UNITED STATES SECURITIES
AND EXCHANGE COMMISSION
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: June 30, 2001
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 number: 333-53841
WAM!NET Inc.
(Exact name of registrant as specified in its charter)
Minnesota 41-1795247
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
655 Lone Oak Dr
Eagan, Minnesota 55121
(Address of principal executive offices)
(Zip Code)
(651) 256-5100
(Registrant's telephone number, including area code)
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 such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes [X] No [_]
As of July 31, 2001 there were 12,228,630 shares of the Corporation's Common
Stock, par value $.01 per share, outstanding.
Total number of pages in this report: 35
WAM!NET Inc.
INDEX TO FORM 10-Q
Part I--Financial Information
Page No.
--------
Item 1--Financial Statements
Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000................ 3
Consolidated Statements of Operations for the three month and six month periods
ended June 30, 2001 and 2000....................................................... 5
Consolidated Statements of Cash Flows for the three month and six month periods
ended June 30, 2001 and 2000....................................................... 6
Notes to Consolidated Financial Statements........................................... 8
Item 2--Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 11
Risk Factors......................................................................... 19
Item 3--Quantitative and Qualitative Disclosures About Market Risk.......................... 29
Part II--Other Information
Item 2--Changes in Sercurities and Use of Proceeds.......................................... 30
Item 6--Exhibits and Reports on Form 8-K.................................................... 30
Signature-- ................................................................................... 31
Exhibit Index-- ................................................................................... 32
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Part I--FINANCIAL INFORMATION
Item 1--Financial Information
WAM!NET Inc.
Consolidated Balance Sheets
(Dollars in thousands)
June 30, December 31,
2001 2000
------------ --------------
Assets
Current assets:
Cash and cash equivalents ..................................................... $ 2,246 $ 3,207
Accounts receivable, net of allowance of $1,152 and $1,570, respectively ...... 6,588 8,344
Inventory ..................................................................... 444 533
Prepaid expenses and other current assets ..................................... 2,987 6,919
-------- --------
Total current assets ............................................................... 12,265 19,003
Property, plant, and equipment, net ................................................ 82,402 369,796
Goodwill, net ...................................................................... 50 15,475
Deferred financing charges, net .................................................... 16,479 12,392
Other assets ....................................................................... 739 1,105
-------- --------
Total assets ....................................................................... $111,935 $417,771
======== ========
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WAM!NET Inc.
Consolidated Balance Sheets (continued)
(Dollars in thousands)
June 30, December 31,
2001 2000
--------- ----------
Liabilities and shareholders' deficit
Current liabilities:
Accounts payable ................................................................. $ 25,134 $ 17,407
Accrued salaries and wages ....................................................... 5,942 5,246
Accrued expenses ................................................................. 10,986 7,654
Accrued restructuring expenses ................................................... 5,706 --
Deferred revenue 5,894 7,069
Current portion of long-term debt ................................................ 6,015 27,931
--------- ---------
Total current liabilities ............................................................. 59,677 65,307
Deferred revenue ...................................................................... 10,000 10,000
Network Facilities Financing .......................................................... -- 235,786
Long-term debt, less current portion .................................................. 309,159 264,387
Class A Redeemable Preferred Stock..................................................... 1,340 1,300
Class E Convertible Preferred Stock ................................................... 111,333 107,515
Class H Convertible Preferred Stock ................................................... 62,297 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 ..................................................................... 122 121
Additional paid-in capital ....................................................... 168,043 170,951
Accumulated deficit .............................................................. (607,321) (475,789)
Accumulated other comprehensive loss ............................................. (2,803) (2,235)
--------- ---------
Total shareholders' deficit ........................................................... (441,871) (306,864)
--------- ---------
Total liabilities and shareholders' deficit ........................................... $ 111,935 $ 417,771
========= =========
See accompanying notes.
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WAM!NET Inc.
Consolidated Statements of Operations
(Dollars in thousands, except share and per share data)
Three months ended Six months ended
June 30, June 30,
-------- --------
2001 2000 2001 2000
---- ---- ---- ----
(Unaudited)
Revenues:
Net service revenue......................................... 12,427 7,274 26,654 13,457
Software and hardware sales................................. 985 1,741 2,311 3,453
------------ ------------ ------------ ------------
Total revenue............................................... 13,412 9,015 28,965 16,910
Operating expenses:
Network communications...................................... 7,222 6,962 14,289 14,134
Cost of other service revenue............................... 11,919 -- 15,899 --
Cost of software and hardware............................... 230 488 601 1,034
Technical operations........................................ 4,880 5,370 11,353 10,791
Selling, general and administrative......................... 9,548 13,422 20,814 25,039
Depreciation and amortization............................... 9,935 9,811 20,796 18,464
Restructuring charge........................................ 21,003 -- 21,003 --
Loss on termination of network facilities agreement......... 527 -- 35,736 --
------------ ------------ ------------ ------------
65,264 36,053 140,491 69,462
------------ ------------ ------------ ------------
Loss from operations........................................ (51,852) (27,038) (111,526) (52,552)
Other income (expense):
Interest income........................................ 29 419 121 625
Interest (expense)..................................... (12,148) (10,059) (22,187) (25,320)
Other income........................................... 1,100 477 2,060 1,269
------------ ------------ ------------ ------------
Net loss.................................................... $ (62,871) $ (36,201) $ (131,532) $ (75,978)
Less preferred dividends.................................... (5,142) (3,857) (10,196) (6,101)
------------ ------------ ------------ ------------
Net loss applicable to common stock......................... $ (68,013) $ (40,058) $ (141,728) $ (82,079)
============ ============ ============ ============
Net loss applicable per common share - basic and diluted.... $ (5.56) $ (3.94) $ (11.62) $ (8.33)
============ ============ ============ ============
Weighted average number of common shares outstanding........ 12,227,220 10,176,625 12,197,047 9,852,136
============ ============ ============ ============
See accompanying notes.
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WAM!NET Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
Six months ended
June 30,
-------------------------
2001 2000
---------- -----------
Operating activities
Net loss .................................................................. $(131,532) $ (75,978)
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on sale of building ............................................. (359) --
Loss on termination of network facilities agreement .................. 35,204 --
Depreciation and amortization ........................................ 20,796 18,464
Write-off of goodwill included in restructuring charge ............... 11,702 --
Noncash interest expense, including related warrants values .......... 15,583 14,444
Value of stock options issued to employees and consultants ........... 178 259
Changes in operating assets and liabilities:
Accounts receivable ............................................. 1,756 (299)
Prepaid expenses and other assets ............................... 4,372 1,124
Accounts payable ................................................ 7,730 (6,262)
Deferred Revenue ................................................ (1,175) --
Accrued expenses ................................................ 9,735 9,064
--------- ---------
Net cash used in operating activities ..................................... (26,010) (39,184)
Investing activities
Net purchases of property and equipment ................................... (4,908) (16,327)
Patent Expenditures ....................................................... (36) --
Proceeds from sale of building ............................................ 830 --
Business acquisitions (net of cash acquired) .............................. -- (353)
--------- ---------
Net cash used in investing activities ..................................... (4,114) (16,680)
Financing activities
Proceeds from sale of preferred stock ..................................... 19,847 68,852
Proceeds from borrowings (net of financing costs) ......................... 30,956 1,068
Proceeds from exercise of stock options ................................... 34 1,154
Payments on borrowings .................................................... (21,105) (26,954)
--------- ---------
Net cash provided by financing activities ................................. 29,732 44,120
Effect of foreign currencies on cash ...................................... (569) (543)
--------- ---------
Net increase in cash and cash equivalents ................................. (961) (12,287)
Cash and cash equivalents at beginning of period .......................... 3,207 27,180
--------- ---------
Cash and cash equivalents at end of period ................................ $ 2,246 $ 14,893
========= =========
See accompanying notes.
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WAM!NET Inc.
Consolidated Statements of Cash Flows (continued)
(Dollars in thousands)
Six months ended
June 30,
------------------------
2001 2000
---------- ----------
Supplemental schedule of noncash financing activities
Value of interest costs assigned to warrants................... 2,850 --
Dividends declared but unpaid ................................. 5,968 2,102
Change in market value of investments ......................... -- 13,705
Issuance of common stock relating to acquisition............... -- 459
Exchange of preferred stock for investment .................... -- 50,000
Supplemental schedule of cash flow information
Cash paid for interest ........................................ $ 5,102 $10,123
See accompanying notes.
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WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and per share data)
1. Consolidated Financial Statements
The accompanying consolidated financial statements have been prepared by WAM!NET
Inc. (the "Company") without audit and reflect all adjustments (consisting only
of normal and recurring adjustments and accruals) which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
periods presented. The statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of regulation S-X, but omit
certain information and footnote disclosures required by generally accepted
accounting principles for a complete set of financial statements. The results of
operations for the interim periods presented are not necessarily indicative of
the results to be expected for the full fiscal year. These financial statements
should be read in conjunction with the Company's audited Consolidated Financial
Statements for the year ended December 31, 2000. The December 31, 2000 balance
sheet was derived from audited financial statements, but does not include all
disclosures required by generally accepted accounting principles for a complete
set of financial statements. Certain amounts for the prior year have been
reclassified to conform to current year presentation.
2. 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 period-end exchange
rates, while elements of the income statement are translated at average exchange
rates in effect during the period. 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.
3. Preferred Stock
In accordance with the Securities Purchase Agreement entered into with Winstar
Communications, Inc. (Winstar) in September 2000, the Company sold the remaining
20,000 shares of Class H convertible preferred stock for an aggregate of $20
million in January 2001. As a result Winstar received a warrant for 1,450,000
shares of common stock at an exercise price of $0.01. The warrant is immediately
exercisable and expires on December 31, 2005.
4. Termination of Commercial Agreements with Winstar
The Company has various commercial relationships with Winstar Communications,
Inc. and its subsidiaries, Winstar Wireless, Inc. and Winstar Credit Corp. (the
three Winstar entities being collectively referred to as "Winstar"). In early
2001 the parties each claimed the other was in default of the terms and
conditions of the commercial agreements and sought to terminate the commercial
agreements.
In December 1999 the Company entered the following commercial agreements with
Winstar:
The Company acquired an indefeasible right over 20 years to use backbone
capacity and wireless local loop facilities. Under this agreement, and other
related agreements, the Company made a $20 million initial payment in January
2000 for the indefeasible right to use these facilities with additional
contemplated quarterly payments of $5.0 million and increasing to approximately
$24.9 million over the seven-year period ending December 15, 2006. The
indefeasible right of use was capitalized in property, plant and equipment, and
the Company recorded a related liability of $260.3 million that bore an
effective interest rate of 8.3%. At December 31, 2000, the outstanding balance
of the liability was $239.6 million. Due to continuing non-performance by
Winstar as specified in the agreement, which non-performance resulted in an
Event of Default, on April 12, 2001, the Company sent a notice to Winstar
terminating these arrangements effective April 30, 2001, citing (1) breaches of
representations and
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warranties by Winstar, (2) breaches of Winstar's obligations to meet deadlines
to deliver and install facilities and (3) Winstar's failure to insure that these
facilities performed to applicable specifications. The Company wrote off the
related asset of $275 million and the related obligation of $240 million and
recorded a $35 million loss on termination in the first quarter of 2001. On
April 18, 2001, Winstar and a number of related entities filed for protection
under Chapter 11 of the United States Bankruptcy Code. On or about April 27,
2001, Winstar responded to the Company's termination notice by alleging that the
giving of the notice was a breach of the arrangements (and, consequently, did
not terminate these arrangements) and seeking to make the Company commence
certain dispute resolution procedures.
In addition, 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.
In early 2001, payments were suspended by the Company and Winstar. At June 30,
2001 the outstanding balance of the liability was $11,990.
Additionally, 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. At
June 30, 2001 the deferred revenue remains at $12,500.
In August 2001, the Company and Winstar entered into a settlement agreement. The
settlement provides, among other things, that (1) the Company pay Winstar $1
million upon the signing of the settlement agreement and an additional $4
million on the closing of the senior secured discounted debt and equity
financing arrangement between the Company and Cerberus Capital Management, L.P.
and or its affiliates and designees (Cerberus), (2) the Company issued to
Winstar a secured senior note in the principal amount of $7.5 million at the
closing of the Cerberus Financing, which note would bear interest at the rate of
12.75% per annum with monthly principal and interest payments beginning in
January 2003 and terminating in January 2006 (3) the Company would return
certain network equipment (primarily radios) to Winstar, relinquish various
circuits and other network assets and move out of various collocation sites on a
prescribed schedule, (4) the parties would execute mutual releases, and (5)
Winstar would relinquish a number of its rights, including the right to
designate directors of the Company.
The Company believes that it will recognize a gain of approximately $11.9
million in the third quarter of 2001. The settlement agreement with Winstar will
be subject to the approval of bankruptcy court having jurisdiction over Winstar.
5. Bank Credit Facilities
The Company had 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 was guaranteed by MCI WorldCom. At December 31, 2000,
the amount outstanding on the line of credit was $15,000. On January 10, 2001,
the Company repaid the remaining $15,000 and closed the line of credit.
In February 2001, the Company entered into a $30,000 credit facility, which
expires in January 2003. The credit facility is a revolving credit facility
under which the lender will advance to the Company up to $30,000 based upon a
borrowing base consisting of the Company's cash collections. Amounts outstanding
under the credit facility incur interest at the reference rate plus 3.25% (10.0%
at June 30, 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 cancelled in accordance with its terms. As of June
30, 2001, the Company has borrowed $12,895 under the credit facility.
In addition, the Company obtained additional financing under the credit
facility, as described below. This interim financing is expected to be included
as part of a proposed $115 million senior secured discounted debt and equity
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financing arrangement between the Company and Cerberus Capital Management, L.P.
and or its affiliates and designees, expected to close in the third quarter of
2001.
On April 27, 2001 the Company obtained a $2,400 term loan under the credit
facility. The term loan expires in accordance with the original credit facility
and has a fixed interest rate of 12%.
In May and June, 2001 the Company obtained $17,569 through a term loan under the
credit facility. The term loan expires in accordance with the original credit
facility and has a fixed interest rate of 19.5%. In addition it gives the
financial investor the ability to own up to 32.8% of the Company and 32.8% of
the Company's wholly-owned subsidiary, WAM!NET Government Services, Inc.
("WGSI") on a fully diluted basis. This right can be exercised by converting
debt or through the exercise of a five-year warrant for $7,950 and $15,850 for
the Company or WGSI, respectively. The fair value of the warrant granted was
calculated using the minimum value method with the following assumptions: zero
dividend yield, risk free interest rate of 5% and an expected life of 5 years
and 1.5 years for the Company and WGSI warrant, respectively. The fair value of
the warrant granted was $1,725 and $1,125 for the Company and WGSI,
respectively.
Subsequent to June 30, 2001 the Company received an additional $15,307 through a
term loan under the bank credit facility. The term loan expires in accordance
with the original bank credit facility and has a fixed interest rate of 19.5%.
In addition it gives the financial investor the ability to own an additional
16.2% of the Company and 16.2% of ("WGSI") on a fully diluted basis. This right
can be exercised by converting debt or through the exercise of a five-year
warrant for $4,050 and $12,150 for the Company or WGSI, respectively. The fair
value of the warrant granted was calculated using the minimum value method with
the following assumptions: zero dividend yield, risk free interest rate of 5%
and an expected life of 5 years and 1.5 years for the Company and WGSI warrant,
respectively. The fair value of the warrant granted was $875 and $860 for the
Company and WGSI, respectively.
6. Purchase Committment
On February 1, 2001 the Company entered into an agreement with a strategic
vendor. Under the agreement the Company will purchase a minimum of 250 media
transport devices over three years. The media transport devices range in prices
from $25 to $71 per device.
7. Comprehensive Income
Comprehensive income for the Company includes net loss, the effects of currency
translation which are charged or credited to the cumulative translation
adjustment account within stockholders' equity, and the unrealized gain/loss on
investments available for sale which is recorded within stockholders' equity.
Comprehensive income for the six months ended June 30, 2001 and 2000 was as
follows:
- -------------------------------------------------------------------------------------------------------------------
For the six months
ended June 30,
- -------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2001 2000
---- ----
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Netloss $(131,532) $ (75,978)
- -------------------------------------------------------------------------------------------------------------------
Changes in cumulative translation adjustments (569) (543)
- -------------------------------------------------------------------------------------------------------------------
Unrealized gain/loss on investments -- (13,705)
--------- ---------
- -------------------------------------------------------------------------------------------------------------------
Comprehensive loss $(132,101) $ (90,226)
- -------------------------------------------------------------------------------------------------------------------
8. Restructuring Charge
In the second quarter of 2001 the Company recorded a $21,003 restructuring
charge. Due to the current financial condition of the Company and the overall
general economy for technology companies, management finalized a restructuring
plan in June 2001. Upon finalizing this plan the Company determined that it was
necessary to significantly reduce headcount and close various offices throughout
North America, Europe and Asia. Of the total restructuring charge approximately
$11.7 million related to the write-off of goodwill related primarily to the
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acquisition of 4-Sight in March of 1998. Based upon the historical performance
of this business unit as well the Company's future strategy and projected
operating cash flows for this unit it was determined appropriate to write-off
the entire goodwill balance. Additionally, the restructuring charge includes$9.3
million relating to the write-off of certain assets, property contract
termination costs and severance and related benefits due to employee reductions.
Item 2--Management's Discussion and Analysis of Results of Operations and
Financial Condition
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. (the "Company") and should be read in conjunction with the
Company's Financial Statements included 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 and related portfolio of managed network, data storage, hosting
and professional services 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.
Our managed data services include: 1) digital transport services 2) digital data
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 subscription and/or transactional charge per use. By using
our services, customers gain access to leading-edge technology without the high
cost and challenges of managing technology themselves.
Our IP network and associated network, storage and hosting infrastructure
services provide customers a common electronic platform to seamlessly integrate
their production processes and connect with their customers, business partners
and other supply chain or "community of interest" members to accelerate the
adoption of online digital collaboration. In the commercial marketplace our
global customer base is primarily made up of companies in the graphic arts,
advertising, publishing, printing, retail, financial services, entertainment,
broadcast, 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 marketplace by
receiving 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 for both business and war fighting purposes. 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
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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 expanded our professional services offering by acquiring a
fifty member professional services company, is.com.
Access to our services is provided through our WAM!NET Direct Service, WAM!NET
ISDN Tracked Service and WAM!NET Internet Gateway Service. Our initial focus
through 1998 was our WAM!NET 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
managed network with a dedicated leased line.
In the first quarter of 1999 we began to provide access to our network through
our WAM!NET ISDN 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 WAM!NET Internet Gateway Service in the third quarter of 1999.
WAM!NET 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 WAM!NET InfoCenter, Electronic Job Tickets and
Remote Proofing.
We commercially introduced our WAM!NET WAM!BASE Digital Storage Service in the
first quarter of 2000 and our web-based storage service, WAM!NET WorkSpace, in
fourth quarter of 2000. Also in the first quarter of 2000, we began offering
WAM!NET Render 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, designed for transport of compressed
video files in MPEG 1 and MPEG 2 formats.
We introduced our managed application and infrastructure 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 workflows to augment our service
offerings.
As of June 30, 2001, we had approximately 2,000 customer points-of-presence
consisting of dedicated CPOP devices and local bandwidth connectivity. Of these,
about 95 have WAM!NET storage services that customers access through the CPOP.
In addition, we had over 15,000 users of our Internet and dial-up services
globally.
Revenues
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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. 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 February 9, 2001, we entered into a definitive Subcontract Agreement 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 record and recognize revenue based upon performance on the number of
seats ordered. We began recognizing revenue from the subcontract with EDS in the
fourth quarter of 2000 under a Pre-Subcontract Authorization Agreement.
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 decline in 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
-13-
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. 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.
Cost of other service revenues
Cost of other service revenues represents direct labor costs associated with our
professional service revenue and costs directly associated with performing under
the NMCI contract.
Cost of software and hardware
Software and hardware expense reflects the costs of software and hardware sold.
Technical operations
Technical operations 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 technical 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, and the costs of ongoing
marketing activities such as promotions and channel development. Our sales and
marketing efforts are focused on expanding opportunities with our existing
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 our administrative infrastructure necessary to manage our global 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 debt financing as well as other intangible assets
related to acquisitions. We anticipate additional capital investments in our
network, hosting and storage infrastructure commensurate with customer demand
and market opportunity.
Results of Operations
Three and Six Month Periods Ended June 30, 2001 Compared with Three and Six
Month Periods Ended June 30, 2000
-14-
Revenues
Total revenue for the three months ended June 30, 2001 was $13.4 million
compared to $9.0 million for the three months ended June 30, 2000, an increase
of $4.4 million or 48.8%. Total revenue for the six months ended June 30, 2001
was $29.0 million compared to $16.9 million for the six months ended June 30,
2000, an increase of $12.1 million or 71.3%.
Net service revenue was $12.4 million for the three months ended June 30, 2001
compared to $7.3 million for the three months ended June 30, 2000, an increase
of $5.1 million or 70.8%. Net service revenue was $26.7 million for the six
months ended June 30, 2001 compared to $13.5 million for the six months ended
June 30, 2000, an increase of $13.2 million or 98.1%. We recognized $4.3 million
and $8.6 million for the three and six month periods ended June 30, 2001 from
government service revenue primarily related to the NMCI contract with EDS. The
remaining increase relates to our expanded service offerings introduced in first
quarter 2000 and the acquisition of is.com, a professional service company, in
November 2000.
Revenues from software and hardware sales for the three months ended June 30,
2001 and 2000 were $1.0 million and $1.7 million, respectively. Revenues from
software and hardware sales for the six months ended June 30, 2001 and 2000 were
$2.3 million and $3.5 million, respectively. 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 three months ended June 30, 2001 was $7.2
million compared to $7.0 million for the three months ended June 30, 2000, an
increase of $0.2 million or 3.7%. Network communication expense for the six
months ended June 30, 2001 was $14.3 million compared to $14.1 million for the
six months ended June 30, 2000, an increase of $0.2 million or 1.1%. 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. We expect network communications expense to remain at the same
level. for the last six months of the current fiscal year.
Other service revenue costs
Other service revenue costs for the three and six months ended June 30, 2001
were $11.9 million and $15.9 million, respectively. These costs are related to
our direct costs of professional services and our direct costs associated with
the subcontract with EDS for the NMCI project. We expect direct costs related to
the NMCI project to increase as we continue to perform under the contract.
Software and hardware
The cost of software and hardware for the three months ended June 30, 2001 was
$0.2 million compared to $0.5 million for the three months ended June 30, 2000,
a decrease of $0.3 million. The cost of software and hardware for the six months
ended June 30, 2001 was $0.6 million compared to $1.0 million for the six months
ended June 30, 2000, a decrease of $0.4 million. The decrease reflects the
decline in software and hardware sales.
Technical operations
Technical operations expense for the three months ended June 30, 2001 was $4.9
million compared to $5.4 million for the three months ended June 30, 2000, a
decrease of $0.5 million or 9.1%. Technical operations expense for the six
months ended June 30, 2001 was $11.4 million compared to $10.8 million for the
six months ended June 30, 2000, an increase of $0.6 million or 5.2%. The decline
in technical operations costs in the second quarter relate to an overall plan to
reduce costs.
-15-
Selling, general and administrative
Selling, general and administrative (SG&A) expense for the three months ended
June 30, 2001 was $9.5 million compared to $13.4 million, a decrease of $3.9
million or 28.9%. Selling, general and administrative expense for the six months
ended June 30, 2001 was $20.8 million compared to $25.0 million, a decrease of
$4.2 million or 16.9%. The decrease in SG&A expense for the three month and six
month periods ended June 30, 2001 is primarily due to an overall plan to reduce
our operating costs.
Depreciation and amortization
Depreciation and amortization for the three months ended June 30, 2001 was $9.9
million compared to $9.8 million for the three months ended June 30, 2000.
Depreciation and amortization for the six months ended June 30, 2001 was $20.8
million compared to $18.5 million for the six months ended June 30, 2000, an
increase of $2.3 million or 12.6%. This increase was primarily due to
depreciation of additional network and related equipment. Included in these
totals for 2001 and 2000 was $3.7 million and $3.5 million of amortization
expense relating to the goodwill recorded in connection with acquisitions.
Interest expense
Interest expense for the three months ended June 30, 2001 was $12.1 million
compared to $10.1 million for the three months ended June 30, 2000, an increase
of $2.0 million or 19.9%. Interest expense for the six months ended June 30,
2001 was $22.2 million compared to $25.3 million for the six months ended June
30, 2000, an decrease of $3.1 million or 12.4%. The decrease in interest expense
is due to the termination of the network facilities agreement with Winstar,
resulting in the writeoff of the related asset and obligation in the first
quarter of 2001 (see footnote 4 to the financial statements), offset by
additional interest expense incurred on bank financing (see footnote 5 to the
financial statements). Included in interest expense for the three months ended
June 30, 2001 and 2000, are non-cash charges of $8.0 million and $7.3 million,
and $15.5 million and $14.4 million for the six months ended June 30, 2001 and
2000, related to the amortization of deferred financing charges, the
amortization of the value of warrants issued in connection with debt financing
transactions and the accretion of debt.
Loss on termination of network facilities agreement
The Company has various commercial relationships with Winstar Communications,
Inc. and its subsidiaries, Winstar Wireless, Inc. and Winstar Credit Corp. (the
three Winstar entities being collectively referred to as "Winstar"). In early
2001 the parties each claimed the other was in default of the terms and
conditions of the commercial agreements and sought to terminate the commercial
agreements.
In December 1999 the Company entered the following commercial agreements with
Winstar:
The Company acquired an indefeasible right over 20 years to use backbone
capacity and wireless local loop facilities. Under this agreement, and other
related agreements, the Company made a $20 million initial payment in January
2000 for the indefeasible right to use these facilities with additional
contemplated quarterly payments of $5.0 million and increasing to approximately
$24.9 million over the seven-year period ending December 15, 2006. The
indefeasible right of use was capitalized in property, plant and equipment, and
the Company recorded a related liability of $260.3 that bore an effective
interest rate of 8.3%. At December 31, 2000, the outstanding balance of the
liability was $239.6 million. Due to continuing non-performance by Winstar as
specified in the agreement, which non-performance resulted in an Event of
Default, on April 12, 2001, the Company sent a notice to Winstar terminating
these arrangements effective April 30, 2001, citing (1) breaches of
representations and warranties by Winstar, (2) breaches of Winstar's obligations
to meet deadlines to deliver and install facilities and (3) Winstar's failure to
insure that these facilities performed to applicable specifications. The Company
wrote off the related asset of $275 million and the related obligation of $240
million and recorded a $35 million loss on termination in the first quarter of
2001. On April 18, 2001, Winstar and a number of related entities filed for
protection under Chapter 11 of the United States Bankruptcy Code. On or about
April 27, 2001, Winstar responded to the Company's termination notice by
alleging that the giving of the notice was a breach of the arrangements (and,
consequently, did
-16-
not terminate these arrangements) and seeking to make the Company commence
certain dispute resolution procedures.
In addition, 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.
In early 2001, payments were suspended by the Company and Winstar. At June 30,
2001 the outstanding balance of the liability was $11,990.
Additionally, 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. At
June 30, 2001 the deferred revenue remains at $12,500.
In August 2001, the Company and Winstar entered into a settlement agreement. The
settlement provides, among other things, that (1) the Company pay Winstar $1
million upon the signing of the settlement agreement and an additional $4
million on the closing of the senior secured discounted debt and equity
financing arrangement between the Company and Cerberus Capital Management, L.P.
and or its affiliates and designees (Cerberus), (2) the Company issued to
Winstar a secured senior note in the principal amount of $7.5 million at the
closing of the Cerberus Financing, which note would bear interest at the rate of
12.75% per annum with monthly principal and interest payments beginning in
January 2003 and terminating in January 2006 (3) the Company would return
certain network equipment (primarily radios) to Winstar, relinquish various
circuits and other network assets and move out of various collocation sites on a
prescribed schedule, (4) the parties would execute mutual releases, and (5)
Winstar would relinquish a number of its rights, including the right to
designate directors of the Company.
The Company believes that it will recognize a gain of approximately $11.9
million in the third quarter of 2001. The settlement agreement with Winstar will
be subject to the approval of bankruptcy court having jurisdiction over Winstar.
Restructuring Charge
In the second quarter of 2001 the Company recorded a $21,003 restructuring
charge. Due to the current financial condition of the Company and the overall
general economy for technology companies, management finalized a restructuring
plan in June 2001. Upon finalizing this plan the Company determined that it was
necessary to significantly reduce headcount and close various offices throughout
North America, Europe and Asia. Of the total restructuring charge approximately
$11.7 million related to the write-off of goodwill related primarily to the
acquisition of 4-Sight in March of 1998. Based upon the historical performance
of this business unit as well the Company's future strategy and projected
operating cash flows for this unit it was determined appropriate to write-off
the entire goodwill balance. Additionally, the restructuring charge includes
$9.3 million relating to the write-off of certain assets, property contract
termination costs and severance and related benefits due to employee reductions.
Other income
Other income for the three months ended June 30, 2001 was $1.1 million compared
to $0.5 million for the three months ended June 30, 2000, an increase of $0.6
million. Other income for the six months ended June 30, 2001 was $2.1 million
compared to $1.3 million for the six months ended June 30, 2000, an increase of
$0.8 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
-17-
At June 30, 2001, we had approximately $375 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.
Liquidity and Capital Resources
Through June 30, 2001, we have issued equity and debt securities and incurred
other borrowings resulting in cash received by us of $520.2 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 2001, we entered into the following financing transactions in order to
continue to fund our operating and capital requirements:
The Company had a $25 million line of credit agreement with a bank, which was
orginally due in September 2000 and was subsequently extended to January 10,
2001. The line of credit was guaranteed by MCI WorldCom. At December 31, 2000,
the amount outstanding on the line of credit was $15 million. On January 10,
2001, the Company repaid the remaining $15 million and closed the line of
credit.
In February 2001, the Company entered into a $30 million 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 million 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% (10.0% at June 30, 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 cancelled in accordance with its
terms. As of June 30, 2001, the Company has borrowed $12.9 million under the
credit facility.
In addition, the Company obtained additional financing under the bank credit
facility as described below. This interim financing is expected to be included
as part of a $115 million senior secured discounted debt and equity financing
arrangement between the Company and Cerberus Capital Management, L.P. and or its
affiliates and designees, expected to close in third quarter 2001.
On April 27, 2001 the Company obtained a $2.4 million term loan under the bank
credit facility. The term loan expires in accordance with the original bank
credit facility and has a fixed interest rate of 12%.
In May and June, 2001 the Company obtained $17.6 million through a term loan
under the bank credit facility. The term loan expires in accordance with the
original bank credit facility and has a fixed interest rate of 19.5%. In
addition it gives the financial investor the ability to own 32.8% of the Company
and 32.8% of WAM!NET Government Services, Inc. ("WGSI") on a fully diluted
basis. This right can be exercised by converting debt or through the exercise of
a five-year warrant for $7.9 million and $15.8 million for the Company or WGSI,
respectively. The fair value of the warrant granted was calculated using the
minimum value method with the following assumptions: zero dividend yield, risk
free interest rate of 5% and an expected life of 5 years and 1.5 years for the
Company and WGSI warrant, respectively. The fair value of the warrant granted
was $1.7 million and $1.1 million for the Company and WGSI, respectively.
Subsequent to June 30, 2001 the Company received an additional $15.3 million
through a term loan under the bank credit facility. The term loan expires in
accordance with the original bank credit facility and has a fixed interest rate
of 19.5%. In addition it gives the financial investor the ability to own an
additional 16.2% of the Company and 16.2% of ("WGSI") on a fully diluted basis.
This right can be exercised by converting debt or through the exercise of a
five-year warrant for $4.0 million and $12.1 million for the Company or WGSI,
respectively. The fair value of
-18-
the warrant granted was calculated using the minimum value method with the
following assumptions: zero dividend yield, risk free interest rate of 5% and an
expected life of 5 years and 1.5 years for the Company and WGSI warrant,
respectively. The fair value of the warrant granted was $0.9 million and $0.9
million for the Company and WGSI, respectively.
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 $607.3 million as of June 30,2001. Management expects to
continue to operate at a net loss and experience negative cash flow from
operating activities through the end of this current fiscal year. At June 30,
2001, 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 is currently in the process of negotiating a $115 million senior
secured discounted debt and equity financing arrangement between the Company and
Cerberus Capital Management, L.P. and or its affiliates and designees, expected
to close in third quarter 2001. 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
for the fiscal year ended December 31, 2000 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.
Additional Factors That May Affect Future Results
The following risk factors and other information included in this Quarterly
Report should be carefully considered. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not
presently known to us or that we currently deem immaterial also may impair our
business operations. If any of the following risks occur, our business,
financial condition, operating results and cash flows could be materially
adversely affected.
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 $607.3 million as of June 30, 2001. Management expects to
continue to operate at a net loss and experience negative cash flow from
operating activities through the foreseeable future. At June 30, 2001, 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 is currently in the process of negotiating a $115 million senior
secured discounted debt and equity financing arrangement between the Company and
Cerberus Capital Management, L.P. and or its affiliates and designees, expected
to close in third quarter 2001. 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
for the fiscal year ended December 31, 2000 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.
-19-
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:
. increase the size of our customer base and utilization of our network
and services;
. successfully perform our NMCI subcontract;
. raise additional capital;
. successfully manage our relationships and activities with our strategic
partners and distributors, including EDS, SGI, and Sumitomo, and
develop new relationships and activities with influential suppliers and
channel distributors in our target markets;
. successfully market our branded services;
. continue to attract and retain qualified personnel;
. accurately assess potential markets and effectively respond to
competitive developments;
. continue to maintain and upgrade our operational, support and business
systems;
. comply with evolving governmental regulatory requirements and obtain
any required governmental authorizations;
. continue to upgrade our services and applications to address new
technologies;
. provide acceptable customer service; and
. effectively manage our 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 June 30, 2001, we had
an accumulated deficit of approximately $607.3 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:
-20-
. costs relating to performance of our NMCI subcontract with EDS;
. costs relating to the sales and marketing of our branded services;
. costs to be incurred in maintaining our network, hosting and
storage infrastructure;
. recurring telephony, hardware and installation costs resulting
from providing service to subscribers to our Direct Service;
. 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 maintain our technology, network and infrastructure 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:
. slow the expansion of our network, hosting and storage infrastructure;
. scale back or delay the development of new services and applications;
. reduce our marketing efforts; and
. 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
-21-
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 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:
. the rate of customer acquisition and turnover;
. the amount and timing of expenditures relating to the expansion of our
infrastructure and the introduction of new services;
. the amount and timing of expenditures relating to the performance of
our NMCI subcontract with EDS;
. introduction of new services or technologies by our competitors;
. price competition;
. the ability of our equipment and service suppliers to meet our needs;
. regulatory developments, including interpretations of the 1996
Telecommunications Act;
. technical difficulties or network downtime;
. the success of our strategic alliances; and
. 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 June 30, 2001, we had approximately $490.1
million of outstanding debt, including redeemable preferred stock. The most
significant portion of the 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 $191.5 million
at June 30, 2001, 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 $3.3
million during the
-22-
remainder of 2001. We have recorded as quasi-equity on our balance sheet as of
June 30, 2001, redeemable and convertible preferred stock of $175.0 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:
. impair our ability to obtain additional financing to fund our operating
losses or meet our working capital and capital expenditure
requirements;
. 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;
. hinder our ability to adjust rapidly to changes in market conditions,
including changes in technology that might affect our competitive
position; and
. make us more vulnerable in the event of a downturn in our business or
in general economic conditions.
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:
. borrow more funds (other than equipment financing);
. incur liens;
. make minority investments;
. sell assets;
. engage in transactions with stockholders and affiliates; and
. 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 fiscal quarters of 2000 is less than or equal
to 5 to 1. We incurred negative cash flow from operating activities for the
first fiscal quarter ended June 30, 2001. 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:
. we could be unable to obtain additional financing in the future to:
-23-
. fund our operating losses;
. meet our capital expenditure requirements;
. further develop or deploy services and applications; or
. allow us to conduct necessary corporate activities;
. we could be unable to obtain lower borrowing costs than are available
from secured lenders;
. we could be unable to engage in strategic joint ventures in which we
are a minority partner; or
. 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 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
-24-
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.
Adaptation of our network infrastructure may be necessary in order to respond
to:
. demands for transmission and storage of larger amounts of data; and
. changes to our customers' service requirements.
The 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 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 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.
-25-
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:
. effectively manage our operational, managerial, financial and
accounting resources;
. hire, train and manage additional qualified personnel;
. maintain our sales force, external installation capacity, customer
service teams and information systems;
. continue to expand our NMCI implementation work force;
. expand and upgrade our core technologies; and
. 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
extent that we are unable to secure suitable installation, maintenance or
on-call repair services from third-party vendors, we
-26-
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 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 10,437,096 shares of our common stock, or 46.1% of our
outstanding shares of common stock as of August 14, 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 31,593,975 shares of our
common stock, or 72.1% of our outstanding shares of common stock as of August
14, 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.
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 9,482,503 shares of our common stock, or 43.7% of
our outstanding shares of common stock, as of August 14, 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
-27-
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.
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
-28-
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:
. uncertainty of acceptance of our services by different cultures;
. unforeseen changes in regulatory requirements;
. differing technology standards;
. difficulties in staffing and managing multinational operations;
. government-imposed restrictions on the repatriation of funds;
. difficulties imposed by language barriers;
. difficulties in finding appropriate distribution channels; and
. 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 maintain 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 3--Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Rates
During the six month period ended June 30, 2001, our revenue originating outside
the U.S. was 19.1% 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
-29-
Cash balances in foreign currencies overseas are operating balances and are
invested in short-term deposits of the local operating bank.
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 quarter ended June 30, 2001, 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.
Part II--OTHER INFORMATION
Item 2 - Changes in Securities and Use of Proceeds
(c) The information required by this Item 2 of Part II has been previously
reported in Item 2 of Part I of this Form 10-Q, and is incorporated herein by
reference. For a complete discussion of the transactions involving recent sales
of unregistered securities of the Company please see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
Item 6--Exhibits and Reports on Form 8-K
(a) Exhibits
See Exhibit Index
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on July 27, 2001.
-30-
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed by the
undersigned thereunto duly authorized.
WAM!NET Inc.
Date: August 20, 2001
By: /s/ Terri F. Zimmerman
-----------------------
Terri F. Zimmerman
Chief Financial Officer
-31-
EXHIBIT INDEX
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 therein.
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.
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.
-32-
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 the Secretary 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 million 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.
10.8 (1) Guaranty Agreement dated September 26, 1997, by and between the Company and MCI WorldCom,
Inc.
10.9 (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 (10) Amendment No. 1 to the 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.
10.14 (10) Amendment No. 2 to the 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.
10.15 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
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(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 omitted pursuant to a request for
confidential treatment and have been filed with the Securities Commission under separate
cover).
10.23 (2) Sale and Purchase Agreement by and between Silicon Graphics, Inc., on behalf of itself and
its wholly-owned subsidiary, Cray Research, L.L.C., and the Company dated as of March 4,
1999.
10.24 (2) Lease by and between the Company and Silicon Graphics, Inc. on behalf of itself and its
wholly-owned subsidiary, Cray Research, L.L.C., with respect to the Company's corporate
campus facility located in Eagan, Minnesota dated as of March 4, 1999.
10.25 Intentionally omitted.
10.26 Intentionally omitted.
10.27 (4) Loan and Security Agreement, dated July 16, 199, by and between Foothill Capital Corporation
and the Company.
10.28 (5) Purchase and Sale Agreement and Escrow Instructions, dated September 30, 1999, between the
Company and CCPRE-Eagan, LLC.
10.29 (5) Amendment 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 Agreement by and between Winstar Wireless, Inc. and the Company, dated December 31,
1999.
10.32 * Amendment No. 3 to the 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.
10.33 * Amendment No. 4 (a) to the 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.
10.34 * Amendment No. 4 (b) to the 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.
10.35 * Amendment No. 4 (c) to the 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.
10.36 * Amendment No. 4 (d) to the 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.
10.37 * Amendment No. 4 (e) to the 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.
10.38 * Amendment No. 4 (f) to the 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.
(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.
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(9) Incorporated herin by reference to our Annual Report on Form 10-K,
filed with the SEC on April 16, 2001.
(10) Incorporated herin by reference to our Quarterly Report on Form 10-
Q, filed with the SEC on May 21, 2000.
* Filed herewith.
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