-----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, FPsBdfqY7+EFt+c5/UtBlNI7CLNhCmn0h38ufN0NjTRIK4bVAIyX05aJYpzOFE94 dH7lDa28Yg8wROSGZHD8ag== 0001005150-98-000295.txt : 19980402 0001005150-98-000295.hdr.sgml : 19980402 ACCESSION NUMBER: 0001005150-98-000295 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TEL SAVE HOLDINGS INC CENTRAL INDEX KEY: 0000948545 STANDARD INDUSTRIAL CLASSIFICATION: RADIO TELEPHONE COMMUNICATIONS [4812] IRS NUMBER: 232827736 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26728 FILM NUMBER: 98584311 BUSINESS ADDRESS: STREET 1: 6805 ROUTE 202 CITY: NEW HOPE STATE: PA ZIP: 18938 BUSINESS PHONE: 2158621500 MAIL ADDRESS: STREET 1: 6805 RIYTE 202 CITY: NEW HOPE STATE: PA ZIP: 18938 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Year Ended December 31, 1997 Commission File No. 0 - 26728 TEL-SAVE HOLDINGS, INC. (Exact name of registrant as specified an its charter) DELAWARE 23-2827736 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 6805 ROUTE 202 NEW HOPE, PENNSYLVANIA 18938 (215) 862-1500 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- None Not applicable
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the registrant as of March 30, 1998 was approximately $895,030,756 based on the average of the high and low prices of the Common Stock on March 30, 1998 of $22.59 per share as reported on the Nasdaq National Market. As of March 30, 1998, the Registrant had outstanding 64,585,012 shares of its Common Stock, par value $.01 per share. TEL-SAVE HOLDINGS, INC. INDEX TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997
ITEM PAGE NO. NO. - ---- ---- PART I 1. BUSINESS.................................................................................................. 1 2. PROPERTIES............................................................................................... 16 3. LEGAL PROCEEDINGS........................................................................................ 16 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................................................... 17 PART II 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.................................... 19 6. SELECTED CONSOLIDATED FINANCIAL DATA..................................................................... 20 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................... 21 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................................. 26 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE................................... 42 PART III 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT....................................................... 42 11 EXECUTIVE COMPENSATION................................................................................... 42 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................................... 42 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................................... 42 PART IV 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.......................................... 43
i PART I ITEM 1. BUSINESS For the definition of certain terms used in this Form 10-K, see "Glossary." OVERVIEW Tel-Save Holdings, Inc. (the "Company") provides long distance services throughout the United States to small and medium-sized businesses, and to increasing numbers of residential customers as a result of the Company's recent online marketing efforts. The Company's long distance service offerings include outbound service, inbound toll-free 800 service, and dedicated private line services for data. Until 1997, the Company operated primarily as a switchless, nonfacilities-based reseller of AT&T long distance services to small and medium-sized businesses. By purchasing large usage volumes from AT&T pursuant to contract tariffs, the Company has been and continues to be able to procure substantial discounts and offer low cost, high quality long distance services to its customers at rates generally more favorable than those offered directly by AT&T. In order to reduce its dependence on AT&T contract tariffs and increase its growth opportunities, the Company has deployed its own nationwide telecommunications network, One Better Net ("OBN"). OBN features five Company-owned, AT&T (now Lucent Technologies, Inc., hereinafter "Lucent") manufactured 5ESS-2000 switches connected with AT&T digital transmission facilities. OBN's reduced cost structure allows the Company to offer rates competitive with those of non-AT&T resellers while continuing to provide the quality of AT&T (now Lucent) manufactured switches and AT&T-provided transmission facilities and billing services. OBN allows the Company to pursue the non-AT&T based switchless resale market, which represents the majority of the switchless resale long distance market. In February 1997, as part of its efforts to expand its business by taking advantage of online marketing, billing and customer service, the Company entered into a Telecommunications Marketing Agreement (the "AOL Agreement") with America Online, Inc. ("AOL"), under which the Company provides long distance telecommunications services marketed by AOL to the subscribers to AOL's online network. The Company's services were launched on the AOL online network on October 9, 1997 on a limited basis and the general public promotion of the service began at the end of 1997. The AOL Agreement has an initial term of three years and can be extended by AOL on an annual basis thereafter. The Company's strategy for expanding its business is principally to target new retail customers through the Company's online marketing, expanded services to be offered to the Company's online customer base, local service and dial around long distance service. The Company also intends to attract new partitions and support existing partitions, to grow through acquisitions and strategic partnerships and to expand into the college and university market. The Company will approach online customers through the AOL Agreement and similar opportunities, such as the Company's recently announced arrangement with CompuServe Interactive, Inc. ("CompuServe") pursuant to which the Company will provide long distance telecommunications services to be marketed by CompuServe to its online network subscribers. The Company intends to attract new partitions and support existing partitions by, among other things, continuing its current practice of offering advances to new partitions to enable such partitions to pay outstanding balances due to their existing long distance providers in order for such partitions to transfer their end users to the Company's service, and to existing partitions to support their marketing efforts. The Company regularly evaluates potential acquisition candidates and strategic partners with which the Company could achieve its expansion goals. The Company, with the recent completion of the acquisition of Compco, Inc. ("Compco"), intends to leverage the relationships that Compco has as a leading provider of communications software in the college and university marketplace by offering bundled communications services to the college and university market. The Company has also recently gained certification in many states to sell local services, although it does not yet offer such services. Although the Company expects to expand its business through these and other opportunities, in view of the intense competition in this industry and other contingencies, there can be no assurance that the Company will be able to expand its business. Tel-Save, Inc., the Company's predecessor ("Predecessor Corporation") and now its principal operating subsidiary, was incorporated in Pennsylvania in May 1989. The Company was incorporated in Delaware in June 1995. The address of the Company's principal executive offices is 6805 Route 202, New Hope, Pennsylvania 18938, and its telephone number is (215) 1 862-1500. Unless the context otherwise requires, the "Company" or "Tel-Save" includes the Predecessor Corporation and the Company's other subsidiaries. DEVELOPMENT OF THE COMPANY The Company was formed to capitalize on the Federal Communications Commission ("FCC") mandate allowing the resale of AT&T services. The Company initially marketed AT&T's multi-location calling plan ("MLCP"), which provided incremental discounts earned by inclusion of the usage volume of diverse end user locations under a single service plan. The Company was successful in marketing MLCP, but realized that there were significant barriers to growth associated with the product, primarily the lack of reporting from AT&T, product inflexibility and the lack of control over end user accounts. In late 1989, the Company successfully obtained an additional AT&T service plan developed by AT&T and marketed as Software Defined Network Service ("SDN"), an AT&T product designed for larger business customers. SDN provided the Company with higher margins, network controls, advanced features and the ability to rebill its end users through AT&T and AT&T's College and University Systems ("ACUS"), thus enabling the Company to have more control over the end user account. As a result of SDN, the Company began to offer services on a wholesale basis through partitions. The Company thereby outsourced its marketing and end user service expenses to partitions, allowing it to focus on managing the AT&T relationship and to further develop its billing and information systems. In December 1992, the Company obtained the first contract tariff created by AT&T specifically for the Company. The contract tariff provided the Company with significant additional price advantages at stabilized rates and the ability to absorb the traffic of competitors' plans into the contract tariff. The Company subsequently obtained other contract tariffs, which also provide AT&T inbound 800 services and AT&T private line services, in order to diversify its service offerings. This in turn enabled the Company to increase the number of its partitions and end users. Prior to 1997, the Company operated primarily as a "switchless," nonfacilities-based reseller of AT&T long distance services. The Company offered, and continues to offer, its partitions and end users nationwide access to AT&T long distance network services through contract tariffs, including outbound long distance, 800 service and private line service. Outbound long distance service accommodates voice, data and video transmissions. The Company's 800 service is currently provided by reselling AT&T's 800 Service (Readyline, Megacom 800, etc.), which is AT&T's inbound, toll-free (recipient of the call pays the charges) long distance service. The Company's private line service is currently provided by reselling AT&T Private Line Service, which includes dedicated transmission lines connecting pairs of sites. The Company successfully established its position as a switchless reseller of AT&T long distance services as a result of its ability to negotiate with and obtain favorable contract tariffs from AT&T, manage and distribute data, bill accurately and provide partition support. Contract tariff subscriptions do not impose restrictions on the rates the Company may charge its partitions and end users. By purchasing large usage volumes from AT&T pursuant to such contract tariffs, the Company is able to procure substantial volume discounts and offer long distance services to its partitions and end users at rates generally more favorable than those offered directly by AT&T. With its information systems, the Company is able to manage and distribute to partitions information such as data about end user usage and payment history. In order to reduce its dependence on the AT&T contract tariffs and increase its growth opportunities, the Company developed its own network, OBN. Since 1996, the Company has deployed five 5ESS-2000 switches in Chicago, Dallas, Jacksonville, New York and San Francisco. As of March 30, 1998, the Company has provisioned approximately one million lines (representing approximately 71% of the total lines then using the Company's services) of the Company's end users) to OBN and most of the Company's new outbound lines are now being provisioned to OBN. OBN enables the Company to offer its end users and partitions more competitive rates than in the past and to improve customer provisioning, as well as to improve reporting to existing and new partitions. RECENT DEVELOPMENTS The Company believes that eventually it must either be, or become part of, a larger organization in order to succeed in the long term. To that end, the Company has been exploring the possibility of being acquired by larger entities that have expressed interest in the Company. The Company has previously disclosed that it has had discussions with potential suitors and that the Company has retained Salomon Smith Barney to advise the Company on any proposed acquisition of the Company. 2 There can be no assurance that any transaction will take place and no prediction can be made as to the price at which an acquisition of the Company, if any, may be consummated or whether any such transaction would be for cash or securities. Moreover, the Company has not made any determination to be acquired, and may remain independent. The Company does not plan to make any further public statements regarding the possible acquisition of the Company until it has reached a definitive agreement regarding such a transaction, or has determined not to continue to pursue such possibility. At the same time, the Company continues to seek and consider potential acquisitions and strategic partnerships. On February 3, 1998, the Company completed the acquisition of Symetrics Industries, Inc. ("Symetrics"), a Florida corporation, for approximately $25 million in cash, plus assumed liabilities. Symetrics designs, develops and manufactures electronic systems, system components and related software for defense-related products and for telecommunications applications. In the telecommunications field, Symetrics has developed hardware and software to make telephone switching more efficient for small telephone networks, such as in college dormitories and apartments. The equipment routes room-to-room calls itself and sends only billing information back to the service provider's switch, freeing space on the system to handle more calls. The Company intends to dispose of Symetrics' assets related to non-telecommunications businesses, although there can be no assurance that any such transaction will be consummated. The Company has announced that its Board has authorized the repurchase from time to time of up to eight million shares of its Common Stock. It is anticipated that the repurchased shares will be held in treasury for issuance upon exercise of outstanding options and warrants and upon conversion, if any, of convertible notes, and for other general corporate purposes. In connection with the AOL Agreement, the Company issued two warrants to AOL to purchase shares of the Company's Common Stock, including a warrant to purchase 5 million shares at an exercise price of $15.50 per share, which warrant became fully vested on February 22, 1998. AOL is exercising this warrant as to 1 million shares of Company Common Stock on a net issuance basis and the Company is repurchasing from AOL all of the 380,624 shares issued upon such net issuance exercise for $23 1/4 per share. In connection with such purchases, AOL agreed not to dispose of any shares of the Company's Common Stock acquired by AOL under any of these warrants until March 30, 1999. SALES AND MARKETING Online The Company launched a major new initiative for the marketing and provisioning of its telecommunication services online when, in February 1997, it entered into the AOL Agreement, under which the Company provides long distance telecommunications services that are marketed by AOL to the subscribers of AOL's online network. The AOL Agreement has an initial term of three years and can be extended by AOL on an annual basis thereafter. Under the AOL Agreement, the Company also has certain rights to offer, on a comparable basis, local and wireless telecommunications services when available. The Company's services, which include provision for online sign-up, call detail and reports and credit card payment, were launched on the AOL online network on October 9, 1997 on a limited basis, and general public promotion of the services began at the end of 1997. AOL subscribers who sign-up for the telecommunications services are customers of the Company, as the carrier providing such services. Under the AOL Agreement, AOL provides, each month over the term of the Agreement, certain minimum amounts of online advertising and promotion of the services and provides all of its subscribers with access to a dedicated Company service area online. Effective January 25, 1998, the Company and AOL entered into an amendment (the "AOL Amendment") to the AOL Agreement to provide for the acceleration of some of AOL's online advertising and promotion obligations under the AOL Agreement into a special promotional period (the "Special Promotional Period") during the latter part of the first quarter of 1998, as well as to provide for offline marketing through other media, such as directed mail promotions and print and radio promotions of the services, the costs of which would be borne by the Company. The Company made an initial payment of $100 million to AOL at the signing of the AOL Agreement and agreed to provide marketing payments to AOL based on a percentage of the Company's profits from the services (between 50% and 70% depending on the level of revenues from the services). The AOL Agreement provides that $43 million of the initial $100 million payment will be offset and recoverable by the Company through reduction of such profit-based marketing payments during the initial term of the AOL Agreement or, subject to certain monthly reductions of the amount thereof, directly by AOL upon certain earlier terminations of the AOL Agreement. The $57 million balance of the initial payment is solely recoverable by offset against a percentage of such profit-based marketing payments made after the first five years of the AOL Agreement (when extended beyond the initial term) and by offset against a percentage of AOL's share of the profits from the services after termination or expiration of the AOL Agreement. Any portion of the $43 million not previously repaid or reduced in amount would be added to the $57 million and would be recoverable similarly. Also under the AOL Agreement, the Company issued to AOL at signing two warrants to purchase shares of the Company Common Stock at a premium over the market value of such stock on the issuance date. One warrant is for 5 million shares, at an exercise price of $15.50 per share, one-half of which shares vested on October 9, 1997 when the Company's service was launched on the AOL online network in accordance with the AOL Agreement and the balance of which vested on February 22, 1998, the first anniversary of issuance. See "RECENT DEVELOPMENTS." The other warrant (the "Supplemental Warrant") is for up to 7 million shares, at an exercise price of $14.00 per share, which vest, commencing December 31, 1997, based on the number of subscribers to the services and would vest fully if there are at least 3.5 million such subscribers at any one time. The Company also agreed to issue to AOL an additional warrant to purchase 1 million shares of the Company Common Stock, at market value at the time of issuance, upon each of the first two annual 3 extensions by AOL of the term of the AOL Agreement, which warrants also will vest based on the number of subscribers to the services. Under the AOL Amendment, the Company agreed to pay to AOL an additional bonus fee for each new subscriber (up to an aggregate of 1,000,000 subscribers) to the Company's services under the AOL Agreement who subscribed during the Special Promotional Period or after this Period in response to AOL telemarketing efforts and to direct mail solicitations to AOL subscribers and who continued as a customer of the Company services for at least 30 days. Such bonus payments also would continue as to additional qualifying subscribers who subscribe in response to certain AOL telemarketing efforts. Under the AOL Amendment, the Company guaranteed, with respect to these bonus payments, that it would pay to AOL, as of April 3, 1998, an amount (the "Excess Amount") equal to $10 million reduced by the amount of bonus fees paid to AOL before such date and by an amount based on the number of shares of Company Common Stock that vested under the Supplemental Warrant during the Special Promotional Period. Any Excess Amount would be credited against, and solely recoverable from, any bonus fees subsequently payable to AOL. The Company also entered into a Telecommunications Marketing Agreement, dated as of February 6, 1998 (the "CompuServe Agreement"), with CompuServe, a wholly owned subsidiary of AOL, under which the Company will provide long distance telecommunications services to be marketed by CompuServe to all of the subscribers of CompuServe's online network in substantially the same manner as under the AOL Agreement. The CompuServe Agreement has an initial term of three years that can be extended by CompuServe on an annual basis thereafter and is also subject to earlier termination by CompuServe if the AOL Agreement shall have terminated upon payment of $10 million to the Company. As with the AOL Agreement, the Company also has certain rights under the CompuServe Agreement to offer, on a comparable basis, local and wireless telecommunications services when available. The Company anticipates that the services will be offered generally to CompuServe subscribers in the third quarter of 1998. Under the CompuServe Agreement, which is similar to the AOL Agreement, the Company services will include provision for online sign-up, call detail and reports and credit card payment. CompuServe will provide, each month over the term of the CompuServe Agreement, certain minimum amounts of online and offline advertising and promotion of the Company services and provide all of its subscribers with access to a dedicated Company service area online. CompuServe subscribers who sign up for the telecommunications services will be customers of the Company, as the carrier providing such services. The Company will provide marketing payments to CompuServe based on a percentage of the Company's profits from the services under the CompuServe Agreement (between 50% and 70% depending on the level of revenues from such services). Under the CompuServe Agreement, the Company made an initial payment of $3,500,000 as an advance against profit-sharing payments to be made to CompuServe; the Comapny will make an additional, non-refundable payment of $3,500,000 (the "Base Payment") on the date that the Company's services first are made generally available to substantially all of the CompuServe subscribers (but, generally, not later than November 1, 1998); and, 18 months after the date such services are first made generally available and if the CompuServe Agreement has not earlier terminated the Company will make a further advance (the "Midterm Advance") of an amount up to $7,000,000 and based on the then number of subscribers to the CompuServe service. The CompuServe Agreement provides that the initial $3.5 million advance and the Midterm Advance will be offset and recoverable by the Company through reduction of the profit-based marketing payments to be made to CompuServe during the initial term of the CompuServe Agreement or, subject to certain monthly reductions of the amount thereof, directly by CompuServe upon certain earlier terminations of the CompuServe Agreement. The Base Payment is generally not recoverable by the Company. Under the CompuServe Agreement, the Company also agreed to pay to CompuServe a $10 fee for each new subscriber to the Company's services under the CompuServe Agreement who subscribes within the first six months after the date that the Company's services first are made generally available to substantially all of the CompuServe subscribers and who continues as a subscriber for at least 60 days, which fees also are not recoverable by the Company. Under the terms of the AOL Amendment, subscribers to the Company services under the CompuServe Agreement will be counted as subscribers for purposes of vesting under the AOL Supplemental Warrant. In connection with the AOL Agreement, the Company and AOL jointly developed the online marketing and advertising for the services and the Company and CompuServe will jointly develop the marketing and advertising under the CompuServe Agreement. The Company provides online customer service as well as inbound calling customer service to the AOL member base in connection with the services and will do so for the Compuserve member base. Customer service representatives for these services are located in the Company's Clearwater, Florida facility. The Company anticipates that it will incur expenses for the promotion of the services under the AOL Agreement and for the start-up and development of the services contemplated in the CompuServe Agreement primarily during the first half of 1998, including expenses for the continued expansion of the Clearwater operation, for software programming and for software and hardware additions to the Company's network, OBN, to expand its capacity for the traffic. The profitability of the AOL and CompuServe Agreements for the Company depends on the Company's ability to continue to develop (and, in the case of CompuServe, to develop) and to maintain online ordering, call detail, billing and customer services for the AOL and CompuServe members, which will require, among other things, the ability to identify and employ sufficient personnel qualified to provide the necessary programming; the ability of the Company and AOL and CompuServe to work together effectively to 4 develop jointly the marketing contemplated by the AOL and CompuServe Agreements; a rapid response rate to online promotions to AOL's and CompuServe's online subscribers, most of whom are expected to be potential residential customers rather than business customers to which Tel-Save has marketed historically; and the Company's ability to expand OBN to accommodate increased traffic levels; and, in the case of CompuServe, CompuServe's ability to maintain its subscriber base in light of its recently completed acquisition by AOL. Since the $100 million initial payment under the AOL Agreement and up to $10.5 million of the payments that may be made by the Company under the CompuServe Agreement are recoverable only through the profits from the services under the respective Agreements, to the extent that the respective Agreement is unsuccessful, such respective amounts are subject to potential non-recovery or limited recovery by the Company. The Company currently estimates that between 2% and 6% of AOL's customers will need to sign up for the Company's long distance service in order for the Company to break even on its investment in the AOL Agreement. Partitions Prior to 1997, the Company primarily marketed its services to small and medium-sized business end users (i.e., generally businesses with fewer than 200 employees) throughout the United States through independent long distance and marketing companies known as "partitions." While the Company explored the use of direct marketing in 1997, it has determined (as described below) to continue to market its services to small and medium sized business end users primarily through partitions. Partitions resell and market the Company's products, allowing the Company to minimize its marketing and end user overhead. Partitions offer end users a variety of services and rates. As compensation for their services, partitions generally receive the difference between the amount received from end users and the amount charged by the Company to the partition for providing such services. The Company offers customer service to end users, including end users of certain partitions. Customer service representatives are located in the Company's facilities in Clearwater, Florida and New Hope, Pennsylvania. A substantial number of the Company's partitions have executed partition agreements with the Company pursuant to which the Company agrees to provide services utilizing the AT&T network service or OBN and to arrange for end user billing services at agreed upon prices or discounts. The Company requires that the partitions adhere to certain Company established guidelines in marketing the Company's services and comply with federal and state regulations. These requirements include certain representations by each organization that it is acting as an independent contractor with regard to the resale of the Company's services, and not as a joint venture partner, agent or employee of the Company, along with provisions for the proper completion of forms and other sales procedures. In addition, payments for long distance services made by end users are either paid directly into a lock-box controlled by the Company or are made to the end-user's local exchage carrier ("LEC"), which payments are then forwarded by a third-party billing company to the Company. The Company's partition agreements typically run for three years or for the term of the applicable tariffs, whichever is less. The partitions generally make no minimum use or revenue commitments to the Company under these agreements with respect to the resale of services. The agreements also are generally non-exclusive. If the Company were to lose access to services on the AT&T network or billing services or experience difficulties with OBN, the Company's agreements with partitions could be adversely affected. The Company intends to continue to promote increased marketing activities of certain of its partitions through advances collateralized by assets of such partitions. In return for providing such marketing advances, the Company seeks long-term arrangements with such partitions. In 1997, the Company entered into long term arrangements with several existing and new partitions. One partition, Group Long Distance, Inc., accounted for approximately 13% of the Company's sales in 1997; however, the Company does not expect that any partition will account for 10% or more of the Company's sales in 1998. In the event that any of the partitions, and particularly the partition specifically noted above, were to cease doing business with the Company, the financial condition or results of operations of the Company could be materially adversely affected. The Company believes that the discounts it offers partitions and end users using OBN, together with the functionality and quality of OBN and the accuracy of the billing services used, will enable it to continue to attract current and future partitions to OBN. The Company will continue its policy of advancing funds to most partitions to support their marketing efforts. Historically, partitions of the Company have continued to do business under their partition agreements following changes in the Company's service offerings. Current marketing practices, including the methods and means to convert a customer's long distance telephone service from one carrier to another, have recently been subject to increased regulatory review at both the federal and state levels. See "REGULATION". This increased regulatory review could affect the current business of existing partitions and also could affect possible future acquisitions of new business from new partitions or other resellers. Provisions in the Company's partition agreements mandate compliance by the partitions with applicable state and federal regulations. A partition's failure to comply with applicable state and federal regulations could have an adverse effect on the Company. Such a failure could result in state and 5 federal authorities imposing sanctions on a partition (such as restrictions on the partition's business practices, loss of its right to do business, or fines or forfeitures) that would hinder the partition's ability to resell the Company's services or raise its costs of doing so. Such sanctions also could make it difficult for the Company to engage in an asset sale, merger, or other transaction with the partition, and might impair any loans that the partition has outstanding from the Company. State or federal authorities also might attempt to hold the Company responsible for the partition's misconduct. Because the Company's partitions are independent carriers and marketing companies, the Company is unable to control such partitions' activities. The Company is also unable to predict the extent of its partitions' compliance with applicable regulations or the effect of such increased regulatory review. The Company's partitions that resell AT&T long distance service are under a contractual obligation to the Company to comply with AT&T's guidelines on the use of the AT&T name and logo in connection with their resale of AT&T long distance service. AT&T recently announced that it intends to enforce those guidelines with renewed vigor. A partition's failure to comply with AT&T's guidelines could have an adverse effect not only on the partition but also on the Company, which might be sued by AT&T, be subject to increased rates from AT&T or loss of service from AT&T. Colleges and Universities In late November, 1997, the Company acquired Compco, Inc., a provider of communications software for the college and university marketplace, for $15 million in cash and stock. Compco primarily licenses proprietary communications software to colleges and universities. This software assists the institution in its management of the billing, services and facilities related to its telecommunications network. In addition to the licensing of its telemanagement software, Compco also offers and provides billing services and training to such institutions. Compco's customers include approximately 100 academic institutions in the country. The Company intends to leverage the relationships Compco has with these institutions by offering bundled communications services to the college and university market. Direct Telemarketing In 1996, Tel-Save began to telemarket its long distance service directly to small and medium-sized businesses and, in December 1996, acquired substantially all of the assets, and hired substantially all of the employees, of American Business Alliance, Inc. ("ABA"), a switchless reseller of long distance services and a partition of Tel-Save, which acquisition significantly increased Tel-Save's direct telemarketing capabilities. In the second quarter of 1997, Tel-Save determined to change its business practice and de-emphasize the use of direct telemarketing to solicit customers for Tel-Save as the carrier, and, in October 1997, Tel-Save decided to discontinue its internal telemarketing operations, which were primarily conducted through the ABA business that it had acquired. Both federal and state officials are tightening the rules governing the telemarketing of telecommunications services and the requirements imposed on carriers acquiring customers in that manner. See "REGULATION". Customer complaints of unauthorized conversion or "slamming" are widespread in the long distance industry and are beginning to occur with respect to newly competitive local services. While Tel-Save's discontinuance of its internal telemarketing operations should reduce its exposure to customer complaints and federal or state enforcement actions with respect to telemarketing practices, certain state officials have made inquiries with respect to the marketing of Tel-Save's services and there is the risk of enforcement actions by virtue of its prior, telemarketing efforts and its ongoing support of its customer/partitions. Some direct telemarketing is being used in connection with the AOL and Compuserve Agreements. INFORMATION AND BILLING SERVICES The Company has developed and will seek to continue to develop and to improve systems for customer care and billing services, including online sign-up, call detail and billing reports and credit card payments. The Company is currently implementing these technologies in connection with the AOL Agreement. Any delay or difficulties in developing these systems or in hiring personnel could adversely affect the success of this service offering and the offering to AOL subscribers. The Company also utilizes the billing services of AT&T and ACUS, a wholly owned strategic business unit of AT&T, as well as the billing services of the LECs. Detailed call information on the usage of each end user is produced by AT&T (in the case of the switchless resale business) and by the Company (in the case of OBN business). In each case, AT&T or the LEC then processes the information and provides billing information to the Company and bills the end users. In addition, the Company has developed its own information systems in order to have its own billing capacity, although the Company has not provided such direct billing services to end users in the past except in connection with the online billing area under the AOL Agreement. The Company provides to each partition computerized management systems that control order processing, accounts receivable, billing and status information in a streamlined fashion between the Company and its partitions. Furthermore, when applicable, the systems interface with the AT&T Provisioning System and ACUS for order processing and billing services, 6 respectively. Enhancements and additional features are provided as needed. Electronic processing and feature activation are designed to maintain the Company's goal of minimizing overhead. The information functions of the system are designed to provide easy access to all information about an end user, including volume and patterns of use, which will help the Company and partitions identify value-added services that might be well suited for that end user. The Company also expects to use such information to identify emerging end user trends and respond with services to meet end users' changing needs. Such information also allows the Company and its partitions to identify unusual or declining use by an individual end user, which may indicate fraud or that an end user is switching its service to a competitor. Recently released FCC rules, however, may limit the Company's use of such customer proprietary network information. See "REGULATION." ONE BETTER NET ("OBN") In order to reduce its dependence on AT&T contract tariffs and to increase its growth opportunities, the Company developed its own telecommunications network, OBN, which utilizes AT&T (now Lucent) manufactured switches owned by the Company in conjunction with AT&T-provided lines and digital cross-connect equipment (herein referred to as "transmission facilities") and AT&T-provided billing systems that the Company uses pursuant to agreements with AT&T and ACUS. OBN includes five AT&T (now Lucent) 5ESS-2000 switches, which are generally considered the most reliable switches in the telecommunications industry. The Company was one of the first installation sites for AT&T's 5ESS-2000 switching equipment featuring the new Digital Networking Unit--SONET technology, a switching interface designed to increase the reliability of the 5ESS-2000 and to provide much greater capacity in a significantly smaller footprint. OBN allows the Company to offer long distance services directly to its end users and partitions throughout the continental United States at rates that are competitive with or below those offered by the major long distance providers. OBN also allows the Company to control provisioning of end user accounts. The Company's current contract tariffs under which it resells AT&T services require the Company to pay one all-inclusive "bundled" charge to AT&T for the delivery of services, including switching and transmission services and the payment of LEC access fees. As a result of the deployment of OBN, for customers provisioned on OBN, the Company pays "unbundled" charges consisting of charges paid directly to the LECs for access charges and, under AT&T contract tariffs, charges paid to AT&T for use of its network transmission facilities. The Company pays AT&T "bundled" charges for use of its international facilities to handle the international portion of a call on OBN. The total cost per call to the Company for the LEC access fees, the charges for use of AT&T's transmission facilities and the overhead cost for calls using OBN is less than the per call cost incurred by the Company as a switchless reseller paying "bundled" charges to AT&T. LEC access fees represent a substantial portion of the total cost of providing long distance services. As a result of the Telecommunications Act, it is generally expected that the entry over time of competitors into LEC markets will result in lowering of access fees, but there is no assurance that this will occur. To the extent it does occur, the Company, by using OBN, will receive the benefit of any future reduction in LEC access fees, which it would not automatically receive under contract tariffs. See "REGULATION" for a discussion of universal service contributions imposed on carriers, which may offset some or all of the savings from lower access charges. In October 1996, the Company subscribed to a new AT&T contract tariff, which was amended in December 1996 and May 1997 and which permits the Company to continue to resell through mid-1998 AT&T long distance services, including AT&T SDN service and other services, at rates that are more favorable to the Company than prior tariffs. As a result, the Company decided only to provision new end users on OBN and to leave existing end users on AT&T service. The 1996 AT&T contract has enabled the Company to earn higher margins on existing traffic and minimize possible attrition that might result from moving existing end users from the AT&T network to OBN. This has permitted a more gradual introduction of OBN, which has reduced the expense of providing the capacity required in a more rapid phase-in of OBN and lessened the impact of any technical difficulties during the phase-in of OBN. See "AT&T CONTRACT TARIFFS." While the Company expects to continue to offer private line service as a reseller, in 1998 the Company also will begin to offer private line service using OBN to new and existing customers. In order for the Company to provide service over OBN, the Company has installed and operates, and is responsible for the maintenance of, its own switching equipment. The Company also has installed lines to connect its OBN switches to LEC 7 switches and is responsible for maintaining these lines. The Company entered into a contract with GTE with respect to the monitoring, servicing and maintenance of the switching equipment purchased from AT&T (now Lucent). Additional management personnel and information systems are required to support OBN, the costs of which have increased the Company's overhead. Moreover, operation as a switch-based provider subjects the Company to risk of significant interruption in the provision of services on OBN in the event of damage to the Company's facilities (switching equipment or connections to AT&T transmission facilities) such as could be caused by fire or natural disaster. Such interruption could have a material adverse impact on the Company's financial condition and results of operations. The Company began testing new customer calls over OBN in the third quarter of 1996. In the fourth quarter of 1996, the Company began provisioning on a test basis new customer orders on OBN. In early 1997, the Company deployed OBN. Of the over 1.4 million lines using the Company's services, OBN currently provides services to approximately one million lines and most of the Company's new outbound lines are now being provisioned to OBN. The Company has continued to expand the capacity of OBN to meet its increased demands and believes that such capacity may be further expanded at reasonable cost to meet the Company's needs in the foreseeable future, including under the AOL and CompuServe Agreements. Separately, the Company is operating under an interim agreement with AT&T to purchase its Carrier Solutions Platform ("CSP") service, subject to either party's right to terminate such agreement. The Company is negotiating a long term agreement with AT&T for such service. The CSP service provides OBN with significant additional capacity and enables the Company to accommodate large numbers of additional customers on OBN by handling their peak load or overflow traffic. AT&T CONTRACT TARIFFS The Company historically has obtained services from AT&T through contract tariffs and has been able to obtain the services it seeks and to do so at increasingly favorable contract tariff rates. The deployment of OBN decreases the Company's dependence on AT&T contract tariffs or other service arrangements. To the extent the Company will need future service from AT&T, there is no guarantee the Company will be able to obtain favorable contract tariffs or other service arrangements, although the Company has been successful in the past in obtaining such arrangements. In October 1996, the Company subscribed to a new AT&T contract tariff ("Contract Tariff No. 5776"), which was amended in December 1996 and May 1997 and which permits the Company to continue to resell AT&T long distance services, including AT&T-SDN service, through mid-1998 and also includes, through late 2000, other AT&T services (such as international long distance, inbound and outbound services) that will be used in the Company's network, OBN. The rates that the Company pays under Contract Tariff No. 5776 are more favorable to the Company than under previous tariffs. During its term, Contract Tariff No. 5776 enables the Company to minimize possible attrition that might result from moving existing end users from the AT&T network to OBN. Contract Tariff No. 5776 also permitted a more gradual introduction of OBN, which has reduced the expense of providing the capacity required in a more rapid phase-in of OBN and lessened the impact of any technical difficulties during the phase-in of OBN. Contract Tariff No. 5776 commits the Company to purchase $285 million of service from AT&T over its 4 year term, including at least $1 million per month of international service. The Company can terminate Contract Tariff No. 5776 without liability to AT&T effective April 30, 1998 if the Company has generated at least $105 million in usage charges, including at least $15 million in international usage charges; the Company had exceeded these thresholds by the end of 1997. If minimum usage requirements are not met, the Company is obligated to pay shortfall fees to AT&T based on a percentage of the difference between the minimum requirement and the actual billed usage. In addition, if the contract tariffs with AT&T are terminated prior to the end of the contract tariff term, either by the Company or by AT&T for non-payment, the Company may be liable for "termination with liability" or "termination charges" and subject to material monetary 8 penalties. The Company also may discontinue Contract Tariff No. 5776 without liability if, prior to April 30, 1998, the Company and AT&T enter into a new contract tariff or another contract with a revenue commitment of at least $7.5 million per month and a term of at least the difference between 18 months and the number of months that the Company subscribed to the contract tariff, provided that the Company must purchase or pay for AT&T services under the contract tariff of at least $6.7 million per month for the months prior to such termination, including $1 million per month of international usage. The Company is considering terminating Contract Tariff No. 5776 as of April 30, 1998, since, based on its traffic growth to date, the Company has a one-time opportunity to do so without termination liability and the Company believes that it will be able to replace the services thereunder on more favorable terms. Such termination would free the Company from the minimum usage and other financial obligations to AT&T under that contract tariff. It also, however, would require the Company to make other arrangements to obtain critical services for the Company's operation and provision of service to its customers with AT&T or with another carrier, either another large customer of AT&T or another facilities-based carrier. The Company is in the process of negotiating a new Master Carrier Agreement (MCA) with AT&T which would replace all of the Company's existing tariffs with AT&T (including the interim agreement for provision of CSP services) and is expected to include certain minimum usage commitments. The Company has also engaged in discussions with other carriers to explore alternative arrangements. There can be no assurance that the Company will be successful in these negotiations with AT&T or other carriers. Should the Company terminate Contract Tariff No. 5776 and not reach a new agreement with AT&T by such termination, the Company could be forced to move its traffic to other AT&T tariffs at rates significantly higher than the Company is paying today. If the Company concludes an agreement with another carrier, the rates could be higher or lower than the Company is paying today. If the other carrier provides these services to the Company over its own network, end-user customers of the Company who want to keep their service on an AT&T network-based carrier, and partitions who want to remain on an AT&T network-based carrier, may choose to terminate their service with the Company. In that circumstance, the Company may also be obliged to notify customers of a change in underlying facilities-based carrier and the Company's billing arrangements with AT&T and ACUS would have to be replaced. As a nondominant carrier, AT&T is subject to the same regulations as other long distance service providers. AT&T remains subject to Title II of the Communications Act (47 U.S.C. Section 151, et seq.) and is required to offer service under rates, terms and conditions that are just, reasonable and not unreasonably discriminatory. AT&T is also subject to the FCC's complaint process and is required to file tariffs, though under streamlined procedures. In addition, AT&T is also required to give notice to the FCC and to affected customers prior to discontinuing, reducing, or impairing any services. COMPETITION The long distance telecommunications industry is highly competitive and affected by the introduction of new services by, and the market activities of, major industry participants. Competition in the long distance business is based upon pricing, customer service, billing services and perceived quality. The Company competes against various national and regional long distance carriers composed of both facilities-based providers and switchless resellers offering essentially the same services as the Company. Several of the Company's competitors are substantially larger and have greater financial, technical and marketing resources. Although the Company believes it has the human and technical resources to pursue its strategy and compete effectively in this competitive environment, its success will depend upon its continued ability to provide profitably high quality, high value services at prices generally competitive with, or lower than, those charged by its competitors. End users are not obligated to purchase any minimum usage amount and can discontinue service, without penalty, at any time. There can be no assurance that end users will continue to buy their long distance telephone service through the Company or through partitions that purchase service from the Company. In the event that a significant portion of the Company's end users decides to purchase long distance service from another long distance service provider, there can be no assurance that the Company will be able to replace its end user base from other sources. A high level of attrition is inherent in the long distance industry, and the Company's revenues are affected by such attrition. Attrition is attributable to a variety of factors, including termination of customers by the Company for non-payment and the initiatives of existing and new competitors as they engage in, among other things, national advertising campaigns, telemarketing programs and cash payments and other incentives. AT&T and other carriers have announced new price plans aimed at residential customers (the Company's primary target audience under the AOL Agreement) with significantly simplified rate structures, which may have the impact of lowering overall long distance prices. There can be no assurance that AT&T or other carriers will not make similar offerings available to 9 the small to medium-sized businesses that the Company serves. Additional pricing pressure may come from a new technology, Internet telephony, which uses packet switching to transmit voice communications at a cost today apparently below that of traditional circuit-switched long distance service. While Internet telephony is not yet available in all areas, requires the dialing of additional digits, and produces sound quality inferior to traditional long distance service, it could eventually be perceived as a substitute for traditional long distance service, and put additional downward pricing pressure on long distance rates. Although OBN makes the Company more price competitive, a reduction in long distance prices still may have a material adverse impact on the Company's profitability. One of the Company's principal competitors, AT&T, is also a major supplier of services to the Company. The Company links its switching equipment with transmission facilities and services purchased or leased from AT&T and resells services obtained from AT&T. The Company also utilizes AT&T and ACUS to provide services. There can be no assurance that either AT&T or ACUS will continue to offer services to the Company at competitive rates or on attractive terms. The Telecommunications Act of 1996 (the "Telecommunications Act") was intended to introduce more competition to U.S. telecommunications markets. The legislation opens the local services market by requiring LECs to permit interconnection to their networks and establishing, among other things, LEC obligations with respect to access, resale, number portability, dialing parity, access to rights-of-way, and mutual compensation. The legislation also codifies the LECs' equal access and nondiscrimination obligations and preempts most inconsistent state regulation. The Company in the future may take advantage of the opportunities provided by the Telecommunications Act for competition in the local services market by reselling local services. The Telecommunications Act also was intended to increase competition in the market for long distance services by overturning the prohibition in the Consent Decree on RBOC provision of interLATA interexchange telecommunications services. See "INDUSTRY BACKGROUND." Under Section 271 of the Telecommunications Act, RBOCs may provide certain interLATA services immediately, and other interLATA services after state and federal regulators certify that the RBOCs have satisfied certain conditions. No RBOC has yet been certified by both state and federal regulators as having satisfied the conditions for provision of all interLATA services. However, the FCC recently has indicated that it will work more cooperatively with the RBOCs in helping them to satisfy the conditions necessary for certification. Several members of Congress also have expressed dissatisfaction over the slow pace of certification, and legislation is being considered to speed up RBOC entry into the long distance market. In addition, one federal district court has found that the restrictions on RBOC provision of interLATA services are an unconstitutional bill of attainder, but this decision has been stayed and is under appeal. RBOC entry into the long distance market means that the Company will face new competition from well-capitalized, well-known companies. The Telecommunications Act includes certain safeguards against anticompetitive conduct by the RBOCs in the provision of interLATA service. Anticompetitive conduct could result, among other things, from a RBOC's access to all subscribers on its existing network as well as its potentially lower costs related to the termination and origination of calls within its territory. It is impossible to predict whether such safeguards will be adequate to protect against anticompetitive conduct by the RBOCs and the impact that any anticompetitive conduct would have on the Company's business and prospects. Because of the name recognition that the RBOCs have in their existing markets and the established relationships that they have with their existing local service customers, and their ability to take advantage of those relationships, as well as the possibility of interpretations of the Telecommunications Act favorable to the RBOCs, it may be more difficult for other providers of long distance services, such as the Company, to compete to provide long distance services to RBOC customers. At the same time, as a result of the Telecommunications Act, RBOCs have become potential customers for the Company's long distance services. Consolidation and alliances across geographic regions (e.g., Bell Atlantic/Nynex and SBC Communications Inc./Pacific Telesis Group) and in the interexchange market (e.g., WorldCom/MCI domestically and France Telecom/Deutsche Telekom/Sprint internationally) and across industry segments (e.g., WorldCom/MFS/UUNet and AT&T/Teleport) may also intensify competition in the telecommunications market from significantly larger, well-capitalized carriers and materially adversely affect the position of the Company. Such consolidation and alliances are providing some of the Company's competitors with the capacity to offer a wide range of services, including local, long distance, and wireless telephone service, as well as Internet access. The Company, which currently offers only long distance service, may be at a competitive disadvantage because of its inability to offer so-called "one stop shopping." The Company's online marketing of long distance service is spawning imitators that are attempting to copy its major features, including online sign-up and billing and automatic payment through a credit card. The Company cannot predict what effect these competitors will have on its online marketing of long distance service. 10 INDUSTRY BACKGROUND The $82 billion U.S. long distance industry is dominated by the nation's four largest long distance providers, AT&T, MCI, Sprint and WorldCom, which together generated approximately 83% of the aggregate revenues of all U.S. long distance interexchange carriers in 1996. Other long distance companies, some with national capabilities, accounted for the remainder of the market. Based on published FCC estimates, toll service revenues of U.S. long distance interexchange carriers have grown from $38.8 billion in 1984 to $82 billion in 1996. The aggregate market share of all interexchange carriers other than AT&T, MCI and Sprint has grown from 2.6% in 1984 to 22.5% in 1996. During the same period, the market share of AT&T declined from 90.1% to 47.9%. Prior to the Telecommunications Act, the long distance telecommunications industry had been principally shaped by a court decree between AT&T and the United States Department of Justice, known as the Modification of Final Judgment (the "Consent Decree") that in 1984 required the divestiture by AT&T of its 22 Bell operating companies and divided the country into some 200 Local Access and Transport Areas ("LATAs"). The 22 operating companies, which were combined into the RBOCs, were given the right to provide local telephone service, local access service to long distance carriers and intraLATA toll service (service within LATAs), but were prohibited from providing interLATA service (service between LATAs). The right to provide interLATA service was maintained by AT&T and other carriers. To encourage the development of competition in the long distance market, the Consent Decree and the FCC required most LECs to provide all carriers with access to local exchange services that is "equal in type, quality and price" to that provided to AT&T and with the opportunity to be selected by customers as their preferred long distance carrier. These so-called "equal access" and related provisions are intended to prevent preferential treatment of AT&T. Further market opening, access and non-discrimination provisions were built into the Telecommunications Act. Regulatory, legislative, judicial and technological factors have helped to create the foundation for smaller companies to emerge as competitive alternatives to AT&T, MCI, and Sprint for long distance telecommunication services. The FCC requires that AT&T not restrict the resale of its services, and the Consent Decree, the Telecommunications Act and regulatory proceedings have ensured that access to LEC networks is, in most cases, available to all long distance carriers. Long distance companies that have their own transmission facilities and switches, such as AT&T, are referred to as facilities-based carriers. Facilities-based carriers are switch-based carriers, meaning that they have at least one switch to direct their long distance traffic. Nonfacilities-based carriers either (i) depend upon facilities-based carriers for switching and transmission facilities ("switchless resellers") or (ii) install and operate their own switches but depend on facilities-based carriers for transmission facilities ("switch-based resellers"). The relationship between resellers and the major long distance carriers is predicated primarily upon the fact that the pricing strategies and cost structures of the major long distance carriers have resulted historically in their charging higher rates to the small to medium business customer. Small to medium business customers typically are not able to make the volume commitments necessary to negotiate reduced rates under individualized contracts. By committing to large volumes of traffic, the reseller is guaranteeing traffic to the major long distance carrier but the major long distance carrier is relieved of the administrative burden of qualifying and servicing large numbers of medium to small accounts. The successful reseller has lower overhead costs and is able to market efficiently the long distance product, process orders, verify credit and provide customer service to large numbers of accounts. REGULATION The Company's provision of communications services is subject to government regulation. Federal law regulates interstate and international telecommunications, while states have jurisdiction over telecommunications that originate and terminate within the same state. Changes in existing policies or regulations in any state or by the federal government could 11 materially adversely affect the Company's financial condition or results of operations, particularly if those policies make it more difficult for the Company to obtain service from AT&T or other long distance companies at competitive rates, make it more difficult for customers to change carriers or otherwise increase the cost and regulatory burdens of marketing and providing service. There can be no assurance that the regulatory authorities in one or more states or the FCC will not take action having an adverse effect on the business or financial condition or results of operations of the Company. Regulatory action by the FCC or the states also could adversely affect the partitions, or otherwise increase the partitions' cost and regulatory burdens of marketing and providing long distance services. The Company is classified by the FCC as a nondominant carrier. After the recent reclassification of AT&T as nondominant, only the LECs are classified as dominant carriers among domestic carriers. As a consequence, the FCC regulates many of the rates, charges, and services of the LECs to a greater degree than the Company's. Because AT&T is no longer classified as a dominant carrier, certain pricing restrictions that formerly applied to AT&T have been eliminated, which could make it easier for AT&T to compete with the Company for low volume long distance subscribers. The FCC generally does not exercise direct oversight over charges for service of nondominant carriers, although it has the statutory power to do so. Nondominant carriers are required by statute to offer interstate services under rates, terms, and conditions that are just, reasonable and not unreasonably discriminatory. The FCC has the jurisdiction to act upon complaints filed by third parties, or brought on the FCC's own motion, against any common carrier, including nondominant carriers, for failure to comply with its statutory obligations. Nondominant carriers have been required to file tariffs listing the rates, terms and conditions of service, which were filed pursuant to streamlined tariffing procedures. The FCC also has the authority to impose more stringent regulatory requirements on the Company and change its regulatory classification from nondominant to dominant. In the current regulatory atmosphere, the Company believes, however, that the FCC is unlikely to do so. The FCC imposes only minimal reporting, accounting and record-keeping obligations. International nondominant carriers, including the Company, must maintain international tariffs on file with the FCC. The FCC has issued an order requiring non-dominant carriers to withdraw their domestic tariffs, but as of the date hereof, a court has stayed the FCC's order. The Company currently has two tariffs on file with the FCC. Although the tariffs of nondominant carriers, and the rates and charges they specify, are subject to FCC review, they are presumed to be lawful and are seldom contested. The Company is permitted to make tariff filings on a single day's notice and without cost support to justify specific rates. IXCs are also subject to a variety of miscellaneous regulations that, for instance, govern the documentation and verifications necessary to change a subscriber's long distance carrier, limit the use of 800 numbers for pay-per-call services, require disclosure of certain information if operator assisted services are provided and govern interlocking directors and management. The Telecommunications Act grants explicit authority to the FCC to "forbear" from regulating any telecommunications services provider in response to a petition and if the agency determines that enforcement is unnecessary and the public interest will be served. At present, the FCC exercises its regulatory authority to set rates primarily with respect to the rates of dominant carriers, and it has increasingly relaxed its control in this area. Even when AT&T was classified as a dominant carrier, the FCC most recently employed a "price cap" system, which essentially exempted most of AT&T's services, including virtually all of its commercial and 800 services, from traditional rate of return regulation because the FCC believes that these services were subject to adequate competition. Similarly, the FCC is in the process of changing the regulation and pricing of access charges including the local transport component of access charges (i.e., the fee for use of the LEC transmission facilities connecting the LECs' central offices and the IXC's access points). In addition, the LECs have been afforded a degree of pricing flexibility in setting interstate access charges where adequate competition exists. The impact of such repricing and pricing flexibility on IXCs, such as the Company, cannot be determined at this time. The Company is subject to varying levels of regulation in the states in which it is currently authorized to provide intrastate telecommunications services. The vast majority of the states require the Company to apply for certification to provide intrastate telecommunications services, or at least to register or to be found exempt from regulation, before commencing intrastate service. The vast majority of states also require the Company to file and maintain detailed tariffs listing its rates for intrastate service. Many states also impose various reporting requirements and/or require prior approval for transfers of control of certified carriers, corporate reorganizations, acquisitions of telecommunications operations, assignments of carrier assets, including subscriber bases, carrier stock offerings and incurrence by carriers of significant debt obligations. Certificates of authority can generally be conditioned, modified, canceled, terminated or revoked by state regulatory authorities for failure to comply with state law and the rules, regulations and policies of the state regulatory authorities. Fines and other penalties, including the return of all monies received for intrastate traffic from residents of a state, may be imposed for such violations. In certain states, prior regulatory approval may be required for acquisitions of telecommunications operations. Currently, the Company is certificated and tariffed to provide intrastate interLATA service in substantially all states where such authorization can be obtained. The Company's prior direct marketing efforts, the Company's marketing of its AOL and CompuServe-based services and the marketing efforts of the Company's partitions require compliance with relevant federal and state regulations that govern 12 direct sales of telecommunications services. FCC rules prohibit switching a customer from one long distance carrier to another without the customer's consent and specify how that consent can be obtained and must be verified. Most states also have consumer protection laws that further define the framework within which the Company's marketing activities must be conducted. The constraints of federal and state restrictions could impact the success of the Company's direct marketing efforts. Federal and state restrictions on the marketing of telecommunications services are becoming stricter in the wake of widespread consumer complaints throughout the industry about "slamming" (the unauthorized conversion of a customer's preselected telecommunications carrier) and "cramming" (the unauthorized provision of additional telecommunications services). Section 258 of the Telecommunications Act of 1996 authorized strengthened penalties against slamming, and the FCC is expected shortly to issue rules implementing Section 258 and overhauling federal rules on the verification of orders for telecommunications services. Congress is considering additional legislation that would further increase penalties for slamming and cramming. Several states also have been active in combating abusive marketing practices through new legislation and regulation, as well as through enhanced enforcement activities. In addition, to combat slamming, many local exchange carriers have initiated "PIC freeze" programs that, once selected by the customer, then require a customer seeking to change long distance carriers to contact the local carrier directly in lieu of having the long distance carrier contact the local carrier on behalf of the customer. While the Company vigorously supports curbs on abusive marketing practices, such measures, unless carefully designed, can have the incidental effect of entrenching incumbent carriers and hindering the emergence of new competitors, such as the Company. Statutes and regulations designed to protect consumer privacy also may have the incidental effect of hindering the growth of newer telecommunications carriers, such as the Company. The FCC recently released rules to implement Section 222 of the Telecommunications Act of 1996 that severely restrict the use of "customer proprietary network information" (information that a carrier obtains about its customers through their use of the carrier's services). These rules may make it more difficult for the Company to market additional services (such as local and wireless) to its existing customers if and when the Company begins to offer such services. The FCC has announced rules implementing Section 254 of the Telecommunications Act of 1996 that require the Company and other providers of telecommunications services to contribute to the universal service fund, which helps to subsidize the provision of local telecommunications services and other services to low-income consumers, schools, libraries, health care providers, and rural and insular areas that are costly to serve. The Company's required contributions to the universal service fund could increase over time, and some of the Company's potential competitors (such as providers of Internet telephony) are not currently, and in the future may not be, required to contribute to the universal service fund. To the extent that the Company makes additional telecommunications service offerings, the Company may encounter additional regulatory constraints. EMPLOYEES As of December 31, 1997, the Company employed 235 persons, of whom 5 were engaged in marketing and sales, 179 were engaged in partition and end user support, and 51 were engaged in systems development, finance, administration and management. None of the Company's employees is covered by collective bargaining agreements. The Company considers relations with its employees to be good. 13 GLOSSARY ACUS: AT&T College and University Systems, a wholly owned strategic business unit of AT&T Corp. AIN: Advanced Intelligent Network. Consent Decree: A 1984 U.S. Department of Justice decree that, among other things, ordered AT&T to divest its wholly-owned local Bell operating subsidiaries. End users: Customers that utilize long distance telephone services. Equal Access: Connection provided by a LEC permitting a customer to be automatically connected to the IXC of the customer's choice when the customer dials "1." Facilities-based provider: Long distance service providers who own transmission facilities. 5ESS-2000: The switching equipment manufactured by AT&T (now Lucent), which the Company acquired from AT&T (now Lucent). FCC: Federal Communications Commission. Inbound "800" Service: A service that bills long distance telephone charges to the called party. IXC: Interexchange carrier, a long distance carrier providing services between local exchanges. LATA: Local Access and Transport Areas, the approximately 200 geographic areas defined pursuant to the Consent Decree between which the RBOCs are generally prohibited from providing long distance service. LEC: Local Exchange Carrier, a company providing local telephone services. MEGACOM: An outbound long distance service offering by AT&T that requires dedicated access. MEGACOM 800: An inbound 800 service offering provided by AT&T that requires dedicated access. MCI: MCI Communications Corporation. MLCP: AT&T's multi-location calling plan (a discounted long distance program). Network: An integrated system composed of switching equipment and transmission facilities designed to provide for the direction, transport and recording of telecommunications traffic. Nonfacilities-based provider: Long distance service providers that do not own transmission facilities. OBN: One Better Net, the Company's nationwide long distance network. Partition: An independent long distance and marketing company that contracts with the Company to purchase or otherwise provide to end users the long distance services provided by the Company. Private Line: A full-time leased line directly connecting two points. Provisioning: The process of initiating a carrier's service to an end user. PUC: A state regulatory body empowered to establish and enforce rules and regulations governing public utility companies and others, such as the Company in many of its state jurisdictions. RBOC: Regional Bell Operating Company -- Any of seven regional Bell holding companies that the Consent Decree established to serve as parent companies for the Bell operating companies. 14 Readyline: An Inbound 800 service offering provided by AT&T. SDN: The AT&T Software Defined Network. Sprint: Sprint Corporation. Switching Equipment: A computer that directs telecommunication traffic in accordance with programmed instructions. Tariff: The schedule of rates and regulations set by communications common carriers and filed with the appropriate Federal and state regulatory agencies; the published official list of charges, terms and conditions governing provision of a specific communication service or facility, which functions in lieu of or with a contract between the user and the supplier or carrier. 15 ITEM 2. PROPERTIES The Company owns the 24,000 square foot facility in New Hope, Pennsylvania which serves as the Company's headquarters. The Company leases properties in the cities in which OBN switches have been installed. With respect to the Company's customer service operations with respect to the AOL Agreement, the Company owns the 32,000 square foot facility located in Clearwater, Florida. With respect to the Company's Symetrics operations, Symetrics' corporate office and primary engineering and manufacturing facility is a 40,000 square foot building, which it owns, on approximately five acres in Melbourne, Florida. Symetrics uses 40% of this facility for its own business and leases and/or offers for lease the balance of the building for terms typically of one to five years. Rental rates charged by Symetrics are consistent with rates for similar type buildings in the area. The Company also owns the adjoining property to the east which consists of a 50,000 square foot building on a five-acre lot. The Company leases a 14,500 square foot building for $6,360 per month, with 27 months remaining on the term thereof, for the Symetrics commercial contract manufacturing operations. Symetrics' subsidiary leases a 14,428 square foot building for approximately $7,500 per month, with 47 months remaining on the lease. ITEM 3. LEGAL PROCEEDINGS The Company is a party to certain legal actions arising in the ordinary course of business. The Company believes that the ultimate outcome of these actions will not result in any liability that would have a material adverse effect on the Company's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Company's Annual Meeting of Stockholders was held on December 1, 1997 ("Annual Meeting"); (b) Not applicable; (c) At the Annual Meeting, the stockholders of the Company considered and approved the following proposals: (i) At the Annual Meeting, the stockholders approved a proposal to amend the Company's Certificate of Incorporation to increase the number of shares of Common Stock that may be issued by the Company from 100,000,000 to 300,000,000. This proposal received 51,571,254 votes in favor, 4,483,173 votes opposed such proposal and 27,485 votes abstained from such matter. (ii) Election of Directors. The following sets forth the nominees who were elected directors of the Company for the term expiring in the year indicated as well as the number of votes cast for, against or withheld:
VOTES ----- Term (year expires) Name For Against Withheld -------------------------------------------------------------------------------------------------- 2000 Gary W. McCulla 55,981,895 0 100,017 2000 George P. Farley 55,981,952 0 99,960 1999 Harold First 55,981,952 0 99,960
(iii) At the Annual Meeting the stockholders approved the appointment of BDO Seidman LLP as independent certified public accounts of the Company. The appointment received 56,047,874 votes in favor, 6,180 votes in opposition and 27,858 votes abstained from such matter. 16 (iv) At the Annual Meeting the stockholders approved a proposal to approve the grant of an option to purchase 800,000 shares of the Company's Common Stock to Edward B. Meyercord, III. This proposal received 55,776,343 votes in favor, 273,819 votes in opposition and 31,750 votes abstained from such matter. 17 EXECUTIVE OFFICERS OF THE COMPANY The executive officers of the Company are as follows:
NAME AGE POSITION - --------------------------------- --- -------------------------------------------------------------- Daniel Borislow 36 Chairman of the Board, Chief Executive Officer and Director Gary W. McCulla 38 President and Director of Sales and Marketing and Director Emanuel J. DeMaio 38 Chief Operations Officer and Director George P. Farley 59 Chief Financial Officer, Treasurer and Director Edward B. Meyercord, III 32 Executive Vice President, Marketing and Corporate Development Mary Kennon 38 Director of Customer Care and Human Resources Aloysius T. Lawn, IV 39 General Counsel and Secretary Kevin R. Kelly 33 Controller
DANIEL BORISLOW. Mr. Borislow founded the Company and has served as a director and as Chief Executive Officer of the Company since its inception in 1989. Prior to founding the Company, Mr. Borislow formed and managed a cable construction company. GARY W. MCCULLA. Mr. McCulla currently serves as President and Director of Sales and Marketing. In 1991, Mr. McCulla founded GNC and was its President. Until March 1994, GNC was a privately-held independent marketing company and one of the Company's partitions. At that time, the Company acquired certain assets of GNC. EMANUEL J. DEMAIO. Mr. DeMaio joined the Company in February 1992 and currently serves as Chief Operations Officer. Prior to joining the Company, from 1981 through 1992, Mr. DeMaio held various technical and managerial positions with AT&T. GEORGE P. FARLEY. Mr. Farley became Chief Financial Officer and Treasurer of Tel-Save effective October 29, 1997. Mr. Farley is formerly Group Vice President of Finance/Chief Financial Officer of Twin County Grocers, Inc. ("Twin County"), a food distribution company. Prior to joining Twin County in September 1995, Mr. Farley was a partner of BDO Seidman, LLP, where he had served as a partner since 1974. EDWARD B. MEYERCORD, III. Mr. Meyercord joined the Company in September 1996 and currently serves as Executive Vice President, Marketing and Corporate Development. From 1993 until joining the Company, Mr. Meyercord worked in the corporate finance department of Salomon Brothers, where he held various positions, the most recent of which was Vice President. Prior to joining Salomon Brothers, Mr. Meyercord worked in the corporate finance department at Paine Webber Incorporated. MARY KENNON. Ms. Kennon joined the Company in October 1994 and currently serves as Director of Customer Care and Human Resources. Prior to joining the Company, from 1984 through 1994, Ms. Kennon held various managerial positions with AT&T. ALOYSIUS T. LAWN, IV. Mr. Lawn joined the Company in January 1996 and currently serves as General Counsel and Secretary of the Company. Prior to joining the Company, from 1985 through 1995, Mr. Lawn was an attorney in private practice. KEVIN R. KELLY. Mr. Kelly joined the Company in April 1994 and currently serves as Controller. From 1987 to 1994, Mr. Kelly held various managerial positions with a major public accounting firm. Mr. Kelly is a certified public accountant. 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock, $.01 par value per share ("Common Stock"), is traded on the Nasdaq National Market, and high and low quotations listed below are actual sales prices as quoted in the Nasdaq National Market under the symbol "TALK." The price per share in the following table sets forth the high and low price in the Nasdaq National Market for the quarter indicated as reported by Bloomberg L.P.:
Price Range of Common Stock High Low ---- --- 1995 First Quarter (from September 20, 1995) $ 5 21/64 $ 4 27/64 1996 First Quarter 8 7/16 4 5/64 Second Quarter 11 7/8 8 1/4 Third Quarter 14 3/4 9 5/8 Fourth Quarter 14 1/2 10 3/8 1997 First Quarter 20 1/2 12 5/8 Second Quarter 17 1/4 13 9/16 Third Quarter 24 1/16 14 1/4 Fourth Quarter 26 1/16 16 5/16 1998 First Quarter (through March 30, 1998) 30 19 1/4
As of March, 1998, there were approximately 299 record holders of Common Stock. The Company has never declared or paid any cash dividends on its capital stock. The Company currently intends to retain any future earnings to finance the growth and development of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES On November 26, 1997, the Company acquired all of the outstanding shares of Compco for $15,000,000, comprised of a cash payment of $7,500,000 and the issuance to Compco's stockholders of 339,982 shares of the Company's Common Stock. The Company believes that such sale of stock was exempt from registration under Section 4(2) under the Securities Act. On December 10, 1997, the Company sold $200,000,000 aggregate principal amount of 5% Convertible Subordinated Notes due 2004 (the "5% Notes") to Smith Barney Inc., Deutsche Morgan Grenfell Inc. and UBS Securities LLC, who acted as Initial Purchasers in an offering relying on the exemption in ss. 4(2) of the Securities Act of 1933, as amended. Proceeds to the Company were $195,000,000. The 5% Notes are convertible, at the option of the holder thereof, at any time after 90 days following the date of issuance thereof and prior to maturity, into shares of Common Stock at a conversion price of $25.47, subject to adjustment in certain events. 19 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements included elsewhere in this Form 10-K.
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands, except per share amounts) Consolidated Statements of Income Data: Sales $304,768 $232,424 $180,102 $82,835 $31,940 Cost of sales 355,169 200,597 156,121 70,104 26,715 Gross profit (loss) (50,401) 31,827 23,981 12,731 5,225 Selling, general and administrative expenses 34,650 10,039 6,280 3,442 2,060 Operating income (loss) (85,051) 21,788 17,701 9,289 3,165 Investment and other income, net 50,715 10,585 331 66 108 Income (loss) before income taxes (34,336) 32,373 18,032 9,355 3,273 Provision (benefit) for income taxes(1) (13,391) 12,205 7,213 3,742 1,309 Net income (loss) (1) $(20,945) $ 20,168 $ 10,819 $ 5,613 $ 1,964 Net income (loss) per share - Basic (1) $ (0.33) $ 0.38 $ 0.34 $ 0.20 $ 0.07 Weighted average common shares outstandin- Basic 64,168 52,650 31,422 28,650 28,650 Net income (loss) per share - Diluted(1) $ (0.33) $ 0.35 $ 0.32 $ 0.18 $ 0.07 Weighted average common and common equivalent shares outstanding -Diluted 64,168 57,002 33,605 30,663 29,452 AT DECEMBER 31, ---------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (In thousands) Consolidated Balance Sheets Data: Working capital $634,788 $175,597 $38,171 $12,265 $4,502 Total assets 814,891 257,008 71,388 21,435 6,694 Convertible debt 500,000 -- -- -- -- Total stockholders' equity 222,828 230,720 41,314 14,042 4,687
- ---------- (1) For the years and period ended December 31, 1993, 1994 and September 19, 1995, the Predecessor Corporation elected to report as an S corporation for federal and state income tax purposes. Accordingly, the Predecessor Corporation's stockholders included their respective shares of the Company's taxable income in their individual income tax returns. The pro forma income taxes reflect the taxes that would have been accrued if the Company had elected to report as a C corporation. See Note 12 to the Consolidated Financial Statements. 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements included elsewhere in this Form 10-K. OVERVIEW In 1997, the Company raised approximately $500 million in connection with two private placements of convertible notes. In addition, as part of its efforts to expand its business into the online market, the Company entered into the AOL Agreement, under which the Company provides long distance telecommunications services to be marketed by AOL. The Company's results of operations for 1997 were negatively impacted by the pre-tax charges of $60.7 million primarily related to the AOL Agreement, $30.0 million primarily related to the restructuring of its sales and marketing efforts and $11.5 million primarily as a result of the Company's change in accounting for customer acquisition costs. These charges were offset by $32 .1 million of other income, net of related costs, associated with the break-up of a proposed merger between the Company and Shared Technologies Fairchild, Inc. ("STF"). RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain financial data as a percentage of sales:
1997 1996 1995 ---- ---- ---- Sales 100.0% 100.0% 100.0% Cost of sales 116.5 86.3 86.7 ----- ----- ----- Gross profit (loss) (16.5) 13.7 13.3 Selling, general and administrative expenses 11.4 4.3 3.5 ----- ----- ----- Operating income (loss) (27.9) 9.4 9.8 Investment and other income, net 16.6 4.5 0.2 ----- ----- ----- Income (loss) before income taxes (11.3) 13.9 10.0 Provision (benefit) for income taxes (4.4) 5.2 4.0(A) ----- ----- ----- Net income (loss) (6.9)% 8.7% 6.0% ===== ===== =====
- ---------- (A) Pro forma tax provisions have been calculated as if the Company's results of operations were taxable as a C corporation (the Company's current tax status) for the year ended December 31, 1995. Prior to September 20, 1995, the Company was an S Corporation with all earnings taxed directly to its shareholders. 21 YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Sales. Sales increased by 31.1% to $304.8 million in 1997 from $232.4 million in 1996. The increase in sales resulted primarily from the marketing of the Company's OBN services and the addition of new partitions. One partition, Group Long Distance Inc., accounted for approximately 13% of the Company's sales in 1997. Although the Company expects sales to increase by virtue of the AOL Agreement and, based on its expertise to date, to have attracted approximately 1,000,000 lines to its service by June 30, 1998 as a result of its marketing campaign under the AOL Agreement in view of the intense competition in this industry, there can be no assurance that the Company will increase sales on a quarter-to-quarter or year-to-year basis. Cost of Sales. The Company's cost of sales increased by 77.1% to $355.2 million in 1997 from $200.6 million in 1996 as a result of increased sales and charges of $11.5 million primarily as a result of the Company's change in its accounting for customer acquisition costs (Note 3), $60.7 million primarily related to the AOL Agreement (Note 4) and $30.0 million primarily related to the restructuring of its sales and marketing efforts (Note 3). Prior to 1997, network usage costs consisted solely of "bundled" charges from AT&T. Beginning in 1997, the Company also incurred "unbundled" charges, including local access fees, associated with the operation of OBN. Both "bundled" and "unbundled" charges are directly related to calls made by the Company's end users. During 1997, the Company acquired most of the services purchased from AT&T for resale or use in OBN under AT&T Contract Tariff No. 5776, which was entered into in late 1996 and provides rates that are more favorable than under previous tariffs. The Company has the opportunity to terminate this AT&T tariff without termination liability effective as of April 30, 1998 and currently expects it will do so since it believes that it can replace these services at more favorable rates. While the Company is currently negotiating a new master services contract with AT&T, which would replace all of the Company's existing AT&T tariffs with what the Company expects would be lower rate tariffs, there can be no assurance that such agreement can be reached. If the Company terminates Contract Tariff No. 5776 and is unsuccessful in reaching a more favorable agreement with AT&T, it would be required to pay more to obtain these services from AT&T or negotiate an agreement with another carrier, either another large customer of AT&T or another facilities based carrier, which may be at rates higher or lower than the Company is paying today. OBN and the operation of the Company's own switches and network have to date and will in the future require the Company to incur systems and equipment maintenance, lease and network personnel expenses significantly above the levels historically experienced by the Company as a switchless reseller of AT&T services. However, these per call costs, in combination with "unbundled" charges paid to LECs and AT&T, were, in 1997, and are expected in the future, to be less than the per call cost currently incurred by the Company as a switchless reseller paying "bundled" charges to AT&T. The Company made an initial payment of $100 million to AOL at the signing of the AOL Agreement and issued to AOL at signing two warrants to purchase shares of the Company's Common Stock at a premium over the market value of such stock on the issuance date (See Note 4). Of the prepaid AOL marketing costs, approximately $57.0 million was charged to expense in 1997. The remaining portion of the prepaid AOL marketing costs (approximately $63.6 million at December 31, 1997) will be recognized ratably over the balance of the term of the AOL Agreement, the initial term of which expires on June 30, 2000, as advertising services are received. The AOL warrant for up to 7 million shares will be valued and charged to expense as and when subscribers to the Company's services under the AOL Agreement sign-up and the shares under such warrant vest. The amount of such charges, which could be significant, will be based on the extent to which such AOL warrants vest and the market prices of the Company's Common Stock at the time of vesting and therefore such charges are not currently determinable. Generally, the higher the market price of the Company's Common Stock at the time of vesting, the larger the amount of the charge will be. The Company also anticipates that it may incur up to $100 million in additional AOL marketing expenses in 1998 for such marketing efforts as direct mail, media campaigns and special pricing and other promotions. 22 The Company has traditionally operated primarily as a wholesale reseller of long distance services. With the introduction of the AOL Agreement, the Company has begun to focus on a more retail-oriented business plan. As discussed above, the Company has incurred, and expects to continue to incur, significant upfront expenses for marketing under the AOL Agreement, the revenues from which may not be realized for some period of time after the expenditures. In addition, approximately 15-20% of the orders under the AOL Agreement have required special attention by the Company because of PIC freezes imposed by the regional Bell operating companies. See "ITEM 1--BUSINESS--REGULATIONS." As the Company focuses more on the retail market in 1998, continuing its activities under the AOL and CompuServe Agreements and venturing into other telecommunications services such as dial-around and local service, with the increased development and promotional expenses, such as special pricing and other promotion and retention devices, entailed in retail marketing and the greater time period between expenditures and resulting revenues, the Company anticipates that its 1998 revenues and income could be adversely affected. Gross Margin. Gross margin decreased to (16.5)% in 1997 from 13.7% in 1996. The decrease in gross margin was primarily due to the charges discussed above. Absent these charges, gross margin increased to 17.0% in 1997 from 13.7% in 1996, due to lower network costs for OBN services which were lower on a per call basis when compared to those paid to AT&T. Price competition continues to intensify for the Company's products and this trend can be expected to continue to put downward pressure on gross margins. Selling, general and administrative expenses. Selling, general and administrative expenses increased by 245.2% to $34.7 million in 1997 from $10.0 million in 1996. The increase in selling, general and administrative expenses was due primarily to compensation expenses related to the issuance of options to and the purchase of shares of Company Common Stock by executive officers of the Company in connection with the commencement of their employment with the Company, the costs associated with hiring additional personnel to support the Company's continuing growth, the development costs associated with AOL and increased fees for professional services. The Company expects selling, general and administrative expenses to continue to increase as it operates and maintains OBN and as it markets the AOL service offering. The additional selling, general and administrative expenses may be offset by the increased sales and gross profit gained as a result of the implementation of the components of the Company's strategic plan, but increased costs may have an adverse impact on results of operations and there can be no assurances of such increased sales and profits. The Company granted options to purchase 810,000 shares of Company Common Stock at an exercise price of $17.50 per share to an executive officer and two outside directors. The options granted are subject to the approval of the stockholders and are being submitted for approval at the Company's stockholder meeting scheduled in May of 1998. Approval of the option grants will result in compensation expense equal to the difference between the exercise price and the market value of the Company Common Stock on the date of such approval. Other Income. Other income was $50.7 million in 1997 versus $10.6 million in 1996. Other income consists primarily of fees for customer service and support for the marketing operations of the Company's carrier partitions in 1997 of $8.1 million and investment income earned by the Company. In 1997, other income also includes $32.1 million, net of related costs, associated with the break-up of a proposed merger between the Company and STF. Provision for income taxes. The Company's effective tax rate increased to 39.0% in 1997 from the effective tax rate of 37.7% in 1996 due to an anticipated higher effective state tax rate in 1997. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Sales. Sales increased by 29.1% to $232.4 million in 1996 from $180.1 million in 1995. The increase in sales related primarily to the continued expansion of the Company's distribution network of partitions, as well as increases in the number of orders submitted by the Company's existing partitions. One partition, The Furst Group, Inc., accounted for approximately 11% of the Company's sales in 1996 versus zero in 1995. In addition, significant partition marketing efforts focused on inbound 800 service resulted in sales of $75.3 million for the year ended December 31, 1996 versus $55.6 million for the year ended December 31, 1995. Cost of Sales. The Company's cost of sales, consisting primarily of network usage charges for AT&T long distance services, increased by 28.5% to $200.6 million in 1996 from $156.1 million in 1995 and is directly related to the 29.1% increase in sales. Gross Margin. Gross margin, the gross profit as a percentage of sales, increased to 13.7% for the year ended December 31, 1996 from 13.3% for the year ended December 31, 1995. The increase in gross margin was due to greater discounts obtained from AT&T on network usage partially offset by direct marketing expenses and higher volume discounts granted to certain partitions. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by 59.9% to $10.0 million in 1996 from $6.3 million in 1995. The increase in selling, general and administrative expenses was due primarily to the costs associated with hiring additional management personnel to support the Company's continuing growth and increased fees for professional services. Other Income. Other income was $10.6 million in 1996 versus $331,000 in 1995. Other income for the year ended December 31, 1996 includes two nonrecurring gains: a $1.4 million gain on the sale of securities of another long distance 23 company and a $1.5 million gain on the sale of short term U.S. Treasury securities. The remainder of other income consists primarily of investment income earned on the Company's cash balances resulting primarily from the unapplied proceeds of the Company's public offering in April and May 1996 and excess cash from operations. Provision for income taxes. The Company's effective tax rate declined to 37.7% in 1996 from the pro forma effective tax rate of 40.0% in 1995 due to the lower effective state tax rate in 1996. LIQUIDITY AND CAPITAL RESOURCES The Company has since September 1995 raised capital primarily through public and private distributions of its securities. In fall 1995 and spring 1996, the Company consummated public offerings of shares of the Company's Common Stock and received net proceeds of $42.8 million and $139.1 million, respectively. In September 1997, the Company privately sold $300 million of 4 1/2% Convertible Subordinated Notes which mature on September 15, 2002 (the "2002 Convertible Notes"). Interest on the 2002 Convertible Notes is due and payable semiannually on March 15 and September 15 of each year. The 2002 Convertible Notes are convertible, at the option of the holder thereof, at any time after December 9, 1997 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $24.61875 per share. The 2002 Convertible Notes are redeemable, in whole or in part, at the Company's option, at any time on or after September 15, 2000 at 101.80% of par prior to September 14, 2001 and 100.90% of par thereafter. In December 1997, the Company privately sold $200 million of 5% Convertible Subordinated Notes which mature on December 15, 2004 (the "2004 Convertible Notes"). Interest on the 2004 Convertible Notes is due and payable semiannually on June 15 and December 15 of each year. The 2004 Convertible Notes are convertible, at the option of the holder thereof, at any time after March 5, 1998 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $25.47 per share. The 2004 Convertible Notes are redeemable, in whole or in part at the Company's option, at any time on or after December 15, 2002 at 101.43% of par prior to December 14, 2003 and 100.71% of par thereafter. During 1996, certain options and warrants to purchase shares of the Company's Common Stock were exercised and the Company repurchased approximately 428,000 shares, which are held as treasury shares, yielding to the Company net proceeds of $7.8 million. During 1997, certain options and warrants to purchase shares of the Company's Common Stock were exercised and the Company repurchased certain Common Stock Warrants, yielding to the Company net proceeds of $16.9 million. In addition, during 1997 the Company repurchased approximately 3.5 million shares of the Company's Common Stock, which are held as treasury shares, for approximately $72.0 million. The tax benefit realized from the options and warrants was approximately $21.3 million in 1996 and $25.7 million in 1997 and is reflected as an adjustment to additional paid-in capital. The Company's working capital was $634.8 million and $175.6 million at December 31, 1997 and December 31, 1996, respectively. The significant increase in working capital is primarily a result of the sale of the 2002 and 2004 Convertibles Notes, discussed above. In the first quarter of 1998, the Company invested $300 million in a tax exempt bond fund, $245 million in government bond funds and incurred $155 million of margin account indebtedness in connection with these investments. While the Investment Company Act of 1940, as amended (the "Investment Company Act"), principally regulates vehicles for pooled investments in securities, such as mutual funds, it also may be deemed to be applicable to companies that are not organized for the purpose of investing or trading in securities but nonetheless have more than a specified percentage of their assets in investment securities. The Company is engaged in the telecommunications business, and the availability of cash and liquid securities is important to the Company's ability to take advantage of opportunities to acquire other telecommunications businesses, assets and technologies from time to time. The Company believes, therefore, that its activities do not and will not subject the Company to regulation under the Investment Company Act. However, if the Company were to be deemed to be an investment company within the meaning of the Investment Company Act, the Company would become subject to certain restrictions relating to the Company's activities, including, but not limited to, restrictions on the conduct of its business, the nature of its investments, the issuance of securities and transactions with affiliates. Therefore, the characterization of the Company as an investment company would have a material adverse effect on the Company. In the Indenture governing the 2002 Convertible Notes, the Company has covenanted that it will not become an investment company within the meaning of the Investment Company Act and that it will take all such actions as are necessary in order to continue not to be deemed an investment company. In light of the Company's cash position, the Company recently notified its bank of its intention to terminate its line of credit. The Company invested $28.9 million in capital equipment during 1997, of which $17.1 million was used for the acquisition of capital equipment and installation costs relating to the deployment of OBN and the remainder of which was primarily used for the acquisition of computer equipment utilized in connection with the offering of the Company's services on AOL. To date, through December 31, 1997, the Company has invested $41.9 million for the acquisition of capital equipment and installation costs relating to the deployment of OBN. The Company generally does not have a significant concentration of credit risk with respect to accounts receivable due to the large number of partitions and end users comprising the Company's customer base and their dispersion across different geographic regions. The Company maintains reserves for potential credit losses and, to date, such losses have been within the Company's expectations. The Company has announced that its Board has authorized the repurchase up to eight million shares of its Common Stock. It is anticipated that the repurchased shares will be held in treasury for issuance upon exercise of outstanding options and warrants and upon conversion, if any, of convertible notes, and for other general corporate purposes. As noted above in connection with the AOL Agreement, the Company issued two warrants to AOL to purchase shares of the Company's Common Stock, including a warrant to purchase 5 million shares at an exercise price of $15.50 per share. AOL is exercising this warrant as to 1 million shares of Company Common Stock on a net issuance basis and the Company is repurchasing from AOL all of the 380,624 shares issued upon such net issuance exercise for $23 1/4 per share. In connection with such purchases, AOL agreed not to dispose of any shares of the Company's Common Stock acquired by AOL under any of these warrants until March 30, 1999. 24 The Company believes that its current cash position, marketable securities and the cash flow expected to be generated from operations, will be sufficient to fund its capital expenditures, working capital and other cash requirements for at least the next twelve months. YEAR 2000 The "Year 2000" issue refers to the potential harm from computer programs that identify dates by the last two digits of the year rather than using the full four digits. As such, dates after January 1, 2000 could be misidentified, and such programs could fail. The Company has examined its computer-based systems and believes that the "Year 2000" problem is not present in such systems. However, the Company is dependent upon computer systems operated by third parties, such as LECs, AT&T, AOL and other vendors. If those systems were to malfunction due to the "Year 2000" problem, the Company's services could fail, as well. Such failures could have a material adverse effect upon the Company's business, results of operations and financial condition. The Company is inquiring of such third parties to determine the effect, if any, of the "Year 2000" problem on the systems upon which the Company is dependent, and to obtain appropriate assurances that no such problem exists. * * * * * Certain of the statements contained herein may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements are identified by the use of forward-looking words or phrases, including, but not limited to, "estimates," "expects," "expected," "anticipates," and "anticipated." These forward-looking statements are based on the Company's current expectations. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct. Forward-looking statements involve risks and uncertainties and the Company's actual results could differ materially from the Company's expectations. Important factors that could cause such actual results to differ materially include, among others, adverse developments in the Company's relationship with AT&T or AOL, increased price competition for long distance services, failure of the marketing of long distance services under the AOL Agreement, attrition in the number of end users, and changes in government policy, regulation and enforcement. The Company undertakes no obligation to update its forward-looking statements. 25 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants 27 Consolidated balance sheets as of December 31, 1997 and 1996 28 Consolidated statements of operations for the years ended December 31, 1997, 1996, and 1995 29 Consolidated statements of stockholders' equity for the years ended December 31, 1997, 1996 and 1995 30 Consolidated statements of cash flows for the years ended December 31, 1997, 1996 and 1995 31 Notes to consolidated financial statements 32
26 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Tel-Save Holdings, Inc. We have audited the accompanying consolidated balance sheets of Tel-Save Holdings, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tel-Save Holdings, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. BDO Seidman, LLP New York, New York February 5, 1998 27 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT FOR SHARE DATA)
DECEMBER 31, ------------------------------------------- 1997 1996 ---- ---- ASSETS CURRENT: Cash and cash equivalents $316,730 $ 8,023 Marketable securities 212,269 149,237 Accounts receivable, trade net of allowance for uncollectible accounts of $2,419 and $987, respectively 44,587 19,971 Advances to partitions and note receivables 26,110 13,410 Due from broker 21,087 867 Prepaid AOL marketing costs - current 30,857 -- Deferred taxes - current 30,916 -- Prepaid expenses and other current assets 8,495 10,377 -------- -------- Total current assets 691,051 201,885 Property and equipment, net 55,835 30,097 Intangibles, net 10,590 21,102 Prepaid AOL marketing costs 32,722 -- Other assets 24,693 3,924 -------- -------- Total assets $814,891 $257,008 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT: Accounts payable and accrued expenses: Trade and other $ 16,858 $ 19,404 Partitions 7,740 4,398 Interest and other 10,578 1,619 Securities sold short 21,087 867 --------- --------- Total current liabilities 56,263 26,288 Convertible debt 500,000 -- Deferred revenue 35,800 -- - ---------------- --------- --------- Total liabilities 592,063 26,288 --------- --------- Commitments and Contingencies Stockholders' equity Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares outstanding -- -- Common stock - $.01 par value, 300,000,000 shares authorized; 67,249,635 and 62,237,998 issued, respectively 672 622 Additional paid-in capital 291,952 210,616 Retained earnings 3,097 24,042 Treasury stock (72,893) (4,560) -------- -------- Total stockholders' equity 222,828 230,720 -------- -------- Total liabilities and stockholders' equity $814,891 $257,008 ======== ========
See accompanying notes to consolidated financial statements. 28 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
1997 1996 1995 ---- ---- ---- Sales $304,768 $232,424 $180,102 Cost of sales 355,169 200,597 156,121 -------- -------- -------- Gross profit (loss) (50,401) 31,827 23,981 Selling, general and administrative expenses 34,650 10,039 6,280 -------- -------- -------- Operating income (loss) (85,051) 21,788 17,701 Investment and other income, net 50,715 10,585 331 -------- -------- -------- Income (loss) before provision for income taxes (34,336) 32,373 18,032 Provision (benefit) for income taxes (13,391) 12,205 8,997 -------- -------- -------- Net income (loss) $(20,945) $ 20,168 $ 9,035 ======== ======== ======== Net income (loss) per share - Basic $ (.33) $ .38 ======== ======== Weighted average common shares outstanding - Basic 64,168 52,650 ======== ======== Net income (loss) per share - Diluted $ (.33) $ .35 ======== ======== Weighted average common and common equivalent shares 64,168 57,002 ========= ======== outstanding - Diluted Pro forma: Income before provision for income taxes $ 18,032 Pro forma provision for income taxes 7,213 -------- Pro forma net income $ 10,819 ======== Pro forma net income per share - Basic $ .34 ======== Weighted average common share outstanding - Basic 31,422 ======== Pro forma net income per share - Diluted $ .32 ======== Weighted average common and common equivalent shares 33,605 ======== outstanding - Diluted
See accompanying notes to consolidated financial statements. 29 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK ADDITIONAL TREASURY STOCK -------------------------- PAID-IN RETAINED -------------------------- SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT TOTAL ----------- ----------- ------------- ----------- ----------- ------------ --------- Balance, January 1, 1995 9,550 $ 95 $ -- $ 13,947 -- $ -- $ 14,042 Net income -- -- -- 9,035 -- -- 9,035 Cash distributions -- -- -- (13,200) -- -- (13,200) Stock redemption -- -- -- (11,400) -- -- (11,400) Reclassification of S Corporation deficit -- -- (5,492) 5,492 -- -- -- Sale of common stock 3,450 35 42,802 -- -- -- 42,837 Three-for-two stock split 6,500 65 (65) -- -- -- --------- ------ --------- -------- ----- -------- --------- Balance, December 31, 1995 19,500 195 37,245 3,874 -- -- 41,314 Net income -- -- -- 20,168 -- -- 20,168 Issuance of warrants to partitions . -- -- 1,077 -- -- -- 1,077 Sale of common stock 8,534 85 138,984 -- -- -- 139,069 Exercise of common stock options 1,079 11 4,927 -- -- -- 4,938 Exercise of warrants 2,006 20 7,383 -- -- -- 7,403 Income tax benefit related to exercise of common -- -- 21,311 -- -- -- 21,311 stock options and warrants Acquisition of treasury stock -- -- -- -- (428) (4,560) (4,560) Two-for-one stock split 31,119 311 (311) -- -- -- -- -------- --------- ---------- -------- ----- -------- -------- Balance, December 31, 62,238 622 210,616 24,042 (428) (4,560) 230,720 1996 Net loss -- -- -- (20,945) -- -- (20,945) Issuance of warrants to AOL -- -- 21,200 -- -- -- 21,200 Issuance of common stock for acquired business 141 1 2,217 -- -- -- 2,218 Exercise of common stock warrants 2,662 27 11,977 -- -- -- 12,004 Exercise of common stock options 2,209 22 9,318 -- -- -- 9,340 Purchase of common stock warrants -- -- (4,400) -- -- -- (4,400) Issuance of common stock options for compensation -- -- 13,372 -- -- -- 13,372 Acquisition of -- -- -- -- (3,520) (71,959) (71,959) treasury stock Issuance of treasury stock for acquired business -- -- 1,999 -- 340 3,626 5,625 Income tax benefit related to exercise of common stock options and warrants -- -- 25,653 -- -- -- 25,653 -------- -------- --------- -------- ------- --------- --------- Balance, December 31, 1997 67,250 $672 $291,952 $ 3,097 (3,608) $(72,893) $222,828 ======== ========= ========= ======== ======= ========= =========
See accompanying notes to consolidated financial statements. 30 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
1997 1996 1995 ---- ---- ---- Cash flows from operating activities: Net income (loss) $ (20,945) $ 20,168 $ 9,035 Adjustment to reconcile net income to net cash provided by operating activities: Unrealized loss on securities 1,865 179 234 Provision for bad debts 1,579 38 (28) Depreciation and amortization 5,429 2,462 1,287 Charge for customer acquisition costs 11,550 -- -- Write-off of intangibles 23,032 -- -- Compensation charges 13,372 -- -- AOL marketing costs 58,185 -- -- Deferred credits -- (280) -- Income tax benefit related to exercise of options and warrants 25,653 21,311 -- (Increase) decrease in: Accounts receivable, trade (26,048) (1,065) (2,996) Advances to partitions and note receivables (12,700) (20,797) (1,700) Prepaid AOL marketing costs (100,564) Prepaid expenses and other current assets (38,259) (10,183) 1,400 Other assets (20,769) (3,924) -- Increase (decrease) in: Accounts and partition payables and accrued expenses 9,608 7,978 12,047 Deferred revenue 35,800 -- -- Income taxes payable -- (5,184) 5,184 --------- ------- -------- Net cash (used in) provided by operating activities (33,212) 10,703 24,463 --------- ------- -------- Cash flows from investing activities: Acquisition of intangibles (9,293) (9,800) (1,057) Capital expenditures, net (28,876) (27,679) (2,330) Securities sold short 17,700 (411) 866 Due from broker (20,220) 233 (1,100) Loans to stockholder -- (3,034) (2,075) Repayment of stockholder loans -- 5,109 -- Purchase of marketable securities (62,377) (149,238) -- --------- -------- -------- Net cash used in investing activities (103,066) (184,820) (5,696) --------- -------- -------- Cash flows from financing activities: Proceeds from sale of convertible subordinated notes 500,000 -- -- Payments to related parties -- -- (1,725) Payment of note payable to stockholder -- (5,921) (979) Proceeds from sale of common stock -- 139,069 42,837 Proceeds from exercise of options and warrants 21,344 12,341 -- Purchase of common stock warrants (4,400) -- -- Acquisition of treasury stock (71,959) (4,560) -- Distributions to stockholders -- -- (13,200) Stock redemption -- -- (4,500) --------- --------- -------- Net cash provided by financing activities 444,985 140,929 22,433 --------- --------- -------- Net increase (decrease) in cash and cash equivalents 308,707 (33,188) 41,200 Cash and cash equivalents, at beginning of period 8,023 41,211 11 --------- ---------- -------- Cash and cash equivalents, at end of period $316,730 $ 8,023 $ 41,211 ========= ========== ========
See accompanying notes to consolidated financial statements. 31 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- SUMMARY OF ACCOUNTING POLICIES (a) Business Tel-Save Holdings, Inc. (the "Company"), which is incorporated in Delaware, provides long distance services to small and medium-sized businesses located throughout the United States. The Company's long distance service offerings include outbound service, inbound toll-free 800 service and dedicated private line services for data. (b) Reorganization On September 21, 1995, the Company consummated its initial public offering ("IPO") (Note 10(b)). The shares of Tel-Save, Inc., a Pennsylvania corporation (the "Predecessor Corporation"), owned by the two founding stockholders were contributed to the Company as of the date of the IPO. The majority stockholder exchanged all of his shares of the Predecessor Corporation for 21,060,000 shares of the common stock of the Company plus loans of up to $5,000,000. The majority stockholder repaid his outstanding indebtedness, including interest, using a portion of his proceeds from the sale of 1,500,000 shares of common stock in connection with the Company's public offering in April 1996 (Note 10(a)). The minority stockholder exchanged all his shares of the Predecessor Corporation for 7,590,000 shares of the common stock of the Company, $4,500,000 in cash plus a note (the "Cash Flow Note") in the original principal amount of $6,900,000 bearing interest at 10% per annum which was guaranteed by the majority stockholder. The payment and the issuance of the Cash Flow Note to the minority stockholder are accounted for as a distribution of capital. In January 1996, the Company paid the remaining balance of $5,921,000 due under the Cash Flow Note. The transactions described above are collectively referred to as the "Reorganization." (c) Basis of financial statements presentation The consolidated financial statements include the accounts of Tel-Save Holdings, Inc. and its wholly-owned subsidiaries and have been prepared as if the entities had operated as a single consolidated group since their respective dates of incorporation. All intercompany balances and transactions have been eliminated. In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. (d) Recognition of revenue The Company recognizes revenue upon completion of telephone calls by end users. Allowances are provided for estimated uncollectible usage. (e) Cash and cash equivalents The Company considers all temporary cash investments purchased with a maturity of three months or less to be cash equivalents. (f) Marketable securities The Company buys and holds securities principally for the purpose of selling them in the near term and therefore, they are classified as trading securities and carried at market. Unrealized holding gains and losses (determined by specific identification) on investments classified as trading securities are included in earnings. (g) Advances to partitions and note receivables The Company makes advances to partitions to support their marketing activities. The advances are secured by partition assets, including contracts with end users and collections theron. (h) Property and equipment and depreciation Property and equipment are recorded at cost. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of the assets, as follows: Buildings and building improvement 39 years Switching equipment 15 years Equipment, vehicles and other 5-7 years 32 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (i) Intangibles and amortization Intangibles include the costs to acquire billing bases of customer accounts, long-distance service contract pricing plans and goodwill arising from business acquisitions. Amortization is computed on a straight-line basis over the estimated useful lives of the intangibles which is 15 years. (j) Deferred revenue Deferred revenue is recorded for a prepayment for telecommunications services under an agreement with Shared Technologies Fairchild, Inc. ("STF") and is amortized over the five year term of the agreement. This agreement is terminable by either party on thirty days notice. Termination by either party would accelerate recognition of the deferred revenue. (k) Long-lived assets The Company adopted SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" as of January 1, 1996 and its implementation did not have a material effect on the consolidated financial statements. (l) Income taxes Deferred tax assets and liabilities are recorded for the estimated future tax effects attributable to temporary differences between the basis of assets and liabilities recorded for financial and tax reporting purposes (Note 12). (m) Net income per share During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"). "Earnings per Share," which provides for the calculation of "basic" and "diluted" earnings per share. This Statement is effective for financial statements issued for periods ending after December 15, 1997. Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of common shares issuable upon exercise of stock options. As required by this Statement, all periods presented have been restated to comply with the provisions of SFAS No. 128. The computation of basic net income per share is based on the weighted average number of common shares outstanding during the period. In 1996 and 1995, diluted earnings per share also includes the effect of 4,352,000 and 2,183,000 common shares, respectively, issuable upon exercise of common stock options and warrants. Net income per share for the year ended December 31, 1995 is based on pro forma net income. All references in the consolidated financial statements with regard to average number of common stock and related per share amounts have been calculated giving retroactive effect to the exchange of shares in the Reorganization and the stock splits. (n) Financial instruments and risk concentration Financial instruments which potentially subject the Company to concentrations of credit risk are cash investments and marketable securities. At December 31, 1997, a large majority of the Company's cash investments and marketable securities were invested in money market funds and commercial paper. The carrying amount of these cash investments approximates the fair value due to their short maturity. The Company believes no significant concentration of credit risk exists with respect to these cash investments and marketable securities. In the first quarter of 1998, the Company invested $300 million in a tax exempt bond fund, $245 million in government bond funds and incurred $155 million of margin account indebtedness in connection with these investments. (o) Securities sold short/financial investments with off-balance sheet risk At December 31, 1997, securities sold short by the Company, which consist of equity securities valued at market, resulted in an obligation to purchase such securities at a future date. Securities sold short may give rise to off-balance sheet market risk. The Company may incur a loss if the market value of these securities subsequently increases. (p) Stock-based Compensation The Company accounts for its stock option awards under the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value based method, compensation cost is the excess. if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. The Company makes pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied as required by Statement of Financial Accounting Standards ("SFAS") 123, "Accounting for Stock-Based Compensation." (q) New Accounting Pronouncements In June 1997, the FASB issued SFAs No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income, its components and accummulated balances, comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, SFAS 130 requires that all items that are required to be rocognized under current accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominance as other financial statements. SFAS 130 is effective for financial statements for periods beginning after December 25, 1997 and requires comparative information for earlier years to be restated. Because of the recent issuance of this standard, management has been unable to fully evaluate the impact, if any, the standard may have on future financial statement disclosures. Results of operations and financial position, however, will be unaffected by implementation of this standard. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131. Disclosures about Segments of an Enterprise and Related Information, (SFAS 131) which supercedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. SFAS 131 establishes standards for the way that public companies report information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial statements issued to the public. It also establishes standards for customers. SFAS 131 defines operating segments as components of a company about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and is assessing performance. SFAS 131 is effective for financial statements for periods beginning after December 15, 1997 and requires comparative information for earlier years to be restated. Because of the relatively recent issuance of this standard, management has been unable to fully evaluate the impact, if any, it may have on future financial statement disclosures. Results of operations and financial position, however, will be unaffected by implementation of this standard. 33 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 2 -- MAJOR PARTITIONS Partitions who provided end user accounts, which in the aggregate account for more than 10% of sales, are as follows:
Number of Total Percentage Partitions Of Sales ----------------------- ----------------------- Year ended December 31, 1997 1 13% Year ended December 31, 1996 1 11% Year ended December 31, 1995 -- --
NOTE 3 -- CUSTOMER ACQUISITION The Company determined in the second quarter of 1997 to de-emphasize the use of direct marketing to solicit customers for the Company as the carrier and to focus the majority of its existing direct marketing resources on customer service and support for the marketing operations of its carrier partitions, on a fee basis. The Company recognized fees of $8.1 million for the year ended December 31, 1997, included in other income, from the services net of related costs of $14.6 million for the year ended December 31, 1997. The Company recorded a one-time charge of $11.5 million in the quarter ended June 30, 1997, primarily as a result of the Company as cost of sales changing its accounting for customer acquisition costs to expense them in the period incurred versus the Company's prior treatment of capitalizing customer acquisition costs and amortizing them over a six month period. In October 1997, the Company decided to discontinue its internal telemarketing operations which were primarily conducted through American Business Alliance (which was acquired by the Company in December 1996), as part of its restructuring of its sales and marketing efforts and wrote-off as cost of sales approximately $23.0 million of intangible assets. NOTE 4 -- AOL AGREEMENT In conjunction with the Telecommunications Marketing Agreement (the "AOL Agreement") with America Online, Inc. ("AOL"), the Company paid AOL a total of $100 million and issued two warrants to purchase shares of the Company's stock, one warrant (the "First Warrant") to purchase, at an exercise price of $15.50 per share, up to 5,000,000 shares, which vested as to 2,500,000 shares on October 9, 1997 ("Commercial Launch Date"), when the Company's service was launched on the AOL online network, and as to 2,500,000 shares on February 22, 1998, and one warrant (the "Second Warrant") to purchase, at an exercise price of $14.00 per share, up to 7,000,000 shares, which will vest, commencing December 31, 1997, based on the number of subscribers to the Company's service and would vest fully if there are at least 3.5 million such subscribers at any one time. As of December 31, 1997 the second warrant was vested as to approximately 120,000 shares. The initial term of the AOL Agreement runs to June 30, 2000, and the AOL Agreement provides for annual extensions by AOL of its term thereafter. The $100 million cash payment, the $20.0 million value of the First Warrant and $0.6 million of agreement related costs is accounted for as follows: (i) $35.9 million was charged to expense ratably over the period from the signing of the AOL Agreement to December 31, 1997, as payment for certain exclusivity rights for that period; (ii) $13.2 million was treated as production of advertising costs and was charged to expense on October 9, 1997, the Commercial Launch Date; and (iii) $71.5 million, the balance of the cash payment and the value of the First Warrant and AOL Agreement related costs, represents the combined value of advertising and exclusivities which extend over the term of the AOL Agreement and will be recognized ratably after the Commercial Launch Date as advertising services are received. For the year ended December 31, 1997, the Company recognized $57.0 million of expense, related to items discussed above. The AOL Agreement also provides for marketing payments to AOL based on the "pre-tax profit" (as defined in the AOL Agreement) in each calendar quarter from the telecommunications services provided by the Company. AOL's share of the pre-tax profit will vary from 50% to 70%, depending upon the level of revenues from such services. The Company will withhold a portion of AOL's share of the pre-tax profit as a recovery of the initial $100 million cash payment. The Company is permitted to withhold up to $4.3 million in each of the 10 quarters ending after December 31, 1997 and to withhold 33% of AOL's share of the pre-tax profits for every quarter ending after June 30, 2002 until the entire $100 million cash payment has been recovered. AOL's share of pre-tax profits in excess of the $4.3 million and 33% will be distributed as earned. The AOL Agreement also provides for the grant to AOL of additional warrants to purchase up to an aggregate of 2 million shares if AOL extends its obligations under the AOL Agreement beyond June 30, 2000. The fair value of any such additional warrants that may be granted to AOL will be charged as an expense in the statement of operations. 34 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 5 -- PROPERTY AND EQUIPMENT
DECEMBER 31, ----------------------------------------------- 1997 1996 --------------------- ---------------------- (In thousands) Land $ 220 $ 220 Buildings and building improvements 4,259 3,398 Switching equipment 41,915 -- Switching equipment under construction -- 24,861 Equipment, vehicles and other 13,078 2,117 -------- --------- 59,472 30,596 Less: Accumulated depreciation (3,637) (499) -------- --------- $ 55,835 $30,097 ======== =========
NOTE 6 -- INTANGIBLES
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1997 1996 --------------------- ---------------------- (In thousands) Goodwill $10,590 $18,356 Other -- 6,533 ------- ------- 10,590 24,889 Less: Accumulated depreciation -- 3,787 ------- ------- $10,590 $21,102 ======= =======
NOTE 7 -- ACQUISITIONS In November 1997 the Company acquired Compco, Inc. ("Compco") a provider of communications software in the college and university marketplace, for a total purchase price of $13,125,000, comprised of a cash payment of $7,500,000 and 339,982 shares of Company common stock. This transaction was accounted for as a purchase with the results of Compco included in the consolidated financial statements from acquisition date. The cost in excess of the net asset acquired (goodwill) was approximately $10,590,000. In February 1998, the Company completed the acquisition of Symetrics Industries, Inc. ("Symetrics"), a Florida corporation for approximately $25 million in cash, plus assumed liabilities. Symetrics designs, develops and manufactures electronic systems, system components and related software for defense-related products and for telecommunication applications. This transaction will be accounted for as a purchase. The Company is in the process of allocating the purchase price among the assets of Symetrics. 35 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) NOTE 8 -- CONVERTIBLE DEBT In September 1997, the Company sold $300 million of 4 1/2% Convertible Subordinated Notes which mature on September 15, 2002 (the "2002 Convertible Notes"). Interest on the 2002 Convertible Notes are due and payable semiannually on March 15 and September 15 of each year. The 2002 Convertible Notes are convertible, at the option of the holder thereof, at any time after December 9, 1997 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $24.61875 per share. The 2002 Convertible Notes are redeemable, in whole or in part, at the Company's option, at any time on or after September 15, 2000 at 101.80% of par prior to September 14, 2001 and 100.90% of par thereafter. In December 1997, the Company sold $200 million of 5% Convertible Subordinated Notes which mature on December 15, 2004 (the "2004 Convertible Notes"). Interest on the 2004 Convertible Notes are due and payable semiannually on June 15 and December 15 of each year. The 2004 Convertible Notes are convertible, at the option of the holder thereof, at any time after March 5, 1998 and prior to maturity, unless previously redeemed, into shares of the Company's Common Stock at a conversion price of $25.47 per share. The 2004 Convertible Notes are redeemable, in whole or in part at the Company's option, at any time on or after December 15, 2002 at 101.43% of par prior to December 14, 2003 and 100.71% of par thereafter. NOTE 9 -- RELATED PARTY TRANSACTIONS At December 31, 1997, executive officers of the Company had outstanding loans from the Company of $4,237,000 which were repaid during the first quarter of 1998. In connection with the Reorganization (Note 1(b)), the Company made distributions of the Company's 1995 taxable income through September 19, 1995 of approximately $13,200,000 in 1995 to its two founding stockholders. NOTE 10 -- STOCKHOLDERS' EQUITY (a) 1996 Public Offering The Company consummated a public offering (the "1996 Offering") of 18,568,000 shares of common stock (adjusted to reflect the most recent stock split, Note 10(c)), including the underwriter's over-allotment, at a price of $8.75 per share in April and May, 1996. Of the 18,568,000 shares offered, 17,068,000 were sold by the Company and 1,500,000 were sold by the majority stockholder. Proceeds of the 1996 Offering to the Company, less underwriting discounts of approximately $9,302,000, were approximately $140,043,000. Expenses for the 1996 Offering were approximately $974,000 resulting in net proceeds to the Company of approximately $139,069,000. The majority stockholder used a portion of his proceeds to repay his outstanding indebtedness, including interest, to the Company. (b) Initial Public Offering In September and October, 1995, the Company consummated its IPO of 10,350,000 shares of common stock (adjusted to reflect stock splits, Note 10(c)), including the underwriter's overallotment option, at a price of $4.59 per share. Proceeds of the offering less underwriting discounts of approximately $3,151,000 were $44,287,000. Expenses for the IPO totaled approximately $1,450,000, resulting in net proceeds to the Company of approximately $42,837,000. In connection with the IPO, the Company issued warrants to purchase 900,000 shares of common stock to the underwriter. The exercise price of the warrants is $5.73 per share of common stock and such warrants expire on September 21, 2000. (c) Stock Splits On January 3, 1997, the Company's Board of Directors approved a two-for-one split of the common stock in the form of a 100% stock dividend. The additional shares resulting from the stock split were distributed on January 31, 1997 to all stockholders of record at the close of business on January 17, 1997. The consolidated balance sheet as of December 31, 1996 and the consolidated statement of stockholders' equity for the year ended December 31, 1996 reflect the recording of the stock split as if it had occurred on December 31, 1996. 36 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) On February 16, 1996, the Company's Board of Directors approved a three-for-two split of the common stock in the form of a 50% stock dividend. The additional shares resulting from the stock split were distributed on March 15, 1996, to all stockholders of record at the close of business on February 29, 1996. The consolidated balance sheet as of December 31, 1995 and the consolidated statement of stockholders' equity for the year ended December 31, 1995 reflect the recording of the stock split as if it had occurred on December 31, 1995. Further, all references in the consolidated financial statements to average number of shares outstanding and related prices, per share amounts, warrant and stock option data have been restated for all periods to reflect the stock splits. (d) Authorized Shares During 1997, the Board of Directors and stockholders approved the increase in the number of authorized shares of the Company's $0.01 par value common stock to 300,000,000 shares. NOTE 11 -- STOCK OPTIONS AND WARRANTS (a) Stock Options The Company has both qualified and non-qualified stock option agreements with most of its key employees. Prior to the Company's Initial Public Offering in September, 1995, the Company granted ten key employees options to purchase shares of the Company's common stock. The exercise price of the options, was based on the fair market value of the Company at the date of grant. The options vest 22 months from the date of issuance and expire five years from the date of grant. All options were vested as of December 31, 1996. In 1995, 1996 and 1997, the Company granted options to purchase a total of 100,000 shares of common stock to each of the two nonemployee directors of the Company. In September 1995, the Company's Board of Directors and stockholders adopted the Company's 1995 Employee Stock Option Plan (the "Option Plan") which provided for the granting of up to 1,950,00 shares of common stock. An amendment to the Option Plan was approved by the Board of Directors and stockholders in April 1996 increasing the authorized number of options which can be granted under the Option Plan to 5,000,000 shares of common stock. As of December 31, 1997, 4,985,000 options had been granted under the Option Plan. In 1996 and 1997 the Company granted certain employees 3,561,000 and 2,741,000, respectively, non-qualified options to purchase shares of the Company's common stock. These options become exercisable from one to three years from the date of the grant. During 1997, The company recognized $13,371,785 of compensation expenses related to the grant of options or the purchase of the Company's stock at prices below the quoted market price at date of grant or purchase date. SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to provide pro forma information regarding net income and earnings per share as if compensation cost for the Company's stock options had been determined in accordance with the fair value-based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1995, 1996 and 1997, respectively: no dividends paid for all years; expected volatility of 40.4% in 1995 and 1996 and 55.8% in 1997; weighted average risk-free interest rates of 5.8%, 5.7%, and 5.49%, respectively; and expected lives of 1 to 5 years. 37 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Under the accounting provisions of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below.
1997 1996 1995 ---- ---- ---- (In thousands, except for per share data) NET INCOME: As reported $ (20,945) $20,168 $10,819 Pro forma (30,942) $16,521 $10,436 BASIC EARNINGS PER SHARE: As reported $ (.33) $ .38 $ .34 Pro forma $ (.48) $ .31 $ .31 DILUTED EARNINGS PER SHARE: As reported $ (.33) $ .35 $ .32 Pro forma $ (.48) $ .29 $ .31
The following tables contain information on stock options for the three year period ended December 31, 1997:
EXERCISE WEIGHTED OPTION PRICE RANGE AVERAGE SHARES PER SHARE EXERCISE PRICE ---------------- ---------------- ---------------- Outstanding, December 31, 1994 2,455,800 $ .32-$1.57 $ .48 Granted 1,950,000 $ 4.58 $ 4.58 ---------------- ---------------- ---------------- Outstanding, December 31, 1995 4,405,800 $ .32-$4.58 $ 2.30 Granted 6,736,000 $ 4.09-$12.00 $ 7.96 Exercised (2,158,000) $ .32-$5.67 $ 2.28 ---------------- ---------------- ---------------- Outstanding, December 31, 1996 8,983,800 $ .32-$12.00 $ 6.54 Granted 2,801,000 $ 5.67-$22.06 $16.02 Exercised (2,208,812) $ .32-$12.78 $ 4.25 Cancelled (690,000) $ 5.67-$13.25 $11.98 ---------------- ---------------- ---------------- Outstanding, December 31, 1997 8,885,988 .32-$22.06 $ 9.26 === ==== ================ ================ ================ EXERCISE WEIGHTED OPTION PRICE RANGE AVERAGE EXERCISABLE AT YEAR ENDED DECEMBER 31, SHARES PER SHARE EXERCISE PRICE - ------------------------------------------- ---------------- ---------------- ---------------- 1995 1,515,600 $ .32 $ .32 1996 2,649,800 $ .32-$4.58 $ 2.82 1997 3,866,987 $ .32-$14.50 $ 7.24 WEIGHTED-AVERAGE OPTIONS GRANTED IN FAIR VALUE - ------------------ ---------- 1995 $1.14 1996 $2.39 1997 $6.99
The following table summarizes information about stock options outstanding at December 31, 1997:
RANGE OF EXERCISE PRICE --------------------------------------------------------------------------------------- $.32-$5.00 $5.01-$10.00 $10.01-$15.00 $15.00-$22.06 $.32-$22.06 ------------- ------------- ---------------- --------------- -------------- OUTSTANDING OPTIONS: Number outstanding at December 31, 1997 2,776,988 2,382,000 1,989,500 1,742,500 8,885,988 Weighted-Average remaining contractual life (Years) 1.94 1.69 2.11 3.12 2.18 Weighted-average exercise price $ 3.48 $ 8.52 $ 11.47 $ 17.57 $ 9.26 EXERCISABLE OPTIONS: Number outstanding at December 31, 1997 1,596,988 779,000 1,490,999 - 3,866,987 Weighted-average exercise price $ 2.68 $ 8.66 11.37 - $ 7.23
(b) Warrants 38 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) At December 31, 1996, the Company had warrant agreements with certain partitions and the underwriter for its IPO (Note 10(b)). All warrants were issued with exercise prices equal to or above the market price of the underlying stock at the date of the grant. These warrants are accounted for based on their fair value. At December 31, 1996, 3,712,000 warrants were outstanding with exercise prices ranging from $4.67 to $5.73 and an average weighted exercise price of $5.00 and 600,000 which were currently exercisable at a weighted exercise price of $5.73. The remaining warrants are exercisable over a one to two year period beginning in January 1997. In January 1997, 800,000 of these warrants were purchased by the Company and recorded as a reduction in additional paid-in capital and 2,662,000 warrants were exercised. At December 31, 1997, warrants to purchase 12,250,000 shares were outstanding; these consisted of the 12,000,000 AOL warrants (Note 4) and 250,000 of the warrants issued to the underwriter for the Company's IPO (Note 10(b)). NOTE 12 -- INCOME TAXES On June 1, 1991, the Company, with the consent of its stockholders, elected to be taxed as an S Corporation. As a result of the election, all earnings of the Predecessor Corporation were taxed directly to the stockholders. Accordingly, the statements of operations prior to September 20, 1995 did not include provisions for income taxes. In connection with the Company's IPO, as described in Note 10(b), on September 19, 1995, the Company terminated its S Corporation status. Pro forma tax provisions have been calculated as if the Company's results of operations were taxable as a C Corporation under the Internal Revenue Code for the year ended December 31, 1995. The following summarizes the provision for pro forma income taxes: YEAR ENDED DECEMBER 31, --------------- 1995 ---- (In thousands) Current: Federal $5,574 State and local 1,639 ------- Pro forma provision for income taxes $7,213 ======= 39 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The provision for pro forma income taxes on adjusted historical income for the year ended December 31, 1995 differs from the amounts computed by applying the applicable Federal statutory rates due to the following: YEAR ENDED DECEMBER 31, ---------------- 1995 ---- (In thousands) Provision for Federal income taxes at the statutory rate $6,311 State and local income taxes, net of Federal benefit 1,082 Other (180) ------- Pro forma provision for income taxes $7,213 ======== As a result of the termination, the Company was required to provide for taxes on income for the period subsequent to September 19, 1995 and for the previously earned and untaxed S Corporation income which has been deferred primarily as a result of reporting on a cash basis. The provision (benefit) for income taxes for the years ended December 31, 1997, 1996 and 1995 consisted of the following:
YEAR ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 ---- ---- ---- (In thousands) Current: Federal $ - $10,995 $4,379 State and local - 1,817 1,809 ------- ------- ------ Total current - 12,812 6,188 ======= ======= ====== Deferred: Federal (11,111) (607) 2,201 State and local (2,280) - 608 ------- ------- ------ Total deferred (13,391) (607) 2,809 ------- ------- ------ $(13,391) $12,205 $8,997 ======= ======= ======
A reconciliation of the Federal statutory rate to the provision (benefit) for income taxes is as follows:
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 1997 1996 1995 ----------------------- --------------------------- ------------------------- (In thousands) Federal income taxes computed at the statutory rate $(12.018) (35.0)% $11,331 35.0% $6,311 35.0% Increase (decrease): Federal income taxes at the statutory rate from January 1, 1995 to September 19, 1995 - - - - (4,086) (22.7) Federal and state taxes resulting from cash to Accrual basis for tax reporting - - - - 6,399 35.5 State income taxes less Federal benefit (1.482) (4.3) 1,199 3.7 373 2.1 Other 109 .3 (325) (1.0) - - --------- -------- -------- ------ -------- ------ Total provision (benefit) for income taxes $(13,391) (39.0)% $12,205 37.7% $8,997 49.9% ======= ===== ======= ==== ====== ====
40 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Deferred tax (assets) liabilities at December 31, 1997, 1996 and 1995 are comprised of the following elements:
YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 ---- ---- ---- (In thousands) Taxable loss carryforwards $ (21,548) $ (3,705) $ -- Deferred revenue taxable currently (13,897) -- -- Stock based compensation (4,951) -- -- Allowance for uncollectible accounts (2,198) -- -- Federal and state taxes resulting from cash to accrual basis for tax reporting 1,337 2,342 3,130 Amortization of certain intangibles - (85) (227) Other 869 (55) (94) ------------ ------------ ---------- Deferred tax (assets) liabilities $ (40,388) $ (1,503) $ 2,809 ============ ============ ==========
The Company has recorded net deferred tax assets as December 31, 1997 and 1996 primarily representing net operating loss carryforwards and other temporary differences. Management believes that no valuation allowance is required for these assets due to future reversals of existing taxable temporary differences and the exception that the Company will generate taxable income in future years. NOTE 13 -- STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------------- 1997 1996 1995 ---- ---- ---- (In thousands) Supplemental disclosure of cash flow information: Cash paid for: Interest $915 $ 47 $ 24 Income taxes $ -- $ 1,090 $ 3,813
During 1997, the Company recorded an asset of $20,000,000 in connection with the issuance of warrants to AOL (Note 4). In connection with the acquisition of Compco in 1997, the Company issued 339,982 shares of Company common stock with a value of $5,625,000 (Note 7). In connection with the acquisition of the assets of ABA in 1996, the Company released ABA of its outstanding obligations to the Company of $10,949,000. During 1996, the Company recorded an intangible of $1,077,000 in connection with the issuance of warrants to certain partitions (Note 11(b)). During 1995, the Company issued the Cash Flow Note in the amount of $6,900,000 to the minority stockholder of the Predecessor Corporation in connection with the IPO and Reorganization (Note 1(b)). NOTE 14 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER(2) ------- ------- ------- ------- (In thousands, except for per share data) 1997 Sales $71,160 $75,032 $80,314 $78,262 Gross profit (loss) 9,375 (9,264)(1) 2,097 (52,609)(1) Operating income (loss) 6,082 (13,924) (3,243) (73,966) Net income (loss) 5,430 (5,865) 721 (21,231) Net income (loss) per share - Basic 0.09 (0.09) 0.01 (0.32) Net income (loss) per share - Diluted 0.08 (0.09) 0.01 (0.32) 1996 Sales $51,065 $57,015 $60,079 $64,265 Gross profit 6,832 7,387 8,323 9,285 Operating income 4,546 4,882 5,871 6,489 Net income 3,377 4,058 7,032 5,701 Net income per share - Basic 0.09 0.08 0.12 0.10 Net income per share - Diluted 0.08 0.07 0.11 0.09
(1) See Note 3. (2) Includes $321.1 million (pre-tax) of other income associated with the break- up of a proposed merger between the Company and STF. 41 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10 THROUGH 13 Information required by Part III (Items 10 through 13) of this Form 10-K is incorporated by reference to the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held in May, 1998, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year to which this Form 10-K relates. 42 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Annual Report on Form 10-K. 1. Consolidated Financial Statements: The Consolidated Financial Statements filed as part of this Form 10-K are listed in the "Index to Consolidated Financial Statements" in Item 8. 2. Consolidated Financial Statement Schedule: The Consolidated Financial Statement Schedule filed as part of this report is listed in the "Index to S-X Schedule." Schedules other than those listed in the accompanying Index to S-X Schedule are omitted for the reason that they are either not required, not applicable, or the required information is included in the Consolidated Financial Statements or notes thereto. 43 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES INDEX TO S-X SCHEDULE PAGE ---- Report of Independent Certified Public Accountants 55 Schedule II -- Valuation & Qualifying Accounts 56 44 [LOGO] REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Tel-Save Holdings, Inc. The audits referred to in our report dated February 5, 1998 relating to the consolidated financial statements of Tel-Save Holdings, Inc. and subsidiaries, which is contained in Item 8 of this Form 10-K, included the audits of the financial statement schedule listed in the accompanying index for each of the three years in the period ended December 31, 1997. This financial statement schedule is the responsibility of management. Our responsibility is to express an opinion on this schedule based on our audits. In our opinion, the financial statement Schedule II -- Valuation and Qualifying Accounts, presents fairly, in all material respects, the information set forth therein. BDO Seidman, LLP New York, New York February 5, 1998 45 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT BEGINNING OF COSTS AND OTHER END OF DESCRIPTION PERIOD EXPENSES CHANGES DEDUCTIONS PERIOD ----------- ------ -------- ------- ---------- ------ Year ended December 31, 1997: Reserves and allowances deducted from as- set accounts: Allowance for uncollectible accounts $987 $1,285 $ 147 (a) $-- $2,419 ==== ====== ========== === ====== Year ended December 31, 1996: Reserves and allowances deducted from as- set accounts: Allowance for uncollectible accounts $804 $ 38 $ 145 (a) $-- $ 987 ==== ======= ========== === ====== Year ended December 31, 1995: Reserves and allowances deducted from as- set accounts: Allowance for uncollectible accounts $987 $ (13) $(170)(a) $-- $ 804 ==== ========= ========= === ======
- ---------- (a) Amount represents portion of change in allowance for uncollectible accounts applied against Accounts Payable Partitions. 46 (3) EXHIBITS: EXHIBIT NUMBER DESCRIPTION - ------ ----------- 2.1 Plan of Reorganization between and among Tel-Save Holdings, Inc., a Delaware corporation, Tel-Save, Inc., a Pennsylvania corporation, Daniel Borislow and Paul Rosenberg, and Exhibits Thereto (incorporated by reference to Exhibit 2.1 to the Company's registration statement on Form S-1 (File No. 33-94940)). 3.1 Amended and Restated Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 to the Company's registration statement on Form S-4 (File No. 333-38943)). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's registration statement on Form S-1 (File No. 33-94940)). 9.1 Voting Trust Agreement between Daniel Borislow and Paul Rosenberg (included as part of Exhibit 2.1). 10.1* Employment Agreement between the Company and Daniel Borislow and related Agreement (incorporated by reference to Exhibit 10.1 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.2 * Employment Agreement between the Company and Emanuel J. DeMaio (incorporated by reference to Exhibit 10.2 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.3 * Employment Agreement between the Company and Gary W. McCulla (incorporated by reference to Exhibit 10.3 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.4 * Employment Agreement between the Company and George P. Farley (incorporated by reference to Exhibit 10 to the Company's report on Form 10-Q for the Quarter ended September 30, 1997). 10.5 * Employment Agreement between the Company and Aloysius T. Lawn, IV (incorporated by reference to Exhibit 10.5 to the Company's registration statement on Form S-1 (File No. 333-2738)). 10.6 * Employment Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996). 10.7 Indemnification Agreement between the Company and Daniel Borislow (incorporated by reference to Exhibit 10.4 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.8 Indemnification Agreement between the Company and Emanuel J. DeMaio (incorporated by reference to Exhibit 10.5 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.9 Indemnification Agreement between the Company and Gary W. McCulla (incorporated by reference to Exhibit 10.6 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.10 Indemnification Agreement between the Company and Joseph M. Morena (incorporated by reference to Exhibit 10.7 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.11 Indemnification Agreement between the Company and Peter K. Morrison (incorporated by reference to Exhibit 10.8 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.12 Indemnification Agreement between the Company and Kevin R. Kelly (incorporated by reference to Exhibit 10.9 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.13 Indemnification Agreement between the Company and Aloysius T. Lawn, IV (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995). 10.14 Indemnification Agreement between the Company and Edward B. Meyercord, III (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996). 10.15 Agreement dated as of March 15, 1994 between the Company and Global Network Communications (incorporated by reference to Exhibit 10.10 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.16 AT&T Contract Tariff No. 516 (incorporated by reference to Exhibit 10.11 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.17 AT&T Contract Tariff No. 1715 (incorporated by reference to Exhibit 10.15 to the Company's registration statement on Form S-1 (File No. 333-2738)). 10.18 AT&T Contract Tariff No. 2039 (incorporated by reference to Exhibit 10.16 to the Company's registration statement on Form S-1 (File No. 333-2738)). 10.19 AT&T Contract Tariff No. 2432 (incorporated by reference to Exhibit 10.17 to the Company's registration statement on Form S-1 (File No. 333-2738)). 10.20 AT&T Contract Tariff No. 3628 (incorporated by reference to Exhibit 10.18 to the Company's registration statement on Form S-1 (File No. 333-2738)). 10.21 AT&T Contract Tariff No. 5776 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996). 47 EXHIBIT NUMBER DESCRIPTION - ------ ----------- 10.22 General Agreement between Tel-Save, Inc. and AT&T Corp. dated June 26, 1995 (incorporated by reference to Exhibit 10.14 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.23* Tel-Save Holdings, Inc. 1995 Employee Stock Option Plan (incorporated by reference to Exhibit 10.15 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.24* Tel-Save Holdings, Inc. Employee Bonus Plan (incorporated by reference to page 13 of the Company's Proxy Statement for the Company's 1996 Annual Meeting of Stockholders dated April 3, 1996). 10.25* Non-Qualified Stock Option Agreement between the Company and Daniel Borislow (incorporated by reference to Exhibit 10.17 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.26* Non-Qualified Stock Option Agreement between the Company and Emanuel J. DeMaio (incorporated by reference to Exhibit 10.18 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.27* Non-Qualified Stock Option Agreement between the Company and Mary Kennon (incorporated by reference to Exhibit 10.19 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.28* Non-Qualified Stock Option Agreement between the Company and Gary W. McCulla (incorporated by reference to Exhibit 10.20 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.29* Non-Qualified Stock Option Agreement between the Company and Peter K. Morrison (incorporated by reference to Exhibit 10.22 to the Company's registration statement on Form S-1 (File No. 33-94940)). 10.30+ Telecommunications Marketing Agreement by and among the Company, Tel-Save, Inc. and America Online, Inc., dated February 22, 1997 (incorporated by reference to Exhibit 10.32 to the Company's Form 10-K for the year ended December 31, 1996). 10.31++ Amendment No 1, dated as of January 25, 1998, to the Telecommunications Marketing Agreement dated as of February 22, 1997 by and among the Company, Tel-Save, Inc. and America Online, Inc. 10.32 Indenture dated as of September 9, 1997 between the Company and First Trust of New York, N.A. (incorporated by reference to Exhibit 4.3 to the Company's registration statement on Form S-3 (File No. 333-39787)). 10.33 Registration Agreement dated as of September 3, 1997 between the Company and Salomon Brothers Inc, Deutsche Morgan Grenfell Inc., Bear, Stearns & Co. Inc., Smith Barney Inc., Robertson Stephens & Company LLC (incorporated by reference to the Company's registration statement on Form S-3 (File No. 333-39787)). 10.34 Indenture dated as of December 10, 1997 between the Company and First Trust of New York, N.A. 10.35 Registration Agreement dated as of December 10, 1997 between the Company and Smith Barney Inc. 11.1 Net Income Per Share Calculation. 21.1 Subsidiaries of the Company. 23.1 Consent of BDO Seidman, LLP. 27 Financial Data Schedule. - ---------- * Management contract or compensatory plan or arrangement. + Confidential treatment previously has been granted for a portion of this exhibit. ++ Confidential treatment has been requested for portions of this exhibit. (b) Reports on Form 8-K. The following Current Reports on Form 8-K were filed by the Company during the three months ended December 31, 1997: 1. Current Report on Form 8-K dated December 5, 1997. 2. Current Report on Form 8-K dated November 25, 1997. 3. Current Report on Form 8-K dated November 20, 1997. 4. Current Report on Form 8-K dated October 29, 1997. 5. Current Report on Form 8-K dated October 26, 1997. 48 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: TEL-SAVE HOLDINGS, INC. By: /s/ Daniel Borislow --------------------------- Daniel Borislow Chairman of the Board of Directors, Chief Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE /s/ Daniel Borislow Chairman of the Board - ----------------------------- of Directors, Chief Executive Officer and Daniel Borislow Director (Principal Executive Officer) /s/ Gary W. McCulla President, Director of Sales and - ----------------------------- Marketing and Director Gary W. McCulla /s/ Emanuel J. DeMaio Chief Operations Officer and Director - ----------------------------- Emanuel J. DeMaio /s/ George P. Farley Chief Financial Officer and Director - ----------------------------- (Principal Financial Officer) George P. Farley /s/ Kevin R. Kelly Controller (Principal Accounting Officer) - ----------------------------- Kevin R. Kelly /s/ Harold First Director - ----------------------------- Harold First /s/ Ronald R. Thoma Director - ----------------------------- Ronald R. Thoma
49 EX-10.31 2 EXHIBIT 10.31 AMENDMENT NO. 1 This AMENDMENT NO. 1 (the "Amendment"), dated as of January 25, 1998 (the "Amendment Effective Date"), by and among Tel-Save, Inc. ("TS"), a Pennsylvania corporation, and Tel-Save Holdings, Inc. ("Holdings"), a Delaware corporation, with their principal offices at 6805 Route 202, New Hope, Pennsylvania 18938, on the one hand, and America Online, Inc., a Delaware corporation with its principal offices at 22000 AOL Way, Dulles, Virginia 20166 ("AOL"), on the other hand (each a "party" and, collectively, the "parties"). INTRODUCTION TS, Holdings and AOL are parties to the Telecommunications Marketing Agreement, dated as of February 22, 1997, as heretofore corrected and amended by letter, dated April 23, 1997 (as so corrected and amended to the date hereof, but without giving effect to this Amendment, the "Agreement"). Capitalized terms used in this Amendment without other definition are defined as in the Agreement. The parties have since considered further the marketing and advertising expenditures provided in the Agreement, and, in light of both parties' desire to increase the number of End Users of the Long Distance Telecommunications Services, hereby agree as follows: TERMS 1. The Agreement is amended to provide that references in the Agreement to "this Agreement" or "the Agreement" (including indirect references such as "hereunder," "hereby," "herein" and "hereof") shall be deemed to be references to the Agreement as amended hereby. 2. Section I.A of the Agreement is hereby amended to add the following definitions: "1.A. "Additional Promotion Period" means the period from the Amendment Effective Date through March 31, 1998 (as such period may be shortened as provided herein). "5.A. "Amendment" means the Amendment No. 1 to the Agreement dated as of the Amendment Effective Date. "5.B. "Amendment Effective Date" means January 25, 1998." 3. Section I.A.19 of the Agreement is amended to read in its entirety as follows: "19. "Gross Revenues" for any calendar quarter shall mean the sum of (a) total billings by TS to End Users for the provision of Services during such quarter and (b) if such billings are in a material amount, total billings by TS to any other end users of telecommunications services provided by TS that would meet the definition of "Restricted Services," which such other end users became such as a direct result of marketing by TS that used the AOL Marks or any variation of the AOL name (whether or not such marketing has been approved by AOL or is otherwise in compliance with this Agreement, and without waiver of AOL's rights hereunder with respect to such approval or compliance) ("Other End Users"), less * * * " 4. Section III.A.1 of the Agreement is amended to add "(a)" before "During each" at the beginning of such section and to add the following at the end of such section: "(b) Notwithstanding anything to the contrary in this Agreement, the parties agree that, commencing February 1, 1998 and until the end of the Additional Promotion Period, AOL shall provide TS with additional online promotions and advertisements, including Pop-Up Ads, in form and substance as determined pursuant to the foregoing portion of this Section III.A.1, with an Ad Value of at least * * * per month (or the pro-rata amounts thereof for portions of months) in addition to the Ad Values to be provided pursuant to Section III.A.1(a) (the "Additional Promotions"). Pop-Up Ads during the Additional Promotion Period shall be made available onscreen for at least * * * days (instead of the number required pursuant to Section I.A.31 hereof), and any Pop-Up Ads included by AOL during the Additional Promotion Period in excess of * * * Pop-Up Ads per month and any Pop-Up Ads included by AOL with TS's approval during the remainder of the Introductory Period in excess of * * * per month shall be counted toward AOL's satisfaction of the * * * monthly requirement set forth in Section III.A.1(a) above. Following the expiration of the Additional Promotion Period, AOL shall not be obligated to provide any promotions or advertisements other than those promotions or advertisements that were required of AOL pursuant to the Agreement, but without regard to this Section III.A.1.(b). (c) In the event that AOL has not delivered each of the "AOL Deliverables" (as set forth in Attachment A) in accordance with the terms hereof or has not delivered the Ad Values of promotions and advertisements required by Sections III.A.1(a) and (b) to be provided during the Additional Promotion Period, in each case, on or before February 28, 1998, TS may elect in its sole discretion that the Additional Promotion Period end as of February 28, 1998 so long as TS has provided AOL with written notice of such election by fascimile to the attention of David Colburn (fax no. 703-265-1202) no later than 5:00 p.m. EST on February 28, 1998. In such case: (i) TS will be relieved of any obligation to pay AOL the bounties provided for hereunder with respect to any customers who first signed up for Services subsequent to February 28, 1998, (ii) the additional guaranteed amount to be paid by TS pursuant to this Amendment shall be as adjusted as described below and (iii) AOL will not deliver the additional promotions contemplated hereunder thereafter. (d) Except for those AOL Deliverables noted as "ongoing" obligations on Attachment A ("Ongoing Deliverables"), an AOL Deliverable shall be deemed delivered in the event AOL completes delivery of the AOL Deliverable on or before the due date specified on Attachment A; provided that AOL shall be 2 entitled to a cure period of five (5) business days following such due date within which to complete its delivery. Any Ongoing Deliverable shall be deemed delivered if AOL has commenced delivery of such item and is continuing without default its delivery as of February 28, 1998; provided that AOL shall be entitled to a cure period of five (5) business days following any interruption in delivery of such AOL Deliverable within which to restore its ongoing delivery of such item. Notwithstanding the foregoing, the cure periods with respect to the AOL Deliverable relating to * * * requirements and the AOL Deliverable relating to * * * shall be only one (1) day. AOL shall be entitled to only one (1) cure period with respect to each AOL Deliverable; provided that (i) AOL shall be entitled to two (2) one-day cure periods with respect to the AOL Deliverable relating to * * * and (ii) there shall be no cure period with respect to the AOL Deliverable relating to* * *. (e) In the event that TS fails to deliver any "TS Deliverable" (as set forth in Attachment A), AOL may extend the due date set forth on Attachment A for any AOL Deliverable that (as indicated in Attachment A) depends on receipt of a TS Deliverable specified in Attachment A for a period equal to the number of days by which TS's delivery is overdue. AOL may toll its delivery of any Ongoing Deliverable until TS has delivered the TS Deliverable specified on Attachment A as necessary for the delivery of such AOL Deliverable. In the event that TS has not delivered any TS Deliverable as of February 28, 1998, any AOL Deliverable specified on Attachment A as corresponding to such TS Deliverable shall be deemed delivered by AOL as of such date. Except as otherwise expressly provided herein, (a) either party's failure to deliver its respective deliverables set forth in Attachment A shall not be deemed a breach of the Agreement and (b) following the expiration of the Additional Promotion Period, neither party shall be obligated with respect to any deliverables set forth on Attachment A other than (x) those deliverables that were required of such party pursuant to the Agreement (other than by reason of the Amendment) and (y) the * * * or the * * * program (each, as described herein), if any, that may be provided in the Extended Offline Promotion Period (as defined in Section V.C.1)." (f) Notwithstanding anything to the contrary herein, in connection with any * * * efforts directed to subscribers to the AOL Service that may be provided hereunder, AOL reserves the right to (i) approve all procedures, scripts and other materials used in connection with any such effort, such approval not to be unreasonably withheld, (ii) subject to the proviso at the end of this clause (ii), cease, or otherwise limit the amount, duration or frequency of, any such effort in the event AOL determines in its reasonable discretion that such effort (including, without limitation, any statement or claim made by TS in connection with such effort or the Services (e.g., comments made during a * * *call) is false or inaccurate or misrepresents or mischaracterizes the true nature of the Services or of any party's role in providing the Services and has resulted or is resulting in significant complaints by recipients of such efforts or material disruptions of AOL's relations with existing and potential customers, provided that AOL shall 3 have provided to TS at least five (5) days prior written notice of its intention so to cease or limit such effort, which notice shall include a specific statement of the basis for such action, including reasonable evidence of such basis, and TS shall not have, within five (5) days of such notice, modified the terms of such effort or taken such other actions as shall be reasonably likely, in AOL's discretion, to (x) prevent a continuation or recurrence of the circumstances forming the basis of such notice or (y) remedy material harm to AOL's business arising from such prior occurrence (as the case may be); and (iii) monitor such efforts for quality assurance and for compliance with the terms and conditions hereof. 5. Section III.A.2 of the Agreement is amended to add at the end thereof the following: "Notwithstanding anything to the contrary in this Agreement, the parties agree that any Pop-Up Ads included by AOL with TS's approval subsequent to the Introductory Period and during the Term in excess of * * * shall be counted toward AOL's satisfaction of the * * * monthly requirement set forth in this Section III.A.2. The total Ad Value of all promotions and advertisements to be provided by AOL pursuant to this Section III.A.2 during the period from July 1, 1999, through June 30, 2000, shall be reduced by the amount of the Ad Value of the Additional Promotions provided by AOL pursuant to Section III.A.1 above, such reduction to be applied ratably to the Ad Value to be provided during such period." 6. Section III.A.4(a) of the Agreement is amended to add at the end thereof the following: "Notwithstanding the preceding sentence, during the Additional Promotion Period, AOL shall not deploy Pop-Up Ads having * * * ." 7. Section III.A.4 of the Agreement is amended to add the following new Section III.A.4(d): "(d) Notwithstanding anything to the contrary in this Agreement, the parties agree that AOL may in its sole discretion replace any Pop-Up Ad required hereunder (or otherwise scheduled to be provided by AOL) with * * * (e.g., for purposes of fulfilling requirements of law or court order or issuing announcements regarding AOL members or AOL policies) (each an "Excluded Pop-Up"); provided that AOL delivers the replaced Pop-Up Ad as soon as reasonably possible thereafter (without resulting in simultaneous Pop-Up Ads) * * * ." 8. Section V of the Agreement is amended to add the following new Section V.B.6: "6. TS shall provide AOL biweekly with information with respect to any * * * efforts during the Additional Promotion Period and the Extended Offline Promotion Period (as defined herein) which is reasonably required for (a) measuring TS's efforts hereunder or (b) delivery of the applicable AOL Deliverable (and any other information mutually agreed upon by the parties), but 4 in no event less information than would be required of TS pursuant to Section V.B.4 hereof." 9. Section V of the Agreement is amended to add the following new Section V.C: "C. Additional Promotion Period. 1. In addition to any other payments required hereunder (and in addition to any Warrant Shares due AOL pursuant to the Supplemental Warrant and any amendments thereto), TS shall pay to AOL Bounty Fees (as defined below) as follows: a. TS shall pay to AOL the applicable Bounty Fee for each Qualified End User (as defined below) who subscribes to the Long Distance Telecommunications Services (i) during the Additional Promotion Period or (ii) following the Additional Promotion Period but only insofar as such subscription following the Additional Promotion Period is the result of * * * efforts directed to subscribers to the AOL Service that may be provided hereunder; provided however, that, from and after the total number of Qualified End Users for which TS has paid AOL a Bounty Fee pursuant to this Amendment equals one million (1,000,000), , TS shall not, subsequent to such date, be required to pay any further Bounty Fees with respect to End Users acquired as a result of any such * * * efforts. b. A "Qualified End User" is an End User who remains an End User for at least thirty (30) consecutive days. c. On the first day of each month commencing March 1, 1998, TS shall pay AOL the aggregate amount of such Bounty Fees owing to AOL with respect to the preceding month (or the preceding 35 days, in the case of the first such payment). 2. "Bounty Fee" means (i) with respect to any Qualified End User who subscribed to the Services on or before the Change Time (as defined below), $* * * and (ii) with respect to any Qualified End User who subscribed to the Services after the Change Time, $* * * , provided that the amount of any Bounty Fee payable to any Qualified End User (i) whose subscription is the result of * * * efforts directed to subscribers to the AOL Service and (ii) who subscribes to any Services at any time after the 120th day after the commencement of such * * * efforts will be one-half (1/2) of the amount set forth in clause (i) or (ii), as the case may be. "Change Time" means the time at which an aggregate of * * * persons or entities shall have subscribed to the Services since the Effective Date and become End Users (and regardless of whether such persons or entities shall then be End Users). 3. In addition to any other payments required hereunder (and in addition to any Warrant Shares due AOL pursuant to the Supplemental Warrant and any amendments thereto) and provided that AOL shall have delivered the Ad Values of promotions and advertisements required by Sections III.A.1(a) and (b) 5 to be provided during the Additional Promotion Period, on April 3, 1998, in consideration of the Additional Promotions and any additional promotion or marketing provided by AOL to TS during the Additional Promotion Period, TS shall pay to AOL a guaranteed, non-refundable amount (the "Excess Amount") equal to (i) $10,000,000 (or $3,000,000 in the event that the Additional Promotion Period is terminated as of February 28, 1998 pursuant to Section III.A.1(c) hereof) less (ii) the sum of (x) the aggregate Bounty Fees, if any, paid to AOL by TS prior to April 3, 1998, and (y) the product of (i) the Adjustment Value (as defined below) times (ii) the number of the Warrant Shares, if any, that shall have vested pursuant to the Supplemental Warrant as of March 31, 1998, with respect to the period between the Amendment Effective Date and the end of the Additional Promotion Period. "Holdings Share Price" shall mean the average of the closing prices (as defined in Section 6(d) of the Supplemental Warrant) for one (1) share of Holdings' Common Stock during each of the four (4) consecutive business days prior to April 3, 1998. The "Adjustment Value" shall mean the dollar figure that shall be determined using the schedule set forth in Attachment B. The Excess Amount shall be credited against any subsequent TS obligations to pay Bounty Fees pursuant to the Agreement on or after April 3, 1998 until the full amount of such Excess Amount shall have been so credited and, following payment of the Excess Amount to AOL, TS shall not be required to pay the Bounty Fees otherwise payable to AOL hereunder until such time as the aggregate amount of otherwise payable Bounty Fees equals the Excess Amount. TS shall thereafter commence payment of Bounty Fees to AOL as otherwise provided herein." 10. The following new Section V.D is added to Section V of the Agreement: "D. Offline Marketing Costs. TS shall be responsible for all costs and expenses associated with (a) any * * * efforts by TS or AOL or either party's agents, (b) any * * * efforts by AOL or its agents (including, without limitation, any related * * * efforts) and (c) any * * * efforts by AOL or its agents (specifically including Incentive Payments, as defined below, if any, and specifically excluding any television or print media marketing campaigns) (collectively, the "Offline Marketing Costs"); provided that all Offline Marketing Costs incurred by AOL shall be approved in writing in advance by TS. The Offline Marketing Costs shall not be included in the calculation of Actual Services Costs. Except with respect to the Estimated * * * Costs (as defined below), TS shall pay AOL within thirty (30) days of receipt of a monthly invoice from AOL detailing the Offline Marketing Costs for the preceding month. Subject to TS' right to approve in advance all Offline Marketing Costs, as provided above, TS shall pay AOL in advance with respect to the Offline Marketing Costs for any * * * efforts in an amount equal to AOL's reasonable estimate for the costs of each effort that AOL provides to TS reasonably in advance of the dates payments are due (such estimated costs, the "Estimated * * * Costs"). which Estimated * * * Costs shall be payable on the first day of each month (subject to AOL's having provided the estimate for such month), commencing March 1, 1998, with respect to Estimated * * * Costs for such 6 month. As promptly as reasonably possible after the end of each month, AOL shall provide TS with a statement detailing the Offline Marketing Costs incurred for any * * * efforts in such month and, to the extent the aggregate Costs included on such statement are less than the Estimated * * * Costs previously paid by TS to AOL with respect to such month, AOL shall promptly pay to TS the amount of such difference and, to the extent the aggregate Costs included on such statement are greater than the Estimated * * * Costs previously paid by TS to AOL with respect to such month, TS shall promptly pay to AOL the amount of such difference. The parties will mutually agree on how to allocate any costs and expenses other than the Offline Marketing Costs associated with any further offline marketing and promotional activities occurring during the remainder of the Term, including, without limitation, any joint promotional offers with respect to both the AOL Service and the Long Distance Telecommunications Services." "Incentive Payments" shall mean such payments as TS may elect to fund, at its option, pursuant to incentive programs to be implemented for * * * agents, which programs will be in form and substance to be mutually agreed upon by the parties. 11. The following new Sections V.F.1 and V.F.2 are added to Section V of the Agreement: "1. Substantially concurrently herewith, TS and Holdings are entering into a written agreement with CompuServe Interactive Services, Inc. ("CompuServe") with respect to the exclusive marketing of TS's telecommunications services by CompuServe (the "CompuServe Agreement") on the CompuServe Service (as defined in the CompuServe Agreement). In the event a Change Event occurs, AOL shall pay, or shall cause CompuServe to pay, TS within thirty (30) days of such Change Event an amount (the "Repayment Amount") which shall be calculated in accordance with Attachment E hereto; provided that, with respect to that portion of the Repayment Amount allocable to the Base Payment (the "Base Payment Portion"),, AOL may, at its option, elect, in lieu of paying the Base Payment Portion, to provide TS with an additional amount of promotion and marketing with respect to either the AOL Service or the CompuServe Service (as mutually agreed upon by the parties) (the "Change Event Promotions") with a value, as measured and calculated using the Ad Value, as defined herein, if the parties elect to deliver the Change Event Promotions with respect to the AOL Service, and the "Ad Value" (as defined in the CompuServe Agreement), if the parties elect to deliver such promotions with respect to the CompuServe Service, equal to (a) * * * times (b) the amount of the Base Payment Portion. For purposes of Attachment E: (i) "Credit Amount" shall mean, as of the date of the Change Event, the aggregate amounts theretofore credited to TS pursuant to Sections V.C.1(b) and (c); (ii) "Measurement Date" means the date sixty (60) days subsequent to the Effective Date; and (iii) "Change Event" means * * *. Immediately following the Change Event, the parties shall cause the CompuServe Agreement to be terminated; provided that such termination shall not affect the advertising to be delivered pursuant to Section V.F.1 (in the event AOL elects to deliver such advertising in lieu of paying the Base Payment Portion due to TS in connection with a Change Event). TS hereby expressly 7 acknowledges and agrees that neither the CompuServe online service (however defined in this Agreement or the CompuServe Agreement) nor the end users thereof (including, without limitation, "End Users" as defined in the CompuServe Agreement) are or shall be deemed to be within the scope of this Agreement (including, without limitation, the exclusivity provisions set forth in Section VI.A hereof), (i) by reason of the consummation of AOL's recent acquisition of CompuServe Interactive Services, Inc. (or the fact of such acquisition) or (ii) based on the facts known to TS existing as of the execution date of this Amendment. 3. Unless and until a Change Event shall have occurred, (a) no user of the TS telecommunications services marketed thereunder pursuant to the CompuServe Agreement (the "TS/CS Services") shall for any purposes of this Agreement (excluding any purpose related to the Supplemental Warrant) be, or be deemed to be, an "End User" as defined and used herein, (b) the TS/CS Services shall not be, or be deemed to be, "Services" as defined and used herein, (c) no revenues generated under or by reason of the CompuServe Agreement shall form a part of, or in any respect be included in, "Gross Revenues" as defined and used herein, and (d) TS's exclusivity rights set forth in Section VII.A herein shall not apply in any manner to CompuServe's marketing of the TS/CS Services. 4. From and after the date a Change Event shall have occurred, (a) each user of the TS/CS Services shall for all purposes of this Agreement and the Warrants be, and shall be deemed to be, an "End User" as defined and used herein, (b) the TS/CS Services shall be, and shall be deemed to be, "Services" as defined and used herein, (c) all revenues generated under or by reason of the CompuServe Agreement shall form a part of, and be included in, "Gross Revenues" as defined and used herein, and (d) TS's exclusivity rights set forth in Section VII.A herein shall apply to CompuServe's marketing of the TS/CS Services; provided that, to the extent that the CompuServe Service shall be operated as a separately accessible online service (e.g., subscribers are not required to access the service by first accessing the America Online brand service) (and without acknowledgment or agreement by AOL that such CompuServe Service satisfies the definition of AOL Service set forth Section I.A.9 hereof), AOL agrees that TS shall continue to have the access, linkage, designated area, display and other similar rights within and with respect to such CompuServe and the billing and servicing of any End Users thereon that are provided in the CompuServe Agreement." 5. AOL hereby consents to TS' and Holdings' entering into, and performing under, the CompuServe Agreement and agrees that, in and of itself, such conduct shall not constitute a breach by TS or Holdings of Section VII.A.6 of this Agreement or require the payment of any override pursuant thereto. 8 12. The following clause (iv) is added to the end of Section XI.A.2 of the Agreement: "and (iv) any claim relating to (a) the content of any statement or claim made by TS in connection with the Services or (b) the content of any promotion, advertisement or other marketing (whether offline or online, including * * *) relating to the Services (excluding any content that was submitted by AOL), which content AOL (x) advised TS that it was not reviewing, (y) did not receive from TS or was not otherwise provided a reasonable opportunity to review or (z) reviewed and provided comments, suggestions or input that were not reflected by TS in the content (and the claim is based on the content that was not reflected)." 13. The parties hereby agree to execute an amendment to the Supplemental Warrant (the "Warrant Amendment"), as soon as reasonably practicable following the Amendment Effective Date, which shall provide that each "End User" (as defined in the CompuServe Agreement) acquired through the CompuServe Service shall be included in the calculation of Warrant Shares pursuant to Section 1(a) of the Supplemental Warrant. Until such time as the parties have executed the Warrant Amendment, this paragraph shall serve as a valid amendment to the Supplemental Warrant and shall be fully self-executing in all respects. 14. The parties hereby agree that (a) the number of End Users who subscribed to the Long Distance Telecommunications Services between the Effective Date and December 31, 1997, is a minimum of * * * and (b) the number of End Users who subscribed to the Long Distance Telecommunications Services between December 31, 1997, and January 25, 1998 is * * *. The parties acknowledge that AOL is utilizing the figure of * * * net End Users as of December 31, 1997 for purposes of calculating the number of Warrant Shares due to AOL as of such date; provided that, to the extent the actual number of net End Users from the period between the Effective Date and December 31, 1997 is greater than * * * (the "Excess End Users"), then TS shall continue to be responsible to provide AOL Warrant Shares in consideration of such actual Excess End Users as of December 31, 1998. 15. This Amendment does not, and shall not be construed to, modify any term or condition of the Agreement (including, without limitation, any payment obligations under the Agreement) other than those specific terms and conditions expressly referenced in this Amendment. Except as herein provided, the Agreement shall remain unchanged and in full force and effect. In the event of any inconsistency or discrepancy between the Agreement and this Amendment, the terms and conditions set forth in this Amendment shall control. Neither party shall be bound by, and each party specifically objects to, any term, condition or other provision that is different from or in addition to the provisions of this Amendment and the Agreement (whether or not it would materially alter this Amendment or the 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 in accordance with the terms of the Agreement. This Amendment may be executed in multiple counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same document. This 9 Amendment shall be governed by the internal laws of the State of New York, without giving effect to the principles of conflict of laws thereof. 10 IN WITNESS WHEREOF, the undersigned have caused this Amendment to be signed on their behalf as of the Amendment Effective Date. AMERICA ONLINE, INC. By /s/ David M. Colburn ---------------------------- Name: David M. Colburn Title: Senior Vice-President TEL-SAVE, INC. By /s/ Daniel Borislow ---------------------------- Name: Daniel Borislow Title: Chairman & CEO TEL-SAVE HOLDINGS, INC. By /s/ Daniel Borislow ---------------------------- Name: Daniel Borislow Title: Chairman & CEO 11 ATTACHMENT A DELIVERABLES DURING THE ADDITIONAL PROMOTION PERIOD AOL Deliverables Date Description Status as of Signing * * * * * * * * * TS Deliverables Date Description Status as of Signing * * * * * * * * * [Endnotes* * * ] Attachment B Adjustment Value Schedule The "Adjustment Value" shall mean, as of any date of calculation thereof, the average of the amounts set forth in the TS column and the AOL column below with respect to the Holdings Share Price as of such calculation date, provided that such Adjustment Value with respect to a Holdings Share Price between the prices set forth in the column below shall be determined by interpolation.
SHARE PRICE HOLDINGS TS AOL AVERAGE ------------- -------------- ------------- -------------- $ 15.00 $ 8.93 $ 8.13 $ 8.53 $ 16.00 $ 9.77 $ 8.98 $ 9.38 $ 17.00 $ 10.62 $ 9.83 $ 10.23 $ 18.00 $ 11.48 $ 10.68 $ 11.08 $ 19.00 $ 12.35 $ 11.54 $ 11.95 $ 20.00 $ 13.22 $ 12.39 $ 12.81 $ 21.00 $ 14.11 $ 13.29 $ 13.70 $ 22.00 $ 15.00 $ 14.21 $ 14.61 $ 23.00 $ 15.89 $ 15.12 $ 15.51 $ 24.00 $ 16.79 $ 16.04 $ 16.42 $ 25.00 $ 17.70 $ 16.96 $ 17.33 $ 26.00 $ 18.61 $ 17.87 $ 18.24 $ 27.00 $ 19.53 $ 18.79 $ 19.16 $ 28.00 $ 20.45 $ 19.70 $ 20.08 $ 29.00 $ 21.37 $ 20.62 $ 21.00 $ 30.00 $ 22.30 $ 21.57 $ 21.94 $ 31.00 $ 23.23 $ 22.53 $ 22.88 $ 32.00 $ 24.17 $ 23.48 $ 23.83 $ 33.00 $ 25.11 $ 24.44 $ 24.78 $ 34.00 $ 26.05 $ 25.40 $ 25.73 $ 35.00 $ 26.99 $ 26.35 $ 26.67
Attachment E The Repayment Amount shall be calculated as the sum of the amounts with respect to the Initial Payment, the Base Payment and the Midterm Payment, as each are determined as follows (and subject to Section __ of the Agreement): Initial Payment With respect to any date on which the Change Event occurs: 1. If before MD IA 2. If after MD but before CL IA x [1 - ((#M GREATER THAN MD) /22)] - CA 3. If after CL IA x [1 - ((#M GREATER THAN MD) /22)] - CA Base Payment With respect to any date on which the Change Event occurs: 1. If before MD and after CL BP 2. If after MD and after CL BP x [1 - ((#M GREATER THAN CL) / (24 - #M@CL)] Midterm Advance With respect to any date on which the Change Event occurs: 1. At all times: MA x [1 - (#M GREATER THAN MA) / 12] Key: IA = Initial Advance BP = Base Payment MA = Midterm Advance CE = Change Event CA = Credit Amount CL = Commercial Launch Date MD = Measurement Date #M GREATER THAN = Number of months (or portions of months) since [X] #M@cl = Number of months (or portions of months) since Effective Date in which CL occurs EX-10.34 3 EXHIBIT 10.34 ================================================================================ TEL-SAVE HOLDINGS, INC. TO FIRST TRUST OF NEW YORK, NATIONAL ASSOCIATION TRUSTEE ----------- INDENTURE DATED AS OF DECEMBER 10, 1997 5% CONVERTIBLE SUBORDINATED NOTES DUE 2004 ================================================================================ 1 TABLE OF CONTENTS
Page ---- ARTICLE I Definitions and Incorporation by Reference - ------------------------------------------ SECTION 1.01. Definitions..............................................1 SECTION 1.02. Other Definitions........................................6 SECTION 1.03. Incorporation by Reference of Trust Indenture Act........7 SECTION 1.04. Rules of Construction....................................7 ARTICLE II The Securities - -------------- SECTION 2.01. Form and Dating..........................................7 SECTION 2.02. Execution, Authentication and Delivery...................9 SECTION 2.03. Registrars, Paying Agents and Conversion Agents.........10 SECTION 2.04. Paying Agent to Hold Money in Trust.....................10 SECTION 2.05. Noteholder Lists........................................10 SECTION 2.06. Transfer and Exchange...................................10 SECTION 2.07. Replacement Securities..................................13 SECTION 2.08. Outstanding Securities..................................14 SECTION 2.09. Treasury Securities.....................................14 SECTION 2.10. Temporary Securities; Exchange of Global Security for Certificated Securities...............................14 SECTION 2.11. Cancellation............................................15 SECTION 2.12. Defaulted Interest......................................15 ARTICLE III
i
Redemption - ---------- SECTION 3.01. Notices to Trustee......................................15 SECTION 3.02. Selection of Securities to be Redeemed..................15 SECTION 3.03. Notice of Redemption....................................17 SECTION 3.04. Effect of Notice of Redemption..........................17 SECTION 3.05. Deposit of Redemption Price.............................17 SECTION 3.06. Securities Redeemed in Part.............................17 SECTION 3.07. Optional Redemption.....................................17 SECTION 3.08. Designated Event Offer..................................17 ARTICLE IV Covenants - --------- SECTION 4.01. Payment of Securities...................................19 SECTION 4.02. SEC Reports.............................................19 SECTION 4.03. Compliance Certificate..................................20 SECTION 4.04. Stay, Extension and Usury Law...........................20 SECTION 4.05. Corporate Existence.....................................21 SECTION 4.06. Taxes...................................................21 SECTION 4.07. Designated Event........................................21 SECTION 4.08. Investment Company Act..................................23 ARTICLE V Conversion - ---------- SECTION 5.01. Conversion Privilege....................................22 SECTION 5.02. Conversion Procedure....................................22 SECTION 5.03. Fractional Shares.......................................22 ii
SECTION 5.04. Taxes on Conversion.....................................23 SECTION 5.05. Company to Provide Stock................................23 SECTION 5.06. Adjustment of Conversion Price..........................24 SECTION 5.07. No Adjustment...........................................27 SECTION 5.08. Other Adjustments.......................................27 SECTION 5.09. Adjustments for Tax Purposes............................27 SECTION 5.10. Adjustments by the Company..............................27 SECTION 5.11. Notice of Adjustment....................................28 SECTION 5.12. Notice of Certain Transactions..........................28 SECTION 5.13. Effect of Reclassifications, Consolidations, Mergers or Sales on Conversion Privilege.......................28 SECTION 5.14. Trustee's Disclaimer....................................29 ARTICLE VI Subordination - ------------- SECTION 6.01. Agreement to Subordinate................................29 SECTION 6.02. No Payment on Securities if Senior Debt in Default......30 SECTION 6.03. Distribution on Acceleration of Securities; Dissolution and Reorganization; Subrogation of Securities..........................................31 SECTION 6.04. Reliance by Senior Debt on Subordination Provisions.....34 SECTION 6.05. No Waiver of Subordination Provisions...................34 SECTION 6.06. Trustee's Relation to Senior Debt.......................34 SECTION 6.07. Other Provisions Subject Hereto.........................35 ARTICLE VII Successors - ---------- SECTION 7.01. Merger, Consolidation or Sale of Assets.................35 iii
SECTION 7.02. Successor Corporation Substituted.......................36 ARTICLE VIII Defaults and Remedies - --------------------- SECTION 8.01. Events of Default.......................................36 SECTION 8.02. Acceleration............................................38 SECTION 8.03. Other Remedies..........................................38 SECTION 8.04. Waiver of Past Defaults.................................38 SECTION 8.05. Control by Majority.....................................38 SECTION 8.06. Limitation on Suits.....................................39 SECTION 8.07. Rights of Noteholders to Receive Payment................39 SECTION 8.08. Collection Suit by Trustee..............................39 SECTION 8.09. Trustee May File Proofs of Claim........................39 SECTION 8.10. Priorities..............................................40 SECTION 8.11. Undertaking for Costs...................................40 ARTICLE IX Trustee - ------- SECTION 9.01. Duties of Trustee.......................................40 SECTION 9.02. Rights of Trustee.......................................41 SECTION 9.03. Individual Rights of Trustee............................41 SECTION 9.04. Trustee's Disclaimer....................................42 SECTION 9.05. Notice of Defaults......................................42 SECTION 9.06. Reports by Trustee to Noteholders.......................42 SECTION 9.07. Compensation and Indemnity..............................42 SECTION 9.08. Replacement of Trustee..................................43
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SECTION 9.09. Successor Trustee by Merger, Etc........................44 SECTION 9.10. Eligibility; Disqualification...........................44 SECTION 9.11. Preferential Collection of Claims Against Company.......44 ARTICLE X Discharge of Indenture - ---------------------- SECTION 10.01. Termination of Company's Obligations...................44 SECTION 10.02. Repayment to Company...................................44 ARTICLE XI Amendments, Supplements and Waivers - ----------------------------------- SECTION 11.01. Without Consent of Noteholders.........................45 SECTION 11.02. With Consent of Noteholders............................45 SECTION 11.03. Compliance with Trust Indenture Act....................46 SECTION 11.04. Revocation and Effect of Consents......................46 SECTION 11.05. Notation on or Exchange of Securities..................47 SECTION 11.06. Trustee Protected......................................47 ARTICLE XII Miscellaneous - ------------- SECTION 12.01. Trust Indenture Act Controls...........................47 SECTION 12.02. Notices................................................47 SECTION 12.03. Communication by Noteholders with Other Noteholders....48 SECTION 12.04. Certificate and Opinion as to Conditions Precedent.....48 SECTION 12.05. Statements Required in Certificate or Opinion..........48 SECTION 12.06. Rules by Trustee and Agents............................49 SECTION 12.07. Legal Holidays.........................................49
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SECTION 12.08. No Recourse Against Others.............................49 SECTION 12.09. Counterparts...........................................49 SECTION 12.10. Variable Provisions....................................49 SECTION 11.11. GOVERNING LAW..........................................50 SECTION 12.12. No Adverse Interpretation of Other Agreements..........50 SECTION 12.13. Successors.............................................50 SECTION 12.14. Severability...........................................50 SECTION 12.15. Table of Contents, Headings, Etc.......................50
vi EXHIBIT A FORM OF CONVERTIBLE SUBORDINATED NOTE.........................A-1 EXHIBIT B FORM OF TRANSFER CERTIFICATE..................................B-1 EXHIBIT C FORM OF ACCREDITED INVESTOR TRANSFEREE CERTIFICATE............C-1 EXHIBIT D FORM OF REGISTRATION AGREEMENT ...............................E-1 vii INDENTURE dated as of December 10, 1997 between Tel-Save Holdings, Inc., a Delaware corporation (the "Company"), and First Trust of New York, National Association, as trustee (the "Trustee"). Each party agrees as follows for the benefit of the other party and for the equal and ratable benefit of the Noteholders of the Company's 5% Convertible Subordinated Notes Due 2004 (the "Securities"): ARTICLE I Definitions and Incorporation by Reference SECTION 1.01. Definitions. "Affiliate" of any specified person means any other person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified person. For the purposes of this definition, "control" (including, with correlative meanings, the terms "controlling", "controlled by" and "under common control with"), as used with respect to any person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such person, whether through the ownership of voting securities or by agreement or otherwise. "Agent" means any Registrar, Paying Agent or Conversion Agent. "Board of Directors" means the Board of Directors of the Company or any authorized committee of the Board. "Board Resolution" means a copy of a resolution of the Board of Directors certified by the Secretary or an Assistant Secretary of the Company to be in full force and effect on the date of such certification and delivery to the Trustee. "Business Day" means any day that is not a Legal Holiday. "Capital Stock" means any and all shares, interests, participations, rights or other equivalents (however designated) of equity interests in any entity, including, without limitation, corporate stock and partnership interests. "Change of Control" means any event where: (i) any "person" or "group" (as such terms are used in Section 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act) of shares representing more than 50% of the combined voting power of the then-outstanding securities entitled to vote generally in elections of directors of the Company ("Voting Stock"), (ii) the Company consolidates with or merges into any other corporation, or any other person merges into the Company, and, in the case of any such transaction, the outstanding Common Stock of the Company is reclassified into or exchanged for any other property or security, unless the stockholders of the Company immediately before such transaction own, directly or indirectly immediately following such transaction, at least a majority of the combined voting power of the outstanding voting securities of the corporation resulting from such transaction in substantially the same proportion as their ownership of the Voting Stock immediately before such transaction, (iii) the Company conveys, transfers or leases all or substantially all of its assets to any person (other than to one or more wholly-owned subsidiaries of the Company) or (iv) any time the Continuing Directors do not constitute a majority of the Board of Directors of the Company (or, if applicable, a successor corporation to the Company). "Common Stock" means the common stock of the Company as the same exists at the date of the execution of this Indenture or as such stock may be constituted from time to time. "Company" means the party named as such above until a successor replaces it in accordance with Article VII and thereafter means the successor. "Continuing Directors" means as of any date of determination, any member of the Board of Directors of the Company who (i) was a member of such Board of Directors on the date of this Indenture or (ii) was nominated for election or elected to such Board of Directors with the approval of a majority of the Continuing Directors who were members of such board at the time of such nomination or election. "Daily Market Price" means the price of a share of Common Stock on the relevant date, determined (a) on the basis of the last reported sale price regular way of the Common Stock as reported on the Nasdaq Stock Market's National Market (the "NNM"), or if the Common Stock is not then listed on the NNM, as reported on such national securities exchange upon which the Common Stock is listed, or (b) if there is no such reported sale on the day in question, on the basis of the average of the closing bid and asked quotations regular way as so reported, or (c) if the Common Stock is not listed on the NNM or on any national securities exchange, on the basis of the average of the high bid and low asked quotations regular way on the day in question in the over-the-counter market as reported by the National Association of Securities Dealers Automated Quotation System, or if not so quoted, as reported by National Quotation Bureau, Incorporated, or a similar organization. "Default" means any event that is, or with the passage of time or the giving of notice or both, would be an Event of Default. "Depositary" means The Depository Trust Company, its nominees and their respective successors. "Designated Event" means the occurrence of a Change of Control or a Termination of Trading. "Designated Senior Debt" means (i) any Senior Debt which, as of the date of this Indenture, has an aggregate principal amount outstanding of at least $15 million, and (ii) any Senior Debt which, at the date of determination, has an aggregate principal amount outstanding of, or commitments to lend up to, at least $15 million and is specifically designated by the Company in the instrument evidencing or governing such Senior Debt as "Designated Senior 2 Debt" for purposes of this Indenture (provided, that such instrument may place limitations and conditions on the right of such Senior Debt to exercise the rights of Designated Senior Debt). "Exchange Act" means the Securities Exchange Act of 1934, as amended. "GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession, which are in effect from time to time. "Global Securities Legend" means the legend labeled as such and that is set forth in Exhibit A hereto. "Guarantee" means a guarantee (other than by endorsement of negotiable instruments for collection in the ordinary course of business), direct or indirect, in any manner (including, without limitation, letters of credit and reimbursement agreements in respect thereof), of all or any part of any Indebtedness. "Indebtedness" means, with respect to any person, all obligations, whether or not contingent, of such person (i)(a) for borrowed money (including, but not limited to, any indebtedness secured by a security interest, mortgage or other lien on the assets of such person which is (1) given to secure all or part of the purchase price of property subject thereto, whether given to the vendor of such property or to another, or (2) existing on property at the time of acquisition thereof), (b) evidenced by a note, debenture, bond or written instrument, (c) under a lease required to be capitalized on the balance sheet of the lessee under GAAP or under any lease or related document (including a purchase agreement) which provides that such person is contractually obligated to purchase or to cause a third party to purchase such leased property, (d) in respect of letters of credit, bank guarantees or bankers' acceptances (including reimbursement obligations with respect to any of the foregoing), (e) with respect to Indebtedness secured by a mortgage, pledge, lien, encumbrance, charge or adverse claim affecting title or resulting in an encumbrance to which the property or assets of such person are subject, whether or not the obligation secured thereby shall have been assumed or Guaranteed by or shall otherwise be such person's legal liability, (f) in respect of the balance of the deferred and unpaid purchase price of any property or assets, and (g) under interest rate or currency swap agreements, cap, floor and collar agreements, spot and forward contracts and similar agreements and arrangements; (ii) with respect to any obligation of others of the type described in the preceding clause (i) or under clause (iii) below assumed by or guaranteed in any manner by such person or in effect guaranteed by such person through an agreement to purchase (including, without limitation, "take or pay" and similar arrangements), contingent or otherwise (and the obligations of such person under any such assumptions, guarantees or other such arrangements); and (iii) any and all deferrals, renewals, extensions, refinancings and refundings of, or amendments, modifications or supplements to, any of the foregoing. "Indenture" means this Indenture as amended from time to time. 3 "Initial Purchasers" means Smith Barney Inc., Deutsche Morgan Grenfell Inc. and UBS Securities LLC. "Issuance Date" means the date on which the Securities are first authenticated and issued. "Material Subsidiary" means any Subsidiary of the Company which, at the date of determination, is a "significant subsidiary" as defined in Rule 1-02(w) of Regulation S-X under the Securities Act and the Exchange Act (as such Regulation is in effect on the date hereof). "Noteholder" or "holder" means a person in whose name a Security is registered. "Obligations" means any principal, interest, penalties, fees, indemnifications, reimbursements, damages and other liabilities payable under the documentation governing any Indebtedness. "Offering Memorandum" means the offering memorandum relating to the Securities dated December 5, 1997. "Officers' Certificate" means a certificate signed by two Officers, one of whom must be the Chairman of the Board, the Chief Executive Officer, the President, the Chief Financial Officer or the Treasurer of the Company. See Sections 12.04 and 12.05 hereof. "Opinion of Counsel" means a written opinion from legal counsel who is acceptable to the Trustee. The counsel may be an employee of or counsel to the Company or the Trustee. See Sections 12.04 and 12.05 hereof. "person" means any individual, corporation, partnership, joint venture, association, joint stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. "principal" of a debt security means the principal of the security plus the premium, if any, on the security. "Registration Agreement" means the Registration Agreement relating to the Securities dated December 10, 1997, between the Company and the Initial Purchasers, a form of which is attached as Exhibit D hereto. "Representative" means the trustee, agent or representative (if any) for an issue of Senior Debt. "Restricted Securities Legend" means the legend labeled as such and that is set forth in Exhibit A hereto. "SEC" means the Securities and Exchange Commission. 4 "Securities" means the Securities described in the preamble above that are issued, authenticated and delivered under this Indenture. "Securities Act" means the Securities Act of 1933, as amended. "Senior Debt" means the principal of, interest on and other amounts due on Indebtedness of the Company, whether outstanding on the date of the Indenture or thereafter created, incurred, assumed or Guaranteed by the Company; unless, in the instrument creating or evidencing or pursuant to which Indebtedness is outstanding, it is expressly provided that such Indebtedness is not senior in right of payment to the Securities. Senior Debt includes, with respect to the obligations described above, interest accruing, pursuant to the terms of such Senior Debt, on or after the filing of any petition in bankruptcy or for reorganization relating to the Company, whether or not post-filing interest is allowed in such proceeding, at the rate specified in the instrument governing the relevant obligation. Notwithstanding anything to the contrary in the foregoing, Senior Debt shall not include: (a) Indebtedness of or amounts owed by the Company for compensation to employees, or for goods, services or materials purchased in the ordinary course of business; (b) Indebtedness of the Company to a Subsidiary of the Company; or (c) any liability for Federal, state, local or other taxes owed or owing by the Company. "Shelf Registration Statement" shall have the meaning set forth in the Registration Agreement. "Subsidiary" means any corporation, association or other business entity of which more than 50% of the total voting power of shares of Capital Stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by any person or one or more of the other Subsidiaries of that person or a combination thereof. "Termination of Trading" means an event where the Common Stock (or other securities into which the Securities are then convertible) is neither listed for trading on a United States national securities exchange nor approved for trading on an established automated over-the-counter trading market in the United States. "TIA" means the Trust Indenture Act of 1939 (15 U.S. Code ss.ss. 77aaa-77bbbb) as in effect on the date of execution of this Indenture. "Trading Day" shall mean (A) if the applicable security is listed or admitted for trading on the New York Stock Exchange or another national securities exchange, a day on which the New York Stock Exchange or such other national securities exchange is open for business, (B) if the applicable security is quoted on the NNM, a day on which trades may be made thereon or (C) if the applicable security is not so listed, admitted for trading or quoted, any day other than a Saturday or Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. 5 "Trustee" means the party named as such above until a successor replaces it in accordance with the applicable provisions of this Indenture and thereafter means the successor. "Trust Officer" means any officer or assistant officer of the Trustee assigned by the Trustee to administer this Indenture. SECTION 1.02. Other Definitions. Defined in Term Section - ---- ------- "Agent Members".........................................................2.01 "Bankruptcy Law"........................................................8.01 "Cedel Bank"............................................................2.01 "Commencement Date".....................................................3.08 "Conversion Agent"......................................................2.03 "Conversion Date".......................................................5.02 "Conversion Price"......................................................5.01 "Conversion Shares".....................................................5.06 "Current Market Price"..................................................5.06 "Custodian".............................................................8.01 "Designated Event Offer"................................................4.07 "Designated Event Payment"..............................................4.07 "Designated Event Payment Date".........................................3.08 "Distribution Date".....................................................5.06 "Distribution Record Date"..............................................5.06 "Excess Payment"...................................................... 5.06 "Euroclear".............................................................2.01 "Event of Default"......................................................8.01 "Global Security".......................................................2.01 "Legal Holiday"........................................................12.07 "Non-Global Purchasers".................................................2.01 "Offer Amount"..........................................................3.08 "Officer"..............................................................12.10 "Paying Agent"..........................................................2.03 "Payment Blockage Notice"...............................................6.02 "Payment Blockage Period"...............................................6.02 "Payment Default".......................................................8.01 "Purchase Agreement"....................................................2.01 "Purchase Date".........................................................5.06 "QIBs"..................................................................2.01 "Registrar".............................................................2.03 "Regulation S"..........................................................2.01 "Restricted Securities".................................................2.01 "Rights"................................................................5.06 6 "Rule 144A".............................................................2.01 "Tender Period".........................................................3.08 SECTION 1.03. Incorporation by Reference of Trust Indenture Act. Whenever this Indenture refers to a provision of the TIA, the provision is incorporated by reference in and made a part of this Indenture. The following TIA terms used in this Indenture have the following meanings: "indenture securities" means the Securities; "indenture security holder" means a Noteholder; "indenture to be qualified" means this Indenture; "indenture trustee" or "institutional trustee" means the Trustee; and "obligor" on the Securities means the Company or any other obligor on the Securities. All other terms used in this Indenture that are defined by the TIA, defined by TIA reference to another statute or defined by SEC rule under the TIA have the meanings so assigned to them. SECTION 1.04. Rules of Construction. Unless the context otherwise requires: (a) a term has the meaning assigned to it; (b) an accounting term not otherwise defined has the meaning assigned to it in accordance with GAAP consistently applied; (c) "or" is not exclusive; (d) words in the singular include the plural, and words in the plural include the singular; and (e) provisions apply to successive events and transactions. ARTICLE II The Securities SECTION 2.01. Form and Dating. The Securities and the Trustee's certificate of authentication shall be substantially in the form of Exhibit A which is hereby incorporated in and expressly made a part of this Indenture. 7 The Securities may have notations, legends or endorsements required by law, stock exchange rule, agreements to which the Company is subject, if any, or usage (provided that any such notation, legend or endorsement is in a form acceptable to the Company). The Company shall furnish any such legend not contained in Exhibit A to the Trustee in writing. Each Security shall be dated the date of its authentication. The terms and provisions of the Securities set forth in Exhibit A are part of the terms of this Indenture and to the extent applicable, the Company and the Trustee, by their execution and delivery of this Indenture, expressly agree to such terms and provisions and to be bound thereby. (a) Global Securities. The Securities are being offered and sold by the Company pursuant to a Purchase Agreement relating to the Securities, dated December 5, 1997, among the Company and the Initial Purchasers (the "Purchase Agreement"). Securities offered and sold (i) in reliance on Regulation S under the Securities Act ("Regulation S") shall be issued in the form of one or more permanent global Securities in definitive, fully registered form without interest coupons with the Global Securities Legend set forth in Exhibit A hereto or (ii) to Qualified Institutional Buyers ("QIBs") in reliance on Rule 144A under the Securities Act ("Rule 144A"), each as provided in the Purchase Agreement, shall be issued in the form of one or more permanent global Securities in definitive, fully registered form without interest coupons with the Global Securities Legend and Restricted Securities Legend set forth in Exhibit A hereto (together, the "Global Securities"). Each Global Security shall be deposited on behalf of the purchasers of the Securities represented thereby with the Trustee, at its New York office, as custodian for the Depositary, and registered in the name of the Depositary or a nominee of the Depositary (and, in the case of Regulation S, for the accounts of designated agents holding on behalf of the Euroclear System ("Euroclear") or Cedel Bank, societe anonyme ("Cedel Bank")), duly executed by the Company and authenticated by the Trustee as hereinafter provided. The aggregate principal amount of the Global Security may from time to time be increased or decreased by adjustments made on the records of the Trustee and the Depositary or its nominee as hereinafter provided. (b) Book-Entry Provisions. This Section 2.01(b) shall apply only to a Global Security deposited with or on behalf of the Depositary. The Company shall execute and the Trustee shall, in accordance with this Section 2.01(b) and the written order of the Company, authenticate and deliver initially one or more Global Securities that (i) shall be registered in the name of Cede & Co. or other nominee of such Depositary and (ii) shall be delivered by the Trustee to such Depositary or pursuant to such Depositary's instructions or held by the Trustee as custodian for the Depositary pursuant to a FAST Balance Certificate Agreement between the Depositary and the Trustee. Members of, or participants in, the Depositary ("Agent Members") shall have no rights under this Indenture with respect to any Global Security held on their behalf by the Depositary or by the Trustee as the custodian of the Depositary or under such Global Security, and the Depositary may be treated by the Company, the Trustee and any agent of the Company or the Trustee as the absolute owner of such Global Security for all purposes whatsoever. 8 Notwithstanding the foregoing, nothing herein shall prevent the Company, the Trustee or any agent of the Company or the Trustee from giving effect to any written certification, proxy or other authorization furnished by the Depositary or impair, as between the Depositary and its Agent Members, the operation of customary practices of such Depositary governing the exercise of the rights of a holder of a beneficial interest in any Global Security. (c) Certificated Securities. Except as provided in Section 2.10, owners of beneficial interests in Global Securities will not be entitled to receive physical delivery of certificated Securities. Purchasers of Securities who are not QIBs and did not purchase Securities sold in reliance on Regulation S under the Securities Act (referred to herein as the "Non-Global Purchasers") will receive certificated Securities bearing the Restricted Securities Legend set forth in Exhibit A hereto ("Restricted Securities"). Restricted Securities will bear the Restricted Securities Legend set forth on Exhibit A unless removed in accordance with Section 2.06(b) hereof and may not be exchanged for a Global Security, or interest therein, at any time. After a transfer of any Securities during the period of the effectiveness of a Shelf Registration Statement with respect to the Securities, all requirements pertaining to legends on such Security will cease to apply, the requirements requiring any such Security issued to certain holders to be issued in global form will cease to apply, and a certificated Security without legends will be available to the holder of such Securities. SECTION 2.02. Execution, Authentication and Delivery. Two Officers shall sign the Securities for the Company by manual or facsimile signature. The Company's seal shall be reproduced on the Securities. If an Officer whose signature is on a Security no longer holds that office at the time the Security is authenticated, the Security shall nevertheless be valid. A Security shall not be valid until authenticated by the manual signature of an authorized officer of the Trustee. The signature shall be conclusive evidence that the Security has been authenticated under this Indenture. Upon a written order of the Company signed by two Officers, the Trustee shall authenticate the Securities for original issue up to an aggregate principal amount of $240,000,000 and deliver such authenticated securities as directed in such order. The aggregate principal amount of Securities outstanding at any time shall not exceed such amount except as provided in Section 2.07. The Trustee may appoint one or more authenticating agents acceptable to the Company to authenticate Securities. An authenticating agent may authenticate Securities whenever the Trustee may do so. Each reference in this Indenture to authentication by the Trustee includes authentication by such agent. An authenticating agent has the same rights as an Agent to deal with the Company or an Affiliate. 9 SECTION 2.03. Registrar, Paying Agent and Conversion Agent. The Company shall maintain in the Borough of Manhattan, City of New York, State of New York (i) an office or agency where Securities may be presented for registration of transfer or for exchange (the "Registrar"), (ii) an office or agency where Securities may be presented for payment (the "Paying Agent") and (iii) an office or agency where Securities may be presented for conversion (the "Conversion Agent"). The Registrar shall keep a register of the Securities and of their transfer and exchange. The Company has initially appointed the Trustee as its Registrar, Paying Agent and Conversion Agent in New York. The Company may appoint one or more co-registrars, one or more additional paying agents and one or more additional conversion agents in such other locations as it shall determine. The term "Registrar" includes any co-registrar, the term "Paying Agent" includes any additional paying agent and the term "Conversion Agent" includes any additional conversion agent. The Company may change any Paying Agent, Registrar or Conversion Agent without prior notice to any Noteholder. The Company shall notify the Trustee of the name and address of any newly-appointed Agent not a party to this Indenture. If the Company fails to appoint or maintain another entity as Registrar, Paying Agent or Conversion Agent, the Trustee shall act as such. SECTION 2.04. Paying Agent to Hold Money in Trust. The Company shall require each Paying Agent other than the Trustee to agree in writing that the Paying Agent will hold in trust for the benefit of Noteholders or the Trustee all money held by the Paying Agent for the payment of principal or interest on the Securities, and will notify the Trustee of any default by the Company in making any such payment. While any such default continues, the Trustee may require a Paying Agent to pay all money held by it to the Trustee. The Company at any time may require a Paying Agent to pay all money held by it to the Trustee and to account for any money disbursed by it. Upon payment over to the Trustee, the Paying Agent (if other than the Company or an Affiliate of the Company) shall have no further liability for the money. If the Company or an Affiliate of the Company acts as Paying Agent, it shall segregate and hold in a separate trust fund for the benefit of the Noteholders all money held by it as Paying Agent. SECTION 2.05. Noteholder Lists. The Trustee shall preserve in as current a form as is reasonably practicable the most recent list available to it of the names and addresses of Noteholders. If the Trustee is not the Registrar, the Company shall furnish to the Trustee on or before each interest payment date and at such other times as the Trustee may request in writing a list in such form and as of such date as the Trustee may reasonably require of the names and addresses of Noteholders. SECTION 2.06. Transfer and Exchange. Where Securities are presented to the Registrar with a request to register a transfer or to exchange them for an equal principal amount of Securities of other denominations, such Registrar shall register the transfer or make the exchange if its requirements for such transactions are met. To permit registrations of transfers and exchanges, the Company shall issue and the Trustee shall authenticate Securities at the Registrar's request. No service charge shall be made for any registration of transfer or exchange (except as otherwise expressly permitted herein), but the Company may require payment of a sum sufficient to cover any transfer tax or similar governmental charge payable in connection 10 therewith (other than any such transfer tax or similar governmental charge payable upon exchanges pursuant to Sections 2.10, 3.06, 3.08, 5.02 or 11.05 hereof). The Company shall not be required (i) to issue, register the transfer of, or exchange Securities during a period beginning at the opening of business 15 days before the day of any selection of Securities for redemption under Section 3.02 hereof and ending at the close of business on the day of selection, or (ii) to exchange or register the transfer of any Security so selected for redemption in whole or in part, except the unredeemed portion of any Security being redeemed in part. (a) Notwithstanding any provision to the contrary herein, so long as a Global Security remains outstanding and is held by or on behalf of the Depositary, transfers of a Global Security, in whole or in part, or of any beneficial interest therein, shall only be made in accordance with Section 2.01(b) and this Section 2.06(a); provided, however, that beneficial interests in a Global Security may be transferred to persons who take delivery thereof in the form of a beneficial interest in the same Global Security in accordance with the transfer restrictions set forth under the heading "Notice to Investors" in the Offering Memorandum and, if applicable, in the Restricted Securities Legend. (i) Except for transfers or exchanges made in accordance with any of clauses (ii) through (iv) of this Section 2.06(a), transfers of a Global Security shall be limited to transfers of such Global Security in whole, but not in part, to nominees of the Depositary or to a successor of the Depositary or such successor's nominee. (ii) Global Security to Restricted Security. If an owner of a beneficial interest in a Global Security deposited with the Depositary or with the Trustee as custodian for the Depositary wishes at any time to transfer its interest in such Global Security to a person who is required to take delivery thereof in the form of a Restricted Security, such owner may, subject to the rules and procedures of Euroclear or Cedel Bank, if applicable, and the Depositary, cause the exchange of such interest for one or more Restricted Securities of any authorized denomination or denominations and of the same aggregate principal amount at maturity. Upon receipt by the Registrar of (1) instructions from Euroclear or Cedel Bank, if applicable, and the Depositary directing the Trustee to authenticate and deliver one or more Restricted Securities of the same aggregate principal amount at maturity as the beneficial interest in the Global Security to be exchanged, such instructions to contain the name or names of the designated transferee or transferees, the authorized denomination or denominations of the Restricted Securities to be so issued and appropriate delivery instructions, (2) a certificate substantially in the form of Exhibit B attached hereto given by the owner of such beneficial interest and stating that the person transferring such interest in such Global Security reasonably believes that the person acquiring the Restricted Securities for which such interest is being exchanged is an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) of Regulation D under the Securities Act) and is acquiring such Restricted Securities having an aggregate principal amount of not less than $250,000 for its own account or for one or more accounts as to which the transferee exercises sole investment discretion, (3) a 11 certificate in the form of Exhibit C attached hereto given by the person acquiring the Restricted Securities for which such interest is being exchanged, to the effect set forth therein, and (4) such other certifications, legal opinions or other information as the Company may reasonably require to confirm that such transfer is being made pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act, then Euroclear or Cedel Bank, if applicable, or the Registrar, as the case may be, will instruct the Depositary to reduce or cause to be reduced such Global Security by the aggregate principal amount at maturity of the beneficial interest therein to be exchanged and to debit or cause to be debited from the account of the person making such transfer the beneficial interest in the Global Security that is being transferred, and concurrently with such reduction and debit the Company shall execute, and the Trustee shall authenticate and deliver, one or more Restricted Securities of the same aggregate principal amount at maturity in accordance with the instructions referred to above. (iii) Restricted Security to Restricted Security. If a holder of a Restricted Security wishes at any time to transfer such Restricted Security to a person who is required to take delivery thereof in the form of a Restricted Security, such holder may, subject to the restrictions on transfer set forth herein and in such Restricted Security, cause the exchange of such Restricted Security for one or more Restricted Securities of any authorized denomination or denominations and of the same aggregate principal amount at maturity. Upon receipt by the Registrar of (1) such Restricted Security, duly endorsed as provided herein, (2) instructions from such holder directing the Trustee to authenticate and deliver one or more Restricted Securities of the same aggregate principal amount at maturity as the Restricted Security to be exchanged, such instructions to contain the name or names of the designated transferee or transferees, the authorized denomination or denominations of the Restricted Securities to be so issued and appropriate delivery instructions, (3) a certificate from the holder of the Restricted Security to be exchanged in the form of Exhibit B attached hereto, (4) a certificate in the form of Exhibit C attached hereto given by the person acquiring the Restricted Securities for which such interest is being exchanged, to the effect set forth therein, and (5) such other certifications, legal opinions or other information as the Company may reasonably require to confirm that such transfer is being made pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act, then the Registrar, shall cancel or cause to be canceled such Restricted Security and concurrently therewith, the Company shall execute, and the Trustee shall authenticate and deliver, one or more Restricted Securities of the same aggregate principal amount at maturity, in accordance with the instructions referred to above. (iv) Other Exchanges. In the event that a Global Security is exchanged for Securities in definitive registered form pursuant to Section 2.10, prior to the effectiveness of a Shelf Registration Statement with respect to such Securities, such Securities may be exchanged only in accordance with such procedures as are substantially consistent with the provisions of clauses (ii) and (iii) above (including the certification requirements intended to ensure that such transfers comply with Rule 144A or Regulation S under the 12 Securities Act, as the case may be) and such other procedures as may from time to time be adopted by the Company. (b) Except in connection with a Shelf Registration Statement contemplated by and in accordance with the terms of the Registration Agreement, if Securities are issued upon the registration of transfer, exchange or replacement of Securities bearing the Restricted Securities Legend set forth in Exhibit A hereto, or if a request is made to remove such Restricted Securities Legend on Securities, the Securities so issued shall bear the Restricted Securities Legend, or the Restricted Securities Legend shall not be removed, as the case may be, unless there is delivered to the Company such satisfactory evidence, which may include an opinion of counsel licensed to practice law in the State of New York, as may be reasonably required by the Company, that neither the legend nor the restrictions on transfer set forth therein are required to ensure that transfers thereof comply with the provisions of Rule 144A, Rule 144 or Regulation S under the Securities Act or, with respect to Restricted Securities, that such Securities are not "restricted" within the meaning of Rule 144 under the Securities Act. Upon provision to the Company of such satisfactory evidence, the Trustee, at the written direction of the Company, shall authenticate and deliver Securities that do not bear the legend. (c) Neither the Trustee nor any Agent shall have any responsibility for any actions taken or not taken by the Depositary. SECTION 2.07. Replacement Securities. If the holder of a Security claims that the Security has been lost, destroyed or wrongfully taken or if such Security is mutilated and is surrendered to the Registrar, the Company shall issue and the Trustee shall authenticate a replacement Security if the Trustee's and the Company's requirements (as shall have been previously communicated to the Trustee in a written letter of standing instruction) are met. If required by the Trustee, the Registrar or the Company, an indemnity bond must be sufficient in the judgment of each of the foregoing to protect the Company, the Trustee, any Agent or any authenticating agent from any loss which any of them may suffer if a Security is replaced. The Company may charge for its expenses in replacing a Security. In case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, or is about to be redeemed or purchased by the Company pursuant to Article III hereof or converted into shares of Common Stock pursuant to Article V hereof, the Company in its discretion may, instead of issuing a new Security, pay, redeem or convert such Security, as the case may be. Every replacement Security is an additional obligation of the Company. SECTION 2.08. Outstanding Securities. The Securities outstanding at any time are all the Securities authenticated by the Trustee except for those canceled by it, those delivered to it for cancellation, and those described in this Section as not outstanding. 13 If a Security is replaced, paid, redeemed or converted pursuant to Section 2.07 hereof, it ceases to be outstanding unless, in the case of a replaced Security, the Trustee receives proof satisfactory to it that the replaced Security is held by a bona fide purchaser. If Securities are considered paid under Section 4.01 hereof, they cease to be outstanding and interest on them ceases to accrue. A Security does not cease to be outstanding because the Company or an Affiliate of the Company holds the Security. SECTION 2.09. Treasury Securities. In determining whether the Noteholders of the required principal amount of Securities have concurred in any direction, waiver or consent, Securities owned by the Company or an Affiliate of the Company shall be considered as though they are not outstanding, except that for the purposes of determining whether the Trustee shall be protected in relying on any such direction, waiver or consent, only Securities which a Trust Officer knows are so owned shall be so disregarded. SECTION 2.10. Temporary Securities; Exchange of Global Security for Certificated Securities. (a) Until definitive Securities are ready for delivery, the Company may prepare and the Trustee shall authenticate temporary Securities. Temporary Securities shall be substantially in the form of definitive Securities but may have variations that the Company considers appropriate for temporary Securities. Without unreasonable delay, the Company shall prepare and the Trustee shall authenticate definitive Securities in exchange for temporary Securities. (b) A Global Security deposited with the Depositary or with the Trustee as custodian for the Depositary pursuant to Section 2.01 shall be transferred to the beneficial owners thereof in the form of certificated securities only if such transfer complies with Section 2.06 and (i) the Depositary notifies the Company that it is unwilling or unable to continue as Depositary for such Global Security or if at any time such Depositary ceases to be a "clearing agency" registered under the Exchange Act and a successor Depositary is not appointed by the Company within 90 days of such notice, or (ii) an Event of Default has occurred and is continuing. (c) Any Global Security that is transferable to the beneficial owners thereof in the form of certificated Securities pursuant to this Section 2.10 shall be surrendered by the Depositary to the Trustee located in the Borough of Manhattan, The City of New York, to be so transferred, in whole or from time to time in part, without charge, and the Trustee shall authenticate and deliver, upon such transfer of each portion of such Global Security, an equal aggregate principal amount at maturity of Securities of authorized denominations in the form of certificated Securities. Any portion of a Global Security transferred pursuant to this Section shall be executed, authenticated and delivered only in denominations of $1,000 and any integral multiple thereof and registered in such names as the Depositary shall direct. Any Securities in the form of certificated Securities delivered in exchange for an interest in the Global Security 14 shall, except as otherwise provided by Section 2.06(b), bear the Restricted Securities Legend set forth in Exhibit A hereto. (d) Prior to any transfer pursuant to Section 2.10(b), the registered holder of a Global Security may grant proxies and otherwise authorize any person, including Agent Members and persons that may hold interests through Agent Members, to take any action which a holder is entitled to take under this Indenture or the Securities. (e) In the event of the occurrence of either of the events specified in Section 2.10(b), the Company will promptly make available to the Trustee a reasonable supply of certificated Securities in definitive form without interest coupons. SECTION 2.11. Cancellation. The Company at any time may deliver Securities to the Registrar for cancellation. The Registrar, Paying Agent and Conversion Agent shall forward to the Trustee any Securities surrendered to them for registration of transfer, redemption, conversion, exchange or payment. The Trustee shall promptly cancel all Securities surrendered for registration of transfer, redemption, conversion, exchange, payment, replacement or cancellation and shall destroy all canceled Securities unless the Company otherwise directs. The Company may not issue new Securities to replace Securities that it has paid or that have been delivered to the Registrar for cancellation or that any holder has converted. SECTION 2.12. Defaulted Interest. If the Company fails to make a payment of interest on the Securities, it shall pay such defaulted interest plus any interest payable on the defaulted interest, in any lawful manner. It may pay such defaulted interest, plus any such interest payable on it, to the persons who are Noteholders on a subsequent special record date. The Company shall fix any such record date and payment date. At least 15 days before any such record date, the Company shall mail to Noteholders a notice that states the record date, payment date, and amount of such interest to be paid. ARTICLE III Redemption SECTION 3.01. Notices to Trustee. If the Company elects to redeem Securities pursuant to Section 3.07 hereof, it shall notify the Trustee of the redemption date and the principal amount of Securities to be redeemed. The Company shall give each notice provided for in this Section 3.01 at least 45 days before the redemption date (unless a shorter notice period shall be satisfactory to the Trustee). SECTION 3.02. Selection of Securities to be Redeemed. If less than all the Securities are to be redeemed, the Trustee shall select the Securities to be redeemed by a method that complies with the requirements of the principal national securities exchange, if any, on which the Securities are listed, or, if the Securities are not so listed, on a pro rata basis, by lot or by such other method as the Trustee considers fair and appropriate. The Trustee shall make the selection not more than 60 days and not less than 30 days before the redemption date from 15 Securities outstanding not previously called for redemption. The Trustee may select for redemption portions of the principal of Securities that have denominations larger than $1,000. Securities and portions of them it selects shall be in amounts of $1,000 or integral multiples of $1,000. Provisions of this Indenture that apply to Securities called for redemption also apply to portions of Securities called for redemption. The Trustee shall notify the Company promptly of the Securities or portions of Securities to be called for redemption. If any Security selected for partial redemption is converted in part after such selection, the converted portion of such Security shall be deemed (so far as may be) to be the portion to be selected for redemption. The Securities (or portions thereof) so selected shall be deemed duly selected for redemption for all purposes hereof, notwithstanding that any such Security is converted in whole or in part before the mailing of the notice of redemption. Upon any redemption of less than all the Securities, the Company and the Trustee may treat as outstanding any Securities surrendered for conversion during the period 15 days next preceding the mailing of a notice of redemption and need not treat as outstanding any Security authenticated and delivered during such period in exchange for the unconverted portion of any Security converted in part during such period. SECTION 3.03. Notice of Redemption. At least 30 days but not more than 60 days before a redemption date, the Company shall mail a notice of redemption to each holder whose Securities are to be redeemed at such holder's registered address. The notice shall identify the Securities to be redeemed and shall state: (a) the redemption date; (b) the redemption price; (c) if any Security is being redeemed in part, the portion of the principal amount of such Security to be redeemed and that, after the redemption date, upon cancellation of such Security, a new Security or Securities in principal amount equal to the unredeemed portion will be issued in the name of the holder thereof; (d) the name and address of the Paying Agent; (e) that Securities called for redemption must be surrendered to the Paying Agent to collect the redemption price plus accrued interest; (f) that, unless the Company defaults in making such redemption payment or the Paying Agent is prohibited from making such payment pursuant to the terms of this Indenture, by law or otherwise, interest on Securities called for redemption ceases to accrue on and after the redemption date; and (g) the paragraph of the Securities pursuant to which the Securities called for redemption are being redeemed. 16 Such notice shall also state the current Conversion Price and the date on which the right to convert such Securities or portions thereof into Common Stock of the Company will expire. At the Company's request, the Trustee shall give notice of redemption in the Company's name and at its expense. SECTION 3.04. Effect of Notice of Redemption. Once notice of redemption is mailed, Securities called for redemption become due and payable on the redemption date at the price set forth in the Security. SECTION 3.05. Deposit of Redemption Price. On or before the redemption date, the Company shall deposit with the Trustee or the Paying Agent money sufficient to pay the redemption price of and accrued interest up to but not including the redemption date on all Securities to be redeemed on that date (subject to the right of holders of record on the relevant record date to receive interest due on an interest payment date) unless theretofore converted into Common Stock pursuant to the provisions hereof. The Trustee or such Paying Agent shall return to the Company any money not required for that purpose. SECTION 3.06. Securities Redeemed in Part. Upon surrender of a Security that is redeemed in part, the Company shall issue and the Trustee shall authenticate for the holder at the expense of the Company a new Security equal in principal amount to the unredeemed portion of the Security surrendered. SECTION 3.07. Optional Redemption. The Company may redeem all or any portion of the Securities, upon the terms and at the redemption prices set forth in each of the Securities. Any redemption pursuant to this Section 3.07 shall be made pursuant to the provisions of Section 3.01 through 3.06 hereof. SECTION 3.08. Designated Event Offer. (a) In the event that, pursuant to Section 4.07 hereof, the Company shall commence a Designated Event Offer, the Company shall follow the procedures in this Section 3.08. (b) The Designated Event Offer shall remain open for a period specified by the Company which shall be no less than 30 calendar days and no more than 40 calendar days following its commencement on the date of the mailing of notice in accordance with Section 4.07(b) hereof (the "Commencement Date"), except to the extent that a longer period is required by applicable law (the "Tender Period"). Upon the expiration of the Tender Period (the "Designated Event Payment Date"), the Company shall purchase the principal amount of Securities required to be purchased pursuant to Section 4.07 hereof (the "Offer Amount"). (c) If the Designated Event Payment Date is on or after an interest payment record date and on or before the related interest payment date, any accrued interest to the related interest payment date will be paid to the person in whose name a Security is registered at the 17 close of business on such record date, and no additional interest will be payable to Noteholders who tender Securities pursuant to the Designated Event Offer. (d) The Company shall provide the Trustee with written notice of the Designated Event Offer at least 10 Business Days before the Commencement Date. (e) Subject to Section 4.07(b), on or before the Commencement Date, the Company or the Trustee (at the request and expense of the Company) shall send, by first class mail, a notice to each of the Noteholders, which shall govern the terms of the Designated Event Offer and shall state: (i) that the Designated Event Offer is being made pursuant to this Section 3.08 and Section 4.07 hereof and that all Securities tendered will be accepted for payment; (ii) the Offer Amount, the purchase price (as determined in accordance with Section 4.07 hereof), the length of time the Designated Event Offer will remain open and the Designated Event Payment Date; (iii) that any Security or portion thereof not tendered or accepted for payment will continue to accrue interest; (iv) that, unless the Company defaults in the payment of the Designated Event Payment, any Security or portion thereof accepted for payment pursuant to the Designated Event Offer shall cease to accrue interest after the Designated Event Payment Date; (v) that Noteholders electing to have a Security or portion thereof purchased pursuant to any Designated Event Offer will be required to surrender the Security, with the form entitled "Option of Noteholder To Elect Purchase" on the reverse of the Security completed, to the Paying Agent at the address specified in the notice prior to the close of business on the third Business Day preceding the Designated Event Payment Date; (vi) that Noteholders will be entitled to withdraw their election if the Paying Agent receives, not later than the close of business on the second Business Day preceding the Designated Event Payment Date, or such longer period as may be required by law, a letter or a telegram, telex, facsimile transmission (receipt of which is confirmed and promptly followed by a letter) setting forth the name of the Noteholder, the principal amount of the Security or portion thereof the Noteholder delivered for purchase and a statement that such Noteholder is withdrawing his election to have the Security or portion thereof purchased; and (vii) that Noteholders whose Securities are being purchased only in part will be issued new Securities equal in principal amount to the unpurchased portion of the Securities surrendered, which unpurchased portion must be equal to $1,000 in principal amount or an integral multiple thereof. 18 In addition, the notice shall contain all instructions and materials that the Company shall reasonably deem necessary to enable such Noteholders to tender Securities pursuant to the Designated Event Offer. (f) At least one Business Day prior to the Designated Event Payment Date, the Company shall irrevocably deposit with the Trustee or the Paying Agent in immediately available funds an amount equal to the Offer Amount to be held for payment in accordance with the terms of this Section 3.08. On the Designated Event Payment Date, the Company shall, to the extent lawful, (i) accept for payment the Securities or portions thereof tendered pursuant to the Designated Event Offer, (ii) deliver or cause to be delivered to the Trustee Securities so accepted and (iii) deliver to the Trustee an Officers' Certificate stating such Securities or portions thereof have been accepted for payment by the Company in accordance with the terms of this Section 3.08. The Paying Agent shall promptly (but in any case not later than five calendar days after the Designated Event Payment Date) mail or deliver to each tendering Noteholder an amount equal to the purchase price of the Securities tendered by such Noteholder, and the Trustee shall promptly authenticate and mail or deliver to such Noteholders a new Security equal in principal amount to any unpurchased portion of the Security surrendered, if any; provided, that each new Security shall be in a principal amount of $1,000 or an integral multiple thereof. Any Securities not so accepted shall be promptly mailed or delivered by or on behalf of the Company to the holder thereof. The Company will publicly announce the results of the Designated Event Offer on, or as soon as practicable after, the Designated Event Payment Date. (g) The Designated Event Offer shall be made by the Company in compliance with all applicable provisions of the Exchange Act, and all applicable tender offer rules promulgated thereunder, and shall include all instructions and materials that the Company shall reasonably deem necessary to enable such Noteholders to tender their Securities. ARTICLE IV Covenants SECTION 4.01. Payment of Securities. The Company shall pay the principal of and interest on the Securities on the dates and in the manner provided in the Securities. Principal and interest shall be considered paid on the date due if the Paying Agent (other than the Company or an Affiliate of the Company) holds on that date money designated for and sufficient to pay all principal and interest then due and such Paying Agent is not prohibited from paying such money to the Noteholders on that date pursuant to the terms of this Indenture. To the extent lawful, the Company shall pay interest (including post-petition interest in any proceeding under any Bankruptcy Law) on overdue installments of interest (without regard to any applicable grace period) at the rate borne by the Securities, compounded semiannually. SECTION 4.02. SEC Reports. Whether or not required by the rules and regulations of the SEC, so long as any Securities are outstanding, the Company will file with the SEC and furnish to the Trustee and to the holders of Securities all quarterly and annual financial 19 information required to be contained in a filing with the SEC on Forms 10-Q and 10-K, including a "Management's Discussion and Analysis of Financial Conditions and Results of Operations" and, with respect to annual information only, a report thereon by the Company's certified independent accountants. SECTION 4.03. Compliance Certificate. The Company shall deliver to the Trustee, within 120 days after the end of each fiscal year of the Company, an Officers' Certificate stating that a review of the activities of the Company and its subsidiaries during the preceding fiscal year has been made under the supervision of the signing Officers with a view to determining whether the Company has kept, observed, performed and fulfilled its obligations under, and complied with the covenants and conditions contained in, this Indenture, and further stating, as to each such Officer signing such certificate, that to the best of such Officer's knowledge the Company has kept, observed, performed and fulfilled each and every covenant, and complied with the covenants and conditions contained in this Indenture and is not in default in the performance or observance of any of the terms, provisions and conditions hereof (or, if a Default or Event of Default shall have occurred, describing all such Defaults or Events of Default of which such Officer may have knowledge) and that to the best of such Officer's knowledge no event has occurred and remains in existence by reason of which payments on account of the principal or of interest, if any, on the Securities are prohibited. One of the Officers signing such Officers' Certificate shall be either the Company's principal executive officer, principal financial officer or principal accounting officer. The Company will, so long as any of the Securities are outstanding, deliver to the Trustee, forthwith upon becoming aware of: (a) any Default, Event of Default or default in the performance of any covenant, agreement or condition contained in this Indenture; or (b) any event of default under any other mortgage, indenture or instrument as that term is used in Section 8.01(e), an Officers' Certificate specifying such Default, Event of Default or default. Immediately upon the occurrence of any event giving rise to an increase in the interest rate on the Securities in accordance with paragraph 11 of the form thereof or the termination of any such increase, the Company shall give the Trustee notice of such increase or termination, of the interest rate borne by the Securities after giving effect to such increase or termination and of the event giving rise to such increase or termination (such notice to be contained in an Officers' Certificate), and prior to receipt of such Officers' Certificate the Trustee shall be entitled to assume that no such increase or termination has occurred, as the case may be. SECTION 4.04. Stay, Extension and Usury Law. The Company covenants (to the extent that it may lawfully do so) that it will not at any time insist upon, plead, or in any 20 manner whatsoever claim or take the benefit or advantage of, any stay, extension or usury law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent it may lawfully do so) hereby expressly waives all benefit or advantage of any such law, and covenants that it will not, by resort to any such law, hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law has been enacted. SECTION 4.05. Corporate Existence. Except as provided in Article VII hereof, the Company will do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence and the corporate, partnership or other existence of each Subsidiary of the Company in accordance with the respective organizational documents of each Subsidiary and the rights (charter and statutory), licenses and franchises of the Company and its Subsidiaries; provided, however, that the Company shall not be required to preserve any such right, license or franchise, or the corporate, partnership or other existence of any Subsidiary, if the Board of Directors shall determine that the preservation thereof is no longer desirable in the conduct of the business of the Company and its Subsidiaries taken as a whole and that the loss thereof is not adverse in any material respect to the Noteholders. SECTION 4.06. Taxes. The Company shall, and shall cause each of its Subsidiaries to, pay prior to delinquency all taxes, assessments and governmental levies, except as contested in good faith and by appropriate proceedings. SECTION 4.07. Designated Event. (a) Upon the occurrence of a Designated Event, each holder of Securities shall have the right, in accordance with this Section 4.07 and Section 3.08 hereof, to require the Company to repurchase all or any part (equal to $1,000 or an integral multiple thereof) of such holder's Securities pursuant to the terms of Section 3.08 (the "Designated Event Offer") at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest thereon to the Designated Event Payment Date (the "Designated Event Payment"). (b) Within 30 days following any Designated Event, the Company shall mail to each holder the notice provided by Section 3.08(e). SECTION 4.08. Investment Company Act. As long as any Notes are outstanding, the Company will conduct its business and operations so as not to become an "investment company" within the meaning of the Investment Company Act of 1940, as amended (the "Investment Company Act"), and will take all steps required in order for it to continue not to be an "investment company" and not to be required to be registered under the Investment Company Act, including, if necessary, redeployment of the assets of the Company. 21 ARTICLE V Conversion SECTION 5.01. Conversion Privilege. A holder of a Security may convert the principal amount thereof (or any portion thereof that is an integral multiple of $1,000) into fully paid and nonassessable shares of Common Stock of the Company at any time after 90 days following the Issuance Date and prior to the close of business on the Business Day immediately preceding the maturity date of the Security at the Conversion Price then in effect, except that, with respect to any Security called for redemption, such conversion right shall terminate at the close of business on the Business Day immediately preceding the redemption date (unless the Company shall default in making the redemption payment when it becomes due, in which case the conversion right shall terminate on the date such default is cured). The number of shares of Common Stock issuable upon conversion of a Security is determined by dividing the principal amount of the Security converted by the conversion price in effect on the Conversion Date (the "Conversion Price"). The initial Conversion Price is stated in paragraph 10 of the Securities and is subject to adjustment as provided in this Article V. Provisions of this Indenture that apply to conversion of all of a Security also apply to conversion of a portion of it. A holder of Securities is not entitled to any rights of a holder of Common Stock until such holder of Securities has converted such Securities into Common Stock, and only to the extent that such Securities are deemed to have been converted into Common Stock under this Article 5. SECTION 5.02. Conversion Procedure. To convert a Security, a holder must satisfy the requirements in paragraph 10 of the Securities. The date on which the holder satisfies all of those requirements is the conversion date (the "Conversion Date"). As soon as practicable after the Conversion Date, the Company shall deliver to the holder through the Conversion Agent a certificate for the number of whole shares of Common Stock issuable upon the conversion and a check for any fractional share determined pursuant to Section 5.03. The person in whose name the certificate is registered shall become the stockholder of record on the Conversion Date and, as of such date, such person's rights as a Noteholder with respect to the converted Security shall cease; provided, however, that no surrender of a Security on any date when the stock transfer books of the Company shall be closed shall be effective to constitute the person entitled to receive the shares of Common Stock upon such conversion as the stockholder of record of such shares of Common Stock on such date, but such surrender shall be effective to constitute the person entitled to receive such shares of Common Stock as the stockholder of record thereof for all purposes at the close of business on the next succeeding day on which such stock transfer books are open; provided further, however, that such conversion shall be at the Conversion Price in effect on the date that such Security shall have been surrendered for conversion, as if the stock transfer books of the Company had not been closed. 22 No payment or adjustment will be made for accrued and unpaid interest on a converted Security or for dividends or distributions on shares of Common Stock issued upon conversion of a Security, but if any holder surrenders a Security for conversion after the close of business on the record date for the payment of an installment of interest and prior to the opening of business on the next interest payment date, then, notwithstanding such conversion, the interest payable on such interest payment date shall be paid to the holder of such Security on such record date. In such event, unless such Security has been called for redemption on or prior to such interest payment date, such Security, when surrendered for conversion, must be accompanied by payment in funds acceptable to the Company of an amount equal to the interest payable on such interest payment date on the portion so converted. If a holder converts more than one Security at the same time, the number of whole shares of Common Stock issuable upon the conversion shall be based on the total principal amount of Securities converted. Upon surrender of a Security that is converted in part, the Trustee shall authenticate for the holder a new Security equal in principal amount to the unconverted portion of the Security surrendered. SECTION 5.03. Fractional Shares. The Company will not issue fractional shares of Common Stock upon conversion of a Security. In lieu thereof, the Company will pay an amount in cash based upon the Daily Market Price of the Common Stock on the trading day prior to the date of conversion. SECTION 5.04. Taxes on Conversion. The issuance of certificates for shares of Common Stock upon the conversion of any Security shall be made without charge to the converting Noteholder for such certificates or for any tax in respect of the issuance of such certificates, and such certificates shall be issued in the respective names of, or in such names as may be directed by, the holder or holders of the converted Security; provided, however, that in the event that certificates for shares of Common Stock are to be issued in a name other than the name of the holder of the Security converted, such Security, when surrendered for conversion, shall be accompanied by an instrument of assignment or transfer, in form satisfactory to the Company, duly executed by the registered holder thereof or his duly authorized attorney; and provided further, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of any such certificates in a name other than that of the holder of the converted Security, and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid or is not applicable. SECTION 5.05. Company to Provide Stock. The Company shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, solely for the purpose of issuance upon conversion of Securities as herein provided, a sufficient number of shares of Common Stock to permit the conversion of all outstanding Securities for shares of Common Stock. 23 All shares of Common Stock which may be issued upon conversion of the Securities shall be duly authorized, validly issued, fully paid and nonassessable when so issued. SECTION 5.06. Adjustment of Conversion Price. The Conversion Price shall be subject to adjustment from time to time as follows: (a) In case the Company shall (1) pay a dividend in shares of Common Stock to holders of Common Stock, (2) make a distribution in shares of Common Stock to holders of Common Stock, (3) subdivide its outstanding shares of Common Stock into a greater number of shares of Common Stock or (4) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, the Conversion Price in effect immediately prior to such action shall be adjusted so that the holder of any Security thereafter surrendered for conversion shall be entitled to receive the number of shares of Common Stock which he would have owned immediately following such action had such Securities been converted immediately prior thereto. Any adjustment made pursuant to this subsection (a) shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of a subdivision or combination. (b) In case the Company shall issue rights or warrants to substantially all holders of Common Stock entitling them (for a period commencing no earlier than the record date for the determination of holders of Common Stock entitled to receive such rights or warrants and expiring not more than 45 days after such record date) to subscribe for or purchase shares of Common Stock (or securities convertible into Common Stock) at a price per share less than the Current Market Price (as determined pursuant to subsection (f) below) of the Common Stock on such record date, the Conversion Price shall be adjusted so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to such record date by a fraction of which the numerator shall be the number of shares of Common Stock outstanding on such record date, plus the number of shares of Common Stock which the aggregate offering price of the offered shares of Common Stock (or the aggregate conversion price of the convertible securities so offered) would purchase at such Current Market Price, and of which the denominator shall be the number of shares of Common Stock outstanding on such record date plus the number of additional shares of Common Stock offered (or into which the convertible securities so offered are convertible). Such adjustments shall become effective immediately after such record date. (c) In case the Company shall distribute to all holders of Common Stock shares of any class of Capital Stock of the Company other than Common Stock, evidences of indebtedness or other assets (other than cash dividends out of current or retained earnings), or shall distribute to substantially all holders of Common Stock rights or warrants to subscribe for securities (other than those Securities referred to in subsection (b) above), then in each such case the Conversion Price shall be adjusted so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the date of such distribution by a fraction of which the numerator shall be the Current Market Price (determined as provided in subsection (f) below) of the Common Stock on the record date mentioned below less the then fair market value (as determined by the Board of Directors, whose determination shall be conclusive 24 evidence of such fair market value and described in a Board Resolution) of the portion of the assets so distributed or of such subscription rights or warrants applicable to one share of Common Stock, and of which the denominator shall be such Current Market Price of the Common Stock. Such adjustment shall become effective immediately after the record date for the determination of the holders of Common Stock entitled to receive such distribution. Notwithstanding the foregoing, in case the Company shall issue rights or warrants to subscribe for additional shares of the Company's capital stock (other than those referred to in subsection (b) above) ("Rights") to substantially all holders of Common Stock, the Company may, in lieu of making any adjustment pursuant to this Section 5.06, make proper provision so that each holder of a Security who converts such Security (or any portion thereof) after the record date for such distribution and prior to the expiration or redemption of the Rights shall be entitled to receive upon such conversion, in addition to the shares of Common Stock issuable upon such conversion (the "Conversion Shares"), a number of Rights to be determined as follows: (i) if such conversion occurs on or prior to the date for the distribution to the holders of Rights of separate certificates evidencing such Rights (the "Distribution Date"), the same number of Rights to which a holder of a number of shares of Common Stock equal to the number of Conversion Shares is entitled at the time of such conversion in accordance with the terms and provisions of and applicable to the Rights; and (ii) if such conversion occurs after the Distribution Date, the same number of Rights to which a holder of the number of shares of Common Stock into which the principal amount of the Security so converted was convertible immediately prior to the Distribution Date would have been entitled on the Distribution Date in accordance with the terms and provisions of and applicable to the Rights. (d) In case the Company shall, by dividend or otherwise, at any time distribute to all holders of its Common Stock cash (including any distributions of cash out of current or retained earnings of the Company but excluding any cash that is distributed as part of a distribution requiring a Conversion Price adjustment pursuant to paragraph (c) of this Section) in an aggregate amount that, together with the sum of (x) the aggregate amount of any other distributions to all holders of its Common Stock made in cash plus (y) all Excess Payments, in each case made within the 12 months preceding the date fixed for determining the stockholders entitled to such distribution (the "Distribution Record Date") and in respect of which no Conversion Price adjustment pursuant to paragraphs (c) or (e) of this Section or this paragraph (d) has been made, exceeds 15% of the product of the Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Distribution Record Date multiplied by the number of shares of Common Stock outstanding on the Distribution Record Date (excluding shares held in the treasury of the Company), the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying such Conversion Price in effect immediately prior to the effectiveness of the Conversion Price reduction contemplated by this paragraph (d) by a fraction of which the numerator shall be the Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Distribution Record Date less the amount of such cash and other consideration (including any Excess Payments) so distributed applicable to one share of Common Stock (equal to the aggregate amount of such cash and other consideration (including any Excess Payments) divided by the number of shares of Common Stock outstanding 25 on the Distribution Record Date) and the denominator shall be such Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Distribution Record Date, such reduction to become effective immediately prior to the opening of business on the day following the Distribution Record Date. (e) In case a tender offer or other negotiated transaction made by the Company or any Subsidiary of the Company for all or any portion of the Common Stock shall be consummated, if an Excess Payment is made in respect of such tender offer or other negotiated transaction and the amount of such Excess Payment, together with the sum of (x) the aggregate amount of all Excess Payments plus (y) the aggregate amount of all distributions to all holders of the Common Stock made in cash (including any distributions of cash out of current or retained earnings of the Company), in each case made within the 12 months preceding the date of payment of such current negotiated transaction consideration or expiration of such current tender offer, as the case may be (the "Purchase Date"), and as to which no adjustment pursuant to paragraph (c) or paragraph (d) of this Section or this paragraph (e) has been made, exceeds 15% of the product of the Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Purchase Date multiplied by the number of shares of Common Stock outstanding (including any tendered shares but excluding any shares held in the treasury of the Company or any Subsidiary of the Company) on the Purchase Date, the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying such Conversion Price in effect immediately prior to the effectiveness of the Conversion Price reduction contemplated by this paragraph (e) by a fraction of which the numerator shall be the Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Purchase Date less the amount of such Excess Payments and such cash distributions, if any, applicable to one share of Common Stock (equal to the aggregate amount of such Excess Payments and such cash distributions divided by the number of shares of Common Stock outstanding on the Purchase Date) and the denominator shall be such Current Market Price per share (determined as provided in paragraph (f) of this Section) of the Common Stock on the Purchase Date, such reduction to become effective immediately prior to the opening of business on the day following the Purchase Date. (f) The "Current Market Price" per share of Common Stock on any date shall be deemed to be the average of the Daily Market Prices for the shorter of (i) 30 consecutive Business Days ending on the last full Trading Day on the exchange or market referred to in determining such Daily Market Prices prior to the time of determination or (ii) the period commencing on the date next succeeding the first public announcement of the issuance of such rights or such warrants or such other distribution or such negotiated transaction through such last full trading day on the exchange or market referred to in determining such Daily Market Prices prior to the time of determination. (g) "Excess Payment" means the excess of (A) the aggregate of the cash and fair market value of other consideration paid by the Company or any of its Subsidiaries with respect to the shares acquired in a tender offer or other negotiated transaction over (B) the Daily Market 26 Price on the Trading Day immediately following the completion of such tender offer or other negotiated transaction multiplied by the number of acquired shares. (h) In any case in which this Section 5.06 shall require that an adjustment be made immediately following a record date for an event, the Company may elect to defer, until such event, issuing to the holder of any Security converted after such record date the shares of Common Stock and other Capital Stock of the Company issuable upon such conversion over and above the shares of Common Stock and other Capital Stock of the Company issuable upon such conversion only on the basis of the Conversion Price prior to adjustment; and, in lieu of the shares the issuance of which is so deferred, the Company shall issue or cause its transfer agents to issue due bills or other appropriate evidence of the right to receive such shares. SECTION 5.07. No Adjustment. No adjustment in the Conversion Price shall be required until cumulative adjustments amount to 1% or more of the Conversion Price as last adjusted; provided, however, that any adjustments which by reason of this Section 5.07 are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Article V shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. No adjustment need be made for rights to purchase Common Stock pursuant to a Company plan for reinvestment of dividends or interest. No adjustment need be made for a change in the par value or no par value of the Common Stock. SECTION 5.08. Other Adjustments. (a) In the event that, as a result of an adjustment made pursuant to Section 5.06 above, the holder of any Security thereafter surrendered for conversion shall become entitled to receive any shares of Capital Stock of the Company other than shares of its Common Stock, thereafter the Conversion Price of such other shares so receivable upon conversion of any Securities shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to Common Stock contained in this Article V. (b) In the event that shares of Common Stock are not delivered after the expiration of any of the rights or warrants referred to in Section 5.06(b) and Section 5.06(c) hereof, the Conversion Price shall be readjusted to the Conversion Price which would otherwise be in effect had the adjustment made upon the issuance of such rights or warrants been made on the basis of delivery of only the number of shares of Common Stock actually delivered. SECTION 5.09. Adjustments for Tax Purposes. The Company may, at its option, make such reductions in the Conversion Price, in addition to those required by Section 5.06 above, as it determines to be advisable in order that any stock dividend, subdivision of shares, distribution of rights to purchase stock or securities or distribution of securities convertible into or exchangeable for stock made by the Company to its stockholders will not be taxable to the recipients thereof. SECTION 5.10. Adjustments by the Company. The Company from time to time may, to the extent permitted by law, reduce the Conversion Price by any amount for any period of at least 20 days, in which case the Company shall give at least 15 days' notice of such 27 reduction in accordance with Section 5.11, if the Board of Directors has made a determination that such reduction would be in the best interests of the Company, which determination shall be conclusive. SECTION 5.11. Notice of Adjustment. Whenever the Conversion Price is adjusted, the Company shall promptly mail to Noteholders at the addresses appearing on the Registrar's books a notice of the adjustment and file with the Trustee an Officers' Certificate briefly stating the facts requiring the adjustment and the manner of computing it. The certificate shall be conclusive evidence of the correctness of such adjustment. SECTION 5.12. Notice of Certain Transactions. In the event that: (1) the Company takes any action which would require an adjustment in the Conversion Price; (2) the Company takes any action that would require a supplemental indenture pursuant to Section 5.13; or (3) there is a dissolution or liquidation of the Company; a holder of a Security may wish to convert such Security into shares of Common Stock prior to the record date for or the effective date of the transaction so that he may receive the rights, warrants, securities or assets which a holder of shares of Common Stock on that date may receive. Therefore, the Company shall mail to Noteholders at the addresses appearing on the Registrar's books and the Trustee a notice stating the proposed record or effective date, as the case may be. The Company shall mail the notice at least 15 days before such date; however, failure to mail such notice or any defect therein shall not affect the validity of any transaction referred to in clause (1), (2) or (3) of this Section 5.12. SECTION 5.13. Effect of Reclassifications, Consolidations, Mergers or Sales on Conversion Privilege. If any of the following shall occur, namely: (i) any reclassification or change of outstanding shares of Common Stock issuable upon conversion of Securities (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), (ii) any consolidation or merger to which the Company is a party other than a merger in which the Company is the continuing corporation and which does not result in any reclassification of, or change (other than a change in name, or par value, or from par value to no par value, or from no par value to par value or as a result of a subdivision or combination) in, outstanding shares of Common Stock or (iii) any sale or conveyance of all or substantially all of the property or business of the Company as an entirety, then the Company, or such successor or purchasing corporation, as the case may be, shall, as a condition precedent to such reclassification, change, consolidation, merger, sale or conveyance, execute and deliver to the Trustee a supplemental indenture in form satisfactory to the Trustee providing that the holder of each Security then outstanding shall have the right to convert such Security into the kind and amount of shares of stock and other securities and property (including cash) receivable upon such reclassification, change, consolidation, merger, sale or conveyance 28 by a holder of the number of shares of Common Stock deliverable upon conversion of such Security immediately prior to such reclassification, change, consolidation, merger, sale or conveyance. Such supplemental indenture shall provide for adjustments of the Conversion Price which shall be as nearly equivalent as may be practicable to the adjustments of the Conversion Price provided for in this Article V. The foregoing, however, shall not in any way affect the right a holder of a Security may otherwise have, pursuant to clause (ii) of the last sentence of subsection (c) of Section 5.06, to receive Rights upon conversion of a Security. If, in the case of any such consolidation, merger, sale or conveyance, the stock or other securities and property (including cash) receivable thereupon by a holder of Common Stock includes shares of stock or other securities and property of a corporation other than the successor or purchasing corporation, as the case may be, in such consolidation, merger, sale or conveyance, then such supplemental indenture shall also be executed by such other corporation and shall contain such additional provisions to protect the interests of the holders of the Securities as the Board of Directors of the Company shall reasonably consider necessary by reason of the foregoing. The provision of this Section 5.13 shall similarly apply to successive consolidations, mergers, sales or conveyances. In the event the Company shall execute a supplemental indenture pursuant to this Section 5.13, the Company shall promptly file with the Trustee an Officers' Certificate briefly stating the reasons therefor, the kind or amount of shares of stock or securities or property (including cash) receivable by holders of the Securities upon the conversion of their Securities after any such reclassification, change, consolidation, merger, sale or conveyance and any adjustment to be made with respect thereto. SECTION 5.14. Trustee's Disclaimer. The Trustee has no duty to determine when an adjustment under this Article V should be made, how it should be made or what such adjustment should be, but may accept as conclusive evidence of the correctness of any such adjustment, and shall be protected in relying upon the Officers' Certificate with respect thereto which the Company is obligated to file with the Trustee pursuant to Section 5.11. The Trustee makes no representation as to the validity or value of any securities or assets issued upon conversion of Securities, and the Trustee shall not be responsible for the Company's failure to comply with any provisions of this Article V. The Trustee shall not be under any responsibility to determine the correctness of any provisions contained in any supplemental indenture executed pursuant to Section 5.13, but may accept as conclusive evidence of the correctness thereof, and shall be protected in relying upon, the Officers' Certificate with respect thereto which the Company is obligated to file with the Trustee pursuant to Section 5.13. ARTICLE VI Subordination SECTION 6.01. Agreement to Subordinate. The Company, for itself and its successors, and each Noteholder, by his acceptance of Securities, agree that the payment of the principal of or interest on or any other amounts due on the Securities is subordinated in right of 29 payment, to the extent and in the manner stated in this Article VI, to the prior payment in full of all existing and future Senior Debt. The Securities shall rank pari passu with the Company's 4 1/2% Convertible Subordinated Notes due 2002. SECTION 6.02. No Payment on Securities if Senior Debt in Default. Anything in this Indenture to the contrary notwithstanding, no payment on account of principal of or redemption of, interest on or other amounts due on the Securities (including the making of a deposit pursuant to Section 3.05), and no redemption, purchase, or other acquisition of the Securities, shall be made by or on behalf of the Company (i) unless full payment of amounts then due for principal and interest and of all other amounts then due on all Senior Debt has been made or duly provided for pursuant to the terms of the instrument governing such Senior Debt, (ii) if, at the time of such payment, redemption, purchase or other acquisition, or immediately after giving effect thereto, there shall exist under any Senior Debt, or any agreement pursuant to which any Senior Debt is issued, any default, which default shall not have been cured or waived and which default shall have resulted in the full amount of such Senior Debt being declared due and payable or (iii) if, at the time of such payment, redemption, purchase or other acquisition, the Trustee shall have received written notice from the Representative of the holders of Designated Senior Debt (a "Payment Blockage Notice") that there exists under such Designated Senior Debt, or any agreement pursuant to which such Designated Senior Debt is issued, any default, which default shall not have been cured or waived, permitting the holders thereof to declare any amounts of such Designated Senior Debt due and payable, but only for the period (the "Payment Blockage Period") commencing on the date of receipt of the Payment Blockage Notice and ending (unless earlier terminated by notice given to the Trustee by the Representative of the holders of such Designated Senior Debt) on the earlier of (a) the date on which such event of default shall have been cured or waived or (b) 180 days from the receipt of the Payment Blockage Notice. Notwithstanding the provisions described in the immediately preceding sentence (other than in clauses (i) and (ii)), unless the holders of such Designated Senior Debt or the Representative of such holders shall have accelerated the maturity of such Designated Senior Debt, the Company may resume payments on the Securities after the end of such Payment Blockage Period. Not more than one Payment Blockage Notice may be given in any consecutive 365-day period, irrespective of the number of defaults with respect to Senior Debt during such period. In the event that, notwithstanding the provisions of this Section 6.02, payments are made by or on behalf of the Company in contravention of the provisions of this Section 6.02, such payments shall be held by the Trustee, any Paying Agent or the holders, as applicable, in trust for the benefit of, and shall be paid over to and delivered to, the Representative of the holders of Senior Debt or the trustee under the indenture or other agreement (if any), pursuant to which any instruments evidencing any Senior Debt may have been issued for application to the payment of all Senior Debt ratably according to the aggregate amounts remaining unpaid to the extent necessary to pay all Senior Debt in full in accordance with the terms of such Senior Debt, after giving effect to any concurrent payment or distribution to or for the holders of Senior Debt. 30 The Company shall give prompt written notice to the Trustee and any Paying Agent of any default or event of default under any Senior Debt or under any agreement pursuant to which any Senior Debt may have been issued. SECTION 6.03. Distribution on Acceleration of Securities; Dissolution and Reorganization; Subrogation of Securities. (a) If the Securities are declared due and payable because of the occurrence of an Event of Default, the Company shall give prompt written notice to the holders of all Senior Debt or to the trustee(s) for such Senior Debt of such acceleration. The Company may not pay the principal of or interest on or any other amounts due on the Securities until five Business Days after such holders or trustee(s) of Senior Debt receive such notice and, thereafter, the Company may pay the principal of or interest on or any other amounts due on the Securities only if the provisions of this Article VI permit such payment. (b) Upon (i) any acceleration of the principal amount due on the Securities because of an Event of Default or (ii) any direct or indirect distribution of assets of the Company upon any dissolution, winding up, liquidation or reorganization of the Company (whether in bankruptcy, insolvency or receivership proceedings or upon an assignment for the benefit of creditors or any other dissolution, winding up, liquidation or reorganization of the Company): (1) the holders of all Senior Debt shall first be entitled to receive payment in full of the principal thereof, the interest thereon and any other amounts due thereon before the holders are entitled to receive payment on account of the principal of or interest on or any other amounts due on the Securities; (2) any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities (other than securities of the Company as reorganized or readjusted or securities of the Company or any other corporation provided for by a plan of reorganization or readjustment the payment of which is subordinate, at least to the extent provided in this Article with respect to the Securities, to the payment in full without diminution or modification by such plan of all Senior Debt), to which the holders or the Trustee would be entitled (other than in respect of amounts payable to the Trustee pursuant to Section 9.07) except for the provisions of this Article, shall be paid by the liquidating trustee or agent or other person making such a payment or distribution, directly to the holders of Senior Debt (or their representative(s) or trustee(s) acting on their behalf), ratably according to the aggregate amounts remaining unpaid on account of the principal of or interest on and other amounts due on the Senior Debt held or represented by each, to the extent necessary to make payment in full of all Senior Debt remaining unpaid, after giving effect to any concurrent payment or distribution to the holders of such Senior Debt; and (3) in the event that, notwithstanding the foregoing, any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities (other than securities of the Company as reorganized or readjusted, or securities of the Company or any other corporation provided for by a plan of reorganization or readjustment the payment of which is subordinate, at least to the extent provided in this Article with respect to the Securities, to the payment in full without diminution or modification by such plan of Senior 31 Debt), shall be received by the Trustee (other than in respect of amounts payable to the Trustee pursuant to Section 9.07) or the holders before all Senior Debt is paid in full, such payment or distribution shall be held in trust for the benefit of, and be paid over to upon request by a holder of the Senior Debt, the holders of the Senior Debt remaining unpaid (or their representatives) or trustee(s) acting on their behalf, ratably as aforesaid, for application to the payment of such Senior Debt until all such Senior Debt shall have been paid in full, after giving effect to any concurrent payment or distribution to the holders of such Senior Debt. Subject to the payment in full of all Senior Debt, the holders shall be subrogated to the rights of the holders of Senior Debt to receive payments or distributions of cash, property or securities of the Company applicable to the Senior Debt until the principal of and interest on the Securities shall be paid in full and, for purposes of such subrogation, no such payments or distributions to the holders of Senior Debt of cash, property or securities which otherwise would have been payable or distributable to holders shall, as between the Company, its creditors other than the holders of Senior Debt, and the holders, be deemed to be a payment by the Company to or on account of the Senior Debt, it being understood that the provisions of this Article are and are intended solely for the purpose of defining the relative rights of the holders, on the one hand, and the holders of Senior Debt, on the other hand. Nothing contained in this Article or elsewhere in this Indenture or in the Securities is intended to or shall (i) impair, as between the Company and its creditors other than the holders of Senior Debt, the obligation of the Company, which is absolute and unconditional, to pay to the holders the principal of and interest on the Securities as and when the same shall become due and payable in accordance with the terms of the Securities, (ii) affect the relative rights of the holders and creditors of the Company other than holders of Senior Debt or, as between the Company and the Trustee, the obligations of the Company to the Trustee, or (iii) prevent the Trustee or the holders from exercising all remedies otherwise permitted by applicable law upon default under this Indenture, subject to the rights, if any, under this Article of the holders of Senior Debt in respect of cash, property and securities of the Company received upon the exercise of any such remedy. Upon distribution of assets of the Company referred to in this Article, the Trustee, subject to the provisions of Section 9.01 hereof, and the holders shall be entitled to rely upon a certificate of the liquidating trustee or agent or other person making any distribution to the Trustee or to the holders for the purpose of ascertaining the persons entitled to participate in such distribution, the holders of the Senior Debt and other indebtedness of the Company, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Article. The Trustee, however, shall not be deemed to owe any fiduciary duty to the holders of Senior Debt. Nothing contained in this Article or elsewhere in this Indenture, or in any of the Securities, shall prevent the good faith application by the Trustee of any moneys which were deposited with it hereunder, prior to its receipt of written notice of facts which would prohibit such application, for the purpose of the payment of or on account of the principal of or interest on, the Securities unless, prior to the date on which such application is 32 made by the Trustee, the Trustee shall be charged with actual notice under Section 6.03(d) hereof of the facts which would prohibit the making of such application. (c) The provisions of this Article shall not be applicable to any cash, properties or securities received by the Trustee or by any holder when received as a holder of Senior Debt and nothing in Section 9.11 hereof or elsewhere in this Indenture shall deprive the Trustee or such holder of any of its rights as such holder. (d) The Company shall give prompt written notice to the Trustee of any fact known to the Company which would prohibit the making of any payment of money to or by the Trustee in respect of the Securities pursuant to the provisions of this Article. The Trustee, subject to the provisions of Section 9.01 hereof, shall be entitled to assume that no such fact exists unless the Company or any holder of Senior Debt or any trustee therefor has given notice thereof to the Trustee. Notwithstanding the provisions of this Article or any other provisions of this Indenture, the Trustee shall not be charged with knowledge of the existence of any fact which would prohibit the making of any payment of moneys to or by the Trustee in respect of the Securities pursuant to the provisions in this Article, unless, and until three Business Days after, the Trustee shall have received written notice thereof from the Company or any holder or holders of Senior Debt or from any trustee therefor; and, prior to the receipt of any such written notice, the Trustee, subject to the provisions of Section 9.01 hereof, shall be entitled in all respects conclusively to assume that no such facts exist; provided that if on a date not less than three Business Days immediately preceding the date upon which, by the terms hereof, any such moneys may become payable for any purpose (including, without limitation, the principal of or interest on any Security), the Trustee shall not have received with respect to such moneys the notice provided for in this Section 6.03(d), then anything herein contained to the contrary notwithstanding, the Trustee shall have full power and authority to receive such moneys and to apply the same to the purpose for which they were received, and shall not be affected by any notice to the contrary which may be received by it on or after such prior date. The Trustee shall be entitled to rely conclusively on the delivery to it of a written notice by a person representing himself to be a holder of Senior Debt (or a trustee on behalf of such holder) to establish that such notice has been given by a holder of Senior Debt (or a trustee on behalf of any such holder or holders). In the event that the Trustee determines in good faith that further evidence is required with respect to the right of any person as a holder of Senior Debt to participate in any payment or distribution pursuant to this Article, the Trustee may request such person to furnish evidence to the reasonable satisfaction of the Trustee as to the amount of Senior Debt held by such person, the extent to which such person is entitled to participate in such payment or distribution and any other facts pertinent to the rights of such person under this Article, and, if such evidence is not furnished, the Trustee may defer any payment to such person pending judicial determination as to the right of such person to receive such payment; nor shall the Trustee be charged with knowledge or the curing or waiving of any default of the character specified in Section 6.02 hereof or that any event or any condition preventing any payment in respect of the Securities shall have ceased to exist, unless and until the Trustee shall have received written notice to such effect. 33 (e) The provisions of this Section 6.03 applicable to the Trustee shall (unless the context requires otherwise) also apply to any Paying Agent for the Company. SECTION 6.04. Reliance by Senior Debt on Subordination Provisions. Each holder of any Security by his acceptance thereof acknowledges and agrees that the foregoing subordination provisions are, and are intended to be, an inducement and a consideration for each holder of any Senior Debt, whether such Senior Debt was created or acquired before or after the issuance of the Securities, to acquire and continue to hold, or to continue to hold, such Senior Debt, and such holder of Senior Debt shall be deemed conclusively to have relied on such subordination provisions in acquiring and continuing to hold, or in continuing to hold, such Senior Debt. Notice of any default in the payment of any Senior Debt, except as expressly stated in this Article, and notice of acceptance of the provisions hereof are hereby expressly waived. Except as otherwise expressly provided herein, no waiver, forbearance or release by any holder of Senior Debt under such Senior Debt or under this Article shall constitute a release of any of the obligations or liabilities of the Trustee or holders of the Securities provided in this Article. SECTION 6.05. No Waiver of Subordination Provisions. Except as otherwise expressly provided herein, no right of any present or future holder of any Senior Debt to enforce subordination as herein provided shall at any time in any way be prejudiced or impaired by any act or failure to act on the part of the Company or by any act or failure to act, in good faith, by any such holder, or by any noncompliance by the Company with the terms, provisions and covenants of this Indenture, regardless of any knowledge thereof any such holder may have or be otherwise charged with. Without in any way limiting the generality of the foregoing paragraph, the holders of Senior Debt may, at any time and from time to time, without the consent of, or notice to, the Trustee or the holders of the Securities, without incurring responsibility to the holders of the Securities and without impairing or releasing the subordination provided in this Article VI or the obligations hereunder of the holders of the Securities to the holders of Senior Debt, do any one or more of the following: (i) change the manner, place or terms of payment of, or renew or alter, Senior Debt, or otherwise amend or supplement in any manner Senior Debt or any instrument evidencing the same or any agreement under which Senior Debt is outstanding; (ii) sell, exchange, release or otherwise dispose of any property pledged, mortgaged or otherwise securing Senior Debt; (iii) release any person liable in any manner for the collection of Senior Debt; and (iv) exercise or refrain from exercising any rights against the Company or any other person. SECTION 6.06. Trustee's Relation to Senior Debt. The Trustee in its individual capacity shall be entitled to all the rights set forth in this Article in respect of any Senior Debt at any time held by it, to the same extent as any holder of Senior Debt, and nothing in Section 9.11 hereof or elsewhere in this Indenture shall deprive the Trustee of any of its rights as such holder. Anything in this Indenture to the contrary notwithstanding, amounts payable to the Trustee from time to time pursuant to Section 9.07 shall be treated for purposes of this Article as if such amounts constituted Senior Debt hereunder. 34 With respect to the holders of Senior Debt, the Trustee undertakes to perform or to observe only such of its covenants and obligations, as are specifically set forth in this Article, and no implied covenants or obligations with respect to the holders of Senior Debt shall be read into this Indenture against the Trustee. The Trustee shall not owe any fiduciary duty to the holders of Senior Debt but shall have only such obligations to such holders as are expressly set forth in this Article. Each holder of a Security by his acceptance thereof authorizes and directs the Trustee on his behalf to take such action as may be necessary or appropriate to effectuate the subordination provided in this Article and appoints the Trustee his attorney-in-fact for any and all such purposes, including, in the event of any dissolution, winding up or liquidation or reorganization under any applicable bankruptcy law of the Company (whether in bankruptcy, insolvency or receivership proceedings or otherwise), the timely filing of a claim for the unpaid balance of such holder's Securities in the form required in such proceedings and the causing of such claim to be approved. If the Trustee does not file a claim or proof of debt in the form required in such proceedings prior to 30 days before the expiration of the time to file such claims or proofs, then any holder or holders of Senior Debt or their representative or representatives shall have the right to demand, sue for, collect, receive and receipt for the payments and distributions in respect of the Securities which are required to be paid or delivered to the holders of Senior Debt as provided in this Article and to file and prove all claims therefor and to take all such other action in the name of the holders or otherwise, as such holders of Senior Debt or representative thereof may determine to be necessary or appropriate for the enforcement of the provisions of this Article. Anything in this Indenture to the contrary notwithstanding, amounts payable to the Trustee from time to time pursuant to Section 9.07 shall be treated for purposes of this Article as if such amounts constituted Senior Debt hereunder. SECTION 6.07. Other Provisions Subject Hereto. Except as expressly stated in this Article, notwithstanding anything contained in this Indenture to the contrary, all the provisions of this Indenture and the Securities are subject to the provisions of this Article. However, nothing in this Article shall apply to or adversely affect the claims of, or payment to, the Trustee pursuant to Section 9.07. Notwithstanding the foregoing, the failure to make a payment on account of principal of or interest on the Securities by reason of any provision of this Article VI shall not be construed as preventing the occurrence of an Event of Default under Section 8.01. ARTICLE VII Successors SECTION 7.01. Merger, Consolidation or Sale of Assets. The Company may not consolidate or merge with or into any person (whether or not the Company is the surviving corporation), or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its properties or assets unless: 35 (a) the Company is the surviving corporation or the Person formed by or surviving any such consolidation or merger (if other than the Company) or to which such sale, assignment, transfer, lease, conveyance or other disposition shall have been made is a corporation organized or existing under the laws of the United States, any state thereof or the District of Columbia; (b) the corporation formed by or surviving any such consolidation or merger (if other than the Company) or the corporation to which such sale, assignment, transfer, lease, conveyance or other disposition will have been made assumes all the Obligations of the Company, pursuant to a supplemental indenture in a form reasonably satisfactory to the Trustee, under the Securities and the Indenture; (c) any such sale, assignment, transfer, lease, conveyance or other disposition of all or substantially all of the Company's properties or assets shall be as an entirety or virtually as an entirety to one corporation; (d) immediately after such transaction no Default or Event of Default exists; and (e) the Company or such corporation shall have delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such transaction and the supplemental indenture comply with the Indenture and that all conditions precedent in the Indenture relating to such transaction have been satisfied. SECTION 7.02. Successor Corporation Substituted. Upon any consolidation or merger, or any sale, assignment, transfer, lease, conveyance or other disposition of all or substantially all of the assets of the Company in accordance with Section 7.01 hereof, the successor corporation formed by such consolidation or into or with which the Company is merged or the corporation to which such sale, assignment, transfer, lease, conveyance or other disposition is made shall succeed to, and be substituted for and may exercise every right and power of, the Company under this Indenture with the same effect as if such successor person has been named as the Company herein; provided, however, that the predecessor Company in the case of a sale, assignment, transfer, lease, conveyance or other disposition shall not be released from the obligation to pay the principal of and interest on the Securities. ARTICLE VIII Defaults and Remedies SECTION 8.01. Events of Default. An "Event of Default" occurs if: (a) the Company defaults in the payment of interest on any Security when the same becomes due and payable, and the Default continues for a period of 30 days after the date due and payable; 36 (b) the Company defaults in the payment of the principal of any Security when the same becomes due and payable at maturity, upon redemption or otherwise; (c) the Company fails to observe or perform any covenant or agreement contained in Section 4.07 hereof; (d) the Company fails to observe or perform any other covenant or agreement contained in this Indenture or the Securities required by it to be performed and the Default continues for a period of 60 days after the receipt of written notice from the Trustee to the Company or from the holders of 25% in aggregate principal amount of the then outstanding Securities to the Company and the Trustee stating that such notice is a "Notice of Default"; (e) there is a default under any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any Indebtedness for money borrowed by the Company or any Material Subsidiary of the Company (or the payment of which is guaranteed by the Company or any Material Subsidiary of the Company), whether such Indebtedness or guarantee now exists or is created after the Issuance Date, which default (i) is caused by a failure to pay when due principal of or interest on such Indebtedness within the grace period provided for in such Indebtedness (which failure continues beyond any applicable grace period) (a "Payment Default") or (ii) results in the acceleration of such Indebtedness prior to its express maturity (without such acceleration being rescinded or annulled) and, in each case, the principal amount of any such Indebtedness, together with the principal amount of any other such Indebtedness under which there is a Payment Default or the maturity of which has been so accelerated, aggregates $10 million or more; (f) a final, non-appealable judgment or final non-appealable judgments (other than any judgment as to which a reputable insurance company has accepted full liability) for the payment of money are entered by a court or courts of competent jurisdiction against the Company or any Material Subsidiary of the Company and remain undischarged for a period (during which execution shall not be effectively stayed) of 60 days, provided that the aggregate of all such judgments exceeds $5 million; (g) the Company or any Material Subsidiary pursuant to or within the meaning of any Bankruptcy Law: (i) commences a voluntary case, (ii) consents to the entry of an order for relief against it in an involuntary case in which it is the debtor, (iii) consents to the appointment of a Custodian of it or for all or substantially all of its property, (iv) makes a general assignment for the benefit of its creditors, or (v) makes the admission in writing that it generally is unable to pay its debts as the same become due; or (h) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that: (i) is for relief against the Company or any Material Subsidiary of the Company in an involuntary case, (ii) appoints a Custodian of the Company or any Material Subsidiary of the Company or for all or substantially all of its property, and the 37 order or decree remains unstayed and in effect for 60 days or (iii) orders the liquidation of the Company or any Material Subsidiary of the Company, and the order or decree remains unstayed and in effect for 60 days. The term "Bankruptcy Law" means Title 11, U.S. Code or any similar Federal or state law for the relief of debtors. The term "Custodian" means any receiver, trustee, assignee, liquidator or similar official under any Bankruptcy Law. SECTION 8.02. Acceleration. If an Event of Default (other than an Event of Default specified in clauses (g) and (h) of Section 8.01 hereof) occurs and is continuing, the Trustee by notice to the Company, or the Noteholders of at least 25% in principal amount of the then-outstanding Securities by notice to the Company and the Trustee, may declare all the Securities to be due and payable. Upon such declaration, the principal of, premium, if any, and accrued and unpaid interest on the Securities shall be due and payable immediately. If an Event of Default specified in clause (g) or (h) of Section 8.01 hereof occurs, such an amount shall ipso facto become and be immediately due and payable without any declaration or other act on the part of the Trustee or any Noteholder. The Noteholders of a majority in aggregate principal amount of the then-outstanding Securities by notice to the Trustee may rescind an acceleration and its consequences if the rescission would not conflict with any judgment or decree, if all amounts payable to the Trustee pursuant to Section 9.07 hereof have been paid and if all existing Events of Default have been cured or waived except nonpayment of principal or interest that has become due solely because of the acceleration. SECTION 8.03. Other Remedies. If an Event of Default occurs and is continuing, the Trustee may pursue any available remedy to collect the payment of principal or interest on the Securities or to enforce the performance of any provision of the Securities or this Indenture. The Trustee may maintain a proceeding even if it does not possess any of the Securities or does not produce any of them in the proceeding. A delay or omission by the Trustee or any Noteholder in exercising any right or remedy accruing upon an Event of Default shall not impair the right or remedy or constitute a waiver of or acquiescence in the Event of Default. All remedies are cumulative to the extent permitted by law. SECTION 8.04. Waiver of Past Defaults. The Noteholders of a majority in aggregate principal amount of the then-outstanding Securities by notice to the Trustee may waive an existing Default or Event of Default and its consequences except a continuing Default or Event of Default in the payment of the Designated Event Payment or the principal of, or interest on, any Security. When a Default or Event of Default is waived, it is cured and ceases; but no such waiver shall extend to any subsequent or other Default or impair any right consequent thereon. SECTION 8.05. Control by Majority. The Noteholders of a majority in principal amount of the then-outstanding Securities may direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power 38 conferred on it. However, the Trustee may refuse to follow any direction that conflicts with law or this Indenture, is unduly prejudicial to the rights of other Noteholders, or would involve the Trustee in personal liability. SECTION 8.06. Limitation on Suits. A Noteholder may pursue a remedy with respect to this Indenture or the Securities only if: (a) the Noteholder gives to the Trustee notice of a continuing Event of Default; (b) the Noteholders of at least 25% in principal amount of the then-outstanding Securities make a request to the Trustee to pursue the remedy; (c) such Noteholder or Noteholders offer to the Trustee indemnity satisfactory to the Trustee against any loss, liability or expense; (d) the Trustee does not comply with the request within 60 days after receipt of the request and the offer of indemnity; and (e) during such 60-day period the Noteholders of a majority in principal amount of the then-outstanding Securities do not give the Trustee a direction inconsistent with the request. A Noteholder may not use this Indenture to prejudice the rights of another Noteholder or to obtain a preference or priority over another Noteholder. SECTION 8.07. Rights of Noteholders to Receive Payment. Notwithstanding any other provision of this Indenture, the right of any Noteholder of a Security to receive payment of principal and interest on the Security, on or after the respective due dates expressed in the Security, or to bring suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of the Noteholder made pursuant to this Section. SECTION 8.08. Collection Suit by Trustee. If an Event of Default specified in Section 8.01(a) or (b) occurs and is continuing, the Trustee may recover judgment in its own name and as trustee of an express trust against the Company for the whole amount of principal and interest remaining unpaid on the Securities and interest on overdue principal and interest and such further amount as shall be sufficient to cover the costs and, to the extent lawful, expenses of collection, including the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel. SECTION 8.09. Trustee May File Proofs of Claim. The Trustee may file such proofs of claim and other papers or documents as may be necessary or advisable in order to have the claims of the Trustee and the Noteholders allowed in any judicial proceedings relative to the Company, its creditors or its property. Nothing contained herein shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Noteholder any plan of 39 reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Noteholder thereof, or to authorize the Trustee to vote in respect of the claim of any Noteholder in any such proceeding. SECTION 8.10. Priorities. If the Trustee collects any money pursuant to this Article, it shall pay out the money in the following order: First: to the Trustee for amounts due under Section 9.07 hereof; Second: to the holders of Senior Debt to the extent required by Article VI; Third: to the Noteholders, for amounts due and unpaid on the Securities for principal and interest, ratably, according to the amounts due and payable on the Securities for principal and interest, respectively; and Fourth: to the Company. Except as otherwise provided in Section 2.12 hereof, the Trustee may fix a record date and payment date for any payment to Noteholders made pursuant to this Section. SECTION 8.11. Undertaking for Costs. In any suit for the enforcement of any right or remedy under this Indenture or in any suit against the Trustee for any action taken or omitted by it as a Trustee, a court in its discretion may require the filing by any party litigant in the suit of an undertaking to pay the costs of the suit, and the court in its discretion may assess reasonable costs, including reasonable attorneys' fees, against any party litigant in the suit, having due regard to the merits and good faith of the claims or defenses made by the party litigant. This Section does not apply to a suit by the Trustee, a suit by a holder pursuant to Section 8.07 hereof, or a suit by Noteholders of more than 10% in principal amount of the then-outstanding Securities. ARTICLE IX Trustee SECTION 9.01. Duties of Trustee. (a) If an Event of Default has occurred and is continuing, the Trustee shall exercise such of the rights and powers vested in it by this Indenture, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of his or her own affairs. (b) Except during the continuance of an Event of Default: (i) the Trustee need perform only those duties that are specifically set forth in this Indenture and no others and (ii) in the absence of bad faith on its part, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to the Trustee and, if required by the terms hereof, conforming to the requirements of this Indenture. However, the Trustee shall examine the certificates and opinions to determine whether or not they conform to the requirements of this Indenture. During the continuance of an 40 event of Default, the Trustee may consult with its legal counsel and rely upon advice from such counsel with respect to legal matters. (c) The Trustee may not be relieved from liability for its own negligent action, its own negligent failure to act, or its own willful misconduct, except that: (i) this paragraph does not limit the effect of paragraph (b) of this Section 9.01; (ii) the Trustee shall not be liable for any error of judgment made in good faith by a Trust Officer, unless it is proved that the Trustee was negligent in ascertaining the pertinent facts and (iii) the Trustee shall not be liable with respect to any action it takes or omits to take in good faith in accordance with a direction received by it pursuant to Section 8.05 hereof. (d) Every provision of this Indenture that in any way relates to the Trustee is subject to paragraphs (a), (b) and (c) of this Section 9.01. (e) The Trustee may refuse to perform any duty or exercise any right or power unless it receives indemnity satisfactory to it against any loss, liability or expense. (f) The Trustee shall not be liable for interest on any money received by it except as the Trustee may agree in writing with the Company. Money held in trust by the Trustee need not be segregated from other funds except to the extent required by law. SECTION 9.02. Rights of Trustee. (a) The Trustee may rely on any document believed by it to be genuine and to have been signed or presented by the proper person. The Trustee need not investigate any fact or matter stated in the document. (b) Before the Trustee acts or refrains from acting, it may require an Officers' Certificate or an Opinion of Counsel, or both. The Trustee shall not be liable for any action it takes or omits to take in good faith in reliance on such Officers' Certificate or Opinion of Counsel. (c) The Trustee may act through agents and shall not be responsible for the misconduct or negligence of any agent appointed with due care. (d) The Trustee shall not be liable for any action it takes or omits to take in good faith which it believes to be authorized or within its rights or powers. (e) The Trustee shall not be charged with knowledge of any Event of Default under subsection (c), (d), (e), (f), (g) or (h) of Section 8.01 unless either (1) a Trust Officer assigned to its corporate trust department shall have actual knowledge thereof, or (2) the Trustee shall have received notice thereof in accordance with Section 12.02 hereof from the Company or any holder. SECTION 9.03. Individual Rights of Trustee. The Trustee in its individual or any other capacity may become the owner or pledgee of Securities and may otherwise deal with the Company or an Affiliate with the same rights it would have if it were not Trustee. Any 41 Agent may do the same with like rights. However, the Trustee is subject to Sections 9.10 and 9.11 hereof. SECTION 9.04. Trustee's Disclaimer. The Trustee makes no representation as to the validity or adequacy of this Indenture or the Securities, it shall not be accountable for the Company's use of the proceeds from the Securities, and it shall not be responsible for any statement of the Company in the Indenture or any statement in the Securities (other than its authentication) or for compliance by the Company with the Registration Agreement. SECTION 9.05. Notice of Defaults. If a Default or Event of Default occurs and is continuing and if it is known to the Trustee, the Trustee shall mail to Noteholders a notice of the Default or Event of Default within 90 days after it occurs. Except in the case of a Default or Event of Default in payment on any Security, the Trustee may withhold the notice if and so long as a committee of its Trust Officers in good faith determines that withholding the notice is in the interests of Noteholders. SECTION 9.06. Reports by Trustee to Noteholders. Within 60 days after the reporting date stated in Section 12.10, the Trustee shall mail to Noteholders a brief report dated as of such reporting date that complies with TIA ss. 313(a) if and to the extent required by such ss. 313(a). The Trustee also shall comply with TIA ss. 313(b)(2). The Trustee shall also transmit by mail all reports as required by TIA ss. 313(c). A copy of each report at the time of its mailing to Noteholders shall be filed with the SEC and each stock exchange on which the Securities are listed. The Company shall notify the Trustee when the Securities are listed on any stock exchange. SECTION 9.07. Compensation and Indemnity. The Company shall pay to the Trustee from time to time reasonable compensation for its services hereunder. The Trustee's compensation shall not be limited by any law on compensation of a trustee of an express trust. The Company shall reimburse the Trustee upon request for all reasonable disbursements, expenses and advances incurred or made by it. Such disbursements and expenses may include the reasonable disbursements, compensation and expenses of the Trustee's agents and counsel. The Company shall indemnify the Trustee against any loss or liability incurred by it except as set forth in the next paragraph. The Trustee shall notify the Company promptly of any claim for which it may seek indemnity. The Company shall defend the claim and the Trustee shall cooperate in the defense. The Trustee may have separate counsel and the Company shall pay the reasonable fees, disbursements and expenses of such counsel. The Company need not pay for any settlement made without its consent, which consent shall not be unreasonably withheld. The Company need not reimburse any expense or indemnify against any loss or liability incurred by the Trustee through the Trustee's negligence or bad faith. 42 To secure the Company's payment obligations in this Section, the Trustee shall have a lien equivalent to that of Senior Debt and prior to the Securities on all money or property held or collected by the Trustee, except money or property held in trust to pay principal and interest on particular Securities. When the Trustee incurs expenses or renders services after an Event of Default specified in Section 8.01(g) or (h) occurs, the expenses and the compensation for the services are intended to constitute expenses of administration under any Bankruptcy Law. SECTION 9.08. Replacement of Trustee. A resignation or removal of the Trustee and appointment of a successor Trustee shall become effective only upon the successor Trustee's acceptance of appointment as provided in this Section. The Trustee may resign by so notifying the Company. The Noteholders of a majority in principal amount of the then-outstanding Securities may remove the Trustee by so notifying the Trustee and the Company. The Company may remove the Trustee if: (a) the Trustee fails to comply with Section 9.10 hereof, unless the Trustee's duty to resign is stayed as provided in TIA ss. 310(b); (b) the Trustee is adjudged a bankrupt or an insolvent or an order for relief is entered with respect to the Trustee under any Bankruptcy Law; (c) a Custodian or public officer takes charge of the Trustee or its property; or (d) the Trustee becomes incapable of acting. If the Trustee resigns or is removed or if a vacancy exists in the office of Trustee for any reason, the Company shall promptly appoint a successor Trustee. Within one year after the successor Trustee takes office, the Noteholders of a majority in principal amount of the then-outstanding Securities may appoint a successor Trustee to replace the successor Trustee appointed by the Company. If a successor Trustee does not take office within 60 days after the retiring Trustee resigns or is removed, the retiring Trustee, the Company or the Noteholders of at least 10% in principal amount of the then-outstanding Securities may petition any court of competent jurisdiction for the appointment of a successor Trustee. If the Trustee fails to comply with Section 9.10 hereof, unless the Trustee's duty to resign is stayed as provided in TIA ss. 310(b), any Noteholder who has been a bona fide holder of a Security for at least six months may petition any court of competent jurisdiction for the removal of the Trustee and the appointment of a successor Trustee. A successor Trustee shall deliver a written acceptance of its appointment to the retiring Trustee and to the Company. Thereupon the resignation or removal of the retiring Trustee shall become effective, and the successor Trustee shall have all the rights, powers and 43 duties of the Trustee under this Indenture. The successor Trustee shall mail a notice of its succession to Noteholders. The retiring Trustee shall promptly transfer all property held by it as Trustee to the successor Trustee, subject to the lien provided for in Section 9.07 hereof. Notwithstanding the resignation or replacement of the Trustee pursuant to this Section 9.08, the Company's obligations under Section 9.07 hereof shall continue for the benefit of the retiring trustee with respect to expenses and liabilities incurred by it prior to such resignation or replacement. SECTION 9.09. Successor Trustee by Merger, Etc. If the Trustee consolidates, merges or converts into, or transfers all or substantially all of its corporate trust business to, another corporation, the successor corporation without any further act shall be the successor Trustee. SECTION 9.10. Eligibility; Disqualification. This Indenture shall always have a Trustee who satisfies the requirements of TIA ss. 310(a)(1) and (5). The Trustee shall always have a combined capital and surplus as stated in Section 12.10 hereof. The Trustee is subject to TIA ss. 310(b). SECTION 9.11. Preferential Collection of Claims Against Company. The Trustee is subject to TIA ss. 311(a), excluding any creditor relationship listed in TIA ss. 311(b). A Trustee who has resigned or been removed shall be subject to TIA ss. 311(a) to the extent indicated therein. ARTICLE X Discharge of Indenture SECTION 10.01. Termination of Company's Obligations. This Indenture shall cease to be of further effect (except that the Company's obligations under Sections 9.07 and 10.02 hereof shall survive) when all outstanding Securities theretofore authenticated and issued have been delivered to the Trustee for cancellation and the Company has paid all sums payable hereunder. Thereupon, the Trustee upon request of the Company, shall acknowledge in writing the discharge of the Company's obligations under this Indenture, except for those surviving obligations specified above. SECTION 10.02. Repayment to Company. The Trustee and the Paying Agent shall promptly pay to the Company upon request any excess money or securities held by them at any time. The Trustee and the Paying Agent shall pay to the Company upon written request any money held by them for the payment of principal or interest that remains unclaimed for two years after the date upon which such payment shall have become due; provided, however, that the Company shall have first caused notice of such payment to the Company to be mailed to each 44 Noteholder entitled thereto no less than 30 days prior to such payment. After payment to the Company, the Trustee and the Paying Agent shall have no further liability with respect to such money and Noteholders entitled to the money must look to the Company for payment as general creditors unless any applicable abandoned property law designates another person. ARTICLE XI Amendments, Supplements and Waivers SECTION 11.01. Without Consent of Noteholders. The Company and the Trustee may amend or supplement this Indenture or the Securities without the consent of any Noteholder: (a) to cure any ambiguity, defect or inconsistency; (b) to comply with Sections 5.13 and 7.01 hereof; (c) to provide for uncertificated Securities in addition to certificated Securities; (d) to make any change that does not adversely affect the legal rights hereunder of any Noteholder; (e) to qualify this Indenture under the TIA or to comply with the requirements of the SEC in order to maintain the qualification of the Indenture under the TIA; or (f) to make any change that provides any additional rights or benefits to the holders of Securities. An amendment under this Section may not make any change that adversely affects the rights under Article VI of any holder of Senior Debt then outstanding unless the holders of such Senior Debt (or any group or representative thereof authorized to give a consent) consent to such change. SECTION 11.02. With Consent of Noteholders. Subject to Section 8.07 hereof, the Company and the Trustee may amend or supplement this Indenture or the Securities with the written consent (including consents obtained in connection with any tender or exchange offer for Securities) of the Noteholders of at least a majority in principal amount of the then-outstanding Securities. Subject to Sections 8.04 and 8.07 hereof, the Noteholders of a majority in principal amount of the Securities then outstanding may also by their written consent (including consents obtained in connection with any tender offer or exchange offer for Securities) waive any existing Default as provided in Section 8.04 or waive compliance in a particular instance by the Company with any provision of this Indenture or the Securities. However, without the consent of each Noteholder affected, an amendment, supplement or waiver under this Section may not (with respect to any Securities held by a nonconsenting Noteholder): 45 (a) reduce the amount of Securities whose Noteholders must consent to an amendment, supplement or waiver; (b) reduce the rate of or change the time for payment of interest on any Security; (c) reduce the principal of or change the fixed maturity of any Security or alter the redemption provisions with respect thereto; (d) make any Security payable in money other than that stated in the Security; (e) make any change in Section 8.04, 8.07 or 11.02 hereof (this sentence); (f) waive a default in the payment of the Designated Event Payment or principal of, or interest on, any Security (other than as provided in Section 8.04); (g) waive a redemption payment payable on any Security; or (h) make any change that adversely affects the right of Noteholders to convert Securities into Common Stock of the Company. To secure a consent of the Noteholders under this Section 11.02, it shall not be necessary for the Noteholders to approve the particular form of any proposed amendment, supplement or waiver, but it shall be sufficient if such consent approves the substance thereof. After an amendment, supplement or waiver under this Section becomes effective, the Company shall mail to Noteholders a notice briefly describing the amendment or waiver. SECTION 11.03. Compliance with Trust Indenture Act. Every amendment to this Indenture or the Securities shall be set forth in a supplemental indenture that complies with the TIA as then in effect. SECTION 11.04. Revocation and Effect of Consents. Until an amendment, supplement or waiver becomes effective, a consent to it by a Noteholder of a Security is a continuing consent by the Noteholder and every subsequent Noteholder of a Security or portion of a Security that evidences the same debt as the consenting Noteholder's Security, even if notation of the consent is not made on any Security. However, any such Noteholder or subsequent Noteholder may revoke the consent as to such Noteholder's Security or portion of a Security if the Trustee receives the notice of revocation before the date on which the Trustee receives an Officers' Certificate certifying that the Noteholders of the requisite principal amount of Securities have consented to the amendment, supplement or waiver. The Company may, but shall not be obligated to, fix a record date for the purpose of determining the Noteholders entitled to consent to any amendment, supplement or waiver. If a record date is fixed, then notwithstanding the provisions of the immediately preceding paragraph, those persons who were Noteholders at such record date (or their duly designated proxies), and only those persons, shall be entitled to consent to such amendment, supplement or 46 waiver or to revoke any consent previously given, whether or not such persons continue to be Noteholders after such record date. No consent shall be valid or effective for more than 90 days after such record date unless consents from Noteholders of the principal amount of Securities required hereunder for such amendment or waiver to be effective shall have also been given and not revoked within such 90-day period. After an amendment, supplement or waiver becomes effective it shall bind every Noteholder, unless it is of the type described in any of clauses (a) through (h) of Section 11.02 hereof. In such case, the amendment or waiver shall bind each Noteholder who has consented to it and every subsequent Noteholder that evidences the same debt as the consenting Noteholder's Security. SECTION 11.05. Notation on or Exchange of Securities. The Trustee may place an appropriate notation about an amendment or waiver on any Security thereafter authenticated. The Company in exchange for all Securities may issue and the Trustee shall authenticate new Securities that reflect the amendment or waiver. SECTION 11.06. Trustee Protected. The Trustee shall sign all supplemental indentures, except that the Trustee may, but need not, sign any supplemental indenture that adversely affects its rights. As a condition to executing, or accepting the additional trusts created by, any supplemental indenture permitted by this Article or the modifications thereby of the trust created by this Indenture, the Trustee shall be entitled to receive (in addition to those documents required by Section 12.04), and (subject to Section 315 of the TIA) shall be fully protected in relying upon, an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture. ARTICLE XII Miscellaneous SECTION 12.01. Trust Indenture Act Controls. If any provision of this Indenture limits, qualifies, or conflicts with another provision which is automatically deemed to be incorporated in this Indenture by the TIA, the incorporated provision shall control. SECTION 12.02. Notices. Any notice or communication by the Company or the Trustee to the other is duly given if in writing and delivered in person or mailed by first-class mail to the other's address stated in Section 12.10 hereof. The Company or the Trustee by notice to the other may designate additional or different addresses for subsequent notices or communications. Any notice or communication to a Noteholder shall be mailed by first-class mail to his address shown on the register kept by the Registrar. Failure to mail a notice or communication to a Noteholder or any defect in it shall not affect its sufficiency with respect to other Noteholders. 47 If a notice or communication is mailed in the manner provided above within the time prescribed, it is duly given, whether or not the addressee receives it. If the Company mails a notice or communication to Noteholders, it shall mail a copy to the Trustee and each Agent at the same time. All other notices or communications shall be in writing. In case by reason of the suspension of regular mail service, or by reason of any other cause, it shall be impossible to mail any notice as required by the Indenture, then such method of notification as shall be made with the approval of the Trustee shall constitute a sufficient mailing of such notice. SECTION 12.03. Communication by Noteholders with Other Noteholders. Noteholders may communicate pursuant to TIA ss. 312(b) with other Noteholders with respect to their rights under this Indenture or the Securities. The Company, the Trustee, the Registrar and anyone else shall have the protection of TIA ss. 312(c). SECTION 12.04. Certificate and Opinion as to Conditions Precedent. Upon any request or application by the Company to the Trustee to take any action under this Indenture, the Company shall furnish to the Trustee: (a) an Officers' Certificate stating that, in the opinion of the signers, all conditions precedent, if any, provided for in this Indenture relating to the proposed action have been complied with; and (b) an Opinion of Counsel stating that, in the opinion of such counsel, all such conditions precedent have been complied with. SECTION 12.05. Statements Required in Certificate or Opinion. Each certificate or opinion with respect to compliance with a condition or covenant provided for in this Indenture (other than pursuant to Section 4.03) shall include: (a) a statement that the person signing such certificate or rendering such opinion has read such covenant or condition; (b) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such certificate or opinion are based; (c) a statement that, in the opinion of such person, such person has made such examination or investigation as is necessary to enable such person to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether or not, in the opinion of such person, such condition or covenant has been complied with. 48 SECTION 12.06. Rules by Trustee and Agents. The Trustee may make reasonable rules for action by, or a meeting of, Noteholders. The Registrar or Paying Agent may make reasonable rules and set reasonable requirements for its functions. SECTION 12.07. Legal Holidays. A "Legal Holiday" is a Saturday, a Sunday or a day on which banking institutions in the State of New York are not required to be open. If a payment date is a Legal Holiday at a place of payment, payment may be made at that place on the next succeeding day that is not a Legal Holiday, and no interest shall accrue for the intervening period. If any other operative date for purposes of this Indenture shall occur on a Legal Holiday then for all purposes the next succeeding day that is not a Legal Holiday shall be such operative date. SECTION 12.08. No Recourse Against Others. A director, Officer, employee or stockholder, as such, of the Company shall not have any liability for any obligations of the Company under the Securities or the Indenture or for any claim based on, in respect of or by reason of such obligations or their creation. Each Noteholder by accepting a Security waives and releases all such liability. The waiver and release are part of the consideration for the issue of the Securities. SECTION 12.09. Counterparts. This Indenture may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. SECTION 12.10. Variable Provisions. "Officer" means the Chairman of the Board, the Chief Executive Officer, the President, any Vice-President, the Chief Financial Officer, the Treasurer, the Secretary, any Assistant Treasurer, any Assistant Secretary or the Controller of the Company. The Company initially appoints the Trustee as Paying Agent, Registrar and Conversion Agent, and the Trustee hereby accepts such appointments. The first certificate pursuant to Section 4.03 hereof shall be for the fiscal year ending on December 31, 1997. The reporting date for Section 9.06 hereof is April 15 of each year. The first reporting date is April 15, 1998. The Trustee shall always have a combined capital and surplus of at least $50,000,000 as set forth in its most recent published annual report of condition. 49 The Company's address for purposes of the Indenture is: Tel-Save Holdings, Inc. 6805 Route 202 New Hope, Pennsylvania 18938 The Trustee's address is: First Trust of New York, National Association 100 Wall Street New York, New York 10005 The Company or the Trustee may change its address for purposes of this Indenture by written notice to the other. SECTION 12.11. GOVERNING LAW. THE INTERNAL LAWS OF THE STATE OF NEW YORK SHALL GOVERN THIS INDENTURE AND THE SECURITIES, WITHOUT REGARD TO THE CONFLICT OF LAWS PROVISIONS THEREOF. SECTION 12.12. No Adverse Interpretation of Other Agreements. This Indenture may not be used to interpret another indenture, loan or debt agreement of the Company or an Affiliate. Any such indenture, loan or debt agreement may not be used to interpret this Indenture. SECTION 12.13. Successors. All agreements of the Company in this Indenture and the Securities shall bind its successor. All agreements of the Trustee in this Indenture shall bind its successor. SECTION 12.14. Severability. In case any provision in this Indenture or in the Securities shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. SECTION 12.15. Table of Contents, Headings, Etc. The Table of Contents and headings of the Articles and Sections of this Indenture have been inserted for convenience of reference only, are not to be considered a part hereof, and shall in no way modify or restrict any of the terms or provisions hereof. 50 IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed, all as of the date first written above. Tel-Save Holdings, Inc., as Company, by ----------------------------------------------- Name: Title: First Trust of New York, National Association, as Trustee, by ----------------------------------------------- Name: Title: 51 STATE OF NEW YORK ) ) ss.: COUNTY OF NEW YORK ) Personally appeared before me, the undersigned authority in and for the said county and state, on this day of December, 1997, within my jurisdiction, the within named ____________________, who acknowledged that he is a __________________ of ___________________, and that for and on behalf of the said corporation, and as its act and deed he executed the above and foregoing instrument, after first having been duly authorized by said corporation so to do. ----------------------------- NOTARY PUBLIC [Notarial Seal] EXHIBIT A FORM OF CONVERTIBLE SUBORDINATED NOTE [FORM OF FACE OF NOTE] [Global Securities Legend] UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), NEW YORK, NEW YORK, TO THE COMPANY OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC) ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR THEREOF OR SUCH SUCCESSOR'S NOMINEE AND TRANSFERS OF PORTIONS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN THE INDENTURE REFERRED TO ON THE REVERSE HEREOF. [Restricted Securities Legend] THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). THE HOLDER HEREOF, BY PURCHASING THIS SECURITY, AGREES FOR THE BENEFIT OF THE COMPANY THAT THIS SECURITY MAY NOT BE RESOLD, PLEDGED OR OTHERWISE TRANSFERRED (X) PRIOR TO THE SECOND ANNIVERSARY OF THE ISSUANCE HEREOF (OR ANY PREDECESSOR SECURITY HERETO) OR (Y) BY ANY HOLDER THAT WAS AN AFFILIATE OF THE COMPANY AT ANY TIME DURING THE THREE MONTHS PRECEDING THE DATE OF SUCH TRANSFER, IN EITHER CASE, OTHER THAN (1) TO THE COMPANY, (2) SO LONG AS THIS SECURITY IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"), TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A, PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (3) IN AN OFFSHORE TRANSACTION IN A-1 ACCORDANCE WITH REGULATION S UNDER THE SECURITIES ACT (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (4) TO AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a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a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND THAT IT IS HOLDING THIS SECURITY FOR INVESTMENT PURPOSES AND NOT FOR DISTRIBUTION OR (3) A NON-U.S. PERSON OUTSIDE THE UNITED STATES WITHIN THE MEANING OF (OR AN ACCOUNT SATISFYING THE REQUIREMENTS OF PARAGRAPH (o)(2) OF RULE 902 UNDER) REGULATION S UNDER THE SECURITIES ACT. A-2 No. _________ Cusip No. TEL-SAVE HOLDINGS, INC. 5% CONVERTIBLE SUBORDINATED NOTE DUE 2004 TEL-SAVE HOLDINGS, INC. Tel-Save Holdings, Inc., a Delaware corporation (the "Company"), promises to pay to _________________________________________________________________ or registered assigns, the principal sum [indicated on Schedule A hereof]* [of _________ Dollars]** on __________, ____. Interest Payment Dates: June 15 and December 15, commencing June 15, 1998. Record Dates: June 1 and December 1. Reference is hereby made to the further provisions of this Convertible Note set forth on the reverse hereof which further provisions shall for all purposes have the same effect as if set forth at this place. - --------------- * Applicable to Global Securities only. ** Applicable to certificated Securities only. A-3 IN WITNESS WHEREOF, Tel-Save Holdings, Inc. has caused this Convertible Note to be signed manually or by facsimile by its duly authorized Officers and a facsimile of its corporate seal to be affixed hereto or imprinted hereon. Dated: ------------------------------- TEL-SAVE HOLDINGS, INC., by by [Seal] TRUSTEE'S CERTIFICATE OF AUTHENTICATION This is one of the 5% Convertible Subordinated Notes Due 2004 described in the within- mentioned Indenture. _____________, as Trustee, by Authorized Officer A-4 TEL-SAVE HOLDINGS, INC. 5% Convertible Subordinated Note Due 2004 1. Interest. TEL-SAVE HOLDINGS, INC., a Delaware corporation (the "Company"), is the issuer of the 5% Convertible Subordinated Notes Due 2004 (the "Convertible Notes"), of which this Convertible Note is a part. The Company promises to pay interest on the Convertible Notes in cash semiannually on each June 15 and December 15, commencing on June 15, 1998, to holders of record on the immediately preceding June 1 and December 1. Interest on the Convertible Notes will accrue from the most recent date to which interest has been paid, or if no interest has been paid, from December 10, 1997. Interest will be computed on the basis of a 360-day year of twelve 30-day months. To the extent lawful, the Company shall pay interest (including post-petition interest in any proceeding under any Bankruptcy Law) on overdue installments of interest (without regard to any applicable grace period) at the rate borne by the Convertible Notes, compounded annually. 2. Method of Payment. The Company will pay interest on the Convertible Notes (except defaulted interest) to the persons who are registered holders of the Convertible Notes at the close of business on the record date for the next interest payment date even though Convertible Notes are canceled after the record date and on or before the interest payment date. The Noteholder hereof must surrender Convertible Notes to a Paying Agent to collect principal payments. The Company will pay principal and interest in money of the United States that at the time of payment is legal tender for payment of public and private debts. However, the Company may pay principal and interest by check payable in such money. It may mail an interest check to a holders' registered address. 3. Paying Agent and Registrar. The Trustee will act as Paying Agent, Registrar and Conversion Agent. The Company may change any Paying Agent, Registrar, or Conversion Agent without prior notice. 4. Indenture. The Company issued the Convertible Notes under an indenture, dated as of December 10, 1997 (the "Indenture"), between the Company and First Trust of New York, National Association, as Trustee. The terms of the Convertible Notes include those stated in the Indenture and those made part of the Indenture by the Trust Indenture Act of 1939 (15 U.S. Code ss.ss. 77aaa-77bbbb) as in effect on the date of the Indenture. The Convertible Notes are subject to, and qualified by, all such terms, certain of which are summarized hereon, and Noteholders are referred to the Indenture and such Act for a statement of such terms. The Convertible Notes are general unsecured obligations of the Company limited to an aggregate principal amount of $240,000,000. The Indenture does not limit the ability of the Company or any of its Subsidiaries to incur indebtedness or to grant security interests or liens in respect of their assets. 5. Optional Redemption. The Convertible Notes are not redeemable at the Company's option prior to December 18, 2002. Thereafter, the Convertible Notes will be subject to redemption at the option of the Company, in whole or in part (in any integral multiple A-5 of $1,000), at the following redemption prices (expressed as percentages of the principal amount), if redeemed during the 12-month period beginning December 15 of the years indicated: Redemption Year Price - ---- ----- 2002........................................................ 101.43% 2003........................................................ 100.71% and at 100% at December 15, 2004, in each case together with accrued interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on an interest payment date). On or after the redemption date, interest will cease to accrue on the Convertible Notes, or portion thereof, called for redemption. 6. Notice of Redemption. Notice of redemption will be mailed at least 30 days but not more than 60 days before the redemption date to each holder of the Convertible Notes to be redeemed at his address of record. The Convertible Notes in denominations larger than $1,000 may be redeemed in part but only in integral multiples of $1,000. In the event of a redemption of less than all of the Convertible Notes, the Convertible Notes will be chosen for redemption by the Trustee in accordance with the Indenture. Unless the Company defaults in making such redemption payment, or a Paying Agent is prohibited from making such payment pursuant to the Indenture, by law or otherwise, interest ceases to accrue on the Convertible Notes or portions of them called for redemption on and after the redemption date. If this Convertible Note is redeemed subsequent to a record date with respect to any interest payment date specified above and on or prior to such interest payment date, then any accrued interest will be paid to the person in whose name this Convertible Note is registered at the close of business on such record date. 7. Mandatory Redemption. The Company will not be required to make mandatory redemption payments with respect to the Convertible Notes. There are no sinking fund payments with respect to the Convertible Notes. 8. Repurchase at Option of Holder. If there is a Designated Event, the Company shall be required to offer to purchase on the Designated Event Payment Date all outstanding Convertible Notes at a purchase price equal to 101% of the principal amount thereof on the date of purchase, plus accrued and unpaid interest to the Designated Event Payment Date. Holders of Convertible Notes that are subject to an offer to purchase will receive a Designated Event Offer from the Company prior to any related Designated Event Payment Date and may elect to have such Convertible Notes or portions thereof in authorized denominations purchased by completing the form entitled "Option of Noteholder To Elect Purchase" appearing below. Noteholders have the right to withdraw their election by delivering a written notice of withdrawal to the Company or the Paying Agent in accordance with the terms of the Indenture. 9. Subordination. The payment of the principal of, interest on or any other amounts due on the Convertible Notes is subordinated in right of payment to all existing and future Senior Debt of the Company, as described in the Indenture. Each Noteholder, by A-6 accepting a Convertible Note, agrees to such subordination and authorizes and directs the Trustee on its behalf to take such action as may be necessary or appropriate to effectuate the subordination so provided and appoints the Trustee as its attorney-in-fact for such purpose. The Securities shall rank pari passu with the Company's 4 1/2% Convertible Subordinated Notes due 2002. 10. Conversion. The holder of any Convertible Note has the right, exercisable at any time after 90 days following the Issuance Date and prior to the close of business (New York City time) on the Business Day immediately preceding the date of the Convertible Note's maturity, to convert the principal amount thereof (or any portion thereof that is an integral multiple of $1,000) into shares of Common Stock at the initial Conversion Price of $25.47 per share, subject to adjustment under certain circumstances, except that if a Convertible Note is called for redemption, the conversion right will terminate at the close of business (New York City time) on the Business Day immediately preceding the date fixed for redemption. To convert a Convertible Note, a holder must (1) complete and sign a notice of election to convert substantially in the form set forth below, (2) surrender the Convertible Note to a Conversion Agent, (3) furnish appropriate endorsements or transfer documents if required by the Registrar or Conversion Agent and (4) pay any transfer or similar tax, if required. Upon conversion, no adjustment or payment will be made for interest or dividends, but if any Noteholder surrenders a Convertible Note for conversion after the close of business on the record date for the payment of an installment of interest and prior to the opening of business on the next interest payment date, then, notwithstanding such conversion, the interest payable on such interest payment date will be paid to the registered holder of such Convertible Note on such record date. In such event, unless such Security has been called for redemption on or prior to such interest payment date, such Convertible Note, when surrendered for conversion, must be accompanied by payment in funds acceptable to the Company of an amount equal to the interest payable on such interest payment date on the portion so converted. The number of shares of Common Stock issuable upon conversion of a Convertible Note is determined by dividing the principal amount of the Convertible Note converted by the Conversion Price in effect on the Conversion Date. No fractional shares will be issued upon conversion but a cash adjustment will be made for any fractional interest. A Convertible Note in respect of which a holder has delivered an "Option of Noteholder to Elect Purchase" form appearing below exercising the option of such holder to require the Company to purchase such Convertible Note may be converted only if the notice of exercise is withdrawn as provided above and in accordance with the terms of the Indenture. The above description of conversion of the Convertible Notes is qualified by reference to, and is subject in its entirety by, the more complete description thereof contained in the Indenture. 11. Registration Agreement. The holder of this Convertible Note is entitled to the benefits of a Registration Agreement, dated December 10, 1997, between the Company and the Initial Purchasers (the "Registration Agreement"). Pursuant to the Registration Agreement the Company has agreed for the benefit of the holders of the Convertible Notes, that (i) it will, at its cost, within 120 days after the closing of the sale of the Convertible Notes (the "Closing"), file a shelf registration statement (the "Shelf Registration Statement") with the Securities and A-7 Exchange Commission (the "Commission") with respect to resales of the Convertible Notes and the Common Stock issuable upon conversion thereof, (ii) the Company will use its best efforts to ensure that within 180 days after the Closing, such Shelf Registration Statement shall be declared effective by the Commission and (iii) the Company will use its best efforts to keep such Shelf Registration Statement continuously effective under the Securities Act until the earliest of (a) the second anniversary of the date of the Closing, (b) the date on which the Convertible Notes or the Common Stock issuable upon conversion thereof may be sold pursuant to paragraph (k) of Rule 144 (or any successor provision) promulgated by the Commission under the Securities Act and (c) the date as of which all the Convertible Notes or the Common Stock issuable upon conversion thereof have been sold pursuant to such Shelf Registration Statement (the "Shelf Registration Period"). If the Company fails to comply with clause (i) above then, at such time, the per annum interest rate on the Convertible Notes will increase by 25 basis points. Such increase will remain in effect until the date on which such Shelf Registration Statement is filed, on which date the interest rate on the Convertible Notes will revert to the interest rate originally borne by the Convertible Notes plus any increase in such interest rate pursuant to the following sentence. If the Shelf Registration Statement is not declared effective as provided in clause (ii) above, then, at such time and on each date that would have been the successive 30th day following such time, the per annum interest rate on the Convertible Notes (which interest rate will be the original interest rate on the Convertible Notes plus any increase or increases in such interest rate pursuant to the preceding sentence and this sentence) will increase by an additional 25 basis points; provided that the interest rate will not increase by more than 50 basis points pursuant to this sentence and will not increase by more than 75 basis points pursuant to this sentence and the preceding sentence. Such increase or increases will remain in effect until the date on which such Shelf Registration Statement is declared effective, on which date the interest rate on the Convertible Notes will revert to the interest rate originally borne by the Convertible Notes. Pursuant to clause (iii) above, however, if the Company fails to keep the Shelf Registration Statement continuously effective for the period specified above, then at such time as the Shelf Registration Statement is no longer effective and on each date thereafter that is the successive 30th day subsequent to such time and until the earlier of (i) the date that the Shelf Registration Statement is again deemed effective or (ii) the termination of the Shelf Registration Period, the per annum interest rate on the Convertible Notes will increase by an additional 25 basis points; provided, however, that the interest rate will not increase by more than 50 basis points pursuant to this sentence. Pursuant to the Registration Agreement, the Company may suspend the use of the prospectus which is a part of the Shelf Registration Statement for a period not to exceed 30 days in any three-month period or three periods not to exceed an aggregate of 90 days in any twelve-month period under certain circumstances. The holders of Convertible Notes will not be entitled to additional interest as set forth in the preceding paragraph solely because of such suspension. 12. Denominations, Transfer, Exchange and Replacement. The Convertible Notes are in registered form, without coupons, in denominations of $1,000 and integral multiples of $1,000. The transfer of Convertible Notes may be registered, and Convertible Notes may be exchanged, as provided in the Indenture. The Registrar may require a Noteholder, among other things, to furnish appropriate endorsements and transfer documents and to pay any taxes and fees A-8 required by law or permitted by the Indenture. The Registrar need not exchange or register the transfer of any Convertible Note or portion of a Convertible Note selected for redemption (except the unredeemed portion of any Convertible Note being redeemed in part). Also, it need not exchange or register the transfer of any Convertible Note for a period of 15 days before a selection of Convertible Notes to be redeemed. Replacement Convertible Notes for lost, stolen or mutilated Convertible Notes may be issued in accordance with the terms of the Indenture. 13. Persons Deemed Owners. The registered Noteholder of a Convertible Note may be treated as its owner for all purposes. 14. Unclaimed Money. If money for the payment of principal or interest remains unclaimed for two years, the Trustee and the Paying Agent shall pay the money back to the Company at its request. After that, Noteholders of Convertible Notes entitled to the money must look to the Company for payment, unless an abandoned property law designates another person, and all liability of the Trustee and such Paying Agent with respect to such money shall cease. 15. Defaults and Remedies. The Convertible Notes shall have the Events of Default as set forth in Section 8.01 of the Indenture. Subject to certain limitations in the Indenture, if an Event of Default occurs and is continuing, the Trustee by notice to the Company or the Noteholders of at least 25% in aggregate principal amount of the then-outstanding Convertible Notes by notice to the Company and the Trustee may declare all the Convertible Notes to be due and payable immediately, except that in the case of an Event of Default arising from certain events of bankruptcy or insolvency, all unpaid principal and interest accrued on the Convertible Notes shall become due and payable immediately without further action or notice. Upon acceleration as described in either of the preceding sentences, the subordination provisions of the Indenture preclude any payment being made to Noteholders for at least 5 Business Days except as otherwise provided in the Indenture. The Noteholders of a majority in principal amount of the Convertible Notes then outstanding by written notice to the Trustee may rescind an acceleration and its consequences if the rescission would not conflict with any judgment or decree and if all existing Events of Default have been cured or waived except nonpayment of principal or interest that has become due solely because of the acceleration. Noteholders may not enforce the Indenture or the Convertible Notes except as provided in the Indenture. Subject to certain limitations, Noteholders of a majority in principal amount of the then-outstanding Convertible Notes issued under the Indenture may direct the Trustee in its exercise of any trust or power. The Company must furnish compliance certificates to the Trustee annually. The above description of Events of Default and remedies is qualified by reference to, and subject in its entirety by, the more complete description thereof contained in the Indenture. 16. Amendments, Supplements and Waivers. Subject to certain exceptions, the Indenture or the Convertible Notes may be amended or supplemented with the consent of the Noteholders of at least a majority in principal amount of the then-outstanding Convertible Notes (including consents obtained in A-9 connection with a tender offer or exchange offer for Convertible Notes), and any existing default may be waived with the consent of the Noteholders of a majority in principal amount of the then-outstanding Convertible Notes, including consents obtained in connection with a tender offer or exchange offer for Convertible Notes. Without the consent of any Noteholder, the Indenture or the Convertible Notes may be amended, among other things, to cure any ambiguity, defect or inconsistency, to provide for assumption of the Company's obligations to Noteholders, to make any change that does not adversely affect the rights of any Noteholder, to qualify the Indenture under the TIA, or to comply with the requirements of the SEC in order to maintain the qualification of the Indenture under the TIA. 17. Trustee Dealings with the Company. The Trustee, in its individual or any other capacity, may become the owner or pledgee of the Convertible Notes and may otherwise deal with the Company or an Affiliate with the same rights it would have, as if it were not Trustee, subject to certain limitations provided for in the Indenture and in the TIA. Any Agent may do the same with like rights. 18. No Recourse Against others. A director, Officer, employee or stockholder, as such, of the Company shall not have any liability for any obligations of the Company under the Convertible Notes or the Indenture or for any claim based on, in respect of or by reason of such obligations or their creation. Each Noteholder, by accepting a Convertible Note, waives and releases all such liability. The waiver and release are part of the consideration for the issue of the Convertible Notes. 19. Governing Law. THE INTERNAL LAWS OF THE STATE OF NEW YORK SHALL GOVERN THE INDENTURE AND THE CONVERTIBLE NOTES WITHOUT REGARD TO CONFLICT OF LAW PROVISIONS THEREOF. 20. Authentication. The Convertible Notes shall not be valid until authenticated by the manual signature of an authorized officer of the Trustee or an authenticating agent. 21. Abbreviations. Customary abbreviations may be used in the name of a Noteholder or an assignee, such as: TEN COM (for tenants in common), TEN ENT (for tenants by the entireties), JT TEN (for joint tenants with right of survivorship and not as tenants in common), CUST (for Custodian), and U/G/M/A (for Uniform Gifts to Minors Act). 22. Definitions. Capitalized terms not defined in this Convertible Note have the meaning given to them in the Indenture. The Company will furnish to any Noteholder of the Convertible Notes upon written request and without charge a copy of the Indenture and the Registration Agreement. Request may be made to: Tel-Save Holdings, Inc. Attn: General Counsel and Secretary 6805 Route 202 New Hope, Pennsylvania 18938 (215) 862-1500 A-10 ASSIGNMENT FORM To assign this Convertible Note, fill in the form below: (I) or (we) assign and transfer this Convertible Note to - ----------------------------------------------------------------------------- (Insert assignee's social security or tax I.D. no.) - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- (Print or type assignee's name, address and zip code) and irrevocably appoint ________________________________________ agent to transfer this Convertible Note on the books of the Company. The agent may substitute another to act for him. Your Signature: _____________________________________________ (Sign exactly as your name appears on the other side of this Convertible Note) Date: ___________________ Medallion Signature Guarantee: _____________________________ In connection with any transfer of any of the Convertible Notes evidenced by this certificate occurring prior to the date that is two years after the later of the date of original issuance of such Convertible Notes and the last date, if any, on which such A-11 Convertible Notes were owned by the Company or any Affiliate of the Company, the undersigned confirms that such Convertible Notes are being transferred: CHECK ONE BOX BELOW (1) [ ] to the Company; or (2) [ ] pursuant to and in compliance with Rule 144A under the Securities Act of 1933; or (3) [ ] pursuant to and in compliance with Regulation S under the Securities Act of 1933; or (4) [ ] to an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act of 1933) that has furnished to the Trustee a signed letter containing certain representations and agreements (the form of which letter can be obtained from the Trustee); or (5) [ ] pursuant to an exemption from registration under the Securities Act of 1933 provided by Rule 144 thereunder. Unless one of the boxes is checked, the Registrar will refuse to register any of the Convertible Notes evidenced by this certificate in the name of any person other than the registered holder thereof; provided, however, that if box (3), (4) or (5) is checked, the Trustee may require, prior to registering any such transfer of the Convertible Notes such legal opinions, certifications and other information as the Company has reasonably requested in writing, by delivery to the Trustee of a standing letter of instruction, to confirm that such transfer is being made pursuant to an exemption from, A-12 or in a transaction not subject to, the registration requirements of the Securities Act of 1933. -------------------------- Signature Medallion Signature Guarantee: - ------------------------ -------------------------- Signature - -------------------------------------------------------------------------------- TO BE COMPLETED BY PURCHASER IF (2) ABOVE IS CHECKED. The undersigned represents and warrants that it is purchasing this Convertible Note for its own account or an account with respect to which it exercises sole investment discretion and that it and any such account is a "qualified institutional buyer" within the meaning of Rule 144A under the Securities Act of 1933, and is aware that the sale to it is being made in reliance on Rule 144A and acknowledges that it has received such information regarding the Company as the undersigned has requested pursuant to Rule 144A or has determined not to request such information and that it is aware that the transferor is relying upon the undersigned's foregoing representations in order to claim the exemption from registration provided by Rule 144A. Dated: ---------------------------- -------------------- NOTICE: To be executed by an executive officer - ----------------------------- A-13 [TO BE ATTACHED TO GLOBAL SECURITIES] SCHEDULE A The initial principal amount at maturity of this Global Security shall be $200,000,000. The following increases or decreases in the principal amount of this Global Security have been made:
============================================================================================================== Amount of increase in Principal Amount of this Global Amount of decrease in Principal Amount of Signature of Security including Principal Amount of this Global Security authorized officer Date Made upon exercise of this Global Security following such of Trustee or over-allotment option decrease or increase Securities Custodian - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------
A-14 OPTION OF NOTEHOLDER TO ELECT PURCHASE If you want to elect to have this Convertible Note or a portion thereof repurchased by the Company pursuant to Section 3.08 or 4.07 of the Indenture, check the box: |_| If the purchase is in part, indicate the portion ($1,000 or any integral multiple thereof) to be purchased: ____________ Your Signature: --------------------------------------------- (Sign exactly as your name appears on the other side of this Convertible Note) Date: ____________ Medallion Signature Guarantee: _______________________ A-15 ELECTION TO CONVERT To Tel-Save Holdings, Inc.: The undersigned owner of this Convertible Note hereby irrevocably exercises the option to convert this Convertible Note, or the portion below designated, into Common Stock of TEL-SAVE HOLDINGS, INC. in accordance with the terms of the Indenture referred to in this Convertible Note, and directs that the shares issuable and deliverable upon conversion, together with any check in payment for fractional shares, be issued in the name of and delivered to the undersigned, unless a different name has been indicated in the assignment below. If shares are to be issued in the name of a person other than the undersigned, the undersigned will pay all transfer taxes payable with respect thereto. The undersigned agrees to be bound by the terms of the Registration Agreement relating to the Common Stock issuable upon conversion of the Convertible Notes. Date: In whole ____ or Portion of Convertible Note to be converted ($1,000 or any integral multiple thereof): $ -------------- Your Signature: -------------------------------------- (Sign exactly as your name appears on the other side of this Convertible Note.) Please Print or Typewrite Name and Address, Including Zip Code, and Social Security or other Identifying Number Medallion Signature Guarantee:* ------------------- - ------------------------ * Signature must be guaranteed by a commercial bank, trust company or member firm of the New York Stock Exchange. A-16 EXHIBIT B FORM OF TRANSFER CERTIFICATE FOR TRANSFER FROM GLOBAL SECURITY OR RESTRICTED SECURITY TO RESTRICTED SECURITY (Transfers pursuant to ss. 2.06(a)(ii) or ss. 2.06(a)(iii) of the Indenture) __________, as Registrar Attn: [ ] Department Re: Tel-Save Holdings, Inc. 5% Convertible Subordinated Notes Due 2004 (the "Convertible Notes") --------------------------------------------------------- Reference is hereby made to the Indenture dated as of December 10, 1997 (the "Indenture") between Tel-Save Holdings, Inc., as Issuer, and First Trust of New York, National Association, as Trustee. Capitalized terms used but not defined herein shall have the meanings given them in the Indenture. This letter relates to U.S. $200,000,000 aggregate principal amount of Convertible Notes which are held [in the form of the [Restricted] [Global] Security (CUSIP No. ) with the Depositary]* in the name of [name of transferor] (the "Transferor") to effect the transfer of the Securities. In connection with such request, and in respect of such Convertible Notes, the Transferor does hereby certify that such Convertible Notes are being transferred in accordance with (i) the transfer restrictions set forth in the Convertible Notes and (ii) to a transferee that the Transferor reasonably believes is an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) of Regulation D under the Securities Act of 1933, as amended) and is acquiring at least $250,000 principal amount of Convertible Notes for its own account or for one or more accounts as to which the transferee exercises sole investment discretion and (iii) in accordance with applicable securities laws of any state of the United States. [Name of Transferor], by ------------------------------------- Name: Title: Dated: cc: Tel-Save Holdings, Inc. Attn: Secretary - ------------------------ * Insert, if appropriate B-1 EXHIBIT C FORM OF ACCREDITED INVESTOR TRANSFEREE CERTIFICATE (Transfers pursuant to ss. 2.06(a)(ii) and ss. 2.06(a)(iii)) __________, as Registrar Attn: [ ] Department Re: Tel-Save Holdings, Inc. 5% Convertible Subordinated Notes Due 2004 (the "Convertible Notes") ---------------------------------- Reference is hereby made to the Indenture dated as of December 10, 1997 (the "Indenture") between Tel-Save Holdings, Inc., as Issuer, and First Trust of New York, National Association, as Trustee. Capitalized terms used but not defined herein shall have the meanings given them in the Indenture. This letter relates to U.S. $200,000,000 aggregate principal amount of Convertible Notes which are held in the form of the [Restricted] [Global] Security (CUSIP No. _________) with the Depositary in the name of [name of transferor] (the "Transferor") to effect the transfer of the Convertible Notes to the undersigned. In connection with such request, and in respect of such Convertible Notes we confirm that: 1. We understand that the Convertible Notes have not been and will not be registered under the U.S. Securities Act of 1933 (the "Securities Act"), and are being sold to us in a transaction that is exempt from the registration requirements of the Securities Act. 2. We are a corporation, partnership or other entity having such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of an investment in the Convertible Notes, and we are (or any account for which we are purchasing under paragraph 4 below is) an institutional accredited investor as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act, able to bear the economic risk of our proposed investment in the Convertible Notes. 3. We are acquiring the Convertible Notes for our own account (or for accounts as to which we exercise sole investment discretion and have authority to make, and do make, the statements contained in this letter) and not with a view to any distribution of the Convertible Notes, subject, nevertheless, to the understanding that the disposition of our property shall at all times be and remain within our control. C-1 4. We are, and each account (if any) for which we are purchasing Convertible Notes is, purchasing Convertible Notes having an aggregate principal amount of not less than $250,000. 5. We understand that (a) the Convertible Notes will be delivered to us in registered form only and that the certificate delivered to us with respect to the Convertible Notes will bear a legend substantially to the following effect: "THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). THE HOLDER HEREOF, BY PURCHASING THIS SECURITY, AGREES FOR THE BENEFIT OF THE COMPANY THAT THIS SECURITY MAY NOT BE RESOLD, PLEDGED OR OTHERWISE TRANSFERRED (X) PRIOR TO THE SECOND ANNIVERSARY OF THE ISSUANCE HEREOF (OR ANY PREDECESSOR SECURITY HERETO) OR (Y) BY ANY HOLDER THAT WAS AN AFFILIATE OF THE COMPANY AT ANY TIME DURING THE THREE MONTHS PRECEDING THE DATE OF SUCH TRANSFER, IN EITHER CASE, OTHER THAN (1) TO THE COMPANY, (2) SO LONG AS THIS SECURITY IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"), TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A, PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (3) IN AN OFFSHORE TRANSACTION IN ACCORDANCE WITH REGULATION S UNDER THE SECURITIES ACT (AS INDICATED BY THE BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS SECURITY), (4) TO AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE 501(a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a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND THAT IT IS HOLDING THIS SECURITY FOR INVESTMENT PURPOSES AND NOT FOR DISTRIBUTION OR (3) A NON-U.S. PERSON OUTSIDE THE UNITED STATES WITHIN THE MEANING OF (OR AN ACCOUNT SATISFYING THE REQUIREMENTS OF PARAGRAPH (o)(2) OF RULE 902 UNDER) REGULATION S UNDER THE SECURITIES ACT." and (b) such certificates will be reissued without the foregoing legend only in accordance with the terms of the Indenture. 6. We agree that in the event that at some future time we wish to dispose of any of the Convertible Notes, we will not do so unless the Convertible Notes are being transferred: (a) to the Company or any Subsidiary thereof; (b) pursuant to and in compliance with Rule 144A under the Securities Act; (c) pursuant to and in compliance with Regulation S under the Securities Act; (d) to an institution that is an "accredited investor" as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act, that is acquiring at least $250,000 principal amount of the Convertible Notes for investment purposes and not for distribution and that, prior to such transfer, furnishes to the Trustee a signed letter containing certain representations and agreements relating to the restrictions on transfer of the Convertible Notes (the form of which letter can be obtained from such Trustee); (e) pursuant to an exemption from registration under the Securities Act provided by Rule 144 under the Securities Act; or (f) pursuant to an effective registration statement under the Securities Act. Very truly yours [PURCHASER] by --------------------------------- C-3 Name: Title: Dated: cc: Tel-Save Holdings, Inc. Attn: General Counsel and Secretary 6805 Route 202 New Hope, Pennsylvania 18938 Attn: Secretary C-4 EXHIBIT D FORM OF REGISTRATION AGREEMENT - -------- * Applicable to Global Securities only. ** Applicable to certificated Securities only. * Signature must be guaranteed by a commercial bank, trust company or member firm of the New York Stock Exchange. * Insert, if appropriate. EX-10.35 4 EXHIBIT 10.35 TEL-SAVE HOLDINGS, INC. 5% Convertible Subordinated Notes Due 2004 REGISTRATION AGREEMENT New York, New York December 10, 1997 Smith Barney Inc. As Representative of the Initial Purchasers Named in Schedule I to the Purchase Agreement (as defined below) 388 Greenwich Street New York, New York 10013 Ladies and Gentlemen: Tel-Save Holdings, Inc., a Delaware corporation (the "Company"), proposes to issue and sell (such issuance and sale, the "Initial Placement") to you (the "Initial Purchasers"), upon the terms set forth in a purchase agreement of even date herewith (the "Purchase Agreement"), $200,000,000 principal amount (plus an additional $40,000,000 principal amount to cover over-allotments, if any) of its 5% Convertible Subordinated Notes Due 2004 (the "Securities"). The Securities will be convertible into shares of Common Stock, par value $0.01 per share (the "Common Stock"), of the Company at the conversion price set forth in the Offering Memorandum. As an inducement to you to enter into the Purchase Agreement and in satisfaction of a condition to your obligations thereunder, the Company agrees with you, (i) for your benefit and (ii) for the benefit of the holders from time to time of the Securities or the Common Stock issuable upon conversion of the Securities (including you) (each of the foregoing, a "Holder" and together, the "Holders"), as follows: 1. Definitions. Capitalized terms used herein without definition shall have the respective meanings set forth in the Purchase Agreement. As used in this Agreement, the following capitalized terms shall have the following meanings: "Act" means the Securities Act of 1933, as amended, and the rules and regulations of the Commission promulgated thereunder. "Affiliate" of any specified person means any other person that, directly or indirectly, is in control of, is controlled by, or is under common control with, such specified person. For purposes of this definition, control of a person means the power, direct or indirect, to direct or cause the direction of the management and policies of such person whether by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Closing Date" has the meaning set forth in the Purchase Agreement. "Commission" means the Securities and Exchange Commission. 1 "Exchange Act" means the Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission promulgated thereunder. "Holder" has the meaning set forth in the preamble hereto. "Indenture" means the Indenture relating to the Securities dated as of December 10, 1997, between the Company and First Trust of New York, National Association, as trustee, as the same may be amended from time to time in accordance with the terms thereof. "Initial Placement" has the meaning set forth in the preamble hereto. "Initial Purchasers" has the meaning set forth in the preamble hereto. "Majority Holders" means the Holders of a majority of the then outstanding aggregate principal amount of Securities registered under a Shelf Registration Statement; provided that Holders of Common Stock issued upon conversion of Securities shall be deemed to be Holders of the aggregate principal amount of Securities from which such Common Stock was converted. "Managing Underwriters" means the Underwriter or Underwriters that shall administer an Underwritten Offering. "Offering Memorandum" has the meaning set forth in the Purchase Agreement. "Prospectus" means the prospectus included in any Shelf Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A under the Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Securities or Common Stock issuable upon conversion thereof, covered by such Shelf Registration Statement, and all amendments and supplements to such prospectus, including post-effective amendments. "Purchase Agreement" has the meaning set forth in the preamble hereto. "Securities" has the meaning set forth in the preamble hereto. "Shelf Registration" means a registration effected pursuant to Section 2 hereof. "Shelf Registration Period" has the meaning set forth in Section 2(b) hereof. "Shelf Registration Statement" means a "shelf" registration statement of the Company pursuant to the provisions of Section 2 hereof which covers some or all of the Securities and the Common Stock issuable upon conversion thereof, as applicable, on 2 an appropriate form under Rule 415 under the Act, or any similar rule that may be adopted by the Commission, and all amendments and supplements to such registration statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. "Trustee" means the trustee with respect to the Securities under the Indenture. "Underwriter" means any underwriter of Securities or Common Stock issuable upon conversion thereof in connection with an offering thereof under a Shelf Registration Statement. "Underwritten Offering" means an offering in which the Securities or Common Stock are sold to an Underwriter or with the assistance of an Underwriter for reoffering to the public. 2. Shelf Registration; Suspension of Use of Prospectus. (a) The Company shall prepare and, not later than 120 days following the Closing Date, shall file with the Commission and thereafter, but no later than 180 days following the Closing Date, shall use its best efforts to cause to be declared effective under the Act a Shelf Registration Statement relating to the offer and sale of the Securities and the Common Stock issuable upon conversion thereof by the Holders from time to time in accordance with the methods of distribution elected by such Holders and set forth in such Shelf Registration Statement. (b) The Company shall use its best efforts to keep the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by Holders until the earliest of (i) the second anniversary of the Closing Date, (ii) the date on which the Securities or Common Stock issuable upon conversion thereof may be sold pursuant to paragraph (k) of Rule 144 (or any successor provision) promulgated by the Commission under the Act and (iii) such date as of which all the Securities or the Common Stock issuable upon conversion thereof have been sold pursuant to the Shelf Registration Statement (in any such case, such period being called the "Shelf Registration Period"). The Company shall be deemed not to have used its best efforts to keep the Shelf Registration Statement effective during the requisite period if it voluntarily takes any action that would result in Holders of Securities covered thereby not being able to offer and sell such Securities during that period, unless such action is required (x) by applicable law or (y) pursuant to Section 2(c) hereof, and, in either case, so long as the Company promptly thereafter complies with the requirements of Section 3(i) hereof, if applicable. (c) The Company may suspend the use of the Prospectus for a period not to exceed 30 days in any three-month period or for three periods not to exceed an aggregate of 90 days in any twelve-month period for valid business reasons, to 3 be determined by the Company in its sole reasonable judgment (not including avoidance of the Company's obligations hereunder), including, without limitation, the acquisition or divestiture of assets, public filings with the Commission, pending corporate developments and similar events; provided that the Company promptly thereafter complies with the requirements of Section 3(i) hereof, if applicable. 3. Registration Procedures. In connection with any Shelf Registration Statement, the following provisions shall apply: (a) The Company shall furnish to you, prior to the filing thereof with the Commission, a copy of any Shelf Registration Statement, and each amendment thereof and each amendment or supplement, if any, to the Prospectus included therein and shall use its best efforts to reflect in each such document, when so filed with the Commission, such comments as Smith Barney Inc. reasonably may propose. (b) The Company shall ensure that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any amendment or supplement thereto comply in all material respects with the Act and the rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any amendment or supplement to such Prospectus, does not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; provided that no representation or agreement is made hereby with respect to information with respect to you, any Underwriter or any Holder required to be included in any Shelf Registration or Prospectus pursuant to the Act or the rules and regulations thereunder. (c) (1) The Company shall advise you and the Holders and, if requested by you or any such Holder, confirm such advice in writing: (i) when a Shelf Registration Statement and any amendment thereto has been filed with the Commission and when the Shelf Registration Statement or any post-effective amendment thereto has become effective; and (ii) of any request by the Commission for amendments or supplements to the Shelf Registration Statement or the Prospectus included therein or for additional information. (2) The Company shall advise you and the Holders and, if requested by you or any such Holder, confirm such advice in writing: 4 (i) of the issuance by the Commission of any stop order suspending the effectiveness of the Shelf Registration Statement or the initiation of any proceedings for that purpose; (ii) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Securities included in any Shelf Registration Statement for sale in any jurisdiction or the initiation or threat of any proceeding for such purpose; and (iii) of the suspension of the use of the Prospectus pursuant to Section 2(c) hereof or of the happening of any event that requires the making of any changes in the Shelf Registration Statement or the Prospectus so that, as of such date, the statements therein are not misleading and do not omit to state a material fact required to be stated therein or necessary to make the statements therein (in the case of the Prospectus, in light of the circumstances under which they were made) not misleading (which advice shall be accompanied by an instruction to suspend the use of the Prospectus until the requisite changes have been made). (d) The Company shall use its best efforts to obtain the withdrawal of any order suspending the effectiveness of any Shelf Registration Statement at the earliest possible time. (e) The Company shall furnish to each Holder of Securities or the Common Stock issued upon conversion thereof included within the coverage of any Shelf Registration Statement, without charge, at least one copy of such Shelf Registration Statement and any post-effective amendment thereto, including financial statements and schedules, and, if the Holder so requests in writing, all exhibits (including those incorporated by reference). (f) The Company shall, during the Shelf Registration Period, deliver to each Holder of Securities or the Common Stock issued upon conversion thereof included within the coverage of any Shelf Registration Statement, without charge, as many copies of the Prospectus (including each preliminary Prospectus) included in such Shelf Registration Statement and any amendment or supplement thereto as such Holder may reasonably request; and the Company consents to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders in connection with the offering and sale of the Securities or the Common Stock issued upon conversion thereof covered by the Prospectus or any amendment or supplement thereto. (g) Prior to any offering of Securities or the Common Stock issued upon conversion thereof pursuant to any Shelf Registration Statement, the Company shall register or qualify or cooperate with the Holders of Securities or the Common Stock issued upon conversion thereof included therein and their respective counsel in connection with the registration or qualification of such 5 Securities or Common Stock for offer and sale under the securities or blue sky laws of such jurisdictions as any such Holders reasonably request in writing and do any and all other acts or things necessary or advisable to enable the offer and sale in such jurisdictions of the Securities and the Common Stock issued upon conversion thereof covered by such Shelf Registration Statement; provided, however, that the Company will not be required to qualify generally to do business in any jurisdiction where it is not then so qualified or to take any action which would subject it to general service of process or to taxation in any such jurisdiction where it is not then so subject. (h) The Company shall cooperate with the Holders to facilitate the timely preparation and delivery of certificates representing Securities or the Common Stock issued upon conversion thereof to be sold pursuant to any Shelf Registration Statement free of any restrictive legends and in such denominations and registered in such names as Holders may request prior to sales of Securities or the Common Stock issued upon conversion thereof pursuant to such Shelf Registration Statement. (i) Upon the occurrence of any event contemplated by paragraph (c)(2)(iii) above, the Company shall promptly prepare a post-effective amendment to any Shelf Registration Statement or an amendment or supplement to the related Prospectus or file any other required document so that, as thereafter delivered to purchasers of the Securities or the Common Stock issued upon conversion thereof included therein, the Prospectus will not include an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. (j) The Company shall use its best efforts to cause The Depository Trust Company ("DTC") on the first Business Day following the effective date of any Shelf Registration Statement hereunder or as soon as possible thereafter to remove (i) from any existing CUSIP number assigned to the Securities any designation indicating that the Securities are "restricted securities", which efforts shall include delivery to DTC of a letter executed by the Company substantially in the form of Exhibit A hereto and (ii) any other stop or restriction on DTC's system with respect to the Securities. In the event the Company is unable to cause DTC to take actions described in the immediately preceding sentence, the Company shall take such actions as Smith Barney Inc. may reasonably request to provide, as soon as practicable, a CUSIP number for the Securities registered under such Shelf Registration Statement and to cause such CUSIP number to be assigned to the Securities (or to the maximum aggregate principal amount of the securities to which such number may be assigned). Upon compliance with the foregoing requirements of this Section 3(j), the Company shall provide the Trustee with global certificates for such Securities, in a form eligible for deposit with The Depository Trust Company. (k) The Company shall use its best efforts to comply with all applicable rules and regulations of the Commission and shall make generally available to its 6 security holders as soon as practicable after the effective date of the applicable Shelf Registration Statement an earnings statement satisfying the provisions of Section 11(a) of the Act and Rule 158 promulgated by the Commission thereunder. (l) The Company shall use its best efforts to cause the Indenture to be qualified under the Trust Indenture Act in a timely manner. (m) The Company may require each Holder of Securities or the Common Stock issued upon conversion thereof to be sold pursuant to any Shelf Registration Statement to furnish to the Company such information regarding the Holder and the distribution of such Securities or Common Stock as may, from time to time, be required by the Act and the rules and regulations promulgated thereunder, and the obligations of the Company to any Holder hereunder shall be expressly conditioned on the compliance of such Holder with such request. (n) The Company shall, if requested, use its best efforts to promptly incorporate in a Prospectus supplement or post-effective amendment to a Shelf Registration Statement (i) such information as the Majority Holders provide or, if the Securities or Common Stock are being sold in an Underwritten Offering, as the Managing Underwriters and the Majority Holders reasonably agree should be included therein and provide to the Company in writing for inclusion in the Shelf Registration Statement or Prospectus, and (ii) such information as a Holder may provide from time to time to the Company in writing for inclusion in a Prospectus or any Shelf Registration Statement concerning such Holder and the distribution of such Holder's Securities and Common Stock and, in either case, shall make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after being notified in writing of the matters to be incorporated in such Prospectus supplement or post-effective amendment. (o) The Company shall enter into such agreements (including underwriting agreements) and take all other appropriate actions as may be reasonably requested in order to expedite or facilitate the registration or the disposition of the Securities or the Common Stock issuable upon conversion thereof, and in connection therewith, if an underwriting agreement is entered into, cause the same to contain indemnification provisions and procedures no less favorable than those set forth in Section 5 (or such other provisions and procedures acceptable to the Majority Holders and the Managing Underwriters, if any, with respect to all parties to be indemnified pursuant to Section 5 from Holders of Securities or the Common Stock issuable upon conversion thereof to the Company). (p) The Company shall (i) make reasonably available for inspection by the Holders of Securities or the Common Stock issued upon conversion thereof to be registered under a Shelf Registration Statement, any Underwriter participating in any disposition pursuant to such Shelf Registration Statement, and any attorney, accountant or other agent retained by the Holders or any such 7 Underwriter all relevant financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries; (ii) cause the Company's officers, directors and employees to supply all relevant information reasonably requested by the Holders or any such Underwriter, attorney, accountant or agent in connection with any such Shelf Registration Statement as is customary for similar due diligence examinations; provided, however, that any information that is designated in writing by the Company, in its sole discretion, as confidential at the time of delivery of such information shall be kept confidential by the Holders or any such Underwriter, attorney, accountant or agent, unless disclosure thereof is made in connection with a court proceeding or required by law, or such information has become available to the public generally through the Company or through a third party without an accompanying obligation of confidentiality; (iii) make such representations and warranties to the Holders of Securities or the Common Stock issued upon conversion thereof registered thereunder and the Underwriters, if any, in form, substance and scope as are customarily made by issuers to Underwriters and covering matters including, but not limited to, those set forth in the Purchase Agreement; (iv) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions, in form, scope and substance, shall be reasonably satisfactory to the Managing Underwriters, if any) addressed to each selling Holder and the Underwriters, if any, covering such matters as are customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such Holders and Underwriters; (v) obtain "cold comfort" letters and updates thereof from the independent certified public accountants of the Company (and, if necessary, any other independent certified public accountants of any subsidiary of the Company or of any business acquired by the Company for which financial statements and financial data are, or are required to be, included in the Shelf Registration Statement), addressed to each selling Holder of Securities or the Common Stock issued upon conversion thereof registered thereunder (provided such Holder furnishes the accountants with such representations as the accountants customarily require in similar situations) and the Underwriters, if any, in customary form and covering matters of the type customarily covered in "cold comfort" letters in connection with primary underwritten offerings; and (vi) deliver such documents and certificates as may be reasonably requested by the Majority Holders and the Managing Underwriters, if any, including those to evidence compliance with Section 3(i) and with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. The foregoing actions set forth in clauses (iii), (iv), (v) and (vi) of this Section 3(p) shall be performed at (A) the effectiveness of such Shelf Registration Statement and each post-effective amendment thereto and (B) each closing under any underwriting or similar agreement as and to the extent required thereunder. 4. Registration Expenses. The Company shall bear all expenses incurred in connection with the performance of its obligations under Sections 2 and 3 hereof and shall reimburse the Holders for the reasonable fees and disbursements of one firm or counsel designated by the Majority Holders to act as counsel for the Holders in 8 connection therewith. Notwithstanding the provisions of this Section 4, each Holder shall bear the expense of any broker's commission, agency fee or Underwriter's discount or commission. 5. Indemnification and Contribution. (a) (i) In connection with any Shelf Registration Statement, the Company agrees to indemnify and hold harmless each Holder of Securities or Common Stock issued upon conversion thereof covered thereby (including the Initial Purchasers), the directors, officers, employees and agents of each such Holder and each person who controls any such Holder within the meaning of either the Act or the Exchange Act against any and all losses, claims, damages or liabilities, joint or several, to which they or any of them may become subject under the Act, the Exchange Act or other Federal or state statutory law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Shelf Registration Statement as originally filed or in any amendment thereof, or in any preliminary Prospectus or Prospectus, or in any amendment thereof or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and agrees to reimburse each such indemnified party, as incurred, for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any case to the extent that any such loss, claim, damage or liability arises out of or is based upon (A) any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of any such Holder or any Initial Purchaser specifically for inclusion therein, (B) use of a Shelf Registration Statement or the related Prospectus during a period when a stop order has been issued in respect of such Shelf Registration or any proceedings for that purpose have been initiated or use of a Prospectus when use of such Prospectus has been suspended pursuant to Section 2(c); provided, further, in each case, that Holders received prior notice of such stop order, initiation of proceedings or suspension or (C) if the Holder fails to deliver a Prospectus or the then current Prospectus. This indemnity agreement will be in addition to any liability which the Company may otherwise have. (ii) The Company also agrees to indemnify or contribute to Losses, as provided in Section 5(d), of any Underwriters of Securities or the Common Stock issued upon conversion thereof registered under a Shelf Registration Statement, their officers and directors and each person who controls such Underwriters on substantially the same basis as that of the indemnification of the Initial Purchasers and the selling Holders provided in this Section 5(a) and shall, 9 if requested by any Holder, enter into an underwriting agreement reflecting such agreement, as provided in Section 3(o) hereof. (b) Each Holder of Securities or Common Stock issued upon conversion thereof covered by a Shelf Registration Statement (including the Initial Purchasers) severally agrees to indemnify and hold harmless (i) the Company, (ii) each of its directors, (iii) each of its officers who signs such Shelf Registration Statement and (iv) each person who controls the Company within the meaning of either the Act or the Exchange Act to the same extent as the foregoing indemnity from the Company to each such Holder, but only with reference to written information relating to such Holder furnished to the Company by or on behalf of such Holder specifically for inclusion in the documents referred to in the foregoing indemnity. This indemnity agreement will be in addition to any liability which any such Holder may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 5 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 5, notify the indemnifying party in writing of the commencement thereof; but the failure so to notify the indemnifying party (i) will not relieve it from liability under paragraph (a) or (b) above unless and to the extent it did not otherwise learn of such action and such failure results in the forfeiture by the indemnifying party of substantial rights and defenses and (ii) will not, in any event, relieve the indemnifying party from any obligations to any indemnified party other than the indemnification obligation provided in paragraph (a) or (b) above. The indemnifying party shall be entitled to appoint counsel of the indemnifying party's choice at the indemnifying party's expense to represent the indemnified party in any action for which indemnification is sought (in which case the indemnifying party shall not thereafter be responsible for the fees and expenses of any separate counsel retained by the indemnified party or parties except as set forth below); provided, however, that such counsel shall be reasonably satisfactory to the indemnified party. Notwithstanding the indemnifying party's election to appoint counsel to represent the indemnified party in an action, the indemnified party shall have the right to employ separate 10 counsel (including local counsel), and the indemnifying party shall bear the reasonable fees, costs and expenses of such separate counsel (and local counsel) if (i) the use of counsel chosen by the indemnifying party to represent the indemnified party would present such counsel with a conflict of interest, (ii) the actual or potential defendants in, or targets of, any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, (iii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of the institution of such action or (iv) the indemnifying party shall authorize the indemnified party to employ separate counsel at the expense of the indemnifying party; provided further, that the indemnifying party shall not be responsible for the fees and expenses of more than one separate counsel (together with appropriate local counsel) representing all the indemnified parties under paragraph (a)(i), paragraph (a)(ii) or paragraph (b) above. An indemnifying party will not, without the prior written consent of the indemnified parties, settle or compromise or consent to the entry of any judgment with respect to any pending or threatened claim, action, suit or proceeding in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified parties are actual or potential parties to such claim or action) unless such settlement, compromise or consent includes an unconditional release of each indemnified party from all liability arising out of such claim, action, suit or proceeding. (d) In the event that the indemnity provided in paragraph (a) or (b) of this Section 5 is unavailable to or insufficient to hold harmless an indemnified party for any reason, then each applicable indemnifying party, in lieu of indemnifying such indemnified party, shall have a joint and several obligation to contribute to the aggregate losses, claims, damages and liabilities (including legal or other expenses reasonably incurred in connection with investigating or defending same) (collectively "Losses") to which such indemnified party may be subject in such proportion as is appropriate to reflect the relative benefits received by such indemnifying party, on the one hand, and such indemnified party, on the other hand, from the Initial Placement and the Shelf Registration Statement which resulted in such Losses; provided, however, that in no case shall the Initial Purchasers be responsible, in the aggregate, for any amount in excess of the purchase discount or commission applicable to such Security, as set forth on the cover page of the Offering Memorandum, nor shall any Underwriter be responsible for any amount in excess of the underwriting discount or commission applicable to the Securities and Common Stock issued upon conversion thereof purchased by such Underwriter under the Shelf Registration Statement which resulted in such Losses. If the allocation provided by the immediately preceding sentence is unavailable for any reason, the indemnifying party and the indemnified party shall contribute in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of such indemnifying party, on the one hand, and such indemnified party, on the other hand, in connection with the statements or omissions which resulted in such Losses as well as any other relevant equitable considerations. Benefits received by the Company shall be deemed to be equal to the sum of (x) the total net proceeds from the Initial Placement (before deducting expenses) as set forth on the cover page of the Offering Memorandum and (y) the total amount of additional interest which the Company was not required to pay as a result of registering the Securities and Common Stock issued upon conversion thereof covered by the Shelf Registration Statement which resulted in such Losses. Benefits received by the Initial Purchasers shall be deemed to be equal to the total purchase discounts and commissions as set forth on the cover page of the Offering Memorandum, and benefits received by any other Holders shall be deemed to be equal to the value of 11 receiving Securities or the Common Stock issuable upon conversion thereof registered under the Act. Benefits received by any Underwriter shall be deemed to be equal to the total underwriting discounts and commissions, as set forth on the cover page of the Prospectus forming a part of the Shelf Registration Statement which resulted in such Losses. Relative fault shall be determined by reference to whether any alleged untrue statement or omission relates to information provided by the indemnifying party, on the one hand, or by the indemnified party, on the other hand. The parties agree that it would not be just and equitable if contribution were determined by pro rata allocation or any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this paragraph (d), no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 5, each person who controls a Holder within the meaning of either the Act or the Exchange Act and each director, officer, employee and agent of such Holder shall have the same rights to contribution as such Holder, and each person who controls the Company within the meaning of either the Act or the Exchange Act, each officer of the Company who shall have signed the Shelf Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to the applicable terms and conditions of this paragraph (d). (e) The provisions of this Section 5 will remain in full force and effect, regardless of any investigation made by or on behalf of any Holder or the Company or any of the officers, directors or controlling persons referred to in Section 5 hereof, and will survive the sale by a Holder of Securities covered by a Shelf Registration Statement. 6. Miscellaneous. (a) No Inconsistent Agreements. The Company has not, as of the date hereof, entered into nor shall it, on or after the date hereof, enter into, any agreement with respect to its Securities that is inconsistent with the rights granted to the Holders herein or otherwise conflicts with the provisions hereof. (b) Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, qualified, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, unless the Company has obtained the written consent of the Majority Holders; provided that with respect to any matter that directly or indirectly affects the rights of the Initial Purchasers hereunder, the Company shall obtain the written consent of the Initial Purchasers against which such amendment, qualification, supplement, waiver or consent is to be effective. Notwithstanding the foregoing (except the foregoing proviso), a waiver or consent to departure from the provisions hereof with respect to a matter that relates exclusively to the rights of Holders whose Securities are being sold pursuant to a 12 Shelf Registration Statement and that does not directly or indirectly affect the rights of other Holders may be given by the Majority Holders, determined on the basis of Securities being sold rather than registered under such Shelf Registration Statement. (c) Notices. All notices and other communications provided for or permitted hereunder shall be made in writing by hand-delivery, first-class mail, telex, telecopier, or air courier guaranteeing overnight delivery: (1) if to you, initially at the address set forth in the Purchase Agreement; (2) if to any other Holder, at the most current address given by such Holder to the Company in accordance with the provisions of this Section 6(c), which address initially is, with respect to each Holder, the address of such Holder maintained by the Registrar under the Indenture, with a copy in like manner to Smith Barney Inc.; and (3) if to the Company, initially at its address set forth in the Purchase Agreement. All such notices and communications shall be deemed to have been duly given when received, if delivered by hand or air courier, and when sent, if sent by first-class mail, telex or telecopier. The Initial Purchasers or the Company by notice to the other may designate additional or different addresses for subsequent notices or communications. (d) Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties, including, without the need for an express assignment or any consent by the Company thereto, subsequent Holders. The Company hereby agrees to extend the benefits of this Agreement to any Holder and any such Holder may specifically enforce the provisions of this Agreement as if an original party hereto. (e) Counterparts. This agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. (f) Headings. The headings in this agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. (g) Governing Law. This agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to agreements made and to be performed in said State, without regard to the conflicts of law rules thereof. 13 (h) Severability. In the event that any one of more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable in any respect for any reason, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions hereof shall not be in any way impaired or affected thereby, it being intended that all of the rights and privileges of the parties shall be enforceable to the fullest extent permitted by law. (i) Securities Held by the Company, etc. Whenever the consent or approval of Holders of a specified percentage of principal amount of Securities or the Common Stock issuable upon conversion thereof is required hereunder, Securities or the Common Stock issued upon conversion thereof held by the Company or its Affiliates (other than subsequent Holders of Securities or the Common Stock issued upon conversion thereof if such subsequent Holders are deemed to be Affiliates solely by reason of their holdings of such Securities) shall not be counted in determining whether such consent or approval was given by the Holders of such required percentage. 14 Please confirm that the foregoing correctly sets forth the agreement between the Company and you. Very truly yours, TEL-SAVE HOLDINGS, INC. ---------------------------- Name: Title: The foregoing Agreement is hereby confirmed and accepted as of the date first above written. SMITH BARNEY INC. For itself and the other Initial Purchasers named in Schedule I to the Purchase Agreement. BY: SMITH BARNEY INC. By ------------------------- Name: Title: EXHIBIT A FORM OF LETTER TO BE PROVIDED BY ISSUER TO THE DEPOSITORY TRUST COMPANY The Depository Trust Company 7 Hanover Square, 23rd Floor New York, NY 10004 Re: 5% Subordinated Convertible Notes Due 2004 (the "Securities") of Tel-Save Holdings, Inc. Ladies and Gentlemen: Please be advised that the Securities and Exchange Commission has declared effective a Registration Statement on Form S-3 under the Securities Act of 1933, as amended, with regard to all of the Securities referenced above. Accordingly, there is no longer any restriction as to whom such Securities may be sold and any restrictions on the CUSIP designation are no longer appropriate and may be removed. I understand that upon receipt of this letter, DTC will remove any stop or restriction on its system with respect to this issue. As always, please do not hesitate to call if we can of further assistance. Very truly yours, Authorized Officer EX-11.1 5 EXHIBIT 11.1 EXHIBIT 11.1 TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS)
Year Ended December 31, --------------------------------------------- 1997 1996 1995(A) ------------ ------------ ------------ Net income (loss) $(20,945) $20,168 $10,819 ======== ======= ======= BASIC Weighted average common shares - Basic 64,168 52,650 31,422 ======== ======= ======= Net income (loss) per share - Basic $ (0.33) $ 0.38 $ 0.34 ======== ======= ======= DILUTED Weighted average common and common equivalent shares outstanding - Diluted: Weighted average shares 64,168 52,650 31,422 Weighted average equivalent shares -- 4,352 2,183 -------- ------- ------- Weighted average common and common equivalent shares - Diluted 64,168 57,002 33,605 ====== ======= ======= Net income (loss) per share - Diluted $ (0.33) $ 0.35 $ 0.32 ======= ======= =======
- ---------- (A) Pro forma tax provisions have been calculated as if the Company's results of operations were taxable as a C corporation (the Company's current tax status) for the year ended December 31, 1995. Prior to September 20, 1995, the Company was an S corporation with all earnings taxed directly to its shareholders. EX-21.1 6 EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT Name State of Incorporation - ---- ---------------------- Tel-Save, Inc. .........................................................Delaware Emergency Transport, Inc. ..............................................Delaware Compco, Inc. ...........................................................Delaware Symetrics Industries, Inc. ..............................................Florida EX-23 7 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Tel-Save Holdings, Inc. New Hope, Pennsylvania We hereby consent to the incorporation by reference in the Prospectus constituting a part of the Registration Statements on Forms S-8, Nos. 333-04479, 333-005923 and 333-42111 and Forms S-3, Nos. 333-14549, 333-23193 and 333-39787 of our reports dated February 5, 1998, relating to the consolidated financial statements and schedule of Tel-Save Holdings, Inc. and subsidiaries, appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. We also consent to the reference to us under the caption "Experts" in the Prospectuses. BDO Seidman, LLP New York, New York March 31, 1998 EX-23.1 8 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Tel-Save Holdings, Inc. New Hope, Pennsylvania We hereby consent to the incorporation by reference in the Prospectus constituting a part of the Registration Statements on Forms S-8, Nos. 333-04479, 333-05923 and 333-4211 and Forms S-3, Nos. 333-14549, 333-23193 and 333-39787 of our reports dated February 5, 1998, relating to the consolidated financial statements and schedule of Tel-Save Holdings, Inc. and subsidiaries, appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. We also consent to the reference to us under the caption "Experts" in the Prospectuses. BDO Seidman, LLP New York, New York March 31, 1998 EX-27 9 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 OF TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 US DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 316,730,000 212,269,000 47,006,000 2,419,000 0 691,051,000 59,472,000 3,637,000 814,891,000 56,263,000 500,000,000 0 0 672,000 222,156,000 814,891,000 0 304,768,000 0 355,169,000 0 0 0 (34,336,000) (13,391,000) (20,945,000) 0 0 0 (20,945,000) (.33) (.33)
EX-27 10 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1997 AND THE UNAUDITED CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1997 OF TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 U.S. DOLLARS 3-MOS DEC-31-1996 JAN-01-1997 MAR-31-1997 1 $15,719,000 24,459,000 32,520,000 1,348,000 0 165,654,000 36,297,000 706,000 274,310,000 24,112,000 0 0 0 630,000 249,568,000 274,310,000 0 71,160,000 0 61,785,000 0 0 0 8,901,000 3,471,000 5,430,000 0 0 0 5,430,000 0.09 0.08
EX-27 11 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996 AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER, 1996 OF TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 US DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 8,023,000 149,237,000 20,958,000 987,000 0 201,885,000 30,596,000 499,000 257,008,000 26,288,000 0 622,000 0 0 230,098,000 257,008,000 0 232,424,000 0 200,597,000 0 0 0 32,373,000 12,205,000 20,168,000 0 0 0 20,168,000 0.38 0.35
EX-27 12 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1996 AND THE UNAUDITED CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 OF TEL-SAVE HOLDINGS, INC. AND SUBSIDIARES AND IS QUALIFIED IN ITS ENTIREITY BY REFERNCE TO SUCH FINANCIAL STATEMENTS. 1 US DOLLARS 9-MOS DEC-31-1995 JAN-01-1996 SEP-30-1996 1 160,226,000 12,737,000 22,883,000 931,000 0 212,137,000 22,925,000 398,000 239,378,000 28,583,000 0 0 0 290,000 207,506,000 239,378,000 0 168,159,000 0 145,617,000 0 0 0 23,221,000 8,754,000 14,467,000 0 0 0 14,467,000 0.29 0.27
EX-27 13 FDS --
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1996 AND THE UNAUDITED CONSOLIDATED STATEMENT OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1996 OF TEL-SAVE HOLDINGS, INC. AND SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATMENTS. 1 US DOLLARS 6-MOS DEC-31-1995 JAN-01-1996 JUN-30-1996 1 9,422,000 164,464,000 20,611,000 892,000 0 206,947,000 20,829,000 336,000 230,903,000 28,781,000 0 0 0 290,000 199,061,000 230,903,000 0 108,080,000 0 93,861,000 0 0 0 11,934,000 4,499,000 7,435,000 0 0 0 7,435,000 0.16 0.15
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