned Works (in cash or such other consideration as may be agreed to by the Parties), then N2P shall own all right, title and interest in and to such Commissioned Works (provided, however, that in such case, ICQ shall have a fully paid-up, -------- ------- royalty-free, non-exclusive, non-transferable and worldwide license for the Term to use, reproduce, directly and indirectly distribute, transmit, display, perform, sublicense and adapt such Commissioned Works), (b) ICQ pays (in cash or such other consideration as may be agreed to by the Parties) for any such Commissioned Works pursuant to this Section 2.3.4, then ICQ shall own all right, title and interest in and to such Commissioned Works, and (c) the Parties so agree, the Parties shall co-own all right, title and interest in and to such Commissioned Works, which shall be treated as Joint Work Product for purposes of this Agreement. Each Party shall cooperate with the other Party in documenting and perfecting all rights with respect to the Commissioned Works, including executing any necessary assignments, applications or other documentation with respect to the Commissioned Works. 2.3.5 Disagreement. In the event that the Parties ------------ disagree as to the development or deployment of any Additional ICQ Modification, including any disagreement as to the terms and conditions for the development or deployment thereof, the Parties shall submit such Dispute to the Management Committee in accordance with the terms of Section 17 of this Agreement. 2.4 Expansion to Cover Other Services and Platforms of ICQ. ------------------------------------------------------ 2.4.1 Request by ICQ to Encompass Expanded Service Within an ICQ ---------------------------------------------------------- Telephony Service. ICQ may in its discretion, from time to time ----------------- during the Initial Term, seek to expand any ICQ IP Telephony Service(s) to provide service through any and all platforms and services hereafter offered by ICQ or an Affiliate of ICQ (other than the ICQ Service) (the "Expanded Services"). In such event, ICQ may in its discretion request that N2P develop or deploy or assist with the development or deployment of any such Expanded Services. Upon the receipt of any such request, and before any development or deployment of any Expanded Services, the Parties shall negotiate in good faith regarding the request for any such Expanded Services, including, without limitation, with respect to the appropriate schedule for any development and deployment, and the relevant business terms (e.g., the amount of any payments for any development, the revenue model for the Expanded Services, etc.). If and when the Parties reach agreement on the terms and conditions related to the development and deployment of such Expanded Services, each Party shall allocate development and deployment resources on a high priority basis towards the development and deployment of an updated version of the applicable ICQ IP Telephony Software to support such Expanded Services in accordance with the terms and conditions agreed upon by the Parties. 2.4.2 Failure to Agree. In the event that the Parties disagree ---------------- as to the development or deployment of any Expanded Service, including any disagreement as to the terms and conditions for the development or deployment thereof, the Parties shall submit such Dispute to the Management Committee in accordance with the terms of Section 17 of this Agreement; provided, however, that in the event that the -------- ------- Management Committee is unable to agree as to the terms and conditions regarding such development and deployment, such Expanded Service shall not constitute an ICQ IP Telephony 6 CONFIDENTIAL EXECUTION VERSION Service for purposes of this Agreement, and N2P shall not have any rights or obligations with respect to such Expanded Service. 2.4.3 Agreement. Nonetheless, if the Parties agree to add an --------- Expanded Service to this Agreement, such Expanded Service, for all purposes hereof, shall be considered part of the ICQ IP Telephony Services, and all rights and obligations of ICQ and N2P hereunder shall apply to such Expanded Service and users of such services shall be considered ICQ Users for purposes of this Agreement. For purposes of calculating the Revenue Share and the Revenue Threshold hereunder, any such agreed-upon Expanded Service shall be aggregated with the ICQ IP Telephony Services as if only one service existed (unless otherwise agreed upon by the Parties). 2.5 Delivery and Acceptance. ----------------------- 2.5.1 Initial Versions. Following the completion of the ---------------- development and internal testing of each initial version of the Core Premium Services, N2P shall deliver each such initial version to ICQ for evaluation and acceptance in accordance with the delivery dates set forth on Exhibit I hereto. ICQ shall have thirty (30) days following such delivery by N2P to evaluate whether each such initial version functions in accordance with the Specifications and without any Severity 1 or Severity 2 Problems. If ICQ reasonably determines that any such initial version of any Core Premium Service does not function in material conformity with the Specifications and/or without Severity 1 or Severity 2 Problems, ICQ may reject such version by providing N2P with written notice within such thirty (30) day period specifying in detail the reason for rejection. Any initial version of the Core Premium Services that has not been so rejected within such thirty (30) day period shall be deemed accepted. If ICQ rejects any initial version of any Core Premium Service, then following such rejection, N2P shall use commercially reasonable efforts to correct (as promptly as commercially possible but in any case by the applicable Cutoff Date) in all material respects, the deficiencies in such initial version that were specified in ICQ's notice of rejection. If the deficiencies specified in any such ICQ notice of rejection have not been remedied in all material respects by such Cutoff Date, ICQ shall have the right to terminate the exclusivity (as set forth in Section 9 of this Agreement) with respect to such Core Premium Service and thereby enter into an agreement with any third party (including a N2P Competitor) with respect to such Core Premium Service. 2.5.2 Subsequent Versions. Following the completion of the ------------------- development and internal testing of each subsequent version (i.e., subsequent to the initial version) of any Core Premium Service (or any initial version of any Optional Service, Expanded Service or other IP Telephony service mutually agreed upon by the Parties to be provided by N2P hereunder) (each, a "Subsequent Version"), N2P shall deliver each such Subsequent Version to ICQ for evaluation and acceptance. ICQ shall have thirty (30) days following such delivery by N2P to evaluate whether such Subsequent Version functions in accordance with the Specifications and without any Severity 1 or Severity 2 Problems. If ICQ reasonably determines that any such Subsequent Version does not function in material conformity with the Specifications and without Severity 1 or Severity 2 Problems, ICQ may reject such Subsequent Version by providing N2P with written notice within such thirty (30) day period specifying in detail the reason for rejection. Any Subsequent Version that has not been so rejected within such thirty (30) day period shall be deemed accepted. 2.5.3 Acceptance Process. The acceptance criteria set forth in ------------------- Sections 2.5.1 and Section 2.5.2 of this Agreement shall not include as factors the Core ICQ Obligations, and ICQ shall not withhold any such acceptance due to its failure to comply with the Core ICQ Obligations. 7 CONFIDENTIAL EXECUTION VERSION 2.6 Assistance from ICQ. ICQ shall provide N2P with reasonable ------------------- consultative assistance in connection with the development obligations of N2P as set forth in this Section 2. In addition, during the Term, ICQ agrees to notify N2P in advance of any modifications and/or changes to the ICQ Service that ICQ believes may result in incompatibility between the Parties' respective systems or interruptions in the ICQ IP Telephony Services (including without limitation, network configuration changes and system maintenance). The Parties shall work together to resolve any such potential or actual incompatibility, or interruptions, in connection with ICQ's implementation of any such change and/or modification. 2.7 Other Modifications. ICQ reserves the right to redesign and/or modify ------------------- the organization, structure, "look and feel," navigation, features and other elements of the ICQ Service and the ICQ IP Telephony Services (subject to (i) the technical limitations and design requirements of the N2P Services and N2P System (which shall themselves remain subject to the Specifications) and (ii) the requirement that such ICQ Service and ICQ IP Telephony Services remain in compliance with the terms and conditions of this Agreement. ICQ shall provide N2P with reasonable notice of any proposed redesign and/or modification in advance of developing such redesign or modification, and the Parties shall consult in good faith on how to avoid any adverse effect on the ICQ Telephony Services (including, without limitation, any adverse effect on the functionality or performance thereof) as a result of such redesign and/or modification. Such notice shall be sufficiently in advance of the proposed redesign or modification such that the Parties will have a reasonable opportunity to complete the process, and avoid the adverse effect on the ICQ IP Telephony Services, as contemplated by this Section 2.7. 2.8 Meetings. In furtherance of the rights and obligations of the Parties -------- under this Agreement, the Parties shall meet, in person on a quarterly basis (the "Quarterly Meetings") and by telephone on a monthly basis (the "Telephone Meetings"). With respect to the four (4) Quarterly Meetings to take place during each Year of the Initial Term, two (2) such Quarterly Meetings shall take place in Israel (at ICQ headquarters or such other location as mutually agreed upon by the Parties) and the other two (2) such Quarterly Meetings shall take place in the United States (at N2P headquarters or such other location as mutually agreed upon by the Parties). The Quarterly Meetings shall be used to discuss, inter alia, long-term planning, strategic and ----- ---- development issues, and marketplace and performance information regarding the obligations and criteria applicable to the Parties hereunder (including the obligations and criteria under Section 3), and shall be attended by the Technical Liaisons and appropriate senior development and management personnel. The Parties anticipate that the first such Quarterly Meeting shall occur as promptly as possible following the Effective Date but in no event later than two (2) months following the Effective Date. The Telephone Meetings shall be used to discuss, among other things, the activities and relationship contemplated by this Agreement, including the proposed implementation and/or progress of any Updates or Additional ICQ Modifications, changes to the operating standards set forth on Exhibit B, Exhibit C or Exhibit D hereto, ICQ Exclusive Offers to be provided during the subsequent quarter, and the redesign or modification of elements of the ICQ Service or ICQ IP Telephony Services. 2.9 No Support for ICQ Modifications. The Parties acknowledge that any -------------------------------- modifications or additions to the ICQ IP Telephony Services that are carried out by ICQ (or carried out for ICQ by a third party not contracted or subcontracted by N2P) shall not affect the determination of whether N2P has met its obligations or the criteria set forth in Sections 1.3 or 3 of this Agreement. 8 CONFIDENTIAL EXECUTION VERSION 3. N2P PERFORMANCE --------------- 3.1 Pricing and Terms. N2P will ensure that the prices (including any ----------------- other required consideration) for each Core Premium Service and other aspects of such Core Premium Service (including, without limitation, the terms and conditions related to such Core Premium Service, the scope, quality and functionality of each such Core Premium Service, customer service and billing, user experience and interface) are, taken as a whole, not materially less favorable as compared to the corresponding N2P Service as offered by or on behalf of N2P directly to retail customers through any Additional N2P Channel. In the event that at any time during the Initial Term, N2P fails to comply with such obligation (i) as to any pricing aspect of a Core Premium Service (a "Pricing Failure"), and such Pricing Failure is not cured within four (4) business days after notice to N2P of such Pricing Failure (unless otherwise agreed upon in writing by the Parties), or (ii) as to a non-pricing aspect of a Core Premium Service (a "Non-Pricing Failure"), and such Non-Pricing Failure is not cured within fifteen (15) days after notice thereof to N2P (unless otherwise agreed upon in writing by the Parties), ICQ shall have the right to suspend, until such time as N2P cures such failure, (i) distribution of such Core Premium Service, (ii) any of ICQ's promotional obligations hereunder related specifically to such Core Premium Service, and/or (iii) any Listings related specifically to such Core Premium Service. In addition, in the event that N2P fails to cure such Pricing Failure within fifteen (15) days after notice thereof to N2P or such Non- Pricing Failure within thirty (30) days after notice thereof to N2P (or, in each case, such shorter period as is reasonably feasible) ICQ shall have the right to terminate the exclusivity granted to N2P hereunder with respect to such non-compliant Core Premium Service (and in the event that N2P shall have failed to cure, within thirty (30) days after notice thereof to N2P, any such Pricing Failure and/or Non- Pricing Failure as to a total of two (2) Core Premium Services during the Initial Term, then ICQ shall have the right to terminate this Agreement in accordance with Section 16.6 hereof). For purposes of this Section 3.1, the categorization of what constitutes retail customers, as opposed to wholesale customers, shall be consistent with general telecommunications industry practice, and the characterization (as retail or wholesale) of services provided to customers through a N2P Affiliate shall be based on the delivery mechanism of such services by such N2P Affiliate to any third party (i.e., if the services are sold by N2P Affiliates to third parties on a retail basis, then such services shall be deemed to be retail services for purposes of this Section 3.1). Any dispute as to such categorization shall be submitted to the Management Committee in accordance with Section 17 of this Agreement. 3.2 Operating Standards. ------------------- 3.2.1 Compliance. During the Term, N2P will cause the ICQ IP ---------- Telephony Services to comply in all material respects with the standards set forth in each of Exhibit B, Exhibit C and Exhibit D. To the extent standards are not established in Exhibits B, C or D with respect to any aspect of the ICQ IP Telephony Services, N2P will use commercially reasonable efforts to provide such aspect at a level of quality, completeness or timeliness which meets or exceeds prevailing standards in the IP Telephony industry. Without limiting the generality of the foregoing, N2P will use commercially reasonable efforts to provide all hardware, software, telecommunications lines and other infrastructure necessary to meet traffic and usage demands on the ICQ Service in connection with the offering of the ICQ IP Telephony Services. 9 CONFIDENTIAL EXECUTION VERSION 3.2.2 N2P Technical Problem. --------------------- (a) Occurrence; Cure Period. In the event of any ----------------------- material technical problem (over which N2P exercises control) affecting the use by ICQ Users of any ICQ IP Telephony Service and constituting a Severity 1 Problem or Severity 2 Problem (an "N2P Technical Problem"), ICQ shall have the right to suspend (i) distribution of such ICQ IP Telephony Service, (ii) any of ICQ's promotional obligations hereunder related specifically to such ICQ IP Telephony Service, and/or (iii) any Listings related specifically to the such ICQ IP Telephony Service until such time as N2P corrects such N2P Technical Problem. Prior to suspending any such distribution of any particular ICQ IP Telephony Service, related promotional obligations of ICQ or related Listings hereunder, ICQ shall provide N2P with notice and an opportunity to cure, as provided below, unless, in its reasonable discretion, ICQ will be materially and adversely affected in a substantial manner by failing to act immediately or at some subsequent time prior to the completion of the notice and cure period. Any such notice shall be in writing and shall contain a reasonably detailed explanation for ICQ's intention to suspend (and, in reasonable detail, the reasons for suspending) access to the particular ICQ IP Telephony Service and related promotional obligations and Listings due to the occurrence of the N2P Technical Problem. Upon receipt of such notice, N2P will have at least three (3) business days to cure the applicable N2P Technical Problem to ICQ's reasonable satisfaction and, if cured, ICQ shall not suspend the affected ICQ IP Telephony Service(s) and/or related promotional obligations or Listings. ICQ will make good faith efforts to facilitate N2P's cure efforts and to extend the cure period as appropriate, so long as ICQ, in its reasonable discretion, is not materially adversely affected by any such extension. In the event ICQ suspends distribution of any ICQ IP Telephony Service, any ICQ promotional obligations and/or any Listings due to the occurrence of any such N2P Technical Problem, ICQ will notify N2P in writing within twenty-four (24) hours of such decision, setting forth in reasonable detail the explanation therefor. (b) Cure; Resumption of Distribution. When and if the cure --------------------------------- to an N2P Technical Problem is demonstrated to ICQ's reasonable satisfaction, which satisfaction shall not be unreasonably withheld, ICQ shall resume distribution of the affected ICQ IP Telephony Service, promotional obligations and Listings as soon as commercially practical; provided, however, that (in addition -------- ------- to any other remedies available to ICQ in this Agreement, including, without limitation, in Section 16.6 hereof) in the event that N2P shall fail to cure any such N2P Technical Problem within thirty (30) days following notice thereof by ICQ to N2P, then ICQ shall have the right to terminate the exclusivity (as set forth in Section 9 of this Agreement) with respect to the Core Premium Service(s) affected by such N2P Technical Problem and thereby enter into an agreement with any third party (including any N2P Competitor) to promote (or offer the services of) such third party with respect to such Core Premium Service(s). 3.3 Competitive Performance Standards. N2P will use commercially --------------------------------- reasonable efforts during the Initial Term to cause each of the Core Premium Services included in the ICQ IP Telephony Services to be "Best of Breed." For purposes of this Agreement, "Best-of-Breed" means, as to each Core Premium Service, that, as determined by a cross-section of mutually agreed-upon third-party reviewers who are recognized authorities in the IP Telephony industry, (i) such Core Premium Service is competitive, when taken as a whole, with the same or substantially similar services offered by any N2P Competitor through any similar online distribution channel; (ii) the rates associated with such Core Premium Service (including per-minute rates), when taken as a whole, are equal to or lower than the rates, when taken as a whole, for the same or substantially similar 10 CONFIDENTIAL EXECUTION VERSION products or services offered by any N2P Competitor; and (iii) N2P is included within the top two (2) providers of such IP Telephony Service (when taken as a whole) in the IP Telephony industry, taking into consideration, as a whole, such factors as pricing, scope and selection of products and services, technology platform and other aspects of the distribution channel, quality and ease of use of products and services, functionality, call quality, quality of customer support, success rates of call completion and overall level of customer satisfaction. The determination of "Best-of-Breed" shall not take into account limited promotions (e.g., discounts for particular countries or particular periods of time, or services offered only to a particular country or to limited countries) In the event that at any time during the Initial Term, a Core Premium Service fails to be Best-of-Breed, ICQ may notify N2P of such failure (including the reasons therefor and the basis for the determination thereof under this Agreement) and of its intention to terminate exclusivity with respect to the non-Best-of-Breed Core Premium Service. For a period of sixty (60) days following receipt of such notice, N2P shall have the opportunity to remedy the failure. Notwithstanding the foregoing (and in addition to any other remedies available to ICQ in this Agreement, including, without limitation, in Section 16.6 hereof), in the event that N2P has not cured any such failure (regardless of the level of effort by N2P to cure such failure) by the end of such sixty (60) day period (unless the Parties mutually agree in writing to extend such cure period), ICQ shall have the right to terminate the exclusivity (as set forth in Section 9 of this Agreement) with respect to such non-Best-of-Breed Core Premium Service and thereby enter into an agreement with any third party (including a N2P Competitor) to promote (or offer the services of) such third party with respect to the corresponding non-Best-of-Breed Core Premium Service. 3.4 No Payment by ICQ. For the avoidance of doubt, the Parties ----------------- acknowledge that ICQ shall not be required to pay N2P any compensation in connection with any modification, addition, deletion, feature or functionality or other improvement required to be provided by N2P in order for N2P to comply with its obligations under Section 3 of this Agreement. 3.5 N2P Not Responsible for Core ICQ Obligations. The Parties acknowledge --------------------------------------------- that the Core ICQ Obligations shall not affect the determination as to whether N2P has satisfied the criteria and obligations set forth in Section 3 of this Agreement. The Parties also acknowledge that the determination of whether N2P has satisfied the criteria and obligations set forth in Sections 3.1, 3.2 or 3.3 of this Agreement shall not be affected by features or functionality that N2P offers to ICQ and that ICQ (a) declines to implement or support or (b) cannot (e.g., due to technological or operational constraints within the control of ICQ) reasonably implement or support, provided that (i) in either such case, N2P provides ICQ with reasonable prior, informal, written notice (e.g., by e-mail) of the anticipated effects of ICQ's not implementing or supporting the features or functions on the ICQ IP Telephony Services and (ii) in the case of technological or operational constraints within ICQ's control, N2P provides ICQ with reasonable prior informal notice of such constraints. 4. DISTRIBUTION AND PROMOTION -------------------------- 4.1 Distribution and Promotion Requirements. During the Term, subject to --------------------------------------- the terms and conditions herein, the Parties agree to the following: 4.1.1. Access to ICQ IP Telephony Service. ICQ shall distribute ---------------------------------- the ICQ IP Telephony Services and the ICQ IP Telephony Software, provided that ICQ shall determine in its reasonable discretion (upon consultation with N2P) the manner in which such distribution occurs (e.g., through the bundling with the ICQ Client of the ICQ-customized N2P IP Telephony Software, through a "plug-in" of such software, etc.). 4.1.2 Distribution of ICQ IP Telephony Software. ----------------------------------------- 11 CONFIDENTIAL EXECUTION VERSION (a) PTP Calling Card Service. Promptly upon the ------------------------ acceptance by ICQ of the initial version of the PTP Calling Card Service (including any Updates thereto), ICQ shall promote and distribute such initial version as part of the ICQ Service subject to the remainder of this Section 4.1.2. (b) Secondary ICQ IP Telephony Services. Following the ----------------------------------- acceptance by ICQ of the initial version of any Secondary ICQ IP Telephony Service (including any Updates thereto) and subject to the remainder of this Section 4.1.2, ICQ shall promote and distribute such accepted Secondary ICQ IP Telephony Service as part of the 2000a ICQ Client and related version of the ICQ Service. ICQ shall launch (i.e., make generally commercially available) such 2000a ICQ Client and version of the ICQ Service no later than **** provided, however, that in the event -------- ------- that ICQ shall not have launched the 2000a Client and related version of the ICQ Service by **** (as N2P's sole and exclusive remedy hereunder), the Initial Term shall be extended by one day for each day beyond **** that ICQ fails to launch the 2000a ICQ Client and related version of the ICQ Service. (c) Distribution. The version of the ICQ Client that is ------------ generally made available for downloading on the ICQ Service or otherwise generally distributed in connection with the ICQ Service shall include either the ICQ IP Telephony Software or a means (consistent with Section 4.1.4 of this Agreement) by which ICQ Users can access and use the ICQ IP Telephony Services. (d) Exceptions. ICQ shall be relieved of the foregoing ---------- obligations under the conditions of, and in accordance with, Section 4.2 and the other terms of this Agreement. In addition, ICQ may also support other IP Telephony services (including those of N2P Competitors) as to which, and in the countries in which, N2P (on the Effective Date or thereafter) does not have exclusivity. Moreover, but subject to the requirements of this Agreement, ICQ may provide to a particular customer a version of the ICQ Client that does not include the customizations developed by N2P hereunder or any other IP Telephony capability if such customer requests (provided that ICQ does not encourage such customer to so request or offer such customer in a prominent fashion an opportunity to so request) that it receive a version of the ICQ Client that does not include N2P customizations. (e) Subsequent Versions. Following the acceptance by ICQ ------------------- of any Subsequent Version, ICQ will distribute such Subsequent Version with the ICQ Service within a time period (of not more than six (6) months) to be determined by ICQ in its reasonable discretion (e.g., taking into account such factors as the imminence of the launch of a new version of the ICQ Client, etc.), upon consultation with N2P. 4.1.3 Localized Versions. At such time as ICQ makes generally ------------------ commercially available localized versions of the ICQ Client (including, without limitation, any translation service distributed by ICQ in connection therewith) for use in the Collective International Gateways (or in any other countries in which the Parties agree that N2P shall provide the ICQ IP Telephony Services) (collectively, the "Localized Versions"), N2P shall cause (within a commercially reasonable time period) to be fully prepared for launch through the ICQ Service versions of the Core Premium Services, if any, that are required to be compatible with such Localized Versions. The Parties shall use commercially reasonable efforts to develop, make available and otherwise distribute Updates to such Localized Versions, from time to time as Updates for the U.S. English-language versions of [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 12 CONFIDENTIAL EXECUTION VERSION the ICQ IP Telephony Services are publicly released. ICQ shall be responsible for the localization of the ICQ GUI. 4.1.4 N2P Listing and Promotion. ICQ (together with any Affiliate of ------------------------- ICQ that offers the ICQ Service) shall feature, offer and promote the ICQ IP Telephony Services prominently in the ICQ Service. (a) In furtherance and as part of the foregoing, the initial implementation of such promotional requirement shall include, where feasible, the following (and any future implementation shall be consistent in terms of prominence (e.g., in terms of size, location, appearance and the like) with the following): (i) Each ICQ IP Telephony Service will be "sub-branded" with the name "Net2Phone," "N2P" or any other N2P Mark designated by N2P, subject to the approval of ICQ not to be unreasonably withheld (the "N2P Name"). "Sub-branding" means that each ICQ IP Telephony Service will be labeled and marketed with the name "****Phone" or such other ICQ name as ICQ designates (the "ICQ Name"), but that each such ICQ IP Telephony Service shall, where feasible and to the extent not inconsistent with the ICQ Look and Feel, have a prominent tag line such as "Powered by Net2Phone" or "Provided by Net2Phone", and a N2P Mark. The N2P tag line and Mark (the "Brandings") will be included prominently in (and where feasible, will be placed within reasonable proximity to the ICQ brandings in) the (A) areas which provide information regarding the use of and enable ICQ users to launch the ICQ IP Telephony Service (collectively, the "Support Area"), (B) other areas within the ICQ Service that relate principally to the ICQ IP Telephony Services (including, without limitation, the pages where users may read/write/send communications or modify settings), and (C) the ICQ IP Telephony Software or areas within the ICQ Client that relate principally to an ICQ IP Telephony Service (the "Branded Areas"). (ii) The Brandings will also appear prominently in advertising, promotional, public relations and marketing material relating principally to the ICQ IP Telephony Services. (iii) There will be links (evidenced by the ICQ Name or a graphical image of a telephone, or such other link as ICQ selects) to the PC-originated ICQ IP Telephony Services (initially, the PC-to-PC Service and PC-to-Phone Service) throughout the ICQ Service in areas providing ICQ Users with the ability to perform communication functions (e.g., white page results, yellow page results, directory search results, the menu that first appears after clicking on the name of a "buddy" or on the menu for ICQ services that one sees upon the opening of the ICQ Client etc.) (collectively, the "Links"). The Links will launch the ICQ IP Telephony Services. (b) The name, design and "look and feel" of the Branded Areas, the Brandings and the Links (collectively, the "Listings") will be determined by ICQ in its reasonable discretion in consultation with N2P. The Listings will properly convey the functionality of the ICQ IP Telephony Services. (c) ICQ generally will provide to N2P branding, marking and promotion that are no less prominent, in terms of size, placement, appearance and the like, than those accorded to other similarly. In the event that ICQ begins to sell advertising inventory on the "front end" of the ICQ Client, ICQ shall provide N2P with an opportunity to bid on the purchase of a placement within such inventory. (d) Subject to the other requirements of this Section 4.1.4 and the other provisions of this Agreement, the foregoing will not preclude users from [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 13 CONFIDENTIAL EXECUTION VERSION linking to another such provider from the ICQ Service, provided that the link to such other provider is limited to a textual -------- reference in a general list or directory of services that is no more prominent than any similar reference to N2P. Nothing in this Agreement shall prevent ICQ from offering (whether through buttons, icons or otherwise) an AOL PC-to-PC communication function on the ICQ Service, subject to the other requirements of this Section 4.1.4. 4.1.5 Promotion of ICQ Service by N2P; Promotion of ICQ IP Telephony -------------------------------------------------------------- Services by ICQ. --------------- (a) N2P. N2P shall promote the ICQ Service to its --- customers and partners, and shall use reasonable efforts to encourage such customers and partners to adopt the ICQ Service as an integrated component of the IP Telephony products and services provided to such customers and partners by N2P, as and to the extent set forth in Exhibit E. ICQ shall assist N2P, as reasonably requested by N2P, in such promotional efforts. (b) ICQ. ICQ shall use reasonable efforts to encourage its --- partners to consider using the ICQ IP Telephony Services as part of the products and services offered to their respective users. N2P shall assist ICQ, as reasonably requested by ICQ, in such promotional efforts. 4.2 General Conditions to Distribution and Promotional Obligations. -------------------------------------------------------------- Notwithstanding anything contained in this Section 4, ICQ shall have no obligation to promote a particular version of the ICQ IP Telephony Services, to distribute to ICQ Users a particular version of the ICQ IP Telephony Services or to provide any Listing therefor to the extent that and for so long as: (i) ICQ has received notice (whether written or verbal) of, and reasonably believes, that the reproduction, use or distribution of such version of the ICQ IP Telephony Services in accordance with this Agreement infringes or misappropriates the intellectual property rights of any third party, provided that -------- ICQ may not promote or offer access to any other IP Telephony product unless ICQ reasonably believes that it raises a lesser risk of infringement or misappropriation; or (ii) An aspect of any such version of the ICQ IP Telephony Service exists, other than an acknowledged security risk that a corporation/user accepts by opening up holes in its firewall to enable use of any such ICQ IP Telephony Service (and other than security risks ordinarily associated with Web-based communications products), that could be exploited in a manner that ICQ reasonably believes (a) would expose ICQ Users to potential efforts to invade their privacy or damage or modify data, software or hardware in an unauthorized manner or (b) would otherwise result in meaningful and serious claims that any such ICQ IP Telephony Service presents a security risk to its users, provided that ICQ may not promote or offer access to any -------- other IP Telephony product unless ICQ reasonably believes that it raises a lesser security risk. 4.3 Exclusive Offers/ICQ User Benefits. N2P shall offer through the ---------------------------------- ICQ Service on a regular and consistent basis (but no less than once per quarter) special offers comparable to those available through Additional N2P Channels (e.g., preferred rates to specific termination points to be offered periodically, raffle or sweepstakes conducted from time to time, etc.), which such special offers shall be exclusively available to ICQ Users (the "ICQ Exclusive Offers"). Each ICQ Exclusive Offer made available by N2P shall provide a substantial member benefit to ICQ Users, either by virtue of a meaningful price discount, product enhancement, unique service benefit or other special feature. N2P will provide ICQ with reasonable prior notice of ICQ Exclusive Offers so that ICQ 14 CONFIDENTIAL EXECUTION VERSION can market the availability of such ICQ Exclusive Offers in the manner ICQ deems appropriate in its reasonable discretion; provided that ICQ -------- shall consult with N2P regarding the marketing of the ICQ Exclusive Offers. 4.4 ICQ Search Keywords. During the Initial Term, subject to the ------------------- terms and conditions hereof, ICQ (in its sole discretion) may provide N2P with ICQ Search Keywords to be mutually agreed upon by the Parties. 5. ICQ USER REGISTRATION AND INFORMATION ------------------------------------- 5.1 Ownership of Assets and Customer Relationships. ICQ shall own ---------------------------------------------- all tangible and intangible assets (and all personal and intellectual property) provided by ICQ in developing the ICQ IP Telephony Services (except as otherwise expressly set forth herein) and the Support Area, including all materials provided by ICQ to N2P for the purpose of branding the ICQ IP Telephony Service and the Support Area ("ICQ Branding Materials"), and the relationship with ICQ IP Telephony Users, including, without limitation, all aspects of such relationship specified in this Section 5. ICQ shall own any and all rights in the call detail records generated in providing the ICQ IP Telephony Services which shall be treated as Confidential Information for purposes of this Agreement (collectively, the "Call Detail Records"). ICQ hereby grants N2P a non-exclusive, non-transferable, worldwide, royalty-free license to use the Call Detail Records only to the extent necessary to provide the ICQ IP Telephony Services to be provided by N2P hereunder (including any related planning and development). Such license shall continue through the end of the Term, but shall survive expiration of the Term with respect to the provision by N2P of the PTP Calling Card Service. 5.2 ICQ User Relationship. --------------------- 5.2.1 Registration Information. In order to use the Surcharged ------------------------ ICQ IP Telephony Services, an ICQ User will be required to register for such ICQ IP Telephony Services. The Parties shall determine by mutual agreement the terms and conditions of use to be agreed to by such ICQ Users (including, without limitation, with respect to any special access codes to be used by such ICQ Users in connection with the ICQ IP Telephony Services, provided, that neither Party shall -------- unreasonably withhold such agreement with respect to the use of such special access codes), and ICQ shall determine both (i) the information to be collected from the ICQ Users as part of the registration process (provided that such information shall in any -------- event include information that N2P reasonably requests in connection with the provision of the ICQ IP Telephony Services, including, without limitation, any Personal Identification Numbers (PINs) for use by ICQ Users in connection with the ICQ IP Telephony Services) and (ii) any domain names, unique identifier numbers, e-mail addresses and passwords to be assigned and/or used by such ICQ Users in connection with such ICQ IP Telephony Services. Notwithstanding the foregoing, it is the Parties' intention that ICQ Users initially shall not be required to register for, or provide any information in connection with the use of, the PC-to-PC Service. Registration for the ICQ IP Telephony Services shall take place at the Support Area or at such other location as may be mutually agreed upon by the Parties. ICQ shall use reasonable efforts to build into the end of the registration process for the ICQ Service (the "ICQ Registration Process") a sub- routine for the registration for the ICQ IP Telephony Services. Notwithstanding the foregoing, in the event that any ICQ Users shall not have registered for the Surcharged ICQ IP Telephone Services prior to attempting to use any such service, ICQ shall cause any such ICQ User to register for the Surcharged ICQ IP Telephony Services prior to the use thereof. N2P shall determine the pricing for the Core Premium Services and other ICQ IP Telephony Services to be provided by N2P hereunder. In addition, N2P shall handle the assignment of applicable phone numbers to ICQ Users (using the ICQ User unique identifier number as an identifier and provided that such phone numbers and -------- special access codes (unless 15 CONFIDENTIAL EXECUTION VERSION otherwise agreed upon in writing by the Parties) shall be different from any phone numbers and access numbers used in connection with any N2P Services), and shall handle the billing and collection of any fees or other amounts to be charged to ICQ Users from time to time in connection with the ICQ IP Telephony Services (collectively, the "IPT Fees"); provided, however that, unless otherwise expressly consented -------- ------- to in writing by ICQ, N2P shall not directly contact or communicate with any ICQ IP Telephony Users other than in connection with the billing and collection of the IPT Fees, or in connection with maintenance and customer support for the ICQ IP Telephony Services; provided, further, that such communications shall be limited to -------- ------- obtaining billing information, providing pricing information related to the ICQ IP Telephony Services and ensuring collection of the IPT Fees or providing maintenance or customer support, and shall not be used by N2P as a platform to sell, market, advertise or promote any products or services other than the ICQ IP Telephony Services. 5.2.2 Billing Transition. Notwithstanding the foregoing, at any ------------------ time during the Term and at ICQ's sole discretion, ICQ shall have the right to assume responsibility for the aforementioned billing and collection obligations with respect to the IPT Fees (collectively, the "Billing Transition"); provided, however, that (i) ICQ shall give N2P -------- ------- reasonable advance notice of any such Billing Transition; (ii) the Billing Transition shall be subject to agreement of the Parties on arrangements (a) for N2P to receive the same portion of revenue from the ICQ IP Telephony Services as it would have received before the Billing Transition (and on procedures to verify the proper payment of such revenue), (b) for handling fraud, and (c) for the handling of the billing for the PTP Calling Card Service after the Initial Term, and (iii) ICQ shall be responsible for all costs and out-of-pocket expenses incurred by N2P in connection with such Billing Transition. In the event of such Billing Transition, N2P hereby agrees to provide ICQ with reasonable assistance (and to otherwise cooperate with ICQ), at ICQ's expense, regarding such Billing Transition, and following such Billing Transition, ICQ shall use commercially reasonable efforts to ensure that the billing services comply in all material respects with the standards set forth in Exhibits B and C of this Agreement. 5.3 ICQ User Information and Solicitation. ------------------------------------- 5.3.1 Ownership of ICQ User Information. ICQ shall own any and --------------------------------- all information collected from ICQ Users in connection with the ICQ IP Telephony Services, including, without limitation, information collected during the registration processes for the ICQ Service and/or any ICQ IP Telephony Service, respectively, and information then or subsequently obtained from any use of the ICQ Service and/or any ICQ IP Telephony Services, including without limitation all information relating to ICQ User names, passwords, ICQ numbers, phone numbers, special access codes, email addresses, domain names, addresses, credit card information, user preferences or history or other identifying information of ICQIP Telephony Users (collectively, "User Information"). All User Information shall be deemed Confidential Information of ICQ. N2P agrees, both during and after the Term, not to (i) use any User Information for any purpose other than in connection with the operation of the ICQ IP Telephony Services or (ii) disclose any such information to any third party without the prior written consent of ICQ, which consent may be granted or withheld in ICQ's sole and absolute discretion; provided, however, that N2P may disclose User Information solely as necessary (and only to the extent necessary) to comply with applicable laws, regulations and government orders or requests; provided, further, that N2P shall use all reasonable -------- ------- efforts to limit any such disclosure to the maximum extent possible and to provide ICQ with as much advance written notice of N2P's intended use or disclosure as is practicable. N2P agrees to comply with the ICQ Privacy Policy to the same extent as ICQ, as such policy exists on the Effective Date (i.e., the ICQ Privacy Policy dated as of January 26, 1999), as the same may be modified and notified to N2P from time to time. N2P shall not sell, license, rent or otherwise transfer any ICQ User Information or any list of ICQ Users for any 16 CONFIDENTIAL EXECUTION VERSION purpose whatsoever, without ICQ's prior written consent. Notwithstanding the foregoing, N2P shall have the right to use User Information to the extent necessary to provide the PTP Calling Card Service to then-existing ICQ User customers following the expiration of the Initial Term, and ICQ shall provide N2P with the customer records and other information to the extent necessary for N2P to continue providing the PTP Calling Card Service to such customers for the two (2) year period immediately following the expiration of the Initial Term, subject to Section 5.3.2 and 5.3.3 of this Agreement and prohibitions, if any, under applicable law. 5.3.2 No Competitive Solicitation. During the Term and for the --------------------------- two (2) year period following the expiration or termination of this Agreement (and without limiting any other provision of this Agreement, including Section 5.3.1), neither N2P nor its agents shall use the ICQ Service or the ICQ IP Telephony Services or information owned by ICQ or an ICQ Affiliate to (i) solicit third parties or ICQ Users when that solicitation is for the benefit of any entity (including N2P) which could reasonably be construed to be or to become in competition with ICQ, the ICQ Service or the ICQ IP Telephony Services, or (ii) promote any services or products which could reasonably be construed to be in competition with services or products provided by ICQ, through the ICQ Service or through the ICQ IP Telephony Services. Except as otherwise prohibited in this Section 5, nothing in this Section 5.3.2 shall be construed to prohibit N2P or its agents from soliciting or promoting the N2P Services to any third party, whether during the Term or thereafter, provided that, in connection with such solicitation or promotion, N2P complies with the terms of (a) Section 9 (Exclusivity) during the Initial Term and (b) Section 13 (Confidential Information) during the Term (and after the Term for the period set forth in such Section 13). The Parties acknowledge that any incidental (i.e., de minimis) failure by N2P to comply with the terms of this provision shall not be deemed a material breach of this Agreement; provided, however, that N2P shall take appropriate steps to -------- ------- prevent any further failure to comply with the terms of this Section 5.3.2. 5.3.3 No Communication. During the Term and for the two (2) ---------------- year period following the expiration or termination of this Agreement (and without limiting any other provision of this Agreement, including Section 5.3.1), N2P agrees not to send any ICQ User any messages or communications on or through the Qualified ICQ Services for any commercial purpose, unless N2P has an Independent Business Relationship with such ICQ User. Any commercial e-mail communications (i.e., e-mail communications offering products or services) to ICQ Users on or through the ICQ Service or the ICQ IP Telephony Services which are otherwise permitted hereunder (i.e., permitted as exceptions to general prohibitions included in this Agreement) shall include a prominent and easy means to "opt-out" of receiving any future commercial e-mail communications from N2P. The Parties acknowledge that any incidental (i.e., de minimis) failure by N2P to comply with the terms of this provision shall not be deemed a material breach of this Agreement; provided, however, that N2P shall take appropriate -------- ------- steps to prevent any further failure to comply with the terms of this Section 5.3.3. 6. TECHNICAL SUPPORT ----------------- N2P shall provide all frontline technical and customer support to ICQ Users as set forth in Exhibit B, including, without limitation, technical and customer support for ICQ Users who have problems with, or questions concerning, the installation, use, operation or maintenance of the ICQ IP Telephony Service (collectively, the "Frontline Support"). The Parties acknowledge that N2P may provide such Frontline Support using e-mail and/or telephone support, at N2P's option. N2P shall, at no cost to ICQ, provide to ICQ the back-end support regarding the ICQ IP Telephony Service specified on Exhibit D. During the Term, each Party will designate one (1) internal technical contact (each such contact, 17 EXECUTION VERSION a "Technical Liaison") and will conduct technical communication activities as may be necessary for the optimization of the integration of the ICQ IP Telephony Services into the ICQ Service. ICQ will use commercially reasonable efforts to provide technical and marketing assistance, including facilitating the maintenance of regular communication channels between relevant personnel, for the purpose of assisting both Parties in abiding by their respective obligations under this Agreement. The initial Technical Liaison for N2P shall be David Span and the initial Technical Liaison for ICQ shall be David Cole, unless otherwise designated from time to time by the Parties. Each Party may change its Technical Liaison from time to time, in its sole discretion. Unless otherwise agreed upon by the Parties, N2P shall not be obligated to provide support for any modifications or additions to the ICQ IP Telephony Services carried out by ICQ (or carried out for ICQ by a third party not contracted or subcontracted by or on behalf of N2P); provided, however, that where not required to -------- ------- provide such support pursuant to the terms of this Section 6, N2P shall assist in the support of such work to the extent necessary for either Party to comply with its obligations under this Agreement. 7. PAYMENT AND REVENUE PROVISIONS ------------------------------ 7.1 Guaranteed Payments; Refund. In partial consideration for ICQ's --------------------------- marketing of the ICQ IP Telephony Services, N2P shall pay to ICQ a non-refundable guaranteed payment of Seven Million Five Hundred Thousand Dollars (US$7,500,000) as follows: (i) Four Million Dollars (US$4,000,000) on the Effective Date, and (ii) Three Million Five Hundred Thousand Dollars (US$3,500,000) on the earlier of (a) the one (1) year anniversary of the Effective Date or (b) consummation of an initial public offering of shares of N2P under the Securities Act of 1933, as amended. In the event of any termination of this Agreement before expiration of the Initial Term in accordance with (i) Section 16.2 due to a material breach by ICQ of this Agreement, (ii) Section 16.3 due to a Change of Control of ICQ by a N2P Competitor or a Parent Company Competitor or (iii) Section 16.5 due to the occurrence of a Regulated Entity Event, ICQ shall refund to N2P the pro rata portion --- ---- (based on a four (4) year term) of any guaranteed payments made by N2P prior to the date of such early termination (e.g., if such termination occurs on the two (2) year anniversary of the Effective Date, and N2P has paid ICQ Seven Million Five Hundred Thousand Dollars (US$7,500,000) in guaranteed payments as required by the terms of this Agreement, ICQ shall refund to N2P fifty percent (50%) of such guaranteed payments, or Three Million Seven Hundred Fifty Thousand Dollars (US$3,750,000). In the event of any termination of this Agreement before the expiration of the Initial Term in accordance with Section 16.6(i)(c) or Section 16.6(i)(d), then ICQ shall refund to N2P fifty percent 50% of the pro rata portion (based on a four (4) year --- ---- term) of any guaranteed payments made by N2P prior to the date of such early termination. In partial consideration for such guaranteed payments, ICQ shall provide N2P during the Initial Term with promotional placements (on areas of the ICQ Service to be determined by ICQ in its reasonable discretion as further set forth in Section 4.1.4) with a value of One Million Two-Hundred Fifty Thousand Dollars (US$1,250,000) (based on average amounts actually charged by ICQ for comparable Advertisements or, if unavailable, amounts set forth on ICQ's advertising rate card). 7.2 Net Advertising Revenue for IP Telephony Services. 7.2.1 Advertising Sales. ICQ shall have the right to license or ----------------- sell promotions, advertisements, links, sponsorships, pointers or similar services or rights ("Advertisements") through the ICQ Service, subject to ICQ's then-applicable advertising policies. 18 CONFIDENTIAL EXECUTION VERSION 7.2.2 Revenue Sharing. --------------- (a) Net Advertising Revenue. As partial ----------------------- consideration for its marketing efforts hereunder, ICQ shall retain **** percent (****%) of the Net Advertising Revenue. ICQ shall pay N2P, within thirty (30) days following the end of each quarter during the Term, the remaining **** percent (****%) of the Net Advertising Revenue that is actually collected by ICQ or any Affiliate of ICQ (collectively, the "Advertising Revenue Share"). (b) Net Button Advertising Revenue. In the event ------------------------------ that ICQ sells (which such decision to sell shall be in ICQ's sole discretion) any buttons that appear on the ICQ IP Telephony client (the "Special Buttons"), (i) N2P shall receive (1) **** percent (****%) of the Net Button Advertising Revenue generated from the sale (without N2P participation or support) of any such Special Button or (2) **** percent (****%) of the Net Button Advertising Revenue generated from the sale (with N2P participation or support) of any such Special Button, and (ii) ICQ shall retain the remainder of such Net Button Advertising Revenue (clauses (i) and (ii) above, collectively, the "Net Button Advertising Revenue Share"). Notwithstanding the foregoing, in no event shall the total portion of the Net Button Advertising Revenue received by N2P during the Term exceed **** Dollars (US$****) (i.e., after the receipt by N2P of US$**** in Net Button Advertising Revenue, ICQ shall retain **** (****%) of such Net Button Advertising Revenue). In the event that ICQ utilizes such Special Buttons to promote any ICQ or other commercial products or services, ICQ shall utilize a portion of such Special Buttons (i.e., at least one such Special Button) to promote the ICQ IP Telephony Services. 7.2.3 Definition of Net Advertising Revenue. For purposes of ------------------------------------- this Agreement, "Net Advertising Revenue" shall mean, for any calendar quarter, (i) the gross revenue (including cash and the value of any non-cash consideration) received by ICQ, or any Affiliate of ICQ, from Advertisements in (a) the Support Area, (b) other areas within the ICQ Service that principally list the ICQ IP Telephony Services, or (c) the ICQ IP Telephony Software or areas within the ICQ Client that principally list the ICQ IP Telephony Services (collectively, the "Designated Advertising Areas"), less (ii) the actual commissions paid to third party agencies by ICQ in connection with the placement of such Advertisements (or, if no such commissions were incurred, fifteen percent (15%) of the gross revenues received by ICQ for such Advertisements). If Advertisements in the Designated Advertising Areas are sold or otherwise made available to a party that also purchases or obtains Advertisements through one or more other areas or media of ICQ or an Affiliate (collectively, a "Combined Sale"), the revenue from the Combined Sale shall be allocated pro rata between --- ---- such Designated Advertising Areas and such other areas or media (based on list prices for such Designated Advertising Areas and other areas or media). For the avoidance of doubt, "Net Advertising Revenues" shall not include Net Button Advertising Revenues. 7.2.4. Ownership of Advertising. The right of N2P to ------------------------ participate in the Net Advertising Revenue pursuant to the provisions of this Section 7.2 shall in no way create any ownership interest in N2P with respect to ICQ advertising inventory. ICQ owns all right, title and interest in and to the Advertisements and promotional spaces within the ICQ Service, including the Support Area and the ICQ Client, and ICQ has the sole authority to market and sell such Advertisements; provided, however, that ICQ agrees that, during the Initial Term -------- ------- within the Designated Advertising Areas, ICQ shall not include any Advertisements for (or sell any advertising inventory to) N2P Competitors with respect to [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 19 CONFIDENTIAL EXECUTION VERSION (i) the Core Premium Services (to the extent that N2P enjoys exclusivity with respect thereto under this Agreement) and (ii) any Optional Service(s) or Expanded Service(s) which the Parties mutually agree from time to time shall be exclusive to N2P). Further, ICQ shall be responsible for all obligations, liabilities and duties under any and all agreements that ICQ has with third parties and otherwise with regard to such Advertisements, including serving such advertisements, subject to Section 15 of this Agreement. 7.3 Transaction Revenues Sharing Arrangement. ---------------------------------------- 7.3.1 Revenue Threshold. If at any time (i) during Year One the ----------------- amount of Transaction Revenues received by N2P during such year exceeds **** Dollars (US$****) or (ii) during each of Years Two through Four of this Agreement, the amount of the Transaction Revenues received by N2P exceed **** Dollars (US$****) (for each such Year, the "Revenue Threshold"), then N2P will pay ICQ, in partial consideration for ICQ's marketing and distribution efforts hereunder, the Revenue Share with respect to the incremental Transaction Revenues received during any such Year above the Revenue Threshold for such Year (the "Incremental Transaction Revenues"). N2P will pay all of the foregoing amounts within thirty (30) days following the end of the Year in which the applicable Transaction Revenues were received. At the end of each such Year, the calculation of Transaction Revenues for purposes of this Section 7.3.1 shall recommence. N2P shall have the right to collect and retain all Transaction Revenues other than the Revenue Share paid to or retained by ICQ. To the extent mutually agreed upon by the Parties in writing in connection with any Billing Transition, ICQ shall be responsible (following any such Billing Transition) for calculating the Revenue Share and for paying N2P its portion of such Revenue Share as contemplated by this Section 7.3.1. 7.3.2 Revenue Share. The "Revenue Share" shall mean the amounts ------------- to be paid to ICQ (in each case, determined as a percentage of Incremental Transaction Revenues) set forth on Exhibit H hereto. 7.3.3 Netscape Users. To the extent that N2P is required to -------------- share revenue with Netscape to agreements in full force and effect on the Effective Date) for transaction revenues generated with respect to the Core Premium Services, any Transaction Revenue received by N2P hereunder from any Netscape user with respect to the Core Premium Services shall not constitute Transaction Revenues for purposes of this Section. 7.4 No Other Revenue Sharing. Except as expressly provided in this ------------------------ Section 7 and on Exhibit H, neither Party shall be entitled to any revenues derived from, or related to, the activities of the other Party. 7.5 Alternative Revenue Streams. In the event that N2P receives or --------------------------- desires to receive (directly or indirectly) any compensation in connection with the ICQ Service from the sale of any Products other than the ICQ IP Telephony Services or as otherwise agreed to by the Parties (an "Alternative Revenue Stream"), N2P will promptly inform ICQ in writing, and the Parties will negotiate in good faith regarding whether N2P will be allowed to market the Products producing such Alternative Revenue Stream (the "Alternative Products") through the ICQ Service, and if so, the equitable portion of revenues from such Alternative Revenue Stream (if applicable) that will be shared with ICQ. [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 20 CONFIDENTIAL EXECUTION VERSION 7.6 Reports and Payments. Each Party (the "Paying Party") shall comply -------------------- with the following requirements in connection with its payment obligations to the other Party (the "Payee Party") under this Agreement: Within thirty (30) days following the end of each payment period, the Paying Party shall provide the Payee Party with a report that contains information detailing the amount payable for such payment period. Such report shall, with reasonable detail, explain the basis upon which such payment has been determined and shall be accompanied by payment in full of all amounts indicated on such report as due for such period. Each such report shall constitute Confidential Information of the Paying Party. Without limiting the generality of the foregoing: 7.6.1 Reports on Transaction Revenues. N2P will provide ------------------------------- ICQ with a report in a mutually agreed-upon format, detailing the following activity in such period (and any other information mutually agreed upon by the Parties as required for measuring Transaction Revenues): (i) summary sales information (e.g., total number of orders, average sales per customer and per order); and (ii) detailed sales information to be agreed upon by the Parties (collectively, "Sales Reports"). ICQ will be entitled to use the Sales Reports only in its internal business operations, subject to the terms of this Agreement. The report will also contain information which supports the payment based on Transaction Revenues, including information identifying gross Transaction Revenues and all items deducted or excluded from gross Transaction Revenues to produce Transaction Revenues, including, without limitation, charge-backs and credits for returned or canceled goods or services (and, where reasonably practicable, an explanation in general of the types of reasons therefor (e.g., bad credit card information, poor customer service, etc.)). 7.6.2 Reports on Advertising Revenue Share. ICQ will provide ------------------------------------ N2P with a quarterly report in a mutually agreed-upon format, detailing the following in such quarter (and any other information mutually agreed upon by the Parties as required for measuring Advertising Revenues): (i) aggregate cash, plus the fair market value (and basis for determining the fair market value) of any non-cash consideration received (such as barter advertising), received by ICQ or any ICQ Affiliate from Advertisements in the Designated Advertising Areas, (ii) to the extent applicable, the agency fees incurred in connection with the placement of such Advertisements, and (iii) if applicable, the basis for allocating revenue from Combined Sales to Advertisements in the Designated Advertising Areas. 7.7 Late Payments; Wired Payments. All amounts owed hereunder not paid ----------------------------- when due and payable will bear interest from the date such amounts are due and payable at the prime rate in effect at such time. All payments required to be paid to ICQ hereunder will be paid in immediately available, non-refundable U.S. funds wired to the "America Online" account, Account Number **** at the Chase Manhattan Bank, 1 Chase Manhattan Plaza New York, N.Y. 10081 (****). All payments required to be paid to N2P hereunder will be paid in immediately available, non- refundable U.S. funds wired to an account to be designated by N2P (within thirty (30) days following the Effective Date) in a written notification to ICQ. 7.8 Audit Rights. Each Party (as Paying Party) will maintain complete, ------------ clear and accurate records of the information required to determine the amounts of payments made hereunder. For the sole purpose of ensuring compliance with the payment obligations of this Agreement, either Party (as Payee Party) will have the right to request that an independent certified accountant selected by the Parties (and which accountant enters into a confidentiality agreement mutually agreed to by the Parties) conduct (no more than twice per calendar year of this Agreement) a reasonable and necessary inspection of portions of such books and records as are necessary to verify the correctness of the [****] REPRESENTS MATERIAL, WHICH HAS BEEN REDACTED AND SEPARATELY FILED WITH THE COMMISSION, PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 406 UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 21 CONFIDENTIAL EXECUTION VERSION payments made hereunder. Any such audit may be conducted after twenty (20) business days prior written notice to the Paying Party. The Payee Party shall bear the expense of any audit conducted pursuant to this Section 7.8 unless such audit shows an error in the Payee Party's favor amounting to a deficiency in excess of five percent (5%) of the actual amounts payable to the Payee Party hereunder, in which event the Paying Party shall bear the reasonable costs and expenses incurred in connection with such audit. The Paying Party shall pay the Payee Party the amount of any deficiency discovered by the Payee Party within thirty (30) days after receipt of notice thereof from the Payee Party, except to the extent disputed in good faith by the Paying Party. 7.9 Taxes. Each Party will collect and pay, and indemnify and hold ----- harmless the other Party from, any sales, use, excise, import or export value added or similar tax or duty required to be collected and paid by such Party, including any penalties and interest, as well as any costs associated with the collection or withholding thereof, including attorneys' fees (collectively, the "Taxes"). 7.10 Fraudulent Transactions. To the extent permitted by applicable law, ----------------------- N2P will (i) provide ICQ with prompt notice of any fraudulent order (a "Fraudulent Order"), including the date, screen name or e-mail address and amount associated with such order, promptly following N2P obtaining knowledge that the order is, in fact, fraudulent and (ii) as promptly as possible following the occurrence of any such Fraudulent Order (but in no event later than one (1) month after the occurrence thereof), provide ICQ with a report regarding any such order and the steps taken by N2P with respect thereto. 7.11 Most Favored Customer. N2P represents that the terms and conditions --------------------- accorded to ICQ under this Agreement (including any consideration provided to ICQ and any of its Affiliates in connection herewith) are, taken as a whole, no less favorable than the terms and conditions accorded to any (i) ICQ Competitor, (ii) AOL Competitor or (iii) telecommunications service reseller or provider which is subject to regulation by the Federal Communications Commission (a "Regulated Telecommunications Service Provider") with respect to the N2P Services provided to ICQ hereunder. In addition, if during the Initial Term, N2P enters into an agreement with an ICQ Competitor, AOL Competitor or Regulated Telecommunications Service Provider with respect to the N2P Services provided hereunder that accords to such ICQ Competitor, AOL Competitor or Regulated Telecommunications Service Provider terms and conditions that, taken as a whole, are more favorable than those accorded to ICQ under this Agreement (including any such consideration provided to ICQ and any of its Affiliates in connection herewith), then N2P shall adjust the terms and conditions of this Agreement so that ICQ obtains terms and conditions (including any such consideration provided to ICQ and any of its Affiliates in connection herewith) that, taken as a whole, are no less favorable than those accorded to such ICQ Competitor, AOL Competitor or Regulated Telecommunications Service Provider (as the case may be) (including any consideration provided to such ICQ Competitor, AOL Competitor or Regulated Telecommunications Service Provider (as the case may be) and any Affiliates thereof). 8. STOCK WARRANTS -------------- Attached hereto as Exhibit G is a form of common stock warrant to be executed by N2P on behalf of ICQ, or, if ICQ so directs N2P in writing, any parent, subsidiary or affiliate entity of ICQ (including AOL.). In the event that ICQ directs N2P to issue such warrant to such other entity, the Parties agree that such entity shall have the right to enforce the terms of such warrant against N2P. 22 CONFIDENTIAL EXECUTION VERSION 9. EXCLUSIVITY ----------- 9.1 Scope. ----- 9.1.1 N2P Exclusivity. Except to the extent that ICQ is --------------- expressly relieved of its exclusivity obligations under this Agreement, N2P shall be the exclusive provider of the Core Premium Services on the ICQ Service during the Initial Term (the "N2P Exclusivity"); provided, however, that ICQ shall be free to enter into -------- ------- agreements with third parties (including, without limitation, with any N2P Competitor) for the use, integration, offering and/or promotion of IP Telephony services (and any other telecommunications services or products) other than the Core Premium Services within the ICQ Service. Provided that N2P retains exclusivity hereunder with respect to any Core Premium Service, ICQ will not promote on the ICQ Service any IP Telephony service which is comparable to such Core Premium Service. Notwithstanding the foregoing, unless otherwise agreed by the Parties, the N2P Exclusivity shall not extend to any country outside the United States other than the Collective International Gateways. The Parties hereby acknowledge and agree that the N2P Exclusivity may be terminated with respect to particular ICQ IP Telephony Services (or with respect to particular Collective International Gateways) in accordance with the terms of this Agreement. 9.1.2 ICQ Exclusivity. N2P agrees that N2P shall not (i) --------------- authorize the public release before June 1, 2000 of a product in which N2P or any third party has integrated (e.g., through any bundling arrangement, downloading of software, "plug-in" etc.) the N2P IP Telephony Software (or any portion thereof) into or with an instant messaging or similar online, real time messaging product of an ICQ Competitor or an AOL Competitor or (ii) announce or authorize the announcement of the release (whether planned or actual) of such an integrated product of an ICQ Competitor or an AOL Competitor (or announce or authorize the announcement of the distribution of the N2P IP Telephony Software by or through any ICQ Competitor or AOL Competitor where the announcement refers to any instant messaging or similar online real time communications service (e.g., chat, buddy list, etc.))) before the earlier of June 1, 2000 or the date for public release of each of the initial versions of the Core Premium Services ("ICQ Exclusivity"). During the Initial Term, N2P will promote ICQ as a preferred integrated instant messaging service and product; provided, however, that during the Initial Term, N2P shall -------- ------- not promote an instant messaging service or similar online, real time messaging product of an ICQ Competitor or an AOL Competitor more prominently than ICQ. Notwithstanding the foregoing, the Parties hereby acknowledge that N2P shall have the right to offer its PC-to-PC voice-enabled chat service to any third party following the earlier of (a) June 5, 2000 or (b) three (3) months following the date on which ICQ integrates such voice-enabling chat service into the ICQ Service. 9.2 Optional Services. With respect to all Optional Services and other IP ----------------- Telephony services not expressly contemplated by this Agreement, ICQ shall offer N2P a right of first negotiation (not to exceed thirty (30) days) with respect to the offering of such additional services through the ICQ Service. In the event that the Parties cannot agree, within such time period, to the terms and conditions regarding the provision of any such additional service to ICQ Users through the ICQ Service, ICQ shall have the right to offer such additional service(s) to ICQ Users through any third party (including, without limitation, any N2P Competitor). 9.3 Termination of Exclusivity. In the event that ICQ is entitled to -------------------------- relief from the N2P Exclusivity as to a particular Core Premium Service and/or country in accordance with the express terms and conditions of this Agreement, then only the N2P Exclusivity with respect to such Core Premium Service and/or country (as the case may be and subject to Section 16 hereof) shall terminate. 23 CONFIDENTIAL EXECUTION VERSION 9.4 Exception to Exclusivity. For the avoidance of doubt, the Parties ------------------------ acknowledge that the N2P Exclusivity does not preclude the listing of N2P Competitors or any AOL PC-to-PC communication function in any whites pages, yellow pages or other online search or directory service, subject to Section 4.1.4 and Section 7.2.4. 10. LICENSE FROM N2P ---------------- 10.1 License. ------- 10.1.1 Software License. Subject to all the terms and ---------------- conditions of this Agreement, N2P hereby grants to ICQ a worldwide, non-exclusive, non-transferable, royalty-free license for the Term to use, reproduce, distribute directly and indirectly, transmit, display, perform and sublicense (i.e., grant to end-users the right to use) and adapt the ICQ IP Telephony Software, including any and all components contained in the ICQ IP Telephony Software necessary to effectuate the provision of the ICQ IP Telephony Services to ICQ, and the use by end- users of the ICQ IP Telephony Services, in each case, in object code form only (except as provided in Section 10.2) in accordance with the terms of this Agreement. To the extent reasonably requested by ICQ, N2P shall deliver the ICQ IP Telephony Software electronically to ICQ. 10.1.2 Purpose of License. The foregoing license is expressly ------------------ intended to permit (and limited to permitting) ICQ to effectuate all of its rights and conduct all of the business expressly contemplated hereunder, including distributing the ICQ IP Telephony Services pursuant to the terms and conditions of this Agreement. Except as set forth in Sections 10.2 and 12.1 or as otherwise set forth in this Agreement (including, without limitation, with respect to the ICQ GUI), ICQ acknowledges and agrees that N2P and its licensors retain all rights, title and interest in and to the ICQ IP Telephony Software in both object and source code forms. ICQ shall not have any right under any circumstances, or authorize any third party (which, for avoidance of doubt, includes any Affiliate of ICQ), to (i) adapt the ICQ IP Telephony Software (other than adaptation in accordance with Section 10.1.1 or as otherwise authorized by the Source Code Escrow Agreement or license described in Section 10.2), (ii) reverse engineer, decompile, disassemble or otherwise attempt to reconstruct the source code for or underlying algorithms, processes or methods of the ICQ IP Telephony Software that is provided in object code form, or (iii) reproduce or distribute the ICQ IP Telephony Software to any third party (other than as expressly provided in this Agreement). All copies of the ICQ IP Telephony Software made hereunder shall include all proprietary notices included on the copy provided by N2P, and ICQ shall not remove, deface or obscure or authorize to be removed, defaced or obscured any of N2P's or its licensors' proprietary rights notices on or in the ICQ IP Telephony Software or on output generated by the software; provided that the placement of such notices, if any, in the ICQ IP Telephony Software that are visible in the user interface of such software shall be subject to ICQ's prior written approval, which approval will not be unreasonably withheld. ICQ agrees that any and all copies of the ICQ IP Telephony Software distributed to third parties shall be pursuant to binding license agreements no less restrictive or protective of N2P's rights than this Section 10.1. ICQ agrees that any material violation of this Section 10.1 by ICQ that is not cured by ICQ within thirty (30) days shall constitute a material breach of this Agreement. N2P agrees to provide the ICQ IP Telephony Software in object code form, including all required Documentation, to ICQ as and when needed for ICQ to exercise its rights under this Agreement. For the avoidance of doubt, the Parties acknowledge that the host components of the ICQ IP Telephony Software, if any, are for use only by ICQ and may not be provided to any third party. 24 CONFIDENTIAL EXECUTION VERSION 10.2 Source Code License and Escrow. ------------------------------ 10.2.1 Escrow Agreement. N2P and ICQ will enter into an escrow ---------------- agreement (the "Source Code Escrow Agreement"), containing terms and conditions subject to the mutual agreement of the Parties, for the limited use by ICQ of the ICQ IP Telephony Software in source code form (the "Source Code") solely for the purposes of undertaking any activity which N2P is obligated to perform or undertake hereunder and fails to perform or undertake as required hereunder. The Source Code Escrow Agreement shall provide that ICQ shall be entitled to a copy of the Source Code only upon the occurrence of all of the following three (3) events (collectively, the "Release Conditions"): (i) N2P's material breach of its material obligations hereunder to provide, maintain or support the ICQ IP Telephony Software, which breach materially adversely affects the ICQ IP Telephony Services; (ii) ICQ's written notice to N2P detailing such material breach; and (iii) N2P fails to cure such material breach within ninety (90) days of receipt of such notice. The license will not include any right to sublicense, transfer, assign, disclose or distribute the Source Code to any third party without N2P's prior written consent, and the Source Code Escrow Agreement will contain provisions, reflective of the sensitivity of the Source Code, to preclude the unauthorized use or disclosure of the Source Code or information derived therefrom. Promptly after execution of this Agreement, and in any event within thirty (30) days, N2P and ICQ shall negotiate and enter into the Source Code Escrow Agreement with Data Securities International or another escrow holder acceptable to each Party. The Source Code Escrow Agreement will contain provisions for N2P to provide ICQ with reasonable assistance in understanding and using the Source Code upon occurrence of the Release Conditions. 10.2.2 Limited Source Code License. To the extent reasonably --------------------------- necessary for ICQ to modify, develop, add, delete or use any functionality or features of the ICQ IP Telephony Services in connection with the development of any Additional ICQ Modifications pursuant to Section 2.3.4, N2P shall provide to ICQ APIs to the ICQ IP Telephony Software so that such Additional Modifications (whether developed by N2P, ICQ or any third party) can interoperate with (including use of the principal functions of) the ICQ IP Telephony Software; provided, however, that, to the extent that such APIs are -------- ------- insufficient to enable such interoperability, N2P shall either (i) modify, as promptly as commercially practicable, the APIs (at no cost to ICQ), the ICQ IP Telephony Software or the Additional Modifications to enable such interoperability, or (ii) in the event that (a) N2P does not perform the work described in clause (i) of this Section 10.2.2 as promptly as commercially practicable or (b) elects not to perform such work, provide to ICQ portions of the Source Code for the ICQ IP Telephony Software (and grant a license) necessary to permit ICQ to modify the APIs or ICQ IP Telephony Software to enable such interoperability. If N2P elects to do the modifications, it shall make the modifications as promptly as is commercially reasonable. ICQ's use of the Source Code pursuant to this Section 10.2.2 will not include any right to sublicense, transfer, assign, disclose or distribute the Source Code to any third party without N2P's prior written consent, and will be subject to mutually agreed provisions, reflective of the sensitivity of the Source Code, to preclude the unauthorized use or disclosure of the Source Code or information derived therefrom. 10.2.3 Limits on Use. ICQ's use of the Source Code shall not ------------- exceed the narrow purpose set forth in Section 10.2.1 or Section 10.2.2. 10.3 Trademark License. Subject to the terms and conditions of this ----------------- Agreement, N2P will be entitled to use the following trade names, trademarks, and service marks of ICQ: the "ICQ(TM)" trademark and service mark and other trademarks and service marks relating specifically to one or more of the ICQ IP Telephony Services, provided that ICQ has approved in writing the use of each such other trademarks or service marks (collectively, 25 CONFIDENTIAL EXECUTION VERSION the "ICQ Marks"). Subject to the terms and conditions of this Agreement, ICQ will be entitled to use the trademarks and service marks of N2P set forth on Exhibit J hereto and other trademarks and service marks relating specifically to one or more of the N2P IP Telephony Services, provided that N2P has approved in writing the use of such other trademarks or service marks (collectively, the "N2P Marks") (collectively, together with the ICQ Marks, the "Marks"); provided that: (i) each Party does not create a unitary composite mark -------- involving a Mark of the other Party without the prior written approval of such other Party; (ii) each Party displays symbols and notices clearly and sufficiently indicating the trademark status and ownership of the other Party's Marks in accordance with applicable trademark law and practice; and (iii) all such uses of the other Party's Marks shall be subject to the quality standards set forth in Section 10.5 of this Agreement, and the granting Party's prior written approval. 10.4 Ownership of Trademarks. Each Party acknowledges the ownership ----------------------- right of the other Party in the Marks of the other Party and agrees that all use of the other Party's Marks will inure to the benefit, and be on behalf, of the other Party. Each Party acknowledges that its utilization of the other Party's Marks will not create in it, nor will it represent it has, any right, title, or interest in or to such Marks other than the licenses expressly granted herein. Each Party agrees not to do anything contesting or impairing the rights of the other Party in such other Party's Marks. 10.5 Quality Standards. Each Party agrees that the nature and quality ----------------- of its products and services supplied in connection with the other Party's Marks will conform to quality standards set by the other Party. Each Party agrees to supply the other Party, upon request, with a reasonable number of samples of any materials publicly disseminated by such Party which utilize the other Party's Marks. Each Party will comply with all applicable laws, regulations, and customs and obtain any required government approvals pertaining to use of the other Party's Marks. 10.6 Infringement Proceedings. ------------------------ 10.6.1 Notification. Each Party agrees to promptly notify the ------------ other Party of any third party's unauthorized use of the other Party's Marks or other intellectual property rights (including, without limitation, those set forth in Section 12) of which it has actual knowledge. Each Party will have the sole right and discretion to bring proceedings alleging infringement of its Marks and other intellectual property rights; provided, however, that each Party -------- ------- agrees to provide the other Party with its reasonable cooperation and assistance with respect to any such infringement proceedings. 10.6.2 Infringement Claims. In addition to the remedies set ------------------- forth in Sections 16.2 and 16.7 of this Agreement, in the event that during the Initial Term, one (1) or more infringement actions, claims or proceedings are brought against either Party concerning (i) the ICQ IP Telephony Services, the ICQ IP Telephony Software (or any portion thereof) or (ii) the use of the N2P marks (each an "Infringement Claim" and collectively, "Infringement Claims") and such Infringement Claim or Infringement Claims result(s) in the issuance of a preliminary or permanent injunction prohibiting the promotion, distribution or use of two (2) or more of the Core Premium Services during the Initial Term, and which last (with respect to each such service) thirty (30) days following the issuance thereof, ICQ shall have the following rights and remedies with respect to N2P: (a) ICQ may immediately terminate its exclusivity obligations with respect to such preliminarily or permanently enjoined Core Premium Services upon delivery of notice to N2P; and 26 CONFIDENTIAL EXECUTION VERSION (b) ICQ shall be entitled to immediately terminate this Agreement in the event that (a) an injunction or injunctions (whether preliminary or permanent) is or are issued with respect to any Core Premium Service or Core Premium Services, and (b) any such injunction or injunctions lasts or last, in the aggregate, for a period of one hundred eighty (180) days. 11. PUBLICITY --------- 11.1 Press Releases. After execution of this Agreement, N2P may issue an -------------- initial press release, with terms to be mutually agreed by the Parties, regarding this Agreement and the relationship between the Parties established hereby. Prior to (i) the launch of the PTP Calling Card Service and (ii) the launch of the 2000a ICQ Client, N2P may issue an additional press release, with terms to be mutually agreed by the Parties in advance. The Parties will mutually agree on the appropriate timing of each such release and any other public announcement of the relationship. Each Party agrees that it shall not issue any other press release or make any public announcement regarding this Agreement, including ICQ or the ICQ IP Telephony Services, without the prior written consent of the other Party; provided, however, that each Party shall be permitted, without the -------- ------- other Party's prior consent, merely to list the other Party's as one of its industry partners and to repeat factual information or statements contained in any mutually agreed-upon press release. 11.2 Statements to Third Parties. Neither Party shall make, publish, or --------------------------- otherwise communicate, or cause to be made, published, or otherwise communicated, any deleterious remarks whatsoever to any third parties concerning the other Party or its affiliates, directors, officers, employees or agents, including without limitation, the other Party's products, services, business projects, business capabilities, performance of duties and services or financial position. 12. OWNERSHIP --------- 12.1 ICQ Properties. As between the Parties, ICQ owns all copyrights, -------------- patents, trade secrets, trademarks, trade name rights, other intellectual property rights, and all other right, title and interest, in and to (i) the components of the ICQ Client and the ICQ Service, and any Updates thereto, including, but not limited to the ICQ GUI, that (in each case) are developed or supplied by ICQ and (ii) the Commissioned Works (but excluding the Joint Work Product), subject to the rights expressly granted to N2P as set forth in this Agreement. Without limiting the generality of the foregoing, all right, title and interest in and to all servers and server-based technology related to the ICQ Service developed or supplied by ICQ (including, without limitation, protocols, parameters, designs, specifications and user identification algorithms and technology underlying such algorithms) shall be owned by ICQ. 12.2 N2P Properties. As between the Parties, N2P owns all copyrights, -------------- patents, trade secrets, trademarks, trade name rights, other intellectual property rights, and all other right, title and interest, in and to the N2P System, the N2P Services (including, but not limited to, the elements of graphics, design, organization, presentation, layout, navigation and stylistic convention (including the digital implementations thereof) of the graphical user interface generally associated with online areas contained within the N2P System and the N2P Services), the N2P IP Telephony Software, the ICQ IP Telephony Software and the ICQ IP Telephony Services (including, in each case, Updates thereto) that (in each case) are developed or supplied by N2P (but excluding the ICQ GUI, the Joint Work Product and the Commissioned Works), subject to the rights expressly granted to ICQ as set forth in this Agreement. Without limiting the generality of the foregoing, all right, title 27 CONFIDENTIAL EXECUTION VERSION and interest in and to all servers and server-based technology related to the N2P System and the N2P Services developed or supplied by N2P, including, without limitation, protocols, parameters, designs, specifications and user identification algorithms and technology underlying such algorithms, shall be owned by N2P. 12.3 Co-Development. Any works, including without limitation, software or -------------- other copyrightable materials, as to which both Parties (or their employees, contractors or agents) are joint authors, and any patents as to which both Parties (or their employees, contractors, or agents) are co-inventors (collectively, the "Joint Work Product") shall be jointly owned by the Parties (with each Party having the right to use and exploit, or authorize the use or exploitation by others of such Joint Work Product, provided that such use or exploitation is not in breach of this Agreement), without an obligation to obtain the consent of, or to account to, the other Party and subject to N2P's and ICQ's respective proprietary rights in any underlying software, works, or technology to the extent incorporated or included in such Joint Work Product. Notwithstanding the foregoing, to the extent that with respect to any co-developed works created under this Agreement, the Parties shall not constitute co-authors or co-inventors, and N2P owns such works or inventions as a matter of law, any and all such works or inventions shall be deemed included in the license set forth in Section 10.1, and ICQ shall be deemed by this reference to have a fully paid-up, royalty-free, non-exclusive, non-transferable and worldwide license for the Term to use, reproduce, distribute (directly and indirectly), transmit, display, perform, sublicense and adapt such works as set forth in Section 10.1 of this Agreement. Each Party shall cooperate with the other Party in documenting and perfecting all rights with respect to the Joint Work Product, including executing any necessary assignments, applications or other documentation with respect to the Joint Work Product. 13. CONFIDENTIAL INFORMATION ------------------------ Each Party acknowledges that Confidential Information may be disclosed to the other Party during the course of this Agreement. Each Party agrees that it will take reasonable steps, at least substantially equivalent to the steps it takes to protect its own proprietary information (and, in no event, with less than the exercise of reasonable care), during the Term, and for a period of three (3) years following expiration or termination of this Agreement, to prevent the duplication or disclosure of Confidential Information of the other Party, other than by or to its employees or agents who must have access to such Confidential Information to perform such Party's obligations hereunder, each of whom shall agree to comply with this Section. Notwithstanding the foregoing, either Party may disclose Confidential Information without the consent of the other Party, to the extent such disclosure is required by law, rule, regulation or government or court order. In such event, the disclosing Party will provide at least five (5) business days' prior written notice of such proposed disclosure to the other Party. Furthermore, in the event that such disclosure is required of either Party under the laws, rules or regulations of the Securities and Exchange Commission or any other applicable governing body, such Party will (i) redact portions of this Agreement (as reasonably agreed to by both Parties) to the fullest extent permitted under applicable laws, rules and regulations and (ii) submit a request to such governing body that such portions and other provisions of this Agreement receive confidential treatment under the laws, rules and regulations of the governing body or otherwise be held in the strictest confidence to the fullest extent permitted under such laws, rules and regulations. 14. REPRESENTATIONS AND WARRANTIES; INDEMNITIES ------------------------------------------- 14.1 Joint. Each Party represents and warrants to the other Party that: ----- (i) such Party has the full corporate right, power and authority to enter into this Agreement, to grant the licenses 28 EXECUTION VERSION granted hereunder and to perform the acts required of it hereunder; (ii) the execution of this Agreement by such Party, and the performance by such Party of its obligations and duties hereunder, do not and shall not violate any agreement to which such Party is a party or by which it is otherwise bound or any applicable law; (iii) when executed and delivered by such Party, this Agreement shall constitute the legal, valid and binding obligation of such Party, enforceable against such Party in accordance with its terms; and (iv) to the best of its knowledge after due inquiry, the N2P Indemnified Properties (in the case of N2P) and the ICQ Indemnified Properties (in the case of ICQ) do not infringe, misappropriate or violate any patents, copyrights, trade secrets, trademarks or other proprietary rights of any third parties. Additionally, N2P hereby represents, to the best of its knowledge and after due inquiry, that it possesses (and warrants that it will obtain during the Term) all authorizations, approvals, consents, licenses, permits, certificates and all other rights and permissions necessary for it to (a) perform under this Agreement or (b) to offer the ICQ IP Telephony Software and the ICQ IP Telephony Services hereunder (including, without limitation, the N2P Services and N2P IP Telephony Software offered as part thereof). 14.2 Intellectual Property Indemnity. Each Party (the "IP Indemnifying ------------------------------- Party") shall, at its sole cost and expense, indemnify, hold harmless and defend the other Party, and such other Party's officers, directors, agents, affiliates, distributors, franchisees and employees (the "IP Indemnified Party"), from any and all claims, demands, liabilities, costs or expenses of third parties (including, without limitation, reasonable attorney's fees) (collectively, the "Liabilities") arising from or in connection with a third-party claim that the N2P Indemnified Properties (in the case of N2P) or the ICQ Indemnified Properties (in the case of ICQ) infringes upon any patents, copyrights, trade secrets, trademarks or other proprietary rights of such third party. The IP Indemnifying Party shall pay any damages (including costs and attorneys' fees) finally awarded against the IP Indemnified Party by a court of competent jurisdiction as a result of such claim (or pay any settlement of such claim agreed to by the IP Indemnifying Party). The foregoing obligation of the Indemnifying Party shall not apply to any such claim to the extent that it is based on or arises out of services, software, materials or rights specifically granted pursuant to this Agreement by the IP Indemnified Party. The IP Indemnified Party shall promptly notify the IP Indemnifying Party in writing of any indemnifiable claim after the IP Indemnified Party first learns of such claim, and shall provide the Indemnifying Party with such assistance and cooperation as the IP Indemnifying Party may reasonably request from time to time in connection with the defense or settlement thereof. The IP Indemnified Party shall have the right to employ separate counsel and to participate in the defense of any such claim at its own expense. If any settlement requires a material affirmative obligation of, results in any material ongoing liability to, or prejudices or detrimentally impacts in any material way, the IP Indemnified Party, then such settlement shall require the IP Indemnified Party's written consent, which shall not be unreasonably withheld. If the IP Indemnified Party is enjoined or restrained from exercising any of its rights under this Agreement as a result of an infringement claim, or if any such claim is brought or threatened, the IP Indemnifying Party shall have the right, at its option, to (i) obtain a license at no cost to the IP Indemnified Party permitting continued use of the software or other materials that are the subject of such claim on terms and conditions consistent with the rights granted to the IP Indemnified Party hereunder, (ii) modify the software or other materials that are the subject of such claim to perform their intended function without infringing third party rights and without materially affecting the functionality or performance of such software or other materials, (iii) substitute software or other materials that are the subject of such claim with items of comparable functionality and performance, or (iv) if none of the foregoing is reasonably practicable, terminate this Agreement. 29 CONFIDENTIAL EXECUTION VERSION 14.3 Indemnity. Each Party (the "Indemnifying Party") shall, at its --------- sole cost and expense, indemnify, hold harmless and defend the other Party, and its officers, directors, agents, affiliates, distributors, franchisees and employees (the "Indemnified Party"), from any and all Liabilities arising from or in connection with a third-party claim based upon the Indemnifying Party's material breach of any duty, representation or warranty contained in this Agreement, and shall pay any damages (including costs and attorneys' fees) finally awarded against the Indemnified Party by a court of competent jurisdiction as a result of such claim (or pay any settlement of such claim agreed to by the Indemnifying Party). The foregoing obligation of the Indemnifying Party shall not apply to any such claim to the extent that it is based on or results from services, software, materials, information or rights provided by the Indemnified Party. The Indemnified Party shall promptly notify the Indemnifying Party in writing of any indemnifiable claim after the Indemnified Party first learns of such claim, and shall provide the Indemnifying Party with such assistance and cooperation as the Indemnifying Party may reasonably request from time to time in connection with the defense or settlement thereof. The Indemnified Party shall have the right to employ separate counsel and to participate in the defense of any such claim at its own expense. If any settlement requires a material affirmative obligation of, results in any material ongoing liability to, or prejudices or detrimentally impacts the Indemnified Party in any material way, then such settlement shall require the Indemnified Party's written consent, which shall not be unreasonably withheld. 15. LIMITATION ON LIABILITY; DISCLAIMER ----------------------------------- 15.1 Liability. UNDER NO CIRCUMSTANCES WILL EITHER PARTY BE LIABLE TO THE --------- OTHER PARTY FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR EXEMPLARY DAMAGES (EVEN IF THAT PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES), ARISING FROM BREACH OF OR OTHERWISE RELATING TO THIS AGREEMENT OR THE SUBJECT MATTER HEREOF, INCLUDING, WITHOUT LIMITATION, THE SALE OF PRODUCTS, THE USE OR INABILITY TO USE THE ICQ SERVICE, THE ICQ CLIENT, THE ICQ IP TELEPHONY SERVICE, THE SUPPORT AREA, THE ICQ IP TELEPHONY SOFTWARE, THE N2P SYSTEM, OR THE N2P IP TELEPHONY SOFTWARE, INCLUDING, BUT NOT LIMITED TO, LOSS OF REVENUE OR ANTICIPATED PROFITS OR LOST BUSINESS (COLLECTIVELY, "DISCLAIMED DAMAGES"); PROVIDED THAT EACH PARTY WILL REMAIN LIABLE TO THE OTHER PARTY TO THE EXTENT ANY DISCLAIMED DAMAGES ARE PAYABLE TO A THIRD PARTY AND ARE SUBJECT TO INDEMNIFICATION PURSUANT TO SECTION 14.2 OR 14.3. EXCEPT FOR SUCH LIABILITY UNDER SECTIONS 14.2 AND 14.3, (I) LIABILITY ARISING UNDER THIS AGREEMENT WILL BE LIMITED TO DIRECT, OBJECTIVELY MEASURABLE DAMAGES, AND (II) THE MAXIMUM LIABILITY OF ONE PARTY TO THE OTHER FOR ANY CLAIMS ARISING IN CONNECTION WITH THIS AGREEMENT WILL NOT EXCEED (EXCLUSIVE OF AMOUNTS ALREADY PAID BY EITHER PARTY TO THE OTHER PARTY HEREUNDER) SEVEN MILLION FIVE HUNDRED THOUSAND DOLLARS ($7,500,000); PROVIDED THAT EACH PARTY WILL REMAIN LIABLE FOR THE AGGREGATE AMOUNT OF ANY PAYMENT OBLIGATIONS DUE AND PAYABLE TO THE OTHER PARTY PURSUANT TO THE AGREEMENT. 15.2 No Additional Warranties. EXCEPT AS EXPRESSLY SET FORTH IN THIS ------------------------ AGREEMENT, NEITHER PARTY MAKES, AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS, ANY REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED, INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE AND IMPLIED WARRANTIES ARISING FROM COURSE OF DEALING OR COURSE OF PERFORMANCE. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, EACH PARTY SPECIFICALLY DISCLAIMS ANY WARRANTY REGARDING THE 30 CONFIDENTIAL EXECUTION VERSION REVENUE FROM OR SUCCESS OF THE ICQ IP TELEPHONY SERVICES. 16. TERM AND TERMINATION -------------------- 16.1 Term. ---- 16.1.1 Initial Term. Unless earlier terminated as set forth ------------ herein, the initial term of this Agreement (the "Initial Term") shall be four (4) years from the Effective Date. 16.1.2 Extension Periods. Upon the expiration of the Initial ----------------- Term, ICQ may elect, in its sole discretion, to extend the term of this Agreement for two additional periods of one (1) year each (each, an "Extension Period"), up to an aggregate maximum of two (2) years (the Initial Term, together with any Extension Periods, collectively referred to herein as the "Term"). ICQ shall be deemed to have exercised its option for any Extension Period unless, at least thirty (30) days prior to the expiration of the Initial Term (or, as to the second Extension Period, at least thirty (30) days prior to the end of the first Extension Period), ICQ provides written notice to N2P that ICQ does not wish to exercise its option for the forthcoming Extension Period. During any Extension Period, the obligations of the Parties with respect to exclusivity, development, promotions and performance shall not apply. Without limitation of the generality of the foregoing, during any Extension Period, (i) the Parties will not be subject to the obligations of Sections 2.3, 2.4, 2.8, 2.9, 3, 4, 7.1, 7.5, 7.11, 9, 10.2 and 16.6 of this Agreement; (ii) N2P shall not be required to pay ICQ any guaranteed fixed payments; and (iii) N2P shall continue to pay ICQ the Revenue Share set forth in Exhibit H hereto with respect to all Transaction Revenues generated during the Extension Period and ICQ shall continue to pay to N2P the Advertising Revenue Share set forth in Section 7.2.2 of this Agreement. In addition, N2P reserves the right during any Extension Period to cease providing particular ICQ IP Telephony Services in particular countries, provided that it may not cease providing the ICQ IP -------- Telephony Services in the top fifty percent (50%) of Collective International Gateways, based on the respective amount of Transaction Revenues generated in or from each such Collective International Gateway during the Initial Term. 16.2 Termination for Breach. Except as expressly provided elsewhere in ---------------------- this Agreement, either Party may terminate this Agreement at any time in the event of a material breach of the Agreement by the other Party which remains uncured after thirty (30) days written notice thereof to the other Party (or such other period as may be expressly specified elsewhere in this Agreement); provided that the cure period with -------- respect to any scheduled payment shall be thirty (30) days following receipt by the Party owing such payment of written notice of the failure to make such payment. For avoidance of doubt, the Parties acknowledge that, if a particular provision of this Agreement includes a right to terminate this Agreement due to breach of such provision after a cure period set forth in such provision, only such other cure period shall apply, and the thirty (30) day cure period set forth in this Section 16.2 shall not be in addition to such other cure period. 16.3 Termination on Change of Control. Promptly upon undergoing any Change -------------------------------- of Control, each Party shall provide the other Party with written notice thereof. In the event of (i) a Change of Control of N2P resulting in Control of N2P by an ICQ Competitor or AOL Competitor or (ii) in the event that N2P is (at the time of such Change of Control) Controlled by the Parent Company, any Change of Control of the Parent Company resulting in Control of the Parent Company by any ICQ Competitor or AOL Competitor, ICQ shall have the right to terminate this Agreement by providing thirty (30) days' prior 31 CONDFIDENTIAL EXECUTION VERSION written notice of such intent to terminate. In the event of (i) a Change of Control of ICQ resulting in Control of ICQ by an N2P Competitor or Parent Company Competitor or (ii) if ICQ is (at the time of such Change of Control) Controlled by AOL, any Change of Control of AOL resulting in Control of AOL by any N2P Competitor or Parent Company Competitor, N2P may terminate this Agreement by providing thirty (30) days' prior written notice of such intent to terminate. Notwithstanding anything to the contrary, each Party's termination right under this Section 16.3 shall be exercised no later than thirty (30) days following such Party's receipt of written notice of the Change of Control triggering such termination right, and shall expire if not exercised within such thirty (30) day period. 16.3.1 ICQ Buyout Right. Notwithstanding the provisions of the ---------------- Section 16.3, if during the Initial Term, AOL or ICQ is acquired by or acquires a telecommunications company with a market capitalization in excess of the Buyout Threshold, ICQ shall have the right to terminate this Agreement by providing thirty (30) days prior written notice to N2P and ICQ shall refund to N2P an amount equal to the product of the pro rata portion (based on a four (4) year term) of any guaranteed --- ---- payments made by N2P prior to the date of such early termination multiplied by three (3) (e.g., if such termination occurs on the two (2) year anniversary of the Effective Date, and N2P has paid ICQ Seven Million Five Hundred Thousand Dollars (US$7,500,000) in guaranteed payments as required by the terms of this Agreement, ICQ shall refund to N2P fifty percent (50%) of such guaranteed payments multiplied by three (3), or Eleven Million Two Hundred Fifty Thousand ($11,250,000) Dollars ($****)). 16.4 Termination for Bankruptcy/Insolvency. Either Party may terminate ------------------------------------- this Agreement immediately following written notice to the other party if the other party (i) ceases to do business in the normal course, (ii) becomes or is declared insolvent or bankrupt, (iii) is the subject of any proceeding related to its liquidation or insolvency (whether voluntary or involuntary) which is not dismissed within ninety (90) calendar days or (iv) makes an assignment for the benefit of creditors. 16.5 Termination for Regulated Entity Event. -------------------------------------- 16.5.1 United States. The Parties acknowledge that in ------------- undertaking the obligations set forth herein, ICQ is not offering services as a reseller of telecommunications services or as a provider of telecommunications services. It is understood and agreed that if, during the Term, the Federal Communications Commission or any other relevant United States federal regulatory body issues (or is reasonably likely to issue) a ruling that subjects (or is reasonably likely to subject, as the case may be) ICQ to regulation as a reseller or provider of telecommunications services (or similar regulation) (collectively, a "Regulated Entity Event"), the Parties agree to work together in good faith to amend this Agreement to ensure that ICQ can secure the benefit of the bargain under this Agreement without being subject to telecommunications related regulation in the United States as a telecommunications reseller or provider (or similar status). If the Parties are unable to agree upon such amendments within ninety (90) days of ICQ's notification of the Regulatory Entity Event, ICQ may terminate this Agreement without liability by providing written notice of its intention to terminate. 16.5.2 International. In the event that during the Term any ------------- non-US regulatory body issues (or is reasonably likely to issue) a ruling that subjects (or is reasonably likely to subject, as the case may be) ICQ to a telecommunications or similar regulation that could prevent ICQ from obtaining the benefit of the bargain under this Agreement (e.g., regulation as a reseller or provider of telecommunications services (or similar status)), the Parties shall work together in good faith to amend this Agreement to ensure that ICQ can 32 CONFIDENTIAL EXECUTION VERSION secure the benefit of the bargain under this Agreement without being subject to telecommunications related or similar regulation in such country. If the Parties are unable to agree upon such amendments within ninety (90) days of ICQ's notification of the regulatory event likely to cause ICQ to be subjected to any such regulation, ICQ may terminate this Agreement with respect to the country (or countries) in which such regulatory event applies without liability, upon delivery of written notice. 16.6 Termination for Non-Competitiveness. At any time following the one ----------------------------------- (1) year anniversary of the Effective Date, (i) ICQ shall have the right to terminate this Agreement, in the event that: (a) two (2) or more of the Core Premium Services do not satisfy the requirements of Section 3.1 of this Agreement; (b) two (2) or more of the Core Premium Services do not satisfy the requirements of Section 3.2 of this Agreement; (c) two (2) or more of the Core Premium Services are not Best of Breed as defined in Section 3.3(i) or Section 3.3(ii) of this Agreement (notwithstanding N2P's efforts to satisfy such standard); (d) N2P is not Best of Breed as defined in Section 3.3(iii) of this Agreement (notwithstanding N2P's efforts to satisfy such standard); or (e) N2P shall have missed the Cutoff Dates for two (2) or more Core Premium Services in accordance with and subject to Section 1.3 of this Agreement; unless (ii) N2P cures such failure within the applicable cure ------ periods set forth in Section 3.1 (in the case of clause (a) above), Section 3.2 (in the case of clause (b) above), Section 3.3 (in the case of clauses (c) and (d) above) or Section 1.3 and Exhibit I (in the case of clause (e) above), respectively. 16.7 ICQ IP Termination Right. At any time during the Term, in the event ------------------------ that any Infringement Claim(s) materially adversely affect the integration, distribution, promotion or offering of the ICQ IP Telephony Software or any ICQ IP Telephony Service, then ICQ shall have the right to terminate this Agreement upon thirty (30) days prior written notice to N2P, and without any refund to N2P (collectively, the "IP Termination Right"). 16.8 Termination for Strategic Relationship; Termination Fee. ------------------------------------------------------- If at any time after the two (2) year anniversary of the Effective Date, AOL enters into a broad-ranging, strategic relationship with (i) any major national or international telecommunications company (e.g., AT&T, Deutsche Telekom, MCIWorldcom, etc.), (ii) any Regional Bell Operating Company (RBOC) or (iii) any major wireless carrier (e.g. AT&T Wireless, Sprint PCS, Docomo, Voice Stream, Nextel, etc.) for the distribution of telecommunication services across substantially all of the properties of AOL and its Affiliates as in existence on the Effective Date (collectively, the "New Strategic Relationship"), then ICQ shall have the right to terminate this Agreement; provided, -------- however, that ICQ and AOL (as applicable) shall use commercially ------- reasonable efforts to have such company enter into an agreement with N2P to distribute or otherwise offer the Core Premium Services in connection with such New Strategic Relationship on terms and 33 CONFIDENTIAL EXECUTION VERSION conditions comparable to those contained herein (including those with respect to promotion, distribution, exclusivity for N2P and revenue share to N2P, but specifically excluding any warrants or similar rights). In the event of any such termination of this Agreement pursuant to this Section 16.8, ICQ shall pay N2P (as its sole and exclusive remedy), within ninety (90) days after the earlier of notice to N2P of the New Strategic Relationship or the public announcement by AOL of the New Strategic Relationship, a termination fee of Sixty Million dollars (US$60,000,000); provided, however, that (a) if, -------- ------- before the expiration of such ninety (90) day period, such company and N2P have entered into such an agreement to distribute or otherwise offer some but not all of the Core Premium Services in connection with such New Strategic Relationship, then ICQ shall instead pay N2P (as its sole and exclusive remedy) a termination fee equal to the pro rata share of such Sixty Million Dollars (US$60,000,000), based on the percentage of the aggregate Transaction Revenues to date represented by the Core Premium Service(s) that will not be distributed or otherwise offered by such company (i.e., the Core Premium Services of N2P that are not included in such agreement between such company and N2P) (e.g., in the event such company does not agree with N2P to distribute or otherwise offer the PC-to-PC Service and the PC-to-Phone Service in connection with such New Strategic Relationship, and the Transaction Revenues generated by such services represent seventy-five percent (75%) of the aggregate Transaction Revenues to date, then ICQ shall pay N2P Forty-Five Million dollars (US$45,000,000)); or (b) if, before the expiration of such ninety (90) day period, such company and N2P have entered into such an agreement to distribute or otherwise offer all of the Core Premium Services in connection with such New Strategic Relationship, then ICQ shall have no obligation to pay any such termination fee to N2P. The Parties acknowledge and agree that the payment contemplated by this Section 16.8 is solely a termination fee agreed to by the Parties, and shall not be used to determine any damages payable by either Party to the other Party hereunder, which shall be determined in accordance with the remainder of this Agreement (including, without limitation, Section 15.1 hereof) and applicable law. 16.9 Transition Assistance. In the event of any termination of this --------------------- Agreement other than pursuant to Sections 16.1, 16.4 or 16.5, each Party will provide to the other Party the dedicated, full-time services of one (1) qualified engineer for a period of ninety (90) days to assist the other Party in effecting an orderly termination of this Agreement, including minimizing disruption for customers of the ICQ IP Telephony Services. In the event of termination due to an ICQ material breach of this Agreement pursuant to Section 16.2, or a Change of Control of ICQ under Section 16.3, or the occurrence of a Regulated Entity Event under Section 16.5, ICQ shall pay N2P the actual, reasonable, fully-allocated costs incurred in connection with N2P's assistance in the migration or transition. In the event of termination due to a N2P material breach of this Agreement pursuant to Section 16.2, a Change of Control of N2P under Section 16.3, or the exercise by ICQ of its IP Termination Right under Section 16.7 of this Agreement, N2P shall pay for the actual, reasonable, fully-allocated costs incurred in connection with ICQ's assistance in the migration or transition. In the event of any other termination of this Agreement, each Party shall pay for its own costs and out-of-pocket expenses incurred in connection with such migration or transition. For the avoidance of doubt, such migration or transition assistance shall not include development obligations. At ICQ's request, at the end of the Initial Term, N2P shall use commercially reasonable efforts to transfer to ICQ the phone numbers and special access codes referred to in Section 5.2.1 of this Agreement unless such phone numbers are used for N2P Services other than the ICQ IP Telephony Services. 16.10 Transition Period. For a period of up to ninety (90) days following ----------------- the termination or expiration of this Agreement (the duration of which, up to ninety (90) days, shall be determined by ICQ and notified to N2P) (the "Transition Period"), the Parties shall cooperate to effect an orderly termination of this Agreement, including minimizing disruption for customers of the ICQ IP Telephony Services. During the Transition Period, each of ICQ and N2P shall have all of the rights and obligations set forth in this Agreement (including, without limitation, with respect to the ICQ IP Telephony Services) that they had prior to the date of termination or expiration (including, in the case of ICQ, all rights necessary to enable ICQ to transition the ICQ IP Telephony Services (other than PTP Calling Card Services) to another system without interruption of service). Notwithstanding the foregoing, during the Transition Period, N2P shall be entitled to Transaction Revenues to the same extent as before such termination or expiration, but the Parties shall not be subject to the obligations and criteria in this Agreement with respect to exclusivity, promotions, development, delivery, performance and Updates. During the Transition Period, N2P shall remain obligated to provide to ICQ the support services described in Section 6. Also, during the Transition Period, N2P shall provide ICQ with reasonable assistance in migrating or transitioning the ICQ IP Telephony 34 EXECUTION VERSION Services (other than PTP Calling Card Services) to another provider. Each Party shall be entitled to seek injunctive relief such as specific performance in the event the other Party fails to comply with its transition obligations under this Section 16.10; provided, -------- however, that, following any termination or expiration of this ------- Agreement, in the event either Party fails to comply with its transition obligations under this Section 16.10, the Parties shall attempt to resolve such failure to the satisfaction of both Parties through the Management Committee, and in the event that the Parties are unable to do so, ICQ shall be entitled to seek injunctive relief in accordance with this Section 16.10. Notwithstanding the foregoing, all end-user sublicenses of the ICQ IP Telephony Software shall survive the termination or expiration of this Agreement pursuant to the terms of such end user license agreement as provided herein. 16.11 Return of Information. Upon the expiration or termination of this --------------------- Agreement, each Party shall, upon the written request of the other Party, return or destroy (at the option of the party receiving the request) all Confidential Information of the other Party. 16.12 Survival. Notwithstanding anything to the contrary contained -------- herein, the provisions of Sections 7.1, 7.2, 7.3 and 7.6 (as to amounts accrued but unpaid), 7.7, 7.8, 7.9, 12, 13, 14, 15, 16.8, 16.9, 16.10, 16.11, 16.12, 17, 18.1, 18.3, 18.5 and 18.14 shall survive the termination, cancellation or expiration of this Agreement. In addition, all payment terms of this Agreement and any provision which, by its nature, must survive the expiration, termination or cancellation of this Agreement, shall survive the expiration, termination or cancellation of this Agreement. All licenses granted by either Party to the other pursuant to this Agreement shall terminate upon termination or expiration of this Agreement except as otherwise expressly set forth herein with respect to the Transition Period. 17. DISPUTE RESOLUTION ------------------ 17.1 Management Committee. The Parties will act in good faith and use -------------------- commercially reasonable efforts to promptly resolve any claim, dispute, controversy or disagreement between the Parties or any of their respective Affiliates, successors and assigns under or related to this Agreement (including, without limitation) any document executed pursuant to this Agreement or any of the transactions contemplated hereby or any rights or obligations hereunder (each, a "Dispute"). If the Parties cannot resolve any such Dispute within ten (10) business days, such Dispute will be submitted to the Management Committee for resolution. For ten (10) days following submission of the Dispute to the Management Committee, the Management Committee will have the exclusive right to resolve such Dispute; provided, -------- further, that the Management Committee will have the final and ------- exclusive right to resolve Disputes arising from any provision of the Agreement which expressly or implicitly provides for the Parties to reach mutual agreement as to certain terms. If the Management Committee is unable to amicably resolve the Dispute during the ten (10) day period, then such Dispute shall be subject to the resolution mechanisms described below. Neither Party shall seek, nor shall be entitled to seek, binding outside resolution of the Dispute unless and until the Parties have been unable amicably to resolve the Dispute as set forth in this Section 17.1 and then, only in compliance with the procedures set forth in this Section 17. For the avoidance of doubt, neither Party shall be required to submit any Dispute to the Management Committee or to arbitration prior to issuing any notice of suspension or termination under Sections 3, 4, 9 or 16 of this Agreement. In addition, the submission of any Dispute to the Management Committee or to arbitration hereunder shall not affect either Party's right to exercise any such suspension or termination right under this Agreement, except as otherwise determined, pursuant to a binding decision or order, by a court of competent jurisdiction (in accordance with Section 17.4 of this Agreement) or an arbitral panel (in accordance with Section 17.2 of this Agreement). 35 EXECUTION VERSION 17.2 Arbitration. ----------- 17.2.1 Arbitration. Any Dispute not resolved by amicable ----------- resolution as set forth in Section 17.1 shall be governed exclusively and finally by arbitration conducted by the American Arbitration Association ("AAA") in New York, New York in accordance with the Commercial Arbitration Rules ("Commercial Rules") of the AAA, including the AAA Supplementary procedures for Large Complex Commercial Disputes ("Complex Procedures"), as such rules shall be in effect on the date of delivery of a demand for arbitration ("Demand"), except to the extent that such rules are inconsistent with the provisions set forth herein. Notwithstanding the foregoing, the Parties may agree in good faith that the Complex Procedures shall not apply in order to promote the efficient arbitration of Disputes where the nature of the Dispute, including without limitation the amount in controversy, does not justify the application of such procedures. 17.2.2 Selection of Arbitrators. The arbitration panel shall ------------------------ consist of three (3) arbitrators. Each Party shall name one (1) arbitrator within ten (10) days after the delivery of the Demand, and the two Party-appointed arbitrators shall appoint the third arbitrator. The third arbitrator shall be a neutral participant, with no prior working relationship with either Party. If the two arbitrators are unable to select a third arbitrator within ten (10) days, a third neutral arbitrator shall be appointed by the AAA from the panel of commercial arbitrators of any of the AAA Large and Complex Resolution Programs. 17.2.3 Arbitral Rules. The Federal Arbitration Act, 9 U.S.C. -------------- Secs. 1-16, and not state law, shall govern the arbitrability of all Disputes. The arbitrators shall allow such discovery as is appropriate to the purposes of arbitration in accomplishing a fair, speedy and cost-effective resolution of the Disputes. The arbitrators shall reference the Federal Rules of Civil Procedure then in effect in setting the scope and timing of discovery. 17.2.4 Arbitration Awards. The arbitrators shall have the ------------------ authority to award compensatory damages only. Any award by the arbitrators shall be accompanied by a written opinion setting forth the findings of fact and conclusions of law relied upon in reaching the decision. The award rendered by the arbitrators shall be final, binding and non-appealable, and judgment upon such award may be entered by any court of competent jurisdiction. The Parties agree that the existence, conduct and content of any arbitration shall be kept confidential and no Party shall disclose to any person any information about such arbitration, except as may be required by law or by any governmental authority or for financial reporting purposes in each Party's financial statements. 17.2.5 Arbitration Expenses. Each Party shall pay the fees of -------------------- its own attorneys, expenses of witnesses and all other expenses and costs in connection with the presentation of such Party's case (collectively, "Attorneys' Fees"). The remaining costs of the arbitration, including without limitation, fees of the arbitrators, costs of records or transcripts and administrative fees (collectively, "Arbitration Costs") shall be borne equally by the Parties. Notwithstanding the foregoing, the arbitrators may modify the allocation of Arbitration Costs and award Attorneys' Fees in those cases where fairness dictates a different allocation of Arbitration Costs between the Parties and an award of Attorneys' Fees to the prevailing Party as determined by the arbitrators. 17.3 Governing Law. This Agreement shall be governed by and interpreted -------------- under the laws of the State of New York, without reference to New York's choice of law rules. 36 EXECUTION VERSION 17.4 Limited Interim Injunctive Relief; Consent to Jurisdiction. ---------------------------------------------------------- Notwithstanding the foregoing, the Parties hereby acknowledge and agree that the Parties may seek interim injunctive relief with respect to any Disputes arising under Sections 5.3, 10.3 and 13 of this Agreement. In connection with any such Disputes, each of ICQ and N2P: (i) irrevocably consents to the exclusive jurisdiction of any state or Federal court located in the Borough of Manhattan, City of New York, State of New York over any and all such interim injunctive relief; (ii) waives personal service of any and all process upon it in connection with such interim injunctive relief; (iii) consents that any such service of process in connection therewith shall be made by registered mail directed to ICQ or N2P (as the case may be), and that such service shall be deemed to have been completed on the date determined in accordance with Section 18.3 of this Agreement; and (iv) waives any objection based upon forum non conveniens and any objection ----- --- ---------- to venue in connection with any such interim injunctive relief. 18. GENERAL PROVISIONS ------------------ 18.1 Acknowledgment. ICQ AND N2P EACH ACKNOWLEDGE THAT THE PROVISIONS OF -------------- THIS AGREEMENT WERE NEGOTIATED TO REFLECT AN INFORMED, VOLUNTARY ALLOCATION BETWEEN THEM OF ALL RISKS (BOTH KNOWN AND UNKNOWN) ASSOCIATED WITH THE TRANSACTIONS CONTEMPLATED HEREUNDER. THE LIMITATIONS AND DISCLAIMERS RELATED TO WARRANTIES AND LIABILITY CONTAINED IN THIS AGREEMENT ARE INTENDED TO LIMIT THE CIRCUMSTANCES AND EXTENT OF LIABILITY. THE PROVISIONS OF THIS SECTION 18.1 SHALL BE ENFORCEABLE INDEPENDENT OF AND SEVERABLE FROM ANY OTHER ENFORCEABLE OR UNENFORCEABLE PROVISION OF THIS AGREEMENT. 18.2 Independent Contractors. The Parties to this Agreement are ----------------------- independent contractors. Neither Party is an agent, representative, or partner of the other Party. Neither Party shall have any right, power or authority to enter into any agreement for or on behalf of, or incur any obligation or liability of, or to otherwise bind, the other Party. This Agreement shall not be interpreted or construed to create an association, agency, joint venture or partnership between the parties or to impose any liability attributable to such a relationship upon either Party. 18.3 Notice. Any formal notice under this Agreement will be given in ------ writing and will be deemed to have been delivered and given for all purposes (i) on the delivery date if delivered by confirmed facsimile; (ii) on the delivery date if delivered personally to the Party to whom the same is directed; (iii) one (1) business day after deposit with a commercial overnight carrier, with written verification of receipt; or (iv) five (5) business days after the mailing date, whether or not actually received, if sent by U.S. mail, return receipt requested, postage and charges prepaid, or any other means of rapid mail delivery for which a receipt is available. To ICQ: To N2P: ICQ, Inc. Net2Phone Inc. 22000 AOL Way 171 Main Street Dulles, Virginia 20166 Hackensack, NJ 07601 Attention: Donn Davis Attention: Jonathan Reich Phone: (703) 265-2727 Phone: (201) 928-4438 Fax: (703) 265-1204 Fax: (201) 928-2970 E-mail: DonnDavis@aol.com E-mail: jreich@net2phone.com In the case of ICQ, such notice also will be provided to both the Senior Vice President for 37 EXECUTION VERSION Business Affairs (fax no. 703-265-1206 and the Deputy General Counsel (fax no. 703-265-1105), each at the address set forth above. In the case of N2P, such notice also will be provided to the General Counsel at the address and fax number set forth above. 18.4 No Waiver. The failure of either Party to insist upon or enforce strict performance by the other Party of any provision of this Agreement or to exercise any right under this Agreement shall not be construed as a waiver or relinquishment to any extent of such Party's right to assert or rely upon any such provision or right in that or any other instance; rather, the same shall be and remain in full force and effect. 18.5 Entire Agreement. This Agreement sets forth the entire agreement, and supersedes any and all prior and contemporaneous agreements of the Parties with respect to the transactions set forth herein. Neither Party shall be bound by, and each Party specifically objects to, any term, condition or other provision which is different from or in addition to the provisions of this Agreement (whether or not it would materially alter this Agreement) and which is proffered by the other Party in any correspondence or other document, unless the party to be bound thereby specifically agrees to such provision in writing. 18.6 Amendment. No change, amendment or modification of any provision of this Agreement will be valid unless set forth in a written instrument signed by each Party by an executive or officer authorized to bind such Party. 18.7 Assignment. Neither Party may assign any of its rights, interest or ---------- benefits or delegate any of its duties under this Agreement, or otherwise transfer this Agreement without the prior written consent of the other Party; provided that either party may assign this Agreement as part of a reincorporation, change of domicile or merger of a Party with or into, or sale of all or substantially all of the assets of a Party to another entity that is not a competitor of the non-assigning Party (i.e., an ICQ Competitor or AOL Competitor if ICQ is the non- assigning Party or an N2P Competitor or Parent Company Competitor if N2P is the non-assigning Party) if, in any such event, the assignee (and any successor entity) agrees to be bound by this Agreement to the same extent as the assigning Party. Subject to the foregoing, this Agreement shall be fully binding upon, inure to the benefit of and be enforceable by the Parties hereto and their respective successors and assigns. 18.8 Construction. In the event that any provision of this Agreement conflicts with the law under which this Agreement is to be construed or if any such provision is held invalid by a court with jurisdiction over the parties to this Agreement, (i) such provision shall be deemed to be restated to reflect as nearly as possible the original intentions of the Parties in accordance with applicable law, and (ii) the remaining terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect. 18.9 Export Controls. With respect to their activities under this Agreement, both Parties shall adhere to all applicable laws, regulations and rules relating to the export of technical data and shall not export or re-export any technical data, any products received from the other Party or the direct product of such technical data to any proscribed country listed in such applicable laws, regulations and rules unless properly authorized. 18.10 Headings. The captions and headings used in this Agreement are inserted for convenience only and shall not affect the meaning or interpretation of this Agreement. 18.11 Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same document. This Agreement may also be signed by facsimile transmission and any 38 EXECUTION VERSION signature sent or received via facsimile transmission shall constitute an original signature. 18.12 Force Majeure. N2P shall not be responsible for (any delays, errors, failures to perform, interruptions or disruptions caused by or resulting from any acts of God, strikes, lockouts, riots, acts of war, fire, power failure, earthquakes, severe weather, floods or other natural disaster or from any other unforeseeable events outside of N2P's reasonable control (not including any subcontractor of services provided by N2P hereunder) that prevents N2P from complying with any of its material obligations under this Agreement (each, a "Force Majeure Event"). The foregoing shall not relieve N2P from responsibility to the extent that reasonable actions or actions normally undertaken in the industry would have made such events within N2P's reasonable control or prevented any such delays, errors, failures, interruptions or disruptions. In addition, in no event will a Force Majeure Event permit any delay, error, failure, interruption or disruption for longer than a commercially reasonable time considering the event (or beyond any applicable cure period expressly set forth in this Agreement), and after such reasonable time period (or express cure period, as the case may be), the Force Majeure Event shall no longer be deemed to exist or apply. 18.13 Insurance. N2P, at its cost and expense, shall secure and maintain --------- adequate insurance coverage as is necessary for N2P to bear all of its obligations under this Agreement. Maintenance of such insurance shall not be deemed to relieve or limit N2P of any responsibility or obligation hereunder whatsoever. N2P assumes full and complete liability for all injuries to, or death of, any person or for any damages to property arising from its acts or omissions. N2P will add ICQ as an additional insured on all appropriate insurance policies, including all liability policies, with endorsements that require thirty (30) days notice of ICQ of any cancellation of such policies, and shall promptly provide ICQ with copies of such policies and endorsements and any changes thereto from time to time. N2P's insurance shall be primary as to any other insurance ICQ may have. 18.14 Remedies. Except where otherwise specified, the rights and remedies -------- granted to a Party under this Agreement are cumulative and in addition to, and not in lieu of, any other rights or remedies which the Party may possess at law or in equity; provided that, in connection with any -------- dispute hereunder, neither Party will be entitled to offset any amounts that it claims to be due and payable from the other Party against amounts otherwise payable by such Party to the other Party. 18.15 Disclaimers. Each ICQ IP Telephony Service shall contain an ------------ appropriate disclaimer (the specific form and substance to be mutually agreed upon by the Parties). IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the date first above written. ICQ, INC. NET2PHONE INC. /s/ David M. Colburn /s/ Jonathan Reich By: _______________________________ By: __________________________________ Print Name: David M. Colburn Print Name: Jonathan Reich Title: Senior Vice President Title: Executive Vice President 39 EX-10.30 4 AMENDMENT TO EMPLOYMENT AGREEMENT EXHIBIT 10.30 AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT This Amendment No. 1 (the "Amendment") to the Employment Agreement (the "Agreement"), originally dated July 2, 1999, between Net2Phone, Inc., a Delaware corporation (the "Company"), and Jonathan Fram (the "Executive"), is made as of the 16th day of July 1999. WHEREAS, the Company and the Executive desire to amend the Agreement to eliminate the Loan (as defined in the Agreement) and in lieu thereof to issue additional options to purchase 100,000 shares to the Executive. NOW THEREFORE, in consideration of the mutual covenants and promises contained herein, the parties hereby agree as follows: 1. Section 4(d) of the Agreement is hereby deleted in its entirety and replaced with the following language: (d) ADDITIONAL OPTIONS The Company shall grant to the Executive additional options to purchase 100,000 shares (the "Additional Options") of Common Stock pursuant to the Company's 1999 Stock Option and Incentive Plan at an exercise price per share equal to the price per share to the public in the Company's proposed initial public offering of its Common Stock (the "IPO"). All of the Additional Options shall be immediately exercisable. The Additional Options also shall be subject to the last two sentences of Section 4(c) of the Agreement. 2. All other terms of the Agreement shall remain in full force and effect. 1 IN WITNESS WHEREOF, the undersigned have executed this Amendment No. 1 as of this 16th day of July, 1999. NET2PHONE, INC. By: /s/ Clifford M. Sobel ---------------------------- Name: Clifford M. Sobel Title: Chairman EXECUTIVE /s/ Jonathan Fram -------------------------------- Jonathan Fram 2 EX-23.1 5 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Selected Financial Data" and "Experts" and to the use of our report dated May 11, 1999 (except for Note 9, as to which the date is June 25, 1999), in Amendment No. 5 to the Registration Statement (Form S-1 No. 333-78713) and related Prospectus of Net2Phone, Inc. for the registration of shares of its common stock. /s/ Ernst & Young LLP New York, New York July 27, 1999 -----END PRIVACY-ENHANCED MESSAGE-----