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, 2000
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 26, 2001, there were 12,193,019 shares of the Company's Common Stock
outstanding.
Documents Incorporated by Reference--Not applicable.
====================================================
FORM 10-K
TABLE OF CONTENTS
ITEM PAGE
- ---- ----
PART I
ITEM 1. BUSINESS................................................... 1
ITEM 2. PROPERTIES................................................. 20
ITEM 3. LEGAL PROCEEDINGS.......................................... 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........ 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..................................... 21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA....................... 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................... 23
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK............................................. 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................ 30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................... 30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......... 30
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............................................. 42
IMPORTANT FACTORS RELATING TO FORWARD-LOOKING STATEMENTS................. 45
SIGNATURES - WAM!NET INC................................................. 46
FINANCIAL STATEMENT SCHEDULES............................................ F-1
ITEM 1. BUSINESS.
Overview
We own and operate a globally networked Information Technology (IT) platform
that we market and sell as a utility to commercial and government customers who
require a common digital computing and communications infrastructure to
collaborate online with their communities of interest. Our IT platform tightly
integrates a global high bandwidth network with highly capable data storage and
hosting centers and vertically tailored software applications. Customers use our
services to digitize mission-critical business processes and integrate these
into their enterprise or supply chains.
We offer our customers a suite of managed data services including 1) digital
transport services 2) digital storage services 3) application hosting services
4) managed hosting services and 5) professional services. Customers purchase our
services on an outsourced basis in which they pay a transactional charge per
use, similar to a utility. Through our services customers gain access to
leading-edge technology without the high cost and challenges of managing
technology themselves.
Customers apply our services to a wide range of business needs that includes the
primary requirement of digital collaboration in the sharing, storage and
management of large data volumes. A primary application of our IT platform
includes the production, management and distribution of media. Examples of media
include advertising, product packaging and general brand marketing materials; TV
programming; films, video games, recorded music and other entertainment; news
content and publications; video; web materials; and general graphical rich
communications content.
Our commercial customers are primarily brand-recognized companies in the
entertainment, broadcast, advertising, publishing, printing, retail, financial
services, and consumer goods industries. They use WAM!NET's services to digitize
the process of collaborative workflow among their supply chains to produce,
manage and distribute media content. Our services and our IT infrastructure
provide these customers a common electronic platform to seamlessly integrate
their production processes and digitally collaborate online. We enable these
customers to achieve measurable operating efficiencies, productivity gains, cost
savings, as well as improved time-to-market for media-based products and new
revenue-generating opportunities.
As government agencies are among of the largest producers and distributors of
media content, we began offering our services to government agencies during
2000. Our government customers use WAM!NET services for media production and
management. An example is our participation as a tier one subcontractor on the
EDS-led consortium that is creating, delivering and managing the Navy Marine
Corps Intranet (NMCI), a common computing and communications environment to link
more than 300 Navy and Marine Corps bases located in the U.S., certain
territories and possessions and Guantanamo Bay, Cuba. This Intranet is designed
to enhance communication and the readiness of the U.S. Armed Forces for both
war-fighting and business purposes. Our principle role for NMCI is to design,
install and manage each of the base area networks and local area networks within
each base; and use our experience and expertise in the creation and management
of our global WAM!NET network.
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. The media
production supply chain is made of small, medium and large companies. Our
offering provides a range of services to meet customers' varying needs and also
provides them 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.
We specifically target companies that own the resulting media content. We call
these firms "specifiers" as they decide the partners with whom they will work on
a given media production project, as well as how they will all work together.
Many of these specifiers actively encourage their partners to purchase our
services and, in some cases, pay the fees incurred by their partners.
As the number of influential, industry-leading firms that rely on our services
grows, the value of our network and services to current and prospective
customers increases. We believe businesses that gain the most cost savings by
digitally integrating their supply chains via WAM!NET will become the strongest
proponents of our services. As of December 31, 2000, we had over 2,100 sites
consisting of dedicated customer points of presence (C-POP) devices and
dedicated high-speed local access to our network. In addition, we had over
14,700 users who access our suite of services using the public Internet and
dial-up services globally.
Users of our services include:
o Entertainment customers including Miramax, Turner Studios, Lyrick Studios,
Universal Music, and Square, the world's largest animator serving the video
game industry
o Broadcast customers including the BBC and Nickelodeon
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o Advertising customers including Young & Rubicam Inc., J. Walter Thompson,
Inc, DDB Needham, Saatchi & Saatchi, Colle & McVoy, and Foote, Cone and
Belding
o Publishing customers including Time Inc., Forbes, The Economist, LA Times,
Pearson Education, Trader Publishing, and USA Today
o Printing/prepress customers including Colorhouse, Bowne Printing, AGT/Seven
Worldwide, and American Color
o Retail customers including Sears Roebuck & Co., Williams-Sonoma, Office
Max, Victoria's Secret, and Jack-In-The-Box
o Financial services customers including Bank of America, MetLife, and
Merrill Lynch
o Consumer goods/service customers including Delta Faucet, Avon, Caterpillar,
Ford Motor Company, Tyson Foods, Fruit of the Loom, Frito Lay/Pepsico,
Glaxo Wellcome, Carnival Cruise Lines, and Mandalay Bay.
o Government users of our services include General Services Administration,
Navy Marine Corps, and Immigration and Naturalization Services.
Market Opportunity
WAM!NET is addressing a significant market opportunity that is being driven by
trends to outsourced IT services like transport, storage, hosting and
application management. The following are what we see as key drivers of our
market opportunity.
o Global Media Production and Storage Spending is Significant: According to
GISTICS, a leading media industry research firm, companies spent $850
billion producing and distributing media worldwide in 1999. Of this, $60
billion was spent on physical couriers in the transport of analog tapes,
CDs, reels, and final output plus the final storage of this content on
disks, tapes and local hard drives.
o IT Outsourcing/Utility Trend: The market is increasing for broad IT
services. According to Gartner, Forrester and IDC, by 2003, the markets for
Network Infrastructure, Storage Infrastructure and Hosting Services are
projected to be $100 billion, $48 billion, and $18 billion, respectively.
o Media Assets Driving Outsourced Data Storage Requirements: Forrester
Research estimates that online storage for the Global 2,500 alone will grow
nearly 80% annually during the next two years. However, this research is
primarily focused on traditional corporate data storage needs, not media
management needs. For companies in media production, these estimates are
expected to be much higher primarily because of the move to video and
graphic-rich communication. These companies now create upwards of one
Petabyte (one billion megabytes) of media per day - nearly all of which is
on analog platforms that are in the process of converting to digital. For
example, a typical full length digitized film is 2 million megabytes and a
full-page photography advertisement is 75 megabytes, while a full page of
text is only about 1 megabyte.
This growth in data, combined with the trend toward outsourcing, has resulted in
a significant demand by media-oriented firms and corporate marketing departments
for outsourced storage services in the very near future, as well as a preference
to work with a single full-service provider.
We believe businesses that work online with their media production, management
and distribution supply chain partners in a collaborative digital environment
will enjoy considerable competitive advantages including:
o increased operating efficiencies;
o considerable cost-savings;
o improved time-to-market for media-based materials and products; and
o improved ability to more rapidly exploit market opportunities;
We believe our government market opportunity is also very substantial and is
being driven by similar trends. For example, the NMCI contract awarded to EDS
has a five-year value of $4.6 billion and is one of the largest IT contracts
ever awarded.
Business Strategy
Our objective is to create the global industry standard for online collaborative
media production, management and distribution and for the provision of network
design, management and infrastructure services for enterprise networks such as
NMCI. We plan to achieve this objective through the following key strategies:
o Capitalize in our first-to-market and leadership advantage with our
existing influential customer base.
o Leverage our large customer base by delivering new services that further
integrate their workflow and media supply chains.
o Continue significant momentum in gaining additional top-tier customers and
penetrating their trading communities with multiple, highly profitable
services
o Continue our open IP infrastructure approach. Integrate public and private
IP infrastructures to meet the global needs of our customers most
effectively. And continue attracting and integrating software applications
that are geared toward the needs of our chosen markets.
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o Leverage our involvement with the NMCI initiative and our success with
other government customers to gain new business in the government
marketplace worldwide.
o Leverage our success in the media market to gain easier entry into and
apply our business model to other "bandwidth hungry" community of interest
vertical markets (such as health care, engineering, etc.)
o Continue expansion into global markets such as Europe and Asia Pacific Rim
o Leverage strategic relationships to expand distribution channels, integrate
emerging technologies, develop new hosted applications and services, and
reduce costs.
Services
We provide our commercial and some government customers with secure, seamless
access to network and Industry Smart network services including managed
transport, storage and hosting services. Our customers use our services to
collaborate efficiently with their production supply chain for the creation,
management and distribution of media. We offer our services on a utility model.
Our customers pay for our services as used with a minimum purchase requirement.
This allows our customers to gain access to current technologies without
incurring themselves the high cost and the challenges of acquiring and managing
technology infrastructures.
We offer the following services:
o Managed Digital Transport Services;
o Managed Digital Storage Services;
o Application Hosting and Complex Hosting Services;
o Professional Services
Managed Digital Transport Services:
We offer managed digital transport services supporting static and motion media
formats. We provide managed services with Service Level Agreements (SLAs)
ranging from very high SLAs over WAM!NET's Private IP Network to lower SLAs over
the public Internet. Our transport services allow customers to access our
Private WAM!NET network, and all of our services, including storage and hosted
media application services. By integrating WAM!NET's private IP Network with the
public Internet, customers can quickly plug into a common workflow platform and
choose the SLA that best fits their needs.
o Direct Service. This is our fastest, most secure and most reliable
transport service supporting static media formats. This service offers
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 C-POP device on our customers'
premises, a dedicated leased line or wireless connection to our network,
and access to our Industry Smart user interface, applications and tools, as
well as training and support on a 24 hours per day, seven days per week
basis. Customers may choose among various speeds and capacities to meet
their individual requirements. Direct service prices include a monthly
service fee and a use fee per transaction.
Compressed Video Service. This service utilizes our Direct service and a desktop
video appliance for the transport and viewing of compressed video material in
MPEG 1 and MPEG 2 formats. The service is primarily used for digital transport
of broadcast advertising, film, and special effects material supporting the
iterative review process between the client and its supply chain partners doing
the creative video work. We support the appliance for the different capability
requirements. WAM!NET began commercially offering this service in the first half
of 2000. Pricing for this service includes a monthly service fee and a
transaction per megabyte pay-per-use fee.
Tracked Service. Offered at a lower price point than our Direct Service, our
Tracked Service does not require a dedicated on-site C-POP device or dedicated
connection to our network. Our Tracked Service is geared toward static media
formats and offers the security and predictability of dial-up connectivity to
our network, at slower transmission speeds and without the performance level of
Direct Service. Tracked service is designed for customers with confidential and
time-sensitive work who do not exchange a sufficient volume of data to require a
dedicated Direct service connection. With Tracked Service, we provide access to
our network and Industry Smart users interface, applications and tools, a
dial-up networking card, training and customer support on a 24 hours per day,
seven days per week basis. Tracked Service is priced on a transactional, per
megabyte, pay-per-use basis. We commercially released our 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 the service through our website at
www.wamnet.com. Internet Gateway users have access to the same sophisticated
Industry Smart tracking, reporting and directory applications and tools that are
available with our Direct and Tracked Services. 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 Service is also priced on a
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transactional basis by megabyte, pay-per-use basis.
In addition to allowing subscribers to set up their own Internet Gateway
accounts, we offer Direct Service subscribers the opportunity to create and host
Internet Gateway accounts for their employees, customers and workflow partners
to standardize their exchange of data. In this arrangement, hosts pay the
transaction fees for their hosted participants. The host, for example, 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 and digitize their collaborative media
supply chain workflow.
Managed Digital Storage Services:
Our storage services are accessible to our customers on our network. Customers
choose price and performance levels, which include minimum storage volume
requirements under an annual or multi-year contract. Our customers pay 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.
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 expenditure and simplified pay-per-use
pricing plans. Our services permit efficient collaboration as the stored files
are easily accessible via WAM!NET's Direct service by media supply chain
partners.
We commercially released our WAM!BASE storage services in the first half of
2000. The service is used primarily by customers for Collaborative Digital Asset
Management -- the management of corporate brand assets through the digitization,
cataloging and central storage of brand materials like logos and product images
to enable efficient re-use and re-purposing of assets by supply chain partners.
This service is accessible only through Direct service. It incorporates a 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, and later this year, 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. We intend to
continue to enhance the WAM!BASE service by integrating a number of versatile
applications and multiple storage options in the future.
Applications Hosting and Complex Hosting Services:
Media Applications Hosting
- --------------------------
We provide hosting services to media-oriented software vendors in our data
center/hosting facilities. We target application software vendors in the media
production, management and distribution arena, although we have and continue to
look to vendors that have strong applications aligned with our growth
strategies. The services are accessible through the WAM!NET network and are
similarly priced on a transactional basis.
We currently offer hosted Rendering On Demand (ROD) services. The rendering
process requires specialized software and extensive computing power. We host
industry-leading rendering software 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 compute a rendering job. Firms
that perform rendering services in-house typically incur significant expenses to
purchase rendering software and high-performance computing hardware and employ
trained personnel to conduct the rendering functions and maintain the technology
platform. Our service allows customers to avoid investing in this technology.
Firms that currently maintain their own servers also may require our service to
serve as overflow capacity for peak project times. We price the ROD 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.
We also host Industry Smart (vertically tailored) software applications and
tools that are bundled with our Managed Transport Service that add significant
value to the service, including:
o Transmission Director. This application serves as the primary user
interface for our Direct and Tracked Services. Transmission Director
provides customers with the capacity to establish and maintain address
books, specify workflow routing instructions, create and use job
tickets and specify file and job ticket editing criteria. We have also
developed Transmission Director 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.
o Remote Proofing. WAM!PROOF is our remote proofing and printing
solution that allows Direct customers to print automatically to a
remote output device such as color proofers, color copiers, or laser
printers manufactured by 15 major suppliers, including Kodak,
Polaroid, Imation and DuPont. This application allows customers to
rapidly distribute color
4
proof copies of printed media to supply chain partners for review and
approval of production jobs, eliminating the delays and errors
associated with messengers, overnight couriers or manual processes.
o Info Center. This tool enables customers to manage their supply chain
relationships on WAM!NET and to track their use of our services.
Customers can search and view 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.
They can also create, authorize, restrict and manage the exchange of
data among their partners.
o Electronic Job Tickets. This tool 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. Customers may choose
between our standard job tickets or, for a fee, create customized job
tickets to meet their specific needs.
Managed Hosting Services
- ------------------------
We provide fully managed hosting services for our customers where we integrate,
own and operate a technology platform for a customers' specific needs. These
services were first made available in third quarter 2000 and are designed to
enable reliable, scalable, mission-critical e-commerce/e-business solutions.
Managed hosting services are typically custom-oriented solutions and are priced
according to the customers' equipment and capacity requirements.
Professional Services:
In the fourth quarter of 2000, we acquired a small professional services firm
specializing in Internet-oriented process re-engineering. We intend to offer our
customers fee-based consulting services that will facilitate more efficient use
of our services.
Our Network
We own and operate a private, IP-based global network connecting major media
centers around the world. Our network consists of high-speed, ATM backbone and
leased dedicated high-bandwidth fiber optic capacity connecting our two
strategically located storage and hosting centers with our 30 data aggregation
hubs. Our network and services are designed to accommodate the workflow
automation requirements of our subscribers including the need to transmit and
store large media files with greater speed, predictability, reliability and
efficiency than many other networks and storage services including those based
on the public Internet. Our network and storage infrastructure 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 globally networked infrastructure includes the following:
o Storage and hosting centers. We have established and deploy primary data
centers in North America (Eagan, Minnesota) and Europe (Brussels, Belgium).
We maintain a back-up data center facility in Las Vegas, Nevada. Our data
centers serve as control centers for our network, housing specialized
equipment to manage and monitor our network 24 hours per day, seven days
per week. Each of our two centers is capable of managing all of our data
transportation, hosting and storage operations, and the back up data center
can be made operational overnight in the event of catastrophe. Automated
network monitoring provides continuous monitoring capabilities, including a
problem notification system that automatically alerts network engineers of
problems. Key aspects of our network are continuously monitored, including
data center equipment, distribution hub equipment, backbone lines, local
customer connections and C-POP devices. We notify customers in the event of
service disruptions or equipment failures, and manage the restoration of
service.
o Network Backbone. Our 30 distribution hubs are interconnected for speed and
redundancy with a meshed ATM backbone provided by various carriers under
operating agreements that permit us to increase backbone bandwidth as
needed. Additional network redundancy is provided by a series of private
lines leased from diverse carriers on different paths that 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 155Mb per second on various routes in the United
States.
o Network Local Loop. In North America, local loop connections linking
distribution hubs and C-POP devices at customer sites are currently
provided by MCI WorldCom, Winstar, Competitive Local Exchange Carriers, 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 Post Telegraph
and Telephone ("PTT") providers to provide such services elsewhere in the
world. Winstar has agreed to provide wireless local loops at speeds ranging
from multiple 1.5Mb to 155Mb per second to some customers in major metro
areas. This wireless technology eliminates the cost and time required to
deploy fiber.
o Network Points of Presence. Our hubs consist of large router configurations
from Cisco Systems, Inc. that serve to route data
5
traffic across our network. Our hubs are co-located with MCI WorldCom,
Winstar, or other providers. Each hub is interconnected over our meshed ATM
backbone through at least two diverse routes. We have hubs in the following
cities:
North America Europe Asia/Pac Rim
Atlanta Amsterdam Tokyo
Boston Brussels Singapore
Chicago Copenhagen Sydney
Dallas Frankfurt
Denver Hamburg
Detroit London
Las Vegas Manchester
Los Angeles Paris
Miami Stockholm
Minneapolis
New York City
Newark
Oakland
Philadelphia
Seattle
St. Louis
Toronto
Washington D.C.
* Direct Customer Points of Presence (C-POP) devices. A key differential of our
network is our deployment of C-POP devices on our customers' premises. We have
installed on customer premises over 2,100 C-POP devices of varying size and
complexity based on customer requirements. These devices usually contain a
UNIX-based system, a Cisco router, a CSU/DSU, an uninterruptible power supply
and disk storage. Our C-POP devices directly connect our customers to our hubs
using a dedicated, local loop fixed bandwidth circuit, to provide a secure,
predictable and reliable connection to our private backbone network. We control
all of our C-POP devices remotely, allowing us to fully manage the network
end-to-end and rapidly provision new services. In addition, our C-POPs are
scalable to allow for increase customer use.
o Storage and Hosting 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 facility and includes
over 40,000 square feet of environmentally controlled floor space suitable
for housing large-scale computer, hosting and storage systems. A back-up
facility is located in our Las Vegas data center and an additional data
center, hosting and storage infrastructure is 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
Since inception, we have made significant investments in building a direct sales
channel to serve the graphic communication segment of the media and
entertainment industry. Our initial sales and marketing strategies were aimed at
penetrating the segments of the media market that were already aware of the
importance and benefits of online collaborative workflow. These initial targets
required less education on the value of complete digital workflow. In addition,
they included companies that influence others in the industry as they make
technology purchasing decisions. These initial efforts obtained customers for
our services from many of the leading advertising agencies, magazine and book
publishing companies, commercial printers and pre-press firms.
More recently, we added to our commercial market focus the motion media segment
of media and entertainment including film studios broadcast companies and
post-production and animation firms, as well as consumer goods/services and
retail segments.
Our current selling approach in the commercial market is based on a consultative
selling model, which leverages our strategic partnerships and customer
relationships. Our sales and marketing objectives include:
o expanding a customer's online supply chain by leveraging relationships with
the content owner who can influence and/or specify the sale of our services
to its partners;
o increasing utilization of services among existing customers by expanding
their online supply chain, as well integrating additional services such as
digital storage, rendering, hosting and professional services;
o capturing additional multi-site customer opportunities;
6
o developing new channels to sell and support our services; and
o marketing and selling to new vertical industries worldwide.
Our commercial sales organization is structured to support our markets on a
global basis. We currently have sales groups in North America, Europe, Japan and
Australia. Our direct sales force includes coverage in cities such as: New York,
Chicago, Boston, Los Angeles, Washington D.C., Dallas, San Francisco, Atlanta,
Seattle, Minneapolis, London, Amsterdam, Frankfurt, Hamburg, Paris, Stockholm,
Sydney, and Tokyo. Our sales group performs the following activities:
o Account Management: We work with our existing customers to expand
online workflow among the customers' supply 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 content
owners and thus influential within their media production supply
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:
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.
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.
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.
During the first half of 2000, we began marketing our services to agencies of
the federal, state and local governments. We created a separate marketing and
sales group with significant government experience to sell our services directly
to the government, and we developed teaming relationships to package our
services in multi-provider offerings to the government. In the second quarter of
2000, we obtained listing of our services on the General Services Administration
(GSA) Schedule. GSA listing permits federal agencies to issue purchase orders
for listed services. In January 2001, through contract with the GSA, we began
hosting the GSA action site at which the GSA auctions surplus property. The site
may be viewed at gsaauctions.gov. Through teaming arrangements and subcontracts,
we provide the Immigration and Naturalization Services (INS) the ability to
review at one central facility the required x-rays taken at eight border
crossings in Texas, California and New York.
Through a teaming agreement and subsequent subcontract with Electronic Data
Systems, Inc. (EDS), we provide base area and local area network design,
installation and management services for the Navy Marine Corps Intranet (NMCI).
The NMCI contract awarded to EDS has a five-year value, subject to annual
appropriations, of $4.6 billion and options for three additional years that
bring the value in excess of $5.6 billion. The NMCI contact covers approximately
300 naval bases located throughout the U.S., certain territories and
possessions, and Guantanamo Bay, Cuba. Naval bases in Europe and the Pacific
will be covered by separate bid in which we also plan to participate under a
separate teaming arrangement.
For NMCI, we use the expertise and experience gained from operating our own
network and delivering services under a utility model to perform our
subcontractor role. While NMCI is the first instance we have offered our
services for a dedicated, customer-owned network, we intend to provide similar
services in the future.
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 global 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.
7
In addition, we also offer Web-based customer support capabilities through our
InfoCenter online tool. Using this tool, customers can log service requests,
submit questions and access service documentation on-line.
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. These competitors include:
o Overland and air courier service providers. The majority of our competition
continues to come from traditional overland and air courier services.
o Digital courier and digital file transfer service providers.
o Large telecommunications and Internet-oriented service providers.
o Application infrastructure providers and applications service providers.
o Disk and tape storage equipment companies.
o Storage service providers.
o System integrators which design and build infrastructure that is typically
managed inhouse by a customer.
o Government contractors.
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 data
transport services between 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 50
governments have agreed to permit the competitive provision of enhanced services
(i.e., value-added) by nationals of WTO member countries. Nevertheless, certain
countries in Europe, Asia and elsewhere in the world may 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.
Our participation in government contracts subject us to a variety of law,
regulations and ordinances that establish affirmative duties in the operations
of our business, as well as extensive record keeping and reporting requirements.
Failure to comply with these duties and requirements could affect the individual
contract and the ability to obtain future contracts.
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.
8
We have designed most of the proprietary software necessary for the management
of our services and applications, including C-POP device operations and a
graphic user interface, InfoCenter, WAM!PROOF and WAM!BASE services,
applications and tools. 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 and storage
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 $10 million per occurrence. We
also presently maintain $10 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,
2000:
Number of
employees
Marketing and Sales........................................... 151
Technical Operations (Development, Customer Service
& Operations) ................................................ 221
Administration................................................ 91
Professional Services....................................... 54
---
Total................................................. 517
===
The Company's executive and technical personnel have significant experience in
the design, programming, implementation, marketing, sales and support of complex
data networks, storage services 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.
Risk factors
The risks and uncertainties described below are not the only ones facing our
company.
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 $475.8 million as of December 31, 2000. Management
expects to continue to operate at a net loss and experience negative cash flow
from operating activities through the foreseeable future. At December 31, 2000,
our cash resources and available borrowings are insufficient to fund operations
for the next 12 months without raising additional debt and/or equity capital.
These factors raise substantial doubt about its ability to continue as a going
concern. The financial statements do not include any adjustments relating to the
recoverability and classification of reported asset amounts or the amount or
classification of liabilities, which might result from the outcome of this
uncertainty.
9
Management currently is exploring available options for additional capital
including borrowings secured by otherwise unencumbered assets, private issuances
of secured borrowings or preferred or common stock, or strategic alliances or
partnerships. However, there is no assurance that such funds will be available
or available on terms acceptable to the Company. If the Company is not
successful in obtaining additional funding, it may not be able to continue as a
going concern.
The report of our independent auditors on our consolidated financial statements
includes an explanatory paragraph, which states that the recurring losses from
operations, working capital deficiency, net capital deficiency and limited
liquid resources raise substantial doubt about our ability to continue as a
going concern.
Our limited operating history makes it difficult for you to evaluate our
performance.
Although we commenced operations in March 1995, we only recently began offering
several services from which we expect to generate a substantial portion of our
revenues in the future. Our prospects must be considered in light of the recent
release of these services, and the uncertainties, expenses and difficulties
frequently encountered by companies at a comparable stage of development. To
address these risks and uncertainties, we must, among other things:
o increase the size of our customer base and utilization of our network
and services;
o successfully perform our NMCI subcontract;
o raise additional capital;
o successfully manage our relationships and activities with our
strategic partners and distributors, including EDS, SGI, Winstar,
Sumitomo and 3M, and develop new relationships and activities with
influential suppliers and channel distributors in our target markets;
o successfully market our branded services;
o expand the capacity and geographic coverage of our network
infrastructure to meet industry and customer requirements;
o continue to attract and retain qualified personnel;
o accurately assess potential markets and effectively respond to
competitive developments;
o continue to maintain and upgrade our operational, support and business
systems;
o comply with evolving governmental regulatory requirements and obtain
any required governmental authorizations;
o continue to upgrade our services and applications to address new
technologies;
o provide acceptable customer service; and
o effectively manage our expanding operations.
We cannot assure you that we will be successful in accomplishing any or all of
the above, and our failure to do so could have an adverse effect on our
business.
We have experienced substantial negative cash flow from operating activities,
operating losses and net losses and may not be able to achieve profitability.
We have incurred substantial losses. Our substantial operating costs have
resulted in our cash flow being insufficient to pay our operating expenses or
fund our capital expenditures. There can be no assurance that we will be able to
increase our revenue in an amount sufficient to generate positive cash flow or
to achieve and maintain profitability.
We had negative cash flow from operating activities, operating losses and net
losses of approximately, $55.9 million, $102.4 million and $121.9 million in
1998, $65.7 million, $104.9 million and $145.1 million in 1999 and $73.1
million, $105.1 million and $186.6 million in 2000. As of December 31, 2000, we
had an accumulated deficit of approximately $475.8 million. We expect to
continue to experience negative cash flow and substantial operating and net
losses for the foreseeable future due to the significant costs involved at this
stage of our development, including the following:
o costs relating to performance of our NMCI subcontract with EDS;
10
o costs relating to the sales and marketing of our branded services;
o costs to be incurred in expanding the geographic coverage and capacity
of our network, hosting and storage infrastructure;
o telephony, hardware and installation costs and recurring telephony
charges resulting from the addition of new subscribers to our Direct
Service;
o costs relating to the development and deployment of new services and
applications; and
o costs relating to significant recurring operating and general
administrative expenses.
To fund our operating losses, pay our operating costs and meet our capital needs
we will need additional financing, which may not be available to us.
As a result of our lack of positive cash flow, our ability to continue to fund
our operating losses, to upgrade our technology, network and infrastructure, to
develop new services and applications and to successfully market our services on
a worldwide scale depends largely on our ability to obtain cash from our
financing activities. There can be no assurance that we will be able to raise
the additional working capital necessary for us to continue to implement our
business plan or fund our operations.
We have historically derived substantially all of our cash from the issuance of
short-term and long-term debt instruments and equity securities. Our future
financing activities will most likely consist of equipment financings,
borrowings in the bank and capital markets and private or public sales of our
capital stock. We are already highly leveraged, and to the extent that we incur
additional debt, the risks described under "-- Our substantial leverage creates
financial and operating risks" below will increase. However, our ability to
incur indebtedness is subject to restrictions contained in our financing
agreements. See "-- We may not be able to incur sufficient debt to finance our
future operations or capital needs due to restrictions in our financing
agreements" below. To the extent that we raise funds through the sale of a
significant number of shares of common stock or other equity securities, the
trading price of our common stock may be adversely affected. Any equity
securities we sell could have rights senior to those of our common stock.
We cannot, in any event, assure you that we will be able to obtain sufficient
funding from our future financing activities. If we are unable to obtain
sufficient funding, we may be required to, among other things:
o slow the expansion of our network, hosting and storage infrastructure;
o scale back or delay the development of new services and applications;
o reduce our marketing efforts; and
o reduce the number of our employees.
If any of the actions listed above are taken, the rate at which we are able to
add customers to our network and increase network utilization could be slowed,
and we could suffer some erosion in our subscriber base. A decrease in the rate
at which we add subscribers and increase network utilization may delay or
preclude our ability to generate positive cash flow and achieve profitability.
Because our market is new and evolving, we cannot predict its future evolution,
growth or ultimate size.
We believe that we are the first company to offer business-to-business
e-services to the media industry that enable businesses to digitally collaborate
on-line with their workflow chains. Because this market is relatively new, we
cannot accurately predict the ultimate size of the market or the rate at which
we will be able to add customers or otherwise increase the utilization of our
network and services. Furthermore, we cannot be certain that this market will
evolve in the manner we predicted when we designed our network and services or
that a demand for our services will exist in the future. If the market for our
services grows more slowly or evolves differently than anticipated or fails to
materialize at all, our business could be adversely affected.
Our ability to increase our customer base depends in part on the active
participation of existing customers and channel distributors in our marketing
efforts.
Part of the marketing efforts for our services involves collaborating with
existing customers to promote the use of our service by their workflow partners.
This can often involve customers participating in joint presentations and
implementing suitable workflow solutions. In addition to our direct sales force,
our marketing efforts utilize authorized channel partners who are responsible
for ascertaining potential customers' requirements and who may work with our
software developers to create attractive and cost-effective solutions. These
authorized channel partners may also be responsible for ongoing support of our
customers. The failure of our
11
customers to remain actively involved in our marketing efforts or the inability
of our channel distributors to properly manage customer accounts could adversely
impact our business. Because our authorized channel partners may use our WAM!NET
and WAM!BASE brands, if these agents are not successful, they could damage our
brand and reputation.
Our operating results in one or more future periods may fluctuate significantly
or fail to meet or exceed the expectations of securities analysts or investors.
Our annual and quarterly operating results may fluctuate significantly in
the future due to numerous factors, many of which are outside of our control.
These factors include:
o the rate of customer acquisition and turnover;
o the amount and timing of expenditures relating to the expansion of our
infrastructure and the introduction of new services;
o the amount and timing of expenditures relating to the performance of
our NMCI subcontract with EDS;
o introduction of new services or technologies by our competitors;
o price competition;
o the ability of our equipment and service suppliers to meet our needs;
o regulatory developments, including interpretations of the 1996
Telecommunications Act;
o technical difficulties or network downtime;
o the success of our strategic alliances; and
o the condition of the telecommunications and network service industries
in general.
Because of these factors, our operating results in one or more future periods
may fail to meet the expectations of securities analysts or investors. In that
event, the trading price of our common stock could decline.
Our substantial leverage creates financial and operating risks.
We are highly leveraged. As of December 31, 2000, we had approximately $677.3
million of outstanding debt, including redeemable preferred stock. The most
significant portion of the debt relates to the purchase of a 20-year
indefeasible right of use for backbone capacity and the purchase of wireless
local loop facilities from Winstar. As of December 31, 2000, the outstanding
balance of this network facility financing was $239.6 million, which is to be
paid over a seven-year period ending December 15, 2006. Another significant
portion of our debt is attributable to our 13.25% senior discount notes due
2005, which have a principal amount at maturity of $208.5 million. The 13.25%
senior discount notes had an accreted principal amount of $179.6 million at
December 31, 2000, and will begin to accrue interest, payable in cash, on March
1, 2002. We are committed to make principal payments in the total amount of
$27.9 million in 2001. We have recorded as quasi-equity on our balance sheet as
of December 31, 2000, redeemable and convertible preferred stock of $149.2
million.
We are not currently generating sufficient cash flow with which to repay our
substantial indebtedness, fund our operating losses or meet our capital
requirements. Hence, we expect to seek additional financing in the future.
Our substantial indebtedness could have important consequences. For
example, it could:
o impair our ability to obtain additional financing to fund our
operating losses or meet our working capital and capital expenditure
requirements;
o require that we devote a significant portion of the cash we receive
from our operating and financing activities to make debt service
payments, thereby reducing the amount we can use for other purposes;
o hinder our ability to adjust rapidly to changes in market conditions,
including changes in technology that might affect our competitive
position; and
o make us more vulnerable in the event of a downturn in our business or
in general economic conditions.
12
We may not be able to raise sufficient capital to finance our future operations
or capital needs due to restrictions in our financing agreements.
The operating and financial restrictions and covenants in the indenture
governing our 13.25% senior discount notes may adversely affect our ability to
finance our future operations and capital needs. We may also enter into credit
arrangements in the future that have the same effect.
The indenture governing our 13.25% senior discount notes contains financial
and operating covenants that may limit our ability to:
o borrow more funds (other than equipment financing);
o incur liens;
o make minority investments;
o sell assets;
o engage in transactions with stockholders and affiliates; and
o engage in mergers, including mergers that result in a change of
control.
In the case of borrowing funds, we are generally prohibited from obtaining
additional indebtedness other than equipment financing unless, after giving
effect thereto, the ratio of our consolidated indebtedness to our consolidated
operating cash flow for the four preceding fiscal quarters is less than or equal
to 5 to 1. We incurred negative cash flow from operating activities for the four
fiscal quarters ended December 31, 2000. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
The restrictions contained in the indenture for our 13.25% senior discount notes
could have the following adverse effects, among others:
o we could be unable to obtain additional financing in the future to:
-- fund our operating losses;
-- meet our capital expenditure requirements;
-- further develop or deploy services and applications; or
-- allow us to conduct necessary corporate activities;
o we could be unable to obtain lower borrowing costs than are available
from secured lenders;
o we could be unable to engage in strategic joint ventures in which we
are a minority partner; or
o we could be unable to engage in some mergers, including mergers that
could provide a substantial premium to our shareholders for their
stock.
The success of our business depends upon our ability to prevent system failure.
Our commercial business depends on the efficient and uninterrupted operation of
our network and service offerings. We believe that our reputation for providing
reliable service to our customers is critical to our future success. Despite our
efforts to protect our network infrastructure against damage, the occurrence of
a natural disaster or other unanticipated problem may cause an interruption in
our services. We have structured our network backbone with redundant circuits
obtained from telecommunications providers to minimize interruption of our
services; however, we generally do not obtain redundant circuits for local loop
connections between our network and our customers. As a result, we have
experienced occasional interruption of service to individual customer sites due
to loss of service in these local loop circuits. To date, we believe these
interruptions have not had a significant effect on our business.
Our commercial services use a combination of telecommunications equipment,
computer hardware and software, operating protocols and proprietary applications
for high-speed transportation and storage of large quantities of digital data.
Given the complexity of our services, it is possible that data files may be lost
or distorted. Moreover, most of our customers' needs are extremely
time-sensitive, and delays in data delivery may cause significant losses to a
customer using our services. Despite our testing efforts, our network and
services, including future enhancements and adaptations, may contain undetected
design faults and software "bugs" that are
13
discovered only after use by our customers. The failure of any equipment or
facility on our network could result in the interruption of service to the
customers serviced by that equipment or facility until necessary repairs are
effected or replacement equipment is installed. Such failures, faults or errors
could cause delays or require modifications that could have a material adverse
effect on our business.
Our commercial service is vulnerable to unauthorized access, computer viruses
and other disruptive problems.
Despite our security systems, our network, hosting and storage infrastructure
and commercial services may be vulnerable to unauthorized access, computer
viruses and other disruptive problems. Eliminating computer viruses and
alleviating other security problems may require interruptions, delays or
cessation of service to our customers, which could have an adverse effect on our
business.
We depend in part on the Internet for the quality of our Internet Gateway
Service.
Our Internet Gateway Service customers are dependent on the Internet to
transport their data to our network and to receive files from other customers on
our network. The recent growth in the Internet has placed strains on its
infrastructure and has required the upgrade of routers, switches,
telecommunications links and other components forming this infrastructure. The
benefits of our Internet Gateway Service and its commercial acceptance are
therefore dependent in part on the activities of Internet service providers and
other third-parties, over whom we have no control, to ensure the continued
upgrading of the Internet to avoid any degradation in its performance. If the
security, reliability or performance of the Internet is compromised or degraded,
the success of our Internet-based services, and the pricing of those services,
could be materially and adversely impacted.
We are exposed to liability for damages resulting from failure of data
transportation or loss of data.
Our contracts with customers generally contain provisions limiting our liability
for failure of data transportation or loss of stored data to $100 per
occurrence, with a maximum liability equal to the subscriber's cumulative
monthly payments for a year and, in the case of rendering services, to
replacement service. Nevertheless, we may be subject to significant claims and
potential liabilities for data losses or delays in the transportation, storage
or rendering of data through our network.
In addition to general business liability insurance, we maintain $10 million of
errors and omissions insurance coverage for our services, $10 million of
business interruption insurance coverage for losses from fire and natural
disasters, and $10 million of insurance coverage for losses of data due to
physical damage to our data archive. We also maintain $25 million of umbrella
coverage for loss or liability above our other policies. We cannot be certain
that this amount of insurance coverage will be adequate to cover all data loss
claims or that additional insurance will be available on affordable terms.
We may not be able to adapt our network, hosting and storage infrastructure to
our customers' evolving requirements.
Our ability to generate revenues will depend on our ability to add customers,
which is a function, in part, of our ability to expand our infrastructure and
support services and to provide our services at prices our customers are willing
to pay. The continued development and expansion of our network will require that
we enter into additional agreements with equipment and service providers. We
cannot be certain that any or all of the required agreements can be obtained on
satisfactory terms and conditions.
Future expansion and adaptation of our network infrastructure may be necessary
in order to respond to:
o more customers;
o demands for transmission and storage of larger amounts of data; and
o changes to our customers' service requirements.
The expansion and adaptation of our network, hosting and storage infrastructure
will require substantial financial, operational and managerial resources. We
cannot be certain that we will be able to expand or adapt our infrastructure and
manage it to meet the evolving requirements of our targeted industries and
customers on a timely basis or at a commercially reasonable cost.
We face uncertain and changing regulatory restrictions which could limit our
operating flexibility or increase our costs.
We purchase telephone equipment, computer hardware, routers and relays for use
in 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, the services that we offer to our customers are interstate information
(enhanced) services. Consequently, we are not required to obtain licenses or
other approvals from the FCC
14
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 spend substantial time and money to acquire the
appropriate licenses and to comply with state regulations. We 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 that encourage unimpeded cross-border provision of enhanced
services like the ones we offer. Pursuant to the World Trade Organization's
General Agreement on Trade and Services, over 50 governments have agreed to
permit the competitive provision of value-added services by nationals of WTO
member countries. Nevertheless, certain other countries in Europe, Asia and
elsewhere might seek to license and regulate our services. Any such license or
regulation may limit, delay or increase the costs of operations associated with
additional international locations to which we may desire 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 could result in economic burdens or
technical or legal constraints that could adversely affect our business.
If we are unable to retain our key personnel, our business may suffer.
Our successful operation depends on the services of key executives and
significant employees, some of whom we have only recently employed. The loss of
the services of any of these persons could have a material adverse effect on us.
We have entered into employment agreements with substantially all of our
officers and significant employees, and have purchased life insurance policies
on certain employees. See "Management." We believe our future success will
depend on our ability to retain the services of these personnel and to attract
and retain qualified technical and marketing personnel. We cannot be certain
that we will be able to continue to attract and retain the personnel necessary
for the successful conduct of our business.
Our failure to manage growth could adversely affect us.
We have rapidly and significantly expanded our operations. We are expanding the
geographic coverage and capacity of our network, providing new services and
media workflow applications as we seek to expand our customer base and achieve
our business objectives. Moreover, we have rapidly expanded our workforce in
recent months in order to perform our NMCI subcontract with EDS. To manage the
growth of our operations, we must:
o effectively manage our operational, managerial, financial and
accounting resources;
o hire, train and manage additional qualified personnel;
o continue to expand our sales force, external installation capacity,
customer service teams and information systems;
o continue to expand our NMCI implementation work force;
o expand and upgrade our core technologies; and
o effectively manage multiple relationships with our customers,
suppliers, strategic partners and other third-parties.
We may not be able to install management information and control systems in an
efficient and timely manner, and our current or planned personnel, systems,
procedures and controls may not be adequate to support our future operations.
Failure to manage our future growth effectively could adversely affect the
expansion of our customer base and service offerings. Any failure to
successfully address these issues could have a material adverse effect on our
business.
We depend on third-party suppliers for equipment and services, and our business
could be adversely affected if these relationships are disrupted.
Our business depends on third-party local and long distance carriers and on
third-party suppliers of the computers, software, routers and related components
used on our network and the disk drives, software systems and controllers used
in our hosting and storage infrastructure. Many of these supplier arrangements
are for terms of less than one year and are terminable by the other party in
specified circumstances. We also depend on the services of third-parties for
Direct Service customer site installations, routine maintenance and on-call
repair services. We may experience delays and additional costs if any of these
relationships are terminated and we are unable to reach suitable agreements with
alternate vendors, suppliers or carriers in a timely manner. Furthermore, to the
15
extent that we are unable to secure suitable installation, maintenance or
on-call repair services from third-party vendors, we may be required to
substantially increase our own workforce to perform these services, and our
growth may be constrained while we build and train our workforce. There can be
no assurances that we will be able to maintain our relationships with
third-party suppliers for equipment and services or that we will be able to find
suitable alternative products and services at a commercially reasonable price,
or at all.
The loss of our affiliation with SGI, Winstar or MCI WorldCom could adversely
impact our ability to operate our business.
We have significant investment, supply and/or distribution relationships with
each of SGI, Winstar and MCI WorldCom.
SGI currently holds convertible preferred stock that entitles it to elect one
director to our board. If SGI were to convert all of its convertible preferred
stock, it would own 11,782,134 shares of our common stock, or 49.1% of our
outstanding shares of common stock as of March 26, 2001, assuming none of the
other holders of our options, warrants or convertible securities exercised their
conversion rights. Because of its holdings and representation on our board, SGI
may be able to exercise significant influence over our affairs. SGI is currently
a primary supplier of components for network access devices, which we use to
connect customers directly to our network. A loss of our strategic relationship
with SGI could have a material adverse effect on our business.
Winstar currently holds convertible preferred stock that entitles it to elect
one director to our board. If Winstar were to convert all of its convertible
preferred stock and exercisable warrants, it would own 32,836,913 shares of our
common stock, or 72.9% of our outstanding shares of common stock as of March 26,
2001, assuming none of the other holders of our options, warrants or convertible
securities exercised their conversion rights. Because of its holdings and right
to representation on our board, Winstar may also be able to exercise significant
influence over our affairs. Winstar is currently our sole supplier of wireless
communication equipment and facilities, which we intend to use for high capacity
bandwidth connections between our network and customers. We have purchased a 20-
year indefeasible right of use for backbone capacity and purchased wireless
local loop facilities from Winstar at an agreed-upon fair value of $260.3
million, which will be paid over a seven-year period ending December 15, 2006.
We will be dependent on Winstar to adequately perform certain installation,
maintenance and repair functions for the equipment and facilities in order to
establish and maintain connectivity between our customers that use such
equipment and our network. A loss of our strategic relationship with Winstar
could have a material adverse effect on our business.
MCI WorldCom currently holds convertible debt and preferred stock and
exercisable warrants, which, if converted or exercised in full, would result in
MCI WorldCom owning at least 11,577,382 shares of our common stock, or 48.7% of
our outstanding shares of common stock, as of March 26, 2001, assuming that none
of our other holders of options, warrants or convertible securities exercised
their conversion rights See "Use of Proceeds." MCI WorldCom previously had three
designees on our Board of Directors. In August 1999, MCI WorldCom agreed to
become a passive investor and maintain a strategic relationship with us.
Accordingly, its three designees resigned from our Board and MCI WorldCom
relinquished its right to elect directors to our Board. Because of its
significant holdings, however, MCI WorldCom continues to be able to exercise
significant influence over our affairs. MCI WorldCom and its affiliates are our
largest supplier of meshed DS3, ATM backbone which interconnects our
distribution hubs, and of local loop connections between our distribution hubs
and network access devices on our customers' premises. We also co-locate a
significant portion of the routers and switches for our distribution hubs at MCI
WorldCom's points of presence on a month-to-month basis. A loss of our strategic
relationship with MCI WorldCom could have a material adverse effect on our
business.
Our business may be affected by competition.
We face competition from a variety of companies in the provision of data
transport, hosting, storage and workflow management services to the media
industry as well in the provision of services to the government. Many of our
competitors have an established market presence and substantially greater
financial, technological, marketing and research and development resources than
we do, and may offer competitive services and applications. Our competitors and
potential competitors for our commercial services include overland and air
carrier service providers, digital courier and digital file transfer service
providers, large telecommunication carriers and service providers, data network
and application service providers, and disk and tape storage equipment
companies; and for our government services include many of the same competitors
as well as others specializing in the provision of services to the government.
Technological changes could render our services obsolete or non-competitive.
We are at risk from fundamental technological changes in the development of
digital data delivery and archiving solutions. Evolving industry standards, new
product and service introductions, demand and market acceptance for recently
introduced products and services are subject to uncertainty of customer
acceptance. There can be no assurance that we will be able to adapt to future
technological changes or that developments by competitors will not render our
services and related applications obsolete or noncompetitive.
16
We may not be able to maintain proprietary rights in our intellectual property.
Our ability to maintain our proprietary rights in our technology will affect the
success of our business. We have applications for four U.S. patents pending for
certain aspects of our technology. We rely on a combination of trade secrets and
copyright protection, as well as patents to protect our proprietary rights in
our technology. We also rely on trademark protection concerning various names,
marks, logos and other devices that serve to identify us as the source for and
originator of our services and applications.
We offer our services and applications in foreign countries. Some of these
countries lack intellectual property protection comparable to that afforded by
the intellectual property laws of the U.S. Our proprietary rights in the
technology underlying our network, hosting and storage infrastructure and
related services and applications will be protected only to the extent that
patent, trade secret, copyright or other protection is available in countries in
which we market our services and applications, and only to the extent we are
able to obtain such protection and enforce such rights. We cannot be certain
that the steps taken by us to protect our intellectual property and proprietary
rights will be adequate to deter misappropriation of our technology or
development of technologies that are substantially equivalent to our technology.
Misappropriation of our technology or development of competitive technologies
could have a material adverse effect on our business. We could incur substantial
expense in protecting and enforcing our intellectual property rights.
Intellectual property litigation is complex, and we cannot be certain of its
outcome. We have conducted a limited inquiry regarding the possibility of
infringement on patents and intellectual property rights of others. We are not
aware of any infringements nor have we received any claims for such
infringements. Any future intellectual property litigation, regardless of
outcome, could result in substantial expense to us and significant diversion of
the efforts of our technical and management personnel. An adverse determination
in any such proceeding could subject us to significant liabilities to
third-parties, require disputed rights to be licensed from such parties or
require us to cease using disputed technology.
Loss of significant customers and their workflow chains could have a significant
effect on our business.
During the year ended December 31, 2000, EDS, Time and Quebecor World, Inc. were
our largest customers, representing 8.4%, 1.8% and 2.5%, respectively, of our
total revenue. Although Time and Quebecor World do not individually represent a
significant percentage of our revenue, both companies have developed important
workflow chains of vendors, suppliers and customers who use our network. If
either Time or Quebecor World were to significantly reduce or terminate (at the
end of their current service contract or otherwise) their use of our network and
services, their workflow partners might do the same, and our business, financial
condition and results of operations could be materially adversely affected. The
loss of EDS as a customer would have a significant adverse effect on future
revenues.
We are subject to the risks associated with foreign investment and international
operations.
Our operations extend outside of the U.S. During 1999 and 2000, a significant
portion of our revenue was generated in Europe, and, to a lesser extent, Asia.
We are exposed to the risk of changes to laws and policies that govern foreign
investment in countries where we have operations, as well as changes in U.S.
laws and regulations relating to investing in or trading with countries in which
we may have investments.
Certain countries in which we operate or may operate are subject to a
substantially greater degree of social, political and economic instability than
in the U.S. Risks associated with social, political and economic instability in
a particular country could materially adversely affect our business and could
result in the loss of our assets in that country. In addition, some markets in
which we have undertaken or may in the future undertake international expansion
have technology and communications industries that are less developed than in
the U.S.
Risks inherent in doing business in international markets include the following:
o uncertainty of acceptance of our services by different cultures;
o unforeseen changes in regulatory requirements;
o differing technology standards;
o difficulties in staffing and managing multinational operations;
o government-imposed restrictions on the repatriation of funds;
o difficulties imposed by language barriers;
o difficulties in finding appropriate distribution channels; and
17
o potentially adverse tax consequences.
These factors could harm our ability to successfully operate internationally and
could have a material adverse effect on our business.
We are subject to risks related to foreign currency exchange rates and
repatriation.
As we expand our operations outside of the U.S., our results of operations and
the value of our assets will be affected by the currency exchange rates between
the U.S. dollar and the functional currency of countries in which we transact
business. During the years ended December 31, 2000 and 1999, 28.1% and 35.7%,
respectively, of our revenue was generated outside of the U.S. We typically sell
our services and applications in foreign countries in the local functional
currency. As a result, we may experience an economic loss solely as a result of
foreign currency exchange rate fluctuations. Currently, we do not employ
currency hedging strategies to reduce the risks associated with the fluctuation
of foreign currency exchange rates.
We may acquire interests in companies that operate in countries where the
removal or conversion of currency is restricted. We cannot be certain that
countries that do not have such restrictions at the time we establish operations
will not subsequently impose them, especially in situations where there is a
deterioration in a country's balance of payments or where the local currency is
being heavily converted into other currencies.
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 239,000 square
feet of this facility. SGI subleases 242,000 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 September 30, 2002. SGI has the option to
extend the sublease for a ninety day term with written notice.
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 18,540 square foot office facility located in
Bloomington, Minnesota which we currently sublease;
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 approzimately 8,000 square foot manufacturing and warehouse
facility located in Eagan;
o small offices in Des Moines , Iowa; Missoula, Montana; Plano,
Texas; San Jose, California; Los Angeles, California; 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 a 16,000 square foot office space located in Bournemouth, Dorset,
England.
ITEM 3. LEGAL PROCEEDINGS.
We are engaged in certain legal proceedings and claims arising in the ordinary
course of our business. The ultimate liabilities, if any,
18
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.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
In February 2000, we 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 our common stock, subject to anti-dilution adjustments, and is mandatorily
convertible in the event of an underwritten public offering our common stock 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, we 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 our 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, we sold to Winstar Communications, Inc. 85,000 shares of our
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, we 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 our common stock, subject to
anti-dilution adjustments, and is mandatorily convertible in the event of an
underwritten public offering our common stock on the last trading day of the
first 20 consecutive trading days during which the average (weighted by daily
trading volume) closing price of the stock is at least $8.00. We will be
required to redeem all of the outstanding shares of Class E Convertible
Preferred Stock at a redemption price per share equal to the liquidation amount
per share on such date, as adjusted pursuant to the term of the Certificate of
Designation of the Class E Convertible Preferred Stock. Exemption from
registration is claimed under Section 4(2) of the Act and Rule 506 of the Rules.
In September 2000, we and Winstar entered into a Securities Purchase Agreement
(the "Agreement"), pursuant to which we sold to Winstar up to 60,000 shares of
Class H Convertible Preferred Stock, par value $.01 per share, at a purchase
price of $1,000 per share, upon certain dates and in certain amounts pursuant to
the terms of the Agreement. In connection with the execution of the Agreement,
we issued an immediately exercisable warrant to Winstar to purchase up to
3,000,000 shares of common stock of the Company at a price of $.01 per share,
which warrant shall expire on December 31, 2005. The rights and preferences of
the Class H convertible preferred stock, including its conversion provisions,
are substantially the same as the rights and preferences of the Class E
convertible preferred stock. The Class H convertible preferred stock is
convertible into shares of common stock at an initial conversion rate of $5.16
per share, subject to anti-dilution provision. As of December 31, 2000, the
Company sold 40,000 shares of Class H convertible preferred stock for an
aggregate of $40 million in cash and 1,550,000 shares of common stock are
exercisable pursuant to the warrant. In January 2001, we sold 20,000 shares of
Class H convertible preferred stock for an aggregate of $20 million in cash. On
December 31, 2008, we will be required to redeem all of the outstanding shares
of Class H Convertible Preferred Stock at a redemption price per share equal to
the liquidation amount per share on such date, as adjusted pursuant to the term
of the Certificate of Designation of the Class H Convertible Preferred Stock.
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, 2000. We derived our selected historical consolidated financial
data as of and for each of the three years in the period ended December 31, 2000
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, 1996 and 1997 from our
audited consolidated financial statements that are not included in this Annual
Report on Form 10-K.
19
Years Ended December 31,
--------------------------------------------------------------------------------
1996 1997 1998 1999 2000
------------ ------------ ------------ ------------ ------------
(dollars in thousands, except per share data)
Statement of Operations Data:
Revenues:
Net Service Revenue ..................... $ 279 $ 1,555 $ 6,799 $ 17,319 $ 34,107
Software and hardware sales ............. -- -- 10,791 7,476 6,334
------------ ------------ ------------ ------------ ------------
Total revenues ............................ 279 1,555 17,590 24,795 40,441
Operating expenses:
Network communication ................... 816 7,364 18,259 26,318 28,428
Cost of other service revenue costs ..... -- -- -- -- 2,199
Cost of software and hardware ........... -- -- 3,537 2,905 2,027
Technical operations .................... 1,109 7,478 35,095 22,928 22,259
Selling, general and administrative ..... 4,664 13,527 45,422 42,692 50,569
Depreciation and amortization ........... 447 2,668 17,668 34,875 40,035
------------ ------------ ------------ ------------ ------------
Total operating expenses .................. 7,036 31,037 119,981 129,718 145,517
Loss from operations ...................... (6,757) (29,482) (102,391) (104,923) (105,076)
Interest and other income (expense), net... (839) (4,154) (20,839) (34,304) (67,099)
Income tax benefit ........................ -- -- 1,352 -- --
------------ ------------ ------------ ------------ ------------
Net loss .................................. (7,596) (33,636) (121,878) (139,227) (172,175)
Less preferred dividends .................. -- (70) (70) (5,890) (14,383)
------------ ------------ ------------ ------------ ------------
Net loss applicable to common stock ....... $ (7,596) $ (33,706) $ (121,948) $ (145,117) $ (186,558)
============ ============ ============ ============ ============
Net loss applicable per common share ...... $ (1.18) $ (5.19) $ (13.87) $ (15.58) $ (17.73)
Weighted average number of common shares
outstanding .............................. 6,445,785 6,496,345 8,793,961 9,315,900 10,523,789
Other Financial Data:
Net cash used in operating activities ..... $ (6,218) $ (23,917) $ (55,878) $ (65,670) $ (80,121)
Net cash used in investing activities ..... (5,244) (15,599) (71,304) (25,942) (10,696)
Net cash provided by financing activities . 24,578 25,346 132,817 113,497 67,944
EBITDA(1) ................................. (6,310) (26,814) (84,684) (69,473) (62,374)
Capital expenditures ...................... 4,244 16,599 54,584 25,208 43,467
Subscriber Contracts (end of period):
Direct Service Contracts(2) ............... 33 496 1,479 1,918 2,117
ISDN Tracked Service Contracts(3) ......... -- -- -- 2,659 3,611
Internet Gateway Subscribers(4) ........... -- -- -- 4,167 11,103
Years Ended December 31,
------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
(dollars in thousands)
Balance Sheet Data (end of Period):
Cash and cash equivalents............... $ 14,444 $ 274 $ 6,272 $ 27,180 $ 3,207
Total assets ........................... 20,070 29,134 125,459 435,255 417,771
Total debt(5) .......................... 21,473 54,826 210,378 547,612 677,259
Shareholders' deficit .................. (2,683) (30,671) (109,854) (147,885) (306,864)
(1) 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.
(2) Represents the number of customer points of presence at which a network
access device is installed. Does not include executed contracts for
installations currently in process from which we have not begun to receive
service fees.
(3) 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.
20
(4) Represents the number of subscribers with accounts to use our Internet
Gateway Service.
(5) 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
We own and operate an integrated global Information Technology (IT)
infrastructure that we market and sell as a utility to commercial and government
customers. Customers use our services to digitize mission-critical business
processes and integrate these into their enterprise or supply chains.
We offer our customers a suite of managed data services including 1) digital
transport services 2) digital storage services 3) application hosting services
4) managed hosting services and 5) professional services. Customers purchase our
services on an outsourced basis in which they pay a transactional charge per
use, similar to a utility. By using our services, customers gain access to
leading-edge technology without the high cost and challenges of managing
technology themselves.
Our services and IP-based network, storage and hosting infrastructure provide
businesses a common electronic platform to seamlessly integrate their production
processes and accelerate the adoption of online digital collaboration. In the
commercial marketplace our global customer base is primarily made up of
companies in the entertainment, broadcast, advertising, publishing, printing,
retail, financial services, and consumer goods industries. These customers use
our services to collaborate on-line within their supply chains to produce,
manage and distribute rich media content such as: advertising, product packaging
and general brand marketing materials; TV programming; films, video games,
recorded music and other entertainment; news content and publications; video;
and web materials. Creating these materials is a highly collaborative process
involving many firms.
In July 2000, we initiated direct sales to the government with the receipt of
approval to sell on the General Services Administration (GSA) Schedule for
Electronic Commerce Services. The GSA listing permits government entities to
purchase our service without the need for lengthy and time-consuming bidding or
request-for-proposal processes. In October of 2000, WAM!NET, as a tier one
subcontractor, was part of the EDS-led team that won the $6.9 billion Navy
Marine Corps Intranet (NMCI) contract. This intranet is a common computing and
communications environment to link more than 300 Navy and Marine Corps bases
throughout the U.S., Iceland, Puerto Rico, Guam, Hawaii and Guantanamo Bay,
Cuba. It is designed to enhance communication and the readiness of the U.S.
Armed Forces. Under our subcontract with EDS, we will provide Base Area and
Local Area Network design, installation and management at each base.
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 substantial and skilled customer service
and professional service groups, which make 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 and 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 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. We have integrated
the 4-Sight technology into our managed digital transport services.
In September 1999 we opened an office in Tokyo and established a joint venture
with Sumitomo to support the sales and marketing of our services to the Japanese
market. In July 2000 we opened an office in Sydney, Australia, to develop
business opportunities in the Australian market.
In November, 2000, we purchased all of the outstanding common stock of is.com
for 500,000 shares of the Company's common stock. The acquisition was accounted
for under the purchase method of accounting and, accordingly, the operating
results of is.com have been included in the consolidated operating results since
the date of acquisition. The inclusion of the is.com operating
21
results for periods prior to the date of acquisition would not have materially
affected results of operations. In connection with the acquisition, the Company
issued a warrant to the sole owner of is.com to purchase 100,000 shares of
common stock.
Access to our services is provided through our Direct Service, Tracked Service
and Internet Gateway Service. Our initial focus through 1998 was our Direct
Service. This is our fastest, most secure and reliable managed transport
service, providing direct, guaranteed access and transport over our managed
network. Our Customer Point of Presence (CPOP) devices are installed on our
customers' premises and are connected to our network with a dedicated leased
line. In December 1999 we 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 customers' premises.
In the first quarter of 1999 we began to provide access to our network through
our Tracked Service. This 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
dedicated onsite CPOP device or a dedicated connection to our network. We
introduced our Internet Gateway Service in the third quarter of 1999. Internet
Gateway Service allows connection to our network and services over the Internet.
We provide media production-tailored tools with our managed transport services
including InfoCenter, Electronic Job Tickets and Remote Proofing.
We commercially introduced our WAM!BASE Digital Storage Service in the first
quarter of 2000 and our web-based storage service, Workspace, in fourth quarter
of 2000. Direct service is required to access WAM!BASE storage service.
Also in the first quarter of 2000, we began offering Rendering on Demand, a
hosted service that requires specialized software and extensive computing power
to generate high-resolution computer animation for film and broadcast special
effects. In the first quarter of 2000 we began offering our Compressed Video
Service, our transport service for compressed video in MPEG 1 and MPEG 2
formats.
We introduced our managed hosting services in third quarter 2000. These services
are designed to enable reliable, scalable, mission-critical e-business
applications for a wide range of customers. In the fourth quarter 2000, we
acquired is.com, a 50-member professional services firm specializing in
e-business solutions and workflow to augment our service offering.
As of December 31, 2000, we had over 2,100 customer points-of-presence
consisting of dedicated CPOP devices and local bandwidth connectivity. Of these,
about 60 have WAM!NET storage services that customers access through the CPOP.
In addition, we had over 14,700 users of our Internet and dial-up services
globally.
Revenues
Net Service Revenue
Our net service revenue from commercial customers is directly related to the
number of customers, type of service, and volume of data moved, stored or
processed. This revenue is derived primarily from media market customers who are
purchasing our managed transport, managed storage, hosted applications and
managed hosted services. Revenue is based on 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 usage level. We record monthly service
revenue for Direct Service, Compressed Video Service and 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 unit hour and revenues are recognized as the service is
provided to the customer. We began to earn service revenue from Tracked Service
and Internet Gateway Service in March and September 1999, respectively. Our
WAM!BASE digital storage and Workspace services are priced on the basis of
megabytes stored per month. We began earning storage revenue in first quarter of
2000. Our managed hosting services are typically custom-oriented solutions and
are priced according to the customers' equipment and capacity requirements.
We began earning Professional Services revenues in fourth quarter 2000,
primarily from our acquisition of a 50-member firm that specializes in
e-commerce and workflow consulting services. Revenues are based on consulting
engagements that are billed on an hourly rate, depending on the expertise
required to meet customer requirements. Revenues are included in net service
revenue in the Consolidated Statement of Operations.
Our revenue from government customers primarily includes revenue from our
subcontract with EDS for NMCI, as well as revenue generated from other
government customers.
On November 28, 2000, we entered into a Pre-Subcontract Authorization Agreement
with EDS. The period of performance was from
22
October 7, 2000 through February 9, 2001 (the date the Definitive Subcontract
Agreement was signed) and detailed out certain milestones and the related
values. We invoiced EDS $7 million in 2000 based upon the achievement of certain
milestones and received payments of $1 million in December 2000 and $6 million
in January 2001. We recorded $3.4 million of revenues as of December 31 2000
under this agreement. Government service revenues are included in net service
revenue in the Consolidated Statement of Operations.
On February 9, 2001, we entered into a definitive Subcontract Agreement with
EDS. The contract, which was awarded under the Federal Acquisition Regulation
(FAR) Part 12 procedures, is an indefinite quantity type contract (with minimum
purchase commitments) where delivery or performance shall be made only as
authorized by orders issued by the Navy under the ordering clause of the NMCI
contract with EDS. The contract contains a base period of five program years
effective October 7, 2000, and an option to extend the period of performance an
additional three years. We will record and recognize revenue based upon
performance on the number of seats ordered beginning in February 2001.
Our full range of services are also sold to government entities through the GSA
listing, direct marketing efforts and channel activity. These services are
billed to government customers using the same billing model as used for our
commercial customers.
Software and hardware sales
Revenue from software and hardware sales has resulted primarily from the sale of
4-Sight ISDN 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 continue to shift the existing 4-Sight customers from
software to our managed transport service. We expect that software and hardware
sales will continue at approximately the same level for 2001.
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 wireless local loop facilities from Winstar. Winstar's wireless
technology 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.
Cost of professional services
The cost of professional services represents direct labor costs associated with
our professional service revenue.
Cost of government services
The cost of government services represents costs directly associated with
government operations and our direct costs related to performing under the NMCI
contract.
Cost of software and hardware
Software and hardware expense reflects the costs of software and hardware sold.
23
Technical operations
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 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 is.com, 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, 2000, 1999 and 1998
Revenues
Total revenue for the years ended December 31, 2000, 1999 and 1998, was $40.4
million, $24.8 million and $17.6 million. The increases in revenues are due to
increased service offerings and greater demand for our services.
Net service revenue was $34.1 million, $17.3 million and $6.8 million for the
years ended December 31, 2000, 1999 and 1998. This increase in net service
revenue was primarily due to growth in the number of subscribers purchasing our
services and increased utilization by subscribers. During the fourth quarter of
2000 we also began providing services to the government as well as began
providing services and receiving revenue under the NMCI contract. At December
31, 2000, we were providing services to approximately 16,800 users, as compared
to approximately 8,700 and 1,475 subscribers, at December 31, 1999 and 1998.
Revenues from software and hardware sales for the years ended December 31, 2000,
1999 and 1998, were $6.3 million, $7.5 million and $10.8 million. The decrease
in software and hardware sales 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.
Operating Expenses
Network communication
Network communication expense for the years ended December 31, 2000, 1999 and
1998, was $28.4 million, $26.3 million and $18.3 million. The increase in
network communication expenses from 1999 to 2000 was a result of increased local
loop connections directly related to growth in the number of our Direct Service
customers. Approximately $5.0 million of the increase in network communication
expenses from 1998 to 1999 is a result of increased local loop connections
related to growth in the number of our Direct Service customers and
approximately $3.0 million of the increase was from an entire year of expenses
incurred as a result of
24
expanding our domestic and foreign network operations through the installation
of additional hubs. The network expansion was substantially complete by the end
of 1998. 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.
Other Service Revenue Costs
Other service revenue costs for the year ended December 31, 2000 were $2.2
million. These costs are related to our direct costs of professional services
and government.
Software and hardware
The cost of software and hardware for the years ended December 31, 2000, 1999
and 1998 was $2.0 million, $2.9 million and $3.5 million. The decreases reflects
the decline in software and hardware sales as described above.
Technical Operations
Technical operations expense for the years ended December 31, 2000, 1999 and
1998, was $22.3 million, $22.9 million and $35.1 million. The expenses remained
flat from 1999 to 2000 we were able to manage costs and leverage the existing
systems and organization. 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.
Selling, general and administrative
Selling, general and administrative expense for the years ended December 31,
2000, 1999 and 1998, was $50.6 million, $42.7 million and $45.4 million. 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 1999 to 2000 was
due to 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, however we
expect selling, general and administrative expenses will continue to decline as
a percentage of revenue. 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 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 $8.7 million, over the comparable adjusted amount
for the year ended December 31, 1998.
Depreciation and amortization
Depreciation and amortization for the years ended December 31, 2000, 1999 and
1998, was $40.0 million, $34.9 million and $17.7 million. This increase was
primarily due to depreciation of additional network and related equipment
purchased for network expansion during 2000, 1999 and 1998. Included in these
totals for 2000, 1999 and 1998 was $7.3 million, $6.6 million and $5.3 million
of amortization expense relating to the goodwill recorded in connection with
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.
Loss on investment
Loss on investment for the year ended December 31, 2000 was $23.5 million. The
loss on investment was due to the sale of Winstar common stock. All shares of
Winstar common stock were sold during 2000.
Interest expense
Interest expense for the years ended December 31, 2000, 1999 and 1998, was $47.0
million, $35.7 million and $22.6 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, 2000, 1999 and 1998, are non-cash charges of $30.5 million, $29.3
million and $18.3 million related to the amortization of deferred financing
charges and the value of warrants issued in connection with debt financing
transactions.
25
Other income
Other income for the years ended December 31, 2000 and 1999 was $2.7 million and
$0.6 million. Other income 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, 2000, we had $318 million of United States net operating loss
carryforwards. These carryforwards are available to offset future taxable income
through the year 2020 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
Through December 31, 2000, we have issued equity and debt securities and
incurred other borrowings resulting in cash received by us of $471.2 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.
In 2000, we entered into the following financing transactions in order to
continue to fund our operating and capital requirements:
In December, 1999, we 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 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 3 for 2 Winstar stock split declared in February
2000). All shares of Winstar common stock were sold during 2000. Other investors
purchased 16,725 shares of Class E convertible preferred stock for an aggregate
of $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 elect one director and vote on an
as-converted basis on all matters submitted to the vote of common stock holders
including the election of directors. In the event that any holder of Class E
preferred stock possesses voting power in excess of 17.5% of the voting power of
the Company, such holder's voting power shall be reduced to, at most, 17.5% of
the total voting power of all the equity holders of the Company. 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 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, if 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. On December 31, 2008, the
Company will be required to redeem all of the outstanding shares of Class E
Convertible Preferred Stock at a redemption price per share equal to the
liquidation amount per share on such date, as adjusted pursuant to the term of
the Certificate of Designation of the Class E Convertible Preferred Stock.
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 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.
In September 2000, we entered into a Securities Purchase Agreement (the
"Agreement") with Winstar, pursuant to which we have the right to sell to
Winstar 60,000 shares of Class H Convertible Preferred Stock, par value $.01 per
share, at a purchase price of $1,000 per share upon certain dates and in certain
amounts pursuant to the terms of the Agreement. In connection with the execution
of the Agreement, we issued an immediately exercisable warrant to Winstar to
purchase up to 3,000,000 shares of our common stock at a price of $.01 per
share, which warrant shall expire on December 31, 2005. The rights and
preferences of the Class H convertible preferred stock, including its conversion
provisions, are substantially the same as the rights and preferences of the
Class E convertible
26
preferred stock. The holders of the Class H 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 shareholders. In addition, Winstar or any
subsidiary thereof, individually or as a group, have the right to appoint up to
two directors to serve as directors on our Board of Directors. Pursuant to the
terms of the Class H preferred stock, Winstar and its subsidiaries, by virtue of
their ownership of Class E preferred stock and Class H preferred stock have the
right, collectively, to appoint only one person to serve on our Board of
Directors. To the extent that Winstar or any subsidiary thereof, individually or
as a group, is entitled to more than the number of votes equal to 17.5% of all
votes cast at any meeting at which a vote is being taken, by virtue of its
ownership of Class E preferred stock, Class H preferred stock or any common
stock issued upon the exercise of warrants issued in connection with the
issuance of the Class H preferred stock, such holder of Class H preferred stock
shall have its voting power reduced to, at most, 17.5% of the total voting power
of all equity holders of the Company. On December 31, 2008, the Company will be
required to redeem all of the outstanding shares of Class H Convertible
Preferred Stock at a redemption price per share equal to the liquidation amount
per share on such date, as adjusted pursuant to the term of the Certificate of
Designation of the Class H Convertible Preferred Stock.
The Class H convertible preferred stock is convertible into shares of common
stock at an initial conversion rate of $5.16 per share, subject to anti-dilution
provision. As of December 31, 2000, we sold 40,000 shares of Class H convertible
preferred stock for an aggregate of $40 million in cash and 1,550,000 shares of
common stock are exercisable pursuant to the warrant. In January 2001, we sold
20,000 shares of Class H convertible preferred stock for an aggregate of $20
million in cash and 3,000,000 shares of common stock are exercisable pursuant to
the warrant.
In February 2001, we entered into a $30 million bank credit facility ,which
expires in January 2003. The credit facility is a $30 million revolving credit
facility based upon a borrowing base consisting of our cash collections. Amounts
outstanding under the credit facility incur interest at the banks reference rate
plus 3.25% (11.75% at February 28, 2001). The credit facility is secured by a
lien on certain unencumbered and lienable assets. The credit facility requires
us to maintain certain financial covenants. The credit facility is automatically
renewable at maturity until canceled in accordance with its terms. As of
February 28, 2001, we have borrowed $14.7 million under the credit facility.
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 $475.8 million as of December 31, 2000. Management
expects to continue to operate at a net loss and experience negative cash flow
from operating activities through the foreseeable future. At December 31, 2000,
our cash resources and available borrowings are insufficient to fund operations
for the next 12 months without raising additional debt and/or equity capital.
These factors raise substantial doubt about its ability to continue as a going
concern. The financial statements do not include any adjustments relating to the
recoverability and classification of reported asset amounts or the amount or
classification of liabilities, which might result from the outcome of this
uncertainty.
Management currently is exploring available options for additional capital
including borrowings secured by otherwise unencumbered assets, private issuances
of secured borrowings or preferred or common stock, or strategic alliances or
partnerships. However, there is no assurance that such funds will be available
or available on terms acceptable to the Company. If the Company is not
successful in obtaining additional funding, it may not be able to continue as a
going concern.
The report of our independent auditors on our consolidated financial statements
includes an explanatory paragraph, which states that the recurring losses from
operations, working capital deficiency, net capital deficiency and limited
liquid resources raise substantial doubt about our ability to continue as a
going concern.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Exchange Rates
During the year ended December 31, 2000, our revenue originating outside the
U.S. was 28.1% 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.
27
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 some of our
outstanding debt. The outstanding loan balance under our 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, 2000, 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.
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.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth, as of March 15, 2001, the names, ages and
positions of our executive officers and directors. Their respective backgrounds
are described below.
Name Age Position
- ---- --- --------
Edward J. Driscoll............... 40 Chairman of the Board and Chief Executive Officer
William E. Sullivan.............. 52 President
Terri F. Zimmerman............... 37 Chief Financial Officer
Allen L. Witters................. 41 Chief Technology Officer
Lisa A. Gray..................... 45 Executive Vice-President, Business Affairs and General Counsel
Richard G. Marklund.............. 57 Executive Vice-President, International and Business Development
Kenneth L. Coleman............... 58 Director
Patrick J. Dirk.................. 61 Director
Robert L. Hoffman................ 72 Director
William M. Kelly................. 47 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.
William E. Sullivan has served as our president since September of 2000. He
joined the company in March 2000 as Senior Vice President of Global Marketing
from PR21, a New York-based public relations firm, where he was chief executive
officer. Prior to that, Sullivan served as chief marketing officer, Imation
Corp., where he played a key role in launching the $2.3 billion imaging and
information storage company from 3M. Prior to Imation, he was chief executive
officer of Rowland Worldwide, a public relations firm owned by Saatchi and
Saatchi, and held a number of managerial positions with 3M in the areas of
public relations and marketing communications from 1979 to 1987. Sullivan brings
more than 25 years of business experience in domestic and international markets.
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 Director of
Finance, Vice President of Finance and Operations, 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.
28
Allen L. Witters is one of our founders and a principal shareholder. He has
served as our Chief 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.
Lisa A. Gray has served as our Corporate General Counsel since December 1998. In
September 2000, her role was expanded to include the area of business affairs.
Her current title is Executive Vice President of Business Affairs and General
Counsel. 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.
Richard G. Marklund is our executive vice president, International and Business
Development, responsible for our subsidiary companies outside the United States.
He joined the company in June 2000 from Hyperport International, Inc., where he
served as president and chief executive officer. Marklund brings more than 30
years experience, having served in a variety of executive management and board
positions with both public and private companies, ranging from small
entrepreneurial start-ups to large multi-billion dollar corporations.
Kenneth L. Coleman has served as a director since March 2000. Mr. Coleman is
executive vice president of Global Sales, Service and Marketing for SGI, where
he served in a number of key senior management positions throughout the past 13
years. In his current role he manages an organization with some 4,000 employees
in 179 offices in 41 countries, generating revenues of $2.7 billion in FY 1999.
Prior to joining SGI, Mr. Coleman was vice president of Product Development at
Activision, Inc., responsible for software development activities. Earlier, he
spent 10 years at Hewlett-Packard Company, where he held several management
positions. Mr. Coleman is a member of the board of directors of the following
institutions: Acclaim Entertainment, Inc., The American Leadership Foundation of
Silicon Valley, MIPS Technologies, The Ohio State University Alumni Advisory
Council and The Ohio State University Business Dean's Advisory Council. He
earned a B.S. degree in Industrial Management and MBA from The Ohio State
University.
Patrick J. Dirk has served as a director since February 2000. Mr. Dirk has been
the Chairman of the Board and Chief Executive Officer of Troy Group, Inc. since
he co-founded the company in May 1982. From March 1982 to August 1999, Mr. Dirk
also served as President of Troy. Mr. Dirk is the Chairman of the Board and
Chief Executive Officer of each of the Troy Group's subsidiaries. From 1980 to
1982 Mr. Dirk served as President and a director of Kroy Inc. where he was
employed in various capacities from 1973 until 1982. Kroy Inc. is 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 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, 2000, 1999 and 1998.
29
Summary Compensation Table
Long-Term
Annual Compensation Compensation Awards
------------------- -------------------
Securities
Underlying
Name and Principal Position Year Salary Bonus Options(#)
- --------------------------- ---- ------ ----- ----------
Edward J. Driscoll. III ........................... 2000 $ 230,620 $ 237,312(6) --
Chairman of the Board and Chief 1999 195,000 87,126 500,000
Executive Officer 1998 195,000 -- 750,000
William E. Sullivan ............................... 2000 $ 164,225(1) $ 220,000(6) 1,500,000
President 1999 -- -- --
1998 -- -- --
Terri F. Zimmerman ................................ 2000 $ 207,911 $ 103,824(6) --
Chief Financial Officer 1999 75,769(2) 29,622 1,600,000
1998 -- -- --
Allen L. Witters .................................. 2000 $ 218,744 $ 222,480(6) --
Chief Technology Officer 1999 195,000 76,236 500,000
1998 195,000 -- 750,000
Lisa A. Gray ...................................... 2000 $ 188,019 $ 96,250(6) 175,000
Executive Vice President of Business Affairs and 1999 145,333 78,417 600,000
General Counsel 1998 18,333(3) -- 25,000
Gary L. Hokkanen .................................. 2000 $ 969,538(7) $ 108,768(6)
1999 183,330 122,870
1998 -- --
Denice Y. Gibson .................................. 2000 $ 562,000(7) $ 93,443(6)
1999 97,820 38,242
1998 -- --
(1) Mr. Sullivan's employment began in March 2000.
(2) Ms. Zimmerman's employment began in August 1999.
(3) Ms. Gray's employment began in November 1998.
(4) Mr. Hokkanen served as President from April 1999 to September 2000.
(5) Ms. Gibson served as Senior Vice President of Global Operations from July
1999 to September 2000.
(6) Reflects amounts earned, a portion of which has not yet been paid.
(7) The foregoing amounts include severance compensation which pursuant to the
terms of the agreement has not yet been paid in full.
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, 2000.
For the fiscal year ended December 31, 2000, 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.
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(4)
Options in Fiscal Price ------------------
Name Granted Year ($/Sh) Expiration Date 5% 10%
---- ------- ---- ------ --------------- -- ---
Edward J. Driscoll III ....... -- -- -- -- -- --
William E. Sullivan .......... 750,000(1) 8% 2.00 March 7, 2010 $ 943,342 $2,390,614
250,000(2) 3% 2.00 March 7, 2010 314,447 796,871
500,000(1) 5% 2.00 September 1, 2010 628,895 1,593,742
Terri F. Zimmerman............ -- -- -- -- -- --
Allen L. Witters ............. -- -- -- -- -- --
Lisa A. Gray ................. 125,000(3) 1% 2.00 January 1, 2010 157,224 398,436
50,000(1) * 2.00 September 1, 2010 62,889 159,374
* Represents less than one percent of total options granted to employees in
fiscal year 2000.
(1) These options vest monthly, over 48 months.
(2) These options immediately vest.
(3) These options vest annually, over 3 years.
(4) 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) 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.
30
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, 2000.
None of the persons listed in the table below exercised any stock options during
2000.
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 III ...... 2,875,000 375,000 $2,080,000 $--
William E. Sullivan.......... 421,873 1,078,127 -- --
Allen L. Witters ............ 2,875,000 375,000 2,080,000 --
Terri F. Zimmerman .......... 587,496 1,012,504 -- --
Lisa A. Gray ................ 476,020 323,980 -- --
(1) Amount based on the fair market value of our common stock on December 31,
2000, as determined by our Board of Directors, less the exercise price payable
under the options.
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 2000, we granted Mr. Hoffman an additional 20,000 stock
options at an exercise price of $2.00 per share vesting monthly over 36 months
and expiring December 31, 2010. 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. In December 2000, we granted Mr. Kelly an
additional 20,000 stock options at an exercise price of $2.00 per share vesting
monthly over 36 months and expiring December 31, 2010. In February 2000, we
granted Mr. Dirk 75,000 stock options at an exercise price of $2.00 per share
vesting 25,000 immediately, 25,000 on February 23, 2001 and 25,000 on February
23, 2002 and expiring February 23, 2010. In March 2000, we granted Mr. Coleman
75,000 stock options at an exercise price of $2.00 per share vesting 25,000
immediately, 25,000 on March 17, 2001 and 25,000 on March 17, 2002 and expiring
March 17, 2010.
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 officers 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
2000, none of our executive officers served on the compensation committee or as
a director of another entity
31
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, is a shareholder of Larkin, Hoffman, Daly & Lindgren,
Ltd. See "Certain Transactions -- Other Agreements."
Employment Agreements
We have entered into employment agreements with Edward J. Driscoll III, William
E. Sullivan, Terri F. Zimmerman, Allen L. Witters 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) 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.
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, 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
32
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, 2000, there were 5,255,515 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, 2000, there
were 14,265,800 options issued and outstanding under the 1998 combined stock
option plan, at exercise prices ranging from $0.00 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 5,390,000 shares of
common stock at exercise prices ranging from $0.45 to $3.90 per share.
33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information as of March 26, 2001, 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 26, 2001, 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 Beneficially Owned
- ------------------- ------------------ ------------------
Edward J. Driscoll(2) .......................... 4,916,664 32.5%
William E. Sullivan(3) ......................... 552,078 4.3
Terri F. Zimmerman(4) .......................... 649,996 5.1
Allen L. Witters(2) ............................ 4,916,664 32.5
Lisa A. Gray(5) ................................ 549,990 4.3
Richard G. Marklund(6) ......................... 349,998 2.8
Robert L. Hoffman(7) ........................... 152,800 1.2
William M. Kelly(8) ............................ 77,800 *
Patrick J. Dirk(9) ............................. 145,790 1.2
Kenneth L. Coleman(10) ......................... 25,000 *
MCI WorldCom, Inc.(11) ......................... 11,577,382 48.7
Winstar(12) .................................... 32,836,913 72.9
SGI(13) ........................................ 11,782,134 49.1
Cerberus(14) ................................... 3,213,354 20.9
Sumitomo(15) ................................... 1,073,606 8.1
James L. Ecker(16) ............................. 922,520 7.6
James R. Clancy(17) ............................ 899,999 6.9
George H. Frisch(18) ........................... 708,333 5.6
David A. Townsend(19) .......................... 1,317,300 10.8
All directors and executive
officers as a group
(10 persons)(2)(3)(4)(5)(6)(7)(8).............. 12,336,780 60.6
---------------------------------
* 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.
34
(2) Includes 2,895,831 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 499,996 shares issuable upon exercise of vested stock options
and 52,082 shares issuable upon exercise of stock options which will vest
within 60 days.
(4) Includes 568,746 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 537,389 shares issuable upon exercise of vested stock options
and 12,501 shares issuable upon exercise of stock options which will vest
within 60 days.
(6) Includes 316,664 shares issuable upon exercise of vested stock options
and 33,334 shares issuable upon exercise of stock options which will vest
within 60 days.
(7) Includes 151,680 shares issuable upon exercise of vested stock options
and 1,120 shares issuable upon options which will vest within 60 days.
Address: Larkin, Hoffman, Daly & Lindgren, Ltd., 1500 Northwest Financial
Center, 7900 Xerxes Avenue South, Bloomington, MN 55431.
(8) Includes 76,680 shares issuable upon exercise of vested stock options
and 1,120 shares issuable upon options which will vest within 60 days.
Address: Davis Polk and Wardwell, 1600 El Camino Road, Menlo Park, CA 94025
(9) Includes 25,000 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
(11) Includes 3,350,000 shares issuable upon exercise of warrants that are
currently exerciseable, 5,000,000 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 3,227,382 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. MCI WorldCom also
owns 115,206 shares of Class A preferred stock.
(12) Includes 85,000 shares of Class E convertible preferred stock which
are currently convertible into 18,209,007 shares of common stock and 60,000
shares of Class H convertible preferred stock which are currently
convertible into 11,627,906 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. Also includes 3,000,000 shares issuable
upon exercise of warrants that are currently exercisable. Address: 685
Third Ave., New York, NY 10017
(13) Includes 5,710,425 shares of Class B convertible preferred stock which
are currently convertible into 8,338,227 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,
878,527 shares of Class C convertible preferred stock which are mandatorily
convertible into 1,290,953 shares of common stock upon completion of an
underwritten public offering at offering price of $12.52 per share and
10,000 shares of Class F convertible preferred stock which are currently
convertible into 2,152,954 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: 2011 N. Shoreline Blvd.,
Mountain View, CA 94043-1389.
(14) Includes 15,000 shares of Class E convertible preferred stock which
are currently convertible into 3,213,354 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
(15) Includes 5,000 shares of Class G convertible preferred stock which are
currently convertible into 1,073,606 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
(16) 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.
35
(17) Includes 896,874 shares issuable upon exercise of vested stock options
and 3,125 shares issuable upon exercise of stock option which will vest
within 60 days.
(18) Includes 707,291 shares issuable upon exercise of currently
exercisable options and warrants and 1,042 shares issuable upon exercise of
stock option which will vest within 60 days. Address: 5030 Woodlawn Blvd.,
Minneapolis, MN 55417.
(19) Address: 64-68 Norwich Avenue West Bournemouth, Dorset BH2-6AW
England.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
1996 MCI WorldCom Convertible Subordinated Note
In September 1996, we issued the 1996 $5.0 million convertible subordinated note
to MCI WorldCom. As of December 31, 2000, $6.7 million was outstanding under the
note, which included $1.7 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. In 1999
MCI WorldCom exchanged its shares of Class A preferred stock for 115,206 shares
of a new series of Class A preferred stock (1999 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 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 $24.4 million
aggregate principal amount was outstanding as of December 31, 2000. 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. The shares of common stock issuable upon exercise of the warrants are
subject to registration rights. See guarantee entered into on September 29, 2000
below under "1998 MCI Worldcom Agreement"
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 "--
1998 MCI WorldCom Agreement" below.
MCI WorldCom Guaranteed Revolving Credit Facility
In September 1997, we entered into a bank revolving credit facility . 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, 2000, the amount outstanding on the
line of credit was $15.0 million. 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
expired in December 2000. The Class B warrants were originally exercisable only
if the revolving credit facility was not repaid.
On September 29, 2000, MCI WorlCom agreed to extend its guarantee of the line of
credit until January 10, 2001 and cancel 40,388,505 warrants based on timely
repayments, as specified in the agreement, of the line of credit. As of December
31, 2000, 17,787,500 of the 20,787,500 warrants (`1996 warrants') issued to MCI
WorldCom in November 1996 in connection with subordinated notes and the
8,396,170 Class A warrants issued to MCI WorldCom in connection with the line of
credit, were cancelled. On January 10, 2001, the Company repaid the remaining
$15 million and closed the line of credit. The 14,204,835 Class B warrants
issued to MCI WorldCom were cancelled in connection with the repayment of the
line in January 2001. As part of the agreement, the Company agreed to extend the
expiration date of the remaining 3,000,000 1996 warrants as follows: 1,000,000
until December 31, 2001; 1,000,000 until December 31, 2002; and 1,000,000 until
December 31, 2003. The Company further agreed that the exercise price for all
3,000,000 of these warrants be fixed at $1.18 per share until expiration.
36
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 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 $13.9 million,
$16.7 million and $11.8 million for the years ended December 31, 2000, 1999 and
1998. 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 and Class C convertible
preferred stock is currently convertible. 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.
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."
37
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 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%. As of December 31, 2000, the
outstanding balance of the liability was $239.6 million.
In December 1999, Winstar 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 March 2000, 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. On December 31, 2008, the Company will be required to redeem all of
the outstanding shares of Class E Convertible Preferred Stock at a redemption
price per share equal to the liquidation amount per share on such date, as
adjusted pursuant to the term of the Certificate of Designation of the Class E
Convertible Preferred Stock.
In September 2000, the Company and Winstar entered into a Securities Purchase
Agreement (the "Agreement"), pursuant to which the Company has the right to sell
to Winstar up to 60,000 shares of Class H Convertible Preferred Stock, par value
$.01 per share, at a purchase price of $1,000 per share, at the Company's
discretion, upon certain dates and in certain amounts pursuant to the terms of
the Agreement,. In connection with the execution of the Agreement, the Company
issued a warrant to Winstar to purchase up to 3,000,000 shares of common stock
of the Company at a price of $.01 per share, which warrant shall expire on
December 31, 2005. The right to purchase 500,000 shares of Common Stock pursuant
to the warrant became exercisable upon execution of the Agreement, and the right
to purchase the remainder of the Common Stock shall become exercisable as the
Company sells the Shares to Winstar pursuant to a schedule set forth in the
Agreement. The rights and preferences of the Class H convertible preferred
stock, including its conversion provisions, are substantially the same as the
rights and preferences of the Class E convertible preferred stock. The Class H
convertible preferred stock is convertible into shares of common stock at an
initial conversion rate of $5.16 per share, subject to anti-dilution provision.
As of December 31, 2000, the Company had sold 40,000 shares of Class H
convertible preferred stock for an
38
aggregate of $40 million in cash and 1,550,000 shares of common stock were
exercisable pursuant to the warrant. On December 31, 2008, the Company will be
required to redeem all of the outstanding shares of Class H Convertible
Preferred Stock at a redemption price per share equal to the liquidation amount
per share on such date, as adjusted pursuant to the term of the Certificate of
Designation of the Class H Convertible Preferred Stock. In January 2001, the
Company sold 20,000 shares of Class H convertible preferred stock for an
aggregate of $20 million in cash and a cumulative 3,000,000 shares of common
stock are exercisable pursuant to the warrant. Cumulative dividends in arrears
were $340 at December 31, 2000.
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, has been President of WAM!NET Government Services, Inc., a wholly owned
subsidiary for government contracting, since its formation in October 2000. He
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
and was granted additional options to purchase up to 400,000 shares of common
stock at a price of $2.00 per share, in all cases as partial consideration for
his agreement to provide additional consulting services to us. Mr. Driscoll is
also 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, 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,
and in January 2000, an option to purchase up to 25,000 shares of common stock
at a price of $2.00 per share, in all 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.
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 shareholders 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.
39
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.
No Current Reports were filed during the three months ended December 31,
2000:
(c) Exhibits
Item
Number Description
- ------ -----------
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 the Company, NetCo Acquisition Corporation, FreeMail, Inc. and the shareholders listed
therin.
3.1 (7) 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 ($200.0 million).
4.2b (1) Certificate for the Rule 144A Original Notes ($8.0 million).
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.
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, MCI
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 MCI 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, ($25.0 million
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 MCI 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 dated January 13, 1999.
40
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 the 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.
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 (6) Certificate of Designation of Rights and Preferences of Class E Convertible Preferred Stock of the
Company filed with tSecretary of State of the State of Minnesota on February 16, 2000, as corrected
and filed with the Secretary of State of the State of Minnesota on March 1 and March 8, 2000.
4.32 (6) 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, 2000, as
corrected and filed with the Secretary of State of the State of Minnesota on March 1 and March 9,
2000.
4.33 (6) Certificates 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 February 6, 2000.
4.34 (6) Securities Purchase Agreement, dated as of December 31, 1999, by and between the Company and
Winstar Communications, Inc.
4.35 (6) Securities Purchase Agreement, dated as March 14, 2000, by and between the Company and Cerberus
Partners, L.P.
4.36 (6) Securities Purchase Agreement, dated February 3, 2000, by and between the Company and Silicon
Graphics, Inc.
4.37 (6) 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 (6) Form of Certificate for Shares of Class E Convertible Preferred Stock of the Company.
4.39 (6) Form of Certificate for shares of Class F Convertible Preferred Stock of the Company.
4.40 (6) Form of Certificate for shares of Class G Convertible Preferred Stock of the Company.
4.41 (6) 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.
4.42 (8) Securities Purchase Agreement, dated as of March 14, 2000, by and between the Company and the
buyers listed on Schedule 1.1 thereto.
4.43 (8) Securities Purchase Agreement, dated as of September 29, 2000, by and between the Company, Winstar
Communications, Inc. and Winstar Credit Corp.
4.44 (8) Certificate for 3,000,000 Warrants to purchase shares of Common Stock for the purchase price of
$.01 per share issued to Winstar Communications, Inc. in connection with the Securities Purchase
Agreement, dated September 29, 2000.
4.45 (8) Certificate of Designation of Rights and Preferences of Class
H Convertible Preferred Stock of the Company filed with the
Secretary of State of the State of Minnesota on October 3, 2000.
4.46 (8) Form of Certificate for shares of Class H Convertible Preferred Stock of the Company.
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 MCI WorldCom, Inc., dated
September 12, 1996 ($5.0 million Note).
10.3 (1) Preferred Stock, Subordinated Note and Warrant Purchase Agreement between the Company and MCI
WorldCom, Inc., dated November 14, 1996.
10.4 (1) $28.5 millioin Seven Percent Subordinated Note due December 31, 2003, payable to MCI WorldCom, Inc.
10.5 Intentionally omitted.
10.6 Intentionally omitted.
10.7 (1) Right of Refusal Agreement Among WorldCom Inc., Edward Driscoll III and Alan L. Witters dated
December 16, 1996.
41
10.8 (1) Guaranty Agreement dated September 26, 1997, by and between the Company and MCI WorldCom, Inc.
10.9 * Loan and Security Agreement dated February 13, 2001 by and among the Company and each of its
subsidiaries as Borrowers and the Lenders that are Signatories
thereto as the Lenders, and Foothill Capital Corporation as the
Arranger and Administrative Agent.
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 MCI 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 MCI 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 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 MCI 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 ommitted 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, 199, by and between Foothill Capital Corporation and
the Company.
10.28 (5) Purchase and Sale Agreement and Escrow Instreuctins, dated September 30, 1999, between the Company
and CCPRE-Eagan, LLC.
10.29 (5) Amendment No. 1 to the 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 (6) Master Agrement by and between Winstar Wireless, Inc. and the Company, dated December 31, 1999.
- ----------------
(1) Incorporated herein by reference to our Registration Statement on Form S-4
(File No. 333-53841), filed with the SEC on May 28, 1998.
(2) Incorporated herein by reference to our Annual Report on Form 10-K, filed
with the SEC on March 31, 1999.
(3) Incorporated herin by reference to our Quarterly Report on Form 10-Q, filed
with the SEC on May 17, 1999.
(4) Incorporated herin by reference to our Quarterly Report on Form 10-Q, filed
with the SEC on August 4, 1999.
(5) Incorporated herin by reference to our Quarterly Report on Form 10-Q, filed
with the SEC on November 12, 1999.
(6) Incorporated herin by reference to our Annual Report on Form 10-K, filed
with the SEC on March 15, 2000.
(7) Incorporated herin by reference to our Quarterly Report on Form 10-Q, filed
with the SEC on May 15, 2000.
(8) Incorporated herin by reference to our Quarterly Report on Form 10-Q, filed
with the SEC on November 14 , 2000.
* Filed herewith.
42
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.
43
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 16th day of April, 2001.
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 April 16, 2001
-------------------------- and Chief Executive
Edward J. Driscoll III Officer
/s/ Robert L. Hoffman Director April 16, 2001
--------------------------
Robert L. Hoffman
/s/ William M. Kelly Director April 16, 2001
--------------------------
William M. Kelly
/s/ Patrick J. Dirk Director April 16, 2001
--------------------------
Patrick J. Dirk
/s/ Kenneth L. Coleman Director April 16, 2001
--------------------------
Kenneth L. Coleman
44
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-
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, 1999 and 2000, and the related consolidated statements of
operations, shareholders' deficit and cash flows for each of the three years in
the period ended December 31, 2000. Our audits also included the financial
statement schedule listed in the Index at Item 14 (a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule 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, 1999 and 2000, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, 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.
The accompanying financial statements have been prepared assuming that WAM!NET
Inc. will continue as a going concern. As more fully described in note 2, the
Company has incurred recurring operating losses, has a working capital
deficiency, and is dependent upon raising additional capital to continue
operations. These conditions raise substantial doubt about the company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in note 2. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or amounts and classification of liabilities that may
result from the outcome of this uncertainty.
Ernst & Young LLP
Minneapolis, Minnesota
January 26, 2001, except for note 18,
as to which the date is February 28, 2001
F-2
WAM!NET Inc.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31,
------------
1999 2000
---- ----
Assets
Current assets:
Cash and cash equivalents ................................... $ 27,180 $ 3,207
Accounts receivable, net of allowance of $1,570 and $1,333 at
December 31, 1999 and 2000 ................................. 3,982 8,344
Inventory ................................................... 1,254 533
Prepaid expenses and other current assets ................... 4,018 6,919
--------- ---------
Total current assets ........................................... 36,434 19,003
Property, plant and equipment, net ............................. 358,336 369,796
Goodwill, net .................................................. 21,421 15,475
Deferred financing charges, net ................................ 18,300 12,392
Other assets ................................................... 764 1,105
--------- ---------
Total assets ................................................... $ 435,255 $ 417,771
========= =========
Liabilities and shareholders' deficit Current liabilities:
Accounts payable ............................................ $ 13,732 $ 17,407
Accrued salaries and wages .................................. 2,839 5,246
Accrued expenses ............................................ 6,450 7,654
Deferred revenue ............................................ 2,500 7,069
Current portion of long-term debt ........................... 55,950 27,931
--------- ---------
Total current liabilities ...................................... 81,471 65,307
Deferred revenue ............................................... 10,000 10,000
Long-term debt, less current portion ........................... 490,450 500,173
Class A Redeemable Preferred Stock ............................. 1,219 1,300
Class E Convertible Preferred Stock ............................ -- 107,515
Class H Convertible Preferred Stock ............................ -- 40,340
Shareholders' deficit:
Class B Convertible Preferred Stock ......................... 57 57
Class C Convertible Preferred Stock ......................... 9 9
Class D Convertible Preferred Stock ......................... 22 22
Class F Convertible Preferred Stock ......................... -- --
Class G Convertible Preferred Stock ......................... -- --
Common Stock ................................................... 95 121
Additional paid-in capital ..................................... 156,680 170,951
Accumulated deficit ............................................ (303,614) (475,789)
Accumulated other comprehensive loss ........................... (1,134) (2,235)
--------- ---------
Total shareholders' deficit .................................... (147,885) (306,864)
--------- ---------
Total liabilities and shareholders' deficit..................... $ 435,255 $ 417,771
========= =========
See accompanying notes.
F-3
WAM!NET Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Year Ended December 31,
-----------------------
1998 1999 2000
---- ---- ----
Revenues:
Net service revenue .......................... $ 6,799 $ 17,319 $ 34,107
Software and hardware sales .................. 10,791 7,476 6,334
------------ ------------ ------------
Total revenues .................................. 17,590 24,795 40,441
Operating expenses:
Network communication fees ................... 18,259 26,318 28,428
Cost of other service revenues ............... -- -- 2,199
Cost of software and hardware ................ 3,537 2,905 2,027
Technical operations ......................... 35,095 22,928 22,259
Selling, general and administrative .......... 45,422 42,692 50,569
Depreciation and amortization ................ 17,668 34,875 40,035
------------ ------------ ------------
119,981 129,718 145,517
------------ ------------ ------------
Loss from operations ............................ (102,391) (104,923) (105,076)
Other income (expense):
Loss on investment ........................... -- -- (23,512)
Interest income .............................. 1,748 814 793
Interest (expense) ........................... (22,626) (35,693) (47,047)
Other income ................................. 39 575 2,667
------------ ------------ ------------
Net loss before income tax benefit ........... (123,230) (139,227) (172,175)
Income tax benefit ........................... 1,352 -- --
------------ ------------ ------------
Net loss ........................................ (121,878) (139,227) (172,175)
Less preferred dividends ..................... (70) (5,890) (14,383)
------------ ------------ ------------
Net loss applicable to common shareholders ...... $ (121,948) $ (145,117) $ (186,558)
============ ============ ============
Net loss applicable per common share -- basic and
diluted ...................................... $ (13.87) $ (15.58) $ (17.73)
============ ============ ============
Weighted average number of common shares
outstanding -- basic and diluted ............. 8,793,961 9,315,900 10,523,789
============ ============ ============
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, 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)
Accumulated dividends in connection
with Class A, E and H Preferred
Stock .................................... -- -- -- -- (6,211) -- -- (6,211)
Amortization of stock options .............. -- -- -- -- 456 -- -- 456
Issuance of Convertible Preferred
Stock .................................... -- -- 20 -- 16,331 -- -- 16,331
Issuance of Common Stock for acquisitions .. 694 7 -- -- 1,993 -- -- 2,000
Exercise of stock options/warrants ......... 1,927 19 -- -- 1,702 -- -- 1,721
Comprehensive loss:
Net loss ................................. -- -- -- -- -- (172,175) -- (172,175)
Foreign currency translation adjustment .. -- -- -- -- -- -- (1,101) (1,101)
---------
Total comprehensive loss ................... -- -- -- -- -- -- -- (173,276)
--------- --------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2000 ................. 12,116 $ 121 8,805 $ 88 $ 170,951 $(475,789) $ (2,235) $(306,864)
========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes.
F-5
WAM!NET Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
-----------------------
1998 1999 2000
---- ---- ----
Operating activities
Net loss ............................................................... $(121,878) $(139,227) $(172,175)
Adjustments to reconcile net loss to net cash used in
operating activities:
Loss on sale of investment .......................................... -- -- 23,512
Noncash interest expense, including related warrant values .......... 18,295 29,080 30,470
Value of stock options issued to employees and consultants .......... 12,522 166 456
Depreciation and amortization ....................................... 17,668 34,875 40,035
Loss on disposal of property and equipment .......................... 69 1,746 --
Changes in operating assets and liabilities:
Accounts receivable ............................................... 647 (516) (4,032)
Prepaid expenses and other assets ................................. (8,424) (969) (2,538)
Accounts payable .................................................. 14,795 (3,359) 3,536
Deferred Revenue .................................................. -- 12,500 4,569
Accrued expenses .................................................. 10,428 34 3,066
--------- --------- ---------
Net cash used in operating activities .................................. (55,878) (65,670) (73,101)
Investing activities
Purchases of property and equipment .................................... (54,584) (25,208) (43,467)
Patent expenditures .................................................... (370) (87) (34)
Proceeds from sale of investment ....................................... -- -- 26,486
Business acquisitions (net of cash acquired) ........................... (16,350) (647) 397
--------- --------- ---------
Net cash used in investing activities .................................. (71,304) (25,942) (16,618)
Financing activities
Proceeds from sale of preferred stock .................................. -- 34,707 108,056
Proceeds from borrowings (net of financing expenses) ................... 161,800 95,771 --
Proceeds from exercise of stock options and warrants ................... 15 5 1,721
Payments on borrowings ................................................. (28,998) (16,986) (42,931)
--------- --------- ---------
Net cash provided by financing activities .............................. 132,817 113,497 66,846
Effect of foreign currencies on cash ................................... 363 (977) (1,100)
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents ................... 5,998 20,908 (23,973)
Cash and cash equivalents at beginning of year ......................... 274 6,272 27,180
--------- --------- ---------
Cash and cash equivalents at end of year ............................... $ 6,272 $ 27,180 $ 3,207
========= ========= =========
Supplemental schedule of noncash financing activities
Value of interest cost assigned to warrants ............................ 10,047 4,297 --
Conversion of accrued interest to subordinated debt .................... 1,965 1,837 --
Issuance of convertible preferred stock in exchange for
land, building, and furniture and fixtures .......................... -- 40,000 --
Exchange of preferred stock for investment ............................. -- -- 50,000
Dividends accrued but unpaid ........................................... 70 60 6,211
Purchase of network facilities ......................................... -- 260,280 --
Issuance of common stock relating to acquisition ....................... 20,000 -- 2,000
Conversion of convertible subordinated debenture for common stock....... 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 ................................................. 2,276 6,332 29,427
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 information technology services to
government and commercial customers. Our services are sold on an outsourced
transactional basis and enable organizations to convert to more efficient and
cost-effective digital business processes. In our commercial business we focus
on companies that produce and distribute media-rich content including broadcast,
film and other entertainment companies, as well as corporations that promote
brands, advertising agencies, publishers and related businesses. Our services
allow these firms to collaborate online with their supply chain partners to
improve the process of creating and distributing media-rich content. Our
government business consists of selling services offered to our commercial
customers as well as the large contract where we are a tier 1 subcontractor to
the Navy Marine Corps Intranet Project (see footnote 16).
Consolidation Policy and Foreign Currency Translations
The consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiaries and its 60% 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 statement of operations 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 also may offer service rebates which are netted
against revenue. 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.
In December 1999, the SEC issued Staff Accounting Bulletin, SAB 101, entitled
"Revenue Recognition in Financial Statements" as amended, effective as of
October 1, 2000, which summarizes the SEC's views in applying generally accepted
accounting principles to revenue recognition. The adoption of this Bulletin had
no effect on the Company's financial position or results of operations.
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 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.
F-7
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
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 two 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 $11,954 and $19,344 at December 31, 1999 and 2000.
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 $11,135 and $17,043 at December 31, 1999 and 2000.
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 1998, 1999 and 2000 were
$13,447, $8,278 and $8,256, respectively. The Company capitalized 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 1999
and 2000 the Company capitalized $3,129 and $0. Accumulated amortization was
$1,976 and $4,258 at December 31, 1999 and 2000.
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.
Net Loss Per Common Share
The Company's basic net loss per share applicable to common shareholders 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.
F-8
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
In March 2000, the FASB issued Financial Accounting Series Interpretation No. 44
entitled "Accounting for Certain Transactions involving Stock Compensation,"
which provides clarification to Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." The adoption of this Interpretation
had no effect on the Company's financial position or results of operations.
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 1998 and 1999 amounts have been reclassified to conform to the 2000
presentation.
2. Liquidity
Since inception, the Company has incurred net losses and experienced negative
cash flow from operating activities. Net losses since inception have resulted in
an accumulated deficit of $476,000 as of December 31, 2000. Management expects
to continue to operate at a net loss and experience negative cash flow from
operating activities through the foreseeable future. At December 31, 2000, the
Company's cash resources and available borrowings are insufficient to fund
operations for the next 12 months without raising additional debt and/or equity
capital. These factors raise substantial doubt about its ability to continue as
a going concern. The financial statements do not include any adjustments
relating to the recoverability and classification of reported asset amounts or
the amount or classification of liabilities, which might result from the outcome
of this uncertainty.
Management currently is exploring available options for additional capital
including borrowings secured by otherwise unencumbered assets, private issuances
of secured borrowings or preferred or common stock, strategic alliances or
partnerships, or the public offering of common stock. However, there is no
assurance that such funds will be available or available on terms acceptable to
the Company. If the Company is not successful in obtaining additional funding,
it may not be able to continue as a going concern.
3. Property, Plant and Equipment
Property, plant and equipment is summarized as follows:
December 31,
------------
1999 2000
---- ----
Land ............................. $ 8,800 $ 8,800
Building ......................... 30,931 31,741
Network facilities ............... 260,280 274,825
Network equipment ................ 65,941 82,730
Other support equipment .......... 23,989 33,907
Furniture and fixtures ........... 4,180 4,738
Leasehold improvements ........... 3,888 3,926
--------- ---------
398,009 440,667
Less accumulated depreciation..... (39,673) (70,871)
--------- ---------
$358,336 $369,796
========= =========
The company capitalized $14,461 of interest relating to the Network facilities
during 2000. The capitalized interest will be amortized over the life of the
Network facilities.
F-9
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
4. Deferred Revenue
In December 1999, the Company entered into an agreement with Winstar, whereby
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
revenue remains deferred at December 31,2000.
5. Long-Term Debt
Long-term debt consists of:
December 31,
------------
1999 2000
---- ----
13.25% senior discount notes ................... $ 157,999 $ 179,627
Lines of credit ................................ 27,137 15,000
Equipment financing ............................ 21,041 11,433
Sale-leaseback financing ....................... 38,246 39,344
Subordinated notes payable ..................... 29,165 31,003
Other financing ................................ 12,532 12,094
Network facilities financings (see Note 6)...... 260,280 239,603
--------- ---------
546,400 528,104
Less current portion ........................... (55,950) (27,931)
--------- ---------
$ 490,450 $ 500,173
========= =========
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, $1,166 and $1,325 for the years ended December 31,
1998, 1999 and 2000.
Lines of Credit
The Company has a $25,000 line of credit agreement with a bank, which was
originally due in September 2000 and was subsequently extended to January 10,
2001. The line of credit is guaranteed by MCI WorldCom. At December 31, 2000,
the amount outstanding on the line of credit was $15,000. 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 (7.35 % at December 31,
2000) and prime (9.5% at December 31, 2000). 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 expired in December, 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, 1998, 1999 and 2000 was $1,589,
$1,589 and $1,191. The Class B warrants were originally exercisable only if the
line of credit was not repaid, under the terms of the agreement. The Class B
warrants were deemed to have no value based on management's intentions and
ability to repay the line of credit in accordance with the agreement.
F-10
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
On September 29, 2000, MCI WorlCom agreed to extend its guarantee of the line of
credit until January 10, 2001 and cancel 40,388,505 warrants based on timely
repayments, as specified in the agreement, on the line of credit. As of December
31, 2000, 17,787,500 of the 20,787,500 warrants (`1996 warrants') issued to MCI
WorldCom in November 1996 in connection with subordinated notes and the
8,396,170 Class A warrants issued to MCI WorldCom in connection with the line of
credit, were cancelled. On January 10, 2001, the Company repaid the remaining
$15,000 and closed the line of credit. The 14,204,835 Class B warrants issued to
MCI WorldCom were cancelled in connection with the repayment of the line in
January 2001. As part of the agreement, the Company agreed to extend the
expiration date of the remaining 3,000,000 1996 warrants as follows: 1,000,000
until December 31, 2001; 1,000,000 until December 31, 2002; and 1,000,000 until
December 31, 2003. The Company further agreed that the exercise price for all
3,000,000 of these warrants be fixed at $1.18 per share until expiration.
In July 1999, the Company entered into a $20,000 bank credit facility. At
December 31, 1999 the outstanding balance was $2,137. In March 2000, the Company
repaid the $2,137 and closed the bank credit facility.
Equipment Financing
The Company has entered into various notes payable with equipment financing
companies. Monthly payments on the installment notes range from $2 to $149,
including imputed interest at rates ranging from 8.74% to 15.58%. The various
notes are due between April 2001 through September 2004 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.
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 10% Convertible
Subordinated Note 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 1999 and 2000, $507 and $508, of accrued interest was converted into
additional subordinated notes. As of December 31, 1999 and 2000 the outstanding
balance of the note was $6,142 and $6,650.
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
F-11
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
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 8), 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,
1999 and 2000, the accumulated and unpaid dividends were $67 and $148.
Under the Subordinated Note Agreement contained in the Investment 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 each of 1999
and 2000, $1,330 of accrued interest was converted into additional subordinated
notes. The amount outstanding on the subordinated note agreement was $23,023 and
$24,353 at December 31, 1999 and December 31, 2000.
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. As discussed
above under "Lines of Credit", 17,787,500 of the warrants were cancelled in
December 2000. The Company agreed to extend the expiration date on the remaining
3,000,000 warrants and further agreed to fix the exercise price at $1.18 per
share as discussed under "Lines of Credit". 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, 1998, 1999 and 2000, the Company recorded amortization expense of
$1,226.
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.
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.
Other Financing
In December, 1999 the Company entered into a sublease agreement with Winstar for
space in the Company's Minnesota data center. In December 1999 Winstar made a
one-time advance payment 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.
Winstar is required to make monthly payments of approximately $81 over 10 years.
The carrying amounts of the Company's debt instruments in the balance sheets at
December 31, 1999 and 2000 approximate fair value.
Maturities of long-term debt as of December 31, 2000 are as follows:
2001 ............................ $ 27,931
2002 ............................ 55,453
2003 ............................ 25,116
2004 ............................ 41,796
2005 ............................ 275,423
Thereafter ....................... 102,385
---------
528,104
Less current maturities........... (27,931)
---------
$ 500,173
=========
F-12
6. 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 related liability at the agreed-upon fair value of
$260,280, which liability bears an effective interest rate of 8.3%.
7. Capital Stock
The Company has the following classes of capital stock:
o Undesignated preferred stock, 864,525 shares authorized which may be
issued in one or more series; none issued and outstanding at December
31, 1998, 1999, and 2000.
o Class A redeemable preferred stock, 115,206 shares authorized of $10
par value; 100,000, 115,206 and 115,206 shares issued and outstanding
at December 31, 1998, 1999 and 2000 (see Note 5).
o Class B convertible preferred stock, 5,710,425 shares authorized of
$.01 par value; 5,710,425 and 5,710,425 shares issued and outstanding
at December 31, 1999 and 2000 (see Note 8).
o Class C convertible preferred stock, 878,527 shares authorized of $.01
par value; 878,527 and 878,527 shares issued and outstanding at
December 31, 1999 and 2000 (see Note 8).
o Class D convertible preferred stock, 2,196,317 shares authorized of
$.01 par value; 2,196,317 and 2,196,317 shares issued and outstanding
at December 31, 1999 and 2000 (see Note 8).
o Class E convertible preferred stock, 115,000 shares authorized of $.01
par value, 101,725 issued and outstanding at December 31, 2000 (See
Note 8).
o Class F convertible preferred stock, 50,000 shares authorized of $.01
par value, 10,000 issued and outstanding at December 31, 2000 (See
Note 8).
o Class G convertible preferred stock, 10,000 shares authorized of $.01
par value, 10,000 issued and outstanding at December 31, 2000 (See
Note 8).
o Class H convertible preferred stock, 60,000 shares authorized of
$.01par value; 40,000 shares issued and outstanding at December 31,
2000 (see Note 6).
o Common Stock, 490,000,000 shares authorized of $.01 par value;
9,288,194, 9,494,797 and 12,115,613 shares issued and outstanding at
December 31, 1998, 1999 and 2000.
F-13
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
8. 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. Cumulative dividends in arrears were $1,453 and $3,203 at December
31,1999 and 2000 respectively. 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. Class B cumulative
dividends in arrears were $3,777 and $8,327 at December 31, 1999 and 2000
respectively. Class C cumulative dividends in arrears were $581 and $1,281 at
December 31, 1999 and 2000 respectively.
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). All shares of Winstar common stock were sold during 2000 resulting in a
loss of $23,512. 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. Cumulative dividends in
arrears were $0 and $5,790 at December 31, 1999 and 2000 respectively. 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 on all matters submitted
to the vote of common stock holders including the election of directors. In the
event that any holder of Class E preferred stock possesses voting power in
excess of 17.5% of the voting power of the Company, such holder's voting power
shall be reduced to, at most, 17.5% of the total voting power of all the equity
holders of the Company. The Class E convertible preferred stock is currently
convertible into 19,714,147 shares of common stock at an initial conversion rate
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. On December 31, 2008, the Company will be required to redeem all of the
outstanding shares of Class E Convertible Preferred Stock at a redemption price
per share equal to the liquidation amount per share on such date, as adjusted
pursuant to the term of the Certificate of Designation of the Class E
Convertible Preferred Stock.
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 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. Cumulative dividends in arrears were $660
at December 31, 2000.
In February 2000, the Company sold to Sumitomo Corporation 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
F-14
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
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. Cumulative dividends in arrears were $593 at December
31, 2000.
In September 2000, the Company and Winstar entered into a Securities Purchase
Agreement (the "Agreement"), pursuant to which the Company to sell to Winstar
60,000 shares of Class H Convertible Preferred Stock, par value $.01 per share,
at a purchase price of $1,000 per share upon certain dates and in certain
amounts pursuant to the terms of the Agreement,. In connection with the
execution of the Agreement, the Company issued an immediately exercisable
warrant to Winstar to purchase up to 3,000,000 shares of common stock of the
Company at a price of $.01 per share, which warrant shall expire on December 31,
2005. The rights and preferences of the Class H convertible preferred stock,
including its conversion provisions, are substantially the same as the rights
and preferences of the Class E convertible preferred stock. The holders of the
Class H 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
shareholders. In addition, Winstar or any subsidiary thereof, individually or as
a group, have the right to appoint up to two directors to serve as directors on
the Company's Board of Directors. Pursuant to the terms of the Class H preferred
stock, Winstar and its subsidiaries, by virtue of their ownership of Class E
preferred stock and Class H preferred stock have the right, collectively, to
appoint only one person to serve on the Board of Directors of the Company. To
the extent that Winstar or any subsidiary thereof, individually or as a group,
is entitled to more than the number of votes equal to 17.5% of all votes cast at
any meeting at which a vote is being taken, by virtue of its ownership of Class
E preferred stock, Class H preferred stock or any common stock issued upon the
exercise of warrants issued in connection with the issuance of the Class H
preferred stock, such holder of Class H preferred stock shall have its voting
power reduced to, at most, 17.5% of the total voting power of all equity holders
of the Company. On December 31, 2008, the Company will be required to redeem all
of the outstanding shares of Class H Convertible Preferred Stock at a redemption
price per share equal to the liquidation amount per share on such date, as
adjusted pursuant to the term of the Certificate of Designation of the Class H
Convertible Preferred Stock.
The Class H convertible preferred stock is convertible into shares of common
stock at an initial conversion rate of $5.16 per share, subject to anti-dilution
provision. As of December 31, 2000, the Company had sold 40,000 shares of Class
H convertible preferred stock for an aggregate of $40 million in cash and
1,550,000 shares of common stock were exercisable pursuant to the warrant. In
January 2001, the Company sold 20,000 shares of Class H convertible preferred
stock for an aggregate of $20 million in. Cumulative dividends in arrears were
$340 at December 31, 2000.
9. 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 four 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.
F-15
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
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, 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
Granted ....................................... (9,755,712) 9,755,712 -- 1.98
Canceled ...................................... 3,979,680 (3,979,680) -- 2.59
Exercised ..................................... -- (1,235,356) (75,000) .94
----------- ----------- ----------- -----
Balance at December 31, 2000 ..................... 11,181,432 19,521,315 5,390,000 $2.39
=========== =========== =========== =====
At December 31, 1998, 1999 and 2000, 8,937,698, 12,017,861 and 14,216,742
options were exercisable with weighted average exercise prices of $2.20, $2.42
and $2.39.
The following information applies to grants that are outstanding at December 31,
2000:
Options Outstanding
------------------- Options Exercisable
Weighted -------------------
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
- -------------- ----------- ---- ----- ----------- -----
$0.00 to 0.45 386,400 1.9 years $ .44 376,400 $ .43
0.46 to 0.96 7,116,908 4.8 years .96 7,116,908 .96
0.97 to 2.00 13,788,405 8.5 years 2.00 3,841,287 2.00
2.01 to 3.90 956,467 3.3 years 3.90 903,968 3.90
3.91 to 8.00 2,663,135 7.3 years 8.00 1,978,179 8.00
---------- ---------- --------
$0.00 to $8.00 24,911,315 7.0 years $ 2.39 14,216,742 $ 2.39
========== ========== ========
The fair values of the options granted during 1998, 1999 and 2000 were $1.57,
$.97 and $ .45 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 1998, 1999 and 2000: risk-free interest rate of
4.78%, 5.88% and 5.13%; 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.
F-16
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
For purposes of pro forma disclosures, as required by FASB Statement No. 123,
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:
1998 1999 2000
---- ---- ----
Net loss applicable to common stock,
as reported ................................. $(121,948) $(145,117) $(186,558)
Pro forma net loss ............................. (127,304) (147,423) (188,126)
Net loss per common share as reported........... $ (13.87) $ (15.58) $ (17.73)
Pro forma net loss per common share ............ (14.48) (15.82) (17.88)
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, 1997 .............. 50,160,170 35,955,335 .60-3.90
Granted:
13.25% Senior Discount Notes
(see Note 5) ...................... 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 8) ...................... 350,000 350,000 .01 2004
Sale-Leaseback Financing
(see Note 5) ...................... 325,000 325,000 12.00 2009
----------- -----------
Balance at December 31, 1999 .............. 52,092,606 37,887,771 $.01-$12.00
Granted:
Class H Convertible Preferred Stock
(see Note 8) ...................... 3,000,000 1,550,000 .01 2007
Acquisition of is.com
(see Note 13) ..................... 100,000 100,000 14.00 2003
Cancelled:
Line of Credit
(see Note 5) ...................... (8,396,170) (8,396,170)
MCI WorldCom Subordinated Notes
(see Note 5) ...................... (17,787,500) (17,787,500)
Exercised ......................... (616,665) (616,665) .60-1.20
Balance at December 31, 2000 .............. 28,392,271 12,737,436 $.01-$14.00
=========== =========== ===========
On January 10, 2001, 14,204,835 of the 28,392,271 outstanding warrants at
December 31, 2000 were cancelled (see Note 5).
10. Income Taxes
At December 31, 2000, the Company had net operating loss carryforwards of
approximately $354,500. These carryforwards are available to offset future
taxable income through 2020 and are subject to the limitations of Internal
Revenue Code Section 382 resulting from changes in ownership.
F-17
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
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:
1998 1999 2000
---- ---- ----
Tax at statutory rate ........................... 34.0% 34.0% 34.0%
State income taxes .............................. 6.0 6.0 4.0
Foreign tax benefit ............................. (1.1) -- --
Impact of net operating loss carryforward........ (40.0) (40.0) (38.0)
----- ----- -----
(1.1)% -- % -- %
===== ===== =====
Components of deferred tax assets are as follows:
December 31,
------------
1999 2000
---- ----
Deferred assets:
Net operating loss ............... $ 74,276 $ 134,573
Unearned revenue ................. -- 6,483
Deferred interest ................ 10,206 14,601
Stock option amortization ........ 4,937 4,947
Other ............................ 6,783 3,060
--------- ---------
96,202 163,663
Deferred liability:
Depreciation and amortization..... (3,193) (276)
--------- ---------
Net deferred income tax assets ...... 93,009 163,387
Valuation allowance ................. (93,009) (163,387)
--------- ---------
Net deferred income taxes ........... $ -- $ --
========= =========
11. 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 $11,840, $16,735 and $13,901 for the years
ended December 31, 1998, 1999 and 2000.
F-18
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Guaranteed monthly usage levels of data communications with certain of the
Company's telecommunication vendors and MCI WorldCom at December 31, 2000
aggregate to the following annual amounts:
Guaranteed Guaranteed
Usage Usage
(all vendors) (MCI WorldCom)
------------- -------------
2001....................... $5,191 $1,658
2002 ...................... 1,756 --
2003 ...................... 788 --
2004 ...................... 254 --
2005 ...................... 56 --
------ ------
$8,045 $1,658
====== ======
The termination contingency of data communications with certain of the Company's
telecommunication vendors and MCI WorldCom at December 31, 2000 aggregates to
the following annual amounts:
Termination Termination
Contingency Contingency
(all vendors) (WorldCom)
------------- ----------
December 31:
2000........................ $5,710 $2,069
2001 ....................... 1,102 350
2002 ....................... 446 --
2003 ....................... 405 --
2004 ....................... 416 --
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 $2,189, $2,586 and
$1,789 for the years ended December 31, 1998, 1999 and 2000. Future minimum
lease obligations in excess of one year at December 31, 2000 are as follows:
2001........................ $2,625
2002 ....................... 2,152
2003 ....................... 1,607
2004 ....................... 1,495
2005 ....................... 1,077
Thereafter ................. 437
------
$9,393
======
Contingent Liabilities
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.
F-19
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
12. 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.
13. Business Acquisitions
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, 2000. 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, 1998
----------------------------
(Unaudited)
Revenues........................ $ 21,109
Net loss ....................... (121,922)
Net loss per share ............. $ (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 projection of future results and do
not reflect any synergies that might be achieved from combined operations.
Acquisition of is.com
On November 29, 2000, the Company purchased all of the outstanding common stock
of is.com for 500,000 shares of the Company's Common Stock. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
operating results of is.com have been included in the consolidated operating
results since the date of acquisition. The inclusion of the is.com operating
results for periods prior to the date of acquisition would not have materially
affected results of operations. In connection with the acquisition, the Company
issued a warrant to purchase 100,000 shares of Common Stock to the sole owner of
is.com.
14. 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 owned 90% of WAM!NET Japan K.K., and Sumitomo
owned 10%. In February 2000, Sumitomo purchased an additional 30% ownership
interest in WAM!NET Japan K.K. bringing their total ownership interest to 40%.
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 and 2000 were not material.
F-20
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
15. 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 Chief Executive Officer assumed an executive position with a
subsidiary of the company. He owns 250,000 shares of Common Stock of the Company
and holds an option to purchase 300,000 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, 1998, 1999 and 2000, the Company incurred
legal fees and expenses of approximately $1,111, $1,277 and $1,009, to such firm
for services rendered in connection with litigation and for general legal
services. Management believes the fees paid for these services rendered to the
Company were on terms at least as favorable to the Company as could have been
obtained from an unrelated party.
16. Major Customers
In 1998, 1999 and 2000, no single customer accounted for more than 10% of net
sales.
On October 6, 2000, the Company was part of the Electronic Data Systems-led team
that won the $6.9 billion Navy Marine Corps Intranet (NMCI) contract. This
intranet is to become a common computing and communications environment linking
more that 300 Navy and Marine Corps bases throughout the U. S., Iceland, Puerto
Rico, Guam, Hawaii and Guantanamo Bay, and Cuba. It is designed to enhance
communication and the readiness of the U. S. Armed Forces. As a tier one
subcontractor, the company's responsibility is to provide management services of
the intranet IP infrastructure and deliver data services at the seat level to
the bases. This model is similar to how we manage our network, storage and
hosting infrastructure and deliver services to commercial customers.
On November 28, 2000, EDS and WAM!NET entered into a Pre-Subcontract
Authorization Agreement. The period of performance was from October 7, 2000
through February 9, 2001 (the date the Definitive Subcontract Agreement was
signed) and detailed out certain milestones and the related values. The Company
invoiced EDS $7,000 in 2000 based upon the achievement of certain milestones and
received payments of $1,000 in December 2000 and $6,000 in January 2001. The
Company recorded $3,400 of revenues as of December 31 2000 under this agreement.
On February 9, 2001, EDS and WAM!NET entered into a definitive Subcontract
Agreement The contract, which was awarded under the Federal Acquisition
Regulation (FAR) Part 12 procedures, is an indefinite quantity type contract
(with minimum purchase commitments) where delivery or performance shall be made
only as authorized by orders issued by the Navy under the ordering clause of the
NMCI contract with EDS. The contract contains a base period of five program
years effective October 7, 2000, and an option to extend the period of
performance an additional three years. The Company will record and recognize
revenue based upon performance on the number of seats ordered beginning in
February 2001.
17. 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,
-----------------------
1998 1999 2000
---- ---- ----
Net sales to unaffiliated customers:
United States.......................... $ 8,216 $15,879 $29,091
Europe ................................ 9,005 8,797 10,804
Rest of World ......................... 369 119 546
------- ------- -------
Total net sales .......................... $17,590 $24,795 $40,441
======= ======= =======
F-21
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Dollars in thousands, except share and per share amounts)
Identifiable assets:
United States.................. $107,101 $419,777 $403,369
Europe ........................ 18,358 15,358 13,224
Rest of World ................. -- 120 1,178
-------- -------- --------
Total assets ..................... $125,459 $435,255 $417,770
======== ======== ========
"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.
18. Subsequent Events
In February 2001, the Company entered into a $30,000 bank credit facility ,which
expires in January 2003. The credit facility is a revolving credit facility
under which the bank will lend the Company up to the $30,000 based upon a
borrowing base consisting of the Company's cash collections. Amounts outstanding
under the credit facility incur interest at the banks reference rate plus 3.25%
(11.75% at February 28, 2001). 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. The credit facility is
automatically renewable at maturity until canceled in accordance with its terms.
As of February 28, 2001, the Company has borrowed $14,667 under the credit
facility.
F-22
Schedule II -- Valuation and qualifying accounts
Deductions
-------------------------
Charged
Balance at to allowance Charged Balance at
Beginning for doubtful to other end of
Description of period Additions accounts accounts period
----------- --------- ----------- ------------ -------- ----------
Allowance for doubtful accounts
December 31, 2000 $1,570,000 $ 881,000 $1,118,000 $ -- $1,333,000
December 31, 1999 430,000 1,393,000 245,000 8,000 1,570,000
December 31, 1998 10,000 420,000 -- -- 430,000
F-23