<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 16, 1996
REGISTRATION NO. 333-05871
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 6
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
DIGEX, INCORPORATED
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
MARYLAND 4813 52-1672337
(STATE OR OTHER (PRIMARY STANDARD (IRS EMPLOYER
JURISDICTION OF INDUSTRIAL IDENTIFICATION NUMBER)
INCORPORATION OR CLASSIFICATION CODE
ORGANIZATION) NUMBER)
---------------
6800 VIRGINIA MANOR ROAD
BELTSVILLE, MARYLAND 20705
(301) 847-5000
(ADDRESS AND TELEPHONE NUMBER
OF PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE OF BUSINESS)
---------------
CHRISTOPHER R. MCCLEARY, CHAIRMAN,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
6800 VIRGINIA MANOR ROAD
BELTSVILLE, MARYLAND 20705
(301) 847-5000
(NAME, ADDRESS, AND TELEPHONE NUMBER
OF AGENT FOR SERVICE)
---------------
Copies to:
JOHN D. WATSON, JR., ESQ. J. WARREN GORRELL, JR.
LATHAM & WATKINS DAVID B. H. MARTIN, JR.
1001 PENNSYLVANIA AVENUE, N.W. HOGAN & HARTSON L.L.P.
SUITE 1300 555 THIRTEENTH STREET, N.W.
WASHINGTON, D.C. 20004-2505 WASHINGTON, D.C. 20004-1109
(202) 637-2200 (202) 637-5600
---------------
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION
STATEMENT.
---------------
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
CALCULATION OF REGISTRATION FEE
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- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH PROPOSED MAXIMUM AGGREGATE AMOUNT OF
CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE OFFERING REGISTRATION
TO BE REGISTERED REGISTERED(1) PER SHARE PRICE(2) FEE(3)
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$.01
per share............. * * $56,925,000 $19,629.31
</TABLE>
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- -------------------------------------------------------------------------------
(1) Includes shares issuable upon exercise of an option to be granted to the
Underwriters solely to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) promulgated under the Securities Act ("Rule
457(o)").
(3) A registration fee of $18,965.52 based on the initial proposed maximum
aggregate offering price of $55,000,000 was previously paid. The remainder
of the registration fee was paid by federal wire on October 15, 1996.
* Information omitted pursuant to Rule 457(o)
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION
STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING
PURSUANT TO SECTION 8(A), MAY DETERMINE.
- -------------------------------------------------------------------------------
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 15, 1996
PROSPECTUS
[LOGO OF DIGEX BUSINESS INTERNET APPEARS HERE]
4,500,000 SHARES OF COMMON STOCK
All of the shares of Common Stock, $.01 par value per share (the "Common
Stock"), offered hereby (the "Shares") are being sold by DIGEX, Incorporated
(the "Company"). Prior to this offering (the "Offering"), there has been no
public market for the Common Stock. It is currently anticipated that the
initial public offering price will be between $9.00 and $11.00 per share. See
"Underwriting" for a discussion of the factors to be considered in determining
the initial public offering price.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "DIGX."
SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT COMPANY (1)
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<S> <C> <C> <C>
Per Share..................................... $ $ $
Total (2)..................................... $ $ $
</TABLE>
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- --------------------------------------------------------------------------------
(1) Before deducting expenses payable by the Company estimated at $1,200,000.
(2) The Company has granted the Underwriters a 30-day option to purchase up to
an aggregate of 675,000 additional shares of Common Stock at the Price to
Public, less the Underwriting Discount, solely to cover over-allotments, if
any. If the Underwriters exercise such option in full, the total Price to
Public, Underwriting Discount and Proceeds to Company will be $ , $
and $ , respectively. See "Underwriting."
The Shares are offered subject to receipt and acceptance by the Underwriters,
to prior sale and to the Underwriters' right to reject any order in whole or in
part and to withdraw, cancel or modify the offer without notice. It is expected
that delivery of the Shares will be made at the office of Friedman, Billings,
Ramsey & Co., Inc., Arlington, Virginia, or through the facilities of The
Depository Trust Company, on or about October , 1996.
-----------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
The date of this Prospectus is October , 1996.
<PAGE>
[LOGO OF DIGEX BUSINESS INTERNET APPEARS HERE]
[MAP OF THE UNITED STATES APPEARS HERE]
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED IN THE OVER-THE-COUNTER MARKET
(INCLUDING THE NASDAQ NATIONAL MARKET) OR OTHERWISE. SUCH STABILIZING, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form SB-2 under the Securities Act
with respect to the Common Stock offered hereby (the "Registration
Statement"). This Prospectus, which constitutes a part of the Registration
Statement, does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and the shares of Common Stock offered
hereby, reference is hereby made to the Registration Statement, including the
exhibits, financial statements and schedules thereto. Statements contained in
this Prospectus regarding the contents of any contract or other document are
not necessarily complete; with respect to each such contract or document filed
as an exhibit to the Registration Statement, reference is made to the exhibit
for a more complete description of the matter involved, and each such
statement shall be deemed qualified in its entirety by such reference.
As a result of this Offering, the Company will be subject to the
informational requirements of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and, in accordance therewith, will file reports and
other information with the Commission. A copy of the Registration Statement,
including the exhibits, financial statements and schedules thereto, may be
inspected without charge at the principal office of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549 and
at its regional offices located at Seven World Trade Center, New York, New
York 10048 and Citicorp Center, 500 West Madison Street, Chicago, Illinois
60661, and copies of such material may be obtained from the Public Reference
Section of the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Room
1024, Washington, D.C. 20549 upon payment of the fees prescribed by the
Commission. The Commission also maintains a "web site' that contains
registration statements, reports, proxy and information statements and other
materials that are filed through the Commission's Electronic Data Gathering,
Analysis, and Retrieval system. This web site can be accessed at
http://www.sec.gov.
REPORTS TO STOCKHOLDERS
The Company intends to furnish to its stockholders annual reports containing
consolidated financial statements audited by its independent certified public
accountants and quarterly reports containing unaudited summary financial
information for the first three quarters of each fiscal year.
3
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements, including the notes thereto, appearing
elsewhere in this Prospectus. Investors should carefully consider the
information set forth under "Risk Factors." Unless otherwise indicated, all
information in this Prospectus assumes (i) no exercise of the Underwriters'
over-allotment option, (ii) the issuance of 2,680,336 shares of common stock,
$.01 par value (the "Common Stock"), upon the conversion (the "Preferred Stock
Conversion") of all outstanding shares of the Company's Series A and Series B
convertible preferred stock, $1.00 par value (collectively, the "Preferred
Stock"), at or prior to the offering of Common Stock made hereby (the
"Offering"), (iii) the exercise of warrants to purchase 1,868,408 shares of
Common Stock concurrently with the Preferred Stock Conversion (the "Warrant
Exercise") and (iv) reincorporation of the Company as a Delaware corporation.
All share totals stated herein reflect the Company's 505.26-for-1 stock split
of March 1995, the 10-for-1 stock split of August 1995 and a 1-for-2.5 reverse
stock split which occurred on October 9, 1996. See "Glossary" for the
definitions of certain terms and acronyms used herein.
THE COMPANY
DIGEX, Incorporated ("DIGEX" or the "Company") is a leading independent
national Internet service provider ("ISP") that focuses exclusively on
businesses, government agencies and other institutional customers ("business
customers"). The Company offers a comprehensive range of INDUSTRIAL STRENGTH
Internet solutions, including business connectivity, Web server hosting and
security and other network products. After receiving its first major infusion
of institutional equity capital in March 1995, the Company reoriented its
strategy to focus exclusively on business customers, who generally require high
bandwidth connectivity, and also began to develop its Web server hosting
business. Additionally, in the first half of 1996, the Company brought in an
experienced management team and completed a DS-3 backbone ring around the
continental United States. As a result, the Company's leased line and server
customers have grown from approximately 65 accounts at April 30, 1995 to
approximately 1050 accounts at August 31, 1996.
The Company believes that Internet solutions are increasingly achieving
"mission critical" status for business customers as the role of the Internet
and corporate intranets grows. International Data Corporation ("IDC") has
estimated that the number of Internet users was approximately 56 million in
1995, approximately 71% of which (or 40 million) were business users, and that
the aggregate number of users will grow to approximately 200 million by 1999.
In addition, according to Netcraft, Ltd., the number of corporate Internet
sites, defined as domain names ending in ".com," has increased from 4,912 in
August 1995 to 171,738 in June 1996.
DIGEX's nationwide network infrastructure provides Internet connectivity to
business customers in 33 U.S. metropolitan areas through 40 points of presence
("POPs"). Leveraging off a strong and well-established presence in the eastern
United States, the Company has embarked on a major expansion program which will
result in a total of 55 POPs (serving 48 U.S. metropolitan areas) by the end of
1996. The Company's network infrastructure is designed to provide business
customers with a high degree of reliability, enhanced performance and scalable
bandwidth. It uses Cisco Systems 7513 routers and a redundant clear channel DS-
3 loop architecture which provides 90 Mbps of coast-to-coast capacity,
monitored by a 24x7x365 network operations center ("NOC"). Unlike the network
infrastructure of regional ISPs, which typically connect at only one peering
point, the Company's network connects with the networks of other national ISPs
at the three major peering points across the U.S.
4
<PAGE>
The Company's objective is to be a single-source provider of reliable high-
performance INDUSTRIAL STRENGTH Internet solutions that serve the needs of
business customers. To achieve this objective, the Company will focus
exclusively on business customers, expand and optimize its nationwide network,
provide a comprehensive range of Internet solutions, implement multiple
distribution channels for its solutions and focus on customer acquisition and
retention.
As part of its distribution strategy, the Company is targeting
telecommunications service providers who wish to provide private label Internet
services to their customers without building their own facilities. The Company
recently entered into its first such multi-year private network agreements with
LCI International, Inc. ("LCI"), WinStar Communications, Inc. ("WinStar") and
Orion Atlantic, L.P. ("Orion"). Through its private network agreement with the
Company, Orion will resell the Company's connectivity services to its customers
in Europe. The Company expects that its ability to attract additional private
network customers will be significantly enhanced by the announcement of these
agreements.
In June 1996, the Company entered into an agreement with Microsoft
Corporation ("Microsoft"), pursuant to which Microsoft's Consulting Services
Group built a "Server Farm" for the Company with servers running Microsoft's
Windows NT 4.0 operating system. Under this agreement, the Company introduced
the world's first Windows NT 4.0 hosted server product line on September 3,
1996. The Company is currently engaged in discussions with Microsoft to include
DIGEX in Microsoft's Solution Provider Program, which would result in the
Company being designated a preferred vendor for Microsoft's corporate
customers. There can be no assurance, however, that these discussions will
culminate in an agreement with Microsoft.
The Company was founded in 1990 by a group of Internet pioneers as a Maryland
corporation under the name "Digital Express Group, Inc." The Company, which is
now named "DIGEX, Incorporated," is reincorporating as a Delaware corporation
in connection with the Offering. The Company's principal executive offices are
located at 6800 Virginia Manor Road, Beltsville, Maryland 20705, and the
Company's telephone number is (301) 847-5000. The Company's Web site is located
at http://www.digex.net.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered......................... 4,500,000 shares (1)
Common Stock Outstanding after the Offering.. 10,600,964 shares (1)(2)
Use of Proceeds.............................. The Company intends to use $1.5 million
of the net proceeds of the Offering to
repay the Bridge Loan (as defined). The
Company currently anticipates that of
the approximately $39 million in net
proceeds remaining after repayment of
the Bridge Loan, the Company will use up
to $15 million to acquire equipment
(including routers, servers and other
computer-related equipment) for
continued expansion of its network and
Web server hosting facilities and the
balance to fund operating losses
(including excess trade payable balances
of approximately $4 million at August
31, 1996) and working capital
requirements associated with the
expansion of the Company's customer
base. The actual allocation between
equipment acquisitions and the funding
of future operating losses and working
capital requirements will depend on such
factors as operating performance and
availability of equipment financing. See
"Risk Factors--Future Capital Needs;
Uncertainty of Additional Financing;
Risks Associated with Current Financing
Arrangements." The operating losses are
expected to be incurred in connection
with, among other things, payments for
circuit leasing and collocation
facilities, sales and marketing efforts,
and the development of customer service
and administrative infrastructure. The
Company reserves the right to use a
portion of the net proceeds to acquire
business-focused regional ISPs or to
purchase their subscriber bases to the
extent attractive acquisition
opportunities arise. However, no
agreements have been reached regarding
any such acquisition and no discussions
or negotiations are presently ongoing
with respect thereto. See "Risk
Factors--Possible Use of a Portion of
Net Proceeds for Acquisitions" and "Use
of Proceeds."
Nasdaq National Market Symbol................ DIGX
</TABLE>
- --------
(1) Excludes shares of Common Stock subject to the Underwriters' over-allotment
option granted by the Company.
(2) Based on the number of shares outstanding as of June 30, 1996 (assuming the
Preferred Stock Conversion and the Warrant Exercise, both of which will
occur at or prior to the consummation of the Offering). In calculating the
number of shares of Common Stock outstanding after the Offering, the
Company has assumed that the exercise price of the warrants being exercised
in the Warrant Exercise has been paid by the tender to the Company of
shares of Common Stock valued at $10.00 per share. Does not include
2,283,300 shares issuable upon the exercise of options at a weighted
average exercise price of $3.37 per share presently outstanding under the
Company's Incentive Stock Option Plan (the "1995 Stock Option Plan") and
the Company's Equity Participation Plan (the "Equity Plan" and, together
with the 1995 Stock Option Plan, the "Stock Option Plans"), as well as
202,280 shares issuable upon the exercise of options authorized but not
granted under the Equity Plan. See "Management--Incentive Stock Option
Plans." Also does not include warrants to purchase 240,000 shares of Common
Stock at an exercise price of $3.75 per share granted to WinStar in
connection with the Company's private network agreement with WinStar (the
"WinStar Warrants").
The Company has applied for federal registration of the following
servicemark: INDUSTRIAL STRENGTH Internet /SM/. This Prospectus also includes
product names and other trade names of the Company and of other organizations.
6
<PAGE>
SUMMARY FINANCIAL DATA
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- -----------------------
1993 1994 1995 1995 1996
-------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue................. $431,098 $1,577,609 $ 5,075,316 $1,665,432 $ 5,235,204
Costs and expenses:
Cost of revenue........ 216,656 1,002,503 4,471,500 1,321,663 5,246,961
Sales and marketing.... 18,326 263,075 1,710,234 561,093 2,587,472
General and administra-
tive.................. 135,238 366,392 2,715,752 588,116 3,376,091
-------- ---------- ----------- ---------- -----------
Total expenses.......... 370,220 1,631,970 8,897,486 2,470,872 11,210,524
-------- ---------- ----------- ---------- -----------
Income (loss) from oper-
ations................. 60,878 (54,361) (3,822,170) (805,440) (5,975,320)
Other income (expense):
Interest and other in-
come.................. -- -- 72,002 17,453 47,746
Interest expense....... -- (23,693) (226,745) (45,249) (1,167,149)
-------- ---------- ----------- ---------- -----------
-- (23,693) (154,743) (27,796) (1,119,403)
-------- ---------- ----------- ---------- -----------
Income (loss) before in-
come taxes............. 60,878 (78,054) (3,976,913) (833,236) (7,094,723)
Income taxes............ (25,540) (3,470) -- -- --
-------- ---------- ----------- ---------- -----------
Net income (loss)....... 35,338 (81,524) (3,976,913) (833,236) (7,094,723)
Accretion of Preferred
Stock to redemption
value.................. -- -- (338,698) (109,163) (252,881)
-------- ---------- ----------- ---------- -----------
Net income (loss) at-
tributable to common
stockholders........... $ 35,338 $ (81,524) $(4,315,611) $ (942,399) $(7,347,604)
======== ========== =========== ========== ===========
Pro forma net income
(loss) per common
share(1)............... $ (0.47) $ (0.69)
=========== ===========
Pro forma average common
and common equivalent
shares outstanding(1).. 8,254,069 8,689,950
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1996
------------------------
PRO FORMA
AS
ACTUAL ADJUSTED(2)
----------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 6,269,000 $46,919,000
Working capital (deficit).............................. (6,018,179) 34,631,821
Total assets........................................... 18,841,779 59,491,779
Total indebtedness, less current portion............... 1,714,283 1,714,283
Mandatorily redeemable preferred stock................. 10,518,159 --
Total stockholders' equity (deficit)................... (7,939,558) 43,228,601
</TABLE>
- --------
(1) Pro forma net loss per common share adjusts historical earnings per share
for the assumed conversion of convertible securities which are not included
in the historical computations. These convertible securities will
automatically convert into shares of Common Stock upon the consummation of
the Offering. Historical net loss was reduced by $450,871 for the year
ended December 31, 1995 and $1,311,347 for the six months ended June 30,
1996 to adjust for interest expense and preferred stock accretion related
to the convertible securities. See Note 2 to Financial Statements.
(2) The pro forma as adjusted data give effect to (i) the Preferred Stock
Conversion and the Warrant Exercise, both of which will occur upon
consummation of the Offering and (ii) the issuance and sale by the Company
of the shares of Common Stock offered hereby (at an assumed offering price
of $10.00 per share, after deducting estimated underwriting discount and
expenses of the Offering payable by the Company).
7
<PAGE>
RISK FACTORS
Investment in the Common Stock offered hereby involves a high degree of
risk. Prospective investors should carefully consider the factors set forth
below, together with the other information contained in this Prospectus,
before making a decision to purchase the Common Stock offered hereby.
ACCUMULATED DEFICIT; NET LOSSES; LIMITED OPERATING HISTORY
At June 30, 1996, the Company had an accumulated deficit of approximately
$11.8 million. The Company experienced net losses of approximately $4.0
million and $7.1 million in the year ended December 31, 1995 and in the six
months ended June 30, 1996, respectively. The Company is currently making
significant capital expenditures intended to expand the Company's network and
organizational infrastructure, and expects to incur operating and net losses
in 1996 and 1997. The Company expects that its operating and net losses during
the last two quarters of 1996 will increase significantly compared to its
operating and net losses for the first two quarters of 1996. The grant of
options through June 30, 1996 will result in a $2.7 million non-cash
compensation charge during the period July 1, 1996 through December 31, 1999.
There can be no assurance that the Company will achieve or sustain
profitability in the future.
Although the Company has been in existence since 1990, it reoriented its
strategy in March 1995 to focus exclusively on business customers. As a
result, prospective investors have limited relevant operating and financial
data upon which to base an evaluation of the Company and an investment in the
Common Stock offered hereby.
INTENSE COMPETITION
The market for Internet connectivity services is extremely competitive.
There are no substantial barriers to entry, and the Company expects that
competition will intensify in the future.
Currently, the Company's primary competitors are other ISPs focused on
business customers, including UUNET Technologies, Inc. ("UUNET"), BBN
Corporation ("BBN") and PSINet Inc. ("PSI"). UUNET, BBN and PSI, in
particular, all have significantly greater market presence and financial,
technological and personnel resources than the Company and have more extensive
network infrastructures than the Company. To a lesser extent, the Company
competes with other national and regional ISPs, of which there are currently
more than 1500, including NETCOM On-Line Communications Services, Inc.
("NETCOM"). The Company also currently competes with AT&T Corp. ("AT&T"), MCI
Communications Corporation ("MCI") and Sprint Corporation ("Sprint"). The
Telecommunications Act of 1996 is removing a number of regulatory obstacles to
the entry of other telecommunications companies into the Internet connectivity
market. Accordingly, the Company expects all of the other major
telecommunications service providers, including the Regional Bell Operating
Companies ("RBOCs"), to compete fully in the Internet connectivity market.
Deregulation of the telecommunications industry has already led to significant
horizontal integration through acquisitions and joint ventures, and the
Company expects these trends to continue.
The telecommunications companies with which the Company competes have access
to significantly greater financial, technological and personnel resources than
the Company and also have large existing business customer bases. In addition,
interexchange carriers ("IXCs"), including AT&T, MCI and Sprint, possess
existing nationwide telecommunications networks and generally face lower
infrastructure costs in providing Internet connectivity than the Company.
Although its WorldNet offering targets the consumer market, AT&T is party to
an agreement with BBN pursuant to which it can market BBN's business
connectivity services to AT&T's business customer base or, in the alternative,
provide its own Internet connectivity. In addition, MCI and British
Telecommunications P.L.C. have announced that they intend to merge their
international high-speed data networks and their Internet backbones, thus
offering their customers international Internet connectivity services. GTE
Corp. ("GTE") and UUNET have also recently announced a strategic alliance
whereby GTE's customers may obtain access to the Internet through UUNET's
network.
8
<PAGE>
Although most local exchange carriers ("LECs"), such as the RBOCs, and
competitive access providers ("CAPs") do not currently possess nationwide
networks, they generally have lower communications costs than the Company in
providing leased lines to businesses in the areas in which they operate.
Moreover, significant consolidation among RBOCs, including SBC Communications
Inc.'s recently-announced proposal to acquire Pacific Telesis Group ("PacTel")
and the proposed merger of NYNEX Corp. and Bell Atlantic Corporation ("Bell
Atlantic"), could result in the expansion of networks which can compete for
Internet connectivity customers. In addition, MFS Communications Company, Inc.
("MFS") has acquired UUNET and can now offer its customers expanded Internet
connectivity, and World Com, Inc. has recently announced an agreement to
acquire MFS. PacTel has also announced an offering of consumer connectivity to
customers in California.
Certain companies are also exploring the possibility of providing high-speed
data services using alternative delivery methods. For example, @Home, a joint
venture between Tele-Communications, Inc. and Kleiner Perkins Caufield &
Byers, has stated its intent to provide high-speed data services over cable
television plant, and Hughes Network Systems, Inc. ("HNS") has launched
DirecPC, which will deliver high-speed data through direct broadcast satellite
technology. If these technologies gain commercial acceptance, operators of
cable television and direct broadcast satellite systems could become
competitors of the Company. CAI Wireless Systems, Inc., a wireless cable
television service, also has announced that it has begun testing the first
Internet connectivity product delivered by wireless cable.
The Company also competes, to a lesser extent, with certain on-line service
providers which offer Internet connectivity in conjunction with their primary
products or services. For example, Microsoft provides Internet connectivity
through its Microsoft Network, which was built by UUNET (in which Microsoft
holds a significant minority stake) and which is a standard integrated feature
of its Windows 95 operating system, and International Business Machines
Corporation ("IBM") offers its OS/2 WARP operating system preconfigured to
provide Internet connectivity through the Advantis network, which is
controlled by IBM. Microsoft has also recently announced strategic marketing
alliances for Internet access with MCI, AT&T and NETCOM. In addition, America
Online, Inc. ("AOL"), CompuServe, Inc. ("CompuServe") and Prodigy Services
Company ("Prodigy"), currently provide Internet connectivity and have
announced plans to offer expanded Internet connectivity capabilities.
The market for Web server hosting services is highly fragmented and
extremely competitive. There are no substantial barriers to entry and the
Company expects that competition will intensify in the future. Currently the
Company's primary competitors are other ISPs, including BBN, UUNET and PSI,
and companies whose primary business is developing and operating "Server
Farms," such as Internet Direct, Inc. ("Internet Direct"). In addition, many
organizations currently host Web servers at their own facilities.
As a result of an increase in the number of competitors, and vertical and
horizontal integration in the industry, the Company currently encounters and
expects to encounter significant pricing pressure and other competition in the
future. Advances in technology as well as changes in the marketplace and the
regulatory environment are constantly occurring, and the Company cannot
predict the effect that ongoing or future developments may have on the
Internet connectivity and Web server hosting markets generally or on the
Company specifically. See "Risk Factors--Dependence Upon Product Development;
Risks of Changing Technology and Industry Standards" and "--Potential
Liability for Information Disseminated Over Network; Regulation."
DIFFICULTIES IN MANAGING GROWTH; PAST DEFICIENCIES IN INTERNAL CONTROL
STRUCTURE; NEW MANAGEMENT; NEED TO HIRE ADDITIONAL PERSONNEL
The rapid growth of the Company's business and its product and service
offerings has placed, and is expected to continue to place, a significant
strain on the Company's managerial, operational and accounting resources.
9
<PAGE>
Demands on the Company's operational and accounting information systems and
controls, including its billing, accounts receivable and payable tracking and
other accounting systems, have grown rapidly with the Company's expanding
customer base and its new focus on business customers. In the past, the
Company has experienced difficulties in billing its customers, pursuing
delinquent accounts receivable balances, recording payables in the proper
period, performing timely reconciliations of financial statement data on a
monthly basis and maintaining adequate accounting controls. These difficulties
were considered by the Company's independent auditors to be evidence of
material weaknesses in the internal control structure, as communicated to
management and the Board of Directors at the completion of the audit of the
Company's financial statements for the year ended December 31, 1995. The
Company has taken actions to upgrade and improve its accounting systems and
controls and to increase the number of qualified accounting personnel during
the six months ended June 30, 1996, and the Company's auditors, in connection
with their audit of the Company's financial statements for the six months
ended June 30, 1996, communicated to management and the Board of Directors
that they noted no material weaknesses involving the Company's internal
control structure and operations. Notwithstanding these upgrades and
improvements, additional actions with respect to the Company's accounting
systems and controls may be required, particularly if the Company should
experience significant additional growth.
Increasing demands for the Company's Internet solutions and related customer
support services have also created additional demands on the Company's network
infrastructure and technical support and customer services personnel. The
Company has in the past experienced difficulties making installations on a
timely basis and providing adequate customer support. Although the Company has
hired additional support and customer service personnel and has established a
24x7x365 NOC, it is possible that such difficulties will continue in the
future.
The Company has a new management team and a substantial number of new
employees. At December 31, 1994, the Company had 32 employees, and at
September 24, 1996, the Company had 263 employees. In addition, key members of
the Company's current management team, including Christopher R. McCleary, the
Company's Chairman, President and Chief Executive Officer; Thomas M. Brandt,
Jr., the Company's Senior Vice President, Finance and Administration, and
Chief Financial Officer; Brian M. Deobald, the Company's Vice President,
Telecommute Products Group; Earl P. Galleher, the Company's Vice President,
Internet Server Products Group; and Nicholas J. Magliato, the Company's Vice
President, Private Networks Group, have joined the Company since February
1996.
To manage its growth, the Company must continue to improve its operational
and accounting information systems and controls and must attract and retain
additional highly qualified management, financial, technical, sales and
marketing and customer service personnel. Any failure of the Company to manage
its growth effectively could have a material adverse effect on the Company's
business, financial condition and results of operations.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING; RISKS ASSOCIATED
WITH CURRENT FINANCING ARRANGEMENTS
The Company currently anticipates that funds advanced by WinStar under the
terms of its private network agreement and the net proceeds of the 1996
Venture Financing (as defined) and the Offering, together with existing and
anticipated financing arrangements and funds from operations, will be
sufficient to meet the Company's anticipated working capital, lease
commitments and capital expenditure requirements in 1996 and 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." In this regard, the Company
currently anticipates that it may seek to arrange as much as $15 million in
equipment financing in order to fund planned expansion of its network through
the end of 1997. There can be no assurance that the Company will be able to
arrange such equipment financing on acceptable terms or at all. Moreover, the
Company may need to raise additional funds through public or private debt or
equity financing in the event that the Company's estimates of operating losses
and capital requirements change or prove inaccurate or in order for the
Company to respond to unanticipated competitive pressures or to take
10
<PAGE>
advantage of unanticipated opportunities. Such opportunities could include the
acquisition of business-focused regional ISPs or the purchase of their
subscriber bases, international expansion, acquisitions of complementary
businesses or technologies and the development of new products. There can be no
assurance that additional financing will be available on terms favorable to the
Company, or at all. If adequate funds are not available or are not available on
acceptable terms, the Company may not be able to continue its network
expansion, to take advantage of market opportunities, to develop new products
or otherwise to respond to competitive pressures. Such inability could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In addition, the Company's financing arrangements are secured by
substantially all of the Company's assets, require the Company to satisfy
certain financial covenants and restrict the payment of dividends. Such
collateral security arrangements entitle the Company's secured lenders to
foreclose upon the Company's assets in the event of a default under the
Company's financing arrangements and may adversely affect the Company's ability
to obtain additional financing.
The Company's obligations under its private network agreement with WinStar
are also secured by substantially all of the Company's assets. This security
interest will terminate by its terms upon the consummation of the Offering.
DEPENDENCE ON NETWORK INFRASTRUCTURE; MAINTENANCE OF PEERING RELATIONSHIPS
The Company's success will depend upon the geographic reach, capacity,
reliability and security of its network infrastructure. The Internet is
comprised of many ISPs who operate their own networks and interconnect with
other ISPs at various peering points. The establishment and maintenance of
peering relationships with other ISPs is necessary in order to exchange traffic
with other ISPs without having to pay retail rates. The Company expects the
industry's current practice regarding peering to evolve by the end of 1996 to
require an ISP to have (i) a coast-to-coast DS-3 backbone, (ii) 45 Mbps
connections to three U.S. peering points and (iii) a 24x7x365 NOC in order to
qualify for peering with the major national ISPs. Although the Company
currently meets these requirements, there is no assurance that other national
ISPs will maintain peering relationships with the Company. In addition, there
may develop increasing requirements associated with maintaining peering with
the major national ISPs with which the Company may have to comply. The Company
also expects to be required to expand and adapt its network infrastructure in
order to respond to its growing number of customers, demands to transmit
increasing amounts of data and changes to its customers' product and service
requirements. The expansion and adaptation of the Company's network
infrastructure will require substantial financial, operational and managerial
resources. There can be no assurance that the Company will be able to expand or
adapt its network infrastructure to meet the industry's evolving standards or
its customers' growing demand and changing requirements on a timely basis, at a
commercially reasonable cost, or at all, or that the Company will be able to
deploy successfully any expanded and adapted network infrastructure.
RISKS TO PHYSICAL NETWORK; RISKS TO INTEGRITY OF DATA ON NETWORK
The Company's operations are dependent upon its ability to protect its
network infrastructure against damage from fire, earthquakes, severe flooding,
mudslides, power loss, telecommunications failures and similar events or to
construct networks which are not vulnerable to the effects of these events. A
significant portion of the Company's computer equipment, including components
critical to the operation of its Internet backbone, is located at the Company's
facilities in Beltsville, Maryland. The Company experienced a four-hour service
interruption due to severe flooding in Pennsylvania in 1996. The Company
believes that this type of service interruption is not abnormal in the
industry. However the occurrence of a natural disaster or other unanticipated
problems at the Company's NOC, its hubs (sites at which the Company has located
routers, switches and other computer equipment which make up the backbone of
the Company's network infrastructure) or at a number of the Company's POPs in
the future could cause additional major interruptions in the services provided
by the Company. Furthermore, the failure of an individual POP would result in
interruption of service to the customers served by such POP until necessary
repairs were effected or replacement equipment was installed.
In addition, some ISPs have in the past experienced interruptions in service
as a result of the accidental or intentional actions of Internet users, current
and former employees or others, and the Company has experienced
11
<PAGE>
interruptions in service as a result of accidental or intentional actions of
Internet users. Further interruptions of service may occur in the future. In
the past, there have been break-ins to computers connected to the Internet at
General Electric Company, Sprint and IBM, as well as the computer systems of
NETCOM and the San Diego Supercomputer Center, and there have also been
incidents involving hackers bypassing firewalls and stealing sensitive
information. Unauthorized use of the Company's network could jeopardize the
security of confidential information stored in the computer systems of the
Company and its customers, which may result in liability of the Company to its
customers or deter potential subscribers. The industry-standard network
security measures in use by the Company have been circumvented at other
companies' facilities and educational facilities in the past but not at the
Company's facilities. However, there can be no assurance that such measures
will not be circumvented in the future at the Company.
The failure of the Company to adequately manage service disruptions
resulting from physical damage to its network or breaches of the network's
integrity, could have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE UPON SUPPLIERS; LIMITED SOURCES OF SUPPLY
The Company relies on other companies to supply certain key components of
its network infrastructure, including telecommunications services and
networking equipment which, in the quantities and quality demanded by the
Company, are available only from limited sources. For example, the Company
currently relies on Cisco Systems, Inc. ("Cisco") to supply routers critical
to the Company's network, and the Company could be adversely affected if
routers from Cisco were to become unavailable on commercially reasonable
terms. MCI, which is a competitor of the Company, and Cable & Wireless, Inc.
("Cable & Wireless") are the Company's primary providers of data
communications facilities and network capacity and lease physical space to the
Company for routers, modems and other equipment. The Company is also dependent
upon LECs and CAPs to provide telecommunications services to the Company and
its customers. The Company expects these telecommunications companies to
become competitors of the Company as well. The Company has from time to time
experienced delays in receiving telecommunications services, and there can be
no assurance that the Company will be able to obtain such services on the
scale and within the time frames required by the Company at a commercially
reasonable cost, or at all.
Certain of the Company's suppliers, including the RBOCs and certain other
LECs, are currently subject to tariff controls and other price constraints
which in the future could be changed. In addition, regulations under the
Telecommunications Act of 1996 will affect the prices charged to the Company
by the RBOCs and certain other LECs. Such regulatory changes could result in
increased prices of services and products to the Company. See "--Potential
Liability for Information Disseminated Over Network; Regulation."
DEPENDENCE UPON KEY PERSONNEL
The Company's success will depend upon the continued service of its senior
management team and its technical, marketing and sales personnel. The
Company's employees, including members of its management team, may voluntarily
terminate their employment with the Company at any time, and competition for
qualified employees in the Internet industry is intense. Six senior executives
do, however, have employment agreements with the Company which run through
March or May 1997 (or, in the case of Christopher McCleary, the Company's
Chairman, President and Chief Executive Officer, through December 1999).
Although most of these employment agreements contain non-competition and non-
disclosure agreements, there can be no assurance that these provisions will be
enforceable in whole or in part. Except for key-person insurance the Company
maintains on Douglas E. Humphrey, its Senior Vice President, Chief Technology
Officer and co-founder, the Company does not maintain key-person insurance on
any executive officer of the Company. The loss of the services of key
personnel could have a material adverse effect upon the Company's business,
financial condition, and results of operations.
DEPENDENCE UPON CONTINUED DEVELOPMENT OF BUSINESS MARKET
A substantial portion of the Company's revenues to date have been, and
substantially all of the Company's revenues for the foreseeable future will
be, derived from the sale of its Internet solutions to business customers.
12
<PAGE>
The Company's success will depend upon the continued development and expansion
of the business market for Internet solutions and the networks which comprise
the Internet, as well as the extent to which Internet connectivity becomes
critical to achievement of the objectives of the Company's business customers.
Certain key issues concerning the extensive use of the Internet by business
customers, including data security, network reliability, ease and cost of
access and quality of service remain unresolved and may impact the growth of
Internet use by business customers. In particular, numerous published reports
have indicated that a perceived lack of security of commercial data, such as
credit card numbers, has significantly impeded commercial exploitation of the
Internet to date, and there can be no assurance that encryption or other
technologies will be developed that satisfactorily addresses these security
concerns. Published reports have also indicated that capacity constraints
caused by growth in the use of the Internet may, unless resolved, impede
further development of the Internet to the extent that users experience
delays, transmission errors and other difficulties. The failure of the market
for business-related Internet solutions to continue to develop would adversely
impact the Company's business, financial condition and results of operations.
DEPENDENCE UPON PRODUCT DEVELOPMENT; RISKS OF CHANGING TECHNOLOGY AND INDUSTRY
STANDARDS
The Company's success will depend upon its ability to respond to the rapidly
changing requirements of its business customers for Internet solutions. The
Internet industry is characterized by rapidly changing technology and evolving
industry standards, emerging competition and frequent new product and service
introductions. There can be no assurance that the Company can successfully
identify new product opportunities or develop and bring new products and
services to market in a timely manner. The Company is also at risk from
fundamental technological changes in the way Internet solutions are marketed
and delivered. Integrating technological advances may require substantial time
and expense, and there can be no assurance that the Company will succeed in
adapting its network infrastructure.
In addition, new technologies or industry standards have the potential to
replace or provide lower cost alternatives to the Company's existing products
and services. The adoption of such new technologies or industry standards
could render the Company's existing products and services obsolete and
unmarketable. For example, the Company's services rely on the continued
widespread commercial use of Transmission Control Protocol/Internet Protocol
("TCP/IP"). Alternative open and proprietary protocol standards that compete
with TCP/IP, including proprietary protocols developed by IBM and Novell,
Inc., have been or are being developed.
Failure of the Company to adapt to changes in technology and industry
standards would have a material adverse effect on the Company's business,
financial condition and results of operations.
POSSIBLE USE OF A PORTION OF NET PROCEEDS FOR ACQUISITIONS
The Company has the discretion to use a portion of the net proceeds of the
Offering to acquire business-focused regional ISPs or to purchase their
subscriber bases, although the Company has no plans, commitments or agreements
with respect to any such acquisitions and no discussions or negotiations are
presently ongoing with respect thereto. To the extent that any acquisition
candidates are identified and acquisitions are consummated (and the Company is
unable to predict with certainty whether such acquisitions will occur),
acquisitions may present significant business risks, including difficulties in
the integration of operations and systems and the diversion of management's
attention from other business concerns. There can be no assurance that any
acquisition that may be undertaken by the Company will benefit the Company.
POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED OVER NETWORK; REGULATION
The law relating to the liability of on-line service providers and ISPs for
information carried on or disseminated through the facilities of their
networks is currently unsettled. Several lawsuits seeking a judgment of such
liability are currently pending. In one case brought against an ISP, Religious
Technology Center v. Netcom On-Line Communication Services, Inc., the United
States District Court for the Northern District of
13
<PAGE>
California ruled in a preliminary phase that under certain circumstances ISPs
could be held liable for copyright infringement. The case has not reached
final judgment. No such case has been brought against the Company, although
the Company has recently received notice of allegations that content carried
on third-party Web pages hosted by the Company may infringe on other persons'
copyrights. The Telecommunications Act of 1996 prohibits and imposes criminal
penalties and civil liability for using an interactive computer service for
transmitting certain types of information and content, such as indecent or
obscene communications. This provision has been declared unconstitutional by
the United States District Court for the Eastern District of Pennsylvania,
which has issued a preliminary injunction against its enforcement. The United
States Department of Justice has asked the United States Supreme Court to
review the decision. Numerous states have adopted or are currently considering
similar types of legislation. The imposition upon ISPs or Web server hosts of
potential liability for materials carried on or disseminated through their
systems could require the Company to implement measures to reduce its exposure
to such liability, which may require the expenditure of substantial resources
or the discontinuation of certain product or service offerings. The Company
believes that it is currently unsettled whether the Telecommunications Act of
1996 prohibits and imposes liability for any services provided by the Company
should the content of information transmitted be subject to the statute.
Although the Company is not currently subject to direct regulation by the
Federal Communications Commission (the "FCC") or any other federal or state
agency, changes in the regulatory environment relating to the Internet
connectivity market, including regulatory changes which directly or indirectly
affect telecommunications costs or increase the likelihood or scope of
competition from the RBOCs or other telecommunications companies, could affect
the prices at which the Company may sell its services. For example, proposed
regulations at the FCC would require discounted Internet connectivity rates
for schools and libraries. In addition, certain localities have imposed a tax
on companies that connect customers to the Internet, and other localities may
impose similar taxes. The Company cannot predict the impact, if any, that
future regulation or regulatory changes may have on its business.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's quarterly operating results have in the past and may in the
future vary significantly depending upon a number of factors, such as the
pricing and mix of services and products sold by the Company, terminations of
service, new product introductions by the Company and its competitors, the
timing of the expansion of the Company's network infrastructure, market
acceptance of new and enhanced versions of the Company's products and
services, changes in pricing policies by its competitors, the Company's
ability to obtain sufficient supplies of limited source components and the
lengthening of the Company's sales cycle. Many of these factors are beyond the
Company's control. In addition, the timing of the installation of significant
orders by the Company's suppliers in the past has been, and in the future may
be, delayed by lags in the installations of lines and equipment by the
Company's telecommunications subcontractors. For example, the severe winter
weather which struck the eastern United States in January 1996 resulted in
significant installation delays for new customers and consequent delays in the
recognition of revenue from these new customers. In addition, in response to
competitive pressures, the Company could be forced to take certain pricing or
marketing actions that would have a material effect on the amount of revenues
in the short term. The Company's expense levels are relatively fixed in the
short term; as a result, variations in the timing and amounts of revenues
recognized could have a material adverse effect on the Company's quarterly
operating results.
SHARES ELIGIBLE FOR FUTURE SALE; POTENTIAL ADVERSE EFFECT ON STOCK PRICE
Future sales of substantial amounts of the Company's Common Stock could
adversely affect the market price of the Common Stock. Several of the
Company's principal stockholders hold a significant portion of the Company's
outstanding Common Stock, and a decision by one or more of these stockholders
to sell their shares could adversely affect the market price of the Common
Stock. The Shares offered hereby (plus any shares issued upon exercise of the
Underwriters' over-allotment option) will be freely tradeable without
restriction, except to the extent that such shares are purchased by
"affiliates" of the Company. The holders of Common Stock, and certain holders
of warrants to purchase Common Stock, including officers and directors of the
Company, have entered into contractual agreements with the Underwriters (the
"Lock-Up Agreements") providing that they will
14
<PAGE>
not offer, sell or contract to sell, or otherwise dispose of, directly or
indirectly, any shares of Common Stock of the Company beneficially owned by
them or any securities convertible into, or exchangeable for, Common Stock for
a period of 180 days after the date of the Underwriting Agreement without the
prior written consent of the Underwriters, other than shares of stock disposed
of as bona fide gifts. As a result, notwithstanding possible earlier
eligibility for sale under the provisions of Rules 144 and 144(k) under the
Securities Act of 1933, as amended (the "Act"), shares subject to the Lock-Up
Agreements will not be saleable until the Lock-Up Agreements expire or their
terms are waived by the Underwriters. Assuming the Underwriters do not release
stockholders from the Lock-Up Agreements, the following shares will be
eligible for sale in the public market at the following times: beginning on
the effective date of the Registration Statement (the "Effective Date"), only
the shares sold in the Offering to non-affiliates will be immediately
available for sale in the public market; and beginning 180 days after the date
of the Underwriting Agreement, 1,617,907 shares will be eligible for sale
pursuant to Rule 144, all of which are held by affiliates of the Company. An
additional 4,483,057 shares will become eligible for sale pursuant to Rule 144
at various times during the two-year period following the Effective Date
(although such shares will continue to be subject to the Lock-Up Agreements
until the expiration of the terms thereof). The holders of approximately
4,254,992 shares of the Common Stock are entitled to certain rights with
respect to the registration of such shares under the Act beginning six months
after the Effective Date. In addition, the Company may register certain shares
of Common Stock issuable under the Stock Option Plans, and such registration
shall be effective upon filing with the Commission. As of August 31, 1996,
there were outstanding options under the Stock Option Plans to purchase
2,283,300 shares, of which options for 313,266 shares were fully vested and
exercisable. No shares have been issued to date under the Stock Option Plans.
See "Shares Eligible for Future Sale."
CONTROL BY CERTAIN STOCKHOLDERS; ANTI-TAKEOVER MEASURES
Following the Offering, the Company's executive officers, directors and
principal stockholders will beneficially own or control approximately 53.9% of
the outstanding shares of Common Stock, assuming exercise of vested options,
the Preferred Stock Conversion and the Warrant Exercise. As a result, these
stockholders will have the ability to control the election of the Company's
Board of Directors and the outcome of corporate actions requiring stockholder
approval. See "Principal Stockholders."
Certain provisions of the Company's Certificate of Incorporation and Bylaws
could make it more difficult for a third party to acquire, and could
discourage a third party from attempting to acquire, control of the Company.
Certain of these provisions allow the Company to issue Preferred Stock with
rights senior to those of the Common Stock without any further vote or action
by the stockholders, eliminate the right of stockholders to act by written
consent, provide for a classified board of directors and impose various
procedural and other requirements which could make it more difficult for
stockholders to effect certain corporate actions. The provisions of the
Company's Certificate of Incorporation which permit the Board of Directors to
authorize the issuance of one or more classes of Preferred Stock, as well as
certain other charter provisions and certain provisions of Delaware law, could
limit the price that certain investors might be willing to pay in the future
for shares of Common Stock and may have the effect of delaying or preventing
transactions involving a change in control of the Company, including
transactions in which stockholders might receive a substantial premium for
their shares over then-current market prices. The issuance of Preferred Stock
also could decrease the amount of earnings and assets available for
distribution to the holders of Common Stock or could adversely affect the
rights and powers, including voting rights, of the holders of the Common
Stock. See "Description of Capital Stock--Common Stock" "--Preferred Stock,"
and "--Delaware Law and Limitations on Change in Control."
ABSENCE OF PUBLIC MARKET; DETERMINATION OF PUBLIC OFFERING PRICE; POSSIBLE
VOLATILITY OF STOCK PRICE
Prior to the Offering, there has been no public market for the Common Stock,
and there can be no assurance that an active public market will develop or be
sustained after the Offering. The initial public offering price will be
determined by negotiations between the Company and the Underwriters'
representative. See "Underwriting" for a discussion of the factors to be
considered in determining the initial public offering price. The stock market
has from time to time experienced significant price and volume fluctuations
which have particularly affected the market prices of the stocks of ISPs and
other technology companies and which may be unrelated to the operating
15
<PAGE>
performance of particular companies. Factors such as quarterly variations in
actual or anticipated operating results, changes in earnings estimated by
analysts, market conditions in the industry, announcements by competitors,
regulatory actions and general economic conditions may have a significant
effect on the market price of the Common Stock.
DILUTION
Purchasers of the Common Stock offered hereby will suffer an immediate and
substantial dilution, in the amount of $5.92 per share, in the pro forma net
tangible book value per share of the Common Stock as of June 30, 1996, from
the initial public offering price. See "Dilution."
USE OF PROCEEDS
The net proceeds to the Company of the Offering, at an assumed offering
price of $10.00 per share, after deducting estimated underwriting discount and
expenses of the Offering payable by the Company, will be approximately $40.6
million (approximately $47.0 million if the Underwriters' over-allotment
option is exercised in full). The Company intends to use $1.5 million of the
net proceeds of the Offering to repay a bridge loan (the "Bridge Loan") in the
amount of $1.5 million extended to the Company on October 7, 1996 by Blue Chip
Capital Fund Limited Partnership ("Blue Chip"). Mr. John H. Wyant, the
president of the general partner of Blue Chip, is a director of the Company.
The Bridge Loan bears interest at 9.0% per annum, compounded monthly, and is
due on the earlier of the consummation by the Company of certain specified
types of financing (including the Offering) or April 7, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Certain Transactions." The
Company currently anticipates that of the approximately $39 million in net
proceeds remaining after repayment of the Bridge Loan, the Company will use up
to $15 million to acquire equipment (including routers, servers and other
computer-related equipment) for continued expansion of its network and Web
server hosting facilities and the balance to fund operating losses (including
excess trade payable balances of approximately $4 million at August 31, 1996)
and working capital requirements associated with the expansion of the
Company's customer base. The actual allocation between equipment acquisitions
and the funding of future operating losses and working capital requirements
will depend on such factors as operating performance and availability of
equipment financing. See "Risk Factors--Future Capital Needs; Uncertainty of
Additional Financing; Risks Associated with Current Financing Arrangements."
The operating losses are expected to be incurred in connection with, among
other things, payments for circuit leasing and collocation facilities, sales
and marketing efforts, and the development of customer service and
administrative infrastructure. The Company reserves the right to use a portion
of the net proceeds to acquire business-focused regional ISPs or to purchase
their subscriber bases to the extent attractive acquisition opportunities
arise. However, the Company has no current specific plans, commitments or
agreements with respect to any such potential acquisitions and no discussions
or negotiations are ongoing with respect thereto. Pending such uses, the net
proceeds to the Company will be invested in U.S. government securities and
other short term, investment grade, interest-bearing securities.
DILUTION
The net tangible book value of the Company at June 30, 1996 (after giving
effect to the 1996 Venture Financing, the Warrant Exercise and the Preferred
Stock Conversion) was $2,578,601, or approximately $0.42 per share of Common
Stock. Net tangible book value per share is determined by dividing the
Company's tangible net worth (tangible assets less total liabilities) by the
number of shares of Common Stock outstanding. After giving effect to the sale
of 4,500,000 shares of Common Stock offered hereby and the receipt of the
estimated net proceeds therefrom (at the assumed public offering price of
$10.00 per share and after deducting estimated underwriting discount and
expenses of the Offering payable by the Company), the pro forma net tangible
book value of the Company at June 30, 1996 would have been $43.2 million, or
$4.08 per share. This represents an immediate dilution of $5.92 per share to
purchasers of Common Stock in the Offering. Dilution is determined by
16
<PAGE>
subtracting the pro forma net tangible book value per share after the Offering
from the initial offering price per share. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Initial offering price per share.................................. $10.00
Pro forma net tangible book value per share before the Offering. $0.42
Increase in net tangible book value per share attributable to
new investors ................................................. 3.66
-----
Pro forma net tangible book value per share after the Offering.... 4.08
------
Dilution per share to new investors............................... $ 5.92
======
</TABLE>
The following table summarizes, as of June 30, 1996, on a pro forma basis
and after giving effect to the Offering, the number of shares of Common Stock
purchased from the Company, the total consideration paid to the Company and
the average price per share paid by the existing stockholders and by new
investors purchasing Common Stock in the Offering. Based on an assumed initial
public offering price of $10.00 per share before deducting estimated
underwriting discount and expenses of the Offering payable by the Company, the
number of shares of Common Stock purchased from the Company is 4,500,000, the
total consideration paid to the Company is $45,000,000, the average price per
share paid by the existing stockholders is $2.10 and the price per share paid
by new investors is $10.00.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------ ------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders....... 6,100,964 58% $12,782,784 21% $ 2.10
New investors............... 4,500,000 42% 45,000,000 79% 10.00
---------- --- ----------- ---
Total..................... 10,600,964 100% $57,126,391 100%
========== === =========== ===
</TABLE>
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<PAGE>
CAPITALIZATION
The following table sets forth, as of June 30, 1996, (i) the Company's
actual capitalization, (ii) the pro forma capitalization after giving effect
to the Preferred Stock Conversion and the Warrant Exercise, and (iii) the pro
forma capitalization, as adjusted for the issuance and sale by the Company of
the 4,500,000 shares of Common Stock offered hereby, after deducting estimated
underwriting discount and expenses of the Offering payable by the Company (at
the assumed public offering price of $10.00 per share). This table should be
read in conjunction with the Company's financial statements and the notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1996
--------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
----------- ----------- ------------
<S> <C> <C> <C>
Current portion of capital lease
obligations............................ $ 1,497,563 $ 1,497,563 $ 1,497,563
----------- ----------- -----------
Total current indebtedness.......... $ 1,497,563 $ 1,497,563 $ 1,497,563
=========== =========== ===========
Capital lease obligations, less current
portion................................ $ 1,714,283 $ 1,714,283 $ 1,714,283
Series A mandatorily redeemable
preferred stock, $1.00 par value(1):
Authorized shares--70,000 actual and
pro forma; none pro forma as adjusted
Issued and outstanding shares--45,455
actual; none pro forma and pro forma
as adjusted.......................... 2,391,770 -- --
Series B mandatorily redeemable
preferred stock, $1.00 par value(1):
Authorized shares--130,000 actual and
pro forma; none pro forma as adjusted
Issued and outstanding shares--81,264
actual; none pro forma and pro forma
as adjusted.......................... 8,126,389 -- --
Stockholders' equity (deficit):
Common stock, $.01 par value:
Authorized shares--19,920,000 actual
and pro forma; 47,000,000 pro forma
as adjusted
Issued and outstanding shares--
1,617,907 actual; 6,100,964 pro
forma; 10,600,964 pro forma as
adjusted(2)......................... 16,179 61,010 106,010
Additional paid-in capital............ 3,824,636 14,297,964 54,902,964
Accumulated deficit................... (11,780,373) (11,780,373) (11,780,373)
----------- ----------- -----------
Total stockholders' equity
(deficit).......................... (7,939,558) 2,578,601 43,228,601
----------- ----------- -----------
Total capitalization.............. $ 4,292,884 $ 4,292,884 $44,942,884
=========== =========== ===========
</TABLE>
- --------
(1) Preferred Stock is not presented in this table as a part of stockholders'
equity of the Company because it is mandatorily redeemable at the option
of the holders thereof. Each outstanding share of the Company's Preferred
Stock will convert into shares of Common Stock upon the closing of this
Offering and will be cancelled, retired and returned to the shares which
the Company is authorized to issue. See "Description of Capital Stock" and
Notes 8, 9 and 18 of Notes to Financial Statements. In addition, upon
completion of the Offering, the Board of Directors will have the authority
to issue up to 3,000,000 shares of Preferred Stock in one or more series.
(2) Excludes 2,500,480 shares of Common Stock reserved for issuance to
employees under the Stock Option Plans (of which options to purchase
2,283,300 shares are outstanding). See "Management--Incentive Stock Option
Plans," "Shares Eligible for Future Sale" and Note 13 of Notes to the
Company's Financial Statements. Also excludes 240,000 shares of Common
Stock reserved for issuance to WinStar pursuant to the WinStar Warrants.
18
<PAGE>
DIVIDEND POLICY
The Company does not currently pay dividends on its Common Stock and does
not anticipate paying dividends in the foreseeable future. It is the present
policy of the Company's Board of Directors to retain earnings, if any, to
finance the expansion of the Company's business. The payment of dividends in
the future will depend on the results of operations, financial condition,
capital expenditure plans and other cash obligations of the Company and will
be at the sole discretion of the Board of Directors. In addition, the
Company's line of credit with Silicon Valley Bank prohibits the Company from
declaring dividends while borrowings are outstanding, and provisions of future
financing arrangements of the Company may also prohibit or limit the Company's
ability to pay dividends. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
19
<PAGE>
SELECTED FINANCIAL AND PRO FORMA FINANCIAL DATA
The selected financial data for each of the three years in the period ended
December 31, 1995 and the six-month periods ended June 30, 1995 and June 30,
1996 have been derived from the Company's audited financial statements which
are included elsewhere in this Prospectus. The selected financial data should
be read in conjunction with and is qualified in its entirety by reference to
the financial statements of the Company and the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- ------------------------
1993 1994 1995 1995 1996
-------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue................. $431,098 $1,577,609 $ 5,075,316 $ 1,665,432 $ 5,235,204
Costs and expenses:
Cost of revenue....... 216,656 1,002,503 4,471,500 1,321,663 5,246,961
Sales and marketing... 18,326 263,075 1,710,234 561,093 2,587,472
General and adminis-
trative.............. 135,238 366,392 2,715,752 588,116 3,376,091
-------- ---------- ----------- ----------- -----------
Total expenses.......... 370,220 1,631,970 8,897,486 2,470,872 11,210,524
-------- ---------- ----------- ----------- -----------
Income (loss) from oper-
ations................. 60,878 (54,361) (3,822,170) (805,440) (5,975,320)
Other income (expense):
Interest and other in-
come................. -- -- 72,002 17,453 47,746
Interest expense...... -- (23,693) (226,745) (45,249) (1,167,149)
-------- ---------- ----------- ----------- -----------
-- (23,693) (154,743) (27,796) (1,119,403)
-------- ---------- ----------- ----------- -----------
Income (loss) before
income taxes........... 60,878 (78,054) (3,976,913) (833,236) (7,094,723)
Income taxes............ (25,540) (3,470) -- -- --
-------- ---------- ----------- ----------- -----------
Net income (loss)....... 35,338 (81,524) (3,976,913) (833,236) (7,094,723)
Accretion of Preferred
Stock to redemption
value.................. -- -- (338,698) (109,163) (252,881)
-------- ---------- ----------- ----------- -----------
Net income (loss)
attributable to common
stockholders........... $ 35,338 $ (81,524) $(4,315,611) $ (942,399) $(7,347,604)
======== ========== =========== =========== ===========
Pro forma net income
(loss) per common
share(1)............... $ (0.47) $ (0.69)
=========== ===========
Pro forma average common
and common equivalent
shares outstanding(1).. 8,254,069 8,689,950
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1996
----------------------------
DECEMBER 31, PRO FORMA
1995 ACTUAL AS ADJUSTED (2)
------------ ----------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............ $ 832,582 $ 6,269,000 $ 46,919,000
Working capital (deficit)............ (1,820,464) (6,018,179) 34,631,821
Total assets......................... 5,051,786 18,841,779 59,491,779
Total indebtedness, less current por-
tion................................ 821,709 1,714,283 1,714,283
Mandatorily redeemable preferred
stock............................... 2,138,889 10,518,159 --
Total stockholders' equity (deficit). (1,527,742) (7,939,558) 43,228,601
</TABLE>
- --------
(1) Pro forma net loss per common share adjusts historical earnings per share
for the assumed conversion of convertible securities which are not
included in the historical computations. These convertible securities will
automatically convert into shares of Common Stock upon the consummation of
the Offering. Historical net loss was reduced by $450,871 for the year
ended December 31, 1995 and $1,311,347 for the six months ended June 30,
1996 to adjust for interest expense and preferred stock accretion related
to the convertible securities. See Note 2 to Financial Statements.
(2) The pro forma as adjusted data give effect to (i) the Preferred Stock
Conversion and the Warrant Exercise, both of which will occur upon
consummation of the Offering and (ii) the issuance and sale by the Company
of the shares of Common Stock offered hereby (at the assumed public
offering price of $10.00 per share, after deducting estimated underwriting
discount and expenses of the Offering payable by the Company).
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
DIGEX is a leading national ISP that focuses exclusively on business
customers. The Company was founded in 1990 by a group of Internet pioneers as
a local provider of dial-up Internet connectivity. After receiving its first
major infusion of institutional equity capital in March 1995, the Company
reoriented its strategy to focus exclusively on business customers, who
generally require high bandwidth connectivity, and also began to develop its
Web server hosting business. The Company brought in an experienced management
team in the first quarter of 1996. In the second quarter of 1996, the Company
completed a DS-3 backbone ring around the continental United States, enabling
the Company to provide its solutions to business customers nationwide.
The Company derives its revenue from providing a comprehensive range of
INDUSTRIAL STRENGTH Internet solutions, including business connectivity, Web
server hosting and security and other network products. Business connectivity
and Web server hosting customers are typically signed to contracts with
minimum terms of one year. Revenues generated from these customers are
typically in the form of recurring monthly fees, installation and start-up
charges and sales of related equipment, applications and services.
The Company has made significant investments in developing and expanding its
network infrastructure and its customer service and sales and marketing
efforts. The substantial costs incurred in connection with this expansion
contributed heavily to the Company's operating losses in 1995 and the six
months ended June 30, 1996. In anticipation of future growth, the Company
expects to continue to make significant investments in its network
infrastructure, to be funded primarily from equipment financing, to the extent
that the Company is able to arrange such financing on favorable terms,
throughout the remainder of 1996 and in 1997. The Company's leased line and
server customers have expanded from approximately 65 accounts at April 30,
1995 to approximately 1050 accounts at August 31, 1996.
The Company's quarterly operating results have fluctuated and will continue
to fluctuate from period to period depending upon factors such as the timing
and installation of significant orders, the pricing and mix of services and
products sold by the Company, terminations of service, new product
introductions by the Company and its competitors, market acceptance of new and
enhanced versions of the Company's products and services, changes in pricing
policies by its competitors, the Company's ability to obtain sufficient
supplies of limited source components, the lengthening of the Company's sales
cycle and the timing of the expansion of the Company's network infrastructure.
In view of the significant growth of the Company's operations, the Company
believes that period-to-period comparisons of its financial results should not
be relied upon as an indication of future performance and that the Company may
experience future period-to-period fluctuation in operating results. The
Company's short-term focus is on building and expanding its customer base,
which will require it to make significant investments in its network
infrastructure, personnel, marketing and the development of new products and
services, and which may adversely impact short-term operating results. The
Company expects to incur operating and net losses in 1996 and 1997. The
Company expects that its operating and net losses during the last two quarters
of 1996 will increase significantly compared to its operating and net losses
for the first two quarters of 1996. There can be no assurance that the Company
will achieve or sustain profitability in the future.
RESULTS OF OPERATIONS
The following table sets forth the percentage of the Company's revenue and
total expenses represented by certain line items from the Company's statement
of operations.
21
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
----------------- -------------
1993 1994 1995 1995 1996
---- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C>
Revenue..................... 100% 100% 100% 100% 100%
Costs and expenses:
Cost of revenue........... 50 63 88 79 100
Sales and marketing....... 4 17 34 34 49
General and administra-
tive..................... 32 23 53 35 65
--- --- --- ---- -----
Total expenses.............. 86 103 175 148 214
--- --- --- ---- -----
Income (loss) from opera-
tions...................... 14 (3) (75) (48) (114)
Interest expense, net....... -- (2) (3) (2) (21)
--- --- --- ---- -----
Income (loss) before income
taxes...................... 14 (5) (78) (50) (135)
Income taxes ............... 6 0 -- -- --
--- --- --- ---- -----
Net income (loss)....... 8% (5)% (78)% (50)% (135)%
=== === === ==== =====
</TABLE>
SIX MONTHS ENDED JUNE 30, 1996 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1995
REVENUE
The Company derives its revenue from providing a comprehensive range of
INDUSTRIAL STRENGTH Internet solutions, including business connectivity, Web
server hosting and security and other network products. Revenue grew 214% from
$1.7 million in the six months ended June 30, 1995 to $5.2 million in the six
months ended June 30, 1996, the majority of which was due to the change in the
Company's strategy to focus exclusively on business customers, who generally
require high bandwidth connectivity, and the associated expansion of its sales
and marketing efforts, including the creation of a direct sales force, and to
a lesser extent the development of the Company's Web server hosting business.
COST OF REVENUE
Cost of revenue consists primarily of local access costs, network
infrastructure, leased network backbone circuit costs and network operations
and support costs. Network operations and support costs consist primarily of
personnel expenses relating to the operation of the network infrastructure,
including monitoring network traffic and quality, and costs of providing
technical support to customers. Cost of revenue increased 297% from $1.3
million in the six months ended June 30, 1995 to $5.2 million in the same
period in 1996. Cost of revenue increased as a percentage of revenues from 79%
in the 1995 period to 100% in the 1996 period. The increase in cost of revenue
was primarily due to costs associated with the Company's change in strategy to
focus exclusively on business customers. These costs include the hiring of
additional personnel to support the Company's expanding customer base and the
higher support requirements of business customers as well as the expansion of
the network backbone, the establishment of a 24x7x365 NOC, and the building of
redundant facilities. For example, the Company's customer support and network
operations personnel increased from 42 at June 30, 1995 to 69 at June 30,
1996. The Company plans to continue to expand its network through 1996 and
1997, which in turn will continue to increase cost of revenue. As the costs
associated with this expansion have been and will be incurred by the Company
in anticipation of growth in its customer base, the Company believes that,
over time, cost of revenue as a percentage of revenues will decline as its
customer base expands.
SALES AND MARKETING
Sales and marketing costs consist primarily of salaries and expenses of
sales and marketing personnel, advertising and promotion and marketing
materials. Sales and marketing costs rose 361% from $0.6 million in the six
months ended June 30, 1995 to $2.6 million in the same period in 1996. Sales
and marketing costs increased as a percentage of revenues from 34% in the 1995
period to 49% in the 1996 period. The increase in
22
<PAGE>
sales and marketing costs was primarily due to the Company's change in
strategy to focus exclusively on business customers. The Company's prior
business strategy required minimal sales and marketing. The change in strategy
required the hiring of additional sales and marketing personnel (from 27 at
June 30, 1995 to 85 at June 30, 1996) and the expansion of advertising and
promotional activities and product development efforts. The Company expects to
continue to invest heavily in sales and marketing in 1996 and 1997.
GENERAL AND ADMINISTRATIVE
General and administrative costs consist primarily of expenses associated
with the Company's management, accounting, finance and administrative
functions. General and administrative costs increased 474% from $0.6 million
in the six months ended June 30, 1995 to $3.4 million in the same period in
1996. These costs increased as a percentage of revenues from 35% in the six
months ended June 30, 1995 to 65% in the same period in 1996. This increase in
general and administrative expenses was due primarily to the hiring of 28
additional senior management, finance, accounting and administrative personnel
to support the Company's expanding operations. The Company expects to hire
additional personnel in anticipation of continued expansion of its operations.
General and administrative costs were also affected by a $400,000 non-cash
compensation charge in the six months ended June 30, 1996 related to the grant
of stock options. In addition, based on options granted through June 30, 1996,
additional compensation charges of $2.7 million will be reported as general
and administrative costs during the period July 1, 1996 through December 31,
1999. See Note 13 to the financial statements for additional information with
respect to compensation expense related to stock option grants. The increase
in the general and administrative costs resulted principally from the increase
in the Company's general and administrative staff from 13 at June 30, 1995 to
41 at June 30, 1996. The Company expects to hire additional personnel in
anticipation of continued expansion of its operations.
INTEREST EXPENSE
Interest expense increased from $45,249 in the six months ended June 30,
1995 to $1,167,149 in the same period in 1996. The increase in interest
expense during the 1996 period was primarily due to the Company's issuance of
subordinated debentures in November 1995 and February 1996 and increased
equipment financing and capital lease obligations incurred to finance network
expansion and to fund working capital requirements.
YEAR ENDED DECEMBER 31, 1995 COMPARED WITH YEAR ENDED DECEMBER 31, 1994
REVENUE
Revenue grew 222% from $1.6 million in 1994 to $5.1 million in 1995, the
majority of which was due to the change in the Company's strategy to focus
exclusively on business customers, who generally require high bandwidth
connectivity, and to a lesser extent the development of the Company's Web
server hosting business. In addition, the equity financing in March 1995
contributed to this increase by allowing the Company to greatly expand its
customer acquisition effort by building a direct sales force. The Company's
leased line and server customers expanded from approximately 16 accounts at
December 31, 1994 to approximately 360 accounts at December 31, 1995.
COST OF REVENUE
Cost of revenue increased 346% from $1.0 million in 1994 to $4.5 million in
1995. Cost of revenue increased as a percentage of revenues from 63% in 1994
to 88% in 1995. The increase in cost of revenue was primarily due to costs
associated with the Company's change in strategy to focus exclusively on
business customers. These costs included the hiring of additional personnel to
support the Company's expanding customer base as well as the expansion of the
network backbone, the establishment of a 24x7x365 NOC, and the building of
redundant facilities. The Company's customer support and network operations
personnel increased from 21 at December 31, 1994 to 53 at December 31, 1995.
The increased use of the network and the increase in capital expenditures to
expand the network infrastructure created an increase in depreciation and
amortization expense during 1995.
23
<PAGE>
SALES AND MARKETING
Sales and marketing costs rose 550% from $0.3 million in 1994 to $1.7
million in 1995. Sales and marketing costs increased as a percentage of
revenues from 17% in 1994 to 34% in 1995. The increase in sales and marketing
costs was primarily due to the Company's change in strategy to focus
exclusively on business customers. The Company's prior business strategy
required minimal sales and marketing. The Company's change in focus required
the hiring of additional sales and marketing personnel (from 8 at December 31,
1994 to 36 at December 31, 1995), expanding advertising and promotional
activities and product development efforts. The Company expects to continue to
invest heavily in sales and marketing in 1996.
GENERAL AND ADMINISTRATIVE
General and administrative costs increased 641% from $0.4 million in 1994 to
$2.7 million in 1995. These costs increased as a percentage of revenues from
23% in 1994 to 53% in 1995. This increase in general and administrative
expenses was due primarily to the hiring of 12 additional senior management,
finance, accounting and administrative personnel to support the Company's
expanding operations. The Company expects to hire additional personnel in
anticipation of continued expansion of its operations. General and
administrative costs were also affected by a $475,000 non-cash compensation
charge in 1995 related to the grant of stock options and a $301,000 write-off
of accounts receivable in 1995 compared to no write-offs during 1994. See Note
13 to the financial statements for additional information with respect to
compensation expense related to stock options. The Company's general and
administrative staff increased from 5 at December 31, 1994 to 17 at December
31, 1995. The Company expects to hire additional personnel in anticipation of
continued expansion of its operation.
INTEREST EXPENSE
Interest expense increased from $24,000 in 1994 to $227,000 in 1995. The
increase in interest expense during 1995 was primarily due to interest of
$112,000 on $2.0 million of subordinated debentures and an increase in
equipment financing and capital lease obligations incurred to finance network
expansion and to fund working capital requirements.
YEAR ENDED DECEMBER 31, 1994 COMPARED WITH YEAR ENDED DECEMBER 31, 1993.
REVENUE
Revenue grew 266% from $0.4 million in 1993 to $1.6 million in 1994, as a
result of increases in the number of the Company's customers due to the
commercialization of the Internet and significant growth in its usage. The
customer base in 1993 and 1994 was comprised primarily of individual dial-up
customers.
COST OF REVENUE
Cost of revenue increased 363% from $0.2 million in 1993 to $1.0 million in
1994. Cost of revenue increased as a percentage of revenues from 50% in 1993
to 63% in 1994. The increase in cost of revenue was primarily due to an
increase in the hiring of additional personnel to support the Company's
expanding customer base, relocation of the Company's headquarters to larger
facilities and the increase in capital expenditures to expand the network
infrastructure, which created an increase in depreciation and amortization
expense during 1994.
SALES AND MARKETING
Sales and marketing costs rose from $18,000 in 1993 to $263,000 in 1994.
Sales and marketing costs increased as a percentage of revenues from 4% in
1993 to 17% in 1994. The increase in sales and marketing costs was due to
expansion of the advertising and promotional activities and the hiring of
dedicated sales representatives.
24
<PAGE>
GENERAL AND ADMINISTRATIVE
General and administrative costs increased 171% from $0.1 million in 1993 to
$0.4 million in 1994. These costs decreased as a percentage of revenues from
31% in 1993 to 23% in 1994. This increase in general and administrative costs
was due primarily to the hiring of additional management, finance, accounting
and administrative personnel to support the Company's expanding customer base.
INTEREST EXPENSE
Interest expense was $24,000 in 1994. There was no interest expense in 1993.
The interest expense incurred during 1994 was primarily due to equipment
financing and capital lease obligations incurred to finance network expansion
and to fund working capital requirements.
INCOME TAXES
Income tax expense decreased from $26,000 in 1993 to $3,000 in 1994 due to
the operating loss.
QUARTERLY RESULTS
The following table sets forth unaudited quarterly revenue for the six
quarters ended June 30, 1996. In the opinion of management, the unaudited
information set forth below has been prepared in accordance with generally
accepted accounting principles for interim financial information and Item
310(b) of Regulation S-B.
<TABLE>
<CAPTION>
1995 1996
THREE MONTHS ENDED THREE MONTHS ENDED
------------------------------------------ ---------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30
-------- -------- ------------ ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Revenue................. $739,700 $925,300 $1,318,200 $2,092,100 $2,232,500 $3,002,700
</TABLE>
The Company's quarterly results may in the future vary significantly
depending on a variety of factors. See "Risk Factors--Potential Fluctuations
in Quarterly Operating Results." In view of the significant historic growth of
the Company's operations, the Company believes that period-to-period
comparisons of revenue should not be relied upon to estimate future revenue.
LIQUIDITY AND CAPITAL RESOURCES
The Company satisfied its cash requirements in 1995 and in the first six
months of 1996 principally through a combination of sales of equity and debt
securities to venture capital investors. The Company received $6.0 million in
1995 from the sale of equity and debt securities to venture capital investors.
In February 1996, the Company sold additional debt securities to venture
capital investors, together with warrants to purchase shares of Common Stock,
for gross proceeds of $1.0 million. Proceeds from these financings were used
to fund the rapid expansion of the Company's network infrastructure and
internal operations, including purchases of capital equipment and the hiring
of additional personnel. See "Certain Transactions."
In April 1996, to provide additional liquidity, the Company entered into a
Loan and Security Agreement with Silicon Valley Bank that provides a revolving
credit line secured by accounts receivable. The credit line allows the Company
to borrow a maximum amount equal to the lesser of $1.5 million or 80% of the
Company's eligible accounts receivable, at the rate announced from time to
time by Silicon Valley Bank as its "prime rate" plus 1% per annum, which was
9.25% at June 30, 1996. The Company is currently unable to draw under the
credit line due to non-compliance with certain financial covenants; however,
the Company is actively engaged in negotiations with an asset-based lender
regarding the establishment of a secured credit line which would replace the
Loan and Security Agreement with Silicon Valley Bank and under which the
Company would be permitted to draw up to $3.0 million for working capital and
equipment purchases. However, to date no agreement has been reached with the
fixed asset lender, and there can be no assurance that any such agreement will
be reached on acceptable terms or at all.
In April 1996, the Company obtained a commitment for an equipment lease line
under which the Company may lease equipment with a total cost of up to $2.0
million through December 31, 1996. The lease terms will
25
<PAGE>
range from 42 months to 50 months and will be accounted for as capital leases
with annual effective interest rates approximating 14% per annum. The
Company's capital lease obligations as of June 30, 1996 were $3.2 million and
its future minimum lease payments through 2000 under certain operating leases
were $2.0 million. Since June 30, 1996, the Company has entered into
approximately $4 million of additional lease financing arrangements in order
to fund network expansion.
In May 1996, the Company entered into agreements with venture capital
investors pursuant to which the Company issued shares of Series B Preferred
Stock in exchange for total cash consideration of $5.0 million. Proceeds from
this transaction, are being used to finance the Company's network
infrastructure expansion. In October 1996 the Company obtained $1.5 million in
interim financing pursuant to the Bridge Loan from Blue Chip, which the
Company will repay using a portion of the net proceeds of the Offering. See
"Use of Proceeds." In connection with the Bridge Loan, the Company agreed to
issue to Blue Chip warrants to purchase 150,000 shares of Common Stock at an
exercise price of $1.00 per share if, but only if, the Company's initial
public offering of Common Stock is not consummated on or before October 31,
1996. The Company presently expects that this Offering will be consummated
prior to October 31, 1996 and, accordingly, that no warrants will be issued in
connection with the Bridge Loan. The Company also has received, in addition to
the Bridge Loan, a standby commitment from certain of its current venture
capital investors to purchase up to $5.0 million of convertible subordinated
debentures and warrants to purchase shares of Common Stock in the event that
the Company requires additional liquidity prior to completion of the Offering.
The Company does not presently expect that it will be required to make any
draws pursuant to the $5.0 million standby commitment. See "Certain
Transactions."
In June 1996, the Company entered into a multi-year private network
agreement with WinStar. As part of the agreement, WinStar advanced $5.0
million in cash for connectivity services to be provided under such agreement
and received warrants to purchase 240,000 shares of Common Stock. The
estimated value of the WinStar Warrants, $228,000, was recorded as additional
paid-in capital and deferred revenue associated with such agreement was
recorded in the amount of $4,772,000. See Note 11 to the Financial Statements.
The Company's obligations to WinStar under such agreement are secured by
substantially all of the Company's assets, which security interest will
terminate by its terms upon the consummation of the Offering.
The Company generated positive cash flow from operating activities of
$124,000 in 1993 and $133,000 in 1994, compared to a negative cash flow from
operating activities of $2.5 million in 1995. The change in operating cash
flows from 1994 to 1995 was due primarily to increased costs relating to
expansion of the Company's network and organizational infrastructure,
including the hiring of additional management, marketing and sales, finance,
accounting and administrative personnel. In addition, purchases of fixed
assets increased from $98,000 in 1993, to $350,000 in 1994, and to $1.2
million in 1995, primarily to support the expansion of the Company's network
infrastructure.
The Company currently anticipates that funds advanced by WinStar under the
terms of its private network agreement, and the net proceeds of the 1996
Venture Financing and the Offering, together with existing and anticipated
financing arrangements and funds from operations, will be sufficient to meet
the Company's anticipated working capital, lease commitments and capital
expenditure requirements through the end of 1997. In this regard, the Company
currently anticipates that it may seek to arrange as much as $15 million in
equipment financing in order to fund planned expansion of its network through
the end of 1997. There can be no assurance that the Company will be able to
arrange such equipment financing on acceptable terms or at all. Moreover, the
Company may need to raise additional funds through public or private debt or
equity financings in order to take advantage of unanticipated opportunities,
including international expansion, acquisitions of complementary businesses or
technologies, development of new products or otherwise responding to
unanticipated competitive pressures. In addition, the Company may need to
raise additional funds in the event that the Company's estimates of operating
losses and capital requirements change or prove inaccurate. There can be no
assurance that the Company will be able to raise such capital on favorable
terms or at all. See "Risk Factors--Future Capital Needs; Uncertainty of
Additional Financing; Risks Associated With Current Financing Arrangements"
and "Use of Proceeds."
26
<PAGE>
BUSINESS
DIGEX is a leading independent national ISP that focuses exclusively on
businesses, government agencies and other institutional customers ("business
customers"). The Company offers a comprehensive range of INDUSTRIAL STRENGTH
Internet solutions, including business connectivity, Web server hosting and
security and other network products. After receiving its first major infusion
of institutional equity capital in March 1995, the Company reoriented its
strategy to focus exclusively on business customers, who generally require
high bandwidth connectivity, and also began to develop its Web server hosting
business. Additionally, the Company brought in an experienced management team
in the first quarter of 1996 and completed a DS-3 backbone ring around the
continental United States in the first half of 1996. As a result, the
Company's leased line and server customers have grown from approximately 65
accounts at April 30, 1995 to approximately 1050 accounts at August 31, 1996.
The Company offers its INDUSTRIAL STRENGTH Internet solutions through four
separate and highly focused business units. The Business Connectivity Group
offers Internet connectivity solutions and other value-added solutions to
business customers, while the Telecommute Products Group focuses on the home-
office connectivity requirements of small businesses and high-end
professionals employed by companies that are served by the Business
Connectivity Group. The Internet Server Products Group provides Web server
hosting solutions enabling customers to deploy highly reliable Web servers
that are connected directly to the Internet backbone and are monitored on a
24x7x365 basis at the Company's network operations center ("NOC"). The Private
Networks Group seeks to create customized solutions for businesses looking to
provide private label Internet services without building their own facilities.
The Company recently entered into its first multi-year private network
agreements with LCI, WinStar and Orion. Through its private network agreement
with the Company, Orion will resell the Company's connectivity services to its
customers in Europe. The Company expects that its ability to attract
additional private network customers will be significantly enhanced by the
announcement of these agreements.
In June 1996, the Company entered into an agreement with Microsoft, pursuant
to which Microsoft's Consulting Services Group built a "Server Farm" for the
Company with servers running Microsoft's Windows NT 4.0 operating system.
Under such agreement, the Company introduced the world's first Windows NT 4.0
hosted server product line on September 3, 1996. The Company is currently
engaged in discussions with Microsoft to include DIGEX in Microsoft's Solution
Provider Program, which would result in the Company being designated a
preferred vendor for Microsoft's corporate customers. There can be no
assurance, however, that these discussions will culminate in an agreement with
Microsoft.
INDUSTRY BACKGROUND
The Internet is a global collection of computer networks that enables
businesses, government agencies, other institutional customers and individuals
to communicate, access and share information and conduct business remotely.
Use of the Internet has grown rapidly since the early 1990s, due in large part
to increasing personal computer and modem penetration, the development of the
World Wide Web, the introduction of easy-to-use navigational tools and
utilities for the Web and the availability of informational, entertainment and
commercial applications. Technological advances relating to the Internet have
occurred and continue to occur rapidly, resulting in a more robust, lower-cost
infrastructure, improved security and increased value-added services and
content. IDC has estimated that the number of Internet users will reach
approximately 200 million in 1999, from approximately 56 million in 1995.
While there has been significant media interest in the use of the Internet
by consumers, business customers currently account for a more significant
percentage of Internet use. According to IDC, approximately 71%, or 40
million, of the approximately 56 million Internet users in 1995 were business-
related users. Internet capabilities, including corporate Internet sites, are
becoming an increasingly important part of doing business. According to
Netcraft, Ltd., the number of corporate Internet sites, defined as domain
names ending in ".com", has increased from 4,912 in August 1995 to 171,738 in
June 1996.
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<PAGE>
Because Internet and corporate intranet solutions are increasingly achieving
"mission critical" status, business customers are demanding advanced, highly
reliable solutions designed specifically for the needs of business.
Furthermore, as the use of the Internet expands, business customers are
requiring that providers offer a comprehensive range of services, including
connectivity, Web server hosting and security and other network products.
Finally, business customers often require knowledgeable and highly responsive
sales and customer service representatives in order to determine their optimal
Internet strategy quickly and to resolve any problems with their current
solutions.
THE DIGEX SOLUTION
The Company provides a comprehensive range of INDUSTRIAL STRENGTH Internet
solutions that serves the needs of business customers, who often desire a
responsive, single-source provider of reliable, high-performance Internet
connectivity and Web server hosting products and services.
Connectivity. DIGEX offers a complete product line of Internet connectivity
solutions to its business customers with a variety of service and pricing
programs based on bandwidth requirements. To complement its connectivity
offerings, the Company also sells customer-premise routers, firewall security
options and assigns and manages IP and E-mail addresses.
Web Server Hosting. The Company also offers a complete range of Web server
hosting solutions. The Company's business customers are able to locate highly
reliable Web sites on dedicated servers at the Company's "Server Farm," which
enables users to gain high speed access to the Web server given the server's
direct connection to the Internet backbone. In addition, the Company provides
24x7x365 monitoring of the server and Internet connection by the Company's
highly experienced technical staff, as well as easy server upgradability as
the customer's speed and capacity requirements grow.
The Company's Internet solutions are supported by its state-of-the-art
network infrastructure, including the Company's NOC and Server Farm located in
suburban Washington, D.C. The Company has built a redundant nationwide DS-3
backbone connecting to the three major Internet peering points at 45 Mbps and
has established peering relationships with other national ISPs, allowing DIGEX
to route its customers' traffic to the desired Internet address. The Company
believes that its combination of a nationwide network and peering
relationships significantly differentiates the Company from regional ISPs who,
without peering relationships, may have to pay retail rates to national
providers in order to exchange network traffic.
THE DIGEX STRATEGY
After receiving its first major infusion of institutional equity capital in
March 1995, the Company reoriented its strategy to focus on becoming the ISP
of choice for business customers. DIGEX's strategy focuses on five key
elements:
Focus on Businesses Customers. The Company believes that business customers
offer the greatest potential market for the Company's solutions due to this
market's low customer turnover and need for the higher value-added Internet
solutions which the Company provides. By focusing on these customers, the
Company believes it will be able to develop innovative, specialized products
and services that address the constantly evolving needs of business customers
at competitive prices. In addition, the Company believes that its less-focused
competition will have difficulty fulfilling the demanding needs of these
customers.
Provide Comprehensive Range of Internet Solutions. The Company provides a
comprehensive range of Internet solutions, enabling it to satisfy the needs of
business customers, who often seek a sole provider for all their Internet
requirements. The Company's sales forces for each of its business units are
incentivized to cross-market all of DIGEX's products and services.
Expand and Optimize Its Nationwide Network. The Company aims to expand its
highly reliable, nationwide DS-3 network, which the Company has designed to
specifically address the growing reliability and
28
<PAGE>
bandwidth requirements of business customers, so as to offer a comprehensive
range of connectivity solutions to such customers across the United States.
The Company believes that as it expands its network to more cities, it can
offer its solutions to additional business customers more cost-effectively
than its consumer-focused competitors, because fewer POPs are required to
reach business customers, who are largely concentrated in urban centers. In
addition, the Company attempts to optimize its network efficiency by
counterbalancing business connectivity, which makes greater use of the
Company's network during business hours, with Web server hosting, which makes
greater use of the network during non-business hours.
Implement Multiple Distribution Channels. The Company aims to reach its
customers through the Company's own direct sales force as well as through
other innovative methods of distribution. These methods currently include
agent relationships with advertising agencies and Web site developers who
resell the Company's Web server hosting solutions and the efforts of the
Company's Private Networks Group, which enters into long-term agreements with
telecommunications service providers to resell the Company's connectivity
solutions under their own brand names.
Focus on Customer Acquisition and Retention. In addition to acquiring
customers through its existing distribution channels, the Company believes
that as consolidation of the industry continues and it becomes more difficult
for regional ISPs to compete, the Company may be able to acquire
opportunistically business-focused regional ISPs or purchase their subscriber
bases. The Company also believes that customer responsiveness is becoming a
key ingredient of success for ISPs and has formed four focused business units
to better serve and retain customers. To aid in this effort, the Company has
developed a highly trained direct sales force with extensive Internet
expertise which, based on customer feedback, the Company believes
significantly differentiates the Company from its competitors.
NETWORK INFRASTRUCTURE
DIGEX's current network infrastructure is based upon a DS-3 ring around the
continental United States which provides two 45 Mbps paths between the east
and west coasts, allowing for a combined bandwidth of 90 Mbps when fully
operational. As shown on the map on the following page, customers can connect
to the Company's network from major cities across the United States. Clear
channel DS-3 circuits in the ring connect core routers in DIGEX POPs located
in cities on the ring. In the event of single points of failure, traffic can
be routed around the loop, providing for a minimum of 45 Mbps even in the
event of such a failure. Other network circuits connect routers in DIGEX POPs
in cities not located along the ring to nearby DIGEX routers residing on the
ring. The network backbone uses state-of-the-art routing platforms, including
Cisco Systems, Inc. ("Cisco") 7513 routers.
DIGEX customers are connected via high-speed leased lines, frame relay, SMDS
or other technologies to the local DIGEX POP, where data enters the DIGEX
backbone. If the destination of the data is on the DIGEX network, then the
data is delivered without ever leaving DIGEX's facilities. If the data is
destined for an Internet customer connected via another national ISP which has
a peering relationship with DIGEX, then the data is routed to the nearest
peering location where the data is passed from the DIGEX router to the router
of the other ISP, who then carries that traffic to the final destination. If
the destination is an ISP which does not have a peering relationship, then the
data is delivered to the national ISP from whom such ISP purchases its
Internet connectivity.
Currently, DIGEX's comprehensive range of connectivity solutions are
available in 33 U.S. metropolitan areas through 40 POPs, and the Company
expects to make its connectivity solutions available in a total of 48 U.S.
metropolitan areas through 55 POPs by the end of 1996. DIGEX currently leases
the majority of its intercity backbone DS-3 circuits from MCI and Cable &
Wireless, as well as collocation space at their facilities for DIGEX
equipment. The Company has a five-year agreement with MCI as well as three-
year commitments from Cable & Wireless for the lease of such circuits and the
use of collocation space to house DIGEX equipment. Management believes that it
will be able to renew or replace such contracts at comparable rates. Other
DIGEX network segments and customer connections are provided through LECs and
CAPs.
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<PAGE>
DIGEX's POPs and Nationwide Network Backbone
[MAP OF UNITED STATES APPEARS HERE]
DIGEX's network is monitored on a 24x7x365 basis by its NOC. Trouble calls
are serviced by the technical staff of either the Business Connectivity Group,
in the case of backbone or customer leased line difficulties, or the Internet
Server Products Group, in the case of problems with customer servers. MCI and
Cable & Wireless provide installation and maintenance services to assist DIGEX
at all locations where the Company collocates equipment. For equipment for its
remote POPs, DIGEX purchases routers from Cisco, CSU/DSUs from Digital Link
Corporation, IDSUs and DSUs from Kentrox Industries Inc. and modems and ISDN
from Cisco. Protected AC or DC power is used at all sites to protect against
power outages affecting the network.
In addition to these backbone facilities, DIGEX presently operates a Server
Farm at its suburban Washington, D.C. headquarters and intends to construct an
additional Server Farm and a back-up NOC on the west coast by the end of 1997.
The Company may decide to build additional Server Farms in the future to
better serve customer needs. Multiple Server Farms allow Internet users to
access the server closest to them and thus provide a better level of service,
and would allow DIGEX to minimize the amount of server-related traffic which
it must carry long distances over its network. Geographic distribution of
customer data also provides for redundancy in case of hardware, software or
network failure, contributing to increased uptime and service reliability.
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<PAGE>
PRODUCTS AND SERVICES
The Company offers its INDUSTRIAL STRENGTH Internet solutions through four
separate and highly focused business units.
Business Connectivity Group
DIGEX provides complete connectivity solutions to its business customers,
including frame relay, leased lines and SMDS, with availability limited only
by the capabilities of the in-market LECs. See"--Network Infrastructure." The
majority of the revenue generated by the Business Connectivity Group is
derived from its frame relay and leased line products. The Company offers
several configurations and monthly pricing plans, each based on the bandwidth
supplied and thus on the speed and capacity of the facility. In addition,
customers are strongly encouraged to enter into long-term contracts. The
Company's products are highly scalable and are designed to facilitate ease of
upgrade as the customer's needs evolve. The following chart describes the
Company's Business Connectivity options:
<TABLE>
<CAPTION>
SERVICE TYPE SUMMARY DESCRIPTION
----------------------------------------- -----------------------------------
<C> <S>
Frame Relay Flat rate, scalable 32 Kbps to 1.54
Mbps connectivity solutions based
on frame relay technology for small
to medium size business customers,
running all standard Internet
applications.
Leased Line A complete range (56 Kbps to 45
Mbps) of dedicated, clear channel
circuits for local-area/wide-area
networks and enterprises running
all standard and high-bandwidth
Internet applications.
Ethernet Plus 2 Mbps to 16 Mbps connectivity
solutions for small to large
business customers; provides an
easy "plug and play" solution for
Ethernet-based networks running all
Internet applications.
Switched Multimegabit Data Service (SMDS) A wide range of scalable solutions
(1.17 Mbps to 34 Mbps); designed
for metropolitan-central business
customers seeking a cost-effective
way to support all Internet
applications.
</TABLE>
In addition to basic connectivity service, DIGEX sells and configures
customer-premise routers, firewall security options and other value-added
services. DIGEX is an authorized reseller of the Eagle firewall product family
from Raptor Systems, Inc., and Firewall-1 from Check Point Software
Technologies Ltd. The Company also offers Secure Computing Corporation's
Sidewinder Internet firewall software. In addition, the Company helps
customers with initial use of their particular DIGEX solution. The Company
began providing business connectivity solutions in 1994 and plans to introduce
new products on a controlled basis, to ensure that the quality of delivery,
from both a sales and a support perspective, is in place, thus solidifying the
Company's reputation and building on its promise for delivering INDUSTRIAL
STRENGTH Internet solutions.
Internet Server Products Group
The Company has offered a complete range of Web server hosting solutions
since 1994. The Company's business customers are able to locate highly
reliable Web sites on dedicated servers at the Company's "Server Farm," which
enables users to gain high speed access to the Web server given the server's
direct connection to the Internet backbone. In addition, the Company provides
24x7x365 monitoring of the server and Internet connection by the Company's
highly experienced technical staff as well as easy server upgradability as the
customer's speed and capacity requirements grow. As Web server needs evolve,
DIGEX's goal is to continue to meet the market with the most advanced server
solutions available. In September 1996, the Company introduced the world's
first Windows NT 4.0 hosted server product line.
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<PAGE>
Private Networks Group
The Private Networks Group creates customized solutions for
telecommunications service providers looking to offer highly reliable private
label Internet connectivity solutions without incurring the lead time and
costs associated with building their own facilities. In turn, these providers
absorb customer-acquisition costs that would otherwise be borne by the
Company. When an individual contract is secured, a customized implementation
and service organization will be created to provide a premium level of support
for the private network customer. The Company expects that the operations of
the private network customer and the DIGEX support team will be integrated to
enhance customer support.
The Company began offering private network solutions in 1996 and recently
entered into multi-year private network agreements with LCI, WinStar, Orion
and World Reservation Systems, Inc. Through its private network agreement with
the Company, Orion will resell the Company's connectivity services to its
customers in Europe. The Private Network Group seeks to enter into multi-year
agreements having either take-or-pay commitments or bulk discounts based on
the aggregate amount of Internet solutions purchased. Under the Company's
private network agreement with LCI, dated May 29, 1996, LCI has agreed to
purchase, subject to certain terms and conditions, a minimum of $5 million of
Internet products and services over the 42-month term of the contract.
Similarly, under WinStar's private network agreement with the Company, WinStar
will purchase during the next six years a minimum of $5.0 million of Internet
connectivity solutions with the right to purchase additional amounts, in each
case on a discounted basis. DIGEX's agreement with Orion provides for bulk
discounts over a 36-month period based on the aggregate amount of Internet
services purchased, while World Reservation Systems, Inc.'s private network
agreement with the Company includes a $1.3 million take-or-pay commitment to
purchase telecommute connectivity solutions.
Telecommute Products Group
The Telecommute Products Group began offering its solutions in 1990 and
offers a variety of high-end, dial-up options to business professionals,
telecommuters and small businesses. The group's products range from lower-
cost, limited-access capability products to premium-priced, high-speed, low-
latency products. This group focuses on two distinct customer groups: (i)
professionals who require reliable at-home Internet connectivity and whose
usage is frequently paid for as part of an integrated, total-solution
connectivity package procured on a large scale by their employers and (ii)
small businesses that are likely to broaden and upgrade their solutions,
eventually becoming Business Connectivity Group and Internet Server Products
Group customers. The Company is currently engaged in discussions with
Microsoft to include DIGEX in Microsoft's Solution Provider Program, which
would result in the Company's being designated a preferred vendor for
Microsoft's corporate customers. There can be no assurance, however, that
these discussions will culminate in an agreement with Microsoft. The Company
believes that the Telecommute Products Group complements the Business
Connectivity Group by providing high-end solutions to professionals employed
by Business Connectivity customers.
CUSTOMERS
The Company's leased line and server customers have expanded to
approximately 1050 accounts at August 31, 1996. In 1995, no customer accounted
for more than five percent of the Company's total revenues. In addition to its
leased line and server customers, the Company had approximately 5,000 dial-up
customers at August 31, 1996. The following are lists of selected DIGEX
customers:
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<PAGE>
BUSINESS CONNECTIVITY INTERNET SERVERS
ALCOA AMTRAK
COMSAT Corporation ASPLUNDH
Credit Suisse Campmor, Inc.
Disclosure, Inc. CIGNA Corp.
Freeloader, Inc. Emmy Awards
ITT Avionics Federal Reserve Bank of Richmond
Litton Systems, Incorporated Grand Heritage Hotel Company
Lucent Technologies Inc. Maryland Dept. of Agriculture
Merrill Lynch & Co., Inc. Graduate School
National Basketball Association National Association of Investors
Oracle Corporation Orbit Questal Inc. Philadelphia
Piper & Marbury, LLP Federal Credit Union
PointCast, Inc. PointCast, Inc.
SAIC TeeVee Toons, Inc.
Southwestern Bell Corp. 20/20 Software, Inc.
TRW The World Bank
University of Maryland
U.S. Dept. of Commerce/NOAA
Westinghouse Electric Corp.
Wheat First Butcher Singer, Inc.
The World Bank
SALES AND MARKETING
As of September 24, 1996, the Company employed 135 people in sales and
marketing. To date, the Company has sold its Internet solutions primarily
through its direct telephone sales force. Call activity is generated both by
"cold calling" and in response to customer referrals, E-mail correspondence
through the Company's Web site and a variety of promotional programs,
including advertising in general business and specialty periodicals,
participation in industry trade shows and press relations. In addition, the
Company engages in local promotional programs to support newly opened service
locations. In order to better serve the needs of its customers, the Company
has developed a specialized marketing approach for each business unit.
The sales force for the Company's Business Connectivity Group continues to
grow to meet the demands of customers along DIGEX's growing nationwide
network. The Company plans to add sales representatives who will focus on the
cities where the Company is opening new POPs along the network and to support
them with marketing programs to generate quality sales leads. In addition, the
Company purchases prequalified sales leads, solicits customers through direct
mail advertising, conducts sales seminars, advertises in national trade
publications and to participate in industry trade shows. The Company believes
that active marketing and lead generation efforts will allow the sales force
to become even more productive and efficient.
In addition to using the Business Connectivity Group's sales force for
marketing its products and services, the Internet Server Products Group has
created an Alliance Partner program, which is a national network of agents
selling its products. In connection with the Alliance Partner program, DIGEX
has entered into agent agreements with organizations in select cities
nationwide, such as advertising agencies, graphic design firms and development
companies whose primary business is the creation of Web sites. In addition,
DIGEX has deployed regional account executives to support these organizations
and to develop and maintain relationships with targeted end users.
The Private Networks Group has a dedicated business development team which
targets a number of types of potential customers, including IXCs, LECs, cable
operators, large private network providers, and CAPs. The Company seeks to
enter into long-term, non-exclusive arrangements with these potential
resellers.
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<PAGE>
The Telecommute Products Group sells its services through the Company's
direct sales force, through private network providers and through direct
marketing to the group's target markets. The Company's targeted businesses
include telecommuters who may purchase connectivity through a customer of the
Business Connectivity Group and small or home office users who are likely to
upgrade their services in the future.
COMPETITION
The market for all types of Internet connectivity services is extremely
competitive. There are no substantial barriers to entry, and the Company
expects that competition will intensify in the future. As a result of an
increase in the number of competitors, and vertical and horizontal integration
in the industry, the Company expects to encounter significant pricing pressure
and other competition in the future. Advances in technology as well as changes
in the marketplace and the regulatory environment are constantly occurring,
and the Company cannot predict the effect that ongoing or future developments
may have on the Internet industry generally or on the Company specifically.
See "Risk Factors--Competition," "--Dependence Upon Product Development; Risks
of Changing Technology and Industry Standards" and "--Potential Liability for
Information Disseminated Over Network; Regulation."
Connectivity
ISPs. Currently, the Company's primary competitors are other ISPs focused on
business customers including UUNET, BBN and PSI. UUNET, BBN and PSI in
particular have significantly greater market presence and financial,
technological and personnel resources than the Company and have extensive
coast-to-coast Internet backbones.
A number of these competitors, however, including UUNET and PSI, have chosen
to pursue individual connectivity customers in an effort to balance the use of
their networks, since business customers tend to use the Internet during
business hours, while individual customers tend to use the Internet after
business hours. As a result, these ISPs have been forced to build out their
networks beyond what would be necessary to serve business customers. DIGEX, on
the other hand, has found that it can maintain its focus on business customers
and build a network infrastructure that can serve a substantial majority of
the business marketplace with fewer POPs than its competitors. In addition,
the Company's Web server hosting business, while offering additional Internet
solutions to its business customers, generates a substantial portion of its
traffic after business hours, and thus balances the usage of the Company's
network. Thus, given its more focused business strategy and more efficient use
of capital, DIGEX can offer a comprehensive range of business Internet
solutions on a cost-effective basis.
To a lesser extent, the Company competes with other national and regional
ISPs, of which there are currently over 1500. Many of these competitors,
however, including NETCOM, do not share DIGEX's business focus. In addition,
due to the substantial increase in the amount of data traffic carried by the
networks of certain national ISPs, the Company expects the industry's current
practice regarding peering to evolve by the end of 1996 to require an ISP to
possess (i) a coast-to-coast DS-3 backbone, (ii) 45 Mbps connections to three
U.S. peering points and (iii) a 24x7x365 NOC in order to qualify for peering
with the major national ISPs. The Company expects ISPs which do not satisfy
these requirements by the end of 1996 either to be acquired by the large
national ISPs or to be forced to become resellers of Internet connectivity
services, purchasing their network bandwidth at retail rates from national
ISPs.
Telecommunications Companies. The Company currently competes with AT&T, MCI
and Sprint. In addition, a number of regulatory obstacles to the entry of
other telecommunications companies into the Internet connectivity market are
being removed. Accordingly, the Company expects competition to increase with
other major telecommunications companies, including MFS and the RBOCs. In
addition, deregulation of the telecommunications industry has already led to
significant horizontal integration through acquisitions and joint ventures,
and the Company expects these trends to continue.
The telecommunications companies the Company competes with have access to
significantly greater financial, technological and personnel resources than
the Company and large existing commercial customer
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<PAGE>
bases. In addition, IXCs, including AT&T, MCI and Sprint, possess existing
nationwide telecommunications networks and generally face lower network
infrastructure costs in providing Internet connectivity than the Company.
Although its WorldNet offering targets the consumer market, AT&T is party to
an agreement with BBN pursuant to which it can market BBN's business
connectivity services to AT&T's commercial customer base or, in the
alternative, provide its own Internet connectivity. GTE Corp. ("GTE") and
UUNET have also recently announced a strategic alliance whereby GTE's
customers may obtain access to the Internet through UUNET's network. While
these telecommunications companies have little experience with TCP/IP
networking in general, and Internet connectivity in particular, they now may
employ their larger sales organizations to sell Internet connectivity to their
existing telephony customers, both commercial and consumer. However, the
Company believes that its sales and marketing personnel, which have
backgrounds in data-oriented services, particularly TCP/IP will be able to
sell Internet connectivity more effectively than the sales forces of most
telecommunications companies, which possess backgrounds largely in voice-
oriented services.
Most LECs, such as the RBOCs, and CAPs, on the other hand, do not currently
possess nationwide networks. In order to address the Internet connectivity
requirements of their current business customer bases, these companies must
either buy connectivity to an Internet network infrastructure or build such a
network. For example, MFS has acquired UUNET and can now offer expanded
Internet connectivity along with its traditional telecommunications services,
and World Com, Inc. has recently announced its agreement to acquire MFS. The
Company seeks to capitalize on the market opportunity created by
telecommunications companies that have chosen to buy, not build, Internet
connectivity for resale through its Private Networks Group, which sells
DIGEX's Internet connectivity services to telecommunications companies to be
remarketed under their own brands.
Cable Television and Direct Broadcast Satellite. Certain companies are
exploring the possibility of providing high-speed data services using
alternative delivery methods. For example, @Home, a joint venture between
Tele-Communications, Inc. and Kleiner Perkins Caufield & Byers, has stated its
intent to provide high-speed data services over cable television plant, and
HNS has lauched DirecPC, which will deliver high-speed data through direct
broadcast satellite technology. CAI Wireless Systems, Inc., a wireless cable
television service, also has announced that it has begun testing the first
Internet connectivity product delivered by wireless cable. However, since they
do not currently possess nationwide networks, these companies, in order to
provide Internet access, must either buy access to an Internet network
infrastructure or build such a network.
On-Line Service Providers. The Company also competes, to a lesser extent,
with certain on-line service providers who offer Internet connectivity in
conjunction with their primary products or services. For example, Microsoft
provides connectivity to the Internet through the Microsoft Network, which was
built by UUNET (in which Microsoft holds a significant minority stake), as a
standard integrated feature of its Windows 95 operating system, and IBM's OS/2
WARP operating system is preconfigured to provide Internet connectivity
through the Advantis network, which is controlled by IBM. Microsoft has also
recently announced strategic marketing alliances for Internet access with MCI,
AT&T and NETCOM. In addition, AOL, CompuServe and Prodigy currently provide
connectivity to the Internet, and many have announced plans to offer expanded
Internet connectivity capabilities. Currently, on-line service providers are
primarily focused on the consumer marketplace.
Web Server Hosting
The market for Web server hosting is highly fragmented and extremely
competitive. There are no substantial barriers to entry and the Company
expects the competition will intensify in the future. Currently, the Company's
primary competitors are other ISPs, including BBN, UUNET and PSI, and
companies whose primary business is developing and operating "Server Farms"
such as Internet Direct. In addition, many organizations currently host Web
servers at their own facilities. The Company believes, however, that as
bandwidth requirements increase, it will become more economical for these
organizations to outsource their needs. The Company believes that it
significantly differentiates itself from its competitors by offering flat-rate
billing, dedicated servers, 24x7x365 monitoring, upgradability and other
value-added services demanded by high-end business customers.
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PROPERTIES
The Company's administrative offices, as well as its NOC and Server Farm,
are located in Beltsville, Maryland, where the Company currently leases
approximately 73,000 square feet under leases that expire in 1998 and 2000.
The Company believes that this facility will meet its needs through at least
the remainder of 1996. The Company intends to lease space on the west coast of
the United States to house its second Server Farm, which the Company expects
to construct in 1997. The Company also leases space (typically less than 200
square feet) in various geographic locations to house the telecommunications
equipment for each of its POPs. See "Network Infrastructure" for a description
of the components of the Company's nationwide network, the Company's NOC and
the current Server Farm.
EMPLOYEES
As of September 24, 1996, the Company employed 263 persons full-time,
including 135 in sales and marketing, 86 in network operations (including
eight in technical support) and 42 in general and administrative functions.
None of the Company's employees is represented by a labor union, and the
Company considers its employee relations to be good.
LEGAL PROCEEDINGS
The Company is not involved in any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The Company's executive officers, directors and other key employees, and
their ages as of October 1, 1996, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Christopher R. McCleary(1) 44 Chairman of the Board, President,
Chief Executive Officer
Clyde A. Heintzelman 57 Senior Vice President, Chief Operating
Officer, General Manager--Business
Connectivity Group
Thomas M. Brandt, Jr. 45 Senior Vice President, Chief Financial
Officer, Secretary
Earl P. Galleher 36 Vice President, General Manager--
Internet Server Products Group
Nicholas J. Magliato 30 Vice President, General Manager--
Private Networks Group
Brian M. Deobald 34 Vice President, General Manager--
Telecommute Products Group
William A. Pendley 32 Vice President, Assistant General
Manager--Business Connectivity Group
John C. Welling 31 Vice President, Controller
Douglas E. Humphrey 36 Senior Vice President, Chief
Technology Officer, Director
Sheryl R. Richeson 40 Vice President, Customer Service--
Business Connectivity Group
Edward J. Kern 28 Vice President, Network--Business
Connectivity Group
William F. Webb, Jr. 30 Vice President, Internet Server
Technical Operations
Michael T. Doughney 38 Vice President, Director
Frank A. Adams(1)(2) 51 Director
Thomas H. Cato(3) 54 Director
William F. Earthman III(1)(2) 45 Director
Ray A. Rothrock(1)(3) 41 Director
Robert M. Stewart(2) 42 Director
John H. Wyant(3) 50 Director
</TABLE>
- --------
(1) Member of the Executive Committee.
(2) Member of the Compensation Committee.
(3) Member of the Audit Committee.
37
<PAGE>
Christopher R. McCleary joined DIGEX as President and Chief Executive
Officer in February 1996. Mr. McCleary has served as a director since joining
the Company and was elected Chairman of the Board of Directors in June 1996,
succeeding Frank A. Adams, who remains a director. Mr. McCleary was one of the
founding management team members at American Mobile Satellite Corporation
("AMSC"), where he served as a Vice President and General Manager, Satellite
Telephone Service from 1990 until joining DIGEX in 1996. Prior to joining
AMSC, Mr. McCleary was founder and President of the Satellite Network Antenna
Division of Radiation Systems, Inc. Mr. McCleary received his Bachelor's
degree from the University of Kentucky.
Clyde A. Heintzelman has served as Senior Vice President and Chief Operating
Officer since May 1995. From 1992 to 1994, Mr. Heintzelman was Vice President
of Sales and Marketing for Connective Strategies, Inc. ("CSI"), an ISDN
startup company. Mr. Heintzelman spent 28 years with Bell Atlantic prior to
joining CSI, serving as General Manager of Marketing and Sales for Bell
Atlantic Directory Services from 1990 until 1992 and as Vice President of
Sales and Marketing for the Business Market at C&P Telephone from 1985 to
1990. Mr. Heintzelman was President and CEO of Bell Atlanticom from 1983 to
1985 and, prior to that, was the general manager who established Bell
Atlantic's Federal Systems Division. Mr. Heintzelman received his Bachelor's
degree from the University of Delaware and has also done graduate work at the
Wharton School, the University of Pittsburgh and the University of Michigan.
Thomas M. Brandt, Jr. joined DIGEX as Senior Vice President and Chief
Financial Officer in June 1996. Mr. Brandt was named Secretary in late June
1996. Mr. Brandt was a director at Price Waterhouse LLP from 1993 until he
joined DIGEX. From 1987 through 1992, Mr. Brandt served as Vice President and
Chief Financial Officer for U.S. Metalsource Corporation, a metals
distribution business. Mr. Brandt received his M.B.A. degree from the Wharton
School of the University of Pennsylvania and his Bachelor's degree from Duke
University.
Earl P. Galleher joined DIGEX as Vice President and General Manager--
Internet Server Products in March 1996. Prior to joining DIGEX, Mr. Galleher
was Director of Marketing at AMSC, which he joined in November 1991. Mr.
Galleher led the development of AMSC's product positioning, branding strategy
and subscriber acquisition investment plan. Prior to AMSC, Mr. Galleher was
Manager of Market Development at Southwestern Bell Mobile Systems Washington-
Baltimore system, which he joined in April 1990. Mr. Galleher received his
Bachelor of Arts degree from Denison University.
Nicholas J. Magliato joined DIGEX as Vice President and General Manager--
Private Networks in March 1996. Prior to joining DIGEX, Mr. Magliato was the
Director of Land Mobile Sales and Distribution at AMSC, which he joined in
April 1993. His responsibilities at AMSC included creating product plans for
wireless voice and data services and developing and implementing a nationwide
sales and distribution strategy. Prior to AMSC, Mr. Magliato was a
telecommunications consulting manager at Andersen Consulting LLP, which he
joined in August 1987. Mr. Magliato received a Bachelor's degree,
concentrating in Computer and Information Services, from Syracuse University.
Brian M. Deobald joined DIGEX as Vice President and General Manager--
Telecommute Products in March 1996. Prior to joining DIGEX, Mr. Deobald was
the Director of Product Management at AMSC, which he joined in November 1991.
At AMSC, Mr. Deobald created the company's business plan and developed and
introduced services, subscriber hardware, and pricing. Mr. Deobald joined AMSC
from AT&T International Communications Services where he managed strategic and
business planning since July 1989. Mr. Deobald received an M.B.A. from the
Wharton School and holds a Master's degree from Johns Hopkins University and a
Bachelor's degree from Georgetown University.
William A. Pendley joined DIGEX in December 1994 as Chief Financial Officer
and currently serves as Vice President and Assistant General Manager--Business
Connectivity. In 1995, Mr. Pendley was responsible for developing DIGEX's
financial business plan and securing the first-level financing with venture
capital investors. Prior to joining DIGEX, Mr. Pendley was Chief Financial
Officer for Intrafed, Inc., a software developer and system integrator, from
1994 and prior to that, served in a financial management position for IBM
Federal Systems from 1989. Mr. Pendley holds an M.B.A. in finance from New
York University and a Bachelor's degree from Georgetown University.
38
<PAGE>
John C. Welling joined DIGEX as a Vice President and Controller in April
1996. Prior to joining DIGEX, Mr. Welling was a senior manager at KPMG Peat
Marwick LLP, focusing on publicly-held companies, from 1987 until 1996. Mr.
Welling received a Bachelor's degree, with a concentration in accounting, from
Loyola College in Baltimore, Maryland.
Douglas E. Humphrey is the Senior Vice President, Chief Technology Officer
and co-founder of DIGEX. Mr. Humphrey has also served as a director of the
Company since 1990 and served as the Chief Executive Officer from the
Company's inception until Mr. McCleary joined DIGEX in February 1996. Mr.
Humphrey was a senior TCP/IP networking and computer security specialist for
Tandem Computers, Inc. from September 1987 to March 1993. From 1983 to 1987,
Mr. Humphrey was President and CEO of Computer Time Share Corporation.
Mr. Humphrey attended the University of Maryland at College Park.
Sheryl R. Richeson is Vice President, Customer Service--Business
Connectivity. Ms. Richeson joined DIGEX as Director of Customer Service in
October 1995. Ms. Richeson is an experienced telecommunications executive with
more than 14 years of management experience with Bell Atlantic, which she
joined in 1981. Ms. Richeson served as Director of Large Business Services and
as regional manager for Field Sales Support for Bell Atlantic. Ms. Richeson
holds a Master's degree from Johns Hopkins University and a Bachelor of
Science degree from the University of Colorado.
Edward J. Kern joined DIGEX in 1992 as Manager of Systems and was promoted
to Vice President, Network--Business Connectivity in May 1996. Prior to
joining DIGEX, Mr. Kern spent seven years building and managing TCP/IP
networks as a consultant for various companies. Mr. Kern is an active member
of the Internet Engineering Task Force.
William F. Webb, Jr. joined DIGEX as Vice President, Internet Server
Technical Operations in May 1996. Prior to joining DIGEX, Mr. Webb was a
manager at Andersen Consulting LLP beginning in June 1990. At Andersen
Consulting, Mr. Webb worked in the Telecommunications Industry Market Unit,
focusing on service activation systems for major telecommunications clients.
Mr. Webb holds an M.B.A. degree from Virginia Polytechnic Institute and State
University and a Bachelor of Science degree in Computer Science and
Mathematics from Eastern Nazarene College.
Michael T. Doughney is a Vice President and co-founder of DIGEX and has
served as a director of the Company since 1990. Mr. Doughney majored in
computer science and electrical engineering at the University of Maryland.
Frank A. Adams has been a director of the Company since April 1995. Mr.
Adams served as Chairman of the Board from April 1995 until June 1996, when
Mr. McCleary was elected Chairman. Mr. Adams is currently President and CEO of
Grotech Capital Group which he co-founded in 1984. Mr. Adams has held
positions with public companies, including PHH Corporation, RLC/Matlack and
Westinghouse. Mr. Adams is also a director of several private companies. Mr.
Adams received his Bachelor's and Juris Doctor degrees from the University of
Baltimore and has completed advanced management programs at Stanford
University and Harvard University.
Thomas H. Cato joined DIGEX in July 1996 as a director. Mr. Cato is a
business consultant in information systems and health care. From 1985 until
founding his consulting business in June 1995, Mr. Cato was president of HCA
Information Services, a wholly-owned subsidiary of Hospital Corporation of
America. Mr. Cato was a co-founder of ENDATA, a public information services
company. Mr. Cato, a retired colonel from the United States Army Reserves,
received his B.B.A. from Tulane University.
William F. Earthman III has been a director of the Company since April 1995.
Mr. Earthman is a general partner of Southern Venture Fund II, L.P. and a
Partner of Massey Burch Capital Corporation. Before joining Massey Burch
Capital Corporation as Vice President in 1989, he served at the firms of J.C.
Bradford & Co., Prudential-Bache Securities and, most recently, First
Nashville Corporation. Mr. Earthman is also a director of Ensys Environmental
Products Inc. Mr. Earthman received his Bachelor's degree from the University
of Virginia.
39
<PAGE>
Ray A. Rothrock has been a director of the Company since April 1995. Mr.
Rothrock is a general partner of Venrock Associates and Venrock Associates II,
L.P. and has been with the firm since 1988. Mr. Rothrock was with Sun
Microsystems Inc. for four years prior to joining Venrock. Mr. Rothrock
received his M.B.A. degree from Harvard Business School, an MS in Nuclear
Engineering from Massachusetts Institute of Technology, and a Bachelor of
Science in Nuclear Engineering from Texas A&M University. He serves as a
director of Spyglass, Inc. and Check Point Software Technologies, Ltd. of Tel
Aviv, Israel and several private companies.
Robert M. Stewart has been a director of the Company since December 1995.
Mr. Stewart has been a Managing Director of the Anchor Financial Group LLC
since November 1995, a private investment banking firm in Washington, D.C.
Prior to joining Anchor Financial Group, Mr. Stewart was a Principal with
Armata Partners L.P. from April 1993 and, prior to that, a Vice President of
Legg Mason Wood Walker, Inc., which he joined in February 1989. Mr. Stewart
holds an M.B.A. from the Babcock Graduate School of Management of Wake Forest
University and a B.A. from Hampden-Sydney College.
John H. Wyant began serving as a director of the Company in June 1996. Mr.
Wyant is the president of Blue Chip Venture Company, which he founded in 1990.
Mr. Wyant is also a director of Zaring Homes Inc. and several private
companies. Mr. Wyant received his B.A. degree from Denison University and his
J.D. degree from Chase College of Law.
Each officer serves at the discretion of the Board of Directors. There are
no family relationships among any of the directors and executive officers of
the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has established an Executive Committee, an Audit
Committee and a Compensation Committee.
The Executive Committee consists of Mr. Adams (Chairman), Mr. Earthman, Mr.
McCleary and Mr. Rothrock. The Executive Committee reviews, evaluates and
makes decisions and recommendations with respect to specific matters delegated
to the Executive Committee by the Board of Directors.
The Audit Committee consists of Mr. Rothrock (Chairman), Mr. Wyant and Mr.
Cato. The Audit Committee makes recommendations to the Board of Directors
regarding the selection of independent auditors, reviews the results and scope
of the audit and other services provided by the Company's independent
auditors, and reviews and evaluates the Company's audit and control functions.
The Compensation Committee consists of Mr. Earthman (Chairman), Mr. Adams
and Mr. Stewart. The Compensation Committee administers the Company's Stock
Option Plans and makes decisions concerning salaries and incentive
compensation for employees and consultants of the Company.
DIRECTORS' COMPENSATION
Non-employee directors are reimbursed for reasonable expenses incurred by
them in attending Board meetings. Pursuant to the terms of the Securities
Purchase Agreement by and among the Company, Mr. Humphrey, Mr. Doughney,
Grotech Capital Partners IV, L.P. ("Grotech IV"), Venrock Associates
("Venrock"), and Southern Venture Fund II, L.P. ("Southern"), dated as of
March 24, 1995 (the "Securities Purchase Agreement"), the Company pays to each
of Grotech IV, Venrock and Southern an annual director's fee of $10,000 for
the respective directors designated by such entities. Under that certain
Purchase and Exchange Agreement (as defined), the Company also pays Blue Chip
an annual director's fee of $10,000 for the director designated by such
entity. Upon consummation of the Offering, the non-employee directors shall
cease to be entitled to receive such fees but shall continue to receive
reimbursement for reasonable expenses incurred in their capacity as directors.
In addition, non-employee directors are eligible for the grant of stock
options under the Company's Equity Plan. Each director who is not an employee
of the Company has been granted options to
40
<PAGE>
purchase 8,000 shares of Common Stock. In addition, each non-employee director
will be granted options to purchase 8,000 shares of Common Stock at each
annual meeting at which such director is re-elected as a director. See "--
Incentive Stock Option Plans--Equity Plan."
BOARD COMPOSITION
In connection with the reincorporation of the Company as a Delaware
corporation, the Company will amend and restate its Certificate of
Incorporation and Bylaws. The Certificate of Incorporation and Bylaws of the
Company will provide that the directors of the Company are divided into three
classes. A class of directors will be elected by plurality vote, with no
cumulative voting, at each annual meeting of stockholders. Messrs. Adams,
Humphrey and McCleary will be designated Class I directors and will serve
until the meeting of stockholders in 1997. Messrs. Doughney, Stewart and Wyant
have been designated Class II directors and will serve until the meeting of
stockholders in 1998. Messrs. Cato, Earthman and Rothrock will be designated
Class III directors and will serve until the meeting of stockholders in 1999.
Thereafter, each class of directors will have a term of three years, with a
term of one class expiring each year.
Under the Securities Purchase, Conversion and Exchange Agreement (the
"Purchase and Exchange Agreement"), dated as of May 30, 1996, by and among the
Company, Grotech IV, Grotech Partners III, L.P. ("Grotech Partners"), Grotech
III Companion Fund, L.P. ("Grotech Companion"), Grotech III Pennsylvania Fund,
L.P. ("Grotech Pennsylvania"), Venrock, Venrock Associates II, L.P. ("Venrock
II"), Southern, Blue Chip, Crisler Capital Company, Limited Partnership
("Crisler," and together with Grotech IV, Grotech Partners, Grotech Companion,
Grotech Pennsylvania, Venrock, Venrock II, Southern, and Blue Chip, the "1996
Venture Investors"), Mr. Humphrey and Mr. Doughney, the 1996 Venture Investors
and Messrs. Humphrey and Doughney have agreed to vote their shares of voting
stock of the Company for the election of: (i) four directors designated by
Messrs. Humphrey and Doughney (Mr. Humphrey, Mr. Doughney, Mr. Stewart and Mr.
McCleary), (ii) one director designated by Grotech IV (Mr. Adams), (iii) one
director designated by Venrock (Mr. Rothrock), (iv) one director designated by
Southern (Mr. Earthman), (v) one director designated by Blue Chip (Mr. Wyant)
and (vi) one director to be jointly designated by the 1996 Venture Investors
and Mr. Humphrey (Mr. Cato). This agreement superseded provisions of the
Securities Purchase Agreement concerning the election of directors. The
provisions of the Purchase and Exchange Agreement concerning election of
directors terminate effective immediately prior to consummation of the
Offering. Accordingly, no stockholder shall be obligated to vote in favor of
election of any person nominated for election of the Board of Directors by any
other stockholder following consummation of the Offering.
41
<PAGE>
EXECUTIVE COMPENSATION
The following table summarizes all compensation earned by Douglas E.
Humphrey (the "Named Executive Officer"), who served as the Company's Chief
Executive Officer during the fiscal year ended December 31, 1995. No other
executive officers of the Company earned in excess of $100,000 of salary and
bonus during the fiscal year ended December 31, 1995.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
--------------------
NAME AND ALL OTHER
PRINCIPAL FISCAL SALARY BONUS COMPENSATION
POSITION YEAR ($) ($) ($)(2)
- --------- ------ ---------- --------- ------------
<S> <C> <C> <C> <C>
Douglas E. Humphrey(1)................ 1995 $ 100,000 $ 20,000 $6,600
Chief Executive Officer
</TABLE>
- --------
(1) Mr. Humphrey was Chief Executive Officer of the Company until February
1996, when Mr. McCleary succeeded him. Mr. Humphrey is currently a Senior
Vice President and Chief Technology Officer of the Company.
(2) This amount represents a car allowance.
OPTION GRANTS IN 1995
No options were granted for the fiscal year ended December 31, 1995 to the
Named Executive Officer and no stock appreciation rights have been granted to
date. In addition, the Named Executive Officer currently holds no options for
the Common Stock and did not exercise any options during the fiscal year ended
December 31, 1995.
INCENTIVE STOCK OPTION PLANS
1995 STOCK OPTION PLAN
The Board of Directors has adopted an Incentive Stock Option Plan (the "1995
Stock Option Plan"). Under the 1995 Stock Option Plan, employees are entitled
to purchase Common Stock of the Company by cash payment or by delivery of
existing shares of Common Stock held by such employee. The purpose of the 1995
Stock Option Plan and of granting options to specified employees of the
Company pursuant thereto is to further the growth, development and financial
success of the Company by providing additional incentives to such persons by
assisting them to acquire shares of Common Stock of the Company and to benefit
directly from the Company's growth, development and financial success. Options
granted under the 1995 Stock Option Plan vest in accordance with one of the
following schedules or in accordance with an alternative schedule approved by
the Board of Directors: (i) 25% of the aggregate amount of options granted to
a particular employee upon the first anniversary of the date of hire of such
employee and the remaining 75% of the aggregate amount of options on a
quarterly basis, evenly spread out over the three-year period following the
first anniversary of the date of hire or (ii) 33% of the aggregate amount of
options granted to a particular employee upon the first anniversary of the
date of hire of such employee and the remaining 67% of the aggregate amount of
options on a quarterly basis, evenly spread out over the two-year period
following the first anniversary of the date of hire. Options granted under the
1995 Stock Option Plan expire on the tenth anniversary of the date of grant.
The Company has reserved 1,099,054 shares of Common Stock for issuance under
the 1995 Stock Option Plan, none of which have been issued to date. As of July
19, 1996, options for the purchase of 1,099,054 shares of Common Stock are
outstanding under the 1995 Stock Option Plan. The exercise price for all of
such outstanding options is $0.25 per share. No new options will be granted
under the 1995 Stock Option Plan.
EQUITY PLAN
The Company adopted the DIGEX, Incorporated 1996 Equity Participation Plan
(the "Equity Plan") effective as of May 31, 1996. The principal purposes of
the Equity Plan are to provide incentives for officers,
42
<PAGE>
employees and consultants of the Company through granting of options,
restricted stock and other awards ("Awards"), thereby stimulating their
personal and active interest in the Company's development and financial
success, and inducing them to remain in the Company's employ. In addition to
Awards made to officers, employees or consultants, the Equity Plan provides
for the granting of options ("Director Options") to the Company's independent
non-employee directors pursuant to a formula, as described in further detail
below.
Under the Equity Plan, not more than 1,401,426 shares of Common Stock (or
the equivalent in other equity securities) are authorized for issuance upon
exercise of options, stock appreciation rights ("SARs") and other Awards, or
upon vesting of restricted or deferred stock Awards; provided however, that
Awards with respect to additional shares may be granted to the extent that
options expire or are otherwise terminated unexercised under the 1995 Stock
Option Plan. In the aggregate, no more than 2,500,480 shares may be
outstanding under the 1995 Stock Option Plan and the Equity Plan. As of the
date hereof, 1,136,246 nonqualified stock options to purchase Common Stock
have been granted to employees under the Equity Plan and 1,136,246 are
outstanding and Director Options to purchase 48,000 shares of Common Stock
have been granted to non-employee directors under the Equity Plan. No other
Awards have been made under the Equity Plan. The exercise price for all such
outstanding options ranges from $3.73 to $10.00 per share.
The shares available under the Equity Plan upon exercise of stock options,
SARs and other Awards, and for issuance as restricted or deferred stock
Awards, may be either previously unissued shares or treasury shares, and may
be equity securities of the Company other than Common Stock. The Compensation
Committee or a subcommittee thereof (the "Compensation Committee") (the Board
with respect to Director Options) has the discretion to make appropriate
adjustments in the number and kind of securities subject to the Equity Plan
and to outstanding Awards thereunder to reflect dividends or other
distributions; a recapitalization, reclassification, stock split, reverse
stock split, or reorganization, merger or consolidation of the Company; the
split-up, spin-off, combination, liquidation or dissolution of the Company; or
disposition of all or substantially all of the assets of the Company or
exchange of Common Stock or other securities of the Company; or other similar
corporate transaction or event.
If any portion of a stock option, SAR or other Award terminates or lapses
unexercised, or is cancelled upon grant of a new option, SAR or other Award
(which may be at a higher or lower exercise price than the option, SAR or
other Award so cancelled), the shares which were subject to the unexercised
portion of such option, SAR or other Award, will continue to be available for
issuance under the Equity Plan.
The principal features of the Equity Plan are summarized below, but the
summary is qualified in its entirety by reference to the Equity Plan itself.
Administration
Prior to the Offering, the Board of Directors of the Company will administer
the Equity Plan; following the closing of the Offering, the Compensation
Committee will administer the Equity Plan with respect to awards and the full
Board will administer the Equity Plan with respect to Director Options. The
Compensation Committee will consist of at least two members of the Board,
neither of whom is an employee of the Company and if the Board so determines,
each of whom will be a "non-employee director" for purposes of Rule 16b-3
under the Securities Exchange Act of 1934, as amended ("Rule 16b-3"). Subject
to the terms and conditions of the Equity Plan, the Compensation Committee has
the authority to select the persons to whom Awards are to be made, to
determine the number of shares to be subject thereto and the terms and
conditions thereof, and to make all other determinations and to take all other
actions necessary or advisable for the administration of the Equity Plan.
Similarly, the Board has discretion to determine the terms and conditions of
grants of Director Options and to interpret and administer the Equity Plan
with respect to Director Options, consistent with the specific formula terms
described in more detail below. The Compensation Committee (and the Board) are
also authorized to adopt, amend and rescind rules relating to the
administration of the Equity Plan.
43
<PAGE>
Amendment and Termination
Amendments of the Equity Plan to increase the number of shares as to which
Awards may be made (except for adjustments resulting from stock splits and the
like, and mergers, consolidations and other corporate transactions) require
the approval of the Company's stockholders. In all other respects the Equity
Plan can be amended, modified, suspended or terminated by the Compensation
Committee or the Board, unless such action would otherwise require stockholder
approval as a matter of applicable law, regulation or rule. Amendments of the
Equity Plan will not, without the consent of the participant, affect such
person's rights under an Award previously awarded, unless the Award Agreement
governing such Award itself otherwise expressly so provides. Unless sooner
terminated by the Board or the Compensation Committee, the Equity Plan will
expire on May 31, 2006. Such termination will not affect the validity of any
Award outstanding under the Equity Plan on the date of termination.
Eligibility
Options, SARs, restricted stock and other Awards under the Equity Plan may
be granted to individuals who are then officers or other employees of the
Company or any of its present or future subsidiaries. Such Awards also may be
granted to consultants of the Company selected by the Compensation Committee
for participation in the Equity Plan. Approximately 263 employees are eligible
to be granted Awards under the Equity Plan. More than one option, SAR,
restricted stock Award or other Award may be granted to an employee or
consultant, but the aggregate fair market value (determined at the time of
grant) of shares with respect to which an Incentive Stock Option is first
exercisable by an optionee (i.e. "vests") during any calendar year cannot
exceed $100,000. Non-employee directors may only be granted Director Options.
Payment for Shares
The exercise or purchase price for all options, Director Options, SARs,
restricted stock and other Awards that provide a right to acquire Common
Stock, together with any applicable tax required to be withheld, must be paid
in full in cash at the time of exercise or purchase or may, with the approval
of the Compensation Committee (or Board for Director Options) be paid in whole
or in part in Common Stock valued at their fair market value on the date of
exercise (which may, except with respect to incentive stock options, include
an assignment of the right to receive the cash proceeds from the sale of
Common Stock subject to an option or other right pursuant to a "cashless
exercise" procedure) or by delivery of other property, or by a recourse
promissory note payable to the Company, or by a combination of the foregoing.
Awards under the Equity Plan
The Equity Plan provides that the Compensation Committee may grant or issue
stock options, SARs, restricted stock, deferred stock, dividend equivalents,
performance awards, stock payments and other stock related benefits, or any
combination thereof. Each Award will be set forth in a separate agreement with
the person receiving the Award and will indicate the type, terms and
conditions of the Award.
Nonqualified Stock Options ("NQSOs") will provide for the right to purchase
Common Stock at a specified price which, except with respect to NQSOs intended
to qualify as performance-based compensation under Section 162(m) of the
Internal Revenue Code of 1986, as amended (the "Code"), may be less than fair
market value on the date of grant (but not less than par value), and usually
will become exercisable (in the discretion of the Compensation Committee) in
one or more installments after the grant date, subject to the participant's
continued employment with the Company and/or subject to the satisfaction of
individual or Company performance targets established by the Compensation
Committee. NQSOs may be granted for any term specified by the Compensation
Committee.
Incentive Stock Options ("ISOs") will be designed to comply with the
provisions of the Code, and will be subject to certain restrictions contained
in the Code. Among such restrictions, ISOs must have an exercise price not
less than the fair market value of a share of Common Stock on the date of
grant, may only be granted to
44
<PAGE>
employees, must expire within a specified period of time following the
Optionee's termination of employment, and must be exercised within the ten
years after the date of grant; but may be subsequently modified to disqualify
them from treatment as ISOs. In the case of an ISO granted to an individual
who owns (or is deemed to own) at least 10% of the total combined voting power
of all classes of stock of the Company, the Equity Plan provides that the
exercise price must be at least 110% of the fair market value of a share of
Common Stock on the date of grant and the ISO must expire upon the fifth
anniversary of the date of its grant.
Restricted Stock may be sold to participants at various prices (but not
below par value) and made subject to such restrictions as may be determined by
the Compensation Committee. Restricted stock, typically, may be repurchased by
the Company at the original purchase price if the conditions or restrictions
are not met. In general, restricted stock may not be sold, or otherwise
transferred or hypothecated, until restrictions are removed or expire.
Purchasers of restricted stock, unlike recipients of options, will have voting
rights and will receive dividends prior to the time when the restrictions
lapse.
Deferred Stock may be awarded to participants, typically without payment of
consideration, but subject to vesting conditions based on continued employment
or on performance criteria established by the Committee. Like restricted
stock, deferred stock may not be sold, or otherwise transferred or
hypothecated, until vesting conditions are removed or expire. Unlike
restricted stock, deferred stock will not be issued until the deferred stock
award has vested, and recipients of deferred stock generally will have no
voting or dividend rights prior to the time when vesting conditions are
satisfied.
SARs may be granted in connection with stock options or other Awards, or
separately. SARs granted by the Compensation Committee in connection with
stock options or other awards typically will provide for payments to the
holder based upon increases in the price of the Common Stock over the exercise
price of the related option or other Awards, but alternatively may be based
upon criteria such as book value. Except as required by Section 162(m) of the
Code with respect to an SAR intended to qualify as performance-based
compensation as described in Section 162(m)(4)(C) of the Code, there are no
restrictions specified in the Equity Plan on the exercise of SARs or the
amount of gain realizable therefrom, although restrictions may be imposed by
the Compensation Committee in the SAR agreements. The Compensation Committee
may elect to pay SARs in cash or in Common Stock or in a combination of both.
Dividend Equivalents represent the value of the dividends per share paid by
the Company, calculated with reference to the number of shares covered by the
stock options, SARs or other Awards held by the participant.
Performance Awards may be granted by the Compensation Committee on an
individual or group basis. Generally, these Awards will be based upon specific
performance targets and may be paid in cash or in Common Stock or in a
combination of both. Performance Awards may include "phantom" stock Awards
that provide for payments based upon increases in the price of the Common
Stock over a predetermined period. Performance Awards may also include bonuses
which may be granted by the Compensation Committee on an individual or group
basis and which may be payable in cash or in Common Stock or in a combination
of both.
Stock Payments may be authorized by the Compensation Committee in the form
of shares of Common Stock or an option or other right to purchase Common Stock
as part of a deferred compensation arrangement in lieu of all or any part of
compensation, including bonuses, that would otherwise be payable in cash to
the employee or consultant.
Director Options
Director Options are NQSOs granted to non-employee directors of the Company
pursuant to a formula. Under the formula in the Equity Plan, following the
closing of the Offering, when a director is initially elected to the Board and
is at that time a non-employee director, he or she automatically shall be
granted an NQSO to purchase 8,000 shares of Common Stock. During the term of
the Plan, each then current non-employee director shall automatically be
granted an NQSO to purchase 8,000 shares of Common Stock at each subsequent
annual
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<PAGE>
meeting at which he or she is reelected to the Board. Members of the Board who
are employees who subsequently terminate employment with the Company and
remain on the Board will not receive an initial NQSO grant as a non-employee
director, but, to the extent they are otherwise eligible, will receive NQSOs
as described in the preceding sentence after such termination of employment.
The exercise price of the Director Options shall be the fair market value of a
share of Common Stock on the date of grant. Each Director Option shall become
exercisable in cumulative annual installments of one-third on each of the
first, second and third annual meeting of shareholders that are subsequent to
the date of grant and at which directors are elected, subject to the
director's continued service as a director; provided, however, to the extent
permitted by Rule 16b-3, the Board may accelerate the exercisability of
Director Options upon the occurrence of certain specified extraordinary
corporate transactions or events and provided further, that in any event, upon
the occurrence of a "Change in Control" of the Company (as defined in the
Equity Plan) all outstanding Director Options shall become immediately
exercisable. No portion of a Director Option shall be exercisable after the
tenth anniversary of the date of grant and no portion of a Director Option
shall be exercisable upon the expiration of one year following the Director's
termination of services as a director of the Company.
Miscellaneous Provisions
The Compensation Committee (or Board with respect to Director Options) has
discretion under the Equity Plan to provide that options and other rights to
acquire Common Stock will expire at specified times following, or become
exercisable in full upon, the occurrence of certain specified "extraordinary
corporate events;" but in such event the Compensation Committee may also give
optionees and other grantees the right to exercise their outstanding options
or rights in full during some period prior to such event, even though the
options or other Awards have not yet become fully exercisable, and the
Compensation Committee may also provide that all restrictions imposed on some
or all shares of restricted stock and/or deferred stock shall lapse, and some
or all shares of restricted stock may cease to be subject to the Company's
right to repurchase after such event.
The Equity Plan specifies that the Company may make loans to participants to
enable them to exercise options, purchase shares or realize the benefits of
other Awards granted under the Equity Plan. The terms and conditions of such
loans, if any are made, are to be set by the Compensation Committee (or the
Board with respect to Director Options).
The dates on which options or other Awards under the Equity Plan first
become exercisable and on which they expire will be set forth in individual
Award agreements setting forth the terms of the Awards. Such agreements
generally will provide that options and other Awards expire upon termination
of the participant's status as an employee, consultant or director, although
the Compensation Committee may provide that options or other Awards granted to
employees or consultants continue to be exercisable following a termination
without Cause (as defined in the Equity Plan), or following a Change in
Control of the Company (as defined in the Equity Plan), or because of the
grantee's retirement, death, disability or otherwise. Similarly, restricted
stock granted under the Equity Plan which has not vested generally will be
subject to repurchase by the Company in the event of the grantee's termination
of employment or consultancy, although the Compensation Committee may make
exceptions, based on the reason for termination or on other factors.
No option, SAR, Director Option or other Award granted under the Equity Plan
may be assigned or transferred by the grantee, except by will or the laws of
descent and distributions, although the shares underlying such Awards may be
transferred if all applicable restrictions have lapsed. During the lifetime of
the holder of any option or right, the option or right may be exercised only
by the holder.
As a condition to the issuance or delivery of stock or payment of other
compensation pursuant to the exercise or lapse of restrictions of any option
or other Award granted under the Equity Plan, the Company requires
participants to discharge applicable withholding tax obligations. Shares held
by or to be issued to a participant may also be used to discharge tax
withholding obligations related to exercise of options or receipt of other
Awards, subject to the discretion of the Compensation Committee to disapprove
such use. In addition, the Compensation Committee may grant to employees a
cash bonus in the amount of any tax related to awards.
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<PAGE>
In May and June of 1996, the Company granted NQSOs. The value of options
granted under the Equity Plan depends on the future market value of a share of
Common Stock on the date of exercise and such value is not presently
determinable.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES WITH RESPECT TO THE EQUITY PLAN
The tax consequences of the Equity Plan under current federal law are
summarized in the following discussion which deals with the general tax
principles applicable to the Equity Plan, and is intended for general
information only. Alternative minimum tax and state and local income taxes are
not discussed. Tax laws are complex and subject to change and may vary
depending on individual circumstances and from locality to locality. The tax
information summarized is not tax advice.
Nonqualified Stock Options. For federal income tax purposes, an optionee
generally will not recognize taxable income on the grant of an NQSO under the
Equity Plan, but will recognize ordinary income, and the Company generally
will be entitled to a deduction, upon the exercise of an NQSO. The amount of
income recognized (and the amount generally deductible by the Company)
generally will be equal to the excess, if any, of the fair market value of the
shares at the time of exercise over the aggregate exercise price paid for the
shares, regardless of whether the exercise price is paid in cash or in shares
or other property. An optionee's basis for the stock for purposes of
determining his or her gain or loss upon a subsequent disposition of the
shares generally will be the fair market value of the stock on the date of
exercise of the NQSO, and any subsequent gain or loss will generally be
taxable as capital gains or losses.
Incentive Stock Options. An optionee generally will not recognize taxable
income upon either the grant or exercise of an ISO; however, the amount by
which the fair market value of the shares at the time of exercise exceeds the
exercise price will be an "item of tax preference" for the optionee.
Generally, upon the sale or other taxable disposition of the shares of the
Common Stock acquired upon exercise of an ISO, the optionee will recognize
income taxable as capital gains in an amount equal to the excess, if any, of
the amount realized in such disposition over the option exercise price,
provided that no disposition of the shares has taken place within either (a)
two years from the date of grant of the ISO or (b) one year from the date of
exercise. If the shares of Common Stock are sold or otherwise disposed of
before the end of the one-year and two-year periods specified above, the
difference between the ISO exercise price and the fair market value of the
shares on the date of exercise generally will be taxable as ordinary income;
the balance of the amount realized from such disposition, if any, generally
will be taxed as capital gain. If the shares of Common Stock are disposed of
before the expiration of the one-year and two-year periods and the amount
realized is less than the fair market value of the shares at the date of
exercise, the optionee's ordinary income generally is limited to excess, if
any, of the amount realized in such disposition over the option exercise price
paid. The Company (or other employer corporation) generally will be entitled
to a tax deduction with respect to an ISO only to the extent the optionee has
ordinary income upon sale or other disposition of the shares of Common Stock.
SARs. No taxable income is generally recognized upon the receipt of an SAR,
but upon exercise of the SAR the fair market value of the shares (or cash in
lieu of shares) received generally will be taxable as ordinary income to the
recipient in the year of such exercise. The Company generally will be entitled
to a compensation deduction for the same amount which the recipient recognizes
as ordinary income.
Restricted Stock and Deferred Stock. An employee to whom restricted or
deferred stock is issued generally will not recognize taxable income upon such
issuance and the Company generally will not then be entitled to a deduction,
unless, in the case of restricted stock, an election is made under Section
83(b) of the Code. However, when restrictions on shares of restricted stock
lapse, such that the shares are no longer subject to a substantial risk of
forfeiture, the employee generally will recognize ordinary income and the
Company generally will be entitled to a deduction for an amount equal to the
excess of the fair market value of the shares at the date such restrictions
lapse over the purchase price therefor. Similarly, when deferred stock vests
and is issued to the employee, the employee generally will recognize ordinary
income and the Company generally will be entitled to a deduction for the
amount equal to the fair market value of the shares at the date of issuance.
If an election is
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<PAGE>
made under Section 83(b) with respect to qualifying restricted stock, the
employee generally will recognize ordinary income at the date of issuance
equal to the excess, if any, of the fair market value of the shares at that
date over the purchase price therefor and the Company will be entitled to a
deduction for the same amount. The Code does not permit a Section 83(b)
election to be made with respect to deferred stock.
Dividend Equivalents. A recipient of a dividend equivalent award generally
will not recognize taxable income at the time of grant, and the Company will
not be entitled to a deduction at that time. When a dividend equivalent is
paid, the participant generally will recognize ordinary income, and the
Company will be entitled to a corresponding deduction.
Performance Awards. A participant who has been granted a performance award
generally will not recognize taxable income at the time of grant, and the
Company will not be entitled to a deduction at that time. When an award is
paid, whether in cash or Common Stock, the participant generally will
recognize ordinary income, and the Company will be entitled to a corresponding
deduction.
Stock Payments. A participant who receives a stock payment in lieu of a cash
payment that would otherwise have been made will generally be taxed as if the
cash payment has been received, and the Company generally will be entitled to
a deduction for the same amount.
Deferred Compensation. Participants who defer compensation generally will
recognize no income, gain or loss for federal income tax purposes when NQSOs
are granted in lieu of amounts otherwise payable, and the Company will not be
entitled to a deduction at that time. When and to the extent such NQSOs are
exercised, the rules regarding NQSOs outlined above will generally apply.
EMPLOYMENT CONTRACTS
In May 1995, the Company entered into an employment agreement with Mr.
Heintzelman. Pursuant to the terms of the agreement, Mr. Heintzelman's base
salary is $125,000 per year, plus a bonus, which was $20,000 in 1995. In
addition, Mr. Heintzelman also receives a $12,000 per year auto allowance
pursuant to the agreement. Mr. Heintzelman was granted options to purchase
200,000 shares of Common Stock of the Company at an exercise price of $0.25
per share at the time of entering into the agreement and additional options to
purchase 10,800 shares of Common Stock of the Company at an exercise price of
$0.25 per share in January 1996. Grants were made pursuant to the 1995 Stock
Option Plan and vest as follows: 40,000 options vested 90 days after the date
of the agreement, one-third of the remaining aggregate options vested on the
first anniversary of the date of hire and the remainder will vest ratably on a
quarterly basis during the two years following the first anniversary. In May
1996, options to purchase 149,200 shares of Common Stock of the Company at an
exercise price of $3.73 per share were granted to Mr. Heintzelman pursuant to
the Stock Option Plans. These options vest as follows: one-third of the
options will vest on the first anniversary of the date of grant and the
remaining two-thirds of the options will vest ratably on a quarterly basis
during the two years following the first anniversary of the date of grant.
In February 1996, the Company entered into an employment agreement with Mr.
McCleary. Pursuant to the terms of the agreement, Mr. McCleary's base salary
is $175,000 per year ($25,000 of which is conditioned upon the completion of
the Offering), plus a bonus to be awarded annually as part of the Company's
bonus program for its management. Under the agreement, Mr. McCleary is also
entitled to participate in any Company incentive compensation plans, savings
plans, retirement plans, and other employee benefit plans as well as to
receive an auto and expenses allowance. Mr. McCleary was also granted options
to purchase 241,874 shares of Common Stock of the Company at an exercise price
of $0.25 per share at the time of entering into the agreement. The grant was
made pursuant to the 1995 Stock Option Plan and vests as follows: one-third of
the options vest on the first anniversary of the date of hire and the
remaining two-thirds of the options vest ratably on a quarterly basis during
the two years following the first anniversary. In May 1996, options to
purchase an additional 238,126 shares of Common Stock of the Company at an
exercise price of $3.73 per share were granted to Mr. McCleary pursuant to the
Stock Option Plans. These options vest as follows: one-third of the options
vest
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<PAGE>
on the first anniversary of the date of grant and the remaining two-thirds of
the options vest ratably on a quarterly basis during the two years following
the first anniversary of the date of grant. The initial term of the agreement
expires on December 31, 1999, but the agreement is subject to automatic
renewal terms of one year each.
In March 1996, the Company entered into employment agreements with Messrs.
Deobald, Galleher, and Magliato. Pursuant to the terms of these agreements,
these officers' base salaries are $120,000 per year, plus a bonus to be
awarded annually as part of the Company's bonus program for management. These
officers are also entitled to participate in any Company incentive
compensation plans, retirement plans, and other employee benefit plans as well
as to receive a $6,600 per year auto allowance. Messrs. Deobald, Galleher, and
Magliato were each granted options to purchase 40,000 shares of Common Stock
of the Company at an exercise price of $0.25 per share at the time of entering
into their respective employment agreements. Grants were made pursuant to the
1995 Stock Option Plan and vest as follows: one-third of the options vest on
the first anniversary of the date of hire and the remaining two-thirds of the
options vest on a quarterly basis during the two years following the first
anniversary. In addition, each was granted options to purchase 16,000 shares
of Common Stock of the Company at an exercise price of $3.73 per share,
effective as of May 31, 1996, and 64,000 shares of Common Stock of the Company
at an exercise price of $10.00 per share, effective as of July 19, 1996.
Grants were made pursuant to the Stock Option Plans and vest as follows: one-
third of the options vest on the first anniversary of the date of grant and
the remaining two-thirds of the options vest on a quarterly basis during the
two years following the first anniversary. The initial terms of the agreements
expire in March 1997, but the agreements are subject to automatic renewal
terms of one year each.
In April 1996, the Company entered into an employment agreement with Mr.
Pendley. Pursuant to the terms of the agreement, Mr. Pendley's base salary is
$89,000 per year, plus a bonus to be awarded annually each December as part of
the Company's bonus program for its management. Under the agreement, Mr.
Pendley is also entitled to participate in any Company incentive compensation
plans, savings plans, retirement plans, and other employee benefit plans as
well as to receive an auto and expenses allowance. Mr. Pendley was also
granted options to purchase 120,000 shares of Common Stock of the Company at
an exercise price of $0.25 per share in September 1995 and options to purchase
an additional 6,400 shares of Common Stock of the Company at an exercise price
of $0.25 per share in January 1996. Grants were made pursuant to the 1995
Stock Option Plan and vest as follows: one-third of the aggregate options
vested on December 15, 1995, the first anniversary of the date of hire, and
the remaining two-thirds of the aggregate options vest ratably on a quarterly
basis during the two years following the first anniversary, a portion of which
have already vested. In May 1996, options to purchase an additional 89,600
shares of Common Stock of the Company at an exercise price of $3.73 per share
were granted to Mr. Pendley pursuant to the Stock Option Plans. These options
vest as follows: one-third of the options will vest on the first anniversary
of the dates of grant and the remaining two-thirds of the options will vest
ratably on a quarterly basis during the two years following the first
anniversary of the date of grant. The initial term of the agreement expires on
March 31, 1997, but the agreement is subject to automatic renewal terms of one
year each.
In June 1996, the Company entered into an employment agreement with Mr.
Brandt. Pursuant to the terms of the agreement, Mr. Brandt's base salary is
$125,000 per year, plus a bonus to be awarded annually each December as part
of the Company's bonus program for its management. Under the agreement, Mr.
Brandt is also entitled to participate in any Company incentive compensation
plans, savings plans, retirement plans, and other employee benefit plans as
well as to receive an auto and expenses allowance. Mr. Brandt was also granted
options to purchase 40,000 shares of Common Stock of the Company, at an
exercise price of $3.73 per share in May 1996, and 40,000 shares of Common
Stock of the Company, at an exercise price of $10.00 per share in June 1996.
Grants were made pursuant to the Stock Option Plans and vest as follows: one-
third of the options vest on the first anniversary of the date of grant and
the remaining two-thirds of the options vest on a quarterly basis during the
two years following the first anniversary. The grant was made pursuant to the
Stock Option Plan and the options vest in accordance with the four-year
schedule contained therein. The initial term of the agreement expires on May
31, 1997, but the agreement is subject to automatic renewal terms of one year
each.
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CERTAIN TRANSACTIONS
The Company was incorporated on January 8, 1990 by Mr. Humphrey and Mr.
Doughney (the "Founders"). Mr. Humphrey contributed certain computer hardware
to the Company in exchange for 970,744 shares of Common Stock, and Mr.
Doughney contributed certain computer software to the Company in exchange for
647,163 shares of Common Stock.
In July 1994, Robert M. Stewart, a director of the Company, and six other
individuals who are not affiliated with the Company loaned the Company
$300,000 in cash. In consideration for their loan, the Company issued to these
individuals (i) 8% promissory notes (the "Bridge Notes") in aggregate
principal amount of $300,000 and (ii) warrants to purchase 190,883 shares of
the Common Stock (the "Bridge Warrants"). The Bridge Notes, as subsequently
amended in connection with the execution of the Securities Purchase Agreement,
were to mature on the earlier of July 12, 1995 and the date on which certain
payments were made under the Securities Purchase Agreement. Mr. Stewart loaned
the Company $25,000 and was issued Bridge Notes in like amount and Bridge
Warrants representing the right to purchase 15,906 shares of Common Stock at
an exercise price of $1.58 per share in this transaction.
On March 24, 1995, the Company entered into the Securities Purchase
Agreement with the Founders and Grotech IV, Venrock and Southern, pursuant to
which the Company issued a total of 45,454.54 shares of convertible preferred
stock (since redesignated Series A Convertible Preferred Stock), par value
$1.00 per share, together with warrants to purchase 1,120,000 shares of Common
Stock of the Company, for an aggregate cash investment of $4,000,000. The
Bridge Notes were repaid at their face amount with a portion of the proceeds
of this investment. Grotech IV was issued 18,181.82 shares of Series A
Preferred Stock and warrants to purchase 448,000 shares of Common Stock in
consideration of its investment of $1.6 million in cash, Venrock was issued
15,909.09 shares of Series A Preferred Stock (4,925.83 shares of which were
assigned to Venrock II) and warrants to purchase 392,000 shares of Common
Stock (121,348 of which were assigned to Venrock II) in consideration of its
investment of $1.4 million in cash and Southern was issued 11,363.63 shares of
Series A Preferred Stock and warrants to purchase 280,000 shares of Common
Stock in consideration of its investment of $1.0 million in cash.
Representatives of each of Grotech IV, Venrock and Southern were elected to
the Company's Board of Directors pursuant to the Securities Purchase
Agreement.
As a fee for arranging the above investment, the Company made a cash payment
of $200,000 to Armata Partners, L.P., the employer of Mr. Stewart at the time,
and issued warrants to purchase 91,200 shares of Common Stock to Mr. Stewart
and nine other individuals (the "Fee Warrants" and, together with the Bridge
Warrants, the "Initial Warrants"). These individuals (other than Mr. Stewart)
are not affiliated with the Company. Mr. Stewart received Fee Warrants
representing the right to purchase 23,566 shares of Common Stock at an
exercise price of $2.63 per share in this transaction.
Pursuant to a Stockholders Agreement (the "Stockholders Agreement"), dated
March 24, 1995, by and among the Company, Grotech IV, Venrock, Southern, Mr.
Humphrey and Mr. Doughney, the parties thereto agreed to grant rights of first
refusal to the other parties to such agreement in the event of the death,
disability or termination of employment of either Mr. Humphrey or Mr. Doughney
or in the event that either Mr. Humphrey or Mr. Doughney wishes to transfer
any of their shares of Common Stock of the Company. The provisions of the
Stockholders Agreement will terminate effective immediately prior to
consummation of the Offering.
In connection with the issuance of the Initial Warrants, the Company and the
holders of the Initial Warrants also entered into a stockholders agreement
dated March 24, 1995 pursuant to which, among other things, the holders of the
Initial Warrants guaranteed to the Other Holders and the Company a right of
first refusal with respect to the Initial Warrants and the shares of Common
Stock issuable upon exercise of the Initial Warrants. The provisions of such
agreement will terminate effective immediately prior to consummation of the
Offering.
On November 28, 1995, Grotech IV, Venrock, Southern and Venrock Associates
II, L.P. ("Venrock II" and, together with Grotech IV, Venrock and Southern,
the "Investors") loaned to the Company $800,000,
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$483,307, $500,000 and $216,693 in cash, respectively. In consideration of
these loans, the Company issued 10% promissory notes due June 1, 1996 in the
principal amount of $2,000,000 (the "November 1995 Notes") and warrants to
purchase 299,946 shares of Common Stock to Grotech IV, Venrock, Venrock II and
Southern as follows: Grotech IV purchased promissory notes in the principal
amount of $800,000 and warrants to purchase 119,978 shares of Common Stock;
Venrock purchased promissory notes in the amount of $483,307 and warrants to
purchase 72,483 shares of Common Stock; Venrock II purchased promissory notes
in the principal amount of $216,693 and warrants to purchase 32,498 shares of
Common Stock; and Southern purchased promissory notes in the principal amount
of $500,000 and warrants to purchase 74,987 shares of Common Stock.
On February 23, 1996, the Company issued additional 10% promissory notes due
June 1, 1996 in the principal amount of $1,000,000 (the "February 1996 Notes")
and additional warrants to purchase 166,378 shares of Common Stock to the
Investors as follows: Grotech IV purchased promissory notes in the principal
amount of $400,000 and warrants to purchase 66,551 shares of Common Stock for
a cash purchase price of $400,000; Venrock purchased promissory notes in the
principal amount of $217,000 and warrants to purchase 36,104 shares of Common
Stock for a cash purchase price of $217,000; Venrock II purchased promissory
notes in the principal amount of $133,000 and warrants to purchase 22,128
shares of Common Stock for a cash purchase price at $133,000; and Southern
purchased promissory notes in the principal amount of $250,000 and warrants to
purchase 41,595 shares of Common Stock for a cash purchase price of $250,000.
On May 21, 1996, the Company issued additional promissory notes in the
principal amount of $1,000,000 (the "Convertible Notes") convertible into
shares of Series B Preferred Stock of the Company to the Investors as follows:
Grotech IV purchased promissory notes in the principal amount of $400,000 for
a cash purchase price of $400,000; Venrock purchased promissory notes in the
principal amount of $217,000 for a cash purchase price of $217,000; Venrock II
purchased promissory notes in the principal amount of $133,000 for a cash
purchase price of $133,000; and Southern purchased promissory notes in the
principal amount of $250,000 for a cash purchase price of $250,000.
On May 30, 1996, the Company, the Founders, the Investors, Grotech Partners,
Grotech Companion, Grotech Pennsylvania, Blue Chip and Crisler Capital
Company, Limited Partnership (together with the Investors, Grotech Partners,
Grotech Companion, Grotech Pennsylvania and Blue Chip, the "Purchasers")
entered into the Purchase and Exchange Agreement, whereby the Investors
exchanged $2.0 million principal amount of November 1995 Notes and $1.0
million principal amount February 1996 Notes (together with the right to
receive $126,389 in accrued interest thereon from the date of issuance) for
31,263.89 shares of Series B Convertible Preferred Stock of the Company, par
value $1.00 per share (the "Series B Preferred Stock"), and converted $1.0
million principal amount of Convertible Notes, in accordance with their terms,
into 10,000 shares of Series B Preferred Stock. In addition, the Purchasers
paid $4,000,000 in cash in exchange for a further 40,000 shares of Series B
Preferred Stock. The above-referenced exchange, conversion, and purchase
resulted in the following acquisitions of Series B Preferred Stock: Grotech IV
acquired 22,505.56 shares of Series B Preferred Stock; Grotech Partners
acquired 8,537 shares of Series B Preferred Stock; Grotech Companion acquired
930 shares of Series B Preferred Stock; Grotech Pennsylvania acquired 533
shares of Series B Preferred Stock; Venrock acquired 10,914.77 shares of
Series B Preferred Stock; Venrock II acquired 5,860.92 shares of Series B
Preferred Stock. Southern acquired 11,982.64 shares of Series B Preferred
Stock; Blue Chip acquired 16,000 shares of Series B Preferred Stock; and
Crisler acquired 4,000 shares of Series B Preferred Stock.
The transactions of May 21 and May 30, 1996 are collectively referred to
herein as the "1996 Venture Financing." A representative of Blue Chip holds a
seat on the Company's Board of Directors pursuant to the terms of the Purchase
and Exchange Agreement. The rights of representatives of each of Grotech IV,
Venrock and Southern, as well as each of the Founders, to have seats on the
Company's Board of Directors, granted pursuant to the Securities Purchase
Agreement, were restated in the Purchase and Exchange Agreement. In addition,
pursuant to the Purchase and Exchange Agreement, Crisler obtained the right to
designate a representative (R. Dean Meiszer) to act as an observer at meetings
of the Company's Board of Directors. Such stockholders' rights to designate
directors or representatives to attend board meetings under the Purchase and
Exchange Agreement will terminate effective immediately prior to consummation
of the Offering. See "Management--Board Composition."
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The holders of all outstanding shares of Series A Preferred Stock and Series
B Preferred Stock have agreed to convert their outstanding shares of Series A
Preferred Stock and Series B Preferred Stock, in accordance with their
respective terms, into 2,680,336 shares of Common Stock at or prior to the
consummation of the Offering (the "Preferred Stock Conversion"). As of the
date hereof, each share of Series A Preferred Stock is convertible into
approximately 11.0 shares of Common Stock and each share of Series B Preferred
Stock is convertible into approximately 26.83 shares of Common Stock. In
addition, all holders of warrants to purchase Common Stock (other than WinStar
and one holder of Initial Warrants) will exercise such warrants to purchase
1,868,408 shares of Common Stock upon consummation at or prior to the Offering
(the "Warrant Exercise"). See "Capital Stock of the Company--Warrants."
In October 1996 the Company obtained $1.5 million in interim financing
pursuant to the Bridge Loan from Blue Chip, which the Company will repay using
a portion of the net proceeds of the Offering. See "Use of Proceeds." In
connection with the Bridge Loan, the Company agreed to issue to Blue Chip
warrants to purchase 150,000 shares of Common Stock at an exercise price of
$1.00 per share if, but only if, the Company's initial public offering of
Common Stock is not consummated on or before October 31, 1996. The Company
presently expects that this Offering will be consummated prior to October 31,
1996 and, accordingly, that no warrants will be issued in connection with the
Bridge Loan. The Company also has received, in addition to the Bridge Loan, a
standby funding commitment from certain of its current venture capital
investors to purchase up to $5.0 million of convertible subordinated
debentures and warrants to purchase shares of Common Stock in the event that
the Company requires additional liquidity prior to completion of the Offering.
The Company does not presently expect that it will be required to make any
draws pursuant to the $5.0 million standby commitment.
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PRINCIPAL STOCKHOLDERS
The following table sets forth, as of August 31, 1996 and as adjusted to
reflect the Preferred Stock Conversion and the Warrant Exercise, certain
information with respect to the beneficial ownership of the Company's Common
Stock by: (i) each person (or group of affiliated persons) of the Company
known by the Company to own beneficially more than five percent of the
outstanding Common Stock; (ii) each director of the Company; (iii) the Named
Executive Officer and (iv) all directors and executive officers as a group.
Information is set forth on both a pre-Offering and a post-Offering basis.
Except as indicated in the footnotes to this table, the persons named in the
table, based on information provided by such persons, have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them.
<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL SHARES(1)
SHARES OF -----------------
STOCK BENEFICIALLY BEFORE AFTER
NAME OWNED OFFERING OFFERING
---- ------------------ -------- --------
<S> <C> <C> <C>
Grotech Investors(2)...................... 1,706,664 26.1% 15.5%
Venrock Investors(3)...................... 1,180,311 18.0 10.7
Douglas E. Humphrey....................... 970,744 14.9 8.8
Southern Venture Fund II, L.P.(4)......... 843,079 12.9 7.6
Michael T. Doughney....................... 647,163 9.9 5.9
Blue Chip Capital Fund Limited Partner-
ship(5).................................. 429,285 6.6 3.9
Robert M. Stewart......................... 39,472 * *
Frank A. Adams(2)......................... 1,706,664 26.1 15.5
Ray A. Rothrock(3)........................ 1,180,311 18.0 10.7
William F. Earthman III(4)................ 843,079 12.9 7.6
John H. Wyant(5).......................... 429,285 6.6 3.9
Christopher R. McCleary(6)................ -- -- --
Thomas H. Cato............................ -- -- --
All directors and executive officers as a
group
(14 persons)(7).......................... 5,941,316 91.0 53.9
</TABLE>
- --------
*Less than one percent.
(1) Assumes no exercise of the Underwriters' over-allotment option. The
Company has granted the Underwriters an over-allotment option to purchase
up to 675,000 shares of Common Stock.
(2) The Grotech Investors consist of Grotech IV, Grotech Partners, Grotech
Companion, and Grotech Pennsylvania. The address of the Grotech Investors
is 9690 Deereco Road, Timonium, MD 21093. The shares represent 1,438,361,
229,050, 24,952, and 14,228 shares owned by Grotech IV, Grotech Partners,
Grotech Companion, and Grotech Pennsylvania respectively. Mr. Adams, a
director of the Company, is also the general partner of Grotech Partners,
Grotech Capital Group IV, Inc. (the general partner of Grotech IV), and
Grotech Capital Group, Inc. (the general partner of Grotech Companion and
Grotech Pennsylvania). Mr. Adams disclaims beneficial ownership of the
shares held by the Grotech Investors, except to the extent of his economic
interest in the shares held by the Grotech Investors.
(3) The Venrock Investors consist of Venrock and Venrock II. The address of
the Venrock Investors is 30 Rockefeller Plaza, Suite 5508, New York, New
York 10112. The shares represent 797,014 shares held by Venrock and
383,296 shares held by Venrock II. Mr. Rothrock, a director of the
Company, is also a general partner of Venrock and Venrock II. Mr. Rothrock
disclaims beneficial ownership of the shares held by the Venrock
Investors, except to the extent of his economic interest in the shares
held by the Venrock Investors.
(4) The address of Southern Venture Fund II, L.P. is 310 25th Avenue, North,
Suite 103, Nashville, TN 37203. Mr. Earthman, a director of the Company,
is also the general partner of Southern. Mr. Earthman disclaims beneficial
ownership of the shares held by Southern, except to the extent of his
economic interest in the shares held by Southern.
(5) Blue Chip Capital Fund Limited Partnership's address is 2000 PNC Center,
201 East Fifth Street, Cincinnati, OH 45202. Mr. Wyant is the president of
Blue Chip Venture Company, the general partner of Blue Chip. Mr. Wyant
disclaims beneficial ownership of the shares held by Blue Chip, except to
the extent of his economic interest in the shares held by Blue Chip.
(6) Mr. McCleary, the Chairman, President and Chief Executive Officer of the
Company holds options to purchase 480,000 shares of Common Stock, none of
which are exercisable within 60 days of August 31, 1996.
(7) Includes 124,599 options held by Mr. Heintzelman that are presently
exercisable or that will become exercisable within 60 days of August 31,
1996. See Notes 2, 3, 4, and 5 above.
53
<PAGE>
CAPITAL STOCK OF THE COMPANY
The following description of the Company's capital stock does not purport to
be complete and is subject in all respects to applicable Delaware law and to
the provisions of the Company's Certificate of Incorporation and Bylaws,
copies of which have been filed as exhibits to the Registration Statement of
which this Prospectus is a part.
The authorized capital stock of the Company currently consists of 19,920,000
shares of Common Stock, $0.01 par value, and 200,000 shares of Preferred
Stock, $1.00 par value. As of August 31, 1996 there were 1,617,907 shares of
Common Stock issued and outstanding, 45,454.54 shares of Series A Preferred
Stock issued and outstanding, and 81,263.89 shares of Series B Preferred Stock
issued and outstanding. For a description of the terms of the currently
outstanding Series A Preferred Stock and Series B Preferred Stock, see Note 8
and Note 9 to the Company's Financial Statements. Upon consummation of the
Offering, the Preferred Stock Conversion and the Warrant Exercise and assuming
no exercise of the Underwriters' over-allotment option, there will be
10,600,964 shares of Common Stock issued and outstanding and no shares of
Preferred Stock issued and outstanding. An additional 2,283,300 shares of
Common Stock will be issuable upon exercise of outstanding options granted
under the Stock Option Plans, and 240,000 shares of Common Stock will be
issuable upon exercise of warrants held by WinStar.
In connection with the reincorporation of the Company as a Delaware
corporation, the Company will amend and restate its Certificate of
Incorporation. Thereafter, the authorized capital stock of the Company shall
consist of 47,000,000 shares of Common Stock and 3,000,000 shares of Preferred
Stock.
COMMON STOCK
Each holder of Common Stock is entitled to one vote per share of record on
all matters to be voted upon by the shareholders. Holders will not have
cumulative voting rights in connection with the election of directors (or any
other matter). Subject to the preferential rights of any preferred stock that
may at the time be outstanding, each share of Common Stock will have an equal
and ratable right to receive dividends when, if and as declared from time to
time by the Board of Directors out of funds legally available therefor. The
Company has been, and may in the future be, subject to certain agreements
which restrict the payment of dividends. The Company does not anticipate
paying cash dividends in the foreseeable future. See "Dividend Policy."
In the event of liquidation, dissolution or winding up of the Company,
holders of Common Stock are entitled to share ratably in all assets remaining
after payments to creditors and after satisfaction of the liquidation
preference, if any, of any preferred stock that may at the time be
outstanding. Holders of Common Stock have no preemptive or redemption rights
and are not subject to further calls or assessments by the Company.
Immediately upon consummation of the Offering, all of the then outstanding
shares of Common Stock will be validly issued, fully paid and nonassessable.
As of August 31, 1996, there were two record holders of the Common Stock.
After giving effect to the Preferred Stock Conversion and the Warrant
Exercise, but before giving effect to the consummation of the Offering, there
will be approximately 21 record holders of the Common Stock.
PREFERRED STOCK
The holders of all outstanding shares of Preferred Stock have agreed to
convert all of such shares into a total of 2,680,335 shares of Common Stock
upon consummation of the Offering. Thereafter, the Board of Directors will
have the authority to issue up to 3,000,000 shares of Preferred Stock in one
or more series, to fix the rights, preferences, privileges and restrictions
granted to or imposed upon any unissued shares of Preferred Stock and to fix
the number of shares constituting any series and the designations of such
series, without any further vote or action by the stockholders. The Board of
Directors, without stockholder approval, will be able to issue Preferred Stock
with voting and conversion rights which could adversely affect the voting
power of the holders of Common Stock. The Company has no present plans to
issue any Preferred Stock. As of August 31, 1996, there were nine holders of
the Preferred Stock of the Company.
54
<PAGE>
WARRANTS
The Company has issued warrants to purchase an aggregate of 2,108,408 shares
of Common Stock. Upon consummation of the Offering and the Warrant Exercise,
the warrants held by WinStar to purchase 240,000 shares of Common Stock (the
"WinStar Warrants") will remain outstanding. The exercise price of the WinStar
Warrants is $3.75 per share, and the WinStar Warrants expire on June 10, 2001.
All other holders of warrants to purchase Common Stock have agreed to exercise
such warrants at or prior to the consummation of the Offering.
DELAWARE LAW AND LIMITATIONS ON CHANGES IN CONTROL
Section 203 of the Delaware General Corporation Law (the "DGCL") prevents an
"interested stockholder" (defined in Section 203, generally, as a person
owning 15% or more of a corporation's outstanding voting stock) from engaging
in a "business combination" (as defined in Section 203) with a publicly-held
Delaware corporation for three years following the date such person became an
interested stockholder unless (i) before such person became an interested
stockholder, the board of directors of the corporation approved the
transaction in which the interested stockholder became an interested
stockholder or approved the business combination; (ii) upon consummation of
the transaction that resulted in the interested stockholder's becoming an
interested stockholder, the interested stockholder owns at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding stock held by directors who are also officers of the
corporation and by employee stock plans that do not provide employees with the
right to determine confidentially whether shares held subject to the plan will
be tendered in a tender or exchange offer); or (iii) following the transaction
in which such person became an interested stockholder, the business
combination is approved by the board of directors of the corporation and
authorized at a meeting of stockholders by the affirmative vote of the holders
of 66 2/3% of the outstanding voting stock of the corporation not owned by the
interested stockholder.
The Company's Bylaws will generally require 50 days advance notice of any
action to be proposed at any meeting of stockholders and set forth other
specific procedures that a stockholder must follow. There will also be
specific procedures, including advance notice, for the nomination of a person
to the Board of Directors when such person is nominated other than at the
direction of the Board. In addition, the Certificate of Incorporation will
provide that a special meeting of the Company's stockholders may only be
called by the Board of Directors; no such meeting may be called by the
stockholders. Further, the Certificate of Incorporation will eliminate the
ability of stockholders to act by written consent and consequently
stockholders may only act at meetings thereof. Any amendment of certain
provisions of the Certificate of Incorporation and Bylaws by stockholders will
require the affirmative vote of the holders of at least 75% of the shares of
the Common Stock then outstanding.
In addition, the directors of the Company will be divided into three class,
with the term of one class expiring each year. Directors may be removed, with
or without cause, only with affirmative vote of holders of at least 75% of the
shares of Common Stock than outstanding. This provision could delay the
replacement of a majority of the directors and have the effect of making
changes in the Board of Directors more difficult than if such provision were
not in place.
These Certificate of Incorporation and Bylaw provisions, including the
provisions authorizing the Board of Directors to issue preferred stock without
stockholder approval, and the provisions of Section 203 of the DGCL could have
the effect of delaying, deferring or preventing a transaction involving a
change in control of the Company or the removal of existing management,
including transactions in which stockholders might receive a substantial
premium for their shares over then-current market prices. See "Risk Factors--
Control by Certain Stockholders; Anti-Takeover Measures."
LIMITATION ON DIRECTORS' AND OFFICERS' LIABILITY
The Certificate of Incorporation will provide that a director of the Company
will not be personally liable to the Company or its stockholders for monetary
damages for any breach of fiduciary duty as a director, except in
55
<PAGE>
certain cases where liability is mandated by the DGCL. The provision will have
no effect on any non-monetary remedies that may be available to the Company or
its stockholders, nor will it relieve the Company or its directors from
compliance with federal or state securities laws. The Bylaws of the Company
will generally provide that the Company shall indemnify, to the fullest extent
permitted by law, any person who was or is a party or is threatened to be made
a party to any threatened, pending or completed action, suit, investigation,
administrative hearing or any other proceeding (each, a "Proceeding") by
reason of the fact that he is or was a director or officer of the Company, or
is or was serving at the request of the Company as a director, officer,
employee or agent of another entity, against expenses (including attorneys'
fees) and losses, claims, liabilities, judgments, fines and amounts paid in
settlement actually incurred by him in connection with such Proceeding.
CERTAIN EFFECTS OF AUTHORIZED BUT UNISSUED STOCK
Upon consummation of the Offering, there will be 36,399,036 shares of Common
Stock and 3,000,000 shares of Preferred Stock available for future issuance
without stockholder approval (assuming no exercise of the Underwriters' over-
allotment option), subject to compliance with rules applicable to companies
whose securities are traded on the Nasdaq National Market. These additional
shares may be utilized for a variety of corporate purposes, including future
public offerings to raise additional capital or to facilitate corporate
acquisitions. The Company does not currently have plans to issue additional
shares of capital stock, other than shares of Common Stock which may be issued
upon the exercise of employee options or the WinStar Warrants. See "Shares
Eligible for Future Sale."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company.
SHARES ELIGIBLE FOR FUTURE SALE
GENERAL
Future sales of substantial amounts of the Company's Common Stock could
adversely affect the market price of the Common Stock. Several of the
Company's principal stockholders hold a significant portion of the Company's
outstanding Common Stock, and a decision by one or more of these stockholders
to sell their shares could adversely affect the market price of the Common
Stock. The Shares offered hereby (plus any shares issued upon exercise of the
Underwriters' over-allotment option) will be freely tradeable without
restriction, except to the extent that such shares are purchased by
"affiliates" of the Company. The holders of Common Stock and certain holders
of warrants to purchase Common Stock, including officers and directors of the
Company that hold shares of Common Stock, have entered into contractual
agreements with the Underwriters (the "Lock-Up Agreements") providing that
they will not offer, sell or contract to sell, or otherwise dispose of,
directly or indirectly, or announce an offering of, any shares of Common Stock
of the Company beneficially owned by them or any securities convertible into,
or exchangeable for, the Common Stock for a period of 180 days after the date
of the Underwriting Agreement without the prior written consent of the
Underwriters' representative, other than shares of stock disposed of as bona
fide gifts. As a result, notwithstanding possible earlier eligibility for sale
under the provisions of Rules 144 and 144(k) under the Act, shares subject to
the Lock-Up Agreements will not be saleable until the Lock-Up Agreements
expire or their terms are waived by the Underwriters' representative. Assuming
the Underwriters do not release stockholders from the Lock-Up Agreements, the
following shares will be eligible for sale in the public market at the
following times: beginning on the Effective Date, only the shares sold in the
Offering to non-affiliates will be immediately available for sale in the
public market; beginning 180 days after the date of the Underwriting
Agreement, 1,617,907 shares will be eligible for sale pursuant to Rule 144,
all of which are held by affiliates of the Company. An additional 4,483,057
shares will become eligible for sale pursuant to Rule 144 at various times
during the two-year period following the Effective Date (although such shares
will continue to be subject to the Lock-Up Agreements until the expiration of
the terms thereof). The holders of approximately 4,254,992 shares of the
Common Stock are entitled to certain rights with respect to the registration
of such shares under the Act beginning six months after the Effective Date. In
addition, the
56
<PAGE>
Company may register certain shares of Common Stock issuable under the Stock
Option Plans, and such registration shall be effective upon filing with the
Commission. As of August 31, 1996, there were outstanding options under the
Stock Option Plans to purchase 2,283,300 shares, of which options for 313,266
shares were fully vested and exercisable. No shares have been issued to date
under the Stock Option Plans.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate of the Company, who has
beneficially owned shares for at least two years (including holding periods of
prior owners other than affiliates) is entitled to sell, within any three-
month period commencing 90 days after the closing of this Offering, a number
of shares that does not exceed the greater of (i) 1% of the then outstanding
shares of Common Stock (106,010 shares immediately after the Offering) or (ii)
the average weekly trading volume in the Common Stock during the four calendar
weeks preceding such sale, subject to the filing of a Form 144 with respect to
such sale and certain other limitations and restrictions. In addition, a
person who is not deemed to have been an affiliate of the Company at any time
during 90 days preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least three years (including holding periods of
prior owners other than affiliates), would be entitled to sell such shares
under Rule 144(k) without regard to the requirements described above.
REGISTRATION RIGHTS
Pursuant to the Securities Purchase Agreement, as amended by the Purchase
and Exchange Agreement, Grotech IV, Grotech Partners, Grotech Companion,
Grotech Pennsylvania, Venrock, Venrock II, Southern, Blue Chip and Crisler are
entitled to certain rights with respect to the registration of their shares of
Registrable Securities (as defined therein) under the Act. Subject to certain
limitations, on the first two occasions that the Company registers any of its
securities under the Act, either for its own account or the account of other
security holders, such holders are entitled to written notice of the
registration and are entitled to include (at the Company's expense) such
holder's shares therein; provided, among other conditions, that the
underwriters of any such offering have the right to limit the number of such
shares included in the registration. Pursuant to the warrant certificates
evidencing the Initial Warrants, the individuals to whom the Initial Warrants
were issued hold the rights described above. In addition, pursuant to the
warrant certificate evidencing the WinStar Warrants, WinStar also holds
registration rights identical to those described above, except that WinStar's
rights are not limited to the first two registrations. Moreover, holders of at
least a majority of the shares of Registrable Securities can require the
Company, at any time after six months from the effective date of the initial
offering of shares of its Common Stock pursuant to a registration statement
under the Act, but on only one occasion, to file a registration statement
under the Act with respect to such shares, and the Company is required to
effect such registration and maintain the effectiveness of such registration
for a period of three months, subject to certain conditions and limitations.
All fees, costs and expenses of such registration of securities (other than
underwriting discounts in the case of the first type of registrations
described above, and other than legal and accounting expenses of such holders)
will be borne by the Company. However, Grotech IV, Grotech Partners, Grotech
Companion, Grotech Pennsylvania, Venrock, Venrock II, Southern, Blue Chip,
Crisler and Mr. Stewart have agreed to waive any and all rights to cause the
Company to register any securities held by the holder under the Act, or the
securities laws of any state in connection with a Qualifying IPO. For the
purposes thereof, a "Qualifying IPO" means an underwritten public offering of
the Company of shares of Common Stock which is consummated on or before
December 31, 1996, the net proceeds of which exceed $25,000,000.
57
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
between the Company and the Underwriters (the "Underwriting Agreement"), the
Company has agreed to sell to each of the Underwriters named below, and the
Underwriters, for whom Friedman, Billings, Ramsey & Co., Inc. is acting as
representative (the "Representative"), have severally agreed to purchase from
the Company, the respective number of shares of Common Stock set forth below
opposite their respective name. Under the Underwriting Agreement, the
Underwriters are obligated to purchase all of the 4,500,000 shares of Common
Stock offered hereby if any are purchased.
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
Friedman, Billings, Ramsey & Co., Inc....................
---------
Total................................................ 4,500,000
=========
</TABLE>
The Underwriters have advised the Company that the Underwriters propose to
initially offer the shares of Common Stock to the public at the initial public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such price less a concession not in excess of $ per share. After
the shares of Common Stock have been released for sale to the public, the
price to public and such concessions may be changed.
The Company has granted the Underwriters an option, exercisable for 30 days
after the date of this Prospectus, to purchase up to 675,000 additional shares
of Common Stock solely to cover over-allotments, if any, at the public
offering price, less the underwriting discount, shown on the cover page of
this Prospectus.
The Underwriters have reserved up to 250,000 shares of the Common Stock
offered hereby for sale at the initial public offering price to directors,
officers, and employees of the Company and their business affiliates and
related parties who have expressed an interest in purchasing such shares. Such
purchases will be made on the same terms and conditions as will be initially
offered by the Underwriters to others in the Offering, and affiliated
purchasers will, prior to acquiring any shares, be required to represent to
the Underwriters and the Company that they are purchasing such shares for
investment purposes only with no present intention to resell the shares.
The Representative has informed the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
The Company, its directors, officers and holders of its Common Stock, and
certain holders of warrants to purchase its Common Stock, have each agreed,
not to offer, sell, contract to sell or otherwise dispose of any shares of
Common Stock, or any security convertible into or exercisable for shares of
Common Stock, for a period of 180 days after the date of this Prospectus
without the prior written consent of the Representative. However, the Company
may issue shares of Common Stock in connection with the Preferred Stock
Conversion and the Warrant Exercise and issue, or grant options to purchase,
shares of Common Stock or under the Stock Option Plans and may file a
registration statement on Form S-8 or successor form with the SEC in respect
of such grants or issuances under the Stock Option Plans.
In the Underwriting Agreement, the Company has agreed to indemnify the
Underwriters against certain liabilities, including civil liabilities under
the Act. Each of the Underwriters may be deemed to be an "underwriter" for
purposes of the Act in connection with the Offering. The Company will
reimburse the Underwriters for their reasonable out-of-pocket expenses
(including legal fees and expenses) incurred in connection with the Offering.
Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price will be determined by negotiation between
the Company and the Representative. In determining such price, consideration
will be given to, among other things, the financial and operating history and
trends of the Company, the experience of its management, the position of the
Company in its industry, the Company's prospects and the Company's financial
results. Additionally, consideration will be given to the status of the
securities markets, market conditions for new offerings of securities and the
prices of similar securities of comparable companies.
58
<PAGE>
The Common Stock has been authorized for inclusion in the Nasdaq National
Market under the symbol "DIGX". In order to meet one of the requirements for
including the Common Stock on the Nasdaq National Market, the Underwriters
have undertaken to sell shares of Common Stock to a minimum of 400 beneficial
holders. There can be no assurance, however, that the Company will be able to
maintain the inclusion of the Common Stock in the Nasdaq National Market or
that an active trading market will develop.
LEGAL MATTERS
The legality of the Common Stock offered hereby will be passed upon for the
Company by Latham & Watkins, Washington, D.C. Certain legal matters will be
passed upon for the Underwriter by Hogan & Hartson L.L.P., Washington, D.C.
EXPERTS
The financial statements of the Company at December 31, 1994, December 31,
1995 and June 30, 1996, and for each of the three years in the period ended
December 31, 1995 and the six-month periods ended June 30, 1995 and 1996,
appearing in this Prospectus have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and are included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.
59
<PAGE>
GLOSSARY
<TABLE>
<S> <C>
56 Kbps........................ Equivalent to a single high-speed telephone
service line; capable of transmitting one voice
call or 56 Kbps of data. Currently in widespread
use by medium and large businesses primarily for
entry level high-speed data and very low-speed
video applications.
ATM............................ Asynchronous Transfer Mode. An information
transfer standard for routing traffic based on
an address contained within the first five bytes
of a fifty-three byte-long, fixed-length packet
or cell.
Backbone....................... A centralized high-speed network that
interconnects smaller, independent networks.
Bandwidth...................... The number of bits of information which can move
through a communications medium in a given
amount of time; the capacity of a
telecommunications circuit/network to carry
voice, data and video information. Typically
measured in Kbps and Mbps. Bandwidth from public
networks is typically available to business and
residential end-users in increments from 56 Kbps
to T-3.
CAP............................ Competitive Access Provider. A
telecommunications company that provides an
alternative to a LEC for local transport of
private line and special access
telecommunications services.
CSU/DSU (also IDSU, SMDSU)..... Channel Service Unit/Digital Service Unit. A
device used to terminate telephone company
equipment and prepare data for router interface.
DS-1 or T-1.................... A data communications circuit capable of
transmitting data at 1.5 Mbps; can transmit
compressed full motion video. Currently in
widespread use by medium and large businesses
for video, voice, and data applications.
DS-3 or T-3.................... A data communications circuit capable of
transmitting data at 45 Mbps. Equivalent to 28
T-1's of data capacity. Can also transmit
uncompressed, TV broadcast quality, full motion
video. Currently used only by
businesses/institutions and carriers for high
end applications.
Ethernet....................... A common method of networking computers in a
LAN. Ethernet will handle about 10 Mbps and can
be used with almost any kind of computer.
FDDI........................... Fiber Distributed Data Interface. A standard for
transmitting data on optical-fiber cables at a
rate of around 100 Mbps (10 times as fast as
Ethernet, about twice as fast as T-3).
Firewall....................... A system placed between networks that filters
data passing through it and prevents
unauthorized traffic, thereby enhancing the
security of the network.
</TABLE>
60
<PAGE>
<TABLE>
<S> <C>
Frame Relay................... An information transfer standard for relaying
traffic based on an address contained in the six
byte header of a variable length packet that is
up to 2,106 bytes long. Frame Relay has less
overhead than ATM but may be difficult to
implement at speeds greater than 45 Mbps.
Internet...................... A global collection of interconnected computer
networks which use TCP/IP, a common
communication protocol.
ISDN.......................... Integrated Services Digital Network. An
information transfer standard for transmitting
digital voice and data over telephone lines at
speeds up to 128 Kbps.
IXC........................... Interexchange Carrier. A telecommunications
company that provides telecommunications
services between local exchanges on an
interstate or intrastate basis.
Kbps.......................... Kilobits per second. A transmission rate. One
kilobit equals 1,024 bits of information.
LAN........................... Local Area Network. A data communications
network designed to interconnect personal
computers, workstations, minicomputers, file
servers and other communications and computing
devices within a localized environment.
Leased line................... Telecommunications line dedicated to a
particular customer along a predetermined
routes.
LEC........................... Local Exchange Carrier. A telecommunications
company that provides telecommunications
services in a geographic area in which calls
generally are transmitted without toll charges.
MAE-East...................... A major peering point (exchange point for
traffic) among ISPs, located in Falls Church,
Virginia.
MAE-West...................... A major peering point (exchange point for
traffic) among ISPs, located in Santa Clara,
California.
Mbps.......................... Megabits per second. A transmission rate. One
megabit equals 1,024 kilobits.
Modem......................... A device for transmitting digital information
over an analog telephone line.
NAP........................... Network Access Point. A location at which ISPs
exchange each other's traffic.
On-line service............... Commercial information services that offer a
computer user access to a specified slate of
information, entertainment, and communications
menus on what appears to be a single system.
Peering....................... The commercial practice under which nationwide
ISPs exchange each other's traffic without the
payment of settlement charges.
POP........................... Point of Presence. Telecommunications facility
through which the Company provides local
connectivity to its customers.
</TABLE>
61
<PAGE>
<TABLE>
<S> <C>
Router......................... A system placed between networks that relays
data to those networks based upon a destination
address contained in the data packets being
routed.
SLIP........................... Serial Line Internet Protocol. An information
transfer standard for transmitting Internet
Protocol packets over asynchronous data
connections between two points.
TCP/IP......................... Transmission Control Protocol/Internet Protocol.
A suite of network protocols that allow
computers with different architectures and
operating system software to communicate with
other computers on the Internet.
UNIX........................... A computer operating system for workstations and
PCs and noted for its portability and
communications functionality.
Web Site....................... A server connected to the Internet from which
Internet users can obtain information.
World Wide Web or Web.......... A collection of computer systems supporting a
communications protocol that permits multi-media
presentation of information over the Internet.
</TABLE>
62
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................. F-2
Financial Statements
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Equity (Deficit)............................... F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
DIGEX, Incorporated
We have audited the accompanying balance sheets of DIGEX, Incorporated as of
December 31, 1994, December 31, 1995 and June 30, 1996, and the related
statements of operations, stockholders' equity (deficit), and cash flows for
each of the three years in the period ended December 31, 1995 and the six-
month periods ended June 30, 1995 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of DIGEX, Incorporated at
December 31, 1994, December 31, 1995 and June 30, 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1995 and the six-month periods ended June 30, 1995 and 1996 in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Baltimore, Maryland
July 17, 1996, except for Note 19, as to which the date is October 9, 1996
F-2
<PAGE>
DIGEX, INCORPORATED
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- PRO FORMA
1994 1995 JUNE 30, 1996 JUNE 30, 1996
-------- ---------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents... $ 2,441 $ 832,582 $ 6,269,000 $ 6,269,000
Accounts receivable, less
allowance of $0 in 1994,
$50,000 in 1995 and
$126,579 in 1996........... 141,488 908,572 1,416,891 1,416,891
Due from officers and
employees.................. 24,124 -- 11,972 11,972
Inventory and prepaid
expenses................... 41,926 49,631 825,172 825,172
Deferred income taxes....... 14,679 7,681 7,681 7,681
-------- ---------- ----------- -----------
Total current assets..... 224,658 1,798,466 8,530,716 8,530,716
Property and equipment:
Computer equipment and
software................... 431,415 3,439,014 10,959,400 10,959,400
Office furniture and
equipment.................. 20,630 152,805 203,908 203,908
Leasehold improvements...... 8,871 163,811 287,705 287,705
-------- ---------- ----------- -----------
460,916 3,755,630 11,451,013 11,451,013
Accumulated depreciation and
amortization............... 109,789 764,966 1,689,779 1,689,779
-------- ---------- ----------- -----------
351,127 2,990,664 9,761,234 9,761,234
Deferred financing costs.... 77,857 -- 245,218 245,218
Other assets................ 1,500 262,656 304,611 304,611
-------- ---------- ----------- -----------
Total assets................ $655,142 $5,051,786 $18,841,779 $18,841,779
======== ========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued
expenses................... $208,329 $ 959,528 $ 7,974,939 $ 7,974,939
Notes payable, net of
discount of $13,734........ 286,266 -- -- --
Deferred revenue............ 153,049 389,472 5,076,393 5,076,393
Income taxes payable........ 20,910 -- -- --
Current portion of capital
lease obligations.......... -- 858,765 1,497,563 1,497,563
10% Convertible Debentures,
net of discount of $588,835
in 1995.................... -- 1,411,165 -- --
-------- ---------- ----------- -----------
Total current
liabilities............. 668,554 3,618,930 14,548,895 14,548,895
Deferred income taxes....... 6,998 -- -- --
Capital lease obligations,
less current portion....... -- 821,709 1,714,283 1,714,283
Series A Mandatorily
Redeemable Convertible
Preferred Stock, $1 par
value; 70,000 shares
authorized; 45,455 shares
issued and outstanding (pro
forma: none); redemption
price and liquidation
preference of $100 per
share, aggregating
$4,545,500................. -- 2,138,889 2,391,770 --
Series B Mandatorily
Redeemable Convertible
Preferred Stock, $1 par
value; 130,000 shares
authorized; 81,263.89
shares issued and
outstanding (pro forma:
none); redemption price and
liquidation preference $100
per share, aggregating
$8,126,389................. -- -- 8,126,389 --
Stockholders' equity
(deficit):
Common stock, $.01 par
value:
Authorized shares 1,000
shares in 1994 and
19,920,000 in 1995 and
1996....................
Issued and outstanding
shares 1,717,907 in
1994; 1,617,907 in 1995
and 1996 (pro forma:
6,100,964).............. 17,179 16,179 16,179 61,010
Additional paid-in
capital................... 25,393 2,834,672 3,824,636 14,297,964
Accumulated deficit........ (62,982) (4,378,593) (11,780,373) (11,780,373)
-------- ---------- ----------- -----------
Total stockholders' equity
(deficit).................. (20,410) (1,527,742) (7,939,558) 2,578,601
-------- ---------- ----------- -----------
Total liabilities and
stockholders' equity
(deficit).................. $655,142 $5,051,786 $18,841,779 $18,841,779
======== ========== =========== ===========
</TABLE>
See notes to financial statements.
F-3
<PAGE>
DIGEX, INCORPORATED
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------------- -----------------------
1993 1994 1995 1995 1996
-------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Net Revenue:
Online services....... $431,098 $1,577,609 $ 4,425,172 $1,594,440 $ 4,659,586
Equipment sales....... -- -- 650,144 70,992 575,618
-------- ---------- ----------- ---------- -----------
431,098 1,577,609 5,075,316 1,665,432 5,235,204
Costs and Expenses:
Data communications
and operations....... 216,656 1,002,503 4,013,377 1,264,635 4,734,327
Cost of equipment
sales................ -- -- 458,123 57,028 512,634
Sales and marketing... 18,326 263,075 1,710,234 561,093 2,587,472
General and
administrative....... 135,238 366,392 2,715,752 588,116 3,376,091
-------- ---------- ----------- ---------- -----------
Total expenses.......... 370,220 1,631,970 8,897,486 2,470,872 11,210,524
-------- ---------- ----------- ---------- -----------
Income (loss) from
operations............. 60,878 (54,361) (3,822,170) (805,440) (5,975,320)
Other income (expense):
Interest and other
income............... -- -- 72,002 17,453 47,746
Interest expense...... -- (23,693) (226,745) (45,249) (1,167,149)
-------- ---------- ----------- ---------- -----------
-- (23,693) (154,743) (27,796) (1,119,403)
-------- ---------- ----------- ---------- -----------
Income (loss) before
income taxes........... 60,878 (78,054) (3,976,913) (833,236) (7,094,723)
Income taxes............ (25,540) (3,470) -- -- --
-------- ---------- ----------- ---------- -----------
Net income (loss)....... 35,338 (81,524) (3,976,913) (833,236) (7,094,723)
Accretion of Series A
Mandatorily Redeemable
Convertible Preferred
Stock to redemption
value.................. -- -- (338,698) (109,163) (252,881)
-------- ---------- ----------- ---------- -----------
Net income (loss)
attributable to common
stockholders........... $ 35,338 $ (81,524) $(4,315,611) $ (942,399) $(7,347,604)
======== ========== =========== ========== ===========
Net income (loss) per
common share
attributable to common
stockholders........... $ -- $ (0.01) $ (0.63) $ (0.14) $ (0.98)
======== ========== =========== ========== ===========
Pro forma net loss per
common share
attributable to common
stockholders........... $ (0.47) $ (0.69)
=========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
DIGEX, INCORPORATED
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL DEFICIT TOTAL
------- ---------- ------------ -----------
<S> <C> <C> <C> <C>
Balance at January 1, 1993...... $17,179 $ -- $ (16,796) $ 383
Net income for 1993............. -- -- 35,338 35,338
------- ---------- ------------ -----------
Balance at December 31, 1993.... 17,179 -- 18,542 35,721
Issuance of 190,883 warrants to
purchase common stock.......... -- 25,393 -- 25,393
Net loss for 1994............... -- -- (81,524) (81,524)
------- ---------- ------------ -----------
Balance at December 31, 1994.... 17,179 25,393 (62,982) (20,410)
Issuance of warrants to purchase
1,120,000 shares of common
stock, net of expenses of
$262,756....................... -- 1,650,459 -- 1,650,459
Issuance of warrants to purchase
299,946 shares of common stock. -- 682,378 -- 682,378
Value of vested common stock
options granted to employees... -- 475,442 -- 475,442
Accretion of Series A
Mandatorily Redeemable
Convertible Preferred Stock to
redemption value............... -- -- (338,698) (338,698)
Retirement of 100,000 shares of
common stock................... (1,000) 1,000 -- --
Net loss for 1995............... -- -- (3,976,913) (3,976,913)
------- ---------- ------------ -----------
Balance at December 31, 1995.... 16,179 2,834,672 (4,378,593) (1,527,742)
Issuance of warrants to purchase
166,378 shares of common stock. -- 361,872 -- 361,872
Issuance of warrants to purchase
240,000 shares of common stock. -- 228,000 -- 228,000
Value of vested common stock
options granted to employees... -- 400,092 -- 400,092
Accretion of Series A
Mandatorily Redeemable
Convertible Preferred Stock to
redemption value............... -- -- (252,881) (252,881)
Dividends accrued on Series B
Mandatorily Redeemable
Convertible Preferred Stock.... -- -- (54,176) (54,176)
Net loss for six months ended
June 30, 1996.................. -- -- (7,094,723) (7,094,723)
------- ---------- ------------ -----------
Balance at June 30, 1996........ $16,179 $3,824,636 $(11,780,373) $(7,939,558)
======= ========== ============ ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
DIGEX, INCORPORATED
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------------- -----------------------
1993 1994 1995 1995 1996
--------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Operating activities:
Net income (loss)....... $ 35,338 $ (81,524) $(3,976,913) $ (833,236) $(7,094,723)
Adjustments to reconcile
net income (loss) to
net cash provided by
(used in) operating
activities:
Depreciation and
amortization.......... 22,158 83,948 655,177 154,707 924,813
Amortization of debt
discount charged to
interest expense...... -- 11,659 107,277 13,734 950,707
Non-cash compensation
recorded for vested
stock option grants... -- -- 475,442 -- 400,093
Deferred income taxes.. 17,859 (25,540) -- -- --
Changes in operating
assets and liabilities:
Accounts receivable... (72,352) (65,868) (767,084) (207,965) (508,319)
Inventory and prepaid
expenses............. -- (41,926) (7,705) 39,915 (775,541)
Cash overdraft........ 4,347 (4,347) -- -- --
Accounts payable and
accrued expenses..... 43,873 163,461 751,199 168,843 7,087,624
Deferred revenue...... 64,901 79,976 236,423 95,060 4,686,921
Income taxes payable.. 7,681 13,229 (20,910) (20,910) --
--------- --------- ----------- ---------- -----------
Net cash provided by
(used in) operating
activities............. 123,805 133,068 (2,547,094) (589,852) 5,671,575
Investing activities:
Due from officers and
employees.............. (22,670) (6,222) 24,124 (1,500) (11,972)
Purchase of property and
equipment.............. (98,273) (350,132) (1,199,160) (447,450) (5,576,515)
Decrease (increase) in
other assets........... (5,084) 3,584 (261,156) (143,338) (41,955)
--------- --------- ----------- ---------- -----------
Net cash used in
investing activities... (126,027) (352,770) (1,436,192) (592,288) (5,630,442)
Financing activities:
Proceeds from issuance
of (repayment of)
notes notes payable and
detachable stock
warrants............... -- 300,000 (300,000) (300,000) --
Borrowings under
revolving line of
credit................. -- -- -- -- 1,166,745
Repayments under
revolving line of
credit................. -- -- -- -- (1,166,745)
Repayment of capital
leases................. -- -- (415,080) (77,235) (587,497)
Proceeds from issuance
of 10% Subordinated
Debentures and
detachable stock
warrants............... -- -- 2,000,000 -- 1,000,000
Proceeds from issuance
of Series A Mandatorily
Redeemable Convertible
Preferred Stock and
detachable stock
warrants, net of
expenses of issuance... -- -- 3,528,507 3,528,507 --
Proceeds from issuance
of Series B Mandatorily
Redeemable Convertible
Preferred Stock........ -- -- -- -- 5,000,000
Proceeds from issuance
of warrants to purchase
common stock to
customer............... -- -- -- -- 228,000
Increase in deferred
financing costs........ -- (77,857) -- -- (245,218)
--------- --------- ----------- ---------- -----------
Net cash provided by
financing activities... -- 222,143 4,813,427 3,151,272 5,395,285
--------- --------- ----------- ---------- -----------
Net increase (decrease)
in cash and cash
equivalents............ (2,222) 2,441 830,141 1,969,132 5,436,418
Cash and cash
equivalents at
beginning of period.... 2,222 -- 2,441 2,441 832,582
--------- --------- ----------- ---------- -----------
Cash and cash
equivalents at end of
period................. $ -- $ 2,441 $ 832,582 $1,971,573 $ 6,269,000
========= ========= =========== ========== ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1996
1. SIGNIFICANT ACCOUNTING POLICIES
Description of Business
DIGEX, Incorporated (the "Company"), is a national Internet service
provider. The Company's principal customers are businesses, government
agencies and other institutional customers. The services provided by the
Company include business connectivity, Web server hosting, individual dial-up
network access, education services, and security and other network products.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all short-term, highly liquid investments with
maturities of three months or less when purchased to be cash equivalents.
Inventory
Inventory, consisting primarily of computer equipment, is stated at the
lower of the first-in, first-out cost, or market.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed for owned
assets using the straight-line method over estimated useful lives of five
years. Assets capitalized under capital leases are amortized using the
straight-line method over the lesser of the lease term or the useful life of
the asset.
Deferred Financing Costs
Deferred financing costs at December 31, 1994 consist of costs incurred in
1994 to obtain equity financing. These costs were capitalized in 1994 and
accounted for as a reduction of Series A Mandatorily Redeemable Convertible
Preferred Stock in 1995 upon the closing of the transaction (see Note 8).
Deferred financing costs at June 30, 1996 consist of direct costs incurred
related to the initial filing of a registration statement for the sale of
common stock with the Securities and Exchange Commission.
Other Assets
Other assets consist primarily of security deposits on leased computer
equipment and office furniture and equipment. The deposits will be applied
against the final months lease payments.
Revenue Recognition & Accounts Receivable
The Company offers annual subscriptions to its customers for Internet access
and also may arrange for advance payments under contracts to deliver business
connectivity services. Advance payments for these services are deferred and
recognized in the periods in which the services are performed. Equipment sales
are recognized upon commencement of the related service. Receivables generally
are due within 30 days. The Company does not generally require collateral from
its customers.
F-7
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense
totaled approximately $3,100, $24,600 and $488,900 in 1993, 1994 and 1995,
respectively.
Stock Options Granted to Employees
The Company records compensation expense for all stock-based compensation
plans using the intrinsic value method prescribed by APB Opinion 25,
Accounting for Stock Issued to Employees. In October 1995, the Financial
Accounting Standards Board issued FASB Statement No. 123, Accounting for
Stock-Based Compensation, which encourages companies to recognize expense for
stock-based awards based on their estimated value on the date of grant.
Statement 123, effective for 1996, does not require companies to change their
existing accounting for stock-based awards, but if the new fair value method
is not adopted, pro forma income and earnings per share data should be
provided in the notes to the financial statements. The Company intends to
continue to account for stock-based compensation plans using the intrinsic
value method, and will supplementally disclose in its 1996 annual financial
statements the required pro forma information as if the fair value method had
been adopted.
Income Taxes
The Company uses the liability method in accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
Interim Financial Data
The financial statements of the Company for the six months ended June 30,
1995 and 1996 have been prepared on the same basis as the annual financial
statements and, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary to state fairly
the financial information set forth therein, in accordance with generally
accepted accounting principles.
The results of operations for the six months ended June 30, 1996 are not
necessarily indicative of results expected for the full fiscal year.
F-8
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. EARNINGS PER SHARE
The following table summarizes the computations of share amounts used in the
computation of historical earnings (loss) per share presented in the
accompanying statements of operations (in thousands of shares):
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
----------------- ---------------
1993 1994 1995 1995 1996
----- ----- ----- ------- -------
<S> <C> <C> <C> <C> <C>
Weighted average number of shares of common
stock outstanding during the period......... 1,718 1,718 1,708 1,618 1,618
Options and warrants to purchase common stock
issued within one year of registration
statement................................... 2,990 2,990 2,990 2,990 2,990
Convertible debentures and preferred stock
issued within one year of registration
statement................................... 2,180 2,180 2,180 2,180 2,180
----- ----- ----- ------- -------
Total common and common equivalent shares of
stock considered outstanding during the
year........................................ 6,888 6,888 6,878 6,788 6,788
===== ===== ===== ======= =======
</TABLE>
Earnings (loss) per share is based upon the average number of shares of
common stock outstanding during each period. As required by the Securities and
Exchange Commission, all common stock warrants, options, convertible
debentures, and convertible preferred stock issued by the Company at exercise
prices or conversion rates below the expected public offering price during the
twelve-month period prior to the anticipated offering date have been included
in the computations as if they were outstanding for all periods presented. As
the Company expects the initial public offering price to exceed the exercise
prices or conversion rates for all securities issued after June 1995, all of
the securities issued between July 1, 1995 and the latest filing date have
been included in the computation of historical net income (loss) per common
share attributable to common shareholders.
The assumed conversion of all other potentially dilutive securities (issued
prior to July 1995) is anti-dilutive for all years presented, and therefore is
not considered in the computations.
Net loss per common share attributable to common shareholders for the six
months ended June 30, 1996 was reduced by $670,871 of interest expense
attributable to debentures converted into Series B Preferred Stock during the
period.
Pro forma net loss per share is presented to disclose the additional effect
on loss per share for the year ended December 31, 1995 and for the six months
ended June 30, 1996 assuming that the antidilutive convertible securities
which are not included in the historical calculations and which will convert
into common stock upon the closing of the proposed initial public offering
were converted into common stock on January 1, 1995, or their issuance date,
whichever date is later. Historical net loss was reduced by $450,871 for the
year ended December 31, 1995 and $1,311,347 for the six months ended June 30,
1996 to adjust for interest expense and preferred stock accretion.
F-9
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes the computations of share amounts used in the
computation of pro forma earnings (loss) per share presented in the
accompanying statements of operations (in thousands of shares):
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
DECEMBER 31, JUNE 30,
1995 1996
------------ ---------
(UNAUDITED)
<S> <C> <C>
Weighted average number of shares of common stock
outstanding during the period.......................... 1,708 1,618
Options and warrants to purchase common stock issued
within one year of registration statement.............. 2,990 2,990
Convertible debentures and preferred stock issued within
one year of registration statement..................... 2,180 2,180
Pro forma conversion of preferred stock and warrants.... 1,376 1,902
----- -----
Total common and common equivalent shares of stock
considered outstanding during the year................. 8,254 8,690
===== =====
</TABLE>
3. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
-------------------------- ---------------------
1993 1994 1995 1995 1996
------- ------------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
Cash paid during the period
for:
Interest...................... $ -- $ -- $ 105,100 $ 45,200 $ 118,700
Taxes......................... $ 7,700 $ -- $ -- $ -- $ --
Non-cash investing and
financing activities:
Equipment acquired under
capital lease................ $ -- $ -- $ 2,095,600 $1,048,300 $2,118,900
Conversion of 10% Convertible
Debentures and accrued
interest into Series B
Mandatorily Redeemable
Convertible Preferred Stock.. $ -- $ -- $ -- $ -- $3,126,400
</TABLE>
4. NOTES PAYABLE
In July 1994, the Company received $300,000 in connection with the issuance
of notes with a face value of $300,000 and detachable stock warrants to
purchase 190,883 shares of common stock for $1.58 per share. The portion of
the proceeds allocable to the warrants of $25,393, as estimated by the
Company, was accounted for as additional paid-in capital. The notes were
repaid in conjunction with the issuance of the Series A Mandatorily Redeemable
Convertible Preferred Stock in March 1995.
5. BORROWINGS UNDER LINE OF CREDIT
In April 1996, the Company entered into a loan agreement with a bank that
provides a revolving line of credit secured by accounts receivable. The credit
line allows the Company to borrow a maximum of $1.5 million, subject to
restrictions based on the available collateral, and expires on February 28,
1997. The credit line bears interest at a floating rate equal to the bank's
prime rate plus 1% per annum. In connection with this credit line, the Company
is required to comply with certain financial ratios and covenants. At June 30,
1996, the Company did not have any borrowings outstanding under this facility.
F-10
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. CAPITAL LEASE OBLIGATIONS
The Company leases equipment under capital leases. Property and equipment
includes the following amounts for leases that have been capitalized at June
30, 1996:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 JUNE 30, 1996
----------------- -------------
<S> <C> <C>
Computer equipment.............................. $1,985,436 $4,033,066
Office furniture and equipment.................. 110,118 110,118
---------- ----------
2,095,554 4,143,184
Less accumulated amortization................... 444,683 940,616
---------- ----------
$1,650,871 $3,202,568
========== ==========
</TABLE>
Amortization of leased assets is included in depreciation and amortization
expense.
Future minimum payments under capital lease obligations consist of the
following at June 30, 1996:
<TABLE>
<S> <C>
Through December 31, 1996........................................... $ 885,376
1997................................................................ 1,508,220
1998................................................................ 903,432
1999................................................................ 293,147
2000................................................................ 1,333
----------
Total minimum lease payments........................................ 3,591,508
Amounts representing interest....................................... 379,662
----------
Present value of net minimum lease payments (including current por-
tion of $1,497,563)................................................ $3,211,846
==========
</TABLE>
7. 10% CONVERTIBLE DEBENTURES AND DETACHABLE STOCK WARRANTS
On November 28, 1995, the Company issued $2,000,000 of 10% Convertible
Debentures with detachable stock warrants for cash proceeds of $2,000,000. The
debentures were due on June 1, 1996. As discussed more fully in Note 9, in May
1996 the holders of the 10% Convertible Debentures converted their debentures
into shares of Series B Preferred Stock.
The detachable stock warrants entitle the holders to purchase 299,946 shares
of common stock at an exercise price of $0.25 per share and expire in November
2001. The exercise price is payable either in cash or through the retirement
of stock warrants. The warrants were valued at $682,378, or $2.28 per share,
based on an independent valuation of the Company's common stock and the use of
a generally accepted warrant valuation methodology. The estimated value of the
warrants was recorded as additional paid-in capital and the 10% Convertible
Debentures have been recorded net of a discount of $682,378. The Company
recognized interest expense of $93,543 and $588,835 for the year ended
December 31, 1995 and the six months ended June 30, 1996, respectively,
related to the amortization of this discount.
On February 15, 1996, the Company issued $1,000,000 of 10% Convertible
Debentures with detachable stock warrants for cash proceeds of $1,000,000. The
debentures have terms identical to those issued in November 1995, and were
also converted into Series B Preferred Stock in May 1996. The detachable stock
warrants entitle the holders to purchase 166,378 shares of common stock at an
exercise price of $0.25 per share and expire in February 2002. The exercise
price is payable either in cash or through the retirement of stock warrants.
The warrants were valued at $361,872, or $2.17 per share, based on an
independent valuation of the Company's common stock and the use of a generally
accepted warrant valuation methodology. The estimated value of the
F-11
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
warrants was recorded as additional paid-in capital and the 10% Convertible
Debentures have been recorded net of a discount of $361,872. The Company
recognized interest expense of $361,872 the period from February 15, 1996
through June 30, 1996 related to the amortization of this discount.
8. SERIES A MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND DETACHABLE
STOCK WARRANTS
The Company has authorized the issuance of 200,000 shares of Series A
Mandatorily Redeemable Convertible Preferred Stock ("Series A"). In March and
April 1995, the Company issued 45,455 shares of Series A with detachable stock
warrants for cash proceeds of $4,000,000. Dividends on the Series A are
cumulative at an annual rate of $6 per share beginning March 15, 1997 and $10
per share beginning March 15, 1999.
The detachable stock warrants entitle the holders to purchase 1,120,000
shares of common stock for an aggregate exercise price of $100 and expire six
years from the date of the final redemption of the Series A. The warrants were
valued at $1,913,215, or $1.71 per share, based on an estimate at the date of
the transaction of the relative values of the Series A and the warrants. The
costs of the issuance of $549,350 have been deducted proportionately from the
proceeds allocated to the warrants and the Series A.
The Series A was recorded at estimated fair value on the date of issuance,
less issue costs. The excess of the redemption value over the carrying value
is being accreted by periodic charges to retained earnings over the life of
the issue using the interest method.
The Company must redeem the Series A in 24 equal monthly installments of
1,894 shares commencing January 1, 2000 at a redemption price of $100 per
share plus any accrued and unpaid dividends. The Company may, at its option,
redeem at any time all, but not less than all, of the Series A for $100 per
share plus any accrued and unpaid dividends. If the Company redeems the Series
A prior to March 15, 1997, the redemption price will be reduced, but in no
event will the redemption price be less than $88 per share. The Series A is
also convertible at any time into 500,000 shares of common stock based on a
conversion rate defined in the Amended and Restated Articles of Incorporation.
The Series A will automatically convert into 500,000 shares of common stock
immediately prior to the closing of an initial public offering consummated on
or before December 31, 1996 generating net proceeds to the Company of at least
$25 million.
Each share of Series A has substantially the same voting rights as the
number of shares of common stock into which it can be converted, as provided
for in the Amended and Restated Articles of Incorporation. The holders of the
Series A (in conjunction with the holders of the Series B Preferred Stock
issued in May 1996 as discussed in Note 9) independently appoint three
directors to the Board of Directors. In the event the Company fails to meet
its obligations to the holders of the Series A under the aforementioned
redemption provisions or upon certain other events, the holders of the
preferred stock are entitled to elect a majority of the directors of the Board
of Directors.
In connection with the issuance of the Series A, the Company also issued
warrants to purchase 91,200 shares of common stock with an exercise price of
$2.63 per share to investment bankers. These warrants expire in March 2002.
9. SERIES B MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
In May 1996, the Company amended its Articles of Incorporation to authorize
the issuance of 130,000 shares of Series B Preferred Stock ("Series B") with a
par value of $1. Cumulative annual cash dividends on the Series B at the rate
of $8 per share become payable monthly commencing on the first date
outstanding through March 15, 1999, and after March 15, 1999, at the rate of
$12 per share per annum.
F-12
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Company must redeem the Series B in monthly installments of 3,387 shares
beginning January 1, 2001 at $100 per share plus any unpaid dividends or,
immediately, if certain events specified in the Articles of Incorporation
occur and holders of 63% of the shares of Series B vote for redemption. In
addition, at any time after the earlier of May 24, 1999 or the date on which
all shares of Series A Preferred Stock have been redeemed, the holders of the
Series B may require the Company to redeem their shares at the greater of $200
per share or fair market value, as determined by an independent investment
banking firm. Each share of Series B is convertible at the option of the
holder at any time after issuance into 33.54 shares of common stock. The
Series B holders have the same voting rights as the holders of common stock,
assuming conversion.
On May 30, 1996, the Company issued 50,000 shares of Series B for $5
million. The Series B will automatically convert into 1,341,515 shares of
common stock immediately prior to the closing of an initial public offering
consummated on or before December 31, 1996 generating net proceeds to the
Company of at least $25 million.
In connection with the issuance of the Series B, the holders of the 10%
Convertible Debentures (face value of $3 million, plus accrued interest of
$126,000) converted the debentures into 31,264 shares of Series B.
10. COMMON STOCK
In March 1995, the Company amended and restated the Articles of
Incorporation to authorize the issuance of 49,800,000 shares of $.01 par value
common stock and 200,000 shares of $1 par value Series A Mandatorily
Redeemable Convertible Preferred Stock with a redemption price and liquidation
value of $100 per share. In conjunction with the amendment, the Board of
Directors approved a 505.26-for-1 stock split, effected in the form of a stock
dividend. In August 1995, the Board of Directors approved a 10-for-1 stock
split, also effected in the form of a stock dividend. All share and per share
amounts in the accompanying financial statements have been restated to
retroactively reflect all splits. (See also Note 19).
11. AGREEMENT WITH CUSTOMER
In June 1996, the Company entered into a six-year private network agreement
with WinStar Communications, Inc. As part of the agreement, WinStar will
purchase $5 million of connectivity services which was paid in advance in June
1996. WinStar also received warrants to purchase 240,000 shares of common
stock for $3.75 per share. The warrants were valued at $228,000, or $0.95 per
share, based on independent valuation of the Company's common stock and the
use of a generally accepted warrant valuation methodology. The estimated value
of the warrants was recorded as additional paid-in capital of $228,000 and
deferred revenue associated with the contract was recorded in the amount of
$4,772,000.
12. SHARES RESERVED FOR FUTURE ISSUANCE
The Company as of June 30, 1996 has reserved 6,844,244 shares of common
stock for future issuance upon the conversion of the Series A and Series B
Mandatorily Redeemable Convertible Preferred Stock, the exercise of all
outstanding stock purchase warrants, and the exercise of all outstanding stock
options.
13. STOCK OPTION PLAN
In 1995, the Company approved and adopted its 1995 Stock Option Plan (the
"Plan"). In 1996, the Company approved and adopted its 1996 Equity
Participation Plan. The Plans are administered by the Board of Directors. The
Plans provides for the granting of either qualified or non-qualified options
to purchase an
F-13
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
aggregate of up to 2,500,480 shares of common stock to eligible employees,
officers, directors and consultants of the Company. The 1996 Equity
Participation also provides for the granting of other equity participation
instruments.
The following table summarizes the stock option activity of the Company:
<TABLE>
<CAPTION>
SHARES EXERCISE PRICE
OUTSTANDING EXERCISABLE PER SHARE
----------- ----------- --------------
<S> <C> <C> <C>
Balances at January 1, 1995............. -- -- --
Granted................................ 632,280 -- $0.25
Became exercisable..................... -- 188,280 $0.25
Exercised/Surrendered
Canceled............................... (2,050) -- $0.25
--------- ------- --------------
Balances at December 31, 1995........... 630,230 188,280 $0.25
Granted................................ 1,438,120 -- $0.25 - $10.00
Became exercisable..................... -- 111,553 $0.25
Exercised/Surrendered
Canceled............................... (12,850) -- $0.25
--------- ------- --------------
Balances at June 30, 1996............... 2,055,500 299,833 $0.25 - $10.00
========= ======= ==============
</TABLE>
All of the options granted through June 30, 1996 are non-qualified stock
options and vest over 3 or 4 years. At the dates of grant, the estimated fair
value of a share of the Company's common stock ranged from $2.28 to $10.00.
The Company will record compensation expense of $2,659,221 over the vesting
period of the options. For the year ended December 31, 1995 and the six months
ended June 30, 1996, the Company recorded $475,442 and $400,092 of
compensation expense, respectively. The Company will record additional
compensation expense related to option grants through June 30, 1996 as
follows:
<TABLE>
<S> <C>
Six months ended December 31, 1996.................................. $ 389,423
Year ended December 31, 1997........................................ 747,161
1998................................................................ 527,628
1999................................................................ 119,475
----------
Total............................................................. $1,783,687
==========
</TABLE>
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
The Series A and Series B Mandatorily Redeemable Convertible Preferred Stock
will automatically convert into common stock upon the expected closing of an
initial public offering in August 1996. Upon conversion, the securities will
not be considered financial instruments.
F-14
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
15. INCOME TAXES
The tax provisions for the six months ended June 30, 1995 and 1996 are based
on the estimated annual effective tax rate applicable for the full years.
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1994 1995
-------- -----------
<S> <C> <C>
Deferred tax liability:
Tax over book depreciation.............................. $ 6,998 $ 49,581
Deferred tax assets:
Net operating loss carryforward......................... 32,402 1,382,447
Allowance for doubtful accounts......................... -- 19,310
Stock option compensation expense....................... -- 183,615
Accrued bonuses......................................... -- 23,172
-------- -----------
Total deferred tax assets................................ 32,402 1,608,544
-------- -----------
Net future income tax benefit............................ 25,404 1,558,963
Valuation allowance for net deferred tax assets.......... (17,723) (1,551,282)
-------- -----------
Net deferred tax assets.................................. $ 7,681 $ 7,681
======== ===========
</TABLE>
As of December 31, 1995, the Company had net operating loss carryforwards of
$3.6 million. These carryforwards expire in 2009 and 2010. The amount
available to be used in any given year will be limited by operation of certain
provisions of the Internal Revenue Code.
Income tax expense (benefit) consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1993 1994 1995
-------- -------- -------
<S> <C> <C> <C>
Current:
Federal.............................................. $ 5,237 $ 22,250 $ --
State................................................ 2,444 6,760 --
-------- -------- -----
7,681 29,010 --
Deferred (benefit):
Federal.............................................. 14,622 (20,911) --
State................................................ 3,237 (4,629) --
-------- -------- -----
17,859 (25,540) --
-------- -------- -----
$ 25,540 $ 3,470 $ --
======== ======== =====
</TABLE>
The Company's provision for income taxes resulted in effective tax rates
that varied from the statutory federal income tax rate as follows:
<TABLE>
<CAPTION>
1993 1994 1995
------- -------- -----------
<S> <C> <C> <C>
Expected federal income tax (benefit) at 34%..... $20,699 $(26,538) $(1,352,150)
State income taxes, net of federal benefit....... 2,813 (3,606) (183,733)
Expenses not deductible for tax purposes......... 2,028 4,357 3,602
Effect of valuation allowance.................... -- 17,723 1,533,559
Other............................................ -- 11,534 (1,278)
------- -------- -----------
Total............................................ $25,540 $ 3,470 $ --
======= ======== ===========
</TABLE>
F-15
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
16. OPERATING LEASES
The Company leases certain office space and equipment under noncancelable
operating leases that expire in various years through 2000. Future minimum
payments under noncancelable operating leases with initial terms of one year
or more consisted of the following at December 31, 1995:
<TABLE>
<S> <C>
1996........................................................... $ 531,665
1997........................................................... 504,723
1998........................................................... 485,930
1999........................................................... 314,931
2000........................................................... 205,184
----------
Total minimum lease payments................................... $2,042,433
==========
</TABLE>
Rental expense consisted of the following:
<TABLE>
<CAPTION>
1993 1994 1995
------- ------- --------
<S> <C> <C> <C>
Office and storage.................................... $18,882 $19,200 $123,749
Furniture and equipment............................... 4,037 28,915 133,889
------- ------- --------
$22,919 $48,115 $257,638
======= ======= ========
</TABLE>
17. EMPLOYEE BENEFIT PLAN
The Company established a defined contribution benefit plan effective July
1, 1995. The plan covers substantially all employees who have three months of
service with the Company or who were employed by the Company on July 1, 1995.
Participants may contribute from 1% to 15% of their annual compensation to the
plan. In addition, the Company may make discretionary profit-sharing
contributions to the plan. No contributions were made by the Company during
1995.
18. PRO FORMA BALANCE SHEET
In connection with the issuance of the Series B, the holders of warrants to
purchase 1,868,408 shares of common stock agreed to exercise their warrants
immediately prior to the closing of an initial public offering consummated on
or before December 31, 1996 that generates net proceeds to the Company of at
least $25 million.
In June 1996 the Board of Directors approved the filing of a registration
statement for the sale of common stock with the Securities and Exchange
Commission that, upon closing, would meet the criteria for the automatic
exercise of warrants to purchase 1,868,408 shares of common stock, and the
conversion of the outstanding Series A Preferred Stock and Series B Preferred
Stock, all into common stock. The pro forma balance sheet assumes that the
exercise price of the warrants being exercised is paid by the tender to the
Company of 65,687 shares of common stock valued at $10.00 per share.
F-16
<PAGE>
DIGEX, INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes the components of the pro forma balance sheet
(in thousands):
<TABLE>
<CAPTION>
ASSUMED
HISTORICAL CONVERSION TOTAL
JUNE 30, OF SECURITIES PRO
1996 UPON IPO FORMA
---------- ------------- --------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 6,269 $ -- $ 6,269
Other current assets........................ 2,262 -- 2,262
-------- ------- --------
Total current assets......................... 8,531 -- 8,531
Property and equipment, net.................. 9,761 -- 9,761
Other noncurrent assets...................... 550 -- 550
-------- ------- --------
Total assets................................. $ 18,842 $ -- $ 18,842
======== ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses....... $ 7,975 $ -- $ 7,975
Other current liabilities................... 6,574 -- 6,574
-------- ------- --------
Total current liabilities.................... 14,549 -- 14,549
Capital lease obligations.................... 1,714 -- 1,714
Series A Preferred Stock..................... 2,392 (2,392) --
Series B Preferred Stock..................... 8,126 (8,126) --
Stockholders' equity:
Common stock................................ 16 45 61
Additional paid-in capital.................. 3,825 10,473 14,298
Accumulated deficit......................... (11,780) -- (11,780)
-------- ------- --------
Total stockholders' equity................... (7,939) 10,518 2,579
-------- ------- --------
Total liabilities and stockholders' equity... $ 18,842 $ -- $ 18,842
======== ======= ========
</TABLE>
19. SUBSEQUENT EVENT
On October 9, 1996 the Board of Directors approved a 1-for-2.5 reverse stock
split pursuant to the Company's initial public offering of common stock. All
share and per share amounts in the accompanying financial statements have been
restated to retroactively reflect the reverse split.
F-17
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION
NOT CONTAINED IN THIS PROSPECTUS, AND ANY INFORMATION OR REPRESENTATIONS NOT
CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COM-
PANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL
OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO
ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE
SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE
DATE HEREOF.
-----------------
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
PAGE
<S> <C>
Additional Information.................................................... 3
Reports to Stockholders................................................... 3
Prospectus Summary........................................................ 4
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 16
Dilution.................................................................. 16
Capitalization............................................................ 17
Dividend Policy........................................................... 18
Selected Financial and Pro Forma
Financial Data........................................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 21
Business.................................................................. 27
Management................................................................ 37
Certain Transactions...................................................... 50
Principal Stockholders.................................................... 53
Capital Stock of the Company.............................................. 54
Shares Eligible for Future Sale........................................... 56
Underwriting.............................................................. 58
Legal Matters............................................................. 59
Experts................................................................... 59
Glossary.................................................................. 60
Index to Financial Statements............................................. F-1
</TABLE>
UNTIL NOVEMBER, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL DEALERS
EFFECTING TRANSACTIONS IN THE SHARES OF COMMON STOCK, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
4,500,000 SHARES
[LOGO OF DIGEX BUSINESS INTERNET APPEARS HERE]
COMMON STOCK
-----------------
PROSPECTUS
-----------------
FRIEDMAN, BILLINGS,
RAMSEY & CO., INC.
OCTOBER , 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Amended and Restated Certificate of Incorporation of DIGEX, Incorporated
(the "Registrant" or "Company"), as amended (the "Amended and Restated
Certificate of Incorporation"), provides that the Registrant shall indemnify
to the fullest extent permitted by Section 145 of the General Corporation Law
of the State of Delaware (the "Delaware Law") any person whom it may indemnify
thereunder. The By-laws of the Registrant provide that indemnification shall
be made by the Registrant only upon a determination that indemnification is
proper in the circumstances because the individual met the applicable standard
of conduct. Advances for such indemnification may be made pending such
determination upon receipt of an undertaking by the director or officer to
repay all amounts so advanced in the event that it shall ultimately be
determined that such director or officer is not entitled to be indemnified by
the Registrant. In addition, the Amended and Restated Certificate of
Incorporation provides for the limitation to the extent permitted by the
Delaware Law of personal liability of directors to the Registrant and its
stockholders for monetary damages for breach of fiduciary duty as directors of
the Registrant.
The Company is obtaining a directors' and officers' insurance and company
reimbursement policy in the amount of $5,000,000. The policy insures directors
and officers against unindemnified loss arising from certain wrongful acts in
their capacities and reimburses the Registrant for such loss for which the
Registrant has lawfully indemnified its directors and officers. The policy
contains various exclusions, none of which will relate to the offering
hereunder.
ITEM 25. OTHER EXPENSES OF ISSUANCES AND DISTRIBUTION.
The following table sets forth the fees and expenses in connection with the
issuance and distribution of the securities being registered hereunder. Except
for the SEC registration fee and the NASD fee, all amounts are estimates.
<TABLE>
<S> <C>
SEC Registration Fee.......................................... $ 19,629.31
NASD Filing Fee............................................... 6,000.00
Printing and Engraving Expenses............................... 300,000.00
Legal Fees and Expenses....................................... 400,000.00
Accounting Fees and Expenses.................................. 250,000.00
Blue Sky Fees and Expenses.................................... 19,125.00
Directors' and Officers' Insurance............................ 200,000.00
Miscellaneous Expenses........................................ 5,245.69
-------------
Total...................................................... $1,200,000.00
=============
</TABLE>
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
The Company was incorporated on January 8, 1990 by Mr. Humphrey and Mr.
Doughney (the "Founders"). Mr. Humphrey contributed certain computer hardware
to the Company in exchange for 970,744 shares of Common Stock, and Mr.
Doughney contributed certain computer software to the Company in exchange for
647,163 shares of Common Stock.
On July 1, 1994, Robert M. Stewart, a director of the Company, and six other
individuals who are not affiliated with the Company loaned the Company
$300,000 in cash. In consideration for their loan, the Company issued to these
individuals (i) 8% promissory notes (the "Bridge Notes") in aggregate
principal amount of $300,000 and (ii) warrants to purchase 190,883 shares of
the Common Stock (the "Bridge Warrants"). The Bridge Notes were to mature on
the earlier of July 12, 1995 and the date on which certain payments were made
under the Securities Purchase Agreement.
II-1
<PAGE>
On March 24, 1995, the Company entered into the Securities Purchase
Agreement with the Founders and Grotech IV, Venrock and Southern, pursuant to
which the Company issued a total of 45,454.54 shares of convertible preferred
stock (since redesignated Series A Convertible Preferred Stock), par value
$1.00 per share, together with warrants to purchase 1,120,000 shares of Common
Stock of the Company, for an aggregate cash investment of $4,000,000. The
Bridge Notes were repaid at their face amount with a portion of the proceeds
of this investment. Grotech IV was issued 18,181.82 shares of Series A
Preferred Stock and warrants to purchase 448,000 shares of Common Stock in
consideration of its investment of $1.6 million in cash, Venrock was issued
15,909.09 shares of Series A Preferred Stock (4,925.83 shares of which were
assigned to Venrock II) and warrants to purchase 392,000 shares of Common
Stock (121,348 of which were assigned to Venrock II) in consideration of its
investment of $1.4 million in cash and Southern was issued 11,363.63 shares of
Series A Preferred Stock and warrants to purchase 280,000 shares of Common
Stock in consideration of its investment of $1.0 million in cash.
Representatives of each of Grotech IV, Venrock and Southern were elected to
the Company's Board of Directors pursuant to the Securities Purchase
Agreement.
As a fee for arranging the above investment, the Company made a cash payment
of $200,000 and issued warrants to purchase 91,200 shares of Common Stock to
Mr. Stewart and nine other individuals (the "Fee Warrants" and, together with
the Bridge Warrants, the "Initial Warrants"). These individuals (other than
Mr. Stewart) are not affiliated with the Company.
Pursuant to a Stockholders Agreement (the "Stockholders Agreement"), dated
March 24, 1995, by and among the Company, Grotech IV, Venrock, Southern, Mr.
Humphrey and Mr. Doughney, the parties thereto agreed to grant rights of first
refusal to the other parties to such agreement in the event of the death,
disability or termination of employment of either Mr. Humphrey or Mr. Doughney
or in the event that either Mr. Humphrey or Mr. Doughney wishes to transfer
any of their shares of Common Stock of the Company. The provisions of the
Stockholders Agreement will terminate effective immediately prior to
consummation of the Offering.
On November 28, 1995, Grotech IV, Venrock, Southern and Venrock Associates
II, L.P. ("Venrock II" and, together with Grotech IV, Venrock and Southern,
the "Investors") loaned to the Company $800,000, $483,307, $500,000 and
$216,693 in cash, respectively. In consideration of these loans, the Company
issued 10% promissory notes due June 1, 1996 in the principal amount of
$2,000,000 (the "November 1995 Notes") and warrants to purchase 299,946 shares
of Common Stock to Grotech IV, Venrock, Venrock II and Southern as follows:
Grotech IV purchased promissory notes in the principal amount of $800,000 and
warrants to purchase 119,978 shares of Common Stock; Venrock purchased
promissory notes in the amount of $483,307 and warrants to purchase 72,483
shares of Common Stock; Venrock II purchased promissory notes in the principal
amount of $216,693 and warrants to purchase 32,498 shares of Common Stock; and
Southern purchased promissory notes in the principal amount of $500,000 and
warrants to purchase 74,987 shares of Common Stock.
On February 23, 1996, the Company issued additional 10% promissory notes due
June 1, 1996 in the principal amount of $1,000,000 (the "February 1996 Notes")
and additional warrants to purchase 166,378 shares of Common Stock to the
Investors as follows: Grotech IV purchased promissory notes in the principal
amount of $400,000 and warrants to purchase 66,551 shares of Common Stock for
a cash purchase price of $400,000; Venrock purchased promissory notes in the
principal amount of $217,000 and warrants to purchase 36,104 shares of Common
Stock for a cash purchase price of $217,000; Venrock II purchased promissory
notes in the principal amount of $133,000 and warrants to purchase 22,128
shares of Common Stock for a cash purchase price at $133,000; and Southern
purchased promissory notes in the principal amount of $250,000 and warrants to
purchase 41,595 shares of Common Stock for a cash purchase price of $250,000.
On May 21, 1996, the Company issued additional promissory notes in the
principal amount of $1,000,000 (the "Convertible Notes") convertible into
shares of Series B Preferred Stock of the Company to the Investors as follows:
Grotech IV purchased promissory notes in the principal amount of $400,000 for
a cash purchase price of $400,000; Venrock purchased promissory notes in the
principal amount of $217,000 for a cash purchase price of $217,000; Venrock II
purchased promissory notes in the principal amount of $133,000 for a cash
purchase price of $133,000; and Southern purchased promissory notes in the
principal amount of $250,000 for a cash purchase price of $250,000.
II-2
<PAGE>
On May 30, 1996, the Company, the Founders, the Investors, Grotech Partners,
Grotech Companion, Grotech Pennsylvania, Blue Chip and Crisler Capital
Company, Limited Partnership (together with the Investors, Grotech Partners,
Grotech Companion, Grotech Pennsylvania and Blue Chip, the "Purchasers")
entered into the Purchase and Exchange Agreement, whereby the Investors
exchanged $2.0 million principal amount of November 1995 Notes and $1.0
million principal amount February 1996 Notes (together with the right to
receive $126,389 in accrued interest thereon from the date of issuance) for
31,263.89 shares of Series B Convertible Preferred Stock of the Company, par
value $1.00 per share (the "Series B Preferred Stock"), and converted $1.0
million principal amount of Convertible Notes, in accordance with their terms,
into 10,000 shares of Series B Preferred Stock. In addition, the Purchasers
paid $4,000,000 in cash in exchange for a further 40,000 shares of Series B
Preferred Stock. The above-referenced exchange, conversion, and purchase
resulted in the following acquisitions of Series B Preferred Stock: Grotech IV
acquired 22,505.56 shares of Series B Preferred Stock; Grotech Partners
acquired 8,537 shares of Series B Preferred Stock; Grotech Companion acquired
930 shares of Series B Preferred Stock; Grotech Pennsylvania acquired 533
shares of Series B Preferred Stock; Venrock acquired 10,914.77 shares of
Series B Preferred Stock; Venrock II acquired 5,860.92 shares of Series B
Preferred Stock. Southern acquired 11,982.64 shares of Series B Preferred
Stock; Blue Chip acquired 16,000 shares of Series B Preferred Stock; and
Crisler acquired 4,000 shares of Series B Preferred Stock.
The transactions of May 21 and May 30, 1996 are collectively referred to
herein as the "1996 Venture Financing." A representative of Blue Chip holds a
seat on the Company's Board of Directors pursuant to the terms of the Purchase
and Exchange Agreement. The rights of representatives of each of Grotech IV,
Venrock and Southern, as well as each of the Founders, to have seats on the
Company's Board of Directors, granted pursuant to the Securities Purchase
Agreement, were restated in the Purchase and Exchange Agreement. In addition,
pursuant to the Purchase and Exchange Agreement, Crisler obtained the right to
designate a representative (R. Dean Meiszer) to act as an observer at meetings
of the Company's Board of Directors. Such stockholders' rights to designate
Directors or representatives to attend board meetings under the Purchase and
Exchange Agreement will terminate effective immediately prior to consummation
of the Offering. See "Management--Board Composition."
The holders of all outstanding shares of Series A Preferred Stock and Series
B Preferred Stock have agreed to convert their outstanding shares of Series A
Preferred Stock and Series B Preferred Stock, in accordance with their
respective terms, into 2,680,336 shares of Common Stock at or prior to the
consummation of the Offering (the "Preferred Stock Conversion"). As of the
date hereof, each share of Series A Preferred Stock is convertible into
approximately 11.0 shares of Common Stock and each share of Series B Preferred
Stock is convertible into approximately 26.83 shares of Common Stock. In
addition, all holders of warrants to purchase Common Stock (other than WinStar
and one holder of Initial Warrants) will exercise such warrants to purchase
1,868,408 shares of Common Stock upon consummation at or prior to the Offering
(the "Warrant Exercise").
In June 1996, the Company entered into a multi-year private network
agreement with WinStar. As part of the agreement, WinStar advanced $5,000,000
to the Company for connectivity services and received warrants to purchase
240,000 shares of Common Stock.
In October 1996 the Company obtained $1.5 million in interim financing
pursuant to the Bridge Loan from Blue Chip Capital Fund Limited Partnership
("Blue Chip"), which the Company will repay using a portion of the net
proceeds of the Offering. See "Use of Proceeds." In connection with the Bridge
Loan, the Company agreed to issue to Blue Chip warrants to purchase 150,000
shares of Common Stock at an exercise price of $1.75 per share if, but only
if, the Company's initial public offering of Common Stock is not consummated
by October 31, 1996. The Company presently expects that this Offering will be
consummated prior to October 31, 1996 and, accordingly, that no warrants will
be issued in connection with the Bridge Loan. The Company also has received,
in addition to the Bridge Loan, a standby funding commitment from certain of
its current venture capital investors to purchase up to $5.0 million of
convertible subordinated debentures and warrants to purchase shares of Common
Stock in the event that the Company requires additional liquidity prior to
completion of the Offering. The Company does not presently expect that it will
be required to make any draws pursuant to the $5.0 million standby commitment.
II-3
<PAGE>
No underwriters were involved in any of the foregoing transactions. The
sales of all such securities were deemed to be exempt from registration under
the Act, in reliance on Section 4(2) thereunder, as transactions by an issuer
not involving any public offering.
Since September 18, 1995, the Company at various times has granted options
to purchase shares of Common Stock of the Company to certain Company
employees. Options to purchase 2,298,200 shares of Common Stock have been
granted in the aggregate, at exercise prices ranging from $0.25 to $10.00 per
share. These grants were exempt from registration pursuant to Section 4(2) of
the Act, Rule 701 thereunder or other applicable exemptions.
II-4
<PAGE>
ITEM 27. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
1.1 Form of Underwriting Agreement.(4)
3.1 Certificate of Incorporation of the Registrant.(2) (in force as of
date of filing)
3.2 By-Laws of the Registrant (in force as of date of filing)
(a) Amended and Restated By-laws of the Registrant.(2)
(b) Amendment No. 1 to Amended and Restated By-laws.(2)
3.3 Amended and Restated Certificate of Incorporation of the
Registrant (in force as of date of effectiveness)(4)
3.4 By-Laws of the Registrant (in force as of date of
effectiveness)(4)
4.1 Form of Common Stock certificate.(2)
5.1 Opinion of Latham & Watkins with respect to the legality of the
securities being registered.(5)
10.1 MCI Special Customer Arrangement between MCI Telecommunications
Corporation and Digital Express Group, Inc. dated March 28,
1996.(2)**
10.2 Customer contract with LCI International, Inc. dated May 29,
1996.(6)**
10.3 Customer contract with WinStar Communications, Inc. dated June 6,
1996.(5)
10.4 Warrant agreement with WinStar Communications, Inc. dated June 6,
1996.(2)
10.5 Peering agreements
(a) Agreement for T1 Gateway Attachment Services, as amended, with
ANS CO+RE Systems Inc. dated February 1, 1994.(2)**
(b)Bilateral Interconnection Agreement with PSINet Inc. dated
February 7, 1996.(2)
(c) Peering Agreement with MCI Telecommunications Corporation
dated April 21, 1995.(2)
10.6 Microsoft consulting services master services agreement, dated
August 13, 1996.(5)
10.7 Lease agreement with Banbury Associates Limited Partnership dated
November 17, 1994.(2)
10.8 Lease Agreement with George Christancos, dated December 4,
1995.(2)
10.9 Lease Agreement with Executive Office Network, Ltd.(1)
10.10 Sublease Agreement with A.S. McGaughaan.(2)
10.11 Employment and consulting agreements
(a)Clyde A. Heintzelman, dated March 19, 1995.(1)
(b)Christopher R. McCleary, dated February 1, 1996.(1)
(c)Brian M. Deobald, dated March 25, 1996.(3)
(d)Earl P. Galleher, dated March 25, 1996.(3)
(e)Nicholas J. Magliato, dated March 25, 1996.(3)
(f)William A. Pendley, dated July 15, 1996.(3)
(g)Thomas M. Brandt, Jr., dated June 1, 1996.(1)
10.12 Stock option plans
(a)Incentive Stock Option Plan.(5)
(b)1996 Equity Participation Plan.(5)
10.13 Securities Purchase Agreement with Grotech Partners IV, L.P.,
Venrock Associates, Southern Venture Fund II, L.P., Douglas E.
Humphery and Michael T. Doughney dated March 24, 1995.(1)
10.14 Stockholders Agreement with Grotech Partners IV, L.P., Venrock
Associates, Southern Ventures II, L.P. Douglas E. Humphery and
Michael T. Doughney dated March 24, 1995.(1)
10.15 (a)Warrant Agreement with Grotech Partners IV, L.P. dated March
24, 1995.(1)
(b)Warrant Agreement with Venrock Associates dated March 24,
1995.(1)
(c)Warrant Agreement with Southern Venture Fund II, L.P. dated
March 24, 1995.(1)
10.16 Loan and Security Agreement with Silicon Valley Bank dated April
11, 1996.(1)
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
10.17 First Amendment to Loan and Security Agreement with Silicon Valley
Bank dated May , 1996.(1)
10.18 Revolving Promissory Note with Silicon Valley Bank dated April 11,
1996.(1)
10.19 Securities Purchase, Conversion and Exchange Agreement with
Grotech Partners IV, L.P., Grotech Partners III, L.P., Grotech III
Companion Fund, L.P., Grotech III Pennsylvania Fund, L.P., Venrock
Associates, Venrock Associates II, L.P., Southern Venture Fund II,
L.P., Blue Chip Capital Fund Limited Partnership, Crisler Capital
Company, Limited Partnership dated May 30, 1996.(1)
10.20 Series C Subordinated Convertible Debentures Agreement of
September 27, 1996(4)
10.21 Promissory Note with Blue Chip Capital Fund Limited Partnership,
dated October 7, 1996(4)
10.22 Form of Warrant agreement with Blue Chip Capital Fund Limited
Partnership(4)
23.1 Consent of Ernst & Young LLP(6)
23.2 Consent of Latham & Watkins (to be included in Exhibit 5.1).(5)
27 Financial Data Schedule(3)
</TABLE>
- --------
(1) Previously filed with the Company's Registration Statement on Form SB-2,
File No. 333-05871, filed June 12, 1996.
(2) Previously filed with Amendment No. 1 to the Registration Statement on
Form SB-2, filed July 5, 1996.
(3) Previously filed with Amendment No. 2 to the Registration Statement on
Form SB-2, filed July 23, 1996.
(4) Previously filed with Amendment No. 4 to the Registration Statement on
Form SB-2, filed October 8, 1996.
(5) Previously filed with Amendment No. 5 to the Registration Statement on
Form SB-2, filed October 15, 1996.
(6) Filed herewith.
** Subject to a request for confidential treatment; the entirety of this
exhibit has been filed separately with the Commission.
ITEM 28. UNDERTAKINGS
The undersigned Registrant hereby undertakes that:
(1) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 (the "Act") may be permitted to directors, officers
and controlling persons of the small business issuer pursuant to the
foregoing provisions, or otherwise, the small business issuer has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the small business issuer of expenses incurred
or paid by a director, officer or controlling person of the small business
issuer in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with
the securities being registered, the small business issuer will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of
whether such indemnification by it is against public policy as expressed in
the Act and will be governed by the final adjudication of such issue.
(2) For determining any liability under the Act, treat the information
omitted from the form of prospectus filed as part of this registration
statement in reliance upon Rule 430A and contained in the form of
prospectus filed by the small business issuer under Rule 424(b)(1), or (4),
or 497(h) under the Act as part of this registration statement as of the
time the Commission declared it effective.
(3) For determining any liability under the Act, treat each post-
effective amendment that contains a form of prospectus as a new
registration statement for the securities offered in the registration
statement, and that offering of the securities at that time as the initial
bona fide offering of those securities.
(4) It will provide to the Underwriters at the closing specified in the
Underwriting Agreement certificates in such denominations and registered in
such names as required by the Underwriters to permit prompt delivery to
each purchaser.
II-6
<PAGE>
SIGNATURES
IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE
REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS
ALL OF THE REQUIREMENTS FOR FILING ON FORM SB-2 AND AUTHORIZED THIS AMENDMENT
NO. 6 TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, IN THE CITY OF
BELTSVILLE, STATE OF MARYLAND, ON OCTOBER 16, 1996.
DIGEX, Incorporated
/s/ Christopher R. McCleary
By: _________________________________
Christopher R. McCleary
Chief Executive Officer, President
and Chairman of the Board
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 6 has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
* Director October 16, 1996
- -------------------------------------
FRANK A. ADAMS
/s/ Christopher R. McCleary Chief Executive October 16, 1996
- ------------------------------------- Officer, President
CHRISTOPHER R. MCCLEARY and Chairman of the
Board (principal
executive officer)
* Senior Vice October 16, 1996
- ------------------------------------- President, Chief
THOMAS M. BRANDT, JR. Financial Officer
(principal
financial officer)
* Vice President, October 16, 1996
- ------------------------------------- Controller
JOHN C. WELLING (principal
accounting officer)
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
* Senior Vice President, October 16, 1996
- ------------------------------------- Director
DOUGLAS E. HUMPHREY
* Vice President, Director October 16, 1996
- -------------------------------------
MICHAEL T. DOUGHNEY
Director October 16, 1996
- -------------------------------------
THOMAS H. CATO
* Director October 16, 1996
- -------------------------------------
WILLIAM F. EARTHMAN, III
* Director October 16, 1996
- -------------------------------------
RAY A. ROTHROCK
* Director October 16, 1996
- -------------------------------------
ROBERT M. STEWART
* Director October 16, 1996
- -------------------------------------
JOHN H. WYANT
/s/ Christopher R. McCleary
*By: ________________________________
ATTORNEY-IN-FACT
</TABLE>
II-8
<PAGE>
EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIAL
PAGE
EXHIBIT NO. DESCRIPTION OF EXHIBIT NUMBER
----------- ---------------------- ----------
<C> <S> <C>
1.1 Form of Underwriting Agreement.(4)
3.1 Certificate of Incorporation of the Registrant.(2)
(in force as of date of filing)
3.2 By-Laws of the Registrant (in force as of date of
filing)
(a) Amended and Restated By-laws of the
Registrant.(2)
(b) Amendment No. 1 to Amended and Restated By-
laws.(2)
3.3 Amended and Restated Certificate of Incorporation of
the Registrant (in force as of date of
effectiveness)(4)
3.4 By-Laws of the Registrant (in force as of date of
effectiveness)(4)
4.1 Form of Common Stock certificate.(2)
5.1 Opinion of Latham & Watkins with respect to the
legality of the securities being registered.(5)
10.1 MCI Special Customer Arrangement between MCI
Telecommunications Corporation and Digital Express
Group, Inc. dated March 28, 1996.(2)**
10.2 Customer contract with LCI International, Inc. dated
May 29, 1996.(6)**
10.3 Customer contract with WinStar Communications, Inc.
dated June 6, 1996.(5)
10.4 Warrant agreement with WinStar Communications, Inc.
dated June 6, 1996.(2)
10.5 Peering Agreements
(a) Agreement for T1 Gateway Attachment Services, as
amended, with ANS CO+RE Systems Inc. dated
February 1, 1994.(2)**
(b) Bilateral Interconnection Agreement with PSINet
Inc. dated February 7, 1996.(2)
(c) Peering Agreement with MCI Telecommunications
Corporation dated April 21, 1995.(2)
10.6 Microsoft consulting master services agreement, dated
August 13, 1996.(5)
10.7 Lease agreement with Banbury Associates Limited
Partnership dated November 17, 1994.(2)
10.8 Lease Agreement with George Christancos, dated
December 4, 1995.(2)
10.9 Lease Agreement with Executive Office Network,
Ltd.(1)
10.10 Sublease Agreement with A.S. McGaughaan.(2)
10.11 Employment and consulting agreements
(a) Clyde A. Heintzelman, dated March 19, 1995.(1)
(b) Christopher R. McCleary, dated February 1,
1996.(1)
(c) Brian M. Deobald, dated March 25, 1996.(3)
(d) Earl P. Galleher, dated March 25, 1996.(3)
(e) Nicholas J. Magliato, dated March 25, 1996.(3)
(f) William A. Pendley, dated July 15, 1996.(3)
(g) Thomas M. Brandt, Jr., dated June 1, 1996.(1)
10.12 Stock option plans
(a) Incentive Stock Option Plan.(5)
(b) 1996 Equity Participation Plan.(5)
10.13 Securities Purchase Agreement with Grotech Partners
IV, L.P., Venrock Associates, Southern Venture Fund
II, L.P., Douglas E. Humphery and Michael T.
Doughney dated March 24, 1995.(1)
10.14 Stockholders Agreement with Grotech Partners IV,
L.P., Venrock Associates, Southern Ventures II, L.P.
Douglas E. Humphery and Michael T. Doughney dated
March 24, 1995.(1)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SEQUENTIAL
PAGE
EXHIBIT NO. DESCRIPTION OF EXHIBIT NUMBER
----------- ---------------------- ----------
<C> <S> <C>
10.15 (a) Warrant Agreement with Grotech Partners IV, L.P.
dated March 24, 1995.(1)
(b) Warrant Agreement with Venrock Associates dated
March 24, 1995.(1)
(c) Warrant Agreement with Southern Venture Fund II,
L.P. dated March 24, 1995.(1)
10.16 Loan and Security Agreement with Silicon Valley Bank
dated April 11, 1996.(1)
10.17 First Amendment to Loan and Security Agreement with
Silicon Valley Bank dated May , 1996.(1)
10.18 Revolving Promissory Note with Silicon Valley Bank
dated April 11, 1996.(1)
10.19 Securities Purchase, Conversion and Exchange
Agreement with Grotech Partners IV, L.P., Grotech
Partners III, L.P., Grotech III Companion Fund,
L.P., Grotech III Pennsylvania Fund, L.P., Venrock
Associates, Venrock Associates II, L.P., Southern
Venture Fund II, L.P., Blue Chip Capital Fund
Limited Partnership, Crisler Capital Company,
Limited Partnership dated May 30, 1996.(1)
10.20 Series C Subordinated Convertible Debentures
Agreement of September 27, 1996(4)
10.21 Promissory Note with Blue Chip Capital Fund Limited
Partnership, dated October 7, 1996(4)
10.22 Form of Warrant agreement with Blue Chip Capital Fund
Limited Partnership(4)
23.1 Consent of Ernst & Young LLP(6)
23.2 Consent of Latham & Watkins (to be included in
Exhibit 5.1).(5)
27 Financial Data Schedule(3)
</TABLE>
- --------
(1) Previously filed with the Company's Registration Statement on Form SB-2,
File No. 333-05871, filed June 12, 1996.
(2) Previously filed with Amendment No. 1 to the Registration Statement on
Form SB-2, filed July 5, 1996.
(3) Previously filed with Amendment No. 2 to the Registration Statement on
Form SB-2, filed July 23, 1996.
(4) Previously filed with Amendment No. 4 to the Registration Statement on
Form SB-2 filed October 8, 1996.
(5) Previously filed with Amendment No. 5 to the Registration Statement on
Form SB-2, filed October 15, 1996.
(6) Filed herewith.
** Subject to a request for confidential treatment; the entirety of this
exhibit has been filed separately with the commission.
<PAGE>
Exhibit 10.2
Digital Express Group Inc., a Maryland corporation, with offices at 6800
Virginia Manor Road, Beltsville, Maryland 20705, hereinafter referred to as
"DIGEX", and LCI International Telecom Corp. with offices at 8180 Greensboro
Drive, Suite 800 McLean, Virginia 22102 hereinafter referred to as "LCI", agree
that the following terms and conditions shall govern the sale and discounting of
Products as herein defined.
1. Definitions.
-----------
1.1 Parties, Party. "Parties" means DIGEX and LCI, collectively.
--------------
"Party" means either DIGEX or LCI.
1.2 Agreement. "Agreement" means this authorized LCI Agreement.
---------
1.3 Territory. "Territory" is designated as Continental United States.
---------
1.4 Service(s). The term "Service" or "Services" as used herein shall
----------
mean one or more of the items listed on EXHIBIT "1" hereto, as
changed from time to time in accordance with the provisions of this
Agreement.
1.5 Ramp Period. The term "Ramp Period" refers to the period beginning
-----------
on the Effective Date of the Agreement and ending *
after the Effective Date of the Term.
1.6 Total Network Availability. The term "Total Network Availability" is
--------------------------
defined as the cumulative time the "Network Backbone" (as defined
below) is available to process internet usage as measured by the HP
Open View software package (as defined in EXHIBIT "1")
1.7 Network Backbone. The term "Network Backbone" is defined as any
----------------
network interconnection that exists between a DIGEX Internet gateway
interconnection or Network Access Point ("NAP") and any DIGEX
interconnection device(s).
2. Appointment and Territory.
-------------------------
2.1 Authorization. DIGEX hereby authorizes LCI to purchase wholesale
-------------
nationwide Internet access and market, distribute and solicit orders
for Services to LCI Customers (defined as customers of LCI utilizing
DIGEX internet access services on a non-exclusive basis) subject to
the terms and conditions of this Agreement.
2.2 Public Release of Information. No news releases, articles,
brochures, advertisements, speeches or other informational releases
concerning this Agreement, the terms contained herein, or the
relationship of the Parties shall be made without written approval of
LCI. DIGEX agrees to give LCI reasonable advance time for review of
any material submitted to LCI for approval.
2.3 Non-Assignability. The Parties' rights under this Agreement are
-----------------
non-transferable, and may not be assigned or sub-licensed without the
prior written authorization of the other party, provided, however
should a party be subject to a Change in Control (as defined below)
during the term of the Agreement, either party may terminate the
agreement, without penalty. For purposes of this provision, a "Change
in Control" will be considered to have occurred on the date of the
acquisition (whether by purchase, merger, consolidation or otherwise)
by any person, entity or group (within the meaning of Section
13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934), of more
than fifty percent (50%) of the then outstanding voting securities of
a party (or the surviving corporation in the event of a merger or
consolidation involving such party) entitled to vote generally in the
election of the board of directors.
2.4 No Authority to Make Agreements. Except as expressly permitted
-------------------------------
herein, neither Party shall have the authority to make any agreement
or incur any liability on behalf of the other party.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
-1-
<PAGE>
2.5 Reserved Rights. DIGEX reserves the right to market the Services in
---------------
any manner and without limitation both within and outside of the
Territory.
3. Effective Date and Term.
-----------------------
3.1 Effective Date. This Agreement shall be effective, after execution
--------------
by both Parties, on the commencement date specified herein.
3.2 Term. The initial term of this Agreement shall be for forty-two (42)
----
months from the commencement date specified herein.
3.3 Renewal. LCI has option, exercisable in its sole discretion, to
-------
extend the term of this Agreement for up to two (2), one (1) year
periods by giving DIGEX written notice of its election to extend the
Agreement at least thirty (30) days before the expiration date. Any
renewal terms will not be subject to the Commitment (as provided
below).
4. Port Acquisition and Revenue.
----------------------------
4.1 Annual Reconciliation. DIGEX shall deliver to LCI a reconciliation
---------------------
at every twelve (12) month anniversary of the Term setting forth:
a) LCI's "Port Acquisition and Revenue Rates" from the Commencement
Date, or as appropriate, the previous Anniversary Date, to the most
recent Anniversary date and; b) the applicable rates set forth in
EXHIBIT 2 for that period. For purposes of this Agreement, "Port
Acquisition and Revenue Rates" are, as of any date, the total number
of Ports billed to LCI (at the rates set forth in EXHIBIT "1") as of
such date for service initiated from or directed to a LCI Customer
activated by DIGEX at the request of LCI and any other payments made
by LCI in DIGEX under the Agreement.
5. Commitment
----------
5.1 Total Commitment. LCI hereby commits to purchase from DIGEX Five
----------------
Million ($5,000,000) dollars of Services at the Port Acquisition and
Revenue Rates (defined above) less any Service Credits (as defined in
EXHIBIT "1") received by LCI from DIGEX for failure to meet
Performance Specifications or any other credits or offsets given to
LCI over a forty two (42) month period (the "Commitment"),
irrespective of whether LCI uses or resells all of the commitment
during the Term.
5.2 LCI's satisfaction of the Commitment will vary depending on the Term
remaining as follows:
a. Inclusive of the Ramp Period, LCI shall use not less than ten
(10%) percent of the Commitment of Services during
* of the Agreement ("First Commitment
Level"). If LCI does not meet the First Commitment Level by the
end of * , LCI shall pay to DIGEX an amount
equal to the difference between * to
LCI for usage of the Services and an underutilization amount
equal to the * (the "Initial Shortfall"). LCI will be permitted
to pay any Initial Shortfall in * equal installments over * of
the Agreement.
b. During * , LCI shall use
not less than thirty (30%) percent of the Commitment of Services
described in the Agreement ("Second Commitment Level"). If LCI
does not meet the Second Commitment Level by the end of
* , LCI shall pay to DIGEX amount equal to the
difference between * to LCI for usage
of the services and an underutilization amount equal to *
(the "Second Shortfall"). LCI will be permitted to pay
any Second shortfall in * equal installments over
* of the Agreement.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
-2-
<PAGE>
c. Finally, during * , LCI shall
use not less than sixty (60%) percent of the Commitment for Services
described in the Agreement ("Final Commitment Level"). If LCI does
not meet the Final Commitment Level by the end of *
* , LCI shall pay to DIGEX amount equal to the difference between
the * to LCI for usage of the Services and an
underutilization amount equal to *
(the "Final Shortfall"). LCI shall pay the Final Shortfall within
thirty (30) days of the termination of the Agreement.
6. Responsibilities of LCI.
-----------------------
6.1 LCI agrees to provide to DIGEX, on a monthly basis, a rolling three
month sales forecast by Site ("Site" is defined as any city that DIGEX
interconnects its Network Backbone to a LCI's Point of Presence
("POP")). This plan will initially be submitted by LCI to DIGEX for
review and approval in conjunction with the signing of the Agreement;
subsequently the forecast is due the first Monday of every month during
the Term of this Agreement for review and incorporation into the DIGEX's
network operations and planning, Point of Presence ("POP") build-out,
and revenue forecasts.
6.2 LCI shall not use in its marketing effort any materials or make any
warranties or representations to LCI Customers regarding the Services or
DIGEX that are misleading or inaccurate, or otherwise not in accordance
with DIGEX's specifications, unless approved in advance in writing by
DIGEX.
6.3 LCI will coordinate, register, and maintain all domain name services for
LCI Customers.
6.4 LCI will act as a single point of contact for its customers and will be
responsible for all initial trouble-shooting, marketing, sales and
billing issues.
7. Responsibilities of DIGEX.
-------------------------
DIGEX's responsibilities under this Agreement shall, in addition to any
others contained herein, be as follows:
7.1 Provision of Service. DIGEX will provide the Service for use throughout
--------------------
the United States and other areas within the coverage of DIGEX's
network. The Service will be available following the successful
placement into revenue service of a POP, completion, integration, and
testing of the POP, and receipt by DIGEX of all necessary regulatory
approvals, permits, licenses and certifications for the POP.
7.2 Port Access Records. DIGEX will provide LCI on a monthly basis with the
-------------------
Port Access Records of LCI Customers in reasonable detail sufficient to
enable LCI to bill its customers, but in no greater detail than DIGEX
generates for its own billing and record keeping purposes. DIGEX will
provide the Port Access Records to LCI on media and in a format agreed
upon by the Parties; provided, however, DIGEX reserves the right to
charge LCI for providing the Port Access Records as described in this
paragraph 7.2, based on DIGEX's costs of preparation and delivery,
including but not limited to any hardware/software modifications
required to be made to DIGEX's systems in the event that LCI requests
that the Port Access Records be tailored to a more detailed format.
DIGEX will advise LCI and obtain LCI approval in writing of any such
costs prior to the generation of a new formatted report.
7.3 Deactivation of Internet Services. DIGEX shall, upon receipt of written
---------------------------------
notice from LCI requesting deactivation of Internet Services, promptly
arrange for such deactivation, but LCI shall be liable for all charges
for port fees for LCI, activated at LCI's request, until the end of the
business day immediately following the date on which DIGEX receives
notice from LCI to deactivate such Services.
- --------
*Confidential treatment
Material omitted and filed separately with the Commission.
-3-
<PAGE>
7.4 DIGEX will provide to LCI upon LCI's request product training and
technical assistance to LCI as required at a fee of *
per day for training and expenses, and the Parties
will each pay fifty percent (50%) of the expense incurred for the
production of a training video. DIGEX will provide, at a reasonable
price, the necessary marketing and technical materials required to
effectively market the DIGEX Service offerings.
7.5 DIGEX will provide the Service to LCI Customers comparable to or
better than the services provided to other DIGEX customers.
7.6 DIGEX will provide, install and own the Internet node configuration,
hardware and software including, but not limited to, nodal routers and
news servers.
7.7 DIGEX will assign to LCI any rights that it receives as the result of
its application to the interNIC for blocks of registered addresses
allocated to LCI customer (the "CIDR Blocks"). Further, the Parties
will jointly coordinate the assignment of internet protocol addresses
from such CIDR BLocks to LCI Customers.
7.8 DIGEX will purchase network interconnection from LCI at or below such
rates offered by LCI competitors (defined as "Competitive Rates") for
similar volume, term, traffic, distribution, and access/termination
type commitments. LCI will have the right, but not the legal
obligation, to offer such Competitive Rates to DIGEX. If LCI cannot or
will not match the Competitive Rates, DIGEX will have the right to
accept the Competitive Rates. ("Competitive Rates" are defined as
those rates provided and offered in writing by MCI, Spring, AT & T,
and Worldcom for similar volume, term, traffic, distribution, and
access/termination type commitments.)
7.9 DIGEX will be responsible for and shall pay the costs associated with
carrying the access of Services, including the DS3 backhaul costs, for
the following:
a. The DIGEX POP to the internet Network Access Point ("NAP"); and
b. The LCI POP to the DIGEX POP for the following cities: Los Angeles,
Chicago, New York, Washington D.C., and Atlanta.
7.10 DIGEX agrees to schedule any downtime maintenance at times which will
minimize LCI Customer interruption. DIGEX will notify LCI of its
downtime maintenance schedule, and upon reasonable request from LCI,
DIGEX will re-schedule such maintenance at the convenience of LCI.
7.11 Performance Specifications. DIGEX agrees to meet the "Performance
--------------------------
Specifications" (as set forth in EXHIBIT "1") including but not
limited to the Tier 2 customers service obligations.
7.12 DIGEX shall not be responsible for the performance, maintenance, or
ongoing support of customer premises equipment.
8. Service Integration.
-------------------
8.1 Testing and implementation: The Parties shall within 30 days after the
date of this Agreement, enter into a plan for testing and
implementation of the Service with LCI ("Implementation Plan"). The
Implementation Plan shall address, at a minimum, the following:
a. The schedule for implementation of individual Services provided by
DIGEX, e.g. Leased Line, Frame Relay, SMDS, FNS, Servers, and
Software products.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
-4-
<PAGE>
b. Testing of the Service, both as to geographic coverage,
transmission quality and integration of the Service with LCI's
other products, services and facilities;
c. HOW customer service will be provided to LCI and LCI Customers;
d. Installation and maintenance of equipment, including procedures for
commissioning;
e. Procedures for billing and provision of services, subject to the
provisions of this Agreement;
f. Plans and procedures for addressing the failure, if any, of the
Services to meet acceptable quality standards; and
g. Such other procedures, policies, and matters as the Parties may
agree upon in writing.
8.2 Subject to terms and conditions of the Agreement, including such
charges as may be agreed upon by the Parties, the Implementation Plan
may include provisions for LCI to utilize customer service, billing
service and the installation and maintenance contractors retained by
DIGEX for DIGEX'S own customers. Use of such support personnel and
systems by LCI, may also be developed with specific terms, conditions
and charges.
9. Fraud prevention.
------------------
9.1 The Services are provided subject to the condition that there will be
no abuse or fraudulent use thereof. Abuse and fraudulent use include,
but are not limited to, the following:
a. Obtaining, interrupting, accessing, altering, or destroying, or
attempting to obtain, interrupt, access, alter, or destroy, any
files, programs, information and/or use of the Services of or by
another DIGEX customer or user by rearranging, tampering with, or
making connection to any facilities of DIGEX by any trick, scheme,
false representation, or through any other fraudulent means or
devices; or
b. Assisting another to perform any of the acts prohibited in
subparagraph a of this section 9.1.
9.2 LCI and DIGEX shall cooperate to prevent abuse or fraudulent usage of
the Services, and LCI shall promptly terminate any LCI Customers, or
participation in or access to the Services by its vendors after receipt
of notice from DIGEX.
10. Rates.
-----
10.1 Rates and charges for the Services shall be as set forth in EXHIBIT
"2", which is attached to and made a part of this Agreement.
10.2 Most Favored Nations Clause: DIGEX will assure LCI of the status of a
---------------------------
"Most Favored Customer" (as defined below) for existing Services and
new services maintained or ordered during the Term of the Agreement.
"Most Favored Customer" is defined as the understanding between the
Parties that the prices, contractual and business benefits offered by
DIGEX to LCI shall be comparable to or better than the prices, business
and contractual benefits provided to other DIGEX customers, having
similar or less volume commitments (including resellers) and purchasing
similar Services. In the event that DIGEX shall fail in this regard as
determined by (the "Audit") set forth in section 10.3 below, DIGEX
shall credit LCI the required difference for the period of time LCI did
not receive Most Favored Customer status and provide LCI the pricing,
contractual, and business benefits not received.
10.3 The Audit. Not more than once annually, and upon not less than fifteen
---------
(15) days written notice to the other party, LCI shall have the right
to engage a certified public accounting firm or such other assistance,
other than the assistance of a direct competitor of DIGEX, as it deems
desirable to conduct an audit of all books and records of DIGEX
directly related to the status of LCI as a Most Favored Customer
hereunder. LCI may cause any person or firm retained for this purpose
to execute a non-disclosure agreement in favor of DIGEX. Such audit
shall be conducted during regular business hours at the offices of the
audited Party where such books and records are regularly maintained and
shall be paid for by LCI.
-5-
<PAGE>
10.4 * : For LCI's purchase of Services
-------------------------------------
equal to or greater than the Commitment. DIGEX agrees to provide to LCI
at all times at least a * for Services to LCI below
what DIGEX provides to its own retail customers. Further, DIGEX agrees to
provide pricing to LCI such that the LCI prices will always remain at
least * below the *
of standalone Internet Leased Line Services for long distances
carriers including (MCI, AT&T, Sprint and WorldCom); Regional Bell
Operating Companies; and Tier 1 Internet services providers including
UUNET, PSINet, Netcom and BBN Planet.
10.5 The rates shown in EXHIBIT "1" are based on the Commitment. In addition,
if LCI exceeds the Commitment, LCI shall pay the applicable Rates set
forth in EXHIBIT "1" depending on the level of LCI's purchase of Services
above the Commitment ("Revenue Threshold"). For example, if LCI purchases
* Dollars of Services from
DIGEX, LCI shall receive the Rates for the *
Revenue Threshold level but less than or equal to
* Dollar level. Upon LCI exceeding the Commitment,
DIGEX shall re-adjust LCI's Rates within thirty (30) days. The revised
Rates shall be effective the earlier of the remainder of the then-current
Term of this Agreement or until LCI reaches the next Revenue Threshold as
provided in EXHIBIT "2".
11 Billing of charges.
------------------
LCI shall pay all charges for access to and use of the Services as set
forth in this SECTION 11.
11.1 Monthly billing. Port and Installation charges will be billed in arrears
---------------
in the month following the month in which they are incurred. For purposes
of computing partial month charges for Port charges, each day is
considered to be 1/30 (one-thirtieth) of a month. A first invoice may
contain charges from a previous billing period for service provided from
the date of installation through the current invoice period.
12. Taxes.
-----
All rates set forth in this Agreement are exclusive of Applicable Taxes.
For purposes of this Agreement, "Applicable Taxes" are taxes,
assessments, surcharges, levies, or similar items assessed by a
governmental body. LCI is liable for, and shall indemnify DIGEX from and
against, all Applicable Taxes which may be passed directly through to LCI
or LCI Customers, and all Applicable Taxes properly chargeable to LCI or
LCI Customers with respect to DIGEX's provision of Service to LCI or
relating to LCI's use, resale, or lease of the Service to LCI Customers
or others, and/or any penalty and interest theron if assessed by the
applicable governmental body. DIGEX will invoice LCI for such penalties
and interest, and LCI shall pay such invoices in accordance with the
provisions of SECTION 13 of this Agreement.
13. Terms of payment.
----------------
13.1 Payment due date. LCI shall pay to DIGEX all invoiced charges, including
----------------
Applicable Taxes and any penalties and interest thereon, whether or not
such charges have been paid to LCI by LCI Customers, within thirty (30)
days of the date of invoice, without deduction or setoff. Payments
received will be applied to the earliest outstanding amounts due under
this Agreement.
13.2 Disputed amounts. LCI shall notify DIGEX in writing within sixty (60)
----------------
days after the date of invoice of any dispute or disagreement with
invoiced charges. All disputed amounts resolved in LCI's favor will be
credited against amounts owing on subsequent invoices.
14. Record keeping and Audit.
------------------------
14.1 Maintenance of records. As required by law, each party shall, directly or
----------------------
through a third party service bureau, create and maintain full, complete
and accurate records of business conducted pursuant to this
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
-6-
<PAGE>
Agreement, including but not limited to data relating to customer
activations, deposits, port charges, invoices, payments, and Service
credits
15. Service credits.
---------------
15.1 In the event of a service outage (as defined in EXHIBIT "1"), DIGEX
will grant to LCI service credit(s) (as set forth in EXHIBIT "1").
16. Termination by DIGEX.
--------------------
DIGEX may suspend or terminate the provision of the Service hereunder
to LCI and/or terminate this Agreement without any liability to LCI or
any third party in the event of a default by LCI. LCI shall be deemed
to be in default under any of the following circumstances:
16.1 LCI fails to pay all charges hereunder, including, without limitation,
all charges based on the Port Acquisition and Revenue Rates, within
sixty (60) days after receipt of notice from DIGEX that the same are
overdue; and
16.2 LCI fails, upon written notice from DIGEX, to terminate, as required
under SECTION 16 of this Agreement, a customer or vendor that has made
fraudulent use of or access to the Service or any other DIGEX
facility; provided, however, such termination shall not violate any
laws, statutes and regulations.
17. Termination by LCI of the Agreement With or Without Cause.
---------------------------------------------------------
17.1 Without Cause: LCI may terminate this Agreement at LCI's convenience
-------------
provided LCI pays to DIGEX within thirty (30) days of termination the
following Early Termination Penalty:
a. If LCI terminates in the * of the
Agreement, LCI agrees to pay an amount equal to *
of the Commitment less any amounts already paid by LCI to DIGEX
under this Agreement;
b. IF LCI terminates in * of
the Agreement, LCI agrees to pay an amount equal to *
* of the Commitment less any amounts already paid by LCI to
DIGEX under this Agreement; or,
c. If LCI terminates in * of the
Agreement, LCI agrees to pay an amount equal to *
of the Commitment less any amounts already paid by LCI to DIGEX
under this Agreement.
17.2 With Cause: In addition to LCI's right to terminate for DIGEX's
----------
breach of the terms and conditions of this Agreement including EXHIBIT
1, LCI may also terminate this Agreement, as expressly provided in
EXHIBIT 1, without penalty or liability to DIGEX or any third party,
if the following occurs: a) DIGEX breaches the Service Performance
Guarantees in Section III of EXHIBIT 1 or b) DIGEX provides any
information to, or makes any representations or warranties to, LCI in
connection with the Service, or otherwise in connection with any
information required to be provided by it hereunder, which proves to
have been false or misleading in any material respect as of the date
provided or made.
18. Termination by either party.
---------------------------
Either DIGEX or LCI (the "Terminating Party") may terminate this
Agreement and the use of the Services hereunder if the other party
(the "Defaulting Party") is in default of the provisions of this
Agreement including but not limited to the following:
-7-
- --------------
*Confidential treatment
Material omitted and filed separately with the Commission.
<PAGE>
18.1 Either party makes an unauthorized assignment of its rights, duties
and/or obligations under this Agreement;
18.2 The Defaulting Party dissolves or liquidates;
18.3 The Defaulting Party becomes the subject of voluntary or involuntary
bankruptcy, insolvency, reorganization or liquidation proceedings, makes
an assignment for the benefit of creditors, or admits in writing its
inability to pay its debts as they mature, or a receiver is appointed
for any of its assets or properties, and the same is not dismissed,
vacated, or stayed within thirty (30) days, or the party seeking to
terminate has reason to believe that the commencement of any such
proceeding or assignment for the benefit of creditors is imminent; or
18.4 Termination under this SECTION 18 shall be effective immediately upon
receipt by the Defaulting Party of written notice of default, or at the
end of such period as the Terminating Party may grant for the cure of
the default; and the non-defaulting Party may pursue any remedies
available to it in law or equity. If LCI terminates DIGEX under this
Section, LCI will not have any financial obligations to DIGEX, including
the payment of the Commitment.
19. Termination Rights.
------------------
19.1 Upon any termination of the Service, DIGEX promptly shall refund or
return to LCI, as appropriate, any payments and/or all deposits, letters
of credit and other forms of security provided by LCI, less only such
amounts as are due for use of the Service before termination and such
other amounts as DIGEX reasonably shall determine are due and owing, or
will become due and owing, from LCI. DIGEX shall pay LCI simple interest
on the amount of any cash deposit so refunded from the date of its
deposit with DIGEX to the date refunded at a per annum rate equal to the
prime lending rate published in the "Money Rates" column of The Wall
--------
Street Journal as of the date of the termination of the Service.
--------------
19.2 Upon termination of this Agreement, DIGEX shall, at its expense,
promptly return to LCI, including but not limited to, all copies of LCI
Confidential Information, any marketing or other materials relating to
LCI, and any information regarding the internet protocol addresses for
LCI Customers.
19.3 Upon termination of this Agreement by LCI, with or without cause, DIGEX
shall cooperate and assist LCI with the conversion of LCI Customers to
the new Internet service provider.
19.4 The Parties agree that upon termination of the Agreement, with or
without cause, LCI shall continue to have the right to keep the Internet
protocol addresses for all LCI Customers.
20. Delay in Commencement Date.
--------------------------
If the Commencement Date is delayed beyond June 15, 1996, due to LCI, as
determined by DIGEX in its reasonable discretion, either party may
terminate its obligations under this Agreement on thirty (30) days'
notice to the other party without liability hereunder.
21. Non-Solicitation of Employees.
-----------------------------
In order to protect DIGEX's trade secrets and confidential information
and to prevent the disclosure of important competitive information, LCI
agrees that, during the term of this Agreement and for a period of six
(6) months after its termination or expiration, it shall not, directly
solicit employment of any person employed in a full-time position by
DIGEX at that time, or who has been employed by DIGEX within the six-
month period prior to the offer of employment. LCI agrees that this
restriction is reasonable and necessary to protect proprietary
information of DIGEX and, thus, a material term of this Agreement.
-8-
<PAGE>
22. Warranty Limitations.
---------------------
a. DIGEX warrants that the Service furnished under the Agreement
will be free from defects and delivered pursuant to the highest
standards in the industry, and
b. DIGEX had obtained and shall maintain full authority to grant
the rights herein without the consent of any other person or
entity.
THE EXPRESS WARRANTIES IN THIS AGREEMENT ARE IN LIEU OF ALL
OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED
TO, THOSE OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR
PURPOSE. IN ADDITION TO ALL OTHER REMEDIES AT LAW AND IN EQUITY
AVAILABLE TO IT. LCI SHALL HAVE THE RIGHT TO SEEK REPLACEMENT OF
THE DEFECTIVE MATERIALS OR A REFUND OF THE PAYMENTS MADE BY LCI
TO DIGEX FOR THE AFFECTED SERVICES AFTER LCI HAS PROVIDED DIGEX
WITH A THIRTY (30) DAY PERIOD TO CURE.
23. Indemnification and Limitation of Damages.
------------------------------------------
In light of the rapidly changing regulatory environment applicable to
Services and the technological limitations involved in the provision of
Services, DIGEX will NOT be responsible for the following, provided,
however, DIGEX is in full compliance with all applicable laws and fully
satisfying industry standards required of other Internet Service
providers: (a) protecting from unauthorized access LCI Customers'
transmissions facilities or LCI Customer-owned premise equipment, or for
alteration, theft or destruction of LCI or LCI Customers' data files,
programs, or information through any means; or (b) claims or damages
caused by a LCI Customer (including relating to the transmissions or
storage of defamatory content), to a third party through fault or
negligence to perform LCI Customers' responsibilities; claims against a
LCI Customer by any other party, or any act of omission of any third
party furnishing services or products to LCI Customers.
Subject to the limitations of the previous paragraph, DIGEX shall agree
to indemnify and hold LCI harmless from and against claims, damages and
liabilities (including reasonable attorney's fees and costs) asserted by
a third-party which result directly from any breach by DIGEX, or by any
of its employees or agents, of this Agreement or any of its
representations, covenants or obligations as provided for in this
Agreement, or from any act or omission of that party, its employees and
agents.
Notwithstanding anything to the contrary in this Agreement or the
EXHIBITS or Appendices hereto, in no event will either party be liable
to the other party for special, indirect or consequential damages, under
any theory of recovery, unless such damages are part of an award to a
third party for which indemnification is properly due hereunder.
24. Compliance with Law.
--------------------
LCI and DIGEX shall comply with all applicable laws, statutes, and
regulations relating to the performance of their respective duties and
obligations under this Agreement.
25. Patent/Copyright Indemnification.
---------------------------------
DIGEX shall defend and indemnify any suit or proceeding brought against
LCI based on a claim of a third party that the Services or any part
thereof (but not any information transmitted or stored by a customer or
any third-party by using the Services) furnished by DIGEX constitutes an
infringement of any United States patent or copyright, provided that
DIGEX is notified promptly in writing and given
-9-
<PAGE>
authority, information and assistance (at DIGEX's expense) for the
defense of such a suit or proceeding, and DIGEX will pay all damages and
costs awarded against LCI. LCI will have the right to participate in the
selection of counsel and any settlement negotiations. If a claim of
infringement occurs and the use of Services is enjoined, DIGEX, at its
expense, shall either (a) promptly replace and/or modify the Service(s)
so that they become non-infringing; or (b) promptly contain the right for
LCI to continue using the Service(s). In the event that DIGEX cannot
satisfy (a) or (b) above, in addition to all other legal rights in law
and equity available to LCI, DIGEX agrees to assist LCI in finding an
alternative Internet service provider and to compensate LCI and its
customers for the expenses associated in migrating the affected
Service(s) to such new Internet services provider.
EXCEPT AS EXPRESSLY SET FORTH HEREIN, DIGEX SHALL HAVE NO OTHER LIABILITY
OR OBLIGATION TO LCI WITH RESPECT TO PATENT OR COPYRIGHT INFRINGEMENT
MATTERS.
26. General
-------
26.1 Confidential Information. Should confidential or proprietary information
------------------------
of either LCI or DIGEX be disclosed to the other party in the performance
of this Agreement, the Party receiving such confidential or proprietary
information (hereinafter "Recipient") hereby agrees to receive such
information in confidence, and take such precautions as may be necessary
to protect same from disclosure to others during the Term of this
Agreement and for three (3) years following termination of this
Agreement. Precautions taken shall be at least equivalent to Recipient's
precautions with respect to its own confidential and proprietary
information, but in no event less than a reasonable standard of care.
("Confidential Information") shall mean the proprietary and confidential
data or information of a Party which is of tangible or intangible value
to that Party and is not public information or is not generally known or
available to that Party's competitors but is known only to that Party and
those of its employees, independent contractors, consultants, customers
or agents to whom it must be confidential in order to apply it to the
uses intended, including, without limitation, information regarding that
party's customers or prospective customers, marketing methods and
business plans gained by the other Party.) Confidential Information shall
not include information which (i) at the time of disclosure to Recipient
is in the public domain through no acts or omission of Recipient, (ii) as
shown by written records, as already known by Recipient, (iii) is
revealed to Recipient by a third party who does not thereby breach any
obligation of confidentiality and who discloses such information in good
faith; or (iv) is disclosed pursuant to a legal obligation to disclose
same to any governmental entity or pursuant to judicial or quasi judicial
action (so long as Recipient gives disclosing Party prompt written notice
sufficient to allow disclosing Party to seek a protective order or other
appropriate remedy.) Recipient agrees to disclose only such confidential
information as is legally required and will use its best efforts to
obtain confidential treatment for any confidential or proprietary
information so disclosed.
26.2 Each party acknowledges that the disclosing Party's information is
proprietary, and agrees, that in the event of an unauthorized disclosure,
the disclosing Party is entitled to seek equitable relief, including
without limitation, specific performance and injunctions, in addition to
any other remedies at law or equity.
26.3 Arbitration. All disputes concerning the terms and conditions of this
Agreement shall be subject to binding arbitration of the American
Arbitration Association ("AAA") subject to the rules of the AAA then in
effect. The AAA shall decide, as required, on the number and identity of
the arbitrators and the place of the arbitration. Judgement upon the
award rendered in any arbitration may be entered in any court having
jurisdiction of the matter.
26.4 Attorney's Fees. If any arbitration, litigation, or other legal
proceeding occur between the Parties relating to this Agreement, the
prevailing Party shall be entitled to recover (in addition to any other
relief
-10-
<PAGE>
awarded or granted) its reasonable costs and expenses, including
attorneys' fees, incurred in the proceeding.
26.5 Notices. Unless otherwise expressly provided for, all notices, requests,
-------
demands, consents or other communications required or pertaining to this
Agreement must be in writing and must be delivered personally or sent by
certified or registered mail (postage prepaid and return receipt
requested) to the other Party at the address set forth below (or to any
other address given by either Party to the other Party in writing):
TO: DIGEX-Private Network Group
6800 Virginia Manor Road
Beltsville, Maryland 20705
Attention: DIGEX/LCI PNC Senior Account Manager
TO: LCI International Telecom Corp.
8180 Greensboro Drive, Suite 800
McLean, Virginia 22102
Attention: General Counsel
In case of mailing, the effective date of delivery of any notice,
demand, or consent shall be considered to be five (5) days after proper
mailing.
26.6 Waiver and Amendment. No waiver, amendment, or modification of this
--------------------
Agreement shall be effective unless in writing and signed by the Party
against whom the waiver, amendment, or modification is sought to be
enforced. no failure or delay by either Party in exercising any right,
power or remedy under this Agreement shall operate as a waiver of the
right, power or remedy.
26.7 Benefit. Subject to the restrictions in this Agreement on the assignment
-------
by LCI, this Agreement is binding upon and insures to the benefit of the
successors and assigns of the Parties.
26.8 No Third Parties' Rights. This Agreement is not for the benefit of any
------------------------
third party and shall not be deemed to grant any right or remedy to any
third party, whether or not referred to in this Agreement.
26.9 Headings. The SECTION and paragraph headings of this Agreement are
--------
intended as a convenience only, and shall not affect the interpretation
of its provisions.
26.10 Singular and Plural Terms. Where the context of this Agreement requires,
-------------------------
singular terms shall be considered plural and plural terms shall be
considered singular.
26.11 Severability. If any provision(s) of this Agreement is finally held by a
-------------
court or arbitration panel of competent jurisdiction to be unlawful, the
remaining provisions of this Agreement shall remain in full force and
effect to the extent that the intent of the Parties can be enforced.
26.12 Governing Law and Forum. The validity construction, and performance of
-----------------------
this Agreement is governed by the laws of New York. LCI agrees that this
Agreement is considered to be entered into New York, and that all
obligations of DIGEX under this Agreement are incurred in and are to be
performed in New York. The Parties consent to personal jurisdiction in
New York with respect to any arbitration or suit brought relating to
this Agreement. The Parties waive all objections to venue to the extent
permitted by law.
26.13 Relationship of the Parties. This Agreement does not constitute a
---------------------------
partnership agreement, nor does it create a joint venture or agency
relationship between the Parties.
-11-
<PAGE>
26.14 Survivorship. All obligations and duties hereunder which shall by their
------------
nature extend beyond the expiration or termination of this Agreement,
including 21, 22, 23, 24, 25, and 26 shall survive and remain in effect
beyond any expiration or termination hereof.
26.15 Force Majeure. Neither Party shall be responsible for any delay or
-------------
failure in performance of any part of this Agreement to the extent that
such delay or failure is caused by fire, flood, explosion, war, strike,
embargo, government requirement, action of civil or military authority,
or act of God. In the event of any such delay, the time of performance
that was delayed for such causes will be extended for a period equal to
the time lost by reason of the delay.
26.16 Conflicting Terms. The Parties agree that the terms and conditions of
-----------------
this Agreement shall prevail, notwithstanding the contrary or
additional terms, in any purchase order, sales acknowledgement,
confirmation or any other document issued by either Party effecting the
purchase and/or sale of Services.
26.17 Entire Agreement. This Agreement, including all appendices, constitutes
----------------
the complete and final Agreement between the Parties, and supercedes
all prior negotiations and agreements between the Parties concerning
its subject matter. This Agreement may be executed in counterparts, all
of which, when taken together, shall constitute one original Agreement.
26.18 Escalation Procedures. Any customer service or operational system
---------------------
problems will be handled by DIGEX in accordance with EXHIBIT "3".
IN WITNESS WHEREOF, the Parties have duly executed this Agreement this 29th day
----
of May, 1996.
---
Digital Express Group, Inc. LCI International Telecom Corp.
By: /s/ ANTHONY D. ALBERICO, JR. By: /s/ LAWRENCE J. BOWMAN
---------------------------- ------------------------
Anthony D. Alberico, Jr.
Title: Director of Sales Title: SVP Technology
-------------------------- ----------------------
Date: May 29 / 96 Date: 5/29/96
--------------------------- -----------------------
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<PAGE>
Exhibit I
- --------------------------------------------------------------------------------
PERFORMANCE SPECIFICATIONS
--------------------------
Performance Specifications Supplemental to Agreement. Timely performance of the
obligations provided hereunder is of the essence; therefore failure to timely
perform shall constitute a breach of the Agreement. Any credits received by LCI
from DIGEX will reduce the Commitment (as defined in the Agreement).
Definitions
The following terms as used in the Agreement have the following meaning:
A. Month - A month is equivalent to a calendar month of the Term.
B. Customer Port - the access point where LCI Customers connect with DIGEX's
Point of Presence ("POP").
C. Availability - The ability to utilize Services and successfully send and
receive packets of data to and from the DIGEX POP/router to an Internet Network
Access Point ("NAP")
D. Customer Port Availability - The total number of minutes of Availability of a
Customer Port per Month divided by the total number of minutes in a Month.
E. Customer Port Downtime - The total number of minutes that a Customer Port
does not have Availability per Month divided by the total number of minutes in a
Month.
F. Monthly Network Availability - The sum of minutes that all Customer Ports
have Availability divided by the number of minutes in a Month multiplied by the
number of Customer Ports. Monthly Network Availability will be measured and
determined by the mutually agreed upon network performance monitoring tool,
Hewlett Packard Open View software, and/or measured by customer reported outages
that are cause by DIGEX.
G. Yearly Network Availability - The average of the Monthly Network Availability
determined for twelve (12) successive months as determined on a rolling basis.
I. Provisioning
A.1. DIGEX will provide to LCI the services identified in Exhibit "2" (the
"Services") at the corresponding rates (the "Rates") attached thereto.
A.2. Access Service Types
DIGEX shall support both Frame Relay and Private Line access types at the full
range of speeds from 56 kbps to 1.54 Mbps (56k, 128k, 129k, 256k, 384k, 512k,
768k, 1.54Mbps) (defined herein as "Access Service Types") and shall be
responsible for the performance of all Network Backbone, Network Backbone
equipment and transmission facilities from the DIGEX POP to the Internet NAP
connection; provided, however, DIGEX shall not be responsible for failure caused
by Force Majeure.
<PAGE>
Exhibit 1
- --------------------------------------------------------------------------------
A.3 Throughput of Access Service Types
1. "Throughput" is defined as follows:
a) For each LCI Private Line Access Customer, DIGEX will provide
a level of throughput at or greater than the Access Service
Types.
b) For each LCI Frame Relay Access Customer, DIGEX will support a
level of throughput greater than or equal to the committed
information rate ("CIR") which is entered on the LCI Customer
order form at the time of initial order entry or when service
modification orders are successfully processed and confirmed
by DIGEX, provided that the failure of Throughput is not
caused by a LCI network failure.
2. If DIGEX fails to meet the Throughput level requirements in any month of
the Term, DIGEX will credit to LCI one hundred (100%) precent of the affected
LCI Customers' monthly recurring charge for that month ("MRC") incurred by LCI
Customers for utilization of Services.
A.4 Provisioning Intervals
a) DIGEX shall provision the Services listed in Exhibit "2"
within twenty business days (20) from the receipt of an order
(such activity defined as "Provisioning"). For T-3 service
(defined herein as a T-3 Leased Line), Provisioning shall be
performed within a period of forty-five (45) business days. In
the event that DIGEX fails to meet the Provisioning timeframe,
and such failure is not the direct result of an Inaccurate
Forecast by LCI, DIGEX will provide a credit to LCI equal to
one hundred percent (100%) of the affected customers'
installation fee billed to LCI. In the event that DIGEX fails
to meet the Provisioning requirement for twenty-five percent
(25%) or more of the LCI Customer orders in a given month for
any three (3) months of the Term or in any two (2) consecutive
months of the Term, such failure will constitute a material
breach and LCI shall have the right to terminate the Agreement
immediately. The only exception to the timeframes set forth
above in Section A.4(a) is an "Inaccurate Forecast" (defined
in Section D.1) by LCI. In the event of an Inaccurate
Forecast, LCI Customers whose purchase of Services exceeds the
one hundred fifteen percent (115%) sales forecast by LCI of
Services (defined as "Sales Forecast Threshold") in a
particular month for a particular Site shall be considered
"Overflow Customers" and will receive Provisioning as follows:
(i) In the event that an Inaccurate Forecast
directly causes a Router Shortfall (defined in
Section D.1) during the Ramp Period, DIGEX will
have sixty (60) business days to procure
additional Router capacity and perform
Provisioning (as opposed to the twenty (20)
business day period generally applicable) for
the Overflow Customers. If Provisioning is not
performed for the Overflow Customers within
sixty (60) business days, DIGEX will provide a
credit to LCI equal to one hundred percent
(100%) of the Overflow Customers' fees incurred
for installation of Services ("Installation
Fees").
(ii) In the event that an Inaccurate Forecast
directly causes a Router Shortfall during
* of the Term,
DIGEX will have a maximum of forty-five (45)
business days to procure additional Router
capacity and perform Provisioning (as opposed to
twenty (20) business day period generally
applicable) for the Overflow Customers. If
Provisioning is not performed for the Overflow
Customers within the forty-five (45) business
days, DIGEX will provide a credit to LCI equal
to one hundred (100%) percent of the Overflow of
the Customers' Installation Fees.
* Confidential treatment
Material omitted and filed separately with the Commission.
<PAGE>
Exhibit 1
- --------------------------------------------------------------------------------
b) All LCI Customers whose purchase of Services fall within the
Sales Forecast Threshold will receive Provisioning of twenty (20)
business days or DIGEX will be considered in breach of the
Agreement.
II. Maintenance
The Parties shall perform the following maintenance:
B.1 Customer Service Support for Trouble Resolution
a) LCI shall provide first level support ("Tier 1"). Tier 1
consists of the following:
1. First point contact for all LCI Customer problems;
2. Resolution of all customer premises equipment-problems;
3. Resolution of all customer circuit-related problems;
4. Resolution of all primary Domain Name Services ("DNS")
problems; and
5. Referral of trouble tickets to DIGEX.
b) DIGEX shall provide second level support ("Tier 2"). Tier 2
consists of the following:
1. Acceptance of trouble tickets from LCI via electronic
mail;
2. Resolution of all Internet Protocol routing-related
problems;
3. Resolution of all Network Backbone and/or network elements
(routers, bridges, switches) and related problems; and
4. Performance of all other maintenance services necessary
for LCI Customers to procure and utilize the Services
hereunder, as listed in Exhibit 2.
c) From 8 a.m. to 8 p.m. daily, EST time, DIGEX shall respond to
telephone calls or electronic trouble notification messages
within fifteen (15) minutes; from 8:01 p.m. to 7:59 a.m., EST
time, DIGEX must respond to telephone calls or electronic trouble
notification messages within thirty (30) minutes. DIGEX will
provide "Network Operations Center Support" (defined below) to
LCI on a seven (7) days a week, twenty-four (24) hours a day,
three hundred and sixty-five (365) days a year (cumulatively
referred to as "24x7x365"). ("Network Operations Center Support"
is defined as DIGEX's provisioning of customer service and/or
network management support.)
B.2 Time to Repair Standards
a) "Unmanned" Point of Presence ("POP") locations. ("Unmanned" means
no personnel at the POP for repair) For Unmanned locations, DIGEX
will repair the routers and all other elements needed for
Services as follows:
1. Router Replacement: Not to exceed eight (8) hours if LCI
is not providing diverse transmission paths;
2. Router Replacement: Not to exceed six (6) hours if LCI is
providing diverse transmission paths; and
3. All other Service Repair: Not to exceed six (6) hours.
b) "Manned" POP Locations (including Hayward, California; Chicago,
Illinois; Waynesville, Ohio; Atlanta, Georgia; Houston, Texas;
Washington D.C. and New York, New York.) ("Manned" means
personnel at the POP for repairs). The will be Manned 24x7x365
with the exception of Houston, Texas which will be Manned. Monday
through Friday, 24x7x365. For Manned locations, DIGEX will
repair the routers and all other elements needed for Services as
follows:
1. Router Replacement: eight (8) hours if LCI is not
providing diverse transmission paths;
2. Router Replacement: two (2) hours if LCI is providing
diverse transmission paths; and
<PAGE>
Exhibit 1
- --------------------------------------------------------------------------------
3. All other Service Repair: two (2) hours.
c). Failure of Network Backbone (defined in Section 1 of the
Agreement): time to reroute-Not to exceed four (4) hours to reroute
Services from the time of the failure of the Network Backbone.
d). DIGEX shall credit one hundred (100%) percent of the MRC charge of
LCI Customers affected by DIGEX's failure to meet the Time to
Repair/Re-Route Standards provided above.
III. Service Performance Guarantees.
Network-Level Measurements.
C.1. Yearly Network Availability Target. DIGEX shall provide a Yearly Network
Availability of at least ninety-nine and nine-tenths (99.9%) percent
(defined as the "Yearly Network Availability Target"), but excluding
from such calculation any Months that DIGEX, as the direct result of
LCI's Inaccurate Forecast (as defined below), has failed to meet a
Monthly Network Availability Target (defined below), or is in a cure
period (as provided in C.3 below.) LCI may terminate the Agreement in
accordance immediately for DIGEX's failure to meet the Yearly Network
Availability Target.
C.2. Monthly Network Availability Target. DIGEX shall provide a Monthly
Network Availability of ninety-nine and nine-tenths (99.9%) percent per
month (defined as the "Monthly Network Availability Target") If DIGEX
fails to meet the Monthly Network Performance Target and LCI did not
---
provide DIGEX with an Inaccurate Forecast for that month, DIGEX shall
credit to LCI one hundred (100%) percent of the MRC for all LCI
Customers. If DIGEX fails to meet the Monthly Network Availability
Target for three (3) Months of the Term or in any two (2) consecutive
Months of the Term, and DIGEX's failure to meet the Monthly Network
Availability Target was not the direct result of LCI submitting to DIGEX
an Inaccurate Forecast, LCI may terminate the Agreement.
C.3. In the event that LCI has provided DIGEX with an Inaccurate Forecast for
a Month, DIGEX shall meet the appropriate Revised Monthly Network
Availability Target (as opposed to the Monthly Network Availability
Target) based upon the discrepancy of LCI's actual sale of Services over
the Sales Forecast Threshold per DIGEX POP per Month, and DIGEX shall
have forty-five (45) business days from the day that the Sales Forecast
Threshold was exceeded by one hundred and fifteen (115%) percent in a
Month to meet the Monthly Network Availability Target; provided, in no
event shall DIGEX's Monthly Network Availability fall below the Revised
Monthly Network Availability Target. If either (a) DIGEX fails to meet
the Monthly Network Availability Target after such forty-five (45)
business day cure period, or (b) DIGEX'S Monthly Network Availability
falls below the Revised Monthly Network Availability Target in a Month,
such event shall be considered a "Monthly Network Performance Failure".
In the event of a Monthly Network Performance Failure, DIGEX shall
credit to LCI one hundred percent (100%) of the MRC for all LCI
Customers. If the Monthly Network Performance Failure occurs for three
(3) Months of the Term or two (2) consecutive Months, LCI may terminate
the Agreement for material breach.
Customer-Level Measurements
Customer Port Availability Target. In addition to the Performance Specifications
provided above, DIGEX shall meet the Customer Port AVailability of ninety-nine
and nine-tenths (99.9%) percent per Month for all LCI Customers less scheduled
Customer Port Downtime, and Customer Port Downtime shall not exceed thirty (30)
consecutive minutes per Customer Port within a twenty-four (24) hour period
(such
<PAGE>
Exhibit 1
- --------------------------------------------------------------------------------
conditions shall be collectively defined as "Customer Port Availability
Target".) If DIGEX fails to meet the Customer Port Availability Target, DIGEX
will credit to LCI one hundred percent (100%) of all affected LCI Customers'
port MRC for that month.
IV. Inaccurate Forecast
D.1. On a monthly basis, LCI shall provide DIGEX with a rolling three month
sales forecast by Site to be used for forecast planning. If LCI exceeds
its Sales Forecast Threshold (of one hundred fifteen percent (115%) in a
Month for a particular Site), and as a direct result of such activity,
DIGEX's Router is maximized to its full capacity so that it can no
longer carry any additional LCI Customer traffic ("Router Shortfall"),
such activity is referred to as an ("Inaccurate Forecast")
D.2. "Revised Network Availability Target". As provided in Section C.3 of
-------------------------------------
this Exhibit, if LCI provided an Inaccurate Forecast, depending on the
percentage of inaccuracy between the Sales Forecast Threshold and LCI's
actual sale of Services per month per Site, DIGEX shall meet or exceed
the Revised Monthly Network Availability Target for a forty-five (45)
day period. After such forty-five (45) day period, DIGEX shall meet the
Monthly Network Availability Target:
(Sales Forecast Threshold) Revised Network Availability
-------------------------- ----------------------------
Target
------
116-135% 90%
136-140% 85%
equal to or greater than 140% 80%
<PAGE>
(Exhibit 2 Page 1 of 5)
DIGEX's LCI Price - Schedule II-A
DIGEX Port & Installation Fees
* Discount Schedule
-------------------------------------------
<TABLE>
<CAPTION>
LCI Standard Discount:
- ----------------------
DIGEX List Price L.C.I. Discount Price
Minimum Port speed/ Installation Monthly Installation Monthly
Service CTB Burnt Rate Fee Recurring Fee Recurring
------- --- ---------- --- --------- --- ---------
<S> <C> <C> <C> <C> <C> <C>
56 Kings Frame Relay 32 Kbps 56 Kbps * * * *
T-I Frame Relay 68 Kbps 128 Kbps * * * *
96 Kbps 193 Kbps * * * *
128 Kbps 256 Kbps * * * *
192 Kbps 386 Kbps * * * *
256 Kbps 512 Kbps * * * *
384 Kbps 768 Kbps * * * *
763 Kbps 1.52 Kbps * * * *
56 Kbps Leased Line 56 Kbps 56 Kbps * * * *
T-I Leased Line 1.54 Mbps 1.56 Kbps * * * *
Principal T-1 125 Kbps * * * *
192 Kbps * * * *
256 Kbps * * * *
384 Kbps * * * *
512 Kbps * * * *
768 Kbps * * * *
T-3 Leased Line 45 Mbps 45 Kbps * * * *
SMDS 1.37 Mbps * * * *
4 Mbps * * * *
10 Mbps * * * *
16 Mbps * * * *
15 Mbps * * * *
32 Mbps * * * *
FMS-Kiberum 10 Mbps * * * *
FMS-Token Ring 4 Mbps * * * *
16 Mbps * * * *
L.C.I. Customer Resellar Rates:
- -------------------------------
56 Kbps Leased Line 56 Kbps * * * *
T-3 Leased Line 1.56 Mbps * * * *
</TABLE>
L.C.I. Employment Dial Up Rates
<TABLE>
<CAPTION>
Monthly Users 500 750 1000
------------- --- --- ----
<S> <C> <C> <C>
Activation without Help Desk * * *
Monthly Access Fee * * *
</TABLE>
* Confidential treatment
Material omitted and filed separately with the Commission.
- - SMDS T-3 & FMS are not available in all locations, please contact the
LCI/DIGEX account team for availability.
- - All Leased Line services include Domain Name Services, NNTP newsfeed and
network addresses as required
- - $100 fee InterNIC domain name registration is not included and is the sole
responsibility of the end customers to the NIC
- - DIGEX installation time is * business days, excluding Telco circuit
installation
<PAGE>
DIGEX
(Exhibit 2 Page 2 of 5)
DIGEX's LCI Discount Price - Schedule I-A
DIGEX Port & Installation Fees
<TABLE>
<CAPTION>
* Discount Schedule
----------------------------------
LCI Standard Discount:
- ----------------------
DIGEX List Price LCI Discount Price
Minimum Port speed/ Installation Monthly Installation Monthly
Service CTR Burst Rate Fee Recurring Fee Recurring
------- --- ---------- --- --------- --- ---------
<S> <C> <C> <C> <C> <C> <C>
56 Kbps Frame Relay 32 Bps 36 Kbps * * * *
T-I Frame Relay 64 Kbps 128 Kbps * * * *
96 Kbps 192 Kbps * * * *
128 Kbps 256 Kbps * * * *
192 Kbps 384 Kbps * * * *
254 Kbps 512 Kbps * * * *
384 Kbps 768 Kbps * * * *
56 Kbps Leased Line 56 Mkps 56 Mkps * * * *
T-I Leased Line 134 Mbps 134 Mbps * * * *
Fractional T-1 128 Kbps * * * *
192 Kbps * * * *
234 Kbps * * * *
384 Kbps * * * *
512 Kbps * * * *
768 Kbps * * * *
T-3 Leased Line 45 Mbps 43 Mbps * * * *
SMDS 1.17 Mbps * * * *
4 Mbps * * * *
10 Mbps * * * *
16 Mbps * * * *
25 Mbps * * * *
34 Mbps * * * *
FNS-Etherene 10 Mbps * * * *
FNS-Token Ring 4 Mbps * * * *
16 Mbps * * * *
LCI Customer Reseller Rates:
- ----------------------------
56 Kbps Leased Line 56 Kbps * * * *
T-I Leased Line 1.54 ???? * * * *
</TABLE>
<TABLE>
<CAPTION>
LCI Internal Employment Dial Up Rates
- -------------------------------------
Monthly Users 500 750 1000
------------- --- --- ----
<S> <C> <C> <C>
Activation without Help Desk * * *
Monthly Access Fee * * *
Activities without Help Desk * * *
Monthly Access Fee * * *
</TABLE>
* Confidential treatment
Material omitted and filed separately with the Commission.
- - SMDS, T-3, & FMS are not available in all locations, please contact the
LCI/DIGEX account team for availability.
- - All Leased Line services, Domain Name Services, NNTP newsfeed and network
addresses as required
- - $100 fee InterNIC Domain Name Registration is not included and is the sole
responsibility of the end customers to the NIC
- - DIGEX installation time is * business days, excluding Telco circuit
installation
<PAGE>
Appendix B (Exhibit 2 Page 3 of 5)
DIGEX's LCI Price - Schedule III - A
DIGEX Part & Installation Fees
<TABLE>
<CAPTION>
* Discount Schedule
------------------------------------
LCI Standard Discount: DIGEX List Price LCI Discount Price
- ----------------------
Minimum Port Speed Installation Monthly Installation Monthly
Service CIR Burst Rate Fee Recurring Fee Recurring
------- --- ---------- --- --------- --- ---------
<S> <C> <C> <C> <C> <C> <C>
56 Kbps Price Relay 32 Kbps 56 Kbps * * * *
T-1 Frame Relay 65 Kbps 125 Kbps * * * *
96 Kbps 192 Kbps * * * *
128 Kbps 256 Kbps * * * *
198 Kbps 334 Kbps * * * *
256 Kbps 512 Kbps * * * *
321 Kbps 768 Kbps * * * *
768 Kbps 1.54 Kbps * * * *
58 Kbps Leased Line 56 Kbps 56 Kbps * * * *
T-1 Leased Line 1.50 Mbps 1.54 Kbps * * * *
Fractional T-1 128 Kbps * * * *
192 Kbps * * * *
256 Kbps * * * *
384 Kbps * * * *
312 Kbps * * * *
768 Kbps * * * *
T-3 Leased Line 45 Mbps 45 Mbps * * * *
SMDG 1.17 Mbps * * * *
4 Mbps * * * *
10 Mbps * * * *
16 Mbps * * * *
25 Mbps * * * *
34 Mbps * * * *
FRS - Ethernet 10 Mbps * * * *
FMS - Token Ring 4 Mbps * * * *
16 Mbps * * * *
LCI Customer Reseller Rates:
- ---------------------------
36 Kbps Leased Line 56 Kbps * * * *
T-1 Leased Line 1.54 Mbps * * * *
</TABLE>
<TABLE>
<CAPTION>
LCI Internal Employee Dial Up Rates:
Monthly Users 500 750 1000
------------- --- --- ----
<S> <C> <C> <C>
Activation Without Help Desk * * *
Monthly Access Fee * * *
</TABLE>
- - SMDS T-3 & FMS are not available in all locations, please contact the
LCI/DIGEX account team availability.
- - All Leased Line services include Domain Name Services NMTP newsfeed and
network addresses as required.
- - $100 fee InterNIC domain name registration is not included and is the sole
responsibility of the end customers to the NIC.
- - DIGEX installation time is * business days, excluding Telco circuit
installation.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
<PAGE>
Appendix B
Exhibit 2 Page 4 of 5
DIGEX's LCI Price - Schedule I-B
DIGEX Server Fees
DIGEX Internet Servers
Service includes:
Hardware Configuration Options:
- -------------------------------
<TABLE>
<CAPTION>
LCI LCI
Price Monthly
Hardware Platform Memory/Disk Equipment Recurring
- ----------------- ----------- --------- ---------
<S> <C> <C> <C>
Sun 3/60 4 MB RAM/50 MB * *
Sun 3/60 12 MB RAM/100 MB * *
Sun Sparc Station 2 16 MB RAM/1 GB * *
Sun Sparc Station 2 32 MB RAM/2 GB * *
Sun Sparc Station 5 32 MB RAM/2 GB * *
Sun Sparc Station 5 64 MB RAM/4 GB * *
Custom configuration available upon request.
Dedicated tape backup * *
Dedicated CD-ROM drive * *
<CAPTION>
Server Software Options:
Additional Network Server Software:
- -----------------------------------
<S> <C> <C> <C>
World Wide Web (WWW) server * *
anonymous FTP server * *
Gopher server * *
POP3 mail server * *
Mailing list Server * *
Server Management Options:
- --------------------------
Root access privilege
(privileged user) * *
Initial domain name
(domain.com)
Additional domain names
(domain2.com) * *
Temporary CD-ROM drive * *
CD-ROM mounting * *
User Accounts (on the
DIGEX Server)
Administrative account * *
Additional accounts
(configured by user)
Telnet access * *
</TABLE>
*DIGEX's pricing is subject to change with * written notice to LCI.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
<PAGE>
DIGEX's LCI Price - Schedule 1-C
DIGEX's Firewall/Software Services
Raptor Eagle TM Firewall Security Solutions
- -------------------------------------------
Complete, proven firewall solutions using the Raptor Eagle Firewall product
family. Includes hardware, software, two day on-site installation (subject to
city location) and 30 day customer support (phone and e-mail).
Eagle Firewall Hardware Platform Sun SPARC 4 model 110 (new) or a Sun SPARC 2
(refurbished). Both systems come with a one year warranty and are configured
with 32 MB RAM, 1 GB disk drive, CD-ROM, 5 GB 4mm DAT tape drive, two ethernet
interfaces, 15" color monitor, keyboard, floppy drive. Other platforms (call
your DIGEX Rep. for availability). Installation does not include travel time or
additional expenses.
Windows NT version available on 133 MHz Pentium with 32MB RAM, 1 GB disk drive,
CD-ROM, two ethernet interface, 14" color monitor, keyboard, floppy drive, SGB
DAT tape drive optional.
<TABLE>
<CAPTION>
Sun SPARC2 Sun SPARC4 Pentium
LCI LCI (WINDOWS NT)
Eagle Firewall Price Price LCI Price
-------------- ---------- ---------- ------------
<S> <C> <C> <C>
50 users * * *
200 users * * *
unlimited users * * *
Eagle Enterprise Firewall
- -------------------------
50 users
200 users
unlimited users
Eagle LAN
- ---------
Unlimited users * * *
Eagle Remote
- ------------
50 users * * *
200 users * * *
unlimited users * * *
Eagle Nomad/Eagle Desk
- ----------------------
*
</TABLE>
HOT XXXXX Systems
- -----------------
Clone of primary firewall systems, used as an on-site "hot" swap spare. Includes
hardware, software, installation, and training on hot spare implementation
procedures.
<TABLE>
<CAPTION>
Eagle Firewall Hot XXXXX
- ------------------------
<S> <C> <C> <C>
50 users * * *
200 users * * *
unlimited users * * *
Eagle Enterprise Firewall Hot XXXXX
- -----------------------------------
50 users * *
200 users * *
unlimited users * *
</TABLE>
Annual Hardware Maintenance Programs
- ------------------------------------
1 year hardware warranty included with all Eagle Firewall product to SPARC 4
hardware support program offered by Sun Microsystem. SPARC 2 hardware support is
provided via third party.
* *
<TABLE>
<CAPTION>
Annual Software Maintenance Programs
- ------------------------------------
Eagle Eagle Eagle
(UNIX) Eagle (NI) Enterprises Remote
------ ---------- ----------- ------
<S> <C> <C> <C> <C>
Eagle 50 users * * * *
Eagle 200 users * * * *
Eagle unlimited users * * * *
Eagle LAN * * * *
Eagle Nomad/Desk
</TABLE>
*
DIGEX. XXXXX
Firewall XXXXX is included with an Eagle or Eagle Enterprise firewall purchase.
*DIGEX's pricing is subject to change with * written notice to LCI.
- -----------
*Confidential treatment
Material omitted and filed separately with the Commission.
<PAGE>
(Exhibit 3 Page 1 of 2)
DIGEX Private Network Customer
Escalation Procedures
Overview
This plan has been established to provide DIGEX procedures for notifying higher
management of customer service or operational system problems. This escalation
procedure may also apply to installation of new customer services. DIGEX
customer, backbone, & operational system problems are tracked in the DIGEX
trouble reporting system. If DIGEX has determined that the problem is due to
customer equipment or premises wiring changes, escalation procedures may be
halted. The following information will be tracked on all troubles:
Name of person at DIGEX NOC
Customer name/location
Circuit ID
Trouble Start time
Description of trouble
Category or Escalation Stage
Name of LEC/Inter-exchange carrier DNCC person & call back #
Log of current status, vendor commitments, and required action
(time stamped)
Service restoration time
Outages Categories:
A. Individual Private Network Customer (PNC) Network Facility Outage
B. Critical Network Facility Outage (multiple customers, backbone, or
facility/network outage.
C. Routing Failure.
A. Individual Private Network Customer Network Facility Outage
1. DIGEX NOC technician immediately detects alarm which indicates
that a customer's circuit is down. Technician ascertains if
trouble is isolated to an individual client. If outage impacts a
DIGEX backbone/systems failure, escalate immediately to (B)
critical outage status. Clock starts for outage.
2. Within 10 minutes, DIGEX e-mails PNC NOC to notify that an outage
has been detected on a PNC customer circuit.
B. Critical Network Facility Outage
Applies to DIGEX backbone network facilities or host/backbone circuits which
support multiple customer's (e.g. FR or leased line backbone circuits) and/or
other network elements (router, bridge, switch, etc.).
1. DIGEX NOC technician immediately detects alarm which indicates an
outage of a DIGEX network backbone facility or element (impacting
multiple customers).
2. Immediately, DIGEX technician contacts:
-FR/SMDS "host/stub" circuit: LEC or Inter-exchange carrier
-FDDI; LEC
-DS1/DS3 backbone circuit: LEC or inter-exchange carrier,
systems organization & DIGEX Telecom Department (if necessary)
*DIGEX router/network equipment: DIGEX systems
3. With vendor technician on line, ascertain if DNCC sees LMI on
line. If not, request dispatch on circuit. If LMI is seen,
ascertain if PVC is active. If not, re-build of PVC by DNCC
(Frame Relay/SMDS). Ongoing trouble log update.
4. Within 30 minutes, immediately escalate to Stage 2 (DIGEX
escalation) customer service manager, telacom manager and systems
manager (off duty). Escalate to vendor operations
manager/supervisor. If outage impacts dial up service, notify
help desk. Help desk should update systems status message.
Customer notification will begin. Ongoing trouble log update.
<PAGE>
(Exhibit 3 page 2 Of 2)
DIGEX PNC Escalation Procedures
- --------------------------------------------------------------------------------
5. Within 1 hour, escalate to Stage 3 (DIGEX escalation) customer
service director.- Customer service director or systems manager may
escalate to other vendor resources such as the service manager. NOC
or telecom my halt escalation to customer service director if vendor
has identified problem and has given ETR of less than 1 hour. NOC or
telecom may also escalate immediately to service manager or third
tier technical support if necessary. Update customer(s), help desk
(if appropriate) & ongoing trouble log update.
6. If NOC or telecom halted escalation, but ETR has exceeded 1 hour,
then escalation to DIGEX stage 3 (customer service director) must
continue.
7. Within 2 hours, Customer Service Director or Systems Manager will
escalate internally to stage 4 (DIGEX escalation) DIGEX upper
management (COO). Upper Management to ensure that adequate resources
are available to assist trouble isolation & restoration. Further
escalation within the vendors technical resource organization is at
the discretion of the DIGEX customer services director, systems
manager or upper management and the vendor service manager or third
tier technical support. Update customer(s) & help desk (for dial up).
Ongoing update log.
8. Upon service restoral, stop clock, change systems status message
(help desk) & notify customer(s). Update log, including explanation
of root cause. Update customers on root cause of outage. Ensure that
service has been restored.
9. If outage was escalated to customer service director, an outage
notification will be provided to the appropriate Sales Manager and
Upper Management (COO & CEO) which explains the outage duration and
root cause. If outage impacted dial up customers, post to DIGEX.GEN.
C. DIGEX Routing Failures
1. Within 10 minutes DIGEX NOC technician escalates critical routing
failures which are global (i.e. routing is not going anywhere) to
stage 2 (DIGEX escalation). This includes notification of the Systems
Manager & Technical Specialist. The Customer Services Manager is also
informed of routing failures. Identify specialist and escalate
involvement. Open ticket.
2. Within 2 hours, escalate to Stage 3 (DIGEX) Customer Service
Director. Customer notification will begin. Ongoing trouble log
update. Inform upper management (COO) as necessary. Systems Manager
may halt escalation process if trouble has been isolated and ETR is
less than 1-2 hours. ETR that exceeds 2 hours must be escalated to
Director. Director will notify upper management COO as appropriate.
3. Non-critical routing failures will be addressed for swift problem
resolution (and possible referral to other providers/customer) if
isolated to other network provider networks.
4. Upon service restoral, stop clock & notify customer(s). Update log,
including explanation of root cause.
5. If outage was escalated to customer service director, an outage
notification will be provided to the appropriate Sales Manager and
Upper Management (C00 & CEO) which explains the outage duration and
root cause.
<PAGE>
Exhibit 23.1
Consent Of Ernst & Young LLP, Independent Auditors
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated July 17, 1996 (except for Note 19, as to which the date
is October 9, 1996), in Amendment No. 6 to the Registration Statement (Form SB-2
No. 333-05871) and related Prospectus of DIGEX, Incorporated for the
registration of 4,500,000 shares of its common stock.
Baltimore, Maryland
October 16, 1996
