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 March 31, 1997.
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 001-12281
DIGEX, Incorporated
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 52-1986462
- -------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
One DIGEX Plaza
Beltsville, MD 20705
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
(301) 847- 5000
- --------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Not applicable
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Check whether the issuer (1) 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 X No
---------- ----------
Applicable Only to Corporate Issuers
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practical date:
Common Stock, $.01 Par Value: 11,490,715 shares outstanding as of May 12, 1997
Transitional Small Business Disclosure Format (check one):
Yes No X
---------- ----------
<PAGE>
INDEX PAGE
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets--December 31, 1996 and March 31, 1997 3
Statements of Operations--Three Months Ended March 31,
1996 and 1997 4
Statements of Cash Flows--Three Months Ended March 31,1996
and 1997 5
Notes to Financial Statements--March 31, 1997 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 11
Exhibit (11), computation of earnings per share, is not presented
herein but the related information is included in notes to
financial statements.
Signatures 12
2
<PAGE>
DIGEX, Incorporated
Balance Sheets
(in thousands)
December 31, 1996 March 31, 1997
----------------- --------------
ASSETS (audited) (unaudited)
Current assets:
Cash and cash equivalents $32,667 $23,192
Accounts receivable, less allowance of $777 at
December 31, 1996 and $924 at March 31, 1997 3,298 5,571
Inventory and prepaid assets 1,250 1,451
Deferred income taxes 8 8
------- -------
Total current assets 37,223 30,222
Property and equipment:
Computer equipment and software 20,302 25,519
Office furniture and equipment 1,099 2,078
Leasehold improvements 793 962
------- -------
Total property and equipment 22,194 28,559
Accumulated depreciation and amortization 3,616 5,156
------- -------
Net property and equipment 18,578 23,403
Other assets 972 1,833
------- -------
Total assets $56,773 $55,458
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $8,501 $12,460
Deferred revenue 4,931 4,716
Current portion of capital lease obligations 2,843 4,045
Current portion of long-term debt 896 1,061
------- -------
Total current liabilities 17,171 22,282
Capital lease obligations, less current portion 4,878 7,381
Long-term debt 1,018 1,134
Stockholders' equity:
Preferred stock, $1.00 par value:
Authorized shares -- 3,000 at December 31, 1996
and March 31, 1997; Issued and outstanding shares --
none at December 31, 1996 and March 31, 1997
Common Stock, $.01 par value:
Authorized shares 47,000 at December 31, 1996 and
March 31, 1997; Issued and outstanding shares --
11,285 at December 31, 1996 and 11,295 at March
31, 1997 113 113
Additional paid-in capital 61,947 62,540
Accumulated deficit (28,354) (37,992)
------- -------
Total stockholders' equity 33,706 24,661
------- -------
Total liabilities and stockholders' equity $56,773 $55,458
======= =======
See notes to financial statements.
3
<PAGE>
DIGEX, Incorporated
Statements of Operations
(in thousands, except per share amounts)
Three Months Ended
March 31
---------------------
1996 1997
-------- ---------
(audited) (unaudited)
Net revenue:
Business Internet services $ 1,996 $ 7,688
Equipment sales 236 1,053
-------- --------
Total revenue 2,232 8,741
Costs and expenses:
Network operations 1,771 8,221
Cost of equipment sales 189 911
Sales and marketing 674 5,720
General and administrative 557 1,790
Depreciation and amortization 347 1,623
-------- --------
Total expenses 3,538 18,265
-------- --------
Loss from operations (1,306) (9,524)
Other income (expense):
Interest and other income 15 232
Interest expense (541) (346)
-------- --------
(526) (114)
-------- --------
Net loss (1,832) (9,638)
Accretion of Series A Mandatorily Redeemable
Convertible Preferred Stock to redemption
value (123) --
-------- --------
Net loss attributable to common stockholders $ (1,955) $ (9,638)
======== ========
Net loss per common share attributable
to common stockholders $ (0.13) $ (0.85)
======== ========
Average common and common equivalent shares
outstanding 15,580 11,295
======== ========
See notes to financial statements.
4
<PAGE>
DIGEX, Incorporated
Statements of Cash Flows
(in thousands)
Three Months Ended March 31
1996 1997
------- --------
(audited) (unaudited)
Operating Activities:
Net loss $(1,832) $ (9,638)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 347 1,623
Amortization of debt discount charged to interest
expense 439 --
Non-cash compensation recorded for vested stock
option grants 121 187
Non-cash compensation recorded for 401(K) matching -- 119
Changes in operating assets and liabilities:
Accounts receivable, net (203) (2,029)
Inventory and prepaid expenses (59) (201)
Accounts payable and accrued expenses 1,373 3,959
Deferred revenue 8 (215)
------- --------
Net cash provided by (used in) operating activities 194 (6,195)
Investing Activities:
Purchases of property and equipment, net (1,109) (1,610)
Acquisition of Electronic Press Services Group -- (844)
Increase in other assets (39) (263)
------- --------
Net cash used in investing activities (1,148) (2,717)
Financing Activities:
Proceeds from issuances of long-term debt -- 477
Repayment of long-term debt -- (196)
Repayment of capital lease obligations (151) (844)
Issuance of debentures and detachable stock warrants 1,000 --
------- --------
Net cash provided by (used in) financing activities 849 (563)
------- --------
Net decrease in cash and cash equivalents (105) (9,475)
Cash and cash equivalents at beginning of period 833 32,667
======= ========
Cash and cash equivalents at end of period $ 728 $ 23,192
======= ========
Interest paid $ 41 $ 359
======= ========
See notes to financial statements.
5
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
March 31, 1997
(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 three month period ended March 31, 1997
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1997. For further information, refer to the financial
statements and footnotes thereto included in the DIGEX, Incorporated annual
report on Form 10-KSB for the year ended December 31, 1996.
Certain reclassifications have been made to prior years' financial
statements to conform to current years' presentation.
2. Acquisition of Electronic Press Services Group
On January 3, 1997, the Company acquired all of the assets of Electronic
Press Services Group (EPSG) for approximately $805 in cash and the assumption of
approximately $20 in liabilities. Additionally, the Company issued to the
sellers warrants to purchase 175,000 shares of common stock. These warrants are
exercisable at any time during the period from December 31, 1997 through January
1, 2000 at $10.38 per share. The acquisition was accounted for as a purchase and
the excess of the purchase price over the fair value of the assets received of
$613 has been recorded as goodwill, which will be amortized over a ten year
period.
EPSG designs, integrates and manages electronic commerce solutions for
corporate Internet Web sites. The acquisition of EPSG is an element of the
Company's heightened focus on and evolving commitment to the most critical and
highest revenue-producing customers, such as software publishers and
mission-critical applications with high access and reliability requirements.
3. Capital Lease Obligations
The Company leases equipment under capital leases. Property and equipment
includes the following amounts for leases that have been capitalized:
December 31, 1996 March 31, 1997
----------------- --------------
Computer equipment ............................. $9,679 $14,339
Office furniture and equipment ................. 110 110
------ -------
9,789 14,449
Less accumulated amortization .................. 2,214 3,116
------ -------
$7,575 $11,333
====== =======
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
3. Capital Lease Obligations (Continued)
Amortization of leased assets is included in depreciation and amortization
expense.
Future minimum payments under capital lease obligations consist of the
following at March 31, 1997:
Through December 31, 1997............................................. $ 4,016
1998............................................. 4,888
1999............................................. 3,760
2000............................................. 1,099
2001............................................. 111
-------
Total minimum lease payments ......................................... 13,874
Amounts representing interest ........................................ 2,448
-------
Present value of net minimum lease payments (including current
portion of $ 4,045)................................................. $11,426
=======
4. Loss Per Share
The following table summarizes the computations of share amounts used in
the computation of loss per share for the periods ended March 31, 1996 and March
31, 1997 (in thousands of shares):
Three Months Ended
March 31,
1996 1997
----------------
Weighted average number of shares of common stock
outstanding during the period 4,045 11,295
Effect of options and warrants to purchase common
stock issued within one year of registration
statement 6,082 --
Effect of convertible debentures and preferred stock
issued within one year of the registration
statement 5,453 --
----------------
Total shares considered outstanding 15,580 11,295
================
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. As required by the Securities
and Exchange Commission, all common stock options, warrants, 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 initial public offering date have been included
in the computation as if they were outstanding for all of the periods included
in the initial public offering Registration Statement, which included the first
three months of 1996, even if the result was anti-dilutive.
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
4. Loss Per Share (Continued)
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share, which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. The impact of Statement
128 on the calculation of primary and fully diluted earnings per share for these
quarters is not expected to be material.
5. Income Taxes
No provision for income taxes is expected for 1997 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."
8
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
DIGEX is a leading national Internet carrier that focuses exclusively on
business customers. The Company was founded and incorporated 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 that generally require high bandwidth connectivity, and began to
develop its Web Site management business. Additionally, 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
site management and security and other network products. Business connectivity
and Web site management 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 1996 and the three
months ended March 31, 1997. In anticipation of future growth, the Company
expects to continue to make significant investments in its network
infrastructure, to be funded primarily from existing cash and equipment
financing. In addition, the Company expects to focus in the near term on
increasing its subscriber base of high-end Web Site management and business
connectivity customers, which will require it to increase and accelerate its
overall sales and marketing costs, as higher sales and marketing costs are
incurred in the first half of 1997 in order to capture high-end customers more
quickly. This effort is likely to have an adverse effect on operating results,
at least in the near term. The Company's business connectivity and Web Site
management customers have expanded from approximately 500 and 1,500 accounts at
December 31, 1995 and December 31, 1996, respectively, to approximately 2,000
accounts at March 31, 1997.
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 fluctuations 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 the development of new products and services, and, in
particular, sales and marketing costs, and which may adversely impact short-term
operating results. The Company expects to incur operating and net losses in
1997. There can be no assurance that the Company will achieve or sustain
profitability in the future.
9
<PAGE>
Results of Operations
Three Months Ended March 31, 1997 Compared With Three Months Ended March
31, 1996
Revenue
The Company derives its revenue from providing a comprehensive range of
Internet solutions, including business connectivity, Web Site management and
security and other network products. Revenue grew 292% from $ 2.2 million in the
three months ended March 31, 1996 to $ 8.7 million in the three months ended
March 31, 1997, the majority of which was due to the Company's increased focus
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 the development of the Company's Web
Site management 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, and cost of equipment sales. 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 366% from $
2.0 million in the three months ended March 31, 1996 to $ 9.1 million in the
three months ended March 31, 1997. Cost of revenue increased as a percentage of
revenues from 88% in the 1996 period to 104% in the 1997 period. The increase in
cost of revenue was primarily due to costs associated with the Company's
increased focus 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 51 at March 31, 1996 to
187 at March 31, 1997. The Company plans to continue to expand its network
through 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. However, in 1997, the Company expects its contribution
margin to be insufficient to absorb expected levels of selling, general and
administrative costs.
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 749% from $674,000 for the three
months ended March 31, 1996 to $5.7 million in the same period in 1997. Sales
and marketing costs increased as a percentage of revenues from 30% in the 1996
period to 65% in the 1997 period. The increase in sales and marketing costs was
primarily due to the Company's increased focus 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 38 at March 31, 1996 to 209 at March 31, 1997) and the expansion
of advertising and promotional activities and product development efforts. In
addition, the Company expects to focus in the near term on increasing its
subscriber base of high-end Web Site management and business connectivity
customers, which will require it to increase and accelerate its overall sales
and marketing cost, as higher sales and marketing costs are incurred in the
first half of 1997 in order to capture high-end customers more quickly. This
effort is likely to have an adverse effect on operating results, at least in the
near term.
10
<PAGE>
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 221% from $ 557,000 in the three
months ended March 31, 1996 to $ 1.8 million in the same period in 1997. 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. The increase in the
general and administrative costs resulted principally from the increase in the
Company's general and administrative staff from 23 at March 31, 1996 to 55 at
March 31, 1997.
Depreciation and Amortization
Depreciation and amortization increased from $347,000 in the three months
ended March 31, 1996 to $1.6 million in the three months ended March 31, 1997.
The increase in 1997 is the result of significant investments related to
developing and expanding the Company's network infrastructure.
Interest Expense, Net
Interest expense, net decreased from $526,000 in the three months ended
March 31, 1996 to $114,000 in the same period in 1997. The decrease in interest
expense, net during the period was primarily due to interest income earned on
short term investments.
Liquidity and Capital Resources
Net cash used in operating activities was $6.2 million for the three
months ended March 31, 1997 compared with cash provided by operating activities
of $195,000 for the three months ended March 31, 1996. The increase in cash used
in operating activities in 1997 was primarily the result of higher net losses
caused by increased costs relating to the expansion of the Company's network and
organizational infrastructure, including the hiring of additional management,
marketing and sales, finance, accounting and administrative personnel.
Net cash used in investing activities was $1.1 million and $3.0 million
for the periods ended March 31, 1996 and March 31, 1997, respectively. The
increase in cash used in investing activities resulted from increased fixed
asset purchases, made primarily to support the Company's network infrastructure
and Web Site management facilities, and the purchase of EPSG in January of 1997.
Net cash provided by financing activities was $849,000 for the period
ended March 31, 1996 compared to net cash used of $276,000 for the same period
in 1997. The decrease is primarily due to repayment of capital lease obligations
and the reduction of debt financing in the 1997 period.
The Company currently anticipates that the remaining proceeds of the
Company's 1996 initial public offering, together with approximately $15 million
of secured lease financing and other financing arrangements and funds from
operations, will be sufficient to meet the Company's anticipated working
capital, lease commitments, network expansion and capital expenditure
requirements in 1997. However, the Company anticipates that it will seek to
arrange additional public or private or equity financing, including potentially,
additional equipment financing, to afford the Company greater liquidity and
flexibility. The Company expects that it will need to obtain such financing no
later than the first quarter of 1998. Moreover, the Company may seek to raise
additional funds in the event that the Company's estimate 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 advantage of
unanticipated opportunities. There can be no assurance that additional financing
will be available to the Company or that such financing will be available on
acceptable terms.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed herewith:
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no Reports on Form 8-K during the three months ended
March 31, 1997.
11
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGEX, Incorporated
Date: May 13, 1997 /s/ Christopher R. McCleary
------------ ---------------------------
Christopher R. McCleary
Chairman of the Board, President
Chief Executive Officer
Date: May 13, 1997 /s/ John C. Welling
------------ -------------------
John C. Welling
(principal financial and chief accounting officer)
Vice President, Chief Financial Officer,
Controller and Secretary
12
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<PERIOD-START> Jan-01-1997
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