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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
Form 10-Q
(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarter Ended June 30, 2000
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number: 000-26873
----------------
DIGEX, INCORPORATED
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 59-3582217
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
One Digex Plaza
Beltsville, MD 20705
(Address of principal executive offices)
(240) 264-2000
Telephone Number
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [_]
As of July 31, 2000, there were 24,175,000 and 39,350,000 shares of the
Registrant's Class A and Class B Common Stock outstanding, respectively.
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<PAGE>
DIGEX, INCORPORATED
INDEX
<TABLE>
<CAPTION>
Page
No.
----
PART I. FINANCIAL INFORMATION
<C> <S> <C>
ITEM 1. Financial Statements (Unaudited):
Condensed Statements of Operations--Three and six months ended
June 30, 2000 and 1999......................................... 3
Condensed Balance Sheets--June 30, 2000 and December 31, 1999.. 4
Condensed Statements of Cash Flows--Six months ended June 30,
2000 and 1999.................................................. 5
Notes to Condensed Financial Statements........................ 6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 9
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk..... 17
<CAPTION>
PART II. OTHER INFORMATION
<C> <S> <C>
ITEM 1. Legal Proceedings.............................................. 18
ITEM 2. Changes in Securities and Use of Proceeds...................... 18
ITEM 3. Defaults Upon Senior Securities................................ 18
ITEM 4. Submission of Matters to a Vote of Security Holders............ 18
ITEM 5. Other Information.............................................. 19
ITEM 6. Exhibits and Reports on Form 8-K............................... 19
SIGNATURES.............................................................. 20
</TABLE>
2
<PAGE>
PART 1: FINANCIAL INFORMATION
Item 1. Financial Statements
DIGEX, INCORPORATED
CONDENSED STATEMENTS OF OPERATIONS
Unaudited (Amounts in thousands, except share and per share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues.................. $ 42,222 $ 12,629 $ 70,196 $ 22,021
Costs and expenses:
Cost of operations...... 9,098 2,694 13,038 4,346
Cost of services........ 16,828 3,478 28,224 7,430
Selling, general and
administrative......... 35,216 18,658 62,992 26,727
Deferred compensation... 996 -- 1,990 --
Depreciation and
amortization........... 17,981 5,652 30,552 9,966
----------- ----------- ----------- -----------
Total costs and expenses.. 80,119 30,482 136,796 48,469
----------- ----------- ----------- -----------
Loss from operations...... (37,897) (17,853) (66,600) (26,448)
Other income (expense):
Interest expense........ (429) (239) (872) (239)
Interest and other
income................. 3,901 -- 7,401 --
----------- ----------- ----------- -----------
Net loss before income tax
benefit.................. (34,425) (18,092) (60,071) (26,687)
Income tax benefit........ -- 4,839 -- 4,839
----------- ----------- ----------- -----------
Net loss.................. $ (34,425) $ (13,253) $ (60,071) $ (21,848)
=========== =========== =========== ===========
Net loss per common
share--basic and
diluted.................. $ (0.54) $ (0.27) $ (0.95) $ (0.44)
=========== =========== =========== ===========
Shares used in computing
basic and diluted net
loss per share........... 63,503,516 50,000,000 63,062,198 50,000,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
3
<PAGE>
DIGEX, INCORPORATED
CONDENSED BALANCE SHEETS
(Amounts in thousands, except share information)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 206,112 $ 88,778
Accounts receivable, net of allowance of $3,780 and
$4,362 in 2000 and 1999, respectively............. 31,602 17,271
Due from Intermedia................................ 84 3,110
Prepaid expenses and other current assets.......... 5,363 1,496
----------- ----------
Total current assets............................. 243,161 110,655
----------- ----------
Property and equipment, net.......................... 275,562 205,903
Intangible assets, net............................... 25,217 27,213
Other assets......................................... 855 538
----------- ----------
Total assets..................................... $ 544,795 $ 344,309
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.............. $ 33,430 $ 33,619
Deferred revenue................................... -- 222
Current portion of note payable.................... 2,675 1,235
Current portion of capital lease obligations....... 1,134 801
----------- ----------
Total current liabilities........................ 37,239 35,877
Note payable......................................... 1,376 2,477
Capital lease obligations............................ 15,174 15,766
----------- ----------
Total liabilities................................ 53,789 54,120
----------- ----------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized; 100,000 designated as Series A
Convertible; 100,000 shares issued and outstanding
in 2000........................................... 1 --
Class A common stock, $.01 par value; 100,000,000
shares authorized; 24,175,000 and 11,500,000
shares issued and outstanding in 2000 and 1999,
respectively...................................... 242 115
Class B common stock, $.01 par value; 50,000,000
shares authorized; 39,350,000 and 50,000,000
shares issued and outstanding in 2000 and 1999,
respectively...................................... 393 500
Additional paid-in capital......................... 616,775 354,553
Accumulated deficit................................ (112,839) (52,768)
Deferred compensation.............................. (13,566) (12,211)
----------- ----------
Total stockholders' equity....................... 491,006 290,189
----------- ----------
Total liabilities and stockholders' equity....... $ 544,795 $ 344,309
=========== ==========
</TABLE>
See accompanying notes to condensed financial statements.
4
<PAGE>
DIGEX, INCORPORATED
CONDENSED STATEMENTS OF CASH FLOWS
Unaudited (Amounts in thousands)
<TABLE>
<CAPTION>
Six months ended
June 30,
----------------------
2000 1999
---------- ----------
<S> <C> <C>
Operating activities:
Net loss............................................. $ (60,071) $ (21,848)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization...................... 30,552 9,966
Provision for doubtful accounts.................... 2,953 2,045
Amortization of deferred compensation.............. 2,026 --
Loss on sale/disposals of telecommunications
equipment......................................... 313 --
Deferred income taxes.............................. -- (4,839)
Accretion of interest on note payable and capital
lease obligations................................. 312 --
Changes in operating assets and liabilities:
Accounts receivable................................ (17,284) (6,612)
Prepaid expenses and other current assets.......... (3,867) (1,989)
Other assets....................................... (317) (17)
Accounts payable, accrued expenses and other
liabilities....................................... (28) 4,601
Due from Intermedia................................ 3,026 8,749
Deferred revenue................................... (222) --
---------- ----------
Net cash used in operating activities................ (42,607) (9,944)
Investing activities:
Purchases of property and equipment.................. (97,078) (77,332)
---------- ----------
Net cash used in investing activities................ (97,078) (77,332)
Financing activities:
Principal payments on long-term note payable and
capital leases...................................... (397) (96)
Proceeds from subsequent public offering, net of
issuance costs...................................... 171,641 --
Proceeds from issuance of preferred stock............ 85,000 --
Proceeds from exercise of common stock options....... 775 --
Net contributions from Intermedia.................... -- 87,372
---------- ----------
Net cash provided by financing activities............ 257,019 87,276
Net increase in cash and cash equivalents............ 117,334 --
Cash and cash equivalents at beginning of the
period.............................................. 88,778 --
---------- ----------
Cash and cash equivalents at end of period........... $ 206,112 $ --
========== ==========
Supplemental disclosure of cash flow information:
Interest Paid........................................ $ 872 $ 155
Assets purchased under capital lease obligations..... -- 17,032
</TABLE>
See accompanying notes to condensed financial statements.
5
<PAGE>
DIGEX, INCORPORATED
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Digex, Incorporated ("Digex") was incorporated on April 26, 1999, under the
laws of the State of Delaware. Digex's business was operated as the Web site
hosting unit of Intermedia Communications Inc. ("Intermedia") since its
acquisition by Intermedia on July 7, 1997. On that date, Intermedia acquired
Business Internet, Inc. (previously known as DIGEX, Incorporated), including
the Web site hosting unit (the "Predecessor"), in a business combination
accounted for as a purchase. The Web site hosting unit presented in the
accompanying financial statements had no legal status or existence prior to the
incorporation of Digex on April 26, 1999. Prior to April 30, 1999, the
Registrant had no assets or liabilities.
Digex's operations began in January 1996 to provide managed Web hosting
services, principally to Fortune 2000 companies. Digex's services include
implementing and maintaining secure, scalable, high-performance Web sites on
the Internet 24 hours a day. In addition, Digex provides a comprehensive suite
of Web management services, including business process solutions and value-
added testing services directed toward improving its customers' overall
Internet performance.
2. Basis of Presentation
The accompanying condensed interim financial statements have been prepared
by Digex, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (the "Commission"). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles ("GAAP") have been
omitted pursuant to such rules and regulations. The unaudited condensed interim
financial statements should be read in conjunction with the financial
statements, notes thereto and other information included in the Form 10-K of
Digex for the year ended December 31, 1999.
The accompanying unaudited condensed interim financial statements reflect,
in the opinion of management, all adjustments, which are of a normal and
recurring nature, necessary for a fair presentation of the financial condition
and results of operations and cash flows for the periods presented. The
preparation of financial statements in accordance with GAAP requires management
to make estimates and assumptions. Such estimates and assumptions affect the
reported amounts of assets and liabilities, as well as the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates. The results of operations for
the interim periods are not necessarily indicative of the results for the
entire year.
The financial statements for periods prior to April 30, 1999 represent the
carved-out operations of the managed Web site and application hosting unit of
Intermedia. Digex's accumulated deficit of $112.8 million arose after April 30,
1999. Accumulated losses and capital contributions from Intermedia were
included in owner's net investment prior to April 30, 1999 and were transferred
to additional paid-in capital upon the capitalization of Digex. Intermedia
contributed approximately $115.1 million in assets and certain liabilities on
April 30, 1999. Intermedia also contributed additional capital of $48.1 million
to Digex beginning May 1 through August 4, 1999, principally by way of
contributions of telecommunications assets. These contributions were accounted
for at Intermedia's underlying book values on the date of contribution.
6
<PAGE>
DIGEX, INCORPORATED
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
3. Stockholders' Equity
On January 12, 2000, Digex sold 100,000 shares of its preferred stock,
designated as Series A Convertible Preferred Stock (the "Preferred Stock"),
with detachable warrants to purchase 1,065,000 shares of its Class A Common
Stock (the "Warrants"), for an aggregate of $100.0 million, of which $15.0
million was in the form of equipment purchase credits. Approximately $1.5
million was used for equipment purchases in the second quarter of 2000. The
remaining credit of $13.5 million is netted against equity as of June 30, 2000.
The Preferred Stock has an aggregate liquidation preference of $100.0 million,
and is convertible into approximately 1,462,000 shares of Class A Common Stock.
The Warrants can be exercised at any time over their three-year term at a price
of $57.00 per share (the fair value of Digex's Class A Common Stock on the
transaction commitment date). The proceeds from the offering were allocated
between the Preferred Stock and the Warrants based upon their relative fair
values.
On February 16, 2000, Digex completed a public offering of 12,650,000 shares
of Class A Common Stock. Digex sold 2,000,000 shares of Class A Common Stock
and received net proceeds of approximately $171.6 million. Intermedia sold
10,650,000 shares of Class B Common Stock. The Class B Common Stock sold by
Intermedia automatically converted into Class A Common Stock at the closing of
the offering. Each share of Class B Common Stock is entitled to 10 votes while
each share of Class A Common Stock is entitled to one vote. As a result, while
Intermedia owns approximately 62.0% of Digex's equity interests, it controls
approximately 94.2% of Digex's voting interest.
4. Deferred Compensation
Since July 29, 1999, Digex granted options to purchase 1,442,500 shares of
Class A Common Stock under the Digex Long-Term Incentive Plan to certain
employees of Digex at exercise prices below market value. During the six months
ended June 30, 2000, Digex also recorded $3.4 million of deferred compensation,
a separate component of stockholders' equity, to be expensed over the four-year
vesting period of the options. Deferred compensation expense of approximately
$1.0 million and $2.0 million was expensed during the three and six month
periods ended June 30, 2000, respectively.
5. Loss Per Share
The following table presents the computation of basic and diluted loss per
share of common stock:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss, as reported... $ (34,425) $ (13,253) $ (60,071) $ (21,848)
============ ============ ============ ============
Weighted average number
of common shares....... 63,503,516 50,000,000 63,062,198 50,000,000
============ ============ ============ ============
Loss per share:
Basic................. $ (0.54) $ (0.27) $ (0.95) $ (0.44)
============ ============ ============ ============
Diluted............... $ (0.54) $ (0.27) $ (0.95) $ (0.44)
============ ============ ============ ============
</TABLE>
Convertible securities were excluded in the computation of diluted loss per
share because assumed exercise or conversion would be anti-dilutive.
7
<PAGE>
DIGEX, INCORPORATED
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. Related Party Agreements
On April 30, 1999, Digex entered into a General and Administrative Services
Agreement (the "G&A Agreement") with Intermedia. Under the terms of the G&A
Agreement, as amended to date, Intermedia provides Digex with back office and
administrative services such as human resources, finance and accounting, tax
services, investor relations, and information management services. The initial
term of the agreement is two years, and the charge for these services was $4.0
million and $10.0 million for the three and six months ended June 30, 2000,
respectively.
Digex also entered into three two-year Network Services Agreements with
Intermedia. Under the terms of these agreements, Intermedia provides Digex with
east and west coast Internet transit, Internet access and managed firewall
services. The charges for these services amounted to $1.7 million and $3.6
million for the three and six months ended June 30, 2000, respectively.
On June 1, 2000, Digex entered into an Asset Migration Agreement with
Intermedia. Under the terms of the agreement, Digex purchased certain assets,
including certain licensed third-party software, machinery, and equipment from
Intermedia at cost to provide independent managed firewall services. Digex paid
a purchase price of $4.5 million for net book value of these assets and
services on June 30, 2000, the closing date of the agreement. Under the Asset
Migration Agreement, Digex will also be making equal monthly installments
amounting to a total of $0.9 million for Intermedia's support and consultation
for the six month period ending on December 31, 2000. In connection with the
purchase of firewall-related assets from Intermedia, the Managed Firewall
Services Agreement between Digex and Intermedia was terminated.
Digex entered into three agreements with Intermedia to sell to Intermedia
certain telecommunications related assets that are purchased by Digex with the
net proceeds of certain offerings of Digex securities. The assets are sold to
Intermedia at Digex's cost. The proceeds from the sale of telecommunications
related assets to Intermedia were approximately $8.5 million and $35.7 million
during the three and six months ended June 30, 2000, respectively. These
proceeds were unrestricted and were used to fund Digex's operating expenses.
7. Subsequent Events
On July 11, 2000, Intermedia announced that it is exploring strategic
alternatives with regard to Digex, including, without limitation, the possible
sale of its ownership position in Digex.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the condensed
financial statements and related notes herein, and with the Management's
Discussion and Analysis of Financial Condition and Results of Operations and
audited financial statements and related notes included in Digex's Form 10-K,
as filed with the Commission on March 10, 2000.
Overview
We are a leading provider of managed Web hosting services to businesses
operating mission-critical, multi-functional Web sites. In addition, we provide
Web hosting services to the rapidly growing number of application service
providers enabling them to more efficiently deliver their application services
to their customers over the Internet. We provide the computer hardware,
software, network technology, and systems management necessary to provide our
customers comprehensive, managed Web site hosting and application hosting
solutions. We also offer related value-added services such as firewall
management, stress testing and consulting services, including capacity and
migration planning and database optimization. We currently provide such
services to a diversified customer base consisting of over 670 customers. As of
June 30, 2000, we managed 3,647 Windows NT and UNIX-based servers in our state-
of-the-art data centers which are strategically positioned on the east and west
coasts of the United States and in Europe.We believe our singular focus on
delivering mission-critical Web site and application hosting solutions has been
the major contributor to our growth.
In May 2000, we created European operating entities to support our
international operations and opened our first data center outside of the United
States in Europe. Located in London, our European SmartCenterSM gives Digex
customers in Europe the superior level of technology, security, and support
services in Europe they have come to rely on in the United States. The data
center is a leased facility which became operational in July 2000.
We are among the first Web hosting providers to achieve the Statements of
Auditing Standards No. 70 (SAS 70) Type I certification, which focused on our
systems for providing the most reliable and secure environment for conducting
on line transactions to its customers.
On June 1, 2000, we entered into an Asset Migration Agreement with
Intermedia. Under the terms of the agreement, we purchased certain assets,
including certain licensed third-party software, machinery, and equipment from
Intermedia at cost to provide independent managed firewall services. We paid a
purchase price of $4.5 million for net book value of these assets and services
on June 30, 2000, the closing date of the agreement. Under the Asset Migration
Agreement, we will also be making equal monthly installments amounting to a
total of $0.9 million for Intermedia's support and consultation for the six
month period ending on December 31, 2000. In connection with the purchase of
firewall-related assets from Intermedia, the Managed Firewall Services
Agreement between Digex and Intermedia was terminated.
On June 29, 2000, we entered into a ten-year lease commencing in September
2000 for our new corporate headquarters facility in Laurel, Maryland. The lease
agreement requires an initial security deposit of $2.0 million in the form of a
letter of credit. This letter of credit may be reduced at the commencement of
the seventh lease year to an amount equal to the then current one month's base
rent if certain conditions are met annually prior to the seventh year of the
lease.
Revenue. Our revenues consist primarily of monthly fees from our managed Web
site and application hosting services. Contracts for these services are
typically between one and three years in length. In addition to Web site and
application hosting, we also offer enterprise services and consulting services
and believe that we will begin to derive increasing amounts of revenues from
the sale of these services in the future.
9
<PAGE>
Costs and Expenses. Costs and expenses include:
. cost of operations;
. cost of services;
. selling, general and administrative expenses;
. deferred compensation; and
. depreciation and amortization expense.
Cost of operations consist primarily of the costs for our network
connectivity and firewall services. We expect our network connectivity
requirements to grow in conjunction with the growth of our overall business and
accordingly expect these costs to increase in the future. Expenses directly
attributed to the sale of third party equipment is also included.
Cost of services consist primarily of facilities administration expenses
including rent, maintenance and utilities to support our data centers and
salaries and related benefits for our technical operations. We expect our cost
of services to increase in dollar amount but to decline as a percentage of
revenue due to economies of scale and expected improvements in technology and
productivity.
Selling, general and administrative expenses consist primarily of salaries
and benefits for our marketing, sales and support personnel, advertising costs,
consultants' fees, provision for doubtful accounts and other miscellaneous
expenses. We expect selling, general and administrative expenses to increase in
dollar amount and to decline as a percentage of revenue over time.
Deferred compensation expense is recorded to amortize the resulting deferred
compensation cost over the four-year vesting period of the options. Stock
options were granted by Digex to certain employees at exercise prices below
market value.
Depreciation and amortization expense consists primarily of depreciation of
our data centers, servers and related equipment and amortization of our
intangible assets. We expect these expenses to increase due to our plans to
invest significant capital to continue to expand our data center capacity.
Plan of Operation
We plan to expand our Web site and application hosting business by focusing
on large companies which are looking to develop a presence on the Internet by
both providing e-commerce business solutions to their customers and outsourcing
the management of their Web sites and web-enabled business applications. In the
fourth quarter of 1999, we opened our state-of-the-art data centers on the east
and west coasts of the United States. We anticipate that these data centers,
when operating at full capacity, will support servers generating in excess of
$800.0 million in annualized revenue. We believe that the new data centers in
the United States and Europe will place us in a stronger competitive position
to successfully provide outsourced solutions of scalable Web site and
application hosting solutions. We also offer value-added services, such as
firewall management, stress testing, and consulting services, including
capacity and migration planning and database optimization, and believe that we
will derive increasing amounts of revenue from these services in the future.
10
<PAGE>
Results of Operations
The following table presents certain information derived from our Unaudited
Condensed Statements of Operations for the three and six months ended June 30,
2000 and 1999, expressed as a percentage of revenue.
<TABLE>
<CAPTION>
Six months
Three months ended ended
June 30, June 30,
------------------- -------------
2000 1999 2000 1999
--------- --------- ----- ------
<S> <C> <C> <C> <C>
Revenues.................................... 100.0% 100.0% 100.0% 100.0%
Costs and expenses:
Cost of operations........................ 21.5 21.3 18.6 19.7
Cost of services.......................... 39.9 27.5 40.2 33.7
Selling, general and administrative....... 83.4 147.8 89.7 121.4
Deferred compensation..................... 2.4 -- 2.8 --
Depreciation and amortization............. 42.6 44.8 43.5 45.3
-------- --------- ----- ------
Total costs and expenses.................... 189.8 241.4 194.9 220.1
-------- --------- ----- ------
Loss from operations........................ (89.8) (141.4) (94.9) (120.1)
Other income (expense):
Interest expense.......................... (1.0) (1.9) (1.2) (1.1)
Interest and other income................. 9.2 -- 10.5 --
-------- --------- ----- ------
Net loss before income tax benefit.......... (81.6) (143.3) (85.6) (121.2)
Income tax benefit.......................... -- 38.4 -- 22.0
-------- --------- ----- ------
Net loss.................................... (81.6) (104.9) (85.6) (99.2)
======== ========= ===== ======
</TABLE>
Three Months ended June 30, 2000 Compared to Three Months ended June 30, 1999
Revenue
Total revenue increased 234.3% to $42.2 million for the second quarter of
2000 compared to $12.6 million for the same period in 1999. The increase in
revenue was due to new customer growth, a significant increase in the number of
managed servers per customer, and a rise of monthly revenue per server. Our
installed base of servers increased 139.2% to 3,647 at the end of the second
quarter of 2000 from 1,525 at the end of the second quarter of 1999. In
addition to revenue from managed Web site and application hosting services,
Digex recognized $5.0 million of third party equipment sales revenue in the
second quarter of 2000.
Cost of Operations
Cost of operations increased 237.7% to $9.1 million for the second quarter
of 2000 compared to $2.7 million for the same period in 1999. The increase was
due to additional network costs resulting from our expanded customer base and
increase in service offerings. As a percentage of revenue excluding equipment
sales, cost of operations excluding equipment cost decreased to 14.1% for the
second quarter of 2000 compared to 21.3% for the same period in 1999 due to the
net effect of improved network utilization associated with the revenue
improvement. Expenses directly attributed to the sale of third party equipment
is included in the cost of operations.
Cost of Services
Cost of services increased 383.8% to $16.8 million for the second quarter of
2000 compared to $3.5 million for the same period in 1999. The increase was
primarily related to the increased level of operations and the expansion of our
new data centers including costs related to the hiring of additional
consultants and personnel in customer service, engineering, and facilities
administration supporting server growth. As a percentage of revenue, total cost
of services increased to 39.9% for the second quarter of 2000 compared to 27.5%
for the same period in 1999.
11
<PAGE>
Selling, General and Administrative
Selling, general and administrative expenses increased 88.7% to $35.2
million for the second quarter of 2000 compared to $18.7 million for the same
period in 1999. Through 2000, as part of our growth strategy, we continue to
build up our infrastructure and administrative requirements to operate as a
separate public company. Increases in selling, general and administrative
expenses for 2000 include the costs associated with an increased employee base,
advertising campaigns, back office support (including the G&A Agreement, as
amended, with Intermedia), an increased provision for doubtful accounts
receivable and the addition of key executive management to support the growth
of the business. We expect that our growth strategy will continue to require
significant sales and marketing activities, including an expansion of our sales
force and further development of brand name recognition. In addition, we will
continue to build our personnel base to support our growth strategy in the
managed Web site and application hosting industry. As a result, we believe that
our selling, general and administrative expenses will continue to increase in
the future. As a percentage of revenue, total selling, general and
administrative expenses decreased to 83.4% for the second quarter of 2000
compared to 147.8% for the same period in 1999 due primarily to the significant
revenue growth which decreases the expense as a percentage of revenue.
Deferred Compensation
Deferred compensation expense of approximately $1.0 million for the second
quarter of 2000 resulted from stock options granted to certain employees at
exercise prices below market value since July 29, 1999. We recorded
approximately $13.5 million of deferred compensation in 1999 and $0.8 million
in the second quarter of 2000 to be expensed over a four-year vesting period of
the options.
Depreciation and Amortization
Depreciation and amortization expenses increased 218.1% to $18.0 million for
the second quarter of 2000 compared to $5.7 million for the same period in
1999. The increase was principally due to additional servers and other
facilities and equipment placed in service since June 30, 1999. We have
electronics, computer hardware, and computer software with useful lives ranging
from three years to five years. As a percentage of revenue, depreciation and
amortization expenses decreased to 42.6% for the second quarter of 2000
compared to 44.8% for the same period in 1999 due primarily to the significant
revenue growth which decreases the expense as a percentage of revenue. We
expect increases in depreciation charges though 2000 due to the continued
expansion of our new data centers and due to future increased server
installations.
Interest Expense
Interest expense increased 79.5% to $0.4 million for the second quarter of
2000 compared to $0.2 million for the same period in 1999. The increase
resulted from the capital leases assigned to us by Intermedia during the second
quarter of 1999. Additionally, a note payable was issued by us to a third party
during the third quarter of 1999. As a percentage of revenue, interest expense
decreased to 1% for the second quarter of 2000 compared to 1.9% for the same
period in 1999 due primarily to the significant revenue growth which decreases
the expense as a percentage of revenue.
Interest and Other Income
Interest and other income of $3.9 million for the three months ended June
30, 2000 resulted principally from interest earned on the cash proceeds from
the investment in Digex by Microsoft and a subsidiary of Compaq, and an initial
and subsequent public equity offering.
12
<PAGE>
EBITDA
EBITDA, as defined below, decreased 55.1% to $(18.9) million in the second
quarter of 2000 compared to $(12.2) million for the same period in 1999. The
change is primarily attributable to costs associated with our growth strategy.
Costs associated with the administration and maintenance of our expanded data
centers and increased selling, general and administrative costs will continue
to represent a large portion of expenses during our planned expansion. In
addition, we expect to continue to experience rapid growth in marketing and
selling expenses as new customers are acquired.
EBITDA consists of earnings (loss) before interest expense, interest and
other income, income tax benefit, deferred compensation, and depreciation and
amortization. EBITDA does not represent funds available for management's
discretionary use and is not intended to represent cash flow from operations.
EBITDA should also not be construed as a substitute for operating income or a
better measure of liquidity than cash flow from operating activities, which are
determined in accordance with generally accepted accounting principles. This
caption excludes components that are significant in understanding and assessing
our results of operations and cash flows. In addition, EBITDA is not a term
defined by generally accepted accounting principles and as a result our measure
of EBITDA might not be comparable to similarly titled measures used by other
companies. However, we believe that EBITDA is relevant and useful information
which is often reported and widely used by analysts, investors and other
interested parties in the Web site and application hosting industry.
Accordingly, we are disclosing this information to permit a more comprehensive
analysis of our operating performance, as an additional meaningful measure of
performance and liquidity, and to provide additional information with respect
to our ability to meet future debt service, capital expenditure and working
capital requirements. See the unaudited condensed financial statements and
notes thereto contained elsewhere in this report for more detailed information.
Six Months ended June 30, 2000 Compared to Six Months ended June 30, 1999
Revenue
Total revenue increased 218.8% to $70.2 million for the six months ended
June 30, 2000 compared to $22.0 million for the same period in 1999. The
increase in revenue was due to new customer growth, a significant increase in
the number of managed servers per customer, and a rise of monthly revenue per
server. Our installed base of servers increased 139.2% to 3,647 at the end of
the six months ended June 30, 2000 from 1,525 at the end of the six months
ended June 30, 1999. In addition to revenue from managed Web site and
application hosting services, Digex recognized $5.0 million of third party
equipment sales revenue in the second quarter of 2000.
Cost of Operations
Cost of operations increased 200.0% to $13.0 million for the six months
ended June 30, 2000 compared to $4.3 million for the same period in 1999. The
increase was due to additional network costs resulting from our expanded
customer base and increase in service offerings. As a percentage of revenue
excluding equipment sales, cost of operations excluding the cost of third party
equipment decreased to 13.1% for the six months ended June 30, 2000 compared to
19.7% for the same period in 1999 due to the net effect of improved network
utilization associated with the revenue improvement. Expenses directly
attributed to the sale of third party equipment is included in the cost of
operations.
Cost of Services
Cost of services increased 279.9% to $28.2 million for the six months ended
June 30, 2000 compared to $7.4 million for the same period in 1999. The
increase was primarily related to the increased level of operations and the
expansion of our new data centers including costs related to the hiring of
additional personnel in customer service, engineering, and facilities
administration supporting server growth. As a percentage of revenue, total cost
of services increased to 40.2% for the six months ended June 30, 2000 compared
to 33.7% for the same period in 1999.
13
<PAGE>
Selling, General and Administrative
Selling, general and administrative expenses increased 135.7% to $63.0
million for the six months ended June 30, 2000 compared to $26.7 million for
the same period in 1999. Through 2000, as part of our growth strategy, we
continue to build up our infrastructure and administrative requirements to
operate as a separate public company. Increases in selling, general and
administrative expenses for 2000 include the costs associated with an increased
employee base, advertising campaigns, back office support (including the G&A
Agreement, as amended, with Intermedia), an increased provision for doubtful
accounts receivable and the addition of key executive management to support the
growth of the business. We expect that our growth strategy will continue to
require significant sales and marketing activities, including an expansion of
our sales force and further development of brand name recognition. In addition,
we will continue to build our personnel base to support our growth strategy in
the managed Web site and application hosting industry. As a result, we believe
that our selling, general and administrative expenses will continue to increase
in the future. As a percentage of revenue, total selling, general and
administrative expenses decreased to 89.7% for the six months ended June 30,
2000 compared to 121.4% for the same period in 1999 due primarily to the
significant revenue growth which decreases the expense as a percentage of
revenue.
Deferred Compensation
Deferred compensation expense of approximately $2.0 million for the six
months ended June 30, 2000 resulted from stock options granted to certain
employees at exercise prices below market value since July 29, 1999. We
recorded approximately $13.5 million of deferred compensation in 1999 and $2.1
million in the six months ended June 30, 2000 to be expensed over a four-year
vesting period of the options.
Depreciation and Amortization
Depreciation and amortization expenses increased 206.6% to $30.6 million for
the six months ended June 30, 2000 compared to $10.0 million for the same
period in 1999. The increase was principally due to additional servers and
other facilities and equipment placed in service since June 30, 1999. We have
electronics, computer hardware, and computer software with useful lives ranging
from three years to five years. As a percentage of revenue, depreciation and
amortization expenses decreased to 43.5% for the six months ended June 30, 2000
compared to 45.3% for the same period in 1999 due primarily to the significant
revenue growth which decreases the expense as a percentage of revenue. We
expect increases in depreciation charges though 2000 due to the continued
expansion of our new data centers and due to future increased server
installations.
Interest Expense
Interest expense increased 264.9% to $0.9 million for the six months ended
June 30, 2000 compared to $0.2 million for the same period in 1999. As a
percentage of revenue, interest expense increased to 1.2% for the six months
ended June 30, 2000 compared to 1.1% for the same period in 1999. The increase
resulted from the capital leases assigned to us by Intermedia during the second
quarter of 1999. Additionally, a note payable was issued by us to a third party
during the third quarter of 1999.
Interest and Other Income
Interest and other income of $7.4 million for the six months ended June 30,
2000 resulted principally from interest earned on the cash proceeds from the
investment in Digex by Microsoft and a subsidiary of Compaq, and an initial and
subsequent public equity offering.
14
<PAGE>
EBITDA
EBITDA, as defined below, decreased 106.6% to $(34.1) million in the six
months ended June 30, 2000 compared to $(16.5) million for the same period in
1999. The change is primarily attributable to costs associated with our growth
strategy. Costs associated with the administration and maintenance of our
expanded data centers and increased selling, general and administrative costs
will continue to represent a large portion of expenses during our planned
expansion. In addition, we expect to continue to experience rapid growth in
marketing and selling expenses as new customers are acquired.
EBITDA consists of earnings (loss) before interest expense, interest and
other income, income tax benefit, deferred compensation, and depreciation and
amortization. EBITDA does not represent funds available for management's
discretionary use and is not intended to represent cash flow from operations.
EBITDA should also not be construed as a substitute for operating income or a
better measure of liquidity than cash flow from operating activities, which are
determined in accordance with generally accepted accounting principles. This
caption excludes components that are significant in understanding and assessing
our results of operations and cash flows. In addition, EBITDA is not a term
defined by generally accepted accounting principles and as a result our measure
of EBITDA might not be comparable to similarly titled measures used by other
companies. However, we believe that EBITDA is relevant and useful information
which is often reported and widely used by analysts, investors and other
interested parties in the Web site and application hosting industry.
Accordingly, we are disclosing this information to permit a more comprehensive
analysis of our operating performance, as an additional meaningful measure of
performance and liquidity, and to provide additional information with respect
to our ability to meet future debt service, capital expenditure and working
capital requirements. See the unaudited condensed financial statements and
notes thereto contained elsewhere in this report for more detailed information.
Liquidity and Capital Resources
Net cash used in operating activities was $42.6 million and $9.9 million
during the six months ended June 30, 2000 and 1999, respectively. Net cash used
for operating activities in each of these periods was primarily the result of
operating losses and changes in working capital.
Net cash used for investing activities during the six months ended June 30,
2000 and 1999 was $97.1 million and $77.3 million, respectively. Net cash used
for investing activities in each of these periods was primarily the result of
capital expenditures for data center infrastructure, as well as leasehold
improvements, furniture and fixtures, computers, and other equipment. Although
we have plans to invest significantly in property and equipment, we have no
material commitments for such items at this time.
On January 12, 2000, we sold 100,000 shares of our Preferred Stock and
Warrants to purchase 1,065,000 shares of Class A Common Stock to Microsoft and
a subsidiary of Compaq for aggregate gross proceeds of $100.0 million, of which
$85.0 million was paid in cash and $15.0 million was paid in the form of
equipment credits from Compaq. The Preferred Stock has an aggregate liquidation
preference of $100.0 million and is convertible into approximately 1,462,000
shares of Class A Common Stock. The Warrants can be exercised at any time over
their three-year term at a price of $57.00 per share (the fair value of our
Class A Common Stock on the transaction commitment date). The proceeds from the
offering were allocated between the Preferred Stock and the Warrants based upon
their relative fair values.
To the extent necessary to perform our obligations under our agreement with
Compaq, the proceeds from the investment by a subsidiary of Compaq will be used
toward the development of a platform for the delivery of high-performance
application hosting services, which will include capital expenditures and
research and development expenditures. Therefore, we do not expect the proceeds
of the investment by a subsidiary of Compaq to be available for general
corporate purposes. We also intend to use the proceeds of the investment by
Microsoft to fund this development project.
15
<PAGE>
On February 16, 2000, Digex completed a public offering of 12,650,000 shares
of Class A Common Stock. We sold 2,000,000 shares of Class A Common Stock and
received net proceeds of approximately $171.6 million. Intermedia sold
10,650,000 shares of Class B Common Stock. The Class B Common Stock sold by
Intermedia automatically converted into Class A Common Stock at the closing of
the offering.
The net proceeds of our public offerings and the cash proceeds of the
investments by Microsoft and a subsidiary of Compaq must be used to purchase
telecommunications related assets due to restrictions in Intermedia's debt
instruments. Therefore, to provide for the funding of our operating expenses,
we have made arrangements with Intermedia to sell to Intermedia certain
telecommunications related assets that are purchased by Digex with the net
proceeds of these offerings. The assets are sold to Intermedia for cash at our
cost. For the six months ended June 30, 2000, we had received approximately
$35.7 million from Intermedia related to the sale of telecommunications related
assets. These proceeds were unrestricted and were used to fund our operating
expenses. Cash payments for capital assets for the six months ended June 30,
2000 were approximately $97.1 million.
In June 2000, the Department of Business and Economic Development of
Maryland received approval from the Maryland General Assembly Legislative
Policy Committee to provide $3.0 million in funding to Digex for the
development of a Web hosting facility in Prince George's County, Maryland under
the Sunny Day Fund initiative. The funds will initially be provided to Digex in
the form of a conditional loan which will accrue deferred interest at 5%. If
certain conditions are met, the conditional loan and accrued interest will
convert to a grant. The Committee also approved Digex's eligibility to seek an
additional $1.0 million in such funding.
We anticipate we will have significant cash requirements for several years
as we expand our data center capacity, increase servers under management,
increase our employee base, acquire additional office space to support our
expanding operations and invest in our marketing organization. In addition, we
expect to invest significantly in the purchase of property and equipment and
for research and development, including funding the expenses associated with
our research and development alliance with Microsoft and a subsidiary of
Compaq. We expect our capital expenditures to increase due to the growth of
servers under management and our continuing data center expansion in the United
States and abroad. Subject to the limitations discussed under the caption
"Market for Registrant's Common Equity and Related Stockholder Matters -- Use
of Proceeds from a Sale of Registered Securities" on our Form 10-K for the
period ended December 31, 1999 as filed with the Commission on March 10, 2000,
we believe we have sufficient capital to sustain our current operations and
capital expenditure plans into early 2001. We intend to continue to seek
funding from external sources to meet our cash needs subsequent to that time
period. There can be no assurance that such funding will be available on terms
satisfactory to us.
Recent Accounting Pronouncements
In December 1999, the Commission issued Staff Accounting Bulletin No. 101
("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes
certain of the staff's views in applying generally accepted accounting
principles to revenue recognition in financial statements. On June 26, 2000,
the Commission deferred the effective date of SAB 101 to require adoption of
SAB 101 by the fourth quarter of the first fiscal year beginning after December
15, 1999. Digex is currently awaiting additional guidance related to the
implementation of SAB 101 to determine the impact on its various revenue
recognition policies, including those pertaining to nonrefundable installation
fees which Digex currently recognizes as revenue upon completion of the
service.
16
<PAGE>
In June 2000, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards ("Statement") No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities", an
amendment of FASB Statement No. 133, which is effective for fiscal years
beginning after June 15, 2000. Digex does not anticipate that the adoption of
this Standard will have a significant effect on its results of operations or
financial position.
Information Regarding Forward-Looking Statements
The information set forth above in "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" includes forward-looking
statements that involve numerous risks and uncertainties. Forward-looking
statements can be identified by the use of forward-looking terminology such as
"estimates," "projects," "anticipates," "expects," "intends," "believes," or
the negative thereof or other variations thereon or comparable terminology or
by discussions of strategy that involve risks and uncertainties. This report
includes forward-looking statements, which could differ from actual results.
See "Risk Factors" in our Form 10-K for the year ended December 31, 1999 as
filed with the Commission on March 10, 2000.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Beginning in the third quarter of 2000, we expect to recognize revenue from
international sales denominated in foreign currency. As a global concern, we
could face exposure to adverse movements in foreign currency exchange rates on
the financial results of foreign subsidiaries that are translated into
U.S. dollars upon consolidation. These exposures may change over time as
business practices evolve and could affect our financial results. Currently, we
do not hedge against any foreign currency risk and, as a result, could incur
gains or losses.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We do not believe that there are any pending or threatened legal proceedings
that, if adversely determined, would have a material adverse effect on us.
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None.
Use of Proceeds from a Sale of Registered Securities
For the six months ended June 30, 2000, we used $52.0 million of the net
proceeds of our initial public offering to purchase telecommunications related
assets held by us and $35.7 million for the purchase of telecommunications
related assets subsequently sold to Intermedia. The proceeds of the sales of
assets to Intermedia were unrestricted and were used to fund our operating
expenses. All proceeds of our initial public offering have been used as of June
30, 2000.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Matters submitted to a vote at the Annual Meeting of Stockholders held on
June 1, 2000 and the results of such meeting are as follows:
<TABLE>
<CAPTION>
Votes Votes Votes Votes
For Against Withheld Abstained
----------- --------- --------- ---------
<C> <S> <C> <C> <C> <C>
1. Election of directors to serve
until the 2001 Annual Meeting
of Stockholders.
John C. Baker................. 406,838,006 -- 7,221 --
Philip A. Campbell............ 406,838,006 -- 7,221 --
Richard A. Jalkut............. 406,838,006 -- 7,221 --
George F. Knapp............... 406,837,492 -- 7,735 --
Robert M. Manning............. 406,729,417 -- 115,810 --
Jack E. Reich................. 406,837,810 -- 7,417 --
David C. Ruberg............... 403,482,588 -- 3,362,639 --
Mark K. Shull................. 406,729,289 -- 115,938 --
2. Approval of the proposal to
ratify the Company's Long-Term
Incentive Plan................ 400,694,318 2,781,769 -- 281,735
3. Approval to increase the
number of shares of Common
Stock authorized for issuance
under the Company's Long-Term
Incentive Plan from 9,000,000
to 15,000,000 shares.......... 397,909,044 5,566,915 -- 281,863
4. Approval of Ernst & Young LLP
as independent auditors of the
Company for the year ending
December 31, 2000............. 406,837,007 2,058 -- 6,162
</TABLE>
18
<PAGE>
A majority of the votes present, in person or by proxy, and entitled to vote
at the meeting, were cast in favor of the four proposals.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Number Exhibit
------ -------
<C> <C> <S>
3.1 -- Certificate of Incorporation of Digex, as amended. Incorporated
herein by reference to Digex's Form 10-Q (File No. 000-26873)
filed with the Commission on September 13, 1999.
3.2 -- By-laws of Digex. Incorporated herein by reference to Digex's
Form 10-Q (File No. 000-26873) filed with the Commission on May
12, 2000.
3.3 -- Certificate of Designation for the Series A Preferred Stock.
Incorporated herein by reference to Digex's registration
statement on Form S-1 (File No. 333-94879) filed with the
Commission on January 18, 2000.
10.1 -- Amendment No. 2, dated as of June 29, 2000, to General and
Administrative Services Agreement between Digex and Intermedia.
10.2 -- Asset Migration Agreement, dated as of June 1, 2000, between
Digex and Intermedia.
10.3 -- Lease by and between Digex and Riggs & Company, dated as of
June 29, 2000. (2)
10.4 -- Employment Letter dated March 22, 2000 between Digex and Thomas
Davidsson. (1)
10.5 -- Employment Letter dated July 5, 2000 between Digex and Todd
Carlson. (1)
10.6 -- Employment Letter dated July 6, 2000 between Digex and Bruce F.
Metge. (1)
27.1 -- Financial Data Schedule (For SEC Use Only).
</TABLE>
--------
(1) Management contract or compensatory plan or arrangement.
(2) Confidential treatment of certain provisions of this exhibit was
requested from the Commission as of the filing date of this Form
10-Q.
(b) Reports on Form 8-K
The following report on Form 8-K of Digex was filed during the second
quarter of 2000:
Digex filed a Current Report on Form 8-K, dated May 4, 2000, reporting under
Item 5 the issuance of press releases discussing Digex's first quarter results
and the establishment of its London SmartCenterSM. Digex also reported under
Item 7 the filing of the press releases as exhibits to the Form 8-K.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Digex, Incorporated
(Registrant)
/s/ Timothy M. Adams
By: _________________________________
Timothy M. Adams
Chief Financial Officer
/s/ T. Scott Zimmerman
By: _________________________________
T. Scott Zimmerman
Vice President and Controller
Dated: August 14, 2000
20
