<PAGE>
DIGEX, Incorporated
United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
[x] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934 For the Period Ended September 30, 1996.
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 For the Transition Period From to
------ ------
Commission file number 333-05871
-----------------
DIGEX, Incorporated
- --------------------------------------------------------------------------------
(Exact name of small business owner as specified in its charter)
Delaware 52-1986462
- -------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6800 Virginia Manor Road
Beltsville, MD 20705
- -------------- ---------
(Address of principal executive offices) (Zip Code)
(301) 847- 5200
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter periods that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes No X
------ ------
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 Par Value 11,285,387 shares as of November 22, 1996
---------- --
<PAGE>
<TABLE>
<CAPTION>
INDEX PAGE
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
<S> <C> <C>
Balance sheets--December 31,
1995 and September 30, 1996 3
Statements of Operations-- Three
Months and Nine Months Ended
September 30, 1995 and 1996 4
Statements of Cash flows-- Nine Months
Ended September 30,1995 and 1996 5
Notes to Financial Statements--
September 30, 1996 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibit (11), computation of earnings per share, is not presented herein but the
related information is included in notes to financial statements.
The Company did not file any reports on Form 8-K during the three months ended
September 30, 1996.
Signatures 18
</TABLE>
2
<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>
Three Months Ended Nine Months Ended
September 30 September 30
----------------------- ------------------------
1995 1996 1995 1996
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Net Revenue
Online services $ 1,219 $ 3,768 $ 2,813 $ 8,428
Equipment sales 100 685 171 1,261
-------- -------- -------- --------
Total revenue 1,319 4,453 2,984 9,689
Operating Costs and Expenses
Data communications and operations 1,027 4,244 2,161 8,192
Cost of equipment sales 80 520 137 1,033
Sales and marketing 431 4,441 992 7,028
General and administrative 375 1,839 939 5,076
Depreciation and amortization 201 905 356 1,830
-------- -------- -------- --------
Total operating costs and expenses 2,114 11,949 4,585 23,159
-------- -------- -------- --------
Loss from operations (795) (7,496) (1,601) (13,470)
Other income (expense)
Interest and other income - 53 17 101
Interest expense (24) (94) (69) (1,261)
-------- -------- -------- --------
(24) (41) (52) (1,160)
-------- -------- -------- --------
Net loss (819) (7,537) (1,653) (14,630)
Accretion of Series A Mandatorily Redeemable
Convertible Preferred Stock to redemption
value (115) (136) (224) (389)
-------- -------- -------- --------
Net loss attributable to common stockholders $ (934) $ (7,673) $ (1,877) $(15,019)
======== ======== ======== ========
Net loss per common share attributable
to common stockholders $ (0.14) $ (4.74) $ (0.28) $ (2.76)
======== ======== ======== ========
Pro forma net loss per common share attributable
to common stockholders $ (0.67) $ (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>
<CAPTION>
<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 - 62
Issuance of warrants to
purchase 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>
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- $10.00
Canceled (37) - $0.25- $10.00
------- ----- -------------
2,308 377 $0.25- $10.00
Balances at September 30, 1996 ======= ===== =============
</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 three months and nine months ended September 30,
1996, the Company recorded $199 and $599 of compensation expense, respectively.
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 three months ended September 30, 1995 and 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>
Three Months Ended Nine Months Ended
September 30, September 30,
1995 1996 1995 1996
---------------------------------------
<S> <C> <C> <C> <C>
Weighted average number of
shares of common stock
outstanding during the
period 1,708 1,618 1,618 1,618
Adjustment for options,
warrants and preferred
stock issued within one
year of registration
statement 5,170 5,170 3,447
---------------------------------------
Total shares considered
outstanding 6,878 1,618 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 periods ended September 30, 1996
as presented in the accompanying statement of operations (in thousands of
shares):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
-------------------------------------
<S> <C> <C>
Weighted average number of
shares of common stock
outstanding 1,618 1,618
Common stock issued to the
public in October 1996 4,500 4,500
Exercise of over-allotment
option 675 675
Warrant exercise, net of
shares tendered in exercise 1,812 1,812
Conversion of Series A and
B preferred stock 2,680 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 11,285 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. For the computation for the three months ended
September 30, 1996, net loss was reduced by Series A preferred stock accretion
of $136. 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, Icorporated
Item 2. 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>
Three Months Nine Months
Ended Ended
September 30, September30,
1995 1996 1995 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue.......................100% 100% 100% 100%
Costs and expenses:
Cost of revenue............. 84 107 77 95
Sales and marketing.......... 33 100 33 73
General and administration... 28 41 32 52
Depreciation and amortization.15 20 12 19
-- -- -- --
Total expenses................160 268 154 239
--- --- --- ---
Loss from operations..........(60) (168) (54) (139)
Interest expense, net..........(2) (1) (1) (12)
--- ----- ---- -----
Net loss......................(62)% (169)% (55)% (151)%
==== ===== ==== =====
</TABLE>
Three Months Ended September 30, 1996 Compared With Three 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 238% from
$1.3 million in the three months ended September 30, 1995 to $ 4.5 million in
the three 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 $ 1.1
million in the three months ended September 30, 1995 to $ 4.8 million in the
same period in 1996. Cost of revenue increased as a percentage of revenues from
84% in the 1995 period to 107% 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 which was completed in June 1996, the
establishment of a 24x7x365 Network Operations Center, and the building of
redundant facilities. For example, during the quarter, the Company's customer
support and network operations personnel was constant at 45 employees from
July 1, 1995 to September 30, 1995, but increased from July 1, 1996 to September
30, 1996 by 23 employees, for a total of 92 employees as of 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 $ 431,000 in the three
months ended September 30, 1995 to $ 4.4 million in the same period in 1996.
Sales and marketing costs increased as a percentage of revenues from 33% in the
1995 period to 100% 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 (no change in the quarter ended
September 30, 1995 with 27 employees compared to an increase of 55 employees in
the quarter ended September 30, 1996 for a total of 140 employees as of
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 $ 375,000 in the three months
ended September 30, 1995 to $ 1.8 million in the same period in 1996. These
costs increased as a percentage of revenues from 28% in the three months ended
September 30, 1995 to 41% in the same period in 1996. This increase in general
and administrative expenses was due primarily to the hiring of additional senior
management, finance, accounting and administrative personnel to support the
Company's expanding operations. General and administrative costs were affected
by a $199,000 compensation charge in the three months ended September 30, 1996
related to the grant of stock options. 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 employees at September 30, 1995 to 33 employees 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 $ 24,000 in the three months ended
September 30, 1995 to $94,000 in the same period in 1996. The increase in
interest expense during the 1996 period was primarily due to 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 $ 201,000 in the three months
ended September 30, 1995 to $ 905,000 in the same period in 1996. The increase
in 1996 is a result of the significant investments made in developing and
expanding the Company's network infrastructure.
14
<PAGE>
DIGEX, Incorporated
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 employees at
September 30, 1995 to 92 employees at September 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 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 employees at September 30,
1995 to 140 employees 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
15
<PAGE>
DIGEX, Incorporated
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 employees at
September 30, 1995 to 33 employees 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. The subordinated debentures
were converted into shares of Series B Preferred Stock on May 30, 1996.
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 the Company's network infrastructure.
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
16
<PAGE>
DIGEX, Incorporated
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.
17
<PAGE>
DIGEX, Incorporated
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGEX, Incorporated
Date November 25, 1996 /s/ Christopher R. McCleary
----------------------- --------------------------------
Christopher R. McCleary
Chairman of the Board, President
Chief Executive Officer
Date November 25, 1996 /s/ Thomas M. Brandt, Jr.
----------------------- ---------------------------------
Thomas M. Brandt, Jr.
Senior Vice President, Secretary
Chief Financial Officer
18
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