DIGEX INC/DE, 10-Q, 2000-11-14

DIGEX INC/DE
10-Q, 2000-11-14
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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 SEPTEMBER 30, 2000

[ ] 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 October 31, 2000, there were 24,513,631 and 39,350,000 shares of the
Registrant's Class A and Class B Common Stock outstanding, respectively.

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DIGEX, INCORPORATED

INDEX

<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited):

Condensed Consolidated Statements of Operations --
Three and nine months ended September 30, 2000 and
1999...................................................... 1
Condensed Consolidated Balance Sheets --
September 30, 2000 and December 31, 1999................ 2
Condensed Consolidated Statements of Cash Flows --
Nine months ended September 30, 2000 and 1999........... 3
Notes to Condensed Consolidated Financial Statements........ 4
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
ITEM 3. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 18

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings........................................... 19

ITEM 2. Changes in Securities and Use of Proceeds................... 19

ITEM 3. Defaults Upon Senior Securities............................. 19

ITEM 4. Submission of Matters to a Vote of Security Holders......... 19

ITEM 5. Other Information........................................... 19

ITEM 6. Exhibits and Reports on Form 8-K............................ 20

SIGNATURES............................................................ 21
</TABLE>
<PAGE> 3

PART 1: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIGEX, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues.................................. $ 46,531 $ 16,111 $ 116,727 $ 38,132
Costs and expenses:
Cost of operations...................... 4,237 2,698 17,275 7,044
Cost of services........................ 21,256 6,331 49,480 13,761
Selling, general and administrative..... 38,880 20,119 101,872 46,846
Deferred compensation................... 1,087 509 3,077 509
Depreciation and amortization........... 21,883 8,146 52,435 18,112
----------- ----------- ----------- -----------
Total costs and expenses.................. 87,343 37,803 224,139 86,272
----------- ----------- ----------- -----------
Loss from operations...................... (40,812) (21,692) (107,412) (48,140)
Other income (expense):
Interest expense........................ (523) (373) (1,395) (612)
Interest and other income............... 2,838 1,293 10,239 1,293
Merger-related expenses................. (2,708) -- (2,708) --
----------- ----------- ----------- -----------
Total Interest and other income......... 130 1,293 7,531 1,293
----------- ----------- ----------- -----------
Net loss before income tax benefit........ (41,205) (20,772) (101,276) (47,459)
Income tax benefit........................ -- -- -- 4,839
----------- ----------- ----------- -----------
Net loss.................................. $ (41,205) $ (20,772) $ (101,276) $ (42,620)
=========== =========== =========== ===========
Net loss per common share -- basic and
diluted................................. $ (0.65) $ (0.36) $ (1.60) $ (0.81)
=========== =========== =========== ===========
Shares used in computing basic and diluted
net loss per share...................... 63,616,765 57,250,000 63,248,403 52,443,223
=========== =========== =========== ===========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

1
<PAGE> 4

DIGEX, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS

Current assets:
Cash and cash equivalents................................. $ 142,732 $ 88,778
Restricted investments.................................... 2,000 --
Accounts receivable, net of allowance of $3,586 and $4,362
in 2000 and 1999, respectively......................... 32,569 17,271
Due from Intermedia....................................... -- 3,110
Prepaid expenses and other current assets................. 9,072 1,496
--------- ---------
Total current assets.............................. 186,373 110,655
--------- ---------
Property and equipment, net................................. 326,783 205,903
Intangible assets, net...................................... 24,220 27,213
Other assets................................................ 1,184 538
--------- ---------
Total assets...................................... $ 538,560 $ 344,309
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued expenses..................... $ 49,837 $ 33,619
Deferred revenue.......................................... -- 222
Due to Intermedia......................................... 326 --
Current portion of note payable........................... 2,730 1,235
Current portion of capital lease obligations.............. 1,694 801
--------- ---------
Total current liabilities......................... 54,587 35,877
Note payable................................................ 1,405 2,477
Capital lease obligations................................... 27,204 15,766
--------- ---------
Total liabilities................................. 83,196 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; 24,492,510 and 11,500,000 shares issued and
outstanding in 2000 and 1999, respectively............. 245 115
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................................ 620,593 354,553
Accumulated deficit....................................... (154,044) (52,768)
Deferred compensation..................................... (11,824) (12,211)
--------- ---------
Total stockholders' equity........................ 455,364 290,189
--------- ---------
Total liabilities and stockholders' equity........ $ 538,560 $ 344,309
========= =========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

2
<PAGE> 5

DIGEX, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss.................................................. $(101,276) $ (42,620)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization.......................... 52,434 18,112
Provision for doubtful accounts........................ 4,739 3,918
Amortization of deferred compensation.................. 3,113 509
Loss on sale/disposals of telecommunications
equipment............................................. 732 94
Deferred income taxes.................................. -- (4,839)
Accretion of interest on note payable and capital lease
obligations........................................... 395 --
Changes in operating assets and liabilities:
Accounts receivable.................................... (20,070) (12,115)
Prepaid expenses and other current assets.............. (7,576) (340)
Other assets........................................... (646) (19)
Accounts payable, accrued expenses and other
liabilities........................................... 16,374 8,228
Due from Intermedia.................................... 3,439 947
Deferred revenue....................................... (222) --
--------- ---------
Net cash used in operating activities..................... (48,564) (28,125)
INVESTING ACTIVITIES:
Purchases of property and equipment....................... (156,707) (119,426)
Purchase of restricted investments........................ (2,000) --
--------- ---------
Net cash used in investing activities..................... (158,707) (119,426)
FINANCING ACTIVITIES:
Proceeds from subsequent public offering, net of costs.... 171,645 --
Proceeds from issuance of preferred stock................. 85,000 --
Proceeds from exercise of common stock options............ 5,244 --
Principal payments on long-term note payable and capital
leases................................................. (664) (1,273)
Proceeds from initial public offering, net of costs....... -- 179,244
Net contributions from Intermedia......................... -- 102,424
--------- ---------
Net cash provided by financing activities................. 261,225 280,395
Net increase in cash and cash equivalents................. 53,954 132,844
Cash and cash equivalents at beginning of the period...... 88,778 --
--------- ---------
Cash and cash equivalents at end of period................ $ 142,732 $ 132,844
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Assets purchased under capital lease obligations.......... $ 12,857 $ 17,111
Assets purchased by issuance of note payable.............. -- 4,672
Interest Paid............................................. 1,315 528
</TABLE>

See accompanying notes to condensed consolidated financial statements.

3
<PAGE> 6

DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED 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.

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. On September 1, 2000, Intermedia
entered into a merger agreement with WorldCom, Inc. ("WorldCom") whereby, upon
consummation of the merger, a subsidiary of WorldCom will be merged with and
into Intermedia and Intermedia will become a subsidiary of WorldCom. As a result
of the merger, WorldCom will beneficially own a majority of the capital stock of
Digex and will have voting control of Digex. The merger is expected to be
consummated in the first half of 2001.

2. BASIS OF PRESENTATION

The accompanying condensed consolidated interim financial statements have
been prepared by Digex, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission (the "SEC"). 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
consolidated 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. Certain prior period amounts
have been reclassified to conform to the current period presentation.

The accompanying unaudited condensed consolidated interim financial
statements include the accounts of Digex and its wholly-owned European
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.

The accompanying unaudited condensed consolidated 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.

4
<PAGE> 7
DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

The financial statements for periods prior to April 30, 1999 represent the
carved-out operations of the managed Web and application hosting unit of
Intermedia. Digex's accumulated deficit of $154.0 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.

3. RECENT ACCOUNTING PRONOUNCEMENTS

In December 1999, the SEC 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 SEC 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. On October
12, 2000, the SEC released its Frequently Asked Questions and Answers ("Q&A")
document to serve as additional guidance for revenue recognition in financial
statements. Digex is currently analyzing the Q&A document and determining the
impact of SAB 101 on its various revenue recognition policies, including those
pertaining to non-refundable installation fees which Digex currently recognizes
as revenue upon completion of service.

Based upon the expected implementation of SAB 101, Digex does not
anticipate a material effect on its consolidated financial statements. Digex has
preliminarily determined that it will record a decrease of approximately $6.0 to
$8.0 million in revenue and an increase in deferred revenue during the fourth
quarter as a result of the implementation. Digex also expects a decrease in
costs of approximately $6.0 to $8.0 million during the fourth quarter and an
increase in deferred costs as a result of the implementation. Digex will
recognize the deferred revenue and deferred costs over the remaining term of the
applicable agreements in 2001 and 2002. With the adoption of SAB 101, Digex does
not expect there to be any economic impact to its business operations or cash
flows.

In June 2000, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," an amendment of SFAS No. 133, which is effective for fiscal years
beginning after June 15, 2000. Digex anticipates that the adoption of SFAS No.
133, as amended, will not have a significant effect on its consolidated
financial statements.

4. 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. Of the $15.0 million 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 September 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.

5
<PAGE> 8
DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

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 61.6% of Digex's equity interests, it controls
approximately 94.1% of Digex's voting interest as of September 30, 2000.

5. DEFERRED COMPENSATION

Since July 29, 1999, Digex granted options to purchase 1,288,125 shares
(net of 154,375 forfeited options) 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 nine months ended September 30, 2000, Digex recorded
$2.7 million of deferred compensation (net of forfeitures), a separate component
of stockholders' equity, to be expensed over the four-year vesting period of the
options. Deferred compensation was reduced by $0.7 million in the third quarter
of 2000 for forfeited stock options. There were no additional grants of options
at exercise prices below market value in the third quarter. Deferred
compensation expense of approximately $1.1 million and $3.1 million was expensed
during the three and nine months ended September 30, 2000, respectively.

6. LOSS PER SHARE

The following table presents the computation of basic and diluted loss per
share of common stock:

Convertible securities were excluded in the computation of diluted loss per
share because assumed exercise or conversion would be anti-dilutive.

7. COMMITMENTS

On June 29, 2000, Digex entered into a ten-year lease commencing in
September 2000 for its 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. Property and equipment include the present value of
the capital lease which is amortized over the term of the lease.

6
<PAGE> 9
DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

8. 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 $3.0
million and $13.0 million for the three and nine months ended September 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 $1.5 million and $5.0
million for the three and nine months ended September 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. In
connection with the purchase of firewall-related assets from Intermedia, the
Managed Firewall Services Agreement between Digex and Intermedia was terminated.
Digex paid a purchase price of $4.5 million for the 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 $0.9 million for Intermedia's support and consultation
for the six month period ending on December 31, 2000. The charges for these
services amounted to $0.5 million for the three and nine months ended September
30, 2000.

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 $5.0 million and $40.5 million
during the three and nine months ended September 30, 2000, respectively. These
proceeds were unrestricted and were used to fund Digex's operating expenses.

9. CONTINGENCIES

The following 10 purported class actions were filed against Intermedia,
Digex, the directors of Digex, and, in some cases, WorldCom, in the Court of
Chancery of the State of Delaware in and for New Castle County:

- Mohamed Yassin v. Intermedia et al., on September 5, 2000;

- Gerard F. Hug v. Intermedia et al., on September 5, 2000;

- Taam Associates v. Intermedia et al., on September 6, 2000;

- David Reynoldson v. Intermedia et al., on September 12, 2000;

- John F. Prince v. Intermedia et al., on September 11, 2000;

- Thomas Turberg v. Intermedia et al., on September 14, 2000;

- Jason Reiner v. Digex et al., on September 8, 2000;

- Marilyn Kalabsa v. Digex et al., on September 13, 2000;

- TCW Technology Limited Partnership v. Intermedia et al., on September 20,
2000, which is also a purported derivative suit, as described below; and

7
<PAGE> 10
DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

- Kansas Public Employee Retirement System (KPER) v. Intermedia et al., on
October 4, 2000, which is also a purported derivative suit as described
below.

These actions purported to be class actions brought on behalf of all
persons, other than the defendants, who own the common stock of Digex, against
Intermedia, Digex, the directors of Digex who are also directors or executive
officers of Intermedia, and in the case of the first six actions listed,
WorldCom and the independent directors of Digex.

Each of the foregoing complaints made substantially similar allegations
that the defendants, other than WorldCom, breached their fiduciary duties to the
class members by acting to further their own interests at the expense of Digex
public stockholders, engaged in self-dealing with and did not act in good faith
towards the Digex public stockholders, and caused irreparable harm to such
stockholders. In addition, in Reiner v. Digex et al., KPER v. Intermedia et al.,
Kalabsa v. Digex et al. and TCW Technology v. Intermedia et al., the plaintiffs
alleged that the Digex board members who are also directors or executive
officers of Intermedia conferred a substantial benefit on Intermedia at the
expense of the Digex public stockholders by voting to waive application of
section 203 of the Delaware General Corporation Law to WorldCom. The foregoing
actions, except for Reiner v. Digex et al., KPER v. Intermedia et al., Kalabsa
v. Digex et al. and TCW Technology v. Intermedia et al., also alleged that
WorldCom aided and abetted Intermedia's and Digex's wrongdoing. The complaints
sought injunctive relief and unspecified damages, including orders:

- preliminarily and permanently enjoining the defendants and all persons
acting in concert with them, from proceeding with, consummating or
closing the contemplated transactions;

- in the event the contemplated transaction is consummated, rescinding it
and setting it aside or awarding rescissory damages to the class members;

- directing the defendants to account to the class members for their
damages sustained as a result of the wrongs complained of;

- awarding the plaintiffs the costs of the actions, including reasonable
allowances for attorneys' and experts' fees; and

- in the case of Reiner v. Digex et al., KPER v. Intermedia et al., Kalabsa
v. Digex et al., and TCW Technology v. Intermedia et al., enjoining the
waiver by the Digex board of directors of section 203 of the Delaware
General Corporation Law's application to WorldCom.

Additionally the following five actions were filed against the directors of
Digex, Intermedia, as the majority stockholder of Digex common stock, and Digex,
as a nominal defendant, in the Court of Chancery of the State of Delaware in and
for New Castle County:

- David J. Steinberg et al. v. Ruberg et al., on September 7, 2000;

- Crandon Capital Partners v. Ruberg et al., on September 12, 2000;

- TCW Technology v. Intermedia et al., which was also a purported class
action complaint as described above;

- Sinha v. Ruberg et al., on October 4, 2000; and

- KPER v. Intermedia et al., which was also a purported class action
complaint as described above.

These actions purported to be stockholder derivative actions brought on
behalf of Digex. Each of these complaints made substantially similar allegations
that Intermedia breached its fiduciary duties to Digex by usurping an alleged
Digex corporate opportunity for itself, and the Digex directors breached their
fiduciary duty of loyalty to Digex by permitting Intermedia to usurp Digex's
alleged corporate opportunity and

8
<PAGE> 11
DIGEX, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

approving the merger. The complaints sought injunctive relief and unspecified
damages, including orders substantially similar to those sought in the purported
class actions described above.

The Court established a schedule to conduct expedited discovery and a
hearing on the preliminary injunctions sought in TCW Technology v. Intermedia et
al. case scheduled for November 29, 2000. The defendants intend to defend
vigorously these actions.

Thereafter, on October 17, 2000, the Court ordered all thirteen purported
derivative and class action lawsuits listed above to be consolidated into a
single action to proceed according to the schedule set for TCW Technology v.
Intermedia, et al. Accordingly, on October 19, 2000, all of the above listed
plaintiffs filed a "Consolidated Class Action and Derivative Complaint." The
claims in the consolidated action are essentially identical to the claims in the
prior thirteen separate actions, except that the consolidated complaint also
alleges that the individual defendants breached fiduciary duties as officers and
directors of Digex by allegedly causing Digex to provide confidential
information to Bear Stearns with knowledge that the provision of that
information was either contrary to Digex's interests or would not result in any
benefit to Digex. The consolidated action also differs from some of the prior
separate actions insofar as Digex directors Richard A. Jalkut and Jack Reich,
named as defendants in certain of the prior actions, were not named as
defendants in the consolidated action. Following the filing of the consolidated
complaint, plaintiffs also voluntarily dismissed defendant Digex director Mark
K. Shull.

9
<PAGE> 12

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
consolidated 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 SEC on March 10, 2000.

OVERVIEW

We are a leading provider of managed Web and application 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 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 650 customers.
As of September 30, 2000, we managed 3,914 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 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 SmartCenter(SM) 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 our 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 $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.

On September 1, 2000, Intermedia entered into a merger agreement with
WorldCom. During the third quarter, we have incurred legal fees, investment
advisory fees, and certain travel expenses associated with due diligence
activities relating to the merger and the possible sale of Digex. Merger-related
costs of $2.7 million were expensed as incurred during the third quarter of 2000
and were included in Interest and Other Income.

In October 2000, we entered into a Prime/Subcontractor Agreement with
WorldCom whereby we have agreed to provide managed hosting services to WorldCom
customers in the United States and in all International locations we presently
serve or in the future for certain service fees. Under the terms of the
agreement, we will provide the computer hardware, software, network technology,
Internet connectivity and systems management necessary to offer WorldCom's
customers comprehensive outsourced Web site and

10
<PAGE> 13

application hosting solutions. We expect to generate revenues of at least $6.0
million under the agreement during the fourth quarter of 2000.

Revenue. Our revenues consist primarily of monthly fees from our managed
Web and application hosting services. Contracts for these services are typically
between one and three years in length. In addition to Web 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. Revenue earned from the sale of third party
equipment is also included.

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,
including the expansion of our business abroad through our wholly-owned
subsidiaries, 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 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 those we continue to develop in 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.

11
<PAGE> 14

RESULTS OF OPERATIONS

The following table presents certain information derived from our Condensed
Consolidated Statements of Operations for the three and nine months ended
September 30, 2000 and 1999, expressed as a percentage of revenue.

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 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....................................... 9.1 16.7 14.8 18.4
Cost of services......................................... 45.7 39.3 42.4 36.1
Selling, general and administrative...................... 83.6 124.9 87.3 122.9
Deferred compensation.................................... 2.3 3.1 2.6 1.3
Depreciation and amortization............................ 47.0 50.6 44.9 47.5
----- ------ ----- ------
Total costs and expenses......................... 187.7 234.6 192.0 226.2
----- ------ ----- ------
Loss from operations....................................... (87.7) (134.6) (92.0) (126.2)
Other income (expense):
Interest expense......................................... (1.1) (2.3) (1.2) (1.6)
Interest and other income................................ 0.3 8.0 6.5 3.3
----- ------ ----- ------
Net loss before income tax benefit......................... (88.5) (128.9) (86.7) (124.5)
Income tax benefit......................................... -- -- -- 12.7
----- ------ ----- ------
Net loss................................................... (88.5) (128.9) (86.7) (111.8)
===== ====== ===== ======
</TABLE>

THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1999

Revenue

Total revenue increased 188.8% to $46.5 million for the third quarter of
2000 compared to $16.1 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 96% to 3,914 at the end of the third quarter
of 2000 from 1,993 at the end of the third quarter of 1999.

Cost of Operations

Cost of operations increased 57.0% to $4.2 million for the third 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
increases in service offerings. As a percentage of revenue, cost of operations
decreased to 9.1% for the third quarter of 2000 compared to 16.7% for the same
period in 1999 due to the net effect of improved network utilization associated
with the revenue improvement.

Cost of Services

Cost of services increased 235.7% to $21.3 million for the third quarter of
2000 compared to $6.3 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
and consultants in customer service, engineering, and facilities administration
supporting server growth. As a percentage of revenue, total cost of services
increased to 45.7% for the third quarter of 2000 compared to 39.3% for the same
period in 1999.

12
<PAGE> 15

Selling, General and Administrative

Selling, general and administrative expenses increased 93.3% to $38.9
million for the third quarter of 2000 compared to $20.1 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 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 83.6% for the third quarter of 2000 compared to 124.9% 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 increased 113.6% to $1.1 million for the
third quarter of 2000 compared to $0.5 million for the same period in 1999. The
increase was due primarily to increases in 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 $2.7 million
(net of forfeitures) in the nine months ended September 30, 2000 to be expensed
over a four-year vesting period of the options. Deferred compensation was
reduced by $0.7 million in the third quarter of 2000 for forfeited stock
options. There were no additional grants of options at exercise prices below
market value in the third quarter.

Depreciation and Amortization

Depreciation and amortization expenses increased 168.6% to $21.9 million
for the third quarter of 2000 compared to $8.1 million for the same period in
1999. The increase was principally due to additional servers and other
facilities and equipment placed in service since September 30, 1999. We have
electronics, computer hardware, and computer software with useful lives ranging
from three to five years. As a percentage of revenue, depreciation and
amortization expenses decreased to 47.0% for the third quarter of 2000 compared
to 50.6% 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 based on
customer demand.

Interest Expense

Interest expense increased 40.2% to $0.5 million for the third quarter of
2000 compared to $0.4 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 and the capital lease for our new corporate headquarters facility in the
third quarter of 2000. 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 decreased 89.9% to $0.1 million for the three
months ended September 30, 2000 compared to $1.3 million for the same period in
1999. Expenses associated with due diligence activities relating to the merger
and the possible sale of Digex were included in Interest and Other Income.
Interest and other income excluding merger-related costs, increased 119.5% to
$2.8 million for the nine months ended September 30, 2000 compared to $1.3
million for the same period in 1999. The increase resulted principally from
interest earned on the cash proceeds from the investment in Digex by Microsoft
and a subsidiary of Compaq, an initial and subsequent public equity offering,
and exercised stock options.

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<PAGE> 16

EBITDA

EBITDA, as defined below, increased 36.9% to $(17.8) million in the third
quarter of 2000 compared to $(13.0) 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 growth in marketing and selling expenses as
new customers are acquired.

EBITDA consists of earnings (loss) before interest expense, interest and
other income, merger-related expenses, foreign exchange gains (losses), 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
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 consolidated financial statements and notes thereto
contained elsewhere in this report for more detailed information.

NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999

Revenue

Total revenue increased 206.1% to $116.7 million for the nine months ended
September 30, 2000 compared to $38.1 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 96% to 3,914 at the end of the
nine months ended September 30, 2000 from 1,993 at the end of the nine months
ended September 30, 1999. In addition to revenue from managed Web 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 145.2% to $17.3 million for the nine months
ended September 30, 2000 compared to $7.0 million for the same period in 1999.
The increase was due to additional network costs resulting from our expanded
customer base and increases in service offerings. As a percentage of revenue
excluding second quarter equipment sales, cost of operations excluding the
second quarter cost of third party equipment decreased to 12.0% for the nine
months ended September 30, 2000 compared to 18.4% 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 in the second quarter is included in the cost of operations.

Cost of Services

Cost of services increased 259.6% to $49.5 million for the nine months
ended September 30, 2000 compared to $13.8 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 and consultants in customer service, engineering, and
facilities administration supporting server

14
<PAGE> 17

growth. As a percentage of revenue, total cost of services increased to 42.4%
for the nine months ended September 30, 2000 compared to 36.1% for the same
period in 1999.

Selling, General and Administrative

Selling, general and administrative expenses increased 117.5% to $101.9
million for the nine months ended September 30, 2000 compared to $46.8 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 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 87.3% for the nine months ended September
30, 2000 compared to 122.9% 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 increased 504.5% to $3.1 million for the
third quarter of 2000 compared to $0.5 million for the same period in 1999. The
increase was primarily due to increases in 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 $2.7 million
(net of forfeitures) in the nine months ended September 30, 2000 to be expensed
over a four-year vesting period of the options. Deferred compensation was
reduced by $0.7 million in the third quarter of 2000 for forfeited stock
options. There were no additional grants of options at exercise prices below
market value in the third quarter.

Depreciation and Amortization

Depreciation and amortization expenses increased 189.5% to $52.4 million
for the nine months ended September 30, 2000 compared to $18.1 million for the
same period in 1999. The increase was principally due to additional servers and
other facilities and equipment placed in service since September 30, 1999. We
have electronics, computer hardware, and computer software with useful lives
ranging from three to five years. As a percentage of revenue, depreciation and
amortization expenses decreased to 44.9% for the nine months ended September 30,
2000 compared to 47.5% 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 based on customer demand.

Interest Expense

Interest expense increased 127.9% to $1.4 million for the nine months ended
September 30, 2000 compared to $0.6 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 and the capital lease for our new corporate
headquarters facility in the third quarter of 2000. 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 increased 482.4% to $7.5 million for the nine
months ended September 30, 2000 compared to $1.3 million for the same period in
1999. Expenses associated with due diligence activities relating to the merger
and the possible sale of Digex were included in Interest and Other Income.
Interest and

15
<PAGE> 18

other income excluding merger-related costs, increased 691.9% to $10.2 million
for the nine months ended September 30, 2000 compared to $1.3 million for the
same period in 1999. The increase resulted principally from interest earned on
the cash proceeds from the investment in Digex by Microsoft and a subsidiary of
Compaq, an initial and subsequent public equity offering, and exercised stock
options.

EBITDA

EBITDA, as defined below, increased 75.9% to $(51.9) million in the nine
months ended September 30, 2000 compared to $(29.5) 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 growth in marketing
and selling expenses as new customers are acquired.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities was $48.6 million and $28.1 million
during the nine months ended September 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 nine months ended
September 30, 2000 and 1999 was $158.7 million and $119.4 million, respectively.
Net cash used for investing activities in each of these periods was primarily
the result of capital expenditures for data center infrastructure which includes
servers purchased for customer use, as well as leasehold improvements, furniture
and fixtures, computers, and other equipment, including a $2.0 million letter of
credit pursuant to a ten-year lease entered into by us on June 29, 2000 for our
new corporate headquarters facility in Laurel, Maryland. 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

16
<PAGE> 19

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.

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 nine months ended September 30, 2000, we had received
approximately $40.5 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
nine months ended September 30, 2000 were approximately $156.7 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.

In accordance with the Digex Long-Term Incentive Plan, stock options
granted to employees of Digex and Intermedia became vested and exercisable
during the second and third quarters of 2000. Cash proceeds of $5.2 million were
received from exercised stock options during the nine months ended September 30,
2000. Digex may continue to receive cash proceeds from stock options in the
future as an increasing number of options will become exercisable according to
each optionee's respective vesting schedule.

On September 1, 2000, Intermedia entered into a merger agreement with
WorldCom whereby, upon consummation of the merger, a subsidiary of WorldCom will
be merged with and into Intermedia and Intermedia will become a subsidiary of
WorldCom. As a result of the merger, WorldCom will beneficially own a majority
of our capital stock and will have voting control of us. The merger is expected
to be consummated in the first half of 2001.

On October 31, 2000, Intermedia increased the commitments available to it
under its Revolving Credit Facility ("Credit Facility") from $100.0 million to
$350.0 million. The Credit Facility is fully guaranteed by WorldCom. As a
subsidiary of Intermedia, we will be a limited guarantor under the Credit
Facility. Through Intermedia, we expect to have access to the proceeds available
under the Credit Facility to fund our operations, working capital needs and
capital expenditures as liquidity needs arise consistent with our projections.

On October 31, 2000, Intermedia also entered into a Note Purchase Agreement
with WorldCom. Intermedia authorized the issue and sale of up to $225.0 million
aggregate principal amount of 14.12% Senior Subordinated Notes due 2009 and
22,500 shares of Series H Preferred Stock. Through Intermedia, we expect the
proceeds from these financings will be available to fund our operations, working
capital needs and capital expenditures as liquidity needs arise.

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
17
<PAGE> 20

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. With our existing cash
resources and financing available from Intermedia, and 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 SEC on March 10, 2000, we believe we have sufficient capital to sustain
our current operations and capital expenditure plans into mid 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 SEC 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 SEC 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. On October
12, 2000, the SEC released its Frequently Asked Questions and Answers ("Q&A")
document to serve as additional guidance for revenue recognition in financial
statements. We are currently analyzing the Q&A document and determining the
impact of SAB 101 on our various revenue recognition policies, including those
pertaining to non-refundable installation fees which we currently recognize as
revenue upon completion of service.

Based upon the expected implementation of SAB 101, we do not anticipate a
material effect on our consolidated financial statements. We have preliminarily
determined that we will record a decrease of approximately $6.0 to $8.0 million
in revenue and an increase in deferred revenue during the fourth quarter as a
result of the implementation. We also expect a decrease in costs of
approximately $6.0 to $8.0 million during the fourth quarter and an increase in
deferred costs as a result of the implementation. We will recognize the deferred
revenue and deferred costs over the remaining term of the applicable agreements
in 2001 and 2002. With the adoption of SAB 101, we do not expect there to be any
economic impact to our business operations or cash flows.

In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities," an amendment of SFAS No.
133, which is effective for fiscal years beginning after June 15, 2000. We
anticipate that the adoption of SFAS No. 133, as amended, will not have a
significant effect on our consolidated financial statements.

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 SEC on March 10, 2000.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We expect to continue recognizing 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.

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<PAGE> 21

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The legal proceedings discussed in Note 9 of the Notes to the Condensed
Consolidated Financial Statements in Part I, Item 1, above, are hereby
incorporated by reference herein. We do not believe that there are any other
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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

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NUMBER EXHIBIT
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<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 SEC 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 SEC
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 SEC on January 18, 2000.
10.1 -- Letter Agreement dated July 31, 2000 between Digex and
Lemis O. Altan. (1)
10.2 -- Amended and Restated Guaranty Agreement, dated as of
October 31, 2000, by Digex, as Guarantor, on behalf of
Bank of America, N.A., as Administrative Agent for
Lenders, amending and restating the Guaranty Agreement,
dated as of December 22, 1999, by Digex, as Guarantor, on
behalf of Bank of America N.A., as Administrative Agent
for Lenders.
10.3 -- Amended and Restated Security Agreement, dated as of
October 31, 2000, between Digex, as Debtor, and Bank of
America, N.A., as the Secured Party on behalf of Lenders,
amending and restating the Security Agreement, dated as
of December 22, 1999, between Digex, as Debtor, and Bank
of America, N.A., as the Secured Party on behalf of
Lenders.
10.4 -- Amendment, dated as of October 24, 2000, to the Use of
Proceeds Agreement between Digex and Intermedia, dated as
of January 24, 2000.
27.1 -- Financial Data Schedule (For SEC Use Only).
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(1) Management contract or compensatory plan or arrangement.

(b) Reports on Form 8-K

The following reports on Form 8-K of Digex were filed during the third
quarter of 2000:

Digex filed a Current Report on Form 8-K, dated August 1, 2000,
reporting under Item 5 the issuance of a press release discussing Digex's
second quarter results. Digex also reported under Item 7 the filing of the
press releases as an exhibit to the Form 8-K.

Digex filed a Current Report on Form 8-K, dated September 7, 2000,
reporting under Item 5 the issuance of a press release announcing that a
subsidiary of WorldCom will be merged with and into Intermedia. Digex also
reported under Item 7 the filing of the merger agreement as an exhibit to
the Form 8-K.

Digex filed a Current Report on Form 8-K, dated September 18, 2000,
reporting under Item 5 the complaints that have been filed in connection
with the merger agreement between Intermedia and WorldCom. Digex also
reported under Item 7 the filing of the complaints as exhibits to the Form
8-K.