<PAGE>
<TABLE>
<CAPTION>
<S> <C>
PROSPECTUS SUPPLEMENT NO. 1 Filed Pursuant to Rules 424(b)(3)and 424(c)
(To Prospectus dated October 16, 1996) Registration Statement No. 333-05871
</TABLE>
DIGEX, INCORPORATED
COMMON STOCK
(Par Value $.01 per Share)
------------------------------
The following information supplements, and must be read in conjunction
with, the information contained in the Prospectus, dated October 16, 1996 (the
"Prospectus"), of DIGEX, Incorporated (the "Company"). This Prospectus
Supplement No. 1 must be delivered along with a copy of the Prospectus, to the
extent that delivery of the Prospectus is legally required on or after the date
hereof. All capitalized terms not otherwise defined herein have the meanings
given to them in the Prospectus.
Financial Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations for the Nine Months Ended
September 30, 1996. This Prospectus Supplement consists of this page and the
attached financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," in each case for the Nine
Months Ended September 30, 1996.
------------------------------
FRIEDMAN, BILLINGS, RAMSEY & CO., INC.
------------------------------
The date of this Prospectus Supplement is November 15, 1996.
<PAGE>
DIGEX, Incorporated
Balance Sheets
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma
ASSETS December 31, 1995 September 30, 1996 September 30, 1996
----------------- ------------------ ------------------
(audited) (unaudited) (unaudited)
See Note 11
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 832 $ 411 $ 49,205
Accounts receivable, less allowance of $50 at December 31, 1995
and $274 at September 30, 1996 908 2,180 2,180
Inventory and prepaid assets 50 831 831
Deferred income taxes 8 8 8
------- -------- --------
Total current assets 1,798 3,430 52,224
Property and equipment:
Computer equipment and software 3,439 16,658 16,658
Office furniture and equipment 153 408 408
Leasehold improvements 164 704 704
------- -------- --------
Total property and equipment 3,756 17,770 17,770
Accumulated depreciation and amortization 765 2,591 2,591
------- -------- --------
Net property and equipment 2,991 15,179 15,179
Deferred financing costs - 845 -
Other assets 263 440 440
------- -------- --------
Total assets $ 5,052 $ 19,894 $ 67,843
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 960 $ 13,938 $ 14,293
Deferred revenue 389 5,080 5,080
Current portion of capital lease obligations 859 2,715 2,715
10% Convertible Debentures, net of discount of $589 in 1995 1,411 - -
------- -------- --------
Total current liabilities 3,619 21,733 22,088
Capital lease obligations, less current portion 822 3,098 3,098
Series A Mandatorily Redeemable Convertible Preferred Stock,
$1 par value; 70 shares authorized; 45 shares issued and outstanding
(pro forma: none); redemption price and liquidation preference
$100 per share, aggregating $4,546 2,139 2,511 -
Series B Mandatorily Redeemable Convertible Preferred Stock,
$1 par value; 130 shares authorized; 81 shares issued and outstanding
(pro forma: none); redemption price and liquidation preference
$100 per share, aggregating $8,126 - 8,126 -
Stockholders' equity (deficit):
Common Stock, $.01 par value:
Authorized shares 19,920 in 1995 and 1996
Issued and outstanding shares 1,618 in 1995 and 1996
(pro forma: 11,285) 16 16 113
Additional paid-in capital 2,835 4,024 62,158
Accumulated deficit (4,379) (19,614) (19,614)
------- -------- --------
Total stockholders' equity (deficit) (1,528) (15,574) 42,657
------- -------- --------
Total liabilities and stockholders' equity (deficit) $ 5,052 $ 19,894 $ 67,843
======= ======== ========
</TABLE>
See notes to financial statements.
3
<PAGE>
DIGEX, Incorporated
Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
-------------------------
1995 1996
---------- ----------
<S> <C> <C>
Net Revenue
Online services $ 2,813 $ 8,428
Equipment sales 171 1,261
------- --------
Total revenue 2,984 9,689
Operating Costs and Expenses
Data communications and operations 2,161 8,192
Cost of equipment sales 137 1,033
Sales and marketing 992 7,028
General and administrative 939 5,076
Depreciation and amortization 356 1,830
------- --------
Total operating costs and expenses 4,585 23,159
------- --------
Loss from operations (1,601) (13,470)
Other income (expense)
Interest and other income 17 101
Interest expense (69) (1,261)
------- --------
(52) (1,160)
------- --------
Net loss (1,653) (14,630)
Accretion of Series A Mandatorily
Redeemable Convertible Preferred Stock
to redemption value (224) (389)
------- --------
Net loss attributable to common stockholders $(1,877) $(15,019)
======= ========
Net loss per common share attributable
to common stockholders $ (0.28) $ (2.76)
======= ========
Pro forma net loss per common share
attributable to common stockholders $ (1.05)
========
</TABLE>
See notes to financial statements.
4
<PAGE>
DIGEX, Incorporated
Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30
1995 1996
------------ ------------
<S> <C> <C>
Operating Activities:
Net loss $(1,653) $(14,630)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 356 1,830
Amortization of debt discount charged to interest expense 14 951
Non-cash compensation recorded for vested stock
option grants - 599
Loss on sale of fixed assets - 2
Changes in operating assets and liabilities:
Accounts receivable, net (545) (1,271)
Inventory and prepaid expenses (139) (781)
Accounts payable and accrued expenses 717 12,978
Income taxes (21) -
Deferred revenue 235 4,690
------- --------
Net cash provided by (used in) operating activities (1,036) 4,368
Investing Activities:
Purchases of property and equipment (855) (9,007)
Increase in other assets (143) (177)
------- --------
Net cash used in investing activities (998) (9,184)
Financing Activities:
Repayment of notes payable (300) -
Borrowings under revolving line of credit - 1,167
Repayments under revolving line of credit - (1,167)
Repayment of capital lease obligations (232) (988)
Proceeds from issuance of 10% Subordinated
Debentures and detachable stock warrants - 1,000
Proceeds from issuance of Series A Mandatorily Redeemable
Convertible Preferred Stock and detachable stock warrants,
net of expenses of issuance 3,518 -
Proceeds from issuance of Series B Mandatorily Redeemable
Convertible Preferred Stock - 5,000
Proceeds from issuance of warrants to purchase common
stock to customer - 228
Increase in deferred financing costs - (845)
------- --------
Net cash provided by financing activities 2,986 4,395
------- --------
Net increase (decrease) in cash and cash equivalents 952 (421)
Cash and cash equivalents at beginning of period 2 832
------- --------
Cash and cash equivalents at end of period $ 954 $ 411
======= ========
Interest paid $ 69 $ 197
======= ========
</TABLE>
See notes to financial statements.
5
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
September 30, 1996
(In thousands, except share and per share amounts)
1. Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB and Item 310 (b) of
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine month period ended September 30,
1996 are not necessarily indicative of the results that may be expected for the
year ended December 31, 1996. For further information, refer to the financial
statements for the year ended December 31, 1995 incorporated by reference in
the Company's registration statement on Form 8-A filed in October 1996.
2. Capital Lease Obligations
The Company leases equipment under capital leases. Property and equipment
includes the following amounts for leases that have been capitalized at
September 30, 1996:
<TABLE>
<CAPTION>
December 31, 1995 September 30, 1996
----------------- ------------------
<S> <C> <C>
Computer equipment..................... $1,985 $6,993
Office furniture and equipment......... 110 110
------ ------
2,095 7,103
Less accumulated amortization.......... 445 1,538
------ ------
$1,650 $5,565
====== ======
</TABLE>
Amortization of leased assets is included in depreciation and amortization
expense.
Future minimum payments under capital lease obligations consist of the
following at September 30, 1996:
<TABLE>
<S> <C>
Through December 31, 1996................................................................ $ 693
1997................................................................ 2,628
1998................................................................ 2,046
1999................................................................ 1,298
2000................................................................ 118
------
Total minimum lease payments ............................................................ 6,783
Amounts representing interest............................................................ 970
------
Present value of net minimum lease payments (including current portion of $ 2,715)....... $5,813
======
</TABLE>
6
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. 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 $5,000 of connectivity services and equipment 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 and
deferred revenue associated with the contract was recorded in the amount of
$4,772.
4. 10% Convertible Debentures and Detachable Stock Warrants
On February 15, 1996, the Company issued $1,000 of 10% Convertible
Debentures with detachable stock warrants for cash proceeds of $1,000. 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 $362, 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
warrants was recorded as additional paid-in capital and the 10% Convertible
Debentures were recorded net of a discount of $362. The Company recognized
interest expense of $362 for the period from February 15, 1996 through September
30, 1996 related to the amortization of this discount.
In connection with the issuance of the Series B Preferred Stock described in
Note 5, the holders of the 10% Convertible Debentures converted the debentures
into 31,264 shares of Series B.
5. 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 became 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.
On May 30, 1996, the Company issued 50,000 shares of Series B for $5,000.
In connection with this issuance, the holders of the 10% Convertible Debentures
(face value of $3,000, plus accrued interest of $126) converted the debentures
into 31,264 shares of Series B.
The Series B was subject to certain mandatory redemption requirements and
was convertible at the option of the holder into common stock. In addition,
the Series B was subject to automatic conversion into common stock 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 $25,000. On October 22, 1996,
the Company completed its initial public offering, which met the automatic
conversion criteria, and the Series B converted into 2,180,336 shares of common
stock (see also Note 11).
7
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
6. Stockholders' Equity (Deficit)
The components of stockholders' equity are as follows:
<TABLE>
<CAPTION>
Additional
Common Paid In Accumulated
Stock Capital Deficit Total
--------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 $16 $2,835 $ (4,378) $ (1,527)
Issuance of warrants to purchase 166,378 shares
of common stock - 362 - 362
Issuance of warrants to purchase 240,000 shares
of common stock - 228 - 228
Value of vested common stock options granted to
employees - 599 - 599
Accretion of Series A Mandatorily Redeemable
Convertible Preferred Stock to redemption
value - - (389) (389)
Dividends accrued on Series B Mandatorily
Redeemable Convertible Preferred Stock - - (217) (217)
Net loss for nine months ended September 30,
1996 - (14,630) (14,630)
--------------------------------------------
Balance at September 30, 1996 $16 $4,024 $(19,614) $(15,574)
=== ====== ======== ========
</TABLE>
7. Stock Option Plan
The Company maintains two stock option plans, the 1995 Stock Option Plan
and the 1996 Equity Participation Plan (collectively, the "Plans"). The Plans
are administered by the Board of Directors. The Plans provide for the granting
of either qualified or non-qualified options to purchase an 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.
8
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
7. Stock Option Plan (continued)
The following table summarizes the stock option activity of the Company for the
nine months ended September 30, 1996 (shares in thousands):
<TABLE>
<CAPTION>
Average
Shares Shares Exercise Price
Outstanding Exercisable Per Share
----------- ----------- --------------
<S> <C> <C> <C>
Balances at December 31, 1995 630 188 $0.25
Granted 1,720 - $0.25- $10.00
Became exercisable - 194 $0.25- $10.00
Exercised/Surrendered (5) (5) $0.25
Canceled (37) - $0.25- $10.00
----- --- -------------
Balances at September 30, 1996 2,308 377 $0.25- $10.00
===== === =============
</TABLE>
All of the options granted during the nine months ended September 30, 1996 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 over the vesting period of options granted since
inception of the plans. For the nine months ended September 30, 1996, the
Company recorded $599 of compensation expense. The Company will record
additional compensation expense related to option grants as follows:
<TABLE>
<S> <C>
Three months ended December 31, 1996...................... $ 198
Year ended December 31, 1997.............................. 747
1998.............................. 528
1999.............................. 112
------
Total.................................................... $1,585
======
</TABLE>
8. Loss Per Share and Pro Forma Loss Per Share
Loss per share is based on the average number of shares of common stock
outstanding during the period, adjusted for the effect of other outstanding
securities as described in the following sentence. Pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 83 ("SAB 83"), certain
options, warrants, and shares of preferred stock issued by the Company at prices
below its initial public offering price during the twelve month period prior to
the initial public offering date have been included in the calculation of loss
per share for the nine months ended September 30, 1996 and 1995 as if they were
outstanding for the periods included in the initial public offering Registration
Statement. The assumed conversion or exercise of all other potentially dilutive
securities is anti-dilutive during the periods presented, and therefore are not
considered in the computation. The following table summarizes the computations
of share amounts used in the computation of historical loss per share for the
periods ended September 30, 1995 and 1996 (in thousands of shares):
9
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
8. Loss Per Share and Pro Forma Loss Per Share (continued)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1995 1996
-----------------
<S> <C> <C>
Weighted average number of shares of common stock
outstanding during the period 1,618 1,618
Adjustment for options, warrants and preferred stock issued
within one year of registration statement 5,170 3,447
-----------------
Total shares considered outstanding 6,788 5,065
=================
</TABLE>
In calculating net loss per share attributable to common stockholders for
the nine months ended September 30, 1996, the net loss was reduced by $1,058 for
interest expense attributable to debentures converted into Series B Preferred
Stock during the period. The Series B was assumed to have been converted into
common stock in the calculation above.
On October 22, 1996 the Company completed its initial public offering for
the sale of 4,500,000 shares of common stock. Immediately prior to the closing
of this offering, holders of the Series A and Series B convertible preferred
stock converted their shares of preferred stock into 2,680,336 shares of common
stock. In addition, holders of outstanding warrants to purchase 1,868,408 shares
of common stock exercised their warrants immediately prior to the closing of the
offering. On November 11, 1996 the underwriters of the Company's initial public
offering exercised their over-allotment option to purchase an additional 675,000
shares of common stock. Pro forma loss per share is computed on the same basis
as historical loss per share, adjusted to give effect to the additional shares
of common stock issued upon the closing of the offering, the preferred stock
conversion, the warrant exercise and the exercise of the underwriter's over-
allotment option, to the extent that these additional shares are not included
in the historical computation as a result of the application of SAB 83 and as if
these additional shares of common stock were issued at the beginning of the
period presented.
The following table summarizes the computation of share amounts used in the
computation of pro forma loss per share for the nine months ended September 30,
1996 as presented in the accompanying statement of operations (in thousands of
shares):
<TABLE>
<S> <C>
Weighted average number of shares of common stock outstanding 1,618
Common stock issued to the public in October 1996 4,500
Exercise of over-allotment option 675
Warrant exercise, net of shares tendered in exercise 1,812
Conversion of Series A and B preferred stock 2,680
Adjustment for options, warrants, and preferred stock issued within one
year of registration statement, and not converted into common stock 1,683
------
Total shares considered outstanding for pro forma loss per share 12,968
======
</TABLE>
10
<PAGE>
DIGEX, Incorporated
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
In calculating pro forma net loss per share attributable to common
stockholders for the nine months ended September 30, 1996, the net loss was
reduced by (i) interest expense of $1,058 attributable to debentures converted
into Series B Preferred Stock during the period and (ii) Series A preferred
stock accretion of $ 389. The Series A and B preferred stocks were assumed to
have been converted into common stock in the calculation above.
9. Income Taxes
No provision for income taxes is expected for 1996 as the Company expects
to incur a net loss for the year and does not meet the criteria for recognizing
an income tax benefit under the provisions of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes."
10. Subsequent Event--Stock Split
On October 9, 1996 the Board of Directors approved a 1-for-2.5 reverse
stock split in connection with 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.
11. Pro Forma Balance Sheet
At September 30, 1996 the Company's outstanding Series A Preferred Stock,
Series B Preferred Stock and warrants to purchase 1,868,408 shares of common
stock were automatically convertible into a total of 4,548,744 shares of common
stock immediately prior to the closing of an initial public offering consummated
on or before December 31, 1996 that generated net proceeds of at least $25,000
to the Company. In October 1996, the Company completed its initial public
offering and received $ 42,351 of net proceeds (prior to estimated offering
expenses of $1,200) causing the aforementioned conversions of preferred stock
and exercise of warrants. In connection with the warrant exercise, the Company
received cash of $87 and 56,264 shares of common stock in consideration for the
issuance of 1,868,408 shares of common stock (net shares issued of 1,812,144).
On November 11, 1996 the underwriters of the Company's initial public
offering exercised their over-allotment option to purchase an additional 675,000
shares of common stock. The Company received net cash proceeds of $6,356 as a
result of the exercise of the option.
The accompanying pro forma balance sheet as of September 30, 1996 presents
the financial condition of the Company as of September 30, 1996, assuming that
the preferred stock conversions, the exercise of the warrants, the initial
public offering and the exercise of the over-allotment option occurred on that
date.
11
<PAGE>
DIGEX, Incorporated
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 the nine months ended
September 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 1,150 accounts
at September 30, 1996.
The Company's 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 the fourth quarter of 1996 and in fiscal 1997.
There can be no assurance that the Company will achieve or sustain profitability
in the future.
12
<PAGE>
DIGEX, Incorporated
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.
<TABLE>
<CAPTION>
Nine Months
Ended
September 30,
1995 1996
---- ----
<S> <C> <C>
Revenue.......................................... 100% 100%
Costs and expenses:
Cost of revenue................................ 77 95
Sales and marketing............................ 33 73
General and administration..................... 32 52
Depreciation and amortization.................. 12 19
--- ---
Total expenses................................... 154 239
--- ---
Loss from operations............................. (54) (139)
Interest expense, net............................ (1) (12)
--- ----
Net loss......................................... (55) (151)
=== ====
</TABLE>
Nine Months Ended September 30, 1996 Compared With Nine Months Ended September
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 225% from
$3.0 million in the nine months ended September 30, 1995 to $9.7 million in the
nine months ended September 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 of data communications and operations expense
and cost of equipment sales. Data communications costs primarily consist 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
from $2.3 million in the nine months ended September 30, 1995 to $9.2 million
in the same period in 1996. Cost of revenue increased as a percentage of
revenues from 77% in the 1995 period to 95% 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 Network
Operations Center, and the building of redundant facilities. For example, the
Company's customer support and network operations personnel increased from 45 at
September 30, 1995 to 92 at September 30, 1996.
13
<PAGE>
DIGEX, Incorporated
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 increased from $992,000 in the nine
months ended September 30, 1995 to $7.0 million in the same period in 1996.
Sales and marketing costs increased as a percentage of revenues from 33% in the
1995 period to 73% in the 1996 period. The increase in sales and marketing
costs was primarily due to the Company's strategy to build market share
comprised of 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 September 30, 1995 to 140
at September 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 from $939,000 in the nine months
ended September 30, 1995 to $5.1 million in the same period in 1996. These costs
increased as a percentage of revenues from 32% in the nine months ended
September 30, 1995 to 52% in the same period in 1996. This increase in general
and administrative expenses was due primarily to the hiring of 26 additional
senior management, finance, accounting and administrative personnel to support
the Company's expanding operations. General and administrative costs were
affected by a $599,000 compensation charge in the nine months ended September
30, 1996 related to the grant of stock options. In addition, based on options
granted through September 30, 1996, additional compensation charges of $1.6
million will be reported as general and administrative costs during the period
October 1, 1996 through December 31, 1999. See Note 7 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 September 30, 1995 to 33 at September 30, 1996.
The Company expects to hire additional personnel in anticipation of continued
expansion of its operations.
Interest Expense
Interest expense increased from $69,000 in the nine months ended September
30, 1995 to $1.3 million 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.
Depreciation and Amortization
Depreciation and amortization increased from $356,000 in the nine months
ended September 30, 1995 to $1.8 million in the same period in 1996. The
increase in 1996 is a result of the significant investments made in developing
and expanding its network infrastructure.
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DIGEX, Incorporated
Liquidity and Capital Resources
The Company historically has satisfied its cash requirements principally
through a combination of sales of equity securities and borrowings from banks
and other third parties. On October 22, 1996, the Company completed its initial
public offering for the sale of 4,500,000 shares of common stock. The Company
received $42.4 million of net proceeds from the offering, and repaid $1.5
million in interim financing pursuant to a bridge loan from one of its venture
capital investors. On November 11, 1996 the underwriters of the Company's
initial public offering exercised their over-allotment option to purchase an
additional 675,000 shares of common stock. The Company received net cash
proceeds of $6.4 million as a result of the exercise of the option. The Company
currently anticipates that the approximately $48.6 million in net proceeds
remaining will be used for the continued expansion of its network and Web server
hosting facilities and to fund operating losses and working capital requirements
associated with the expansion of the Company's customer base.
Despite an increase in net loss from $1.7 million for the nine months ended
September 30, 1995 to $14.6 million for the nine months ended September 30,
1996, the Company generated cash flow from operations of $4.4 million for the
nine months ended September 30, 1996, a $5.4 million increase over the amount
for the nine months ended September 30, 1995. This increase is primarily
attributable to growth in accounts payable and accrued expenses and a customer
advance payment, included in deferred revenue, of approximately $4.8 million. In
addition, purchases of fixed assets for the nine months increased from $855,000
in 1995 to $9.0 million in 1996, primarily to support the expansion of the
Company's network infrastructure. The Company currently anticipates that
proceeds from the initial public offering, current 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. The Company currently anticipates that it
will use equipment financing to fund in part the planned expansion of its
facilities. Since September 30, 1996, the Company has arranged approximately $5
million of such financing and anticipates that it will arrange as much as an
additional $10 million of equipment financing for future capital projects. There
can be no assurance that the Company will be able to arrange additional
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.
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