-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DbRNGN50DniFrIUiuKoXlK8U30qxEbpCbXMWZ4Y3qemMDZAsI4e2Cgtc8aaViwGs VReUV5uRbUCPVBqEPgyPpA== 0000912057-01-542504.txt : 20020412 0000912057-01-542504.hdr.sgml : 20020412 ACCESSION NUMBER: 0000912057-01-542504 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011207 ITEM INFORMATION: Other events ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 20011207 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERMEDIA COMMUNICATIONS INC CENTRAL INDEX KEY: 0000885067 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 592913586 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20135 FILM NUMBER: 1809216 BUSINESS ADDRESS: STREET 1: ONE INTERMEDIA WAY CITY: TAMPA STATE: FL ZIP: 33647 BUSINESS PHONE: 8138290011 MAIL ADDRESS: STREET 1: ONE INTERMEDIA WAY CITY: TAMPA STATE: FL ZIP: 33647 FORMER COMPANY: FORMER CONFORMED NAME: INTERMEDIA COMMUNICATIONS OF FLORIDA INC DATE OF NAME CHANGE: 19930328 8-K 1 a2065443z8-k.txt 8-K - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported): December 7, 2001 - -------------------------------------------------------------------------------- Intermedia Communications Inc. - -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 0-20135 59-2913586 (State or Other (Commission File (IRS Employer Jurisdiction of Number) Identification Number) Incorporation) One Intermedia Way Tampa, FL 33647 (Address of Principal Executive Offices) Registrant's telephone number, including area code: (813) 829-0011 - -------------------------------------------------------------------------------- Item 5. Other Events On December 7, 2001, Digex, Incorporated, a Delaware corporation and a majority owned subsidiary of Intermedia Communications Inc., filed Amendment No. 2 to its Annual Report on Form 10-K/A for the year ended December 31, 2000 and Amendment No. 1 to its Quarterly Reports on Form 10-Q/A for the quarters ended March 31, 2001 and June 30, 2001, a copy of which is attached hereto as Exhibit 99.1, Exhibit 99.2 and Exhibit 99.3, respectively. Item 7. Financial Statements and Exhibits Exhibit 99.1 Amendment No. 2 to the Annual Report on Form 10-K/A of Digex, Incorporated for the year ended December 31, 2000 (as filed with the United States Securities and Exchange Commission on December 7, 2001). Exhibit 99.2 Amendment No. 1 to the Quarterly Report on Form 10-Q/A of Digex, Incorporated for the quarter ended March 31, 2001 (as filed with the United States Securities and Exchange Commission on December 7, 2001). Exhibit 99.3 Amendment No. 1 to the Quarterly Report on Form 10-Q/A of Digex, Incorporated for the quarter ended June 30, 2001 (as filed with the United States Securities and Exchange Commission on December 7, 2001). 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 hereunto duly authorized. INTERMEDIA COMMUNICATIONS INC. By: /s/ Jeanne M. Walters ---------------------------------- Jeanne M. Walters Vice President, Controller and Chief Accounting Officer Dated: December 7, 2001 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION OF EXHIBIT 99.1 Amendment No. 2 to the Annual Report on Form 10-K/A of Digex, Incorporated for the year ended December 31, 2000 (as filed with the United States Securities and Exchange Commission on December 7, 2001). 99.2 Amendment No. 1 to the Quarterly Report on Form 10-Q/A of Digex, Incorporated for the quarter ended March 31, 2001 (as filed with the United States Securities and Exchange Commission on December 7, 2001). 99.3 Amendment No. 1 to the Quarterly Report on Form 10-Q/A of Digex, Incorporated for the quarter ended June 30, 2001 (as filed with the United States Securities and Exchange Commission on December 7, 2001). EX-99.1 3 a2065443zex-99_1.txt EXHIBIT 99.1 Exhibit 99.1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-K/A (AMENDMENT NO. 2) (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 000-26873 DIGEX, INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE 59-3582217 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 14400 SWEITZER LANE LAUREL, MD 20707 (Address of principal executive offices) (240) 264-2000 Telephone Number Securities registered pursuant to Section12(b) of the Act: NONE Securities registered pursuant to Section12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment in this Form 10-K. [ ] Aggregate market value of the voting stock held by non-affiliates (1) of the registrant on February 28, 2001: $444,735,381. As of February 28, 2001, there were 24,622,028 and 39,350,000 shares of the Registrant's Class A and Class B Common Stock outstanding, respectively. DOCUMENTS INCORPORATED BY REFERENCE Part III of the Form 10-K will be incorporated by reference from the Registrant's Proxy Statement for the 2001 Annual Meeting of Stockholders. (1) As used herein, "voting stock held by non-affiliates" means shares of Common Stock held by persons other than executive officers, directors and persons holding in excess of 5% of the registrant's Common Stock. The determination of market value of the Common Stock is based on the last reported sale price as reported by the Nasdaq Stock Market on the date indicated. The determination of the "affiliate" status for purposes of this report on Form 10-K shall not be deemed a determination as to whether an individual is an "affiliate" of the registrant for any other purposes. DIGEX, INCORPORATED INDEX
PAGE ---- PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters........ 1 Item 6 Selected Financial and Other Operating Data.................................. 3 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................................ 7 Item 7A Quantitative and Qualitative Disclosures About Market Risk .................. 18 Item 8 Financial Statements and Supplementary Data.................................. 18 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................. 18 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.............. 19 Signatures................................................................... 24
INTRODUCTORY NOTE Digex, Incorporated hereby amends its Annual Report on Form 10-K for the year ended December 31, 2000, originally filed with the Securities and Exchange Commission on April 2, 2001, to restate the selected financial and other operating data (Part II, Item 6) and consolidated financial statements (Part IV, Item 14). Certain information in the market for registrant's common equity and related stockholder matters (Part II, Item 5), management's discussion and analysis of financial condition and results of operations (Part II, Item 7), and notes to the consolidated financial statements (Part IV, Item 14) were also updated. The carrying amount of the Series A preferred stock was originally reported in stockholders' equity in the consolidated balance sheets included in the quarterly reports on Form 10-Q for each of the quarters in the period March 31, 2000 through September 30, 2000 and in the Annual Report on Form 10-K for the year ended December 31, 2000. However, because of certain redemption features of the preferred stock, the carrying amount was reclassified from stockholders' equity to redeemable preferred stock at December 31, 2000 in this Annual Report on Form 10-K/A. The restatement had no effect on Digex's net loss or net loss per share, total assets or total liabilities for the year ended December 31, 2000. Refer to Note 5 and Note 17 to the consolidated financial statements for additional information. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our Class A Common Stock trades on The Nasdaq Stock Market under the symbol "DIGX." As of December 31, 2000, based upon 42 holders of record and an estimate of the number of individual participants represented by security position listings, there are approximately 16,294 beneficial holders of our Class A Common Stock. All of our outstanding Class B Common Stock is held by Intermedia Financial Company. The approximate high and low closing prices for our Class A Common Stock are as reported by The Nasdaq Stock Market.
CLOSING PRICE -------------------------- HIGH LOW ------------ ------------ 1999 Third quarter (from July 29, 1999) .......... $ 33.25 $ 15.50 Fourth quarter .............................. 86.88 21.19 2000 First quarter ............................... $ 171.50 $ 56.06 Second quarter .............................. 111.00 35.25 Third quarter ............................... 94.00 46.88 Fourth quarter .............................. 58.44 21.19
DIVIDEND POLICY We do not anticipate paying any dividends on any of our common stock in the foreseeable future. Moreover, because we are subject to restrictions under the Intermedia indentures, we are effectively prohibited from paying dividends. We may also incur indebtedness in the future, which may prohibit or effectively restrict the payment of dividends. 1 The Litigation Settlement provides for a settlement fund to be established consisting of WorldCom common stock having a "stated value" of $165.0 million. The "stated value" of the WorldCom stock to be placed in the fund will be determined by taking the average trading price on the Nasdaq National Market for ten trading days randomly selected by lot from the 20 consecutive trading days ending on the third trading day immediately preceding the closing date of the Intermedia - WorldCom Merger. The WorldCom common stock placed in the fund, less the amount awarded to plaintiffs' counsel for legal fees and expenses, will be distributed on a per share basis to the holders of Digex Class A common stock as follows: (i) 50% will be distributed to the record holders of Digex Class A common stock as of the closing of business on September 1, 2000; and (ii) 50% will be distributed to the record holders of Digex Class A common stock of a record date to be established in the future that is expected to be on or about the closing date of the Intermedia - WorldCom Merger. This allocation of the WorldCom stock is subject to approval by the Delaware Chancery Court, and the parties to the litigation settlement have agreed they will change this allocation in whatever manner is necessary to obtain final court approval of the litigation settlement. In addition, because of the formula for determining the value of the WorldCom stock to be placed in the settlement fund, it is possible that the "stated value" produced by such formula may be higher or lower than the actual trading prices of the WorldCom common stock on the date of deposit into the settlement fund or the distribution of such stock to Digex Class A common stock holders. RECENT SALES OF UNREGISTERED SECURITIES. On January 12, 2000, we sold 100,000 shares of our non-voting preferred stock, designated as Series A Convertible Preferred Stock, with detachable warrants to purchase 1,065,000 shares of our Class A common stock, to Microsoft Corporation and CPQ Holdings, Inc., a subsidiary of Compaq Computer Corporation, for an aggregate of $100.0 million, of which $15.0 million was in the form of equipment purchase credits. Of the $15.0 million of equipment purchase credits, approximately $2.7 million was used for equipment purchases in 2000. The warrants can be exercised at any time on or before January 12, 2003 at an initial price of $57.00 per share, subject to certain adjustments. The proceeds from the offering were allocated between the preferred stock and the warrants based upon their relative fair values. In the event of liquidation, each share of preferred stock is entitled to a liquidation preference of $1,000 per share before any amount may be paid to common stockholders. The holders of the preferred stock are also not entitled to receive dividends. We may not issue any stock with the same or senior preferences or priorities to this series without the consent of the majority of our preferred stockholders. Each share of preferred stock is convertible into shares of Class A common stock at a conversion price of $68.40 per share, subject to certain adjustments, for a total of approximately 1,462,000 shares of Class A common stock. Unless earlier converted, on January 12, 2005, each share of preferred stock will automatically convert into the number of shares of Class A common stock equal to $1,000 divided by the average of the closing prices of the Class A common stock for the twenty consecutive trading days prior to January 12, 2005. Subject to the legal availability of funds, the preferred stock is redeemable in cash at the option of the holders after January 12, 2004 or upon our change of control at a price of $1,000 per share if the redemption is then permitted under those indentures of Digex and Intermedia which existed on January 10, 2000. If the restrictions under these agreements terminate at an earlier date, the holders may require us to redeem the preferred stock before entering into an agreement which would restrict our ability to redeem the preferred stock. We are not required to make sinking fund payments with respect to the preferred stock. Based on representations by the purchasers, the issuances were made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act, as a transaction by an issuer not involving a public offering. 2 USE OF PROCEEDS FROM A SALE OF REGISTERED SECURITIES On July 29, 1999, the Registration Statement relating to our initial public offering (SEC File No. 333-77105) was declared effective. The net proceeds of the offering were approximately $178.9 million. Under the terms of Intermedia's indentures, described under "Risk Factors--Digex is controlled by a controlling stockholder, which could involve multiple risks for you as a stockholder," we were required to use all of the net proceeds of our offerings to purchase telecommunications related assets. Telecommunications-related assets mean assets used in connection with the business of: (1) transmitting, or providing services relating to the transmission of, voice, video or data through owned or leased transmission facilities; (2) creating, developing and marketing communications related network equipment, software and other devices for use relating to (1); or (3) evaluating, participating in or pursuing any other activity or opportunity that is related to those identified in (1) or (2); all as determined in good faith by the board of directors of Intermedia. We have entered into a letter agreement with Intermedia pursuant to which Intermedia will purchase from us, at our cost, some of the Telecommunications Related Assets purchased with the net proceeds of our offerings. Intermedia paid us for these Telecommunications Related Assets to the extent necessary with funds not subject to restrictions under the Intermedia indentures that we used for working capital purposes and to fund operating losses. From July 29, 1999 through the period ended June 30, 2000, we used $133.2 million of the net proceeds of our initial public offering to purchase telecommunications related assets held by us and $45.7 million for the purchase of telecommunications related assets subsequently sold to Intermedia. The proceeds of the sales of assets to Intermedia were unrestricted and were used to fund our operating expenses. All proceeds of our initial public offering have been used as of June 30, 2000. ITEM 6. SELECTED FINANCIAL AND OTHER OPERATING DATA The following table sets forth selected historical financial data of Digex for the period from July 7, 1997, the date of acquisition by Intermedia of the Web site hosting unit (the "Predecessor"), to December 31, 1997, and the years ended December 31, 1998, 1999 and 2000 of the Predecessor for the year ended December 31, 1996 and the period from January 1, 1997 to July 6, 1997. The selected historical financial data has been derived from Digex's and the Predecessor's audited financial statements. The following table also sets forth pro forma financial information of Digex for the year ended December 31, 1997. The pro forma financial information gives effect to the purchase by Intermedia of the Predecessor as if such acquisition had occurred on January 1, 1997. The presentation of pro forma financial information was made to permit useful comparison of results of operations between periods presented. This pro forma financial information is not necessarily indicative of the operating results Digex would have achieved if the Predecessor had been acquired on January 1, 1997. The relationship between Business Internet and the Predecessor is more fully described in Note 1 to the consolidated financial statements. In the following table, basic and diluted net loss per share have been calculated assuming that the common shares issued in connection with our recapitalization in April 1999 were outstanding for all periods of Digex presented, and giving effect to the 50,000-for-one stock split of our Class B Common Stock effected in July 1999 prior to the closing of our initial public offering. 3 The following financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and our consolidated financial statements and related notes, included elsewhere in this report.
PREDECESSOR DIGEX ------------------------------ ---------------------------------------------------------------------- HISTORICAL HISTORICAL PRO FORMA (1) HISTORICAL ------------------------------ -------------- -------------- ---------------------------------------- PERIOD FROM JULY 7, 1997 PERIOD FROM (DATE OF JANUARY 1, ACQUISITION) YEAR ENDED YEAR ENDED 1997 TO YEAR ENDED DECEMBER 31, DECEMBER 31, TO JULY 6, DECEMBER 31, DECEMBER 31, ---------------------------------------- 1996 1997 1997 1997 1998 1999 2000 -------------- --------------- -------------- -------------- ----------- ------------ ------------- (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenues................ $ 2,803 $ 4,420 $ 7,192 $ 11,612 $ 22,635 $ 59,786 $ 168,085 Costs and expenses: Cost of operations.. 2,002 4,149 1,739 2,808 6,710 9,656 21,244 Cost of services.... 684 1,817 1,611 3,428 7,044 21,750 69,658 Selling, general and administrative..... 3,194 7,001 6,087 13,088 17,512 70,213 144,876 Deferred compensation -- -- -- -- -- 1,299 4,101 Depreciation and amortization....... 591 519 2,753 4,850 8,109 29,070 78,819 Charge off of purchased in-process research and development.... -- -- 15,000 (2) 15,000 (2) -- -- -- -------------- --------------- -------------- -------------- ----------- ------------ ------------- Total costs and expenses 6,471 13,486 27,190 39,174 39,375 131,988 318,698 -------------- --------------- -------------- -------------- ----------- ------------ ------------- Loss from operations.... (3,668) (9,066) (19,998) (27,562) (16,740) (72,202) (150,613) Other income (expense): Interest expense... -- -- -- -- -- (1,094) (2,008) Interest and other income ............ -- -- -- -- -- 3,458 12,608 Merger-related expenses ......... -- -- -- -- -- -- (2,922) -------------- --------------- -------------- -------------- ----------- ------------ ------------- Loss before income tax benefit ............ (3,668) (9,066) (19,998) (27,562) (16,740) (69,838) (142,935) Income tax benefit...... -- -- 1,440 4,710 159 4,839 -- -------------- --------------- -------------- -------------- ----------- ------------ ------------- Loss before cumulative effect of change in accounting principle (3,668) (9,066) (18,558) (22,852) (16,581) (64,999) (142,935) Cumulative effect of change in accounting principle .......... -- -- -- -- -- -- (166) -------------- --------------- -------------- -------------- ----------- ------------ ------------- Net loss ............... $ (3,668) $ (9,066) $ (18,558) $ (22,852) $ (16,581) $ (64,999) $ (143,101) ============== =============== ============== ============== =========== ============ =============
4
PREDECESSOR DIGEX ------------------------------ ---------------------------------------------------------------------- HISTORICAL HISTORICAL PRO FORMA (1) HISTORICAL ------------------------------ -------------- -------------- ---------------------------------------- PERIOD FROM JULY 7, 1997 PERIOD FROM (DATE OF JANUARY 1, ACQUISITION) YEAR ENDED YEAR ENDED 1997 TO YEAR ENDED DECEMBER 31, DECEMBER 31, TO JULY 6, DECEMBER 31, DECEMBER 31, ---------------------------------------- 1996 1997 1997 1997 1998 1999 2000 -------------- --------------- -------------- -------------- ----------- ------------ ------------- (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) PROFORMA AMOUNTS, ASSUMING THE ACCOUNTING CHANGE IS APPLIED RETROACTIVELY: Net loss .............. $ (3,668) $ (9,066) $ (18,558) $ (22,852) $ (16,618) $ (65,115) $ (142,935) ============== =============== ============== ============== =========== ============ ============= Net loss per common share: basic and diluted ... -- -- $ (0.37) $ (0.46) $ (0.33) $ (1.19) $ (2.25) ============== =============== ============== ============== =========== ============ ============= Shares used in computing basic and diluted net loss per share and proforma net loss per share ............... -- -- 50,000,000 50,000,000 50,000,000 54,726,027 63,404,839 ============== =============== ============== ============== =========== ============ ============= OTHER DATA: EBITDA before certain charges (3)............ $ (3,077) $ (8,547) $ (2,245) $ (7,712) $ (8,631) $ (41,833) $ (67,693) Net cash used in operating activities.. (2,565) (7,172) (6,079) (13,251) (10,930) (20,515) (62,520) Net cash used in investing activities.. (1,445) (1,004) (55,237) (56,241) (30,969) (170,193) (204,604) Net cash provided by financing activities . 4,010 8,176 61,316 69,492 41,899 279,486 261,818 Capital expenditures.... 1,445 1,004 8,016 9,020 30,969 170,396 202,604
PREDECESSOR DIGEX -------------- --------------------------------------------------------- DECEMBER 31, DECEMBER 31, 1996 1997 1998 1999 2000 -------------- ------------ ------------- ------------ -------------- (RESTATED) (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents (4) ................... $ -- $ -- $ -- $ 88,778 $ 83,434 Restricted investment ........................... -- -- -- -- 2,000 Working capital (deficit) ....................... (1,237) (351) 1,231 74,778 71,922 Property and equipment, net...................... 2,599 12,930 39,059 205,903 348,975 Total assets..................................... 3,173 49,693 77,739 344,309 521,051 Long-term note payable, including current portion ......................................... -- -- -- 3,712 4,207 Capital lease obligations, including current portion ......................................... 1,745 1,980 2,089 16,567 29,002 Redeemable preferred stock (5) ................. -- -- -- -- 71,572 Total stockholders'/owner's equity (5) .......... $ 342 $ 45,527 $ 70,845 $290,189 $ 345,056
- ---------- (1) The pro forma statement of operations data for the year ended December 31, 1997, represents the combining of the historical Predecessor statement of operations data for the period from January 1, 1997 5 to July 6, 1997 and the historical Digex statement of operations data for the period from July 7, 1997 to December 31, 1997, as adjusted for the following items: o A decrease in cost of operations of $3,080 which represents reduced network expenses. o An increase in depreciation and amortization of $1,578 which represents amortization of intangible assets arising from the acquisition. o An increase in income tax benefit of $3,270 which represents the income tax effect of purchase accounting adjustments. (2) This amount represents a one-time charge to operations for charge off of purchased in-process research and development related to the Predecessor in connection with Intermedia's purchase of Business Internet on July 7, 1997. (3) 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, charge off of purchased in-process research and development, 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. (4) Prior to our initial public offering in July 1999, we participated in Intermedia's and the Predecessor's centralized cash management system, and, as a result, did not carry cash balances on our financial statements for any period prior to the initial public offering. Since that date, we have maintained and reported cash balances on our financial statements. (5) See Note 17 "Restatement" to the consolidated financial statements. 6 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 December 31, 2000, we managed approximately 4,216 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. Our revenues grew at a compounded annual growth rate of 178% between 1996 and 2000, from $2.8 million in 1996 to $168.1 million in 2000. We believe our singular focus on delivering mission-critical Web site and application hosting solutions has been the major contributor to our growth. In January 2000, Microsoft and a subsidiary of Compaq invested $100.0 million in Digex, of which $85.0 million was paid in cash and $15.0 million was paid in the form of equipment credits from Compaq. We also entered into strategic development agreements with both companies to advance our capabilities to more rapidly install, manage and upgrade large numbers of Microsoft Windows-based servers and to streamline the order, delivery and installation of Compaq hardware and storage devices. On February 16, 2000, we completed a public offering of 12,650,000 shares of our Class A Common Stock. We sold 2,000,000 shares of Class A Common Stock and received net proceeds of approximately $171.6 million. Intermedia sold 10,650,000 shares of Class B Common Stock. The Class B Common Stock sold by Intermedia automatically converted into Class A Common Stock at the closing of the offering. In May 2000, we created European operating entities to support our international operations and opened our first data center outside of the United States. Located in London, our European SmartCenterSM gives Digex customers in Europe the superior level of technology, security, and support services in Europe they have come to rely on in the United States. The data center is a leased facility which became operational in July 2000. We recently completed two rigorous assessments of our operating environment. These assessments included a Type II review based on the American Institute of Certified Public Accountants (AICPA)'s Statement on Auditing Standards No. 70 (SAS 70), and the Ernst & Young Cyber Process Certification. These reviews examined Digex's managed data center facilities in three locations in the United States and the United Kingdom. SAS 70 was established by the AICPA to provide a basis for examinations of the internal controls of service organizations related to financial transaction processing. Digex had successfully completed a SAS 70 Type I review in May 2000. The Type II review -- which requires testing of controls by the auditing firm -- was conducted by Ernst & Young for the period July 1, 2000 through December 31, 2000. Also, Ernst & Young's Cyber Process Certification evaluated and tested the design and operational effectiveness of controls to achieve the objectives specified in the report, related to Digex's Web hosting services. Both reviews focused on the control environment which govern the company's; (1) physical security, (2) electronic security measures, (3) customer server infrastructure, implementation, and maintenance, (4) network services and problem management, and (5) business continuity. In February 2001, we successfully completed the Type II review and the Cyber Process Certification for the six month period July 1, 2000 to December 31, 2000. On June 1, 2000, we entered into an Asset Migration Agreement with Intermedia. Under the terms of the agreement, we purchased certain assets, including certain licensed third-party software, machinery, and equipment from Intermedia at cost to provide independent managed firewall services. We paid a purchase price of $4.5 million for net book value of these assets and services on June 30, 2000, the closing date of the 7 agreement. Under the Asset Migration Agreement, we made equal monthly installments amounting to $0.9 million for Intermedia's support and consultation for the six month period ended December 31, 2000. In connection with the purchase of firewall-related assets from Intermedia, the Managed Firewall Services Agreement between Digex and Intermedia was terminated. On June 29, 2000, we entered into a ten-year lease commencing in September 2000 for our new corporate headquarters facility in Laurel, Maryland. The lease agreement requires an initial security deposit of $2.0 million in the form of a letter of credit. This letter of credit may be reduced at the commencement of the seventh lease year to an amount equal to the then current one month's base rent if certain conditions are met annually prior to the seventh year of the lease. On September 1, 2000, Intermedia entered into a merger agreement with WorldCom. During the third quarter, we have incurred legal fees, investment advisory fees, accounting fees, and certain travel expenses associated with due diligence activities relating to the merger and the possible sale of Digex. Merger-related costs of $2.9 million were expensed as incurred during the year ended December 31, 2000. In October 2000, we entered into a Prime/Subcontractor Agreement with WorldCom whereby we have agreed to provide managed hosting services to WorldCom customers in the United States and in all international locations we presently serve or in the future for certain service fees. Under the terms of the agreement, we will provide the computer hardware, software, network technology, Internet connectivity and systems management necessary to offer WorldCom's customers comprehensive outsourced Web site and application hosting solutions. 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 Digex. Through the arrangement, we will be 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. We will also utilize WorldCom's sales force to enhance its global 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. Revenue earned from the sale of third party equipment is also included. COSTS AND EXPENSES. Costs and expenses include: o cost of operations; o cost of services; o selling, general and administrative expenses; o deferred compensation; and o depreciation and amortization expense. 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 8 these costs to increase in the future. Expenses directly attributed to the sale of third party equipment is also included. 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 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, was 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 will allow us to purchase bandwidth and connectivity from WorldCom in the United States and around the globe to support our managed Web hosting activities. Through the arrangements, we will be 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. 9 RESULTS OF OPERATIONS The following table presents certain information derived from our audited financial statements for the years ended December 31, 2000, 1999, and 1998 expressed as a percentage of revenue.
YEAR ENDED DECEMBER 31, --------------------------------------------------- 2000 1999 1998 ---------------- --------------- -------------- Revenues..................................... 100.0% 100.0% 100.0% Costs and expenses: Cost of operations...................... 12.6 16.2 29.6 Cost of services........................ 41.4 36.4 31.1 Selling, general and administrative..... 86.2 117.4 77.5 Deferred compensation ................. 2.4 2.2 -- Depreciation and amortization........... 46.9 48.6 35.8 ---------------- --------------- -------------- Total costs and expenses............ 189.6 220.8 174.0 ---------------- --------------- -------------- Loss from operations......................... (89.6) (120.8) (74.0) Other income (expense): Interest expense ...................... (1.2) (1.8) -- Interest and other income ............. 7.5 5.8 -- Merger-related expense ................ (1.7) -- -- ---------------- --------------- -------------- Loss before income tax benefit .............. (85.0) (116.8) (74.0) Income tax benefit........................... -- 8.1 0.7 ---------------- --------------- -------------- Loss before cumulative effect of change in accounting principle.......... (85.0)% (108.7)% (73.3)% ================ ================ ==============
YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999 REVENUE Total revenue increased 181.1% to $168.1 million in 2000 compared to $59.8 million in 1999. The increase in revenue was due to customer growth of 12% from December 31, 1999 to December 31, 2000, a significant increase in the number of managed servers per customer, and a rise of average monthly revenue per server in the fourth quarter of $4,259 in 2000 compared to $3,354 for the same period in 1999. Our installed base of servers increased 82% to 4,216 at December 31, 2000 from 2,311 at December 31, 1999. In addition to revenue from managed Web and application hosting services, Digex recognized $5.0 million of third party equipment sales revenue in the second quarter of 2000. COST OF OPERATIONS Cost of operations increased 120.0% to $21.2 million in 2000 compared to $9.6 million in 1999. The increase was due to additional network costs resulting from our expanded customer base and increases in service offerings. As a percentage of revenue excluding second quarter equipment sales, cost of operations excluding the second quarter cost of third party equipment decreased to 10.7% in 2000 compared to 16.2% in 1999 due to the net effect of improved network utilization. 10 COST OF SERVICES Cost of services increased 220.3% to $69.7 million in 2000 compared to $21.7 million in 1999. 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 41.4% in 2000 compared to 36.4% in 1999. Costs did not increase proportionally with revenue due primarily to additional costs incurred in 2000 related to the asset migration agreement. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased 106.3% to $144.9 million in 2000 compared to $70.2 million in 1999. Through 2000, as part of our growth strategy, we continued to build our infrastructure and administrative requirements to operate as a separate public company. Increases in selling, general and administrative expenses for 2000 included the costs associated with an increased employee base, advertising campaigns, back office support (including the G&A Agreement, as amended, with Intermedia), rent for additional office space, consultants' professional fees, an increased provision for doubtful accounts receivable 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 86.2% in 2000 compared to 117.4% in 1999 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 215.7% to $4.1 million in 2000 compared to $1.3 million in 1999. The increase was primarily due to increases in stock options granted to certain employees at exercise prices below market value since July 29, 1999. We recorded approximately $13.5 million of deferred compensation in 1999 and $2.1 million (net of forfeitures) in 2000, 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 171.1% to $78.8 million in 2000 compared to $29.0 million in 1999. The increase was principally due to additional servers and other facilities and equipment placed in service since December 31, 1999. We entered into a capital lease for our corporate headquarters facility in the third quarter of 2000, 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 through 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 83.5% to $2.0 million in 2000 compared to $1.1 million in 1999. The increase resulted from the capital leases assigned to us by Intermedia during the second quarter of 1999 and the capital lease for our new corporate headquarters facility in the third quarter of 2000. Additionally, a note payable was 11 issued by us to a third party during the third quarter of 1999. INTEREST AND OTHER INCOME Interest and other income increased 264.6% to $12.6 million in 2000 compared to $3.5 million in 1999. The increase resulted principally from interest earned on the cash proceeds from the investment in Digex by Microsoft and a subsidiary of Compaq, an initial and subsequent public equity offering, and exercised stock options. MERGER-RELATED EXPENSES Merger-related expenses of $2.9 million associated with due diligence activities relating to the merger and the possible sale of Digex were incurred in 2000. EBITDA BEFORE CERTAIN CHARGES EBITDA before certain charges, as defined below, increased 61.8% to $(67.7) million in 2000 compared to $(41.8) million in 1999. 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. 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. YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 1998 REVENUE Total revenue increased 164.6% to $59.8 million in 1999 compared to $22.6 million in 1998. The increase in revenue was due primarily to new customer growth and to an increase in the number of servers per customer and revenue per server. Our installed base of servers increased 120.5% from 1,048 at December 31, 1998 to 2,311 at December 31, 1999. 12 COST OF OPERATIONS Cost of operations increased 43.3% to $9.6 million in 1999 compared to $6.7 million in 1998. The increase was primarily due to additional network costs resulting from our expanded customer base and increase in service offerings since December 31, 1998. In addition, there were more servers on line since December 31, 1998. As a percentage of revenue, cost of operations decreased to 16.2% in 1999 compared to 29.6% in 1998 as a result of improved network utilization associated with the revenue improvement discussed above. COST OF SERVICES Cost of services increased 210.0% to $21.7 million in 1999 compared to $7.0 million in 1998. The increase was due primarily to increased facilities and engineering costs to support our growth and to support the expansion of our data centers. As a percentage of revenue, cost of services increased to 36.4% in 1999 compared to 31.1% in 1998. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased 301.1% to $70.2 million in 1999 compared to $17.5 million in 1998. As a percentage of revenue, total selling, general and administrative expenses increased to 117.4% in 1999 compared to 77.5% in 1998 due primarily to the significant administrative requirements to support our growth strategy. During 1998, the managed Web site and application hosting business operated as part of a wholly owned subsidiary of Intermedia. During 1999, as part of our growth strategy, we continued building up our infrastructure to operate as a separate public company. Increases in selling, general and administrative expenses for 1999 include the costs associated with an increased employee base, advertising campaigns, back office support (including the General and Administrative Services Agreement with Intermedia), an increased provision for doubtful accounts receivable, 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 site and application hosting industry. As a result, we believe that our selling, general and administrative expenses will continue to increase in the future. DEFERRED COMPENSATION During 1999, we granted stock options to certain employees at exercise prices below market value. As a result, we recorded approximately $12.2 million and $1.3 million of deferred compensation in the third and fourth quarter of 1999, respectively, to be expensed over the four-year vesting period of the options. DEPRECIATION AND AMORTIZATION Depreciation and amortization expenses increased 258.0% to $29.0 million in 1999 compared to $8.1 million in 1998. The increase was principally due to additional servers and other facilities and equipment placed in service since December 31, 1998. We expect increases in depreciation charges next year due to the continued expansion of our data centers and due to future increased server installations. 13 INTEREST EXPENSE Interest expense of $1.1 million in 1999 resulted from the capital leases assigned to us by Intermedia during the second quarter of 1999 and a note payable issued by us during the third quarter of 1999. INTEREST AND OTHER INCOME Interest and other income of $3.5 million resulted principally from interest earned on the cash proceeds from the initial public offering completed in August 1999. LOSS BEFORE INCOME TAX BENEFIT Net loss before income tax benefit increased 318.0% to $(69.8) million in 1999 compared to $(16.7) million in 1998. As more fully discussed above, the increased loss is attributable to growth strategy costs in excess of current period revenues. INCOME TAX BENEFIT In connection with Intermedia's contribution of assets on April 30, 1999, we recorded a deferred tax liability, net of deferred tax assets, of $4.8 million. The deferred tax liability was related to certain identifiable intangible assets. Since the date of the contribution, we experienced taxable losses and non-deductible expenses that resulted in recognition of deferred tax assets in excess of the deferred tax liability. Accordingly, we recorded a $4.8 million deferred tax benefit during the second quarter of 1999. EBITDA BEFORE CERTAIN CHARGES EBITDA before certain charges, as defined below, increased 386.0% to $(41.8) million in 1999 compared to $(8.6) million in 1998. 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 our expenses during our planned expansion. In addition, we expect to continue to experience rapid growth in marketing and selling expenses as new customers are acquired. EBITDA BEFORE CERTAIN CHARGES CONSISTS OF EARNINGS (LOSS) BEFORE INTEREST EXPENSE, INTEREST AND OTHER INCOME, INCOME TAX BENEFIT, DEFERRED COMPENSATION, DEPRECIATION AND AMORTIZATION, AND THE CHARGE OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT. 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 SITE 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 FINANCIAL STATEMENTS AND NOTES THERETO CONTAINED ELSEWHERE IN THIS REPORT FOR MORE DETAILED INFORMATION. 14 LIQUIDITY AND CAPITAL RESOURCES We have used cash in our operating and investing activities during all periods since inception. These cash usages have been funded by permanent contributions to capital from Intermedia. Such contributions amounted to $148.3 million in 1999 and $41.9 million in 1998. Since the date of our initial public offering, there have been no permanent capital contributions made by Intermedia. Net cash used in operating activities was $62.5 million in 2000, $20.5 million in 1999, and $10.9 million in 1998. 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 was $204.6 million in 2000, $170.2 million in 1999, and $31.0 million in 1998. 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 and computers and other equipment, including a $2.0 million letter of credit pursuant to a ten-year lease entered into by us on June 29, 2000 for our new corporate headquarters facility in Laurel, Maryland. Although we have plans to invest significantly in property and equipment, we have no material commitments for such items at this time. Prior to the date of our initial public offering, our capital expenditures and operating expenses were principally funded by Intermedia. On August 4, 1999, we sold 11,500,000 shares of Class A Common Stock in our initial public offering. The net proceeds from the offering were approximately $178.9 million. On January 12, 2000, we sold 100,000 shares of our non-voting, redeemable preferred stock, designated as Series A Convertible Preferred Stock, with detachable warrants to purchase 1,065,000 shares of our Class A common stock, to Microsoft Corporation and CPQ Holdings, Inc., a subsidiary of Compaq Computer Corporation, for an aggregate of $100.0 million, of which $15.0 million was in the form of equipment purchase credits. Of the $15.0 million of equipment purchase credits, approximately $2.7 million was used for equipment purchases in 2000. The warrants can be exercised at any time on or before January 12, 2003 at an initial price of $57.00 per share, subject to certain adjustments. The proceeds from the offering were allocated between the preferred stock and the warrants based upon their relative fair values. To the extent necessary to perform our obligations under our agreement with Compaq, the proceeds from the investment by a subsidiary of Compaq will be used toward the development of a platform for the delivery of high-performance application hosting services, which will include capital expenditures and research and development expenditures. Therefore, we do not expect the proceeds of the investment by a subsidiary of Compaq to be available for general corporate purposes. We also intend to use the proceeds of the investment by Microsoft to fund this development project. On February 16, 2000, we completed a public offering of 12,650,000 shares of our Class A Common Stock. We sold 2,000,000 shares of Class A Common Stock and received net proceeds of approximately $171.6 million. Intermedia sold 10,650,000 shares of Class B Common Stock. The Class B Common Stock sold by Intermedia automatically converted into Class A Common Stock at the closing of the offering. The net proceeds of our public offerings and the cash proceeds of the investments by Microsoft and Compaq were used to purchase telecommunications related assets due to restrictions in Intermedia's debt instruments. Therefore, to provide for the funding of our operating expenses, we made arrangements with Intermedia to sell to Intermedia certain telecommunications related assets that were purchased by Digex with the net proceeds of these offerings. The assets were sold to Intermedia for cash at our cost. We received approximately $33.7 million in 2000 and $25.3 million in 1999 from Intermedia related to the sale of telecommunications related assets. These 15 proceeds were unrestricted and were used to fund our operating expenses. See "Market for Registrant's Common Equity and Related Stockholder Matters--Use of Proceeds from a Sale of Registered Securities." In June 2000, the Department of Business and Economic Development of Maryland received approval from the Maryland General Assembly Legislative Policy Committee to provide $3.0 million in funding to Digex for the development of a Web hosting facility in Prince George's County, Maryland under the Sunny Day Fund initiative. The funds will initially be provided to us in the form of a conditional loan which will accrue deferred interest at 5%. If certain conditions are met, the conditional loan and accrued interest will be forgiven. The Committee also approved our eligibility to seek an additional $1.0 million in such funding on or after January 1, 2005 if certain conditions are met. We received the proceeds from the $3.0 million conditional loan in January 2001. In accordance with the Digex Long-Term Incentive Plan, stock options granted to certain employees of Digex and Intermedia became vested and exercisable beginning in the second quarter of 2001. Cash proceeds of $6.1 million were received from exercised stock options during the year ended December 31, 2000. We may continue to receive cash proceeds from stock options in the future as an increasing number of options will become exercisable according to each optionee's respective vesting schedule. 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 consummated in the second quarter of 2001. See "Business--Recent Developments." On October 31, 2000, Intermedia increased the commitments available to it under its Revolving Credit Facility ("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 Credit Facility to fund a portion of our capital expenditures as liquidity needs arise consistent with our projections. As of December 31, 2000, Intermedia had $113.0 million outstanding on its Credit Facility. 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 not made any borrowings under these financings as of December 31, 2000. We expect to enter 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 agreement ranges from 24 to 36 months. We also have an option to purchase the equipment at the end of the initial lease term. 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. In addition, 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. 16 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. There can be no assurance that such funding will be available on terms satisfactory to us. 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 Factor-- "The failure of the Intermedia - WorldCom Merger to close would adversely impact us." Intermedia is and will continue to be highly leveraged. At December 31, 2000 and 1999, Intermedia had outstanding approximately $2.8 billion and $3.2 billion of debt and other liabilities including trade payables, respectively, and a total of approximately $1.1 million and $916.8 million of obligations with respect to five outstanding series of preferred stock. In addition, as of December 31, 2000, Intermedia borrowed $113.0 million under its $350.0 million credit facility. Intermedia has also entered into a $225.0 million Note Purchase Agreement with WorldCom. 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's level of debt will require it to dedicate a substantial portion of its future cash flow from operations for payment of principal and interest on its debt, as well as dividends on and the redemption of its preferred stock. Historically, Intermedia has not generated sufficient cash flow to cover its operating and investing expenses. For the years ended December 31, 2000 and 1999, Intermedia's earnings were insufficient to cover combined fixed charges and dividends on preferred stock. The auditors of Intermedia have also expressed in their opinion that while Intermedia's consolidated financial statements have been prepared assuming that it will continue as a going concern, Intermedia has incurred recurring operating losses and has a net capital deficiency, and as a result, these conditions raise substantial doubt about Intermedia's ability to continue as a going concern. 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 within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements concerning the future outcome of litigation and the completion of the Intermedia - WorldCom Merger. 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. See "Risk Factors--This report includes forward-looking statements which could differ from actual results." INCOME TAXES 17 We account for income taxes under SFAS No. 109, ACCOUNTING FOR INCOME TAXES. At December 31, 2000, a full valuation allowance was provided on net deferred tax assets of $75.2 million based upon our deficit in earnings and the uncertainty surrounding our ability to recognize such assets. The valuation allowance relates primarily to a net operating loss carryforward. Income tax accounting information is disclosed in Note 9 to the Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We expect to continue recognizing revenue from international sales denominated in foreign currency. As a global concern, we could face exposure to adverse movements in foreign currency exchange rates on the financial results of foreign subsidiaries that are translated into U.S. dollars upon consolidation. These exposures may change over time as business practices evolve and could affect our financial results. Currently, we do not hedge against any foreign currency risk and, as a result, could incur gains or losses. While our long-term note payable bears an effective fixed interest rate, the fair market value of our fixed rate long-term note payable is sensitive to changes in interest rates. We run the risk that market rates will decline, and the required payments will exceed those based on current market rates. Under our current risk management policies, we do not use interest rate derivative instruments to manage our exposure to interest rate changes. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements listed in Item 14 are included in this report beginning on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 18 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENT AND FINANCIAL STATEMENT SCHEDULES The following consolidated financial statements of the Company and the notes thereto, the related reports thereon of the independent auditors, and financial statement schedules, are filed pursuant to Item 8 of this Report: INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Auditors ................................................................................ F-1 Consolidated Balance Sheets as of December 31, 2000 and 1999 .................................................. F-2 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999, and 1998 ................... F-3 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2000, 1999, and 1998 ........ F-4 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999, and 1998 ................... F-5 Notes to Consolidated Financial Statements..................................................................... F-6 FINANCIAL STATEMENT SCHEDULES Schedule II--Valuation and Qualifying Accounts ................................................................. F-31
All other financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission (the "SEC") are not required pursuant to the instructions to Item 8 or are inapplicable and therefore have been omitted. 19 EXHIBIT INDEX All Exhibits listed below were filed with the original Form 10-K, unless specifically stated to be incorporated by reference to other documents previously filed with the SEC. EXHIBIT NUMBERS DESCRIPTION ------- ----------- 2.1 -- Contribution Agreement by and between Digex and Business Internet, Inc., dated as of April 30, 1999.* 2.2 -- Assignment and Assumption Agreement by and between Digex and Business Internet, Inc., dated as of April 30, 1999.* 2.3 -- Trademark Assignment by and between Digex and Business Internet, Inc., dated as of April 30, 1999.* 2.4 -- Bill of Sale to the Contribution Agreement, dated as of April 30, 1999.* 2.5 -- Agreement and Plan of Merger among WorldCom, Inc., Wildcat Acquisition Corp. and Intermedia Communications Inc., dated as of September 1, 2000. Incorporated herein by reference to Digex's Form 8-K (File No. 000-26873) filed with the SEC on September 7, 2000. 3.1 -- Certificate of Incorporation of Digex, as amended. Incorporated herein by reference to Digex's Form 10-Q (File No. 000-26873) filed with the SEC on September 13, 1999. 3.2 -- Bylaws of Digex, as amended. Incorporated herein by reference to 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.** 3.4 -- See the Certificate of Incorporation of Digex, as amended to date, filed as Exhibit 3.1. 3.5 -- Proposed Amendment to the Certificate of Incorporation. Incorporated herein by reference to Digex's Form 8-K (File No. 000-26873) filed with the SEC on February 15, 2001. 4.1 -- Warrant Agreement, dated as of January 12, 2000, among Digex, Microsoft Corporation and CPQ Holdings, Inc.** 4.2 -- Registration Rights Agreement, dated as of January 12, 2000, among Digex, Microsoft Corporation and CPQ Holdings, Inc.** 10.1 -- Intentionally Omitted. 10.2 -- Lease by and between Intermedia and Intel Corporation, dated as of November 10, 1998.* 10.3 -- Lease by and between Intermedia and Ammendale Commerce Center Limited Partnership, dated as of April 15, 1998.* 20 10.4 -- Lease by and between Intermedia and 1111 19th Street Associates, dated as of July 23, 1998.* 10.5 -- Contract for Construction by and between Intermedia and R.W. Murray Company, d/b/a The Murray Company, dated as of February 19, 1999.* 10.6 -- Contract for Construction by and between Intermedia and R.W. Murray Company, d/b/a The Murray Company, dated as of January 4, 1999.* 10.7 -- Software License and Services Agreement by and between Digex and Oracle Corporation, dated as of May 27, 1999.* 10.8 -- License Agreement by and between Digex and Microsoft Corporation.* 10.9 -- Consulting Letter Agreement by and between Digex, Intermedia and Andersen Consulting LLP, dated as of April 1, 1999.* 10.10 -- Internet Transit Services Agreement (East Coast) between Digex and Business Internet, Inc., dated as of April 30, 1999. (2)* 10.11 -- Internet Transit Services Agreement (West Coast) between Digex and Business Internet, Inc., dated as of April 30, 1999. (2)* 10.12 -- Managed Firewall Services Agreement between Digex and Business Internet, Inc., dated as of April 30, 1999. (2)* 10.13 -- Employment Letter dated June 29, 1999 between Digex and Mark K. Shull, and amendments thereto. (1)** 10.14 -- Employment Letter dated December 14, 1998 between Digex and Nancy G. Faigen, and amendments thereto. (1)** 10.15 -- Employment Letter dated July 9, 1999 between Digex and Rebecca Ward, and amendments thereto. (1)** 10.16 -- Employment Letter dated July 9, 1999 between Digex and Bryan T. Gernert, and amendments thereto. (1)** 10.17 -- Employment Letter dated December 15, 1999 between Digex and Timothy M. Adams, and amendments thereto. (1)** 10.18 -- Employment Letter dated September 11, 1996 between Digex and Robert B. Patrick, and amendments thereto. (1)** 10.19 -- Digex Long-Term Incentive Plan. (1)** 10.20 -- Intermedia 1996 Long-Term Incentive Plan. (1)** 10.21 -- General and Administrative Services Agreement between Digex and Intermedia, dated as of April 30, 1999. * 10.22 -- Amendment No. 1, dated as of January 17, 2000, to General and Administrative Services Agreement between Digex and Intermedia.** 21 10.23 -- Use of Proceeds Agreement between Digex and Intermedia, dated as of June 2, 1999.** 10.24 -- Use of Proceeds Agreement between Digex and Intermedia, dated as of January 11, 2000.** 10.25 -- Use of Proceeds Agreement between Digex and Intermedia, dated as of January 24, 2000.** 10.26 -- Expense Summary and Indemnity Arrangement Agreement between Digex and Intermedia, dated as of January 24, 2000.** 10.27 -- Employment Letter dated March 22, 2000 between Digex and Thomas Davidsson. (1)*** 10.28 -- Employment Letter dated July 5, 2000 between Digex and Todd Carlson, and amendments thereto. (2)*** 10.29 -- Employment Letter dated July 6, 2000 between Digex and Bruce F. Metge. (1)*** 10.30 -- Lease by and between Digex and Riggs & Company, dated as of June 29, 2000. (3)*** 10.31 -- Amendment No. 2, dated as of June 29, 2000, to the General and Administrative Services Agreement between Digex and Intermedia. *** 10.32 -- Asset Migration Agreement, dated as of June 1, 2000, between Digex and Intermedia.*** 10.33 -- Letter Agreement dated July 31, 2000 between Digex and Lemis O. Altan. (1)**** 10.34 -- Amended and Restated Guaranty Agreement, dated as of October 31, 2000, by Digex, as Guarantor, on behalf of Bank of America, N.A., as Administrative Agent for Lenders, amending and restating the Guaranty Agreement, dated as of December 22, 1999, by Digex, as Guarantor, on behalf of Bank of America N.A., as Administrative Agent for Lenders. **** 10.35 -- Amended and Restated Security Agreement, dated as of October 31, 2000, between Digex, as Debtor, and Bank of America, N.A., as the Secured Party on behalf of Lenders, amending and restating the Security Agreement, dated as of December 22, 1999, between Digex, as Debtor, and Bank of America, N.A., as the Secured Party on behalf of Lenders.**** 10.36 -- Amendment, dated as of October 24, 2000, to the Use of Proceeds Agreement between Digex and Intermedia, dated as of January 24, 2000. **** 10.37 -- Employment Letter dated October 26, 2000 between Digex and Howard Weizmann. (1) 10.38 -- Master Channel Agreement between Digex and MCI WorldCom Network Services, Inc., dated as of January 1, 2001. Incorporated herein by reference to Digex's Form 8-K (File No. 000-26873) filed with the SEC on March 5, 2001. 10.39 -- Master Facilities Agreement between Digex and MCI WorldCom Network Services, Inc., dated as of January 1, 2001. Incorporated herein by reference to Digex's Form 8-K (File No. 000-26873) filed with the SEC on March 5, 2001. 22 23.1 -- Consent of Ernst & Young LLP. - ---------- (1) Management contract or compensatory plan or arrangement. (2) Confidential treatment of certain provisions of this exhibit was requested and granted by the SEC in connection with the filing of Digex's registration statement on Form S-1 (File No. 333-77105). (3) Confidential treatment of certain provisions of this exhibit was requested and granted by the SEC in connection with the filing of Digex's Form 10-Q for the quarter ended June 30, 2000 (File No.000-26873) filed with the SEC on August 14, 2000. * Incorporated herein by reference to Digex's registration statement on Form S-1 (File No. 333-77105) filed with the SEC. ** Incorporated herein by reference to Digex's registration statement on Form S-1 (File No. 333-94879) filed with the SEC. *** Incorporated herein by reference to Digex's Form 10-Q for the quarter ended June 30, 2000 (File No. 000-26873) filed with the SEC on August 14, 2000. **** Incorporated herein by reference to Digex's Form 10-Q for the quarter ended September 30, 2000 (File No. 000-26873) filed with the SEC on November 14, 2000. (b) REPORTS ON FORM 8-K The following Current Reports on Form 8-K were filed during the fourth quarter of 2000: Digex filed a Current Report on Form 8-K, dated October 13, 2000, reporting under Item 5 reporting the filing of multiple shareholder complaints against Intermedia, Digex, certain interested directors of Digex, and WorldCom in connection with the Merger Agreement between Intermedia and WorldCom. The Company also reported under Item 7 the filing of the complaint as an exhibit to the Form 8-K. Digex filed a Current Report on Form 8-K, dated October 26, 2000, reporting under Item 5 reporting the filing of a consolidated shareholders complaint against Intermedia, Digex, certain interested directors of Digex, and WorldCom. The Company also reported under Item 7 the filing of the complaint as an exhibit to the Form 8-K. Digex filed a Current Report on Form 8-K, dated October 27, 2000, reporting under Item 5 the issuance of a press release discussing Digex's third quarter results. The Company 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 November 20, 2000, reporting under Item 9 Regulation FD Disclosure discussing its Analyst Day presentation to financial analysts and others. The Company also reported under Item 7 the filing of selected presentation slides as an exhibit to the Form 8-K. Digex filed a Current Report on Form 8-K, dated December 15, 2000, reporting under Item 5 reporting the Legal Opinion of the Court of Chancery of the State of Delaware in and for New Castle County In Re: Digex, Inc. Shareholders Litigation, dated December 13, 2000. The Company also reported under Item 7 the filing of the Opinion as an exhibit to the Form 8-K. 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: December 7, 2001 DIGEX, INCORPORATED (Registrant) By: /s/ TIMOTHY M. ADAMS ---------------------------- Timothy M. Adams Chief Financial Officer 24 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Digex, Incorporated We have audited the accompanying consolidated balance sheets of Digex, Incorporated as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Digex, Incorporated at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 1 to the consolidated financial statements, in 2000 the Company changed its method of accounting for revenue recognition. As discussed in Note 17, the consolidated financial statements have been restated to exclude redeemable preferred stock from total stockholders' equity. /s/ ERNST & YOUNG LLP McLean, Virginia January 30, 2001 Except for Notes 14 and 16, as to which the date is March 2, 2001, and except for Notes 5 and 17, as to which the date is November 27, 2001 F-1 DIGEX, INCORPORATED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
DECEMBER 31, ------------------------------------ 2000 1999 --------------- --------------- (RESTATED) ASSETS Current assets: Cash and cash equivalents ............................................. $ 83,434 $ 88,778 Restricted investments ................................................ 2,000 -- Accounts receivable, net of allowance of $4,741 and $4,362 in 2000 and 1999, respectively........................................... 42,201 17,271 Due from Intermedia ................................................... 40 3,110 Deferred costs ........................................................ 8,627 -- Prepaid expenses and other current assets.............................. 7,452 1,496 --------------- --------------- Total current assets............................................ 143,754 110,655 Property and equipment, net................................................. 348,975 205,903 Intangible assets, net...................................................... 23,222 27,213 Other assets................................................................ 5,100 538 --------------- --------------- Total assets.................................................... $ 521,051 $ 344,309 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses.................................. $ 59,455 $ 33,619 Current portion of deferred revenue.................................... 7,734 222 Current portion of note payable........................................ 2,772 1,235 Current portion of capital lease obligations........................... 1,871 801 --------------- --------------- Total current liabilities....................................... 71,832 35,877 Deferred revenue............................................................ 4,025 -- Note payable................................................................ 1,435 2,477 Capital lease obligations................................................... 27,131 15,766 --------------- --------------- Total liabilities............................................... 104,423 54,120 --------------- --------------- Redeemable 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 (aggregate liquidation preference of $100,000)................................................ 71,572 -- Stockholders' equity: Class A common stock, $.01 par value; 100,000,000 shares authorized; 24,546,543 and 11,500,000 shares issued and outstanding in 2000 and 1999, respectively ................................................ 245 115 Class B common stock, $.01 par value; 50,000,000 shares authorized; 39,350,000 and 50,000,000 issued and outstanding in 2000 and 1999, respectively ...................................................... 394 500 Additional capital..................................................... 550,465 354,553 Accumulated deficit.................................................... (195,869) (52,768) Deferred compensation.................................................. (10,141) (12,211) Accumulated other comprehensive loss ................................. (38) -- --------------- --------------- Total stockholders' equity...................................... 345,056 290,189 --------------- --------------- Total liabilities and stockholders'equity....................... $ 521,051 $ 344,309 =============== ===============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-2 DIGEX, INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED DECEMBER 31, --------------------------------------------------- 2000 1999 1998 ---------------- --------------- --------------- Revenues................................................. $ 168,085 $ 59,786 $ 22,635 Costs and expenses: Cost of operations.................................. 21,244 9,656 6,710 Cost of services.................................... 69,658 21,750 7,044 Selling, general and administrative................. 144,876 70,213 17,512 Deferred compensation .............................. 4,101 1,299 -- Depreciation and amortization ...................... 78,819 29,070 8,109 ---------------- --------------- --------------- Total costs and expenses................................. 318,698 131,988 39,375 ---------------- --------------- --------------- Loss from operations..................................... (150,613) (72,202) (16,740) Other income (expense): Interest expense.................................... (2,008) (1,094) -- Interest and other income........................... 12,608 3,458 -- Merger-related expenses ............................ (2,922) -- -- ---------------- --------------- --------------- Loss before income tax benefit........................... (142,935) (69,838) (16,740) Income tax benefit....................................... -- 4,839 159 ---------------- --------------- --------------- Loss before cumulative effect of change in accounting principle.......................................... (142,935) (64,999) (16,581) Cumulative effect of change in accounting principle ..... (166) -- -- ---------------- --------------- --------------- Net loss ................................................ $(143,101) $(64,999) $ (16,581) ================ =============== =============== LOSS PER COMMON SHARE- BASIC AND DILUTED: Loss before cumulative effect of change in accounting principle ......................................... $ (2.25) $ (1.19) $ (0.33) Cumulative effect of change in accounting principle ..... (0.01) -- -- ---------------- --------------- --------------- Net loss per common share ............................... $ (2.26) $ (1.19) $ (0.33) ================ =============== =============== PRO FORMA AMOUNTS, ASSUMING THE ACCOUNTING CHANGE IS APPLIED RETROACTIVELY: Net loss ................................................ $(142,935) $(65,115) $ (16,618) ================ =============== =============== Net loss per common share ............................... $ (2.25) $ (1.19) $ (0.33) ================ =============== =============== Shares used in computing basic and diluted net loss per share .............................................. 63,404,839 54,726,027 50,000,000 ================ =============== ===============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3 DIGEX, INCORPORATED CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (RESTATED) (AMOUNTS IN THOUSANDS)
REDEEMABLE PREFERRED STOCK STOCKHOLDERS' EQUITY ------------------ ------------------------------------------- COMMON STOCK CLASS A CLASS B SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------ ------ ------ ------ ------ ------ BALANCE AT DECEMBER 31, 1997 .......... -- -- -- -- -- -- Total allocated costs ................. -- -- -- -- -- -- Funding for working capital ........... -- -- -- -- -- -- Funding for purchases of property, plant and equipment ................ -- -- -- -- -- -- Net loss .............................. -- -- -- -- -- -- ------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1998 .......... -- -- -- -- -- -- Total allocated costs ................. -- -- -- -- -- -- Funding for working capital ........... -- -- -- -- -- -- Funding for purchases of property, plant and equipment ................ -- -- -- -- -- -- Recapitalization by Intermedia ........ -- -- -- -- 50,000 500 Contributions from Intermedia following recapitalization ......... -- -- -- -- -- -- Initial public offering of common stock, net of issuance cost ........ -- -- 11,500 115 -- -- Issuance of stock options under long-term compensation plan ........ -- -- -- -- -- -- Amortization of deferred compensation . -- -- -- -- -- -- Net loss .............................. -- -- -- -- -- -- ------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1999 .......... -- -- 11,500 115 50,000 500 Issuance of Series A Convertible preferred stock and warrants, net of available equipment credits ..... 100 71,572 -- -- -- -- Subsequent public offering of common stock, net of issuance cost ....... -- -- 12,650 126 (10,650) (106) Issuance of stock options under long-term compensation plan, net of forfeitures ........................ -- -- -- -- -- -- Exercise of common stock options ...... -- -- 397 4 -- -- Amortization of deferred compensation . -- -- -- -- -- -- Foreign currency translation adjustment -- -- -- -- -- -- Net loss .............................. -- -- -- -- -- -- ------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 2000 (RESTATED) 100 $ 71,572 24,547 $ 245 39,350 $ 394 ======================================================================== STOCKHOLDERS' EQUITY ------------------------------------------------------------------------ ACCUMULATED OWNER'S OTHER NET ADDITIONAL ACCUMULATED DEFERRED COMPREHENSIVE INVESTMENT CAPITAL DEFICIT COMPENSATION LOSS (DEFICIT) TOTAL ------- ------- ------------ ---- --------- ----- BALANCE AT DECEMBER 31, 1997 .......... -- -- -- -- $ 45,527 $ 45,527 Total allocated costs ................. -- -- -- -- 10,018 10,018 Funding for working capital ........... -- -- -- -- 912 912 Funding for purchases of property, plant and equipment ................ -- -- -- -- 30,969 30,969 Net loss .............................. -- -- -- -- (16,581) (16,581) ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998 .......... -- -- -- -- 70,845 70,845 Total allocated costs ................. -- -- -- -- 3,541 3,541 Funding for working capital ........... -- -- -- -- 11,443 11,443 Funding for purchases of property, plant and equipment ................ -- -- -- -- 89,574 89,574 Recapitalization by Intermedia ........ 114,566 -- -- -- (115,066) -- Contributions from Intermedia following recapitalization ......... 47,689 -- -- -- (48,106) (417) Initial public offering of common stock, net of issuance cost ........ 178,788 -- -- -- -- 178,903 Issuance of stock options under long-term compensation plan ........ 13,510 -- (13,510) -- -- -- Amortization of deferred compensation . -- -- 1,299 -- -- 1,299 Net loss .............................. -- (52,768) -- -- (12,231) (64,999) ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1999 .......... 354,553 (52,768) (12,211) -- -- 290,189 Issuance of Series A Convertible preferred stock and warrants, net of available equipment credits ..... 16,100 -- -- -- -- 16,100 Subsequent public offering of common stock, net of issuance cost ....... 171,623 -- -- -- -- 171,643 Issuance of stock options under long-term compensation plan, net of forfeitures ........................ 2,067 -- (2,067) -- -- -- Exercise of common stock options ...... 6,122 -- -- -- -- 6,126 Amortization of deferred compensation . -- -- 4,137 -- -- 4,137 Foreign currency translation adjustment -- -- -- (38) -- (38) Net loss .............................. -- (143,101) -- -- -- (143,101) ----------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 (RESTATED) $ 550,465 $(195,869) $ (10,141) $ (38) -- $ 345,056 =============================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4 DIGEX, INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ----------------------------------- 2000 1999 1998 --------- --------- --------- OPERATING ACTIVITIES: Net loss ....................................................... $(143,101) $ (64,999) $ (16,581) Cumulative effect of change in accounting principle ............ 166 -- -- --------- --------- --------- Loss before cumulative effect of accounting change ............. (142,935) (64,999) (16,581) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization ................................ 78,819 29,070 8,109 Provision for doubtful accounts .............................. 10,649 4,265 1,491 Amortization of deferred compensation ........................ 4,137 1,299 -- Loss on sale/ disposals of telecommunications equipment .................................................. 655 52 -- Deferred income taxes ........................................ -- (4,839) (159) Accretion of interest on note payable and capital lease obligation ................................................. 467 -- -- Changes in operating assets and liabilities: Accounts receivable .......................................... (35,612) (15,409) (5,559) Due from Intermedia .......................................... 3,077 (3,110) -- Deferred costs ............................................... (8,627) -- -- Prepaid expenses and other current assets .................... (5,956) (606) (550) Other assets ................................................. (4,562) (79) (459) Accounts payable and accrued expenses ........................ 25,997 33,619 2,778 Deferred revenue ............................................. 11,371 222 -- --------- --------- --------- Net cash used in operating activities .......................... (62,520) (20,515) (10,930) INVESTING ACTIVITIES: Purchases of property and equipment ............................ (202,604) (170,396) (30,969) Purchase of restricted investments ............................. (2,000) -- -- Proceeds from sale of telecommunication assets ................. -- 203 -- --------- --------- --------- Net cash used in investing activities .......................... (204,604) (170,193) (30,969) FINANCING ACTIVITIES: Proceeds from subsequent public offering, net of costs ......... 171,645 -- -- Proceeds from issuance of preferred stock ...................... 85,000 -- -- Proceeds from exercise of common stock options ................. 6,126 -- -- Principal payments on long-term note payable and capital leases (953) (1,424) -- Proceeds from initial public offering, net of costs ............ -- 178,903 -- Net contributions from Intermedia .............................. -- 102,007 41,899 --------- --------- --------- Net cash provided by financing activities ...................... 261,818 279,486 41,899 Effect of exchange rate on cash and cash equivalents .............. (38) -- -- Net increase in cash and cash equivalents ......................... (5,344) 88,778 -- Cash and cash equivalents at beginning of the year ................ 88,778 -- -- --------- --------- --------- Cash and cash equivalents at end of year .......................... $ 83,434 $ 88,778 $ -- ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Assets acquired through capital leases .......................... $ 13,249 $ 17,111 $ 958 Asset purchase financed by note payable ......................... -- 4,672 -- Interest paid ................................................... 1,696 1,010 --
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Digex, Incorporated ("Digex") was incorporated on April 26, 1999, under the laws of the State of Delaware. Digex's business was operated as the Web site hosting unit of Intermedia Communications Inc. ("Intermedia") since its acquisition by Intermedia on July 7, 1997. On that date, Intermedia acquired Business Internet, Inc. (previously known as DIGEX, Incorporated), including the Web site hosting unit, in a business combination accounted for as a purchase. The Web site hosting unit presented in the accompanying financial statements had no legal status or existence prior to the incorporation of Digex on April 26, 1999. Prior to April 30, 1999, Digex had no assets or liabilities. Digex's predecessor operations began in January 1996 to provide managed Web hosting services, principally to Fortune 2000 companies. Digex's services include implementing and maintaining secure, scalable, high performance Web sites on the Internet 24 hours a day. In addition, Digex provides a comprehensive suite of Web management services, including business process solutions and value-added testing services directed toward improving its customers' overall Internet performance. On July 11, 2000, Intermedia announced that it was exploring strategic alternatives with regard to Digex, including, without limitation, the possible sale of its ownership position in Digex. 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. The merger is expected to be consummated in the second quarter of 2001. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Digex and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The 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. Certain prior period amounts have been reclassified to conform to the current period presentation. F-6 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The financial statements for periods prior to April 30, 1999 represent the carved-out operations of the managed Web and application hosting unit of Intermedia. Digex's accumulated deficit of $195.9 million arose after April 30, 1999. Accumulated losses and capital contributions from Intermedia were included in owner's net investment prior to April 30, 1999 and were transferred to additional capital upon the capitalization of Digex. Intermedia contributed approximately $115.1 million in assets and certain liabilities on April 30, 1999. Intermedia also contributed additional capital of $48.1 million to Digex beginning May 1 through August 4, 1999, principally by way of contributions of telecommunications assets. These contributions were accounted for at Intermedia's underlying book values on the date of contribution. As more fully discussed in Note 2, "Related Party Corporate Allocations," the financial statements for 1998 and 1999 include allocations of network costs and corporate expenses. In addition, for financial reporting purposes, the equity activity of Digex prior to its incorporation has been accumulated into a single disclosure caption entitled "Owner's Net Investment." SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles 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. CASH EQUIVALENTS Digex considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the property and equipment, ranging from three years for electronics to five years for furniture and office equipment. Buildings under capital leases and leasehold improvements are amortized over the lesser of the lease term or the useful life. Property and equipment acquired under capital leases is amortized using the straight-line method over the lesser of the lease term or the estimated useful life of the asset. F-7 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) INTANGIBLE ASSETS Intangible assets include assets that arose in connection with the purchase of Business Internet, Inc. by Intermedia. Identifiable intangible assets arising from the purchase are stated at cost and consist of trade name, customer lists, acquired workforce, developed technology and goodwill. Amortization of these assets is computed using the straight-line method over the estimated periods of benefit, generally five years for developed technologies and ten years for all other intangible assets. IMPAIRMENT OF LONG-LIVED ASSETS In accordance with Statement of Financial Accounting Standards (SFAS) No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, Digex reviews its long-lived assets for impairment when events or changes in circumstances indicate the carrying value of such assets may not be recoverable. This review consists of a comparison of the carrying value of the asset with the asset's expected future undiscounted cash flows without interest costs. Estimates of expected future cash flows represent management's best estimate based on reasonable and supportable assumptions and projections. If the expected future cash flow exceeds the carrying value of the asset, no impairment indicator is considered present. If the carrying value exceeds the future cash flow, an impairment indicator is considered present. Such impairment would be measured and recognized using a discounted cash flow method. FINANCIAL INSTRUMENTS The carrying value of Digex's financial instruments, including cash and cash equivalents, restricted investments, accounts receivable, accounts payable, note payable and capital lease obligations approximate their fair market values. REVENUE RECOGNITION Revenues principally consist of installation fees and monthly service fees charged to customers under contracts having terms that typically range from one to three years. Installation fees along with related costs are deferred and recognized over the contract period. Monthly services fees are recognized in the month the service is rendered. Certain customer payments for managed Web hosting services received in advance of service delivery are deferred until the service is performed. Additional services are recognized in the month the services are performed. Refer to "Change in Accounting Principle" in Note 1 to the consolidated financial statements for further discussion. F-8 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) ADVERTISING COSTS Digex expenses advertising costs as incurred. Advertising expense amounted to $21.9 million in 2000, $6.8 million in 1999, and $2.5 million in 1998 and is included in the consolidated statements of operations as selling, general and administrative expense. RESEARCH AND DEVELOPMENT COSTS Digex expenses research and development costs ("R&D costs") as incurred, except for equipment that have alternative future uses, in accordance with SFAS No. 2, ACCOUNTING FOR RESEARCH AND DEVELOPMENT COSTS. Indirect costs and general administrative expenses directly related to a joint development project and normal business development activities are expensed as incurred. R&D costs amounted to $9.5 million in 2000, $0.6 million in 1999, and $1.0 million in 1998 and are included in the consolidated statements of operations as selling, general, and administrative expense. Costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional development costs are capitalized in accordance with SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED. Product development costs incurred for internal use software are expensed as incurred until the application development state, after which costs are capitalized in accordance with Statement of Position 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. STOCK-BASED COMPENSATION Digex accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. Accordingly, in cases where exercise prices at the date of the grant equal or exceed fair market value of the underlying common stock, Digex recognizes no compensation expense. In cases where exercise prices at the date of the grant are less than the fair value, compensation is recognized over the period of performance or vesting period. INCOME TAXES Digex accounts for income taxes under the provisions of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. F-9 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) LOSS PER SHARE Digex has applied the provisions of SFAS No. 128, EARNINGS PER SHARE, which establishes standards for computing and presenting earnings per share. Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This standard requires that total comprehensive income (loss) be disclosed with equal prominence as net income. Comprehensive income is defined as changes in stockholder's equity exclusive of transactions with owners, such as capital contributions and dividends. Digex adopted this standard in 1998 and implemented the standard for all years presented herein. Digex's only component of accumulated other comprehensive income for 2000 resulted from foreign currency translation. Comprehensive losses were equal to net losses for 1999 and 1998. FOREIGN CURRENCY TRANSLATION The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, FOREIGN CURRENCY TRANSLATION. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Income statement amounts have been translated using the average exchange rate for the period. Foreign currency translation adjustments are reported as a component of accumulated other comprehensive income within stockholders' equity. The gains and losses of $0.07 million resulting from foreign currency transactions are reported in the results of operations in 2000. CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially expose Digex to credit risk consist primarily of cash and cash equivalents, restricted investments and accounts receivable. Digex places its cash and temporary cash investments with high-quality institutions. Fair value of the restricted investment approximates the cost due to the short period of time to maturity. Accounts receivable are due from commercial entities to whom credit is extended based on evaluation of the customer's financial condition, and in certain cases collateral is required. Anticipated credit losses are provided for in the consolidated financial statements and have been within management's expectations for all periods presented. As of December 31, 2000, Digex does not have any significant concentrations of business transacted with a particular customer, supplier or lender that could, if suddenly eliminated, severely impact its operations. F-10 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 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). The cumulative effect of the change on prior years resulted in a net charge of $0.2 million ($5.3 million revenue less related direct incremental costs), which is included in the Consolidated Statement of Operations for the year ended December 31, 2000. The effect of the change on the year ended December 31, 2000 was to increase net loss before the cumulative effect of the accounting change by $0.25 million (less than $0.01 per share). For the year ended December 31, 2000, Digex recognized revenue of $4.6 million and direct incremental costs of $4.4 million that was included in the cumulative effect adjustment as of January 1, 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. The pro forma amounts presented in the Consolidated Statements of Operations were calculated assuming the accounting change was made retroactively to prior periods. 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. Digex anticipates that the adoption of SFAS No. 133, as amended, will not have a significant effect on its consolidated financial statements. 2. RELATED PARTY CORPORATE ALLOCATIONS Prior to August 4, 1999, Digex utilized the central cash management systems of Business Internet and Intermedia. Cash requirements during these periods were satisfied by cash transactions and transfers that were accounted for through an intercompany account. In addition, Intermedia charged Digex for identifiable corporate and operating expenses, such as network cost and corporate overhead cost. Intercompany account balances for periods prior to July 29, 1999 have been treated as permanent contributions and have been reflected as a component of owner's net investment in the accompanying consolidated financial statements. F-11 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The following table summarizes corporate charges and allocations included in the accompanying consolidated financial statements (in thousands):
STATEMENT OF OPERATIONS CAPTION 1999 1998 -------------------------------- ------------- ------------ Cost of operations...................... $ 9,190 $ 6,494 Cost of services........................ 494 1,320 Selling, general and administrative..... 18,123 2,204 ------------- ------------ $27,807 $ 10,018 ============= ============
Amounts presented for 1999 in the table above include expenses recorded as a result of certain related party agreements with Intermedia. Management believes that the allocation methodology applied is reasonable. However, it was not practicable to determine whether the allocated amounts represent amounts that would have been incurred on a standalone basis. Explanations of the composition and the method of allocation for the above captions are as follows: COST OF OPERATIONS Allocated costs within this caption were the costs of telecommunications backbone circuits. These costs were allocated to Digex based upon circuit usage and rate information. COST OF SERVICES Allocated costs within this caption were the costs associated with two data centers (maintenance, utilities and support and employment costs for network engineering and support, and certain other overhead). These costs were allocated based upon the employee base. SELLING, GENERAL AND ADMINISTRATIVE Allocated costs within this caption were the costs of human resources, information systems services, accounting and back office support, executive salaries and other general and administrative costs, including rent. All costs except accounting and back office support were allocated based upon the employee base. Accounting and back office support were allocated based upon the relative percentage of monthly recurring revenues. Refer to Note 12 to the consolidated financial statements for additional related party transactions and agreements. F-12 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 3. PROPERTY AND EQUIPMENT Property and equipment consisted of the following (in thousands):
DECEMBER 31, ------------------------------- 2000 1999 -------------- ------------- Buildings ....................................... $ 30,178 $ 17,344 Electronics and computer equipment............... 276,587 126,389 Computer software................................ 54,845 29,053 Furniture and office equipment................... 8,532 2,427 Leasehold improvements .......................... 84,485 61,981 -------------- ------------- 455,627 237,194 Less accumulated depreciation and amortization... (105,652) (31,291) -------------- ------------- $ 348,975 $205,903 ============== =============
Property and equipment included buildings, electronics and computer equipment, and furniture and office equipment of $30.5 million and $20.3 million at December 31, 2000 and 1999, respectively, that were capitalized pursuant to the terms of capital lease agreements. Accumulated amortization of assets recorded under capital leases amounted to $3.4 million and $1.3 million at December 31, 2000 and 1999, respectively. Amortization of these assets is included in depreciation and amortization expense. 4. INTANGIBLE ASSETS Intangible assets consisted of the following (in thousands):
DECEMBER 31, ------------------------------------- 2000 1999 ---------------- ----------------- Goodwill.......................... $ 19,099 $ 19,099 Trade name........................ 9,750 9,750 Customer list..................... 3,120 3,120 Developed technologies............ 2,720 2,720 Acquired workforce................ 1,253 1,253 ---------------- ----------------- 35,942 35,942 Less accumulated amortization..... (12,720) (8,729) ---------------- ----------------- $ 23,222 $ 27,213 ================ =================
Amortization expense amounted to $4.0 million in 2000, $4.0 million in 1999 and $3.2 million in 1998. F-13 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 5. SERIES A CONVERTIBLE PREFERRED STOCK In January 2000, Digex sold 100,000 shares of its non-voting preferred stock, designated as Series A Convertible Preferred Stock, with detachable warrants to purchase 1,065,000 shares of its Class A common stock, for an aggregate of $100.0 million, of which $15.0 million was in the form of equipment purchase credits. Of the $15.0 million of equipment purchase credits, approximately $2.7 million was used for equipment purchases in 2000. The warrants can be exercised at any time on or before January 12, 2003 at an initial price of $57.00 per share, subject to certain adjustments. The proceeds from the offering were allocated between the preferred stock and the warrants based upon their relative fair values. In the event of liquidation, each share of preferred stock is entitled to a liquidation preference of $1,000 per share before any amount may be paid to common stockholders. The holders of the preferred stock are also not entitled to receive dividends. Digex may not issue any stock with the same or senior preferences or priorities to this series without the consent of the majority of its preferred stockholders. Each share of preferred stock is convertible into shares of Class A common stock at a conversion price of $68.40 per share, subject to certain adjustments, for a total of approximately 1,462,000 shares of Class A common stock. Unless earlier converted, on January 12, 2005, each share of preferred stock will automatically convert into the number of shares of Class A common stock equal to $1,000 divided by the average of the closing prices of the Class A common stock for the twenty consecutive trading days prior to January 12, 2005. Subject to the legal availability of funds, the preferred stock is redeemable in cash at the option of the holders after January 12, 2004 or upon a change of control of Digex at a price of $1,000 per share if the redemption is then permitted under those indentures of Digex and Intermedia which existed on January 10, 2000. If the restrictions under these agreements terminate at an earlier date, the holders may require Digex to redeem the preferred stock before entering into an agreement which would restrict the ability to redeem the preferred stock. Digex is not required to make sinking fund payments with respect to the preferred stock. See also Note 17, "Restatement", to the consolidated financial statements. 6. STOCKHOLDERS' EQUITY In connection with the recapitalization, Digex filed a Certificate of Incorporation and certain amendments in the state of Delaware. Pursuant to the Certificate, as amended, the number of authorized shares of common stock is 150,000,000 (including 100,000,000 Class A shares and 50,000,000 Class B shares) and the number of authorized shares of preferred stock is 5,000,000 shares. The Class A and Class B common stock are identical in all respects except that the Class A is entitled to one vote for each share and the Class B is entitled to ten votes for each share. On August 4, 1999, Digex sold 11,500,000 shares of its Class A Common Stock in an initial public offering (also referred to as the "Offering"). The shares sold represented approximately 18.7% of the F-14 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) aggregate number of shares of Class A and Class B Common Stock then outstanding. After the Offering, Intermedia retained a 97.8% voting interest in the Company. The net proceeds from the Offering were approximately $178.9 million and could be used only to purchase telecommunications related assets due to restrictions in Intermedia's debt instruments. On February 16, 2000, Digex completed a public offering of 12,650,000 shares of Class A Common Stock. Digex sold 2,000,000 shares of Class A Common Stock and received net proceeds of approximately $171.6 million. Intermedia sold 10,650,000 shares of Class B Common Stock. The Class B Common Stock sold by Intermedia automatically converted into Class A Common Stock at the closing of the offering. Each share of Class B Common Stock is entitled to 10 votes while each share of Class A Common Stock is entitled to one vote. As a result, while Intermedia owns approximately 61.6% of Digex's equity interests, it controls approximately 94.1% of Digex's voting interest as of December 31, 2000. 7. DEFERRED COMPENSATION Since July 29, 1999, Digex granted options to purchase 1,241,250 shares (net of 188,750 forfeited options) of Class A Common Stock under the Digex Long Term Incentive Plan to certain employees of Digex at exercise prices below market value. Digex recorded deferred compensation of $4.2 million in 2000 and $13.5 million in 1999, a separate component of stockholders' equity, to be expensed over the four-year vesting period of the options. Deferred compensation was reduced by $2.1 million in the year ended December 31, 2000 for forfeited stock options. Deferred compensation expense of $4.1 million and $1.3 million was recorded during the years ended December 31, 2000 and 1999, respectively. 8. EMPLOYEE BENEFIT PLANS STOCK-BASED COMPENSATION PLAN Under the provisions of the Intermedia 1996 Long-Term Incentive Plan (1996 Plan), certain employees and directors of Digex were granted options to buy shares of Intermedia common stock, generally at market value with terms of five to ten years. The Digex Long-Term Incentive Plan adopted on July 23, 1999 (1999 Plan) and administered by the compensation committee of the Board of Directors permits awards of stock, stock options, stock appreciation rights, restricted stock and other stock-based awards as incentives to current and prospective employees, officers, directors and consultants, and those of Digex's subsidiaries or of any person that owns over 50% of the voting power of our authorized and outstanding voting shares. Stock options are generally vested over a four-year period for officers and employees. Exercisable options expire ten years following the date of the grant. On June 1, 2000, a majority of Digex stockholders ratified the Board's amendment to the 1999 Plan, increasing the aggregate number of shares of Class A Common Stock authorized for issuance under the 1999 Plan to 15,000,000 shares. As of December 31, 2000, the Board has 6,677,408 shares of Common F-15 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Stock reserved for issuance to employees, officers, directors, and consultants of Digex pursuant to the 1999 Plan. The following table summarizes the stock option activity related to employees of Intermedia and Digex:
NUMBER OF PER SHARE SHARES OPTION PRICE -------------- -------------- Outstanding Intermedia options at December 31, 1997 359,988 $ 0.26-10.82 Granted ...................................... 130,900 16.38-37.00 Exercised .................................... (87,521) 0.26-10.82 Canceled ..................................... (183,187) 0.26-37.00 -------------- -------------- Outstanding Intermedia options at December 31, 1998 220,180 $ 0.26-37.00 ============== ============== Digex options granted on July 29, 1999 ........... 5,031,500 $ 5.00-17.00 Granted ...................................... 1,360,170 5.00-54.19 Exercised .................................... -- -- Canceled ..................................... (687,650) 17.00-54.19 -------------- -------------- Outstanding Digex options at December 31, 1999 .... 5,704,020 5.00-54.19 Granted ...................................... 4,545,993 11.00-139.38 Exercised .................................... (396,543) 5.00-29.13 Canceled ..................................... (1,927,421) 5.00-139.38 -------------- -------------- Outstanding Digex options at December 31, 2000 .... 7,926,049 $ 5.00-139.38 ============== ============== Exercisable Intermedia options at December 31, 1998 75,244 $ 0.26-37.00 ============== ============== Exercisable Digex options at December 31, 1999 .... 30,000 $ 17.00 ============== ============== Exercisable Digex options at December 31, 2000 .... 1,320,256 $ 5.00-54.19 ============== ==============
Digex has adopted the disclosure only provisions of SFAS No. 123, ACCOUNTING FOR STOCK COMPENSATION. Pro forma net loss and net loss per share, assuming that Digex had applied the fair value model (Black-Scholes Pricing Model) required by SFAS No. 123, is as follows (in thousands): F-16 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEAR ENDED DECEMBER 31, ------------------------------------------------------- 2000 1999 1998 ----------------- ---------------- ----------------- Net loss............................ $ (185,803) $ (71,800) $ (16,828) Net loss per share.................. $ (2.93) $ (1.31) $ (0.34)
The following table summarizes the significant assumptions used in developing the information:
YEAR ENDED DECEMBER 31, ---------------------------------------------- 2000 1999 1998 -------------- -------------- ------------- Risk-free interest rate............. 5.5% 5.6% 5.4% Volatility factor.................... 1.379 .60 .53 Dividend yield....................... -- -- -- Weighted average life................ 5 years 5 years 5 years
The following table summarizes the weighted average exercise prices of option activity:
YEAR ENDED DECEMBER 31, ------------------------------- 2000 1999 -------------- -------------- Balance at beginning of year.......... $ 18.45 $ -- Granted.......................... 78.36 18.92 Exercised........................ 15.55 -- Canceled......................... 60.63 22.76 Balance at end of year................ 42.55 $ 18.45
The weighted average exercise price of exercisable options was $16.60 in 2000, $17.00 in 1999, and $8.07 in 1998. The per share weighted average fair value of options granted were $40.66 in 2000, $12.67 in 1999, and $14.84 in 1998. Under the 1999 Plan, options were granted to certain employees of Digex at exercise prices below the fair market value of Digex common stock at the date of the grant. The options granted during 2000 and 1999 are summarized as follows: F-17 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
2000 1999 ------------------------------ ----------------------------- Weighted Weighted Weighted average Weighted average average exercise average exercise fair value price fair value price --------------- -------------- -------------- -------------- Exercise Price = Fair Market Value .......... $ 64.60 $ 79.30 $ 12.13 $ 21.33 Exercise Price > Fair Market Value........... -- -- 8.47 17.00 Exercise Price < Fair Market Value........... 57.69 41.15 15.63 9.85 $ 40.66 $ 78.36 $ 12.67 $ 18.92
The range of option exercise prices for options outstanding as of December 31, 2000 was $5.00 to $139.38. The range of exercise prices for options is wide due primarily to the increasing price of Digex common stock over the period in which the option grants were awarded. The options outstanding as of December 31, 2000 are summarized in ranges as follows:
Options Outstanding Options Exercisable -------------------------------------------------- ----------------------------- Weighted Weighted average Weighted average remaining average exercise contractual life exercise Range of exercise prices Shares price (in years) Shares price - ------------------------------- ----------------- ------------- ------------------ --------------- ------------- $ 5.00 -- $ 10.00 941,156 $ 5.29 8.62 284,736 $ 5.22 $17.00 -- $ 17.00 2,673,461 17.00 8.58 855,246 16.61 $21.18 -- $ 48.18 1,646,650 40.60 9.30 155,209 31.38 $54.18 -- $ 74.94 1,831,702 67.79 9.46 25,065 54.19 $78.00 -- $139.38 833,080 115.02 9.23 -- -- ----------------- ------------- ------------------ --------------- ------------- 7,926,049 $ 42.55 9.01 1,320,256 $16.60
RETIREMENT PLAN Digex has established a 401(k) plan. Employees 21 years or older with at least three months of service are eligible to participate in the plan. Participants may elect to contribute, on a tax-deferred basis, up to 15% of their compensation, not to exceed $10,500 during the taxable year. Digex will match one-half of a participant's contribution, up to a maximum of 7% of the participant's compensation. Digex's matching contribution fully vests after three years of service. Digex's contributions to the plan were $1.1 million in 2000, $0.5 million in 1999, and $0.2 million in 1998. F-18 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 9. INCOME TAX INFORMATION Digex files a consolidated income tax return with its wholly owned domestic subsidiary. Separate returns are filed for its foreign subsidiaries. The consolidated tax provision, therefore, is based upon the separate tax provisions of the domestic and foreign jurisdictions. Domestic and foreign loss before the benefit from income taxes consists of the following (in thousands):
YEAR ENDED DECEMBER 31, ---------------------------------------------- 2000 1999 1998 --------------- -------------- -------------- Domestic ................. $ (135,171) $ (69,838) $ (16,740) Foreign .................. (7,764) -- -- --------------- -------------- -------------- Total .......... $ (142,935) $ (69,838) $ (16,740) =============== ============== ==============
Income tax benefit for the tax years ended December 31 is comprised of the following (in thousands):
YEAR ENDED DECEMBER 31, --------------------------------------------- 2000 1999 1998 -------------- -------------- --------------- Current................... $ -- $ -- $ -- Deferred: Federal......... -- 4,244 144 State........... -- 595 15 -------------- -------------- --------------- $ -- $ 4,839 $ 159 ============== ============== ===============
F-19 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The following table reconciles the assumed statutory tax rate with the effective rate to income tax expense:
YEAR ENDED DECEMBER 31, ----------------------------------------------- 2000 1999 1998 -------------- -------------- -------------- Tax benefit at statutory rate................. (34.0)% (34.0)% (34.0)% Reconciling items: State income taxes, net.................. (3.2)% (3.2)% (3.1)% Non-deductible items ................... 0.7% 3.3% -- Change in valuation allowance............ 36.3% 19.1% 32.0% Foreign taxes ........................... 0.2% -- -- Other items.............................. -- 7.8% 4.1% -------------- -------------- -------------- Effective tax rate............................ (0.0)% (7.0)% (1.0)% -------------- -------------- --------------
At December 31, 2000 and 1999, Digex had temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets and liabilities were as follows (in thousands):
DECEMBER 31, --------------------------------- 2000 1999 --------------- --------------- Deferred tax liabilities: Depreciation and amortization ............................. $ (6,485) $ -- Identifiable intangible assets ............................ (3,748) (4,299) --------------- --------------- Total deferred tax liabilities.......................... (10,233) (4,299) Deferred tax assets: Net operating loss carryforwards - U.S. ................... 74,567 18,449 Net operating loss carryforwards - Foreign................. 2,320 -- Allowance for bad debts.................................... 2,289 1,636 Depreciation and amortization ............................. -- 1,867 Contingent tax accrual .................................... 266 352 Deferred revenue .......................................... 4,410 -- Stock-based compensation................................... 1,630 487 --------------- --------------- Total deferred tax assets............................... 85,482 22,791 Less: valuation allowance............................... (75,249) (18,492) --------------- --------------- Net deferred tax asset............................. 10,233 4,299 --------------- --------------- Net deferred tax asset (liability).............................. $ -- $ -- =============== ===============
F-20 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) As a result of the recapitalization of Digex on April 30, 1999, the net operating loss carryforwards of Digex as of December 31, 1998 did not transfer to Digex after the recapitalization. Accordingly, a net deferred tax liability of $4.8 million relating to identifiable intangible assets was recorded as a result of the recapitalization on April 30, 1999. Digex generated net operating losses and non-deductible expenses in excess of the deferred tax liability after the recapitalization and recorded the deferred tax asset associated with the future deductible items. Accordingly, Digex recorded a $4.8 million deferred tax benefit during the year ended December 31, 1999. SFAS 109 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, management has determined that a $75.2 million valuation allowance at December 31, 2000 is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The increase in the valuation allowance for the current year is $56.8 million. At December 31, 2000, Digex's net operating loss carryforwards for income tax purposes are approximately $205.2 million, with expiration periods beginning in 2019 through 2020. 10. LOSS PER SHARE On April 30, 1999, Digex issued 1,000 shares of Class B Common Stock to Intermedia in connection with the contribution of assets to Digex. Loss per share is presented on a pro forma basis prior to that period assuming that the common shares issued in connection with the recapitalization on April 30, 1999 were outstanding for all periods of Digex presented. On July 23, 1999, the Board of Directors authorized a 50,000-for-one split of the Class B Common Stock, effective as of August 4, 1999 and paid in the form of a stock dividend for shares outstanding as of July 8, 1999. The basic and diluted net loss per common share were calculated assuming that the stock split was effective for all periods presented. All share information presented gives effect to the stock split. The following table sets forth computation of basic and diluted loss per share of common stock (amounts in thousands, except share and per share information):
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 ---------------- ---------------- ---------------- Net loss, as reported................................ $ (143,101) $ (64,999) $ (16,581) ================ ================ ================ Weighted average number of common shares............. 63,404,839 54,726,027 50,000,000 ================ ================ ================ Loss per share: basic and diluted............................... $ (2.26) $ (1.19) $ (0.33) ================ ================ ================
Convertible securities (convertible preferred stock, warrants, and stock options) were excluded from the computation of diluted loss per share because assumed exercise or conversion would be anti-dilutive. F-21 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 11. COMPREHENSIVE LOSS The following table reflects the calculation of comprehensive losses for the year ended December, 31, 2000, 1999, and 1998 (in thousands):
2000 1999 1998 --------- --------- --------- Net loss applicable to common stockholders ......... $(143,101) $ (64,999) $ (16,581) --------- --------- --------- Other comprehensive loss: Foreign currency translation adjustments ...... (38) -- -- --------- --------- --------- Comprehensive loss applicable to common stockholders $(143,139) $ (64,999) $ (16,581) ========= ========= =========
12. RELATED PARTY AGREEMENTS GENERAL AND ADMINISTRATIVE SERVICES AGREEMENT On April 30, 1999, Digex entered into a General and Administrative Services Agreement (the "G&A Agreement") with Intermedia. Under the terms of the G&A Agreement, as amended to date, Intermedia provided Digex with back office and administrative services such as human resources, finance and accounting, tax services, investor relations, treasury, and information management services. This agreement has an initial term of two years and expires in April 2001. The charge for these services was $15.0 million in 2000 and $16.5 million in 1999. Rates charged to Digex in 1999 and 1998 for these services prior to the G&A Agreement are believed to be consistent with the allocations in the accompanying financial statements. Rates for services not previously provided to Digex (e.g. investor relations) were based upon Intermedia and Digex's best estimate of the fair value of those services. NETWORK SERVICES AGREEMENTS Pursuant to three Network Services Agreements between Intermedia and Digex entered into in July 1999, Intermedia has been providing Digex with east and west coast Internet transit, Internet access and managed firewall services. These agreements have an initial term of two years and expire in July 2001. The charges for these services amounted to $5.0 million in 2000 and $7.8 million in 1999. Rates charged to Digex in 1999 and 1998 prior to the Network Services Agreements were generally consistent with rates incurred during the periods presented in the accompanying consolidated financial statements. ASSET MIGRATION AGREEMENT F-22 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) On June 1, 2000, Digex entered into an Asset Migration Agreement with Intermedia. Under the terms of the agreement, Digex purchased certain assets, including certain licensed third-party software, machinery, and equipment from Intermedia at cost to provide independent managed firewall services. In connection with the purchase of firewall-related assets from Intermedia, the Managed Firewall Services Agreement between Digex and Intermedia was terminated. Digex paid a purchase price of $4.5 million for the net book value of these assets and services on June 30, 2000, the closing date of the agreement. Under the Asset Migration Agreement, Digex has made equal monthly installments of $0.9 million for Intermedia's support and consultation for the six months ended December 31, 2000. EXPENSE SHARING AND INDEMNITY ARRANGEMENTS On January 24, 2000, Digex agreed with Intermedia to allocate and pay the expenses of its February 2000 public offering, including any amounts arising from any indemnification or contribution obligations, in proportion to the number of shares of Class A Common Stock sold by Digex and by Intermedia. Expenses of $0.3 million were allocated to Digex in 2000 and were netted against offering proceeds. SALE OF TELECOMMUNICATIONS RELATED ASSETS TO INTERMEDIA Digex entered into three Use of Proceeds Agreements with Intermedia on June 2, 1999, January 11, 2000, and January 24, 2000, respectively, to sell to Intermedia certain telecommunications related assets that were purchased by Digex with the net proceeds of certain offerings of Digex securities and the cash proceeds of the investments by Microsoft and Compaq. The assets were sold to Intermedia at Digex's cost. The proceeds from the sale of telecommunications related assets to Intermedia were approximately $33.7 million and $25.3 million during the years ended December 31, 2000 and 1999, respectively. These proceeds were unrestricted and used to fund Digex's operating expenses. Net proceeds from the equity offerings were fully used as of December 31, 2000. GUARANTY AGREEMENT On October 31, 2000, Intermedia increased the commitments available to it under its Revolving Credit Facility ("Credit Facility") from $100.0 million to $350.0 million. As a subsidiary of Intermedia, Digex will be a limited guarantor under the Credit Facility to the greater of $90.0 million or the amounts borrowed by Digex. The Credit Facility is also fully guaranteed by WorldCom. At December 31, 2000, Intermedia had $113.0 million outstanding under its Credit Facility. SOFTWARE, EQUIPMENT AND SERVICES PURCHASED FROM MICROSOFT AND COMPAQ In January 2000, Digex entered into strategic development agreements and joint marketing arrangements with Microsoft and Compaq. Digex and Microsoft will work together to advance Digex's capabilities to more rapidly install, manage and upgrade large numbers of Microsoft Windows-based servers for Web site and application hosting. Digex and Compaq will work jointly to streamline the order, delivery F-23 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) and installation of Compaq's server hardware and storage devices. In connection with these agreements, Microsoft and a subsidiary of Compaq made a $100.0 million equity investment in Digex, of which $85.0 million was paid in cash and $15.0 million was paid in the form of equipment credits from Compaq. Digex has in the past purchased and expect to continue to purchase computer hardware, software and certain consulting services from both Microsoft and Compaq pursuant to certain arrangements negotiated prior to or in connection with the investment by Microsoft and Compaq in Digex. Digex purchased $2.7 million in 2000, $3.1 million in 1999, and $1.1 million in 1998 for products and services provided by Microsoft. Digex purchased $26.6 million (excluding $2.7 million of equipment credits) in 2000, $18.7 million in 1999, and $7.5 million in 1998 for products and services provided by Compaq. F-24 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 13. LEASE COMMITMENTS AND NOTE PAYABLE On June 29, 2000, Digex entered into a ten-year lease commencing in September 2000 for its new corporate headquarters facility in Laurel, Maryland. The lease agreement requires an initial security deposit of $2.0 million in the form of a letter of credit. This letter of credit may be reduced at the commencement of the seventh lease year to an amount equal to the then current one month's base rent if certain conditions are met annually prior the seventh year of the lease. Property and equipment include the present value of the capital lease which is amortized over the term of the lease. Digex leases office space and vehicles under capital lease arrangements. Digex also leases office space and office equipment under operating leases. Future noncancelable lease payments under Digex's lease commitments at December 31, 2000 are as follows (in thousands):
CAPITAL OPERATING LEASES LEASES --------------- ----------------- Future minimum lease payments: Year ending December 31: 2001............................... $ 4,374 $ 3,921 2002............................... 4,483 2,925 2003............................... 4,716 2,401 2004............................... 4,642 2,378 2005............................... 4,774 2,014 Thereafter.............................. 19,920 3,129 --------------- ----------------- 42,909 $ 16,768 ================= Less amount representing interest ..... (13,907) --------------- Present value of lease payments ........ 29,002 Current portion of capital leases....... (1,871) --------------- Noncurrent portion of capital leases.... $ 27,131 ===============
Rent expense amounted to $3.9 million, $2.0 million, and $0.8 million for the years ended December 31, 2000, 1999, and 1998, respectively. Lease payments under operating leases include certain rent allocated to Digex in 1999. Digex expects to enter 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 agreement ranges from 24 to 36 months. Digex has an option to purchase the equipment at the end of the initial lease term. F-25 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) A note payable of $4.7 million was issued in 1999 in connection with the purchase of software. The note accrues at an effective interest rate of 7.00% per annum and matures in January 2002. Principal repayments until maturity are as follows (in thousands): Year ending December 31: 2001....................... $ 2,772 2002....................... 1,435 --------------- Total .......................... $ 4,207 ===============
Interest cost incurred and charged to expense related to the note payable was $0.3 million in 2000 and $0.2 million in 1999. 14. CONTINGENCIES On September 5, 2000, and thereafter, Intermedia, Digex, the directors of Digex, and in some cases, WorldCom, were named as defendants in a total of thirteen lawsuits in the Court of Chancery of the State of Delaware in and for New Castle County. Of those thirteen lawsuits, eight were brought as class actions on behalf of Digex public shareholders, three were brought as derivative actions, purportedly on behalf of Digex, and two advanced both class action and derivative claims. On October 17, 2000, the Court ordered that all thirteen lawsuits to be consolidated into a single combined derivative and class action. In general, the complaints advanced substantially similar allegations that the defendants breached their fiduciary duties to the class members by acting to further their own interests at the expense of Digex public stockholders, by engaging in self-dealing and by failing to act in good faith towards the Digex public stockholders. The complaints claimed that such alleged wrongdoing caused irreparable harm to such stockholders. In addition, four of the complaints alleged that the Digex board members who are also directors or executive officers of Intermedia conferred a substantial benefit on Intermedia at the expense of the Digex public stockholders by voting to waive application of Section 203 of the Delaware General Corporation Law to future transactions between WorldCom and Digex. These complaints also alleged that WorldCom aided and abetted the wrongdoing of Intermedia's and the Intermedia-affiliated directors of Digex. The complaints sought injunctive relief and unspecified damages. On February 15, 2001, a memorandum of understanding was executed on behalf of all interested parties in the consolidated actions, setting forth an agreement in principle providing for the settlement of all actions in their entirety. WorldCom will make a settlement payment of WorldCom common stock having a total value of $165.0 million for distribution to Digex common stock holders. 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 will be amended to change the consideration to be paid to Intermedia F-26 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) shareholders in connection with the merger. All 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 proposed 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. WorldCom has also agreed to enter into certain commercial agreements with Digex. A further provision of the settlement will make Section 203 of the Delaware General Corporation Law inapplicable to future transactions between WorldCom and Digex. The proposed settlement would, if approved by the Court, fully resolve all claims in the lawsuit. On March 2, 2001, Digex, WorldCom, and Intermedia entered into a definitive Stipulation of Settlement with all relevant parties to settle all claims related to the consolidated class action and derivative action in accordance with the terms agreed to in the February 15, 2001 memorandum of understanding. The Court has entered an order directing that notice of the settlement be sent to members of the class and has scheduled a settlement hearing to be held on April 6, 2001 in the Delaware Court of Chancery in Wilmington, Delaware. The final settlement of the suit is subject to the satisfaction of certain conditions as well as final court approval. Based on the memorandum of understanding and the Stipulation of Settlement, Digex does not expect to have any future liability from the outcome of this litigation. Digex also does not believe that there are any other 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. 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of unaudited quarterly results of operations for the years ended December 31, 2000 and 1999 (in thousands):
2000 --------------------------------------------------------------------------------------- FIRST SECOND THIRD FOURTH As As As As As As previously restated previously restated previously restated reported (1) reported (1) reported (1) --------- --------- --------- --------- --------- --------- --------- Revenues ..................... $ 27,974 $ 25,796 $ 42,222 $ 40,368 $ 46,531 $ 43,979 $ 57,942 Operating expenses ........... 56,677 54,568 80,119 78,325 87,343 84,875 100,930 --------- --------- --------- --------- --------- --------- --------- Loss from operations ......... (28,703) (28,772) (37,897) (37,957) (40,812) (40,896) (42,988) Other income (expense) ....... 3,057 3,057 3,472 3,472 (393) (393) 1,542 Income tax benefit ........... -- -- -- -- -- -- -- --------- --------- --------- --------- --------- --------- --------- Loss before cumulative effect of change in accounting principle .................. (25,646) (25,715) (34,425) (34,485) (41,205) (41,289) (41,446) Cumulative effect of change in accounting principle ...... -- (166) -- -- -- -- -- --------- --------- --------- --------- --------- --------- --------- Net loss ..................... $ (25,646) $ (25,881) $ (34,425) $ (34,485) $ (41,205) $ (41,289) $ (41,446) ========= ========= ========= ========= ========= ========= ========= F-27 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Loss per Common Share (2): basic and diluted .......... $ (0.41) $ (0.41) $ (0.54) $ (0.54) $ (0.65) $ (0.65) $ (0.65) ========= ========= ========= ========= ========= ========= =========
1999 ----------------------------------------------- FIRST SECOND THIRD FOURTH -------- -------- -------- -------- Revenues ................... $ 9,392 $ 12,629 $ 16,111 $ 21,654 Operating expenses ......... 17,987 30,482 37,803 45,716 -------- -------- -------- -------- Loss from operations ....... (8,595) (17,853) (21,692) (24,062) Other income (expense) ..... -- (239) 920 1,683 Income tax benefit ......... -- 4,839 -- -- -------- -------- -------- -------- Net loss ................... $ (8,595) $(13,253) $(20,772) $(22,379) ======== ======== ======== ======== Loss per Common Share: basic and diluted ...... $ (0.17) $ (0.27) $ (0.36) $ (0.36) ======== ======== ======== ========
- ---------- (1) Restated for the effect of the implementation of SAB 101 (see Note 1). (2) Represents loss before cumulative effect of change in accounting principle and net loss per common share. 16. SUBSEQUENT EVENTS In January 2001, Digex received 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 George'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. Also in January 2001, the Federal Communications Commission approved the merger between WorldCom and Intermedia on the condition it comply with an agreement reached with antitrust authorities that WorldCom divest certain Intermedia assets and operations. On March 2, 2001, Digex and certain subsidiaries of WorldCom agreed to enter into four commercial agreements. These commercial agreements will become effective at or before the consummation of the Intermedia - WorldCom Merger pursuant to the merger agreement. The principal terms of the four commercial agreements are generally described as follows: F-28 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) -- SALES CHANNEL AGREEMENT. Under this agreement, WorldCom will resell the Digex portfolio of managed Web hosting products. 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's Board of Directors will review the Digex business plans for 2001 and 2002 approved by the Digex Board of Directors. If these business plans are approved by the WorldCom Board of Directors, WorldCom agrees to loan Digex funds for these business plans; the loan rate will be LIBOR plus 300 basis points. Repayment will be made over a four-year period commencing in 2003. However, the funding agreement would not prevent Digex from seeking replacement funding from other sources. -- FACILITIES AGREEMENT. Managed Web hosting facilities for Digex will be built into several WorldCom data centers in the United States and around the globe. Digex will lease space from WorldCom at these data centers based on customer demand. -- NETWORK AGREEMENT. This agreement permits Digex to purchase bandwidth and connectivity from WorldCom in the United States to support its managed Web hosting activities. 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. As described above, Digex has entered into a series of commercial arrangements with WorldCom. These favorable agreements are subject to termination if, among other things, the Intermedia-WorldCom Merger is not completed prior to December 31, 2001. Completion of the Intermedia-WorldCom Merger is subject to a number of conditions. While Digex 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. In the event the Intermedia - WorldCom Merger does not close, Digex's intention would be to access the capital markets for their 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 capital markets to obtain 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. F-29 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 17. RESTATEMENT Digex has restated its consolidated balance sheet and consolidated statement of stockholders' equity as of December 31, 2000 to reclassify its Series A convertible preferred stock outside of stockholders' equity. The result of the reclassification was to reduce additional capital and stockholders' equity in the amount of $71.6 million (the aggregate fair value of the outstanding preferred stock at issuance, net of $16.1 million allocated to the warrants and $12.3 million of available equipment purchase credits.) The restatement had no effect on Digex's net loss or net loss per share, total assets or total liabilities for the year ended December 31, 2000. As discussed in Note 5, "Series A Convertible Preferred Stock," the holders of the preferred stock have the right, under certain circumstances, to require Digex to redeem the preferred stock. Digex will accrete the preferred stock discount of $16.1 million to the mandatory conversion date in January 2005. The accretion will not have an impact on its business operations or cash flows. To date, Digex believes that a redemption event is not probable due to the covenants contained in the indentures of Digex and Intermedia restricting redemption and the requirement of legal availability of funds, which would prohibit redemption of the securities. F-30 DIGEX, INCORPORATED SCHEDULE II VALULATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS)
ADDITIONS --------------------- BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE AT BEGINNING COSTS AND TO OTHER ------ END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DESCRIBE PERIOD - --------------------------------------- ---------- ---------- -------- ----------- ---------- For the year ended December 31, 1998: Deducted from asset accounts: Allowance for doubtful accounts ... $ 369 $ 1,491 -- $ 1,141 (1) $ 719 ============================================================== Allowance for deferred tax accounts -- $ 5,349 -- -- $ 5,349 ============================================================== For the year ended December 31, 1999: Deducted from asset accounts: Allowance for doubtful accounts ... $ 719 $ 4,265 -- $ 622 (1) $ 4,362 ============================================================== Allowance for deferred tax accounts $ 5,349 $ 13,143 -- -- $ 18,492 ============================================================== For the year ended December 31, 2000: Deducted from asset accounts: Allowance for doubtful accounts ... $ 4,362 $ 10,649 -- $ 10,270 (1) $ 4,741 ============================================================== Allowance for deferred tax accounts $ 18,492 $ 56,757 -- -- $ 75,249 ==============================================================
- ---------- (1) Uncollectible accounts written off, net of recoveries. F-31 EX-99.2 4 a2065443zex-99_2.txt EXHIBIT 99.2 Exhibit 99.2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-Q/A (AMENDMENT NO. 1) (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 59-3582217 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 14400 SWEITZER LANE LAUREL, MD 20707 (Address of principal executive offices) (240) 264-2000 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. DIGEX, INCORPORATED INDEX PAGE NO. ---- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements (Unaudited): Consolidated Statements of Operations-- Three months ended March 31, 2001 and 2000 ..................... 4 Consolidated Balance Sheets-- March 31, 2001 and December 31, 2000............................ 5 Consolidated Statements of Cash Flows-- Three months ended March 31, 2001 and 2000...................... 6 Notes to Consolidated Financial Statements.......................... 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................. 13 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.......... 20 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings................................................... 20 ITEM 2. Changes in Securities and Use of Proceeds........................... 20 ITEM 3. Defaults Upon Senior Securities..................................... 20 ITEM 4. Submission of Matters to a Vote of Security Holders................. 20 ITEM 5. Other Information................................................... 21 ITEM 6. Exhibits and Reports on Form 8-K.................................... 21 Signatures.......................................................... 23 2 INTRODUCTORY NOTE Digex, Incorporated hereby amends its Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, originally filed with the Securities and Exchange Commission on May 15, 2001, to restate the consolidated financial statements and update certain information in the notes to the consolidated financial statements (Part I, Item 1). The carrying amount of the Series A preferred stock was originally reported in stockholders' equity in the consolidated balance sheets included in the quarterly reports on Form 10-Q for each of the quarters in the period March 31, 2000 through June 30, 2001 and in the Annual Report on Form 10-K for the year ended December 31, 2000. However, because of certain redemption features of the preferred stock, the carrying amount was reclassified from stockholders' equity to redeemable preferred stock at December 31, 2000 in Amendment No. 2 to its Annual Report on Form 10-K/A and at March 31, 2001 in this Form 10-Q/A. Refer to Notes 3 and 9 to the consolidated financial statements for additional information. 3 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 ------------------ ------------------- (RESTATED) 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) Accretion of preferred stock discount ................................ (1,007) -- --------------- --------------- Net loss available to common stockholders ............................ $ (45,226) $ (25,881) =============== =============== LOSS PER COMMON SHARE - BASIC AND DILUTED: Loss before cumulative effect of change in accounting principle....... $ (0.71) $ (0.41) Cumulative effect of change in accounting principle .................. -- -- --------------- --------------- Net loss per common share ............................................ $ (0.71) $ (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. 4 DIGEX, INCORPORATED CONSOLIDATED BALANCE SHEETS RESTATED (AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
MARCH 31, DECEMBER 31, 2001 2000 --------- --------- (UNAUDITED) 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 --------- --------- Redeemable 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 (aggregate liquidation preference of $100,000) ................................................................... 74,567 71,572 Stockholders' equity: 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 ........................................................ 549,617 550,465 Accumulated deficit ....................................................... (240,088) (195,869) Deferred compensation ..................................................... (8,219) (10,141) Accumulated other comprehensive loss ...................................... (123) (38) --------- --------- Total stockholders' equity ......................................... 301,827 345,056 --------- --------- Total liabilities and stockholders'equity .......................... $ 470,464 $ 521,051 ========= =========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 5 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. 6 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. 7 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) 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. 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 the 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. 8 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) -- 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, Digex 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 Digex 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 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, Digex'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. SERIES A CONVERTIBLE PREFERRED STOCK In January 2000, Digex sold 100,000 shares of its non-voting preferred stock, designated as Series A Convertible Preferred Stock, with detachable warrants to purchase 1,065,000 shares of its Class A common stock, for an aggregate of $100.0 million, of which $15.0 million was in the form of equipment purchase credits. Of the $15.0 million of equipment purchase credits, approximately $2.0 million and $2.7 million was used for equipment purchases in 2001 and 2000, respectively. The warrants can be exercised at any time on or before January 12, 2003 at an initial price of $57.00 per share, subject to certain adjustments. The proceeds from the offering were allocated between the preferred stock and the warrants based upon their relative fair values. In the event of liquidation, each share of preferred stock is entitled to a liquidation preference of $1,000 per share before any amount may be paid to common stockholders. The holders of the preferred 9 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) stock are also not entitled to receive dividends. Digex may not issue any stock with the same or senior preferences or priorities to this series without the consent of the majority of its preferred stockholders. Each share of preferred stock is convertible into shares of Class A common stock at a conversion price of $68.40 per share, subject to certain adjustments, for a total of approximately 1,462,000 shares of Class A common stock. Unless earlier converted, on January 12, 2005, each share of preferred stock will automatically convert into the number of shares of Class A common stock equal to $1,000 divided by the average of the closing prices of the Class A common stock for the twenty consecutive trading days prior to January 12, 2005. Subject to the legal availability of funds, the preferred stock is redeemable in cash at the option of the holders after January 12, 2004 or upon a change of control of Digex at a price of $1,000 per share if the redemption is then permitted under those indentures of Digex and Intermedia which existed on January 10, 2000. If the restrictions under these agreements terminate at an earlier date, the holders may require Digex to redeem the preferred stock before entering into an agreement which would restrict the ability to redeem the preferred stock. Digex is not required to make sinking fund payments with respect to the preferred stock. 4. COMPREHENSIVE LOSS The following table reflects the calculation of comprehensive losses (in thousands):
THREE MONTHS ENDED MARCH 31, -------------------- 2001 2000 -------- -------- (RESTATED) Net loss available to common stockholders .............. $(45,226) $(25,881) Other comprehensive loss: Foreign currency translation adjustments .......... (85) -- -------- -------- Comprehensive loss applicable to common stockholders ... $(45,311) $(25,881) ======== ========
5. COMMITMENTS In January 2001, Digex 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 George's County, Maryland. At December 31, 2008, the principal amounts and any accrued 10 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) interest outstanding may convert to a grant upon the achievement of certain requirements by Digex. In March 2001, Digex 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. 6. RELATED PARTY AGREEMENTS On April 30, 1999, Digex 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. 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. 7. 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 11 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) 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. 8. SUBSEQUENT EVENTS In April 2001, Digex 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. 9. RESTATEMENT Digex has restated its consolidated balance sheets as of March 31, 2001 and December 31, 2000 to reclassify its Series A preferred stock outside of stockholders' equity. The result of the reclassification was to reduce stockholders' equity in the amount of $74.6 million at March 31, 2001 and $71.6 million at December 31, 2000 (the aggregate fair value of the outstanding preferred stock at issuance, net of $16.1 million allocated to the warrants and $10.3 million at March 31, 2001 and $12.3 million at December 31, 2000 of available equipment purchase credits). As discussed in Note 3 "Series A Convertible Preferred Stock," the holders of the preferred stock will have the right, under certain circumstances, to require Digex to redeem the preferred stock. Digex is accreting the preferred stock discount of $16.1 million to the mandatory conversion date in January 2005. The effect of the accretion is to increase net loss available to common stockholders by approximately $1.0 million (or $0.02 per share) for the three months ended March 31, 2001. The accretion will not have an impact on its business operations or cash flows. To date, Digex believes that a redemption event is not probable due to the covenants contained in the indentures of Digex and Intermedia restricting redemption and the requirement of legal availability of funds, which would prohibit redemption of the securities. 12 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. 13 COSTS AND EXPENSES. Costs and expenses include: o cost of operations; o cost of services; o selling, general and administrative expenses; o deferred compensation; and o depreciation and amortization expense. 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. 14 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. 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. 15 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. SELLING, 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 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 16 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. 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. 17 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 George'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. In April 2001, we 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. 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 George'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 George's County to finance a portion of the cost of acquiring equipment and constructing facilities within Prince George's County, Maryland. 18 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. 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. 19 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. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The legal proceedings discussed in Note 7 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. 20 ITEM 5. OTHER INFORMATION None. 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, Richard A. Jalkut, Jack E. Reich, and Mark K. Shull, 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. 21 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. 22 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/ Timothy M. Adams ----------------------- Timothy M. Adams CHIEF FINANCIAL OFFICER /s/ T. Scott Zimmerman ----------------------- T. Scott Zimmerman VICE PRESIDENT AND CONTROLLER Dated: December 7, 2001 23 EX-99.3 5 a2065443zex-99_3.txt EXHIBIT 99.3 Exhibit 99.3 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-Q/A (AMENDMENT NO. 1) (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 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 59-3582217 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 14400 SWEITZER LANE LAUREL, MD 20707 (Address of principal executive offices) (240) 264-2000 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 July 31, 2001, there were 24,788,466 and 39,350,000 shares of the Registrant's Class A and Class B Common Stock outstanding, respectively. DIGEX, INCORPORATED INDEX
PAGE NO. ---- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements (Unaudited): Consolidated Statements of Operations-- Three and six months ended June 30, 2001 and 2000 ...................................... 4 Consolidated Balance Sheets-- June 30, 2001 and December 31, 2000..................................................... 5 Consolidated Statements of Cash Flows-- Six months ended June 30, 2001 and 2000................................................. 6 Notes to Consolidated Financial Statements.................................................. 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................................... 14 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.................................. 24 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings........................................................................... 25 ITEM 2. Changes in Securities and Use of Proceeds................................................... 25 ITEM 3. Defaults Upon Senior Securities............................................................. 25 ITEM 4. Submission of Matters to a Vote of Security Holders......................................... 25 ITEM 5. Other Information........................................................................... 25 ITEM 6. Exhibits and Reports on Form 8-K............................................................ 25 Signatures.................................................................................. 27
2 INTRODUCTORY NOTE Digex, Incorporated hereby amends its Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, originally filed with the Securities and Exchange Commission on August 14, 2001, to restate the consolidated financial statements and update certain information in the notes to the consolidated financial statements (Part I, Item 1). The carrying amount of the Series A preferred stock was originally reported in stockholders' equity in the consolidated balance sheets included in the quarterly reports on Form 10-Q for each of the quarters in the period March 31, 2000 through June 30, 2001 and in the Annual Report on Form 10-K for the year ended December 31, 2000. However, because of certain redemption features of the preferred stock, the carrying amount was reclassified from stockholders' equity to redeemable preferred stock at December 31, 2000 in Amendment No. 2 to its Annual Report on Form 10-K/A and at June 30, 2001 in this Form 10-Q/A. Refer to Notes 3 and 9 to the consolidated financial statements for additional information. 3 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 SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------------- ---------------------------------- 2001 2000 2001 2000 ---------------- ----------------- ---------------- ---------------- (RESTATED) (RESTATED) Revenues......................................... $ 53,791 $ 40,368 $ 106,843 $ 66,164 Costs and expenses: Cost of operations.......................... 4,375 9,098 9,531 13,038 Cost of services............................ 26,455 16,055 51,000 26,543 Selling, general and administrative......... 36,606 34,195 73,786 60,770 Deferred compensation ...................... 734 996 1,806 1,990 Depreciation and amortization............... 32,149 17,981 61,036 30,552 ------------- ------------- ------------- ------------- Total costs and expenses......................... 100,319 78,325 197,159 132,893 ------------- ------------- ------------- ------------- Loss from operations............................. (46,528) (37,957) (90,316) (66,729) Other income (expense): Interest expense............................ (739) (429) (1,445) (872) Interest income and other................... (56) 3,901 219 7,401 ------------- ------------- ------------- ------------- Loss before cumulative effect of change in accounting principle.......................... (47,323) (34,485) (91,542) (60,200) Cumulative effect of change in accounting principle..................................... -- -- -- (166) ------------- ------------- ------------- ------------- Net loss......................................... (47,323) (34,485) (91,542) (60,366) Accretion of preferred stock discount ........... (1,006) -- (2,013) -- ------------- ------------- ------------- ------------- Net loss available to common stockholders ....... $ (48,329) $ (34,485) $ (93,555) $ (60,366) ============= ============= ============= ============= LOSS PER COMMON SHARE - BASIC AND DILUTED: Loss before cumulative effect of change in accounting principle.......................... $ (0.76) $ (0.54) $ (1.47) $ (0.95) Cumulative effect of change in accounting principle..................................... -- -- -- (0.01) ------------- ------------- ------------- ------------- Net loss per common share ....................... $ (0.76) $ (0.54) $ (1.47) $ (0.96) ============= ============= ============= ============= Shares used in computing basic and diluted net loss per share ............................. 64,075,828 63,503,516 64,013,802 63,062,198 ============= ============= ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 4 DIGEX, INCORPORATED CONSOLIDATED BALANCE SHEETS RESTATED (AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
JUNE 30, DECEMBER 31, 2001 2000 --------------- ------------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents ............................................. $ 14,730 $ 83,434 Restricted investments ................................................ 3,158 2,000 Accounts receivable, net of allowance of $4,978 in 2001 and $4,741 in 2000, respectively................................................. 41,068 42,201 Due from Intermedia ................................................... -- 40 Deferred costs ........................................................ 7,685 8,627 Prepaid expenses and other current assets.............................. 7,122 7,452 --------------- ------------------ Total current assets............................................ 73,763 143,754 Property and equipment, net................................................. 355,557 348,975 Intangible assets, net...................................................... 21,226 23,222 Other assets................................................................ 3,279 5,100 --------------- ------------------ Total assets.................................................... $ 453,825 $ 521,051 =============== ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses.................................. $ 58,254 $ 59,455 Current portion of deferred revenue.................................... 7,032 7,734 Current portion of notes payable....................................... 4,317 2,772 Current portion of capital lease obligations........................... 2,032 1,871 Due to Intermedia ..................................................... 5,614 -- Note payable to Intermedia ............................................ 12,000 -- --------------- ------------------ Total current liabilities....................................... 89,249 71,832 Deferred revenue............................................................ 2,565 4,025 Notes payable............................................................... 3,236 1,435 Capital lease obligations................................................... 27,343 27,131 --------------- ------------------ Total liabilities............................................... 122,393 104,423 --------------- ------------------ Redeemable 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 (aggregate liquidation preference of $100,000)................................................................ 76,661 71,572 Stockholders' equity: Class A common stock, $.01 par value; 100,000,000 shares authorized; 24,788,466 and 24,546,543 shares issued and outstanding in 2001 and 2000, respectively ................................................ 248 245 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..................................................... 547,819 550,465 Accumulated deficit.................................................... (287,411) (195,869) Deferred compensation.................................................. (6,035) (10,141) Accumulated other comprehensive loss ................................. (244) (38) --------------- ------------------ Total stockholders' equity...................................... 254,771 345,056 --------------- ------------------ Total liabilities and stockholders'equity....................... $ 453,825 $ 521,051 =============== ==================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 5 DIGEX, INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED (AMOUNTS IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, ----------------------------------- 2001 2000 ---------------- ---------------- OPERATING ACTIVITIES: Net loss ............................................................. $ (91,542) $ (60,366) Cumulative effect of change in accounting principle .................. -- 166 ---------------- ---------------- Loss before cumulative effect of change in accounting principle ...... (91,542) (60,200) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization....................................... 61,036 30,552 Provision for doubtful accounts..................................... 7,499 2,953 Amortization of deferred compensation............................... 1,806 2,026 Loss on sale/ disposals of telecommunications equipment............. 854 313 Accretion of interest on note payable and capital lease obligations 56 312 Changes in operating assets and liabilities: Accounts receivable................................................. (6,366) (17,284) Deferred costs ..................................................... 942 (9,021) Prepaid expenses and other current assets........................... 330 (3,867) Other assets........................................................ 1,407 (317) Accounts payable and accrued expenses .............................. (1,201) (28) Deferred revenue ................................................... (2,162) 8,928 Due to (from) Intermedia ........................................... 5,654 3,026 ---------------- ---------------- Net cash used in operating activities................................. (21,687) (42,607) INVESTING ACTIVITIES: Purchases of property and equipment................................... (62,428) (97,078) Proceeds from sale of telecommunication assets ....................... 313 -- Purchase of restricted investments ................................... (1,158) -- ---------------- ---------------- Net cash used in investing activities................................. (63,273) (97,078) FINANCING ACTIVITIES: Proceeds from subsequent public offering, net of costs ............... -- 171,641 Proceeds from issuance of preferred stock ............................ -- 85,000 Proceeds from issuances of notes payable ............................. 15,300 -- Proceeds from exercises of common stock options....................... 2,084 775 Principal payments on note payable and capital lease obligations .... (922) (397) ---------------- ---------------- Net cash provided by financing activities............................. 16,462 257,019 Effect of exchange rate on cash and cash equivalents .................... (206) -- Net (decrease) increase in cash and cash equivalents .................... (68,704) 117,334 Cash and cash equivalents at beginning of the period ................... 83,434 88,778 ---------------- ---------------- Cash and cash equivalents at end of period .............................. $ 14,730 $ 206,112 ================ ================ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Assets acquired through capital leases ................................ $ 1,285 $ -- Interest paid.......................................................... 1,299 872
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 6 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared by Digex, Incorporated, 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 second quarter of 2000 has been restated to reflect the accounting change. For the quarter ended June 30, 2001, Digex recognized revenue of $2.2 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. 7 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) RECENT ACCOUNTING PRONOUNCEMENTS In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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. In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS, which requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. Currently, Digex does not believe that the adoption of SFAS No. 141 will have any impact on its financial statements. Also in June 2001, the FASB issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. In addition, the statement includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. Goodwill and other intangibles, acquired prior to July 1, 2001, may be amortized until the adoption of the statement. Digex will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Digex is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. 2. INTERMEDIA - WORLDCOM MERGER On July 1, 2001, pursuant to the terms of the agreement and plan of merger, dated September 1, 2000, and the amendments thereto, a wholly-owned subsidiary of WorldCom, Inc. was merged with and into Intermedia Communications Inc. with Intermedia continuing as the surviving corporation and as a subsidiary of WorldCom (the "Intermedia - WorldCom Merger"). As a result of the Intermedia - WorldCom Merger, WorldCom now owns all of the capital stock of Intermedia, other than the 13-1/2% series B preferred stock, and approximately 90% of the voting securities of Intermedia. Therefore, WorldCom has an indirect controlling interest of Digex through Intermedia as Intermedia continues to own approximately 61.4% of Digex's equity interests and controls 94.1% of Digex's voting interests, calculated based on total common stock outstanding, as of July 1, 2001. 8 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) Digex and certain subsidiaries of WorldCom have 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 the 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. WorldCom has agreed to provide funding for the Digex business plans for 2001 and 2002 as approved by the Digex and WorldCom boards of directors. To date, the Digex and WorldCom board of directors have approved the Digex 2001 business plan. The preparation of the Digex business plan for 2002 is currently underway and is expected to be submitted to the WorldCom board of directors for approval no later than December 1, 2001. Subject to terms and conditions of the note purchase agreement dated July 31, 2001, Digex will issue and WorldCom will purchase (or cause an affiliate to purchase) a series of senior notes up to an aggregate principal amount sufficient to satisfy Digex's net cash requirements under the approved business plan. Interest on the unpaid principal balance is payable monthly at a rate equal to LIBOR plus 300 basis points. Repayment of principal is due on December 31, 2002 and may be extended to December 31, 2006 upon the election of Digex by written notice given by December 13, 2002. Any changes to Digex's business plans that require increased funding would require the WorldCom board of directors' approval before WorldCom would be obligated to fund any such increase. - -- 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. 3. SERIES A CONVERTIBLE PREFERRED STOCK In January 2000, Digex sold 100,000 shares of its non-voting preferred stock, designated as Series A Convertible Preferred Stock, with detachable warrants to purchase 1,065,000 shares of its Class A common stock, for an aggregate of $100.0 million, of which $15.0 million was in the form of equipment purchase credits. Of the $15.0 million of equipment purchase credits, approximately $3.1 million and $2.7 million was used for equipment purchases in 2001 and 2000, respectively. The warrants can be exercised at any time on or before January 12, 2003 at an initial price of $57.00 per share, subject to certain adjustments. The proceeds from the offering were allocated between the preferred stock and the warrants based upon their relative fair values. 9 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) In the event of liquidation, each share of preferred stock is entitled to a liquidation preference of $1,000 per share before any amount may be paid to common stockholders. The holders of the preferred stock are also not entitled to receive dividends. Digex may not issue any stock with the same or senior preferences or priorities to this series without the consent of the majority of its preferred stockholders. Each share of preferred stock is convertible into shares of Class A common stock at a conversion price of $68.40 per share, subject to certain adjustments, for a total of approximately 1,462,000 shares of Class A common stock. Unless earlier converted, on January 12, 2005, each share of preferred stock will automatically convert into the number of shares of Class A common stock equal to $1,000 divided by the average of the closing prices of the Class A common stock for the twenty consecutive trading days prior to January 12, 2005. Subject to the legal availability of funds, the preferred stock is redeemable in cash at the option of the holders after January 12, 2004 or upon a change of control of Digex at a price of $1,000 per share if the redemption is then permitted under those indentures of Digex and Intermedia which existed on January 10, 2000. If the restrictions under these agreements terminate at an earlier date, the holders may require Digex to redeem the preferred stock before entering into an agreement which would restrict the ability to redeem the preferred stock. Digex is not required to make sinking fund payments with respect to the preferred stock. 4. COMPREHENSIVE LOSS The following table reflects the calculation of comprehensive losses (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------- -- ----------------------------- 2001 2000 2001 2000 ------------- ------------ ------------ ------------- (RESTATED) (RESTATED) Net loss available to common stockholders..... $ (48,329) $ (34,485) $ (93,555) $(60,366) Other comprehensive loss: Foreign currency translation adjustments .. (121) -- (206) -- ------------- ------------ ------------ ------------- Comprehensive loss applicable to common stockholders ............................... $ (48,450) $ (34,485) $ (93,761) $(60,366) ============= ============ ============ =============
5. COMMITMENTS In January 2001, Digex 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 10 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) permanent, full time employees and the expenditures for the development of a Web hosting facility in Prince George'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 the first and second quarters of 2001, Digex entered into master lease and financing agreements with two vendors for lines of credit to facilitate the leasing of computer hardware and software. 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. As of June 30, 2001, Digex had acquired $1.2 million of computer equipment under these capital lease arrangements. Subject to the satisfaction of certain borrowing conditions, lines of credit totaling $20.8 million are available for future capital lease arrangements as of June 30, 2001. In April 2001, Digex 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. In the second quarter of 2001, Digex received proceeds for a $12.0 million loan from Intermedia. The loan is governed by the terms under the revolving credit agreement dated as of December 22, 1999, and amendments to date, among Intermedia, Bank of America N.A., the Bank of New York and Toronto Dominion (Texas), Inc. Repayment was due on demand at the earlier of: (1) the consummation of the Intermedia - WorldCom Merger; (2) July 3, 2001; (3) the cancellation or termination of the credit facility; and (4) following default which would accelerate the amounts due. Through June 30, 2001, variable interest on the unpaid principal balance was paid monthly at an average LIBOR rate of approximately 4.50% per annum. Intermedia has not demanded payment of the outstanding principal amount as of August 14, 2001. On June 26, 2001, Digex borrowed an additional $6.0 million from Intermedia as an intercompany loan. Digex expects to refinance both loans from Intermedia with proceeds from the issuance of notes under the note purchase agreement between WorldCom and Digex. 6. RELATED PARTY AGREEMENTS Under the terms of the network services agreements with Intermedia, which expired in July 2001, Intermedia provided Digex with east and west coast Internet transit and Internet access. The charges for the Internet transit and access services amounted to $0.2 million and $0.4 million for the three and six months ended June 30, 2001. 7. CONTINGENCIES On April 6, 2001, a final settlement of the consolidated derivative and class action suits was approved by 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. 11 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) Pursuant to the settlement, WorldCom made a payment of WorldCom common stock having a total value of $165.0 million for distribution to Digex common stock holders following the closing of the Intermedia - WorldCom Merger in July 2001. One half of the settlement fund net of plaintiffs' attorneys fees was distributed to record holders of Digex common stock as of September 1, 2000. The balance of the settlement fund net of attorneys' fees was paid to record holders of Digex stock as of June 29, 2001. Neither Intermedia nor its affiliates was 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 was paid out of the settlement fund. In connection with the settlement, WorldCom has agreed to 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 makes Section 203 of the Delaware General Corporation Law inapplicable to future transactions between WorldCom and Digex. For every one share of WorldCom Group common stock paid into the settlement fund, 1/25th of a share of MCI Group common stock was also paid into such fund. The value of the WorldCom Group common stock and the MCI Group common stock was based upon the average trading price of 10 trading days randomly selected from a 20-day trading period from May 31, 2001 through June 27, 2001. Based on a randomly selected average trading price of $16.672 per share, WorldCom deposited 9,896,833 shares of WorldCom Group common stock and 395,873 shares of MCI Group common stock into the settlement fund on July 2, 2001. Approximately 7.5% of the shares deposited into the settlement fund was distributed to the legal counsel for the plaintiffs in the litigation, approximately 46.25% of the settlement fund was distributed to the holders of record of Digex Class A common stock as of September 1, 2000, and the remaining 46.25% was distributed to holders of record of Digex Class A common stock as of June 29, 2001. On July 9, 2001, Digex received $12.5 million from WorldCom for the reimbursement of certain merger-related fees and expenses associated with the litigation. 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. 8. SUBSEQUENT EVENTS In the third quarter of 2001, Digex has acquired $9.3 million of computer equipment under the master lease and financing agreement with a vendor. The terms of the associated schedules ranges from 12 months for financing a maintenance contract to 36 months for leasing computer equipment. Digex will have an option to purchase the equipment at the end of the initial lease term. 12 DIGEX, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) 9. RESTATEMENT Digex has restated its consolidated balance sheets as of June 30, 2001 and December 31, 2000 to reclassify its Series A preferred stock outside of stockholders' equity. The result of the reclassification was to reduce stockholders' equity in the amount of $76.7 million at June 30, 2001 and $71.6 million at December 31, 2000 (the aggregate fair value of the outstanding preferred stock at issuance, net of $16.1 million allocated to the warrants and $9.2 million at June 30, 2001 and $12.3 million at December 31, 2000 of available equipment purchase credits.) As discussed in Note 3 "Series A Convertible Preferred Stock," the holders of the preferred stock will have the right, under certain circumstances, to require Digex to redeem the preferred stock. Digex is accreting the preferred stock discount of $16.1 million to the mandatory conversion date in January 2005. The effect of the accretion is to increase net loss available to common stockholders by approximately $1.0 million (or $0.02 per share) and $2.0 million (or $0.04 per share) for the three and six months ended June 30, 2001, respectively. The accretion will not have an impact on its business operations or cash flows. To date, Digex believes that a redemption event is not probable due to the covenants contained in the indentures of Digex and Intermedia restricting redemption and the requirement of legal availability of funds, which would prohibit redemption of the securities. 13 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 June 30, 2001, we managed approximately 3,764 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, in Europe and Asia. We believe our singular focus on delivering mission-critical Web 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. In the second quarter of 2001, we operationalized data centers built in WorldCom facilities in New Jersey, France, Germany, and Japan. 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 and application 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. In the second quarter of 2001, we have fully transitioned to the WorldCom global IP network as our primary network. 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. 14 COSTS AND EXPENSES. Costs and expenses include: o cost of operations; o cost of services; o selling, general and administrative expenses; o deferred compensation; and o depreciation and amortization expense. 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. Since December 31, 2000, we have operationalized data centers built in WorldCom facilities in Virginia, New Jersey, Japan, France, and Germany. 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. 15 Our commercial agreements with WorldCom allow us to purchase bandwidth and connectivity from WorldCom in the United States and around the world to support our managed Web and application 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. In the second quarter of 2001, we have fully transitioned to the WorldCom global IP network as our primary network. RESULTS OF OPERATIONS The following table presents certain information derived from our consolidated statements of operations for the three and six months ended June 30, 2001 and 2000, expressed as a percentage of revenue.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------- --------------------------- ---------------------------- --------------------------- 2001 2000 2001 2000 ----------- ----------- ----------- ----------- Revenues ................................... 100.0 100.0% 100.0% 100.0% Costs and expenses: Cost of operations .................... 8.1 22.5 8.9 19.7 Cost of services ...................... 49.2 39.8 47.7 40.1 Selling, general and administrative ... 68.0 84.7 69.1 91.8 Deferred compensation ................. 1.4 2.5 1.7 3.0 Depreciation and amortization ......... 59.8 44.5 57.1 46.2 ----------- ----------- ----------- ----------- Total costs and expenses ................... 186.5 194.0 184.5 200.9 ----------- ----------- ----------- ----------- Loss from operations ....................... (86.5) (94.0) (84.5) (100.9) Other income (expense): Interest expense ...................... (1.4) (1.1) (1.4) (1.3) Interest income and other ............ (0.1) 9.7 0.2 11.2 ----------- ----------- ----------- ----------- Loss before cumulative effect of change in accounting principle ................... (88.0) (85.4) (85.7) (91.0) Cumulative effect of change in accounting principle .............................. -- -- -- (0.3) ----------- ----------- ----------- ----------- Net loss .................................. (88.0) (85.4) (85.7) (91.3) =========== =========== =========== ===========
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000 REVENUE Total revenue increased 33.3% to $53.8 million for the second quarter of 2001 compared to $40.4 million for the same period in 2000. The increase in revenue was due to sales to new customers and additional services to existing customers in the second quarter of 2001 compared to the same period in 2000. In the second quarter of 2000, Digex recognized $5.0 million of one-time equipment sales revenue to a customer in addition to revenue from managed Web and application hosting services. 16 COST OF OPERATIONS Cost of operations decreased 51.9% to $4.4 million for the second quarter of 2001 compared to $9.1 million for the same period in 2000. The decrease was primarily due to improved operating efficiencies and lower costs attributed to our amended network agreement with Intermedia in the second quarter of 2001. As a percentage of revenue, cost of operations decreased to 8.1% for the second quarter of 2001 compared to 14.8% for the same period in 2000 (excluding third party equipment sales and costs in the second quarter of 2000) as a result of improved network utilization. COST OF SERVICES Cost of services increased 64.8% to $26.5 million for the second quarter of 2001 compared to $16.1 million for the same period in 2000. The increase was primarily related to the increased level of operations, 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, and accruals for changes in employee benefits. As a percentage of revenue, total cost of services increased to 49.2% in 2001 compared to 39.8% in 2000. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased 7.1% to $36.6 million for the second quarter of 2001 compared to $34.2 million for the same period in 2000. 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, the addition of key executive management to support the growth of the business, and accruals for changes in employee benefits. 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. 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 68.0% in 2001 compared to 84.7% in 2000 primarily because our revenue grew while a portion of the selling, general and administrative cost remained fixed. DEFERRED COMPENSATION Deferred compensation expense decreased 26.3% to $0.7 million for the second quarter of 2001 compared to $1.0 million for the same period in 2000. The decrease was primarily due to forfeitures in stock options granted to certain employees at exercise prices below market value since June 30, 2000. During the year ended June 30, 2001, approximately $4.2 million of unearned compensation was forfeited. Since June 30, 2000, we recorded approximately $0.9 million of deferred compensation, 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 78.8% to $32.1 million for the second quarter of 2001 compared to $18.0 million for the same period in 2000. The increase was principally due to additional servers and other facilities and equipment placed in service since June 30, 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. 17 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 72.3% to $0.7 million for the second quarter of 2001 compared to $0.4 million for the same period in 2000. The increase resulted from the capital lease for our new corporate headquarters facility, capital leases for vehicles, and from issuances of $15.3 million of notes payable since June 30, 2000. INTEREST INCOME AND OTHER Interest income and other decreased 101.4% to $0.1 million for the second quarter of 2001 compared to $3.9 million for the same period in 2000. The decrease resulted principally from declining cash balances and falling interest rates during the period. EBITDA BEFORE CERTAIN CHARGES EBITDA before certain charges, as defined below, decreased 28.1% to $(13.6) million for the second quarter of 2001 compared to $(19.0) million for the same period in 2000. The change is primarily attributable to increased revenue and a slower growth rate in costs due to operational efficiencies. 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. EBITDA BEFORE CERTAIN CHARGES CONSISTS OF EARNINGS (LOSS) BEFORE INTEREST EXPENSE, INTEREST INCOME AND OTHER, 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. 18 SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 REVENUE Total revenue increased 61.5% to $106.8 million for the six months ended June 30, 2001 compared to $66.2 million for the same period in 2000. The increase in revenue was due to sales to new customers and additional services to existing customers in the first half of 2001 compared to the same period in 2000. In the second quarter of 2000, Digex recognized $5.0 million of one-time equipment sales revenue to a customer in addition to revenue from managed Web and application hosting services. COST OF OPERATIONS Cost of operations decreased 26.9% to $9.5 million for the six months ended June 30, 2001 compared to $13.0 million for the same period in 2000. The decrease was primarily due to improved operating efficiencies and lower costs attributed to our amended network agreement with Intermedia in the second quarter of 2001. As a percentage of revenue, cost of operations decreased to 8.9% for the six months ended June 30, 2001 compared to 15.0% for the same period in 2000 (excluding third party equipment sales and costs in the second quarter of 2000) as a result of improved network utilization. Expenses directly attributed to the sale of third party equipment in the second quarter of 2000 is included in the cost of operations. COST OF SERVICES Cost of services increased 92.1% to $51.0 million for the six months ended June 30, 2001 compared to $26.5 million for the same period in 2000. The increase was primarily related to the increased level of operations, the expansion of our new data centers including costs related to the hiring of additional personnel in customer service, engineering, and facilities administration supporting server growth, and accruals for changes in employee benefits. As a percentage of revenue, total cost of services increased to 47.7% for the six months ended June 30, 2001 compared to 40.1% for the same period in 2000. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased 21.4% to $73.8 million for the six months ended June 30, 2001 compared to $60.8 million for the same period in 2000. Increases in selling, general and administrative expenses for 2001 include the costs associated with an increased employee base, advertising campaigns, an increased provision for doubtful accounts receivable, research and development costs, the addition of key executive management to support the growth of the business, and accruals for changes in employee benefits. 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. 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 69.1% for the six months ended June 30, 2001 compared to 91.8% for the same period in 2000 primarily because our revenue grew while a portion of the selling, general and administrative cost remained fixed. 19 DEFERRED COMPENSATION Deferred compensation expense decreased 9.2% to $1.8 million for the six months ended June 30, 2001 compared to $2.0 million for the same period in 2000. The decrease was primarily due to forfeitures in stock options granted to certain employees at exercise prices below market value since June 30, 2000. During the year ended June 30, 2001, approximately $4.2 million of unearned compensation was forfeited. Since June 30, 2000, we recorded approximately $0.9 million of deferred compensation, 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 99.8% to $61.0 million for the six months ended June 30, 2001 compared to $30.6 million for the same period in 2000. The increase was principally due to additional servers and other facilities and equipment placed in service since June 30, 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 65.7% to $1.4 million for the six months ended June 30, 2001 compared to $0.9 million for the same period in 2000. The increase resulted from the capital lease for our new corporate headquarters facility, capital leases for vehicles, and from issuances of $15.3 million of notes payable since June 30, 2000. INTEREST INCOME AND OTHER Interest income and other decreased 97.0% to $0.2 million for the six months ended June 30, 2001 compared to $7.4 million for the same period in 2000. The decrease resulted principally from declining cash balances and falling interest rates during the period. EBITDA BEFORE CERTAIN CHARGES EBITDA before certain charges, as defined below, decreased 19.6% to $(27.5) million in the six months ended June 30, 2001 compared to $(34.2) million for the same period in 2000. The change is primarily attributable to increased revenue and a slower growth rate in costs due to operational efficiencies. 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 rapid growth in marketing and selling expenses as new customers are acquired. 20 EBITDA BEFORE CERTAIN CHARGES CONSISTS OF EARNINGS (LOSS) BEFORE INTEREST EXPENSE, INTEREST INCOME AND OTHER, 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 $21.7 million and $42.6 million during the six months ended June 30, 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 six months ended June 30, 2001 and 2000 was $63.3 million and $97.1 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 July 1, 2001, pursuant to the terms of the merger agreement, dated September 1, 2000, and the amendments thereto, a wholly-owned subsidiary of WorldCom was merged with and into Intermedia with Intermedia continuing as the surviving corporation and as a subsidiary of WorldCom. As a result of the merger, WorldCom beneficially owns a majority of our capital stock and has voting control of us. On July 31, 2001, we entered into a note purchase agreement with WorldCom whereby WorldCom has agreed to provide funding for the Digex business plans for 2001 and 2002 as approved by the Digex and WorldCom boards of directors. To date, the Digex and WorldCom boards of directors have approved the Digex 2001 business plan. The preparation of the Digex business plan for 2002 is currently underway and is expected to be submitted to the WorldCom board of directors for approval no later than December 1, 2001. Subject to the terms and conditions of the agreement, we will issue and WorldCom will purchase (or cause an affiliate to purchase) a series of senior notes up to an aggregate principal amount sufficient to satisfy our net cash requirements under the approved business plan. Interest on the unpaid principal balance is payable monthly at a rate equal to LIBOR plus 300 basis points. Repayment of principal is due on December 31, 2002 and may be extended to December 31, 2006 upon our election by written notice. Any changes to our business plans that require increased funding would require the WorldCom board of directors' approval before WorldCom would be obligated to fund any such increase. 21 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 were a limited guarantor under the credit facility to the greater of $90.0 million or the amounts borrowed by Digex. At June 30, 2001, Intermedia had $258.0 million outstanding under its credit facility. Borrowings of $12.0 million were for Digex. We issued a promissory note, governed by the terms of the revolving credit facility agreement dated December 22, 1999, as amended to date, to Intermedia for the $12.0 million borrowing in the second quarter of 2001. Repayment was due on demand at the earlier of: (1) the consummation of the Intermedia - WorldCom Merger; (2) July 3, 2001; (3) the cancellation or termination of the credit facility; and (4) following default which would accelerate the amounts due. Through June 30, 2001, variable interest on the unpaid principal balance was paid monthly at an average LIBOR rate of approximately 4.50% per annum. Intermedia has not demanded payment of the outstanding principal amount as of August 14, 2001. We expect to refinance this loan with proceeds from issuance of notes under the note purchase agreement, dated July 31, 2001, between WorldCom and Digex. Following the completion of the Intermedia - WorldCom Merger in July 2001, WorldCom repaid the total amount outstanding under the credit facility and entered into a second amendment to the revolving credit agreement on July 2, 2001 to decrease the aggregate commitments available under the credit facility from $350.0 million to $175.0 million. The termination date was also extended to the earlier of August 1, 2001 and the cancellation of the credit facility. There were no amounts outstanding under the credit facility as of August 1, 2001. 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. Intermedia had $119.0 million outstanding under these financings as of June 30, 2001. Borrowings of $6.0 million were for Digex and was recorded as an intercompany loan. We expect to refinance this loan with proceeds from issuance of notes under the note purchase agreement, dated July 31, 2001, between WorldCom and 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 George'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. In April 2001, we 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. 22 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 George'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 George's County to finance a portion of the cost of acquiring equipment and constructing facilities within Prince George's County, Maryland. In the first and second quarters of 2001, we entered into master lease and financing agreements with two vendors for lines of credit to facilitate the leasing of computer hardware and software. 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. As of June 30, 2001, we have acquired $1.2 million of computer equipment under these capital lease arrangements. Subject to the satisfaction of certain borrowing conditions, lines of credit totaling $20.8 million are available for future capital lease arrangements as of June 30, 2001. 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, 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. If necessary, we intend to draw on available vendor lines of credit of up to $20.8 million, pursuant to the master lease and financing agreements and subject to the satisfaction of certain borrowing conditions, to facilitate the leasing of computer hardware and software in the future. We will also use the proceeds of $3.3 million in loans from the State of Maryland and Prince George's County to finance a portion of the cost of acquiring equipment and construction at our headquarter facilities in Laurel, Maryland. With our existing cash resources and financing available from Intermedia and WorldCom, we believe we have sufficient capital to sustain our current operations and capital expenditure plans through 2001. Once the Digex business plan for 2002 is approved by the Digex and WorldCom boards of directors, we expect to have adequate funding for our 2002 operations and capital expenditure requirements as well. Because the note purchase agreement provides us with access to readily available cash, we plan to maintain minimal cash balances and borrow only when required to sustain our operations. 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. In June 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS, which requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. Currently, we do not believe that the adoption of SFAS No. 141 will have any impact on our financial statements. 23 Also in June 2001, the FASB issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests. In addition, the statement includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. Goodwill and other intangibles, acquired prior to July 1, 2001, may be amortized until the adoption of the statement. We will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. We are currently assessing but have not yet determined the impact of SFAS No. 142 on our financial position and results of operations. 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. 24 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. 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. 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. 25 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 -- Promissory Note, dated May 29, 2001, between Digex and Intermedia. (b) REPORTS ON FORM 8-K The following report on Form 8-K of Digex was filed during the second quarter of 2001: Digex filed a Current Report on Form 8-K, dated May 2, 2001, reporting under Item 5 the issuance of a press release discussing Digex's first quarter 2001 results. Digex also reported under Item 7 the filing of the press release as an exhibit to the Form 8-K. 26 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/ TIMOTHY M. ADAMS -------------------------------- Timothy M. Adams CHIEF FINANCIAL OFFICER /s/ T. SCOTT ZIMMERMAN -------------------------------- T. Scott Zimmerman VICE PRESIDENT AND CONTROLLER Dated: December 7, 2001 27 -----END PRIVACY-ENHANCED MESSAGE-----