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EXHIBIT 99.1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 2001
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: 000-26873
DIGEX, INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 00-0000000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
XXX XXXXX XXXXX
XXXXXXXXXX, XX 00000
(Address of principal executive offices)
(000) 000-0000
Telephone Number
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [ ]
As of April 30, 2001, there were 24,711,090 and 39,350,000 shares of the
Registrant's Class A and Class B Common Stock outstanding, respectively.
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DIGEX, INCORPORATED
INDEX
PAGE
NO.
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PART I. FINANCIAL INFORMATION
ITEM Financial Statements (Unaudited):
1.
Consolidated Statements of Operations --
Three months ended March 31, 2001 and 2000.............. 1
Consolidated Balance Sheets --
March 31, 2001 and December 31, 2000.................... 2
Consolidated Statements of Cash Flows --
Three months ended March 31, 2001 and 2000.............. 3
Notes to Consolidated Financial Statements.................. 4
ITEM Management's Discussion and Analysis of Financial Condition
2. and Results of Operations................................. 8
ITEM Quantitative and Qualitative Disclosures about Market
3. Risk...................................................... 14
PART II. OTHER INFORMATION
ITEM Legal Proceedings........................................... 15
1.
ITEM Changes in Securities and Use of Proceeds................... 15
2.
ITEM Defaults Upon Senior Securities............................. 15
3.
ITEM Submission of Matters to a Vote of Security Holders......... 15
4.
ITEM Other Information........................................... 15
5.
ITEM Exhibits and Reports on Form 8-K............................ 16
6.
SIGNATURES............................................................ 17
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PART 1: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGEX, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2001 2000
----------- -----------
Revenues.................................................... $ 53,052 $ 25,796
Costs and expenses:
Cost of operations........................................ 5,156 3,940
Cost of services.......................................... 24,545 10,488
Selling, general and administrative....................... 37,180 26,575
Deferred compensation..................................... 1,072 994
Depreciation and amortization............................. 28,887 12,571
----------- -----------
Total costs and expenses.................................... 96,840 54,568
----------- -----------
Loss from operations........................................ (43,788) (28,772)
Other income (expense):
Interest expense.......................................... (698) (443)
Interest and other income................................. 267 3,500
----------- -----------
Loss before cumulative effect of change in accounting
principle................................................. (44,219) (25,715)
Cumulative effect of change in accounting principle......... -- (166)
----------- -----------
Net loss.................................................... $ (44,219) $ (25,881)
=========== ===========
LOSS PER COMMON SHARE -- BASIC AND DILUTED:
Loss before cumulative effect of change in accounting
principle................................................. $ (0.69) $ (0.41)
Cumulative effect of change in accounting principle......... -- --
----------- -----------
Net loss per common share................................... $ (0.69) $ (0.41)
=========== ===========
Shares used in computing basic and diluted net loss per
share..................................................... 63,951,087 62,620,879
=========== ===========
See accompanying notes to consolidated financial statements.
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DIGEX, INCORPORATED
CONSOLIDATED BALANCE SHEETS
UNAUDITED (AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 33,849 $ 83,434
Restricted investments.................................... 2,000 2,000
Accounts receivable, net of allowance of $4,956 in 2001
and $4,741 in 2000, respectively....................... 41,096 42,201
Deferred costs............................................ 8,686 8,627
Prepaid expenses and other current assets................. 6,665 7,492
-------- --------
Total current assets.............................. 92,296 143,754
-------- --------
Property and equipment, net................................. 351,697 348,975
Intangible assets, net...................................... 22,224 23,222
Other assets................................................ 4,247 5,100
-------- --------
Total assets...................................... $470,464 $521,051
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 46,813 $ 59,455
Current portion of deferred revenue....................... 8,222 7,734
Current portion of note payable........................... 4,235 2,772
Current portion of capital lease obligations.............. 1,969 1,871
-------- --------
Total current liabilities......................... 61,239 71,832
Deferred revenue............................................ 3,157 4,025
Note payable................................................ 3,000 1,435
Capital lease obligations................................... 26,674 27,131
-------- --------
Total liabilities................................. 94,070 104,423
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized; 100,000 shares designated as Series A
Convertible; 100,000 Series A Convertible shares issued
and outstanding........................................ 1 1
Class A common stock, $.01 par value; 100,000,000 shares
authorized; 24,624,090 and 24,546,543 shares issued and
outstanding in 2001 and 2000, respectively............. 246 245
Class B common stock, $.01 par value; 50,000,000 shares
authorized; 39,350,000 issued and outstanding in 2001
and 2000, respectively................................. 394 394
Additional capital........................................ 624,183 622,036
Accumulated deficit....................................... (240,088) (195,869)
Deferred compensation..................................... (8,219) (10,141)
Accumulated other comprehensive loss...................... (123) (38)
-------- --------
Total stockholders' equity........................ 376,394 416,628
-------- --------
Total liabilities and stockholders' equity........ $470,464 $521,051
======== ========
See accompanying notes to consolidated financial statements.
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DIGEX, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED (AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
OPERATING ACTIVITIES:
Net loss.................................................. $(44,219) $(25,881)
Cumulative effect of change in accounting principle....... -- 166
-------- --------
Loss before cumulative effect of change in accounting
principle.............................................. (44,219) (25,715)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization.......................... 28,887 12,571
Provision for doubtful accounts........................ 2,898 1,990
Amortization of deferred compensation.................. 1,072 994
Loss on sale/ disposals of telecommunications
equipment............................................. 602 196
Accretion of interest on note payable and capital lease
obligations........................................... 28 230
Changes in operating assets and liabilities:
Accounts receivable.................................... (1,793) (7,725)
Deferred costs......................................... (59) (7,225)
Prepaid expenses and other current assets.............. 827 5,189
Other assets........................................... 853 (151)
Accounts payable and accrued expenses.................. (12,642) (15,613)
Deferred revenue....................................... (380) 7,128
-------- --------
Net cash used in operating activities..................... (23,926) (28,131)
INVESTING ACTIVITIES:
Purchases of property and equipment....................... (29,380) (33,847)
Proceeds from sale of telecommunication assets............ 254 --
-------- --------
Net cash used in investing activities..................... (29,126) (33,847)
FINANCING ACTIVITIES:
Proceeds from subsequent public offering, net of costs.... -- 171,675
Proceeds from issuance of preferred stock................. -- 85,000
Proceeds from issuance of note payable.................... 3,000 --
Proceeds from exercise of common stock options............ 1,009 --
Principal payments on note payable and capital lease
obligations............................................ (457) (135)
-------- --------
Net cash provided by financing activities................. 3,552 256,540
Effect of exchange rate on cash and cash equivalents...... (85) --
Net (decrease) increase in cash and cash equivalents...... (49,585) 194,562
Cash and cash equivalents at beginning of the period...... 83,434 88,778
-------- --------
Cash and cash equivalents at end of period................ $ 33,849 $283,340
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Assets acquired through capital leases.................... $ 98 $ --
Interest paid............................................. 641 443
See accompanying notes to consolidated financial statements.
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DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by
Digex, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission (the "SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles ("GAAP") have been omitted
pursuant to such rules and regulations. The unaudited consolidated financial
statements should be read in conjunction with the consolidated financial
statements, notes thereto and other information included in the Form 10-K of
Digex for the year ended December 31, 2000.
The accompanying unaudited consolidated financial statements include the
accounts of Digex and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
The accompanying unaudited consolidated financial statements reflect, in
the opinion of management, all adjustments, which are of a normal and recurring
nature, necessary for a fair presentation of the financial condition and results
of operations and cash flows for the periods presented. The preparation of
financial statements in accordance with GAAP requires management to make
estimates and assumptions. Such estimates and assumptions affect the reported
amounts of assets and liabilities, as well as the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. The results of operations for the interim
periods are not necessarily indicative of the results for the entire year.
Change in Accounting Principle
Effective January 1, 2000, Digex changed its method of accounting for
revenue recognition in accordance with Staff Accounting Bulletin No. 101 ("SAB
101"), Revenue Recognition in Financial Statements. Historically, Digex has
recognized installation revenue, in accordance with industry practice, upon
completion of the managed Web hosting solution. The direct costs associated with
the installation were expensed as incurred. Under the new accounting method
adopted retroactive to January 1, 2000, Digex now recognizes installation
revenue and related direct incremental costs of performing the installation over
the contract term (generally 24 months). Accordingly, the consolidated statement
of operations for the first quarter of 2000 has been restated to reflect the
accounting change.
For the quarter ended March 31, 2001, Digex recognized revenue of $2.6
million that was recorded as deferred revenue as of December 31, 2000. With the
adoption of SAB 101, there was no economic impact to Digex's business operations
or cash flows. There was also no material effect to Digex's consolidated
financial statements.
Recent Accounting Pronouncements
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities," an amendment of SFAS No.
133, which is effective for fiscal years beginning after June 15, 2000. With the
adoption of SFAS No. 133, as amended, effective January 1, 2001, there is no
effect on Digex's consolidated financial statements as it has not entered into
any derivative contracts.
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DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
2. PROPOSED INTERMEDIA -- WORLDCOM MERGER
On September 1, 2000, Intermedia entered into a merger agreement with
WorldCom, Inc. ("WorldCom") whereby, upon consummation of the merger, a
subsidiary of WorldCom will be merged with and into Intermedia and Intermedia
will become a subsidiary of WorldCom (the "Intermedia -- WorldCom Merger). As a
result of the merger, WorldCom will beneficially own a majority of the capital
stock of Digex and will have voting control of Digex. On May 14, 2001, WorldCom
and Intermedia entered into the second amendment to the original merger
agreement to make certain technical changes to the amended merger agreement in
connection with completing the merger. WorldCom and Intermedia also agreed that
if the conditions in the amended merger agreement are timely satisfied or
waived, the closing of the merger would become effective on July 1, 2001.
On March 1, 2001, Digex and certain subsidiaries of WorldCom entered into
four commercial agreements. The principal terms of the four commercial
agreements are generally described as follows:
-- Sales Channel Agreement. Under this agreement, effective January 1,
2001, WorldCom will purchase Digex portfolio of managed Web hosting
products for resale to WorldCom customers. If Digex satisfies certain
service level commitments, WorldCom agrees to purchase up to a total of
$500.0 million during the period from 2001 through 2003. Digex and
WorldCom will share costs and profits generated from the WorldCom sales
channel.
-- Funding Agreement. After the completion of the Intermedia -- WorldCom
Merger, WorldCom has agreed to provide funding for the Digex business
plans for 2001 and 2002. The loan rate will be LIBOR plus 300 basis
points. Repayment will be made over a four-year period commencing in
2003. Nothing in the funding agreement would prevent Digex from seeking
replacement funding from other sources. The funding arrangement is
subject to the negotiation of a definitive funding agreement and the
approval of the 2001 and 2002 business plans by WorldCom, each of which
is expected to occur prior to the completion of the
Intermedia -- WorldCom Merger.
-- Facilities Agreement. Effective January 1, 2001, managed Web hosting
facilities for Digex will be built in several WorldCom data centers in
the United States and around the world. Digex will lease space from
WorldCom at these data centers based on customer demand.
-- Network Agreement. This agreement, effective January 1, 2001, provides
terms for Digex to purchase bandwidth and connectivity from WorldCom in
the United States to support its managed Web hosting activities.
As described above, Xxxxx has entered into a series of commercial
arrangements with WorldCom. These agreements are subject to termination if,
among other things, the Intermedia -- WorldCom Merger is not completed prior to
December 31, 2001. The completion of the Intermedia -- WorldCom Merger is
subject to a number of conditions. While Xxxxx believes it is probable the
Intermedia -- WorldCom Merger will close, if for any reason it does not, Digex
might no longer have the benefit of the WorldCom commercial agreements or the
funding to be made available by WorldCom for its 2001 and 2002 business plans.
In addition, if the Intermedia -- WorldCom Merger did not close, Intermedia
would no longer be able to borrow under its existing credit facility or note
purchase agreement with WorldCom and would unlikely be able to provide Digex
with any additional funding for working capital needs, operating losses or
capital expenditure requirements.
Digex expects to continue experiencing negative cash flow from operating
and investing activities due to its plans for expansion and the growth of the
business. If necessary, Digex intends to draw on a vendor line of credit of up
to $25.0 million, pursuant to the master lease and financing agreement, to
facilitate the leasing of computer hardware and software in the future. Digex
will also use the proceeds of $3.3 million in loans from
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DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
the State of Maryland and Prince George's County to finance a portion of the
cost of acquiring equipment and construction at its headquarter facilities in
Laurel, Maryland.
In the event the Intermedia -- WorldCom Merger does not close, Xxxxx's
intention would be to access the capital markets for its necessary funding.
Management has had preliminary discussions with third party sources regarding
potential financing, including vendor financing facilities or other asset backed
secured financing. Based on these discussions, management believes Digex will
have access to sufficient funding to continue its business plans as described
above or, at a minimum, in an amount that would provide sufficient funding to
execute a modified or curtailed plan into 2002. However, there can be no
assurance that such financing would be available to Digex or, if available, that
the terms would be as favorable to Digex as those that would be available if the
Intermedia -- WorldCom Merger were to close.
3. COMPREHENSIVE LOSS
The following table reflects the calculation of comprehensive losses (in
thousands):
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
-------- --------
Net loss applicable to common stockholders.................. $(44,219) $(25,715)
-------- --------
Other comprehensive loss:
Foreign currency translation adjustments.................. (85) --
-------- --------
Comprehensive loss applicable to common stockholders........ $(44,304) $(25,715)
======== ========
4. COMMITMENTS
In January 2001, Xxxxx received proceeds for a $3.0 million loan from the
State of Maryland Department of Business and Economic Development under the
Sunny Day Fund initiative. The loan is subject to multiple maturity dates, and
is guaranteed by Intermedia. Interest on the unpaid principal balances accrues
at 5% per annum. The principal amounts and any accrued interest will be deferred
each year through December 31, 2008 if Digex meets certain annual conditions
regarding the hiring of permanent, full time employees and the expenditures for
the development of a Web hosting facility in Prince Xxxxxx's County, Maryland.
At December 31, 2008, the principal amounts and any accrued interest outstanding
may convert to a grant upon the achievement of certain requirements by Digex.
In March 2001, Xxxxx entered into a master lease and financing agreement
with a vendor for a line of credit of up to $25.0 million to facilitate the
leasing of computer hardware and software in the future. The initial term of the
associated schedules will range from 24 to 36 months. Digex will have an option
to purchase the equipment at the end of the initial lease term.
5. RELATED PARTY AGREEMENTS
On April 30, 1999, Xxxxx entered into a general and administrative services
agreement with Intermedia which expired on April 1, 2001. Under the terms of
this agreement, as amended to date, Intermedia provided Digex with treasury
services in the first quarter of 2001. The charge for these services was minimal
for the three months ended March 31, 2001.
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DIGEX, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Under the terms of the network services agreements with Intermedia, which
expire in July 2001, Intermedia provides Digex with east and west coast Internet
transit and Internet access. The charges for the Internet transit and access
services amounted to $1.3 million for the three months ended March 31, 2001.
6. CONTINGENCIES
On February 15, 2001, a memorandum of understanding was executed on behalf
of all interested parties in the consolidated shareholder derivative and class
action suit, setting forth an agreement in principle providing for the
settlement of all actions in their entirety. Pursuant to the settlement,
WorldCom will make a payment of WorldCom common stock having a total value of
$165.0 million for distribution to Digex common stock holders upon the closing
of the Intermedia -- WorldCom Merger. One half of the settlement fund net of
plaintiffs' attorneys fees will be distributed to record holders of Digex common
stock on September 1, 2000. The balance of the settlement fund net of attorneys'
fees will be paid to record holders of Digex stock at the time of the
consummation of the merger. Neither Intermedia nor its affiliates will be
entitled to any distribution from the settlement fund. The merger agreement
between Intermedia and WorldCom was amended, among other things, to change the
consideration to be paid to Intermedia shareholders in connection with the
merger. The fees and expenses of all plaintiffs and all counsel representing all
plaintiffs in the action will also be paid out of that settlement fund. In
connection with the settlement, WorldCom will reimburse Digex for certain fees
and expenses incurred by Digex associated with the merger and the consolidated
lawsuit in an amount not to exceed $15.0 million. A further provision of the
settlement will make Section 203 of the Delaware General Corporation Law
inapplicable to future transactions between WorldCom and Digex.
On April 6, 2001, the Court approved of the final settlement of the suit at
the settlement hearing held in the Delaware Court of Chancery in Wilmington,
Delaware. On May 7, 2001, the appeals period for appealing the Chancery Court's
approval of the settlement expired with no appeals having been filed. The
settlement is contingent upon a number of events occurring, including the
consummation of the Intermedia -- WorldCom Merger. In the event that the merger
does not occur or the other terms of the settlement are not fulfilled, the
plaintiffs to the lawsuits may seek to have the order and settlement set aside
and have the lawsuits reinstated. Digex does not expect to incur any future
liability from the outcome of this litigation.
Digex also does not believe that there are any pending or threatened legal
proceedings that, if adversely determined, would have a material adverse effect
on Digex's results of operations, cash flows, or financial position.
7. SUBSEQUENT EVENTS
In April 2001, Xxxxx received proceeds for a $300,000 loan from Prince
George's County Economic Development Corporation. The loan matures on April 6,
2006, and is guaranteed by Intermedia. Interest on the unpaid principal balances
accrues at 5% per annum. Interest and principal are payable monthly, beginning
May 6, 2001.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and related notes herein, and with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and audited consolidated financial statements and related notes
included in Digex's Form 10-K, as filed with the SEC on April 2, 2001.
OVERVIEW
We are a leading provider of managed Web and application hosting services
to businesses operating mission-critical, multi-functional Web sites. We provide
the computer hardware, software, network technology, and systems management
necessary to provide our customers comprehensive, managed Web hosting and
application hosting solutions. We also offer related value-added services such
as firewall management, stress testing and consulting services, including
capacity and migration planning and database optimization. We currently provide
such services to a diversified customer base consisting of over 600 customers.
As of March 31, 2001, we managed approximately 4,107 Windows- and UNIX-based
servers in our state-of-the-art data centers which are strategically positioned
on the east and west coasts of the United States and in Europe. We believe our
singular focus on delivering mission-critical Web site and application hosting
solutions has been the major contributor to our growth.
In March 2001, as part of the settlement of shareholder litigation, we
entered into certain commercial agreements with WorldCom. Through the sales
channel agreement, WorldCom has commenced reselling our portfolio of managed Web
hosting products. If we satisfy certain service level commitments, WorldCom
agrees to purchase up to a total of $500.0 million during the period from 2001
through 2003. We share costs and profits generated from the WorldCom sales
channel with WorldCom. In November 2000, WorldCom announced the immediate U.S.
availability of an expanded global Web hosting product suite to include high-
end managed hosting services through arrangements with us. We also utilize
WorldCom's sales force to enhance our global presence.
Through our facilities agreement with WorldCom, we have commenced building
managed Web hosting facilities in existing WorldCom data centers in the United
States and around the world. We will lease space from WorldCom at these data
centers based on customer demand. These hosting facilities will be patterned
after our facilities in the U.S. Our first data center completed through this
agreement is located in Ashburn, Virginia and became operational in the first
quarter of 2001.
Our network agreement with WorldCom provides us with terms to purchase
bandwidth and connectivity from WorldCom in the United States to support our
managed Web hosting activities. Through the arrangement, we were able to connect
our Internet data centers to the WorldCom global IP network that runs through
North America, South America, Europe, Asia, and Australia with over 2,500 points
of presence.
Revenue. Our revenues consist primarily of monthly fees from our managed
Web and application hosting services. Contracts for these services are typically
between one and three years in length. In addition to Web and application
hosting, we also offer enterprise services and consulting services and believe
that we will begin to derive increasing amounts of revenues from the sale of
these services in the future.
Costs and Expenses. Costs and expenses include:
- cost of operations;
- cost of services;
- selling, general and administrative expenses;
- deferred compensation; and
- depreciation and amortization expense.
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Cost of operations consist primarily of the costs for our network
connectivity and firewall services. We expect our network connectivity
requirements to grow in conjunction with the growth of our overall business,
including the expansion of our business abroad through our wholly-owned
subsidiaries, and accordingly expect these costs to increase in the future.
Cost of services consist primarily of facilities administration expenses
including rent, maintenance and utilities to support our data centers and
salaries and related benefits for our technical operations. We expect our cost
of services to increase in dollar amount but to decline as a percentage of
revenue due to economies of scale and expected improvements in technology and
productivity.
Selling, general and administrative expenses consist primarily of salaries
and benefits for our marketing, sales and support personnel, advertising costs,
consultants' fees, provision for doubtful accounts, research and development
costs and other miscellaneous expenses. We expect selling, general and
administrative expenses to increase in dollar amount and to decline as a
percentage of revenue over time.
Deferred compensation expense relates to stock options that were granted by
Digex to certain employees at exercise prices below market value.
Depreciation and amortization expense consists primarily of depreciation of
our data centers, servers and related equipment and amortization of our
intangible assets. We expect these expenses to increase due to our plans to
invest significant capital to continue to expand our data center capacity.
PLAN OF OPERATION
We plan to expand our Web and application hosting business by focusing on
large companies which are looking to develop a presence on the Internet by both
providing e-commerce business solutions to their customers and outsourcing the
management of their Web sites and Web-enabled business applications. In the
fourth quarter of 1999, we opened our state-of-the-art data centers on the east
and west coasts of the United States. Our first international data center,
located in London, became operational in July 2000. We anticipate that these
data centers, when operating at full capacity, will support servers generating
in excess of $800.0 million in annualized revenue. We believe that the new data
centers in the United States and those we continue to develop internationally
will place us in a stronger competitive position to successfully provide
outsourced solutions of scalable managed Web and application hosting solutions.
We also offer value-added services, such as firewall management, stress testing,
and consulting services, including capacity and migration planning and database
optimization, and believe that we will derive increasing amounts of revenue from
these services in the future.
Our commercial agreements with WorldCom allows us to purchase bandwidth and
connectivity from WorldCom in the United States and around the world to support
our managed Web hosting activities. Through the arrangements, we were able to
connect our Internet data centers in the U.S. to the WorldCom global IP network
that runs through North America, South America, Europe, Asia, and Australia with
over 2,500 points of presence.
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RESULTS OF OPERATIONS
The following table presents certain information derived from our
consolidated statements of operations for the three months ended March 31, 2001
and 2000, expressed as a percentage of revenue.
THREE MONTHS
ENDED
MARCH 31,
--------------
2001 2000
----- ------
Revenues.................................................... 100.0% 100.0%
Costs and expenses:
Cost of operations..................................... 9.7 15.3
Cost of services....................................... 46.3 40.7
Selling, general and administrative.................... 70.1 103.0
Deferred compensation.................................. 2.0 3.9
Depreciation and amortization.......................... 54.5 48.7
----- ------
Total costs and expenses.......................... 182.5 211.5
----- ------
Loss from operations........................................ (82.5) (111.5)
Other income (expense):
Interest expense....................................... (1.3) (1.7)
Interest and other income.............................. 0.5 13.6
----- ------
Loss before cumulative effect of change in accounting
principle................................................. (83.4) (99.7)
Cumulative effect of change in accounting principle......... -- (0.6)
----- ------
Net loss.................................................... (83.4) (100.3)
===== ======
THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED MARCH 31, 2000
Revenue
Total revenue increased 105.7% to $53.1 million for the first quarter of
2001 compared to $25.8 million for the same period in 2000. The increase in
revenue was due to new customer growth, a significant increase in the number of
managed servers per customer, and a rise of monthly revenue per server in the
first quarter of $4,249 in 2001 compared to $3,293 for the same period in 2000.
Our installed base of servers increased 41.1% to 4,107 at the end of the first
quarter of 2001 from 2,911 at the end of the first quarter of 2000.
Cost of Operations
Cost of operations increased 30.9% to $5.2 million for the first quarter of
2001 compared to $3.9 million for the same period in 2000. The increase was due
to additional network costs resulting from our expanded customer base and
increase in service offerings. As a percentage of revenue, cost of operations
decreased to 9.7% for the first quarter of 2001 compared to 15.3% for the same
period in 2000 as a result of improved network utilization.
Cost of Services
Cost of services increased 134.0% to $24.5 million for the first quarter of
2001 compared to $10.5 million for the same period in 2000. The increase was
primarily related to the increased level of operations and the expansion of our
new data centers including costs related to the hiring of additional personnel
and consultants in customer service, engineering, and facilities administration
supporting server growth. As a percentage of revenue, total cost of services
increased to 46.3% in 2001 compared to 40.7% in 2000.
Xxxxxxx, General and Administrative
Selling, general and administrative expenses increased 39.9% to $37.2
million for the first quarter of 2001 compared to $26.6 million for the same
period in 2000. Through 2001, as part of our growth strategy, we
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continued to build our infrastructure and administrative requirements to operate
as a separate public company. Increases in selling, general and administrative
expenses for 2001 included the costs associated with an increased employee base,
advertising campaigns, rent for additional office space, consultants'
professional fees, an increased provision for doubtful accounts receivable,
research and development costs and the addition of key executive management to
support the growth of the business. We expect that our growth strategy will
continue to require significant sales and marketing activities, including an
expansion of our sales force and further development of brand name recognition.
In addition, we will continue to build our personnel base to support our growth
strategy in the managed Web and application hosting industry. As a result, we
believe that our selling, general and administrative expenses will continue to
increase in the future. As a percentage of revenue, total selling, general and
administrative expenses decreased to 70.1% in 2001 compared to 103.0% in 2000
due primarily to revenue growth and because the selling portion of the selling,
general and administrative cost is fixed, expenses will not increase
proportionally according to revenue.
Deferred Compensation
Deferred compensation expense increased 7.8% to $1.1 million in 2001
compared to $1.0 million in 2000. The increase was primarily due to increases in
stock options granted to certain employees at exercise prices below market value
since March 31, 2000. As of March 31, 2001 and 2000, respectively, we recorded
approximately $18.7 million and $16.0 million of deferred compensation
(excluding forfeitures), a separate component of stockholders' equity, to be
expensed over the four-year vesting period of the options.
Depreciation and Amortization
Depreciation and amortization expenses increased 129.8% to $28.9 million in
2001 compared to $12.6 million in 2000. The increase was principally due to
additional servers and other facilities and equipment placed in service since
March 31, 2000. We entered into a capital lease for our corporate headquarters
facility in the third quarter of 2000 and capital leases for vehicles in the
fourth quarter of 2000 and in 2001, which also contributed to the increase in
expense. We have electronics, computer hardware, and computer software with
useful lives ranging from three to five years. We expect increases in
depreciation charges though 2001 due to the continued expansion of our new data
centers and due to future increased server installations based on customer
demand.
Interest Expense
Interest expense increased 57.6% to $0.7 million in 2001 compared to $0.4
million in 2000. The increase resulted from the capital lease for our new
corporate headquarters facility entered into during the third quarter of 2000,
capital leases for vehicles entered into during the fourth quarter of 2000, and
additional capital leases for vehicles and accrued interest under the $3.0
million loan in the first quarter of 2001.
Interest and Other Income
Interest and other income decreased 92.4% to $0.3 million in 2001 compared
to $3.5 million in 2000. The decrease resulted principally from interest earned
on the remaining cash proceeds from the investment in Digex by Microsoft and a
subsidiary of Compaq and exercised stock options in 2000. Cash proceeds from the
initial and subsequent equity offerings were depleted as of December 31, 2000.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, decreased 9.1% to $(13.8)
million in 2001 compared to $(15.2) million in 2000. The change is primarily
attributable to costs associated with our growth strategy. Costs associated with
the administration and maintenance of our expanded data centers and increased
selling, general and administrative costs will continue to represent a large
portion of expenses during our planned expansion. In addition, we expect to
continue to experience growth in marketing and selling expenses as new customers
are acquired.
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EBITDA before certain charges consists of earnings (loss) before interest
expense, interest and other income, merger-related expenses, foreign exchange
gains (losses), income tax benefit, deferred compensation, and depreciation and
amortization. EBITDA before certain charges does not represent funds available
for management's discretionary use and is not intended to represent cash flow
from operations. EBITDA before certain charges should also not be construed as a
substitute for operating income or a better measure of liquidity than cash flow
from operating activities, which are determined in accordance with generally
accepted accounting principles. This caption excludes components that are
significant in understanding and assessing our results of operations and cash
flows. In addition, EBITDA before certain charges is not a term defined by
generally accepted accounting principles and as a result our measure of EBITDA
before certain charges might not be comparable to similarly titled measures used
by other companies. However, we believe that EBITDA before certain charges is
relevant and useful information which is often reported and widely used by
analysts, investors and other interested parties in the Web and application
hosting industry. Accordingly, we are disclosing this information to permit a
more comprehensive analysis of our operating performance, as an additional
meaningful measure of performance and liquidity, and to provide additional
information with respect to our ability to meet future debt service, capital
expenditure and working capital requirements. See the consolidated financial
statements and notes thereto contained elsewhere in this report for more
detailed information.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $23.9 million and $28.1 million
during the three months ended March 31, 2001 and 2000, respectively. Net cash
used for operating activities in each of these periods was primarily the result
of operating losses and changes in working capital.
Net cash used for investing activities during the three months ended March
31, 2001 and 2000 was $29.1 million and $33.8 million, respectively. Net cash
used for investing activities in each of these periods was primarily the result
of capital expenditures for data center infrastructure which includes servers
purchased for customer use, as well as leasehold improvements, furniture and
fixtures, computers, and other equipment. Although we have plans to invest
significantly in property and equipment, we have no material commitments for
such items at this time.
On October 31, 2000, Intermedia increased the commitments available to it
under its revolving credit facility from $100.0 million to $350.0 million. The
credit facility is fully guaranteed by WorldCom. As a subsidiary of Intermedia,
we are a limited guarantor under the credit facility to the greater of $90.0
million or the amounts borrowed by Digex. Through Intermedia, we expect to have
access to the proceeds available under the revolving credit facility to fund a
portion of our capital expenditures as liquidity needs arise consistent with our
projections. At March 31, 2001, Intermedia had $191.0 million outstanding under
its credit facility. None of the borrowings were for Digex.
On October 31, 2000, Intermedia also entered into a note purchase agreement
with WorldCom. Intermedia authorized the issue and sale of up to $225.0 million
aggregate principal amount of 14.12% Senior Subordinated Notes due 2009 and
22,500 shares of Series H Preferred Stock. Through Intermedia, we expect the
proceeds from these financings will be available to fund our operations, working
capital needs and capital expenditures as liquidity needs arise. Intermedia had
$31.0 million outstanding under these financings as of March 31, 2001. None of
the borrowings were for Digex.
In January 2001, we received proceeds for a $3.0 million loan from the
State of Maryland Department of Business and Economic Development under the
Sunny Day Fund initiative. The loan is subject to multiple maturity dates, and
is guaranteed by Intermedia. Interest on the unpaid principal balances accrues
at 5% per annum. The principal amounts and any accrued interest will be deferred
each year through December 31, 2008 if we meet certain annual conditions
regarding the hiring of permanent, full time employees and the expenditures for
the development of a Web hosting facility in Prince Xxxxxx's County, Maryland.
At December 31, 2008, the principal amounts and any accrued interest outstanding
may convert to a grant upon the achievement of certain requirements by us.
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In April 2001, we received proceeds for a $300,000 loan from Prince
Xxxxxx's County Economic Development Corporation. The loan matures on April 6,
2006, and is guaranteed by Intermedia. Interest on the unpaid principal balances
accrues at 5% per annum. Interest and principal are payable monthly, beginning
May 6, 2001.
We will use the proceeds from these loans to finance a portion of the cost
of acquiring equipment and construction at our headquarter facilities in Laurel,
Maryland. Subject to the terms of the loan agreements and the approval by the
State of Maryland and/or Prince Xxxxxx's County, on or after January 1, 2005, we
may be eligible for an additional loan of $1.0 million under the Sunny Day Fund
initiative from the State of Maryland and/or $100,000 from Prince Xxxxxx's
County to finance a portion of the cost of acquiring equipment and constructing
facilities within Prince George's County, Maryland.
In March 2001, we entered into a master lease and financing agreement with
a vendor for a line of credit of up to $25.0 million to facilitate the leasing
of computer hardware and software in the future. The initial term of the
associated schedules will range from 24 to 36 months. We will have an option to
purchase the equipment at the end of the initial lease term.
On September 1, 2000, Intermedia entered into a merger agreement with
WorldCom whereby, upon consummation of the merger, a subsidiary of WorldCom will
be merged with and into Intermedia and Intermedia will become a subsidiary of
WorldCom. As a result of the merger, WorldCom will beneficially own a majority
of our capital stock and will have voting control of us. The merger is expected
to be completed on July 1, 2001, subject to the satisfaction or waiver of the
various conditions to completion of the merger.
After the anticipated closing of the Intermedia -- WorldCom Merger,
WorldCom has agreed that it will provide funding to us for the performance of
our 2001 and 2002 business plans as approved by the Digex and WorldCom boards of
directors. Such funding will bear interest at a rate equal to LIBOR plus 300
basis points and will be repayable over a four-year period commencing in 2003.
The terms of such funding are expected to contain conditions to borrowing,
covenants and other terms that have not yet been negotiated but could restrict
our access to the availability to such funds. Nothing in the funding agreement
would prevent us from seeking replacement funding from other sources. Any
changes to our business plans that requires increased funding would require the
WorldCom board of directors' approval before WorldCom would be obligated to fund
any such increase.
We expect to continue experiencing negative cash flow from operating and
investing activities due to our plans for expansion and the growth of our
business. We anticipate we will have significant cash requirements for several
years as we expand our data center capacity, increase servers under management,
increase our employee base, acquire additional office space to support our
expanding operations and invest in our marketing organization. In addition, we
expect to invest significantly in the purchase of property and equipment and for
research and development, including funding the expenses associated with our
research and development alliance with Microsoft and a subsidiary of Compaq. We
expect our capital expenditures to increase due to the growth of servers under
management and our continuing data center expansion in the United States and
abroad. With our existing cash resources and financing available from
Intermedia, we believe we have sufficient capital to sustain our current
operations and capital expenditure plans into mid 2001. Upon depletion of these
financing sources, we intend to rely on WorldCom for funding. In the event the
Intermedia -- WorldCom Merger does not close, our intention would be to access
the capital markets for our necessary funding. Management has had preliminary
discussions with third party sources regarding potential financing, including
vendor financing facilities or other asset backed secured financing. Based on
these discussions, management believes we will have access to the capital
markets to obtain sufficient funding to continue our business plans as described
above or, at a minimum, in an amount that would provide sufficient funding to
execute a modified or curtailed plan into 2002. See "Risk Factors -- The failure
of the Intermedia -- WorldCom Merger to close would adversely impact us" in our
Form 10-K for the year ended December 31, 2000 as filed with the SEC on April 2,
2001.
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities," an amendment of SFAS No.
133, which is effective for fiscal years beginning after June 15, 2000. With the
adoption of SFAS No. 133, as amended, effective January 1, 2001, there is no
effect on our consolidated financial statements as we have not entered into any
derivative contracts.
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
The information set forth above in "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" includes forward-looking
statements that involve numerous risks and uncertainties. Forward-looking
statements can be identified by the use of forward-looking terminology such as
"estimates," "projects," "anticipates," "expects," "intends," "believes," or the
negative thereof or other variations thereon or comparable terminology or by
discussions of strategy that involve risks and uncertainties. This report
includes forward-looking statements, which could differ from actual results. See
"Risk Factors" in our Form 10-K for the year ended December 31, 2000 as filed
with the SEC on April 2, 2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No changes.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The legal proceedings discussed in Note 6 of the Notes to the Consolidated
Financial Statements in Part I, Item 1, above, are hereby incorporated by
reference herein. We do not believe that there are any pending or threatened
legal proceedings that, if adversely determined, would have a material adverse
effect on us.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
None.
Use of Proceeds from a Sale of Registered Securities
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
NUMBER EXHIBIT
------ -------
3.1 -- Certificate of Incorporation of Digex, as amended.
Incorporated herein by reference from Digex's Form 10-Q
(File No. 000-26873) filed with the SEC on September 13,
1999.
3.2 -- By-laws of Digex. Incorporated herein by reference from
Digex's Form 10-Q (File No. 000-26873) filed with the SEC
on May 12, 2000.
3.3 -- Certificate of Designation for the Series A Preferred
Stock. Incorporated herein by reference from Digex's
registration statement on Form S-1 (File No. 333-94879)
filed with the SEC on January 18, 2000.
3.4 -- Proposed Amendment to the Certificate of Incorporation.
Incorporated herein by reference from Digex's Form 8-K
(File No. 000-26873) filed with the SEC on February 15,
2001.
10.1 -- Master Channel Agreement between Digex and MCI WorldCom
Network Services, Inc., dated as of January 1, 2001.*
10.2 -- Master Facilities Agreement between Digex and MCI
WorldCom Network Services, Inc., dated as of January 1,
2001.*
10.3 -- Stipulation of Settlement between all parties to the
consolidated action entitled In Re: Digex, Inc.
Shareholders Litigation, Consolidated Civil Action No.
18336 NC pending in the Court of Chancery of the State of
Delaware, Xxxxxxx X. Xxxxxx, Xxxx X. Xxxxx, and Xxxx X.
Xxxxx, dated as of March 2, 2001.*
---------------
* Incorporated herein by reference from Digex's Form 8-K (File No.
000-26873) filed with the SEC on March 5, 2001.
(b) Reports on Form 8-K
The following reports on Form 8-K of Digex were filed during the first
quarter of 2001:
Digex filed a Current Report on Form 8-K, dated February 2, 2001,
reporting under Item 5 the issuance of a press release discussing Digex's
fourth quarter and year 2000 results. Digex also reported under Item 7 the
filing of the press release as an exhibit to the Form 8-K.
Digex filed a Current Report on Form 8-K, dated February 16, 2001,
reporting under Item 5 the issuance of a press release announcing the
proposed settlement of the consolidated shareholder class action suit
arising out of WorldCom's planned acquisition of a controlling interest in
Digex through a merger with Intermedia. Digex also reported under Item 7
the filing of the Memorandum of Understanding and press release as exhibits
to the Form 8-K.
Digex filed a Current Report on Form 8-K, dated February 20, 2001,
reporting under Item 9 Regulation FD Disclosure the conference call for
analysts, investors, and other interested parties to discuss the
announcement of the proposed settlement of the consolidated shareholder
class action suit. Digex also reported under Item 7 the filing of the
conference call transcript as an exhibit to the Form 8-K.
Digex filed a Current Report on Form 8-K, dated March 5, 2001,
reporting under Item 5 the execution of a definitive Stipulation of
Settlement to settle all claims related to the consolidated shareholder
class action suit. Digex also reported under Item 7 the filing of the court
order and final judgment, stipulation of settlement, scheduling order,
notice of proposed settlement, master channel and master facilities
agreements dated January 1, 2001 between Digex and MCI WorldCom Network
Services as exhibits to the Form 8-K.
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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
(Registrant)
/s/ XXXXXXX X. XXXXX
------------------------------------
Xxxxxxx X. Xxxxx
Chief Financial Officer
/s/ X. XXXXX XXXXXXXXX
------------------------------------
X. Xxxxx Xxxxxxxxx
Vice President and Controller
Dated: May 15, 2001
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