-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IJElGytUgR1kyw+CKfVMkki9f/z79P6QRtEV7PqDnKs7Aia8RaPUK6OOzD8W6fg8 G7ReFDKPArcuvvxP4pErPw== 0000912057-00-015721.txt : 20000403 0000912057-00-015721.hdr.sgml : 20000403 ACCESSION NUMBER: 0000912057-00-015721 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 22 FILED AS OF DATE: 20000331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FREEI NETWORKS INC CENTRAL INDEX KEY: 0001083427 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 911930473 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-33812 FILM NUMBER: 591742 BUSINESS ADDRESS: STREET 1: 909 S 336TH STREET 110 STREET 2: 888-841-9828 CITY: FEDERAL WAY STATE: WA ZIP: 98003 MAIL ADDRESS: STREET 1: 2505 S. 320TH STREET STREET 2: SUITE 200 CITY: FEDERAL WAY STATE: WA ZIP: 98003 S-1 1 FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 31, 2000 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- FREEI NETWORKS, INC. (Name of issuer in its charter) -------------------------- WASHINGTON 7370 91-1930473 (State or Other (Primary Standard (I.R.S. Employer Jurisdiction of Industrial Identification Number) Incorporation or Classification Code Organization) Number)
-------------------------- 2505 S. 320(TH) STREET, SUITE 200 FEDERAL WAY, WASHINGTON 98003 (253) 796-6500 (Address and telephone number of principal executive offices and principal place of business) ------------------------------ ROBERT MCCAUSLAND CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER 2505 S. 320(TH) STREET, SUITE 200 FEDERAL WAY, WASHINGTON 98003 (253) 796-6500 (Name, address and telephone number of agent for service) ------------------------------ COPIES OF ALL COMMUNICATIONS TO BE SENT TO: MICHAEL J. ERICKSON, ESQ. CARY K. HYDEN, ESQ. LAURA A. BERTIN, ESQ. JONN R. BEESON, ESQ. MARK F. WORTHINGTON, ESQ. LATHAM & WATKINS SUMMIT LAW GROUP, PLLC 650 TOWN CENTER DRIVE 1505 WESTLAKE AVENUE NORTH, SUITE 300 TWENTIETH FLOOR SEATTLE, WASHINGTON 98109 COSTA MESA, CALIFORNIA 92626 (206) 281-9881 (714) 540-1235
-------------------------- APPROXIMATE DATE OF COMMENCEMENT OF 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, 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 under the Securities Act, check the following box. / / -------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM TITLE OF EACH CLASS OF AGGREGATE OFFERING AMOUNT OF SECURITIES TO BE REGISTERED PRICE (1) REGISTRATION FEE Common Stock, no par value.................................. $172,500,000 $45,540
(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS 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. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUBJECT TO COMPLETION, DATED MARCH 31, 2000 PROSPECTUS SHARES [LOGO] FREEI NETWORKS, INC. COMMON STOCK This is an initial public offering of our common stock. We are selling all of the shares offered under this prospectus. There is currently no public market for the shares. We will apply to have our common stock listed for quotation on the Nasdaq National Market under the symbol "FREI." SEE "RISK FACTORS" BEGINNING ON PAGE 5 TO READ ABOUT RISKS THAT YOU SHOULD CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------
PER SHARE TOTAL ------------------------ ------------------------ Public offering price........................... $ $ Underwriting discounts and commissions.......... $ $ Proceeds, before expenses, to us................ $ $
------------------------ The underwriters may purchase up to an additional shares from us at the initial public offering price less the underwriting discount to cover over-allotments. The underwriters are severally underwriting the shares being offered. The underwriters expect to deliver the shares against payment in New York, New York on , 2000. ------------------------ BEAR, STEARNS & CO. INC. BANC OF AMERICA SECURITIES LLC DAIN RAUSCHER WESSELS WARBURG DILLON READ LLC PACIFIC CREST The date of this prospectus is , 2000. Inside Front Cover: Four maps of the United States reflecting service availability, current POPs and future POPs. Text: Freei internet.com - Logo U.S. Market Coverage Freeinternet.com offers dial up access in over 1,300 cities in North America. Each city designated with a red dot below has free internet service available. The green stars are our current freei owned POPs. The yellow starts designate our projected year 2000 POPs. These cities and others offer dial up access via a local phone number. Inside gatefold: Samples of promotion material for Subway private label program Text: FreeInternet.com Private Label Program and Co-Branded Service Picture of Home Page Text: FreeInternet.com Home Page Picture of the Company's "Baby Bob" Text: FreeInternet.com Logo "I was made for this job!" Read my lips! Totally free internet service. 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 UNDER CIRCUMSTANCES AND 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 THE PROSPECTUS OR OF ANY SALE OF THE COMMON STOCK. ------------------------ TABLE OF CONTENTS
PAGE -------- Prospectus Summary.................... 1 Risk Factors.......................... 5 Forward-Looking Statements............ 19 Use of Proceeds....................... 19 Dividend Policy....................... 19 Capitalization........................ 20 Dilution.............................. 21 Selected Financial Data............... 22 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 23
PAGE -------- Business.............................. 30 Management............................ 41 Related-Party Transactions............ 48 Principal Shareholders................ 50 Description of Capital Stock.......... 51 Shares Eligible for Future Sale....... 54 Underwriting.......................... 57 Legal Matters......................... 59 Experts............................... 59 Where to Find Additional Documents.... 59 Index to Financial Statements......... F-1
------------------------ THROUGH AND INCLUDING , 2000 (THE 25(TH) DAY AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. PROSPECTUS SUMMARY THE FOLLOWING SUMMARY HIGHLIGHTS INFORMATION THAT WE PRESENT MORE FULLY ELSEWHERE IN THIS PROSPECTUS. YOU SHOULD READ THIS ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE SECTION TITLED "RISK FACTORS" AND THE FINANCIAL STATEMENTS AND THE NOTES RELATING TO THOSE STATEMENTS. AS REFERRED TO IN THIS PROSPECTUS, THE TERMS "WE," "US," "OUR," "FREEINTERNET.COM" AND SIMILAR TERMS REFER TO FREEI NETWORKS, INC. OUR BUSINESS Freeinternet.com is a leading provider of free internet access to consumers and also offers private label and co-branded free internet access solutions to businesses and affinity groups, both domestically and internationally. We provide access to the internet that is free, anonymous and reliable. We help maximize the effectiveness of the online marketing efforts of our advertisers and sponsors by enabling them to target specific demographic segments of our large consumer audience on both a local and national basis. Since the launch of our service in December 1998, the number of our registered users has grown to approximately 2.2 million as of March 26, 2000. During the 30 days prior to March 26, 2000, approximately 1.1 million of these registered users accessed our service and over 1.3 billion advertising impressions were delivered to our active users in the United States. Our free internet access service is designed to be reliable, easy to use and fun. We offer a content-rich website featuring a wide selection of channels, such as business, entertainment and health; customizable homepages with pre-selected user preferences and localized information; a fully enabled e-commerce site; and comprehensive customer service and technical support. We were ranked as the overall number one free internet service provider, or ISP, by PC WORLD MAGAZINE in its April 2000 edition. Our private label and co-branding programs offer our strategic partners a wide range of turnkey internet solutions. Through these solutions, our partners have the ability to offer free internet services to their customers, increasing their website traffic, building brand loyalty and expanding their revenue streams. We anticipate that these programs will allow us to rapidly increase the number of consumers to whom our advertising offerings are delivered and expand our revenue-sharing opportunities. In December 1999, our free service was launched in Singapore, and we are currently in discussions to initiate service in several other countries. When users register for our service, they anonymously provide selected demographic information, which allows advertisers and sponsors to customize their marketing to specific online audiences. Our advertisers and sponsors are able to reach their target audience through a variety of advertising options. Our iSee Window(SM), a small advertising and navigational banner displayed on the user's computer screen while online, provides our advertisers with a continuous medium to reach our large user base. In addition, we offer sponsorship and advertisements in content-specific channels, targeted emails and placement within our online shopping channel, the FreeiMall. Since we do not require a user's name, street address or phone number, registered users enjoy complete anonymity. We also voluntarily adhere to the same decency standards followed by the radio and television industries. We believe a key competitive advantage is our national telecommunications infrastructure. Unlike most other free ISPs, we maintain our own "points of presence," or POPs, in major markets. POPs are telecommunications facilities located in a particular market which allow users to access the internet through a local telephone call. We established our first POP in December 1998 and currently maintain 25 POPs in major markets. In addition, we supplement our POPs and help ensure service redundancy by contracting with third-party telecommunications service providers such as Cable & Wireless USA, Inc., PSINet, Inc. and Splitrock Services, Inc. We believe this approach enhances the reliability of our services and provides us with lower network costs compared to other free ISPs. Users can access our services through a local telephone call in more than 1,300 cities throughout the United States. 1 OUR MARKET OPPORTUNITY We believe we are well positioned to capitalize on the significant market opportunity to provide free internet access, online services and targeted advertising. The internet has become an increasingly significant medium for communication, information and commerce. International Data Corporation, or IDC, an industry research firm, estimates that as of 1999, there were over 80 million web users in the United States and over 106 million users outside of the United States. IDC projects that by the end of 2003, these numbers will increase to over 177 million web users in the United States and over 325 million users outside of the United States. There has also been a substantial increase in online advertising expenditures and consumer e-commerce revenues. Jupiter Communications, an industry research firm, has projected that online advertising expenditures in the United States will grow from an estimated $3.2 billion in 1999 to $11.5 billion in 2003. Furthermore, according to the GartnerGroup, an industry research firm, worldwide consumer electronic commerce revenues are expected to grow from $31.2 billion in 1999 to $380.5 billion in 2003. OUR STRATEGY Our goal is to become the dominant provider of access to the internet. We intend to achieve this goal by: - attracting users through brand promotion and appealing marketing programs; - retaining users by offering reliable internet access while providing a user-friendly and fun online experience; - offering our advertisers and sponsors effective marketing solutions to reach their target audiences; - continuing to develop private label and other strategic relationships; - building out a reliable and cost-effective telecommunications network; - pursuing aggressive international expansion; and - capitalizing on wireless, broadband and other emerging technologies. We were incorporated in the State of Washington in September 1998. Our principal executive offices are located at 2505 South 320(th) Street, Suite 200, Federal Way, Washington 98003, and our telephone number is (253) 796-6500. Our World Wide Web address is www.freeinternet.com. Information on our website does not constitute a part of this prospectus. 2 THE OFFERING Common stock offered by us................... shares Common stock to be outstanding after this offering................................... shares Use of proceeds.............................. To operate and expand our network infrastructure; to promote brand awareness and other user acquisition activities; and other general corporate purposes. See "Use of Proceeds" on page 19. Proposed Nasdaq National Market Symbol....... FREI
UNLESS OTHERWISE INDICATED, THE INFORMATION IN THIS PROSPECTUS REFLECTS THE NUMBER OF SHARES OUTSTANDING ON MARCH 26, 2000, ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION AND GIVES EFFECT, UPON THE CLOSING OF THIS OFFERING, TO THE CONVERSION OF ALL CURRENTLY OUTSTANDING SHARES OF OUR OUTSTANDING PREFERRED STOCK INTO SHARES OF COMMON STOCK. THE NUMBER OF SHARES OF COMMON STOCK TO BE OUTSTANDING AFTER THIS OFFERING EXCLUDES 10,421,128 SHARES OF COMMON STOCK RESERVED FOR ISSUANCE UNDER OUR STOCK OPTION PLAN, OF WHICH 4,749,003 SHARES ARE ISSUABLE UPON EXERCISE OF OUTSTANDING OPTIONS AS OF MARCH 26, 2000, AND 2,000,000 SHARES OF COMMON STOCK RESERVED FOR ISSUANCE UNDER OUR EMPLOYEE STOCK PURCHASE PLAN. PLEASE SEE "CAPITALIZATION" ON PAGE 20 FOR A MORE COMPLETE DISCUSSION REGARDING THE OUTSTANDING SHARES OF COMMON STOCK, OPTIONS TO PURCHASE COMMON STOCK AND OTHER RELATED MATTERS. SUMMARY FINANCIAL DATA The following table sets forth our summary financial data. The summary financial data as of and for the year ended December 31, 1999 have been derived from and are qualified by reference to our audited financial statements. The summary financial data for the quarterly periods ended March 31, 1999, June 30, 1999, September 30, 1999 and December 31, 1999 have been derived from our unaudited financial statements. See Note 2 to our audited financial statements for a description of how pro forma net loss per share is calculated. This table does not present all of our financial information. You should read this information together with our financial statements and the related notes included elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
THREE MONTHS ENDED ------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, YEAR ENDED 1999 1999 1999 1999 DEC. 31, 1999 --------- -------- --------- -------- ------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenues....................................... $ 17 $ 91 $ 213 $ 662 $ 983 Gross profit (loss)............................ (359) (705) (2,059) (4,586) (7,709) Net loss....................................... (737) (1,249) (3,739) (13,020) (18,745) Pro forma net loss per share................... $ (0.03) $ (0.05) $ (0.12) $ (0.34) $ (0.62) Shares used to compute pro forma net loss per share........................................ 24,704 26,879 32,061 38,175 30,477
3 The following table presents summary balance sheet data at December 31, 1999, on a pro forma basis adjusted to reflect the conversion of shares of preferred stock then-outstanding as of December 31, 1999 into 12,729,458 shares of common stock and on a pro forma as adjusted basis to reflect the sale of shares of our common stock in this offering and the application of the estimated proceeds, less estimated expenses. See "Use of Proceeds" and "Capitalization."
AT DECEMBER 31, 1999 ---------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED -------- --------- ----------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents................................. $ 20,342 $20,342 $ Working capital........................................... 10,649 10,649 Total assets.............................................. 50,429 50,429 Long-term obligations, net of current portion............. 20,137 20,137 Mandatorily redeemable preferred stock.................... 33,892 -- Shareholders' equity (deficit)............................ (15,779) 18,113
4 RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING OUR COMMON STOCK. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. ANY OF THE FOLLOWING RISKS COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS, OPERATING RESULTS, FINANCIAL CONDITION AND CASH FLOWS AND COULD RESULT IN A COMPLETE LOSS OF YOUR INVESTMENT. RISKS RELATED TO OUR BUSINESS OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE AN EXTREMELY LIMITED OPERATING HISTORY AND OUR FREE INTERNET SERVICE PROVIDER BUSINESS MODEL IS UNPROVEN. We were incorporated in September 1998 and launched our internet operations in December 1998. Accordingly, we have an extremely limited operating history. An investor in our common stock must consider the risks, uncertainties, expenses and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets, including the internet market. These risks and difficulties include our ability to: - generate revenues from sources other than user fees; - control our costs; - increase the number of registered and active users; - attract a large number of advertisers and strategic partners who desire to reach our users; - build our brand; - offer compelling online content, services and e-commerce opportunities; - respond effectively to the offerings of competitive internet service providers; - address the risks associated with expanding our business internationally; - update and enhance our technology to respond to changes in industry standards; - maintain a stable and scalable telecommunications network; - implement adequate accounting and financial systems and controls; and - attract, retain and motivate qualified personnel. We also depend on the growing use of the internet for advertising, commerce and communication. Our business model assumes that users will choose to access the internet through our service and that advertisers and strategic partners will enter into relationships with us. This business model is not yet proven. We cannot assure you that our business model will be successful or that we will successfully address these risks or difficulties. If we fail to address adequately any of these risks or difficulties our business would likely suffer. WE HAVE A HISTORY OF LOSSES AND NEGATIVE CASH FLOW AND EXPECT CONTINUED LOSSES FOR THE FORESEEABLE FUTURE. Since our inception, we have incurred significant losses and negative cash flow and, as of December 31, 1999, had accumulated net losses of approximately $19.0 million. We have not achieved profitability and expect to continue to incur operating losses for the foreseeable future as we fund operating and capital expenditures related to our user acquisition strategies and the build-out of our infrastructure to meet the needs of a larger user base. We cannot assure you that we will ever achieve or sustain profitability or that our operating losses will not increase in the future. Our expansion efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently to offset these higher expenses. Even if we do achieve profitability, we cannot be 5 certain that we can sustain or increase profitability on a quarterly or annual basis in the future. If we fail to do so, the market price for our common stock could suffer. WE MAY REQUIRE ADDITIONAL FUNDING TO SUCCESSFULLY OPERATE AND GROW OUR BUSINESS. Although we believe that the proceeds from this offering and our cash reserves will be adequate to fund our operations for at least the next 12 months, these resources may prove to be inadequate. Consequently, we may require additional funds during this period and will likely require funds after this period. Additional financing may not be available to us on favorable terms or at all. If we raise additional funds by selling stock, the percentage ownership of our then-current shareholders will be reduced. If we cannot raise adequate funds to satisfy our capital requirements, we may have to limit our operations significantly. SINCE WE DO NOT CHARGE OUR USERS ANY FEES FOR OUR INTERNET ACCESS OR ONLINE SERVICES, WE MUST GENERATE SUFFICIENT REVENUES FROM OTHER SOURCES TO BE ABLE TO SUPPORT OUR OPERATIONS. We do not charge our users any fees for our internet access and online services. As a result, our success is dependent on our ability to generate revenues from other sources, including from advertising and sponsorship fees, private label and co-branded relationships, web referrals and content placement payments. We have limited experience pricing, marketing and structuring these types of arrangements and have limited experience with respect to their performance. As such, we do not know if we are appropriately pricing, marketing or structuring our arrangements or whether we will be able to generate sufficient revenues from these sources to support our operations. To date, we have been substantially dependent on advertising revenues and expect to derive a significant amount of our revenues from advertising and sponsorships in the future. The internet advertising market is rapidly evolving, and we cannot predict its effectiveness as compared to traditional media advertising such as television, radio, cable and print media. As a result, demand for and market acceptance of internet advertising solutions are uncertain. Most of our current or potential advertising customers have allocated only a portion of their advertising budgets to internet advertising. The adoption of internet advertising, particularly by those entities that have historically relied upon traditional media for advertising, requires the acceptance of a new way of conducting business, exchanging information and advertising products and services. Advertisers may find internet advertising to be less effective for promoting their products and services relative to traditional advertising media. If the market for internet advertising fails to develop or develops more slowly than we expect, our business would suffer. IF WE FAIL TO GROW AND RETAIN OUR USER BASE, OUR ABILITY TO GENERATE REVENUES WILL BE ADVERSELY AFFECTED. If we are unable to grow and retain our user base, we may not be able to attract advertisers and other strategic partners, which would decrease our ability to generate revenues or implement our business strategy. We intend to increase our user base through aggressive user acquisition programs, including building the freeinternet.com brand and engaging in national and local advertising campaigns. These acquisition methods will require significant expenditures and may prove more expensive or less effective than anticipated, which could have a negative effect on our financial condition. Our success also depends on our ability to retain a large active user base. During the 30-day period prior to March 26, 2000, only approximately 50% of our registered users had accessed our service. Over time, we anticipate that our number of active users will decline as a percentage of our registered user base. There are a variety of reasons why users might access our services less frequently or discontinue using our service altogether, including: - connectivity delays or interruptions, which we have experienced in the past and could experience in the future, may cause user frustration and dissatisfaction; 6 - users may decide they do not like the always-present nature of the iSee Window or the prevalence of our other advertising channels, including "pop-up" commercials; - our user support services may be insufficient to satisfy the needs of our users who have difficulty using our service, especially as we increasingly target first-time internet users; - our content may not be compelling, relevant or engaging enough to retain the interest of our users for extended periods of time; - users may not like having to periodically provide demographic information; or - dial-up internet access may become obsolete as high speed or other internet access technologies become more widely available at increasingly attractive prices. ADVERTISERS MAY BE RELUCTANT TO DEVOTE SIGNIFICANT RESOURCES TO ADVERTISING WITH US IF THEY PERCEIVE OUR SERVICE TO BE A LIMITED OR INEFFECTIVE ADVERTISING MEDIUM. Our success depends on our ability to demonstrate to advertisers and sponsors that we offer a cost-effective and results-generating advertising alternative to that offered by traditional advertising channels or by our competitors. We may be unable to persuade advertisers to advertise with us for a number of reasons, including: - IF WE ARE UNABLE TO OFFER RELIABLE TARGETED ADVERTISING DUE TO INACCURATE OR INSUFFICIENT INFORMATION ABOUT OUR ACTIVE USERS. We believe our users have in the past and may in the future provide false information when registering for our service, which we do not corroborate. In addition, the enforcement of current laws or promulgation of future regulations governing privacy may prevent us from collecting information about our users. To the extent we are unable to gather accurate and relevant information about our users, advertisers may no longer value the targeted advertising opportunities we provide. - IF PROGRAMS WHICH CAN DISABLE THE ISEE WINDOW OR FAILURES IN OUR ADVERTISEMENT DELIVERY SOFTWARE BECOME PREVALENT. Various "filter" software programs have been developed, and methods of accessing our internet service have been utilized, that enable the user to blank out, or block, banner advertisements on the iSee Window, completely delete the iSee Window from their screens or disable the operation of "cookies." Cookies are a standard industry technology consisting of files stored on a user's computer that allow us to recognize the user so that we can provide targeted advertising. We believe that a meaningful number of our active users may be using one or more of these software programs and access methods. In addition, we may experience from time to time failures in our advertisement delivery systems. These techniques and failures impede our ability to deliver advertisements to a user and decrease the efficacy of our advertisement opportunities. - IF THE DEMAND FOR BANNER ADVERTISING DECREASES. Banner advertising, from which we currently derive a significant portion of our revenue, may not be perceived as an effective advertising method in the future. As a result, advertisers may elect not to use banner advertising, which may cause our advertising revenues to suffer. Adoption of online direct marketing is an important part of our business model. We may need to engage in intensive marketing and sales efforts to educate advertisers regarding the uses and benefits of our products and services to generate demand for our direct marketing services. Enterprises may be reluctant or slow to adopt a new approach that may compete with their current direct market systems. In order to encourage advertisers to use our services, we may be required to increasingly offer performance-based pricing structures. If a sufficient number of users do not click on advertisements or otherwise satisfy the criteria mandated by these pricing plans, our advertising revenues would suffer. 7 WE ARE DEPENDENT ON PRIVATE LABEL AND CO-BRANDING AGREEMENTS AS A SOURCE OF REVENUES, AND OUR BUSINESS COULD SUFFER IF ANY OF THESE AGREEMENTS ARE TERMINATED. We have agreements, or are in discussions, with a number of third parties under which we provide private label and co-branded internet access. We believe that revenues generated from these agreements may constitute a significant portion of our revenues in the future. These parties could terminate their agreements with us on short notice. If any of our agreements are terminated, we cannot assure you that we will be able to replace the terminated agreement with an equally beneficial arrangement. In addition, we expect that we will not be able to renew all of our current agreements when they expire or, if we are, that we will be able to do so on acceptable terms. Some of these agreements provide that, upon termination, the users of that internet service will not remain accessible to us. We also do not know whether we will be successful in entering into additional agreements, or that any additional relationships, if entered into, will be on terms favorable to us. In addition, our agreements with these parties may be on a non-exclusive basis, and thus these parties may be, or may become, our competitors. Our receipt of revenues from these agreements may also be dependent on factors which are beyond our control, such as the quality of the products or services offered by these parties. WE MUST ESTABLISH, MAINTAIN AND STRENGTHEN OUR BRAND IN ORDER TO ATTRACT USERS, ADVERTISERS AND STRATEGIC PARTNERS. If we are unsuccessful in establishing or maintaining the freeinternet.com brand, we may not be able to generate advertising and sponsorship revenues, content placement fees and private label relationships. In addition, in this very competitive market, we may also need to devote substantial resources beyond our current expectations to further develop our distinctive brand. If we incur excessive expenses in promoting our brand, our financial results could be seriously harmed. IN ORDER TO ATTRACT AND RETAIN AN ACTIVE USER BASE, WE MUST PROVIDE CONTENT, TOOLS AND OTHER FEATURES THAT MEET THE CHANGING PREFERENCES AND NEEDS OF OUR USERS. We must provide online content, interactive tools and other features that satisfy the changing preferences and needs of our users. Competition for high quality and distinctive content will likely increase, and since a majority of our content is provided to us on a non-exclusive basis, we may need to develop other means of differentiating our offerings from those of our competitors. In order to continue to attract and retain our audience of users, we will not only have to expend significant funds and other resources to continue to improve our website, but we must also properly anticipate and respond to consumer preferences and demands. If we fail to expand the breadth of our offerings quickly, or these offerings fail to achieve market acceptance, our business may suffer significantly. IF WE DO NOT MAINTAIN OUR RELATIONSHIP WITH INFOSPACE, WE MAY HAVE DIFFICULTY OBTAINING CONTENT FOR OUR WEBSITE, AND OUR ADVERTISING REVENUES AND OPERATING RESULTS MAY SUFFER. We currently license a majority of our online content from InfoSpace on a non-exclusive basis. If our relationship with InfoSpace were to deteriorate, we may have difficulty obtaining on a timely basis comparable content for our website. Any failure by us to continue to acquire appealing and relevant content would adversely affect our efforts to grow our active user base, which in turn would diminish our ability to attract advertisers and strategic partners and generate revenues. 8 OUR MARKET SHARE AND REVENUES WILL SUFFER IF WE ARE NOT ABLE TO COMPETE EFFECTIVELY FOR INTERNET USERS, ADVERTISERS AND STRATEGIC PARTNERS. The ISP industry is extremely competitive and highly fragmented. We currently compete or expect to compete for users, advertisers and strategic partners with a wide variety of companies, including: - established online service and content providers, such as America Online and The Microsoft Network; - independent national ISPs, such as EarthLink, Inc. and Prodigy Communications Corporation, and numerous regional and local commercial internet service providers; - other companies offering free internet access, such as NetZero Inc. and Juno Online Services, Inc. in the United States and Freeserve plc in Europe; - private label ISPs, such as 1stUp.com Corporation and Spinway; - national long-distance carriers, such as Sprint Corporation and MCI WorldCom, Inc.; - local telephone companies and regional Bell operating companies, such as GTE Corporation; - cable operators, online cable services and other broadband service providers, such as Excite@Home; and - internet portals and search engines, such as Yahoo!, Alta Vista and Lycos. Our current and prospective competitors include many large companies that have substantially greater market presence and financial, technical, marketing and other resources than us. Some of these competitors may have their own telecommunications networks and thus could offer their own internet access services to subscribers at a much lower cost than we do. In addition, cable television and other broadband service providers have begun to offer their own internet access service or align themselves with competing ISPs. If broadband internet access becomes the preferred means by which users access the internet and we are unable to gain access to broadband networks on reasonable terms, our ability to compete could be harmed. We expect that competition for users, advertisers and strategic partners will continue to intensify for the foreseeable future. Increased competition could result in additional sales and marketing expenses and user-acquisition costs and could also result in increased user turnover and decreased advertising revenues. We may not be able to generate sufficient revenues to offset the effects of these increased costs, and we may not have the resources to continue to compete successfully. The ability of our competitors to acquire other ISPs or to enter into strategic alliances or joint ventures could also put us at a significant competitive disadvantage. We cannot assure you that we will be able to compete successfully for users, advertisers and strategic partners against current or future competitors, or that competitive pressures will not harm our business. Competition for advertising dollars is intense. We must compete with television, radio, cable, print media and other websites providing opportunities for online advertisements for a share of advertisers' total advertising budgets. Advertisers may be reluctant to devote a significant portion of their advertising budget to internet advertising, or to our services in particular, if they perceive the internet or our services to be a limited or ineffective advertising medium. Our inability to compete effectively for advertisers would harm our business. See "Business--Competition" on page 36 for a discussion of some of the factors that will affect our ability to successfully compete in our industry. 9 WE MUST ADAPT TO TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS, INCLUDING THE INCREASING AVAILABILITY OF BROADBAND TECHNOLOGIES, TO REMAIN COMPETITIVE. The internet market is characterized by rapid changes due to technological innovation, evolving industry standards, changes in customer needs and frequent new service and product introductions. Services and products based on emerging technologies or new industry standards expose us to the risk that our infrastructure or services will become obsolete. In particular, we are also at risk due to fundamental changes in the way that internet access may be delivered in the future. Our service is currently offered via dial-up modems which are limited to access speeds of up to 56 kbps. Through broadband technologies, subscribers can transmit and receive print, video, voice and data in digital form at significantly faster access speeds ranging from two times to over 100 times the speed of dial-up modems. Even if we seek to offer broadband service in the future, the telephone, cable and other companies that own broadband networks may prevent us from offering broadband internet access through the wire and cable networks that they own on reasonable terms or at all. If we are unable to gain access to broadband networks in a timely manner on reasonable terms, or at all, our ability to compete could be harmed. In order to compete successfully in the internet access industry, we will need to adapt rapidly to new technologies, continue to develop our technical expertise and enhance our existing services. Our continued development and implementation of these technological advances may require substantial time and expense, and we cannot be certain that we will succeed in adapting our internet access services to alternative access devices and conduits. IF WE ARE UNABLE TO CONTINUE THE EXPANSION OF OUR NETWORK OF COMPANY-MAINTAINED TELECOMMUNICATIONS FACILITIES, OUR OPERATING COSTS MAY INCREASE AND OUR FINANCIAL RESULTS COULD SUFFER. A key element of our business strategy is to reduce operating costs through the build-out of our network of company-maintained POPs in major markets. This network build-out may be more costly than we currently anticipate. Our failure to maintain and expand our company-owned telecommunications network in a cost-efficient manner could result in higher operating costs, which could have an adverse effect on our financial results. Our POP network is composed of a complex system of routers, switches, transmission lines and other hardware used to provide internet access and other services. We currently acquire hardware components used in our POP network system from a few primary sources. In addition, we currently rely on several local telephone companies to lease to us data communications capacity via local and long-distance telecommunications lines. We also have relationships with competitive local exchange carriers. Our suppliers and telecommunications carriers also sell or lease products and services to our competitors and may be, or may become, our competitors. We cannot assure you that our suppliers and telecommunications carriers will continue to sell or lease their products and services to us at commercially reasonable prices or at all. IF OUR TELECOMMUNICATIONS EXPENSES INCREASE AT A GREATER RATE THAN OUR REVENUES, OUR FINANCIAL CONDITION WOULD SUFFER. Our business could be harmed if telecommunications costs increase. We cannot assure you that our telecommunications providers will continue to provide their services on commercially acceptable price terms, or that alternative services will be available on similar terms. In addition, we run the risk of purchasing excessive amounts of telecommunications products and services based on incorrect projections regarding increased usage. In that event, we would be required to bear the costs of excess telecommunications capacity. Any increases in telecommunications costs without commensurate increases in revenues would have an adverse effect on our profitability. 10 IF WE ARE UNABLE TO MAINTAIN AN OPERATING TELECOMMUNICATIONS NETWORK AND PROVIDE RELIABLE ACCESS TO THE INTERNET, OUR USERS, ADVERTISERS AND STRATEGIC PARTNERS WILL BECOME DISSATISFIED AND OUR ABILITY TO GENERATE REVENUES WILL SUFFER. Our ability to provide a reliable and operating telecommunications network to ensure uninterrupted internet access for our users may be impeded by a number of factors, including: - IF WE FAIL TO OR ARE UNABLE TO SCALE OUR OPERATIONS IN A TIMELY MANNER TO MEET INCREASED DEMAND FROM OUR USER BASE. We may from time to time experience increases in our telecommunications usage from our current user base that exceed our then-available telecommunications capacity. In addition, a key element of our business strategy is to rapidly grow our user base. In connection with this growth, we will need to accurately anticipate our future telecommunications capacity needs within lead-time requirements. If we are unable to procure sufficient quantities of telecommunications products and services, either through the construction of additional POPs or the contracting for additional services with third parties, we may be unable to provide our current and future users with acceptable service levels on a timely basis and at a commercially reasonable cost to us, or at all. Excessive demand could also result in system failures of our internal server networks, which would prevent us from generating advertising revenues. - IF OUR THIRD-PARTY TELECOMMUNICATIONS PROVIDERS REFUSE TO OFFER US SERVICE OR DELIVER UNACCEPTABLE SERVICE QUALITY. We rely on third parties to provide telecommunications services to our users. Only a limited number of telecommunications providers offer the network services we require. There has been significant consolidation in the telecommunications industry, and there is a significant risk that further consolidation could make us reliant on an even smaller number of providers. Most of the telecommunications services we purchase are provided to us under short-term agreements that the providers can terminate or elect not to renew. If this occurs, we may not be able to replace these services at attractive prices, or at all. In addition, each of our telecommunications carriers provides network access to some of our competitors and could choose to grant those competitors preferential network access, potentially limiting our users' ability to access the internet or connect to our central computers. Furthermore, several of our telecommunications providers compete, or have announced an intention to compete, with us in the free internet market. If our telecommunications service providers were to decrease the levels of service or access provided to us, or if they were to terminate their relationships with us for competitive or other reasons, our business and financial results would suffer. Moreover, since we do not have direct control over the network reliability and quality of the service provided by our third-party telecommunications providers, we cannot assure you that we will be able to offer consistently reliable internet access for our users. - IF OUR SOFTWARE OR HARDWARE CONTAIN ERRORS OR DEFECTS. The software and hardware used to operate and provide our services is complex and, accordingly, may contain undetected errors or failures. We have in the past, and may in the future, encounter errors or defects in the software or hardware used to operate and provide our services, which may result in users being disconnected or unable to access our service and a loss of data. Moreover, we intend to release a new version of our software in the near future which is substantially different from our current software and significantly increases the risk of errors or defects. - IF WE SUFFER A COMPUTER VIRUS OR THERE IS INAPPROPRIATE USE OF OUR INTERNET SERVICE. Computer viruses or problems caused by our users or other third parties, such as excessive volumes of unsolicited bulk e-mail, or "spam," or the bombarding of our website with messages, could lead to interruptions, delays or cessation in service to our users. - THE OCCURRENCE OF A NATURAL DISASTER. A significant portion of our computer equipment, including critical equipment dedicated to our internet access services, is located at our facilities in Federal Way, Washington. Also, a significant portion of our facilities are housed in locations that are outside of our control. Despite precautions taken by us and our third-party network providers, a natural disaster such as a fire or earthquake, or other unanticipated problems at our facilities, or within a third-party network provider's network, could cause interruptions in the services which we provide. 11 Any prolonged or repeated disruption or inaccessibility of our services would have a material adverse effect on our reputation and likely cause our users to abandon their use of our service. Because our advertising revenues are directly related to the number of advertisements we deliver to our users, system interruptions or delays would reduce the number of impressions delivered and reduce our revenues. We presently have limited redundant facilities and systems and are in the process of implementing our formal disaster recovery plan. While we have business interruption insurance to compensate for short-term financial losses, any interruption to our business could harm our ability to attract or retain users, advertisers and strategic partners. IF WE FAIL TO ADEQUATELY UPGRADE AND SCALE OUR INFORMATION AND PROCESSING SYSTEMS, OUR ABILITY TO OPERATE OUR BUSINESS WOULD BE IMPAIRED. We believe that establishing sophisticated information and processing systems is vital to our growth and our ability to achieve operating efficiencies. If these systems fail or prove to be inadequate, our ability to effectively conduct our business would be impaired. Systems we have identified as being presently inadequate to meet the increased demands of our anticipated growth include our accounting and financial systems. We are in the process of replacing these systems with systems that we believe are capable of meeting our planned future needs. We cannot assure you that this transition will not cause delays or interruptions in our monitoring and billing activities. We may also be unable to implement improvements that enhance our systems or integrate new technology into our systems on a timely basis or at all, and these systems may not perform as expected. Our inability to implement solutions in a timely or cost-effective manner or to upgrade existing systems as necessary could harm our business. OUR ABILITY TO OPERATE OUR BUSINESS COULD BE SERIOUSLY HARMED IF WE LOSE, OR FAIL TO ASSIMILATE, MEMBERS OF OUR SENIOR MANAGEMENT TEAM AND OTHER KEY EMPLOYEES. Most of our senior management team has joined us within the past six months. We cannot assure you that we will successfully assimilate our recently hired officers or that we can successfully locate, hire, assimilate and retain qualified key management personnel. Our business is largely dependent on the personal efforts and abilities of our senior management and other key personnel, including Robert McCausland, our president, chief executive officer and chairman of the board. Any of our officers or employees can terminate his or her employment relationship at any time. The loss of these key employees or our inability to attract or retain other qualified employees could seriously harm our business and prospects. WE MUST HIRE ADDITIONAL PERSONNEL TO EXPAND OUR OPERATIONS AND GENERATE REVENUES. Our future success depends on our ability to locate, hire, assimilate, train, retain and motivate highly skilled executive, sales and marketing, technical, business development, managerial and administrative personnel. We intend to hire a significant number of personnel during the next year, including a substantial number of sales, marketing and business development personnel, in order to expand our advertiser and strategic partner acquisition efforts and help generate revenues. Competition for qualified personnel is intense, particularly in the technology and internet markets, and we may be required to expend significant resources to hire our required personnel. If we fail to successfully attract and retain a sufficient number of qualified personnel, or integrate them with our current operations, our ability to manage and expand our business or generate advertising revenues could suffer. WE HAVE RECENTLY EXPERIENCED AND ARE CURRENTLY EXPERIENCING RAPID GROWTH IN OUR BUSINESS, AND OUR INABILITY TO MANAGE THIS GROWTH COULD HARM OUR BUSINESS. Our rapid growth has placed, and is expected to continue to place, a significant strain on our managerial, technical, network, operational and financial resources. To manage our growth, we must implement additional management information systems, further develop our operational, administrative and financial systems and expand, train and manage our work force. We will also need to manage an 12 increasing number of complex relationships with suppliers, marketing partners and other third parties. We cannot guarantee that our systems, procedures or controls will be adequate to support our current or future operations or that our management will be able to effectively manage our expansion. Our failure to do so could seriously harm our ability to deliver our services in a timely and cost-effective fashion, fulfill existing commitments and attract and retain new users, advertisers and other strategic partners. WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS. We regard our intellectual property rights as critical to our success, and to protect our proprietary rights we rely on trademark and copyright law, trade secret protection and confidentiality and license agreements with our employees, customers and others. Despite our precautions, unauthorized third parties might copy portions of our software or reverse engineer and use information that we regard as proprietary. Any misappropriation of our proprietary information by third parties could adversely affect our business by enabling third parties to compete more effectively with us. In addition, as we expand our operations internationally, we may be unable to obtain or enforce the intellectual property rights necessary to promote our brand in these markets. We do not currently own any issued patents, and we cannot assure you that any future patent application will result in an issued patent, or that any future patent will not be challenged, invalidated or circumvented, or that the rights granted under any patent will provide us with a competitive advantage. Moreover, it is possible that other companies with businesses similar to ours may be issued "business model" or other patents that could prevent us from continuing to execute our business plan. The laws of some countries do not protect proprietary rights to the same extent as the laws of the United States, and our means of protecting our proprietary rights abroad may not be adequate. OUR BRAND AND BUSINESS COULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO PROTECT OUR DOMAIN NAMES OR ACQUIRE OTHER RELEVANT DOMAIN NAMES. We have registered the domain name relating to our brand, freeinternet, as well as numerous other related web domain names, both domestically and in some international markets. We may be unable to acquire or maintain relevant domain names in the countries in which we conduct, or plan to conduct, business. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon, dilute or otherwise decrease the value of our trademarks and other proprietary rights. WE MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS. We have been, are currently, and may in the future be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming and could divert our management's attention away from running our business. We cannot be certain that our technology does not infringe issued patents or other intellectual property rights of others. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software. WE MAY HAVE LIABILITY FOR INFORMATION LOCATED ON OUR WEBSITE OR WHICH IS ACCESSED FROM OUR WEBSITE OR AS A RESULT OF THE INAPPROPRIATE USE OF OUR INTERNET SERVICES BY THIRD PARTIES. The law relating to the liability of ISPs for information carried on or disseminated through their networks is unsettled. Because material may be posted to our website by third parties or downloaded by our users and subsequently distributed to others, there is a potential that claims will be made against us for negligence, defamation, copyright or trademark infringement or other theories based on the nature and content of this material. In addition, although we believe we are in compliance with the safe 13 harbor provisions required under the Digital Millineum Copyright Act, we could also be sued for the content and services that are accessible from our website through links to other websites or through content and materials that may be posted by our users in chat rooms or bulletin boards. These types of claims have been brought, sometimes successfully, against online services in the past. Although we carry general liability insurance, our insurance may not cover claims of these types, or may not be adequate to indemnify us against this type of liability. Any imposition of liability, and in particular liability that is not covered by our insurance or is in excess of our insurance coverage, could harm our reputation and our operating results. In addition, the sending of "spam" through our network could result in third parties asserting claims against us. We cannot assure you that we would prevail in such claims and our failure to do so could result in large judgments against us. Our users or other parties could also potentially jeopardize the security of confidential information stored in our computer systems or our users' computer systems by inappropriate use of the internet, which could cause losses to us or our users. Internet users or third parties may also potentially expose us to liability by "identity theft," or posing as another freeinternet.com registered user. OUR INTERNATIONAL OPERATIONS WILL INVOLVE ADDITIONAL RISKS RELATED TO GEOGRAPHIC, POLITICAL AND ECONOMIC CONDITIONS. As we expand internationally, our international operations will expose us to a number of risks, including the following: - more stringent controls over internet services in foreign countries; - greater difficulty in protecting intellectual property due to less stringent foreign intellectual property laws and enforcement policies; - our potential inability to obtain the necessary intellectual property rights to protect our brand; - greater difficulty in managing foreign operations due to the lack of proximity between our home office and our foreign operations; - increased burdens related to collecting accounts receivable; - ability to implement and monitor foreign accounting and financial systems; - unfavorable changes in regulatory practices, tariffs and other trade barriers; - adverse changes in tax laws; - the effect of fluctuating exchange rates between the U.S. dollar and foreign currencies or the imposition of foreign exchange controls; and - general economic and political conditions in Asian and European markets. These risks could substantially increase the financial and managerial resources required to run our foreign operations and have a negative effect on our future international revenues. IF WE ARE UNABLE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS INTO OUR OPERATIONS, OUR BUSINESS AND FINANCIAL RESULTS MAY BE HARMED. We may make acquisitions or undertake other business combinations that can complement our current or planned business activities. Acquiring a business involves many risks, including: - disruption of our ongoing business and diversion of resources and management time; - unforeseen obligations or liabilities; - difficulty assimilating the acquired operations and personnel; - risks of entering markets in which we have little or no direct prior experience; 14 - potential impairment of relationships with employees or users as a result of changes in management; and - potential dilutive issuances of equity, large and immediate write-offs, the incurrence of debt and amortization of goodwill or other intangible assets. We cannot assure you that we will make any acquisitions or that we will be able to obtain additional financing for such acquisitions, if necessary. If any acquisitions are made, we cannot assure you that we will be able to successfully integrate the acquired business into our operations or that the acquired business will perform as expected. To date, we have not made any acquisitions of other businesses. OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND ARE NOT RELIABLE INDICATORS OF FUTURE PERFORMANCE. Our quarterly operating results may fluctuate significantly because of a variety of factors, many of which are outside of our control, including: - overall usage levels of the internet and our services in particular; - demand for internet advertising and the loss of advertising; - seasonal trends in internet use and advertising; - costs relating to the expansion of our operations and the amount and timing of our capital expenditures; and - costs relating to technical difficulties or service interruptions. If a large number of advertisers do not advertise in a given quarter or if advertising revenues are deferred, our revenues in that quarter could be substantially reduced. This could have a negative effect on our operating results. Our quarterly results of operations are not necessarily indicative of our operating results for any future period, and you should not rely on them as an indication of our future performance. RISKS RELATED TO OUR INDUSTRY IF INTERNET USAGE DOES NOT CONTINUE TO GROW, WE MAY NOT BE ABLE TO GROW OUR BUSINESS AND INCREASE OUR REVENUES. Widespread use of the internet is a relatively recent phenomenon. Our future success depends on continued growth in the use of the internet and the continued development of the internet as a viable commercial medium. We cannot be certain that internet usage will continue to grow at or above its historical rates or that extensive internet content will continue to be developed or accessible for free or at nominal cost to users. If internet use does not continue to grow or users do not accept our services, our ability to generate revenues will suffer. THE LAWS RELATING TO THE INTERNET INDUSTRY ARE EVOLVING, AND INCREASED GOVERNMENTAL REGULATION OF OUR SERVICES OR OPERATIONS OR NEW CASE LAW COULD ADVERSELY AFFECT OUR ABILITY TO GENERATE REVENUE AND EXPOSE US TO LIABILITY. The laws relating to our business and operations are evolving and few clear legal precedents have been established. The adoption of new laws or the application of existing laws may reduce the use of the internet, affect telecommunications costs or increase the likelihood or scope of competition from regional telephone companies. These results could decrease the demand for our services or increase our cost of doing business, each of which would cause our gross margins and revenues to decline. In particular, risks with respect to the following could occur: - REGULATION OF INTERNET CONTENT AND RESTRICTED ACCESS COULD LIMIT OUR ABILITY TO GENERATE REVENUES AND EXPOSE US TO LIABILITY. A variety of restrictions on internet content and access, primarily as they relate to intellectual property infringement and childrens' access to the internet, have been enacted or proposed, 15 including laws which would require ISPs to employ mechanisms to remove potentially infringing material or to supply filtering technologies to limit or block the ability of minors to access unsuitable materials on the internet. These content restrictions and the potential liability to us for materials carried on or disseminated through our service may require us to implement measures to reduce our exposure to liability. These measures may require the expenditure of substantial resources or the interruption of our service. Further, we could incur substantial costs in defending against any claims that are brought against us, and we may be required to pay large judgments or settlements or alter our business practices. - OUR ABILITY TO SELL TARGETED ADVERTISING MAY BE ADVERSELY AFFECTED IF NEW LAWS RELATING TO USER PRIVACY ARE ENACTED. Our ability to sell targeted advertising depends on our ability to collect and analyze personal information provided by our users. Application of existing laws or implementation of new laws relating to the collection and use of personal information on the internet may require us to change the way we conduct our business, make it cost-prohibitive to operate our business and prevent us from pursuing our business strategies, including the sale of targeted advertising. - OUR MARGINS AND COSTS WOULD BE ADVERSELY AFFECTED IF INTERNET ACTIVITIES BECOME SUBJECT TO TAXATION. The tax treatment of activities on or relating to the internet is currently unsettled. A number of proposals have been made at the federal, state and local levels and by foreign governments that could impose taxes on the online sale of goods and services and other internet activities. We cannot assure you that future laws imposing taxes or other regulations on commerce over the internet would not substantially impair the growth of internet commerce and, as a result, harm our margins or make it cost-prohibitive to operate our business. - TELECOMMUNICATIONS REGULATION COULD MAKE IT MORE EXPENSIVE FOR US TO DO BUSINESS. As an internet service provider, we are not currently directly regulated by the Federal Communications Commission or any other agency, other than regulations applicable to businesses generally. Nevertheless, internet- related regulatory policies are continuing to develop, and it is possible that we could be exposed to regulation in the future. We could be adversely affected if any regulatory change results in the application of access charges to internet service providers because this would substantially increase the cost of using the internet. Since a significant component of our operating costs is comprised of telecommunications costs, any increase in such costs would harm our gross margins. We could also be affected by any change in the ability of our users to reach our network through a dial-up telephone call without any additional charges. SEASONAL TRENDS IN INTERNET USAGE AND ADVERTISING SALES MAY NEGATIVELY AFFECT OUR BUSINESS. We believe that our revenues may be subject to seasonal fluctuations because advertisers generally place fewer advertisements in the first and third quarters of each calendar year. In addition, to the extent that our advertising revenues depend on the amount of usage by our users, seasonal fluctuations in internet usage could affect our advertising revenues. Furthermore, the rate at which new users sign up for our services may be lower during certain seasons and holiday periods. Because our operating history is so limited, it is difficult for us to accurately predict these trends and plan accordingly. Since our operating expenses are based on our expectations of future revenues, it is possible that seasonal fluctuations could negatively affect our revenues and our operating results. RISKS RELATED TO THIS OFFERING THERE HAS BEEN NO PRIOR PUBLIC MARKET FOR OUR COMMON STOCK. Before this offering, there has been no public market for our common stock. We cannot assure you that an active trading market for the shares offered by this prospectus will develop. If such a market does develop, we cannot assure you that it will continue or how liquid that market might become following this offering, nor can we assure you that purchasers in this offering will be able to resell their shares at prices equal to or greater than the initial public offering price. The initial public 16 offering price was determined through negotiations between us and the underwriters and may not be indicative of the market price for these shares following this offering. You should read the section entitled "Underwriting" beginning on page 57 for a discussion of the factors considered in determining the initial public offering price. THE MARKET FOR OUR SHARES OF COMMON STOCK MAY EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS. The stock market has, from time to time, experienced extreme price and volume fluctuations. Many factors may adversely affect the market price for our common stock following this offering, including: - the demand for our common stock; - the number of market makers for our common stock; - investor perception of the internet, the internet industry generally and the internet service provider industry in particular; - the operating and market performance of our direct competitors; - general technology or economic trends; - revenues and operating results failing to meet or surpass the expectations of securities analysts or investors in any quarter; and - changes in securities analysts' estimates or general market conditions. In the past, companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation. If we become the object of securities class action litigation, it could result in substantial costs and a diversion of our management's attention and resources and harm our business. A SMALL NUMBER OF OUR EXISTING SHAREHOLDERS CAN EXERT CONTROL OVER US. After this offering, our executive officers, directors and principal shareholders holding more than 5% of our common stock will together control approximately % of our outstanding common stock. Accordingly, these shareholders, if they act together, will be able to control our management and affairs and all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. As a result, purchasers of shares in this offering may not have any meaningful control over us. In addition, this concentration of ownership may have the effect of delaying or preventing a change in control of us and might adversely affect the market price of our common stock. IT MIGHT BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE BENEFICIAL TO OUR SHAREHOLDERS. Provisions of our amended articles of incorporation, bylaws and Washington law may discourage, delay or prevent a change in the control of us or a change in our management even if doing so would be beneficial to our shareholders. Our board of directors has the authority under our amended articles of incorporation to issue preferred stock with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily with terms calculated to delay or prevent a change in control of our company or make removal of our management more difficult. In addition, as of the closing of this offering, our board of directors will be divided into three classes. The directors in each class will serve for three-year terms, one class being elected each year by our shareholders. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for shareholders to replace a majority of our directors. In addition, Chapter 19 of the Washington Business Corporation Act generally prohibits a "target corporation" from engaging in significant business transactions with a defined "acquiring person" for a 17 period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the time of acquisition. This provision may have the effect of delaying, deterring or preventing a change in control of our company. The existence of these antitakeover provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. THE SUBSTANTIAL NUMBER OF SHARES THAT WILL BE ELIGIBLE FOR SALE IN THE FUTURE MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON STOCK. Sales of a substantial number of shares of our common stock in the public market following this offering could adversely affect the market price for the common stock. As additional shares of our common stock become available for resale in the public market, the supply of our common stock will increase, which could decrease the price. The number of shares of common stock available for sale in the public market is limited by restrictions under the federal securities laws and under agreements which our shareholders, directors and employees have entered into with the underwriters. The following table shows the timing of when shares outstanding on March 26, 2000, assuming conversion of all currently outstanding shares of preferred stock, may be eligible for resale in the public market after this offering:
NUMBER OF SHARES DATE ---------------- ------------------------------------------------------------ ..................... - Closing of this offering 39,818,458.................... - After 180 days from the date of this prospectus, subject, in some cases, to limitations under Rule 144 2,290,886..................... - At March 7, 2001, subject, in some cases, to limitations under Rule 144 412,869....................... - At March 31, 2001, subject, in some cases, to limitations under Rule 144
NEW INVESTORS WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION. Investors in our common stock in this offering will experience immediate and substantial dilution in the net tangible book value of their shares. At an assumed initial public offering price of $ per share, dilution to new investors will be $ per share. Additional dilution will occur upon the exercise of outstanding stock options and warrants. 18 FORWARD-LOOKING STATEMENTS Some of the statements under "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus constitute forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms and other comparable terminology. These statements involve known and unknown risks, uncertainties and other factors, including those listed under "Risk Factors," that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. USE OF PROCEEDS We expect to receive approximately $ million in net proceeds from the sale of the shares of common stock in this offering, or $ if the underwriters exercise their over-allotment option in full, based upon an assumed initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses paid and payable by us. We expect to use the net proceeds to operate and expand our network infrastructure; to promote brand awareness and other user acquisition activities; and other general corporate purposes. Pending such uses, we intend to invest the net proceeds of this offering in investment grade, interest-bearing securities. We may use a portion of the net proceeds to acquire additional businesses, products and technologies that we believe will complement our current or future business. However, we have no specific plans, agreements or commitments to do so, and are not currently engaged in any negotiations for any such acquisition. DIVIDEND POLICY We have never paid cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business. Therefore, we do not currently anticipate paying any cash dividends in the foreseeable future. 19 CAPITALIZATION The following table sets forth our capitalization as of December 31, 1999 on the following three bases: - on an actual basis; - on a pro forma basis after giving effect to the conversion of then-outstanding shares of convertible preferred stock into 12,729,458 shares of common stock upon the closing of this offering and the filing of amendments to our articles of incorporation to provide for authorized capital stock of 400,000,000 shares of common stock and 20,000,000 shares of preferred stock; and - on a pro forma as adjusted basis after giving effect to our receipt of the net proceeds from the sale of shares of common stock at an assumed initial public offering price of $ per share in this offering, after deducting underwriting discounts and commissions and estimated expenses. The outstanding share information set forth in the table below excludes as of December 31, 1999 4,171,560 shares of common stock that are reserved for issuance upon exercise of outstanding stock options under our stock option plan at a weighted-average exercise price of $0.78 per share and 3,518,524 shares of common stock reserved for issuance upon exercise of outstanding warrants at a weighted average exercise price of $0.52 per share. The capitalization information set forth in the table below is qualified by and should be read in conjunction with the more detailed financial statements and related notes appearing elsewhere in this prospectus.
DECEMBER 31, 1999 ---------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED -------- --------- ----------- (IN THOUSANDS, EXCEPT SHARE DATA) Cash and cash equivalents................................... $ 20,342 $ 20,342 $ ======== ======== ======= Long-term obligations, net of current portion............... $ 20,137 $ 20,137 $ -------- -------- ------- Mandatorily redeemable convertible preferred stock, no par value: 10,000,000 shares authorized, 6,364,729 shares issued and outstanding, actual; 20,000,000 shares authorized, no shares issued and outstanding, pro forma and pro forma as adjusted................................. 33,892 -- Shareholders' equity (deficit): Common stock, no par value: 50,000,000 shares authorized, 26,879,000 shares issued and outstanding, actual; 400,000,000 shares authorized, 39,608,458 shares issued and outstanding, pro forma; 400,000,000 shares authorized, shares issued and outstanding, pro forma as adjusted....................................... 11,086 44,978 Deferred compensation....................................... (7,848) (7,848) Accumulated deficit......................................... (19,017) (19,017) -------- -------- ------- Total shareholders' equity (deficit).................... (15,779) 18,113 -------- -------- ------- Total capitalization.................................. $ 38,250 $ 38,250 $ ======== ======== =======
20 DILUTION If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. We calculate net tangible book value per share by dividing the net tangible book value, which equals total assets less intangible assets and total liabilities, by the number of outstanding shares of common stock. At December 31, 1999, our pro forma net tangible book value, after giving effect to the automatic conversion of all then-outstanding shares of convertible preferred stock into 12,729,458 shares of common stock upon the closing of this offering, was $18.1 million, or $0.46 per share of common stock. After giving effect to the sale of the shares of common stock in this offering at an assumed initial public offering price of $ per share, less estimated underwriting discounts and commissions and estimated expenses we expect to pay in connection with this offering, our pro forma as adjusted net tangible book value at December 31, 1999 would have been $ million, or $ per share. This represents an immediate increase in the pro forma as adjusted net tangible book value of $ per share to existing shareholders and an immediate dilution of $ per share to new investors, or approximately % of the assumed offering price of $ per share. The following table illustrates this dilution on a per share basis: Assumed initial public offering price per share............. $ ------- Pro forma net tangible book value per share at December 31, 1999...................................................... $0.46 Increase per share attributable to new investors............ ----- Pro forma as adjusted net tangible book value per share after this offering....................................... ------- Dilution per share to new investors......................... $ =======
The following table shows on a pro forma as adjusted basis at December 31, 1999, after giving effect to the automatic conversion of all then-outstanding shares of convertible preferred stock into shares of common stock upon the closing of this offering, the number of shares of common stock purchased from us, the total consideration paid to us and the average price paid per share by existing shareholders and by new investors purchasing common stock in this offering, before deducting underwriting discounts and commissions and estimated offering expenses, at an assumed initial public offering price of $ per share:
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE --------------------- ---------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- -------- ----------- -------- --------- Existing shareholders...................... 39,608,458 % $36,551,000 % $0.92 New investors.............................. $ Total.................................. % $ %
The above computations assume no exercise of options or warrants after December 31, 1999. The number of shares outstanding at December 31, 1999 excludes 4,171,560 and 3,518,524 shares of common stock issuable upon exercise of outstanding options and warrants, respectively, having weighted-average exercise prices of $0.78 and $0.52 per share, respectively. To the extent these outstanding options or warrants are exercised, or we grant any options or warrants in the future, there will be further dilution to new investors. For a more detailed discussion of our stock plans and outstanding options and warrants to purchase common stock, see Notes 9 and 10 to our financial statements included elsewhere in this prospectus. 21 SELECTED FINANCIAL DATA The following statement of operations and balance sheet data should be read in conjunction with our financial statements and related notes 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 July 1, 1998 (inception) through December 31, 1998 and for the fiscal year ended December 31, 1999 and the balance sheet data at December 31, 1998 and December 31, 1999 are derived from audited financial statements included elsewhere in this prospectus. Pro forma balance sheet data at December 31, 1999 gives effect to the conversion of preferred stock outstanding at December 31, 1999 into 12,729,458 shares of common stock. See Note 2 to our financial statements for a description of how pro forma net loss per share is calculated. The historical results are not necessarily indicative of the operating results to be expected in the future.
PERIOD FROM JULY 1, 1998 YEAR ENDED (INCEPTION) TO DECEMBER 31, 1998 DECEMBER 31, 1999 -------------------------------- ----------------- (IN THOUSANDS, EXCEPT SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenues.......................................... $ -- $ 983 Cost of revenues.................................. 78 8,692 ------ -------- Gross profit (loss)............................... (78) (7,709) ------ -------- Operating expenses: Sales and marketing............................. 52 8,175 Product development............................. 28 312 General and administrative...................... 115 1,362 Stock-based compensation........................ -- 876 ------ -------- Total operating expenses...................... 195 10,725 ------ -------- Loss from operations.............................. (273) (18,434) Interest income................................... 1 156 Interest expense.................................. -- (429) Other expense..................................... -- (38) ------ -------- Net loss.......................................... $ (272) $(18,745) ====== ======== Basic and diluted net loss per share.............. $(0.08) $ (2.16) ====== ======== Shares used to compute basic and diluted net loss per share....................................... 3,279 8,696 ====== ======== Pro forma net loss per share...................... $ (0.62) ======== Shares used to compute pro forma net loss per share........................................... 30,477 ========
AT DECEMBER 31, 1999 AT DECEMBER 31, --------------------- 1998 ACTUAL PRO FORMA --------------- --------- --------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents................................. $333 $ 20,342 $20,342 Working capital (deficit)................................. (47) 10,649 10,649 Total assets.............................................. 918 50,429 50,429 Long-term obligations, net of current portion............. 259 20,137 20,137 Mandatorily redeemable convertible preferred stock........ -- 33,892 -- Shareholders' equity (deficit)............................ 279 (15,779) 18,113
22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are a leading provider of free internet access to consumers and also offer private label and co-branded free internet access solutions to businesses and affinity groups, both domestically and internationally. Our free internet access service is designed to be reliable, easy to use and fun. Our private label and co-branding programs offer our strategic partners a wide range of turnkey internet solutions. Through these solutions, our partners have the ability to offer free internet services to their customers, increasing their website traffic, building brand loyalty and expanding their revenue streams. We anticipate that these programs will allow us to rapidly increase the number of consumers to whom our advertising offerings are delivered and expand our revenue-sharing opportunities. When users register for our service, they anonymously provide selected demographic information which allows advertisers and sponsors to customize their marketing to specific online audiences. Since the launch of our service in December 1998, the number of our registered users has grown to approximately 2.2 million as of March 26, 2000. During the 30 days prior to March 26, 2000, approximately 1.1 million of these registered users accessed our service and we delivered over 1.3 billion advertising impressions to our active users in the United States. For the period from inception until the December 1998 launch of our service, our operating activities related primarily to the development of our proprietary software and network infrastructure. From January 1, 1999 to March 26, 2000, we: - expanded our network infrastructure coverage from the Seattle metropolitan area to nationwide coverage; - activated 24 additional POPs; - increased the number of employees from 17 to 242; - expanded our product offering to include email, chat, instant messaging and the FreeiMall; - launched our portal, including our content channels, the customizable MyFreei and My Neighborhood; and - launched our nationwide television advertising campaign, including our "Baby Bob" campaign. To date, our revenues have been derived principally from the sale of advertisements and sponsorship placements within our site. We sell a variety of advertising packages to clients, including banner advertisements, website sponsorships, referral arrangements, targeted advertisements and content placements. Our advertising revenues are derived principally from short-term advertising arrangements, which typically average one to three months. Advertising revenues are recognized ratably over the period in which the advertisement is displayed, if no significant company obligations remain and collection of the resulting receivable is probable. Payments received from advertisers before displaying their advertisements on our website are recorded as deferred revenues and are recognized as revenue in the period over which the advertisement is displayed. Significant obligations generally consist of guaranteed minimum numbers of impressions or click-throughs. To the extent minimum guaranteed impression and click-through levels are not met, we defer recognition of the corresponding revenues until guaranteed levels are achieved. In addition to advertising revenues, we derive revenues from electronic commerce. A number of recent arrangements with our electronic commerce partners provide us with a share of any sales resulting from direct links from our website. Electronic commerce revenues have not been significant to date, but are expected to increase as our existing electronic commerce arrangements grow and new arrangements are entered into. We recognize revenues from our share of the proceeds upon notification from our partners of sales attributable to our website. 23 In the future, we may derive revenues from other sources, including the provision of internet access solutions under private and co-branding label arrangements and performance-based arrangements. Under private and co-branding label arrangements we expect to receive a combination of a monthly fee per user and either a share or all of the advertising revenues related to the arrangement. We will recognize revenues from monthly fees as we provide our private or co-branded label services. We will recognize advertising revenues on a basis consistent with advertising within our own site. Performance-based arrangements, such as "pop-up" commercials and Freei "intromercials," will be billed based on various performance criteria, such as the number of advertisements delivered. Revenues will be recognized as the related performance criteria are met. COST OF REVENUES. Cost of revenues consists of telecommunications costs, depreciation of our network equipment, co-location costs, personnel and related expenses of providing customer service and maintaining our network. Generally, telecommunications costs include costs for providing local telephone lines into each company-managed POP, costs associated with leased lines connecting each POP to our network operation center, costs for our connections from our network operating center to the internet, and costs associated with the lease of ports from telecommunications carriers. We intend to expand and improve our network to support our increasing user base, which will result in increased telecommunications costs and depreciation expense. Telecommunications costs are expensed as incurred. Network equipment is capitalized and depreciated over its estimated useful life. SALES AND MARKETING. Sales expenses consist primarily of salaries, sales commissions, travel and related expenses for our direct sales force. Marketing expenses consist primarily of advertising, public relations, salaries and trade shows. We intend to significantly increase spending on sales and marketing to increase brand awareness and our user base. Sales and marketing costs are expensed in the period incurred. PRODUCT DEVELOPMENT. Product development costs consist primarily of costs for salaries and benefits of software developers in connection with the development of new or improved technologies designed to enhance the performance of our service. Costs incurred in the development of core software for our website infrastructure are capitalized and are amortized over the expected useful life of the developed software. Costs incurred in the development of content for the website are expensed as incurred. We believe that a significant level of product development activity is necessary to improve and expand our services and intend to increase significantly the amount of spending to fund this activity. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of salaries, employee benefits and related expenses for our executive, finance, legal, human resources and administrative personnel, third party professional service fees and an allocation of our facilities expense. We expect general and administrative expenses to increase in the future, reflecting anticipated growth in our operations and the costs associated with being a public company. STOCK-BASED COMPENSATION. In 1999, we recorded total deferred stock-based compensation of $8.7 million in connection with stock options granted during 1999 at prices subsequently deemed to be below the fair market value of common stock on the date of grant. Options granted are typically subject to a four-year vesting period. We are amortizing the deferred compensation over the vesting periods of the applicable options. Amortization for the year ended December 31, 1999 was $876,000. The remaining balance of deferred compensation at December 31, 1999 to be expensed in future years is $7.8 million. We expect to record additional deferred stock-based compensation of approximately $16 million in the quarter ending March 31, 2000 related to options granted subsequent to December 31, 1999. 24 INTEREST AND OTHER INCOME (EXPENSE). Interest income consists of earnings on our cash and cash equivalents. Interest expense consists primarily of interest expense on capital equipment leases. INCOME TAXES. We initially elected to be taxed as an S-corporation. As a result of the March 1999 financing, our tax status automatically changed to that of a C-corporation. We have not recorded a provision for income taxes because we have incurred net losses to date. As of December 31, 1999, we had net operating loss carryforwards of approximately $16.3 million available to offset future taxable income. These carryforwards expire beginning in 2019. Utilization of the net operating losses may be subject to a substantial annual limitation due to the ownership change limitations contained in the Internal Revenue Code. There is sufficient uncertainty regarding the recoverability of the deferred tax assets such that a full valuation allowance has been recorded. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization. See Note 6 of the notes to our audited financial statements included elsewhere in this prospectus. Our historical operating results should not be relied upon as indicative of future performance. Our prospects should be considered in light of the risks, expenses and difficulties encountered by companies in the early stages of development, particularly companies in the rapidly evolving internet market. Although we have experienced revenue growth in recent periods, we anticipate that we will incur operating losses for the foreseeable future due to a high level of planned operating and capital expenditures. In particular, we expect to increase our operating expenses and capital expenditures in order to continue to expand our sales and marketing organization and network infrastructure. QUARTERLY RESULTS OF OPERATIONS The following table sets forth our unaudited quarterly statement of operations data for the four quarters ended December 31, 1999. In the opinion of our management, this information was prepared on substantially the same basis as our audited financial statements included in this prospectus. In the opinion of our management, all necessary adjustments (consisting of only normal recurring adjustments) have been included in the amounts stated below to present fairly the unaudited quarterly results. You should read this quarterly data in conjunction with our audited financial statements and accompanying notes included in this prospectus. Our operating results for any quarter are not necessarily indicative of the operating results for any future period.
THREE MONTHS ENDED ------------------------------------------- MARCH 31, JUNE 30, SEPT. 30, DEC. 31, 1999 1999 1999 1999 --------- -------- --------- -------- (IN THOUSANDS) Revenues............................................... $ 17 $ 91 $ 213 $ 662 Cost of revenues....................................... 376 796 2,272 5,248 ----- ------- ------- -------- Gross profit (loss).................................... (359) (705) (2,059) (4,586) ----- ------- ------- -------- Operating expenses: Sales and marketing.................................. 224 277 987 6,687 Product development.................................. 24 46 96 146 General and administrative........................... 116 148 353 745 Stock-based compensation............................. -- -- 15 861 ----- ------- ------- -------- Total operating expenses........................... 364 471 1,451 8,439 ----- ------- ------- -------- Loss from operations................................... (723) (1,176) (3,510) (13,025) Interest and other income (expense), net............... (14) (73) (229) 5 ----- ------- ------- -------- Net loss............................................... $(737) $(1,249) $(3,739) $(13,020) ===== ======= ======= ========
25 REVENUES. Revenues grew in each quarter presented primarily due to the increase in the sale of advertisements by our sales force. COST OF REVENUES. Cost of revenues increased in each quarter presented primarily due to increased spending on our network infrastructure and the hiring of additional customer support representatives to support our growing user base. SALES AND MARKETING. Sales and marketing expenses increased in each quarter presented. These increases were primarily due to the hiring of additional sales personnel, the payment to sales representatives of increased commissions resulting from increased sales, and additional marketing expenses. The increase in sales and marketing expenses during the fourth quarter of 1999 was due to increased spending on television advertising and other brand awareness initiatives. PRODUCT DEVELOPMENT. Product development costs have increased steadily in each quarter presented as result of increased personnel costs related to the continued enhancement of our client software applications and our internal systems. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased in each quarter presented. These increases were primarily due to the hiring of additional executive and administrative personnel. STOCK-BASED COMPENSATION. Amortization of stock-based compensation increased during the third and fourth quarters of 1999 due to the increase in the issuance of options to new employees and directors and the increase in the deemed value of the Company's common stock as compared to the exercise price of the options granted, as well as the amortization of deferred compensation on prior grants. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE PERIOD FROM INCEPTION THROUGH DECEMBER 31, 1998 We began business operations in July 1998 and, as a result, operating results for the period from inception through December 31, 1998, include no revenues and limited cost of revenues and operating expenses. Accordingly, the results for this period are not meaningful or material in comparison to the operating results for the year ended December 31, 1999. REVENUES. Revenues for the year ended December 31, 1999 were $983,000 compared to no revenue for the period ended December 31, 1998. The increase was primarily attributable to sales of banner advertisements by our sales force. COST OF REVENUES. Cost of revenues for the year ended December 31, 1999 was $8.7 million compared to $78,000 for the period ended December 31, 1998. The increase was primarily attributable to telecommunications expenses related to the growth in our user base and depreciation related to our network infrastructure costs. SALES AND MARKETING. Sales and marketing expenses for the year ended December 31, 1999 were $8.2 million compared to $52,000 for the period ended December 31, 1998. The increase was primarily due to an increase in advertising and the hiring of additional direct sales force and marketing personnel. PRODUCT DEVELOPMENT. Product development expenses for the year ended December 31, 1999 were $312,000 compared to $28,000 for the period ended December 31, 1998. The increase was primarily due to the hiring of additional software engineers. 26 GENERAL AND ADMINISTRATIVE. General and administrative expenses for the year ended December 31, 1999 were $1.4 million compared to $115,000 for the period ended December 31, 1998. The increase was primarily due to the hiring of additional executive and administrative personnel, increased facilities costs and an increase in professional fees. STOCK-BASED COMPENSATION. In the year ended December 31, 1999, we recorded total deferred compensation of $8.7 million in connection with stock option grants. We are amortizing this amount over the vesting periods of the applicable options, resulting in an expense of $876,000 for the year ended December 31, 1999. INTEREST AND OTHER INCOME (EXPENSE). Interest income for the year ended December 31, 1999 was $156,000 compared to $1,000 for the period ended December 31, 1998. The increase was primarily attributable to interest earned on the $35.8 million in net proceeds from our common and preferred stock financings in 1999. Interest expense for the year ended December 31, 1999 was $429,000 compared to no interest expense for the year ended December 31, 1998. This increase was primarily attributable to an increase in capital equipment leases. LIQUIDITY AND CAPITAL RESOURCES Since our inception, we have financed our operations primarily through the private placement of equity securities, raising approximately $36.5 million through December 31, 1999, prior to expenses. In March 2000 we raised an additional $53 million, prior to expenses, through the sale of a new series of preferred stock. At December 31, 1999, we had $20.3 million in cash and cash equivalents and $10.6 million in working capital, compared to $333,000 in cash and cash equivalents and negative working capital of $47,000 at December 31, 1998. Net cash used for our operating activities was $13.5 million for the year ended December 31, 1999. Net cash used for operating activities consisted primarily of net operating losses and increases in accounts receivable and prepaid expenses, which were partially offset by increases in depreciation, stock-based compensation, accounts payable and accrued liabilities. For the period ended December 31, 1998, no cash was used in or provided by operating activities. Net cash used for our investing activities was $66,000 and $2.3 million for the periods ended December 31, 1998 and 1999, respectively. Net cash used for investing activities in 1998 and 1999 consisted primarily of capital expenditures for network and computer equipment, purchased software, office equipment and leasehold improvements. As our operations expand, we anticipate that our planned purchases of capital equipment will require significant additional expenditures over the next 12 months. Net cash provided by our financing activities was $399,000 and $35.8 million for the periods ended December 31, 1998 and 1999, respectively. Net cash provided by financing activities in 1999 was principally attributable to the private sale of convertible preferred stock, which was partially offset by principal payments made on capital leases. As of December 31, 1999, our principal commitments consisted of office and equipment leases. Future minimum cash payments under these non-cancelable commitments are $48.1 million through the year 2003. In addition, we have a commitment to MP3.com to spend up to $4.0 million in online advertising, marketing and promotions before December 31, 2000. We expect to continue to incur significant capital expenditures and operating expenses in the future, including improvements to our network infrastructure and other computer and telecommunications equipment, enhancement and expansion of our services, and increases in our sales and marketing activities. Our actual capital expenditures and operating expenses will depend on the 27 growth rate of our user base, which is difficult to predict and which could change dramatically over time. We believe that our existing cash and cash equivalents and the net proceeds from this offering will be sufficient to fund our operating activities, capital expenditures and other obligations through at least the next 12 months and do not currently anticipate the need to raise additional capital within that period of time. If we do seek to raise additional capital, we cannot assure you that additional financing will be available on acceptable terms, if at all. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133. SFAS No. 133 is effective for our fiscal year ending December 31, 2001. We do not use derivative instruments, and therefore do not expect that the adoption of this statement will have any effect on our results of operations, financial position or cash flows. In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." This pronouncement summarizes certain of the SEC staff's views on applying generally accepted accounting principles to revenue recognition. We are required to adopt SAB No. 101 for our fiscal year ending December 31, 2000. We do not expect the adoption of SAB No. 101 to have an effect on our results of operations, financial position or cash flows. 28 BUSINESS FREEINTERNET.COM We are a leading provider of free internet access to consumers and also offer private label and co-branded free internet access solutions to businesses and affinity groups, both domestically and internationally. Our free internet access service is designed to be reliable, easy to use and fun. Our private label and co-branding programs offer our strategic partners a wide range of turnkey internet solutions. Through these solutions, our partners have the ability to offer free internet services to their customers, increasing their website traffic, building brand loyalty and expanding their revenue streams. We anticipate that these programs will allow us to rapidly increase the number of consumers to whom our advertising offerings are delivered and expand our revenue-sharing opportunities. When users register for our service, they anonymously provide selected demographic information which allows advertisers and sponsors to customize their marketing to specific online audiences. We launched our services in December 1998 in the Seattle metropolitan area, acquiring approximately 32,000 registered users by April 30, 1999. In May 1999, we expanded our service to five major metropolitan areas, including Los Angeles, Chicago and Washington D.C., acquiring approximately 322,000 registered users by October 1, 1999, at which time we launched our service nationally. Since October 1999, we have added approximately 1.7 million registered users in the United States. Since the December 1999 launch of our service in Singapore, we have acquired 150,000 users in southeast Asia. During the 30 days prior to March 26, 2000, over 1.3 billion advertising impressions were delivered to our active users in the United States. We believe a key competitive advantage is our national telecommunications infrastructure. Unlike most other free internet service providers, or ISPs, we maintain our own POPs in major markets, which we supplement by contracting with third-party telecommunications service providers. We established our first POP in December 1998 and currently maintain 25 POPs in major markets. We believe this approach enhances the reliability of our services and provides us with lower network costs compared to other free ISPs. Users can access our services through a local telephone call in more than 1,300 cities throughout the United States. INDUSTRY BACKGROUND The internet has become an increasingly significant medium for communication, information and commerce. According to International Data Corporation, or IDC, an industry research firm, the number of worldwide web users is expected to grow from 186 million in 1999 to 502 million in 2003. We believe that continued growth in internet usage is expected to be fueled by a number of factors, including advances in the performance and speed of personal computers and internet access generally, the decline in computer prices and increased consumer awareness of the internet's potential for commercial and personal use. The rapid growth of internet usage has resulted in the proliferation of regional and local ISPs in the United States. According to Jupiter Communications, an industry research firm, ISPs vary widely in the quality and reliability of internet access they provide, the level of customer service they maintain and the selection of subscriber services they offer. ISPs generally offer access to the internet through dial-up modem and various forms of broadband technologies. Jupiter Communications predicts that in 2003, 77% of U.S. online households will access the internet via dial-up modem, while the remainder will access via broadband and other technologies. ISPs have historically charged internet users monthly access fees. We believe that increasing numbers of new and existing internet users will demand reduced access fees and, if given comparable quality, will migrate to free ISPs. As this migration occurs, ISPs will need to increasingly rely on 29 revenue from advertising services. Total worldwide ISP revenue from advertising services is expected to grow from $3.2 billion in 1999 to $11.5 billion in 2003 according to Jupiter Communications. Businesses and consumers are increasingly using the internet for e-commerce transactions. According to Forrester Research, an industry research firm, worldwide business-to-business electronic commerce revenues are expected to grow from $131 billion in 1999 to $1.52 trillion in 2003, and, according to the GartnerGroup, an industry research firm, worldwide consumer electronic commerce revenues are expected to grow from $31.2 billion in 1999 to $380.5 billion in 2003. The internet serves as a powerful direct marketing and sales channel for conducting commercial transactions and providing a real-time platform from which users can access dynamic content and interactive communications features. Online merchants can use the internet to reach a broader customer base with a larger selection of products at lower costs, and merchants advertising their goods can target specific demographic groups, evaluate the effectiveness of their advertising campaigns and modify them in direct response to consumer feedback. In order to maintain an active user base to which advertisers can market their goods and services, ISPs must provide "sticky" features. Forrester Research states that the top four reasons users cited for continuing to visit their favorite sites are high quality content (75%), ease of use (66%), quick download time (58%) and frequent updates (54%). THE FREEINTERNET.COM STRATEGY Our goal is to become the dominant provider of access to the internet. We intend to achieve this goal by: ATTRACTING USERS THROUGH BRAND PROMOTION AND APPEALING MARKETING PROGRAMS. Our strategy is to promote freeinternet.com as a brand that consumers associate with a fun and user-friendly experience and that advertisers and sponsors associate with a highly effective means to target potential customers. We believe the freeinternet.com name is easy for consumers to understand and remember. We will continue to build and reinforce the freeinternet.com brand through a variety of media, including national and local television and radio campaigns, outdoor advertising and online promotions on third-party websites. We recently commenced our critically acclaimed "Baby Bob" marketing campaign. In addition, Shaquille O'Neal and Claudia Schiffer have agreed to promote our brand. RETAINING USERS BY OFFERING RELIABLE ACCESS WHILE PROVIDING A USER-FRIENDLY AND FUN ONLINE EXPERIENCE. Currently, we offer our users content-specific channels, customizable features, localized information, e-commerce and other value-added features. We plan to frequently enhance this comprehensive portal with additional channels, features and local and national content. In addition, we will continue to invest in our network to provide our users with a reliable and high quality internet connection, and are committed to providing a high level of responsive and effective customer service. OFFERING OUR ADVERTISERS AND SPONSORS EFFECTIVE MARKETING SOLUTIONS TO REACH THEIR TARGET AUDIENCES. To be successful, we must continue to increase our advertising and sponsorship revenues. We offer advertisers and sponsors the ability to maximize the effectiveness of their online marketing by targeting specific demographic audiences on a local and national basis. Our advertisers and sponsors are able to reach their target audience through a variety of advertising options, including banner advertisements, sponsorship and "intromercials." Moreover, we are continuing to develop a network of local sales representatives to promote and increase our local advertising offerings. CONTINUING TO DEVELOP PRIVATE LABEL AND OTHER STRATEGIC RELATIONSHIPS. We plan to rapidly expand our private label and co-branding programs. These programs allow our strategic partners to provide branded internet access and online services to their customers. We anticipate that these programs will allow us to rapidly increase the number of consumers to whom our advertising offerings are delivered and expand our revenue-sharing opportunities. 30 BUILDING OUT A RELIABLE AND COST-EFFECTIVE TELECOMMUNICATIONS NETWORK. We plan to continue building and maintaining our own POPs in major markets in order to provide a reliable network, reduce our cost per user and accommodate user growth. We have augmented our network with additional telecommunications services from third-party providers in order to strategically provide service in smaller markets and to provide system redundancy. PURSUING AGGRESSIVE INTERNATIONAL EXPANSION. We believe that international expansion represents a significant growth opportunity for us. We have entered into agreements to provide co-branded services in Singapore and Australia. In December 1999, our free service was launched in Singapore and we anticipate launching our service in Australia later this year. We are currently in discussions to initiate service in several other countries. CAPITALIZE ON WIRELESS, BROADBAND AND OTHER EMERGING TECHNOLOGIES. We continuously monitor emerging technologies and are committed to developing new services to leverage these evolving platforms and enhance our service offerings. For example, we are currently exploring opportunities to offer internet services via wireless and broadband technologies. We have recently entered into an agreement with InfoSpace to jointly offer our services on wireless devices. FREEINTERNET.COM SERVICES THE FREEINTERNET.COM USER EXPERIENCE We offer consumers free internet access designed to be reliable, easy to use and fun. We were ranked as the overall number one free ISP by PC WORLD MAGAZINE in its April 2000 edition. FREE AND ANONYMOUS INTERNET ACCESS. We offer users free, unlimited access to the internet. To use our services, users download our proprietary internet access software from our website or install it from a CD-ROM. Our software is compatible with both Windows and Macintosh operating systems. Upon completion of a brief online questionnaire, registered users can immediately begin accessing the internet through our freeinternet.com services. Since we do not require a user's name, street address or phone number, registered users enjoy complete anonymity. COMPREHENSIVE PORTAL. Our goal is to provide a content- and feature-rich online destination for our users. - FULL CONTENT. We offer a full content site with headline news, weather, stock reports, white and yellow pages, along with over 30 content-specific channels, such as business, finance, entertainment, health and classifieds. - CUSTOMIZABLE HOMEPAGE. Our users have the ability to create "myfreei," a personalized home page that contains information specifically customized by that registered user. These pre-selected preferences can include personal stocks, horoscopes, specific news or sports information. - LOCALIZED INFORMATION. Our "my neighborhood" section provides localized information such as weather reports, entertainment information, local government resources and restaurant locations based on a user's zip code. - VALUE-ADD FEATURES. We provide each user with free email and other valuable online services, including free online storage space, chat rooms and instant messaging. - ONLINE SHOPPING. We have entered into an agreement with Inktomi, a leader in shopping engines, to provide our users with one of the broadest selections of merchandise available in online shopping through the FreeiMall, our shopping channel. The FreeiMall currently hosts approximately 350 merchants and a wide selection of products, allowing users to do comparative shopping. 31 - USER AND TECHNICAL SUPPORT. We provide telephone, email and online assistance to our users. In addition, we continuously monitor our nationwide telecommunications network service to help maintain high availability and throughput for our users and ensure virtually uninterrupted access to the internet. ADVERTISING AND MARKETING SERVICES We offer advertisers and sponsors an attractive online advertising medium by providing an opportunity for uninterrupted exposure to our large user base during online sessions. We also provide advertisers and sponsors with the ability to target their advertising messages and receive feedback regarding the effectiveness of their marketing programs. To date, companies that have purchased national advertisements from us include Amazon.com, Inc., eBay Inc., Egghead.com, Inc., Gateway 2000, Inc. and PETsMART.com, Inc. Advertisers who have purchased local advertisements from us include the Seattle Mariners and Lomas Eye Care Center. CONTINUOUS ADVERTISING CHANNEL. Our iSee Window is designed to remain in view throughout a user's session, including while pages download and while the user navigates the internet or engages in non-browsing activities such as sending or receiving e-mail. TARGETED AND INNOVATIVE ADVERTISING OPPORTUNITIES. While advertisers can purchase untargeted banner advertising from us, we also enable them to target their marketing efforts based on user demographics and channel content. We collect this demographic information from our users when they register for our services and from time to time thereafter. - ISEE WINDOW. We have the ability to deliver targeted advertising to users who meet the profile criteria specified by our advertisers, including gender, interests, age, income and zip code. Moreover, the iSee Window contains a number of fixed features available for sponsorship by advertisers, including website link buttons and a scrolling marquee. - FREEI PORTAL. Companies can purchase sponsorships or advertisements throughout our content-rich Freei portal. As a result, advertisers can place their message alongside content typically viewed by users with the advertisers' preferred demographic characteristics. Advertisers can also customize their message to the projected demographics of the channel in which it is placed. - "POP-UP" COMMERCIALS AND FREEI "INTROMERCIALS." Advertisers can also purchase pop-up commercials and full motion intromercials. Pop-up commercials are small windows displaying advertisements which are launched periodically while a user is online. Intromercials use Macromedia Flash technology to provide full color, full motion advertisements and are displayed while our home page downloads to a user's computer, while a user clicks on another channel, or while a user logs off our service. CAPACITY TO PROVIDE DETAILED FEEDBACK TO OUR ADVERTISERS. Using our proprietary technology, we are able to provide advertisers with direct feedback as to the effectiveness of their online marketing campaigns. For example, advertisers can access our server on a 24-hour basis through the use of a password to obtain information about their advertisements, including the number of impressions or page views delivered and the number of "clicks" on their advertisements. PRIVATE LABEL AND CO-BRANDED SOLUTIONS BENEFITS TO US. We anticipate that our private label and co-branded solutions will provide us with: - a rapid increase in the number of consumers to whom our advertising offerings are delivered; - diverse revenue-sharing opportunities, including banner ads, button and tile sponsorships, email advertisements and e-commerce; and 32 - greater name recognition and promotion of the freeinternet.com brand. PRIVATE LABEL SOLUTIONS. We offer a range of turnkey private label solutions that allow our strategic partners to use our proprietary online services to offer free internet access to their customers and members. At the strategic partner's option, our internet services can be branded completely with the partner's name, look and feel, including a partner-specific CD-ROM, user interface, dialog box and default start page. Each start page contains our tagline "powered by freeinternet.com." In constructing their private label program, our strategic partners have a variety of revenue-sharing options, including having us place all of the advertisements on their site, having their own sales force be responsible for advertisement acquisition, or a combination of both. Through our private label program, our strategic partners can: - provide their customers with feature-rich content and various internet services, including personalized email, instant messaging and chat rooms; - instantly increase traffic to their own website; - benefit from an increase in e-commerce business; - build strong customer loyalty and brand awareness; - begin targeting their products and services more effectively to their customer base; - receive more detailed user information so they can better serve their customers. We have entered into private label agreements with companies such as AT&T and InfoSpace, and anticipate launching these services in the near future. CO-BRANDED PROMOTIONS. For partners who want to leverage the freeinternet.com brand name, our co-branded program offers the ability to quickly go to market with free internet access for their customers, branded together with the freeinternet.com name, reputation and services. Under this model, our co-brand partners have the ability to provide their customers with customized CD-ROMs that contain our software and look and feel, but also include partner-specific advertisements and instant messaging services. We have recently entered into a co-branding arrangement to provide free internet access to the customers of Subway Restaurants. We provide our free co-branded internet services to customers of Singapore Telecommunications. Since the launch of our service in Singapore in December 1999, we have acquired approximately 150,000 users in this market. Although to date we have received limited revenue under this arrangement, we believe that as we grow this user base, we will begin to generate advertising and content-placement revenues. These services are provided through a licensee who is in the process of formalizing its relationship with Singapore Telecommunications. MARKETING AND SALES MARKETING--USER ACQUISITION We attract new users through aggressive marketing and brand awareness campaigns. Our marketing strategy is to promote the freeinternet.com brand as user friendly and fun through national and local television, radio, print and trade advertising. We have recently commenced a critically acclaimed national television and radio advertising campaign featuring "Baby Bob," a talking infant with a high I.Q. whose mission is to spread the word about freeinternet.com. In addition, Shaquille O'Neal and Claudia Schiffer have agreed to promote the freeinternet.com brand. Users can access our service by downloading our software from our website or can call our toll-free number to request a free CD-ROM containing our software. We also distribute CD-ROMs through targeted promotions and strategic partnerships. To date, we have experienced a strong "word-of-mouth" referral rate from our current users. 33 We intend to continue to enter into private label and co-branding arrangements with strategic partners in order to expand our user base, both domestically and internationally. We have also entered into arrangements to have our software installed on or with various hardware and software computer products. For example, our software was incorporated in MacAddict magazine's bundled software distributed with its February 2000 issue and is incorporated in CD-ROMs distributed by MP3.com, Inc. It is also installed on personal computers manufactured by Aopen America Incorporated, a wholly owned subsidiary of Acer America Computer. We were recently invited to participate in an exclusive university information center marketing program by CampusLink, a network of on-campus, multi-media centers with exposure to over 600,000 students in 17 major universities across the United States, including Arizona State University, University of California at Los Angeles, Michigan State University and Ohio State University. SALES--ADVERTISER ACQUISITION We have divided our sales efforts into distinct channels, each with its own specialization. DIRECT SALES. Our direct sales representatives focus their efforts on advertising agencies and major customer accounts through direct client contact. These representatives have primary responsibility for selling our higher-value targeted advertising. We currently have direct sales staff in New York, San Francisco, Los Angeles, Seattle, Chicago and Phoenix, and are hiring staff in Boston, Philadelphia, Atlanta and Dallas. INSIDE SALES. Our inside sales force, which concentrates on smaller national accounts and regional businesses, generates sales through telephone interaction with potential advertisers. These representatives are responsible for our less expensive traditional banner advertising, including run-of-site, cost-per-click and cost-per-acquisition sales. Our inside sales force is based in our Seattle-area headquarters. ADVERTISING FIRMS. We have established relationships with multiple internet advertising firms to sell, on a wholesale basis, any remaining advertising inventory on our site. In addition, we are currently in discussions with local advertising firms to create advertising partnerships that will assist us in our efforts to sell local targeted advertising. CONTENT PROVIDERS. We have revenue sharing agreements with content providers. Under these agreements, we benefit from the selling efforts of our content providers whose own internal sales forces sell advertisements that appear on our site. USER SUPPORT We are dedicated to building long-term relationships with our users by providing high quality customer service. To this end, we offer live telephone support, a telephone-based self-help system, an online information database and email assistance. Telephone support is available seven days a week, 24 hours a day. While we currently handle all telephone inquiries in-house, we have entered into an agreement with Stream International Services Corp., a third-party call center, who will handle our basic customer care questions. Complex questions will be routed back to our internal technical support department. We also provide an interactive voice response unit that allows callers to obtain automated, first-tier customer support or the option to talk to a user support representative. Freei Help, a self-help database developed by our internal technical support staff, is available on our website and contains solutions to a variety of common access and usage problems. It also has an extensive "frequently asked questions," or FAQ, section. Additionally, users can email questions directly to our user support representatives. Our email support software provides an auto-response to commonly asked questions. If the user's question is more complex, a user support representative will provide a customized response via email. 34 COMMUNICATIONS NETWORK To access our network, users initiate telephone connections between their personal computers and computer hardware in local or regional POPs. While most major free internet access providers contract for these POPs from wholesale providers, we maintain our own POPs in major markets to provide dependable user connectivity to our network. We believe that maintaining our POPs in major markets will also lead to lower operating costs. These POPs, which currently serve 25 major markets, are housed in carrier-class communication facilities provided by vendors such as AT&T and MCI WorldCom. We plan to maintain our own POPs in all major markets where we believe it is economically viable to do so. To augment our network of company-maintained POPs and provide a national footprint, we have contracted for additional telecommunications services from providers such as Cable & Wireless, PSINet and Splitrock. With the combination of company-maintained and contracted POPs, we provide local dial-up access in over 1,300 cities in all 50 states, offering our users access to our network at no cost, other than the cost of a local or regional phone call. We are seeking to develop comparable technology worldwide as we expand internationally. We support point-to-point access to the internet using the v.90 modem standard for 56 kpbs connections. We continuously monitor our network service to help maintain high availability and throughput for our users. Our servers and data center reside in Federal Way, Washington at our corporate headquarters and are equipped with uninterrupted power supplies and generator power backup systems to prevent service failures due to power outages. We presently have limited redundant facilities or systems, and are in the process of implementing our disaster recovery plan. SOFTWARE AND OTHER TECHNOLOGY We have developed and continue to enhance a suite of proprietary software systems that, together with our telecommunications infrastructure, enable us to provide our users with high quality internet access while delivering demographically targeted advertising to their computer desktops. The major components of our software systems include the following: CLIENT SOFTWARE APPLICATION. Our client software application is used by our users to connect to our network. One of the distinguishing characteristics of our client application is the iSee Window, a component that is always visible during the user's online session. Major functions performed by our client software application include: - establishing a connection to our network; - displaying current news, weather and other featured content, with links to our other services such as email, chat and shopping; - downloading and displaying demographically targeted advertising; - reporting advertisement impressions and click-throughs; - offering instant messaging and chat; - offering one-button, instant internet search capabilities; - providing security and control functions to confirm that the iSee Window and the advertisements in the iSee Window are being displayed to our users. Our client software is available on both Microsoft Windows and Apple Macintosh platforms. Additional versions of the software are planned for wireless and other devices on platforms such as Linux, Palm OS and Windows CE. The Windows platforms are programmed in Win32 MFC to provide optimal performance within Windows 95, Windows 98 and Windows NT 4.0. The Apple Macintosh version of our client software is programmed in RealBasic and is functionally identical to the Windows 35 version. Because our software is written using software languages native to each platform, we believe that it is faster and more reliable for the user. We regularly release new versions of our client software to provide improved and enhanced features and functionality. In addition, further modifications to the client software are required from time to time in order to facilitate the rapid deployment of private label partnerships. FREEI NETWORK. Our network is comprised of a group of software applications running on multiple computers that manage both the user's online experience, as well as provide for the delivery and management of advertising and rich media content. This network consists of the following components: - ADVERTISEMENT MANAGEMENT SYSTEM. Our proprietary advertisement management system houses the distribution parameters of our advertising campaigns and is integrated with our client software to manage the delivery of advertisements to our users during their online sessions. Intelligence built into this system allows focused targeting based on a variety of user demographics, which are captured from periodic user surveys. A custom-developed interface allows new advertisements to be placed into rotation on a real-time basis. A reporting module provides information on numbers of impressions and click-throughs. Planned enhancements to this system will allow for targeting based on individual user preferences, as determined from an analysis of historical and current-session traffic patterns. - CONTENT SYSTEM. This system houses and delivers the content provided to our user base, including our own content as well as the content of advertisers and other third-party providers. - AUTHENTICATION AND VERIFICATION SYSTEMS. These systems authenticate our users when they initially connect to our service and also monitor user sessions to help determine whether the iSee Window is being properly displayed. - DATA COLLECTION SYSTEM. Reporting from this system includes information on registered and active users, geographical usage and session length. Planned enhancements include the capture and reporting of our users' online experience, including historical traffic patterns. - EMAIL. We provide free email access on two common email platforms--web-based and POP3. Web-based email provides our users access from platforms or accounts that provide web access. POP3 allows our users to access their email account using their preferred POP3 email application such as Microsoft's Outlook Express or Netscape's Communicator. We have developed and integrated a number of custom anti-spamming measures designed to protect against misuse of our free email service. This includes security applications to prevent the unauthorized access of information provided by our users. Underlying all of these software applications is a load-balancing, high-availability architecture designed to enhance scalability as our user base continues to grow. The modular design of this architecture allows us to add incremental capacity to the system in response to the growth of our user base. The applications above are built on a technology suite including Sun and Intel processors, the Oracle relational database management system, Network Appliance disk arrays, Cisco routers, Radius servers and Lucent/Ascend remote access servers. Our research and development team is responsible for the design, development and release of our software and services. Members of our research and development staff work closely with our sales and marketing department, as well as with our business development team, to better understand the market needs and requirements of our users, advertisers and partners. COMPETITION The market for internet services is intensely competitive, subject to rapid technological change and significantly affected by new product and service offerings. We compete against a number of companies 36 with significantly greater financial, technical, marketing and other resources than us, including America Online, Microsoft and EarthLink. Our ability to compete depends upon many factors, many of which are outside of our control. We compete for users, and advertisers and strategic partners. COMPETITION FOR USERS. We believe that the key factors to our success in competing for users include compelling content, the reliability and quality of our service, effective user support, geographic coverage of our service and overall user satisfaction. While we believe that we compete favorably with respect to these factors, many of our competitors may have an advantage over us with respect to these and other factors. Competition may also intensify as a result of industry consolidation and the ability of some of our competitors to bundle internet services with other products and services. We currently compete with the following: - established online service and content providers, such as America Online and The Microsoft Network; - independent national ISPs, such as EarthLink and Prodigy and numerous regional and local ISPs; - other companies offering free internet access, such as NetZero and Juno in the United States and Freeserve in Europe; - private label ISPs, such as 1stUp.com and Spinway; - national long-distance carriers, such as Sprint and MCI WorldCom; - local telephone companies and regional Bell operating companies, such as GTE; - cable operators, online cable services and other broadband service providers, such as Excite@Home; and - internet portals and search engines, such as Yahoo!, Alta Vista and Lycos. COMPETITION FOR ADVERTISERS. We face intense competition from both traditional and online advertising and direct marketing businesses. We compete with traditional television, radio, cable and print media for a share of advertisers' total advertising budget. In addition, we expect that online competition will increase due to the lack of significant barriers to entry in the online advertising market. Our ability to compete effectively for advertisers depends upon many factors, including the: - size and demographic profile of our user base; - frequency and duration of use of our service by our user base; - ability to target users based on demographic information; - advertising and sponsorship costs; - capacity of our technology infrastructure to meet the needs of our users, advertisers and strategic partners; - ability to increase awareness of the freeinternet.com brand; and - effectiveness of our sales and marketing efforts and those of our competitors. COMPETITION FOR STRATEGIC PARTNERS. We believe the market for private label and co-branding opportunities is rapidly expanding. Currently, these services are offered by a limited number of service providers, including 1stUp.com and Spinway. The key factors to our success in this market include the quality of service, time-to-market, numbers of users delivered, ability to provide diverse distribution channels and the capacity to offer attractive revenue-sharing arrangements. 37 INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS Our success and ability to compete are substantially dependent on our internally developed technologies and trademarks, which we protect through a combination of copyright, trade secret and trademark law. We have not claimed any patents or filed any patent applications. We generally enter into confidentiality or noncompete agreements with our employees, consultants and corporate partners and generally control access to and distribution of our technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our processes or technologies. We cannot be certain that the steps we have taken will prevent misappropriation of our processes or technologies, particularly in foreign countries where the laws or law enforcement may not protect our proprietary rights as fully as in the United States. We have licensed, and may license in the future, elements of our trademarks, trade dress and similar proprietary right to third parties. While we attempt to ensure that the quality of our brand is maintained by these third parties, they may take actions that could materially and adversely affect the value of our proprietary rights or reputation. We have been, are currently, and may be in the future subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. We are currently subject to two intellectual property infringement claims. See "--Legal Proceedings" on page 40 for a discussion of these claims. GOVERNMENTAL REGULATION Our business is or could be in the future subject to different types of government regulation as the law relating to our business evolves. REGULATION OF CONTENT AND ACCESS A variety of restrictions on content and access, primarily as they relate to children, have been enacted or proposed. The Children's Online Privacy Protection Act of 1998 prohibits and imposes criminal penalties and civil liability on anyone engaged in the business of selling or transferring, by means of the World Wide Web, material that is harmful to minors, unless access to this material is blocked to persons under 17 years of age. In addition, the Federal Telecommunications Act of 1996 imposes fines on any entity that knowingly permits any telecommunications facility under such entity's control to be used to make obscene or indecent material available to minors via an interactive computer service. Numerous states have adopted or are currently considering similar types of legislation. In addition, laws have been proposed which would require internet service providers to supply, at cost, filtering technologies to limit or block the ability of minors to access unsuitable materials on the internet. Although the sections of the Communications Decency Act of 1996 that proposed to impose criminal penalties on anyone distributing indecent material to minors over the internet were held to be unconstitutional by the U.S. Supreme Court, similar laws may be proposed, adopted and upheld. The nature of future legislation and the manner in which it may be interpreted and enforced cannot be fully determined and, therefore, legislation similar to the Communications Decency Act could subject us and/or our customers to potential liability, which in turn could harm our business. The adoption of any of these types of laws or regulations might decrease the growth of the internet, which in turn could decrease the demand for our services or increase our cost of doing business or in some other manner harm our business. 38 USER PRIVACY ISSUES Regulations regarding internet user privacy have been enacted or proposed to limit the use of personal information by website operators. For example, the Children's Online Privacy Protection Act of 1998 requires, among other things, that online operators obtain verifiable parental consent for the collection, use or disclosure of personal information from children. The Act further mandates that the Federal Trade Commission publish regulations for the collection of data from children by commercial website operators. TELECOMMUNICATIONS REGULATION Although we are not currently regulated by the Federal Communications Commission as a "telecommunications provider," advances in voice and data telephony technology could subject us to state or federal governmental regulation in the future. In addition, we could also be affected by any change in the ability of our users to reach our network through a dial-up telephone call without any additional charges. The FCC has ruled that connections linking end users to their internet service providers are jurisdictionally interstate rather than local, but the FCC did not subject such calling to the access charges that apply to traditional telecommunications companies. Local telephone companies assess access charges to long distance companies for the use of the local telephone network to originate and terminate long distance calls, generally on a per-minute basis. We could be adversely affected by any regulatory change that would result in the application of access charges to internet service providers because this would substantially increase the cost of using the internet. DIGITAL MILLENNIUM COPYRIGHT ACT A variety of restrictions on internet content, primarily as it relates to potential intellectual property infringement, have been enacted with the passage of the Digital Millenium Copyright Act. The Digital Millennium Copyright Act provides immediate relief from monetary damages for certain common internet activities through a number of safe harbor provisions. These activities include intermediate and transient storage of materials (such as web pages or chat room discussions) in the course of transmitting, rating or providing connections; system caching; placing information on a system or network at the direction of users; and the use of information location tools, such as directories, indexes and hypertext links. For each covered activity, ISPs must meet certain conditions to qualify for protection, including, but not limited to, not receiving any financial benefit directly attributable to the infringing activity, not having the requisite level of knowledge of the infringing activity, and not modifying any of the transmitted material. In addition, the safe harbor provisions require ISPs to designate an agent to receive copyright infringement notices and file this information with the Copyright Office; provide information to its users regarding ongoing compliance with copyright law; prepare a policy and guidelines manual warning its users about the consequences of repeat infringement; and complying with certain notice and takedown procedures. PRIVACY POLICY AND DECENCY STANDARDS We believe that issues relating to the privacy of internet users and the use of information about these users are critically important as the internet and its commercial use grow. We have adopted and disclosed to our users a detailed policy outlining the permissible uses of information about users and the extent to which such information may be shared with others. Our users must acknowledge and agree to this policy before registering to use our service. Although we request certain demographic information, we do not require a user's name, street address or phone number and therefore we cannot trace the information back to an individual user. We do not sell or license to third parties any personally identifiable information about users. In some cases, users may be required to provide additional personal information when entering third-party websites accessed through links on our site. We are a member of the TRUSTe program, an independent non-profit organization that audits the 39 privacy statements of Web-sites and their adherence to those privacy statements. In addition, we voluntarily adhere to the same decency standards followed by the radio and television industries. EMPLOYEES As of March 26, 2000, we had 242 employees. None of our employees is represented by a labor union, and we believe we have good relations with our employees. FACILITIES We lease approximately 106,000 square feet of space in three buildings in Federal Way, Washington under three separate leases. One lease expires as of December 31, 2002, the second lease expires as of February 1, 2005 and the third is on a month-to-month basis. We believe that our facilities will be adequate to meet our needs for at least the next twelve months. LEGAL PROCEEDINGS Juno Online Services, Inc., registrant of the federally registered mark E-MAIL WAS MEANT TO BE FREE, recently filed an action against us in the Federal District Court for the Southern District of New York, Civil Action No. 00 CIV. 2080, for trademark infringement, unfair competition and misrepresentation and dilution under federal, state and common law arising from our use of the mark BECAUSE THE INTERNET WAS MEANT TO BE FREE. In its complaint, Juno is seeking an injunction against us and punitive damages. In addition, WebPower, Inc., applicant for federal registration of the mark IFRIENDS, has asserted that our use of the mark FREEIFRIENDS infringes WebPower's mark. Any such claims, and any resultant litigation, could subject us to significant liability for damages and could result in the invalidation of our proprietary rights. These or other claims or litigation may also result in limitations on our ability to use such trademarks, patents and other intellectual property unless we enter into arrangements with such third parties, which may be unavailable on commercially reasonable terms. We do not believe that the result of these claims will have a material adverse effect on our business. We are not a party to any other material legal proceedings. 40 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information regarding our executive officers and directors:
NAME AGE POSITION - ---- -------- ----------------------------------------------------- Robert McCausland...................... 39 Chairman of the Board, President and Chief Executive Officer Ned Menninger.......................... 37 Chief Financial Officer Steve Bourg............................ 23 Chief Technical Officer Robert Pack............................ 44 Vice President, Sales Laura Stutsman......................... 39 Vice President, Marketing Rod Hamlin............................. 34 Vice President, Business Development Ron Erickson(1)........................ 56 Director Mark Stevens(1)........................ 40 Director William Owens(1)....................... 59 Director Naveen Jain............................ 40 Director
- ------------------------ (1) Member of audit and compensation committees ROBERT MCCAUSLAND, PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD. Mr. McCausland is our founder and has been our president, chief executive officer and chairman of the board since our incorporation in September 1998. Prior to that, Mr. McCausland founded Home Mortgage USA, a commercial and residential lender, in February 1993. Mr. McCausland was the sole owner and served as chief executive officer of Home Mortgage USA through January 1999. At the time Mr. McCausland sold Home Mortgage USA in August 1999, it had approximately 135 employees and operated in 46 states. Mr. McCausland graduated cum laude with a bachelor's degree in business management and marketing from Southern Oregon State College and graduated cum laude from City University with a master's degree in business administration. NED MENNINGER, CHIEF FINANCIAL OFFICER. Mr. Menninger has been our chief financial officer since October 1999. Prior to joining our company, Mr. Menninger was co-founder, vice president and chief financial officer of Puresource, a biomedical technology company, from March 1998 to August 1999. From August 1995 to March 1998, Mr. Menninger worked at Microsoft Corporation as a manager in the strategic business decisions group, and from January 1993 to August 1995 Mr. Menninger was the co-founder and chief financial officer of Dare to Dream Intertainment, which was acquired by Microsoft in August 1995. Prior to that, Mr. Menninger served as chief financial officer at Sequoia Capital, a venture capital firm, for three years. Mr. Menninger is a certified public accountant and holds a bachelor's degree in business administration from the University of Southern California. STEVE BOURG, CHIEF TECHNICAL OFFICER. Mr. Bourg has been our chief technical officer since our incorporation in September 1998. Before joining our company, Mr. Bourg served as the director of technology at Home Mortgage USA from July 1995 to October 1998. ROBERT PACK, VICE PRESIDENT, SALES. Mr. Pack has been our vice president, sales since October 1999. Mr. Pack was the vice president of sales at NetZero from July 1998 to August 1999. Prior to that, from February 1997 to July 1998 Mr. Pack served as an independent consultant to several Internet companies, and from May 1996 to January 1997 he served as director of worldwide sales at 41 Cybergold Inc. From May 1994 to May 1996, Mr. Pack was the director of sales for AOL. Mr. Pack holds a bachelor's degree in business from the University of Southern California. LAURA STUTSMAN, VICE PRESIDENT, MARKETING. Ms. Stutsman has been our vice president, marketing since October 1999. Prior to her employment with us, Ms. Stutsman worked at PACCAR Automotive, Inc., a subsidiary of PACCAR Inc., from June 1988 to October 1999 where she held various positions, most recently as vice president of marketing and pricing. At PACCAR, Ms. Stutsman supervised all aspects of marketing for a 200-store retail chain including advertising, promotions, merchandising/store design, e-commerce, customer service programs and corporate communications. Prior to her employment at PACCAR, Ms. Stutsman held senior positions in national and international advertising agencies, including media director at Ferguson-Propp & Associates from December 1986 to June 1988, providing strategic guidance to clients such as Computerland, Apple Computer, NEC and Toshiba. Ms. Stutsman earned a bachelor's degree in communications from the University of California at Santa Barbara. ROD HAMLIN, VICE PRESIDENT, BUSINESS DEVELOPMENT. Mr. Hamlin has been our vice president, business development since September 1999. Prior to that, Mr. Hamlin worked at Onyx Software, Inc., a provider of web-based customer relationship management solutions, where he served as vice president of worldwide channel sales from December 1998 to September 1999 and director of international sales from May 1997 to December 1998. During his employment at Onyx, Mr. Hamlin oversaw the establishment of subsidiaries and strategic partnerships in over 22 countries. Prior to his employment at Onyx, Mr. Hamlin served as director of business development for Saros Corporation, a software development company, from December 1992 to May 1997, building and managing relationships with major internet service and product providers. After Saros was acquired by FileNET Corporation in December 1995, Mr. Hamlin was appointed director of business development and international sales for FileNET's Saros business unit. Mr. Hamlin earned bachelor's degrees in journalism and computer science from Pacific Lutheran University and completed graduate studies in business at Seattle University. MARK A. STEVENS, DIRECTOR. Mr. Stevens has been a director of our company since August 1999. Mr. Stevens joined Sequoia Capital, a venture capital firm, in 1989 and has been a general partner of Sequoia Capital since 1993. Mr. Stevens serves on the boards of directors of MP3.com, an online music internet company, NVidia Corporation, a supplier of graphics processors and software, Medicalogic, Inc., an online health records company, and Terayon Communications, Inc., a broadband equipment supplier, and several privately held companies. Mr. Stevens received bachelor's and master's degrees in computer engineering from the University of Southern California and a master's degree in business administration from Harvard University. RON ERICKSON, DIRECTOR. Mr. Erickson has been a director of our company since December 1999. Mr. Erickson is currently the chairman of the board of eCharge Corporation, an online payment company, a position he has held since November 1999, and from September 1998 to November 1999 he served as the chief executive officer of eCharge. Prior to his employment at eCharge, Mr. Erickson served as chairman of the board, president, chief executive officer and a director of GlobalTel Resources, Inc., a provider of telecommunications services and messaging and intranet solutions, from January 1995 to August 1998. From August 1994 to January 1995, he was managing director of Globalvision L.L.C., an international strategic consulting firm, and from September 1992 to August 1994, he served variously as chairman and vice chairman of the board, president and chief executive officer of Egghead Software, Inc., a retailer of software and computer peripheral products. Currently, Mr. Erickson is also a director of Upgrade International, a publicly traded storage technology company, and Intrinsyc Software, Inc., a developer of software tools and components. Mr. Erickson holds a degree from Central Washington University, a master's degree from the University of Wyoming and a juris doctorate from the University of California at Davis School of Law. 42 WILLIAM OWENS, DIRECTOR. Mr. Owens has been a director of our company since February 2000. Mr. Owens is currently the co-chief executive officer and vice chairman of Teledesic Corporation, a developer of a global satellite communications network, a position he has held since August 1998. Previously, Mr. Owens was president, chief operating officer and vice chairman of Science Applications International, a systems integrator telecommunications company, from March 1996 to August 1998. From February 1994 to February 1996, Mr. Owens was vice chairman of the Joint Chiefs of Staff. Mr. Owens has also served as the deputy chief of Naval Operations of Resources, Warfare Requirements and Assessments, commander of the U.S. Sixth Fleet, senior military assistant to Secretaries of Defense Frank Carlucci and Dick Cheney, and director of the Office of Program Appraisal for the Secretary of the Navy. Mr. Owens currently serves on the boards of directors of ViaSat, Inc., a broadband digital satellite communications company, Microvision, Inc., a retinal imaging technology company, Polycom, Inc., an audioconferencing technology company, and BioLase Technology, Inc., a biomedical laser technology company. Mr. Owens is a graduate of the U.S. Naval Academy with a bachelor's degree in mathematics. He has bachelor's and master's degrees in politics, philosophy and economics from Oxford University and a master's in management from George Washington University. NAVEEN JAIN, DIRECTOR. Mr. Jain has been a director of our company since March 2000. Mr. Jain has served as chief executive officer of InfoSpace, an internet portal, since its inception in March 1996, as its president since its inception to November 1998, and as its sole director from its inception to June 1998, when he was appointed chairman of the board. From June 1989 to March 1996, Mr. Jain held various positions at Microsoft Corporation, including group manager for MSN, Microsoft's online service. Mr. Jain holds a degree from the University of Roorkee and a master's degree in business administration from St. Xavier's School of Management. BOARD OF DIRECTORS We have five directors. Currently all directors hold office until the next annual meeting of shareholders or until their successors are duly elected, and will continue to do so following the closing of this offering. However, our amended and restated articles of incorporation will provide that as of the closing of this offering, our board of directors will be divided into three classes, each with staggered three-year terms. As a result, only one class of directors will be elected at each annual meeting of our shareholders, with the other classes continuing for the remainder of their respective three-year terms. COMMITTEES Our board of directors currently has an audit committee and a compensation committee. The audit committee consists of Mr. Owens, Mr. Erickson and Mr. Stevens. The audit committee makes recommendations to our board of directors regarding the selection of independent auditors, reviews the scope of audit and other services by our independent auditors, reviews the accounting principles and auditing practices and procedures to be used for our financial statements and reviews the results of our audits. The compensation committee consists of Mr. Erickson and Mr. Stevens. The compensation committee reviews and approves the compensation and benefits for our executive officers, grants stock options under our stock option plan and makes recommendations to our board of directors on compensation matters. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists between any member of our board of directors or compensation committee and any member of the board of directors or compensation committee of any other company, nor has any such interlocking relationship existed in the past. 43 In August 1999, we sold 9,624,148 shares of Series A Preferred Stock to Sequoia Capital and its affiliates for aggregate consideration of $10 million. Mark Stevens, a managing director of Sequoia, became a director of our company in connection with this investment. In November 1999, we sold 1,242,124 shares of Series B Preferred Stock to MP3.com, Inc. for aggregate consideration of $10 million. Mr. Stevens is a director of MP3.com. Upon closing of this offering, each outstanding share of preferred stock will convert into one share of common stock. In addition, each of Messrs. Stevens, Erickson and Owens have been granted options to purchase shares of common stock under our stock option plan. See "--Compensation." COMPENSATION Our directors are reimbursed for expenses incurred in connection with attending board and committee meetings but are not otherwise compensated for their services as board members. In addition, we granted to: - Mark Stevens, effective as of August 12, 1999, an option to purchase up to 160,000 shares of common stock at an exercise price of $0.50 per share, which option vests over four years; - Ron Erickson, effective as of December 3, 1999, an option to purchase up to 160,000 shares of common stock at an exercise price of $1.00 per share, which option vests over four years; and - William Owens, effective as of March 24, 2000, an option to purchase up to 160,000 shares of common stock at an exercise price of $5.00 per share, which option vests over four years. EXECUTIVE OFFICERS Our executive officers are elected by, and serve at the discretion of, our board of directors. There are no family relationships among our directors and officers. EXECUTIVE COMPENSATION The following table sets forth the total compensation for services rendered to us in all capacities during the fiscal year ended December 31, 1999 by our chief executive officer. No other executive officer received salary and/or bonus from us for fiscal 1999 in excess of $100,000.
ANNUAL LONG-TERM ALL OTHER COMPENSATION COMPENSATION COMPENSATION ------------------- ----------------------- --------------------- SECURITIES HEALTH LIFE AND UNDERLYING INSURANCE DISABILITY MOVING NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS(#S) PREMIUMS PREMIUMS EXPENSES - --------------------------- -------- -------- ----------- --------- ---------- -------- Robert McCausland PRESIDENT AND CHIEF EXECUTIVE OFFICER......... $74,000 $ -- -- $ -- $ -- $ --
OPTION GRANTS IN FISCAL YEAR 1999 We did not grant to our chief executive officer any stock options during the fiscal year ended December 31, 1999. AGGREGATE OPTION EXERCISES IN FISCAL YEAR 1999 AND FISCAL YEAR-END OPTION VALUES Our chief executive officer did not exercise any options during the fiscal year ended December 31, 1999. 44 EMPLOYEE BENEFIT PLANS STOCK OPTION PLAN Our board of directors adopted and our shareholders approved our stock option plan on March 31, 1999. As of December 31, 1999, we had reserved a total of 8,421,128 shares of common stock for issuance under the stock option plan. The stock option plan provides for the granting to our employees, including officers and directors, of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986 and for the granting to employees, consultants and non-employee directors of nonstatutory stock options. If an optionee would have the right in any calendar year to exercise for the first time incentive stock options for shares having an aggregate fair market value (determined for each share as of the date the option to purchase the shares was granted) in excess of $100,000, any such excess options shall be treated as nonstatutory stock options. Unless terminated earlier by our board of directors, the plan will terminate on April 9, 2009. As of December 31, 1999, options to purchase 4,171,560 shares of common stock were outstanding under this plan and no shares had been issued upon exercise of options. The stock option plan may be administered by our board of directors or a committee of our board. Our board of directors determines the terms of each option granted under the stock option plan, including the number of shares subject to an option, exercise price, vesting schedule and duration. The exercise price of all incentive stock options granted under the stock option plan cannot be less than the fair market value of the common stock on the date of grant and, in the case of incentive stock options granted to holders of more than 10% of our voting power, not less than 110% of the fair market value. Generally, options granted under the stock option plan have a term of ten years, vest annually over a four-year period and are nontransferable. Payment of the exercise price of options may be made in cash or other consideration as determined by our board of directors. Our board of directors has the authority to amend or terminate the stock option plan as long as such action does not adversely affect any outstanding option and provided that shareholder approval for any amendments to the stock option plan shall be obtained to the extent required by applicable law. EMPLOYEE STOCK PURCHASE PLAN Our board of directors and shareholders adopted an employee stock purchase plan in March 2000. We will implement the employee stock purchase plan effective as of the date of this prospectus. The employee stock purchase plan provides a convenient and practical means by which employees may participate in stock ownership. Our board of directors believes that the opportunity to acquire a proprietary interest in our success through the acquisition of shares of common stock pursuant to the employee stock purchase plan is an important aspect of our ability to attract and retain highly qualified and motivated employees. The employee stock purchase plan is intended to qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Internal Revenue Code. The employee stock purchase plan may be administered by our board of directors or by a committee appointed by our board of directors. The plan administrator has the power to make and interpret all rules and regulations it deems necessary to administer the employee stock purchase plan. Our board of directors has broad authority to amend the employee stock purchase plan, subject in some instances to shareholder approval. All of our employees who customarily work more than 20 hours per week, including our officers, are eligible to participate in the employee stock purchase plan. Eligible employees may elect to contribute from 1% to 10% of the compensation paid to them during each pay period towards stock purchases under the plan. Other than the first offering, which will have a duration of approximately 17 months, each participant may enroll in an 18-month offering in which shares of common stock are purchased on the last day of each six-month period during the offering. The first offering will commence on the date of this prospectus and will terminate on November 14, 2001. Thereafter, a separate offering will commence on November 15 and May 15 of each year. The purchase 45 price for shares purchased under the employee stock purchase plan will be equal to 85% of the lower of: - the fair market value of our common stock on the enrollment date of the offering; or - the fair market value on the date of purchase. Neither payroll deductions credited to an employee's account nor any rights with regard to the purchase of shares under the employee stock purchase plan may be assigned, transferred, pledged or otherwise disposed of in any way by a participant, except that a participant may designate a beneficiary in the event of his or her death. Upon termination of employment due to death, retirement or disability, the payroll deductions credited to an employee's account will be used to purchase shares on the next purchase date. Any remaining balance will be returned to the participant or his or her beneficiary. Upon termination of employment for any other reason, any payroll deductions credited to an employee's account will be returned to the participant. We have authorized the issuance of up to 2,000,000 shares of common stock under the employee stock purchase plan. In the event of a merger, consolidation or acquisition by another corporation of all or substantially all of our assets, each outstanding right to purchase shares under the employee stock purchase plan shall be assumed or an equivalent stock purchase right substituted by the successor corporation. If the successor corporation refuses to assume or substitute for the stock purchase right, the offering period during which a participant may purchase stock will be shortened to a specified date before the proposed merger or sale. Similarly, in the event of our liquidation or dissolution, the offering period during which a participant may purchase stock will be shortened to a specified date before the date of the liquidation or dissolution. 401(K) PLAN Effective as of February 1, 1999, our board of directors adopted a tax-qualified employee savings and retirement plan for eligible U.S. employees. Eligible employees may elect to defer a percentage of their eligible compensation in the 401(k) plan, subject to the statutorily prescribed annual limit. Our board has the discretion to make matching contributions on behalf of all participants in the 401(k) plan in such amounts as it determines, provided that the matching contributions must apply uniformally across all plan participants. We intend the 401(k) plan to qualify under Sections 401(k) and 501 of the Internal Revenue Code so that contributions by employees or us to the 401(k) plan, and income earned, if any, on plan contributions, are not taxable to employees until withdrawn from the 401(k) plan, and so that we will be able to deduct our contributions when made. The trustee of the 401(k) plan, at the direction of each participant, invests the assets of the 401(k) plan in any of a number of investment options. EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS On November 11, 1999, Robert McCausland entered into a three-year employment agreement with us as our president and chief executive officer. The agreement provides for an annual salary of $120,000 per year. The annual salary is reviewed on a yearly basis and any increase is at the discretion of our board of directors. Mr. McCausland receives employee benefits that include three weeks annual vacation leave and reimbursement for all reasonable business and travel expenses incurred in connection with the performance of services under the agreement, and he is entitled to participate in our medical and dental plans, life and disability insurance plans and retirement plans pursuant to their terms and conditions consistent with our policies for senior executives. Mr. McCausland initially owned 22,800,000 shares of common stock. This stock was restricted under the terms of Mr. McCausland's employment agreement. Of these shares, 5,700,000 vested on August 13, 1999 when we entered into a stock purchase agreement with Sequoia Capital and its 46 affiliates. The remaining 17,100,000 shares fully vest upon an initial public offering, Mr. McCausland's termination with us, the sale of substantially all of our assets or the merger of us into another entity. In the absence of one of these events, the 17,100,000 shares will vest in equal amounts of 475,000 per month. On November 11, 1999, Steve Bourg entered into a three-year employment agreement with us as our chief technical officer. The agreement provides for an annual salary of $100,000 per year. The annual salary is reviewed on a yearly basis and any increase is at the discretion of our board of directors. Mr. Bourg receives employee benefits that include three weeks annual vacation leave, reimbursement for all reasonable business and travel expenses incurred in connection with the performance of services under the agreement, and he is entitled to participate in our medical and dental plans, life and disability insurance plans and retirement plans pursuant to their terms and conditions consistent with our policies for senior executives. Mr. Bourg initially owned 800,000 shares of common stock. This stock was restricted under the terms of Mr. Bourg's employment agreement. Of these shares, 200,000 vested on August 13, 1999 when we entered into a stock purchase agreement with Sequoia Capital and its affiliates. The remaining 600,000 shares fully vest upon an initial public offering, Mr. Bourg's termination with us, the sale of substantially all of our assets or the merger of us into another entity. In the absence of one of these events, the 600,000 shares will vest in equal amounts of 16,666.6 shares per month. Our stock option plan provides that in the event a third party acquires us through the purchase of all or substantially all of our assets, a merger or other business combination, unless the options are assumed by the acquiring company, the unexercised portion of outstanding options will vest and become immediately exercisable. DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY Our articles of incorporation limit the liability of directors and officers to the fullest extent currently permitted by the Washington Business Corporation Act or as it may be amended in the future. Consequently, subject to the WBCA, no director will be personally liable to us or our shareholders for monetary damages resulting from his conduct as our director, except liability for: - acts or omissions involving intentional misconduct or knowing violations of law; - unlawful distributions; or - transactions from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. Our articles of incorporation also provide that we shall indemnify any individual made a party to a proceeding because that individual is or was one of our directors or officers and shall advance or reimburse reasonable expenses incurred by such individual in advance of the final disposition of the proceeding to the fullest extent permitted by applicable law. Any repeal of or modification to our articles of incorporation may not adversely affect any right of any of our directors who is or was a director at the time of such repeal or modification. To the extent the provisions of our articles of incorporation provide for indemnification of directors for liabilities arising under the Securities Act, those provisions are, in the opinion of the Securities and Exchange Commission, against public policy as expressed in the Securities Act and are therefore unenforceable. Finally, we intend to purchase and maintain a liability insurance policy, pursuant to which our directors and officers will be indemnified against liability they may incur for serving in their capacities as our directors and officers. We believe that the limitation of liability provisions in our articles of incorporation and the liability insurance policy will facilitate our ability to continue to attract and retain qualified individuals to serve as our directors and officers. 47 RELATED-PARTY TRANSACTIONS In August 1999, we sold 9,624,148 shares of Series A Preferred Stock for an aggregate purchase price of $10 million. Purchasers of our Series A Preferred Stock were Sequoia Capital and its affiliates, who collectively hold more than 5% of our outstanding common stock on an as-converted basis, and of which one of our directors, Mark Stevens, is a managing director. Mr. Stevens was elected to our board of directors under the terms of the stock purchase agreement pursuant to which the investors purchased the Series A Preferred Stock. In November 1999, we sold 3,105,310 shares of Series B Preferred Stock for an aggregate purchase price of $25 million. One of the purchasers of our Series B Preferred Stock was MP3.com, Inc., which holds 1,242,124 shares of common stock on an as-converted basis, and of which one of our directors, Mark Stevens, is a director. In March 2000, we sold 2,703,755 shares of Series C Preferred Stock for an aggregate purchase price of $53 million. Purchasers of our Series C Preferred Stock included InfoSpace, which purchased 254,543 shares, and Internet Ventures LLC, which purchased 152,726 shares. Mr. Jain, one of our directors, is the chief executive officer and a director of InfoSpace and is a member of Internet Ventures. Upon the closing of this offering, each outstanding share of preferred stock will convert into one share of common stock. In connection with the sale of the preferred stock, the investors were granted registration rights, and we may therefore become obligated to effect registrations under the Securities Act of shares of common stock held by these investors upon the conversion of their preferred stock. In June 1999, we entered into a master equipment lease agreement with Partners Capital Group which was guaranteed by Home Mortgage USA, a company wholly owned by Robert McCausland, our president and chief executive officer. No consideration was given by us in exchange for this guarantee. In addition, in November 1998 we entered into a master equipment lease agreement with Ascend Credit Corporation on which Home Mortgage USA served as our co-lessee, and in each of May and August 1999 we entered into purchase and sale leaseback agreements with Ascend on which Home Mortgage USA served as our co-seller. No consideration was given by us in exchange for the agreement of Home Mortgage USA to serve as co-lessee. During 1999, Home Mortgage USA paid expenses on our behalf including rent, office supplies and utilities. These expenses totalled $205,000. In November 1999, we entered into an advertising, promotion and marketing agreement with MP3.com, Inc. Under the agreement, we will purchase from MP3.com advertising, promotion and marketing services in the amount of $4,000,000. In November 1999, we entered into an internet content agreement with InfoSpace whereby we license from InfoSpace content for placement on our website. In March 2000, we entered into an agreement with InfoSpace whereby we provide certain private label services to InfoSpace. In addition, in March 2000, we entered into a phone site service agreement with InfoSpace whereby we agreed to jointly offer our services on wireless devices. InfoSpace currently holds 254,432 shares of our common stock on an as-converted basis and Mr. Jain, one of our directors, is the chief executive officer and a director of InfoSpace. All transactions between us and our officers, directors and principal shareholders and their affiliates were subject to approval by a majority of our independent directors and we believe were on terms no less favorable to us than we could obtain from unaffiliated third parties. Our board has adopted a policy that all such future transactions will be subject to similar criteria. 48 We granted options to purchase shares of common stock to the following officers and directors on the date, for the number of shares and with an exercise price indicated opposite each person's name:
EFFECTIVE NUMBER OF SHARES NAME GRANT DATE UNDERLYING OPTIONS EXERCISE PRICE - ---- ---------- ------------------ -------------- Ned Menninger........................................ 10/11/99 360,000 $1.00 Steve Bourg.......................................... 04/01/99 254,540 0.50 Rod Hamlin........................................... 11/22/99 360,000 1.00 03/24/00 240,000 5.00 Robert Pack.......................................... 10/11/99 600,000 1.00 Laura Stutsman....................................... 10/25/99 250,000 1.00 03/24/00 150,000 5.00 Mark Stevens......................................... 08/12/99 160,000 0.50 Ron Erickson......................................... 12/03/99 160,000 1.00 William Owens........................................ 03/24/00 160,000 5.00
49 PRINCIPAL SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of our common stock as of March 26, 2000, and as adjusted to reflect the sale of the common stock offered hereby, by: - each shareholder known by us to own beneficially more than 5% of our outstanding common stock; - each of our directors; - each of our named executive officers; and - all current executive officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. For purposes of calculating the number of shares beneficially owned by a shareholder and the percentage ownership of that shareholder, shares of common stock subject to options that are currently exercisable or exercisable within 60 days of March 26, 2000 by that shareholder are deemed outstanding. These options are listed below under the heading "Number of Shares Underlying Options" and are not treated as outstanding for the purpose of computing the percentage ownership of any other shareholder. Percentage ownership is based on 42,522,213 shares of common stock outstanding on March 26, 2000, assuming conversion of all currently outstanding shares of preferred stock, and shares outstanding upon completion of this offering. Unless otherwise noted below, the address for each shareholder below is: c/o Freei Networks, Inc., 2505 South 320(th) Street, Federal Way, WA 98003. Unless otherwise noted, we believe that each of the shareholders has sole investment and voting power with respect to the common stock indicated, except to the extent shared by spouses under applicable law.
PERCENTAGE OF SHARES NUMBER OUTSTANDING OF SHARES --------------------- NUMBER OF UNDERLYING BEFORE AFTER NAME AND ADDRESS OF BENEFICIAL OWNER SHARES OPTIONS OFFERING OFFERING - ------------------------------------ ---------- ---------- --------- --------- Robert McCausland(1).................................. 22,800,000 -- 53.6% % Entities affiliated with Sequoia Capital(2)........... 9,624,148 -- 22.6 c/o Sequoia Capital 3000 Sand Hill Road, Suite 280 Menlo Park, California 94025 Mark Stevens(3)....................................... 9,624,148 -- 22.6 Naveen Jain(4)........................................ 407,269 -- 1.0 William Owens......................................... -- -- -- Ron Erickson.......................................... -- -- -- All executive officers and directors as a group (10 persons)(5)..................................... 33,707,780 63,635 79.3% %
- -------------------------- * Less than 1% (1) Includes 800,000 shares of common stock subject to a pledge agreement for which Mr. McCausland retains voting and investment power. (2) Includes 7,190,200 shares held by Sequoia Capital IX, 1,106,778 shares held by Sequoia Capital Angel Fund and 1,327,170 shares held by Sequoia Capital IX Principals Fund. (3) Includes 7,190,200 shares held by Sequoia Capital IX, 1,106,778 shares held by Sequoi Capital Angel Fund and 1,327,170 shares held by Sequoia Capital IX Principals Fund, all of which are funds managed by Sequoia Capital. Mr. Stevens is a managing director of Sequoia Capital. Mr. Stevens directly or indirectly shares voting and investment power with respect to such shares but disclaims beneficial ownership. (4) Represents 254,542.93 shares held by InfoSpace, of which Mr. Jain is the chief executive officer and a director, and 152,725.76 shares held by Internet Ventures LLC, of which Mr. Jain is a member. Mr. Jain disclaims beneficial ownership of the shares owned by InfoSpace. (5) See footnotes 1 through 4 above. Includes 800,000 shares held by Steve Bourg directly, 63,635 shares that are issuable upon the exercise of an option held by Mr. Bourg and 76,362.88 shares held by Robert Pack. 50 DESCRIPTION OF CAPITAL STOCK GENERAL Upon completion of this offering, we will be authorized to issue up to 400,000,000 shares of common stock, no par value, and 20,000,000 shares of preferred stock, no par value. The following is a summary of the material provisions of our common stock and preferred stock. We encourage you to read the provisions of our articles of incorporation and bylaws which are included as exhibits to the registration statement of which this prospectus is a part, and the applicable provisions of Washington law, before investing in the common stock. COMMON STOCK As of March 26, 2000, assuming conversion of all currently outstanding shares of preferred stock, there were 42,522,213 shares of common stock outstanding that were held of record by 89 shareholders. After giving effect to the sale of common stock offered in this offering, there will be shares of common stock outstanding, assuming no exercise of outstanding options. As of December 31, 1999, there were outstanding options to purchase a total of 4,171,560 shares of common stock. The holders of common stock are entitled to one vote per share on all matters to be voted on by the shareholders. Subject to preferences that may be granted to any outstanding shares of preferred stock, the holders of common stock are entitled to receive ratably only those dividends our board of directors declares out of funds legally available for the payment of dividends as well as any other distributions to the shareholders. If we are liquidated, dissolved or wound-up, the holders of common stock are entitled to share pro rata all of our assets remaining after payment of our liabilities and liquidation preferences of any then-outstanding shares of preferred stock. Holders of common stock have no preemptive rights or rights to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and non-assessable, and the shares of common stock to be issued in this offering will be fully paid and non-assessable. PREFERRED STOCK Upon the closing of this offering, all outstanding shares of preferred stock will be converted into 15,433,213 shares of common stock. Thereafter, pursuant to our amended and restated articles of incorporation, our board of directors will have the authority, without further action by the shareholders, to issue up to 20,000,000 shares of preferred stock in one or more series and to fix the relative designations, powers, preferences and privileges of the preferred stock, any or all of which may be greater than the rights of the common stock. Our board of directors, without shareholder approval, can issue preferred stock with voting, conversion or other rights that could adversely affect the voting power and other rights of the holders of common stock. Preferred stock could thus be issued quickly with terms that could delay or prevent a change in control of us or make removal of our management more difficult. Additionally, the issuance of preferred stock may decrease the market price of the common stock and may adversely affect the voting and other rights of the holders of common stock. We have no present plans to issue any preferred stock. REGISTRATION RIGHTS CONVERTIBLE PREFERRED STOCK After this offering, the holders of 15,764,763 shares of common stock, including 331,550 shares issuable upon the exercise of an outstanding warrant, will be entitled to rights with respect to the registration of such shares under the Securities Act pursuant to an investor rights agreement among such holders and us dated August 12, 1999, as amended, and the warrant agreement. Under the terms 51 of these agreements, if we propose to register any of our securities under the Securities Act, either for our own account or for the account of other security holders exercising registration rights, such holders are entitled to notice of the registration and to include their shares of common stock in the registration at our expense. Additionally, such holders are entitled to demand registration rights pursuant to which they may require us to file registration statements under the Securities Act at our expense with respect to their shares of common stock. All of these registration rights are subject to the right of the underwriters of an offering to limit the number of shares included in such registration. The holders of these registration rights have agreed to enter into lock-up agreements and to waive their registration rights until 180 days following the closing of this offering. ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR ARTICLES OF INCORPORATION, BYLAWS AND WASHINGTON LAW Our board of directors, without shareholder approval, has the authority under our articles of incorporation to issue preferred stock with rights superior to the rights of the holders of common stock. As a result, preferred stock could be issued quickly and easily, could adversely affect the rights of holders of common stock and could be issued with terms calculated to delay or prevent a change in control of us or make removal of our management more difficult. In addition, as of the closing of this offering, our board of directors will be divided into three classes. The directors in each class will serve for three-year terms, one class being elected each year by our shareholders, and directors can only be removed for cause. This system of electing and removing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of our company because it generally makes it more difficult for shareholders to replace a majority of the directors. Chapter 19 of the Washington Business Corporation Act generally prohibits a "target corporation" from engaging in certain significant business transactions with an "acquiring person," which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the time of acquisition. Prohibited significant business transactions include, among other things: - a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from, the acquiring person; - termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares; or - allowing the acquiring person to receive any disproportionate benefits as a shareholder. After the five-year period, a "significant business transaction" may occur as long as it complies with certain "fair price" provisions of the statute. A corporation may not "opt out" of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of our company. Upon the completion of this offering, a member of our board of directors may be removed from the board only for an action by the director involving willful malfeasance having a material adverse effect on us, or if that director is convicted of a felony. A director may not, however, be removed from the board of directors if the director believed such action was not opposed to the best interests of our company or is entitled to be indemnified for such action by us under our articles of incorporation. As a result, our shareholders will not be able to remove a member of the board of directors without cause, except by taking action at a meeting of shareholders. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is ChaseMellon Shareholder Services, L.L.C. The transfer agent's address is 520 Pike Street, Suite 1220, Seattle, Washington 98101, and its telephone number is (206) 292-3795. 52 NATIONAL MARKET LISTING We intend to apply to list our common stock on The Nasdaq Stock Market's National Market under the symbol "FREI." 53 SHARES ELIGIBLE FOR FUTURE SALE Future sales of substantial amounts of shares of our common stock in the public market could adversely affect prevailing market prices. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of contractual and legal restrictions on resale, as described below, sales of substantial amounts of common stock in the public market after the restrictions lapse could adversely affect the prevailing market price. Upon completion of this offering, we will have shares ( shares if the underwriters' over-allotment option is exercised in full) of common stock outstanding, including the 9,624,148 shares of common stock issuable upon the automatic conversion of our series A preferred stock, 3,105,310 shares of common stock issuable upon the automatic conversion of our series B preferred stock and 2,703,755 shares of common stock issuable upon the automatic conversion of our series C preferred stock, each upon the closing of this offering, and also assuming no exercise of options or warrants after March 26, 2000. The shares ( shares if the underwriters' over-allotment option is exercised in full) sold in this offering will be freely tradable in the public market without restriction under the Securities Act, unless such shares are held by our "affiliates," as that term is defined in Rule 144 under the Securities Act. The remaining shares of common stock that will be outstanding after this offering will be restricted shares because they were sold in private transactions in reliance on exemptions from registration under the Securities Act. Substantially all of these restricted securities are entitled to demand and piggy-back registration rights as described below. The following table shows the timing of when shares outstanding on March 26, 2000, assuming conversion of all currently outstanding shares of preferred stock, may be eligible for resale in the public market after effectiveness of this offering assuming no exercise of options or warrants after December 31, 1999, and excluding: - 4,171,560 shares of common stock that are reserved for issuance upon exercise of stock options outstanding as of December 31, 1999; and - 3,518,524 shares of common stock reserved for issuance upon exercise of warrants outstanding as of December 31, 1999.
NUMBER OF SHARES DATE - ------------------------------ ------------------------------------------------------------ ..................... - Closing of this offering 39,818,458.................... - After 180 days from the date of this prospectus, subject, in some cases, to limitations under Rule 144 2,290,886..................... - At March 7, 2001, subject, in some cases, to limitations under Rule 144 412,869....................... - At March 31, 2001, subject, in some cases, to limitations under Rule 144
S-8 REGISTRATION STATEMENTS As of December 31, 1999, there were a total of 4,171,560 shares of common stock subject to outstanding options under our stock option plan, none of which were vested. Within 90 days after effectiveness of this offering, we intend to file a registration statement on Form S-8 under the Securities Act to register shares of common stock issued or reserved for future issuance under our stock option plan and our employee stock purchase plan. After the effective dates of the registration 54 statement on Form S-8, shares purchased upon the exercise of options granted pursuant to our stock option plan and employee stock purchase plan generally would be available for resale in the public market without restriction. RULE 144 In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned restricted shares (as that term is defined in Rule 144) for at least one year from the later of the date such shares were acquired from us or, if applicable, the date they were acquired from an affiliate would be entitled to sell in any three-month period up to the greater of: - 1% of the then-outstanding shares of common stock, or approximately shares immediately after this offering; and - the average weekly trading volume of the common stock during the four calendar weeks preceding the filing of a Form 144 with respect to such sale. Sales under Rule 144 are also subject to requirements concerning the manner of sale and notice requirements and to the availability of current public information about us. RULE 701 Subject to limitations on the aggregate offering price of a transaction, our employees, directors, officers, consultants or advisors who purchased shares from us in connection with a written stock or option plan before the effective date of this offering are entitled to rely on the resale provisions of Rule 701, subject to the lock-up agreements described above. In general, Rule 701 permits non-affiliates to sell their Rule 701 shares 90 days after the effectiveness of a registration statement relating to a company's initial public offering without having to comply with the public information, holding period, volume limitation or notice provisions of Rule 144 and permits affiliates to sell their Rule 701 shares without having to comply with the holding period of Rule 144. RULE 144(K) Under Rule 144(k), a person who has not been one of our affiliates during the preceding 90 days and who has beneficially owned the restricted shares for at least two years from the later of the date restricted securities were acquired from us or, if applicable, the date they were acquired from an affiliate of ours, is entitled to sell them without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. LOCK-UP AGREEMENTS All of our officers, directors and significant shareholders have agreed to enter into lock-up agreements providing that they will not offer, sell, contract to sell, grant any option to purchase, pledge or otherwise dispose of, or, in any manner, transfer all or a portion of the economic consequences associated with the ownership of any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock beneficially owned by them during the 180-day period following the date of this prospectus without the prior written consent of Bear, Stearns & Co. Inc. Transfers may be made earlier: - as a bona fide gift or gifts, provided the donee or donees agree in writing to be bound by this restriction; - as a transfer to members of the transferor's immediate family or to trusts for the benefit of members of the transferor's immediate family, provided that the transferees agree in writing to be bound by the terms of this restriction; or 55 - as a distribution to partners, shareholders or beneficiaries of the transferor, provided that the distributees agree in writing to be bound by the terms of this restriction. In addition, Mr. McCausland has been granted an exemption in his lock up agreement which provides that he will be permitted to pledge such number of shares as are necessary to secure the repayment of a $10 million loan from a financial institution in the event he desires to obtain such a loan. Bear, Stearns & Co. Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. When determining whether or not to release shares from the lock-up agreements, Bear, Stearns & Co. Inc. will consider, among other factors, the shareholder's reasons for requesting the release, the number of shares for which the release is being requested and market conditions at the time. 56 UNDERWRITING Subject to the terms and conditions set forth in an underwriting agreement among the underwriters and freeinternet.com, each of the underwriters named below, through their representatives Bear, Stearns & Co. Inc., Banc of America Securities LLC, Dain Rauscher Incorporated, Warburg Dillon Read LLC, and Pacific Crest Securities Inc., has severally agreed to purchase from freeinternet.com the aggregate number of shares of common stock set forth opposite its name below:
UNDERWRITER NUMBER OF SHARES - ----------- ---------------- Bear, Stearns & Co. Inc..................................... Banc of America Securities LLC.............................. Dain Rauscher Incorporated.................................. Warburg Dillon Read LLC..................................... Pacific Crest Securities Inc................................
The underwriting agreement provides that the obligations of the several underwriters are subject to approval of legal matters by counsel and to various other customary conditions, including the effectiveness of the registration statement of which this prospectus forms a part, the continuing accuracy of our representations to them, their receipt of an opinion of our counsel and a comfort letter from our accountants, the listing of the stock to be sold in this offering on the Nasdaq National Market and the absence of an occurrence that would have a material adverse effect on our business. The nature of the underwriters' obligations is such that they are committed to purchase and pay for all of the above shares of common stock, other than those shares covered by the over-allotment option described below, if any are purchased. The underwriting agreement also provides that we will indemnify the underwriters against liabilities specified in the underwriting agreement under the Securities Act, or will contribute to payments that the underwriters may be required to make in respect of such liabilities. The underwriters propose to offer the shares of common stock directly to the public at the "price to public" set forth on the cover page of this prospectus and at such price less a concession not in excess of $ per share of common stock to other dealers who are members of the National Association of Securities Dealers, Inc. The underwriters may allow, and such dealers may reallow, concessions not in excess of $ per share of common stock to other dealers. After the initial public offering, the offering price, concessions and other selling terms may be changed by the underwriters. The common stock is offered subject to receipt and acceptance by the underwriters and to other conditions, including the right to reject orders in whole or in part. We have granted a 30-day over-allotment option to the underwriters to purchase up to an aggregate of additional shares of our common stock exercisable at the "price to public" less the "underwriting discounts and commissions," each as set forth on the cover page of this prospectus. If the underwriters exercise such option in whole or in part, then each of the underwriters will be severally committed, subject to various customary conditions, including those described above with respect to the initial purchase by the underwriters, to purchase the additional shares of common stock in proportion to their respective purchase commitments as indicated in the preceding table. The following table summarizes the compensation and expenses we will pay in connection with this offering, assuming an initial public offering price of $ per share. The compensation we will pay to the underwriters will consist solely of the "underwriting discounts and commissions" as set forth on the cover page to this prospectus. The underwriters have not received and will not receive from us any other item of compensation or expense in connection with this offering considered by the National Association of Securities Dealers, Inc. to be underwriting compensation under its rules of fair practice. 57 The underwriting discount per share of common stock is % of the initial public offering price per share of common stock.
PER SHARE TOTAL ------------------------------- ------------------------------- WITHOUT WITH WITHOUT WITH OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT -------------- -------------- -------------- -------------- Underwriting discounts and commissions paid by us............................ Expenses payable by us.................. Deemed compensation paid by us..........
The principal components of the offering expenses payable by us will include the fees and expenses of our accountants and attorneys, the fees of our registrar and transfer agent, the cost of printing this prospectus, The Nasdaq Stock Market listing fees, and filing fees paid to the Securities and Exchange Commission and the National Association of Securities Dealers, Inc. The underwriters, at our request, have reserved for sale at the initial public offering price up to shares of common stock to be sold in this offering to our employees. The number of shares available for sale to the general public will be reduced to the extent that any reserved shares are purchased. Any reserved shares not so purchased will be offered by the underwriters on the same basis as the other shares offered hereby. All of our directors, officers and significant shareholders have agreed to enter into lock-up agreements under which they will not dispose of their shares of our common stock for a period of 180 days from the date of this prospectus. See "Shares Eligible for Future Sale--Lock-up Agreements." In addition, we have agreed that for a period of 180 days after the date of this prospectus we will not, without the prior written consent of Bear, Stearns & Co. Inc., offer, sell or otherwise dispose of any shares of common stock except for the shares of common stock offered hereby and the shares of common stock issuable upon exercise of currently outstanding options and warrants. Prior to this offering, there has been no public market for our common stock. Consequently, the initial offering price for the common stock will be determined by negotiations between us and the underwriters and will not reflect the market price of the common stock following the offering. Among the factors to be considered in such negotiations are: - our results of operations in recent periods and the information in this prospectus and otherwise available to the underwriters; - estimates of our future prospects and the prospects of the industry in which we compete; - an assessment of our management; - the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies; - the general state of the securities markets at the time of this offering; and - the prices of similar securities of generally comparable companies. We have applied to list our common stock on the Nasdaq National Market under the symbol "FREI." We cannot assure you, however, that an active or orderly trading market will develop for our common stock or that our common stock will trade in the public markets subsequent to this offering at or above the initial offering price. Please see "Risk Factors--There has been no prior public market for our common stock." In order to facilitate this offering, the representatives and others participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock during and after this offering. Specifically, the underwriters may over-allot or otherwise create a short position 58 in the common stock for their own account by selling more shares of common stock than we have sold to them. The underwriters may elect to cover any such short position by purchasing shares of common stock in the open market or by exercising the over-allotment option granted to the underwriters. In addition, the underwriters may stabilize or maintain the price of the common stock by bidding for or purchasing shares of common stock in the open market and may impose penalty bids in accordance with Regulation M under the Securities Exchange Act, under which selling concessions allowed to syndicate members or other broker-dealers participating in this offering are reclaimed if shares of common stock previously distributed in this offering are repurchased in connection with stabilization transactions or otherwise. The effect of these transactions may be to stabilize or maintain the market price at a level above that which might otherwise prevail in the open market. The imposition of a penalty bid may also affect the price of the common stock to the extent that it discourages resales thereof. The underwriters have not made any representation as to the magnitude or effect of any such stabilization or other transactions. Such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for Freei Networks, Inc. by Summit Law Group, PLLC, Seattle, Washington. Some members of Rainier Investors II, which owns 4,073 shares of our common stock, are affiliated with Summit Law Group, PLLC. Legal matters in connection with this offering will be passed upon for the underwriters by Latham & Watkins, Costa Mesa, California. EXPERTS The financial statements as of December 31, 1998 and 1999 and for the period from July 1, 1998 (inception) through December 31, 1998 and for the year ended December 31, 1999 included in this prospectus have been included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. WHERE TO FIND ADDITIONAL DOCUMENTS We have filed with the Securities and Exchange Commission a registration statement on Form S-1. This prospectus, which forms a part of the registration statement, does not contain all the information included in the registration statement. Some information is omitted and you should refer to the registration statement and its exhibits. With respect to references made in this prospectus to any of our contracts or other documents, such references may not contain all of the information that is important to you, and you should refer to the exhibits attached to the registration statement for copies of the actual contract or document. You may read and copy the registration statement, including exhibits and schedules filed with it, at the Securities and Exchange Commission's public reference facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Securities and Exchange Commission's public reference facilities by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as us, that file electronically with the Securities and Exchange Commission. Upon completion of this offering, we will become subject to the information and periodic reporting requirements under the Exchange Act and, in accordance with this law, will file periodic reports, proxy statements and other information with the Securities and Exchange Commission. These periodic reports, proxy statements and other information will be available for inspection and copying at the Securities and Exchange Commission's public reference facilities and the website of the Securities and Exchange Commission referred to above. 59 FREEI NETWORKS, INC. INDEX TO FINANCIAL STATEMENTS
PAGE ---------------- Report of Independent Accountants........................... F-2 Balance Sheets.............................................. F-3 Statements of Operations.................................... F-4 Statements of Shareholders' Equity (Deficit)................ F-5 Statements of Cash Flows.................................... F-6 Notes to Financial Statements............................... F-7-F-18
F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Freei Networks, Inc. The preferred stock split and the increases in the authorized capital stock described in paragraphs 2 and 4 of Note 13 to the financial statements have not been consummated at March 29, 2000. When they have been consummated, we will be in a position to furnish the following report. "In our opinion, the accompanying balance sheets and the related statements of operations, of shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Freei Networks, Inc. at December 31, 1998 and 1999 and the results of its operations and its cash flows for the period from July 1, 1998 (inception) to December 31, 1998 and for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. 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 audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above." PricewaterhouseCoopers LLP Seattle, Washington March 29, 2000 F-2 FREEI NETWORKS, INC. BALANCE SHEETS
DECEMBER 31, PRO FORMA ------------------- DECEMBER 31, 1998 1999 1999 (NOTE 2) -------- -------- ------------- (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS Current assets Cash and cash equivalents................................. $ 333 $ 20,342 Accounts receivable, net of allowances of $0 and $52...... -- 358 Prepaid expenses and other current assets................. -- 2,128 ----- -------- Total current assets.................................. 333 22,828 Restricted cash............................................. -- 100 Property and equipment, net................................. 585 27,307 Other assets................................................ -- 194 ----- -------- Total assets.......................................... $ 918 $ 50,429 ===== ======== LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities Accounts payable.......................................... $ 38 $ 2,663 Accrued liabilities....................................... 7 1,833 Obligations under capital leases.......................... 74 6,461 Note payable.............................................. -- 306 Payable to related party.................................. 261 365 Deferred revenue.......................................... -- 551 ----- -------- Total current liabilities............................. 380 12,179 Obligations under capital leases............................ 259 19,943 Note payable................................................ -- 194 ----- -------- Total liabilities..................................... 639 32,316 ----- -------- Commitments and contingencies Mandatorily redeemable Series A and B convertible preferred stock, no par value; 20,000,000 shares authorized; 0 and 12,729,458 issued and outstanding actual, 0 issued and outstanding pro forma (unaudited)......................... -- 33,892 $ -- ----- -------- -------- Shareholders' equity (deficit) Common stock, no par value; 400,000,000 shares authorized; 24,000,000 and 26,879,000 shares issued and outstanding actual, 39,608,458 issued and outstanding pro forma (unaudited)............................................. 551 11,086 44,978 Deferred compensation..................................... -- (7,848) (7,848) Accumulated deficit....................................... (272) (19,017) (19,017) ----- -------- -------- Total shareholders' equity (deficit).................. 279 (15,779) $ 18,113 ----- -------- ======== Total liabilities, mandatorily redeemable convertible preferred stock and shareholders' equity (deficit)........................................... $ 918 $ 50,429 ===== ========
The accompanying notes are integral part of these financial statements. F-3 FREEI NETWORKS, INC. STATEMENTS OF OPERATIONS
PERIOD FROM JULY 1, 1998 (INCEPTION) TO YEAR ENDED DECEMBER 31, DECEMBER 31, 1998 1999 -------------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) Net revenues................................................ $ -- $ 983 Cost of revenues............................................ 78 8,692 ------ -------- Gross profit (loss)..................................... (78) (7,709) ------ -------- Operating expenses Sales and marketing....................................... 52 8,175 Product development....................................... 28 312 General and administrative................................ 115 1,362 Stock-based compensation.................................. -- 876 ------ -------- Total operating expenses.................................... 195 10,725 ------ -------- Loss from operations.................................... (273) (18,434) Interest income............................................. 1 156 Interest expense............................................ -- (429) Other expense............................................... -- (38) ------ -------- Net loss................................................ $ (272) $(18,745) ====== ======== Basic and diluted net loss per share........................ $(0.08) $ (2.16) ====== ======== Shares used to calculate basic and diluted net loss per share..................................................... 3,279 8,696 ====== ======== Pro forma net loss per share (unaudited) Basic and net diluted loss per share...................... $ (0.62) ======== Shares used to calculate basic and diluted net loss per share................................................... 30,477 ========
The accompanying notes are integral part of these financial statements. F-4 FREEI NETWORKS, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
COMMON STOCK --------------------- DEFERRED ACCUMULATED SHARES AMOUNT COMPENSATION DEFICIT TOTAL ---------- -------- ------------ ----------- -------- (IN THOUSANDS, EXCEPT SHARE DATA) Balance, July 1, 1998 (inception)........... -- $ -- $ -- $ -- $ -- Issuance of founders' shares.............. 24,000,000 551 551 Net loss.................................. (272) (272) ---------- ------- ------- -------- -------- Balance, December 31, 1998.................. 24,000,000 551 -- (272) 279 Issuance of common stock and warrants..... 2,879,000 1,431 1,431 Issuance of warrants as Series A preferred stock issue costs....................... 272 272 Warrant issued in conjunction with loan agreement............................... 108 108 Deferred compensation..................... 8,724 (8,724) -- Amortization of deferred compensation..... 876 876 Net loss.................................. (18,745) (18,745) ---------- ------- ------- -------- -------- $(19,017) Balance, December 31, 1999.................. 26,879,000 $11,086 $(7,848) $(15,779) ========== ======= ======= ======== ========
The accompanying notes are integral part of these financial statements. F-5 FREEI NETWORKS, INC. STATEMENTS OF CASH FLOWS
PERIOD FROM JULY 1, 1998 (INCEPTION) TO YEAR ENDED DECEMBER 31, DECEMBER 31, 1998 1999 -------------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA) CASH FLOWS FROM OPERATING ACTIVITIES Net loss.................................................. $(272) $(18,745) Adjustments to reconcile net loss to net cash provided by (used in) operating activities Depreciation and amortization......................... 26 1,857 Non-cash interest expense for warrants................ -- 18 Stock-based compensation.............................. -- 876 Non-cash contribution from founding shareholder....... 152 -- Changes in operating assets and liabilities Accounts receivable................................. -- (358) Prepaid expenses and other current assets........... -- (2,059) Accounts payable.................................... 38 2,625 Accrued liabilities and payable to related party.... 56 1,930 Deferred revenue.................................... -- 551 Other assets........................................ -- (194) ----- -------- Net cash provided by (used in) operating activities.................................... -- (13,499) ----- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment........................ (66) (2,169) Restricted cash........................................... -- (100) ----- -------- Net cash used in investing activities........... (66) (2,269) ----- -------- CASH FLOWS FROM FINANCING ACTIVITIES Contributions from founding shareholders.................. 399 -- Proceeds from issuance of common stock and warrants....... -- 1,431 Proceeds from issuance of Series A preferred stock, net... -- 9,484 Proceeds from issuance of Series B preferred stock, net... -- 24,680 Principal payments on capital leases...................... -- (318) Proceeds from issuance of note payable.................... -- 500 ----- -------- Net cash provided by financing activities....... 399 35,777 ----- -------- Net increase in cash and cash equivalents................... 333 20,009 Cash and cash equivalents Beginning of period....................................... -- 333 ----- -------- End of period............................................. $ 333 $ 20,342 ===== ======== SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest...................................... $ -- $ 429 ===== ======== NON-CASH TRANSACTIONS Property and equipment acquired under capital lease......... $ 333 $ 26,389 ===== ======== Value ascribed to common stock warrants issued in conjunction with the sale of Series A preferred stock..... $ -- $ 272 ===== ======== Value ascribed to common stock warrants issued in conjunction with note payable............................. $ -- $ 108 ===== ========
The accompanying notes are integral part of these financial statements. F-6 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS 1. BUSINESS The Company is a leading provider of free internet access and online services. The Company's internet service offerings are designed to attract and retain subscribers, provide online advertisers with access to a large consumer audience and the ability to target its marketing efforts more effectively, and furnish strategic partners with a wide range of internet solutions. The Company began development of its service in July 1998, was incorporated in September 1998 and launched its service in December 1998. The Company currently provides internet access and online service to subscribers throughout the United States. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. CASH EQUIVALENTS The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of deposits in money market funds and certificates of deposit. CONCENTRATION OF RISK Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents are deposited with financial institutions. At times, such balances with any one financial institution may be in excess of FDIC insurance limits. The Company's accounts receivable are derived primarily from revenue earned from customers located in the United States. The Company extends credit based upon an evaluation of the customer's financial condition and generally collateral is not required. The Company maintains an allowance for doubtful accounts based upon the expected collectibility of accounts receivable. To date such losses have been within management's expectations. One customer comprised 17% of the accounts receivable balance at December 31, 1999. No customers comprised greater than 10% of revenues for the year ended December 31, 1999. SOURCES OF SUPPLIES The Company relies on third party networks, local telephone companies and other companies to provide data communications capacity. Although management believes that alternate telecommunications facilities could be found in a timely manner, any disruption of these services could have an adverse effect on the Company's financial position, results of operations and cash flows. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, notes payable and lease obligations are carried at historical cost, which approximates F-7 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) their fair value because of the short-term maturity of these instruments or because interest rates approximate current market rates. PROPERTY AND EQUIPMENT Property and equipment are stated at historical cost. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets, generally three to five years, or the shorter of the lease term or the estimated useful lives of the assets, if applicable. LONG-LIVED ASSETS When conditions warrant, the Company evaluates the recoverability of its long-lived assets based on expected undiscounted cash flows and recognizes impairment of the carrying value of long-lived assets, if any, based on the fair value of such assets. REVENUE RECOGNITION The Company's revenues have been derived primarily from the sale and delivery of short-term advertising and sponsorships and from referrals of users to sponsors' websites. These arrangements average one to three months. Banner advertising and sponsorship revenues are recognized ratably over the period in which the advertising or sponsorship is displayed, provided that no significant obligations for the Company remain and collection of the related receivable is probable. To the extent that minimum guaranteed number of impressions or click-throughs are not met, the Company defers recognition of the corresponding revenues until guaranteed impressions or click-throughs are achieved. Revenues from performance based arrangements, which include website referral arrangements, are recognized as the performance criteria are met. Revenues from the Company's share of proceeds from electronic commerce partners' sales are recognized upon notification by the electronic commerce partner. Revenues from electronic commerce were not significant in 1999. WEBSITE DEVELOPMENT COSTS Costs incurred in the development of core software for the Company's website infrastructure are capitalized in accordance with Statement of Position 98-1 "Accounting for the Costs of Software Developed or Obtained for Internal Use" and are amortized over the expected useful life of the developed software ranging from 1-3 years. Costs incurred in the development of content for the Company's website and maintenance costs are expensed as incurred. ADVERTISING EXPENSE Advertising costs are expensed the first time the advertising takes place. Advertising costs totaled $20,000 and $5.8 million for the period from July 1, 1998 (inception) to December 31, 1998 and for the year ended December 31, 1999, respectively. Advertising costs incurred for which the advertising had not yet taken place totaled $1.1 million at December 31, 1999, and are included in prepaid expenses. F-8 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related interpretations, and complies with the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force Issue 96-18. INCOME TAXES The Company accounts for income taxes under the liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax bases of the Company's assets and liabilities and their financial statement reported amounts. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. A valuation allowance is provided against net deferred tax assets unless it is more likely than not that they will be realized. NET LOSS PER SHARE The Company computes net loss per share in accordance with SFAS No. 128, "Earnings per Share" and SEC Staff Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed by dividing the net loss for the period by the weighted-average number of common shares outstanding during the period. Weighted-average shares exclude common shares subject to repurchase ("restricted shares"). Diluted net loss per share is computed by dividing the net loss for the period by the weighted-average number of common and potential common shares outstanding during the period, if dilutive. Potential common shares are composed of unvested restricted shares, incremental common shares issuable upon the exercise of stock options and warrants and, upon conversion, of Series A convertible preferred stock and Series B convertible preferred stock. The following table sets forth the computation of basic and diluted net loss per share for the period from July 1, 1998 (inception) to December 31, 1998 and for the year ended December 31, 1999:
PERIOD FROM JULY 1, 1998 YEAR ENDED (INCEPTION) TO DECEMBER 31, DECEMBER 31, 1998 1999 ------------------ ------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Numerator--net loss............................. $ (272) $(18,745) ======== ======== Denominator Weighted-average common shares outstanding.... 24,000 26,343 Weighted-average unvested common shares subject to repurchase....................... (20,721) (17,647) -------- -------- Denominator for basic and diluted calculations................................ 3,279 8,696 ======== ======== Basic and diluted net loss per share............ $ (0.08) $ (2.16) ======== ========
F-9 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Unvested restricted shares, preferred shares convertible into 12,729,458 shares of common stock, options to purchase 4,171,560 shares of common stock at an average exercise price of $0.78 per share and warrants to purchase 3,518,524 shares of common stock at an average exercise price of $0.52 per share, have not been included in the computation of diluted net loss per share for the year ended December 31, 1999, as their effect would have been anti-dilutive. PRO FORMA NET LOSS PER SHARE (UNAUDITED) Pro forma net loss per share for the year ended December 31, 1999 is computed by dividing the net loss by the weighted-average number of common shares outstanding, including the pro forma effects of the automatic conversion of the Company's convertible preferred stock into shares of the Company's common stock and the removal of the right of repurchase on founders' stock effective upon the closing of the Company's initial public offering as if such conversion occurred on January 1, 1999 or at the date of original issuance, if later. The resulting pro forma adjustment includes an increase in weighted-average shares used to compute basic and diluted net loss per share of 21,781,000 for the year ended December 31, 1999. PRO FORMA SHAREHOLDERS' EQUITY (UNAUDITED) Effective upon the closing of the Company's planned initial public offering, the outstanding shares of Series A convertible preferred stock and Series B convertible preferred stock, will automatically convert into 9,624,148 and 3,105,310 shares, respectively, of common stock. The pro forma effects of these transactions are unaudited and have been reflected in the accompanying pro forma shareholders' equity at December 31, 1999. COMPREHENSIVE INCOME/LOSS To date, the Company has not had any transactions that are required to be reported in comprehensive income/loss and net loss is the same as comprehensive loss for all periods presented. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133. SFAS No. 133 is effective for the Company's fiscal year ending December 31, 2001. The Company does not have derivative instruments, and therefore does not expect that the adoption of this statement will have any effect on the Company's results of operations, financial position or cash flows. F-10 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. BALANCE SHEET COMPONENTS PROPERTY AND EQUIPMENT
DECEMBER ------------------- 1998 1999 -------- -------- (IN THOUSANDS) Network and computer equipment.............................. $523 $28,354 Furniture and fixtures...................................... 48 60 Capitalized software........................................ 40 631 Leasehold improvements...................................... -- 124 ---- ------- 611 29,169 Accumulated depreciation and amortization................... (26) (1,862) ---- ------- $585 $27,307 ==== =======
Assets held under capital leases of $333,000 and $26.7 million are included in network and computer equipment at December 31, 1998 and 1999, respectively. Accumulated amortization on capital leases is $11,000 and $1.6 million at December 31, 1998 and 1999, respectively. PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid advertising......................................... $ -- $1,117 Prepaid network access costs................................ -- 600 Other....................................................... -- 411 ------ ------ $ -- $2,128 ====== ======
ACCRUED LIABILITIES Accrued network access costs................................ $ -- $ 795 Accrued advertising......................................... -- 400 Other....................................................... 7 638 ------ ------ $ 7 $1,833 ====== ======
4. RELATED-PARTY TRANSACTIONS In 1998, the Company issued a total of 23,200,000 shares of common stock to a founder in consideration for a cash contribution of $399,000 and payment of expenses of $152,000, and a further 800,000 shares of common stock to two other co-founders in consideration for intellectual property contributed to the Company, which was recorded at their book value of $0. During 1998 and 1999 certain expenses of the Company were paid by a related company, wholly owned by the founder of the Company. These expenses included 1) expenses specifically incurred on behalf of the Company and 2) certain shared expenses for rent, office supplies and utilities which were allocated based on respective headcounts of the two companies. These expenses totaled $203,000 and $205,000 in 1998 and 1999, respectively. The Company believes that the allocated costs are indicative of the costs that would have been incurred by the Company as a stand-alone entity. Amounts not F-11 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 4. RELATED-PARTY TRANSACTIONS (CONTINUED) reimbursed by the Company or contributed as capital by the founder are recorded in amounts payable to related party at December 31, 1998 and 1999. In 1998, the Company also acquired property and equipment with a net book value of $212,000 from the related company. This amount was included in the amounts payable to the related party at December 31, 1998 and 1999. The related company served as a co-lessee on an equipment capital lease agreement, under which purchases of $6.8 million were made in 1999. In April 1999 the related company also guaranteed equipment capital leases totaling $646,000. 5. BORROWINGS In June 1999, the Company entered into a loan and stock purchase warrant agreement with a lender providing for maximum borrowings of $2,000,000 until December 31, 1999. The original $500,000 loan provided under this agreement was contingent upon the Company ordering $8,000,000 in equipment from the lender; any additional loans were contingent upon the Company ordering additional equipment. No further advances have been made under this loan agreement. The loan bears interest at 11.75% per annum and is collateralized by substantially all of the Company's assets. The loan is repayable in 18 equal monthly payments ending on August 1, 2001. The principal and all accrued but unpaid interest will become immediately payable, on i) the effective date of the IPO or ii) the date of a change of control. The agreement with the lender includes various covenants which, among other things, require the Company to maintain insurance which covers the collateral. In connection with this loan, the Company issued to the lender a warrant to purchase 331,550 shares of common stock at $1.20645 per share (see Note 9). Principal payments under the loan are due as follows:
YEARS ENDING DECEMBER 31, - ------------------------- 2000........................................................ $306 2001........................................................ 194 ---- $500 ====
6. INCOME TAXES The Company was originally incorporated as an S-Corporation and accordingly did not record any provision for income taxes. In March 1999 as a result of the sale of common stock to outside investors, the Company's status was changed to a C-Corporation. No provision for income taxes has been recorded since March 1999, as the Company has incurred net losses from that date. At December 31, 1999, the Company had approximately $16.3 million of federal net operating loss carryforwards available to offset future taxable income, if any, which expire in varying amounts beginning in 2019. Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards may be limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50% as defined, over a three year period. F-12 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INCOME TAXES (CONTINUED) As of December 31, 1999, the Company had gross deferred tax assets of approximately $6.1 million, related primarily to net operating loss carryforwards, stock-based compensation and certain allowances that are not currently deductible for tax purposes. Management believes that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets that a full valuation allowance is required. 7. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK Convertible preferred stock at December 31, 1999 consists of the following:
SHARES AMOUNT, NET OF ------------------------ LIQUIDATION ISSUANCE SERIES DESIGNATED OUTSTANDING AMOUNT COSTS - ------ ---------- ----------- ----------- -------------- (IN THOUSANDS) A............................ 9,624,148 9,624,148 $10,000 $ 9,212 B............................ 3,105,310 3,105,310 25,000 24,680 ---------- ---------- ------- ------- 12,729,458 12,729,458 $35,000 $33,892 ========== ========== ======= =======
The holders of the convertible preferred stock have various rights and preferences as follows: VOTING Each share of Series A and B convertible preferred stock has voting rights equal to an equivalent number of shares of common stock into which it is convertible and votes together as one class with the common stock. As long as at least 1,000,000 shares of convertible preferred stock remain outstanding, the Company must obtain approval from a majority of the holders of convertible preferred stock in order to alter the articles of incorporation as related to the rights, preferences or privileges of the convertible preferred stock. As long as any shares of convertible preferred stock remain outstanding, the Company must obtain approval from a majority of the holders of convertible preferred stock in order to change the authorized number of shares of convertible preferred stock, change the authorized number of Directors, authorize a dividend for any class or series other than convertible preferred stock, create a new class of stock or effect a merger, consolidation or sale of assets where the existing stockholders retain less than 50% of the voting stock of the surviving entity. DIVIDENDS Holders of Series A and B convertible preferred stock are entitled to receive noncumulative dividends at the per annum rate of $0.083 and $0.614 per share, respectively, when and if declared by the Board of Directors. After the dividend preference of the preferred stock has been paid in full for a given calendar year, the preferred stock will participate pro rata with the common stock in the receipt of any additional dividends on an as-converted basis. No dividends on convertible preferred stock or common stock have been declared from inception through December 31, 1999. F-13 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED) LIQUIDATION In the event of any liquidation, dissolution or winding up of the Company, including a merger, acquisition or sale of assets where the beneficial owners of the common stock and convertible preferred stock own less than 50% of the resulting voting power of the surviving entity, the holders of Series A and B convertible preferred stock are entitled to receive an amount of $1.03905 and $8.05073 per share, respectively, plus any declared but unpaid dividends prior to and in preference to any distribution to the holders of common stock. Any remaining funds and assets of the Company legally available for distribution to shareholders will be distributed pro rata among the holders of the common stock. If the Company has insufficient assets to permit payment of the preference amount in full to all preferred shareholders, then the assets of the Company will be distributed ratably to the holders of the preferred stock in proportion to the preference amount each such holder would otherwise be entitled to receive. CONVERSION Each share of Series A and B convertible preferred stock is convertible, at the option of the holder, according to a conversion ratio which is subject to adjustment for dilution. In addition, each share of Series A and B convertible preferred stock automatically converts into the number of shares of common stock into which such shares are convertible, at the then effective conversion ratio, upon: (1) the closing of a public offering of common stock at a per share price of at least $10.00 per share for a total public offering price of not less than $20,000,000 or (2) the consent of the holders of the majority of convertible preferred stock. MANDATORY REDEMPTION The convertible preferred stock contains a provision which, in the event of a change in the control of the Company (as defined), could be construed to give the holders of the convertible preferred stock the right to receive a cash distribution equal to the liquidation preference on the convertible preferred stock. In accordance with the rules of the Securities and Exchange Commission the convertible preferred stock has not been included in shareholders' equity and is presented as mandatorily redeemable convertible preferred stock at December 31, 1999. At December 31, 1999, the Company has reserved 9,624,148 and 3,105,310 shares of common stock for the conversion of Series A and B convertible preferred stock, respectively. 8. COMMON STOCK During 1999, the Company entered into stock restriction agreements with the three founders of the Company. The stock restriction agreements give the Company the right to repurchase the founders' common shares at the original purchase price in the event that the founders' service with the Company terminates for any reason. The Company's repurchase right generally lapses as the founders' perform services over a four-year period. The right of repurchase on one-quarter of the shares was removed on the completion of the Series A preferred stock financing and will lapse on the remaining shares at the rate of 1/48 of the shares after each additional month of service thereafter. The right of repurchase lapses on the initial public offering of the Company or in the event of a change in control. At December 31, 1999, there were 16,000,000 common shares subject to repurchase. F-14 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. WARRANTS In March 1999, in connection with the sale of common stock to initial investors, the Company issued warrants to purchase 2,879,000 shares of the common stock at $0.50 per share. These warrants expire in March 2002. These warrants were considered an issue cost of the common stock. Warrants to purchase 210,000 shares of common stock were exercised in March 2000. In June 1999, the Company issued a warrant to purchase 331,550 shares of the common stock at an exercise price of $1.20645 per share to a lender in connection with the borrowings described in Note 6. The warrant expires in June 2004. The Company determined the fair value of the warrants to be $108,000 using the Black-Scholes option pricing model. The fair value of the warrants was recorded as loan issuance costs and is amortized as interest expense over the life of the borrowings. In connection with the sale of Series A convertible preferred stock in August 1999, the Company issued warrants to purchase 307,974 shares of common stock at an exercise price of $0.001 per share as a placement fee. These warrants expire through 2009. Using the Black-Scholes pricing model, the Company estimated the fair value of the warrants at the date of grant was $272,000 which was recorded as a stock issuance cost. 10. STOCK OPTIONS On April 12, 1999, the Company adopted the Stock Option Plan (the "Plan"). The Plan provides for the granting of stock options to employees, consultants and non-employee Directors of the Company. Options granted under the Plan may be either incentive stock options or nonqualified stock options. Incentive stock options ("ISO") may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options ("NSO") may be granted to Company employees, consultants and non-employee Directors. The Company has reserved 8,421,128 shares of common stock for issuance under the Plan. Options under the Plan may be granted for periods of up to ten years. The exercise price of an ISO cannot be less than 100% of the estimated fair value of the common stock on the date of grant, and the exercise price of an ISO granted to a 10% shareholder cannot be less than 110% of the estimated fair value of the shares on the date of grant. To date, options granted generally vest over four years. The following table presents activity under the Plan:
OUTSTANDING OPTIONS ---------------------- WEIGHTED- SHARES AVERAGE AVAILABLE NUMBER EXERCISE FOR GRANT OF SHARES PRICE ----------- ---------- --------- Shares reserved............................ 8,421,128 Options granted............................ (4,225,560) 4,225,560 $0.78 Options forfeited.......................... 54,000 (54,000) 0.96 ----------- ---------- Balance, December 31, 1999................. 4,249,568 4,171,560 0.78 =========== ==========
No options were exercisable at December 31, 1999. F-15 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. STOCK OPTIONS (CONTINUED) OPTIONS OUTSTANDING AT DECEMBER 31, 1999
WEIGHTED-AVERAGE REMAINING EXERCISE PRICE NUMBER OUTSTANDING CONTRACTUAL LIFE - -------------- ------------------ ---------------- $0.50....................................... 2,047,560 9.37 $1.00....................................... 2,036,000 9.82 $2.00....................................... 88,000 9.98 --------- 4,171,560 ---------
FAIR VALUE DISCLOSURES The weighted-average fair values of options granted during 1999 were as follows:
WEIGHTED- WEIGHTED- AVERAGE AVERAGE EXERCISE PRICE FAIR VALUE -------------- ---------- Exercise price equal to market value.................. $0.50 $ 0.27 Exercise price less than market value................. $1.00 $ 3.98
Had compensation cost for the Company's stock-based compensation plan been determined based on the fair value at the grant dates for the awards under a method prescribed by SFAS No. 123, the Company's net loss for 1999 would have increased by approximately $245,000. The Company calculated the fair value of each option grant using the Black-Scholes pricing model with the following assumptions:
1999 -------- Risk-free interest rates.................................... 5.68% Expected life............................................... 4 years Expected dividends.......................................... 0 Expected volatility......................................... 65%
DEFERRED STOCK COMPENSATION In the year ended December 31, 1999, the Company recorded deferred stock compensation expense of approximately $8.7 million related to the issuance of stock options at prices subsequently determined to be below fair market value. These charges are being amortized over a period of four years from the date of option issuance using the method specified in FASB Interpretation No. 28. Amortization of $876,000 has been recognized as stock compensation expense in the year ended December 31, 1999. 11. EMPLOYEE BENEFITS PLANS The Company sponsors a 401(k) defined contribution plan covering all employees. Contributions made by the Company are determined annually by the Board of Directors. The Company matches contributions on a discretionary basis provided that matching contributions must apply uniformly to all F-16 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. EMPLOYEE BENEFITS PLANS (CONTINUED) plan participants. Company matching contributions to the Plan in the year ended December 31, 1999 totaled $9,000. 12. COMMITMENTS The Company leases office space and equipment under noncancelable operating and capital leases with various expiration dates through 2003. Telecommunications services are provided pursuant to cancellable short-term agreements. The terms of the facility lease, entered into subsequent to December 31, 1999, provide for rental payments on a graduated scale. The facility lease expires in December 2002. The Company will recognize rent expense on a straight-line basis over the lease period. During the periods ended December 31, 1998 and 1999, the Company entered into certain noncancelable lease obligations for network and computer equipment. These capital leases are collateralized by the Company's assets. The future minimum lease payments are discounted using an interest rate of 10.0% over the 36 to 42 month lease terms. Future minimum lease obligations as of December 31, 1999 are as follows:
CAPITAL OPERATING YEARS ENDING DECEMBER 31, LEASES LEASES - ------------------------- -------- --------- (IN THOUSANDS) 2000..................................................... $ 9,212 $ 6,360 2001..................................................... 10,958 7,078 2002..................................................... 9,604 3,150 2003..................................................... 1,746 -- ------- ------- Total minimum lease payments............................. 31,520 $16,588 ======= Less: Amount representing interest....................... 5,116 ------- Present value of obligations under capital leases........ 26,404 Less: Current portion.................................... 6,461 ------- Non-current portion of obligations under capital leases................................................. $19,943 =======
Rental expense including telecommunications services amounts for the period from July 1, 1998 (inception) to December 31, 1998 and for the year ended December 31, 1999 was $27,000 and $5.7 million, respectively. In November 1999, the Company entered into an agreement to purchase advertising, promotion and marketing services for $4.0 million from a Company which is also a preferred stock shareholder. The agreement is for a one-year period ending in December 2000. 13. SUBSEQUENT EVENTS STOCK SPLITS In January 2000, the Company authorized a 2 for 1 common stock split. All share and per share amounts for common stock have been retroactively restated to give effect to this common stock split. F-17 FREEI NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. SUBSEQUENT EVENTS (CONTINUED) In March 2000, the Company authorized, subject to shareholder approval, a 2 for 1 preferred stock split. All share and per share amounts have been retroactively restated to give effect to this preferred stock split. AMENDMENTS TO CERTIFICATE OF INCORPORATION In January 2000, the Company approved an amendment to the Company's Articles of Incorporation to provide for an increase in the authorized capital stock to 200,000,000 shares of common stock. In March 2000, the Company approved an amendment, subject to shareholder approval, to the Company's Articles of Incorporation to provide for an increase in the authorized capital stock to 400,000,000 shares of common stock and 20,000,000 shares of preferred stock. SALE OF SERIES C CONVERTIBLE PREFERRED STOCK (UNAUDITED) In March 2000, the Company issued 2,703,755 shares of Series C convertible preferred stock ("Series C preferred") at a price of $19.69 per share for aggregate net proceeds of $53.1 million. All holders of Series C convertible preferred have voting, dividend and liquidation preferences substantially the same as holders of convertible preferred stocks Series A and Series B convertible preferred stock. The Series C convertible preferred stock is convertible into 2,703,755 shares of common stock. F-18 Back Cover: FreeInternet.com Logo Text: Freei Networks, Inc. 100% Free Internet access!!! Have a wonderful day. PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the costs and expenses, other than the underwriting discounts and commissions, payable by the registrant in connection with the sale of the securities being registered. All amounts are estimates except the Securities and Exchange Commission registration fee, the NASD filing fee and The Nasdaq National Market listing fee. Securities and Exchange Commission Registration Fee......... $ 45,540 NASD Filing Fee............................................. 20,000 Nasdaq National Market Filing Fee........................... 90,000 Printing Costs.............................................. 200,000 Legal Fees and Expenses..................................... 375,000 Accounting Fees and Expenses................................ 250,000 Directors' and Officers' Insurance Policy Premium........... 500,000 Blue Sky Fees and Expenses.................................. 5,000 Transfer Agent and Registrar Fees........................... 5,000 Miscellaneous............................................... 59,460 ---------- Total................................................. $1,550,000 ==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Sections 23B.08.500 through 23B.08.600 of the Washington Business Corporation Act (the "WBCA") authorize a corporation to indemnify its directors, officers, employees and agents against certain liabilities they may incur in such capacities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"), provided they acted in good faith and in a manner reasonably believed to be in or not opposed to the best interests of the corporation. The registrant's Articles of Incorporation (Exhibit 3.1 hereto) and Bylaws (Exhibit 3.2 hereto) require the registrant to indemnify its officers and directors to the fullest extent permitted by Washington law. Section 23B.08.320 of the WBCA authorizes a corporation to limit or eliminate a director's liability to the corporation or its shareholders for monetary damages for breaches of fiduciary duties, other than for (1) acts or omissions that involve intentional misconduct or a knowing violation of law, (2) unlawful distributions to shareholders, or (3) transactions from which a director derives an improper personal benefit. The registrant's Amended and Restated Articles of Incorporation (Exhibit 3.1 hereto) contain provisions implementing, to the fullest extent permitted by Washington law, such limitations on a director's liability to the registrant and its shareholders. The Underwriting Agreement (Exhibit 1.1 hereto) provides for indemnification between the underwriters and the registrant from and against certain liabilities arising in connection with the offering which is the subject of this registration statement. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. The following is a description of all securities that the registrant has sold within the past three years without registering the securities under the Securities Act: Effective as of September 22, 1998, the registrant issued an aggregate of 24,000,000 shares of its common stock to three of its employees in exchange for $551,000 in cash, intellectual property rights and payment of company expenses. These issuances were exempt from registration pursuant to Section 4(2) of the Securities Act. II-1 On March 9, 1999 the registrant sold and aggregate of 2,879,999 shares of its common stock at a price of $1.00 per share, and issued warrants to purchase 2,879,000 shares of its common stock at an exercise price of $0.50 per share to 22 accredited investors in a private transaction for an aggregate offering price of approximately $2.80 million. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On March 16, 1999, the registrant granted a warrant to an accredited investor to purchase up to 307,974 shares of its common stock at an exercise price $0.001 per share as payment of placement fees equal to $272,000. This issuance was exempt from registration pursuant to Section 4(2) of the Securities Act. On June 28, 1999, the registrant granted a warrant to an accredited investor to purchase up to 331,550 shares of its common stock at an exercise price of $1.20 per share as payment of loan issuance costs equal to $108,000. This issuance was exempt from registration pursuant to Section 4(2) of the Securities Act. On August 12, 1999, the registrant sold 9,624,148 shares of its Series A Convertible Preferred Stock at a price of $1.03905 per share to three accredited investors in a private transaction for an aggregate offering price of $10.0 million. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On November 12, 1999, the registrant sold 3,105,310 shares of its Series B Convertible Preferred Stock at a price of $8.05073 per share to four accredited investors in a private transaction for an aggregate offering price of $25.0 million. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. On March 7 and March 31, 2000, the registrant sold an aggregate of 2,703,755 shares of its Series C Convertible Preferred Stock at a price of $19.643052 per share to 49 accredited investors in a private transaction for an aggregate offering price of approximately $53.1 million. This issuance was exempt from registration pursuant to Rule 506 of Regulation D under Section 4(2) of the Securities Act. From April 1, 1999 to March 26, 2000, the registrant granted options to purchase up to 5,274,862 shares of the registrant's common stock under the registrant's stock option plan at a weighted average exercise price of $1.32 per share. These grants were exempt from registration pursuant to Rule 701 under the Securities Act. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits.
NUMBER DESCRIPTION - ------ ------------------------------------------------------------ 1.1* Form of Underwriting Agreement. 3.1 Articles of Incorporation and all amendments thereto. 3.1(a)* Form of Amended and Restated Articles of Incorporation. 3.2 Bylaws. 4.1 See Exhibits 3.1, 3.2, 10.9, 10.9(a) and 10.9(b) for provisions defining the rights of the holders of common stock. 5.1* Opinion of Summit Law Group, PLLC regarding legality of shares. 10.1 Stock Option Plan. 10.2 Employee Stock Purchase Plan.
II-2
NUMBER DESCRIPTION - ------ ------------------------------------------------------------ 10.3 401(k) Plan. 10.4 Employment Agreement with Robert McCausland dated November 11, 1999. 10.5 Employment Agreement with Steve Bourg dated November 11, 1999. 10.6+ Advertising, Promotion and Marketing Agreement with MP3.com, Inc. dated November 12, 1999. 10.7 Freei Networks, Inc. Series A Preferred Stock Purchase Agreement dated as of August 12, 1999. 10.8 Freei Networks, Inc. Series B Stock Purchase Agreement dated as of November 12, 1999. 10.9 Investor Rights Agreement dated August 12, 1999. 10.9(a) Amendment No. 1 to Investor Rights Agreement dated November 12, 1999. 10.9(b)* Second Amendment to Investor Rights Agreement dated March 7, 2000. 10.10 Freei Networks, Inc. Series C Stock Purchase Agreement dated as of March 7, 2000 and March 31, 2000. 10.11+ Internet Content (World Wide Web Site) Distribution Agreement dated as of November 24, 1999, by and between InfoSpace.com, Inc. and Freei Networks, Inc. 10.12 Commercial Lease dated November 15, 1999, made between Inter Co-op USA No. III and Freei Networks, Inc. 10.13 Office Building Lease between All Service West Campus & Washington General Partnership and Washington Mortgage Svcs. Inc. dated January 18, 1997. 10.14* Lease Agreement dated as of January 21, 2000, by and between Primestar Investment Corp. and Freei Networks, Inc. 10.15+ Customer Agreement for WholeSale and Virtual ISP Integrated Solutions Dial-Up Internet Access Services dated December 23, 1999, by and between Cable & Wireless USA, Inc. and Freei Networks, Inc. 10.16+ Master Services Agreement dated as of September 30, 1999, by and between SplitRock Services Inc. and Freei Networks, Inc. 10.17+* Dial Access Agreement dated October 18, 1999, as amended, by and between PSINet, Inc. and Freei Networks, Inc. 10.18+* United States Internet Content (Worldwide Web Site) Distribution Agreement dated March 30, 2000, by and between InfoSpace.com, Inc. and Freei Networks, Inc. 10.19+ Phone Site Service Agreement dated as of March 30, 2000, by and between InfoSpace.com, Inc. and Freei Networks, Inc. 10.20+* License Agreement dated as of March 31, 2000 by and between Freei.net Sdn. Bhd. and Freei Networks, Inc. 23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants. 23.2 Consent of Summit Law Group, PLLC (contained in the opinion filed as Exhibit 5.1 hereto). 24.1 Power of Attorney (See Page II-4). 27.1 Financial Data Schedule.
- ------------------------ * To be filed by amendment. + Confidential treatment requested. II-3 (b) Financial Statement Schedules. All schedules are omitted because they are inapplicable or the requested information is shown in the financial statements of the registrant or related notes thereto. ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting 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 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 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 questions whether such indemnification by it is against public policy as expressed in the Securities Act 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, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be a 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, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial BONA FIDE offering thereof. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Federal Way, State of Washington, on the 31st day of March, 2000. FREEI NETWORKS, INC. BY: /S/ ROBERT MCCAUSLAND ----------------------------------------- Robert McCausland, PRESIDENT AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY Each person whose individual signature appears below hereby authorizes and appoints Robert McCausland and Ned Menninger, and each of them, with full power of substitution and resubstitution and full power to act without the other, as his true and lawful attorney-in-fact and agent to act in his name, place and stead and to execute in the name and on behalf of each person, individually and in each capacity stated below, and to file, any and all amendments to this registration statement, including any and all post-effective amendments thereto and any registration statement relating to the same offering as this registration statement that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended, 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 and agents, and each of them, full power and authority to do and perform each and every act and thing, ratifying and confirming all that said attorneys-in-fact and agents or any of them or their or his substitute or substitutes may lawfully do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities indicated below on the 31st day of March, 2000.
SIGNATURE TITLE --------- ----- /s/ ROBERT MCCAUSLAND Chairman of the Board, Chief Executive Officer ------------------------------------------- and President (Principal Executive Officer) Robert McCausland /s/ NED MENNINGER Chief Financial Officer (Principal Financial ------------------------------------------- and Accounting Officer) Ned Menninger /s/ RONALD ERICKSON Director ------------------------------------------- Ronald Erickson /s/ MARK STEVENS Director ------------------------------------------- Mark Stevens /s/ WILLIAM OWENS Director ------------------------------------------- William Owens /s/ NAVEEN JAIN Director ------------------------------------------- Naveen Jain
II-5 EXHIBIT INDEX
NUMBER DESCRIPTION - ------ ------------------------------------------------------------ 1.1* Form of Underwriting Agreement. 3.1 Articles of Incorporation and all amendments thereto. 3.1(a)* Form of Amended and Restated Articles of Incorporation. 3.2 Bylaws. 4.1 See Exhibits 3.1, 3.2, 10.9, 10.9(a) and 10.9(b) for provisions defining the rights of the holders of common stock. 5.1* Opinion of Summit Law Group, PLLC regarding legality of shares. 10.1 Stock Option Plan. 10.2 Employee Stock Purchase Plan. 10.3 401(k) Plan. 10.4 Employment Agreement with Robert McCausland dated November 11, 1999. 10.5 Employment Agreement with Steve Bourg dated November 11, 1999. 10.6+ Advertising, Promotion and Marketing Agreement with MP3.com, Inc. dated November 12, 1999. 10.7 Freei Networks, Inc. Series A Preferred Stock Purchase Agreement dated as of August 12, 1999. 10.8 Freei Networks, Inc. Series B Stock Purchase Agreement dated as of November 12, 1999. 10.9 Investor Rights Agreement dated August 12, 1999. 10.9(a) Amendment No. 1 to Investor Rights Agreement dated November 12, 1999. 10.9(b)* Second Amendment to Investor Rights Agreement dated March 7, 2000. 10.10 Freei Networks, Inc. Series C Stock Purchase Agreement dated as of March 7, 2000 and March 31, 2000. 10.11+ Internet Content (World Wide Web Site) Distribution Agreement dated as of November 24, 1999, by and between InfoSpace.com, Inc. and Freei Networks, Inc. 10.12 Commercial Lease dated November 15, 1999, made between Inter Co-op USA No. III and Freei Networks, Inc. 10.13 Office Building Lease between All Service West Campus & Washington General Partnership and Washington Mortgage Svcs. Inc. dated January 18, 1997. 10.14* Lease Agreement dated as of January 21, 2000, by and between Primestar Investment Corp. and Freei Networks, Inc. 10.15+ Customer Agreement for WholeSale and Virtual ISP Integrated Solutions Dial-Up Internet Access Services dated December 23, 1999, by and between Cable & Wireless USA, Inc. and Freei Networks, Inc. 10.16+ Master Services Agreement dated as of September 30, 1999, by and between SplitRock Services Inc. and Freei Networks, Inc. 10.17+* Dial Access Agreement dated October 18, 1999, as amended, by and between PSINet, Inc. and Freei Networks, Inc. 10.18+* United States Internet Content (Worldwide Web Site) Distribution Agreement dated March 30, 2000, by and between InfoSpace.com, Inc. and Freei Networks, Inc.
II-6
NUMBER DESCRIPTION - ------ ------------------------------------------------------------ 10.19+ Phone Site Service Agreement dated as of March 30, 2000, by and between InfoSpace.com, Inc. and Freei Networks, Inc. 10.20+* License Agreement dated as of March 31, 2000 by and between Freei.net Sdn. Bhd. and Freei Networks, Inc. 23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants. 23.2 Consent of Summit Law Group, PLLC (contained in the opinion filed as Exhibit 5.1 hereto). 24.1 Power of Attorney (See Page II-4). 27.1 Financial Data Schedule.
- ------------------------ * To be filed by amendment. + Confidential treatment requested. II-7 EX-3.1 2 EXHIBIT 3.1 FREEI NETWORKS, INC. SERIES C CONVERTIBLE PREFERRED STOCK DESIGNATION OF RIGHTS AND PREFERENCES The undersigned President of Freei Networks, Inc., a Washington corporation (the "Corporation"), in accordance with the provisions of RCW 23B.06.020, does hereby certify that, pursuant to the authority conferred upon the Board of Directors by the Articles of Incorporation of the Corporation, the following resolution creating a series of Series C Convertible Preferred Stock was duly adopted by the Board of Directors of the Corporation as of February 24, 2000: RESOLVED, that pursuant to the authority expressly granted to and vested in this Board of Directors by the provisions of the Articles of Incorporation of the Corporation, this Board of Directors hereby designates a series of Preferred Stock to be known as Series C Convertible Preferred Stock (the "SERIES C STOCK") consisting of 2,545,430 shares, no par value per share, having the following rights and preferences: I. DIVIDENDS. 1.1 The holders of the Series C Stock shall be entitled to receive dividends at the rate of 8% per share ($1.57144416 per share) (as adjusted for any stock dividends, combinations or splits with respect to such shares) per annum, payable out of funds legally available therefor, on a PARI PASSU basis. Such dividends shall be non-cumulative and payable only when, as, and if declared by the Board of Directors, but always in preference and priority to any payment of dividends on the Common Stock of the Corporation. The Series C Stock dividend shall be subordinate to the dividend rights of the Series A Preferred Stock ("Series A Stock") and Series B Preferred Stock ("Series B Stock"). After payment of the Series C dividend in full for a given calendar year, subject to the dividend rights of the Series A Stock and Series B Stock, the Series C Stock shall participate PARI PASSU (on an as-converted basis) with the Series A Stock and the Series B Stock and the Common Stock of the Corporation in any dividends paid thereon. No dividends (other than those payable solely in the Common Stock of the Corporation) shall be paid on any Common Stock of the Corporation during any fiscal year of the Corporation until dividends in the total amount $1.57144416 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) on the Series C Stock shall have been paid or declared and set apart during the fiscal year. 1.2 No dividend shall be paid on or declared and set apart for, nor shall any distribution be made upon, the Common Stock of the Corporation (other than a dividend or distribution payable in shares of Common Stock), nor shall any shares of Common Stock be purchased or redeemed by the Corporation (other than pursuant to the Corporation's repurchase rights under its standard stock option and stock purchase agreements with employees, directors, and consultants), nor shall any moneys be paid to or made available for a sinking fund for the purchase or redemption of any Common Stock, unless in each instance (a) a like dividend for the same dividend period, ratably in proportion to the annual dividend rate fixed for the Series C Stock, shall be paid on or declared and set apart for the Series C Stock, and (b) the holders of a majority of the issued and outstanding Series C Stock shall have consented in writing to such action. 1.3 In the event that the Corporation shall declare a distribution (other than a distribution described in Section 1.1 or 1.2) payable in securities of other persons, evidences of 1 indebtedness, non-cash assets, or options or rights to purchase any such securities or indebtedness, then, in each case, the holders of the Series C Stock shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of the Corporation into which their respective shares of Series C Stock are convertible as of the record date fixed for the determination of the holders of the Common Stock of the Corporation entitled to receive such distribution. 2. LIQUIDATION. 2.1 Upon any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, after payment of any liquidation preference amounts owing to the holders of the Series A Stock and Series B Stock, but before any distribution or payment is made upon any Common Stock, the holders of the shares of Series C Stock shall be entitled to be paid an amount equal to the $19.643052 (the "STATED VALUE") per share (as adjusted for any stock dividends, combinations or splits with respect to such shares), plus an amount equal to all declared and unpaid dividends thereon, such amounts referred to herein as the "LIQUIDATION PREFERENCE PAYMENTS." Upon any such liquidation, dissolution or winding-up of the Corporation, after the holders of the Series A Stock and the Series B Stock and the Series C Stock shall have been paid in full the amounts to which they shall be entitled, the remaining net assets of the Corporation may be distributed to the holders of Common Stock pro rata. 2.2 If upon such liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, after payment of any liquidation preference amounts owing to the holders of the Series A Stock and Series B Stock, the assets to be distributed among the holders of Series C Stock shall be insufficient to permit payment to the holders of Series C Stock of their Liquidation Preference Payments, then the entire remaining assets of the Corporation legally permitted to be distributed shall be distributed ratably among the holders of Series C Stock in proportion to the respective Liquidation Preference Payments that each such holder otherwise would have been entitled to receive. 2.3 Written notice of such liquidation, dissolution or winding-up, stating a payment date, the amount of the Liquidation Preference Payments, and the place where said sums will be payable shall be given by mail, postage prepaid, not less than 30 days prior to the payment date stated therein, to the holders of record of the Series C Stock, such notice to be addressed to each shareholder at his or its mailing address as shown by the records of the Corporation. 2.4 The sale, lease or other disposition by the Corporation of all or substantially all of its assets or the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the, Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity surviving such transaction shall be deemed to be a liquidation, dissolution or winding-up of the Corporation within the meaning this Section 2. 3. CONVERSION. 3.1 VOLUNTARY CONVERSION. 3.1.1 Subject to the terms and conditions of this Section 3, the holder of any share or shares of Series C Stock shall have the right, at its option at any time, to convert any such shares of Series C Stock into such number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation as is obtained by (i) multiplying the number of shares of Series C Stock to be converted by the Stated Value and (ii) dividing the result by the Conversion Price (as defined below). The term "CONVERSION PRICE" shall mean $19.643052 per share, as adjusted and in effect pursuant 2 to this Section 3, at the date any share or shares of Series C Stock are surrendered for conversion. 3.1.2 The rights of conversion contained in Section 3.1.1 may be exercised by the holder of shares of Series C Stock by giving written notice that such holder elects to convert a stated number of shares of Series C Stock into Common Stock, and by surrender of a certificate or certificates for the shares so to be converted to the Corporation at its principal office (or such other office or agency of the Corporation as the Corporation may designate by notice in writing to the holder or holders of the Series C Stock) at any time during its usual business hours, together with a statement of the name or names (with address) in which the certificate or certificates for shares of Common Stock shall be issued. Upon any liquidation, dissolution or winding-up of the Corporation, the right of conversion shall terminate at the close of business on the last full business day next preceding the date fixed for payment of the Liquidation Preference Payments. 3.1.3 All rights, preferences, and privileges granted to the Series C Stock, including, without limitation, the right to receive any declared but unpaid dividends, shall terminate with respect to any shares of Series C Stock upon the conversion thereof into Common Stock. 3.2 UPON ELECTION OF SERIES C STOCK HOLDERS. All outstanding shares of Series C Stock shall, upon the vote or written consent of the holders of not less than a majority of the then-outstanding shares of Series C Stock, be automatically converted into the number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation calculated in the manner set forth in Section 3.1.1 without any further action by the holders of such shares. Notice hereof shall be given by the Corporation to the holders of Series C Stock within 30 days of such vote or consent. The effective date of such conversion hereunder shall be the date specified in the vote causing conversion, or if no such date is specified, the date such vote is taken. 3.3 MANDATORY CONVERSION. 3.3.1 Each share of the Series C Stock shall be converted automatically into validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation upon the closing of an underwritten public offering of shares of the Common Stock of the Corporation at a public offering price of not less than ten dollars ($10.00) per share, as adjusted for stock splits or subdivisions, and an aggregate public offering price of not less than twenty million dollars ($20,000,000). 3.4 ADJUSTMENT OF CONVERSION PRICE. The Conversion Price shall be subject to adjustment from time to time as follows: 3.4.1 ADJUSTMENT FOR STOCK SPLITS AND COMBINATIONS, If the Corporation, at any time or from time to time after the Series C Stock is issued, shall effect a subdivision or split of the outstanding Common Stock, the Conversion Price then in effect immediately before that subdivision or split shall be proportionately decreased. Conversely, if this Corporation at any time or from time to time after the Series C Stock is issued shall combine the outstanding shares of Common Stock, the Conversion Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 3.4.1 shall become effective at the close of business on the date the subdivision, split or combination becomes effective. 3.4.2 ADJUSTMENT FOR CERTAIN DIVIDENDS AND DISTRIBUTIONS. If the Corporation at any time or from time to time after the Series C Stork is issued shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Conversion Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been 3 fixed, as of the close of business on such record date, by multiplying the Conversion Price for such Series C Stock then in effect by a fraction: (i) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date; and (ii) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time, of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, that if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Conversion Price for such Series C Stock shall be recalculated accordingly as of the close of business on such record date, and thereafter the Conversion Price for Series C Stock shall be adjusted pursuant to this Section 3.4.2 as of the time of actual payment of such dividends or distributions. 3.4.3 ADJUSTMENT FOR RECLASSIFICATION, EXCHANGE OR SUBSTITUTION. If the Common Stock issuable upon the conversion of the Series C Stock shall be changed into the same or a different number of shares of any class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares or stock dividend provided for above), then and in each such event the holder of each share of Series C Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, reclassification or other change, by holders of the number of shares of Common Stock into which such shares of Series C Stock might have been converted immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided herein. 3.4.4 ADJUSTMENT FOR DILUTIVE ISSUANCE. If the Corporation at any time or from time to time issues additional shares of Common Stock or any securities convertible, exercisable or exchangeable into shares of Common Stock ("COMMON STOCK EQUIVALENTS") for a consideration per share of Common Stock less than the Conversion Price in effect on the date immediately prior to such issuance (a "DILUTIVE ISSUANCE"), then and in such event, the Conversion Price for the Series C Stock shall be adjusted, concurrently with such issue, according to the following formula: CP X (X + (Y/CP)) ----------- (X + Z) where: CP= Conversion Price in effect immediately prior to the Dilutive Issuance; X= Number of shares of Common Stock outstanding immediately prior to the Dilutive Issuance; Y= Aggregate proceeds of the Dilutive Issuance; and Z= Number of additional shares of Common Stock issued in the Dilutive Issuance (or issuable upon exercise or exchange for, or conversion into, shares of Common Stock, in the case of a Dilutive Issuance of Common Stock 4 Equivalents). For purposes of the above calculation, the number of shares of Common Stock outstanding immediately prior to a Dilutive Issuance shall be calculated on a fully diluted basis, as if all shams of Series C Stock and all outstanding Common Stock Equivalents had been fully exchanged or exercised for, or converted into, shares of Common Stock immediately prior to such issuance. Notwithstanding the foregoing, a Dilutive Issuance shall not include the issuance, regardless of offering price, of (i) of up to an aggregate of 8,421,128 shares of Common Stock or Common Stock Equivalents (as adjusted for any stock dividends, combinations or splits with respect thereto), net of any repurchases by the Corporation of its Common Stock or Common Stock Equivalents and any expirations of any options, warrants, or other Common Stock Equivalents), to employees, officers, directors, consultants, contractors or advisors of the Corporation pursuant to stock purchase or stock option plans or agreements or other incentive stock arrangements on terms unanimously approved by the Board of Directors, (ii) shares of Common Stock or Common Stock Equivalents issued to leasing companies, landlords, lenders and other vendors of goods and services to the Corporation, provided that such shares represent less than 2% of the then current outstanding capital stock of the Company on a fully diluted basis; (iii) 331,550 shares of Common Stork issuable upon exercise of a warrant issued to Lucent Technologies, Inc., and; (iv) 307,974 shares of Common Stock issuable upon exercise of a warrant issued to Pacific Crest Securities, Inc., (v) 2,879,900 shares of Common Stock issuable upon exercise of warrants initially issued to 22 investors on March 9, 1999 (the "Angel Round Warrants"), and shares of Common Stock issuable upon conversion of Series A Stock or Series B Stock. 3.4.5 ADJUSTMENT NOTICE. Whenever the Conversion Price shall be adjusted as provided in this Section 3.3, this Corporation promptly shall file, at the office of the Secretary of this Corporation and any transfer agent for the Series C Stock, a statement, signed by its President or any Vice President and by its Treasurer, an Assistant Treasurer, its Secretary or an Assistant Secretary, showing in detail the facts requiring such adjustment and the Conversion Price that shall be in effect after such adjustment This Corporation shall also cause a copy of such statement to be sent by mail, first-class postage prepaid, facsimile or overnight express delivery, to each holder of shares of Series C Stock at each such holder's address appearing on this Corporation's records. Where appropriate, such copy may be given in advance and may be included as part of a notice required to be mailed under the provisions of subsection 7 following. 3.4.6 NOTICE OF ACTION. In the event this Corporation shall propose to take any action of the types described in subsection 3.4.1, 3.4.2, 3.4.3, or 3.4.4, the Corporation shall give notice to each holder of shares of Series C Stock, in the manner set forth in subsection 3.4.5, which notice shall specify the record date, if any, with respect to any such action and the date on which such action is to take place. Such notice shall also set forth such facts with respect thereto as shall be reasonably necessary to indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the Conversion Price and the number, kind or class of shares or other securities or property which shall be deliverable or purchasable upon the occurrence of such action or deliverable upon conversion of shams of Series C Stock. In the case of any action that would require the fixing of a record date, such notice shall be given at least ten days prior to the date so fixed, and in case of all other action, such notice shall be given at least 20 days prior to the taking of such proposed action. Failure to give such notice, or any defect therein, shall not affect the legality or validity of any such action. 3.5 NO FRACTIONAL SHARES OR ADJUSTMENTS. No fractional shams of Common Stock shall be issued upon conversion of any Series C Stock, but in lieu of fractional shares this Corporation shall pay an amount in cash equal to the fair value of such fractional interest If the Common Stock is listed on an exchange or market, the fair value shall be the closing price thereon as of the day preceding 5 the date of conversion, or if traded on the over-the-counter market the average of the closing bid and asked prices on such date; if such stock is not publicly traded, the fair value shall be as determined in good faith by the Board of Directors. No adjustment in the Conversion Price shall be made if such adjustment would result in a change of less than one cent ($0.01) thereto. Any adjustment of less than one cent ($0.01) that is not made shall be carried forward and made at the time of and together with any subsequent adjustment that, on a cumulative basis, amounts to in adjustment of one cent ($0.01) or more in the Conversion Price. 3.6 RESERVED SHARES. As long as any of the Series C Stock remains outstanding, this Corporation shall take all steps necessary to reserve and keep available a number of its authorized but unissued shares of Common Stock sufficient for issuance upon conversion of all such outstanding shares of Series C Stock. 4. VOTING RIGHTS. 4.1 Except as otherwise provided by law and the Articles of Incorporation, as amended, the holders of Series C Stock shall be entitled to notice of any meeting of the shareholders of the Corporation (the "SHAREHOLDERS") in accordance with the Bylaws of the Corporation and to vote, together with the holders of Common Stock as a single class, on any matter submitted to the Stockholders for a vote as follows: (i) the holders of Series C Stock shall have one vote for each share of Common Stock such holder would have if such holder converted all of its shares of Series C Stock into Common Stock pursuant to Section 3, and (ii) the holders of Common Stock shall have one vote per share. 4.2 For so long as 250,000 shares of the Series C Preferred Stock shall remain outstanding, the Corporation shall not, without the affirmative vote or written consent of the holders of not less than a majority of the then outstanding shares of Series C Stock: (i) amend or change any of the rights, preferences, privileges or powers of, or the restrictions provided for the benefit of, the Series C Stock; (ii) take any action that authorizes, creates or issues shuts of any class of stock having preferences superior to or on a parity with the Series C Stock; (iii) take any action that reclassifies any outstanding shares into shares having preferences or priority as to dividends or assets senior to or on a parity with the preferences of the Series C Stock; (iv) amend the Corporation's Articles of Incorporation in any manner that could affect the rights of the Series C Stock; (v) authorize the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity; (vi) undertake the sale, lease or other disposition by the Corporation of all or substantially all of its assets; (vii) authorize the liquidation of dissolution of the Corporation; (viii) declare or pay any dividends on the Common Stock or Series C Stock 6 (other than a dividend payable solely in shares of Common Stock); (ix) take any action that increases or decreases the authorized number of shares of Common Stock or Series C Stock; or (x) redeem any shares of Common Stock (other than pursuant to equity incentive agreements with service providers that grant the Corporation the right to repurchase such shares upon the termination of services). 5. NO PREEMPTIVE RIGHTS. Except for the rights of the holders of Series C Stock set forth in any agreement with the Corporation that grants purchase rights in respect of future issuance of securities by the Corporation, no holder of the Series C Stock, as such, shall have any preemptive rights to subscribe for shares, obligations, warrants, or other securities of the Corporation, of this or any other class or series, whether now or hereafter authorized. 6. REDEMPTION. The shares of Series C Stock shall not be subject to mandatory redemption under any event (whether at the option of the Corporation, the holder, upon the occurrence of any event or otherwise). The Corporation may not purchase or redeem any shares of Series C Stock without the prior written consent of the holders of a majority of the issued and outstanding Series C Stock. 7. NOTICES. Notices to this Corporation with respect to the Series C Stock shall be addressed to the attention of the Secretary at the principal office of the Corporation (909 S. 336th, Suite 110, Federal Way, Washington, 98003) or to such other place as the Corporation may from time to time direct by written notice to all holders of the Series C Stock. Any and all notices required or permitted to be given to a party pursuant to the provisions of this Certificate will be in writing and will be effective and deemed to provide such party sufficient notice under this Certificate on the earliest of the following: (i) at the time of personal delivery, if delivery is in person; (ii) at the time of transmission by facsimile, addressed to the other party at its facsimile number specified herein (or hereafter modified by subsequent notice to the parties hereto), with confirmation of receipt made by both telephone and printed confirmation sheet verifying successful transmission of the facsimile; (iii) one business day after deposit with an express overnight courier for deliveries within a country, or two business days after such deposit for international deliveries or (iv) three business days after deposit in mail by certified mail (return receipt requested) or equivalent for deliveries within a country. All notices for international delivery will be sent by facsimile or by express courier. Any party hereto (and such party's permitted assigns) may be notice so given change its address for future notices hereunder. Notice shall conclusively be deemed to have been given in the manner set forth above. 8. WAIVER; AMENDMENT. Except as otherwise provided, any provision of this Certificate of Designation may be waived (i) by any individual holder of Series C Stock, with respect to such holder; or (ii) by the consent of the holders of a majority of all outstanding shares of Series C Stock, with respect to all holders of Series C Stock. Any provision of this Certificate of Designation may be amended by the vote or consent, either in writing or at a meeting, of the holders of a majority of the shares of Series C Stock then outstanding. 9. NO IMPAIRMENT. This Corporation will not, by amendment of its Articles of Incorporation or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by this Corporation but will at all times in good faith assist in the carrying out of all the provisions of this Statement of Rights and Preferences and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holders of the Series C Stock against impairment. 7 IN WITNESS WHEREOF, the undersigned has executed and subscribed this Certificate and does affirm the foregoing as true as of the 24th day of February, 2000. FREEI NETWORKS, INC. By: /s/ Robert McCausland ------------------------------------ Robert McCausland, President 8 ARTICLES OF AMENDMENT OF FREEI NETWORKS, INC. Pursuant to RCW 23B.10.060, the undersigned corporation adopts the following Articles of Amendment to its Articles of Incorporation: FIRST: The name of the corporation is Freei Networks, Inc. (the "Corporation"). SECOND: Paragraph A of Article VI of the Articles of Incorporation is hereby amended in its entirety as follows: ARTICLE VI AUTHORIZED CAPITAL A. AUTHORIZED CAPITAL. This corporation is authorized to issue Two Hundred Million (200,000,0000) shares of common capital stock with no par value, and Ten Million (10,000,000) shares of preferred capital stock with no par value. THIRD: The amendment does not provide for an exchange, reclassification, or cancellation of issued shares. FOURTH: The foregoing amendment was adopted by the Board of Directors of the Corporation on January 7, 2000, and by the shareholders of the Corporation pursuant to RCW 23B.07.040(5) effective January 7, 2000, and written notice to all nonconsenting shareholders has been given pursuant to RCW 23B.07.040(5). Dated: February 28, 2000. Freei Networks, Inc., a Washington corporation By: /s/ Bob McCausland ---------------------------- Bob McCausland, President STATE of WASHINGTON [SEAL] SECRETARY OF STATE 1, RALPH MUNRO, SECRETARY OF STATE OF THE STATE OF WASHINGTON AND CUSTODIAN OF ITS SEAL, hereby issue this CERTIFICATIFICATE OF AMENDMENT to FREEI NETWORKS, INC. a Washington Profit corporation. Articles of Amendment were filed for record in this office on the date indicated below. UBI Number: 601 902 953 Date: November 12,1999 [SEAL] GIVEN UNDER MY HAND AND THE SEAL OF THE OF WASHINGTON AT OLYMPIA, THE STATE CAPITAL /s/ Ralph Munro ------------------------------- RALPH MUNRO, SECRETARY OF STATE State of Washington Corporations Division Office of the Secretary of State ARTICLES OF AMENDMENT OF FREEI NETWORKS, INC. Pursuant to ARTICLE VI of the Articles of Incorporation and RCW 23B.06.020 of the Washington Business Corporation Act, the Board of Directors hereby adopts and incorporates the attached Statement of Rights and Preferences of Series B Preferred Stock to the corporation's Articles of Incorporation: I. The name of the corporation is Freei Networks, Inc. 2. The text of each amendment as adopted is as follows: ARTICLE VI of the Articles of Incorporation shall be amended to adopt and incorporate the attached Statement of Rights and Preferences of SERIES B Preferred Stock (the "Series B Statement"). Said amendment, by its terms, amends the Statement of Rights and Preferences of the Series A Preferred Stock filed August 12, 1999 (the "Series A Statement"). To the extent there is a conflict between this Series B Statement and the Series A Statement this Series B Statement shall control. 3. No amendment provides for an exchange, reclassification, or cancellation of issued shares. 4. The date of adoption of each amendment was November 11, 1999, by the Board of Directors. Common shareholder action was not required. The Series A Shareholders unanimously approved of the amendment pursant to RCW23B.10.030 and RCW 23B.10.040. 5. These Articles will be effective upon filing. Dated: November 11, 1999. FREEI NETWORKS, INC. By: /s/ Robert G. McCausland ----------------------------------------- Robert G. McCausland President and Secretary EXHIBIT A FREEI NETWORKS, INC. 1,552,655 SHARES SERIES B CONVERTIBLE PREFERRED STOCK, NO PAR VALUE STATED VALUE - $16.10146 PER SHARE STATEMENT OF RIGHTS AND PREFERENCES The rights, preferences, privileges, and limitations granted to and imposed on the Series B Convertible Preferred Stock (the "SERIES B STOCK"), which series shall consist of 1,552,655 shares, are as set forth below. I. DIVIDENDS. 1.1 The holders of the Series B Stock shall be entitled to receive dividends at the rate of 8% per share ($1.2881161 per share) (as adjusted for any stock dividends, combinations or splits with respect to such shares) per annum, payable out of funds legally available therefor. Such dividends shall be non-cumulative and payable only when, as, and if declared by the Board of Directors, but always in preference and priority to any payment of dividends on the Common Stock of the Corporation. The Board of Directors must declare and pay this Series B Stock dividend PARI PASSU with any dividend declared and payable on the Series A Preferred Stock ("Series A Stock"). After payment of any such dividends on the Series A Stock and the Series B Stock, the Series B Stock shall participate PARI PASSU (on an as-converted basis) with the Series A Stock and the Common Stock of the Corporation in any dividend paid thereon. No dividends (other than those payable solely in the Common Stock of the Corporation) shall be paid on any Common Stock of the Corporation during any fiscal year of the Corporation until dividends in the total amount $1.2881161 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) on the Series B Stock shall have been paid or declared and set apart during the fiscal year. 1.2 No dividend shall be paid on or declared and set apart for, nor shall any distribution be made upon, the Common Stock of the Corporation (other than a dividend or distribution payable in shares of Common Stock), nor shall any shares of Common Stock be purchased or redeemed by the Corporation (other than pursuant to the Corporation's repurchase rights under its standard stock option and stock purchase agreements with employees, directors, and consultants), nor shall any moneys be paid to or made available for a sinking fund for the purchase or redemption of any Common Stock, unless in each instance (a) a like dividend for the same dividend period, ratably in proportion to the annual dividend rate fixed for the Series B Stock, shall be paid on or declared and set apart for the Series B Stock, and (b) the holders of a majority of the issued and outstanding Series B Stock shall have 1 consented in writing to such action. 1.3 In the event that the Corporation shall declare a distribution (other than a distribution described in Section 1.1 or 1.2) payable in securities of other persons, evidences of indebtedness, non-cash assets, or options or rights to purchase any such securities or indebtedness, then, in each case, the holders of the Series B Stock shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of the Corporation into which their respective shares of Series B Stock are convertible as of the record date fixed for the determination of the holders of the Common Stock of the Corporation entitled to receive such distribution. 2. LIQUIDATION. 2.1 Upon any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the holders of the shares of Series B Stock, PARI PASSU with the holders of Series A Stock, shall be entitled, before any distribution or payment is made upon any Common Stock, to be paid an amount equal to the $16.10146 (the "STATED VALUE") per share (as adjusted for any stock dividends, combinations or splits with respect to such shares), plus an amount equal to all declared and unpaid dividends thereon, such amounts referred to herein as the "LIQUIDATION PREFERENCE PAYMENTS." Upon any such liquidation, dissolution or winding-up of the Corporation, after the holders of the Series A Stock and the Series B Stock shall have been paid in full the amounts to which they shall be entitled, the remaining net assets of the Corporation may be distributed to the holders of Common Stock pro rata. 2.2 If upon such liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the assets to be distributed among the holders of Series A and Series B Stock of the Corporation shall be insufficient to permit payment to the holders of Series A and Series B Stock of the their respective Liquidation Preference Payments, then the entire assets of the Corporation legally permitted to be distributed shall be distributed ratably among the holders of Series A and Series B Stock in proportion to the respective Liquidation Preference Payments that each such holder otherwise would have been entitled to receive. 2.3 Written notice of such liquidation, dissolution or winding-up, stating a payment date, the amount of the Liquidation Preference Payments, and the place where said sums will be payable shall be given by mail, postage prepaid, not less than 30 days prior to the payment date stated therein, to the holders of record of the Series B Stock, such notice to be addressed to each shareholder at his or its mailing address as shown by the records of the Corporation. 2.4 The sale, lease of other disposition by the Corporation of all or substantially all of its assets or the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power 2 of the entity surviving such transaction shall be deemed to be a liquidation, dissolution or winding-up of the Corporation within the meaning this Section 2. 3. CONVERSION. 3.1 VOLUNTARY CONVERSION 3.1.1 Subject to the terms and conditions of this Section 3, the holder of any share or shares of Series B Stock shall have the right, at its option at any time, to convert any such shares of Series B Stock into such number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation as is obtained by (i) multiplying the number of shares of Series B Stock to be converted by the Stated Value and (ii) dividing the result by the Conversion Price (as defined below). The term "CONVERSION PRICE" shall mean $16.10146 per share, as adjusted and in effect pursuant to this Section 3, at the date any share or shares of Series B Stock are surrendered for conversion. 3.1.2 The rights of conversion contained in Section 3.1.1 maybe exercised by the holder of shares of Series B Stock by giving written notice that such holder elects to convert a stated number of shares of Series B Stock into Common Stock, and by surrender of a certificate or certificates for the shares so to be converted to the Corporation at its principal office (or such other office or agency of the Corporation as the Corporation may designate by notice in writing to the holder or holders of the Series B Stock) at any time during its usual business hours, together with a statement of the name or names (with address) in which the certificate or certificates for shares of Common Stock shall be issued. Upon any liquidation, dissolution or winding-up of the Corporation, the right of conversion shall terminate at the close of business on the last full business day next preceding the date fixed for payment of the Liquidation Preference Payments. 3.1.3 All rights, preferences, and privileges granted to the Series B Stock, including, without limitation, the right to receive any declared but unpaid dividends, shall terminate with respect to any shares of Series B Stock upon the conversion thereof into Common Stock. 3.2 UPON ELECTION OF SERIES B STOCK HOLDERS. All outstanding shares of Series B Stock shall, upon the vote or written consent of the holders of not less than a majority of the then-outstanding shares of Series B Stock, be automatically converted into the number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation calculated in the manner set forth in Section 3.1.1 without any further action by the holders of such shares. Notice hereof shall be given by the Corporation to the holders of Series B Stock within 30 days of such vote or consent. The effective date of such conversion hereunder shall be the date specified in the vote causing conversion, or if no such date is specified, the date such vote is taken. 3.3 MANDATORY CONVERSION. 3 3.3.1 Each share of the Series B Stock shall be converted automatically into validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation upon the closing of an underwritten public offering of shares of the Common Stock of the Corporation at a public offering price of not less than thirty-two dollars ($32.00) per share, as adjusted for stock splits or subdivisions, and an aggregate public offering price of not less than forty million dollars ($40,000,000). 3.4 ADJUSTMENT OF CONVERSION PRICE. The Conversion Price shall be subject to adjustment from time to time as follows: 3.4.1 ADJUSTMENT FOR STOCK SPLITS AND COMBINATIONS. If the Corporation, at any time or from time to time after the Series B Stock is issued, shall effect a subdivision or split of the outstanding Common Stock, the Conversion Price then in effect immediately before that subdivision or split shall be proportionately decreased. Conversely, if this Corporation at any time or from time to time after the Series B Stock is issued shall combine the outstanding shares of Common Stock, the Conversion Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 3.4.1 shall become effective at the close of business on the date the subdivision, split or combination becomes effective. 3.4.2 ADJUSTMENT FOR CERTAIN DIVIDENDS AND DISTRIBUTIONS. If the Corporation at any time or from time to time after the Series B Stock is issued shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Conversion Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Conversion Price for such Series B Stock then in effect by a fraction: (i) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date; and (ii) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, that if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Conversion Price for such Series B Stock shall be recalculated accordingly as of the close of business on such record date, and thereafter the Conversion Price for Series B Stock shall be adjusted pursuant to this Section 3.4.2 as of the time of actual payment of such dividends or distributions. 3.4.3 ADJUSTMENT FOR RECLASSIFICATION, EXCHANGE OR SUBSTITUTION. If the 4 Common Stock issuable upon the conversion of the Series B Stock shall be changed into the same or a different number of shares of any class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares or stock dividend provided for above), then and in each such event the holder of each share of Series B Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, reclassification or other change, by holders of the number of shares of Common Stock into which such shares of Series B Stock might have been converted immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided herein. 3.4.4 ADJUSTMENT FOR DILUTIVE ISSUANCE. If the Corporation at any time or from time to time issues additional shares of Common Stock or any securities convertible, exercisable or exchangeable into shares of Common Stock ("COMMON STOCK EQUIVALENTS") for a consideration per share of Common Stock less than the Conversion Price in effect on the date immediately prior to such issuance (a "DILUTIVE ISSUANCE"), then and in such event, the Conversion Price for the Series B Stock shall be adjusted, concurrently with such issue, according to the following formula: CP X (X + (Y/CP)) ------------ (X + Z) where: CP= Conversion Price in effect immediately prior to the Dilutive Issuance; X= Number of shares of Common Stock outstanding immediately prior to the Dilutive Issuance; Y= Aggregate proceeds of the Dilutive Issuance; and Z= Number of additional shares of Common Stock issued in the Dilutive Issuance (or issuable upon exercise or exchange for, or conversion into, shares of Common Stock, in the case of a Dilutive Issuance of Common Stock Equivalents). For purposes of the above calculation, the number of shares of Common Stock outstanding immediately prior to a Dilutive Issuance shall be calculated on a fully diluted basis, as if all shares of Series B Stock and all outstanding Common Stock Equivalents had been fully exchanged or exercised for, or converted into, shares of Common Stock immediately prior to such issuance. Notwithstanding the foregoing, a Dilutive Issuance shall not include the issuance, regardless of offering price, of (i) of up to an aggregate of 4,210,564 shares of Common Stock or Common Stock Equivalents (as adjusted for any stock dividends, combinations or splits with respect thereto), net of any repurchases by the Corporation of its Common Stock or Common 5 Stock Equivalents and any expirations of any options, warrants, or other Common Stock Equivalents), to employees, officers, directors, consultants, contractors or advisors of the Corporation pursuant to stock purchase or stock option plans or agreements or other incentive stock arrangements on terms unanimously approved by the Board of Directors, (ii) shares of Common Stock or Common Stock Equivalents issued to leasing companies, landlords lenders and other vendors of goods and services to the Corporation; (iii) 165,775 shares of Common Stock issuable upon exercise of a warrant issued to Lucent Technologies, Inc., and; (iv) 153,987 shares of Common Stock issuable upon exercise of a warrant issued to Pacific Crest Securities, Inc., (v) 1,439,500 shares of Common Stock issuable upon exercise of warrants initially issued to 22 investors on March 9, 1999 (the "Angel Round Warrants"), and 4,812,074 shares of Common Stock issuable upon conversion of Series A Stock. 3.4.5 ADJUSTMENT NOTICE. Whenever the Conversion Price shall be adjusted as provided in this Section 3.3, this Corporation promptly shall file, at the office of the Secretary of this Corporation and any transfer agent for the Series B Stock, a statement, signed by its President or any Vice President and by its Treasurer, an Assistant Treasurer, its Secretary or an Assistant Secretary, showing in detail the facts requiring such adjustment and the Conversion Price that shall be in effect after such adjustment. This Corporation shall also cause a copy of such statement to be sent by mail, first-class postage prepaid, facsimile or overnight express delivery, to each holder of shares of Series B Stock at each such holder's address appearing on this Corporation's records. Where appropriate, such copy may be given in advance and maybe included as part of a notice required to be mailed under the provisions of subsection 3.3.7 following. 3.4.6 NOTICE OF ACTION. In the event this Corporation shall propose to take any action of the types described in subsection 3.4.1, 3.4.2, 3.4.3, or 3.4.4, the Corporation shall give notice to each holder of shares of Series B Stock, in the manner set forth in subsection 3.4.5, which notice shall specify the record date, if any, with respect to any such action and the date on which such action is to take place. Such notice shall also set forth such facts with respect thereto as shall be reasonably necessary to indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the Conversion Price and the number, kind or class of shares or other securities or property which shall be deliverable or purchasable upon the occurrence of such action or deliverable upon conversion of shares of Series B Stock. In the case of any action that would require the fixing of a record date, such notice shall be given at least ten days prior to the date so fixed, and in case of all other action, such notice shall be given at least 20 days prior to the taking of such proposed action. Failure to give such notice, or any defect therein, shall not affect the legality or validity of any such action. 3.5 NO FRACTIONAL SHARES OR ADJUSTMENTS. No fractional shares of Common Stock shall be issued upon conversion of any Series B Stock, but in lieu of fractional shares this Corporation shall pay an amount in cash equal to the fair value of such fractional interest. If the Common Stock is listed on an exchange or market, the fair value shall be the closing price thereon as of the day preceding the date of conversion, or if traded on the over-the-counter market, the average of the closing bid and asked prices on such date; if such stock is 6 not publicly traded, the fair value shall be as determined in good faith by the Board of Directors. No adjustment in the Conversion Price shall be made if such adjustment would result in a change of less than one cent ($0.01) thereto. Any adjustment of less than one cent ($0.01) that is not made shall be carried forward and made at the time of and together with any subsequent adjustment that, on a cumulative basis, amounts to an adjustment of one cent ($0.01) or more in the Conversion Price. 3.6 RESERVED SHARES. As long as any of the Series B Stock remains outstanding, this Corporation shall take all steps necessary to reserve and keep available a number of its authorized but unissued shares of Common Stock sufficient for issuance upon conversion of all such outstanding shares of Series B Stock. 4. VOTING RIGHTS. 4.1 Except as otherwise provided by law and the Articles of Incorporation, as amended, the holders of Series B Stock shall be entitled to notice of any meeting of the shareholders of the Corporation (the "SHAREHOLDERS") in accordance with the Bylaws of the Corporation and to vote, together with the holders of Common Stock as a single class, on any matter submitted to the Stockholders for a vote as follows: (i) the holders of Series B Stock shall have one vote for each share of Common Stock such holder would have if such holder converted all of its shares of Series B Stock into Common Stock pursuant to Section 3, and (ii) the holders of Common Stock shall have one vote per share. 4.2 The Board of Directors consists of five members. The members of the Board of Directors shall be elected at each meeting or pursuant to each consent of the Corporation's shareholders for the election of directors, as follows: (i) The holders of the Series A Stock and the Series B Stock, voting as a class, shall be entitled to elect one member of the Board of Directors; (ii) The holders of the Common Stock, voting as a class, shall be entitled to elect two members of the Board of Directors; and (iii) The holders of the Series A Stock and the holders of the Series B Stock, voting as a single class, and the holders of the Common Stock, voting as a separate class, together shall agree on the remaining two members of the Board of Directors. 4.3 For so long as 500,000 shares of the Series B Preferred Stock shall remain outstanding, the Corporation shall not, without the affirmative vote or written consent of the holders of not less than a majority of the then outstanding shares of Series B Stock: (i) amend of change any of the rights, preferences, privileges or powers of, or the restrictions provided for the benefit of, the Series B Stock; 7 (ii) take any action that authorizes, creates or issues shares of any class of stock having preferences superior to or on a parity with the Series B Stock; (iii) take any action that reclassifies any outstanding shares into shares having preferences or priority as to dividends or assets senior to or on a parity with the preferences of the Series B Stock; (iv) amend the Corporation's Articles of Incorporation in any manner that could affect the rights of the Series B Stock; (v) authorize the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity; (vi) undertake the sale, lease or other disposition by the Corporation of all or substantially all of its assets; (vii) authorize the liquidation of dissolution of the Corporation; (viii) declare or pay any dividends on the Common Stock or Series B Stock or (other than a dividend payable solely in shares of Common Stock); (ix) take any action that increases or decreases the authorized number of shares of Common Stock or Series B Stock; (x) redeem any shares of Common Stock (other than pursuant to equity incentive agreements with service. providers that grant the Corporation the right to repurchase such shares upon the termination of services); or (xi) take any action to issue additional shares of Series B Stock other than the 1,552,655 share sold pursuant to the Series B Stock Purchase Agreement dated as of November 12, 1999. 5. NO PREEMPTIVE RIGHTS. Except for the rights of the holders of Series B Stock set forth in any agreement with the Corporation that grants purchase rights in respect of future issuance of securities by the Corporation, no holder of the Series B Stock, as such, shall have any preemptive rights to subscribe for shares, obligations, warrants, or other securities of the Corporation, of this or any other class or series, whether now or hereafter authorized. 6. REDEMPTION. The shares of Series B Stock shall not be subject to mandatory redemption under any event (whether at the option of the Corporation, the holder, upon the occurrence of any event or otherwise). The Corporation may not purchase or redeem any shares of Series B Stock without the prior written consent of the holders of a majority of the 8 issued and outstanding Series B Stock. 7. NOTICES. Notices to this Corporation with respect to the Series B Stock shall be addressed to the attention of the Secretary at the principal office of the Corporation (909 S. 336th, Suite 110, Federal Way, Washington, 98003) or to such other place as the Corporation may from time to time direct by written notice to all holders of the Series B Stock. Any notice required by the provisions hereof to be given to the holders of the shares of the Series B Stock shall be deemed given only if sent by facsimile, express overnight, registered or certified mail, postage prepaid, and addressed to each of the holders of record of the Series B Stock at the addresses shown for such holders in the stock transfer books of the Corporation. 8. WAIVER; AMENDMENT. Except as otherwise provided, any provision of this Statement of Rights and Preferences may be waived (i) by any individual holder of Series B Stock, with respect to such holder; or (ii) by the consent of the holders of a majority of all outstanding shares of Series B Stock, with respect to all holders of Series B Stock. Any provision of this Statement of Rights and Preferences may be amended by the vote or consent, either in writing or at a meeting, of the holders of a majority of the shares of Series B Stock then outstanding. 9. NO IMPAIRMENT. This Corporation will not, by amendment of its Articles of Incorporation or through any reorganization, recapitalization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by this Corporation but will at all times in good faith assist in the carrying out of all the provisions of this Statement of Rights and Preferences and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holders of the Series B Stock against impairment. 9 STATE OF WASHINGTON [SEAL] SECRETARY of STATE I, RALPH MUNRO, SECRETARY OF STATE OF THE STATE OF WASHINGTON AND CUSTODIAN OF ITS SEAL, hereby issue this CERTIFICATE OF AMENDMENT to FREEI NETWORKS, INC. a Washington Profit corporation. Articles of Amendment were filed for record in this office on the date indicated below. UBI Number: 601 902 953 Date: August 12,1999 [SEAL] GIVEN UNDER MY HAND AND THE SEAL OF THE STATE OF WASHINGTON AT OLYMPIA, THE STATE CAPITAL /s/ Ralph Munro ------------------------------------ RALPH MUNRO, SECRETARY OF STATE State of Washington Corporations Division Office of the Secretary of State ARTICLES OF AMENDMENT OF FREEI NETWORKS, INC. Pursuant to ARTICLE VI and RCW 23B.06.020 of the Washington Business Corporation Act, the Board of Directors hereby adopts and incorporates the attached Statement of Rights and Preferences of Series A Preferred Stock to the corporation's Articles of Incorporation: 1. The name of the corporation is Freei Networks, Inc. 2. The text of each amendment as adopted is as follows: ARTICLE VI of the Articles of Incorporation shall be amended to adopt and incorporate the attached Statement of Rights and Preferences of Series A Preferred Stock. 3. No amendment provides for an exchange, reclassification, or cancellation of issued shares. 4. The date of adoption of each amendment was August 9, 1999, by the Board of Directors. Shareholder action was not required. 5. These Articles will be effective upon filing. Dated: August 8th, 1999. FREEI NETWORKS, INC. By: /s/ Robert G. McCausland ------------------------------------- Robert G. McCausland, President and Secretary EXHIBIT A FREEI NETWORKS, INC. 4,812,074 SHARES SERIES A CONVERTIBLE PREFERRED STOCK, NO PAR VALUE STATED VALUE - $2.0781 PER SHARE STATEMENT OF RIGHTS AND PREFERENCES The rights, preferences, privileges, and limitations granted to and imposed on the Series A Convertible Preferred Stock (the "SERIES A STOCK"), which series shall consist of 4,812,074 shares, are as set forth below. 1. DIVIDENDS. 1.1 The holders of the Series A Stock shall be entitled to receive dividends at the rate of $0.166248 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) per annum, payable out of funds legally available therefor. Such dividends shall be non-cumulative and payable only when, as, and if declared by the Board of Directors, but always in preference and priority to any payment of dividends on the Common Stock of the Corporation. After payment of any such dividends on the Series A Stock, the Series A Stock shall participate PARI PASSU (on an as-converted basis) with the Common Stock of the Corporation in any dividend paid thereon. No dividends (other than those payable solely in the Common Stock of the Corporation) shall be paid on any Common Stock of the Corporation during any fiscal year of the Corporation until dividends in the total amount of $0.166248 per share (as adjusted for any stock dividends, combinations or splits with respect to such shares) on the Series A Stock shall have been paid or declared and set apart during the fiscal year. 1.2 No dividend shall be paid on or declared and set apart for, nor shall any distribution be made upon, the Common Stock of the Corporation (other than a dividend or distribution payable in shares of Common Stock), nor shall any shares of Common Stock be purchased or redeemed by the Corporation (other than pursuant to the Corporation's repurchase rights under its standard stock option and stock purchase agreements with employees, directors, and consultants), nor shall any moneys be paid to or made available for a sinking fund for the purchase or redemption of any Common Stock, unless in each instance (a) a like dividend for the same dividend period, ratably in proportion to the annual dividend rate fixed for the Series A Stock, shall be paid on or declared and set apart for the Series A Stock, and (b) the holders of a majority of the issued and outstanding Series A Stock shall have consented in writing to such action. 1 1.3 In the event that the Corporation shall declare a distribution (other than a distribution described in Section 1.1 or 1.2) payable in securities of other persons, evidences of indebtedness, non-cash assets, or options or rights to purchase any such securities or indebtedness, then, in each case, the holders of the Series A Stock shall be entitled to a proportionate share of any such distribution as though they were the holders of the number of shares of Common Stock of the Corporation into which their respective shares of Series A Stock are convertible as of the record date fixed for the determination of the holders of the Common Stock of the Corporation entitled to receive such distribution. 2. LIQUIDATION 2.1 Upon any liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the holders of the shares of Series A Stock shall be entitled, before any distribution or payment is made upon any Common Stock, to be paid an amount equal to the $2.0781 (the "STATED VALUE") per share (as adjusted for any stock dividends, combinations or splits with respect to such shares), plus an amount equal to all declared and unpaid dividends thereon, such amounts referred to herein as the "LIQUIDATION PREFERENCE PAYMENTS." Upon any such liquidation, dissolution or winding-up of the Corporation, after the holders of the Series A Stock shall have been paid in full the amounts to which they shall be entitled, the remaining net assets of the Corporation may be distributed to the holders of Common Stock. 2.2 If upon such liquidation, dissolution or winding-up of the Corporation, whether voluntary or involuntary, the assets to be distributed among the holders of Series A Stock of the Corporation shall be insufficient to permit payment to the holders of Series A Stock of the Liquidation Preference Payments, then the entire assets of the Corporation legally permitted to be distributed shall be distributed ratably among the holders of Series A Stock in proportion to the Liquidation Preference Payments that each such holder otherwise would have been entitled to receive. 2.3 Written notice of such liquidation, dissolution or winding-up, stating a payment date, the amount of the Liquidation Preference Payments, and the place where said sums will be payable shall be given by mail, postage prepaid, not less than 30 days prior to the payment date stated therein, to the holders of record of the Series A Stock, such notice to be addressed to each shareholder at his or its mailing address as shown by the records of the Corporation. 2.4 The sale, lease or other disposition by the Corporation of all or substantially all of its assets or the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity surviving such transaction shall be deemed to be a liquidation, dissolution or winding-up of the Corporation within the meaning this Section 2. 2 3. CONVERSION. 3.1 VOLUNTARY CONVERSION. 3.1.1 Subject to the terms and conditions of this Section 3, the holder of any share or shares of Series A Stock shall have the right, at its option at any time, to convert any such shares of Series A Stock into such number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation as is obtained by (i) multiplying the number of shares of Series A Stock to be converted by the Stated Value and (ii) dividing the result by the Conversion Price (as defined below). The term "CONVERSION PRICE" shall mean $2,0781 per share, as adjusted and in effect pursuant to this Section 3, at the date any share or shares of Series A Stock are surrendered for conversion. 3.1.2 The rights of conversion contained in Section 3.1.1 may be exercised by the holder of shares of Series A Stock by giving written notice that such holder elects to convert a stated number of shares of Series A Stock into Common Stock, and by surrender of a certificate or certificates for the shares so to be converted to the Corporation at its principal office (or such other office or agency of the Corporation as the Corporation may designate by notice in writing to the holder or holders of the Series A Stock) at any time during its usual business hours, together with a statement of the name or names (with address) in which the certificate or certificates for shares of Common Stock shall be issued. Upon any liquidation, dissolution or winding-up of the Corporation, the right of conversion shall terminate at the close of business on the last full business day next preceding the date fixed for payment of the Liquidation Preference Payments. 3.1.3 All rights, preferences, and privileges granted to the Series A Stock, including, without limitation, the right to receive any declared but unpaid dividends, shall terminate with respect to any shares of Series A Stock upon the conversion thereof into Common Stock. 3.2 UPON ELECTION OF SERIES A STOCK HOLDERS. All outstanding shares of Series A Stock shall, upon the vote or written consent of the holders of not less than a majority of the then-outstanding shares of Series A Stock, be automatically converted into the number of validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation calculated in the manner set forth in Section 3.1.1 without any further action by the holders of such shares. Notice hereof shall be given by the Corporation to the holders of Series A Stock within 30 days of such vote or consent. The effective date of such conversion hereunder shall be the date specified in the vote causing conversion, or if no such date is specified, the date such vote is taken. 3.3 MANDATORY CONVERSION. 3.3.1 Each share of the Series A Stock shall be converted automatically into validly issued, fully paid, and nonassessable whole shares of Common Stock of the Corporation upon the earliest of (i) the closing of an underwritten public offering of shares of 3 the Common Stock of the Corporation at a public offering price of not less than ten dollars ($10.00) per share and an aggregate public offering price of not less than twenty million dollars ($20,000,000). 3.4 ADJUSTMENT OF CONVERSION PRICE. The Conversion Price shall be subject to adjustment from time to time as follows: 3.4.1 ADJUSTMENT FOR STOCK SPLITS AND COMBINATIONS. If the Corporation, at any time or from time to time after the Series A Stock is issued, shall effect a subdivision or split of the outstanding Common Stock, the Conversion Price then in effect immediately before that subdivision or split shall be proportionately decreased. Conversely, if this Corporation at any time or from time to time after the Series A Stock is issued shall combine the outstanding shares of Common Stock, the Conversion Price then in effect immediately before the combination shall be proportionately increased. Any adjustment under this Section 3.4.1 shall become effective at the close of business on the date the subdivision, split or combination becomes effective. 3.4.2 ADJUSTMENT FOR CERTAIN DIVIDENDS AND DISTRIBUTIONS. If the Corporation at any time or from time to time after the Series A Stock is issued shall make or issue, or fix a record date for the determination of holders of Common Stock entitled to receive, a dividend or other distribution payable in additional shares of Common Stock, then and in each such event the Conversion Price then in effect shall be decreased as of the time of such issuance or, in the event such a record date shall have been fixed, as of the close of business on such record date, by multiplying the Conversion Price for such Series A Stock then in effect by a fraction: (i) the numerator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date; and (ii) the denominator of which shall be the total number of shares of Common Stock issued and outstanding immediately prior to the time of such issuance or the close of business on such record date plus the number of shares of Common Stock issuable in payment of such dividend or distribution; provided, however, that if such record date shall have been fixed and such dividend is not fully paid or if such distribution is not fully made on the date fixed therefor, the Conversion Price for such Series A Stock shall be recalculated accordingly as of the close of business on such record date, and thereafter the Conversion Price for Series A Stock shall be adjusted pursuant to this Section 3.4.2 as of the time of actual payment of such dividends or distributions. 3.4.3 ADJUSTMENT FOR RECLASSIFICATION, EXCHANGE OR SUBSTITUTION. If the Common Stock issuable upon the conversion of the Series A Stock shall be changed into the same or a different number of shares of any class or classes of stock, whether by capital reorganization, reclassification, or otherwise (other than a subdivision or combination of shares 4 or stock dividend provided for above), then and in each such event the holder of each share of Series A Stock shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, reclassification or other change, by holders of the number of shares of Common Stock into which such shares of Series A Stock might have been converted immediately prior to such reorganization, reclassification or change, all subject to further adjustment as provided herein. 3.4.4 ADJUSTMENT FOR DILUTIVE ISSUANCE. If the Corporation at any time or from time to time issues additional shares of Common Stock or any securities convertible, exercisable or exchangeable into shares of Common Stock ("COMMON STOCK EQUIVALENTS") for a consideration per share of Common Stock less than the Conversion Price in effect on the date immediately prior to such issuance (a "DILUTIVE ISSUANCE"), then and in such event, the Conversion Price for the Series A Stock shall be adjusted, concurrently with such issue, according to the following formula: CP X (X + (Y/CP)) ----------------- (X + Z) where: CP = Conversion Price in effect immediately prior to the Dilutive Issuance; X = Number of shares of Common Stock outstanding immediately prior to the Dilutive Issuance; Y = Aggregate proceeds of the Dilutive Issuance; and Z = Number of additional shares of Common Stock issued in the Dilutive Issuance (or issuable upon exercise or exchange for, or conversion into, shares of Common Stock, in the case of a Dilutive Issuance of Common Stock Equivalents). For purposes of the above calculation, the number of shares of Common Stock outstanding immediately prior to a Dilutive Issuance shall be calculated on a fully diluted basis, as if all shares of Series A Stock and all outstanding Common Stock Equivalents had been fully exchanged or exercised for, or converted into, shares of Common Stock immediately prior to such issuance. Notwithstanding the foregoing, a Dilutive Issuance shall not include the issuance, regardless of offering price, of (i) of up to an aggregate of 4,210,564 shares of Common Stock or Common Stock Equivalents (as adjusted for any stock dividends, combinations or splits with respect thereto), net of any repurchases by the Corporation of its Common Stock or Common Stock Equivalents and any expirations of any options, warrants, or other Common Stock Equivalents), to employees, officers, directors, consultants, contractors or advisors of the Corporation pursuant to stock purchase or stock option plans or agreements or other incentive 5 stock arrangements on terms unanimously approved by the Board of Directors, (ii) shares of Common Stock or Common Stock Equivalents issued to leasing companies, landlords, lenders and other vendors of goods and services to the Corporation; (iii) 165,775 shares of Common Stock issuable upon exercise of a warrant issued to Ascend Communications, Inc., (iv) 153,987 shares of Common Stock issuable upon exercise of a warrant issued to Pacific Crest Securities, and (v) 1,439,500 shares of Common Stock issuable upon exercise of warrants initially issued to 22 investors on March 9, 1999. 3.4.5 ADJUSTMENT NOTICE. Whenever the Conversion Price shall be adjusted as provided in this Section 3.3, this Corporation promptly shall file, at the office of the Secretary of this Corporation and any transfer agent for the Series A Stock, a statement, signed by its President or any Vice President and by its Treasurer, an Assistant Treasurer, its Secretary or an Assistant Secretary, showing in detail the facts requiring such adjustment and the Conversion Price that shall be in effect after such adjustment. This Corporation shall also cause a copy of such statement to be sent by mail, first-class postage prepaid, to each holder of shares of Series A Stock at each such holder's address appearing on this Corporation's records. Where appropriate, such copy may be given in advance and may be included as part of a notice required to be mailed under the provisions of subsection 3.3.7 following. 3.4.6 NOTICE OF ACTION. In the event this Corporation shall propose to take any action of the types described in subsection 3.4.1, 3.4.2, 3.4.3, or 3.4.4, the Corporation shall give notice to each holder of shares of Series A Stock, in the manner set forth in subsection 3.4.5, which notice shall specify the record date, if any, with respect to any such action and the date on which such action is to take place. Such notice shall also set forth such facts with respect thereto as shall be reasonably necessary to indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the Conversion Price and the number, kind or class of shares or other securities or property which shall be deliverable or purchasable upon the occurrence of such action or deliverable upon conversion of shares of Series A Stock. In the case of any action that would require the fixing of a record date, such notice shall be given at least ten days prior to the date so fixed, and in case of all other action, such notice shall be given at least 20 days prior to the taking of such proposed action. Failure to give such notice, or any defect therein, shall not affect the legality or validity of any such action. 3.5 NO FRACTIONAL SHARES OR ADJUSTMENTS. No fractional shares of Common Stock shall be issued upon conversion of any Series A Stock, but in lieu of fractional shares this Corporation shall pay an amount In cash equal to the fair value of such fractional interest. If the Common Stock is listed on an exchange or market, the fair value shall be the closing price thereon as of the day preceding the date of conversion, or if traded on the over-the-counter market, the average of the closing bid and asked prices on such date; if such stock is not publicly traded, the fair value shall be as determined in good faith by the Board of Directors. No adjustment in the Conversion Price shall be made if such adjustment would result in a change of less than one cent ($0.01) thereto. Any adjustment of less than one cent ($0.01) that is not made shall be carried forward and made at the time of and together with any subsequent adjustment that, on a cumulative basis, amounts to an adjustment of one cent 6 ($0.01) or more in the Conversion Price. 3.6 RESERVED SHARES. As long as any of the Series A Stock remains outstanding, this Corporation shall take all steps necessary to reserve and keep available a number of its authorized but unissued shares of Common Stock sufficient for issuance upon conversion of all such outstanding shares of Series A Stock. 4. VOTING RIGHTS. 4.1 Except as otherwise provided by law and the Articles of Incorporation, as amended, the holders of Series A Stock shall be entitled to notice of any meeting of the shareholders of the Corporation (the "SHAREHOLDERS") in accordance with the Bylaws of the Corporation and to vote, together with the holders of Common Stock as a single class, on any matter submitted to the Stockholders for a vote as follows: (i) the holders of Series A Stock shall have one vote for each share of Common Stock such holder would have if such holder converted all of its shares of Series A Stock into Common Stock pursuant to Section 3, and (ii) the holders of Common Stock shall have one vote per share. 4.2 The Board of Directors shall consist of five members. The members of the Board of Directors shall be elected at each meeting or pursuant to each consent of the Corporation's shareholders for the election of directors, as follows: (i) The holders of the Series A Stock, voting as a class, shall be entitled to elect one member of the Board of Directors; (ii) The holders of the Common Stock, voting as a class, shall be entitled to elect two members of the Board of Directors; and (iii) The holders of the Series A Stock and the holders of the Common Stock, voting as separate classes, together shall be entitled to elect two members of the Board of Directors. 4.3 For so long as at least 1,000,000 shares of Series A Stock shall remain outstanding, the Corporation shall not, without the affirmative vote or written consent of the holders of not less than a majority of the then outstanding shares of Series A Stock: (i) amend of change any of the rights, preferences, privileges or powers of, or the restrictions provided for the benefit of, the Series A Stock; (ii) take any action that authorizes, creates or issues shares of any class of stock having preferences superior to or on a parity with the Series A Stock; (iii) take any action that reclassifies any outstanding shares into shares having preferences or priority as to dividends or assets senior to or on a parity with the preferences of the Series A Stock; 7 (iv) amend the Corporation's Articles of Incorporation in any manner that could adversely affect the rights of the Series A Stock; (v) authorize the acquisition of the Corporation by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Corporation's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity; (vi) undertake the sale, lease or other disposition by the Corporation of all or substantially all of its assets; (vii) authorize the liquidation of dissolution of the Corporation; (viii) declare or pay any dividends on the Common Stock or Series A Stock or (other than a dividend payable solely in shares of Common Stock); (ix) take any action that increases or decreases the authorized number of shares of Common Stock or Series A Stock; or (x) redeem any shares of Common Stock (other than pursuant to equity incentive agreements with service providers that grant the Corporation the right to repurchase such shares upon the termination of services). 5. NO PREEMPTIVE RIGHTS. Except for the rights of the holders of Series A Stock set forth in any agreement with the Corporation that grants purchase rights in respect of future issuance of securities by the Corporation, no holder of the Series A Stock, as such, shall have any preemptive rights to subscribe for shares, obligations, warrants, or other securities of the Corporation, of this or any other class or series, whether now or hereafter authorized. 6. REDEMPTION. The shares of Series A Stock shall not be subject to mandatory redemption under any event (whether at the option of the Corporation, the holder, upon the occurrence of any event or otherwise). The Corporation may not purchase or redeem any shares of Series A Stock without the prior written consent of the holders of a majority of the issued and outstanding Series A Stock. 7. NOTICES. Notices to this Corporation with respect to the Series A Stock shall be addressed to the attention of the Secretary at the principal office of the Corporation or to such other place as the Corporation may from time to time direct by written notice to all holders of the Series A Stock. Any notice required by the provisions hereof to be given to the holders of the shares of the Series A Stock shall be deemed given only if sent by registered or certified mail, postage prepaid, and addressed to each of the holders of record of the Series A Stock at the addresses shown for such holders In the stock transfer books of the Corporation. 8 8. WAVER; AMENDMENT. Except as otherwise provided, any provision of this Statement of Rights and Preferences may be waived (i) by any individual holder of Series A Stock, with respect to such holder; or (ii) by the consent of the holders of a majority of all outstanding shares of Series A Stock, with respect to all holders of Series A Stock. Any provision of this Statement of Rights and Preferences may be amended by the vote or consent, either in writing or at a meeting, of the holders of a majority of the shares of Series A Stock then outstanding. 9 STATE OF WASHINGTON [SEAL] SECRETARY of STATE I, RALPH MUNRO, SECRETARY OF STATE OF THE STATE OF WASHINGTON AND CUSTODIAN OF ITS SEAL, hereby issue this CERTIFICATE OF AMENDMENT TO FREEI NETWORKS, INC. a Washington Profit corporation. Articles of Amendment were filed for record in this office on the date indicated below. UBI Number: 601 902 953 Date: July 21, 1999 [SEAL] GIVEN UNDER MY HAND AND THE SEAL OF THE STATE OF WASHINGTON AT OLYMPIA, THE STATE CAPITAL /s/ Ralph Munro ------------------------------------------- RALPH MUNRO, SECRETARY State of Washington Corporations Division Office of the Secretary of State ARTICLES OF AMENDMENT OF FREEI NETWORKS, INC. Pursuant to RCW 23B.10.060 of the Washington Business Corporation Act, the undersigned corporation hereby submits the following amendments to the corporation's Articles of Incorporation: 1. The name of the corporation is Freei Networks, Inc. 2. The text of each amendment as adopted is as follows: Article IV of the Articles of Incorporation shall be amended in its entirety to read as follows: ARTICLE IV NO PREEMPTIVE RIGHTS Except as may otherwise be provided by the Board of Directors, no preemptive rights shall exist with respect to shares of stock or securities convertible into shares of stock of this corporation. Article V of the Articles of Incorporation shall be amended in its entirety to read as follows ARTICLE V NO CUMULATIVE VOTING At each election of directors, every shareholder entitled to vote at such election has the right to vote in person or by proxy the number of shares held by such shareholder for as many persons as there are directors to be elected. No cumulative voting for directors shall be permitted. -1- Article VI of the Articles of Incorporation shall be amended in its entirety to read as follows ARTICLE VI AUTHORIZED CAPITAL A . AUTHORIZED SHARES. This corporation is authorized to issue Fifty Million (50,000,000) shares of common capital stock with no par value, and Ten Million (10,000,000) shares of preferred capital stock with no par value. B. ISSUANCE OF PREFERRED STOCK IN SERIES. The preferred stock may be issued from time to time in one or more series in any manner permitted by law and the provisions of these Articles of Incorporation of the corporation, as determined from time to time by the Board of Directors and stated in the resolution or resolutions providing for the issuance thereof, prior to the issuance of any shares thereof. The Board of Directors shall have the authority to fix and determine and to amend, subject to the provisions hereof, the designation, preferences, limitations and relative rights of the shares of any series that is wholly unissued or to be established. Unless otherwise specifically provided in the resolution establishing any series, the Board of Directors shall further have the authority, after the issuance of shares of a series whose number it has designated, to amend the resolution establishing such series to decrease the number of shares of such series then outstanding. C. DIVIDENDS. The holders of shares of preferred stock shall be entitled to receive dividends, out of the funds of the corporation legally available therefor, at the rate and at the time or times, whether cumulative or noncumulative, as may be provided by the Board of Directors in designating a particular series of preferred stock. If such dividends on any preferred stock shall be cumulative, then if dividends shall not have been paid, the deficiency shall be fully paid or the dividends declared and set apart for payment at such rate, but without interest on cumulative dividends, before any dividends on the common stock shall be paid or declared and set apart for -2- payment. The holders of the preferred stock shall not be entitled to receive any dividends thereon other than the dividends referred to in this section. D. REDEMPTION. Preferred stock may be redeemable at such price, in such amount, and at such time or times as may be provided by the Board of Directors in designating a particular series of preferred stock. In any event, such preferred stock may be repurchased by the corporation to the extent legally permissible. E. LIQUIDATION. In the event of any liquidation, dissolution, or winding up of the affairs of the corporation, whether voluntary or involuntary, then, before any distributions shall be made to the holders of common stock, the holders of preferred stock at the time outstanding shall be entitled to be paid the preferential amount or amounts per share as may be provided by the Board of Directors in designating a particular series of preferred stock and dividends accrued thereon to the date of such payment. The holders of preferred stock shall not be entitled to receive any distributive amounts upon the liquidation, dissolution, or winding up of the affairs of the corporation other than the distributive amounts referred to in this section, unless otherwise provided by the Board of Directors in designating a particular series of preferred stock. F. CONVERSION. Shares of preferred stock may be convertible into common stock of the corporation upon such terms and conditions, at such rate and subject to such adjustments as may be provided by the Board of Directors in designating a particular series of preferred stock. The Board of Directors is hereby expressly authorized to issue the preferred capital stock of this corporation in one or more series as it may determine by resolution from time to time. In the resolution establishing a series, the Board of Directors shall give to the series a distinctive designation so as to distinguish it from all other series and classes of stock, shall determine the number of shares in such series and shall fix the preferences, limitations and relative rights thereof -3- A new Article XI shall be added and shall read as follows: ARTICLE XI SHAREHOLDER ACTION WITHOUT MEETING Section 1. ACTION BY LESS THAN UNANIMOUS SHAREHOLDER CONSENT. To the extent permitted by RCW 23B.07.040, action may be taken by shareholders without a vote or a meeting, provided, the action is taken in writing by shareholders holding of record or otherwise entitled to vote in the aggregate not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote on the action were present and voted, and at the time the action is taken the corporation is not a public company. Section 2. NOTICE. Except as otherwise provided in RCW 23B.07.040, any Shareholder action taken pursuant to Section I above shall not be effective until five (5) days after the mailing of a notice of the proposed action to the nonconsenting shareholders. 3. No amendment provides for an exchange, reclassification, or cancellation of issued shares. 4. The date of adoption of each amendment was April 12, 1999. 5. The amendments were adopted by duly approved shareholder action in accordance with the provisions of RCW 23B.10.030 and RCW 23B.10.040. 6. These Articles will be effective upon filing. Dated: June 15th, 1999. /s/ Robert McCausland ----------------------------- Robert McCausland, President -4- STATE of WASHINGTON [SEAL] SECRETARY of STATE 1, RALPH MUNRO, SECRETARY OF STATE OF THE STATE OF WASHINGTON AND CUSTODIAN OF ITS SEAL, hereby issue this CERTIFICATE OF AMENDMENT to FREEI NETWORKS, INC. a Washington Profit corporation. Articles of Amendment were filed for record in this office on the date indicated below. UBI Number: 601 902 953 Date: January 22, 1999 [SEAL] GIVEN UNDER MY HAND AND THE SEAL OF THE STATE OF WASHINGTON AT OLYMPIA, THE STATE CAPITAL /s/ Ralph Munro --------------------------------------- RALPH MUNRO, SECRETARY OF STATE ARTICLES OF AMENDMENT Pursuant to the provisions of RCW 23B.10.020 of the Washington Business Corporation Act, the following Articles of Amendment to Articles of Incorporation are herewith submitted for filing. ARTICLE 1: The name of record of the corporation is: FREEI NETWORKS, INC. ARTICLE 2: The amendment(s) to the Articles of incorporation is (are) adopted as follows: ARTICLE VI shall read as follows: AUTHORIZED CAPITAL STOCK The authorized capital stock of the corporation which may be issued shall consist of the following: 50,000,000 shares of non par common voting stock. ARTICLE 3: The date of adoption of the amendment was: December 18, 1998 1 certify that I am an officer of the above-named corporation and am authorized to execute these Articles on behalf of the corporation. Dated this 18th day of December, 1998 /s/ Robert McCausland ------------------------ Robert McCausland President STATE of WASHINGTON [SEAL] SECRETARY of STATE I, RALPH MUNRO, SECRETARY OF STATE OF THE STATE OF WASHINGTON AND CUSTODIAN OF ITS SEAL, hereby issue this CERTIFICATE OF INCORPORATION to FREEI NETWORKS, INC. a Washington Profit corporation. Articles of Incorporation were filed for record in this office on the date indicated below. UBI Number 601 902 953 Date: September 22, 1998 [SEAL] GIVEN UNDER MY HAND AND THE SEAL OF THE STATE OF WASHINGTON AT OLYMPIA, THE STATE CAPITAL /s/ Ralph Munro -------------------------------------- RALPH MUNRO, SECRETARY OF STATE ARTICLES OF INCORPORATION OF FREEI NETWORKS, INC. I, Robert McCausland, a resident of the State of Washington, citizen of the United States of America and being over the age of 21 years, do hereby certify and adopt in duplicate the following Articles of Incorporation for purposes of forming a corporation under the Washington Business Corporation Act. ARTICLE I NAME AND DURATION The name of the corporation shall be Freei Networks, Inc., and its existence shall be perpetual. ARTICLE II REGISTERED OFFICE AND AGENT The location and post office address of the registered office of the corporation in this state shall be CT Corporation System, 520 Pike Street, Seattle, Washington 98101. The registered agent of the corporation shall be CT Corporation System, whose address is 520 Pike Street, Seattle, Washington 98101. ARTICLE III PURPOSES The purposes and objects for which this corporation is formed are, in the corporation's own behalf or in partnership or association with others: 1. To engage as an internet-based provider of information and services. 2. To engage in generally and carry on any lawful business or trade which may, in the judgment of the Board of - 1 - Directors, at any time to be necessary, useful or advantageous to this corporation. 3. In furtherance and not in limitation of the general powers conferred by the laws of the State of Washington, it is expressly provided that this corporation shall also the following powers: a. To acquire by purchase or otherwise and to own, hold, cancel, reissue, sell, pledge and otherwise deal in the stock of this corporation; b. To acquire by purchase or otherwise and to own, hold, cancel, reissue, sell, pledge and otherwise deal in the bonds, debentures, notes and other securities and obligations of this corporation; c. To borrow money and to give security therefor; d. To indemnify, guarantee and hold harmless the obligations of other parties, businesses and corporations, whether or not owned in whole or in part by this corporation, provided that such promise be in consideration for some benefit, direct or indirect, to this corporation; e. To enter into, make, perform and carry out contracts of every kind for any lawful purposes pertaining to its business, with any individual, entity, firm, association or corporation, or with any governmental, municipal or public authority, domestic or foreign; f. To do everything necessary, proper, convenient or incidental to the accomplishment of the purposes and objects of, this corporation or which is calculated directly or indirectly to promote the welfare or interest of the corporation or enhance the value or render profitable any of its property or rights; g. To do any and all of the things in this Article set forth to the same extent a - 2 - natural person might or could do, and in any part of the world, as principal, agents, contractors, trustees, or otherwise, either alone or in company with others; h. To hold shares of stock in other corporations; to act as a joint venturer and/or a partner either general or limited, or both, in any transaction, business or venture. ARTICLE IV PREEMPTIVE RIGHTS Shareholders of this corporation shall have preemptive rights to acquire additional share offered for sale by the corporation. ARTICLE V CUMULATIVE VOTING Cumulative voting shall be allowed by the shareholders of this corporation. ARTICLE VI AUTHORIZED CAPITAL The authorized capital stock of the corporation which may be issued shall consist of the following: 1,000,000 shares of non par common voting stock. ARTICLE VII MANAGEMENT SECTION 1. The management of the corporation shall be vested in a Board of Directors which shall consist of not less than one (1) member. The number, qualifications, terms of office, manner of election, time and place of meetings and powers and duties of the directors shall be such as are prescribed by the Bylaws of the corporation. SECTION 2. The power to adopt, alter, amend or repeal said Bylaws or adopt new Bylaws from time to time - 3 - shall be vested in the Board of Directors as well as the Shareholders in accordance with Washington State law. SECTION 3. The corporation may enter into contracts and otherwise transact business as vendor, purchaser, or otherwise, with its directors, officers and stockholders with corporations, associations, firms and entities in which they are or may be or become interested as directors, officers, shareholders, members or otherwise, as freely as though such adverse interests did not exist, even though the vote, action, or presence of such director, officer or stockholder may be necessary to obligate the corporation upon such contracts or transactions; and in the absence of fraud, no such contract or transaction shall be voided and no such director, officer or stockholder shall be held liable to account to the corporation, by reason of such office or stock ownership, for any profit or benefit realized by him through any such contract or transaction, provided that in the case of directors and officers off the corporation (but not in the case of stockholders who are not directors or officers) the nature of the interest of such director or officer, though not necessarily the details or expense thereof, be disclosed or known to the Board of Directors of the corporation at the meeting thereof at which such contract or transaction is authorized or confirmed. A general notice that a director or officer of the corporation is interested in any corporation, association, firm or entity shall be sufficient to disclosure as to such director or officer with respect to all contracts and transactions with that corporation, association, firm or entity. SECTION 4. Any contract, transaction or act of the corporation or of the directors or of any officers of the corporation which shall be ratified by a majority of a quorum of the stockholders of the corporation at any annual meeting or any special meeting called for such purpose shall, insofar as permitted bylaw, be as valid and as - 4 - binding as though ratified by every stockholder of the corporation. SECTION 5. The corporation shall be entitled to treat registered holder of any share or shares of stock as the absolute owner thereof and, accordingly, shall not, except as ordered by a court of competent jurisdiction or as by statute required, be bound to recognize any equitable or other claim to or interest in such shares or shares on the part off any person, firm or corporation. The corporation shall have a first lien upon the shares of stock of the shareholders and upon all dividends due them or any indebtedness, liquidated or unliquidated, of the said shareholders to the corporation. ARTICLE VIII INDEMNIFICATION SECTION 1. Any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit, or proceedings, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director, officer, employee or agent of this corporation, or is or was serving at the request of this corporation as a director, officer, principal, partner, employee or agent of another corporation shall be indemnified against expenses (including attorney's fees), judgments, fines and amounts paid in settlement, actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner he reasonably believed to be in or not opposed to be the best interest of this corporation, and, with respect to any criminal action of proceeding, he had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, -5- settlement, conviction, or upon a plea of note contendere or its equivalent, shall not, or itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, nor, with respect to any criminal action or proceeding, that he had reasonable cause to believe that his conduct was unlawful. SECTION 2. When any director, officer, employee or agent of the corporation shall have been successful in defending on the merits or otherwise of any action, suit or proceeding referred to in Section 1 of this Article, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorney's fees) actually and reasonably incurred by him upon providing appropriate evidence and substantiation thereof to the Board of Directors. SECTION 3. Any indemnification under Section 1 herein (unless specifically ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification is proper in the circumstances because the director, officer, employee or agent has met the applicable standards of conduct set in Section 1. Such determination shall be made: a. By court order; or b. By a majority vote of a quorum of the Board of Directors consisting of directors who were not parties to such action, suit or proceeding; or c. If such a quorum is not obtainable, or, even if obtainable and a quorum of disinterested directors so direct, then a majority of all directors based on a written opinion of independent counsel; or d. By a vote of shareholders. SECTION 4. Expenses incurred in defending a civil or criminal action, suit or proceeding, may be paid by the -6- corporation in advance of the final disposition of such action, suit or proceeding if authorized by the Board of Directors and upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the corporation. SECTION 5. The indemnification provided by this Article shall not be deemed to be exclusive of any other right to which a person seeking indemnification may be entitled under any Bylaws, agreement, vote of the shareholders or disinterested or otherwise, both as to action in this official capacity and as to action in another capacity while holding such office and shall continue as to a person who has ceased to be a director, officer, employee, or agent, or who has ceased to serve at the request of he corporation as a director, officer, principal, partner, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, and shall inure to the benefit of the heirs, executors, administrators and assigns of such a person. ARTICLE IX DIRECTORS The first directors of this corporation shall be one (1) in number and his name and address is as follows: Robert McCausland 2521 - 208th Avenue East Sumner, Washington 98390 The term of the first directors shall be for a period of one year or until their successors are elected. - 7 - ARTICLE X INCORPORATOR The name and address of the sole incorporator hereof is: Robert McCausland, 2521 208th Avenue East,Sumner, Washington 98390. Signed and dated this 17th day of Sept., 1998. /s/ Bob McCausland --------------------------- Incorporator STATE OF WASHINGTON ) ) ss. COUNTY OF King ) On this 17th day of September, 1998, before me, the undersigned, a Notary Public in and for the State of Washington, duly commissioned and sworn, personally appeared Robert McCausland to me known to be the individual described in and who executed the foregoing instrument, and acknowledged to me that he signed and sealed the said instrument as his free and voluntary act and deed for the uses and purposes therein mentioned. GIVEN under my hand and official seal the day and year first above written. /s/ Cindy M. Black ----------------------------- NOTARY PUBLIC in and for the State of Washington, residing at [illegible] -------------------. My commission expires: 11/29/99 - 8 - CONSENT TO SERVE AS REGISTERED AGENT C T CORPORATION SYSTEM hereby agrees to serve as Registered Agent in the State of Washington, for the following: FREEI NETWORKS, INC., A WASHINGTON CORPORATION I understand that as agent, it will be my responsibility to receive service of process: to forward and mail; and to immediately notify the Office of the Secretary of State in the event of my resignation, or of any changes in the Registered Office address: /s/ Jack Caskey ------------------------------------ Jack Caskey, Asst.V.P. 9/18/98 ARTICLES OF AMENDMENT OF FREEI NETWORKS, INC. Pursuant to RCW 23B.10.060, the undersigned corporation adopts the following Articles of Amendment to its Articles of Incorporation: FIRST: The name of the corporation is Freei Networks, Inc. (the "Corporation"). SECOND: Paragraph A of Article VI of the Articles of Incorporation is hereby amended in its entirety as follows: ARTICLE VI AUTHORIZED CAPITAL A. AUTHORIZED CAPITAL. This corporation is authorized to issue Four Hundred Million (400,000,0000) shares of common capital stock with no par value, and Twenty Million (20,000,000) shares of preferred capital stock with no par value. THIRD: Article VI of the Articles of Incorporation is hereby amended to increase the number of authorized shares of Series A Convertible Stock from 4,812,074 shares to 9,624,148 shares. FOURTH: Article VI of the Articles of Incorporation is hereby amended to increase the number of authorized shares of Series B Convertible Stock from 1,552,655 shares to 3,105,310 shares. FIFTH: Article VI of the Articles of Incorporation and the Designation of Rights and Preferences filed thereto on March 3, 2000 are hereby amended to increase the number of authorized shares of Series C Convertible Stock from 2,545,430 shares to 3,054,515 shares. SIXTH: Article VIII of the Articles of Incorporation shall be amended in its entirety to read as follows: ARTICLE VIII INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS (a) The capitalized terms in this Article VIII shall have the meanings set forth in RCW 23B.08.500. (b) The corporation shall indemnify and hold harmless each individual who is or was serving as a Director or officer of the corporation or who, while serving as a Director or officer of the corporation, is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against any and all Liability incurred with respect to any Proceeding to which the individual is or is threatened to be made a Party because of such service, and shall make advances of reasonable Expenses with respect to such 1 Proceeding, to the fullest extent permitted by law, without regard to the limitations in RCW 23B.08.510 through 23B.08.550; PROVIDED, HOWEVER, that the payment of Expenses in advance of the final disposition of a Proceeding shall be made upon delivery to the corporation of an undertaking, by or on behalf of such Director or officer, to repay all amounts so advanced if it shall ultimately be determined that such Director or officer is not entitled to be indemnified under this Article or otherwise; PROVIDED FURTHER, that no such indemnity shall indemnify any Director or officer from or on account of (1) acts or omissions of the Director or officer finally adjudged to be intentional misconduct or a knowing violation of law; (2) conduct of the Director or officer finally adjudged to be in violation of RCW 23B.08.310; or (3) any transaction with respect to which it was finally adjudged that such Director or officer personally received a benefit in money, property, or services to which the Director or officer was not legally entitled. Except as provided in Subsection (f) of this Article, the corporation shall not indemnify a Director or officer in connection with a Proceeding (or part thereof) initiated by the Director or officer unless such Proceeding (or part thereof) was authorized by the Board of Directors of the corporation. (c) The corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the corporation or, who, while a director, officer, employee, or agent of the corporation, is or was serving at the request of the corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise against Liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a director, officer, employee, or agent, whether or not the corporation would have power to indemnify the individual against such Liability under RCW 23B.08.510 or 23B.08.520. (d) If, after the effective date of this Article VIII, the Act is amended to authorize further indemnification of Directors or officers, then Directors and officers of the corporation shall be indemnified to the fullest extent permitted by the Act as so amended. (e) To the extent permitted by law, the rights to indemnification and advance of reasonable Expenses conferred in this Article VIII shall not be exclusive of any other right which any individual may have or hereafter acquire under any statute, provision of the Bylaws, agreement, vote of shareholders or disinterested directors, or otherwise. The right to indemnification conferred in this Article VIII shall be a contract right upon which each Director or officer shall be presumed to have relied in determining to serve or to continue to serve as such. Any amendment to or repeal of this Article 6 shall not adversely affect any right or protection of a Director or officer of the corporation for or with respect to any acts or omissions of such Director or officer occurring prior to such amendment or repeal. (f) If a claim under this Article is not paid in full by the corporation within sixty (60) days after a written claim has been received by the corporation, except in the case of a claim for expenses incurred in defending a proceeding in advance of its final disposition, in which case the applicable period shall be twenty (20) days, the claimant may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, to the extent successful in whole or in part, the Director or officer shall be entitled to be paid also the expense of prosecuting such claim. Neither the failure of the corporation (including its Board of Directors, its shareholders or independent legal counsel) to have made a determination prior to the commencement of such action that indemnification of or reimbursement or advancement of expenses to the claimant is proper in the circumstances, nor an actual determination by the corporation (including its Board of Directors, its shareholders or independent legal counsel) that the Director or officer is not entitled to indemnification or to the reimbursement or advancement 2 of expenses, shall be a defense to the action or create a presumption that the Director or officer is not so entitled. (g) If the corporation indemnifies or advances expenses to a Director or officer pursuant to this Article VIII in connection with a Proceeding by or in the right of the corporation, the corporation shall report the indemnification or advance in writing to the shareholders with or before the notice of the next shareholders' meeting. (h) If any provision of this Article VIII or any application thereof shall be invalid, unenforceable, or contrary to applicable law, the remainder of this Article VIII, and the application of such provisions to individuals or circumstances other than those as to which it is held invalid, unenforceable, or contrary to applicable law, shall not be affected thereby. SEVENTH: A new Article XII shall be added and shall read as follows: ARTICLE XII LIMITATION OF DIRECTOR LIABILITY No director of the corporation shall be personally liable to the corporation or its shareholders for monetary damages for his or her conduct as a director on or after the date this Article becomes effective, except for: (i) acts or omissions that involve intentional misconduct or a knowing violation of law by the director, (ii) approval of certain distributions or loans in violation of RCW 23B.08.310, or (iii) any transaction from which the director will personally receive a benefit in money, property or services to which the director is not legally entitled. If, after approval by shareholders of this Article, the Washington Business Corporation Act is amended to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the corporation shall be eliminated or limited to the fullest extent permitted by the Washington Business Corporation Act, as so amended. Any amendment to or repeal of this Article shall not adversely affect any right or protection of a director of the corporation for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. EIGHTH: The amendment does not provide for an exchange, reclassification, or cancellation of issued shares. NINTH: The foregoing amendment was adopted by the Board of Directors of the Corporation on March 24, 2000 and by the shareholders of the Corporation pursuant to RCW 23B.07.040(5) effective _____________, 2000, and written notice to all nonconsenting shareholders has been given pursuant to RCW 23B.07.040(5). Dated: _____________, 2000. Freei Networks, Inc., a Washington corporation By: _____________________________ Robert McCausland, President 3 EX-3.2 3 EXHIBIT 3.2 BYLAWS OF FREEI NETWORKS, INC. ARTICLE I REGISTERED OFFICE AND REGISTERED AGENT The registered office of the corporation shall be located in the State of Washington at such place as may be fixed from time to time by the Board of Directors upon filing of such notices as may be required by law, and the registered agent shall have a business office identical with such registered office. Any change in the registered agent or registered office shall be effective upon filing such change with the office of the Secretary of State of the State of Washington. ARTICLE II SHAREHOLDERS' MEETINGS Section 1. ANNUAL MEETINGS. The annual meeting of the shareholders of this corporation, for the purpose of election of directors and for such other business as may come before it, shall be held at the registered office of the corporation, or such other place as may be designated by the notice of the meeting, on the second Monday of September of each and every year, beginning with the year following the year of incorporation, at the hour of 12 o'clock noon, but in case such day shall be a legal holiday, the meeting shall be held at the same hour and place on the next succeeding day not a holiday. Section 2. SPECIAL MEETINGS. Special meetings of the shareholders of this corporation may be called at any time by the holders of not less than one-tenth of the voting shares of the corporation, or by the President, or by a majority of the Board of Directors. No business shall be transacted at any special meeting of shareholders except as is specified in the notice calling for said meeting. The Board of Directors may designate any place as the place of any special meeting called by the President or the Board of Directors, and special meetings called at the request of shareholders shall be held at such place as may be determined by the Board of Directors and placed in the notice of such meetings. Section 3. NOTICE OF MEETINGS. Written notice of annual or special meetings of shareholders stating the place, day and hour of the meeting, and, in the case of 4 special meeting, -1- the purpose or purposes for which the meeting is called, shall be given by the Secretary or persons authorized to call the meeting to each shareholder of record entitled to vote at the meeting. Such notice shall be given not less than ten (10) nor more than sixty (60) days prior to the date of the meeting, except that notice of a meeting to act on an amendment to the Articles of Incorporation, a plan of merger or share exchange, a proposed sale, lease, exchange or other disposition of all or substantially all of the assets of the corporation other than in the usual or regular course of business, or the dissolution of the corporation shall be given no fewer than twenty (20) days nor more than sixty (60) days before the meeting date. Notice may be transmitted by: mail, private carrier or personal delivery; telegraph of teletype; or telephone, wire or wireless equipment which transmits a facsimile of the notice. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail addressed to the shareholder at his or her address as it appears on the stock transfer books of the corporation. Section 4. WAIVER OF NOTICE. Notice of the time, place and purpose of any meeting may be waived in writing (either before or after such meeting) and will be waived by any shareholder by his or her attendance thereat in person or by proxy, unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting. Any shareholder so waiving shall be bound by the proceedings of any such meeting in all respects as if due notice thereof had been given. Section 5. QUORUM AND ADJOURNED MEETING . Unless otherwise -provided in the Articles of Incorporation, a majority of the outstanding shares of the corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. A quorum of shares of each voting group entitled to vote shall be necessary for the transaction of business at all meetings of the shareholders. A majority of the shares represented at a meeting, even if less than a quorum, may adjourn the meeting from time to time without further notice. At such reconvened meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally notified. The shareholders present at a duly organized meeting may continue to transact business at such meeting and at any adjournment of such meeting (unless a new record date is or must be set for the adjourned meeting), notwithstanding the withdrawal of enough shareholders from either meeting to leave less than a quorum. Section 6. PROXIES. At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder of by his or her duly authorized attorney in fact. Such proxy shall be filed with the Secretary of the corporation before or at the time of the meeting. No proxy shall be valid after eleven (11) months from the date of Us execution, unless otherwise provided in the proxy. Section 7. VOTING RECORD. After fixing a record date for a shareholders' meeting, the corporation shall prepare an alphabetical list of the names of all shareholders on the record date who are entitled to notice of the shareholders' meeting. The list shall be arranged by voting -2- group, and within each voting group by class or series of shares, and show the address of and number of shares held by each shareholder. A shareholder, shareholder's agent, or a shareholder's attorney may inspect the list of shareholders, beginning ten (10) days prior to the shareholders' meeting and continuing through the meeting, at the corporation's principal office or at a place identified in the meeting notice in the city where the meeting will be held during regular business hours and at the shareholder's expense. The list of shareholders shall be kept open for inspection- during such meeting or any adjournment. Failure to comply with the requirements of this Section 7 shall not affect the validity of any action taken at such meeting. Section 8. VOTING OF SHARES. Except as otherwise provided in the Articles of Incorporation or in these Bylaws, every shareholder of record shall have the right at every shareholders' meeting to one vote for every share standing in his or her name on the books of the corporation. Action on a matter, other than the election of directors, shall be approved by a voting group if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action, unless the Articles of Incorporation or the Washington Business Corporation Act, including any amendments or succeeding provisions thereto, require a greater number of affirmative votes. Except as otherwise provided in the Articles of Incorporation, in any election of directors, the candidates elected shall be those receiving the largest number of votes cast by the shares entitled to vote in the election, up to the number of directors to be elected by such shares. Section 9. RECORD DATE. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or any adjournment thereof, or entitled to receive payment of any dividend, the Board of Directors may fix in advance a record date for any such determination of shareholders, such date to be not more than seventy (70) days prior to the date on which the particular action requiring such determination of shareholders is to be taken. If no record date is fixed for the determination of shareholders, or shareholders entitled to receive payment of a dividend, the day before the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. A determination of shareholders entitled to vote at any meeting of shareholders that has been made as provided in this section shall apply to any adjournment thereof, unless the Board of Directors fixes a new record date, which the Board shall do if the meeting is adjourned to a date more than one hundred twenty (120) days after the date fixed for the original meeting. -3- ARTICLE III BOARD OF DIRECTORS Section 1. GENERAL POWERS. All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation shall be managed under the direction of, the Board of Directors, except as otherwise provided by the Washington Business Corporation Act, including any amendments or succeeding provisions thereto, or in the Articles of Incorporation. Section 2. NUMBER. The number of directors of the corporation shall be no less than one and not more than five. The number of directors may be increased or decreased from time to time by amending this Section 2, provided that the number shall be not less than one (1) nor more than ten (10) directors, the specific number to be set by resolution of the Board of Directors or the shareholders. Section 3. TENURE AND QUALIFICATIONS. Each director shall hold office until the next annual meeting of shareholders and until his or her successor shall have been elected and qualified. Directors need not be residents of the State of Washington or shareholders of the corporation. Section 4. ELECTION. The directors shall be elected by the shareholders at their annual meeting each year; and it for any cause, the directors shall not have been elected at an annual meeting, they may be elected at a special meeting of shareholders called for that purpose in the manner provided by these Bylaws. Section 5. VACANCIES. In case of any vacancy in the Board of Directors, including a vacancy resulting from an increase in the number of directors, a majority of the remaining directors, whether constituting a quorum or not, or the shareholders, may fill the vacancy. Section 6. RESIGNATION. Any director may resign at any time by delivering written notice to the Board of Directors, its Chairperson, the President, or the Secretary of the corporation. A resignation shall be effective when the notice is delivered unless the notice specifies a later effective date. Section 7. REMOVAL OF DIRECTORS. At a meeting of shareholders called expressly for that purpose, the entire Board of Directors, or any member thereof, my be removed, with or without cause, only if the number of votes cast to remove the director or directors by the holders of shares then entitled to vote at an election of such director or directors exceeds the number of votes cast not to remove the director or directors -4- Section 8. MEETINGS a. The annual meeting of the Board of Directors shall be held immediately after the annual shareholders' meeting at the same place as the annual shareholders' meeting or at such other place and at such time as may be determined by the Board of Directors. No notice of the annual meeting of the Board of Directors shah be necessary. b. Special meetings may be called at any time and place upon the call of the President, Secretary or one-third of all directors. Notice of the time and place of each special meeting shall be given by the Secretary, or the persons calling the meeting, by mail, private carrier, radio, telegraph, telegram, facsimile transmission, personal communication by telephone or otherwise at least two (2) days in advance of the time of the meeting. The purpose of the meeting need not be given in the notice. Notice of any special meeting may be waived in writing or by telegram (either before or after such meeting) and will be waived by any director by attendance thereat. c. Regular meetings of the Board of Directors shall be held at such place and on such day and hour as shall from time to time be fixed by resolution of the Board of Directors. No notice of regular meetings of the Board of Directors shall be necessary. d. At any meeting of the Board of Directors at which a quorum is present, any business may be transacted, and the Board may exercise all of its powers. Section 9. QUORUM AND VOTING. a. A majority of the directors then in office shall constitute a quorum, but a lesser number may adjourn any meeting from time to time until a quorum is obtained, and no further notice thereof need be given. b. At each meeting of the Board at which a quorum is present, the act of a majority of the directors present at the meeting shall be the act of the Board of Directors. The directors present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough directors to leave less than a quorum. Section 10. COMPENSATION. By resolution of the Board of Directors, the directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each Meeting of the Board of Directors or a stated salary as director. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Section 11. PRESUMPTION OF ASSENT. A director of the corporation who is present Pt 4 meeting of the Board of Directors at which action on any corporate matter is taken shall be -5- presumed to have assented to the action taken unless: a. The director objects at the beginning of the meeting, or promptly upon the director's arrival, to holding it or transacting business at the meeting; b. The director's dissent or abstention from the action taken is entered in the minutes of the meeting; or c. The director delivers written notice of the director's dissent or abstention to the presiding officer of the meeting before its adjournment or to the corporation within a reasonable time after adjournment of the meeting. The right of dissent or abstention is not available to a director who votes in favor of the action taken. Section 12. COMMITTEES. The Board of Directors, by resolution adopted by a majority of the full Board of Directors, my designate from among its members one or more committees, each of which must have two or more members and, to the extent provided in such resolution, shall have and may exercise all the authority of the Board of Directors, except that no such committee shall have the authority to: (a) authorize or approve a distribution except according to a general formula or method prescribed by the Board of Directors; (b) approve or propose to shareholders action that the Washington Business Corporation Act requires to be approved by shareholders; (c) fill vacancies on the Board of Directors or on any of its committees; (d) amend any Articles of Incorporation not requiring shareholder approval; (e) adopt, amend or repeal Bylaws; (f) approve a plan of merger not requiring shareholder approval; or (g) authorize or approve the issuance, sale, or contract for sale of shares, or determine the designation and relative rights, preferences and limitations of a class or series of shares, except that the Board of Directors may authorize a committee, or a senior executive officer of the corporation, to do so within limits specifically prescribed by the Board of Directors. -6- ARTICLE IV SPECIAL MEASURES FOR CORPORATE ACTION Section 1. ACTIONS BY WRITTEN CONSENT. Any corporate action required or permitted by the Articles of Incorporation, Bylaws, or the Washington Business Corporation Act, including any amendments or succeeding provisions thereto, to be voted upon or approved at a duty called meeting of the directors, committee of directors, or shareholders may be accomplished without a meeting if one or more unanimous written consents of the respective directors or shareholders, setting forth the actions so taken, shall be signed, either before or after the action taken, by all the directors, committee members, or shareholders, as the case may be. Action taken by unanimous written consent of the directors or a committee thereof is effective when the last director or committee member signs the consent, unless the consent specifies a later effective date. Action taken by unanimous written consent of the shareholders is effective when all consents are in possession of the corporation, unless the consent specifies a later effective date. Section 2. MEETINGS BY CONFERENCE TELEPHONE. Members of the Board of Directors, members of a committee of directors, or shareholders may participate in their respective meetings by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other at the same time. Participation in a meeting by such means shall constitute presence in person at such meeting. ARTICLE V OFFICERS Section 1. OFFICERS DESIGNATED. The officers of the corporation shall be a Chief Executive Officer, President, one or more Vice Presidents (the number thereof to be determined by the Board of Directors), a Secretary, and a Treasurer, each of whom shall be elected by the Board of Directors. Such other officers and assistant officers, as may be deemed necessary may be elected or appointed by the Board of Directors. Any two or more offices may be held by the same person. The Board of Directors may, in its discretion, elect a Chairperson of the Board of Directors; and, if a Chairperson has been elected, the Chairperson shall, when present, preside at all meetings of the Board of Directors and the shareholders and shall have such other powers as the Board may prescribe. Section 2. ELECTION QUALIFICATION AND TERM OF 0FFICE. Each of the officers shall be elected by the Board of Directors. None OF said officers, except the President and the Chairperson of the Board of Directors, need be a director, but a Vice President who is not a -7- director cannot succeed to or fill the office of President. The officers shall be elected by the Board of Directors at each annual meeting of the Board of Directors. Except as hereinafter provided, each of said officers shall hold office from the date of his or her election until the next annual meeting of the Board of Directors and until his or her successor shall have been duly elected and qualified. Section 3. POWERS AND DUTIES. a. CHIEF EXECUTIVE OFFICER. The Chief Executive Officer shall, subject to the direction and control of the Board of Directors, have general charge and supervision over the corporation's property, business and affairs. He or she shall, unless a Chairperson of the Board of Directors has been elected and is present, preside at meetings of the shareholders and the Board of Directors. b. PRESIDENT. Except as otherwise provided herein, in the absence of the Chief Executive Officer or his or her inability to act, the President shall act in his or HER PLACE and stead and shall have all the powers and authority of the Chief Executive Officer, except as limited by resolution of the Board of Directors. c. VICE PRESIDENT. Except as otherwise provided herein, in the absence of the President or his or her inability to act, the Senior Vice President shall act in his or her place and stead and shall have all the powers and authority of the President, except as limited by resolution of the Board of Directors. d. SECRETARY. The Secretary shall: (1) keep the minutes of the shareholders and of the Board of Directors' meetings IN one or more books provided for that purpose; (2) see that all notices are duly given in accordance with the provisions of these Bylaws or as required by law; (3) be custodian of the corporate records and of the seal of the corporation and affix the seal of the corporation to all documents as may be required; (4) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such shareholder; (5) sign with the President, or a Vice President, certificates for shares of the corporation, the issuance of which shall have been authorized by resolution of the Board of Directors; (6) have general charge of the stock transfer books of the corporation; and (7) in general perform all duties incident to the office of Secretary AND such other duties as from time to time may be assigned to him or her by the President or by the Board of Directors. e. ASSISTANT SECRETARIES. An Assistant Secretary (or in the event there BE more than one Assistant Secretary, the Assistant Secretaries in the order designated by the Board of Directors, or in the absence of any designation then IN the order of their election) shall in the absence or disability of the Secretary, of in the event that for any reason it is impracticable for -8- the Secretary to act, have the powers and duties of the Secretary. f. TREASURER. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate account of receipts and disbursements in books belonging to the corporation. He or she shall deposit all monies and other valuables in the name and to the credit of the corporation in such depositories as may be designated by the Board of Directors. The Treasurer shall disburse the funds of the corporation as may be ordered by the Board of Directors, the Chairman of the Board (if there is one), or the President, taking proper vouchers for such disbursements. He or she shall render to the Chairman of the Board (if there is one), the President and Board of Directors at the regular meetings of the Board of Directors, or whenever they may request it, and to the shareholders at the annual meeting of the shareholders, an account of all his or her transactions as Treasurer and of the financial condition of the corporation. If required by the Board of Directors, he or she shall give the corporation a bond for the faithful discharge of his or her duties in such amount and with such surety as the Board shall prescribe. The Treasurer shall also perform such other duties as may be assigned to him or her by the Chairman of the Board (if there is one), the President or the Board of Directors. g. ASSISTANT TREASURERS. An Assistant Treasurer (or in the event there be more than one Assistant Treasurer, the Assistant Treasurers in the order designated by the Board of Directors, or in the absence of any designation, then in the order of their election) shall, in the absence of the Treasurer, or in the event that for any reason it is impracticable for the Treasurer to act, have the powers and the duties of the Treasurer. If required by the Board of Directors, be or she shall give the corporation a bond for the faithful discharge of his or her duties in such amount and with such surety as the Board shall prescribe. Section 5. RESIGNATION; REMOVAL. The Board of Directors shall have the right to remove any officer, with or without cause. An officer may resign at any time by delivering notice to the corporation. Such resignation shall be effective when the notice is delivered, unless the notice specifies a later effective date. Section 6. VACANCIES. The Board of Directors shall fill any office which becomes vacant with a successor who shall hold office for the unexpired term and until his or her successor shall have been duly elected and qualified. Section 7. SALARIES. The salaries of all officers of the corporation shall be fixed by the Board of Directors. -9- ARTICLE VI STOCK Section 1. CERTIFICATE OF STOCK. Certificates of stock shall be issued in numerical order, and each shareholder shall be entitled to a certificate signed by the President or a Vice President, and by the Secretary or an Assistant Secretary, and, if there is one, sealed with the corporate seal. Every certificate of stock shall state upon the face thereof. a. The state of incorporation; b. The name of the person to whom issued; c. The number and class of shares, and the designation of the series, if any, which such certificate represents. Every certificate representing shares issued by the corporation at a time it is authorized to issue shares of more than one class shall set forth upon the face or back of the certificate, or shall state that the corporation will furnish to any shareholder upon request and without charge, a full statement of the designations, preferences, limitations, and relative rights of the shares of each class authorized to be issued and, if the corporation is authorized to issue any preferred or special class in series, the variations in the relative rights and preferences between the shares of each such series so far as the same have been fixed and determined and the authority of the Board of Directors to fix and determine the relative rights and preferences of subsequent series. No certificate shall be issued for any share until the consideration established for its issuance has been paid. Section 2. TRANSFER OF SHARES. The shares of the corporation shall be transferable only upon its books by the record holders thereof in person or by their duly authorized attorneys or legal representatives, and upon such transfer the old certificates shall be surrendered to the corporation by the delivery thereof to the person in charge of the stock and transfer books and ledgers, or to such other person as the Board of Directors may designate, by whom they shall be cancelled, and new certificates shall thereupon be issued. The returned certificates shall be marked "cancelled" with the date of cancellation and shall be inserted in the stock book Each certificate to be transferred shall be accompanied either by an assignment in writing on the back of or separate from the certificate, or by a written power to- sell, assign and transfer the same, signed by the record holder of the certificate. Except as otherwise specifically provided in these Bylaws, no shares of stock shall be transferred on the books of the corporation until the outstanding certificate therefor has been surrendered to the corporation. Section 3. LOST CERTIFICATES. A new certificate of stock may be issued in the place of any certificate theretofore issued by the corporation, alleged to have been lost or destroyed, and the -10- Board of Directors may, in its discretion, require the owner of the lost or destroyed certificate, or his or her legal representative, to give the corporation: a. An affidavit of loss or destruction and/or an indemnity agreement in a form acceptable to the Board of Directors; and/or b. A bond, in such form and in such sum is the Board my direct, to indemnify the corporation against any claim that may be made against it on account of the alleged loss of any such certificate, or the ISSUANCE of any such new certificate. Section 4. RESTRICTIONS ON TRANSFER. The restrictions, if any, on the transfer of shares shall be as stated in the Articles of Incorporation, the Bylaws, or in an agreement between the shareholders, or the shareholders and the corporation, as the case may be. ARTICLE VII BOOKS AND RECORDS Section 1. BOOKS OF ACCOUNTS. MINUTES AND SHARE REGISTER. The corporation shall keep as permanent records minutes of all meetings of its shareholders and Board of Directors, a record of all actions taken by the shareholders or Board of Directors without a meeting, and a record of all actions taken by a- committee of the Board of Directors exercising the authority of the Board of Directors on behalf of the corporation. The corporation or its agent shall maintain appropriate accounting records. The corporation shall maintain a record of its shareholders, in a form that permits preparation of a fist of the names and addresses of all shareholders, in alphabetical order by class of shares showing the number and class of shares held by each. The corporation or its agent shall keep a copy of the following records, which records shall be available for inspection by its shareholders at its principal office upon written notice as provided in the Washington Business Corporation Act, including any amendments or succeeding provisions thereto: (a) the Articles or Restated Articles of Incorporation and all amendments to them currently in effect; (b) the Bylaws or Restated Bylaws and all amendments to them currently in effect; (c) the minutes of all shareholders' meetings, and records of all actions taken by shareholders without a meeting, for the past three years; (d) its financial statements for the past three years, including balance sheets showing in reasonable detail the financial condition of the corporation as of the close of each fiscal year, and an income statement showing the results of its operations during each fiscal year prepared on the basis of generally accepted -accounting principles or, if not, prepared on a basis explained therein; (e) all written communications to shareholders generally within the past three years; (f) a list of the names and business addresses of its current directors and officers; and (g) its most recent annual report delivered to the Secretary of State of the State of Washington. Section 2. COPIES OF RESOLUTIONS. Any person dealing with the corporation may rely -11- upon a copy of any of the records of the proceedings, resolutions, or votes of the Board of Directors or shareholders, when certified by the President or Secretary. ARTICLE VIII CORPORATE SEAL The Board of Directors may provide for a corporate seal which shall have inscribed thereon the name of the corporation, the year and state of incorporation and the words "corporate seal." ARTICLE IX AMENDMENT OF ARTICLES AND BYLAWS Section 1. AMENDMENT OF ARTICLES. a. BY THE BOARD. The Board may, by majority vote and without shareholder action, amend the Articles: (1) To delete the name(s) and address(es) of the initial director(s); (2) To change the initial registered agent and/or the registered office of the corporation; (3) To change the corporate name; (4) To change the number of authorized shares to effectuate a stock split or stock dividend to be paid in the corporation' s shares if, at the time of the amendment, the corporation has only one class of shares outstanding; or (5) To make any other changes expressly permitted by law to be made without shareholder action. b. BY THE BOARD AND SHAREHOLDERS. The Board may submit to the shareholders for approval one or more proposed amendments to the Articles. Following notice to all shareholders of a shareholders' meeting in accordance with the provisions of Article 11, the shareholders may adopt the proposed amendment if two-thirds (2/3) of the votes in each voting group entitled to vote on each amendment approve. Section 2. AMENDMENT OF BYLAWS BY THE SHAREHOLDERS. The shareholders may amend, alter, or repeal the Bylaws at any meeting of the shareholders, or by unanimous written consent. -12- The shareholders may amend the Bylaws at a special shareholders' meeting only if a copy of the proposed amendments accompanies the notice of the meeting. Section 3. AMENDMENT OF BYLAWS BY THE BOARD. The Board may amend, alter, or repeal the Bylaws by vote of a majority of the Board at any meeting of the Board, or by unanimous written consent of the Board. The Bylaws may be amended at a special meeting of the Board only if notice of the proposed amendment was contained in the notice of the meeting. The shareholders may repeal, by majority vote, any amendment to or alteration of the Bylaws adopted by the Board. ARTICLE X FISCAL YEAR The fiscal year of the corporation shall be set by resolution of the Board of Directors. ARTICLE XI MISCELLANEOUS Section 1. CHECKS. All checks, drafts or other orders for the payment of money, and notes or other evidences of indebtedness issued in the name of the corporation shall be signed by such officers or agents of the corporation and in such manner as shall be determined from time to time by resolution of the Board of Directors. Section 2. RULES OF ORDER. The rules contained in the most recent edition of Robert's Rules of Order, Revised, shall govern all meetings of the shareholders and directors where those rules are not inconsistent with the Articles of Incorporation, these Bylaws or any special rules of order of the corporation. Section 3. LOANS. No loans shall be contracted on behalf of the corporation and no evidence of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances. No loans exceeding or more favorable than those which are customarily made to shareholders shall be made by the corporation to its directors or officers. -13- CERTIFICATE OF ADOPTION The foregoing were duly adopted as the Bylaws of the corporation by the Board of Directors effective on the 31st day of December, 1999. /s/ Robert McCausland ---------------------------------------- Robert McCausland, Secretary -14- EX-10.1 4 EXHIBIT 10.1 Exhibit 10.1 STOCK OPTION PLAN 1. PURPOSE OF THE PLAN. Under this Stock Option Plan (the "Plan") of Freei Networks, Inc. (the "Company") options may be granted to eligible employees to purchase shares of the Company's capital stock. The Plan is designed to enable the Company and its subsidiaries to attract, retain and motivate their employees by providing for or increasing the proprietary interests of such employees in the Company. The Plan provides for options which qualify as incentive stock options ("Incentive Options") under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), as well as options which do not so qualify. 2. STOCK SUBJECT TO PLAN. The maximum number of shares of stock for which options granted hereunder may be exercised shall be 1,500,000 shares of no par common stock, subject to the adjustments provided in Sections 6 and 11. Shares of stock subject to the unexercised portions of any options granted under this Plan which expire or terminate or are cancelled may again be subject to options under the Plan. However, if stock appreciation rights are granted with respect to any options under this Plan, the total number of shares of stock for which further options may be granted under this Plan shall be irrevocably reduced not only when there is an exercise of an option granted under this Plan, but also when such option is surrendered upon an exercise of a stock appreciation right granted under this Plan, in either case by the number of shares covered by the portion of such option which is exercised or surrendered. When the exercise price for an option granted under this Plan is paid with previously outstanding shares or with shares as to which the option is being exercised, as permitted in Section 9, the total number of shares of stock for which further options may be granted under this Plan shall be irrevocably reduced by the total number of shares for which such option is thus exercised, without regard to the number of shares received or retained by the Company in connection with that exercise, but if that exercise results in the grant of a replacement option in accordance with Section 15 the total number of shares of stock for which further options may be granted under this Plan shall not be reduced by the number of received or retained shares for which that replacement option is granted until and unless the replacement option itself is exercised, whereupon it shall be reduced by the number of shares for which the replacement option is exercised. 3. ELIGIBLE EMPLOYEES. The employees eligible to be considered for the grant of options hereunder are any persons regularly employed by the Company or its parent(s) or subsidiaries in a managerial, professional or technical capacity on a full-time, salaried basis. 4. MINIMUM EXERCISE PRICE. The exercise price for each option granted hereunder shall be not less than 100% of the fair market value of the stock at the date of the grant of the option. 5. NONTRANSFERABILITY. Any option granted under this Plan shall by its terms be nontransferable by the optionee other than by will or the laws of descent and distribution and is exercisable during the optionee's lifetime only by him or by his guardian or legal representative. 6. ADJUSTMENTS. If the outstanding shares of stock of the class then subject to this Plan are increased or decreased, or are changed into or exchanged for a different number or kind of shares or securities, as a result of one or more reorganizations, recapitalizations, stock splits, reverse stock splits, stock dividends or the like, appropriate adjustments shall be made in the number and/or kind of shares or securities for which options may thereafter be granted under this Plan and for which options then outstanding under this Plan may thereafter be exercised. Any such adjustment in outstanding options shall be made without changing the aggregate exercise price applicable to the unexercised portions of such options. 7. MAXIMUM OPTION TERM. NO option granted under this Plan may be exercised in whole or in part more than ten years after its date of grant. 8. PLAN DURATION. Options may not be granted under this Plan more than ten years after the date of the adoption of this Plan, or of shareholder approval thereof, whichever is earlier. 9. PAYMENT. Payment for stock purchased upon any exercise of an option granted under this Plan shall be made in full in cash concurrently with such exercise, except that, if and to the extent the instrument evidencing the option so provides and if the Company is not then prohibited from purchasing or acquiring shares of such stock, such payment may be made in whole or in part with shares of the same class of stock as that then subject to the option, delivered in lieu of cash concurrently with such exercise, the shares so delivered to be valued on the basis of the fair market value of the stock (determined in a manner specified in the instrument evidencing the option) on the day preceding the date of exercise. If and while payment with stock is permitted for the exercise of an option granted under this Plan in accordance with the foregoing provision, the person then entitled to exercise that option may, in lieu of using previously outstanding shares therefor, use some of the shares as to which the option is then being exercised. 10. ADMINISTRATION. The Plan shall be administered by the Company's board of directors (the "Board") or, at the discretion of the Board, by a committee (the "Committee") of not less than two members of the Board each of whom shall not at any time during his service as an administrator of the Plan be an officer or employee of the Company or of any parent or subsidiary corporation of the Company. The interpretation and construction by the Committee of any term or provision of the Plan or of any option granted under it shall be final, unless otherwise determined by the Board in which event such determination by the Board shall be final. The Board or the Committee may from time to time adopt rules and regulations for carrying out this Plan and, subject to the provisions of this Plan, may prescribe the form or forms of the instruments evidencing any option granted under this Plan. Subject to the provisions of this Plan, the Board or, by delegation from the Board, the Committee, shall have full and final authority in its discretion to select the employees to be granted options, to grant such options and to determine the number of shares to be subject thereto, the exercise prices, the terms of exercise, expiration dates and other pertinent provisions thereof. 11. CORPORATE REORGANIZATIONS. Upon the dissolution or liquidation of the Company, or upon a reorganization, merger or consolidation of the Company as a result of which the outstanding 2 securities of the class then subject to options hereunder are changed into or exchanged for cash or property or securities not of the Company's issue, or any combination thereof, or upon a sale of substantially all the property of the Company to, or the acquisition of stock representing more than eighty percent (80%) of the voting power of the stock of the Company then outstanding by, another corporation or person, the Plan shall terminate, and all options theretofore granted hereunder shall terminate, unless provision be made in writing in connection with such transaction for the continuance of the Plan and/or for the, assumption of options covering the stock of a successor employer corporation, or a parent or a subsidiary thereof, with appropriate adjustments as to the number and kind of shares and prices, in which event the Plan and options theretofore granted shall continue in the manner and under the terms so provided. If the Plan and unexercised options shall terminate pursuant to the foregoing sentence, all persons entitled to exercise any unexercised portions of options then outstanding shall have the right, at such time prior to the consummation of the transaction causing such termination as the Company shall designate, to exercise the unexercised portions of their options, including the portions thereof which would, but for this paragraph entitled "Corporate Reorganizations," not yet be exercisable. The instrument evidencing any option may also provide for such acceleration of otherwise unexercisable portions of the option upon other specified events or occurrences, such as involuntary terminations of the option holder's employment following certain changes in the control of the Company. 12. STOCK APPRECIATION RIGHTS. If the instrument evidencing the option so provides, an option granted under this Plan (herein sometimes referred to as the "corresponding option") may include the right (a "Stock Appreciation Right") to receive an amount equal to some or all of the excess of the fair market value (determined in a manner specified in the instrument evidencing the corresponding option) of the shares subject to unexercised portions of the corresponding option over the aggregate exercise price for such shares under the corresponding option as of the date the Stock Appreciation Right is exercised. The amount payable upon exercise of a Stock Appreciation Right may be paid in cash or in shares of the class then subject to the corresponding option (valued on the basis of their fair market value, determined as specified with respect to the measurement of the amount payable as aforesaid), or in a combination of cash and such shares so valued. No Stock Appreciation Right may be exercised in whole or in part (a) other than in connection with the contemporaneous surrender without exercise of such corresponding option, or the portion thereof that corresponds to the portion of the Stock Appreciation Right being exercised, or (b) except to the extent that the corresponding option or such portion thereof is exercisable on the date of exercise of the Stock Appreciation right by the person exercising the Stock Appreciation Right, or (c) unless the class of stock then subject to the corresponding option is then "publicly traded." For this purpose, a class of stock is "publicly traded" if it is listed or admitted to unlisted trading privileges on a national securities exchange or on the NASDAQ National Market or if sales or bid and offer quotations therefor are reported on the automated quotation system ("NASDAQ") operated by the National Association of Securities Dealers, Inc. or on any then operative successor to the NASDAQ system. 13. RESTRICTED STOCK If the instrument evidencing the option so provides, shares of stock issued on exercise of an option granted under this Plan may upon issuance be subject to the following restrictions (and, as used herein, "restricted stock" means shares issued on exercise of 3 options granted under this Plan which are still subject to restrictions imposed under this Section 13 that have not yet expired or terminated): (a) shares of restricted stock may not be sold or otherwise transferred or hypothecated; (b) if the employment of the holder of shares of restricted stock with the Company or a subsidiary is terminated for any reason other than his death, normal or early retirement in accordance with his employer's established retirement policies or practices, or total disability, the Company (or any subsidiary designated by it) shall have the option for sixty (60) days after such termination of employment to purchase for cash all or any part of his restricted stock at the lesser of (i) the price paid therefor by the holder, or (ii) the fair market value of the restricted stock on the date of such termination of employment (determined in a manner specified in the instrument evidencing the option); and (c) as to the shares of stock affected thereby, any additional restrictions that may be imposed on particular shares of restricted stock as specified in the instrument evidencing the option. The restrictions imposed under this Section 13 shall apply as well to all shares or other securities issued in respect of restricted stock in connection with any stock split, reverse stock split, stock dividend, recapitalization, reclassification, spin-off, split-off, merger, consolidation or reorganization, but such restrictions shall expire or terminate at such time or times as shall be specified therefor in the instrument evidencing the option which provides for the restrictions. 14. FINANCIAL ASSISTANCE The Company is vested with authority under this Plan to assist any employee to whom an option is granted hereunder (including any director or officer of the Company or any of its subsidiaries who is also an employee) in the payment of the purchase price payable on exercise of that option, by lending the amount of such purchase price to such employee on such terms and at such rates of interest and upon such security (or unsecured) as shall have been authorized by or under authority of the Board. 15. REPLACEMENT OPTIONS. If the instrument evidencing the option so provides, when the exercise price of an option granted under this Plan (herein sometimes referred to as the "reloaded option") is paid with previously outstanding shares or with shares as to which the option is being exercised, as permitted in Section 9, such exercise of the reloaded option shall result in the automatic and simultaneous grant to the exercising optionee of a supplemental option under this Plan (herein sometimes referred to as a "replacement option") for a number of shares equal to the number of shares delivered by the optionee or retained by the Company in the exercise of the reloaded option, subject to the adjustments provided in Sections 6 and 11, at an exercise price per share equal to the fair market value (determined in a manner specified in the instrument evidencing the reloaded option) of the shares subject to the replacement option on the date the reloaded option is thus exercised. The replacement option shall expire on the expiration date of the reloaded option and shall in other respects contain the same terms and provisions as the reloaded option, except that:* (a) the replacement option shall not itself provide for any further replacement options upon its exercise; and (b) the replacement option may not be exercised 4 before the earlier of (i) the expiration of one year after the date it is granted or (ii) the first day of the calendar month in which it is scheduled to expire, subject to any acceleration of its exercisability under Section 11 hereof. 16. RESTRICTIONS APPLICABLE UNTIL THE COMPANY IS SUBJECT TO FEDERAL REPORTING REQUIREMENTS. Notwithstanding any other provisions of this Plan, unless and until the Company has become a reporting company with respect to any class of its equity securities under the Securities Exchange Act of 1934, as amended: (a) no, option, granted under this Plan may be exercised prior to the calendar month in which that option is scheduled to expire by its terms (without regard to any provisions for premature termination or cancellation); (b) prior to that calendar month in which the option is scheduled to expire by its terms, the Company has the right, exercisable at its discretion, to cancel and purchase any such option for an amount equal to the excess, if any, of the fair market value (determined in a manner specified in the instrument evidencing the option) of the stock subject to that option over its exercise price; and (c) no option granted under this Plan may be transferred, except upon the death of the grantee of the option to that grantee's estate or the administrator(s) or executor(s) of that estate (this exception does not extend to or permit the distribution or other transfer by that estate or executor(s) or administrator(s) to the grantee's heirs or other beneficiaries of the estate, and under the circumstances described in this paragraph any portion of the option remaining unexercised at the time of the final distribution of that estate will then terminate). 17. AMENDMENT AND TERMINATION. The Board may alter, amend, suspend or terminate this Plan, provided that no such action shall deprive an optionee, without his consent, of any option granted to the optionee pursuant to this Plan or of any of his rights under such option. Except as herein provided, no such action of the Board, unless taken with the approval of the shareholders of the Company, may: (a) increase the maximum number of shares for which options granted under this Plan may be exercised; (b) reduce the minimum permissible exercise price; (c) extend the ten-year duration of this Plan set forth herein; or (d) alter the class of employees eligible to receive options under the Plan. ADOPTED BY FREEI NETWORKS, INC. SHAREHOLDERS AT MEETING HELD ON APRIL 12,1999. ----------------------------- Secretary 5 STOCK OPTION AGREEMENT Freei Networks, Inc. (the "Company"), desiring to afford an opportunity to the Grantee named below to purchase certain shares of the Company's no par common stock, to provide the Grantee with an added incentive as an employee of the Company or of one or more of its subsidiaries, hereby grants to Grantee, and the Grantee hereby accepts, an option to purchase the number of such shares optioned as specified below, during the term ending at midnight (prevailing local time at the Company's principal offices) on the expiration date of this Option specified below, at the option exercise price specified below, subject to and upon the following terms and conditions: 1. IDENTIFYING PROVISIONS: As used in this Option, the following terms shall have the following respective meanings: (a) Grantee: (b) Date of grant: (c) Number of shares optioned: (d) Option exercise price per share: (e) Expiration date: This Option is not intended to be and shall not be treated as an incentive stock option under Section 422 of the Internal Revenue Code unless this sentence has been manually lined out and its deletion is followed by the signature of the corporate officer who signed this Option on behalf of the Company: 2. TIMING OF PURCHASES: This Option is not exercisable in any part until one (1) year after the date of grant. Upon the expiration of one (1) year after the date of grant and subject to the provisions for termination and acceleration herein, this Option shall become exercisable in installments as follows: This Option may not in the aggregate be exercised as to more than twenty-five percent (25%) of the total number of shares optioned until one (1) year after the date of grant. Following each quarter after April 30, 2000 (i.e., July 31, October 31, January 31, April 30) an additional 6.35% of this Option may be exercised. Upon the expiration of four (4) years after the date of grant, this Option may be exercised as to all optioned shares for which it had not previously been exercised, until and including the expiration date of this Option whereupon the Option shall expire and may thereafter no longer be exercised. 3. RESTRICTIONS ON EXERCISE: The following additional provisions shall apply to the exercise of this Option: (i) TERMINATION OF EMPLOYMENT. If the Grantee's employment by the Company or any of its subsidiaries is terminated for any reason other than death only that portion of this Option exercisable at the time of such termination of employment may thereafter be exercised, and it may not be exercised more than three (3) months after such termination nor after the expiration date of this Option, whichever date is sooner, unless such termination is by reason of the Grantee's permanent and total disability, in which case such period of three (3) months shall be extended to one (1) year. In all other respects, this Option shall terminate upon such termination of employment. (ii) DEATH OF GRANTEE. If the Grantee shall die during the term of this Option, the Grantee's legal representative or representatives, or the person or persons entitled to do so under the Grantee's last will and testament or under applicable intestate laws, shall have the right to exercise this Option, but only for the number of shares as to which the Grantee was entitled to exercise this Option in accordance with Section 2 hereof on the date of his death, and such right shall expire and this Option shall terminate one (1) year after the date of the Grantee's death or on the expiration date of this Option, whichever date is sooner. In all other respects, this Option shall terminate upon such death. (iii) CONTINUITY OF EMPLOYMENT. This Option shall not be exercisable by the Grantee in any part unless at all times beginning with the date of grant and ending no more than three (3) months prior to the date of exercise, the Grantee has, except for military service leave, sick leave or other bona fide leave of absence (such as temporary employment by the United States Government) been in the continuous employ of the Company or a parent or subsidiary thereof, except that such period of three (3) months shall be one (1) year following any termination of the Grantee's employment by reason of his permanent and total disability. 4. NON-TRANSFERABLE: The Grantee may not transfer this Option except by will or the laws of descent and distribution. This Option shall not be otherwise transferred, assigned, pledged, hypothecated or disposed of in any way, whether by operation of law or otherwise, and shall be exercisable during the Grantee's lifetime only by the Grantee or his guardian or legal representative. 5. ADJUSTMENTS AND CORPORATE REORGANIZATIONS: Subject to the provisions of the Company's Stock Option Plan under which this Option is granted, if the outstanding shares of the class then subject to this Option are increased or decreased, or are changed into or exchanged for a different number or kind of shares or securities, as a result of one or more reorganizations, recapitalizations, stock splits, reverse stock splits, stock dividends or the like, appropriate adjustments shall be made in the number and/or kind of shares or securities for which the unexercised portions of this is Option may thereafter be exercised, all without any change in the aggregate exercise price applicable to the unexercised portions of this Option, but with a corresponding adjustment in the exercise price per share or other unit. No fractional share of stock shall be issued under this Option or in connection with any such adjustment. Such adjustments shall be made by or under authority of the Company's board of directors whose determinations as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. Upon the dissolution or liquidation of the Company, or upon a reorganization, merger or consolidation of the Company as a result of which the outstanding securities of the class then subject to this Option are changed into or exchanged for cash or property or securities not of the 2 Company's issue, or any combination thereof, or upon a sale of substantially all the property of the Company to, or the acquisition of stock representing more than eighty percent (80%) of the voting power of the stock of the Company then outstanding by, another corporation or person, this Option shall terminate, unless provision be made in writing in connection with such transaction for the assumption of options theretofore granted under the Stock Option Plan under which this Option was granted, or the substitution for such options of any options covering the stock of a successor employer corporation, or a parent or, subsidiary thereof, with appropriate adjustments as to, the number and kind of shares and prices, in which event this Option shall continue in the manner and under the terms so provided. If this Option shall terminate pursuant to the foregoing sentence, the Grantee shall have the right, at such time prior to the consummation of the transaction causing such termination as the Company shall designate, to exercise the unexercised portions of this Option, including the portions thereof which would, but for this Section entitled "Adjustments and Corporate Reorganizations," not yet be exercisable. 6. CHANGES IN CONTROL: Notwithstanding any other provisions hereof, this Option shall accelerate so that the Grantee shall have the right, at all times until the expiration or earlier termination of the Option, to exercise the unexercised portions of this Option, including the portions thereof which would, but for this Section entitled "Changes in Control," not yet be exercisable, from and after any Involuntary Termination within twenty-four (24) months after a Change in Control that occurs while the Grantee is an employee of the Company or any of its subsidiaries. For purposes of this paragraph: (a) an "Involuntary Termination" is any termination of the Grantee's employment with the Company or any of its subsidiaries for reasons other than (1) the Grantee's death, (2) the Grantee's total and permanent disability, (3) the Grantee's retirement under circumstances that entitle the Grantee to full benefits under one or another of his employer's retirement or pension plans or programs generally applicable to salaried employees, (4) termination for cause (meaning (i) an act by the Grantee resulting or intended to result directly or indirectly in substantial gain or personal enrichment at the expense of the Company or any of its affiliated corporations, or (ii) the Grantee's willful engagement in misconduct that results in material injury to the Company or any of its affiliated corporations, or (iii) the Grantee's willful and continued failure substantially to perform the Grantee's duties to the Company or a subsidiary after a written demand for substantial performance is delivered to the Grantee by the Company's chief executive officer, or by the Company's board of directors if the Grantee is the chief executive officer, which specifically identifies the manner in which it is believed that the Grantee has not substantially performed his duties), or (5) the Grantee's voluntary termination of employment following the assignment to the Grantee by his employer of any duties that are significantly incompatible with, and detract from, the Grantee's position, duties, titles, offices, responsibilities or status with the Company or a subsidiary immediately before the Change in Control; and (b) a "Change in Control" means any of the following events if they occur after the date of grant of this Option and after the class of stock then subject to this Option becomes Publicly Traded (as defined herein): the direct or indirect beneficial ownership (within the meaning of Section 13(d) of the Securities Exchange Act of 1934 and Regulation 13D-G thereunder) of 50% or more of the class of securities then subject to this Option is acquired or becomes held by any person or group of persons (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934), or the sale, mortgage, lease or other transfer in one or more transactions not in the ordinary course of the Company's business of assets or 3 earning power constituting more than 50% of the assets or earning power of the Company and its subsidiaries (taken as a whole) to any such person or group of persons. 7. EXERCISE, PAYMENT FOR AND DELIVERY OF STOCK: This Option may be exercised by the Grantee or other person then entitled to exercise it by giving four (4) business days' written notice of exercise to the Company specifying the number of shares to be purchased and the total purchase price, accompanied by a check to the order of the Company in payment of such price. If the Company is required to withhold on account of any present or future tax imposed as a result of such exercise, the notice of exercise shall be accompanied by a check to the order of the Company in payment of the amount of such withholding. 8. ALTERNATIVE PAYMENT WITH STOCK: Notwithstanding the foregoing provisions requiring payment by check, payment of such purchase price or any portion thereof may be made with shares of stock of the same class as the shares then subject to this Option, if shares of that class are then Publicly Traded (as defined herein), such shares to be credited toward such purchase price on the valuation basis set forth below, in which event the stock certificates evidencing the shares so to be used shall accompany the notice of exercise and shall be duly endorsed or accompanied by duly executed stock powers to transfer the same to the Company; provided, however, that such payment in stock instead of cash shall not be effective and shall be rejected by the Company if (i) the Company is then prohibited from purchasing or acquiring shares of the class of its stock thus tendered to it, or (ii) the right or power of the person exercising the Option to deliver such shares in payment of said purchase price is subject to the prior interests of any other person (excepting the Company), as indicated by legends upon the certificate(s) or as known to the Company. For credit toward the purchase price, shares so surrendered shall be valued at their Fair Market Value (as defined herein) as of the day immediately preceding the delivery to the Company of the certificate(s) evidencing such shares. If the Company rejects the payment in stock, the tendered notice of exercise shall not be effective hereunder unless promptly after being notified of such rejection the person exercising the Option pays the purchase price in acceptable form. If and while payment of the purchase price with stock is permitted in accordance with the foregoing provisions, the person then entitled to exercise this Option may, in lieu of using previously outstanding shares therefor, use some of the shares as to which this Option is then being exercised, in which case the notice of exercise need not be accompanied by any stock certificates but shall include a statement directing the Company to withhold so many of the shares that would otherwise have been delivered upon that exercise of this Option as equals the number of shares that would have been transferred to the Company if the purchase price had been paid with previously issued stock. 9. RIGHTS IN SHARES BEFORE ISSUANCE AND DELIVERY: No person shall be entitled to the privileges of stock ownership in respect of any shares issuable upon exercise of this Option, unless and until such shares have been issued to such person as fully paid shares. 10. REQUIREMENTS OF LAW AND OF STOCK EXCHANGES: By accepting this Option, the Grantee represents and agrees for himself and his transferees by will or the laws of descent and distribution that, unless a registration statement under the Securities Act of 1933 is in effect as to shares purchased upon any exercise of this Option, (i) any and all shares so purchased shall be 10 acquired for his personal account and not with a view to or for sale in connection with any distribution, and (ii) each notice of the exercise of any portion of this Option shall be accompanied by a representation and warranty in writing, signed by the person entitled to exercise the same, that the shares are being so acquired in good faith for his personal account and not with view to or for sale in connection with any distribution. No certificate or certificates for shares of stock purchased upon exercise of this Option shall be issued and delivered prior to the admission of such shares to listing on notice of issuance on any stock exchange or other securities market on which shares of that class are then listed, nor unless and until, in the opinion of counsel for the Company, such securities may be issued and delivered without causing the Company to be in violation of or incur any liability under any federal, state or other securities law, any requirement of any securities exchange listing agreement to which the Company may be a party, or any other requirement of law or of any regulatory body having jurisdiction over the Company. 11. [RESERVED] 12. RESTRICTED STOCK PROVISIONS: Shares of stock issued on exercise of this Option shall upon issuance be subject to the following restrictions (and, as used herein, "restricted stock" means shares issued on exercise of this Option which are still subject to the restrictions imposed under this paragraph that have not yet expired or terminated): (a) Such shares of restricted stock may not be sold or otherwise transferred or hypothecated; (b) If the employment of the Grantee with the Company or a subsidiary of the Company is terminated for any reason other than his death, normal or early retirement in accordance with his employer's established retirement policies and practices, or total disability, the Company (or any subsidiary designated by it) shall have the option for sixty (60) days after such termination of employment to purchase for cash all or any part of his restricted stock at the lesser of (i) the price paid therefor upon exercise of this Option, or (ii) the Fair Market Value (as defined herein) of the restricted stock on the date of such termination of employment. The restrictions imposed under this paragraph shall apply as well to all shares or other securities issued in respect of restricted stock in connection with any stock split, reverse stock split, stock dividend, recapitalization, reclassification, spin-off, split-off, merger, consolidation or reorganization, but such restrictions shall expire or terminate on the earliest to occur of the following: (i) The ninetieth (90th) day after the date on which shares of the same class of stock as such restricted stock first become Publicly Traded (as defined herein). (ii) The tenth (10th) anniversary of the date of grant hereof. 5 (iii) As to any shares for which the Company's (or a subsidiary's) sixty (60) day option to purchase upon termination of employment shall have become exercisable but shall expire without having been exercised, on the first business day of the calendar month next following the expiration of such sixty (60) day option period. (iv) The first business day of the calendar month next following the termination of the Grantee's employment with the Company or a subsidiary because of his death, normal or early retirement in accordance with his employer's established employment policies or practices, or total disability. (v) The occurrence of any event or transaction upon which this Option terminates by reason of the provisions of paragraph 5 hereof. Any certificates evidencing shares of restricted stock may contain such legends as the Company may deem necessary or advisable to reflect and give effect to the restrictions imposed thereon hereunder. 13. [RESERVED] 14. RESTRICTIONS APPLICABLE UNTIL THE COMPANY IS SUBJECT TO FEDERAL REPORTING REQUIREMENTS. Notwithstanding any other provisions of this Option, unless and until the Company has become a reporting company with respect to any class of its equity securities under the Securities and Exchange Act of 1934, as amended: (a) this Option may not be exercised prior to the calendar month in which its expiration date (see paragraph I above) occurs; (b) prior to that calendar month in which the expiration date of this Option occurs, the Company has the right, exercisable at its discretion, to cancel and purchase this Option for an amount equal to the excess, if any, of the Fair Market Value (as defined herein) of the stock subject to this Option over its exercise price; and (c) this Option may not be transferred, except upon the death of the Grantee to the Grantee's estate or the administrator(s) or executor(s) of that estate (this exception does not extend to or permit the distribution or other transfer by that estate or executor(s) or administrator(s) to the Grantee's heirs or other beneficiaries of the estate, and under the circumstances described in this paragraph any portion of this Option remaining unexercised at the time of the final distribution of that estate will then terminate). The Company's right to cancel and purchase the Option under this paragraph is exercised when the Company gives written notice to the Grantee of the cancellation and purchase of the Option under this paragraph, specifying the Fair Market Value of the stock on the basis of which payment is to be made and a date, not later than the Option's expiration date, on which the purchase price is to be paid. 15. CERTAIN DEFINITIONS. As used in this Option: "Fair Market Value" of corporate stock shall mean: 6 (a) If the stock is then Publicly Traded: The closing price of stock of that class as of the day in question (or, if such day is not a trading day in the principal securities market or markets for such stock, on the nearest preceding trading day), as reported with respect to the market (or the composite of markets, if more than one) in which shares of such stock are then traded, or, if no such closing prices are reported, on the basis of the mean between the high bid and low asked prices that day on the principal market or quotation system on which shares of such stock are then quoted, or, if not so quoted, as furnished by a professional securities dealer making a market in such stock selected by or under authority of the board of directors of the Company. (b) If the stock is then not Publicly Traded: The price at which one could reasonably expect such stock to be sold in an arm's length transaction, for cash, other than on an installment basis, to a person not employed by, controlled by, in control of or under common control with the issuer of such shares. Such Fair Market Value shall be that which has currently or most recently been determined for this purpose by the Company's board of directors, or at the discretion of that board by an independent appraiser or appraisers selected by the board, in either case giving due consideration to recent transactions involving shares of such stock, if any, the issuer's net worth, prospective earning power and dividend-paying capacity, the goodwill of the issuer's business, the issuer's industry position and its management, that industry's economic outlook, the values of securities of issuers whose stock is Publicly Traded and which are engaged in similar businesses, the effect of transfer restrictions to which such stock may be subject under law and under the applicable terms of any contract governing such stock, the absence of a public market for such stock and such other matters as the board or its appraiser or appraisers deem pertinent. The determination by the Company's board of directors or its appraiser or appraisers of the Fair Market Value shall, if not unreasonable, be conclusive and binding notwithstanding the possibility that other persons might make a different, and also reasonable, determination. If the Fair Market Value to be used was thus fixed more than sixteen months prior to the day as of which Fair Market Value is being determined, it shall in any event be no less than the book value of the stock being valued at the end of the most recent period for which financial statements of the issuer are available. Corporate stock is "Publicly Traded" if stock of that class is listed or admitted to unlisted trading privileges on a national securities exchange or on the NASDAQ National Market or if sales or bid and offer quotations are reported for that class of stock in the automated quotation system ("NASDAQ") operated by the National Association of Securities Dealers, Inc. ("NASD"). 16. STOCK OPTION PLAN: This Option is subject to, and the Company and the Grantee agree to be bound by, all of the terms and conditions of the Company's Stock Option Plan under which this Option was granted, as the same shall have been amended from time to time in accordance with the terms thereof, provided that no such amendment shall deprive the Grantee, without his consent, of this Option or 7 any of his rights hereunder. Pursuant to said Plan, the board of directors of the Company or its Committee established for such purposes is vested with final authority to interpret and construe the Plan and this Option, and is authorized to adopt rules and regulations for carrying out the Plan. A copy of the Plan in its present form is available for inspection during business hours by the Grantee or other persons entitled to exercise this Option at the Company's principal office. 17. NOTICES: Any notice to be given to the Company shall be addressed to the Company in care of its Secretary at its principal office, and any notice to be given to the Grantee shall be addressed to him at the address given beneath his signature hereto or at such other address as the Grantee may hereafter designate in writing to the Company. Any such notice shall be deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, registered or certified, and deposited, postage and registry or certification fee prepaid, in a post office or branch post office regularly maintained by the United States Postal Service. 18. LAWS APPLICABLE TO CONSTRUCTION: This Agreement has been executed and delivered by the Company in Washington, and this Agreement shall be construed and enforced in accordance with the laws of said State. 8 IN WITNESS WHEREOF, the Company has granted this Option on the date of grant specified above. FREEI NETWORKS, INC. By ------------------------ Its: ---------------------- - ------------------------ Signature - ------------------------ Grantee - ------------------------ Street Address - ------------------------ City and State 9 EX-10.2 5 EXHIBIT 10.2 Exhibit 10.2 FREEI NETWORKS, INC. 2000 EMPLOYEE STOCK PURCHASE PLAN I. PURPOSE OF PLAN As a means by which Employees may share in the Company's growth and success, Freei Networks, Inc. (the "Company") believes that ownership of shares of its Common Stock by its Employees is desirable. To this end, and as an incentive to better performance and improved profits, the Company has established the Freei Networks, Inc. 2000 Employee Stock Purchase Plan (the "Plan"). The Company intends that the Plan will constitute an "employee stock purchase plan" within the meaning of Section 423 of the Code. II. DEFINITIONS Terms that are capitalized within this document shall have the meanings as set forth in Exhibit A, unless otherwise specified within the text. III. EMPLOYEE PARTICIPATION PARTICIPATION Subject to the provisions of this Section III, an Employee may elect to participate in the Plan effective as of any Enrollment Date by completing and filing a Payroll Deduction Authorization Form in the form attached hereto as EXHIBIT B, as provided in Section IV. As of each Enrollment Date, the Company hereby grants a right to purchase Shares under the terms of the Plan to each eligible Employee who has elected to participate in the Offering commencing on that Enrollment Date. REQUIREMENTS FOR PARTICIPATION A person shall become eligible to participate in the Plan on the first Enrollment Date on which that person meets the following requirements: a) The person is an Employee, and b) The person's customary period of Employment is more than twenty (20) hours per week. Any eligible Employee may enroll in the Plan as of the Enrollment Date of any Offering by filing timely written notice of such participation, subject to the following provisions: (i) In order to enroll in the Plan initially, an eligible Employee must complete, sign and submit to the Company the following forms: (A) Payroll Deduction Authorization Form. This form must be received by the Company at least fifteen (15) days prior to the Enrollment Date of an Offering to be effective for that Offering. (B) ESPP New Account Form. This form must accompany the Payroll Deduction Authorization Form submitted for enrollment in the Plan. An ESPP New Account Form must be received by the Company at least fifteen (15) days prior to the Enrollment Date of an Offering to be effective for that Offering. (ii) A Participant in an ongoing Offering may elect as of any Enrollment Date to enroll in the new Offering commencing on that Enrollment Date by filing a Payroll Deduction Authorization Form making such election prior to 4:00 p.m. Pacific Time on the Enrollment Date. An election by a current Participant to enroll in a new Offering shall constitute a withdrawal, effective as of such Enrollment Date, from the ongoing Offering and simultaneous reenrollment in the new Offering. A reenrollment shall not affect the purchase of Shares under the ongoing Offering occurring on the Purchase Date immediately preceding the Enrollment Date. A Participant may make an ongoing election to reenroll on any Enrollment Date as of which the fair market value of the Shares for purposes of Section VI is less than it was as of the Enrollment Date for the Offering in which the Participant is currently participating. Unless otherwise specified by the Participant, any such ongoing reenrollment election shall be subject to revocation; provided, however, that to be effective to prevent reenrollment on any Enrollment Date, such revocation must be received by the Company prior to 4:00 p.m. Pacific Time on the Enrollment Date. (iii) Absent withdrawal from the Plan pursuant to Section VII, a Participant will automatically be re-enrolled in the Offering commencing on the Enrollment Date immediately following the expiration of the Offering of which that person is then a Participant. A Participant shall become ineligible to participate in the Plan and shall cease to be a Participant when the Participant ceases to meet the eligibility requirements as defined above. LIMITATIONS ON PARTICIPATION No Employee may obtain a right to purchase Shares under the Plan if, immediately after the right is granted, the Employee owns or is deemed to own Shares possessing five percent (5%) or more of the combined voting power or value of all classes of stock of the Company or any parent or subsidiary of the Company. For purposes of determining share ownership, the rules of Section 425(d) of the Code shall apply and Shares that the Employee may purchase under any options or rights to purchase, whether or not vested, shall be treated as Shares owned by the Employee. No Employee may obtain a right to purchase Shares under the Plan that permits the Employee's rights to purchase Shares under the Plan and any other employee stock purchase plan within the meaning of Section 423 of the Code of the Company or any parent or subsidiary of the Company to accrue at a rate which exceeds $25,000 in fair market value of Shares (determined as of the Enrollment Date) for each calendar year of the Offering. This section shall be interpreted to permit an Employee to purchase the maximum number of Shares permitted under Section 423(b)(8) of the Code and regulations and interpretations adopted thereunder. The maximum number of Shares that an Employee may purchase in an Offering shall not exceed 10,000 shares, no more than one-third of which may be purchased on any Purchase Date with respect to that Offering. VOLUNTARY PARTICIPATION Participation in the Plan shall be strictly voluntary. IV. PAYROLL DEDUCTIONS PAYROLL DEDUCTION AUTHORIZATION An Employee may contribute to the Plan only by means of payroll deductions. A Payroll Deduction Authorization Form must be filed with the Company's stock administrator at least fifteen (15) days prior to the Enrollment Date as of which the payroll deductions are to take effect. AMOUNT OF DEDUCTIONS A Participant may specify that the person desires to make contributions to the Plan at a rate not less than 1% and not more than 10% of the Compensation paid to the Participant during each pay period in the Offering, or other such minimum or maximum percentages as the Plan Administrator shall establish from time to time. Such specification shall apply during any period of continuous participation in the Plan, unless otherwise modified or terminated as provided in this Section IV or as otherwise provided in the Plan. If a payroll deduction cannot he made in whole or in part because the Participant's pay for the period in question is insufficient to fund the deduction after having first withheld all other amounts deductible from that person's pay, the amount that was not withheld cannot be made up by the Participant nor will it be withheld from subsequent pay checks. COMMENCEMENT OF DEDUCTIONS Payroll deductions for a Participant shall commence on the Enrollment Date of the Offering for which that person's Payroll Deduction Authorization Form is effective and shall continue indefinitely, unless modified or terminated as provided in this Section IV or as otherwise provided in the Plan. ACCOUNTS All payroll deductions made for a Participant shall be credited to his or her Account under the Plan. each Purchase Date, the Plan Administrator shall promptly deliver a report to each Participant setting forth the aggregate payroll deductions credited to such Participant's Account during the preceding six months and the number of Shares purchased and delivered to the Custodian for deposit into the Participant's Custodial Account. MODIFICATION OF AUTHORIZED DEDUCTIONS A Participant may, prior to the commencement of each Offering in which that person will be a Participant, and not more than three times during each Offering, increase or decrease the amount of that person's payroll deduction effective for all applicable payroll periods, by completing an amended Payroll Deduction Authorization Form and filing it with the Company's stock administrator in accordance with this Section IV. A Participant may at any time discontinue the Participant's payroll deductions, without withdrawing from the Plan, by completing an amended Payroll Deduction Authorization Form and filing it with the Company's stock administrator. Previous payroll deductions will then be retained in the Participant's Account for application to purchase Shares on the next Purchase Date, after which the Participant's participation in the Offering and in the Plan will terminate unless the participant has timely filed another Payroll Deduction Authorization Form to resume payroll deductions. For purposes of the above, an amended Payroll Deduction Authorization form shall be effective for a specific pay period when filed 15 days prior to the last day of such payroll period. V. CUSTODY OF SHARES DELIVERY AND CUSTODY OF SHARES Shares purchased pursuant to the Plan shall be delivered to and held by the Custodian. CUSTODIAL ACCOUNT As soon as practicable after each Purchase Date, the Company shall deliver to the Custodian the full Shares purchased for each Participant's Account. The Shares will be held in a Custodial Account specifically established for this purpose. An Employee must open a Custodial Account with the Custodian in order to be eligible to purchase Shares under the Plan. In order to open a Custodial Account, the Participant must complete an ESPP New Account Form and file it with the stock administrator no later than fifteen (15) days prior to the Enrollment Date of the Offering as of which the enrollment is to take effect; provided, however, that an ESPP New Account Form that effects a change in the status of the Custodial Account may be filed at any time during participation in the Plan. TRANSFER OF SHARES Upon receipt of appropriate instructions from a Participant on forms provided for that purpose, the Custodian will transfer into the Participant's own name all or part of the Shares held in the Participant's Custodial Account and deliver such Shares to the Participant. STATEMENTS The Custodian will deliver to each Participant a semi-annual statement showing the activity of the Participant's Custodial Account and the balance as to both Shares and cash. Participants will be furnished such other reports and statements, and at such intervals, as the Custodian and Plan Administrator shall determine from time to time. VI. PURCHASE OF SHARES PURCHASE OF SHARES Subject to the limitations of Section VII, on each Purchase Date in an Offering, the Company shall apply the amount credited to each Participant's Account to the purchase of as many full Shares that may be purchased with such amount at the price set forth in this Section VI, and shall promptly deliver such Shares to the Custodian for deposit into the Participant's Custodial Account. Payment for Shares purchased under the Plan will be made only through payroll withholding deductions in accordance with Section IV. PRICE The price of Shares to be purchased on any Purchase Date shall be the lower of: (a) Eighty-five percent (85%) of the fair market value of the Shares on the Enrollment Date of the Offering; or (b) Eighty-five percent (85%) of the fair market value of the Shares on the Purchase Date. FAIR MARKET VALUE The fair market value of the Shares on any date shall be equal to the closing trade price of such shares on the Valuation Date, as reported on the NASDAQ National Market System or such other quotation system that supersedes it. UNUSED CONTRIBUTIONS Any amount credited to a Participant's Account and remaining therein immediately after a Purchase Date because it was less than the amount required to purchase a full Share shall be carried forward in such Participant's Account for application on the next succeeding Purchase Date. VII. TERMINATION AND WITHDRAWAL TERMINATION OF EMPLOYMENT Upon termination of a Participant's Employment for any reason other than death, Retirement or Disability, the payroll deductions credited to such Participant's Account shall be returned to the Participant. A Participant shall have no right to accrue Shares upon termination of the person's Employment. TERMINATION UPON DEATH, RETIREMENT OR DISABILITY Upon termination of the Participant's Employment because of that person's death, Retirement or Disability, the payroll deductions credited to that person's Account shall be used to purchase Shares as provided in Section VI on the next Purchase Date. Any remaining balance in the Participant's Account shall be returned to that person or, in the case of death, any Shares purchased and any remaining balance shall be transferred to the deceased Participant's Beneficiary, or if none, to that person's estate. DESIGNATION OF BENEFICIARY Each Participant may designate, revoke, and redesignate Beneficiaries. All changes to designation of Beneficiary shall be in writing and will be effective upon delivery to the Plan Administrator. WITHDRAWAL A Participant may withdraw the entire amount credited to that individual's Account under the Plan and thereby terminate participation in the current Offering at any time by giving written notice to the Company, but in no case may a Participant withdraw accounts within the 15 days immediately preceding a Purchase Date for the Offering. Any amount withdrawn shall be paid to the Participant promptly after receipt of proper notice of withdrawal and no further payroll deductions shall be made from the person's Compensation unless a Payroll Deduction Authorization Form directing further deductions is or has been submitted. STATUS OF CUSTODIAL ACCOUNT Upon termination of a Participant's Employment for any reason other than death, the Participant may, (a) Elect to retain with the Custodian the Shares held in the Participant's Custodial Account. The Participant will bear the cost of any annual fees resulting from maintaining such an account. (b) Request issuance of the Shares held in the Participant's Custodial Account by submitting to the Custodian the appropriate forms provided for that purpose. Upon termination of a Participant's Employment as a result of death, any Shares held by the Custodian for the Participant's Account shall be transferred to the person(s) entitled thereto under the laws of the state of domicile of the Participant upon a proper showing of authority. VIII. SHARES PURCHASED UNDER THE PLAN SOURCE AND LIMITATION OF SHARES The Company has reserved for sale under the Plan 2,000,000 shares of common stock, subject to adjustment upon changes in capitalization of the Company as provided in Section X. Shares sold under the Plan may be newly issued Shares or Shares reacquired in private transactions or open market purchases, but all Shares sold under the Plan regardless of source shall be counted against the 2,000,000 Share limitation. If there is an insufficient number of Shares to permit the full exercise of all existing rights to purchase Shares, or if the legal obligations of the Company prohibit the issuance of all Shares purchasable upon the full exercise of such rights, the Plan Administrator shall make a pro rata allocation of the Shares remaining available in as nearly a uniform and equitable manner as possible, based pro rata on the aggregate amounts then credited to each Participant's Account. In such event, payroll deductions to be made shall be reduced accordingly and the Plan Administrator shall give written notice of such reduction to each Participant affected thereby. Any amount remaining in a Participant's Account immediately after all available Shares have been purchased will be promptly remitted to such Participant. Determination by the Plan Administrator in this regard shall be final, binding and conclusive on all persons. No deductions shall be permitted under the Plan at any time when no Shares are available. DELIVERY OF SHARES As promptly as practicable after each Purchase Date, the Company shall deliver to the Custodian the full Shares purchased for each Participant's Account. INTEREST IN SHARES The rights to purchase Shares granted pursuant to this Plan will in all respects be subject to the terms and conditions of the Plan, as interpreted by the Plan Administrator from time to time. The Participant shall have no interest in Shares purchasable under the Plan until payment for the Shares has been completed at the close of business on the relevant Purchase Date. The Plan provides only an unfunded, unsecured promise by the Company to pay money or property in the future. Except with respect to the Shares purchased on a Purchase Date, an Employee choosing to participate in the Plan shall have no greater rights than an unsecured creditor of the Company. After the purchase of Shares, the Participant shall be entitled to all rights of a shareholder of the Company. IX. ADMINISTRATION PLAN ADMINISTRATOR At the discretion of the Board of Directors, the Plan shall be administered by the Board of Directors or by a Committee appointed by the Board of Directors. Each member of the Committee shall be a director, an officer or an Employee of the Company. Each member shall serve for a term commencing on a date specified by the Board of Directors and continuing until that person dies, resigns or is removed by the Board of Directors. POWERS The Plan Administrator shall be vested with full authority to make, administer and interpret the rules and regulations as it deems necessary to administer the Plan. Any determination, decision or act of the Plan Administrator with respect to any action in connection with the construction, interpretation, administration or application of the Plan shall be final, binding and conclusive upon all Participants and any and all other persons claiming under or through any Participant. The provisions of the Plan shall be construed in a manner consistent with the requirements of Section 423 of the Code. X CHANGES IN CAPITALIZATION, MERGER, ETC. RIGHTS OF THE COMPANY The grant of a right to purchase Shares pursuant to this Plan shall not affect in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or other changes in its capital or business structure or to merge, consolidate or dissolve, liquidate or transfer all or any part of its divisions, subsidiaries, business or assets. RECAPITALIZATION Subject to any required action by shareholders, the number of Shares covered by the Plan as provided in Section VIII and the price per Share shall be proportionately adjusted for any increase or decrease in the number of issued Shares of the Company resulting from a subdivision or consolidation of Shares or the payment of a stock dividend or any other increase or decrease in the number of such Shares effected without receipt or payment of consideration by the Company. CONSOLIDATION OR MERGER In the event of the consolidation or merger of the Company with or into any other business entity, or sale by the Company of substantially all of its assets, the successor may at its discretion continue the Plan by adopting the same by resolution of its Board of Directors or agreement of its partners or proprietors or substitute an equivalent Plan therefor. If the successor refuses to continue or substitute for the Plan, the Plan Administrator will shorten the Offering to a specified date before the proposed consolidation, merger or sale. Similarly, in the event of a liquidation or dissolution of the Company, the Plan Administrator will shorten the Offering to a specified date before the proposed liquidation or dissolution. XI. TERMINATION OF EMPLOYMENT VACATION, LEAVE OR LAYOFF A person's Employment shall not terminate on account of an authorized leave of absence, sick leave or vacation, or on account of a military leave described in this Section XI, or a direct transfer between Employers. Failure to return to work upon expiration of any leave of absence, sick leave or vacation shall be considered a resignation effective as of the expiration of such leave of absence, sick leave or vacation. MILITARY LEAVE Any Employee who leaves the Employer directly to perform services in the Armed Forces of the United States or in the United States Public Health Service under conditions entitling the Employee to reemployment rights provided by the laws of the United States, shall be on military leave. An Employee's military leave shall expire if the Employee voluntarily resigns from the Employer during the leave or if that person fails to make an application for reemployment within a period specified by such law for preservation of employment rights. In such event, the individual's Employment shall terminate by resignation on the day the military leave expires. XII. SHAREHOLDER APPROVAL AND RULINGS The Plan is expressly made subject to (a) the approval of the Plan within twelve (12) months after the Plan is adopted by the shareholders of the Company and (b) at the Company's election, to the receipt by the Company from the Internal Revenue Service of a ruling in scope and content satisfactory to counsel to the Company, affirming qualification of the Plan within the meaning of Section 423 of the Code. If the Plan is not so approved by the shareholders within 12 months after the date the Plan is adopted and if, at the election of the Company a ruling from the Internal Revenue Service is sought but not received on or before one year after this Plan's adoption by the Board of Directors, this Plan shall not come into effect. In that case, the Account of each Participant shall forthwith be paid to the Participant. XIII. MISCELLANEOUS PROVISIONS AMENDMENT AND TERMINATION OF THE PLAN The Board of Directors of the Company may at any time amend the Plan. Except as otherwise provided herein, no amendment may adversely affect or change any right to purchase Shares without prior approval of the shareholders of the Company if the amendment would: (i) Permit the sale of more Shares than are authorized under Section VIII; (ii) Permit the sale of Shares to employees of entities which are not Employers; (iii) Materially increase the benefits accruing to Participants under the Plan; or (iv) Materially modify the requirements as to eligibility for participation in the Plan. The Plan is intended to be a permanent program, but the Company reserves the right to declare the Plan terminated at any time. Upon such termination, amounts credited to the Accounts of the Participants with respect to whom the Plan has been terminated shall be returned to such Participants. NON-TRANSFERABILITY Neither payroll deductions credited to a Participant's Account nor any rights with regard to the purchase of Shares under the Plan may be assigned, transferred, pledged or otherwise disposed of in any way by the Participant except as provided in Section VII, and any attempted assignment, transfer, pledge, or other disposition shall be null and void. The Company may treat any such act as an election to withdraw funds in accordance with Section VII. USE OF FUNDS All payroll deductions received or held by the Company under the Plan may be used by the Company for any corporate purposes and the Company shall not be obligated to segregate the payroll deductions. EXPENSES All expenses of administering the Plan shall be borne by the Company. The Company will not pay expenses, commissions or taxes incurred in connection with sales of Shares by the Custodian at the request of a Participant. Expenses to be paid by a Participant will be deducted from the proceeds of sale prior to remittance. TAX WITHHOLDING Each Participant who has purchased Shares under the Plan shall immediately upon notification of the amount due, if any, pay to the Employer in cash amounts necessary to satisfy any applicable federal, state and local tax withholding determined by the Employer to be required. If the Employer determines that additional withholding is required beyond any amounts deposited at the time of purchase, the Participant shall pay such amount to the Employer on demand. If the Participant fails to pay the amount demanded, the Employer may withhold that amount from other amounts payable by the Employer to the Participant, including salary, subject to applicable law. NO INTEREST No Participant shall be entitled, at any time, to any payment or credit for interest with respect to or on the payroll deductions contemplated herein, or on any other assets held hereunder for the Participant's Account. REGISTRATION AND QUALIFICATION OF SHARES The offering of Shares hereunder shall be subject to the effecting by the Company of any registration or qualification of the Shares under any federal or state law or the obtaining of the consent or approval of any governmental regulatory body which the Company shall determine, in its sole discretion, is necessary or desirable as a condition to, or in connection with, the offering or the issue or purchase of the Shares covered thereby. The Company shall make every reasonable effort to effect such registration or qualification or to obtain such consent or approval. RESPONSIBILITY AND INDEMNITY Neither the Company, its Board of Directors, the Custodian, nor any member, officer, agent or employee of any of them, shall be liable to any Participant under the Plan for any mistake of judgment or for any omission or wrongful act unless resulting from gross negligence, willful misconduct or intentional misfeasance. The Company will indemnify and save harmless its Board of Directors, the Custodian and any such member, officer, agent or employee against any claim, loss, liability or expense arising out of the Plan, except such as may result from the gross negligence, willful misconduct or intentional misfeasance of such entity or person. PLAN NOT A CONTRACT OF EMPLOYMENT The Plan is strictly a voluntary undertaking on the part of the Employer and shall not constitute a contract between the Employer and any Employee, or consideration for or an inducement or a condition of employment of an Employee. Except as otherwise required by law, or any applicable collective bargaining agreement, nothing contained in the Plan shall give any Employee the right to be retained in the service of the Employer or to interfere with or restrict the right of the Employer, which is hereby expressly reserved, to discharge or retire any Employee at any time, with or without cause and with or without notice. Except as otherwise required by law, inclusion under the Plan will not give any Employee any right or claim to any benefit hereunder except to the extent such right has specifically become fixed under the terms of the Plan. The doctrine of substantial performance shall have no application to any Employee, Participant, or Beneficiary. Each condition and provision, including numerical items, has been carefully considered and constitutes the minimum limit on performance which will give rise to the applicable right. SERVICE OF PROCESS The Secretary of the Company is hereby designated agent for service or legal process on the Plan. NOTICE All notices or other communications by a Participant to the Company under or in connection with the Plan shall be deemed to have been duly given when received by the Plan Administrator. Any notice required by the Plan to be received by the Company prior to an Enrollment Date, payroll period or other specified date, and received by the Plan Administrator subsequent to such date shall be effective on the next occurring Enrollment Date, payroll period or other specified date to which such notice applies. GOVERNING LAW The Plan shall be interpreted, administered and enforced in accordance with the Code, and the rights of Participants, former Participants, Beneficiaries and all other persons shall be determined in accordance with it. To the extent state law is applicable, the laws of the State of Washington shall apply. REFERENCES Unless the context clearly indicates to the contrary, reference to a Plan provision, statute, regulation or document shall be construed as referring to any subsequently enacted, adopted or executed counterpart. EXHIBIT A DEFINITIONS ACCOUNT Shall mean each separate account maintained for a Participant under the Plan collectively or singly as the context requires. Each Account shall be credited with a Participant's contributions, and shall be charged for the purchase of Shares. A Participant shall be fully vested in the cash contributions to that person's Account at all times. The Plan Administrator may create special types of Accounts for administrative reasons, even though the Accounts are not expressly authorized by the Plan. BENEFICIARY Shall mean a person or entity entitled under Section VII of the Plan to receive Shares purchased by, and any remaining balance in, a Participant's Account on the Participant's death. BOARD OF DIRECTORS Shall mean the Board of Directors of the Company. CODE Shall mean the Internal Revenue Code of 1986, as amended, or the corresponding provisions of any future tax code. COMMITTEE Shall mean the Committee appointed by the Board of Directors in accordance with Section IX of the Plan. COMPENSATION Shall mean the total cash compensation (except as otherwise set forth below), before tax withholding, paid to an Employee in the period in question for services rendered to the Employer by the Employee. Compensation shall include the earnings waived by an Employee pursuant to a salary reduction arrangement under any cash or deferred or cafeteria plan that is maintained by the Employer and that is intended to be qualified under Section 40 1(k) or 125 of the Code. An Employee's Compensation shall not include severance pay, hiring or relocation bonuses, or pay in lieu of vacations or sick leave COMMON STOCK Shall mean the common stock of the Company. COMPANY Shall mean Freei Networks, Inc., a Washington Corporation. CUSTODIAN Shall mean the investment or financial firm appointed by the Plan Administrator to hold all Shares pursuant to the Plan. CUSTODIAL ACCOUNT Shall mean the account maintained by the Custodian for a Participant under the Plan. DISABILITY Shall refer to a mental or physical impairment which is expected to result in death or which has lasted or is expected to last for a continuous period of twelve (12) months or more and which causes the Employee to be unable, in the opinion of the Company and two independent physicians, to perform his or her duties as an Employee of the Company. Disability shall be deemed to have occurred on the first day after the Company and two independent physicians have furnished their opinion of Disability to the Plan Administrator. EMPLOYEE Shall mean an individual who renders services to the Employer pursuant to a regular-status employment relationship with such Employer. A person rendering services to an Employer purportedly as an independent consultant or contractor shall not be an Employee for purposes of the Plan. EMPLOYER Shall mean, collectively, the Company and its Subsidiaries or any successor entity that continues the Plan. All Employees of entities which constitute the Employer shall be treated as employed by a single company for all purposes of the Plan. EMPLOYMENT Shall mean the period during which an individual is an Employee. Employment shall commence on the day the individual first performs services for the Employer as an Employee and shall terminate on the day such services cease, except as determined under Section XI. ENROLLMENT DATE Shall mean the first day of each Offering. ESPP NEW ACCOUNT FORM Shall mean the form provided by the Company on which a Participant shall elect to open an Account with the Custodian and authorize delivery to the Custodian of all Shares issued for the Participant's Account. OFFERING Shall mean any one of the separate overlapping eighteen (18) month periods commencing on May 15 and November 15 of each calendar year under the Plan; provided, however, the first Offering shall commence on the effective date of the Company's registration statement filed in connection with the Company's initial public offering and end on November 14, 2001. PARTICIPANT Shall mean any Employee who is participating in any Offering under the Plan pursuant to Section III. PAYROLL DEDUCTION Shall mean the form provided by the Company on which a Participant shall elect to participate in the Plan and the Offering under the Plan and designate the percentage of that individual's compensation to be contributed to that individual's Account through payroll deductions. PLAN AUTHORIZATION FORM Shall mean this document. PLAN ADMINISTRATOR Shall mean the Board of Directors or the Committee, whichever shall be administering the Plan from time to time in the discretion of the Board of Directors, as described in Section IX. PURCHASE DATE Other than the first Offering, Purchase Date shall mean the last day of each of the sixth-, twelfth- and eighteenth-month periods of each Offering; accordingly, Purchase Dates for every Offering other than the first Offering shall occur on May 14 and November 14 of each year, beginning with November 14, 2000. For purposes of the first Offering (which shall commence on the effective date of the Company's registration statement filed in connection with the Company's initial public offering and end on November 14, 2001), the Purchase Dates shall be November 14, 2000, May 14, 2001 and November 14, 2001. RETIREMENT Shall mean a Participant's termination of Employment on or after attaining the age of 65 or after the Plan Administrator has determined that the individual has suffered a Disability. SHARE Shall mean one share of Common Stock. SUBSIDIARIES Shall mean any corporation in which at least eighty percent (80%) or more of the total combined voting power of all classes of stock are owned directly or indirectly by Freei Networks, Inc. VALUATION DATE Shall mean the date upon which the fair market value of Shares is to be determined for purposes of setting the price of Shares under Section VI (that is, the Enrollment Date or the applicable Purchase Date). If the Enrollment Date or the Purchase Date is not a date on which the fair market value may be determined in accordance with Section VI, the Valuation Date shall be the first day prior to the Enrollment Date or the Purchase Date, as applicable, for which such fair market value may be determined. VESTED Shall mean non-forfeitable. EXHIBIT B Freei Networks, Inc. 2000 Employee Stock Purchase Plan Payroll Deduction Authorization Form NAME_________________________________ SOCIAL SECURITY:_____________________ DATE OF HIRE:______________________ Please complete the sections below which apply. Initial enrollments, withdrawals and changes in payroll deductions are effective for a specific pay period if submitted to the Stock Administrator 15 days prior to the last day of the payroll period. Re-enrollments must be received by the Stock Administrator by 4:00 PM on the Enrollment Date. Beneficiary designations are effective immediately and remain in effect until revoked. Enrollment Dates are on November 15 and May 15. Each Offering is in effect for 18 months. 1. __ INITIAL ENROLLMENT Complete 5 below. Attach Stock Broker New Account forms (Account Agreement, Information Sheet, and W-9), if you do not already have a custodial account with Stock Broker. I elect to participate in the Freei Networks, Inc. 2000 Employee Stock Purchase Plan, effective as of the next Enrollment Date. I authorize a deduction of ___% per pay period (not less than 1% or more than 10%) of my Compensation. On any Enrollment Date on which the market price of the shares is less than the initial market price of Freei Networks, Inc. shares in the Offering in which I am currently participating, I hereby elect to withdraw from the Offering in which I am currently participating and reenroll in the new Offering beginning on such Enrollment Date. 2. CHANGE IN PAYROLL DEDUCTION I elect to change the amount of my payroll deduction to per pay period (not less than 1% or more than 10%) of my Compensation. I understand that the Plan permits modifications not more than three times during each 18 month Offering Period. I elect to discontinue my payroll deduction, without withdrawing from the Plan. I request that the aggregate balance in my Account be used to purchase Shares on the next Purchase Date, after which my participation in the Plan will terminate unless I timely file another Payroll Deduction Authorization form to resume payroll deductions. 3. WITHDRAWAL/TERMINATION I elect to withdraw from the Plan and terminate participation in the Offering in which I am currently participating. I request that my contributions be discontinued and the aggregate balance in my Account be returned to me. I understand that my Account balance will not be returned unless my election to withdraw is submitted at least 15 days prior to the next Purchase Date. 4. RE-ENROLLMENT Effective as of the first Enrollment Date that is either on or after the date of this Form, I elect to withdraw from the Offering in which I am currently participating and re-enroll in the new Offering beginning on such Enrollment Date. 5. BENEFICIARY DESIGNATION OR CHANGE I designate the following individual(s) as my beneficiary: (Name) (Relationship) --------------------------------- --------------------------------- --------------------------------- --------------------------------- I have read the Freei Networks, Inc. 2000 Employee Stock Purchase Plan and understand the terms and conditions stated in the Plan. I authorize the transactions indicated above. I understand that my current elections remain in effect until I submit a new election, in writing and on a timely basis, to the Stock Administrator. EX-10.3 6 EXHIBIT 10.3 Exhibit 10.3 FREEI NETWORKS, INC. SUMMARY PLAN DESCRIPTION FOR FREEI NETWORKS, INC. 401(k) PLAN TABLE OF CONTENTS I INTRODUCTION TO YOUR PLAN II GENERAL INFORMATION ABOUT YOUR PLAN 1. General Plan Information ................................................1 2. Employer Information ....................................................2 3. Plan Administrator Information ..........................................2 4. Plan Trustee Information ................................................3 5. Service of Legal Process ................................................3 III PARTICIPATION IN YOUR PLAN 1. Eligibility Requirements. ...............................................3 2. Participation Requirements ..............................................4 IV CONTRIBUTIONS TO YOUR PLAN 1. Employer Contributions to the Plan ......................................4 2. Participant Salary Reduction Election....................................5 3. Your Share of Employer Contributions.....................................6 4. Compensation.............................................................7 5. Forfeitures..............................................................7 5. Transfers From Qualified Plans (Rollovers)...............................7 7. Directed Investments ....................................................8 V BENEFITS UNDER YOUR PLAN 1. Distribution of Benefits Upon Normal Retirement..........................8 2. Distribution of Benefits Upon Late Retirement ...........................8 3. Distribution of Benefits Upon Death......................................8 4. Distribution of Benefits Upon Disability.................................9 5. Distribution of Benefits Upon Termination of Employment..................9 6. Vesting in Your Plan.....................................................10 7. Benefit Payment Options .................................................10 8. Hardship Distribution of Benefits........................................11 9. Treatment of Distributions From Your Plan................................12 10. Domestic Relations Order.................................................12 11. Pension Benefit Guaranty Corporation.....................................13 VI YEAR OF SERVICE RULES 1. Year of Service and Hour of Service .....................................13 2. 1-Year Break in Service .................................................14 VII YOUR PLAN'S TOP HEAVY RULES 1. Explanation of Top Heavy Rules ..........................................15 VIII LOANS 1. Loan Requirements........................................................15 IX CLAIMS BY PARTICIPANTS AND BENEFICIARIES 1. The Claims Review Procedure..............................................17 X STATEMENT OF ERISA RIGHTS 1. Explanation of Your ERISA Rights.........................................18 XI AMENDMENT AND TERMINATION OF YOUR PLAN 1. Amendment................................................................19 2. Termination..............................................................19 FREEI NETWORKS, INC. 401(K) PLAN SUMMARY PLAN DESCRIPTION I INTRODUCTION TO YOUR PLAN Freei Networks, Inc. wishes to recognize the efforts its employees have made to its success and to reward them by adopting a 401(k) Profit Sharing Plan and Trust. This 401(k) Profit Sharing Plan and Trust will be for the exclusive benefit of eligible employees and their beneficiaries. Your Plan is a "salary reduction plan." It is also called a "401(k) plan." Under this type of plan, you may choose to reduce your compensation and have these amounts contributed to this Plan on your behalf. The purpose of this Plan is to reward eligible employees for long and loyal service by providing them with retirement benefits. Between now and your retirement, your Employer intends to make contributions for you and other eligible employees. When you retire, you will be eligible to receive the value of the amounts which have accumulated in your account. This Summary Plan Description is a brief description of your Plan and your rights, obligations, and benefits under that Plan. Some of the statements made in this Summary Plan Description are dependent upon this Plan being "qualified" under the provisions of the Internal Revenue Code. This Summary Plan Description is not meant to interpret, extend, or change the provisions of your Plan in any way. The provisions of your Plan may only be determined accurately by reading the actual Plan document, including the Adoption Agreement. A copy of your Plan and the Adoption Agreement are on file at your Employer's office and may be read by you, your beneficiaries, or your legal representatives at any reasonable time. If you have any questions regarding either your Plan, the Adoption Agreement or this Summary Plan Description, you should ask your Plan's Administrator. In the event of any discrepancy between this Summary Plan Description and the actual provisions of the Plan, the Plan will govern. II GENERAL INFORMATION ABOUT YOUR PLAN There is certain general information which you may need to know about your Plan. This information has been summarized for you in this Section. 1. General Plan Information Freei Networks, Inc. 401(k) Plan Is the name of your Plan. Your Employer has assigned Plan Number 001 to your Plan. 1 The provisions of your Plan become effective on February 1, 1999, which is called the Effective Date of the Plan. Your Plan's records are maintained on a twelve-month period of time. This is known as the Plan Year. The Plan Year begins on January I and ends on December 31, except that the Plan Year beginning on February 1, 1999 is a short Plan Year ending on December 31, 1999. Certain valuations and distributions are made on the Anniversary Date of your Plan. This date is December 31. The contributions made to your Plan will be held and invested by the Trustee of your Plan. Your Plan and Trust will be governed by the laws of the State of Washington. 2. Employer Information Your Employer's name, address and identification number are: Freei Networks, Inc. 909 South 336th Street, Suite 201 Federal Way, Washington 98003 91-1930473 Your Plan allows other employers to adopt its provisions. You or your beneficiaries may examine or obtain a complete list of employers, if any, who have adopted your Plan by making a written request to the Administrator. 3. Plan Administrator Information The name, address and business telephone number of your Plan's Administrator are: Freei Networks, Inc. 909 South 336th Street, Suite 201 Federal Way, Washington 98003 (253) 796-6501 Your Plan's Administrator keeps the records for the Plan and is responsible for the administration of the Plan. The Administrator has discretionary authority to construe the terms of the Plan and make determinations on questions which may affect your eligibility for benefits. Your Plan's Administrator will also answer any questions you may have about your Plan. 2 4. Plan Trustee Information The names of your Plan's Trustees are: Robert McCausland Donna Hyder The Trustees will collectively be referred to as Trustee throughout this Summary Plan Description. The principal place of business of your Plan's Trustee is: 909 South 336th Street, Suite 201 Federal Way, Washington 98003 Your Plan's Trustee has been designated to hold and invest Plan assets for the benefit of you and other Plan participants. The trust fund established by the Plan's Trustee will be the funding medium used for the accumulation of assets from which benefits will be distributed. 5. Service of Legal Process The name and address of your Plan's agent for service of legal process are: Freei Networks, Inc. 909 South 336th Street, Suite 201 Federal Way, Washington 98003 Service of legal process may also be made upon the Trustee or Administrator. III PARTICIPATION IN YOUR PLAN Before you become a member or a "participant" in the Plan, there are certain eligibility and participation rules which you must meet. These rules are explained in this Section. 1. Eligibility Requirements You will participate in the Plan at, of the Effective Date of the Plan which is February 1 1999 if you were employed on such date, Otherwise, you will be eligible to participate in the Plan if you have completed three months and have attained age 21. You should review the Article In this Summary entitled "YEAR OF SERVICE RULES" for a, further explanation of these eligibility requirements. 3 2. Participation Requirements Once you have satisfied your Plan's eligibility requirements, your next step will be to actually become a member or a "participant" in the Plan. You will become a participant on a specified day of the Plan Year. This day is called the Effective Date of Participation. Your effective Date of Participation is the First of each Calendar Quarter, provided you satisfy the eligibility requirements. IV CONTRIBUTIONS TO YOUR PLAN 1. Employer Contributions to the Plan Each year, your Employer will contribute to your Plan the following amounts: (a) The total amount of the salary reduction you elected to defer. (See the Section in this Article entitled "Participant Salary Reduction Election.") (b) A discretionary matching contribution equal to a percentage of the amount of the salary reduction you elected to defer, which percentage will be determined each year by the Employer. However, in applying this matching percentage, only salary reductions up to 6% of your compensation will be considered. For a participant to qualify for a matching contribution, the following conditions apply: - If you are actively employed on the last day of the Plan Year, you will share regardless of the number of Hours of Service credited during the Plan Year. - If you terminate employment (not actively employed on the last day of the Plan Year), you will receive a matching contribution regardless of the number of Hours of Service credited for the Plan Year. - You will share in the matching contribution for the year regardless of the number of Hours of Service credited in the year of your death, disability or retirement. (c) On behalf of each participant, a special discretionary contribution equal to a percentage of your compensation. This contribution is not required, but if such a contribution is made the percentage contributed will be determined each year by the, Employer. (d) A discretionary amount in addition to the special contribution, which amount, if any, will be determined each year by your Employer. For a participant to qualify for the discretionary and special contributions, the following conditions apply: 4 - If you are actively employed on the last day of the Plan Year, you will share regardless of the number of Hours of Service credited during the Plan Year. - If you terminate employment (not actively employed on the last day of the Plan Year), you must be credited with more than 500 Hours of Service. - You will share for the year regardless of the number of Hours of Service credited in the year of your death, disability or retirement. 2. Participant Salary Reduction Election As a participant, you may elect to defer up to 18% of your compensation each year instead of receiving that amount in cash. However, your total deferrals in any taxable year may not exceed a dollar limit which is set by law. The limit for 1999 is $10,000. This limit will be increased in future years for cost of living changes. You may elect to defer your salary as of January 1, April 1, July 1, October 1. Such election will become effective as soon as administratively feasible. Your election will remain in effect until you modify or terminate it. You may modify your election as of January 1, April 1, July 1, October 1 of any year. The modification will become effective as soon as administratively feasible. The amount you elect to defer, and any earnings on that amount, will not be subject to income tax until it is actually distributed to you. This money will, however, be subject to Social Security taxes at all times. You should also be aware that the annual dollar limit is an aggregate limit which applies to all deferrals you may make under this plan or other cash or deferred arrangements (including tax-sheltered 403(b) annuity contracts, simplified employee pensions or other 401(k) plans in which you may be participating). Generally, if your total deferrals under all cash or deferred arrangements for a calendar year exceed the annual dollar limit, the excess must be included in your income for the year. For this reason, it is desirable to request in writing that these excess deferrals be returned to you. If you fail to request such a return, you may be taxed a second time when the excess deferral is ultimately distributed from the Plan. You must decide which plan or arrangement you would like to have return the excess. If you decide that the excess should be distributed from this Plan, you should communicate this in writing to the Administrator no later than the March 1st following the close of the calendar year in which such excess deferrals were made. The Administrator may then return the excess deferral and any earnings to you by April 15th. In the event you receive a hardship distribution from your deferrals to this Plan or any other plan maintained by your Employer, you will not be allowed to make additional salary reductions for a period of twelve (12) months after you receive the distribution, Furthermore, the dollar limitation set by law with respect to your taxable year following the year in which you received the distribution will be reduced by your salary reductions, If any, for the taxable year of the distribution. 5 You will always be 100% vested in the amount you deferred. This means that you will always be entitled to all of the deferred amount. This money will, however, be affected by any investment gains or losses. If the Trustee invested this money and there was a gain, the balance in your account would increase, Of course, if there was a loss, the balance in your account would decrease. Distributions from your deferred account are not permitted before age 59 1/2 EXCEPT in the event of: (a) death; (b) disability; (c) termination of employment; or (d) reasons of proven financial hardship (See the Section in Article V entitled "Hardship Distribution of Benefits"). In addition, if you are a highly compensated employee (generally owners, officers or individuals receiving wages in excess of certain amounts established by law), a distribution from your deferred account of certain excess contributions may be required to comply with the law. The Administrator will notify you when a distribution is required. 3. Your Share of Employer Contributions Your Employer will allocate the amount you elect to defer to an account maintained on your behalf. If you are eligible, your Employer will also allocate the matching contribution and the special contribution made to the Plan on your behalf. (See the Section in this Article entitled "Employer Contributions to the Plan.") Your Employees discretionary contribution will be "allocated" or divided among participants eligible to share in the contribution for the Plan Year. Your share of the contribution will depend upon how much compensation you received during the year and the compensation received by other eligible participants. Your share of your Employer's discretionary contribution is determined by the following fraction: Your Compensation Employer's X Discretionary Contribution --------------------------------- Total Compensation of All Participants Eligible to Share For example: Suppose the Employer's discretionary contribution for the Plan Year is $20,000. Employee A's compensation for the Plan Year is $25,000. The total compensation of 6 all participants eligible to share, including Employee A, is $250,000. Employee A's share will be: $20,000 X $25,000 or $2,000 ------------ $250,000 In addition to the Employer's contributions made to your account, your account, will be credited annually with a share of the investment earnings or losses of the trust fund. You should also be aware that the law imposes certain limits on how much money may be allocated to your account for a year. These limits are extremely complex, but generally no more than the lesser of $30,000 or 25% of your compensation may be allocated to you (excluding earnings) in any year. The Administrator will inform you if these limits have affected you. 4. Compensation For the purposes of your Plan, compensation has a special meaning. Compensation is defined as your total salary, wages and other amounts which are includible in your income for purposes of income taxes that is paid during the Plan Year. In addition, salary reduction contributions to any cafeteria plan, tax sheltered annuity, SEP or 401(k) plan will be included as compensation for Plan purposes. For the first year of your participation in the Plan, your compensation will be recognized for benefit purposes for the entire Plan Year. For the Plan Year beginning in 1997 and for Plan Years thereafter, the Plan, by law, cannot recognize compensation in excess of $160,000. This amount will be adjusted in future years for cost of living increases. It will also be applied to certain highly compensated employees and their family members as if they were a single participant. If you or a member of your family may be affected by this rule, ask your Administrator for further details. 5. Forfeitures Forfeitures are created when participants terminate employment before becoming entitled to their full benefits under the Plan, Your account may grow from the forfeitures of other participants. Forfeitures will be "allocated" or divided among participants eligible to share for a Plan Year. However, a portion of forfeited amounts will be used to reduce your Employers contributions to the Plan. 6. Transfers From Qualified Plans (Rollovers) At the discretion of the Administrator, you may be permitted to deposit into your Plan distributions you have received from other plans. Such a deposit Is called a "rollover" and may result in tax savings to you. You should consult qualified counsel to determine if a rollover is in your best interest. 7 Your rollover will be placed in a separate account called a "participant's rollover account." The Administrator may establish rules for investment. You will always be 100% vested in your "rollover account." This means that you will always be entitled to all of your rollover contributions. Rollover contributions will be affected by any investment gains or losses, If the Trustee invested this money and there was a gain, the balance in your account would increase. Of course, if there was a loss from an investment, the balance in your account would decrease. 7. Directed Investments The Administrator may establish rules for investment of your account balance. If the Administrator approves, you may direct the investment of your account balance. V BENEFITS UNDER YOUR PLAN 1. Distribution of Benefits Upon Normal Retirement Your Normal Retirement Date is the first day of the month coinciding with or next following your 65th birthday (Normal Retirement Age). At your Normal Retirement Age, you will be entitled to 100% of your account balance. Payment of your benefits will begin as soon as practicable following your Normal Retirement Date. 2. Distribution of Benefits Upon Late Retirement You may remain employed past your Plan's Normal Retirement Date and retire instead on your Late Retirement Date. Your Late Retirement Date is the first day of the month coinciding With or next following the date you choose to retire after first having reached your Normal Retirement Date, On your Late Retirement Date, you will be entitled to 100% of your account balance. Actual benefit payments will begin as soon as practicable following your Late Retirement Date. 3. Distribution of Benefits Upon Death Your beneficiary will be entitled to a single lump-sum distribution of 100% of your account balance upon your death. If you are married at the time of your death, your spouse will be the beneficiary of the death benefit, unless you otherwise elect in writing on a form to be furnished to you by the Administrator. IF YOU WISH TO DESIGNATE A BENEFICIARY OTHER THAN YOUR SPOUSE, HOWEVER, YOUR SPOUSE MUST IRREVOCABLY CONSENT TO WAIVE ANY RIGHT TO THE DEATH BENEFIT YOUR SPOUSE'S CONSENT MUST BE IN WRITING, BE WITNESSED BY A NOTARY OR A PLAN REPRESENTATIVE AND ACKNOWLEDGE THE SPECIFIC NONSPOUSE BENEFICIARY. 8 If, however, (a) your spouse has validly waived any right to the death benefit in the manner outlined above, (b) your spouse cannot be located, or (c) you are not married at the time of your death, then your death benefit will be paid to the beneficiary of your own choosing in a single lump sum. You may designate the beneficiary on a form to be supplied to you by the Administrator. If you change your designation, your spouse must again consent to the change. Regardless of the method of distribution selected, your entire death benefit must generally be paid to your beneficiaries within five years after your death (the "5-year rule"). However, if your designated beneficiary is a person (instead of your estate or most trusts), then you or your beneficiary may elect to have minimum distributions begin within one year of your death and it may be paid over the designated beneficiary's life expectancy (the "1-year rule"). If your spouse is the beneficiary, then under the "1-year rule" the start of payments may be delayed until the year in which you would have attained age 70 1/2, The election to have death benefits distributed under the "1 -year rule" instead of the "5-year rule" must be made no later than the time at which minimum distributions must commence under the "l-year rule" (or, in the case of a surviving spouse, the "5-year rule," if earlier). Since your spouse participates in these elections and has certain rights in the death benefit, you should immediately report any change in your marital status to the Administrator. 4. Distribution of Benefits Upon Disability Under your Plan, disability is defined as a physical or mental condition resulting from bodily injury, disease, or mental disorder which renders you incapable of continuing any gainful occupation with your Employer. Your disability will be determined by a licensed physician chosen by the Administrator. However, if your condition constitutes total disability under the federal Social Security Act, then the Administrator may deem that you are disabled for purposes of the Plan. If you become disabled while a participant, you will be entitled to 100% of your account balance. Payment of your disability benefits will be made to you as if you had retired. (See the Section in this Article entitled "Benefit Payment Options.") 5. Distribution of Benefits Upon Termination of Employment Your Plan is designed to encourage you to stay with your Employer until retirement. Payment of your account balance under your Plan is generally only available upon your death, disability or retirement. If your employment terminates for reasons other than those listed above, you will, be entitled to receive only your "vested percentage" of your account balance and the remainder 9 of your account will be forfeited. Only contributions made by your Employer are subject to forfeiture. (See the Section in this Article entitled "Vesting in Your Plan.") If you so elect, the Administrator will direct the Trustee to distribute your vested benefit to you before the date it would normally be distributed (upon your death, disability or retirement). If your vested benefit under the Plan at the time of any prior distribution exceeded $3,500 or currently exceeds $3,500, you must give written consent before the distribution may be made. Amounts of $3,500 or less will be distributed without the need for consent. Under the Plan's administrative procedures, if the value of your vested account is zero, any non-vested account balance will be forfeited immediately. 6. Vesting in Your Plan Your "vested percentage" in your account is determined under the following schedule and is based on vesting Years of Service. You will always, however, be 100% vested upon your Normal Retirement Age. (See the Section in this Article entitled "Distribution of Benefits Upon Normal Retirement.")
Vesting Schedule Years of Service Percentage 2 20% 3 40% 4 60% 5 80% 6 100%
Regardless of this vesting schedule, you are always 100% vested in your salary reduction amounts contributed to the Plan. Additionally, you are always 100% vested in your Employer's special contributions made to the Plan. 7. Benefit Payment Options At the time you are entitled to receive a distribution under the Plan, the Administrator will direct the distribution of your benefits to you in one lump-sum cash payment. GENERALLY, WHENEVER A DISTRIBUTION IS TO BE MADE TO YOU ON OR BEFORE AN ANNIVERSARY DATE, IT MAY BE POSTPONED BY THE PLAN FOR A PERIOD OF UP TO 180 DAYS, FOR ADMINISTRATIVE CONVENIENCE. HOWEVER, UNLESS YOU ELECT IN WRITING TO DEFER THE RECEIPT OF BENEFITS, NO DISTRIBUTION MAY BEGIN LATER THAN THE 60TH DAY AFTER THE CLOSE OF THE PLAN YEAR IN WHICH THE LATEST OF THE FOLLOWING EVENTS OCCURS; (a) the date on which you reach the age of 65 or your Normal Retirement Age; 10 (b) the 10th anniversary of the year in which you became a participant in the Plan; (c) the date you terminated employment with your Employer. Regardless of whether you elect to delay the receipt of benefits, there are other rules which generally require minimum payments to begin no later than the April 1st following the year in which you reach age 70 1/2. You should see the Administrator if you feel you may be affected by this rule. 8. Hardship Distribution of Benefits The Administrator may direct the Trustee to distribute up to 100% of your account balance in the event of immediate and heavy financial need. This hardship distribution is not in addition to your other benefits and will therefore reduce the value of the benefits you will receive at normal retirement. Withdrawal will be authorized only if the distribution is to be used for one of the following purposes: (a) The payment of medical expenses (described in Section 213(d) of the Internal Revenue Code) previously incurred by you or your dependent or necessary for you or your dependent to obtain medical care; (b) The costs directly related to the purchase of your principal residence (excluding mortgage payments); (c) The payment of tuition and related educational fees for the next twelve (12) months of post-secondary education for yourself, your spouse or dependent; (d) The payment necessary to prevent your eviction from your principal residence or foreclosure on the mortgage of your principal residence. There are restrictions placed on hardship distributions which are made from certain accounts. These accounts are generally the accounts which receive your salary reduction contributions and other Employer contributions which are used to satisfy special rules that apply to 401(k) plans. Any hardship distribution from these accounts will be limited to your salary reduction contributions. Ask your Administrator if you need further details. In addition, a distribution will be made from these accounts only if you certify and agree that all of the following conditions are satisfied: (a) The distribution is not in excess of the amount of your immediate and heavy financial need; (b) You have obtained all distributions, other than hardship distributions, and all nontaxable loans currently available under all plans maintained by your Employer; 11 (c) That your elective contributions and employee contributions will be suspended for at least twelve (12) months after your receipt of the hardship distribution; and (d) That you will not make elective contributions for your taxable year immediately following the taxable year of the hardship distribution, except to the extent permitted by the Plan. 9. Treatment of Distributions From Your Plan Whenever you receive a distribution from your Plan, it will normally be subject to income taxes. You may, however, reduce, or defer entirely, the tax due on your distribution through use of one of the following methods: (a) The rollover of all or a portion of the distribution to an Individual Retirement Account (IRA) or another qualified employer plan. This will result in no tax being due until you begin withdrawing funds from the IRA or other qualified employer plan. The rollover of the distribution, however, MUST be made within strict time frames (normally, within 60 days after you receive your distribution). Under certain circumstances all or a portion of a distribution may not qualify for this rollover treatment. In addition, most distributions will be subject to mandatory federal income tax withholding at a rate of 20%. This will reduce the amount you actually receive. For this reason, if you wish to roll over all or a portion of your distribution amount, the direct transfer option described in paragraph (b) below would be the better choice. (b) You may request that a direct transfer of all or a portion of your distribution amount be made to either an Individual Retirement Account (IRA) or another qualified employer plan willing to accept the transfer. A direct transfer will result in no tax being due until you withdraw funds from the IRA or other qualified employer plan. Like the rollover, under certain circumstances all or a portion of the amount to be distributed may not qualify for this direct transfer. If you elect to actually receive the distribution rather than request a direct transfer, then in most cases 20% of the distribution amount will be withheld for federal income tax purposes. (c) The election of favorable income tax treatment under "10-year forward averaging," "5-year forward averaging" or, if you qualify, "capital gains" method of taxation. WHENEVER YOU RECEIVE A DISTRIBUTION, THE ADMINISTRATOR WILL DELIVER TO YOU A MORE DETAILED EXPLANATION OF THESE OPTIONS. HOWEVER, THE RULES WHICH DETERMINE WHETHER YOU QUALIFY FOR FAVORABLE TAX TREATMENT ARE VE RY COMPLEX. YOU SHOULD CONSULT WITH QUALIFIED TAX COUNSEL BEFORE MAKING A CHOICE. 10. Domestic Relations Order As a general rule, your interest in your account, including your "vested interest," may not be alienated. This means that your interest may not be sold, used as collateral for a 12 loan, given away or otherwise transferred. In addition, your creditors may not attach, garnish or otherwise interfere with your account. There is an exception, however, to this general rule. The Administrator may be required by law to recognize obligations you incur as a result of court ordered child support or alimony payments. The Administrator must honor a "qualified domestic relations order." A "qualified domestic relations order" is defined as a decree or order issued by a court that obligates you to pay child support or alimony, or otherwise allocates a portion of your assets in the Plan to your spouse, former spouse, child or other dependent. If a qualified domestic relations order is received by the Administrator, all or a portion of your benefits may be used to satisfy the obligation. The Administrator will determine the validity of any domestic relations order received. 11. Pension Benefit Guaranty Corporation Benefits provided by your Plan are NOT insured by the Pension Benefit Guaranty Corporation (PBGC) under Title IV of the Employee Retirement Income Security Act of 1974 because the insurance provisions under ERISA are not applicable to your Plan. VI YEAR OF SERVICE RULES 1. Year of Service and Hour of Service The term "Year of Service" is used throughout this Summary Plan Description and throughout your Plan. A Year of Service for eligibility purposes is defined as follows: You will have completed a Year of Service if, at the end of your first twelve consecutive months of employment with your Employer, you have been credited with 1000 Hours of Service. You will have completed a Year of Service for vesting purposes if you are credited with 1000 Hours of Service during a Plan Year, even if you were not employed on the first or last day of the Plan Year. An "Hour of Service" has a special meaning for Plan purposes. You will be credited with an Hour of Service for: (a) each hour for which you are directly or indirectly compensated by your Employer for the performance of duties during the Plan Year; (b) each hour for which you are directly or indirectly compensated by your Employer for reasons other then performance of duties (such as vacation, holidays, sickness, disability, lay-off, military duty, jury duty or leave of absence during the Plan Year); and (c) each hour for back pay awarded or agreed to by your Employer. You will not be credited for the same Hours of Service both under (a) or (b), as the case may be, and under (c). 13 2. 1-Year Break in Service A 1-Year Break in Service is a computation period during which you have not completed more than 500 Hours of Service with your Employer. A 1-Year Break in Service does NOT occur, however, in the computation period in which you enter or leave the Plan for reasons of: (a) an authorized leave of absence; (b) certain maternity or paternity absences. The Administrator will be required to credit you with Hours of Service for a maternity or paternity absence. These are absences taken on account of pregnancy, birth, or adoption of your child. No more than 501 Hours of Service will be credited for this purpose and these Hours of Service will be credited solely to avoid your incurring a 1-Year Break in Service. The Administrator may require you to furnish proof that your absence qualifies as a maternity or paternity absence. These break in service rules may be illustrated by the following examples: Employee A works 300 hours in a Plan Year. At the end of the Plan Year, Employee A will have a 1-Year Break in Service because she has worked less than 501 hours in a Plan Year. Employee B works 300 hours in a Plan Year and takes an authorized leave of absence for which he is credited with an additional 250 hours. Employee B will NOT have a 1-Year Break in Service because he is credited with more than 500 hours in a Plan Year. If you are reemployed after a 1-Year Break in Service and were vested in any portion of your account derived from Employer contributions, you will receive credit for all Years of Service credited to you before your 1-Year Break in Service. If you do not have a "vested Interest" in the Employer contributions allocated to your account when you terminate your employment, you will lose credit for your pre-break Years of Service when your consecutive 1-Year Breaks in Service equal or exceed the greater of 5 years, or your pre-break Years of Service, For example: Employee B terminated employment on January 1, 2000 with 2 Years of Service, Employee B was not vested at the time of his termination of employment. Employee B returns to work on January 1, 2003. Employee B will be credited with his 2 pre-break Years of Service because his period of termination (3 years) did not exceed 5 years. 14 VII YOUR PLAN'S TOP HEAVY RULES 1. Explanation of Top Heavy Rules A 401(k) Profit Sharing Plan that primarily benefits "key employees" is called a "top heavy plan." Key employees are certain owners or officers of your Employer. A Plan is a "top heavy plan" when more than 60% of the contributions or benefits have been allocated to key employees. Each year, the Administrator is responsible for determining whether your Plan is a "top heavy plan." If your Plan becomes top heavy in any Plan Year, then non-key employees will be entitled to certain "top heavy minimum benefits," and other special rules will apply. Among these top heavy rules are the following: (a) Your Employer may be required to make a contribution equal to 3% of your compensation to your account; (b) If you are a participant in more than one Plan, you may not be entitled to minimum benefits under both Plans. VIII LOANS You may apply to the Administrator for a loan from the Plan. Your application must be in writing on forms which the Administrator will provide to you. The Administrator may also request that you provide additional information, such as financial statements, tax returns and credit reports. After considering your application, the Administrator may, in its discretion, determine that you qualify for the loan. The Administrator will inform the Trustee that you qualify. The Trustee may then review the Administrator's determination and make a loan to you if it is a prudent investment for the Plan. 1. Loan Requirements There are various rules and requirements that apply for any loan. These rules are outlined in this Section. In addition, your Employer has established a written loan program which explains these requirements in more detail. You can request a copy of the loan program from the Administrator. Generally, the rules for loans include the following: (a) Loans must be made available to all participants and their beneficiaries on a uniform and non-discriminatory basis. (b) All loans must be adequately secured. You may use up to one-half (1/2) of your vested account balance under the Plan as security for the loan. If more security is required, your principal residence may be used, if permitted by State law. The Plan may also require that repayments on the loan obligation be by payroll deduction. 15 (c) All loans must bear a reasonable rate of interest. The interest rate must be one a bank or other professional lender would charge for making a loan in a similar circumstance. (d) All loans must have a definite repayment period which provides for payments to be made not less frequently than quarterly, and for the loan to be amortized on a level basis over a reasonable period of time, not to exceed five (5) years. However, if you use the loan to acquire your principal residence, you may repay the loan over a reasonable period of time that may be longer than five (5) years. (e) The amount the Plan may loan to you is limited by rules under the internal Revenue Code. All loans, when added to the outstanding balance of all other loans from the Plan, will be limited to the lesser of: (1) $50,000 reduced by the excess, if any, of your highest outstanding balance of loans from the Plan during the one-year period prior to the date of the loan over your current outstanding balance of loans; or (2) 1/2 of your vested account balance. Also, no loan in an amount less than $1,000 will be made. (f) If you fail to make payments when they are due under the loan, you will be considered to be "in default." The Trustee would then have authority to take all reasonable actions to collect the balance owing on the loan. This could include filing a lawsuit or foreclosing on the security for the loan. Under certain circumstances, a loan that is in default may be considered a distribution from the Plan, and could result in taxable income to you. In any event, your failure to repay a loan will reduce the benefit you would otherwise be entitled to from the Plan. (g) Loans will not be made to any "shareholder-employees" unless exemptions for such loans are obtained from the Department of Labor. A shareholder-employee is a participant who owns more than 5% of your Employer's outstanding capital stock during any year in which your Employer elects to be taxed as a small business corporation. IX CLAIMS BY PARTICIPANTS AND BENEFICIARIES Benefits will be paid to participants and their beneficiaries without the necessity of formal claims. You or your beneficiaries, however, may make a request for any Plan benefits to which you may be entitled. Any such request must be made in writing, and it should be made to the Administrator. (See the Article in this Summary entitled "GENERAL INFORMATION ABOUT YOUR PLAN.") Your request for Plan benefits will be considered a claim for Plan benefits, and it will be subject to a full and fair review, If your claim is wholly or partially denied, the Administrator will furnish you with a written notice of this denial. This written notice must be 16 provided to you within a reasonable period of time (generally 90 days) after the receipt of your claim by the Administrator. The written notice must contain the following information: (a) the specific reason or reasons for the denial; (b) specific reference to those Plan provisions on which the denial is based; (c) a description of any additional information or material necessary to correct your claim and an explanation of why such material or information is necessary; and (d) appropriate information as to the steps to be taken if you or your beneficiary wishes to submit your claim for review. If notice of the denial of a claim is not furnished to you in accordance with the above within a reasonable period of time, your claim will be deemed denied. You will then be permitted to proceed to the review stage described in the following paragraphs. If your claim has been denied, and you wish to submit your claim for review, you must follow the Claims Review Procedure. 1. The Claims Review Procedure (a) Upon the denial of your claim for benefits, you may file your claim for review, in writing, with the Administrator. (b) YOU MUST FILE THE CLAIM FOR REVIEW NO LATER THAN 60 DAYS AFTER YOU HAVE RECEIVED WRITTEN NOTIFICATION OF THE DENIAL OF YOUR CLAIM FOR BENEFITS OR, IF NO WRITTEN DENIAL OF YOUR CLAIM WAS PROVIDED, NO LATER THAN 60 DAYS AFTER THE DEEMED DENIAL OF YOUR CLAIM. (c) You may review all pertinent documents relating to the denial of your claim and submit any issues and comments, in writing, to the Administrator. (d) Your claim for review must be given a full and fair review. If your claim is denied, the Administrator must provide you with written notice of this denial within 60 days after the Administrator's receipt of your written claim for review. There may be times when this 60-day period may be extended. This extension may only be made, however, where there are special circumstances which are communicated to you in writing within the 60-day period. If there is an extension, a decision will be made as soon as possible, but not later than 120 days after receipt by the Administrator of your claim for review. (e) The Administrator's decision on your claim for review will be communicated to you in writing and will include specific references to the pertinent Plan provisions on which the derision was based. 17 (f) If the Administrator's decision on review is not furnished to you within the time limitations described above, your claim will be deemed denied on review. (g) If benefits are provided or administered by an insurance company, insurance service, or other similar organization which is subject to regulation under the insurance laws, the claims procedure relating to these benefits may provide for review. If so, that company, service, or organization will be the entity to which claims are addressed. If you have any questions regarding the proper person or entity to address claims, you should ask the Administrator. X STATEMENT OF ERISA RIGHTS 1. Explanation of Your ERISA Rights As a participant in this Plan you are entitled to certain rights and protections under the Employee Retirement Income Security Act of 1974, also called ERISA. ERISA provides that all Plan participants are entitled to: (a) examine, without charge, all Plan documents, including: (1) insurance contracts; (2) collective bargaining agreements; and (3) copies of all documents filed by the Plan with the U.S. Department of Labor, such as detailed annual reports and Plan descriptions. This examination may take place at the Administrators office and at other specified employment locations of the Employer (See the Article in this Summary entitled "GENERAL INFORMATION ABOUT YOUR PLAN"); (b) obtain copies of all Plan documents and other Plan information upon written request to the Plan Administrator. The Administrator may make a reasonable charge for the copies; (c) receive a summary of the Plan's annual financial report. The Administrator is required by law to furnish each participant with a copy of this summary annual report; (d) obtain a statement jelling you whether you have a right to receive a retirement benefit at Normal Retirement Age and, if so, what your benefits would be at Normal Retirement Age if you stop working under the Plan now. If you do not have a right to a retirement benefit, the statement will tell you how many years you have to work to get a right to a retirement benefit. THIS STATEMENT MUST BE REQUESTED IN WRITING AND IS NOT REQUIRED TO BE GIVEN MORE THAN ONCE A YEAR. The Plan must provide the statement free of charge. In addition to creating rights for Plan participants, ERISA imposes duties upon the people who are responsible for the operation of the Plan. The people who operate your 18 Plan, called "fiduciaries" of the Plan, have a duty to do so prudently and in the interest of you and other Plan participants and beneficiaries. No one, including your employer or any other person, may fire you or otherwise discriminate against you in any way to prevent you from obtaining a pension benefit or exercising your rights under ERISA. If your claim for a retirement benefit is denied in whole or in part, you must receive a written explanation of the reason for the denial. You have the right to have the Administrator review and reconsider your claim. (See the Article in this Summary entitled "CLAIMS BY PARTICIPANTS AND BENEFICIARIES.") Under ERISA, there are steps you can take to enforce the above rights. For instance, if you request materials from the Plan and do not receive them within 30 days, you may file suit in a federal court. In such a case, the court may require the Administrator to provide the materials and pay you up to $110.00 a day until you receive the materials, unless the materials were not sent because of reasons beyond the control of the Administrator. If you have a claim for benefits which is denied or ignored, in whole or in part, you may file suit in a state or federal court. If the Plan's fiduciaries misuse the Plan's money, or if you are discriminated against for asserting your rights, you may seek assistance from the U.S. Department of Labor, or you may file suit in a federal court. The court will decide who should pay court costs and legal fees. If you are successful, the court may order the person you have sued to pay these costs and fees. If you lose, the court may order you to pay these costs and fees if, for example, it finds your claim is frivolous. If you have any questions about this statement, or about your rights under ERISA, you should contact the nearest Regional Office of the U.S. Department of Labor's Pension and Welfare Benefits Administration. XI AMENDMENT AND TERMINATION OF YOUR PLAN 1. Amendment Your Employer has the right to amend your Plan at any time. In no event, however, will any amendment: (a) authorize or permit any part of the Plan assets to be used for purposes other than the exclusive benefit of participants or their beneficiaries; or (b) cause any reduction in the amount credited to your account; or (c) cause any part of your Plan assets to revert to the Employer. 2. Termination Your Employer has the right to terminate the Plan at any time. Upon termination, all amounts credited to your accounts will become 100% vested. 19 EX-10.4 7 EXHIBIT 10.4 Exhibit 10.4 EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT is entered into by and between FREEI NETWORKS, INC., a Washington corporation (the "Company"), and Robert McCausland the undersigned individual ("Executive"). RECITAL The Company and Executive desire to enter into an Employment Agreement setting forth the terms and conditions of Executive's employment with the Company. AGREEMENT NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, the Company and Executive agree as follows: 1. EMPLOYMENT. (a) TERM. The Company hereby employs Executive to serve as President of the Company and Chief Executive Officer and to serve in such additional or different position or positions as the Company may determine in its sole discretion. The term of employment shall be for a period of three (3) years ("Employment Period"), to commence on the date hereof. The term shall be for the Employment Period unless earlier terminated as set forth herein. (b) DUTIES AND RESPONSIBILITIES. Executive will be reporting to the Company's Board of Directors. Within the limitations established by the By-laws of the Company, the Executive shall have each and all of the duties and responsibilities of President and CEO and such other or different duties on behalf of the Company, as may be assigned from time to time by the Company's Board. (c) LOCATION. The initial principal location at which Executive shall perform services for the Company shall be 909 S. 336th Ave Suite #110, Federal Way, Washington 98002. 2. COMPENSATION. (a) BASE SALARY. Executive shall be paid a base salary ("Base Salary") at the annual rate of $120,000 payable in biweekly installments consistent with Company's payroll practices. The annual Base Salary shall be reviewed on or before January 1 of each year, unless Executive's employment hereunder shall have been terminated earlier pursuant to this Agreement, by the Board of Directors of the Company to determine if such Base Salary should be increased for the following year in recognition of services to the Company. 1 (b) PAYMENT. Payment of all compensation to Executive hereunder shall be made in accordance with the relevant Company policies in effect from time to time, including normal payroll practices, and shall be subject to all applicable employment and withholding taxes. 3. OTHER EMPLOYMENT BENEFITS. (a) BUSINESS EXPENSES. Upon submission of itemized expense statements in the manner specified by the Company, Executive shall be entitled to reimbursement for reasonable business and travel expenses duty incurred by Executive in the performance of his duties under this Agreement. (b) BENEFIT PLANS. Executive shall be entitled to participate in the Company's medical and dental plans, life and disability insurance plans and retirement plans pursuant to their terms and conditions. Executive shall be entitled to participate in any other benefit plan offered by the Company to its employees during the term of this Agreement (other than stock option or stock incentive plans, which are governed by Section 3(d) below). Nothing in this Agreement shall preclude the Company or any affiliate of the Company from terminating or amending any employee benefit plan or program from time to time. (c) Vacation. Executive shall be entitled to three (3) weeks of vacation each year of full employent, exclusive of legal holidays, as long as the scheduling of Executive's vacation does not interfere with the Company's normal business operations. (d) FOUNDER' STOCK. Executive shall be entitled to retain his founder's stock, subject to the following terms: (i) Executive initially owned 11,400,000 shares of founders stock. 2,850,000 shares vested on August 13, 1999 when the Company executed a stock purchase agreement with Sequoia Capital and its affiliates. The remaining 8,550,000 shares will fully vest in the event of an initial public offering. Executive's termination of employment by the Company, the stile of substantially all the Company's assets or the merger of the Company into another entity (each a "Vesting Event"). In the absence of a Vesting Event, the 8,550,000 shares will vest in equal amounts of 237,500 per month. (e) NO OTHER BENEFITS. Executive understands and acknowledges that the compensation specified in Sections 2 and 3 of this Agreement shall be in lieu or any and all other compensation, benefits and plans. 4. EXECUTIVE'S BUSINESS ACTIVITIES. Executive shall devote the substantial portion of his entire business time, attention and energy exclusively to the business and affairs of the Company and its affiliates, as its business and affairs now exist and as they hereafter may be changed. Executive may serve as a member of the Board of Directors of other organizations that do not compete with 2 the Company, and may participate in other professional, civic, governmental organizations and activities that do not materially affect his ability to carry out his duties hereunder. 5. TERMINATION OF EMPLOYMENT. (a) FOR CAUSE. Notwithstanding anything herein to the contrary, the Company may terminate Executive's employment hereunder for cause for any one of the following reasons: (i) conviction of a felony, or a misdemeanor where imprisonment is imposed, (ii) commission of any act of theft, fraud, dishonesty, or falsification of any employment or Company records, (iii) improper disclosure of the Company's confidential or proprietary information, (iv) any action by the Executive which has a detrimental effect on the Company's reputation or business, (v) Executive's failure or inability to perform any reasonable assigned duties after written notice from the Company of, and a reasonable opportunity to cure, such failure or inability, (vi) any breach of this Agreement, which breach is not cured within ten (10) days following written notice of such breach, (vii) a course of conduct amounting to gross incompetence, (viii) chronic and unexcused absenteeism, (ix) unlawful appropriation of a corporate opportunity, or (x) misconduct in connection with the performance of any of Executive's duties, including, without limitation, misappropriation of funds or property of the Company, securing or attempting to secure personally any profit in, connection with any transaction entered into, on behalf of the Company, misrepresentation to the Company, or any violation of law or regulations on Company premises or to which the Company is subject. Upon termination of Executive's employment with the Company for cause, the Company shall be under no further obligation to Executive, except to pay all accrued but unpaid base salary and accrued vacation to the date of termination thereof, and to fully vest executive's founder's shares. (b) WITHOUT CAUSE. The Company may terminate Executive's employment hereunder at any time without cause, provided, however, that Executive shall be entitled to severance pay in the amount of one year (12) months of Base Salary in addition to accrued but unpaid Base Salary and accrued vacation, less deductions required by law, but if, and only if, Executive executes a valid and comprehensive release of any and all claims that the Executive may have against the Company in a form provided by the Company and Executive executes such form within seven (7) days of tender. (c) RESIGNATION. UPON TERMINATION OF EMPLOYMENT, EXECUTIVE SHALL BE DEEMED TO HAVE RESIGNED FROM THE BOARD OF DIRECTORS OF THE COMPANY IF HE IS A DIRECTOR. (d) COOPERATION. After notice of termination, Executive shall cooperate with the Company, as reasonably requested by the Company, to effect a transition of Executive's responsibilities and to ensure that the Company is aware of all matters being handled by Executive. 6. DISABILITY OF EXECUTIVE. The Company may terminate this Agreement without liability if Executive shall be permanently prevented from properly performing his essential duties hereunder with reasonable accommodation by reason of illness or other physical or mental incapacity for a 3 period of more than 120 consecutive days. Upon such termination, Executive shall be entitled to all accrued but unpaid Base Salary and vacation. 7. DEATH OF EXECUTIVE. In the event of the death of Executive during the Employment Period, the Company's obligations hereunder shall automatically cease and terminate; provided, however, that within 15 days the Company shall pay to the Executive's heirs or personal representatives Executive's Base Salary and accrued vacation accrued to the date of death. 8. CONFIDENTIAL INFORMATION AND INVENTION ASSIGNMENTS. Executive is simultaneously executing a Confidential Information and Invention Assignment Agreement (the "Confidential Information and Invention Assignment Agreement"). The obligations under the Confidential Information and Invention Assignment Agreement shall survive termination of this Agreement for any reason. 9. EXCLUSIVE EMPLOYMENT. During employment with the Company, Executive will not do anything to compete with the Company's present or contemplated business, nor will he or she plan or organize any competitive business activity. Executive will not enter into any agreement which conflicts with his duties or obligations to the Company. Executive will not during his employment or within one (1) year after it ends, without the Company's express written consent, directly or indirectly, solicit or encourage any employee, agent, independent contractor, supplier, customer, consultant on any other person or company to terminate or alter a relationship with the Company. 10. ASSIGNMENT AND TRANSFER. Executive's rights and obligations under this Agreement shall not be transferable by assignment or otherwise, and any purported assignment, transfer or delegation thereof shall be void. This Agreement shall inure to the benefit of, and be binding upon and enforceable by, any purchaser of substantially all of Company's assets, any corporate successor to Company or any assignee thereof. 11. NO INCONSISTENT OBLIGATIONS. Executive is aware or no obligations, legal or otherwise, inconsistent with the terms of this Agreement or with his undertaking employment with the Company. Executive will not disclose to the Company, or use, or induce the Company to use, any proprietary information or trade secrets of others. Executive represents and warrants that he or she has returned all property and confidential information belonging to all prior employers. 12. MISCELLANEOUS. (a) ATTORNEYS' FEES. Should either party hereto, or any heir, personal representative, successor or assign, of either party hereto, resort to legal proceedings in connection with this Agreement or Executive's employment with the Company, the party or parties prevailing in such legal proceedings shall be entitled, in addition to such other relief as may be granted, to recover its or their reasonable attorneys' fees and costs in such legal proceedings from the non-prevailing party or parties; provided, however, that nothing herein is intended to affect the provisions of Section 13(l). 4 (b) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Washington without regard to conflict of law principles. (c) ENTIRE AGREEMENT. Except for the attached exhibits and the Confidential Information and Invention Assignment Agreement, this Agreement contains the entire agreement and understanding between the parties hereto and supersedes any prior or contemporaneous written or oral agreements, representations and warranties between them respecting the subject matter hereof. (d) AMENDMENT. This Agreement may be amended only by a writing signed by Executive and by a duly authorized representative of the Company. (e) Severability. If any term, provision, covenant or condition of this Agreement, or the application thereof to any person, place or circumstance, shall be held to be invalid, unenforceable or void, the remainder of this Agreement and such term, provision, covenant or condition as applied to other persons, places and circumstances shall remain in full force and effect. (f) CONSTRUCTION. The headings and captions of this Agreement are provided for convenience only and are intended to have no effect in construing or interpreting this Agreement. The language in all parts of this Agreement shall be in all cases construed according to its fair meaning and not strictly for or against the Company or Executive. (g) RIGHTS CUMULATIVE. The rights and remedies provided by this Agreement are cumulative, and the exercise of any right or remedy by either party hereto (or by its successor), whether pursuant to this Agreement, to any other agreement, or to law, shall not preclude or waive its right to exercise any or all other rights and remedies. (h) NONWAIVER. No failure or neglect of either party hereto in any instance to exercise any right, power or privilege hereunder or under law shall constitute a waiver of any other right, power or privilege or of the same right, power or privilege in any other instance. All waivers by either party hereto must be contained in a written instrument signed by the party to be charged and, in the case of the Company, by an officer of the Company (other than Executive) or other person duly authorized by the Company. (i) REMEDY FOR BREACH; ATTORNEYS' FEES. The parties hereto agree that, in the event of breach or threatened breach of any covenants of Executive, the damage or imminent damage to the value and the goodwill of the Company's business shall be inestimable, and that therefor any remedy at law or in damages shall be inadequate. Accordingly, the parties hereto agree that the Company shall be entitled to injunctive relief against Executive in the event of any breach or threatened breach of any of such provisions by Executive, in addition to any other relief (including damages) available to the Company under this Agreement or under law. The prevailing party in any action instituted pursuant to this Agreement shall be entitled to recover from the other party its reasonable attorneys' fees and other expenses incurred in such action. 5 (j) NOTICES. Any notice, request, consent or approval required or permitted to be given under this Agreement or pursuant to law shall be sufficient if in writing, and if and when sent by certified or registered mail, with postage prepaid, to Executive's residence (as noted in the Company's records), or to the Company's principal office, as the case may be. (k) ASSISTANCE IN LITIGATION. Executive shall, during and after termination of employment, upon reasonable notice, furnish such information and proper assistance to the Company as may reasonably be required by the Company in connection with any litigation in which it or any of its subsidiaries or affiliates is, or may become a party; provided, however, that such assistance following termination shall be furnished at mutually agreeable times and for mutually agreeable compensation. (l) ARBITRATION. Any controversy, claim or dispute arising out of or relating to this Agreement or the employment relationship, either during the existence of the employment relationship or afterwards, between the parties hereto, their assignees, their affiliates, their attorneys, or agents, shall be settled by arbitration in Seattle, Washington. Such arbitration shall be conducted in accordance with the then prevailing commercial arbitration rules of the American Arbitration Association (but the arbitration shall be in front of an arbitrator appointed by JAMS/Endispute ("JAMS")), with the following exceptions if in conflict: (a) one arbitrator shall be chosen by JAMS; (b) each party to the arbitration will pay its pro rata share of the expenses and fees of the arbitrator(s), together with other expenses of the arbitration incurred or approved by the arbitrator(s); and (c) arbitration may proceed in the absence of any party if written notice (pursuant to the JAMS' rules and regulations) of the proceedings has been given to such party. The parties agree to abide by all decisions and awards rendered in such proceedings. Such decisions and awards rendered by the arbitrator shall be final and conclusive and may be entered in any court having jurisdiction thereof as a basis of judgment and of the issuance of execution for its collection. All such controversies, claims or disputes shall be settled in this manner in lieu of any action at law or equity; provided however, that nothing in this subsection shall be construed as precluding the Company from bringing an action for injunctive relief or other equitable relief or relief under the Confidential Information and Invention Assignment Agreement. The arbitrator shall not have the right to award punitive damages, consequential damages, lost profits or speculative damages to either party. The parties shall keep confidential the existence of the claim, controversy or disputes from third parties (other than the arbitrator), and the determination thereof, unless otherwise required by law or necessary for the business of the Company. The arbitrator(s) shall be required to follow applicable law. IF FOR ANY REASON THIS ARBITRATION CLAUSE BECOMES NOT APPLICABLE, THEN EACH PARTY, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW , HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY AS TO ANY ISSUE RELATING HERETO IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER MATTER INVOLVING THE PARTIES HERETO. 6 IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date set forth below. FREEI NETWORKS, INC. By: /s/ Robert (Bob) McCausland ----------------------------- Robert (Bob) McCausland ----------------------------- EXECUTIVE: Name: /s/ Robert (Bob) McCausland --------------------------- Title: President / CEO -------------------------- Date: 11-11-99 --------------------------- 7 EX-10.5 8 EXHIBIT 10.5 Exhibit 10.5 EMPLOYMENT AGREEMENT This EMPLOYMENT AGREEMENT is entered into by and between FREEI NETWORKS, INC., a Washington corporation (the "Company"), and Steve Bourg the undersigned individual ("Executive"). RECITAL The Company and Executive desire to enter into an Employment Agreement setting forth the terms and conditions of Executive's employment with the Company. AGREEMENT NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter set forth, the Company and Executive agree as follows: 1. EMPLOYMENT. (a) TERM. The Company hereby employs Executive to serve as Chief Technical Officer of the Company and to serve in such additional or different position or positions as the Company may determine in its sole discretion. The term of employment shall be for a period of three (3) years ("Employment Period"), to commence on the date hereof. The term shall be for the Employment Period unless earlier terminated as set forth herein. (b) DUTIES AND RESPONSIBILITIES. Executive will be reporting to the Company's Chief Executive Officer. Within the limitations established by the By-laws of the Company, the Executive shall have each and all of the duties and responsibilities listed on Schedule I hereto and such other or different duties on behalf of the Company, as May be assigned from time to time by the Company's Chief Executive Officer. (c) LOCATION. The initial principal location at which Executive shall perform services for the Company shall be 909 S. 336th Ave Suite #110 Federal Way, Washington 98003. 2. COMPENSATION. (a) BASE SALARY. Executive shall be paid a base salary ("Base Salary") at the annual rate of $100,008 payable in biweekly installments consistent with Company's payroll practices. The annual Base Salary shall be reviewed on or before January 1 of each year, unless Executive's employment hereunder shall have been terminated earlier pursuant to this Agreement, by the Board of Directors of the Company to determine if such Base Salary should be increased for the following year in recognition of services to the Company. 1 (b) PAYMENT. Payment of all compensation to Executive hereunder shall be made in accordance with the relevant Company policies in effect from time to time, including normal payroll practices, and shall be subject to all applicable employment and withholding taxes. 3. OTHER EMPLOYMENT BENEFITS. (a) BUSINESS EXPENSES. Upon submission of itemized expense statements in the manner specified by the Company, Executive shall be entitled to reimbursement for reasonable business and travel expenses duly incurred by Executive in the performance of his duties under this Agreement. (b) BENEFIT PLANS. Executive shall be entitled to participate in the Company's medical and dental plans, life and disability insurance plans and retirement plans pursuant to their terms and conditions. Executive shall be entitled to participate in any other benefit plan offered by the Company to its employees during the term of this Agreement (other than stock option or stock incentive plans, which are governed by Section 3(d) below). Nothing in this Agreement shall preclude the Company or any affiliate of the Company from terminating or amending any employee benefit plan or program from time to time. (c) VACATION. Executive shall be entitled to three (3) weeks of vacation each year of full employment, exclusive of legal holidays, as long as the scheduling of Executive's vacation does not interfere with the Company's normal business operations. (d) FOUNDER' STOCK. Executive shall be entitled to retain his founder's stock, subject to the following terms: (i) Executive initially owned 400,000 shares of founders stock. 100,000 shares vested on August 13, 1999 when the Company executed a stock purchase agreement, with Sequoia Capital and its affiliates. The remaining 300,000 shares will fully vest in the event of an initial public offering, Executive's termination of employment by the Company, the sale of substantially all the Company's assets or the merger of the Company into another entity (each a "Vesting Event"). In the absence of a Vesting Event, the 300,000 shares will vest in equal amounts of 8,333.3 per month. (e) NO OTHER BENEFITS. Executive understands and acknowledges that the compensation specified in Sections 2 and 3 of this Agreement shall be in lieu of any and all other compensation, benefits and plans. 4. EXECUTIVE'S BUSINESS ACTIVITIES. EXecutive shall devote the substantial portion of his entire business time, attention and energy exclusively to the business and affairs of The Company and its affiliates, as its business and affairs now exist and as they hereafter may be changed. Executive may serve as a member of the Board of Directors of other organizations that do not compete with 2 the Company, and may participate in other professional, civic, governmental organizations and activities that do not materially affect his ability to carry out his duties hereunder. 5. TERMINATION OF EMPLOYMENT. (a) FOR CAUSE. Notwithstanding anything herein to the contrary, the Company may terminate Executive's employment hereunder for cause for any one of the following reasons: (i) conviction of a felony, or a misdemeanor where imprisonment is imposed, (ii) commission of any act of theft, fraud, dishonesty, or falsification of any employment or Company records, (iii) improper disclosure of the Company's confidential or proprietary information, (iv) any action by the Executive which has a detrimental effect on the Company's reputation or business, (v) Executive's failure or inability to perform any reasonable assigned duties after written notice from the Company of, and a reasonable opportunity to cure, such failure or inability, (vi) any breach of this Agreement, which breach is not cured within ten (10) days following written notice of such breach, (vii) a course of conduct amounting to gross incompetence, (viii) chronic and unexcused absenteeism, (ix) unlawful appropriation of a corporate opportunity, or (x) misconduct in connection with the performance of any of Executive's duties including, without limitation, misappropriation of funds or property of the Company, securing or attempting to secure personally any profit in connection with any transaction entered into on behalf of the Company, misrepresentation to the Company, or any violation of law or regulations on Company premises or to which the Company is subject. Upon termination of Executive's employment with the Company for cause, the Company shall be under no further obligation to Executive, except to pay all accrued but unpaid base salary and accrued vacation to the date of termination thereof; and to fully vest Executive's founder shares. (b) WITHOUT CAUSE. The Company may terminate Executive's employment hereunder at any time without cause, provided, however, that Executive shall be entitled to severance pay in the amount of One Year (12) months of Base Salary in addition to accrued but unpaid Base Salary and accrued vacation, less deductions required by law, but if, and only if, Executive executes a valid and comprehensive release of any and all claims that the Executive may have against the Company in a form provided by the Company and Executive executes such form within seven (7) days of tender. (c) COOPERATION. After notice of termination, Executive shall cooperate with the Company, as reasonably requested by the Company, to effect a transition of Executive's responsibilities and to ensure that the Company is aware of all matters being handled by Executive. 6. DISABILITY OF EXECUTIVE. The Company may terminate this Agreement without liability if Executive shall be permanently prevented from properly performing his essential duties hereunder with reasonable accommodation by reason of illness or other physical or mental incapacity for a period of more than 120 consecutive days. Upon such termination, Executive shall be entitled to all accrued but unpaid Base Salary and vacation. 3 7. DEATH OF EXECUTIVE. In the event of the death of Executive during the Employment Period, the Company's obligations hereunder shall automatically cease and terminate; provided, however, that within 15 days the Company shall pay to the Executive's heirs or personal representatives Executive's Base Salary and accrued vacation accrued to the date of death. 8. CONFIDENTIAL INFORMATION AND INVENTION ASSIGNMENTS. Executive is simultaneously executing a Confidential Information and Invention Assignment Agreement (the "Confidential Information and Invention Assignment Agreement"). The obligations under the Confidential Information and Invention Assignment Agreement shall survive termination of this Agreement for any reason. 9. EXCLUSIVE EMPLOYMENT. During employment with the Company, Executive will not do anything to compete with the Company's present or contemplated business, nor will he or she plan or organize any competitive business activity. Executive will not enter into any agreement which conflicts with his duties or obligations to the Company. Executive will not during his employment or within one (1) year after it ends, without the Company's express written consent, directly or indirectly, solicit or encourage any employee, agent, independent contractor, supplier, customer, consultant on any other person or company to terminate or alter a relationship with the Company. 10. ASSIGNMENT AND TRANSFER. Executive's rights and obligations under this Agreement shall not be transferable by assignment or otherwise, and any purported assignment, transfer or delegation thereof shall be void. This Agreement shall inure to the benefit of, and be binding upon and enforceable by, any purchaser of substantially all of Company's assets, any corporate successor to Company or any assignee thereof 11. NO INCONSISTENT OBLIGATIONS. Executive is aware of no obligations, legal or otherwise, inconsistent with the terms of this Agreement or with his undertaking employment with the Company. Executive will not disclose to the Company, or use, or induce the Company to use, any proprietary information or trade secrets of others. Executive represents and warrants that he or she has returned all property and confidential information belonging to all prior employers. 12. MISCELLANEOUS. (a) ATTORNEYS' FEES. Should either party hereto, or any heir, personal representative, successor or assign of either party hereto, resort to legal proceedings in connection with this Agreement or Executive's employment with the Company, the party or parties prevailing in such legal proceedings shall be entitled, in addition to such other relief as may be granted, to recover its or their reasonable attorneys' fees and costs in such legal proceedings from the non-prevailing party or parties; provided, however, that nothing herein is intended to affect the provisions of Section 13(l). (b) GOVERNING LAW. This agreement shall be governed by and construed in accordance with the laws of the State of Washington without regard to conflict of law principles. 4 (c) ENTIRE AGREEMENT. Except for the attached exhibits and the Confidential Information and Invention Assignment Agreement, this Agreement contains the entire agreement and understanding between the parties hereto and supersedes any prior or contemporaneous written or oral agreements, representations and warranties between them respecting the subject matter hereof. (d) AMENDMENT. This Agreement may be amended only by a writing signed by Executive and by a duly authorized representative of the Company. (e) SEVERABILITY. If any term, provision, covenant or condition of this Agreement, or the application thereof to any person, place or circumstance, shall be held to be invalid, unenforceable or void, the remainder of this Agreement and such term, provision, covenant or condition as applied to other persons, places and circumstances shall remain in full force and effect. (f) CONSTRUCTION. The headings and captions of this Agreement are provided for convenience only and are intended to have no effect in construing or interpreting this Agreement. The language in all parts of this Agreement shall be in all cases construed according to its fair meaning and not strictly for or against the Company or Executive. (g) RIGHTS CUMULATIVE. The rights and remedies provided by this Agreement are cumulative, and the exercise of any right or remedy by either party hereto (or by its successor), whether pursuant to this Agreement, to any other agreement, or to law, shall not preclude or waive its right to exercise any or all other rights and remedies. (h) NONWAIVER. No failure or neglect of either party hereto in any instance to exercise any right, power or privilege hereunder or under law shall constitute a waiver of any other right, power or privilege or of the same right, power or privilege in any other instance. All waivers by either party hereto must be contained in a written instrument signed by the party to be charged and, in the case of the Company, by an officer of the Company (other than Executive) or other person duly authorized by the Company. (i) REMEDY FOR BREACH; ATTORNEYS' FEES. The parties hereto agree that, in the event of breach or threatened breach of any covenants of Executive, the damage or imminent damage to the value and the goodwill of the Company's business shall be inestimable, and that therefor any remedy at law or in damages shall be inadequate. Accordingly, the parties hereto agree that the Company shall be entitled to injunctive relief against Executive in the event of any breach or threatened breach of any of such provisions by Executive, in addition to any other relief (including damages) available to the Company under this Agreement or under law. The prevailing party in any action instituted pursuant to this Agreement shall be entitled to recover from the other party its reasonable attorneys' fees and other expenses incurred in such action. (j) NOTICES. Any notice, request, consent or approval required or permitted to be given under this Agreement or pursuant to law shall be sufficient if in writing, and if and when sent by certified 5 or registered mail, with postage prepaid, to Executive's residence (as noted in the Company's records), or to the Company's principal office, as the case may be. (k) ASSISTANCE IN LITIGATION. Executive shall, during and after termination of employment, upon reasonable notice, furnish such information and proper assistance to the Company as may reasonably be required by the Company in connection with any litigation in which it or any of its subsidiaries or affiliates is, or may become a party; provided, however, that such assistance following termination shall be furnished at mutually agreeable times and for mutually agreeable compensation. (l) ARBITRATION. Any controversy, claim or dispute arising out of or relating to this Agreement or the employment relationship, either during the existence of the employment relationship or afterwards, between the parties hereto, their assignees, their affiliates, their attorneys, or agents, shall be settled by arbitration in Seattle, Washington. Such arbitration shall be conducted in accordance with the then prevailing commercial arbitration rules of the American Arbitration Association (but the arbitration shall be in front of an arbitrator appointed by JAMS/Endispute ("JAMS")), with the following exceptions if in conflict: (a) one arbitrator shall be chosen by JAMS; (b) each party to the arbitration will pay its pro rata share of the expenses and fees of the arbitrator(s), together with other expenses of the arbitration incurred or approved by the arbitrator(s); and (c) arbitration may proceed in the absence of any party if written notice (pursuant to the JAMS' rules and regulations) of the proceedings has been given to such party. The parties agree to abide by all decisions and awards rendered in such proceedings. Such decisions and awards rendered by the arbitrator shall be final and conclusive and may be entered in any court having jurisdiction thereof as a basis of judgment and of the issuance of execution for its collection. All such controversies, claims or disputes shall be settled in this manner in lieu of any action at law or equity; provided however, that nothing in this subsection shall be construed as precluding the Company from bringing an action for injunctive relief or other equitable relief or relief under the Confidential Information and Invention Assignment Agreement. The arbitrator shall not have the right to award punitive damages, consequential damages, lost profits or speculative damages to either party. The parties shall keep confidential the existence of the claim, controversy or disputes from third parties (other than the arbitrator), and the determination thereof, unless otherwise required by law or necessary for the business of the Company. The arbitrator(s) shall be required to fellow applicable law. IF FOR ANY REASON THIS ARBITRATION CLAUSE BECOMES NOT APPLICABLE, THEN EACH PARTY, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY AS TO ANY ISSUE RELATING HERETO IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER MATTER INVOLVING THE PARTIES HERETO. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date set forth below. 6 FREEI NETWORKS, INC. By: /s/ BOB MCCAUSLAND ---------------------------------------- Robert (Bob) McCausland ---------------------------------------- EXECUTIVE: Name: /s/ [ILLEGIBLE] ------------------------------------- Title: Chief Technical Officer ------------------------------------- Date: 11-11-99 --------------------------------------- 7 SCHEDULE I List of Executive's Duties Oversee the direction and implementation of all technically related functions of the company. 8 EX-10.6 9 EXHIBIT 10.6 Exhibit 10.6 ADVERTISING, PROMOTION AND MARKETING AGREEMENT THIS ADVERTISING, PROMOTION AND MARKETING AGREEMENT ("Agreement") is made and entered into as of the latest date of signature of a party hereto ("Effective Date"), by and between MP3.COM, INC., a Delaware corporation ("MP3.com") having an address at 4790 Eastgate Mail San Diego, CA 92121, and FREEI NETWORKS, INC.., a Washington corporation Freei"). MP3.com and Freei may each be referred to individually as a "Party" and collectively be referred to as the "Parties." WHEREAS, MP3.com owns and operates the web site at WWW.MP3.COM (tile "Web Site") and seeks to promote the marketing, branding and traffic to the Web Site; WHEREAS, Freei owns and operates the web site at WWW.FREEI.NET (the "Freei Site") and seeks to promote the marketing, branding and traffic to the Freei Site and its related software interface products and services; WHEREAS, MP3.com desires to obtain, and Freei desires to provide, certain promotion of the Web Site within the Freei Site and Freei's software interface product under the terms and conditions set forth herein; WHEREAS, Freei desires to purchase, and MP3.com desires to provide, $4,000,000 of advertising, promotion and marketing services under the terms and conditions set forth herein; and WHEREAS, as a condition precedent to this Agreement becoming effective, MP3.com is purchasing certain equity holdings in Freei pursuant to that certain stock purchase agreement of even date herewith (the "Stock Purchase Agreement"). NOW, THEREFORE, in exchange for the consideration set forth herein, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. WELCOME SCREEN PROMOTION. Freei shall include an "MP3.com Link" to the Web Site on the front page of the Freei Site and in the "Welcome Screen" of each copy of Freei's software interface product that is downloaded, shipped or delivered during the Term. Any graphics, placement and position of the MP3.com Link on the Freei Site and the Welcome Screen shall be determined by the mutual agreement of the Parties, which shall be made in good faith and with commercial reasonableness by the Parties. Hereinafter, for all provisions of this Agreement requiring mutual agreement of the Parties, the Parties agree that they shall use and apply good faith and commercial reasonableness standards in their negotiations for such mutual agreement(s). 2. MUSIC GENRE REGISTRATION INFORMATION. Freei shall, commencing no later than the effective date AND continuing throughout the Term, incorporate into the survey completed by individuals subscribing to Freei's free internet service for the first time such questions reasonably designed to determine which of MP3.com's top 10 music genres are preferred by such user. Freei agrees to share any and all information derived from such questions with MP3.com subject to Freei's privacy policy and any restrictions or obligations 1 [*] = Confidential Treatment Requested undertaken by Freei with respect to its subscribers or users. As permitted under Freei's privacy policy that may then be in effect. Freei will distribute at least one (1) e-mail promotion on behalf of MP3.com, subject to MP3.com's approval, to all of the e-mail addresses in Freei's e-mail registry in a format and manner as mutually agreed-upon by the Parties and shall contain MP3.com-recommended songs in each e-mail recipient's preferred musical genre. 3. MUSIC-ORIENTED CHANNEL PROMOTION. Freei shall include an MP3.com Link in all music-oriented "content channels" contained in each copy of Freei's software interface product that is downloaded, shipped or delivered during the Term. Placement and position of the MP3.com Link within each such content channel shall be determined by the mutual agreement of the Parties. 4. ADVERTISING, PROMOTION AND MARKETING COMMITMENT. 4.1 MEDIA PURCHASE. Freei agrees to purchase from MP3.com various advertising, promotional and marketing items and services, in the amounts and in the manner set forth in this Agreement. Such items and services may include, but not be limited to, free CD sales promotions, banner ads, portals, graphical buttons, e-mail marketing sponsorships, event and tour sponsorships, CD sampler sponsorships, webcast sponsorships, co-branded media programs, artist acquisition programs, artist and consumer education programs, other sponsorships, on- and off-line promotions and related services, and any other channels or means of advertising, marketing or promotions that are presently offered by MP3.com or may be created by MP3.com during the applicable purchase periods under this Agreement (collectively, "Media"). Such Media purchases shall be Subject to MP3.com's standard terms and conditions applicable to each such Media, except with respect to any terms or conditions which may contradict or violate the terms of this Agreement, in which case the terms and conditions of this Agreement shall apply. 4.2 MEDIA PREPAYMENTS. Subject to the payment conditions in Section 4.4 herein, Freei further agrees that it shall purchase, on a prepaid basis for each quarterly period set forth on Exhibit A attached hereto (each a "Quarter") during the term of this Agreement, no less than the full dollar amount of Media as set forth opposite such Quarter on Exhibit A attached hereto. Should Freei not fully use any amount of Media that it has paid for in any given Quarter (except as provided in Section 10 herein), provided such total amount of unused Media shall be no greater than [*] of such Quarter's Media payments, Freei's rights to such unused Media shall carry over to the following Quarter without penalty. Notwithstanding the foregoing, in the event that (i) Freei's total amount of unused Media for a given Quarter is greater than [*] of such Quarter's Media payments, or (ii) Freei has not allocated and used all of its Media purchased under this Agreement by November 30, 2000, all of Freei's rights to such unused Media shall terminate, all remaining payment obligations of Freei shall remain in effect and any advance payments for such Quarter (or Quarters, as applicable), shall remain the sole property of MP3.com with no further obligations whatsoever with respect to the Media scheduled for such Quarter (or Quarters, as applicable). 4.3 QUARTERLY MEDIA ALLOCATION; DEFAULT ALLOCATION. Freei and MP3.com shall meet no later than two weeks prior to the beginning of each Quarter to discuss the manner in which the Media to be purchased during such Quarter shall be allocated. MP3.com and Freei 2. shall use their best efforts to mutually agree upon the specific allocation of such Media, and shall set forth such allocation in a written document signed by both parties no later than the first day of each Quarter. Notwithstanding the foregoing, the Parties agree that on a commercially reasonable basis, MP3.com and Freei may meet from time to time to adjust any allocations of Media buys during any month in any Quarter. Notwithstanding the foregoing, in the event MP3.com and Freei are unable to mutually agree upon the specific allocation of any Quarter's Media, such Quarter's Media shall be allocated in the same manner as in the prior Quarter; provided, however, that if a particular type of Media is not available in such current Quarter, the amount attributable to that particular Media shall be allocated proportionately among the other categories from the prior Quarter. MP3.com and Freei agree to negotiate in good faith with the type, the respect to lie type, quantity, frequency, placement and price of the Media to be purchased during each Quarter. 4.4 MEDIA FEES. There shall be twelve (12) payments by Freei for the Media buys in accordance with the schedule set forth in Exhibit A hereto. Freei shall make all such prepayments referred to herein to MP3.com in the form of (i) a wire transfer to MP3.com's account at Imperial Bank, 701 "B" Street, Suite 600, San Diego, CA 92101 Routing # 122201444, Account # 0038-051-008, or any other account previously approved in writing by MP3.com, (ii) actual delivery of a check to MP3.com, or (iii) as otherwise agreed to in writing by MP3.com. 4.5 LATE PAYMENTS; TAXES. Any late payments under this Agreement will be assessed a service the of one and one-half' percent (1.5%) per month, to the extent allowed by law. The calculation of the service fee shall be based on a per day basis for each day the payment may be late; for example and without limitation, if a payment arrives one day late, then the service fee shall be the number equal to the amount then due times 18% divided by 365 (or 366 in a leap year such as the year 2000). All fees owed by Freei to MP3.com are exclusive of, and Freei shall pay, all sales, use, excise and other similar taxes which may be levied upon either party in connection with this Agreement, except for taxes based on MP3.com's net income and/or gross receipts. 5. DELIVERY OF ADVERTISER CONTENT. Freei will deliver to MP3.com such materials, logos and designs as may be reasonably required by Freei and/or requested by MP3.com in connection with the performance of MP3.com's obligations under this Agreement. Any materials so delivered are hereinafter referred to as "Advertiser Content." In the event that any Advertiser Content as delivered does not conform to the technical specifications supplied by MP3.com or any Advertiser Content does not arrive when specified by MP3.com in order to meet the agreed-upon start date for delivery of the related Media under this Agreement, then MP3.com may, in its discretion: (a) refuse such Advertiser Content and, if available, substitute any prior Advertiser Content and, if available, substitute any prior Advertiser Content in MP3.com's possession or (b) delay delivery of the related Media until Freei shall have delivered a corrected copy of such Advertiser Content. 6. LICENSE. 6.1 ADVERTISER CONTENT LICENSE. Freei hereby grants to MP3.com a nonexclusive, royalty-free, worldwide license to use, reproduce, distribute, create derivative works of, publicly perform, publicly display and digitally perform the Advertiser Content on or in 3. conjunction with the Web Site and the Media delivered hereunder. Title to and ownership of all intellectual property rights of the Advertiser Content shall remain with Freei or its third party licensors. 6.2 MP3.COM CONTENT LICENSE. MP3.com hereby grants to Freei a nonexclusive, royalty-free, worldwide license to use, reproduce, distribute, create derivative works of, publicly perform, publicly display and digitally perform the materials solely owned, or entitled to be assigned or exclusively sublicensed, by MP3.com that are delivered to Freei in connection with Sections 1 and 3 of this Agreement (the "MP3.com Content"). Title to and ownership of all intellectual property rights of the MP3.com Content shall remain with MP3.com or its third party licensors. 6.3 TRADEMARKS. None of' the Parties hereto may use any other Party's trademarks, service marks, trade names, logos, or other commercial or product designations (collectively, "Marks") for any purpose whatsoever without the prior written consent of the other Party. Notwithstanding the foregoing, each Party hereby grants to the other Party a nonexclusive, nontransferable, royalty-free, worldwide license to use such Party's Marks on the Web Site or the Freei Site, as applicable, for the purposes of marketing, promotion, and content directories or indexes, and in electronic or printed advertising, publicity, press releases, newsletters and mailings about the Web Site or the Freei Site, as applicable, or the Parties; provided, however, that such use of each Party's marks shall be subject to the prior approval of such Party, which approval shall not be unreasonably withheld so long as the goodwill of a Party's Marks is not damaged as determined in the good faith and reasonable determination of the Party owning the Marks. 7. REPORTS. Within a commercially reasonable amount of time after each calendar month in which Media is delivered under this Agreement, MP3.com will provide Freei standard MP3.com reports summarizing the quantity, frequency, placement and distribution of the Media delivered during the preceding month. Freei acknowledges and agrees that any statistics or other Information provided to Freei pursuant to this Section 7 shall be deemed "Confidential Information" of MP3.com, except to the extent that such Confidential Information is not already in the lawful possession of Freei from independent, unprivileged sources. Freei agrees to hold such Confidential Information in strict confidence and not to disclose such Confidential Information to any third parties, provided that any successor-in-interest to Freei shall have the same rights as Freei to use such Confidential Information for its own benefit, and further provided that any advertising agency or other independent consultant or venture capital firm, underwriter, or investor, shall be entitled to review such Confidential Information when such third party has signed a confidentiality agreement incorporating the terms of this Section 7. 8. RECORDS AND AUDITS. MP3.com shall keep complete and accurate records pertaining to the pricing and sale or other disposition of the Media in sufficient detail to permit Freei to confirm the accuracy of all purchases made hereunder. Freei shall have the right to cause an independent, certified public accountant reasonably acceptable to MP3.com to audit such records to confirm the determination of pricing hereunder for the preceding year. Such audits may be exercised during normal business hours upon at least 30 working days' prior written notice to MP3.com. Audits may be conducted no more than once in any calendar year. Freei shall bear the full cost of any such audits; provided, however, that if the total pricing 4. variance, as determined by the results of such audit, exceeds ten percent (10%) in the aggregate, then MP3.com shall bear the costs of any such audit. 9. REPRESENTATIONS AND WARRANTIES. 9.1 ADVERTISER MATERIAL. Freei shall be solely responsible for any legal liability arising out of or relating to the composition of the Advertiser Content and any material to which users can link through the Advertiser Content (collectively, the "Advertiser Material"). Freei represents and warrants that the Advertiser Material does not and will not: (a) infringe on any third party's copyright, patent, trademark, trade secret or other proprietary rights or right of publicity or privacy; (b) violate any law, statute, ordinance or regulation, including without limitation the laws and regulations governing export control, unfair competition, antidiscrimination or false advertising; (c) be defamatory or trade libelous; (d) be defamatory, harmful to minors, obscene or child pornographic; (e) be materially false, misleading or inaccurate or cannot be promptly fulfilled, or (f) contain viruses, trojan horses, worms, time bombs, cancelbots or other similar harmful or deleterious programming routines. Freei agrees to defend, indemnify and hold harmless MP3.com and its directors, officers, agents and employees for any and all losses, costs, liabilities or expenses (including without limitation reasonable attorneys' and expert witnesses' fees) incurred or arising from: (a) any breach of the foregoing representations or warranties; (b) any claim arising from the sale of license of Freei's goods or services; or (c) any other act, omission or representation by Freei. MP3.com may participate in the defense at its option and expense. 9.2 MP3.COM MATERIAL. MP3.com shall be solely responsible for any legal liability arising out of or relating to the composition of the MP3.com Content and any material to which users can link through the MP3.com Content that is solely owned by MP3.com or may be assigned or exclusively sublicensed by MP3.com (collectively, the "MP3.com Material"). MP3.com represents and warrants that the MP3.com Material does not and will not: (a) infringe on any third party's copyright, patent, trademark, trade secret or other proprietary rights or right of publicity or privacy; (b) violate any law, statute, ordinance or regulation, including without limitation the laws and regulations governing export control, unfair competition, antidiscrimination or false advertising; (c) be defamatory or trade libelous; (d) be defamatory, harmful to minors, obscene or child pornographic; (e) be materially false, misleading or inaccurate or cannot be promptly fulfilled, or (f) contain viruses, trojan horses, worms, time bombs, cancelbots or other similar harmful or deleterious programming routines. MP3.com agrees to defend, indemnify and hold harmless Freei and its directors, officers, agents and employees for any and all losses, costs, liabilities or expenses (including without limitation reasonable attorneys' and expert witnesses' fees) incurred or arising from: (a) any breach of the foregoing representations or warranties; (b) any claim arising from the sale of license of MP3.com's goods or services; or (c) any other act, omission or representation by MP3.com. Freei may participate in the defense at its option and expense. 9.3 DUE AUTHORIZATION. Each Party represents and warrants to the other Party that it has all necessary corporate power and authority under all applicable provisions of law to execute and deliver this Agreement and to carry out its provisions. All corporate action on each Party's part required for the lawful execution and delivery of this Agreement and any related agreements has been effectively taken. Upon its execution and delivery, this Agreement will be 5. a valid and binding obligation of each Party, enforceable in accordance with its terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting enforcement of creditors' rights and (b) general principles of equity that restrict the availability of equitable remedies. 10. DISCLAIMER OF WARRANTIES; LIMITED REMEDY. Each Party provides its web site and all services performed hereunder "AS IS" and without any warranty of any kind. EACH PARTY MAKES NO REPRESENTATIONS, WARRANTIES OR GUARANTEES OF ANY KIND, EITHER EXPRESS OR IMPLIED WITH RESPECT TO THE MEDIA PROVIDED HEREUNDER. SUCH PARTY'S CONTENT OR MATERIALS (EXCEPT WITH RESPECT TO THE EXPRESS WARRANTIES PROVIDED IN SECTION 9 ABOVE) OR THE FUNCTIONALITY, PERFORMANCE OR RESULTS OF USE THEREOF, INCLUDING, WITHOUT LIMITATION, ANY WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR OTHER WARRANTIES ARISING BY USAGE OF TRADE, COURSE OF DEALING OR COURSE OF PERFORMANCE. Neither, Party guarantees continuous or uninterrupted display or distribution of the other Party's Content and Materials. In the event of interruption of display or distribution of the Advertiser Content, MP3.com sole obligation shall be to restore service as soon as commercially practicable. If MP3.com does not deliver a specific Media that it had previously agreed to deliver within a given Quarter, Freei's sole remedy shall be to receive a refund of an amount equal to the dollar amount allocated for that specific Media in such Quarter; PROVIDED, HOWEVER, that if such failure to deliver specific Media is due to an interruption in service on the Web Site. In lieu of such a refund, MP3.com may deliver the specific Media as soon as practicable in the following Quarter as determined by the mutual agreement of the Parties. 11. CONSEQUENTIAL DAMAGES DISCLAIMER. IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR ANY SPECIAL, INDIRECT, INCIDENTAL OR CONSEQUENTIAL DAMAGES (INCLUDING BUT NOT LIMITED TO SUCH DAMAGES ARISING FROM BREACH OF CONTRACT OR WARRANTY OR FROM NEGLIGENCE OR STRICT LIABILITY), OR FOR INTERRUPTED COMMUNICATIONS, LOSS OF USE, LOST BUSINESS, LOST DATA OR LOST PROFITS, INCOME OR GOODWILL, THE REJECTION OR REMOVAL OF ANY ADVERTISER CONTENT, OR ANY DELAY IN DISPLAYING OR THE FAILURE TO DISPLAY ANY ADVERTISER, CONTENT, ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT. 12. LIMITATION OF LIABILITY. EXCEPT FOR CLAIMS RELATED TO SECTIONS 9.1 OR 9.2 ABOVE, NOTWITHSTANDING ANY OTHER PROVISIONS OF THIS AGREEMENT, EACH PARTY'S AGGREGATE LIABILITY TO THE OTHER PARTY UNDER ANY CLAIMS RELATING TO OR ARISING OUT OF THIS AGREEMENT SHALL NOT EXCEED AN AMOUNT GREATER THAN THE AMOUNTS RECEIVED UNDER THIS AGREEMENT BY SUCH PARTY DURING THE' TWELVE (12) MONTH PERIOD IMMEDIATELY PRECEDING SUCH CLAIM. 6. 13. TERM AND TERMINATION. 13.1 TERM OF AGREEMENT. The term of this Agreement shall commence on the Effective Date and shall remain in full force and effect until November _, 2001 (the "Term"). 13.2 TERMINATION FOR DEFAULT. Freei or MP3.com may terminate this Agreement: (a) Except as set forth in Section 10, immediately upon written notice if the other Party breaches a material term or condition of the Agreement and does not cure such breach (or commence a cure in a manner reasonably satisfactory to the non-breaching party) within ninety (90) days (or ten (10) days in the event of nonpayment of money) after written notice of such breach; or (b) Immediately upon written notice if the other ceases to do business, or otherwise terminates its business operations, except as a result of a permitted assignment; or (c) Immediately upon written notice if the other shall fail to promptly secure or renew any license, registration, permit, authorization or approval for the conduct of its business in the manner contemplated by this Agreement or if any such license, registration, permit, authorization or approval is revoked or suspended. 13.3 RIGHTS AND OBLIGATIONS UPON TERMINATION. In the event this Agreement expires or is terminate: (a) each Party shall cooperate with the others in order to effect an orderly termination of the relationship created by this Agreement, including each Party's prompt return of any Confidential Information. Termination of this Agreement shall not limit any Party from pursuing other remedies available to it, including in injunctive relief. The parties' rights and obligation under Sections 9, 10, 11, 12, 13 and 14, and the provisions regarding "Confidential Information" under Section 7, shall survive termination or expiration of this Agreement. 14. GENERAL PROVISIONS. 14.1 EFFECTIVENESS. This Agreement shall not become effective until and unless the Stock Purchase Agreement is entered into between the Parties. 14.2 ENTIRE AGREEMENT. This Agreement, together with any Exhibits attached hereto, represents the entire agreement between the Parties with respect to the subject matter hereof and thereof and shall supersede all prior agreements and communications of the Parties, oral or written. 14.3 AMENDMENT AND WAIVER. No amendment to, or waiver of, any provision of this Agreement shall be effective unless in writing and signed by all Parties hereto. The waiver by any party of any breach or default shall not constitute a waiver of any different or subsequent breach or default. 14.4 PUBLICITY. Freei agrees that it shall not issue a press release or public announcement pertaining to the transactions contemplated by this Agreement at any time, unless MP3.com expressly agrees otherwise and agrees to the form and substance of such press release 7. or announcement, which consent shall not be unreasonably withheld. Unless expressly otherwise agreed to by MP3.com, Freei will not disclose the transactions contemplated by this Agreement and will maintain the confidentiality of these transactions, except (x) to the extent required by law, (y) in connection with any bona fide due diligence investigation conducted by a potential investor, acquiror, commercial lender, investment bank or the like where such party executes Freei's customary nondisclosure agreement or (z) to the extent that Freei, after consultation with outside legal counsel, determines that such disclosure is required to be made in any filing made pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, as applicable. 14.5 GOVERNING LAW. MP3.com and Freei agree to submit any dispute or controversy arising out of or relating to this Agreement, including without limitation the interpretation, performance, breach, termination or validity thereof, to mediation before a single mediator to be selected by the parties or, if they cannot agree on a mediator within seven days of a request for mediation under this paragraph, before a single mediator to be selected in accordance with rules and procedures of the American Arbitration Association. The mediation shall take place in (i) San Diego, California, if such action was initiated by Freei or (ii) Seattle, Washington, if such action was initiated by MP3.com, at a location and time to be agreed upon by the parties and the mediator or, in the absence of agreement, by the mediator. Each party shall share equally in the compensation and costs of the mediator. In the event the dispute is not resolved by mediation within thirty days of the request for mediation, the dispute shall be resolved by arbitration administered by the American Arbitration Association in accordance with its Commercial Rules then in effect, and judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The arbitrator or arbitration panel shall have the authority to award only those damages permitted in the Agreement, subject to any disclaimers of damages and liability limits set forth in this Agreement, and shall not have the authority to reform, modify or materially change this Agreement. The arbitration shall take place in (i) San Diego, California, if such action was initiated by Freei or (ii) Seattle, Washington, if such action was initiated by MP3.com, at a location and time to be agreed upon by the parties or, in the absence of agreement, by the arbitrator. The expense of the arbitration, including the compensation of the arbitrator, shall be borne in accordance with the award of the arbitrator. Notwithstanding anything in this Section to the contrary, either party may seek injunctive relief in any appropriate jurisdiction for any violation of such party's intellectual property rights. This Agreement shall be governed by and interpreted in accordance with the laws of the State of California without giving effect to principles of conflicts of laws. Each party hereby agrees to submit to jurisdiction in California and further agrees that any cause of action arising under this Agreement must be brought exclusively in a court in San Diego County, California. 14.6 SUCCESSORS AND ASSIGNS. No Party shall assign its rights or obligations under this Agreement without the prior written consent of the other Party, which shall not unreasonably be withheld or delayed. Notwithstanding the foregoing, each Party may assign this Agreement to an entity who acquires substantially all of the stock or assets of a Party to this Agreement; provided that consent will be required in the event that the non-assigning Party reasonably determines that the assignee will not have sufficient capital or assets to perform its obligations hereunder. All terms and provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective permitted transferees, successors and assigns. 8. 14.7 FORCE MAJEURE. No Party shall be liable for failure to perform or delay in performing any obligation (other than the payment of money) under this Agreement if such failure or delay is due to fire, flood, earthquake, strike, war (declared or undeclared), embargo, blockade, legal prohibition, governmental action, riot, insurrection, damage, destruction or any other similar cause beyond the control of such party. 14.8 NOTICES. All notices, requests and other communications called for by this agreement shall be deemed to have been given immediately if made by telecopy or electronic mail (confirmed by concurrent written notice sent via overnight courier for delivery by the next business day), if to MP3.com at 4790 Eastgate Mall, San Diego, CA 92121, attention Director, Legal Affairs (e-mail: przes@mp3.com), and if to Freei at the physical and electronic mail addresses set forth on the signature page of this Agreement, or to such other addresses as each Party shall specify to the other Party. Notice by any other means shall be deemed made when actually received by the Party to which notice is provided. 14.9 SEVERABILITY. If any provision of this Agreement is held to be invalid, illegal or unenforceable for any reason, such invalidity, illegality or unenforceability shall not effect any other provisions of this Agreement, and this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein. 14.10 WAIVER OF BREACH. The waiver by any party of a breach or default of any provision of this Agreement by any other party shall not be construed as a waiver of any succeeding breach of the same or any other provision, nor shall any delay or omission on the part of any party to exercise or avail itself of any right, power or privilege that it has, or may have hereunder, operate as a waiver of any right, power or privilege by such party. 14.11 COUNTERPARTS; FACSIMILE SIGNATURES. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement, and shall become effective when one or more such counterparts have been signed by each party and delivered to each other party. This Agreement may be executed and delivered by facsimile and the parties agree that such facsimile execution and delivery shall have the same force and effect as delivery of an original document with original signatures, and that each party may use such facsimile signatures as evidence of the execution and delivery of this Agreement by all parties to the same extent that an original signature could be used. 14.12 AUTHORITY. Each of the Parties represents and warrants that the negotiation and entry of this Agreement will not violate, conflict with, interfere with, result in a breach of, or constitute a default under any other agreement to which they are a party. 14.13 ATTORNEYS FEES. The prevailing party in any action to enforce this Agreement shall be entitled to reimbursement of its expenses. including reasonable attorneys' fees. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 9. IN WITNESS WHEREOF, the Parties have caused this Agreement to be duly executed as of the Effective Date. MP3.com, INC. FREEI.NET, INC. By: Rob Richards By: /s/ Robert McCausland ------------------------- --------------------------------- Name: Name: Robert (Bob) McCausland ----------------------- ------------------------------- Title: President Title: President / CEO ---------------------- ------------------------------ Address: 4790 Eastgate Mall Address: 909 S. 336th St. #110 San Diego, CA 92121 Federal Way, WA 98003 e-mail: przes@mp3.com e-mail: bobm@freei.net ALSO SEND NOTICES TO: jolene@freei.net 10. EXHIBIT A
QUARTER SCHEDULE: PURCHASE AMOUNT: Q1: December 1, 1999 through February 29, 2000 $1,000,000 Q2: March 1, 2000 through May 31, 2000 $1,000,000 Q3: June 1, 2000 through August 31, 2000 $1,000,000 Q4: September 1, 2000 through November 30, 2000 $1,000,000 TOTAL: $4,000,000
SCHEDULED PAYMENT DATE: TOTAL PAYMENT: ----------------------- -------------- December 1, 1999 $333,333 January 1, 2000 $333,333 February 1, 2000 $333,334 March 1, 2000 $333,333 April 1, 2000 $333,333 May 1, 2000 $333,334 June 1, 2000 $333,333 July 1, 2000 $333,333 August 1, 2000 $333,334 September 1, 2000 $333,333 October 1, 2000 $333,333 November 1, 2000 $333,334 TOTAL $4,000,000
EX-10.7 10 EXHIBIT 10.7 Exhibit 10.7 FREEI NETWORKS, INC. SERIES A PREFERRED STOCK PURCHASE AGREEMENT DATED AS OF AUGUST 12, 1999 TABLE OF CONTENTS Page ---- 1. Purchase and Sale of Stock ............................................................. 1 1.1 Sale and Issuance of Series A Stock........................................... 1 1.2 Closing....................................................................... 1 2. Representations and Warranties of the Company........................................... 2 2.1 Organization, Good Standing and Qualification................................. 2 2.2 Capitalization................................................................ 2 2.3 Subsidiaries.................................................................. 3 2.4 Authorization................................................................. 3 2.5 Valid Issuance of Preferred and Common Stock.................................. 3 2.6 Governmental Consents; Compliance With Laws .................................. 4 2.7 Litigation.................................................................... 4 2.8 Intellectual Property......................................................... 5 2.9 Compliance With Other Instruments............................................. 5 2.10 Agreements; Action............................................................ 6 2.11 Disclosure.................................................................... 6 2.12 Registration Rights .......................................................... 6 2.13 Corporate Documents........................................................... 7 2.14 Title to Property and Assets; Condition of Assets ............................ 7 2.15 Licenses ..................................................................... 7 2.16 Financial Statements ......................................................... 7 2.17 Undisclosed Liabilities ...................................................... 7 2.18 Changes ...................................................................... 8 2.19 Employee Benefit Plans........................................................ 9 2.20 Taxes ........................................................................ 9 2.21 Minutes ...................................................................... 10 2.22 Brokers or Finders ........................................................... 10 2.23 Employees .................................................................... 10 2.24 Environmental and Safety Laws................................................. 10 2.25 Offering Valid................................................................ 11 2.26 Real Property Holding Corporation............................................. 11 2.27 Involvement in Certain Legal Proceedings...................................... 11 3. Representations and Warranties of the Investors......................................... 11 3.1 Authorization................................................................. 11 3.2 Purchase Entirely for Own Account............................................. 12 3.3 Investment Experience......................................................... 12
-i- 3.4 Restricted Securities......................................................... 12 3.5 Legends....................................................................... 13 3.6 Residency..................................................................... 14 3.7 Access to Information......................................................... 14 4. Conditions of Investors' Obligations at the Closing..................................... 14 4.1 Representations and Warranties................................................ 14 4.2 Performance................................................................... 14 4.3 Compliance Certificate........................................................ 15 4.4 Qualifications................................................................ 15 4.5 Proceedings and Documents..................................................... 15 4.6 Investor Rights Agreement..................................................... 15 4.7 Opinion of Company Counsel.................................................... 15 4.8 Board of Directors............................................................ 17 5. Conditions of the Company's Obligations at the Closing.................................. 17 5.1 Representations and Warranties................................................ 17 5.2 Payment of Purchase Price..................................................... 18 5.3 Securities Laws Qualification................................................. 18 5.4 Performance................................................................... 18 6 Miscellaneous........................................................................... 18 6.1 Use of Proceeds............................................................... 18 6.2 Survival of Warranties........................................................ 18 6.3 Successors and Assigns........................................................ 18 6.4 Governing Law................................................................. 19 6.5 Counterparts.................................................................. 19 6.6 Titles and Subtitles.......................................................... 19 6.7 Notices....................................................................... 19 6.8 Due Diligence Expenses; Attorneys' and Accountants' Fees...................... 19 6.9 Finder's Fees................................................................. 19 6.10 Amendments and Waivers........................................................ 20 6.11 Severability.................................................................. 20 6.12 Entire Agreement.............................................................. 20
-ii- SERIES A PREFERRED STOCK PURCHASE AGREEMENT This SERIES A PREFERRED STOCK PURCHASE AGREEMENT (this "AGREEMENT ") is made as of August 12, 1999, by and between Freei Networks, Inc., a Washington corporation (the "COMPANY"), Sequoia Capital IX, Sequoia Capital Angel Fund, and Sequoia Capital IX Principals Fund (individually,. an "INVESTOR " and collectively, the "INVESTORS"). THE PARTIES HEREBY AGREE AS FOLLOWS: 1. PURCHASE AND SALE OF STOCK 1.1 SALE AND ISSUANCE OF SERIES A STOCK (a) The Company has adopted and filed with the Secretary of State of the State of Washington the Restated Articles of Incorporation with the designation of the Series A Convertible Preferred Stock (the "SERIES A STOCK ") in the form attached hereto as EXHIBIT A (the "ARTICLES OF INCORPORATION"). (b) Subject to the terms and conditions of this Agreement, the Investors agree to purchase, and the Company agrees to sell and issue to the Investors, at the Closing (as defined in Section 1.2(a)), an aggregate of 4,812,074 shares of Series A Stock at $2.0781 per share, for a total purchase price of $9,999,970.98. 1.2 CLOSING (a) The purchase and sale of the Series A Stock (the "CLOSING") shall take place at the offices of Stoel Rives LLP, One Union Square, 600 University Street, Seattle, Washington, after satisfaction of the conditions set forth in Sections 4 and 5 on a date mutually acceptable to the Company and the Investors, but in no event later than August 13, 1999. (b) At the Closing, the Company shall deliver to the Investors certificates representing the number of shares of Series A Stock set forth below and registered in the name of the respective Investor against payment to the Company of the purchase price for such shares by wire transfer of funds or a bank check payable to the Company's order:
RECORD HOLDER NUMBER OF SHARES ------------- ---------------- Sequoia Capital IX 3,595,100 shares
-1- Sequoia Capital Angel Fund 553,389 shares Sequoia Capital IX Principals Fund 663,585 shares 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Investors that, except as set forth on a Schedule of Exceptions attached hereto as EXHIBIT B: 2.1 ORGANIZATION, GOOD STANDING AND QUALIFICATION The Company is a corporation duly organized and validly existing under the laws of the State of Washington and has all requisite corporate power and authority to own and operate its properties and assets, to execute and deliver this Agreement, to issue and sell the Series A Stock and the Common Stock issuable upon conversion thereof (the "CONVERSION SHARES"), to carry out its obligations under this Agreement, the Investor Rights Agreement, and the Articles of Incorporation and to carry on its business as presently conducted and as recently proposed to be conducted. The Company is duly qualified to transact business and is in good standing in each jurisdiction in which the failure to so qualify would have a material adverse effect on its business or properties. 2.2 CAPITALIZATION The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (a); (b) and (c) below. (a) PREFERRED STOCK There are 10,000,000 shares of preferred stock authorized, 4,812,074 of which have been designated as Series A Stock and none of which is outstanding. The rights, privileges, and preferences of the preferred stock. generally and of the Series A Stock are as stated in the Articles of Incorporation, as amended. (b) COMMON STOCK There are 50,000,000 shares of Common Stock authorized, 13,439,500 shares of which are currently outstanding. Of the authorized but unissued Common Stock, 4,812,074 shares are reserved for issuance upon the conversion of the Series A Stock; effective as of August 21, 1999, 4,210,564 shares are reserved for issuance upon the exercise of stock options granted or to be granted' under the Company's stock option plan (the "OPTION PLAN"); 1,439,500 shares are -2- reserved by board action for issuance upon the exercise of warrants granted to certain investors (the "FIRST ROUND INVESTORS"); 165,775 shares are reserved by board action for issuance upon the exercise of warrants granted to Ascend Communications, Inc. ("ASCEND "); and 153,987 shares are reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999. (c) RIGHTS Except for the conversion privileges of the Series A Stock and other rights, privileges and agreements contemplated pursuant to this Agreement, and as set forth in subsection 2.2(b), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights), agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock or, to the Company's knowledge, any voting agreements with respect to the Company's securities. 2.3 SUBSIDIARIES The Company does not presently own or control, directly or indirectly, any interest in any other corporation, association, partnership or other business or investment entity. 2.4 AUTHORIZATION All corporate action necessary for the authorization, execution, and delivery by the Company of this Agreement and the other agreements and transactions provided for herein, the performance of all obligations of the Company hereunder and thereunder, and the authorization, issuance, and delivery of the Series A Stock and the Conversion Shares have been taken or will be taken before the Closing. This Agreement and the other agreements provided for herein constitute valid and legally binding obligations of the Company, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement, and (c) the availability of equitable remedies. 2.5 VALID ISSUANCE OF PREFERRED AND COMMON STOCK (a) The Series A Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued, fully paid and nonassessable, and free of any liens or encumbrances created by the Company. The Conversion Shares have been duly and validly reserved for issuance and, upon Issuance in accordance with the terms of the Articles of Incorporation, as amended, will be duly and -3- validly issued, fully paid and nonassessable, and free of any liens or encumbrances created by the Company. (b) The outstanding shares of Common Stock (i) have been duly authorized and validly issued to the persons listed on the Schedule of Exceptions, (ii) are fully paid and nonassessable, and (iii) were issued in compliance with all applicable state and federal laws concerning the issuance of securities. 2.6 GOVERNMENTAL CONSENTS; COMPLIANCE WITH LAWS No consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any federal, regional, state or local governmental authority on the part of the Company is required in connection with the consummation of the transactions contemplated by this Agreement, except for filings, if any, required pursuant to applicable state securities laws, which filings will be made within the required statutory period, and the filing pursuant to Regulation D of the Securities and Exchange Commission (the which filing will be effected within 15 days of the Closing. The Company is not in violation of any applicable statute, rule, regulation, order or restriction of any domestic or foreign government or any instrumentality or agency thereof in respect of the conduct of its business or the ownership of its properties which violation would materially and adversely affect the business, assets, financial condition, or operations of the Company. 2.7 LITIGATION There is no action, suit, claim, proceeding or investigation pending or, to the Company's knowledge, currently threatened against the Company that questions the validity of this Agreement or the other agreements provided for herein or the right of the Company to enter into any of such agreements, or to consummate the transactions provided for hereby or thereby, or that could, individually or in the aggregate, have a material adverse effect on the business, assets, financial condition or operations of the Company, or any change in the current equity ownership of the Company, nor is the Company aware that there is any basis for the foregoing. The foregoing includes, without limitation, actions pending or threatened (or any basis therefor known to the Company) involving the prior employment of the Company's employees, their use In connection with the Company's business of any information or techniques allegedly proprietary to any of their former employers, or their obligations under any agreements with prior employers, There is no action, suit, proceeding or investigation by the Company currently pending or that the Company intends to initiate. The Company is not a party or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality that could have a material adverse effect on its business, assets, financial condition of operations. -4- 2.8 INTELLECTUAL PROPERTY To its knowledge, the conduct of the Company's business does not conflict with or infringe on the patents, trademarks, service marks, trade names, copyrights, trade secrets, proprietary rights and processes (the "INTELLECTUAL PROPETY ") of others. To its knowledge, the Company has sufficient title to or rights to use all Intellectual Property necessary for the conduct of its business. The Company has not granted any options, licenses or agreements of any kind relating to any of its Intellectual Property, nor is the Company bound by or a party to any options, licenses or agreements with respect to the Intellectual Property of any other person or entity. The Company is not aware that any of its employees is obligated under any contract (including licenses, covenants or commitments of any nature) or other agreement, or subject to any judgment, decree or order of any court or administrative agency, that would interfere with their duties to the Company or that would conflict with the Company's business. The execution or delivery of this Agreement, the carrying on of the Company's business by the employees of the Company, and the conduct of the Company's business as proposed, will not, to the Company's knowledge, conflict with or result in a breach of the terms, conditions or provisions of, or constitute a default under, any contract, covenant or instrument under which any employee is now obligated. The Company does not believe it is or will be necessary to use any inventions, trade secrets or proprietary information of any of its employees made prior to their employment by the Company, except for inventions, trade secrets or proprietary information that have been assigned to the Company. 2.9 COMPLIANCE WITH OTHER INSTRUMENTS The Company is not in violation of any provision of its Articles of Incorporation or Bylaws or in violation or default of any provision of any instrument, judgment, order, writ, decree or contract to which it is a party or by which it is bound, or in violation of any provision of federal or state statute, rule or regulation applicable to the Company, which violation or default would have a material adverse effect on its business, assets, financial condition or operations. The execution, delivery, and performance of this Agreement and the consummation of the transactions provided for herein will not result in any such violation or default or require any consent under or be in conflict with or constitute, with or without the passage of time and giving of notice, either a violation or default under any such provision, Instrument, judgment, order, writ, decree or contract or an event which results in the creation of any lien, charge or encumbrance upon any assets of the Company which violation, default, lien, charge or encumbrance, individually or in the aggregate with any other such violation, default, lien, charge or encumbrance would have a material adverse effect on its business, assets, financial condition or operations. -5- 2.10 AGREEMENTS; ACTION (a) There are no agreements, understandings, instruments, contracts or proposed transactions to which the Company is a party or by which it is bound that involve obligations or payments to the Company in excess of $25,000. (b) The Company has not (i) declared or paid any dividends, or authorized or made any distribution upon or with respect to any class or series of its capital stock, (ii) made any loans or advances to any person, other than in the ordinary course of business, (iii) sold, exchanged or otherwise disposed of any of its assets or rights, other than in the ordinary course of business, (iv) redeemed or obligated itself to redeem any of its capital stock (other than the Series A Stock), or (v) incurred any indebtedness for money borrowed or incurred any other liabilities in excess of $25,000. (c) Except for agreements explicitly contemplated hereby, there are no agreements, understandings or proposed transactions between the Company and any of its officers, directors, affiliates or any affiliate thereof. 2.11 DISCLOSURE The Company has fully provided the Investors and their attorneys and agents with all the information in the Company's possession that they have requested for deciding whether to purchase the Series A Stock. This Agreement, the Exhibits hereto and all other documents delivered by the Company to the Investors or their attorneys or agents in connection herewith or therewith or with the transactions provided for herein or therein, do not contain any untrue statement of a material fact nor omit to state a material fact necessary in order to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading. There are no facts which (individually or in the aggregate) materially adversely affect the business, assets, financial condition or operations of the Company that have not been set forth in this Agreement, the Exhibits hereto or other documents delivered to the Investors or their attorneys or agents in connection herewith. 2.12 REGISTRATION RIGHTS Except as provided in the Investor Rights Agreement, the Company has not granted or agreed to grant any registration rights to say person or entity. -6- 2.13 CORPORATE DOCUMENTS The Articles of Incorporation are, or at the Closing will be, in the form attached hereto as EXHIBIT A hereto. The Bylaws of the Company are in the form attached hereto as EXHIBIT C. 2.14 TITLE TO PROPERTY AND ASSETS; CONDITION OF ASSETS The Company owns its property and assets free and clear of all mortgages, liens, loans and encumbrances, except liens and encumbrances that arise in the ordinary course of business and do not materially impair the Company's ownership or use of such property or assets. With respect to the property and assets it leases, the Company is in compliance with such leases in all material respects and holds a valid leasehold interest free of any liens, claims or encumbrances. All facilities and all material machinery, equipment, fixtures, vehicles, and other properties owned, leased or used by the Company are in good operating condition and repair and are reasonably fit and usable for the purposes for which they are being used. 2.15 LICENSES The Company has all governmental licenses and permits (federal, state, foreign, and local) the failure to obtain which would have a material adverse effect on its business, assets financial condition or operations, and such licenses and permits are in full force and effect. No violations have been communicated to the Company in respect of such licenses or permits and no proceeding is pending or, to the Company's knowledge, threatened toward the revocation of any of such licenses or permits. 2.16 FINANCIAL STATEMENTS The Company has delivered to the Investors its unaudited balance sheet as at June 30, 1999 and unaudited statements of income and cash flows for the six months ended June 30, 1999, and its unaudited balance sheet as of December 31, 1998, and unaudited statements of income and cash flows for the year ended December 31, 1998 (collectively, the "FINANCIAL STATEMENTS"). The Financial Statements, together with the notes thereto, are complete and correct in all material respects, have been prepared consistent with methods used in prior years and present fairly the financial condition and position of the Company as of the dates and for the periods indicated. 2.17 UNDISCLOSED LIABILITIES Except as and to the extent reflected or reserved against in the Financial Statements, the Company did not have, as of the respective dates of the Financial Statements, any material -7- debts, liabilities or obligations of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, including, without limitation, liabilities or obligations on account of taxes or other governmental charges or penalties, interest or fines thereon or in respect thereof required by generally accounting principles to be shown or reflected thereon that were not so shown or reflected. The Company does not know and does not have any reasonable grounds to know of any basis for, any assertion against the Company of any material debt, liability or obligation of any nature or in any amount not fully reflected or reserved against in the Financial Statements or disclosed in this Agreement. 2.18 CHANGES Since June 30, 1998, there has not been: (a) Any change in the business, assets, financial condition or operations of the Company, except changes in the ordinary course of business, none of which has been materially adverse, and all of which in the aggregate have not been materially adverse, to the Company; (b) Any damage, destruction or loss (whether or not covered by insurance) materially and adversely affecting the business, assets, financial condition or operations of the Company; (c) Any material increase in the compensation or rate of compensation or commissions payable or to become payable by the Company to any of its directors, officers, salaried employees. sales persons or agents, or any hiring of any employee at a salary in excess of $60,000 per annum, or any payment in excess of $5,000 of any bonus, profit-sharing amount or other extraordinary compensation to any employee, or any material change in any then existing bonus, profit-sharing, retirement or other similar plan, agreement or arrangement, or any adoption of or entry Into of any new bonus, profit-sharing, group life or health insurance, or other similar plan, agreement or arrangement; (d) Any material change in the accounting methods or practices followed by the Company; (e) Any material debt, obligation or liability (whether absolute or contingent) incurred by the Company (whether or not presently outstanding) except (i) current liabilities incurred, and obligations under agreements entered into, in the ordinary course of business and (ii) obligations or liabilities entered into or incurred in connection with the execution of this Agreement; -8- (f) Any sale, lease, abandonment or other disposition by the Company of any real property or, other than in the ordinary course of business, of any equipment or other operating properties or any sale, assignment, transfer, license or other disposition by the Company of any Intellectual Property or other intangible asset; (g) Any labor trouble, strike or any other occurrence, event or condition of any similar character that materially and adversely affects or may materially and adversely affect the business, assets, financial condition or prospects of the Company; (h) Any change, except in the ordinary course of business, in the contingent obligations of the Company by way of guaranty, endorsement, indemnity, warranty or otherwise; (i) Any waiver by the Company of a valuable right or a material debt owed to it except in the ordinary course of business; (j) Any direct or indirect loans made by the Company to any shareholder, employee, officer or director of the Company, other than advances made in the ordinary course of business; or (k) Any declaration or payment of any dividend or other distribution of the assets of the Company. 2.19 EMPLOYEE BENEFIT PLANS The Company does not have any "employee benefit plan" as defined in the Employee Retirement Income Security Act of 1974, as amended. 2.20 TAXES The Company has filed all tax returns (federal, state, foreign, and local) required to be filed by it and all taxes shown to be due and payable on such returns or on any assessments received by the Company and all other taxes (federal, state, foreign, and local) due and payable by the Company on or before the date hereof have been paid. There are no agreements, waivers or other arrangements providing for an extension of time with respect to the assessment of any tax or deficiency against the Company, nor are there any actions, suits, proceedings, investigations or claims now pending against the Company in respect of any tax or assessment, or, to the Company's knowledge, any matters under discussion within any federal, state, foreign or local authority relating to any taxes or assessments, or any claims for additional taxes or assessments asserted by any such authority. The provisions made for taxes -9- in the Financial Statements are sufficient for the payment of all unpaid federal, state, foreign, and local taxes of the Company for all periods prior to such date. 2.21 MINUTES The minutes of the Company reflect all meetings of directors and shareholders since the incorporation of the Company and reflect all transactions referred to in such minutes accurately in all material respects. 2.22 BROKERS OR FINDERS The Company has not incurred and will not incur, directly or indirectly, any liability for brokers' or finders' fees, agents' commissions or other similar charges in connection with this Agreement or the transactions contemplated hereby. 2.23 EMPLOYEES The Company has no collective bargaining agreements with any of its employees. There is no labor union organizing activity ending or, to the Company's knowledge, threatened with respect to the Company. No employee has any agreement or contract, written or verbal, regarding his or her employment. To the Company's knowledge, no employee of the Company, nor any consultant with whom the Company has contracted, is in violation of any term of any employment contract, proprietary information agreement, patent disclosure agreement or any other agreement relating to the right of any such individual to be employed by, or to contract with, the Company because of the nature of the business to be conducted by the Company and, to the Company's knowledge, the continued employment by the Company of its present employees, and the performance of the Company's contracts with its independent contractors, will not result in any such violation. The Company has not received any notice alleging that any such violation has occurred. No employee of the Company has been granted the right to continued employment by the Company or to any material compensation following termination of employment with the Company. The Company is not aware that any officer or key employee, or that any group of key employees, intends to terminate their employment with the Company, nor does the Company have a present intention to terminate the employment of any officer, key employee or group of key employees. 2.24 ENVIRONMENTAL AND SAFETY LAWS To its knowledge, the Company is not in violation of any applicable statute, law or regulation relating to the environment or occupational health and safety, and, to its knowledge, no material expenditures are or will be required to comply with any such existing statute, law or regulation. -10- 2.25 OFFERING VALID Assuming the accuracy of the representations and warranties of the Investors contained in Section 3 hereof, the offer, sale, and issuance of the Series A Stock and the Conversion Shares will be exempt from the registration requirements of the Securities Act of 1933, as amended (the "SECURITIES ACT"), and will have been registered or qualified (or are exempt from registration and qualification) under the registration, permit or qualification requirements of all applicable state securities laws. Neither the Company nor any agent on its behalf has solicited or will solicit any offers to sell or has offered to sell or will offer to sell all or any part of the Series A Stock to any person or persons so as to bring the sale of such Series A Stock by the Company within the registration provisions of the Securities Act. 2.26 REAL PROPERTY HOLDING CORPORATION The Company is not a real property holding corporation within the meaning of Internal Revenue Code Section 897(c)(2) and any regulations promulgated thereunder. 2.27 INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS None of Bob McCausland, Steve Bourg or Gus Bourg has been subject and is not currently subject to any order, judgment or decree, not subsequently revised, suspended or vacated, of any court or any governmental agency that could materially adversely affect the business of the Company as presently conducted or as proposed to be conducted. 3. REPRESENTATIONS AND WARRANTIES OF THE INVESTORS Each Investor hereby represents and warrants that: 3.1 AUTHORIZATION All acts and conditions necessary for the authorization, execution, delivery, and consummation by the Investor of this Agreement and the other agreements and transactions contemplated herein have been, or will before the Closing be, taken, performed, and obtained. This Agreement and the other agreements contemplated herein constitute valid and legally binding obligations of the Investor, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement, and (c) the availability of equitable remedies. The Investor has full power and authority to execute, deliver, and perform its obligations under this Agreement and the other agreements contemplated herein and to own the Series A Stock. The execution, delivery, and performance of this Agreement and the other agreements contemplated herein and the -11- consummation of the transactions contemplated hereby and thereby (including the ownership of Series A Stock) by the Investor does not violate any provision of, or constitute a material breach of or default under, any term, condition or provision of any agreement, indenture or other instrument to which the Investor is a party, or by which it or its properties or assets are bound, or of any order, judgment or decree against or binding upon the Investor. 3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT The Series A Stock to be received by the Investor and the Conversion Shares (collectively, the "SECURITIES") will be acquired for investment for the Investor's own account and not with a view to the distribution of any part thereof. The Investor has no present intention of selling, granting any participation in, or otherwise distributing the Securities in a manner contrary to the Securities Act, or applicable state securities laws. 3.3 INVESTMENT EXPERIENCE The Investor is an investor in securities of companies in the development stage, qualifies as an "accredited investor" as defined in Rule 501 of Regulation D promulgated by the SEC, and acknowledges that the Securities are a speculative risk. The Investor is able to fend for itself in the transactions contemplated by this Agreement, can bear the economic risk of its investment (including possible complete loss of such investment) for an indefinite period of time, and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities. The Investor represents it has not been organized for the purpose of acquiring the Securities. The Investor understands that the Securities have not been registered under the Securities Act, or under the securities laws of any jurisdiction, by reason of reliance upon certain exemptions, and that the reliance of the Company on such exemptions is predicated upon the accuracy of the Investor's representations and warranties in this Section 3. 3.4 RESTRICTED SECURITIES The Investor understands that the Securities are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that, under such laws and applicable regulations, such securities may be transferred or resold without registration under the Securities Act only in certain limited circumstances and in accordance with the terms and conditions set forth 14 the legend described in Section 3.5. In this connection, the Investor represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations Imposed thereby and by the Securities Act. -12- 3.5 LEGENDS It is understood that the certificates evidencing the Securities may bear one or all of the following legends: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR APPLICABLE STATE LAW, AND NO INTEREST THEREIN MAY BE SOLD, DISTRIBUTED, ASSIGNED, OFFERED, PLEDGED OR OTHERWISE TRANSFERRED UNLESS (i) THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS COVERING ANY SUCH TRANSACTION INVOLVING SAID SECURITIES OR (ii) SUCH TRANSACTION IS EXEMPT FROM REGISTRATION. AFTER AUGUST 13, 2001, THIS LEGEND WILL BE CANCELED, AND A CERTIFICATE FREE FROM SUCH LEGEND ISSUED TO THE HOLDER HEREOF UPON COMPLIANCE WITH THE FOLLOWING CONDITIONS: (a) SURRENDER OF THIS CERTIFICATE TO THIS CORPORATION IN THE MANNER AND AT THE PLACE DESIGNATED FOR CANCELLATION, (b) A REPRESENTATION BY THE HOLDER THAT IT HAS BENEFICIALLY HELD THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR NOT LESS THAN TWO YEARS, AND THAT IT IS NOT, AND HAS NOT WITHIN THE PRECEDING 90 DAYS BEEN, AN AFFILIATE (AS THAT TERM IS DEFINED FOR PURPOSES OF RULE 144 UNDER THE ACT OR ANY SUCCESSOR RULE) OF THIS CORPORATION, AND (c) AN UNDERTAKING THAT IF AT ANY TIME THE HOLDER SHALL AGAIN BECOME AN AFFILIATE OR OTHERWISE CEASE TO ENJOY FREE TRANSFERABILITY OF SUCH SECURITIES UNDER RULE 144 EITHER BY REASON OR CHANGE OF CIRCUMSTANCE OR AMENDMENT OF RULE 144, IT SHALL FORTHWITH SURRENDER ANY UNLEGENDED CERTIFICATES(S) RECEIVED BY IT IN RESPECT OF THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR IMPOSITION OF ANY APPROPRIATE LEGEND. THE COMPANY HAS COMMON STOCK AND PREFERRED STOCK AUTHORIZED. THE FULL STATEMENT OF THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF (THE "STATEMENT OF RIGHTS AND PREFERENCES") OF THE SHARES OF EACH SUCH SERIES OR CLASS OF STOCK IS SET FORTH IN THE ARTICLES OF INCORPORATION OF THE COMPANY, AS AT ANY TIME AMENDED, AND ANY EFFECTIVE STATEMENT OF RELATIVE RIGHTS AND PREFERENCES OF PREFERRED STOCK, ON FILE IN THE OFFICE OF THE SECRETARY OF STATE OF THE STATE OF WASHINGTON. THE COMPANY WILL FURNISH COPIES OF THE STATEMENT OF RIGHTS AND PREFERENCES TO THE RECORD HOLDER OF THIS CERTIFICATE WITHOUT -13- CHARGE UPON WRITTEN REQUEST TO THE COMPANY AT ITS PRINCIPAL PLACE OF BUSINESS OR REGISTERED OFFICE. 3.6 RESIDENCY For purposes of the application of state securities laws, the Investor represents that it is a resident of the State of California. 3.7 ACCESS TO INFORMATION The investor has received and reviewed information about the Company, including the Offering Memorandum of the Company prepared by Pacific Crest Securities, has had an opportunity to discuss the Company's business, management, and financial affairs with its management and to review the Company's facilities. The investor understands that these discussions, as well as any written information issued by the Company, were intended to describe the aspects of the Company's business and prospects that the Company considers material, but were not necessarily exhaustive. The foregoing, however, does not limit or modify the representations and warranties of the Company in Section 2 of this Agreement or the right of the Investors to rely thereon. 4. CONDITIONS OF INVESTORS' OBLIGATIONS AT THE CLOSING The obligations of the Investors under subsection 1.1(b) are subject to the fulfillment at or before the Closing (unless otherwise specified) of each of the following conditions, unless waived by the Investors: 4.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of the Company contained in Section 2 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the date of the Closing. 4.2 PERFORMANCE The Company shall have performed and complied with all agreements, obligations and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. -14- 4.3 COMPLIANCE CERTIFICATE The President and Chief Executive Officer of the Company, on behalf of the Company, shall deliver to the Investors at the Closing a certificate that the conditions specified in Sections 4.1 and 4.2 have been fulfilled and stating that there has been no material adverse change in the business, assets, financial condition or operations of the Company from the date of this Agreement to the time of the Closing. 4.4 QUALIFICATIONS The offer and sale of the Securities to the Investors pursuant to this Agreement shall be qualified or exempt from qualification under all applicable federal and state securities laws. 4.5 PROCEEDINGS AND DOCUMENTS All corporate and other proceedings in connection with the transactions contemplated at the Closing and all documents incident thereto, including evidence of filing the Articles of Incorporation with the Secretary of State of the State of Washington, shall be reasonably satisfactory in form and substance to the Investor's counsel, and the Investors and their counsel shall have received all counterpart original and certified or other copies of such documents as they may reasonably request. 4.6 INVESTOR RIGHTS AGREEMENT The Company and the Investors shall have entered into an Investor Rights Agreement in the form attached hereto as EXHIBIT D (the "INVESTOR RIGHTS AGREEMENT"). 4.7 OPINION OF COMPANY COUNSEL The Investors shall have received from Williams Kastner & Gibbs, PLLC, counsel for the Company, an opinion, dated as of the Closing, in form and substance satisfactory to the Investor, to the effect that: (a) The Company is a corporation, validly existing under the laws of the State of Washington, and the Company has the requisite corporate power and corporate authority to conduct its business as now being conducted. (b) The Company is qualified to do business in any state or jurisdiction of the United States In which the failure to so qualify would have a material adverse effect on its business or properties. -15- (c) The Company has the requisite corporate power and corporate authority to execute, deliver, and perform this Agreement and the Investor Rights Agreement. All corporate action necessary for the authorization, execution and delivery by the Company of this Agreement and the Investor Rights Agreement and the authorization, issuance, and delivery of the Series A Stock being sold hereunder and the Conversion Shares has been taken, and this Agreement and the Investor Rights Agreement have been duly and validly authorized, executed, and delivered by the Company and constitute valid and legally binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited or affected by applicable laws relating to or affecting the enforcement of creditors' rights and by equitable principles. (d) The Series A Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued, fully paid, and nonassessable. The Conversion Shares have been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Articles of Incorporation, will be duly and validly issued, fully paid, and nonassessable. (e) The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (i), (ii) and (iii) below: (i) Preferred Stock There are 10,000,000 shares of preferred stock authorized, 4,812,074 of which have been designated as Series A Stock and none of which is outstanding. The rights, privileges, and preferences of the preferred stock generally and of the Series A Stock are as stated in the Articles of Incorporation. (ii) Common Stock There are 50,000,000 shares of Common Stock authorized, 13,439,500 shares of which are currently outstanding. Of the authorized but unissued Common Stock; 4,812,074 shares are reserved for issuance upon the conversion of the Series A Stock; effective as of August 21, 1999, 4,210,564 shares will be reserved for issuance upon the exercise of stock options granted or to be granted under the Option Plan; 1,439,500 shares are reserved by board action FOR issuance upon the exercise of warrants granted to the First Round Investors; 165,775 shares are reserved by board action for issuance upon the exercise of warrants granted to Ascend; and 153,987 shares are reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999 -16- (iii) Rights Except for the conversion privileges of the Series A Stock and other rights, privileges and agreements contemplated pursuant to this Agreement or as enumerated in subparagraph (e)(ii), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights) agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock, or, to such counsel's knowledge, any voting agreements with respect to the Company's securities. (f) The respective rights, privileges, and preferences of the Series A Stock are as stated in the Articles of Incorporation. The certificates representing shares of the Series A Stock are in due and proper form and have been duly and validly executed by the officers of the Company named thereon. (g) Based in part upon the representations of the Investors and on the facts and circumstances contemplated by this Agreement, and except that such counsel need give no opinion as to whether information provided to the Investors was sufficient and assuming that the offer and sale of the Series A Stock is a discrete transaction and not integrated with any other offering or sale of securities by the Company, the offer and sale of the Series A Stock to the Investors pursuant to the terms of this Agreement are exempt from the registration requirements of Section 5 of the Securities Act. 4.8 BOARD OF DIRECTORS Effective upon the Closing, the authorized number of directors shall be three, and Bob McCausland and Mark Stevens shall be directors of the Company. 5. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING The obligations of the Company to the Investors under this Agreement are subject to the fulfillment on or before the Closing of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of each Investor contained in Section 3 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the Closing. -17- 5.2 PAYMENT OF PURCHASE PRICE The Investors shall have delivered the purchase price specified in subsection 1.1(b) to be delivered at the Closing, in the form of a bank check payable to the Company's order or bank wire transfer to the Company's designated account. 5.3 SECURITIES LAWS QUALIFICATION The offer and sale to the Investors of the Securities shall be qualified or exempt from qualification under all applicable federal and state securities laws. 5.4 PERFORMANCE The Investors shall have performed and complied with all agreements, obligations, and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 6. MISCELLANEOUS 6.1 USE OF PROCEEDS Except as described in Section 6.1 of the Schedule of Exceptions to this Agreement, the Company shall use the proceeds of the sale of the Series A Stock under this Agreement as working capital to be used for the development of the Company pursuant to a formal budget prepared by the Company and approved by the Investor. 6.2 SURVIVAL OF WARRANTIES The warranties and representations contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the Closing for a period of two years after Closing. 6.3 SUCCESSORS AND ASSIGNS The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. Nothing in this Agreement express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. -18- 6.4 GOVERNING LAW This Agreement shall be governed by and construed under the laws of the State of Washington as applied to agreements among Washington residents entered into and to be performed entirely within the State of Washington. 6.5 COUNTERPARTS 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 6.6 TITLES AND SUBTITLES The titles and subtitles used in this Agreement are for convenience only and are not to be considered in construing or interpreting this Agreement. 6.7 NOTICES Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified (including via facsimile transmission) or upon deposit with the United States Post Office, postage prepaid, registered or certified with return receipt requested and addressed to the party to be notified at the address indicated for such party on the signature page hereof or at such other address as such party may designate by ten days' advance written notice to the other parties given in the foregoing manner. 6.8 DUE DILIGENCE EXPENSES; ATTORNEYS' AND ACCOUNTANTS' FEES The Company shall reimburse at the Closing the reasonable due diligence costs, including legal and accounting fees and expenses, incurred by the Investors in an amount not to exceed $20,000. If the parties fail to close the transactions contemplated by this Agreement, each party shall be responsible for its own expenses. 6.9 FINDER'S FEES Each party represents that it neither is, nor will be, obligated for a finder's fee or commission in connection with this transaction, except as described in Section 6.1 of the Schedule of Exceptions to this Agreement. The Investors agree to indemnify and hold the Company harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which the Investors or any of their officers, partners, employees or representatives is -19- responsible. The Company agrees to indemnify and hold the Investors harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which the Company or any of its officers, employees or representatives is responsible. 6.10 AMENDMENTS AND WAIVERS After the Closing, any term of this Agreement may be amended and the observance of any term may be waived (either generally or in a particular instance and either retroactively or prospectively) only with the written consent of the Company and the holders of a majority of the aggregate shares of Series A Stock and/or the Conversion Shares (excluding shares of Common Stock that are no longer "restricted securities" under the Securities Act). Any amendment or waiver effected in accordance with this Section 7.9 shall be binding upon each holder of any securities purchased under this Agreement at the time outstanding (including securities into which such securities are convertible), each future holder of any such securities, and the Company. 6.11 SEVERABILITY If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement, and the balance of this Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 6.12 ENTIRE AGREEMENT This Agreement, including the Exhibits attached hereto, and the other documents delivered at the Closing constitute the full and entire understanding and agreement between the parties with respect to the subject matter hereof and supersede all prior agreements with respect to the subject matter hereof. The following Exhibits are attached hereto: Exhibit A - Restated Articles of Incorporation Exhibit B - Schedule of Exceptions Exhibit C - Bylaws Exhibit D - Form of Investor Rights Agreement -20- IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. COMPANY: INVESTORS: FREEI NETWORKS, INC, SEQUOIA CAPITAL IX SEQUOIA CAPITAL ANGEL FUND SEQUOIA CAPITAL IX PRINCIPALS FUND By. SC IX Management, LLC A California Limited Liability Company Its General Partner By: /s/ Mark Stevens -------------------------------- ---------------------------------- Bob McCausland Managing Member President and Chief Executive Officer IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. COMPANY: INVESTORS: FREEI NETWORKS, INC, SEQUOIA CAPITAL IX SEQUOIA CAPITAL ANGEL FUND SEQUOIA CAPITAL IX PRINCIPALS FUND By. SC IX Management, LLC A California Limited Liability Company Its General Partner By: /s/ BOB MCCAUSLAND ------------------------------- --------------------------------- Bob McCausland Managing Member President and Chief Executive Officer EX-10.8 11 EXHIBIT 10.8 Freei Networks, Inc. SERIES B PREFERRED STOCK PURCHASE AGREEMENT Dated as of November 12,1999 TABLE OF CONTENTS
Page ---- 1. PURCHASE AND SALE OF STOCK 1.1 SALE AND ISSUANCE OF SERIES A STOCK...................................1 1.2 CLOSING...............................................................1 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY ............................1 2.1 ORGANIZATION, GOOD STANDING AND QUALIFICATION.........................2 2.2 CAPITALIZATION........................................................2 2.3 SUBSIDIARIES..........................................................2 2.4 AUTHORIZATION ........................................................3 2.5 VALID ISSUANCE OF PREFERRED AND COMMON STOCK .........................3 2.6 GOVERNMENTAL CONSENTS; COMPLIANCE WITH LAWS...........................4 2.7 LITIGATION .......... ................................................4 2.8 INTELLECTUAL PROPERTY ................................................5 2.9 COMPLIANCE WITH OTHER INSTRUMENTS.....................................5 2.10 AGREEMENTS: ACTION...................................................6 2.11 DISCLOSURE...........................................................6 2.12 REGISTRATION RIGHTS..................................................6 2.13 CORPORATE DOCUMENTS .................................................7 2.14 TITLE TO PROPERTY AND ASSETS; CONDITION OF ASSETS ...................7 2.15 LICENSES ............................................................7 2.16 FINANCIAL STATEMENTS ................................................7 2.18 CHANGES..............................................................8 2.19 EMPLOYEE BENEFIT PLANS...............................................9 2.20 TAXES................................................................9 2.21 MINUTES.............................................................10 2.22 BROKERS OR FINDERS..................................................10 2.23 EMPLOYEES...........................................................10 2.24 ENVIRONMENTAL AND SAFETY LAWS ......................................10 2.25 OFFERING VALID......................................................11 2.26 REAL PROPERTY HOLDING CORPORATION...................................11 2.27 INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS............................11 3. REPRESENTATIONS AND WARRANTIES OF THE INVESTOR...........................11 3.1 AUTHORIZATION........................................................11 3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT....................................12 3.3 INVESTMENT EXPERIENCE................................................12 3.4 RESTRICTED SECURITIES................................................12 3.5 LEGENDS..............................................................13 3.6 RESIDENCY............................................................14 3.7 ACCES TO INFORMATION.................................................14 4. CONDITIONS OF INVESTOR'S OBLIGATIONS AT THE CLOSING......................14 4.1 REPRESENTATIONS AND WARRANTIES.......................................15 4.2 PERFORMANCE..........................................................15 4.3 COMPLIANCE CERTIFICATE...............................................15 4.4 QUALIFICATIONS.......................................................15 4.5 PROCEEDINGS AND DOCUMENTS............................................15
4.6 INVESTOR RIGHTS AGREEMENT............................................15 4.7 OPINION OF COMPANY COUNSEL...........................................15 4.8 BOARD OF DIRECTORS...................................................17 5. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING ..................18 5.1 REPRESENTATIONS AND WARRANTIES ......................................18 5.2 PAYMENT OF PURCHASE PRICE ...........................................18 5.3 SECURITIES LAWS QUALIFICATION .......................................18 5.4 PERFORMANCE .........................................................18 6. MISCELLANEOUS............................................................18 6.1 USE OF PROCEEDS......................................................18 6.2 SURVIVAL OF WARRANTIES...............................................19 6.3 SUCCESSORS AND ASSIGNS...............................................19 6.4 GOVERNING LAW........................................................19 6.5 COUNTERPARTS.........................................................19 6.6 TITLES AND SUBTITLES.................................................19 6.7 NOTICES..............................................................19 6.8 DUE DILIGENCE EXPENSES; ATTORNEYS' AND ACCOUNTANTS' FEES.............20 6.9 FINDER'S FEES........................................................20 6.10 AMENDMENTS AND WAIVERS..............................................20 6.11 SEVERABILITY........................................................20 6.12 ENTIRE AGREEMENT....................................................21 EXHIBIT A - ARTICLES OF INCORPORATION.................................... EXHIBIT B - SCHEDULE OF EXCEPTIONS....................................... EXHIBIT C - BYLAWS....................................................... EXHIBIT D - FORM OF INVESTOR RIGHTS AGREEMENT............................ SCHEDULE I...............................................................
SERIES B PREFERRED STOCK PURCHASE AGREEMENT This SERIES B PREFERRED STOCK PURCHASE AGREEMENT (this "AGREEMENT") is made as of November 12, 1999, by and between FREEI NETWORKS, INC., a Washington corporation (the "COMPANY"), and MP3.COM, INC., AXP VARIABLE PORTFOLIO STRATEGY AGGRESSIVE FUND ("AXPVP"), AXP STRATEGY AGGRESSIVE FUND ("AXPSAF"), and IDS LIFE SERIES, FUND, INC. EQUITY PORTFOLIO ("IDS") (the "Investors") THE PARTIES HEREBY AGREE AS FOLLOWS: 1. PURCHASE AND SALE OF STOCK 1.1 SALE AND ISSUANCE OF SERIES B STOCK (a) The Company has adopted and filed with the Secretary of State of the State of Washington the Restated Articles of Incorporation with the designation of the Series B Convertible Preferred Stock (the "SERIES B STOCK") in the form attached hereto as Exhibit A (the "ARTICLES OF INCORPORATION"). (b) Subject to the terms and conditions of this Agreement, each Investor agrees severally to purchase, the number of shares listed on Schedule 1, and the Company agrees to sell and issue to each Investor, at the Closing (as defined in Section* 1.2(a)) a total of 1,552,655 shares of Series B Stock at $ 16.10146 per share, for a total purchase price of $25,000,012.3 8. Each Investor's purchase price and number of acquired shares of Series B Stock are listed on Schedule I hereto which is incorporated herein by this reference. 1.2 CLOSING (a) The purchase and sale of the Series B Stock (the "Closing") shall take place at the offices of Williams, Kastner & Gibbs PLLC, Two Union Square Suite 4100 Seattle Washington 98111, after satisfaction of the conditions set forth in Sections 4 and 5 on a date mutually acceptable to the Company and the Investors, but in no event later than November 12, 1999. (b) At the Closing, the Company shall deliver to the Investors certificates representing 1,552,655 shares of Series B Stock against payment to the Company of the purchase price therefor by wire transfer of funds or a bank check payable to the Company's order. The certificates and the purchase price shall be as indicated on Schedule I. 1 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Investors that, except as set forth on a Schedule of Exceptions attached hereto as Exhibit B: 2.1 ORGANIZATION, GOOD STANDING AND QUALIFICATION The Company is a corporation duly organized and validly existing under the laws of the State of Washington and has all requisite corporate power and authority to own and operate its properties and assets, to execute and deliver this Agreement and the Investor Rights Agreement as amended by the First Amendment to Investor Rights Agreement, to issue and sell the Series B Stock and the Common Stock issuable upon conversion thereof (the "CONVERSION SHARES"), to carry out its obligations under this Agreement, the Investor Rights Agreement, and the Articles of Incorporation and to carry on its business as presently conducted and as recently proposed to be conducted. The Company is duly qualified to transact business and is in good standing in each jurisdiction in which the failure to so qualify would have a material adverse effect on its business or properties. 2.2 CAPITALIZATION The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (a), (b) and (c) below. (a) PREFERRED STOCK There are 10,000,000 shares of preferred stock authorized, 4,812,074 of which have been designated as Series A Stock, all of which is outstanding. 1,552,655 of which have been designated as Series B Stock, none of which is outstanding. The rights, privileges, and preferences of the preferred stock generally and of the Series A and Series B Stock are as stated in the Articles of Incorporation, as amended, (b) COMMON STOCK There are 50,000,000 shares of Common Stock authorized, 13,439,500 shares of which arc currently outstanding. Of the authorized but unissued Common Stock, 4,812,074 shares are reserved for issuance upon the conversion of the Series A Stock; 4,210,564 shares are reserved for issuance upon the exercise of stock options granted or to be granted under the Company's stock option plan (the "OPTION PLAN"); 1,439,500 shares are reserved by board action for issuance upon the exercise of warrants granted to certain investors (the "First Round Investors"); 165,775 2 shares are reserved by board action for issuance upon the exercise of warrants granted to Lucent Technologies f/k/a Ascend Communications, Inc. ("Lucent"); and 153,987 shares are reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999. (c) RIGHTS Except for the conversion privileges of the Series A Stock and other rights, privileges and agreements contemplated for the Series B Stock pursuant to this Agreement, and as set forth in subsection 2.2(b), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights), agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock or, to the Company's knowledge, any voting agreements with respect to the Company's securities. 2.3 SUBSIDIARIES The Company does not presently own or control, directly or indirectly, any interest in any other corporation, association, partnership or other business or investment entity. 2.4 AUTHORIZATION All corporate action necessary for the authorization, execution, and delivery by the Company of this Agreement and the other agreements and transactions provided for herein, the performance of all obligations of the Company hereunder and thereunder, and the authorization, issuance, and delivery of the Series B Stock and the Conversion Shares have been taken or will be taken before the Closing. This Agreement and the other agreements provided for herein constitute valid and legally binding obligations of the Company, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect. of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement, and (c) the availability of equitable remedies. 2.5 VALID ISSUANCE OF PREFERRED AND COMMON STOCK (a) The Series B Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein; will be duly and. validly issued, fully paid and nonassessable, and free of any liens or encumbrances created by the Company. The Conversion Shares have been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Articles of Incorporation, as amended, will be duly and validly 3 issued, fully paid and nonassessable, and free of any liens or encumbrances created by the Company. (b) The outstanding shares of Common Stock (i) have been duly authorized and validly issued to the persons listed on the Schedule of Exceptions, (ii) are fully paid and nonassessable, and (iii) were issued in compliance with all applicable state and federal laws concerning the issuance of securities. 2.6 GOVERNMENTAL CONSENTS; COMPLIANCE WITH LAWS No consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any federal, regional, state or local governmental authority on the part of the Company is required in connection with the consummation of the transactions contemplated by this Agreement, except for filings, if any, required pursuant to applicable state securities laws, which filings will be made within the required statutory period, and the filing pursuant to Regulation D of the Securities and Exchange Commission (the "SEC"), which filing will be effected within 15 days of the Closing. The Company is not in violation of any applicable statute, rule, regulation, order or restriction of any domestic or foreign government or any instrumentality or agency thereof in respect of the conduct of its business or the ownership of its properties which violation would materially and adversely affect the business, assets, financial condition, or operations of the Company. 2.7 LITIGATION There is no action, suit, claim, proceeding or investigation pending or, to the Company's knowledge, currently threatened against the Company that questions the validity of this Agreement or the other agreements provided- for herein or the right of the Company to enter into any of such agreements, or to consummate the transactions provided for hereby or thereby, or that could, individually or in the aggregate, have a material adverse effect on the business, assets, financial condition or operations of the Company, or any change in the current equity ownership of the Company, nor is the Company aware that there is any basis for the foregoing. The foregoing includes, without limitation, actions pending or threatened (or any basis therefor known to the Company) involving the prior employment of the Company's employees, their use in connection with the Company's business of any information or techniques allegedly proprietary to any of their. former employers, or their obligations under any agreements with prior employers. There is no action, suit, proceeding or investigation by the Company currently pending or that the Company intends to initiate. The Company is not a party or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality that could have a material adverse' effect on its business, assets, financial condition or operations. 4 2.8 INTELLECTUAL PROPERTY To its knowledge, the conduct of the Company's business does not conflict with or infringe on the patents, trademarks, service marks, trade names, copyrights, trade secrets, proprietary rights and processes (the "INTELLECTUAL PROPERTY") of others. To its knowledge, the Company has sufficient title to or rights to use all Intellectual Property necessary for the conduct of its business.- The ' Company has not granted any options, licenses or agreements of any kind relating to any of its Intellectual Property, nor is the Company bound by or a party to any options, licenses or agreements with respect to the Intellectual Property of any other person or entity. The Company is not aware that any of its employees is obligated under any contract (including licenses, covenants or commitments of any nature) or other agreement, or subject to any judgment, decree or order of any court or administrative agency, that would interfere with their duties to the Company or that would conflict with the Company's business. The execution or delivery of this Agreement, the carrying on of the Company's business by the employees of the Company, and the conduct of the Company's business as proposed, will not, to the Company's knowledge, conflict with or result in a breach of the terms, conditions or provisions of, or constitute a default under, any contract, covenant or instrument under which any employee is now obligated. The Company does not believe it is or will be necessary to use any inventions, trade secrets or proprietary information of any of its employees made prior to their employment by the Company, except for inventions, trade secrets or proprietary information that have been assigned to the Company. 2.9 COMPLIANCE WITH OTHER INSTRUMENTS The Company is not in violation of any provision of its Articles of Incorporation or Bylaws or in violation or default of any provision of any instrument, judgment, order, writ, decree or contract to which it is a party or by which it is bound, or in violation of any provision of federal or state statute, rule or regulation applicable to the Company, which violation or default would have a material adverse effect on its business, assets, financial condition or operations. The execution, delivery, and performance of this Agreement and the consummation of the transactions provided for herein will not result in any such violation or default or require any consent under or be in conflict with or constitute, with or without the passage of time and giving of notice, either a violation or default under any such provision, instrument, judgment, order, writ, decree or contract or an event which results in the creation of any lien, charge or encumbrance upon any assets of the Company which violation, default, lien, charge or encumbrance, individually or in the aggregate with any other such violation, default, lien, charge or encumbrance would have a material adverse effect on its business, assets, financial condition or operations. 5 2.10 AGREEMENTS; ACTION (a) There are no agreements, understandings, instruments, contracts or proposed transactions to which the Company is a party or by which it is bound that involve obligations or payments to the Company in excess of $50,000. (b) The Company has not (i) declared or paid any dividends, or authorized or made any distribution upon or with respect to any class or series of its capital stock, (ii) made any loans or advances to any person, other than in the ordinary course of business, (iii) sold, exchanged or otherwise disposed of any of its assets or rights, other than in the ordinary course of business, (iv) redeemed or obligated itself to redeem any of its capital stock (other than the Series A Stock), or (v) incurred any indebtedness for money borrowed or incurred any other liabilities in excess of $50,000. (c) Except for agreements explicitly contemplated hereby, there are no agreements, understandings or proposed transactions between the Company and any of its officers, directors, affiliates or any affiliate thereof. 2.11 DISCLOSURE The Company has fully provided the Investors and its attorneys and agents with all the information in the Company's possession that they have requested for deciding whether to purchase the Series B Stock. This Agreement, the Exhibits hereto and all other documents delivered by the Company to the Investors or its attorneys or agents in connection herewith or therewith or with the transactions provided for herein or therein, do not contain any untrue statement of a material fact nor omit to state a material fact necessary in order to make the statements contained herein or therein, in fight of the circumstances under which they were made, not misleading. There are no facts which (individually or in the aggregate) materially adversely affect the business, assets, financial condition or operations of the Company that have not been set forth in this Agreement, the Exhibits hereto or other documents delivered to the Investors or its attorneys or agents in connection herewith. 2.12 REGISTRATION RIGHTS Except as provided in the Investor Rights Agreement as amended by the First Amendment to Investor Rights Agreement, the Company has not granted or agreed to grant any registration rights to any person or entity. 6 2.13 CORPORATE DOCUMENTS The Articles of Incorporation are, or at the Closing will be, in the form attached hereto as EXHIBIT A hereto. The Bylaws of the Company are in the form attached hereto as EXHIBIT C. 2.14 TITLE TO PROPERTY AND ASSETS; CONDITION OF ASSETS The Company owns its property and assets free and clear of all mortgages, liens, loans and encumbrances, except liens and encumbrances that arise in the ordinary course of business and do not materially impair the Company's ownership or use of such property or assets. With respect to the property and assets it leases, the Company is in compliance with such leases in all material respects and holds a valid leasehold interest free of any liens, claims or encumbrances. AU facilities and all material machinery, equipment, fixtures, vehicles, and other properties owned, leased or used by the Company are in good operating condition and repair and are reasonably fit and usable for the purposes for which they are being used. 2.15 LICENSES The Company has all governmental licenses and permits (federal, state, foreign, and local) the failure to obtain which would have a material adverse effect on its business, assets, financial condition or operations, and such licenses and permits are in full force and effect. No violations have been communicated to the Company in respect of such licenses or permits and no proceeding is pending or, to the Company's knowledge, threatened toward the revocation of any of such licenses or permits. 2.16 FINANCIAL STATEMENTS The Company has delivered to the Investors its unaudited balance sheet as at June 30, 1999, and unaudited statements of income and cash flows for the six months ended June 3 0, 1999, and its unaudited balance sheet as of December 31, 1998, and unaudited statements of income and cash flows for the year ended December 31, 1998 (collectively, the "FINANCIAL STATEMENTS"). The Financial Statements, together with the notes thereto, are complete and correct in all material respects, have been prepared consistent with methods used in prior years and present fairly the financial condition and position of the Company as of the dates and for the periods indicated. 2.17 UNDISCLOSED LIABILITIES Except as and to the "tent reflected or reserved against in the Financial Statements, the Company did not have, as of the respective dates of the Financial Statements, any material debts, 7 liabilities or obligations of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, including, without limitation, liabilities or obligations on account of taxes or other governmental charges or penalties, interest or fines thereon or in respect thereof required by generally accounting principles to be shown or reflected thereon that were not so shown or reflected. The Company does not know and does not have any reasonable grounds to know of any basis for any assertion against the Company of any material debt, liability or obligation of any nature or in any amount not fully reflected or reserved against in the Financial Statements or disclosed in this Agreement. 2.18 CHANGES Since June 30, 1999, there has not been: (a) Any change in the business, assets, financial condition or operations of the Company, except changes in the ordinary course of business, none of which has been materially adverse, and all of which in the aggregate have not been materially adverse, to the Company; (b) Any damage, destruction or loss (whether or not covered by insurance) materially and adversely affecting the business, assets, financial condition or operations of the Company; (c) Any material increase in the compensation or rate of compensation or commissions payable or to become payable by the Company to any of its directors, officers, salaried employees, sales persons or agents, or any hiring of any employee at a salary in excess of $60,000 per annum, or any payment in excess of $5,000 of any bonus, profit-sharing amount or other extraordinary compensation to any employee, or any material change in any then existing bonus, profit-sharing, retirement or other similar plan, agreement or arrangement, or any adoption of or entry into of any new bonus, profit-sharing, group life or health insurance, or other similar plan, agreement or arrangement; (d) Any material change in the accounting methods or practices followed by the Company; (e) Any material debt, obligation or liability (whether absolute or contingent) incurred by the Company (whether or not presently outstanding) except (i) current liabilities incurred, and obligations under agreements entered into, in the ordinary course of business and (ii) obligations or liabilities entered into or incurred in connection with the execution of this Agreement; 8 (f) Any sale, lease, abandonment or other disposition by the Company of any real property or, other than in the ordinary course of business, of any equipment or other operating properties or any sale, assignment, transfer, license or other disposition by the Company of any Intellectual Property or other intangible asset; (g) Any labor trouble, strike or any other occurrence, event or condition of any similar character that materially and adversely affects or may materially and adversely affect the business, assets, financial condition or prospects of the Company; (h) Any change, except in the ordinary course of business, in the contingent obligations of the Company by way of guaranty, endorsement, indemnity, warranty or otherwise; (i) Any waiver by the Company of a valuable right or a material debt owed to it except in the ordinary course of business; (j) Any direct or indirect loans made by the Company to any shareholder, employee, officer or director of the Company, other than advances made in the ordinary course of business; or (k) Any declaration or payment of any dividend or other distribution of the assets of the Company. 2.19 EMPLOYEE -BENEFIT PLANS The Company does not have any "employee benefit plan" as defined in the Employee Retirement Income Security Act of 1974, as amended. 2.20 TAXES The Company has filed all tax returns (federal, state, foreign, and local) required to be filed by it and all taxes shown to be due and payable on such returns or on any assessments received by the Company and all other taxes (federal, state, foreign, and -local) due and payable by the Company on or before the date hereof have been paid. There are no agreements, waivers or other arrangements providing for an extension of time with respect to the assessment of any tax or deficiency against the Company, nor are there any actions, suits, proceedings, investigations or claims now pending against the Company in respect of any tax or assessment, or, to the Company's knowledge, any matters under discussion within any federal, state, foreign or local authority relating to any. taxes or assessments, or any claims for additional taxes or assessments asserted by any such authority. The provisions made for taxes in the Financial 9 Statements are sufficient for the payment of all unpaid federal, state, foreign, and local taxes of the Company for all periods prior to such date. 2.21 MINUTES The minutes of the Company reflect all meetings of directors and shareholders since the incorporation of the Company and reflect all transactions referred to in such minutes accurately in all material respects. 2.22 BROKERS OR FINDERS The Company has not incurred and will not incur, directly or indirectly, any liability for brokers' or finders' fees, agents' commissions or other similar charges in connection with this Agreement or the transactions contemplated hereby. 2.23 EMPLOYEES The Company has no collective bargaining agreements with any of its employees. There is no labor union organizing activity ending or, to the Company's knowledge, threatened with respect to the Company. No employee has any agreement or contract, written or verbal, regarding his or her employment. To the Company's knowledge, no employee of the Company, nor any consultant with whom the Company has contracted, is in violation of any term of any employment contract, proprietary information agreement, patent. disclosure agreement or any other agreement relating to the right of any such individual to be employed by, or to contract with, the Company because of the nature of the business to be conducted by the Company and, to the Company's knowledge, the continued employment by the Company of its present employees, and the performance of the Company's contracts with its independent contractors, will not result in any such violation. The Company has not received any notice alleging that any such violation has occurred. No employee of the Company has been granted the right to continued employment by the Company or to any material compensation following termination of employment with the Company. The Company is not aware that any officer or key employee, or that any group of key employees, intends to terminate their employment. with the Company, nor does the Company have a present intention to terminate the employment of any officer, key employee or group of key employees. 2.24 ENVIRONMENTAL AND SAFETY LAWS To its knowledge, the Company is not in violation of any applicable statute, law or regulation relating to the environment or occupational health and safety,, and, to its knowledge, 10 no material expenditures are or will be required to comply with any such existing statute, law or regulation. 2.25 OFFERING VALID Assuming the accuracy of the representations and warranties of the Investors contained in Section 3 hereof, the offer, sale, and issuance of the Series B Stock and the Conversion Shares will be exempt- from the registration requirements of the Securities Act of 1933, as amended (the "SECURITIES ACT"), and will have been registered or qualified (or are exempt from registration and qualification) under the registration, permit or qualification requirements of all applicable state securities laws. Neither the Company nor any agent on its behalf has solicited or will solicit any offers to sell or has offered to sell or will offer to sell all or any part of the Series B Stock to any person or persons so as to bring the sale of such Series B Stock by the Company within the registration provisions of the Securities Act. 2.26 REAL PROPERTY HOLDING CORPORATION The Company is not a real property holding corporation within the meaning of Internal Revenue Code Section 897(c)(2) and any regulations promulgated thereunder. 2.27 INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS None of Robert McCausland, Steven Bourg or Gus Bourg has been subject and is not currently subject to any order, judgment or decree, not subsequently revised, suspended or vacated, of any court or any governmental agency that could materially adversely affect the business of the Company as presently conducted or as proposed to be conducted. 3. REPRESENTATIONS AND WARRANTIES OF THE INVESTORS Each Investor hereby represents and warrants that: 3.1 AUTHORIZATION All acts and conditions necessary for the authorization, execution, delivery, and consummation by the Investor of-this Agreement and the other agreements and transactions contemplated herein have been, or will before the Closing be, taken, performed, and obtained. This Agreement and the other agreements contemplated herein constitute valid and legally binding obligations of the Investor, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement and (c) 11 the availability of equitable remedies. The Investor has full power and authority to execute, deliver, and perform its obligations under this Agreement and the other agreements contemplated herein and to own the Series B Stock. The execution, delivery, and performance of this Agreement and the other agreements contemplated herein and the consummation of the transactions contemplated hereby and thereby (including the ownership of Series B Stock) by the Investor does not violate any provision of, or constitute a material breach of or default under, any term, condition or provision of any agreement, indenture or other instrument to which the Investor is a party, or by which it or its properties or assets are bound, or of any order, judgment or decree against or binding upon the Investor. 3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT The Series B Stock to be received by the Investor and the Conversion Shares (collectively, the "SECURITIES") will be acquired for investment for the Investor's own account and not with a view to the distribution of any part thereof as such term is used under Section 2(11) of the Securities Act. The Investor has no present intention of selling, granting any participation in, or otherwise distributing the Securities in a manner contrary to the Securities Act, or applicable state securities laws. 3.3 INVESTMENT EXPERIENCE Each Investor is an investor in securities of companies in the development stage, qualifies as an "accredited investor" as defined in Rule 501 of Regulation D promulgated by the SEC, and acknowledges that the Securities are a speculative risk. Each Investor is able to fend for itself in the transactions contemplated by this Agreement, can bear the economic risk of its investment (including possible complete loss of such investment) for an indefinite period of time, and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities. Each Investor represents it has not been organized for the purpose of acquiring the Securities. Each Investor understands that the Securities have not been registered under the Securities Act, or under the securities laws of any jurisdiction, by reason of reliance upon certain exemptions, and that the reliance of the Company on such exemptions is predicated upon the accuracy of - -each Investor's representations and warranties in this Section 3. 3.4 RESTRICTED SECURITIES Each Investor understands that the Securities are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that under such laws and applicable regulations, such -securities may be transferred or resold without registration under the Securities Act only in 12 certain limited circumstances and in accordance with the terms and conditions set forth in the legend described in Section 3.5. In this connection, the Investor represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Securities Act. 3.5 LEGENDS It is understood that the certificates evidencing the Securities may bear one or all of the following legends: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR APPLICABLE STATE LAW, AND NO INTEREST THEREIN MAY BE SOLD, DISTRIBUTED, ASSIGNED, OFFERED, PLEDGED OR OTHERWISE TRANSFERRED UNLESS (i) THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS COVERING ANY SUCH TRANSACTION INVOLVING SAID SECURITIES OR (ii) SUCH TRANSACTION IS EXEMPT FROM REGISTRATION. AFTER OCTOBER 2001, THIS LEGEND WILL BE CANCELED, AND A CERTIFICATE FREE FROM SUCH LEGEND ISSUED TO THE HOLDER HEREOF UPON COMPLIANCE WITH THE FOLLOWING CONDITIONS: (a) SURRENDER OF THIS CERTIFICATE TO THIS CORPORATION IN THE MANNER AND AT THE PLACE DESIGNATED FOR CANCELLATION, (b) A REPRESENTATION BY THE HOLDER THAT IT HAS BENEFICIALLY HELD THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR NOT LESS THAN TWO YEARS, AND THAT IT IS NOT, AND HAS NOT WITHIN THE PRECEDING 90 DAYS BEEN, AN AFFILIATE (AS THAT TERM IS DEFINED FOR PURPOSES OF RULE 144, UNDER THE ACT OR ANY SUCCESSOR RULE) OF THIS CORPORATION, AND (c) AN UNDERTAKING THAT IF AT ANY TIME THE HOLDER SHALL AGAIN BECOME AN AFFILIATE OR OTHERWISE CEASE TO ENJOY FREE TRANSFERABILITY OF SUCH SECURITIES UNDER RULE 144 EITHER BY REASON OR CHANGE OF CIRCUMSTANCE OR AMENDMENT OF RULE 144, IT SHALL FORTHWITH SURRENDER ANY UNLEGENDED CERTIFICATES(S) RECEIVED BY IT IN RESPECT OF THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR IMPOSITION OF ANY APPROPRIATE LEGEND. THE COMPANY HAS COMMON STOCK AND PREFERRED STOCK AUTHORIZED. THE FULL STATEMENT OF THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF (THE "STATEMENT OF RIGHTS AND PREFERENCES") OF THE SHARES OF EACH SUCH SERIES OR CLASS OF STOCK IS SET FORTH IN THE ARTICLES OF INCORPORATION OF THE 13 COMPANY, AS AT ANY TIME AMENDED, AND ANY EFFECTIVE STATEMENT OF RELATIVE RIGHTS AND PREFERENCES OF PREFERRED STOCK, ON FILE IN THE OFFICE OF THE SECRETARY OF STATE OF THE STATE OF WASHINGTON, THE COMPANY WILL FURNISH COPIES OF THE STATEMENT OF RIGHTS AND PREFERENCES TO THE RECORD HOLDER OF THIS CERTIFICATE WITHOUT CHARGE UPON WRITTEN REQUEST TO THE COMPANY AT ITS PRINCIPAL PLACE OF BUSINESS OR REGISTERED OFFICE. 3.6 RESIDENCY For purposes of the application of state securities laws, each Investor represents that it is a resident of the state indicated on Schedule I hereto. 3.7 ACCESS TO INFORMATION Each Investor has received and reviewed information about the Company, including the Private Placement Memorandum, and has had an opportunity to discuss the Company's business, management, and financial affairs with its management and to review the Company's facilities. Each Investor understands that these discussions, as well as any written information issued by the Company, were intended to describe the aspects of the Company's business and prospects that the Company considers material, but were not necessarily exhaustive. The foregoing, however, does not limit or modify the representations and warranties of the Company in Section 2 of this Agreement or the right of the Investors to rely thereon. 4. CONDITIONS OF INVESTORS' OBLIGATIONS AT THE CLOSING The obligations of the Investors under subsection 1.1(b) are subject to the fulfillment at or before the Closing (unless otherwise specified) of each of the following conditions, unless waived by the Investors: 4.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of the Company contained in Section 2 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the date of the Closing. 14 4.2 PERFORMANCE The Company shall have performed and complied with all agreements, obligations and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 4.3 COMPLIANCE CERTIFICATE The President and Chief Executive Officer of the Company, on behalf of the Company, shall deliver to the Investors at the Closing a certificate that the conditions specified in Sections 4.1 and 4.2 have been fulfilled and stating that there has been no material adverse change in the business, assets, financial condition or operations of the Company from the date of this Agreement to the time of the Closing. 4.4 QUALIFICATIONS The offer and sale of the Securities to the Investors pursuant to this Agreement shall be qualified or exempt from qualification under all applicable federal and state securities laws. 4.5 PROCEEDINGS AND DOCUMENTS All corporate and other proceedings in connection with the transactions contemplated at the Closing and all documents incident thereto, including evidence of filing the Articles of Incorporation with the Secretary of State of the State of Washington, shall be reasonably satisfactory in form and substance to the Investors or their counsel, and the Investors or their counsel shall have received all counterpart original and certified or other copies of such documents as they may reasonably request. 4.6 INVESTOR RIGHTS AGREEMENT The Company, the holders of Series A Stock and the Investors shall have entered into a First Amendment to Investor Rights Agreement in the form attached hereto as EXHIBIT D (the "INVESTOR RIGHTS AGREEMENT"). 4.7 OPINION OF COMPANY COUNSEL The Investors shall have received from Williams Kastner & Gibbs, PLLC, council for the Company, an opinion, dated as of the Closing, in form and substance satisfactory to the Investors, to the effect that: 15 (a) The Company is a corporation, validly existing under the laws of the State of Washington, and the Company has the requisite corporate power and corporate authority to conduct its business as now being conducted. (b) The Company is qualified to do business in any state or jurisdiction of the United States in which the failure to so qualify would have a material adverse effect on its business or properties. (c) The Company has the requisite corporate power and corporate authority to execute, deliver, and perform this Agreement and the Investor Rights Agreement. All corporate action necessary for the authorization, execution and delivery by the Company of this Agreement and the Investor Rights Agreement and the authorization, issuance, and delivery of the Series B Stock being sold hereunder and the Conversion Shares has been taken, and this Agreement and the Investor Rights Agreement have been duly and validly authorized, executed, and delivered BY the Company and constitute valid and legally binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited or affected by applicable laws relating to or affecting the enforcement of creditors' rights and BY equitable principles. (d) The Series B Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued, fully paid, and nonassessable. The Conversion Shares have been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Articles of Incorporation, will be duly and validly issued, fully paid, and nonassessable. (e) The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (i), (ii) and (iii) below: (i) Preferred Stock There are 10,000,000 shares of preferred stock authorized,. 4,812,074 of which have been designated as Series A Stock and all of which is outstanding; 1,552,655 of which have been designated as Series B Stock, none of which is outstanding. The' rights, privileges, and preferences of the preferred stock generally and of the Series B Stock are as stated in the Articles of Incorporation. (ii) Common Stock There are 50,000,000 shares of Common Stock authorized, 13,439,500 shares of which are currently outstanding. Of the authorized but unissued Common Stock, 4,812,074 shares are 16 reserved for issuance upon the conversion of the Series A Stock, 1,552,655 shares are reserved for issuance upon the conversion of the Series B Stock, 4,210,564 shares are reserved for issuance upon the exercise of stock options granted or to be granted under the Option Plan; 1,439,500 shares are reserved by board action for issuance upon the exercise of warrants granted to the First Round Investors; 165,775 shares are reserved by board action for issuance upon the exercise of warrants granted to Lucent; and 153,987 shares are reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999. (iii) Rights Except for the conversion privileges and right of first refusal of the Series A Stock, Series B Stock and other rights, privileges and agreements contemplated pursuant to this Agreement or as enumerated in subparagraph (e)(ii), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights) agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock, or, to such counsel's knowledge, any voting agreements with respect to the Company's securities. (f) The respective rights, privileges, and preferences of the Series B Stock are as stated in the Articles of Incorporation. The certificates representing shares of the Series B Stock are in due and proper form and have been duly and validly executed by the officers of the Company named thereon. (g) Based in part upon the representations of the Investors and on the facts and circumstances contemplated by this Agreement, and except that such counsel need give no opinion as to whether information provided to the Investors was sufficient and assuming that the offer and sale of the Series B Stock is a discrete transaction and not integrated with any other offering or sale of securities by the Company, the offer and sale of the Series B Stock to the Investors pursuant to the terms of this Agreement are exempt from the registration requirements of Section 5 of the Securities Act. 4.8 BOARD OF DIRECTORS Effective upon the Closing, the authorized number of directors shall be up to five, and Bob McCausland and Mark Stevens shall be directors of the Company. 17 5. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING The obligations of the Company to the Investors under this Agreement are subject to the fulfillment on or before the Closing of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of the Investors contained in Section 3 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the Closing. 5.2 PAYMENT OF PURCHASE PRICE The Investors shall have delivered the purchase price specified in subsection 1. 1 (b) to be delivered at the Closing, in the form of a bank check payable to the Company's order or bank wire transfer to the Company's designated account. 5.3 SECURITIES LAWS QUALIFICATION The offer and sale to the Investors of the Securities shall be qualified or exempt from qualification under all applicable federal and state securities laws. 5.4 PERFORMANCE The Investors shall have performed and complied with all agreements, obligations, and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 6. MISCELLANEOUS 6.1 USE OF PROCEEDS The Company s hall use the proceeds of the sale of the Series B Stock under this Agreement as working capital to be used for the development of the Company pursuant to a formal budget prepared by the Company and approved by the Investors. 18 6.2 SURVIVAL OF WARRANTIES The warranties and representations contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the Closing for a period of two years after Closing. 6.3 SUCCESSORS AND ASSIGNS The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. Nothing in this Agreement express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. 6.4 GOVERNING LAW This Agreement shall be governed by and construed under the laws of the State of Washington as applied to agreements among Washington residents entered into and to be performed entirely within the State of Washington. 6.5 COUNTERPARTS 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 6.6 TITLES AND SUBTITLES The titles and subtitles used in this Agreement are for convenience only and are not to be considered in construing or interpreting this Agreement. 6.7 NOTICES Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified (including via facsimile transmission or overnight express delivery) or upon deposit with the United States Post Office, postage prepaid, registered or certified with return receipt requested and addressed to the party to be notified at the address indicated for such party on the signature page hereof, Schedule I or at such other address as such party may designate by ten days' advance written notice to the other parties given in the foregoing manner. 19 6.8 DUE DILIGENCE EXPENSES; ATTORNEYS' AND ACCOUNTANTS' FEES The Company shall reimburse at the Closing the reasonable due diligence costs, including legal and accounting fees and expenses, incurred by the Investors in an amount not to exceed $20,000. If the parties fail to close the transactions contemplated by this Agreement, each party shall be responsible for its own expenses. 6.9 FINDER'S FEES Each party represents that it neither is, nor will be, obligated for a finder's fee or commission in connection with this transaction, except as described in Section 6.1 of the Schedule of Exceptions to this Agreement. Each Investor agrees, severally, but not jointly, to indemnify and hold the Company harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which such Investor or any of its officers, partners, employees or representatives is responsible. The Company agrees to indemnify and hold the Investors harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which the Company or any of its officers, employees or representatives is responsible. 6.10 AMENDMENTS AND WAIVERS After the Closing, any term of this Agreement may be amended and the observance of any term may be waived (either generally or in a particular instance and either retroactively or prospectively) only with the written consent of the Company and the holders of a majority of the aggregate shares of Series B Stock and/or the Conversion Shares (excluding shares of Common Stock that are no longer "restricted securities" under the Securities Act). Any amendment or waiver effected in accordance with this Section 6. 10 shall be binding upon each holder of any securities purchased- under this Agreement at the time outstanding (including securities into which such securities are convertible), each future holder of any such securities, and the Company. 6.11 SEVERABILITY If one or more provisions of this Agreement are held to be unenforceable under applicable law, such. provision shall be excluded from this Agreement, and the' balance of this AGREEMENT SHALL be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 20 6.12 Entire Agreement This Agreement, including the Exhibits attached hereto, and the other documents delivered at the Closing constitute the full and entire understanding and agreement between the parties with respect to the subject matter hereof and supersede all prior agreements with respect to the subject matter hereof The following Exhibits are attached hereto: Exhibit A - Articles of Incorporation Exhibit B - Schedule of Exceptions Exhibit C - Bylaws Exhibit D - Form of Investor Rights Agreement Schedule I 21 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. COMPANY: FREEI NETWORKS, INC. By: /s/ BOB McCAUSLAND ------------------------------------- Bob McCausland President and Chief Executive Officer 909 S. 336th Street, Suite 110 Federal Way, Washington 98003 Fax (253) 661-3431 INVESTOR MP3 com, Inc.: By: /s/ [illegible] ------------------------------------- Its: President ------------------------------------- INVESTOR: AXP VARIABLE PORTFOLIO-STRATEGY AGGRESSIVE FUND By: /s/ [illegible] ------------------------------------- Its: Vice President ------------------------------------- INVESTOR: AXP STRATEGY AGGRESSIVE FUND By: /s/ [illegible] ------------------------------------- Its: Vice President ------------------------------------- INVESTOR: IDS LIFE SERIES FUND, INC. - EQUITY PORTFOLIO By: /s/ [illegible] ------------------------------------- Its: Vice President ------------------------------------- EX-10.9 12 EXHIBIT 10.9 Exhibit 10.9 INVESTOR RIGHTS AGREEMENT This INVESTOR RIGHTS AGREEMENT is made as of August 12, 1999, by and among Freei Networks, Inc., a Washington corporation (the "COMPANY"), Sequoia Capital IX, Sequoia Capital Angel Fund, and Sequoia Capital IX Principals Fund (individually, an "INVESTOR" and collectively, the "INVESTOR"). RECITALS WHEREAS, the Company proposes to sell and issue an aggregate of 4,812,074 shares of its Series A Convertible Preferred Stock (the "SERIES A STOCK") to the Investors pursuant to the Series A Preferred Stock Purchase Agreement (the "PURCHASE AGREEMENT") of even date herewith; WHEREAS, as a condition of entering into the Purchase Agreement, the Investors have requested that the Company extend to them registration rights, information rights, and certain other rights as set forth below, and the Company is willing to grant such rights to the Investors; NOW, THEREFORE, in consideration of the mutual promises, representations, warranties, covenants, and conditions set forth herein and in the Purchase Agreement, the parties mutually agree as follows: 1. DEFINITIONS As used in this Agreement, the following terms shall have the following respective meanings: "ACT" means the Securities Act of 1933, as amended. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "FORM S-3 " means such form under the Act as in effect on the date hereof or any registration form under the Act subsequently adopted by the SEC that permits inclusion or incorporation of substantial information by reference to other documents filed by the Company with the SEC. "HOLDER" means any person owning or having the right to acquire Registrable Securities or any assignee thereof in accordance with Section 2.12 hereof. "INITIAL OFFERING" means the Company's initial firm commitment underwritten public offering of its Common Stock registered under the Act. "REGISTER," "REGISTERED," and "REGISTRATION" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Act, and the declaration or ordering of effectiveness of such registration statement or document. "REGISTRABLE SECURITIES " means (i) the shares of Common Stock issuable or issued upon conversion of the Series A Stock and (d) any shares of Common Stock of the Company issued (or issuable upon the conversion or exercise of any warrant, right or other security which is issued) as a dividend or other distribution with respect to, or in exchange for or in replacement of the shares referenced in (i) above, excluding in all cases, however, any Registrable Securities sold by a person in a private transaction in which the transferor's rights under Section 2 are. not assigned or assignable and any Registrable Securities sold to the public pursuant to a registration statement or Rule 144 promulgated under the Act. "REGISTRABLE SECURITIES THEN OUTSTANDING" means (i) the aggregate number of shares of Common Stock outstanding and (ii) the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities, that are Registrable Securities. "SEC" means the Securities and Exchange Commission. "SHARES" means any shares of, or securities convertible into or exercisable for any shares of, any class of the Company's capital stock. 2. REGISTRATION RIGHTS 2.1 DEMAND REGISTRATION (a) If the Company shall receive at any time or from time to time after the earlier of (1) the effective date of the registration statement pertaining to the Initial 2 Offering or (ii) December 31, 2002, a written request from the Holders of at least fifty percent (50%) of the Registrable Securities then outstanding (the "INITIATING HOLDERS") that the Company file a registration statement under the Act covering the registration of the Registrable Securities then outstanding, then the Company shall, within ten (10) days after receipt thereof, give written notice of such request to all Holders and shall, subject to the limitations set forth in Section 2.1 (b), use its best efforts to effect, as soon as practicable and in any event within sixty (60) days -after the receipt of such request, the registration under the Act of all Registrable Securities that the Holders request to be registered within twenty (20) days of the mailing of such notice by the Company in accordance with Section 6.5, provided that the Registrable Securities requested by the Holders to be registered pursuant to such request must have an anticipated aggregate public offering price of not less than five million dollars ($5,000,000). (b) If the Initiating Holders intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to subsection 2.1 (a) and the Company shall include such information in the written notice referred to in subsection 2.1 (a). The underwriter will be selected by the Company and shall be reasonably acceptable to a majorityin-interest of the Initiating Holders, provided that such underwriter shall be of nationally recognized standing and shall agree to firmly underwrite such offering. In such event, the right of any Holder to include his Registrable Securities in such registration shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority-in-interest of the Initiating Holders and such Holder) to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company as provided in subsection 2.3(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting. Notwithstanding any other provisions of this Section 2.1, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holders shall so advise all Holders of Registrable Securities that would otherwise be underwritten pursuant hereto, and the number of shares of Registrable Securities that may be included in the underwriting shall be allocated among all Holders thereof, including the Initiating Holders, in proportion (as nearly as practicable) to the amount of Registrable Securities of the Company owned by each Holder; provided, however, that the number of shares of Registrable Securities to be included in such underwriting shall not be reduced unless all other securities are first entirely excluded from the underwriting. 3 (c) Notwithstanding the foregoing, if the Company shall furnish to Holders requesting a registration statement pursuant to this Section 2. 1, a certificate signed by the Chief Executive Officer of the Company stating that, in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company and its shareholders for such registration statement to be filed and it is therefore essential to defer the Ming of such registration statement, the Company shall have the right to defer taking action with respect to such filing for a period of not more than ninety (90) days after receipt of the request of the Initiating Holders; provided, however, that the Company may not invoke this right more than once in any twelve (12) month period. (d) The Company shall not be obligated to effect, or to take any action to effect any registration pursuant to Section 2.1: (i) if, within thirty (30) days after receipt of a written request from the Initiating Holders pursuant to Section 2.1 (a), the Company gives notice to the Holders of its intent to undertake its Initial Offering within ninety (90) days of such notice; (ii) during the period commencing on the date of filing of, and ending on the date one hundred eighty (180) days after the effective date of, a registration statement pertaining to a public offering of Shares, provided that the Company is actively employing in good faith all reasonable efforts to cause such registration statement to become effective; or (iii) after the Company has effected two registrations pursuant thereto and such registrations have been declared or ordered effective; 2.2 COMPANY REGISTRATION If (but without any obligation to do so) the Company proposes to register (including for this purpose a registration effected by the Company for shareholders other than the Holders) any of its stock or other securities under the Act In connection with the public offering of such securities solely for cash (other than registrations relating solely to Company stock or option plans or with respect to corporate reorganizations or other transactions under Rule 145 under the Act), the Company shall, at such time, promptly give each Holder written notice of such registration. Upon the written request of each Holder given within twenty (20) days after mailing of such notice by the Company in accordance with Section the Company shall, subject to the provisions of 4 Section 2.7, cause to be registered under the Act all of the Registrable Securities that each such Holder has requested to be registered. 2.3 OBLIGATIONS OF THE COMPANY. Whenever required under this Section 2 to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for a period of up to one hundred eighty (180) days provided, however, that (i) such 180-day period shall be extended for a period of time equal to the period the Holder refrains from selling any securities included in such registration at the request of an underwriter of Common Stock (or other securities) of the Company; and (ii) in the case of any registration of Registrable Securities on Form S-3 which are intended to be offered on a continuous or delayed basis, such 180-day period shall be extended, if necessary, to keep the registration statement effective until all such RegistrableSecurities are sold, provided that Rule 415, or any. successor rule under the Act, permits an offering on a continuous or delayed basis, and provided further that applicable rules under the Act governing the obligation to file a post-effective amendment permit, in lieu of filing a post-effective amendment that (I) includes any prospectus required by Section 10(a)(3) of the Act or (II) reflects facts or events representing a material or fundamental change in the information set forth in the registration statement, the incorporation by reference of information required to be included in (I) and (II) above to be contained in periodic reports filed pursuant to Section 13 or 15(d) of the 1934 Act in the registration statement. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as MAY BE necessary to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement. (C) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Act, and such other documents AS they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them. 5 (d) Use its best efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions, unless the Company is already subject to service in such jurisdiction and except as may be required by the Act. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. Each Holder participating in such underwriting also shall enter into and perform its obligations under such an agreement. (f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (g) Cause all such Registrable Securities registered pursuant hereto to be listed on each securities exchange on which similar securities issued by the Company are then listed. (h) Provide a transfer agent and registrar for all Registrable Securities registered pursuant hereto and a CUSIP number for all such Registrable Securities, in each case not later than the effective date of such registration. (i) Furnish, at the request of any Holder requesting registration of Registrable Securities pursuant to this Section 2, on the date that such Registrable Securities are delivered to the underwriters for We in connection with a registration pursuant to this Section 2, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters, on the Otte that the registration statement with respect to such securities becomes effective, (I) an opinion, dated such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten PUBLIC offering, addressed to the underwriters, if any, and 6 to the Holders requesting registration of Registrable Securities, and (ii) a letter, dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Holders requesting registration of Registrable Securities. 2.4 FURNISH INFORMATION. It shall be a condition precedent to the obligations of the Company to take any action pursuant to this Section 2 with respect to the Registrable Securities of any selling Holder that such Holder shall furnish to the Company such information regarding itself, the Registrable Securities held by it, and the intended method of disposition of such securities, as shall be required to effect the registration of such Holder's Registrable Securities. 2.5 EXPENSES OF DEMAND REGISTRATION. All expenses other than underwriting discounts and commissions incurred in connection with registrations, filings or qualifications pursuant to Section 2.1 (which right may be assigned as provided in Section 2.12), including (without limitation) all registration, filing, qualification, printers' and accounting fees, fees and disbursements of counsel for the Company (including fees and disbursements of counsel for the Company in its capacity as counsel to the selling Holders hereunder; if Company counsel does not make itself available for this purpose, the Company will pay the reasonable fees and disbursements, not to exceed fifteen thousand dollars ($15,000), of one counsel for the selling Holders) shall be borne by the Company; provided, however, that the Company shall not be required to pay for any expenses of any registration proceeding begun pursuant to Section 2.1 if the registration request is subsequently withdrawn at the request of the Holders of a ma ority of the Registrable Securities to be registered (in which case all participating Holders shall bear such expenses), unless the Holders of a majority of the Registrable Securities agree to forfeit their demand registration rights pursuant to Section 2. 1; provided further, however, that if at the time of such withdrawal, the Holders have learned of a material adverse change in the condition, business, or prospects of the Company from that known to the Holders at the time of their request and have withdrawn the request with reasonable promptness following disclosure by the Company of such material adverse change, then the Holders shall not be required to pay any of such expenses and shall retain their rights pursuant to Section 2.1. 7 2.6 EXPENSES OF COMPANY REGISTRATIO . The Company shall bear and pay all expenses incurred in connection with any registration, filing or qualification of Registrable Securities with respect to the registrations pursuant to Section 2.2 for each Holder (which right may be assigned as provided in Section 2.12), including (without limitation) all registration, filing, qualification, printers' and accounting fees, fees and disbursements of counsel for the Company (including fees and disbursements of counsel for the Company in its capacity as counsel to the selling Holders hereunder; if Company counsel does not make itself available for this purpose, the Company will pay the reasonable fees and disbursements, not to exceed fifteen thousand dollars ($15,000), of one counsel for the selling Holders), but excluding underwriting discounts and commissions relating to Registrable Securities. 2.7 UNDERWRITING REQUIREMENTS. (a) In connection with any offering involving an underwriting of Shares, the Company shall not be required under Section 2.2 to include any of the Registrable Securities in such underwriting unless the Holders thereof accept the terms of the underwriting as agreed upon between the Holders of a majority of the Registrable Securities that indicated interest in including,: their Registrable Securities in the underwriting, the Company and the underwriters selected by it (or by other persons entitled to select the underwriters), and then only in such quantity as the underwriters determine, in their sole discretion, will not jeopardize the success of the offering by the Company. (b) If the total number of Shares, including Registrable Securities, requested by shareholders to be included in such offering exceeds the number of Shares to be sold (other than by the Company) that the underwriters determine, in their sole discretion, will be compatible with the success of the offering, then the Company shall be required to include In the offering only that number of Shares, including Registrable Securities, that the underwriters determine in their sole discretion wi 11 not jeopardize the success of the offering. The Shares held by selling shareholders to be included in such offering shall be apportioned pro rata among the selling shareholders according to the total number of Shares entitled to be included therein owned by each selling shareholder or in such other proportions as they shall mutually agree, but in no event shall (i) the number of Registrable Securities included in the offering be reduced below twenty-five percent (25%) of the total number of shares (including shares sold by the company) included in such offering, unless such offering is the initial offering in which case the selling shareholders may be excluded if the underwriters make the determination described above and no other shareholder's securities are included; or (ii) any 8 shares being sold by a shareholder exercising a demand registration right be excluded from such offering, notwithstanding (i) above. (c) In apportioning the Shares in accordance with Section 2.7(b), if a to selling shareholder" is a Holder of Registrable Securities and a partnership or corporation, then the partners, retired partners and shareholders-of such Holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing persons, shall be deemed to be a single "selling shareholder," and any pro-rata reduction with respect to such "selling shareholder" shall be based upon the aggregate number of shares having registration rights owned by all entities and individuals deemed to be such "selling shareholder." 2.8 DELAY OF REGISTRATION. No Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Section 2. 2.9 INDEMNIFICATION. In the event any Registrable Securities are included in a registration statement under this Section. 2: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, any underwriter (as defined in the Act) for such Holder and each person, if any, who controls such Holder or underwriter within the meaning of the Act or the Exchange Act, against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Act, the Exchange Act or other federal or state law, insofar as such losses, claims, damages, or liabilities or actions in respect thereof) arise out of or are based upon any of the following statements I omissions or violations (collectively a "VIOLATION"): (i) any untrue statement or alleged untrue statement of a material fact contained In any registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto; (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements made therein not misleading; or (iii) any violation or alleged violation by the Company of the Act, the Exchange Act, any state securities law, or any rule or regulation promulgated under the act, and the company will pay to each such holder, underwriter or controlling person, as incurred, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; 9 provided; however, that the indemnity agreement contained in this subsection 2.9(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation that occurs in reliance upon and in conformity with-written information furnished expressly for use in connection with such registration by any such Holder, underwriter or controlling person. (b) To the extent permitted by law, each selling Holder will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Act, any underwriter, any other Holder selling securities in such registration statement and any controlling person or any such underwriter or Holder, against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the act, the exchange Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation,; in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such registration; and each such Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this subsection 2.9(b), in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the indemnity agreement contained in this subsection 2.9(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Holder, which consent shall net be unreasonably withheld; provided, however, that in no event shall any indemnity under this subsection 2.9(b) exceed the net proceeds from the offering received by such Holder. (c) Promptly after receipt by an indemnified party under this Section 2.9 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this section 2.9, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the Indemnifying party so desires, jointly with any other indemnifying party similarly notified, to assume the defense thereof with counsel mutually satisfactory to the 10 parties; provided, however, that an indemnified party (together with all other indemnified parties that may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the coun sel retained by the indemnifying party would be inappropriate due to actual or potential conflicts of interest between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this Section 2.9, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 2.9. (d) If the indemnification provided for in this Section 2.9 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense, as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with an underwritten public offering are in conflict with the foregoing provisions, the provisions of the underwriting agreement shall control. (f) The obligations of the Company and Holders under this Section 2.9 shall survive the completion of any offering of Registrable Securities in a registration statement under this Section 2. and otherwise. 11 2.10 EXCHANGE ACT REPORTS. With a view to making available to the Holders the benefits of Rule 144 promulgated under the Act and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, the Company agrees to: (a) make and keep public information available, as those terms are understood and defined in SEC Rule 144, at all times after ninety (90) days after the effective date of the registration statement pertaining to the Initial Offering; (b) take such action, including the voluntary registration of its Common Stock under Section 12 of the Exchange Act, as is necessary to enable the Holders to use Form S-3 for the sale of their Registrable Securities, such action to be taken as soon as practicable after the end of the fiscal year in which the first registration statement filed by the Company for the offering of its securities to the general public is declared effective; (c) file with the SEC in a timely manner all reports and other documents required of the Company under the Act and the Exchange Act; and (d) furnish to any Holder, so long as the Holder owns any Registrable Securities, promptly upon request (i) a written statement by the Company that it has complied with the reporting requirements of SEC Rule 144 (at any time after ninety (90) days after the effective date of the first registration statement filed by the Company), the Act, and the Exchange Act (at any time after it has become subject to such reporting requirements), or that it qualifies as a registrant whose securities may be resold pursuant to Form S-3 (at any time after it so qualifies); (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company; and (iii) such other information as may be reasonably requested in availing any Holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. 2.11 FORM S-3 REGISTRATION. In case the Company shall receive from any Holder or Holders 4 written request or requests that the Company effect a registration on Form S-3 and any related qualification or compliance with respect to all or a part of the registrable securities owned by such Holder or Holders, the company will, 12 (a) promptly give written notice of the proposed registration, and any related qualification or compliance, to all other Holders; and (b) as soon as practicable, effect such registration and all such qualifications and compliances as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Holder's or Holders' Registrable Securities as are specified in -such request, together with all or such portion of the Registrable Securities of any other Holder or Holders joining in such request as are specified in a written request given within fifteen (15) days after receipt of such written notice from the Company;. provided, however, that the Company shall not be obligated to effect any such registration, qualification or compliance, pursuant to this Section 2.1 1 (i) if Form S-3 is not available for offering by the Holders; (ii) if the Holders, together with the holders of any other securities of the Company entitled to inclusion in such registration, propose to sell Registrable Securities and such other securities (if any) at an aggregate price to the public (net of any underwriters' discounts or commissions) of less than five hundred thousand dollars ($500,000); (iii) if the Company shall furnish to the Holders a certificate signed by the President of the Company stating that, in the good faith judgment of the Board of Directors of the Company, it would be seriously detrimental to the Company and its shareholders for such Form S-3 Registration to be effected at such time, in which event the Company shall have the right to defer the filing of the Form S-3 registration statement for a period of not more than ninety (90) days after receipt of the request of the Holder or Holders under this Section 2. 11; provided, however, that the Company shall not invoke this right more than once in any twelve (12) month period; (iv) if the Company has, within the twelve (12) month period preceding the date of such request, already effected one registration on Form S-3 for the Holders pursuant to this Section 2. 11; or (v) In any particular jurisdiction in which the Company would be required to qualify to do business or to execute a general consent to service of process in effecting such registration, qualification or compliance. (c) Subject to the foregoing, the Company shall file a registration statement covering the Registrable Securities and other securities so requested to be registered as soon as practicable after receipt of the request or requests of the Holders. The Company shall bear and pay all expenses incurred in connection with a registration requested pursuant to Section 2.11, including (without limitation) all registration, filing, qualification, printer's and accounting fees, fees and disbursements of counsel for the company (including fees and disbursements of counsel for the company in its capacity as counsel to the selling Holder or Holders hereunder; if Company counsel does not make itself available for this purpose, the 13 Company will pay the reasonable fees and disbursements of one counsel for the selling Holder or Holders), but excluding underwriting discounts and commissions relating to the sale of the Registrable Securities; provided, however, that the Company shall not be obligated to pay registration expenses under this paragraph if the Company has already effected two registrations on Form S-3 pursuant to this Section 2.11. Registrations effected pursuant to this Section 2.11 shall not be counted as registrations effected pursuant to Sections 2.1 or 2.2. 2.12 ASSIGNMENT OF REGISTRATION RIGHTS. The rights to cause the Company to register Registrable Securities pursuant to this Section 2 may be assigned (but only with all related obligations) by a Holder to any partner or retired partner of a Holder that is a partnership, any family member or trust for the benefit of a Holder that is a natural person, or any transferee or assignee who acquires not less than five hundred thousand (500,000) Registrable Securities, provided (a) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (b) such transferee or assignee agrees in writing to be bound by and subject to the terms and conditions of this Agreement, including without limitation the provisions of Section 2.14; and (c) such assignment shall b-. effective only if, immediately following such transfer, the further disposition of such securities by the transferee or assignee is restricted under the Act. 2.13 LIMITATIONS ON SUBSEQUENT REGISTRATION RIGHTS. From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders of not less than two-thirds of Registrable Securities then outstanding, enter into any agreement with any holder or prospective holder of any securities of the Company that would allow such bolder or prospective holder (a) to include such securities in any registration filed under Section 2.1 hereof, unless under the terms of such agreement, such holder or prospective holder may include such securities in any such registration. only to the extent that the inclusion of his securities will not reduce the amount of the registrable securities of the holders that is included therein, (b) to make a demand registration that could result in such registration statement being declared effective prior to the earlier of either of the dates set forth in section 2.1 (a) or within one hundred twenty (120) days of the effective date of any registration effected pursuant to Section 2.1, or (c) to include such holder or prospective holder's securities in any registration by the Company of any of its stock or other securities in connection with the public offering thereof if such inclusion would reduce the number of registrable securities includable therein by the Holders pursuant to Section 2.2 hereof, 14 2.14 "MARKET STAND-OFF" AGREEMENT. Each Holder hereby agrees that, during the period of duration specified by the Company and the managing underwriter of the Initial Offering, it shall not, to the extent requested by the Company and such underwriter, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the Comp any held by it at any time during such period except common stock included in such registration; provided, however, that: (a) such agreement shall be applicable only with respect to the Initial Offering; (b) all officers and directors of the Company, all other persons with registration rights (whether or not pursuant to this Agreement) and all shareholders who hold greater than one percent (1 %) of the Company's outstanding stock enter into similar agreements; (c) such market stand-off time period shall not exceed one hundred eighty (180) days after the effective date of the registration statement pertaining to the Initial Offering; and (d) such agreement shall not apply to any Registrable Securities included in the registration statement pertaining to the Initial Offering. In order to enforce the foregoing covenant, the Company may impose stoptransfer instructions with respect to the Registrable Securities of each Holder (and the shares or securities of every other person subject to the foregoing restriction) until the end of the period. Notwithstanding the foregoing, the obligations described in this Section 2.14 shall not apply to a registration relating solely to employee benefit plans on Form S-1 or Form S-8 or similar forms that may be promulgated in the future, or a registration relating solely to a Commission Rule 145 transaction on Form s-4 or similar forms that may be promulgated in the future. 15 2.15 TERMINATION OF REGISTRATION RIGHTS. (a) No Holder shall be entitled to exercise any right provided for in this Section 2 after five (5) years following the closing of the Initial Offering. (b) In addition, the right of any Holder to request registration or inclusion in any -registration pursuant to Section 2 shall terminate on such date, after the closing of the Initial Offering, that all shares of Registrable Securities held or entitled to be held upon conve rsion by such Holder may immediately be sold under Rule 144 during any 90-day period; provided, however, that the provisions of this Section 2.15(b) shall not apply to any Holder who owns at least one percent (1%) of the Company's outstanding stock. 3. COVENANTS OF THE COMPANY 3.1 DELIVERY OF FINANCIAL STATEMENTS. (a) The Company shall deliver to each Holder who holds any shares of Preferred Stock or the shares issued or issuable upon conversion thereof: (i) as soon as practicable, but in any event within ninety (90) days after the end of each fiscal year of the Company, an income statement for such fiscal year, a balance sheet of the Company and statement of shareholder's equity as of the end of such year, and a statement of cash flows for such year, such year-end financial reports to be prepared in accordance with generally accepted accounting principles ("GAAP"), and audited and certified by independent public accountants of nationally recognized standing selected by the Company's Board of Directors; and (ii) as soon as practicable, but in any event within forty-five (45) days after the end of each of the first three (3) quarters of each fiscal year of the Company, an unaudited profit or loss statement, statement of cash flows for such fiscal quarter and an unaudited balance sheet as of the end of such fiscal quarter, together with an instrument executed by the Chief Financial Officer or President of the Company certifying that such financial reports were prepared in accordance with GAAP consistently applied with prior practice for earlier periods (with the exception of footnotes that may be required by GAAP) 16 and fairly present the financial condition of the Company and its results of operation for the period specified, subject to year-end audit adjustments. (b) The Company shall deliver to each Holder who holds at least one million (1,000,000) Registrable Securities (or Common Stock issued or issuable upon conversion thereof, as adjusted for stock splits, stock, dividends, and the like): (i) as soon as practicable, but in any event thirty (30) days prior to the end of each fiscal year, a budget and business plan for the next fiscal year, prepared on a monthly basis, including balance sheets and statements of cash flows for such months (the "ANNUAL FINANCIAL PLAN") and, as soon as prepared, any other budgets or revised budgets prepared by the Company; (ii) within twenty (20) days of the end of each month, an unaudited income statement and statement of cash flows and balance sheet for and as of the end of such month, in reasonable detail, and comparing the results to the Annual Financial Plan and to the prior year comparable period, together with an instrument executed by the Chief Financial Officer or president of the company certifying that such financial reports were prepared in accordance with GAAP consistently applied with prior practice for earlier periods (with the exception of footnotes that may be required by gaap) and fairly present the financial condition of the company and its results of operation for the period specified, subject to yearend audit adjustments; and (iii) such other information relating to the financial condition, business, prospects or corporate affairs of the company as any of such holders or any assignee of any of such holders may from time to time request; provided, however, that the company shall not be obligated under this subsection (b)(iii) or any other subsection of section 3.1 to provide information that it deems in good faith to be a trade secret or similar confidential information unless the holder or holders provide assurances in writing to the company that it will maintain the confidentiality of the information. 3.2 INSPECTION. the company shall permit each holder, at such holder's expense, to visit and inspect the company's properties, to examine its books of account and records, and to discuss the company's affairs, finances and accounts with its officers, all at such reasonable times as may be requested by such holder; provided, however, that the Company shall not be obligated pursuant to this section 3.2 to provide access to any 17 information that it reasonably considers to be a trade secret or similar confidential information unless such Holder provides assurances in writing to the Company that it will maintain the confidentiality of the information. 3.3 DIRECTORS' EXPENSES. The Company shall pay all reasonable out-of-pocket expenses incurred by members of the Company's Board of Directors when such members are acting on behalf of the Company, including attending meetings of the Board of Directors. 3.4 LIFE INSURANCE. The Company shall use its best efforts to obtain and maintain from an insurer satisfactory to the Investors a key man life insurance policy, the proceeds of which are payable to the Company, in the amount of $1,500.000, on the life of Bob McCausland. 3.5 CERTAIN OPERATING COVENANTS. Without the consent of the Holders of a majority of the Registrable Securities, the Company shall not: (a) invest in, acquire an equity interest in, or otherwise acquire, any other business entity; (b) make any loan or guarantee (excluding accounts receivable) in excess of $10,000 per transaction; (c) make any material change within two years of the date of this Agreement in the nature of the business as now conducted or as contemplated by the Company's current business plan; (d) engage in any material transaction not in the ordinary course of the Company's business; or (e) engage in any transaction of a business nature with any member of management of the Company, other than the payment of compensation, including, but not limited to, base salaries, cash bonuses, and employee stock option grants, in the ordinary course of business as approved by the board of directors. the company shall not, without the unanimous approval of all members of its board of directors, increase the number of shares reserved for issuance pursuant to the company's stock option plans to more than 4,210,564 shares of the company's common stock. 18 3.6 EMPLOYMENT AGREEMENTS. The Company shall enter into employment agreements with Bob McCausland, Gus Bourg and Steve Bourg (the "FOUNDERS") within ten (10) business days of the date hereof. The employment agreements will provide that 3,000,000 shares of the 12,000,000 shares owned by the Founders will have vested upon the date hereof, and that the remaining 9,000,000 shares will vest in equal monthly increments for a 36 month period beginning on the date hereof. Any unvested shares owned by the Founders shall vest in full upon the completion of the Company's initial public offering, the sale or merger of the Company or the termination of the Founder's employment by the Company. The employment agreements will provide that the Company will have a right to repurchase vested shares upon a termination of employment for the fair market value of the shares at the time of termination. 3.7 CONFIDENTIALITY AND EMPLOYEE INVENTIONS AGREEMENT. The Company shall cause each of its officers, employees, consultants, and independent contractors to enter into a confidentiality and employee inventions agreement with the Company (which agreement shall be in a form acceptable to the investor) that restricts the disclosure, of the company's proprietary information to third parties and provides for assignment to the Company of all inventions and intellectual property created and developed by such employees, consultants, and contractors in the course of their employment or engagement, as the case may be, by the Company. 3.8 ASSIGNMENT OF COMPANY RIGHTS. In the event the Company elects not to exercise any right of first refusal or right of first offer that the Company may have on a proposed transfer of any of the Company's outstanding capital stock pursuant to the Company's charter documents, by contract or otherwise, the Company shall, to the extent it may do so, assign such right of first refusal or right of first offer to the Investor. In the event of such assignment, the Investors shall have a right to purchase the capital stock proposed to be transferred. 3.9 STOCK VESTING. Unless otherwise approved unanimously by the Board of Directors, all shares of the Company's capital stock, stock options, and other stock equivalents Issued after the date of this Agreement to employees, directors, consultants and other service providers shall be subject to vesting as follows: (a) twenty-five percent (25 %) of such stock, options, or equivalents shall vest at the end of the first year following the earlier of the date of issuance or the date of commencement of such person's services to the Company, and (b) seventy-five percent (75 %) of such stock, options, or equivalents shall vest quarterly over the remaining three (3) years thereafter. with respect to any stock, options, or equivalents issued to any such person, the Company's repurchase option shall provide that, upon such person's termination of employment or service with the company, prior to the company's initial Offering with or without cause, the company or its assignee (to the extent permissible under 19 applicable securities laws and other laws) shall have the option to purchase, at fair market value, such stock, options, or equivalents, less the exercise price of any vested options held by such person. 3. 10 TERMINATION OF COVENANTS. The covenants set forth in this Section 3 shall, except as otherwise specifically provided, terminate and be of no further force or effect upon the earlier of. (a) the effective date of the Registration Statement pertaining to the Initial Offering; (b) the closing date of (i) a sale, lease or other disposition of all or substantially all of the Company's assets, or (ii) an acquisition of the Company by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Company's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity surviving such transaction; or (c) when the Company first becomes subject to the periodic reporting requirements of Section 15(d) of the Securities Exchange Act of 1934, as amended; 4. RIGHT OF FIRST REFUSAL 4.1 FUTURE SALES OF SHARES. Subject to the terms and conditions specified in this Section 4, the Company hereby grants to each Holder who holds at least one million (1,000,000) Registrable Securities a right of first refusal with respect to future sales by the Company of its Shares. For purposes of this, Section 4, a "Holder" includes any general partners, affiliates, immediate family members (or a trust for the benefit therefor) to whom Registrable Securities were gifted or transferred, and any trust for the benefit of a Holder (collectively, "ALL RELATED PARTIES"). Each Holder shall be entitled to apportion the right of first offer hereby granted it among itself and all related parties in such proportions as it deems appropriate. 4.2 EXERCISE OF RIGHT. Each time the Company proposes to offer any Shares, the Company shall first make an offer of such shares to each holder as follows: 20 (a) The Company shall deliver a notice ("NOTICE") to each Holder stating (i) the Company's bona fide intention to offer such Shares, (ii) the number of such Shares to be offered, and (iii) the price and other terms upon which it proposes to offer such Shares. (b) By written notification received by the Company, within seven (7) days after receiving the Notice, a Holder may elect to purchase or obtain, at the price and on the terms specified in the Notice, up to that portion of such Shares that equals the proportion that the number of shares of Common Stock issued and held, or issuable upon conversion of the Series A Stock then held, by such Holder bears to the total number of shares of Common Stock outstanding, or issuable upon conversion of outstanding Series A Preferred Stock. 4.3 SALE TO THIRD PARTIES. If all Shares that the Holders are entitled to purchase or obtain pursuant to Section 4.2(b) are not elected to be purchased or obtained, the Company may, during the sixty (60) day period following the expiration of the period provided in Section 4.2(b), offer the remaining subscribed portion of such Shares to any person or persons at a price not less than that, and upon terms no more materially favorable to the offeree than those, specified in the Notice, If the Company does not enter into an agreement for the sale of the Shares within such period, or if such agreement is not consummated within fifteen (15) days of the execution thereof, the right provided hereunder shall be deemed to be revived and such Shares shall not be offered unless first reoffered to the Holders in accordance herewith. 4.4 EXCLUDED SHARES, The right of first refusal in this Section 4 shall not be applicable to (a) up to an aggregate of 3,890,802 shares of Common Stock issuable or issued to directors, employees or consultants of or advisors to the Company, pursuant to stock purchase or stock option plans or any other arrangements approved by the Board of Directors; (b) up to 153,987 shares of Common Stock issuable upon the exercise of a warrant held by Pacific Crest Securities Inc.; (c) up to 165,775 shares of Common Stock issuable upon the exercise of a warrant held by Ascend Communications Inc.; (d) up to an aggregate of 1,439,500 shares issuable upon the exercise of certain warrants issued to prior investors; and (e) shares of Common Stock issued or issuable to leasing companies, investment bankers, landlord, lenders, and other vendors of goods and services to the Company; or (f) shares of Common Stock issued or Issuable to any Holder. 4.5 ASSIGNMENT OF RIGHTS. The rights of first refusal set forth in this Section 4 may be assigned or transferred to the same parties, subject to the same restrictions, as any transfer or assignment of registration rights as set forth in Section 2.12, 4.6 TERMINATION OF RIGHTS. The rights of first refusal set forth in this Section 4 shall terminate upon the earlier of (a) The effective date of the registration statement 21 pertaining to a public offering of shares of Common Stock that results in the Series A Stock being converted to Common Stock; (b) a sale, lease or other disposition of all or substantially all of the Company's assets; or (c) an acquisition of the Company by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Company's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity surviving such transaction. 5. RIGHT OF CO-SALE 5.1 RIGHT OF CO-SALE Subject to the terms and conditions specified in this Section 5, each of Bob McCausland, Steve Bourg, and Gus Bourg (individually, a "FOUNDER" and collectively, the "FOUNDERS") grants the Holders the right to participate in any sale, assignment, gift, bequest, pledge or other transfer ("TRANSFER") of any Shares owned by the Founder on the same terms and conditions on which they, or any one of them, proposes to Transfer their Shares. To the extent that the Holders exercise their right of co-sale as set forth below, the number of shares that the Founders, or any one of them, may Transfer in a proposed the transaction shall be correspondingly reduced. 5.2 EXERCISE OF RIGHT. Each time a Founder proposes to Transfer any Shares, he shall first notify the Investors as follows: (a) The selling Founder shall deliver a notice ("PARTICIPATION NOTICE") to the Holders stating (i) the Founder's bona fide intention to Transfer his Shares, (ii) the number of such Shares to be Transferred, and (iii) the price and other terms upon which he proposes to Transfer his Shares. (b) By written notification received by the selling Founder within thirty (30) days after receiving the Participation Notice, the Holders may elect to Transfer, at the price and on the terms specified in the Participation Notice, up to that portion of such Shares that equals the proportion that the number of shares of common stock issued and held, or issuable upon conversion of the series a stock then held, by such holder bears to the total number of shares of common stock outstanding, or issuable upon conversion of outstanding Series A Preferred Stock. (c) Each Holder shall effect its participation in the transfer by promptly delivering to the selling founder, for transfer to the prospective purchaser, one or more cerfificates, properly endorsed for transfer, which represent (i) the type and number of Shares that the Holder elects to transfer; or (ii) that number of Shares of Series A Stock that is at such time convertible into the number of Shares of Common Stock that such Holder elects to sell; provided, however, that if the prospective purchaser objects to the delivery of Series A 22 stock in lieu of Common Stock, such Holder shall convert such Series A Stock into Common Stock and deliver Common Stock to the prospective purchaser. The Company agrees to make any such conversion concurrent with the actual transfer of such shares to the purchaser. 5.3 OBLIGATION TO EFFECT TRANSFER. The stock certificate or certificates that the Holders deliver to the selling Founder pursuant to paragraph 5.2(c) shall be transferred to the prospective purchaser upon consummation of the Transfer of the Shares pursuant to the terms and conditions specified in the Participation Notice, and the Founder shall concurrently therewith remit to each participating Holder that portion of the Transfer proceeds to which such Holder is entitled by reason of its participation in such Transfer. 5.4 TERMINATION OF RIGHTS. The rights of co-sale set forth in this Section 5 shall terminate upon die earlier of (a) the effective date of the registration statement pertaining to a public offering of shares of Common Stock that results in the Series A Stock being converted to Common Stock; (b) a sale, lease or other disposition of all or substantially all of the Company's assets; or (c) an acquisition of the Company by another entity by stock purchase, consolidation, merger or other reorganization in which the holders of the Company's outstanding voting stock immediately prior to such transaction own, immediately after such transaction, securities representing less than fifty percent (50%) of the voting power of the entity surviving such transaction. 6. MISCELLANEOUS 6.1 SUCCESSORS AND-ASSIGNS. Except as otherwise provided herein, the terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties, including permitted transferees of any Registrable Securities. Nothing in this Agreement, express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. 6.2 GOVERNING LAW. This Agreement shall be governed by and construed under the laws of the State of Washington as applied to agreements among Washington residents entered into and to be performed entirely within Washington. 6.3 COUNTERPARTS. 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. 23 6.4 TITLES AND SUBTITLES. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 6.5 NOTICES. Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with the United States Post Office, by registered or certified mail, postage prepaid or upon delivery to a recognized courier service and addressed to the party to be notified at the address indicated for such party on the signature page hereof, or at such other address as such party may designate by ten (10) days' advance written notice to the other parties. 6.6 EXPENSES. If any action at law or in equity is necessary to enforce or interpret the terms of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees, costs and necessary disbursements in addition to any other relief to which such party may be entitled. 6.7 AMENDMENTS AND WAIVER . Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and the Holders of more than fifty percent (50%) of the Registrable Securities. Any amendment or waiver effected in accordance with this paragraph shall be binding upon each Holder of any Registrable Securities, or shares of Series A Stock, then outstanding and the Company. 6.8 SEVERABILITY. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 6.9 AGGREGATION OF STOCK. All shares of Registrable Securities or Series A Preferred Stock held or acquired by an Investor and All Related Parties of such Investor shall be aggregated together for the purpose of determining the availability of any rights under this Agreement. 6.10 ENTIRE AGREEMENT. This Agreement and the Purchase Agreement constitute the full and entire understanding and agreement between the parties with regard to the subject matter hereof and thereof. 24 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. THE COMPANY: FREEI NETWORKS, INC. By: /s/ Bob McCausland ------------------------------ Printed Name: Bob McCausland Title: President INVESTORS: SEQUOIA CAPITAL IX SEQUOIA CAPITAL ANGEL FUND SEQUOIA CAPITAL IX PRINCIPALS FUND By: SC IX Management, LLC A California Limited Liability Company Its General Partner Illegible ------------------------------ Title: Managing Member IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. THE COMPANY: FREEI NETWORKS, INC. By: ------------------------- Printed Name: Bob McCausland Title: President INVESTORS: SEQUOIA CAPITAL IX SEQUOIA CAPITAL ANGEL FUND SEQUOIA CAPITAL IX PRINCIPALS FUND By: SC IX Management, LLC A California Limited Liability Company Its General Partner By: Illegible ------------------------- Title: Managing Member FOUNDER: BOB McCAUSLAND /s/ Bob McCausland ----------------------------- FOUNDER: STEVE BOURG /s/ Steve Bourg ---------------------------- FOUNDER GUS BOURG /s/ Gus Bourg ---------------------------- EX-10.9(A) 13 EXHIBIT 10.9(A) Exhibit 10.9(a) FIRST AMENDMENT TO INVESTOR RIGHTS AGREEMENT This FIRST AMENDMENT TO INVESTOR RIGHTS AGREEMENT (this "First Amendment") is made as of November 12 1999, by and among FREEI NETWORKS INC., a Washington corporation (the "COMPANY"), SEQUOIA CAPITAL IX, SEQUOIA CAPITAL ANGEL FUND, SEQUOIA CAPITAL IX PRINCIPALS FUND (individually and collectively, the "Series A Investors"), MP3.COM ("MP3"), AXP VARIABLE PORTFOLIO-STRATEGY AGGRESSIVE FUND ("AXPVP"), AXP STRATEGY AGGRESSIVE FUND ("AXPSAF"), IDS LIFE SERIES FUND, INC.-EQUITY PORTFOLIO ("IDS"), with respect to that certain Investor Rights Agreement dated August 12, 1999 between the Company and the Series A Investors (the "INVESTOR'S RIGHTS AGREEMENT"), a true and correct copy of which is attached hereto as Exhibit A and incorporated herein by this reference. RECITALS WHEREAS, the Company entered into a purchase and sale agreement with the Series A Investors for the sale of an aggregate of 4,812,074 shares of its Series A Convertible Preferred Stock (the "Series A Stock") pursuant to a Series A Preferred Stock Purchase Agreement dated as of August 12, 1999 (the "SERIES A PURCHASE AGREEMENT"), and WHEREAS, as a condition of entering into the Series A Preferred Stock Purchase Agreement, the Series A Investors were extended certain registration, information, and other rights as set forth in the Investor Rights Agreement, and WHEREAS, the Company proposes to sell and issue 1,552,655 shares of its Series B Convertible Preferred Stock (the "SERIES B STOCK") to MP3, AXPVP, AXPSAF and IDS (each individually a "SERIES B INVESTOR" and collectively, the "SERIES B INVESTORS") pursuant to the Series B Preferred Stock Purchase Agreement the "SERIES B PURCHASE AGREEMENT") of even date herewith; WHEREAS, as a condition of entering into the Series B Preferred Stock Purchase Agreement, the Series B Investors have requested that the Company extend to them registration rights, information rights, and certain other rights as set forth below, and the Company is willing to grant such rights to the Series B Investors on terms substantially similar as those already granted to the Series A Investors pursuant to the Investor Rights Agreements; NOW, THEREFORE, in consideration of the mutual promises, representations, warranties, covenants, and conditions set forth herein and in the Series B Purchase Agreement, the parties hereto mutually agree to amend the Investor Rights Agreement, for the benefit of the Series B Investors, to provide as follows: 1 1. DEFINITIONS A. The definition of "Registrable Securities" set forth in the Investor Rights Agreement is hereby deleted in its entirety and replaced with the following definition: "REGISTRABLE SECURITIES" means (i) the shares of Common Stock issuable or issued upon conversion of the Series A Stock or Series B Stock and (ii) any shares of Common Stock of the Company issued (or issuable upon the conversion or exercise of any warrant, right or other security which is issued) as a dividend or other distribution with respect to, or in exchange for or in replacement of the shares referenced in (i) above, excluding in all cases, however, any Registrable Securities sold by a person in a private transaction in which the transferor's rights under Section 2 are not assigned or assignable and any Registrable Securities sold to the public pursuant to a registration statement or Rule 144 promulgated under the Act B. The definition of "INVESTOR" and "INVESTORS" as set forth in the Preamble to the Investor Rights Agreement is hereby amended by adding the Series B Investors such that each of the Series A Investors and Series B Investors shall individually be considered an "Investor," and collectively they shall be considered "Investors." C. Unless the context requires otherwise, the term "PREFERRED STOCK" shall mean both Series A Stock and Series B Stock. D. Each reference to "Series A Preferred Stock" or "Series A Stock" in Sections 4.2(b), 4.6, 5.2(b), 5.2(c), 5.4 and 6.7 shall be deleted and replaced with "Preferred Stock." 2. REGISTRATION RIGHTS Section 2.1(a) is hereby deleted and replaced with the following: 2.1 DEMAND REGISTRATION (a) If the Company shall receive at any time or from time to time after the earlier of (i) the effective date of the registration statement pertaining to the Initial Offering or (ii) December 31, 2002 a written request from the Holders of at least twenty five percent (25%) of the Registrable Securities then outstanding (the "INITIATING HOLDERS") that the Company file a registration statement under the Act covering the registration of the Registrable Securities then outstanding, then the Company shall, within ten (10) days after the receipt thereof, give written notice of such request to all Holders and shall, subject to the limitations set forth in Section 2.1(b), use its best efforts to effect, as soon as practicable and in any event within sixty (60) days after the receipt of such request, the registration under the Act of all Registrable Securities that Holders request to be registered within twenty days (20) of the delivery of such notice by the Company in accordance with Section 6.5, provided that the Registrable Securities requested by the Holders to be registered pursuant to such request must have an anticipated aggregate public offering price of not less than five million dollars' ($5,000,000). 2 3. COVENANTS OF THE COMPANY Section 3.1(b) is hereby deleted and replaced with the following: 3.1 DELIVERY OF FINANCIAL STATEMENTS. (b) The Company shall deliver to each Holder who holds at least five hundred thousand (500,000) Registrable Securities (or Common Stock issued or issuable upon conversion thereof, as adjusted for stock splits, stock dividends, and the like):....[remainder of section unchanged]. 4. RIGHT OF FIRST REFUSAL The first sentence of Section 4.1 is hereby deleted and replaced with the following: 4.1 FUTURE SALES OF SHARES. Subject to the terms and conditions specified in Section 4 of the Investor Rights Agreement, the Company hereby grants to each Holder who holds at least five hundred thousand (500,000) Registrable Securities a right of first refusal with respect to future sales by the Company of its Shares. The remainder of Section 4.1 is unchanged 6. MISCELLANEOUS THE FOLLOWING SECTIONS ARE ADDED 6.11 RATIFICATION. Except as expressly set forth in this First Amendment, the terms of the Investor Rights Agreement shall remain in full force and effect, binding on all the parties to this First Amendment as if each party hereto were an original signatory of the Investor Rights Agreement. In the event of a conflict between the terms of this First Amendment and the terms of the Investor Rights Agreement, the terms of this First Amendment shall control. 6.12 CONSENT TO STATEMENT OF RIGHTS AND PREFERENCES OF SERIES B STOCK. The holders of Series A Stock unanimously consent to the filing of the Statement of Rights and Preferences of Series B Stock (the "Series B Statement") as part of the Company's Articles of Incorporation. The holders of the Series A Stock acknowledge that the filing of the Series B Statement will materially after the rights and preferences of the Series A Stock but agree that the purchase price paid to the Company by the holders of Series B Stock constitutes fair consideration for such alteration of tights and preferences. 3 IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first above written. THE COMPANY: FREEI NETWORKS, INC. By: ROBERT MCCAUSLAND ---------------------------- Printed Name: Robert McCausland Title: President 4 INVESTOR SEQUOIA CAPITAL IX SEQUOIA CAPITAL ANGEL FUND SEQUOIA CAPITAL IX PRINCIPALS FUND BY: SC IX Management, LLC A California. Limited Liability Company Its General Partner By:/s/ Mark Stevens ---------------------------------- Its: Managing Member 5 INVESTOR: MP3.COM By: /s/ Robert Richards ------------------- Printed Name: Robert Richards --------------- Title: President 6 INVESTOR: AXP VARIABLE PORTFOLIO-STRATEGY AGGRESSIVE FUND By: FREDERICK C. QUIRSTFELD ----------------------------------- Printed Name: FREDERICK C. QUIRSTFELD ------------------------- Title: VICE PRESIDENT --------------------------------- INVESTOR: AXP STRATEGY AGGRESSIVE FUND By: FREDERICK C. QUIRSTFELD ----------------------------------- Printed Name: FREDERICK C. QUIRSTFELD ------------------------- Title: VICE PRESIDENT --------------------------------- INVESTOR: IDS LIFE SERIES FUND, INC.- EQUITY PORTFOLIO By: FREDERICK C. QUIRSTFELD ----------------------------------- Printed Name: FREDERICK C. QUIRSTFELD ------------------------- Title: VICE PRESIDENT --------------------------------- 7 FOUNDER: ROBERT MCCAUSLAND ROBERT MCCAUSLAND ------------------- FOUNDER: STEVE BOURG STEVE BOURG ------------------- FOUNDER: GUS BOURG GUS BOURG ------------------- 8 EX-10.10 14 EXHIBIT 10.10 Exhibit 10.10 SERIES C PREFERRED STOCK PURCHASE AGREEMENT This SERIES C PREFERRED STOCK PURCHASE AGREEMENT (this "AGREEMENT") is made as of March 7, 2000, by and between FREEI NETWORKS, INC., a Washington corporation (the "COMPANY"), and the Investors listed on SCHEDULE I hereto (the "Investors"). THE PARTIES HEREBY AGREE AS FOLLOWS: 1. PURCHASE AND SALE OF STOCK 1.1 SALE AND ISSUANCE OF SERIES C STOCK (a) The Company has adopted and filed with the Secretary of State of the State of Washington the Certificate of Designation with the designation of the Series C Convertible Preferred Stock (the "SERIES C STOCK") in the form attached hereto as EXHIBIT A (the "CERTIFICATE OF DESIGNATION"). (b) Subject to the terms and conditions of this Agreement, each Investor agrees severally to purchase, the number of shares listed on Schedule I, and the Company agrees to sell and issue to each Investor, at the Closing (as defined in Section 1.2(a)) a total of 2,545,430 shares of Series C Stock at $19.643052 per share, for a total purchase price of $50,000,000.00. Each Investor's purchase price and number of acquired shares of Series C Stock are listed on Schedule I hereto which is incorporated herein by this reference. 1.2 CLOSING (a) The purchase and sale of the Series C Stock (the "Closing") shall take place at the offices of Summit Law Group, PLLC, 1505 Westlake Avenue N., Suite 300, Seattle Washington 98109, after satisfaction of the conditions set forth in Sections 4 and 5 on a date mutually acceptable to the Company and the Investors, but in no event later than March 10, 2000. (b) At the Closing, the Company shall deliver to the Investors certificates representing 2,545,430 shares of Series C Stock against payment to the Company of the purchase price therefor by wire transfer of funds or a bank check payable to the Company's order. The certificates and the purchase price shall be as indicated on Schedule I. 1 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Investors that, except as set forth on a Schedule of Exceptions attached hereto as EXHIBIT B: 2.1 ORGANIZATION, GOOD STANDING AND QUALIFICATION The Company is a corporation duly organized and validly existing under the laws of the State of Washington and has all requisite corporate power and authority to own and operate its properties and assets, to execute and deliver this Agreement and the Investor Rights Agreement as amended by the First and Second Amendments to Investor Rights Agreement, to issue and sell the Series C Stock and the Common Stock issuable upon conversion thereof (the "CONVERSION SHARES"), to carry out its obligations under this Agreement, the Investor Rights Agreement, the Articles of Incorporation and the Certificate of Designation and to carry on its business as presently conducted and as recently proposed to be conducted. The Company is duly qualified to transact business and is in good standing in each jurisdiction in which the failure to so qualify would have a material adverse effect on its business or properties. 2.2 CAPITALIZATION The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (a), (b) and (c) below. (a) PREFERRED STOCK There are 10,000,000 shares of preferred stock authorized, 4,812,074 of which have been designated as Series A Stock, all of which is outstanding, 1,552,655 of which have been designated as Series B Stock, all of which is outstanding and 2,545,430 of which have been designated as Series C Stock, none of which is outstanding. The rights, privileges, and preferences of the preferred stock generally and of the Series A, Series B and Series C Stock are as stated in the Company's Articles of Incorporation, as amended, and the Certificate of Designation. (b) COMMON STOCK As of Closing, there will be 200,000,000 shares of Common Stock authorized, 26,879,000 shares of which are currently outstanding. Of the authorized but unissued Common Stock, 9,624,148 shares are reserved for issuance upon the conversion of the Series A Stock, 3,105,310 are reserved for issuance upon the conversion of the Series B Stock and 2,545,430 will be reserved for issuance upon conversion of the Series C Stock; 2,879,000 shares are reserved by 2 board action for issuance upon the exercise of warrants granted to certain investors (the "First Round Investors"); and 8,421,128 shares are reserved for issuance upon the exercise of stock options granted or to be granted under the Company's stock option plan (the "OPTION PLAN"); provided, however, that this number includes 331,550 shares that have reserved by board action for issuance upon the exercise of warrants granted to Lucent Technologies f/k/a Ascend Communications, Inc. ("Lucent"); and 307,974 shares that have been reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999. (c) RIGHTS Except for the conversion privileges of the Series A Stock and Series B Stock and other rights, privileges and agreements contemplated for the Series C Stock pursuant to this Agreement, and as set forth in subsection 2.2(b), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights), agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock or, to the Company's knowledge, any voting agreements with respect to the Company's securities. 2.3 SUBSIDIARIES The Company does not presently own or control, directly or indirectly, any interest in any other corporation, association, partnership or other business or investment entity. 2.4 AUTHORIZATION All corporate action necessary for the authorization, execution, and delivery by the Company of this Agreement and the other agreements and transactions provided for herein, the performance of all obligations of the Company hereunder and thereunder, and the authorization, issuance, and delivery of the Series C Stock and the Conversion Shares have been taken or will be taken before the Closing. This Agreement and the other agreements provided for herein constitute valid and legally binding obligations of the Company, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement, and (c) the availability of equitable remedies. 2.5 VALID ISSUANCE OF PREFERRED AND COMMON STOCK (a) The Series C Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued, fully 3 paid and nonassessable, and free of any liens or encumbrances created by the Company. The Conversion Shares have been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Articles of Incorporation, as amended, and the Certificate of Designation, will be duly and validly issued, fully paid and nonassessable, and free of any liens or encumbrances created by the Company. (b) The outstanding shares of Common Stock (i) have been duly authorized and validly issued to the persons listed on the Schedule of Exceptions, (ii) are fully paid and nonassessable, and (iii) were issued in compliance with all applicable state and federal laws concerning the issuance of securities. 2.6 GOVERNMENTAL CONSENTS; COMPLIANCE WITH LAWS No consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any federal, regional, state or local governmental authority on the part of the Company is required in connection with the consummation of the transactions contemplated by this Agreement, except for filings, if any, required pursuant to applicable state securities laws, which filings will be made within the required statutory period, and the filing pursuant to Regulation D of the Securities and Exchange Commission (the "SEC"), which filing will be effected within 15 days of the Closing. The Company is not in violation of any applicable statute, rule, regulation, order or restriction of any domestic or foreign government or any instrumentality or agency thereof in respect of the conduct of its business or the ownership of its properties which violation would materially and adversely affect the business, assets, financial condition, or operations of the Company. 2.7 LITIGATION There is no action, suit, claim, proceeding or investigation pending or, to the Company's knowledge, currently threatened against the Company that questions the validity of this Agreement or the other agreements provided for herein or the right of the Company to enter into any of such agreements, or to consummate the transactions provided for hereby or thereby, or that could, individually or in the aggregate, have a material adverse effect on the business, assets, financial condition or operations of the Company, or any change in the current equity ownership of the Company, nor is the Company aware that there is any basis for the foregoing. The foregoing includes, without limitation, actions pending or threatened (or any basis therefor known to the Company) involving the prior employment of the Company's employees, their use in connection with the Company's business of any information or techniques allegedly proprietary to any of their former employers, or their obligations under any agreements with prior employers. There is no action, suit, proceeding or investigation by the Company currently pending or that the Company intends to initiate. The Company is not a party or subject to the 4 provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality that could have a material adverse effect on its business, assets, financial condition or operations. 2.8 INTELLECTUAL PROPERTY To its knowledge, the conduct of the Company's business does not conflict with or infringe on the patents, trademarks, service marks, trade names, copyrights, trade secrets, proprietary rights and processes (the "INTELLECTUAL PROPERTY") of others. To its knowledge, the Company has sufficient title to or rights to use all Intellectual Property necessary for the conduct of its business. The Company has not granted any options, licenses or agreements of any kind relating to any of its Intellectual Property, nor is the Company bound by or a party to any options, licenses or agreements with respect to the Intellectual Property of any other person or entity. The Company is not aware that any of its employees is obligated under any contract (including licenses, covenants or commitments of any nature) or other agreement, or subject to any judgment, decree or order of any court or administrative agency, that would interfere with their duties to the Company or that would conflict with the Company's business. The execution or delivery of this Agreement, the carrying on of the Company's business by the employees of the Company, and the conduct of the Company's business as proposed, will not, to the Company's knowledge, conflict with or result in a breach of the terms, conditions or provisions of, or constitute a default under, any contract, covenant or instrument under which any employee is now obligated. The Company does not believe it is or will be necessary to use any inventions, trade secrets or proprietary information of any of its employees made prior to their employment by the Company, except for inventions, trade secrets or proprietary information that have been assigned to the Company. 2.9 COMPLIANCE WITH OTHER INSTRUMENTS The Company is not in violation of any provision of its Articles of Incorporation or Bylaws or in violation or default of any provision of any instrument, judgment, order, writ, decree or contract to which it is a party or by which it is bound, or in violation of any provision of federal or state statute, rule or regulation applicable to the Company, which violation or default would have a material adverse effect on its business, assets, financial condition or operations. The execution, delivery, and performance of this Agreement and the consummation of the transactions provided for herein will not result in any such violation or default or require any consent under or be in conflict with or constitute, with or without the passage of time and giving of notice, either a violation or default under any such provision, instrument, judgment, order, writ, decree or contract or an event which results in the creation of any lien, charge or encumbrance upon any assets of the Company which violation, default, lien, charge 5 or encumbrance, individually or in the aggregate with any other such violation, default, lien, charge or encumbrance would have a material adverse effect on its business, assets, financial condition or operations. 2.10 AGREEMENTS; ACTION (a) There are no agreements, understandings, instruments, contracts or proposed transactions to which the Company is a party or by which it is bound that involve obligations or payments to the Company in excess of $200,000. (b) The Company has not (i) declared or paid any dividends, or authorized or made any distribution upon or with respect to any class or series of its capital stock, (ii) made any loans or advances to any person, other than in the ordinary course of business, (iii) sold, exchanged or otherwise disposed of any of its assets or rights, other than in the ordinary course of business, (iv) redeemed or obligated itself to redeem any of its capital stock (other than the Series A Stock and Series B Stock), or (v) incurred any indebtedness for money borrowed or incurred any other liabilities in excess of $200,000. (c) Except for agreements explicitly contemplated hereby, there are no agreements, understandings or proposed transactions between the Company and any of its officers, directors, affiliates or any affiliate thereof. 2.11 DISCLOSURE The Company has fully provided the Investors and its attorneys and agents with all the information in the Company's possession that they have requested for deciding whether to purchase the Series C Stock. This Agreement, the Exhibits hereto and all other documents delivered by the Company to the Investors or its attorneys or agents in connection herewith or therewith or with the transactions provided for herein or therein, do not contain any untrue statement of a material fact nor omit to state a material fact necessary in order to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading. There are no facts which (individually or in the aggregate) materially adversely affect the business, assets, financial condition or operations of the Company that have not been set forth in this Agreement, the Exhibits hereto or other documents delivered to the Investors or its attorneys or agents in connection herewith. 2.12 REGISTRATION RIGHTS Except as provided in the Investor Rights Agreement, as amended by the First and Second Amendments to Investor Rights Agreement, the Company has not granted or agreed to grant any registration rights to any person or entity. 6 2.13 CORPORATE DOCUMENTS The Certificate of Designation is, or at the Closing will be, in the form attached hereto as EXHIBIT A hereto. The Articles of Incorporation of the Company, as amended, are in the form attached hereto as EXHIBIT C hereto. The Bylaws of the Company are in the form attached hereto as EXHIBIT D. 2.14 TITLE TO PROPERTY AND ASSETS; CONDITION OF ASSETS The Company owns its property and assets free and clear of all mortgages, liens, loans and encumbrances, except liens and encumbrances that arise in the ordinary course of business and do not materially impair the Company's ownership or use of such property or assets. With respect to the property and assets it leases, the Company is in compliance with such leases in all material respects and holds a valid leasehold interest free of any liens, claims or encumbrances. All facilities and all material machinery, equipment, fixtures, vehicles, and other properties owned, leased or used by the Company are in good operating condition and repair and are reasonably fit and usable for the purposes for which they are being used. 2.15 LICENSES The Company has all governmental licenses and permits (federal, state, foreign, and local) the failure to obtain which would have a material adverse effect on its business, assets, financial condition or operations, and such licenses and permits are in full force and effect. No violations have been communicated to the Company in respect of such licenses or permits and no proceeding is pending or, to the Company's knowledge, threatened toward the revocation of any of such licenses or permits. 2.16 FINANCIAL STATEMENTS The Company has delivered to the Investors its unaudited balance sheets as at December 31, 1999 and December 31, 1998, and unaudited statements of income and cash flows for each of the years ended December 31, 1999 and December 31, 1998, respectively (collectively, the "FINANCIAL STATEMENTS"). The Financial Statements, together with the notes thereto, are complete and correct in all material respects, have been prepared consistent with methods used in prior years and present fairly the financial condition and position of the Company as of the dates and for the periods indicated. 7 2.17 UNDISCLOSED LIABILITIES Except as and to the extent reflected or reserved against in the Financial Statements, the Company did not have, as of the respective dates of the Financial Statements, any material debts, liabilities or obligations of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, including, without limitation, liabilities or obligations on account of taxes or other governmental charges or penalties, interest or fines thereon or in respect thereof required by generally accounting principles to be shown or reflected thereon that were not so shown or reflected. The Company does not know and does not have any reasonable grounds to know of any basis for any assertion against the Company of any material debt, liability or obligation of any nature or in any amount not fully reflected or reserved against in the Financial Statements or disclosed in this Agreement. 2.18 CHANGES Since December 31, 1999, there has not been: (a) Any change in the business, assets, financial condition or operations of the Company, except changes in the ordinary course of business, none of which has been materially adverse, and all of which in the aggregate have not been materially adverse, to the Company; (b) Any damage, destruction or loss (whether or not covered by insurance) materially and adversely affecting the business, assets, financial condition or operations of the Company; (c) Any material increase in the compensation or rate of compensation or commissions payable or to become payable by the Company to any of its directors, officers, salaried employees, sales persons or agents, or any hiring of any employee at a salary in excess of $150,000 per annum, or any payment in excess of $50,000 of any bonus, profit-sharing amount or other extraordinary compensation to any employee, or any material change in any then existing bonus, profit-sharing, retirement or other similar plan, agreement or arrangement, or any adoption of or entry into of any new bonus, profit-sharing, group life or health insurance, or other similar plan, agreement or arrangement; (d) Any material change in the accounting methods or practices followed by the Company; (e) Any material debt, obligation or liability (whether absolute or contingent) incurred by the Company (whether or not presently outstanding) except (i) current liabilities incurred, and obligations under agreements entered into, in the ordinary course of business and 8 (ii) obligations or liabilities entered into or incurred in connection with the execution of this Agreement; (f) Any sale, lease, abandonment or other disposition by the Company of any real property or, other than in the ordinary course of business, of any equipment or other operating properties or any sale, assignment, transfer, license or other disposition by the Company of any Intellectual Property or other intangible asset; (g) Any labor trouble, strike or any other occurrence, event or condition of any similar character that materially and adversely affects or may materially and adversely affect the business, assets, financial condition or prospects of the Company; (h) Any change, except in the ordinary course of business, in the contingent obligations of the Company by way of guaranty, endorsement, indemnity, warranty or otherwise; (i) Any waiver by the Company of a valuable right or a material debt owed to it except in the ordinary course of business; (j) Any direct or indirect loans made by the Company to any shareholder, employee, officer or director of the Company, other than advances made in the ordinary course of business; or (k) Any declaration or payment of any dividend or other distribution of the assets of the Company. 2.19 EMPLOYEE BENEFIT PLANS The Company does not have any "employee benefit plan" as defined in the Employee Retirement Income Security Act of 1974, as amended. 2.20 TAXES The Company has filed all tax returns (federal, state, foreign, and local) required to be filed by it and all taxes shown to be due and payable on such returns or on any assessments received by the Company and all other taxes (federal, state, foreign, and local) due and payable by the Company on or before the date hereof have been paid. There are no agreements, waivers or other arrangements providing for an extension of time with respect to the assessment of any tax or deficiency against the Company, nor are there any actions, suits, proceedings, investigations or claims now pending against the Company in respect of any tax or assessment, or, to the Company's knowledge, any matters under discussion within any federal, state, foreign 9 or local authority relating to any taxes or assessments, or any claims for additional taxes or assessments asserted by any such authority. The provisions made for taxes in the Financial Statements are sufficient for the payment of all unpaid federal, state, foreign, and local taxes of the Company for all periods prior to such date. 2.21 MINUTES The minutes of the Company reflect all meetings of directors and shareholders since the incorporation of the Company and reflect all transactions referred to in such minutes accurately in all material respects. 2.22 BROKERS OR FINDERS The Company has not incurred and will not incur, directly or indirectly, any liability for brokers' or finders' fees, agents' commissions or other similar charges in connection with this Agreement or the transactions contemplated hereby. 2.23 EMPLOYEES The Company has no collective bargaining agreements with any of its employees. There is no labor union organizing activity ending or, to the Company's knowledge, threatened with respect to the Company. No employee has any agreement or contract, written or verbal, regarding his or her employment. To the Company's knowledge, no employee of the Company, nor any consultant with whom the Company has contracted, is in violation of any term of any employment contract, proprietary information agreement, patent disclosure agreement or any other agreement relating to the right of any such individual to be employed by, or to contract with, the Company because of the nature of the business to be conducted by the Company and, to the Company's knowledge, the continued employment by the Company of its present employees, and the performance of the Company's contracts with its independent contractors, will not result in any such violation. The Company has not received any notice alleging that any such violation has occurred. No employee of the Company has been granted the right to continued employment by the Company or to any material compensation following termination of employment with the Company. The Company is not aware that any officer or key employee, or that any group of key employees, intends to terminate their employment with the Company, nor does the Company have a present intention to terminate the employment of any officer, key employee or group of key employees. 10 2.24 ENVIRONMENTAL AND SAFETY LAWS To its knowledge, the Company is not in violation of any applicable statute, law or regulation relating to the environment or occupational health and safety, and, to its knowledge, no material expenditures are or will be required to comply with any such existing statute, law or regulation. 2.25 OFFERING VALID Assuming the accuracy of the representations and warranties of the Investors contained in Section 3 hereof, the offer, sale, and issuance of the Series C Stock and the Conversion Shares will be exempt from the registration requirements of the Securities Act of 1933, as amended (the "SECURITIES ACT"), and will have been registered or qualified (or are exempt from registration and qualification) under the registration, permit or qualification requirements of all applicable state securities laws. Neither the Company nor any agent on its behalf has solicited or will solicit any offers to sell or has offered to sell or will offer to sell all or any part of the Series C Stock to any person or persons so as to bring the sale of such Series C Stock by the Company within the registration provisions of the Securities Act. 2.26 REAL PROPERTY HOLDING CORPORATION The Company is not a real property holding corporation within the meaning of Internal Revenue Code Section 897(c)(2) and any regulations promulgated thereunder. 2.27 INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS None of Robert McCausland, Steven Bourg, Gus Bourg or Ned Menninger has been subject and is not currently subject to any order, judgment or decree, not subsequently revised, suspended or vacated, of any court or any governmental agency that could materially adversely affect the business of the Company as presently conducted or as proposed to be conducted. 3. REPRESENTATIONS AND WARRANTIES OF THE INVESTORS Each Investor hereby represents and warrants that: 11 3.1 AUTHORIZATION All acts and conditions necessary for the authorization, execution, delivery, and consummation by the Investor of this Agreement and the other agreements and transactions contemplated herein have been, or will before the Closing be, taken, performed, and obtained. This Agreement and the other agreements contemplated herein constitute valid and legally binding obligations of the Investor, enforceable in accordance with their terms, subject to (a) the laws of bankruptcy and the laws affecting creditors' rights generally, (b) the effect of public policy on the indemnification provisions of Section 2.9 of the Investor Rights Agreement, and (c) the availability of equitable remedies. The Investor has full power and authority to execute, deliver, and perform its obligations under this Agreement and the other agreements contemplated herein and to own the Series C Stock. The execution, delivery, and performance of this Agreement and the other agreements contemplated herein and the consummation of the transactions contemplated hereby and thereby (including the ownership of Series C Stock) by the Investor does not violate any provision of, or constitute a material breach of or default under, any term, condition or provision of any agreement, indenture or other instrument to which the Investor is a party, or by which it or its properties or assets are bound, or of any order, judgment or decree against or binding upon the Investor. 3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT The Series C Stock to be received by the Investor and the Conversion Shares (collectively, the "SECURITIES") will be acquired for investment for the Investor's own account and not with a view to the distribution of any part thereof as such term is used under Section 2(11) of the Securities Act. The Investor has no present intention of selling, granting any participation in, or otherwise distributing the Securities in a manner contrary to the Securities Act, or applicable state securities laws. 3.3 INVESTMENT EXPERIENCE Each Investor is an investor in securities of companies in the development stage, qualifies as an "accredited investor" as defined in Rule 501 of Regulation D promulgated by the SEC, and acknowledges that the Securities are a speculative risk. Each Investor is able to fend for itself in the transactions contemplated by this Agreement, can bear the economic risk of its investment (including possible complete loss of such investment) for an indefinite period of time, and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities. Each Investor understands that the Securities have not been registered under the Securities Act, or under the securities laws of any jurisdiction, by reason of reliance upon certain exemptions, and that the reliance of the Company on such exemptions is predicated upon the accuracy of each Investor's representations and 12 warranties in this Section 3. Notwithstanding the foregoing, to the extent an Investor was formed for the purpose of acquiring such securities, such investor represents that all members, shareholders or investors within such entity are "accredited investors" as defined in Rule 501 of Regulation D. 3.4 RESTRICTED SECURITIES Each Investor understands that the Securities are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that, under such laws and applicable regulations, such securities may be transferred or resold without registration under the Securities Act only in certain limited circumstances and in accordance with the terms and conditions set forth in the legend described in Section 3.5. In this connection, the Investor represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Securities Act. 3.5 LEGENDS It is understood that the certificates evidencing the Securities may bear one or all of the following legends: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR APPLICABLE STATE LAW, AND NO INTEREST THEREIN MAY BE SOLD, DISTRIBUTED, ASSIGNED, OFFERED, PLEDGED OR OTHERWISE TRANSFERRED UNLESS (i) THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS COVERING ANY SUCH TRANSACTION INVOLVING SAID SECURITIES OR (ii) SUCH TRANSACTION IS EXEMPT FROM REGISTRATION. AFTER MARCH 2002, THIS LEGEND WILL BE CANCELED, AND A CERTIFICATE FREE FROM SUCH LEGEND ISSUED TO THE HOLDER HEREOF UPON COMPLIANCE WITH THE FOLLOWING CONDITIONS: (a) SURRENDER OF THIS CERTIFICATE TO THIS CORPORATION IN THE MANNER AND AT THE PLACE DESIGNATED FOR CANCELLATION, (b) A REPRESENTATION BY THE HOLDER THAT IT HAS BENEFICIALLY HELD THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR NOT LESS THAN TWO YEARS, AND THAT IT IS NOT, AND HAS NOT WITHIN THE PRECEDING 90 DAYS BEEN, AN AFFILIATE (AS THAT TERM IS DEFINED FOR PURPOSES OF RULE 144 UNDER THE ACT OR ANY SUCCESSOR RULE) OF THIS CORPORATION, AND (c) AN UNDERTAKING THAT IF AT ANY TIME THE HOLDER SHALL AGAIN BECOME AN AFFILIATE OR OTHERWISE CEASE TO ENJOY FREE TRANSFERABILITY OF SUCH SECURITIES UNDER RULE 144 EITHER 13 BY REASON OR CHANGE OF CIRCUMSTANCE OR AMENDMENT OF RULE 144, IT SHALL FORTHWITH SURRENDER ANY UNLEGENDED CERTIFICATES(S) RECEIVED BY IT IN RESPECT OF THE SECURITIES EVIDENCED BY THIS CERTIFICATE FOR IMPOSITION OF ANY APPROPRIATE LEGEND. THE COMPANY HAS COMMON STOCK AND PREFERRED STOCK AUTHORIZED. THE FULL STATEMENT OF THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL OR OTHER SPECIAL RIGHTS AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS THEREOF (THE "STATEMENT OF RIGHTS AND PREFERENCES") OF THE SHARES OF EACH SUCH SERIES OR CLASS OF STOCK IS SET FORTH IN THE ARTICLES OF INCORPORATION AND CERTIFICATE OF DESIGNATION OF THE COMPANY, AS AT ANY TIME AMENDED, AND ANY EFFECTIVE STATEMENT OF RELATIVE RIGHTS AND PREFERENCES OF PREFERRED STOCK, ON FILE IN THE OFFICE OF THE SECRETARY OF STATE OF THE STATE OF WASHINGTON. THE COMPANY WILL FURNISH COPIES OF THE STATEMENT OF RIGHTS AND PREFERENCES TO THE RECORD HOLDER OF THIS CERTIFICATE WITHOUT CHARGE UPON WRITTEN REQUEST TO THE COMPANY AT ITS PRINCIPAL PLACE OF BUSINESS OR REGISTERED OFFICE. 3.6 RESIDENCY For purposes of the application of state and international securities laws, each Investor represents that it is a resident of the state or country indicated on Schedule I hereto. 3.7 ACCESS TO INFORMATION Each Investor has received and reviewed information about the Company, and has had an opportunity to discuss the Company's business, management, and financial affairs with its management and to review the Company's facilities. Each Investor understands that these discussions, as well as any written information issued by the Company, were intended to describe the aspects of the Company's business and prospects that the Company considers material, but were not necessarily exhaustive. The foregoing, however, does not limit or modify the representations and warranties of the Company in Section 2 of this Agreement or the right of the Investors to rely thereon. 4. CONDITIONS OF INVESTORS' OBLIGATIONS AT THE CLOSING The obligations of the Investors under subsection 1.l(b) are subject to the fulfillment at or before the Closing (unless otherwise specified) of each of the following conditions, unless waived by the Investors: 14 4.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of the Company contained in Section 2 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the date of the Closing. 4.2 PERFORMANCE The Company shall have performed and complied with all agreements, obligations and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 4.3 COMPLIANCE CERTIFICATE The President and Chief Executive Officer of the Company, on behalf of the Company, shall deliver to the Investors at the Closing a certificate that the conditions specified in Sections 4.1 and 4.2 have been fulfilled and stating that there has been no material adverse change in the business, assets, financial condition or operations of the Company from the date of this Agreement to the time of the Closing. 4.4 QUALIFICATIONS The offer and sale of the Securities to the Investors pursuant to this Agreement shall be qualified or exempt from qualification under all applicable federal and state securities laws. 4.5 PROCEEDINGS AND DOCUMENTS All corporate and other proceedings in connection with the transactions contemplated at the Closing and all documents incident thereto, including evidence of filing the Certificate of Designation with the Secretary of State of the State of Washington, shall be reasonably satisfactory in form and substance to the Investors or their counsel, and the Investors or their counsel shall have received all counterpart original and certified or other copies of such documents as they may reasonably request. 4.6 INVESTOR RIGHTS AGREEMENT The Company, the holders of Series A Stock and Series B Stock, and the Investors shall have entered into a Second Amendment to Investor Rights Agreement in the form attached hereto as EXHIBIT E (the "INVESTOR RIGHTS AGREEMENT"). 15 4.7 OPINION OF COMPANY COUNSEL The Investors shall have received from Summit Law Group, PLLC, counsel for the Company, an opinion, dated as of the Closing, in form and substance satisfactory to the Investors, to the effect that: (a) The Company is a corporation, validly existing under the laws of the State of Washington, and the Company has the requisite corporate power and corporate authority to conduct its business as now being conducted. (b) The Company is qualified to do business in any state or jurisdiction of the United States in which the failure to so qualify would have a material adverse effect on its business or properties. (c) The Company has the requisite corporate power and corporate authority to execute, deliver, and perform this Agreement and the Investor Rights Agreement, as amended. All corporate action necessary for the authorization, execution and delivery by the Company of this Agreement and the Investor Rights Agreement and the authorization, issuance, and delivery of the Series C Stock being sold hereunder and the Conversion Shares has been taken, and this Agreement and the Investor Rights Agreement have been duly and validly authorized, executed, and delivered by the Company and constitute valid and legally binding obligations of the Company, enforceable against the Company in accordance with their terms, except as enforceability may be limited or affected by applicable laws relating to or affecting the enforcement of creditors' rights and by equitable principles. (d) The Series C Stock, when issued, sold, and delivered in accordance with the terms hereof for the consideration expressed herein, will be duly and validly issued, fully paid, and nonassessable. The Conversion Shares have been duly and validly reserved for issuance and, upon issuance in accordance with the terms of the Articles of Incorporation and Certificate of Designation, will be duly and validly issued, fully paid, and nonassessable. (e) The authorized capital stock of the Company consists of the preferred stock, common stock and rights described in paragraphs (i), (ii) and (iii) below: (i) Preferred Stock There are 10,000,000 shares of preferred stock authorized, 4,812,074 of which have been designated as Series A Stock, all of which is outstanding, 1,552,655 of which have been 16 designated as Series B Stock, all of which is outstanding and 2,545,430 of which have been designated as Series C Stock, none of which is outstanding. (ii) Common Stock As of Closing, there will be 200,000,000 shares of Common Stock authorized, 26,879,000 shares of which are currently outstanding. Of the authorized but unissued Common Stock, 9,624,148 shares are reserved for issuance upon the conversion of the Series A Stock, 3,105,310 are reserved for issuance upon the conversion of the Series B Stock and 2,545,430 will be reserved for issuance upon conversion of the Series C Stock; 2,879,000 shares are reserved by board action for issuance upon the exercise of warrants granted to certain investors (the "First Round Investors"); and 8,421,128 shares are reserved for issuance upon the exercise of stock options granted or to be granted under the Company's stock option plan (the "OPTION PLAN"); provided, however, that this number includes 331,550 shares that have reserved by board action for issuance upon the exercise of warrants granted to Lucent Technologies f/k/a Ascend Communications, Inc. ("Lucent"); and 307,974 shares that have been reserved by board action for issuance upon the exercise of warrants granted to Pacific Crest Securities Inc. pursuant to an engagement letter executed March 16, 1999. (iii) Rights Except for the conversion privileges and right of first refusal of the Series A Stock, Series B Stock and other rights, privileges and agreements contemplated pursuant to this Agreement or as enumerated in subparagraph (e)(ii), there are not outstanding any options, warrants, subscriptions, rights (including conversion or preemptive rights or first refusal rights) agreements for the purchase or acquisition from the Company or by the Company of any shares of the Company's capital stock or securities convertible into its capital stock, or, to such counsel's knowledge, any voting agreements with respect to the Company's securities. (f) The rights, privileges, and preferences of the preferred stock generally and of the Series A, Series B and Series C Stock are as stated in the Company's Articles of Incorporation, as amended, and the Certificate of Designation. (g) Based in part upon the representations of the Investors and on the facts and circumstances contemplated by this Agreement, and except that such counsel need give no opinion as to whether information provided to the Investors was sufficient and assuming that the offer and sale of the Series C Stock is a discrete transaction and not integrated with any other offering or sale of securities by the Company, the offer and sale of the Series C Stock to the Investors pursuant to the terms of this Agreement are exempt from the registration requirements of Section 5 of the Securities Act. 17 5. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING The obligations of the Company to the Investors under this Agreement are subject to the fulfillment on or before the Closing of the following conditions: 5.1 REPRESENTATIONS AND WARRANTIES The representations and warranties of the Investors contained in Section 3 shall be true in all material respects on and as of the Closing with the same effect as though such representations and warranties had been made as of the Closing. 5.2 PAYMENT OF PURCHASE PRICE The Investors shall have delivered the purchase price specified in subsection 1.1(b) to be delivered at the Closing, in the form of a bank check payable to the Company's order or bank wire transfer to the Company's designated account. 5.3 SECURITIES LAWS QUALIFICATION The offer and sale to the Investors of the Securities shall be qualified or exempt from qualification under all applicable federal and state securities laws. 5.4 PERFORMANCE The Investors shall have performed and complied with all agreements, obligations, and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 6. MISCELLANEOUS 6.1 PRESS RELEASES The Investors and the Company agree to consult with each other prior to the dissemination of any press release or public communications concerning this Agreement, the Investors' Rights Agreement or any ancillary agreement or the transactions contemplated by this Agreement, the Investors' Rights Agreement or any ancillary agreement. 18 6.2 USE OF PROCEEDS The Company shall use the proceeds of the sale of the Series C Stock under this Agreement as working capital to be used for the development of the Company. 6.3 SURVIVAL OF WARRANTIES The warranties and representations contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement and the Closing for a period of two years after Closing. 6.4 SUCCESSORS AND ASSIGNS The terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. Nothing in this Agreement express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. The Company may not assign or transfer any of its rights under the Agreement without the consent of the majority of the Investors, which consent shall not be unreasonably withheld. 6.5 GOVERNING LAW This Agreement shall be governed by and construed under the laws of the State of Washington as applied to agreements among Washington residents entered into and to be performed entirely within the State of Washington. 6.6 COUNTERPARTS 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 6.7 TITLES AND SUBTITLES The titles and subtitles used in this Agreement are for convenience only and are not to be considered in construing or interpreting this Agreement. 19 6.8 NOTICES Any and all notices required or permitted to be given to a party pursuant to the provisions of this Agreement will be in writing and will be effective and deemed to provide such party sufficient notice under this Agreement on the earliest of the following: (i) at the time of personal delivery, if delivery is in person; (ii) at the time of transmission by facsimile, addressed to the other party at its facsimile number specified herein (or hereafter modified by subsequent notice to the parties hereto), with confirmation of receipt made by both telephone and printed confirmation sheet verifying successful transmission of the facsimile; (iii) one business day after deposit with an express overnight courier for deliveries within a country, or two business days after such deposit for international deliveries or (iv) three business days after deposit in mail by certified mail (return receipt requested) or equivalent for deliveries within a country. All notices for international delivery will be sent by facsimile or by express courier. Any party hereto (and such party's permitted assigns) may be notice so given change its address for future notices hereunder. Notice shall conclusively be deemed to have been given in the manner set forth above. 6.9 DUE DILIGENCE EXPENSES; ATTORNEYS' AND ACCOUNTANTS' FEES The Company shall reimburse at the Closing the reasonable due diligence costs, including legal and accounting fees and expenses, incurred by the Investors in an amount not to exceed $15,000. If the parties fail to close the transactions contemplated by this Agreement, each party shall be responsible for its own expenses. 6.10 FINDER'S FEES Each party represents that it neither is, nor will be, obligated for a finder's fee or commission in connection with this transaction, except as described in Section 6.1 of the Schedule of Exceptions to this Agreement. Each Investor agrees, severally, but not jointly, to indemnify and hold the Company harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which such Investor or any of its officers, partners, employees or representatives is responsible. The Company agrees to indemnify and hold the Investors harmless from any liability for any commission or compensation in the nature of a finder's fee (and the costs and expenses of defending against such liability or asserted liability) for which the Company or any of its officers, employees or representatives is responsible. 20 6.11 AMENDMENTS AND WAIVERS After the Closing, any term of this Agreement may be amended and the observance of any term may be waived (either generally or in a particular instance and either retroactively or prospectively) only with the written consent of the Company and the holders of a majority of the aggregate shares of Series C Stock and/or the Conversion Shares (excluding shares of Common Stock that are no longer "restricted securities" under the Securities Act). Any amendment or waiver effected in accordance with this Section 6.10 shall be binding upon each holder of any securities purchased under this Agreement at the time outstanding (including securities into which such securities are convertible), each future holder of any such securities, and the Company. 6.12 SEVERABILITY If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement, and the balance of this Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 6.13 ENTIRE AGREEMENT This Agreement, including the Exhibits attached hereto, and the other documents delivered at the Closing constitute the full and entire understanding and agreement between the parties with respect to the subject matter hereof and supersede all prior agreements with respect to the subject matter hereof. 21 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. COMPANY: FREEI NETWORKS, INC. By: __________________________________ Bob McCausland President and Chief Executive Officer 909 S. 336th Street, Suite 110 Federal Way, Washington 98003 Fax (253) 661-3431 22 SERIES C INVESTORS: EAGLE RIVER INVESTMENTS, LLC BY:_________________________ PRINTED NAME: TITLE: SERIES C INVESTORS: CEDAR GROVE INVESTMENTS, LLC BY:_________________________ PRINTED NAME: TITLE: SERIES C INVESTORS: CAPITAL RESEARCH AND MANAGEMENT COMPANY, ON BEHALF OF NEW ECONOMY FUND By:_________________________ Printed Name: Michael J. Downer Title: Secretary SERIES C INVESTORS: INFOSPACE VENTURE CAPITAL FUND 2000, LLC, BY INFOSPACE.COM, INC. AS ITS SOLE MEMBER BY: ________________________ PRINTED NAME: ____________ TITLE: _________________________ SERIES C INVESTORS: LAKESIDE I By: ________________________ Printed Name: ____________ Title: ________________________ SERIES C INVESTORS: DOLCE FREEI, L.L.C. BY: ________________________ PRINTED NAME: ____________ TITLE: _________________________ SERIES C INVESTORS: REMO INTERNATIONAL INC. By: ________________________ Printed Name: ____________ Title: ________________________ SERIES C INVESTORS: ROBERT PACK -------------------------------- SERIES C INVESTORS: PPC PARTNERS LLC By: ________________________ Printed Name: ____________ Title: ________________________ SERIES C INVESTORS: WASHINGTON MUTUAL By: ________________________ Printed Name: Craig E. Tall Title: Vice Chair SERIES C INVESTORS: INTERNET VENTURES LLC BY:________________________ PRINTED NAME: TITLE: SERIES C INVESTORS: KELLETT PARTNERS, L.P. BY: ________________________ PRINTED NAME: TITLE: SERIES C INVESTORS: CLEAR FIR PARTNERS, L.P. By:________________________ Printed Name: Title: SERIES C INVESTORS: GARY V. SLEDGE ________________________ SERIES C INVESTORS: CASCADE GROUP By:________________________ Printed Name: Title: SERIES C INVESTORS: CARL STORK ________________________ Freei Networks, Inc. SERIES C PREFERRED STOCK PURCHASE AGREEMENT Dated as of March 7, 2000 TABLE OF CONTENTS -----------------
PAGE ---- 1. PURCHASE AND SALE OF STOCK..................................................................................1 1.1 SALE AND ISSUANCE OF SERIES C STOCK...................................................................1 1.2 CLOSING...............................................................................................1 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY...............................................................2 2.1 ORGANIZATION, GOOD STANDING AND QUALIFICATION.........................................................2 2.2 CAPITALIZATION........................................................................................2 2.3 SUBSIDIARIES..........................................................................................3 2.4 AUTHORIZATION.........................................................................................3 2.5 VALID ISSUANCE OF PREFERRED AND COMMON STOCK..........................................................4 2.6 GOVERNMENTAL CONSENTS; COMPLIANCE WITH LAWS...........................................................4 2.7 LITIGATION............................................................................................4 2.8 INTELLECTUAL PROPERTY.................................................................................5 2.9 COMPLIANCE WITH OTHER INSTRUMENTS.....................................................................5 2.10 AGREEMENTS; ACTION....................................................................................6 2.11 DISCLOSURE............................................................................................6 2.12 REGISTRATION RIGHTS...................................................................................7 2.13 CORPORATE DOCUMENTS...................................................................................7 2.14 TITLE TO PROPERTY AND ASSETS; CONDITION OF ASSETS.....................................................7 2.15 LICENSES..............................................................................................7 2.16 FINANCIAL STATEMENTS..................................................................................7 2.18 CHANGES...............................................................................................8 2.19 EMPLOYEE BENEFIT PLANS................................................................................9 2.20 TAXES.................................................................................................9 2.21 MINUTES..............................................................................................10 2.22 BROKERS OR FINDERS...................................................................................10 2.23 EMPLOYEES............................................................................................10 2.24 ENVIRONMENTAL AND SAFETY LAWS........................................................................11 2.25 OFFERING VALID.......................................................................................11 2.26 REAL PROPERTY HOLDING CORPORATION....................................................................11 2.27 INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS.............................................................11 3. REPRESENTATIONS AND WARRANTIES OF THE INVESTOR.............................................................11 3.1 AUTHORIZATION........................................................................................12 3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT....................................................................12 3.3 INVESTMENT EXPERIENCE................................................................................12 3.4 RESTRICTED SECURITIES................................................................................13 3.5 LEGENDS..............................................................................................13 3.6 RESIDENCY............................................................................................14 3.7 ACCESS TO INFORMATION................................................................................14
4. CONDITIONS OF INVESTOR'S OBLIGATIONS AT THE CLOSING........................................................14 4.1 REPRESENTATIONS AND WARRANTIES.......................................................................15 4.2 PERFORMANCE..........................................................................................15 4.3 COMPLIANCE CERTIFICATE...............................................................................15 4.4 QUALIFICATIONS.......................................................................................15 4.5 PROCEEDINGS AND DOCUMENTS............................................................................15 4.6 INVESTOR RIGHTS AGREEMENT............................................................................15 4.7 OPINION OF COMPANY COUNSEL...........................................................................16 5. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING.....................................................18 5.1 REPRESENTATIONS AND WARRANTIES.......................................................................18 5.2 PAYMENT OF PURCHASE PRICE............................................................................18 5.3 SECURITIES LAWS QUALIFICATION........................................................................18 5.4 PERFORMANCE..........................................................................................18 6. MISCELLANEOUS..............................................................................................18 6.1 PRESS RELEASES.......................................................................................18 6.2 USE OF PROCEEDS......................................................................................19 6.3 SURVIVAL OF WARRANTIES...............................................................................19 6.4 SUCCESSORS AND ASSIGNS...............................................................................19 6.5 GOVERNING LAW........................................................................................19 6.6 COUNTERPARTS.........................................................................................19 6.7 TITLES AND SUBTITLES.................................................................................19 6.8 NOTICES..............................................................................................19 6.9 DUE DILIGENCE EXPENSES; ATTORNEYS'AND ACCOUNTANTS'FEES...............................................20 6.10 FINDER'S FEES........................................................................................20 6.11 AMENDMENTS AND WAIVERS...............................................................................20 6.12 SEVERABILITY.........................................................................................21 6.13 ENTIRE AGREEMENT.....................................................................................21
EXHIBIT A - CERTIFICATE OF DESIGNATION EXHIBIT B - SCHEDULE OF EXCEPTIONS EXHIBIT C - ARTICLES OF INCORPORATION EXHIBIT D - BYLAWS EXHIBIT E - SECOND AMENDMENT TO INVESTOR RIGHTS AGREEMENT SCHEDULE I SCHEDULE I Schedule of Investors
- --------------------------------------------------------- ------------------------- ---------------------------------- NAME AND ADDRESS NUMBER OF SHARES PURCHASE PRICE - --------------------------------------------------------- ------------------------- ---------------------------------- Capital Research and Management Company, on behalf of 1,018,172 $20,000,000 the New Economy Fund, 34th Floor 333 So. Hope St. Los Angeles, CA 90071 Attention: Michael J. Downer Ph: (213) 486-9425 Fax: (213) 486-9041 - --------------------------------------------------------- ------------------------- ---------------------------------- InfoSpace Venture Capital Fund 2000, LLC 254,543 $5,000,000 15375 NE 90th Street Redmond, WA 98052 - --------------------------------------------------------- ------------------------- ---------------------------------- Lakeside I 279,997 $5,500,000 c/o Lakeside Capital Management, LLC 1938 43rd Ave East Seattle, WA 98112 206-324-2600 (voice) 206-726-0663 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Washington Mutual, Inc. 203,634 $4,000,000 1201 Third Avenue, Suite 1500 WA 98101 Attn: Craig E. Tall, Vice Chair - --------------------------------------------------------- ------------------------- ---------------------------------- Internet Ventures LLC 152,726 $3,000,000 - --------------------------------------------------------- ------------------------- ---------------------------------- Dolce Freei, L.L.C. 101,818 $2,000,000 c/o Williams, Kastner & Gibbs Two Union Square 601 Union Street, Suite 4100 Seattle, Washington 98101-2380 - --------------------------------------------------------- ------------------------- ---------------------------------- Robert Pack 76,363 $1,500,000 c/o Freei Networks, Inc. 909 S. 336th Street #110 Federal Way, Washington 98003 - --------------------------------------------------------- ------------------------- ---------------------------------- Kellett Partners LP 66,945 $1,315,000 Kellett Investment Corp. 200 Galleria Parkway Suite 1800 Atlanta, Ga 30339 - --------------------------------------------------------- ------------------------- ---------------------------------- Remo International Inc. 50,909 $1,000,000 P.O. Box 3151 Road Town Tortola, British Virgin Islands - --------------------------------------------------------- ------------------------- ----------------------------------
- --------------------------------------------------------- ------------------------- ---------------------------------- scmp.com Holdings Limited 50,909 $1,000,000 P.O. Box 3151 Road Town Tortola, British Virgin Islands - --------------------------------------------------------- ------------------------- ---------------------------------- Carl Stork 25,454 $500,000 4451 91st Ave NE Yarrow Point WA 98004 - --------------------------------------------------------- ------------------------- ---------------------------------- PPC Partners LLC 25,454 $500,000 One Union Square 600 Union, Ste. 2901 Seattle, Washington 98101 - --------------------------------------------------------- ------------------------- ---------------------------------- Clear Fir Partners, L.P. 7,636 $150,000 Kellett Investment Corp. 200 Galleria Parkway, Suite 1800 Atlanta, GA 30339 - --------------------------------------------------------- ------------------------- ---------------------------------- Gary V. Sledge 1,273 $25,000 Kellett Investment Corp. 200 Galleria Parkway Suite 1800 Atlanta, GA 30339 - --------------------------------------------------------- ------------------------- ---------------------------------- Cascade Group 509 $10,000 Kellett Investment Corp. 200 Galleria Parkway Suite 1800 Atlanta, GA 30339 - --------------------------------------------------------- ------------------------- ---------------------------------- Cedar Grove Investments $200,000 2415 Carillon Point Kirkland, WA 98033 (425) 828-8111 phone (425) 828-8101 fax - --------------------------------------------------------- ------------------------- ---------------------------------- Bill Hoglund $100,000 C/o Eagle River 2300 Carillon Point Kirkland, Washington 98033 (425) 828-8000 (ph) - --------------------------------------------------------- ------------------------- ---------------------------------- Brian Marcinek $50,000 C/o Eagle River 2300 Carillon Point Kirkland, Washington 98033 (425) 828-8000 (ph) - --------------------------------------------------------- ------------------------- ---------------------------------- Spanish Caravan Investments, L.L.C. $250,000 1616 Federal Avenue East Seattle, Washington 98102 Attn: Jim Judson (425) 828 8499 (ph) (425) 828 8061 (fax) - --------------------------------------------------------- ------------------------- ----------------------------------
- --------------------------------------------------------- ------------------------- ---------------------------------- Dennis Weibling $200,000 C/o Eagle River 2300 Carillon Point Kirkland, Washington 98033 (425) 828-8000 (ph) - --------------------------------------------------------- ------------------------- ---------------------------------- Art Harrigan $150,000 999 Third Avenue, Suite 4400 Seattle, Washington 98104 (206) 623-1700 (ph) (206) 623-8717 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Keith Grinstein $100,000 Nextel International, Inc. 1191 Second Avenue, #1600 Seattle, Washington 98101 (206) 749-8350 (ph) (206) 749-8384 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Steve Hooper $200,000 4001 Hunts Point Road Bellevue, WA 98004 - --------------------------------------------------------- ------------------------- ---------------------------------- 787, L.L.C. $250,000 9919 S.E 5th Street Bellevue, Washington 98004 (206) 601-8901 (ph) (425) 454-2548 (fax) Attn: Jim Voelker - --------------------------------------------------------- ------------------------- ---------------------------------- Pat Broe $1,000,000 252 Clayton Street, 4th Floor Denver, CO 80206 - --------------------------------------------------------- ------------------------- ---------------------------------- James E. Sierk $50,000 850 So. Boulder Hwy, S-189 Henderson, NV 89105 - --------------------------------------------------------- ------------------------- ---------------------------------- Alicia Ruth Evans $25,000 Drugstore.com 13920 S.E. Eastgate Way, Suite 300 Bellevue, WA 98005 - --------------------------------------------------------- ------------------------- ---------------------------------- Stuart M. Sloan $200,000 Sloan Capital Companies 1301 Fifth Avenue, Suite 3000 Seattle, WA 98101 (206) 340-1818 (ph) (206) 340-9055 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Gaylord Kellogg $50,000 270 Lake Dell Avenue Seattle, Washington 98122 (206) 726-9480 (ph) (206) 860-3866 (fax) - --------------------------------------------------------- ------------------------- ----------------------------------
- --------------------------------------------------------- ------------------------- ---------------------------------- Bob Ratliffe $25,000 C/o Eagle River 2300 Carillon Point Kirkland, Washington 98033 (425) 828-8000 (ph) - --------------------------------------------------------- ------------------------- ---------------------------------- Sugar Mountain Capital LLC $300,000 2415 Carillon Point Kirkland, Washington 98033 Attn: Kurt Dammeir (425) 828-8108 (ph) (425) 828-8101 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Lenard Lee $25,000 Vista.com 116 N.W. 41st Seattle, Washington - --------------------------------------------------------- ------------------------- ---------------------------------- Jeff Stock $25,000 c/o Omni Properties, Inc. 36201 Enchanted Parkway South Federal Way, WA 98003-7197 (253) 661-8030 (ph) (253) 661-8099 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Peter von Reichbauer $25,000 King County Courthouse Room 1200 516 3rd Avenue Seattle, WA 98104-3272 (206) 296-1007 (ph) (206) 296-0323 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Peter Holland $50,000 10645 N.E. 38th Place, Suite A Kirkland, WA 98033 (425) 576-4500 (ph) (425) 576-4600 (fax) - --------------------------------------------------------- ------------------------- ---------------------------------- Brad Silverberg $1,000,000 P.O. Box 866 Bellevue, WA 98009 - --------------------------------------------------------- ------------------------- ---------------------------------- Cameron Mhyrvold $600,000 - --------------------------------------------------------- ------------------------- ---------------------------------- Jon Anderson $500,000 - --------------------------------------------------------- ------------------------- ---------------------------------- Rich Tong $500,000 - --------------------------------------------------------- ------------------------- ---------------------------------- Jon Roberts $250,000 641 33rd Avenue E. Seattle, Washington 98112 - --------------------------------------------------------- ------------------------- ---------------------------------- G. Christopher Peters $250,000 - --------------------------------------------------------- ------------------------- ----------------------------------
- --------------------------------------------------------- ------------------------- ---------------------------------- 3444 Evergreen Point Road Medina, Washington 98033 - --------------------------------------------------------- ------------------------- ---------------------------------- Glentel, Inc. $1,000,000 Suite 2800 4710 Kingsway Ave. Burnaby, British Columbia V5H 4M2 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- Thomas E. Skidmore $20,000 Suite 2800 4710 Kingsway Ave. Burnaby, British Columbia V5H 4M2 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- A. Allan Skidmore $20,000 Suite 2800 4710 Kingsway Ave. Burnaby, British Columbia V5H 4M2 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- Ronald E. Sowerby $20,000 Suite 2800 4710 Kingsway Ave. Burnaby, British Columbia V5H 4M2 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- Allan L. Rosenhek $10,000 8501 Commerce Court Burnaby, British Columbia V5A 4N3 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- Richard Miller $10,000 Suite 2800 4710 Kingsway Ave. Burnaby, British Columbia V5H 4M2 Canada - --------------------------------------------------------- ------------------------- ---------------------------------- Siltanen/Keehn $75,000 3110 Main Street #210 Santa Monica, CA 90405 (310) 450-6622 (ph) - --------------------------------------------------------- ------------------------- ----------------------------------
EX-10.11 15 EX-10.11 Exhibit 10.11 [Logo] INTERNET CONTENT (WORLD WIDE WEB SITE) DISTRIBUTION AGREEMENT THIS AGREEMENT, dated as of November 24, 1999 (the "Effective Date"), is made by and between InfoSpace.com, Inc., a Delaware corporation, ("InfoSpace"), with offices at 15375 NE 90th Street, Redmond, WA 98052, and Freei Networks Inc., a Washington corporation ("Company"), with offices at 909 South 336th St. Suite 110, Federal Way, WA 98003. RECITALS This Agreement is entered into with reference to the following facts: A. InfoSpace maintains on certain locations of its Web Sites (as defined below) and makes available to Internet users certain content, resources, archives, indices, software, catalogs and collections of information (collectively, such materials are identified in Exhibit A and referred to herein as the "Content"). B. InfoSpace wishes to grant certain rights and licenses to Company with respect to access to the Content and certain other matters, and Company wishes to grant certain rights and licenses to InfoSpace with respect to the Company Web Sites (as defined below) and certain other matters, as set forth in this Agreement. AGREEMENT The parties agree as follows: SECTION 1. DEFINITIONS. As used herein, the following terms have the following defined meanings: "BANNER ADVERTISEMENT" means a rotating banner advertisement of up to approximately 468 x 60 pixels located at the top and/or bottom of a Web Page, or other advertisements, sponsorships or other promotions on or related to a Personal Desktop Portal Page, as may be designated by InfoSpace and Company. "CO-BRANDED PAGES" means, collectively, Query Pages, Results Pages and Personal Desktop Portal Pages. "COMPANY MARKS" means those Trademarks of Company set forth on Exhibit B hereto and such other Trademarks (if any) of Company which Company may own or use from time to time. "COMPANY WEB SITES" means, collectively, all Web Sites maintained by or on behalf of Company and its affiliates. "GRAPHICAL USER INTERFACE" means a graphical user interface, to be designed by Company and InfoSpace and implemented by InfoSpace pursuant to the terms of this Agreement, that contains or implements branding, graphics, navigation, content or other characteristics or features such that a user reasonably would conclude that such interface is part of the Company Web Sites. "IMPRESSION" means a user's viewing of any discrete screen of a Co-branded Page containing any Banner Advertisement. [*] = Confidential Treatment Requested -1- "INFOSPACE MARKS" means those Trademarks of InfoSpace set forth on Exhibit B hereto and such other Trademarks (if any) as InfoSpace may from time to time notify Company in writing to be "InfoSpace Marks" within the meaning of this Agreement. "INFOSPACE WEB SITES" means, collectively: (a) the Web Site the primary home page of which is located at http://www.infospace.com; and (b) other Web Sites maintained by InfoSpace and its affiliates. "INTELLECTUAL PROPERTY RIGHTS" means any patent, copyright, rights in Trademarks, trade secret rights, moral rights and other intellectual property or proprietary rights arising under the laws of any jurisdiction. "PERSON" means any natural person, corporation, partnership, limited liability company or other entity. "PERSONAL DESKTOP PORTAL APPLICATION" means a version (as designated by InfoSpace) of a downloadable software application currently known as "The InfoSpace Personal Desktop Portal" whereby end users are able to access and display certain content, and any successors and/or revisions to such application as InfoSpace may designate in its sole discretion. "PERSONAL DESKTOP PORTAL PAGE" means any page hosted on the InfoSpace Web Sites, and served to an end user who accessed such page through a version of the Personal Desktop Portal Application that such end user downloaded from a Query Page or Results Page, which may incorporate a Graphical User Interface and/or on which users may input queries and searches relating to the Content. "QUERY PAGE" means any page hosted on the InfoSpace Web Sites which may incorporate the Graphical User Interface and/or on which users clicking directly from the Company Web Sites may input queries and searches relating to the Content or may include download of or access to Content. "RESULTS PAGE" means any page hosted on the InfoSpace Web Sites which may incorporate the Graphical User Interface and/or displays Content in response to queries and searches made on a Query Page or Personal Desktop Portal Page. "TRADEMARKS" means any trademarks, service marks, trade dress, trade names, corporate names, proprietary logos or indicia and other source or business identifiers. "WEB SITE" means any point of presence maintained on the Internet or on any other public data network. With respect to any Website maintained on the World Wide Web, such Website includes all HTML pages (or similar unit of information presented in any relevant data protocol) that either (a) are identified by the same second-level domain (such as infospace.com) or by the same equivalent level identifier in any relevant address scheme, or (b) contain branding, graphics, navigation or other characteristics such that a user reasonably would conclude that the pages are part of an integrated information or service offering. 2. CERTAIN RIGHTS GRANTED. 2.1 INFOSPACE GRANT. Subject to the terms and conditions of this Agreement, InfoSpace hereby grants to Company the following rights: (a) the right to include on the Company Web Sites hypertext links (whether in graphical, text or other format) which enable "point and click" access to locations of the InfoSpace Web Sites specified by InfoSpace (and subject to change by InfoSpace from time to time); and (b) the right to permit users to link to Results Pages via Query Pages and/or to Personal Desktop Portal Pages hosted on the InfoSpace Web Sites. 2.2 COMPANY GRANT. Subject to the terms and conditions of this Agreement, Company hereby grants InfoSpace the following rights: -2- (a) the right to include on the InfoSpace Web Sites hypertext links (whether in graphical, text or other format) which enable "point and click" access to locations of the Company Web Sites specified by Company (and subject to change by Company from time to time); (b) the right to sell and serve Banner Advertisements and other promotions on the Co-branded Pages; and (c) the right to track the number of Impressions. 2.3 LIMITATIONS. Company and its affiliates shall have no right to reproduce or sub-license, re-sell or otherwise distribute all or any portion of the Content to any Person including via the Internet (including the World Wide Web) or any successor public or private data network. This Agreement and delivery of the Content or any portion hereunder to Company shall not cause InfoSpace to be in violation of any law of any jurisdiction or third party agreement, and InfoSpace may at any time modify its grant of rights to the extent necessary to ensure compliance. InfoSpace may from time to time issue additional guidelines with respect to use or display of any of-the Content, to which Company will adhere. Company shall implement and/or cooperate with InfoSpace in its implementation of bug fixes, updates, and minimum build requirements for any Content supplied by InfoSpace, promptly upon the request of InfoSpace. Neither party shall have any right to: (a) edit or modify any Banner Advertisements submitted for a Cobranded Page (but without limiting InfoSpace's right to reject any Banner Advertisements pursuant to this Agreement); or (b) remove, obscure or alter any notices of Intellectual Property Rights appearing in or on any materials (including Banner Advertisements) provided by the other party. 2.4 COMPANY MARKS LICENSE. Subject to Section 2.6, Company hereby grants InfoSpace the right to use, reproduce, publish, perform and display the Company Marks: (a) on the InfoSpace Web Sites in connection with the posting of hyperlinks to the Company Web Sites; (b) in and in connection with the development use, reproduction, modification, adaptation, publication, display and performance of the Graphical User Interface, Results Pages and (if applicable) the Personal Desktop Portal Pages; and (c) in promotional and marketing materials, content directories and indexes, and electronic and printed advertising, publicity, press releases, newsletters and mailings about InfoSpace. 2.5 INFOSPACE MARKS LICENSE. Subject to Section 2.6, InfoSpace hereby grants the right to use, reproduce, publish, perform and display the InfoSpace Marks: (a) on the Company Web Sites in connection with the posting of hyperlinks to the InfoSpace Web Sites; (b) in and in connection with the development, use, reproduction in promotional and marketing materials, content directories and indexes, and electronic and printed advertising, publicity, press releases, newsletters and mailings about Company. 2.6 APPROVAL OF TRADEMARK USAGE. InfoSpace shall not use or exploit in any manner any of the Company Marks, and Company shall not use or exploit in any manner any of the InfoSpace Marks, except in such manner and media as the other party may consent to in writing, which consent shall not be unreasonably withheld or delayed. Either party may revoke or modify any such consent upon written notice to the other party. 2.7 NONEXCLUSIVITY. Each party acknowledges and agrees that the rights granted to the other party in this Agreement are non-exclusive, and that, without limiting the generality of the foregoing, nothing in this Agreement shall be deemed or construed to prohibit either party from participating in similar business arrangements as those described herein including soliciting third party advertisements or other materials, serving advertisements or other materials to third parties' Web Sites, or hosting or permitting third parties to place advertisements on such party's Web Site, whether or not, in each such case, such advertisements are competitive with the products, services or advertisements of the other party. 3. CERTAIN OBLIGATIONS OF THE PARTIES. 3.1 GRAPHICAL USER INTERFACE AND CO-BRANDED PAGES. To the extent provided in this Agreement, Company and InfoSpace will cooperate to design the user-perceptible elements of the Graphical User Interface, with the goals of: (a) conforming the display output of the "look and feel" -3- associated with the applicable Company Web Sites; and (b) maximizing the commercial effectiveness thereof. Following agreement by the parties upon the design specifications thereof, InfoSpace will use commercially reasonable efforts to develop the Graphical User Interface and to implement the same on Co-branded Pages. InfoSpace shall have no liability or obligation for failure to develop or implement the Graphical User Interface or any Co-branded Pages as contemplated by this Section 3. 1, or for any nonconformity with the design specifications agreed upon by the parties, provided InfoSpace has used commercially reasonable efforts to develop and implement the same as provided in this Section 3.1. The URL for the Co-Branded Pages shall not include Company's domain name. 3.2 COMPANY OBLIGATIONS. Unless otherwise designated by InfoSpace, the InfoSpace logo and at least one other link pointing to pages of the InfoSpace Web Sites specified by InfoSpace (and subject to change by InfoSpace from time to time) will be present on all Co-branded Pages. Each link contemplated by this Section 3.2 shall be: (a) prominent in relation to links to other Web Sites on the applicable page (and in any event at least as prominent as any link to any third party Web Site); and (b) above-the-fold (i.e., immediately visible to any user accessing the applicable page without the necessity of scrolling downward or horizontally). 3.3 ACCESSIBILITY OF WEB SITES. Each party will use commercially reasonable efforts to maintain accessibility of its Web Sites. 3.4 IMPRESSION AND OTHER INFORMATION. InfoSpace shall track and allow the Company on a monthly basis to remotely access in electronic form information maintained by InfoSpace concerning as applicable 1)Number of Impressions. 2) each click-through to Infospace applications 3) data regarding Banner Inventory on co-branded pages; 4) gross revenues received by Infospace from banner sales. 3.5 PUBLICITY. The parties may work together to issue publicity and general marketing communications concerning their relationship and other mutually agreed-upon matters, provided, however, that neither party shall have any obligation to do so. In addition, neither party shall issue such publicity and general marketing communications concerning their relationship without the prior written consent of the other party (not to be unreasonably withheld). Neither party shall disclose the terms of this Agreement to any third party other than its outside counsel, auditors, and financial advisors, except as required by law. 4. ADVERTISING AND REVENUE. 4.1 PLACEMENT OF BANNER ADVERTISEMENTS. In addition to the terms and conditions otherwise set forth in this Agreement, Banner Advertisements sold on the Co-branded Pages shall be governed by the terms and conditions set forth on Exhibit C. 4.2 REMUNERATION; COLLECTION. The Company or Infospace will pay the amounts as set forth on Exhibit C. Any amount not paid when due, or as invoiced, will be subject to a finance charge equal to one and one-half percent (1.5%) per month or the highest rate allowable by law, whichever is less, determined and compounded daily from the date due until the date paid. Payment of such finance charges will not excuse or cure any breach or default for late payment. InfoSpace or Company may accept any check or payment without prejudice to its rights to recover the balance due or to pursue any other right or remedy. No endorsement or statement on any check or payment or letter accompanying any check or payment or elsewhere will be construed as an accord or satisfaction. Unless explicitly stated on Exhibit C, all amounts payable under this Agreement are denominated in United States dollars and Company will pay all amounts payable under this Agreement in lawful money of the United States. Unless explicitly stated on Exhibit C, InfoSpace shall have no obligation to share with, allow Company to sell, or account to Company regarding, any sums received by InfoSpace or any of its affiliates from any advertisements or promotions on any of the InfoSpace Web Sites. In the event Company or Infospace fails to make timely payment, InfoSpace or Company shall have the right, in addition to all other rights under this Agreement, to immediately terminate all links, content, or services provided to the other party under this Agreement. If Company or Infospace fails to make timely payment, the defaulting party will be responsible for all reasonable expenses (including attorney fees) incurred by the other party in collecting such amounts. -4- 5. Warranties, Indemnification and Limitation of Direct Liability. 5.1 Warranties The parties to this Agreement represent and warrant as follows: a) Each party warrants that it has the full corporate right, power and authority to enter into this Agreement and to perform the acts required of it hereunder; b) Each party warrants that its execution of this Agreement by such party and performance of its obligations hereunder, do not and will not violate any agreement to which it is a party or by which it is bound; and in performance under and related to this Agreement, the parties shall comply with all applicable laws, rules and regulations (including, without limitation, privacy, export control and obscenity laws); and c) Each party warrants that when executed and delivered, this Agreement will constitute the legal, valid and binding obligation of such party, enforceable against it in accordance with its terms. d) Each party warrants that its Web Sites and the content contained therein, and all Banner Advertisements served or submitted to the Co-branded Pages, as the case may be, will not contain any material that is obscene, pornographic, profane, fraudulent, libelous or defamatory, or infringing of any third party Intellectual Property Rights. 5.2 INDEMNIFICATION. Each party (the "Indemnifying Party") will defend, indemnify and hold harmless the other party (the "Indemnified Party"), and the respective directors, officers, employees and agent of the Indemnified Party, from and against any and all claims, costs, losses, damages, judgments and expenses (including reasonable attorneys' fees) arising out of or in connection with any third-party claim alleging any breach of such party's representations or warranties or covenants set forth in this Agreement. The Indemnified Party agrees that the Indemnifying Party shall have sole and exclusive control over the defense and settlement of any such third party claim. The Indemnified Party shall promptly notify the Indemnifying Party of any such claim of which it becomes aware and shall: (a) at the Indemnifying Party's expense, provide reasonable cooperation to the Indemnifying Party in connection with the defense or settlement of any such claim; and (b) at the Indemnified Party's expense, be entitled to participate in the defense of any such claim. The Indemnifying Party shall not acquiesce to any judgment or enter into any settlement that adversely affects the Indemnified Party's rights or interests without prior written consent of the Indemnified Party. 5.3 LIMITATION OF LIABILITY; DISCLAIMER. (a) Liability. UNDER NO CIRCUMSTANCES SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR EXEMPLARY DAMAGES (EVEN IF THAT PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES), ARISING FROM ANY PROVISION OF THIS AGREEMENT, SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE OR ANTICIPATED PROFITS OR LOST BUSINESS. INFOSPACE'S LIABILITY (WHETHER ARISING IN TORT, CONTRACT OR OTHERWISE AND NOTWITHSTANDING ANY FAULT, NEGLIGENCE (WHETHER ACTIVE, PASSIVE OR IMPUTED), PRODUCT LIABILITY OR STRICT LIABILITY OF INFOSPACE) UNDER THIS AGREEMENT OR WITH REGARD TO ANY OF THE PRODUCTS OR SERVICES RENDERED BY THE PARTIES UNDER THIS AGREEMENT (INCLUDING ANY SERVERS OR OTHER HARDWARE, SOFTWARE AND ANY OTHER ITEMS USED OR PROVIDED BY THE PARTIES OR ANY THIRD PARTIES IN CONNECTION WITH HOSTING THE CO-BRANDED PAGES OR PROVIDING CONTENT), THE PARTIES' WEB SITES AND ANY OTHER ITEMS OR SERVICES FURNISHED UNDER THIS AGREEMENT. IN NO EVENT WILL EITHER PARTYS' AGGREGATE LIABILITY TO THE OTHER PARTY UNDER THIS AGREEMENT EXCEED THE COMPENSATION PAID THE OTHER PARTY UNDER THIS AGREEMENT. -5- (b) No Additional Warranties. EXCEPT AS SET FORTH IN THIS AGREEMENT, NEITHER PARTY MAKES, AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS, ANY REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED (INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE AND IMPLIED WARRANTIES ARISING FROM COURSE OF DEALING OR COURSE OF PERFORMANCE.), AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS ANY CLAIM IN TORT (INCLUDING NEGLIGENCE), IN EACH CASE, REGARDING THEIR WEB SITES, ANY PRODUCTS OR SERVICES DESCRIBED THEREON, ANY BANNER ADVERTISEMENTS, ANY SOFTWARE, OR ANY OTHER ITEMS OR SERVICES PROVIDED UNDER THIS AGREEMENT. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, BOTH PARTIES ACKNOWLEDGE THAT THE PARTIES' WEB SITES AND THE CONTENT (INCLUDING ANY SERVERS OR OTHER HARDWARE, SOFTWARE AND ANY OTHER ITEMS USED OR PROVIDED BY THE PARTIES OR ANY THIRD PARTIES IN CONNECTION WITH HOSTING THE WEB SITES OR THE CONTENT OR PERFORMANCE OF ANY SERVICES HEREUNDER) ARE PROVIDED "AS IS" WITHOUT ANY WARRANTIES OF ANY KIND. THE PARTIES MAKE NO WARRANTY THAT THEY WILL CONTINUE TO OPERATE THEIR WEB SITES OR OFFER THE CONTENT IN THEIR CURRENT FORM, THAT THEIR WEB SITES OR THE CONTENT WILL BE ACCESSIBLE WITHOUT INTERRUPTION, THAT THE SITES OR THE CONTENT WILL MEET THE REQUIREMENTS OR EXPECTATIONS OF THE OTHER PARTY, OR THAT THE CONTENT, SOFTWARE OR ANY OTHER ANY MATERIALS ON ITS WEB SITES OR THE SERVERS AND SOFTWARE THAT MAKES ITS WEB SITES AVAILABLE ARE FREE FROM ERRORS, DEFECTS, DESIGN FLAWS OR OMISSIONS. 6. TERM AND TERMINATION. THE TERM OF THIS AGREEMENT IS AS SET FORTH ON EXHIBIT C. 6.2 TERMINATION. Either party may terminate the Term upon not less than thirty (30) days' prior written notice to the other party of any material breach hereof by such other party, provided that such other party has not cured such material breach within such thirty (30) day period. 6.3 Either Party may terminate this agreement, without cause, by providing a thirty (30) day prior written notice to the other party. 6.4 EFFECT OF TERMINATION. Upon termination or expiration of the Term for any reason, all rights and obligations of the parties under this Agreement shall be extinguished, except that: (a) all accrued payment obligations hereunder shall survive such termination or expiration; and (b) the rights and obligations of the parties under Sections 4.2, 4.3, 5, 6, 7 and 8 shall survive such termination or expiration. 7. INTELLECTUAL PROPERTY. 7.1 COMPANY. AS BETWEEN THE PARTIES, Company retains all right, title and interest in and to the Company Web Sites (including, without limitation, any and all content, data, URLs, domain names, technology, software, code, user interfaces, "look and feel", Trademarks and other items posted thereon or used in connection or associated therewith; but excluding any Content or other items supplied by InfoSpace) and the Company Marks along with all Intellectual Property Rights associated with any of the foregoing. All goodwill arising out of InfoSpace's use of any of the Company Marks shall inure solely to the benefit of Company. 7.2 INFOSPACE. As between the parties, InfoSpace retains all right, title and interest in and to the Content and the InfoSpace Web Sites (including, without limitation, any and all content, data, URLs, domain names, technology, software (including, without limitation, the Personal Desktop Portal Application), code, user interfaces, "look and feel", Trademarks and other items posted thereon or used in connection or associated therewith; but excluding any items supplied by Company), user data gathered -6- from or through any InfoSpace tools or applications, and the InfoSpace Marks, along with all Intellectual Property Rights associated with any of the foregoing. All goodwill arising out of Company's use of any of the InfoSpace Marks shall inure solely to the benefit of InfoSpace. 7.3 COPYRIGHT NOTICES. All Co-branded Pages will include the following acknowledgment, along with the InfoSpace logo. "Powered by InfoSpace" or "Powered by InfoSpace.com" InfoSpace and Company acknowledge that the Co-branded Pages may also contain copyright and patent notices of copyrighted or copyrightable works, including those of InfoSpace Content providers. InfoSpace will be given credit in advertisements of Company which promote the Content services provided by InfoSpace in a manner such as "brought to you by InfoSpace.com" or similar text. 7.4 OTHER TRADEMARKS. InfoSpace shall not register or attempt to register any of the Company Marks or any Trademarks which Company reasonably deems to be confusingly similar to any of the Company Marks. Company shall not register or attempt to register any of the InfoSpace Marks or any Trademarks which InfoSpace reasonably deems to be confusingly similar to any of the InfoSpace Marks. 7.5 FURTHER ASSURANCES. Each party shall take, at the other party's expense, such action (including, without limitation, execution of affidavits or other documents) as the other party may reasonably request to effect, perfect or confirm such other party's ownership interests and other rights as set forth above in this Section 7. 8. GENERAL PROVISIONS. 8.1 CONFIDENTIALITY. Each party (the "Receiving Party") undertakes to retain in confidence the terms of this Agreement and all other non-public information and know-how of the other party disclosed or acquired by the Receiving Party pursuant to or in connection with this Agreement which is either designated as proprietary and/or confidential or by the nature of the circumstances surrounding disclosure, ought in good faith to be treated as proprietary and/or confidential ("Confidential Information"); provided that each party may disclose the terms and conditions of this Agreement to its immediate legal and financial consultants in the ordinary course of its business. Each party agrees to use commercially reasonable efforts to protect Confidential Information of the other party, and in any event, to take precautions at least as great as those taken to protect its own confidential information of a similar nature. Company acknowledges that the terms of this Agreement and user information are Confidential Information of InfoSpace. The foregoing restrictions shall not apply to any information that: (a) was known by the Receiving Party prior to disclosure thereof by the other party; (b) was in or entered the public domain through no fault of the Receiving Party; (c) is disclosed to the Receiving Party by a third party legally entitled to make such disclosure without violation of any obligation of confidentiality; (d) is required to be disclosed by applicable laws or regulations (but in such event, only to the extent required to be disclosed); or (e) is independently developed by the Receiving Party without reference to any Confidential Information of the other party. Upon request of the other party, or in any event upon any termination or expiration of the Term, each party shall return to the other all materials, in any medium, which contain, embody, reflect or reference all or any part of any Confidential Information of the other party. Each party acknowledges that breach of this provision by it would result in irreparable harm to the other party, for which money damages would be an insufficient remedy, and therefore that the other party shall be entitled to seek injunctive relief to enforce the provisions of this Section 8.1. 8.2 INDEPENDENT CONTRACTORS. Company and InfoSpace are independent contractors under this Agreement, and nothing herein shall be construed to create a partnership, joint venture, franchise or agency relationship between Company and InfoSpace. Neither party has any authority to enter into agreements of any kind on behalf of the other party. 8.3 ASSIGNMENT. Company may not assign this Agreement or any of its rights or delegate any of its duties under this Agreement without the prior written consent of InfoSpace; except that either -7- party may, without the other party's consent, assign this Agreement or any of its rights or delegate any of its duties under this Agreement: (a) to any affiliate of such party; or (b) to any purchaser of all or substantially all of such party's assets or to any successor by way of merger, consolidation or similar transaction. Subject to the foregoing, this Agreement will be binding upon, enforceable by, and inure to the benefit of the parties and their respective successors and assigns. 8.4 CHOICE OF LAW; FORUM SELECTION. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Washington without reference to its choice of law rules. Company hereby irrevocably consents to exclusive personal jurisdiction and venue in the state and federal courts located, in King County, Washington with respect to any actions, claims or proceedings arising out of or in connection with this Agreement, and agrees not to commence or prosecute any such action, claim or proceeding other than in the aforementioned courts. 8.5 NONWAIVER. No waiver of any breach of any provision of this Agreement shall constitute a waiver of any prior, concurrent or subsequent breach of the same or any other provisions hereof, and no waiver shall be effective unless made in writing and signed by an authorized representative of the waiving party. 8.6 FORCE MAJEURE. Neither party shall be deemed to be in default of or to have breached any provision of this Agreement as a result of any delay, failure in performance or interruption of service, resulting directly or indirectly from acts of God, acts of civil or military authorities, civil disturbances, wars, strikes or other labor disputes, fires, transportation contingencies, interruptions in telecommunications or Internet services or network provider services, failure of equipment and/or software, other catastrophes or any other occurrences which are beyond such party's reasonable control. 8.7 NOTICES. Any notice or other communication required or permitted to be given hereunder shall be given in writing and delivered in person, mailed via confirmed facsimile or e-mail, or delivered by recognized courier service, properly addressed and stamped with the required postage, to the individual signing this Agreement on behalf of the applicable party at its address specified in the opening paragraph of the agreement and shall be deemed effective upon receipt. Either party may from time to time change the individual to receive notices or its address by giving the other party notice of the chance in accordance with this section. In addition, a copy of any notice sent to InfoSpace shall also be sent to the following address: InfoSpace.com, Inc. Freei Networks, Inc. 15375 NE 90th Street 909 South 336th St. Suite 110 Redmond, WA 98052 Federal Way, WA 98003 Fax: (425) 883-4846 Fax: (253) 661-3431 Attention: General Counsel Attention: Jolene Smith 8.8 SAVINGS. In the event any provision of this Agreement shall for any reason be held to be invalid, illegal or unenforceable in any respect, the remaining provisions shall remain in full force and effect. If any provision of this Agreement shall, for any reason, be determined by a court of competent jurisdiction to be excessively broad or unreasonable as to scope or subject, such provision shall be enforced to the extent necessary to be reasonable under the circumstances and consistent with applicable law while reflecting as closely as possible the intent of the parties as expressed herein. 8.8 INTEGRATION. This Agreement contains the entire understanding of the parties hereto with respect to the transactions and matters contemplated hereby, supersedes all previous agreements or negotiations between InfoSpace and Company concerning the subject matter hereof, and cannot be amended except by a writing signed by both parties. This Agreement does not constitute an offer by InfoSpace and it shall not be effective until signed by both parties. 8.9 COUNTERPARTS; ELECTRONIC SIGNATURE. This Agreement may be executed in counterparts, each of which will be deemed an original, and all of which together constitute one and the same instrument. To expedite the process of entering into this Agreement, the parties acknowledge that Transmitted Copies of the Agreement will be equivalent to original documents until such time as original documents are -8- completely executed and delivered. "Transmitted Copies" will mean copies that are reproduced or transmitted via photocopy, facsimile or other process of complete and accurate reproduction and transmission. IN WITNESS WHEREOF, the parties have duly executed and delivered this Agreement as of the Effective Date. FREEI NETWORKS, INC. INFOSPACE.COM, INC. ("Company) ("InfoSpace") By: /s/ Bob McCausland By /s/ Charles Stubbs -------------------------- ----------------------------- Name Robert (Bob) McCausland Name: Charles Stubbs Title President/CEO Title: V.P. Bus. Dev. -9- EXHIBIT A CONTENT The Content consists of, but is not limited to, the following indexes, directories and other items and services (as the same may by updated, revised or modified by InfoSpace in its sole discretion from time to time): 1. Yellow Pages 2. White Pages 3. Netsearch 4. Classifieds 5. City Guides 6. Finance 7. News 8. Sports news 9. Community 10. Government 11. E-Shopping 12. International Listings 13. Business Services 14. Entertainment 15. ActiveShopper 16. InfoSpace "Personal Desktop Portal" 17. Other items and services that may from time to time be added to the InfoSpace Web Sites by InfoSpace (in its sole discretion) 18. MyFreei - personal section The following items are not included as part of the Content: 1. Web Page Creator 2. Event Manager 3. Forums 4. Web-based email 5. Address Book 6. Chat The actual name of these services may change. Company must obtain the prior approval of InfoSpace if Company desires to change the name of any of these services. -10- EXHIBIT B TRADEMARKS COMPANY MARKS [Logo] - FREEI.NET (STYLIZED) - FREEI.NET (TYPED) - FREEI NETWORKS - IREPORTS - ISEE - FREEISEARCH - INET - FREEIMALL (TYPED) - FREEIMALL (STYLIZED) - FREEIVALUES - FREEICHAT - FREEIPAGE - FREEITOWN - FOR FREE INTERNET ACCESS & EMAIL SERVICES GO TO FREEI NETWORKS AT HTTP://WWW.FREEI.NET/ - BECAUSE THE INTERNET WAS MEANT TO BE FREE - GET YOUR 100% FREE INTERNET ACCESS & EMAIL AT WWW.FREEI.NET - YOUR 100% FREE INTERNET ACCESS & EMAIL SERVICE PROVIDER - FREEIFRIENDS INFOSPACE MARKS InfoSpace InfoSpace.com The Brand That's Building The Internet [Logo] Powered By InfoSpace Powered by InfoSpace.com ActiveShopper PageExpress Search Engine For The Real World The Stuff That Portals Are Made Of Personal Desktop Portal -11- EXHIBIT C 1. DEFINITIONS. As used in this Agreement, the following terms have the following defined meanings: CO-BRAND Fee" means a monthly nonrefundable sum in the amount of [*]. "IMPRESSION THRESHOLD DATE" means the first date on which the number of Impressions meets or exceeds the Impression Threshold. 2. TERM. The term of this Agreement shall commence on the Effective Date and, unless earlier terminated or extended as provided in this Agreement, shall end upon the [*] anniversary of this Agreement ("Term"). 3. CO-BRAND FEE. Infospace [*] the co-brand fee. 4. BANNER ADVERTISEMENTS. InfoSpace and/or Company shall have the right to serve Banner Advertisements on the Co-branded Pages, to be determined from the choices listed below. The appearance of the Banner Advertisements will be as reasonably determined by InfoSpace; provided, that InfoSpace may reject any Banner Advertisement if such Banner Advertisement would materially adversely affect the download time or performance of such Co-branded page. Any available inventory of Banner Advertisements sold by the Company for the Co-branded Pages shall be "run of site" (e.g., not targeted to any specific type or area of the Co-branded Pages). - The Company shall provide the content for any Banner Advertisements sold by the Company to InfoSpace at the Company's sole expense and in a form and format approved by InfoSpace. Neither party will submit for any Co-branded Page any Banner Advertisement which contains any material that is libelous or defamatory or that infringes any Intellectual Property Right or other right of any third party. FOUR OPTIONS FOR GENERATING REVENUE FROM CO-BRANDED PAGES: The parties will agree in writing to one of the following four options in connection with the sale of Banner Advertisements on the Co-branded pages. 1. Infospace and COMPANY WILL divide banner inventory on Co-branded Pages [*] and each party will be entitled to retain all sums it receives from the sale of its banner inventory. 2. Infospace may sell the Banner Advertisements exclusively. Infospace will retain [*] of gross revenue as cost of sales and will deliver to Company [*] of the remaining gross revenue. 3. Company may sell the Banner Advertisements exclusively, Company will retain [*] of gross revenues to cover cost of sales and will deliver to InfoSpace [*] of the remaining gross revenue. 4. Infospace shall have the exclusive right to sell banner inventory and will pay to Company on a monthly basis [*] for each click-through to Infospace applications. 5. RECORDS AND AUDIT; LATE PAYMENTS. During the Term, the parties shall maintain accurate records of click-through revenues and fees payable to the other party pursuant to this Exhibit C. Either party may, upon ten (10) days advance notice to the other party, examine and audit such records of the other party in order to verify the figures reported in any reports made to the other party and any amounts owed to the other party under this Agreement. Any such audit shall be conducted, to the extent possible, in a manner that does not interfere with the ordinary business operations of the other party. In the event that any audit shall reveal an underpayment of more than five percent (5%) of the amounts due for any quarter, the other party will reimburse the other party for the actual costs of such audit. -12- [*] = Confidential Treatment Requested EX-10.12 16 EX-10.12 Exhibit 10.12 COMMERCIAL LEASE THIS COMMERCIAL LEASE ("Lease"), dated November 15, 1999, is made between INTER CO-OP USA NO. III [ILLEGIBLE] NETWORKS, INC. ("Tenant"). In consideration of the mutual convenants in this Lease, Landlord and Tenant agree as follows: 1. BASIC PROVISIONS AND DEFINITIONS. The following terms, whenever used in this Lease, with the first letter of each word capitalized, will have the meanings set forth in this Section, unless the context otherwise requires: 1.1. PREMISES. The leased portion of the property as shown on the floor plan attached as Exhibit A. The Premises as located on the real property legally described on Exhibit B. 1.2 BUILDING NAME AND ADDRESS. CAMPUS BUSINESS CENTER 33761 9TH AVENUE SOUTH FEDERAL WAY, WA 98003 1.3 TENANT'S SQUARE FOOTAGE & PROPORTIONATE SHARE. Tenant's Square Footage is approximately 2,721. Tenant's Proportionate Share of the entire net leasable space in the property is agreed to be 4.05%. 1.4 DATE OF EXECUTION. The date above written, which is the date of full execution hereof. 1.5 COMMENCEMENT DATE (SECTION 4). January 1, 2000. 1.6 TERM (SECTION 3). The period beginning on the Commencement Date and ending on December 31, 2002 (which date shall be the last day of a month)("Lease Term End Date"). 1.7 MINIMUM RENT FOR INITIAL (SECTION 7). Months 1-6: $1,576.80 per month plus NNN (as described in Paragraph 9) Months 7 - 12: $1,624.10 per month plus NNN. Months 13 - 18: $1,672.83 per month plus NNN. Months 19 - 24: $1,723.01 per month plus NNN. Months 25 - 30: $1,774.70 per month plus NNN. Months 31 - 36: $1,827.94 per month plus NNN.
1.8 RENT PAYMENT. Monthly, in advance on the first calendar day of each month. 1.9 DEPOSITS (SECTION 8). Rent Deposit $1,576.80. Security Deposit $1,827.94 1.10 LANDLORD'S NOTICE AND PAYMENT ADDRESS (SECTION 24.15).
NOTICE: PAYMENT: c/o Morris Piha Real Estate Services c/o Morris Piha Real Estate Services. 14100 SE 36th Street 14100 SE 36th Street Suite 200 Suite 200 Bellevue, WA 98006-1334 Bellevue, WA 98006-1134 Telephone (425) 643-8400 Telephone (425) 643-8400
TENANT'S BILLING AND NOTICE ADDRESS (SECTION 24.15) 909 S. 336th St. #110 Federal Way, WA 98003 1.12 GUARANTOR'S ADDRESS (SECTION 24.18). -1- 1.13 TENANT'S TRADE NAME (IF ANY), Freei Net. 1.14 STATE OF ORGANIZATION OF TENANT (IF OTHER THAN INDIVIDUAL). WA 1.15 PERMITTED USERS UNDER LEASE (SECTION 5). General Office Use and use as a call center. 1.16 RIDERS & EXHIBITS TO THE LEASE (SECTION 24.20). Riders #: 28 & 29. Exhibit Letters: A & B 1.17 BROKER FEE (IF ANY, OWNED BY LANDLORD) (SECTION 25). By separate letter 2. PREMISES. Landlord hereby leases the Premises to Tenant and Tenant hereby leases the Premises from Landlord, upon the term and condition set forth in this Lease. The Premises are a part of the building which is situated at the Building Address as set out in Section 1. 3. TERM. Tenant leases from Landlord the Premises for a lease term described in Section 1.6 (the "Lease Term"). The Lease Term will begin on the Commencement date and end at midnight on the Lease Term End Date unless sooner terminated or extended as provided elsewhere in this Lease. 4. POSSESSION. 4.1 POSSESSION. Except as provided elsewhere in this Lease, Tenant will be entitled to possession of the Premises on the Commencement Date. 4.2 DELAY OF POSSESSION. If Landlord, for any reason, cannot deliver possession of the Premises to Tenant upon the Commencement Date, this Lease shall not be void or voidable, nor shall Landlord be liable to Tenant for any loss or damage resulting from ??? but then shall be a rent abatement covering the period between the Commencement Date and the time the Landlord ??? to tenant and all of the terms and conditions of this Lease shall remain in full force and effect. If Landlord does not deliver possession of the Premises to Tenant within 120 days after the Commencement Date (the "Delivery period"), Tenant may, at its option cancel this Lease by written notice delivered to Landlord within the ten day period immediately succeeding the final day of the Delivery Period. If Tenant does not deliver such written notice to Landlord, within that ten-day period, Tenant's right to cancel this Lease will terminate and be of no further force or effect, and the terms and conditions of this Lease will remain in full force and effect, except that Tenant's rent abatement shall continue until the time Landlord delivery possession of the Premises to Tenant. 4.3 EARLY POSSESSION. Landlord and Tenant may agree to Tenant's occupancy of the Premises prior to the Commencement Date as per PARAGRAPH #29. If Tenant occupies the Premises prior to the Commencement Date, the occupancy will be subject to all provisions of this Lease, the occupancy shall not advance the termination date and Tenant shall pay rent throughout the period of early occupancy as set forth in Sections 7, 8 and 9 of this Lease. 4.4 SURRENDER OF PREMISES. At the expiration or sooner termination of this Lease, Tenant shall return the Premises to Landlord in the same condition in which received, broom clean, reasonable wear and tear excepted. Tenant shall remove all personal property trade fixtures, appliances and equipment ("Fixtures"). Where such removal will require structural changes or damage to the Premises, Landlord will have the option to have same removed at Tenant's expense and under Landlord's supervision. Tenant shall also remove any and all alterations which Landlord designates to be removed pursuant to Section 10.4 below, and shall restore the Premises to the condition they were in prior to the installation or construction of said alterations. If Tenant has failed to fully pay all amounts due under this lease, Landlord may, at Landlord's option, designate any or all Fixtures paid for by Tenant and installed on the Premises. Landlord's payment in full or in part of any such unpaid amounts, and Tenant shall provide Landlord with a Bill of Sale correctly evidence the transfer of ownership. If Tenant fails to remove any fixture, at Landlord's option, Tenant shall agree to designate and permit Landlord to remove the same at Tenant's expense. Tenant shall return all keys to the Landlord within 12 hours following termination of this Lease or pay for the cost of new keys, if the Landlord so requires. Tenant's obligation to perform this covenant shall survive the expiration of termination of this Lease. Landlord may place and maintain "For Lease" signs in conspicuous places on the Premises for 180 days prior to the expiration or early termination of this Lease, and reserves the right to enter any part of the Premises during the same 180-day period to show the Premises to prospective tenants. 5. USE. 5.1 USE. Tenant covenants that at all times during the Lease term and such other time as Tenant occupies the Premises, Tenant shall use the Premises for the Permitted Uses and for no other purposes without the prior written consent of Landlord, as set forth in Section 1.13. 5.2 USES PROHIBITED. Tenant shall not do or permit anything to be done in nor about the Premises or bring or keep anything therein which will in any way increase or affect the existing rate of any fire or other insurance policy upon the Premises or the Building, or cause a cancellation of any such insurance policy covering said Premises, nor which will in any way obstruct or interfere with the right of other -2- tenants or occupants of the Building or injure or annoy them, nor shall the Tenant use or allow the Premises to be used for any improper, immoral, unlawful, objectionable or offensive purpose, nor shall Tenant cause, maintain or suffer or permit any ??? on or about the Premises. Tenant shall not commit or allow to be committed any waste in or upon the Premises and shall refrain from using or permitting the use of the Premises or any portion thereof as living quarters, sleeping quarters or for lodging purposes. Tenant shall not do or permit anything to be done in or about the Premises, nor bring or keep anything thereon that is or will constitute or create a hazardous waste or substance or violate any environmental law. Tenant will indemnify and hold the Landlord harmless from any and all damages related to the Tenant's introduction to, or creation of, hazardous waste on the Premises. Tenant shall advise Landlord in writing immediately of any environmental concern related to Tenant's use and occupancy of the Premises brought to Tenant's attention by any private party or governmental agency or official. Landlord shall have the right to remedy any environmental problem and to conduct any environmental tests reasonably necessary to discover a hazardous waste or other environmental problem and Tenant shall be liable for all costs and expenses related to such tests or remedial action if a hazardous waste or environmental problem created by Tenant is found to exist. 5.3 BUILDING CODES AND ZONING. Tenant has investigated all applicable building and zoning codes, regulations and ordinances to determine whether Tenant's intended use of the Premises is permitted. Based upon this investigation, Tenant accepts the Premises "as is" subject to all applicable statutes, ordinances, rules and regulations governing Tenant's use of the Premises. Any and all expenses required to comply with all applicable statutes, ordinances, rules, regulations and requirements in effect during the Lease Term or part thereof regulating Tenant's use of the Premises will be borne exclusively by Tenant. Tenant agrees to comply with all such statutes, ordinances, rules and regulations throughout the Lease Term. 5.4 CONDITION OF PREMISES. Tenant has inspected the plumbing, lighting, air conditioning, heating, doors, windows, interior walls, flooring and all other elements of the Premises prior to execution of this Lease. Based upon that inspection, Tenant accepts the Premises "as is" in the absence of any material change in its condition prior to the Commencement Date or the date the Tenant takes possession of the Premises, whichever is earlier. Tenant acknowledges that neither Landlord nor Landlord's agent has made any representation or warranty as to the present or future suitability of the Premises for the conduct of Tenant's business. 6. COMMON AREAS. 6.1 AREAS. Landlord shall make available such areas and facilities for the common use of all tenants of the Building including but not limited to parking areas, driveways, truckways, delivery passages, truck-loading area, access and egress roads, wall ??? and landscaped and planted areas) as Landlord shall reasonably deem appropriate ("Common Areas"). The roof and exterior walls of the Building and the utility systems up to the exterior walls of the Premises are Common Areas. Landlord or its agents shall operate, manage, equip, light, repair, replace and maintain the Common Areas for the intended purposes in such manner as Landlord shall reasonably, in its sole discretion, determine. Landlord may, from time to time, change the size, location, nature and use of any Common Area, and make installations therein and move and remove the same, provided that Tenant's access to the Premises is not materially altered. All expenses in connection with the Common Areas are Operating Expenses for the purposes of Section 9 below. 6.2 RIGHTS. Tenant and its employees, agents and invitees shall have the non-exclusive right (in common with other Tenants of the Building and Landlord) to use the Common Areas, subject to any Rules, as defined in Section 18. Landlord's Rules may include the documentation of specific areas in which cars owned by Tenant, its employees, agents and invitees must be parked. Landlord may at any time temporarily close any Common Areas due to construction, maintenance, repair or changes to any part of the Building or the real property upon which the Building is located, with prior notice to Tenant. 6.3 PARKING. Tenant shall be entitled to use, on a non-reserved basis, parking available to the Building. Tenant shall not at any time interfere with the rights of Landlord or of other tenants of the Building or other adjacent buildings or invitees of the same to use any of the parking areas. Twenty-four hour parking on the real property upon which the Premises are located shall not be permitted by Tenant, its employees, agents or invitees. 7. MINIMUM RENT. 7.1 AMOUNT. During the Lease Term, Tenant agrees to pay to Landlord at Landlord's Payment Address or such other place as designated, the Minimum Rent, in the manner described in Section 7.2. 7.2 RENT PAYMENT. The Minimum Rent for the Lease Term shall be paid in advance of the first day of each calendar month of the Lease Term or any period prior or subsequent thereto while Tenant is in possession of the Premises. The Minimum Rent for any partial month shall be prorated based upon a 30-day month. The Minimum Rent is exclusive of any sales, franchise, business and occupation or other tax based on rents. Should any such taxes apply during the term of this Lease, the Minimum Rent shall be increased by such amount. In the event percentage or other additional rent is payable by the Tenant under this Lease, it shall be paid in the manner and at the time set forth in the Riders attached hereto and by reference made a part of this Lease. All Minimum Rent, Additional Rent (as hereinafter defined) and other amounts payable under this Lease shall be paid without deduction or offset. -3- 8. FIRST MONTH'S RENT AND SECURITY DEPOSIT. 8.1 DEPOSITS. As set out in Section 1.9, Tenant has paid Landlord the Rent Deposit, which shall be credited to the payment of the first month's rent. Tenant has also deposited the Security Deposit for the performance of all of the terms, covenants and conditions of this Lease and as additional consideration for entering into this Lease. Landlord shall not be required to keep the Security Deposit separate from its general accounts and Tenant shall not be entitled to interest on such deposit. Tenant may not apply the Security Deposit to the last month's rent. 8.2 APPLICATIONS ON DEFAULT. If Tenant is in default under this Lease, Landlord may use the Security Deposit, or any portion thereof to cure the default or to compensate Landlord for damages (including attorneys' fees) sustained by Landlord resulting from Tenant's default, including, but not limited to, the payment of rent and the cost of cleaning and/or repairing the Premises. Any payment to Landlord from the Security Deposit, whether during the Lease Term or upon termination of this Lease, shall not be considered a payment of liquidated damages. Tenant shall, within ten days after written demand, deposit cash with Landlord in an amount sufficient to restore the Security Deposit to the full amount provided in this Lease, and Tenant's failure to do so shall be a material breach of this Lease. If Tenant is not in default at the expiration of the Lease Term and after Tenant has vacated the Premises, Landlord shall return the Security Deposit (less any amounts deducted by Landlord that Tenant has not restored pursuant to this Section 8.2 and less any amounts used by Landlord to restore the Premises to the condition required in Section 4.4) within 45 days of the latter of such expiration of this Lease or vacation of the Premise. No trust relationship is created between Landlord and Tenant with respect to the Security Deposit. 9. OPERATING EXPENSES. 9.1 NET LEASE. The purpose of this Section 9 is to insure that, in addition to Minimum Rent, Tenant pays its Proportionate Share of all expenses relating to the use, maintenance, ownership, repair and insurance of the Premises, except costs specifically assumed by Landlord according to other terms of this Lease. 9.2 DIRECT EXPENSE. The expenses listed in this Section 9.2 ("Direct Expenses") are to be paid directly by Tenant: 9.2.1 UTILITIES AND BUILDING SERVICES. Tenant agrees to pay before delinquency and at its sole cost and expense, all charges for utilities and building services supplied to the Premises including, without limitation, water, electricity, gas, sewer, waste disposal, security, heating, ventilating, and air conditioning, throughout the full Lease Term. Landlord shall not be liable for the failure of any of these services for any reason whatsoever. If charges for any or all of such utility services are charged for the Building as a whole, Tenant agrees to pay, upon demand, Tenant's Proportionate Share of such charges. If charges for any or all of such utility or building services are charged for a larger space containing the Premises, Tenant agrees to pay upon demand a share of any such charges based on the proportion that the square footage of the Premises bears to such larger space or a share determined by Landlord based upon Landlord's estimate of Tenant's consumption relative to other Tenant's sharing such utilities or building services. 9.2.2 INSURANCE PROCURED BY TENANT. Throughout the Lease Term and any other period(s) of occupancy of the Premises by Tenant, Tenant shall, at Tenant's expense, obtain and maintain the following insurance policies, naming as additional insureds, the Landlord, Morris Piha Management Group, Inc. and Landlord's lender, as instructed by Landlord: (a) LIABILITY INSURANCE. A commercial general liability insurance policy providing coverage for bodily injury liability, property damage liability and personal injury liability with minimum limits of not less than $1,000,000 Combined Single Limit per accident and $2,000,000 General Aggregate. Such insurance policies shall include Blanket Contractual Liability and Owners and Contractors Protective endorsements. Landlord may increase or decrease the required limit as it deems necessary based upon periodic insurance reviews. The insurance required by this Section shall be on an occurrence basis, and underwritten by an acceptable insurer licensed to do business in the State of Washington. If Tenant is unable to obtain this insurance on an occurrence basis, it may be on a claims-made basis provided that, in addition, Tenant, at Tenant's expense, obtains an owner's protective policy issued in the name of Landlord only, which is on an occurrence basis for the limits required by this Section 9.2.2(a). The insurance shall be written as a primary policy not contributing with and not in excess of coverage which Landlord may carry. (b) PERSONAL PROPERTY INSURANCE. A special form policy of property insurance (or the equivalent) covering all Tenant's personal property, including but not limited to Tenant's furniture, fixtures, leasehold improvements, equipment and inventory, in the amount of its full replacement costs. Such property insurance coverage shall at a minimum insure against loss resulting from fire, lightning and extended or broad form perils. Landlord shall be named as Loss Payee as its interest may appear in tenant improvements and betterments. -4- (c) BUSINESS INTERRUPTION AND PLATE GLASS INSURANCE. Business interruption insurance in an amount sufficient to protect Tenant against any additional costs and lost income associated with a move to temporary space due to a business interruption. In addition, plate glass insurance in an amount sufficient to replace windows in the Premises in the event of breakage. Tenant shall obtain the insurance required by this Section 9.2.2 from companies reasonably acceptable to Landlord licensed to do business in the State of Washington. Before occupying the Premise, Tenant shall deliver to Landlord or Landlord's agent, copy of the insurance policies required by this Section 9.2.2, or certificates evidencing the existence and amount of such insurance. If required by Landlord, or Landlord's agent, Tenant shall deliver the original policy to Landlord's lender. Not later than ten days before expiration of these policies, the Tenant shall deliver to Landlord evidence that insurance required by this Section 9.2.2 has been continued. The policies shall not be cancelable or subject to reduction of coverage until after 30 days prior written notice to Landlord, or its Agent, and Landlord's lender, if any. If Tenant fails to maintain the required insurance Landlord may, but it is not required to, procure the same at Tenant's expense. 9.2.3 PERSONAL PROPERTY TAXES. Tenant shall pay, before delinquency, any and all taxes levied or assessed and payable during the Lease Term upon all Tenant's equipment, furniture, fixtures and any other personal property located on the Premises. If any of the same are assessed or taxed with the building or real property upon which the Building is located, Tenant shall pay Landlord the amount of such taxes within ten days after receipt of a written statement setting forth the amount of such taxes that Landlord has determined to be attributable to Tenant's personal property. 9.2.4 LICENSES AND TAXES. Tenant shall be liable for, and shall pay throughout the Lease Term, all license and excise fees and occupation taxes covering the business conducted on the premises. If any governmental authority or unit under any present or future law effective at any time during the Lease Term shall in any manner levy a tax on rents payable under this Lease or rent accruing from use of the premises or a tax in any form against Landlord because of, or measured by, income derived from the leasing or rental of said property, such tax shall be paid by Tenant, either directly or through Landlord, and upon Tenant's default therein, Landlord shall have the same remedies as upon failure to pay Minimum Monthly Rent. It is understood and agreed, however, that Tenant shall not be liable to pay any net income tax imposed on Landlord unless, and then only to the extent that, the net income tax is a substitute for real estate taxes. 9.3 ADDITIONAL RENT. Tenant shall pay as additional rent ("Additional Rent") in the manner set forth in Section 9.4, Tenant's Proportionate Share of the following expenses 9.3.1 INSURANCE PROCURED BY LANDLORD. Throughout the Lease term, Tenant's Proportionate Share of the following insurance policies, obtained and maintained by Landlord, insuring the Landlord and Landlord's lender or any other insurance that Landlord may deem necessary, including but not limited to earthquake and flood insurance. (a) LIABILITY INSURANCE. A commercial general liability insurance policy providing coverage for bodily injury liability, property damage liability and personal injury liability with in such amounts and with such endorsements as Landlord may reasonably determine from time to time. (b) FIRE AND CASUALTY INSURANCE. A fire and casualty insurance policy with extended coverage endorsements for the full replacement value of the Premises as the Landlord may reasonably determine from time to time. (c) BOILER AND RENTAL LOSS INSURANCE. Boiler interruption and rental loss insurance in an amount sufficient to protect Landlord from any loss of rental income resulting from boiler failure or any other reason. 9.3.2 REAL PROPERTY TAXES AND ASSESSMENTS. Tenant's Proportionate Share of all real property taxes and general and special assessments levied and assessed against the Building improvements on the land of which the Premises are a part. Each year Landlord shall notify Tenant of Landlord's calculation of Tenant's Proportionate Share of the real property taxes and assessments. Tenant shall pay Tenant's Proportionate Share of said taxes or assessments in the manner set forth in Section 9.4. Upon written request, Landlord will furnish Tenant with a copy of the Tax assessment bill. Landlord may require from Tenant, upon reasonable written notice from Landlord, a payment of the Tenant's Proportionate Share of such real property taxes and/or assessments to Landlord on a periodic basis. If this Lease commences or terminates other than on January 1 and December 31 respectively, taxes and assessments payable shall be prorated in the first and last calendar years of the Lease Term. 9.3.3 COMMON AREA EXPENSES. To the extent not covered by other provisions of this Lease, Tenant shall pay Tenant's Proportionate Share of the following costs associated with Common Areas of the Building in the manner set forth in Section 9.4: -5- (a) All real estate taxes, including assessments, all insurance costs, all sprinkler, fire, life safety system utility costs and all other costs to maintain, repair and replace common areas (including common area signage), parking lots, sidewalks, driveways and other areas used in common by the tenants of the Building (including, but not limited to HVAC, signs and parking), as well as personal property used in common by the tenants of the Building. (b) All costs to supervise and administer the Common Areas, parking lots, driveways and other areas used in common by the tenant or occupants of the Building. The costs shall include such fees as may be paid to a third party, including management fees in connection with the same and shall include, in addition, a fee to Landlord to supervise and administer the same in an amount equal to 15 percent of the total costs of Subsection (a) and (b). (c) Any parking charges, utility subcharges, or any other costs levied, assessed or imposed by or at the direction of, or resulting from statutes or regulations, or interpretations thereof, promulgated by any governmental authority in connection with the use or occupancy of the Premises or the parking facilities serving the Premises. 9.3.4 PAYMENT IN LIEU OF ACTUAL COSTS. In lieu of the actual cost of replacing the roof of the building, replacing or repaving parking areas and drive aisles, and repainting all or substantially all of the Building, Tenant shall pay Landlord each month during the Lease Term an amount equal to 2 percent of the applicable Minimum Rent. 9.4 PAYMENT OF ADDITIONAL RENT. Tenant shall pay Additional Rent described in Section 9.3 or elsewhere, in the manner set forth herein: 9.4.1 ADDITIONAL MONTHLY RENT. On the Commencement Date or as soon as possible thereafter, Landlord shall submit to Tenant a statement of the estimated total Additional Rent owed by Tenant under Section 9.3 for the period from the Commencement Date to the end of the calendar year. Tenant shall pay such estimated Additional Rent in monthly payments equal to the amount of the Additonal Rent divided by the number of full months remaining in the period from the Commencement date to the end of the calendar year (the "Additional Monthly Rent"). The Additional Monthly Rent shall be paid concurrently with the monthly payment of the Minimum rent and shall be adjusted as provided in Section 9.4.2 herein. 9.4.2 ADJUSTMENTS STATEMENT. By March 1 of each year of the Lease Term, Landlord shall endeavor to provide Tenant with a statement showing the actual Additional Rent for the prior calendar year (the "Adjustments Statement"). If the total of the Additional Monthly Rent payments which the Tenant has made for the prior calendar year is less than Tenant's Proportionate Share of the actual Additional Rent for such period, Tenant shall pay within ten days after receipt of the Adjustments Statement, an amount equal to (i) the deficiency for the previous calendar year, plus (ii) the definiency due to Additional Monthly Rent payments made in the current calendar year prior to such Additional Monthly Rent being adjusted as set forth in Section 9.4.3. Failure of Landlord to submit Adjustment Statements shall not be deemed a waiver of Tenant's obligation to pay sums as required by this Section 9.4. 9.4.3 ADJUSTMENT OF ADDITIONAL MONTHLY RENT. The amount of Additional Monthly Rent owing in the current calendar year shall be adjusted concurrently with Landlord's provision of the Adjustments Statement to Tenant. Taking into account the actual amount of the Additional Rent for the previous calendar year, Landlord shall submit to Tenant as part of the Adjustments Statement (i) an estimate of the total Additional Rent for the current calendar year and (ii) the adjusted Additional Monthly Rent amount based on such estimate. 9.4.4 DEFICIENCY/OVERPAYMENT. Even though the term has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's Proportionate Share of the Additional Rent for the year in which the Lease terminates, Tenant shall immediately pay any deficiency between the total of the Additional Monthly Rent payment made and the actual Additional Rent due. Any overpayment made shall be immediately rebated by Landlord to Tenant, provided there are no outstanding rents or charges due. This provision shall survive termination of this Lease. 9.4.5 TENANT AUDIT. Tenant may have performed an audit of the amount or the calculation of the Additional Rent, provided that (a) the Tenant shall have no right to have such an audit performed for any Additional Rent unless tenant provides notice of Tenant's intention to do so within 60 days of the date that Tenant receives the Adjustments Statement related to such Additional Rent, (b) any such audit shall be at Tenant's sole cost and expense, (c) the audit shall be performed by a recognized independent accounting firm that is not being compensated on a contingency fee basis, and (d) the audit shall not unreasonably interfere with the business of Landlord or its agent. 10. MAINTENANCE, REPAIRS AND ALTERATIONS. 10.1 LANDLORD'S OBLIGATIONS. Landlord shall maintain and repair the foundations, exterior walls (excluding Paint) and the roof structure (excluding the roof membrane) of the Building. Except as otherwise required by Section 13 regarding subrogation, if any of this maintenance and/or repair in whole or in part because of the negligence or willful misconduct of Tenant, its agents or -6- invitees, Tenant shall pay to Landlord the reasonable cost of the repairs. Except as provided by Section 14 regarding reconstruction, there shall be no abatement of rent, and no liability of Landlord, due to any injury or interference with Tenant's business arising from Landlord's performance of any maintenance or repair which it is required or permitted to perform. Tenant waives any right which it may have under any current or future law or ordinance to make repairs at Landlord's expense. 10.2 TENANT'S OBLIGATIONS. Tenant shall, at Tenant's sole cost and expense, keep in good condition and repair all portions of the Premises not required to be maintained by Landlord under Section 10.1, including, without limitation, the maintenance, repair and replacement of any storefront, all interior walls or partitions and interior portions of exterior walls, doors, exterior and interior glass and window casements, roof covering (but not roof structure) and all utility systems within the Premises including heating, ventilation and air conditioning systems ("HVAC"). Tenant shall, upon expiration or sooner termination of this Lease, surrender the Premises to Landlord in good and clean condition, ordinary wear accepted. Any damage to adjacent premises caused by Tenant's use of the Premises shall be repaired at the sole cost and expense of Tenant. If Tenant fails to perform the maintenance, repair or replacement required by this Section 10.2 or to surrender the Premises in the condition required by this Section, Landlord shall have the right, but not the obligation to perform the necessary work at Tenant's expense, and Tenant agrees to reimburse all costs incurred by Landlord. Landlord shall have the right to contract for such services as HVAC maintenance and bill Tenant for cost for such service. 10.3 GOVERNMENT REPAIRS. In the event any governmental agency requires major repairs or modifications to be made to the Premises, which repairs are the obligation of Landlord and cannot, in Landlord's judgment, be justified by the Minimum Rent, the Landlord shall have the right to cancel and terminate this Lease by giving Tenant 90 days written notice. Major repairs for purposes of this Section shall be repairs or modifications with a cost exceeding six months' Minimum Rent under this Lease. However, Tenant may elect in writing within 15 days of Tenant's receipt of the 90 days notice of cancellation from Landlord to make these repairs at its sole cost and expense in which event this Lease shall remain in full force and effect. 10.4 ALTERATIONS AND ADDITIONS. Tenant shall not make or permit any alteration, addition or improvement to the Premises without the prior written consent of Landlord. Tenant shall pay any and all costs incurred by Landlord in reviewing and evaluating any request for the consent required by this section. Any alteration, addition or improvement consented to by Landlord shall be made in a good workmanlike manner at Tenant's sole cost and expense and shall comply with all applicable laws, codes, ordinances, rules and regulations. All alterations, additions or improvements (including but not limited to wall and window covering, paneling and built-in cabinet work, but excluding movable furniture and trade fixtures) shall at once become a part of the Premises belonging to the Landlord and shall be surrendered with the Premises at the expiration of this Lease, unless Landlord demands their removal as set forth below. Upon expiration or sooner termination of the Lease Term, Tenant shall, at Tenant's sole cost and expense, with all diligence, remove any alterations, additions or improvements made by Tenant and designated by Landlord to be removed; provided Landlord gives Tenant not less than 30 days advance written notice prior to termination of this Lease. Tenant shall, at its sole cost and expense, repair any damage to the Premises caused by such removal. If Tenant fails to remove any such alterations, additions or improvements, Landlord may do the same at Tenant's expense. 11. LIENS. 11.1 LIENS. Tenant shall keep the Premises free from any liens arising out of any work performed, materials furnished or obligations incurred by Tenant, and agrees to hold Landlord harmless from the same. Landlord may require, at Landlord's sole option, that Tenant provide, at Tenant's sole cost and expense, a materialman's labor and performance bond acceptable to Landlord in an amount equal to one and one-half times the estimated cost of any improvements, additions or alterations to the Premises which the Tenant desires to make, to insure Landlord against any liability for mechanics' and materialmen's liens, and to insure completion of the work. 11.2 ENCUMBRANCES. The Tenant shall not cause or suffer to be placed, filed or recorded against the title to the Premises, the Building, or any part thereof, or against Tenant's leasehold interest in the Premises any mortgage, deed of trust, security agreement, financing statement or other encumbrances. Further, in no event shall Tenant lien or mortgage any leasehold improvements alterations, additions or improvements thereto, except trade fixtures, appliances and equipment which are owned by Tenant and which are not, and which do not become a part of the Premises. The form of any such mortgage, deed of trust or other security agreement or financing statement which includes a legal description of the Premises or the Building shall be subject to Landlord's prior written approval, which approval shall be subject to such conditions as the Landlord may deem appropriate. 12. HOLD HARMLESS. Tenant agrees to indemnify and hold Landlord and its agents harmless from any and all claims arising from the use of the Premises by Tenant, its agents and invitees, from the conduct of Tenant's business, or from any activity, work or things done or permitted to be done by Tenant, its agents and invitees on the premises or elsewhere. Tenant further agrees to indemnify and hold Landlord and its agents harmless from any and all claims arising from, in connection with, or related to any default by Tenant in the performance of its obligations under this Lease, or any act, omission or neglect of Tenant, its agents or invites. Tenant further agrees to indemnify and hold Landlord and its agents harmless from all costs (including but not limited to attorney's fees) incurred by Landlord in connection with its defense against any claim made against the Landlord as to which Tenant is required to indemnify Landlord pursuant to this Section. Tenant shall give prompt notice to Landlord of any casualty or accident in the Premises. -7- Upon notice by Landlord, Tenant, at Tenant's expense, shall defend Landlord, through counsel reasonably satisfactory to Landlord in any action or proceeding brought against Landlord by reason of any such claim. Tenant further assumes all risk of, and waives and releases all claims against Landlord for any damages to person or property sustained by Tenant, or any person claiming through Tenant, which damage results from any accident or occurrence in or on the Premises from any cause whatsoever. 13. SUBROGATION. Neither Landlord nor Tenant shall be liable to the other or to any insurance company (by way of subrogation or otherwise) insuring the other party for any loss or damage to any building, structure or other tangible property, or any resulting loss of income, or losses under worker's compensation laws and benefits, even though such loss or damage might have been occasioned by the negligence of such party, agents or employees if any such loss or damage is covered by insurance benefiting the party suffering such loss or damage or was required to be covered by insurance pursuant to this Lease. 14. RECONSTRUCTION. 14.1 EFFECT OF INSURED LOSS. Except as provided below, if the Premises are damaged by fire or other cause covered by Landlord's property insurance, Landlord agrees to repair the same, and this Lease shall remain in full force and effect. 14.2 LANDLORD'S OPTIONS. Landlord shall have the option either to repair or rebuild the Premises or to terminate this Lease if the Premises any portion of the Building is damaged if: (a) The damage results from any cause not covered by Landlord's insurance; (b) Insurance proceeds are insufficient to fully pay for repair and restoration; (c) The cost to repair exceeds 25 percent of the then complete replacement cost of the Premises and the Building; (d) The repair or restoration, in Landlord's opinion, cannot be completed within six months of the damage; or (e) The damage occurs during the last 12 months of the Lease Term. Landlord shall exercise its option to terminate this Lease by giving to Tenant, at any time within 60 days after the damage, written notice of its election to terminate this Lease as of the date specified in the notice. The termination date shall not be less than 30 nor more than 60 days after the date of notice. If Landlord fails to give notice within the 60 days, it shall be deemed to have elected to repair or restore the damage. If Landlord terminates this Lease as provided by this Section 14.2, this Lease shall automatically terminate on the date specified in Landlord's notice. Neither party shall have further liability to the other, except for obligations which were accrued and unpaid as of the date of termination specified in Landlord's notice, and except that Landlord shall return any unused balance of the Security Deposit to Tenant. 14.3 RENT ABATEMENT. This Lease shall remain in full force and effect if Landlord elects to repair the damage, or until the termination date specified in the notice of termination, as applicable, except that the Minimum Rent and any Additional Rent shall be proportionately abated from the date of damage until the repairs are completed, or until the specified termination date, as applicable. Such proportionate abatement shall be based upon the extent to which the damage materially interferes with the business carried on by Tenant in the Premises. 14.4 TENANT'S REPAIR OBLIGATIONS. Landlord shall not be required to repair or replace any leasehold improvements, fixtures or other personal property of Tenant, all of which shall be repaired or replaced promptly by Tenant. 15. EMINENT DOMAIN. 15.1 TOTAL OR PARTIAL TAKING. If any portion of the Premises is taken or appropriated by any public or quasi-public authority under the power of eminent domain, or is purchased by the condemnor in lieu of condemnation proceedings, either party shall have the right to terminate this Lease upon 30 days written notice given to the other party within 60 days after the date that possession is surrendered to the condemnor. If neither party elects to terminate, the Minimum Rent and any Additional Rent thereafter to be paid shall be equitably reduced. If any part of the Building other than the Premises is so taken or appropriated, or is purchased by the condemned in lieu thereof, Landlord shall have the right at its option to terminate this Lease upon 30 days written notice to Tenant given within 60 days after the date that possession is surrendered to the condemnor. 15.2 DAMAGES. Landlord reserves all rights to the entire damage award or payment for any taking by eminent domain and Tenant shall make no claim whatsoever against Landlord for damages for termination of its leasehold interest in the Premises or for interference with its business. Tenant hereby grants and assigns to Landlord any right Tenant may now have or hereafter acquire to damages related to any taking by eminent domain and agrees to execute and deliver such further instruments of assignment thereof as Landlord may from time -8- to time request. Tenant shall, however, have the right to claim from the condemning authority all compensation that may be recoverable by Tenant on account of any loss incurred by Tenant in removing Tenant's merchandise, furniture, trade fixtures and equipment or for damage to Tenant's business provided, however, that Tenant may claim such damages only if they are awarded separately in the eminent domain proceeding and not as part of Landlord damages. 16. ASSIGNMENT AND SUBLETTING. 16.1 RESTRICTION. Tenant shall not, without the prior written consent of Landlord: (a) Voluntarily, involuntarily or by operation of law, assign, transfer, mortgage, pledge, hypothecate or otherwise encumber this Lease, or any interest in it, or any right or privilege appurtenant to it; (b) Sublet all or any part of the Premises; or (c) Allow any other person, except the agents and invitees of Tenant, to occupy or use any portion of the Premises. Landlord's consent may be withheld in Landlord's discretion. In determining whether to consent to any assignment, transfer, encumbrance or subletting, Landlord may consider any commercially reasonable basis for approving or disapproving any such request including, without limitation, the following: (i) the experience or business reputation of the proposed transferee, (ii) whether the use clientele, personnel or foot traffic that will be generated by the proposed transferee is consistent, in Landlord's opinion, with the business of other tenants of the Building at the time of the proposed transfer, and (iii) notwithstanding that Tenant and others would remain liable upon transfer, whether the proposed transferee has a net worth and financial strength and credit record satisfactory to Landlord. Any assignment, transfer, encumbrance, subletting or use without Landlord's consent shall be void and shall, at the option of Landlord, constitute a material default under this Lease. An assignment or sublease consented to by Landlord shall not be binding upon Landlord unless the assignee or subtenant delivers to Landlord: (a) An original executed assignment or sublease; (b) Any collateral agreements; and (c) An instrument containing said assignee's or sublessee's assumption of all of the obligations of the Tenant under this Lease, in form and substance satisfactory to Landlord. The assignee's or sublessee's failure to execute such a covenant shall not waive, release or discharge the assignee or subleasee from its liability for the performance of the Tenant's obligations under this Lease. Regardless of Landlord's consent, no subletting or assignment shall release Tenant or Guarantor of their obligations or alter the primary liability of Tenant to pay rent and to perform all the obligations of the Tenant under this Lease. 16.2 COSTS. Tenant shall reimburse Landlord and Landlord's agent for all attorney's fees and other costs incurred by Landlord in connection with the review of and preparation of documents incident to any request by Tenant for Landlord's consent. Each request for Landlord's consent shall be accompanied by a deposit in the amount of $200 to be applied to such costs. 16.3 INCLUDED TRANSFERS. If Tenant is a corporation, partnership, limited liability company or other entity, and transfer of this Lease by merger, consolidation, reorganization or dissolution shall constitute a transfer for the purposes of this Section. If Tenant is such an entity, any change in the ownership of, or power to vote, a percentage of Tenant's now-outstanding stock or ownership interest which results in a change of controlling persons, or any transfer of all or substantially all the assets of Tenant shall constitute a transfer for the purposes of this Section. If Tenant is a partnership, any partial or total withdrawal of any of the present general partners, and any transfer by a general partner of all or part of his partnership interest shall constitute a transfer for the purposes of this Section. 16.4 JUDICIALLY IMPOSED ASSIGNMENT. If the non-assignment provisions of this Section are deemed to be unenforceable in any bankruptcy proceeding, Landlord and Tenant agree that a showing of adequate assurance of future performance by a prospective assignee of this Lease must include, without limitation, clear and convincing evidence that: (a) Landlord will receive the full benefit of each and every term of its bargain in this Lease, except for the non-assignment and related termination clauses; (b) The Premises will continue to be used solely for the use permitted by this Lease; (c) A judicially imposed assignment will not cause an acceleration or increase in the interest rate on, or fees in connection with, any indebtedness of Landlord secured by Landlord's interest in the building or this Lease; and -9- (d) The prospective assignee has the means, expertise and experience to operate the business to be conducted upon the Premises in a first-class manner. 16.5 ASSIGNMENT BY LANDLORD. If Landlord shall assign its interest under this Lease or transfer its interest in the Premises, Landlord shall be relieved of any obligation accruing hereunder after such assignment or transfer, and such transferee shall thereafter be deemed to be the Landlord under this Lease. Landlord may transfer Tenant's Security Deposit to such transferee and Tenant shall look solely to the transferee for the return of such deposit. 17. DEFAULT. 17.1 EVENTS OF DEFAULT. The following events are referred to, collectively, as "Events of Default" or, individually, as an "Event of Default": (a) Tenant defaults in the due and punctual payment of rent or Additional Rent, and such default continues for three days after written notice from Landlord; however, Tenant will not be entitled to more than one written notice for monetary defaults during any 12 month period, and if after such written notice any rent or Additional Rent is not paid when due, an Event of Default will be considered to have occurred without further notice; (b) Tenant vacates or abandons the Premises or fails to operate its business on the Premises; (c) This Lease or the Premises or any part of the Premises are taken upon execution or by other process of law directed against Tenant, or are taken upon or subject to any attachment by any creditor of Tenant or claimant against Tenant, and said attachment is not discharged or disposed of within 15 days after its levy; (d) Tenant files a petition in bankruptcy or insolvency or for reorganization or arrangement under the bankruptcy laws of the United States or under any insolvency act of any state, or admits the material allegations of any such petition by answer or otherwise, or is dissolved or makes an assignment for the benefit of creditors; (e) Involuntary proceedings under any such bankruptcy law or insolvency act or for the dissolution of Tenant are instituted against Tenant, or a receiver or trustee is appointed for all or substantially all of the property of Tenant, and such proceeding is not dismissed or such receivership or trusteeship vacated within 60 days after such institution or appointment, or (f) Tenant makes, causes to be made or suffers to exist on the Premises noise of any type (including music) that, in the opinion of Landlord, could reasonably be expected to interfere with the rights of quiet enjoyment of other tenants in the Building or in the complex of which the Premises are a part, and such default continues or occurs for ten days after written notice from Landlord, however, Tenant will not be entitled to more than one written notice of such defaults during any 12 month period, and if after such written notice a default under this provision exists or occurs, an Event of Default will be considered to have occurred without further notice; (g) Tenant breaches any of the other agreements, terms, covenants, or conditions that this Lease requires Tenant to perform, and such breach continues for a period of 30 days after written notice from Landlord to Tenant or, if such breach cannot be cured reasonably within such 30-day period, if Tenant fails to diligently commence to cure such breach within 30 days after written notice from Landlord and to complete such cure within a reasonable time thereafter (but not to exceed 90 days). 17.2 LANDLORD'S REMEDIES. If any one or more Events of Default set forth in Section 17.1 occur, then Landlord has the right, at its election: (a) To give Tenant written notice of Landlord's intention to terminate this Lease on the earliest date permitted by law or on any later date specified in such notice, in which case Tenant's right to possession of the Premises will cease and this Lease will be terminated, except as to Tenant's liability, as if the expiration of the term fixed in such notice were the end of the term; (b) Without further demand or notice, to reenter and take possession of the Premises or any part of the Premises, repossess the same, expel Tenant and those claiming through or under Tenant, and remove the effects of both or either, using such force for such purposes as may be necessary, without being liable for prosecution, without being deemed guilty of any manner of trespass, and without prejudice to any remedies for arrears of monthly rent or other amounts payable under this Lease or as a result of any preceding breach of covenants or conditions; or (c) Without further demand or notice to cure any Event of Default and to charge Tenant for the cost of effecting such cure, including without limitation reasonable attorneys' fees and interest on the amount so advanced at the rate of 15 percent per annum, provided that Landlord will have no obligation to cure any such Event of Default of Tenant. -10- Should Landlord elect to reenter as provided in Section 17.2(b), or should Landlord take possession pursuant to legal proceedings or pursuant to any notice provided by law, Landlord may, from time to time, without terminating this Lease, relet the Premises or any part of the Premises in Landlord's or Tenant's name, but for the account of Tenant, for such term or terms (which may be greater or less than the period that would otherwise have constituted the balance of the term) and on such conditions and upon such other terms (which may include concessions of free rent and alteration and repair of the Premises) as Landlord, in its reasonable discretion, may determine, and Landlord may collect and receive the rent. Landlord will in no way be responsible or liable for any failure to relet the Premises, or any part of the Premises, or for any failure to collect any rent due upon such reletting. No such reentry or taking possession of the Premises by Landlord will be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention is given to Tenant. No written notice from Landlord under this Section 17.2 or under a forcible or unlawful entry and detainer statute or similar law will constitute an election by Landlord to terminate this Lease unless such notice specifically so states. Landlord reserves the right following any such reentry or reletting to exercise its right to terminate this Lease by giving Tenant such written notice, in which event this Lease will terminate as specified in such notice. 17.3 CERTAIN DAMAGES. In the event that Landlord does not elect to terminate this Lease as permitted in Section 17.2(a), but on the contrary elects to take possession as provided in Section 17.2(b), Tenant will pay to Landlord monthly rent and other sums as provided in this Lease that would be payable under this Lease if such repossession had not occurred, less the net proceeds, if any, of any reletting of the Premises after deducting all of Landlord's reasonable expenses in connection with such reletting, including without limitation all repossession costs, brokerage commissions, attorneys' fees, expenses of employees, alteration and repair costs, and expenses of preparation for such reletting. If, in connection with any reletting, the new Lease term extends beyond the existing term, or the Premises covered by such new lease include other Premises not part of the Premises, a fair apportionment of the rent received from such reletting and the expenses incurred in connection with such reletting as provided in this Section will be made in determining the net proceeds from such reletting, and any rent concessions will be equally apportioned over the term of the new lease. Tenant will pay such rent and other sums to Landlord monthly on the day on which the monthly rent would have been payable under this Lease if possession had not been retaken, and Landlord will be entitled to receive such rent and other sums from Tenant on each such day. 17.4 CONTINUING LIABILITY AFTER TERMINATION. If this Lease is terminated on account of the occurrence of an Event of Default, Tenant will remain liable to Landlord for damages in an amount equal to monthly rent and other amounts that would have been owing by Tenant for the balance of the term, had this Lease not been terminated, less the net proceeds, if any, of any reletting of the Premises by Landlord subsequent to such termination, after deducting all of Landlord's expenses in connection with such reletting, including without limitation the expenses enumerated in Section 17.3. Landlord will be entitled to collect such damages from Tenant monthly on the day on which monthly rent and other amounts would have been payable under this Lease if this Lease had not been terminated, and Landlord will be entitled to receive such monthly rent and other amounts from Tenant on each such day. Alternatively, at the option of Landlord, in the event this Lease is so terminated, Landlord will be entitled to recover against Tenant as damages for loss of the bargain and not as a penalty: (a) The worth at the time of award of the unpaid rent that had been earned at the time of termination; (b) The worth at the time of award of the amount by which the unpaid rent that would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided. (c) the worth at the time of award of the amount by which the unpaid rent for the balance of the term of this Lease (had the same not been so terminated by Landlord) after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; and (d) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which would be likely to result therefrom. The "worth at the time of award" of the amounts referred to in (a) and (b) above is computed by adding interest at the interest rate of 15D percent per annum from the Termination Date until the time of the award. The "worth at the time of award" of the amount referred to in (c) above is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco, at the time of award plus 1 percent. 17.5 CUMULATIVE REMEDIES. Any suit or suits for the recovery of the amounts and damages set forth in Sections 17.3 and 17.4 may be brought by Landlord, from time to time, at Landlord's election, and nothing in this Lease will be deemed to require Landlord to await the date upon which this Lease or the term would have expired had there occurred no Event of Default. Each right and remedy provided for in this Lease is cumulative and is in addition to every other right or remedy provided for in this Lease or now or after the Lease date existing at law or in equity or by statute or otherwise, and the exercise or beginning of the exercise by Landlord of any one or more of the rights or remedies provided for in this Lease or at law, in equity or by statute or otherwise will not preclude the simultaneous or later exercise by Landlord of any or all other rights or remedies provided for in this Lease or at law, in equity or by statute or otherwise. All costs incurred by Landlord in collecting any amounts and damages owing by Tenant pursuant to the provisions of this Lease or to -11- enforce any provision of this Lease, including reasonable attorneys' fees from the date any such matter is turned over to an attorney, whether or not one or more actions are commenced by Landlord, will also be recoverable by Landlord from Tenant. 17.6 WAIVER OF REDEMPTION. Tenant waives any right of redemption arising as a result of Landlord's exercise of its remedies under this Article 17. 17.7 LATE CHARGES. Tenant acknowledges that late payment by Tenant to Landlord of rent and other sums due under this Lease will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. These costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any mortgage or deed of trust covering the Premises. Accordingly, if any installment of rent or other sums due from Tenant shall not be received by Landlord or Landlord's agent within five days after the amount shall be due or if payment is made with a check that is returned for lack of sufficient funds, then without any requirement of notice to Tenant, Tenant shall pay to Landlord a late charge equal to the greater of 10 percent of the delinquent amount or $75, plus 1 percent per month interest on the delinquencies from the date due until payment. The parties agree that this late charge plus interest represents a fair and reasonable estimate of the cost Landlord will incur by reason of late payment by Tenant. Acceptance of the late charge by Landlord shall in no event constitute a waiver of Tenant's default with respect to the overdue amount, nor prevent Landlord from exercising any of the other rights or remedies granted to Landlord under this Lease, or at law or equity. 17.8 DEFAULT BY LANDLORD. Landlord shall not be in default unless Landlord fails to perform obligations required of Landlord within a reasonable time, but in any event 30 days after written notice by certified mail by Tenant to Landlord and to the holder of any first mortgage or deed of trust covering the Premises whose name and address shall have theretofore been furnished to Tenant in writing. Said notice shall specify wherein Landlord has failed to perform such obligation; provided, however, that if the nature of Landlord's obligation is such that more than 30 days are required for performance, then Landlord shall not be in default if Landlord commences performance within such 30-day period and thereafter diligently prosecutes the same to completion. Tenant further agrees not to invoke any of its remedies under this Lease until said 30 days have elapsed. In no event shall Tenant have the right to terminate this Lease as result of Landlord's default and Tenant's remedies shall be limited to damages and/or an inunction; and in no case may the Tenant withhold rent or claim a set-off or deduction from rent. 18. RULES AND REGULATIONS. Tenant shall faithfully observe and comply with all recorded covenants, conditions and restrictions affecting the Premises, all rules and regulations that Landlord may from time to time make to facilitate the reasonable operation of the Building of which the Premises are a part or the complex in which it is located or to comply with the requirements of any governmental entity or insurance company, including, without limitation, those rules and regulations attached to this Lease (collectively called "Rules"). Landlord reserves the right to modify the Rules from time to time. The Rules and any modifications shall be binding upon Tenant upon delivery of a copy of the Rules to Tenant. Landlord shall not be responsible to Tenant for the failure of any other tenants or occupants to comply with the Rules. 19. HOLDING OVER. 19.1 HOLDING OVER. If Tenant remains in possession of the Premises or any part thereof, after the expiration of the Lease Term with the express written consent of Landlord (which consent may be granted, withheld or conditioned at the sole discretion of Landlord), such occupancy shall be a tenancy from month to month at a minimum rent in an amount equal to 150 percent of the last monthly Minimum Rent, plus all additional rent and other charges payable hereunder, and upon all the terms hereof applicable to a month-to-month tenancy. 19.2 ABANDONMENT. Tenant agrees not to vacate or abandon the Premises at any time during the Lease Term. Should Tenant vacate or abandon said Premises or be dispossessed by process of law or otherwise, such abandonment, vacation or dispossession shall be deemed a breach of this Lease and, in addition to any other rights which Landlord may have, Landlord may remove any personal property belonging to Tenant which remains on the Premises and store the same, the cost of such removal and storage to be Tenant's liability. 19.3 VOLUNTARY SURRENDER. The voluntary or other surrender of this Lease by Tenant, or a mutual cancellation thereof, shall not work a merger, but shall, at the option of Landlord, terminate all or any existing subleases or subtenancies, or operate as an assignment to it of any or all such subleases or subtenancies. 20. ENTRY BY LANDLORD. Landlord reserves the right to enter the Premises to inspect the same, to show the Premises to prospective purchasers or tenants, to perform any alterations, improvements, repairs or maintenance, to provide any services that Landlord may deem necessary or desirable and to do any other act permitted under this Lease. Tenant hereby waives all claims for damages occasioned by such entry. Landlord may retain a key with which to unlock all of the doors in the premises (excluding Tenant's vaults, safes and files). No entry by Landlord shall be construed or deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an eviction of Tenant from all or any portion of the Premises. -12- 21. ESTOPPEL CERTIFICATE. Upon not less than five days' prior written notice from Landlord, Tenant shall execute, acknowledge and deliver to Landlord a written estoppel certificate stating certain facts including, but not limited to: (a) That this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease as so modified is in full force and effect); (b) The date to which the Minimum Rent and other charges are paid; and (c) That there are not, to Tenant's knowledge, any uncured defaults on the part of the Landlord (or specifying such defaults if any are claimed.) The statement shall be in any form that Landlord provides to Tenant. Any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Building or the real property upon which it is located. 22. SIGNS. Tenant shall not place any signs or symbols in the windows or on the doors of the Premises or upon any part of the Building without the prior written consent of Landlord. Any signs or symbols shall be in conformity with other signs on the Premises and the Building, the Rules, and all applicable laws, ordinances and regulations. Tenant shall maintain any such sign or symbol in good condition and repair at its sole cost and expense. Tenant shall remove such sign or symbol at its sole cost and expense upon termination of the Lease Term, and shall repair all damage caused by the removal. If Tenant fails to remove any sign or symbol and/or repair any damage caused by its removal, Landlord may have the same removed and/or repaired at Tenant's expense. 23. AUTHORITY; LIABILITY. 23.1 AUTHORITY. If Tenant is a corporation, partnership, limited liability company or other form of entity, each individual executing this Lease on behalf of said entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on behalf of said entity, in accordance with a duly adopted resolution of the board of directors of said entity authorizing and consenting to this Lease; specifically authorizing the designated officers signing this Lease to execute, acknowledge and deliver the same without the consent of any other officer or officers; resolving that such action and execution is in accordance with the bylaws of said corporation; and, resolving that this Lease is binding upon said entity in accordance with its terms. 23.2 LIABILITY. If the Landlord herein is a limited or general partnership, it is understood and agreed that any claims by Tenant against Landlord shall be limited to the assets of the limited or general partnership, and furthermore, Tenant expressly waives any and all rights to proceed against the individual partners, or the officers, directors or shareholders of any corporate partner, except to the extent of their interest in said limited general partnership. 24. GENERAL PROVISIONS. 24.1 EXHIBITS AND ADDENDUMS. Any exhibits and addendums attached to this Lease are a part hereof and are fully incorporated in this Lease by this reference. 24.2 NON-WAIVER OF DEFAULT. Landlord's waiver of any term, covenant or condition of this Lease shall not be deemed to be a waiver of any other term, covenant or condition or any subsequent default under the same or any other term, covenant or condition. Landlord's acceptance of any sum shall not be deemed to be a waiver of any preceding default by Tenant, other than the failure of Tenant to pay the particular sum so accepted, regardless of Landlord's knowledge of such preceding default at the time it accepts the sum. 24.3 JOINT OBLIGATIONS. If there is more than one Tenant, the obligations of the Tenants under this Lease shall be joint and several. 24.4 SECTION TITLES. The Section titles of this Lease are not a part of this Lease and shall have no effect upon its construction or interpretations. 24.5 TIME. Time is of the essence of this Lease and each and all of its provisions in which performance is a factor, including, but not limited to, Tenant's execution of estoppel certificates and subordinates and Tenant reimbursements to Landlord. 24.6 SUCCESSORS AND ASSIGNS. The covenants and conditions of this Lease apply to and bind the heirs, successors, executors, administrators and assigns of all parties of this Lease. 24.7 RECORDATION. A short form memorandum may be recorded at the request of either party, and at the requesting party's expense. -13- 24.8 QUIET POSSESSION. Subject to all the provisions of this Lease and provided Tenant pays all sums due under this Lease and observes and performs all of the other covenants, conditions and provisions to be observed and performed by Tenant, Tenant shall have quiet possession of the Premises for the entire Lease Term, against any adverse claim of Landlord or any party claiming under Landlord. 24.9 PRIOR AGREEMENTS. This Lease contains the full agreement of the parties with respect to any matter covered or mentioned in this Lease. No prior agreements or understandings pertaining to any such matter shall be effective for any purpose. This Lease may be amended or supplemented only by an agreement in writing signed by the parties or their respective successors in interest. 27.14. Tenant agrees to make any modifications of the terms and provisions of this Lease required or requested by any lending institution providing financing for the Building, or project, as the case may be, provided that no such modifications will materially adversely affect Tenant's rights and obligations under this Lease. 24.10 INABILITY TO PERFORM. Except as provided in Sections 13 and 14, this Lease and Tenant's obligations hereunder, including Tenant's obligation to make payments, shall not be affected or impaired because Landlord is unable to fulfill any of its obligations, or is delayed in doing so, if such inability or delay is caused by reason of weather, strike, labor troubles, acts of God, or any other cause beyond the reasonable control of the Landlord. 24.11 SEVERABILITY. Any provision of this Lease which shall prove to be invalid, void or illegal, shall in no way affect, impair, or invalidate any other provision, and all other provisions shall remain in full force and effect. 24.12 CUMULATIVE REMEDIES. No remedy or election under this Lease shall be deemed to be exclusive but shall, whenever possible, be cumulative with all other remedies at law or in equity. 24.13 CHOICE OF LAW. This Lease shall be governed by the laws of State of Washington. 24.14 ATTORNEYS' FEES. In the event any action or proceeding is brought by either party against the other arising out of or in connection with this Lease, the prevailing party shall be entitled to recover its costs, including, but not limited to, reasonable attorneys' and accountants' fees, incurred in such action or proceedings, including any such costs and fees incurred on appeal, in any arbitration proceeding and in any bankruptcy proceeding. 24.15 NOTICES. All notices or demands which are required or permitted to be given by either party to the other under this Lease shall be in writing. Except as otherwise provided in any addendum, all notices and demands to the Tenant shall be either personally delivered or sent by the U.S. Mail, registered or certified, postage prepaid, addressed to the Tenant at the Premises, or at the address set forth below, or to such other place as Tenant may from time to time designate in a notice to the Landlord. Except as provided in any addendum, all notices and demands to the Landlord shall be either personally delivered or sent by U.S. Mail, registered or certified, postage prepaid, addressed to the Landlord at the address set forth below, or to such other person or place as the Landlord may from time to time designate in a notice to the Tenant. Any notices sent by US Mail as provided above shall be deemed to have been received three days after deposit into the mail as set out in Section 1.11 and 1.12. 24.16 SUBORDINATION. At Landlord's option, this Lease shall be subject to and subordinate to the lien of any existing or future mortgages or deeds of trust in any amount or amounts whatsoever, now or hereafter placed in or against the Building or the real property upon which it is located, and to any extensions, renewals or replacements thereof, without the necessity of the execution and delivery of any further instruments on the part of Tenant to effectuate such subordination. Within five days of Landlord's request, Tenant will execute and deliver such further instruments as Landlord deems necessary to evidence such subordination of this Lease. As long as Tenant is not in default under this Lease, said subordination shall not disturb Tenant's right to possession of the Premises. 24.17 ATTORNMENT. In the event of foreclosure, or the exercise of the power of sale under any mortgage or deed of trust made by Landlord covering the Premises, or in the event of any sale in lieu thereof, Tenant shall attorn to the purchaser upon any such foreclosure or sale and recognize such purchaser as Landlord under this Lease; provided said purchaser expressly agrees in writing that, so long as Tenant is not in default under the Lease, Tenant's possession and occupancy of the Premises shall not be disturbed and said purchaser will thereafter perform all of the obligations of Landlord under this Lease. 24.18 GUARANTOR. In the event that there is a Guarantor of this Lease, Guarantor hereby agrees to jointly and severally perform all payment and other obligations of Tenant under this Lease. Guarantor waives all suretyship defenses that would otherwise be available to Guarantor. 24.19 COMPLIANCE WITH ENVIRONMENTAL LAWS. The parties acknowledge that there are certain federal, state and local laws, regulations and guidelines now in effect and that additional laws, regulations and guidelines may hereafter be enacted relating to or affecting the Premises and the larger parcel of land upon which the demised Premises may be a part, concerning the impact on the environment of construction, land use, the maintenance and operation of structures, and the conduct of business. Tenant shall not cause, or permit to be caused, any act or practice by negligence, or omission, or otherwise, that would adversely affect the environment or do anything or -14- permit anything to be done that would violate any of said laws, regulations or guidelines. Any violation of this covenant shall be an Event of Default under this Lease. Tenant shall indemnify and hold Landlord harmless from any and all cost, expense, claims, losses, damages, fines and penalties, including reasonable attorneys' fees, that may in any manner arise out of or be imposed because of the failure of Tenant to comply with this covenant. The foregoing shall cover all requirements whether or not foreseeable at the present time and regardless of the expense attendant thereto. 24.20 RIDERS AND EXHIBITS. The Riders and Exhibits referred to in Section 1.16 are attached to this Lease and made a part of it. 24.21 LIMITATION ON RECOURSE. Tenant specifically agrees to look solely to Landlord's interest in the Premises for the recovery of any judgments from Landlord. It is agreed that Landlord (and its shareholders, venturers, members and partners, and their shareholders, venturers, members and partners and all of their officers, directors, and employees) will not be personally liable for any such judgment. The provisions contained in the preceding sentences are not intended to and will not limit any right that Tenant might otherwise have to obtain injunctive relief against Landlord. 24.22 TAX CREDITS. Landlord is entitled to claim all tax credits and depreciation attributable to leasehold improvements in the Premises. Promptly after Landlord's demand, Landlord and Tenant will prepare a detailed list of the leasehold improvements and fixtures and the respective costs for which Landlord or Tenant has paid. Landlord will be entitled to all credits and depreciation for those items for which Landlord has paid by means of any Tenant finish allowance or otherwise. Tenant will be entitled to any tax credits and depreciation for all items for which Tenant has paid with funds not provided by Landlord. 24.23 RELOCATION OF THE PREMISES. 24.24 LANDLORD'S FEES. Whenever Tenant requests Landlord to take any action or give any consent required or permitted under this Lease, Tenant will reimburse Landlord for all of Landlord's reasonable costs incurred in reviewing the proposed action or consent, including without limitation reasonable attorneys', engineers' or architects' fees, within ten days after Landlord's delivery to Tenant of a statement of such costs. Tenant will be obligated to make such reimbursement without regard to whether Landlord consents to any such proposed action. 24.25 DISCLOSURE OF AGENCY REPRESENTATION. At the signing of this Lease Agreement, Morris Piha Management Group, Inc. represented the Landlord. Each party signing this document confirms that prior oral and/or written disclosure of agency was provided to them in this transaction. 24.26 RULES OF CONSTRUCTION. The parties agree that (a) in the event of any inconsistency between the provisions of Section 1 and the other provisions of this Lease, the other provisions of this Lease shall govern; (b) in the event of any inconsistency between the provisions of the body of this Lease and the Riders attached hereto, the provisions set forth in the Riders shall govern; (c) in the event of any ambiguity regarding which party is responsible for costs or expenses, Tenant shall be responsible; and (d) ambiguities shall not be construed against the party that drafted this Lease. 24.27 WAIVER OF JURY TRIAL. LANDLORD, TENANT AND GUARANTOR BY THIS SECTION 24.22 WAIVE TRIAL BY JURY IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM BROUGHT BY EITHER OF THE PARTIES TO THIS LEASE AGAINST THE OTHER ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, THE RELATIONSHIP OF LANDLORD AND TENANT, TENANT'S USE OR OCCUPANCY OF THE PREMISES, OR ANY OTHER CLAIMS (EXCEPT CLAIMS FOR PERSONAL INJURY OR PROPERTY DAMAGE), AND ANY EMERGENCY STATUTORY OR ANY OTHER STATUTORY REMEDY. 25. BROKERS. Tenant warrants that it has had no dealing with any real estate broker or agent in connection with the negotiation of this Lease except for Morris Piha Management Group, Inc., and it knows of no other real estate broker or agent who is entitled to a commission in connection with this Lease. Landlord agrees to pay Morris Piha Management Group, Inc. upon the execution of this Lease by both Landlord and Tenant, the Broker Fee for negotiating this Lease. 26. LEGAL DOCUMENT. Tenant understands that this is a legally binding contract. Tenant has carefully read each of its provisions, and prior to execution of the Lease, represents and warrants that Tenant has been advised to discuss the legal effect of the Lease with Tenant's legal counsel. -15- 27. DISCLOSURE OF AGENCY REPRESENTATION. At the signing of this Lease Agreement, Morris Piha Real Estate Services represents the Landlord and Kidder Mathews Segner/Oncor International represents the Tenant. Each party signing this document confirms that prior oral and/or written disclosure of agency was provided to them in this transaction. -16- IN WITNESS WHEREOF, the parties have executed this instrument as of the day and year first above written: LANDLORD: Inter Co-Op USA No. 111 By _______________________________ Title ____________________________ TENANT: Freei Networks, Inc By /s/ Robert McCausland ------------------------------- Title President/CEO ---------------------------- -17- (CORPORATE NOTARY TO BE ADDED HERE) STATE OF WASHINGTON ) )ss. COUNTY OF King ) -------- On this 15TH day of November, 1999, before me, the undersigned, a Notary Public in and for the State of Washington, duly commissioned and sworn personally appeared Robert McCausland, to me known to be the person who signed as CEO/President of the Freei Networks, Inc that executed the within and foregoing instrument, and acknowledged said instrument to be the free and voluntary act and deed of said partnership for the uses and purposes therein mentioned, and on oath stated that He was authorized to execute said instrument on behalf of the partnership. IN WITNESS WHEREOF I have hereunto set my hand and official seal the day and year first above written. /s/ Cindy M. Black --------------------------------------- (Signature of Notary) Cindy Black --------------------------------------- (Print or stamp name of Notary) NOTARY PUBLIC in and for the State of Washington, residing at Milton ------ My appointment expires: 11-29-99 -18- EXHIBIT A MAP OF PREMISES AND/OR LEGAL DESCRIPTION [ DIAGRAM ] PARCEL "CAMPUS BUSINESS CENTER" Lots 15 and 19 of West Campus Business Park, as per Plat recorded in Volume 97 of Plats, page 78 through 82. Records of King County: Together with that portion of Lots 20 and 21 of said Plat described as follows: Beginning at the Northeast corner of said Lot 20: Thence Southerly, along the East line thereof, South 09DEG.28'57" East 374.09 Feet to the Northeast corner of said Lot 21: Thence Southwesterly, along the East line thereof, South 13DEG.46'37" West 101.29 Feet, Thence leaving said East line North 09DEG.28'37" West 466.74 Feet to a point on the South margin of South 336th Street (the radial line through said point bears North 10DEG.39'11" West); Thence Easterly, along said margin on a curve to the right having a radius of 1,958.00 Feet, through a central angle 01DEG.10'14" an arc distance of 40.00 feet to the point of beginning Situate in the County of King, State of Washington -19- EXHIBIT B [DIAGRAM] TO BE MADE A PART OF THE COMMERCIAL LEASE DOCUMENT UNDER DATE OF November 15, 1999 BY AND BETWEEN INTER CO-OP USA NO.III as ("Landlord") AND FREEI NET as ("Tenant"). RIDER #28 - EARLY CANCELLATION Provided Tenant has not been in default at any time during this Lease, Tenant shall have the right to cancel this lease every six (6) months by providing Landlord 60 days advance written notice of its intent to cancel. This Lease shall continue in full force and effect in the absence of such written notice. RIDER #29 - EARLY OCCUPANCY Tenant may have occupancy of the Premises upon mutual execution of this Lease. Tenant shall be responsible for payment ??? triple net charges during the month of December 1999. RIDER #30 - SATELLITE DISH Tenant has the right to install a small satellite dish and antenna on the roof at tenant's sole cost and expense. Tenant will be responsible for all maintenance and repair and will consult with Landlord's agent if any roof penetrations are necessary prior to such installation. At the end of the lease term, tenant will remove the dish and leave it in the same condition as at the time of occupancy. RIDER #31 - HANDICAP PARKING STALL At tenant's expense, a handicap stall will be added behind the existing roll-up door (which will be turned into a false wall). RIDER #32 - TENANT IMPROVEMENTS Tenant accepts the Premises in "As Is" condition with the exception of some paint cans left over from the previous tenant, which will be removed as soon as practical. Additional tenant improvements as shown in Exhibit "A" are approved by Landlord and will be done at tenant's sole cost and expense. RIDER #33 - HVAC The existing HVAC on the premises has been serviced regularly and should be in good working order at the time of Tenant's possession of the Premises. Tenant will notify Landlord within the initial 15 days of possession of the Premises if the HVAC is in need of repair, in which case the Landlord will repair it at its cost. -2- EX-10.13 17 EX-10.13 Exhibit 10.13 [LOGO] November 19, 1997 Mr. Bob McCausland Home Mortgage U.S.A. 909 S. 336th Avenue Federal Way, WA 98003 Dear Bob: For your records, this letter acknowledges that upon my receipt of the deposit amount for the additional space, $3,945.67, due and payable on December 1, 1997, your total deposit will be $23,424.34. Sincerely, /s/ Jeff Stock Jeff Stock LEASE ADDENDUM "A" Washington Mortgage Services In addition to the existing lease dated February 18, 1997, for the premises located at 909 S. 336th Avenue, Federal Way, WA 98003, effective December 1, 1997, the rentable premise space as indicated by the attached floor plan, will increase by approximately 3,382 sq. ft. The total monthly base rental rate for this space will be $3,945.67 per month. Deposit to be increased $3,945.67. The date and amount of the rent and expense increase will follow the terms of and run concurrently with the original lease. Landlord: All Services West Campus Tenant: Washington Mortgage Svcs By: /s/ Jeff Stock By: /s/ Robert McCausland ------------------------------- ----------------------------- Jeff Stock Robert McCausland Its: Its: President ------------------------------ ----------------------------- 11/13/97 11/13/97 - ---------------------------------- --------------------------------- Date Date OFFICE BUILDING LEASE This Lease between All Service West Campus & Washington General Partnership ("Landlord") and Washington Mortgage Svcs Inc., a Washington Corporation ("Tenant"), Is dated January 18th, 1997. 1. LEASE ON PREMISES In consideration of the Rent (as defined at Section 5.4) and the provisions of this Lease, Landlord leases to Tenant and Tenant leases from Landlord the Premises shown by diagonal lines on the floor plan attached hereto as Exhibit "A," and further described at Section 21. The Premises are located within the Building and Project described in Section 2a. Tenant shall have the non-exclusive right (unless otherwise provided herein) in common with Landlord, other Tenants, Subtenants and invitees, to use of the Common Areas (as defined at Section 2e). 2. DEFINITIONS As used in this Lease, the following terms shall have the following meanings: a. BASE RENT: $ 112,000 ($14.00) per [ILLEGIBLE]_________[/s/ INITIALS] b. BASE YEAR: The calendar year of N/A c. Broker(s) and Sales Agent(s): Kiddu, Mathew & Segner d. Commencement Date: February 18th, 1997 e. Common Areas: The building lobbies, common corridors and hallways, restrooms, garage and parking areas, stairways, elevators and other generally understood public or common areas. Landlord shall have the right to regulate the use of the Common Areas. f. Expense Stop: fill in it applicable): $ N/A g. Expiration Date: February 28th, 1999, unless otherwise sooner terminated in accordance with the provisions of this Lease. h. Index (Section 5.2): United State Department of Labor, Bureau of Labor Statistics Consumer Price Index for All Urban Consumers, U.S. Average, Subgroup "All Items" (1987 = 100). i. Landlord's Mailing Address: 31919 1ST AVE., SOUTH, STE 100 Federal Way, WA 98023 j. Tenant's Mailing Address: 909 S. 336TH Street, Ste 200 Federal Way, WA 98003 k. Monthly Installments of Base Rent: $ 9,333.33 per month. l. Parking: Tenant shall be permitted, upon payment of the then prevailing monthly rate (as set by Landlord from time to time) to park -0- cars on a non-exclusive basis in the area(s) designated by Landlord lot parking. Tenant shall abide by any and all parking regulations and rules established from time to time by Landlord or Landlord's parking operator. Landlord reserves the right to separately charge Tenant's guests and visitors for parking. m. Premises: That portion of the Building containing approximately 8,000 square feet of rentable area, actual sq. footage to be verified by Landlord & Tenant /s/ [INITIALS] shown by diagonal lines on Exhibit "A", located on the 2ND floor of the Building and known as Suite_________. n. Project: The building of which the Premises are a part (the "Building") and any other buildings or improvements on the real property (the "Property") located at 909 S. 336TH Street, Ste 200 Federal Way, WA 98003 and further described at Exhibit "D". The Project is Known as Omni Building o. Rentable Area: As to both the Premises and the Project, the respective measurements of floor area as may from time to time be subject to lease by Tenant and all tenants of the Project, respectively, as determined by Landlord and applied on a consistent basis throughout the Project. p. Security Deposit (Article 7): $ 9,333.33 q. State: The State of Washington r. Tenant's First Adjustment Date (Section 5.2): the first day of the calendar month following the Commencement date plus 12 months. s. Tenant's Proportionate Share: N/A%. Such share is a fraction, the numerator of which is the Rentable Area of the Premises, and the denominator of which is the Rentable Area of the Project, as determined by Landlord from time to time. The Project consists of 1 building(s) containing a total Rentable Area of 39,835 square feet. t. Tenants Use Clause (Article 8): Business use only u. Term: The period commencing on the Commencement Date and expiring at midnight on the Expiration Date. 3. EXHIBITS AND ADDENDA The exhibits and addenda listed below (unless lined out) are incorporated by reference in this Lease: Exhibit "A" - Floor Plan showing the Premises Exhibit "B" - Site Plan of the Project [LINED OUT] Exhibit "C" - Building Standard Work Letter [LINED OUT] Exhibit "D" - Rules and Regulations Exhibit "E" - Guarantee Addenda: i 4. DELIVERY OF POSSESSION If any reason Landlord does not deliver possession of the Premises to Tenant on the Commencement Date, Landlord shall not be subject to any liability for such failure, the Expiration Date shall not change and the validity of this Lease shall not be impaired, but Rent shall be abated until delivery of possession, "Delivery of possession" shall be deemed to occur on the date Landlord completes Landlord's Work as defined in Exhibit "C." If Landlord permits Tenants to enter into possession of the Premises before the Commencement Date, such possession shall be subject to the provisions of this Lease, including, without limitation, the payment of Rent. 5. RENT: 1. Payment of Base Rent. Tenant agrees to pay the Base Rent for the Premises. Monthly Installments of Base Rent shall be payable in advance on the first day of each calendar month of the Term. If the Term begins (or ends) other than the first (or last) day of a calendar month, the Base Rent for the partial month shall be prorated on a per diem basis: Tenant shall pay Landlord the first Monthly Installment of Base Rent when Tenant executes the Lease. 6. INTEREST AND LATE CHANGES If Tenant fails to pay when due any Rent or other amounts or charges which Tenant is obligated to pay under the terms of this Lease, the unpaid amounts shall bear interest at the maximum rate then allowed by law. Tenant acknowledges that the late payment of any Monthly Installment of Base Rent will cause Landlord to lose the use of that money and incur costs and expenses not contemplated under this Lease, including without limitation, administrative and collection costs and processing and accounting expenses, the exact amount of which is extremely difficult to ascertain. Therefore, in addition to interest, if any such installment is not received by Landlord within ten (10) days from the date it is due, Tenant shall pay Landlord a late charge equal to 5% of such installment. Landlord and Tenant agree that this late charge represents reasonable estimate of such costs and expenses and is fair compensation to Landlord for the loss suffered from such nonpayment by Tenant. Acceptance of any interest or late charge shall not constitute a waiver of Tenant's default with respect to such nonpayment by Tenant nor prevent Landlord from exercising any other rights or remedies available to Landlord under this Lease. 7. SECURITY DEPOSIT Tenant agrees to deposit with Landlord the Security Deposit set forth at Section 2 upon execution of this Lease, as security for Tenant's faithful performance of its obligations under this Lease. Landlord and Tenant agree that the Security Deposit may be commingled with funds of Landlord and Landlord shall have no obligation or liability for payment of interest on such deposit. Tenant shall not mortgage, assign, transfer or encumber the Security Deposit without the prior written consent of Landlord and any attempt by Tenant to do so shall be void, without force or effect and shall not be binding upon Landlord. If Tenant fails to pay any Rent or other amount when due and payable under this Lease, or fails to perform any of the terms hereof, Landlord may appropriate and apply or use all or any portion of the Security Deposit for Rent payments or any other amount then due and unpaid, for payment of any amount for which Landlord has become obligated as a result of Tenant's default or breach, and for any loss or damage sustained by Landlord as a result of Tenant's default or breach, and Landlord may so apply or use this deposit without prejudice to any other remedy. Landlord may have by reason of Tenant's default or breach. If Landlord so uses any of the Security Deposit, Tenant shall, within ten (10) days after written demand therefor, restore the Security Deposit to the full amount originally deposited; Tenant's failure to do so shall constitute an act of default hereunder and Landlord shall have the right to exercise any remedy provided for at Article 27 hereof. Within fifteen (15) days after the Term (or any extension thereof) has expired or Tenant has vacated the Premises, whichever shall last occur, and provided Tenant is not then in default on any of its obligations hereunder, Landlord shall return the Security Deposit to Tenant, or if Tenant has assigned its interest under this Lease, to the last assignee of Tenant. If Landlord sells its interest in the Premises, Landlord may deliver this deposit to the purchaser of Landlord's Interest and thereupon be relieved of any further liability or obligation with respect to the Security Deposit. 8. TENANT'S USE OF THE PREMISES Tenants shall use the Premises solely for the purposes set forth in Tenant's Use Clause. Tenant shall not use or occupy the Premises in violation of law or any covenant, condition or restriction affecting the Building or Project or the certificate of occupancy issued for the Building or Project, and shall, upon notice from Landlord, immediately discontinue any use of the Premises which is declared by any governmental authority having jurisdiction to be a violation of law or the certificate of occupancy. Tenant, at Tenant's own cost and expense, shall comply with all laws, ordinances, regulations, rules, and/or any directions of any governmental agencies or authorities having jurisdiction which shall, by reason of the nature of Tenant's use or occupancy of the Premises, impose any duty upon such laws, ordinances, regulations, rules and/or directions of any governmental agencies or authorities having jurisdiction which shall, by reason of the nature of Tenant's use or occupancy of the Premises, impose any duty upon Tenant or Landlord with respect to the Premises or it's use or occupation. If judgment of any court of competent jurisdiction or the admission by Tenant in any action or proceeding against Tenant has violated any such laws, ordinances, regulations, rules and/or directions so the use of the Premises shall be deemed to be a conclusive determination of that fact as between Landlord and Tenant. Tenant shall not do or permit to be done anything which will invalidate or increase the cost of any fire, extended coverage or other insurance policy covering the Building or Project and/or property located therein, and shall comply with all rules, orders, regulations, requirements and recommendations of the Insurance Services Office or any other organization performing a similar function. Tenant shall promptly upon demand reimburse Landlord for any additional premium charged for such policy by reason of Tenant's failure to comply with the provisions of this Article. Tenant shall not do or permit anything to be done in or about the Premises which will in any way obstruct or interfere with the rights of other Tenants or occupants of the Building or Project, or injure or annoy them, or use or allow the Premises to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit any nuisance in, on or about the Premises. Tenant shall not commit or suffer to be committed any waste in or upon the Premises. 9. SERVICE AND UTILITIES Provided that Tenant is not in default hereunder, Landlord agrees to furnish to the Premises during generally recognized business days, and during hours determined by Landlord in its sole discretion, and subject to the Rules and Regulations of the Building or Project, electricity for normal desk top office equipment and normal copying equipment, and heating, ventilation and air conditioning (*HVAC*) as required in Landlord's judgment for the comfortable use and occupancy of the Premises. If Tenant desires HVAC at any other time, Landlord shall use reasonable efforts to furnish such service upon reasonable notice from Tenant and Tenant shall pay Landlord's charges therefor on demand. Landlord shall also maintain and keep lighted the common stairs, common entries and restrooms in the Building. Landlord shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the Rent be abated by reason of (I) the installation, use or interruption of use of any equipment in connection with the furnishing of any of the foregoing services, (II) failure to furnish or delay in furnishing any such services where such failure or delay is caused by accident or any condition or event beyond the reasonable control of Landlord, or by the making of necessary repairs or improvements to the Premises, Building or Project, or (III) the limitation, curtailment, or rationing of, or restrictions on, use of water, electricity, gas or any other form of energy serving the Premises, Building or Project. Landlord shall not be liable under any circumstances for a loss of or injury to property or business, however occurring, through or in connection with or incidental to failure to furnish any such services. If Tenant [ILLEGIBLE] machines or equipment in the Premises which affect the temperature otherwise maintained by the HVAC system, Tenant shall not, without the written consent of Landlord, use any apparatus or device in the Premises, including without limitation, electronic data processing machines, punch card machines or machines using in excess of 120 volts, which consumes more electricity than is usually furnished or supplied for the use of premises as general office space, as determined by Landlord, Tenant shall not connect any apparatus with electric current except through existing electrical outlets in the Premises. Tenant shall not consume water or electric current in excess of that usually furnished or supplied for the use of premises as general office space (as determined by Landlord), without first procuring the written consent of Landlord, which Landlord may refuse, and in the event of consent, Landlord may have installed a water meter or electrical current meter in the Premises to measure the amount of water or electric current consumed. The cost of any such meter and of its installation, maintenance and repair shall be paid for by the Tenant and Tenant agrees to pay to Landlord promptly upon demand for all such water and electric current consumed as shown by said meters, at the rates charged for such services by the local public utility plus any additional expense incurred in keeping account of the water and electric current so consumed. If a separate meter is not installed, the excess cost for such water and electric current shall be established by an estimate made by a utility company or electrical engineer hired by Landlord at Tenant's expense. Landlord shall furnish elevator service, lighting replacement for building standard lights, restroom supplies, window washing and janitor services in a manner that such services are customarily furnished to comparable office buildings in the area. 10. CONDITION OF THE PREMISES Tenant's taking possession of the Premises shall be deemed conclusive evidence that as of the date of taking possession the Premises are in good order and satisfactory condition, except for such matters as to which Tenant or Landlord notice on or before the Commencement Date. No promise of Landlord to alter, remodel, repair or improve the Premises, the Building or the Project and no representation, express or implied, respecting any matter or thing relating to the Premises, Building, Project or this Lease (including, without limitation, the condition of the Premises, the Building or the Project) have been made to Tenant by Landlord or its Broker or Sales Agent, other than as may be contained herein or in a separate exhibit or addendum signed by Landlord and Tenant. 11. CONSTRUCTION, REPAIRS AND MAINTENANCE a. Landlord's Obligations. Landlord shall perform Landlord's Work to the Premises as described in Exhibit "C", Landlord shall maintain in good order, condition and repair the Building and all other portions of the Premises which are not the obligation of Tenant or of any other tenant in the Building. b. Tenant's Obligations (1) Tenant shall perform Tenant's Work in the Premises as described in Exhibit "C." (2) Tenant at Tenant's sole expense shall, except for services furnished by Landlord pursuant to Article 9 hereof, maintain the Premises in good order, condition and repair, including the interior surfaces of the ceilings, walls and floors, all doors, all interior windows, all plumbing, pipes and fixtures, electrical wiring, switches and fixtures, electrical wiring, switches and fixtures, Building Standard furnishings and special items and equipment installed by or at the expense of Tenant. (3) Tenant shall be responsible for all repairs and alterations in and to the Premises, Building and Project and the facilities and systems thereof, the need for which arises out of (I) Tenant's use or occupancy of the Premises, (II) the installation, removal, use or operation of Tenant's Property (as defined in Article 13) in the Premises, (III) the moving of Tenant's Property into or out of the Building, or (IV) the act, omission, misuse or negligence of Tenant, its agents, contractors, employees or invitees. (4) If Tenant fails to maintain the Premises in good order, condition and repair, Landlord shall give Tenant notice to do such acts as are reasonable required to so maintain the Premises. If Tenant fails to promptly commence such acts and diligently prosecute it to completion, then Landlord shall have the right to do such acts and expend such funds at the expense of Tenant as are reasonably required to perform such work. Any amount so expended by Landlord shall be paid by Tenant promptly after demand with interest at the prime commercial rate then being charged by Bank of America NT & SA plus two percent (2%) per annum, from the date of such work, but not to exceed the maximum rate then allowed by law. Landlord shall have no liability to Tenant for any damage, inconvenience, or interference with the use of the Premises by Tenant as a result of performing any such work. c. Compliance with Law. Landlord and Tenant shall each do all acts required to comply with all applicable laws, ordinances and rules of any public authority relating to their respective maintenance obligations as set forth herein. d. Waiver by Tenant. Tenant expressly waives the benefits of any statute now or hereafter in effect which would otherwise afford the Tenant the right to make repairs at Landlord's expense or to terminate this Lease because of Landlord's failure to keep the Premises in good order, condition and repair. e. Load and Equipment Limits. Tenant shall not place a load upon any floor of the Premises which exceeds, the load per square foot which such floor was designed to carry, as determined by Landlord or Landlord's structural engineer. The cost of any such determination made by Landlord's structural engineer shall be paid for by Tenant upon demand. Tenant shall not install business machines or mechanical equipment which cause noise or vibration to such a degree as to be objectionable to Landlord or other Building tenants. f. Except as otherwise expressly provided in this Lease, Landlord shall have no liability to Tenant nor shall Tenant's obligations under this Lease be reduced or abated in any manner whatsoever by reason of any inconvenience, annoyance, interruption or injury to business arising from Landlord's making any repairs or changes which Landlord is required or permitted g. Tenant shall give Landlord prompt notice of any damage to or defective condition in any part or appurtenance of the Building's mechanical, electrical, plumbing, HVAC or other systems serving, located in, or passing through the Premises. h. Upon the expiration or earlier termination of this lease, Tenant shall return the Premises to Landlord clean and in the same condition as on the date Tenant took possession, except for normal wear and tear. Any damage to the Premises, including any structural damage, resulting from Tenant's use or from the removal of Tenant's fixtures, furnishings and equipment pursuant to Section 13b shall be repaired by Tenant at Tenant's expense. 12. ALTERATIONS AND ADDITIONS a. Tenant shall not make any additions, alterations or improvements to the Premises without obtaining the prior written consent of Landlord. Landlord's consent may be conditioned on Tenant's removing any such additions, alterations or improvements upon the expiration of the term and restoring the Premises to the same condition as on the date Tenant took possession. All work with respect to any addition, alteration or improvement shall be done in a good and workmanlike manner by properly qualified and licensed personnel approved by Landlord, and such work shall be diligently prosecuted to completion. Landlord may, at Landlord's option require that any such work be performed by Landlord's contractor, in which case the cost of such work shall be paid for before commencement of the work. Tenant shall pay to Landlord upon completion of any such work by Landlord's contractor, an administrative fee of fifteen percent (15%) of the cost of the work. b. Tenant shall pay the costs of any work done on the Premises pursuant to Section 12a, and shall keep the Premises, Building and Project free and clear of liens of any kind. Tenant shall indemnify, defend against and keep Landlord free and harmless from all liability, loss, damage, costs, attorneys' fees and any other expense incurred on account of claims by any person performing work or furnishing materials or supplies for Tenant or any person claiming under Tenant. Tenant shall keep Tenant's leasehold interest, and any additions or improvements which are or become the property of Landlord under this Lease, free and clear of all attachment or judgment leins. Before the actual commencement of any work for which a claim or lien may be filed, Tenant shall give Landlord notice of the intended commencement date a sufficient time before that date to enable Landlord to post notices of nonresponsibility or any other notices which Landlord deems necessary for the proper protection of Landlord's interest in the Premises, Building or the Project, and Landlord shall have the right to enter the Premises and post such notices at any reasonable time. c. Landlord may require, at Landlord's sole option, that Tenant provide to Landlord, at Tenant's expense, a lien and completion bond amount equal to at lease one and one-half (1-1/2) times the total estimated cost of any additions, alterations or improvements to be made in or to the Premises, to protect Landlord against any liability for mechanics and materialmen's liens and to insure timely completion of the work. Nothing contained in this Section 12c shall relieve Tenant of its obligations under Section 12b to keep the Premises, Building and Project free of all liens. d. Unless their removal is required by Landlord as provided in Section 12a, all additions, alterations and improvements make to the Premises shall become the property of Landlord and be surrendered with the Premises upon the expiration of the Term; provided, however, Tenant's equipment, machinery and trade fixtures which can be removed without damage to the Premises shall remain the property of Tenant and may be removed, subject to the provisions of Section 13b. 13. LEASEHOLD IMPROVEMENTS; TENANT'S PROPERTY a. All fixtures, equipment, improvements and appurtenances attached to or built into the Premises at the commencement of or during the Term, whether or not by or at the expense of Tenant ("Leasehold Improvements"), shall be and remain a part of the Premises, shall be the property of Landlord and shall not be removed by Tenant, except as expressly provided in Section 13b. b. All movable partitions, business and trade fixtures, machinery and equipment, communications equipment and office equipment located in the Premises and acquired by or for the account of Tenant, without expense to Landlord, which can be removed without structural damage to the Building, and all furniture, furnishings and other articles of movable personal property owned by Tenant and located in the Premises (collectively "Tenant's Property") shall be and shall remain the property of Tenant and may be removed by Tenant of any time during the Term; provided that if any of Tenant's Property is removed, Tenant shall promptly repair any damage to the Premises or to the Building resulting from such removal. 14. RULES AND REGULATIONS Tenant agrees to comply with (and cause its agents, contractors, employees and invitees to comply with the rules and regulations attached hereto as Exhibit "D" and with such reasonable modifications thereof and additions hereto as Landlord may from time to time make. Landlord shall not be responsible for any violation of said rules and regulations by other tenants or occupants of the Building or Project. 15. CERTAIN RIGHTS RESERVED BY LANDLORD Landlord reserves the following rights, exercisable without liability to Tenant for (a) damage or injury to property, person or business, (b) causing an actual or constructive eviction from the Premises, or (c) disturbing Tenant's use or possession of the Premises: a. To name the building and Project and to change the name or street address of the Building or Project; b. To install and maintain all signs on the exterior and interior of the Building and Project; c. To have pass keys to the Premises and all doors within the Premises, excluding Tenant's vaults and safes; d. At any time during the Term, and on reasonable prior notice to Tenant, to inspect the Premises, and to show the Premises to any prospective purchaser or mortgagee of the Project, or to any assignee of any mortgage on the Project, or to others having an interest in the Project or Landlord, and during the last six months of the term, to show the Premises to prospective Tenants. e. To enter the Premises for the purpose of making inspections, repairs, alterations, additions or improvements to the Premises or the Building (including, without limitation, checking, calibrating, adjusting or balancing controls and other parts of the HVAC system), and to take all steps as may be necessary or desirable for the safety, protection, maintenance or preservation of the Premises or the Building or Landlord's interest therein, or as may be necessary or desirable for the operation or improvement of the Building or in order to comply with laws, orders or requirements of governmental or other authority. Landlord agrees to use its best efforts (except in an emergency) to minimize interference with Tenant's business in the Premises in the course of any such entry. 16. ASSIGNMENT AND SUBLETTING Assignment of this Lease or sublease of all or any part of the Premises shall be permitted, except as provided for in Article 16. a. Tenant shall not, without the prior written consent of Landlord, assign or hypothecate this Lease or any interest herein or sublet the Premises or any part thereof, or permit the use of the Premises by any party other than Tenant. Any of the foregoing acts without such consent shall be void and shall, at the option of Landlord, terminate this Lease. This lease shall not, nor shall any interest of Tenant herein, be assignable by operation of law without the written consent of Landlord. b. If at any time or from time to time during the Term Tenant desires to assign this Lease or sublet all or any part of the Premises, Tenant shall give notice to landlord setting forth the terms and provisions of the proposed assignment or sublease, and the identity of the proposed assignee or subtenant. Tenant shall promptly supply Landlord with such information concerning the business background and financial condition of such proposed assignee or subtenant as Landlord may reasonably request. Landlord shall have the option, exercisable by notice given to Tenant within twenty (20) days after Tenant's notice is given, either to sublet such space from Tenant at the rental and on the other terms set forth in this Lease of the term, set forth in Tenant's notice, or, in the case of an assignment, to terminate this Lease, If Landlord does not exercise such option, Tenant may assign the Lease or sublet such space to such proposed assignee or subtenant on the following further conditions: (1) Landlord shall have the right to approve such proposed assignee or subtenant, which approval shall not be unreasonably withheld; (2) The assignment or sublease shall be on the same terms set forth in the notice given to Landlord; (3) No assignment or sublease shall be valid and no assignee or subleasee shall take possession of the Premises until an executed counterpart of such assignment or sublease has been delivered to Landlord; (4) No assignee or subleasee shall have a further right to assign or sublet expect on the terms herein contained; and (5) Any sums or other economic consideration received by Tenant as a result of such assignment or subletting, however denominated under the assignment or sublease, which exceed, in the aggregate, (I) the total sums which Tenant is obligated to pay Landlord under this Lease (prorated to reflect obligations allocable to any portion of the Premises subleased), plus (II) any real estate brokerage commissions or fees payable in connection with such assignment or subletting, shall be paid to landlord as additional rent under this Lease without affecting or reducing any other obligations of Tenant hereunder. c. Notwithstanding the provisions of paragraphs a and b above, Tenant may assign this Lease or sublet the premises, or any portion thereof, without Landlord's consent and without extending any recapture or termination option to Landlord, to any corporation which controls, is controlled by or is under common control with Tenant, or to any corporation resulting from a merger or consolidation with Tenant, or to any person or entity which acquires all the assets of Tenant's business as a going concern, provided that (I) the assignee or subleasee assumes, in full, the obligations of Tenant under this Lease, (II) Tenant remains fully liable under this Lease, and (III) the use of the Premises under Article 0 remains unchanged. d. No subletting or assignment shall release Tenant or Tenant's obligations under this Lease or alter the primary liability of the Tenant to pay the Rent and to perform all other obligations to be performed by Tenant hereunder. The acceptance of Rent by Landlord from any other person shall not be deemed to be a waiver by Landlord of any provision hereof. Consent to one assignment or subletting shall not be deemed consent to any subsequent assignment or subletting. In the event of default by an assignee or subtenant of Tenant or any successor of Tenant in the performance of any of the terms hereof, Landlord may proceed directly against Tenant without the necessity of exhausting remedies against such assignee, subtenant or successor. Landlord may consent to subsequent assignments of the Lease or sublettings or amendments or modifications to the Lease with assignees of Tenant, without notifying Tenant, or any successor of Tenant, and without obtaining its or their consent thereto and any such actions shall not relieve Tenant of liability under this Lease. e. If Tenant assigns the Lease or sublets the Premises or requests the consent of Landlord to any assignment or subletting or it Tenant requests the consent of Landlord for any act that Tenant proposes to do, then Tenant shall, upon demand, pay Landlord an administrative fee of One Hundred Fifty and No/100ths ($150.00) plus any attorneys fees reasonably incurred by Landlord in connection with such act or request. 17. HOLDING OVER If after expiration of the Term, or extentions hereof, Tenant remains in possession of the Premises with Landlord's permission (express or implied), Tenant shall become a Tenant from month to month only, upon all the provisions of this lease (except to Term and Base Rent), but the "Monthly Installments of Base Rent" payable by Tenant shall be increase to one hundred fifty percent (150%) of the Monthly Installments of Base Rent payable by Tenant at the expiration of a Term. Such monthly rent shall be payable in advance on or before the first day of each month. If either party desires to terminate such month to month tenancy, it shall give the other party not less that thirty (30) days advance written notice of the date of termination. 18. SURRENDER OF PREMISES A Tenant shall peaceably surrender the Premises to Landlord on the Expiration Date, in broom-clean condition and in as good condition as which Tenant took possession, except for (I) reasonable wear and tear, (II) loss by fire or other casualty, and b. If tenant abandons or surrenders the Premises, or is dispossessed by process of law or otherwise, any of Tenant's Property left on the Premises shall be deemed to be abandoned, and, at Landlord's option, title shall pass to Landlord under this Lease as by a bill of sale. If Landlord elects to remove all or any part of such Tenant's Property, the cost of removal, including repairing any damage to the Premise or Building caused by such removal, shall be paid by Tenant. On the Expiration Date Tenant shall surrender all keys to the Premises. 19. DESTRUCTION OR DAMAGE a. If the premises or the portion of the Building necessary for Tenant's occupancy is damaged by fire, earthquake or other Acts of God, the elements or other casualty, Landlord shall, subject to the provision of this Article, promptly repair the damage. If such repairs can, in Landlord's opinion, be completed within ninety (90) days. If Landlord determines that repairs can be completed within ninety (90) days, this Lease shall remain in full force and effect, except that if such damage is not the result of the negligence or willful misconduct of Tenant or Tenant's agents, employees, contractors, licensees or invitees, the Base Rent shall be abated to the extent Tenant's use of the premises is impaired, commencing with the date of damage and continuing until completion of the repairs required of Landlord under Section 10d. b. If in Landlord's opinion, such repairs to the Premises or portion of the Building necessary for Tenant's occupancy cannot be completed within ninety (90) days, Landlord may elect, upon notice to Tenant given within thirty (30) days after the date of such fire or other casualty, to repair such damage, in which event this Lease shall continue in full force and effect, but the Base Rent shall be partially abated as provided in Section 10a. If Landlord does not so elect to make such repairs, this Lease shall terminate as of the date of such fire or other casualty. c. If any other portion of the Building or Project is totally destroyed or damaged to the extent that in Landlord's opinion repair thereof cannot be completed within ninety (90) days. Landlord may elect upon notice to Tenant given within thirty (30) days after the date of such fire or other casualty, to repair such damage. In which event this Lease shall continue in full force and effect, but the Base Rent shall be partially abated as provided in Section 19a. If Landlord does not elect to make such repairs, this Lease shall terminate as of the date of such fire or other casualty. d. If the Premises are to be repaired under this Article, Landlord shall repair at its cost any injury or damage to the Building and Building Standard work in the Premises. Tenant shall be responsible at its sole cost and expense for the repair, restoration and replacement of any other Leasehold improvements and Tenant's Property. Landlord shall not be liable for any loss of business, inconvenience or annoyance arising from any repair or restoration of any portion of the Premises, Building or Project as a result of any damage from fire or other casualty. e. This Lease shall be considered an express agreement governing any case of damage to or destruction of the Premises, Building or Project by fire or other casualty, and any present or future law which purports to govern the rights of Landlord and Tenant in such circumstances in the absence of express agreement, shall have no application. 20. EMINENT DOMAIN a. If the whole of the Building or Premises is lawfully taken by condemnation or in any other manner for any public or quasi-public purpose, this Lease shall terminate as of the date of such taking, and Rent shall be prorated to such date. If less than the whole of the Building or Premise is so taken, this Lease shall be unaffected by such taking, provided that (I) Tenant shall have the right to terminate this Lease by notice to Landlord given within ninety (90) days after the date of such taking if twenty percent (20%) or more of the Premises is taken and the remaining area of the Premises is not reasonably sufficient for Tenant to continue operation of its business, and (II) Landlord shall have the right to terminate this Lease by notice to Tenant given within ninety (90) days after the date of such taking. If either Landlord or Tenant so elects to terminate this Lease, the Lease shall terminate on the thirtieth (30) day after either such notice. The Rent shall be prorated to the date of termination. If this Lease continues in force upon such partial taking, the Base Rent and Tenant's Proportionate Share shall be equitably adjusted according to the remaining Rentable Area of the Premises and Project. b. In the event of any taking, partial or whole, all of the proceeds of any award, judgment or settlement payable by the condemning authority shall be the exclusive property of Landlord, and Tenant hereby assigns to Landlord all of its right, title and interest in any award, judgment or settlement from the condemning authority, Tenant, however, shall have the right, to the extent that Landlord's award is not reduced or prejudiced, to claim from the condemning authority (but not from Landlord) such compensation as may be recoverable by Tenant in its own right for relocation expenses and damage to Tenant's personal property. c. In the event of a partial taking of the Premises which does not result in a termination of this Lease, Landlord shall restore the remaining portion of the Premises as nearly as practicable to its condition prior to the condemnation or taking, but only to the extent of Building Standard Work. Tenant shall be responsible at its sole cost and expense for the repair, restoration and replacement of any other Leasehold improvements and Tenant's Property. 21. INDEMNIFICATION a. Tenant shall indemnify and hold Landlord harmless against and from liability and claims of any kind for loss or damage to property of tenant or any other person, or for any injury to or death of any person, arising out of: (1) Tenant's use and occupancy of the Premises, or any work, activity or other things allowed or suffered by Tenant, to be done in; on or about the Premises; (2) any breach or default by Tenant of any of Tenant's obligations under this Lease; or (3) any negligent or otherwise tortious act or omission of Tenant, its agents, employees, invitees or contractors. Tenant shall, at Tenant's expense, and by counsel satisfactory to Landlord, defend Landlord in any action or proceeding arising from any such claim and shall indemnify Landlord against all costs, attorneys' fees, expert witness fees and any other expenses incurred in such action or proceeding. As a material part of the consideration for Landlord's execution of this Lease, Tenant hereby assumes all risk of damage or injury to any person or property in, on or about the Premises from any cause. b. Landlord shall not be liable for injury or damage which may be sustained by the person or property of Tenant, its employees, invitees or customers, or any other person in or about the Premises, caused by or resulting from fire, steam, electricity, gas, water or rain which may leak or flow from or into any part of the Premises, or from the breakage, leakage, obstruction or other defects of pipes, sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures, whether such damage or injury results from conditions arising upon the Premises or upon other portions of the Building or Project ???. 22. TENANT'S INSURANCE a. All insurance required to be carried by Tenant hereunder shall be issued by responsible insurance companies acceptable to Landlord and Landlord's lender and qualified to do business in the State. Each policy shall name Landlord, and at Landlord's request any mortgagee of Landlord, as an additional insured, as their respective interests may appear. Each policy shall contain (I) a cross-liability endorsement, (II) a provision that such policy and the coverage evidenced thereby shall be primary and non-contributing with respect to any policies carried by Landlord and that any coverage carried by Landlord shall be excess insurance, and (III) a waiver by the insurer of any right of subrogation against Landlord, its agents, employees and representatives, which arises or might arise by reason of any payment under such policy or by reason of any act or omission of Landlord, its agents, employees or representatives. A copy of each paid up policy (authenticated by the insurer) or certificate of the insurer evidencing the existence and amount of each insurance policy required hereunder shall be delivered to Landlord before the date Tenant is first given the right of possession of the Premises, and thereafter within thirty (30) days after any demand by Landlord there for, Landlord may, at any time and from time to time, inspect and/or copy any insurance policies required to be maintained by Tenant hereunder. No such policy shall be cancellable except after twenty (20) days written notice to Landlord and Landlord's Lender. Tenant shall furnish Landlord with renewals or "binders" of any such policy at least ten (10) days prior to the expiration thereof. Tenant agrees that if Tenant does not take out and maintain such insurance, Landlord may (but shall not be required to) procure said insurance on Tenant's behalf and charge the Tenant the premiums together with a twenty-five percent (25%) handling charge, payable upon demand. Tenant shall have the right to provide such insurance coverage pursuant to blanket policies obtained by the Tenant, provided such blanket policies expressly afford coverage to the Premises, Landlord, Landlord's mortgagee and Tenant as required by this Lease. b. Beginning on the date Tenant is given access to the Premises for any purpose and continuing until expiration of the Term, Tenant shall procure, pay for and maintain in effect policies of casualty insurance covering (1) all Leasehold improvements (including any alterations, additions or improvements as may be made, by Tenant pursuant to the provisions of Article 12 hereof), and (II) trade fixtures, merchandise and other personal property from time to time in, on or about the Premises, in an amount not less than one hundred percent (100%) of their actual replacement cost from time to time, providing protection against any peril included with the classification "Fire and Extended Coverage" together with insurance against sprinkler damage, vandalism and malicious mischief. The proceeds of such insurance shall be used for the repair or replacement of the property so insured. Upon termination of this Lease following a casualty as set forth herein, the proceeds under (1) shall be paid to Landlord, and the proceeds under (II) above shall be paid to Tenant. c. Beginning on the date Tenant is given access to the Premises for any purpose and continuing until expiration of the Term, Tenant shall procure, pay for and maintain in effect workers compensation insurance as required by law and comprehensive public liability and property damage insurance with respect to the construction of improvements on the Premises, the use, operation or condition of the Premises and the operations of Tenant in, on or about the Premises, providing personal injury and broad form property damage coverage for not less than One Million Dollars ($1,000,000.00) combined single limit for bodily injury, death and property damage liability. d. Not less than every three (3) years during the term, Landlord and Tenant shall mutually agree to increases in all of Tenant's insurance policy limits for all insurance to be carried by Tenant as set forth in this Article. In the event Landlord and Tenant cannot mutually agree upon the amounts of said increases, then Tenant agrees that all insurance; policy limits as set forth in this article shall be adjusted for increases in the cost of living in the same manner as is set forth in Section 5.2 hereof for the adjustment of the Base Rent. 23. WAIVER OF SUBROGATION Landlord and Tenant each hereby waive all rights of recovery against the other and against the officers, employees, agents and representatives of the other, on account of loss by or damage to the waiving party or its property of the property of others under its control, to the extent that such loss or damage is insured against under any fire and extended coverage insurance policy which either may have in force at the time of the loss or damage. Tenant shall upon obtaining the policies of insurance required under this Lease, give notice to the insurance carrier or carriers that the foregoing mutual waiver of subrogation is contained in this Lease. 24. SUBORDINATION AND ATTORNMENT Upon written request of Landlord, or any first mortgagee or first deed of trust beneficiary of Landlord, or ground Lessor of Landlord, Tenant shall, in writing, subordinate its rights under this Lease to the lien of any first mortgage or first deed of trust, or to the interest of any lease in which Landlord is leasee, and to all advances made or hereafter to be made thereunder. However before signing any subordination agreement, Tenant shall have to right to obtain from any lender or lessor of Landlord requesting such subordination, an agreement in writing providing as long as Tenant is not in default hereunder, this Lease shall remain in effect for the full Term. The holder of security interest may, upon written notice to Tenant, elect to have this Lease prior to its security interest regardless of the time of the granting or recording of such security interest. In the event of any foreclosure sale, transfer in lieu of foreclosure or termination of the lease in which Landlord, its Lessee, Tenant may attorn to the purchaser, transferee or Lessor as the case may be, and recognize that party as Landlord under this Lease, provided such party acquires and accepts the Premises subject to this Lease. 25. TENANT ESTOPPEL CERTIFICATES Within ten (10) days after written request from Landlord, Tenant shall execute and deliver to Landlord or Landlord's designee, a written statement certifying (a) that this Lease is unmodified and in full force and effect, or is in full force and effect as modified and stating the modifications; (b) the amount of Base Rent and the date to which Base Rent and additional rent have been paid in advance; (c) the amount of any security deposited with Landlord; and (d) that Landlord is not in default hereunder or, if Landlord is claimed to be in default, stating the nature of any claimed default. Any such statement may be called upon by a purchaser, assignee or lender. Tenant's failure to execute and deliver such statement within the time required shall at Landlord's election be a default under this Lease and shall also be conclusive upon ??? 26. TRANSFER OR LANDLORD'S INTEREST In the event of any sale or transfer by Landlord of the Premises, Building or Project, and assignment of this Lease by Landlord, Landlord shall be and is hereby entirely freed and relieved of any and all liability and obligations contained in or derived from this Lease arising out of any act, occurrence or omission relating to the Premises, Building, Project or Lease occurring after the consummation of such sale or transfer, providing the purchaser shall expressly assume all of the covenants and obligations of Landlord under this Lease. If any security deposit or prepaid Rent has been paid by Tenant, Landlord may transfer the security deposit or prepaid Rent to Landlord's successor and upon such transfer, Landlord shall be relieved of any and all further liability with respect thereto. 27. DEFAULT 27.1 TENANT'S DEFAULT. The occurrence of any one or more of the following events shall constitute a default and breach of this Lease by Tenant: a. If Tenant abandons or vacates the Premises; or b. If Tenant fails to pay any Rent or any other charges required to be paid by Tenant under this Lease and such failure continues for five (10) days after such payment is due and payable; or c. If Tenant fails to promptly and fully perform any other covenant, condition or agreement contained in this Lease and so failure continues for thirty (30) days after written notice thereof from Landlord to Tenant; or d. If a writ of attachment or execution is levied on this Lease or on any of Tenant's Property; or e. If Tenant makes a general assignment for the benefit of creditors, or provides for an arrangement, composition, extension or adjustment with its creditors; or f. If Tenant files a voluntary position for relief or if a petition against Tenant is a proceeding under the federal bankruptcy laws or other insolvency laws is filed and not withdrawn or dismissed within forty-five (45) days hereafter, or if under the provisions of any law providing for reorganization or winding up of corporations, any court of competent jurisdiction assumes jurisdiction, custody or control of Tenant or any substantial part of its property and such jurisdiction, custody or control remains in force unrelinquished, unstayed or unterminated for a period of forty-five (45) days; or g. If in any proceeding or action in which Tenant is a party, a trustee, receiver, agent or custodian is appointed to take charge of the Premises or Tenant's Property (or has the authority to do so) for the Purpose of enforcing a lien against the Premises or Tenant's Property; or h. If Tenant is a partnership or consists of more than one (1) person or entity, if any partner of the partnership or other person or entity is involved in any of the acts or events described in subparagraphs d through g above. 27.2 REMEDIES. In the event of Tenant's default hereunder, then in addition to any other rights or remedies Landlord may have under any law, Landlord shall have the right, at Landlord's option, without further notice or demand of any kind to do the following: a. Terminate this Lease and Tenant's right to possession of the Premises and reenter the Premises and take possession thereof, and Tenant shall have no further claim the Premises or under this Lease; or b. Continue this Lease in effect, reenter and occupy the Premises for the account of Tenant, and collect any unpaid Rent or other changes which have or thereafter become due and payable; or c. Reenter the Premises under the provisions of subparagraph b, and thereafter elect to terminate this Lease and Tenant's right to possession of the Premises. If Landlord reenters the Premises under the provisions of subparagraphs b or c above, Landlord shall not be deemed to have terminated this Lease or the obligation of Tenant to pay any Rent or other changes thereafter accruing, unless Landlord notifies Tenant in writing of Landlord's election to terminate this Lease. In the event of any reentry or retaking of possession by Landlord, Landlord shall have the right, but not the obligation, to remove all or any part of Tenant's Property in the Premises and to place such property in storage at a public warehouse at the expense and risk of Tenant. If Landlord elects to relet the premises for the account of Tenant, the rent received by Landlord from such reletting shall be applied as follows; first, to the payment of any indebtedness other than rent due hereunder from Tenant to Landlord; second, to the payment of any costs of such reletting third, to the payment of the cost of any alterations or repairs to the Premises; fourth to the payment of rent due and unpaid hereunder; and the balance, if any, shall be held by Landlord and applied in payment of future Rent as it become due. If that portion of rent received from the reletting which is applied against the Rent due hereunder is less than the amount of the Rent due, Tenant shall pay the deficiency to Landlord promptly upon demand by Landlord. Such deficiency shall be calculated and paid monthly. Tenant shall also pay to Landlord, as soon as determined, any costs and expenses incurred by Landlord in connection with such reletting or in making alterations and repairs to the Premises, which are not covered by the rent received from the reletting. Should Landlord elect to terminate this Lease under the provisions of subparagraph a or c above, Landlord may recover as damages from Tenant the following: 1. PAST RENT. The worth at the time of the award of any unpaid Rent which had been earned at the time of termination; plus 2. RENT PRIOR TO AWARD. The worth at the time of the award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that tenant proves could have been reasonably avoided; plus 3. RENT AFTER AWARD. The worth of the time of the award of the amount by which the unpaid Rent for the balance of the Term 4. PROXIMATELY CAUSED DAMAGES. Any other amount necessary to compensate Landlord for all detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, any costs or expenses (including attorney's fees), incurred by Landlord in (a) retaking possession of the Premises, (b) maintaining the Premises after Tenant's default, (c) preparing the Premises for reletting to a new tenant, including any repairs or alterations and (d) reletting the Premises, including brokers' commissions. "The worth at the time of the award" as used in subparagraphs 1 and 2 above, is to be computed by allowing interest at the rate of ten percent (10%) per annum. "The worth at the time of the award" as used in subparagraph five is to be computed by discounting the amount at the discount rate of the Federal Reserve Bank situated nearest to the Premises at the time of the award plus one percent (1%). The waiver by Landlord of any breach of any term, covenant or condition of this Lease shall not be deemed a waiver of such term, covenant or condition or of any subsequent breach of the same or any other term, covenant or condition. Acceptance of Rent by Landlord subsequent to any breach hereof shall not be deemed a waiver of any preceding breach other than the failure to pay the particular Rent so accepted, regardless of Landlord's knowledge of any breach at the time of such acceptance of Rent. Landlord shall not be deemed to have waived any term, covenant or condition unless Landlord gives Tenant written notice of such waiver. LANDLORD'S DEFAULT. If Landlord fails to perform any covenant, condition or agreement contained in this Lease within thirty (30) days after receipt of written notice from Tenant specifying such default, or if such default cannot reasonable be cured with thirty (30) days. If Landlord fails to commence to cure within that thirty (30) day period, then Landlord shall be liable to Tenant for any damages sustained by Tenant as a result of Landlord's breach; provided, however, it is expressly understood and agreed that if Tenant obtains a money judgement against Landlord resulting from any default or other claim arising under this Lease, that judgment shall be satisfied only if the rents, issues, profits, and other income actually received on account of Landlord's right, title and interest in the Premises, Building or Project, and no other real, personal or mixed property or Landlord (or of any of the Partners which comprise Landlord, if any) wherever situated shall be subject of levy to satisfy such judgment. After notice to Landlord of default, Landlord (or any first mortgagee or first deed of trust beneficiary of Landlord) fails to cure the default as provided herein, than Tenant shall have the right to cure that default at Landlord's expense. Tenant shall not have the right to terminate this Lease or to withhold, reduce or offset any amount against any payments of Rent or any other charges due and payable under this Lease except as otherwise specifically provided herein. 28. BROKERAGE FEES Tenant warrants and represents that it has not dealt with any real estate broker or agent in connection with this Lease or its negotiation except Broker and Sales Agent. Tenant shall indemnify and hold Landlord harmless from any cost, expense or liability (including costs of suit and reasonable attorneys' fees) for any compensation, commission or fees claimed by any other real estate broker or agent on connection with this Lease or its negotiation by reason of any act of Tenant. 29. NOTICES. All approvals and demands permitted or required to be given under this Lease shall be in writing and deemed duly served or given if personally delivered or sent by certified or registered U.S. mail, postage prepaid, and addressed as follows: (a) if to Landlord, to Landlord's Mailing Address and to the Building manager, and (b) if to Tenant, to Tenant's Mailing Address; provided, however, notices to Tenant shall be deemed duly served or given, delivered or mailed to Tenant at the Premises. Landlord and Tenant may from time to time by notice to the other designated another place for receipt of future notices. 30. GOVERNMENT ENERGY OR UTILITY CONTROLS In the event of imposition of federal, state or local government controls, rules, regulations, or restrictions on the use consumption of energy or other utilities during the Term, both Landlord and Tenant shall be bound thereby. In the event of a difference in interpretation by Landlord and Tenant of any such controls, the interpretation of Landlord shall prevail, and Landlord shall have the right to enforce compliance therewith, including the right of entry into the Premises to effect compliance. 33. OBSERVANCE OF LAW. Tenant shall not use the Premises or permit anything to be done in or about the Premises which will in any way conflict with any law, statute, ordinance or governmental rule or regulations now in force or which may hereafter be in force, with the requirements of any board of fire insurance underwriters or other similar bodies now or hereafter constituted, related to or affecting by Tenant's improvements or acts. The judgment of any court of competent jurisdiction or the admission of Tenant in any action against Tenant, whether Landlord is a party thereto or not, that Tenant violated any law, statute, ordinance or governmental rule, regulation or requirement, shall be conclusive of that fact as between Landlord and Tenant. 34. FORCE MAJEURE. Any prevention, delay or stoppage of work to be performed by Landlord or Tenant which is due to strikes, labor, disputes inability to obtain labor, materials, equipment or reasonable substitutes therefor, acts of God, governmental restrictions or regulations or controls, judicial orders, enemy or hostile governmental actions, civil commotion, or other casualty, or other casualty beyond the reasonable control of the party obligated to perform hereunder, shall excuse performance of the work by that party for a period equal to the duration of that prevention, delay or stoppage. Nothing in this Article 34 shall excuse or delay Tenant's obligation to pay Rent or other charges under this Lease. 35. CURING TENANT'S DEFAULTS If Tenant defaults in the performance of any of its obligations under this Lease, Landlord may (but shall not be obligated to) without waiving such default, perform the same for the account and at the expense of Tenant, Tenant shall pay Landlord all costs of such performance promptly upon receipt of a bill therefor. 36. SIGN CONTROL. Tenant shall not affix, paint, erect or inscribe any sign, projection, awning, signal or advertisement of any kind to any part of the Premises, Building or Project, including without limitation, the inside or outside of windows or doors without the written consent of Landlord. Landlord shall have the right to remove any signs or other matter, installed without Landlord's permission, without being liable to Tenant by reason of such removal, and to charge the cost of removal to Tenant as additional rent hereunder, payable within ten (10) days of written demand by Landlord. 37. MISCELLANEOUS Accord and Satisfaction; Allocation of Payments. No payment by Tenant or Receipt by Landlord of a lesser amount than the Rent provided for in this Lease shall be deemed to be other than on account of the earliest due rent, nor shall any endorsement or statement on any check or letter accompanying any check or payment as rent be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of the Rent or pursue any other remedy provided for in this Lease. In connection with the foregoing, Landlord shall have the absolute right in its sole discretion to apply any payment received from Tenant to any account or other payment of Tenant then not current and due or delinquent. Addenda. If any provision contained in an addendum to this Lease is inconsistent with any other provision herein, the provision contained in the addendum shall control, unless otherwise provided in the addendum. Attorney's Fees. If any action or proceeding is brought by either party against the other pertaining to or arising out of this Lease, the finally prevailing party shall be entitled to recover all costs and expenses, including reasonable attorney's fees, incurred on account of such action or proceeding. Captions, Articles and Section Numbers. The captions appearing within the body of this Lease have been inserted as a matter of convenience and for reference only and in no way define, limit or enlarge the scope or meaning of this Lease. All references to Article and Section numbers refer to Articles and Sections in this Lease. Changes Requested by Lender: Neither Landlord or Tenant shall unreasonably withhold its consent to changes or amendments to this Lease requested by the lender on Landlord's interest, so long as those changes do not alter the basic business terms of this Lease or otherwise materially diminish any rights or materially increase any obligations of the party from whom consent to such change or amendment is requested. Choice of Law. This Lease shall be construed and enforced in accordance with the Laws of the State. Consent. Notwithstanding anything contained in this Leasee to the contrary, Tenant shall have no claim and hereby waives the right to any claim against Landlord for money damages by reason of any refusal: withholding or delaying by Landlord of any consent, approval or statement of satisfaction and in such event, Tenant's only remedies therefor shall be an action for specific performance, injunction or declaratory judgment to enforce any right to such consent, etc. Corporate Authority. If Tenant is a corporation, each individual signing this Lease on behalf of Tenant represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the corporation, and that this Lease is binding on Tenant in accordance with its terms. Tenant shall, at Landlord's request, deliver a certified copy of a resolution of its board of directors authorizing such execution. Counterparts. This Lease may be executed in multiple counterparts, all of which shall constitute one and the same Lease. Execution of Lease; No Option. The submission of this Lease to Tenant shall be for examination purposes only and does not and shall not constitute a reservation of or option for Tenant to lease, or otherwise create any interest of Tenant in the Premises or any other premises within the Building or Project, Execution of this Lease by Tenant and its return to Landlord shall not be binding on Landlord notwithstanding any time interval, until Landlord has in fact signed and delivered this Lease to Tenant. Furnishing of Financial Statements; Tenant's Representations. In order to induce Landlord to enter into this Lease Tenant agrees that it shall promptly furnish Landlord, from time to time, upon Landlord's written request with financial statements reflection Tenant's current financial condition. Tenant represents and warrants that all financial statements, records and information furnished by Tenant to Landlord in connection with this Lease are true, correct and complete in all respects. Further Assurances. The parties agree to promptly sign all documents reasonably requested to give effect to the provisions of this Lease. Mortgagee Protection. Tenant agrees to send by certified or registered mail to any first mortgagee or first deed of trust beneficiary of Landlord whose address has been furnished to Tenant, a copy of any notice of default served by Tenant on Landlord. If Landlord fails to cure such default within the time provided for in this Lease, such mortgagee or beneficiary shall have an additional thirty (30) days to cure such default; provided that if such default cannot reasonably be cured within that thirty (30) day period, then such mortgagee or beneficiary shall have such additional time to cure the default as is reasonably necessary under the circumstances. Prior Agreements; Amendments. This Lease contains all of the agreements of the parties with respect to any matter covered or mentioned. In this Lease, and no prior agreement or understanding pertaining to any such matter shall be effective for any purpose. No provision of this Lease may be amended or added to except by an agreement in writing signed by the parties or their respective successors in interest. Recording. Tenant shall not record this Lease without the prior written consent of Landlord. Tenant, upon the request of Landlord, shall execute and acknowledge a "short form" memorandum of this Lease for recording purposes. Severability. A final determination by a court of competent jurisdiction that any provision of this Lease is invalid shall not affect the validity of any provision, and any provision shall determined to be invalid shall, to the extent possible, be construed to accomplish its intended effect. Successors and Assigns. This Lease shall apply to and bind the heirs, personal representatives, and permitted successors and assigns of the parties. Time of the Essence. Time is of the essence of this Lease. Waiver. No delay or omission in the exercise of any right or remedy of Landlord upon any default by Tenant shall repair such right or remedy or be construed as a waiver of such default. The receipt and acceptance of Landlord of delinquent Rent shall not constitute a waiver of any other default; it shall constitute only a waiver of timely payment of the particular Rent payment involved. No act or conduct of Landlord, including, without limitation, the acceptance of keys to the Premises, shall constitute an acceptance of the surrender of the Premises by Tenant before the expiration of the Term. Only a written notice from Landlord to Tenant shall constitute acceptance of the surrender of the Premises and accomplish a termination of the Lease. Landlord's consent to or approval of any act by Tenant requiring Landlord's consent or approval shall not be deemed to waive or render unnecessary Landlord's consent to or approval of any subsequent act by Tenant. Any waiver by Landlord of any default must be in writing and shall not be a waiver of any other default concerning the same or any other provision of the Lease. The parties hereto have executed this Lease as of the date set forth on page one (1). /s/ Jeff Stock /s/ Robert McCausland - ----------------------------------- ----------------------------------- 1-24-97 Washington Mortgage Services Inc. - ----------------------------------- ----------------------------------- 1/24/97 - ----------------------------------- ----------------------------------- - ----------------------------------- ----------------------------------- Landlord Tenant RIDER: GUARANTEE OF LEASE WHEREAS, the Landlord under this lease requires as a condition to its execution of said lease that the undersigned guarantee the full performance of the obligations of Tenant under said Lease; and WHEREAS, the undersigned is desirous that Landlord enter into said lease with Tenant. NOW, THEREFORE, in consideration of the execution of said lease by Landlord, the undersigned hereby unconditionally guarantees the full performance of each and all of the terms, covenants and conditions of said lease to be kept and performed by said Tenant, including the payment of all rentals and all other charges to accrue thereunder. The undersigned further agrees as follows: 1. That this covenant and agreement on its part shall continue in favor of the Landlord notwithstanding any extension modification or alteration of said lease entered into by and between the parties thereto, their successors or into by an between the parties thereto, their successors or assigns, or notwithstanding any assignment of said lease, with or without consent of Landlord, and no extension, modification, alteration or assignment of the above referred to lease shall in any manner release or discharge the undersigned, and it does hereby consent thereto. 2. This guarantee will continue unchanged by any bankruptcy, reorganization or insolvency of the Tenant or any successor of assignees thereof or by any abandonment by a trustee of the Tenant. 3. Landlord may, without notice, assign this guarantee in whole or in part and no assignment or transfer of the lease shall operate to distinguish or diminish the liability of the undersigned hereunder. 4. The liability of the undersigned under this guarantee shall be primary and that in any right of action which shall accrue to Landlord under the lease, Landlord may, at its option, proceed against the undersigned without having consumenced any action, or having obtained any judgement against the Leasee. 5. To pay Landlord's reasonable attorney's fees and all costs and other expenses incurred in any collection or attempt a collection (including any suit or action or any appeal thereon) or in any negotiations relative to the legal obligations hereby guaranteed or lawfully enforcing this guarantee against the undersigned, individually and jointly. 6. That it does hereby waive notice of any demand by the Landlord, as well as any notice of default in the payment of rent or any other amounts contained or reserved in the lease. The use of the singular herein shall include the plural. The obligation of two or more parties shall be joint and several. The terms and provisions of this guarantee shall be binding upon and inure to the benefit of the respective successors and assigns of the parties herein named. IN WITNESS WHEREOF, the undersigned have each caused this guarantee to be executed on the date set forth opposite early signature below. 1/24/97 /s/ Robert McCausland - ------------------------------- --------------------------------- Date Name - ------------------------------- --------------------------------- Date Name - ------------------------------- --------------------------------- Date Name " A D D E N D U M A " 1. Actual footage to be determined as used Additional space at, then current monthly rent. 2. Landlord may not lease out any of top floor until July 1, 1997. Anytime after that date, tenant shall have right of first refusal within two business days. If top floor has been fully leased, tenant then may have right of first refusal on any remaining space on first floor or basement. 3. Tenant has the right to cancel lease with 120 days written notice. Jeff Stock 1-24-97 Robert McCausland 1/24/97 " A D D E N D U M B " 1. Tenant may renew for an additional two year period at current rate plus C.P.I if notified within 75 days expiration of lease. PROPOSED FLOORPLAN FOR WASHINGTON HOME MORTGAGE - EAST WING [MAP] PROPOSED FLOORPLAN FOR WASHINGTON HOME MORTGAGE - WEST WING Standard buildout to include in Aprox. $16,000, 20 offices + lunchroom and kitchen. Kitchen to include sink countertop approx. 4' of countertop with drawers and a set of overhead cabinets. Plumbed and wired for fridge, dishwasher, and microwave. [MAP] [MAP] EXHIBIT "A" SECOND FLOOR PLAN EX-10.15 18 EX-10.15 Exhibit 10.15 CUSTOMER AGREEMENT FOR WHOLESALE AND VIRTUAL ISP INTEGRATED SOLUTIONS DIAL-UP INTERNET ACCESS SERVICES This AGREEMENT (the "Agreement") is made and entered into as of the date of signature of the last party sign (the "Effective Date"), by and between Cable & Wireless USA, Inc., a District of Columbia corporation with its principal place of business at 8219 Leesburg Pike, Vienna, Virginia, 22182 ("C&W USA") and FreeiNetworks, Inc. a Washington corporation with offices at 909 S. 33 W Street Federal Way, WA 98003 ("Customer") (each being referred to individually as a "Party" and together as the "Parties"). Whereas, C&W USA provides certain Internet services including Internet access, transport, interconnection, web hosting, support, and other related services; WHEREAS, Customer desires to purchase from C&W USA and to offer or resell to subscribers and other end users ("End Users") certain of C&W USA's Internet services ("Service") as defined herein, for which Customer will act as the Internet Service Provider ("ISP") to End Users in accordance with the terms set out herein; NOW THEREFORE, in consideration of the mutual promises set forth below, the Parties hereby agree as follows: 1. DEFINITIONS: (a) "Customer", as used herein, means a sole proprietorship, partnership, corporation, or other legal entity that incurs usage charges for the Service (as defined herein) for its own use or who pays or bears the primary obligation to pay such charges on behalf of one or more End Users contracting with Customer for the Services as resold by the Customer, in Customer's capacity s an Internet Service Provider ("ISP"). (b) "End User", as used herein, means a user to whom the Service is made available by Customer and may include an individual, a corporation, or a legal entity who incurs usage charges to the Customer for the Service. (c) "C&W USA", as used herein, means Cable & Wireless USA Inc. [*] Confidential Treatment Requested (d) "Service", as used herein, means the Internet services provided by C&W USA to Customer as set forth in Exhibit B attached hereto. 2. SERVICE: 2.1 C&W USA INTERNET SERVICES: C&W USA will provide to Customer for resale or reprovisioning to End Users analog or digital access to the Internet as follows and as described in Exhibit B, according to Customer's agreed pricing and service level. a. TRAFFIC HANDLING. . C&W USA will provide Internet transport of IP packets, including store and forward, routing, and recovery, to Customer and its End Users using the same equipment, error handling, redundancy, routing efficiencies, and otherwise in the same manner as C&W USA handles C&W USA's customers Internet traffic, except as otherwise provided herein. b. TRAFFIC DELIVERY. C&W USA will deliver Customer's Internet traffic transiting C&W USA's Internet facilities ("C&W USA Network") based on Internet Protocol (IP) addressing. C&W USA IS NOT RESPONSIBLE FOR TRANSMISSION OF CUSTOMER TRAFFIC BEYOND C&W USA NETWORK. c. SERVICE LIMITATIONS. Customer hereby acknowledges that the Services are subject to certain conditions generally beyond the control of C&W USA, including the type and condition of the equipment (personal computer, modem, etc.) of Customer and/or End Users. The Service may be temporarily unavailable or limited because of capacity limitations and may be temporarily interrupted or curtailed due to equipment modifications, upgrades, relocations, repairs, and similar activities necessary for the proper operation of the Service. 2.2 CUSTOMER RESPONSIBILITIES. 2.2.1 GENERAL OBLIGATIONS. Customer hereby agrees to: (I) Notify C&W USA within 24 hours of any changes in account status for any End User, including addition of a new End User and termination of an End User account if and only if Customer is purchasing Virtual ISP Integrated Dial-up Internet Access Services; (ii) Remit to C&W USA all payments within thirty (30) days of the date of invoices for Service provided by C&W USA according to the terms set forth herein and in Exhibit B hereto; (iii) Provide notice of any disputed item contained in an invoice received from C&W USA for prompt resolution; (iv) Notify C&W USA promptly of any perceived degradation in the Service and cooperate with C&W USA to thee fullest possible in order to determine the cause of and 2 resolve any such degradation; (v) Comply fully with all applicable federal, state, and local laws, regulations, and ordinances relating to the Service to be provided hereunder and the resale of the Service to the End Users, and (vi) Otherwise comply with the terms and conditions as set forth herein. 2.2.2 CUSTOMER REPRESENTATIVE. Customer will provide a single point of contact for administrating of this Agreement. Customer shall cooperate with C&W USA in the performance and delivery of the Service hereunder. 2.2.3 CUSTOMER EQUIPMENT. Customer shall be responsible to provide for the proper installation, operation, and maintenance of Customer's equipment used in connection with the Service, and Customer shall ensure that such equipment is technically and operationally compatible with the Service and in compliance with applicable Federal Communications Commission rules and regulations. 2.2.4 END USER TERMS AND CONDITIONS. Customer warrants that it will require each End User to agree in writing to comply with and Customer shall cause each End User to so comply with terms substantially similar to the terms and conditions identified in Exhibit C attached hereto. 2.2.5 ACCEPTABLE USAGE OF DIAL-UP ACCOUNTS: Customer will let End Users use dial-up accounts solely on an active "dial-up" basis, and in no way on a standby or inactive basis in order to maintain a connection. A dial-up account may be used for World Wide Web browsing, reading or posting to Usenet (see Section 11 below) newsgroups, sending, receiving and reading electronic mail and transferring files via the file transfer protocol. Automated processes may not be used such as checking e-mail or pinging the host to maintain a constant connection. Without limitation of the foregoing, Customer and End Users shall abide by the provisions regarding usage set forth in Section 11 of this Agreement and in Exhibits B and C attached hereto. 3. PRICE: Customer shall pay to C&W USA the charges associated with the rate plan selected in accordance with Exhibit A attached hereto, including, but not limited to, applicable taxes and toll-free number charges. If service access is not provided via a local telephone number, Customer will also be responsible for toll or other charges. 3 Notwithstanding anything to the contrary herein, C&W USA may upon advance written notice adjust its rates or charges or impose additional rates and charges in order to recover amounts it may be required by governmental or quasi-governmental authorities to collect from or pay to others to support statutory or regulatory programs during the term of this Agreement (e.g., the "Universal Service Fund"). 4. PAYMENT: C&W USA shall bill Customer as described herein for all applicable charges on a monthly basis. Amounts not paid within 30 days after the date of the invoice are past due. A 1-1/2% per month late fee shall be assessed to Customer on all past due amounts . Prices do not include applicable taxes, for which Customer is responsible. At C&W USA's request, Customer shall post a bond in a form and amount acceptable to C&W USA, or provide a security deposit to assure payment. 5. TERM AND TERMINATION: This Agreement becomes effective as of its Effective Date and shall remain in effect for the period indicated in Exhibit A attached hereto or until terminated as provided herein. This Agreement shall continue in effect for successive consecutive additional terms as provided in Exhibit A following the initial Term until either Party gives the other party notice of termination at least thirty (30) days prior to the expiration of the then-current term. In the event Customer terminates this Agreement, then without limitation to any other remedy C&W USA may have, Customer will pay to C&W USA upon discontinuance of the Service the termination charge set forth on Exhibit A. 6. END USER COMPLIANCE ASSURANCE C&W USA reserves the right to review, either randomly or periodically or any combination thereof, End User-provide Content, including webpages, to confirm End User compliance with the terms of this Agreement using reasonable commercial and technical means available, in C&W USA's sole discretion. 7. ACCESS: Service access will be provided via a local telephone number where coverage is available. C&W USA is not responsible for any toll or other fee or charge. The Service may be remotely accessed via a toll-free number at an additional charge to be agreed upon by the parties. 8. CREDIT: There shall be no credits, reductions, or setoff against the charges for Service for downtime or interruption of Service unless such Service interruption exceeds 24 consecutive hours in duration. C&W USA shall provide Customer with a credit equal to 4 1/30 of the recurring monthly charge for Service for each twenty-four hour period from the tie of notice of interruption until Service restoration, provided Customer notifies C&W USA of the Service interruptions. No adjustments shall be made by accumulating periods of non-continuous interruption . A credit allowance will not be given for mistakes, omissions, interruptions, delays, errors, defects or curtailments in the Service caused by the negligence or willful act of Customer or others, or mistakes, omissions, interruptions, delays, errors or defects caused by failure of equipment or of Service as described in Section 2. 9. LIMITATION OF LIABILITY 9.1 SERVICE. C&W USA SHALL NOT BE LIABLE FOR OMISSIONS, INTERRUPTIONS, DELAYS, ERRORS, DEFECTS OR CURTAILMENTS IN THE SERVICE INTERRUPTIONS CAUSED BY FAILURE OF EQUIPMENT OR SERVICES NOT PROVIDED BY C&W USA, FAILURE OF COMMUNICATIONS, POWER OUTAGES, OR OTHER INTERRUPTION NOT WITHIN THE COMPLETE CONTROL OF C&W USA, NOR SHALL C&W USA BE LIABLE FOR PERFORMANCE DEFICIENCIES CAUSED OR CREATED BY CUSTOMER'S OR END USERS' EQUIPMENT. 9.2 CONTENT. C&W USA SHALL HAVE NO LIABILITY TO CUSTOMER, END USERS, OR OTHER THIRD PARTIES WITH RESPECT TO ITS OBLIGATIONS UNDER THIS AGREEMENT OR OTHERWISE FOR CONSEQUENTIAL, EXEMPLARY, SPECIAL, INCIDENTAL, INDIRECT OR PUNITIVE DAMAGES ARISING OUT OF ANY CONTENT TRANSMITTED UNDER THE TERMS OF THIS AGREEMENT. CUSTOMER HEREBY RELEASES C&W USA FROM LIABILITY ARISING FROM ANY CONTENT ACCESSED VIA THE SERVICE. 9.3 FORCE MAJEURE: C&W USA's performance under this Agreement shall be excused in case of labor difficulties, governmental orders, civil commotions, acts of god, or other conditions or circumstances beyond its reasonable control. 9.4 EQUIPMENT: C&W USA shall not be liable if changes in operation, procedures, or services require modification or alteration of Customer's or End User's equipment, render the same obsolete or otherwise affect its performance. 9.5 IN NO EVENT SHALL C&W USA BE LIABLE FOR ANY INCIDENTAL, SPECIAL, CONSEQUENTIAL, OR PUNITIVE DAMAGES INCLUDING BUT NOT LIMITED TO LOSS OF PROFITS, LOSS OF BUSINESS OR BUSINESS OPPORTUNITY, LOSS OF USE, 5 ETC. THE LIABILITY OF C&W USA FOR ACTUAL PROVEN DAMAGES FOR ANY CAUSE WHATSOEVER, INCLUDING BUT NOT LIMITED TO ANY FAILURE OF OR DISRUPTION OF SERVICES, REGARDLESS OF THE FORM OF ACTION, WHETHER IN CONTRACT OR IN TORT OR OTHERWISE, INCLUDING NEGLIGENCE, SHALL BE LIMITED TO AN AMOUNT EQUIVALENT TO CHARGES PAYABLE BY CUSTOMER UNDER THIS AGREEMENT FOR THE SERVICE DURING THE PERIOD SUCH DAMAGES OCCUR. 9.6 NO WARRANTIES. EXCEPT AS SET FORTH IN THIS AGREEMENT, C&W USA MAKES NO WARRANTIES OR REPRESENTATIONS, EITHER EXPRESS OR IMPLIED, CONCERNING THE SERVICE, AND EXPRESSLY DISCLAIMS WARRANTIES OF FITNESS FOR A PARTICULAR USE OR PURPOSE, THE WARRANTY OF MERCHANTABILITY AND ANY OTHER WARRANTY IMPLIED BY LAW. 9.7 CONTENT, ACCURACY OF INFORMATION: C&W USA and its affiliates, along with any parties from whom C&W USA obtains network services, exercise no control whatsoever over the content of the information passing through C&W USA's network. C&W USA makes no warranties of any kind, whether express or implied, for the content of the information passing through its network. Use of an information obtained via the C&W USA network is at Customer's and its End Users' own risk or the risk of their affiliates. C&W USA specifically denies any responsibility for the accuracy or quality of information obtained through its Service. 6 9.8 OFFENSIVE AND/OR HARMFUL INFORMATION: The Internet hosts some material deemed unfit for viewing and reading by minors under the age of 18. Some sites contain information both in text and graphical formats that Customer and/or End Users may consider obscene and/or harmful. Customer and/or End Users agree to not hold C&W USA responsible for sites and postings that could be considered obscene, lewd, offensive, and/or harmful. Customers are responsible for their own monitoring and viewing habits and their End Users, including minors. C&W USA does not block, filter or screen postings or sites on the Internet in whole or in part. 10. INDEMNIFICATION 10.1 GENERAL. Customer shall protect, indemnify, and hold harmless C&W USA and its officers, directors, employees, agents and third party suppliers along with any parties from whom C&W USA obtains network services from and against any loss, cost, claim, liability, damage, or expense (including reasonable attorneys' fees) to third parties, relating to or arising from: (i) the use of the Service by Customer, End User, or any of their personnel, whether or not Customer or End User has knowledge of or has authorized such access or use, including, without limitation, claims for libel, slander, invasion of privacy, infringement of copyright, patent infringement (where Customer or End User has used, connected, or combined the Service with the products or services of others), negligence, or tortuous behavior, (ii) Content including, without limitation, any claims arising out of Content, that damage another party or that violate t he law and/or (iii) arising out of injury or death to persons, damage to property, Customer's breach of any of the terms of this Agreement, or customer's misrepresentation, fraud, or negligence with respect to any End User. Customer acknowledges and agrees that C&W USA shall have no obligation to Customer, End User, or any member of Customer's organization other than as expressly set forth in this Agreement. 10.2 CUSTOMER INTELLECTUAL PROPERTY. Customer represents an warrants that it or End User owns or has a license to use all copyrights, licenses, trademarks, service marks, patents, and intellectual property rights for all elements of its content transmitted or made available over the Internet through the use of the Service, and that there is no geographic restriction on Customer or End User use of any of these intellectual property elements. Customer specifically grants C&W USA the worldwide right to transmit, download, copy or cache all such intellectual property elements necessary for C&W USA to provide the Service. Customer agrees to defend and/or handle at its own expense any claim or action against C&W USA or any of its affiliated entities for actual or alleged infringement of any US or International intellectual or industrial 7 property right, including, without imitation, trademarks, service marks, patents, copyrights, misappropriation of trade secrets or any similar proprietary rights arising out of Customer's or End User's Content or particular use of he Service. 10.3 C&W USA INTELLECTUAL PROPERTY. C&W USA shall, at its own expense, defend any suit or claim instituted against Customer and indemnify Customer against any award of damages and costs entered against Customer by a final judgment of a court of competent jurisdiction in any such suit insofar as the same is based on a claim that the C&W USA-furnished equipment and/or the C&W USA services constitute an infringement of any United States patent, copyright, trademark or similar proprietary right of a third party; provided that Customer gives C&W USA prompt written notice of the institution of such suit or the assertion of such claim and permits C&W USA to defend the same and gives C&W USA all reasonably available information and assistance and authority to enable C&W USA to do so. C&W USA shall have control of the defense of any such suit, including appeals and all negotiations thereof, including the right to effect settlement or compromise. At any time during the course of any such litigation, or if in C&W USA's opinion the C&W USA-furnished equipment and/or the C&W USA services are likely to become the subject of such a clam or suit, C&W USA shall have the following options: (i) procure for Customer, at C&W USA's expense, the right to continue using the C&W USA-furnished equipment and/or the C&W USA services; (ii) replace or modify the C&W USA-furnished equipment and/or the C&W USA services, at C&W USA's expense, so that it become non-infringing; (iii) grant to Customer an interruption credit, as described elsewhere in this Agreement, for the period during which the C&W USA-furnished equipment and/or the C&W USA services are unavailable to Customer; (iv) discontinue providing and release Customer from any further obligations for the C&W USA-furnished equipment and/or the C&W USA services. C&W USA shall have no liability to Customer if the infringement is based upon the use of the C&W USA-furnished equipment or the C&W USA services with any service, equipment or software not made or furnished by C&W USA. The foregoing states the entire liability of C&W USA with respect to infringement of patents, copyrights, trademarks or similar proprietary rights of a third party by the C&W USA-furnished equipment and/or the C&W USA services and any resulting unavailability of such services and/or equipment. 11. USE OF SERVICE: 11.1 ACCEPTABLE USE POLICY: Customer agrees to abide and cause End Users to abide by the terms of C&W USA Internet Acceptable Use Policy, which is set forth at HTTP://WWW.CWUSA.COM/INTERNET_AUP.HTM. 8 11.2 EXPORT COMPLIANCE. Customer further agrees to comply and cause End Users to comply with U.S. export laws concerning the transmission of technical data and other regulated materials via the Services. 12. DEFAULT 12.1 In the event Customer fails to comply with any term of this Agreement, including, without limitation, failure to make timely payment of any amount due C&W USA or failure to comply with the restrictions on use of Service set forth in Section 11, Customer shall be in Default ("Default") of this Agreement. In the event of a non-payment Default, C&W USA shall provide notification to Customer of default ("Notice of Default"). Except for a payment Default or a Default involving a violation of C&W USA's Acceptable Use Policy, C&W USA shall continue to provide Service to Customer, for a period of 90 days commencing with Notice of Default to Customer. Except as otherwise provided in this Section, Customer shall be afforded the opportunity to cure the Default or to migrate its End Users to another Internet service other than that provided by C&W USA during this 90-day period. If at the end of the 90-day period Customer has not cured the Default to the satisfaction of C&W USA, C&W USA shall in its sole discretion, and without limiting its remedies or incurring any liability to Customer, either temporarily discontinue or permanently terminate the furnishing of Service to Customer in whole or in part. 12.2 DEFAULT AFFECTING C&W USA SERVICE OR NETWORK INTEGRITY. Where Customer's or End User's equipment is used with Service provided by C&W USA in violation of any of the provisions herein, C&W USA will notify Customer and take such action as is necessary for the protection of the Service for use b its other customers. Where Customer or an End User engages in a violation of the C&W USA's Acceptable Use Policy, Customer shall correct the violation immediately and shall confirm in writing to C&W USA within 72 hours that such use has ceased or that the violation has been corrected. If Customer fails to correct, C&W USA will disconnect Customer's Service, without any credit allowance, until such time as Customer compliance with the provisions hereof. C&W USA reserves the right to charge a reconnect fee for any discontinued Service that is subsequently reconnected. C&W USA RESERVES THE RIGHT TO TEMPORARILY SUSPEND OR BLOCK SERVICE TO CUSTOMER OR ANY OF ITS END USERS OR TAKE ANY OTHER STEPS THAT C&W USA DEEMS NECESSARY TO PREVENT HARM TO C&W USA AND ITS CUSTOMERS TO OTHERWISE PROTECT THE INTEGRITY OF THE C&W USA NETWORK OR AS REQUIRED BY APPLICABLE LAW OR COURT ORDER. 9 13. GOVERNING LAW AND FORUM SELECTION This Agreement shall be governed by, construed under, and enforced in accordance with, the laws of the Commonwealth of Virginia, exclusive of its conflict of laws rules. Any legal action of whatever nature by or against the Parties arising out of or related in any respect to the Agreement shall be brought solely in either the United States District Court for the Eastern District of Virginia or the appropriate court of the Commonwealth of Virginia located in the jurisdiction where C&W USA has its principal place of business. Customer hereby consents to (and waives any challenge or objection to) personal jurisdiction in Virginia, and consent to legal process by mail in accordance with the provisions of Code of Virginia Annotated and the Virginia rules of procedure. 14. MISCELLANEOUS In the event of a conflict between this Agreement and any applicable tariff, the tariff shall prevail. If any provision of this Agreement shall be held to be invalid or unenforceable, the validity and enforceability of the remaining provisions of this Agreement shall not be affected thereby. This Agreement embodies the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements and understandings, whether written or oral, and all contemporaneous oral agreements and understandings relating to the subject matter hereof. Neither Party shall issue a news release, public announcement, advertisement, or other form of publicity concerning the existence or the terms of this Agreement without obtaining prior written approval from the other Party. This Agreement is subject to modification by any authorized regulatory agency. C&W USA reserves the right to withhold certain End User information in compliance with foreign privacy laws. Customer may not assign this Agreement without C&W USA's prior written consent. This Agreement shall b binding on the parities hereto and their respective personal and legal representatives, successors, and permitted assigns. 10 IN WITNESS WHEREOF, C&W USA and FREEI NETWORKS, Incorporated have caused this Agreement to be executed by their duly authorized representatives as of the date first written above. Customer Cable & Wireless USA, Inc. FREEI NETWORKS, INC. - ---------------------------------- BY: /S/ROBERT (BOB) MCCAUSLAND by: /S/TINA CORNER ------------------------------- -------------------- Name: ROBERT ((BOB) MCCAUSLAND Name: TINA CORNER ---------------------------- --------------------- Title: PRESIDENT/CEO Title: SVP, RETAIL SALES ---------------------------- --------------------- Date: 12.23.99 Date: 2/3/00 --------------------------- ---------------------- 11 CABLE & WIRELESS USA ADDENDUM TO CUSTOMER AGREEMENT FOR WHOLESALE AND VIRTUAL ISP INTEGRATED SOLUTIONS DIAL-UP INTERNET ACCESS SERVICES This Addendum ("Addendum") to the Customer Agreement for Wholesale and Virtual ISP Integrated Solutions Dial-Up Internet Access Services ("Agreement") is entered into by and between Cable & Wireless USA, Inc. ("C&W USA") and FREEi NETWORKS, INC. ("Customer"). This Addendum only modifies the Agreement to the extent specifically set forth below. Any capitalized terms not specifically defined in the Addendum shall have the same meaning as defined in the Agreement. This Addendum shall be effective on the date of the last party to sign below. The following changes are made to the Agreement: 1. SERVICE LIMITATIONS. Add the following at the end of Section 2.1.(c), Service Limitations: "C&W USA shall normally provide notice to Customer at least seventy-two (72) hours prior to performing any preventive maintenance that adversely affects Customer's use of the Service . Preventive maintenance is normally performed by C&W USA starting at 2:00 a.m. (local time/any day of the week) and all other networkwide maintenance and networkwide upgrades/optimizations are normally performed by C&W USA starting at 2:00 a.m. (Eastern Time/any day of the week)." 2. CUSTOMER REPRESENTATIVE. In the second sentence of Section 2.2.2., CUSTOMER REPRESENTATIVE, delete "hereunder" and replace it with "under this Agreement". 3. DEPOSIT REQUIREMENTS. Add the following at the end of Section 4, Payment: "Customer shall pay an initial deposit amount to C&W USA of $[*] ("Security Deposit Amount") to be received by C&W USA within two (2) business days of receipt of notice from C&W USA of such requirement. Thereafter, C&W USA reserves the right, at any time, to require the Customer to pay additional funds. If C&W USA requires Customer to pay any additional deposit amounts in accordance with the preceding sentence, Customer shall make such a payment within two (2) business days after receipt of notice from C&W USA of such requirement. Upon the termination of the Agreement, C&W USA shall refund the then current Security Deposit Amount held by C&W USA plus accrued interest at the applicable rate set by regulation of the state in which C&W USA invoices Customer (except if Customer is in breach of the Agreement), less any outstanding amounts then owed to C&W USA by Customer under the Agreement. Starting with the second (2nd ) Monthly Billing Period after C&W USA first makes available the Service for registration by Customer's End User's, C&W USA shall start crediting the $[*] Security Deposit Amount to Customer's account under this Agreement in increments of $[*] each Monthly Billing Period (defined below); provided that, Customer promptly pays all invoice amounts (which are not subject to a bona fide dispute) in accordance with the payment terms of Section 4, Payment, of the Agreement." 4. TERM AND TERMINATION. Delete Section 5, Term and Termination, and replace it with the following: "5. TERM AND TERMINATION The initial Term of this Agreement shall become effective as of its effective Date and shall remain in effect for the period indicated in Exhibit A attached hereto or until terminated by either Party by providing written notice to the other Party at least thirty (30) days prior to the end of the initial Term. After the initial Term, this Agreement shall continue in effect on a month-to-month basis until either party provides the other Party written notice of termination at least thirty (30) days in advance. In the event Customer terminates this Agreement prior to the end of the initial Term or during a month-to-month period in the manner set forth above, then without limitation to any other remedy C&W USA may have, Customer will pay to C&W USA upon discontinuance of the Service the termination charge set forth on Exhibit A. Within ninety (90) days of the Effective Date of this Agreement ("90-Day Period"), C&W USA shall provide a web interface which enables Customer to disconnect all End Users at any point during any session established by Customer's authentication. This interface may accept as input either (i) a radius session id and NAS IP address, or (ii) an account name; but must accept at least one. The disconnect must be completed within thirty (30) seconds of sending the HTTP response header. In the event C&W USA is unable to provide the web interface referenced herein within the 90-Day Period, Customer may, by providing prior Page 1 of 3 written notice to C&W USA, terminate this Agreement without incurring any liability or termination charges, except for fees for Services utilized by Customer through the effective date of such termination. 5. CREDIT. In the first sentence of Section 8, Credit, delete "24 consecutive hours in duration" and replace it with "8 consecutive hours in duration". 6. FORCE MAJEURE. Delete section 9.3., Force Majeure, and replace it with the following: "9.3. FORCE MAJEURE. Except for Customer's obligation to pay C&W USA for the Services, each party shall be excused from its performance under this Agreement in case of labor difficulties, governmental orders, civil commotions, acts of God, or other conditions or circumstances beyond its reasonable control. Notwithstanding the above, if C&W USA experiences a force majeure event ("Force Majeure Event") that affects its ability to provide the Services to Customer under this Agreement such that Customer cannot meet its Minimum Monthly Port Commitment (defined in Exhibit A), the Customer shall not be obligated to meet the Minimum Monthly Port Commitment applicable to the period during which the Force Majeure Event occurs and continuing until such time as the Services are restored by C&W USA. 7. EQUIPMENT. Add the following at the end of Section 9.4., Equipment: "C&W USA shall make reasonable efforts to provide a reasonable prior notice to Customer for material changes that C&W USA believes may require modification and alteration of Customer's or End User's equipment or render the same obsolete or otherwise affect its performance." 8. ACCEPTABLE USE POLICY. Delete Section 1.1.1., ACCEPTABLE USE POLICY, and replace it with the following: "11.1 ACCEPTABLE USE POLICY. Customer agrees to abide by, and to use its best efforts to require End Users to abide by, the terms of C&W USA Internet Acceptable Use Policy, which is set forth at HTTP://WWW.CWUSA.COM/INTERNET_AUP.HTM. C&W USA shall provide a forty-eight (48) hour advance notice to Customer prior to any termination suspension of the Service due to a violation of C&W USA's Acceptable Use Policy. Notwithstanding the preceding, C&W USA may immediately terminate or suspend the Service to prevent damage to or degradation of its internet network integrity which may be caused by the Customer, End Users or anyone using Customer's access, or to comply with any law, regulation, court order, or other governmental request or order which requires immediately action." 9. GOVERNING LAW AND FORUM SELECTION. Delete the second and third sentences of Section 13, Governing Law and Forum Selection, and replace it with the following: "Any legal action of whatever nature by or against the Parties arising out of or related in any respect to the Agreement shall be brought either in the courts of the Commonwealth of Virginia or the courts of the State of Washington. If legal action is brought in the Commonwealth of Virginia, Customer consents to legal process served by mail in accordance with the provisions of the Code of Virginia Annotated and the Virginia rules of procedure." 10. PORT AVAILABILITY. The Service shall meet an average monthly availability specification of 99.9% ("Average Monthly Port Availability Specification") based on the average monthly availability, on a 24 hours/day, 7 days/week basis, for all ports provided under this Agreement. Periods when a port is not avilable due to a cause beyond C&W USA's reasonable control or due to C&W USA performing scheduled network maintenance work or network optimizations shall be excluded when calculating the actual availability. If the actual monthly port availability during a particular month is less than the Average Monthly Port Availability Specification, the Customer may notify C&W USA in writing ("Port Availability Notice"). The ort Availability Notice must detail the period(s) of times during which the Service was not meeting the Average Monthly Port Availability Specification. C&W USA shall have up to thirty (3) days from its receipt of the Port Availability Notice to cure such service problem ("Cure Period"). If C&W USA does not cure such service problem (i.e., meet the Average Monthly Poet Availability Specification during the month after the Cure Period), the Customer may (as its sole an exclusive remedy) terminate the Agreement by providing five (5) business days' prior written notice of termination to C&W USA. Upon such a termination, the following shall apply: (a) Customer shall pay for all Service provided through the date of Service discontinuance; and (b) C&W USA shall waive the termination charge." 11. PRICING. The following changes are made to Exhibit A, Pricing Schedule: a. PRICING, RAMP-UP SCHEDULE AND MINIMUM MONTHLY PORT COMMITMENT. Delete the "Pricing" portion of Section 1 and replace it with the following: "PRICING. (i) PORT PRICING. Customer shall pay C&W USA the rates per port as set forth below: Page 2 of 3 a. $[*] per port effective during the period starting on the date C&W USA first makes available the Service for registration by Customer's End Users ("Service Start Date") and ending on the date which is the earlier of either (1) the ninetieth (90th) day after the Service Start date, or (2) the date C&W USA implements the disconnect server. b. $[*] per port effective at the end of the period defined in Section (i) a. above. It is acknowledged that the Customer shall be providing its own customer service, billing and fulfillment to its End Users. Therefore, the above rate applies only to internet network access and does not include any C&W USA-provided customer service, billing or fulfillment to End Users. Further, it is understood that C&W USA is only selling wholesale dial internet service originating in the U.S. Therefore, the above rates apply only to such services. (ii) RAMP-UP SCHEDULE AND MINIMUM MONTHLY PORT COMMITMENT. The Customer must use the minimum number of ports (each, a "Minimum Monthly Port Commitment") during each of the Monthly Billing Periods as set forth below. If the Customer does not meet the Minimum Monthly Port Commitment for a particular Monthly Billing Period, for that month, the Customer shall pay C&W USA the Minimum Monthly Port Commitment applicable to that monthly Billing Period multiplied by the applicable rate per port set forth above. FOR EXAMPLE, if during the 1st Monthly Billing Period, the Customer used 9,5000 ports, the Customer shall pay C&W USA $[*] for that month (i.e.,, the Minimum Monthly Port Commitment for that Monthly Billing period of 10,000 ports multiplied by $[*].
----------------------------------------------------------------------------------------------------- Monthly Billing Periods Minimum Monthly Port Commitment for each Monthly Billing Period** ----------------------------------------------------------------------------------------------------- 1st Monthly Billing Period* [*] ports ----------------------------------------------------------------------------------------------------- 2nd Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 3rd Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 4th Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 5th Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 6th Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 7th Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 8th Monthly Billing Period [*] ports ----------------------------------------------------------------------------------------------------- 9th Monthly Billing Period and each monthly 40,000 ports per each Billing Period thereafter Monthly Billing Period -----------------------------------------------------------------------------------------------------
* Starting with the first full month after Service is first made available to Customer's End Users for registration." ** Port quantities are subject to availability to be determined by Starting with the first full month after Service is first made available to Customer's End Users for registration. If Starting with the first full month after Service is first made available to Customer's End Users for registration cannot provide port quantities during a particular Monthly Billing period which results in the Customer not being able to meet its Minimum Monthly Port Commitment that Monthly Billing Period, the Customer shall pay Starting with the first full month after Service is first made available to Customer's End Users for registration for the actual port quantity used that month and not the Minimum Monthly Port Commitment for that Monthly Billing Period. b. Term. Delete Section 11, Term, and replace it with the following: "11. This Agreement shall have an initial term of thirty-three (33) months and it shall automatically renew on a month-to-month basis thereafter until either Party terminates this Agreement as provided in Section 5."
FREEI NETWORKS, INC. Cable & Wireless USA, Inc. -------------------- ----------------------------- Signature: /s/Robert (Bob) McCausland Signature: /S/TINA CORNER ----------------------------- ---------------------- Printed Name: ROBERT ((BOB) MCCAUSLAND Printed Name: TINA CORNER ----------------------------- ---------------------- Title: PRESIDENT/CEO Title: SVP, RETAIL SALES ----------------------------- ---------------------- Date: 12.23.99 Date: 2/3/00 ----------------------------- ---------------------- Page 3 of 3
[*] = Confidential Treatment Requested EX-10.16 19 EX-10.16 Exhibit 10.16 SPLITROCK MASTER SERVICES AGREEMENT NO.____________ The Master Services Agreement (the "MSA") is made by SPLITROCK SERVICES, INC. a Delaware corporation with its principal office at 9012 New Trails Drive, The Woodlands, Texas 77381, ("SPLITROCK"), and FreeiNetworks, Inc., a Washington corporation, with its principal office at 909 South 336th Street, Suite 110, Federal Way, WA 98003 ("CUSTOMER"), effective September 30, 1999 (the "Effective Date"). SPLITROCK and Customer agree that the following terms and conditions apply to the provision and use of the products and services referenced in any attachments to this Agreement and Customer Orders signed by Customer and accepted in writing by SPLITROCK. DEFINITIONS Commitment: A commitment for Service which, if made by Customer in the MSA, a Customer Order, or in any other form specified and accepted by SPLITROCK, obligates Customer to pay for a minimum revenue, subscribers, usage or volume of Service and commences upon billing unless otherwise specified. Confidential Information: Non-public information regarding the business of a Party provided to either Party by the other where such information is marked or otherwise communicated as being "proprietary" or "confidential" or the like, or where such information is, by its nature, confidential. Customer: The person, firm or corporation so named herein and on the Customer Order. Customer Order: A request for SPLITROCK Service submitted by Customer on a form provided by SPLITROCK. Party: Either SPLITROCK or Customer may be referred to individually as a Party or collectively as the Parties herein. Premises: The location(s) occupied by Customer or its end users specified in the Customer Order to or from which Services will be delivered. Service: Any data communications or related products or service(s) offered by SPLITROCK pursuant to a Customer Order. Start Billing Date: Billing begins upon confirmation to Customer of installation by SPLITROCK and continues for the term set forth. Term: The number of months of customer commitment for Service from SPLITROCK in the MSA; herein, thirty-six (36) months from the Effective Date. Termination Charges: The standard Termination Charges of SPLITROCK which shall apply for Customer terminating service at the conclusion of the term on the Customer Order. Termination Charges shall also apply for early termination by either Party prior to expiration of the term on the Customer Order. SECTION 1. CUSTOMER ORDERS 1.1 SUBMISSION OF CUSTOMER ORDERS. Customer shall submit to SPLITROCK signed customer Order forms requesting the provision of Service. SPLITROCK shall confirm the accuracy of information on the Customer Order form and the availability of the Service requested and return the Customer Order form countersigned constituting SPLITROCK's acceptance. The term on the Customer Order shall not extend beyond the expiration date of the MSA without an Amendment to the MSA. SECTION 2. BILLING AND PAYMENT 2.1 PAYMENT AND RENDERING OF BILLS. SPLITROCK shall bill all charges incurred by and credits due to Customer on a monthly basis. SPLITROCK shall bill in advance charges for all Service to be provided during the ensuing month except for charges which are dependent upon usage of Service, which charges shall be billed in arrears. Adjustments for the quantities of Service established or discontinued in any billing period during the Term will be prorated to the number of days based on a thirty (30) day month. 2.2 PAYMENT OF BILLS. All invoices are issued on the 20th of the month, subject to changes, are due by the due date stated on the invoice, and become past due if not received by the due date. The unpaid balance of any past due amounts shall bear at the rate of the one percent (1%) per month, or the highest rate allowed by law, whichever is less. 2.3 TAXES AND FEES. Except for taxes based on SPLITROCK's net income and except with respect to ad valorem personal and real property taxes imposed on SPLITROCK's property, Customer shall be responsible for payment of all sales, use, gross receipts, excise, access, bypass, franchise or other local, state and federal taxes, fees, charges, or surcharges, however designated, imposed on or based upon the provision, sale or use of the Service delivered by SPLITROCK. 2.4 REGULATORY AND LEGAL CHANGES. SPLITROCK may elect or be required by law to file with the appropriate regulatory agency tariffs respecting the delivery of certain Service. In the event and to the extent that such tariffs have been or are filed respecting Service ordered by Customer, the terms set forth in the applicable tariff shall govern SPLITROCK's delivery of, and Customer's consumption or use of, such service. In the event of any change in applicable law or regulation that materially increases the cost of delivery of Service, SPLITROCK and Customer shall renegotiate regarding the rates charged to Customer to reflect such increase in cost and, in the event that the Parties are unable to reach agreement respecting new rates, then (a) Customer may elect to continue the affected Customer Order at the new rates, or (b) Customer may terminate the affected Customer Order upon thirty (30) days' written notice without payment of any Termination Charge. 2.5 DISPUTED BILLS. In the event that Customer disputes greater than ten percent (10%) of the bill. Customer must timely pay the undisputed portion of the Invoice in full and submit a documented claim for the disputed amount. All claims must be submitted to SPLITROCK within sixty (60) days of the due date stated on the invoice. If Customer does not submit a claim within such period and in the manner stated above, Customer waives all rights to dispute such charges. 2.6 CREDIT ALLOWANCE. SPLITROCK shall issue a credit for any total Service outage of twenty-four (24) 2.7 CREDIT APPROVAL AND DEPOSITS. Customer shall provide SPLITROCK with credit information as requested in advance of the commencement of delivery of Service under any Customer Order. SPLITROCK may require Customer to make a deposit; A. As a condition to SPLITROCK's acceptance of any Customer Order submitted by Customer, B. As a condition to SPLITROCK's continuation of Service under any Customer Order, but only when Customer's consumption of Service materially exceeds Customer's anticipated use, C. When, in SPLITROCK's reasonable discretion, such deposit is required in order to secure Customer's anticipated use, or D. When, in SPLITROCK's reasonable discretion, such deposit is required in order to secure Customer's continued payment obligation, which deposit shall be held by SPLITROCK as security for payment of charges. At such time as the provision of Service to Customer is terminated, the amount of the deposit shall be credited to Customer's account and any credit balance which may remain shall be refunded. 2.8 FRAUDULENT USE OF SERVICE. Customer shall comply with SPLITROCK's Acceptable Use Policy and shall be solely responsible for all charges incurred respecting Service, even if such charges were incurred through or as a result of fraudulent or unauthorized use of the Service, unless SPLITROCK has actual knowledge of such fraudulent or unauthorized use and fails to inform Customer thereof. Nothing in this subsection 2.7, however, shall be construed to obligate SPLITROCK to detect or report unauthorized or fraudulent use of Services. SECTION 3. CANCELLATION OF CUSTOMER ORDERS 3.1 CANCELLATION OF CUSTOMER ORDER BY SPLITROCK. SPLITROCK may immediately discontinue Service without incurring any liability: A. For nonpayment, upon five (5) days' written notice when there is an unpaid balance for Service that is past due. B. For violation of any law, rule, regulation or policy of any government authority having jurisdiction over such Service or by reason of any order or decision of a court or other government authority having jurisdiction over Service, without notice. C. For any Customer filing of bankruptcy or reorganization or failing to discharge an involuntary petition within sixty (60) days after filing. D. For consumption of Service that materially exceeds Customer's credit limit, upon five (5) days written notice and provided Customer has not provided additional security for payment which is sufficient in SPLITROCK's reasonable discretion. E. For breach of a material term of the MSA. 3.2 EFFECT OF CANCELLATION. Upon cancellation of Service to Customer prior to expiration of the term on the Customer Order, whether by SPLITROCK pursuant to subsection 3.1 or by Customer, SPLITROCK may, in addition to all other remedies that may be available to SPLITROCK at law or in equity, assess and collect from Customer Termination Charges. Termination Charges include (i) all charges incurred by SPLITROCK to terminate Service, and (ii) fifty percent (50%) of the minimum unpaid monthly Commitment, or of the average monthly charges for the three (3) full calendar months preceding termination multiplied by the months remaining under the term in the Customer Order, whichever is lower. SPLITROCK shall have the sole and absolute discretion to restore such Service only after satisfaction of such conditions as SPLITROCK determines to be required for its protection. Nonrecurring charges will be applied to restoration of Service. SECTION 4. DELIVERY OF SERVICES 4.1 SPLITROCK FACILITIES. Customers shall not and shall not permit others to rearrange, disconnect, remove, attempt to repair, or otherwise tamper with any of the facilities or equipment installed by SPLITROCK, except upon the written consent of SPLITROCK. Equipment provided or installed by SPLITROCK for use in connection with the Service shall not be used for any purpose other than that for which SPLITROCK provided it. In the event that Customer or a third party attempts to operate or maintain any SPLITROCK-owned equipment without first obtaining SPLITROCK's written approval, in addition to any other remedies of SPLITROCK for breach by Customer of Customer's obligations hereunder, Customer shall pay SPLITROCK for any damage to SPLITROCK-owned equipment and service charges in the event that maintenance or inspection of the equipment as required as a result of Customer's breach of this Section upon invoice. In no event shall SPLITROCK be liable to Customer or any other person for interruption of Service or for any other loss, cost or damage caused or related to improper use or maintenance of SPLITROCK-owned equipment. 4.2 CUSTOMER-PROVIDED EQUIPMENT. SPLITROCK shall not be responsible for the operation or maintenance of any Customer-provided communications equipment. SPLITROCK shall not be responsible for the transmission or reception of signals by Customer-provided equipment or for the quality of, or defects in, such transmission. 4.3 NO LIABILITY FOR FAILURE TO TRANSMIT MESSAGES. SPLITROCK does not undertake to transmit messages, but offers the use of its Service when available, and, as more fully set forth elsewhere in these terms and conditions and applicable Customer Orders, shall not be liable for errors in transmission or for failure to establish connections. SECTION 5. OBLIGATIONS AND LIABILITY LIMITATION 5.1 OBLIGATIONS OF THE CUSTOMER. Customer shall be responsible for: A. The payment of all charges applicable to the Service (including charges incurred as a result of fraud or unauthorized use of the Service). B. Compliance with SPLITROCK's Acceptable Use Policy; C. Providing the level of power, heating and air conditioning necessary to maintain the proper environment on the Premises for the provision of Service; 5.2 LIMITATIONS OF LIABILITY OF SPLITROCK. The liability of SPLITROCK for damages, if any, arising out of the furnishing of Service, including but not limited to mistakes, omissions, interruptions, delays, tortious conduct of errors, or other defects, representations, use of Service or arising out of the failure to furnish Service, whether caused by acts of commission or omission shall be limited to the extension of credit allowances. The extension of such credit allowance or refunds shall be the sole remedy of Customer and the sole liability of SPLITROCK. Neither Party shall be liable for any indirect, incidental, special, consequential, exemplary or punitive damages (including but not limited to damages for lost profits or lost revenues), whether or not caused by the acts or omissions or negligence of its employees or agents, and regardless of whether such Party has been informed of the possibility or likelihood of such damages. 5.3 DISCLAIMER OF WARRANTIES. SPLITROCK MAKES NO WARRANTIES OR REPRESENTATIONS, EXPRESS OR IMPLIED EITHER IN FACT OR BY OPERATION OF LAW. STATUTORY OR OTHERWISE, INCLUDING WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR USE, EXCEPT THOSE EXPRESSLY SET FORTH HEREIN OR IN ANY APPLICABLE SERVICE LEVEL AGREEMENT. SECTION 6. CONFIDENTIAL INFORMATIOON 6.1 DISCLOSURE AND USE. The Confidential Information disclosed by either Party constitutes the confidential and proprietary information of the disclosing Party and the receiving Party shall retain same in strict confidence and not disclose to any third party except as authorized by these terms and conditions without the disclosing Party's express written consent. 6.2 Exceptions. Notwithstanding the foregoing, each Party's confidentiality obligations hereunder shall not apply to information which: A. is already known to the receiving Party: B. becomes publicly available without fault of the receiving Party; C. is rightfully obtained by the receiving Party from a third party without restriction as to disclosure, or is approved for release by written authorization of the disclosing Party; D. is developed independently by the receiving Party without sue of the disclosing Party's Confidential Information; or E. is required to be disclosed by law. 6.3 Publicity. This MSA shall not be construed as granting to either Party any right to *use Party's or its affiliates' trademarks, service marks or trade names or otherwise refer to the other Party in any marketing * or activities with the forgoing publication or press release contractual relationship between SPLITROCK and Customer, without the written consent of the other Party, except as may be required by law. SECTION 7. GENERAL TERMS 7.1 FORCE MAJEURE. Except with respect to payment obligations, neither Party shall be liable, nor shall any credit allowance or other remedy be extended, for any failure of performance or equipment due to causes beyond such Party's reasonable control, including but not limited to: acts of God, fire, flood or other catastrophes; any law, order, regulation, direction, action, or request of any governmental entity or agency, or any civil or military authority; national emergencies, insurrections, riots, wars, unavailability of rights-of-way or materials; or strikes, lock-outs work stoppages, or other labor difficulties. 7.2 ASSIGNMENT OF TRANSFER. Customer may not transfer or assign this MSA without the express prior written consent of SPLITROCK, whose consent shall not be unreasonably withheld, and then only when such transfer or assignment can be accomplished without interruption of the use or location of Service. These terms and conditions shall apply to all such permitted transferees or assignees. Customer shall, unless otherwise expressly agreed by SPLITROCK in writing, remain liable for the payment of all charges due under each Customer Order. 7.3 NOTICES. Any notice between the Parties shall be deemed properly given when delivered, if delivered in person, or when sent via overnight courier, electronic mail or when deposited with the U.S. Postal Service to the addresses first listed above. 7.4 INDEMNIFICATION BY CUSTOMER. Customer shall indemnify, defend and hold SPLITROCK harmless from claims, loss, damage, expense (including attorney's fees and court costs), or liability (including liability for patent infringement) arising from (1) any claims made against SPLITROCK by any end user in connection with the delivery or consumption of Service. (2) use of facilities furnished by SPLITROCK in a manner inconsistent with the terms thereof or in a manner that SPLITROCK did not contemplate and over which SPLITROCK exercises no control and (3) all other ___________ damage expense including attorney's fees and court costs, or liability arising out of any commission or omission by Customer in connection with the Service. 7.5 INDEMNIFICATION BY SPLITROCK. SPLITROCK shall indemnify, defend and hold Customer harmless from claims, loss, damage, expense (including attorney's fees and court costs), or liability (including liability for patent infringement) arising from all claims, loss, damage expense (including attorney's fees and court costs), or liability for property damage or personal injury to the extent that such claims arise out of or are caused by SPLITROCK's negligence or willful misconduct. 7.6 CONTENTS OF COMMUNICATIONS. SPLITROCK shall have no liability or responsibility for the content of any communications transmitted via the Service by Customer or any other party, and Customer shall hold SPLITROCK harmless from any and all claims (including claims by governmental entities seeking to impose sanctions) related to such content. 7.7 ENTIRE UNDERSTANDING. These terms and conditions, including any Customer Orders executed hereunder (and any tariff applicable to the delivery of Service), constitute the entire understanding of the Parties related to the subject matter hereof. In the event of a conflict between these terms and conditions and any Customer Order executed hereunder, the Customer Order shall control. These terms and conditions shall be governed and constructed in accordance with the laws of the State of Texas. 7.8 NO WAIVER. No failure by either Party to enforce any rights hereunder shall constitute a waiver of such right unless otherwise specifically set forth herein. Notwithstanding any other section of these terms and conditions, the non-breaching Party shall be entitled to seek equitable relief is protect its interests including but not limited to preliminary and permanent injunctive relief. Nothing stated herein shall be constructed to limit any other remedies available to the Parties. 7.9 DISPUTE RESOLUTION. Any dispute which the parties are unable to resolve upon written notice to the Defaulting Party, may immediately be submitted to the American Arbitration association for binding arbitration pursuant to the Commercial Arbitration Rules with proceedings conducted in Houston, Texas; however, the Parties shall immediately proceed to negotiate a resolution in good faith until such proceeding. Notwithstanding any other section of these terms and conditions, the nonbreaching Party shall be entitled to seek equitable relief to protect its interests, including but not limited to preliminary and permanent injunctive relief. Nothing stated herein shall be constructed to limit any other remedies available to the Parties. 7.10 INTELLECTUAL Property. Nothing contained in this MSA shall be construed as conferring by implication, estoppel or otherwise, any license or right under any patent, trade name or copyright of SPLITROCK or Customer. 7.11 Conflicting Provisions. In the event of a conflict between the provisions of the MSA and any Attachment thereto, the following hierarchy shall control in interpreting the conflicting language: (i) IDL-001R, (ii) OAF-001, (iii) IDL-004, (iv) IDL-005, and (v) MSA. Free Network, Inc. ("Customer") SPLITROCK SERVICES, INC. ("SPLITROCK") Signature /s/ Bob McCausland Signature /s/ David M. Boatner -------------------------- ------------------------------ Name Robert (Bob) McCausland Name David M. Boatner ------------------------------ ---------------------------------- Title President/CEO Title EVP & CMO ------------------------------ ---------------------------------- Date 10-1- 99 Date 9-30-99 ------------------------------ ---------------------------------- SPLITROCK SERVICE DESCRIPTION: INTERNET DIAL STANDARD FEATURES: o V.90/56Kdial Access to the Internet o 24 X 7 NOC support o RADIUS proxy to customer end point authentication server OPTIONAL FEATURES: o Primary and Secondary DNS o Customer Care Web site o Splitrock run RADIUS authentication Commitments o SPLITROCK requires a minimum volume commitment from Customer to sign a specified number of Subscribers within twelve (12) months, and a 3-year contract term. o SPLITROCK requires Fee of Twenty-Five Thousand Dollars ($25,000) that will be applied against billing upon the achievement of minimum committed volume within the agreed ramp period. Application of the $25,000 begins on the 13th month. Pricing: SEE ATTACHMENT SPLITROCK ACCEPTABLE USE POLICY Inc. ("SPLITROCK and applies to all SPLITROCK's Customers and Customer's Subscribers (collectively "Users"). Use of the SPLITROCK Network continues on the User acceptance of and agreement to abide by all policies of SPLITROCK including this which is in addition and supplements the terms of the applicable Master Services Agreement and SPLITROCK reserves the right to modify this policy at any time, effective upon posting to the SPLITROCK web page http: WWW.SPLITROCK.NET. SPLITROCK does not monitor, verify, warrant or validate the integrity, accuracy or quality of information or data it receives or transmits. Accordingly, SPLITROCK neither controls nor accepts responsibility for the content of any communications that are transmitted or made available to Users of its network and or services. A. Lawful Use The SPLITROCK Network may be used only strictly in accordance with all international, federal, state and local laws, tariffs, ordinances and regulations and SPLITROCK may report to legal authorities any content that is or is believe to be unlawful, may disclose to such authority the author of such content and will cooperate with law enforcement agencies and other parties investigating or prosecuting claims of illegal or inappropriate activity. This includes without limitation, material protected by copyright, trademark, trade secret or other intellectual property right, material that is obscene or constitutes child pornography, material that is libelous, defamatory, hateful, or constitutes an illegal threat or abuse material that violates export control laws or regulations and material that encourages conduct that would constitute criminal offense or give rise to civil liability. B. Privacy SPLITROCK makes no guarantee regarding the security and integrity of any data or information transmitted. Users must respect the privacy of others, shall not intentionally seek information on, obtain copies of , or modify files, other data or passwords belonging to others or represent themselves as another User unless explicitly authorized to do so by that User. Revealing a User password to others is strictly prohibited. Attempting to obtain access beyond that for which User is authorized is strictly prohibited, including illegal or unauthorized accessing known as "hacking." C. Network Integrity Use of SPLITROCK's Network and/or any attached network in a manner that precludes or significantly hampers its use by others is not allowed. Connections which create routing patterns that are inconsistent with the effective and shared use of the network may not be established . Users must respect the integrity of computing and network systems. Examples of prohibited uses include, without limitation: (i.) Unauthorized access to or use of data, systems or networks, including any attempt to probe, scan or test the vulnerability of a system or network or to breach security or authentication measures without express authorization of the owner of the system or network; (ii.) Unauthorized monitoring of data or traffic on any network or system without express authorization of the owner of the system or network; (iii.) Interference with service to any User, host or networking including, without limitation, mailbombing, flooding, deliberate attempts to overload a system and broadcast attacks; (iv.) Distribution of Internet Viruses, Worms. Trojan Horses or other destructive activities; and (v.) Modification of IP packet content in a malicious manner or forging of any TCP-IP packet header or any part of the header information in an e-mail, chat room or a newsgroup posting. Page 1 of 2 D. E-Mail Unsolicited advertising is prohibited. Other prohibited activities include: i. Sending unsolicited commercial or bulk e-mail. ii. Using another site's mail server to ready mail, without express permission of the site. iii. Repeated, unsolicited and or unwanted communication of an intrusive nature iv. Posing or e-mailing of scams such as "make-money fast" schemes or pyramid chain letters and v. Making fraudulent offers of products items or services originating from your account. E. USENET.CHAT All SPLITROCK Users agree to comply with the guidelines and restrictions of each news or chat group unconditionally as incorporated herein by reference. Without limitation of the foregoing, the following activities are prohibited: (i) Engaging in excessive cross-posting or multi-posting ("spamming"); (ii) Making any posting for commercial purposes (including without limitation the posting to specific URL's for commercial purposes), except where such postings are expressly permitted under the charter and/or Frequently Asked Questions (FAQ) of an applicable newsgroup; (iii) Canceling newsgroup postings other than their own, or using auto-responders or cancel-boss (or similar automated or manual routines) which generate excessive network traffic or disrupt Usenet newsgroup e-mail use by other (except in cases of official newsgroup moderators performing their duties): and (iv) Disrupting newsgroups and or discussion groups with materials, postings, or activities that are frivolous, unlawful, obscene, threatening, abusive, libelous, hateful, excessive, or repetitious, unless such materials or activities are expressly allowed or encouraged under the newsgroup's name, FAQ, or charter. F. Remedial Action Responsibility for avoiding the harmful activities as described herein rests primarily with the User. When SPLITROCK learns of possible inappropriate use, it may take any of a variety of actions, including but not limited to, removing information that violates its policies, and/or restricting or terminating access to the SPLITROCK Network without notice. How to Report Abuse If you become aware of inappropriate use, direct the information to ABUSE@SPLITROCK.NET who will evaluate all information before taking any action and upon evaluation may take any appropriate action, including but not limited to : (i) Issuing written or verbal warnings; (ii) Suspending newsgroup posting privileges; (iii) Suspending the User account; and (iv) Terminating the User Account G. Limitation of Liability SPLITROCK SHALL NOT BE LIABLE FOR ANY INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL, OR PUNITIVE DAMAGES, INCLUDING BUT NOT LIMITED TO LOSS OF PROFITS, LOSS OF BUSINESS OR BUSINESS OPPORTUNITY, LOSS OF USE, ETC., EVEN IF ADVISED OF THE POSSIBILITY OF SUCH DAMAGES BY USER. SPLITROCK SHALL NOT BE LIABLE FOR ANY DIRECT OR ACTUAL DAMAGES OF USER, EXCEPT TO THE EXTENT SPECIFIED IN A WRITTEN OR ELECTRONIC AGREEMENT ENTERED INTO BETWEEN SPLITROCK AND CUSTOMER. SPLITROCK MAKES NO WARRANTIES OR REPRESENTATIONS HEREIN, EITHER EXPRESS OR IMPLIED. CONCERNING THE SPLITROCK NETWORK, AND EXPRESSLY DISCLAIMS WARRANTIES OF FITNESS FOR A PARTICULAR USE OR PURPOSE, THE WARRANTY OF MERCHANTABILITY AND ANY OTHER WARRANTY IMPLIED BY LAW. Page 2 of 2 EX-10.19 20 EX-10.19 Exhibit 10.19 PHONE SITE SERVICE AGREEMENT THIS AGREEMENT, dated as of March 30, 2000 (the "Effective Date"), is made by and between InfoSpace.com. Inc., a Delaware corporation. ("InfoSpace"), with offices at 15375 NE 90th Street, Redmond, WA 98052, and Freei Networks, Inc. ("Company"), with offices at 2505 S. 320th Street, Suite 200, Federal Way, WA 98003. RECITALS This Agreement is entered into with reference to the following facts: A. InfoSpace has developed and provides a mechanism for delivering content to portable and non-portable computing devices, including mobile phones, and InfoSpace maintains on certain locations of its Web Sites (as defined below) and makes available to Internet users certain content, resources, archives, indices, catalogs and collections of information (collectively, such materials are identified in Exhibit A and referred to herein as the "Content"). Company desires that it and its customers have access to the InfoSpace Content. B. InfoSpace wishes to grant certain rights and licenses to Company with respect to access to the Content and certain other matters, and Company wishes to grant certain rights and licenses to InfoSpace with respect to the Company Materials (as defined below) and certain other matters, as set forth in this Agreement. AGREEMENT The parties agree as follows: SECTION 1. DEFINITIONS. As used herein, the following terms have the following defined meanings: "CO-BRANDED PAGES" means the HDML Pages hosted on the InfoSpace Web Sites that comprise the Phone Site. "COMMERCIAL SERVICE DATE" means the date on which the Company Wireless/Web Services are made available to the public or the date of July 1, 2000, whichever occurs first. "COMPANY MARKS" means those Trademarks of Company set forth on Exhibit B hereto and such other Trademarks (if any) as Company may from time to time notify InfoSpace in writing to be "Company Marks" within the meaning of this Agreement. "COMPANY MATERIALS" means the Company Marks and any other graphical or other content or materials supplied by Company to InfoSpace for inclusion on the Phone Site. "COMPANY WIRELESS/WEB SERVICES" means the packages of service offered by Company that enable customers of Company to access the Phone Site and other integrated services on the web, on mobile phones, and on other devices supported by Company. "CONTENT" means the content, applications and services made available by InfoSpace for the Phone Site as described in Exhibit A, subject to third party content provider arrangements and display constraints (e.g. required formatting for display on an information appliance). "HDML PAGES" means web pages that are prepared using HDML and intended for presentation to users using mobile/wireless phones as their terminal/display device. "INFOSPACE MARKS" means those Trademarks of InfoSpace set forth on Exhibit B hereto and such other Trademarks (if any) as InfoSpace may from time to time notify Company in writing to be "InfoSpace Marks" within the meaning of this Agreement. "INFOSPACE WEB SITES" means, collectively: (a) the Web Site the primary home page of which is located at http://www.infospace.com; and (b) other Web Sites maintained by InfoSpace and its affiliates, other than the Phone Site. "IMPRESSION" means a user's viewing of any discrete screen of a page on the Phone Site. "INTELLECTUAL PROPERTY RIGHTS" means any patent, copyright, rights in Trademarks, trade secret rights, and other intellectual property or proprietary rights arising under the laws of any jurisdiction. "PHONE SITE" means the new Web Site (and all modifications, upgrades and revisions thereto) that will be created for Company by InfoSpace in HDML pursuant to this Agreement, which will contain or implement a graphical user interface with branding, graphics, navigation, content or other characteristics or features such that it will have the look and feel as specified by the Company, and a user reasonably conclude that such new Web Site is part of the Company's existing Web Sites, and which will serve as the location and mechanism through which the Content will be delivered to Subscribers, all as set forth in this Agreement, and pursuant to the specifications of Exhibit A. "PERSON" means any natural person, corporation, partnership, limited liability company or other entity. "SUBSCRIBER" means a customer of the Company that uses the Company Wireless/Web Services. "TECHNOLOGY" means any know-how, graphics, techniques, methods, formulae, drawings, designs, source code, concepts, ideas, documentation, or any improvement or upgrade thereto, whether or not patentable or copyrightable and whether or not reduced to practice related to InfoSpace's web-based Content delivery mechanism that is used to create and populate the Phone Site with InfoSpace-specific Content but does not include the Phone Site itself. "TRADEMARKS" means any trademarks, service marks, trade dress, trade names, corporate names, proprietary logos or indicia and other source or business identifiers. "WEB SITE" means any point of presence maintained on the Internet or on any other public data network. With respect to any Web Site maintained on the World Wide Web, such Web Site includes all HTML and HDML pages (or similar unit of information presented in any relevant data protocol) that either are identified by the same second-level domain (such as infospace.com) or by the same equivalent level identifier in any relevant address scheme. 2. CERTAIN RIGHTS GRANTED. 2.2 INFOSPACE GRANT. Subject to the terms and conditions of this Agreement, InfoSpace hereby grants to Company the following rights: (a) During the Term (as defined in Section 6.1) the right to enable persons who are employees or customers of Company to access the available Content on the Phone Site on wireless phones, devices and appliances via wireless network access; (b) During the Term the right to include on the Phone Site hypertext links (whether on graphical, text or other format) which enable "point and click" access to the locations on the InfoSpace Web Sites specified by InfoSpace (and subject to change by InfoSpace from time to time); and (c) During the Term the right to include on the Phone Site hypertext links (whether graphical, text or other format) that enable "point and click" access to the locations on the Freei Web Sites and, subject to any necessary third-party consents, Web Sites of third-party content providers. -2- 2.2 COMPANY GRANT. Subject to the terms and conditions of this Agreement, Company hereby grants InfoSpace the following rights: (a) the right to include the Company Materials on the Phone Site; (b) the right to include on the InfoSpace Web Sites hypertext links (whether in graphical, text or other format) which enable "point and click" access to locations of the Phone Site specified by Company (and subject to change by Company from time to time) for the purpose of integrating Content into the Phone Site; (c) the right to sell and serve Banner Advertisements directly on the Phone Site, subject to the limitations on such advertising set forth elsewhere in this Agreement; and (d) the right to track the number of Impressions. 2.3 LIMITATIONS. (a) Company and its affiliates shall have no right to reproduce or sub-license, re-sell or otherwise distribute all or any portion of the Content to any Person via the Internet (including the World Wide Web) or any successor public or private data network, other than providing access to the Content to users of the Phone Site. This Agreement and delivery of the Content or any portion hereunder to Company shall not cause InfoSpace to be in violation of any law of any jurisdiction or third party agreement, and InfoSpace may at any time modify its grant of rights to the extent necessary to ensure compliance. InfoSpace may from time to time issue additional guidelines with respect to use or display of any of the Content, or issue requirements based upon InfoSpace's obligations to third party Content providers. Company shall allow InfoSpace to implement and/or cooperate with InfoSpace in its implementation of any bug fixes, updates, and minimum build requirements for any Content supplied by InfoSpace upon request. In addition, Company shall not have any right to (a) remove, obscure, or alter any legal notices, including notices of Intellectual Property Rights present on or in the Content provided hereunder or any other materials provided by InfoSpace; or (b) "frame" Content unless expressly allowed by InfoSpace. (b) InfoSpace and its affiliates shall have no right to reproduce or sub-license, re-sell or otherwise distribute all or any portion of the Company Materials to any Person via the Internet (including the World Wide Web) or any successor public or private data network, other than providing access to the Company Materials to users of the Phone Site. (c) Each party shall comply with all then-current laws, rules, regulations and policies related to privacy. 2.4 COMPANY MARKS LICENSE. Subject to Section 2.6, Company hereby grants InfoSpace the right to use, reproduce, publish, perform and display the Company Marks; (a) on the InfoSpace Web Sites in connection with the posting of hyperlinks to the Phone Site for the purpose of serving Content with the Company brand onto or through the Phone Site; (b) in and in connection with the development, use, reproduction, modification, adaptation, publication, display and performance of the Phone Site for the purpose of serving Content with the Company brand onto or through the Phone Site.; and (c) with the prior written approval of Company and subject to the provisions of this Agreement relating to publicity, in promotional and marketing materials, content directories and indices, and electronic and printed advertising, publicity, newsletters and mailings about InfoSpace and its relationship with Company and the Phone Site. 2.5 INFOSPACE MARKS LICENSE. Subject to Section 2.6, InfoSpace hereby grants the right to use, reproduce, publish, perform and display the InfoSpace Marks: (a) on the Phone Site in connection with the posting of hyperlinks to the Content; and (b) with the prior written approval of InfoSpace and subject to the provisions of -3- this Agreement relating to publicity, in and in connection with the development, use, reproduction in promotional and marketing materials, content directories and indices, and electronic and printed advertising, publicity, newsletters and mailings about Company and its relationship with InfoSpace. 2.6 USE OF TRADEMARKS. Prior to the first use of any of the other party's Trademarks in the manner permitted herein, the party using such Trademarks shall submit a sample of such proposed use to the other party for its prior written approval, which shall not be unreasonably withheld or delayed. Without limiting the generality of the foregoing, each party shall strictly comply with all standards with respect to the other party's Trademarks which may be furnished by such party from time to time, and all uses of the other party's Trademarks in proximity to the trade name, trademark, service name or service mark of any other person shall be consistent with the standards furnished by the other party from time to time. Further, neither party shall create a combination mark consisting of one or more Trademarks of each party. All uses of the other party's Trademarks shall inure to the benefit of the party owning such Mark. Each party hereby acknowledges and agrees that, as between the parties hereto, the other party is the owner of the Trademarks identified as its Trademarks on the applicable attachment to the Agreement. Either party may update or change the list of Trademarks usable by the other party hereunder at any time by written notice to the other party. 2.7 NONEXCLUSIVITY. Each party acknowledges and agrees that the rights granted to the other party in this Agreement are non-exclusive, and that, without limiting the generality of the foregoing, nothing in this Agreement shall be deemed or construed to prohibit either party from participating in similar business arrangements as those described herein. 3. CERTAIN OBLIGATIONS OF THE PARTIES. 3.1 PHONE SITE. Company and InfoSpace will cooperate to design, and InfoSpace will implement in accordance with Exhibit A, the user-perceptible elements of the graphical use interface for the Phone Site, with the goals of: (a) conforming the graphical user interface with branding, graphics, navigation, content or other characteristics or features of the display output of the "look and feel" of the Phone Site to that associated with the applicable existing Company Web Sites; (b) integrating content and commerce services from third parties according to terms of this Agreement; (c) maximizing the commercial effectiveness thereof; and (d) optimizing the presentation of the relevant Content for access from mobile phones. Following agreement by the parties upon the design specifications thereof, InfoSpace will use commercially reasonable efforts to develop the graphical user interface and to implement the same on Co-branded Pages. 3.2 COMPANY OBLIGATIONS. Company shall integrate the acknowledgement "Powered by InfoSpace" or equivalent attribution at the bottom of a single prominent page of the Phone Site in a manner mutually agreeable to both parties. 3.3 IMPRESSION INFORMATION. InfoSpace shall track and allow the Company to remotely access in electronic form information maintained by InfoSpace concerning the number of Impressions. 3.4 PUBLICITY. The parties may work together to issue publicity and general marketing communications concerning their relationship and other mutually agreed-upon matters, provided, however, that neither party shall have any obligation to do so. In addition, neither party shall issue any such publicity and general marketing communications concerning their relationship without the prior written consent of the other party (not to be unreasonably withheld). 3.5 [*] 4. REVENUE SHARE. -4- [*] = Confidential Treatment Requested 4.1 FEES AND REVENUE SHARE. In addition to the terms and conditions otherwise set forth in this Agreement, Setup/Integration Fees, Subscriber Fee, and Transaction Revenue Share shall be governed by the terms and conditions set forth on Exhibit C. 4.2 REMUNERATION; COLLECTION. Each party will pay to the other party the amounts as set forth on Exhibit C. Any undisputed amounts not paid when due, or as invoiced, will be subject to a finance charge equal to one and one-half percent (1.5%) per month from the date due until the date paid. Payment of such finance charges will not excuse or cure any breach or default for late payment. Each party may accept any check or payment without prejudice to its rights to recover the balance due or to pursue any other right or remedy. No endorsement or statement on any check or payment or letter accompanying any check or payment or elsewhere will be construed as an accord or satisfaction. Unless explicitly stated on Exhibit C, all amounts payable under this Agreement are denominated in United States dollars and each party will pay all amounts payable under this Agreement in lawful money of the United States. Other than as explicitly stated on Exhibit C, InfoSpace shall have no obligation to share with, allow Company to sell, or account to Company regarding, any sums received by InfoSpace or any of its affiliates from any advertisements or promotions on any of the InfoSpace Web Sites (including, without limitation, any of the Co-branded Pages). In the event Company fails to make timely payment, InfoSpace shall have the right, in addition to all other remedies, to remove all links, content, or services provided by InfoSpace under the Agreement. Company and InfoSpace will be responsible for all reasonable expenses (including attorney fees) incurred by the other party in collecting such amounts due under the terms of this Agreement. 4.3 RECORDS AND AUDIT. During the Term, each party shall maintain accurate records of Transaction Revenues or Subscriber Fees received and calculations of the fees payable to the other party pursuant to this Agreement. Either party, at its expense, and upon ten (10) days' advance notice to the other party, shall have the right no more than twice during the Term to examine or audit such records in order to verify the figures reported in any quarterly report and the amounts owned to such party under this Agreement. Any such audit shall be conducted, to the extent possible, in a manner that does not interfere with the ordinary business operations of the audited party. In the event that any audit shall reveal an underpayment of more than ten percent (10%) of the amounts due to the auditing party for any quarter, the other party will reimburse such party for the reasonable cost of such audit. 5. WARRANTIES, INDEMNIFICATION AND LIMITATION OF DIRECT LIABIITY. 5.1 WARRANTIES Each party to this Agreement represents and warrants to the other party that: a) it has the full corporate right, power and authority to enter into this Agreement and to perform the acts required of it hereunder; b) its execution of this Agreement by such party and performance of its obligations hereunder, do not and will not violate any agreement to which it is a party or by which it is bound; c) when executed and delivered, this Agreement will constitute the legal, valid and binding obligation of such party, enforceable against it in accordance with its terms; and d) all Content or other content or materials served or submitted by it to or through the Phone Site, as the case may be, will not contain any material that is obscene, libelous or defamatory, or infringing of any Intellectual Property Rights or other rights of any third party. 5.2 INDEMNIFICATION. Each party (the "Indemnifying Party") will defend, indemnify and hold harmless the other party (the "Indemnified Party"), and the respective directors, officers, employees and agent of the Indemnified Party, from and against any and all claims, costs, losses, damages, judgements and expenses -5- (including reasonable attorney's fees) arising out of or in connection with any third-party claim alleging any breach of such part's representations or warranties or covenants set forth in this Agreement or alleging that any Content, Banner Advertisements or other content or materials served or submitted by such party or through the Phone Site, as the case may be, contains any material that is obscene, libelous or defamatory, or infringing of any Intellectual Property Rights or other rights of any third party. The Indemnified Party agrees that the Indemnifying Party shall have sole and exclusive control over the defense and settlement of any such third party claim. However, the Indemnifying Party shall not acquiesce to any judgment or enter into any settlement that adversely affects the Indemnified Party's rights or interests without prior written consent of the Indemnified Party. The Indemnified Party shall promptly notify the Indemnifying Party of any such claim of which it becomes aware and shall: (a) at the Indemnifying Party's expense, provide reasonable cooperation to the Indemnifying Party in connection with the defense or settlement of any such claim; and (b) at the Indemnified Party's expense, be entitled to participate in the defense of any such claim. 5.3 LIMITATION OF LIABILITY; DISCLAIMER. (a) Liability. UNDER NO CIRCUMSTANCES SHALL EITHER PARTY BE LIABLE TO THE OTHER PARTY FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR EXEMPLARY DAMAGES (EVEN IF THAT PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES), ARISING FROM ANY PROVISION OF THIS AGREEMENT, SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE OR ANTICIPATED PROFITS OR LOST BUSINESS. NEITHER INFOSPACE'S NOR COMPANY'S LIABILITY (WHETHER ARISING IN TORT, CONTRACT OR OTHERWISE AND NOTWITHSTANDING ANY FAULT, NEGLIGENCE (WHETHER ACTIVE, PASSIVE OR IMPUTED), PRODUCT LIABILITY OR STRICT LIABILITY OF SUCH PARTY) UNDER THIS AGREEMENT OR WITH REGARD TO ANY OF THE PRODUCTS OR SERVICES RENDERED BY EITHER PARTY UNDER THIS AGREEMENT (INCLUDING ANY SERVERS OR OTHER HARDWARE, SOFTWARE AND ANY OTHER ITEMS USED OR PROVIDED BY INFOSPACE OR ANY THIRD PARTIES IN CONNECTION WITH HOSTING THE PHONE SITE), THE INFOSPACE WEB SITES, THE CONTENT AND ANY OTHER ITEMS OR SERVICES FURNISHED UNDER THIS AGREEMENT WILL IN NO EVENT EXCEED THE COMPENSATION PAID OR PAYABLE BY COMPANY TO INFOSPACE UNDER THIS AGREEMENT. (b) No Additional Warranties. EXCEPT AS SET FORTH IN THIS AGREEMENT, NEITHER PARTY MAKES, AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS, ANY REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED (INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE AND IMPLIED WARRANTIES ARISING FROM COURSE OF DEALING OR COURSE OF PERFORMANCE), AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS ANY CLAIM IN TORT (INCLUDING NEGLIGENCE), IN EACH CASE, REGARDING THEIR WEB SITES, ANY PRODUCTS OR SERVICES DESCRIBED THEREON, OR ANY OTHER ITEMS, SOFTWARE OR SERVICES PROVIDED UNDER THIS AGREEMENT. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, INFOSPACE AND COMPANY ACKNOWLEDGES THAT BOTH THE INFOSPACE AND COMPANY WEB SITES, THE TECHNOLOGY AND THE CONTENT (INCLUDING ANY SERVERS OR OTHER HARDWARE, SOFTWARE AND ANY OTHER ITEMS USED OR PROVIDED BY INFOSPACE, COMPANY OR ANY THIRD PARTIES IN CONNECTION WITH HOSTING THE INFOSPACE OR COMPANY WEB SITES OR THE CONTENT OR PERFORMANCE OF ANY SERVICES HEREUNDER) ARE PROVIDED "AS IS" WITHOUT ANY WARRANTIES OF ANY KIND. COMPANY AND INFOSPACE ACKNOWLEDGE THAT INFOSPACE AND COMPANY MAKE NO WARRANTY THAT IT WILL CONTINUE TO OPERATE ITS WEB SITES OR OFFER THE CONTENT IN ITS CURRENT FORM, THAT ITS WEB SITES OR THE CONTENT WILL BE ACCESSIBLE WITHOUT INTERRUPTION, THAT THE SITES OR THE CONTENT WILL MEET THE REQUIREMENTS OR EXPECTATIONS OF THE OTHER PARTY, OR THAT THE CONTENT, SOFTWARE OR ANY OTHER MATERIALS ON ITS WEB SITES OR THE SERVERS AND SOFTWARE THAT MAKES ITS WEB SITES AVAILABLE ARE FREE FROM ERRORS, DEFECTS, DESIGN FLAWS OR OMISSIONS. -6- 6. TERMS AND TERMINATION. 6.1 TERM. The term of this Agreement shall commence on the Effective Date and, unless earlier terminated as provided below, shall end on the second anniversary of the Commercial Service Date (the "Term"). 6.2 TERMINATION. Either party may terminate this Agreement upon not less than thirty (30) days' prior written notice to the other party of any material breach hereof by such other party, provided that such other party has not cured such material breach within such thirty (30) day period. 6.3 EFFECT OF TERMINATION. Upon termination of this Agreement or expiration of the Term for any reason, all rights and obligations of the parties under this Agreement shall be extinguished, except that: (a) all accrued payment obligations hereunder shall survive such termination or expiration; and (b) the rights and obligations of the parties under Sections 4, 5, 6, 7 and 8 shall survive such termination or expiration. 7. INTELLECTUAL PROPERTY. 7.1 COMPANY. As between the parties, Company retains all right, title and interest in and to the Phone Site (including, without limitation, any and all content, data, URLs, domain names, technology, software, code, user interfaces, "look and feel", Trademarks and other items posted thereon or used in connection or associated therewith; but excluding any Content supplied by InfoSpace and excluding the underlying Technology used to create the Phone Site or to populate it with InfoSpace's specific Content) and the Company Marks, and Company Material, along with all Intellectual Property Rights associated with any of the foregoing. 7.2 INFOSPACE. As between Company and InfoSpace, InfoSpace reserves and retains all right, title and interest, including but not limited to all Intellectual Property Rights in the Technology utilized under this Agreement and no license or title to nor ownership of any of the Technology is granted or otherwise transferred to Company or any other Person under this Agreement. As between the parties, InfoSpace retains all right, title and interest in and to the Content and the InfoSpace Web Sites (including, without limitation, any and all content, data, URLs, domain names, technology, software, code, user interfaces, "look and feel", Trademarks and other items posted thereon or used in connection or associated therewith; but excluding any items supplied by Company) and the InfoSpace Marks, along with all Intellectual Property Rights associated with any of the foregoing. Company obtains no right to use InfoSpace Intellectual Property Rights beyond the Term of this Agreement. 7.3 COPYRIGHT NOTICES. Attribution will take place on the HDML Pages as specified in Section 3.2. InfoSpace and Company acknowledge that the Phone Site pages may also contain copyright and patent notices of copyrighted or copyrightable works, including those of InfoSpace, Content providers, and of Company. 7.4 OTHER TRADEMARKS. InfoSpace shall not register or attempt to register any of the Company Marks or any Trademarks that Company reasonably deems to be confusingly similar to any of the Company Marks. Company shall not register or attempt to register any of the InfoSpace Marks or any Trademarks that InfoSpace reasonably deems to be confusingly similar to any of the InfoSpace Marks. 7.5 FURTHER ASSURANCES. Each party shall take, at the other party's expense, such action (including, without limitation, execution of affidavits or other documents) as the other party may reasonably request to effect, perfect or confirm such other party's ownership interests and other rights as set forth above in this Section 7. 8. GENERAL PROVISIONS 8.1 CONFIDENTIALITY. Each party (the "Receiving Party") undertakes to retain in confidence the terms of this Agreement, the Technology, and all other non-public information and know-how of the other party disclosed or acquired by the Receiving Party pursuant to or in connection with this Agreement which is either designated as proprietary and/or confidential or by the nature of the circumstances surrounding disclosure, ought in good faith to be treated as proprietary and/or confidential ("Confidential Information"); provided that each party may -7- disclose the terms and conditions of this Agreement to its immediate legal and financial consultants in the ordinary course of its business. Each party agrees to use commercially reasonable efforts to protect Confidential Information of the other party, and in any event, to take precautions at least as great as those taken to protect its own confidential information of a similar nature. The foregoing restrictions shall not apply to any information that: (a) was known by the Receiving Party prior to disclosure thereof by the other party; (b) was in or entered the public domain through no fault of the Receiving Party; (c) is disclosed to the Receiving Party by a third party legally entitled to make such disclosure without violation of any obligation of confidentiality; (d) is required to be disclosed by applicable laws or regulations (but in such event, only to the extent required to be disclosed); or (e) is independently developed by the Receiving Party without reference to any Confidential Information of the other party. Upon request of the other party, each party shall return to the other all materials, in any medium, which contain, embody, reflect or reference all or any part of any Confidential Information of the other party. Each party acknowledges that breach of this provision by it would result in irreparable harm to the other party, for which money damages would be an insufficient remedy, and therefore that the other party shall be entitled to seek injunctive relief to enforce the provisions of this Section 8.1. 8.2 INDEPENDENT CONTRACTORS. Company and InfoSpace are independent contractors under this Agreement, and nothing herein shall be construed to create a partnership, joint venture, franchise or agency relationship between Company and InfoSpace. Neither party has any authority to enter into agreements of any kind on behalf of the other party. 8.3 ASSIGNMENT; MERGER. Neither party may assign this Agreement or any of its rights or delegate any of its duties under this Agreement without the proper written consent of the other party, not to be unreasonably withheld. Notwithstanding the foregoing, either party may assign this Agreement, without the other party's consent, (i) to any parent, subsidiary, or affiliate entity, or (ii) to any purchase of all or substantially all of such party's assets or to any successor by way of merger, consolidation or similar transaction. Subject to the foregoing, this Agreement will be binding upon, enforceable by, and inure to the benefit of the parties and their respective successors and assigns. 8.4 CHOICE OF LAW. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Washington without reference to its choice of law rules. Company hereby irrevocably consents to exclusive personal jurisdiction and venue in the state and federal courts located in King County, Washington with respect to any actions, claims or proceedings arising out of or in connection with this Agreement, and agrees not to commence or prosecute any such action, claim or proceeding other than in the aforementioned courts. 8.5 NONWAIVER. No waiver of any breach of any provision of this Agreement shall constitute a waiver of any prior, concurrent or subsequent breach of the same or any other provisions hereof, and no waiver shall be effective unless made in writing and signed by an authorized representative of the waiving party. 8.6 FORCE MAJEURE. Neither party shall be deemed to be in default of or to have breached any provision of this Agreement as a result of any delay, failure in performance or interruption of service, resulting directly or indirectly from acts of God, acts of civil or military authorities, civil disturbances, wars, strikes or other labor disputes, fires, transportation contingencies, interruptions in telecommunications or Internet services or network provider services, failure of equipment and/or software, other catastrophes or any other occurrences which are beyond such party's reasonable control. 8.7 NOTICES. Any notice or other communication required or permitted to be given hereunder shall be given in writing and delivered in person, mailed via confirmed facsimile or e-mail, or delivered by recognized courier service, properly addressed and stamped with the required postage, to the applicable party at its address specified below and shall be deemed effective upon receipt. Either party may from time to time change the individual to receive notices or its address by giving the other party notice of the change in accordance with this section. -8- To Company: To InfoSpace: Freei Networks, Inc.____ InfoSpace.com, Inc. 2505 S. 320th Street, Suite 600 15375 NE 90th Street Federal Way, WA 98003 Redmond, WA 98052 Attn: Bob McCausland Attn: Charles Stubbs In addition, a copy of any notice of change of address, or of termination or any alleged breach of this Agreement, shall be thus sent to the applicable party at the following address: To Company: To InfoSpace: Freei Networks, Inc. InfoSpace.com, Inc. 2505 S. 320th Street, Suite 200 15375 NE 90th Street Federal Way, WA 98003 Redmond, WA 98052 Fax: (425) 883-4846 Attention: Gregory P. Cavagnaro Attention: General Counsel 8.8 SAVINGS. In the event any provision of this Agreement shall for any reason by held to be invalid, illegal or unenforceable in any respect, the remaining provisions shall remain in full force and effect. If any provision of this Agreement shall, for any reason, be determined by a court of competent jurisdiction to be excessively broad or unreasonable as to scope or subject, such provision shall be enforced to the extent necessary to be reasonable under the circumstances and consistent with applicable law while reflecting as closely as possible the intent of the parties as expressed herein. 8.9 INTEGRATION. This Agreement contains the entire understanding of the parties hereto with respect to the transactions and matters contemplated hereby, supersedes all previous agreements or negotiations between InfoSpace and Company concerning the subject matter hereof, and cannot be amended except by a writing signed by both parties. 8.10 COUNTERPARTS; ELECTRONIC SIGNATURE. This Agreement may be executed in counterparts, each of which will be deemed an original, and all of which together constitute one and the same instrument. To expedite the process of entering into this Agreement, the parties acknowledge that Transmitted Copies of the Agreement will be equivalent to original documents until such time as original documents are completely executed and delivered. "Transmitted Copies" will mean copies that are reproduced or transmitted via photocopy, facsimile or other process of complete and accurate reproduction and transmission. -9- IN WITNESS WHEREOF, the parties have duly executed and delivered this Agreement as of the Effective Date. FREEI NETWORKS, INC. INFOSPACE.COM, INC. ("COMPANY") ("INFOSPACE") By (signature) /s/ BOB McCAUSLAND By (signature) /s/ Naveen Jain - ----------------------------------- ----------------------------------- Name Bob McCausland Name Naveen Jain - ----------------------------------- ----------------------------------- Title CEO Title CEO - ----------------------------------- ----------------------------------- -11- EXHIBIT A DELIVERABLES InfoSpace will, in cooperation with the Company, develop and maintain the Phone Site, consisting of HDML pages. InfoSpace will be responsible for implementing the graphical user interface and related design elements for the Phone Site that displays the Content. Company will design and supply the graphical content to be used in the Phone Site. in order to insure that the display output conforms to the Company's "look and feel". InfoSpace shall make the Content listed below available to Company on the Phone Site. These services shall be made available at a mutually agreed upon date. All categories of Content shall be used by Company at its discretion. i) BASIC CONTENT: The following Basic Content categories will be made available to the Company on the Phone site: --------------------------------------- FOR PHONE (HDML) ACCESS --------------------------------------- -- Yellow Page -- White Page -- Directions -- City Guide -- Finance -- News -- Sports -- E-Shopping -- Entertainment -- ActiveShopper --------------------------------------- If a fee is assessed by content provider to InfoSpace on a per Subscriber or per-query basis to access this additional content via wireless medium, an [*] may be required. Company shall be notified and approve in writing of any [*] prior to incurring such Fee. These fees will be determined on a case by case basis. ii) PERSONALIZED CONTENT: The following personalized content shall be made available to Company on the Phone Site: --------------------------------------- PERSONALIZED ON PHONE SITE VIA FEATURE HDML --------------------------------------- MyNews: User specifies X which categories and number of headlines --------------------------------------- MyPortfolio: User specifies X which stock quotes to include --------------------------------------- MyWeather: User specifies zip X code --------------------------------------- [*] = Confidential Treatment Requested
- ----------------------------------------------------------------- PERSONALIZED ON PHONE SITE VIA FEATURE HDML - ----------------------------------------------------------------- MySports: X User selects league and team to receive scores - ----------------------------------------------------------------- MyHoroscope: X User specifies birth date - ----------------------------------------------------------------- MyLottery: X user specifies state of interest - ----------------------------------------------------------------- Bookmarks: X User specifies url addresses and site names - ----------------------------------------------------------------- local Information: X User specifies zip code, home, work address - -----------------------------------------------------------------
iii) PIM SERVICE: InfoSpace will provide Company the following services on the Phone Site: - Web Based Email with POP3 access - Calendar - Address Book - Synchronization capability with MS Outlook on the desktop iv) LOCALIZATION SERVICE: InfoSpace will provide Company, as an integrated part of the Phone Site, the ability for users to find points of interest based on proximity to their home or work address. v) INTEGRATION WITH COMPANY CONTENT AND SERVICES: InfoSpace will integrate links to designated Company services and content (e.g. customer care, billing, etc.) as specified by Company. vi) INTEGRATION OF THIRD PARTY CONTENT AND SERVICES: InfoSpace will provide a mutually agreeable content integration program to Company as specified in Exhibit D and will coordinate the integration of links to third party content and services. [*] vii) ACTIVE SHOPPER AND SINGLE-CLICK PURCHASING: InfoSpace shall provide Company, at Company's request, the ActiveShopper comparison shopping tool. Additionally, InfoSpace shall provide Company with "e-wallet" technology that will enable Subscribers to complete single-click purchases for products and services based on the Subscriber's stored transaction profile on terms to be mutually agreed upon by the parties. viii) InfoSpace shall provide Company, at Company's request, with timing to be mutually agreed, the Instant Messaging solution at no incremental cost to Company. The functionality shall include, at a minimum, the ability to set up group lists, device lists, and to send and receive messages from a browser-enabled mobile Phone to Phone, Phone to PC). -12- [*] = Confidential Treatment Requested EXHIBIT B TRADEMARKS INFOSPACE MARKS - --------------- INFOSPACE INFOSPACE.COM [graphic] POWERED BY INFOSPACE POWERED BY INFOSPACE.COM THE ULTIMATE DIRECTORY ACTIVESHOPPER PAGEEXPRESS SEARCH ENGINE FOR THE REAL WORLD THE STUFF THAT PORTALS ARE MADE OF PERSONAL DESKTOP PORTAL THE BRAND THAT'S BUILDING THE INTERNET COMPANY MARKS - ------------- -13- EXHIBIT C TERMS TERMS 1. DEFINITIONS. As used in this Agreement, the following terms have the following defined meanings: "ACTIVE SUBSCRIBER" means, for any month of the Term, any Subscriber that effects at least [*] queries on the Phone Site during such month. The number of Active Subscribers shall be measured on the last day of each month. "BASIC CONTENT" means the services described in Section (i) of Exhibit A. "COMMERCE PARTNER" means any Person that provides services involving a commercial transaction to InfoSpace or Company. "SERVICE AND MAINTENANCE FEE" means a monthly nonrefundable sum in the amount of [*]. This fee is a minimum monthly fee, and shall be paid to InfoSpace on or before the first day of each month during the first year of the Term. "SETUP/INTEGRATION FEE" means a sum in the amount of [*] for the setup and integration effort undertaken by InfoSpace to configure and provide services to Company. "SUBSCRIBER FEES" means the amount of $[*] payable per Active Subscriber for each calendar month of the [*] of the Term. "TRANSACTION REVENUE" means the net revenue (i.e., gross revenues less any taxes, commissions and any required fees payable to third parties) received from merchants as a commission on transactions completed by users of the Company Wireless/Web Services. Any and all deductions from gross revenue (e.g. taxes, commission and fees payable to third parties) shall not exceed [*] of the gross revenue. 2. SETUP/INTEGRATION FEE. The Company will pay to InfoSpace the Setup/Integration Fee as follows: The Setup/Integration Fee is payable on the Effective Date. InfoSpace will commence the setup effort for the Phone Site upon, but not prior to, receipt of this portion of the Setup/Integration Fee. This fee is non-refundable. 3. SERVICE AND MAINTENANCE FEE; SUBSCRIBER FEES. The initial Service and Maintenance Fee is payable on the Commercial Service Date on a pro-rata basis from the Commercial Service Date through the end of such calendar month. Thereafter, Service and Maintenance Fees are due on the first day of each calendar month of the Term. At the end of each calendar quarter of the [*] of the Term, an assessment shall be made of Subscriber Fees due. If Subscriber Fees due are less than Service and Maintenance Fees paid or payable for that calendar quarter, then no additional payment is due for Subscriber Fees. If the Subscriber Fees due are greater than the Service and Maintenance Fees paid or payable for that calendar quarter, then Company shall remit payment for the difference between the Subscriber Fees due and the Service and Maintenance Fees paid or payable (the "Incremental Subscriber Fee"). InfoSpace will send an invoice to Company for the Incremental Subscriber Fees when they become due. The Incremental Subscriber Fees will be payable by Company thirty (30) days from the date of invoice. 5. TRANSACTION REVENUE SHARE. Company and InfoSpace shall share Transaction Revenue as follows: (a) INFOSPACE BRINGS COMMERCE PARTNER. In the event that InfoSpace brings a Commerce Partner to the Phone Site from which Transaction Revenue results, InfoSpace shall remit [*] of such Transaction Revenue to Company. -14- [*] = Confidential Treatment Requested (b) COMPANY BRINGS COMMERCE PARTNER AND INFOSPACE PROVIDES TRANSACTION CAPABILITY. In the event that Company brings a Commerce Partner to the Phone Site from which Transaction Revenue results, and InfoSpace provides the transaction capabilities for completing transactions with that partner, Company shall remit [*] of Transaction Revenue to InfoSpace. (c) COMPANY BRINGS COMMERCE PARTNER AND INFOSPACE DOES NOT PROVIDE TRANSACTION CAPABILITY. In the event that Company brings a Commerce Partner from which Transaction Revenue results, and InfoSpace merely provides a link on the Phone Site to access such Commerce Partner, Company shall not be obligated in sharing Transaction Revenues in this event. However, InfoSpace may charge Company a one time flat fee to include such Commerce Partner's link on the Phone Site. One-time flat fee to include the Commerce Partner's link on the Phone site shall not exceed what is commercially reasonable for similar services. (d) TRANSACTION REVENUE PAYMENTS. Transaction Revenue share payments will be reconciled and paid within thirty (30) days following the calendar quarter in which the applicable revenues are received by the party that brings the Commerce Party to the Phone Site (the "Selling Party"). The Selling Party will provide with each such payment a report setting forth Transaction Revenues received by it for such quarter and the percentage thereof payable to the other party. 6. CUSTOMIZATION. InfoSpace may require additional Setup/Integration Fees for any customization necessary to enable the delivery of the Phone Site to different wireless platforms (e.g., WAP, GSM, TDMA, CDMA, etc.) or specific phone models. Company shall consent to any additional fees contemplated under the provision in writing prior to incurring any liability for such changes. -15- [*] = Confidential Treatment Requested EX-23.1 21 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS We hereby consent to the use in this Registration Statement on Form S-1 of our report dated March 29, 2000, relating to the financial statements of Freei Networks, Inc., which appear in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Registration Statement. /s/ PRICEWATERHOUSECOOPERS Seattle, Washington March 31, 2000 EX-27.1 22 EX-27.1
5 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 20,342 0 410 (52) 0 22,828 28,169 (1,862) 50,429 12,179 0 33,892 0 11,086 (7,848) (15,779) 0 983 0 8,692 10,763 52 429 (18,745) 0 (18,745) 0 0 0 (18,745) (2.16) (2.16)
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