-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TQValP+5RtQWW6eMduGBLExGXjt2xDgxQlfO6eq7EQQk/5SciOpD6BEI6PJoKV9g eWVnTzTIoHv1K4Ysg89HKA== 0001045969-99-000372.txt : 19990518 0001045969-99-000372.hdr.sgml : 19990518 ACCESSION NUMBER: 0001045969-99-000372 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WAM NET INC CENTRAL INDEX KEY: 0001060274 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 333-53841 FILM NUMBER: 99627161 BUSINESS ADDRESS: STREET 1: 6100 W 110TH ST CITY: MINNEAPOLIS STATE: MN ZIP: 55438 BUSINESS PHONE: 6128865100 MAIL ADDRESS: STREET 1: 6100 W 110TH ST CITY: MINNEAPOLIS STATE: MN ZIP: 55438 10-Q 1 FORM 10-Q 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: March 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ____________ Commission file 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) 6100 West 110th Street Minneapolis, Minnesota 55438 (Address of principal executive offices) (Zip Code) (612) 886-5100 (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 [ ] No [X] As of April 30, 1999 there were 9,297,427 shares of the Corporation's Common Stock, par value $.01 per share, outstanding. Total number of pages in this report: 19 WAM!NET Inc. INDEX TO FORM 10-Q Part I--Financial Information Page No. -------- Item 1--Financial Statements Consolidated Balance Sheets as of March 31, 1999 (unaudited) and December 31, 1998........................................... 3 Consolidated Statements of Operations for the three months in the periods ended March 31, 1999 and 1998 (unaudited)........ 5 Consolidated Statements of Cash Flows for the three months in the periods ended March 31, 1999 and 1998 (unaudited)........ 6 Notes to Consolidated Financial Statements (unaudited)............ 8 Item 2--Management's Discussion and Analysis of Results of Operations and Financial Condition........................... 9 Item 3--Quantitative and Qualitative Disclosures About Market Risk.... 16 Part II--Other Information Item 2--Changes in Sercurities and Use of Proceeds.................... 17 Item 6--Exhibits and Reports on Form 8-K.............................. 17 Signature --................................................................ 18 Exhibit Index--............................................................. 19 -2- Part I--FINANCIAL INFORMATION Item 1--Financial Information WAM!NET Inc. Consolidated Balance Sheets (dollars in thousands, except share data)
March 31, December 31, 1999 1998 --------- ---------- (Unaudited) Assets Current assets: Cash and cash equivalents.............................................. $ 30,171 $ 6,272 Accounts receivable, net of allowance of $546 and $430, respectively... 4,008 3,466 Inventory.............................................................. 1,744 1,534 Prepaid expenses and other current assets.............................. 3,547 3,187 -------- -------- Total current assets.............................................. 39,470 14,459 Property and equipment: Building and land...................................................... 39,605 605 Network equipment...................................................... 57,446 50,907 Other support equipment................................................ 20,211 18,046 Furniture and fixtures................................................. 4,165 2,802 Leasehold improvements................................................. 5,689 6,506 -------- -------- 127,116 78,866 Accumulated depreciation............................................... 21,403 16,399 -------- -------- 105,713 62,467 Goodwill, net of accumulated amortization of $6,954 and $5,308, respectively................................................. 25,773 27,734 Deferred financing charges, net of accumulated amortization of $7,219 and $5,959, respectively................................. 18,922 20,183 Other assets........................................................... 662 616 -------- -------- Total assets...................................................... $190,540 $125,459 ======== ========
-3- WAM!NET Inc. Consolidated Balance Sheets (continued) (dollars in thousands, except share data)
March 31, December 31, 1999 1998 -------- -------- (Unaudited) Liabilities and shareholders' deficit Current liabilities: Accounts payable................................................ $ 11,630 $ 17,098 Accrued salaries and wages...................................... 3,013 4,801 Accrued expenses................................................ 3,336 3,176 Current portion of equipment financing and obligations under capitalized leases..................................... 8,287 5,324 -------- -------- Total current liabilities.................................. 26,266 30,399 Long-term debt: Subordinated notes payable...................................... 27,861 27,403 Line of credit.................................................. 24,500 24,000 Equipment financing............................................. 12,164 13,536 13.25% Senior Discounted Notes.................................. 143,481 138,975 Redeemable Preferred Stock, Class A, $10.00 par value: Authorized shares--115,206 Issued and outstanding shares--115,206 and 100,000 at March 31, 1999 and December 31, 1998................. 1,152 1,000 Shareholders' deficit: Convertible Preferred Stock, Class B, $.01 par value: Authorized, issued and outstanding--5,710,425 and 0........ 57 -- Convertible Preferred Stock, Class C, $.01 par value: Authorized, issued and outstanding--878,527 and 0 ......... 9 -- Convertible Preferred Stock, Class D $.01 par value: Authorized, issued and outstanding--2,196,317 and 0........ 22 -- Undesignated shares, $.01 par value--1,099,525 Common Stock, $.01 par value: Authorized shares--490,000,000 Issued and outstanding shares--9,297,427 and 9,288,194 at March 31, 1999 and December 31, 1998 ................... 93 93 Additional paid-in capital................................. 156,598 54,302 Accumulated deficit........................................ (201,182) (164,387) Cumulative foreign currency translation adjustment......... (481) 138 -------- -------- Total shareholders' deficit................................ (44,884) (109,854) -------- -------- Total liabilities and shareholders' deficit................ $190,540 $125,459 ======== ========
See accompanying notes. -4- WAM!NET Inc. Consolidated Statements of Operations (dollars in thousands, except share and per share data)
Three months ended March 31, ------------------------- 1999 1998 ---------- ---------- (Unaudited) Revenues: WAM!NET revenues..................................... $ 3,763 $ 1,320 Less rebates......................................... (635) (271) ---------- ---------- Net WAM!NET user fees..................................... 3,128 1,049 Software and hardware sales............................... 1,739 831 ---------- ---------- Total revenues............................................ 4,867 1,880 Operating expenses: Network communication fees........................... 6,477 3,152 Cost of software and hardware........................ 823 261 Network operations................................... 5,285 3,259 Sales and marketing.................................. 7,026 2,352 General and administrative........................... 3,971 14,467 Depreciation and amortization........................ 8,206 1,921 ---------- ---------- 31,788 25,412 ---------- ---------- Loss from operations...................................... (26,921) (23,532) Other income (expense): Interest income...................................... 200 293 Interest (expense)................................... (10,074) (3,444) ---------- ---------- Net loss.................................................. $ (36,795) $ (26,683) Less preferred dividends.................................. (555) (18) ---------- ---------- Net loss applicable to common stock....................... $ (37,350) $ (26,701) ========== ========== Net loss applicable per common share - basic and diluted.. $ (4.01) $ (3.65) ========== ========== Weighted average number of common shares outstanding...... 9,294,127 7,305,734 ========== ==========
See accompanying notes. -5- WAM!NET Inc. Consolidated Statements of Cash Flows (dollars in thousands)
Three months ended March 31, --------------------- 1999 1998 -------- -------- (Unaudited) Operating activities Net loss.......................................................... $(36,795) $(26,683) Adjustments to reconcile net loss to net cash used in operating activities: Noncash interest expense, including related warrants values.. 8,564 2,274 Value of stock options issued to employees and consultants... 87 11,914 Depreciation and amortization................................ 8,206 2,024 Changes in operating assets and liabilities: Accounts receivable..................................... (542) 633 Inventory............................................... (210) 399 Prepaid expenses and other assets....................... (420) (211) Accounts payable........................................ (5,467) 439 Income taxes............................................ -- 251 Accrued expenses........................................ (962) 1,008 -------- -------- Net cash used in operating activities............................. (27,539) (7,952) Investing activities Purchases of property and equipment............................... (9,791) (10,143) Purchase of 4-Sight (net of cash acquired)........................ -- (16,315) -------- -------- Net cash used in investing activities............................. (9,791) (26,458) Financing activities Proceeds from exercise of stock options........................... 5 -- Net proceeds from sale of convertible preferred stock............. 59,514 -- Proceeds from 13.25% Senior Discount Notes........................ -- 120,626 Proceeds from line of credit...................................... 500 5,203 Payments on line of credit........................................ -- (24,003) Proceeds from equipment financing................................. 3,000 1,809 Payments on equipment financing................................... (1,472) (948) Capitalized financing costs....................................... -- (1,824) -------- -------- Net cash provided by financing activities......................... 61,547 100,863 Effect of foreign currencies on cash (318) 33 -------- -------- Increase (decrease) in cash and cash equivalents.................. 23,899 66,486 Cash and cash equivalents at beginning of period.................. 6,272 274 -------- -------- Cash and cash equivalents at end of period........................ $ 30,171 $ 66,760 ======== ========
See accompanying notes. -6- WAM!NET Inc. Consolidated Statements of Cash Flows (continued) (dollars in thousands)
Three months ended March 31, ---------------------- 1999 1998 ------- ------- (Unaudited) Supplemental schedule of noncash financing activities Conversion of accrued interest to subordinated debt................ $ 458 $ 585 Conversion of accrued dividends to preferred stock................. 152 -- Issuance of convertible preferred stock in exchange for land, building and furniture & fixtures............................ 40,000 -- Issuance of common stock relating to acquisition................... -- 20,000 Conversion of convertible subordinated debenture for common stock.. -- 25 Supplemental schedule of cash flow information Cash paid for interest............................................. $ 1,033 $ 677
See accompanying notes. -7- WAM!NET INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures necessary to present the statements in accordance with generally accepted accounting principles. 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, 1998. The December 31, 1998 balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles Certain amounts for the prior year have been reclassified to conform to current year presentation. 2. Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: FreeMail, Inc., NetCo Communications of Canada, Inc. and WAM!NET U.K. Limited (formerly 4-Sight Limited). All intercompany transactions have been eliminated. 3. Preferred Stock In January 1999, the Company issued the 1999 MCI WorldCom Convertible Note and in January 1999 and March 1999, the Company borrowed $10.0 million and $15.0 million, respectively, thereunder. The 1999 MCI WorldCom Convertible Note was converted into 2,196,317 shares of the Company's Class D Convertible Preferred Stock, par value $.01 per share (the "Class D Preferred Stock"), immediately prior to the closing of the Silicon Graphics, Inc. Investment ("SGI Investment"). In connection with the MCI WorldCom Convertible Note, the Company issued warrants to purchase a total of 350,000 shares of Common Stock. The warrants have an exercise price of $.01 and are exercisable from April 30, 1999 until April 30, 2004. In March 1999, the Company entered into the SGI Investment, providing for the purchase by SGI of 5,710,425 shares of the Company's Class B Convertible Preferred Stock, par value $.01 per share (the "Class B Preferred Stock"), and 878,527 shares of the Company's Class C Convertible Preferred Stock, par value $.01 per share (the "Class C Preferred Stock"). The holders of a majority of the Class B Preferred Stock will have the right to designate one member of the Company's Board of Directors. The aggregate consideration received by the Company for the Class B Preferred Stock and the Class C Preferred Stock was $75 million, of which $35 million was paid in cash and $40 million was paid by transfer to the Company of a campus facility. The Class B Preferred Stock and the Class C Preferred Stock will be convertible on a one-to one basis into Common Stock and will have the right to vote such percentage with the Common Stock as a single class. The Class B Preferred Stock and Class C Preferred Stock are convertible immediately following the issuance date and 18 months following the issuance date, respectively. The shares of Common Stock into which the Class B Preferred Stock and the Class C Preferred Stock are subject to certain registration rights. -8- 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 and pro forma results of WAM!NET Inc. (the "Company") and should be read in conjunction with the Company's Financial Statements included herein. Overview The Company provides a managed, high speed, digital data delivery network service (the "WAM!NET Service"). The WAM!NET Service allows users to transmit, receive and store large digital data files. The Company has developed applications for companies in the graphic arts, printing, publishing, advertising, pre-press and corporate communication (collectively, "Graphic Arts") and entertainment industries, and is evaluating applications of the WAM!NET Service for the medical imaging industry as well. The Company integrates industry-specific software applications with commercially available computer and telephony technologies to provide its customers with rapid, secure and reliable transportation and storage of digital data. The Company provides customers with a choice of solutions for their data transportation and workflow needs, ranging from a turn-key, single source solution for high-volume data requirements to solutions for subscribers having less intensive data requirements. The Company focuses its software development, service, sales and marketing efforts on vertical markets within targeted industries by providing services and products specifically tailored for an industry sector, "Industry Smart(TM)" applications, which serve to improve a customer's productivity and output under a simple, monthly fee and usage pricing plan that requires no up-front capital investment by the customer. The WAM!NET Service connects customers and trading partners within an industry, thereby implementing the Company's Industry Smart approach. The Company's applications combine rapid, secure data transportation services with industry specific software applications that allow remote users to work together, eliminate production deadlines imposed by courier schedules, eliminate delays and copying errors associated with the transportation of physical media (such as disks or tapes) and permit access to and use of the Company's remote storage and retrieval services. The Company has initially capitalized on the growing need to transmit data in the Graphic Arts industry. The Company believes that the WAM!NET Service is achieving wide acceptance among leading firms within the Graphic Arts industry. The Company expects that this acceptance will in turn encourage other industry participants with whom such firms share digital information (their "workflow community of interest") to subscribe to the WAM!NET Service. The Company has also developed and released advanced software applications to its Graphic Arts customers such as an on-line "Customer Information System" ("CIS") that includes digital job tracking and a billing system, and WAM!PROOF(R), an application enabling remote proofing. The WAM!PROOF(R) service was commercially released in the second quarter of 1998. The WAM!BASE(R) service, a remote data archiving, retrieval and distribution system, was released to the printed catalog division of Sears, Roebuck & Company and four of its primary vendors on November 1, 1998, and is expected to be released nationally during 1999. The WAM!NET(R) service was also released in the United Kingdom during the fourth quarter of 1998. The Company is developing separate applications for the WAM!BASE(R) service, the first directed to high volume, long-term data storage suitable to the requirements of computer-to-plate printing systems, and the second directed to video-on-demand entertainment applications. The Company is also developing an Internet Gateway application providing access to the WAM!NET(R) network for use by workflow partners with incidental data transport requirements. The Company is also developing an application for remote rendering of computer animations for the entertainment industry. The Company intends to introduce these new applications during 1999. -9- The Company's diversified product line addresses the requirements of customers who exchange data with workflow partners, regardless of the volume of data transmitted or stored. In addition to the Company's current single source, turn-key solution for data-intensive customers, the Company has developed software applications which permit access to the WAM!NET Service by customers with lower data volume requirements. The first such application is a fifth generation graphical user interface, Transmission Manager, which provides worldwide access to the Company's redundantly interconnected proprietary purpose-built network hubs ("Distribution Hubs") via leased high-bandwidth telephone circuits (the "WAM!NET Network"). The dial-up version of Transmission Manager utilizes ISDN telephone circuits and was released in March of 1999. The Company intends to continue its strategy of providing Industry Smart solutions for vertical markets requiring mass transport and storage of digital data beyond the Graphics Arts industry. The Company has created two new business units, WAM!NET Entertainment and WAM!NET Medical, to develop and market Industry Smart network services and applications for the entertainment and medical industries. In particular, the Company is developing Industry Smart solutions to address the video data transportation and storage and related workflow needs of the entertainment industry and is also considering applications for its WAM!NET Service for the transportation, storage and retrieval of medical images and data for use by the medical industry. On March 4, 1999, the Company consummated the "SGI Investment," a transaction with Silicon Graphics, Inc. ("SGI"), which provided for an equity investment by SGI of $75.0 million and the establishment of certain strategic relationships between the Company and SGI, including a preferred provider relationship pursuant to which the Company will be able to purchase hardware, software and services from SGI based on SGI's most favored pricing models. In addition, SGI will act as sales agent for the Company's products in the entertainment industry. The Company believes that the SGI Investment will provide many strategic benefits, including: - a networking and storage partnering relationship with an established industry leader; - access to a powerful new distribution channel for the WAM!NET Service, including premier accounts in the entertainment industry; and - the ability to partner with SGI's professional services group on large, multi-year, multi-site deals which require customization and involve complex implementation. Transmission Manager was released in March of 1999. The release of Transmission Manager will provide a common user interface for both high and low data volume customers and will enable WAM!NET U.K. customers (more than 30,000 worldwide) to upgrade to this product and connect to the WAM!NET Network. The Company's goal is to digitally connect both high and low volume customers through the WAM!NET Network worldwide beginning in early 1999. Increasing the number of customers, both large and small, significantly increases the value of the WAM!NET Network and product offerings. In February 1999, WAM!NET's entertainment group began offering its entertainment customers the WAM!NET Service and a compressed video viewing application. The Company expects its initial focus to be on selling existing WAM!NET transportation and storage service to the post-production market connecting post-production facilities with advertising agencies for the delivery of review quality video during the television advertisement creation process. Additional segments, including network clearance for television advertisements, large data file transfer and storage applications and video on demand are also being targeted. The Company believes that this opportunity will be further expanded and leveraged by WAM!NET's relationship with SGI and will target higher bandwidth transport applications, video storage and distribution and rendering applications. Due to costs associated with the design, development, installation and operation of the WAM!NET Network and its related applications, the Company has operated at a loss since inception and expects to incur substantial operating losses in the future. The Company has incurred an accumulated deficit of approximately $201.2 million through March 31, 1999. -10- Revenue. The Company's revenue is derived primarily from WAM!NET Service contracts which usually are annual, automatically renewable service contracts with a minimum monthly fee and additional charges for usage exceeding the monthly minimum. The Company offers the WAM!NET Service at scaled minimum usage fees, ranging from $650 per month to $4,000 per month for high volume users requiring equipment and phone service installed by the Company, from $45 per month to $180 per month for less volume intensive users who access the service using ISDN dial up connections, and intends to offer a pay by transaction system (Internet Gateway) for low volume users accessing the service over the internet. The Company begins to earn gross revenue following installation of service at a customer's premises; however, the Company incurs cost of service rebates which offset such gross revenue. Furthermore, free trial periods under the Company's various promotional programs have ranged from 60 days to six months and have been extended to 60% of the Company's customer base. As a result, the Company's generation of net revenue from any customer may lag contract signing by a period of three to nine months, a practice that is not customary in the digital data delivery industry but is a key component in the Company's market penetration strategy. The Company's experience with promotional programs has been favorable to date, with approximately 93% of customers continuing to subscribe to the WAM!NET Service following expiration of the promotional period extended to them. The Company expects the use of promotional programs in the Graphic Arts sector of the media industry to decline with increasing penetration of the market, but the Company will likely use similar promotional programs to introduce the WAM!NET Service to the entertainment and medical imaging industries. The Company also plans to continue to develop new Industry Smart applications to increase the volume of files transferred over the WAM!NET Network. In connection with the SGI Investment, SGI and the Company entered into the Preferred Provider Agreement pursuant to which both parties have developed a list of existing SGI customers in the entertainment industry which the Company believes represents a significant sales revenue opportunity for it over the next three years. The Company and SGI have agreed to jointly develop a marketing, sales and implementation plan to address these accounts, including field resource commitments, compensation to SGI for field activities and professional services, and such other matters applicable to the sale of the WAM!NET Service to such potential customers. In addition, SGI and the Company intend to explore a broader strategic relationship that is intended to enable the Company to obtain the benefit of SGI's presence in the entertainment industry, other selected commercial accounts and the U.S. federal government sector. Network Communications Fees. Network communications fees include both the costs of the high bandwidth carrier services interconnecting the Company's national infrastructure of network operating centers ("NOCs") and Distribution Hubs and the costs of local telephone circuits connecting network access devices to the nearest Distribution Hub. Local telephone circuit connections account for approximately 80% of these charges, with significant differences between urban and rural connection costs. National carrier service, provided primarily by MCI WorldCom, accounts for most of the balance of these charges. Network communication fees are generally a fixed monthly cost per circuit. The excess of these fees over revenue represents excess capacity costs which the Company expects will decline with the increasing utilization of the WAM!NET Network. The Company actively seeks to obtain and deploy technologies that will reduce the costs of local telephone circuit connections, such as wireless technologies and remote dial-up capabilities. The Company also intends to use its network management tools to optimize the use of existing and planned network capacity as volume increases and traffic patterns begin to emerge. The Company has implemented new pricing strategies for its services which take into account the significant cost differential between urban and rural local telephone circuit connections. The Company also believes that growing competition among telephony and communications providers may reduce the cost of local telephone circuit connections. Network Operations Expense. Network operations expense represents costs directly associated with developing, maintaining, managing and servicing the global WAM!NET Network. Such costs include direct labor, vendor service fees, point-of-presence charges and development charges, which are often incurred in advance of receiving revenue. The Company's currently installed NOCs, which account for the substantial majority of direct labor and network operating costs, are capable of providing for and managing the Company's current and planned North American, European and Asian operations. Costs associated with the development of the WAM!BASE, -11- WAM!PROOF and other network applications related to medical media transport and storage are also contained in network operations expense and are incurred in advance of revenue receipt. The Company expects that network operations costs will increase as the WAM!NET Network expands; however, the cost of network operations as a percentage of revenue is expected to decline. Pursuant to the Preferred Provider Agreement, the Company has agreed to purchase hardware, software and services from SGI over a four year period with a firm commitment to purchase $35 million during the period commencing January 1, 1999 and ending December 31, 2000. The Company has the ability to purchase such products at prices based on SGI's most favored pricing models. The Company believes that the discounted prices, reduced commissions and lower servicing fees for such products will result in lower network operations expenses in the future. Sales and Marketing Expense. The Company's sales and marketing efforts are intended to create global awareness of the WAM!NET Service, communicate its potential for work flow enhancement, demonstrate its reliability and establish strong brand recognition. As a result, the Company aggressively markets the WAM!NET Service through a combination of trade journal advertising, trade show attendance, promotional programs, direct field sales, tele-sales, cooperative sales presentations and active participation in industry-sponsored seminars and publications. The Company expects to continue to incur significant sales and marketing expenses to obtain increased penetration of the global media industry, to generate increased traffic among its existing customers and to market the WAM!NET media transport service to other targeted industries. General and Administrative Expense. The Company's general and administrative expense includes administrative salaries, related overhead and professional service fees. These costs reflect expenditures related to the rapid growth and expansion of the Company's administrative infrastructure necessary to manage its expanding operations, and professional service fees for financing activities, contract negotiations and acquisitions. The Company expects to continue to incur substantial general and administrative expense as the Company deploys the WAM!NET Service internationally; however, the cost of general and administrative expense as a percentage of revenue is expected to decline. Depreciation and Amortization. To facilitate entry into its target markets, the Company furnishes its global customers with all the hardware and software necessary for them to use the WAM!NET Service on a turn-key, pay-by-use basis. As a result, the Company retains ownership of the network access devices it furnishes to customers for their use of the WAM!NET Service. Depreciation and amortization expense includes depreciation of network access devices, Distribution Hubs and equipment located in the NOCs. The Company's network infrastructure is generally organized to use the most expensive equipment in the NOCs, less expensive equipment for Distribution Hubs and the least expensive equipment in the network access devices. The Company anticipates substantial capital investments for additional North American and international Distribution Hubs, WAM!BASE storage facilities to be located in the existing NOCs and network access devices to be located at customer premises. As a result, the Company anticipates that depreciation and amortization expense will continue to increase in future periods as the Company continues to purchase equipment. Results of Operations Three Month Period Ended March 31, 1999 Compared with Three Month Period Ended March 31, 1998 Revenue. Revenue for the three month period ended March 31, 1999 was $3,762,467 compared to $1,320,026 for the three month period ended March 31, 1998, an increase of $2,442,441, or 185.0%. This increase in revenue was primarily due to increased market penetration of the North American graphic-arts segment by the Company's high end media transport service and an increase of the average monthly invoice for high volume users to $756 for the period ending March 31, 1999 from $664 for the period ending March 31, 1998, an increase of $92 or 13.9%. Installed network access device media transport services increased from 744 sites for the three month -12- period ended March 31, 1998 to 1,676 sites for the three month period ended March 31,1999; an increase of 932 sites or 125.3%. Service rebates for the years ended March 31, 1999 and March 31, 1998 were $634,859 or 16.9% of gross revenue, and $271,000 or 20.5% of gross revenue, respectively; an increase of $363,859 or 134.3%. Service rebates are primarily the result of marketing programs that allow customers who sign up for the Company's high end media transport services to participate in a trial period that under certain circumstances can rebate the associated monthly minimum charges for a period of two to six months. During 1998, approximately 60% of newly installed customers participated in a trial period and approximately 93% of those customers have remained on the network after the lapse of their initial trial period. Revenue for software and hardware sales for the three month period ended March 31, 1999 was $1,738,998, compared to $831,000 for the three month period ended March 31, 1998, an increase of $907,998, or 109.3%. Software and hardware sales revenue for the three month period ended March 31, 1999 were primarily derived from continuing media-transport software sales of WAM!NET U.K. following its integration with 4-Sight Limited ("4-Sight") on March 13, 1999. Operating Expenses. Network communications fees for the three month period ended March 31, 1999 were $6,477,253, compared to $3,151,571 for the three month period ended March 31, 1998, an increase of $3,325,682, or 105.5%. This increase was due primarily to an increase of 125% in the number of customers purchasing the Company's media transport services. Network communications fees represent the largest direct cost associated with providing the Company's media transport service to customers. Although network communications fees increased 105.5% from the period ending March 31, 1998 to the period ending March 31, 1999, the average monthly communications fees incurred by the Company to provide media transport services to a single North American customer was $1,112 for the period ending March 31, 1999 compared to $1,558 for the period ending March 31, 1998, a decrease of $446 or 40.1%. Network operations expense for the three month period ended March 31, 1999 was $5,285,349, compared to $3,259,126 for the three month period ended March 31, 1998, an increase of $2,026,223, or 62.2%. This increase was due to several significant factors relating to the design and implementation of the Company's global media transport infrastructure and the shift from a primarily North American operational focus to a global operational focus. Sales and marketing expense for the three month period ended March 31, 1999 was $7,025,933, compared to $2,352,529 for the three month period ended March 31, 1998, an increase of $4,673,404, or 198.7%. This increase is primarily due (i) to the expansion of the North American sales and marketing force and the creation of a European sales and marketing force to increase market penetration, (ii) enhancing product recognition within the existing North American market and (iii) implementing global sales and marketing strategies throughout Europe and Asia. General and administrative expense for the three month period ended March 31, 1999 was $3,970,682, compared to $14,466,910 for the three month period ended March 31, 1998, a decrease of $10,496,228, or 72.6%. The increase in general and administrative expenses during 1998 was primarily the result of large non-cash compensation expenses relating to the vesting of certain option and warrant contracts held by various officers of the Company which totaled $12,528,726. This decrease is primarily due to a $11,539,000 non-cash compensation charge relating to the vesting of certain option contracts held by various officers of the Company in the period ended March 31, 1998. After adjusting for this charge, general and administrative expense increased $1,042,772 or 35.6% over the comparable adjusted period of the previous year. The adjusted increase in general and administrative expense was due to vastly increased operational support requirements due to the rapid expansion of the Company's global services and corporate facilities. Depreciation and amortization for the three month period ended March 31, 1999 was $8,205,818, compared to $1,921,248 for the three month period ended March 31, 1998, an increase of $6,284,570, or 327.1%. This increase is primarily due to the purchasing of network equipment and other support equipment used in the expansion of the network during 1998 and 1999 in the amount of $56,797,000 and the increase of $32,557,000 in goodwill that resulted from the acquisition of 4-Sight. -13- Interest expense for the three month period ended March 31, 1999 was $10,073,504, compared to $3,444,282 for the three month period ended March 31, 1998, an increase of $6,629,222, or 192.5%. The increase was primarily due to the increase in long-term unsecured debt the Company incurred during 1998 to fund its operations and the acquisition of 4-Sight, consisting primarily of the Company's 13.25% Senior Discounted Notes due 2005 (the "1998 Notes") in the amount of $138,975,368. At March 31, 1999, equipment financing borrowings were $20,450,401 compared to $10,424,421 at March 31, 1998 an increase of $10,025,980 or 96.2%. In the three month period ended March 31, 1999, the Company had also incurred interest expense in the amount of $2,796,500 in connection with the 13.25% Subordinated Unsecured Convertible Note due August 28, 2005 (the "1999 MCI WorldCom Convertible Note"). Interest income for the three month period ended March 31, 1999 was $199,813, compared to $293,671 for the three month period ended March 31, 1998, a decrease of $93,858, or 32.0%. The decrease in interest income was primarily due to the decrease in the Company's average monthly balance of cash and cash equivalents, which was $26,334,201 for the three month period ended March 31, 1999 compared to the average monthly balance of $52,243,321 for the three month period ended March 31, 1998. The Company invests a large portion of its cash proceeds into highly liquid investments with staggered maturities ranging from 30 to 180 days, corresponding with the Company's operational cash requirements. These investments consist of high-grade (A1/P1) rated commercial paper, certificates of deposits and securities backed by the United States government. The cost of hardware and software sales for the three month period ended March 31, 1999 was $822,779, compared to $261,000 for the three month period ended March 31, 1998, an increase of $561,779, or 215.2%. These costs are directly related to the software and hardware sales revenue associated with the acquisition of 4-Sight and its subsequent integration into WAM!NET U.K. Income Taxes. For the three month period ended March 31, 1999, the Company experienced net losses of $36,812,339 and paid no income taxes. These losses are available to offset future taxable income through the year 2014 and are subject to the limitations of Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"). These limitations may result in expiration of net operating loss carry-forwards before they can be utilized. Liquidity and Capital Resources The Company continues to incur substantial operating losses as a direct result of its continuing efforts to expand the WAM!NET Network throughout North America, Europe and Asia. Net losses since the Company's inception have resulted in an accumulated deficit balance of approximately $201.2 million. Though these losses are not unexpected, the Company's ability to continue to fund these operating losses and its ability to continue to purchase and install the required WAM!NET Network hardware to provide the WAM!NET Service to its increasing global customer base depends on its ability to obtain additional sources of funds for working capital during 1999. Sources of such funds which the Company will continue to seek include but are not limited to long- and short-term secured equipment financing from vendors, financial institutions and banks, long-term unsecured senior debt, long-term property mortgages on its existing facilities and the issuance of the Company's equity securities. Though the Company believes it can secure additional funding by one or more of the above sources, there can be no assurances that such funding can be obtained. From inception through March 31, 1999, the Company has derived substantially all of its operating capital from the issuance of short- and long-term debt and equity instruments. At March 31, 1999, the Company had a total of approximately $216.3 million in long-term debt, of which approximately $8.3 million becomes payable in the next twelve months. The Company's available operating capital as of March 31, 1999, as evidenced by cash, cash equivalent investments and commitments from financial institutions for additional equipment financing, totaled approximately $50 million. If additional sources of funding cannot be obtained during the course of the Company's fiscal year ending December 31, 1999, due to a constraint of available operating capital, the Company will be required to significantly slow its global market penetration, network growth and product development. In addition, should the Company be unable to generate cash to fund its operations and network growth during 1999, management expects -14- that it would implement plans to reduce cash expenditures. The reduction of cash expenditures would have a material adverse effect on the Company's global revenue and network expansion plans. The Company believes that the most evident and clearly measurable impact resulting from these reductions would be a significant decrease of installed network customers for the year ending December 31, 1999. A material reduction in the base of installed customers would slow the growth of the Company's recurring revenue stream, which is dependent upon customer utilization of the Company's excess network capacity. Reductions in network utilization would directly impact the Company's network revenue and could ultimately defer overall profitability of the Company's service and products. Another possible impact of the above outlined expenditure reductions, would be potentially material delays in software product development, the impact of which could further erode customer retention and network utilization. The Company's source of liquidity since inception has primarily come from the issuance of debt and equity instruments and from credit facilities and other borrowings. The Company has received approximately $171.7 million net cash proceeds from the issuance of long- and short-term debt and collateralized equipment financing. An additional $61.9 million of net cash proceeds has been received from the sale of equity securities. The Company has utilized these proceeds by investing $77.7 million into its globally expanding WAM!NET Network and investing $20.3 million to acquire 4-Sight. Since inception, the Company has also expended $140.6 million to fund its globally expanding operating activities. To date, the Company has not generated positive cash flow from operating activities and remains dependent upon its ability to generate operating capital for its global expansion from credit facilities or other borrowings, or the issuance of additional short- and long-term debt and equity instruments. During September of 1997, the Company established the revolving credit facility (the "Revolving Credit Facility") pursuant to an agreement with the First National Bank of Chicago, the proceeds of which were used by the Company to fund its operations and purchase WAM!NET Network equipment. The maximum amount that can be borrowed under the Revolving Credit Facility is $25.0 million. MCI WorldCom guaranteed the Company's obligations under the Revolving Credit Facility. At March 31, 1999, the Company had $24.5 million borrowed under the Revolving Credit Facility. Interest and principal on the Revolving Credit Facility become payable in September 1999. Borrowings by the Company under the Revolving Credit Facility require the prior consent of MCI WorldCom. The Company expects to repay all amounts outstanding under the Revolving Credit Facility prior to September 1999. On January 13, 1999, the Company issued the 1999 MCI WorldCom Convertible Note pursuant to the Subordinated Unsecured Convertible Note and Warrant Purchase Agreement by and between MCI WorldCom and the Company, dated January 13, 1999 (the "1999 MCI WorldCom Convertible Note Purchase Agreement"). Under the 1999 MCI WorldCom Convertible Note the Company borrowed $10.0 million on January 13, 1999 and $15.0 million on March 4, 1999. The 1999 MCI WorldCom Convertible Note automatically converted into 2,196,317 shares of the Company's Class D Convertible Preferred Stock, par value $.01 per share (the "Class D Preferred Stock"), immediately prior to the closing of the SGI Investment. The Class D Preferred Stock is immediately convertible in the aggregate into approximately 2.9% of the Common Stock (calculated on a fully diluted basis). In connection with the issuance of the 1999 MCI WorldCom Convertible Note, the Company also (i) issued warrants to purchase 150,000 shares of Common Stock at an exercise price of $.01 per share after April 30, 1999 and exerciable until April 30, 2004 and (ii) expects to issue warrants to purchase 200,000 shares of Common Stock at an exercise price of $.01 per share, (together the "1999 MCI WorldCom Warrants"). The Class D Preferred Stock and the 1999 MCI WorldCom Warrants are subject to certain registration rights. On March 4, 1999, the Company consummated the SGI Investment pursuant to which SGI purchased 5,710,425 shares of the Company's Class B Convertible Preferred Stock, par value $.01 per share (the "Class B Preferred Stock"), and 878,527 shares of the Company's Class C Convertible Preferred Stock, par value $.01 per share (the "Class C Preferred Stock" and together with the Class B Preferred Stock, the "SGI Preferred Stock"). The SGI Preferred Stock is subject to certain registration rights. The holders of the Class B Preferred Stock, voting separately as a class, have the right to designate one member of the Company's Board of Directors. The SGI Preferred Stock is convertible in the aggregate into approximately 8.7% of the Common Stock (calculated on a fully -15- diluted basis); provided that the Class C Preferred Stock may not be converted until the earlier of September 4, 2000 or a public offering of the Common Stock at a minimum specified price. The aggregate consideration received by the Company in the SGI Investment was $75.0 million, of which $35.0 million was paid in cash and $40.0 million was paid by transfer to the Company of a corporate campus office facility located in Eagan, Minnesota. In connection with the SGI Investment, SGI and the Company entered into the Preferred Provider Agreement pursuant to which both parties have developed a list of existing SGI customers in the entertainment industry which the Company believes represents a significant sales revenue opportunity for it over the next three years. The Company and SGI have agreed to jointly develop a marketing, sales and implementation plan to address these accounts, including field resource commitments, compensation to SGI for field activities and professional services, and such other matters applicable to the sale of the WAM!NET Service to such potential customers. In addition, SGI and the Company intend to explore a broader strategic relationship that the Company believes will enable it to obtain the benefit of SGI's presence in the entertainment industry and other selected commercial accounts. Pursuant to the Preferred Provider Agreement, the Company has agreed to purchase hardware, software and services from SGI over a four year period with a firm commitment to purchase $35 million during the period commencing December 1, 1998 and ending December 31, 2000. The Company has the ability to purchase such products at prices based on SGI's most favored pricing models. The Company believes that the discounted prices, reduced commissions and lower servicing fees for such products will result in lower network operations expenses in the future. Item 3--Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Rates. The Company's revenue originating outside the U.S. for the period ending March 31, 1998 was 38% of total revenues. As the Company expands its operations into countries outside of the U.S., its results of operations and the value of its assets will be affected by the currency exchange rates between the U.S. dollar and the functional currency of countries in which the Company has assets. The Company may also sell products and services in certain countries in the local functional currency or in a currency other than the U.S. dollar. In addition, the Company may acquire interests in companies that operate in countries where the removal or conversion of currency is restricted. The Company cannot be certain that countries that do not have such restrictions regarding removal or conversion of currency at the time it establishes operations in those countries 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. The Company does not currently hedge against such fluctuations. Gains and losses from such fluctuations have not been material to the Company's consolidated results of operations. A 10% shift in such local currencies against the U.S. dollar as of March 31, 1999 would not have had a material effect on the Company's pretax earnings over the fiscal quarter ending March 31, 1999. Currently, all of the Company's contracts are denominated in U.S. dollars except for those contracts entered into by WAM!NET U.K. which denominates all of its contracts in pounds sterling other than its German sales contracts which are denominated in Euro, the single European currency. The Company's 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, the Company's future results could be materially and adversely impacted by changes in these or other factors. Interest Rates. The Company invests its cash in a variety of financial instruments, including bank time deposits and fixed rate obligations of governmental entities and agencies. These investments are denominated in U.S. dollars. Cash balances in foreign currencies overseas are operating balances and are invested in short-term time deposits of the local operating bank. -16- Investments in fixed rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates. Due in part to these factors, the future investment income of the Company may fall short of expectations due to changes in interest rates, or the Company may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates. The Company's investment securities are held for purposes other than trading. The Company is exposed to market risk from changes in the interest rates on certain of its outstanding debt. The outstanding loan balance under the 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 period ended March 31, 1999, a 100 basis point change in interest rates would not change interest expense by a material amount. For fixed rate debt such as the Company's 1998 Notes, interest rate changes effect the fair market value thereof, 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." The sale and purchase of the 1999 MCI WorldCom Note and the conversion thereof into the Class D Preferred Stock and the sale and purchase of the Class B Preferred Stock, the Class C Preferred Stock and the 1999 MCI WorldCom Warrants were exempt from the registration requirements of Section 5 of the Securities Act of 1933 (the "Securities Act") pursuant to the provisions of Section 4(2) of the Securities Act. Item 6--Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index (b) The Company filed the following Current Reports on Form 8-K during the three-month period ending March 31, 1999: Current Report on Form 8-K, filed on March 9, 1999, announcing the consummation of the SGI Investment. -17- 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: May 17, 1999 By: /s/ Bradley E. Sparks ---------------------------- Bradley E. Sparks Executive Vice President and Chief Financial Officer -18- 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. 3.1 (1) Amended and Restated Articles of Incorporation of the Company. 3.2 (1) By-Laws of the Company. 4.1 (1) Indenture dated as of March 5, 1998, between the Company, as Issuer, and First Trust National Association, as Trustee. 4.2a (1) Certificate for the Rule 144A Original Notes ($200,000,000). 4.2b (1) Certificate for the Rule 144A Original Notes ($8,030,000). 4.3 (1) Certificate for the Regulation S Original Notes. 4.4 (1) Certificate for the Rule 144A Warrants. 4.5 (1) Certificate for the Regulation S Warrants. 4.6a (1) Rule 144A Unit Certificate. (200,000 Units) 4.6b (1) Rule 144A Unit Certificate. (8,030 Units) 4.7 (1) Certificate for the Regulation S Units. 4.8 (1) Form of Certificate for the Exchange Notes (incorporated herein by reference and included in Exhibit 4.1 to the Company's Registration Statement on Form S-4 filed with Securities and Exchange Commission on May 28, 1998). 4.9 (1) Common Stock Certificate. 4.10 (1) Registration Rights Agreement, dated March 5, 1998, among the Company and Merrill Lynch Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation and First Chicago Capital Markets, Inc. 4.11 (1) Common Stock Registration Rights Agreement, dated as of March 5, 1998, among the Company, WorldCom Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse First Boston Corporation and First Chicago Capital Markets, Inc. 4.12 (1) Warrant Agreement, dated as of March 5, 1998, by and between the Company and First Trust National Association, as Warrant Agent, to purchase common stock of the Company. 4.13 (2) Certificate Representing 100,000 Shares of Class A Preferred Stock of the Company issued to WorldCom Inc. on December 16, 1996 (Incorporated herein by reference to exhibit 10.5 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). 4.14 (2) Warrants to purchase 4,157,500 Shares of Common Stock of the Company exercisable on or before December 31, 2000, issued to WorldCom Inc. on December 16, 1996 (Incorporated herein by reference to exhibit 10.6 of the Company's Registration Statement on Form S-4 (File No. 333-53841) filed with the Securities and Exchange Commission on May 28, 1998). 4.15 (2) Certificate for 13.25% Subordinated Unsecured Convertible Note due August 28, 2005 ($25,000,000 Note) issued to MCI WorldCom, Inc. on January 13, 1999. 4.16 (2) Certificate for 1,679,234 Class A Warrants and 2,840,967 Class B Warrants to purchase Common Stock of the Company, issued to WorldCom Inc. on September 26, 1997 (Incorporated herein by reference to exhibit 10.9 of the Company's Registration Statement on Form S-4 (File No. 333-53841) filed with the Securities and Exchange Commission on May 28, 1998). 4.17 (2) Subordinate Unsecured Convertible Note and Warrant Purchase Agreement between the Company and MCI WorldCom, Inc. dated January 13, 1999. -19- 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 this State of Minnesota on March 5, 1999. 4.21 (2) Certificate of Designation of Rights and Preferences of Class B Convertible Preferred Stock of the Company filed with the Secretary of State of the State of Minnesota on March 4, 1999. 4.22 (2) Certificate of Designation of Rights and Preferences of Class C Convertible Preferred Stock of the Company filed with the Secretary of State of the State of Minnesota on March 4, 1999. 4.23 (2) Certificate of Designation of Rights and Preferences of Class D Convertible Preferred Stock of the Company filed with the Secretary of State of the State of Minnesota on March 4, 1999. 4.24 (2) Certificate representing 115,206 shares of Class A Preferred Stock of the Company issued to MCI WorldCom. Inc. on March 4, 1999. 4.25 (2) Certificate representing 5,710,425 shares of Class B Convertible Preferred Stock of the Company issued to Silicon Graphics, Inc. on March 4, 1999. 4.26 (2) Certificate representing 878,527 shares of Class C Convertible Preferred Stock of the Company issued to Silicon Graphics, Inc. on March 4, 1999. 4.27 (2) Certificate representing 2,196,317 shares of Class D Convertible Preferred Stock of the Company issued to MCI WorldCom. Inc. on March 4, 1999. 4.28 (2) Stockholders Agreement by and among the Company, Silicon Graphics, Inc. and MCI WorldCom, Inc. dated as of March 4, 1999. 4.29 (2) Class A Preferred Stock Exchange Agreement by and between the Company and MCI WorldCom, Inc. dated as of March 4, 1999. 4.30 (2) Class D Preferred Stock Conversion Agreement by and between the Company and MCI WorldCom, Inc. dated as of March 4, 1999. 10.1 (1) Credit Agreement among the Company, the Lending Institutions party thereto, as Lenders, The First National Bank of Chicago, as Agent, dated as of September 26, 1997. 10.2 (1) Ten Percent Convertible Note Purchase Agreement between the Company and WorldCom Inc. dated September 12, 1996 ($5,000,000 Note). 10.3 (1) Preferred Stock, Subordinated Note and Warrant Purchase Agreement between the Company and WorldCom Inc. dated November 14, 1996. 10.4 (1) $28,500,000 Seven Percent Subordinated Note due December 31, 2003, payable to WorldCom Inc. 10.5 Intentionally omitted. 10.6 Intentionally omitted. 10.7 (1) Right of Refusal Agreement Among WorldCom Inc., Edward Driscoll III and Alan L. Witters dated December 16, 1996. 10.8 (1) Guaranty Agreement dated September 26, 1997, by and between the Company and WorldCom Inc. 10.9 Intentionally omitted. 10.10 (1) Sublease dated September 24, 1997 between the Company and 1250895 Ontario Limited, relating to the property located at 6100 110th Street West, Bloomington, Minnesota. 10.11 (1) Service Provision Agreement dated as of July 18, 1997, by and between the Company and Time Inc. 10.12 (1) Standby Agreement dated as of July 19, 1997 by and between WorldCom Inc. and Time Inc. 10.13 (1) Employment Agreement dated as of November 14, 1996, by and between the Company and Edward J. Driscoll III. 10.14 (1) Employment Agreement dated as of November 14, 1996, by and between the Company and Allen Witters. 10.15 (1) Employment Agreement dated as of April 16, 1996, by and between the Company and James R. Clancy. 10.16 (1) Employment Agreement dated as of May 10, 1995, as amended, by and between the Company and Mark Marlow. -20- 10.17 (1) Agreement dated February 11, 1998 between the Company and WorldCom, Inc. modifying certain terms of the (i) 10% Convertible Subordinated Note, due September 30, 1999, (ii) 7% Subordinated Note, due December 31, 2003, and (iii) 100,000 shares of Series A Preferred Stock, all of which are held by MCI WorldCom, Inc. (incorporated herein by reference to exhibit No. 4.17 to the Company's Registration Statement on Form S-4 (File No. 333-53841) filed with the Securities and Exchange Commission on May 28, 1998) 10.18 (1) 1994 Stock Option Plan 10.19 (1) Amended and Restated 1994 Stock Option Plan 10.20 (1) 1998 Combined Stock Option Plan. 10.21 (1) Agreement dated June 5, 1997 between the Company and WorldCom, Inc. regarding data services provided by WorldCom, Inc. to the Company. 10.22 Preferred Provider Agreement by and between the Company and Silicon Graphics, Inc., dated as of March 4, 1999 (portions of this exhibit have been ommitted pursuant to a request for confidential treatment and have been filed with the Securities Commission under separate cover). 10.23 (2) Sale and Purchase Agreement by and between Silicon Graphics, Inc., on behalf of itself and its wholly-owned subsidiary, Cray Research, L.L.C., and the Company dated as of March 4, 1999. 10.24 (2) Lease by and between the Company and Silicon Graphics, Inc. on behalf of itself and its wholly-owned subsidiary, Cray Research, L.L.C., with respect to the Company's corporate campus facility located in Eagan, Minnesota dated as of March 4, 1999. 10.25 (2) Employment Agreement dated January 1, 1998 by and between John R. Kauffman and the Company. 10.26 (2) Employment Agreement dated November 3, 1997 by and between David T. Ottinger and the Company. 10.27 (2) Employment Agreement dated September 8, 1998 by and between the Bradley E. Sparks and the Company. 27.1 Financial Data Schedule. - ---------- (1) Incorporated herein by reference to the Company's Registration Statement on Form S-4 (File No. 333-53841), filed with the SEC on May 28, 1998. (2) Incorporated herein by reference to the Company's Annual Report on Form 10-K, filed with the SEC on March 31, 1999. -21- EX-10.22 2 PREFERRED PROVIDER AGREEMENT Exhibit 10.22 PREFERRED PROVIDER AGREEMENT This Preferred Provider Agreement (this "Agreement") is entered into as of March 4, 1999 ("Effective Date") by and between WAM!NET Inc., a Minnesota corporation having a place of business at 6100 West 110th Street, Minneapolis, MN 55438 ("WNI"), and Silicon Graphics, Inc. a Delaware corporation having a place of business at 2011 North Shoreline Blvd., Mountain View, CA 94043 ("SGI"). RECITALS WHEREAS, WNI and SGI desire to establish a strategic relationship, pursuant to which SGI will invest in WNI pursuant to the terms of that certain Preferred Stock Purchase Agreement (together with all agreements, instruments and documents contemplated thereby and set forth as Exhibits thereto) of even date herewith, WNI will purchase products, support and services from SGI, and SGI will promote the services of WNI to SGI's customers; WHEREAS, WNI desires to purchase certain products (whether or not originally manufactured by SGI), support and services of SGI, including, without limitation, computer hardware, storage, peripheral devices, network devices, integrated products, software, technical and maintenance support, and custom engineering and professional services (collectively, "SGI Products"); and WHEREAS, WNI desires that SGI promote the sale of certain services of WNI, including, without limitation, WAM!NET, WAM!BASE and entertainment specific services ("WNI Services"). NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, SGI and WNI, for themselves, their successors and permitted assigns, hereby agree as follows: ARTICLE I. SGI PRODUCTS 1.1. General. WNI will, over a four (4) year period commencing January 1, 1999 and ending December 31, 2002 (the "Purchase Period"), purchase SGI Products as provided in Sections 1.2 through 1.5 below. The parties agree that with respect to purchases of SGI Products, and subject to the terms and conditions of this Agreement, WNI will treat SGI as the preferred provider of such goods and services and SGI will treat WNI as a preferred customer for such goods and services. 1.2. Firm Commitment. WNI shall have a firm and unconditional obligation to purchase from SGI not less than $35 million of SGI Products during the period commencing December 1, 1998 and ending December 31, 2000 (the "Firm Commitment"). If WNI fails to satisfy its purchase commitment during such period, as evidenced by its issuance to SGI of confirmed, irrevocable, noncancellable purchase orders for an aggregate amount at least equal to the Firm Commitment, then WNI shall pay to SGI a sum equal to 10% of the remaining outstanding balance of the Firm Commitment. 1.3. Computer Hardware and Software Product Pricing; Preferred Provider. 1.3.1. Standard Product Pricing. With respect to SGI's standard hardware and software products, and the associated standard customer support programs, listed in SGI's published Price Book (the "Standard Products"), the pricing models SGI offers to WNI during the Purchase Period will be based upon SGI's most favored pricing models (by product) applicable to resellers (excluding US government, educational institutions and associated agencies) with aggregate purchases at least equal to the Firm Commitment. 1.3.2. Modified Product Pricing. With respect to Standard Products and the associated customer support offerings that SGI agrees to modify or build in accordance with WNI's stated requirements (the "Modified Products"), the pricing that SGI offers to WNI during the Purchase Period will be ** . 1.3.3. Limited Exclusive Provider. WNI agrees to purchase computer hardware, software and support products of the type included within the Standard Products and Modified Products, other than SGI Services (as defined below), solely from SGI during the Purchase Period, subject to the following terms and conditions: (a) the Standard and Modified Products then being offered by SGI shall be suitable for WNI's requirements (a product is suitable if it conforms to the specifications set by WNI for the specific product); and (b) SGI's pricing to WNI for Standard and Modified Products shall be at Competitive Prices (as defined below); provided however, that, if SGI's pricing is not at Competitive Prices with regard to the applicable Standard and Modified Products, SGI shall then have a period of seven (7) business days in its sole discretion to reduce its pricing to Competitive Prices and notify WNI of such price reduction. 1.3.3.1. Standard Products. For the purposes of this Section 1.3.3, "Competitive Prices" as it relates to Standard Products means (i) with regard to servers, supercomputers, workstations and related software, pricing over a six-month period that is not more than ** of the price offered by a third-party vendor for products substantially similar to the applicable Standard Products, and (ii) with regard to storage, personal computers and related software, pricing over a six-month period that is not more than ** of the price offered by a third-party vendor for products substantially similar to the applicable Standard Products. 1.3.3.2. Modified Products. For the purposes of this Section 1.3.3, "Competitive Prices" as it relates to Modified Products means pricing and other material terms and conditions that are **. 1.4. SGI Services. With respect to technical consulting, application development, hardware design, product development, custom manufacturing, integration, custom product support and related professional and custom engineering services as they pertain to Standard and/or Modified Products offered by SGI (the "SGI Services"), WNI agrees that it will treat SGI as a preferred provider and shall provide SGI with the opportunity to bid on any WNI requirements or specifications for services similar to the SGI Services. ** 1.5. Terms and Conditions. The terms and conditions governing the purchase of the SGI Products by WNI will be set forth in the following agreements, as the same may be amended, modified and supplemented from time to time: (a) the Master Purchase Agreement , a general form of which is attached hereto as Exhibit A and the specific terms of which shall be negotiated in good faith by the parties; (b) with respect to Standard Products installed at WNI's facilities only, a Customer Support Agreement, a general form of which is attached hereto as Exhibit B and the specific terms of which shall be negotiated in good faith by the parties; (c) a Master Services Agreement, the general terms of which - -------- ** Confidential information omitted and filed separately with the Securities and Exchange Commission. are described in Exhibit C and the specific terms of which shall be negotiated in good faith by the parties; and (d) with respect to Modified Products, hardware and software products developed in connection with the Services and which are installed at WNI's customers' facilities, a Field Support Agreement, the general terms of which are described in Exhibit D and the specific terms of which shall be negotiated in good faith by the parties. 1.6. SGI Indemnity for Third Party Suppliers. In the event that SGI engages third parties in order to provide the SGI Products, SGI agrees to indemnify and hold harmless WNI and any of its employees, directors, officers, agents or other representatives in connection with any loss, damage or expense (including reasonable attorneys' fees) resulting from any claim of a third party related to the foregoing to the extent such claim arises as a result of SGI's negligence or willful misconduct. ARTICLE II. WNI SERVICES 2.1. General. SGI and WNI have developed a list of existing SGI customers in the entertainment industry which the parties believe in good faith represent a sales revenue opportunity for WNI ** (based upon WNI list prices) over the three (3) year period commencing on January 1, 1999 (the "Joint Customers"). WNI and SGI will jointly develop a marketing, sales and implementation plan to address these accounts, including field resource commitments, compensation to SGI for field activities and professional services, and such other matters applicable to the sale of WNI Services to such Joint Customers. In addition, SGI and WNI will explore a broader strategic relationship that is intended to enable WNI to obtain the benefit of SGI's presence in the entertainment industry, other selected commercial accounts and the U.S federal government sector. Such relationship will be embodied in one or more further agreements to be negotiated in good faith between the parties. ARTICLE III. RESPONSIBLE EXECUTIVES AND MEETINGS 3.1. Responsible Executives. Upon execution of this Agreement, and from time to time as appropriate, each party shall designate in a writing to the other its executives responsible for managing the Preferred Provider relationship described in this Agreement, as well as for discussing any emerging issues concerning the relationship (the "Responsible Executives"). SGI's Responsible Executives initially shall include a Senior Vice President from its Server and Supercomputing Business; a Senior Vice President or Vice President from its Customer and Professional Services Division; and a Senior Vice President or Vice President from its Worldwide Sales and Marketing Division. WNI's Responsible Executives initially shall include its Chief Executive Officer, Chief Operating Officer and Chief Technical Officer. In addition, each party shall designate one Responsible Executive who shall serve as the primary point of contact for the other party with respect to the relationship described in this Agreement. 3.2. Quarterly Management Meetings. During the Purchase Period, the Responsible Executives of WNI and SGI shall meet on a quarterly basis, at times and places to be agreed upon, to review the status of the relationship between the parties, including forecasts for and analysis of sales of WNI Services and purchases of SGI Products for each of the next four quarters and the remainder of the Purchase Period. At least five (5) business days prior to a meeting, each party shall submit an agenda of issues proposed to be discussed at the meeting. Twice yearly at such meetings, the parties shall review - ---------- ** Confidential information omitted and filed separately with the Securities and Exchange Commission. SGI's pricing with respect to Standard and Modified Products as set forth in Section 1.3.3 above. The parties shall bear their respective costs and expenses in connection with attending and participating at all such meetings. ARTICLE IV. CONFIDENTIALITY AND PUBLICITY 4.1. Confidentiality. (a) "Confidential Information" means (i) any information relating to either party's products, designs, schematics, diagrams, drawings, costs, prices, finances, marketing or business plans, business opportunities, customers, partners, research, development, know-how or trade secrets; (ii) all information that, by the nature of the circumstances surrounding the disclosure, ought in good faith to be treated as confidential; and (iii) the terms and conditions of this Agreement. Confidential Information may include confidential, proprietary and/or trade secret information that is owned by third parties, which have granted sufficient rights to a party to permit that party to provide information to the other party hereunder. (b) Disclosure of Confidential Information. Each party agrees that it may be desirable to disclose to the other party Confidential Information. Confidential Information is provided hereunder solely for the purpose of facilitating the relationship described in this Agreement and the parties agree to maintain the Confidential Information in confidence; not to use any Confidential Information for any purpose except as contemplated by this Agreement; and not to disclose, or permit the disclosure of, the Confidential Information to any third party. The use and access to Confidential Information shall be limited by the parties to their respective directors, officers, employees, counsel, accountants and agents who need to know such Confidential Information, provided that the party so disclosing such information shall advise each such recipient of the confidentiality obligations under this Article IV. The party receiving any Confidential Information (the "Recipient") shall reproduce and include in all copies of Confidential Information prepared by Recipient the copyright notices and proprietary legends of the party disclosing such information (the "Discloser") as they appear therein as furnished to Recipient by Discloser. Recipient shall not remove any proprietary, copyright, mask work, trademarks or other legend from any form of Confidential Information. The parties acknowledge and agree that harm not adequately compensable might result from unauthorized disclosure of Confidential Information. Either party may seek injunctive relief, without posting a bond, if the other party breaches its obligations of confidentiality as set forth in this Article 4. (c) Exclusions to Obligations of Confidentiality. Recipient shall have no obligation to maintain the confidentiality of information provided by the other party that: (a) is known to Recipient at the time of disclosure; (b) is independently developed by Recipient provided Recipient can show by written evidence to Discloser's reasonable satisfaction that such development was accomplished by or on behalf of Recipient without the use of or any reference to Confidential Information supplied by the other party; (c) becomes rightfully known to Recipient from a source other than the other party without restriction on subsequent disclosure or use; (d) is or becomes a part of the public domain through no wrongful act of Recipient; or, (e) is rightfully received by the Recipient from a third party without any duty of confidentiality. Further, Recipient may disclose Confidential Information if it is advised by counsel that such disclosure is required, pursuant to law, regulation, judicial or government request, requirement or order, provided that Recipient gives the other party prompt and sufficient prior notice to contest, or to seek a protective order restricting further disclosure of Confidential Information provided in response to, such request, requirement or order. (d) No Ownership Interest Transferred. Recipient acknowledges that it is granted only the limited right to use Confidential Information provided pursuant to this Agreement. Neither party transfers to the other any right of ownership in or title to any Confidential Information or other intellectual property hereunder, either expressly, by implication, estoppel or otherwise. 4.2. Publicity. Unless otherwise agreed by the parties in writing, no press releases, conferences, interviews or other public announcements, in whatever form, shall be made or given by either party regarding the subject matter of this Agreement. The parties agree to cooperate with each other in promoting the existence of this strategic relationship and in otherwise supporting each other's marketing and public relations efforts. Each party also agrees that, upon the reasonable request of the other party, it will provide customer satisfaction references with respect to the other party provided such references can be made in good faith. ARTICLE V. MISCELLANEOUS 5.1. No Agency. Nothing in this Agreement shall constitute or be deemed to constitute a partnership or joint venture between the parties hereto or constitute or be deemed to constitute any party the agent or employee of the other party for any purpose whatsoever and neither party shall have authority or power to bind the other or to contract in the name of, or to create a liability against, the other in any way or for any purpose. 5.2. Entire Agreement. This Agreement and any other writing signed by the parties that specifically references this Agreement constitute the entire agreement between the parties with respect to the subject matter hereof and supersede all prior agreements, understandings and negotiations, both written and oral, between the parties with respect to the subject matter hereof. This Agreement is not intended to confer upon any person other than the parties hereto and their successors and permitted assigns any rights or remedies hereunder. 5.3. Termination. After the end of the Purchase Period, either party may terminate this Agreement upon thirty (30) days prior written notice to the other. 5.4. Information. Subject to applicable law and privileges, each party hereto covenants and agrees to provide the other party with all information regarding itself and transactions under this Agreement that the other party reasonably believes are required to comply with all applicable federal, state, county and local laws, ordinances, regulations and codes, including, but not limited to, securities laws and regulations. 5.5. Mediation. SGI and WNI agree to negotiate in good faith in an effort to resolve any dispute related to this Agreement that may arise between the parties, prior to the institution of litigation. If the dispute cannot be resolved promptly by negotiation, then the Responsible Executives shall meet at a time and place they mutually agree to negotiate in good faith to resolve the dispute. If the dispute is not resolved by such negotiation among the Responsible Executives, either party may give the other party written notice that the dispute should be submitted to mediation. The mediation shall include the Responsible Executives and also at least one other executive from each party. Promptly thereafter, a mutually acceptable mediator shall be chose by the parties, who shall share the cost of mediation services equally. If the dispute has not been resolved by mediation within 60 days after the date of written notice requesting mediation, then either party may initiate litigation and pursue all and any remedies at law or at equity that such party is entitled to. Nothing contained in this paragraph shall prohibit a party, in the case of irreparable harm, from seeking an immediate injunction or other provisional remedy. 5.6. Notices. Any notice, instruction, direction or demand under the terms of this Agreement required to be in writing will be duly given upon delivery, if delivered by hand, facsimile transmission, or US mail, to the following addresses: (a) If to WNI, to: WAM!NET INC. 6100 West 110th Street Minneapolis, MN 55438 Attention: President Telephone: 612-886-5100 Telefax: 612-887-2165 With a copy to: Willkie Farr & Gallagher 787 Seventh Avenue New York, NY 10019-6099 Attention: Daniel D. Rubino Telephone: 212-728-8000 Facsimile: 212-728-8111 (b) If to SGI, to: Silicon Graphics, Inc. 2011 North Shoreline Blvd. Mountain View, CA 94043 Attention: Neil McGowan Telephone: 650-933-3799 Telefax: 650-932-0208 With a copy to: SGI Legal Services or to such other addresses or telecopy numbers as may be specified by like notice to the other parties. 5.7. Governing Law. This Agreement shall be construed in accordance with and governed by the substantive internal laws of the State of Minnesota, without regard to its choice of law rules. 5.8. Severability. If any provision of this Agreement shall be invalid or unenforceable, such invalidity or unenforceability shall not render the entire Agreement invalid. Rather, the Agreement shall be construed as if not containing the particular invalid or unenforceable provision, and the rights and obligations of each party shall be construed and enforced accordingly. 5.9. Survival. The parties' obligations under Articles IV and V shall survive any termination and/or expiration of this Agreement. 5.10. Amendment. This Agreement may only be amended by a written agreement executed by both parties hereto. 5.11. Counterparts. This Agreement may be executed in separate counterparts, each of which shall be deemed an original and all of which, when taken together, shall constitute one agreement. 5.12. Assignment. No assignment of rights or delegation of duties arising under this Agreement may be made by any party without the prior written consent of the other party, which consent may not be unreasonably withheld or delayed. IN WITNESS WHEREOF, the parties have caused this Agreement to be signed by their duly authorized representatives. WAM!NET Inc. By: /s/ Allen Witters --------------------------- Name: Allen Witters Title: Chief Technology Officer Silicon Graphics, Inc. By: /s/ William M. Kelley --------------------------- Name: William M. Kelley Title: Senior Vice President EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 30,171 0 4,554 546 1,744 39,470 127,116 21,403 190,540 26,266 208,006 1,152 88 93 (44,884) 190,540 1,739 4,867 823 7,300 24,488 1,069 10,074 (36,795) 0 (36,795) 0 0 0 (37,350) (4.01) (4.01)
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