<PAGE>
As filed with the Securities and Exchange Commission on July 14, 1999
Registration No. 333-78713
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
Net2Phone, Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Delaware 4813 22-3559037
<S> <C> <C>
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
171 Main Street
Hackensack, New Jersey 07601
(201) 907-5304
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Howard S. Balter
Chief Executive Officer
Net2Phone, Inc.
171 Main Street
Hackensack, New Jersey 07601
(201) 907-5304
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------
Copies to:
<TABLE>
<S> <C>
Ira A. Greenstein, Esq. Alexander D. Lynch, Esq.
Morrison & Foerster LLP Kenneth R. McVay, Esq.
1290 Avenue of the Americas Brobeck, Phleger & Harrison LLP
New York, New York 10104 1633 Broadway, 47th Floor
(212) 468-8000 New York, New York 10019
(212) 581-1600
</TABLE>
--------------
Approximate date of commencement of the proposed sale to the public:
As soon as practicable after this registration statement becomes effective.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
--------------
We hereby amend the registration statement on such date or dates as may be
necessary to delay its effective date until we shall file a further amendment
which specifically states that the registration statement shall thereafter
become effective in accordance with Section 8(a) of the Securities Act of 1933
or until the registration statement shall become effective on such date as the
Securities and Exchange Commission, acting pursuant to said Section 8(a), may
determine.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 14, 1999
PROSPECTUS
4,800,000 Shares
[NET2PHONE LOGO]
Common Stock
This is an initial public offering of common stock by Net2Phone, Inc.
Net2Phone is selling 4,800,000 shares of common stock. The estimated initial
public offering price is between $10.00 and $12.00 per share.
--------
At the request of Net2Phone, the underwriters intend to reserve up to 300,000
shares of common stock to be sold in this offering to National Broadcasting
Company, Inc., up to 200,000 shares of common stock to be sold in this offering
to GE Capital Equity Investments, Inc. and up to 100,000 shares of common stock
to be sold to Jonathan Fram, our President, each at the initial offering price.
Any reserved shares not sold to NBC, GE Capital or Mr. Fram will be offered to
the general public on the same basis as the other shares offered hereby.
We have applied for listing of Net2Phone's common stock on the Nasdaq
National Market under the symbol NTOP.
--------
<TABLE>
<CAPTION>
Per Share Total
<S> <C> <C>
Initial public offering price................................... $ $
Underwriting discounts and commissions.......................... $ $
Proceeds to Net2Phone, before expenses.......................... $ $
</TABLE>
Net2Phone has granted the underwriters an option for a period of 30 days to
purchase up to 720,000 additional shares of our common stock.
--------
Investing in the common stock involves a high degree of risk.
See "Risk Factors" beginning on page 5.
--------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
Hambrecht & Quist BT Alex. Brown
--------
Bear, Stearns & Co. Inc.
, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary................................................... 1
Risk Factors......................................................... 5
Forward-Looking Statements........................................... 13
Use of Proceeds...................................................... 14
Dividend Policy...................................................... 14
Capitalization....................................................... 15
Dilution............................................................. 16
Selected Financial Data.............................................. 17
Management's Discussion and Analysis of
Financial Condition and Results of Operations....................... 18
Business............................................................. 27
Management........................................................... 44
Principal Stockholders............................................... 53
Certain Transactions................................................. 55
Description of Capital Stock......................................... 62
Shares Eligible for Future Sale...................................... 65
Underwriting......................................................... 67
Legal Matters........................................................ 70
Experts.............................................................. 70
Where You Can Find More Information.................................. 70
Index to Financial Statements ....................................... F-1
</TABLE>
We maintain Web sites at www.Net2Phone.com and www.EZSurf.com. Information
contained on our Web sites does not constitute part of this prospectus.
"Net2Phone" and "Net2Fax" are our registered marks. Applications to register
the service marks "Phone2Phone," "Click2Talk," "N2P," "Net2Phone Pro" and
"Fax2Fax" have been filed with the United States Patent and Trademark Office.
This prospectus also includes references to registered service marks and
trademarks of other entities.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. This summary may not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including "Risk Factors" and the financial statements,
before making an investment decision.
Net2Phone
Net2Phone is a leading provider of services enabling users to make high
quality, low-cost telephone calls over the Internet. These services are
commonly referred to as Internet telephony. Our Internet telephony services
enable our customers to call individuals and businesses worldwide using their
personal computers or traditional telephones. According to Frost & Sullivan, a
leading market research firm, we were the largest provider of Internet calls in
the world in 1997 with a 30% market share.
In August 1996, we introduced our first service, "PC2Phone." We believe that
PC2Phone was the first commercial telephone service to connect calls between
personal computers and telephones over the Internet. In September 1997, we
introduced "Phone2Phone," a service that enables international and domestic
calls to be made over the Internet using traditional telephones. Our customers
often pay substantially less for long-distance calls they make using our
services than they would for calls made over traditional long distance
networks, such as those owned by AT&T, Sprint and MCI.
We are using our expertise in Internet telephony to integrate live voice
capabilities into the Web. We have developed simple, easy to use PC2Phone
software that operates on a personal computer and allows individuals and
businesses to:
. speak with sales or customer service representatives of online retailers
and other Web-based businesses while visiting their Web sites;
. speak with individuals or businesses listed on various online
directories, such as Yahoo! People Search; and
. call almost any telephone number in the world.
We promote our services through relationships with international resellers
and leading Internet companies. For example, our PC2Phone software will be
embedded on an exclusive basis into future versions of Netscape's Internet
browser, including Netscape Navigator and Netscape Communicator, for the term
of our agreement. Netscape will also include a Net2Phone icon on the Netscape
Navigator Personal Toolbar and integrate our services into Netscape Netcenter,
allowing Netscape users to access our services from anywhere on the Web.
Our strategy for building on our leadership position in our market and
making live voice communication a common feature on the Internet includes the
following key elements:
. marketing our services widely;
. pursuing multiple sources of revenue;
. enhancing brand recognition;
. making our software readily available worldwide; and
. expanding and enhancing our products and services.
Upon completion of this offering, IDT will own approximately 58.2% of our
outstanding capital stock. IDT owns Class A stock that has twice the voting
power of our common stock. As a result, IDT will control 65.2% of our vote.
Our principal executive offices are located at 171 Main Street, Hackensack,
New Jersey 07601, and our telephone number at that address is (201) 907-5304.
1
<PAGE>
Recent Developments
The Offering
<TABLE>
<C> <S>
Common stock offered by Net2Phone............ 4,800,000 shares
Capital stock to be outstanding after this
offering.................................... 46,797,619 shares
Common stock................................ 10,161,429 shares
Class A stock............................... 36,636,190 shares
Use of proceeds.............................. $7.0 million of the net
proceeds from this offering
will be used to repay a portion
of a note outstanding to IDT
Corporation. $1.5 million will
be used to pay to NBC for the
purchase of television
advertising. We have not made
any other specific allocations
with respect to the proceeds.
We expect to use the balance of
the proceeds: for developing
and maintaining strategic
Internet relationships; for
advertising and promotion; for
research and development; for
upgrading and expanding our
network; and for general
corporate purposes, including
working capital.
Nasdaq National Market symbol................ NTOP
</TABLE>
--------------------
This information excludes:
. 3,666,366 shares subject to options outstanding as of July 13, 1999 at a
weighted average exercise price of $3.33 per share; and
. an additional 920,000 shares subject to options granted to Mr. Fram as
of July 13, 1999, of which 460,000 shares were granted at an exercise
price of $3.33 per share and the remaining 460,000 shares were granted
at the lower of our initial public offering price or $11.00 per share.
. 6,030,378 shares reserved for issuance under our 1999 Stock Incentive
Plan, as of July 13, 1999, approximately 2,011,000 of which we expect to
grant prior to the closing of this offering.
Unless otherwise noted, the information in this prospectus:
. reflects a 10,320-for-one stock split on our common stock, which took
place in April 1999;
. reflects a three-for-one stock split on our common stock and Class A
stock, which took place in June 1999;
2
<PAGE>
. assumes 4,683,237 shares of common stock outstanding in June 1999;
. assumes 27,621,982 shares of Class A stock outstanding in June 1999;
. assumes the exercise of warrants to purchase 272,400 shares of our
common stock at a price of $3.33 per share prior to the closing of this
offering for proceeds of $907,092;
. gives effect to the conversion of 405,792 shares of Class A stock to
common stock upon the transfer of these shares from IDT to Clifford M.
Sobel, our Chairman, at the closing of this offering; and
. gives effect to the conversion of all 3,140,000 outstanding shares of
our Series A convertible preferred stock into 9,420,000 shares of Class
A stock at the closing of this offering.
Each share of Class A stock entitles the holder to two votes, while holders
of our common stock are entitled to only one vote. Each share of Class A stock
is convertible into one share of common stock, and automatically converts into
common stock upon transfer.
--------------------
Our fiscal year ends on July 31 of each calendar year. All references to
fiscal years in this prospectus refer to the fiscal years ending in the
indicated calendar years. For example, "fiscal 1998" refers to the fiscal year
ended July 31, 1998.
3
<PAGE>
The table below sets forth summary financial information for the periods
indicated. This information is not necessarily indicative of the results of
operations or financial position which would have resulted had we operated as
an independent entity during the periods indicated. It is important that you
read this information together with the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our financial statements and the notes thereto included elsewhere in this
prospectus.
Summary Financial Information
<TABLE>
<CAPTION>
Period from Year Ended Nine Months Ended
January 2, 1996 July 31, April 30,
(inception) to ------------------------ -----------------------
July 31, 1996 1997 1998 1998 1999
--------------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Statement of Operations:
Revenue............... $ -- $ 2,652,303 $12,005,972 $7,954,374 $22,203,257
Loss from operations.. (507,758) (1,697,647) (3,544,689) (673,922) (2,905,966)
Net loss.............. $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966)
Net loss per share--
basic and diluted.... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09)
Shares used in
calculation of basic
and diluted loss per
share................ 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000
</TABLE>
The pro forma balance sheet data summarized below gives effect to:
. the sale of 3,140,000 shares of Series A convertible preferred stock,
which are convertible into 9,420,000 shares of our Class A common stock,
and warrants to purchase 180,000 shares of our common stock in May 1999
for net proceeds of $29.9 million;
. the conversion of all outstanding shares of our Series A convertible
preferred stock into shares of our Class A stock at the closing of this
offering;
. the issuance of warrants to purchase 92,400 shares of our common stock
granted to the placement agent in May 1999 in connection with the sale
of our Series A convertible preferred stock;
. the repayment of $8.0 million of the amounts owed to IDT in May 1999;
and
. the exercise of options to purchase 1,345,219 shares of common stock in
May 1999 in exchange for $3.1 million in promissory notes and $1.3
million in cash.
The pro forma as adjusted balance sheet summarized below reflects:
. the sale of 4,800,000 shares of common stock in this offering;
. the application of $7.0 million of the estimated net proceeds from this
offering to pay a portion of the amounts due to IDT;
. the application of $1.5 million of the estimated net proceeds from this
offering to pay NBC for television advertising;
. the exercise of warrants to purchase 272,400 shares of common stock
prior to the closing of this offering for proceeds of $907,092; and
. the loan of $1.0 million to our President to purchase stock
<TABLE>
<CAPTION>
April 30, 1999
--------------------------------------
Pro Forma
Actual Pro Forma As Adjusted
------------ ----------- ------------
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.............. $ 1,782,194 $25,016,264 $62,237,356
Working capital........................ (17,255,452) 13,978,618 58,199,710
Total assets........................... 19,818,328 43,052,398 83,773,490
Due to IDT............................. 22,000,000 14,000,000 7,000,000
Total stockholders' (deficit) equity... (3,926,122) 27,307,948 75,029,040
</TABLE>
4
<PAGE>
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected. In that event, the trading price of our shares could
decline, and you may lose part or all of your investment.
Risks Related to Our Financial Condition and Our Business
Our limited operating history makes evaluating our business difficult.
IDT formed us as a subsidiary in October 1997. Prior to that, we conducted
business as a division of IDT. Therefore, we have only a limited operating
history with which you may evaluate our business. You must consider the
numerous risks and uncertainties an early stage company like ours faces in the
new and rapidly evolving market for Internet-related services. These risks
include our ability to:
. increase awareness of our brand and continue to build user loyalty;
. maintain our current, and develop new, strategic relationships;
. respond effectively to competitive pressures; and
. continue to develop and upgrade our network and technology.
If we are unsuccessful in addressing these risks, sales of our products and
services, as well as our ability to maintain or increase our customer base,
will be substantially diminished.
We have never been profitable and expect our losses to continue for the
foreseeable future.
We have never been profitable on an annual basis. We had an accumulated
deficit of approximately $8.7 million as of April 30, 1999. We expect to
continue to incur operating losses for the forseeable future. Our operating and
marketing expenses have continuously increased since inception and we expect
them to continue to increase significantly during the next several years.
Accordingly, we will need to generate significant revenue to achieve
profitability. We may not be able to do so. Even if we do achieve
profitability, we cannot assure you that we will be able to sustain or increase
profitability on a quarterly or annual basis in the future.
Further, it is probable that we will have to recognize significant
additional charges relating to non-cash compensation in connection with options
that we granted in May 1999 and that we expect to grant prior to the closing of
this offering. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
We intend to pursue new streams of revenue which we have not attempted to
generate before and which may not be profitable.
In the future, we intend to pursue revenue from new Web-based opportunities,
such as banner and audio advertising, as well as from sponsorship opportunities
on our user interface and our EZSurf.com Internet shopping directory. We also
intend to explore the availability of revenue-sharing opportunities. We have
not attempted to generate this type of revenue before. We intend to devote
significant capital and resources to create these new revenue streams and we
cannot ensure that these investments will be profitable.
We may have difficulties managing our expanding operations, which may reduce
our chances of achieving profitability.
Our future performance will depend, in part, on our ability to manage our
growth effectively. To that end, we will have to undertake the following tasks,
among others:
. develop our operating, administrative, and financial and accounting
systems and controls;
5
<PAGE>
. improve coordination among our engineering, accounting, finance,
marketing and operations personnel;
. enhance our management information systems capabilities; and
. hire and train additional qualified personnel.
If we cannot accomplish these tasks, we will diminish our chances of achieving
profitability.
If we fail to establish and maintain strategic relationships our ability to
increase our sales would suffer.
We currently have strategic relationships with Netscape, Compaq, Yahoo!,
Excite and others. We depend on these relationships to:
. distribute our products to potential customers;
. increase usage of our services;
. build brand awareness; and
. cooperatively market our products and services.
We believe that our success depends, in part, on our ability to develop and
maintain strategic relationships with leading Internet companies and computer
hardware and software companies, as well as key marketing distribution
partners. If any of our strategic relationships are discontinued, sales of our
products and services and our ability to maintain or increase our customer base
may be substantially diminished.
If we hire a reseller who fails to market our products and services effectively
or who provides poor customer service, our reputation will suffer and we
could lose customers.
If we hire a reseller who fails to market our products and services
effectively, we could lose market share. Additionally, if a reseller provides
poor customer service, we could lose brand equity. Therefore, we must maintain
and hire additional resellers throughout the world that are capable of
providing high-quality sales and service efforts. If we lose a reseller in a
key market, or if a current or future reseller fails to adequately provide
customer support, our reputation will suffer and sales of our products and
services and our customer base will be substantially diminished.
Competition could reduce our market share and decrease our revenue.
The market for our services has been extremely competitive. Many companies
offer products and services like ours, and many of these companies have a
substantial presence in this market. Current product offerings include VocalTec
Communications' Internet Phone, QuarterDeck's WebPhone and Microsoft's
NetMeeting.
In addition, a number of large telecommunications providers and equipment
manufacturers, such as Alcatel, Cisco, Lucent, Northern Telecom and Dialogic
(which has entered into an agreement to be acquired by Intel), have announced
that they intend to offer similar products. We expect these products to allow
live voice communications over the Internet between parties using a personal
computer and a telephone and between two parties using telephones. Cisco
Systems has also taken further steps by recently acquiring companies that
produce devices that help Internet service providers carry voice over the
Internet while maintaining traditional phone usage and infrastructure. Other
competitors of ours, such as ICG Communications, IPVoice.com, ITXC, RSL
Communications (through its Delta Three subsidiary) and VIP Calling, route
voice traffic worldwide over the Internet. In addition, major long distance
providers, such as AT&T, Deutsche Telekom, MCI WorldCom and Qwest
Communications, as well as other major companies such as Motorola and Intel,
have all entered or plan to enter the market for carrying voice over the
Internet. These companies are larger than we are and have substantially greater
financial, distribution and marketing resources than we do. We may not be able
to compete successfully in this market.
6
<PAGE>
Pricing pressures may lessen our competitive pricing advantage.
Our success is based on our ability to provide discounted domestic and
international long distance services by taking advantage of cost savings
achieved by carrying voice traffic over the Internet, as compared to carrying
calls over long distance networks, such as those owned by AT&T, Sprint and MCI.
In recent years, the price of long distance calls has fallen. In response, we
have lowered the price of our service offerings. The price of long distance
calls may decline to a point where we no longer have a price advantage over
these traditional long distance services. We would then have to rely on factors
other than price to differentiate our product and service offerings, which we
may not be able to do.
We may not be able to hire and retain the personnel we need to sustain our
business.
We depend on the continued services of our executive officers and other key
personnel. We have an employment agreement with only one of our executive
officers, Clifford M. Sobel, our Chairman and President. We need to attract and
retain other highly-skilled technical and managerial personnel for whom there
is intense competition. If we are unable to attract and retain qualified
technical and managerial personnel, we may never achieve profitability.
If our customers do not perceive our service to be effective or of high
quality, our brand and name recognition would suffer.
We believe that establishing and maintaining a brand and name recognition is
critical for attracting and expanding our targeted client base. We also believe
that the importance of reputation and name recognition will increase as
competition in our market increases. Promotion and enhancement of our name will
depend on the effectiveness of our marketing and advertising efforts and on our
success in continuing to provide high-quality products and services, neither of
which can be assured. If our customers do not perceive our service to be
effective or of high quality, our brand and name recognition would suffer.
We depend on our international operations, which subject us to unpredictable
regulatory and political situations.
As of April 30, 1999, approximately 65% of our customers were based outside
of the United States, generating approximately 58% of our revenues during the
nine months ended on that date. A significant component of our strategy is to
continue to expand internationally. We cannot assure you that we will be
successful in expanding into additional international markets. In addition to
the uncertainty regarding our ability to generate revenue from foreign
operations and expand our international presence, there are certain risks
inherent in doing business on an international basis, including:
. changing regulatory requirements;
. increased bad debt and subscription fraud;
. legal uncertainty regarding liability, tariffs and other trade barriers;
. political instability; and
. potentially adverse tax consequences.
We cannot assure you that one or more of these factors will not materially
adversely affect the growth of our business or our customer base.
All of the telephone calls made by our customers are connected through local
telephone companies and, at least in part, through leased networks that may
become unavailable.
We are not a local telephone company or a registered local exchange carrier.
Our network covers only portions of the United States. Accordingly, we must
route some domestic and all international calls made by our customers at least
in part over leased transmission facilities. Further, because our network does
not
7
<PAGE>
extend to homes or businesses, we must route calls made by our customers
through a local telephone company to reach our network and, ultimately, to
reach their final destinations.
In many of the foreign jurisdictions in which we conduct or plan to conduct
business, the primary provider of significant intra-national transmission
facilities is the national telephone company. Accordingly, we may have to lease
transmission capacity at artificially high rates from a monopolistic provider
and we may not be able to generate a profit on those calls. In addition,
national telephone companies may not be required by law to lease necessary
transmission lines to us or, if applicable law requires national telephone
companies to lease transmission facilities to us, we may encounter delays in
negotiating leases and interconnection agreements and commencing operations.
Additionally, disputes may result with respect to pricing terms and billing.
In the United States, the providers of local telephone service are generally
the incumbent local telephone companies, including the regional Bell operating
companies. The permitted pricing of local transmission facilities that we lease
in the United States is subject to uncertainties. The Federal Communications
Commission has issued an order requiring incumbent local telephone companies to
price those facilities at total element long-run incremental cost, and the
United States Supreme Court recently upheld the FCC's jurisdiction to set a
pricing standard for local transmission facilities provided to competitors.
However, the incumbent local telephone companies can be expected to bring
further legal challenges to the FCC's total element long-run incremental cost
standard and, if they succeed, the result may be to increase the cost of
incumbent local transmission facilities obtained by us.
Our success depends on our ability to handle a large number of simultaneous
calls, which our systems may not be able to accommodate.
We expect the volume of simultaneous calls to increase significantly as we
expand our operations. Our network hardware and software may not be able to
accommodate this additional volume. If we fail to maintain an appropriate level
of operating performance, or if our service is disrupted, our reputation could
be hurt and we could lose customers.
Because we are unable to predict the volume of usage and our capacity needs, we
may be forced to enter into disadvantageous contracts that would reduce our
operating margins.
In order to ensure that we are able to handle additional usage, we have
agreed to pay IDT a one-time fee of approximately $6.0 million for a 20-year
right to use part of a new high capacity network that is under construction.
This network has been pledged by IDT to its lenders under a credit facility. We
may have to enter into additional long-term agreements for leased capacity. To
the extent that we overestimate our call volume, we may be obligated to pay for
more transmission capacity than we actually use, resulting in costs without
corresponding revenue. Conversely, if we underestimate our capacity needs, we
may be required to obtain additional transmission capacity through more
expensive means that may not be available.
We may not be able to obtain sufficient funds to grow our business.
We intend to continue to grow our business. Due to our limited operating
history and the nature of our industry, our future capital needs are difficult
to predict. Therefore, we may require additional capital after this offering to
fund any of the following:
. unanticipated opportunities;
. strategic alliances;
. potential acquisitions;
. changing business conditions; and
. unanticipated competitive pressures.
8
<PAGE>
Obtaining additional financing will be subject to a number of factors,
including market conditions, our operating performance and investor sentiment.
These factors may make the timing, amount, terms and conditions of additional
financings unattractive to us. If we are unable to raise additional capital,
our growth could be impeded.
Any damage to or failure of our systems or operations could result in
reductions in, or terminations of, our services.
Our success depends on our ability to provide efficient and uninterrupted,
high-quality services. Our systems and operations are vulnerable to damage or
interruption from natural disasters, power loss, telecommunication failures,
physical or electronic break-ins, sabotage, intentional acts of vandalism and
similar events that may be or may not be beyond our control. The occurrence of
any or all of these events could hurt our reputation and cause us to lose
customers.
Unauthorized use of our intellectual property by third parties may damage our
brand.
We regard our copyrights, service marks, trademarks, trade secrets and other
intellectual property as critical to our success. We rely on trademark and
copyright law, trade secret protection and confidentiality agreements with our
employees, customers, partners and others to protect our intellectual property
rights. Despite our precautions, it may be possible for third parties to obtain
and use our intellectual property without authorization. Furthermore, the
validity, enforceability and scope of protection of intellectual property in
Internet-related industries is uncertain and still evolving. The laws of some
foreign countries are uncertain or do not protect intellectual property rights
to the same extent as do the laws of the United States. The unauthorized use of
our intellectual property by third parties may damage our brand.
Defending against intellectual property infringement claims could be expensive
and could disrupt our business.
We cannot be certain that our products do not or will not infringe upon
valid patents, trademarks, copyrights or other intellectual property rights
held by third parties. We may be subject to legal proceedings and claims from
time to time relating to the intellectual property of others in the ordinary
course of our business. We may incur substantial expenses in defending against
these third-party infringement claims, regardless of their merit. Successful
infringement claims against us may result in substantial monetary liability or
may materially disrupt the conduct of our business. See "Business--Intellectual
Property."
Year 2000 problems may disrupt our operations.
Many computer systems and software products are coded to understand only
dates that have two digits for the relevant year. These systems and products
need upgrading to accept four digit entries in order to distinguish 21st
century dates from 20th century dates. Without upgrading, many computer
applications could fail or create erroneous results beginning in the year 2000.
The "Year 2000" problems of companies on the Internet generally could affect
our systems or operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Systems Costs" for a
more complete description of the Year 2000 risks that we face and the steps we
have taken to reduce those risks.
9
<PAGE>
Risks Related to Our Relationship with IDT
We have contracted with IDT for various services and for the use of its
telecommunications network, which contracts we may not be able to renew when
they expire.
In May 1999, we entered into agreements with IDT under which IDT will
continue to provide administrative and telecommunication services to us. When
these agreements expire, we will need to extend them, engage other entities to
perform these services or perform these services ourselves. In addition, after
the initial term, these agreements are terminable by either party upon prior
written notice. We cannot assure you that IDT will not terminate these
agreements or continue to provide these services after the initial term of the
agreements. As a result, we may have to purchase these services from third
parties or devote resources to handle these functions internally, which may
cost us more than we paid IDT for the same services. In addition, IDT has
provided us in the past with working capital to fund our operations, and IDT is
not under any obligation, under these agreements or otherwise, to do so in the
future.
We may experience conflicts of interest with IDT, which may not be resolved in
our favor.
Two members of our board of directors are officers and directors of IDT. One
of these directors, Howard S. Jonas, is the Chairman and Chief Executive
Officer of IDT and IDT's controlling shareholder. Additionally, one of our
directors, James R. Mellor, was a director of IDT until June 1999. Clifford M.
Sobel, our Chairman, has an option to transfer his interest in us to IDT in
exchange for an option to purchase 875,000 shares of IDT common stock at a
purchase price of $6.50 per share. See "Certain Transactions." In addition,
certain of our executive officers, directors and employees hold shares of IDT
common stock and options to acquire shares of IDT common stock. These
individuals may have conflicts of interest with respect to certain decisions
involving business opportunities and similar matters that may arise in the
ordinary course of our business or the business of IDT. If conflicts arise with
IDT, we expect to resolve those conflicts on a case-by-case basis, and in the
manner required by applicable law and customary business practices, subject to
our agreement with IDT to resolve disputes involving $5.0 million or less
through mandatory, binding arbitration. Conflicts, if any, could be resolved in
a manner adverse to us and our stockholders, which could harm our business.
Through its ownership of our stock, IDT effectively controls our company and
may exert influence contrary to the interests of other stockholders.
Immediately following this offering, IDT will own approximately 58.2% of our
outstanding capital stock. Because IDT owns Class A stock, which entitles the
holder to two votes per share, IDT will control 65.2% of our voting power.
Therefore, IDT will have the power to determine the election of our directors,
the appointment of new management and the approval of any other action
requiring the approval of our stockholders, including any amendments to our
certificate of incorporation and mergers or sales of our company or of all of
our assets. In addition, without the consent of IDT, we could be prevented from
entering into certain transactions that could be beneficial to us. Third
parties could be discouraged from making a tender offer or bid to acquire us
because of IDT's stockholdings and voting rights. IDT's ownership will increase
further if Clifford M. Sobel exercises his option to transfer his shares of our
stock to IDT in exchange for an option to purchase shares of IDT. See
"Principal Stockholders."
IDT has pledged its shares of our stock to secure a credit facility, which
shares may be transferred to a third party that would effectively control us
if IDT defaults on its obligations.
The shares owned by IDT are pledged as collateral to secure an IDT credit
facility. The lenders under the credit facility have agreed to permit IDT to
transfer our shares free and clear of any liens as and when IDT seeks to
transfer shares of our stock. Such transferability will cease if IDT's
ownership of our capital stock drops below 50% of the number of shares which it
owns 72 hours after the consummation of this offering. If IDT defaults in its
obligations under the credit facility, then a third party could acquire the
voting
10
<PAGE>
rights with respect to the pledged stock and become party to our intercompany
agreements. We cannot assume that a third party would maintain good relations
with us or maintain or renew our agreements with IDT.
Risks Related to Our Industry
If the Internet does not continue to grow as a medium for voice communications,
our business will suffer.
The technology that allows voice communications over the Internet is still
in its early stages of development. Historically, the sound quality of Internet
calls was poor. As the industry has grown, sound quality has improved, but the
technology requires further refinement. Additionally, the Internet's capacity
constraints may impede the acceptance of Internet telephony. Callers could
experience delays, errors in transmissions or other interruptions in service.
Making telephone calls over the Internet must also be accepted as an
alternative to traditional telephone service. Because the Internet telephony
market is new and evolving, predicting the size of this market and its growth
rate is difficult. If our market fails to develop, then we will be unable to
grow our customer base and our opportunity for profitability will be harmed.
Our business will not grow without increased use of the Internet.
The use of the Internet as a commercial marketplace is at an early stage of
development. Demand and market acceptance for recently introduced products and
services over the Internet are still uncertain. We cannot predict whether
customers will be willing to shift their traditional activities online. The
Internet may not prove to be a viable commercial marketplace for a number of
reasons, including:
. concerns about security;
. Internet congestion;
. inconsistent service; and
. lack of cost-effective, high-speed access.
If the use of the Internet as a commercial marketplace does not continue to
grow, we may not be able to grow our customer base, which may prevent us from
achieving profitability.
Governmental regulations regarding the Internet may be passed, which could
impede our business.
To date, governmental regulations have not materially restricted use of the
Internet in our market. However, the legal and regulatory environment that
pertains to the Internet is uncertain and may change. New regulations could
increase our costs of doing business and prevent us from delivering our
products and services over the Internet. The growth of the Internet may also be
significantly slowed. This could delay growth in demand for our products and
services and limit the growth of our revenue.
In addition to new regulations being adopted, existing laws may be applied
to the Internet. See "Business--Regulation." New and existing laws may cover
issues that include:
. sales and other taxes;
. access charges;
. user privacy;
. pricing controls;
. characteristics and quality of products and services;
. consumer protection;
. contribution to the universal service fund, a FCC-administered fund for
the support of local telephone service in rural and high cost areas;
. cross-border commerce;
. copyright, trademark and patent infringement; and
. other claims based on the nature and content of Internet materials.
11
<PAGE>
In September 1998, two regional Bell operating companies advised Internet
telephony providers that these companies would impose access charges on
Internet telephony traffic. One of these operating companies also petitioned
the FCC for a declaratory ruling that providers of interstate Internet
telephony must pay federal access charges, and has petitioned the public
utilities commissions of Nebraska and Colorado for similar rulings concerning
payment of access charges for intrastate Internet telephone calls. The outcome
of these proceedings is uncertain. If these states decide that access charges
may be levied against Internet telephony providers, we would have to pay money
for access in those states. If additional state utility commissions make
similar rulings, we may not be able to operate profitably in any states that
assesses access charges against us.
Our risk management practices may not be sufficient to protect us from
unauthorized transactions or thefts of services.
We may be the victim of fraud or theft of service. From time to time,
callers have obtained our services without rendering payment by unlawfully
using our access numbers and personal identification numbers. We attempt to
manage these theft and fraud risks through our internal controls and our
monitoring and blocking systems.
Risks Related to this Offering
Our stock price is likely to be highly volatile and could drop unexpectedly.
Following this offering, the price for our common stock could be highly
volatile and subject to wide fluctuations in response to the following factors:
. quarterly variations in our operating results;
. announcements of technical innovations, new products or services by us
or our competitors;
. investor perception of us, the Internet telephony market or the Internet
in general;
. changes in financial estimates by securities analysts; and
. general economic and market conditions.
The stocks of many Internet-related companies have experienced significant
fluctuations in trading price and volume. Often these fluctuations have been
unrelated to operating performance. Declines in the market price of our common
stock could also materially adversely affect employee morale and retention, our
access to capital and other aspects of our business.
If our stock price is volatile, we may become subject to securities litigation,
which is expensive and could divert our resources.
In the past, following periods of market volatility in the price of a
company's securities, security holders have instituted class action litigation.
Many companies in our industry have been subject to this type of litigation. If
the market value of our stock experiences adverse fluctuations, and we become
involved in this type of litigation, regardless of the outcome, we could incur
substantial legal costs and our management's attention could be diverted,
causing our business to suffer.
The sale of a substantial number of shares of our common stock after this
offering may affect our stock price.
The market price of our common stock could decline as a result of sales of
substantial amounts of common stock in the public market after the closing of
this offering or the perception that substantial sales could occur. These sales
also might make it difficult for us to sell equity securities in the future at
a time and at a price that we deem appropriate.
12
<PAGE>
We may use the proceeds from this offering in ways with which you may not
agree.
We have significant flexibility in applying the proceeds we receive in this
offering. Other than the repayment of $7.0 million on an outstanding note to
IDT and the payment of $1.5 million to NBC for television advertising, the
proceeds are not required to be allocated to any specific investment or
transaction. Therefore, you cannot determine the value or propriety of our use
of proceeds. If we do not apply the funds we receive effectively, our
accumulated deficit will increase and we may lose significant business
opportunities. See "Use of Proceeds" for a more detailed description of how we
intend to apply the proceeds from this offering.
Our certificate of incorporation, our bylaws and Delaware law make it difficult
for a third party to acquire us, despite the possible benefit to our
stockholders.
Provisions of our certificate of incorporation, our bylaws and Delaware law
could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders. For example, our certificate of
incorporation provides for a classified board of directors, meaning that only
approximately one-third of our directors will be subject to re-election at each
annual stockholder meeting. Moreover, our certificate of incorporation creates
a class of stock with super-voting rights. The holders of Class A stock are
entitled to two votes per share while the holders of common stock are entitled
to one vote per share. Except as otherwise required by law or as described
below, the holders of Class A stock and common stock will vote together as a
single class on all matters presented to the stockholders for their vote or
approval, including the election of directors. The holders of Class A stock may
have the ability to elect all of our directors and to effect or prevent certain
corporate transactions. These provisions could discourage takeover attempts and
could materially adversely affect the price of our stock.
FORWARD-LOOKING STATEMENTS
This prospectus contains "forward-looking statements." These forward-looking
statements include, without limitation, statements about our market
opportunity, strategies, competition, expected activities and expenditures as
we pursue our business plan, and the adequacy of our available cash resources.
Our actual results could differ materially from those expressed or implied by
these forward-looking statements as a result of various factors, including the
risk factors described above and elsewhere in this prospectus.
13
<PAGE>
USE OF PROCEEDS
Net2Phone will receive net proceeds of approximately $47.8 million from the
sale of 4,800,000 shares of common stock (and an additional approximately $7.4
million from the sale of 720,000 shares if the underwriters over-allotment
option is exercised in full) at an assumed initial public offering price of
$11.00 per share after deducting underwriting commissions and discounts of $3.5
million (and an additional $554,400 if the underwriters' over-allotment option
is exercised in full) and estimated expenses of $1.5 million.
$7.0 million of the net proceeds from this offering will be used to repay a
portion of the $14.0 million note outstanding to IDT. $1.5 million will be used
to pay NBC for television advertising. As of the date of this prospectus, we
have not made any other specific allocations with respect to the proceeds.
Therefore, we cannot specify with certainty the particular uses for the net
proceeds to be received upon consummation of this offering. Accordingly, our
management will have significant flexibility in applying the net proceeds from
this offering.
We expect to use the balance of the net proceeds of this offering for:
. developing and maintaining strategic Internet relationships;
. advertising and promotion;
. research and development;
. upgrading and expanding our network; and
. general corporate purposes, including working capital.
Pending any use, the net proceeds of this offering will be invested in
short-term, interest-bearing securities.
DIVIDEND POLICY
We have not paid any dividends in the past and do not intend to pay cash
dividends on our capital stock for the foreseeable future. Instead, we intend
to retain all earnings for use in the operation and expansion of our business.
14
<PAGE>
CAPITALIZATION
The following table sets forth:
. our actual capitalization as of April 30, 1999;
. our pro forma capitalization to give effect to:
. the conversion of IDT's 27,864,000 shares of our common stock into
27,864,000 shares of Class A stock in May 1999,
. the sale of 3,140,000 shares of Series A convertible preferred stock,
which are convertible into 9,420,000 shares of our Class A common stock,
and warrants to purchase 180,000 shares of our common stock in May 1999
for net proceeds of $29.9 million,
. the conversion of all outstanding shares of our Series A convertible
preferred stock into shares of our Class A stock at the closing of this
offering,
. the issuance of warrants to purchase 92,400 shares of our common stock
granted to the placement agent in May 1999 in connection with the sale
of our Series A convertible preferred stock,
. the repayment of $8.0 million of the amounts owed to IDT in May 1999,
. the conversion of 242,018 shares of Class A stock to common stock upon
the transfer of these shares from IDT to Clifford M. Sobel in May 1999,
. the exercise of stock options to purchase 1,375,219 shares of common
stock in May 1999 in exchange for $3.1 million in promissory notes and
$1.3 million in cash; and
. the pro forma as adjusted balance sheet summarized below reflects:
. the sale of 4,800,000 shares of common stock in this offering,
. the application of $7.0 million of the estimated net proceeds from this
offering to pay a portion of the amounts due to IDT,
. the conversion of 405,792 shares of Class A stock to common stock upon
the transfer of those shares from IDT to Clifford M. Sobel at the
closing of this offering,
. exercise of warrants prior to the closing of this offering to purchase
272,400 shares of common stock, and
. the loan of $1.0 million to our President to purchase shares of stock
The information set forth in the table below excludes 3,666,366 shares of
common stock issuable upon exercise of options to purchase our common stock at
a weighted average exercise price of $3.33 per share. This information also
excludes an additional 920,000 shares subject to options granted to Fram, of
which 460,000 shares were granted at an exercise price of $3.33 per share and
the remaining 460,000 shares were granted at the lower of our initial public
offering price or $11.00 per share. This information also excludes the effect
of non-cash compensation in connection with options to purchase 5,040,000
shares of our common stock that were granted in May 1999, and options to
purchase 2,011,000 shares of our common stock that are expected to be granted
prior to the closing of this offering and options to purchase 920,000 granted
to our President. See "Management--1999 Stock Incentive Plan" and "Certain
Transactions--Relationship with Other Investors."
<TABLE>
<CAPTION>
April 30, 1999
-------------------------------------
Pro Forma
Actual Pro Forma As Adjusted
----------- ----------- -----------
<S> <C> <C> <C>
Due to IDT.............................. $22,000,000 $14,000,000 $ 7,000,000
Redeemable convertible preferred stock,
Series A, $.01 par value; 3,150,000
shares authorized, no shares issued and
outstanding............................ -- -- --
Stockholders' (deficit) equity:
Preferred stock, $.01 par value;
6,850,000 shares authorized, no shares
issued and outstanding................. -- -- --
Common stock, $.01 par value;
200,000,000 shares authorized;
30,960,000 (actual) 4,683,237 (pro
forma) and 10,161,429 (pro forma as
adjusted) shares issued and
outstanding............................ 309,600 46,832 101,614
Class A stock, $.01 par value;
37,042,089 shares authorized; none
(actual) 37,041,982 (pro forma) and
36,636,190 (pro forma as adjusted)
shares issued and outstanding.......... -- 370,420 366,362
Additional paid-in capital.............. 4,420,338 38,696,746 87,367,114
Loans to stockholders................... -- (3,149,990) (4,149,990)
Accumulated deficit..................... (8,656,060) (8,656,060) (8,656,060)
----------- ----------- -----------
Total stockholders' (deficit) equity.... (3,926,122) 27,307,948 75,029,040
----------- ----------- -----------
Total capitalization.................... $18,073,878 $41,307,948 $82,029,040
=========== =========== ===========
</TABLE>
15
<PAGE>
DILUTION
The net tangible book value of Net2Phone common stock and Class A stock as
of April 30, 1999, as adjusted to give effect to a private placement of
3,140,000 shares of Series A convertible preferred stock in May 1999 and the
conversion of those shares into Class A stock and the exercise of stock options
to purchase 1,345,219 shares of common stock, was $22.3 million, or $0.53 per
share of common stock and Class A stock. Net tangible book value per share
represents the amount of our total tangible assets less our total liabilities,
divided by the total number of shares of common stock and Class A stock
outstanding.
After giving effect to this offering and the receipt of an assumed $47.8
million of net proceeds from this offering (based on an assumed initial public
offering price of $11.00 per share), the issuance of 3,140,000 shares of Series
A convertible preferred stock in May 1999, the conversion of the Series A
convertible preferred stock into 9,420,000 shares of Class A stock and the
exercise of warrants to purchase 272,400 shares of common stock, the pro forma
net tangible book value of the common stock and Class A stock as of April 30,
1999 would have been $70.0 million, or $1.47 per share. This amount represents
an immediate increase in net tangible book value of $1.13 per share to the
existing stockholders and an immediate dilution in net tangible book value of
$9.53 per share to purchasers of common stock in this offering. Dilution is
determined by subtracting pro forma net tangible book value per share after
this offering from the amount of cash paid by a new investor for a share of
common stock. The following table illustrates such dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................. $11.00
Net tangible book value per share at April 30, 1999 .......... $0.53
Increase per share attributable to new investors.............. 0.94
-----
Pro forma net tangible book value per share after this
offering........................................................ 1.47
------
Dilution per share to new investors............................. $ 9.53
======
</TABLE>
The following table sets forth, as of April 30, 1999, on the pro forma basis
described above, the number of shares of capital stock purchased from us, the
total consideration paid to us and the average price per share paid by existing
stockholders and by new investors who purchase shares of common stock in this
offering, before deducting the estimated underwriting discounts and commissions
and offering expenses.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.. 41,725,219 89.7% $ 88,742,182 62.7% $ 2.11
New investors.......... 4,800,000 10.3% 52,800,000 37.3% 11.00
---------- ----- ------------ -----
Total.............. 46,797,619 100.0% $141,542,182 100.0%
========== ===== ============ =====
</TABLE>
16
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with our
financial statements and related notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this prospectus. The statement of operations data for the period from
January 2, 1996 (inception) to July 31, 1996, fiscal 1997 and fiscal 1998 and
the balance sheet data as of July 31, 1997 and 1998 are derived from our
financial statements that have been audited by Ernst & Young LLP, independent
auditors, which are included elsewhere in this prospectus. The statement of
operations data for the nine months ended April 30, 1998 and 1999 and the
balance sheet data as of April 30, 1999 have been derived from our unaudited
financial statements that have been prepared on the same basis as the audited
financial statements and, in the opinion of management, include all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the financial data for the periods presented. The financial
data for the interim periods is not necessarily indicative of results that may
be expected for any other interim period or for the year as a whole.
<TABLE>
<CAPTION>
Period from Year Ended Nine Months Ended
January 2, 1996 July 31, April 30,
(inception) ------------------------ -------------------------
to July 31, 1996 1997 1998 1998 1999
---------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue:
PC2Phone.............. $ -- $ 2,170,442 $ 7,962,821 $ 5,085,176 $13,774,837
Phone2Phone........... -- 272 2,030,516 1,018,835 6,503,697
Other................. -- 481,589 2,012,635 1,850,363 1,924,723
---------- ----------- ----------- ------------ -----------
Total revenue....... -- 2,652,303 12,005,972 7,954,374 22,203,257
---------- ----------- ----------- ------------ -----------
Cost and expenses:
Direct cost of
revenue, excluding
depreciation......... -- 1,553,443 6,848,759 3,589,301 11,848,089
Sales and marketing... 34,468 76,724 2,887,766 1,363,060 4,746,316
General and
administrative....... 465,015 2,599,283 5,087,628 3,254,287 7,298,106
Depreciation.......... 8,275 120,500 726,508 421,648 1,216,712
---------- ----------- ----------- ------------ -----------
Total costs and
expenses........... 507,758 4,349,950 15,550,661 8,628,296 25,109,223
---------- ----------- ----------- ------------ -----------
Loss from operations
and net loss.......... $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966)
========== =========== =========== ============ ===========
Net loss per share--
basic and diluted..... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09)
========== =========== =========== ============ ===========
Shares used in
calculation of basic
and diluted net loss
per share............. 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000
<CAPTION>
July 31, April 30,
-------------------------------------- -----------
1996 1997 1998 1999
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............... $ -- $ -- $ 10,074 $ 1,782,194
Working capital......................... (681,532) (3,104,830) (11,149,553) (17,255,452)
Total assets............................ 174,674 916,025 6,975,108 19,818,328
Due to IDT.............................. 681,532 2,960,429 11,814,988 22,000,000
Total stockholders' (deficit)........... (507,758) (2,205,305) (5,649,994) (3,926,122)
</TABLE>
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our financial
statements and notes thereto. The historical financial information included in
this prospectus does not necessarily reflect what our financial condition and
results of operations would have been had we been operated as an independent
entity during the periods presented.
Overview
We began our operations in January 1996, launched our first Net2Phone
product in August 1996, and were established as a separate subsidiary of IDT in
October 1997. During the period ended July 31, 1996, we incurred approximately
$500,000 in start-up costs, primarily for research and development. We have
incurred net operating losses since inception and expect to incur additional
losses for the foreseeable future, primarily as a result of increased sales and
marketing efforts. As of April 30, 1999, we had accumulated net losses of
approximately $8.7 million.
We will recognize a significant charge relating to non-cash executive
compensation expense in the current fiscal quarter ending July 31, 1999, and on
an ongoing basis. In connection with 5,040,000 options granted with an exercise
price of $3.33 per share on May 17, 1999, including options granted to IDT
employees, we will recognize approximately $41 million of non-cash charges over
the vesting period of these options. We will recognize a charge of $13 million
in the current quarter, $10 million during fiscal 2000, and $10 million during
fiscal 2001 and $8 million during fiscal 2002. We also plan to grant options to
purchase 2,011,000 shares of our common stock to our employees, consultants and
others prior to the closing of this offering.
In addition, in connection with the 460,000 options granted to our President
with an exercise price of $3.33 per share, we will recognize approximately $3.6
million of non-cash charges over the vesting period of these options. We will
recognize a charge of $1.2 million during the current quarter, $800,000 during
fiscal 2000, $800,000 during fiscal 2001 and $800,000 during fiscal 2002. In
connection with the remaining 460,000 options granted to our President with an
exercise price equal to the lower of our initial offering price or $11.00 per
share. We will recognize a compensation charge if our initial offering price is
more than $11.00 per share. The non cash compensation charge will be equal to
the excess of our initial offering price over $11.00 times the 460,000 shares
and will be amortized over the vesting period of the options.
Sources of Revenue
For the first nine months of fiscal 1999, approximately 62% of our revenue
has been derived from per-minute charges we billed to our customers on a
prepaid basis to use our PC2Phone service, and approximately 29% of our revenue
has been derived from per-minute charges we billed to our customers and our
international resellers on a prepaid basis to use our Phone2Phone service. The
remainder of our revenue has been derived from the sale of Internet telephony
equipment for Net2Phone Pro, a product that integrates our software into
hardware for the personal computer, and for services we provide to IDT and
other carriers. In the future, in order to diversify and further enhance our
revenue sources, we plan to introduce a variety of value-added services and
Internet commerce solutions. In addition, we plan to sell Web-based advertising
to further leverage our customer reach. To date, these additional products and
services have provided no revenue and we do not anticipate material revenue
from these additional products and services through at least December 1999.
Approximately 91% of our revenue is generated from per-minute charges we
charge our customers on a prepaid basis to use our PC2Phone and Phone2Phone
services. As of April 30, 1999, we served over 250,000 active customers who
spent an average of approximately 60 minutes per month placing calls over the
Internet. We recognize revenue as our customers utilize the balances in their
prepaid accounts by placing calls. As such, we have deferred revenue for all
unutilized balances in our customers' accounts. The remaining 9% of our
revenue, which is derived from equipment sales and from services provided to
IDT and other carriers, is recognized upon installation of the equipment and
performance of the services.
18
<PAGE>
Cost Structure
Our costs and expenses include:
. direct cost of revenue, excluding depreciation;
. sales and marketing;
. general and administrative; and
. depreciation.
Direct Cost of Revenue
Direct cost of revenue consists primarily of network costs associated with
carrying our customers' traffic on our network and leased networks, and routing
their calls through a local telephone company to reach their final destination.
These costs exclude depreciation and include:
. amounts paid to other carriers to terminate traffic on a per-minute
basis;
. the cost of leased routers and access servers;
. telecommunications costs, including the cost of local telephone lines to
carry subscriber calls to our network;
. the costs associated with leased lines connecting our network directly
to the Internet or to our operations centers and connecting our
operations centers to the Internet; and
. Internet backbone costs, which are the amounts we pay to Internet
service providers for capacity.
We expect our direct cost of revenue to increase in absolute terms over time
to support our growing customer base. While some of these costs are fixed,
other costs vary on a per minute basis. Therefore, there may be some volatility
in our direct cost of revenue as a percentage of revenue, particularly as we
expand our network. We try to terminate calls on our own network whenever
possible. When we cannot terminate calls on our network, we terminate calls on
the network of other suppliers, primarily IDT. We expect to continue to utilize
this process. We also expect the percentage of our traffic that we terminate
with IDT will decline in the future as we expand our own network.
Sales and Marketing. Sales and marketing includes the expenses associated
with acquiring customers, including commissions paid to our sales personnel,
advertising costs, referral fees and amounts paid to our strategic partners in
connection with revenue-sharing arrangements. We expect sales and marketing
expenses to increase over time as we aggressively market our products and
services. Historically, sales and marketing expenses have been a relatively
variable cost and are expected to increase both in terms of absolute dollars
and as a percentage of revenue as our revenue grows. We expect to spend
significant capital to build brand recognition. Most of our sales and marketing
expenses will go toward securing significant and strategic relationships with a
variety of Internet companies. We have strategic alliances with Netscape,
Snap.com, Yahoo!, ZDNet, and InfoSpace.com, and intend to continue to pursue
relationships with other companies.
General and Administrative. General and administrative expenses consist of
the salaries of our employees and associated benefits, and the cost of
insurance, travel, entertainment, rent and utilities. A large portion of our
general and administrative expenses include operations and customer support.
These include the expenses associated with customer service and technical
support, and consist primarily of the salaries and employment costs of the
employees responsible for those efforts. We expect operations and customer
support expenses to increase over time to support new and existing customers.
We expect general and administrative costs to increase to support our growth,
particularly as we establish a larger organization to implement our business
plan. We include our research and development costs, comprised primarily of
payroll expenses for our technical team of engineers and developers, in general
and administrative expenses. We plan to incur additional costs for research and
development, though they are not expected to increase as a percentage of
revenue. Over time, we expect these relatively fixed general and administrative
expenses to decrease as a percentage of revenue.
Depreciation. Depreciation primarily relates to our hardware infrastructure.
We depreciate our network equipment over its estimated five-year useful life
using the straight-line method. We plan to acquire
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<PAGE>
a domestic high capacity network to provide additional capacity to handle the
expected increase in customer traffic as our business grows. In addition, we
will be adding more network hardware as traffic volumes justify. We expect
depreciation to increase in absolute terms as we expand our network to support
new and acquired customers, but to decrease as a percentage of total revenue.
We have also entered into a strategic agreement with Netscape, part of which
includes the purchase of software and trademark licenses. We expect to amortize
the costs relating to the software and trademark licenses acquired from
Netscape over the two-year term of the agreement.
Dependence on IDT. Historically, we have been dependent on IDT for working
capital, its telecommunications network and for various services. In connection
with establishing ourselves as an independent operating entity, we recently
contracted with IDT for telecommunications services and administrative support.
We believe that the terms of our agreements with IDT are no less favorable than
those we would have obtained from unaffiliated third parties.
Results of Operations
The following table sets forth certain items in our statement of operations
as a percentage of total revenue for the periods indicated:
<TABLE>
<CAPTION>
Percentage of Revenue
-----------------------------------------------
Period from
January 2,
1996 Year Ended Nine Months Ended
(inception) July 31, April 30,
to July 31, ------------- -------------------
1996 1997 1998 1998 1999
----------- ----- ----- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue:
PC2Phone................. -- 81.8% 66.3% 63.9% 62.0%
Phone2Phone.............. -- -- 16.9 12.8 29.3
Other.................... -- 18.2 16.8 23.3 8.7
----- ----- ----- -------- --------
Total revenue........ -- 100.0 100.0 100.0 100.0
----- ----- ----- -------- --------
Cost and expenses:
Direct cost of revenue,
excluding depreciation.. -- 58.6 57.0 45.1 53.4
Sales and marketing...... -- 2.9 24.1 17.1 21.4
General and
administrative........... -- 98.0 42.4 40.9 32.8
Depreciation............. -- 4.5 6.1 5.3 5.5
----- ----- ----- -------- --------
Total costs and
expenses............ -- 164.0 129.6 108.4 113.1
----- ----- ----- -------- --------
Loss from operations and net
loss...................... -- (64.0)% (29.6)% (8.4)% (13.1)%
===== ===== ===== ======== ========
</TABLE>
Comparison of Nine Months Ended April 30, 1998 and 1999
Revenue. Revenue increased approximately 178% from approximately $8.0
million for the nine months ended April 30, 1998 to approximately $22.2 million
for the nine months ended April 30, 1999. Of total revenue for the nine months
ended April 30, 1999, PC2Phone generated approximately $13.8 million and
Phone2Phone generated approximately $6.5 million. The increase in revenue was
primarily due to an increase in minutes of use resulting from additional
marketing of our products and services. Specifically, revenue from PC2Phone
services increased approximately 171% from approximately $5.1 million for the
nine months ended April 30, 1998 to approximately $13.8 million in revenue for
the corresponding nine-month period in fiscal 1999. Revenue from Phone2Phone
increased approximately 550% from approximately $1.0 million for the nine
months ended April 30, 1998 to approximately $6.5 million for the nine months
ended April 30, 1999. We anticipate that revenue from PC2Phone and Phone2Phone
will increase in absolute terms as our products become more widely distributed.
However, as a percentage of revenue, we expect revenue from these products to
decline over the next several years as we begin to market additional products
and services and pursue additional sources of revenue.
20
<PAGE>
In addition, we recognized revenue from certain amounts charged to IDT and
other carriers and from equipment sales, as shown above in the category
"Other." From these transactions, including monitoring IDT's network operations
center for Internet customers, we recognized revenue of approximately $329,000
and $680,000 for the nine months ended April 30, 1998 and 1999, respectively.
We also realized revenue from the sale of equipment, totaling approximately
$1.5 million for the nine months ended April 30, 1998 as compared to equipment
sales of approximately $446,000 for the nine months ended April 30, 1999.
Equipment sales for the nine months ended April 30, 1999 were derived from our
Net2Phone Pro product, while equipment sales for the nine months ended April
30, 1998 represented Internet telephony servers sold, on a one-time
non-recurring basis, to an international Phone2Phone reseller for deployment
abroad. Revenue from equipment sales, particularly revenue from sales of
Internet telephony servers, reflect sales that we believe to be non-recurring
and do not represent any trend.
Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue,
excluding depreciation increased by 228% from $3.6 million for the nine months
ended April 30, 1998 to approximately $11.8 million for the nine months ended
April 30, 1999. As a percentage of total revenue, these costs increased from
approximately 45.1% for the nine months ended April 30, 1998 to approximately
53.4% for the nine months ended April 30, 1999. This increase is primarily
attributable to the fact that we sold approximately $1.5 million of equipment
in the nine months ended April 30, 1998 as compared to approximately $446,000
in the nine months ended April 30, 1999. Such equipment sales have a low cost
of sales associated with them. Over time, we expect direct cost of revenue to
decline on a per-minute basis as international competition among carriers
intensifies, resulting in lower prices from our suppliers, and as we leverage
our position as a large provider of services and expand our own network. As a
percentage of revenue, we expect direct cost of revenue to increase as a result
of a decline in per-minute charges to customers. We expect to continue to
utilize IDT's international and domestic networks at the current fair market
value rates for termination. We also expect to incur additional costs in
connection with the growth of our business, especially in connection with
increasing our own network capacity to handle increased traffic volumes.
Sales and Marketing. Sales and marketing expenses increased approximately
236% from approximately $1.4 million for the nine months ended April 30, 1998
to approximately $4.7 million for the nine months ended April 30, 1999. As a
percentage of total revenue, these costs increased from approximately 17.1% for
the nine months ended April 30, 1998 to approximately 21.4% for the nine months
ended April 30, 1999. This increase primarily reflects the increased marketing
and advertising expenses associated with the agreements established with
Yahoo!, Excite and other strategic partners. We expect to continue to increase
our advertising and marketing expenditures to further build brand recognition,
and to enhance the distribution of our products and services.
General and Administrative. General and administrative expenses increased
approximately 121% from approximately $3.3 million for the nine months ended
April 30, 1998 to approximately $7.3 million for the nine months ended April
30, 1999. As a percentage of total revenue, these costs decreased from
approximately 40.9% for the nine months ended April 30, 1998 to approximately
32.8% for the nine months ended April 30, 1999. This decrease primarily
reflects the efficiencies we have begun to realize from leveraging our sales
and support infrastructure. We believe that general and administrative expenses
will continue to decline as a percentage of total revenue as a result of
greater economies of scale and further efficiencies. In absolute terms, we
expect these expenses to continue to increase as we incur additional costs in
product development and costs associated with hiring additional personnel and
adding new office space. Moreover, in absolute terms, our research and
development expenses will increase as we hire the additional engineers
necessary to continue the development of new products and services. However,
these research and development expenses are not expected to significantly
increase as a percentage of our total revenue.
Depreciation. Depreciation increased from approximately $422,000 for the
nine months ended April 30, 1998 to approximately $1.2 million for the nine
months ended April 30, 1999. This increase is primarily attributable to the
increase in capital expenditures for the deployment of network equipment both
21
<PAGE>
domestically and internationally to manage increased call volumes. Depreciation
will continue to increase as we build out our network and amortize intangibles
such as our licenses and trademark rights acquired under agreements with
strategic partners, including Netscape.
Loss from Operations. Loss from operations was approximately $674,000 for
the nine months ended April 30, 1998 as compared to loss from operations of
approximately $2.9 million for the nine months ended April 30, 1999. This
change is due to the substantial increase in both sales and marketing expenses
as well as general and administrative expenses we incurred as we expanded our
corporate infrastructure and human resources. We anticipate continued and
increasing losses as we pursue our growth strategy.
Comparison of Fiscal Years Ended July 31, 1997 and 1998
Revenue. Revenue increased approximately 344% from approximately $2.7
million for fiscal 1997 to approximately $12.0 million for fiscal 1998. The
increase in revenue was primarily due to an increase in minutes of use
resulting from increased marketing of our Internet telephony products and
services.
Of total revenue for the year ended July 31, 1998, PC2Phone generated
approximately $8.0 million in revenue and Phone2Phone generated approximately
$2.0 million. The increase in revenue was primarily due to an increase in
minutes of use due to the marketing of our Internet telephony products and
services. Specifically, revenue from PC2Phone services increased approximately
264% from approximately $2.2 million in revenue for fiscal 1997 to
approximately $8.0 million in revenue for fiscal 1998. We realized significant
revenue for the first time from our Phone2Phone services for fiscal 1998, as
well as recorded revenue of approximately $1.5 million from the sale of
equipment. In addition, we recognized revenue from amounts charged to IDT
including monitoring the network operations center for IDT's Internet
customers, of approximately $297,000 and $453,000, respectively, for fiscal
1997 and 1998. We do not expect to realize significant revenue from the sale of
equipment in the future.
Direct Cost of Revenue, Excluding Depreciation. Total cost of revenue,
excluding depreciation increased by approximately 325% from approximately $1.6
million for fiscal 1997 to approximately $6.8 million for fiscal 1998. As a
percentage of total revenue, these costs decreased from approximately 58.6% for
fiscal 1997 to approximately 57.0% for fiscal 1998. This decrease is primarily
attributable to the impact of the higher margin equipment sold in the first
half of fiscal 1998. Since we do not expect to realize significant revenue from
the sale of equipment in the future, our direct costs will reflect our ability
to terminate our traffic worldwide cost-effectively through our own network
relationships or via those of IDT, our primary supplier. As a percentage of
revenue we anticipate direct costs to remain approximately the same as our
network expansion efforts mitigate potential pricing pressures.
Sales and Marketing. Sales and marketing expenses increased by a factor of
37 from approximately $77,000 for fiscal 1997 to approximately $2.9 million for
fiscal 1998. As a percentage of total revenue, these costs increased from
approximately 2.9% for fiscal 1997 to approximately 24.1% for fiscal 1998. This
increase primarily reflects the increased marketing and advertising expenses
associated with the agreements established with Yahoo!, Excite and other
strategic partners. We expect to continue to increase significantly our
advertising and marketing expenditures to further build brand recognition, and
to enhance the distribution of our products and services.
General and Administrative. General and administrative expenses increased
approximately 96% from approximately $2.6 million for fiscal 1997 to
approximately $5.1 million for fiscal 1998. As a percentage of total revenue,
these costs decreased from approximately 98.0% for fiscal 1997 to approximately
42.4% for fiscal 1998. This decrease primarily reflects the efficiencies we
have begun to realize from leveraging our sales and support infrastructure. We
expect to continue to see further efficiencies and greater economies of scale,
so that general and administrative expenses will continue to decline as a
percentage of total revenue. In absolute terms, we expect these expenses to
continue to increase as we incur additional costs associated with developing
new products, hiring of additional personnel and adding new office space.
22
<PAGE>
Depreciation. Depreciation increased from approximately $121,000 for fiscal
1997 to approximately $727,000 for fiscal 1998. This increase is primarily
attributable to the increase in capital expenditures for the
deployment of communications equipment both domestically and internationally to
manage increased customer volume.
Loss from Operations. Loss from operations was approximately $1.7 million
for fiscal 1997 as compared to approximately $3.5 million for fiscal 1998. The
increased losses reflect the substantial increase in marketing and general and
administrative costs we incurred as we expanded our corporate infrastructure
and resources to gain additional market share for our products and services.
Period from January 2, 1996 (inception) to July 31, 1996
During the period from January 2, 1996 (inception) to July 31, 1996, we did
not generate any revenue. During this period, we incurred approximately
$500,000 in start-up costs, primarily for research and development, as we
prepared to introduce our products and services.
Quarterly Results of Operations
The following table sets forth certain quarterly financial data for the
seven quarters ended April 30, 1999. This quarterly information is unaudited,
has been prepared on the same basis as the annual financial statements, and, in
our opinion, reflects all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of the information for periods
presented. Operating results for any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------------------------------------------------
Oct. 31, Jan. 31, April 30, July 31, Oct. 31, Jan. 31, April 30,
1997 1998 1998 1998 1998 1999 1999
---------- ---------- ----------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
PC2Phone............... $1,371,598 $1,693,812 $ 2,019,766 $ 2,877,645 $ 3,776,777 $4,809,644 $5,188,416
Phone2Phone............ 70,939 148,572 799,324 1,011,681 1,287,415 2,280,366 2,935,916
Other.................. 825,000 905,000 120,363 162,272 599,227 412,456 913,040
---------- ---------- ----------- ----------- ----------- ---------- ----------
Total revenue........ 2,267,537 2,747,384 2,939,453 4,051,598 5,663,419 7,502,466 9,037,372
Cost and expenses:
Direct cost of
revenue, excluding
depreciation.......... 602,389 1,070,051 1,916,861 3,259,458 3,353,247 3,970,504 4,524,338
Sales and marketing.... 133,963 316,141 912,956 1,524,706 1,299,903 1,691,810 1,754,603
General and
administrative........ 730,893 1,073,165 1,450,229 1,833,341 1,900,234 2,286,770 3,111,102
Depreciation........... 68,169 123,844 229,635 304,860 338,469 400,584 477,659
---------- ---------- ----------- ----------- ----------- ---------- ----------
Total costs and
expenses............ 1,535,414 2,583,201 4,509,681 6,922,365 6,891,853 8,349,668 9,867,702
---------- ---------- ----------- ----------- ----------- ---------- ----------
Income (loss) from
operations and net
income (loss).......... $ 732,123 $ 164,183 $(1,570,228) $(2,870,767) $(1,228,434) $ (847,202) $ (830,330)
========== ========== =========== =========== =========== ========== ==========
<CAPTION>
As a Percentage of Revenue
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
PC2Phone............... 60.5% 61.7% 68.7% 71.0% 66.7% 64.1% 57.4%
Phone2Phone............ 3.1 5.4 27.2 25.0 22.7 30.4 32.5
Other.................. 36.4 32.9 4.1 4.0 10.6 5.5 10.1
---------- ---------- ----------- ----------- ----------- ---------- ----------
Total revenue........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost and expenses:
Direct cost of
revenue, excluding
depreciation.......... 26.6 38.9 65.2 80.4 59.2 52.9 50.1
Sales and marketing.... 5.9 11.5 31.1 37.6 23.0 22.6 19.4
General and
administrative........ 32.2 39.1 49.3 45.2 33.6 30.5 34.4
Depreciation........... 3.0 4.5 7.8 7.5 6.0 5.3 5.3
---------- ---------- ----------- ----------- ----------- ---------- ----------
Total costs and
expenses............ 67.7 94.0 153.4 170.7 121.8 111.3 109.2
---------- ---------- ----------- ----------- ----------- ---------- ----------
Income (loss) from
operations and net
income (loss).......... 32.3% 6.0% (53.4)% (70.7)% (21.8)% (11.3)% (9.2)%
========== ========== =========== =========== =========== ========== ==========
</TABLE>
23
<PAGE>
We have experienced growth in revenue in each quarter since inception,
reflecting greater acceptance and usage of our products and services by our
expanded customer base. We expect our revenue to grow over time as minutes of
use increase. However, we may experience declines in average revenue per minute
due to competitive pressures, promotions and marketing initiatives, increased
commissions paid to our international resellers and increased amounts paid to
our strategic partners under existing and future revenue-sharing arrangements.
Since we derive revenue from more than one source, we have experienced
volatility in our direct costs of revenue. Specifically, our direct cost of
revenue in the first two quarters of fiscal 1998 were low as a percentage of
total revenue due to sales of equipment in these quarters. Since these sales
were on a non-recurring basis, we realized a significant, albeit temporary,
reduced direct cost of revenue for these two quarters.
In the second half of fiscal 1998, we increased our advertising expenditures
as we began marketing our Phone2Phone service. Revenue from our Phone2Phone
service grew from approximately 5% of total revenue in the first half of the
year to approximately 26% of total revenue in the latter half. We experienced
start-up costs for Phone2Phone that increased our direct cost of revenue for
those two quarters. However, we have been able to reduce direct cost of revenue
for our Phone2Phone product as we expanded our network in the first three
quarters of fiscal 1999, which resulted in lower direct cost of revenue. In the
most recent quarter, direct cost of revenue as a percentage of revenue
accounted for approximately 50% as compared to approximately 80% in the quarter
ended July 31, 1998. Our increased sales and marketing expenses reflect the
relationships we have with various online strategic partners with whom we
advertise our PC2Phone and Phone2Phone services. We anticipate increased
investment in sales and marketing to further build brand recognition of our
products and services.
As a result of our limited operating history and the emerging nature of the
markets in which we compete, we are unable to accurately forecast our revenue
and direct cost of revenue as they may be impacted by a variety of factors.
These factors include the level of use of the Internet as a communications
medium, seasonal trends, capacity constraints, the amount and timing of our
capital expenditures, introduction of new services by us or our competitors,
price competition, technical difficulties or system downtime, and the
development of regulatory restrictions.
Liquidity and Capital Resources
Since inception in January 1996, we have financed our operations through
advances from IDT. During the nine months ended April 30, 1999 we also received
capital contributions from IDT of approximately $4.6 million. As of April 30,
1999, we had approximately $1.8 million in cash and cash equivalents. In May
1999 we raised net proceeds of approximately $29.9 million from the sale of
Series A convertible preferred stock and warrants. Our operating activities
generated negative cash flow of approximately $409,000 in the nine months ended
April 30, 1998 compared to negative cash flow of approximately $4.0 million in
the nine months ended April 30, 1999.
Cash used in investing activities was approximately $4.2 million and
approximately $9.0 million for the nine months ended April 30, 1998 and 1999,
respectively. Our use of cash in investing activities was principally for the
purchase of telecommunications and Internet equipment and for the purchase of a
trademark in the 1999 period.
In May 1999, we received $29.9 million in net proceeds from the sale of our
Series A convertible preferred stock and warrants. We applied a portion of the
net proceeds from this sale to repay $8.0 million of the $22.0 million of
advances from IDT that were outstanding as of April 30, 1999. The remaining
$14.0 million due to IDT was converted into a promissory note in May 1999.
24
<PAGE>
Our principal commitments following the closing of this offering are
expected to consist of:
. the repayment of $7.0 million with respect to the $14.0 million note due
to IDT;
. the payment of $1.5 million to NBC for television advertising;
. the $7.0 million note described above, which is payable to IDT in 60
monthly installments of principal and interest at a rate of 9% per
annum, commencing in June 1999;
. the acquisition of a new network with expanded capacity from IDT in
exchange for a $6.0 million note, payable in 60 monthly installments of
principal and interest at a rate of 9% per annum;
. other costs relating to network equipment and expansion; and
. payments to Internet companies in connection with marketing our products
and services, which as of April 30, 1999, were approximately $15
million.
Our future capital requirements will depend on numerous factors, including
market acceptance of our services, brand promotions, the amount of resources we
devote to the development of our current and future products, and the expansion
of our sales force and marketing our services. We may experience a substantial
increase in our capital expenditures and lease arrangements consistent with the
growth in our operations and staffing. Additionally, we will evaluate possible
investments in businesses, products and technologies. We believe that our
current cash balances, expected cash flow from our operations and the proceeds
of this offering will be sufficient to meet our working capital and capital
expenditure needs for at least the next 12 months. However, there can be no
assurance that we will have sufficient capital to finance potential
acquisitions or other growth oriented activities, and may issue additional
equity securities, incur debt or obtain other financing.
Year 2000 Systems Costs
Computer systems, software packages, and microprocessor-dependent equipment
may cease to function or generate erroneous data on or after January 1, 2000.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. For example, computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities. To correctly identify the Year 2000, and therefore be
"Year 2000 compliant," a four-digit date code field is required.
In connection with IDT's review of its own operations and the operations of
its subsidiaries, we have conducted a comprehensive review of the computer
hardware and software that we use in order to ensure that our computer-related
applications are Year 2000 compliant. Our cost of addressing the Year 2000
issue is not expected to be material to our operations or financial position.
However, the consequences of an incomplete or untimely resolution of the Year
2000 issue could be expected to have a material adverse effect upon our
financial results. In the absence of such a resolution, our ability to route
traffic in a cost effective manner, to deliver our services, to properly obtain
payment for these services, and/or to maintain accurate records of our business
and operations, could be substantially impaired until this issue is remedied.
We may become liable for substantial damages in the event that, as a result of
the Year 2000 issue, we fail to deliver any services that we have contracted to
provide. Also, our name and reputation may be harmed if our services are
disrupted due to Year 2000 problems.
Our plan to ensure Year 2000 compliance consisted of the following phases:
. conducting a comprehensive inventory of internal systems;
. assessing and prioritizing any required remediation;
25
<PAGE>
. repairing or, if appropriate, replacing any non-compliant systems;
. testing all remediated systems for Year 2000 compliance; and
. developing contingency plans that may be employed in the event that any
systems used by us is unexpectedly affected by a previously
unanticipated Year 2000 problem.
We have substantially completed each of these phases, and believe that our
internal systems are Year 2000 compliant.
We are conducting an external review of our customers and suppliers, and any
other third parties with whom we do business, to determine their vulnerability
to Year 2000 problems and any potential impact on us. These parties include our
equipment and systems providers. In particular, we may experience problems to
the extent that telecommunications carriers whose networks connect with ours
are not Year 2000 compliant. Our ability to determine the ability of these
third parties to address issues relating to the Year 2000 problem is limited.
To the extent that a limited number of carriers experience disruptions in
service due to the Year 2000 issue, we believe that we will be able to obtain
service from alternate carriers. However, our ability to provide certain
services to customers in selected geographic locations may be limited. There
can be no assurance that such problems will not have a material adverse effect
on our business, reputation or operating results.
We are also in the process of developing contingency plans with regard to
potential or unforeseen Year 2000 problems. We believe that, in the event that
one or more of our systems, or the systems of third parties with which we do
business, is impaired due to unanticipated Year 2000 issues, our contingency
plans will enable us to temporarily conduct operations on a temporarily
modified basis until the impaired system or systems is remediated.
There can be no assurances that our suppliers and customers will achieve
full year 2000 compliance before the end of 1999 or that we will develop or
implement effective contingency plans on a timely basis. A failure of our
computer systems or the failure of our suppliers or customers to effectively
upgrade their software and systems for transition to the Year 2000 could have a
material adverse effect on our business, financial conditions and results of
operations.
Most of our internal systems were developed after developers became aware of
Year 2000 problems. To date, we have not incurred material expenses in
connection with the remediation of Year 2000 related issues. We do not expect
to incur significant costs in connection with Year 2000 related issues.
However, our actual costs may be significant if we discover that any major
portion of our internal systems requires unforeseen remediation. We expense
costs associated with Year 2000 remediation when they are incurred.
Effects of Inflation
Due to relatively low levels of inflation over the last several years,
inflation has not had a material effect on our results of operations.
Impact of Recently Issued Accounting Standards
SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, was issued in June 1997. We will be required to adopt this new
statement for fiscal 1999. This statement requires use of the "management
approach" model for segment reporting. The management approach model is based
on the way a company's management organizes segments within the company for
making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management
structure or any other manner in which management disaggregates a company. We
do not anticipate that the adoption of this statement will have significant
impact on our financial statements.
26
<PAGE>
BUSINESS
Overview
Net2Phone is a leading provider of services enabling users to make high-
quality, low-cost telephone calls over the Internet. This service is commonly
referred to as Internet telephony. Our Internet telephony services enable our
customers to call individuals and businesses worldwide using their personal
computers or traditional telephones. We are leveraging our Internet telephony
expertise to integrate real-time voice communication capabilities into the Web.
We currently offer Web-based Internet telephony services, which enable
customers to make calls and send faxes over the Internet using their personal
computers, and basic Internet telephony services, which enable customers to
make calls using traditional telephones and fax machines.
We have developed a sophisticated PC2Phone software application that enables
the use of our Web-based Internet telephony services. We distribute this
software free of charge through the Internet and through agreements to include
our software with products sold by our strategic partners. In January 1999,
Netscape agreed to embed our PC2Phone software on an exclusive basis into all
versions of Netscape's Internet browser released during the term of our
agreement, including Netscape Navigator and Netscape Communicator. Netscape
also agreed to include a Net2Phone icon on the Netscape Navigator Personal
Toolbar.
We also have entered into strategic marketing and distribution relationships
with leading Internet companies, including, Excite, InfoSpace.com, Snap.com,
Yahoo! and ZDNet. We have also entered into arrangements with leading computer
equipment and software companies, such as IBM, Compaq, Packard Bell-NEC Europe
and Creative Labs to include our software with their products. We promote our
services through direct sales and marketing and through international resellers
who buy minutes of use from us in bulk, and resell them to customers in their
respective countries. Our software is currently available in eight languages
(English, Spanish, Japanese, French, Dutch, Portuguese, Italian and German). We
intend to make our software available in additional languages as we expand our
international customer base and distribution channels.
As of April 30, 1999, we served over 250,000 active customers who made an
average of approximately 60 minutes of calls per month and handled over 20
million minutes of use per month. Our net loss increased from approximately
$500,000 in fiscal 1996 and $1.7 million in fiscal 1997 to $3.5 million in
fiscal 1998. Our total assets increased from $916,000 at July 31, 1997 to $7.0
million at July 31, 1998. Our revenue has grown substantially, increasing from
approximately $2.7 million in fiscal 1997 to approximately $12.0 million in
fiscal 1998. Our revenue for the nine months ended April 30, 1999 was
approximately $22.2 million.
Industry Background
The Internet is experiencing unprecedented growth as a global medium for
communications and commerce. International Data Corporation estimates that the
number of Internet users worldwide will grow from approximately 142 million at
the end of 1998 to 399 million by the end of 2002. These users are increasingly
using the Internet as a communications medium. A recent study by E-Marketer, a
market research firm, estimated that 9.4 billion e-mail messages are delivered
daily. Instant text communication through online "chat" rooms is also gaining
widespread acceptance.
Online commerce is also becoming widely accepted as a means of doing
business. According to International Data Corporation, Internet users worldwide
purchased more than $50 billion of goods and services in 1998. International
Data Corporation projects that commerce over the Internet will to grow to
approximately $1.3 trillion in 2003.
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Emergence of Internet Telephony
TeleGeography, a market research firm, estimates that the international long
distance market will grow to $79 billion in 2001, with consumers and businesses
making an estimated 143 billion minutes of international long distance calls.
Despite the large size of this market and the number of minutes of calls made,
traditional international long distance calls are still relatively expensive
for the consumer. The primary reason for this expense is tariffs set by foreign
governments and carriers that are passed on to consumers in the form of higher
long distance rates.
Internet telephony has emerged as a low cost alternative to traditional long
distance calls. International Data Corporation projects that the Internet
telephony market will grow rapidly to over $23.4 billion in 2003, from
approximately $1.1 billion in 1998.
Internet telephone calls are less expensive than traditional international
long distance calls primarily because these calls are carried over the Internet
or our network and therefore bypass a significant portion of international long
distance tariffs. The technology by which Internet phone calls are made is also
more cost-effective than the technology by which traditional long distance
calls are made.
We use a technology called "packet-switching" to break voice and fax calls
into discrete data packets, route them over the Internet or our network and
reassemble them into their original form for delivery to the recipient.
Traditional international long distance calls, in contrast, are made using a
technology called "circuit switching" which carries these calls over
international voice telephone networks. These networks are typically owned by
governments or carriers who charge a tariff for their use. Circuit switching
requires a dedicated connection between the caller and the recipient that must
remain open for the duration of the call. As a result, circuit-switching
technology is inherently less efficient than packet-switching technology which
allows data packets representing multiple conversations to be carried over the
same line. This greater efficiency creates network cost savings that can be
passed on to the consumer in the form of lower long distance rates.
Integration of Voice into the Web
We believe that Internet telephony offers significant benefits to consumers
and businesses over and above international long distance cost savings. The
technologies that enable Internet telephony can be applied to integrate live
voice capabilities into the Web. We believe that this integration can further
enhance the potential for the Internet to become the preferred medium for both
communications and commerce. For example, the integration of voice into the Web
would supplement existing text-based modes of Internet communication such as e-
mail and online chat by adding a live, secure, low-cost or free voice
alternative. We believe that this will be attractive both to consumers and
businesses.
In addition, voice-enabling the Web would give Internet shoppers the ability
to speak directly with customer service representatives of online retailers in
order to ask questions and alleviate concerns about online security. This may
increase the probability that a sale is made and may give online retailers a
key competitive advantage by providing them with opportunities to sell higher
margin and additional products to these customers. Voice-enabling a commercial
Web site may also give online retailers the ability to provide more responsive
customer support and service.
Integrating live voice capabilities into the Web would also enable Internet
companies to offer enhanced communications services, such as providing Internet
users with a central source for retrieving voicemail, e-mail, faxes and pages.
We believe this would allow these companies to attract more users to their
sites and to increase the amount of time these users spend on their sites. This
increased usage will allow these Internet companies to attract advertisers and
secure higher advertising rates, thereby increasing revenue.
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Limitations of Existing Internet Telephony Solutions
The growth of Internet telephony has been limited to date due to poor sound
quality attributable to technological issues such as delays in packet
transmission and network capacity limitations. However, recent improvements in
packet-switching technology, new software algorithms and improved hardware have
substantially reduced delays in packet transmissions. In addition, the use of
private networks to transmit calls as an alternative to the public Internet is
helping to alleviate network capacity constraints. Finally, the emergence of
new, lower cost Internet access technologies, such as high-speed modems, are
addressing local Internet access issues.
Several large long distance carriers, including AT&T and Sprint, have
announced Internet telephony service offerings. However, many of these service
offerings have not been deployed on a large scale. Many also require users to
purchase other telecommunications services or allow only domestic calling.
Smaller Internet telephony service providers also offer low-cost Internet
telephony services from personal computers to telephones and from telephones to
telephones. These services, however, are available only in limited geographic
areas and require payment by credit card which may preclude many international
customers from signing up for these services. We also believe that existing
Internet telephony service providers rely upon technologies and systems that
lack large-scale billing, network management and monitoring systems, and
customer service capabilities required for the integration of voice
communication into the Web.
In addition, many companies currently provide Internet telephony software
and services that allow Internet telephone calls to be made between personal
computers. However, most of these companies require both the initiator and the
recipient of the call to have the same software installed on their personal
computers and to be online at the same time.
The Net2Phone Solution
We deliver high-quality Internet telephony services and voice-enabling Web
applications to consumers and businesses. Our solution provides the following
benefits to our customers:
. Low Cost. Our PC2Phone software is distributed free of charge, and our
services allow our customers to make telephone calls often at a fraction
of the cost of traditional long distance service. Because international
long distance calls routed over the Internet bypass the international
settlement process, we are able to charge lower rates than traditional
long distance carriers.
. High Voice Quality. We offer high voice quality through our proprietary
packet-switching technologies, which reduce packet loss and delay, route
packets efficiently and perform quality enhancing functions, such as
echo cancellation. We intend to continue to enhance the voice quality of
our services as our customer base and business grow.
. Ease of Use and Access. Our services are designed to be convenient and
easy to access from anywhere in the world. To make a call using our Web-
based services, a customer need only install our free software on a
sound-enabled personal computer, register and be connected to the
Internet. No additional telephone lines or special equipment are
required. Our Phone2Phone service is also easy to use and requires a
customer only to register and dial a toll-free or local access number
from any telephone or fax machine.
. Voice-Enabled Online Retailing. Our services enable users anywhere in
the world to speak with sales or customer service representatives of
online retailers and other Web-based businesses while visiting their Web
sites. This provides customers an opportunity to ask questions of and to
provide credit card information directly to a customer service
representative if they are concerned about Internet security, thereby
increasing the likelihood of consummating an online sale. In addition,
our services allow our customers outside of the United States and Canada
to access telephone numbers that might otherwise be inaccessible to them
through their local carriers. For example, users of our services in
other countries may call United States or Canadian toll-free numbers
(i.e., telephone numbers with 800, 877 or 888 prefixes), which are not
otherwise available to them, at no
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charge. The ability to communicate with international customers in this
manner provides United States and Canadian-based online retailers and
other Web-based businesses with cost effective access to an expansive
international customer base.
. Reliable Service. Our network is reliable because of its technologically
advanced design. This design allows us to expand our network and add
capacity by adding switches to the existing network. Our system also
provides seamless service and high-quality voice transmission through
our ability to reroute packets if problems arise. We believe that our
ability to provide reliable service is essential to voice-enable the
Web.
. Ease of Payment and Online Account Access. Once registered, our
customers are able to make unlimited toll-free calls. In addition, they
can make toll calls by opening a prepaid account using credit cards,
wire transfers or checks payable in United States dollars. Acceptance of
payment in multiple forms enables international customers who may not
necessarily have credit cards to use our services. Our customers can
access their accounts via the Internet in order to view their call
history and account balances, and to increase their prepaid amounts.
. Customer Support. We offer live customer support 24 hours a day, seven
days a week in multiple languages. Our customer support center can be
accessed from anywhere in the world at no charge either by calling our
toll-free number, where available, or by using our Web-based Internet
telephony service. Our integrated customer billing software and call
management system provide our customer support staff with immediate
access to user accounts, calling patterns and billing history to help us
provide better, more responsive customer support.
Strategy
Our mission is to become the premier Web-based communications enabler. We
intend to leverage our leadership position in the Internet telephony market to
make our communications services readily available worldwide on the Internet
and to develop and market online commerce and related products. Our strategy
includes the following key elements:
. Drive Usage through Resellers and Strategic Partners. We promote our
services through direct sales and marketing and through relationships
with international resellers and leading Internet hardware, software and
content companies. We intend to build on these relationships and to add
more partners and resellers to drive usage of our Internet telephony
services. We also intend to partner with large telecommunications
companies to enable them to offer our Internet telephony services under
their brand.
. Pursue Multiple Sources of Revenue. In addition to our minutes-based
revenue, we intend to pursue new Web-based revenue opportunities from
banner and audio advertising, as well as sponsorship opportunities on
our PC2Phone software user interface and our EZSurf.com Web site. We
also intend to explore the availability of revenue-sharing opportunities
with online retailers.
. Enhance Brand Recognition. We have established strong brand identity in
the Internet telephony market in large part due to the high-quality of
our services and our marketing efforts. We have entered into advertising
relationships with leading Web companies such as Netscape, Yahoo! and
Excite in order to promote our services. We intend to continue to
implement aggressive advertising and sales campaigns to increase brand
awareness. In addition, we intend to enhance our brand recognition by
cooperatively marketing our Internet telephony services with leading
computer hardware and software companies and Internet services
providers.
. Make Our Software Readily Available Worldwide. We have entered into
strategic distribution relationships with leading computer equipment and
software companies to expand the availability of our software. For
example, our software will be embedded into future versions of
Netscape's Internet browser and a Net2Phone icon will be prominently
positioned next to AOL's Instant Messenger icon on the Netscape
Navigator Personal Tool Bar. In addition, our software is included with
IBM's Internet services and may be pre-loaded on computers sold by
Compaq internationally.
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We intend to build upon these relationships and enter into new
distribution relationships with other leading companies in order to
enhance the distribution of our software worldwide.
. Expand and Enhance Products and Services. We have committed significant
resources to expand our network, enhance our existing product and
service offerings and to develop and market additional products and
services in order to continue to provide customers with high-quality
Internet telephony services. For example, we plan to introduce new
products and services, including:
. PC2PC, which will allow high-quality Internet telephony from one
personal computer to another,
. voice-enabled chat, which will allow two participants in an online
chat room discussion to establish direct voice communication with
each other while maintaining anonymity,
. unified messaging services, which we anticipate will include voice,
fax and electronic messaging with multiple points of access,
including the Web and conventional telephones,
. online commerce applications, which will provide customer service
representatives of online retailers with real-time access to a
caller's profile and enable them to "push" specific content onto a
caller's personal computer screen in order to better assist the
caller in answering their inquiries,
. customer payment applications, which will allow customers to pay for
online commerce transactions by debiting their Net2Phone account,
and
. video conferencing between two or more personal computer users over
the Internet.
Strategic Relationships
We have entered into strategic distribution, integration and advertising
relationships with leading Internet and computer hardware and software
companies. These relationships typically include arrangements under which we
share with our strategic partners a portion of the revenue they bring to us. We
believe that these relationships are important because they provide incentive
to our partners and allow us to leverage the strong brand names and
distribution channels of these companies to market our products and services.
Our strategic partners include:
Netscape
Netscape has agreed to embed our PC2Phone software on an exclusive basis in
future versions of Netscape's Internet browser released during the term of our
agreement, including Netscape Navigator and Netscape Communicator. Netscape
also has agreed to:
. place a Net2Phone icon on the Netscape Navigator Personal Toolbar
immediately to the right of the AOL Instant Messenger icon, which will
allow Netscape users to use our Web-based Internet telephony services
from anywhere on the Web simply by clicking on our icon;
. integrate our services into, and prominently display our services on,
Netscape Netcenter, including Netscape's Address Book Contacts section
and Voice Communications section, which will allow Netscape users to
make calls using our services simply by clicking on a displayed
telephone number; and
. include the software for our Web-based Internet telephony services in
Netscape's suite of online plug-in software and Netscape Smart Update
programs (both domestically and when available internationally) for
downloading by Netscape users from centralized locations on Netscape's
Web site.
We also have the right to place a specified amount of banner and other
advertisements on Web pages of our choice on Netscape's domestic and
international Web site. The two-year term of our exclusive agreement with
Netscape commences with the beta release of the next version of Netscape's
Internet browser, which we believe will occur later this year.
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Yahoo!, Excite and InfoSpace.com
In 1998 we signed an agreement with Yahoo!, which was recently renewed
through 2000. Our Web-based Internet telephony service is integrated into
Yahoo!'s People Search online telephone directory. As a result of this
integration, an Internet user who performs a search on Yahoo! People Search can
simply click on a displayed telephone number to initiate a call to that number.
Under this agreement, we also have the right to have our banner advertising
appear when an Internet user performs a word- or category-search for "Internet
Telephony" or related phrases on Yahoo! Additionally, we have contracted with
Yahoo! to integrate our PC2Phone service into Yahoo!'s Yellow Pages and White
Pages online directories.
Our Web-based Internet telephony software is also integrated into Excite's
Web sites in its International Network, which includes the United Kingdom,
Germany, France, Japan, Italy, Australia, Sweden and the Netherlands. As a
result, an Internet user in any of these countries will be able to click on any
telephone number that appears on any page on these sites to initiate a call to
that number using our PC2Phone service. In addition, our services will be
prominently featured within the Excite International Network via advertising
and promotion on various channels, including each member's homepage, business,
technology/computer and travel channels, as well as the localized versions of
My Excite, What's New/What's Cool and Mail Excite. We are negotiating with
Excite to have our services integrated into Excite's United States Web sites as
well.
In addition, our Web-based Internet telephony software is integrated into
InfoSpace.com's network of white and yellow page directory services. This
network of sites includes all the white and yellow page listings in Netscape's
Netcenter Web site, the Microsoft Network, the GO Network and Xoom.com.
Other Strategic Relationships
We also have entered into other important strategic relationships with other
leading Internet and computer hardware and software companies, including:
. Compaq. Our software is featured as a download from a special Compaq Web
site accessible directly from the Compaq-branded keyboard, may be pre-
installed on Compaq-branded computers distributed internationally and
may be included with their other products.
. Snap.com. Promotions for our services and a link to our Web site will be
prominently displayed on the Snap.com Web site, and we are their
preferred provider of PC-to-phone services.
. ZDNet. We are the preferred provider of Internet telephony services for
ZDNet and our Web-based Internet telephony service will be integrated
throughout the ZDNet Web site.
. Quicknet Technologies. Our PC2Phone software is integrated into
Quicknet's telephone handset product called Internet PhoneJACK.
. Bigfoot International, WorldPages/Web YP and Internet 800 Directory. Our
PC2Phone service is integrated into these three popular online
directories, which allow Internet users to call any listed telephone
number simply by clicking on the displayed number.
Products and Services
Current Products and Services
Our services enable our customers to make low-cost, high-quality phone calls
over the Internet using their personal computers or traditional telephones. Our
principal current product and service offerings are described in the table
below.
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Product/Service Description Benefits
- --------------------------------------------------------------------------------
Basic Internet
Telephony Services:
. Phone2Phone . Enables customers to . International long
make calls over distance rates are
. Fax2Fax traditional telephones typically 50% to
and fax machines routed 70% lower than the
. Net2Phone Pro over the Internet. rate charged by
Customers must dial a traditional long
local or domestic toll- distance carriers
free access number to for calls
access the Net2Phone originating in the
network. United States, and
up to 95% lower for
. Customers are charged calls originating
for toll and long outside the United
distance calls on a States.
per-minute basis. There
is no charge for
calling United States . Users do not need
and Canadian toll-free to purchase
numbers. expensive hardware
or software.
. Available in the United
States and in many . High voice quality.
international
locations. . Faxes are
transmitted without
. We market Phone2Phone delay and users
under the brand receive immediate
"Net2Phone Direct." delivery
confirmations.
- --------------------------------------------------------------------------------
Web-based Internet
Telephony Services:
. PC2Phone . Enables customers to . Services are
make calls and send available to any
. Click2Talk faxes over the Internet Internet user with
using their personal a sound-equipped
. PC2Fax computers. Customers personal computer.
must install our . International long
software on their distance rates are
personal computers, typically 50% to
register with us and be 70% lower than the
online in order to make rates charged by
calls. When browsing traditional long
Web sites that have a distance carriers
Click2Talk icon, for calls
customers may initiate originating in the
calls to a company United States, and
whose site they are up to 95% lower for
browsing simply by calls originating
clicking on the outside the United
Click2Talk icon. States.
. United States and
. Customers are charged Canadian toll-free
for toll and long numbers can be
distance calls on a accessed from
per-minute basis. There outside the United
is no charge for States and Canada.
calling United States
and Canadian toll-free . Facilitates online
numbers. commerce by
providing live
voice contact
between online
retailers and
Internet shoppers.
. Customers do not
require multiple
telephone lines and
need not log off
the Internet to
initiate a call.
- --------------------------------------------------------------------------------
EZSurf.com . A Web-based shopping . Enables voice
directory powered by communications with
our Web-based Internet over 300 Web sites.
telephony services from
which Internet users
can initiate calls to . Educates users by
listed online retailers providing them with
by clicking on an icon essential
on the Web site. information
required to buy
. Lists useful products online.
information for key
online retailers,
including payment and
shipping options and
return policies.
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Sales, Marketing and Distribution
We distribute our software through the Internet, strategic partnerships and
international resellers. In addition, our software will be embedded into future
versions of Netscape's browser, which, according to International Data
Corporation, was used by 41.5% of all consumer Internet users in mid-1998.
Customers can also download our software at no charge from our Web site and
other Web sites, including Yahoo!'s People Search and Lands' End's home page.
We also distribute our software through strategic relationships with leading
Internet and computer hardware and software companies, including IBM, Compaq,
Packard Bell-NEC Europe and Creative Labs. Our software is included with our
partners' products and services and distributed domestically and
internationally. We expect to distribute over 25 million units of our software
in 1999 as a result of these and other distribution arrangements.
We promote our services through online and Internet-based advertising venues
and traditional print advertising in domestic and international publications.
We will also be advertising our services on the NBC television network. Another
way we sell our services internationally is by entering into exclusive
agreements with resellers in other countries. We sell these resellers bulk
amounts of minutes of use of our products and services to be resold in the
resellers' respective countries. For example, in Asia, we have agreements with
Daewoo and Naray Mobile Telecom in South Korea and Marubeni in Japan. In Europe
and the Middle East, we have agreements with CAPCOM in Spain and Dot.LB in
Lebanon, among others. To facilitate distribution and attract users in foreign
countries, we have developed our software in eight languages (English, Spanish,
Japanese, French, Dutch, Portuguese, Italian and German) and intend to increase
the number of languages as our distribution broadens.
Customer Service
As part of our goal to attract and retain customers, we offer free live
customer support in multiple languages. We employ approximately 67 customer
service representatives, who offer customer support to our users 24 hours a
day, seven days a week. These services can be reached from anywhere in the
world at no cost using either our toll-free number, where available, or our
Web-based Internet telephony services. The customer support staff provides
technical assistance, as well as general service assistance, for all of our
products and services. We also offer customer support via e-mail and fax. Our
integrated customer billing software and call management system provide our
customer support staff with immediate access to user accounts, calling patterns
and billing history, thereby enhancing the quality of service provided to our
customers. In addition, our international resellers typically provide their own
front-line customer support.
Technology
PC2Phone Software
Our PC2Phone software is simple to install and to use and has won various
industry awards. The installation process is wrapped in the industry-standard
"Install Shield" product. During installation, the Net2Phone "wizard" verifies
that the user's microphone and speakers are properly set for Internet
telephony. The installation also has a service registration process that allows
the customer to quickly register for paid time with the product. Our software
has several buttons and drop down headings to enable customization. These
buttons allow the user to change specific properties, access and modify
customer account information, program and use speed dialing and verify rates.
Our PC2Phone software has gone through fourteen releases, each improving
upon our Internet telephony capabilities. The software is a Windows-compliant,
32-bit application written in a high-level PC language. The code is extendible
allowing us to easily add new functionality, yet is relatively compact. The
newest release of our software can record and play sound files allowing us to
deliver voice-mail services and can interface with third party PC mail software
applications such as Eudora and Microsoft Outlook.
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We also have developed a software development kit allowing other companies
to quickly and easily integrate their products with our PC2Phone software. For
example, our services have been successfully integrated with Quicknet's line of
sound cards and telephone interface cards. This integration enables Internet
telephony service to be deployed through inexpensive equipment currently used
throughout the world.
Call Management System
To maintain our leadership position in the Internet telephony market, we
believe that reliable and flexible billing, information management, monitoring
and control systems are critical. Accordingly, we have invested substantial
resources to develop and implement our sophisticated real-time call management
information system. Key elements of this system include:
. Customer Provisioning. The system provides automated online customer
registration and customer registration through call centers and
resellers. It also provides online credit card authorization and batch
billing capabilities that streamline customer registration. A special
remote access application program allows other people access to our
database, enabling sophisticated partners to remotely service customers
through our system, and to tie our system directly to their own business
systems. This remote capability includes remote account management and
continuous real-time call detail and billing information. Additionally,
the system makes customer account records readily available to call
center representatives in the event of customer billing problems.
. Customer Access. Our system allows customers to independently access
their billing records online without the need to contact customer
service representatives.
. Fraud Control. Fraud detection and prevention features include caller
authentication, prevention of multiple simultaneous calls using the same
account, pin code verification and call duration timers. We also
generate reports on suspicious calling patterns to detect caller
registration fraud. We routinely scan for fraudulent content before
credit card purchases are allowed.
. Network Security. Firewalls are employed to prevent attacks on our
network. We use sophisticated techniques to safeguard sensitive database
information. In addition, we encrypt call requests and portions of the
call to prevent "network sniffers" from unauthorized access to data.
. Call Routing. The network management system identifies and routes calls
to the most efficiently priced carrier. The system also automatically
routes calls around links or servers that are experiencing problems,
have failed or have been manually taken out of service for maintenance
or upgrades. This system provides remote administration facilities for
maintaining routing tables and system monitoring.
. Monitoring. The management system provides for real-time monitoring of
all call information. We are able to track potential problems such as
too many short calls on a server or a low percentage of call
completions. The system also provides remote management that allows
partners to monitor and manage their own accounts.
. Reliability. We maintain two separate network operations centers in
Hackensack and Lakewood, New Jersey. These facilities house redundant
equipment and have the ability to track calls simultaneously. This
redundant system gives our network a high degree of reliability,
enabling each network operations center to serve as a back-up to the
other.
. Detailed Call Records. The management software maintains detailed
records for each call, including the account number of the caller, the
caller's phone number, access number used, the point at which the call
enters and exits our network, the account owner, the calling party, the
server/service phone number, the number of the called party, a running
account balance, and rate and billing information, including surcharges.
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The Net2Phone Network
Through an agreement with IDT, we lease capacity on an Internet network
comprised of leased high-speed fiber optic lines connecting eight major cities
across the United States, and lease high-speed fiber optic lines connecting
smaller cities to the network. We have a right to use network capacity leased
by IDT. The network backbone uses state-of-the-art hardware including Cisco
Series 7000 routers and Nortel Passport switches. Our high-speed backbone
connects traffic at four major public Internet exchange points and is also
facilitated by a growing number of private peering or exchange points with
other networks. Through peering arrangements, we exchange Internet traffic with
25 other Internet backbone providers at these points. We operate IDT's network,
one of the largest Internet access networks, providing local dial-up access
through 36 locations. Our Internet network also includes more than 700
additional network access locations owned by local and regional Internet
service providers.
We are able to provide service in areas where we do not have dial-up
equipment by utilizing call-forwarding technology to expand our coverage areas
by increasing the total number of local access numbers. We have been closing
down multiple network access points in a number of states in order to
consolidate our equipment into central "Super Point of Presence" locations. For
example, one Super Point of Presence in New Jersey can supply local access for
the entire state of New Jersey.
The diagram below illustrates the routing of an Internet telephony call
initiated by a customer using a telephone, fax or a personal computer to a
terminating telephone or fax machine over our network.
[Chart showing work flow within Company]
We seek to retain flexibility by utilizing dynamic call routing
alternatives. This approach is intended to enable us to take advantage of the
rapidly evolving Internet market in order to provide low-cost service to our
customers. Accordingly, our network employs an "Open Shortest Path First"
protocol that promotes efficient routing of traffic. Additionally, we have
placed redundant hardware for reliability in high traffic areas to minimize
loss of data packets. Each network data exchange point employs hardware to
direct network traffic and a minimum of two dedicated leased data lines to
further increase reliability.
We manage our network hardware remotely. It is compatible with a variety of
local network systems around the world. We believe our Internet telephony
network can currently support approximately 5,000 simultaneous calls. We
believe our systems are scalable to 10 times their current capacity through the
purchase and installation of certain additional hardware. To date, the highest
number of simultaneous calls serviced by our network was approximately 1,660
simultaneous calls made on Father's Day in June 1999.
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The Network Operations Center
Our Network Operations Center, located in Hackensack, New Jersey, currently
employs a staff of 25 people. There are two groups that work within the network
operations center, the network analysis group and the Internet telephony
monitoring group. Both groups have 24 hours a day, seven days a week coverage
to quickly respond to any issues.
The network analysis group works around-the-clock monitoring network issues,
handling customer requests, repairing outages and solving security problems.
Their key objective is to provide quality service upon which customers can
rely. Our monitoring group oversees a nationwide real-time network analysis
map, which notifies our staff of network errors. They also use software we
developed to monitor our hardware around the world. This group can dynamically
turn on or turn off equipment and re-route Internet telephony traffic, as
necessary.
Customers
We have a diverse, global customer base. As of April 30, 1999, approximately
65% of our customers are based outside of the United States. As of April 30,
1999, we served over 250,000 active customers who had used our services during
the preceding three months. In addition, as of June 25, 1999, we had installed
the Click2Talk service on approximately 150 commercial Web sites.
Competition
Long Distance Market
The long distance telephony market and, in particular, the Internet
telephony market, is highly competitive. There are several large and numerous
small competitors, and we expect to face continuing competition based on price
and service offerings from existing competitors and new market entrants in the
future. The principal competitive factors in the market include price, quality
of service, breadth of geographic presence, customer service, reliability,
network capacity and the availability of enhanced communications services. Our
competitors include AT&T, MCI WorldCom and Sprint in the United States and
foreign telecommunications carriers.
Many of our competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we
have. As a result, certain of these competitors may be able to adopt more
aggressive pricing policies, which could hinder our ability to market our
Internet telephony services. One of our key competitive advantages is the
ability to route calls through Internet service providers, which allows us to
bypass the international settlement process and realize substantial savings
compared to traditional telephone service. Any change in the regulation of an
Internet service provider could force us to increase prices and offer rates
that are comparable to traditional telephone call providers.
Web-Based Internet Telephony Services
As consumers and telecommunications companies have grown to understand the
benefits that may be obtained from transmitting voice over the Internet, a
substantial number of companies have emerged to provide voice over the
Internet. In addition, companies currently in related markets have begun to
provide voice over the Internet services or adapt their products to enable
voice over the Internet services. These related companies may potentially
migrate into the Internet telephony market as direct competitors.
. Internet Telephony Service Providers. During the past several years, a
number of companies have introduced services that make Internet
telephony services available to businesses and consumers. In addition to
us, AT&T Jens (a Japanese affiliate of AT&T), ICG Communications,
IPVoice.com, ITXC, OzEmail (which was recently acquired by MCI
WorldCom), RSL Communications (through
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its Delta Three subsidiary) and VIP Calling provide a range of voice-
over-the-Internet services. These companies offer PC-to-phone or phone-
to-phone services that are similar to the services we offer. Some, such
as AT&T Jens and OzEmail, offer these services within limited geographic
areas. Additionally, a number of companies have recently introduced Web-
based voice-mail services and voice-chat services to Internet users.
. Software/Hardware Providers. Many companies produce software and other
computer equipment that may be installed on a user's computer to permit
voice communications over the Internet. These products generally require
each user to have compatible software and hardware equipment and rely on
the public Internet for the transmission of traffic, which often results
in reduced quality of communications. Representative companies include
VocalTec and Netspeak. We believe VocalTec's software and hardware are
unable to handle large numbers of simultaneous calls. Netspeak focuses
on delivering solutions targeted at traditional call centers that
require significant customization.
. Telecommunications Companies. A number of telecommunications companies,
including AT&T, Deutsche Telekom, MCI WorldCom and Qwest, currently
maintain, or plan to maintain, packet-switched networks to route the
voice traffic of other telecommunications companies. These companies,
which tend to be large entities with substantial resources, generally
have large budgets available for research and development and therefore
may further enhance the quality and acceptance of the transmission of
voice over the Internet. However, many of these companies are new to the
Internet telephony market, and therefore may not build brand recognition
among consumers for these services. These companies also may not have
the range of product and service offerings that are necessary to
independently provide a broad set of voice-enabled Web services. AT&T,
for example, has attempted to enter the market but has focused its
effort on the cable market and it is unclear if it will continue to
pursue voice over the Web. Qwest has taken steps to enter the market by
building a high capacity network in the United States. In addition,
Qwest has also entered into a three-year strategic alliance with
Netscape to provide one-stop access to Internet services including long
distance calling, e-mail, voice mail, faxes, Internet access and
conference calls.
. Network Hardware Manufacturers. Several of the world's major providers
of telecommunications equipment, such as Alcatel, Cisco, Lucent,
Northern Telecom and Dialogic (which has entered into an agreement to be
acquired by Intel) have developed or plan to develop network equipment
that may be used in connection with the provision of voice over the Web
services, including routers, servers and related hardware and software.
By developing this equipment, these manufacturers may exert substantial
influence over the technology that is used in connection with
transmission of voice over the Web and may develop products that
facilitate the quality and timely roll-out of these networks. However,
these companies are dependent upon the operators of Internet telephony
networks to purchase and install their equipment into their networks.
They are also dependent upon the developers of hardware and software to
market their systems to end users. Cisco currently manufactures Internet
telephony equipment for low to medium scale networking, but does not
manufacture high-end Internet telephony equipment for large networks.
However, Cisco recently acquired two companies that produce devices to
help Internet service providers transition voice and data traffic to
packet networks while maintaining traditional phone usage and network
equipment. Lucent has recently co-developed with VocalTec a set of
industry standards that have been adopted by major competitors and is
currently marketing Internet telephony hardware, including servers that
allow the transmission of calls and faxes over the Internet. Lucent also
offers related support products, such as billing centers and "Internet
call centers," which allow Internet access and conversation with a
customer support agent on a single line.
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Research and Development
Strategic Research and Development
At our primary research and development center in Lakewood, New Jersey, we
currently employ 12 engineers, whose specialties include software, hardware,
switching, Internet security, voice compression, engineering real-time online
transactions, billing, and network and call management. This staff is devoted
to the improvement and enhancement of our existing product and service
offerings, as well as to the development of new products and services. Current
research and development activities include enhancements to our customer
billing software and call management system to increase the capacity of these
systems, improvements to our Internet telephony hardware to increase capacity
and modifications to our PC2Phone software to increase functionality. Our
future success will depend, in part, on our ability to improve existing
technology and develop new products services that incorporate leading
technology.
We incurred $473,000 and $481,000 in product development expenses during
fiscal 1997 and fiscal 1998, respectively. For the nine months ended April 30,
1999, we incurred product development expenses of $466,000.
Management Information Systems Research and Development
Our management information systems development team, located in Hackensack,
New Jersey, has eleven programmers and a development manager dedicated to
traditional management information systems development and upgrades. The group
supports back-office accounting and reporting software, customer service
support software and database support. The development schedule is primarily
focused on a detailed list of upgrades that have been identified and
prioritized by a team manager. The database architecture is managed by a senior
developer in our Lakewood laboratory who was responsible for similar database
functions at AT&T's WorldNet division.
Web Research and Development
The majority of our Web research and development is done by a separate Web
development group located in our headquarters in Hackensack. The group of nine
consists of five developers, two programmers, one graphics designer and one
development manager. The team is responsible for our multiple language Web
site, the EZSurf.com Web site and specialized Web interfaces, including the
integration of our PC2Phone client software into Netscape's Internet browser.
Regulation
Regulation of Internet Telephony
The use of the Internet to provide telephone service is a recent market
development. Currently, the Federal Communications Commission is considering
whether to impose surcharges or additional regulations upon certain providers
of Internet telephony. On April 10, 1998, the FCC issued its report to Congress
concerning the implementation of the universal service provisions of the
Telecommunications Act. In the report, the FCC indicated that it would examine
the question of whether certain forms of phone-to-phone Internet telephony are
information services or telecommunications services. The FCC noted that it did
not have, as of the date of the report, an adequate record on which to make a
definitive pronouncement, but that the record suggested that certain forms of
phone-to-phone Internet telephony appear to have the same functionality as non-
Internet telecommunications services and lack the characteristics that would
render them information services. If the FCC were to determine that certain
services are subject to FCC regulation as telecommunications services, the FCC
may require providers of Internet telephony services to make universal service
contributions, pay access charges or be subject to traditional common carrier
regulation. It is also possible that PC2Phone and Phone2Phone services may be
regulated by the FCC differently. In addition, the FCC sets the access charges
on traditional telephony traffic and if it reduces these access charges, the
cost of traditional long distance telephone calls will probably be lowered,
thereby decreasing our competitive pricing advantage.
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In September 1998, two regional Bell operating companies, U S WEST and
BellSouth, advised Internet telephony providers that the regional companies
would impose access charges on Internet telephony traffic. In addition, U S
WEST has petitioned the FCC for a declaratory ruling that providers of
interstate Internet telephony must pay federal access charges, and has
petitioned the public utilities commissions of Nebraska and Colorado for
similar rulings concerning payment of access charges for intrastate Internet
telephone calls. At this time, it is not known whether these companies, U S
WEST and BellSouth, will actually impose access charges or when such charges
will become effective. If these companies succeed in imposing access charges
that may reduce the cost savings of using Internet telephony as compared to
traditional telephone service. The existence of these access charges would
materially adversely affect the development of our Internet telephony business.
In February 1999, the FCC adopted an order concerning payment of reciprocal
compensation that provides support for a possible finding by the FCC that
providers of Internet telephony must pay access charges for at least some
subset of Internet telephony services. If the FCC were to make such a finding,
the payment of access charges could materially adversely effect our business,
results of operations and financial condition. Many of our competitors are
lobbying the FCC for the imposition of access charges on Internet telephony
traffic.
To our knowledge, there are currently no domestic and few foreign laws or
regulations that prohibit voice communications over the Internet. State public
utility commissions may retain jurisdiction to regulate the provision of
intrastate Internet telephony services. A number of countries that currently
prohibit competition in the provision of voice telephony have also prohibited
Internet telephony. Other countries permit but regulate Internet telephony. If
Congress, the FCC, state regulatory agencies or foreign governments begin to
regulate Internet telephony, such regulation may materially adversely affect
our business, financial condition or results of operations.
Regulation of the Internet
Congress has recently adopted legislation that regulates certain aspects of
the Internet, including online content, user privacy, taxation, access charges,
liability for third-party activities and jurisdiction. The European Union has
also enacted several directives relating to the Internet, one of which
addresses online commerce. In addition, federal, state, local and foreign
governmental organizations are considering other legislative and regulatory
proposals that would regulate the Internet. Increased regulation of the
Internet may decrease its growth, which may negatively impact the cost of doing
business via the Internet or otherwise materially adversely affect our
business, results of operations and financial condition.
The Federal Trade Commission has proposed regulations regarding the
collection and use of personal identifying information obtained from
individuals when accessing Web sites, with particular emphasis on access by
minors. These regulations may include requirements that companies establish
certain procedures to disclose and notify users of privacy and security
policies, obtain consent from users for certain collection and use of
information and to provide users with the ability to access, correct and delete
personal information stored by the company. These regulations may also include
enforcement and redress provisions. There can be no assurance that we will
adopt policies that conform with any regulations adopted by the FTC. Moreover,
even in the absence of those regulations, the FTC has begun investigations into
the privacy practices of companies that collect information on the Internet.
One investigation resulted in a consent decree pursuant to which an Internet
company agreed to establish programs to implement the principles noted above.
We may become subject to a similar investigation, or the FTC's regulatory and
enforcement efforts may adversely affect the ability to collect demographic and
personal information from users, which could have an adverse effect on our
ability to provide highly targeted opportunities for advertisers and electronic
commerce marketers. Any of these developments would materially adversely affect
our business, results of operations and financial condition.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. Under the directive, citizens of the
European Union are guaranteed rights to access their data, rights to know where
the data originated, rights to have inaccurate data rectified, rights to
recourse in
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the event of unlawful processing and rights to withhold permission to use their
data for direct marketing. The directive could, among other things, affect
United States companies that collect information over the Internet from
individuals in European Union member countries, and may impose restrictions
that are more stringent than current Internet privacy standards in the United
States. In particular, companies with offices located in European Union
countries will not be allowed to send personal information to countries that do
not maintain adequate standards of privacy. The directive does not, however,
define what standards of privacy are adequate. As a result, the directive may
adversely affect the activities of entities such as us that engage in data
collection from users in European Union member countries.
Intellectual Property
Our performance and ability to compete are dependent to a significant degree
on our proprietary and licensed technology. We rely on a combination of patent,
copyright, trademark and trade secret laws and contractual restrictions to
establish and protect our technology. We do not currently have any issued
patents or registered copyrights. All key employees have signed confidentiality
agreements and we intend to require each newly hired employee to execute a
confidentiality agreement. These agreements provide that confidential
information developed by or with an employee or consultant, or disclosed to
such person during his or her relationship with us, may not be disclosed to any
third party except in certain specified circumstances. These agreements also
require our employees to assign their rights to any inventions to us. The steps
taken by us may not, however, be adequate to prevent the misappropriation of
our proprietary rights or technology. In addition, our competitors may
independently develop technologies that are substantially equivalent or
superior to our technology.
We own the registered service mark for two of the marks used in our business
and have applications pending to register several other service marks relating
to our business.
We have received correspondence from a company claiming that our use of the
mark "Net2Phone" in connection with Internet telephony services infringes one
of that company's United States registered trademarks, and requesting that we
cease and desist from using the Net2Phone mark. We have responded by denying
any infringement and no legal proceedings have been commenced against us with
respect to this matter. AT&T, which uses the terms "Click2Dial",
"Click2Whisper" and "Click2Interact" in its business, has filed with the United
States Patent and Trademark Office for an extension of the time limit for
opposing the service mark application filed by us for our "CLICK2TALK" mark.
AT&T could oppose registration of our CLICK2TALK mark or take other action
aimed at restricting us from using our CLICK2TALK mark. We are also aware of
several other parties that employ marks that are the same or similar to marks
that we employ, though these parties are not in the same business as us. There
can be no assurance that the company which notified us or other companies with
similar marks to our marks will not bring suit to prevent us from using the
Net2Phone mark or other marks. Defending or losing any litigation relating to
intellectual property rights could materially adversely affect our business,
results of operations and financial condition.
In addition, one of our international resellers, a company known as ITM,
operates a Web site at www.net2phone.net without our permission or
authorization, and in violation of the agency agreement ITM entered into with
us for the distribution of the Net2Phone software with certain ITM software.
Furthermore, ITM has also taken steps to secure registration and ownership of
the Net2Phone mark in France. We have notified ITM of this violation, taken
some initial actions to oppose ITM's use of the Net2Phone mark, and will pursue
our claim against them, if necessary, but there can be no assurances that we
can prevent, through litigation or otherwise, ITM from continuing its operation
of the net2phone.net Web site or from obtaining registration and ownership of
the Net2Phone mark in France.
Another company, NetPhone, currently operates a Web site at www.netphone.com
where it sells a family of computer telephony hardware and applications. There
can be no assurance that the existence of NetPhone's business and Web site will
not materially adversely affect our business. Furthermore, we have not taken
steps to assure foreign protection of our trademarks, except for our recent
filing for registration of
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the Net2Phone mark in certain European countries. To the extent trademark
rights are acquired through registration in countries outside the United
States, we may not be able to protect our marks or assure that we are not
infringing other parties' marks in those countries.
There can be no assurance that we will be able to secure significant
protection for all our service marks or trademarks. It is possible that
competitors of ours or others will adopt product or service names similar to
our marks, or try to prevent us from using our marks, thereby impeding our
ability to build brand identity and possible leading to customer confusion.
We have been assigned the rights to patent applications claiming a number of
the technologies underlying our products and services. Our two United States
patent applications have been rejected, but we are continuing to pursue patent
protection for the claimed subject material. There can be no assurance that the
applications will result in the issuance of patents or that, if issued, such
patents would adequately protect us against competitive technology or that they
would be held valid and enforceable against a challenge. In addition, it is
possible that our competitors may be able to design around any such patents.
Also, our competitors may obtain patents that we would need to license or
circumvent in order to make, use, sell or offer for sale the technology.
We believe that we do not infringe upon the proprietary rights of any third
party, and no third party has asserted a patent infringement claim against us.
It is possible, however, that such a claim might be asserted successfully
against us in the future. Our ability to make, use, sell or offer for sale our
products and services depends on our freedom to operate. That is, we must
ensure that we do not infringe upon the proprietary rights of others or have
licensed all such rights. We have not requested or obtained an opinion from our
outside counsel as to whether our products and services infringe upon the
intellectual property rights of any third parties. We are aware that patents
have recently been granted to others based on fundamental technologies in the
Internet telephony area. In addition, we are aware of at least one other patent
application involving potentially similar technologies to our own which if
issued could materially adversely affect our business. Because patent
applications in the Unites States are not publicly disclosed until issued,
other applications may have been filed which, if issued as patents, could
relate to our services and products. However, foreign patent applications do
publish before issuance. We are aware of several such publications that relate
to Internet telephony. One such published application claims as an inventor a
previous consultant to IDT and has been assigned to another company. Issuance
of a patent or patents from this application could materially adversely affect
our ability to operate. A party making an infringement claim could secure a
substantial monetary award or obtain injunctive relief which could effectively
block our ability to provide services or products in the United States or
abroad.
If any of these risks materialize, we could be forced to suspend operations,
to pay significant amounts to defend our rights, and a substantial amount of
the attention of our management may be diverted from our ongoing business, each
of which could materially adversely affect our ability to operate.
We rely on a variety of technology, primarily software, that we license from
third parties. Most of this technology was purchased or licensed on our behalf
by IDT. Continued use of this technology by us may require that we purchase new
or additional licenses from third parties or obtain consents from third parties
to assign the applicable licenses from IDT. There can be no assurances that we
can obtain those third party licenses needed for our business or that the third
party technology licenses that we do have will continue to be available to us
on commercially reasonable terms or at all. The loss or inability to maintain
or obtain upgrades to any of these technology licenses could result in delays
or breakdowns in our ability to continue developing and providing our products
and services or to enhance and upgrade our products and services.
Employees
As of May 31, 1999, we had approximately 171 full-time employees, including
approximately 66 in technical support and customer service, 26 in sales and
marketing, 20 in management and finance, 47 in operations, and 12 in research
and development. Our employees are not represented by any union, and we
consider our employee relations to be good. We have never experienced a work
stoppage.
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Properties
Our primary facilities consist of approximately 15,445 square feet, which
comprise our headquarters, executive offices and customer service and technical
support centers, and are located in two buildings in Hackensack, New Jersey
leased from corporations that are owned and controlled by Howard S. Jonas. Mr.
Jonas is one of our directors, a director of IDT and the controlling
stockholder of IDT. These leases expire at the end of February 2002 and require
us to make annual rental payments of $186,144. We also sublease space for some
of our computer equipment in Piscataway, New Jersey from IDT, which leases this
space from a company also owned and controlled by Mr. Jonas. This lease runs
for a three-year term, beginning in May 1999, with monthly rent of $8,400. In
addition, we lease office space in Lakewood, New Jersey for our research and
development center. Pursuant to this lease, which expires at the end of August
2001, we are required to make annual rental payments of $48,125. See "Certain
Transactions--Facility Leases."
Legal Proceedings
We are not currently a party to any material legal proceedings.
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MANAGEMENT
Executive Officers, Directors and Key Employees
The following persons are our executive officers, directors and director
nominees:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
Clifford M. Sobel......... 49 Chairman of the Board
Howard S. Balter.......... 37 Chief Executive
Officer and Vice
Chairman of the
Board
Jonathan Fram............. 42 President
David Greenblatt.......... 47 Chief Operating
Officer
Ilan M. Slasky............ 29 Chief Financial
Officer
H. Jeff Goldberg.......... 46 Chief Technology
Officer
Jonathan Reich............ 33 Executive Vice
President-
Marketing and
Corporate
Development
Martin Rothberg........... 30 Executive Vice
President-
Strategic Sales
Jonathan Rand............. 36 Executive Vice
President-
International
Sales [and
Treasurer]
Howard S. Jonas........... 43 Director
James A. Courter.......... 57 Director
Gary E. Rieschel.......... 43 Director
James R. Mellor........... 69 Director
Stephen A. Oxman.......... 54 Director Nominee
Raphael S. Grunfeld....... 52 Director Nominee
</TABLE>
Clifford M. Sobel has been Chairman of the board of directors since May
1999, served as our President from October 1997 to July 1999 and served as our
Chief Executive Officer from October 1997 to January 1999. Since 1994, Mr.
Sobel has been Chairman and Chief Executive Officer of SJJ Investment Corp.,
which has invested in Internet, cable, real estate and cosmetics companies.
Prior to this, Mr. Sobel founded several companies in the design and
manufacturing of retail interiors and themed environments, including DVMI and
its subsidiary, Bon-Art International, and Bauchet International. These
companies were sold in 1994 by Bear, Stearns & Co. Inc. Mr. Sobel has testified
before Congress on foreign trade issues and, by Presidential appointment,
served on the Holocaust Memorial Council in Washington, D.C.
Howard S. Balter has been a director since October 1997, our Chief Executive
Officer since January 1999, and our Vice Chairman of the board of directors
since May 1999. Mr. Balter also served as our Treasurer from October 1997 to
January 1999. Prior to his employment with us, Mr. Balter was IDT's Chief
Operating Officer from 1993 to 1998 and Chief Financial Officer from 1993 to
1995. Mr. Balter was a director of IDT from December 1995 to January 1999 and
Vice Chairman of IDT's board from 1996 to 1999. From 1985 to 1993, Mr. Balter
operated his own real estate development firm.
Jonathan Fram became our President in July 1999. Prior to his employment
with us, Mr. Fram was General Manager of Bloomberg L.P.'s New Media Group since
1996, where he was responsible for Bloomberg's Internet strategy. Prior to
that, Mr. Fram was employed as General Manager of Bloomberg's Television and
Radio Group from 1991 through 1996. From 1989 to 1991, Mr. Fram served as the
Chief Executive Officer of FNN:PRO - Institutional Research Network, Inc. Mr.
Fram was also employed by both Bear Stearns & Co. and Paine Webber, Inc. as a
securities analyst and worked for IBM as a computer design engineer.
David Greenblatt has been our Chief Operating Officer since January 1999.
Between January 1998 and January 1999, Mr. Greenblatt served as IDT's Vice
President of Networks, during which time he was primarily responsible for the
operations of Net2Phone. Prior to his employment with IDT in January 1998,
Mr. Greenblatt was Senior Vice President of Research and Development for
Nextwave Communications from 1996 to 1997. From January 1984 to August 1996,
Mr. Greenblatt was a principal of Financial
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Technologies, Inc., where he managed the process of software conversion for
large and medium-sized businesses. From January 1980 to December 1984, Mr.
Greenblatt was an information technologies consultant for various money center
banks. From 1970 to 1980, Mr. Greenblatt has lectured in the areas of Computer
Science and Mathematics at Queens College, New York University, Hunter College
and Pace University.
Ilan M. Slasky has been our Chief Financial Officer since January 1999.
Prior to his employment with us, Mr. Slasky was IDT's Executive Vice President
of Finance from December 1997 to January 1999, IDT's director of carrier
services from November 1996 to July 1997 and IDT's Director of Finance from May
1996 to November 1996. From 1991 to 1996, Mr. Slasky worked for Merrill Lynch
in various areas of finance, including risk management, fixed income trading
and equity derivatives.
H. Jeff Goldberg has been our Chief Technology Officer since January 1999.
From January 1996 to January 1999, Mr. Goldberg was our Director of Technology
and a consultant to IDT. Mr. Goldberg was an independent software consultant
from 1985 to 1995, Vice President of Software and a member of the board of
directors at Charles River Data Systems in Massachusetts from 1979 to 1985 and
a developer of multimedia communications software at AT&T Bell Laboratories
from 1977 to 1979. Mr. Goldberg is a founding member of the UNIX standards
committee.
Jonathan Reich has been our Executive Vice President--Marketing and
Corporate Development since January 1999. Prior to his employment with us, Mr.
Reich was IDT's Senior Vice President of Advertising, Marketing and Business
Development in charge of strategic relationships for both us and IDT from June
1997 to December 1998 and IDT's director of advertising from January 1995 to
November 1997. From 1992 to 1993, Mr. Reich worked for Sanford Bernstein & Co.
as an associate analyst. Prior to this, Mr. Reich was an internal consultant
for Morgan Stanley & Co.
Martin Rothberg has been our Executive Vice President--Strategic Sales since
January 1999 and a key employee since June 1997. Prior to his employment with
us, Mr. Rothberg was IDT's Director of International Sales from September 1996
to June 1997 and IDT's Director of Domestic Sales from June 1995 to September
1996.
Jonathan Rand has been our Executive Vice President--International Sales and
Treasurer since January 1999 and a key employee since January 1998. Prior to
joining us, Mr. Rand was a member of IDT's senior management from 1992 to
January 1999, including service as Senior Vice President--International Sales
and Senior Vice President--Finance. Additionally, Mr. Rand is a co-founder and
director of the International Internet Association. Prior to joining IDT, Mr.
Rand operated his own magazine publishing business from 1986 to 1992 and was
employed by Procter & Gamble from 1985 to 1986 in Brand Management.
Howard S. Jonas was appointed a director in October 1997. Mr. Jonas founded
IDT in August 1990 and has served as Chairman of the Board and Treasurer since
its inception and as Chief Executive Officer since December 1991. Additionally,
he served as President of IDT from December 1991 through September 1996. Mr.
Jonas is also the founder and has been President of Jonas Publishing Corp., a
publisher of trade directories, since its inception in 1979.
James A. Courter has been a director since May 1999. Mr. Courter has been
President of IDT since October 1996 and a director of IDT since March 1996. Mr.
Courter has been a senior partner in the New Jersey law firm of Courter,
Kobert, Laufer & Cohen, P.C. since 1972. He was also a partner in the
Washington, D.C. law firm of Verner, Liipfert, Bernhard, McPherson & Hand from
January 1994 to September 1996. From 1991 to 1994, Mr. Courter was chairman of
the President's Defense Base Closure and Realignment Commission. Mr. Courter
was a member of the United States House of Representatives for 12 years,
retiring in January 1991. Mr. Courter also serves on the board of directors of
Envirogen and The Berkeley School.
Gary E. Rieschel was appointed a director in June 1999. Mr. Rieschel is the
Executive Managing Director of SOFTBANK Technology Ventures, which he joined in
January 1996. Mr. Rieschel has extensive
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overseas experience, having spent over four years in Tokyo as General Manager
of Sequent Computer Systems' Asian operations. He serves as a Director for
several SOFTBANK Technology Ventures' portfolio companies and is a member of
SOFTBANK Corporation's Global Executive Board.
James R. Mellor was appointed a director in June 1999. Mr. Mellor served as
a director of IDT between August 1997 and June 1999. Since 1981, Mr. Mellor
worked for General Dynamics Corporation, a developer of nuclear submarines,
surface combatant ships and combat systems. From 1994 until 1997, Mr. Mellor
served as Chairman and Chief Executive Officer of General Dynamics, and from
1993 to 1994, he served as President and Chief Operating Officer of General
Dynamics. Before joining General Dynamics, Mr. Mellor served as President and
Chief Operating Officer of AM International, Inc. now Multigraphics, Inc.
Before that time, Mr. Mellor spent 18 years with Litton Industries in a variety
of engineering and management positions, including Executive Vice President in
charge of Litton's Defense Group from 1973 to 1997.
Stephen A. Oxman is expected to become a director after the closing of this
offering. Mr. Oxman currently serves as a managing director in the mergers,
acquisitions and corporate advisory group of Deutsche Bank Securities Inc., an
affiliate of BT Alex. Brown Incorporated. He heads the group's
telecommunications practice and also focuses on the firm's work in Europe. In
1995, Mr. Oxman became a partner in the investment banking firm of James D.
Wolfensohn Incorporated, which merged in 1996 with Bankers Trust, which in turn
merged with Deutsche Bank in 1999. From 1993 to 1994, Mr. Oxman served as
Assistant Secretary of State for European and Canadian Affairs. From 1988 to
1993, Mr. Oxman was a managing director of Wasserstein Perella & Co. and Deputy
Chairman of Wasserstein Perella International. From 1980 to 1988, he was a
partner in the law firm of Shearman & Sterling. During the Carter
administration, Mr. Oxman was Executive Assistant to the Deputy Secretary of
State, and subsequently a consultant to the Secretary of State concerning the
Iran hostage crisis.
Raphael S. Grunfeld is expected to become a director after the closing of
this offering. Mr. Grunfeld has served as a partner in the Corporate Department
of Morrison & Forester LLP since March 1999. Since November 1995, Mr. Grunfeld
has served as General Counsel and Secretary of Genesis Direct, Inc., a catalog
and Internet direct marketer. He also served as Vice President of Genesis
Direct from November 1995 until March 1999. From 1992 to 1995, Mr. Grunfeld was
General Counsel and Secretary of First Capital Asset Management, Inc. and its
operating subsidiaries, including newspaper, media, money management and broker
dealer companies. From 1992 to 1994 he also served as Executive Vice President,
General Counsel and Secretary to DSI Industries, Inc., a public holding
company, and to its operating subsidiaries engaged in the businesses of medical
diagnostic imagery, oil drilling equipment leasing and plant nurseries.
In addition, we employ the following additional key employees:
Ira A. Greenstein has been our General Counsel and Secretary since May 1999.
Mr. Greenstein has been a partner in the law firm of Morrison & Foerster LLP
since 1997 where he serves as the chair of that firm's New York office's
Corporate Department. Prior to 1997, Mr. Greenstein was an associate in the
New York and Toronto offices of Skadden, Arps, Slate, Meagher & Flom LLP. From
1991 to 1992, Mr. Greenstein served as counsel to the Ontario Securities
Commission advising on the implementation of the Multijurisdictional Disclosure
System with the Securities and Exchange Commission. Mr. Greenstein also served
on the Securities Advisory Committee to the Ontario Securities Commission from
1992 to 1996. Mr. Greenstein has testified as an expert in the U.S. securities
laws in U.S. District Court.
Chaim Ackerman has been a senior software engineer of ours since February
1996. Prior to his employment with us, Mr. Ackerman was a member of the
technical staff at AT&T Bell Laboratories from 1986 to 1996. From 1984 to 1986,
Mr. Ackerman was a member of the technical staff at AT&T Consumer Products.
From 1980 to 1984, Mr. Ackerman worked for Computer Horizons Corporation as a
consultant to Bell Laboratories.
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Sarah Hofstetter has been our Vice President-Corporate Communications since
May 1999. Prior to her employment with us, Ms. Hofstetter was IDT's Vice
President of Corporate Communications, in charge of public relations and brand
imaging from April 1996 to January 1999. From 1995 to 1996, Ms. Hofstetter
worked at The New York Times Syndicate as an editor of the New America News
Service, a wire service specializing in issues related to diversity in the
marketplace. Ms. Hofstetter sits on the editorial boards of Telecom Business
and TeleCard World magazines, and on the Editorial Roundtable of Intel-Card
News magazine.
Board of Directors and Committees of the Board
Our certificate of incorporation, as amended and restated, provides that the
number of members of our board of directors shall be not less than five and not
more than 11. The number of directors is currently six. Two additional
individuals have been nominated to serve as directors. We also anticipate that
one additional director will be elected after the closing of this offering.
Upon consummation of this offering, the board of directors will be divided into
three classes, with each class to be as nearly equal in number as possible. At
each annual meeting of stockholders, the successors to the class of directors
whose term expires at that time will be elected to hold office for a term of
three years and until their respective successors are elected and qualified.
All of the officers identified above serve at the discretion of our board of
directors.
IDT and Clifford M. Sobel, our Chairman, have agreed to vote all of their
shares in favor of the election of a director nominated by SOFTBANK Technology
Ventures IV and a director nominated by either GE Capital Equity Investments or
NBC, in each case for as long as either entity holds a majority of the shares
of Series A convertible preferred stock originally purchased by them or the
shares into which they are convertible. Gary E. Rieschel was nominated to our
board by Softbank. Neither GE nor NBC has nominated a director.
We have established an audit committee and a compensation committee, the
initial member of each of which will be James R. Mellor. We expect to appoint
one or more additional directors to each of these committees after the closing
of this offering.
The audit committee oversees the retention, performance and compensation of
the independent public accountants, and the establishment and oversight of such
systems of internal accounting and auditing control as it deems appropriate.
The compensation committee reviews and approves the compensation of our
executive officers, including payment of salaries, bonuses and incentive
compensation, determines our compensation policies and programs, and
administers our stock option plans.
The board of directors does not have a nominating committee. However, the
board of directors will consider nomination recommendations from stockholders,
which should be addressed to our corporate secretary at our principal executive
offices.
Executive Compensation
The following table identifies our most highly compensated executive
officers whose salaries and bonuses exceeded $100,000 during fiscal 1998 and
who served as executive officers of Net2Phone during fiscal 1998. Our Chief
Executive Officer, Howard S. Balter was employed as the Chief Operating Officer
and Vice Chairman of IDT during fiscal 1998 and did not serve as an executive
officer of Net2Phone during fiscal 1998. All of the named executive officers
listed below were compensated by IDT during fiscal 1998.
47
<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation
Compensation Awards
------------------ --------------
Securities
Name and Principal Fiscal Underlying All Other
Position Year Salary($) Bonus($) IDT Options(#) Compensation($)
- ------------------ ------ --------- -------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Clifford M. Sobel(1).... 1998 100,000 -- -- --
Chairman and President
David Greenblatt........ 1998 113,174 -- 20,000 --
Chief Operating Officer
H. Jeff Goldberg........ 1998 206,169 -- 50,000 --
Chief Technology
Officer
</TABLE>
- ---------------------
(1) Mr. Sobel served as our Chief Executive Officer from October 1997 to
January 1999 and our President from October 1997 to July 1999.
Option Grants During Fiscal 1998
No options to purchase shares of Net2Phone were granted to the executive
officers named above during fiscal 1998.
The following table describes the options to acquire shares of common stock
of IDT granted to the individuals named above during fiscal 1998:
<TABLE>
<CAPTION>
Potential
Realizable Value
% of at
Number of Total Assumed Annual
Securities Options Rates of Stock
Under- Granted Price
lying IDT to Exercise Appreciation
Options Employees of for Option Term
Granted in Fiscal Base Price Expiration -----------------
Name (#) Year (%) ($/Sh) Date 5% ($) 10% ($)
- ---- ---------- --------- ---------- ---------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
David Greenblatt.. 20,000 1.6 $18.00 Nov. 2007 226,402 573,747
H. Jeff Goldberg.. 50,000 4.0 $24.25 June 2008 762,534 1,932,413
</TABLE>
Value of IDT Options at Year End
The following table describes the value of IDT options exercised in fiscal
1998 and the value of unexercised options held by the individuals named above
at July 31, 1998:
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Number of Underlying Unexercised in-the-Money
Shares Options at Fiscal Year-End Options at Fiscal Year-End
Acquired on --------------------------- -----------------------------
Names Exercise Value Realized Exercisable/Unexercisable Exercisable/Unexercisable (1)
- ----- ----------- -------------- --------------------------- -----------------------------
<S> <C> <C> <C> <C>
Clifford M. Sobel(2).... 100,000 $1,701,500 100,000/875,000 $1,775,000/--
David Greenblatt........ -- -- 20,000/0 125,000/--
H. Jeff Goldberg........ 5,000 111,250 210,000/50,000 3,556,500/0
</TABLE>
- ---------------------
(1) The closing price of IDT's common stock on July 31, 1998, as reported on
the Nasdaq National Market, was $24.25 per share.
(2) Mr. Sobel has an option that may be exercised beginning in September 1999,
to transfer his shares of Net2Phone to IDT in exchange for an option to
acquire 875,000 shares of IDT common stock at a purchase price of $6.50 per
share. Mr. Sobel will be prohibited by an agreement with the underwriters
from exercising this option during the 180-day period following the date of
this prospectus.
48
<PAGE>
Value of Net2Phone Options at Year End
The following table describes the value of Net2Phone options exercised in
fiscal 1998 and the value of unexercised options held by Clifford M. Sobel, our
Chairman and President, at July 31, 1998. None of the other individuals named
in the Summary Compensation Table were granted options to purchase shares of
Net2Phone prior to fiscal 1999.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Number of Underlying Unexercised in-the-Money
Shares Options at Fiscal Year-End Options at Fiscal Year-End
Acquired Value ---------------------------- ----------------------------
Names Exercise Realized(1) Exercisable/Unexercisable(2) Exercisable/Unexercisable(2)
- ----- --------- ----------- ---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Clifford M. Sobel....... 3,096,000 $ 0 0/347,865 0/--
</TABLE>
- ---------------------
(1) For purposes of this table, the per share value of each share of Net2Phone
common stock in January 1998 is assumed to be $.03 per share, based upon a
valuation report prepared by an independent appraiser.
(2) Mr. Sobel received options to purchase an aggregate of 11% of Net2Phone's
capital stock in connection with his May 1997 employment agreement. Mr.
Sobel exercised his option to purchase 10% of Net2Phone's capital stock in
January 1998, and his option to purchase the additional 1% of Net2Phone's
capital stock terminated under an amendment to his employment agreement
entered into in May 1999. Mr. Sobel does not currently own any options to
purchase shares of Net2Phone.
Compensation of Directors
We intend to grant options to purchase shares of common stock to all of our
non-employee directors under the 1999 Stock Incentive Plan, other than non-
employee directors who serve as officers of IDT. See "1999 Stock Incentive
Plan." Other than as will be provided in that plan and the reimbursement of
reasonable expenses incurred with attending board and committee meetings, we
have not yet adopted specific policies on directors' compensation and benefits
following the closing of this offering.
Employment Agreements
Clifford M. Sobel, our Chairman, is employed pursuant to an employment
agreement that was entered into in May 1997 and amended in May 1999. The
agreement commenced in September 1997 and will expire in September 2000, and
will automatically be extended though September 2001 unless either we or Mr.
Sobel notifies the other that the extension will not take effect. Mr. Sobel
receives an annual base salary of $100,000. In January 1998, in connection with
an option set forth in his employment agreement, Mr. Sobel purchased 10% of our
common stock for $100,000. On the closing date of this offering, Mr. Sobel will
receive from IDT that number of shares of our common stock which will maintain
his holdings, when combined with shares owned by a trust for the benefit of his
offspring, at 8% of our total outstanding capital stock as of that date. Mr.
Sobel's employment agreement also provides him with an option to transfer his
interest in us to IDT in exchange for an option from IDT to purchase 875,000
registered shares of IDT common stock at a purchase price of $6.50 per share.
This option is exercisable at any time from September 15, 1999 through
September 15, 2000, so long as he is employed by us as of September 15, 1999
and owns and holds all of the stock he received, other than shares that he
transferred to a trust for the benefit of his offspring. Mr. Sobel will be
prohibited by an agreement with the underwriters from exercising this option
during the 180-day period following the date of this prospectus.
On July 2, 1999, we signed a three-year employment agreement with Jonathan
Fram, who has become our President. After the initial term, our agreement with
Mr. Fram may be renewed annually. We will pay Mr. Fram an annual base salary of
$350,000 and he is entitled to receive an annual bonus calculated on the basis
of our gross revenue, which bonus could be up to $100,000. Additionally, we
granted Mr. Fram options to purchase 920,000 shares of our common stock under
our 1999 Stock Option and Incentive Plan. Of these options, 460,000 were
granted at an exercise price of $3.33, 153,333 of which are
49
<PAGE>
vested and exercisable. The options to purchase the remaining 460,000 shares
were granted at the lower of our initial public offering price or $11.00. Other
than those options vesting July 20, 1999, the remaining 766,667 options will
vest in three equal annual installments, commencing on July 20, 2000. We also
have agreed to extend a three-year, non-recourse, 7% loan to Mr. Fram in the
amount of $1,000,000 to purchase shares of our common stock in this offering.
Mr. Fram has agreed not sell any of his shares of our stock during the 180-day
period following the date of this prospectus. See also "Certain Transactions--
Officer Loans."
At present, none of the other named executive officers or key employees is
party to an employment agreement with us.
1999 Stock Incentive Plan
Our 1999 Stock Option and Incentive Plan was adopted in April 1999. Under
the plan, our officers, directors, key employees and consultants, together with
those of IDT and its subsidiaries, are eligible to receive awards of stock
options, stock appreciation rights, limited stock appreciation rights and
restricted stock. Options granted under the plan may be incentive stock options
or nonqualified stock options. Stock appreciation rights and limited stock
appreciation rights may be granted simultaneously with the grant of an option
or, in the case of nonqualified stock options, at any time during its term.
Restricted stock may be granted in addition to or in lieu of any other award
made under the plan. A total of 11,040,000 shares of common stock have been
authorized to date for issuance under the plan, 5,040,000 of which were granted
through June 21, 1999, and 1,345,219 of which have been exercised. These
options have a weighted average exercise price of $3.33 per share. In
connection with loans granted to several grantees under the plan to exercise a
portion of these options, 23,382 outstanding options were cancelled. Additional
options to purchase 6,996 shares were cancelled in connection with the
termination of the employment of four grantees. We expect to grant options to
purchase approximately 2,011,000 additional shares of our common stock upon the
consummation of this offering.
The 1999 Stock Option and Incentive Plan is administered by the compensation
committee of our board. Subject to the provisions of the plan, the board of
directors or the compensation committee will determine the type of award, when
and to whom awards will be granted, the number of shares covered by each award
and the terms and kind of consideration payable with respect to awards. The
board of directors or the compensation committee may interpret the plan and may
at any time adopt the rules and regulations for the plan as it deems advisable.
In determining the persons to whom awards shall be granted and the number of
shares covered by each award, the board of directors or the compensation
committee may take into account the duties of the respective persons, their
present and potential contribution to our success and other relevant factors.
Stock Options. An option may be granted on the terms and conditions as the
board of directors or the compensation committee may approve, and generally may
be exercised for a period of up to ten years from the date of grant. Generally,
incentive stock options will be granted with an exercise price equal to the
fair market value on the date of grant. Additional limitations will apply to
incentive stock options granted to a grantee that beneficially holds 10% or
more of our voting stock. The board of directors or compensation committee may
authorize loans to individuals to finance their exercise of vested options. See
"Certain Transactions--Officer Loans." Options granted under the 1999 Stock
Option and Incentive Plan will become exercisable at those times and under the
conditions determined by the board of directors or the compensation committee.
To date, the options that have been granted to our executive officers will
generally vest automatically in the event that there is a change of control of
our company, if we are merged into another company or if any of these
individuals are employed by a subsidiary of our company that is sold to another
company.
The 1999 Stock Option and Incentive Plan provides for automatic option
grants to eligible non-employee directors. Options to purchase 10,000 shares of
common stock will be granted to each eligible
50
<PAGE>
non-employee director upon consummation of this offering and options to
purchase 10,000 shares of common stock will be granted to each new eligible
non-employee director upon the director's initial election to the board. In
addition, options to purchase 10,000 shares of common stock are granted
annually to each eligible non-employee director on the anniversary date of his
or her election to the board. Each of these options will have an exercise price
equal to the fair market value of a share of common stock on the date of grant.
All options granted to non-employee directors will be immediately exercisable.
All options held by non-employee directors, to the extent not exercised, expire
on the earliest of:
. the tenth anniversary of the date of grant;
. one year following the optionee's termination of directorship other than
for cause; and
. three months following the optionee's termination of directorship for
cause.
Stock Appreciation Rights and Limited Stock Appreciation Rights. The 1999
Stock Option and Incentive Plan also permits the board of directors or the
compensation committee to grant stock appreciation rights and/or limited stock
appreciation rights with respect to all or any portion of the shares of common
stock covered by options. Generally, stock appreciation rights and limited
stock appreciation rights may be exercised only at that time as the related
option is exercisable. Upon exercise of a stock appreciation right, a grantee
will receive for each share for which an stock appreciation right is exercised,
an amount in cash or common stock, as determined by the board of directors or
the compensation committee, equal to the excess of the fair market value of a
share of common stock on the date the stock appreciation right is exercised
over the exercise price per share of the option to which the stock appreciation
right relates.
Limited stock appreciation rights may be exercised only during the 90 days
following a change in control, or a merger or similar transaction, involving
Net2Phone. Upon exercise of a limited stock appreciation right, a grantee will
receive, for each share for which a limited stock appreciation rights is
exercised, an amount in cash equal to the excess of the highest fair market
value of a share of our common stock during the 90-day period ending on the
date of the limited stock appreciation rights is exercised, or an amount equal
to the highest price per share paid for shares of our common stock in
connection with a merger or a change of control of Net2Phone, whichever is
greater, over the exercise price per share of the option to which the limited
stock appreciation rights relates. In no event, however, may the holder of a
limited stock appreciation right granted in connection with an incentive stock
option receive an amount in excess of the maximum amount that will enable the
option to continue to qualify as an incentive stock option.
Restricted Stock. The 1999 Stock Option and Incentive Plan further provides
for the granting of restricted stock awards, which are awards of common stock
that may not be disposed of, except by will or the laws of descent and
distribution, for a period of time determined by the compensation committee or
the board of directors. The board or the compensation committee may also impose
other conditions and restrictions on the shares as it deems appropriate,
including the satisfaction of performance criteria. All restrictions affecting
the awarded shares will lapse in the event of a merger or similar transaction
involving Net2Phone.
The board may amend or terminate the 1999 Stock Option and Incentive Plan.
However, as required by any law, regulation or stock exchange rule, no change
shall be effective without the approval of our stockholders. In addition, no
change may adversely affect an award previously granted, except with the
written consent of the grantee.
No awards may be granted under the 1999 Stock Option and Incentive Plan
after the tenth anniversary of its initial adoption.
Options and Awards Under the 1999 Stock Option and Incentive Plan. We cannot
now determine the number of options or awards to be granted in the future under
the 1999 Stock Option and Incentive Plan to officers, directors and employees.
51
<PAGE>
Compensation Committee Interlocks and Insider Participation.
We did not have a compensation committee during fiscal 1998. Compensation
decisions relating to our executive officers, key employees and other senior
personnel were made primarily by IDT, which owned all of our outstanding
capital stock at the beginning of fiscal 1998. During fiscal 1998, Howard S.
Jonas, who was serving as our chairman, and Howard S. Balter, who was serving
as our treasurer, also served as directors of IDT.
401(k) Plan
Prior to May 1999, our employees participated in IDT's 401(k) Savings and
Retirement Plan. We are in the process of establishing our own 401(k) plan that
is intended to qualify for preferential tax treatment under section 401(k) of
the Internal Revenue Code. We intend that most of our employees will be
eligible to participate in our 401(k) Savings and Retirement Plan upon
adoption.
52
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our outstanding common stock as of July 13, 1999 and as adjusted
to reflect the sale of the common stock offered hereby by:
. each person who is the beneficial owner of more than 5% of our capital
stock;
. each of our directors and director nominees;
. each of our named executive officers; and
. all of our named executive officers, directors and director nominees as
a group.
Except as otherwise indicated, all of the shares indicated in the table are
shares of common stock.
<TABLE>
<CAPTION>
Percentage
Number of Shares Beneficially
Beneficially Owned Owned(1)
--------------------- -----------------
Prior to After Prior to After
Holders Offering Offering Offering Offering
- -------------------------------------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C>
IDT Corporation(2).................... 27,621,982 27,237,979 65.8% 58.2%
190 Main Street
Hackensack, New Jersey 07601
Howard S. Jonas(3).................... 27,621,982 27,237,979 65.8% 58.2%
c/o IDT Corporation
190 Main Street
Hackensack, New Jersey 07601
James A. Courter(4)................... 27,657,982 28,041,985 65.9% 59.9%
c/o IDT Corporation
190 Main Street
Hackensack, New Jersey 07601
SOFTBANK Technology Ventures IV,
L.P.(5).............................. 4,590,000 4,590,000 10.9% 9.8%
333 West San Carlos Street, Suite 1225
San Jose, California 95110
Gary E. Rieschel(6)(7)................ 4,590,000 4,600,000 10.9% 9.8%
c/o SOFTBANK Technology Ventures IV,
L.P.
333 West San Carlos Street, Suite 1225
San Jose, California 95110
Clifford M. Sobel(8).................. 3,359,806 3,743,809 8.0% 8.0%
c/o Net2Phone, Inc.
171 Main Street
Hackensack, New Jersey 07601
America Online, Inc.(9)............... 2,295,000 2,295,000 5.5% 4.9%
22000 AOL Way
Dulles, Virginia 20166
General Electric Company Group(10).... 2,295,000 2,795,000 5.5% 6.0%
120 Long Ridge Road
Stamford, Connecticut 06927
Howard S. Balter(7)(11)............... 714,978 782,028 1.7% 1.7%
David Greenblatt(7)(12)............... 105,840 135,840 * *
H. Jeff Goldberg(7)(13)............... 105,840 120,840 * *
James R. Mellor(7).................... -- 10,000 * *
Stephen A. Oxman(7)................... -- 10,000 * *
Raphael S. Grunfeld................... -- -- * *
Officers, Directors and Director
Nominees as a Group
(15 Persons)(14)..................... 36,736,461 36,836,461 87.5% 78.6%
</TABLE>
53
<PAGE>
- ---------------------
* Less than one percent.
(1) Percentage of beneficial ownership prior to this offering is based on
4,683,237 shares of common stock and 27,621,982 shares of Class A stock
outstanding at June 25, 1999 plus 9,420,000 shares of Class A stock
issuable upon conversion of the Series A convertible preferred stock at
the same date and the exercise of 272,400 warrants to purchase our common
stock. Percentage of beneficial ownership after this offering is based on
46,797,619 total shares outstanding, which includes all shares outstanding
prior to this offering, plus 4,800,000 shares of common stock to be sold
in this offering at an assumed price of $10 per share. All percentage
calculations assume that all shares of Net2Phone's Class A stock have been
converted into shares of Net2Phone's common stock.
(2) All of the shares held by IDT are Class A stock. IDT has pledged its
shares as collateral to secure a credit facility. The lenders under the
credit facility have agreed to release IDT's shares from collateral to
permit IDT to transfer our shares free and clear of any liens as and when
IDT seeks to transfer our shares. Such transferability will cease if IDT's
ownership of our capital stock drops below 50% of the capital stock owned
by IDT 72 hours after the consummation of this offering. Unless IDT
defaults in its obligations under the pledge agreement, it has the voting
rights with respect to the pledged stock. In addition, in connection with
the employment agreement between IDT, Mr. Sobel and Net2Phone, IDT will
transfer to Mr. Sobel the number of shares of stock upon consummation of
this offering that is necessary to maintain Mr. Sobel's percentage
ownership of our outstanding stock, together with a trust for the benefit
of his offspring, at 8%.
(3) Howard S. Jonas, together with a number of entities formed for the benefit
of charities and members of his family, owns shares of IDT's capital stock
that enable him to vote more than 50% of IDT's capital stock. As a result,
he may be deemed to be the beneficial owner of the shares of Net2Phone
capital stock owned by IDT. Mr. Jonas disclaims beneficial ownership of
these shares.
(4) James A. Courter, one of our directors, is the President, Vice Chairman
and a director of IDT. As a result, in addition to the 36,000 shares of
our common stock that he holds directly, he may be deemed to be the
beneficial owner of the shares of Net2Phone capital stock owned by IDT.
Mr. Courter disclaims beneficial ownership of these additional shares.
(5) Includes 4,415,400 shares of Class A stock and 88,308 shares of common
stock issuable upon conversion of shares of Series A convertible preferred
stock and presently exercisable warrants, respectively, that have been
issued to SOFTBANK Technology Ventures IV, L.P. Also includes 84,600
shares of Class A stock and 1,692 shares of common stock issuable upon
conversion of shares of Series A preferred stock and presently exercisable
warrants, respectively, that have been issued to SOFTBANK Technology
Advisors Fund L.P.
(6) Gary E. Rieschel is the Executive Managing Director of SOFTBANK Technology
Ventures, and as a result, he may exercise the power to vote and to
dispose of the shares held by SOFTBANK.
(7) Shares owned after the offering include 10,000, 67,050, 30,000, 15,000,
10,000 and 10,000, shares of common stock that will be issuable upon the
exercise of stock options that we expect to issue to Messrs. Rieschel,
Balter, Greenblatt, Goldberg, Mellor and Oxman, respectively, upon the
closing of this offering that will be immediately exercisable.
(8) Clifford M. Sobel transferred 1% of our common stock to a trust for the
benefit of his offspring. All of these shares are deemed to be
beneficially owned by Mr. Sobel. In addition, in connection with the
employment agreement between IDT, Mr. Sobel and Net2Phone, IDT will
transfer to Mr. Sobel the number of shares of stock upon consummation of
this offering that is necessary to maintain Mr. Sobel's percentage
ownership of our outstanding stock, together with a trust for the benefit
of his offspring, at 8%.
(9) Includes 2,250,000 shares of Class A stock and 45,000 shares of common
stock issuable upon conversion of shares of Series A convertible preferred
stock and issuable upon exercise of presently exercisable warrants,
respectively.
(10) Includes 1,125,000 of Class A stock issuable upon conversion of shares of
Series A convertible preferred stock that are held of record by GE Capital
Equity Investments, Inc., which shares beneficial ownership with its
parent General Electric Capital Corporation, which is a wholly-owned
subsidiary of the General Electric Company. Also includes 1,125,000 shares
of Class A stock issuable upon exercise of shares of Series A convertible
preferred stock that are beneficially owned by NBC, a wholly-owned
indirect subsidiary of the General Electric Company, of which 300,000
shares are issuable upon conversion of shares of Series A convertible
preferred stock that are held of record by Snap! LLC, an Internet portal
service of NBC and CNET, Inc. Includes 22,500, 16,500 and 6,000 shares of
common stock issuable upon exercise of warrants held by GE Capital Equity
Investments, NBC and Snap! LLC, respectively. Includes the purchase by NBC
of 300,000 shares in this offering and the purchase by GE Capital of
200,000 shares in this offering.
(11) Includes 360,000 shares held of record by a trust for the benefit of
Mr. Balter's family members, of which Mr. Balter and his spouse are the
trustees. Also includes an aggregate of 183,840 shares held of record by
trusts for the benefit of the family members of Messrs. Greenblatt, Slasky
and Rothberg, for which Mr. Balter acts as trustee.
(12) Includes 54,000 shares held of record by a trust for the benefit of Mr.
Greenblatt's family members, of which Mr. Balter is the trustee.
(13) Includes 72,000 shares held of record by a trust for the benefit of Mr.
Goldberg's family members, of which Mr. Goldberg's spouse is the trustee.
(14) Includes the shares of Class A stock held by IDT and the shares of Class A
stock and the shares of common stock issuable upon exercise of presently
exercisable warrants held by SOFTBANK. Also includes 195,050 shares of
common stock that will be granted to our directors and executive officers
upon the closing of this offering. Includes the issuance of 153,333
options to Mr. Fram prior to the offering. Includes the purchase by Mr.
Fram of 100,000 shares in this offering.
54
<PAGE>
CERTAIN TRANSACTIONS
We believe that all of the transactions set forth below were made on an
arms-length basis. All future transactions between us and our officers,
directors, principal stockholders and affiliates will be approved by a majority
of the board of directors, including a majority of the outside directors, and
will continue to be on terms no less favorable to us than could be obtained
from unaffiliated third parties.
Relationship with IDT
Upon the closing of this offering, IDT will own approximately 58.2% of our
capital stock. IDT owns Class A stock that has twice the voting power of our
common stock. Therefore, upon the closing of this offering, IDT will control
65.2% of our vote. Since inception, we have received various services from IDT,
including administration (accounting, human resources, legal), customer
support, telecommunications and joint marketing. IDT has also provided us with
the services of a number of its executives and employees. In consideration for
these services, IDT has historically allocated a portion of its overhead costs
related to those services to us. We believe that the amounts allocated to us
have been no greater than the expenses we would have incurred if we obtained
those services on our own or from unaffiliated third parties. Prior to the
execution of the agreements with IDT described below, none of these services
had been provided to us pursuant to any written agreement.
We entered into a suite of agreements with IDT in May 1999, including an
assignment agreement, a separation agreement, an IDT services agreement, a
Net2Phone services agreement, a tax sharing and indemnification agreement, a
joint marketing agreement and an Internet/telecommunications agreement.
Assignment Agreement
In connection with this agreement, IDT assigned to us certain proprietary
products, information, patent applications, trademarks and related intellectual
property rights used in connection with our business. IDT also licensed to us
certain proprietary business information that relates to our business. We
licensed back to IDT certain software that IDT will use in connection with its
business.
IDT Services Agreement
In connection with this agreement, IDT will continue to provide us with
various administrative services, including general accounting services, payroll
and benefits administration and customer support.
. General Accounting Services. IDT will provide us with accounts payable
services and general ledger services. IDT will charge us cost plus 20%
for these services. This portion of the IDT services agreement may be
cancelled by either party on 30-days prior written notice and may be
renewed by mutual agreement of the parties.
. Payroll and Benefits Administration. IDT will administer our payroll.
Until we terminate this agreement or establish our own benefit plan for
our employees, our employees will continue to be covered under IDT's
health insurance policies. We will pay IDT for administering our payroll
and benefits plans at IDT's cost plus 20%. Additionally, we will
reimburse IDT for the employer's cost of health insurance attributable
to each of our employees participating in IDT's group health insurance
plan and for any other direct costs attributable to our employees'
participation in IDT's benefit plans.
. Customer Support. IDT has agreed to provide customer support services to
our customers on a cost-plus 20% basis.
In the event we request additional services from IDT and IDT agrees to
provide those services, we will enter into an addendum to the IDT Services
Agreement covering those services. We will negotiate in good faith any fees
payable to IDT for those additional services.
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Net2Phone Services Agreement
In connection with this agreement, we will support IDT's debit card
platform, provide technical support for the debit card platform, order lines to
handle calls, manage the debit card database and monitor the network, 24 hours
per day, seven days per week. We will provide these services at the greater of
cost-plus 20% and $.0025 per minute of IDT usage of the debit card platform. In
addition, IDT will reimburse us for all of our direct costs in connection with
the acquisition, maintenance or support of any and all additional or
replacement equipment needed for the debit card platform.
The Net2Phone services agreement has an initial term of one year, which
automatically renews for subsequent one-year periods unless one party gives the
other 30-days prior written notice. In addition, following the initial term,
the Net2Phone services agreement may be terminated at any time at either
party's option upon 30-days prior written notice.
In the event IDT requests services in addition to those described in the
Net2Phone services agreement and we agree to provide those services, we will
enter into an addendum to the Net2Phone services agreement covering those
services. We will negotiate in good faith any fees payable to us for those
additional services.
Tax Sharing and Indemnification Agreement.
In connection with this agreement, IDT and Net2Phone will share certain past
tax liabilities and benefits, including:
. the allocation and payment of taxes for periods during which we and our
subsidiaries, if any, were included in the same consolidated group with
IDT for federal income tax purposes, and are, or were, included in the
same consolidated, combined or unitary returns for state, local or
foreign tax purposes;
. the allocation of responsibility for the filing of tax returns;
. the conduct of tax audits and the handling of tax controversies; and
. various related matters.
For periods during which we and our subsidiaries, if any, were or are
included in IDT's consolidated federal income tax returns or state, local or
foreign consolidated, combined, or unitary tax returns, we are required to pay
an amount of tax equal to the amount we would have paid had we and our
subsidiaries, if any, had filed a tax return as a separate affiliated group of
corporations filing a consolidated federal income tax return or state, local or
foreign consolidated, combined, or unitary tax returns. We are responsible for
our own separate tax liabilities that are not determined on a consolidated or
combined basis with IDT.
As a result of leaving the IDT consolidated group, certain tax attributes of
the IDT group attributable to our operations, such as net operating loss
carryforwards, may be allocated to us. The tax sharing and indemnification
agreement obligates us, where permitted by law, to elect to carry any post-
deconsolidation losses forward, rather than to carry back such losses to tax
years when we were included in the IDT consolidated or combined returns.
We were included in IDT's consolidated group for federal income tax purposes
from our incorporation in October 1997 until May 1999 when we concluded the
sale of our Series A convertible preferred stock. Each corporation that is a
member of a consolidated group during any portion of the group's tax year is
jointly and severally liable for the federal income tax liability of the group
for that year. While the tax sharing and indemnification agreement allocates
tax liabilities between us and IDT during the period on or prior to the closing
date of this offering, in which we are included in IDT's consolidated group, we
could be liable in the event federal tax liability allocated to IDT is
incurred, but not paid, by IDT or any other member of
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IDT's consolidated group for IDT's tax years that include such periods. In such
event, we would be entitled to seek indemnification from IDT pursuant to the
tax sharing and indemnification agreement.
Joint Marketing Agreement.
In connection with this agreement, we agreed to:
. continue to offer links to the other's Web site;
. cross-sell one another's products, including through their promotional
materials and customer services representatives; and
. undertake additional promotions as to which the parties shall agree from
time to time.
IDT will pay to us a fee of $8.00 for each of our customers who becomes a
new customer of IDT as a result of our referral. We will pay IDT a fee of $8.00
for each customer of IDT who becomes a new customer of ours as a result of an
IDT referral. However, in either case, these fees will be payable only with
respect to any new customer who incurs and pays $50.00 or more in charges.
The joint marketing agreement has an initial term of one year, which
automatically renews for subsequent one-year periods unless one party gives the
other party 60-days prior written notice. In addition, following the initial
term, the joint marketing agreement may be terminated at any time at either
party's option upon 60-days prior written notice.
Internet/Telecommunications Agreement.
IDT has granted us an indefeasible right to use portions of its current
high-speed network. We have the right to terminate portions of the existing
network to the extent that the existing network is replaced, the underlying
leases expire or at anytime with IDT's consent. We are obligated to reimburse
IDT for all termination or cancellation charges which it incurs. We have agreed
to pay IDT $60,000 per month for the right to use those portions of its
existing network. This amount will be reduced as IDT terminates portions of the
existing network at our request. IDT also granted us an indefeasible right to
use portions of a new DS3 Network, which it will have the right to use for 20
years. This grant will be effective as construction of this new network is
completed and delivered to IDT. This network has been pledged by IDT to the
lenders under a credit facility. We have agreed to pay IDT an installation fee
of $600,000 for this network, which we will pay as each portion of the new
network is delivered. We also will reimburse IDT for the one-time fee of
approximately $6.0 million payable in monthly installments over a five-year
period, with interest of 9% per annum. We will reimburse IDT for all of
maintenance and upgrade costs incurred by IDT with respect to those portions of
the network that we use.
Further, IDT has granted us a right to use IDT's equipment and other assets
at its backbone points of presence and its network operations center for a two-
year period. We will pay IDT an aggregate of $1.2 million for this right over
the two-year period. At the end of the two-year period, we have the right to
purchase any of this equipment then owned by IDT at fair market value. We must
pay for all repairs, maintenance and upgrades of equipment and other facilities
we use pursuant to this agreement.
IDT also has agreed to enter into transit relationship agreements with us
giving us access substantially identical to IDT's at five different core
locations for a period of one year commencing May 1999. Following the initial
term, the transit relationship agreements may be terminated at any time at
either party's option upon 60-days prior written notice.
IDT retains primary control over the equipment covered by this agreement but
may require assistance from us in gaining Internet access. We have agreed to
assist in facilitating access for a one-year period commencing May 1999. For
each month during the effectiveness of the agreement, IDT will pay us:
. $1.00 for each of IDT's dial-up Internet customers;
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. for each dedicated-line Internet customer, the lesser of $100.00 or 20%
of the fee IDT charges; and
. 25% of all fees charged by IDT for installation of dedicated lines.
Following the initial one year term, this agreement automatically renews for
one-year periods unless one party gives the other 60-days prior written notice
of termination.
Separation Agreement
The separation agreement with IDT provides for the following:
. Releases. This agreement provides for mutual general releases between us
and IDT for alleged liability to the date of the agreement, with certain
limited exceptions, including:
. liability specifically excluded by any of the other agreements
between us and IDT, and
. liability for unpaid amounts for products or services or refunds
owing on products or services due on a value-received basis for work
done by one party at the request or on behalf of the other.
. Indemnification by Net2Phone. We have agreed to indemnify IDT and each
of IDT's directors, officers and employees from all liabilities relating
to, arising out of or resulting from:
. our failure or the failure of any other person to pay, perform or
otherwise promptly discharge any of our liabilities in accordance
with their respective terms, and
. any breach by us of the agreements between us and IDT.
. Indemnification by IDT. IDT has agreed to indemnify us and each of our
directors, officers and employees from all liabilities relating to,
arising out of or resulting from:
. the failure of IDT or any other person to pay, perform or otherwise
promptly discharge any liabilities of IDT other than our
liabilities, and
. any breach by IDT of the agreements between us and IDT.
. Dispute Resolution. We will attempt to resolve disputes by referring
controversial matters to senior management (or other mutually agreed
upon) representatives of the parties. If these efforts are not
successful, either party may submit the dispute to mandatory, binding
arbitration. This agreement contains procedures that are intended to
expedite dispute resolution, including the selection of an arbitrator
and certain limitations on discovery. In the event that any dispute may
be in excess of $5.0 million, or in the event that an arbitration award
in excess of $5.0 million is issued, either party may submit the dispute
to a court of competent jurisdiction. If the parties disagree that the
amount in controversy is in excess of $5.0 million, the parties are
required to submit the disagreement to arbitration.
. Noncompetition; Certain Business Transactions. For a period of 36 months
commencing May 1999, IDT may not directly or indirectly, engage in the
provision of or developmental efforts related to Internet telephony
services and voice enabling Web applications anywhere in the world or
become a stockholder, partner or owner of any entity that is engaged in
such business anywhere in the world. However, subject to our approval,
which may not be unreasonably withheld, IDT may acquire a passive
interest of up to 20% in such entity so long as IDT does not assist that
entity in developing an Internet telephony business or otherwise
engaging in our business. Neither we nor IDT will have any duty to
communicate or offer any corporate opportunity to the other party and
may pursue or acquire any such opportunity for itself or direct such
opportunity to any other person.
Expenses
We have agreed to pay all third-party costs, fees and expenses relating to
this offering, all of the reimbursable expenses of the underwriters pursuant to
the underwriting agreement, all of the costs of
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producing, printing, mailing and otherwise distributing this prospectus, as
well as the underwriters' discount as provided in the underwriting agreement.
See "Underwriting." Except as expressly set forth in the agreements between us
and IDT, whether or not this offering is consummated, each party shall bear its
own respective third-party fees, costs and expenses paid or incurred in
connection with this offering.
Payable to IDT.
Since inception, IDT has provided the funds to finance our operations in the
form of advances (approximately $22.0 million as of April 30, 1999, of which we
repaid $8.0 million in May 1999). These advances have been converted into a
note that is payable in 60 monthly installments of principal and interest. $7.0
million of the proceeds of this offering will be used to prepay a portion of
the note. The balance of the note is payable in 60 monthly installments of
principal and interest at a rate of 9% per annum.
Relationship with Other Investors
Series A Subscription Agreements
Pursuant to Series A Subscription Agreements, dated as of May 13, SOFTBANK
Technology Ventures IV, GE Capital Equity Investments, America Online, Access
Technology Partners, Hambrecht & Quist and its affiliates and BT Alex. Brown
and its affiliates, purchased from us, in the aggregate, 3,140,000 shares of
Series A convertible preferred stock and warrants to purchase 180,000 shares of
our common stock, which expire upon the closing of this offering, for a net
aggregate purchase price of $29.9 million. Additionally, a warrant to purchase
92,400 shares of our common stock was issued to Hambrecht & Quist as part of
its fee as placement agent with respect to the sale of our Series A convertible
preferred stock. This warrant expires upon the closing of this offering. In
connection with the subscription agreements, we also entered into a
registration rights agreement and a stockholders agreement, each of which is
described below.
Registration Rights Agreement
The Series A investors acquired the following registration rights:
. one demand for registration at any time on or after the earlier to occur
of the second anniversary of the Series A offering or 180 days following
the consummation of this offering. This demand registration right may be
made by one or more holders of the Series A convertible preferred stock
that own at least 50% of the shares of Class A stock into which the
Series A convertible preferred stock converts. If our board of directors
determines in good faith that the demand registration would be
materially detrimental to us, we are entitled to postpone the filing of
the registration statement otherwise required to be prepared and filed
by us for a reasonable period of time, not to exceed 90 days;
. piggyback registration rights if we propose to register any securities
under the Securities Act in connection with any offering of our
securities other than a registration statement on Form S-8 or Form S-4,
subject to quantity limitations determined by underwriters if the
offering involves an underwriting; and
. two demand registrations at any time after we become eligible to
register our securities on Form S-3 (or any successor form). Holders
that beneficially own at least 20% of the shares of Class A stock into
which the Series A convertible preferred stock converts may make these
demands.
We agreed to pay all reasonable expenses incurred in connection with any
registration, filing or qualification pursuant to the Registration Rights
Agreement. We also agreed, to the extent permitted by law, to indemnify the
Series A investors against some liabilities in connection with the offering of
the shares, including liabilities arising under the Securities Act.
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Stockholders Agreement
IDT and Clifford M. Sobel, our Chairman, agreed to vote all of their shares
in favor of the election of a director nominated by SOFTBANK Technology
Ventures IV and a director nominated by GE Capital Equity Investments or NBC,
in each case for as long as either entity holds a majority of the shares of
Series A convertible preferred stock originally purchased by them or the shares
into which they are convertible.
In addition, each Series A convertible investor agreed to a lock up with
respect to their shares for a period of 180 days following this offering. The
Series A investors, IDT and Mr. Sobel also agreed not to transfer any of their
shares to any of our competitors for a period of 36 months, and thereafter only
subject to our right of first refusal. However, the stockholders agreement does
permit transfers between Series A investors.
Agreements with NBC
We signed an agreement with NBC on June 25, 1999 to purchase $1.5 million in
television advertising time on the NBC television network. We also have the
right to purchase additional spots to be telecast prior to June 30, 2000.
Additionally, on May 18, 1999, we signed a non-binding letter of intent with
NBC Multimedia, an affiliate of NBC. This letter of intent contemplates a one-
year agreement whereby we will pay NBC Multimedia $280,000 in exchange for the
integration of our services into the NBC.com and NBC Interactive Neighborhood
Web sites. Upon the closing of this offering, assuming that NBC purchases
300,000 shares in this offering, NBC will beneficially own 1,125,000 shares of
our Series A stock and 316,500 shares of our common stock.
Agreements with Netscape
We signed a series of related agreements with Netscape on January 31, 1999,
allowing us to embed our software and services in future versions of Netscape's
Internet browsers. The two-year term of our exclusive arrangement with Netscape
commences with the beta release of the next version of Netscape's Internet
browser, which we believe will occur later this year. In addition, our services
will be displayed on Netscape Netcenter and bundled with Netscape's suite of
software and software updates. We also have a right to place advertisements on
Netscape's Web site. In exchange, we will pay Netscape one-time licensing fees,
a percentage of revenue generated by calls provided through our co-branded
service and a percentage of advertising revenue generated by a co-branded Web
page. Netscape's parent company, America Online, will beneficially own
approximately 5% of our common stock upon the closing of this offering.
Agreement with Snap
We entered into an agreement with Snap on May 17, 1999. Snap, an Internet
postal service of NBC and CNET, will strategically display links to our Web
site and services on its Snap.com Web site. In addition, we are their preferred
provider of PC-to-phone services during the two-year term of this agreement.
Snap also will deliver a preset minimum number of impressions on its site and
agreed to give us the right to a certain amount of online advertising, subject
to certain conditions. In exchange, we agreed to pay Snap a one-time fee, a
percentage of revenue generated through their site and bonus payments for
customers delivered by Snap after meeting certain quotas.
Facility Leases
We have entered into leases for the use of our Hackensack facilities with
corporations that are owned and controlled by Howard S. Jonas, a member of our
board of directors and a director of IDT. Additionally, Mr. Jonas, together
with a number of entities formed for the benefit of charities and members of
his family, owns shares of IDT's capital stock that enable him to vote more
than 50% of IDT'S capital stock. As a result, he may be deemed to be the
beneficial owner of the shares of Net2Phone capital stock owned by IDT. The two
Hackensack leases run for three-year terms, beginning on March 1, 1999 with
monthly rent of $5,600 for 294-298 State Street and $9,912 for 171-173 Main
Street. We have also entered into a sublease with IDT for our Piscataway
facility, which is leased by IDT from a corporation owned and controlled by Mr.
Jonas. The Piscataway sublease runs for a three-year term, beginning in May
1999, with monthly rent of $8,400.
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Officer Loans
In May 1999, Howard S. Balter, Ilan M. Slasky, David Greenblatt, Martin
Rothberg, H. Jeff Goldberg, Jonathan Reich, and Jonathan Rand, each of whom is
an executive officer, borrowed $1,447,240, $352,800, $352,800, $352,800,
$352,800, $98,000 and $44,100, respectively, from us. All of the proceeds of
these loans were used to purchase shares of Net2Phone common stock upon the
exercise of stock options. The loans bear interest at the rate of 7.0% per
annum, and will mature in May 2001. As a condition to receiving these loans,
these officers agreed to surrender their respective right to exercise 8,862,
2,160, 2,160, 2,160, 2,160, 600 and 270 immediately exercisable options,
respectively. Additionally, in July 1999 we agreed to extend a three-year, non-
recourse, 7% loan to Jonathan Fram, our President, in the amount of $1,000,000
to purchase shares of our common stock in this offering.
Relationship with Law Firm
Ira A. Greenstein, our General Counsel and Secretary, and Raphael S.
Grunfeld, a director nominee, are partners of the law firm Morrison & Foerster
LLP, which has provided legal services to us and to IDT and its subsidiaries
since December 1996, and in connection with this offering.
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DESCRIPTION OF CAPITAL STOCK
Authorized Capital Stock
Our certificate of incorporation, as amended and restated, authorizes
247,042,089 shares of capital stock consisting of:
. 6,850,000 shares of preferred stock, $0.01 par value;
. 3,150,000 shares of Series A convertible preferred stock, $0.01 par
value;
. 37,042,089 shares of Class A stock, $0.01 par value; and
. 200,000,000 shares of common stock, $0.01 par value.
Of the shares of common stock, 4,800,000 shares of our common stock are
being offered through this prospectus. Immediately following the closing of the
offering, 10,161,429 shares of common stock and 36,636,190 shares of Class A
stock will be outstanding.
As of July 7, 1999, there were 17 holders of our Series A convertible
preferred stock, one holder of our Class A stock and 33 holders of our common
stock.
Common Stock and Class A Stock
General. The rights of holders of common stock and holders of Class A stock
are identical, except for voting rights, conversion rights and restrictions on
transferability. As of June 25, 1999, there were 4,683,129 shares of common
stock outstanding and 27,622,089 shares of Class A stock outstanding. An
additional 9,420,000 shares of Class A stock are issuable upon conversion of
our outstanding Series A convertible preferred stock.
Voting Rights. The holders of Class A stock are entitled to two votes per
share and the holders of common stock are entitled to one vote per share.
Except as otherwise required by law or as described below, holders of Class A
stock and common stock will vote together as a single class on all matters
presented to the stockholders for their vote or approval, including the
election of directors. Stockholders are not entitled to vote cumulatively for
the election of directors, and no class of outstanding capital stock acting
alone is entitled to elect any directors. IDT will hold 58.2% of our Class A
stock upon consummation of this offering. Accordingly, IDT will retain
effective control of us through holding approximately 65.2% of the combined
voting power of our outstanding capital stock. Therefore, IDT has the ability
to elect all of our directors and to effect or prevent certain corporate
transactions which require majority approval of the combined classes, including
mergers and other business combinations.
Transfer Restrictions. Class A stock is subject to certain limitations on
transferability that do not apply to the common stock. Our certificate of
incorporation provides that shares of Class A stock automatically convert into
an equal number of shares of common stock if there is a transfer of shares of
Class A stock to a person other than a permitted transferee. Thereafter, such
shares of common stock may be freely transferred, subject to restrictions
imposed under applicable securities laws. Shares of Class A stock acquired by
us will be canceled and may not be reissued.
Dividends and Liquidation. Holders of Class A stock and holders of common
stock have an equal right to receive dividends when and if declared by the
board of directors out of legally available funds. In the event of a
liquidation, dissolution or winding up, holders of the shares of Class A stock
and common stock are entitled to share equally, share-for-share, in the assets
available for distribution after payment of all creditors and the liquidation
preferences of our preferred stock.
Optional Conversion Rights. Each share of Class A stock may, at any time and
at the option of the holder, be converted into one fully paid and non-
assessable share of common stock. Upon conversion, such shares of common stock
would not be subject to restrictions on transfer that applied to the shares of
Class A
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stock prior to conversion except to the extent such restrictions are imposed
under applicable securities laws. The shares of common stock are not
convertible into or exchangeable for shares of Class A stock or any other
shares or securities.
Other Provisions. Holders of Class A stock and common stock have no
preemptive rights to subscribe to any additional securities of any class which
we may issue and there are no redemption provisions or sinking fund provisions
applicable to either such class, nor is the Class A stock or the common stock
subject to calls or assessments by us. The rights, preferences, and privileges
of the holders of common stock and Class A stock are subject to and may be
adversely affected by, the rights of the holders of any series of preferred
stock.
Preferred Stock
Our certificate of incorporation provides that we may issue up to 10,000,000
shares of preferred stock in one or more series as may be determined by our
board of directors who may establish the number of shares to be included in
each such series, fix the designation, powers, preferences and relative rights
of the shares of each such series and any qualifications, limitations, or
restrictions thereof, and increase or decrease the number of shares of any such
series without any further vote or action by the stockholders. 3,150,000 shares
of the preferred stock have been designated as Series A. The board of directors
may authorize, without stockholder approval, the issuance of preferred stock
with voting and conversion rights that could adversely affect the voting power
and other rights of holders of common stock or Class A stock. Preferred stock
could be issued quickly with terms designated to delay or prevent a change in
our control or to make the removal of management more difficult. This could
have the effect of decreasing the market price of the common stock. In May
1999, we sold 3,140,000 shares of Series A convertible preferred stock pursuant
to Series A Subscription Agreements. All shares of the Series A convertible
preferred stock will automatically convert into 9,420,000 shares of our Class A
stock at the closing of this offering.
We believe that the ability of the board to issue one or more series of
preferred stock will provide us with flexibility in structuring possible future
financings and acquisitions, and in meeting other corporate needs that might
arise. The authorized shares of preferred stock, as well as shares of common
stock, will be available for issuance without further action by our
stockholders, unless such action is required by applicable law or the rules of
any stock exchange or automated quotation system on which our securities may be
listed or traded.
Although the board has no intention at the present time of doing so, it
could issue a series of preferred stock that could, depending on the terms of
such series, impede the completion of a merger, tender offer or other takeover
attempt. The board will make any determination to issue such shares based on
its judgment as to our best interests and the best interests of our
stockholders. The board could issue preferred stock having terms that could
discourage an acquisition attempt through which an acquirer may be able to
change the composition of the board, including a tender offer or other
transaction that some, or a majority, of our stockholders might believe to be
in their best interests or in which stockholders might receive a premium for
their stock over the then current market price.
Certain Anti-Takeover Effects. Certain provisions of the certificate of
incorporation and bylaws, summarized in the following paragraphs, may be
considered to have an anti-takeover effect and may delay, deter or prevent a
tender offer, proxy contest or other takeover attempt that a stockholder might
consider to be in such stockholder's best interest, including such an attempt
that might result in payment of a premium over the market price for shares held
by stockholders.
The certificate of incorporation and bylaws provide for the board of
directors to be divided into three classes of directors serving staggered
three-year terms upon the consummation of this offering. As a result,
approximately one-third of the board of directors will be elected each year.
Classification of the board of directors expands the time required to change
the composition of a majority of directors and may tend to
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discourage a proxy contest or other takeover bid for us. Moreover, under the
Delaware General Corporation Law, in the case of a corporation having a
classified board of directors, the stockholders may remove a director only for
cause.
The certificate of incorporation provides that a special meeting of
stockholders may be called by any of the following:
. the chairman of our board;
. our president;
. any of our vice presidents; or
. our secretary.
In addition, a special meeting of stockholders may be called by any such
officer at the written request of a majority of the board of directors or at
the written request of stockholders owning a majority of our capital stock
issued and outstanding and entitled to vote.
Section 203 of the Delaware General Corporation Law provides that, subject
to certain exceptions specified therein, an "interested stockholder" of a
Delaware corporation shall not engage in any business combinations, including
mergers or consolidations or acquisitions of additional shares of the
corporation, with the corporation for a three-year period following the date
that such stockholder becomes an interested stockholder unless:
. prior to such date, the board of directors of the corporation
approved either the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder;
. upon consummation of the transaction that resulted in the
stockholder becoming an "interested stockholder," the interested
stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced
(excluding certain shares); or
. on or subsequent to such date, the business combination is approved
by the board of directors of the corporation and authorized at an
annual or special meeting of stockholders by the affirmative vote of
at least 66.67% of the outstanding voting stock that is not owned by
the interested stockholder.
Except as otherwise specified in Section 203 of the Delaware General
Corporation Law, an interested stockholder is defined to include (x) any person
that owns (or, within the prior three years, did own) 15% or more of the
outstanding voting stock of the corporation, or is an affiliate or associate of
the corporation and was the owner of 15% or more of the outstanding voting
stock of the corporation at any time within three years immediately prior to
the date of determination and (y) the affiliates and associates of any such
person.
Under certain circumstances, Section 203 of the Delaware General Corporation
Law makes it more difficult for a person who would be an interested stockholder
to effect various business combinations with a corporation for a three-year
period. We have not elected to be exempt from the restrictions imposed under
Section 203 of the Delaware General Corporation Law. However, IDT and its
affiliates are excluded from the definition of "interested stockholder"
pursuant to the terms of Section 203 of the Delaware General Corporation Law.
The provisions of Section 203 of the Delaware General Corporation Law may
encourage persons interested in acquiring us to negotiate in advance with the
board, since the stockholder approval requirement would be avoided if a
majority of the directors then in office approves either the business
combination or the transaction which results in any such person becoming an
interested stockholder. Such provisions also may have the effect of preventing
changes in our management. It is possible that such provisions could make it
more difficult to accomplish transactions that our stockholders may otherwise
deem to be in their best interests.
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Liability of Directors; Indemnification
The certificate of incorporation contains a provision that is designed to
limit directors' liability to the extent permitted by the Delaware General
Corporation Law. Specifically, directors will not be held liable
to us or our stockholders for monetary damages for any breach of fiduciary duty
as a director, except for liability as a result of:
. any breach of the duty of loyalty to us or our stockholders;
. actions or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. payment of an improper dividend or improper repurchase of our stock
under Section 174 of the Delaware General Corporation Law; or
. actions or omissions pursuant to which the director received an
improper personal benefit.
The principal effect of the limitation of liability provision is that a
stockholder is unable to prosecute an action for monetary damages against a
director of ours unless the stockholder can demonstrate one of the specified
bases for liability. The provision, however, does not eliminate or limit
director liability arising in connection with causes of action brought under
the federal securities laws. The certificate of incorporation does not
eliminate a director's duty of care. The inclusion of this provision in the
certificate of incorporation may discourage or deter stockholders or management
from bringing a lawsuit against directors for a breach of their fiduciary
duties, even though such an action, if successful, might otherwise have
benefited us and our stockholders. This provision should not affect the
availability of equitable remedies such as injunction or rescission based upon
a director's breach of the duty of care.
The bylaws also provide that we will indemnify our directors and officers,
and may indemnify any of our employees and agents, to the fullest extent
permitted by Delaware law. We are generally required to indemnify our directors
and officers for all judgments, fines, penalties, settlements, legal fees and
other expenses incurred in connection with pending, threatened or completed
legal proceedings because of the director's or officer's position with us or
another entity that the director or officer serves at our request, subject to
certain conditions, and to advance funds to its directors and officers to
enable them to defend against such proceedings.
At present, there is no pending or threatened litigation or proceeding
involving any director or officer, employee or agent of ours where such
indemnification will be required or permitted.
Transfer Agent and Registrar
American Stock Transfer & Trust Company will be the transfer agent and
registrar for the common stock.
SHARES ELIGIBLE FOR FUTURE SALE
Of the 10,161,429 shares of common stock and 36,636,190 shares of Class A
stock to be outstanding on the closing of the offering (10,939,029 shares of
common stock if the underwriters exercise their over-allotment option in full),
the 4,800,000 shares of common stock sold in the offering (5,520,000 shares if
the underwriters exercise their over-allotment option in full) will be freely
tradable without restriction under the Securities Act of 1933, except for any
such shares which may be acquired by an affiliate of ours, as that term is
defined in Rule 144 promulgated under the Securities Act of 1933. On the
closing of the offering, IDT will own 27,216,190 shares of Class A stock, which
will constitute approximately 58.2% of our outstanding capital stock
(approximately 57.2% if the underwriters exercise their over-allotment option
in full).
65
<PAGE>
Persons who are affiliates of ours will be permitted to sell the shares of
common stock that are issued in the offering only pursuant to an effective
registration statement under the Securities Act of 1933 or an exemption from
the registration requirements of the Securities Act of 1933, including
exemptions provided by Rule 144 of the Securities Act of 1933.
Upon closing of this offering, we intend to file a registration statement
for the resale of 11,040,000 shares of common stock that are authorized for
issuance under our stock option plan. We expect this registration statement to
become effective immediately upon filing. Shares issued pursuant to our stock
option plan after the effective date of this registration statement (other than
shares issued to our affiliates) generally will be freely tradable without
restriction or further registration under the Securities Act of 1933. As of the
date of this prospectus, options to purchase 5,040,000 shares of common stock
under our stock option plan have been granted, of which 1,375,218 have been
exercised. See "Management--1999 Stock Incentive Plan" for a more complete
description of our employee benefit plans.
The shares of capital stock held by IDT are deemed "restricted securities"
as defined in Rule 144 of the Securities Act of 1933, and may not be sold other
than through registration under the Securities Act of 1933 or pursuant to an
exemption from the regulations thereunder, including exceptions provided by
Rule 144 of the Securities Act of 1933. Subject to applicable law and to the
contractual restriction with the underwriters described below, IDT may sell any
and all of the shares of capital stock it owns after completion of the
offering. We, along with each of our security-holders, our directors and
executive officers, IDT and the Series A investors have agreed, for a period of
180 days after the date of this prospectus, not to offer or sell any shares of
Class A stock or common stock, subject to limited exceptions, without the prior
written consent of Hambrecht & Quist LLC. IDT's shares of our capital stock are
pledged as collateral to secure a credit facility. If IDT defaults in its
obligations under the pledge agreement, then a third party could acquire the
pledged stock and would not be subject to these agreements. See "Underwriting."
Upon closing of this offering, the holders of 9,420,000 shares of our Class
A stock, or their transferees, will be entitled to request that we register
their shares under the Securities Act. See "Certain Transactions--Relationship
with Other Investors--Registration Rights Agreement."
66
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
underwriters named below, through their representatives, Hambrecht & Quist LLC,
BT Alex. Brown Incorporated and Bear, Stearns & Co. Inc., have severally agreed
to purchase from Net2Phone the following respective number of shares of common
stock:
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Hambrecht & Quist LLC...................
BT Alex. Brown Incorporated.............
Bear, Stearns & Co. Inc.................
---------
Total................................... 4,800,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
are subject to certain conditions precedent, including the absence of any
material adverse change in our business and the receipt of certain
certificates, opinions and letters from us, our counsel and the independent
auditors. The underwriters are committed to purchase all of the shares of
common stock offered by us if they purchase any shares.
The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters. Such amounts are shown assuming
both no exercise and full exercise of the underwriters' over-allotment option
to purchase additional shares.
Underwriting Discounts and Commissions
<TABLE>
<CAPTION>
With Without
Over-Allotment Over-Allotment
Exercise Exercise
-------------- --------------
<S> <C> <C>
Per Share................................... $ $
Total....................................... $ $
</TABLE>
We estimate that the total expenses of this offering, excluding underwriting
discounts and commissions, will be approximately $1.5 million.
The underwriters propose to offer the shares of common stock directly to the
public at the initial public offering price set forth on the cover page of this
prospectus and to certain dealers at that price less a concession not in excess
of $ per share. The underwriters may allow and such dealers may reallow a
concession not in excess of $ per share to certain other dealers. After the
initial public offering of the shares, the offering price and other selling
terms may be changed by the underwriters.
We have granted to the underwriters an option, exercisable no later than 30
days after the date of this prospectus, to purchase up to 720,000 additional
shares of common stock at the initial public offering price, less the
underwriting discount set forth on the cover page of this prospectus. To the
extent that the underwriters exercise this option, each of the underwriters
will have a firm commitment to purchase approximately the same percentage
thereof which the number of shares of common stock to be purchased by it shown
in the above table bears to the total number of shares of common stock offered
hereby. We will be obligated, pursuant to the option, to sell shares to the
underwriters to the extent the option is exercised. The underwriters may
exercise this option only to cover over-allotments made in connection with the
sale of shares of common stock offered by us.
67
<PAGE>
The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, and to contribute to payments
the underwriters may be required to make in respect of these liabilities.
All of our security-holders, including the Series A investors, IDT, and our
executive officers and directors have agreed that they will not, without the
prior written consent of Hambrecht & Quist LLC, offer, sell or otherwise
dispose of any shares of capital stock, options or warrants to acquire shares
of capital stock or securities exchangeable for or convertible into shares of
capital stock owned by them for a period of 180 days following the date of this
prospectus. We have agreed that we will not, without the prior written consent
of Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of
capital stock, options or warrants to acquire shares of capital stock or
securities exchangeable for or convertible into shares of capital stock for a
period of 180 days following the date of this prospectus, except that we may
issue shares upon the exercise of options and warrants granted prior to the
date hereof, and may grant additional options under our stock option plans.
Without the prior written consent of Hambrecht & Quist LLC, any additional
options granted shall not be exercisable during this 180-day period.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the common stock at levels above those which might otherwise prevail in the
open market, including by entering stabilizing bids, effecting syndicate
covering transactions or imposing penalty bids. A stabilizing bid means the
placing of any bid or effecting of any purchase, for the purpose of pegging,
fixing or maintaining the price of the common stock. A syndicate covering
transaction means the placing of any bid on behalf of the underwriting
syndicate or the effecting of any purchase to reduce a short position created
in connection with the offering. A penalty bid means an arrangement that
permits the underwriters to reclaim a selling concession from a syndicate
member in connection with the offering when shares of common stock sold by the
syndicate member are purchased in syndicate covering transactions. Such
transactions may be effected on the Nasdaq National Market, in the over-the-
counter market, or otherwise. Such stabilizing, if commenced, may be
discontinued at any time.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price for the common stock will be
determined by negotiations among us and the representatives. Among the factors
to be considered in determining the initial public offering price will be
prevailing market and economic conditions, our revenue and earnings, market
valuations of other companies engaged in activities similar to our business
operations and our management. The estimated initial public offering price
range set forth on the cover of this preliminary prospectus is subject to
change as a result of market conditions or other factors.
At our request the underwriters have reserved at the initial public offering
price the number of shares of common stock that may be purchased for $3.0
million for sale to NBC and the number of shares of common stock that may be
purchased for $2.0 million for sale to GE Capital. Based upon the low end of
the estimated range on the front cover of this prospectus, NBC may therefore
purchase up to 300,000 shares of our common stock and GE Capital may therefore
purchase up to 200,000 shares of our common stock. NBC and GE Capital have
expressed an interest in purchasing these shares, which will be subject to a
lock-up agreement that each company has entered into with the underwriters,
under which they agreed not to sell shares for 180 days after the date of this
prospectus. There can be no assurance that any of the reserved shares will be
purchased. The number of shares available for sale to the general public in
this offering will be reduced by the number of reserved shares sold. Any
reserved shares not so purchased will be offered to the general public on the
same basis as the other shares offered hereby.
68
<PAGE>
In addition, at our request, the underwriters have reserved up to 240,000
shares of common stock for sale at the initial public offering price to our
directors, officers, employees, business associates and related persons. The
number of shares of common stock available for sale to the general public will
be reduced if such persons purchase the reserved shares. Any reserved shares
which are not so purchased will be offered by the underwriters to the general
public on the same basis as the other shares offered hereby.
In connection with this offering, certain underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in our common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid of
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase
limits are exceeded.
Hambrecht & Quist LLC and persons associated with Hambrecht & Quist LLC
beneficially own 20,000 shares of Series A convertible preferred stock and
warrants to purchase 92,400 shares of common stock at an exercise price of
$3.33 per share, which warrants expire upon the closing of this offering.
Additionally, Access Technology Partners, L.P., a fund of outside investors
that is managed by a subsidiary of Hambrecht & Quist California, owns 80,000
shares of Series A convertible preferred stock.
BT Alex. Brown Incorporated and persons associated with BT Alex. Brown
Incorporated own 40,000 shares of Series A convertible preferred stock.
Additionally, Stephen A. Oxman, one of our director nominees, and a managing
director at Deutsche Bank Securities Inc., an affiliate of BT Alex. Brown
Incorporated, will receive options to purchase 10,000 shares of common stock at
the offering price upon the closing of this offering.
Denis Bovin, Vice Chairman-Investment Banking of Bear, Stearns & Co. Inc.,
owns options to purchase 75,000 shares of common stock at an exercise price of
$3.33 per share, which expire in May 2009. Addition- ally, Mr. Bovin will
receive options to purchase 50,000 shares of common stock at the offering price
upon the consummation of this offering.
Prior to the closing of this offering, each of Hambrecht & Quist LLC and
persons associated with it, BT Alex. Brown Incorporated and persons associated
with it, Denis Bovin and Stephen A. Oxman will enter into written agreements
with Net2Phone, whereby each of them will agree, for a period of one year from
the date of this prospectus, not to sell or otherwise transfer any shares of
capital stock, or options or warrants to purchase common stock, owned by them
that are deemed to be underwriting compensation.
Hambrecht & Quist LLC and BT Alex. Brown Incorporated have provided
financial advisory services to Net2Phone and IDT in the past and have received
compensation at market rates for these services.
69
<PAGE>
LEGAL MATTERS
Certain legal matters with respect to the validity of the common stock
offered hereby will be passed upon for us by Morrison & Foerster LLP, New York,
New York. Ira A. Greenstein, our General Counsel and Secretary, and Raphael S.
Grunfeld, one of our director nominees, are partners of Morrison & Foerster
LLP. Certain legal matters relating to this offering will be passed upon for
the underwriters by Brobeck, Phleger & Harrison LLP, New York, New York.
EXPERTS
The financial statements of Net2Phone, Inc. and, for the periods prior to
its incorporation, the Net2Phone division of IDT Corporation, July 31, 1997 and
July 31, 1998 and for the period from January 2, 1996 (date of inception) to
July 31, 1996 and the years ended July 31, 1997 and 1998, appearing in this
prospectus and registration statement have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and are included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act of 1933 with respect to the
common stock offered hereby. This prospectus does not contain all of the
information set forth in the registration statement, certain portions of which
are omitted as permitted by the rules and regulations of the Securities and
Exchange Commission. For further information pertaining to us and the common
stock to be sold in this offering, reference is made to the registration
statement, including the exhibits thereto and the financial statements, notes
and schedules filed as a part thereof. Statements contained in this prospectus
regarding the contents of any contract or other document referred to herein or
therein are not necessarily complete, and in each instance reference is made to
the copy of such contract or other document filed as an exhibit to the
registration statement or such other document, each such statement being
qualified in all respects by such reference.
On the closing of the offering, we will be subject to the informational
requirements of the Securities Exchange Act of 1934 and will file reports,
proxy statements and other information with the Securities and Exchange
Commission. Such reports, proxy statements and other information, as well as
the registration statement and the exhibits and schedules thereto, may be
inspected, without charge, at the public reference facility maintained by the
Securities and Exchange Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, NW, Washington, D.C. 20549, and at the Securities and Exchange
Commission's regional offices located at Seven World Trade Center, New York,
New York 10048 and Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such material may also be obtained
from the Public Reference Section of the Securities and Exchange Commission at
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Such
materials can also be inspected on the Securities and Exchange Commission's Web
site at www.sec.gov.
70
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................ F-2
Balance Sheets as of July 31, 1997 and 1998 and April 30, 1999
(Unaudited).............................................................. F-3
Statements of Operations for the period from January 2, 1996 (date of
inception) to July 31, 1996 and the years ended July 31, 1997 and 1998
and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-4
Statements of Stockholders' Deficit for the period from January 2, 1996
(date of inception) to July 31, 1996 and the years ended July 31, 1997
and 1998 and the nine months ended April 30, 1999 (Unaudited)............ F-5
Statements of Cash Flows for the period from January 2, 1996 (date of
inception) to July 31, 1996 and the years ended July 31, 1997 and 1998
and the nine months ended April 30, 1998 and 1999 (Unaudited)............ F-6
Notes to Financial Statements............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Net2Phone, Inc.
We have audited the accompanying balance sheets of Net2Phone, Inc. and, for
the periods prior to its incorporation, the Net2Phone division of IDT
Corporation (the "Company") as of July 31, 1997 and 1998, and the related
statements of operations, stockholders' deficit and cash flows for the period
from January 2, 1996 (date of inception) to July 31, 1996 and the years ended
July 31, 1997 and 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company at July 31,
1997 and 1998 and the results of its operations and its cash flows for the
period from January 2, 1996 (date of inception) to July 31, 1996 and the years
ended July 31, 1997 and 1998, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
New York, New York
May 11, 1999, except for Note 9,
the date of which is June 25, 1999
F-2
<PAGE>
Net2Phone, Inc.
BALANCE SHEETS
<TABLE>
<CAPTION>
July 31 April 30
------------------------ -----------
1997 1998 1999
----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents............. $ -- $ 10,074 $ 1,782,194
Trade accounts receivable, net........ 16,500 1,465,475 329,577
Due from IDT Corporation.............. -- -- 346,176
Prepaid contract deposits............. -- -- 4,000,000
Other current assets.................. -- -- 31,051
----------- ----------- -----------
Total current assets................ 16,500 1,475,549 6,488,998
Property and equipment, net............. 899,525 5,409,061 8,228,218
Trademark, net.......................... -- -- 5,000,000
Other assets............................ -- 90,498 101,112
----------- ----------- -----------
Total assets........................ $ 916,025 $ 6,975,108 $19,818,328
=========== =========== ===========
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable...................... $ -- $ -- $ 248,675
Deferred revenue...................... 161,001 810,114 1,495,775
Due to IDT Corporation................ 2,960,429 11,814,988 22,000,000
----------- ----------- -----------
Total current liabilities........... 3,121,430 12,625,102 23,744,450
Commitments and contingencies
Redeemable convertible preferred
stock,
Series A, $.01 par value; authorized
shares--
3,150,000; no shares issued and
outstanding.......................... -- -- --
Stockholders' deficit:
Preferred stock, $.01 par value;
authorized shares--6,850,000; no
shares issued and outstanding........ -- -- --
Common stock, $.01 par value;
authorized shares-- 200,000,000;
30,960,000 shares issued and
outstanding at July 31, 1998 and
April 30, 1999 (None at July 31,
1997)................................ -- 100,100 309,600
Class A stock, $.01 par value;
authorized shares 37,042,089; no
shares issued and outstanding........ -- -- --
Additional paid-in capital............ -- -- 4,420,338
Accumulated deficit................... (2,205,405) (5,750,094) (8,656,060)
----------- ----------- -----------
Total stockholders' deficit......... (2,205,405) (5,649,994) (3,926,122)
----------- ----------- -----------
Total liabilities and stockholders'
deficit............................ $ 916,025 $ 6,975,108 $19,818,328
=========== =========== ===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
Net2Phone, Inc.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
January 2, 1996
(date of inception) Nine months ended April
to July 31 Year ended July 31 30
------------------- ------------------------- -------------------------
1996 1997 1998 1998 1999
------------------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
(Unaudited)
Revenues:
Service revenue....... $ -- $ 2,652,303 $ 10,490,972 $ 6,439,374 $ 21,757,721
Product revenue....... -- -- 1,515,000 1,515,000 445,536
---------- ----------- ------------ ----------- ------------
Total revenue....... -- 2,652,303 12,005,972 7,954,374 22,203,257
Costs and expenses:
Direct cost of
revenue:
Service cost of
revenue*............. -- 1,547,443 6,576,523 3,317,065 11,787,689
Product cost of
revenue*............. -- 6,000 272,236 272,236 60,400
---------- ----------- ------------ ----------- ------------
Total direct cost of
revenue*........... -- 1,553,443 6,848,759 3,589,301 11,848,089
Selling and
marketing............ 34,468 76,724 2,887,766 1,363,060 4,746,316
General and
administrative....... 465,015 2,599,283 5,087,628 3,254,287 7,298,106
Depreciation.......... 8,275 120,500 726,508 421,648 1,216,712
---------- ----------- ------------ ----------- ------------
Total costs and
expenses........... 507,758 4,349,950 15,550,661 8,628,296 25,109,223
---------- ----------- ------------ ----------- ------------
Loss from operations
before provision for
income taxes........... (507,758) (1,697,647) (3,544,689) (673,922) (2,905,966)
Provision for income
taxes.................. -- -- -- -- --
---------- ----------- ------------ ----------- ------------
Net loss................ $ (507,758) $(1,697,647) $ (3,544,689) $ (673,922) $ (2,905,966)
========== =========== ============ =========== ============
Net loss per share--
basic and diluted...... $ (0.02) $ (0.06) $ (0.12) $ (0.02) $ (0.09)
========== =========== ============ =========== ============
Weighted average number
of shares used in
calculation of basic
and diluted net loss
per share.............. 27,864,000 27,864,000 30,186,000 29,928,000 30,960,000
========== =========== ============ =========== ============
</TABLE>
- --------
* Excludes depreciation and amortization
See accompanying notes.
F-4
<PAGE>
Net2Phone, Inc.
STATEMENTS OF STOCKHOLDERS' DEFICIT
Period from January 2, 1996 (date of inception) to July 31, 1996 and the years
ended July 31, 1997 and 1998 and the nine months ended April 30, 1999
(unaudited with respect to the nine months ended April 30, 1999)
<TABLE>
<CAPTION>
Common Stock Additional Total
------------------- Paid-In Accumulated Stockholders'
Shares Amount Capital Deficit Deficit
---------- -------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Net loss for the
period January 2,
1996 (date of
inception) to July
31, 1996............. -- $ -- $ -- $ (507,758) $ (507,758)
---------- -------- ---------- ----------- -----------
Balance at July 31, 1996
....................... -- -- -- (507,758) (507,758)
Net loss for the year
ended July 31, 1997.. -- -- -- (1,697,647) (1,697,647)
---------- -------- ---------- ----------- -----------
Balance at July 31,
1997................... -- -- -- (2,205,405) (2,205,405)
Issuance of Stock to
IDT Corporation...... 27,864,000 100 -- -- 100
Sale of Common Stock
to officer........... 3,096,000 100,000 -- -- 100,000
Net loss for the year
ended
July 31, 1998........ -- -- -- (3,544,689) (3,544,689)
---------- -------- ---------- ----------- -----------
Balance at July 31,
1998................... 30,960,000 100,100 -- (5,750,094) (5,649,994)
Capital contributions
from IDT
Corporation.......... -- 209,500 4,420,338 -- 4,629,838
Net loss for the nine
months ended April
30, 1999............. -- -- -- (2,905,966) (2,905,966)
---------- -------- ---------- ----------- -----------
Balance at April 30,
1999................... 30,960,000 $309,600 $4,420,338 $(8,656,060) $(3,926,122)
========== ======== ========== =========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE>
Net2Phone, Inc.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
January 2, 1996
(date of Nine months ended
inception) Year ended July 31 April 30
to July 31 ------------------------ -----------------------
1996 1997 1998 1998 1999
--------------- ----------- ----------- ---------- -----------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss................ $(507,758) $(1,697,647) $(3,544,689) $ (673,922) $(2,905,966)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation........... 8,275 120,500 726,508 421,648 1,216,712
Changes in assets and
liabilities:
Accounts receivable.. -- (16,500) (1,448,975) (555,000) 1,135,898
Due from IDT
Corporation......... -- -- -- -- (346,176)
Prepaid contract
deposits............ -- -- -- -- (4,000,000)
Other current
assets.............. -- -- -- -- (31,051)
Other assets......... -- -- (90,498) (73,323) (10,614)
Accounts Payable..... -- -- -- -- 248,675
Deferred revenue..... -- 161,001 649,113 471,524 685,661
--------- ----------- ----------- ---------- -----------
Net cash used in
operating activities... (499,483) (1,432,646) (3,708,541) (409,073) (4,006,861)
Investing activities
Purchase of trademark... -- -- -- -- (5,000,000)
Purchases of property
and equipment.......... (182,949) (845,351) (5,236,044) (4,230,909) (4,035,869)
--------- ----------- ----------- ---------- -----------
Net cash used in
investing activities... (182,949) (845,351) (5,236,044) (4,230,909) (9,035,869)
Financing activities
Proceeds from issuance
of Common Stock to IDT
Corporation -- -- 100 100 --
Proceeds from issuance
Common Stock to
officer................ -- -- 100,000 -- --
Capital contributions
from IDT Corporation... -- -- -- -- 4,629,838
Net advances from IDT
Corporation............ 682,432 2,277,897 8,854,559 4,639,882 10,185,012
--------- ----------- ----------- ---------- -----------
Net cash provided by
financing activities... 682,432 2,277,987 8,954,659 4,639,982 14,814,850
--------- ----------- ----------- ---------- -----------
Net increase in cash and
cash equivalents....... -- -- 10,074 -- 1,772,120
Cash and cash
equivalents at
beginning of period.... -- -- -- -- 10,074
--------- ----------- ----------- ---------- -----------
Cash and cash
equivalents at end of
period................. $ -- $ -- $ 10,074 $ -- $ 1,782,194
========= =========== =========== ========== ===========
Supplemental disclosure
of cash flow
information:
Cash payments made for
interest............... $ -- $ -- $ -- $ -- $ --
========= =========== =========== ========== ===========
Cash payments made for
income taxes........... $ -- $ -- $ -- $ -- $ --
========= =========== =========== ========== ===========
</TABLE>
See accompanying notes.
F-6
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
1. Description of Business and Basis of Presentation
The accompanying financial statements reflect the historical financial
information of Net2Phone, Inc. and, for the periods prior to its incorporation,
the Net2Phone division of IDT Corporation (the "Company"), a majority owned
subsidiary of IDT Corporation ("IDT"), incorporated in October 1997, to operate
and develop its Internet telephony business. Prior to such time, the Company's
business was conducted as a division of IDT. The incorporation of Net2Phone
Inc. as a subsidiary of IDT was accounted for similar to a recapitalization.
All earnings per share calculations assume that such shares were outstanding
for all prior periods.
The Company's statements of operations include allocations of certain costs
and expenses from IDT (Note 4). Although such allocations are not necessarily
indicative of the costs that would have been incurred if the Company operated
as an unaffiliated entity, management believes that the allocation methods are
reasonable.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
Interim Financial Information
The unaudited interim information as of April 30, 1999 and for the nine
months ended April 30, 1998 and 1999 has been prepared on the same basis as the
annual financial statements and, in the opinion of the Company's management,
contains all adjustments (consisting of normal recurring accruals) necessary
for a fair presentation. Operating results for any interim period are not
necessarily indicative of results to be expected for the entire year.
Revenue Recognition
Internet telephony service revenue is recognized as service is provided.
Revenue derived from equipment sales and from services provided to IDT is
recognized upon installation of the equipment and performance of the services,
respectively. (See Note 4)
Direct Cost of Revenue
Direct cost of revenue consists primarily of telecommunication costs,
connectivity costs, and the cost of equipment sold to customers. Direct cost of
revenue excludes depreciation and amortization.
Property and Equipment
Equipment and furniture and fixtures are recorded at cost and depreciated
using the straight-line method over the estimated useful lives of the assets of
five years.
Computer software is amortized using the straight-line method over the
shorter of five years or the term of the related agreement.
F-7
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
2. Summary of Significant Accounting Policies (continued)
Advertising Costs
The Company expenses the costs of advertising as incurred. For the years
ended July 31, 1997 and 1998 and the nine months ended April 30, 1998 and 1999,
advertising expense totaled approximately $6,000, $1,962,000, $888,000, and
$3,165,000, respectively. There was no advertising expense for the period from
January 2, 1996 (date of inception) to July 31, 1996.
Software Development Costs
Costs for the internal development of new software products and substantial
enhancements to existing software products are expensed as incurred until
technological feasibility has been established, at which time any additional
costs would be capitalized. To date, the Company has essentially completed its
software development concurrently with the establishment of technological
feasibility and, accordingly, no such costs have been capitalized to date.
Software development costs are the Company's only research and development
expenditures. For the period from January 2, 1996 (date of inception) to July
31, 1996, software development costs of $340,000 were expensed. No software
development costs were expensed for the years ended July 31, 1997 and 1998 and
the nine months ended April 30, 1998 and 1999.
Capitalized Internal Use Software Costs
In March 1998, the Accounting Standards Executive Committee of the AICPA
issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. The SOP, which has been
adopted by the Company requires the capitalization of certain costs incurred in
connection with developing or obtaining internal use software. The Company's
policy prior to the adoption of the SOP was to capitalize substantially all
internal use software costs. These costs consisted of payments made to third
parties and the salaries of employees working on such software development.
Therefore, the adoption of the SOP did not have a material effect on the
Company's financial position or results of operations. At July 31, 1997 and
1998 and April 30, 1999, the Company has capitalized $493,000, $2,198,000 and
$3,598,000, respectively, of internal use software costs as computer software.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Cash and cash equivalents
are carried at cost which approximates market value.
Trademark
Costs associated with obtaining the right to use trademarks owned by third
parties are capitalized and amortized on a straight-line basis over the two
year term of the agreement.
Income Taxes
The Company accounts for income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities.
Stock Based Compensation
The Company applies the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. The Company accounts for stock options
using APB Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. Options issued to non-employees are accounted for in
accordance with SFAS No. 123.
F-8
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
2. Summary of Significant Accounting Policies (continued)
Earnings (Loss) Per Share
Earnings (loss) per share is calculated in accordance with FASB Statement
No. 128, Earnings per Share. Basic earnings (loss) per share is computed by
dividing the net income (loss) applicable to common shares by the weighted
average of common shares outstanding during the period. Diluted earnings (loss)
per share adjusts basic earnings (loss) per share for the effects of
convertible securities, stock options and other potentially dilutive financial
instruments, only in the periods in which such effect is dilutive. There were
no dilutive securities in any of the periods presented herein.
Current Vulnerability Due to Certain Concentrations
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of cash, cash equivalents, and trade
receivables. Concentrations of credit risk with respect to trade receivables
are limited due to the large number of customers comprising the Company's
customer base.
Management regularly monitors the creditworthiness of its domestic and
international customers and believes that it has adequately provided for any
exposure to potential credit losses.
Recently Issued Financial Accounting Standards
SFAS No. 131, Disclosure about Segments of an Enterprise and Related
Information, was issued in June 1997. The Company will be required to adopt the
new statement for the year ending July 31, 1999. This statement requires use of
the "management approach" model for segment reporting. The management approach
model is based on the way a company's management organizes segments within the
company for making operating decisions and assessing performance. Reportable
segments are based on products and services, geography, legal structure,
management structure, or any other manner in which management disaggregates a
company. The Company intends to adopt this statement in fiscal 1999 and does
not anticipate that the adoption of the statement will have significant impact
on its financial statements.
3. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
July 31 April 30
--------------------- ----------
1997 1998 1999
--------- ---------- ----------
<S> <C> <C> <C>
Equipment............................... $ 348,625 $3,631,140 $6,094,189
Computer software....................... 679,484 2,595,572 4,118,590
Furniture and fixtures.................. 191 37,632 87,415
--------- ---------- ----------
1,028,300 6,264,344 10,300,194
Accumulated depreciation................ (128,775) (855,283) (2,071,976)
--------- ---------- ----------
Property and equipment, net............. $ 899,525 $5,409,061 $8,228,218
========= ========== ==========
</TABLE>
4. Related Party Transactions
In May 1999, the Company and IDT entered into a separation agreement whereby
the transactions and agreements necessary to govern the relationship between
the two companies necessary to effect their separation were determined. In
accordance with such agreement, it was determined that amounts paid by IDT in
excess of $22 million would be deemed to be capital contributions.
F-9
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
4. Related Party Transactions (continued)
In May 1999, the Company and IDT entered into an Internet/telecommunications
agreement whereby the Company has agreed to pay IDT up to $110,000 per month
for connectivity, the use of certain computer software and equipment owned or
leased by IDT and to provide a platform for IDT's Internet services for a
monthly per customer charge. In connection with such agreement, IDT has also
granted the Company an indefeasible right, for a period of 20 years, to use a
certain telecommunications network as it is completed and delivered for up to
approximately $6.0 million.
In May 1999, the Company and IDT entered into two one-year services
agreements whereby the Company agreed to pay IDT for certain administrative,
customer support and other services that IDT provides to it at the cost of such
services plus 20%. Also, in conjunction with such agreements, the Company has
agreed to provide IDT with certain support services for the cost of such
services plus 20%. The agreement is effective for a period of two years.
In May 1999, the Company and IDT entered into a joint marketing agreement
whereby the companies have agreed to jointly advertise and market their
products. The agreement continues for a term of one year and is automatically
renewable for an additional one year unless terminated by either party. In
conjunction with such agreement, a commission will be earned by each company
for new customers generated by the other company as a result of such programs.
In May 1999, the Company and IDT entered into an assignment agreement
whereby IDT assigned all of its rights in certain trademarks, patents and
proprietary products and information to the Company. These assets were
contributed at IDT's historical cost which was $0.
The accompanying financial statements for periods prior to the signing of
the aforementioned agreements include charges by IDT to the Company for the
aforementioned services. Such charges were based principally upon the Company's
allocable portion of IDT's costs for such services. The ratios used to allocate
these costs were the Company's total payroll to IDT's total payroll and the
Company's total revenue to IDT's total revenue, depending on the type of
services provided. The allocated costs approximate the amounts that would have
been charged under the inter-company agreements if they had been in effect
during such periods.
For the period from January 2, 1996 (date of inception) to July 31, 1996 and
the years ended July 31, 1997 and 1998 and the nine months ended April 30, 1998
and 1999, all of the Company's operations were financed by IDT.
For the years ended July 31, 1997 and 1998 and the nine months ended April
30, 1998 and 1999, the Company recognized revenue for services provided to IDT
of $297,000, $453,000, $323,000, and $680,000, respectively.
At July 31, 1997 and 1998 and April 30, 1999, the due to IDT balance
represents the net amounts owed to IDT as a result of the aforementioned
agreements and financing. No interest was charged on the Company's advances
from IDT. The average balance owed to IDT during the period from January 2,
1996 (date of inception) to July 31, 1996, the years ended July 31, 1997 and
1998, and the nine months ended April 30, 1999 and 1998 were $341,000,
$1,821,000, $7,388,000, $16,907,000 and $5,280,000, respectively.
F-10
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
4. Related Party Transactions (continued)
The activity in the intercompany account with IDT was as follows:
<TABLE>
<CAPTION>
Period from Nine months
January 2, 1996 Year Ended July 31 ended
(date of inception) ----------------------- April 30,
to July 31, 1996 1997 1998 1999
------------------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Opening balance......... $ -- $ 682,432 $ 2,960,429 $11,814,988
Expenses paid by IDT on
behalf of the Company,
net of cash received... 315,565 1,225,771 6,955,525 7,234,992
Net charges to the
Company for services
provided by IDT........ 366,867 1,349,226 2,351,934 3,420,520
Revenue recognized by
the Company for
services provided to
IDT.................... -- (297,000) (453,000) (680,000)
Capital contribution
from IDT............... -- -- 100 209,500
-------- ---------- ----------- -----------
Ending balance.......... $682,432 $2,960,429 $11,814,988 $22,000,000
======== ========== =========== ===========
</TABLE>
5. Income Taxes
The Company files a consolidated Federal income tax return with IDT and has
entered into a tax sharing agreement with IDT. Pursuant to such tax sharing
agreement, the Company would, while included in the IDT consolidated tax
return, be reimbursed for the use of its tax losses to the extent IDT realizes
a tax reduction from the use of such tax losses. When IDT's ownership interest
in the Company falls below 80%, the Company will no longer be a part of the
IDT consolidated Federal tax group.
Significant components of the Company's deferred tax assets and liabilities
consists of the following:
<TABLE>
<CAPTION>
July 31 April 30
------------------ ---------
1997 1998 1999
-------- --------- ---------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......... $ -- $ 314,000 $ 670,000
Deferred tax liabilities:
Depreciation.............................. -- (300,000) (609,000)
-------- --------- ---------
Net deferred tax assets................... -- 14,000 61,000
Valuation allowance....................... -- (14,000) (61,000)
-------- --------- ---------
Total deferred tax assets................. $ -- $ -- $ --
======== ========= =========
</TABLE>
The net deferred tax assets have been fully offset by a valuation allowance
due to the uncertainty of the realization of the assets.
At April 30, 1999, the Company had net operating loss carryforwards for
state income tax purposes of approximately $7.5 million expiring in years
through 2006. These net operating loss carryforwards may be limited to future
taxable earnings of the Company.
<TABLE>
<CAPTION>
Period from Year Ended Nine Months
January 2, 1996 July 31 Ended April 30
(date of inception) -------------------- ------------------
to July 31, 1996 1997 1998 1998 1999
------------------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Tax at effective rate... (173,000) (577,000) (1,205,000) (229,000) (988,000)
Benefit used by IDT for
which the Company
received no
compensation........... 173,000 577,000 1,205,000 229,000 988,000
-------- -------- ---------- -------- --------
Tax provision........... -- -- -- -- --
======== ======== ========== ======== ========
</TABLE>
F-11
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
6. Stockholders' Deficit
In April 1999, the Company amended and restated its Certificate of
Incorporation (the "Amendment"). As a result of the Amendment, the Company
increased its authorized shares of capital stock from 1,500 to 110,000,000, of
which 100,000,000 shares are designated as common stock and 10,000,000 shares
are designated as preferred stock.
Subject to any voting rights which may be provided to future holders of
preferred stock, the holders of common stock have exclusive voting rights on
all matters requiring a vote of the Company and are entitled to one vote per
share of common stock held.
In conjunction with the Amendment, the Company effectuated a 10,320 for one
stock split. The accompanying financial statements give retroactive effect to
the stock split.
7. Commitments
On February 8, 1998, the Company entered into an agreement with an Internet
company to develop a link between its Internet site and that of the Company and
advertise Company products on such site. The agreement is effective for fifteen
months upon the completion of the link and automatically extends for an
additional one year unless terminated by either party. Pursuant to such
agreement, the Company has made payments of $2.85 million through April 30,
1999 for the design, development, installation and implementation of the link
as well as the placement of Company advertisements on the Internet company's
site, of which $750,000 attributable to the establishment of such link was
deferred and is being amortized over the term of the agreement and $2.1 million
attributable to monthly payments for advertising and the maintenance of the
link was expensed monthly as incurred. As of April 30, 1999, the Company was
required to make an additional payment of $150,000 in fiscal 1999 and pay
certain future commissions, as defined, based upon revenue earned and usage of
the link.
On August 4, 1998, the Company entered into an agreement with an Internet
company to advertise Company products on its Internet site. The agreement is
effective as of October 1, 1998, the launch date of the link, and extends
indefinitely until the Internet company fully provides all advertising
impressions guaranteed under the agreement. Pursuant to such agreement, the
Company has made payments of $495,000 through April 30, 1999 for the Company
advertisements on such site. As of April 30, 1999, the Company is required to
make additional payments of $213,000 in fiscal 1999, $975,000 in fiscal 2000,
and $167,000 in fiscal 2001 and pay certain future commissions, as defined,
based upon revenue earned and usage of the link. Advertising expense is
recorded as payments are made, over two years, which the Company believes is
the period over which the guaranteed advertising impressions will be provided.
On February 19, 1999, the Company entered into an agreement under which an
international computer company is to provide connections to its global network.
These connections will allow worldwide transport of the Company's IP traffic.
The agreement is effective for 63 months upon availability of the connections.
Pursuant to such agreement, the Company has made payments of $1 million through
April 30, 1999 which have been reflected on the consolidated balance sheets as
prepaid contract deposits. As of April 30, 1999, the Company is required to
make an additional payment of $1 million when the connections are available and
pay fees for additional connections and usage. The $2 million of prepayments
will be amortized over the term of the agreement beginning at the time the
connections are available for use.
F-12
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
7. Commitments (continued)
On January 31, 1999, the Company entered into a series of agreements with a
third party. The agreements call for the bundling of the Company's Internet
telephony products with the third party's Internet browser, the purchase of
software from the third party and the use the third party's trademark. The
agreements require the Company to pay the third party (i) $5,000,000 for the
use of the trademark (ii) $8,000,000 for the purchase of software and (iii)
commissions on revenues generated from customers that the Company obtains from
the bundling of products. Through April 30, 1999, the Company had paid $5
million for the right to use the trademark and $3 million for certain software.
The Company has capitalized the costs of the right to use the trademark and the
software costs and will amortize them over the term of the bundling agreement
which expires two years after the release of the bundled product.
The Company has distribution agreements under which it has agreed to pay its
agents commissions for obtaining new Internet telephony customers. The
agreements require commissions upon activation of the customers.
In May 1997, the Company entered into a three year employment agreement with
one of its officers. Under the terms of such agreement, which was amended in
May 1999, the Company agreed to, among other things, provide such officer with
an annual salary of $100,000 and the right to purchase a 10% interest in the
Company for $100,000, which was the fair market value of the Company at that
time. Such right, which includes an anti-dilutive provision mandating that the
officer's ownership interest cannot be diluted below 8% of the total
outstanding shares upon consummation of an initial public offering of the
Company's common stock, was exercised during fiscal 1998. The agreement is
automatically renewable on an annual basis after its initial three year term
unless terminated by either party.
8. Customer and Geographical Area
Revenue from customers outside the United States represented approximately
44%, 72%, 63%, and 58% of total revenue during the years ended July 31, 1997
and 1998 and the nine months ended April 30, 1998 and 1999, respectively.
During the year ended July 31, 1998 and the nine months ended April 30, 1998,
revenues derived from equipment sales to a customer in Korea represented
approximately 14% and 19%, respectively, of total revenue. No single geographic
area accounted for more than 10% of total revenue during the year ended July
31, 1997 and the nine months ended April 30, 1999. No customer accounted for
more than 10% of revenue during the year ended July 31, 1997 and the nine
months ended April 30, 1999.
9. Subsequent Events
On June 25, 1999, the Company effectuated a three-for-one stock split. The
financial statements give retroactive effect to the stock split. In addition,
the Company designated 15,000,000 shares of its capital stock as Class A stock.
The holders of Class A stock are identical to those of common stock except for
voting and conversion rights and restrictions or transferability. The Class A
stock is entitled to two votes per share.
In March 1999, the Company entered into two lease agreements with companies
which are owned by the Chairman, Chief Executive Officer and Treasurer of IDT.
Pursuant to such lease agreements, the Company is required to make equal
monthly rental payments aggregating $558,000 to such companies through February
2002.
F-13
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
9. Subsequent Events (continued)
On May 12, 1999, the Company converted a portion of its liability to IDT
into a $14,000,000 promissory note. Such promissory note accrues interest at a
rate of 9% per annum and is payable in 60 equal monthly installments of
principal and interest. Notwithstanding the foregoing, $7,000,000 in principal
will be repaid within 10 days of the consummation of a proposed initial public
offering of the Company's common stock.
On May 13, 1999, the Company designated 3,150,000 shares of its preferred
stock as Series A ("Series A Stock") and sold 3,140,000 of such shares to
unrelated third parties in a private placement transaction for aggregate gross
proceeds of $31,400,000.
The Series A Stock entitles its holders to a non-cumulative dividend of 8%
per annum on the original issue price. Each share of Series A Stock is
convertible into three shares of Class A stock at the option of the holder,
subject to certain adjustments as, defined. Each share of Series A stock also
entitles its holders to vote on corporate matters on an as if converted basis.
Holders of Series A Stock have priority over common stock and Class A stock
with respect to the payment of dividends and in the event of the liquidation or
dissolution of the Company.
The liquidation preference of the Series A Stock is equivalent to the
original issue price plus an amount equal to 8% of the original issue price
compounded on an annual basis from the date of issuance plus any declared, but
unpaid dividends.
In connection with the sale of Series A Stock, the Company granted warrants
to purchase 272,400 shares of common stock at an exercise price of $3.33 per
share, subject to certain adjustments as defined, from the date of issuance
through May 13, 2004 to the Series A Stock investors and placement agent. The
warrants contain a provision whereby they are automatically terminated upon a
merger or sale of the Company or an initial public offering of the Company's
stock. As a result, the warrants are expected to be exercised prior to the
proposed initial public offering of the Company's common stock.
In April 1999, the Company adopted a stock option and incentive plan (the
"Plan"). Pursuant to the Plan, the Company's officers, employees and non-
employee directors, as well as those of IDT, are eligible to receive awards of
incentive and non-qualified stock options, stock appreciation rights, limited
stock appreciation rights and restricted stock.
In May 1999, a total of 5,040,000 shares of common stock were authorized for
issuance under the plan to employees of the Company and to employees and
consultants of IDT, all of which were granted with an exercise price of $3.33
per share and 1,345,219 of which were exercised through June 25, 1999. The
options generally vest over periods up to four years and expire ten years from
the date of grant. In connection with the exercise of such options, the Company
extended $3,150,000 in loans to employees. In order to obtain such loans, the
optionees agreed to the cancellation of 23,382 outstanding options.
Compensation expense in connection with the options to purchase 3,718,503
shares of common stock issued to employees of the Company will be computed in
accordance with APB 25. The expense will be computed as the difference between
the exercise price of $3.33 per share and the fair market value of the stock on
the date of grant ($1 per share). The deferred compensation expense of
approximately $28.5 million will be amortized over the vesting period of the
options. Compensation expense in connection with the options to purchase
1,321,497 shares of common stock issued to employees and consultants of IDT
will be computed in accordance with
F-14
<PAGE>
Net2Phone, Inc.
NOTES TO FINANCIAL STATEMENTS--(Concluded)
July 31, 1998 (unaudited with respect to the
nine months ended April 30, 1998 and 1999)
9. Subsequent Events (continued)
FAS 123. The expense will be computed using the black scholes model with the
fair market value of the common stock on date of grant equal to $11.00 per
share. The deferred compensation expense of approximately $12.4 million will be
amortized over the vesting period of the options. Compensation expense from
both the options issued to the Company's employees and employees and
consultants to IDT will be charged to expense over the vesting period: fiscal
1999, $14.8 million; fiscal 2000, $9.8 million; fiscal 2001, $9.8 million; and
fiscal 2002, $6.5 million. On June 25, 1999 the shares authorized for issuance
under the plan was increased by 6,000,000 shares.
The Company entered into an agreement with Snap, an Internet postal service
of NBC and CNET, on May 17, 1999. Snap will display links to the Company's Web
site and services on its Snap.com Web site. In addition, the Company is Snap's
preferred provider of PC-to-phone services during the two-year term of this
agreement. Snap also will deliver a preset minimum number of impressions on its
site and agreed to give the Company the right to advertise on its Snap.com Web
site, subject to certain conditions. In exchange, the Company agreed to pay
Snap a one-time fee, a percentage of revenue generated through their site and
bonus payments for customers delivered by Snap after meeting certain quotas.
The Company will amortize the up front payment over the term of the agreement.
The Company signed an agreement with NBC on June 25, 1999 to purchase $1.5
million in television advertising time on the NBC television network. The
Company also has the right to purchase additional spots to be telecast prior to
June 30, 2000. The cost of the advertising will be expensed as the spots are
shown.
On July 2, 1999, the Company signed a three-year employment agreement with
its new President. After the initial term, the agreement may be renewed
annually. The Company will pay its President an annual base salary of $350,000
and he is entitled to receive an annual bonus calculated on the basis of the
Company's gross revenue, which bonus could be up to $100,000. The Company
granted its President options to purchase 920,000 shares of its common stock
under its 1999 Stock Option and Incentive Plan. Of these options, 460,000 were
granted at an exercise price of $3.33 per share, 153,333 of which are vested
and exercisable. The options to purchase the remaining 460,000 shares were
granted at the lower of the initial public offering price or $11.00 per share.
Other than those options which are vested, the remaining 766,667 options will
vest in three equal annual installments, commencing on July 20, 2000. The
Company has also agreed to extend a three-year, 7% non-recourse loan to its
President in the amount of $1,000,000 to purchase shares of its common stock
upon the closing of this offering. The Company will record compensation in
connection with (i) the issuance of options with an exercise price less than
the fair market value of the stock and (ii) the non-recourse loan issued to
purchase common stock.
F-15
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
4,800,000 Shares
[NET2PHONE LOGO]
Common Stock
----------------
PROSPECTUS
----------------
HAMBRECHT & QUIST
BT ALEX. BROWN
----------------
BEAR, STEARNS & CO. INC.
----------------
, 1999
----------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
No action is being taken in any jurisdiction outside the United States to
permit a public offering of the common stock or possession or distribution of
this prospectus in that jurisdiction. Persons who come into possession of this
prospectus in jurisdictions outside the United States are required to inform
themselves about and to observe any restrictions as to this offering and the
distribution of this prospectus applicable to that jurisdiction.
Until , 1999, all dealers that buy, sell or trade in our common stock,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Other expenses in connection with the issuance and distribution of the
securities to be registered hereunder, all of which will be paid by us, will be
substantially as follows (all amounts are estimated except the Securities and
Exchange Commission registration fee, the National Association of Securities
Dealers filing fee and the Nasdaq National Market listing fee):
<TABLE>
<CAPTION>
Item Amount
---- ----------
<S> <C>
Securities and Exchange Commission registration fee........... $ 18,415
NASD filing fee............................................... 7,124
Nasdaq National Market listing fee............................ 5,000
Blue Sky filing fees and expenses............................. 20,000
Accounting fees and expenses.................................. 300,000
Legal fees and expenses....................................... 500,000
Transfer agent fees and expenses.............................. 3,500
Printing and engraving expenses............................... 400,000
Miscellaneous expenses........................................ 245,961
----------
Total....................................................... $1,500,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Reference is made to Section 145 of the Delaware General Corporation Law,
which provides for indemnification of directors, officers and other employees
in certain circumstances, and to Section 102(b)(7)of the Delaware General
Corporation Law, which provides for the elimination or limitation of the
personal liability for monetary damages of directors under certain
circumstances. Article Sixth of our certificate of incorporation, as amended
and restated, eliminates the personal liability for monetary damages of
directors under certain circumstances. Our bylaws provide indemnification to
our directors and officers to the fullest extent permitted by the Delaware
General Corporation Law for, among other things, liabilities for judgments in
and settlements of lawsuits and other proceedings and for the advance and
payment of fees and expenses reasonably incurred by the director or officer in
defense of any such lawsuit or proceeding.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
In October 1997, in connection with our initial organization, IDT
Corporation purchased 27,864,000 shares of our common stock for nominal
consideration.
In January 1998, pursuant to the terms of his employment agreement with IDT
Corporation, Mr. Clifford M. Sobel purchased 3,096,000 shares of our common
stock for the purchase price of $100,000. This transaction was exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended.
In May 1999, we issued and sold an aggregate of 3,140,000 shares of Series A
convertible preferred stock at $10.00 per share, which are convertible into
9,420,000 shares of our common stock, together with warrants to purchase
180,000 shares of our class A stock to several investors for an aggregate of
$31,400,000, pursuant to Series A Subscription Agreements, dated as of May 13,
1999. This transaction was exempt from registration under Section 4(2) of the
Securities Act of 1933.
We also issued a warrant to purchase 92,400 shares of our common stock to
the placement agent as partial consideration for its services. This transaction
was exempt from registration under Section 4(2) of the Securities Act of 1933.
In May 1999, we issued options to purchase 5,040,000 shares pursuant to our
1999 Stock Option and Incentive Plan, and issued approximately 1,345,219 shares
of common stock upon exercise of these options. These transactions were exempt
from registration under Section 4(2) of the Securities Act of 1933.
II-1
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<C> <S>
1.1 Form of Underwriting Agreement.
3.1+ Certificate of Incorporation, as amended.
3.2+ Bylaws.
3.3+ Certificate of Amendment to the Restated Certificate of Incorporation
of the Registrant.
4.1 Specimen Common Stock Certificate of the Registrant.
5.1 Form of Opinion of Morrison & Foerster LLP.
10.1+ Employment Agreement, dated May 1, 1997, by and between Clifford M.
Sobel and IDT Corporation.
10.2+ Amendment to Employment Agreement between IDT Corporation and Clifford
M. Sobel, dated as of May 11, 1999, by and between Clifford M. Sobel,
IDT Corporation and the Registrant.
10.3#+ Bundling and Distribution Services Agreement, dated as of January 31,
1999, by and between Netscape Communications Corporation and the
Registrant.
10.4+ General License Terms & Conditions, dated as of January 31, 1999, by
and between Netscape Communications Corporation and the Registrant.
10.5+ Trademark License Agreement, dated as of January 31, 1999, by and
between Netscape Communications Corporation and the Registrant
Assignment .
10.6+ Internet/Telecommunications Agreement, dated as of May 7, 1999, by and
between IDT Corporation and the Registrant.
10.7+ Joint Marketing Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.8+ IDT Services Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.9+ Net2Phone Services Agreement, dated as of May 7, 1999, by and between
IDT Corporation and the Registrant.
10.10+ Assignment Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.11+ Tax Sharing and Indemnification Agreement, dated as of May 7, 1999, by
and between IDT Corporation and the Registrant.
10.12+ Separation Agreement, dated as of May 7, 1999, by and between IDT
Corporation and the Registrant.
10.13+ Lease Agreement, dated as of March 1, 1999, by and between 171-173
Main Street Corporation and the Registrant.
10.14+ Lease Agreement, dated as of March 1, 1999, by and between 294-298
State Street Corporation and the Registrant.
10.15+ The Registrant's Amended and Restated 1999 Stock Option and Incentive
Plan.
10.16+ Series A Subscription Agreement, dated as of May 13, 1999, by and
between the Investors listed therein and the Registrant.
10.17+ Series A Preferred Shareholder Registration Rights Agreement, dated as
of May 13, 1999, by and between the Investors listed therein and the
Registrant.
10.18+ Form of Warrant to Purchase Common Stock.
10.19+ Promissory Note of Registrant to IDT Corporation, dated as of May 12,
1999.
10.20+ Stockholders Agreement, dated as of May 13, 1999, by and among the
Investors listed therein, IDT Corporation, Clifford M. Sobel, the
trustee of the Scott Sobel Annual Gift Trust and the Registrant.
10.21+ Letter agreement, dated as of May 12, 1999, by and among IDT
Corporation, Clifford M. Sobel and the Registrant.
10.22+ Letter agreement, dated as of May 17, 1999, by and among IDT
Corporation, Clifford M. Sobel and the Registrant.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<C> <S>
10.23+ Co-Location and Facilities Management Services Agreement, dated as of
May 20, 1999, by and between IDT Corporation and the Registrant.
10.24+ Form of Loan Agreement between the Registrant and each of its
executive officers.
10.25+ Form of Stock Option Agreement for Executive Officers.
10.26#+ Letter agreement, dated as of June 25, 1999, by and between National
Broadcasting Company, Inc. and the Registrant.
10.27 Employment Agreement, dated July 2, 1999, by and between Jonathan Fram
and the Registrant.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Morrison & Foerster LLP (incorporated by reference into
Exhibit 5.1).
24.1+ Power of Attorney (set forth on the signature page to this
registration statement).
27.1+ Financial Data Schedule.
99.1+ Consent of Director Nominee, Raphael S. Grunfeld.
99.2+ Consent of Director Nominee, Stephen A. Oxman.
</TABLE>
- --------
*To be filed by amendment.
# Confidential treatment has been requested with respect to certain portions of
the Exhibit. Omitted portions will be filed separately with the Securities
and Exchange Commission.
+ Previously filed.
Financial Statements and Schedule:
Financial Statements:
Financial Statements filed as a part of this registration statement are
listed in the Index to Financial Statements of page F-1.
Financial Statement Schedules:
None.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing of the offering specified in the Underwriting Purchase
Agreement, certificates in such denominations and registered in such names as
required by the underwriters to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or
II-3
<PAGE>
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II- 4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 2 to the registration statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in
the City of Hackensack, State of New Jersey, on June 28, 1999.
Net2Phone, Inc.
/s/ Howard S. Balter
By: _________________________________
Howard S. Balter
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints and hereby authorizes Howard S. Balter and Ilan
M. Slasky, severally, such person's true and lawful attorneys-in-fact, with
full power of substitution or resubstitution, for such person and in such
person's name, place and stead, in any and all capacities, to sign on such
person's behalf, individually and in each capacity stated below, any and all
amendments, including post-effective amendments to this registration statement
and to sign any and all additional registration statements relating to the same
offering of securities as this registration statement that are filed pursuant
to Rule 462(b) of the Securities Act of 1933, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact, full
power and authority to do and perform each and every act and thing requisite or
necessary to be done in and about the premises, as fully to all intents and
purposes as such person might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact, or their substitute or substitutes,
may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to the registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name and Signatures Title Date
------------------- ----- ----
<S> <C> <C>
/s/ Clifford M. Sobel Chairman of the Board July , 1999
___________________________________________
Clifford M. Sobel*
/s/ Howard S. Balter Chief Executive Officer July , 1999
___________________________________________ and Director (Principal
Howard S. Balter Executive Officer)
/s/ Ilan M. Slasky Chief Financial Officer July , 1999
___________________________________________ (Chief Accounting
Ilan M. Slasky* Officer)
/s/ James R. Mellor Director July , 1999
___________________________________________
James R. Mellor
</TABLE>
*Executed by attorney-in-fact: Howard S. Balter
II-5
<PAGE>
<TABLE>
<CAPTION>
Name and Signatures Title Date
------------------- ----- ----
<S> <C> <C>
</TABLE>
<TABLE>
<S> <C> <C>
/s/ Howard S. Jonas Director July , 1999
___________________________________________
Howard S. Jonas*
Director July , 1999
___________________________________________
Gary E. Rieschel
/s/ James A. Courter Director July , 1999
___________________________________________
James A. Courter*
</TABLE>
*Executed by attorney-in-fact: Howard S. Balter
II-6
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
------- ---------------------- ------------
<C> <S> <C>
1.1 Form of Underwriting Agreement.
3.1+ Certificate of incorporation, as amended.
3.2+ Bylaws.
3.3+ Certificate of Amendment to the Restated Certificate of
Incorporation.
4.1 Specimen Common Stock Certificate of the Registrant.
5.1 Form of Opinion of Morrison & Foerster LLP.
10.1+ Employment Agreement, dated May 1, 1997, by and between
Clifford M. Sobel and IDT Corporation.
10.2+ Amendment to Employment Agreement between IDT
Corporation and Clifford M. Sobel, dated as of May 11,
1999, by and between Clifford M. Sobel, IDT Corporation
and the Registrant.
10.3#+ Bundling and Distribution Services Agreement, dated as
of January 31, 1999, by and between Netscape
Communications Corporation and the Registrant.
10.4+ General License Terms & Conditions, dated as of January
31, 1999, by and between Netscape Communications
Corporation and the Registrant.
10.5+ Trademark License Agreement, dated as of January 31,
1999, by and between Netscape Communications
Corporation and the Registrant.
10.6+ Internet/Telecommunications Agreement, dated as of May
7, 1999, by and between IDT Corporation and the
Registrant.
10.7+ Joint Marketing Agreement, dated as of May 7, 1999, by
and between IDT Corporation and the Registrant.
10.8+ IDT Services Agreement, dated as of May 7, 1999, by and
between IDT Corporation and the Registrant.
10.9+ Net2Phone Services Agreement, dated as of May 7, 1999,
by and between IDT Corporation and the Registrant.
10.10+ Assignment Agreement, dated as of May 7, 1999, by and
between IDT Corporation and the Registrant.
10.11+ Tax Sharing and Indemnification Agreement, dated as of
May 7, 1999, by and between IDT Corporation and the
Registrant.
10.12+ Separation Agreement, dated as of May 7, 1999, by and
between IDT Corporation and the Registrant.
10.13+ Lease Agreement, dated as of March 1, 1999, by and
between 171-173 Main Street Corporation and the
Registrant.
10.14+ Lease Agreement, dated as of March 1, 1999, by and
between 294-298 State Street Corporation and the
Registrant.
10.15+ The Registrant's Amended and Restated 1999 Stock Option
and Incentive Plan.
10.16+ Series A Subscription Agreement, dated as of May 13,
1999, by and between the Investors listed therein and
the Registrant.
10.17+ Series A Preferred Shareholder Registration Rights
Agreement, dated as of May 13, 1999, by and between the
Investors listed therein and the Registrant.
10.18+ Form of Warrant to Purchase Common Stock.
10.19+ Promissory Note of Registrant to IDT Corporation, dated
as of May 12, 1999.
10.20+ Stockholders Agreement, dated as of May 13, 1999, by
and among the Investors listed therein, IDT
Corporation, Clifford M. Sobel, the trustee of the
Scott Sobel Annual Gift Trust and the Registrant.
10.21+ Letter agreement, dated as of May 12, 1999, by and
among IDT Corporation, Clifford M. Sobel and the
Registrant.
10.22+ Letter agreement, dated as of May 17, 1999, by and
among IDT Corporation, Clifford M. Sobel and the
Registrant.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
------- ---------------------- ------------
<C> <S> <C>
10.23+ Co-Location and Facilities Management Services
Agreement, dated as of May 20, 1999, by and between IDT
Corporation and the Registrant.
10.24+ Form of Loan Agreement between the Registrant and each
of its executive officers.
10.25+ Form of Stock Option Agreement for Executive Officers.
10.26#+ Letter agreement, dated as of June 25, 1999, by and
between National Broadcasting Company, Inc. and the
Registrant.
10.27 Employment Agreement, dated July 2, 1999, by and
between Jonathan Fram and the Registrant.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Morrison & Foerster LLP (incorporated by
reference into Exhibit 5.1).
24.1+ Power of Attorney (set forth on the signature page to
this registration statement).
27.1+ Financial Data Schedule.
99.1+ Consent of Director Nominee, Raphael S. Grunfeld.
99.2+ Consent of Director Nominee, Stephen A. Oxman.
</TABLE>
- --------
*To be filed by amendment.
# Confidential treatment has been requested with respect to certain portions of
the Exhibit. Omitted portions will be filed separately with the Securities
and Exchange Commission.
+ Previously filed.
2
<PAGE>
EXHIBIT 1.1
NET2PHONE, INC.
_________ Shares/1/
Common Stock
UNDERWRITING AGREEMENT
----------------------
_____ __, 1999
HAMBRECHT & QUIST LLC
BT ALEX. BROWN INCORPORATED
BEAR, STEARNS & CO. INC.
As Representatives of the Several Underwriters
c/o Hambrecht & Quist LLC
One Bush Street
San Francisco, CA 94104
Ladies and Gentlemen:
Net2Phone, Inc., a Delaware corporation (herein called the Company),
proposes to issue and sell _________ shares of its authorized but unissued
Common Stock, $.01 par value (herein called the Common Stock) (said _________
shares of Common Stock being herein called the Underwritten Stock). The Company
proposes to grant to the Underwriters (as hereinafter defined) an option to
purchase up to _________ additional shares of Common Stock (herein called the
Option Stock and with the Underwritten Stock herein collectively called the
Stock). The Common Stock is more fully described in the Registration Statement
and the Prospectus hereinafter mentioned.
The Company hereby confirms the agreements made with respect to the
purchase of the Stock by the several underwriters, for whom you are acting,
named in Schedule I hereto (herein collectively called the Underwriters, which
term shall also include any underwriter purchasing Stock pursuant to Section
3(b) hereof). You represent and warrant that you have been authorized by each
of the other Underwriters to enter into this Agreement on its behalf and to act
for it in the manner herein provided.
1. Registration Statement. The Company has filed with the Securities and
Exchange Commission (herein called the Commission) a registration statement on
Form S-1 (No. 333-78713), including the related preliminary prospectus, for the
registration under the Securities Act of 1933, as amended (herein called the
Securities Act) of the Stock. Copies of such registration statement and of each
amendment thereto, if any, including the related preliminary prospectus (meeting
the requirements of Rule 430A of the rules and regulations of the Commission
(herein called the Rules and Regulations)) heretofore filed by the Company with
the Commission have been delivered to you.
- --------------
/1/ Plus an option to purchase from the Company up to __________ additional
shares to cover over-allotments.
1
<PAGE>
The term Registration Statement as used in this agreement shall mean such
registration statement, including all exhibits and financial statements, all
information omitted therefrom in reliance upon Rule 430A and contained in the
Prospectus referred to below, in the form in which it became effective, and any
registration statement filed pursuant to Rule 462(b) of the Rules and
Regulations with respect to the Stock (herein called a Rule 462(b) registration
statement), and, in the event of any amendment thereto after the effective date
of such registration statement (herein called the Effective Date), shall also
mean (from and after the effectiveness of such amendment) such registration
statement as so amended (including any Rule 462(b) registration statement). The
term Prospectus as used in this Agreement shall mean the prospectus relating to
the Stock first filed with the Commission pursuant to Rule 424(b) and Rule 430A
(or if no such filing is required, as included in the Registration Statement)
and, in the event of any supplement or amendment to such prospectus after the
Effective Date, shall also mean (from and after the filing with the Commission
of such supplement or the effectiveness of such amendment) such prospectus as so
supplemented or amended. The term Preliminary Prospectus as used in this
Agreement shall mean each preliminary prospectus included in such registration
statement prior to the time it becomes effective.
The Registration Statement has been declared effective under the Securities
Act, and no post-effective amendment to the Registration Statement has been
filed as of the date of this Agreement. The Company has caused to be delivered
to you copies of each Preliminary Prospectus and has consented to the use of
such copies for the purposes permitted by the Securities Act.
2. Representations and Warranties of the Company and the Parent.
(a) Each of the Company and IDT Corporation, a Delaware corporation
(herein call the Parent), hereby jointly and severally represent and warrant as
follows:
(i) The Company has been duly organized and is validly existing
as a corporation in good standing under the laws of the jurisdiction of its
incorporation, has full corporate power and authority to own or lease its
properties and conduct its business as described in the Registration
Statement and the Prospectus and as being conducted, and is duly qualified
as a foreign corporation and in good standing in all jurisdictions in which
the character of the property owned or leased or the nature of the business
transacted by it makes qualification necessary except where the failure to
be so qualified would not have a material adverse effect on the condition
(financial or otherwise) earnings, operations or business of the Company
(herein called a Material Adverse Effect).
(ii) The outstanding shares of capital stock of the Company have
been duly authorized and validly issued and are fully paid and non-
assessable; the Stock to be issued and sold by the Company have been duly
authorized and, when issued and paid for as contemplated herein, will be
validly issued, fully paid and non-assessable; and no preemptive, co-sale,
registration right, right of first refusal or other similar rights of
stockholders exist with respect to any of the Stock or the issue and sale
thereof, except as set forth in the Registration Statement. No further
approval or authority of the
2
<PAGE>
stockholders or the Board of Directors of the Company will be required for
the issuance and sale of the Stock. Neither the filing of the Registration
Statement nor the offering or sale of the Stock as contemplated by this
Agreement gives rise to any rights, other than those which have been waived
or satisfied, for or relating to the registration of any shares of capital
stock. Except as described in the Prospectus, there are no contracts,
agreements or understandings between the Company and any person granting
such person the right to require the Company to file a registration
statement under the Securities Act with respect to any securities of the
Company owned or to be owned by such person or to require the Company to
include such securities in the securities registered pursuant to the
Registration Statement or in any securities being registered pursuant to
any other registration statement filed by the Company under the Securities
Act. Except as described in the Prospectus, there are no outstanding
subscriptions, rights, warrants, options, calls, convertible securities,
commitments of sale or liens related to or entitling any person to purchase
or otherwise to acquire any shares of the capital stock of, or other
ownership interest in, the Company.
(iii) The information set forth under the caption
"Capitalization" in the Prospectus is true and correct in all material
respects. All of the Stock conforms in all material respects to the
description thereof contained in the Registration Statement. The form of
certificates for the Stock conforms to the legal requirements of the state
of Delaware.
(iv) The Commission has not issued an order preventing or
suspending the use of any Prospectus relating to the proposed offering of
the Stock, nor, to the best knowledge of the Company and the Parent,
instituted proceedings for that purpose.
(v) The financial statements of the Company, together with
related notes and schedules as set forth in the Registration Statement,
present fairly, the financial position and the results of operations and
cash flows of the Company at the indicated dates and for the indicated
periods. Such financial statements and related schedules have been prepared
in accordance with generally accepted principles of accounting,
consistently applied throughout the periods involved, and all adjustments
necessary for a fair presentation of results for such periods have been
made. The summary and selected financial and statistical data included in
the Registration Statement present fairly the information shown therein and
such data has been compiled on a basis consistent with the financial
statements presented therein and the books and records of the Company.
(vi) Ernst & Young LLP, who have certified certain of the
financial statements filed with the Commission as part of the Registration
Statement, are independent public accountants as required by the Securities
Act and the Rules and Regulations.
(vii) Except as disclosed in the Registration Statement,
there is no action, suit, claim or proceeding pending, or, to the knowledge
of the Company and the Parent, threatened against the Company or any of
their respective officers or properties, before any court or administrative
agency or otherwise, which if determined
3
<PAGE>
adversely to the Company could reasonably be expected to result in any
Material Adverse Effect or prevent the consummation of the transactions
contemplated hereby; and there are no agreements, contracts, leases or
documents of the Company of a character required to be described or
referred to in the Registration Statement or Prospectus or to be filed as
an exhibit to the Registration Statement by the Securities Act or the Rules
and Regulations which have not been accurately described in all material
respects or referred to in the Registration Statement or Prospectus or
filed as exhibits to the Registration Statement. The contracts so described
in the Registration Statement and Prospectus are in full force and effect
on the date hereof, and neither the Company nor, to the best of the
Company's or the Parent's knowledge, any other party, is in breach of or
default under any of such contracts where such breach or default would have
a Material Adverse Effect.
(viii) The Company has good and marketable title to all of the
properties and assets reflected in the financial statements (or as
described in the Registration Statement) filed with the Commission as part
of the Registration Statement, free and clear of any lien, mortgage,
pledge, charge or encumbrance of any kind except those reflected in such
financial statements (or as described in the Registration Statement). All
leases to which the Company is a party are valid and binding obligations of
the Company and no default by the Company has occurred or is continuing
thereunder which could reasonably be expected to result in a Material
Adverse Effect, and the Company enjoys peaceful and undisturbed possession
under all such leases to which it is a party as lessee.
(ix) The Company has timely filed all federal, state, local and
foreign income tax returns which have been required to be filed and have
paid all taxes indicted by said returns and all assessments received by
them or any of them to the extent that such taxes have become due and are
not being contested in good faith except where the failure to file such
returns and pay such taxes would not have a Material Adverse Effect. All
tax liabilities (including those being contested in good faith) for the
periods covered by the financial statements of the Company that are
included in the Registration Statement have been adequately provided for in
such financial statements.
(x) Since the respective dates as of which information is given
in the Registration Statement and the Prospectus, there has not occurred
any Material Adverse Effect or any development involving a prospective
Material Adverse Effect whether or not occurring in the ordinary course of
business, and there has not been any material transaction entered into or
any material transaction that is probable of being entered into by the
Company, other than transactions in the ordinary course of business and
changes and transactions described in the Registration Statement and the
Prospectus, as each may be amended or supplemented. The Company has no
material contingent obligations which are not disclosed or provided for in
the Company's financial statements that are included in the Registration
Statement.
(xi) This Agreement has been duly authorized, executed and
delivered by the Company and the Parent and is a valid and binding
agreement of the Company and the Parent, enforceable in accordance with its
terms except insofar as indemnification and contribution provisions may be
limited by applicable law or equitable principles and
4
<PAGE>
except as enforceability may be limited by bankruptcy, insolvency,
reorganization, moratorium or similar laws relating to or affecting
creditors' rights generally or by general equitable principles.
(xii) The Company is not, nor with the giving of notice or lapse
of time or both will be, in violation of or in default under its
Certificate of Incorporation or Bylaws or under any agreement, lease,
contract, indenture or other instrument or obligation to which it is a
party or by which it, or any of its properties, is bound and which default
would have a Material Adverse Effect. The execution and delivery of this
Agreement and the consummation of the transactions herein contemplated and
the fulfillment of the terms hereof will not conflict with or result in a
breach of any of the terms or provisions of, or constitute a default under,
any indenture, mortgage, deed of trust or other agreement or instrument to
which the Company or the Parent is a party, or of the respective
Certificate of Incorporation or Bylaws of the Company or the Parent or, to
the best knowledge of the Company and the Parent, any law, order, rule or
regulation, injunction, judgment, or decree applicable to the Company or
the Parent of any court or of any regulatory body or administrative agency
or other governmental body having jurisdiction over the Company or the
Parent, which conflict, breach or default could have a Material Adverse
Effect.
(xiii) Each approval, consent, order, authorization,
designation, declaration or filing by or with any regulatory,
administrative or other governmental body necessary in connection with the
execution and delivery by the Company and the Parent of this Agreement and
the consummation of the transactions herein contemplated (except such
additional steps as may be required by the National Association of
Securities Dealers, Inc. (herein called the NASD) or such additional steps
as may be necessary to qualify the Stock for public offering by the
Underwriters under state securities or blue sky laws) has been obtained or
made and is in full force and effect.
(xiv) The Company is operating substantially in compliance with
all statutes, laws, regulations, ordinances or court decrees applicable to
its businesses and operations, except where any such non-compliance would
not have a Material Adverse Effect. The Company has not violated any
foreign, federal, state or local law or regulation relating to the
protection of human health and safety, the environment or hazardous or
toxic substances or wastes, pollutants or contaminants or relating to
discrimination in the hiring, promotion or pay of, or to the wages and
hours of, employees, except for such violations as in the aggregate would
not result in any Material Adverse Effect. To the best of Company's and
Parent's knowledge, no labor disturbance by the employees of the Company
exists or is imminent, and the Company is not aware of any existing or
imminent labor disturbance by the employees of any of its principal
suppliers, value added resellers, authorized dealers or distributors that
might be expected to result in a Material Adverse Effect. No collective
bargaining agreement exists with any of the Company's employees and, to the
best of the Company's and the Parent's knowledge, no such agreement is
imminent.
(xv) The Company is in compliance in all material respects with
all currently applicable provisions of the Employee Retirement Income
Security Act of
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1974, as amended, including the regulations and published interpretations
thereunder (herein called ERISA); no "reportable event" (as defined in
ERISA) has occurred with respect to any "pension plan" (as defined in
ERISA) for which the Company would have any liability; the Company has not
incurred and does not expect to incur liability under (i) Title IV of ERISA
with respect to termination of, or withdrawal from, any "pension plan" or
(ii) Sections 412 or 4971 of the Internal Revenue Code of 1986, as amended,
including the regulations and published interpretation thereunder (herein
called the Code); and each "pension plan" for which the Company would have
any liability that is intended to be qualified under Section 401(a) of the
Code is so qualified in all material respects and nothing has occurred,
whether by action or by failure to act, that would cause the loss of such
qualification.
(xvi) The Company holds all material licenses, certificates and
permits from governmental authorities that are necessary to the conduct of
its businesses and as contemplated by the Prospectus.
(xvii) Except as set forth in the Registration Statement,
the Company owns or possesses adequate rights to use all inventions,
designs, computer programs, computer code, communications protocols,
security devices, trade secrets, know-how, trademarks, service marks, trade
names, copyright works or other information (herein collectively called
Intellectual Property) which are necessary to conduct its businesses as
described in the Registration Statement and the Prospectus; Except as set
forth in the Registration Statement, the Company has not received any
notice of, and has no knowledge of, any infringement of or conflict with
any rights of the Company by others with respect to any Intellectual
Property which, singly or in the aggregate, if the subject of an
unfavorable decision, ruling or finding, would have a Material Adverse
Effect; the Company and the Parent have not received any notice of, and
have no knowledge of, any infringement of or conflict with any rights of
others with respect to any Intellectual Property which, singly or in the
aggregate, if the subject of an unfavorable decision, ruling or finding,
would have a Material Adverse Effect; to the Company's and the Parent's
best knowledge, none of the Intellectual Property licensed to or by the
Company are unenforceable or invalid; and the Company is not aware of the
granting of any patent rights to third parties or the filing of any patent
applications by third parties or any other rights of third parties to any
Intellectual Property owned by the Company.
(xviii) The Company has not taken, directly or indirectly, any
action designed to cause or result in, or which has constituted or which
might reasonably be expected to constitute, the stabilization or
manipulation of the price of the shares of Common Stock to facilitate the
sale or resale of the Stock.
(xix) The Company is not an "investment company" or a company
"controlled" by an "investment company" within the meaning of such terms
under the Investment Company Act of 1940, as amended (herein called the
Investment Company Act), and the rules and regulations of the Commission
thereunder.
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(xx) The Company maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions
are executed in accordance with management's general or specific
authorization; (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain accountability for assets; (iii)
access to assets is permitted only in accordance with management's general
or specific authorization; and (iv) the recorded accountability for assets
is compared with existing assets at reasonable intervals and appropriate
action is taken with respect to any differences.
(xxi) The Company carries, or is covered by, insurance
with insurers of nationally recognized reputability in such amounts and
covering such risks as it believes is customary for companies engaged in
similar industries.
(xxii) The Stock has been approved for listing on the Nasdaq
National Stock Market.
(xxiii) The Registration Statement and the Prospectus comply,
and on the Closing Date and the Option Closing Date (as such dates are
hereinafter defined) the Prospectus will comply, in all material respects,
with the provisions of the Securities Act and the Rules and Regulations; on
the Effective Date the Registration Statement did not, and on each of the
Closing Date and the Option Closing Date, will not contain any untrue
statement of a material fact or omit to state any material fact required to
be stated therein or necessary in order to make the statements therein not
misleading; and, on the Effective Date the Prospectus did not and, on each
of the Closing Date and the Option Closing Date, will not contain any
untrue statement of a material fact or omit to state any material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided,
however, that none of the representations and warranties in this Section
2(a)(xxiii) shall apply to statements in, or omissions from, the
Registration Statement or the Prospectus made in reliance upon and in
conformity with information herein or otherwise furnished in writing to the
Company by the Underwriters for use in the Registration Statement or the
Prospectus.
(xxiv) The statements in the Prospectus under the heading
"Certain Transactions" set forth all existing agreements, arrangements,
understandings or transactions, or proposed agreements, arrangements,
understandings or transactions, between or among the Company, on the one
hand, and any officer, director or stockholder of the Company, or with any
partner, affiliate or associate of any of the foregoing persons or
entities, on the other hand, required to be set forth or described
thereunder.
(xxv) There are no issues related to the Company's preparedness
for the Year 2000 that (i) are of a character required to be described or
referred to in the Registration Statement or Prospectus by the Securities
Act or the Rules and Regulations which have not been accurately described
in the Registration Statement or Prospectus or (ii) might reasonably be
expected to result in any Material Adverse Effect. All internal computer
systems and each Constituent Component (as defined below) of those systems
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and all computer-related products and each Constituent Component of those
products of the Company fully comply with the Year 2000 Qualification
Requirements. "Year 2000 Qualification Requirements" means that the
internal computer systems and each Constituent Component of those systems
and all computer-related products and each Constituent Component of those
products of the Company (i) have been reviewed to confirm that they store,
process (including sorting and performing mathematical operations,
calculations and computations), input and output data containing date and
information correctly regardless of whether the date contains dates and
times before, on or after January 1, 2000, (ii) have been designated to
ensure date and time entry recognition, calculations that accommodate same
century and multi-century formulas and date values, leap year recognition
and calculations, and date data interface values that reflect the century,
(iii) accurately manage and manipulate data involving dates and times,
including single century formulas and multi-century formulas, and will not
cause an abnormal ending scenario within the application or generate
incorrect values or invalid results involving such dates, (iv) accurately
process any date rollover and (v) accept and respond to two-digit year date
input in a manner that resolves any ambiguities as to the century.
"Constituent Component" means all software (including operating systems,
programs, packages and utilities), firmware, hardware, networking
components, and peripherals provided as part of the configuration.
(xxvi) The Company has not at any time since its inception (i)
made any unlawful contribution to any candidate for foreign office or
failed to disclose fully any contribution in violation of law, or (ii) made
any payment to any U.S. federal or state governmental officer or official,
or other person charged with similar public or quasi-public duties, other
than payments required or permitted by the laws of the United States or any
jurisdiction thereof.
(xxvii) Neither the Company nor the Parent has distributed and
neither will distribute prior to the later of (i) the Closing Date, or any
date on which Option Stock is to be purchased, as the case may be, and (ii)
completion of the distribution of the Stock, any offering material in
connection with the offering and sale of the Stock other than any
Preliminary Prospectuses, the Prospectus, the Registration Statement and
other materials, if any, permitted by the Securities Act.
(xxviii) The Company has not incurred any liability for any
finder's fees or similar payments in connection with the transactions
contemplated hereby.
3. Purchase of the Stock by the Underwriters.
(a) On the basis of the representations and warranties and subject to
the terms and conditions herein set forth, the Company agrees to issue and sell
_________ shares of the Underwritten Stock to the several Underwriters and each
of the Underwriters agrees to purchase from the Company the respective aggregate
number of shares of Underwritten Stock set forth opposite its name in Schedule
I. The price at which such shares of Underwritten Stock shall be sold by the
Company and purchased by the several Underwriters shall be $___ per share. In
making this Agreement, each Underwriter is contracting severally and not
jointly; except as
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provided in paragraphs (b) and (c) of this Section 3, the agreement of each
Underwriter is to purchase only the respective number of shares of the
Underwritten Stock specified in Schedule I.
(b) If for any reason one or more of the Underwriters shall fail or
refuse (otherwise than for a reason sufficient to justify the termination of
this Agreement under the provisions of Section 8 or 9 hereof) to purchase and
pay for the number of shares of the Stock agreed to be purchased by such
Underwriter or Underwriters, the Company shall immediately give notice thereof
to you, and the non-defaulting Underwriters shall have the right within 24 hours
after the receipt by you of such notice to purchase, or procure one or more
other Underwriters to purchase, in such proportions as may be agreed upon
between you and such purchasing Underwriter or Underwriters and upon the terms
herein set forth, all or any part of the shares of the Stock which such
defaulting Underwriter or Underwriters agreed to purchase. If the non-
defaulting Underwriters fail so to make such arrangements with respect to all
such shares and portion, the number of shares of the Stock which each non-
defaulting Underwriter is otherwise obligated to purchase under this Agreement
shall be automatically increased on a pro rata basis to absorb the remaining
shares and portion which the defaulting Underwriter or Underwriters agreed to
purchase; provided, however, that the non-defaulting Underwriters shall not be
obligated to purchase the shares and portion which the defaulting Underwriter or
Underwriters agreed to purchase if the aggregate number of such shares of the
Stock exceeds 10% of the total number of shares of the Stock which all
Underwriters agreed to purchase hereunder. If the total number of shares of the
Stock which the defaulting Underwriter or Underwriters agreed to purchase shall
not be purchased or absorbed in accordance with the two preceding sentences, the
Company shall have the right, within the 24 hours next succeeding the 24-hour
period above referred to, to make arrangements with other underwriters or
purchasers satisfactory to you for purchase of such shares and portion on the
terms herein set forth. In any such case, either you or the Company shall have
the right to postpone the Closing Date determined as provided in Section 5
hereof for not more than seven business days after the date originally fixed as
the Closing Date pursuant to said Section 5 in order that any necessary changes
in the Registration Statement, the Prospectus or any other documents or
arrangements may be made. If neither the non-defaulting Underwriters nor the
Company shall make arrangements within the 24-hour periods stated above for the
purchase of all the shares of the Stock which the defaulting Underwriter or
Underwriters agreed to purchase hereunder, this Agreement shall be terminated
without further act or deed and without any liability on the part of the Company
to any non-defaulting Underwriter and without any liability on the part of any
non-defaulting Underwriter to the Company. Nothing in this paragraph (b), and no
action taken hereunder, shall relieve any defaulting Underwriter from liability
in respect of any default of such Underwriter under this Agreement.
(c) On the basis of the representations, warranties and covenants
herein contained, and subject to the terms and conditions herein set forth, the
Company grants an option to the several Underwriters to purchase, severally and
not jointly, up to _________ shares in the aggregate of the Option Stock from
the Company at the same price per share as the Underwriters shall pay for the
Underwritten Stock. Said option may be exercised only to cover over-allotments
in the sale of the Underwritten Stock by the Underwriters and may be exercised
in whole or in part at any time (but not more than once) on or before the
thirtieth day after the date of this Agreement upon written or telegraphic
notice by you to the Company setting forth the aggregate number of shares of the
Option Stock as to which the several Underwriters are
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exercising the option. Delivery of certificates for the shares of Option Stock,
and payment therefor, shall be made as provided in Section 5 hereof. The number
of shares of the Option Stock to be purchased by each Underwriter shall be the
same percentage of the total number of shares of the Option Stock to be
purchased by the several Underwriters as such Underwriter is purchasing of the
Underwritten Stock, as adjusted by you in such manner as you deem advisable to
avoid fractional shares.
4. Offering by Underwriters.
(a) The terms of the initial public offering by the Underwriters of
the Stock to be purchased by them shall be as set forth in the Prospectus. The
Underwriters may from time to time change the public offering price after the
closing of the initial public offering and increase or decrease the concessions
and discounts to dealers as they may determine.
(b) The information set forth under "Underwriting" in the Registration
Statement, any Preliminary Prospectus and the Prospectus relating to the Stock
filed by the Company (insofar as such information relates to the Underwriters
and their affiliates) constitutes the only information furnished by the
Underwriters to the Company for inclusion in the Registration Statement, any
Preliminary Prospectus, and the Prospectus, and you on behalf of the respective
Underwriters represent and warrant to the Company that the statements made
therein are correct.
5. Delivery of and Payment for the Stock.
(a) Delivery of certificates for the shares of the Underwritten Stock
and the Option Stock (if the option granted by Section 3(c) hereof shall have
been exercised not later than 10:00 a.m., New York time, on the date two
business days preceding the Closing Date), and payment therefor, shall be made
at the offices of Brobeck, Phleger & Harrison LLP, 1633 Broadway, 47th Floor,
New York, New York, at 10:00 a.m., New York time, on the fourth business day
after the date of this Agreement, or at such time on such other day, not later
than seven full business days after such fourth business day, as shall be agreed
upon in writing by the Company and you. The date and hour of such delivery and
payment (which may be postponed as provided in Section 3(b) hereof) are herein
called the Closing Date.
(b) If the option granted by Section 3(c) hereof shall be exercised
after 10:00 a.m., New York time, on the date two business days preceding the
Closing Date, delivery of certificates for the shares of Option Stock, and
payment therefor, shall be made at the offices of Brobeck, Phleger & Harrison
LLP, 1633 Broadway, New York, New York, at 10:00 a.m., New York time, on the
third business day after the exercise of such option. The date and hour of such
delivery and payment (which may be postponed as provided in Section 3(b) hereof)
are herein called the Option Closing Date.
(c) Payment for the Stock purchased from the Company shall be made to
the Company or its order by one or more certified or official bank check or
checks in same day funds. Such payment shall be made upon delivery of
certificates for the Stock to you for the respective accounts of the several
Underwriters against receipt therefor signed by you. Certificates for the Stock
to be delivered to you shall be registered in such name or names and
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shall be in such denominations as you may request at least one business day
before the Closing Date, in the case of Underwritten Stock, and at least one
business day prior to the purchase thereof, in the case of the Option Stock.
Such certificates will be made available to the Underwriters for inspection,
checking and packaging at the offices of Lewco Securities Corporation, 2
Broadway, New York, New York 10004 on the business day prior to the Closing Date
or, in the case of the Option Stock, by 3:00 p.m., New York time, on the
business day preceding the date of purchase.
It is understood that you, individually and not on behalf of the
Underwriters, may (but shall not be obligated to) make payment to the Company
for shares to be purchased by any Underwriter whose check shall not have been
received by you on the Closing Date or any later date on which Option Stock is
purchased for the account of such Underwriter. Any such payment by you shall
not relieve such Underwriter from any of its obligations hereunder.
6. Further Agreements of the Company. The Company covenants and agrees as
follows:
(a) The Company will (i) prepare and timely file with the Commission
under Rule 424(b) a Prospectus containing information previously omitted at the
time of effectiveness of the Registration Statement in reliance on Rule 430A and
(ii) not file any amendment to the Registration Statement or supplement to the
Prospectus of which you shall not previously have been advised and furnished
with a copy or to which you shall have reasonably objected in writing or which
is not in compliance with the Securities Act or the Rules and Regulations.
(b) The Company will promptly notify each Underwriter in the event of
(i) the request by the Commission for amendment of the Registration Statement or
for supplement to the Prospectus or for any additional information, (ii) the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement, (iii) the institution or notice of intended institution
of any action or proceeding for that purpose, (iv) the receipt by the Company of
any notification with respect to the suspension of the qualification of the
Stock for sale in any jurisdiction, or (v) the receipt by it of notice of the
initiation or threatening of any proceeding for such purpose. The Company will
make every reasonable effort to prevent the issuance of such a stop order and,
if such an order shall at any time be issued, to obtain the withdrawal thereof
at the earliest possible moment.
(c) The Company will (i) on or before the Closing Date, deliver to you
a signed copy of the Registration Statement as originally filed and of each
amendment thereto filed prior to the time the Registration Statement becomes
effective and, promptly upon the filing thereof, a signed copy of each post-
effective amendment, if any, to the Registration Statement (together with, in
each case, all exhibits thereto unless previously furnished to you) and will
also deliver to you, for distribution to the Underwriters, a sufficient number
of additional conformed copies of each of the foregoing (but without exhibits)
so that one copy of each may be distributed to each Underwriter, (ii) as
promptly as possible deliver to you and send to the several Underwriters, at
such office or offices as you may designate, as many copies of the Prospectus as
you may reasonably request, and (iii) thereafter from time to time during the
period in which a prospectus is required by law to be delivered by an
Underwriter or dealer, likewise send to the Underwriters as many additional
copies of the Prospectus and as many copies of any supplement
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to the Prospectus and of any amended prospectus, filed by the Company with the
Commission, as you may reasonably request for the purposes contemplated by the
Securities Act.
(d) If at any time during the period in which a prospectus is required
by law to be delivered by an Underwriter or dealer, any event relating to or
affecting the Company, or of which the Company shall be advised in writing by
you, shall occur as a result of which it is necessary, in the opinion of counsel
for the Company or of counsel for the Underwriters, to supplement or amend the
Prospectus in order to make the Prospectus not misleading in the light of the
circumstances existing at the time it is delivered to a purchaser of the Stock,
the Company will forthwith prepare and file with the Commission a supplement to
the Prospectus or an amended prospectus so that the Prospectus as so
supplemented or amended will not contain any untrue statement of a material fact
or omit to state any material fact necessary in order to make the statements
therein, in the light of the circumstances existing at the time such Prospectus
is delivered to such purchaser, not misleading. If, after the initial public
offering of the Stock by the Underwriters and during such period, the
Underwriters shall propose to vary the terms of offering thereof by reason of
changes in general market conditions or otherwise, you will advise the Company
in writing of the proposed variation, and, if in the opinion either of counsel
for the Company or of counsel for the Underwriters such proposed variation
requires that the Prospectus be supplemented or amended, the Company will
forthwith prepare and file with the Commission a supplement to the Prospectus or
an amended prospectus setting forth such variation. The Company authorizes the
Underwriters and all dealers to whom any of the Stock may be sold by the several
Underwriters to use the Prospectus, as from time to time amended or
supplemented, in connection with the sale of the Stock in accordance with the
applicable provisions of the Securities Act and the Rules and Regulations for
such period.
(e) Prior to the filing thereof with the Commission, the Company will
submit to you, for your information, a copy of any post-effective amendment to
the Registration Statement and any supplement to the Prospectus or any amended
prospectus proposed to be filed.
(f) The Company will cooperate, when and as requested by you, in the
qualification of the Stock for offer and sale under the securities or blue sky
laws of such jurisdictions as you may designate and, during the period in which
a prospectus is required by law to be delivered by an Underwriter or dealer, in
keeping such qualifications in good standing under said securities or blue sky
laws; provided, however, that the Company shall not be obligated to file any
general consent to service of process or to qualify as a foreign corporation in
any jurisdiction in which it is not so qualified. The Company will, from time
to time, prepare and file such statements, reports, and other documents as are
or may be required to continue such qualifications in effect for so long a
period as you may reasonably request for distribution of the Stock.
(g) During a period of five years commencing with the date hereof, the
Company will furnish to you, and to each Underwriter who may so request in
writing, copies of all periodic and special reports furnished to stockholders of
the Company and of all information, documents and reports filed with the
Commission.
(h) Not later than the 45th day following the end of the fiscal
quarter first occurring after the first anniversary of the Effective Date, the
Company will make generally
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available to its security holders an earnings statement in accordance with
Section 11(a) of the Securities Act and Rule 158 thereunder.
(i) The Company agrees to pay all costs and expenses incident to the
performance of its obligations under this Agreement, including all costs and
expenses incident to (i) the preparation, printing and filing with the
Commission and the NASD of the Registration Statement, any Preliminary
Prospectus and the Prospectus, (ii) the furnishing to the Underwriters of copies
of any Preliminary Prospectus and of the several documents required by paragraph
(c) of this Section 6 to be so furnished, (iii) the printing of this Agreement
and related documents delivered to the Underwriters, (iv) the preparation,
printing and filing of all supplements and amendments to the Prospectus referred
to in paragraph (d) of this Section 6, (v) the furnishing to you and the
Underwriters of the reports and information referred to in paragraph (g) of this
Section 6 and (vi) the printing and issuance of stock certificates, including
the transfer agent's fees.
(j) The Company agrees to reimburse you, for the account of the
several Underwriters, for blue sky fees and related disbursements (including
counsel fees and disbursements and cost of printing memoranda for the
Underwriters) paid by or for the account of the Underwriters or their counsel in
qualifying the Stock under state securities or blue sky laws and in the review
of the offering by the NASD.
(k) The Company hereby agrees and shall use its best efforts to cause
all directors, officers and stockholders to agree that, without the prior
written consent of Hambrecht & Quist LLC on behalf of the Underwriters, the
Company will not, and such person or entity will not, for a period of 180 days
following the commencement of the public offering of the Stock by the
Underwriters, directly or indirectly, (i) sell, offer, contract to sell, make
any short sale, pledge, sell any option or contract to purchase, purchase any
option or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or dispose of any shares of capital stock or any securities
convertible into or exchangeable or exercisable for or any rights to purchase or
acquire capital stock or (ii) enter into any swap or other agreement that
transfers, in whole or in part, any of the economic consequences or ownership of
capital stock, whether any such transaction described in clause (i) or (ii)
above is to be settled by delivery of capital stock or such other securities, in
cash or otherwise. The foregoing sentence shall not apply to (I) the Stock to
be sold to the Underwriters pursuant to this Agreement, and (ii) the granting of
options to purchase Common Stock under the Company's stock option plan.
(l) If at any time during the 25-day period after the Registration
Statement becomes effective any rumor, publication or event relating to or
affecting the Company shall occur as a result of which in your opinion the
market price for the Stock has been or is likely to be materially affected
(regardless of whether such rumor, publication or event necessitates a
supplement to or amendment of the Prospectus), the Company will, after written
notice from you advising the Company to the effect set forth above, forthwith
prepare, consult with you concerning the substance of, and disseminate a press
release or other public statement, reasonably satisfactory to you, responding to
or commenting on such rumor, publication or event.
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(m) The Company is familiar with the Investment Company Act and has in
the past conducted its affairs, and will in the future conduct its affairs, in
such a manner to ensure that the Company was not and will not be an "investment
company" or a company "controlled" by an "investment company" within the meaning
of the Investment Company Act and the rules and regulations thereunder.
(n) The Company will comply with the Securities Act and the Rules and
Regulations, and the Securities Exchange Act of 1934 (herein called the Exchange
Act) and the Rules and Regulations, so as to permit the completion of the
distribution of the Stock as contemplated in this Agreement and the Prospectus.
(o) The Company shall apply the net proceeds of its sale of the Stock
as set forth in the Prospectus under the heading "Use of Proceeds."
(p) The Company will not take, directly or indirectly, any action
designed to cause or result in, or that has constituted or might reasonably be
expected to constitute, the stabilization or manipulation of the price of the
Common Stock of the Company.
(q) The Company will maintain a transfer agent and, if necessary under
the jurisdiction of incorporation of the Company, a registrar (which may be the
same entity as the transfer agent) for its Common Stock.
7. Indemnification and Contribution.
(a) The Company and the Parent agree to indemnify and hold harmless
each Underwriter and each person (including each partner or officer thereof) who
controls any Underwriter within the meaning of Section 15 of the Securities Act
from and against any and all losses, claims, damages or liabilities, joint or
several, to which such indemnified parties or any of them may become subject
under the Securities Act, the Exchange Act, or the common law or otherwise, and
the Company agrees to reimburse each such Underwriter and controlling person for
any legal or other expenses (including, except as otherwise hereinafter
provided, reasonable fees and disbursements of counsel) incurred by the
respective indemnified parties in connection with defending against any such
losses, claims, damages or liabilities or in connection with any investigation
or inquiry of, or other proceeding which may be brought against, the respective
indemnified parties, in each case arising out of or based upon (i) any untrue
statement or alleged untrue statement of a material fact contained in the
Registration Statement (including the Prospectus as part thereof and any Rule
462(b) registration statement) or any post-effective amendment thereto
(including any Rule 462(b) registration statement), or 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, or (ii) any untrue
statement or alleged untrue statement of a material fact contained in any
Preliminary Prospectus or the Prospectus (as amended or as supplemented if the
Company shall have filed with the Commission any amendment thereof or supplement
thereto) or the omission or alleged omission to state therein a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided, however,
that (1) the indemnity agreements of the Company and the Parent contained in
this paragraph (a) shall not apply to any such losses, claims, damages,
liabilities or expenses if such statement or omission was made in reliance upon
and in conformity
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with information furnished as herein stated or otherwise furnished in writing to
the Company by or on behalf of any Underwriter for use in any Preliminary
Prospectus or the Registration Statement or the Prospectus or any such amendment
thereof or supplement thereto and (2) the indemnity agreement contained in this
paragraph (a) with respect to any Preliminary Prospectus shall not inure to the
benefit of any Underwriter from whom the person asserting any such losses,
claims, damages, liabilities or expenses purchased the Stock which is the
subject thereof (or to the benefit of any person controlling such Underwriter)
if at or prior to the written confirmation of the sale of such Stock a copy of
the Prospectus (or the Prospectus as amended or supplemented) was not sent or
delivered to such person and the untrue statement or omission of a material fact
contained in such Preliminary Prospectus was corrected in the Prospectus (or the
Prospectus as amended or supplemented) unless the failure is the result of
noncompliance by the Company with paragraph (c) of Section 6 hereof. The
indemnity agreements of the Company and the Parent contained in this paragraph
(a) and the representations and warranties of the Company and the Parent
contained in Section 2 hereof shall remain operative and in full force and
effect regardless of any investigation made by or on behalf of any indemnified
party and shall survive the delivery of and payment for the Stock.
(b) Each Underwriter severally agrees to indemnify and hold harmless
the Company, each of its officers who signs the Registration Statement on his
own behalf or pursuant to a power of attorney, each of its directors, each other
Underwriter and each person (including each partner or officer thereof) who
controls the Company or any such other Underwriter within the meaning of Section
15 of the Securities Act, from and against any and all losses, claims, damages
or liabilities, joint or several, to which such indemnified parties or any of
them may become subject under the Securities Act, the Exchange Act, or the
common law or otherwise and to reimburse each of them for any legal or other
expenses (including, except as otherwise hereinafter provided, reasonable fees
and disbursements of counsel) incurred by the respective indemnified parties in
connection with defending against any such losses, claims, damages or
liabilities or in connection with any investigation or inquiry of, or other
proceeding which may be brought against, the respective indemnified parties, in
each case arising out of or based upon (i) any untrue statement or alleged
untrue statement of a material fact contained in the Registration Statement
(including the Prospectus as part thereof and any Rule 462(b) registration
statement) or any post-effective amendment thereto (including any Rule 462(b)
registration statement) or 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 or (ii) any untrue statement or alleged untrue statement
of a material fact contained in the Prospectus (as amended or as supplemented if
the Company shall have filed with the Commission any amendment thereof or
supplement thereto) or the omission or alleged omission to state therein a
material fact necessary in order to make the statements therein, in the light of
the circumstances under which they were made, not misleading, if such statement
or omission was made in reliance upon and in conformity with information
furnished as herein stated or otherwise furnished in writing to the Company by
such indemnifying Underwriter expressly for use in the Registration Statement or
the Prospectus or any such amendment thereof or supplement thereto. The
indemnity agreement of each Underwriter contained in this paragraph (b) shall
remain operative and in full force and effect regardless of any investigation
made by or on behalf of any indemnified party and shall survive the delivery of
and payment for the Stock.
15
<PAGE>
(c) Each party indemnified under the provision of paragraphs (a) and
(b) of this Section 7 agrees that, upon the service of a summons or other
initial legal process upon it in any action or suit instituted against it or
upon its receipt of written notification of the commencement of any
investigation or inquiry of, or proceeding against, it in respect of which
indemnity may be sought on account of any indemnity agreement contained in such
paragraphs, it will promptly give written notice (herein called the Notice) of
such service or notification to the party or parties from whom indemnification
may be sought hereunder. No indemnification provided for in such paragraphs
shall be available to any party who shall fail so to give the Notice if the
party to whom such Notice was not given was unaware of the action, suit,
investigation, inquiry or proceeding to which the Notice would have related and
was prejudiced by the failure to give the Notice, but the omission so to notify
such indemnifying party or parties of any such service or notification shall not
relieve such indemnifying party or parties from any liability which it or they
may have to the indemnified party for contribution or otherwise on account of
such indemnity agreement. Any indemnifying party shall be entitled at its own
expense to participate in the defense of any action, suit or proceeding against,
or investigation or inquiry of, an indemnified party. Any indemnifying party
shall be entitled, if it so elects within a reasonable time after receipt of the
Notice by giving written notice (herein called the Notice of Defense) to the
indemnified party, to assume (alone or in conjunction with any other
indemnifying party or parties) the entire defense of such action, suit,
investigation, inquiry or proceeding, in which event such defense shall be
conducted, at the expense of the indemnifying party or parties, by counsel
chosen by such indemnifying party or parties and reasonably satisfactory to the
indemnified party or parties; provided, however, that (i) if the indemnified
party or parties reasonably determine that there may be a conflict between the
positions of the indemnifying party or parties and of the indemnified party or
parties in conducting the defense of such action, suit, investigation, inquiry
or proceeding or that there may be legal defenses available to such indemnified
party or parties different from or in addition to those available to the
indemnifying party or parties, then counsel for the indemnified party or parties
shall be entitled to conduct the defense to the extent reasonably determined by
such counsel to be necessary to protect the interests of the indemnified party
or parties and (ii) in any event, the indemnified party or parties shall be
entitled to have counsel chosen by such indemnified party or parties to
participate in, but not conduct, the defense. If, within a reasonable time
after receipt of the Notice, an indemnifying party gives a Notice of Defense and
the counsel chosen by the indemnifying party or parties is reasonably
satisfactory to the indemnified party or parties, the indemnifying party or
parties will not be liable under paragraphs (a) through (c) of this Section 7
for any legal or other expenses subsequently incurred by the indemnified party
or parties in connection with the defense of the action, suit, investigation,
inquiry or proceeding, except that (A) the indemnifying party or parties shall
bear the legal and other expenses incurred in connection with the conduct of the
defense as referred to in clause (i) of the proviso to the preceding sentence
and (B) the indemnifying party or parties shall bear such other expenses as it
or they have authorized to be incurred by the indemnified party or parties. If,
within a reasonable time after receipt of the Notice, no Notice of Defense has
been given, the indemnifying party or parties shall be responsible for any legal
or other expenses incurred by the indemnified party or parties in connection
with the defense of the action, suit, investigation, inquiry or proceeding.
(d) If the indemnification provided for in this Section 7 is
unavailable or insufficient to hold harmless an indemnified party under
paragraph (a) or (b) of this Section 7, then each indemnifying party, in lieu of
indemnifying such indemnified party, shall contribute to
16
<PAGE>
the amount paid or payable by such indemnified party as a result of the losses,
claims, damages or liabilities referred to in paragraph (a) or (b) of this
Section 7 (i) in such proportion as is appropriate to reflect the relative
benefits received by each indemnifying party from the offering of the Stock or
(ii) if the allocation provided by clause (i) above is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in clause (i) above but also the relative fault of
each indemnifying party in connection with the statements or omissions that
resulted in such losses, claims, damages or liabilities, or actions in respect
thereof, as well as any other relevant equitable considerations. The relative
benefits received by the Company and the Underwriters shall be deemed to be in
the same respective proportions as the total net proceeds from the offering of
the Stock received by the Company and the total underwriting discount received
by the Underwriters, as set forth in the table on the cover page of the
Prospectus, bear to the aggregate public offering price of the Stock. Relative
fault shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by each
indemnifying party and the parties' relative intent, knowledge, access to
information and opportunity to correct or prevent such untrue statement or
omission.
The parties agree that it would not be just and equitable if contributions
pursuant to this paragraph (d) were to be determined by pro rata allocation
(even if the Underwriters were treated as one entity for such purpose) or by any
other method of allocation which does not take into account the equitable
considerations referred to in the first sentence of this paragraph (d). The
amount paid by an indemnified party as a result of the losses, claims, damages
or liabilities, or actions in respect thereof, referred to in the first sentence
of this paragraph (d) shall be deemed to include any legal or other expenses
reasonably incurred by such indemnified party in connection with investigation,
preparing to defend or defending against any action or claim which is the
subject of this paragraph (d). Notwithstanding the provisions of this paragraph
(d), no Underwriter shall be required to contribute any amount in excess of the
underwriting discount applicable to the Stock purchased by such Underwriter. No
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation. The Underwriters'
obligations in this paragraph (d) to contribute are several in proportion to
their respective underwriting obligations and not joint.
Each party entitled to contribution agrees that upon the service of a
summons or other initial legal process upon it in any action instituted against
it in respect of which contribution may be sought, it will promptly give written
notice of such service to the party or parties from whom contribution may be
sought, but the omission so to notify such party or parties of any such service
shall not relieve the party from whom contribution may be sought from any
obligation it may have hereunder or otherwise (except as specifically provided
in paragraph (c) of this Section 7).
(e) The Company will not, without the prior written consent of each
Underwriter, settle or compromise or consent to the entry of any judgment in any
pending or threatened claim, action, suit or proceeding in respect of which
indemnification may be sought hereunder (whether or not such Underwriter or any
person who controls such Underwriter within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act is a party to such claim,
action, suit or proceeding) unless such settlement, compromise or consent
includes
17
<PAGE>
an unconditional release of such Underwriter and each such controlling person
from all liability arising out of such claim, action, suit or proceeding.
8. Termination. This Agreement may be terminated by you at any time prior
to the Closing Date by giving written notice to the Company if after the date of
this Agreement trading in the Common Stock shall have been suspended, or if
there shall have occurred (i) the engagement in hostilities or an escalation of
major hostilities by the United States or the declaration of war or a national
emergency by the United States on or after the date hereof, (ii) any outbreak of
hostilities or other national or international calamity or crisis or change in
economic or political conditions if the effect of such outbreak, calamity,
crisis or change in economic or political conditions in the financial markets of
the United States would, in the Underwriters' reasonable judgment, make the
offering or delivery of the Stock impracticable, (iii) suspension of trading in
securities generally or a material adverse decline in value of securities
generally on the New York Stock Exchange, the American Stock Exchange, The
Nasdaq Stock Market, or limitations on prices (other than limitations on hours
or numbers of days of trading) for securities on either such exchange or system,
(iv) the enactment, publication, decree or other promulgation of any federal or
state statute, regulation, rule or order of, or commencement of any proceeding
or investigation by, any court, legislative body, agency or other governmental
authority which in the Underwriters' reasonable opinion materially and adversely
affects or will materially or adversely affect the business or operations of the
Company, (v) declaration of a banking moratorium by either federal or New York
State authorities or (vi) the taking of any action by any federal, state or
local government or agency in respect of its monetary or fiscal affairs which in
the Underwriters' reasonable opinion has a material adverse effect on the
securities markets in the United States. If this Agreement shall be terminated
pursuant to this Section 8, there shall be no liability of the Company to the
Underwriters and no liability of the Underwriters to the Company; provided,
however, that in the event of any such termination the Company agrees to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the Company under this Agreement,
including all costs and expenses referred to in paragraphs (i) and (j) of
Section 6 hereof.
9. Conditions of Underwriters' Obligations. The obligations of the
several Underwriters to purchase and pay for the Stock shall be subject to the
performance by the Company of all its obligations to be performed hereunder at
or prior to the Closing Date or any later date on which Option Stock is to be
purchased, as the case may be, and to the following further conditions:
(a) The Registration Statement shall have become effective; and no
stop order suspending the effectiveness thereof shall have been issued and no
proceedings therefor shall be pending or threatened by the Commission.
(b) The legality and sufficiency of the sale of the Stock hereunder
and the validity and form of the certificates representing the Stock, all
corporate proceedings and other legal matters incident to the foregoing, and the
form of the Registration Statement and of the Prospectus (except as to the
financial statements contained therein), shall have been approved at or prior to
the Closing Date by Brobeck, Phleger & Harrison LLP, counsel for the
Underwriters.
18
<PAGE>
(c) You shall have received from Morrison & Foerster LLP, counsel for
the Company, an opinion, addressed to the Underwriters and dated the Closing
Date, covering the matters set forth in Annex A hereto, and from Oblon, Spivak,
McClelland, Maier & Neustadt, P.C., patent counsel for the Company, an opinion
addressed to the Underwriters, dated the closing date and covering the matters
set forth in Annex B hereto, and if Option Stock is purchased at any date after
the Closing Date, an additional opinions from such counsel, addressed to the
Underwriters and dated the Option Closing Date, confirming that the statements
expressed as of the Closing Date in such opinions remain valid as of such later
date.
(d) You shall be satisfied that (i) as of the Effective Date, the
statements made in the Registration Statement and the Prospectus were true and
correct and neither the Registration Statement nor the Prospectus omitted to
state any material fact required to be stated therein or necessary in order to
make the statements therein, respectively, not misleading, (ii) since the
Effective Date, no event has occurred which should have been set forth in a
supplement or amendment to the Prospectus which has not been set forth in such a
supplement or amendment, (iii) since the respective dates as of which
information is given in the Registration Statement in the form in which it
originally became effective and the Prospectus contained therein, there has not
been any Material Adverse Effect or any development involving a prospective
Material Adverse Effect, whether or not arising from transactions in the
ordinary course of business, and, since such dates, except in the ordinary
course of business, the Company has not entered into any material transaction
not referred to in the Registration Statement in the form in which it originally
became effective and the Prospectus contained therein, (iv) the Company does not
have any material contingent obligations which are not disclosed in the
Registration Statement and the Prospectus, (v) there are not any pending or
known threatened legal proceedings to which the Company is a party or of which
property of the Company is the subject which are material and which are not
disclosed in the Registration Statement and the Prospectus, (vi) there are not
any franchises, contracts, leases or other documents which are required to be
filed as exhibits to the Registration Statement which have not been filed as
required, (vii) the representations and warranties of the Company and the Parent
herein are true and correct in all material respects as of the Closing Date or
any later date on which Option Stock is to be purchased, as the case may be, and
(viii) there has not been any material change in the market for securities in
general or in political, financial or economic conditions from those reasonably
foreseeable as to render it impracticable in your reasonable judgment to make a
public offering of the Stock, or a Material Adverse Effect in market levels for
securities in general (or those of companies in particular) or financial or
economic conditions which render it inadvisable to proceed.
(e) You shall have received on the Closing Date and the Option Closing
Date, dated the Closing Date or the Option Closing Date, as the case may be, and
signed by the President and the Chief Financial Officer of the Company, a
certificate stating that the respective signers of said certificate have
carefully examined the Registration Statement in the form in which it originally
became effective and the Prospectus contained therein and any supplements or
amendments thereto, and that the statements included in clauses (i) through
(vii) of paragraph (d) of this Section 9 are true and correct.
19
<PAGE>
(f) You shall have received from Ernst & Young LLP, a letter or
letters, addressed to the Underwriters and dated the Closing Date and the Option
Closing Date, as the case may be, confirming that they are independent public
accountants with respect to the Company within the meaning of the Securities Act
and the Rules and Regulations and based upon the procedures described in their
letter delivered to you concurrently with the execution of this Agreement
(herein called the Original Letter), but carried out to a date not more than
three business days prior to the Closing Date or such later date on which Option
Stock is purchased (i) confirming, to the extent true, that the statements and
conclusions set forth in the Original Letter are accurate as of the Closing Date
or the Option Closing Date, as the case may be, and (ii) setting forth any
revisions and additions to the statements and conclusions set forth in the
Original Letter which are necessary to reflect any changes in the facts
described in the Original Letter since the date of the Original Letter or to
reflect the availability of more recent financial statements, data or
information. The letters shall not disclose any change, or any development
involving a prospective change, in or affecting the business or properties of
the Company which, in your sole judgment, makes it impractical or inadvisable to
proceed with the public offering of the Stock or the purchase of the Option
Stock as contemplated by the Prospectus. The Original Letter from Ernst & Young
LLP shall be addressed to or for the use of the Underwriters in form and
substance satisfactory to the Underwriters and shall (i) represent, to the
extent true, that they are independent certified public accountants with respect
to the Company within the meaning of the Securities Act and the applicable
published Rules and Regulations, (ii) set forth their opinion with respect to
their examination of the consolidated balance sheet of the Company as of July
31, 1998 and related consolidated statements of operations, stockholders'
equity, and cash flows for the twelve (12) months ended July 31, 1998, (iii)
state that Ernst & Young LLP has performed the procedures set out in Statement
on Auditing Standards No. 71 (herein called SAS 71) for a review of interim
financial information and providing the report of Ernst & Young LLP as described
in SAS 71 on the financial statements for each of the quarters in the period
ended July 31, 1998 and each of the two quarters in the period ended January 31,
1999 (herein called the Quarterly Financial Statements), (iv) state that in the
course of such review, nothing came to their attention that leads them to
believe that any material modifications need to be made to any of the Quarterly
Financial Statements in order for them to be in compliance with generally
accepted accounting principles consistently applied across the periods
presented, (v) state that the underlying information, determinations, estimates
and assumptions contained in the section of the Prospectus entitled Management
Discussion and Analysis and Results of Operations provide a reasonable basis for
the statements contained therein, and (vi) address other matters agreed upon by
Ernst & Young LLP and you. In addition, you shall have received from Ernst &
Young LLP a letter addressed to the Company and made available to you for the
use of the Underwriters stating that their review of the Company's system of
internal accounting controls, to the extent they deemed necessary in
establishing the scope of their examination of the Company's consolidated
financial statements as of January 31, 1999, did not disclose any weaknesses in
internal controls that they considered to be material weaknesses.
(g) You shall have been furnished evidence in usual written or
telegraphic form from the appropriate authorities of the several jurisdictions,
or other evidence satisfactory to you, of the qualification referred to in
paragraph (f) of Section 6 hereof.
20
<PAGE>
(h) Prior to the Closing Date, the Stock to be issued and sold by the
Company shall have been duly authorized for listing by the Nasdaq National
Market upon official notice of issuance.
(i) On or prior to the Closing Date, you shall have received from all
directors, officers and beneficial holders of the outstanding capital stock
agreements, in form reasonably satisfactory to Hambrecht & Quist LLC, stating
that without the prior written consent of Hambrecht & Quist LLC on behalf of the
Underwriters, such person or entity will not, for a period of 180 days following
the commencement of the public offering of the Stock by the Underwriters,
directly or indirectly, (i) sell, offer, contract to sell, make any short sale,
pledge, sell any option or contract to purchase, purchase any option or contract
to sell, grant any option, right or warrant to purchase or otherwise transfer or
dispose of any shares of capital stock or any securities convertible into or
exchangeable or exercisable for or any rights to purchase or acquire capital
stock or (ii) enter into any swap or other agreement that transfers, in whole or
in part, any of the economic consequences or ownership of capital stock, whether
any such transaction described in clause (i) or (ii) above is to be settled by
delivery of capital stock or such other securities, in cash or otherwise.
All the agreements, opinions, certificates and letters mentioned above or
elsewhere in this Agreement shall be deemed to be in compliance with the
provisions hereof only if Brobeck, Phleger & Harrison LLP, counsel for the
Underwriters, shall be satisfied that they comply in form and scope.
In case any of the conditions specified in this Section 9 shall not be
fulfilled, this Agreement may be terminated by you by giving notice to the
Company. Any such termination shall be without liability of the Company to the
Underwriters and without liability of the Underwriters to the Company; provided,
however, that (i) in the event of such termination, the Company agrees to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the Company under this Agreement,
including all costs and expenses referred to in paragraphs (i) and (j) of
Section 6 hereof, and (ii) if this Agreement is terminated by you because of any
refusal, inability or failure on the part of the Company to perform any
agreement herein, to fulfill any of the conditions herein, or to comply with any
provision hereof other than by reason of a default by any of the Underwriters,
the Company will reimburse the Underwriters severally upon demand for all out-
of-pocket expenses (including reasonable fees and disbursements of counsel) that
shall have been incurred by them in connection with the transactions
contemplated hereby.
10. Conditions of the Obligation of the Company. The obligation of the
Company to deliver the Stock shall be subject to the conditions that (a) the
Registration Statement shall have become effective and (b) no stop order
suspending the effectiveness thereof shall be in effect and no proceedings
therefor shall be pending or threatened by the Commission.
In case either of the conditions specified in this Section 10 shall not be
fulfilled, this Agreement may be terminated by the Company by giving notice to
you. Any such termination shall be without liability of the Company to the
Underwriters and without liability of the Underwriters to the Company; provided,
however, that in the event of any such termination the Company agrees to
indemnify and hold harmless the Underwriters from all costs or expenses
21
<PAGE>
incident to the performance of the obligations of the Company under this
Agreement, including all costs and expenses referred to in paragraphs (i) and
(j) of Section 6 hereof.
11. Reimbursement of Certain Expenses. In addition to its other
obligations under Section 7 of this Agreement, the Company hereby agrees to
reimburse on a quarterly basis the Underwriters for all reasonable legal and
other expenses incurred in connection with investigating or defending any claim,
action, investigation, inquiry or other proceeding arising out of or based upon
any statement or omission, or any alleged statement or omission, described in
paragraph (a) of Section 7 of this Agreement, notwithstanding the absence of a
judicial determination as to the propriety and enforceability of the obligations
under this Section 11 and the possibility that such payments might later be held
to be improper; provided, however, that (i) to the extent any such payment is
ultimately held to be improper, the persons receiving such payments shall
promptly refund them and (ii) such persons shall provide to the Company, upon
request, reasonable assurances of their ability to effect any refund, when and
if due.
12. Persons Entitled to Benefit of Agreement. This Agreement shall inure
to the benefit of the Company and the several Underwriters and, with respect to
the provisions of Section 7 hereof, the several parties (in addition to the
Company and the several Underwriters) indemnified under the provisions of said
Section 7, and their respective personal representatives, successors and
assigns. Nothing in this Agreement is intended or shall be construed to give to
any other person, firm or corporation any legal or equitable remedy or claim
under or in respect of this Agreement or any provision herein contained. The
term "successors and assigns" as herein used shall not include any purchaser, as
such purchaser, of any of the Stock from any of the several Underwriters.
13. Notices. Except as otherwise provided herein, all communications
hereunder shall be in writing or by telegraph and, if to the Underwriters, shall
be mailed, telegraphed or delivered to Hambrecht & Quist LLC, One Bush Street,
San Francisco, California 94104, with a copy to Brobeck, Phleger & Harrison LLP,
1633 Broadway, 47th Floor, New York, New York 10019, Attention: Alexander D.
Lynch, Esq.; and if to the Company, shall be mailed, telegraphed or delivered to
it at its office, 171 Main Street, Hackensack, New Jersey 07601, Attention:
Howard S. Balter, with a copy to Morrison & Foerster LLP, 1290 Avenue of the
Americas, New York, New York 10104, Attention: Ira A. Greenstein, Esq. All
notices given by telegraph shall be promptly confirmed by letter.
14. Miscellaneous. The reimbursement, indemnification and contribution
agreements contained in this Agreement and the representations, warranties and
covenants in this Agreement shall remain in full force and effect regardless of
(a) any termination of this Agreement, (b) any investigation made by or on
behalf of any Underwriter or controlling person thereof, or by or on behalf of
the Company or their respective directors or officers, and (c) delivery and
payment for the Stock under this Agreement; provided, however, that if this
Agreement is terminated prior to the Closing Date, the provisions of paragraphs
(k) and (l) of Section 6 hereof shall be of no further force or effect.
This Agreement may be executed in two or more counterparts, each of which
shall be deemed an original, but all of which together shall constitute one and
the same instrument.
22
<PAGE>
This Agreement shall be governed by, and construed in accordance with, the
internal laws of the State of New York.
Please sign and return to the Company the enclosed duplicates of this
letter, whereupon this letter will become a binding agreement between the
Company and the several Underwriters in accordance with its terms.
Very truly yours,
IDT CORPORATION NET2PHONE, INC.
By By
--------------------- --------------------
Name: Name:
Title: Title:
The foregoing Agreement is hereby confirmed
and accepted as of the date first above written.
HAMBRECHT & QUIST LLC
BT ALEX. BROWN INCORPORATED
BEAR, STEARNS & CO. INC.
By: Hambrecht & Quist LLC
By
----------------------
Managing Director
Acting on behalf of the several Underwriters,
including themselves, named in Schedule I hereto.
23
<PAGE>
SCHEDULE I
UNDERWRITERS
Underwriters Number of Shares to be
Purchased
- ------------------------------------------- ----------------------
Hambrecht & Quist LLC......................
BT Alex. Brown Incorporated................
Bear, Stearns & Co. Inc....................
----------------------
Total.................................
======================
<PAGE>
EXHIBIT 4.1
NET2PHONE
Net2Phone, Inc.
NUMBER SHARES
------------------- -----------------
------------------- -----------------
INCORPORATED UNDER THE LAWS OF SEE REVERSE FOR
THE STATE OF DELAWARE CERTAIN DEFINITIONS
- -------------------------------------------------------------------------------
THIS CERTIFIES that CUSIP 64108N 10 6
is the owner of
- --------------------------------------------------------------------------------
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK, PAR VALUE $0.01
PER SHARE, OF
- -------------------------- ------------------------------
- -------------------------- Net2Phone, Inc. ------------------------------
- -------------------------- ------------------------------
transferable on the books of the Corporation by the holder hereof in person or
by duly authorized attorney, upon surrender of this certificate properly
endorsed.
This certificate is not valid until countersigned and registered by the
Transfer Agent and Registrar.
WITNESS the facimile seal of the corporation and the facsimile signatures of
its duly authorized officers.
Dated:
COUNTERSIGNED AND REGISTERED:
AMERICAN STOCK TRANSFER AND TRUST COMPANY
TRANSFER AGENT AND REGISTAR
BY
AUTHORIZED SIGNATURE
/s/ Ira Greenstein NET2PHONE, INC. /s/ Clifford M. Sobel
SECRETARY CORPORATE SEAL CHAIRMAN OF THE BOARD
DELAWARE
1997
<PAGE>
EXHIBIT 5.1
[Morrison & Foerster LLP Letterhead]
July __, 1999
Net2Phone, Inc.
171 Main Street
Hackensack, NJ 07601
Ladies and Gentlemen:
At your request, we have examined the Registration Statement on Form S-1 of
Net2Phone, Inc., a Delaware corporation (the "Company"), to be filed with the
Securities and Exchange Commission (the "Registration Statement"), relating to
the registration under the Securities Act of 1933, as amended, of up to
_____________ shares of the Company's common stock, $.01 par value (the
"Stock"), including up to ________ authorized but unissued shares being offered
by the Company (including up to ______________ shares subject to the
underwriters' over-allotment option). The Stock is to be sold to the
underwriters named in the Registration Statement for resale to the public.
As counsel to the Company, we have examined the proceedings taken by the
Company in connection with the issuance and sale by the Company of up to
_____________ shares of Stock.
We are of the opinion that the shares of Stock to be offered and sold by
the Company have been duly authorized and, when issued and sold by the Company
in the manner described in the Registration Statement and in accordance with the
resolutions adopted by the Board of Directors of the Company, will be legally
issued, fully paid and nonassessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement and further consent to all references to us in the Registration
Statement, the prospectus constituting a part thereof and any amendments
thereto.
Very truly yours,
Morrison & Foerster LLP
<PAGE>
EXHIBIT 10.27
EMPLOYMENT AGREEMENT
This Agreement is made as of the 2nd day of July, 1999, between Net2Phone, Inc.,
a Delaware corporation (the "Company"), and Jonathan Fram, an individual
residing at 20 West 10th Street, New York, NY 10011 (the "Executive").
RECITALS:
WHEREAS, the Company desires to employ the Executive as the President of the
Company, and the Executive desires to serve as the President of the Company, on
the terms and conditions hereinafter set forth.
NOW, THEREFORE, in consideration of the mutual covenants and promises contained
herein, the parties hereto, each intending to be legally bound hereby, agree as
follows:
1. EMPLOYMENT.
The Company hereby employs the Executive as an employee of the Company as of
July 20, 1999 (or such other date as the parties may agree, the "Effective
Date"), and the Executive accepts such employment for the term of employment
specified in Section 3 below (the "Employment Term"). Upon the Effective
Date, the Executive shall become President of the Company. During the
Employment Term, as the President of the Company, the Executive shall,
subject to the direction of the Chief Executive Officer of the Company,
perform such duties consistent with those duties ordinarily and customarily
performed by a person holding such position in similar organizations, as may
from time to time be reasonably assigned to him by the Chief Executive
Officer or the Board of Directors of the Company. During the Employment
Term, the Executive will supervise the Chief Operating Officer of the
Company and the Chief Operating Officer will report to the Executive.
2. PERFORMANCE; LOCATION OF EMPLOYMENT; OTHER ACTIVITIES.
(a) The Executive agrees to devote his reasonable best efforts and
substantially all of his business time to the performance of his duties
hereunder during the Employment Term. During the Employment Term, the
Executive will perform his duties hereunder at the Company's executive
offices located in Hackensack, New Jersey or other such corporate
headquarters in the event that the company relocates to a different
corporate headquarters.
(b) During the Employment Term, the Executive agrees that, unless he has the
express prior written approval of the Chief Executive Officer of the
Company, he shall not accept a membership on a Board of Directors of, or
act as an officer, employee or consultant to, any entity which is in a
similar or competing business of the Company that would in any way conflict
with the business of the Company or the time needed by the Executive to
perform his duties hereunder.
Page 1
<PAGE>
3. EMPLOYMENT TERM.
The term of employment under this Agreement shall begin on the date of this
Agreement and continue until June 30, 2002 (the "Initial Employment Term").
The Employment Term shall thereafter continue on the basis hereby
established for successive one year terms unless, more than ninety days
prior to the expiration of the Initial Employment Term or any successive
one year term, either the Executive or the Company provides the other with
written notice that this Agreement will not be renewed (the "Subsequent
Employment Term" and with the Initial Employment Term, the "Employment
Term"). Employment during the Employment Term shall be subject to earlier
termination in accordance with the terms of this Agreement.
4. COMPENSATION.
(a) SALARY. During the Employment Term, the Company shall pay the Executive a
base salary, payable in equal installments in accordance with the Company's
then current compensation practices for all of its executives (but in no
case longer than monthly installments), subject to withholding and other
applicable taxes, at an annual rate of Three Hundred Fifty Thousand Dollars
($350,000.00). The base salary may be reviewed annually by the Board of
Directors or the Compensation Committee elected thereby, provided that the
base salary shall not be decreased during the Employment Term.
(b) BONUS. The Executive shall be entitled to receive an annual bonus computed
as follows:
A maximum bonus of $100,000 shall be paid to the Executive if the Company's
actual gross revenue for the year ending July 31, 2000 is at least 50% more
than the $84.3 million projected gross revenue for that year (the
"Target"). No bonus will be paid if the actual gross revenue for the year
ending July 31, 2000 is less than 11% more than the Target. If actual gross
revenue is at least 11% more than the Target but less than 50% more than
the Target, the potential bonus shall be paid pro rata.
Any Bonus due hereunder will be paid to the Executive as soon as
practicable after the end of the year ending July 31, 2000. For the
remainder of the Employment Term, the Employee and the Company shall
mutually agree to similarly constructed bonus plans whose performance
objectives will be set forth prior to the start of subsequent fiscal years
covered by this Agreement.
(c) STOCK OPTIONS. Upon the execution and delivery of this Agreement, the
Executive shall be granted stock options (the "Options"), to purchase
920,000 shares of Common Stock of the Company (the "Common Stock") pursuant
to the Company's 1999 Stock Option and Incentive Plan. Of the Options, (i)
460,000 of the Options will be granted at an exercise price equal to $3.33
per share, 153,333 of which shall be immediately vested and exercisable on
the Effective Date, (ii) Options to purchase the remaining 460,000 shares
of Common Stock will be granted at an exercise price equal to a the lower
of (x) the Company's initial public offering price or (y) the $11 price per
share indicated as the mid-point of the filing
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range specified in the Company's amended S-1, filed with the Securities and
Exchange Commission on June 28, 1999. The 766,667 remaining Options shall
vest in three (3) annual installments of 255,555 Options, 255,555 Options,
and 255,556 Options, respectively, commencing on the first anniversary of
the Effective Date. In the event the Executive's employment is terminated
by the Company without Cause (as defined herein) or by the Executive for
Good Reason (as defined herein), all Options shall immediately become
vested and exercisable. In the event that the Company accelerates the
vesting of any options held by any other employee of the Company in
connection with a change of control of the Company, then all Options held
by the Executive shall be accelerated and become vested and exercisable in
the same manner as such other options are accelerated.
(d) LOAN TO PURCHASE STOCK
In the event that the company successfully completes an initial public
offering (an "IPO") during the term of the Executive's employment, the
Company agrees to extend to the Executive a loan (the "Loan") upon
consummation of the IPO in an amount of up to $1,000,000 for the purchase
of common shares to be issued by the Company at a price not to exceed the
IPO price (the "Effective Price") of common shares. The Loan, once drawn by
the Executive for the purchase of stock, shall be for a term of three (3)
years and shall bear interest at the rate of 7% compounded annually.
Interest on the Loan shall accrue until such time as the Executive effects
a sale of Company stock purchased in connection with the Loan, at which
time the Executive shall pay the Company all accrued interest on the Loan
up to such date of sale, and after which time he shall pay interest on the
Loan currently through the term of the Loan. The Executive hereby agrees to
use the Loan only to purchase common stock of the Company. This Loan will
be secured solely by the common stock of the company purchased by the
Executive with the proceeds of the Loan.
(e) LOCK UP. The Executive hereby further agrees not to, directly or
indirectly, sell, offer, contract to sell, transfer the economic risk of
ownership in, make any short sale, pledge or otherwise dispose of any
shares of capital stock of the Company or any securities convertible into
or exchangeable or exercisable for or any other rights to purchase or
acquire capital stock of the Company for a period of 180 days from the
effective date of the Registration Statement related to the IPO. The
Executive further agrees to enter into a "lock up" agreement with the
underwriters of the IPO in form and substance acceptable to such
underwriters.
(f) INSURANCE; OTHER BENEFITS. The Executive and his dependants shall be
entitled to receive those benefits available to other Company employees at
the Company's expense. The Executive shall also be entitled to participate
in all executive benefit plans now existing or hereinafter established by
the Company, including, but not limited to, family medical and dental
plans, group life and disability insurance plans, life insurance plan,
pension, 401(k), profit sharing or bonus plans, and any other benefit plan
or arrangement made available to executive officers of the Company.
(g) VACATION. The Executive shall be entitled to the same paid vacation
benefits as the other executive officers of the Company, but in no case
shall it be less than three weeks of paid
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vacation during each year of the Employment Term, to be taken at such time
or times as shall be mutually convenient and consistent with his duties and
obligations to the Company.
5. EXPENSES. The Executive shall be reimbursed by the Company for all
reasonable out of pocket expenses incurred by him in connection with the
performance of his duties hereunder in accordance with policies established
by the Board of Directors from time to time and upon receipt of appropriate
documentation. Travel, lodging and meals while travelling on behalf of the
Company, client entertainment and cellular phone expenses will be directly
billed to, and paid by, the Company.
6. TERMINATION.
(a) TERMINATION AT END OF TERM. The employment of the Executive hereunder shall
terminate at the end of the Initial Employment Term or any Subsequent
Employment Term if either party provides notice of termination at least 90
days prior to expiration of the Initial Employment Term or Subsequent
Employment Term, or if earlier terminated by the Board of Directors of the
Company pursuant to this Section 6.
(b) TERMINATION BY THE COMPANY WITH CAUSE. The Company shall have the right at
any time to terminate the Executive's employment hereunder upon the
occurrence of any of the following (any such termination being referred to
as a termination for "Cause"): (i) the Executive has misappropriated or
done material, intentional damage to the Company or its business or
financial situation, (ii) the Executive has been convicted of a felony
involving moral turpitude, (iii) any breach by the Executive of Section 2
of this Agreement which breach is not cured by the Executive within ten
(10) business days after written notice thereof is delivered to the
Executive by the Company or (iii) any material malfeasance, willful
misconduct, active fraud or gross negligence (in each case as may be
decided by a court of law) by the Executive in connection with his
employment hereunder, which conduct is not corrected to the reasonable
satisfaction of the Company within ten (10) business days after written
notice thereof is delivered to the Executive by the Company.
(c) TERMINATION UPON DEATH OR DISABILITY. The Executive's employment hereunder
shall automatically terminate upon the Executive's death or upon his
inability to perform his duties hereunder by reason of any mental, physical
or other disability for a period of at least three consecutive months, or
any six months within any 18 month period, as determined by a qualified
physician selected by the Company.
(d) TERMINATION BY THE COMPANY WITHOUT CAUSE.
The Company shall have the right to terminate the Executive's employment at
any time with ten (10) business days written notice. In the event that the
Company terminates the Employee without cause, the company will give the
Executive the opportunity to resign prior to such involuntary termination.
(e) TERMINATION BY THE EXECUTIVE FOR GOOD REASON. The Executive shall have the
right to terminate his employment at any time for Good Reason upon written
notice to the
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Company. For purposes of this Agreement, "Good Reason" shall mean (a) the
Executive's authority or duties are materially changed without the prior
consent of the Executive, which change is not remedied within ten (10)
business days after written notice thereof is delivered to the Company by
the Executive, (b) any material breach of this Agreement by the Company,
which breach is not remedied within ten (10) business days after written
notice thereof is delivered to the Company by the Executive, or (c) the
relocation of Executive's place of work more than 50 miles from the
Hackensack, New Jersey area. For purposes of this Agreement, the
Executive's authority or duties shall be deemed to be "materially changed"
if, without the Executive's consent, there is any material diminution in
the Executive's responsibilities or an adverse modification to the
Executive's title, compensation, or reporting relationship.
(f) VOLUNTARY RESIGNATION. In addition to the right to terminate his employment
for Good Reason under Section 6(e) above, the Executive may voluntarily
terminate his employment at any time upon ten (10) business days notice,
which resignation will result in the immediate loss of all benefits and
responsibilities hereunder other than as afforded by statute.
7. EFFECT OF TERMINATION OF EMPLOYMENT.
(a) WITH CAUSE; RESIGNATION; DEATH OR DISABILITY.
If the Executive's employment is terminated with Cause pursuant to Section
6(b), if the Executive's employment is terminated by the death or
disability of the Executive pursuant to Section 6(c) or if the Executive
elects to terminate his employment voluntarily under Section 6(f) (other
than for Good Reason), the Executive's salary and other benefits specified
in Section 4 shall cease at the time of such termination; provided,
however, that the Executive shall be entitled to continue to participate in
the Company's medical benefit plans to the extent required by law and shall
be entitled to the reimbursement for expenses incurred by him through the
date of termination pursuant to Section 5.
(b) WITHOUT CAUSE BY THE COMPANY.
If the Executive's employment is terminated either by the Company without
Cause pursuant to Section 6(d) or by the Executive for Good Reason pursuant
to Section 6(e), in each case, prior to the expiration of the Initial
Employment Term or any Subsequent Employment Term, the Executive's salary
and other benefits specified in Section 4 shall cease at the time of such
termination, and the Executive shall be entitled to receive a severance
amount (the "Severance Amount") equal to the amounts set forth in the
following schedule:
<TABLE>
<CAPTION>
Termination Date: Severance Amount:
- ----------------- -----------------
<S> <C>
During the first 6 months of employment 9 months of base salary
After 6 months from the initial date of employment 6 months of base salary
</TABLE>
In addition, in any of such events or if the Company does not renew this
Agreement beyond the Initial Employment Term or Subsequent Employment Term (i)
the Executive shall also be entitled to receive any guaranteed bonus and any
bonus accrued or earned by the
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Executive through the date of termination based on achieving the performance
goals set forth in Section 4(b) and the amount of any expenses incurred by
the Executive through the date of termination pursuant to Section 5, (ii)
all stock options then held by the Executive shall immediately vest and
become exercisable, and (iii) the Executive shall continue to receive the
insurance benefits specified in Section 4, at the Company's expense,
covering the same period of time as any Severance Amount the Executive may
receive as set forth above.
8. NOTICE.
Any notices required or permitted hereunder shall be in writing and shall be
deemed to have been given when personally delivered or when mailed,
certified or registered mail, postage prepaid, to the following addresses or
such other address as to which notice is given in the manner provided
herein: If to the Executive: Jonathan Fram, 20 West 10th Street, New York,
NY 10011. If to the Company: Net2Phone, 171 Main Street, Hackensack, NJ
07601, Attn: Howard S. Balter.
9. GENERAL
(a) GOVERNING LAW; SUBMISSION TO JURISDICTION. The terms of this Agreement
shall be governed by and construed under the laws of the State of New York
without regard to its principles of conflicts of laws. Accordingly, to the
extent a restriction contained in this Agreement is more restrictive than
permitted by the laws of any jurisdiction where this Agreement may be
subject to review and interpretation, the terms of such restriction, for
the purpose only of the operation of such restriction in such jurisdiction,
shall be the maximum restriction allowed by the laws of such jurisdiction
and such restriction shall be deemed to have been revised accordingly
herein. The parties hereto irrevocably agree that all claims relating to
this Agreement shall be submitted exclusively to federal and state courts
located in State of New York and irrevocably consent to the jurisdiction
and venue of such courts and service of process by certified or registered
mail, return receipt requested, directed to the parties at the addresses
set forth herein or as otherwise provided by law.
(b) ENTIRE AGREEMENT; MODIFICATION. This Agreement constitutes the entire
agreement of the parties hereto with respect to the subject matter hereof
and they and may not be modified or amended in any way except in writing by
the parties hereto.
(c) DURATION. Notwithstanding the term of employment hereunder, this Agreement
shall continue for so long as any obligations remain under this Agreement.
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IN WITNESS WHEREOF, the parties hereto, intending to be legally bound, have
hereunto executed this Agreement the day and year first written above.
NET2PHONE, INC.
By: /s/ Clifford M. Sobel
---------------------
Name: Clifford M. Sobel
Title: Chairman
EXECUTIVE
/s/ Jonathan Fram
- -----------------
Jonathan Fram
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EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected Financial
Data" and "Experts" and to the use of our report dated May 11, 1999 (except for
Note 9, as to which the date is June 25, 1999), in the Registration Statement
(Form S-1 No. 333-78713) and related Prospectus of Net2Phone, Inc. for the
registration of shares of its common stock.
/s/ Ernst & Young LLP
New York, New York
July 14, 1999
