<PAGE>
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: September 30, 1998
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 [X] No [ ]
As of September 30, 1998 there were 9,284,445 shares of the Corporation's Common
Stock, par value $.01 per share, outstanding.
Total number of pages in this report: 18
<PAGE>
WAM!NET INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PART I--Financial Information
PAGE NO.
--------
<S> <C>
ITEM 1--Financial Statements
Consolidated Balance Sheets as of September 30, 1998 (unaudited) and December 31,
1997............................................................................... 3
Consolidated Statements of Operations for the three and nine months in the periods
ended September 30, 1998 and 1997 (unaudited)...................................... 5
Consolidated Statements of Cash Flows for the nine months in the periods ended
September 30, 1998 and 1997 (unaudited)............................................ 6
Notes to Consolidated Financial Statements (unaudited)............................... 8
ITEM 2--Management's Discussion and Analysis of Results of Operations
and Financial Condition............................................................ 10
ITEM 3--Quantitative and Qualitative Disclosures About Market Risk..................... 16
PART II--Other Information
ITEM 4--Submission of Matters to a Vote of Security Holders............................ 16
ITEM 5--Other Information.............................................................. 17
ITEM 6--Exhibits and Reports on Form 8-K............................................... 17
Signatures--................................................................................ 18
</TABLE>
-2-
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL INFORMATION
WAM!NET INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .............................................. $ 17,626 $ 274
Investments ............................................................ -- --
Accounts receivable, net of allowance of $200 and $10, respectively .... 3,841 459
Inventory .............................................................. 1,287 --
Prepaid expenses and other current assets .............................. 4,289 554
-------- -------
Total current assets .............................................. 27,043 1,287
Property and equipment:
Network equipment ...................................................... 42,202 15,618
Other support equipment ................................................ 15,773 5,242
Furniture and fixtures ................................................. 2,956 1,078
Leasehold improvements ................................................. 2,272 259
-------- -------
63,203 22,197
Accumulated depreciation ............................................... 11,883 2,877
-------- -------
51,320 19,320
Goodwill, net of accumulated amortization of $3,640 and $6,
respectively ....................................................... 29,119 479
Deferred Charges ....................................................... 3,177 --
-------- -------
Total assets ...................................................... $110,659 $21,086
======== =======
</TABLE>
-3-
<PAGE>
WAM!NET INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable.............................................................. $ 11,567 $ 2,460
Accrued salaries and wages.................................................... 2,696 360
Accrued expenses.............................................................. 2,358 2,159
Current portion of equipment financing and obligations under
capitalized leases......................................................... 5,506 3,129
--------- --------
Total current liabilities............................................ 22,127 8,108
Long-term debt:
Subordinated notes payable.................................................... 23,894 21,784
Line of credit................................................................ -- 14,431
Equipment financing........................................................... 14,867 6,434
13.25% Senior Discounted Notes................................................ 119,763 --
Redeemable Preferred Stock, Class A, $10.00 par value:
Authorized shares--100,000, issued and outstanding shares--100,000............ 1,000 1,000
Shareholders' deficit:
Undesignated shares, $.01 par value--9,900,000
Common Stock, $.01 par value:
Authorized shares--490,000,000
Issued and outstanding shares--9,284,445 and 6,699,740 at September 30,
1998 and December 31, 1997 ........................................... 93 67
Additional paid-in capital............................................... 54,272 11,771
Accumulated deficit...................................................... (125,703) (42,509)
Cumulative foreign currency translation adjustment....................... 346 --
--------- --------
Total shareholders' deficit.............................................. (70,992) (30,671)
--------- --------
Total liabilities and shareholders' deficit.............................. $ 110,659 $ 21,086
========= ========
</TABLE>
See accompanying notes.
-4-
<PAGE>
WAM!NET INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
WAM!NET revenues........................................ $ 2,393 $ 456 $ 5,619 $ 822
Less rebates............................................ (611) (50) (1,363) (96)
-------- -------- -------- --------
Net WAM!NET user fees........................................ 1,782 406 4,256 726
Software and hardware sales.................................. 3,739 -- 8,480 --
Other service fees........................................... 9 3 29 62
-------- ------- -------- --------
Total revenues..................................... 5,530 409 12,765 788
Operating expenses:
Network communication fees.............................. 4,602 2,339 11,502 4,452
Cost of software and hardware........................... 1,155 -- 2,631 --
Network operations...................................... 10,313 1,884 19,663 4,042
Sales and marketing..................................... 6,541 2,796 13,462 6,071
General and administrative.............................. 4,730 730 23,927 2,792
Depreciation and amortization........................... 5,328 749 11,353 1,571
-------- ------- -------- --------
32,669 8,498 82,538 18,928
-------- ------- -------- --------
Loss from operations......................................... (27,139) (8,089) (69,773) (18,140)
Other income (expense):
Interest income......................................... 464 7 1,612 192
Interest (expense)...................................... (6,293) (1,247) (15,787) (2,805)
Income tax (expense).................................... 709 -- 754 --
-------- -------- -------- --------
Net loss $(32,259) $(9,329) $(83,194) $(20,753)
Less preferred dividends................................ (18) (18) (52) (52)
-------- ------- -------- --------
Net loss applicable to common stock.......................... $(32,277) $(9,347) $(83,246) $(20,805)
======== ======= ======== ========
Net loss applicable per common share......................... $ (3.74) $ (1.44) $ (9.65) $ (3.21)
======== ======= ======== ========
Weighted average number of common shares outstanding......... 8,627,889 6,478,950 8,627,889 6,478,950
========= ========= ========= =========
</TABLE>
See accompanying notes.
-5-
<PAGE>
WAM!NET INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1997
---- ----
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................................... $ (83,194) $ (20,753)
Adjustments to reconcile net loss to net cash used in operating activities:
Noncash interest expense related to warrants........................... 12,719 920
Capitalized financing costs............................................ (2,098) --
Value of stock options issued to employees and consultants............. 12,492 11
Foreign currency translation adjustment................................ 260 --
Depreciation and amortization.......................................... 11,544 1,571
Loss on disposal of property and equipment............................. 69 --
Changes in operating assets and liabilities:
Accounts receivable............................................... 329 (302)
Inventory......................................................... 70 --
Prepaid expenses and other current assets......................... (3,450) (513)
Accounts payable.................................................. 8,427 1,250
Income taxes...................................................... (1,360) --
Accrued expenses.................................................. 3,846 481
--------- ---------
Net cash used in operating activities....................................... (40,346) (17,335)
INVESTING ACTIVITIES
Purchases of property and equipment......................................... (38,598) (12,129)
Purchase of 4-Sight (net of cash acquired).................................. (16,350) --
Proceeds from sale of investments........................................... -- 1,000
--------- ---------
Net cash used in investing activities....................................... (54,948) (11,129)
FINANCING ACTIVITIES
Proceeds from exercise of stock options..................................... 11 --
Proceeds from 13.25% Senior Discount Notes.................................. 120,626 --
Proceeds from line of credit................................................ 5,203 14,500
Payments on line of credit.................................................. (24,003) --
Interest expense added to subordinated notes payable........................ -- 702
Proceeds from equipment financing........................................... 14,274 1,570
Proceeds from bridge financing.............................................. -- 10,000
Payments on bridge financing................................................ -- (11,075)
Payments on equipment financing............................................. (3,465) (65)
--------- ---------
Net cash provided by financing activities................................... 112,646 15,632
--------- ---------
(Decrease) increase in cash and cash equivalents............................ 17,352 (12,832)
Cash and cash equivalents at beginning of period............................ 274 14,444
--------- ---------
Cash and cash equivalents at end of period.................................. $ 17,626 $ 1,612
========= =========
</TABLE>
See accompanying notes.
-6-
<PAGE>
WAM!NET INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1997
---- ----
(UNAUDITED)
<S> <C> <C>
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES
Conversion of accrued interest to subordinated debt..................... $ 1,504 $1,061
Issuance of common stock relating to acquisition........................ 20,000 --
Warrant valuation reclassed to deferred charges from line of credit..... 4,104 --
Accumulated and unpaid dividends........................................ 52 52
Conversion of convertible subordinated debenture for common stock....... 25 --
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for interest.................................................. $ 1,654 $1,212
</TABLE>
See accompanying notes.
-7-
<PAGE>
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, 1997, as
included in Amendment No. 2 to the Company's Registration Statement on Form S-4
(File No. 333-53841), as filed with the Securities and Exchange Commission on
July 29, 1998. The December 31, 1997 balance sheet was derived from audited
financial statements, but does not include all disclosures required by generally
accepted accounting principles.
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. NET LOSS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings per Share", which the Company adopted on December 31, 1997.
All loss per share amounts for all periods have been presented, and where
necessary, restated to conform to the Statement 128 requirements. Basic earnings
per share is computed on the basis of the average number of common shares
outstanding. Diluted earnings per share is not presented as the effect of
outstanding options and warrants is antidilutive.
4. DEBT OFFERING
On March 5, 1998, the Company sold 208,530 Units consisting of $1,000
principal amount at maturity of 13 1/4% Senior Discount Notes due 2005 ("Notes")
and three warrants. The aggregate principal amount of the Notes payable at
maturity is $208.6 million. The sale of the Units resulted in net proceeds to
the Company of $120.6 million. Cash interest does not accrue nor is it payable
on the Notes prior to March 1, 2002. Thereafter, cash interest on the Notes will
accrue on the Notes at a rate of 13 1/4% per annum (calculated on a semiannual
bond equivalent basis) and will be payable semiannually in arrears on March 1
and September 1 of each year, commencing September 1, 2002.
-8-
<PAGE>
WAM!NET INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the Notes, the Company issued 625,590 warrants to
purchase a total of 1,257,436 shares of common stock. Each warrant entitles the
holder to purchase 2.01 shares of common stock at an exercise price of $.01 per
share. The warrants were deemed to have a value of $10 million which will be
amortized as interest expense over the life of the Notes. The fair value of the
warrants was computed at the date of issuance using the Black-Scholes pricing
model with the following assumptions: (i) price of common stock of $8.00; (ii)
exercise price of warrant of $.01; (iii) dividend yield of 0.0%; (iv) volatility
of common stock of 0.45; (v) expected life of warrant of 8 years; and (vi)
risk-free interest rate of 6.5%. The unamortized value of the warrants has been
reflected in the financial statements as a reduction of the Notes.
5. ACQUISITION
In March 1998, the Company purchased all of the outstanding capital stock
of 4-Sight Limited, a private limited company organized under the laws of the
United Kingdom ("4-Sight"), for $20 million in cash plus related acquisition
expenses of $500,000 and 2.5 million shares of the Company's common stock valued
at $20 million. In addition, the former shareholders of 4-Sight will be entitled
to receive up to an additional 750,000 shares of the Company's common stock in
the event certain sales objectives are met over the next three years.
The acquisition was accounted for under the purchase method of accounting
and, accordingly, the operating results of 4-Sight have been included in the
consolidated operating results since the date of acquisition.
On acquisition, approximately $31.9 million of goodwill was recorded, which
is being amortized on a straight-line basis over 5 years. The following table
shows the pro forma consolidated results of operations as if 4-Sight had been
acquired as of the beginning of the periods presented:
NINE MONTHS
ENDED
SEPTEMBER 30,
1998
UNAUDITED
-------------
Revenues................................................. $ 16,245,000
Net loss................................................. $(83,256,000)
Net loss per share....................................... $ (9.65)
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition had been in effect for the entire periods
presented. In addition, they are not intended to be a projection of future
results and do not reflect any synergies that might be achieved from combined
operations.
-9-
<PAGE>
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 was organized in September 1994 and commenced operations in
March 1995. From March 1995 through February 1996, the Company was engaged
primarily in the design and development of a network of Company-owned national,
regional and local hubs ("Distribution Hubs") interconnected redundantly with
high-bandwidth leased telephone circuits (the "WAM!NET Network") and a managed,
high-speed digital data delivery network service (the "WAM!NET Service"). The
Company announced the commercial release of the WAM!NET Service in February 1996
at a major trade show for the printing, publishing, advertising, pre-press,
corporate communication and graphic arts industries (collectively, "Graphic
Arts"). Through September 30, 1998, the WAM!NET Service had been installed at
1,205 sites in North America and 6 sites in Europe.
The Company has entered into a strategic alliance with WorldCom, Inc.
("WorldCom") that includes equity and debt investments and operating loan
guarantees which together total to approximately $50.0 million. WorldCom is
currently entitled to designate a majority of the Board of Directors of the
Company and, through its ownership of convertible debt and warrants, has the
right to acquire a majority of the common stock, par value $.01 per share (the
"Common Stock") of the Company. WorldCom also provides telecommunication and
other services to the Company on a nonexclusive basis. The Company anticipates
that its relationship with WorldCom will help enable it to access the worldwide
infrastructure, sales and marketing work force, telephony technologies, high
bandwidth carrier service and other services of WorldCom and its affiliates,
including UUNet Technologies, Inc.
On March 13, 1998, the Company consummated the purchase of 4-Sight Limited,
a private limited company incorporated under the laws of England and Wales
("4-Sight"), for $20 million in cash and 2.5 million shares of Common Stock
(which may be increased to 3.25 million shares subject to the satisfaction of
certain conditions) (the "4-Sight Acquisition"). 4-Sight develops and
distributes ISDN data transmission software and related products and
applications targeted to the Graphic Arts industry, with particular emphasis on
European, Asian and North American markets. At December 31, 1997, 4-Sight's
customer base exceeded 30,000 locations, including 3,000 sites in the United
States. The Company expects that the 4-Sight Acquisition will enable the Company
to achieve both broader market coverage in the Graphic Arts market and higher
network utilization by combining 4-Sight's international presence and
penetration of the lower volume user market with the Company's domestic presence
and penetration of the higher volume user market.
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 for the years ending December 31, 1998 and 1999. The Company has incurred
an accumulated deficit of approximately $125.7 million through September 30,
1998.
REVENUE. The Company's revenue is derived primarily from WAM!NET Service
contracts which are usually 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, generally ranging from $250 per month to $3,000 per month. Service
installation typically lags contract signing by approximately 90 days due to the
time required to obtain telephone service installation from local telephone
companies. The Company begins to earn gross revenue following installation of
service at a customer's premise.
-10-
<PAGE>
The Company also grants service rebates that offset the gross revenue generated
by the Company. Free trial periods under the Company's various promotional
programs have ranged from 60 days to six months. 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 96% 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 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 its
other targeted 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.
Revenue is primarily driven by the number of installed customer locations,
the length of time a customer has been using the service, the number of work
flow partners with whom a customer exchanges data and the size of the files
exchanged.
NETWORK COMMUNICATIONS FEES. Network communications fees include both the
costs of the high bandwidth carrier services interconnecting the Company's
national infrastructure of network operations centers ("NOCs") and distribution
hubs and the costs of local telephone circuits connecting network access devices
("NADs") to the nearest distribution hub. Local telephone circuit ("last mile")
connections account for approximately 70% of these charges, with significant
differences between urban and rural connection costs. National carrier service,
provided primarily by 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 increasing utilization of the
WAM!NET Network. The Company actively seeks to obtain and deploy technologies
that will reduce the costs of last mile connections, including wireless and
satellite technologies and remote dial-up capabilities. The Company also intends
to use its network management tools to optimize existing and planned network
capacity as volume increases and traffic patterns begin to emerge. The Company
believes it may benefit from growing competition among telephony and
communications providers for the provision of last mile connectivity.
NETWORK OPERATIONS EXPENSE. Network operations expense represents costs
directly associated with developing, maintaining, managing and servicing the
WAM!NET Network. Such 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. The Company currently operates 3
Network Operation Centers their locations are in Minneapolis, Las Vegas and
Belgium. These account for the majority of direct labor and network operating
costs and are capable of providing for and managing the Company's current and
planned expansion in North America and Europe. Costs associated with the
development of "WAM!BASE," a remote data archiving, retrieval and distribution
system, and "WAM!PROOF," an application enabling remote proofing, and other
network applications 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.
SALES AND MARKETING EXPENSE. The Company's sales and marketing efforts are
intended to create national and international 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
Graphic Arts and industry, to generate increased traffic among customers and to
market the WAM!NET Service to other targeted industries; however the cost of
Sales and Marketing as a percentage of revenue is expected to decline.
-11-
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSE. The Company's general and
administrative expense includes administrative salaries, related overhead and
professional service fees. These costs reflect both those expenditures related
to the rapid growth and expansion of the Company's administrative infrastructure
both national and international and to manage its expanding operations. 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 as a percentage of revenue is expected to
decline.
DEPRECIATION AND AMORTIZATION. To facilitate entry into its target markets,
the Company furnishes its 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 NADs it furnishes to customers for
their use of the WAM!NET Service. Accordingly, the Company does not anticipate
selling NADs (or other hardware and non-4-Sight software) as a means of raising
revenues. Depreciation and amortization expense includes depreciation of NADs,
distribution hubs and equipment located in the NOCs. The Company's network
infrastructure uses the highest concentration of telephony equipment in the NOC,
smaller concentrations for a distribution hub and the least amount for a NAD.
The Company anticipates substantial capital investments for additional
distribution hubs to be located in North America, Europe and Asia, for WAM!BASE
storage facilities to be located in the existing NOCs, and for NADs to be
located at customer premises. As a result, the Company anticipates that
depreciation and amortization expense will continue to increase in future
periods commensurate with Wam!Net network expansion.
RESULTS OF OPERATIONS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE AND
NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997
REVENUE
Revenues from the WAM!NET Service for the three and nine month periods
ended September 30, 1998 were $2,393,333 and $5,618,591, respectively, an
increase of $1,937,688 or 425.3% and $4,796,039 or 583.1% over the comparable
periods of the previous year. This increase was due to a 276.1% increase in the
number of installed customer sites to the WAM!NET Service, from 322 installed
customer sites on September 30, 1997 to 1,211 installed customer sites on
September 30, 1998. Service rebates arising from promotional programs for the
three and nine month periods ended September 30, 1998 were $610,750 and
$1,363,000, respectively, an increase of $560,500 or 1,115.4% and $1,266,750 or
1,316.1%, respectively, over the comparable periods of the previous year.
Revenues from software and hardware sales for the three and nine month
periods ended September 30, 1998 were $3,738,645 and $8,479,968. Software and
hardware sales are a result of the Company's acquisition of 4-Sight, an
international software manufacturer and distributor, which was consummated as of
March 13, 1998.
OPERATING EXPENSES
Network communications fees for the three and nine month periods ended
September 30, 1998 were $4,602,215 and $11,501,806, respectively, an increase of
$2,263,419 or 96.8% and $7,049,665 or 158.3% over the comparable periods of the
previous year. These increases were primarily due to the growth of the WAM!NET
Network from 322 customers receiving services on September 30, 1997 to 1,211
customers receiving services on September 30, 1998, an increase of 889 customers
or 276.1%. However the average communications costs associated with providing
services to a North American Wam!Net Customer for the three month period ended
September 30, 1997 and September 30, 1998 declined from $2,436 to $1,224, a
decrease of $1,212 or 49.8%. This large decrease is due in part to the
geographic dispersion of new Wam!Net customers in urban rather than rural
-12-
<PAGE>
areas, in part by overall decreases in the costs of telephony being purchased by
Wam!Net and in part by a higher installed base of customers being able to use
the fixed portion of Wam!Net's communications infrastructure more effectively
and efficiently.
Cost of software and hardware sales for the three and nine month periods
ended September 30, 1998 was $1,155,252 and $2,630,672, respectively, an
increase from $0 over the comparable periods of the previous year. Costs of
software and hardware sales are a result of the Company's acquisition of
4-Sight, which was consummated as of March 13, 1998.
Network operations expenses for the three and nine month periods ended
September 30, 1998 were $10,313,125 and $19,662,700, respectively, an increase
of $8,429,767 or 447.6% and $15,620,600 or 386.4% over the comparable periods of
the previous year. These increases were primarily due to the increase in the
size of the WAM!NET Network and the Company's vast efforts to develop and
commercialize international products and the accompanying services by the fourth
quarter of 1998.
Sales and marketing expenses for the three and nine month periods ended
September 30, 1998 were $6,540,475 and $13,462,941, respectively, an increase of
$3,744,792 or 133.9% and $7,391,710 or 121.7% over the comparable periods of the
previous year. These increases primarily resulted from the costs associated with
the Company's efforts to enhance global sales and marketing functions for its
products during 1998.
General and administrative expenses for the three and nine month periods
ended September 30, 1998 were $4,729,703 and $23,927,381, respectively, an
increase of $4,000,227 or 548.4% and $21,135,677 or 757.1% over the comparable
periods of the previous year. These increases are primarily due to a $12,492,000
non-cash charge relating to officer compensation expense. This expense arose
after the Company's board of directors elected an accelerated vesting period for
options granted to selected officers. The additional increases in general and
administrative expenses were 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 and nine month periods ended
September 30, 1998 were $5,327,078 and $11,352,657, respectively, an increase of
$4,577,777 or 610.9% and $9,781,616 or 622.6%, respectively, over the comparable
periods of the previous year. As a percentage of gross WAM!NET Service revenue,
depreciation and amortization was 222.6% and 202.1% for the three and nine month
periods ended September 30, 1998, as compared to 164.4% and 191.0% for the
comparable periods of the previous year. The increase in depreciation and
amortization expense is due to both an increase in WAM!NET Network equipment
that has been installed to service the increasing number of WAM!NET Service
customers, and the impact of the 4-Sight Acquisition which resulted in the
recognition of $32.4 million in goodwill. The 4-Sight goodwill is being
amortized over a 60 month period, resulting in approximately a $1.62 million
charge per fiscal quarter.
Interest expense for the three and nine month periods ended September 30,
1998 was $6,293,209 and $15,787,334, respectively, an increase of $5,045,982 or
404.6% and $12,982,386 or 462.8%, respectively, over the comparable periods of
the previous year. These increases were primarily due to the Company's financing
of its 1997 and 1998 operations through the issuance of various debt
instruments, including approximately $24.0 million of long term subordinated
notes to WorldCom, $22.7 million of equipment financing and $208.5 million of
13 1/4% Senior Discount Notes due 2005 ("Notes") issued in March 1998.
INCOME TAXES
For the three and nine month periods ended September 30, 1998, the Company
experienced net operating losses of $32.3 million and $83.3 million,
respectively, and paid no income taxes. The Company paid no income taxes in
1997. These losses are available to offset future taxable income through the
year 2013 and are subject to the
-13-
<PAGE>
limitations of Section 382 of the internal Revenue Code of 1986, as amended.
These limitations may result in expiration of net operating loss carry forwards
before they can be utilized.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had a total of approximately $173.3
million in long-term debt, of which approximately $1.4 million becomes payable
during 1998.
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 $168.7 million net cash
proceeds from the issuance of long- and short-term debt and collateralized
equipment financing. An additional $2.0 million of net cash proceeds has been
received from the sale of equity securities. The Company has utilized these
proceeds by investing $51.0 million into its global WAM!NET Network and
investing $20.3 million to acquire 4-Sight. Since inception the Company has also
expended $71.3 million to fund its operating activities. To date the Company has
not generated cash 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 long- and
short-term debt and equity instruments. From inception through September 30,
1998, the Company has derived substantially all of its operating capital from
the issuance of short- and long-term debt instruments.
During September of 1997, the Company established a revolving credit
facility with The First Bank of Chicago (the "Revolving Credit Facility"), 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. The Revolving Credit Facility was
established under an agreement with WorldCom, by which WorldCom guaranteed the
Company's obligations under the Revolving Credit Facility. At September 30,
1998, the Company had no borrowings under the Revolving Credit Facility.
Interest and principal on the Revolving Credit Facility become payable in July
1999. Borrowings by the Company under the Revolving Credit Facility require the
prior consent of WorldCom.
In December 1997, the Company acquired the outstanding common stock of
FreeMail, Inc. ("FreeMail"). In connection with the acquisition, the Company
issued 125,000 shares of Common Stock, with a fair value of approximately
$488,000, as consideration. The Company is also obligated to pay the former
shareholders of FreeMail as additional contingent consideration on a quarterly
basis amounts equal to five percent of the gross collected revenue derived by
the Company from certain identified FreeMail products; however, the total
amounts of the quarterly payments shall not exceed $3,012,500. As of September
30, 1998, the Company did not record a liability relating to the FreeMail
revenue since no revenue was collected.
On March 5, 1998, the Company consummated an offering (the "Debt Offering")
of 208,530 units, each consisting of $1,000 principal amount at maturity of
Notes and three warrants. Each warrant initially entitles the holder to purchase
2.01 shares of Common Stock at an exercise price of $.01 per share, subject to
adjustment. The Company received net proceeds from the Debt Offering of
approximately $120.6 million. Cash interest does not accrue nor is payable on
the Notes prior to March 1, 2002. Thereafter, cash interest on the Notes will
accrue at a rate of 13 1/4% per annum (calculated on a semi-annual bond
equivalent basis) and will be payable semi-annually in arrears on March 1 and
September 1 of each year, commencing September 1, 2002. The Company used the
proceeds of the Debt Offering as follows: (i) $20.0 million to pay the cash
portion of the 4-Sight Acquisition, (ii) approximately $25.0 million to repay
the borrowings under the Revolving Credit Facility and (iii) the balance to be
used to further the Company's business development and expansion strategy, to
enhance the WAM!NET Service infrastructure, to develop additional value-added
features and services, to optimize marketing, sales and customer support and
service capabilities, and for working capital and other general corporate
purposes.
-14-
<PAGE>
The Company intends to pursue one or more equity and or debt financings in
1998 and 1999. The Company believes that the net proceeds of the Debt Offering
and such financings together with expected cash from operations will be
sufficient to finance the Company's operations. This includes the purchase and
installation of all necessary WAM!NET Network and WAM!BASE equipment required
for both national and international operations, marketing and sales activities,
continued development of enhancements to the WAM!NET Service and service of its
debt obligations. The Company intends to invest an additional $15.0 million in
its global WAM!NET Network infrastructure by year-end 1998 and an additional
$60.0 million in its global WAM!NET Network infrastructure next year. These
investments are necessitated by the need to grow the global communications
network to provide contracted services to the Company's rapidly expanding
customer base. The Company's inability to secure an additional funding by
mid-1999 would adversely affect its ability to expand the WAM!NET Network during
1999 to meet rapidly growing demand for global network services. If the Company
is unable to obtain additional financing when needed, it may be required to
significantly scale back expansion plans and, depending upon cash flow from its
existing business, reduce the scope of its plans and operations.
In September 1996, the Company issued to WorldCom a $5.0 million
Convertible Subordinated Note due September 30, 1999 (the "WorldCom Convertible
Note"). At any time prior to September 30, 1999, WorldCom may convert the
principal amount of the WorldCom Convertible Note into shares of Common Stock at
a conversion price of $1.00 per share, subject to adjustment in the event of
stock splits, reorganizations or recapitalizations. In addition, in November
1996, the Company and WorldCom entered into a Preferred Stock, Subordinated Note
and Warrant Purchase Agreement (the "WorldCom Agreement"). Pursuant to the
WorldCom Agreement, the Company, among other things, issued to WorldCom warrants
to purchase on or before December 31, 2000 up to 20,787,500 shares of Common
Stock at an initial exercise price of $0.962 per share, subject to adjustment in
the event of stock splits, reorganizations or recapitalizations (the "WorldCom
Warrants"). The exercise price automatically increases by the amount of $0.016
per share on the last day of each calendar quarter, subject to certain abatement
provisions, and is currently $1.05 per share. The outstanding debt owed to
Worldcom can be used to exercise these warants at the then current exercise
price. The WorldCom Agreement provides that if the Company is not publicly held
by the year 2000, the Company's managers and Board of Directors will obtain an
independent valuation by a nationally recognized investment bank of the fair
market value per share of the Company's Common Stock, without any premium
allocated for any controlling interest (the "Tender Valuation"). Upon receipt of
the Tender Valuation, WorldCom may, but is not required to tender (the "First
Tender") to purchase all outstanding shares of Common Stock and all outstanding
options, warrants, convertible securities and other rights to purchase shares of
Common Stock for at least the per share amount of the Tender Valuation. If the
owners of a majority of the then outstanding shares of the Company's Common
Stock (excluding shares held by WorldCom or its affiliates) reject the First
Tender, WorldCom will have 60 days following such rejection to again tender (the
"Second Tender") to purchase the same securities. Subject to certain conditions,
WorldCom will sell and the Company will purchase the WorldCom Warrants, any
shares acquired upon exercise of the WorldCom Warrants and any shares acquired
upon the conversion of the WorldCom Convertible Note (collectively, the
"WorldCom Securities") if (i) WorldCom fails to make the First Tender within 90
days after receipt of the Tender Valuation; (ii) owners of a majority of the
then outstanding shares of Common Stock (excluding shares held by WorldCom or
its affiliates) reject the First Tender and WorldCom makes no Second Tender; or
(iii) owners of a majority of the then outstanding shares of Common Stock
(excluding shares held by WorldCom or its affiliates) reject the Second Tender.
The Company's purchase price for the WorldCom Securities will be as follows: (a)
if WorldCom fails to make the First Tender, an amount equal to the Tender
Valuation (or the spread between the Tender Valuation and the exercise price in
the case of warrants); (b) if the First Tender is rejected by the Company's
shareholders and WorldCom does not make the Second Tender, an amount equal to
the purchase price offered by WorldCom in the First Tender (or the spread
between the offer price and the exercise price in the case of warrants); and (c)
if the Second Tender is rejected by the Company's shareholders, an amount equal
to the purchase price offered by WorldCom in the Second Tender (or the spread
between the offer price and the exercise price in the case of warrants). The
Company will have nine months in which to pay the purchase price for the
WorldCom Securities. If the Company fails to timely pay the purchase price for
the WorldCom Securities, WorldCom will be relieved of all obligations to sell
such securities to the Company, the Company will have no right to cause WorldCom
to sell such securities and the Company will not be obligated to pay the
purchase price for such securities. The parties have agreed to waive their
respective obligations thereunder if the Company determines to become, and
thereafter becomes, a publicly-held company.
-15-
<PAGE>
During 1997 the Company, on a pro forma basis after giving effect to the
4-Sight Acquisition, received less than 5% of its total revenue from sales and
operations in Asian countries. As a result, the Company had limited exposure to
the particular risks attendant to doing business in Asia and did not experience
any material adverse effects from the Asian economic crisis; however, the
Company presently intends to expand its operations in that region. The Company
is currently unable to determine the effect, if any, that recent economic
downturns in Asia, particularly Japan, will have on the Company's future
business, operating results or liquidity, although the Company intends to
exercise prudence and sound business judgment prior to making any future
investments in Asia.
Currently, the Company does not employ currency hedging strategies to
reduce the risks associated with the fluctuation of foreign currency exchange
rates. The Company presently denominates all of its contracts in U.S. dollars.
4-Sight denominates all of its contracts in pounds sterling except for its U.S.
sales, which are denominated in U.S. dollars, or its German sales, which are
denominated in German marks. The Company is unable to determine what effect, if
any, the adoption and use of the euro, the single European currency to be
introduced in January of 1999, will have on the Company's business, operating
results, liquidity and financial condition.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement 130, "Reporting Comprehensive
Income." Statement 130 is effective for financial statements for fiscal years
beginning after December 15, 1997. This standard defines comprehensive income as
the changes in equity of an entity except those resulting from shareholder
transactions. All components of comprehensive income are required to be reported
in a new financial statement. The adoption of Statement 130 did not have a
material effect on the Company's financial statements.
In June 1997, the FASB also issued Statement 131, "Disclosures about
Segments of an Enterprise and Related Information." Statement 131 is effective
for financial statements for periods beginning after December 31, 1997.
Statement 131 establishes standards for disclosures about operating segments,
products and services, geographic areas and major customers. The adoption of
Statement 131 did not have a material effect on the Company's financial
statements.
In October 1997, the AICPA issued Statement of Position 97-2, "Software
Revenue Recognition" ("SOP 97-2"), which superseded Statement of Position 91-1
for periods beginning after December 15, 1997. The adoption of SOP 97-2 did not
have a material effect on the timing of the Company's revenue recognition or
cause changes to its revenue recognition policies.
ITEM 3--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pursuant to the General Instructions to Rule 305 of Regulation S-K, the
quantitative and qualitative disclosures called for by this Item 3 and by Rule
305 of Regulation S-K are inapplicable to the Company at this time.
PART II--OTHER INFORMATION
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders of the Company was held on May 30, 1998.
There were 9,377,112 shares of Common Stock outstanding as of the record date
for the meeting and 7,613,015 shares of Common Stock were represented in person
or by proxy at the meeting. The following matters were voted upon:
-16-
<PAGE>
(a) The five nominees for election to the Board of Directors of the
Company, Edward J. Driscoll, III, Robert L. Hoffman, Charles T.
Cannada, K. William Grothe, Jr. and Curtis G. Gray, were elected. Each
nominee respectively received 7,150,560 votes for, 33,890 votes
against, his election, with 428,565 abstentions.
(b) An amendment to the Company's Articles of Incorporation (i) to increase
the authorized capital to 500,000,000 million shares, consisting of
490,000,000 shares of Common Stock, 100,000 shares of preferred stock,
par value $10.00 per share, and 9,900,000 shares of undesignated stock;
and (ii) to amend the requirement regarding the Board of Directors
determination of the value of non-monetary consideration received for
shares of capital stock of the Company, was approved by a vote of
7,543,015 to 70,000.
(c) An amendment to the Company's 1994 Stock Option Plan to amend the
number of shares which may be issued pursuant to options granted under
such plan to 7,000,000 shares of Common Stock was approved by a vote of
7,557,460 to 55,555.
(d) The Company's 1998 Combined Stock Option Plan, which permits incentive
and non-statutory stock options for eligible employees of the Company
and its subsidiaries, including employees in the United Kingdom and
potentially other foreign national employees, was approved by a vote of
7,543,015 to 70,000.
ITEM 5--OTHER INFORMATION
On July 30, 1998, the Company commenced an offer to exchange (the "Exchange
Offer") up to $208,530,000 in aggregate principal amount at maturity of its 13
1/4% Senior Discount Notes due 2005, Series B (the "Exchange Notes") for up to
$208,530,000 in aggregate principal amount at maturity of its 13 1/4% Senior
Discount Notes due 2005, Series A (the "Original Notes" and, together with the
Exchange Notes, the "Notes"), that were issued and sold on March 5, 1998 in
reliance on exemptions from registration under the Securities Act of 1933, as
amended. The terms of the Exchange Notes will be substantially similar
(including principal amount, interest rate, maturity and ranking) to the terms
of the Original Notes for which they may be exchanged pursuant to the Exchange
Offer, except that the Exchange Notes (i) are freely transferable by holders
thereof (except in certain limited cases as described in the registration
statement relating to the Exchange Notes) and will be issued without any
covenant regarding their registration. The Exchange Offer will expire at 5:00
p.m., New York City time, on August 28, 1998, unless extended.
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
3.1 Amended and Restated Articles of Incorporation of the
Company.**
10.19 Amended and Restated 1994 Stock Option Plan.*
10.20 1998 Combined Stock Option Plan.**
----------
* Incorporated herein by reference to the identically numbered
exhibit to the Company's Registration Statement on Form S-4,
Registration No. 333-53841, as filed with the Securities and
Exchange Commission on May 28, 1998.
** Incorporated herein by reference to the identically numbered
exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-4, Registration No. 333-53841, as filed with
the Securities and Exchange Commission on July 10, 1998.
-17-
<PAGE>
b. Current Reports on Form 8-K:
The Corporation did not file any reports on Form 8-K during the three
months ended September 30, 1998.
-18-
<PAGE>
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: November 12, 1998
By: /s/ Bradley E. Sparks
-------------------------------------
Bradley E. Sparks
Executive Vice-President and Chief
Financial Officer
-19-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 17,626
<SECURITIES> 0
<RECEIVABLES> 9,041
<ALLOWANCES> 200
<INVENTORY> 1,287
<CURRENT-ASSETS> 27,043
<PP&E> 63,203
<DEPRECIATION> 11,883
<TOTAL-ASSETS> 110,659
<CURRENT-LIABILITIES> 22,127
<BONDS> 158,524
1,000
0
<COMMON> 93
<OTHER-SE> (71,085)
<TOTAL-LIABILITY-AND-EQUITY> 110,659
<SALES> 3,739
<TOTAL-REVENUES> 5,530
<CGS> 1,155
<TOTAL-COSTS> 5,757
<OTHER-EXPENSES> 26,912
<LOSS-PROVISION> 200
<INTEREST-EXPENSE> 6,293
<INCOME-PRETAX> (31,550)
<INCOME-TAX> (709)
<INCOME-CONTINUING> (31,550)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (32,277)
<EPS-PRIMARY> (3.74)
<EPS-DILUTED> (3.74)
</TABLE>
