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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File No.: 333-53841
WAM!NET Inc.
(Exact Name of Registrant as specified in its charter)
Minnesota 41-1795247
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
655 Lone Oak Drive
Eagan, Minnesota 55121
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (651) 256-5100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all Reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrants' knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _X_
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. ___ No
As of March 7, 2000, there were 9,494,797 shares of the Company's Common
Stock outstanding. The aggregate market value of the voting stock of the company
held by non-affiliates is $20,932,608.
Documents Incorporated by Reference--Not applicable.
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FORM 10-K
TABLE OF CONTENTS
ITEM PAGE
- ---- ----
PART I
ITEM 1. BUSINESS.............................................................1
ITEM 2. PROPERTIES..........................................................15
ITEM 3. LEGAL PROCEEDINGS...................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS...............................................16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA................................17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...............................19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.......................................................27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE...............................28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.................29
ITEM 11. EXECUTIVE COMPENSATION.............................................31
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT........................................................36
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K.......................................................44
IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS.....................50
SIGNATURES - WAM!NET INC.....................................................51
FINANCIAL STATEMENT SCHEDULES...............................................F-1
(1)
PART I
ITEM 1. BUSINESS.
Overview
We are a leading global provider of business-to-business electronic services
to the media industry. We enable entertainment, advertising, publishing,
printing and related media businesses worldwide to collaborate on-line within
their workflow chains. These businesses experience inefficiencies associated
with incompatible systems and largely manual processes involving both analog and
digital data. Our services and network infrastructure address this problem by
providing businesses a common electronic workflow platform to seamlessly
integrate their production processes and accelerate the adoption of digital
workflow collaboration. Our e-services include: (1) managed data transport, (2)
media application hosting, (3) managed data storage, (4) computer animation
rendering and (5) Internet-based services. We offer our services under simple
monthly service fee and pay-per-use pricing plans, which require no up-front
capital investment by our customers. We enable businesses to achieve measurable
operating efficiencies, productivity gains and cost savings.
We own and operate a private, Internet Protocol or IP based global network,
hosting and storage infrastructure that we have integrated with the public
Internet. Customers can access our services and infrastructure through the
Internet or through a dial-up or dedicated connection to our network. This
provides our customers with the global access of the Internet and the
reliability, security, accountability and predictability of a managed private
infrastructure. By design, our network is not dependent on a single technology,
protocol or telephony solution, allowing us to quickly take advantage of new
network, access and storage technologies to enhance our services or reduce
costs.
Our services are tailored to meet the specialized needs of businesses
involved in the creation, exchange, distribution and storage of media, such as
magazines, newspapers, marketing materials, brand advertisements, television and
radio broadcast programming and films. As the number of influential,
industry-leading firms that rely on our services and applications grows, the
value of our network to current and prospective customers increases. We believe
media businesses that gain the most cost savings by digitally integrating their
workflow chains will become the strongest proponents of our workflow platform.
Many of our customers actively encourage their workflow partners to purchase our
services and, in some cases, pay the fees incurred by their partners. As of
December 31, 1999, we had over 1,900 customer points-of-presence consisting of
dedicated network access devices and local bandwidth connectivity. In addition,
we had over 6,800 users of our Internet and dial-up services globally. Users of
our network and services include:
o 11 of the 20 largest U.S. publishers (including Time Inc. and
McGraw-Hill Companies Inc.);
o 18 of the 20 largest U.S. advertising agencies (including Young &
Rubicam Inc. and J. Walter Thompson, Inc.);
o 12 of the 20 largest U.S. retailers (including Albertson's, Inc. and
Lowe's Company, Inc.);
o 16 of the 20 largest U.S. printers (including R.R. Donnelley & Sons
Company, Quebecor World, Inc. and Quad/Graphics, Inc.);
o 19 of the 20 largest U.S. pre-press firms (including American Color
Graphics, Inc. and Applied Graphics Technologies, Inc.);
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o 34 Fortune 100 companies (including Ford Motor Company and Wal-Mart
Stores); and
o 7 of the 20 largest newspaper publishing companies (including
Knight-Ridder, Inc. and The Times Mirror Company).
We have a significant presence with many large influential media companies
that are at an early stage in their adoption of and conversion to complete
digital workflow processes. Consequently, we believe there is significant
opportunity to increase our revenues as these businesses, their trading partners
and the media industry as a whole continue to implement digital workflow
solutions.
Market Opportunity
The emergence of business-to-business e-commerce over the Internet and
private networks is changing the way companies are conducting business.
According to Forrester Research, Inc., a leading independent research firm,
more than $1.3 trillion in business-to-business e-commerce will be transacted
in 2003. We believe that as companies in the media industry increase the amount
of business they conduct over the Internet, these businesses will increase
their digital collaboration and require on-line integrated workflow chains.
This workflow evolution, combined with the success of IT outsourcing, is
increasing demand for industry-specific, standardized e-commerce platforms
through which workflow partners can access a full range of e-services and
seamlessly integrate their media production processes.
The need for a standardized e-commerce platform is heightened by the fact
that businesses involved in media design and production are increasingly using
computers, software applications and other electronic systems in all aspects of
the media production process. The demand for digital media in Web-based e-
commerce and the increasing use of digital tools to create media will continue
to fuel growth in data traffic. GISTICS Incorporated, a leading media research
firm, estimated that in North America alone businesses would spend nearly $20
billion in 1999 on physical and digital media logistics and transportation,
including the transportation of media to workflow partners using traditional
physical processes such as overland or air couriers, including Federal Express,
DHL Worldwide Express and United Parcel Service. We believe that five trends
will continue to drive our market opportunity:
o Rapid growth in the creation of digital media and expenditures for
digital media production. GISTICS estimated that $317 billion would be
spent in North America alone by businesses in the creation and
production of media in 1999. Advances in digital media production and
business-to-business e-commerce applications, coupled with the increased
adoption of the Internet, are fueling rapid growth in expenditures for
digital technologies and services that create, manage and distribute
digital media. Businesses have large inventories of non-digital media
which are difficult to store, manage and re-use. These inventories can
now be digitized, stored and managed electronically for re-use and
re-purposing in a wide array of end-user media materials and formats,
including the Web.
o Expanding use of digital media in workflow collaboration and e-commerce.
The expanding use of digital media in workflow collaboration and the
growth of e-commerce are driving the demand for data management,
transport and storage solutions over the public Internet and private
networks. Media workflow chains that design, produce, buy, sell and
distribute media require many parties to share, manage and store
increasingly large amounts of digital media. For example, the assembly
of one weekly magazine may require hundreds of businesses in the
publishing, printing, advertising and corporate marketing industries to
participate in the creation and assembly of content, including
photographs, advertising, graphics, editorial content and mailing lists.
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o Growing demand for accessible, integrated and on-line media storage and
hosting solutions. The growth in the creation of and demand for digital
content has increased the value and the volume of businesses' digital
media assets, making it more difficult and more critical to effectively
manage those assets. The volume of data generated in today's business
environment continues to grow at a significant rate, driving the
increased use of disk storage. International Data Corporation, a leading
industry research firm, estimates that multi-user disk storage grew from
approximately 10 million petabytes in 1994 to 116 million petabytes in
1998, and will reach approximately 1.4 billion petabytes in 2002 (one
petabyte equals 1 million megabytes).
In meeting these rapidly increasing storage requirements, businesses
involved in media workflow chains face several problems. These
businesses must often purchase and maintain costly storage servers, hire
skilled administrators to maintain these storage systems, add disk
capacity to file servers, and maintain mirror copies of data at remote
sites. The costs associated with the hardware, software and consulting
services necessary for individual enterprises to store, manage, retrieve
and distribute digital data using redundant systems can be formidable.
In addition, businesses involved in media production often deal with
hundreds of vendors. Storing and using media assets for collaboration
among a geographically diverse workflow chain involving different
companies can be cost prohibitive and impractical. This has limited the
implementation of on-line workflow storage solutions. As a result,
businesses in the media industry are increasingly turning to service
providers that can host digital media assets in open and accessible
on-line storage systems.
We believe businesses that effectively manage global access to their
digital media assets will enjoy considerable competitive advantages
including:
-- increased operating efficiencies;
-- reduced time to market cycles;
-- enhanced media re-purposing and deployment;
-- improved ability to more rapidly exploit market opportunities;
and
-- expanded opportunities for collaboration with larger numbers
of customers, suppliers and business workflow partners.
o Emerging need by the media industry for standardized, integrated and
cost-effective e-commerce solutions. We believe managers in the media
industry require digital workflow collaboration to increase efficiency
at each step of the production and distribution process. Individual
businesses within the media industry, however, lack the resources,
expertise and independence to cost-effectively create a common
electronic workflow platform with the capacity to meet the industry's
digital management needs. As a result, we believe managers will
increasingly seek outsourced e-services and infrastructure from a single
independent provider. This includes outsourced workflow applications,
data transportation and storage services that can be adapted to fit
their specific workflow requirements.
o Continuing positive impact of the Internet market on our market. The
growth of the Internet is expanding and transforming the market for
managed transportation, hosting and storage of digital data. The low
cost of access to and ubiquity of the Internet allows small and
medium-sized businesses in geographically diverse locations to
participate cost-effectively in the use of hosted applications,
transport and storage services. In addition, the increased use of the
Internet as a
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medium for commerce will result in an increased number of digital files
being created, transported and stored for marketing and other purposes.
Business Strategy
Our objective is to become the leading global provider of
business-to-business e-services that enable businesses to collaborate on-line
with their workflow chains. We intend to implement the following strategies to
achieve our business objective:
o Capitalize on our first-to-market advantage with our existing
influential customer base to attract new customers worldwide and
increase utilization of our services. We plan to use our first-to-market
position to capitalize on the accelerating use of digital data in media
workflow chains. We have established and deployed a global network,
created significant brand recognition and developed relationships with
many influential customers. We plan to leverage our existing
relationships to draw more workflow partners into our customers'
electronic workflow, to increase utilization of our services and to
become an integral part of our customers' media workflow processes. We
also intend to focus our sales and marketing efforts on capturing
additional large and influential media companies which exert influence
over the adoption of e-services within their workflow chains.
o Provide a complete range of e-services that enable our customers to
accelerate their adoption of digital workflow. As we expand our
business, we will continue to develop and offer additional services and
enhancements that will enable our customers to manage their media
workflow and collaborate more efficiently. We offer our customers a
variety of flexible services that provide productivity gains and cost
savings. In addition to developing our own Industry Smart applications
and e-services, we will continue to enable our customers to access
leading third party applications and services on a transactional basis
over our infrastructure.
o Enter into strategic relationships to expand distribution channels,
integrate emerging technologies, develop new hosted applications and
services, and reduce costs. We will continue to build strategic
relationships with leading suppliers to the media industry to distribute
our services to new customer groups and geographic areas. In addition,
we seek strategic relationships to capitalize on advanced and emerging
technologies that enhance our service offerings and reduce the cost of
our operations. Finally, we will continue to use strategic relationships
to incorporate new applications and services that help our customers
collaborate more efficiently in their media workflow chains.
o Integrate public and private IP infrastructures to meet the global needs
of our customers most effectively. We will continue to offer access to
our services through the Internet to reach a wider group of potential
customers and to enable increased collaboration among our customers and
their workflow partners worldwide. Additionally, we will continue to
integrate our managed private global network, hosting and storage
infrastructure with the Internet to effectively meet the evolving needs
of our large and small customers.
o Apply our business model to other vertical markets worldwide. To take
advantage of economies of scope presented by our e-services and
infrastructure, we will continue to evaluate opportunities to offer our
services to other vertical markets that can benefit from
business-to-business electronic workflow services.
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Services and Applications
To address our customers' global on-line digital workflow needs, we offer
the following two broad categories of e-services and applications:
o managed data services; and
o hosted media applications and managed data storage services.
Our customers can access these services through the Internet at
www.wamnet.com or over our managed private IP global network to collaborate with
their workflow partners on-line. Most of our services are accounted for on a
transactional basis, in terms of megabytes sent, megabytes stored or processing
transactions executed. In addition, many of our services include a monthly
minimum service fee. By offering standard service packages coupled with a
complete menu of service options, we provide our customers with flexible
solutions that can meet their requirements for predictability, performance and
price.
Managed Data Services
Direct Service. This is our fastest, most secure and most reliable media
transport service providing direct, guaranteed access and transport over our
managed network. Customers who use this service typically participate in large
media workflow chains that require a highly managed, predictable and reliable
environment. This service includes installation of our network access device on
our customers' premises, a dedicated leased line or wireless connection to our
network, and access to our hosted Industry Smart applications, as well as
training and support on a 24 hours per day, seven days per week basis. Customers
may choose the capacity of their network access device and the speed of their
network connection to meet their requirements. Pricing for our Direct Service
includes a monthly service fee, and a transactional per megabyte pay-per-use
fee.
ISDN Tracked Service. Offered at a lower price point than our Direct
Service, our ISDN Tracked Service does not require a dedicated on-site network
access device or dedicated connection to our network. Our ISDN Tracked Service
offers the security and predictability of dial-up connectivity to our network,
at slower transmission speeds and without the performance guarantee of Direct
Service. This service is designed for customers with confidential and time
sensitive work who do not exchange a sufficient volume of data to require a
dedicated service connection. With this service, we provide access to our
network and hosted Industry Smart applications, an ISDN card, training and
customer support on a 24 hours per day, seven days per week basis. Customers may
chose either to purchase the software and hardware required for this service, or
to pay a monthly service fee over the life of the contract with no up-front
capital expenditure. ISDN Tracked Service is priced on a transactional, per
megabyte, pay-per-use basis. We commercially released our ISDN Tracked Service
in the first quarter of 1999.
Internet Gateway Service. We commercially released our Internet Gateway
Service in the third quarter of 1999. Our Internet Gateway Service provides
anyone with an Internet connection a more predictable, secure and trackable
means of exchanging digital files than currently available over the Internet.
Internet Gateway Service users access and use our hosted applications through
our website at www.wamnet.com. At the web site, users have access to the same
sophisticated tracking, reporting and directory tools that are available with
our other services to manage deliveries, view account data, and authorize other
WAM!NET users to exchange files with them. Our Internet Gateway Service allows
users to exchange files with any other WAM!NET user and to send files to any
e-mail address or FTP site. Internet Gateway brings the capacity to automate
workflows and processes using other hosted WAM!NET applications, including job
tickets. Internet Gateway Service is priced on a transactional, per megabyte,
pay-per-use basis.
In addition to allowing subscribers to set up their own Internet Gateway
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accounts, we offer Direct Service subscribers the opportunity to create and host
Internet Gateway accounts for their customers and workflow partners, providing a
standard way for them to send and receive data files. In this arrangement, hosts
pay the transaction fees for their workflow partners. For example, the host may
create different workflow groups, select appropriate job tickets and implement
standardized data exchanges. This results in a simplified, more uniform method
for Direct Service users to automate their work flow requirements.
Internet Access. We currently provide dedicated Internet access as a service
option for our Direct Service customers in the U.K. and plan to deploy this
service on a global basis this year. This option permits our Direct Service and
high-speed Internet access to be provided over the same dedicated circuit. With
this service, Direct Service customers can browse the Web, or host Web, FTP,
news or mail servers. We also offer additional services in conjunction with
third party partners, including: network design and consulting services;
firewall configuration and management services; news, Web, mail and FTP server
installation and set-up; and Web-based application development services.
Hosted Media Applications and Managed Data Storage Services
Hosted Media Applications
We host media applications that integrate our services into our customers'
digital workflow processes and are tailored to meet the needs of the media
industry. Customers can access these applications either through the Internet or
through our dedicated infrastructure. We have developed and currently offer our
own applications and plan to partner with leading application developers to host
and offer their applications over our network.
Transmission Manager. This application serves as the primary user interface
for our Direct and ISDN Tracked Services. Transmission Manager provides
customers with the capacity to establish and maintain address books, specify
workflow routing instructions, create and use job ticket and specify file and
job ticket editing criteria. We have also developed Transmission Manager
plug-ins which enable users of industry leading media applications, such as
Adobe Photoshop and Illustrator and Quark Express, to access our data transport
and storage services directly from within these applications. In addition,
Transmission Manager can be used for point-to-point ISDN file transmission.
Info Center. This application enables customers to manage their workflow
relationships and to review their use of our services by searching and viewing
data transmission activities on-line, including details of each file shipment,
such as confirmations of shipment and receipt, billing data and historical
records of usage. In addition, this application includes an address book, which
allows customers to create, authorize, restrict and manage the exchange of data
among workflow partners.
Electronic Job Tickets. This application enables our customers to automate
the scheduling, processing and accounting of exchanged files. Information
contained in the electronic job ticket that accompanies a file can be
automatically entered into the recipient's data systems, with significant
savings in labor costs and the elimination of errors associated with traditional
manual processes. Additionally, job ticket applications can validate, edit and
verify that job ticket contents and attached file formats meet user-defined
criteria. Job tickets can also specify prescribed action steps which can be
automatically initiated in the event of errors. Customers may choose between our
standard job tickets or, for a fee, create customized job tickets to meet their
specific needs.
Remote Proofing. WAM!PROOF is our remote proofing and printing solution that
allows customers
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to print automatically to geographically diverse color proofers, color copiers,
laser printers, and other digital output devices manufactured by 15 major
suppliers, such as Kodak, Polaroid, Imation and DuPont. This application gives
customers a means of rapidly distributing color proof copies of printed media to
workflow chain partners for review and approval of production jobs, eliminating
the delays and errors associated with messengers, overnight couriers or manual
processes.
Managed Data Storage Services
We provide digital data storage services under the WAM!BASE(R) brand. Our
storage services operate over our existing infrastructure and are billed on a
per-megabyte basis. Customers choose price and performance levels, which include
minimum storage volume requirements, under an annual or multi-year contract. Our
customers pay periodic storage charges based upon the volume and duration of
megabytes stored, including a fee per megabyte stored each month for the term of
the contract, with no up-front investment. Our storage services are scalable and
provide multiple benefits to our customers compared to in-house solutions,
including: reduced implementation time, lower implementation costs, minimized
capital expenditures and simplified pay-per-use pricing plans. We commercially
released our WAM!BASE Data Archiving Service in the first quarter of this year.
WAM!BASE Data Archiving Service. We offer this service for customers who
need to store files centrally for access by workflow partners in geographically
diverse locations. This service incorporates a simple Web-based user interface,
a powerful, industry leading search engine and automated workflow backup
functions. Our easy-to-use interface can index, store and search any type of
media, including still images, film and video. Our storage application is hosted
within our infrastructure, allowing workflow partners in multiple locations
secure access to the service without having to buy identical copies of expensive
media asset management software. The customer storing the data pays for the
storage fees and collaborators using the data pay data transportation fees to
download a copy of media assets from the archive. Because it is a hosted
service, there is no up- front capital investment in software or hardware,
making implementation fast and affordable compared to in-house storage
solutions. We believe that influential participants in the workflow process who
implement this service as a core part of their data storage strategy will
encourage other members of their workflow chain to adopt the solution.
WAM!BASE Digital Asset Management Service. We are developing and plan to
deploy a comprehensive storage service that is intended to meet the needs of
companies that require sophisticated digital asset management applications to
store and manage many types of electronic media, including still images, film
and video. Our service will allow subscribers to use third party applications
residing on their local area network, or an application hosted by us, while
still providing the efficiencies associated with storing assets in an off-site
media archive. This service will allow subscribers to choose from multiple
storage and software options, access speeds and pricing levels. Currently, we
have a joint marketing arrangement with Canto, Inc., the developer of a leading
digital asset management application for the graphics arts industry. Canto is
adapting the next release of its application to support WAM!BASE Digital Asset
Management Service to be jointly sold by WAM!NET and Canto. We plan to host and
co-market other third party digital asset management software applications.
Computer Animation Rendering Services
Render on Demand. We offer a hosted service for firms involved in the
production of computer generated special effects and other motion media for the
film and advertising industries. The rendering process requires specialized
software and extensive computing power. We host industry leading rendering
applications on our network and maintain a large number of servers that may be
used for this service. Large rendering projects typically require hundreds of
computer processors to simultaneously
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run sequences of a rendering job. Firms that perform rendering services in-house
typically incur significant expenses to purchase rendering software applications
and hardware and employ trained personnel to conduct the rendering functions.
Our service allows customers to avoid investing in rendering software or a large
number of servers. Our service also appeals to firms that currently maintain
their own servers but may require overflow capacity for peak project times, or
may wish to outsource this service altogether. We price this service based on
computer processing unit hours used, and we offer this service directly and
through co-marketing relationships with leading manufacturers of rendering
software and hardware for the media industry. We commercially released our
Render on Demand Service in the first quarter of 2000.
Our Network
We own and operate a private, IP-based global network connecting major media
centers around the world. Our core network consists of high-speed, ATM backbone
and leased dedicated high-bandwidth fiber optic capacity connecting our three
strategically located network operating centers with our 30 distribution hubs.
Our network and services are designed to accommodate the workflow automation
requirements of our subscribers including the need to transmit large media files
with greater speed, predictability, reliability and efficiency than many other
networks, including the public Internet. Our network is not dependent on a
single technology, protocol or telephony solution, which allows us to quickly
take advantage of new network, access and storage technologies to enhance our
services or reduce costs. This also permits us to offer affordable and versatile
ways for our customers to use our service.
Our infrastructure includes the following:
o Network Operations Centers (NOCs). We have deployed primary network
operations centers in North America (Eagan, Minnesota) and Europe
(Brussels, Belgium). In addition, we maintain a back-up network
operations center facility in Las Vegas, Nevada and are contemplating
deploying a NOC in Asia. Our NOCs serve as control centers for our
network, housing the specialized equipment we need to manage and monitor
our network 24 hours per day, seven days per week. Each of our three
regional network operating centers is capable of managing all of our
data transportation, hosting and storage operations. We believe that
because our customers are in time sensitive, data intensive industries,
many of them rely on our services to provide guaranteed delivery.
Automated network monitoring software from Hewlett Packard has been
installed and configured to provide continuous monitoring capabilities,
including a problem notification system that automatically alerts
network engineers of problems. Key aspects of our network are
continuously monitored, including network operating center equipment,
distribution hub equipment, backbone lines, local customer connections
and network access devices. We notify customers in the event of service
disruptions or equipment failures, and manage the restoration of
service.
o Network Backbone Facilities. Our 31 distribution hubs are interconnected
with a meshed ATM backbone provided by various carriers. Operating
agreements with these carriers enable us to increase backbone bandwidth
to accommodate our growth as needed. Additional network redundancy is
provided by a layer of private lines leased from diverse carriers on
different paths which primarily serve as network back-up. In addition,
we signed an agreement with Winstar in December of 1999 that will
provide WAM!NET backbone bandwidth at speeds ranging from 45Mb to 155 Mb
per second on various routes in the United States.
o Network Local Loop Facilities. In North America, local loop connections
linking distribution hubs and network access devices at customer sites
are currently provided almost exclusively by MCI
8
WorldCom and Regional Bell Operating Companies. We have agreements with
Deutsche Telekom and the Nippon Telegraph and Telephone Corporation to
provide local loop services in Germany and Japan, respectively, and with
other providers to provide such services elsewhere in the world. In
addition Winstar will provide wireless local loops at speeds ranging
from multiple 1.5Mb to 155Mb per second. Winstar's technology will allow
WAM!NET to deliver high speed reliable service to customers in most
targeted major metro areas without the cost and time it takes to deploy
fiber. This bandwidth will allow WAM!NET to offer additional services to
existing customers, or to market to new customers requiring higher
bandwidth.
o Network Points of Presence. Our hubs consist of large Cisco Systems,
Inc. routers and serve to route data traffic across our network. Our
hubs are co-located with MCI WorldCom or other facility management
providers and each is interconnected over our meshed ATM backbone
through at least two diverse routes. We have hubs in the following
cities:
North America Europe Asia
Atlanta Amsterdam Tokyo
Boston Brussels
Chicago Copenhagen
Dallas Frankfurt
Denver Hamburg
Detroit London
Las Vegas Manchester
Los Angeles Munich
Miami Paris
Minneapolis Stockholm
Montreal
New York City
Newark
Oakland
Philadelphia
Seattle
St. Louis
Toronto
Vancouver
Washington D.C.
o Direct Customer Points of Presence (Network Access Devices). A key
differentiator of our network is our deployment of network access
devices on our customers' premises. We have deployed over 1,900 network
access devices of varying size and complexity based on customer needs
and requirements. Our network access devices usually contain a Silicon
Graphics O2 processor, a Cisco router, a CSU/DSU, an uninterruptible
power supply and disk storage. Our network access devices directly
connect our customers to our hubs using a dedicated fixed bandwidth
circuit, providing a secure, predictable and reliable connection to our
private backbone network. We control all of our network access devices
remotely, allowing us to fully manage the network end-to-end and rapidly
provision new services. In addition, our network access devices are
scalable to allow for future customer growth as our customers' needs
expand.
o Storage Network Infrastructure. Our data center infrastructure provides
hosting and redundant storage at mirrored sites in Eagan and Las Vegas.
Our primary data center facility is located in our Eagan network
operating center and includes over 40,000 square feet of environmentally
controlled
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floor space suitable for housing large-scale computer and storage
systems. A back-up facility is located in our Las Vegas data center and
we expect that additional data center, hosting and storage
infrastructure will be available in Brussels to support European
customers as needed. We currently have a variety of installed equipment
with capacity to store over 40,000 petabytes of total on-line primary
and back-up storage capacity and have purchase agreements in place with
major storage vendors to purchase additional on-line storage capacity as
demand warrants. Additionally, we have over 200 high capacity servers
available for hosting our Render on Demand service and other
applications.
Sales and Marketing
Over the past three years we have made significant investments in building a
direct sales channel to service the media industry. Our initial sales and
marketing strategies were aimed at penetrating the top tier of the market, which
includes companies that influence others in the industry as they make technology
purchasing decisions. These initial efforts captured many of the leading
advertising agencies, magazine and book publishing companies, commercial
printers and pre-press firms.
Our current selling approach is based on a consultative selling model which
leverages our strategic partnerships and customer relationships. Our sales and
marketing objectives include:
o expanding workflow chains by leveraging relationships with influential
customers;
o increasing utilization of services among existing customers using a
consultative selling approach;
o capturing additional multi-site customer opportunities;
o developing new channels to sell and support our services; and
o selling and marketing to new vertical industries worldwide.
Our sales organization is structured to support vertical markets on a global
basis. We currently have sales groups in North America, Europe and Japan. Our
direct sales force includes coverage in cities such as: New York, Chicago,
Boston, Los Angeles, Washington D.C., Dallas, San Francisco, Atlanta, Seattle,
Toronto, Minneapolis, London, Amsterdam, Frankfurt, Hamburg, Oslo, Paris,
Stockholm, and Tokyo. Our sales group performs the following activities:
o Account Management: We work with our existing customers to expand
workflow chains, implement additional service offerings, coordinate
training and increase utilization. By managing our relationships with
our existing customers, we seek to capture a larger portion of their
digital workflow and increase our revenues.
o New Customer Acquisition: We identify and target new customers with
significant data transport, workflow application and storage
requirements. In particular, we focus on companies that are influential
in their media workflow chains.
o Channel Development: We develop, implement and manage strategic channel
relationships with leading suppliers to the media industry on a global
basis. We are in the process of negotiating or have entered into
marketing arrangements with the following strategic partners:
-- SGI, a leading provider of hardware and software to the film and
animation production segment of the media industry. We entered into a
joint marketing agreement with SGI whereby they sell our
10
services to their customers.
-- Sony, a leading provider of hardware and software to the post-production
and broadcast segments of the media industry. Our joint marketing
agreement with Sony designates us as its preferred third party digital
asset management outsourcing services provider in North America. Sony
has indicated they will begin marketing and promoting our services in
the second quarter of 2000.
-- Heidelberg, the world's largest manufacturer of web and sheet fed
printing presses. Our multi-year co-marketing agreement with Heidelberg
allows it to bundle our services with its own line of digital printing
presses worldwide. Heidelberg currently has a total installed customer
base of over 55,000 units globally.
-- 3M/Commercial Graphics Division, the global leader in providing total
image graphic solutions through materials, service, imaging systems, and
information management. 3M intends to bundle our data transport services
within the Scotchprint(R) Graphics Network to provide its customers the
ability to send and receive large graphic files securely and
efficiently. 3M also pays a portion of the costs of our service
contracts with their clients.
-- Sumitomo, a global trading company whose electronics division is a
provider of software, hardware and services to the media industry.
Through our joint venture, we have built a sales and marketing
organization to penetrate the Japanese market.
-- Winstar, a leading provider of fixed wireless broadband services. Under
our joint marketing agreement, Winstar, has agreed to resell our
services to its customers. Additionally, Winstar has agreed to purchase
at least $12.5 million of our services for its own use or resale.
-- Impresse, a leading provider of solutions for print job quoting.
Impresse's main service, impresse.com, is an Internet-based application
for bidding and accepting printing jobs. Under our arrangement with
Impresse, we will jointly market our e-services to corporate print
buyers and integrate impresse.com within our network. This integration
will allow impresse.com customers to route print production workflow
through our services.
-- Alias Wavefront, a leading developer and provider of computer animation
rendering software. Our joint marketing agreement with Alias Wavefront
provides that it will introduce and promote the concept of our Render on
Demand service to its customers.
Customer Service
Our services have been designed to incorporate service level agreements that
specify standard customer support service performance parameters. Under our
standard service level agreement, we deliver customer support on a 24 hour per
day, seven days per week basis through our three call centers located in Eagan,
Brussels and Tokyo. Our customer service function is organized around a
three-tier support model. Incoming calls are routed through a programmable phone
system that is integrated with sophisticated customer support management
software. This system automates call processing, automatically logging all
incoming calls and recording the specific customer support activities used to
resolve customer issues. We provide proactive customer support services geared
toward ensuring the smooth operation of our services.
In addition, we also offer Web-based customer support capabilities through
our InfoCenter hosted application. Using this service, customers can log service
requests, submit questions and access
11
application documentation on-line. We also have entered into on-site maintenance
contracts with SGI to provide support and service for the customer premise
equipment that we provide for our Direct Service customers. In connection with
our December 1999 agreement with Winstar for backbone capacity and wireless
local loop facilities, Winstar has agreed to maintain the equipment, including
replacing equipment as needed to connect with Winstar's telecommunications
network at a specified level of functionality over the twenty year term of the
agreement.
At the request of some of our subscribers, we also provide custom service
level agreements for their specialized customer support requirements. These
include provisions for redundant back-up systems including customer premise
equipment and local loop connections and special support for customized workflow
applications.
Competition
We face competition from a variety of companies that offer products or
services that compete with, or serve as alternatives to, one or more of our
service offerings. In addition, several companies have the financial resources
and technical expertise to adapt or expand their product and service offerings
to become directly competitive with our services.
Despite limitations related to the capacity and reliability of the Internet,
developments and advances in Internet technology are continually improving the
functionality of the Internet. Consequently, companies that rely on the Internet
to provide competitive services may be able to compete more effectively in the
future.
The following is a summary of the companies which may provide alternatives
to our services or currently compete with us, or which may compete with us in
the future:
o Overland and air courier service providers. The majority of our
competition comes from traditional overland and air courier services.
Federal Express, DHL Worldwide Express and United Parcel Service (UPS)
provide delivery services which are currently used by many of our
targeted customers to physically transport data files stored on disks.
While our potential customers may continue to use these services for
their data transport, we believe that our managed data transport
services offer superior alternatives for businesses with digital
workflow requirements.
o Digital courier and digital file transfer service providers. Vio
Worldwide Limited, Williams-Vyvx, a business unit of Williams
Communications, Inc., UPS and The docSpace Company each offer services
that compete to varying degrees with our managed data transport
services.
o Large telecommunications carriers and Internet oriented service
providers. Many of the large established and emerging carriers, such as
AT&T Corp., Sprint, MCI WorldCom, Cable & Wireless plc, Global Crossing
Ltd., Qwest Communications International Inc., Level 3 Communications,
Inc. and Exodus Communications, Inc., are expanding their capabilities
to support high-speed, end-to-end communications services. Increasingly,
their bundled services include high-speed local access combined with
metropolitan and wide area network services that may serve as
alternatives to our services. These telecommunications companies have
deployed large scale networks, have large numbers of existing customers
and enjoy strong brand recognition, and, as a result, may become
significant competitors.
o Data network and applications service providers. Several data networking
companies such as Equant N.V., Infonet Services Corporation, Concert
Management Services Inc. and Global One
12
offer data networking services to business customers worldwide. These
services include ATM and frame relay, private line, Internet access and
network outsourcing. These companies have significant experience in
offering tailored services and market their expertise. There are also a
number of entrants, such as IXnet, Inc., Savvis Communication
Corporation and Digital Island Inc., that are targeting specific niches
to deliver customers Internet content, data traffic, and voice services
worldwide. We believe that they may have the ability to expand their
existing networks and service offerings to become more competitive.
o Disk and tape storage equipment companies. Many established firms
currently market, sell and distribute storage equipment that is
primarily used to create on-site storage systems. These firms, including
EMC Corp., IBM, Hitachi, Sun Microsystems, Inc., Sony, Storage
Technologies, Inc. Ciprico, Inc., either have announced plans to
develop, or may in the future develop, network-based storage services
and storage area networks (SANs) that may utilize private networks or
the Internet. These services may have similarities with our planned
storage services and may include transactional, per megabyte pricing.
Government Regulation
We purchase the telephone equipment, routers and relays for use on our
network and we combine that equipment with our software and connect the assembly
with telephone circuits provided by common carriers. The common carriers are
regulated by the FCC, the Canadian Radio-Television and Telecommunications
Commission, or CRTC, and various state regulatory agencies. We believe that
under the FCC's current interpretation of the Communications Act of 1934, as
amended, the services which we offer to our customers are interstate information
(enhanced) services. Consequently, we are not required to obtain licenses or
other approvals from the FCC or state regulatory agencies to offer these
services. However, if at some time our services are deemed to be intrastate
services, certain state regulatory agencies might seek to assert jurisdiction
over our products and services. We would then be required to expend substantial
time and money to acquire the appropriate licenses and to comply with state
regulations. We also believe that under the CRTC's interpretation of Canadian
law, our services do not require us to obtain telecommunications permits or
approvals in Canada.
We believe that European Union directives permit us to provide our services
in E.U. member states without the need to obtain licenses or other governmental
approvals. Bilateral agreements exist between the U.S. and Japan and the U.S.
and Hong Kong which encourage unimpeded cross-border provision of enhanced
services like those offered by us. Pursuant to the World Trade Organization's
General Agreement on Trade and Services, over fifty governments have agreed to
permit the competitive provision of enhanced services (i.e., value-added) by
nationals of WTO member countries. Nevertheless, certain other countries in
Europe, Asia and elsewhere in the world might seek to license and regulate our
services. Any such license or regulation may limit, delay or increase our costs
to provide services in these international locations in which we may seek to
expand our operations.
In addition to telecommunication regulations, we may become subject to other
current or future regulations in the U.S. or abroad as our business continues to
develop and as governments respond to changes brought about by the growth of the
Internet and e-commerce. These regulations may affect data privacy, marketing or
distribution, or may be applicable to specific industries or businesses to which
we may offer services. Such regulations would result in economic burdens or
technical or legal constraints that could adversely affect our business.
13
Intellectual Property and Proprietary Rights
It is our policy to protect our intellectual property, to seek patent
protection for those aspects of our technology that we believe may be patentable
and to preserve any copyrights or trade secrets (to the extent not disclosed in
any patent) that may be applicable to our services and applications and their
related software.
We have designed most of the proprietary software necessary for the
management of our services and applications, including network access device
operations and a graphic user interface, Info Center, WAM!PROOF and WAM!BASE
applications. We believe that our proprietary software and trade secrets
applicable to the operation of our services and applications may be of equal or
greater importance to us than patent or copyright protection. We are not aware
of any claims of infringement of patents or other intellectual property
belonging to others. However, we have conducted only a limited inquiry regarding
the possibility of such claims. We have expanded our service and applications
offerings in foreign countries and we will increasingly offer our services and
applications in foreign countries. Some of these countries may lack intellectual
property protection that is comparable to that afforded by the intellectual
property laws of the U.S.
Liability and Insurance
Our services are supported by telecommunications equipment, software,
operating protocols and proprietary applications for high-speed transmission of
large quantities of data among multiple locations. In such operations, it is
possible that data files may be lost, altered or distorted. Moreover, our
targeted industries' businesses are extremely time-sensitive, and delays in
delivering data or damage to or loss of archival data may cause a significant
loss to a customer. Our network and related services and applications and future
enhancements or adaptations may contain undetected design faults and software
"bugs" that, despite testing, are discovered only after the system has been
installed and used by customers. Such faults or errors could cause delays or
require design modifications that could adversely affect our business, financial
condition and results of operations. Our customer agreements generally contain
provisions limiting our liability for damages resulting from errors in the
transportation or storage of data to a maximum of $100 per incident or the
amount of one year's service charge for all incidents. Nevertheless, we may
still be subject to significant claims and potential liability for data losses
in the transportation and storage of data on our network. In addition to general
business liability insurance coverage, we presently maintain errors and
omissions insurance coverage in the amount of $2 million per occurrence. We also
presently maintain $5 million of business interruption insurance coverage
against losses from fire and other natural disasters. With respect to our data
storage services, we maintain $10 million of insurance coverage against any
damage or loss of data due to physical damage to our Eagan or Las Vegas
facilities. In addition, we maintain a $25 million umbrella policy covering
losses or liabilities above our other policies.
Employees
The following table sets forth a breakdown of our employees as of December
31, 1999:
Number of
employees
---------
Development................................ 89
Marketing and sales........................ 162
Technology and operations.................. 128
Administration............................. 80
---
Total................................. 459
===
14
The Company's executive and technical personnel have significant experience
in the design, programming, implementation, marketing, sales and support of
complex data networks and software programs. We have never had a work stoppage
and no employees are represented under collective bargaining agreements. We
consider our relations with our employees to be good.
ITEM 2. PROPERTIES.
We lease an approximately 481,000 square foot modern corporate campus
located in Eagan, Minnesota, a suburb of Minneapolis. We currently occupy
160,000 square feet of this facility. SGI subleases 326,000 square feet of
space, including common areas, in our corporate campus facility. The term of the
sublease with SGI began on March 4, 1999 and ends on May 31, 2004. Effective as
of June 1, 2001 and on each June 1, 2002 and 2003, SGI has the option to
terminate the sublease by delivering at least six months' prior written notice
of termination.
We own 9,000 square feet of office space in Bournemouth, Dorset, England.
Our other leased properties include:
o an approximately 45,000 square foot office facility located in
Bloomington, Minnesota which we currently sublease;
o an approximately 1,580 square foot office facility located in
Minneapolis where one of our network operation centers is located;
o an approximately 7,970 square foot facility located in Las Vegas, where
another of our network operation centers is located and which serves as
a backup customer service center;
o an approximately 20,000 square foot office space in Brussels, which
contains our European network operation center and customer service
operations;
o an approximately 8,000 square foot manufacturing and warehouse facility
located in Eagan;
o an approximately 1,882 square foot office facility located in Missoula,
Montana;
o small offices in Des Moines, Iowa; Chicago, Illinois; Woburn,
Massachusetts; New York, New York; Hamburg, Germany; Hague, Holland;
Gothenburg, Sweden; Copenhagen, Denmark; and Paris, France for use by
our sales and marketing personnel, business development managers and
account executives stationed in those cities;
o an 18,540 square foot office facility located in Bloomington, Minnesota;
and
o a 16,000 square foot office space located in Bournemouth, Dorset,
England.
ITEM 3. LEGAL PROCEEDINGS.
Certain holders of warrants issued in connection with bridge loans in 1995
and 1996 have commenced litigation seeking a reduction in the exercise price of
those warrants and attorney's fees. Although the warrants provide for downward
adjustments under certain circumstances, we believe no adjustment is required.
Should the warrant holders' litigation be successful, the gross proceeds
receivable by us from exercise of those warrants would be reduced from
approximately $8.4 million to $4.9 million. In
15
February 2000, the court denied the plaintiffs' motion for summary judgment that
the warrant price should be reduced. The suit is scheduled to begin trial in
April 2000.
We are engaged in certain legal proceedings and claims arising in the
ordinary course of our business. The ultimate liabilities, if any, which may
result from these legal actions or claims against us cannot be determined at
this time. However, it is the opinion of management that facts known at the
present time do not indicate that there is a probability that such litigation
will have a material effect on our business, financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 17, 1999, the Company held its 1999 Annual meeting of
shareholders for the sole purpose of electing directors. At the Annual meeting,
Edward J. Driscoll, Robert L. Hoffman and William M. Kelly were elected as the
directors of the Company.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
In January 1999 and March 1999, the Company sold to MCI WorldCom for the
consideration of $10 million and $15 million, respectively, 13.25% convertible
promissory notes (the "MCI Notes") in equal principal amounts together with a
common stock purchase warrant entitling MCI WorldCom to purchase 350,000 shares
of the Company's common stock at a purchase price of $0.01 per share. The MCI
Notes provided that they would be mandatorily converted into a new class of
preferred stock having a parity of rights and preferences with any class of
preferred stock to be issued to SGI in an anticipated transaction between the
Company and SGI. Exemption from registration is claimed under Section 4(2) of
the securities Act of 1933 ("Act") and Rule 506 of the Rules ("Rules")
thereunder.
In March 1999, the Company sold to SGI 5,710,425 shares of Class B
Convertible Preferred Stock ("Class B Stock") and 878,527 shares of Class C
Convertible Preferred Stock ("Class C Stock") for an aggregate purchase price of
$75 million, of which $35 million was paid in cash and $40 million was paid by
conveyance to the Company of the land and building which comprise the Company's
corporate campus facility. Currently, the Class B Stock and the Class C Stock
are mandatorily convertible into 6,923,144 shares and 1,066,625 shares of the
Company's Common Stock, subject to anti-dilution adjustments, in the event the
Company conducts an underwritten public offering at an initial offering price of
$12.13 per share in the case of Class B and $12.52 per share in the case of
Class C. The Class B Stock may be optionally converted by the Holder at any time
and the Class C Stock may be optionally converted by the Holder after September
4, 2000 into such shares of common stock, subject to anti-dilution adjustments.
Exemption from registration is claimed under Section 4(2) of the Act and Rule
506 of the Rules.
In March 1999 the Company sold to MCI WorldCom 2,196,317 shares of Class D
Convertible Preferred Stock ("Class D Stock") for the consideration of $25
million in conversion of the MCI Notes. The Class D Stock is mandatorily
convertible into 2,666,563 shares of the Company's Common Stock, subject to
anti-dilution adjustments, in the event the Company conducts an underwritten
public offering at an initial offering price of $12.52 per share. The Class D
Stock may be optionally converted by the Holder at any time. Exemption from
registration is claimed under Sections 3(a)(9) and 4(2) of the Act and Rule 506
of the Rules.
In February 2000 the Company sold to SGI 10,000 shares of Class F
Convertible Preferred Stock ("Class F Stock") for an aggregate purchase price of
$10 million cash. The Class F Stock is convertible at the option of the holder
into 1,937,984 shares of the Company's common stock, subject to anti-dilution
adjustments, and is mandatorily convertible on the last trading day of the first
20 consecutive trading days during the average (weighted by daily trading
volume) closing price of the stock is at least $8.00. Exemption from
registration is claimed under Section 4(2) of the Act and Rule 506 of the Rules.
In February and March 2000 the Company sold to Sumitomo Corporation and
nine other accredited investors a total of 10,000 shares of Class G Convertible
Preferred Stock ("Class G Stock") for an aggregate purchase price of $10 million
cash. The Class G Stock is convertible at the option of the holder into
1,937,984 shares of the Company's common stock, subject to anti-dilution
adjustments, and is mandatorily convertible in the event of an underwritten
public offering. Exemption from registration is claimed under Section 4(2) of
the Act and Rule 506 of the Rules.
In March 2000, the Company sold to Winstar Communications Corporation
85,000 shares of the Company' of Class E Convertible Preferred Stock ("Class E
Stock") for an aggregate purchase price of $85 million, of which $35 million was
paid in cash and $50 million was paid through the transfer to us of 1,071,429
shares of Winstar's common stock, valued at $46.66 per share (as adjusted for
the 3 for 2 stock split declared by Winstar in February 2000). In
contemporaneous transactions, the Company sold to 13 accredited investors a
total of 16,725 shares of the Class E stock for an aggregate consideration of
$16.7 million. The Class E Stock is convertible at the option of the holder into
19,714,147 shares of the Company's common stock, subject to anti-dilution
adjustments, and is mandatorily convertible on the last trading day of the first
20 consecutive trading days during the average (weighted by daily trading
volume) closing price of the stock is at least $8.00. Exemption from
registration is claimed under Section 4(2) of the Act and Rule 506 of the Rules.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following tables set forth certain historical consolidated financial and
other data of our company for each of the five years in the period ended
December 31, 1999. We derived our selected historical consolidated financial
data as of and for each of the three years in the period ended December 31, 1999
from our audited consolidated financial statements included elsewhere in this
Annual Report on Form 10-K. We derived our selected historical consolidated
financial data as of and for the year ended December 31, 1995 and 1996 from our
audited consolidated financial statements that are not included in this Annual
Report on Form 10-K.
Years Ended December 31,
-------------------------------------------------------------
1995(1) 1996 1997 1998 1999
--------- --------- --------- --------- ---------
(dollars in thousands, except per share data)
Statement of Operations Data:
Revenues:
Net service revenue ................... $ 180 $ 279 $ 1,555 $ 6,799 $ 17,319
Software and hardware sales ........... -- -- -- 10,791 7,476
--------- --------- --------- --------- ---------
Total revenues .......................... 180 279 1,555 17,590 24,795
Operating expenses:
Network communication ................. 46 816 7,364 18,259 26,318
Cost of software and hardware ......... -- -- -- 3,537 2,905
Network operations and development .... 539 1,109 7,478 35,095 22,928
Selling, general and administrative ... 821 4,664 13,527 45,422 43,392
17
Depreciation and amortization ......... 31 447 2,668 17,668 34,875
--------- --------- --------- --------- ---------
Total operating expenses ................ 1,437 7,036 31,037 119,981 130,418
--------- --------- --------- --------- ---------
Loss from operations .................... (1,257) (6,757) (29,482) (102,391) (105,623)
Interest and other income (expense), net (20) (839) (4,154) (20,839) (33,604)
Income tax benefit ...................... -- -- -- 1,352 --
--------- --------- --------- --------- ---------
Net loss ................................ (1,277) (7,596) (33,636) (121,878) (139,227)
Less preferred dividends ................ -- -- (70) (70) (5,890)
--------- --------- --------- --------- ---------
Net loss applicable to common stock ..... $ (1,277) $ (7,596) $ (33,706) $(121,948) $(145,117)
========= ========= ========= ========= =========
Net loss applicable per common share(2) . $ (.24) $ (1.18) $ (5.19) $ (13.87) $ (15.58)
Weighted average number of common shares
outstanding (2) ........................ 5,263,535 6,445,785 6,496,345 8,793,961 9,315,900
Other Financial Data:
Net cash used in operating activities ... $ (747) $ (6,218) $ (23,917) $ (55,878) $ (65,670)
Net cash used in investing activities ... (657) (5,244) (15,599) (71,304) (25,942)
Net cash provided by financing activities 2,732 24,578 25,346 132,817 113,497
EBITDA(3) ............................... (1,226) (6,310) (26,814) (84,684) (69,473)
Capital expenditures .................... 657 4,244 16,599 54,584 25,208
Subscriber Contracts (end of period):
Direct Service Contracts(4) ............. -- 33 496 1,479 1,918
ISDN Tracked Service Contracts(5) ....... -- -- -- -- 2,659
Internet Gateway Subscribers(6) ......... -- -- -- -- 4,167
Years Ended December 31,
-------------------------------------------------------------
1995(1) 1996 1997 1998 1999
--------- --------- --------- --------- ---------
(dollars in thousands)
Balance Sheet Data (end of Period):
Cash and cash equivalents ........ $ 1,328 $ 14,444 $ 274 $ 6,272 $ 27,180
Total assets ..................... 2,075 20,070 29,134 125,459 435,255
Total debt(7) .................... 1,900 21,473 54,826 210,378 547,612
Shareholders' deficit ............ (371) (2,683) (30,671) (109,854) (147,885)
- ------------
(1) We were organized in September 1994 and commenced operations in March 1995.
(2) If the shares of Class B, Class C and Class D convertible preferred stock
had been converted as of their date of issuance in 1999, the net loss per
share would have been $(8.38).
(3) EBITDA represents earnings (loss) from operations before taking into
consideration net interest expense, income tax expense, depreciation expense
and amortization expense. We have included information concerning EBITDA as
it is used by some investors as a measure of a company's ability to service
its debt. EBITDA should not be considered as an alternative to net income or
any other measure of performance or liquidity as determined in accordance
with generally accepted accounting principles or as an indicator of our
overall financial performance. In addition, EBITDA as we have presented it
may not be comparable to other similarly-titled measures of other companies.
(4) Represents the number of customer point of presence at which a network
access device is installed.
18
Does not include executed contracts for installations currently in process
from which we have not begun to receive service fees.
(5) Represents the number of customer premises that subscribe to our ISDN
Tracked Service. Does not include executed contracts for installations
currently in process from which we have not begun to receive service fees.
(6) Represents the number of subscribers with accounts to use our Internet
Gateway Service.
(7) Total debt includes long-term debt, current portion of long-term debt,
obligations under capitalized leases and redeemable preferred stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis is based on the historical results of
WAM!NET Inc. and should be read in conjunction with our consolidated financial
statements and the notes thereto included elsewhere herein. The following
discussion contains forward-looking statements that reflect our plans, estimates
and beliefs. Our actual results could differ materially from those discussed in
the forward-looking statements.
Overview
WAM!NET is a leading global provider of business-to-business e-services for
the media industry. We enable entertainment, advertising, publishing, printing
and related media businesses worldwide to collaborate on-line within their
workflow chains.
We offer our customers a wide array of e-services that meet their need to
collaborate digitally with their workflow partners. Our services, applications
and infrastructure provide a common electronic workflow platform to our
customers, enabling them to achieve measurable operating efficiencies, cost
savings and productivity growth.
We have made substantial investments in building our global network, hosting
and storage infrastructure. In addition, we have developed an array of digital
workflow services to meet the needs and demands of a broad-based customer group.
We have also invested in and developed a substantial and skilled customer
service group, which makes our services more valuable to existing customers and
more attractive to potential customers. Finally, we have made substantial
investments in recruiting, training and developing a skilled and knowledgeable
sales force, operations workforce and an application development workforce. We
use a consultative approach in our sales and marketing efforts to both identify
and meet our customers' diverse needs. Our initial focus and investment has been
in building an installed base of influential customers. We seek to increase the
utilization of our service offerings among our existing customers, as well as to
broaden our market penetration through the addition of new customers.
In December 1997, we acquired Freemail Inc., a developer of file
transmission and job ticket technology, to support our business-to-business
e-services. In March 1998, we established our presence in Europe with the
acquisition of 4-Sight Limited, a developer and worldwide marketer of ISDN based
digital data transmission applications. 4-Sight had primarily sold software and
hardware supporting digital transmission of data to its customer base.
19
We offer a wide array of e-services including: (1) managed data transport,
(2) media application hosting, (3) managed data storage, (4) computer animation
rendering and (5) Internet-based services. Our services and network
infrastructure provide businesses a common electronic platform to seamlessly
integrate their production processes and accelerate the adoption of digital
workflow collaboration. Access to these services is provided through our Direct
Service, ISDN Tracked Service and Internet Gateway Service. Our initial focus
through 1998 was our Direct Service. This is our fastest, most secure and
reliable media transport service, providing direct, guaranteed access and
transport over our managed network. Our network access devices are installed on
our customers' premises and are connected to our network with a dedicated leased
line. We recently acquired a 20-year indefeasible right of use for backbone
capacities and purchased wireless local loop facilities in the U.S. from
Winstar. These facilities will allow us to offer our Direct Service customers
greater bandwidth capacity and eliminate the need for a dedicated leased line at
a customer's premises. In the first quarter of 1999 we began to provide access
to our network through our ISDN Tracked Service. Our ISDN Tracked Service offers
the security and predictability of dial-up connectivity to our network at a
slower transmission speed without the performance guarantee of Direct Service.
This service does not require a network access device or leased line
connectivity. We introduced our Internet Gateway Service in the third quarter of
1999. Internet Gateway Service allows connection to our network over the
Internet. We provide with our managed data services hosted media applications
that further integrate our services into our customers' digital workflow
processes, including Transmission Manager, Info Center, Electronic Job Tickets
and Remote Proofing. We commercially introduced our WAM!BASE Data Archiving
Service in the first quarter of 2000. Also in the first quarter of 2000, we
began to offer Render on Demand, a hosted service that processes computer
generated animation into high resolution motion images such as motion picture
special effects.
At December 31, 1999, we had over 8,700 subscribers using our
business-to-business e-services. Subscribers are customer sites that access our
electronic business-to-business services through our Direct Service, ISDN
Tracked Service and Internet Gateway Service.
Revenues
Service revenue
Our service revenue is directly related to the number of customers, type of
service, and volume of data moved, stored or processed. Service revenue is
derived primarily from annual or multi-year service contracts, many of which
have automatic renewal or extension provisions. These contracts generally
include a minimum monthly fee and additional charges for usage that exceeds a
minimum monthly service level. We currently offer our services at scaled minimum
usage fees, which typically range from $650 per month to $4,000 per month for
Direct Service, and from $45 per month to $360 per month for ISDN Tracked
Service. We record monthly service revenue for Direct Service and ISDN Tracked
Service based upon contracts signed with customers, following installation of
equipment and commencement of service at a customer's premises. Our Internet
Gateway Service is priced primarily on a per-megabyte basis and recognized as
revenue in the month the service is provided. Our Render on Demand service is
billed per computer processing hour and revenues are recognized as the service
is provided to the customer. We began to earn service revenue from ISDN Tracked
Service and Internet Gateway Service in March and September 1999, respectively.
Our WAM!BASE Archive Service is priced on the basis of megabytes stored per
month.
Software and hardware sales
Revenue from software and hardware sales has resulted primarily from the
sale of 4-Sight ISDN
20
Manager software and ISDN cards. Our ISDN Tracked Service customers may choose
to make a single up-front payment to purchase our software or to pay a monthly
service fee. In both cases these purchases appear as software and hardware
revenue. We are in the process of shifting 4-Sight from a product sales focus to
a service model. As a result, we expect software and hardware sales to decline
in the future.
Operating Expenses
Network communication
Network communication expense represents the largest direct cost associated
with providing our Direct Service. Network communication expense includes the
costs of providing local loop telephone circuits connecting our network access
devices from a customer's premises to the nearest distribution hub and the costs
of the high bandwidth backbone carrier services which connect the distribution
hubs with our network operation and data storage centers.
Local telephone circuit connections provided by local exchange carriers
account for the substantial majority of these charges. National and
international service carrier charges account for the balance of these charges.
Network communication expense is generally a fixed monthly cost per circuit. We
believe that growing competition among telephony and communications providers
may reduce the future costs of local telephone circuit and backbone connections.
We actively seek to obtain and deploy technologies that will reduce the costs of
local telephone circuit connections, such as wireless technologies, remote
dial-up capabilities and DSL. We also intend to use our network management tools
to optimize the use of existing and planned network capacity as volume increases
and traffic patterns emerge.
In December 1999, we purchased a 20-year indefeasible right of use for
backbone capacity and purchased wireless local loop facilities from Winstar.
When Winstar's wireless technology is deployed it will allow us to deliver
increased bandwidth, at speeds ranging from 1.5mb to 155mb per second, to
customers in most of the major U.S. metro areas, eliminating the need for local
telephone circuit connections. This increased bandwidth capability will also
allow us to offer additional services to new and existing customers.
Software and hardware
Software and hardware expense reflects the costs of software and hardware
sold.
Network operations and development
Network operations and development expense represents costs directly
associated with developing, maintaining, managing and servicing our global
private network and expanding our service offerings. These costs include direct
labor, vendor service fees, point-of-presence charges and research and
development charges, which are often incurred in advance of receiving revenue.
Our currently installed network operation centers account for the substantial
majority of these direct labor and operating costs. Most of the costs associated
with the development of new services and applications, such as WAM!BASE Data
Archiving Service, WAM!PROOF, ISDN Tracked Service, Internet Gateway Service and
Render on Demand service, are accounted for as network operations expenses and
are incurred in advance of receiving revenue.
Selling, general and administrative
Our selling expense consists primarily of the salaries and commissions of
our direct sales force and
21
our global marketing groups, commissions for channel partners, and the costs of
ongoing marketing activities such as promotions and channel development. Our
sales and marketing efforts are focused on expanding our customer base and
increasing utilization on our network. Accordingly we offer new and existing
services and develop new channels to sell and support our services. We also seek
to increase the utilization of our network with the assistance of our
influential customers who encourage their workflow partners to use our services.
Our general and administrative expense includes administrative salaries,
related overhead and professional service fees. These costs reflect expenditures
related to the rapid growth and expansion of our administrative infrastructure
necessary to manage our globally expanding operations, and professional service
fees incurred in connection with financing activities, contract negotiations and
business acquisitions.
Depreciation and amortization
We generally retain ownership of the customer premise equipment and most of
the hardware and software necessary for our customers to use our services on a
turn-key basis. Depreciation and amortization expense includes depreciation of
this hardware and software as well as the equipment located in our distribution
hubs and network operation, hosting and data storage centers. We also amortize
certain costs relating to the acquisitions of 4-Sight and Freemail, which we
acquired using the purchase method of accounting. We anticipate additional
capital investments in our network, hosting and storage infrastructure
commensurate with customer demand and market opportunity.
Results of Operations
Years Ended December 31, 1999, 1998 and 1997
Revenues
Total revenue for the years ended December 31, 1999, 1998 and 1997, was
$24.8 million, $17.6 million and $1.6 million. These were increases in revenues
are due to greater demand for our services and, in 1998, also due to the
acquisition of 4-Sight.
Net service revenue was $17.3 million, $6.8 million and $1.6 million for the
years ended December 31, 1999, 1998 and 1997. This increase in net service
revenue was primarily due to growth in the number of subscribers purchasing our
services and increased utilization by subscribers. At December 31, 1999, we were
providing transport services to approximately 8,700 subscribers, as compared to
approximately 1,475 and 475 subscribers, at December 31, 1998 and 1997.
Revenues from software and hardware sales for the years ended December 31,
1999 and 1998, were $7.5 million and $10.8 million. There was no revenue from
software and hardware sales in 1997, as 4-Sight was not acquired until March
1998. The decrease in software and hardware sales in 1999, as compared to 1998,
is the direct result of our shifting from sales of 4-Sight software and hardware
as stand-alone products to sales of service contracts, partially offset by
software purchases associated with ISDN Tracked Service agreements.
22
Operating Expenses
Network communication
Network communication expense for the years ended December 31, 1999, 1998
and 1997, was $26.3 million, $18.3 million and $7.4 million. Network
communication expenses increased as a result of increased local loop connections
directly related to growth in the number of our Direct Service customers, and
from expenses incurred as a result of expanding our domestic and foreign network
operations through the installation of additional hubs. Average monthly
communication expense per Direct Service customer has declined and is expected
to continue to decline, as a result of increased customer utilization of our
backbone capacity and declining costs of North American local loop connections.
These trends were partially offset by growth in our Direct Service customer base
in Europe, where local loop costs are generally higher than in North America. We
continue to incur substantial network communication expense as we deploy our
network and related services and applications globally; however, we expect the
network communications expense as a percentage of revenue to decline.
Software and hardware
The cost of software and hardware for the years ended December 31, 1999 and
1998 was $2.9 million and $3.5 million. There were no software and hardware
sales or costs during 1997. This decrease between 1999 and 1998 reflects the
decline in software and hardware sales as described above.
Network operations and development
Network operations and development expense for the years ended December 31,
1999, 1998 and 1997, was $22.9 million, $35.1 million and $7.5 million. The
decrease between 1999 and 1998 was primarily due to completion of several
development projects, including ISDN Tracked Service, Internet Gateway Service
and WAM!BASE Data Archiving Service and the discontinuance of related outsourced
development costs, partially offset by costs incurred for establishing our
network operations center in Belgium and deploying our network in Europe. The
growth in these expenses from 1997 to 1998 was due to the 4-Sight acquisition
and the expansion of our operations. We expect that network operations costs
will increase as our network expands; however, the cost of network operations as
a percentage of revenue is expected to decline.
Selling, general and administrative
Selling, general and administrative expense for the years ended December 31,
1999, 1998 and 1997, was $43.4 million, $45.4 million and $13.5 million. The
decrease between 1999 and 1998 was due to a one-time $11.4 million non-cash
compensation charge related to the accelerated vesting of stock options held by
certain of our officers that occurred in the period ended December 31, 1998.
This decrease was partially offset by increases in other selling, general and
administrative expenses associated with expanded operations during 1999. After
adjusting for the one-time charge during 1998, recurring selling, general and
administrative expense during the year ended December 31, 1999 increased $9.4
million, over the comparable adjusted amount for the year ended December 31,
1998. The increase was primarily due to sales and marketing efforts to launch
new services and expand our customer base. The growth in these expenses from
1997 to 1998 was due to the 4-Sight acquisition and the expansion of our
operations. We expect to continue to incur significant selling, general and
administrative expenses as we continue to increase market penetration and
traffic among existing customers. We expect selling, general and administrative
expenses will continue to decline as a percentage of revenue.
Depreciation and amortization
Depreciation and amortization for the years ended December 31, 1999, 1998
and 1997, was $34.9 million, $17.7 million and $2.7 million. This increase was
primarily due to depreciation of additional
23
network and related equipment purchased for network expansion during 1999, 1998
and 1997. Included in these totals for 1999 and 1998 was $6.6 million and $5.3
million of amortization expense relating to the goodwill recorded in connection
with the 4-Sight and Freemail acquisitions. We anticipate that depreciation and
amortization expense will increase in future periods as we continue to purchase
equipment and expand operations, and as we begin to depreciate the wireless
network facilities purchased from Winstar.
Interest income
Interest income for the years ended December 31, 1999, 1998 and 1997, was
$0.8 million, $1.7 million and $0.2 million. The changes between 1999, 1998, and
1997 were primarily due to the changes in our average monthly balance of cash
and cash equivalents during the periods.
Interest expense
Interest expense for the years ended December 31, 1999, 1998 and 1997, was
$35.7 million, $22.6 million and $4.4 million. The increase during each of the
years is related to the increase in long-term debt necessary to fund operations
and to make strategic acquisitions. Included in interest expense for the years
ended December 31, 1999, 1998 and 1997, are non-cash charges of $29.1 million,
$18.3 million and $1.6 million related to the amortization of deferred financing
charges and the value of warrants issued in connection with debt financing
transactions.
Other income
Other income of $1.3 million in 1999 primarily relates to rental income
received from SGI in connection with leasing a portion of the corporate campus
facility in Eagan which we received as part of an investment by SGI in March
1999.
Income taxes and net loss
At December 31, 1999, we had $195.5 million of net operating loss
carryforwards. These carryforwards are available to offset future taxable income
through the year 2019 and are subject to the limitations of Section 382 of the
Internal Revenue Code of 1986. These limitations may result in the expiration of
net operating loss carryforwards before they can be utilized. We realized an
income tax benefit of $1.4 million as a result of U.K. income tax and VAT
benefits in the year ended December 31, 1998.
Liquidity and Capital Resources
Since inception, we have incurred net losses and experienced negative cash
flow from operating activities. Net losses since inception have resulted in an
accumulated deficit of $303.6 million as of December 31, 1999. We expect to
continue to operate at a net loss and experience negative cash flow from
operating activities for the foreseeable future. Through December 31, 1999, we
have issued equity and debt securities and incurred other borrowings resulting
in cash received by us of $361.4 million. We have used the majority of these
proceeds to expand our global network, to build our customer base and for
geographic expansion. In addition, we expanded our operations in Europe through
the acquisition of 4-Sight for $16.4 million in cash and the issuance of equity
securities. Our ability to achieve profitability and positive cash flow from
operations will be dependent on substantially growing our revenues and realizing
increased operating efficiencies.
24
In 1999, we entered into the following financing transactions in order to
continue to fund our operating and capital requirements:
In January 1999, we issued the 1999 MCI WorldCom Convertible Note and in
January 1999, and March 1999, we borrowed $10.0 million and $15.0 million,
respectively, under the note. In March 1999, the note was converted into
2,196,317 shares of our Class D convertible preferred stock. Dividends
accumulate on the Class D convertible preferred stock at the rate of 7% per year
of the original purchase price per share and are payable solely in additional
shares of preferred stock, of the same class, if and when declared by the Board
of Directors. The Class D convertible preferred stock (including accumulated but
undeclared in-kind dividends) is currently convertible into 2,666,563 shares of
common stock, subject to anti-dilution provisions. In connection with the note,
we issued warrants to purchase a total of 350,000 shares of common stock. The
warrants have an exercise price of $.01 and are exercisable until April 30,
2004.
In March 1999, SGI purchased from us 5,710,425 shares of our Class B
convertible preferred stock and 878,527 shares of our Class C convertible
preferred stock. The aggregate consideration paid by SGI was $75.0 million, of
which $35.0 million was paid in cash and $40.0 million was paid by the transfer
to us of a corporate campus facility located in Eagan, Minnesota. The fair value
of the campus facility was determined by an independent appraisal. The Class B
convertible preferred stock and Class C convertible preferred stock are
currently convertible into 6,923,144 shares and 1,066,625 shares of common
stock, of the same class, subject to anti-dilution provisions. Dividends
accumulate on the Class B and Class C convertible preferred stock at the rate of
7% per year of the original purchase price and are payable solely in additional
shares of convertible preferred stock of the same class, if and when declared by
the Board of Directors.
In connection with the SGI investment, we entered into a preferred provider
agreement that allows us to purchase hardware, software and services from SGI
over a four-year period at prices based on SGI's most favored pricing models. We
have made a firm commitment to purchase $35.0 million under this agreement
during the period from December 31, 1998 to December 31, 2000. As of December
31, 1999, we have made purchases of approximately $12.4 million. In the event
that we do not fulfill this purchase commitment, we are required to pay SGI 10%
of the unfulfilled commitment.
In July 1999, we entered into a two-year $20.0 million credit facility with
Foothill Capital Corporation. As of December 31, 1999, we had $2.1 million in
borrowings outstanding under this facility. This balance was repaid in March
2000.
In September 1999, we entered into a sale-leaseback agreement with
CCPRE-Eagan, LLC, an affiliate of Chase Capital Partners, New York. In
connection with this agreement, we sold our corporate facilities, including
land, building and personal property to CCPRE and received cash proceeds of
approximately $36.5 million, net of financing expenses. As part of the
agreement, we entered into a 20-year lease with three five-year options,
requiring minimum monthly rent payments increasing from $481,000 to $959,000. We
are responsible for all taxes, assessments, utilities and other governmental
charges. We may repurchase the corporate facilities on the 24th or 36th month
anniversary of the agreement. Beginning in September 2002, CCPRE may require us
to repurchase the facilities for approximately $41.8 million, less the amount of
certain payments under the lease. Because of the existence of this put option,
the transaction has been recorded as a financing transaction. The carrying value
of the liability is being accreted to the $41.8 million put value, at an
effective interest rate of 18.9%. As of December 31, 1999, the accreted
outstanding balance of the sale-leaseback agreement was approximately $38.2
million.
In December, 1999, we entered into an agreement with Winstar pursuant to
which we purchased a 20-year indefeasible right of use for backbone capacity and
purchased wireless local loop facilities. Under
25
this agreement, we took title to equipment of varying bandwidth capacity;
Winstar has agreed to maintain the equipment, including replacement as necessary
for connectivity to Winstar's telecommunications network at a specified level of
functionality over the agreement's term. We have the right to assign or sell our
rights under the facility at any time. The cost of the 20-year facility is
payable in an initial $20.0 million payment, which was made in January 2000, and
quarterly payments, beginning at $5.0 million and increasing to approximately
$24.9 million, over a seven-year period ending December 15, 2006. The network
facility has been capitalized in property, plant and equipment, and we have
recorded a related liability at the agreed-upon fair value of $260.3 million,
which liability bears an effective interest rate of 8.3%.
Under related agreements, Winstar has committed to purchase from us $12.5
million of services, which Winstar can use itself or resell to third parties.
Winstar's commitment was prepaid in December 1999, this prepayment has been
recorded as deferred revenue. We have also entered into a sublease agreement
with Winstar for space in our Minnesota data center. In December 1999, Winstar
made a one-time advance payment of approximately $12.5 million. We are required
to repay this advance payment at $200,000 per month over 10 years, at an imputed
interest rate of 15.7%. We have recorded the advance payment as a borrowing.
Winstar is required to make monthly payments of approximately $81,000 over 10
years.
Also in December 1999, we entered into a transaction providing for the
purchase by Winstar of 50,000 shares of our Class E convertible preferred stock
and an option for Winstar, its designated affiliates and others, to purchase an
additional 50,000 shares of the same class of stock. Pursuant to the terms of
this transaction, Winstar purchased a total of 85,000 shares of Class E
convertible preferred stock for $85 million, of which $35 million was paid in
cash and $50 million was paid in the form of 1,071,429 shares of Winstar common
stock valued at $46.66 per share as adjusted for the Winstar 3-for-2 stock split
declared in February 2000. Also in this transaction, other investors purchased
16,725 shares of Class E convertible preferred stock for an aggregate $16.7
million in cash. The Class E convertible preferred stock accumulates dividends
at an annual rate of 7%, which are added monthly to the accreted liquidation
value of the stock. Each of the two largest purchasers of Class E convertible
preferred stock has the right to designate one director, and vote on an as-
converted basis, not to exceed 17.5% of total voting power, on all matters
submitted to the vote of common stock holders, including the election of
directors. The Class E convertible preferred stock is initially convertible into
19,714,147 shares of common stock at an initial conversion rate of $5.16 per
share, subject to anti-dilution provisions. Holders of Class E convertible
preferred shares may convert their shares into common stock at any time, and are
required to convert their shares into common stock on the last trading day of
the first 20 consecutive trading days during which the weighted average closing
price (weighted by daily trading volume) of the common stock is at least $8.00
per share.
In February 2000, SGI purchased 10,000 shares of our Class F convertible
preferred stock from us for $10 million in cash. The rights and preferences of
the Class F convertible preferred stock, including its conversion provisions,
are substantially the same as the rights and preferences of our Class E
convertible preferred stock, except that the holders of Class F convertible
preferred stock do not have the right to separately elect directors and there is
no cap on the voting power of that class. The Class F convertible preferred
stock is initially convertible into a total of 1,937,984 shares of common stock
at an initial conversion rate of $5.16 per share, subject to anti-dilution
provisions.
In February and March 2000, we sold to Sumitomo and other investors 10,000
shares of our Class G convertible preferred stock for $10 million in cash.
Holders of Class G convertible preferred stock have the right to vote, on an
as-converted basis, with holders of common stock on all matters submitted to a
vote of stockholders. The Class G convertible preferred stock is initially
convertible into 1,937,984
26
shares of common stock at an initial conversion rate of $5.16 per share, subject
to anti-dilution provisions. The shares of Class G convertible preferred stock
will mandatorily convert into shares of common stock upon completion of an
initial public offering.
We believe the capital resources obtained from the foregoing transactions,
together with our cash on hand will be sufficient to fund our business plan for
at least the next 12 months.
Impact of Year 2000
In prior years, we developed and implemented plans to become Year 2000
ready. In late 1999, we completed our remediation and testing of systems. As a
result of those implementation efforts, we experienced no significant
disruptions in critical information technology and non-information technology
systems and believe those systems successfully responded to the Year 2000 date
change. Expenses resulting from our Year 2000 efforts were not material. We are
not aware of any material problems resulting from Year 2000 issues, either with
our services, our internal systems, or the products and services of third
parties. We will continue to monitor our critical computer applications and
those of our suppliers and vendors throughout the year 2000 to ensure that any
latent Year 2000 matters that may arise are addressed promptly.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Exchange Rates
During the year ended December 31, 1999, our revenue originating outside the
U.S. was 35.7% of total revenue, substantially all of which was denominated in
the local functional currency. Currently, we do not employ currency hedging
strategies to reduce the risks associated with the fluctuation of foreign
currency exchange rates.
Our international business is subject to risks typical of an international
business, including, but not limited to: differing economic conditions, changes
in political climate, differing tax structures, other regulations and
restrictions, and foreign exchange rate volatility. Accordingly, our future
results could be materially adversely impacted by changes in these or other
factors.
Interest Rates
We invest cash in a variety of financial instruments, including bank time
deposits and fixed rate obligations of governmental entities and agencies. These
investments are denominated in U.S. dollars. Cash balances in foreign currencies
overseas are operating balances and are invested in short-term deposits of the
local operating bank.
Investments in fixed rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted due to a rise in interest rates. Due in part to these
factors, our future investment income may fall short of expectations due to
changes in interest rates, or we may suffer losses in principal if we sell
securities that have seen a decline in market value due to changes in interest
rates. Our investment securities are held for purposes other than trading.
We are exposed to market risk from changes in the interest rates on certain
of our outstanding debt. The outstanding loan balance under our $25 million
revolving credit facility bears interest at a variable rate based on prevailing
short-term interest rates in the U.S. and Europe. Based on the average
outstanding bank debt for the year ended December 31, 1999, a 100 basis point
change in interest rates would not change interest expense by a material amount.
For fixed rate debt such as our 13.25% senior discount notes, interest rate
changes affect its fair market value, but do not impact earnings or cash flows.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
An index to the financial statements and the required financial
statement schedules is set forth in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth, as of February 29, 2000, the names, ages and
positions of our executive officers and directors. Their respective backgrounds
are described below.
Name Age Position
---- --- --------
Edward J. Driscoll... 39 Chairman of the Board and Chief Executive
Officer
Gary L. Hokkanen..... 53 President
Terri F. Zimmerman... 36 Chief Financial Officer
Allen L. Witters..... 40 Chief Technology Officer
Denice Y. Gibson..... 44 Senior Vice President of Global Operations
Lisa A. Gray......... 44 Corporate General Counsel
William E. Sullivan.. 51 Senior Vice President of Global Marketing
Patrick J. Dirk...... 60 Director
Robert L. Hoffman.... 71 Director
William M. Kelly..... 46 Director
Edward J. Driscoll is one of our founders and a principal shareholder. He
has served as our Chairman of the Board and Chief Executive Officer since
inception and was President from our inception until May 1999. Previously, Mr.
Driscoll was the principal shareholder, Chief Executive Officer, and a director
of Cybernet Systems, Inc. Mr. Driscoll founded Cybernet in 1991 to provide
network integration services to the pre-press industry. Prior to founding
Cybernet, he held various marketing and management positions, most recently as
general manager of Roland Marketing, Inc. He holds a Bachelor of Arts degree in
economics from St. John's University, Minnesota and a Master of Business
Administration degree from the University of St. Thomas. Mr. Driscoll currently
serves on the Board of Directors of the Science Museum of Minnesota and on the
Advisory Board for the Center for Graphic Communications Management and
Technology of New York University.
Gary L. Hokkanen has served as our President since May 1999. From 1983 until
joining our company, he served in executive positions in printing,
communications, data and electronics businesses. From 1997 until he joined
WAM!NET, Mr. Hokkanen was Chief Executive Officer of The Miner Group, a
diversified printing/print technology company. From 1994 to 1997, he served as
President and CEO of World Satellite Network, Inc., a satellite communications
company. Prior to that, he was President and CEO of Apollo Communications, Inc.,
a regional data communications company. For more than 5 years before joining our
company he served as President of Cynergi Group, a firm providing senior
management consulting services. Mr. Hokkanen currently serves on the Board of
Directors of the Miner Group International Super Solutions Corporation, and
Grafix, Inc.
Terri F. Zimmerman has served as our Chief Financial Officer since August
1999. From June 1994 to July 1999 she served in various financial management
capacities for Great Plains Software Inc. including the positions of Vice
President of Finance and Operations, Director of Finance, and Chief Financial
Officer. She was previously employed by Deloitte & Touche LLP in Minneapolis as
a Senior Manager. Ms. Zimmerman holds a B.A. from the University of North
Dakota. Ms. Zimmerman is a certified public accountant.
Allen L. Witters is one of our founders and a principal shareholder. He has
served as our Chief
29
Technology Officer since inception. He is principally responsible for designing
and implementing our service architecture. Mr. Witters has been engaged in
technical consulting to the computer industry since 1975, including serving as a
technical consultant from 1992 to 1996 for Cybernet, and has broad experience in
the invention, design, engineering and implementation of software, networks, and
network management systems. From 1987 to 1992, Mr. Witters was the Chief
Executive Officer and a principal shareholder of Datamap, Inc., a company that
was engaged in the development and sale of GIS (geographic information systems)
software.
Denice Y. Gibson has served as our Senior Vice President of Global
Operations since July 1999. From October 1997 until joining our company in July
1999, Ms. Gibson served as Senior Vice President and General Manager of the
Strategic Software Organization of SGI. From May 1995 until October 1997 she
served as Senior Vice President and General Manager of Novell, Inc., a leading
provider of network software enabled by directory services. Prior to Novell, Ms.
Gibson held senior management positions with Tandem Telecommunications, Candle
Corporation and Amdahl Corporation. She holds multiple degrees in psychology and
engineering, including a doctorate in engineering management. Ms. Gibson has
over 25 years experience in the computer industry.
Lisa A. Gray has served as our Corporate General Counsel since December
1998. For more than 5 years prior to joining our company, Ms. Gray was a partner
at the law firm of Larkin, Hoffman, Daly & Lindgren, Ltd.
William E. Sullivan became our Senior Vice President of Global Marketing in
March 2000. From February 1998 until joining our company, he served as President
and Chief Executive Officer of PR 21, a marketing/PR firm and a subsidiary of
Daniel J. Edelman, Inc. Prior to this he was Chief Marketing Officer for
Imation, a $2.3 billion data storage and imaging company that was spun-off from
3M. Dating back to 1979 Mr. Sullivan has had various marketing positions with 3M
and his own consulting firm.
Patrick J. Dirk has served as a director since February 2000. Mr. Dirk has
been the Chairman of the Board, President and Chief Executive Officer of Troy
Group, Inc. since he co-founded the company in May 1982. From March 1984 to
present, Mr. Dirk has served as a Director of Eltrax Systems, Inc., a provider
of managed network services, which he co-founded in March 1984, and served as
its Chairman of the Board from February 1995 until August 1995. From 1973 until
1982, Mr. Dirk was employed in various capacities by Kroy, Inc., a corporation
involved in manufacturing automated lettering machines and related products,
serving most recently as President and as a member of its Board of Directors.
Mr. Dirk also serves as a member of the board of directors and advisory boards
of several private companies.
Robert L. Hoffman has served as a director since October 1995. Mr. Hoffman
is a founder and recently retired shareholder of the law firm of Larkin,
Hoffman, Daly & Lindgren, Ltd., where he practiced law from 1958 to 1999, and
was its Chairman and President. He has been extensively involved in land use and
development for the past 35 years as both an attorney and in various elected and
appointed offices, including 14 years as a member of the Bloomington City
Council, seven years as a member of the Metropolitan Council, a land use law
instructor at Hamline University School of Law, a member of the Urban Land
Institute Development Policies and Regulations Council and a member of the Land
Use Advisory Group for the Public Technologies Institute of Washington, D.C.
William M. Kelly has served as a director since March 1999, originally as
the designee of SGI, the holder of our Class B convertible preferred stock. He
is a partner in the global technology group of the law firm of Davis Polk &
Wardwell, and is based in Menlo Park, California. From 1994 through December
1999, Mr. Kelly held several executive positions at SGI, including at various
times General
30
Counsel, Vice President of Business Development, acting Chief Financial Officer
and head of the Silicon Interactive software business unit. His most recent
position at SGI was as Senior Vice President of Corporate Operations. Mr. Kelly
received his Bachelor of Arts and law degrees from Columbia University. He is
also a director of MIPS Technologies, Inc.
ITEM 11. EXECUTIVE COMPENSATION.
The following table summarizes all compensation paid to our Chief Executive
Officer and to each of our four other most highly compensated executive officers
for each of the years ended December 31, 1999, 1998 and 1997.
Summary Compensation Table
Long-Term
Annual Compensation Compensation Awards
----------------------------------------- -------------------
Securities
Underlying
Name and Principal Position Year Salary Bonus Options(#)
- --------------------------------- ---------- ------------ --------- -------------------
Edward J. Driscoll............... 1999 $ 195,000 $ 87,126 500,000
Chairman of the Board and Chief 1998 195,000 -- 750,000
Executive Officer 1997 150,000 75,000 --
Gary L. Hokkanen................. 1999 $ 183,333(1) $ 122,870 2,250,000
President 1998 -- -- --
1997 -- -- --
Terri F. Zimmerman............... 1999 $ 75,769(2) $ 29,622 1,600,000
Chief Financial Officer 1998 -- -- --
1997 -- -- --
Allen L. Witters................. 1999 $ 195,000 $ 76,236 500,000
Chief Technology Officer 1998 195,000 -- 750,000
1997 150,000 75,000 --
Denice Y. Gibson................. 1999 $ 97,820(3) $ 38,242 1,200,000
Senior Vice President of Global 1998 -- -- --
Operations 1997 -- -- --
- ------------
(1) Mr. Hokkanen's employment began in April 1999.
(2) Ms. Zimmerman's employment began in August 1999.
(3) Ms. Gibson's employment began in July 1999.
The following table sets forth information with respect to stock options
granted to the Chief Executive Officer and to each of our four other most highly
compensated executive officers during the fiscal year ended December 31, 1999.
For the fiscal year ended December 31, 1999, we did not grant any stock
appreciation rights to these executives nor did we grant them any stock options
at an option price below market value on the date of the grant, as determined by
our Board of Directors.
31
Stock Option Grants in Last Fiscal Year
Individual Grants
-------------------------------------------------------------
% of Total Potential Realizable Value
Number of Options at Assumed Annual Rates
Securities Granted to Exercise of Stock Price Appreciation
Underlying Employees or Base for Option Term(3)
Options in Fiscal Price ---------------------------
Name Granted Year ($/Sh) Expiration Date 5% 10%
- ------------------- ----------- ------------ ------------ ------------------ ----------- -----------
Edward J. Driscoll. 500,000(1) 6% $ 2.00 December 30, 2009 $ 628,895 $1,593,742
Gary L. Hokkanen... 750,000(2) 9% 2.00 November 7, 2009 943,342 2,390,614
1,500,000(1) 19% 2.00 December 30, 2009 1,886,684 4,781,227
Terri F. Zimmerman 600,000(2) 7% 2.00 November 7, 2009 754,674 1,912,491
1,000,000(1) 12% 2.00 December 30, 2009 1,257,789 3,187,485
Allen L. Witters... 500,000(1) 6% 2.00 December 30, 2009 628,895 1,593,742
Denice Y. Gibson... 600,000(2) 7% 2.00 November 7, 2009 754,674 1,912,491
600,000(1) 7% 2.00 December 30, 2009 754,674 1,912,491
- ------------
(1) These options vest monthly, over 48 months.
(2) These options vest annually, over 3 years.
(3) The potential realizable dollar value of an option grant is the product of
(a) the difference between (1) the product of the per-share market price at
the time of the grant (which we determined was $2.00 on November 2, 1999,
which was the price per share attributable to the common stock in the
immediately preceding arm's length transaction with an independent third
party) and the sum of 1 plus the adjusted stock price appreciation rate and
(2) the per-share exercise price of the option, and (b) the number of
securities underlying the grant at fiscal year-end.
The following table sets forth information with respect to the value of
unexercised stock options held by the Chief Executive Officer and each of the
four other most highly compensated executive officers as of December 31, 1999.
None of the persons listed in the table below exercised any stock options during
1999.
Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Fiscal Year-End at Fiscal Year-End(1)
--------------------------- --------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------- ----------- ------------- ----------- -------------
Edward J. Driscoll... 2,750,000 500,000 $2,080,000 $ --
Gary L. Hokkanen..... 250,000 2,000,000 -- --
Allen L. Witters..... 2,750,000 500,000 2,080,000 --
Terri F. Zimmerman... 200,000 1,400,000 -- --
Denice Y. Gibson..... 200,000 1,000,000 -- --
- ------------
(1) Amount based on the fair market value of our common stock on December 31,
1999, as determined by our Board of Directors, less the exercise price
payable under the options.
32
Directors' Compensation
We do not pay annual compensation to our directors. Each director is
reimbursed for reasonable out-of-pocket expenses incurred in connection with
attendance at meetings of the Board of Directors. In January 1996, we granted
Mr. Hoffman 75,000 stock options at an exercise price of $0.96 per share, which
options expire November 30, 2005, all of which were vested and exercisable as of
December 31, 1999. In December 1999, we granted Mr. Hoffman an additional 75,000
stock options at an exercise price of $2.00 per share, which options expire
December 31, 2009, all of which were vested and exercisable as of December 31,
1999. In December 1999, we granted Mr. Kelly 75,000 stock options at an exercise
price of $2.00 per share vesting monthly over 12 months and expiring December
31, 2009.
Board Committees
Our board of directors has a compensation committee and an audit committee.
The members of the compensation committee are Messrs. Kelly and Hoffman. The
compensation committee is responsible for determining the salaries and incentive
compensation of our management and key employees and administering our stock
option plan.
The members of the audit committee are Messrs. Kelly, Hoffman and Dirk. The
responsibilities of the audit committee include:
o recommending to our board of directors an independent audit firm to
audit our financial statements and to perform services related to the
audit;
o reviewing the scope and results of our audits with our independent
auditors;
o considering the adequacy of our internal accounting control procedures;
and
o considering auditors' independence.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee is or has ever been an officer or
employee of ours or an officer or employee of any of our subsidiaries. During
1998, none of our executive officers served on the compensation committee or as
a director of another entity whose executive officers served on our compensation
committee or Board of Directors. From inception, certain legal services have
been provided to us by Larkin, Hoffman, Daly & Lindgren, Ltd. Robert L. Hoffman,
a member of the compensation committee, was a shareholder of Larkin, Hoffman,
Daly & Lindgren, Ltd. until 1999. See "Certain Transactions -- Other
Agreements."
Employment Agreements
We have entered into employment agreements with Edward J. Driscoll, Gary L.
Hokkanen, Terri F. Zimmerman, Allen L. Witters, Denice Y. Gibson and Lisa A.
Gray. These agreements are for one-year terms that automatically renew unless
the employee's employment is terminated earlier in accordance with the terms
summarized below. The salary to be received by each executive is the base salary
in effect as of January 1, 2000, which is to be reviewed periodically at
intervals of not more than twelve (12)
33
months in accordance with our salary review policies. Each executive is eligible
to participate in an executive bonus plan as approved by the Board of Directors
on an annual basis and eligible to participate in all benefit programs we offer.
Each of the employment agreements may be terminated by us for cause or by
the respective executive without further obligation on the part of either party.
If any of the executives were terminated without cause, then the executive
would be entitled to:
o base salary through his or her next contract renewal date and any bonus
to which he or she would have been entitled had he or she remained in
our employ through his or her next annual renewal date;
o a severance cash payment equal to two (2) times the executive's then
annual base salary;
o coverage under our health and major medical plans for a period of 18
months after termination; and
o acceleration of any of the executive's unvested stock options.
In the event of a change of control, each executive would have rights
similar to those to which they are entitled if they are terminated for cause.
Each executive is subject to a two-year non-compete agreement after they
leave our employ, except under circumstances where we terminate them without
cause or following a change of control.
Stock Option Plans
The Board of Directors adopted the 1994 stock option plan in September 1994,
and our shareholders approved it in October 1994. The 1994 stock option plan has
been subsequently amended, most recently on April 24, 1998, in conjunction with
the adoption of the 1998 combined stock option plan, to reflect our name change
to WAM!NET Inc., to incorporate prior amendments to the 1994 stock option plan
and to limit the number of shares of common stock available for issuance under
the amended 1994 stock option plan to 7,000,000. The Board of Directors adopted
the 1998 combined stock option plan and the amendments to the 1994 stock option
plan on April 24, 1998, and our shareholders approved the plans on May 30, 1998.
Each stock option plan is currently administered by the Board of Directors.
Our plans provide for the grant of stock options which qualify as "incentive
stock options" under Section 422 of the Federal Tax Code, as well as the grant
of stock options which are "nonqualified options." Under each plan, the Board of
Directors or, if the Board of Directors appoints one, a stock option committee,
has complete discretion to select the grantees and to establish the terms and
conditions of each option, subject in all cases to the applicable provisions of
the plan and the Federal Tax Code. Options granted under a plan are not
transferable and are subject to various other conditions and restrictions.
Participation in the amended 1994 stock option plan is limited to (i) our
officers and regular full-time executive, administrative, professional,
production and technical employees who are salaried employees and (ii)
consultants and non-employee directors. Participation in the combined 1998 stock
option plan is limited to our employees and to non-employee directors and
non-employee consultants. The 1998 combined stock option plan permits the grant
of options to eligible employees who are foreign nationals on such terms and
conditions different from those specified in the 1998 stock option plan as may,
in the judgment of the Board or the stock option committee, be necessary or
desirable to foster and promote achievement of the purposes of the 1998 stock
option plan, and, in furtherance of such purposes,
34
the Board or such committee may make such addenda, modifications, amendments,
procedures and subplans as may be necessary or advisable to comply with
provisions of applicable laws in other countries in which we operate or have
employees. An addendum to the 1998 combined stock option plan extends the
benefits of stock options granted under the 1998 combined stock option plan to
our employees or those of our subsidiaries who are residents of the United
Kingdom.
A total of 7,000,000 shares of common stock have been reserved for issuance
upon the exercise of options granted under the amended 1994 stock option plan
and a total of 25,000,000 shares of common stock have been reserved for issuance
upon the exercise of options granted under the 1998 combined stock option plan,
subject to adjustment for stock splits or recapitalizations. Shares subject to
cancelled, unexercised, lapsed or terminated options are available for
subsequently granted options under a plan. Upon exercise of an option, payment
of the exercise price in cash is required, or, at the Board of Directors'
discretion, by the delivery of shares of common stock already owned by the
optionee or a promissory note for all or a portion of the exercise price of the
shares so purchased or a combination of the foregoing. There is no express
limitation on the duration of a plan; however, incentive stock options may not
be granted after the date that is ten years from the date of shareholder
approval of a plan. The Board of Directors may terminate either plan and,
subject to certain limitations, may amend either plan at any time without
shareholder approval. As of December 31, 1999, there were 6,797,022 options
issued and outstanding under the amended 1994 stock option plan at exercise
prices ranging from $0.45 to $8.00 per share. As of December 31, 1999, there
were 8,183,617 options issued and outstanding under the 1998 combined stock
option plan, at exercise prices ranging from $2.00 to $8.00 per share.
In addition to options granted under the plans, we have also granted certain
officers and consultants options to purchase a total of 5,465,000 shares of
common stock at exercise prices ranging from $0.45 to $3.90 per share.
35
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information as of March 1, 2000, with
respect to the beneficial ownership of our common stock by:
o each person known by us to own beneficially more than five percent of
the outstanding shares of our common stock,
o our directors and our executive officers named in the Summary
Compensation Table under "Management -- Executive Compensation," and
o all directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, based on factors including voting and
investment power with respect to shares. Shares of common stock subject to
options, warrants and convertible securities that are exercisable or convertible
within 60 days of March 1, 2000, are deemed outstanding for the purpose of
computing the percentage ownership of the person holding such options, warrants
or convertible securities, but such shares are not deemed outstanding for
computing the percentage ownership of any other person. Certain of the
outstanding shares of our capital stock are subject to a voting agreement.
Unless otherwise indicated, the address for each stockholder is c/o WAM!NET
Inc., 655 Lone Oak Drive, Eagan, Minnesota 55121.
Shares Percentage
Beneficial Owner(1) Beneficially Owned Beneficial Owned
------------------- ------------------ ----------------
Edward J. Driscoll(2)................... 4,791,666 39.0%
Gary L. Hokkanen(3)..................... 604,165 6.0
Terri F. Zimmerman(4)................... 262,500 2.7
Allen L. Witters(2)..................... 4,791,666 39.0
Denice Y. Gibson(5)..................... 250,000 2.6
Robert L. Hoffman(6).................... 150,000 1.6
William M. Kelly(7)..................... 25,000 *
Patrick J. Dirk(8)...................... 124,957 1.3
MCI WorldCom, Inc.(9)................... 32,355,272 77.3
Winstar(10)............................. 16,472,868 63.4
SGI(11)................................. 8,861,128 48.3
Cerberus(12)............................ 2,906,977 23.4
Sumitomo(13)............................ 968,992 9.3
James L. Ecker(14)...................... 922,520 9.3
James R. Clancy(15)..................... 875,000 8.4
George H. Frisch(16).................... 700,000 7.0
John R. Kauffman(17).................... 575,000 5.7
David A. Townsend(18)................... 1,317,300 13.9
All directors and executive
officers as a group
(10 persons)(2)(3)(4)(5)(6)(7)(8)...... 11,557,245 68.3
- ----------
* Represents beneficial ownership of less than one percent of outstanding
shares of our common stock.
(1) Except as indicated by footnote, we understand the persons named in the
table above have sole voting and investment power with respect to all
shares shown as beneficially owned by them, subject to community property
laws where applicable.
36
(2) Includes 2,770,833 shares issuable upon exercise of vested stock options
and 20,833 shares issuable upon exercise of stock options which will vest
within 60 days.
(3) Includes 302,082 shares issuable upon exercise of vested stock options and
302,083 shares issuable upon exercise of stock options which will vest
within 60 days.
(4) Includes 231,250 shares issuable upon exercise of vested stock options and
31,250 shares issuable upon exercise of stock options which will vest
within 60 days.
(5) Includes 225,000 shares issuable upon exercise of vested stock options and
25,000 shares issuable upon exercise of stock options which will vest
within 60 days.
(6) Issuable upon exercise of vested stock options. Address: Larkin, Hoffman,
Daly & Lindgren, Ltd., 1500 Northwest Financial Center, 7900 Xerxes Avenue
South, Bloomington, MN 55431.
(7) Includes 12,500 shares issuable upon exercise of vested stock options and
12,500 shares issuable upon options which will vest within 60 days.
Address: Davis Polk and Wardwell, 1600 El Camino Road, Menlo Park, CA
94025
(8) Includes 4,167 shares issuable upon exercise of stock options which will
vest within 60 days. Address: TROY Group, Inc., 2331 South Pullman Street,
Santa Anna, CA 72705
(9) Includes 24,688,709 shares issuable upon exercise of warrants that are
currently exerciseable, 5 million shares issuable upon conversion of a
convertible subordinated note in the aggregate principal amount of $5.0
million and 2,196,317 shares of Class D convertible preferred stock which
are currently convertible into 2,666,563 shares of common stock and are
mandatorily convertible into shares upon completion of an underwritten
public offering at an offering price of $12.52 per share. Excludes (i)
19,049,766 shares issuable upon exercise of warrants that will terminate
unexercised upon repayment of our $25 million revolving credit facility
with a portion of the net proceeds from this offering and (ii) shares
issuable upon conversion of accrued interest on a convertible note at fair
market value on the date of conversion. See "Use of Proceeds." MCI
WorldCom also owns 115,206 shares of Class A preferred stock.
(10) Includes 85,000 shares of Class E convertible preferred stock which are
currently convertible into 16,472,868 shares of common stock and are
mandatorily convertible into common stock, at the then effective
conversion rate, at any time after the completion of an underwritten
public offering, on the last trading day of the first consecutive 20
trading days during which the average closing price (weighted by daily
trading volume) of the common stock is at least $8.00 per share. Address:
685 Third Ave., New York, NY 10017
(11) Includes 5,710,425 shares of Class B convertible preferred stock which are
currently convertible into 6,923,144 shares of common stock and are
mandatorily convertible into shares of common stock upon completion of an
underwritten public offering at an offering price of $12.13 per share, and
10,000 shares of Class F convertible preferred stock which are currently
convertible into 1,937,984 shares of common stock and are mandatorily
convertible into shares of common stock, at the then effective conversion
rate, at any time after the completion of an underwritten public offering,
on the last trading day of the first consecutive 20 trading days during
which the average closing price (weighted by daily trading volume) of the
common stock is at least $8.00 per share. Excludes 878,527 shares of Class
C convertible preferred stock which are mandatorily convertible into
1,066,625 shares of common stock upon completion of an underwritten public
offering at
37
offering price of $12.52 per share. The Class C convertible preferred
stock becomes convertible at the option of the holders, beginning
September 2000. Address: 2011 N. Shoreline Blvd., Mountain View, CA
94043-1389.
(12) Includes 15,000 shares of Class E convertible preferred stock which are
currently convertible into 2,906,977 shares of common stock and are
mandatorily convertible into shares of common stock, at the then effective
conversion rate, at any time after the completion of an underwritten
public offering, on the last trading day of the first consecutive 20
trading days during which the average closing price (weighted by daily
trading volume) of the common stock is at least $8.00 per share. Address:
450 Park Ave., New York, NY 10022
(13) Includes 5,000 shares of Class G convertible preferred stock which are
currently convertible into 968,992 shares of common stock and are
mandatorily convertible into common stock upon completion of an
underwritten public offering. Address: 1-2-2 Hitotsubashi, Chiyoda-Ku,
Tokyo, 100 Japan
(14) Includes 416,665 shares issuable upon exercise of warrants that are
currently exercisable and 50,000 shares owned by the Ecker Family Limited
Partnership, of which Mr. Ecker is a partner. Address: 5061 Interlachen
Bluff, Edina, MN 55436.
(15) Includes 812,500 shares issuable upon exercise of vested stock options and
62,500 shares issuable upon exercise of stock option which will vest
within 60 days.
(16) Includes 450,000 shares issuable upon exercise of currently exercisable
options and warrants. Address: 5030 Woodlawn Blvd., Minneapolis, MN 55417.
(17) Includes 575,000 shares issuable upon exercise of vested stock options.
Address: 303 South Kootenia Creek Road, Stevensville, MT 59870.
(18) Address: 2 Poole Road, Bournemouth, Dorset, BH 25 QY England.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
1996 MCI WorldCom Convertible Note
In September 1996, we issued the $5.0 million 1996 MCI WorldCom convertible
note to MCI WorldCom. As of December 31, 1999, $6.1 million was outstanding
under the note, which included $1.1 million of accrued but unpaid interest.
Interest on the 1996 MCI WorldCom convertible note accrues at an annual rate of
10%, payable semi-annually. The principal amount of the convertible note is
convertible into 5 million shares of our common stock. The shares of common
stock issuable upon conversion of the 1996 MCI WorldCom convertible note are
subject to registration rights. We have entered into a subordination agreement
with MCI WorldCom that covers the 1996 MCI WorldCom convertible note. See "--
1998 MCI WorldCom Agreement" below.
1996 MCI WorldCom Preferred Stock, Subordinated Note and Warrant Purchase
Agreement
1999 Class A Preferred Stock. In November 1996, we entered into a preferred
stock, subordinated note and warrant purchase agreement with MCI WorldCom.
Pursuant to this agreement, we issued 100,000 shares of our Class A preferred
stock to MCI WorldCom for an aggregate purchase price of $1.0 million. MCI
WorldCom has exchanged its shares of Class A preferred stock for 115,206 shares
of a new series of Class A preferred stock. Holders of shares of the new series
of Class A preferred stock are entitled to one vote for each share held of
record, voting together with the holders of common stock as a
38
single class, on all matters submitted to a vote of shareholders.
1996 MCI WorldCom Subordinated Note. Pursuant to the preferred stock,
subordinated note and warrant purchase agreement, we also issued to MCI WorldCom
a $28.5 million subordinated note due December 31, 2003, of which $23.0 million
aggregate principal amount was outstanding as of December 31, 1999. Interest on
the outstanding principal amount of the MCI WorldCom subordinated note accrues
at an annual rate of 7%, and is payable semi-annually.
1996 MCI WorldCom Warrants. Pursuant to the preferred stock, subordinated
note and warrant purchase agreement, we also issued to MCI WorldCom warrants to
purchase, on or before December 31, 2000, up to 20,787,500 shares of common
stock. These warrants have an exercise price of $1.16 per share, increasing at a
rate of $0.016 per quarter, subject to anti-dilution provisions. The shares of
common stock issuable upon exercise of the warrants are subject to registration
rights.
The new series of Class A preferred stock and the 1996 MCI WorldCom
Subordinated Note are also covered by our subordination agreement with MCI
WorldCom. See "-- 1988 MCI WorldCom Agreement" below.
MCI WorldCom Guaranteed Revolving Credit Facility
In September 1997, we entered into a revolving credit facility with The
First National Bank of Chicago as lender and agent. The maximum amount that can
be borrowed under the revolving credit facility is $25.0 million. MCI WorldCom
has guaranteed the payment of all amounts owed under the revolving credit
facility. At December 31, 1999, we had borrowed the full $25.0 million available
under the revolving credit facility. In consideration of MCI WorldCom's
guaranty, we granted to MCI WorldCom 8,396,170 Class A warrants and 14,204,835
Class B warrants to purchase shares of common stock at an initial exercise price
of $3.90 per share, subject to anti-dilution provisions. The Class A warrants
may be exercised until December 31, 2000. The Class B warrants are exercisable
only if the revolving credit facility is not repaid in September 2000. We intend
to repay this facility prior to maturity.
1998 MCI WorldCom Agreement
In February 1998, in connection with the issuance of our 13.25% senior
discount notes due 2005, MCI WorldCom agreed to defer, until September 5, 2005,
all cash payments of principal, premium and interest on, or dividend,
distribution, redemption and other payments in respect of the 1996 MCI WorldCom
convertible note, the Class A preferred stock owned by MCI WorldCom and the 1996
MCI WorldCom subordinated note. The agreement provides that the payment of the
principal of and interest on the 1996 MCI WorldCom convertible note and the 1996
MCI WorldCom subordinated note may be accelerated only in the event of the
acceleration of the payment of the principal amount of the 13.25% senior
discount notes following an event of default with respect to those notes. The
agreement grants MCI WorldCom the right to convert into shares of common stock,
at the fair market value on the date of such conversion, (a) accrued but unpaid
interest on the 1996 MCI WorldCom convertible note, and (b) accrued but unpaid
interest on the 1996 MCI WorldCom subordinated note from December 31, 2003
through the date such amount is converted into common stock.
1999 MCI WorldCom Convertible Note
In January 1999, we issued a convertible note to MCI WorldCom in the
principal amount of up to $25 million, due August 28, 2005. On January 13 and
March 4, 1999, respectively, we borrowed $10 million
39
and $15 million on the terms provided for in the note. The note automatically
converted into 2,196,317 shares of our Class D convertible preferred stock
immediately prior to the closing of SGI's March 1999 equity investment described
below. The Class D convertible preferred stock (including accumulated but
undeclared in-kind dividends) is currently convertible into 2,666,563 shares of
our common stock at the conversion price of $10.04 per share, subject to anti-
dilution provisions, and is mandatorily convertible in the event of an
underwritten public offering of our common stock at a price of at least $12.52
per share. In connection with the issuance of the 1999 MCI WorldCom convertible
note, we also issued warrants to MCI WorldCom to purchase 350,000 shares of our
common stock at an exercise price of $0.01 per share. MCI WorldCom is entitled
to registration rights with respect to the common stock underlying the Class D
convertible preferred stock and the 1999 MCI WorldCom warrants.
Other Agreements with MCI WorldCom
MCI WorldCom has guaranteed the performance of our obligations under an
Amended and Restated Service Provision Agreement, dated February 12, 1999
between us and Time Inc.
We have entered into service arrangements with MCI WorldCom, including an
Application for Data Services pursuant to which MCI WorldCom provides us with
interexchange telecommunications service, frame relay service and ATM service,
and co-location agreements pursuant to which we lease space for our distribution
hubs. We believe that these arrangements are on terms that are similar to those
that could be obtained from an independent third-party on an arm's-length basis.
Pursuant to our arrangements with MCI WorldCom, we have guaranteed monthly usage
levels of data communications with MCI WorldCom totaling in aggregate
approximately $2.9 million and $1.7 million for the years ending December 31,
2000 and 2001, respectively. If these agreements are terminated prior to their
expiration date, we will be liable to MCI WorldCom for termination contingencies
equal to the difference between the guaranteed monthly usage level and the
amount actually used each year. Our data communications expense under
telecommunication contracts with MCI WorldCom was approximately $16.7 million,
$11.8 million and $5.5 million for the years ended December 31, 1999, 1998 and
1997. In addition, in connection with the issuance of the 1999 MCI WorldCom
convertible note, we have agreed to make available to MCI WorldCom certain
technology developed by us for integration with MCI WorldCom's infrastructure
and product and service suites on terms mutually acceptable to us and MCI
WorldCom, provided that this technology is provided on terms and conditions that
are at least as favorable, when viewed in their entirety, as we provide (or may
in the future provide) to any other person or entity not affiliated with MCI
WorldCom.
SGI Investments
In March 1999, we consummated a transaction in which SGI purchased (a)
5,710,425 shares of our Class B convertible preferred stock and (b) 878,527
shares of our Class C convertible preferred stock. The Class B convertible
preferred stock is currently convertible while the Class C convertible preferred
stock may not be converted until the earlier of September 4, 2000, or the
consummation of an underwritten public offering of our common stock. The Class B
convertible preferred stock (including accumulated but undeclared in-kind
dividends) is currently convertible into 6,923,144 shares of our common stock at
the conversion price of $9.77 per share. The Class C convertible preferred stock
(including accumulated but undeclared in-kind dividends) is currently
convertible into 1,066,625 shares of our common stock at the conversion price of
$10.04 per share. The Class B and Class C convertible preferred stock are
subject to anti-dilution provisions and are mandatorily convertible in the event
of an underwritten public offering of our common stock at a price of at least
$12.13 and $12.52 per share, respectively. SGI is entitled to registration
rights with respect to the shares of common stock underlying the Class B and
Class C convertible preferred stocks.
40
The Class B convertible preferred stock has the right, voting separately as
a class, to elect one member to our Board of Directors.
As consideration for the issuance of the Class B and the Class C convertible
preferred stock to SGI, we received $75 million, of which $35 million was paid
in cash and $40 million was paid by way of transfer to us of SGI's corporate
campus facility located in Eagan, Minnesota. See "Properties."
In connection with SGI's investment, we entered into a preferred provider
agreement, pursuant to which we have developed a list of existing SGI customers
in the entertainment industry that we believe represent a significant revenue
opportunity for us over the next three years. SGI has agreed to jointly develop
a marketing, sales and implementation plan to address these accounts, including
field resource commitments, compensation to SGI for field activities and
professional services, and other matters applicable to the sale of our service
to these potential customers. In addition, we intend to explore with SGI a
broader strategic relationship that we believe will enable us to obtain the
benefit of SGI's presence in the entertainment industry and other selected
commercial accounts.
The preferred provider agreement also allows us to purchase hardware,
software and services over a four year period at prices based on SGI's most
favored pricing models. Pursuant to our preferred provider agreement, we have
made a firm $35 million purchase commitment during the period commencing
December 1, 1998 and ending December 31, 2000. We will be obligated to pay SGI
an amount equal to 10% of the unpurchased commitment if we do not purchase the
entire commitment amount during that period. As of December 31, 1999, we had
made purchases of approximately $12.4 million. We believe that the discounted
prices, reduced commissions and lower servicing fees for such products and
services will result in lower network operations expense in the future.
In February 2000, SGI purchased additional shares of preferred stock
pursuant to a subscription right we granted to SGI in connection with its
initial equity investment in our company in March 1999. SGI purchased 10,000
shares of Class F convertible preferred stock for $10 million in cash. The Class
F convertible preferred stock accumulates dividends at an annual rate of 7%,
added monthly to the accreted liquidation value of the stock, and votes as a
class on an "as converted" basis with the common stock. The Class F convertible
preferred stock is convertible into a total of 1,937,984 shares of common stock
at a conversion rate of $5.16 per share, subject to anti-dilution provisions.
Stockholders' Agreement
Concurrently with the closing of SGI's initial investment in March 1999, we
entered into a stockholders' agreement with SGI and MCI WorldCom pursuant to
which SGI and MCI WorldCom each agreed to provide the other party with certain
tag-along rights with respect to the transfer of any shares of the Class B,
Class C or Class D convertible preferred stock owned by them, or the transfer of
any shares of common stock into which such stock may be converted. In addition,
the parties have agreed that the terms of future material agreements between us
and MCI WorldCom must be approved by a majority of the disinterested directors
on our Board of Directors. On March 8, 2000, the stockholders' agreement was
amended to provide Winstar and Cerberus Partners, L.P. the same tag-along rights
as SGI and MCI WorldCom, and broadened the securities subject to the terms of
the agreement to include the Class E, F and G convertible preferred stock owned
by the parties.
Winstar Agreement
In December 1999, we entered into an agreement with Winstar pursuant to
which we purchased a 20-year indefeasible right of use for backbone capacity and
purchased wireless local loop facilities. Under
41
this agreement, we took title to equipment of varying bandwidth. Winstar has
agreed to maintain this equipment, including replacement as necessary, and
maintain its connectivity to Winstar's telecommunications network at a specified
level of functionality over the agreement's term. We have the right to assign or
sell our rights under the agreement. We made an initial $20.0 million payment in
January 2000 for our 20- year indefeasible right of use, and are required to
make quarterly payments, beginning at $5.0 million and increasing to
approximately $24.9 million, over the seven-year period ending December 15,
2006. The indefeasible right of use has been capitalized in property, plant and
equipment and we have recorded a related liability at the agreed-upon fair value
of $260.3 million, which liability bears an effective interest rate of 8.3%.
Under related agreements, Winstar has committed to purchase from us $12.5
million of services, which Winstar may sell to third parties. Winstar's
commitment was prepaid in December 1999. This prepayment has been recorded as
deferred revenue. We have also entered into a sublease agreement with Winstar
for approximately 78,000 square feet of computer operation, office and common
area space in our Minnesota data centers. In December 1999, Winstar made a one-
time advance payment of approximately $12.5 million. We are required to repay
this advance payment at $200,000 per month over 10 years, at an imputed interest
rate of 15.75%. We have recorded the advance payment as a borrowing. The
sublease has an initial term of 10 years, during which Winstar must pay monthly
payments in the approximate amount of $81,000 and its prorated share of
utilities, taxes and operating expenses. Winstar has the option to extend the
sublease for two successive 5 year terms at 50% of then prevailing market rates
and its share of those expenses.
In connection with the foregoing agreements with Winstar, Winstar purchased
50,000 shares of our Class E convertible preferred stock and exercised an option
to purchase an additional 35,000 shares of such stock for an aggregate purchase
price of $85 million. Of this amount, $35 million was paid in cash and $50
million was paid through the transfer to us of 1,071,429 shares of Winstar's
common stock valued at $46.66 per share (as adjusted for a 3-for-2 stock split
declared by Winstar in February 2000). The Class E convertible preferred stock
accumulates dividends at an annual rate of 7%, added monthly to the accreted
liquidation value of the stock. Each of the two largest holders of Class E
convertible preferred stock has the right to designate one director, and vote on
an as-converted basis, not to exceed 17.5% of total voting power, on all matters
submitted to the vote of common stock holders, including the election of
directors. The Class E convertible preferred stock is initially convertible into
a total of 19,714,147 shares of common stock at an initial conversion rate of
$5.16 per share, subject to anti-dilution provisions.
Other Agreements
In February and March 2000, Sumitomo and other investors purchased 10,000
shares of our Class G convertible preferred stock for $10 million in cash.
Holders of Class G convertible preferred stock have the right to vote, on an
as-converted basis, with holders of common stock on all matters submitted to a
vote of stockholders. The Class G convertible preferred stock is convertible
into 1,937,984 shares of common stock, at a conversion rate of $5.16 per share,
subject to anti-dilution provisions. The Class G convertible preferred stock
will mandatorily convert into common stock in the event of an underwritten
public offering of our common stock. In March 2000, other investors purchased
16,725 shares of Class E convertible preferred stock from us for $16.7 million
in cash.
Edward J. Driscoll, Jr., father of our Chairman of the Board and Chief
Executive Officer, purchased 250,000 shares of common stock at our inception in
1994. As consideration for such shares, Mr. Driscoll paid us $500 and agreed to
provide consulting services to us. In January 1998, Mr. Driscoll was granted an
option to purchase up to 200,000 shares of common stock at a price of $3.90 per
share as partial
42
consideration for his agreement to provide additional consulting services to us.
Mr. Driscoll is a shareholder of Larkin, Hoffmann, Daly & Lindgren, Ltd., which
provides legal services to us.
George H. Frisch, who provides legal services to us, purchased 250,000
shares of common stock at our inception in 1994. As consideration for such
shares, Mr. Frisch paid us $500 and agreed to provide legal services to us. In
November 1995, Mr. Frisch was granted warrants to purchase an additional 150,000
shares of common stock at the price of $0.60 per share as partial consideration
for his agreement to provide additional legal services to us. In addition, Mr.
Frisch was granted, in July 1997, an option to purchase up to 100,000 shares of
common stock at a price of $0.96 per share, and he was granted, in January 1998,
an option to purchase up to 200,000 shares of common stock at a price of $3.90
per share, in both cases as partial consideration for his agreement to provide
additional legal services to us.
We loaned $305,000 to Allen L. Witters, our Chief Technology Officer, on
September 1, 1998, of which approximately $300,000 remains outstanding. As
security for the repayment of principal of and interest on this indebtedness,
Mr. Witters granted us a lien on 60,000 shares of our common stock.
In consideration for our purchase from David Townend of 31,680,000 ordinary
shares of 4-Sight Limited in connection with the 4-Sight acquisition in February
1998, Mr. Townend received $8.0 million in cash and 1,317,300 shares of common
stock. In addition, Mr. Townend is entitled to receive 48.95% of the 750,000
shares of common stock that comprises the deferred consideration for our
purchase of 4-Sight. Mr. Townend is Managing Director of our subsidiary, WAM!NET
U.K. Limited.
The delivery of the additional 750,000 shares of common stock is contingent
on WAM!NET U.K. Limited achieving certain sales objectives over the three year
period ending March 13, 2001. Specifically, former shareholders of 4-Sight will
be entitled to receive 625,000 shares of common stock if revenues attributable
to customer sites outside the U.S. and Canada and receivable by WAM!NET or any
of its subsidiaries exceeds $50 million for the period from March 13, 1998 to
March 13, 2001. Former shareholders of 4-Sight will be entitled to receive an
additional 125,000 shares of common stock if such revenues exceed $70 million
for such period.
From inception, certain legal services have been provided to us by Larkin,
Hoffman, Daly & Lindgren, Ltd. Edward J. Driscoll, Jr., father of our Chairman
of the Board and Chief Executive Officer, and Robert L. Hoffman, one of our
directors, are shareholder of Larkin, Hoffman, Daly & Lindgren, Ltd. We have
been advised that the amounts paid to this firm have not exceeded 5% of its
total gross revenues in any of the past three years.
43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements. See index immediately following signature page.
(b) Reports on Form 8-K. The Company filed the following Current Reports on
Form 8-K during the three months ended December 31, 1999:
Current Report on Form 8-K filed on October 8, 1999, announcing the
financing with Chase Capital Partners and the restructuring of our
relationship with MCI WorldCom.
(c) Exhibits
2.1 (1) Agreement for the Sale and Purchase of the entire issued share
capital of WAM!NET U.K. Limited dated February 11, 1998, among the
Company, WAM!NET (UK) Limited and the Selling Shareholders listed
therein.
2.2 (1) Agreement and Plan of Reorganization dated December 17, 1997 by
and among NetCo Communications Corporation, NetCo Acquiring
Corporation, FreeMail, Inc. and the shareholders listed therein.
2.3 (4) June 1, 1999 Amendment to the Agreement and Plan of Reorganization
dated December 17, 1997 by and among WAM!NET Inc. (formerly NetCo
Communications Corporation), NetCo Acquiring Corporation,
FreeMail, Inc. and the shareholders listed therein.
3.1 (1) Amended and Restated Articles of Incorporation of the Company.
3.2 (1) By-Laws of the Company.
4.1 (1) Indenture dated as of March 5, 1998, between the Company, as
Issuer, and First Trust National Association, as Trustee.
4.2a (1) Certificate for the Rule 144A Original Notes ($200,000,000).
4.2b (1) Certificate for the Rule 144A Original Notes ($8,030,000).
4.3 (1) Certificate for the Regulation S Original Notes.
4.4 (1) Certificate for the Rule 144A Warrants.
4.5 (1) Certificate for the Regulation S Warrants.
4.6a (1) Rule 144A Unit Certificate. (200,000 Units)
4.6b (1) Rule 144A Unit Certificate. (8,030 Units)
4.7 (1) Certificate for the Regulation S Units.
44
4.8 (1) Form of Certificate for the Exchange Notes (incorporated herein by
reference and included in Exhibit 4.1 to the Company's
Registration Statement on Form S-4 filed with Securities and
Exchange Commission on May 28, 1998).
4.9 (1) Common Stock Certificate.
4.10 (1) Registration Rights Agreement, dated March 5, 1998, among the
Company and Merrill Lynch Pierce, Fenner & Smith Incorporated,
Credit Suisse First Boston Corporation and First Chicago Capital
Markets, Inc.
4.11 (1) Common Stock Registration Rights Agreement, dated as of March 5,
1998, among the Company, WorldCom Inc., Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Credit Suisse First Boston
Corporation and First Chicago Capital Markets, Inc.
4.12 (1) Warrant Agreement, dated as of March 5, 1998, by and between the
Company and First Trust National Association, as Warrant Agent, to
purchase common stock of the Company.
4.13 Intentionally omitted.
4.14 (2) Warrants to purchase 4,157,500 Shares of Common Stock of the
Company exercisable on or before December 31, 2000, issued to
WorldCom Inc. on December 16, 1996 (Incorporated herein by
reference to exhibit 10.6 of the Company's Registration Statement
on Form S-4 (File No. 333-53841) filed with the Securities and
Exchange Commission on May 28, 1998).
4.15 (2) Certificate for 13.25% Subordinated Unsecured Convertible Note due
August 28, 2005 ($25,000,000 Note) issued to MCI WorldCom, Inc. on
January 13, 1999.
4.16 (2) Certificate for 1,679,234 Class A Warrants and 2,840,967 Class B
Warrants to purchase Common Stock of the Company, issued to
WorldCom Inc. on September 26, 1997 (Incorporated herein by
reference to exhibit 10.9 of the Company's Registration Statement
on Form S-4 (File No. 333-53841) filed with the Securities and
Exchange Commission on May 28, 1998).
4.17 (2) Subordinate Unsecured Convertible Note and Warrant Purchase
Agreement between the Company and MCI WorldCom, Inc. dated January
13, 1999.
4.18 (2) Preferred Stock Purchase Agreement by and between the Company and
Silicon Graphics, Inc. dated as of March 3, 1999.
4.19 (2) Certificate for 150,000 Warrants to purchase shares of Common
Stock for the purchase price of $.01 per share issued to MCI
WorldCom, Inc on January 13, 1999.
4.20 (2) Certificate of Designation of Rights and Preferences of Class A
Preferred Stock of the Company filed with the Secretary of State
of the State of Minnesota on March 4, 1999, as corrected and filed
with the Secretary of State of this State of Minnesota on March 5,
1999.
4.21 (2) Certificate of Designation of Rights and Preferences of Class B
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on March 4, 1999.
4.22 (2) Certificate of Designation of Rights and Preferences of Class C
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on March 4, 1999.
45
4.23 (2) Certificate of Designation of Rights and Preferences of Class D
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on March 4, 1999.
4.24 (2) Certificate representing 115,206 shares of Class A Preferred Stock
of the Company issued to MCI WorldCom. Inc. on March 4, 1999.
4.25 (2) Certificate representing 5,710,425 shares of Class B Convertible
Preferred Stock of the Company issued to Silicon Graphics, Inc. on
March 4, 1999.
4.26 (2) Certificate representing 878,527 shares of Class C Convertible
Preferred Stock of the Company issued to Silicon Graphics, Inc. on
March 4, 1999.
4.27 (2) Certificate representing 2,196,317 shares of Class D Convertible
Preferred Stock of the Company issued to MCI WorldCom. Inc. on
March 4, 1999.
4.28 (2) Stockholders Agreement by and among the Company, Silicon Graphics,
Inc. and MCI WorldCom, Inc. dated as of March 4, 1999.
4.29 (2) Class A Preferred Stock Exchange Agreement by and between the
Company and MCI WorldCom, Inc. dated as of March 4, 1999.
4.30 (2) Class D Preferred Stock Conversion Agreement by and between the
Company and MCI WorldCom, Inc. dated as of March 4, 1999.
4.31 * Certificate of Designation of Rights and Preferences of Class E
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on February 16, 1999,
as corrected and filed with the Secretary of State of the State of
Minnesota on March 1 and March 8, 2000.
4.32 * Certificate of Designation of Rights and Preferences of Class F
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on February 11, 1999,
as corrected and filed with the Secretary of State of the State of
Minnesota on March 1 and March 9, 2000.
4.33 * Certificate of Designation of Rights and Preferences of Class G
Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on March 6, 2000.
4.34 * Securities Purchase Agreement dated as of December 31, 1999, by
and between the Company and Winstar Communications, Inc.
4.35 * Securities Purchase Agreement dated as of March 14, 2000, by
and between the Company and Cerberus Partners, L.P.
4.36 * Securities Purchase Agreement dated as of February 3, 2000, by and
between the Company and Silicon Graphics, Inc.
4.37 * Preferred Stock Purchase Agreement, dated as of February 18, 2000,
by and between the Company and the buyers listed on Schedule 1.1
thereto.
4.38 * Form of Certificate for Shares of Class E Convertible Preferred
Stock of the Company.
46
4.39 * Form of Certificate for Shares of Class F Convertible Preferred
Stock of the Company.
4.40 * Form of Certificate for Shares of Class G Convertible Preferred
Stock of the Company.
4.41 * Certificate for 200,000 Warrants to purchase shares of Common
Stock for the purchase price of $.01 per share issued to MCI
WorldCom, Inc. in connection with the 13.25% subordinated
unsecured convertible note, dated January 13, 1999.
10.1 (1) Credit Agreement among the Company, the Lending Institutions party
thereto, as Lenders, The First National Bank of Chicago, as Agent,
dated as of September 26, 1997.
10.2 (1) Ten Percent Convertible Note Purchase Agreement between the
Company and WorldCom Inc. dated September 12, 1996 ($5,000,000
Note).
10.3 (1) Preferred Stock, Subordinated Note and Warrant Purchase Agreement
between the Company and WorldCom Inc. dated November 14, 1996.
10.4 (1) $28,500,000 Seven Percent Subordinated Note due December 31, 2003,
payable to WorldCom Inc.
10.5 Intentionally omitted.
10.6 Intentionally omitted.
10.7 (1) Right of Refusal Agreement Among WorldCom Inc., Edward Driscoll
III and Allen L. Witters dated December 16, 1996.
10.8 (1) Guaranty Agreement dated September 26, 1997, by and between the
Company and WorldCom Inc.
10.9 Intentionally omitted.
10.10 (1) Sublease dated September 24, 1997 between the Company and 1250895
Ontario Limited, relating to the property located at 6100 110th
Street West, Bloomington, Minnesota.
10.11 (1) Service Provision Agreement dated as of July 18, 1997, by and
between the Company and Time Inc.
10.12 (1) Standby Agreement dated as of July 19, 1997 by and between
WorldCom Inc. and Time Inc.
10.13 Intentionally omitted.
10.14 Intentionally omitted.
10.15 Intentionally omitted.
10.16 Intentionally omitted.
10.17 (1) Agreement dated February 11, 1998 between the Company and
WorldCom, Inc. modifying certain terms of the (i) 10% Convertible
Subordinated Note, due September 30, 1999, (ii) 7% Subordinated
Note, due December 31, 2003, and (iii) 100,000 shares of Series A
Preferred Stock, all of which are held by MCI WorldCom, Inc.
(incorporated herein by reference to
47
exhibit No. 4.17 to the Company's Registration Statement on Form
S-4 (File No. 333-53841) filed with the Securities and Exchange
Commission on May 28, 1998)
10.18 (1) 1994 Stock Option Plan
10.19 (1) Amended and Restated 1994 Stock Option Plan
10.20 (1) 1998 Combined Stock Option Plan.
10.21 (1) Agreement dated June 5, 1997 between the Company and WorldCom,
Inc. regarding data services provided by WorldCom, Inc. to the
Company.
10.22 (3) Preferred Provider Agreement by and between the Company and
Silicon Graphics, Inc., dated as of March 4, 1999 (portions of
this exhibit have been omitted pursuant to a request for
confidential treatment and have been filed with the Securities
Commission under separate cover).
10.23 (2) Sale and Purchase Agreement by and between Silicon Graphics, Inc.,
on behalf of itself and its wholly-owned subsidiary, Cray
Research, L.L.C., and the Company dated as of March 4, 1999.
10.24 (2) Lease by and between the Company and Silicon Graphics, Inc. on
behalf of itself and its wholly-owned subsidiary, Cray Research,
L.L.C., with respect to the Company's corporate campus facility
located in Eagan, Minnesota dated as of March 4, 1999.
10.25 Intentionally omitted.
10.26 Intentionally omitted.
10.27 (4) Loan and Security Agreement dated July 16, 1999, by and between
Foothill Capital Corporation and the Company.
10.28 (5) Purchase and Sale Agreement and Escrow Instructions dated
September 30, 1999, between the Company and CCPRE-Eagan, LLC.
10.29 (5) Amendment Number One to Purchase and Sale Agreement and escrow
Instructions dated September 30, 1999, between the Company and
CCPRE-Eagan, LLC.
10.30 (5) Net Lease dated September 30, 1999 between the Company and
CCPRE-Eagan, LLC.
10.31 * Master Agreement, dated as of December 31, 1999, by and between
the Company and Winstar Communications, Inc.
23.1 * Consent of Ernst & Young LLP
27.1 * Financial Data Schedule.
- ----------------
48
(1) Incorporated herein by reference to the Company's Registration Statement
on Form S-4 (File No. 333-53841), filed with the SEC on May 28, 1998.
(2) Incorporated herein by reference to the Company's Annual Report on Form
10-K, filed with the SEC on March 31, 1999.
(3) Incorporated herein by reference to the Company's Quarterly Report on
Form 10-Q filed with the SEC on May 17, 1999.
(4) Incorporated herein by reference to the Company's Quarterly Report on
Form 10-Q filed with the SEC on August 4, 1999.
(5) Incorporated herein by reference to the Company's Quarterly Report on
Form 10-Q filed with the SEC on November 12, 1999.
* Filed herein.
49
IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those projected in such statements. In connection with
certain forward-looking statements contained in this Form 10-K and those that
may be made in the future by or on behalf of the Company, the Company notes that
there are various factors that could cause actual results to differ materially
from those set forth in any such forward-looking statements. The forward-looking
statements contained in this Form 10-K were prepared by management and are
qualified by, and subject to, significant business, economic, competitive,
regulatory and other uncertainties and contingencies, all of which are difficult
or impossible to predict and many of which are beyond the control of the
Company. Factors which could cause or contribute to such differences include,
but are not limited to: (1) the ability of the Company to consummate
acquisitions, integrate such acquisitions into existing operations, manage
expansion, secure our customers and increase utilization of its network and
infrastructure, achieve operating efficiencies and control costs in its
operations; (2) the Company's success in retaining key employees, including its
Chief Executive Officer and Chief Financial Officer and the senior management
teams of its primary operating units; (3) pressures from competitors with
greater resources than those of the Company, as well as competitive pressures
arising from changes in technology and customer requirements; (4) the
availability of raw intellectual property information from alternative sources
for little or no cost; (5) disruptions to operations resulting from Year 2000
issues that might originate with third parties; and (6) the concentration of
ownership among the certain stockholders such as MCI WorldCom, SGI and Winstar
Communications, Inc. who have the ability to control the Company, including the
election of directors and the direction of the affairs and operations of the
business and (7) the ability to secure financing to fund operations.
Accordingly, there can be no assurance that the forward-looking statements
contained in this Form 10-K will be realized or that actual results will not be
significantly higher or lower. The statements have not been audited by, examined
by, compiled by or subjected to agreed-upon procedures by independent
accountants, and no third-party has independently verified or reviewed such
statements. Readers of this Form 10-K should consider these facts in evaluating
the information contained herein. In addition, the business and operations of
the Company are subject to substantial risks which increase the uncertainty
inherent in the forward-looking statements contained in this Form 10-K. The
inclusion of the forward-looking statements contained in this Form 10-K should
not be regarded as a representation by the Company or any other person that the
forward-looking statements contained in this Form 10-K will be achieved. In
light of the foregoing, readers of this Form 10-K are cautioned not to place
undue reliance on the forward-looking statements contained herein. These risks
and others that are detailed in this Form 10-K and other documents that the
Company files from time to time with the Securities and Exchange Commission,
including quarterly reports on Form 10-Q and any current reports on Form 8-K
must be considered by any investor or potential investor in the Company.
50
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 14th day of March, 2000.
WAM!NET INC.
By: /s/ Terri F. Zimmerman
---------------------------
Name: Terri F. Zimmerman
Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on its behalf by the
registrant and in the capacities and on the dates indicated:
Signature Title Date
/s/ Edward J. Driscoll III Chairman of the Board March 15, 2000
- ----------------------------- and Chief Executive
Edward J. Driscoll III Officer
/s/ Robert L. Hoffman Director March 15, 2000
- -----------------------------
Robert L. Hoffman
/s/ William M. Kelly Director March 15, 2000
- -----------------------------
William M. Kelly
/s/ Patrick J. Dirk Director March 15, 2000
- -----------------------------
Patrick J. Dirk
51
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL SCHEDULE OF WAM!NET INC.
1. Financial Statements
Report of Independent Auditors..................... F-2
Consolidated Balance Sheets........................ F-3
Consolidated Statements of Operations.............. F-4
Consolidated Statements of Shareholders' Deficit... F-5
Consolidated Statements of Cash Flows.............. F-6
Notes to Consolidated Financial Statements......... F-7
2. Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts... F-24
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and
therefore have been omitted.
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors
WAM!NET Inc.
We have audited the accompanying consolidated balance sheets of WAM!NET Inc.
as of December 31, 1998 and 1999, and the related consolidated statements of
operations, shareholders' deficit and cash flows for each of the three years in
the period ended December 31, 1999. Our audits also included the financial
statement schedule listed in the Index at Item 14 (a). These financial
statements and schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
WAM!NET Inc. at December 31, 1998 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, present fairly in all material respects the information set forth
therein.
Ernst & Young LLP
Minneapolis, Minnesota
March 2, 2000
F-2
WAM!NET Inc.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31,
---------------------------
1998 1999
------------- ------------
Assets
Current assets:
Cash and cash equivalents............................................ $ 6,272 $ 27,180
Accounts receivable, net of allowance of $430 and $1,570 at
December 31, 1998 and 1999.......................................... 3,466 3,982
Inventory............................................................ 1,534 1,254
Prepaid expenses and other current assets............................ 3,187 4,018
--------- ---------
Total current assets................................................... 14,459 36,434
Property, plant and equipment, net..................................... 62,467 358,336
Goodwill, net.......................................................... 27,734 21,421
Deferred financing charges, net........................................ 20,183 18,300
Other assets........................................................... 616 764
--------- ---------
Total assets........................................................... $ 125,459 $ 435,255
========= =========
Liabilities and shareholders' deficit
Current liabilities:
Accounts payable..................................................... $ 17,098 $ 13,739
Accrued salaries and wages........................................... 4,801 2,839
Accrued expenses..................................................... 3,036 6,450
Deferred revenue..................................................... -- 2,500
Current portion of long-term debt.................................... 5,324 55,950
--------- ---------
Total current liabilities.............................................. 30,259 81,478
Deferred revenue....................................................... -- 10,000
Long-term debt, less current portion................................... 203,914 490,450
Class A Redeemable Preferred Stock..................................... 1,140 1,212
Shareholders' deficit:
Class B Convertible Preferred Stock.................................. -- 57
Class C Convertible Preferred Stock.................................. -- 9
Class D Convertible Preferred Stock.................................. -- 22
Common Stock......................................................... 93 95
Additional paid-in capital........................................... 54,302 156,680
Accumulated deficit.................................................. (164,387) (303,614)
Accumulated other comprehensive income (loss)...................... 138 (1,134)
--------- ---------
Total shareholders' deficit.................................. (109,854) (147,885)
--------- ---------
Total liabilities and shareholders' deficit.................. $ 125,459 $ 435,255
========= =========
See accompanying notes.
F-3
WAM!NET Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Year Ended December 31,
----------------------------------------
1997 1998 1999
------------ ---------- -----------
Revenues:
Net service revenue........................................ $ 1,555 $ 6,799 $ 17,319
Software and hardware sales................................ -- 10,791 7,476
---------- ---------- ----------
Total revenues............................................... 1,555 17,590 24,795
Operating expenses:
Network communication fees................................. 7,364 18,259 26,318
Cost of software and hardware.............................. -- 3,537 2,905
Network operations and development......................... 7,478 35,095 22,928
Selling, general and administrative........................ 13,527 45,422 43,392
Depreciation and amortization.............................. 2,668 17,668 34,875
---------- ---------- ----------
31,037 119,981 130,418
---------- ---------- ----------
Loss from operations......................................... (29,482) (102,391) (105,623)
Other income (expense):
Interest income............................................ 202 1,748 814
Interest (expense)......................................... (4,356) (22,626) (35,693)
Other income............................................... -- 39 1,275
---------- ---------- ----------
Net loss before income tax benefit......................... (33,636) (123,230) (139,227)
Income tax benefit......................................... -- 1,352 --
---------- ---------- ----------
Net loss..................................................... (33,636) (121,878) (139,227)
Less preferred dividends................................... (70) (70) (5,890)
---------- ---------- ----------
Net loss applicable to common stock.......................... $ (33,706) $ (121,948) $ (145,117)
========== ========== ==========
Net loss applicable per common share -- basic and
diluted.................................................... $ (5.19) $ (13.87) $ (15.58)
========== ========== ==========
Weighted average number of common shares
outstanding -- basic and diluted........................... 6,496,345 8,793,961 9,315,900
========== ========== ==========
See accompanying notes.
F-4
WAM!NET Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
(In thousands, except per share amounts)
Convertible Accumulated
Common Stock Preferred Stock Additional Other
--------------- ---------------
Paid-In Accumulated Comprehensive
Description Issued Amount Issued Amount Capital Deficit Income Total
- ----------- ------ ------ ------ ------- -------- ----------- ------------- ---------
Balance at December 31, 1996................. 6,480 $65 -- $ -- $ 6,125 $ (8,873) $ -- $ (2,683)
Accumulated and unpaid
dividends in connection with
Class A Redeemable Preferred Stock........ -- -- -- -- (70) -- -- (70)
Amortization of stock options.............. -- -- -- -- 426 -- -- 426
Value of warrants issued in connection
with line of credit in September......... -- -- -- -- 4,766 -- -- 4,766
Issuance of Common Stock upon merger
with FreeMail............................ 125 1 -- -- 487 -- -- 488
Issuance of Common Stock upon debt
conversion at a price of $.38 per
share.................................... 65 1 -- -- 24 -- -- 25
Exercise of stock options.................. 30 -- -- -- 13 -- -- 13
Net loss................................... -- -- -- -- -- (33,636) -- (33,636)
----- --- ------- ------ -------- --------- ------- ---------
Balance at December 31, 1997................. 6,700 67 -- -- 11,771 (42,509) -- (30,671)
Accumulated and unpaid dividends in
connection with Class A Redeemable....... -- -- -- -- (70) -- -- (70)
Preferred Stock
Amortization of stock options.............. -- -- -- -- 12,538 -- -- 12,538
Value of warrants issued in connection
with Senior Discounted Notes............. -- -- -- -- 10,047 -- -- 10,047
Issuance of Common Stock upon merger
with 4-Sight............................. 2,500 25 -- -- 19,975 -- -- 20,000
Issuance of Common Stock upon debt
conversion at a price of $.38 per
share................................... 65 1 -- -- 24 -- -- 25
Exercise of stock options.................. 23 -- -- -- 17 -- -- 17
Comprehensive loss:
Net loss................................. -- -- -- -- -- (121,878) -- (121,878)
Foreign currency translation
adjustment............................. -- -- -- -- -- -- 138 138
---------
Total comprehensive loss................... -- -- -- -- -- -- -- (121,740)
----- --- ------- ------ -------- --------- ------- ---------
Balance at December 31, 1998................. 9,288 93 -- -- 54,302 (164,387) 138 (109,854)
Accumulated dividends in connection
with Class A Redeemable Preferred
Stock.................................... -- -- -- -- (72) -- -- (72)
Amortization of stock options.............. -- -- -- -- 166 -- -- 166
Value of warrants issued in connection
with financing transaction............... -- -- -- -- 2,796 -- -- 2,796
Issuance of Convertible Preferred
Stock.................................... -- 8,785 88 99,410 -- -- 99,498
Issuance of Common Stock upon debt
conversion at a price of $.38 per
share................................... 198 2 -- -- 73 -- -- 75
Exercise of stock options.................. 9 -- -- -- 5 -- -- 5
Comprehensive loss:
Net loss................................. -- -- -- -- -- (139,227) -- (139,227)
Foreign currency translation adjustment.. -- -- -- -- -- -- (1,272) (1,272)
---------
Total comprehensive loss................... -- -- -- -- -- -- -- (140,499)
----- --- ------- ------ -------- --------- ------- ---------
Balance at December 31, 1999................. 9,495 $95 8,785 $88 $156,680 $(303,614) $(1,134) $(147,885)
===== === ======= ====== ======== ========= ======= =========
See accompanying notes.
F-5
WAM!NET Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-----------------------------------------
1997 1998 1999
----------- ------------ ------------
Operating activities
Net loss..................................................................... $(33,636) $(121,878) $(139,227)
Adjustments to reconcile net loss to net cash used in
operating activities:
Noncash interest expense, including related warrant values................. 1,624 18,295 29,080
Value of stock options issued to employees and consultants................. 426 12,522 166
Depreciation and amortization.............................................. 2,668 17,668 34,875
Loss on disposal of property and equipment................................. 797 69 1,746
Changes in operating assets and liabilities:
Accounts receivable...................................................... (386) 647 (516)
Prepaid expenses and other assets........................................ (415) (8,424) (969)
Accounts payable......................................................... 1,832 14,795 (3,359)
Deferred Revenue......................................................... -- -- 12,500
Accrued expenses......................................................... 3,173 10,428 34
-------- --------- ---------
Net cash used in operating activities........................................ (23,917) (55,878) (65,670)
Investing activities
Purchases of property and equipment.......................................... (16,599) (54,584) (25,208)
Patent expenditures.......................................................... -- (370) (87)
Business acquisitions (net of cash acquired)................................. -- (16,350) (647)
Proceeds from sale of investments............................................ 1,000 -- --
-------- --------- ---------
Net cash used in investing activities........................................ (15,599) (71,304) (25,942)
Financing activities
Proceeds from sale of preferred stock........................................ -- -- 34,707
Proceeds from borrowings (net of financing expenses)......................... 36,958 161,800 95,771
Proceeds from exercise of stock options...................................... -- 15 5
Payments on borrowings....................................................... (11,612) (28,998) (16,986)
-------- --------- ---------
Net cash provided by financing activities.................................... 25,346 132,817 113,497
Effect of foreign currencies on cash......................................... -- 363 (977)
-------- --------- ---------
Net (decrease) increase in cash and cash equivalents......................... (14,170) 5,998 20,908
Cash and cash equivalents at beginning of year............................... 14,444 274 6,272
-------- --------- ---------
Cash and cash equivalents at end of year..................................... $ 274 $ 6,272 $ 27,180
======== ========= =========
Supplemental schedule of noncash financing activities
Value of interest cost assigned to warrants.................................. $ 4,766 $ 10,047 $ 4,297
Equipment financed through equipment financing............................... 1,764 -- --
Conversion of accrued interest to subordinated debt.......................... 1,363 1,965 1,837
Issuance of convertible preferred stock in exchange for
land, building, and furniture and fixtures................................. -- -- 40,000
Dividends declared but unpaid................................................ 70 70 60
Purchase of network facilities............................................... 260,280
Issuance of common stock relating to acquisition............................. 488 20,000 --
Cashless exercise of stock options........................................... 13 -- --
Conversion of convertible subordinated debenture for common stock............ 25 25 75
Conversion of accrued dividends to preferred stock........................... -- -- 152
Conversion of debt to preferred stock........................................ -- -- 24,791
Supplemental schedule of cash flow information
Cash paid for interest....................................................... 1,208 2,276 6,332
See accompanying notes.
F-6
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
1. Significant Accounting Policies
Description of Business
The Company is a leading global provider of business-to-business e-services
for the media industry. The Company enables entertainment, advertising,
publishing, printing and related media businesses worldwide to collaborate on-
line within their workflow chains.
The Company offers customers a wide array of e-services that meet their need
to collaborate digitally with their workflow partners. The Company's services,
applications and infrastructure provide a common electronic workflow platform
for customers, enabling them to achieve measurable operating efficiencies, cost
savings and productivity growth.
Consolidation Policy and Foreign Currency Translations
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries and its 90% owned joint venture. All significant
intercompany accounts and transactions have been eliminated in consolidation.
All assets and liabilities are translated to U.S. dollars at year-end exchange
rates, while elements of the income statement are translated at average exchange
rates in effect during the year. The functional currencies of the Company's
foreign subsidiaries are considered to be the respective subsidiary's local
currency. All translation gains and losses resulting from fluctuations in
currency exchange rates of these subsidiaries are recorded in equity as a
component of accumulated other comprehensive loss.
Revenue Recognition
The Company records revenue from its digital data delivery network services
on a monthly basis based upon service contracts signed with customers. The
service contracts provide for monthly minimum usage amounts by the customer. The
Company recognizes the minimum monthly amount as earned over the life of the
service contract. If a customer's usage exceeds the maximum usage specified in
the service contract, the Company will record additional revenue in the month
that the overage occurs. The Company does not receive initial up-front amounts
or pre-payments from customers. The Company also may offer service rebates.
Revenue from hardware and software sales is recognized upon delivery of the
hardware and software, unless there are remaining obligations. Other service
fees are recognized as revenue in the period the service is provided to the
customer.
Deferred Revenue
Deferred revenue represents amounts received in advance of providing the
related services. (See Note 4).
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at the time of purchase to be cash equivalents. Investments
classified as cash equivalents consist of high grade commercial paper,
certificates of deposit and United States Treasury Bills. Cash equivalents are
considered available for sale and are stated at cost, which approximates fair
value.
Accounts Receivable
The Company grants credit to customers in the normal course of business.
Management performs on-going credit evaluations of customers and maintains
allowances for potential credit losses, which, when
F-7
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
realized, have generally been within management expectations. No single customer
or region represents a significant concentration of credit risk.
Inventories
Inventories, principally software and hardware held for sale, are stated at
the lower of cost or market. Cost is determined using the first-in, first-out
method.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided on a
straight-line basis over the estimated useful life of three to thirty years.
Goodwill
The excess of the cost over the fair value of net assets acquired is
amortized on a straight-line basis over a period of three to five years. The
Company periodically reviews the recoverability of goodwill, on an on-going
basis, based on estimated future cash flows from the related operations.
Accumulated amortization was $5,308 and $11,954 at December 31, 1998 and 1999.
Deferred Financing Costs
Deferred financing costs represent costs related to the issuance of debt and
are capitalized and amortized over the related lives of the debt. Accumulated
amortization was $5,959 and $11,135 at December 31, 1998 and 1999.
Impairment of Long-Lived Assets
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. The amount of impairment loss recorded will be measured as the
amount by which the carrying value of the assets exceeds the fair value of the
assets.
Income Taxes
Income taxes are accounted for under the liability method. Deferred income
taxes are provided for temporary differences between the financial reporting and
tax bases of assets and liabilities.
Product Development
Costs associated with the development of new products and services are
charged to operations in the year incurred. These costs for 1997, 1998 and 1999
were $3,364, $13,447 and $8,278, respectively. The Company capitalizes software
developed for internal use in accordance with Statement of Position 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." The amounts capitalized are amortized over two years. During 1998
and 1999 the Company capitalized $1,659 and $3,129. Accumulated amortization was
$350 and $2,206 at December 31, 1998 and 1999.
Stock Split
In February 1998, the Board of Directors declared a five-for-one Common
Stock split effected in the form of a stock dividend. All references to number
of shares, options and warrants and conversion price and exercise price per
share have been adjusted to reflect this stock split on a retroactive basis.
F-8
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Net Loss Per Common Share
The Company's basic net loss per share is computed by dividing net loss by
the weighted average shares of common stock outstanding during the period.
Diluted earnings per share includes any dilutive effects of options, warrants
and convertible securities. Diluted loss per share as presented is the same as
basic earnings per share as the effect of outstanding options, warrants and
convertible securities is anti-dilutive.
Stock-Based Compensation
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," but applies Accounting Principles Board Opinion No. 25 (APB 25)
and related interpretations in accounting for its stock plans. Under APB 25,
when the exercise price of an employee stock option equals the market price of
the underlying stock on the date of grant, no compensation expense is
recognized.
Use of Estimates
Preparation of the Company's consolidated financial statements requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and related revenues and expenses. Actual results could
differ from those estimates.
Reclassification
Certain 1997 and 1998 amounts have been reclassified to conform to the 1999
presentation.
2. Property, Plant and Equipment
Property, plant and equipment is summarized as follows:
December 31,
---------------------
1998 1999
-------- --------
Land ............................... $ -- $ 8,800
Building ........................... 605 30,931
Network facilities ................. -- 260,280
Network equipment .................. 50,907 65,941
Other support equipment ............ 18,046 23,989
Furniture and fixtures ............. 2,802 4,180
Leasehold improvements ............. 6,506 3,888
-------- --------
78,866 398,009
Less accumulated depreciation ...... (16,399) (39,673)
-------- --------
$ 62,467 $358,336
======== ========
F-9
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
3. Long-Term Debt
Long-term debt consisted of:
December 31,
---------------------
1998 1999
-------- --------
13.25% senior discount notes.................. $138,975 $157,999
Lines of credit............................... 24,000 27,137
Equipment financing........................... 18,860 21,041
Sale-leaseback financing...................... -- 38,246
Subordinated notes payable.................... 27,403 29,165
Other financing (see Note 4).................. -- 12,532
Network facilities financings (see Note 4).... -- 260,280
-------- --------
209,238 546,400
Less current portion.......................... (5,324) (55,950)
-------- --------
$203,914 $490,450
Senior Discount Notes
On March 5, 1998, the Company sold 208,530 units of 13.25% Senior Discount
Notes due 2005 (Notes). Each unit consists of a $1 principal note and three
warrants. The aggregate principal amount of the notes payable at maturity is
$208,530. The sale of the Units resulted in net proceeds to the Company of
$119,203. Cash interest does not accrue nor is it payable prior to March 1,
2002. Thereafter, cash interest on the Notes will accrue on the Notes at a rate
of 13.25% per annum (calculated on a semiannual bond equivalent basis) and will
be payable semiannually in arrears on March 1 and September 1 of each year,
commencing September 1, 2002.
In connection with the Notes, the Company issued 625,590 warrants to
purchase a total of 1,257,436 shares of common stock. Each warrant entitles the
holder to purchase 2.01 shares of common stock at an exercise price of $.01 per
share. The warrants were valued using the Black-Scholes pricing model at
$10,047, which is being amortized as interest expense over the life of the
Notes. Amortization of the warrants value was $867 and $1,166 for the years
ended December 31, 1998 and 1999.
Lines of Credit
The Company has a $25,000 line of credit agreement with a bank which expires
in September 2000. The line of credit is guaranteed by MCI WorldCom and the
Company must obtain MCI WorldCom's consent prior to each borrowing under the
line. At December 31, 1999, the amount outstanding on the line of credit was
$25,000. The line of credit has both Eurodollar and Floating Rate advances. The
Eurodollar and Floating Rate advances accrue interest at LIBOR plus 55 basis
points (6.00 % at December 31, 1999) and prime (8.5% at December 31, 1999).
Interest on the LIBOR borrowings is payable upon maturity and on the prime
borrowings is payable quarterly.
In connection with MCI WorldCom's guarantee of the line of credit agreement,
the Company issued Class A warrants to purchase 8,396,170 common shares and
Class B warrants to purchase 14,204,835 common shares at an initial exercise
price of $3.90 per share. The Class A warrants were immediately exercisable and
expire on December 31, 2000. The Class A warrants were valued at $4,766, using
the Black-Scholes pricing model, and are being amortized as interest expense
over the life of the agreement. Amortization of the warrants for the years ended
December 31, 1997, 1998 and 1999 was $502, $1,589 and $1,589. The Class B
warrants are exercisable only if the line of credit is not repaid in September
2000.
F-10
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
It is management's intention to fully repay the line of credit on or before its
due date. The Class B warrants were deemed to have no value based on
management's intentions and ability to repay the line of credit prior to
maturity.
In July 1999, the Company entered into a $20,000 credit facility with
Foothill Capital Corporation ("Foothill"), which expires in July 2001. The
credit facility contains a $10,000 term loan which was repaid from the proceeds
of the Sale/Lease Back Agreement with CCPRE Eagan, LLC. The remainder of the
facility is a revolving credit facility under which Foothill will lend the
Company up to an additional $10,000 based upon a borrowing base consisting of
the Company's recurring billings and collections from its U.S. customers.
Amounts outstanding under the credit facility incur interest at the Wells Fargo
Bank reference rate plus 1.75% (10.25% at December 31, 1999). The credit
facility is secured by a lien on certain unencumbered and lienable assets. The
credit facility requires the Company to maintain certain financial covenants.
Foothill has agreed under certain circumstances to subordinate or release its
lien on equipment to permit us to obtain equipment financing from third parties.
The credit facility is automatically renewable at maturity until canceled in
accordance with its terms. As of December 31, 1999, the Company has borrowed
$2,137 under the credit facility.
Equipment Financing
The Company has entered into various notes payable with equipment financing
companies. Monthly payments on the installment notes range from $11 to $149,
including imputed interest at rates ranging from 11.65% to 15.58%. The various
notes are due between April 2001 through November 2002 and are secured by
equipment.
Sale-Leaseback Financing
On September 30, 1999, the Company entered into a sale-leaseback back
agreement with CCPRE-Eagan, LLC ("CCPRE"), a Delaware Limited Liability Company,
and an affiliate of Chase Bank, New York. In connection with the agreement, the
Company sold its corporate facilities, including land, building and personal
property to CCPRE and received cash proceeds of $36,538, net of financing
expenses. As part of the agreement, the Company entered into a 20 year lease,
requiring minimum monthly rent payments increasing from $481 to $959, with three
five-year options. The Company is responsible for all taxes, assessments,
utilities and other governmental charges. The Company may repurchase the
corporate facilities on the 24th or 36th month anniversary of the agreement for
$45,600. Beginning in September 2002, CCPRE may require the Company, to
repurchase the facilities for approximately $41,800, less the amount of certain
payments under the lease. Because of the existence of this put option, the
transaction has been recorded as a financing transaction. The carrying value of
the liability is being accreted to the $41,800 put value, at an effective
interest rate of 18.9%.
As additional consideration for the agreement, the Company issued ten-year
warrants to purchase 325,000 shares of common stock at an initial exercise price
of $12.00 per share. The warrants contain an antidilution clause and also
contain a put feature that can be exercised on or after September 30, 2004 if
the Company has not completed an initial public offering. The put feature would
require the Company to repurchase the warrant or shares exercised at 92% of the
appraised value of the common stock, less the exercise price. The warrant, which
is recorded as a liability, was valued at $1,500, using the Black-Scholes
pricing model, and is being amortized as interest expense over a three-year
period.
F-11
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Subordinated Notes Payable
In March through May of 1995, the Company issued a total of $250 of
convertible subordinated notes. From 1995 to 1999, all of the notes were
converted into 657,900 shares of common stock at the conversion price of $.38
per share.
In September 1996, the Company issued to MCI WorldCom a $5,000 convertible
subordinated note originally due September 1999. Interest on the note accrues at
an annual rate of 10%. The Company may redeem the note at any time commencing
January 1, 1998, upon notice to the holder, at the outstanding principal amount
of the note plus interest. The holder has the right to convert the principal
amount of the note into shares of common stock at a conversion price of $1.00
per share. During 1998 and 1999, $635 and $507, of accrued interest was
converted into additional subordinated notes. As of December 31, 1998 and 1999
the outstanding balance of the note was $5,635 and $6,142.
In November 1996, the Company entered into a Preferred Stock, Subordinated
Note and Common Stock Warrant Purchase Agreement ("Investment Agreement") with
MCI WorldCom. Pursuant to the agreement, the Company sold 100,000 shares of
Class A preferred stock, $10.00 par value. The preferred shares, as originally
stated in the agreement, were initially required to be redeemed in December 1999
at a price of $10.00 per share plus an amount equal to all accumulated and
unpaid dividends. In connection with the Silicon Graphics, Inc. investment ("SGI
investment") (see Note 6), MCI WorldCom exchanged its shares of Class A
preferred stock for 115,206 shares of a new Series of 1999 Class A preferred
stock with terms substantially the same as the original Class A preferred stock
entitling one vote for each share held of record, voting together with the
holders of common stock as a single class, on all matters submitted to a vote of
shareholders. Dividends are payable at the rate of 7% and began to cumulate on
January 1, 1997, whether or not earned. As of December 31, 1998 and 1999 the
accumulated and unpaid dividends were $140 and $60.
Under the Subordinated Note Agreement, the Company has available an
aggregate amount of $28,500. The note accrues interest at 7% per annum with an
original due date of December 2003. During 1999, $1,330 of accrued interest was
converted into additional subordinated notes. The amount outstanding on the
subordinated note agreement was $21,693 and $23,023 at December 31, 1998 and
December 31, 1999.
In connection with the Investment Agreement, the Company sold, at a price of
$.01 each, common stock warrants entitling MCI WorldCom to purchase 20,787,500
shares of common stock at an initial exercise price of $.96 share. The warrants
were immediately exercisable and expire on December 31, 2000. The warrants were
valued using the Black-Scholes pricing model at $4,906, which is being amortized
as interest expense over the life of the warrant agreement. In each of the years
ended December 31, 1997, 1998 and 1999 the Company recorded amortization expense
of $1,226. The initial exercise price of $.96 per share increased to $.98 per
share on March 31, 1997, and thereafter increases by an amount of $0.016 per
share on the last day of each calendar quarter during the term of the warrant,
commencing with the calendar quarter ending June 30, 1997. The exercise price
was $1.16 per share on December 31, 1999. None of the warrants have been
exercised as of December 31, 1999.
On February 11, 1998, MCI WorldCom agreed to defer all cash payments of
principal (or premium on) or interest on, or dividend, distribution, redemption
or other payment in respect of the 10% Convertible Subordinated Note, due
September 30, 1999, the Class A preferred stock owned by MCI WorldCom, and the
7% Subordinated Note, due December 31, 2003, until 180 days following the stated
maturity of the 13.25% Senior Discount Notes due 2005. The agreement also
provides that the payment of the principal and interest on the 10% Convertible
Subordinated Note and the 7% Subordinated Note may be accelerated only in the
event of the acceleration of the payment of the principal amount of the 13.25%
Senior Discount Notes following an event of default with respect to the 13.25%
Senior Discount Notes.
F-12
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
The agreement grants MCI WorldCom an option to convert into shares of common
stock at the fair market value on the date of such conversion interest otherwise
due on the 10% Subordinated Note and interest on the outstanding principal
amount of the 7% Subordinated Note from December 31, 2003 through the date such
amount is paid.
The carrying amounts of the Company's debt instruments in the balance sheets
at December 31, 1998 and 1999 approximate fair value.
Maturities of long-term debt as of December 31, 1999 are as follows:
2000......................... $ 55,950
2001......................... 15,085
2002......................... 54,287
2003......................... 25,119
2004......................... 41,805
Thereafter................... 354,154
---------
546,400
Less current maturities ..... (55,950)
---------
$ 490,450
=========
4. Purchase of Network Facilities from Winstar
In December 1999, the Company entered into an agreement with Winstar
Communications (Winstar) pursuant to which the Company purchased a 20-year
indefeasible right of use for backbone and wireless local loop facilities. Under
this agreement, the Company will take title to equipment of varying bandwidth;
Winstar will maintain the equipment, including replacement as necessary, and
maintain its connectivity to Winstar's telecommunications network at a specified
level of functionality over the agreement's term. The Company has the right to
assign or sell its rights under the facility at any time during the agreement's
term. The cost of the 20-year facility is payable in an initial $20,000 payment,
which was paid in January 2000, and quarterly payments, beginning at $5,000 and
increasing to $24,862, over a seven-year period ending December 15, 2006. The
network facility has been capitalized in property, plant and equipment and the
Company has recorded a related liability at the agreed-upon fair value of
$260,280, which liability bears an effective interest rate of 8.3%.
Under a related agreement Winstar made a five-year commitment to purchase
$12,500 of services from the Company, which can be used internally by Winstar or
resold to its customers. The commitment was prepaid in December 1999, and
recorded as deferred revenue. The companies have also entered into a sublease
agreement for space in the Company's Minnesota data center. Winstar will make
monthly payments over 10 years of approximately $81, plus a one-time advance
payment, made in December 1999, of $12,532. The Company is required to repay
this one-time advance at $200 per month over 10 years, at an imputed interest
rate of 15.75%. The advance payment has been recorded by the Company as a
borrowing (see Note 3).
5. Capital Stock
The Company has the following classes of capital stock:
o Undesignated preferred stock, 1,099,525 shares authorized which may be
issued in one or more series; none issued and outstanding at December
31, 1997, 1998, and 1999.
o Class A redeemable preferred stock, 115,206 shares authorized of $10 par
value; 100,000, 100,000 and 115,206 shares issued and outstanding at
December 31, 1997, 1998 and 1999 (see Note 3).
F-13
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
o Class B convertible preferred stock, 5,710,425 shares authorized of $.01
par value; 0, 0 and 5,710,425 shares issued and outstanding at December
31, 1997, 1998 and 1999 (see Note 6).
o Class C convertible preferred stock, 878,527 shares authorized of $.01
par value; 0, 0 and 878,527 shares issued and outstanding at December
31, 1997, 1998 and 1999 (see Note 6).
o Class D convertible preferred stock, 2,196,317 shares authorized of $.01
par value; 0, 0 and 2,196,317 shares issued and outstanding at December
31, 1997, 1998 and 1999 (see Note 6).
o Class E convertible preferred stock, 115,000 shares authorized of $.01
par value, none issued and outstanding at December 31, 1997, 1998, and
1999. (See Note 16).
o Class F convertible preferred stock, 50,000 shares authorized of $.01
par value, none issued and outstanding at December 31, 1997, 1998, and
1999. (See Note 16).
o Class G convertible preferred stock, 10,000 shares authorized of $.01
par value, none issued and outstanding at December 31, 1997, 1998, and
1999.
o Common Stock, 490,000,000 shares authorized of $.01 par value;
6,699,740, 9,288,194 and 9,494,797 shares issued and outstanding at
December 31, 1997, 1998 and 1999.
6. Preferred Stock
In January 1999, the Company issued the 1999 MCI WorldCom Convertible Note
(Note) and in January 1999 and March 1999 the Company borrowed $10,000 and
$15,000 under the Note. In March 1999, the Note was converted into 2,196,317
shares of the Company's Class D convertible preferred stock, par value $.01 per
share. Dividends accumulate on the Class D convertible preferred stock at the
rate of 7% per year of the original purchase price per share and are payable
solely in additional shares of preferred stock if and when declared by the Board
of Directors. The Class D shares of convertible preferred stock are convertible
into shares of common stock on a one for one basis, subject to anti-dilution
provisions. In connection with the Note, the Company issued warrants to purchase
a total of 350,000 shares of common stock. The warrants have an exercise price
of $.01 and are exercisable from April 30, 1999 until April 30, 2004.
In March 1999, the Company entered into an investment with Silicon Graphics,
Inc. (SGI), providing for the purchase of 5,710,425 shares of the Company's
Class B preferred stock and 878,527 shares of the Company's Class C preferred
stock. The holders of a majority of the Class B preferred stock will have the
right to designate one member of the Company's Board of Directors. The aggregate
consideration received by the Company for the Class B preferred stock and the
Class C preferred stock was $75,000, of which $35,000 was paid in cash and
$40,000 was paid by transfer to the Company of a campus facility located in
Eagan, Minnesota. The fair value of the campus facility was determined by an
independent appraisal. The Class B preferred stock and the Class C preferred
stock will be convertible on a one-to-one basis into common stock, subject to
anti-dilution provisions, and will have the right to vote such percentage with
the common stock as a single class. The Class B preferred stock and Class C
preferred stock are convertible immediately following the issuance date and 18
months following the issuance date, respectively. The shares of common stock
into which the Class B preferred stock and the Class C preferred stock are
convertible are subject to certain registration rights. Dividends accumulate on
the Class B and Class C preferred stock at the rate of 7% per year of the
original purchase price and are payable solely in additional shares of preferred
stock if and when declared by the Board of Directors.
In connection with the SGI Investment, the Company entered into a preferred
provider agreement which allows it to purchase hardware, software and services
over a four year period at prices based on SGI's most favored pricing models.
Pursuant to the preferred provider agreement, the Company has made
F-14
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
a firm commitment to purchase $35,000 during the period from December 31, 1998
to December 31, 2000. As of December 31, 1999, the Company has made purchases of
$12,374. In the event the Company does not fulfill this purchase requirement, it
is required to pay SGI 10% of the unfilled commitment.
7. Stock Options and Warrants
Stock Options
The Company's 1994 Incentive Stock Option Plan (1994 Plan) provides for the
granting of incentive and non-qualified stock options to certain eligible
employees and non-employee directors of the Company. Under the 1994 Plan,
7,000,000 shares of common stock have been reserved for the granting of stock
options. In September 1998, the Company adopted the 1998 Combined Stock Option
Plan (1998 Plan). The 1998 Plan provides for the granting of incentive and
non-qualified stock options to certain eligible employees (including foreign
nationals) and non-employee directors and consultants of the Company and any
subsidiary corporation of the Company. Under the 1998 Plan, 25,000,000 shares of
common stock have been reserved for the granting of stock options. Additionally,
the Company has authorized the grant of options to management personnel for up
to 5,465,000 shares of the Company's common stock outside of the Plans. A
majority of the options granted under the above Plans have ten year terms and
vest and become fully exercisable at the end of three years of continued
employment.
In November 1996, the Chief Executive Officer and Chief Technology Officer
were each granted options to purchase 2,000,000 shares of common stock at an
exercise price of $.96, expiring December 31, 2007. These options vested in
incremental amounts based on the number of installed customer sites. In 1998,
the Board of Directors agreed to amend the stock option agreements, vesting the
options immediately. The amendment created a new measurement date which resulted
in the Company recording $11,405 as compensation expense in January 1998.
Option activity is summarized as follows:
Weighted
Shares Average
Available Options Outstanding Exercise
for Grant -------------------------- Price
Under Plans Plans Non-Plan Per Share
----------- ----------- ----------- ---------
Balance at December 31, 1996 ............... 5,079,000 1,992,400 4,377,500 $ .90
Additional shares reserved for issuance .. 15,000,000 -- --
Granted .................................. (3,020,250) 3,020,250 347,500 1.19
Canceled ................................. 157,750 (157,750) -- .80
Exercised ................................ -- (30,000) -- .45
----------- ----------- ----------- -----
Balance at December 31, 1997 ............... 17,216,500 4,824,900 4,725,000 1.00
Additional shares reserved for issuance .. 9,928,600 -- --
Granted .................................. (4,265,000) 4,265,000 750,000 7.31
Canceled ................................. 196,235 (196,235) -- 4.60
Exercised ................................ -- (22,664) -- .77
----------- ----------- ----------- -----
Balance at December 31, 1998 ............... 23,076,335 8,871,001 5,475,000 3.16
Granted .................................. (8,075,970) 8,075,970 -- 2.43
Canceled ................................. 1,957,099 (1,957,099) (10,000) 6.24
Exercised ................................ -- (9,233) -- .50
----------- ----------- ----------- -----
Balance at December 31, 1999 ............... 16,957,464 14,980,639 5,465,000 $2.57
=========== =========== =========== =====
F-15
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
At December 31, 1997, 1998 and 1999, 2,075,226, 8,937,698 and 12,017,861
options were exercisable with weighted average exercise prices of $.78, $2.20
and $2.42.
The following information applies to grants that are outstanding at December
31, 1999:
Options Outstanding
-------------------------------------- Options Exercisable
Weighted ----------------------
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
-------------- ------------ ----------- ----------- ------------ --------
$ .45 703,250 1.8 years $ .45 703,250 $ .45
.96 7,966,528 5.6 years .96 7,481,943 .96
2.00 7,500,720 9.9 years 2.00 840,590 2.00
3.90 1,105,588 6.4 years 3.90 981,422 3.90
8.00 3,169,553 7.9 years 8.00 2,010,656 8.00
---------- ----------
$ .45-- $8.00 20,445,639 7.5 years $ 2.57 12,017,861 $ 2.42
========== ==========
The fair values of the options granted during 1997, 1998 and 1999 was $ .33,
$1.57 and $ .97 per share. The fair value for these options was estimated at the
date of grant using a minimum value option pricing model with the following
weighted-average assumptions for 1997, 1998 and 1999: risk-free interest rate of
6.5%, 4.78% and 5.88%; dividend yield of 0%; and a weighted-average expected
life of the option of five years.
The minimum value option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions.
For purposes of pro forma disclosures, as required by FASB Statement No.
128, the estimated fair value of the options is amortized to expense over the
options' vesting period. The Company's pro forma net loss and net loss per
common share, had the fair value based method been used, are set forth below:
1997 1998 1999
-------- --------- ---------
Net loss applicable to common stock,
as reported ......................... $(33,706) $(121,948) $(145,117)
Pro forma net loss .................... (35,236) (127,304) (147,423)
Net loss per common share as reported . $ (5.19) $ (13.87) $ (15.58)
Pro forma net loss per common share ... (5.42) (14.48) (15.82)
F-16
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Warrants
Warrants have been issued in connection with various financing transactions.
The warrants are immediately exercisable. The following is a table of the
warrants to purchase shares of the Company's common stock:
Exercise
Warrants Price Expiration
Outstanding Exercisable per Share Date
----------- ----------- --------- ----------
Balance at December 31, 1996 ...... 27,559,165 27,559,165 $ .60 - $1.50 2000-2003
Granted:
Line of credit (see Note 3) .. 22,601,005 8,396,170 3.90 2000
---------- ----------
Balance at December 31, 1997 ...... 50,160,170 35,955,335 .60 - 3.90
Granted:
13.25% Senior Discount Notes
(see Note 3) ............... 1,257,436 1,257,436 .01 2005
---------- ----------
Balance at December 31, 1998 ...... 51,417,606 37,212,771 .01 - 3.90
Granted:
1999 MCI WorldCom
Convertible Note (see
Note 6) .................... 350,000 350,000 .01 2004
Sale-Leaseback Financing
(see Note 3) ............... 325,000 325,000 12.00 2009
---------- ----------
Balance at December 31, 1999 ...... 52,092,606 37,887,771 $ .01 -$12.00
========== ==========
8. Income Taxes
At December 31, 1999, the Company had net operating loss carryforwards of
approximately $195,464. These carryforwards are available to offset future
taxable income through 2019 and are subject to the limitations of Internal
Revenue Code Section 382 resulting from changes in ownership.
The Company recorded a foreign income tax benefit of $1,352 in 1998.
The effective tax rate differs from the statutory rate primarily as a result
of the following:
1997 1998 1999
----- ----- -----
Tax at statutory rate...................... 34.0% 34.0% 34.0%
State income taxes......................... 6.0 6.0 6.0
Foreign tax benefit........................ -- (1.1) --
Impact of net operating loss carryforward.. (40.0) (40.0) (40.0)
----- ----- -----
--% (1.1)% --%
===== ===== =====
F-17
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Components of deferred tax assets are as follows:
December 31,
----------------------
1998 1999
-------- --------
Deferred assets:
Net operating loss.............. $ 45,282 $ 74,276
Deferred interest............... 4,323 10,206
Stock option amortization....... 4,892 4,937
Other........................... 199 6,783
-------- --------
54,696 96,202
Deferred liability:
Depreciation and amortization... (1,602) (3,193)
-------- --------
Net deferred income tax assets.... 53,094 93,009
Valuation allowance............... (53,094) (93,009)
-------- --------
Net deferred income taxes......... $ -- $ --
======== ========
9. Commitments and Contingencies
Telecommunications Contracts
The Company enters into various term contracts with suppliers of
telecommunications services for the purpose of receiving discounts off the
standard service offerings. Some of these contracts will result in termination
liabilities if the contract is terminated prior to the expiration date of the
contract. The termination liabilities are generally based upon the minimum
monthly dollar amount committed to the vendor multiplied by a termination
liability percentage, multiplied by the number of months remaining in the
contract. MCI WorldCom is the Company's largest supplier of telecommunications
services accounting for charges of $5,538, $11,840 and $16,735 for the years
ended December 31, 1997, 1998 and 1999.
Guaranteed monthly usage levels of data communications with certain of the
Company's telecommunication vendors and MCI WorldCom at December 31, 1999
aggregate to the following annual amounts:
Guaranteed
Guaranteed Usage
Usage (MCI
(all vendors) WorldCom)
------------- -----------
2000.................... $ 7,204 $ 2,940
2001.................... 4,030 1,658
2002.................... 1,373 --
2003.................... 899 --
2004.................... 187 --
-------- -------
$ 13,693 $ 4,598
======== =======
F-18
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
The termination contingency of data communications with certain of the
Company's telecommunication vendors and MCI WorldCom at December 31, 1999
aggregates to the following annual amounts:
Termination Termination
Contingency Contingency
(all vendors) (WorldCom)
------------- ----------
December 31:
1999...................... $8,408 $3,212
2000...................... 3,096 1,490
2001...................... 707 --
2002...................... 523 --
2003...................... 524 --
Operating Leases
The Company also leases certain general office facilities. Operating
expenses including maintenance, utilities, real estate taxes and insurance are
paid by the Company. Total rent expense under operating leases was $592, $2,189
and $2,586 for the years ended December 31, 1997, 1998 and 1999. Future minimum
lease obligations in excess of one year at December 31, 1999 are as follows:
2000.................................... $ 1,381
2001.................................... 1,189
2002.................................... 942
2003.................................... 664
2004.................................... 417
Thereafter.............................. 627
-------
$ 5,220
=======
Contingent Liabilities
Certain holders of warrants issued in connection with bridge loans in 1995
and 1996 have commenced litigation seeking a reduction in the exercise price of
those warrants and attorney's fees. Although the warrants provide for
adjustments under certain circumstances, the Company believes no adjustment is
required. Should that litigation be successful, the gross proceeds receivable by
the Company from exercise of those warrants would be reduced from approximately
$8,400 to $4,900. In February 2000, the court denied the plaintiff's motion for
summary judgement that the warrant price should be reduced. The suit is
scheduled to begin trial in April 2000.
The Company is engaged in certain legal proceedings and claims arising in
the ordinary course of its business. The ultimate liabilities, if any, which may
result from these or other pending or threatened legal actions against the
Company cannot be determined at this time. However, it is the opinion of
management that facts known at the present time do not indicate that there is a
probability that such litigation will have a material adverse effect on the
financial position of the Company.
10. Savings and Retirement Plan
The Company has a 401(K) savings and retirement plan covering all eligible
employees. Employees may contribute up to 15% of their compensation. The Company
does not make contributions to the plan.
F-19
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
11. Business Acquisitions
Acquisition of FreeMail, Inc.
In December 1997, the Company acquired the outstanding common stock of
FreeMail, Inc. (FreeMail). The results of operations of the acquired business
are included in the accompanying financial statements since the date of
acquisition.
The Company issued 125,000 shares of Common Stock, with a fair value of
$488, as consideration in connection with the acquisition. In accordance with
the acquisition, the Company was to pay a quarterly payment to the former
shareholders of FreeMail as additional contingent consideration equal to 5% of
the gross collected revenue derived by the Company from certain identified
FreeMail products. The total amounts of the quarterly payments were not to
exceed $3,000.
Effective June 1, 1999 the Company amended the agreement to change the
amount and rate of payment of contingent consideration due to the former
FreeMail shareholders. The Company decreased the amount payable from $3,000 to
$2,000, payable $1,000 in cash and $1,000 in shares of our common stock at fair
market value. The rate of payment has also been changed from 5% of revenue from
a selected class of customers to 5% of our total collected revenue, calculated
quarterly. In accordance with this amendment, the first payment was made on
October 30, 1999 for the quarter ended September 30, 1999. As of December 31,
1999, the Company recorded $647 as additional goodwill, which represents the
contingent payments made.
The acquisition was accounted for as a purchase. The inclusion of the
FreeMail operating results for periods prior to the date of acquisition would
not have materially affected results of operations.
Acquisition of 4-Sight Limited
On March 13, 1998, the Company purchased all of the outstanding capital
stock of 4-Sight Limited, a private limited company organized under the laws of
the United Kingdom ("4-Sight"), for $20,000 in cash plus related acquisition
expenses of $500 and 2,500,000 shares of the Company's Common Stock valued at
$20,000. In addition, the former shareholders of 4-Sight will be entitled to
receive up to an additional 750,000 shares of the Company's Common Stock in the
event certain sales objectives are met over the three years ending March 2001.
No shares have been issued as of December 31, 1999. The shares to be issued as
contingent consideration will result in the Company recording additional
goodwill, which will be amortized over its estimated useful life.
The acquisition was accounted for under the purchase method of accounting
and, accordingly, the operating results of 4-Sight have been included in the
consolidated operating results since the date of acquisition.
On acquisition, approximately $32,100 of goodwill was recorded, which is
being amortized on a straight-line basis over five years. The following table
shows the pro forma consolidated results of operations as if 4-Sight had been
acquired as of the beginning of the periods presented:
Year Ended December 31,
-------------------------
1997 1998
---------- ------------
(Unaudited)
Revenues............. $ 20,833 $ 21,109
Net loss............. (37,942) (121,922)
Net loss per share .. $ (4.22) $ (13.86)
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition had been in effect for the entire periods
presented. In addition, they are not intended to be a
F-20
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
projection of future results and do not reflect any synergies that might be
achieved from combined operations.
12. Joint Venture
On July 27, 1999, the Company entered into a joint venture agreement with
Sumitomo Corporation, Electronics Division to distribute services in Japan.
Under this agreement the Company's wholly-owned Japanese subsidiary and Sumitomo
have agreed to form a Japanese joint venture company to be known as WAM!NET
Japan K.K. Initially, the Company will own 90% of WAM!NET Japan K.K., and
Sumitomo will own 10%. Sumitomo has an option to purchase up to 40% ownership
interest in WAM!NET Japan unless that purchase would reduce the Company's
ownership below 51%. The joint venture agreement provides that the Company will
furnish the use of equipment, infrastructure, and some support services.
Additionally, it requires the Company to fund the joint venture future
operations. The operations of the joint venture in 1999 were not material.
13. Related Party Transactions
On September 1, 1998, the Company entered into a $305 Secured Recourse
Promissory Note and Pledge Agreement with its Chief Technology Officer. The Note
accrues interest at 7% annually.
A partner at the Company's external legal counsel is also the father of the
Company's President and Chief Executive Officer and owns 250,000 shares of
Common Stock of the Company and holds an option to purchase 200,000 shares of
the Company's common stock. Additionally, another partner of this firm, is also
a director of the Company and holds an option to purchase 150,000 shares of the
Company's common stock. During the years ended December 31, 1997, 1998 and 1999,
the Company incurred legal fees and expenses of approximately $157, $1,111 and
$1,227, to such firm for services rendered in connection with litigation and for
general legal services.
Management believes the fees paid for the above services rendered to the
Company were on terms at least as favorable to the
Company as could have been obtained from an unrelated party.
14. Major Customers
In 1997 three customers accounted for 24%, in aggregate, of net sales. In
1998 and 1999, no single customer accounted for more than 10% of net sales.
F-21
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
15. Industry Segment and Geographic Information
The Company, operating in a single industry segment, provides a managed,
high speed digital data delivery network service. Information regarding
operations in different geographic areas is as follows:
Year Ended December 31,
---------------------------------
1997 1998 1999
------- --------- ---------
Net sales to unaffiliated customers:
United States...................... $ 1,555 $ 8,216 $ 15,945
Europe............................. -- 9,005 8,333
Rest of World...................... -- 369 517
------- --------- ---------
Total net sales...................... $ 1,555 $ 17,590 $ 24,795
======= ========= =========
Identifiable assets:
United States...................... $29,134 $ 107,101 $ 419,777
Europe............................. -- 18,358 15,358
Rest of World...................... -- -- 120
------- --------- ---------
Total assets......................... $29,134 $ 125,459 $ 435,255
======= ========= =========
"United States" includes United States and Canada. "Rest of World" includes
principally Japan and the Asia-Pacific region. Net revenue from sales to
unaffiliated customers is based on the location of the customer. Identifiable
assets are classified based on the location of the Company's facilities.
16. Subsequent Events
In December, 1999, the Company entered into a transaction providing for the
purchase by Winstar of 50,000 shares of the Company's Class E convertible
preferred stock and an option for Winstar, its designated affiliates and others,
to purchase an additional 50,000 shares of the same class of stock. The purchase
of these shares was finalized in March, 2000. Pursuant to the terms of this
transaction, Winstar purchased a total of 85,000 shares of Class E convertible
preferred stock for $85,000, of which $35,000 was paid in cash and $50,000 was
paid in the form of $1,071,429 shares of Winstar common stock valued at $46.66
per share (as adjusted for the 3 for 2 Winstar stock split declared in February
2000). Other investors purchased 16,725 shares of Class E convertible preferred
stock for an aggregate $16,725 in cash. The Class E convertible preferred stock
accumulates dividends at an annual rate of 7%, which are added monthly to the
accreted liquidation value of the stock. Each of the two largest purchasers of
Class E convertible preferred stock has the right to elect one director, and
vote on an as-converted basis, not to exceed 17.5% of the total voting power, on
all matters submitted to the vote of common stock holders, including the
election of directors. The Class E convertible preferred stock is currently
convertible into 19,714,147 shares of common stock at an initial conversion of
$5.16 per share of common stock subject to anti-dilution provisions. Holders of
Class E convertible preferred stock may convert their shares into common stock
at any time, and are required to convert their shares into common stock, after
an initial public offering of the Company's common stock, the common stock
trades for a price of at least $8.00 per share for twenty consecutive trading
days.
In February 2000, SGI purchased 10,000 shares of Class F convertible
preferred stock for $10,000 in cash. The rights and preferences of the Class F
convertible preferred stock, including its conversion provisions, are
substantially the same as the rights and preferences of the Class E convertible
preferred stock, except that the holders of Class F preferred stock do not have
the right to separately elect directors and there is no cap on the voting power
of that class. The Class F convertible preferred stock is initially
F-22
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
convertible into a total of 1,937,984 shares of common stock, at an initial
conversion rate of $5.16 per share, subject to anti-dilution provisions.
In February 2000, the Company sold to Sumitomo and certain other investors
10,000 shares of Class G convertible preferred stock for an aggregate of $10,000
in cash. Holders of Class G convertible preferred stock have the right to vote,
on an as-converted basis, with holders of common stock on all matters submitted
to a vote of common stockholders. The Class G convertible preferred stock is
initially convertible into 1,937,984 shares of common stock, at an initial
conversion rate of $5.16 per share, subject to anti-dilution provisions. The
shares of Class G convertible preferred stock will mandatorily convert into
shares of common stock upon completion of an initial public offering.
F-23
Schedule II -- Valuation and qualifying accounts
Deductions
--------------------------
Charged
Balance at to costs Charged Balance at
beginning and to other end of
Description of period Additions expenses accounts period
- ----------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts
December 31, 1999 $430,000 $1,148,000 -- $8,000 $1,570,000
December 31, 1998 10,000 420,000 430,000
December 31, 1997 -- 12,500 2,500 10,000
F-24